{"filename":"814046_1993.txt","cik":"814046","year":"1993","section_1":"ITEM 1. BUSINESS\nAll references to \"Notes\" are to Notes to Consolidated Financial Statements contained in this report.\nThe registrant, Arvida\/JMB Partners, L.P. (the \"Partnership\"), is a limited partnership formed in 1987 and currently governed under the Revised Uniform Limited Partnership Act of the State of Delaware. The Partnership was formed to own and develop substantially all of the assets of Arvida Corporation (the \"Seller\"), a subsidiary of The Walt Disney Company, which were acquired by the Partnership from the Seller on September 10, 1987. On September 16, 1987, the Partnership commenced an offering to the public of up to $400,000,000 in Limited Partnership Interests and assignee interests therein (\"Interests\") pursuant to a Registration Statement on Form S-1 under the Securities Act of 1933 (No. 33-14091). A total of 400,000 Interests were sold to the public (at an offering price of $1,000 per Interest before discounts) and the holders of 400,000 Interests were admitted to the Partnership in October 1987. The offering terminated October 31, 1987. In addition, a holder (an affiliate of the dealer-manager of the public offering) of 4,000 Interests was admitted to the Partnership in October 1987. Subsequent to admittance to the Partnership, no holder of Interests (a \"Limited Partner\" or \"Holder\") has made any additional capital contribution. The Limited Partners of the Partnership generally share in their portion of the benefits of ownership of the Partnership's real property investments and other assets according to the number of Interests held.\nPursuant to the Partnership Agreement, the Partnership may continue in existence until December 31, 2087; however, the General Partner shall elect to pursue one of the following courses of action: (i) to cause the Interests to be listed on a national exchange or on the National Association of Securities Dealers Automated Quotation System at any time on or prior to the date ten years from the termination date of the offering of Interests; (ii) to purchase, or cause one of its affiliates to purchase, ten years from the termination of the offering of Interests, all of the Interests at their then appraised fair market value (as determined by an independent nationally recognized investment banking firm or real estate advisory company); or (iii) to commence a liquidation phase ten years from the termination of the offering of Interests in which all of the Partnership's remaining assets will be sold prior to the end of the fifteenth year from the termination of the offering.\nThe assets of the Partnership consist principally of interests in land which is in the process of being developed into master-planned residential communities (the \"Communities\") and, to a lesser extent, commercial and industrial properties; mortgage notes and accounts receivable; certain management and other service contracts; construction, brokerage and other support businesses; real estate assets held for investment; certain club and recreational facilities; and certain cable television businesses serving certain of its Communities. The Partnership is principally engaged in the development of comprehensively planned resort and primary home Communities containing a diversified product mix designed for the middle and upper income segments of the various markets in which the Partnership operates.\nThe Partnership sells individual residential lots and parcels of partially developed and undeveloped land. The third-party builders and developers to whom the Partnership sells homesites and land parcels are generally smaller local builders who require project specific financing for their developments and whose operations are more susceptible to fluctuations in the availability of financing. In addition, within the Communities, the Partnership constructs, or causes to be constructed, a variety of products, including single-family homes, townhouses and condominiums to be developed for sale, as well as related commercial and recreational facilities. The Communities are located primarily throughout the State of Florida, with Communities also located near Atlanta, Georgia; Highlands, North Carolina and in Orange County, California. Additional undeveloped properties owned by the Partnership in or near its Communities are being considered for development as commercial, office and industrial properties. The Partnership also owns or manages certain club and recreational facilities within certain of its Communities. Certain assets located in Florida were acquired by the Partnership from the Seller by purchasing a 99.9% interest in a joint venture partnership in which the General Partner acquired the remaining joint venture partnership interest. In addition, other assets are owned by various partnerships, the interests of which are held by certain indirect subsidiaries of the Partnership and by the Partnership.\nArvida Company (\"Arvida\"), an affiliate of the General Partner, provides certain development and management supervisory personnel to the Partnership for the supervision of all of its projects and operations, subject, in each case, to the overall control of the General Partner on behalf of the Partnership. The Partnership, directly or through certain subsidiaries, provides development and management services to the home ownership associations within the Communities. Two of the Partnership's Communities currently offer cable television systems to certain of their residents, which systems are owned and operated by entities owned by the Partnership.\nThe business of the Partnership is cyclical in nature and certain aspects of the development of Community projects are to some degree seasonal. The Partnership does not expect that such seasonality will have a material impact on its business. A presentation of information about industry segments, geographic regions or raw materials is not applicable and would not be material to an understanding of the Partnership's business taken as a whole.\nThe Communities are in various stages of development. The remaining estimated build-out time for the Communities ranges from one year to 11 years.\nThe Partnership generally follows the practice with respect to Communities of (i) developing an overall master plan for the Community, (ii) creating a unifying architectural theme that is consistent with the Community's master plan, (iii) offering a variety of recreational facilities, (iv) imposing architectural standards and other property restrictions on residents and third-party developers, in order to enhance the long-term value of the Community, (v) establishing property owners' associations to maintain compliance with architectural, landscaping and other requirements and to provide for ownership and maintenance of certain facilities, and\/or (vi) operating and controlling access to golf, tennis and other recreational facilities.\nThe Partnership's development approach, individually or by joint venture, is intended to enhance the value of real estate in successive phases. The first step in the development of a property is to design a Community master plan that addresses the appropriate land uses and product mix, including residential, recreational and, where appropriate, commercial and industrial uses. The Partnership then seeks to obtain the necessary regulatory and environmental approvals for the development of the Community in accordance with the master plan. This approval process is a major factor in determining the viability and prospects for profitability of the Partnership's development projects.\nThe first phase in the regulatory approval process will usually consist of obtaining the proper zoning approvals for the intended development. The Partnership must also comply with state and local laws governing large planned developments which may vary from state to state and community to community. In Florida, for example, land development is subject to the Florida Local Government Comprehensive Planning and Land Development Regulation Act, as administered by the State and implemented by regional, county and municipal authorities. In addition, prior to or contemporaneously with zoning approval, the Partnership, if subject to the applicable filing requirements, must obtain \"Development of Regional Impact\" (\"DRI\") approval from the applicable local governmental agency after review and recommendations from the appropriate regional planning agency, with oversight by the Florida State Department of Community Affairs. With the exception of approximately 2,460 acres of Weston (Weston's Increment III), the Partnership has received DRI approval on all of its Florida Properties. Application with respect to Weston's Increment III DRI approval has been filed and is being processed in the ordinary course of business. Receipt of DRI approval is a prerequisite to obtaining zoning, platting, building permits or other approvals required to begin development or construction. Obtaining such approvals can involve substantial periods of time and expense and may result in the loss of desired densities, and approvals may need to be resubmitted if there is any subsequent deviation in current approved plans. The process may also require committing land for public use and payment of substantial impact fees. In addition, state laws generally provide further that a parcel of land cannot be subdivided into distinct segments without having a plat filed and finalized with the local or municipal authority, which will, in general, require the approval of various local agencies, such as environmental and public works departments. In addition, the Partnership must secure the actual permits for development from applicable Federal (e.g., the Army Corps of Engineers and\/or the Environmental Protection Agency with respect to coastal and wetlands developments, including dredging of waterways) and state or local agencies, including construction, dredging, grading, tree removal and water management and drainage district permits. The Partnership may, in the process of obtaining such permits or approvals for platting or construction activities, incur delays or additional expenses; however, such permits and approvals are customarily obtained to permit development. Failure to obtain or maintain necessary approvals, or rejection of submitted plans, would result in an inability to develop the Community as originally planned and would cause the Partnership to reformulate development plans for resubmission, which might result in a failure to increase, or a loss of, market value of the property. The foregoing discussion and the discussion which follows are also generally applicable to the Partnership's commercial and industrial developments.\nUpon receipt of all approvals and permits required to be obtained by the Partnership for a specific Community, other than actual approvals or permits for final platting and\/or construction activities, the Partnership applies for the permits and other approvals necessary to undertake the construction of infrastructure, including roads, water and sewer lines and amenities such as lakes, clubhouses, golf courses, tennis courts and swimming pools. These expenditures for infrastructure and amenities are generally significant and are usually required early in the development of a Community project, although the Partnership will attempt, to the extent feasible, to develop Communities in a phased manner. See Note 12 for further discussion regarding Tax Increment Financing Entities and their involvement with infrastructure improvements.\nCertain of the Florida Communities described below have applied for and have been designated as a Planned Unit Development (\"PUD\") by the local zoning authority (usually the governing body of the municipality or the county in which the Community is or will be located). Designation as a PUD generally establishes permitted densities (i.e., the number of residential units which may be constructed) with respect to the land covered thereby and, upon receipt, enables the developer to proceed in an orderly, planned fashion. Generally, such PUD approvals permit flexibility between single-unit and multi-unit products since the developer can plan Communities in either fashion as long as permitted densities are not exceeded. As a consequence, developments with PUD status are able to meet changing demand patterns in housing through such flexibility. It should be noted that some of the Communities, while not having received PUD approval, have obtained the necessary zoning approvals to create a planned community development with many of the benefits of PUD approval such as density shifting.\nIn developing the infrastructure and amenities of its Communities and building its own housing products, the Partnership may function as a general contractor although it may also from time to time hire firms for general contracting work. The Partnership generally follows the practice of hiring subcontractors, architects, engineers and other professionals on a project-by- project basis rather than maintaining in-house capabilities, principally to be able to select the subcontractors and consultants it believes are most suitable for a particular development project and to control fixed overhead costs. The Partnership maintains, through a wholly-owned affiliate, a staff to perform certain construction work, to supervise construction and to perform routine maintenance and minor repair work. Although the General Partner does not expect the Partnership to be faced with any significant material or labor shortages, the construction industry in general has from time to time experienced serious difficulties in obtaining certain construction materials and in having available a sufficiently large and adequately trained work force.\nThe Partnership's strategy includes the ownership and development of certain commercial and industrial property not located in a Partnership Community. In addition, certain of the Partnership's Communities contain acreage zoned for commercial use, although, except for the Weston Community, such acreage is generally not substantial. On both of such types of properties, the Partnership, individually or with a joint venture partner, may build shopping centers, office buildings and other commercial buildings and may sell land to be so developed.\nCertain of the Communities and operations are owned by the Partnership jointly with third parties. Such investments by the Partnership are generally in partnerships or ventures which own and operate a particular property in which the Partnership or an affiliate (either alone or with an affiliate of the General Partner) has an interest.\nThe principal assets in which interests have been acquired by the Partnership are described in more detail under Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal assets being developed or managed by the Partnership are described below. The acreage amounts set forth herein are approximations of the gross acreage of the Communities or other properties referred to or described and are not necessarily indicative of the net developable acreage currently owned by the Partnership or its joint ventures. All of the Partnership's properties are subject to mortgages to secure the repayment of the Partnership's indebtedness as discussed in detail in Note 8.\n(a) Palm Beach County, Florida\nThe Partnership owns property in Broken Sound, a 970-acre Community located in Boca Raton. The Community offers a wide range of residential products built by the Partnership or third-party builders and is in its final stage of development.\n(b) Broward County, Florida\nThe Partnership owns property in Weston, a 7,500-acre Community in its mid stage of development. The Community offers a complete range of housing products built by the Partnership or third-party builders, as well as tennis, swim and fitness facilities, a golf course and an equestrian center. In addition, the Partnership owns commercial properties, most of which are currently undeveloped, located in the Weston Community. Reference is made to Note 12 for a discussion of the Partnership's use of certain tax-exempt financing in connection with the development of the Weston Community.\n(c) Sarasota \/ Tampa, Florida\nThe Partnership owns property in the Longboat Key Club, a Community on Longboat Key which is a barrier island on Florida's west coast, approximately four miles from downtown Sarasota and seven miles from Sarasota\/Bradenton airport. The Community is in its late stage of development. The Partnership also owns property in a Community in the Tampa area known as River Hills Country Club which is a 1,200-acre Community in its mid stage of development. The Partnership owned an interest in The Oaks Community in Sarasota, Florida. The Partnership sold its interest in The Oaks during 1993. Reference is made to Note 8 for a discussion of the sale of the Partnership's interest in The Oaks property and the repayment of the mortgage loan secured by such property.\n(d) Jacksonville, Florida\nThe Partnership owns property in two Communities in Ponte Vedra Beach, Florida, twenty-five miles from downtown Jacksonville, known as Sawgrass Country Club and The Players Club at Sawgrass. These Communities are in their final stages of development. The Partnership also owns property in a 730-acre Community known as the Jacksonville Golf and Country Club which is in its mid stage of development.\n(e) Atlanta, Georgia\nThe Partnership owns properties in the Atlanta, Georgia area known as Water's Edge and Dockside, which are in their mid and final stages of development, respectively.\n(f) Highlands, North Carolina\nThe Partnership owns a 600-acre Community near Highlands, North Carolina known as The Cullasaja Club. The Community is in its mid stage of development. At December 31, 1991, the Partnership owned a 50% joint venture interest in this Community; however, during 1992, the Partnership purchased its joint venture partner's 50% interest in the Community. Reference is made to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 7 for further discussion of this joint venture.\n(g) Other\nThe Partnership also owns a 20% joint venture interest in a 4,000-acre Community, known as Coto de Caza, located in Southern Orange County, California. The Community is in its mid stage of development. At December 31, 1991, the Partnership was the managing partner and owned a 50% joint venture interest in the Community; however, during 1992 the Partnership's joint venture partner was reallocated an additional 30% interest in the venture and assumed the role of managing partner in exchange for funding the venture's future cash requirements. Reference is made to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 7 for further discussion of this joint venture. The Partnership also has joint venture interests in Mizner Court and Mizner Tower, located in Mizner Village, which consisted of 335 luxury condominium units in Palm Beach County, Florida, all of which were sold as of December 31, 1991.\nThe Partnership also owns land zoned for commercial use in or near its Communities in Jacksonville, Boca Raton, Atlanta, Georgia and in its Weston Community. The Partnership also owns, either directly or through joint venture interests, various commercial and industrial sites and buildings in Sarasota, Tampa, Ocala, Pompano Beach and Palm Beach County, Florida which are not located in its residential Communities. At December 31, 1993, the joint venture with property in Pompano Beach was encumbered by mortgages in the aggregate principal amount of approximately $4 million. Reference is made to Note 11 for further discussion of this venture and its related indebtedness.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is involved in an Environmental Protection Agency (EPA) administrative enforcement proceeding with regard to the Partnership's Water's Edge property. The EPA has asserted that a dam built to create a lake at the Community during the time the property was owned by the Seller was in violation of Section 404 of the Clean Water Act in that certain wetlands areas had been filled. Pursuant to a Consent Agreement and Order entered into with the EPA, the Partnership acquired certain land (at a cost of approximately $400,000) for which it has developed and implemented a plan of mitigation for the wetlands lost. In accordance with certain provisions of the Consent Agreement and Order, the Partnership must provide the EPA with periodic reports regarding the status of the mitigation plan. An agreement in principle has been reached to settle the dispute between the parties pursuant to which the EPA has agreed to assess a civil penalty of $125,000. The Partnership cannot assure that the settlement agreement in fact will be consummated. The Partnership is actively pursuing indemnification from the Seller for the total costs that will ultimately be incurred to resolve this issue. There can be no assurance that the Partnership will be reimbursed by the Seller.\nThe Partnership has been named as a defendant in a number of homeowner lawsuits, each of which has been filed in the Circuit Court of the 11th Judicial District for Dade County, Florida. Each of these suits allegedly in part arises out of or relates to Hurricane Andrew, which resulted in damage to, among other things, the Country Walk development in South Florida on August 24, 1992. A number of the homeowner lawsuits were brought by various plaintiffs in their individual capacity and other homeowner lawsuits were brought as purported class actions.\nIn general, the complaints in the homeowner lawsuits allege that the various plaintiffs and plaintiff classes purchased and owned homes and\/or condominiums located in the Country Walk development and that the damage or destruction suffered by such homes and\/or condominiums as a result of Hurricane Andrew was beyond what should have been reasonably expected. The allegations further suggest that the damage caused by Hurricane Andrew was a result of the defendants' alleged defective design, construction, inspection and\/or other improper conduct in connection with development, construction and sale of such homes and\/or condominiums; that such misconduct on the part of the defendants constituted, among other things, violations of various building code provisions and breaches of express and implied warranties of merchant- ability and habitability, or constituted intentional tort, negligence, misrepresentation or fraudulent concealment, and caused personal injury. In addition, there are allegations of latent defects that were uncovered by Hurricane Andrew. The complaints allege that the Partnership is liable to the named plaintiffs and plaintiff classes either as a result of the Partnership's own acts of misconduct and\/or as a result of the Partnership's purchase of the assets of the Seller and the stock of three of the Seller's subsidiaries in 1987 and the Partnership's subsequent marketing, management and development of the Country Walk development. The various named plaintiffs and purported plaintiff classes seek compensatory damages in varying and, in some cases, unspecified amounts, and other relief, including, in some of the actions, injunctive relief and\/or punitive damages. The Partnership intends to vigorously defend itself in these lawsuits.\nIn connection with its purchase of assets, including certain assets relating to the Country Walk development from the Seller, then a wholly-owned subsidiary of The Walt Disney Company (\"Disney\"), in September 1987, the Partnership obtained indemnification by Disney for certain liabilities relating to facts or circumstances arising or occurring prior to the closing of the Partnership's purchase of the assets. Over 80% of the Arvida-built homes in Country Walk were built prior to the Partnership's ownership of the Community. The Partnership has tendered each of the above-described lawsuits to Disney for defense and indemnification in whole or in part pursuant to the Partnership's indemnification rights. Where appropriate, the Partnership has also tendered these lawsuits to its various insurance carriers for defense and coverage. The Partnership is unable to determine at this time to what extent damages in these lawsuits, if any, against the Partnership, as well as the Partnership's cost of investigating and defending the lawsuits, will ultimately be recoverable by the Partnership either pursuant to its rights of indemnification by Disney or under contracts of insurance.\nThe Partnership has negotiated the terms of a class action settlement with opposing counsel in one of the pending homeowners' lawsuits, which has the potential for resolving substantial portions of the pending homeowners' lawsuits which have been filed. On June 3, 1993, the Circuit Court of Dade County entered an order preliminarily finding that the Partnership's proposed class action settlement agreement, as revised, was within the range of what appeared to be a fair and adequate settlement of the claims filed by single- family homeowners and condominium owners at Country Walk. On August 10, 1993, the court issued a final order approving the class action settlement. The settlement, which is designed to resolve claims arising in connection with estate and patio homes and condominiums sold by the Partnership after September 10, 1987, is structured to compensate residents for losses not covered by insurance. Settlement amounts payable are a function of the type of unit involved and the claimant's proof regarding the adequacy of insurance proceeds. Settlement class members representing 188 units in Country Walk have accepted the settlement. Those who affirmatively rejected the offer may continue to litigate against the Partnership. The Partnership currently believes that the class action settlement may cost approximately $2.5 million.\nThe settlement is being funded by one of the Partnership's insurers, subject to a reservation of rights. The amount of money, if any, which the insurance company may recover from the Partnership pursuant to its reservation of rights is uncertain.\nOn February 24, 1994, the Partnership was dismissed from the pending class action homeowner lawsuits pursuant to the class action settlement. In addition, the Partnership has been informed that Disney and an insurer have reached agreements to settle five of the individual homeowner actions which were tendered by the Partnership to Disney (\"Disney Settlements\"). These Disney Settlements will be funded without any contribution from the Partnership. The Partnership can give no assurance that the Disney settlements will be finalized.\nAs noted above, those homeowners who affirmatively rejected the offer of settlement may continue to litigate. The Partnership is currently a defendant in eleven lawsuits brought by condominium and patio homeowners, all of whom have declined to accept the terms of the class action settlement. These lawsuits, involving nineteen named individuals, are pending in the Circuit Court of Dade County. In these lawsuits, plaintiffs allege a variety of claims involving, among other things, breach of warranty, negligence and building code violations. The Partnership intends to vigorously defend itself in these matters.\nThe Partnership has resolved a claim for construction related damages brought by the Villages of Country Walk Homeowners' Association, Inc., among others. Two of the Partnership's insurance carriers funded a settlement in the amount of $2,740,000 to resolve claims related to the construction of the common elements of the condominium units at Country Walk. One of the insurance carriers has issued a reservation of rights in connection with these claims and the extent to which that insurance company may ultimately recover any of these proceeds from the Partnership is unknown.\nOn April 19, 1993, a subrogation claim entitled Village Homes At Country Walk Master Maintenance Association, Inc. v. Arvida Corporation et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiffs filed this suit for the use and benefit of American Reliance Insurance Company (\"American Reliance\"). Plaintiffs seek to recover damages and pre- and post-judgment interest in connection with $10,873,000 American Reliance has allegedly paid to its insureds living in condominium units at Country Walk in the wake of Hurricane Andrew. Disney is also a defendant in this suit. On July 1, 1993, a subrogation lawsuit entitled Prudential Property and Casualty Company v. Arvida\/JMB Partners, et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiff seeks to recover damages, costs, and interest in connection with $16,679,622 Prudential allegedly paid to its insureds living in Country Walk at the time of Hurricane Andrew. Disney is also a defendant in this suit. On July 15, 1993, a subrogation lawsuit entitled Allstate Insurance Company v. Arvida\/JMB Partners, et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiff seeks to recover damages, costs, and interest in connection with $18,540,196 Allstate allegedly paid to its insureds living in Country Walk at the time of Hurricane Andrew. Disney is also a defendant in this suit. The Partnership settled a threatened subrogation action by State Farm Insurance Company. The settlement was funded by one of the Partnership's insurance carriers subject to a reservation of rights. The amount of money the insurance carrier may seek to recover from the Partnership for this and any other settlements it has funded is uncertain. The Partnership is a defendant in and anticipates other subrogation claims by insurance companies which have allegedly paid policy benefits to Country Walk residents. The Partnership intends to defend itself vigorously in all such matters.\nOn October 13, 1993, a lawsuit captioned Berry v. Merril (sic) Lynch, Pierce Fenner & Smith, J&B Arvida Limited Partnership (sic) and Does 1 through 100, was filed in the Superior Court of the State of California in and for the County of San Diego, Case No. 669709. The lawsuit was purportedly filed as a class action on behalf of the named plaintiffs and all other persons or entities in the State of California who bought or acquired, directly or indirectly, limited partnership interests (\"Interests\") in the Partnership from September 1, 1987 through the present. The complaint in the action alleges, among other things, that the defendants made misrepresentations and concealed various facts, breached fiduciary duties, and violated the covenant of good faith in connection with the sale of Interests in the Partnership. The complaint further alleges that such conduct violated California state law relating to fraud, breach of fiduciary duty, willful suppression of facts, and breach of the covenant of good faith. Plaintiffs, on behalf of themselves and the purported plaintiff class, seek unspecified compensatory damages, consequential damages, punitive and exemplary damages, interest, costs of the suit, and such other relief as the court may order. The Partnership believes that the lawsuit is without merit and intends to vigorously defend itself.\nOther than as described above, the Partnership is not subject to any material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Partnership. Reference is made to Note 2 regarding certain other litigation involving the Partnership. Reference is also made to Note 11 for a discussion of certain claims by Merrill Lynch for indemnification by the Partnership and the General Partner against losses and expenses that may be suffered by Merrill Lynch relating to claims for arbitration asserted against it by certain investors in the Partnership.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during 1992 and 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nAs of December 31, 1993, there were 27,001 record Holders of Interests of the Partnership. There is no public market for Interests, and it is not anticipated that a public market for Interests will develop. Upon request, the General Partner may provide information relating to a prospective transfer of Interests to an investor desiring to transfer his Interests. The price to be paid for the Interests, as well as any other economic aspects of the transaction, will be subject to negotiation by the investor. However, there are restrictions governing the transferability of these Interests as described in \"Transferability of Partnership Interests\" on pages A-31 to A-33 of the Partnership Agreement and limitations on the rights of assignees of Holders of Interests as described in Sections 3 and 4 of the Assignment Agreement which are hereby incorporated by reference to Exhibits 3 and 4.0, respectively, of the Partnership's Report on Form 10-K dated March 29, 1993 (File No. 0-16976).\nReference is made to Item 1. Business for a discussion of the election to be made by the General Partner with respect to causing a listing of Interests on a national exchange, purchasing or causing an affiliate to purchase all of the Interests at their then appraised fair market value, or commencing a liquidation of all of the Partnership's assets.\nReference is made to Item 6.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1993 and 1992, the Partnership had cash and cash equivalents of approximately $18,907,000 and $7,634,000, respectively. Such funds were available for debt service, working capital requirements and distributions to partners. The favorable variance in cash and cash equivalents at December 31, 1993 as compared to 1992 is due to an increase in cash generated from operating activities due primarily to an overall increase in sales activity, as well as an increase in net cash proceeds received from the Partnership's joint ventures in 1993 as compared to 1992. The source of both short-term and long-term future liquidity is expected to be derived primarily from the sale of housing units, homesites and land parcels and through the Partnership's credit facilities, which are discussed below.\nIn October 1992, the Partnership and its lenders executed a binding agreement to restructure the Partnership's credit facility. The new facility consists of a term loan in the amount of $126,805,195, a revolving line of credit facility up to $45 million, an income property term loan of $20 million and a $15 million letter of credit facility. The term loan, the revolving line of credit and the letter of credit facility are secured by recorded mortgages and security interests on all otherwise unencumbered tangible assets of the Partnership as well as an assignment of all mortgages receivable, equity memberships, certain joint venture interests or proceeds from joint ventures, and cash balances (with the exception of deposits held in escrow). The income property term loan is secured by the recorded first mortgages on a mixed-use center and an office building in Boca Raton, Florida. All of the notes under the new facility are cross-collateralized and cross-defaulted. The Partnership made the required principal repayments under the new term loan agreement of $8 million and $10 million in February 1993 and March 1994, respectively. Principal repayments of $10 million are due in each of the years 1995 and 1996, and the remaining balance outstanding is due in 1997. In addition, the new term loan agreement provides for additional principal repayments based upon a specified percentage of available cash flow and upon the sale of certain assets. For the year ended December 31, 1993, the Partnership made additional term loan payments totalling approximately $10.5 million. Under the new income property term loan, monthly principal and interest payments are required to be paid on a 25-year amortization schedule with the remaining balance outstanding due in July 1994. The revolving line of credit and the letter of credit facility also mature in July 1994. The Partnership is in the process of negotiating a renewal of its credit facilities. Although the Partnership is hopeful these renewals will be obtained, there can be no assurance that such will occur or that the terms, amounts and restrictions of the renewed credit facilities will be similar to those under the Partnership's existing facilities. As of December 31, 1993, all available term loan proceeds had been borrowed, however, $45 million was available under the revolving line of credit facility, subject to certain loan covenant restrictions. Reference is made to Note 8 for further discussion of the Partnership's credit facility.\nThe facility contains significant restrictions with respect to the payment of distributions to partners, the maintenance of certain loan-to-value ratios, the use of proceeds from the sale of the Partnership's assets, and advances to the Partnership's joint ventures. Other than the uncertainty surrounding the funding of any required joint venture advances, which require the lenders' approval, and subject to the successful renewal of the Partnership's credit facilities as discussed above, the Partnership believes that the current and expected future liquidity and capital resources of the Partnership, including its restructured bank credit facilities, generally should be adequate to fund currently expected short and long-term capital requirements for development and other costs of operations.\nDuring November 1993, the Partnership received a commitment from a lender for a $24 million revolving construction line of credit for the first building and certain amenities within the Partnership's new condominium project on Longboat Key, Florida known as Grand Bay. This line of credit was subsequently executed on January 14, 1994. The line of credit bears interest at the lender's prime rate plus 3\/4% and matures January 14, 1996. See Note 15 for further discussion regarding this line of credit.\nA statement of cash flows is required under generally accepted accounting principles that classifies cash receipts and disbursements according to whether they result from operating, investing or financing activities as those terms are defined in Statement of Financial Accounting Standards No. 95. On a cumulative basis, the Partnership has paid distributions from operating, investing and financing activities.\nAt December 31, 1991, the Partnership owned a 50% joint venture interest in the Cullasaja Community. The operations of the venture require periodic cash advances from the partners. Since the fourth quarter of 1990, the Partnership has funded the cash deficits of the venture in their entirety. As a result, during July 1992, the Partnership purchased its joint venture partner's 50% interest in the Community. The Partnership was not required to make any cash payment to the joint venture partner for its interest. Instead, the purchase price of such interest is in the form of subordinated non- recourse promissory notes (the \"Notes\"), the payment of which is solely contingent upon the ultimate net cash flow generated by the venture. The Notes are subordinated to the repayment of the outstanding first mortgage loan and certain advances, plus accrued interest thereon, made to the venture by the partners. To the extent the Partnership has funded 100% of the venture's cash deficits in the past or advances new funds, the repayment of such advances, plus accrued interest thereon, is senior to the repayment of funds previously advanced by both partners. A portion of the cash flow remaining after payment of all senior indebtedness is to be applied annually against the principal and interest (at 10% per annum) owed on the Notes. This agreement was pursued as a more favorable alternative to the remedies included in the previously existing joint venture agreement for situations in which the partners advance unequal funds to the venture. As a result of this transaction, the Partnership changed from the equity method of accounting to the consolidated method of accounting for the joint venture effective January 1, 1992, resulting in a net increase in the Partnership's balance sheet of approximately $12.1 million at that date. Certain of the Partnership's property within the Cullasaja Community is encumbered by a mortgage note with an outstanding balance of approximately $5.4 million at December 31, 1993. The note has a maturity date of March 1, 1994 and bears interest at prime (6% at December 31, 1993) plus 1.25% per annum, payable monthly. The Partnership is currently seeking an extension of this loan. However, there can be no assurance that the Partnership can obtain an extension. The Partnership is required to make repayments on the note in accordance with a homesite lot release provision of $72,750 per lot at closing. The note is collateralized by a first mortgage on certain real estate inventories and 12.5% of the outstanding balance is guaranteed by the Partnership.\nThe Coto de Caza joint venture had utilized the maximum amount available under its operating line of credit and had been seeking alternative financing sources to fund the significant additional cash necessary to continue development of the project and to fund other joint venture operating costs. In the interim, the Partnership and its joint venture partner had each advanced approximately $3.1 million, net of reimbursements, to the joint venture during 1991 and an additional $1.0 million during the first five months of 1992. Given the weak market conditions in Orange County, California and the continued lack of development financing available from traditional lending sources, it was unlikely that the joint venture would be able to secure additional financing in the near term. The Partnership's joint venture partner was willing to continue to advance funds to meet the venture's operating needs. The Partnership determined that it was in its best long-term interest to utilize its capital for the development of its other properties rather than commit additional funds for the development of the Coto de Caza Community. As a result, the venture partner has funded the venture's cash deficits in their entirety since June 1, 1992. As an alternative to advancing funds for the venture's future capital requirements, the Partnership and its joint venture partner amended the joint venture agreement, effective September 15, 1992, and reallocated ownership interests. In exchange for funding the venture's future operating needs, the venture partner was reallocated an additional 30% interest in the venture, and assumed the role of managing general partner. As such, the venture partner has control over the future operations of the Community, including the timing and extent of its development. The Partnership retains a 20% limited partnership interest and is entitled to receive distributions from net cash flow, after repayment of third party loans and advances made by the venture partners, up to an amount agreed upon by the Partnership and its joint venture partner. Certain specified costs and liabilities incurred prior to the reallocation will continue to be shared equally by the Partnership and its joint venture partner. This agreement was pursued as a more favorable alternative to the provisions included in the existing joint venture agreement for reallocation of partnership interests should both partners not advance equal funds to the venture. As a result of the Partnership's decrease in its ownership interest, and its joint venture partner's control over the future operations of the Community, commencing on September 15, 1992, the Partnership accounts for its share of the operations of the Coto de Caza joint venture in accordance with the cost method of accounting.\nDuring 1992, the Partnership sold 60% of its interest in two land parcels located in the Weston Community to unaffiliated third-party purchasers. Subsequent to these transactions, the Partnership and the purchasers each contributed their interests in these land parcels to two joint ventures which were established for the purpose of constructing housing products within Weston. The Partnership entered into development management agreements with these joint ventures. Pursuant to the terms of these agreements, the Partnership has agreed to fund all development and construction costs, as well as certain overheads, incurred on behalf of the joint ventures' projects. Amounts funded are to be reimbursed by the joint ventures from sales revenues generated by each joint venture. Amounts advanced by the Partnership to each respective joint venture earn interest at 8.5% for the first year and prime (6.0% at December 31, 1993) plus 2% per annum thereafter. During the first quarter of 1993, one of the joint ventures obtained project specific financing in the amount of $4,950,000 to fund its development and construction activities. In accordance with the provisions of this financing agreement, as of December 31, 1993, the Partnership had been reimbursed the majority of amounts previously advanced to the joint venture. As a result of this financing arrangement, the Partnership does not anticipate the need for future advances to this venture. Due to significant sales activity, amounts previously advanced to the Partnership's other joint venture were reimbursed in full as of December 31, 1993. These reimbursements are the primary reasons for the decrease in investments in and advances to joint ventures on the accompanying consolidated balance sheets from December 31, 1992 to December 31, 1993. Also contributing to the decrease in investments in and advances to joint ventures on the accompanying consolidated balance sheets at December 31, 1993 as compared to December 31, 1992 is the receipt of distributions from these joint ventures in the amount of $2.6 million, as well as $0.8 million and $0.3 million of distributions from the Mizner Tower and Mizner Court joint ventures, respectively.\nIn anticipation of its future development plans, the Partnership is currently in the process of obtaining permits for development of Increment III of its Weston Community, portions of which are environmentally sensitive areas and are subject to protection as wetlands. The time involved to complete this process, which involves the approvals of the Army Corps of Engineers, the Environmental Protection Agency and comparable state and local regulatory agencies, is expected to be lengthy. It is anticipated that certain costs of mitigation will be incurred in conjunction with obtaining the necessary permits, the amount and extent of which are unknown at this time. The Partnership had previously gone through a similar process and was successful in obtaining approvals for Increment II of the Weston Community. Although there can be no assurance, given the Partnership's prior experience and discussions to date with the appropriate agencies, the Partnership is hopeful that a compromise will ultimately be reached that will adequately address the concerns of the environmental agencies, while allowing the Partnership to continue its development plans for Increment III of Weston.\nIn June 1993, the Partnership executed an agreement with Equitable South Florida Venture (\"Equitable\"), the successor in interest to Tishman Speyer\/Equitable South Florida Venture, the original purchaser of approximately 390 acres of land in Increment III of the Partnership's Weston Community, whereby, in exchange for $5.0 million, the Partnership repurchased approximately 330 acres of the land and Equitable agreed to relieve the Partnership of the obligations under certain provisions of the Sale and Purchase Agreement dated December 15, 1983, which were assumed by the Partnership in connection with the purchase of the assets of Arvida Corporation in September 1987. Of the agreed upon price of $5 million, $2.5 million was paid at the execution of the agreement and the balance of $2.5 million will be paid in equal annual installments of $500,000 together with interest thereon at 8% per annum beginning May 1994. The unpaid principal balance is secured by a mortgage on certain real estate located in the Weston Community. As part of its efforts to obtain the appropriate development permits discussed in the preceding paragraph, the Partnership has included this land as part of its proposed mitigation plan for the development of Increment III of its Weston Community.\nThe Partnership owned an 80% general partnership interest in The Oaks Community located near Sarasota, Florida. During the fourth quarter of 1991, the Partnership's joint venture partner failed to make capital contributions required to fund ongoing operations and pursuant to the joint venture agreement, was in default of the agreement. The Partnership executed an agreement in August 1993 with its joint venture partner, CIS Oaks, Ltd., (\"CIS\"), whereby CIS assigned its 20% interest in The Oaks to the Partnership, thereby vesting 100% control of the assets of the joint venture in the Partnership.\nCertain of the assets of The Oaks joint venture were encumbered by two mortgage loans. A $12,492,200 loan was scheduled to mature in January 1997 and a $3,260,000 loan was scheduled to mature in December 1993. The joint venture had guaranteed $2.7 million of the loans, and the guaranteed amount was with recourse to the Partnership. The joint venture was in default under the terms of these loan agreements as a result of its failure to make principal payments of approximately $1.3 million in January 1993 to release the minimum number of homesite lots as required under these agreements and its failure to pay interest commencing with a payment due in April 1993. The Partnership was able to reach an agreement with its lenders to pay off the existing mortgage loans at a substantial discount from face value. On September 3, 1993, the Partnership paid the joint venture's lenders $6.7 million in full satisfaction of the outstanding mortgage loans, accrued interest and guaranty. This transaction contributed to the decrease in notes and mortgages payable at December 31, 1993 as compared to December 31, 1992 and is the cause of the approximate $9.5 million extraordinary gain on the early extinguishment of debt for the year ended December 31, 1993.\nThe Partnership also sold its remaining land holdings in The Oaks Community and its interest in The Oaks Club, an equity club, to an unaffiliated third-party purchaser for $5.8 million. This sale transaction occurred simultaneously with the repayment of the loans and satisfaction of the mortgages, as discussed above. These transactions are the cause of various changes in the Consolidated Balance Sheets at December 31, 1993 as compared to December 31, 1992. In light of the Partnership's guarantee under the loan agreement of $2.7 million of the outstanding mortgage loans, as well as other factors, these transactions were pursued as the least costly alternative available to the Partnership. These transactions resulted in a minimal net gain for Federal income tax purposes.\nDuring the first quarter of 1993, the Partnership reached a settlement agreement with its joint venture partner in a property located in Ocala, Florida, whereby in exchange for its partner's 50% interest in the venture, the Partnership agreed to dismiss a lawsuit previously filed against its venture partner for failure to perform in accordance with the terms of a $1,600,000 note which had been issued to the Partnership by the joint venture.\nThis agreement was pursued as a more favorable remedy to other alternatives available to the Partnership. As a result of this transaction, the Partnership changed from the equity method of accounting to the consolidated method of accounting for the joint venture effective March 1, 1993. This consolidation contributes to the decrease in mortgages receivable at December 31, 1993 as compared to December 31, 1992.\nDuring October 1993, the Partnership closed on the sale of its Oak Bridge Club near Jacksonville, Florida to an unaffiliated third party for approximately $3.2 million. This is the primary cause for the decrease in property and equipment in the Consolidated Balance Sheets at December 31, 1993 as compared to December 31, 1992.\nReference is made to Note 11 regarding the Partnership's financial guarantees pursuant to the terms of a loan agreement for a commercial\/industrial joint venture in Pompano Beach, Florida in which the Partnership owns a 50% interest. The Partnership also has certain continuing obligations relative to this joint venture as referred to in such Note.\nReference is made to Item 3. Legal Proceedings of this annual report for a discussion of several lawsuits, in which the Partnership is a defendant, allegedly arising out of or relating to Hurricane Andrew and certain property damage allegedly suffered by the plaintiffs at a previously developed community known as Country Walk.\nDuring 1991, the Partnership obtained project specific financing in the amount of $7 million on a retail shopping plaza located in the Partnership's Weston Community. Subsequent to this transaction, the Partnership contributed the assets and related indebtedness associated with the plaza to a joint venture and sold a 21% interest in the venture to an unaffiliated third-party.\nIn July 1991, the Partnership converted the Weston Hills Country Club (the \"Club\") from an equity to a non-equity membership plan in an effort to increase membership and usage of the Club and stimulate sales momentum within the Community.\nIn addition, during 1991 the Partnership closed on the sale of a land parcel in its Broken Sound Community to an unaffiliated third-party builder in conjunction with the repurchase of a land parcel in the Partnership's Weston Community from the same builder. This transaction will alter the timing and amount of expected future revenues.\nThe Partnership's obligations under bonds and standby letters of credit have decreased approximately $13.9 million since December 31, 1992 primarily due to decreased development and construction activity at the Partnership's Broken Sound Community and the release of obligations related to the land repurchased by the Partnership in its Weston Community, as discussed above.\nThe Partnership has been advised by Merrill Lynch that Merrill Lynch has been named a defendant in actions pending in the Eleventh and Seventeenth Judicial Circuit Courts in Dade and Broward Counties, Florida to compel arbitration of claims brought by certain investors of the Partnership representing approximately 4% of the total Interests outstanding. Merrill Lynch has asked the Partnership and its General Partner to confirm an obligation of the Partnership and its General Partner to indemnify Merrill Lynch in these claims against all loss, liability, claim, damage and expense, including without limitation attorney's fees and expenses, under the terms of a certain Agency Agreement dated September 15, 1987 (\"Agency Agreement\") with the Partnership relating to the sale of Interests in the Partnership through Merrill Lynch on behalf of the Partnership. The Partnership is unable to determine at this time the ultimate investment of investors who have filed arbitration claims as to which Merrill Lynch might seek indemnification in the future. At this time, and based upon the information presently available about the arbitration statements of claims filed by some of these investors, the Partnership and its General Partner believe that they have meritorious defenses to demands for indemnification made by Merrill Lynch and intend to vigorously pursue such defenses. In the event Merrill Lynch is entitled to indemnification of its attorney's fees and expenses or other losses and expenses, these amount may prove to be material.\nRESULTS OF OPERATIONS\nThe results of operations for the years ended December 31, 1993, 1992 and 1991 are primarily attributable to the development and sale or operation of the Partnership's assets. See Note 1 for a discussion regarding the recognition of profit from sales of real estate.\nHousing revenues are generated from the sale of homes within the Partnership's Communities. Housing revenues increased significantly for the year ended December 31, 1993 as compared to 1992 due primarily to increased sales activity at the Partnership's Weston, Broken Sound and Jacksonville Golf & Country Club Communities as well as the completion and close-out of the Partnership's Marina Bay condominium project on Longboat Key, Florida. In an effort to capture additional market share in Broward County, Florida, the Partnership introduced several new value-oriented products in Weston in late 1992 and early 1993. The success of these products contributed to the increased closings in Weston and the overall increase in revenues for the year ended December 31, 1993 as compared to 1992. Revenues increased at Broken Sound and Jacksonville Golf & Country Club due to new products introduced in late 1992 which had their initial closings in 1993. Housing revenues increased for the year ended December 31, 1992 as compared to 1991 due primarily to an increase in sales activity at the Partnership's Broken Sound and River Hills Communities. The increase in revenues at Broken Sound is due to the sale of a new product line first offered in 1992, as well as an increase during 1992, as compared to 1991, in sales volume of another housing product offered at the Community. The increase in activity at the River Hills Community was due primarily to the broader market appeal of the Partnership's new lower-priced, value-oriented products.\nApproximately 63% of 1993's housing revenues were generated during the fourth quarter. This substantial increase in revenues was due primarily to an increase in the demand for housing product in Weston combined with the introduction of several new value oriented products in this Community earlier in the year. Also contributing to the increase in revenues during the fourth quarter of 1993 was the completion and close-out of all of the units in the final phase of the Partnership's Marina Bay condominium project on Long Boat Key, Florida in November and December 1993.\nThe gross operating profit from housing sales increased for the year ended December 31, 1993 as compared to 1992 due primarily to the mix of product sold at the Partnership's Weston and Broken Sound Communities. The increase in gross operating profits is also attributable to higher profit margins recognized from the final phase of Marina Bay on Longboat Key, Florida. These closings generated increased revenues due to the desirable location of the final building.\nRevenues from the sale of homesites include amounts earned from the sale of developed lots within the Partnership's Communities. Revenues from the sale of homesites increased for the year ended December 31, 1993 as compared to the same period in 1992 due to the initial closing of lots in several homesite projects introduced early in 1993 in the Weston Hills Country Club section of the Partnership's Weston Community. Also contributing to the favorable variance was the closing of the remaining lots held for sale by the Partnership on Longboat Key, Florida during September 1993. This favorable variance was partially offset by decreased revenues at the Partnership's Broken Sound Community due to the close-out of the final homesites in that Community in 1992. Revenues from homesite sales activities were higher for the year ended December 31, 1992 as compared to 1991 due primarily to an increase in closings at the Partnership's Weston and River Hills Communities. The increased activity was primarily attributable to the introduction of several new products within these Communities in 1992. This favorable volume variance was partially offset by decreased closing activity associated with certain product lines which were substantially or completely sold out in 1991, as well as decreased closing activity at one of the Partnership's Atlanta Communities. In an effort to stimulate sales activity at one of the Atlanta Communities, the Partnership is offering lower-priced homesites more consistent with market demand.\nLand and property revenues are generated from the sale of developed and undeveloped residential or commercial land tracts, as well as the sale of equity memberships in the clubs within the Partnership's Boca Raton, Florida Community, as well as its Communities near Jacksonville, Florida and Highlands, North Carolina. Revenues from land and property sales increased for the year ended December 31, 1993 primarily as a result of the sale of the remaining real estate and equity memberships at the Partnership's Oaks Community. See further discussion regarding this transaction in Liquidity and Capital Resources, above. In addition, the Partnership closed on the sale of the Oak Bridge Club near Jacksonville, Florida to an unaffiliated third-party purchaser in October 1993. The sale of this club also contributed to the increase in land and property revenues for 1993 as compared to 1992. The increase in the gross operating profit from land and property sales in 1993 as compared to 1992 is due primarily to the recognition of deferred revenues in 1993 for sales, primarily at Broken Sound and Weston, which previously did not meet the criteria for revenue recognition in accordance with generally accepted accounting principles (\"GAAP\"). This increase was partially offset, however, by the sale of the remaining real estate and equity memberships at the Partnership's Oaks Community. Certain sales transactions which closed in previous periods but did not meet the criteria for revenue recognition remain deferred at December 31, 1993, and profit will be recognized in future periods as these sales become eligible for revenue recognition in accordance with GAAP. Land and property revenues decreased for the year ended December 31, 1992 as compared to 1991. Land and property revenues in 1992 resulted primarily from the sale of a 17-acre single family residential parcel located in the Partnership's Weston Community, the sale of 60% of the Partnership's interest in two residential land parcels also located in the Weston Community, and the sale of approximately 21 acres of undeveloped residential land located in the Partnership's Broken Sound Community. Certain of these residential sales transactions legally closed in 1992 but were not eligible for accounting profit recognition during the year due to certain contract provisions. However, certain amounts which had been deferred in previous years became eligible for profit recognition in 1992 and are included in 1992 land and property revenues. Sales of undeveloped commercial tracts in 1992 include approximately four acres located in Palm Beach County, Florida, and approximately nine acres located on Longboat Key, Florida. Land and property revenues for the year ended December 31, 1991 resulted primarily from the sale of a 28-acre multi-family residential parcel and a 16-acre single family residential parcel in Palm Beach County, Florida, as well as an 18-acre multi- family residential parcel located in one of the Partnership's Jacksonville Communities.\nRevenues from the sale of equity memberships decreased in 1992 as compared to 1991 due primarily to the inclusion in 1991 of profits related to the sales of Broken Sound equity memberships which had previously been deferred for accounting purposes. The recognition of these deferred profits in 1991 is the primary cause for the decrease in the net margin from land and property sales in 1992 as compared to 1991.\nCosts of revenues pertaining to the Partnership's housing sales reflect the cost of the acquired assets as well as development and construction expenditures, certain capitalized overhead costs, capitalized interest and marketing and disposition costs. The costs related to the Partnership's homesite sales reflect the cost of the acquired assets, related development expenditures, certain capitalized overhead costs, capitalized interest and disposition costs. Land and property costs reflect the cost of the acquired assets, certain development costs and related disposition costs as well as the costs associated with the sale of equity memberships.\nOperating properties represents activity from the Partnership's club and hotel operations, commercial properties and certain other operating assets. Revenues generated by the Partnership's operating properties increased for the year ended December 31, 1993 as compared to 1992 primarily as a result of an increase in membership activity at the Partnership's club facilities in Weston resulting from the overall increase in home sales activity within that Community. In addition, revenues from the Partnership's cable operations in Broken Sound and Weston increased during the year ended December 31, 1993 as compared to 1992 resulting from an increase in the number of cable subscribers within those Communities as well as a change in the cable rate structure. The decrease in the negative net margins for 1993 as compared to 1992 is due primarily to cost reductions implemented at the Partnership's club and hotel operations coupled with an overall increase in revenues from these operations.\nThe Partnership continues to evaluate the operations of its club and hotel facilities and institute additional cost controls as deemed appropriate. The decrease in the negative margins generated from operating properties for the year ended December 31, 1992 as compared to 1991 was primarily the result of increased operating revenues combined with reductions in certain overheads and other operating costs at the Partnership's hotel operation and at several of the Partnership's clubs and commercial and retail operating properties. These favorable variances are partially offset, however, by the inclusion of the funding of deficits for the Cullasaja Club during 1992 resulting from the consolidation of the assets of the Cullasaja Joint Venture, as discussed above in Liquidity and Capital Resources. Contributing to the improvement in the 1992 net margins as compared to 1991 was the inclusion in 1991 of certain costs associated with the conversion of the Weston Hills Country Club from an equity to a non-equity club.\nBrokerage and other operations represents activity from the resale of real estate inside and outside the Partnership's Communities, activity from the sale of builders' homes within the Partnership's Communities, proceeds from the Partnership's property management activities as well as fees earned from various management agreements with joint ventures. The increase in revenues and the corresponding increase in the gross operating profit from brokerage and other operations for the year ended December 31, 1993 as compared to 1992 was attributable to an increase in the volume of resale activity, primarily in the Sarasota, Broward County and Palm Beach County, Florida areas, as well as a decrease in the related cost of revenues resulting from a reduction in commissions paid due to a modification of the Partnership's brokerage commission structure. The increase in revenues and gross operating profit from brokerage and other operations at December 31, 1992 as compared to 1991 is due primarily to an increase in commissions earned by the Partnership from the sale of builder units, primarily at the Partnership's Weston and Broken Sound Communities, as well as the reduction of commissions associated with the sale of these units. Also contributing to the improved margins is the increase in the volume of resale activity in the Weston Community as well as the Jacksonville and Palm Beach County areas.\nSelling, general and administrative expenses include all marketing costs, with the exception of those costs capitalized in conjunction with the construction of housing units, and project and general administrative costs. These expenses are net of the marketing fees earned from third-party builders.\nSelling, general and administrative expenses were significantly lower for the year ended December 31, 1993 as compared to 1992. The significant reductions in selling, general and administrative costs during the past three years are attributable to the implementation of a series of overhead reductions including the consolidation of certain administrative functions, a reduction in the number of employees and other employee-related expenditures, the implementation of more cost-effective marketing programs, as well as an overall reduction of other administrative expenses. The favorable variance in selling, general and administrative expenses for the year ended December 31, 1993 as compared to 1992 is also due in part to an increase in marketing fees earned by the Partnership as a result of the increase in builder unit closings. Management will continue to evaluate the operations of the Partnership and institute additional cost controls as deemed necessary to maximize the Partnership's profits in the future.\nCharges to the carrying value of real estate inventories and other assets represent adjustments to the book values of the Partnership's projects based upon the analysis of each projects' estimated selling price in the ordinary course of business less estimated costs of completion, holding and disposal as compared to its recorded book value. At December 31, 1992, the Partnership recorded charges to the inventory carrying values of certain residential and commercial properties totalling approximately $12.2 million to reflect their estimated net realizable values as determined by management's evaluation of these properties. These charges include approximately $7.4 million to reduce the carrying values of the Partnership's Water's Edge and Dockside Communities located near Atlanta, Georgia and $1.8 million to reduce the carrying value of its River Hills Community in Tampa, Florida. These Communities had been experiencing slower sales absorptions than anticipated due to the pricing of current products not being in line with current market demand. The charges to the inventory carrying values result from the Partnership's plans to offer lower-priced homesite and housing products in these Communities which are more consistent with market demand. The Partnership did reduce the price of homesites in the Water's Edge and Dockside Communities as planned; however, during 1993, the Partnership experienced no significant increase in sales absorptions in these Communities. Recent market studies indicate that the housing product offered for sale by third-party builders in Water's Edge and Dockside continues to be priced higher than market, and further reductions of housing sales prices are warranted. Therefore, during the second quarter of 1993, the Partnership recorded an additional charge totalling approximately $4.9 million to the inventory carrying value of the Water's Edge and Dockside Communities to reflect the adverse impact of these additional reductions in housing prices on future anticipated lot values.\nIn light of the circumstances surrounding The Oaks joint venture as discussed in Liquidity and Capital Resources above, the Partnership, as a matter of prudent accounting practice, recorded a charge to the carrying value of real estate inventories and equity memberships of approximately $2.3 million and $1.0 million, respectively, in the fourth quarter of 1992 to properly reflect the estimated market value of The Oaks property in its current state of development assuming a bulk sale of the entire property under present market conditions. The balance of the charges to reduce real estate inventories at December 31, 1992, totalling approximately $0.7 million, were recorded to reflect the then current market value of several parcels of undeveloped commercial real estate.\nIn the fourth quarter of 1992, the Partnership recorded an approximate $3.4 million charge to the net book value of property and equipment to reflect the reduction in the values of a 29,000 square foot office building located in Palm Beach County, Florida and the golf and country club facility at the Partnership's River Hills Community. The value of the golf and country club facility at River Hills had been adversely impacted by the introduction of new lower-priced products within the Community, which are more in line with market demand, as well as overall economic conditions and the competition from other club facilities within the Tampa, Florida area.\nThe Partnership owns interests in a number of commercial joint ventures located throughout Florida. Due to a significant decline in the demand for undeveloped commercial real estate in the markets in which these properties are located, in 1992 the respective joint ventures recorded charges to the carrying values of their real estate inventories of approximately $7.4 million to reflect their estimated net realizable values.\nThe amenities within the Partnership's Jacksonville Golf and Country Club and Broken Sound Communities are conveyed to homeowners through the sale of equity memberships. The sales of memberships in Jacksonville Golf and Country Club have been adversely impacted during the past several years by the introduction of lower-priced products within the Community in response to market conditions as well as competition from other club facilities located in the Jacksonville area. At Broken Sound, the higher-priced equity memberships had experienced a slowdown in absorptions due primarily to the overall slowdown in the economy and the low levels of consumer confidence. As a result of the above, in 1992 the Partnership recorded charges to the carrying value of its equity memberships at Jacksonville Golf and Country Club and Broken Sound of approximately $2.2 million and $1.0 million, respectively. In addition, equity memberships also included a $1.0 million reduction in the value of The Oaks country club's equity memberships as discussed above.\nCharges to the carrying value of real estate inventories and other assets during 1991 consisted of a charge to income of approximately $1.4 million to reduce the carrying value of the Partnership's interest in a commercial joint venture located in Tampa, Florida. Also included in 1991, was an approximate $0.7 million charge to the carrying value of housing product offered for sale in the Partnership's River Hills Community due to the decision to replace a higher-priced product line with a new lower-priced product more in line with market demand. In addition, the Partnership reduced the carrying value of an undeveloped land parcel held for sale in Jacksonville, Florida.\nInterest income decreased for the year ended December 31, 1993 as compared to 1992 primarily due to an overall decrease in the average amounts invested in short-term instruments during 1993 as compared to 1992. Interest income decreased in 1992 in comparison to 1991 primarily as a result of the Partnership's purchase of its venture partner's interest in the Cullasaja Joint Venture and the resulting consolidation of the venture's operations. Interest income at December 31, 1991 includes interest earned on advances previously made by the Partnership to the joint venture. Also contributing to the decrease in interest income is the Partnership's decision to reserve interest income accrued on advances to the Coto de Caza Joint Venture. Reference is made to the Liquidity and Capital Resources section above for further discussion concerning the Partnership's ownership interest in the Coto de Caza joint venture.\nEquity in earnings of unconsolidated joint ventures increased for the year ended December 31, 1993 as compared to the same periods in 1992 due to the change from the equity to the cost method of accounting for the Partnership's investment in the Coto de Caza joint venture, which resulted in the Partnership no longer recording its ownership share of the loss from the Coto de Caza venture's operations. See Liquidity and Capital Resources above for further discussion of the change in ownership of the Coto de Caza joint venture. The increase was also attributable to the earnings generated from the two joint ventures formed during the second half of 1992 for the purpose of constructing homes within the Partnership's Weston Community. See Liquidity and Capital Resources above and Notes 1 and 7 for further discussion regarding these joint venture interests. The increase in equity in losses of unconsolidated ventures in 1992 in comparison to 1991 is due primarily to the Partnership's ownership interest in the Coto de Caza joint venture. Increased operating losses were generated by the Coto de Caza joint venture primarily due to the expensing of costs that previously qualified for capitalization. In addition, interest income earned by the joint venture decreased in comparison to 1991 due to the sale of the venture's mortgage portfolio in the fourth quarter of 1991. The increase in losses during 1992 is also attributable to the Partnership's ownership interest in a commercial joint venture located in Ocala, Florida. This venture's 1991 results of operations included profits from land sale activity, while no land sales occurred for this venture in 1992. These unfavorable variances were partially offset by the Partnership's interest in the Cullasaja joint venture's losses no longer being included in equity in losses of unconsolidated ventures due to the purchase in 1992 of the joint venture partner's interest in the venture. The results of operations for Cullasaja since that purchase have been consolidated in the accompanying Consolidated Statement of Operations.\nInterest and real estate taxes decreased for the year ended December 31, 1993 as compared to 1992 due to an overall decrease in the Partnership's average debt balance outstanding and an increase in the amount of real estate inventories which meet the requirements for capitalization of these costs.\nNationwide housing starts and total nationwide single-family permits for 1993 increased 7.1 %* and 10.3%**, respectively from 1992. Trends in housing permits for the major markets in which the Partnership's properties are located are shown below. % CHANGE FROM ------------------------------------------ HOUSING PERMITS (SINGLE FAMILY)** 1992-1993 1991-1992 1990-1991 1989-1990 ------------------ --------- --------- --------- --------- Florida Markets: West Palm Beach (includes Boca Raton). +9.4% +22.6% -7.5% -47.7% Miami - Ft. Lauderdale . +27.4% +34.8% -14.9% -30.4% Jacksonville . . . . . . +4.2% +13.9% -1.3% -10.2% Tampa Bay. . . . . . . . +6.4% +23.9% -0.2% -27.5% Atlanta, Georgia . . . . . +14.1% +26.0% +4.9% -6.3% Orange County, California. +24.0% -0.3% -16.8% -57.3%\n* Source: \"Housing Market Statistics\" (February 1994) a publication of the National Association of Home Builders\n** Source: \"U.S. Housing Markets\" (February 2, 1994, February 5, 1993, February 4, 1992, and February 1, 1992) a publication of Lomas Mortgage USA\nFor the year ended December 31, 1993, the Partnership (including its consolidated ventures and its unconsolidated ventures accounted for under the equity method) closed on the sale of 626 housing units, 752 homesite lots, approximately 50 acres of developed and undeveloped residential or commercial\/industrial land tracts as well as the sales of The Oak Bridge Club and the remaining real estate and equity memberships at The Oaks Community. This compares to sales closings in 1992 of 320 housing units, 639 homesite lots and approximately 91 acres of developed and undeveloped residential or commercial\/industrial land tracts. Sales closings in 1991 were for 273 housing units, 594 homesite lots and 107 acres of developed and undeveloped land tracts. Outstanding contracts (\"backlog\") as of December 31, 1993 were for 521 housing units, 127 homesites and approximately 47 acres of developed and undeveloped land tracts. This compares to a backlog as of December 31, 1992 of 270 housing units, 86 homesites and 6 acres of developed and undeveloped land tracts. The backlog as of December 31, 1991 was for 96 housing units, 28 homesites and approximately 34 acres of developed and undeveloped land tracts. The increasing trend in backlog as compared to prior years is indicative of the improvement in sales activity seen at many of the Partnership's Communities.\nAs a result of management's efforts to broaden the appeal of the Partnership's Communities through the introduction of new housing products, the implementation of a series of cost reductions as well as the upward trends in housing activity that the nation as well as the markets in which the Partnership's properties are located have been experiencing, the Partnership was able to generate significant cash flow before debt service during 1993. The Partnership utilized this excess cash flow to make scheduled and accelerated principal repayments on its outstanding debt, as required under the terms of the credit facility agreement, and to increase its cash reserves.\nFurthermore, in February 1994, the Partnership made a distribution of $2,565,433 to its Limited Partners ($6.35 per Interest) and $142,523 to the General Partner and Associate Limited Partners, collectively. As mentioned above, the Partnership's income property term loan, revolving line of credit and letter of credit facility are due for renewal in July 1994. Although the Partnership is hopeful these renewals will be obtained, there can be no assurance that such will occur or that the terms, amounts and restrictions of the renewed credit facilities will be similar to those under the Partnership's existing facilities. As a result, the Partnership will not be able to assess whether or not cash distributions to partners can be made for 1994 until the end of 1994 when the final operating results for the year as well as the terms and conditions of a new credit facility are known.\nINFLATION\nAlthough the relatively low rates of inflation in recent years generally have not had a material effect on the Community development business, inflation in future periods can adversely affect the development of Communities generally because of its impact on interest rates. High interest rates not only increase the cost of borrowed funds to developers, but also have a significant effect on the affordability of permanent mortgage financing to prospective purchasers. In addition, any increased costs of materials and labor resulting from high rates of inflation may, in certain circumstances, be passed through to purchasers of real properties through increases in sales prices, although such increases may reduce sales volume. If such cost increases are not passed through to purchasers, there could be a negative impact on the ultimate margins realized by the Partnership.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nINDEX\nReports of Independent Accountants\nConsolidated Balance Sheets, December 31, 1993 and 1992\nConsolidated Statements of Operations for the years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Changes in Partners' Capital Accounts (Deficit) for the years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991\nNotes to Consolidated Financial Statements\nSCHEDULE\nSupplementary Statements of Operations Information . . . . . . . . X\nSCHEDULES NOT FILED:\nAll schedules other than those indicated in the index have been omitted as the required information is inapplicable or immaterial, or the information is presented in the consolidated financial statements or related notes.\nReport of Independent Accountants\nTo the Partners of Arvida\/JMB Partners, L.P.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1) and (2) present fairly, in all material respects, the financial position of Arivda\/JMB Partners, L.P. (a limited partnership) and its subsidiaries at December 31, 1992, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1992, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express and opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. We have not audited the consolidated financial statements of Arvida\/JMB Partners, L.P. and its subsidiaries for any period subsequent to December 31, 1992.\nPRICE WATERHOUSE Miami, Florida March 23, 1993\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of ARVIDA\/JMB PARTNERS, L.P.\nWe have audited the accompanying consolidated balance sheet of Arvida\/JMB Partners, L.P. and Consolidated Ventures as of December 31, 1993, and the related consolidated statements of operations, changes in partners' capital accounts (deficit), and cash flows for the year then ended. Our audit also included the 1993 financial statement schedule listed in the Index at Item 8. These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arvida\/JMB Partners, L.P. and Consolidated Ventures at December 31, 1993, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related 1993 financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nERNST & YOUNG\nMiami, Florida March 15, 1994\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) BASIS OF ACCOUNTING\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Arvida\/JMB Partners, L.P. (the \"Partnership\") and its consolidated ventures (Note 7). All material intercompany balances and transactions have been eliminated in consolidation. The equity method of accounting has been applied in the accompanying consolidated financial statements with respect to those investments where the Partnership's ownership interest is 50% or less, with the exception of the Partnership's investment in the Coto de Caza Joint Venture which is accounted for in accordance with the cost method of accounting, effective September 15, 1992 (Note 7).\nRecognition of Profit from Sales of Real Estate\nFor sales of real estate, profit is recognized in full when the collecta- bility of the sales price is reasonably assured and the earnings process is virtually complete. When the sale does not meet the requirements for recognition of income, profit is deferred until such requirements are met. For sales of residential units, profit is recognized at the time of closing or if certain criteria are met, on the percentage-of-completion method.\nReal Estate Inventories and Cost of Real Estate Revenues\nReal estate inventories are carried at cost, including capitalized interest and property taxes, but not in excess of the net realizable value determined by the evaluation of individual projects. Management's evaluation of net realizable value is based on each projects' estimated selling price in the ordinary course of business less estimated costs of completion, holding and disposal. These estimates are reviewed periodically and compared to each project's recorded book value. Adjustments to book value, as they become necessary, are reported in the period in which they become known. The total cost of land, land development and common costs are apportioned among the projects on the relative sales value method. Costs pertaining to the Partnership's housing, homesite, and land and property revenues reflect the cost of the acquired assets as well as development costs, construction costs, capitalized interest, capitalized real estate taxes and capitalized overheads.\nCertain marketing costs relating to housing projects, including exhibits and displays, and certain planning and other predevelopment activities, excluding normal period expenses, are capitalized and charged to housing cost of revenues as related units are closed. A warranty reserve is provided as residential units are closed. This reserve is reduced by the cost of subsequent work performed.\nCapitalized Interest and Real Estate Taxes\nInterest and real estate taxes incurred are capitalized to qualifying assets, principally real estate inventories. Such capitalized interest and real estate taxes are charged to cost of revenues as sales of real estate inventories are recognized. Interest, including the amortization of loan fees, of $14,786,169, $17,424,850 and $16,621,042 was incurred for the years ended December 31, 1993, 1992 and 1991, respectively, of which $7,738,179, $4,470,150 and $2,939,326 was capitalized for the years ended December 31, 1993, 1992 and 1991, respectively. Interest payments, including amounts capitalized, of $15,125,383, $15,415,266 and $17,537,916 were made for the years ended December 31, 1993, 1992 and 1991, respectively.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nReal estate taxes of $8,870,693, $9,099,508 and $7,623,857 were incurred for the years ended December 31, 1993, 1992 and 1991, respectively, of which $3,179,099, $2,026,309 and $1,072,410 were capitalized for the years ended December 31, 1993, 1992 and 1991, respectively. Real estate tax payments of $8,733,910, $10,301,400 and $7,217,145 were made for the years ended December 31, 1993, 1992 and 1991, respectively. The preceding analysis of real estate taxes does not include real estate taxes incurred or paid with respect to the Partnership's club facilities and operating properties as these taxes are included in cost of revenues for operating properties.\nProperty and Equipment and Other Assets\nProperty and equipment are carried at cost less accumulated depreciation and are depreciated on the straight-line method over the estimated useful lives of the assets which range from two to forty years. Expenditures for maintenance and repairs are charged to expense as incurred. Costs of major renewals and improvements which extend useful lives are capitalized. Other assets are amortized on the straight-line method, which approximates the interest method, over the useful lives of the assets which range from one to five years. Amortization of debt discounts (1992 and 1991 only) and other assets, excluding loan fees, of approximately $247,400, $1,074,000 and $1,289,100 was incurred for the years ended December 31, 1993, 1992 and 1991, respectively. Amortization of loan fees, which is included in interest expense, of approximately $587,500, $343,800 and $0 was incurred for the years ended December 31, 1993, 1992 and 1991, respectively.\nInvestments in and Advances to Joint Ventures, Net\nIn general, the equity method of accounting has been applied in the accompanying consolidated financial statements with respect to those investments for which the Partnership does not have majority control and where the Partnership's ownership interest is 50% or less. The cost method of accounting has been applied in the accompanying consolidated financial statements with respect to the Coto de Caza joint venture, effective September 15, 1992, as a result of the Partnership's decrease in its ownership interest and its joint venture partner's control over the future operations of the Community. The cost method of accounting is used when a limited partner has virtually no influence over venture operations and financial policies. Under the cost method, income is generally recorded only to the extent of distributions received. Reference is made to Note 7 for further discussion of this joint venture.\nInvestments in joint ventures are carried at the Partnership's proportionate share of the ventures' assets (not in excess of their net realizable value determined by evaluation of individual projects), net of their related liabilities and adjusted for any basis differences. Basis differences result from the purchase of interests at values which differ from the recorded cost of the Partnership's proportionate share of the joint ventures' net assets.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership periodically advances funds to certain of its joint ventures in which it holds ownership interests when deemed necessary and economically justifiable. Such advances are generally interest bearing and are payable to the Partnership from amounts earned through joint venture operations.\nEquity Memberships\nThe amenities within certain of the Partnership's Boca Raton and Jacksonville, Florida Communities, as well as its Community near Highlands, North Carolina are sold to the respective homeowners through the sale of equity memberships. The amounts recorded as equity memberships in the accompanying Consolidated Balance Sheets represent the accumulation of costs incurred in constructing clubhouses, golf courses, tennis courts and various other related assets, less amounts allocated to memberships sold not in excess of their net realizable value determined by evaluations of individual amenities. Equity membership revenues and related cost of revenues are included in land and property in the Consolidated Statements of Operations.\nPartnership Records\nThe Partnership's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying consolidated financial statements have been prepared from such records after making appropriate adjustments where applicable to reflect the Partnership's accounts in accordance with generally accepted accounting principles (\"GAAP\") and to consolidate the accounts of the ventures as described above. The net effect of these items is summarized as follows:\nReference is made to Note 14 for further discussion of the allocation of profits and losses to the General Partner, Associated Limited Partners and Limited Partners.\nThe net income (loss) per Limited Partnership Interest is based upon the number of Limited Partnership Interests outstanding at the end of each period (404,005).\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nReclassifications\nDuring 1992, the Partnership evaluated the presentation and classification of information in its consolidated financial statements, the usefulness of such information and its conformity with the financial statements of other real estate developers and builders. As a result of this evaluation, the Partnership restructured the presentation of financial information in its Consolidated Statements of Operations. Such reclassifications are reflected in the accompanying Consolidated Statements of Operations and the Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991. Certain reclassifications have also been made to the 1991 Consolidated Statement of Cash Flows to conform with the 1992 presentation. Management believes that these reclassifications have resulted in a more informative presentation of the Partnership's financial information.\nCertain reclassifications have also been made to the 1992 and 1991 financial statements to conform to the 1993 presentation.\nIncome Taxes\nNo provision for state or Federal income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership. However, in certain instances, the Partnership has been required under applicable state law to remit directly to the state tax authorities amounts representing withholding on applicable taxable income allocated to partners.\n(2) INVESTMENT PROPERTIES\nThe Partnership's assets consist principally of interests in land which is in the process of being developed into master-planned residential Communities (the \"Communities\") and, to a lesser extent, commercial properties; mortgage notes and accounts receivable; management and other service contracts; construction, brokerage and other support activities; real estate assets held for investment; club and recreational facilities; and cable television businesses serving certain of its Communities.\nOn August 27, 1991, the General Partner, on behalf of the Partnership, initiated a lawsuit in the Circuit Court of Cook County (County Department, Chancery Division), Illinois against The Walt Disney Company (\"Disney\"). The litigation arises out of the Partnership's acquisition of substantially all of the real estate and other assets of Arvida Corporation, a subsidiary of Disney, in September 1987. In the complaint filed on its behalf, the Partnership alleges that under the terms of the contract with Disney for the acquisition, the purchase price of the assets was to be reduced by the amount of certain payments made prior to the closing (the \"Closing\") of the transaction out of funds of Arvida Corporation in order to satisfy certain obligations that were not assumed by the Partnership. The complaint also alleges that the contract entitles the Partnership to (i) reimbursement by Disney for amounts advanced by the Partnership to pay certain other claimed obligations of Arvida Corporation, including certain post-Closing adjustments, in connection with the acquisition and (ii) indemnification by Disney for additional costs and expenses incurred by the Partnership subsequent to the Closing in order to remedy certain environmental conditions that existed prior to the Closing. The complaint further alleges that the Partnership has made various demands on Disney for payment of these amounts and that Disney has refused to make such payments. The Partnership seeks declaratory judgments that the Partnership is entitled to a purchase price reduction from Disney and\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nreimbursement or indemnification by Disney for amounts advanced or costs and expenses incurred by the Partnership for certain obligations of Arvida Corporation, together with interest on all such amounts and costs. During the second quarter of 1992, the Partnership received approximately $0.8 million in settlement of portions of this claim. There is no assurance as to what amounts, if any, the Partnership will recover as a result of the litigation with regard to the remaining open issues under the initially filed complaint. During July 1993, Disney filed an answer denying the substantive allegations of the Partnership's complaint and raising various affirmative defenses. The Partnership believes Disney's defenses are without merit and will continue to pursue its claims. In addition, Disney has filed a three count counterclaim in which it seeks among other things: a complete accounting of liabilities allegedly assumed but not discharged by the Partnership to ascertain whether certain funds, not to exceed $2.9 million, are due Disney in accordance with the purchase agreement; an unspecified amount of damages exceeding $500,000 allegedly representing workers compensation and warranty payments made by Disney, which Disney alleges are obligations of the Partnership; an accounting for funds disbursed from a claims pool in the amount of $3,000,000 established by the parties; and attorney fees and costs. The Partnership believes it has meritorious defenses to these counterclaims and will defend itself vigorously against them.\n(3) CASH, CASH EQUIVALENTS AND RESTRICTED CASH\nAt December 31, 1993 and 1992, cash and cash equivalents primarily consisted of U.S. Government obligations with original maturities of three months or less, money market demand accounts and repurchase agreements, the cost of which approximated market value. Cash and cash equivalents include treasury bills with original maturities of three months or less of approximately $3,900,000 and $0 at December 31, 1993 or 1992. Included in restricted cash are amounts restricted under various escrow agreements. Credit risk associated with cash, cash equivalents and restricted cash is considered low due to the high quality of the financial institutions in which these assets are held.\n(4) MORTGAGES RECEIVABLE\nMortgages receivable generally range in maturity from 1 to 3 years, certain of which are collateralized by liens on the property sold and bear interest with stated rates up to 10% per annum. All mortgages receivable with below market rates are discounted at the market rate prevailing at the date of issue or purchase. The resulting effective interest rates on mortgages receivable range from approximately 11% to 14% per annum. The outstanding principal balances of mortgages receivable at December 31, 1993 and 1992 are summarized as follows:\n1993 1992 ----------- ------------\nTotal gross mortgages receivable . . . . $3,958,649 6,838,848 Unamortized discount and valuation allowances . . . . . . . . . (1,017,688) (1,101,517) ---------- ----------\nMortgages receivable, net . . . . . $2,940,961 5,737,331 ========== ==========\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(5) REAL ESTATE INVENTORIES\nReal estate inventories at December 31, 1993 and 1992 are summarized as follows: 1993 1992 ------------ ------------\nLand held for future development or sale . . . . . . . . . . . . . . . . . $ 24,259,509 30,459,094 Community development inventory: Work in progress and land improvements. . . . . . . . . . 137,048,514 133,507,511 Completed inventory. . . . . . . . . . 27,371,129 25,682,648 ------------ -----------\nReal estate inventories . . . . . . $188,679,152 189,649,253 ============ ===========\nReal estate inventories at December 31, 1992 include charges to the inventory carrying values of certain residential and commercial properties totalling approximately $12.2 million to reflect their estimated net realizable values as determined by management's evaluation of these properties. These charges include approximately $9.2 million to reduce the carrying values of the Partnership's Water's Edge and Dockside Communities located near Atlanta, Georgia and its River Hills Community in Tampa, Florida.\nThese Communities had been experiencing slower sales absorptions than anticipated due to the pricing of products not being in line with market demand. The charges to the inventory carrying values resulted from the Partnership's plans to offer lower-priced homesite and housing products in these Communities which are more consistent with market demand. The Partnership did reduce the price of homesites in the Water's Edge and Dockside Communities as planned; however, during 1993, the Partnership experienced no significant increase in sales absorptions in these Communities. Recent market studies indicate further reductions of housing sales prices in these communities are warranted. Therefore, real estate inventories at December 31, 1993 include an additional charge totalling approximately $4.9 million to the inventory carrying value of the Water's Edge and Dockside Communities to reflect the adverse impact of these additional reductions in housing prices on future anticipated lot values.\nAlso included in real estate inventories at December 31, 1992, is a charge of approximately $2.3 million to reduce the carrying value of real estate inventories at The Oaks to properly reflect the estimated market value of the property assuming a bulk sale of the entire property. The balance of the charges to reduce real estate inventories, of approximately $0.7 million, was recorded to reflect the then current market value of several parcels of undeveloped commercial real estate. See Note 8 for discussion regarding the Partnership's sale of its remaining land holdings in The Oaks Community during 1993.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(6) PROPERTY AND EQUIPMENT\nProperty and equipment at December 31, 1993 and 1992 are summarized as follows:\n1993 1992 ------------ ------------\nLand . . . . . . . . . . . . . . . . . $ 6,566,045 6,560,828 Land improvements. . . . . . . . . . . 18,214,258 19,388,725 Buildings. . . . . . . . . . . . . . . 51,166,841 50,098,289 Equipment and furniture. . . . . . . . 19,024,112 18,225,992 Construction in progress . . . . . . . 1,281,936 873,411 ------------ ------------\nTotal . . . . . . . . . . . . . . 96,253,192 95,147,245\nAccumulated depreciation. . . . . (29,263,615) (25,074,779) ------------ ------------\nProperty and equipment, net . . . $ 66,989,577 70,072,466 ============ ============\nIn the fourth quarter of 1992, the Partnership recorded an approximate $3.4 million charge to the net book value of property and equipment to reflect reductions in the values of a 29,000 square foot office building located in Palm Beach County, Florida and a golf and country club facility at the Partnership's River Hills Community. The value of the golf and country club facility at River Hills had been adversely impacted by the introduction of new lower-priced products within the Community as well as overall economic conditions and the competition from other club facilities within the Tampa, Florida area.\nDepreciation expense of approximately $5,397,200, $6,132,700 and $5,783,600 was incurred for the years ended December 31, 1993, 1992 and 1991, respectively.\n(7) INVESTMENTS IN AND ADVANCES TO JOINT VENTURES, NET\nThe Partnership has numerous investments in real estate joint ventures with ownership interests ranging from 20% to 50%. The Partnership's joint venture interests accounted for under the equity method are as follows:\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nLOCATION OF NAME OF VENTURE % OF OWNERSHIP PROPERTY - --------------- -------------- ------------\nArvida Boose Joint Venture 50 Florida\nArvida Corporate Park Associates 50 Florida\nArvida Pompano Associates Joint Venture 50 Florida\nH.A.E. Joint Venture 33-1\/3 Florida\nMizner Court Associates Joint Venture 50 Florida\nMizner Tower Associates Joint Venture 50 Florida\nOcala 202 Joint Ventures 50 Florida\nTampa 301 Associates Joint Venture 50 Florida\nWindmill Lake Estates Associates Joint Venture 50 Florida\nArvida\/RBG I Joint Venture 40 Florida\nArvida\/RBG II Joint Venture 40 Florida\nThe following is combined summary information of joint ventures accounted for under the equity method. The 1993 and 1992 summary information presented below is not comparable to the 1991 information due to the consolidation of the Cullasaja Joint Venture effective January 1, 1992 and the application of the cost method of accounting, effective September 15, 1992, for the Partnership's ownership interest in the Coto de Caza joint venture. The 1993 summary information presented is not comparable to the 1992 and 1991 information due to the consolidation of AOK Group effective March 1, 1993. See further discussion below regarding the Partnership's accounting for these joint venture interests.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership's share of net income (loss) is based upon its ownership interest in numerous investments in joint ventures which are accounted for in accordance with the equity method of accounting. Equity in earnings (losses) of unconsolidated ventures represents the Partnership's share of net income (loss) and reflects a component of purchase price adjustments included in the Partnership's basis, which are generally being amortized in relation to the cost of revenues of the underlying real estate assets. Equity in earnings (losses) of unconsolidated ventures may also include adjustments to carrying values of the investments as deemed necessary to reflect such investments at their appropriate net realizable values. These factors contribute to the differential in the Partnership's proportionate share of the net income (loss) of the joint ventures and its equity in earnings (losses) of unconsolidated ventures as well as to the basis differential between the Partnership's investments in joint ventures and its equity in underlying net assets, as shown above.\nDue to a significant decline in the demand for undeveloped commercial real estate in the markets in which the Partnership's joint venture properties are located, the respective joint ventures recorded charges to the carrying values of their real estate inventories of approximately $7.4 million in 1992 to reflect their estimated net realizable values. Equity in earnings (losses) of unconsolidated joint ventures for the year ended December 31, 1991 includes a charge to income of approximately $1.4 million to reduce the carrying value of the Partnership's interest in a commercial joint venture located in Tampa, Florida.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership. In addition, under certain circumstances, either pursuant to the joint venture agreements or due to the Partnership's obligations as a general partner, the Partnership may be required to make additional cash advances or contributions to certain of the ventures.\nAt December 31, 1991, the Partnership owned a 50% joint venture interest in the Cullasaja Community. Certain of the venture's property is encumbered by a mortgage. The principal balance outstanding on this note at December 31, 1993 and 1992 was approximately $5,412,000 and $6,649,000, respectively. The note matures on March 1, 1994 and bears interest at a rate of prime (6% at December 31, 1993) plus 1.25% per annum which is payable monthly. The Partnership is required to make repayments on the note in accordance with a homesite lot release provision of $72,750 per lot at closing. The Partnership is currently seeking an extension of this loan. However, there can be no assurance that the Partnership can obtain an extension. The operations of the venture required periodic cash advances from the partners. Since the fourth quarter of 1990, the Partnership has funded the venture's cash deficits in their entirety. As a result, during July 1992, the Partnership reached an agreement to purchase its joint venture partner's 50% interest in the Community. The Partnership was not required to make any cash payment to the joint venture partner for its interest. Instead, the purchase price of such interest is in the form of subordinated non-recourse promissory notes (the \"Notes\"), the payment of which is solely contingent upon the ultimate net cash flow generated by the joint venture. The Notes are subordinated to the repayment of the outstanding first mortgage loan and certain advances, plus accrued interest thereon, made to the venture by the partners. To the extent the Partnership has funded 100% of the venture's cash deficits in the\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\npast or advances new funds, the repayment of such advances, plus accrued interest thereon, is senior to the repayment of funds previously advanced by both partners. A portion of the cash flow remaining after payment of all senior indebtedness is to be applied annually against the principal and interest (at 10% per annum) owed on the Notes. This agreement was pursued as a more favorable alternative to the remedies included in the previously existing joint venture agreement for situations in which the partners advance unequal funds to the venture. As a result of this transaction, the Partnership has changed from the equity method of accounting to the consolidated method of accounting for the joint venture effective January 1, 1992. The consolidation and the issuance of the Notes described above yielded an increase in the Partnership's total assets of approximately $12.1 million.\nThe Coto de Caza joint venture had utilized the maximum amount available under its operating line of credit and had been seeking alternative financing sources to fund the significant additional cash necessary to continue development of the project and to fund the venture's other operating costs. In the interim, the Partnership and its joint venture partner had each advanced, net of reimbursements, approximately $3.1 million to the venture during 1991 and an additional $1.0 million during the first five months of 1992. Interest earned, at 10% per annum, during 1991 had been paid in full as of December 31, 1991. Interest earned during 1993 and 1992 totalling approximately $803,000 was unpaid as of December 31, 1993. Due to the reallocation of the Partnership's interest in the Coto de Caza joint venture effective September 15, 1992, the Partnership has provided an allowance for doubtful accounts with regard to the interest earned and unpaid at December 31, 1993 on advances previously made by the Partnership. Given the weak market conditions in Orange County, California and the continued lack of development financing available from traditional lending sources, it was unlikely that the joint venture would be able to secure additional financing in the near term. The joint venture partner was willing to continue to advance funds to meet the venture's operating needs. Given the finite amount of available capital, the Partnership determined that it was in its best long- term interest to utilize that capital for the development of its other properties rather than commit additional funds for the development of the Coto de Caza Community. As a result, the venture partner has funded the venture's cash deficits in their entirety since June 1, 1992. As an alternative to funding future capital requirements, the Partnership and its joint venture partner agreed to amend the joint venture agreement and reallocate ownership interests. In exchange for funding the venture's future operating needs, the venture partner was reallocated an additional 30% interest in the venture, and assumed the role of managing general partner. As such, the venture partner has control over the future operations of the Community, including the timing and extent of its development. The Partnership retains a 20% limited partnership interest and is entitled to receive distributions from net cash flow, after repayment of third party loans and advances made by the venture partners, up to an amount agreed upon by the Partnership and its joint venture partner. Certain specified costs and liabilities incurred prior to the reallocation will continue to be shared equally by the Partnership and its joint venture partner. This agreement was pursued as a more favorable alternative to the provisions included in the previously existing joint venture agreement for reallocation of partnership interests should both partners not advance equal funds to the venture. As a result of the Partnership's decrease in its ownership interest, and its joint venture partner's control over the future operations of the Community, commencing on September 15, 1992, the Partnership accounts for its share of the operations of the Coto de Caza joint venture in accordance with the cost method of accounting.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDuring 1992 the Partnership sold 60% of its interest in two land parcels located in its Weston Community to unaffiliated third-party purchasers. Subsequent to these transactions, the Partnership and the purchasers each contributed their interests in these land parcels to joint ventures established for the purpose of developing housing products within Weston. The Partnership entered into development management agreements with these joint ventures. Pursuant to the terms of these agreements, the Partnership agreed to fund all development and construction costs, as well as certain overheads, incurred on behalf of the joint venture projects. Amounts funded are reimbursed by the joint ventures from sales revenues generated by each joint venture. Amounts advanced by the Partnership to each respective joint venture earn interest at 8.5% for the first year and prime plus 2% per annum thereafter. During the first quarter of 1993, one of the joint ventures obtained third-party, project specific financing in the amount of $4,950,000 to fund its development and construction activities. In accordance with the provisions of this financing agreement, as of December 31, 1993, the Partnership had been reimbursed the majority of amounts previously advanced to the joint venture. As a result of this financing arrangement, the Partnership does not anticipate the need for future advances to this venture. Due to significant sales activity, amounts previously advanced to the Partnership's other joint venture were reimbursed in full during 1993.\nDuring the first quarter of 1993, the Partnership reached a settlement agreement with AOK Group, its joint venture partner in a property located in Ocala, Florida, whereby in exchange for its joint venture partner's 50% interest in the venture, the Partnership agreed to dismiss a lawsuit previously filed against its joint venture partner for failure to perform in accordance with the terms of a $1,600,000 note which had been issued to the Partnership by the joint venture. This agreement was pursued as a more favorable remedy to other alternatives available to the Partnership. As a result of this transaction, the Partnership has changed from the equity method of accounting to the consolidated method of accounting for the joint venture effective March 1, 1993. This transaction resulted in an increase in the Partnership's total assets of approximately $324,000.\nThe Partnership incurs certain general and administrative expenses, including insurance premiums, which are paid by the Partnership on behalf of the joint ventures in which it holds interests. The Partnership receives reimbursements from the joint ventures for such costs. For the year ended December 31, 1993, the Partnership was entitled to receive approximately $343,000 from certain of the joint ventures in which it holds interests. At December 31, 1993, approximately $64,000 was owed to the Partnership, of which approximately $27,000 was received as of March 15, 1994.\n(8) NOTES AND MORTGAGES PAYABLE\nNotes and mortgages payable at December 31, 1993 and 1992 are summarized as follows:\n1993 1992 ------------ ------------ Term loan credit facility of $126,805,195 bearing interest at approximately 5.6% and 6.5% per annum at December 31, 1993 and 1992, respectively (A). . . . . . . $108,262,248 126,805,195\nIncome property term loan of $20,000,000, bearing interest at approximately 5.6% and 6.0% per annum at December 31, 1993 and 1992, respectively (A). . . . . . . 18,933,328 19,733,332\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n1993 1992 ------------ ------------ Revolving line of credit of $45,000,000 (A) . . . . . . . . . . . . . . . . . . -- --\nOther notes and mortgages payable (B). . 20,575,416 34,397,645 ------------ ------------\nTotal. . . . . . . . . . . . . $147,770,992 180,936,172 ============ ============\n(A) At December 31, 1991, the Partnership had an agreement with two commercial banks permitting the Partnership to borrow up to $225 million under various credit facilities consisting of a term loan originally totalling $150 million and a revolving credit line of up to $75 million. In addition, the Partnership had a letter of credit agreement up to $20 million. Although the Partnership's term loan was not scheduled to mature until February 1998, the lenders required the Partnership to restructure its entire credit facility as part of the extension of the revolving line of credit facility which originally matured on January 15, 1992. The Partnership and its lenders finalized an agreement in October of 1992 for a new facility. The new facility consists of a term loan in the amount of $126,805,195, a revolving line of credit facility up to $45 million, an income property term loan of $20 million, and a $15 million letter of credit facility. The term loan, the revolving line of credit and the letter of credit facility are secured by recorded mortgages on all otherwise unencumbered real property assets of the Partnership as well as an assignment of all mortgages receivables, equity memberships, certain joint venture interests or joint venture proceeds and cash balances (with the exception of deposits held in escrow). The income property term loan is secured by the recorded first mortgages on a mixed-use center and an office building in Boca Raton, Florida. All of the notes under the new facility are cross-collateralized and cross-defaulted. The term loan, the revolving line of credit and the income property term loan bear interest based, at the Partnership's option, on one of the lender's prime rate plus 1% or on the relevant London Inter-Bank Offering Rate (LIBOR) plus 2.25% per annum. At December 31, 1993, $75 million of the Partnership's outstanding credit facility was under two interest rate swap arrangements. For the year ended December 31, 1993, the effective interest rate for the combined term loan, income property term loan and revolving line of credit facility was approximately 9.3% per annum. This rate includes the effect of the interest rate swap agreements, one of which matured in February 1994 and the other of which will mature in October 1994. In addition, the Partnership was required to pay the lenders certain commitment and administration fees as well as all closing costs relating to these borrowings.\nUnder the term loan agreement, the Partnership made the first scheduled principal repayments of $8 million in February 1993 and $10 million in March 1994. Principal repayments of $10 million are due in each of the years 1995 and 1996, and the remaining balance outstanding is due in July 1997. In addition, the term loan agreement provides for additional principal repayments based upon a specified percentage of available cash flow and upon the sale of certain assets. For the year ended December 31, 1993, the Partnership made additional term loan payments totalling approximately $10.5 million. Under the income property term loan, monthly principal and interest payments are required to be paid on a 25-year amortization schedule with the remaining balance outstanding due in July 1994. The revolving line of credit and letter of credit facility also mature in July 1994.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership is in the process of negotiating a renewal of its credit facilities. Although the Partnership is hopeful these renewals will be obtained, there can be no assurance that such will occur or that the terms, amounts and restrictions of the renewed credit facilities will be similar to those under the Partnership's existing facilities. The credit agreement contains significant restrictions with respect to the payment of distributions to partners, the maintenance of certain loan-to-value ratios, the use of proceeds from the sale of the Partnership's assets and advances to the Partnership's joint ventures. As of March 15, 1994, all of the term loan proceeds had been borrowed with a remaining balance of $92,360,145, and $0, $18,733,327 and $11,868,393 were outstanding on the revolving line of credit facility, the income property term loan and the letter of credit facility, respectively.\nLoan fees incurred in connection with the restructuring of the Partnership's credit facility have been capitalized and are being amortized over the lives of the loans included in the credit facility using the straight-line method, which approximates the interest method.\n(B) Other notes and mortgages payable are collateralized by certain real estate inventories, property and equipment and certain investments with a net book value of approximately $22 million at December 31, 1993. These notes and mortgage notes have a weighted average annual effective interest rate of approximately 7.2% and 7.5% at December 31, 1993 and 1992, respectively, and mature in varying amounts through 2017.\nThe Partnership owned an 80% general partnership interest in The Oaks Community located near Sarasota, Florida. The Partnership's joint venture partner was in default under the terms of the joint venture agreement due to its failure to make capital contributions to fund ongoing operations. In August 1993, the Partnership's joint venture partner assigned its 20% interest in The Oaks to the Partnership thereby vesting 100% control of the joint venture assets in the Partnership.\nCertain of the assets of The Oaks joint venture were encumbered by two mortgage loans. A $12,492,200 loan was scheduled to mature in January 1997 and a $3,260,000 loan was scheduled to mature in December 1993. The joint venture had guaranteed $2.7 million of the loans, and the guaranteed amount was with recourse to the Partnership. The joint venture was in default under the terms of these loan agreements as a result of its failure to make principal payments of approximately $1.3 million in January 1993 to release the minimum number of homesite lots as required under these agreements and its failure to pay interest commencing with a payment due in April 1993. The Partnership was able to reach an agreement with the lenders to pay off the existing mortgage loans at a substantial discount from face value. On September 3, 1993, the Partnership paid the joint venture's lenders $6.7 million in full satisfaction of the outstanding mortgage loans, accrued interest and guaranty. This transaction contributes to the decrease in notes and mortgages payable at December 31, 1993 as compared to December 31, 1992 and is the cause of the approximate $9.5 million extraordinary gain on the early extinguishment of debt as of December 31, 1993.\nThe joint venture also sold its remaining land holdings in The Oaks Community and its interest in The Oaks Club to an unaffiliated third party purchaser for $5.8 million simultaneously with the repayment of the loans and satisfaction of the mortgages. These transactions are the cause of various\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nchanges in the consolidated balance sheets at December 31, 1993 as compared to December 31, 1992. In light of the Partnership's guarantee under the loan agreement of $2.7 million of the outstanding mortgage loans, as well as other factors, the above transactions were pursued as the least costly alternative available to the Partnership. These transactions resulted in a minimal net gain for Federal income tax purposes.\nIn anticipation of the above circumstances, the Partnership, as a matter of prudent accounting practice, recorded a charge to the carrying value of real estate inventories and equity memberships of approximately $2.3 million and $1.0 million, respectively, in the fourth quarter of 1992 to properly reflect the estimated market value of the property in its then current state of development assuming a bulk sale of the entire property.\nFollowing is a schedule of the maturities of the notes and mortgages payable at December 31, 1993.\n1994 . . . . . . . . . . . . . . . $ 37,184,325 1995 . . . . . . . . . . . . . . . 10,665,714 1996 . . . . . . . . . . . . . . . 17,374,705 1997 . . . . . . . . . . . . . . . 78,762,248 1998 . . . . . . . . . . . . . . . 500,000 Thereafter . . . . . . . . . . . . 3,284,000 ------------ Total notes and mortgages payable. . . . . . $147,770,992 ============\n(9) EQUITY MEMBERSHIPS\nEquity memberships represent the accumulation of costs incurred in constructing club houses, golf courses, tennis courts and various other related assets, less amounts allocated to memberships sold, not in excess of their net realizable values determined by evaluation of individual amenities. These amenities are conveyed to homeowners through the sale of equity memberships. The sale of memberships in Jacksonville Golf and Country Club has been adversely impacted during the past several years by the introduction of lower-priced products within the Community as well as the competition from other club facilities located in the Jacksonville area. At Broken Sound, the higher-priced equity memberships have experienced a slowdown in absorptions due primarily to the overall slowdown in the economy and the low levels of consumer confidence. As a result of the above, in 1992, the Partnership recorded charges to the carrying value of its equity memberships at Jacksonville Golf and Country Club and Broken Sound of approximately $2.2 million and $1.0 million, respectively. In addition, equity memberships for the year ended December 31, 1992 also include a $1.0 million reduction in the value of The Oaks Country Club's equity memberships as discussed further in Note 8.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership receives reimbursements from or reimburses affiliates of the General Partner for certain general and administrative costs including, and without limitation, salary and salary-related costs relating to work performed by employees of the Partnership and certain out-of-pocket expenditures incurred on behalf of such affiliates. For the year ended December 31, 1993, the total of such costs incurred by the Partnership on behalf of these affiliates totalled approximately $171,000. Approximately $24,700 was outstanding at December 31, 1993, of which approximately $4,400 was received as of March 15, 1994. This amount does not bear interest and is expected to be paid in future periods. For the year ended December 31, 1992, the Partnership was entitled to receive reimbursements of approximately $129,000.\nIn accordance with the Partnership Agreement, the General Partner and Associate Limited Partners have deferred a portion of their distributions of net cash flow from the Partnership totaling approximately $810,000 as of December 31, 1993. This amount does not bear interest and is expected to be paid in future periods subject to certain restrictions contained in the Partnership's credit facility.\nArvida Company (\"Arvida\"), pursuant to an agreement with the Partnership, provides development, construction, management and other personnel and services to the Partnership for all of its projects and operations. Pursuant to such agreement, the Partnership shall reimburse Arvida for all of its out-of-pocket expenditures (including salary and salary-related costs), subject to certain limitations. The total of such costs for the years ended December 31, 1993 and 1992 was approximately $6,686,100 and $6,622,800, respectively, of which approximately $80,000 was unpaid as of December 31, 1993 and all of which was paid as of March 15, 1994.\nThe Partnership and Arvida\/JMB Partners, L.P.-II (a publicly-held limited partnership affiliated with the General Partner) each employ project related and administrative personnel who perform services on behalf of both partnerships. In addition, certain out-of-pocket expenditures related to such services and other general and administrative costs, including certain insurance premiums, are incurred and allocated to each partnership as appropriate. The Partnership receives reimbursements from or reimburses Arvida\/JMB Partners, L.P.-II for such costs (including salary and salary- related costs). For the year ended December 31, 1993, the Partnership was entitled to receive approximately $2,497,400 from Arvida\/JMB Partners, L.P.- II. At December 31, 1993, approximately $26,100 was outstanding, all of which was received as of March 15, 1994. In addition, for the year ended December 31, 1993, the Partnership was obligated to reimburse Arvida\/JMB Partners, L.P.-II approximately $1,234,300, all of which was paid as of December 31, 1993. The net reimbursements paid to the Partnership for the year ended December 31, 1992 was approximately $236,000.\nThe Partnership pays for certain general and administrative costs, including insurance premiums, on behalf of its affiliated clubs, homeowners associations and maintenance associations. The Partnership receives reimbursements from the affiliates for such costs. For the year ended December 31, 1993, the Partnership was entitled to receive approximately $366,400 from its affiliates. At December 31, 1993, approximately $116,700 was owed to the Partnership, of which approximately $23,000 was received as of March 15, 1994. The amount reimbursed to the Partnership for the year ended December 31, 1992 was approximately $2,327,200.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(11) COMMITMENTS AND CONTINGENCIES\nAs security for performance of certain development obligations, the Partnership is contingently liable under standby letters of credit and bonds for approximately $11,651,000 and $11,146,000, respectively, at December 31, 1993. As of December 31, 1992, the Partnership was contingently liable under standby letters of credit and bonds for approximately $18,438,000 and $18,293,000, respectively. In addition, certain joint ventures in which the Partnership holds an interest are also contingently liable under bonds for approximately $1,089,000 and $1,180,000 at December 31, 1993 and 1992, respectively.\nThe Partnership leases certain building space for its management offices, sales offices and other facilities, as well as certain equipment. The building and equipment leases expire over the next 2 to 11 years. Minimum future rental commitments under non-cancelable operating leases having a remaining term in excess of one year as of December 31, 1993 are as follows:\n1994 . . . . . . . . . . . $1,287,841 1995 . . . . . . . . . . . 1,130,218 1996 . . . . . . . . . . . 855,780 1997 . . . . . . . . . . . 228,167 1998 . . . . . . . . . . . 150,437 Thereafter . . . . . . . . 283,835 ----------\n$3,936,278 ==========\nRental expense of $2,786,710, $2,320,028 and $2,865,680 was incurred for the years ended December 31, 1993, 1992 and 1991, respectively.\nThe Partnership is named a defendant in a number of homeowner lawsuits, certain of which purported to be class actions, that allegedly in part arose out of or related to Hurricane Andrew, which on August 24, 1992 resulted in damage to a former community development known as Country Walk. The homeowner lawsuits allege, among other things, that the damage suffered by the plaintiffs' homes and\/or condominiums within Country Walk was beyond what could reasonably be expected from the hurricane and\/or was a result of the defendants' alleged defective design, construction, inspection and\/or other improper conduct in connection with the development, construction and sales of such homes and condominiums, including alleged building code violations. The various plaintiffs seek varying and, in some cases, unspecified amounts of compensatory damages and other relief. In certain of the lawsuits injunctive relief and\/or punitive damages are sought. The Partnership intends to vigorously defend itself in these lawsuits.\nThe various lawsuits arising out of or relating to Hurricane Andrew allege that the Partnership is liable, among other reasons, as a result of its own alleged acts of misconduct or as a result of the Partnership's assumption of Arvida Corporation's liabilities in connection with the Partnership's purchase of Arvida Corporation's assets from the Walt Disney Company (\"Disney\") in 1987, which included certain assets related to the Country Walk development. Pursuant to the agreement to purchase such assets, the Partnership obtained indemnification by Disney for certain liabilities relating to facts or circumstances arising or occurring prior to the closing of the Partnership's purchase of the assets. Over 80% of the Arvida-built homes in Country Walk were built prior to the Partnership's ownership of the\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nCommunity. Where appropriate, the Partnership has tendered or will tender each of the above-described lawsuits to Disney for defense and indemnification in whole or in part pursuant to the Partnership's indemnification rights. Where appropriate, the Partnership is also tendering these lawsuits to its various insurance carriers for defense and coverage. The Partnership is unable to determine at this time to what extent damages in these lawsuits, if any, against the Partnership, as well as the Partnership's cost of investigating and defending the lawsuits, will ultimately be recoverable by the Partnership either pursuant to its rights of indemnification by Disney or under contracts of insurance.\nThe Partnership has negotiated the terms of a class action settlement with opposing counsel in one of the pending homeowners' lawsuits which has the potential for resolving substantial portions of the pending homeowners' lawsuits which have been filed. On June 3, 1993, the Circuit Court of Dade County entered an order preliminarily finding that the Partnership's proposed class action settlement agreement, as revised, was within the range of what appeared to be a fair and adequate settlement of the claims filed by single- family homeowners and condominium owners at Country Walk. On August 10, 1993, the court issued a final order approving the class action settlement. The settlement, which is designed to resolve claims arising in connection with estate and patio homes and condominiums sold by the Partnership after September 10, 1987, is structured to compensate residents for losses not covered by insurance. Settlement amounts payable are a function of the type of unit involved and the claimant's proof regarding the adequacy of insurance proceeds. Homeowners of 188 units of Country Walk have accepted the settlement. Those who affirmatively rejected the offer may continue to litigate against the Partnership. The Partnership currently believes that the class action settlement may cost approximately $2.5 million. The settlement is being funded by one of the Partnership's insurers, subject to a reservation of rights. The amount of money, if any, which the insurance company may recover from the Partnership pursuant to its reservation of rights is uncertain. Due to this uncertainty, the accompanying consolidated balance sheets do not reflect an accrual for such costs.\nOn February 24, 1994, the Partnership was dismissed from the pending class action lawsuits pursuant to the class action settlement. In addition, the Partnership has been informed that Disney and an insurer have reached agreements to settle five of the individual homeowners actions which were tendered by the Partnership to Disney. These Disney Settlements will be funded without any contribution from the Partnership. The Partnership can give no assurance that the Disney settlements will be finalized.\nAs noted above, those homeowners who affirmatively rejected the offer of settlement may continue to litigate. The Partnership is currently a defendant in eleven lawsuits brought by condominium and patio home owners, all of whom have declined to accept the terms of the class action settlement. These lawsuits, involving nineteen named individuals, are pending in the Circuit Court of Dade County. In these lawsuits, plaintiffs allege a variety of claims involving, among other things, breach of warranty, negligence and building code violations. The Partnership intends to vigorously defend itself in these matters.\nOn April 19, 1993, a subrogation claim entitled Village Homes at Country Walk Master Maintenance Association, Inc. v. Arvida Corporation et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiffs filed this suit for the use and benefit of American Reliance Insurance Company (\"American Reliance\"). Plaintiffs seek to recover damages and pre- and post-judgment interest in connection with $10,873,000 American Reliance has allegedly paid to its insureds living in condominium units at Country Walk in the wake of Hurricane Andrew. Disney is also a defendant in this suit. On July 1, 1993, a subrogation lawsuit entitled Prudential Property and Casualty Company v.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nArvida\/JMB Partners, et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiff seeks to recover damages, costs, and interest in connection with $16,679,622 Prudential allegedly paid to its insureds living in Country Walk at the time of Hurricane Andrew. Disney is also a defendant in this suit. On July 15, 1993, a subrogation lawsuit entitled Allstate Insurance Company v. Arvida\/JMB Partners, et al., was filed in the 11th Judicial Circuit for Dade County. Plaintiff seeks to recover damages, costs, and interest in connection with $18,540,196 Allstate allegedly paid to its insureds living in Country Walk at the time of Hurricane Andrew. Disney is also a defendant in this suit. The Partnership settled a threatened subrogation action by State Farm Insurance Company. The settlement was funded by one of the Partnerships insurance carriers subject to a reservation of rights. The amount of money the insurance carrier may seek to recover from the Partnership for this and any other settlements it has funded is uncertain. The Partnership is a defendant in and anticipates other subrogation claims by insurance companies which have allegedly paid policy benefits to Country Walk residents. The Partnership intends to defend itself vigorously in all such matters.\nThe Partnership has resolved a claim for construction related damages brought by the Villages of Country Walk Homeowners' Association, Inc., among others. Two of the Partnership's insurance carriers funded a settlement in the amount of $2,740,000 to resolve claims related to the construction of the common elements of the condominium units at Country Walk. One of the insurance carriers has issued a reservation of rights in connection with these claims and the extent to which that insurance company may ultimately recover any of these proceeds from the Partnership is unknown. Therefore, the accompanying consolidated balance sheets do not reflect an accrual for such costs.\nThe Partnership is involved in an Environmental Protection Agency (EPA) administrative enforcement proceeding with regard to the Partnership's Water's Edge property. The EPA has asserted that a dam built to create a lake at the Community during the time the property was owned by Arvida Corporation was in violation of Section 404 of the Clean Water Act in that certain wetland areas had been filled. Pursuant to a Consent Agreement and Order entered into with the EPA, the Partnership acquired certain land (at a cost of approximately $400,000) for which it has developed and implemented a plan of mitigation for the wetlands lost. In accordance with certain provisions of the Consent Agreement and Order, the Partnership must provide the EPA with periodic reports regarding the status of the mitigation plan. An agreement in principle has been reached to settle the dispute between the parties pursuant to which the EPA has agreed to assess a civil penalty of $125,000. The Partnership is actively pursuing indemnification from Disney for the total costs that will ultimately be incurred to resolve this issue. There can be no assurance that the Partnership will be reimbursed by Disney.\nOn October 13, 1993, a lawsuit captioned Berry v. Merril (sic) Lynch, Pierce Fenner & Smith, J&B Arvida Limited Partnership (sic) and Does 1 through 100, was filed in the Superior Court of the State of California in and for the County of San Diego, Case No. 669709. The lawsuit was purportedly filed as a class action on behalf of the named plaintiffs and all other persons or entities in the State of California who bought or acquired, directly or indirectly, limited partnership interests (\"Interests\") in the Partnership from September 1, 1987 through the present. The complaint in the action alleges, among other things, that the defendants made misrepresentations and concealed various facts, breached fiduciary duties, and violated the covenant of good faith in connection with the sale of Interests in the Partnership. The complaint further alleges that such conduct violated California state law\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nrelating to fraud, breach of fiduciary duty, willful suppression of facts, and breach of the covenant of good faith. Plaintiffs, on behalf of themselves and the purported plaintiff class, seek unspecified compensatory damages, consequential damages, punitive and exemplary damages, interest, costs of the suit, and such other relief as the court may order. The Partnership believes that the lawsuit is without merit and intends to vigorously defend itself.\nIn addition, the Partnership has been advised by Merrill Lynch that Merrill Lynch has been named a defendant in actions pending in the Eleventh and Seventeenth Judicial Circuit Courts in Dade and Broward Counties, Florida to compel arbitration of claims brought by certain investors of the Partnership representing approximately 4% of the total Interests outstanding. Merrill Lynch has asked the Partnership and its General Partner to confirm an obligation of the Partnership and its General Partner to indemnify Merrill Lynch in these claims against all loss, liability, claim, damage and expense, including without limitation attorneys' fees and expenses, under the terms of a certain Agency Agreement dated September 15, 1987 (\"Agency Agreement\") with the Partnership relating to the sale of Interests in the Partnership through Merrill Lynch on behalf of the Partnership. In the actions to compel arbitration, the claimants have advised Merrill Lynch that they will seek to file demands for arbitration and claims for unspecified damages against Merrill Lynch based on Merrill Lynch's alleged violation of applicable state and\/or federal securities laws and alleged violations of the rules of the National Association of Securities Dealers, Inc., together with pendent state law claims. The Agency Agreement generally provides that the Partnership and its General Partner shall indemnify Merrill Lynch against losses occasioned by an actual or alleged misstatements or omission of material facts in the Partnership's offering materials used in connection with the sale of Interests and suffered by Merrill Lynch in performing its duties under the Agency Agreement, under certain specified conditions. The Agency Agreement also generally provides, under certain conditions, that Merrill Lynch shall indemnify the Partnership and its General Partner for losses suffered by the Partnership and occasioned by certain specified conduct by Merrill Lynch in the course of Merrill Lynch's solicitation of subscriptions for Interests. The Partnership is unable to determine at this time the ultimate investment of investors who have filed arbitration claims as to which Merrill Lynch might seek indemnification in the future. At this time, and based upon the information presently available about the arbitration statements of claims filed by some of these investors, the Partnership and its General Partner believe that they have meritorious defenses to demands for indemnification made by Merrill Lynch and intend to vigorously pursue such defenses. In the event Merrill Lynch is entitled to indemnification of its attorney's fees and expenses or other losses and expenses, these amounts may prove to be material.\nThe Partnership is also a defendant in several actions brought against it arising in the normal course of business. It is the belief of the General Partner, based on knowledge of facts and advice of counsel, that the claims made against the Partnership in such actions will not result in any material adverse effect on the Partnership's consolidated financial position or results of operations.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership owns a 50% joint venture interest in 31 acres located within a 209-acre commercial\/industrial park in Pompano Beach, Florida. The joint venture's property is encumbered by a mortgage loan in the principal amount of approximately $4 million as of December 31, 1993. As the Partnership believes the economics of the project do not warrant making additional cash investments or providing further financial guarantees, it was determined in 1991 that the least costly alternative for the venture would be to convey the land to the lender and to make certain cash payments to the lender in connection with the existing guarantees under the venture loan agreement. During April 1992, the Partnership and its joint venture partner each tendered payment in the amount of approximately $3.1 million for their respective shares of the guarantee payment and certain other holding costs to the lender, the majority of which reduced the outstanding mortgage loan to the current balance. Title to the property was not conveyed at that time pending resolution of certain general development obligations of the venture and certain environmental issues. The Partnership has been negotiating with the lender regarding the scope of the development work required to be done and does not anticipate the associated costs to be significant. With respect to the environmental issues, the previous owner remains obligated to undertake the clean up pursuant to, among other things, a surviving obligation under the purchase and sale agreement. During January 1994, the Florida Department of Environmental Protection approved the first phase of a three phase environmental clean-up program. However, no substantial clean-up has occurred to date. If the previous owner is unable to fulfill its obligations as they relate to this environmental issue, the resolution of the environmental issue and its related costs may become an obligation of the venture and ultimately the Partnership. Should this occur, the Partnership does not anticipate the cost of this clean-up to be material to its operations. The lender has recently asserted the mortgage loan is with recourse to the joint venture partners as a result of the partners' failure to perform in accordance with the terms of the loan agreement. The Partnership believes this claim is without merit and will vigorously defend itself against this allegation. The transfer of title, when fully consummated, will not have a significant impact on the Partnership's operations for financial reporting purposes due to the prior payment of the financial guarantees and certain holding costs. However, the Partnership will recognize a loss for Federal income tax purposes.\nIn anticipation of its future development plans, the Partnership is currently in the process of obtaining permits for development of Increment III of its Weston Community, portions of which are environmentally sensitive areas that may be subject to protection as wetlands. The time involved to complete this process, which involves the approvals of the Army Corps of Engineers, the Environmental Protection Agency and other regulatory agencies, is expected to be lengthy. It is anticipated that certain costs of mitigation will be incurred in conjunction with obtaining the necessary permits, the amount and extent of which are unknown at this time. The Partnership had previously gone through a similar process and was successful in obtaining the approvals for Increment II of the Weston Community. Although there can be no assurance, given the Partnership's prior experience and discussions to date with the appropriate agencies, the Partnership is hopeful that a compromise will ultimately be reached that will adequately address the concerns of the environmental agencies, while allowing the Partnership to continue its development plans for Weston's Increment III.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn June 1993, the Partnership reached an agreement with Equitable South Florida Venture (\"Equitable\"), the successor in interest to Tishman Speyer\/Equitable South Florida Venture, the original purchaser of approximately 390 acres of land in Increment III in the Partnership's Weston Community, whereby, in exchange for $5.0 million, the Partnership repurchased approximately 330 acres of the land and Equitable agreed to relieve the Partnership of the obligations under certain provisions of the Sale and Purchase Agreement dated December 15, 1983 which were assumed by the Partnership in connection with the purchase of the assets of Arvida Corporation in September 1987. Of the agreed upon price of $5 million, $2.5 million was paid at closing and the balance of $2.5 million will be paid in equal annual installments of $500,000 together with interest thereon of 8% per annum beginning May 1994. The unpaid principal balance will be secured by a mortgage on certain real estate located in the Partnership's Weston Community.\nAs part of its efforts to obtain the appropriate development permits discussed in the preceding paragraph, the Partnership has included this land as part of its proposed mitigation plan for the development of Increment III of its Weston Community.\nThe Partnership may be responsible for funding certain other ancillary activities for related entities in the ordinary course of business which the Partnership does not currently believe will have any material effect on its consolidated financial position or results of operations.\n(12) TAX INCREMENT FINANCING ENTITIES\nIn connection with the development of the Partnership's Weston Community, which is in the mid stage of development, bond financing is utilized to construct certain on-site and off-site infrastructure improvements, including major roadways, lakes, other waterways and pump stations, which the Partnership would otherwise be obligated to finance and construct as a condition to obtain certain approvals for the project. This bond financing is obtained by The Indian Trace Community Development District (\"District\"), a local government district operating in accordance with Chapter 190 of the Florida Statutes. Under this program, the Partnership is not obligated directly to repay the bonds. Rather, the bonds are expected to be fully serviced by special assessment taxes levied on the property, which effectively collateralizes the obligation to pay such assessments. While the owner of the property, the Partnership is responsible to pay the special assessment taxes until land parcels are sold. At such point, the liability for the assessments related to parcels sold will be borne by the purchasers through a tax assessment on their property. These special assessment taxes are designed to cover debt service on the bonds, including principal and interest payments, as well as the operating and maintenance budgets of the District. The use of this type of bond financing is a common practice for major land developers in South Florida.\nThe District issued $64,660,000 of variable rate bonds in November 1989 and $31,305,000 of variable rate bonds in July 1991. These bonds mature in various years commencing in May 1991 through May 2011. At December 31, 1993, the amount of bonds issued and outstanding totalled $89,950,000. For the twelve months ended December 31, 1993, the Partnership paid special assessments related to these bonds of approximately $5.2 million.\nIn order to take advantage of historically low interest rates and reduce the exposure of variable rate debt, the District is pursuing a new bond issuance. If successful, the proceeds from this offering will be used to refund 1989 and 1991 bonds currently outstanding.\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(13) STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 107 (\"SFAS 107\") - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS 107 requires entities with total assets exceeding $150 million for fiscal years ending after December 15, 1992 to disclose the SFAS 107 values of all financial assets and liabilities for which it is practicable to estimate. Value is defined in SFAS 107 as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its financial instruments (excluding its interest rate swap agreements) approximates SFAS 107 value. The SFAS 107 value of the Partnership's interest rate swap agreements were obtained from dealer quotes. These values represent the estimated amounts the Partnership would be obligated to pay to terminate the agreements, taking into account current interest rates. The notional amounts, the carrying amounts, and SFAS 107 values for the Partnership's interest rate swap agreements are as follows:\nAt December 31, 1993 --------------------------------- Notional Carrying SFAS 107 Amount Amount (1) Value ---------- ---------- ---------- Interest Rate Swap Agreements: In a net payable position. . . $50,000,000 $1,018,902 $1,306,410 In a net payable position. . . 25,000,000 240,838 1,229,232\n(1) The amounts shown under \"carrying amount\" represent interest expense accruals arising from these unrecognized financial instruments.\n(14) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement (and subject to Section 4.2 which allocates Profits, as defined, to the General Partner and Associate Limited Partners), profits or losses of the Partnership will be allocated as follows: (i) profits will be allocated such that the General Partner and the Associate Limited Partners will be allocated profits equal to the amount of cash flow distributed to them for such fiscal period with the remainder allocated to the Limited Partners, except that in all events, the General Partner shall be allocated at least 1% of profits and (ii) losses will be allocated 1% to the General Partner, 1% to the Associate Limited Partners and 98% to the Limited Partners.\nIn the event profits to be allocated in any given year do not equal or exceed cash distributed to the General Partner and the Associate Limited Partners for such year, the allocation of profits will be as follows: The General Partner and the Associate Limited Partners will be allocated profits equal to the amount of cash flow distributed to them for such year. The Limited Partners will be allocated losses such that the sum of amounts allocated to the General Partner, Associate Limited Partners, and Limited Partners equals the profit for the given year.\nSection 4.2F of the Partnership Agreement requires the allocation of Profits (as defined) to the General Partner and Associate Limited Partners in order to take account of a current or anticipated reduction in the Partnership's indebtedness and certain other circumstances. In accordance with Section 4.2F of the Partnership Agreement, for financial reporting and Federal income tax purposes for the year ended December 31, 1992, the General\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPartner and Associate Limited Partners received allocations of Profits in addition to their respective allocations, pursuant to the other allocation provisions of the Partnership Agreement, of the Partnership's loss, as adjusted for such allocation of Profits. The amount of Profits, net of such loss, allocated to the General Partner and Associate Limited Partner, collectively, for tax and financial reporting purposes for 1992 was approximately $9,230,000 and $20,836,000, respectively. In future periods in which the Partnership incurs a loss, the General Partner and Associate Limited Partners may be allocated Profits pursuant to Section 4.2F equivalent to the amount of loss (as adjusted for such allocation of Profits), if any, allocable to them for financial reporting and Federal income tax purposes. For the year ended December 31, 1993, the Partnership had net income for financial reporting and Federal income tax purposes, however, no cash distributions were made during 1993. In accordance with Section 4.2A of the Partnership Agreement, the amount of net income allocated, collectively, to the General and Associate Limited Partners for tax and financial reporting purposes was approximately $19,000 and $293,000, respectively.\nIn general, and subject to certain limitations, the distribution of Cash Flow (as defined) after the initial admission date is allocated 90% to the Holders of Interests and 10% to the General Partner and the Associate Limited Partners (collectively) until the Holders of Interests have received cumulative distributions of Cash Flow equal to a 10% per annum return (non- compounded) on their Adjusted Capital Investments (as defined) plus the return of their Capital Investments; provided, however, that 4.7369% of the 10% amount otherwise distributable to the General Partner and Associate Limited Partners (collectively) will be deferred, and such amount will be paid to the Holders of Interests, until the Holders of Interests receive Cash Flow distributions equal to a cumulative, non-compounded amount of 12% per annum of their Capital Investments (as defined). This deferral provision is in place until the Holders of Interests receive total cash distributions equal to their Capital Investments. Any deferred amounts owed to the General Partner and Associate Limited Partners (collectively) will be distributable to them out of Cash Flow otherwise distributable to the Holders of Interests at such time as such Holders have received a 12% per annum cumulative, non-compounded return on their Capital Investments (as defined) or in any event, to the extent of one-half of Cash Flow otherwise distributable to the Holders of Interests at such time as they have received total distributions of Cash Flow equal to their Capital Investments (as defined). Thereafter, all distributions of Cash Flow will be made 85% to the Holders of Interests and 15% to the General Partner and the Associate Limited Partners (collectively); provided, however, that the General Partner and the Associate Limited Partners (collectively) shall be entitled to receive an additional share of Cash Flow otherwise distributable to the Holders of Interests equal to the lesser of an amount equal to 2% of the cumulative gross selling prices of any interests in real property of the Partnership (subject to certain limitations) or 13% of the aggregate distributions of Cash Flow to all parties pursuant to this sentence.\n(15) Subsequent Events\n(a) During February 1994, the Partnership paid a distribution of $2,565,433 to the Limited Partners ($6.35 per Interest) and $142,523 to the General Partner and Associate Limited Partners, collectively.\n(b) During November 1993, the Partnership received a commitment from a lender for a $24 million revolving construction line of credit for the first building and certain amenities within the Partnership's new condominium project on Longboat Key, Florida known as Grand Bay. This note was subsequently executed on January 14, 1994 and bears interest at the lender's prime rate plus 3\/4%, payable monthly. In addition, the Partnership is required to make repayments on the note in accordance with release provisions as set forth in the credit agreement, with any remaining outstanding principal\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED\nbalance payable at maturity on January 14, 1996. The note is secured by a recorded first mortgage on certain real and personal property in Sarasota County, Florida. As of March 15, 1994, approximately $2.6 million was outstanding under this note. The Grand Bay project is planned to consist of six condominium buildings on 24 acres and will offer certain amenities including a recreation facility with a community pool and two tennis courts. The Partnership intends to obtain additional lines of credit prior to the construction of each of the remaining five buildings at Grand Bay. These buildings are planned to be constructed over the next five years with the final building expected to be completed in 1998.\nSCHEDULE X\nARVIDA\/JMB PARTNERS, L.P. (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nSUPPLEMENTARY STATEMENTS OF OPERATIONS INFORMATION\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nCHARGED TO COSTS AND EXPENSES ---------------------------------------- 1993 1992 1991 ------------ ------------ ------------\nDepreciation and amortization . . . . . $6,232,092 7,550,386 7,072,673\nRepairs and maintenance. . . . . . 2,623,072 2,328,918 1,673,475\nProperty taxes, net of amounts capitalized. . . . . . 6,925,925 8,220,342 7,353,574\nAdvertising costs. . . . 5,051,175 5,240,007 7,561,712 ----------- ----------- -----------\n$20,832,264 23,339,653 23,661,434 =========== =========== ===========\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn November 30, 1993, the General Partner of the Partnership approved the engagement of Ernst & Young as the Partnership's independent auditors for the fiscal year ending December 31, 1993 to replace the firm of Price Waterhouse who were dismissed as auditors of the Partnership effective November 30, 1993.\nThe reports of Price Waterhouse on the Partnership's consolidated financial statements for the year ended December 31, 1992 and 1991 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. In connection with the audits of the Partnership's financial statements for the above-mentioned years and in the subsequent interim period, there were no disagreements with Price Waterhouse on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of Price Waterhouse would have caused Price Waterhouse to make reference to the matter in their report. The change in accountants was previously reported in the Partnership's Report on Form 8-K dated December 8, 1993, a copy of which is filed as Exhibit 99.2 to this report, describing the change in the Partnership's independent auditors.\nThere were no changes or disagreements with auditors during 1992.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTOR AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe General Partner of the Partnership is Arvida\/JMB Managers, Inc., a Delaware corporation, all of whose outstanding shares of stock are owned by JMB Holdings Corporation, an Illinois corporation, 75% of the outstanding shares of which are owned by JMB Realty Corporation (\"JMB\"), a Delaware corporation, and the remaining 25% of which are owned by 900 Partner Investments, an Illinois general partnership whose partners include certain officers and directors of JMB and its affiliates. Arvida\/JMB Managers, Inc. was substituted as general partner of the Partnership as a result of a merger on March 30, 1990 of an affiliated corporation that was the then general partner of the Partnership into Arvida\/JMB Managers, Inc., which, as the surviving corporation of such merger, continues as General Partner. All references herein to \"General Partner\" include Arvida\/JMB Managers, Inc. and its predecessor, as appropriate. The General Partner has responsibility for all aspects of the Partnership's operations. Arvida\/JMB Associates, an Illinois general partnership, of which certain officers and affiliates of JMB are partners and Arvida\/JMB Limited Partnership, an Illinois limited partnership, of which Arvida\/JMB Associates is the general partner, are the Associate Limited Partners of the Partnership. Various relationships of the Partnership to the General Partner and its affiliates are described under the caption \"Conflicts of Interest\" at pages 21-24 of the Prospectus, which description is hereby incorporated herein by reference to Exhibit 28.1 of the Partnership's Report on Form 10-K dated March 29, 1993 (File No. 0-16976).\nThe director, executive officers and certain other officers of the General Partner of the Partnership are as follows:\nSERVED IN NAME OFFICE OFFICE SINCE ---- ------ ------------\nJudd D. Malkin Chairman 04\/08\/87 Neil G. Bluhm President 04\/08\/87 Roger E. Hall Vice President 04\/09\/87 Ernest M. Miller, Jr. Vice President 04\/09\/87 H. Rigel Barber Vice President 04\/08\/87 Ira J. Schulman Vice President 04\/09\/87 Gailen J. Hull Vice President 04\/09\/87 Howard Kogen Vice President and Treasurer 04\/08\/87 Gary Nickele Vice President, General Counsel 04\/08\/87 and Director 12\/18\/90 Vincent P. Donahue, Jr. Vice President 04\/09\/87 James D. Motta Vice President 04\/09\/87 John Garrity Vice President 02\/01\/91 John Grab Vice President 04\/09\/87\nThere is no family relationship among any of the foregoing director or officers. The foregoing director has been elected to serve a one-year term until the annual meeting of the General Partner to be held on June 7, 1994. All of the foregoing officers have been elected to serve one-year terms until the first meeting of the Board of Directors held after the annual meeting of the General Partner to be held on June 7, 1994. There are no arrangements or understandings between or among any of said director or officers and any other person pursuant to which any director or officer was selected as such.\nThe foregoing director and certain of the officers are also officers and\/or directors of various affiliated companies, including JMB, which is the corporate general partner of Carlyle Real Estate Limited Partnership-VII (\"Carlyle-VII\"), Carlyle Real Estate Limited Partnership-IX (\"Carlyle-IX\"), Carlyle Real Estate Limited Partnership-X (\"Carlyle-X\"), Carlyle Real Estate Limited Partnership-XI (\"Carlyle-XI\"), Carlyle Real Estate Limited Partner- ship-XII (\"Carlyle-XII\"), Carlyle Real Estate Limited Partnership-XIII (\"Carlyle-XIII\"), Carlyle Real Estate Limited Partnership-XIV (\"Carlyle-XIV\"), Carlyle Real Estate Limited Partnership-XV (\"Carlyle-XV\"), Carlyle Real Estate Limited Partnership-XVI (\"Carlyle-XVI\"), Carlyle Real Estate Limited Partnership-XVII (\"Carlyle-XVII\"), JMB Mortgage Partners, Ltd. (\"Mortgage Partners\"), JMB Mortgage Partners, Ltd.-II (\"Mortgage Partners-II\"), JMB Mortgage Partners, Ltd.-III (\"Mortgage Partners-III\"), JMB Mortgage Partners, Ltd.-IV (\"Mortgage Partners-IV\"), Carlyle Income Plus, Ltd. (\"Carlyle Income Plus\") and Carlyle Income Plus, Ltd.-II (\"Carlyle Income Plus-II\") and the managing general partner of JMB Income Properties, Ltd.-IV (\"JMB Income-IV\"), JMB Income Properties, Ltd.-V (\"JMB Income-V\"), JMB Income Properties, Ltd.-VI (\"JMB Income-VI\"), JMB Income Properties, Ltd.-VII (\"JMB Income-VII\"), JMB Income Properties, Ltd.-VIII (\"JMB Income-VIII\"), JMB Income Properties, Ltd.-IX (\"JMB Income-IX\"), JMB Income Properties, Ltd.-X (\"JMB Income-X\"), JMB Income Properties, Ltd.-XI (\"JMB Income-XI\"), JMB Income Properties, Ltd.-XII (\"JMB Income-XII\") and JMB Income Properties, Ltd.-XIII (\"JMB-XIII\"). Most of the foregoing director and officers are also officers and\/or directors of various affiliated companies of JMB including Arvida\/JMB Managers-II, Inc. (the general partner of Arvida\/JMB Partners, L.P.-II (\"Arvida-II\") and Income Growth Managers, Inc. (the corporate general partner of IDS\/JMB Balanced Income Growth, Ltd. (\"IDS\/BIG\")). The director and most of such officers are also partners, directly or indirectly, of certain partnerships (the \"Associate Partnerships\") which are associate general partners in the following real estate limited partnerships: Carlyle-VII, Carlyle-IX, Carlyle-X, Carlyle-XI, Carlyle-XII, Carlyle-XIII, Carlyle-XIV, Carlyle-XV, Carlyle-XVI, Carlyle-XVII, JMB Income-VI, JMB-VII, JMB Income-VIII, JMB Income-IX, JMB Income-X, JMB Income-XI, JMB Income-XII, JMB Income-XIII, Mortgage Partners, Mortgage Partners-II, Mortgage Partners-III, Mortgage Partners-IV, Carlyle Income Plus, Carlyle Income Plus-II and IDS\/BIG. The following director and officers are partners, indirectly through other partnerships, of one of the Associate Limited Partners of the Partnership and of the Associate Limited Partner of Arvida-II.\nThe business experience during the past five years of the director and such officers of the Corporate General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 56) is Chairman of the Board of JMB, an officer and\/or director of various JMB affiliates and a partner, directly or indirectly, of the Associate Partnerships. He is also an individual general partner of JMB Income Properties-IV and JMB Income Properties-V. Mr. Malkin has been associated with JMB since October, 1969. He is a Certified Public Accountant.\nNeil G. Bluhm (age 56) is President and a director of JMB and an officer and\/or director of various JMB affiliates and a partner, directly or indirectly, of the Associate Partnerships. He is also an individual general partner of JMB Income Properties-IV and JMB Income Properties-V. Mr. Bluhm has been associated with JMB since August, 1970. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nRoger E. Hall (age 62) is Chairman of Arvida. Prior thereto, he was President-Arvida (September, 1987 to January, 1989).\nErnest M. Miller, Jr. (age 51) is President and Chief Executive Officer of Arvida. Prior thereto, he was Executive Vice President and Chief Financial Officer of Arvida (September, 1987 to February, 1989). From February, 1984, Mr. Miller has been Chairman of Wilson Miller Capital Corp., a real estate investment and consulting business.\nH. Rigel Barber (age 45) is Chief Executive Officer and Executive Vice President of JMB, an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Barber has been associated with JMB since March, 1982. He received a J.D. Degree from the Northwestern Law School and is a member of the Bar of the State of Illinois.\nIra J. Schulman (age 42) is Executive Vice President of JMB, an officer of various JMB affiliates and a partner, directly or indirectly, of various Associate Partnerships. He holds a Masters Degree in Business Administration from the University of Pittsburgh.\nGailen J. Hull (age 46) is a Senior Vice President of JMB, an officer of various JMB affiliates and a partner, directly or indirectly, of various Associate Partnerships. Mr. Hull has been associated with JMB since March, 1982. He holds a Masters degree in Business Administration from Northern Illinois University and is a Certified Public Accountant.\nHoward Kogen (age 58) is Senior Vice President and Treasurer of JMB, an officer of various JMB affiliates and a partner, directly or indirectly, of various Associate Partnerships. Mr. Kogen has been associated with JMB since March, 1973. He is a Certified Public Accountant.\nGary Nickele (age 41) is Executive Vice President, Secretary and General Counsel of JMB, an officer of various JMB affiliates and a partner, directly or indirectly, of various Associate Partnerships. Mr. Nickele has been associated with JMB since February, 1984. He holds a J.D. degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nVincent P. Donahue Jr. (age 40) is Vice President of Finance and Chief Financial Officer of Arvida. Prior thereto, he was Vice President- Acquisitions of Arvida from October, 1987 to October, 1990.\nJames D. Motta (age 37) is President-Community Development Division of Arvida. Prior thereto, he was President-Southeast Division of Arvida (July, 1992 to July, 1993), President-South Florida Division of Arvida (January, 1989 to July, 1992) and Vice President and General Manager--Boca Raton of Arvida (September, 1987 to January, 1989).\nJohn R. Grab (age 37) is Vice President and General Manager - Club\/Hotel Operations. Prior thereto, he was Vice President and Project General Manager - - Weston Hills (October 1990 to October 1993), Vice President and Project General Manager - Jacksonville Golf & Country Club (June 1988 to October 1990), and Vice President of Finance - North Florida Division (September 1987 to June 1988). Previously, he was employed by Arvida Corporation, which he joined in December 1981, and was Vice President - Finance and Accounting with Arvida Hospitality Management, Inc. (October 1986 to September 1987). He is a Certified Public Accountant. He received his B.S. in Accounting from St. Leo College.\nJohn M. Garrity (age 47) is Vice President and General Manager - Arvida Homes, with Arvida Company. Prior thereto, he was Vice President of Construction - Arvida Homes (December 1992 to March 1993) and Vice President and Project General Manager - Weston (February 1991 to December 1992). Previously, he was President of The Key Company (September 1988 to February 1991), and Vice President and Market Manager - Tampa (March 1981 to August 1988). He holds a Masters degree in Business Administration from the University of North Carolina.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe officers and the director of the General Partner receive no current or proposed direct remuneration in such capacities from the Partnership. The General Partner and the Associate Limited Partners are entitled to receive a share of cash distributions, when and as cash distributions are made to the Limited Partners, and a share of profits or losses as described under the caption \"Cash Distributions and Allocations of Profit and Losses\" at pages 61 to 64 of the Prospectus and at pages A-9 to A-16 of the Partnership Agreement, which description incorporated herein by reference to Exhibits 28.1 and 3., respectively, to the Partnership's Report for December 31, 1992 on Form 10-K dated March 29, 193 (File No. 0-16976). Reference is also made to Notes 1 and 14 for a description of such distributions and allocations. The General Partner and the Associate Limited Partners did not receive any cash distributions in 1993. Under certain circumstances they will be entitled to approximately $810,000 which was deferred in 1990. Such payment is subject to certain restrictions contained in the Partnership Agreement and the Partnership's credit facility. Pursuant to the Partnership Agreement, the General Partner and Associate Limited Partners were allocated profits for tax purposes for 1993 of approximately $19,280. Reference is made to Note 14 for further discussion of this allocation.\nThe Partnership is permitted to engage in various transactions involving the General Partner and its affiliates, as described under the captions \"Management of the Partnership\" at pages 56 to 59, \"Conflicts of Interest\" at pages 21-24 of the Prospectus and \"Rights, Powers and Duties of the General Partner\" at pages A-16 to A-28 of the Partnership Agreement, which descriptions are hereby incorporated herein by reference to Exhibits 28.1 and 3., respectively, to the Partnership's Report for December 31, 1992 on Form 10-K dated March 29, 1993 (File No. 0-16976). The relationships of the General Partner (and its director and executive officers and certain other officers) and its affiliates to the Partnership are set forth above in Item 10.\nArvida may be reimbursed fully for all of its out-of-pocket expenditures (including salary and salary-related expenses) incurred while supervising the development and management of the Partnership's properties and other operations, subject to the limitation that such reimbursement may not exceed 5% of the aggregate gross revenues from the business of the Partnership. In 1993, such expenses were approximately $6,686,100, of which approximately $80,000 was unpaid as of December 31, 1993.\nThe Partnership and Arvida\/JMB Partners, L.P.-II (a publicly-held limited partnership affiliated with the General Partner) each employ project related and administrative personnel who perform services on behalf of both partnerships. In addition, certain out-of-pocket expenditures related to such services and other general and administrative expenses, including certain insurance premiums, are incurred and allocated to each partnership as appropriate. The Partnership receives reimbursements from or reimburses Arvida\/JMB Partners, L.P.-II for such costs (including salary and salary- related expenses). The Partnership was entitled to receive approximately $2,497,400 from Arvida\/JMB Partners, L.P.-II for such costs and services incurred in 1993, approximately $26,100 of which was outstanding as of December 31, 1993. In addition, the Partnership was obligated to reimburse Arvida\/JMB Partners, L.P.-II approximately $1,234,300 for the year ended December 31, 1993, all of which was paid at December 31, 1993.\nJMB Insurance Agency, Inc., an affiliate of the General Partner, earned and received insurance brokerage commissions in 1993 of approximately $288,000 in connection with providing insurance coverage for certain of the properties of the Partnership, all of which were paid as of December 31, 1993. Such commissions are at rates set by insurance companies for the classes of coverage provided.\nThe General Partner of the Partnership or its affiliates are entitled to property management fees and may be reimbursed for their direct expenses or out-of-pocket expenses relating to the administration of the Partnership and the acquisition, development, ownership, supervision, and operation of the Partnership assets. In 1993, the General Partner of the Partnership or its affiliates were due reimbursement for such direct or out-of-pocket expenses and property management fees in the amount of approximately $173,600, approximately $165,200 of which was paid as of December 31, 1993. Additionally, the General Partner and its affiliates are entitled to reimbursements for legal and accounting services. Such costs for 1993 were approximately $93,700, none of which was paid as of December 31, 1993.\nThe Partnership was also entitled to receive reimbursements from affiliates of the General Partner for certain general and administrative expenses including, and without limitation, salary and salary-related expenses relating to work performed by employees of the Partnership and certain out-of- pocket expenditures incurred on behalf of such affiliates. The Partnership was owed approximately $171,000 for such costs and services incurred in 1993, approximately $146,300 of which was received as of December 31, 1993.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) No person or group is known by the Partnership to own beneficially more than 5% of the outstanding Interests of the Partnership.\n(b) The General Partner and its officers and directors own the following Interests of the Partnership:\nNAME OF AMOUNT AND NATURE BENEFICIAL OF BENEFICIAL PERCENT TITLE OF CLASS OWNER OWNERSHIP OF CLASS\n- -------------- ---------- ----------------- --------\nLimited Partnership General Partner 125 Interests Less Interests and its officers than 1% and director as a group - ---------------\nNo officer or director of the General Partner of the Partnership possesses a right to acquire beneficial ownership of Interests of the Partnership.\nAll of the outstanding shares of the General Partner of the Partnership are owned by affiliates of its officers and director as set forth above in Item 10.\n(c) There exists no arrangement, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the General Partner, affiliates or their management other than those described in Items 10, 11 and 12 above. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n1. Financial Statements. (See Index to Financial Statements filed with this annual report on Form 10-K).\n2. Exhibits.\n3. Amended and Restated Agreement of Limited Partnership.**\n4.0 Assignment Agreement by and among the General Partner, the Initial Limited Partner and the Partnership.**\n4.1 Amended and Restated Credit Agreement dated October 7, 1992, among Arvida\/JMB Partners, L.P., Arvida\/JMB Partners, Southeast Florida Holdings, Inc., Center Office Partners, Center Retail Partners, Center Hotel Limited Partnership, Weston Hills Country Club Limited Partnership and Chemical Bank and Nationsbank of Florida, N.A. is herein incorporated by reference to Exhibit No. 4.4 to the Partnership's Report on Form 10Q (File number 0-16976) dated November 11, 1992.\n4.2 Security Agreement dated as of October 7, 1992 made by Arvida\/JMB Partners, L.P., Arvida\/JMB Partners, Southeast Florida Holdings, Inc., Center Office Partners, Center Retail Partners, Center Hotel Limited Partnership and Weston Hills Country Club Limited Partnership (as \"grantors\") in favor of Chemical Bank and Nationsbank of Florida, N.A. (as \"lenders\") is herein incorporated by reference to Exhibit No. 4.5 the Partnership's Report on Form 10Q (File number 0-16976) dated November 11, 1992.\n4.3 Pledge Agreement dated as of October 7, 1992 among Arvida\/JMB Partners, L.P., Arvida\/JMB Partners, Southeast Florida Holdings, Inc., Center Office Partners, Center Retail Partners, Center Hotel Limited Partnership and Weston Hills Country Club Limited Partnership (as \"pledgors\") and Chemical Bank and Nationsbank of Florida, N.A. (as \"lenders\") is herein incorporated by reference to Exhibit No. 4.6 the Partnership's Report on Form 10Q (File number 0-16976) dated November 11, 1992.\n4.4 Various mortgages and other security interests dated October 7, 1992 related to the assets of Arvida\/JMB Partners, Center Office Partners, Center Retail Partners, Center Hotel Limited Partnership, Weston Hills Country Club Limited Partnership which secure loans under the Amended and Restated Credit Agreement referred to in Exhibit 4.1 are herein incorporated by reference to Exhibit No. 4.7 the Partnership's Report on Form 10Q (File number 0-16976) dated November 11, 1992.\n4.7. $24,000,000 Consolidated Revolving Promissory Note dated January 14, 1994 by and between Arvida Grand Bay Limited Partnership-I, Arvida Grand Bay Limited Partnership-II, Arvida Grand Bay Limited Partnership-III, Arvida Grand Bay Limited Partnership-IV, Arvida Grand Bay Limited Partnership-V and Arvida Grand Bay Limited Partnership-VI and Barnett Bank of Broward County, N.A. is filed herewith.\n4.8. Amended and Restated Mortgage and Security Agreement dated January 14, 1994 by and between Arvida Grand Bay Limited Partnership-I, Arvida Grand Bay Limited Partnership-II, Arvida Grand Bay Limited Partnership-III, Arvida Grand Bay Limited Partnership-IV, Arvida Grand Bay Limited Partnership-V, Arvida Grand Bay Limited Partnership-VI and Arvida Grand Bay Properties, Inc. and Barnett Bank of Broward County, N.A. is filed herewith.\n4.9. Construction Loan Agreement dated January 14, 1994 by and between Arvida Grand Bay Limited Partnership-I and Arvida Grand Bay Properties, Inc. and Barnett Bank of Broward County, N.A. is filed herewith.\n10.1. Agreement between the Partnership and The Walt Disney Company dated January 29, 1987 is hereby incorporated by reference to Exhibit 10.2 to the Partnership's Registration Statement on Form S-1 (File No. 33-14091) under the Securities Act of 1933 filed on May 7, 1987.\n10.2. Management, Advisory and Supervisory Agreement is hereby incorporated by reference to Exhibit 10.2 to the Partnership's Form 10- K (File No. 0-16976) dated March 27, 1991.\n10.3. Letter Agreement, dated as of September 10, 1987, between the Partnership and The Walt Disney Company, together with exhibits and related documents.*\n10.4. Joint Venture Agreement dated as of September 10, 1987, of Arvida\/JMB Partners, a Florida general partnership. *\n21. Subsidiaries of the Registrant.\n99.1. Pages 21-24, 56-59, 61-64, A-9 to A-28, A-31 to A-33, and B-2 of the Partnership dated September 16, 1987 (relating to SEC Registration Statement File No. 33-14091).*\n99.2. The Registrant's Form 8-K Report (File No. 0-16976) dated December 6, 1993 is incorporated by reference.\n* Previously filed with the Securities and Exchange Commission as Exhibits 10.4 and 10.5, respectively, to the Partnership's Registration Statement (as amended) on Form S-1 (File No. 33-14091) under the Securities Act of 1933 filed on September 11, 1987 and incorporated herein by reference.\n** Previously filed with the Securities and Exchange Commission as Exhibits 3 and 4, respectively, to the Partnership's Form 10-K Report (File No. 0-16976) filed on March 27, 1990 and hereby incorporated herein by reference.\nThe Partnership agrees to furnish to the Securities and Exchange Commission upon request a copy of each instrument with respect to long-term indebtedness of the Partnership and its consolidated subsidiaries, the authorized principal amount of which is 10% or less than the total assets of the Partnership and its subsidiaries on a consolidated basis.\n(b) Reports on Form 8-K\nThe Partnership's report dated December 6, 1993 describing the change in the Partnership's independent auditors for the year ended December 31, 1993. No financial statements were required to be filed therewith.\nNo annual report or proxy material for the fiscal year 1993 has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nARVIDA\/JMB PARTNERS, L.P.\nBY: Arvida\/JMB Managers, Inc. (The General Partner)\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 25, 1994\nPursuant 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 and on the dates indicated.\nBY: Arvida\/JMB Managers, Inc. (The General Partner)\nNEIL G. BLUHM By: Neil G. Bluhm, President (Principal Executive Officer) Date: March 25, 1994\nJUDD D. MALKIN By: Judd D. Malkin, Chairman (Principal Financial Officer) Date: March 25, 1994\nGARY NICKELE By: Gary Nickele, Vice President and Director Date: March 25, 1994\nGAILEN J. HULL By: Gailen J. Hull, Vice President (Principal Accounting Officer) Date: March 25, 1994","section_15":""}
{"filename":"107819_1993.txt","cik":"107819","year":"1993","section_1":"Item 1. BUSINESS\n(a) General\nWisconsin Gas Company (the \"Company\" or \"Wisconsin Gas\") is a Wisconsin corporation and a wholly-owned subsidiary of WICOR, Inc. (\"WICOR\") and maintains its principal executive offices in Milwaukee, Wisconsin. The Company is the largest natural gas distribution public utility in Wisconsin, where all of its business is conducted. At December 31, 1993, Wisconsin Gas distributed gas to approximately 485,000 residential, commercial and industrial customers in 487 communities throughout Wisconsin with an estimated population of 1,867,000 based on the State of Wisconsin's estimates for 1993. The Company is subject to the jurisdiction of the Public Service Commission of Wisconsin (\"PSCW\") as to various phases of its operations, including rates, service and issuance of securities.\nWisconsin Gas' business is highly seasonal, particularly as to residential and commercial sales for space heating purposes, with a substantial portion of its sales occurring in the winter heating season. The following table sets forth the volumes of natural gas delivered by Wisconsin Gas to its customers.\nThe volumes shown as transported represent customer-owned gas that was delivered by Wisconsin Gas to such customers. The remaining volumes represent quantities sold to customers by the Company.\n(b) Gas Supply and Pipeline Capacity\n(1) General\nIn recent years, the natural gas industry has undergone structural changes designed to increase competition. In 1992, the Federal Energy Regulatory Commission (\"FERC\") issued Order No. 636 which fundamentally restructured the interstate natural gas pipeline industry. Prior to Order No. 636, the pipelines serving Wisconsin Gas were major sellers of gas to Wisconsin Gas. They sold gas on a \"bundled\" or delivered-to-Wisconsin basis. Under Order No. 636, the pipelines are required to \"unbundle\" the sale of gas from the related transportation service. Consequently, pipelines may no longer provide the delivered-to-Wisconsin gas sales service. Rather, they must sell gas at or near the point of production in competition with other gas sellers. Under Order No. 636, purchasers such as Wisconsin Gas contract separately with one or more sellers for gas supply and with pipelines for capacity to move the gas to markets or into market area storage for future delivery. In the opinion of management, Order No. 636 will not have a material impact on Wisconsin Gas' earnings.\nThe Company's principal pipeline suppliers, ANR Pipeline Company (\"ANR\") and Northern Natural Gas Company (\"NNG\"), completed the transition to unbundled service on November 1, 1993. Consequently, Wisconsin Gas has replaced all of its \"bundled\" pipeline services with \"unbundled\" firm pipeline transportation and storage services and long-term contracts with producers and marketers for firm gas supply. Thus, 1993 was a transition year in which Wisconsin Gas purchased gas supply and capacity under interim arrangements with pipeline suppliers for much of the year and under the Order No. 636 restructured regime described above for the last two months of the year. The following table sets forth the sources and volumes of gas purchased by Wisconsin Gas and volumes of customer-owned gas transported by Wisconsin Gas.\n*One therm equals 100,000 BTU's.\n(2) Pipeline Capacity\nInterstate pipelines serving Wisconsin originate in three major gas producing areas of North America: the traditional Oklahoma and Texas basins; the Gulf of Mexico off-shore from Texas and Louisiana and the adjacent on-shore producing areas of those states and western Canada. Wisconsin Gas has contracted for long-term firm capacity on a relatively equal basis from each of these areas. This strategy reflects management's belief that overall supply security is enhanced by geographic diversification of the Company's supply portfolio and that Canada represents an important long-term source of reliable, competitively priced gas.\nBecause of the seasonal variations in gas usage in Wisconsin, Wisconsin Gas has also contracted with ANR and NNG for substantial underground storage capacity, primarily in Michigan. There is no known underground storage capability in Wisconsin. Storage enables Wisconsin Gas to optimize its overall gas supply and capacity costs. In summer, gas in excess of market demand is transported into the storage fields, and in winter, gas is withdrawn from storage and combined with gas purchased in or near the production areas (\"flowing gas\") to meet the increased winter market demand. As a result, Wisconsin Gas can contract for less pipeline capacity than would otherwise be necessary, and it can purchase gas on a more uniform daily basis from suppliers year-around. Each of these capabilities enables Wisconsin Gas to reduce its overall costs.\nWisconsin Gas' firm winter daily transportation and storage capacity entitlements from pipelines under long-term contracts are set forth below.\nMaximum (Thousands Pipeline of Therms*) --------------- ----------- ANR Mainline 3,175 Storage 4,996 NNG Mainline 1,226 Storage 149 Viking Mainline 64 ----------- Total 9,610\n*One therm equals 100,000 BTU's.\n(3) Long-Term Gas Supply\nWisconsin Gas has long-term firm contracts with approximately 30 gas suppliers for gas produced in each of the three producing areas discussed above. The following table sets forth Wisconsin Gas' winter season maximum daily firm total gas supply.\nMaximum Daily (Thousands of Therms*) ------------ Domestic flowing gas 2,259 Canadian flowing gas 1,396 Storage withdrawals 5,157 ------------ Total 8,812\n*One therm equal 100,000 BTU's.\n(4) Spot Market Gas Supply\nWisconsin Gas expects to continue to make gas purchases in the 30-day spot market as price and other circumstances dictate. The Company has purchased spot market gas since 1985 and has supply relationships with a number of sellers from whom it purchases spot gas.\n(c) Employees\nThe Company had 1,353 full-time equivalent active employees at December 31, 1993.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nWisconsin Gas owns a distribution system which, on Decem- ber 31, 1993, included approximately 7,800 miles of distribution and transmission mains, 399,000 services and 488,000 active meters. The Company's distribution system consists almost entirely of plastic and coated steel pipe. The Company owns its main office building in Milwaukee, office buildings in certain other communities in which it serves, gas regulating and metering stations, peaking facilities and its major service centers, including garage and warehouse facilities. The Milwaukee and other office buildings, the principal service facilities and the gas distribution systems of Wisconsin Gas are owned by it in fee subject to the lien of its Indenture of Mortgage and Deed of Trust, dated as of November 1, 1950, under which its first mortgage bonds are issued, and to permissible encumbrances as therein defined.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings pending, other than ordinary routine litigation incidental to the Company's business, to which the Company is a party, except as discussed below. There are no material legal proceedings to which any officer or director is a party or has a material interest adverse to the Company's. There are no material administrative or judicial proceedings arising under environmental quality or civil rights statutes pending or known to be contemplated by governmental agencies to which the Company is or would be a party.\nWisconsin Gas has identified two previously owned sites on which it operated manufactured gas plants that are of environmental concern. Such plants ceased operations prior to the mid-1950's. Wisconsin Gas has engaged an environmental consultant to help determine the nature and extent of the contamination at these sites. Based on the test results obtained and the possible remediation alternatives available, the Company has estimated that cleanup costs could range from $22 million to $75 million. As of December 31, 1993, the Company has accrued $40 million for cleanup costs in addition to $1.6 million of costs already incurred. These estimates are based on current undiscounted costs. It should also be noted that the numerous assumptions such as the type and extent of contamination, available remediation techniques, and regulatory requirements which are used in developing these estimates are subject to change as new information becomes available. Any such changes in assumptions could have a significant impact on the potential liability.\nA formal remediation plan is currently being developed for presentation to the Wisconsin Department of Natural Resources (\"DNR\"). Following plan approval and pilot studies, remediation will commence. Barring unforeseen delays, expenditures by Wisconsin Gas on this remediation work will commence in 1994 and increase in future years as plan approvals are obtained. Expenditures over the next three years are expected to total approximately $20 million. Although most of the work and costs will be incurred in the first few years of the plan, monitoring of the sites and other necessary actions may last up to 30 years.\nWisconsin Gas is pursuing recovery of these costs from insurance carriers. Any amounts not recoverable from insurance carriers will be allowed full recovery in rates, based on recent PSCW orders. Accordingly, the accrual has been offset by a deferred charge to a regulatory asset. Certain related investigation costs incurred to date are currently being recovered in utility rates. However, any incurred costs not yet recovered in rates are not allowed by the PSCW to earn a return. As of December 31, 1993, $1.6 million of such costs have been incurred.\nIn 1992, the owner of a portion of one of the properties on which manufactured gas operations were conducted commenced suit in Federal district court against Wisconsin Gas. The suit, which was settled in 1993, generally sought indemnity and contribution under Federal statutes and alleges that Wisconsin Gas is liable for remediating the environmental conditions found to be caused by any releases of hazardous substances from the gasification activities at the site. Under the settlement, Wisconsin Gas agreed to indemnify the owner from any remediation costs attributable to the release of hazardous substances from the gasification activities on the site. In the judgment of management, the suit will not materially change Wisconsin Gas' responsibility as required by Federal and State statutes for remediating the environmental conditions found to be caused by any releases of hazardous substances from the gasification activities at the site, which ceased about 40 years ago, the cost of any remediation actions that may be required, or its ability to recover such costs in its rates or from insurers.\nWisconsin Gas also owns a service center that is constructed on a site that was previously owned by the City of Milwaukee and was used by the City as a public dump site. The Company has conducted a site assessment at the request of the DNR and has sent the report of its assessment to the DNR. Management cannot predict whether or not the DNR will require any remediation action, nor the extent or cost of any remediation actions that may be required. In the judgment of management, any remediation costs incurred by the Company will be recoverable from the City of Milwaukee or in Wisconsin Gas' rates.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOmitted pursuant to General Instruction J (2) (c).\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWICOR owns all the issued and outstanding common stock of the Company. The Wisconsin Business Corporation Law, the Company's Indenture of Mortgage and Deed of Trust and the indentures supplemental thereto, and the agreements under which debt is outstanding each contain certain restrictions on the payment of dividends on common stock. By order of the PSCW, Wisconsin Gas is generally permitted to pay dividends up to the amount projected in its rate case. The Company may pay dividends in excess of the projected dividend amount so long as payment will not caused the equity ratio to fall below 48.43%. If payment of projected dividends would cause its equity ratio to fall below 43% or if payment of additional dividends would cause its equity ratio to fall below 48.43%, Wisconsin Gas must obtain PSCW approval to pay such dividends. Wisconsin Gas has projected the payment of $16 million of dividends during the 12 months ending October 31, 1994. See Note 6 to Notes to Financial Statements. The PSCW desires Wisconsin Gas to target its common equity level at 43% to 50% of total capitalization. For the year ended December 31, 1993, the Company's average common equity level was 45.16%.\nThe Company paid cash dividends of $16,000,000 and $14,000,000 on common stock to WICOR in 1993 and 1992, respectively.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nOmitted pursuant to General Instruction J(2)(a).\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nReference is made to \"Financial Review\" included in Exhibit 13, which, insofar as it pertains to the Company, is hereby incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements for the Company together with the report of independent public accountants are included in Part IV of this report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no change in or disagreement with the Company's independent auditors on any matter of accounting principles or practices or financial statement disclosure required to be reported pursuant to this item.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOmitted pursuant to General Instruction J(2)(c).\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nOmitted pursuant to General Instruction J(2)(c).\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOmitted pursuant to General Instruction J(2)(c).\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOmitted pursuant to General Instruction J(2)(c).\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of the report:\n1. All financial statements and Report of Independent Public Accountants.\nStatement of Income.\nBalance Sheet.\nStatement of Cash Flows.\nStatement of Common Equity.\nStatement of Capitalization.\nNotes to Financial Statements.\n2. Financial statement schedules.\nSchedule V -- Property, Plant and Equipment for the Years Ended December 31, 1993, 1992 and 1991.\nSchedule VI -- Accumulated Depreciation for the Years Ended December 31, 1993, 1992 and 1991.\nSchedule VIII -- Valuation and Qualifying Accounts for the Years Ended December 31, 1993, 1992 and 1991.\nSchedule IX -- Short-term Borrowings for the Years Ended December 31, 1993, 1992 and 1991.\nSchedule X -- Supplemental Income Statement Information for the Years Ended December 31, 1993, 1992 and 1991.\nSchedules other than those referred to above have been omitted as not applicable or not required.\n3. Exhibits\n3.1 Wisconsin Gas Company Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company's Form 10-K Annual Report for 1988).\n3.2 Wisconsin Gas Company By-laws, as amended.\n4.1 Indenture of Mortgage and Deed of Trust dated as of November 1, 1950, between Milwaukee Gas Light Company and Mellon National Bank and Trust Company and D. A. Hazlett, Trustees (incorporated by reference to Exhibit 7-E to the Company's Registration Statement No. 2-8631).\n4.2 Eleventh Supplemental Indenture dated as of February 15, 1982, between Wisconsin Gas Company and Mellon Bank, N.A., and N. R. Smith, Trustees (incorporated by reference to Exhibit 4.5 to the Company's Form S- 3 Registration Statement No. 33-43729).\n4.3 Bond Purchase Agreement dated December 31, 1981, between Wisconsin Gas Company and Teachers Insurance and Annuity Association of America relating to the issuance and sale of $30,000,000 principal amount of First Mortgage Bonds, Adjustable Rate Series due 2002 (incorporated by reference to Exhibit 4-6 to the Company's Form S-3 Registration Statement No. 33-43729).\n4.4 Indenture dated as of September 1, 1990, between Wisconsin Gas Company and First Wisconsin Trust Company, Trustee (incorporated by reference to Exhibit 4.11 to the Company's Form S-3 Registration Statement No. 33-36639).\n4.5 Officers' Certificate dated as of November 28, 1990, setting forth the terms of the Company's 9-1\/8% Notes due 1997 (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K Current Report for November 30, 1990).\n4.6 Officers' Certificate dated as of November 19, 1991, setting forth the terms of Wisconsin Gas Company's 7-1\/2% Notes due 1998 (incorporated by reference to Exhibit 4.1 to Wisconsin Gas Company's Form 8-K Current Report for November 19, 1991).\n4.7 Officers' Certificate, dated as of September 15, 1993, setting forth the terms of the Company's 6.60% debentures due 2013 (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K Current Report for September, 1993).\n4.8 Revolving Credit and Term Loan Agreement dated as of March 29, 1993, among Wisconsin Gas Company and the Bank of New York, Citibank, N.A., Firstar Bank of Milwaukee, N. A. Harris Trust & Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q dated as of August 9, 1993).\n4.9 Loan Agreement dated as of November 4, 1991, by and among M&I Marshall & Ilsley Bank, Wisconsin Gas Company Employee's Savings Plans Trust and WICOR, Inc. (incorporated by reference to Exhibit 4.16 to the Company's Form 10-K Annual Report for 1991).\n10.1 Service Agreement dated as of January 1, 1988, among WICOR, Inc., Wisconsin Gas Company, Sta-Rite Industries, Inc. and WEXCO of Delaware, Inc. (incorporated by reference to Exhibit 10.1 the Company's Form 10-K Annual Report for 1988).\n10.2# WICOR, Inc. 1987 Stock Option Plan, as amended (incorporated by reference to Exhibit 4.1 to the WICOR, Inc. Form S-8 Registration Statement No. 33- 67134).\n10.3# Forms of nonstatutory stock option agreement used in connection with the WICOR, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10.20 to the Company's Form 10-K Annual Report for 1991).\n10.4# WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.1 to WICOR, Inc's Form S-8 Registration No. 33-67132).\n10.5# Form of nonstatutory stock agreement used in conjunction with the WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.2 to WICOR, Inc.'s Form S-8 Registration No. 37-67132).\n10.6# Wisconsin Gas Company Principal Officers' Supplemental Retirement Income Program.\n10.7# Wisconsin Gas Company 1994 Officers' Incentive Compensation Plan.\n10.8# Wisconsin Gas Company Officers' Medical Expense Reimbursement Plan (incorporated by reference to Exhibit 10.22 to the Company's Form 10-K Annual Report in 1992).\n10.9# Wisconsin Gas Company Group Travel Accident Plan (incorporated by reference to Exhibit 10.23 to the Company's Form 10-K Annual Report for 1992).\n10.10# Form of Deferred Compensation Agreement between Wisconsin Gas Company and certain of its officers (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1991).\n10.11# WICOR, Inc. Retirement Plan for Directors, as amended (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1992).\n13 \"Financial Review\" portions of WICOR, Inc. 1993 Annual Report to Shareholders.\n(b) Reports on Form 8-K.\nNo Form 8-K Current Report was filed in the fourth quarter of 1993.\n# Indicates a plan under which compensation is paid or payable to directors or executive officers of the Company. SIGNATURES\nPursuant 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.\nWISCONSIN GAS COMPANY\nDate: March 29, 1994 By JOSEPH P. WENZLER ----------------------- Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on the succeeding pages by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nWISCONSIN GAS COMPANY\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Wisconsin Gas Company:\nWe have audited the accompanying balance sheet and statement of capitalization of WISCONSIN GAS COMPANY (a Wisconsin corporation and a wholly owned subsidiary of WICOR, Inc.) as of December 31, 1993 and 1992, and the related statements of income, common equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Wisconsin Gas Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Notes 5 and 10 to Wisconsin Gas Company's Financial Statements, effective January 1, 1992, Wisconsin Gas Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Supplemental Schedules V, VI, VIII, IX, and X are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nMilwaukee, Wisconsin, February 11, 1994.\ng. Reclassifications\nCertain prior year financial statement amounts have been reclassified to conform to their current year presentation.\n2. Short-Term Borrowings\nAs of December 31, 1993, Wisconsin Gas had lines of credit available from banks of $110.0 million. At December 31, 1993, $108.0 million of commercial paper was outstanding at a weighted average interest rate of 3.3%. At December 31, 1992, $49.0 million of commercial paper was outstanding at a weighted average interest rate of 3.6%. These borrowing arrangements may require the maintenance of average compensating balances, which are generally satisfied by balances maintained for normal business operations, and which may be withdrawn at any time. 3. Long-Term Debt\nIn September 1993, Wisconsin Gas issued $45 million of 6.6% Notes due in 2013, the proceeds of which were used to refinance $45 million of outstanding higher cost first mortgage bonds due in 1994 and 1995. In November, 1991, Wisconsin Gas issued $40 million of 7-1\/2% Notes due 1998. A portion of the proceeds was used to redeem the remaining $10.4 million of 6-5\/8% First Mortgage Bonds at their maturity dates. Substantially all property and plant is subject to a first mortgage lien. Maturities and sinking fund requirements during the succeeding five years on all long-term debt are $2.0 million, $2.0 million, $2.0 million, $52.0 million and $42.0 million in 1994, 1995, 1996, 1997 and 1998, respectively.\n4. Preferred Stock\nAuthorized preferred stock consists of 1.5 million shares of cumulative preferred stock, without par; as of December 31, 1993 and 1992 no such shares were issued or outstanding.\n5. Income Taxes\nIn the fourth quarter of 1992, Wisconsin Gas adopted SFAS No. 109, \"Accounting for Income Taxes\", retroactive to January 1, 1992. Under the liability method prescribed by SFAS No. 109, deferred taxes are provided based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. Changes in Wisconsin Gas' deferred income taxes arising from the adoption represent amounts recoverable or refundable through future rates and have been recorded as regulatory assets totalling $4.6 million and regulatory liabilities totalling $29.7 million on the balance sheet for 1992. Prior years' financial statements have not been restated to apply the provisions of SFAS No. 109.\nThe current and deferred components of income tax expense are as follows:\nThe provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following differences:\n6. Restrictions\nA November 1993 PSCW rate order set an equity range of 43% to 50% and also require Wisconsin Gas to request PSCW approval prior to the payment of dividends on its common stock to WICOR if the payment would reduce its common equity (net assets) below 43% of total capitalization (including short-term debt). Under this requirement, $8.1 million of Wisconsin Gas' net assets at December 31, 1993, plus future earnings, were available for such dividends without PSCW approval. In addition, the PSCW imposed certain limitations on the ability of Wisconsin Gas to pay dividends to WICOR in excess of the level indicated in the projected test year if such dividends would dilute Wisconsin Gas' total equity below 48.43% of its total capitalization. The utility dividend payout indicated in the projected test year ending October 31, 1994 is $16 million, of which $4 million was paid in November, 1993.\n7. Commitments and Contingencies\nCertain commitments have been made in connection with 1994 capital expenditures. Wisconsin Gas capital expenditures for 1994 are estimated at $57.4 million. Wisconsin Gas has variable-term contracts with its interstate pipelines and gas suppliers to purchase transportation capacity and natural gas. PGA provisions permit the recovery of actual purchased capacity and gas costs incurred. Wisconsin Gas has identified two previously owned sites on which it operated manufactured gas plants that are of environmental concern. Such plants ceased operations prior to the mid-1950s. Wisconsin Gas has engaged an environmental consultant to help determine the nature and extent of the contamination at these sites. Based on the test results obtained and the possible remediation alternatives available, the Company has estimated that cleanup costs could range from $22 million to $75 million. As of December 31, 1993 the Company has accrued $40 million for cleanup costs in addition to $1.6 million of costs already incurred. These estimates are based on current undiscounted costs. It should also be noted that the numerous assumptions such as the type and extent of contamination, available remediation techniques and regulatory requirements which are used in developing these estimates are subject to change as new information becomes available. Any such changes in assumptions could have a significant impact on the potential liability. A formal remediation plan is being developed for presentation to the Wisconsin Department of Natural Resources. Following plan approval and pilot studies, remediation work will commence. Barring unforeseen delays, expenditures by Wisconsin Gas on this remediation will commence in 1994 and increase in future years as plan approvals are obtained. Expenditures over the next three years are expected to total approximately $20 million. Although most of the work and costs will be incurred in the first few years of the plan, monitoring of the sites and other necessary techniques may last up to 30 years. Wisconsin Gas is pursuing recovery of these costs from insurance carriers. Any amounts not recoverable from insurance carriers will be allowed full recovery in rates based on recent PSCW orders. Accordingly, the accrual has been offset by a deferred charge to a regulatory asset. Certain related investigation costs incurred to date are currently being recovered in utility rates. However, any incurred costs not yet recovered in rates are not allowed by the PSCW to earn a return. As of December 31, 1993, $1.6 million of such costs have been incurred. The Company is party to various legal proceedings arising in the ordinary course of business which are not expected to have a material effect on the financial statements of the Company. 8. FERC Order No. 636\nOn April 8, 1992, the FERC issued Order No. 636 which restructured the interstate natural gas pipeline business. Pipeline suppliers will be allowed to recover significant transition costs from Wisconsin Gas necessary to implement \"unbundled\" services such that gas supplies would be sold separately from interstate transportation services. Wisconsin Gas' liability for certain of these costs is being contested at FERC and in court. The extent of this future liability is not estimable at this time due to a number of factors including the future cost of gas and the outcome of ongoing litigation. However, on the basis of previous PSCW ratemaking relative to the recovery of gas purchased and related costs, Wisconsin Gas anticipates that pipeline transition cost billings will also be recoverable from ratepayers.\n9. Common Stock and Other Paid-In Capital\nDuring the first, third and fourth quarters of 1993, WICOR invested $2 million, $8 million and $2 million, respectively, in Wisconsin Gas. In the first and third quarters of 1992, WICOR invested $5 million and $10 million, respectively, in Wisconsin Gas.\n10. Benefit Plans\na. Pension Plans\nWisconsin Gas has non-contributory pension plans which cover substantially all employees and include benefits based on levels of compensation and years of service. Employer contributions and funding policies are consistent with funding requirements of Federal law and regulations. Commencing on November 1, 1992, Wisconsin Gas pension costs or credits are calculated in accordance with SFAS No. 87 and are recoverable from or refunded to customers. Prior to this date, pension costs were recoverable in rates as funded.\nThe following table sets forth the funded status of pension plans at December 31, 1993 and 1992:\nThe weighted average discount rate assumptions used in determining the actuarial present value of the projected benefit obligation were 7.5%, 7.75% and 7.75% for 1993, 1992 and 1991, respectively. For 1991 through 1993, the expected long-term rate of return on assets and long-term rate of compensation growth were 8.0% and 6.0%, respectively.\nNet pension costs include the following (income) expense:\nThe following table sets forth the plans' funded status, reconciled with amounts recognized in the Company's Statement of Financial Position at December 31, 1993 and 1992. The Company funds its postretirement benefit plans based on the maximum tax deductible amount.\nThe postretirement benefit cost components for 1993 were calculated assuming health care cost trend rates beginning at 11% in 1993 and decreasing to 6% in 25 years. The health care cost trend rate has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO as of December 31, 1993 by $13.2 million and the aggregate of the service and interest cost components of postretirement expense by $1.8 million. The assumed discount rate used in determining the actuarial present value of the accumulated postretirement benefit obligation was 7.5% and 7.75% in 1993 and 1992, respectively. Plan assets are primarily invested in common stock and fixed income securities.\nc. Retirement Savings Plans\nWisconsin Gas maintains various employee saving plans including 401(k) plans which provide employees a mechanism to contribute amounts up to 16% of their compensation for the year. Company matching contributions may be made up to 5% of eligible compensation including 1% for the Employee Stock Ownership Plan (ESOP). Total contributions were $1.3 million, $1.2 million and $.9 million in 1993, 1992 and 1991, respectively.\nd. Employee Stock Ownership Plan\nIn November 1991 WICOR established an ESOP covering non-union employees of Wisconsin Gas. The ESOP funds employee benefits of up to 1% of compensation with WICOR common stock distributed through the ESOP. The ESOP used the proceeds from a $10 million, 3-year adjustable rate loan with a 3.98% interest rate at December 31, 1993, guaranteed by WICOR, to purchase 431,266 shares of original issue WICOR common stock. Because WICOR has guaranteed the loan, the unpaid balance is shown as long-term debt with a like amount of unearned compensation being recorded as a reduction of common equity on WICOR's balance sheet. The ESOP trustee is repaying the $10 million loan with dividends paid on shares of WICOR common stock in the ESOP and with Wisconsin Gas contributions to the ESOP. e. Postemployment Benefit Plans\nThe FASB has issued a new statement SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" to be adopted no later than January 1, 1994, which requires accrual for all other postemployment benefits. In management's opinion, any unrecorded liabilities are expected to be recoverable in future rates and are not significant.\n11. Fair Value of Financial Instruments\nThe fair value of Wisconsin Gas's long-term debt is estimated based on the quoted market prices of U.S. Treasury issues having a similar term to maturity, adjusted for the Company's bond rating and the present value of future cash flows. Because Wisconsin Gas operates in a regulated environment, WICOR shareholders would probably not be affected by realization of gains or losses on extinguishment of its outstanding fixed-rate debt. Realized gains would be refunded to and losses would be recovered from customers through gas rates.\nThe estimated fair value of Wisconsin Gas's long-term debt at December 31, is as follows:\n12. Quarterly Financial Data (Unaudited)\nBecause seasonal factors significantly affect Wisconsin Gas operations, the following data is not comparable between quarters (thousands of dollars):\nTO EXHIBITS\nPAGE 3.1 Wisconsin Gas Company Restated Articles of Incorporation, as amended (incorporated by reference)\n3.2* Wisconsin Gas Company By-Laws, as amended\n4.1 Indenture of Mortgage and Deed of Trust dated as of November 1, 1950, between Milwaukee Gas Light Company and Mellon National Bank and Trust Company and D. A. Hazlett, Trustees (incorporated by reference)\n4.2 Eleventh Supplemental Indenture dated as of February 15, 1982, between Wisconsin Gas Company and Mellon Bank, N.A., and N. R. Smith, Trustees (incorporated by reference)\n4.3 Bond Purchase Agreement dated December 31, 1981, between Wisconsin Gas Company and Teachers Insurance and Annuity Association of America relating to the issuance and sale of $30,000,000 principal amount of First Mortgage Bonds, Adjustable Rate Series due 2002 (incorporated by reference)\n4.4 Indenture dated as of September 1, 1990, between Wisconsin Gas Company and First Wisconsin Trust Company, Trustee (incorporated by reference)\n4.5 Officers' Certificate dated as of November 28, 1990, setting forth the terms of Wisconsin Gas Company's 9-1\/8% Notes due 1997 (incorporated by reference)\n4.6 Officers' Certificate dated as of November 19, 1991, setting forth the terms of Wisconsin Gas Company's 7-1\/2% Notes due 1988 (incorporated by reference)\n4.7 Officers' Certificate, dated as of September 15, 1993, setting forth the terms of the Company's 6.60% Debentures due 2013 (incorporated by reference)\n4.8 Revolving Credit and Term Loan Agreement dated as of March 29, 1993, among Wisconsin Gas Company and Citibank, N.A., Firstar Bank of Milwaukee, N. A., Harris Trust Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference)\n4.9 Loan Agreement dated as of November 4, 1991, by and among M&I Marshall & Ilsley Bank, Wisconsin Gas Company Employees' Savings Plan Trust and WICOR, Inc. (incorporated by reference).\n10.1 Service Agreement dated as of January 1, 1988, among WICOR, Inc., Wisconsin Gas Company, Sta-Rite Industries, Inc. and WEXCO of Delaware, Inc. (incorporated by reference) (i) PAGE\n10.2# WICOR, Inc. 1987 Stock Option Plan, as amended (incorporated by reference)\n10.3# Form of nonstatutory stock option agreement used in connection with WICOR, Inc. 1987 Stock Option Plan (incorporated by reference)\n10.4# WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference)\n10.5# Form of nonstatutory stock option agreement used in conjunction with the WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference)\n10.6#* Wisconsin Gas Company Principal Officers' Supplemental Retirement Income Program\n10.7#* Wisconsin Gas Company 1994 Officers' Incentive Compensation Plan\n10.8# Wisconsin Gas Company Officers' Medical Expense Reimbursement Plan (incorporated by reference)\n10.9# Wisconsin Gas Company Group Travel Accident Plan (incorporated by reference)\n10.10# Form of Deferred Compensation Agreement between Wisconsin Gas Company and certain of its officers (incorporated by reference)\n10.11# WICOR, Inc. Retirement Plan for Directors, as amended (incorporated by reference)\n13* \"Financial Review\" portion of WICOR, Inc. 1993 Annual Report to Shareholders\n* Indicates document filed herewith\n# Indicates a plan under which compensation is paid or payable to directors or executive officers of the Company.\n(ii)","section_15":""}
{"filename":"356981_1993.txt","cik":"356981","year":"1993","section_1":"ITEM 1 - BUSINESS\nOverview\nSuburban Bancorp, Inc. (the \"Company\") is organized as a multi-bank holding company, with its principal office in Palatine, Illinois. Its princi- pal subsidiaries are thirteen community banks. The banks are located in Cook, DuPage, Lake, Kane, and McHenry counties in suburban areas of metropolitan Chicago. Because most of their market areas are suburban communities, the banks are primarily retail-oriented, providing a wide range of financial services to individuals and small businesses. The market areas of the banks have a diversified economy, with several corporate headquarters and numerous smaller commercial and industrial businesses providing employment, with a large number of residents commuting to work in the City of Chicago.\nThe banks engage in a general full service banking business. The depository and loan products of the banks are generally those offered by competing financial institutions in the communities. Deposit products include several types of interest-bearing transaction accounts and savings and time deposits, including individual retirement accounts. Although numerous types of loans are available, the banks principally make secured commercial loans to small business organizations and secured installment loans to individuals.\nAdditional products and services offered include lock box services, electronic fund transfers, automatic teller machines (ATMs), safe deposit facilities, automatic payroll deposit, cash management and trust services.\nAlthough each bank operates under the direction of its own board of directors, the Company has standard operating policies and procedures regard- ing asset\/liability management, liquidity, investment, lending and deposit structure management. The Company has historically centralized certain opera- tions where economies of scale can be achieved.\nMarket Information\nAs of March 1, 1994, the Company has 13 bank subsidiaries with 30 offices providing direct service to 31 communities in the Chicago metropolitan area. The combined populations of these communities have grown at a signifi- cantly faster pace than the population of the Chicago metropolitan area over the past two decades. Local planners forecast that growth in communities served by the banks will, on a percentage basis, greatly exceed that of the total metropolitan area. Average household income of the communities served by the Company was greater than the average Chicago metropolitan area income, and the Company believes that average incomes of the households it serves will continue to compare favorably to Chicago metropolitan averages for the fore- seeable future.\nSubsidiary Banks\nThe Company has made seven acquisitions in the past nine years. The Suburban Bank of Bartlett was purchased in 1985, both the Marengo State Bank and the Suburban Bank of West Brook in 1986, Suburban National Bank\/Aurora and The State Bank of Woodstock in 1987, Suburban Bank of Oakbrook Terrace in 1988, and The State Bank of Huntley in 1993.\nThe table below presents certain information regarding the subsidiary banks owned by the Company (dollars in thousands.) December 31, 1993 (1) Name of Bank Number ------------------------------------------- (Year Formed\/Year Af- of Total Net Return on Average filiated with Suburban) Locations Assets Equity Income Assets Equity - - ------------------------ -------- -------- ------- ------ -------- -------\n(1) The data presented in this table does not aggregate to the Company's consolidated financial results for 1993, since they do not take into account unallocated parent company expenses and other consolidating adjust- ments.\nNonbank Subsidiaries\nThe Company also owns 100 percent of three nonbank subsidiaries: Brockway Insurance Agency, Inc., a company organized as an insurance broker; Suburban Mortgage Corp., a company organized as a mortgage banker; and Subur- ban Holdings, Inc., a company organized to hold real estate. Suburban Hold- ings, Inc. is the owner of certain parcels of real estate which are being held for use as bank premises and for sale.\nBank Service Corporation Subsidiaries\nThe Company's subsidiary banks own two bank service corporations designed to facilitate certain operations of the banks. Suburban Information Systems, Inc. provides data processing, bookkeeping, and proof of deposit services for the customers of the banks. Suburban Information Systems, Inc. derives substantially all its revenue from the Company's banks. Suburban Remittance Corporation, which is a wholly owned subsidiary of Suburban Infor- mation Systems, processes remittances to large commercial customers requiring specialized services due to high volumes of deposit items.\nCompetition The Company faces intense competition in all phases of its banking business from other banks and financial institutions. In addition to numerous banks in their market area, the Company's banks compete actively with savings and loan institutions, credit unions, insurance companies, investment firms, and retailers. A growing source of local competition comes from out-of-state regional bank holding companies and major Chicago banks which have established themselves in the market areas of the Company's subsidiary banks through loan production offices and affiliated banks. The Company believes that competi- tion for its products and services is based principally on location, conven- ience, quality, and price. The principal pricing factors relate to interest rates charged on loans and paid on deposits.\nEmployees The Company and its subsidiaries employed approximately 575 persons (full time equivalent) on December 31, 1993, of which 21 were employed by the parent company.\nSUPERVISION AND REGULATION\nThe Company. The Company is a corporation organized in 1981 under the General Corpora- tion Law of the State of Delaware, having its principal place of business in Palatine, Illinois. It holds a certificate of authority to do business as a foreign corporation in the State of Illinois. As a corporation listed for quotation on NASDAQ, it is subject to the Delaware anti-takeover legislation adopted February, 1988. That legislation prevents hostile acquirers from engaging in a wide range of business combinations for three years after ac- quiring a 15% interest in the target corporation.\nThe Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the \"Bank Holding Company Act\"), and is registered as such with the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before merging with or consolidating into another bank holding company, acquiring substantially all the assets of any bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank. The Federal Reserve Board may not approve an acquisition by the Company unless such acquisition has been specifically authorized by Illinois statute.\nThe Bank Holding Company Act prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing, and controlling banks or furnishing services to banks and their subsidiaries. The Company, however, may engage in, and may own shares of companies engaged in, certain businesses determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Bank Holding Company Act does not place territorial restrictions on the activities of bank holding companies or their nonbank subsidiaries.\nThe Banks. Under the Bank Holding Company Act, and the regulations promulgated thereunder, the Company is required to file annual reports of its operations and such additional information as the Federal Reserve Board may require and is subject to examination by the Federal Reserve Board. The Federal Reserve Board has jurisdiction to regulate the terms of certain debt issues of the Company, including the authority to impose reserve requirements.\nThree of the Company's subsidiaries are national banks and are subject to regulation and regular examinations by the Comptroller of the Currency. All national banks are members of the Federal Reserve System and are subject to applicable provisions of the Federal Reserve Act. The Com- pany's three national banks are the Suburban National Bank of Palatine, Subur- ban National Bank of Elk Grove Village and Suburban National Bank\/Aurora.\nTen of the Company's banks are state banks, chartered under the Illinois Banking Act. They are subject to regulation and examination by the Illinois Commissioner of Banks and Trust Companies. The Company's state chartered banks are the Suburban Bank of Cary-Grove, Suburban Bank of Hoffman- Schaumburg, Suburban Bank of Barrington, Suburban Bank of Rolling Meadows, Suburban Bank of Bartlett, Suburban Bank of West Brook, Suburban Bank of Oakbrook Terrace, Marengo State Bank, The State Bank of Woodstock and The State Bank of Huntley.\nAll of the banking subsidiaries are members of the Federal Deposit Insurance Corporation (\"FDIC\") and as such are subject to the provisions of the Federal Deposit Insurance Act.\nRegulatory Issues\nThe federal and state laws and regulations generally applicable to banks regulate, among other things, the scope of their business, their invest- ments, their reserves against deposits, the nature and amount of and collater- al for loans, and include restrictions on the number of banking offices and activities which may be performed at such offices.\nSubsidiary banks of a bank holding company are subject to certain restrictions under the Federal Reserve Act and the Federal Deposit Insurance Act on loans and extensions of credit to the bank holding company or to its other subsidiaries, investments in the stock or other securities of the bank holding company or its other subsidiaries, or advances to any borrower collat- eralized by such stock or other securities.\nEffective December 1, 1990, out-of-state bank holding companies are authorized to acquire banks or bank holding companies having their principal place of business in Illinois. Such out-of-state bank holding companies must have their principal place of business in a state whose interstate banking laws are fully reciprocal with those of Illinois. In 1993, the Illinois General Assembly amended the Illinois Banking Act effectively removing all numeric, geographic and home office protection branching restrictions imposed on banks and savings banks under Illinois law.\nOn December 19, the Federal Deposit Insurance Corporation Improvement act of 1991 (\"FDICIA\") was enacted. FDICIA provides for, among other things: the recapitalization of the Bank Insurance Fund; several supervisory reforms, inc- luding required annual regulatory examinations of depository institutions, annual independent audits and related management reports on internal controls; the adoption of safety and soundness standards on matters such as loan under writing and documentation, interest rate risk deposit insurance system; and mandated consumer protection disclosure regarding deposit accounts. FDICIA, together with the regulations promulgated pursuant thereto, have increased certain costs related to examination reporting and disclosure.\nEffective July 1, 1992, banks commonly owned by the same holding company are allowed to establish \"affiliate facilities.\" An affiliate facili- ty is allowed to receive deposits; cash and issue checks drafts and money orders; and receive payments on existing indebtedness.\nDividends.\nThe Company uses funds derived primarily from the payment of divi- dends by its subsidiaries for, among other purposes, the payment of dividends to the Company's stockholders.\nThe directors of a national bank may generally declare a dividend of as much of the net profits (as defined in the National Bank Act) of the bank as they deem proper. However, the approval of the Comptroller of the Currency is required for any dividend paid to the Company by national bank subsidiaries if the total of all dividends, including any proposed dividend declared by that bank in any calendar year, exceeds the total of its net profits (as defined in the National Bank Act) for that year and retained net profits (as defined in the National Bank Act) for the preceding two years.\nUnder provisions of the Illinois Banking Act, dividends may not be declared by the Company's state banking subsidiaries except out of each bank's net profit, and unless each bank has transferred to surplus at least one- tenth of its net profits since the date of the declaration of the last preced- ing dividend until the amount of its surplus is at least equal to its capital. Presently, the surplus of each of the Company's state banks equals or exceeds capital.\nAll dividends paid to the Company by its subsidiary banks and by the Company to its stockholders are further restricted by Capital Asset Guide- lines, adopted in substantially the same form by all the relevant Federal regulatory agencies. The Capital Asset Guidelines have been phased in over several years and are currently effective in their entirety. The Capital Asset Guidelines include two measures, a risk-based measure and a leverage measure. Generally a financial institution's capital ratios must meet both measures. The risk-based measure compares an institution's capital with its assets which have been weighted in accordance with the risks associated with them. The minimum ratio established under the risk-based measure is 8.00 percent. The ratio under the risk-based measure for the Company on a consoli- dated basis was 15.77 percent at December 31, 1993. The leverage measure is flexible. The minimum ranges between 4 percent and 5 percent, except for the strongest institutions, which are permitted to operate with a minimum of 3 percent. The Company had a consolidated capital ratio based on the leverage measure of 7.2 percent at December 31, 1993.\nAt December 31, 1993, the Company's banking subsidiaries had $15,656,000 available for the payment of dividends to the Company.\nMonetary Policy and Economic Conditions.\nThe earnings of bank holding companies and their subsidiary banks are affected by general economic conditions and also by the fiscal and mone- tary policies of governmental authorities, including in particular those of the Federal Reserve Board, which influences conditions in the money and capi- tal markets through, among other means, open market operations. Such opera- tions are designed to affect interest rates and the growth in bank credit and deposits. The above monetary and fiscal policies of the Federal Reserve Board have affected the operating results of all commercial banks in the past and may be expected to do so in the future. The Company cannot predict the nature or the extent of any effects which economic conditions, fiscal, or monetary policies may have on its business and earnings.\nSELECTED STATISTICAL INFORMATION In accordance with general instruction G(2), the information called for by Item 1 of this Form 10-K and Guide 3, Statistical Disclosure by Bank Holding Companies, is incorporated herein by reference to a section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 24 through 36 of the Company's 1993 Annual Report.\nITEM 1(a) - EXECUTIVE OFFICERS OF THE COMPANY The names and ages of the executive officers of the Company, along with a brief account of the business experience of each such person during the past five years, and certain other information follows:\nName (Age) and Positions Principal Occupations and Offices with the Company (year with the Company (and subsidiaries) For first elected to office) Past Five Years and Other Information\nGerald F. Fitzgerald, Jr. (43) President of Suburban National Bank of director (1981) Palatine from 1980 to 1990; chairman president chief executive of the board of Suburban Bank of West officer (1990) Brook since 1986; of Suburban Bank of of Oakbrook Terrace since 1988; of Suburban Bank of Rolling Meadows since 1990; of Suburban National Bank\/ Aurora since 1990; of Suburban National Bank of Elk Grove Village since 1990; of Suburban National Bank of Palatine since 1990; and Suburban Information Systems, Inc. since 1990; president of Brockway Insurance Agency, Inc. since 1990; director \t\t\t\t Suburban Remittance Corp. since 1987; presi- dent of Suburban Holdings, Inc. since 1990.\nJames G. Fitzgerald (42) Chairman of the board since 1990 and director (1981) president since 1983 of Suburban Bank of treasurer and chief Barrington; chairman of the board of financial officer(1981 Marengo State Bank since 1986; vice vice president (1993) chairman and director of The State Bank of Woodstock since 1987; chairman of the board of Suburban Bank of Bartlett since 1990; of Suburban Bank of Cary-Grove since 1990; of Suburban Bank of Hoffman- Schaumburg since 1990; and The State Bank of Huntley since 1993; director of Suburban Information Systems, Inc. since 1990.\nThomas P. MacCarthy (44) President Suburban National Bank of Palatine since 1990; director of Suburban Remittance Corp. since 1993.\nFrancis Catini (48) President Suburban Bank of Cary\/Grove director (1981) since 1981; director Suburban Remittance Corp. since 1993; Trustee Suburban Bancorp, Inc. Employee Benefit Plan since 1983.\nEdward C. Murawski (46) Secretary and treasurer of Brockway senior vice president and Insurance Agency; since 1990; secretary, assistant secretary (1991) treasurer and director of Suburban Holdings comptroller and chief Inc. since 1988; secretary treasurer of accounting officer (1986) Suburban Mortgage Corporation since 1992; treasurer of Suburban Information Systems, Inc.; since 1991.\nGerald F. Fitzgerald, Jr. and James G. Fitzgerald are sons of Gerald F. Fitzgerald, current Chairman of the Board of Directors of the Company. No other executive officers of the Company are related. The officers of the Company hold their offices until such time as their successors are chosen by the Board of Directors or their resignations become effective.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company occupies a total of approximately 282,000 square feet in 30 locations. The Company's principal offices are located in approximately 10,000 square feet of office space in the Suburban National Bank of Palatine building in Palatine, Illinois. Twenty thousand square feet of the Suburban National Bank of Palatine building, six thousand square feet of the Marengo Bank build- ing, and 4,000 square feet of the Suburban Bank of West Brook building are leased to non-affiliated tenants. Except as discussed above, all facilities are used solely to conduct the Company's banking and bank related businesses.\nThe following table sets forth certain information concerning the main offices and branches of the Company's subsidiary banks and of its nonbank sub- sidiaries.\nApproximate Own\/ Property Main\/Branch Square Feet Lease Status ------- ----------- ----------- ----- ------\nCertain subsidiary banks have entered into operating leases for banking premises with unaffiliated third parties which resulted in approx- imately $657,000, $587,000, and $565,000 in lease-related expenses in 1993, 1992 and 1991, respectively. The Company does not anticipate material increases in operating lease-related expenses earlier than 1998, except to the extent, if any, addi- tional leased facilities are opened.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nNone\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference to a section entitled \"Market Price of and Dividends on Company's Common Equity\" on page 36 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nIncorporated by reference to sections entitled \"Selected Financial Data\" on page 22, \"Selected Quarterly Financial Data\" on page 23, and \"Manage- ment's Discussion and Analysis of Financial Condition and Results of Opera- tions\" on page 24 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference to a section entitled \"Management's Discus- sion and Analysis of Financial Condition and Results of Operations\" on pages 24 through 36 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nIncorporated by reference to the consolidated financial statements set forth on pages 7 through 21 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nIncorporated herein by reference to sections entitled \"Election of Directors\" and \"Beneficial Ownership of Securities,\" on pages 1 through 5, of the Company's definitive proxy statement filed with the Securities and Ex- change Commission March 15, 1994, pursuant to Regulation 14A. Information concerning the Executive Officers of the Company is contained in the response to Item 1(a) hereof.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nIncorporated by reference to a section entitled \"Executive Compensation\" on pages 5 through 11 of the Company's definitive proxy statement filed with the Securities and Exchange Commission March 15, 1994, pursuant to Regula- tion 14A.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to a section entitled \"Beneficial Ownership of Securities\" on pages 4 and 5 of the Company's definitive proxy statement filed with the Securities and Exchange Commission March 15, 1994, pursuant to Regulation 14A.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference to a section entitled \"Management Relation- ships and Related Transactions\" on page 12 of the Company's definitive proxy statement filed with the Securities and Exchange Commission March 15, 1994, pursuant to Regulation 14A.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nItem 14(a)(1) and (2)\nSUBURBAN BANCORP, INC. AND SUBSIDIARIES LIST OF FINANCIAL STATEMENT AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of the Company and its subsidiaries are incorporated by reference to the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nPage\nIndependent Auditors' Report 7\nConsolidated Balance Sheets - December 31, 1993 and 1992 8\nConsolidated Statements of Income - Years Ended December 31, 1993, 1992 and 1991 9\nConsolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1993, 1992 and 1991 10\nConsolidated Statements of Changes in Cash Flows - Years Ended December 31, 1993, 1992 and 1991 11\nNotes of Consolidated Financial Statements 12\nSchedules\nThe following Condensed Financial Information (Parent Company Only) is incorporated by reference to note 15 to the Company's Consolidated Finan- cial Statements as set forth on pages 20 and 21 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1993.\nCondensed Balance Sheets - December 31, 1993 and 1992 20\nCondensed Statements of Income - Years Ended December 31, 1993, 1992 and 1991 20\nCondensed Statements of Changes in Cash Flows - Years Ended December 31, 1993, 1992 and 1991 21\nSchedules other than those listed above are omitted for the reason that they are not required or are not applicable or the required information is shown in the financial statements or notes thereto.\nItem 14(a)(3) and 14(c) - Exhibits\n(i) See \"Index to Exhibits\" immediately following signature pages.\n(ii) The following management contracts and compensatory plans and arrangements are listed as exhibits to this Form 10-K:\n10.1 Suburban Bancorp, Inc. Bank Employees Profit Shar- ing Plan - Incorporated by reference to Exhibit 10.8 of Form S-1 of the Company dated June 17, 1986, Registration Number 33-6528 IBRF\n10.2 Suburban Bancorp, Inc. Executive Incentive Plan - Incorporated by reference to Exhibit 10.9 of Form S-1 dated July 16, 1986, Registration Number 33-6528 IBRF\n10.3 1986 Stock Appreciation Rights Plan - Incorporated by reference to Exhibit 10.5 of Form 10-K of the Company for the year ended December 31, 1986, File Number 0-11138 IBRF\n10.4 Deferred Compensation agreement effective as of January 1, 1991 between the Company and Gerald F. Fitzgerald - Incorporated by reference to Exhibit 10.4 of Form 10-K for the year ended December 31, 1991, File Number 0-11138 IBRF\n10.5 Employment Agreement between the Company and Gerald F. Fitzgerald - Incorporated by reference to Exhibit 10.5 to Form 10-K for the year ended December 31, 1992, File No-11138 IBRF\nItem 14(b) - Reports on Form 8-K\nNone\nUpon written request to the Secretary of Suburban Bancorp, Inc., 50 North Brockway, Drawer A, Palatine, Illinois 60067, copies of exhibits listed on the Index to Exhibits are available to stockholders of Suburban Bancorp, Inc. by specifically identifying each exhibit desired in the request. A fee of $0.20 per page will be charged to stockholders requesting copies of exhibits to cover copying and mailing costs.\nSIGNATURES\nPursuant 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.\nSUBURBAN BANCORP, INC. (the Registrant)\nBy: \/s\/ Gerald F. Fitzgerald, Jr. _____________________________ Gerald F. Fitzgerald, Jr. President, Chief Executive Officer, and Director\nMarch 25, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated, on March 25, 1994.\n\/s\/ Gerald F. Fitzgerald ___________________________ ______________________ Gerald F. Fitzgerald John V. Crowe Chairman of the Board Director\n\/s\/ James G. Fitzgerald \/s\/ Gerald F. Fitzgerald, Jr. ____________________________ ___________________________ James G. Fitzgerald Gerald F. Fitzgerald, Jr. Treasurer, Chief Financial President, Chief Executive Officer and Director Officer, and Director\n\/s\/ Edward C. Murawski \/s\/ Thomas G. Fitzgerald ____________________________ ________________________ Edward C. Murawski Thomas G. Fitzgerald Senior Vice President, Secretary and Director Comptroller and Chief Accounting Officer\n\/s\/ Francis Catini \/s\/ James H. Sammons ____________________________ __________________________ Francis Catini James H. Sammons, M.D. Director Director\n\/s\/ Richard J. Riordan ____________________________ ___________________________ Donald J. Cooney Richard J. Riordan Director Director\n\/s\/ Joseph F. Lizzadro ____________________________ Joseph F. Lizzadro Director\nINDEX TO EXHIBITS\nExhibit Document Number Description Filing*\n3.1 Restated Certificate of Incorporation - Incorporated by reference to Exhibit 3.1 of Form S-1 of the Company dated June 17, 1986, under Registration Number 33-6528 IBRF\n3.2 By-laws - Incorporated by reference to Exhibit 3.2 of Form 10-K of the Company for the year ended December 31, 1986, File Number 0-11138 IBRF\n4.1 Copy of specimen certificate for Class A Common Stock - Incorporated by reference to Exhibit 4.1 of Form S-1 of the Company dated June 17, 1986, Registration Number 33-6528 IBRF\n4.2 Copy of specimen certificate for Class B Common Stock - Incorporated by reference to Exhibit 4.2 of Form S-1 of the Company dated June 17, 1986, Registration Number 33-6528 IBRF\n10.1 Suburban Bancorp, Inc. Bank Employees Profit Shar- ing Plan - Incorporated by reference to Exhibit 10.8 of Form S-1 of the Company dated June 17, 1986, Registration Number 33-6528 IBRF\n10.2 Suburban Bancorp, Inc. Executive Incentive Plan - Incorporated by reference to Exhibit 10.9 of Form S-1 dated July 16, 1986, Registration Number 33-6528 IBRF\n10.3 1986 Stock Appreciation Rights Plan - Incorporated by reference to Exhibit 10.5 of Form 10-K of the Company for the year ended December 31, 1986, File Number 0-11138 IBRF\n10.4 Deferred Compensation agreement effective as of January 1, 1991 between the Company and Gerald F. Fitzgerald - Incorporated by reference to Exhibit 10.4 of Form 10-K for the year ended December 31, 1991, File Number 0-11138 IBRF\n10.5 Employment Agreement between the Company and Gerald F. Fitzgerald - Incorporated by reference to Exhibit 10.5 to Form 10-K for the Year ended December 31, 1992, File No. 0-11138 IBRF\nExhibit Document Number Description Filing*\n10.6 Form of Directorship Agreement entered into between the Company and each of its Directors - Incorporated by reference to Exhibit 10.5 of Form 10-K for the year ended December 31, 1991 File Number 0-11138 IBRF\n13 Annual Report to Stockholders for fiscal year ended December 31, 1993 filed on March 15, 1994 IBRF\n21.1 Subsidiaries of Registrant - Incorporated by reference to the definitive proxy statement filed on March 15, 1994 IBRF\n23.1 Opinion of Deloitte & Touche concerning financial statements for the year ended December 31, 1993 filed herewith EF\n* IBRF - Incorporated by Reference EF - Electronically Filed","section_15":""}
{"filename":"868016_1993.txt","cik":"868016","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nSee Item 1.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\n(a) There is no market for the registrant's common stock.\n(b) There was one Common stockholder at September 30, 1993.\n(c) See \"Item 6.","section_6":"Item 6. Selected Financial Data\nThe financial data shown below as of and for the years ended September 30, 1993, 1992, 1991 and for the period July 25, 1990 (date of incorporation) through September 30, 1990 have been derived from, and should be read in conjunction with, the Company's financial statements and related notes appearing elsewhere herein. The financial statements as of and for the year ended September 30, 1993 have been audited by Coopers & Lybrand. The financial statements as of and for the years ended September 30, 1992 and 1991 and for the period July 25, 1990 (date of incorporation) through September 30, 1990 have been audited by BDO Seidman.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nRevenues of the Company increased to $2.8 million in 1993 from $2.4 million in 1992 and $1.0 million in 1991. The growth from 1992 to 1993 is attributable primarily to increased investment earnings on additional outstanding Receivables and increased revenues associated with the sale of repossessed property. The growth from 1991 to 1992 was almost entirely attributable to increased investment earnings on additional outstanding Receivables. The Company has increased its investment in Receivables from $8.2 million at September 30, 1991 to $11.6 million at September 30, 1992 to $19.5 million at September 30, 1993.\nThe Company continued to realize net income from operations during 1993. Net income for the fiscal year ended September 30, 1993 was $283,000 compared to $661,000 in 1992 and $238,000 in 1991. The 1993 decrease in net income is attributable to a reduced spread between interest sensitive income and interest sensitive expense along with increased operating expenses associated with the increased volume of Certificate sales, Receivable investments and real estate held for sale. The 1992 increase in net income is attributable to an increased spread between interest sensitive income and interest sensitive expense along with increased operating expenses associated with the increased volume of Certificate sales, Receivable investments and real estate held for sale.\nThe Company, during 1993, experienced a slight increase in the loss from sale of real estate repossessions and also increased its provision for losses on Receivables.\nSince the date of its incorporation, the Company has benefitted from a declining interest rate environment with lower money costs and relatively consistent yields on Receivables acquired through Metropolitan. In addition, a declining rate environment has positively impacted earnings by increasing the value of the portfolio of predominantly fixed rate Receivables. Higher than normal prepayments in the Receivable portfolio were experienced during 1993 and 1992, allowing the Company to recognize unamortized discounts on Receivables at an accelerated rate. It is anticipated that Metropolitan may begin charging the Company underwriting fees associated with Receivables acquired from Metropolitan. Management anticipates that any such underwriting fee that may be charged by Metropolitan in the future will result in a slightly lower yield over the life of the Receivables. Management is unable to predict the specific impact of any such underwriting fee because no specific fee has been proposed or suggested to date. See \"Business-Investment in Real Estate Receivables.\"\nMaintaining efficient collection procedures and minimizing delinquencies in the Company's Receivable portfolio are ongoing management goals. During 1993, the Company experienced a loss on sale of repossessed real estate of $18,400. Management believes that yields received on Receivables, which currently range from 12-15% (approximately 6-9% in excess of the Treasury, or risk-free, rate), will more than compensate the Company for such risk of loss.\nIn April 1992, the Accounting Standards Division of the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 92-3, \"Accounting for Foreclosed Assets,\" which provides guidance on determining the accounting treatment for foreclosed assets. SOP 92-3 requires that foreclosed assets be carried at the lower of (a) fair value minus estimated costs to sell, or (b) cost. The Company applied the provisions of SOP 92-3 effective October 1, 1992. The initial charge for its application is estimated to be approximately $10,000, before the application of related income taxes, and is included in continuing operations in 1993.\nInterest Sensitive Income and Expense\nManagement continually monitors the interest sensitive income and expense of the Company. Interest sensitive expense is predominantly the interest costs of Investment Certificates, while interest sensitive income includes interest on Receivables, earned discount on Receivables, dividends and other investment income.\nThe spread between interest sensitive income and interest sensitive expense was $362,300 in 1991, $925,300 in 1992 and $695,600 in 1993. The decrease from 1992 to 1993 of approximately $230,000 was the result of management's decision to accumulate cash to fund a contract purchase commitment in excess of $7 million from an affiliate in December 1992. Also, the Company recognized $366,935 of dividend income (13% dividend rate) from its preferred stock investment in its affiliate in 1992 and paid interest to its parent company at prime plus 1 1\/2% on the borrowings used to finance the purchase of the preferred stock. In March 1992, the Company transferred the preferred stock to Metropolitan in full satisfaction of the $6 million payable. Therefore, there were no dividends received by the Company in fiscal 1993 on the preferred stock. See Note 7 to Financial Statements.\nOther Income\nOther income increased from approximately $500 in 1991 to $16,600 in 1992 to $42,700 in 1993. Other income is predominantly miscellaneous fees and charges related to Receivables, thus its growth is primarily due to the growth in Receivables.\nOther Expenses\nOperating expenses increased from approximately $100,600 in 1991 to $178,300 in 1992 to $244,600 in 1993 largely due to the increased volume of Investment Certificate sales and Receivable investments.\nProvision for Losses on Real Estate Receivables\nThe provision for losses on Receivables has increased as the size of the portfolio of Receivables has grown. The following table summarizes the Company's allowance for losses on Receivables:\nGain\/Loss on Real Estate Sold\nDuring 1993, the Company experienced a loss on the sale of real estate of approximately $18,400. At the end of fiscal 1993, the Company had $61,000 in real estate held for sale, less than 1% of total real estate assets.\nEffect of Inflation\nDuring the three year period ended September 30, 1993, inflation has had a generally positive impact on the Company's operations. This impact has primarily been indirect in that the level of inflation tends to influence inflation expectations, which tends to impact interest rates on both Company assets and liabilities. Thus, with lower inflation rates over the past three years, interest rates have been generally declining during this period, which has reduced the Company's cost of funds. Interest rates on Receivables acquired, due to their nature, have not declined to the same extent as the cost of the Company's borrowings. In addition, inflation has not had a material effect on the Company's operating expenses. The main reason for the increase in operating expenses has been an increase in the number of Receivables acquired and serviced and increased sales of Investment Certificates.\nRevenues from real estate sold are influenced in part by inflation, as, historically, real estate values have fluctuated with the rate of inflation. However, the Company is unable to quantify the effect of inflation in this respect.\nAsset\/Liability Management\nAs most of the Company's assets and liabilities are financial in nature, the Company is subject to interest rate risk. Currently, the Company's financial assets (primarily Receivables and fixed income investments) reprice faster than its financial liabilities (primarily Investment Certificates). In a rising rate environment, this will tend to increase earnings, while in a falling rate environment, earnings will decrease. However, yields on Receivables have not been as sensitive to rate fluctuations as have Investment Certificate rates.\nDuring fiscal 1994, approximately $5.8 million of interest sensitive assets (cash and Receivables) are expected to reprice or mature.\nFor liabilities, approximately $2.0 million of Investment Certificates will mature during fiscal 1994, along with about $5,000 of other debt payable.\nThese estimates result in a one year interest rate mismatch\n(interest sensitive assets less interest sensitive liabilities) of approximately $3.8 million, or a ratio of interest sensitive assets to interest sensitive liabilities of approximately 290%.\nNew Accounting Rules\nIn the fourth quarter of fiscal 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), retroactive to October 1, 1992 and resulted in no significant affect on the Company's financial position. SFAS No. 109 requires a company to recognize deferred tax assets and liabilities for the expected future income tax consequences of events that have been recognized in a company's financial statements. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. In 1992 and 1991, the Company accounted for income taxes as required by Accounting Principles Board Opinion No. 11. See Note 1 to Financial Statements.\nIn May, 1993, Statement of Financial Accounting Standards No. 114 (SFAS No. 114) \"Accounting by Creditors for Impairment of a Loan\" was issued. SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loans' effective interest rate or the fair value of the collateral. The Company is required to adopt this new standard by October 1, 1995. The Company does not anticipate that the adoption of SFAS No. 114 will have a material effect on the financial statements.\nIn December 1991, Statement of Financial Accounting Standards No. 107 (SFAS No. 107), \"Disclosures about Fair Value of Financial Instruments,\" was issued. SFAS No. 107 requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. SFAS No. 107 is effective for financial statements issued for fiscal years ending after December 31, 1995 (Summit's fiscal year ending September 30, 1996) for entities with less than $150 million in total assets. This pronouncement does not change any requirements for recognition, measurement or classification of financial instruments in the Company's financial statements.\nStatement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 112 \"Employers' Accounting for Postretirement Benefits\" are not applicable because the Company maintains no programs designed to provide employees with post-retirement or post-employment benefits.\nLiquidity and Capital Resources\nAs a financial institution, the Company's liquidity is largely tied to its ability to renew, maintain or obtain additional sources of cash. The Company has successfully performed this task during the past three years and has continued to invest funds generated by operations and financing activities.\nThe Company has continued to generate cash from operations with net cash provided of $1.4 million in 1993; $1.4 million in 1992; and\n$.5 million in 1991. Cash utilized by the Company in its investing activities increased to $9.2 million in 1993 from $2.6 million in 1992 and $14.1 million in 1991. Cash provided by the Company's financing activities was $5.8 million in 1993 compared to $5.0 million in 1992 and $13.4 million in 1991. These cash flows have resulted in year end cash and cash equivalent balances of $3.6 million in 1993; $5.6 million in 1992; and $1.8 million in 1991. Management considers the cash balance at September 30, 1993 of $3.6 million to be adequate to finance any required debt retirements or planned asset additions.\nDuring 1993, the $2.1 million decrease in cash and cash equivalents resulted from cash provided by operating activities of $1.4 million less cash used in investing activities of $9.2 million plus cash provided by financing activities of $5.7 million. Cash from operating activities resulted primarily from net income of $.3 million and the increase in compound and accrued interest on Investment Certificates of $1.0 million. Cash used in investing activities primarily included: (1) acquisition of real estate Receivables net of payments and sales, of $7.6 million; and (2) an advance to its parent company of $1.7 million for the purchase of Receivables. Cash provided by financing activities included: (1) issuance of Investment Certificates, net of repayments and related debt issue costs, of $7.0 million; less (2) repayment of amounts due its parent of $.4 million; and (3) repayment to banks and others of $.9 million.\nThe Company's investing activities during 1993 were supported by cash from operations and external financing. The Company's increases in Receivables were primarily funded by sales of Investment Certificates. During 1992, the $3.9 million increase in cash and cash equivalents resulted from cash provided by operating activities of $1.4 million less cash used in investing activities of $2.5 million plus cash provided by financing activities of $5.0 million. Cash from operating activities resulted primarily from net income of $.7 million and the increase in compound and accrued interest on Investment Certificates of $.7 million. Cash used in investing activities primarily included the acquisition of real estate Receivables net of payments and sales, of $3.0 million less $.5 million advance repaid by its parent. Cash provided by financing activities included: (1) issuance of Investment Certificates, net of repayments and related debt issue costs, of $4.7 million; (2) borrowings from its parent of $.4 million; less (3) repayment to banks and others of $.1 million.\nThus, during 1992, the Company's investing activities were supported by internal cash from operations and external cash from financing. The Company's increases in Receivables were primarily funded by sales of Investment Certificates.\nDuring 1991, the $.2 million decrease in cash and cash equivalents resulted from cash provided by operating activities of $.5 million less cash used in investing activities of $14.1 million plus cash provided by financing activities of $13.4 million. Cash from operating activities resulted primarily from net income of $.2 million and the increase in compound and accrued interest on Investment Certificates of $.2 million. Cash used in investing activities primarily included the acquisition of real estate Receivables net of payments, of $7.7 million, while the total advanced to or invested in affiliates was $6.5 million. Cash provided by financing activities included: (1) issuance of Investment Certificates, net of repayments and related debt issue\ncosts, of $7.4 million; and (2) borrowings from parent of $6.0 million.\nThus, during 1991 as in 1992 and 1993, the Company's investing activities were supported by internal cash from operations and external cash from financing. The Company's increases in Receivables were primarily funded by sales of Investment Certificates.\nManagement believes that cash flow from operating activities and financing activities will be sufficient for the Company to conduct its business and meet its anticipated obligations as they mature during fiscal 1994. The Company has not defaulted on any of its obligations since its founding in 1990.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nYEARS ENDED SEPTEMBER 30, 1993, 1992 AND 1991\nPage Reports of Independent Certified Public Accountants...................................\nBalance Sheets..........................................\nStatements of Income....................................\nStatements of Stockholder's Equity......................\nStatements of Cash Flows................................\nNotes to Financial Statements...........................\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Directors and Stockholder Summit Securities, Inc.\nWe have audited the accompanying balance sheet of Summit Securities, Inc. (a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc.) as of September 30, 1993, and the related statements of income, stockholder's equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Summit Securities, Inc. as of September 30, 1993 and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 1, the Company changed its methods of accounting for repossessed real property and income taxes in 1993.\n\/S\/ COOPERS & LYBRAND\nCOOPERS & LYBRAND\nSpokane, Washington December 13, 1993\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors of Summit Securities, Inc.\nWe have audited the accompanying balance sheet of Summit Securities, Inc. (a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc.) as of September 30, 1992 and the related statements of income, stockholder's equity, and cash flows for each of the two years in the period ended September 30, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Summit Securities, Inc. at September 30, 1992, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 1992, in conformity with generally accepted accounting principles.\n\/s\/ BDO Seidman\nBDO SEIDMAN\nSpokane, Washington December 7, 1992\nSUMMIT SECURITIES, INC.\nBALANCE SHEETS September 30, 1993 and 1992 ____________\nThe accompanying notes are an integral part of the financial statements.\nSUMMIT SECURITIES, INC.\nSTATEMENTS OF INCOME For the Years Ended September 30, 1993, 1992 and 1991 ____________\nThe accompanying notes are an integral part of the financial statements.\nSUMMIT SECURITIES, INC.\nSTATEMENTS OF STOCKHOLDER'S EQUITY For the Years Ended September 30, 1993, 1992 and 1991 ____________\nThe accompanying notes are an integral part of the financial statements.\nSUMMIT SECURITIES, INC. STATEMENTS OF CASH FLOWS For the Years Ended September 30, 1993, 1992 and 1991 ____________\nSUMMIT SECURITIES, INC.\nSTATEMENTS OF CASH FLOWS, Continued For the Years Ended September 30, 1993, 1992 and 1991 ____________\nThe accompanying notes are an integral part of the financial statements.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS ____________\n1. Summary of Accounting Policies\nBusiness\nSummit Securities, Inc., d\/b\/a National Summit Securities, Inc. in the states of New York and Ohio (\"Summit\" or \"the Company\"), a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc. (\"Metropolitan\") was incorporated on July 25, 1990. Summit purchases contracts and mortgage notes collateralized by real estate, with funds generated from the public issuance of debt securities in the form of investment certificates, cash flow from receivables and sales of real estate.\nCash and Cash Equivalents\nFor purposes of balance sheet classification and the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a remaining maturity of three months or less to be cash equivalents. Cash includes all balances on hand and on deposit in banks and financial institutions. The Company periodically evaluates the credit quality of its financial institutions. Substantially all cash and cash equivalents are on deposit with one financial institution and balances periodically exceed the FDIC insurance limit.\nReal Estate Contracts and Mortgage Notes Receivable\nReal estate contracts and mortgage notes held for investment purposes are carried at amortized cost. Discounts originating at the time of purchase net of capitalized acquisition costs are amortized using the level yield (interest) method. For contracts acquired after September 30, 1992, net purchase discounts are amortized on an individual contract basis using the level yield method over the remaining contractual term of the contract. For contracts acquired before October 1, 1992, the Company accounts for its portfolio of discounted loans using anticipated prepayment patterns to apply the level yield (interest) method of amortizing discounts. Discounted contracts are pooled by the fiscal year of purchase and by similar contract types. The amortization period, which is approximately 78 months, estimates a constant prepayment rate of 10-12 percent per year and scheduled payments, which is consistent with the Company's prior experience with similar loans and the Company's expectations.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nReal Estate Contracts and Mortgage Notes Receivable, Continued\nIn May 1993, Statement of Financial Accounting Standards No. 114 (SFAS No. 114), \"Accounting by Creditors for Impairment of a Loan,\" was issued. SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral. The Company is required to adopt this new standard by October 1, 1995. The Company does not anticipate that the adoption of SFAS No. 114 will have a material effect on the financial statements.\nReal Estate Held for Sale\nReal estate is valued at the lower of cost or market. The Company principally acquires real estate through foreclosure or forfeiture. Cost is determined by the purchase price of the real estate or, for real estate acquired by foreclosure, at the lower of (a) the fair value of the property at date of foreclosure less estimated selling costs, or (b) cost (unpaid contract carrying value).\nProfit on sales of real estate is recognized when the buyers' initial and continuing investment is adequate to demonstrate that (1) a commitment to fulfill the terms of the transaction exists, (2) collectibility of the remaining sales price due is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and transfers all the risks and rewards of ownership to the buyer.\nIn April 1992, the Accounting Standards Division of the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 92-3, \"Accounting for Foreclosed Assets,\" which provides guidance on determining the accounting treatment of foreclosed assets. SOP 92-3 requires that foreclosed assets be carried at the lower of (a) fair value minus estimated costs to sell, or (b) cost. The Company applied the provisions of SOP 92-3 effective October 1, 1992. The application of SOP 92-3, estimated to be approximately $10,000 before the application of related income taxes, is included in continuing operations for the year ended September 30, 1993.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nAllowance for Losses on Real Estate Assets\nThe established allowances for losses on real estate assets include amounts for estimated probable losses on both real estate held for sale and real estate contracts and mortgage notes receivable. Specific allowances are established for all delinquent contract receivables with net carrying values in excess of $100,000. Additionally, the Company establishes general allowances, based on prior actual delinquency and loss experience, for currently performing receivables and smaller delinquent receivables. Allowances for losses are determined on net carrying values of the contracts, including accrued interest. Accordingly, the Company continues interest accruals on delinquent loans until foreclosure, unless the principal and accrued interest on the loan exceed the fair value of the collateral, net of estimated selling costs.\nDeferred Costs\nCommission and other expenses incurred in connection with the registration and public offering of investment certificates are capitalized and amortized using the interest method over the estimated life of the related investment certificates, which range from 6 months to 5 years.\nIncome Taxes\nThe Company is included in the group of companies which file a consolidated income tax return with Metropolitan. The Company is allocated a current and deferred tax provision from Metropolitan as if the Company filed a separate tax return. Effective October 1, 1992, Metropolitan adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). Under this method, deferred tax liabilities and assets are determined on temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. There was no effect on the Company's financial statements of adopting SFAS No. 109. In 1992 and 1991, Metropolitan and the Company accounted for income taxes as required by Accounting Principles Board Opinion No. 11.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nFinancial Instruments\nIn December 1991, Statement of Financial Accounting Standards No. 107 (SFAS No. 107), \"Disclosures about Fair Value of Financial Instruments,\" was issued. SFAS No. 107 requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. SFAS No. 107 is effective for financial statements issued for fiscal years ending after December 31, 1995 (Summit's fiscal year ending September 30, 1996) for entities with less than $150 million in total assets. This pronouncement does not change any requirements for recognition, measurement or classification of financial instruments in the Company's financial statements.\nReclassifications\nCertain amounts in the 1992 and 1991 financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on net income or retained earnings as previously reported.\n2. Real Estate Contracts and Mortgage Notes Receivable\nReal estate contracts and mortgage notes receivable include mortgages collateralized by property located throughout the United States. At September 30, 1993, the Company held first position liens associated with contract and mortgage notes receivable with a face value of approximately $13,800,000 and second position liens of approximately $6,900,000. Approximately 21% of the face value of the Company's real estate contracts and mortgage notes receivable are collateralized by property located in the Pacific Northwest (Washington, Idaho, Montana and Oregon), approximately 9% by property located in California and approximately 27% by property located in Hawaii.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n2. Real Estate Contracts and Mortgage Notes Receivable, Continued\nContracts totaling approximately $6,000,000 which are collateralized by property in Hawaii were purchased from a Metropolitan affiliated company during fiscal 1993. At September 30, 1993, approximately $5,500,000 of these contracts were outstanding. These contracts relate to the sale of time share units in a condominium resort development which is owned by a Metropolitan affiliated company.\nThe face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 1993 and 1992 are grouped by the following dollar ranges:\nContractual interest rates on the face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 1993 and 1992 are as follows:\nThe weighted average contractual interest rate on these receivables at September 30, 1993 is approximately 10.5%. Maturity dates range from 1993 to 2023. The constant effective yield on contracts purchased in fiscal 1993 and 1992 was approximately 12% and 15%, respectively.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n2. Real Estate Contracts and Mortgage Notes Receivable, Continued\nThe following is a reconciliation of the face value of the real estate contracts and mortgage notes receivable to the Company's carrying value:\nThe principal amount of receivables with required principal or interest payments being in arrears for more than three months was approximately $1,662,000 and $529,000 at September 30, 1993 and 1992, respectively. Included in the amount for September 30, 1993 is approximately $680,000 of delinquent contracts purchased from an affiliate during 1993. The Company has a performance holdback of $600,000 to cover any losses related to certain timeshare unit contracts, including these delinquent contracts.\nAggregate amounts of receivables (face amount) expected to be received, based upon prepayment patterns, are as follows:\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n3. Debt Payable\nAt September 30, 1993 and 1992, debt payable consists of:\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n4. Investment Certificates\nAt September 30, 1993 and 1992, investment certificates consist of:\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n5. Deferred Costs\nUnamortized commissions and other capitalized expenses incurred in connection with the sale of investment certificates aggregated $524,376 and $342,650 at September 30, 1993 and 1992, respectively, and are shown as deferred costs on the balance sheets.\nAn analysis of such deferred costs is as follows:\nNo valuation allowance has been established to reduce the deferred tax assets, as it is more likely than not that these assets will be realized due to the future reversals of existing taxable temporary differences. As of September 30, 1993, the Company's share of the consolidated group's net operating loss carryforwards was approximately $659,000, which expires in 2005.\nSUMMIT SECURITIES, INC. NOTES TO FINANCIAL STATEMENTS, Continued ____________ 6. Income Taxes, Continued\nThe provision for income taxes is computed by applying the statutory federal income tax rate to income before income taxes as follows:\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n6. Income Taxes, Continued\nDuring the year ended December 31, 1992, the Company recognized an extraordinary credit of $49,772 by the utilization of net operating loss carryforwards of approximately $146,000.\n7. Related Party Transactions\nSummit receives accounting, data processing, contract servicing and other administrative services from Metropolitan. Charges for these services were approximately $97,000 in fiscal 1993, $50,000 in fiscal 1992 and $0 in fiscal 1991 and were assessed based on the number of real estate contracts and mortgage notes receivable serviced by Metropolitan on Summit's behalf. Other indirect services provided by Metropolitan to Summit, such as management and regulatory compliance, are not directly charged to Summit.\nManagement believes that this allocation is reasonable and results in the reimbursement to Metropolitan of all significant direct expenses incurred on behalf of Summit. Management does not believe that Summit could obtain these services from outside sources for less than the allocated costs, or that these costs would be significantly higher if Summit operated alone.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n7. Related Party Transactions, Continued\nSummit had the following related party transactions with Metropolitan and affiliates during fiscal 1993 and 1992:\nAdvances to parent of $1,710,743 at September 30, 1993 represent advances to Metropolitan for the purchase of Summit's investments in real estate contracts and mortgage notes receivable. Advances from parent of $400,365 at September 30, 1992 represent real estate contracts and mortgage notes and related costs advanced by Metropolitan on behalf of Summit. These advances to and from Metropolitan are non-interest bearing.\nOn March 31, 1991, the Company borrowed $6,000,000 from Metropolitan, which was payable on demand and required monthly interest-only payments. The stated note rate was equal to the prime rate as quoted monthly by the Seattle-First National Bank plus 1.5%. Summit used the funds borrowed from Metropolitan to purchase preferred stock issued by Western United Life Assurance Company (\"Western\"), a full service life insurance company. Metropolitan also owns approximately 96% of the outstanding stock of Western. In March 1992, the Company repaid the $6,000,000 note payable to Metropolitan through the transfer of the Company's preferred stock investment in Western to Metropolitan.\nSUMMIT SECURITIES, INC.\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n8. Supplemental Disclosures for Statements of Cash Flows\nSupplemental information on interest and income taxes paid during the years ended September 30, 1993, 1992 and 1991 is as follows:\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nN\/A. The Company reported a change in accountants in its Form 8-K dated June 25, 1993.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of Registrant.\nSee \"Management\" under Item 1.\nItem 11.","section_11":"Item 11. Executive Compensation.\nSee \"Executive Compensation\" under Item 1.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nSee \"Principal Shareholders\" under Item 1.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nSee \"Certain Transactions\" under Item 1.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1. Financial Statements Included in Part II, Item 8 of this report:\nReports of Independent Certified Public Accountants Balance Sheets at September 30, 1993, and 1992 Statements of Income for the Years Ended September 30, 1993, 1992 and 1991. Statements of Stockholder's Equity for the years Ended September 30, 1993, 1992 and 1991 Statements of Cash Flows for the Years Ended September 30, 1993, 1992 and 1991 Notes to Financial Statements\n(b) 2. Financial Statements Schedules\nIncluded in Part IV of this report:\nReports of Independent Certified Public Accountants on Financial Statement Schedules.\nSchedule I -- Summary of Investments other than Investments in Related Parties Schedule VIII -- Valuation and Qualifying Accounts and Reserves Schedule XII -- Loans on Real Estate\nOther Schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto. Columns may have been omitted from schedules filed because the information is not applicable.\n(c) 3. Exhibits\n3(a). Articles of Incorporation of the Company. (Exhibit 3(a) to (Registration No. 33-36775).\n3(b). Bylaws of the Company. (Exhibit 3(b) to Registration No. 33-36775).\n4(a). Indenture dated as of November 15, 1990 between Summit and West One Bank, Idaho, N.A., Trustee. (Exhibit 4(a) to Registration No. 33-36775).\n4(b). Amendment to Indenture dated as of November 15, 1990 between Summit and West One Bank, Idaho, N.A., Trustee. (Exhibit 4(b) to Registration No. 33-36775).\n*4(c). Form of Statement of Rights, Designations and Preferences of Variable Rate Cumulative Preferred Stock Series S-1.\n*4(d). Form of Variable Rate Cumulate Preferred Stock Certificate.\n*4(e). Form of Investment Certificate.\n10(a). Receivable Purchase Option Agreement between Summit and Metropolitan Mortgage & Securities Co., Inc. dated November 15, 1990. (Exhibit 10(a) to Registration No. 33-36775).\n10(b). Service Contract between Summit and Metropolitan Mortgage & Securities Co., Inc. dated November 15, 1990. (Exhibit 10(b) to Registration No. 33-36775).\n10(c). Promissory Note dated March 31, 1991 between Summit and Metropolitan Mortgage & Securities Co., Inc. (Exhibit 10 to registrant's Annual Report on Form 10-K for the year ended September 30, 1991.)\n11. Computation of Earnings Per Common Share. (See Financial Statements.)\n* Filed herewith\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nThe Directors and Stockholder Summit Securities, Inc.\nIn connection with our audit of the financial statements of Summit Securities, Inc. as of September 30, 1993 and for the year then ended, included herein, we have issued our report thereon, which includes an explanatory paragraph describing changes in the Company's methods of accounting for repossessed real property and income taxes, which financial statements are included in the Form 10-K. We have also audited the 1993 financial statement schedules listed in Item 16 herein.\nIn our opinion, these 1993 financial statement schedules, when considered in relation to the basic 1993 financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ COOPERS & LYBRAND\nCoopers & Lybrand\nSpokane, Washington December 13, 1993\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nThe Directors and Stockholders Summit Securities, Inc.\nThe audits referred to in our report dated December 7, 1992, relating to the financial statements of Summit Securities, Inc., as of September 30, 1992 and for the two years in the period then ended, which is contained in Item 8 of this Form 10-K included the audits of the financial statement schedules listed in the accompanying index for each of the two years in the period ended September 30, 1992. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based upon our audits.\nIn our opinion, such financial statement schedules present fairly, in all material respects, the information set forth therein.\n\/s\/ BDO SEIDMAN\nBDO Seidman\nSpokane, Washington December 7, 1992\nSCHEDULE I\nSUMMIT SECURITIES, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES SEPTEMBER 30, 1993\nSCHEDULE VIII\nSUMMIT SECURITIES, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED SEPTEMBER 30, 1993, 1992 AND 1991\nSchedule XII\nSUMMIT SECURITIES, INC. LOANS ON REAL ESTATE September 30, 1993\nSchedule XII Continued\nSUMMIT SECURITIES, INC. LOANS ON REAL ESTATE September 30, 1993\nSIGNATURES\nPursuant 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.\nSUMMIT SECURITIES, INC.\n\/S\/ C. PAUL SANDIFUR, JR.\nBy_______________________________________________ C. Paul Sandifur, Jr., President, Director and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:\nSignature Title Date\n\/S\/ C. PAUL SANDIFUR, SR. 1\/13\/94 _________________________ Chairman of the Board _________ C. Paul Sandifur, Sr.\n\/S\/ C. PAUL SANDIFUR, Jr. President, Director and 1\/13\/94 _________________________ Chief Executive Officer _________ C. Paul Sandifur, Jr.\n\/S\/ REUEL SWANSON Secretary and 1\/13\/94 _________________________ Director _________ Reuel Swanson\n\/S\/ MICHAEL BARCELO 1\/13\/94 ________________________ Treasurer _________ Michael Barcelo\n\/S\/ STEVEN CROOKS Controller and Principal 1\/13\/94 ________________________ Accounting Officer _________ Steven Crooks\n\/S\/ ALTON R. COGERT Chief Financial Officer 1\/13\/94 ________________________ and Assistant Vice President _________ Alton R. Cogert\nAs filed with the Securities and Exchange Commission on January 13, 1994.\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\n__________________________________\nFORM 10-K\nANNUAL REPORT\nUnder\nTHE SECURITIES EXCHANGE ACT OF 1934\n__________________________\n(Exact name of registrant as specified in charter)\n__________________________\nIdaho 6799\n(State or other jurisdiction of (Primary Standard Industrial incorporation or organization Classification Code Number)\nWest 929 Sprague Avenue Spokane, Washington 99204 82-0438135 (509) 838-3111 (I.R.S. Employer (Address, including zip code Identification No.) and telephone number, including area code, of registrant's principal executive offices)\nC. Paul Sandifur, Jr. President Summit Securities, Inc. W. 929 Sprague Avenue Spokane, WA 99204 Telephone No. (509) 838-3111 _____________________________________ (Name, address, including zip code, and telephone number, including area code, of agent for service) _____________________________________\nEXHIBIT VOLUME\nEXHIBIT INDEX\nPage Number *4(c). Form of Statement of Rights, Designations and Preferences of Variable Rate Cumulative Preferred Stock Series S-1.\n*4(d). Form of Variable Rate Cumulate Preferred Stock Certificate.\n*4(e). Form of Investment Certificate.\n* Filed herewith\nExhibit 4(c)\nFORM OF STATEMENT OF RIGHTS, DESIGNATIONS AND PREFERENCES OF VARIABLE RATE CUMULATIVE PREFERRED STOCK, SERIES S-1 PURSUANT TO\n1.Name of Corporation: Summit Securities, Inc.\n2. Copy of resolution establishing and designating Variable Rate Cumulative Preferred Stock, Series S-1, and determining the relative rights and preferences thereof: Attached hereto.\n3. The undersigned does hereby certify that the attached resolution was duly adopted by the Board of Directors of the corporation on January , 1994.\n______________________________________ Reuel Swanson, Secretary\nExhibit 4(c) continued\nSUMMIT SECURITIES, INC. PREFERRED STOCK SERIES S-1 AUTHORIZING RESOLUTION\nResolved, that pursuant to the authority expressly granted and vested in the Board of Directors (the \"Board\") of this Corporation by its Articles of Incorporation, as amended, a sub-series of Preferred Stock, Series S-1 of the Corporation be, and is hereby, established which will consist of 150,000 shares of the par value of $10.00 per share ($15,000,000), shall be designated \"Variable Rate Cumulative Preferred Stock, Series S-1\" (hereafter called \"Preferred Stock\"), shall be offered at $100.00 per share and which shall have rights, preferences, qualifications and restrictions as follows:\n1. DIVIDENDS.\na) Dividends (or other distributions deemed dividends for purposes of this resolution) on the issued and outstanding shares of Preferred Stock shall be declared and paid monthly at a percentage rate per annum of the liquidation preference of $100.00 per share equal to the \"Applicable Rate,\" as hereinafter defined, or such greater rate as may be determined by the Board. Notwithstanding the foregoing, the Applicable Rate for any monthly dividend period shall, in no event, be less than 6% per annum or greater than 14% per annum. Such dividends shall be cumulative from the date of original issue of such shares and shall be payable, when and as declared by the Board, on such dates as the Board deems advisable, but at least once a year, commencing June 1, 1993. Each such dividend shall be paid to the holders of record of shares of Preferred Stock as they appear on the stock register of the Corporation on such record date as shall be fixed by the Board in advance of the payment date thereof. Dividends on account of arrears for any past Dividend Periods may be declared and paid at any time, without reference to any regular dividend payment date, to holders of record on such date as shall be fixed by the Board in advance of the payment date thereof.\nb) Except as provided below in this section, the Applicable Rate for any monthly dividend period shall be the highest of the Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate (each as defined in Exhibit A attached hereto and incorporated by reference herein) plus one half of one percentage point. In the event that the Board determines in good faith that for any reason one or more of such rates cannot be determined for any dividend period, than the Applicable Rate for such dividend period shall be the higher of whichever of such rates can be so determined. In the event that the Board determines in good faith that none of such rates can be determined for any dividend period, then the Applicable Rate in effect for the preceding dividend period shall be continued for such dividend period. The Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate shall each be rounded to the nearest five hundredths of a percentage point.\nc) No dividend shall be paid upon, or declared or set apart for, any share of Preferred Stock for any Dividend Period unless at the same time a like dividend shall be paid upon, or be declared and set apart for, all shares of Preferred Stock then issued and outstanding\nand all shares of all other series of preferred stock then issued and outstanding and entitled to receive dividends. Holders of Preferred Stock shall not be entitled to any dividend, whether payable in cash, property or stock, in excess of full cumulative dividends as herein provided. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments which may be in arrears on Preferred Stock.\nd) Dividends payable for each full monthly Dividend Period shall be computed by dividing the Applicable Rate for such monthly Dividend Period by twelve and applying such rate against the liquidation preference of $100.00 per share. Dividends shall be rounded to the nearest whole cent. Dividends payable for any period less than a full monthly Dividend Period shall be computed on the basis of 30 day months and a 360 day year. The Applicable Rate with respect to each monthly Dividend Period shall be calculated as promptly as practicable by the Corporation according to the method provided herein. The Corporation will cause notice of such Applicable Rate to be enclosed with the dividend payment check next mailed to the holders of shares of Preferred Stock.\ne) So long as any shares of Preferred Stock are outstanding, (i) no dividend (other than a dividend in common stock or in any other stock ranking junior to Preferred Stock as to dividends and upon liquidation and other than as provided in the foregoing section 1(c)) shall be declared or paid or set aside for payment; (ii) no other distribution shall be declared or made upon common stock or upon any other stock ranking junior to or on a parity with Preferred Stock as to dividends or upon liquidation; and (iii) no common stock or any other stock of the Corporation ranking junior to or on a parity with Preferred Stock as to dividends or upon liquidation shall be redeemed, purchased or otherwise acquired by the Corporation for any consideration (or any monies paid to or made available for a sinking fund for the redemption of any shares of any such stock) except by conversion into or exchange for stock of the Corporation ranking junior to Preferred Stock as to dividends and upon liquidation unless, in each case, the full cumulative dividends on all outstanding shares of Preferred Stock shall have been paid or declared and set apart for all past dividend payment periods.\nf) The holders of Preferred Stock shall be entitled to receive, when and as declared by the Board, dividend distributions out of the funds of the Corporation legally available therefor. Any distribution made which may be deemed to have been made out of the capital surplus of Preferred Stock shall not reduce either the redemption process or the liquidation rights as hereafter specified.\n2. REDEMPTION.\na) The Corporation, at its option, may redeem shares of Preferred Stock, in whole or in part, at any time or from time to time, at redemption prices hereafter set forth plus accrued and unpaid dividends to the date fixed for redemption.\ni) In the event of a redemption of shares pursuant to this subsection prior to January 1, 1995, the redemption price shall be $102.00 per share; and the redemption price shall be $100.00 per share in the event of redemption anytime after December 31, 1994.\nii) In the event that fewer than all of the outstanding shares of Preferred Stock are to be redeemed, the number of shares to be redeemed shall be determined by the Corporation and the shares to be redeemed shall be determined by lot, or pro rata, or by any other method, as may be determined by the Corporation in its sole discretion to be equitable.\niii) In the event that the Corporation shall redeem shares hereunder, notice of such redemption shall be given by first class mail, postage prepaid, mailed not less than 30 days or more than 60 days prior to he redemption date, to each holder of record of the shares to be redeemed, at such holder's address as it appears on the stock register of the Corporation. Each such notice shall state: (i) the redemption date; (ii) the number of shares to be redeemed and, if fewer than all shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (iii) the redemption price; (iv) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; and (v) that dividends on the shares to be redeemed will cease to accrue on such redemption date.\niv) Notice having been mailed as aforesaid, from and after the redemption date (unless default shall be made by the Corporation in providing money for the payment of the redemption price), dividends on the shares so called for redemption shall no longer be deemed to be outstanding, and all rights of the holders thereof as stockholders of the Corporation (except the right to receive from the Corporation the redemption price) shall cease. Upon surrender in accordance with said notice of the certificates representing shares redeemed (properly endorsed or assigned for transfer, if the Board shall so require and the notice shall so state), such shares shall be redeemed by the Corporation at the redemption price aforesaid. In case fewer than all of the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares without cost to the holder thereof.\nb) Discretionary Redemption Upon Request of the Holder: The shares of Preferred Stock are not redeemable at the option of the holder. If, however, the Corporation receives an unsolicited written request for redemption of a block of shares from any holder, the Corporation may, in its sole discretion and subject to the limitations described below, accept such shares for redemption. Any shares so tendered, which the Corporation in its discretion, allows for redemption, shall be redeemed by the Corporation directly, and not from or through a broker or dealer, at a price equal to $97 per share, plus any declared but unpaid dividends to date if redeemed during the first year after the date of original issuance and $99 per share plus any declared but unpaid dividends if redeemed thereafter. The Corporation may change such optional redemption prices at any time with respect to unissued shares.\nFor a period of three years from the date of initial sale of each share of Preferred Stock, any such optional redemption of such share shall occur only upon the death or major medical emergency of the holder or any joint holder of the share requested to be redeemed. Any optional redemption of a share in any calendar year after the third year from the date of sale of the share, not arising from the death or medical emergency of the holder or any joint holder shall occur only\nwhen the sum of all optional redemptions (including those arising out of the death or medical emergency of the holder or any joint holder) of shares of Preferred Stock during that calendar year shall not exceed 10% of the number of shares of Preferred Stock outstanding at the end of the preceding calendar year. In the event the 10% limit is reached in any calendar year, the only redemption which may thereafter occur during that calendar year shall be those arising from the death or medical emergency of the holder or any joint holder; provided, however, that to the extent that total optional redemptions in any calendar year do not reach the 10% limit, the amount by which such optional redemptions shall fall short of the 10% limit may be carried over into ensuing years; and provided further that to the extent that all redemptions, including those involving the death or medical emergency of the holder or any joint holder, exceed the 10% in any year, the amount by which such redemptions exceed the 10% limit shall reduce the limit in the succeeding year for limiting redemptions not involving the death or medical emergency of a holder or any joint holder. In no event shall such optional redemptions of all types in a single calendar year exceed 20% of the number of shares of Preferred Stock outstanding at the end of the preceding calendar year.\nThe Corporation may not redeem any such shares tendered for redemption if to do so would be unsafe or unsound in light of the Corporation's financial condition (including its liquidity position); if payment of interest or principal on any outstanding instrument of indebtedness is in arrears or in default; or if payment of any dividend on Preferred Stock or share of any stock of the Company ranking at least on a parity therewith is in arrears as to dividends.\nc) Any shares of Preferred Stock which shall at any time have been redeemed shall, after such redemption, have the status of authorized but unissued shares of Preferred Stock, without designation as to series until such shares are designated as part of a particular series by the Board.\nd) Notwithstanding the foregoing provisions of this Section 2, if any dividends on Preferred Stock are in arrears, no shares of Preferred Stock shall be redeemed unless all outstanding shares of Preferred Stock are simultaneously redeemed, and the Corporation shall not purchase or otherwise acquire any shares of Preferred Stock; provided, however, that the foregoing shall not prevent the purchase or acquisition of shares of Preferred Stock pursuant to a purchase or exchange offer made on the same terms to holders of all of the outstanding shares of Preferred Stock.\n3. CONVERSION OR EXCHANGE. The holders of shares of Preferred Stock shall not have any rights to convert such shares into or exchange such shares for shares of any other class or series of any class of securities of the Corporation.\n4. VOTING. Except as required from time to time by law, the shares of Preferred Stock shall have no voting powers. Provided, however, not withstanding the foregoing, that whenever and as often as dividends payable on any shares of Preferred Stock shall be in arrears in an amount equal to twenty four full monthly dividends or more per share, the holders of Preferred Stock together with the holders of any other preferred stock hereafter authorized, voting separately and as a single class shall be entitled to elect a majority of the Board of\nDirectors of the Corporation. Such right shall continue until all dividends in arrears on preferred stock have been paid in full.\n5. LIQUIDATION RIGHTS.\na) Upon the dissolution, liquidation or winding up of the Corporation, the holders of the shares of Preferred Stock shall be entitled to receive out of the assets of the Corporation, before any payment or distribution shall be made on the Common Stock, or on any other class of stock ranking junior to Preferred Stock, upon liquidation, the amount of $100.00 per share, plus a sum equal to all dividends (whether or not earned or declared) on such shares accrued and unpaid thereon to the date of final distribution.\nb) Neither the sale, lease or conveyance of all or substantially all the property or business of the Corporation, nor the merger or consolidation of the Corporation into or with any other corporation or the merger or consolidation of any other corporation into or with the Corporation, shall be deemed to be a dissolution, liquidation or winding up, voluntary or involuntary, for the purposes of this Section.\nc) After the payment to the holders of the shares of Preferred Stock of the full preferential amounts provided for in this Section, the holders of Preferred Stock as such shall have no right or claim to any of the remaining assets of the Corporation.\nd) In the event the assets of the Corporation available for distribution to the holders of shares of Preferred Stock upon any dissolution, liquidation or winding up of the Corporation, whether voluntary or involuntary, shall be insufficient to pay in full all amounts to which such holders are entitled pursuant to this Section, no such distribution shall be made on account of any shares or any other series of Preferred Stock or any other class of stock ranking on a parity with the shares of Preferred Stock upon such dissolution, liquidation or winding up, unless proportionate distributive amounts shall be paid on account of the shares of Preferred Stock, ratably in accordance with the sums which would be payable in such distribution if all sums payable in respect of the shares of all series of Preferred Stock and any such other class of stock as aforesaid were discharged in full.\n6. PRIORITIES. For purposes of this Resolution, any stock of any class or classes of the Corporation shall be deemed to rank:\na) Prior to the shares of Preferred Stock, either as to dividends or upon liquidation if the holders of such class or classes shall be entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or winding up of the Corporation, as the case may be, in preference or priority to the holders of shares of Preferred Stock.\nb) On a parity with shares of Preferred Stock, either as to dividends or upon liquidation, whether or not the dividend rates, dividend payment dates or redemption or liquidation prices per share or sinking fund provisions, if any, are different from those of Preferred Stock, if the holder of such stock shall be entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or\nwinding up of the Corporation, as the case may be, in proportion to their respective dividend rates or liquidation prices, without preference or priority, one over the other, as between the holder of such stock and the holders of Preferred Stock; and\nc) Junior to shares of Preferred Stock, either as to dividends or upon liquidation, if the holders of shares of Preferred Stock shall be entitled to receipt of dividends or of amounts distributable upon dissolution, liquidation or winding up of the Corporation, as the case may be, in preference or priority to the holders of shares of such class or classes.\n7. SHARES NON-ASSESSABLE. Any and all shares of Preferred Stock issued, and for which the full consideration has been paid or delivered, shall be deemed fully paid stock and the holder of such shares shall not be liable for any further call or assessment or any other payment thereon.\n8. PRE-EMPTIVE RIGHTS. Holders of Preferred Stock shall have no pre-emptive rights to acquire additional shares of Preferred Stock.\nEXHIBIT A\nTreasury Bill Rate\nExcept as provided below in this paragraph, the \"Treasury Bill Rate\" for each dividend period will be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period (as defined below)) for three-month U.S. Treasury bills, as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the ten calendar days immediately preceding the first day of the dividend period for which the dividend rate on Preferred Stock Series E-5, is being determined. In the event that the Federal Reserve Board does not publish such a weekly per annum market discount rate during any such Calendar Period, then the Treasury Bill Rate for the related dividend period shall be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period) for three-month U.S. Treasury bills, as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company. In the event that a per annum market discount rate for three-month U.S Treasury bills shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Treasury Bill Rate for such dividend period shall be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period) for all of the U.S. Treasury bills then having maturities of not less than 80 nor more than 100 days, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such rates, by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company. In the event that the Company determines in good faith that for any reason no such U.S. Treasury bill rates are published as provided above during such Calendar Period, then the Treasury Bill Rate for such dividend period shall be the arithmetic average of the per annum market discount rates based upon bids during such Calendar Period for each of the issues of marketable non-interest bearing U.S. Treasury securities with a maturity of not less than 80 nor more than 100 days from the date of each such quotation, as quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the Company by at least three recognized primary U.S. Government securities dealers selected by the Company. In the event that the Company determines in good faith that for any reason the Company cannot determine the Treasury Bill Rate for any dividend period as provided above in this paragraph, the Treasury Bill Rate for such dividend period shall be the arithmetic average of the per annum market discount rates based upon the closing bids during such Calendar Period for each of the issues of marketable interest-bearing U.S. Treasury securities with a maturity of not less than 80 nor more than 100 days from the date of each such quotation, as quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the Company by at least three recognized primary U.S. Government securities dealers selected by the Company.\nTen Year Constant Maturity Rate\nExcept as provided below in this paragraph, the \"Ten Year Constant Maturity Rate\" for each dividend period shall be the arithmetic average of the two most recent weekly per annum Ten Year Average Yields (or the one weekly per annum Ten Year Average Yield, if only one such Yield shall be published during the relevant Calendar Period as provided below, as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the ten calendar days immediately preceding the first day of the dividend period for which the dividend rate on Preferred Stock, Series E-5 is being determined. In the event that the Federal Reserve Board does not publish such a weekly per annum Ten Year Average Yield during such Calendar Period, then the Ten Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the two most recent weekly per annum Ten Year Average Yields (or the one weekly per annum Ten Year Average Yield, if only one such Yield shall be published during such Calendar Period), as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company. In the event that a per annum Ten Year Average Yield shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Ten Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the two most recent weekly per annum average yields to maturity (or the one weekly average yield to maturity, if only one such yield shall be published during the relevant Calendar Period) for all of the actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities (as defined below)) then having maturities of not less tan eight nor more than twelve years, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such yields, by any Federal Reserve Bank o by any U.S. Government department or agency selected by the Company. In the event that the Company determines in good faith that for any reason the Company cannot determine the Ten Year Constant Maturity Rate for any dividend period as provided above in this paragraph, then the Ten Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the per annum average yields to maturity based upon the closing bids during such Calendar Period for each of the issues of actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) with a final maturity date not less than eight nor more than twelve years from the date of each such quotation, as quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the Company by at least three recognized primary U.S. Government securities dealers selected by the Company.\nTwenty Year Constant Maturity Rate\nExcept as provided below in this paragraph, the \"Twenty Year Constant Maturity Rate\" for each dividend period shall be the arithmetic average of the two most recent weekly per annum Twenty Year Average Yields (or the one weekly per annum Twenty year Average Yield, if only one such Yield shall be published during the relevant Calendar Period), as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the ten calendar days immediately preceding the first day of the dividend period for which the dividend rate on Preferred Stock, Series E-5 is being determined. In the event\nthat the Federal Reserve Board does not publish such a weekly per annum Twenty Year Average Yield during such Calendar Period, then the Twenty Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the two most recent weekly per annum Twenty Year Average Yields (or the one weekly per annum Twenty Year Average Yield, if only one such Yield shall be published during such Calendar Period), as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company. In the event that a per annum Twenty Year Average Yield shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Twenty Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the two most recent weekly per annum average yields to maturity (or the one weekly average yield to maturity, if only one such yield shall be published during such Calendar Period) for all of the actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) then having maturities of not less than eighteen nor more than twenty-two years, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such yields, by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company. In the event that the Company determines in good faith that for any reason the Company cannot determine the Twenty Year Constant Maturity Rate for any dividend period as provided above in this paragraph, then the Twenty Year Constant Maturity Rate for such dividend period shall be the arithmetic average of the per annum average yields to maturity based upon the closing bids during such Calendar Period for each of the issues of actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) with a final maturity date not less than eighteen nor more than twenty-two years from the date of each such quotation, as quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the Company by at least three recognized primary U.S. Government securities dealers selected by the Company.\nAs used herein, the term \"Calendar Period\" means a period of 14 calendar days; the term \"Special Securities\" means securities which may, at the option of the holder, be surrendered at face value in payment of any federal estate tax or which provide tax benefits to the holder and are priced to reflect such tax benefits or which were originally issued at a deep or substantial discount; the term \"Ten Year Average Yield\" means the average yield to maturity for actively traded marketable U.S. Treasury fixed interest rate securities (adjusted to constant maturities of ten years); and the term \"Twenty Year Average Yield\" means the average yield to maturity for actively traded marketable U.S. Treasury fixed interest rate securities (adjusted to constant maturities of 20 years).\nExhibit 4(d)\n(FORM OF VARIABLE RATE CUMULATIVE PREFERRED STOCK CERTIFICATE)\nCertificate No. Shares\nSUMMIT SECURITIES, INC. INCORPORATED UNDER THE LAWS OF THE STATE OF IDAHO\nVARIABLE RATE CUMULATIVE PREFERRED STOCK SERIES\n(Par Value: $10.00 per share; Liquidation Preference: $100.00 per share)\nThis certifies that is the registered holder of shares of Variable Rate Cumulative Preferred Stock, Series of Summit Securities, Inc. transferable only on the books of the Corporation upon surrender of this certificate properly endorsed by the holder hereof in person or by attorney-in-fact.\nThe Corporation will provide to any registered holder of stock of the Corporation, upon request and without charge, a full statement of the designations, preferences, limitations and relative rights of the shares of each class of stock authorized to be issued by the Corporation, the variations in the relative rights and preferences between the shares of each series of each class of stock so far as the same have been fixed and determined, and the authority of the Board of Directors to fix and determine the rights and preferences of subsequent series.\nIn witness whereof the Corporation has caused this certificate to be signed by its duly authorized officers and the facsimile of its corporate seal imprinted hereon.\nIssue Date:\n________________________________ ________________________________ Secretary or Assistant Secretary President or Vice President\nExhibit 4(e)\nSUMMIT SECURITIES,INC. HARBOR CENTER, 1000 WEST HUBBARD, SUITE 140 COEUR D' ALENE, ID 83814-2276\nINVESTMENT CERTIFICATE, SERIES A\nPrincipal Issue Maturity Interest Certificate Amount Date Date Rate Number\nInterest: Amortization Term: Months:\nIssued To:\nTHE CERTIFICATE This is a duly authorized Certificate of Summit Securities, Inc. (\"Summit\"). This Certificate is issued under an Indenture dated July 25, 1990 (\"Indenture\") between Summit and West One Bank, Idaho, N.A. as Trustee (\"Trustee\"). The Indenture permits Summit to issue an unlimited amount of Certificates, the terms of which may vary according to series. This Certificate is of the series stated above; that series is not limited in aggregate principal amount as stated in the Indenture (or supplemental indentures). The Indenture (and supplemental indentures) contains statements of the rights of the Certificateholders, Summit and the Trustee and provision concerning authentication and delivery of the Certificates. Definitions of certain terms used in the Certificate are also found in the Indenture (and supplemental indentures).\nPAYMENT OF PRINCIPAL For value received, Summit promises to pay the principal amount of this Certificate at the maturity date stated above. Payment will be made to the Person to whom this Certificate is issued or registered assigns.\nPAYMENT OF INTEREST Summit promises to pay interest on the principal amount of this Certificate from the issue date until the principal amount is paid or made available for payment. Interest will be computed at the annual interest rate stated above. Interest will be payable or compounded as stated above or as otherwise elected by the Person entitled to payment of interest. Summit will pay interest to the Person in whose name this Certificate (or one or more Predecessor Certificates) is registered at the close of business on the Regular Record Date for the payment of interest. The Regular Record Date is the 15th date of the calendar month immediately preceding an Interest Payment Date.\nCOMPOUNDING OF INTEREST If the Person entitled to payment of interest so elects, Summit will compound interest rather than pay interest in installments. Interest will be compounded on a semiannual basis at the interest rate\nstated above from the Interest Payment Date immediately preceding receipt by Summit of the compounding election. Interest will be compounded from the issue date of the Certificate if Summit receives the compounding election prior to the first Interest Payment Date. Interest will be compounded until the maturity date stated above and will be paid on such date. Prior to maturity, however, Summit will pay at the Certificateholder's request the interest accumulated in the last two semiannual compounding periods before Summit receives the request, together with the interest accrued from the end of the last such semiannual period. Interest compounded prior to the last two semiannual compounding periods is payable only onthe maturity date stated above.\nALTERNATIVE INSTALLMENT PAYMENTS OF PRINCIPAL AND INTEREST If so elected by the Person to whom this Certificate is originally issued, Summit promises, in lieu of the foregoing provisions for payment of principal and interest, to pay equal monthly installments of principal and interest, commencing thirty days from the issue date, until the maturity date, at which time the remaining principal amount, if any, together with all unpaid accrued interest, shall be paid. The amount of each monthly installment shall be the amount necessary to amortize the principal amount at the specified interest rate during the specified amortization term.\nPREPAYMENT ON DEATH In the event of a Certificateholder's death, any person entitled to receive some or all of the proceeds of this Certificate may elect to have his or her share of the principal and any unpaid interest prepaid in full in five consecutive equal monthly installments. Interest on the declining principal balance of that share will continue to accrue at the interest rate stated above. Any request for prepayment must be made in writing to Summit. The request must be accompanied by the Certificate and evidence, satisfactory to Summit, of the Certificateholder's death. Before Summit prepays the Certificate, it may require additional documents or other material it considers necessary to establish the Persons entitled to receive some or all of the proceeds of the Certificate. Metropolitan may also require proof of other facts relevant to its obligation to prepay the Certificate in the event of death.\nMISCELLANEOUS The provisions on the reverse are part of this Certificate.\nThis Certificate is not entitled to any benefit under the Indenture nor is this Certificate valid or obligatory for any purpose unless the certificate of authentication below has been executed by the Trustee by manual signature. This Certificate is not insured by the United States government, the State of Idaho nor any agency thereof. In witness whereof, Summit has caused this Certificate to be duly executed under its corporate seal.\nSUMMIT SECURITIES, INC.\nAttest:_________________________ By:_______________________________ Secretary or Assistant Secretary Chairman of the Board, President or Vice President\nCERTIFICATE OF AUTHENTICATION This is one of the Certificates referred to in the within-mentioned Indenture\nWEST ONE BANK, IDAHO, N.A. as Trustee\nBy:_____________________________________ Authorized Signature\n(reverse of Certificate)\nTRANSFER AND EXCHANGE Transfer and exchange of this Certificate are conditioned by certain provisions in the Indenture. To effect a transfer, the Holder must surrender this Certificate at Summit's office or agency in Coeur d'Alene, Idaho or such other place as may be designated by Summit. This Certificate must be duly endorsed or accompanied by a written instrument of transfer satisfactory to Summit. Upon transfer, one or more new Certificates of the same series of authorized denominations and for the same aggregate principal amount will be issued to the designated transferee or transferrers. Prior to due presentment for registration of transfer, Summit, the Trustee or any of their agents may treat any Person in whose name this Certificate is registered as the owner of this Certificate, regardless of notice to the contrary or whether this Certificate might be overdue. This Certificate is issuable only as a registered Certificate; it does not bear coupons. As provided in the Indenture, this Certificate is exchangeable for the other Certificates of the same series of authorized denominations with the same aggregate principal amount. To effect an exchange, the Holder must surrender this Certificate at Summit's office or agency in Coeur d' Alene, Idaho or such other place as may be designated by Summit. The Certificate must be duly endorsed or accompanied by a written instrument of exchange satisfactory to Summit. No service charge will be made for a transfer or exchange, but Summit may require payment of a sum sufficient to cover any governmental charge in connection with such transaction.\nAMENDMENT OF THE INDENTURE; WAIVER OF RIGHTS With certain exceptions, the Indenture may be amended, the obligations and rights of Summit may be modified and the rights of the Certificateholders may be modified by Summit at any time with the consent of the Holders of 66-2\/3% in aggregate principal amount of the Certificates at the time Outstanding. The Indenture allows the Holders of specified percentages in aggregate principal amount of the Certificates of a particular series to waive compliance by Summit with certain indenture provisions and to waive past defaults and their consequences on behalf of all the Holders of Certificates of that series. Any such consent or waiver by the Holder of this Certificate will be binding upon that Holder. The consent or waiver will also be binding upon all future Holders of this Certificate and of any Certificate issued upon the transfer of, or in exchange for or in lieu of this Certificate, whether or not that consent or waiver is noted upon the Certificate.\nFAILURE TO PAY INTEREST OR INSTALLMENTS; EVENTS OF DEFAULT If interest or any installment of principal and interest is not punctually paid or duly provided for, it shall cease to be payable to the registered Holder of this Certificate on the applicable Regular Record Date. Instead, the Trustee will fix a Special Record Date for payment of the Defaulted Interest or installments. The Trustee will give the Certificateholders notice of the Special Record Date at lease 10 days prior to the Special Record Date. The Person in whose name this Certificate (or one or more Predecessor Certificates) is registered at the close of business on the Special Record Date will be entitled to payment of the Defaulted Interest or installment. If the Certificates are listed on a securities exchange, however, the\nDefaulted Interest or installment may be paid at any time and in any lawful manner consistent with the requirements of the exchange. If an Event of Default occurs, the principal of all the Certificates may be declared due and payable as provided in the Indenture.\nFORM OF PAYMENT Payment of principal and interest will be made at the office or agency of Summit maintained for that purpose in Coeur d'Alene, Idaho or such other place as may be designated by Summit. Payment will be made in coin or currency of the United States of America that is legal tender for payment of public and private debts at the time of payment. At Summit's option, however, payment of interest may be made by check mailed to the Person entitled to the interest at that Person's address as it appears in the Certificate Register.\nBUSINESS DAYS Whenever any interest Payment Date, the Stated Maturity of this Certificate or any date on which any Defaulted Interest or installment is proposed to be paid is not a business day, the appropriate payment or compounding of interest or principal may be made on the next succeeding Business Day without accrual of additional interest.\nCERTAIN DEFINITIONS Summit is an Idaho corporation. The term \"Summit\" includes any successor corporation under the Indenture. The term \"Trustee: includes any successor Trustee under the Indenture.","section_15":""}
{"filename":"278243_1993.txt","cik":"278243","year":"1993","section_1":"ITEM 1. BUSINESS\nLa Quinta Inns, Inc. (\"La Quinta\" or the \"Company\") is a leader in the upper economy segment of the lodging market. Founded in 1968, the La Quinta chain's 221 inns are located in 29 states with concentrations in Texas, Florida and California. As of January 31, 1994, the Company owned interests in and operated all but one of its inns. The Company maintains a minority interest in nine inns which it manages pursuant to long-term management contracts and has one licensed inn.\nLa Quinta is incorporated under the laws of Texas and maintains its executive offices at Weston Centre, 112 East Pecan Street, P.O. Box 2636, San Antonio, Texas 78299-2636, telephone (210) 302-6000.\nPRODUCT\nLa Quinta inns appeal to guests who desire high-quality rooms and convenient locations at attractive prices and whose needs do not include banquet and convention facilities, in-house restaurants, cocktail lounges or room service. As a result of the cost savings associated with the elimination of these management intensive facilities and services, the Company believes it is able to offer its guests an excellent value -- convenient locations and room quality comparable to mid-priced full service hotels at a lower price.\nLa Quinta inns contain an average of 130 spacious, quiet and comfortably furnished rooms with an average of 300 square feet. Each inn features a choice of rooms for non-smokers and smokers, complimentary continental breakfast, free unlimited local telephone calls, remote-control television with Showtime or The Movie Channel, telecopy services, same day laundry and dry cleaning service, 24-hour front desk and message service and free parking. La Quinta inns are generally located near interstate highways, major traffic arteries or destination areas such as airports and convention centers. Food service to La Quinta guests generally is provided by adjacent free-standing restaurants.\nLa Quinta's strategy is to continue its growth as a high-quality provider in the upper economy segment of the hotel industry, focusing on enhancing revenues, cash flow and profitability. Specifically, the Company's strategy centers upon:\nCONTINUED FOCUS ON UPPER ECONOMY SEGMENT - The upper economy segment of the lodging industry is characterized by inns that provide for the basic needs of cost-conscious business travelers who desire high-quality rooms and convenient locations. Because the Company competes primarily in the upper economy segment, management's attention is totally focused on meeting the needs of La Quinta's target customers. The upper economy segment is one of the fastest growing segments in the lodging industry, growing over 5% annually, since 1989.\nLA QUINTA MANAGEMENT OF INNS - In contrast to many of its competitors, La Quinta manages and has ownership interests in virtually all of its inns. La Quinta manages all but one of the 221 inns in the chain. At January 31, 1994, the Company owned 100% of 166 inns and 40% or more of an additional 45. As a result, the Company believes it is able to achieve a higher level of consistency in both product quality and service than its competition. In addition, La Quinta's position as one of the few primarily owner-operated chains enables La Quinta to offer new services, direct expansion, effect pricing and to make other marketing decisions on a system-wide or local basis as conditions dictate, usually without consulting third-party owners, management companies or franchisees as required of most other lodging chains. The Company's management of the inns also enables it to control costs and allocate resources effectively to provide excellent value to the consumer.\nIMAGE ENHANCEMENT PROGRAM - In 1993, La Quinta has undertaken a comprehensive chainwide image enhancement program intended to give its properties a new, fresh, crisp appearance while preserving their unique character. The program features new signage displaying a new logo as well as exterior and lobby upgrades including brighter colors, more extensive lighting, additional\nlandscaping, enhanced guest entry and a full lobby renovation with contemporary furnishings and seating area for continental breakfast. Thirty nine properties completed the reimaging process in 1993 with program completion targeted for June 1994.\nREGIONALLY FOCUSED GROWTH - La Quinta acquired eleven existing lodging facilities and converted them to the La Quinta brand in 1993 and anticipates expanding in a similar manner in 1994.\nCOMPETITION\nInns operated and licensed by La Quinta are in competition with other major lodging brands. Each La Quinta inn competes in its market area with numerous full service lodging brands, especially in the mid-priced range, and with numerous other hotels, motels and other lodging establishments. Chains such as Hampton Inns, Red Roof Inns, Fairfield Inns and Drury Inns are direct competitors of La Quinta. Other well-known competitors include Holiday Inns, Ramada Inns, Quality Inns, and Travelodge. There is no single competitor or group of competitors of La Quinta that is dominant in the lodging industry. Competitive factors in the industry include reasonableness of room rates, quality of accommodations, degree of service and convenience of locations.\nDemand is affected by normally recurring seasonal patterns. At most La Quinta inns demand is higher in the spring and summer months (March through August) than in the balance of the year. Overall occupancy levels may also be affected by the number of new inns opened by the Company and the length of time such inns have been in operation.\nThe lodging industry in general, including La Quinta, may be adversely affected by national and regional economic conditions and government regulations. The demand for accommodations at a particular inn may be adversely affected by many factors including changes in travel patterns, local and regional economic conditions and the degree of competition with other inns in the area.\nSTRUCTURE AND OWNERSHIP\nThe Company is a combined entity comprised of La Quinta Inns, Inc., which owns and operates 211 inns, four subsidiaries and 16 combined unincorporated partnerships and joint ventures. The combined unincorporated partnerships and joint ventures own 45 inns operated by the Company. The Company manages 9 inns, 99% owned by CIGNA which are accounted for using the equity method in the Company's financial statements.\nDuring 1993, the Company acquired, in separately negotiated transactions, limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures which owned 44 La Quinta inns. The Company purchased the ownership interests for an aggregate purchase price of $87,897,000 which included cash at closing, the assumption of $22,824,000 of existing debt attributable to certain limited partners' interests, and $29,878,000 in notes to certain sellers.\nThe Board of Directors of the Company authorized three-for-two stock splits effective in October 1993 and March 1994. References to the Company's common stock prior to the October split is described herein as \"pre-split\" and references to the Company's common stock after the March split is described herein as \"post split\".\nOn October 27, 1993, the Company entered into a definitive Partnership Acquisition Agreement (the \"Merger Agreement\") with La Quinta Motor Inns Limited Partnership (\"the Partnership\" or \"LQP\") and other parties, pursuant to which the Company, through wholly-owned subsidiaries, would acquire all units of the Partnership (the \"Units\") that it did not beneficially own at a price of $13.00 net per Unit in cash. The Merger Agreement provided for a tender offer (the \"Offer\") for all of the Partnership's outstanding Units at a price of $13.00 net per Unit in cash, which Offer commenced on November 1, 1993 and expired at midnight on November 30, 1993. The Offer resulted in the purchase of 2,805,190 Units (approximately 70.6% of the outstanding Units) by the Company through its wholly-owned subsidiary, LQI Acquisition Corporation. As a result of a contribution of additional units previously owned by the Company subsequent to the Offer, LQI Acquisition Corporation beneficially owned 3,257,890 Units (approximately 82% of the Units) at December 31, 1993. Pursuant to the Merger Agreement, a Special Meeting of Unitholders was then held on January 24, 1994 to approve the merger of a subsidiary of LQI Acquisition Corporation with and into the Partnership, with the Partnership as the surviving entity. As a result of this merger which was approved by the requisite vote of Unitholders on January 24, 1994, all of the Partnership's outstanding Units other than Units\nowned by the Company or any direct or indirect subsidiary of the Company were converted into the right to receive $13.00 net in cash without interest.\nThe following table describes the composition of inns in the La Quinta chain at:\nJOINT VENTURES AND PARTNERSHIPS. La Quinta historically financed its development, in part, through partnerships and joint ventures with large insurance companies or financial institutions. Under the terms of the joint venture and partnership agreements, available cash flow is generally used to pay debt and provide for capital improvements, with remaining cash flow being distributed to the partners in accordance with their respective ownership interests. In 1993 La Quinta began to purchase the interests in the unincorporated joint ventures and partnerships, acquiring 14 by the end of the year. In addition, the Company successfully completed the acquisition of LQP in January 1994. See further discussions above.\nIn March of 1990, the Company entered into the La Quinta Development Partners, L.P. (\"LQDP\" or the \"Development Partnership\") with AEW Partners, L.P. (\"AEW Partners\"). La Quinta Inns, Inc. is the general partner and owns a 40% ownership interest and AEW Partners is the limited partner and owns a 60% ownership interest. This partnership was established for the purpose of owning, operating, acquiring and developing inns. La Quinta originally contributed 18 inns with a deemed value of $44,000,000 (net of existing debt assumed by LQDP) and $4,000,000 in cash. AEW Partners contributed $3,000,000 and a promissory note (\"the AEW Note\") to the Development Partnership in the amount of $69,000,000. Under the terms of the agreement, proceeds from the AEW Note are to be used for the construction of inns or for the acquisition and conversion of existing inns into the La Quinta brand. In 1993, the AEW Partners fully paid the balance of the AEW Note. At December 31, 1993, the Development Partnership had acquired and converted 19 inns (nine during 1993). Under the terms of the Development Partnership agreement, AEW Partners currently has the ability to convert 66 2\/3% of its ownership interest in the Development Partnership to 3,535,976 (post-split) shares of the Company's common stock. Such number of shares is reduced as distributions are made out of the Development Partnership to AEW Partners. The partnership units may be converted at any time prior to December 31, 1998. As of December 31, 1993, no partnership units had been converted. Shares of the Company's common stock issuable upon conversion are antidilutive at December 31, 1993.\nUnder the terms of a management agreement between the Company and the Development Partnership, La Quinta earns management, national advertising, chain services and license fees for the use of its name and services. La Quinta is also entitled to receive acquisition and conversion fees for its services in finding inns suitable for acquisition and in managing the conversion of such inns. La Quinta is also entitled to receive fees on project costs of inns constructed by the Development Partnership.\nMANAGED INNS. In 1987, the Company formed two joint ventures with investment partnerships managed by CIGNA Investments, Inc. (\"CIGNA I\" and \"CIGNA II\"). The Company maintains a 1% ownership interest in\neach of these ventures and manages the inns pursuant to long-term management contracts. As of December 31, 1993, the ventures owned nine inns and six free-standing restaurants operated by third parties.\nLa Quinta receives licensing, management, national advertising and chain services fees for the use of its brand name and services from management of the inns. The Company accounts for its ownership interest in these entities using the equity method.\nLICENSING\nThe Company selectively licensed the name \"La Quinta\" to others for operations in the United States until February 1977, at which time La Quinta discontinued its domestic licensing program to unrelated third parties. One inn remains in operation under a franchise agreement.\nDuring 1990, the Company entered into a licensing agreement with Desarrollos Turisticos Vanguardia S.A. de C.V. (\"Desarrollos\") for expansion of the La Quinta chain into Saltillo, Coahuila, Mexico. In February 1994, one inn developed under the license agreement opened for operation. Under the arrangement, the inn is owned by the licensee and managed by La Quinta under a separate management agreement. The Company is currently reviewing other potential management\/licensing arrangements within Mexico and other Latin American countries.\n\"La Quinta -R-\" and \"teLQuik -R-\" have been registered as service marks by La Quinta with the U.S. Patent and Trademark Office, and in Mexico, Canada and the United Kingdom.\nOPERATIONS\nManagement of the La Quinta chain is coordinated from the Company's headquarters in San Antonio, Texas. Centralized corporate services and functions include marketing, accounting and reporting, purchasing, quality control, development, legal, reservations and training.\nInn operations are currently organized into Eastern and Western divisions with each division headed by a Divisional Vice President. Regional Managers report to the Divisional Vice Presidents and are each responsible for approximately 13 inns. Regional Managers are responsible for the service, cleanliness and profitability of the inns in their regions.\nIndividual inns are typically managed by resident managers who live on the premises. Managers receive inn management training which includes an emphasis on service, cleanliness, cost controls, sales and basic repair skills. Because La Quinta's professionally trained managers are substantially relieved of responsibility for food service, they are able to devote their attention to assuring friendly guest service and quality facilities, consistent with chain-wide standards. On a typical day shift, they will supervise one housekeeping supervisor, eight room attendants, two laundry workers, two general maintenance persons and three front desk service representatives.\nAt December 31, 1993, La Quinta employed approximately 6,100 persons, of whom approximately 88% were compensated on an hourly basis. Approximately 240 individuals were employed at corporate and 5,850 were employed in inn management and services. The Company's employees are not currently represented by labor unions. Management believes its ongoing labor relations are good.\nMARKETING\nLa Quinta's primary media focus is on business travelers, who account for over half of La Quinta's rooms rented. The Company's core market consists of business travelers who visit a given area several times per year. For example, typical customers include salespersons covering a regional territory, government and military personnel and technicians. The profile of a typical La Quinta customer is a college educated business traveler, age 25 to 54, from a two income household who has a middle management, white collar occupation or upper level blue collar occupation. In addition, the Company's target markets include vacation travelers and retired travelers. The Company focuses on reaching its target markets by utilizing advertising, direct sales, programs which provide incentives to repeat travelers, and other marketing programs targeted at specific customer segments.\nThe Company advertises primarily through network and local radio, cable television networks and print advertisements which focus on value. The Company utilizes the same campaign concept throughout the country with minor modifications made to address regional differences. The Company also utilizes billboard advertisements along major highways which announce a La Quinta inn's presence in upcoming towns.\nThe Company markets directly to companies and other organizations through its direct sales force of 24 sales representatives and managers. This sales force calls on companies which have a significant number of individuals traveling in the regions in which La Quinta operates and which are capable of producing a high volume of room nights.\nLa Quinta enjoys a large amount of repeat business. Based on internal surveys conducted in 1993, management estimates the average customer spent approximately 14 nights per year in a La Quinta inn during the year ended December 31, 1993. The Company focuses a number of marketing programs on maintaining the high number of repeat visits. La Quinta promotes a \"Returns Club\" for repeat guests. This club provides its members with preferred status and rates when checking into a La Quinta inn and offers rewards for frequent stays. The Returns Club currently has over 140,000 members.\nThe Company provides a reservation system, \"teLQuik\" -R-, which currently accounts for reservations for approximately 50% of room occupancy. The teLQuik system allows customers to make reservations toll free or from special reservations phones placed in the lobbies of all La Quinta inns. The teLQuik system enables guests to make their next night's reservations from their previous night's La Quinta inn. In 1994, the Company completed a new reservation center which is a part of its program to improve operating results by providing state-of-the-art technology in processing reservations more efficiently. La Quinta, through its national sales managers, markets its reservation services to travel agents and corporate travel planners who may access teLQuik through the five major airline reservation systems.\nASSET MANAGEMENT\nLa Quinta's asset management strategy is founded on the importance of ownership of all or a significant portion of each of its inns. See \"Structure and Ownership\" on this Form 10-K. Management believes that Company ownership and management of La Quinta inns enables the Company to achieve more consistency in quality and service than its competitors.\nHistorically, the Company financed a large part of its development through partnerships and joint ventures with large insurance companies and other financial institutions, while managing the inns. However, during 1993, the Company acquired in separately negotiated transactions limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures that owned 44 La Quinta inns. The Company also completed the acquisition of 100% of the limited partners' interests in an additional 31 inns owned by a subsidiary of LQP in January of 1994, after acquiring 82% of LQP during 1993. Additionally, the Company acquired eleven existing inns during 1993. Currently, the Company owns 100% of 166 inns and between 40%-80% of 45 other inns. The Company manages an additional nine La Quinta inns in which it owns a 1% interest.\nLa Quinta's current development program focuses on the acquisition of competitor properties at discounts to replacement costs. At current prices, acquisition and conversion of existing properties is more cost effective than new construction. In 1993, La Quinta acquired and is converting a total of eleven inns, nine were purchased through the Development Partnership and two were purchased as wholly-owned, with an aggregate of 1,611 rooms, at an average cost of approximately $28,000 per room.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nLa Quinta inns appeal to guests who desire high-quality rooms and whose needs do not include banquet and convention facilities, in-house restaurants, cocktail lounges or room service. La Quinta inns contain an average of 130 rooms and provide spacious, quiet and comfortably furnished rooms with an average of 300 square feet, a choice of rooms for non-smokers and smokers, complimentary continental breakfast, free unlimited local telephone calls, remote-control television with Showtime or The Movie Channel, telecopy services, same-day laundry and dry cleaning service, 24-hour front desk and message service and free parking.\nTo maintain the overall quality of La Quinta's inns and to remain competitive in its service-oriented environment, each inn undergoes refurbishments and capital improvements as needed. Typically, refurbishing has been provided at intervals of between five and seven years, based on an annual review of the condition of each inn. In each of the years ended December 31, 1993, 1992 and 1991, the Company spent approximately $32,600,000 (of which $15,400,000 was spent on the image enhancement program described below), $15,500,000 and $13,800,000, respectively, on capital improvements to existing inns. As a result of these expenditures, the Company believes it has been able to maintain a chainwide quality of rooms and common areas at its properties unmatched by any other national economy hotel chain.\nIn 1993, the Company undertook an image enhancement program intended to give its properties a new, fresh, crisp appearance while preserving their unique character. The program features new signage displaying a new logo as well as exterior and lobby upgrades including brighter colors, additional landscaping, enhanced guest entry and a full lobby renovation with contemporary furnishings and seating area for continental breakfast. Of the chain's 221 inns, 97 began the image enhancement program during 1993, of which 39 were complete as of December 31, 1993. Twenty properties begin the reimaging process every six to eight weeks with program completion targeted for June 1994. Signs displaying the Company's new logo were in place at substantially all properties at December 31, 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Commitments.\"\nAt December 31, 1993, there were 221 inns located in 29 states, with concentrations in Texas, Florida and California. The states and cities in which the inns are located are set forth in the following table:\nTypically, food service for La Quinta guests is provided by adjacent, free standing restaurants. At December 31, 1993, the Company had an ownership interest in 124 restaurant buildings adjacent to its inns. These restaurants generally are leased pursuant to build-to-suit leases that require the operator to pay, in addition to minimum and percentage rentals, all expenses, including building maintenance, taxes and insurance.\nThe Company's inns and restaurants were substantially pledged to secure all long-term debt maturing in various years from 1994 to 2015 (See note 2 of Notes to Combined Financial Statements).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn October 18, 1993, the Company announced that its Board of Directors had authorized its officers to enter into negotiations with La Quinta Motor Inns Limited Partnership (the \"Partnership\") regarding the acquisition of all units of the Partnership which it did not currently own, at a price of up to $12 per unit. See \"Structure and Ownership\" on this Form 10-K. On October 18, 1993, the Board of Directors of the General Partner of the Partnership elected three independent directors (the \"Special Committee\"), among other things, to negotiate the sale of Units to the Company. On October 18, 1993, two separate lawsuits were filed in Delaware Court of Chancery on behalf of the Partnership's unitholders against the Company, the Partnership, La Quinta Realty Corp., a subsidiary of the Company, and general partner of the Partnership (the \"General Partner\") and certain directors and officers of the General Partner (collectively, the \"Defendants\"). The lawsuits are captioned GREENBERG V. SCHULTZ, ET AL., C.A. No. 13199 and GORIN BROTHERS, INC., V. SCHULTZ, ET. AL., C.A. No. 13200 (collectively, the \"Actions\"). The complaints in the Actions allege, among other things, that Defendants breached their fiduciary duties to Unitholders by offering grossly inadequate consideration to entrench themselves in control of the Partnership, by failing to solicit competing bids, and by making inadequate public disclosure regarding the transaction. The complaints additionally allege that the Company used unequal knowledge and economic power, given its affiliation with the General Partner, to the detriment of the Unitholders. The independence of the members of the Special Committee was also questioned, allegedly resulting in the lack of arm's length negotiations and the lack of any independent appraisal or evaluation. The complaints in the Actions sought, among other things, (i) a declaration that the Defendants breached their fiduciary duties to members of the alleged class, (ii) an order preliminarily and permanently enjoining consummation of the proposed transaction, (iii) the award of compensatory damages, and (iv) the award of costs and disbursements. On October 27, 1993, the parties reached a settlement in principle in these actions. The settlement is subject to certain conditions, including court approval. On March 15, 1994, the Delaware Court of Chancery entered an Order and Final Judgment (\"Judgment\") which approved the settlement and dismissed the cases. All persons and entities who were owners of Units of the Partnership at October 18, 1993 and their transferees and successors in interest, immediate and remote (the \"Class\"), are bound by the Judgment. The Company and all other defendants were discharged from any and all liability under any claims which were or could have been brought by plaintiffs or any member of the Class regarding the acquisition and merger of the Partnership. The appeal period on the Judgment will run on April 14, 1994.\nIn September 1993, a former officer of the Company filed suit against the Company and certain of its directors and their affiliate companies. The suit alleges breach of an employment agreement, misrepresentation, wrongful termination, self-dealing, breach of fiduciary duty, usurpation of corporate opportunity and tortious interference with contractual relations. The suit seeks compensatory damages of $2,500,000 and exemplary damages of $5,000,000. The Company believes that the claims are wholly without merit and intends to vigorously defend against this suit.\nActions for negligence or other tort claims occur routinely as an ordinary incident to the Company's business. Several lawsuits are pending against the Company which have arisen in the ordinary course of the business, but none of these proceedings involves a claim for damages (in excess of applicable excess umbrella insurance coverages) involving more than 10% of current assets of the Company. The Company does not anticipate any amounts which it may be required to pay as a result of an adverse determination of such legal\nproceedings and the matters discussed above, individually or in the aggregate, or any other relief granted by reason thereof, will have a material adverse effect on the Company's financial position or results of operations.\nThe Company has established a paid loss program (the \"Paid Loss Program\") for inns owned and managed by the Company, which includes excess umbrella policies for commercial general liability insurance, automobile liability insurance, fire and extended property insurance, workers' compensation and employer's liability insurance for losses above the deductible limits, and such other insurance as is customarily obtained for similar properties and which may be required by the terms of loan or similar documents with respect to the inns. In connection with the general liability, workers' compensation and automobile coverages, all inns participate in the Paid Loss Program, under which claims and expenses are shared pro rata, with excess umbrella insurance being maintained to cover losses, claims and costs in excess of the deductible limits per matter of $500,000 for general liability, $250,000 for workers' compensation and $250,000 for automobile coverage. All pro rata expenses and premiums under the Paid Loss Program with respect to inns owned by persons other than the Company constitute direct operating expenses of said inns under the terms of the respective management agreements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of the year covered by this Annual Report on Form 10-K, no matter was submitted to a vote of Registrant's security holders through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is listed on The New York Stock Exchange. The range of the high and low sale prices, as adjusted for the three-for-two stock split in October 1993 and the three-for-two stock split in March 1994, of the Company's Common Stock for each of the quarters during the years ended December 31, 1993 and 1992 is set forth below:\nThe Company paid cash dividends in both the third and fourth quarters of 1993 in the amount of $.025 per share under its quarterly dividend policy as authorized by the Board of Directors. The Company increased its cash dividend by 50 percent in conjunction with the March 1994 three-for-two stock split to an annual rate of $.10 per share on post-split common shares. For restrictions on the Company's present or future ability to pay cash dividends, see note 2 of Notes to Combined Financial Statements. The declaration and payment of dividends in the future will be determined by the Board of Directors based upon the Company's earnings, financial condition, capital requirements and such other factors as the Board of Directors may deem relevant.\nAs of February 28, 1994, the approximate number of holders of record of the Company's Common stock was 915.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company's financial statements include the accounts of the Company's wholly-owned subsidiaries and unincorporated partnerships and joint ventures in which the Company has at least a 40% interest and over which it exercises substantial legal, financial and operational control. Investments in other entities in which the Company has less than a 40% ownership interest and over which the Company has the ability to exercise significant influence, but does not have control, are accounted for using the equity method.\nDuring 1993, the Company acquired, in separately negotiated transactions, limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures which owned 44 inns. The Company purchased the ownership interests for an aggregate purchase price of $87,897,000 which included cash at closing, the assumption of $22,824,000 of existing debt attributable to certain limited partners' interests, and $29,878,000 in notes to certain sellers.\nAs a result of the following transactions, the operations of LQP for the month of December 1993 were included in the combined financial statements of the Company. On October 27, 1993, the Company entered into a definitive Partnership Acquisition Agreement (the \"Merger Agreement\") with LQP and other parties, pursuant to which the Company, through wholly-owned subsidiaries, would acquire all units of the Partnership (the \"Units\") that it did not beneficially own at a price of $13.00 net per Unit in cash. The Merger Agreement provided for a tender offer (the \"Offer\") for all of the Partnership's outstanding Units at a price of $13.00 net per Unit in cash, which Offer commenced on November 1, 1993 and expired at midnight on November 30, 1993. The Offer resulted in the purchase of 2,805,190 Units (approximately 70.6% of the outstanding Units) by the Company through its wholly-owned subsidiary, LQI Acquisition Corporation. As a result of a contribution of additional units previously owned by the Company subsequent to the Offer, LQI Acquisition Corporation beneficially owned 3,257,890 Units (approximately 82% of the Units) at December 31, 1993. Pursuant to the Merger Agreement, a Special Meeting of Unitholders was then held on January 24, 1994 to approve the merger of a subsidiary of LQI Acquisition Corporation with and into the Partnership, with the Partnership as the surviving entity. As a result of this merger which was approved by the requisite vote of Unitholders on January 24, 1994, all of the Partnership's outstanding Units other than Units owned by the Company or any direct or indirect subsidiary of the Company were converted into the right to receive $13.00 net in cash without interest.\nIn 1993, the Company completed the acquisition of eleven inns and began renovating and converting them to the La Quinta brand. Of these inns, nine were purchased through the Development Partnership and two were purchased as wholly-owned properties. Although these inns remained open for business during conversion construction, hotel operations are disrupted during the typical three-to-four month construction period. Conversion of these inns will be completed during the first quarter of 1994.\nReferences to \"Company Inns\" are to inns owned by the Company or by unincorporated partnerships and joint ventures in which the Company owns at least a 40% interest. References to \"Managed Inns\" are to those inns in which the Company owns less than a 40% interest and which are managed by the Company under long-term management contracts. \"Managed Inns\" include nine inns held in two joint ventures with CIGNA Investments, Inc. (\"CIGNA\") for the year ended December 31, 1993 and the 31 inns of the LQP through November 30, 1993. \"Managed Inns\" were accounted for using the equity method.\nThe following chart shows certain historical operating statistics and revenue data. References to the percentages of occupancy and the average daily rate refer to Company Inns. Managed Inns and the La Quinta licensed inn are excluded from occupancy and average daily rate statistics for all periods for purposes of comparability. All financial data is related to Company Inns unless otherwise specified.\nDuring 1991, the Company implemented certain changes in its operations and organization which resulted in charges of $7,952,000. Such charges included severance costs resulting from a reduction in work force and the termination of four executive officers of the Company, charges related to the write-down of computer equipment and other assets and costs associated with the Company's cost reduction study. During 1992, the Company made additional changes in operations and organization based on a comprehensive review of the Company by its senior management team and recognized charges of approximately $39,751,000. These charges included a provision for the write-down of partnership investments, land, severance and other employee- related costs and other charges which affected corporate expenses and partners' equity in earnings and losses, as more fully described below.\nYEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992\nTOTAL REVENUES increased to $271,850,000 in 1993 from $254,122,000 in 1992, an increase of $17,728,000 or 7.0%. Of the total revenues reported in 1993, 95.1% were revenues from inns, 2.4% were revenues from restaurant rentals and other revenue and 2.5% were revenues from management services.\nINN REVENUES are derived from room rentals and other sources such as charges to guests for long-distance telephone calls, fax machine use and laundry services. Inn revenues increased to $258,529,000 in 1993 from $239,826,000 in 1992, an increase of $18,703,000 or 7.8%. The increase in inn revenues was due primarily to an increase in average room rate, an increase in the number of available rooms and the acquisition of LQP. The average room rate increased to $46.36 in 1993 from $44.33 in 1992, an increase of $2.03 or 4.6%, while occupancy declined .5 percentage points. As anticipated, the Company's image enhancement program caused temporary construction related disruption in normal business operations and occupancies at properties which underwent the process. Newly acquired inns remain open during conversion construction which also disrupts the hotel operations during the typical three-to-four month construction period. Also, management's decision to discontinue a coupon promotion used in 1992 had a positive impact on room rate and had the effect of reducing occupancy in 1993. Available rooms for 1993 were 8,226,000 as compared to 7,916,000 for 1992, an increase of 310,000 available rooms, or 3.9%. The increase in the number of available rooms was due to the acquisitions of 11 inns during the year ended December 31, 1993 and the acquisition of LQP in December of 1993. The acquisition of LQP in December 1993 added $2,758,000 to inn revenues.\nRESTAURANT RENTAL AND OTHER REVENUES includes rental payments from restaurants owned by the Company and leased to and operated by third parties. Restaurant rental and other revenues also include the Company's interest in the earnings (accounted for using the equity method) of two CIGNA joint ventures through the year ended December 31, 1993 and LQP, up to December 1, 1993, and miscellaneous other revenues, such as third party rental revenue from an office building which also housed the Company's corporate offices through May 1993. Restaurant rental and other decreased to $6,464,000 in 1993 from $7,208,000 in 1992, a decrease of $744,000 or 10.3%, primarily due to a reduction in earnings related to investments accounted for on the equity method.\nMANAGEMENT SERVICES REVENUE is primarily related to fees earned by the Company for services rendered in conjunction with Managed Inns. Management service revenue decreased to $6,857,000 in 1993 from $7,088,000\nin 1992, a decrease of $231,000 or 3.3%. Management fees decreased due to there being two less franchisees and the consolidation of LQP in December 1993 eliminating the related management fees charged by the Company to LQP for that month.\nDIRECT EXPENSES include costs directly associated with the operation of Company Inns. In 1993, approximately 42% of direct expenses were represented by salaries, wages, and related costs. Other major categories of direct expenses include utilities, repairs and maintenance, property taxes, advertising and room supplies.\nDirect expenses increased to $148,915,000 ($27.79 per occupied room) in 1993 compared to $135,790,000 ($26.17 per occupied room) in 1992, an increase of $13,125,000 or 9.7%. As a percentage of total revenues, direct expenses increased to 54.8% in 1993 from 53.4% in 1992. The increase in direct expense resulted primarily from the Company's implementation of a complimentary continental breakfast at all La Quinta inns during the first quarter of 1993, (which amounted to $1.08 per occupied room). Newly acquired inns typically incur more direct expenses as a percentage of revenue during the first twelve months of operations compared to the inns which have been operating as a La Quinta for more than a twelve month period. The Company acquired 11 inns during 1993 and did not acquire or convert any inns in the 1992 period. Direct expenses incurred by LQP in December 1993 were $2,048,000.\nCORPORATE EXPENSES include the costs of general management, office rent, training and field supervision of inn managers and other marketing and administrative expenses. The major components of corporate expenses are salaries, wages and related expenses and information systems. Corporate expenses decreased to $19,450,000 ($1.96 per available room, including Managed Inns) in 1993 from $21,055,000 ($2.16 per available room before non-recurring charges, including Managed Inns) in 1992 before non-recurring charges, a decrease of $1,605,000 or 7.6%. As a percent of total revenues, corporate expenses decreased to 7.2% in 1993 from 8.3% in 1992 before non-recurring charges. The 1992 corporate expenses included a non-recurring charge to increase the allowance for certain notes receivable, based upon estimates of the value of the real estate held as collateral for such notes and evaluations of the financial condition of certain borrowers, and a provision related to the settlement of certain litigation.\nThe PROVISION FOR WRITE-DOWN OF PARTNERSHIP INVESTMENTS, LAND AND OTHER in 1992 includes charges related to the write-down of certain joint venture interests, land previously held for future development, computer equipment and other assets, as more fully described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Year Ended December 31, 1992 Compared to Year Ended December 31, 1991.\"\nSEVERANCE AND OTHER EMPLOYEE RELATED COSTS in 1992 consisted of costs related to the severance of certain executive officers and other employees, executive search fees and relocation costs for new officers.\nPERFORMANCE STOCK OPTION relates to the costs of stock options which became exercisable when the average price of the Company's stock reached $30 per share (pre-split) for twenty consecutive days. Performance stock option expense and certain other options were accelerated as a result of this condition being met. See note 5 to the Combined Financial Statements.\nDEPRECIATION, AMORTIZATION AND ASSET RETIREMENTS decreased to $23,711,000 in 1993 from $24,477,000 in 1992, a decrease of $766,000 or 3.1%. The decrease in depreciation, amortization and asset retirements was due to assets which became fully depreciated during 1993 and the write-off of computer equipment and signage in the prior year. Replacement and installation of new computer equipment and signs was substantially completed in the latter part of 1993.\nOPERATING INCOME increased to $75,367,000 in 1993 from $34,575,000 in 1992, an increase of $40,792,000. Operating income before a non-recurring, non-cash charge of approximately $4,407,000 to recognize compensation expense related to the vesting of performance stock options, increased to $79,774,000 in 1993 from $73,112,000 in 1992 before write-downs, severance and employee related costs and other non-recurring charges, an increase of $6,662,000 or 9.1%.\nINTEREST INCOME primarily represents earnings on the note receivable from AEW Partners (the \"AEW Note\") and on the short-term investment of Company funds in money market instruments prior to their use in operations or acquiring inns. Interest income decreased to $5,147,000 in 1993 from $6,041,000 in 1992, a decrease of $894,000 or 14.8%. The decrease in interest income is primarily attributable to principal reductions on the AEW Note of $16,700,000 and $19,300,000 in September and December 1993 respectively, and the\ncorresponding reduction in interest earned thereon. As of December 31, 1993 the AEW Note had been fully collected.\nINTEREST ON LONG-TERM DEBT decreased to $31,366,000 in 1993 from $33,087,000 in 1992, a decrease of $1,721,000 or 5.2%. The decrease in interest expense is attributable to the early extinguishment of approximately $117,000,000 of certain high interest rate debt with proceeds from the 9 1\/4% Senior Subordinated Notes due 2003 and bank financing which more than offset interest on borrowings to purchase limited partners' interests. In addition, certain Industrial Revenue Bond issues were refinanced to obtain more favorable interest rates.\nPARTNERS' EQUITY IN EARNINGS AND LOSSES reflects the interests of partners in the earnings and losses of the combined joint ventures and partnerships which are owned at least 40% and controlled by the Company. Partners' equity in earnings and losses decreased to $12,965,000 in 1993 from $15,081,000 in 1992, a decrease of $2,116,000 or 14.0%. The decrease in partners' equity in earnings and losses is attributable to the acquisition of limited partners' interests in 14 combined unincorporated partnerships and joint ventures partially offset by increases in the earnings of the Development Partnership. As of December 31, 1993, the Development Partnership operated 37 inns compared to 28 inns as of December 31, 1992.\nNET GAIN (LOSS) ON PROPERTY AND INVESTMENT TRANSACTIONS decreased to a loss of ($4,347,000) in 1993 from a gain of $282,000 in 1992. The loss in 1993 includes a $4,900,000 loss related to the Company's conveyance to the mortgagee of the title on the property in which the Company's headquarters were located.\nINCOME TAXES for 1993 were calculated using an estimated effective tax rate of 39%.\nFor the reasons discussed above, the Company reported EARNINGS (LOSS) BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE OF $19,420,000 in 1993 compared with ($7,796,000) in 1992, an increase of $27,216,000.\nThe Company reported EXTRAORDINARY ITEMS, NET OF INCOME TAXES of ($619,000) in 1993 compared with ($958,000) in 1992. The 1993 extraordinary loss consisted of ($6,007,000), ($3,664,0000) net of income taxes, related to the early extinguishment and refinancing of certain debt partially offset by an extraordinary gain of $4,991,000, $3,045,000 net of income taxes, resulting from the Company's transfer of ownership to the mortgagee of property in which the Company's headquarters were located.\nThe cumulative effect of a change in accounting for income taxes of $1,500,000 or $.05 per share in 1993 was the result of the implementation of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes.\"\nFor the reasons discussed above, the Company reported NET EARNINGS of $20,301,000 in 1993 compared with a net loss of ($8,754,000) in 1992, an increase of $29,055,000.\nYEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991\nTOTAL REVENUES increased to $254,122,000 in 1992 from $240,888,000 in 1991, an increase of $13,234,000 or 5.5%. Of the total revenues reported in 1992, 94.4% were revenues from inns, 2.8% were revenues from restaurant rentals and other revenue and 2.8% were revenues from management services.\nINN REVENUES increased to $239,826,000 in 1992 from $227,096,000 in 1991, an increase of $12,730,000 or 5.6%. The increase in inn revenues was due primarily to an increase in average room rate, an increase in the number of available rooms and a slight increase in the percentage of occupancy. The average room rate increased to $44.33 in 1992 from $43.11 in 1991, an increase of $1.22 or 2.8%. The increase in room rate for 1992 was primarily attributable to rate increases made in selected stronger markets in January and June. The percentage of occupancy increased to 65.6% in 1992 from 64.8% in 1991. Available rooms for 1992 were 7,916,000 as compared to 7,817,000 for 1991, an increase of 99,000 available rooms or 1.3%. The increase in the number of available rooms was due to the acquisition of two inns in the fourth quarter of 1991 and the conversion of a licensed inn to a wholly-owned inn in 1992.\nRESTAURANT RENTAL AND OTHER increased slightly to $7,208,000 in 1992 from $6,910,000 in 1991. Management service revenue increased to $7,088,000 in 1992 from $6,882,000 in 1991, an increase of $206,000 or 3.0%.\nIn 1992, approximately 44% of DIRECT EXPENSES were represented by salaries, wages and related costs. Direct expenses were $135,790,000 ($26.17 per occupied room) in 1992 compared to $135,443,000 ($26.75 per\noccupied room) in 1991, an increase of $347,000 or 0.3%. As a percentage of total revenues, direct expenses decreased to 53.4% in 1992 from 56.2% in 1991. The increase in total direct expenses was primarily due to increases in property taxes, insurance and employee health care claims expenses. However, the increase was partially offset by decreases in workers' compensation insurance resulting from new safety programs implemented by the Company, supplies and advertising expenses.\nCORPORATE EXPENSES increased to $21,055,000 ($2.16 per available room, including Managed Inns) in 1992 before $2,906,000 of non-recurring charges from $19,683,000 ($2.04 per available room, including Managed Inns) in 1991, an increase of $1,372,000 or 7.0%. As a percent of total revenues, corporate expenses before non-recurring charges increased to 8.3% in 1992 from 8.2% in 1991. The 1992 non-recurring charge was primarily attributable to an increase of $2,696,000 in the allowance for certain notes receivable, related to inns sold by the company prior to 1985, based on estimates of the value of the real estate held as collateral for such notes and evaluations of the financial condition of certain borrowers. The increase in corporate expense was partially related to a provision for settlement of certain litigation.\nDuring 1992, the Company recorded NON-RECURRING CASH AND NON-CASH CHARGES of approximately $39,751,000. Of these charges $28,383,000 are included as a provision for write-down of partnership investments, land and other; $6,936,000 related to severance and other employee related costs; and the remaining $4,432,000 affected corporate expenses and partners' equity in earnings and losses. All of these charges resulted from certain changes being made in the Company's operations and organization based on a comprehensive review by the Company's senior management team.\nDuring 1991, the Company recognized non-recurring cash and non-cash charges of $7,952,000 resulting from certain changes made in the Company's operations and organization. Of those charges, approximately $4,097,000 were for severance related costs for former employees which resulted from a reduction in the work force of approximately 72 employees, 50 of which were employed at the Company's headquarters and the termination of four executive officers of the Company under the various provisions of their severance agreements. Of the remaining charges, approximately $2,165,000 related to the write-down of computer equipment and other assets and approximately $1,690,000 represented costs associated with the Company's study to enhance shareholder value.\nDEPRECIATION, AMORTIZATION AND ASSET RETIREMENTS decreased to $24,477,000 in 1992 from $34,921,000 in 1991, a decrease of $10,444,000 or 29.9%. Approximately $9,200,000 of the decrease was due to the Company's change in the depreciable lives of the building assets from 30 years to 40 years, effective January 1, 1992.\nOPERATING INCOME decreased to $34,575,000 in 1992 from $42,889,000 in 1991, a decrease of $8,314,000 or 19.4%, primarily due to certain charges recorded in 1992, as more fully described above. Operating income before non-recurring charges and the effect of a change in estimated useful lives of buildings increased to $63,914,000 in 1992 from $50,841,000 in 1991 an increase of $13,073,000 or 25.7%. The net impact of these charges and adjustments on operating income for 1992 amounted to a net charge of $29,339,000 compared with $7,952,000 for 1991. As a percentage of total revenues, operating income decreased to 13.6% in 1992 from 17.8% in 1991.\nINTEREST INCOME decreased to $6,041,000 in 1992 from $8,442,000 in 1991, a decrease of $2,401,000 or 28.4% The decrease in interest income is primarily attributable to a $14,866,000 reduction in principal on the AEW Note in March 1992 and the corresponding reduction in interest earned thereon.\nINTEREST ON LONG-TERM DEBT decreased to $33,087,000 in 1992 from $38,713,000 in 1991, a decrease of $5,626,000 or 14.5%. The decrease in interest expense is related to the refinancing of approximately $42,000,000 in industrial revenue bond issues in 1992 and 1991 to obtain more favorable interest rates, the decline in the prime interest rate and the reduction of the average outstanding balance on the Company's Credit Facility due to improving operating cash flow.\nPARTNERS' EQUITY IN EARNINGS AND LOSSES increased to $15,081,000 in 1992 from $9,421,000 in 1991, an increase of $5,660,000 or 60.1%. The increase in partners' equity in earnings and losses is primarily attributable to a decrease in depreciation expense related to the change in building lives of properties owned by the combined partnerships and joint ventures from 30 years to 40 years and to the increase in earnings of the Development Partnership. As of December 31, 1992, the Development Partnership operated 28 inns compared to 26 inns as of December 31, 1991. Partners' equity in earnings and losses in 1992 was also impacted by a $1,214,000 adjustment to reallocate losses of a joint venture to the Company.\nNET GAIN (LOSS) ON PROPERTY AND INVESTMENT TRANSACTIONS increased to $282,000 in 1992 from a loss of ($1,012,000) in 1991. The majority of the 1991 loss was the result of write-downs on four properties partially offset by gains on three land condemnations.\nThe Company's effective tax rate for 1992 was primarily affected by deferred tax benefits that had not been recognized related to certain charges incurred during the year.\nFor the reasons discussed above, the Company reported a LOSS BEFORE EXTRAORDINARY ITEMS of ($7,796,000) in 1992 compared with the earnings before extraordinary items of $1,398,000 in 1991, a decrease of $9,194,000.\nThe Company reported EXTRAORDINARY ITEMS, NET OF INCOME TAXES of ($958,000) in 1992 compared with ($1,269,000) in 1991. The extraordinary items reported in each period were primarily a result of the refinancing of three industrial revenue bond issues totaling $12,910,000 in principal in 1992 and nine industrial revenue bond issues totaling $28,950,000 in principal in 1991. Extraordinary items in 1992 also relate to the early extinguishment of the Company's 10% Convertible Subordinated Debentures due 2002.\nFor the reasons discussed above, the Company reported a NET LOSS of ($8,754,000) in 1992 compared with net earnings of $129,000 in 1991, a decrease of $8,883,000.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company has historically financed its development program through partnerships with financial institutions, a public debt offering and borrowings under the Company's Credit Facilities. During the years ended December 31, 1993 and 1992, the Company funded a majority of its development program through the Development Partnership. The Company's inns and adjacent restaurant land and buildings are substantially pledged to secure long-term debt of the Company. Distributions of cash, if any, from the Company's joint ventures and partnerships are made from cash available after payment of operating expenses, debt service, capital expenditures and acquisition and development of new inns.\nAt December 31, 1993, the Company had $23,848,000 of cash and cash equivalents, an increase of $10,987,000 from December 31, 1992. The increase was due to the collection of $19,300,000 on AEW Partners' obligation to the Development Partnership in December 1993. In July 1993, the Company completed negotiations on a new $40,000,000 Secured Line of Credit and $30,000,000 Secured Term Credit Facility. On December 22, 1993, the Company completed negotiations on an additional $30,000,000 Secured Line of Credit which bore interest at the prime rate plus 1\/2%. The additional Line of Credit matured upon the closing of the amendment to the $40,000,000 Secured Line of Credit and $30,000,000 Secured Term Credit Facility more fully discussed below. At December 31, 1993 the Company had approximately $31,380,000 available on its credit facility.\nIn January 1994, the Company completed negotiations to amend the $40,000,000 Secured Line of Credit and increase the Secured Term Credit Facility from $30,000,000 to $145,000,000. Borrowings under the $40,000,000 secured line of credit, which will expire May 30, 1997 will be made at varying interest rates of LIBOR plus 1 3\/4%, the prime rate, or certificate of deposit rate plus 1 7\/8%. Borrowings under the $145,000,000 Secured Term Credit Facility, which will expire May 31, 2000, will be made through October 31, 1994 and will bear interest at varying interest rates of LIBOR plus 2%, the prime rate plus 1\/4%, or certificate of deposit rate plus 2 1\/8%. Amounts borrowed under the Secured Term Credit Facility will require semi-annual principal payments commencing November 30, 1994 through May 31, 2000. In February 1994, the Company used the Secured Term Credit Facility to retire $65,742,000 of 11.25% mortgage debt assumed through the acquisition of LQP, which would have matured in November 1994. As of February 28, 1994, the Company had $27,125,000 available on its credit facility.\nAt December 31, 1993, the AEW Note to the Development Partnership had been fully collected. The Company anticipates that substantially all of its development activity in 1994 will occur through the Development Partnership by using the Partnership's available cash and cash from operations and that no distributions of cash will be made to partners.\nNet cash provided by operating activities increased to $77,364,000 in 1993 from $60,543,000 in 1992, an increase of $16,821,000 or 27.8%. The increase was due to increased inn revenues and an increase in accounts payable and accrued expenses due to the timing of payment. Net cash provided by operating activities increased to $60,543,000 in 1992 from $54,056,000 in 1991, an increase of $6,487,000 or 12.0%. The majority of the increase was due to an increase in inn revenues as a result of increased occupancy and average room rates.\nNet cash used by investing activities increased to $145,027,000 in 1993 from $15,166,000 in 1992, an increase of $129,861,000. The increase was related to the acquisition of LQP, the acquisition of partners' interest in 14 unincorporated joint ventures and partnerships, the acquisition of eleven inns and capital expenditures related to the Company's image enhancement program. Net cash used by investing activities decreased to $15,166,000 in 1992 from $35,083,000 in 1991, a decrease of $19,917,000 or 56.8%. This decrease resulted from no inns being acquired during 1992 compared to three inns and a partner's interest in an additional five inns in 1991.\nNet cash provided by financing activities was $78,650,000 in 1993 compared to net cash used by financing activities of ($40,471,000) in 1992. The increase in cash provided by financing activities was the result of the issuance of the 9 1\/4% Senior Subordinated Notes due 2003, the collection of the AEW Note and the decrease in distributions to partners partially offset payments on long-term debt. Net cash used by financing activities increased to $40,471,000 in 1992 from $24,428,000 in 1991, an increase of $16,043,000 or 65.7%. This increase was primarily impacted by a reduction of the Company's average outstanding balance on the Credit Facility.\nCOMMITMENTS\nIn accordance with the unincorporated partnership or joint venture agreements executed by the Company, La Quinta is committed to advance funds necessary to cover operating expenses of a joint venture. In addition, four other unincorporated partnerships and joint ventures executed promissory notes in which the Company guaranteed to fund amounts not to exceed $4,985,000 in the aggregate.\nThe estimated additional cost to complete the conversion and renovation of inns for which commitments have been made is $36,455,000 at December 31, 1993, of which includes amounts for the Company's image enhancement program that were in process or under contract. Funds on hand, committed and anticipated from cash flow are sufficient to complete these projects.\nThe Company has undertaken a comprehensive chainwide image enhancement program intended to give its properties a new, fresh, crisp appearance while preserving their unique character. The program features new signage displaying a new logo as well as exterior and lobby upgrades including brighter colors, more extensive lighting, additional landscaping, enhanced guest entry and full lobby renovation with contemporary furnishings and seating area for continental breakfast. In the first quarter of 1993, the Company began its property and image enhancement program on the La Quinta inns it manages or owns. The Company anticipates that $36,379,000 will be needed to complete the project, including $27,493,000 related to work which was in process or under contract at December 31, 1993. The Company intends to fund its image enhancement program through funds generated from operations and available on its Credit Facility. The Company does not anticipate the funding of this program will have an adverse effect on its ability to fund its operations.\nUnder the terms of a Partnership agreement between the Company and AEW Partners, the Company maintains a reserve for renovating, remodeling and conversion of the inns in the Development Partnership based on 5% of gross room revenue of the Partnership which includes certain amounts required by loan agreements. At December 31, 1993 and 1992 the Company had $3,833,000 and $3,920,000, respectively, of restricted cash which is classified as investments.\nIn accordance with the requirements of an escrow agreement related to a pool of mortgage notes executed by the Company and a third party lender, the Company is required to make annual deposits into an escrow account for the purpose of establishing a reserve for the replacement of furnishings, fixtures and equipment used on or incorporated into the mortgaged properties. The Company shall be relieved of its obligation to make such annual deposits for any year in which the escrow account has an aggregate balance of $2,431,000. At December 31, 1993 and 1992, the Company had reserved $2,431,000 and $5,754,000, respectively.\nIn 1993, the Company entered into a ten year operating lease for its corporate headquarters in San Antonio. In addition, the Company entered into a ten year lease in December 1993 to house the Company's reservation facilities.\nFunds on hand, anticipated from future cash flows and available on the Company's Credit Facility are sufficient to fund operating expenses, debt service and other capital requirements through at least the end of 1994. The Company will evaluate from time to time the necessity of other financing alternatives.\nSEASONALITY\nDemand, and thus room occupancy, is affected by normally recurring seasonal patterns and, in most La Quinta inns, is higher in the spring and summer months (March through August) than in the balance of the year.\nINCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". This Statement requires the use of the asset and liability method of accounting for deferred income taxes and was implemented in 1993. The impact of the Statement's implementation has been disclosed in note 4 of Notes to Combined Financial Statements.\nINFLATION\nThe rate of inflation as measured by changes in the average consumer price index has not had a material effect on the revenues or net earnings (loss) of the Company in the three most recent years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLA QUINTA INNS, INC.\nCOMBINED BALANCE SHEETS (in thousands, except share data) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nSee accompanying notes to combined financial statements.\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nLA QUINTA INNS, INC.\nCOMBINED BALANCE SHEETS (in thousands, except share data) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nSee accompanying notes to combined financial statements. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nLA QUINTA INNS, INC.\nCOMBINED STATEMENTS OF OPERATIONS (in thousands, except per share data) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nSee accompanying notes to combined financial statements. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nLA QUINTA INNS, INC.\nCOMBINED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nSee accompanying notes to combined financial statements. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC.\nCOMBINED STATEMENTS OF CASH FLOWS (in thousands) - ----------------------------------------------------------------------------\nSee accompanying notes to combined financial statements. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nLA QUINTA INNS, INC.\nNOTES TO COMBINED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS AND BASIS OF PRESENTATION\nThe Company develops, owns and operates inns. The combined financial statements include the accounts of subsidiaries (all wholly-owned) and unincorporated partnerships and joint ventures in which the Company has at least a 40% interest and exercises substantial legal, financial and operational control. All significant intercompany accounts and transactions have been eliminated in combination. Investments in other unconsolidated affiliates in which the Company has less than a 40% ownership interest and over which the Company has the ability to exercise significant influence are accounted for using the equity method. Certain reclassifications of prior period amounts have been made to conform with the current period presentation.\nPARTNERS' CAPITAL\nPartners' capital at December 31, 1992 is shown net of a $35,908,000 note receivable to La Quinta Development Partners, L.P. (\"LQDP\" or the \"Development Partnership\") representing a portion of the initial capital contribution to LQDP by AEW Partner's L.P. Collections on this note are reflected as an increase to partners' capital. In 1993, the outstanding balance of this note was fully collected.\nPROPERTY AND EQUIPMENT\nDepreciation and amortization of property and equipment for 1993 and 1992 are computed using the straight-line method over the following estimated useful lives:\nBuildings............................................ 40 years Furniture, fixtures and equipment.................... 4-10 years Leasehold and land improvements...................... 10-20 years\nMaintenance and repairs are charged to operations as incurred. Expenditures for improvements are capitalized.\nDuring the third quarter of 1992, the Company changed the estimated useful lives of its buildings from 30 years to 40 years effective January 1, 1992, based on a review of the depreciable lives of its assets.\nCASH EQUIVALENTS\nAll highly liquid investments with a maturity of three months or less at the date of acquisition are considered cash equivalents.\nDEFERRED CHARGES\nDeferred charges consist primarily of issuance costs related to Senior Subordinated Notes due 2003, Industrial Development Revenue Bonds (\"IRB\"), loan fees, preopening and organizational costs. Issuance costs are amortized over the life of the related debt using the interest method. Preopening costs are amortized over two years, organizational costs over five years and loan fees over the respective terms of the loans using the straight-line method.\nSELF-INSURANCE PROGRAMS\nThe Company uses a paid loss retrospective self-insurance plan for general and auto liability and workers' compensation. Predetermined loss limits have been arranged with insurance companies to limit the Company's per occurrence cash outlay.\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nThe Company maintains a self-insurance program for major medical and hospitalization coverage for employees and dependents which is partially funded by payroll deductions. Payments for major medical and hospitalization to individual participants less than specified amounts are self-insured by the Company. Claims for benefits in excess of these amounts are covered by insurance purchased by the Company.\nProvisions have been made in the combined financial statements which represent the expected future payments based on estimated ultimate cost for incidents incurred through the balance sheet date.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using currently enacted tax rates in effect for the years in which the differences are expected to reverse. In 1993, the Company recorded an adjustment to income of $1,500,000 which represents the net decrease of the deferred tax liability at January 1, 1993. Such amount has been reflected in the combined statement of operations for the year ended December 31, 1993 as the cumulative effect of an accounting change. Prior years' financial statements have not been restated to apply the provisions of SFAS 109. The deferred method under APB Opinion 11 was applied in 1992 and prior years.\nEARNINGS (LOSS) PER SHARE\nEarnings (loss) per share are computed on the basis of the weighted average number of common and common equivalent (dilutive stock options) shares outstanding in each year after giving retroactive effect to the stock splits effected as stock dividends as discussed in note 5 of these Combined Financial Statements. Shares of the Company's common stock issuable upon conversion of the Development Partnership Units are antidilutive at December 31, 1993 and prior years. Primary and fully diluted earnings (loss) per share are not significantly different.\nPROPERTIES HELD FOR SALE\nProperties held for sale are stated at the lower of cost or estimated net realizable value. Charges to reduce the carrying amounts of properties held for sale to estimated net realizable value are recognized in income. The Company recorded charges of $9,926,000 in 1992 and $2,145,000 in 1991 in the statements of operations related to the write-down of properties held for sale.\nAt December 31, 1993, the Company had a $40,000,000 Secured Line of Credit, renegotiated in July 1993, and a $30,000,000 Secured Term Credit Facility with participating banks. On December 22, 1993, the Company completed negotiations on an additional $30,000,000 Secured Line of Credit which bore interest at the prime rate plus 1\/2%. At December 31, 1993, the Company had $31,380,000 available on its Secured Term and Line of Credit. In January 1994, the Company completed negotiations to amend the $40,000,000 Secured Line of Credit and increase its Secured Term Credit Facility from $30,000,000 to $145,000,000. Borrowings under the\n$40,000,000 Secured Line of Credit, which will expire May 30, 1997 will be made at varying interest rates of LIBOR plus 1 3\/4%, the prime rate, or certificate of deposit rate plus 1 7\/8%. Borrowings under the $145,000,000 Secured Term Credit Facility, which will expire May 31, 2000, will be made through October 31, 1994 and will bear interest at varying interest rates of LIBOR plus 2%, the prime rate plus 1\/4%, or certificate of deposit rate plus 2 1\/8%. Amounts borrowed under the Secured Term Credit Facility will require semi-annual principal payments commencing November 30, 1994 through May 31, 2000. The Company pays a commitment fee of .5% per annum on the undrawn portion of the credit line. The annual maturities reflect the payment terms of the amended and restated Secured Line of Credit and Secured Term Credit Facility. Commitment fees totaled $164,000, $105,000 and $71,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nAnnual maturities for the four years subsequent to December 31, 1994 are as follows:\nInterest paid during the years ended December 31, 1993, 1992 and 1991 amounted to $27,913,000, $32,523,000 and $38,320,000, respectively.\nIn December 1993, the Company assumed the outstanding mortgage notes payable of La Quinta Motor Inns Master Limited Partnership (\"LQP\") totaling $65,962,000 (see note 14). The notes bear interest at 11 1\/4% and mature on November 1, 1994. Subsequent to December 31, 1993, the Company paid off the entire outstanding balance with proceeds from its renegotiated Secured Term Credit Facility. In 1993, the Company recognized an extraordinary loss of $986,000 ($602,000 net of income taxes) related to the prepayment fees for the early retirement of this debt.\nIn 1993, the Company completed an offering of $120,000,000 in principal amount of 9 1\/4% Senior Subordinated Notes due 2003. The proceeds of the financing and the Secured Term Credit Facility were used to partially fund the acquisitions of partners' interests in certain consolidated partnerships and joint ventures and to prepay approximately $106,000,000 of existing indebtedness. In addition, the Company refinanced three issues of IRBs totaling $11,200,000 in 1993. In 1992, the Company refinanced three issues of IRBs totaling $12,910,000 and retired its 10% Convertible Subordinated Debentures due 2002. The Company reported extraordinary items, net of income taxes, of $3,062,000 and $958,000 in 1993 and 1992, respectively, related to these refinancings and retirements.\nIn May 1993, the Company conveyed title to the property in which its corporate headquarters was located to the lender holding a $10.1 million non-recourse mortgage on the property. Completion of this transaction resulted in the elimination of the liability for the non-recourse mortgage on the Company's balance sheet. The Company recognized a loss on property transactions of $4,900,000 related to the write-down of the property to its estimated fair value and an extraordinary gain of $4,991,000, $3,045,000 net of income taxes, for the difference between the carrying amount of the debt and the estimated fair value of the building.\nThe Company is obligated by agreements relating to seventeen issues of IRBs in an aggregate amount of $55,515,000 to purchase the bonds at face value prior to maturity under certain circumstances. The bonds have floating interest rates which are indexed periodically. Bondholders may, when the rate is changed, put the bonds to the designated remarketing agent. If the remarketing agent is unable to resell the bonds, it may draw upon an irrevocable letter of credit which secure the IRBs. In such event, the Company would be required to repay the funds drawn on the letters of credit within 24 months.\nAs of December 31, 1993 no draws had been made upon any such letters of credit. The schedule of annual maturities shown above includes these IRBs as if they will not be subject to repayment prior to maturity. Assuming all bonds under such IRB arrangements are presented for payment prior to December 31, 1994 and the remarketing agents are unable to resell such bonds, the maturities of long-term debt shown above would increase by $42,210,000 for the year ending December 31, 1995.\nIn January 1992, the Company entered into several five year interest rate swap agreements with a commercial bank in order to manage exposure to fluctuations in interest rates on certain floating rate long-term obligations. The agreement effectively changes the Company's interest rate exposure on approximately $39,050,000 and $13,218,000 of certain floating rate IRBs outstanding at December 31, 1993 to fixed rates of 5.26% and 6.5%, respectively. Net payments or receipts due under these agreements are included as adjustments to interest expense. The Company is exposed to credit loss in the event of nonperformance by the other party to the interest rate swap agreements, however, the Company does not anticipate nonperformance by the counterparty.\nThe Secured Line of Credit, Secured Term Credit Facility and certain agreements associated with IRBs are governed by a uniform covenant agreement. The most restrictive covenants preclude the following: payment of cash dividends in excess of defined limits, limitations on the incurrence of debt, mergers, sales of substantial assets, loans and advances, certain investments or any material changes in character of business. The agreement contains provisions to limit the total dollar amounts of certain investments and capital expenditures.\nThe Company's 9 1\/4% Senior Subordinated Notes are governed by a Trust Indenture dated May 15, 1993. The Trust Indenture contains certain covenants for the benefit of holders of the notes, including, among others, covenants placing limitations on the incurrence of debt, dividend payments, certain investments, transactions with related persons, asset sales, mergers and the sale of substantially all the assets of the Company.\nAt December 31, 1993, the Company was in compliance with all restrictions and covenants.\n(3) UNINCORPORATED VENTURES AND PARTNERSHIPS\nSummary financial information with respect to unincorporated ventures and partnerships included in the combined financial statements follows. In 1993 the Company acquired several unincorporated ventures and partnerships which are included in the December 1992 financial information for the balance sheet and statement of operations which are not included in the balance sheet at December 31, 1993 or statement of operations for a full year in 1993. LQP was not included in the balance sheet or income statement for 1992, however, as a result of the acquisition of Units by the Company the financial information below includes assets and liabilities at December 31, 1993 and operations for the month of December 31, 1993 (also see note 14):\n(4) INCOME TAXES\nAs discussed in note 1, the Company adopted SFAS 109 effective January 1, 1993.\nIncome tax expense attributable to income from continuing operations consists of:\nThe effective tax rate varies from the statutory rate for the following reasons:\nThe following are cash transactions relating to the Company's income taxes:\nFor the years ended December 31, 1992 and 1991, deferred income tax expense resulted from timing differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax effects of those timing differences are presented below:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1993 are presented below:\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nThe valuation allowance at December 31, 1993 represents the tax benefit of certain future deductible amounts which are not expected to offset future taxable amounts resulting from the reversal of existing taxable temporary differences. The Company anticipates that the reversal of existing taxable temporary differences will provide sufficient taxable income to realize the tax benefits of the remaining deferred tax assets. The valuation allowance decreased by $6,816,000, principally as a result of the acquisition of a substantial portion of the units of the La Quinta Motor Inns Limited Partnership as more fully described in Note 14 of these notes to Combined Financial Statements.\nAt December 31, 1993, the Company had targeted jobs tax credit carryforwards for Federal income tax purposes of approximately $411,000 (expiring 2007 through 2009) which are available to reduce future Federal income taxes. In addition, the Company had alternative minimum tax credit carryforwards of approximately $2,781,000 which are available to reduce future regular Federal income taxes over an indefinite period.\n(5) SHAREHOLDERS' EQUITY\nThe Board of Directors authorized three-for-two stock splits effective in October 1993 and March 1994. Earnings per share, the weighted average number of shares outstanding, shareholders' equity and the following information have been adjusted to give effect to each of these distributions. In January 1994, the Company announced that its Board of Directors authorized the purchase of up to $10,000,000 of its common stock. Such purchases would be made from time to time in the open market as deemed appropriate by the Company.\nThe Company's stock option plans cover the granting of options to purchase an aggregate of 6,155,996 common shares. Options granted under the plans are issuable to certain officers, certain employees and Board Members generally at prices not less than fair market value at date of grant. Options are generally exercisable in four equal installments on successive anniversary dates of the date of grant and are exercisable thereafter in whole or in part. Outstanding options not exercised expire ten years from the date of grant.\nUpon exercise, the excess of the option price received over the par value of the shares issued, net of expenses and including the related income tax benefits, is credited to additional paid-in capital.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nIn 1993, the Company recognized compensation expense of $4,407,000 related to performance stock options for the difference between the option price at the date of grant and a predetermined level when it became probable that the Company's stock would trade at that predetermined level. Beginning in 1992, the Company recognized $367,000 in compensation expense for the difference between the market price and option price on date of grant related to a portion of these options which vested in annual increments.\nUnder the terms of the La Quinta Development Partners, L.P. (\"LQDP\" or the \"Development Partnership\") partnership agreement, AEW Partners, L.P. (\"AEW Partners\") has the ability to convert 66 2\/3% of its 60% ownership in the Development Partnership currently to 3,535,976 shares (post-split) of the Company's common stock after giving retroactive effect to the stock splits effected as stock dividends. Shares of the Company's common stock issuable upon conversion of the Development Partnership Units are antidilutive at December 31, 1993. AEW partner's units in LQDP may be converted over the seven year period beginning December 31, 1991. As of December 31, 1993, AEW Partners had not converted any of its ownership in the Development Partnership into the Company's common stock.\n(6) PENSION PLAN\nThe Retirement Plan and Trust of La Quinta Inns, Inc. (the \"Plan\") is a defined benefit pension plan covering all employees. The Plan was amended in 1993 to allow highly compensated employees to rejoin the Retirement Plan as active participants. Benefits accruing under the Plan are determined according to a career average benefit formula which is integrated with Social Security benefits. For each year of service as a participant in the Plan, an employee accrues a benefit equal to one percent of his or her annual compensation plus .65 percent of compensation in excess of the Social Security covered compensation amount. The Company's funding policy for the Retirement Plan is to annually contribute the minimum amount required by federal law.\nThe Supplemental Executive Retirement Plan and Trust (\"SERP\") continues to cover a select group of management employees. Benefits under the SERP are determined by a formula which considers service and total compensation; the results of the formula-derived benefit are then reduced by the participant's pension entitlement from the qualified Retirement Plan.\nIn accordance with the provisions of Statement of Financial Standards No. 87 - - Employer's Accounting for Pensions, the Company has recorded an additional minimum liability of $4,092,000 at December 31, 1993. This provision represents the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability at the measurement date. An amount of $1,702,000 was recognized as an intangible asset to the extent of unrecognized prior service cost and the balance of $2,390,000 ($1,458,000 net of income tax) is recorded as a reduction of shareholders' equity.\nThe following table sets forth the funded status and amounts recognized in the Company's combined financial statements for the Plan at December 31, 1993 and 1992.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nThe following table sets forth the funded status of the SERP and amounts recognized in the Company's financial statements for the SERP:\nAt December 31, 1993, the Company had accumulated $1,144,000 in a trust account intended for use in settling benefits due under the SERP. These funds, which are included in investments on the accompanying balance sheets, are not restricted for the exclusive benefit of SERP participants and their beneficiaries. The SERP funds are invested primarily in equity investments. However, in the event of a change in the Company's control, as defined, such funds would become restricted for the exclusive benefit of SERP participants and their beneficiaries.\nNet pension cost includes the following components:\nThe assumptions used in the calculations shown above were:\n(7) OPERATING LEASES\nLESSEE\nThe Company leases a portion of the real estate and equipment used in operations. Certain ground lease arrangements contain contingent rental provisions based upon revenues and also contain renewal options at fair market values at the conclusion of the initial lease terms. In 1993, the Company entered into two ten year operating leases for its corporate headquarters in San Antonio and its reservation facilities.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nFuture annual minimum rental payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year at December 31, 1993 follow:\nTotal rental expense for operating leases was $2,840,000, $1,976,000 and $2,359,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nLESSOR\nThe Company leases 107 restaurants it owns to third parties. The leases are accounted for as operating leases expiring during a period from 1994 to 2016 and provide for minimum rentals and contingent rentals based on a percentage of annual sales in excess of stipulated amounts. The following is a summary of restaurant property leased at December 31, 1993.\nMinimum future rentals to be received under the noncancellable restaurant leases in effect at December 31, 1993 follow:\nContingent rental income amounted to $811,000, $854,000, and $669,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\n(8) NON-RECURRING, CASH AND NON-CASH CHARGES\nDuring 1992, the Company recognized charges of $39,751,000 ($27,946,000 net of income taxes and partners' equity) resulting from certain changes being made in the Company's operations and organization based on a review by the Company's senior management team.\nOf those charges, $28,383,000 relate to the write-down of certain joint venture interests, land, computer equipment, and other assets. During the third quarter of 1992, the senior management team re-evaluated the Company's investments in joint venture arrangements and shortly thereafter completed negotiations that resulted in amendments to the agreements related to certain joint venture arrangements and the write-down of the Company's investments in those ventures. The write-down of the land, computer equipment and other assets resulted\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nprimarily from the Company's decisions to sell certain land that had previously been held for future development and to replace the Company's existing computer systems and certain other assets.\nIn addition, the Company recognized $6,936,000 and $4,097,000 for the years ended December 31, 1992 and 1991, respectively, in severance and other employee related charges. Those charges relate to severance benefits for certain terminated employees, costs of hiring and relocating new management and other employee related costs resulting from personnel changes.\nThe remaining $4,432,000 of the charges recognized in 1992 affected various corporate expenses and partners' equity in earnings and losses.\n(9) COMMITMENTS\nIn accordance with the unincorporated partnership or joint venture agreements executed by the Company, La Quinta is committed to advance funds necessary to cover operating expenses of a joint venture. In addition, four other unincorporated partnerships and joint ventures executed promissory notes in which the Company guaranteed to fund amounts not to exceed $4,985,000 in aggregate.\nThe estimated additional cost to complete the conversion and renovation of inns for which commitments have been made is $36,455,000 at December 31, 1993, which includes amounts for the Company's image enhancement program that were in process or under contract. Funds on hand, committed and anticipated from cash flow are sufficient to complete these projects.\nThe Company has undertaken an image enhancement program intended to give its properties a new, fresh, crisp appearance while preserving their unique character. The program features new signage displaying a new logo as well as exterior and lobby upgrades including brighter colors, additional landscaping, enhanced guest entry and full lobby renovation with contemporary furnishings and seating area for continental breakfast. In the first quarter of 1993, the Company began its property and image enhancement program on its La Quinta inns it manages or owns. The Company anticipates that an additional $36,687,000 will be needed to complete the project, including $27,493,000 related to work which was in process or under contract at December 31, 1993. The Company intends to fund its image enhancement program through funds generated from operations and available on its Credit Facility. The Company does not anticipate the funding of this program will have an adverse effect on its ability to fund its operations.\nUnder the terms of a Partnership agreement between the Company and AEW Partners, the Company maintains a reserve for renovating, remodeling and conversion of the inns in the Development Partnership based on 5% of gross room revenue of the Partnership which includes certain amounts required by loan agreements. At December 31, 1993 and 1992 the Company had $3,833,000 and $3,920,000, respectively, of restricted cash which is classified as investments.\nIn accordance with the requirements of an escrow agreement related to a pool of mortgage notes executed by the Company and a third party lender, the Company is required to make annual deposits into an escrow account for the purpose of establishing a reserve for the replacement of furnishings, fixtures and equipment used on or incorporated into the mortgaged properties. The Company shall be relieved of its obligation to make such annual deposits for any year in which the escrow account has an aggregate balance of $2,431,000. At December 31, 1993 and 1992, the Company had reserved $2,431,000 and $5,754,000, respectively.\n(10) CONTINGENCIES\nLITIGATION\nIn connection with the Company's tender offer for the units of limited partnership interest of LQP (see note 14), two separate lawsuits were filed in Delaware Court of Chancery on behalf of the Partnership's unitholders against the Company, the Partnership, La Quinta Realty Corp., a subsidiary of the Company, and general partner of the Partnership (the \"General Partner\") and certain directors and officers of the General Partner. On October 27, 1993, the parties reached a settlement in principle in these actions. The settlement is subject to certain\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nconditions, including court approval. On March 15, 1994, the Delaware Court of Chancery entered an Order and Final Judgment (\"Judgment\") which approved the settlement and dismissed the cases. All persons and entities who were owners of Units of the Partnership at October 18, 1993 and their transferees and successors in interest, immediate and remote (the \"Class\"), are bound by the Judgment. The Company and all other defendants were discharged from any and all liability under any claims which were or could have been brought by plaintiffs or any member of the Class regarding the acquisition and merger of the Partnership. The appeal period on the Judgment will run on April 14, 1994.\nIn September 1993, a former officer of the Company filed suit against the Company and certain of its directors and their affiliate companies. The suit alleges breach of an employment agreement, misrepresentation, wrongful termination, self-dealing, breach of fiduciary duty, usurpation of corporate opportunity and tortious interference with contractual relations. The suits seeks compensatory damages of $2,500,000 and exemplary damages of $5,000,000. The Company intends to vigorously defend against this suit.\nThe Company is also party to various lawsuits and claims generally incidental to its business. The ultimate disposition of these and the above discussed matters are not expected to have a significant adverse effect on the Company's financial position or results of operations.\nSEVERANCE AND EMPLOYMENT AGREEMENT\nThe Company entered into a five year employment agreement which includes a severance provision granting the executive the right to receive certain benefits, including among others, 3.0 times annual base salary and bonus if there occurs a termination (as defined in the agreement) within the five year term of the agreement, or resignation (as defined in the agreement). The maximum contingent liability under the severance provisions of this agreement is $1,627,000.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\n(11) QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe unaudited combined results of operations by quarter are summarized below:\nIn the fourth quarter of 1993, the Company recorded an adjustment of $1,273,000 ($777,000 net of income taxes) to decrease its expense related to the self- insurance program for major medical and hospitalization coverage due to decreases in actual claims and estimates of incurred but not reported claims.\n(12) RELATED PARTY TRANSACTIONS\nLQM OPERATING PARTNERS, L.P.\nIn October 1986, the Company sold 31 inns to LQM Operating Partners, L.P. (\"the Operating Partnership\") which is owned and controlled by La Quinta Motor Inns Limited Partnership (\"LQP\"), a publicly traded master limited partnership. At December 31, 1992, approximately $1,425,000 net of partners' equity, remained deferred on this sale associated with debt assumed by the Partnership. A pre-tax gain on sale of assets of approximately $230,000, $220,000 and $592,000, net of partners' equity, related to this transaction was recognized in the years ended December 31, 1993, 1992 and 1991. The deferred gain balance remaining at December 1, 1993 was treated as a purchase price adjustment upon LQI Acquisition Corporation's acquisition of approximately 82% of the units of limited partnership interest in the LQP. (See note 14 to Combined Financial Statements).\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nMANAGEMENT SERVICES FEE\nAll inns owned by LQP (through November 30, 1993) and by the two joint ventures (the \"Ventures\") between the Company and investment partnerships managed by CIGNA Investments, Inc. (collectively the \"Managed Inns\") operate under the La Quinta name and are managed by the Company in accordance with long-term management agreements. The Company earns management and licensing fees as well as fees for chain services such as bookkeeping, national advertising and reservations.\nOTHER RECURRING TRANSACTIONS\nLa Quinta pays all direct operating expenses on behalf of the partnerships and ventures and is reimbursed for all such payments.\nEMPLOYMENT AGREEMENT\nIn October 1991, the Company and its Chairman of the Board entered into an Employment Agreement (the \"Employment Agreement\"), providing for his employment as the Chairman of the Board of the Company for five years from the date thereof. Under the terms of the Employment Agreement, he is entitled to receive as compensation certain benefits, including, among others, (i) an annual base salary, (ii) incentive compensation awards as a result of his participation in the Company's long-term and short-term incentive bonus plans or programs, and (iii) the amount of $2,200,000, which was treated as prepaid compensation for financial statement purposes. The Employment Agreement generally provides that 20% of the prepaid compensation is earned on each anniversary thereof, with the exception that in the case of the executive's (a) voluntary resignation (except for a voluntary resignation within one year following a change in control or after a constructive termination without cause) or (b) termination for cause, then the remaining unamortized balance will become due and payable over the remaining term in equal monthly installments. As a result of changes in management and reorganization of duties, the remaining compensation of $1,760,000 related to this Employment Agreement was included in the 1992 non-recurring cash and non-cash charges, described in note 8 to these Combined Financial Statements. In March 1994 the Chairman retired from the Company and resigned from the Board of Directors and received certain compensation and benefits as defined in the Employment Agreement.\n(13) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the value of each class of financial instruments for which it is practical to estimate that value:\nCASH AND CASH EQUIVALENTS For those short-term instruments, the carrying amount is a reasonable estimate of fair value.\nNOTES RECEIVABLES The carrying value for notes receivable approximates the fair value based on the estimated underlying value of the collateral.\nINVESTMENTS The fair value of some investments is estimated based on quoted market prices for these or similar investments. For other securities, the carrying amount is a reasonable estimate of fair value.\nLONG-TERM DEBT The fair value of the Company's long-term debt is estimated based on the current market prices for the same or similar issues or on the current rates available to the Company for debt of the same maturities.\nINTEREST RATE SWAP AGREEMENTS The fair value of interest rate swap agreements represents the estimated amount the Company would pay to terminate the agreements, taking into consideration current interest rates and the current creditworthiness of the counterparties.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTAS INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nThe estimated fair values of the Company's financial instruments are summarized as follows:\n(14) ACQUISITION OF PARTNERS' INTERESTS\nOn October 27, 1993, the Company entered into a definitive Partnership Acquisition Agreement (the \"Merger Agreement\") with La Quinta Motor Inns Limited Partnership (\"the Partnership\" or \"LQP\") and other parties, pursuant to which the Company, through wholly-owned subsidiaries, would acquire all units of the Partnership (the \"Units\") that it did not beneficially own at a price of $13.00 net per Unit in cash. The Merger Agreement provided for a tender offer (the \"Offer\") for all of the Partnership's outstanding Units at a price of $13.00 net per Unit in cash, which Offer commenced on November 1, 1993 and expired at midnight on November 30, 1993. The Offer resulted in the purchase of 2,805,190 Units (approximately 70.6% of the outstanding Units) by the Company through its wholly-owned subsidiary, LQI Acquisition Corporation. As a result of a contribution of additional units previously owned by the Company subsequent to the Offer, LQI Acquisition Corporation beneficially owned 3,257,890 Units (approximately 82% of the Units) at December 31, 1993. Pursuant to the Merger Agreement, a Special Meeting of Unitholders was then held on January 24, 1994 to approve the merger of a subsidiary of LQI Acquisition Corporation with and into the Partnership, with the Partnership as the surviving entity. As a result of this merger which was approved by the requisite vote of Unitholders on January 24, 1994, all of the Partnership's outstanding Units other than Units owned by the Company or any direct or indirect subsidiary of the Company were converted into the right to receive $13.00 net in cash without interest. The acquisition has been accounted for as a purchase and the results of LQP's operations have been included in the Company's combined results of operations since December 1, 1993.\nLQI Acquisition Corporation obtained funds to acquire the Units as a result of a capital contribution by La Quinta. In order to make such a capital contribution to LQI Acquisition Corporation, the Company borrowed approximately $45.9 million under its existing credit facility as more fully described in note 2.\nDuring 1993, the Company purchased in separately negotiated transactions, the limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures, which own 44 inns, for an aggregate price of $87,897,000 which included cash at closing, the assumption of $22,824,000 of existing debt attributable to the limited partners' interest, and $29,878,000 of notes to the sellers. The Company was the general partner and owned the remainder of the ownership interests in each of these partnerships and ventures. The Company intends to continue to operate the properties as La Quinta inns.\nThe following unaudited pro forma information reflects the combined results of operations of the Company as if the acquisition of the 82% interest in LQP and the limited partners' interests in the 14 combined partnerships and joint ventures had occurred at the beginning of 1993 and 1992. The pro forma information gives effect to certain adjustments, including additional depreciation expense on property and equipment based on their fair values, increased interest expense on additional debt incurred, elimination of related party revenues and expenses, and extraordinary losses on early extinguishment of debt. The pro forma results are not necessarily indicative of operating results that would have occurred had the acquisitions been consummated as of the beginning of 1993 and 1992, nor are they necessarily indicative of future operating results.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nLA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders La Quinta Inns, Inc.:\nWe have audited the combined balance sheets of La Quinta Inns, Inc. as of December 31, 1993 and 1992 and the related combined statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. In connection with our audits of the combined financial statements, we also have audited the financial statement schedules as listed in Item 14(a)(2) of Form 10-K. These combined financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these combined financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of La Quinta Inns, Inc. as of December 31, 1993 and 1992 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic combined financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1 to the combined financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 in 1993.\nKPMG PEAT MARWICK San Antonio, Texas January 31, 1994, except as to the first paragraph of note 5, which is as of February 9, 1994\nSchedule V\nLA QUINTA INNS, INC.\nProperty, Plant and Equipment (in thousands)\nSchedule VI\nLA QUINTA INNS, INC.\nAccumulated Depreciation and Amortization of Property, Plant and Equipment (in thousands)\nSchedule X\nLA QUINTA INNS, INC.\nSupplemental Income Statement Information (in thousands)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(A) DIRECTORS OF REGISTRANT\nThere is incorporated in this Item 10 by reference that portion of the Company's definitive Proxy Statement, dated on or about April 15, 1994, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions \"Election of Directors,\" and \"Meetings and Committees of the Board of Directors.\"\n(B) EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain information is set forth below concerning the executive officers of the Company, each of whom has been elected to serve until the regular annual meeting of the Board of Directors following the next Annual Meeting of Shareholders and until his\/her successor is duly elected and qualified.\nGary L. Mead 46 President and Chief Executive Officer and Director Michael A. Depatie 37 Sr. Vice President - Finance, Chief Financing Officer William C. Hammett, Jr. 47 Sr. Vice President - Accounting & Administration Thomas W. Higgins 46 Sr. Vice President - Operations R. John Kaegi 45 Sr. Vice President - Marketing Steven T. Schultz 47 Sr. Vice President - Development John F. Schmutz 46 Vice President - General Counsel and Secretary\nGary L. Mead has been Director, President and Chief Executive Officer of the Company since March 1992. He served as Executive Vice President - Finance of Motel 6 G.P., Inc., the managing general partner of Motel 6, L.P., from October 1987 to January 1991.\nMichael A. Depatie has been Senior Vice President - Finance, Chief Financing Officer of the Company since July 1992. He served as Senior Vice President, Summerfield Hotel from May 1989 to July 1992. He served as Managing General Partner of PacWest Capital Partners from April 1988 to April 1989. He served as Vice President - Finance of The Residence Inn Company from July 1984 to July 1986 and Senior Vice President - Finance from July 1986 to March 1988.\nWilliam C. Hammett, Jr. has been Senior Vice President - Accounting and Administration since June 1992. He served as Executive Vice President - Finance of Motel 6 G.P., Inc., from February 1991 to June 1992. He served as Vice President-Controller of Motel 6 G.P., Inc. from September 1988 to February 1991. He served as Controller of Spartan Food Systems from August 1973 to September 1988.\nThomas W. Higgins has been Senior Vice President - Operations of the Company since September 1992. He served as Vice President - Human Resources of the Company from June 1992 to September 1992. He served as Vice President - Human Resources of Motel 6 G.P., Inc. from May 1988 to June 1992. He served as Director of Training\/Employment of General Mills from October 1986 to May 1988.\nR. John Kaegi has been Senior Vice President - Marketing of the Company since July 1992. He served as Senior Vice President - Marketing and Strategic Planning of KinderCare Learning Centers, Inc. from December 1989 to July 1992. He served as Vice President - Marketing of KinderCare Learning Centers, Inc. from July 1987 to December 1989. He served as Director Field Marketing of Holiday Inns, Inc. from November 1985 to July 1987.\nSteven T. Schultz has been Senior Vice President - Development of the Company since June 1992. He served as Senior Vice President - Development of Embassy Suites from October 1986 to June 1992.\nJohn F. Schmutz has been Vice President - General Counsel and Secretary of the Company since June 1992. He served as Vice President - General Counsel of Sbarro, Inc. from May 1991 to June 1992. He served as Vice President - Legal of Hardee's Food Systems, Inc. from April 1983 to May 1991.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThere are incorporated in this Item 11 by reference those portions of the Company's definitive Proxy Statement, dated on or about April 15, 1994, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions \"Executive Compensation,\" \"Compensation Pursuant to Plans,\" \"Other Compensation,\" \"Compensation of Directors,\" and \"Termination of Employment and Change of Control Arrangements.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere are incorporated in this Item 12 by reference those portions of the Company's definitive Proxy Statement, dated on or about April 15, 1994, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions \"Principal Shareholders\" and \"Security Ownership of Management\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is incorporated in this Item 13 by reference that portion of the Company's definitive Proxy Statement, dated on or about April 15, 1994, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the caption \"Certain Relationships and Related Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements\nThe Combined Financial Statements of the Company appearing in Item 8 are as follows:\nCombined Balance Sheets at December 31, 1993 and 1992 Combined Statements of Operations for the years ended December 31, 1993, 1992 and 1991 Combined Statements of Shareholders' Equity for the years ended December 31, 1993, 1992 and 1991 Combined Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991 Notes to Combined Financial Statements Independent Auditors' Report on financial statements and schedules\n(2) Financial Statement Schedules\nSchedule V - Property, Plant and Equipment - For the years ended December 31, 1993, 1992 and 1991. Schedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment - For the years ended December 31, 1993, 1992 and 1991. Schedule X - Supplemental Income Statement Information-For the years ended December 31, 1993, 1992 and 1991.\nAll other schedules for which provision is made in the applicable regulation to the Securities and Exchange Commission are not required under the related instructions or are inapplicable and have been omitted.\n(3) The following exhibits are filed as a part of this Report:\n(3)(a) Restated Articles of Incorporation of La Quinta Inns, Inc., as amended on May 21, 1993. (8)\n(3)(b) Amended and Restated By-Laws of La Quinta Inns, Inc. (1)\n(10)(a) La Quinta Inns, Inc. 1978 Non-Qualified Stock Option Plan, as amended. (2)\n(10)(b) La Quinta Inns, Inc. 1984 Stock Option Plan. (3)\n(10)(c) Amendment No. 1 to La Quinta Inns, Inc. 1984 Stock Option Plan. (4)\n(10)(d) Amendment No. 2 to La Quinta Inns, Inc. 1984 Stock Option Plan. (5)\n(10)(e) Amended and Restated La Quinta Inns, Inc. 1984 Stock Option Plan, as of November 21, 1991. (1)\n(10)(f) La Quinta Development Partners, L.P. Amended and Restated Agreement of Limited Partnership, dated March 21, 1990, by and between Registrant and AEW Partners, L.P. (6)\n(10)(g) La Quinta Development Partners, L.P. Contribution Agreement, dated March 21, 1990, by and between Registrant and AEW Partners, L.P. (6)\n(10)(h) Management and Development Agreement by and between Registrant and La Quinta Development Partners, L.P., dated March 21, 1990. (6)\n(10)(i) Supplemental Executive Retirement Plan and Trust Agreement of Registrant, dated April 20, 1990, by and between Registrant and Frost National Bank. (7)\n(10)(j) La Quinta Inns, Inc. Deferred Compensation Plan, effective June 1, 1987. (7)\n(10)(k) Form of Bonus Agreement dated February 22, 1991, by and between Registrant and each of Messrs. Sam Barshop, David B. Daviss, Alan L. Tallis and Francis P. Bissaillon. (7)\n(10)(l) Form of Indemnification Agreement, made and entered into as of November 15, 1990 and thereafter (with respect to persons who became directors of Registrant after such dates), by and between Registrant and each of its directors. (7)\n(10)(m) Form of Indemnification Agreement, made and entered into as of November 15, 1990 and thereafter (with respect to persons who became directors of Registrant after such dates), by and between Registrant and each of its officers. (7)\n(10)(n) Registration Rights Agreement, dated as of July 31, 1991 by and between Registrant and Sam Barshop and his wife, Ann Barshop. (1)\n(10)(o) Employment Agreement, dated as of October 1, 1991, by and between Registrant and Sam Barshop. (1)\n(10)(p) Employment Agreement, dated as of March 3, 1992, by and between Registrant and Gary L. Mead. (1)\n(10)(q) Non-Qualified Stock Option Agreement, dated as of March 3, 1992, between Registrant and Gary L. Mead. (1)\n(10)(r) Registration Rights Agreement, dated as of March 3, 1992, between Gary L. Mead. (1)\n(10)(s) Second Amended and Restated Master Convenant Agreement dated June 15, 1993. (8)\n(10)(t) $126,795,786.64 Credit Agreement dated June 15, 1993. (8)\n(10)(u) Indenture dated May 15, 1993 Re: $120,000,000 9 1\/4% Senior Subordinated Notes due 1003. (8)\n(10)(v) Partnership Acquisition Agreement dated October 27, 1993, among the Partnership, the General Partner, La Quinta, LQI Acquisition Corporation and LQI Merger Corporation. (9)\n(10)(w) $241,844,955.21 Amended and Restated Credit Agreement Among La Quinta Inns, Inc. Certain lenders and NationsBank of Texas, N.A. as Administrative Lender dated January 25, 1994 filed herewith.\n(10)(x) Third Amended and Restated Master Covenant Agreement dated as of January 25, 1994 filed herewith.\n(11) Statement regarding computation of per share earnings filed herewith.\n(22) Subsidiaries of La Quinta Inns, Inc. as of March 3, 1994 filed herewith.\n(23) Registrant's definitive Proxy Statement, dated on or about April 15, 1994, to be filed by Registrant within 120 days after the end of the fiscal year covered by this Form 10-K.\n(24) Consent by KPMG Peat Marwick dated March 23, 1994 to incorporation by reference of their reports dated January 31, 1994, except as to the first paragraph of note 5, which is as of February 9, 1994, in various Registration Statements filed herewith.\n(25) Powers of Attorney filed herewith.\n(b) Reports on Form 8-K. Registrant filed two Current Reports on Form 8-K, dated November 3, 1993 and December 15, 1993 with the Securities and Exchange Commission. The Report dated November 3, 1993 was filed under Items 5 and 7 describing the Merger Agreement between La Quinta Inns, Inc. and La Quinta Motor Inns Limited Partnership (\"the Partnership\"). The report dated December 15, 1993 was filed under Items 2 and 7 describing the acquisition of the Partnership, the Partnership's December 31, 1992 Consolidated Financial Statements and pro forma information for the year ended December 31, 1992 and the nine month period ended September 30, 1993.\n- ----------------------------\n(1) Previously filed as an exhibit to the Registrant's Registration Statement on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference.\n(2) Previously filed as an exhibit to the Registrant's Registration Statement on Form S-8 (No. 2-65645) and incorporated herein by reference.\n(3) Previously filed as an exhibit to the Registrant's Registration Statement on Form 10-K for the year ended May 31, 1984 and incorporated herein by reference.\n(4) Previously filed as an exhibit to the Registrant's Registration Statement on Form S-8 (No. 2-97266) and incorporated herein by reference.\n(5) Previously filed as an exhibit to the Registrant's Registration Statement and incorporated herein by reference.\n(6) Previously filed as an exhibit to the Registrant's Registration Statement for the Transition Period Report on Form 10-K for the seven months ended December 31, 1989 and incorporated herein by reference.\n(7) Previously filed as an exhibit to the Registrant's Registration Statement on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.\n(8) Previously filed as an exhibit to Registrant's Registration Statement on Form 10-Q for the period ended June 30, 1993.\n(9) Previously filed to the Registrant's Schedule 14D-1 filed November 1, 1993.\nSIGNATURES\nPursuant 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.\nLA QUINTA INNS, INC. (Registrant)\nBy:----------------------------------- William C. Hammett, Jr. Senior Vice President Chief Accounting Officer\nBy:----------------------------------- Michael A. Depatie Senior Vice President Chief Financing Officer Date:\nPursuant 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 and on the date indicated.\nSignature Title\nGary L. Mead President and Chief Executive Officer, Director\nWilliam C. Hammett, Jr. Sr. Vice President - Accounting and Administration\nThomas M. Taylor Chairman of the Board\nMichael A. Depatie Sr. Vice President - Finance\nJoseph F. Azrack Director\nPhilip M. Barshop Director\nWilliam H. Cunningham Director\nBarry K. Fingerhut Director\nGeorge Kozmetsky Director\nDonald J. McNamara Director\nPeter Sterling Director","section_15":""}
{"filename":"810665_1993.txt","cik":"810665","year":"1993","section_1":"Item 1. Business. --------\nAddington Resources, Inc. and its subsidiaries (the \"Company\") are primarily engaged in the development and operation of integrated solid waste disposal systems. The Company is also engaged in the surface mining and marketing of bituminous coal. For certain financial information concerning the Company's mining and environmental industry segments, see Note 19 to the audited Consolidated Financial Statements. Addington Resources, Inc. was incorporated on September 29, 1986, under the laws of Delaware.\nDisposition of Certain Coal Assets in the First Quarter of 1994. - ---------------------------------------------------------------\nPursuant to the Stock Purchase Agreement dated September 24, 1993 (the \"Agreement\") between Addington Holding Company, Inc., a wholly owned subsidiary of the Company, and Pittston Acquisition Company, an indirect wholly owned subsidiary of The Pittston Company (\"Pittston\"), the Company sold to Pittston (the \"Pittston Transaction\") all of the Company's stock in five of its indirect wholly owned coal subsidiaries, Addington, Inc., Appalachian Mining, Inc., Appalachian Land Company, Vandalia Resources, Inc. and Kanawha Development Corporation (collectively the \"Subsidiaries\"). The Pittston Transaction was consummated on January 14, 1994 (the \"Closing Date\").\nIn the Pittston Transaction, the Company transferred to Pittston all its long-term coal sales contracts with electric utilities except as set forth below under Coal Mining Operations-Major Sales Contracts. The Company also transferred to Pittston all of its coal reserves in Ohio, Virginia and West Virginia and, of its Kentucky coal reserves, only those reserves located in the Breathitt County Area of Kentucky. See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ----------\nCoal Resources --------------\nOn January 14, 1994, the Company sold a substantial portion of its coal- related assets to an indirect wholly owned subsidiary of The Pittston Company. See Item 1. Business-Disposition of Certain Coal Assets in the First Quarter of 1994. The information set forth in this Item relates only to the Company's properties retained following the Pittston Transaction.\nThe Company currently operates four active mines, all of which are in the Pike County Area (located in Pike County, Kentucky). The Job 17 mine, which began production in 1986, produced an average of 89,000 tons of coal per month during 1993. The Job 17A mine, which began production in September 1993, produced an average of 44,000 tons of coal per month during 1993 since it opened. The Ivy Creek mine, which began production in 1986, produced an average of 89,000 tons of coal per month in 1993. The Ivy-H mine, which began production in June 1993, produced an average of 30,000 tons of coal per month during 1993 since it opened. Each of these four mines has a production capability of up to approximately 100,000 tons of coal per month and produces high quality low-sulfur coal.\nAs of December 31, 1993, as adjusted for the Pittston Transaction, the Company owned in fee approximately 22,329 acres and controlled, primarily through short-term leases and contract mining agreements, an additional 26,156 acres of reserves in eastern Kentucky. In western Kentucky, the Company leased as of December 31, 1993, approximately 7,503 acres of reserves, and owned in fee approximately 354 acres. Approximately 44% of the Company's coal reserves are low-sulfur compliance reserves.\nAs adjusted for the disposition in The Pittston Transaction, the table below sets forth (in thousands of tons) estimated minimum surface minable coal reserves, recoverable and marketable, as of December 31, 1993. Since the completion of the reserve studies\n- 26 -\nupon which the estimates are based, some leases have expired, and the Company has acquired control of additional properties. Mining has also occurred in most of the areas, and the information has been adjusted to reflect estimated production in each area since the dates of the respective studies. The Company believes that despite its mining activity and the expiration of some leases in the areas covered by reserve studies, the estimates of aggregate minimum surface minable remain accurate in all material respects.\nReserve studies are estimates based on an evaluation of available data, and actual reserves may vary substantially from the estimates. Estimated minimum surface minable reserves are comprised of coal that is considered to be merchantable and economically recoverable by using surface mining practices and techniques prevalent in the coal industry at the time of the reserve study. While the Company has historically used surface mining in almost all of its operations, deep mining may be considered where it would be more profitable than surface mining in the Company's judgment. The Company believes that it can recover a greater proportion of the coal reserves in certain areas through surface mining than is shown in the table below. The Company believes its current reserves exceed its current contractual requirements even if limited to recovery only by current surface mining recovery methods. In this regard, the reserves shown in the table below include a variety of qualities of coal. Where appropriate, the Company has blended coal of different qualities to meet contract specifications.\nA substantial part of the reserves currently available to the Company are represented by leases which expire after a stated number of years. Most of the leases give the Company renewal options, which are usually subject to the condition that mining has commenced on or near the leased property. Most of the leases require various payments in order to maintain the lease if mining has not begun on the property. The Company believes that it has conducted mining activities and made payments to obtain renewal rights with regard to lease properties covering reserves which, when added to reserves owned in fee by the Company, are sufficient to satisfy its current requirements under long-term contracts. However, the availability of reserves on other leased property at the present time does not assure the Company that the reserves will be available at a time that the Company may wish to mine such reserves. Moreover, the availability of reserves on leased property is often subject to uncertainties relating to such matters as the title of the lessor to the coal and precise boundaries. See Item 2. Properties-Controlled Reserves.\n- 27 -\n(1) All minable reserves are categorized as \"Demonstrated Recoverable.\" Minimum Demonstrated Recoverable Reserves is the sum of Measured and Indicated Reserves.\n(2) \"Measured\" reserves represent the portion of total reserve estimates which, in the opinion of the Company, is substantiated by adequate information, including that derived from exploration, current and previous mining operations, outcrop data and knowledge of mining conditions. \"Indicated\" reserves are computed from information of a more preliminary or limited extent. The divisions into these two categories are based upon the general guidelines of the U.S. Geological Survey and judgments related to a combination of factors. The Company believes that the division is a reasonably close estimate of the general order of relative tonnages involved. The figures listed above reflect a 90% recovery factor that has been applied to in-place surface minable reserves. Recovery factors for deep-minable reserves are 65% of the in-place tonnage, except for two coal seams which use 55% of in-place tonnage. \"Surface Mining Permitted Reserves\" are reserves which are approved for surface mining by having met conditions of the local, state and federal regulatory agencies for active disturbance of the reserves and the extraction of the mineral. Such approval under the Surface Coal Mining and Reclamation Act of 1977 is a prerequisite to production and marketing of the coal. This permit process varies from state to state; however, a 12 to 18 month time period is normal for the process in states in which the Company holds reserves.\n(3) All reserves controlled by the Company are listed as \"Steam\" because of the quality characteristics and because current contracts are with electric utilities.\n- 28 -\n(4) The Princess Area properties are located in Boyd, Carter and Greenup Counties, Kentucky. The Pike County Area properties are located in Floyd, Martin and Pike Counties, Kentucky. The Licking River Area is located in Elliott and Lawrence Counties, Kentucky. The South Hill Area and the Aberdeen Area are located in Butler County, Kentucky. The Knottsville Area and the West Louisville Area are located in Daviess County, Kentucky. The Hopkins County Area is located in Hopkins County, Kentucky.\nThe extent to which the Company's coal resources will be mined will depend upon factors over which it has no control, such as future economic conditions, the price and demand for coal of the quality and type controlled by the Company, the price and supply of alternative fuels and future mining practices and regulation. The ability of the Company to mine in areas covered by the reserve studies depends upon the ability of the Company to maintain control of the reserves (other than the properties owned in fee) through extensions or renewals of the leases or other agreements or the ability of the Company to obtain new leases or agreements for other reserves.\nControlled Reserves - -------------------\nThe Company has and plans to continue an active leasing and acquisition program to augment the reserves it controls, particularly in areas where it is currently operating. To date, the Company has not experienced any material difficulty in acquiring leases or the right to mine in areas where it has operations or in which it plans to commence mining in the future.\nGenerally, the Company's leases for its coal reserves are for an initial term, usually of five years. Most of the leases contain an option to renew on the part of the Company, with exercise of the option usually subject to the condition that mining shall have commenced on (or, as specified in some leases, near) the leased property. Most of the leases require the payment of some amount of advance royalties or delay rentals (payments to keep the lease in force if mining has not commenced) on a periodic basis during each year if mining has not begun on the property. After mining commences, the leases generally require the payment of a royalty based on the tonnage mined and sold. The Company's average royalty expense for the year ended December 31, 1993 on reserves retained following the Pittston Transaction was $3.36 per ton.\nNotwithstanding the probable loss of some of its mining rights under its current and future leases due to their expiration, the Company believes that it can maintain or acquire sufficient reserves to enable it to fulfill all of its obligations under its sales contracts and, if it so chooses, sell additional amounts of coal on the spot market.\n- 29 -\nSome of the Company's reserves are owned in fee or are on land owned in fee by the Company, and the balance of its reserves are on land leased or otherwise controlled by the Company. Most of the Company's leases describe the leased property in general terms, and these descriptions are usually not based on actual surveys or boundaries which are otherwise precisely identified. Moreover, because of the short-term nature of its leases and because of the expense involved, the Company does not have title to the leases reviewed by attorneys or other qualified title examiners. As to title to properties acquired by the Company, the Company has relied on the assurances of the parties from whom the properties were acquired, rather than on current title examinations. As to properties the Company leases, a limited title investigation and, to the extent possible, a determination of the precise boundaries of a property is made in most cases only as a part of the process of securing a mining permit shortly before commencement of mining operations. The Company believes that its practices in investigating title and determining boundaries to the properties it owns, leases or otherwise controls are consistent with customary industry practices in Kentucky and that such practices are adequate to enable it to acquire the right to mine such properties.\nLandfill Operations - -------------------\nThe table below sets forth certain information as of December 31, 1993 with respect to the Company's six operating landfills. Permitted Capacity refers to the remaining capacity for which the Company has received construction permits from the appropriate state authorities. The Company constructs its landfills in a series of landfill cells as additional airspace is needed to accommodate customer demand.\n(1) The Company has applied for a permit modification to increase the permitted size of the landfill to an aggregate airspace of 9,243,000 cubic yards or 5,544,000 tons.\n(2) The Company has applied for a permit modification to increase the permitted size of the landfill to an aggregate airspace of 6,896,000 cubic yards or 4,138,000 tons.\n- 30 -\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nThe Company is named as defendant in various actions in the ordinary course of its business. These actions generally involve such matters as property boundaries, mining rights, blasting damage, personal injuries, and royalty payments. The Company believes these proceedings are incidental to its business and are not likely to result in adverse judgments which are material to the Company's results of operations and financial condition.\nThe Company previously sold coal to Consumers Power under a contract acquired by Pittston in January 1994. See Item 1. Business. Although the contract was transferred, the Company retains all obligations with respect to the litigation described below. The contract contains a provision that states that if Consumers Power is able to demonstrate an ability to purchase coal meeting certain requirements for a contract term of ten years or more from another producer located in the U.S. Department of Energy's District No. 8 at a price that is more than $.15 per million BTU below the average FOB mine price of coal purchased and sold under the contract for the previous three-month period, Consumers Power can terminate the contract if the parties negotiate but fail to agree upon the price of future coal shipments. On November 4, 1988, the Company was notified that Consumers Power was prepared to demonstrate its ability to purchase coal from another producer within the parameters of this termination provision. In response to this notice, the Company filed a complaint in Boyd Circuit Court on January 18, 1989, in Boyd County, Kentucky, against Consumers Power. The complaint, as subsequently amended, alleges, among other things, that the conditions necessary to trigger the termination provision have not occurred, that the termination provision is unconscionable and that the competitor's bid tortiously interferes with the Company's contractual relations with Consumers Power. On February 2, 1989, the Company obtained a restraining order preventing Consumers Power from terminating the contract pursuant to the termination provision. On March 21, 1989, Consumer Power filed an answer denying the complaint's allegations and asserting a counterclaim that the Company had breached the contract by not entering into negotiations to reduce the contract price. Consumers Power also alleged the breach of a guaranty by the Company. On May 4, 1989, the Boyd Circuit Court directed the parties to maintain the status quo in their contractual relationship, directed the Company to post a $750,000 bond, and directed the parties to provide for expedited discovery in the case. On November 9, 1990, the Boyd Circuit Court directed the Company to increase the amount of the bond to be posted from $750,000 to $3,000,000 in light of the additional amounts of coal shipped under the contract from the date of the court's previous order.\nOn April 30, 1993, the Boyd Circuit Court entered summary judgment in favor of the Company against Consumers Power that the termination provisions of the Company's coal supply contract with Consumers Power had not been appropriately triggered by Consumers Power. Consumers Power has appealed the grant of summary judgment to the Kentucky Court of Appeals. On June 3, 1993, Consumers Power also filed a motion in Boyd Circuit Court to dissolve the May 4,\n- 31 -\n1989 temporary restraining order that prevents Consumers Power from seeking to terminate the contract pursuant to the contract provision. Although on September 1, 1993, the court subsequently dissolved the temporary restraining order and ordered that the Company's $3,000,000 bond could be released, Consumers Power has not terminated the contract in light of the April 30, 1993 summary judgment decision that the termination provision had not been appropriately triggered. By letter dated October 5, 1993, Consumers Power has notified the Company that it is currently prepared to demonstrate its ability to purchase coal from another producer within the parameters of the termination provision. Consumers Power states that it can obtain coal for approximately $24.90 per ton instead of the $34.16 per ton charged during the three months ended September 30, 1993.\nOn February 15, 1991, Bill Robinson, Sr. filed suit against Addwest Gold, Inc. (\"Addwest Gold\") and Addwest Mining, Inc. (\"Addwest Mining\") in the Montana Second Judicial District Court, Butte-Silver Bow County, Montana. The complaint alleged breach of contract, fraud and bad faith in relation to Robinson's employment with Addwest Gold. Robinson alleged that agents of Addwest Gold induced him to go to work for Addwest Gold by promising him a large bonus on the happening of certain contingencies, and then failed to pay him a bonus in the amount he expected. The Company sold Addwest Gold in January, 1990. On March 29, 1991, the action was removed to the U.S. District Court for the District of Montana, Butte Division. On March 25, 1992, Robinson amended his complaint to add, among others, as defendants Larry Addington and Larry Harrington, individually, and Addington Resources, Inc. and Addington Holding, Inc. Robinson did not claim a specific amount of damages in these pleadings.\nAt the time of the trial in October, 1992, Robinson made a claim for a total of approximately $19 million in damages. On November 5, 1992, the jury returned a verdict against the defendants for approximately $850,000 in compensatory damages, $1,000 in punitive damages against Larry Harrington, $6,000,000 in punitive damages against Larry Addington, and $4,500,000 in punitive damages against Addwest Gold.\nOn February 23, 1993, the judge entered a judgment stating that the defendants Larry Harrington, Addwest Gold, Addington Resources, Addington Holding Company and Addwest Mining are jointly and severally liable to Mr. Robinson for compensatory damages in the amount of $850,000 and that Mr. Robinson is entitled to punitive damages in the amount of $1,000 from Larry Harrington, $6,000,000 from Larry Addington, and $4,500,000 jointly and severally from defendants Addwest Gold, Addington Resources, Addington Holding Company and Addwest Mining.\nWith respect to claims against Larry Addington, although the jury specifically rejected a claim by Mr. Robinson that Mr. Addington had committed fraud upon him, the court found that there was sufficient evidence to sustain the finding of liability upon\n- 32 -\nthe plaintiff's claim for negligent misrepresentation and the imposition of punitive damages against Larry Addington. The court stated that there was sufficient evidence to support a finding that the alleged negligent misrepresentations made by Larry Addington to the plaintiff were accomplished with actual malicious intent within the meaning of the Montana statute relating to claims for punitive damages.\nFollowing the court's denial on October 6, 1993, of post-judgment motions, the defendants filed a notice of appeal on November 1, 1993, to the U.S. Court of Appeals for the Ninth Circuit. After extensive settlement discussions conducted under the supervision of a mediator for the U.S. Court of Appeals for the Ninth Circuit, a settlement has been reached in which Mr. Robinson will release all parties from all claims. As a result of the settlement, the Company expects to pay Mr. Robinson $3,450,000 by April 15, 1994. The parties are currently in the process of drafting appropriate settlement documentation.\nThe Company is obligated for the full amount of this settlement pursuant to certain indemnification agreements. In accordance with Section 145 of the General Corporation Law of the State of Delaware and the Indemnity Agreement of August 1988 between the Company and Larry Addington, the Company agreed to indemnify Larry Addington with respect to this litigation. The Board of Directors (Larry Addington abstaining) found that Mr. Addington did at all times relevant to this litigation act in good faith and in a manner which he reasonably believed to in or not opposed to the best interests of the Company and, therefore, has agreed to indemnify him from and against the amount of any final judgment or settlement entered in the litigation and to pay (and\/or advance) any and all expenses incurred by him in connection with the defense of the litigation or its appeal.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------\nNone.\n- 33 -\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters. ----------------------------------------\nThe Company's Common Stock trades on the NASDAQ National Market System (symbol-ADDR). The table below sets forth the high and low sales prices as reported on NASDAQ for the periods indicated.\nOn March 25, 1994, the closing price of the Company's Common Stock on the NASDAQ National Market System was $16.50 per share. At March 17, 1994, the Company had 258 stockholders of record (including depositaries which hold stock in street name on behalf of other beneficial owners).\nHolders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefor. The Company has not paid any dividends since its initial public offering but expects to reconsider that policy during 1994; no prediction can be made regarding the results of that reconsideration or whether dividends will be paid in the future.\nThe Company currently has a line of credit with a bank with a total commitment of $15 million. In connection with the line of credit, the Company has agreed to certain restrictive covenants which, among others, limit the amount of dividends that the Company can pay, limit its ability to incur additional indebtedness, require an as-defined minimum tangible net worth, and require a minimum current ratio.\n- 34 -\nItem 6.","section_6":"Item 6. Selected Financial Information ------------------------------\nThe following selected financial information of the Company for each of the five years in the period ended December 31, 1993 are derived from the audited Consolidated Financial Statements of the Company. The selected financial information should be read in conjunction with the audited Consolidated Financial Statements and the notes thereto appearing elsewhere herein.\n- 35 -\n_________________________ (1) The fully diluted net income per share calculation for 1989 has not been presented because the effect would be anti-dilutive. The fully diluted net income per share for 1990, 1991, 1992 and 1993 has not been presented due to the conversion of the Convertible Subordinated Debentures in November 1989.\n- 36 -\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results ------------------------------------------------------------------------ of Operations. -------------\nGeneral - -------\nAdverse weather conditions and particularly precipitation can affect the Company's ability to conduct its mining operations. Since heavier precipitation generally occurs in the areas in which the Company conducts its mining operations during late fall and early winter, the Company believes that its revenues and profitability may be adversely affected during those periods.\nResults of Operations - ---------------------\n1993 Compared with 1992 - -----------------------\nNet loss during 1993 was $16,189,000 or $1.04 per share, compared to net income of $11,036,000 or $.72 per share for 1992. Net loss during 1993 was affected by the following:\n(1) Pursuant to the Stock Purchase Agreement dated September 24, 1993, (the \"Agreement\"), the Company entered into an agreement to sell the stock of five of its coal subsidiaries to an indirect wholly owned subsidiary of The Pittston Company (\"Pittston\") for $157 million cash. The Agreement also contemplated that, before closing, certain property, plant and equipment (the net book value of which was approximately $43,000,000 as of December 31, 1993) would be transferred to other subsidiaries of the Company from the subsidiaries to be sold. In addition, the Company will retain all of the net working capital (the net book value of which was approximately $30,000,000 as of December 31, 1993) of the sold subsidiaries as of the date of closing (the \"Closing Date\"). The Agreement also required that within 60 days after the Closing Date, the Company would deliver to Pittston a statement of working capital for the Subsidiaries showing the Subsidiaries' Combined Net Working Capital, as defined in the Agreement, as of the close of business on the Closing Date. If the Combined Net Working Capital exceeds zero, Pittston is to pay the Company an appropriate adjustment. If the Combined Net Working Capital is less than zero, the Company is to pay Pittston an appropriate adjustment. By letter dated March 15, 1994, the Company asserted that Pittston should make a payment in the amount of $2,286,000 to the Company in light of the Subsidiaries' Combined Net Working Capital as of the Closing Date. In accordance with the terms of the Agreement, the Company and Pittston are currently seeking to resolve their differences with respect to the Subsidiaries' Combined Net Working Capital as of the Closing Date. Because the parties are not in agreement with respect to the appropriate adjustment, the\n- 37 -\nCompany cannot predict at this time the amount which will be owed by one party to the other with respect to such an adjustment. In connection with the sale, the Company has provided certain guarantees to Pittston.\nThis transaction was completed on January 14, 1994.\nAs a result of this transaction, the net assets related to the sale appear as a current asset at December 31, 1993 in the Company's audited Consolidated Financial Statements. Additionally, since the Company's $125,000,000 Senior Secured Notes were redeemed in connection with the transaction, they have been classified as a current liability at December 31, 1993 in the audited Consolidated Financial Statements.\nThe Company does not expect to record a loss on this transaction. The Company will record the actual economic impact of the disposal in its 1994 financial statements. However, principally due to the Company's de- emphasis on mining operations, the Company recorded approximately $14,506,000 of pre-tax asset write-offs during 1993. See Note 3 to the audited Consolidated Financial Statements. These write-offs consist principally of $9,384,000 related to the Company's decision to abandon its sulfur mine development project in the western United States. Additionally, the Company has written off approximately $5,122,000 of assets that it has abandoned associated with its environmental projects. These asset write-offs are reflected in income from operations and will be available to offset current and future federal and state income tax liabilities.\nOther terms of the transaction include the Company entering into a coal supply contract with Pittston (the \"Pittston Coal Supply Contract\") for the sale of 4,920,000 tons over 3-1\/2 years at a base price of $26.00 per ton, subject to adjustments. Additionally, the Company will receive a $1.00 per ton production royalty for coal produced from certain West Virginia properties being sold to Pittston with a minimum royalty of $100,000 per month, a maximum aggregate royalty in any one year of $1.5 million, and a maximum aggregate royalty under the agreement of $3.75 million. The Company will also pay Pittston a royalty of $0.50 per ton of coal produced by two highwall mining machines for 3-1\/2 years.\nAfter the transaction discussed above, the Company continues to own and operate four eastern Kentucky mines with estimated annual production capacity of 3,000,000 tons per year. During 1993, these mines produced 2,373,000 tons with an average cost of operations of $25.84 per ton. The average sales price received by the\n- 38 -\nCompany from coal produced by these eastern Kentucky mines during 1993 was $28.59 per ton.\nFuture production from these retained coal mines will be placed on the Pittston Coal Supply Contract and a new coal supply contract entered into with The Cincinnati Gas & Electric Company (the \"CG&E Coal Supply Contract\"). The CG&E Coal Supply Contract calls for the sale of 5,400,000 tons of coal over six years beginning January 1, 1994.\n(2) During 1993, the Company reserved for certain litigation settlements which reduced pre-tax income by $4,050,000. (See Note 13 to the audited Consolidated Financial Statements.)\n(3) During 1993, the Company established a $5,767,000 pre-tax reserve against the note receivable arising out of the 1992 sale of one of its subsidiaries; this write-off is reflected in other income and expense. (See Note 5 to the audited Consolidated Financial Statements.)\n(4) Adverse wet weather conditions during the first four months of 1993 and the month of December 1993 caused major inefficiencies at the Company's mining operations and, as a result, a major increase in production costs.\nNet income during 1992 was $11,036,000 or $.72 per share, compared to net loss of $9,686,000 or $.64 per share for 1991. Net income during 1992 was affected by the following:\n(1) The Company recognized a $10,544,000 pre-tax gain on the sale of certain coal subsidiaries. (See Note 5 to the audited Consolidated Financial Statements.)\n(2) During 1992, the Company recognized $4,285,000 in pre-tax gains on the sale of assets. The majority of this gain was recognized from the sale of certain West Virginia coal reserves.\n(3) During 1992, the Company reached a litigation settlement which reduced pre- tax income by $5,100,000. (See Note 13 to the audited Consolidated Financial Statements.)\n(4) During 1992, the Company recognized an approximately $5,000,000 pre-tax gain on the sale of highwall mining machines.\nThe Company's mining revenues increased from $292,225,000 in 1992 to $358,957,000 in 1993. Contributing to this 23% increase was revenue of $4,827,000 recognized on a fourth highwall mining machine sold to Pittston during 1993. Also contributing was a 31% increase in tons sold from 8,815,000\n- 39 -\ntons sold during 1992 compared to 11,530,000 tons sold during 1993. Additionally,included in mining revenues was $4,255,000 realized from the Company's highwall miner contract mining activities during 1993 compared to $1,480,000 realized from the Company's highwall miner contract mining activities during 1992. This increase in tons sold is primarily a result of the acquisition described in Note 18 to the audited Consolidated Financial Statements.\nTotal environmental revenues and environmental income from operations increased to $24,929,000 and $3,722,000, respectively, during 1993 compared to total environmental revenues of $7,779,000 and environmental income from operations of $1,620,000 during 1992. Included in environmental revenues and environmental income from operations is revenue and income from operations generated by the Company's landfill operations and waste collection services. During 1993, the Company's landfill operations generated $17,264,000 of revenue and $5,818,000 of income from operations. During 1993, the Company's waste collection services generated $7,665,000 of revenues and $2,096,000 of losses from operations. During 1992, the Company's landfill operations generated $4,689,000 of revenues and $1,984,000 of income from operations. During 1992, the Company's waste collection services generated $3,090,000 of revenues and $364,000 of losses from operations. The primary reasons for the substantial increases in total environmental revenues and income from operations is the receipt of operating permits for certain contained landfills during 1992 and the commencement of operations at these landfills. The Company received approximately 753,000 tons of waste at Company-owned landfills during 1993 compared to 196,000 tons of waste received during 1992.\nIn June 1992, the Company entered into a 14-year exclusive licensing agreement that permits Joy Technologies, Inc. (\"Joy\") to manufacture and market a highwall mining system that the Company developed and currently uses in its own mining operations. In accordance with the terms of the June 1992 agreement, Joy plans to market the system to mining companies on the basis of a cost per ton of material mined by the system. If Joy successfully markets the system, the Company will receive approximately $130,000 in origination fees for each of the first eight machines leased and approximately $255,000 in origination fees for each machine leased thereafter, and a royalty based on tons of material mined by these other mining companies. The agreement provides that Joy will charge a lessee a minimum royalty per ton of material mined of $3.77, subject to adjustment for inflation and safety-related changes. The Company will receive 30% of the minimum royalty of $3.77 (as adjusted for inflation) and generally 50% of any part of such royalty payments in excess of $3.77 (as adjusted for inflation). While Joy has not met the Company's anticipated results for leases under the June\n- 40 -\n1992 agreement, Joy has indicated to the Company that Joy's leases of highwall mining machines will increase significantly during 1994.\nIncluded in the Company's other revenues and income from operations in 1993 was $260,000 in origination fees received from Joy. These fees relate to the two highwall miners leased by Joy to third parties during 1993. During 1993, Joy paid no per ton royalty fees related to these two machines.\nAs a percentage of total revenues, cost of operations increased from 79% for 1992 to 86% for 1993. This increase is primarily a result of higher costs being incurred at the Company's mining operations due to adverse weather conditions during the first part of the year and due to the asset write-offs discussed above.\nDepreciation and amortization increased from $25,111,000 in 1992 to $29,939,000 in 1993. This 19% increase is primarily attributable to an increase in depreciation and amortization of landfill property and equipment.\nSelling, general and administrative expenses during 1993 totalled $22,303,000 and remained relatively unchanged compared to $21,274,000 for 1992.\nInterest expense increased from $13,483,000 during 1992 to $16,577,000 during 1993. The 23% increase is primarily due to the decline in the amount of interest capitalized in 1993. The amount of interest capitalized for 1993 was $2,111,000 compared to interest capitalized of $4,806,000 for 1992. The capitalized interest is related primarily to the Company's environmental operations. The decrease in capitalized interest occurred because the Company ceases to capitalize interest after a landfill becomes operational.\nInterest income decreased from $791,000 during 1992 compared to $649,000 during 1993. This 18% decrease is due to a decrease in the average amount of short-term investments outstanding coupled with a decrease in the interest rate yields on short-term investments.\nGain on the sale of assets decreased from $4,285,000 for 1992 to $630,000 for 1993. This decrease is primarily due to a $4,626,000 pre-tax gain recognized from the sale of certain West Virginia coal reserves and land in 1992 which were not included in the Company's current mining plans.\nThe Company's effective tax rate decreased from a 32% provision in 1992 to a 25% benefit in 1993. This decrease in the effective tax rate is primarily a result of several factors, including percentage depletion, state income taxes and the allowance on utilization of minimum tax credits.\n- 41 -\nThe Company's cash and cash equivalents totalled $13,744,000 at December 31, 1993, compared to $32,955,000 at December 31, 1992. This 58% decrease is primarily due to the timing of the receipt of payments on receivables, as well as funding capital additions.\nAccounts receivable at December 31, 1993 totalled $8,946,000, compared to the balance of $33,523,000 at December 31, 1992. This decrease is primarily due to including the accounts receivable related to the coal subsidiaries sold to Pittston in the net assets held for disposal as of December 31, 1993.\nInventories decreased from $28,060,000 at December 31, 1992, compared to $11,803,000 at December 31, 1993 primarily due to including the inventory related to the coal subsidiaries sold in the net assets held for disposal as of December 31, 1993.\nPrepaid expenses and other at December 31, 1993 totalled $7,718,000 compared to the balance of $6,538,000 at December 31, 1992. This increase is primarily due to deferred selling costs of approximately $1,100,000 related to the sale of coal subsidiaries to Pittston on January 14, 1994.\nProperty, plant and equipment decreased to $139,055,000 at December 31, 1993 compared to $212,585,000 at December 31, 1992. This 35% decrease is primarily due to including property, plant and equipment related to the subsidiaries sold to Pittston in the net assets held for disposal to Pittston as of December 31, 1993. However, the Company had property additions during 1993 of approximately $49 million. These additions are primarily: 1) coal related acquisitions as described in Note 18 to the audited Consolidated Financial Statements and 2) landfill and other environmental related development costs.\nThe net balance of coal sales contracts and contract mining agreements decreased from $33,041,000 at December 31, 1992 compared to zero at December 31, 1993. This decrease is due to including the coal sales contracts related to the coal subsidiaries sold to Pittston in the net assets held for disposal as of December 31, 1993.\nAccounts payable at December 31, 1993 decreased to $5,609,000 as compared to the December 31, 1992 balance of $21,865,000, primarily due to including the payables related to the coal subsidiaries sold to Pittston in the net assets held for disposal as of December 31, 1993.\nAccrued expenses and other liabilities increased to $13,714,000 at December 31, 1993 as compared to $12,833,000 at December 31, 1992, primarily due to the litigation reserve\n- 42 -\nestablished at year end, as discussed above, offset by a decrease in reclamation and closure costs.\nThe Company's line of credit balance at December 31, 1993 totalled $23,442,000 compared to the December 31, 1992 balance of $22,535,000. This increase is primarily due to the acquisition of certain coal reserves in West Virginia. (See Note 18 to the audited Consolidated Financial Statements.) The acquisition of these additional coal reserves was financed by drawing on this line of credit.\nThe Company's long-term debt outstanding increased from $3,232,000 at December 31, 1992 to $11,954,000 at December 31, 1993. This increase is primarily due to the $10,000,000 borrowed against the environmental company's line of credit during 1993.\nThe Company's other long-term liabilities increased from $1,331,000 at December 31, 1992 to $2,705,000 at December 31, 1993. This increase is primarily due to the normal increase in landfill closure and post-closure costs accrued, as well as an increase in the accrual for workers' compensation, including black lung benefits.\n1992 Compared with 1991 - -----------------------\nNet income during 1992 was $11,036,000 or $.72 per share, compared to net loss of $9,686,000 or $.64 per share for 1991. Net income during 1992 was affected by the following:\n(1) The Company recognized a $10,544,000 pre-tax gain on the sale of coal subsidiaries. (See Note 5 to the audited Consolidated Financial Statements.)\n(2) During 1992, the Company recognized $4,285,000 in pre-tax gains on the sale of assets. The majority of this gain was recognized from the sale of certain West Virginia coal reserves.\n(3) During 1992, the Company reached a litigation settlement which reduced pre- tax income by $5,100,000. (See Note 13 to the audited Consolidated Financial Statements.)\n(4) During 1992, the Company recognized an approximately $5,000,000 pre-tax gain on the sale of highwall mining machines.\nNet loss during 1991 was affected by the following:\n(1) During 1991, the Company elected to adopt SFAS No. 109 \"Accounting for Income Taxes\". The effect of adopting this new standard for accounting for income taxes as of January 1, 1991 was to increase the Company's net loss by\n- 43 -\n$3,500,000. (See Note 1 to the audited Consolidated Financial Statements.)\n(2) A significant increase in the cost of diesel fuel due to the Persian Gulf crisis caused a major increase in the cost of operations at the Company's mining operation during 1991.\n(3) The high operating costs of three of the Company's mines located in western Kentucky resulted in the Company's decision to close these three mines in 1991. The Company incurred a net loss of approximately $10,681,000 at its western Kentucky operations during 1991, which includes a pre-tax charge to expense of approximately $9,000,000 to write off its investment in its western Kentucky mines and to reserve for future reclamation. See Note 7 to the audited Consolidated Financial Statements.\nThe Company's net mining revenues increased from $271,808,000 during 1991 to $292,225,000 during 1992. The Company's mining revenues increased primarily due to the sales of five of its highwall mining machines. Three of these highwall mining machines were sold to Pittston for aggregate revenues of $12,427,000, while two were sold and leased back from a financing company for aggregate revenues of $6,400,000. Under its licensing agreement with Joy discussed above, the Company is generally prohibited from selling the highwall mining machines to third parties in the future. Although the Company experienced an increase in tons sold from 8,220,000 tons sold during 1991 compared to 8,815,000 tons sold during 1992, the average sales price per ton decreased from $32.83 per ton for 1991 to $30.04 per ton for 1992. This 8.5% decrease in the average sales price is primarily attributable to the March 1992 sale of a coal subsidiary, the assets of which consisted primarily of two long- term coal sales contracts pursuant to which the Company sold during 1991 a total of 957,703 tons of coal at an average per ton sales price of $41.69. (See Note 5 to the audited Consolidated Financial Statements.) In addition, while approximately 90.2 percent of the Company's total coal sales in tons during 1992 were pursuant to contracts with a term of more than one year, see Item 1. \"Business -- Coal Mining Operations,\" the Company is also subject to general conditions in the coal industry, currently including high coal inventories of electric utilities, generally weak demand, and low exports. During 1992, adverse conditions in the coal industry drove down spot coal prices, thus decreasing revenues from the Company's spot market sales which accounted for approximately 9.8 percent of the Company's total coal sales in tons in 1992. General conditions in the coal industry also affect the Company's efforts to negotiate new long-term contracts with utilities. For example, high inventory levels at utilities and low spot coal prices decrease the incentive for an electric utility to enter into a long-term coal sales contract.\n- 44 -\nEnvironmental revenues and net income increased to $7,779,000 and $351,000, respectively, during 1992 compared to environmental revenues of $1,868,000 and net loss of $563,000 during 1993. The primary reasons for these substantial increases are the Company's receipt of operating permits for certain contained landfills in 1992 and the commencement of operations at these landfills; the Company also increased its waste collection services in 1992 through acquisitions of other waste hauling businesses.\nOther revenue decreased to $1,470,000 during 1992 compared to $1,579,000 during 1991. This decrease is due to the Company's sale of its road construction subsidiary during July 1991. During 1992, the Company recorded licensing revenue from Joy of $1,470,000 resulting from the agreement between the Company and Joy that provides Joy the right to manufacture and sell the Company's highwall mining machines. (See Note 12 to the audited Consolidated Financial Statements.)\nAs a percentage of total revenues, cost of operations decreased from 81% during 1991 to 79% during 1992. This decrease is primarily due to the Company's pre-tax charge to expense in 1991 of approximately $9,000,000 to write off its investment in its western Kentucky mines and to reserve for future reclamation.\nDepreciation and amortization decreased from $29,740,000 during 1991 to $25,111,000 during 1992. This 16% decrease is primarily attributable to the amortization of coal contracts no longer being included in depreciation and amortization since the contracts were sold during March 1992. (See Note 5 to the audited Consolidated Financial Statements.)\nSelling, general and administrative expenses decreased from $23,410,000 during 1991 to $21,274,000 during 1992. This 9% decrease is primarily attributable to certain selling expenses associated with Kanawha Land Company, Inc. no longer being incurred since this subsidiary was sold during March 1992. (See Note 5 to the audited Consolidated Financial Statements.)\nInterest expense decreased from $14,446,000 during 1991 to $13,483,000 during 1992. The 7% decrease is primarily due to an overall decrease in interest rates on bank debt tied to the prime interest rate and an overall reduction in outstanding indebtedness. In addition, the Company continued to capitalize interest associated with its investment in those projects still in the development phase. The amount of interest capitalized for 1992 was $4,806,000 compared to interest capitalized of $4,874,000 for 1991.\nInterest income decreased from $2,365,000 during 1991 compared to $791,000 during 1992. This 67% decrease is due to a decrease in the interest rate yields on short-term investments.\nGain on the sale of assets increased from $1,840,000 for 1991 to $4,285,000 for 1992. This increase is primarily due to a $4,626,000 pre-tax gain recognized from the sale of certain West\n- 45 -\nVirginia coal reserves and land which were not included in the Company's current mining plans.\nThe Company's effective income tax rate decreased from a 40% benefit in 1991 to a 32% provision in 1992. This decrease in the effective tax rate is primarily a result of several factors, including percentage depletion and state income taxes.\nLiquidity and Capital Resources - -------------------------------\nThe working capital needs of the Company have been met primarily through a combination of funds provided by banks and other institutions and cash generated through operations.\nAs of December 31, 1993, the Company had approximately $16,558,000 remaining available under its lines of credit secured by certain accounts receivable and coal inventory and substantially all of its environmental assets bearing interest at rates ranging from prime to prime plus 1\/2%.\nThere are certain environmental contingencies related to the Company's coal operations and integrated solid waste disposal system operations, primarily land reclamation obligations and landfill closure obligations, respectively. Under current federal and state surface mining laws, the Company is required to reclaim land where surface mining operations are conducted. Accruals for the estimated cost of restoring the land are provided as mining takes place, based upon engineering estimates of costs. The Company also estimates and records its costs associated with closure and post-closure monitoring and maintenance for operating landfills based upon relevant government regulations. Accruals for these closure and post-closure costs are provided as permitted airspace of the landfill is consumed. The Company revises its estimates on a periodic basis. As of December 31, 1993, the Company had accrued expenses for reclamation and closure costs of approximately $2,524,000. There is a possibility that such obligations, when ultimately paid, may differ substantially from the recorded accrued expenses thus affecting the Company's liquidity. See Note 1 and Note 11 to the audited Consolidated Financial Statements.\nIn 1990, the Company implemented a self-insurance program to cover most of its employees for workers' compensation, including black lung benefits. Black lung expense is being provided, based upon a recent actuarial study, over the estimated remaining working lives of the miners using accounting methods similar to that of a defined benefit pension plan. Benefits provided are subject to federal and state law and, thus, are not under the control of the Company. Workers' compensation (including black lung) expense for the year ended December 31, 1993 was approximately $3,755,000. There is a possibility that workers' compensation (including black lung) obligations, when ultimately settled and paid, may differ substantially from the recorded balance and thus affect the\n- 46 -\nCompany's liquidity. See Note 16 to the audited Consolidated Financial Statements.\nThe Company believes that its present financial condition, considering the funds available under the existing line of credit, the proceeds received from the sale of certain coal subsidiaries (see Note 2 of the audited Consolidated Financial Statements), and internal financial resources, provide adequate capital reserves and liquidity.\nThe overall net increase (decrease) in cash and cash equivalents was $(19,211,000), $30,650,000 and $(6,995,000) for 1993, 1992 and 1991, respectively. Such net increase (decrease) reflects net cash provided by (used in) operating, investing and financing activities.\nNet cash provided by operating activities was $22,756,000, $17,147,000 and $30,699,000 for 1993, 1992 and 1991, respectively. These fluctuations among years primarily reflect changes in working capital terms whereby increases in net working capital would cause a decline in net cash provided by operating activities.\nDuring 1993, the Company's working capital increased by $10,093,000, which primarily consists of a $11,899,000 increase in accounts receivable, a $6,358,000 increase in inventories and a $4,510,000 decrease in deferred income taxes, net of a $10,706,000 increase in accrued expenses and other current liabilities. During 1992, the Company's working capital increased by $5,112,000, primarily due to a $6,584,000 increase in inventories. During 1991, the Company's working capital decreased by $5,833,000, primarily due a $5,087,000 decrease in inventories.\nNet cash provided by (used in) investing activities was $(47,399,000), $26,275,000 and $(37,172,000) for 1993, 1992 and 1991, respectively. The 1993 amount consists of property, plant and equipment purchases of $44,752,000, mineral reserve additions of $6,493,000, and net of proceeds of $3,846,000 received from sale of property, plant and equipment. The major components of the 1992 amount consist of net proceeds from sale of $39,355,000 primarily received from the sale of Kanawha Land Company, Inc. (see Note 5 to the audited Consolidated Financial Statements); net of property, plant and equipment purchases of $38,182,000; the liquidation of $15,000,000 of short-term investments; and net proceeds of $11,831,000 received from the sale of property, plant and equipment. The major components of the 1991 amount consist of property, plant and equipment purchases of $52,209,000, net of the liquidation of $10,382,000 of short-term investments.\nNet cash provided by (used in) financing activities was $5,432,000, $(12,772,000) and $(522,000) for 1993, 1992 and 1991, respectively. The 1993 amount primarily represents proceeds of $4,312,000 from the issuance of common stock and net borrowings of $1,648,000 on long-term debt and the revolving line of credit. The\n- 47 -\n1992 and 1991 amounts primarily represent net repayments of long-term debt and the revolving line of credit.\nInflation has not had a significant effect on the Company's business primarily because the United States economy has been experiencing a period of relatively low inflation.\nThe Company's capital needs, earnings and cash flow are somewhat dependent on events beyond the Company's control, such as weather patterns, the state of the economy, and changes in existing governmental and environmental regulations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. -------------------------------------------\nSee accompanying Table of Contents to Consolidated Financial Statements and Schedules.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and ---------------------------------------------------------------- Financial Disclosure. --------------------\nNone.\n- 48 -\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. --------------------------------------------------\nThe following information is furnished as of March 15, 1994, with respect to the executive officers and directors of the Company.\nAll directors hold office until the next annual meeting of stockholders and until their successors are elected and qualified. Officers serve at the discretion of the Board of Directors. All officers spend substantially full time working for the Company or its subsidiaries.\nLarry Addington, Robert Addington and Bruce Addington have been directors since the organization of the Company. Jack C. Fisher and Carl R. Whitehouse were elected to the Board of Directors on October 21, 1987. Larry Addington, Robert Addington and Bruce Addington are brothers.\nMessrs. Addington have substantial experience in the operation of coal mining ventures. Their first mining company, Addington Brothers Mining Company, began mining coal in eastern Kentucky in 1972 and was sold to Ashland Oil, Inc. in 1976. In 1978, Larry Addington formed Pyramid Mining, Inc. (\"Pyramid\"), which mined coal in western Kentucky and was sold to First Mississippi Corporation, a diversified energy company in 1981.\nLarry Addington has been President of the Company since its organization and was the founder of each of the corporate entities acquired by the Company pursuant to the Company's 1987 reorganization.\nRobert Addington has been Vice President of Operations and Engineering of the Company since its organization. He served in a\n- 49 -\nsimilar capacity for each of the corporate entities acquired by the Company pursuant to the Company's 1987 reorganization.\nBruce Addington has functioned as Vice President of Operations of the Company since its organization.\nWilliam R. Nelson has been Vice President of the Company directing its environmental operations since August 1992. From November 1981 to July 1992, he worked with the Chambers Development Company, Inc., most recently as its Treasurer.\nR. Douglas Striebel has served as Vice President and Chief Financial Officer of the Company since 1988. From 1984 until joining the Company, Mr. Striebel was an Audit Manager with Arthur Andersen & Co.\nJack C. Fisher served as Mayor of Owensboro, Kentucky from 1984 to 1987. He is currently retired. Before 1984, he served as Manager of Mail Processing with the U.S. Postal Service in Owensboro. Mr. Fisher is a member of the Company's Audit Committee.\nCarl R. Whitehouse retired in December 1988 as the Chairman of the Board of Citizens State Bank in Owensboro, Kentucky, where he had served as President and Chief Executive Officer for over five years. Mr. Whitehouse is a member of the Company's Audit Committee.\nCompliance with Section 16(a) of The Exchange Act - -------------------------------------------------\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of the Company's common stock, to file reports (including a year-end report) of ownership and changes in ownership with the Securities and Exchange Commission and to furnish the Company with copies of all reports filed.\nBased solely on a review of the forms furnished to the Company, or written representations from certain reporting persons, the Company believes that all persons who were subject to Section 16(a) in 1993 complied with the filing requirements.\nLimitation on Liability of Directors - ------------------------------------\nPursuant to the Company's Certificate of Incorporation, no director shall be personally liable to the Company or its stockholders for monetary damages for breach of his fiduciary duty as a director, except for a breach of the director's duty of loyalty, for acts and omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, for transactions from which a director derived an improper personal benefit or for unlawful payment of dividends or stock purchases or redemptions pursuant to Section 174 of the Delaware General Corporation Law. This provision offers persons who serve on the Board of Directors of the Company protection against awards of monetary damages for\n- 50 -\nnegligence in the performance of their duties. It does not affect the availability of equitable remedies such as an injunction or rescission based upon a director's breach of the duty of care.\nIn addition, the Company has entered into Indemnity Agreements with its executive officers and directors which establish contractual rights for the executive officers and directors to be indemnified by the Company to the fullest extent permitted by law. See Item 13. Certain Relationships and Related Transactions.\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nThe following table sets forth the aggregate cash compensation paid by the Company for 1993, 1992 and 1991 to the five most highly compensated executive officers of the Company whose salary and bonus compensation exceeded $100,000 in 1993.\nSummary Compensation Table --------------------------\n\/(1)\/ Employment began August 1, 1982.\n\/(2)\/ Represents the premium on term life insurance with a $500,000 death benefit.\n\/(3)\/ Employment began July 1, 1992; Mr. Quillen resigned effective January 14, 1994.\nThe Company has entered into an employment agreement with William R. Nelson. Pursuant to the employment agreement, the Company will employ Mr. Nelson as the President and Chief Executive Officer of its subsidiary, Addington Environmental, Inc. (\"Addington Environmental\"). Mr. Nelson will be paid an annual\n- 51 -\nsalary of $200,000, with a possible bonus pursuant to a plan to be agreed upon by the parties. The employment agreement provides a three-year term ending on July 31, 1995. If Mr. Nelson becomes disabled during the term of the employment agreement, he will be entitled to his full salary during the 12 months following the onset of such disability. Mr. Nelson's employment pursuant to the agreement will terminate upon the occurrence of certain events, including death, mutual agreement, termination for Cause, as defined, a material breach by Mr. Nelson of his obligations, or the expiration of the three-year term. If a Change of Control (as defined) occurs, Mr. Nelson will be entitled to certain severance benefits upon a termination of his employment within three years after the Change of Control, unless his termination is due to death or retirement, for Cause, as defined, or by Mr. Nelson other than for Good Reason, as defined. If Mr. Nelson is entitled to receive severance benefits, the Company will pay him on the 30th day following his termination an amount equal to any accrued but unpaid balance of his salary and prorated bonus, plus an amount equal to his salary at the rate then in effect for a period of three years minus a period equal to the time elapsed between the date upon which a Change of Control occurs and his date of termination. Upon the termination of his employment under the agreement for any reason, Mr. Nelson is subject to certain restrictive covenants set forth in the agreement for a period of three years from the termination. The Company will provide Mr. Nelson the use of an automobile, limited country club dues, and a term life insurance policy with a death benefit of $500,000. The agreement also provided that the Company would incur certain costs in connection with Mr. Nelson's move to Kentucky, including the purchase of his Pennsylvania home. The employment agreement also provides that upon the satisfaction of certain conditions, the Company will grant Mr. Nelson either options to purchase shares of common stock in the entity holding the material portion of the waste management businesses owned by the Company, or options to acquire shares of the Company. No such options have yet been granted.\nEach of Messrs. Addington and the Company's Chief Financial Officer are entitled to receive bonuses if the Company achieves certain target performance levels in sales, operating profits and mining productivity as established annually by the Audit Committee. For the twelve months ended December 31, 1993, the target for annual sales was between 5,000,000 tons and 6,500,000 tons and the target for pre-tax net profit was between $10,000,000 and $22,000,000. Bonuses are paid if the return on stockholders' equity for the twelve months ended December 31, 1993 is at least 12.5%, with the amount of the bonus to be based upon the target performance levels and the return on stockholders' equity achieved. Pursuant to the incentive provision, if the return on stockholders' equity were 12.5%, the minimum bonus to be paid would be $3,432 to each participant; if the maximum target performance levels were achieved and the return on stockholders' equity were 20% or more, the maximum bonus of $120,120 would be paid to each participant. Pursuant to this management incentive program, no bonuses were paid for 1993.\n- 52 -\nCompensation of Directors - -------------------------\nDirectors of the Company who are also officers of the Company receive no compensation for their services as directors. During 1993, the Company's standard directors fees for non-management directors were a base salary of $10,000 per year for services as directors, with an additional $1,000 per Board meeting actually attended, and $500 for each committee meeting actually attended which was not held in conjunction with a meeting of the Board of Directors.\nStock Option Plan - -----------------\nDuring 1988, the Company adopted, with stockholder approval, the Restated Stock Option Plan (the \"Option Plan\"). The purposes of the Option Plan are to encourage certain officers, employees, and independent contractors to use their best efforts for the Company's success and to provide a valuable means of retaining key personnel as well as attracting new personnel when needed for future operations and growth.\nPursuant to the Option Plan, the Company has reserved for issuance 1,500,000 shares of Common Stock for which options may be granted by the Option Committee of the Board of Directors (currently consisting of Messrs. Addington) to officers, employees and independent contractors of the Company and its subsidiaries in amounts and upon terms and conditions to be determined from time to time by the Option Committee. Messrs. Addington are not eligible to receive options pursuant to the Option Plan. During 1993, no options were granted to, or exercised by, any of the executive officers named in the Summary Compensation Table above.\n- 53 -\nAggregated 1993 Year-End Option Value ---------------------\n(1) Based on December 31, 1993 price per share of $19.00.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------\nExcept as otherwise noted in the footnote following the table, the following table sets forth certain information concerning ownership of the Common Stock as of March 15, 1994, by each director, each executive officer named in Item 11, each person or entity who is known to the Company to be the beneficial owner of more than 5% of the Common Stock and all directors and executive officers of the Company as a group. Except as otherwise noted in the footnote following the table, each beneficial owner listed below has sole voting and dispositive power with respect to the shares listed next to his name.\n- 54 -\n_______________ *Represents less than 1% of outstanding shares.\n(1) Mr. Berkowitz, as managing partner of HPB Associates, L.P., has sole voting and dispositive powers with respect to the shares owned by the partnership. Information on the partnership's beneficial ownership is according to a Schedule 13D dated January 20, 1992.\n(2) Includes 1,100 shares owned by Mr. Whitehouse's wife; Mr. Whitehouse has no voting or dispositive powers with respect to these 1,100 shares.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ----------------------------------------------\nIn situations where there will be an ongoing relationship with related parties for the purchase of services or products, it is the Company's policy that a majority of the independent and disinterested directors will be required to approve continuation or initiation of the relationship and will periodically review such transactions to assure that they meet the aforementioned standard.\nTASK Trucking Company (\"TASK\") provides trucking services to the Company and is owned by a brother-in-law of Messrs. Addington. During 1993, the Company's expense was $19,186,000 for trucking services provided through TASK. The Company believes that the price charged for such trucking services was not greater than the prices generally charged by non-affiliated entities in the area.\nLarry Addington owns a 50% interest in an office building in Owensboro, Kentucky in which the Company leases approximately 7,300 square feet of office space for a rent of $110,015 during 1993 plus utilities. The lease is for a term of five years, expiring in 1996. The annual rental beginning in 1994 will be $117,350 plus utilities. The Company believes that the rental paid is not greater than that charged by non-affiliated entities in the area for similar facilities and is comparable to the rate charged to other tenants in the building, none of whom are related to the Company or Messrs. Addington.\nOn February 23, 1993, the U.S. District Court for the District of Montana entered a judgment in a suit by Bill Robinson, Sr.\n- 55 -\nstating that the defendants Larry Addington, Larry Harrington, Addwest Gold, Inc., Addington Resources, Inc., Addington Holding Company, and Addwest Mining, Inc. are jointly and severally liable to Mr. Robinson for compensatory damages in the amount of $850,000 and that Mr. Robinson is entitled to punitive damages in the amount of $1,000 from Larry Harrington, $6,000,000 from Larry Addington, and $4,500,000 jointly and severally from defendants Addwest Gold, Inc., Addington Resources, Inc., Addington Holding Company, and Addwest Mining, Inc. A settlement has been reached in which Mr. Robinson will release all parties from all claims. As a result of the settlement, the Company expects to pay Mr. Robinson $3,450,000 by April 15, 1994. The parties are currently in the process of drafting appropriate settlement documentation. Pursuant to indemnification agreements, including an agreement with Larry Addington discussed below, the Company is obligated for the full amount of the settlement, none of which will be covered by insurance. See Item 3. Legal Proceedings and Note 13 to the audited Consolidated Financial Statements.\nWith respect to claims against Larry Addington, although the jury specifically rejected a claim by Mr. Robinson that Mr. Addington had committed fraud upon him, the court found that there was sufficient evidence to sustain the finding of liability upon the plaintiff's claim for negligent misrepresentation and the imposition of punitive damages against Larry Addington. The court stated that there was sufficient evidence to support a finding that the alleged negligent misrepresentations made by Larry Addington to the plaintiff were accomplished with actual malicious intent within the meaning of the Montana statute relating to claims for punitive damages.\nUpon a determination by the Board of Directors (Larry Addington abstaining) that Larry Addington did at all times relevant to the litigation act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Company, the Company would be obligated to indemnify Mr. Addington against the amount of any final judgment entered against him and any and all expenses incurred by him in connection with the litigation. Because the interests of all the defendants were coincident, no marginal expenses were incurred by Mr. Addington during the trial phase of the litigation. However, Mr. Addington did engage separate counsel on appeal. This indemnification is pursuant to an indemnity agreement entered into with Mr. Addington in August 1988, the form of which was previously approved by the Company's stockholders. The indemnification is also in accordance to Section 145 of the General Corporation Law of the State of Delaware and the Company's Certificate of Incorporation and Bylaws. The Board of Directors, in meetings held on December 18, 1992 and March 29, 1993, at which times it received reports from counsel on the litigation, determined to indemnify Mr. Addington for past and future expenses as well as the trial court judgment.\n- 56 -\nLarry Addington had guaranteed the Company's obligations in connection with the assignment of a coal sales contract subsequently transferred in the Pittston Transaction.\nOn September 4, 1992, in accordance with the terms of an employment agreement, the Company purchased the Pennsylvania home of William R. Nelson, a Vice President of the Company, for a purchase price of $325,000. The Company sold the home on September 16, 1993. The Company incurred aggregate expenses on the purchase and disposition of Mr. Nelson's home, including a loss on the sale of the home and carrying and disposition costs, of approximately $135,000.\n- 57 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. -----------------------------------------------------------------\n(a) (1) List of Financial Statements Filed. See accompanying Index to Consolidated Financial Statements and Schedules.\n(a) (2) List of Financial Statement Schedules Filed. See accompanying Index to Consolidated Financial Statements and Schedules.\n(a) (3) List of Exhibits Filed.\n(3) (A)\/1\/ Restated Certificate of Incorporation of Registrant\n(B)\/1\/ Bylaws of Registrant\n(10)(A)\/2\/ Deed dated June 18, 1985 by and between Martiki Coal Corporation and ARMM Coal, Inc.\n(B)\/2\/ Deed of Conveyance dated June 7, 1984 by and between Franklin Real Estate Company and ARMM Land Co., Inc.\n(C)\/2\/ Contract Mining Agreement and Related Agreements dated June 10, 1986 among Addington, Inc., CJC Leasing, Inc., N.O.R. Mining, Inc., Adams Resources & Energy, Inc., and Third National Bank\n(D)\/3\/ Form of Lease Agreement among Larry Addington and Larry K. Harrington and Addwest Mining, Inc.\n(E)\/4\/ Employment Agreement between R. Douglas Striebel and the Registrant, as amended\n(F)\/5\/ Agreement dated as of April 18, 1990, between Indiana-Kentucky Electric Corporation and Addwest Mining Company, Inc.\n(G) Addington Resources, Inc. Restated Stock Option Plan, as amended.\n(H) Form of Indemnity Agreement between the Registrant and its directors and officers\n(I) Employment Agreement dated as of July 14, 1992, between Addington Environmental, Inc. and William R. Nelson.\n(11) Statement re computation of per share earnings. See page of the audited Consolidated Financial\n- 58 -\nStatements and Schedules filed as part of this report.\n(21) List of subsidiaries of Registrant\n(23) Consent of Arthur Andersen & Co.\n(99)(A)\/2\/ Coal Purchase and Sales Agreement dated September 1, 1984 by and between Fossil Fuels, Inc., Delta Energy Corporation and Consumers Power Company\n(99)(B)\/2\/ Amended and Restated Contract for Purchase and Sale of Coal dated June 27, 1986 by and between Tennessee Valley Authority and Addington, Inc. [Contract No. 86P-65-T4] (See Exhibit (99)(D) and Exhibit (99)(G) pertaining to amendments to Contract No. 86P-65-T4)\n(99)(C)\/2\/ Contract for Purchase and Sale of Coal dated September 12, 1986 by and between Tennessee Valley Authority and Addwest Mining, Inc. [Contract No. 86P-16-T1] (See Exhibit (99)(E) and Exhibit 99(H) pertaining to amendments to Contract No. 86P-16-T1)\n(99)(D)\/6\/ Supplemental Agreement to Contract 86P-65-T4 for Purchase and Sale of Coal dated May 1989, by and between Tennessee Valley Authority and Addington, Inc.\n(99)(E)\/6\/ Supplemental Agreement to Contract 86P-16-T1 for Purchase and Sale of Coal dated February 1, 1989 by and between Tennessee Valley Authority and Addwest Mining, Inc.\n(99)(F)\/6\/ Transfer Agreement dated as of April 3, 1989, by and among Addwest Mining, Inc. and Addington, Inc. and the Tennessee Valley Authority\n(99)(G)\/7\/ Supplemental Agreement dated October 23, 1990, to Contract 86P-16-T4 by and between Addington, Inc. and Tennessee Valley Authority.\n(99)(H)\/3\/ Supplemental Agreements to Contract 86P-16-T1 for Purchase and Sale of Coal dated May 11, 1989 and October 30, 1991 by and between Tennessee Valley Authority and Addwest Mining, Inc.\n____________________\n\/1\/ Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-22164]\n- 59 -\n\/2\/ Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-11918]\n\/3\/ Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 [File No. 0-16498].\n\/4\/ Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 [File No. 0-16498].\n\/5\/ Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1990 [File No. 0-16498].\n\/6\/ Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-29848]\n\/7\/ Incorporated by reference to the Registrant's Annual Report Form 10-K for the fiscal year ended December 31, 1990 [File No. 0-16498].\n(b) Reports on Form 8-K. -------------------\nDuring the quarter ended December 31, 1993, the Company filed no Current Reports on Form 8-K.\n(c) Exhibits. --------\nThe exhibits listed in response to Item 14(a)(3) are filed as a part of this report.\n(d) Financial Statement Schedules. -----------------------------\nThe financial statement schedules listed in response to Item 14(a)(2) are filed as part of this report.\n- 60 -\nADDINGTON RESOURCES, INC.\nTABLE OF CONTENTS TO\nCONSOLIDATED FINANCIAL STATEMENTS & SCHEDULES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Addington Resources, Inc.:\nWe have audited the accompanying consolidated balance sheets of Addington Resources, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1992 and 1993, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Addington Resources, Inc. and subsidiaries as of December 31, 1992 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs explained in Note 1(g) to the financial statements, effective January 1, 1991, the Company changed its method of accounting for income taxes.\n\/s\/ Arthur Andersen & Co.\nARTHUR ANDERSEN & CO.\nMarch 23, 1994 Louisville, Kentucky\nADDINGTON RESOURCES, INC. CONSOLIDATED BALANCE SHEETS ASSETS\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nADDINGTON RESOURCES, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nADDINGTON RESOURCES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nADDINGTON RESOURCES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nADDINGTON RESOURCES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nADDINGTON RESOURCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Note 1)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nADDINGTON RESOURCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Note 1) (Continued)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nADDINGTON RESOURCES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies ------------------------------------------\na. Financial Statement Presentation and Organization- -------------------------------------------------\nThe accompanying consolidated financial statements as of December 31, 1991, 1992 and 1993 include the accounts of Addington Resources, Inc. (the Company) and its wholly-owned subsidiary, Addington Holding Company, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain 1991 and 1992 amounts have been reclassified to conform to 1993 presentation with no effect on net income (loss).\nb. Company Environment- -------------------\nThe mining and environmental industries expose the Company to a number of issues including: the possibility of the termination of sales contracts, fluctuating market conditions, changing governmental regulations, unfavorable mining conditions, loss of key employees and the ability of the Company to control adequate recoverable mineral reserves and obtain the necessary permits for its landfills.\nMost of the Company's revenues have been generated under long-term coal sales contracts with electric utilities located in the eastern United States. Revenues are recognized on coal sales in accordance with the sales agreement, which is usually when the coal is shipped to the customer. Revenues are recognized on environmental sales as services are provided or waste is received in the landfill. The Company grants credit to its customers based on their creditworthiness and generally does not secure collateral for its receivables.\nc. Inventories- -----------\nInventories are stated at average cost, which approximates first-in, first- out (FIFO) cost, and does not exceed market.\nd. Depreciation and Amortization- -----------------------------\nProperty, plant and equipment are stated at cost. Depreciation and amortization are provided using either the straight-line or units produced or consumed methods. The following estimated useful lives are used under the straight-line method:\nYears ----- Mining and other equipment and related facilities 5 to 40 Environmental equipment and related facilities 5 to 40 Transportation equipment 3 to 10 Barge loading facilities 5 to 25 Mine development costs 3 to 15 Furniture and fixtures 3 to 10\nCapitalized environmental development costs include landfill related expenditures for land, permitting and preparation costs. Such landfill costs represent costs related to starting up the operation, developing the entire site and constructing the individual cells. Landfill costs are amortized as the relevant permitted airspace is consumed.\nMineral reserves are amortized using the units-of-production method, based on estimated recoverable reserves.\nFinancing costs (included in Other Assets) are being amortized using the straight-line method, over the life of the related debt, which approximates the interest method.\nIntangible assets primarily consist of customer lists and covenants not to compete. These assets are amortized over their estimated useful lives, usually no longer than five years, using the straight- line method.\nThe amounts assigned to coal sales contracts are amortized to expense based on tons shipped to the customer.\ne. Advance Royalty Payments (included in Other Assets)- ---------------------------------------------------\nThe Company is required, under certain royalty lease agreements, to make minimum royalty payments whether or not mining activity is being performed on the leased property. These minimum payments are recoupable once mining begins on the leased property. The Company capitalizes these minimum royalty payments and amortizes them once mining activities begin or expenses them when the Company has ceased mining or has made a decision not to mine on such property.\nf. Restricted Cash (included in Other Assets)- ------------------------------------------\nThe Company is mining reserves whose ownership is currently being disputed. Royalty payments related to these reserves are being deposited by the Company into an escrow account and will be paid as the disputes are settled.\nThe Company also pays amounts into escrow as required under state regulations related to closure and post-closure costs of its landfills.\nAs of December 31, 1992 and 1993, total restricted cash was $2,221,000 and $2,348,000, respectively.\ng. Accounting Change- -----------------\nEffective January 1, 1991, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, the standard for accounting for income taxes issued by the Financial Accounting Standards Board. The cumulative effect of this accounting change at December 31, 1990 was recorded effective January 1, 1991 and increased net loss by $3,500,000 ($.23 per share).\nh. Net Income (Loss) Per Share- ---------------------------\nNet income (loss) per share is based on the weighted average number of common shares and common equivalent shares outstanding, as applicable, during the periods.\ni. Statements of Cash Flows- ------------------------\nFor purposes of the statements of cash flows, the Company considers investments having maturities of three months or less at the time of purchase to be cash equivalents.\nThe cash amounts of interest and income taxes paid by the Company in 1991, 1992 and 1993 are as follows:\nFor 1993, the statement of cash flows excludes the impact of the reclassification of net assets held for disposal, as such reclassification is non-cash in nature.\nDuring 1991, 1992 and 1993, the Company acquired certain assets, primarily property, plant and equipment and mineral reserves, by assuming liabilities, primarily notes and other payables, and making cash payments. The non-cash portions of approximately $1,005,000, $1,131,000 and $14,788,000 for the years ended December 31, 1991, 1992 and 1993, respectively, have been excluded from the statements of cash flows.\nDuring 1992, the Company also disposed of certain assets, primarily property, plant and equipment and mineral reserves, by accepting a note receivable. The non-cash portion of $10,399,000 has been excluded from the 1992 statement of cash flows.\nj. Reclamation and Closure Cost- ----------------------------\nUnder current Federal and state surface mine laws, the Company is required to reclaim land where surface mining operations are conducted. Accruals for the estimated cost of restoring the land are provided as mining takes place, based upon engineering estimates of costs.\nThe Company also estimates and records its costs associated with closure and post-closure monitoring and maintenance for operating landfills based upon relevant government regulations. Accruals for these closure and post-closure costs are provided as permitted airspace of the landfill is consumed. The Company revises its estimates on a periodic basis.\nk. Income Taxes- ------------\nThe provision (benefit) for income taxes is based on income for financial statement purposes. Deferred income taxes, which arise from temporary differences between the period in which certain income and expenses are recognized for financial reporting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes.\n2. Sale of Certain Coal Subsidiaries ---------------------------------\nDuring September, 1993, the Company entered into an agreement to sell the stock of five of its coal subsidiaries to Pittston Minerals Group, Inc. (\"Pittston\") for $157 million cash. Before closing, certain property, plant and equipment (the net book value of which was approximately $43 million as of December 31, 1993) was transferred to other subsidiaries of the Company from the subsidiaries to be sold. In addition, the Company retained all of the net working capital (the net value of which was approximately $30 million as of December 31, 1993) of the sold subsidiaries as of the date of closing. In connection with the sale, the Company has provided certain guarantees to Pittston.\nThis transaction was completed on January 14, 1994.\nThe subsidiaries sold to Pittston include: Addington, Inc. and its wholly-owned subsidiary, Ironton Coal Company; Appalachian Mining, Inc.; Appalachian Land Company; Vandalia Resources, Inc.; and Kanawha Development Corporation. The operations of these subsidiaries are located in Ohio, West Virginia and Kentucky.\nOther terms of the transaction include the Company entering into a coal supply contract with Pittston for the sale of 4,920,000 tons over 3-1\/2 years at a base price of $26 per ton. Additionally, the Company will receive a $1 per ton production royalty for coal produced from certain West Virginia properties being sold to Pittston with a minimum royalty of $100,000 per month, a maximum aggregate royalty in any one year of $1.5 million, and a maximum aggregate royalty under the agreement of $3.75 million. The Company will also pay Pittston a royalty of $0.50 per ton of coal produced by two retained highwall mining machines for 3-1\/2 years.\nWith respect to the $157,000,000 sale price and the net working capital retained by the Company, approximately $2,500,000 was used to pay the Company's closing costs for the transaction, including a $1,000,000 payment to a consultant for the Company and $500,000 to the financial advisors for their services. The Company used approximately $131,725,000 of the proceeds to provide for the early redemption of its 12% Senior Secured Notes due July 1, 1995, including the payment of $4,288,000 as a redemption premium and approximately $2,437,000 in net interest through March 15, 1994 (the redemption date). In addition, the Company used certain of the proceeds to retire all indebtedness outstanding under the Company's revolving line of credit agreement related to its coal operations. The oustanding balance on the line of credit as of January 14, 1994 was $23,442,000. The Company also used approximately $3,800,000 to compensate its employees for extraordinary efforts expended in connection with the consummation of the transaction, including approximately $416,500 in connection with the termination of stock options held by employees who will become employees of Pittston as a result of the transaction.\nAs a result of this transaction, the net assets relating to the sales transaction appear as net assets held for disposal in the accompanying December 31, 1993 balance sheet. Additionally, since the $125,000,000 Senior Secured Notes were redeemed in connection with the transaction, they have been classified as a current liability in the accompanying December 31, 1993 balance sheet.\nThe Company does not expect to record a loss on this transaction. Accordingly, the Company will record the actual economic impact of the disposal in its 1994 financial statements. However, principally due to the Company's de-emphasis on mining operations, the Company recorded approximately $14,506,000 of asset write-offs in its 1993 financial statements. These write-offs principally relate to its sulfur mine development project ($9,384,000) which has been abandoned. Additionally, the Company has written off approximately $5,122,000 of assets that it has abandoned associated with its environmental projects. These asset write-offs are included in cost of operations in the accompanying 1993 consolidated statement of operations.\nThe Company will continue to own and operate four eastern Kentucky mines with estimated annual production capacity of 3,000,000 tons per year.\n3. Stock Option and Stock Grant Plans ----------------------------------\nThe Company has a non-qualified stock option plan pursuant to which 1,500,000 shares of common stock were reserved for issuance and may be granted to officers, directors, and key employees of the Company and to key independent contractors of the Company in amounts and upon terms and conditions to be determined from time to time by the Company. Stock options generally are exercisable either three years or five years from the date of issuance. The following stock options have been issued, exercised or cancelled as of December 31, 1993:\nAs of December 31, 1993, 278,000 shares were exercisable and 500,000 options were available for issue.\nIn connection with the transaction discussed in Note 2, the Company has determined to terminate all stock options previously granted under its stock option plan to employees who will become employees of Pittston as a result of the transaction. Options for a total of 59,000 shares of the Company's common stock previously granted to 11 employees will be terminated. The Company will compensate each of these employees in the amount of the number of options held by each employee multiplied by the difference between the per share option exercise price and $16. The Company estimates that the total cost for such terminations will be approximately $416,500.\nOn December 6, 1989, the Company adopted a non-qualified stock grant plan pursuant to which 500,000 shares of common stock were reserved for issuance to employees of the Company, except that officers, directors and owners of more than 10% of the Company's common stock are not eligible to receive stock grants. All stock grants issued to date specify that the recipient of the stock grant must remain employed by the Company for 5 years from the date of grant in order to exercise the grant. As of December 31, 1993, no grants were exercisable and the following stock grants were issued or cancelled:\nAs of December 31, 1993, stock grants for 173,900 shares of common stock were outstanding, with 326,100 available for issue.\nIn connection with the transaction discussed in Note 2, the Company has amended the stock grant plan to provide, among other things, that service by an employee with Pittston or an affiliate as a result of the transaction will be counted toward the time of service required under the stock grants and any termination of the employee without cause by Pittston within 120 days of the closing of the transaction shall not result in a cancellation of his stock grant but shall automatically vest his rights in the stock grant. Approximately 256 employees holding stock grants for a total of 92,400 shares of common stock will become employees of Pittston as a result of the transaction.\n4. Environmental Commitments -------------------------\na. Municipal Agreements- --------------------\nIn July, 1990, a wholly-owned subsidiary, Ohio County Balefill (\"Balefill\"), entered into an exclusive 40-year agreement with Ohio County (Kentucky) Fiscal Court to operate the County's landfill. Balefill has been operating the County's landfill since that date.\nIn March, 1992, the Company entered into an agreement with Montgomery County, North Carolina concerning the operation of the County's landfill. During July, 1992, the Company began operating the County's landfill under a 20-year contract. Under the terms of the agreement, the Company has agreed to construct a recycling facility and a new contained landfill adjacent to the current operations.\nb. Green Valley Environmental Corp.- --------------------------------\nOn September 22, 1992, the Company's subsidiary, Green Valley Environmental Corp. (\"Green Valley\") and Kentuckians for the Commonwealth (\"KFTC\") entered into a Settlement Agreement concerning a four-year dispute over Green Valley's landfill in Greenup County, Kentucky. The Settlement Agreement resolves all disputes between Green Valley and KFTC with respect to administrative and judicial actions filed by KFTC and others, including a citizens group known as GROWL. The two co-chairpersons of GROWL also executed the Settlement Agreement, although other individual members did not. Under the Settlement Agreement, Green Valley will install an additional liner to the bottom of the landfill and drill nine new monitoring wells. The new construction is consistent with Kentucky's stringent landfill regulations for landfills intending to operate beyond July 1, 1995. The Settlement Agreement limits the landfill's service area to a 38-county region in Kentucky, Ohio and West Virginia and provides for a full-time inspector. The size of the landfill will be capped at 138 acres or approximately 23 million cubic yards of airspace. The Settlement Agreement also provides that Green Valley will not operate other landfills in Greenup County or the 22,000-acre area contiguous to the landfill. Green Valley will donate three percent of its net profits from operation of the landfill to community cleanup efforts, recycling programs and community environmental education.\n5. Sale of Subsidiaries --------------------\na. Kanawha Land Company, Inc.- --------------------------\nDuring March, 1992, the Company entered into an agreement with Pittston Coal Sales Corp. (\"Pittston\") whereby Pittston acquired all of the outstanding stock of one of the Company's subsidiaries, Kanawha Land Company, Inc. (\"Kanawha\"), for $42.5 million in cash and agreed to purchase certain mining equipment for $17.2 million in cash. The Kanawha assets acquired by Pittston primarily include two long-term coal sales contracts with the Appalachian Power Company and four highwall mining machines. At the date of disposal, the two contracts called for a total of approximately 21 million tons of coal to be delivered over the next 14 years.\nOther terms of the agreement call for Pittston's subsidiaries to purchase up to 1,790,000 tons of coal from one of Addington's mines in West Virginia for a purchase price of $27 per ton through 1994. During October, 1992, the Company modified this agreement, whereby the Company agreed to supply 900,000 tons per year for 1993 and 1994 at prices ranging from $25.50 to $26.00 per ton during 1993. The sales price per ton will escalate during 1994 based on certain producer price indices. The Company also agreed to purchase approximately 2,300,000 tons of low- sulfur compliance coal from one of Pittston's mines in eastern Kentucky through February, 1996 for a purchase price of $25 per ton, with a 3% price escalation per year. The subsidiaries which hold the coal contracts described in this paragraph were included in the sale to Pittston discussed in Note 2. Therefore, after January 14, 1994, the Company has no further committments under the two coal contracts discussed in this paragraph.\nIn connection with the sale of Kanawha, the Company increased its reclamation accrual by $5,000,000 for certain West Virginia operations. This increase in the reclamation accrual is a result of the sale of these two long-term contracts which were being supplied by the West Virginia operations that are currently being phased down. This $5,000,000 reclamation provision has been netted against the gain on sale of coal subsidiary in the accompanying 1992 consolidated statement of operations.\nb. Southern Illinois Mining Company, Inc.- --------------------------------------\nDuring April, 1992, the Company sold all of the outstanding stock of one of its subsidiaries, Southern Illinois Mining Company, Inc. (\"SIMC\"), to Marion Mining Corporation (\"Marion\") for $1 million in cash and an approximately $10.4 million promissory note (the \"SIMC Note\") bearing interest at six percent. The SIMC Note is secured by: (i) a pledge of the capital stock of SIMC; (ii) a Mortgage, a Security Agreement, Assignment of Rents and Profits, and Fixture Financing Statements, all of which encumber coal reserves and related real estate located in Williamson County, Illinois; and (iii) a Security\nAgreement covering certain of the SIMC assets, excluding accounts receivable arising out of the sale of coal to TVA under Contract T-1. At the time of the sale, the assets of SIMC consisted primarily of Contract T-1 with the Tennessee Valley Authority, a deep mine, certain coal reserves and a coal preparation facility. The Company has guaranteed SIMC's performance of Contract T-1.\nOn September 15, 1992, the Company filed suit against Marion and SIMC in Boyd County Circuit Court, Boyd County, Kentucky for, among other claims, breach of contract and misrepresentations. The Company claims that SIMC has ceased its mining operations and is not shipping coal under Contract T-1. On September 21, 1992, the Company obtained a temporary restraining order requiring Marion and SIMC to protect and preserve the assets of SIMC for the Company's benefit. On February 1, 1993, both Marion and SIMC filed bankruptcy.\nOn November 5, 1993, the Company filed a foreclosure action in state court in Illinois to foreclose the security interest in the real property and personal property of SIMC. SIMC subsequently filed an adversary proceeding against the Company in United States Bankruptcy Court for the Eastern District of Kentucky on January 19, 1994. The Complaint seeks the return of $1,000,000 paid by Marion to the Company as partial consideration for its purchase of the SIMC stock, the return of $378,200 in royalties paid to the Company subsequent to the sale and $500,000 in punitive damages. The Company has filed an answer in which it denied the substantive allegations of the Complaint and asserted various affirmative defenses to the claims.\nBecause of the pendency of the adversary proceeding in U.S. Bankruptcy Court, the Company has advised SIMC that it has decided to (i) cease the Illinois Foreclosure Action, (ii) litigate the issues raised by SIMC in the adversary proceeding and (iii) allow the SIMC assets to be sold through the U.S. Bankruptcy Court, with the proceeds of such sale, if any, to be held by the U.S. Bankruptcy Court until it has issued a final order in the adversary proceeding.\nUpon considering the current status of the SIMC proceedings, the Company has determined to record a reserve to the SIMC Note at December 31, 1993 in the amount of $5.8 million (included in other, net in the accompanying 1993 consolidated statement of operations). Such valuation was determined considering the estimated ultimate realizable value from the mineral reserves.\n6. Closure of Western Kentucky Coal Operations -------------------------------------------\nDuring 1991, the Company encountered substantial operating difficulties at its mines in Western Kentucky and, as a result, decided to close its Western Kentucky coal mines. Accordingly, as of December 31, 1991, the Company recorded a pre-tax charge to expense of approximately $9,000,000 to write- off its investment in its remaining Western Kentucky mines and to reserve for future reclamation of these mines.\n7. Debt\nAs of December 31, 1992 and 1993 the Company's debt consisted of the following:\na. Revolving Lines of Credit-\nThe Company's coal subsidiaries had a revolving line of credit agreement with their bank which provided the coal subsidiaries with short-term borrowings up to a maximum line of credit of $30,000,000, bearing interest at the prime interest rate plus 1\/2%. The outstanding balance of this line of credit as of December 31, 1992 and 1993 was approximately $22,535,000 and $23,442,000, respectively. This line of credit was paid off in 1994 in connection with the transaction described in Note 2.\nSubsequent to yearend, the Company's remaining coal subsidiaries entered into a new revolving line of credit agreement with their bank. This new line of credit provides the coal subsidiaries with short-term borrowings, generally equal to 90% of certain accounts receivable plus 50% of certain coal inventory, up to a maximum line of credit of $15,000,000, bearing interest at the prime interest rate. This new $15,000,000 line of credit replaces the Company's former $30,000,000 line of credit. The prime interest rate as of December 31, 1993 was 6.0%.\nDuring May, 1993, the Company's environmental subsidiaries entered into a new $20 million revolving credit agreement with a bank secured by virtually all of the assets and common stock of all environmental subsidiaries. This line of credit bears interest at 1-1\/2% over the bank's base rate or 3-1\/2% over the Eurodollar rate. Since principal payments are not required to be made on this line of credit until it expires in June, 1996, the outstanding balance of this line of credit as of December 31, 1993 of $10,000,000 has been classified as long-term debt.\nIn connection with these lines of credit, the Company has agreed to certain restrictive covenants which, among others, limit the amount of dividends that the Company can pay, limit its ability to incur additional indebtedness, and require the Company to maintain certain as defined financial ratios.\nb. Long-term Debt-\nAs of December 31, 1992 and 1993, long-term debt consisted of the following:\nc. Senior Secured Notes-\nOn July 11, 1988, the Company issued $125,000,000 of 12% Senior Secured Notes (the Notes) that mature on July 1, 1995 and received net proceeds of $120,625,000, which is net of underwriting discounts of $4,375,000. The Notes are secured by a first priority mortgage and security interest in certain real and personal property of the Company with a minimum fair market value of 150% of the outstanding principal amount of the Notes. In connection with the Notes, the Company has agreed to certain restrictive covenants which, among others, limit the amount of dividends that the Company can pay, limit its ability to incur additional indebtedness, require a minimum net equity, limit certain transactions with affiliates, restrict liens on the assets that secure the Notes and place certain restrictions on the Company's ability to receive funds from certain of its subsidiaries. In connection with the transaction dicussed in Note 2, these notes were called for redemption on March 15, 1994. Therefore, the entire $125,000,000 balance of these Senior Secured Notes has been classified as a current liability as of December 31, 1993.\nPrincipal payments required for long-term debt and senior secured notes after December 31, 1993 are as follows:\n8. Property, Plant and Equipment -----------------------------\nProperty, plant and equipment are recorded at cost. Expenditures for major renewals and betterments are capitalized while expenditures for maintenance and repairs are expensed as incurred.\nProperty, plant and equipment are summarized by major classification as follows:\nIncluded in property, plant and equipment as of December 31, 1992 and 1993 are approximately $33,134,000 and $24,062,000, respectively, related to start-up development projects for which depreciation and amortization have not yet commenced. The Company reviews the realization of these projects on a periodic basis.\n9. Inventories ----------- As of December 31, 1992 and 1993, inventories consisted of:\n10. Accrued Expenses and Other -------------------------- As of December 31, 1992 and 1993, accrued expenses and other consisted of:\n11. Income Taxes ------------ SFAS No. 109--\"Accounting for Income Taxes\" was issued by the Financial Accounting Standards Board in February, 1992. In conformity with SFAS No. 109 transition rules, the Company elected to adopt the new income tax accounting standard effective January 1, 1991. The cumulative effect at January 1, 1991 (Note 1) of this accounting change was to increase deferred income taxes by $3,500,000. This increase is primarily due to the elimination of the ability to record the benefits of future projected percentage depletion deductions as a reduction to deferred income taxes, as previously allowed by SFAS No. 96. A requirement of SFAS No. 109 is that deferred income tax liabilities or assets at the end of each period will be determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Accordingly, under the new standard, income tax provisions will increase or decrease in the same period in which a change in tax rates is enacted.\nThe income tax provision (benefit) for the years ended December 31, 1991, 1992, and 1993 consists of the following:\nThe following is a reconciliation of the income tax provision (benefit) at the statutory tax rate of 34% to the Company's effective rate for the years ended December 31, 1991, 1992, and 1993.\nDeferred income taxes arise from recognizing revenue and expense in different years for tax and financial statement purposes. The provision (benefit) for deferred income taxes resulted from the following:\nAt December 31, 1993, the Company had approximately $24,525,000 of deferred tax assets (net of a valuation allowance of $3,788,000) and $31,597,000 of deferred tax liabilities, resulting in a net deferred tax liability of $7,072,000. At December 31, 1992, the Company had approximately $16,235,000 of deferred tax assets and $27,817,000 of deferred tax liabilities, resulting in a net deferred tax liability of $11,582,000. Included in the Company's 1993 deferred tax assets are regular tax net operating loss carryforwards of approximately $25,800,000 which, if not utilized, will expire in the years 2007 and 2008 and alternative minimum tax credit carryforwards of approximately $8,200,000, which have an unlimited carryforward period. In 1993, the Company recorded a valuation allowance of $3,788,000 against these credits due to realizability concerns.\n12. Commitments and Contingencies -----------------------------\na. Coal Sales Contracts- --------------------\nSubsequent to the transaction discussed in Note 2, the Company has commitments to deliver scheduled base quantities of coal annually to three customers under three coal sales contracts. One contract expires in 1994, one expires in 1997 and one expires in 2000. The contracts call for the Company to supply a minimum of 10.8 million tons over the remaining lives of the contracts at prices which are at or above market. The contracts have sales price adjustment provisions, subject to certain limitations and adjustments, based on changes in specified production costs.\nFor additional information concerning coal sales contracts, see Item 1 \"Business - Major Coal Sales Contracts\" of Form 10-K included herein.\nb. Leases- ------\nThe Company has various operating leases for mining and other equipment. Lease expense for the years ending December 31, 1991, 1992 and 1993 was approximately $18,182,000, $22,125,000 and $27,500,000, respectively.\nThe Company also leases coal reserves under agreements that call for royalties to be paid as the coal is mined. Total royalty expense for the years ending December 31, 1991, 1992 and 1993 was approximately $17,006,000, $15,399,000 and $21,225,000, respectively. Certain agreements require minimum annual royalties to be paid regardless of the amount of coal mined during the year.\nApproximate future minimum payments after the transaction discussed in Note 2 are as follows:\nc. Legal Matters- -------------\nThe Company is named as defendant in various actions in the ordinary course of its business. These actions generally involve such matters as property boundaries, mining rights, blasting damage, personal injuries, and royalty payments. The Company believes these proceedings are incidental to its business and are not likely to result in materially adverse judgments.\nThe Company is presently involved in a legal dispute with a customer (Consumers Power) regarding the sales price of coal shipped under a coal sales contract and the potential termination of the contract. On May 4, 1989, the Boyd Circuit Court directed the parties to maintain the status quo in their contractual relationship, directed the Company to post a $750,000 bond and directed the parties to provide expedited discovery in the case. On November 9, 1990, the Boyd Circuit Court directed the Company to increase the amount of the bond to be posted from $750,000 to $3,000,000 in light of the additional amounts of coal shipped under the contract from the date of the court's previous order.\nOn April 30, 1993, the Boyd Circuit Court entered summary judgment in favor of the Company against Consumers Power that the termination provision of the Company's coal supply contract with Consumers Power had not been appropriately triggered by Consumers Power. Consumers Power has appealed the grant of summary judgment to the Kentucky Court of Appeals. On June 3, 1993, Consumers Power also filed a motion in Boyd Circuit Court to dissolve the May 4, 1989 temporary restraining order that prevents Consumers Power from seeking to terminate the contract pursuant to the contract provision. Although on\nSeptember 1, 1993, the court subsequently dissolved the temporary restraining order and ordered that the Company's $3,000,000 bond could be released, Consumers Power has not terminated the contract in light of the April 30, 1993 summary judgment decision that the termination provision had not been appropriately triggered. By letter dated October 5, 1993, Consumers Power has notified the Company that it is currently prepared to demonstrate its ability to purchase coal from another producer within the parameters of the termination provision. Consumers Power states that it can obtain coal for approximately $24.90 per ton instead of the $34.16 per ton charged during the three months ended September 30, 1993.\nThe Company will transfer the contract with Consumers Power to Pittston in the transaction discussed in Note 2. The Company, however, will retain all obligations with respect to any liabilities arising out of the above litigation. While the Company cannot predict the ultimate outcome of the above dispute, it is not anticipated that the outcome will have a materially adverse impact upon the Company's financial position and results of operations.\nd. Licensing Agreement- -------------------\nIn June, 1992, the Company entered into a 14-year licensing agreement that permits Joy Technologies, Inc. to manufacture and market a highwall mining system that the Company developed and currently uses in its own mining operations. Under the terms of the agreement, Joy Technologies plans to market the system to mining companies on the basis of a cost per ton of material mined by the system. The Company and Joy Technologies will share revenues from origination fees and from usage fees based on tons of material mined by these other mining companies. During 1993, Joy Technologies, a world-wide manufacturer of mining equipment, manufactured and leased two highwall mining systems to third party coal companies. Such revenues from this agreement during 1993 were approximately $261,000.\n13. Litigation Settlements ----------------------\na. Addwest Gold- ------------\nOn November 5, 1992, a U.S. District Court jury returned a verdict against Addington Resources, Inc. and others for approximately $850,000 in compensatory damages and $10,501,000 in punitive damages. Subsequently, the verdict was entered by a judgment of the court. The suit arose out of an alleged bonus payment due to a former employee of Addwest Gold in connection with the January, 1990 sale of Addwest Gold by the Company.\nSubsequent to December 31, 1993, the Company reached a settlement with their former employee whereby all claims were dismissed. As a result of the settlement, the Company expects to pay the former employee $3,450,000 by April 15, 1994. The parties are currently in the process of drafting the appropriate settlement documents. This settlement amount is recorded in the December 31, 1993 financial statements.\nb. Ohio River Company- ------------------\nOn August 11, 1992, the Company filed an action for a declaration of rights against the Ohio River Company (\"ORCO\") and SIMC (Note 5) in the U.S. District Court for the Eastern District of Kentucky at Ashland. The action arises from a dispute between the Company and ORCO concerning a transportation agreement for barge transportation of coal being delivered to TVA pursuant to Contract T-1. In connection with Marion's acquisition of SIMC, the Company assigned its rights and obligations under the transportation agreement to SIMC. SIMC's performance was guaranteed by the Company, and SIMC has apparently defaulted. The Company has asked the court to declare the rights of the parties in regard to the transportation agreement. ORCO has asserted counterclaims against both SIMC and the Company in the action. These counterclaims seek unspecified damages for lost future profits and at least $700,000 in damages from the Company for damages allegedly suffered by ORCO to date.\nDuring 1993, the Company reached a settlement with ORCO whereby both parties dismissed their claims against each other and agreed to terminate the Company's obligation under the SIMC transportation agreement. As a result, the Company agreed to pay ORCO $600,000 which relates primarily to SIMC's unpaid transportation fees previously guaranteed by the Company. This settlement amount is recorded in the December 31, 1993 financial statements.\nc. Pyramid Mining- --------------\nOn October 10, 1990, Pyramid Mining, Inc. and Pyramid Equipment, Inc. (\"Pyramid\"), subsidiaries of First Mississippi Corporation, filed a complaint alleging a number of charges against the Company and its wholly-owned subsidiary, Addwest Mining, Inc. (\"Addington Companies\"), among others. Pyramid's complaint sought compensatory and trebled damages against the Addington Companies in an undetermined amount believed to be in excess of $8.9 million. The complaint also sought $20 million in punitive damages and an order for an equitable accounting and constructive trust to recover, among other things, all profits made by Addwest Mining, Inc. through the operation of the Nickle mine and the Jetson mine.\nDuring April, 1992, the Company reached a settlement with Pyramid whereby both parties dismissed their claims against each other. As a result of the settlement, the Company paid Pyramid $5,100,000.\n14. Major Customers ---------------\nMajor customers accounted for 35%, 22%, 15% and 11% of total revenues for the year ended December 31, 1991; for 27%, 13% and 12% of total revenues for the year ended December 31, 1992; and for 28%, 12% and 11% of total revenues for the year ended December 31, 1993.\n15. Workers' Compensation and Black Lung ------------------------------------\nThe operations of the Company are subject to the Federal Coal Mine Health and Safety Act of 1969, as amended, and the related state workers' compensation laws. These laws provide for the payment of benefits to disabled workers and their dependents, including lifetime benefits for pneumoconiosis (black lung).\nThe Company has implemented a self-insurance program to cover most of its employees for workers' compensation, including black lung benefits. Certain other employees are covered under state-administered workers' compensation programs.\nBlack lung expense is being provided, based upon a recent actuarial study, over the estimated remaining working lives of the miners using accounting methods similar to that of a defined benefit pension plan. Black lung expense consists of normal costs for the current period, amortization (over a ten year period) of the $1,750,000 prior service cost at the date the Company became self-insured, plus interest at 8%. Benefits provided are subject to federal and state laws and, thus, are not under the control of the Company.\nWorkers' compensation (including black lung) expense for the years ended December 31, 1991, 1992 and 1993 was approximately $3,379,000, $3,035,000 and $3,755,000, respectively.\n16. Related Party Transactions --------------------------\nThe Company has dealt with certain companies or individuals which are related parties either by having stockholders in common or because they are controlled by stockholders\/officers or by relatives of stockholders\/ officers of the Company. The Company recorded various expenses to related parties consisting of approximately $11,627,000, $17,506,000 and $19,186,000 for trucking services for the years ended December 31, 1991, 1992 and 1993, respectively, approximately $110,000, $112,000 and $110,000 for office rent expense for the years ended December 31, 1991, 1992 and 1993, respectively, and approximately $25,000 for certain deep mining consulting services for the year ended December 31, 1991. The Company has also recorded flight fee income from related parties of approximately $3,000, $5,000 and zero for the years ended December 31, 1991, 1992 and 1993, respectively.\nThe Company had amounts payable to related parties of approximately $632,000 and $391,000 as of December 31, 1992 and 1993, respectively.\n17. Fair Value of Financial Instruments -----------------------------------\nSFAS No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires the Company to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments.\nThe carrying amount of cash equivalents approximates fair value because of the short maturity of cash equivalents. The long-term investment represents a less than 10% interest in a non-public company and fair value is estimated based on recent issue prices. The fair value of long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The 12% Notes ($125 million carrying amount) are valued at a premium due to the relatively high interest rate.\nThe fair value estimates are made at discrete points in time based on relevant market information and information about the financial instruments. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.\n18. Acquisitions ------------\na. NERCO Properties- ----------------\nOn February 4, 1993, in accordance with the terms of an Acquisition Agreement dated January 29, 1993 between coal subsidiaries of the Company and NERCO Coal Corp. (\"NERCO\"), the Company acquired the majority of NERCO's West Virginia mining operations, primarily consisting of inventories, property, plant, equipment, coal sales contracts and the assumption of certain reclamation liabilities, as well as the rights to approximately 80 million tons of coal reserves. The majority of these reserves are considered low sulfur coal.\nAs partial consideration for the acquisition, the Company issued to NERCO a promissory note (the \"Note\") for payment on April 1, 1993 of $3 million plus interest at the prime rate, as defined, plus 1% per annum from the date of closing. The Company will also pay NERCO an overriding royalty payment of $0.75 per ton of coal mined until a total of $9.5 million has been paid, with a minimum annual overriding royalty payment of $750,000. The Company also is assuming certain existing royalty obligations to previous owners with respect to the coal reserves acquired, including both production royalties and a minimum annual royalty payment of $1,625,000 for the next 17 years. In the event of certain defaults, all minimum annual royalty payments to NERCO and the previous owners may be accelerated. The assets acquired by the Company secure payment of the Note and the mining royalties in an amount not to exceed the unpaid principal and interest on the Note plus $5.5 million.\nUnaudited pro forma information for the year ended December 31, 1992 and 1993 has been provided below to reflect the impact on the Company's historical operations as if the acquisition had occurred on January 1, 1992. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the acquisition occurred during the periods presented or of the future results of operations.\nb. West Virginia Coal Reserves- ---------------------------\nOn August 13, 1993, Kanawha Development Corporation (KDC), a newly established coal-related subsidiary of Addington, entered into various agreements, the purpose being to acquire, among other items, a sublease interest in approximately 30 million tons of coal reserves in southern West Virginia.\nConsideration for this acquisition includes the following: (a) KDC paid $2.5 million in recoupable advance royalties to the sublessor; (b) KDC paid $900,000 for related engineering data, permits and mine development; (c) a royalty of 4% of sales value on tonnage mined and sold will be paid to the sublessor with a minimum annual royalty of $1.0 million per year due for ten years; (d) KDC will pay to the former owner of the sublease an overriding royalty of $0.50 per ton for all tons mined and sold; and (3) KDC will assume certain obligations under the sublease agreement.\nThe Company has guaranteed the performance of KDC under the sublease terms. In the event KDC is sold by the Company, the new owner of KDC becomes the guarantor of performance under the sublease terms.\nBoth of the acquisitions discussed in this note were included in the transaction discussed in Note 2.\n19. Segment Information -------------------\nThe Company considers its major business segments to be mining (including coal, gold, silver, sulfur and limestone) and environmental (including sanitary landfills and waste collection, recycling and disposal). Included in the segment \"Other\" for 1992 and 1993 is the Company's technology licensing activities (Note 12d) as well as citrus operations currently in the development stage. In prior years, \"other\" included highway construction activities.\nInformation about the Company's operations for each segment are as follows (in thousands of dollars):\n(1) Includes asset writedown related to sulfur project ($9,384,000 - See Note 2).\n(2) Includes asset writedown related to certain abandoned assets ($5,122,000 - see Note 2).\nRevenues by industry segment are comprised of sales to unaffiliated customers; there are no intersegment sales.\nIdentifiable assets by industry segment are those assets that are used in the Company's operations in each industry. General corporate assets consist of cash and cash equivalents, short-term investments and deferred financing costs.\n(1) Quarters may not add to annual net income per share due to changes in shares outstanding.\n(2) Includes asset writedowns related to abandoned sulfur project ($9,384,000) and environmental projects ($5,122,000), as described in Note 2.\nExhibit 11\nADDINGTON RESOURCES, INC. CALCULATION OF NET INCOME (LOSS) PER SHARE\nNOTE: The dilutive effect of the Company's common stock equivalents (grants and shares under option) for the primary net income per share calculation was insignificant for 1991, 1992 and 1993.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Addington Resources, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Addington Resources, Inc. and subsidiaries included in this Form 10-K and have issued our report thereon dated March 23, 1994. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes effective January 1, 1991, as discussed in Note 1(g) to the consolidated financial statements. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the table of contents (page) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nARTHUR ANDERSEN & CO.\nMarch 23, 1994 Louisville, Kentucky\nADDINGTON RESOURCES, INC. SCHEDULE V PROPERTY, PLANT AND EQUIPMENT\n(1) Represents reclassification of property, plant and equipment to net assets held for disposal.\nADDINGTON RESOURCES, INC. SCHEDULE VI ACCUMULATED DEPRECIATION\n(1) Additions to accumulated depreciation that have been capitalized as environmental development costs\n(2) Represents reclassification of accumulated depreciation to net assets held for disposal.\nADDINGTON RESOURCES, INC. SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS\nADDINGTON RESOURCES, INC. SCHEDULE IX SHORT-TERM BORROWINGS\n(1) The average amount outstanding during the period was computed by dividing the total of the quarter-end outstanding principal balances by five.\n(2) The weighted average interest rate during the period was computed by dividing the interest expense by the average principal amount outstanding during the period.\nADDINGTON RESOURCES, INC. SCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION\nNote: Amounts for advertising costs are not presented, as such amounts are less than 1% of total sales and revenues.\nSIGNATURES ----------\nPursuant 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.\nADDINGTON RESOURCES, INC.\nDate: March 29, 1994 By \/s\/ Larry Addington --------------------- Larry Addington, President\nPursuant 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 and on the dates indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ Larry Addington President and Chairman March 29, 1994 - ------------------------ of the Board of Directors Larry Addington (Chief Executive Officer)\n\/s\/ R. Douglas Striebel Vice President and Chief March 29, 1994 - ------------------------ Financial Officer (Chief R. Douglas Striebel Financial Officer) (Chief Accounting Officer)\n\/s\/ Robert Addington Director March 29, 1994 - ------------------------ Robert Addington\n\/s\/ Bruce Addington Director March 29, 1994 - ----------------------- Bruce Addington\n\/s\/ Carl R. Whitehouse Director March 29, 1994 - ------------------------ Carl R. Whitehouse\n\/s\/ Jack C. Fisher Director March 29, 1994 - ------------------------ Jack C. Fisher\nINDEX TO EXHIBITS\nExhibit Number Exhibit - -------------- -------\n(3)(A)\/1\/ Restated Certificate of Incorporation of Registrant\n(B)\/1\/ Bylaws of Registrant\n(10)(A)\/2\/ Deed dated June 18, 1985 by and between Martiki Coal Corporation and ARMM Coal, Inc.\n(B)\/2\/ Deed of Conveyance dated June 7, 1984 by and between Franklin Real Estate Company and ARMM Land Co., Inc.\n(C)\/2\/ Contract Mining Agreement and Related Agreements dated June 10, 1986 among Addington, Inc., CJC Leasing, Inc., N.O.R. Mining, Inc., Adams Resources & Energy, Inc., and Third National Bank\n(D)\/3\/ Form of Lease Agreement among Larry Addington and Larry K. Harrington and Addwest Mining, Inc.\n(E)\/4\/ Employment Agreement between R. Douglas Striebel and the Registrant, as amended\n(F)\/5\/ Agreement dated as of April 18, 1990, between Indiana- Kentucky Electric Corporation and Addwest Mining Company, Inc.\n(G) Addington Resources, Inc. Restated Stock Option Plan, as amended.\n(H) Form of Indemnity Agreement between the Registrant and its directors and officers\n(I) Employment Agreement dated as of July 14, 1992, between Addington Environmental, Inc. and William R. Nelson\n(11) Statement re computation of per share earnings. See page of\nthe audited Consolidated Financial Statements and Schedules filed as part of this report.\n(21) List of subsidiaries of Registrant\n(23) Consent of Arthur Andersen & Co.\n(99)(A)\/2\/ Coal Purchase and Sales Agreement dated September 1, 1984 by and between Fossil Fuels, Inc., Delta Energy Corporation and Consumers Power Company\n(99)(B)\/2\/ Amended and Restated Contract for Purchase and Sale of Coal dated June 27, 1986 by and between Tennessee Valley Authority and Addington, Inc. [Contract No. 86P-65-T4] (See Exhibit (99)(D) and Exhibit 99(G) pertaining to amendments to Contract No. 86P-65-T4)\n(99)(C)\/2\/ Contract for Purchase and Sale of Coal dated September 12, 1986 by and between Tennessee Valley Authority and Addwest Mining, Inc. [Contract No. 86P-16-T1] (See Exhibit 99(E) and Exhibit 99(H) pertaining to amendments to Contract No. 86P-16=T1)\n(99)(D)\/6\/ Supplemental Agreement to Contract 86P-65-T4 for Purchase and Sale of Coal dated May 1989, by and between Tennessee Valley Authority and Addington, Inc.\n(99)(E)\/6\/ Supplemental Agreement to Contract 86P-16-T1 for Purchase and Sale of Coal dated February 1, 1989 by and between Tennessee Valley Authority and Addwest Mining, Inc.\n(99)(F)\/6\/ Transfer Agreement dated as of April 3, 1989, by and among Addwest Mining, Inc. and Addington, Inc. and the Tennessee Valley Authority\n(99)(G)\/7\/ Supplemental Agreement dated October 23, 1990, to Contract 86P-16-T4 by and between Addington, Inc. and Tennessee Valley Authority.\n(99)(H)\/3\/ Supplemental Agreements to Contract 86P-16-T1 for Purchase and Sale of Coal dated May 11, 1989 and October 30, 1991 by and between Tennessee Valley Authority and Addwest Mining, Inc. ____________________ \/1\/Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-22164]\n\/2\/Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-11918]\n\/3\/Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 [File No. 0-16498].\n\/4\/Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 [File No. 0-16498].\n\/5\/Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1990 [File No. 0-16498].\n\/6\/Incorporated by reference to the Registration Statement on Form S-1 [File No. 33-29848]\n\/7\/Incorporated by reference to the Registrant's Annual Report Form 10-K for the fiscal year ended December 31, 1990 [File No. 0-16498].","section_15":""}
{"filename":"823870_1993.txt","cik":"823870","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nFirst Fidelity Bancorporation (the \"Company\" or \"First Fidelity\") is a bank holding company which was organized as a corporation under New Jersey law in 1987. On February 29, 1988, the Company became the successor to and the holder of all of the capital stock of First Fidelity Incorporated (\"FFI\"), a New Jersey bank holding company, and Fidelcor, Inc. (\"Fidelcor\"), a Pennsylvania bank holding company.\nThe Company has a centralized organizational structure, with uniform policies and procedures. Functions such as asset and liability management, corporate operations and systems, credit policy, audit, legal services, employee hiring and benefits and financial planning are conducted at the holding company level, while day-to-day banking activities are managed by the Company's bank subsidiaries (collectively, the \"Subsidiary Banks\"). Important management decisions are addressed at bi-weekly meetings of the Office of the Chairman of the Company, chaired by Anthony P. Terracciano, Chairman of the Board of Directors, Chief Executive Officer and President of the Company, and including Wolfgang Schoellkopf, Vice Chairman and Chief Financial Officer of the Company, Peter C. Palmieri, Vice Chairman and Chief Credit Officer of the Company, Leslie E. Goodman, Senior Executive Vice President of the Company and Roland K. Bullard II, Senior Executive Vice President of the Company.\nAs of December 31, 1993, the Subsidiary Banks operated a general banking business from 647 full-service offices located in New Jersey, eastern Pennsylvania, Connecticut and in New York State (Westchester County and Riverdale). The Subsidiary Banks also have offices in London, the Cayman Islands and New York City. As of December 31, 1993, the Company and its subsidiaries employed approximately 12,000 persons on a full-time basis.\nRecent Transactions\nDuring 1993, the Company entered into a variety of transactions which, in the aggregate, were significant to its business, operations and structure, including the following:\n(i) Acquisitions and Joint Ventures. During 1993, the Company expanded its branch network into Connecticut, significantly strengthened its presence in Westchester County, New York, and filled in gaps in its branch network in New Jersey. The Company also entered into two strategic joint ventures during the year, including a venture to market check-processing and related services to depository institutions and a marketing alliance to provide private banking services in the Philadelphia area. In addition, during 1993 the Company announced that it had entered into agreements to acquire banking institutions in Fairfield County, Connecticut, Wilkes-Barre, Pennsylvania and Rockland County, New York. These acquisitions are expected to be consummated in the first half of 1994. The transactions are summarized below:\nRecent Acquisitions & Joint Ventures\na. On April 8, 1993, the Company acquired $17 million of performing assets and assumed $16.8 million of deposits of Pitcairn Private Bank located in Jenkintown, Pennsylvania. In connection with the acquisition, the Company entered into a marketing alliance with Pitcairn Trust Company, an affiliate of Pitcairn, under which Pitcairn will refer its customers to the Company's private banking group for general banking and credit services.\nb. In May, 1993, the Company acquired all of the capital stock of Northeast Bancorp, Inc. (\"Northeast\"). On May 4, 1993 (the date on which the first of two mergers was completed between Northeast and subsidiaries of the Company), Northeast had $2.5 billion in assets, $2.4 billion in deposits and, through its Union Trust Company (\"Union Trust\") bank subsidiary, operated 67 bank branches throughout Fairfield and other counties in Eastern and Central Connecticut. In the acquisition, the Company issued 610,845 shares of its common stock, par value $1.00 per share (the \"Common Stock\") to holders of Northeast common stock. The Company also contributed capital of $130 million to that entity in connection with the acquisition, of which $125 million was contributed to Union Trust. After such contribution, Northeast and Union Trust had capital ratios in excess of all regulatory minimums.\nc. On June 30, 1993, the Company acquired 8 branches of The Dime Savings Bank of New Jersey (\"Dime\"). In connection with such acquisition, the Company assumed approximately $329 million of deposits.\nd. On July 1, 1993, First Fidelity and Bankers Trust Company of New York (\"Bankers Trust\") announced a joint venture to create a bank service corporation, Global Processing Alliance, Inc. (\"Global\"), which will provide check-processing and related services to depository institutions. The Company (through First Fidelity Bank, N.A.) and Bankers Trust each owns 50 percent of Global, which will sell its services to other depository institutions as well as provide these services to the founding institutions and their affiliates. Global is headquartered in Totowa, New Jersey.\ne. On August 11, 1993, First Fidelity acquired Village Financial Services, Ltd. (\"Village\") and its 9 branch bank subsidiary, Village Bank, for approximately $40 million in cash and approximately $26.8 million (or 552,678 shares) of Common Stock. Village Bank operates primarily in Westchester County, New York. At closing, Village had assets of $736 million and deposits of $489 million.\nf. On December 30, 1993, the Company acquired the 31 branch Peoples Westchester Savings Bank (\"Peoples\"), a savings bank operating in Westchester County, New York, for a combination of cash ($123 million) and Common Stock (2,442,083 shares), for an aggregate value of $234.9 million. At closing, Peoples had approximately $1.7 billion in assets and $1.5 billion in deposits. Banco Santander, S.A. (\"Santander\"), a 20.1% shareholder of First Fidelity, did not acquire Common Stock in connection with the acquisition as had been previously contemplated. Substantially all of the Common Stock issued to Peoples stockholders in the acquisition came from Treasury Stock, all of which was recently acquired by First Fidelity through open market purchases.\ng. On January 31, 1994, First Fidelity acquired Greenwich Financial Corporation and its 7 branch subsidiary, Greenwich Federal Savings and Loan Association (\"Greenwich Federal\"), for $41.9 million in cash. Greenwich Federal, which reported assets of $425 million and deposits of $255 million at December 31, 1993, operates in the Greenwich\/Stamford area of Fairfield County, Connecticut.\nPending Acquisitions\na. On August 27, 1993, First Fidelity entered into a definitive agreement to acquire BankVest, Inc. and its 2 branch subsidiary, First Peoples National Bank of Edwardsville, Pennsylvania, for $19.6 million in cash. Subject to receipt of the applicable regulatory approvals, the acquisition is expected to close by the end of the first quarter of 1994.\nb. On October 27, 1993, the Company, through First Fidelity Bank, N.A., New York (\"FFB-NY\"), entered into a definitive agreement to acquire The Savings Bank of Rockland County (\"Rockland\") for approximately $5.9 million in cash. Rockland has 4 offices, all in Rockland County, New York. Subject to receipt of the applicable regulatory approvals, the acquisition is expected to be consummated during the second quarter of 1994.\nc. On January 27, 1994, the Company entered into a definitive agreement to acquire First Inter-Bancorp Inc., of Fishkill, New York and its 16 branch, federally-chartered savings bank subsidiary, Mid-Hudson Savings Bank FSB (\"Mid-Hudson\") for approximately $56 million in cash. Mid-Hudson, which operates throughout Dutchess, Ulster, Orange and Putnam Counties in New York State, had approximately $522 million in assets and $460 million in deposits at December 31, 1993. The Company intends to merge Mid-Hudson's operations with those of FFB-NY. The acquisition is subject to shareholder and regulatory approval.\n(ii) Internal Consolidation. As part of the Company's ongoing program of consolidation, on January 11, 1994, the Company consolidated (the \"Bank Consolidation\") its two largest subsidiary banks, First Fidelity Bank, N.A., New Jersey (\"FFB-NJ\") and First Fidelity Bank, N.A., Pennsylvania (formerly Fidelity Bank, N.A. (\"Fidelity\")) into a new entity, First Fidelity Bank, N.A. (\"First Fidelity Bank\"). This Bank Consolidation was effected following the relocation of the head office of Fidelity from Philadelphia, Pennsylvania to Salem, New Jersey, which location became the resulting head office of First Fidelity Bank.\nDuring 1993, in contemplation of the Bank Consolidation, the Company combined a number of its subsidiary banks as well as its holding company subsidiaries. On March 19, 1993, First Fidelity Bank, N.A., South Jersey was merged into FFB-NJ. On June 15, 1993, First Fidelity Trust Company, New York was merged into FFB-NY and on June 18, 1993, Merchants Bank, N.A. and Merchants Bank, North were merged into Fidelity, which changed its name to First Fidelity Bank, N.A., Pennsylvania. On August 25, 1993, the Company merged its second-tier holding company, Fidelcor, Inc. (\"Fidelcor\"), into First Fidelity Incorporated (\"FFI\"), the second-tier holding company parent of First Fidelity Bank.\n(iii) Capital Markets Activities. During 1993, First Fidelity issued $150 million of 6.80% subordinated notes due June 15, 2003 and on February 2, 1994 the Company issued $200 million of floating rate senior notes due August 2, 1996. The Company redeemed several outstanding debt issues during 1993. On April 1, 1993, the Company redeemed at maturity $50 million of 11 1\/2% notes at face value plus accrued interest. On May 15, 1993, the Company redeemed prior to scheduled maturity its $16.2 million 7 3\/4% Capital Debentures, and on July 16, 1993, the Company redeemed $50 million of floating rate subordinated notes originally due to mature in 1997.\nThe Company implemented two separate Common Stock open market purchase programs during 1993. Beginning in April 1993, the Company commenced open market purchases through an independent agent to acquire Common Stock for issuance under its dividend reinvestment plan and stock option plans. On October 21, 1993, the Company's Board of Directors (the \"Board\") authorized the acquisition of up to 2% of First Fidelity's outstanding Common Stock in any calendar year, through open market or privately-negotiated transactions, which amount does not include purchases made in connection with Company employee or stockholder benefit plans. On November 18, 1993, the Board authorized the acquisition of up to an additional 1% of the Company's outstanding Common Stock during 1993. As of December 30, 1993, the Company had repurchased 2,383,451 shares of its Common Stock, at an average price of $42.22 per share, which constituted substantially all of the 3% authorized for repurchase in 1993. All of the acquired shares were reissued in connection with the Company's acquisition of Peoples. Pursuant to the 2% repurchase program, the Company repurchased 654,300 shares of its Common Stock between January 1 and March 7, 1994, at an average price of $43.53 per share. On March 7, 1994, the Board authorized the acquisition of up to an additional 1,300,000 shares of Common Stock in 1994.\nThe Board increased the dividend on the Company's Common Stock on April 20, 1993 from $.33 to $.37 per share. On January 20, 1994, the Board raised the quarterly dividend on the Common Stock by $.05 per share to $.42 per share.\nIn connection with the acquisition of Northeast, the Company issued 3,284,207 shares of its Common Stock to Santander, pursuant to the terms of the Investment Agreement (the \"Investment Agreement\"), dated as of March 18, 1991, between Santander and the Company. 2,376,250 of such shares were issued pursuant to Santander's partial exercise of Warrants to purchase up to 9,505,000 shares of Common Stock at $25.50 per share and the remainder represented the exercise by Santander of its acquisition gross up rights (the \"Acquisition Gross Up Rights\") to acquire Common Stock in connection with certain \"acquisition events\" for consideration of $30.00 per share.\nSimilarly, in connection with the acquisition of Village, First Fidelity issued 893,956 shares of Common Stock to Santander for $30 per share pursuant to its exercise of Acquisition Gross Up Rights. After consummation of the Village acquisition (taking into account the Acquisition Gross Up Rights exercised in connection with the Northeast acquisition), Santander retained Acquisition Gross Up Rights to acquire $45.9 million (remaining from the original $100 million amount under the Investment Agreement) in value of Common Stock (or other equity securities of First Fidelity) and Warrants (exercisable at $25.50 per share) to acquire 4,752,500 shares of Common Stock. By its terms, the Investment Agreement and Santander's rights to exercise its Warrants and Acquisition Gross Up Rights terminate on December 27, 1995. In November 1993, the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") extended its approval for Santander to acquire up to 24.9% of the Company's voting stock to November 25, 1994.\nThe existence of Santander's Warrants and the Acquisition Gross Up Rights held by Santander may affect the Company's acquisition strategy. The Warrants and Acquisition Gross Up Rights provide the Company with convenient access to capital and additional flexibility in terms of timing of an acquisition bid, while at the same time they potentially increase the dilutive effect to earnings per share of Common Stock of an acquisition in which Common Stock is issued.\nThe Investment Agreement also provides Santander with gross up rights in the event that First Fidelity issues equity (other than pursuant to an employee benefit plan or upon conversion of convertible securities) in order to insure that Santander maintains the same proportional interest in any class of outstanding equity. These gross up rights give Santander the right to acquire such equity securities on the same terms (including price) as the terms on which the equity being issued by the Company is issued to third parties.\nBUSINESS OF FIRST FIDELITY'S SUBSIDIARIES\nBank Subsidiaries\nFirst Fidelity's Subsidiary Banks consist of First Fidelity Bank, FFB-NY and Union Trust (a Connecticut-chartered commercial bank). First Fidelity's Subsidiary Banks operate primarily in New Jersey, eastern Pennsylvania, Westchester County, New York and Connecticut. This marketplace is characterized by a diversified industry base (including a number of well known large companies as well as many successful smaller and mid-sized businesses), three key ports on the East Coast (Philadelphia, New York\/Newark and New Haven\/New London) and a well-educated work force.\nFirst Fidelity, through its Subsidiary Banks, offers a broad range of lending, depository and related financial services to individual consumers, businesses and governmental units. Commercial lending services provided by the Subsidiary Banks include short and medium term loans, revolving credit arrangements, lines of credit, asset-based lending, equipment leasing, real estate construction loans and mortgage loans. Consumer banking services include various types of deposit accounts, secured and unsecured loans, consumer installment loans, mortgage loans, automobile leasing and other consumer-oriented services.\nThe Subsidiary Banks offer a wide range of money-market services. They underwrite and distribute general obligations of municipal, county and state governments and agencies. In their respective money-center activities, the Subsidiary Banks deal in U.S. Treasury and U.S. Government agency securities, certificates of deposit, foreign exchange, commercial paper, bankers' acceptances, Federal funds and repurchase agreements.\nFiduciary services are available through all of the Subsidiary Banks and include trustee services for corporate and municipal securities issuers and investment management and advisory services to individuals, corporations, organizations and other institutional investors. The Subsidiary Banks act as investment adviser to and provide management services for a number of mutual funds, including several proprietary funds of First Fidelity designed primarily for trust customers and corporate and retail banking customers of the Subsidiary Banks. The Subsidiary Banks administer, in a fiduciary capacity, pensions, personal trusts and estates. They also act as transfer agent, registrar, paying agent and in other corporate agency capacities.\nThe Subsidiary Banks offer international banking services through their domestic offices, correspondent banks, and foreign offices. The Subsidiary Banks' foreign banking and international activities presently consist primarily of short-term trade related financings and the extension of credit to foreign banks and governments and foreign and multinational companies.\nNonbank Subsidiaries\nThe Company has several nonbank subsidiaries, including entities which provide insurance brokerage services, community development assistance, securities brokerage services and consumer leasing.\nCOMMITMENTS AND LINES OF CREDIT\nThe Subsidiary Banks are obligated under standby and commercial letters of credit on behalf of customers. In addition, the Subsidiary Banks issue lines of credit to customers, generally for periods of up to one year and usually in connection with the provision of working capital for borrowers. For further information regarding such obligations, see Part II, Item 8, \"Financial Statements and Supplementary Data -- Note 16 of the Notes to Consolidated Financial Statements\".\nCOMPETITION\nThe Company and its subsidiaries face vigorous competition from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, federal and state savings and loan associations, savings banks, credit unions and industrial savings banks actively compete to provide a wide variety of banking services. Mortgage banking firms, real estate investment trusts, finance companies, insurance companies, leasing companies, brokerage and factoring companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services. The Subsidiary Banks also currently compete for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives.\nFirst Fidelity's competition is not limited to financial institutions based in New Jersey, Pennsylvania, Connecticut and New York. A number of large out-of-state and foreign banks, bank holding companies, consumer finance companies and other financial institutions have an established market presence in New Jersey, Pennsylvania, Connecticut and the greater New York City area, including Westchester County. Many of the financial institutions operating in First Fidelity's market area engage in local, regional, national and international operations and some of such institutions are larger than the Company.\nSUPERVISION AND REGULATION\nGeneral\nThe Company, Northeast and FFI are bank holding companies within the meaning of the Bank Holding Company Act of 1956, as amended (the \"Act\"), and are registered as such with the Federal Reserve Board. As bank holding companies, the Company and FFI also are subject to regulation by the New Jersey Department of Banking (the \"New Jersey Department\"), and the Company and Northeast are subject to regulation by the Connecticut Department of Banking (the \"Connecticut Department\").\nFirst Fidelity Bank and FFB-NY are national banks subject to the regulation and supervision of, and regular examination by, the Office of the Comptroller of the Currency (the \"OCC\"), as well as regulation by the Federal Deposit Insurance Corporation (the \"FDIC\") and the Federal Reserve Board. Union Trust is subject to the regulation and supervision of, and regular examination by, the FDIC and the Connecticut Department.\nBank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. A change in applicable law or regulation could have a material effect on the business and prospects of the Subsidiary Banks and the Company.\nGovernment Regulation\nEach of First Fidelity, FFI and Northeast is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Act. Annual and other periodic reports also are required to be filed with the New Jersey Department and the Connecticut Department. In addition, the Federal Reserve Board makes examinations of bank holding companies and their subsidiaries. The Act requires each bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire substantially all of the assets of any bank, or before it may acquire, directly or indirectly, ownership or control of any voting shares of any company, including a bank, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such company. See \"Acquisitions -- Interstate Banking\".\nCapital adequacy guidelines may impede a bank holding company's ability to consummate acquisitions involving consideration with a cash component. For a description of certain applicable guidelines, see \"Capital\", \"FDICIA\" and Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nUnder Federal Reserve Board policy, the Company is expected to act as a source of strength to each Subsidiary Bank and to commit resources to support each Subsidiary Bank. Such support may be required at times when, absent\nsuch Federal Reserve Board policy, the Company would not otherwise provide it. In addition, any capital loans by the Company or any subsidiary to any of the Subsidiary Banks would be subordinate in right of payment to deposits and to certain other indebtedness of such Subsidiary Bank.\nThe Act also restricts the types of businesses and operations in which a bank holding company and its subsidiaries may engage. Generally, permissible activities are limited to banking and activities found by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.\nThe operations of the Subsidiary Banks are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and the types of services which may be offered and restrictions on the ability to purchase deposits under certain circumstances. Various consumer laws and regulations also affect the operations of the Subsidiary Banks.\nApproval of the OCC is required for branching of Subsidiary Banks that are national banks and for bank mergers in which the continuing bank is a national bank. Approval of the Office of Thrift Supervision is required in connection with certain acquisitions of thrift institutions as well as for establishment of a de novo federal savings bank. In addition, approval of the relevant state banking authorities and the FDIC is required in connection with certain fundamental corporate changes involving state-chartered banks (such as Union Trust) or other banking entities.\nFederal law provides for the enforcement of any pro rata assessment of stockholders of a national bank to cover impairment of capital stock by sale, to the extent necessary, of the stock of any assessed stockholder failing to pay the assessment. FFI and Northeast, as stockholders of the Subsidiary Banks, are subject to such provisions.\nAcquisitions -- Interstate Banking\nFirst Fidelity is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. Acquisitions that may be under consideration at any time include, without limitation, acquisitions of banking organizations and thrift or savings type associations or their assets or liabilities or acquisitions of other financial services companies or their assets or liabilities. Companies targeted by First Fidelity for acquisition would generally be based in markets in which the Company presently operates or in markets in proximity to one of the Company's then existing markets. First Fidelity contemplates that any such acquisitions would be financed through a combination of working capital and issuances of equity and debt securities.\nFederal law precludes the Federal Reserve Board from approving the acquisition by a bank holding company of the voting shares of, or substantially all the assets of, any bank (or its holding company) located in a state other than that in which the acquiring bank holding company's banking subsidiaries conducted their principal operations on the date such company became a bank holding company unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. Many states, including New Jersey, Pennsylvania, Connecticut and New York, have adopted legislation which permits banks and bank holding companies resident in such states to acquire banks and bank holding companies in states with reciprocal legislation.\nDividend Restrictions\nThe Company is a legal entity separate and distinct from the Subsidiary Banks and its nonbank subsidiaries. Virtually all of the revenue of the Company available for payment of dividends on its capital stock will result from amounts paid to the Company by FFI and Northeast from dividends received from their respective Subsidiary Banks. All such dividends are subject to various limitations imposed by federal and state laws and by regulations and policies adopted by federal and state regulatory agencies.\nEach Subsidiary Bank that is a national association is required by federal law to obtain the approval of the OCC for the payment of dividends if the total of all dividends declared by the Board of Directors of such bank in any year will exceed the total of such bank's net profits (as defined and interpreted by regulation) for that year and the retained net profits (as defined) for the preceding two years, less any required transfers to surplus. The OCC's regulations define the calculation of net profits to include the provision for possible credit losses and exclude actual charge-offs. National banks can only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined).\nIn addition, payment of dividends by a Subsidiary Bank will be prohibited under the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") in the event such Subsidiary Bank would become \"undercapitalized\" under the guidelines described below as a result of such distribution. Moreover, in connection with its approval of deposit insurance for newly-formed national banks, the FDIC has adopted a general policy of restricting the ability of any newly-formed insured entity from paying dividends for a 3 year period following formation. In connection with the formation of FFB-NY in June 1992, First Fidelity agreed to obtain the approval of the FDIC prior to causing FFB-NY to pay out dividends during the bank's first 3 years of existence. Connecticut banking statutes provide that Connecticut-chartered banks may pay dividends only out of \"net profits\", defined as the remainder of earnings from current operations, and limited in amount per year to the total of net profits for that year combined with retained net profits of the preceding two years.\nUnder the above-mentioned restrictions, in 1994 the Subsidiary Banks, without affirmative governmental approvals, could declare aggregate dividends of approximately $281 million plus an amount approximately equal to the net profits (as measured under current regulations), if any, earned by the Subsidiary Banks for the period from January 1, 1994 through the date of declaration less dividends previously paid in 1994, subject to the limitations described elsewhere herein. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nIf, in the opinion of the applicable regulatory authority, a bank or bank holding company under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank or bank holding company, could include the payment of dividends), such authority may require that such bank or bank holding company cease and desist from such practice or, as a result of an unrelated practice, require the bank or bank holding company to limit dividends in the future. In addition, the Federal Reserve Board, the OCC and the FDIC have issued policy statements which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings. Finally, as described elsewhere herein, the regulatory authorities have established guidelines and under FDICIA have adopted regulations (and may in the future adopt additional regulations) with respect to the maintenance of appropriate levels of capital by a bank or bank holding company under their jurisdiction. Compliance with the standards set forth in such policy statements, guidelines and regulations could limit the amount of dividends which the Company and its bank and bank holding company affiliates may pay. In addition, the Company and its Subsidiary Banks discuss overall capital adequacy, including the payment of dividends, on at least a quarterly basis with their respective appropriate Federal regulatory authorities.\nBorrowings by the Company\nFederal law prevents the Company and certain of its affiliates (with certain exceptions), including FFI and Northeast, from borrowing from the Subsidiary Banks, unless such borrowings are secured by specified amounts and types of collateral. Additionally, such secured loans to any one affiliate are generally limited to 10% of each such Subsidiary Bank's capital and surplus and, in the aggregate with respect to the Company and all of such affiliates, to 20% of each such Subsidiary Bank's capital and surplus. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nCapital\nThe Federal Reserve Board measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. The minimum ratio of total risk-based capital to risk-adjusted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the total capital must be common equity and qualifying perpetual preferred stock, less goodwill (\"Tier I capital\"). The remainder (\"Tier II capital\") may consist of mandatory convertible debt securities, a designated amount of qualifying subordinated debt, other preferred stock and a portion of the reserve for possible credit losses.\nIn addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines currently provide for a minimum leverage ratio (Tier I capital to quarterly average total assets less goodwill) of 3% for bank holding companies that meet certain criteria, including that they maintain the highest regulatory rating. All other bank holding companies are required to maintain a leverage ratio of 3% plus an additional cushion of at least 1 to 2 percentage points. The Federal Reserve Board has not advised First Fidelity of\nany specific minimum leverage ratio under these guidelines which would be applicable to First Fidelity. The guidelines also indicate that, when appropriate, including when a bank holding company is undertaking expansion, engaging in new activities or otherwise facing unusual or abnormal risk, the Federal Reserve Board will consider a \"tangible Tier I leverage ratio\" (deducting all intangibles) in making an overall assessment of capital adequacy. Failure to satisfy regulators that a bank holding company will comply fully with capital adequacy guidelines upon consummation of an acquisition may impede the ability of a bank holding company to consummate such acquisition, particularly if the acquisition involves payment of consideration other than common stock. In most cases, the regulatory agencies will not approve acquisitions by bank holding companies and banks unless their capital ratios are well above regulatory minimums.\nIn 1993, the Federal Reserve Board adopted changes to the risk-based capital and leverage ratio calculations which require that most intangibles, including core deposit intangibles and goodwill (but excluding qualifying purchased credit card relationships and purchased mortgage servicing rights), be deducted for the purpose of calculating Tier I and total capital. Under the rule, bank holding companies are permitted (for supervisory purposes but not for application purposes) to include certain identifiable intangible assets, such as core deposit intangibles, in calculating capital to the extent that such intangibles were acquired prior to February 19, 1992. Institutions must deduct all intangible assets (other than qualifying purchased credit card relationships and purchased mortgage servicing rights) in the calculation of capital for application purposes. The rule applies to bank holding companies as well as to state member banks. The OCC adopted similar rules applicable to the Subsidiary Banks. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nThe Company's Subsidiary Banks are subject to capital requirements which generally are similar to those affecting the Company. As described below under \"FDICIA\", the federal banking agencies have established certain minimum levels of capital which are consistent with statutory requirements. As of December 31, 1993 and 1992, the Company and the Subsidiary Banks had capital in excess of all regulatory minimums, including the higher minimum capital and leverage ratios agreed to by the Company in connection with acquisitions during 1990, 1991 and 1992.\nThe Federal Reserve Board, the FDIC and the OCC issued a proposed rule in September 1993 (to become effective for First Fidelity on December 31, 1994) to implement the requirement under FDICIA that risk-based capital standards take account of interest rate risk. The proposed rule focuses on institutions having relatively high levels of measured interest rate risk, and considers the effect that changing interest rates would have upon the value of an institution's assets, liabilities, and off balance-sheet positions. First Fidelity's risk profile (as defined) is such that the rule, if adopted in substantially the form proposed, is expected to have no impact on the capital ratios or operations of the Company and its Subsidiary Banks.\nFDICIA\nUpon its enactment in December 1991, FDICIA substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made revisions to several other federal banking statutes.\nAmong other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" in respect of depository institutions that do not meet minimum capital requirements in order to minimize losses to the FDIC. FDICIA establishes five capital classifications: \"well capitalized\", \"adequately capitalized\", \"undercapitalized\", \"significantly undercapitalized\" and \"critically undercapitalized\" and imposes significant restrictions on the operations of a bank that is not at least adequately capitalized. A depository institution's capital classification depends upon its capital levels in relation to various relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors.\nA depository institution is considered well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets each such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below any such measure and critically undercapitalized if it fails to meet any critical capital level set forth in regulations. The critical capital level is a level of tangible equity equal to not less than 2% of total assets and not more than 65% of the minimum leverage ratio at levels prescribed by regulation (except to the extent that 2% would be higher than such 65% level). An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating or is deemed to be in an unsafe or\nunsound condition or to be engaging in unsafe or unsound practices. Under applicable regulations, for an institution to be well capitalized it must have a total risk-based capital ratio of at least 10%, a Tier I risk-based capital ratio of at least 6% and a Tier I leverage ratio of at least 5% and not be subject to any specific capital order or directive. As of December 31, 1993, all of the Company's Subsidiary Banks were \"well capitalized\" as defined under FDICIA. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nFDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and prohibitions on the payment of interest rates on deposits in excess of 75 basis points above the average market yields for comparable deposits. In addition, such institutions must submit a capital restoration plan which is acceptable to applicable federal banking agencies and which must include a guarantee from the parent holding company that the institution will comply with such plan.\nSignificantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets or to cease accepting deposits from correspondent banks and restrictions on senior executive compensation and on inter-affiliate transactions. Critically undercapitalized institutions are subject to a number of additional restrictions, including the appointment of a receiver or conservator.\nRegulations promulgated under FDICIA also require that an institution monitor its capital levels closely and notify its appropriate federal banking regulators within 15 days of any material events that affect the capital position of the institution. FDICIA also contains a variety of other provisions that affect the operations of the Company, including certain reporting requirements, regulatory standards for real estate lending, \"truth in savings\" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch, certain restrictions on investments and activities of state-chartered insured banks and their subsidiaries, limitations on credit exposure between banks, restrictions on loans to a bank's insiders, guidelines governing regulatory examinations and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well capitalized or are adequately capitalized and have not received a waiver from the FDIC.\nFDICIA directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares (if feasible) and such other standards as the agency deems appropriate.\nFinally, FDICIA limits the discretion of the FDIC with respect to deposit insurance coverage by requiring that, except in very limited circumstances, the FDIC's course of action in resolving a problem bank must constitute the \"least costly resolution\" for the Bank Insurance Fund (\"BIF\") or the Savings Association Insurance Fund (\"SAIF\"), as the case may be. The FDIC has interpreted this standard as requiring it not to protect deposits exceeding the $100,000 insurance limit in more situations than was previously the case. In addition, FDICIA prohibits payments by the FDIC on uninsured deposits in foreign branches of U.S. banks, and effective no later than 1994, will severely limit the \"too big to fail\" doctrine under which the FDIC formerly protected deposits exceeding the $100,000 insurance limit in certain failed banking institutions.\nFIRREA\nUnder the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. \"Default\" is defined generally as the appointment of a conservator or receiver and \"in danger of default\" is defined generally as the existence of certain conditions indicating that a \"default\" is likely to occur in the absence of regulatory assistance. FIRREA and the Crime Control Act of 1990 expand the enforcement powers available to federal banking regulators, including providing greater flexibility to impose enforcement action, expanding the category of persons dealing with a bank who are subject to enforcement\naction, and increasing the potential civil and criminal penalties. In addition, in the event of a holding company insolvency, the Crime Control Act of 1990 affords a priority in respect of capital commitments made by the holding company on behalf of its Subsidiary Banks. The consummation of the Investment Agreement caused the FDIC-insured depository institutions controlled by Santander and the FDIC-insured depository institutions controlled by the Company to become commonly controlled for FIRREA purposes, and would have subjected these institutions to the foregoing provisions were it not for the grant of an exemption from liability by the FDIC which was granted effective December 27, 1991. A condition to effectiveness of such exemption is a requirement that Santander not control 25% or more of the voting securities of the Company. See also \"FDICIA\".\nAnnual Insurance Assessments\nUnder FIRREA, the Federal Savings and Loan Insurance Corporation, which insured savings and loan associations and federal savings banks, was replaced by the SAIF, which is administered by the FDIC. A separate fund, the BIF, which was essentially a continuation of the FDIC's then existing fund, was established for banks and state savings banks. The Subsidiary Banks generally are subject to deposit insurance assessments by BIF. As a result, however, of the Company's acquisition of various branches and deposits of SAIF insured depository institutions, a portion of the Company's deposit base is subject to deposit insurance assessment by SAIF.\nThe FDIC developed a transitional risk-based assessment system, under which, beginning on January 1, 1993, the assessment rate for an insured depository institution varies according to its level of risk. An institution's risk category is based upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution also is to be assigned to one of the following \"supervisory subgroups\": Subgroup A, B or C. Subgroup A institutions are financially sound institutions with few minor weaknesses; Subgroup B institutions are institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration; and Subgroup C institutions are institutions for which there is a substantial probability that the FDIC will suffer a loss in connection with the institution unless effective action is taken to correct the areas of weakness. Based on its capital and supervisory subgroups, each BIF or SAIF member institution will be assigned an annual FDIC assessment rate per $100 of insured deposits varying between 0.23% per annum (for well capitalized Subgroup A institutions) and 0.31% per annum (for undercapitalized Subgroup C institutions), and the FDIC has indicated that it may expand the differential between the maximum and minimum rates. Well capitalized Subgroup B and Subgroup C institutions will be assigned assessment rates per $100 of insured deposits of 0.26% per annum and 0.29% per annum, respectively. As of December 31, 1993, all Subsidiary Banks were well capitalized.\nAlthough it remains possible that BIF and SAIF insurance assessments could be further increased and\/or that there may be a special additional assessment, based upon public statements by regulatory authorities regarding the insurance funds, the Company does not anticipate that there will be any material increase in assessments in the near future. A significant increase in the assessment could have an adverse impact on the Company's results of operations.\nOther Matters\nFirst Fidelity's Common Stock, preferred stock, par value $1.00 per share (the \"Preferred Stock\"), and Preferred Share Purchase Rights are registered under the Securities Exchange Act of 1934. As a result, the Company and such securities are subject to the Securities and Exchange Commission's rules regarding, among other things, the filing of public reports, the solicitation of proxies, the disclosure of beneficial ownership of certain securities, short swing profits and the conduct of tender offers.\nEFFECT OF GOVERNMENTAL POLICIES\nThe earnings of the Subsidiary Banks and, therefore, of the Company are affected not only by domestic and foreign economic conditions, but also by the monetary and fiscal policies of the United States and its agencies (particularly the Federal Reserve Board), foreign governments and other official agencies. The Federal Reserve Board can and does implement national monetary policy, such as the curbing of inflation and combating of recession, by its open market operations in United States Government securities, control of the discount rate applicable to borrowings and the establishment of reserve requirements against deposits and certain liabilities of depository institutions. The actions of the Federal Reserve Board influence the level of loans, investments and deposits and also\naffect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary and fiscal policies are not predictable.\nFrom time to time, various proposals are made in the United States Congress and the New Jersey, Pennsylvania, New York and Connecticut legislatures and before various regulatory authorities which would alter the powers of different types of banking organizations or remove restrictions on such organizations and which would change the existing regulatory framework for banks, bank holding companies and other financial institutions. It is impossible to predict whether any of such proposals will be adopted and the impact, if any, of such adoption on the business of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1993, the Company had 765 properties, of which 397 were owned (including 30 on leased land) and 368 were leased. The owned properties aggregate approximately 4.6 million square feet. The leased properties aggregate approximately 2.7 million square feet and, in 1993, required (with the 30 land leases) approximately $29.5 million in rental payments.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party (as plaintiff or defendant) to a number of lawsuits. While any litigation carries an element of uncertainty, management is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the name and age (as of December 31, 1993) of each current executive officer of the Company, the positions and offices with the Company and its subsidiaries presently held by each such officer and a brief account of the business experience of each such officer for the past five years. Each officer is appointed by the Company's Board of Directors to serve for a term of one year. Unless otherwise noted, each officer has held the position indicated for at least five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nFirst Fidelity's Common Stock is listed on the New York Stock Exchange. The following table sets forth the high and low sales prices of the Common Stock, as reported in the consolidated transaction reporting system, and the dividends declared thereon, for the periods indicated below:\n- --------------- On January 20, 1994, the Company raised its regular quarterly dividend on its Common Stock to $.42 per share.\nFederal and state laws and regulations contain restrictions on the ability of the Company, the Subsidiary Banks and the Company's intermediate bank holding companies to pay dividends. For information regarding restrictions on dividends, see Part I, Item 1, \"Business -- Supervision and Regulation -- Dividend Restrictions\" and Part II, Item 8, \"Financial Statements and Supplementary Data -- Note 12 of the Notes to Consolidated Financial Statements\". In addition, in connection with the formation of FFB-NY, the Company agreed to certain restrictions on the ability of that entity to pay dividends. See Part I, Item 1, \"Business -- Supervision and Regulation -- Dividend Restrictions\".\nAs of December 31, 1993, the Company had approximately 29,600 holders of record of its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with First Fidelity's Consolidated Financial Statements and the accompanying notes presented elsewhere herein.\n- --------------- (1) Anti-dilutive in years prior to 1991. (2) As a result of a change in the schedule of Common Stock dividend declaration dates in 1990, the fourth quarter of 1990 regular common dividend was declared on January 17, 1991, payable on February 8, 1991, to stockholders of record on January 28, 1991. (3) Net income (loss). (4) Net income (loss) applicable to Common Stock. (5) Not statistically meaningful in 1990.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and accompanying notes appearing later in this document. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 1993 data.\nSummary\nFirst Fidelity's net income before the cumulative effect of changes in accounting principles for the year ended December 31, 1993 was $396.5 million, or $4.63 per common share on a primary basis and $4.55 per common share on a fully-diluted basis. These results compare to net income of $313.7 million, or $3.89 per common share on a primary basis and $3.77 per common share on a fully-diluted basis for the year 1992. The Company's net income in 1991 was $221.2 million, or $3.37 per common share on a primary basis and $3.31 per common share on a fully-diluted basis. The cumulative effect of changes in accounting principles, net of related taxes, increased net income $2.4 million, or $.03 per common share on both a primary and fully-diluted basis for 1993. Net income including the cumulative effect of changes in accounting principles was $398.8 million, or $4.66 per common share on a primary basis and $4.58 per common share on a fully-diluted basis.\nThe 27.1% improvement in 1993 net income over 1992 reflects stronger net interest income, a lower provision for possible credit losses and higher non-interest income, partly offset by higher non-interest expense, primarily due to acquisitions, and an increased provision for income taxes.\nTotal non-performing assets decreased 29% to $494.7 million at December 31, 1993, from $695.7 million at December 31, 1992, due to continuing workout and collection efforts, including repayments, charge-offs, transfers to \"assets held for sale\" and fewer additions to non-performing loans. Excluding non-performing assets related to 1993 acquisitions of $61.0 million at December 31, 1993, and including assets classified as \"held for sale\" of $88.4 million at December 31, 1993, total non-performing assets would have declined by $173.6 million from December 31, 1992. The ratio of non-performing loans to total loans declined from 2.76% at December 31, 1992 to 1.77% at December 31, 1993. The ratio reflects significant improvements in the Company's asset quality as well as the transfer of non-performing assets to the \"assets held for sale\" portfolio. The significant decline in non-performing loans, in combination with a slight decrease in the reserve for possible credit losses, resulted in the coverage of non-performing loans by the reserve increasing to 159% at December 31, 1993 from 121% at December 31, 1992.\nThe Company's capital base was further strengthened by $480.8 million in 1993, primarily through the retention of earnings, the issuance of Common Stock in connection with acquisitions, and the exercise of Warrants and Acquisition Gross Up Rights by Santander in connection with the Company's acquisitions of Northeast and Village. Return on average stockholders' equity was 16.19% in 1993, compared to 15.18% in 1992 and 13.69% in 1991. Return on average assets was 1.27% in 1993 compared to 1.06% in 1992 and 0.77% in 1991.\nDuring 1993, the Company expanded its branch network into Connecticut with the acquisition of Northeast and enhanced its New York and New Jersey presence through the acquisitions of Peoples, Village and Dime. The Peoples acquisition, which was consummated on December 30, 1993 and accounted for as a purchase, is reflected in the Company's Consolidated Statement of Condition at December 31, 1993 but had no significant impact on the Company's 1993 earnings.\nIn the last half of 1993, the Company entered into agreements to acquire three banks in Connecticut, Pennsylvania and New York for a total of approximately $67.4 million in cash. The combined assets and deposits at December 31, 1993 of the three banks were approximately $705 million and $508 million, respectively. The proposed acquisitions are not expected to have a significant impact on First Fidelity's liquidity or financial position. The Company also believes that the acquisitions, if consummated as planned, will have a modestly positive effect on its consolidated results of operations for 1994. See Part I, Item 1, \"Business -- Recent Transactions -- Acquisitions and Joint Ventures\".\nRESULTS OF OPERATIONS\nNet Interest Income\nNet interest income is the largest component of First Fidelity's operating income. Net interest income, on a taxable equivalent basis, totaled $1,387 million and $1,248 million in 1993 and 1992, respectively. The increase in net interest income for 1993 was primarily due to a higher level of average earning assets. The increase also reflected a wider spread between the rates earned on earning assets and the average cost of interest-bearing liabilities, as rates paid on deposits and short-term borrowings continued to decline more rapidly than rates earned on loans and securities. In addition, higher noninterest-bearing liabilities, increased stockholders' equity, and a steady decline in non-performing assets had a positive impact. The increase in net interest income also reflects growth in residential mortgage and installment loans, due primarily to acquisitions.\nEarning assets averaged $28.4 billion in 1993, which was $1.4 billion or 5% above the 1992 level. The increase primarily resulted from a $1.6 billion or 29% increase in average mortgage loans, a $564.5 million or 11% increase in average installment loans and a $496.1 million or 8% increase in average securities, partially offset by a $601.8 million or 29% decrease in time deposits with banks, a $420.2 million or 45% decrease in average federal funds sold and securities purchased under agreements to resell and a $215.7 million or 3% decrease in average commercial loans. The increase in average mortgage and installment loans was the result of The Howard Savings Bank (\"Howard\"), Northeast and Village acquisitions, partially offset by paydowns on outstanding loan balances.\nFor 1993, average core deposits, comprised of demand deposits, savings and Negotiable Order of Withdrawal (\"NOW\") accounts, money market deposits and consumer certificates of deposit, increased 8% over the prior year level (as a result of 1993 acquisitions, as well as the full year effect of the Howard acquisition on October 2, 1992) to $25.9 billion and funded 91% of average earning assets. In comparison, average core deposits were $24.1 billion and funded 89% of average earning assets during 1992. The increase consisted of higher levels of savings and NOW account deposits and demand deposits, partially offset by slightly lower levels of consumer certificates of deposit and money market deposit accounts. The higher average deposit balances reflect the impact of acquisitions, partially offset by deposit run-off, which, the Company believes, largely resulted from a shift by consumers to alternative market instruments.\nThe overall increase in relatively inexpensive core deposits enabled the Company to reduce its reliance on funds purchased in the financial markets. Short-term borrowings, primarily federal funds purchased, securities sold under repurchase agreements, demand notes issued to the United States Treasury, and commercial paper, averaged $1.2 billion in 1993 compared to $1.3 billion in 1992. The Company also reduced average long-term debt from $738.2 million in 1992 to $591.4 million in 1993. In June, 1993, the Company issued $150 million of 6.8% subordinated notes. Additionally, on February 2, 1994, the Company issued $200 million of floating rate senior notes. During 1993, average corporate certificates of deposit and deposits in overseas offices remained relatively unchanged from the 1992 level.\nNon-performing assets (which exclude loans 90 days past due and still accruing, segregated assets and assets held for sale) continued to decline during 1993. Total non-performing assets declined 29%, or $200.9 million to $494.7 million at December 31, 1993, compared to $695.7 million at December 31, 1992. Non-accruing and restructured loans were $365.0 million and $13.9 million, respectively, at December 31, 1993 as compared to $470.7 million and $35.6 million, respectively, at December 31, 1992.\nThe net interest margin -- taxable equivalent net interest income as a percentage of earning assets -- increased in 1993 to 4.86% from 4.59% for 1992. The increase in the net interest margin was primarily due to a more rapid decline in the average rates paid on interest-bearing liabilities than earned on earning assets during 1993. Net interest income continued to benefit from a relative shift in the loan portfolio mix to higher-yielding consumer and residential mortgage loans from commercial loans, as well as a shift in the mix of deposits from the currently higher cost consumer time deposits to savings\/NOW accounts. A lower level of non-performing assets, as well as an increase in non-interest-bearing sources of funds such as stockholders' equity and demand deposits, also contributed to the improvement in net interest margin.\nIn 1993, the net interest margin percentage continued to increase during the first and second quarters, declined in the third quarter but increased slightly in the fourth quarter. See Item 8, \"Financial Statements and Supplementary\nData -- (b) Summary of Quarterly Financial Information\". After the first quarter of 1993, average rates paid on interest-bearing liabilities and earned on earning assets declined at nearly the same pace for the remainder of the year. First Fidelity presently expects that its net interest margin percentage may decline modestly in 1994, as higher yielding assets mature, as certain deposit rates may trend higher in 1994, and as recent acquisitions initially tend to reduce the overall average margin while adding to net interest income.\nThe following table reflects the components of net interest income, setting forth, for each of the three years in the period ended December 31, 1993, (i) average assets, liabilities and stockholders' equity, (ii) interest income earned on earning assets and interest expense paid on interest-bearing liabilities, (iii) average rates earned on earning assets and average rates paid on interest-bearing liabilities, (iv) the Company's net interest income\/spread (i.e., the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities) and (v) the net interest margin.\nNET INTEREST INCOME SUMMARY\n- --------------- (1) In this table and in other data presented herein on a taxable equivalent basis, income that is exempt from federal income taxes or taxed at a preferential rate, such as interest on state and municipal securities, has been adjusted to a taxable equivalent basis using a federal income tax rate of 35% for 1993 and 34% for 1992 and 1991.\n(2) Includes non-performing loans. The effect of including such loans is to reduce the average rate earned on the Company's loans.\n(3) Includes Collateralized Mortgage Obligations. Detail not available for 1991, as such securities are included in \"Other Taxable Securities\" for 1991.\nThe following table demonstrates the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities. For purposes of constructing this table, earning asset averages include non-performing loans.\nNET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE(1)\n- --------------- (1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated equally to changes due to volume and changes due to rate. (2) Includes mortgage-backed securities for 1992 vs. 1991.\n1993 vs. 1992: The table above indicates an increase in taxable equivalent net interest income of $139.4 million, reflecting an increase due to volume changes of $110.4 million and an increase due to rate changes of $29.0 million. The increase in net interest income for 1993 was primarily due to the higher levels of earning assets as a result of acquisitions. Earning assets averaged $28.4 billion in 1993, $1.4 billion or 5% above the 1992 level. The volume-related change resulted from increased average balances for consumer loans, primarily mortgage loans. An increase in taxable securities was more than offset by reductions in time deposits with banks, other types of securities and money market instruments. Average total loans increased, resulting in an increase to net interest income, which was offset, in part, by the costs associated with the higher level of deposits used to fund such loans. Average core deposits increased nearly 8% over the 1992 level (as a result of acquisitions) to $25.9 billion and funded 91% of average earning assets. The increase consisted of $1.6 billion in savings and NOW accounts and $.5 billion in demand deposits, partly offset by a $.2 billion decrease in consumer certificates of deposit. The rate-related change was primarily attributable to a wider spread between the rates earned on assets and the average cost of interest-bearing liabilities, as such liabilities continued to reprice more rapidly than earning assets in the declining rate environment which prevailed early in 1993.\n1992 vs. 1991: Net interest income, on a taxable equivalent basis, totaled $1,248 million and $1,104 million in 1992 and 1991, respectively. The increase in net interest income for 1992 was primarily due to a wider spread between the rates earned on earning assets and the average cost of interest-bearing liabilities, along with slightly higher levels of average earning assets as a result of acquisitions. Earning assets averaged $27.0 billion in 1992, $683 million or 3% above the 1991 level. The increase primarily resulted from a $538 million, or 35%, increase in average time deposits with banks and a $369 million, or 7%, increase in average taxable securities along with a $267 million,\nor 27%, reduction in long-term debt, partially offset by a $539 million, or 3%, increase in total average savings and time deposits.\nAverage total loans in 1992 were $17.4 billion compared to $17.5 billion in 1991, reflecting a decrease of $923 million in average commercial loans, primarily the result of modest loan demand in a sluggish economic environment, in addition to repayments and charge-offs. The decrease in average commercial loans was nearly offset by an increase in average mortgage loans (mostly consumer) of $836 million. Average core deposits increased 4% for 1992 over the prior year level to $24.1 billion and funded 89% of average earning assets. Average core deposits funded 88% of average earning assets during 1991. The increase was attributable to higher levels of savings and NOW account deposits, demand deposits, and money market deposit accounts, partially offset by a decrease in consumer certificates of deposit. The higher deposit balances reflected the assumption of deposit balances from branch acquisitions. The overall increase in core deposits enabled the Company to reduce average long-term debt by $267 million to $738 million, and reduce its reliance on funds purchased in the financial markets, which averaged $1.3 billion in 1992 compared to $1.4 billion in 1991. The Company reduced relatively higher cost corporate certificates of deposit and deposits in overseas offices from averages of $645 million and $243 million, respectively, during 1991 to $436 million and $217 million, respectively, in 1992.\nNon-Interest Income\nMAJOR COMPONENTS OF NON-INTEREST INCOME\nVarious types of non-interest income, such as service charges on deposit accounts, trust income, and other service charges, commissions and fees are generated through the Company's core business operations. In addition, non-interest income is derived from other sources, such as gains on the sale of other assets, which may vary significantly in type and amount from period to period. For 1993, total non-interest income increased $51.1 million, or 15%, to $383.5 million from $332.4 million in 1992.\nTrust income increased from $86.4 million in 1992 to $104.5 million for 1993, primarily as a result of the Northeast acquisition and trust marketing campaigns conducted through account relationships and the branch network. Personal trust income and corporate trust income increased 31% and 15%, respectively.\nService charges on deposit accounts and other service charges, commissions and fees accounted for 62% of total non-interest income in 1993. Primarily as a result of additional deposit accounts attributable to acquisitions consummated during 1992 and 1993, as well as changes in the service fee structure, service charges on deposit accounts increased 9% in 1993, to $152.3 million, from $139.3 million in 1992. Other service charges, commissions and fees of $85.7 million were 12% higher than in the prior year, primarily as a result of increased customer relationships from recent acquisitions.\nNet securities transactions were $7.0 million in 1993, compared to $4.8 million in 1992. Other income amounted to $17.0 million in 1993, compared to $8.8 million in 1992. The increase in other income resulted primarily from $7.8 million in net gains on the sale of various assets.\nPrior Years: Non-interest income of $332.4 million in 1992 decreased $61.3 million, or 16%, from 1991. Net securities transactions decreased from $53.6 million in 1991 to $4.8 million in 1992. Primarily during 1991, First Fidelity restructured its investment portfolio. Other income decreased $39.4 million, to $8.8 million in 1992 from $48.2 million in 1991, largely due to the inclusion in 1991 income of the $30.7 million gain on the sale of Fidelcor Business Credit Corporation. Service charges on deposit accounts increased 22% from 1991, primarily as a\nresult of increases in certain fees for deposit products, as well as additional deposit accounts attributable to branch acquisitions during 1992 and 1991. Other service charges, commissions and fees declined by $5.1 million from 1991 to 1992, largely as a result of reduced credit card transaction volume.\nNon-Interest Expense\nMAJOR COMPONENTS OF NON-INTEREST EXPENSE\nNon-interest expense was $1,014.7 million for the year, $97.9 million, or 11%, above the 1992 level. The increase resulted primarily from the incremental operating expenses associated with acquisitions completed in 1992 and 1993, including $64.1 million related to Northeast.\nThe productivity plan initiated in 1990 includes rationalizing and consolidating all support and processing operations along service or product lines, and branch and legal entity consolidations. The consolidation program has resulted in significant reductions in the Company's cost structure; management intends to continue this program in 1994 in connection with acquisitions and to continue to maintain strict expense control in future years.\nSalaries and benefits expense totaled $468.1 million in 1993 compared with $408.8 million in 1992. The $59.2 million, or 15% increase from the prior year, primarily reflects the additional personnel expenses associated with acquisitions completed in 1993 and the full year impact of acquisitions completed in 1992. At December 31, 1993, the Company had approximately 12,000 full-time employees compared to approximately 10,600 at the end of 1992 and 1991. In 1993, personnel increases related to acquisitions were partially offset by the effect of staff reductions arising from the consolidations of certain support and operating departments and branches.\nStatement of Financial Accounting Standards (\"SFAS\") 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which was adopted in 1993, requires accrual, during an employee's active years of service, of the expected costs of providing postretirement benefits (principally health care) to employees and their beneficiaries and dependents. Through 1992, First Fidelity, like most other companies, recognized this expense on an \"as paid\" basis. Primarily due to this change in accounting principle, the Company's postretirement benefit expense increased from $5.8 million in 1992 to $8.2 million for 1993, and the Company recorded a one-time cumulative effect adjustment of $53.3 million (net of tax effect) to recognize the accumulated postretirement benefit obligation in the first quarter of 1993. For information regarding the cumulative effect of the change in accounting principle, see Item 8, \"Financial Statements and Supplementary Data -- Note 2 of the Notes to Consolidated Financial Statements\".\nSFAS 112, \"Employers' Accounting for Postemployment Benefits\", was adopted by the Company beginning in 1993. SFAS 112 requires employers to recognize any obligation to provide postemployment (as differentiated from postretirement) benefits (for example, disability payments) by accruing the estimated liability. The Company's accumulated postemployment benefit obligation at December 31, 1992 of approximately $7.4 million (net of tax effect) was recognized by a one-time cumulative effect adjustment during the first quarter of 1993. For information regarding the cumulative effect of the change in accounting principle, see Item 8, \"Financial Statements and Supplementary Data -- Note 2 of the Notes to Consolidated Financial Statements\". The Company's annual\npostemployment benefit expense was approximately $900 thousand for 1993, as compared with approximately $2 million on the \"as paid\" basis for 1992.\nOccupancy expense, which includes the costs of leasing office space and branches and the expenses associated with owning and maintaining these facilities, increased $5.5 million, or 5% in 1993, due primarily to acquisitions in 1993 and late 1992, partially offset by the effect of branch consolidations. Equipment expense increased $2.6 million, or 6%, for essentially similar reasons.\nFDIC premium expense increased $6.9 million, or 12%, to $63.2 million for 1993 as compared to $56.2 million in 1992. The increase is primarily the result of a higher level of deposits due to acquisitions in 1993 and late 1992. Subsequent changes in deposit insurance assessment rates are possible. See Part I, Item 1, \"Business -- Supervision and Regulation -- FDICIA\" and \"-- Annual Insurance Assessments\".\nExternal data processing expense increased less than 3% over the 1992 and 1991 levels to $48.2 million. To assist in the timely completion of the consolidation program, First Fidelity entered into an agreement with Electronic Data Systems (\"EDS\") in 1990, under which EDS is managing the Company's data center operations. The cost of EDS services is determined by volume considerations and an inflation factor, in addition to an agreed base rate.\nCommunication expense, consisting of telephone and postage, has remained flat despite growth through acquisitions, primarily due to cost control measures which reduced telephone expense.\nAmortization of intangibles increased $8.0 million, or 35%, to $30.8 million for 1993. The increase was related to intangibles generated in conjunction with several acquisitions, primarily Howard in late 1992. This does not reflect the effect of the acquisition of Peoples, which occurred on December 30, 1993.\nExpenses incurred in connection with other real estate owned (\"OREO\") were $28.4 million in 1993 compared to $29.9 million in 1992. The expenses relate primarily to OREO provisions necessitated by property write-downs resulting from declines in OREO property appraisal values and write-downs due to transfers of OREO to the \"assets held for sale\" classification.\nOther expenses increased $15.6 million, or 9%, to $185.9 million in 1993, from $170.3 million in 1992. The overall increase was due primarily to acquisitions, with the largest increases being in advertising and public relations expenses, and professional fees.\nPrior Years: Non-interest expense totaled $916.8 million for 1992, $45.1 million, or 5%, above the 1991 level. This increase resulted primarily from the incremental operating expenses associated with acquisitions completed in 1991 and 1992, as well as higher FDIC insurance rates which took effect in July, 1991 and an increase in expenses related to OREO, partially offset by operating expense reductions related to the ongoing productivity program. Salaries and benefits expense totaled $408.8 million in 1992 compared with $391.0 million in 1991. The $17.8 million, or 5%, increase from the prior year's level reflects the additional staff expenses associated with acquisitions completed in 1991 and 1992. Occupancy expense increased $3.5 million, or 3%, in 1992, due primarily to acquisitions in 1991 and 1992, partially offset by the effect of branch consolidations. Equipment expense decreased $.6 million, or 2%, primarily due to productivity efforts and the effect of branch consolidations, partially offset by acquisitions. FDIC premium expense totaled $56.2 million in 1992 compared to $48.5 million in 1991; premium increases plus a higher level of deposits combined to produce the increase. Total OREO expenses were $29.9 million in 1992 compared to $20.3 million in 1991, due primarily to property write-downs related to valuation adjustments resulting from declines in OREO property appraisal values and to some OREO sales.\nIncome Tax Expense\nDuring the first quarter of 1993, the Company recognized a one-time cumulative benefit and a related deferred tax asset of $63.1 million due to the adoption of SFAS 109, \"Accounting for Income Taxes\". Largely because SFAS 109 required realizable future tax benefits (primarily related to the reserve for possible credit losses, alternative minimum tax credit carryforwards, and accrued postretirement benefits) to be recorded at the adoption date as the cumulative effect of a change in accounting principle, rather than a reduction of future income tax expense, First Fidelity's effective tax rate has increased from approximately 21% in 1992 to 31% in 1993. Income tax expense for 1993 was $178.0 million compared to $82.4 million for 1992. For information regarding the cumulative effect of the change in accounting principle and alternative minimum tax credit carryforwards, see Item 8, \"Financial Statements\nand Supplementary Data -- Note 15 of the Notes to Consolidated Financial Statements\". Other factors affecting income tax expense were the higher level of pretax income and the continuing reduction in tax-exempt interest income.\nPrior Years: Income tax expense increased $23.6 million in 1992, from $58.8 million in 1991 to $82.4 million in 1992. This increase was primarily due to the increase in 1992 pre-tax income and a decrease in tax-exempt interest income compared to 1991, partially offset by the utilization of alternative minimum tax credits available from prior years.\nFINANCIAL CONDITION\nAsset and Liability Management\nThe major objectives of the Company's asset and liability management are to (i) manage exposure to changes in the interest rate environment to achieve a neutral interest sensitivity position within reasonable ranges, (ii) ensure adequate liquidity and funding, (iii) maintain a strong capital base, and (iv) maximize net interest income opportunities. First Fidelity manages these objectives centrally through the Asset and Liability Management Committee. Members of the Committee meet weekly to develop balance sheet and product pricing strategies affecting the future level of net interest income, liquidity and capital. Factors that are considered in asset and liability management include forecasts of balance sheet mix, the economic environment and anticipated direction of interest rates, and the Company's earnings sensitivity to changes in these rates.\nInterest Rate Sensitivity\nThe Company analyzes its interest sensitivity position to manage the risk associated with interest rate movements through the use of \"gap analysis\" and \"income simulation\". Interest rate risk arises from mismatches in the repricing of assets and liabilities within a given time period. Gap analysis is an approach used to quantify these differences. A \"positive\" gap results when the amount of interest-sensitive assets exceeds that of interest-sensitive liabilities within a given time period. A \"negative\" gap results when the amount of interest-sensitive liabilities exceeds that of interest-sensitive assets.\nWhile gap analysis is a general indicator of the potential effect that changing interest rates may have on net interest income, the gap itself does not present a complete picture of interest rate sensitivity. First, changes in the general level of interest rates do not affect all categories of assets and liabilities equally or simultaneously. Second, assumptions must be made to construct a gap table. Money market deposits, for example, which have no contractual maturity, are assigned a repricing interval of 91-180 days. Management can influence the actual repricing of these deposits independent of the gap assumption. Third, the gap table represents a one-day position and cannot incorporate a changing mix of assets and liabilities over time as interest rates change.\nFor this reason, the Company primarily uses simulation techniques to project future net interest income streams, incorporating the current \"gap\" position, the forecasted balance sheet mix, and the anticipated spread relationships between market rates and bank products under a variety of interest rate scenarios. The Company's interest sensitivity in 1993 was essentially neutral within reasonable ranges; for example, at December 31, 1993, interest rate increases or decreases of 200 basis points would not be expected to have a significant impact on the Company's net interest income.\nInterest Rate Gap\nThe following table illustrates First Fidelity's interest rate gap position as of December 31, 1993. At that date, the Company had a positive gap on a 90-day basis and a cumulative negative gap on a 180-day and one-year basis. In view of the Company's expectation of higher interest rates, management reduced the one-year cumulative negative gap to $2.4 billion, or 7.1% of total assets, from last year's $4.0 billion cumulative negative gap (12.8% of total assets). This $1.6 billion change in the Company's one-year cumulative gap position was due to actions taken by management to shorten repricing intervals for assets and lengthen them for liabilities. During the year, the Company's balance sheet grew by $2.3 billion. Interest sensitive assets under one year increased by $2.1 billion while assets beyond one year increased $0.2 billion. Interest sensitive liabilities under one year increased by only\n$0.4 billion while liabilities and equity beyond one year increased by $1.9 billion, or 83% of the total increase in liabilities and equity. Although the securities portfolio increased by $1.5 billion, securities with maturities in excess of one year increased only $0.4 billion. The impact of derivatives on First Fidelity's gap positions was essentially unchanged from December 31, 1992.\nINTEREST RATE GAPS AS OF DECEMBER 31, 1993(1)\n- --------------- (1) Repricing intervals as shown reflect the effects of interest rate swaps and forward commitments, where applicable.\n(2) Amounts shown reflect the effects of futures contracts.\n(3) Trading account securities and Federal funds sold and securities purchased under agreements to resell.\n(4) Includes Collateralized Mortgage Obligations.\n(5) The amount shown as not rate sensitive is that portion which, based upon average balances, is considered stable and not sensitive to changes in interest rates. The Company's historical experience has been that total demand deposit account balances exhibit minimal movement with changes in interest rates. Accordingly, a large percentage of the Company's demand deposit account balances are considered \"Not Rate Sensitive\", with the remainder classified as \"1 to 90 days\".\nDerivatives\nFirst Fidelity uses certain off balance-sheet instruments to assist in managing its interest rate sensitivity. The Company's aggregate derivative positions used for asset\/liability management are shown in the following table.\nDERIVATIVES AS OF DECEMBER 31, 1993\nAs of December 31, 1993, the Company employed a total of $4.3 billion (notional value) of swaps to manage its interest rate sensitivity. Approximately $3.1 billion of fixed interest rate swaps were used to adjust the Company's\nsensitivity to floating rate loans. An additional $1.2 billion of fixed interest rate swaps were used at December 31, 1993 to hedge certain fixed-rate longer-term consumer certificates of deposit and long-term debt. These positions compare with a total of $3.7 billion (notional value) of swaps used for hedging purposes as of December 31, 1992.\nAt December 31, 1993, the Company also held 90 day eurodollar futures contracts with a notional value of $750 million. Such contracts are used to lock in future interest rates on eurodollar placings. As of December 31, 1992, the Company held similar contracts with a notional value of $3.8 billion.\nThe following table sets forth information, based on notional values, regarding the Company's derivatives activity:\n- ---------------\n(1) Receive fixed rates.\nNet interest income from interest rate swaps and futures positions was $141.9 million in 1993, down 7% from 1992, and compares to total net interest income on a tax-equivalent basis of $1.4 billion in 1993. The Company believes it could have achieved its objective of an essentially neutral interest-sensitive asset\/liability position by making correspondingly greater use of appropriate fixed rate assets. The income effect of such an alternative hedging approach, albeit less efficient, would have approximated the result achieved by using derivatives.\nThe Company from time to time also enters into derivative contracts, including forward foreign exchange contracts, to accommodate customer needs. As of December 31, 1993, customer activity in derivative products was not material in amount and virtually all such instruments were covered by offsetting positions.\nThe Company may also use derivatives as part of its trading activity. All positions are marked to market and carried in the Company's trading account, and such activity is strictly monitored by management through the use of trading limits. These positions were insignificant at December 31, 1993.\nThe Company has not experienced a credit loss associated with any such derivative instruments.\nFor additional information regarding derivatives, see Notes 16 and 17 to the consolidated financial statements in Item 8, \"Financial Statements and Supplementary Data\".\nLiquidity and Funding\nFirst Fidelity's liquidity position remained strong during 1993 despite large increases in loans and securities. Total assets grew by $2.3 billion from $31.5 billion at December 31, 1992 to $33.8 billion at December 31, 1993. Total loans increased $3.0 billion, securities increased $1.5 billion, money market assets decreased by $2.4 billion and other assets increased by $.2 billion. Although the size of the investment portfolio increased, the average maturity of the portfolio was shortened by approximately one year to 2.2 years by the end of 1993. Cash flow from the portfolio is expected to provide additional liquidity.\nMuch of the change in liquidity was the result of management's decision to make more efficient use of its resources. During the year, money market assets were reduced and replaced by generally higher-yielding investment securities with average maturities of from 1 to 1 1\/2 years.\nThe increase in assets was funded mainly by increases in consumer deposits of $1.2 billion and equity of $.5 billion during the year. The mix of deposits changed, however, as time deposits, primarily certificates of deposit, decreased by $.6 billion and the generally more stable and lower cost savings and money market deposits and NOW account balances increased by $1.8 billion. There was also an increase of $.6 billion in purchased funds and other liabilities.\nAt December 31, 1993, core deposits represented 129% of total loans, compared to 143% at December 31, 1992. On an average balance basis, this ratio declined from 138% in 1992 to 134% in 1993, as the increase in average core deposits during 1993 was more than offset by growth in average total loans.\nThe Company has other potential sources of liquidity, including its ability to enter into repurchase agreements, primarily using investment securities as collateral. Management believes that First Fidelity's liquidity position is strong, based on its levels of cash, cash equivalents and core deposits, the stability of its other funding sources and the support provided by its capital base.\nCash Flows\nCash and cash equivalents (cash and due from banks, interest-bearing time deposits, federal funds sold and securities purchased under agreements to resell) are the Company's most liquid assets. At December 31, 1993, cash and cash equivalents totaled $2.8 billion, a decrease of $2.5 billion from December 31, 1992. The decrease was primarily attributable to financing activities, which absorbed $3.4 billion in cash and cash equivalents. This was primarily the result of a decline in other consumer time deposits, and secondarily a decline in other core deposits (both exclusive of acquisitions), compared to December 31, 1992, reflecting, in the Company's view, the industrywide shift by consumers to alternative market instruments. The Company increased its long-term debt outstanding during 1993 by $31.6 million. The issuance of Common Stock to Santander, pursuant to the exercise of a portion of the Warrants and Acquisition Gross Up Rights, contributed $114.7 million in cash flows from financing activities. Cash and cash equivalents of $70.3 million were used in investing activities, including net disbursements of $574.6 million for lending activities and $93.4 million for securities, offset by net cash received on acquisitions of $641.4 million. Operating activities provided $963.7 million of cash and cash equivalents for the year.\nThe following table presents certain information regarding the major components of short-term borrowings for each of the years presented:\nSHORT-TERM BORROWINGS\nAt December 31, 1993, corporate certificates of deposit and other time deposits in amounts of $100,000 and over issued by domestic offices matured as follows:\nDOMESTIC TIME DEPOSITS $100,000 AND OVER\nSubstantially all of the Company's deposits in overseas offices of $216.4 million were interest-bearing time deposits in denominations of $100,000 and over.\nCapital\nThe maintenance of appropriate levels of capital is a management priority. Overall capital adequacy and dividend policy are monitored on an ongoing basis by management and are reviewed quarterly by the Company's Board of Directors. Management discusses the Company's capital plans with the Board of Directors on a frequent basis. First Fidelity's principal capital planning goals are to provide an attractive return to stockholders while maintaining the capital levels of the Company and the Subsidiary Banks above the well capitalized level as defined by bank regulatory agencies, and thus provide a sufficient base from which to provide for future growth.\nFor information regarding regulatory agency requirements with respect to capital for bank holding companies and subsidiary banks, see Part I, Item I, \"Business -- Supervision and Regulation -- Capital\".\nThe following tables present information regarding the Company's risk-based capital at December 31, 1993, 1992 and 1991 and selected overall capital ratios.\nCAPITAL ANALYSIS\nCAPITAL RATIOS\nThe Federal Reserve Board, the FDIC and the OCC issued a proposed rule in September 1993 (to become effective for First Fidelity on December 31, 1994) to implement the requirement under FDICIA that risk-based capital standards take account of interest rate risk. The proposed rule focuses on institutions having relatively high levels of measured interest rate risk, and considers the effect that changing interest rates would have upon the value of an institution's assets, liabilities, and off balance-sheet positions. First Fidelity's risk profile (as defined) is such that the rule, if adopted in substantially the form proposed, is expected to have no impact on the capital ratios or operations of the Company and its Subsidiary Banks.\nFor a discussion of regulatory capital requirements affecting the Company and its Subsidiary Banks, see Part I, Item 1, \"Business -- Supervision and Regulation -- Capital\" and \"-- FDICIA\".\nStockholders' equity at December 31, 1993, was $2.7 billion, compared to $2.3 billion at the end of 1992. This increase resulted primarily from net income for the year of $398.8 million less the payment of dividends to stockholders of $131.0 million. The sale of 4,178,163 shares of Common Stock to Santander, pursuant to the exercise of Acquisition Gross Up Rights and a portion of the Warrants acquired by Santander in 1991, resulted in additional capital of $114.7 million. The issuance of 1,222,155 shares of Common Stock for acquisitions, primarily to the former shareholders of Northeast and Village, resulted in additional capital of $65.2 million. An additional 2,383,451 shares of Treasury Stock, acquired at a cost of $100.6 million, was reissued in the Peoples acquisition. In addition, during 1993, the exercise of stock options and the Employee Stock Purchase Plan generated $13.9 million and the Company's Dividend Reinvestment Plan added another $7.8 million of capital. The cost of Treasury Stock acquired and reissued under the stock option plans and Dividend Reinvestment Plan totaled $11.0 million and $3.6 million, respectively. Net unrealized gains on securities available for sale included in stockholders' equity were $27.7 million. Total dividends declared on Common Stock by the Company in 1993 were $110.3 million, a 25% increase from the previous year. The year-to-year increase was primarily the result of dividend increases of $.03 per share in the fourth quarter of 1992 and $.04 per share in the second quarter of 1993. In addition, the sale of Common Stock to Santander in late 1992 and 1993 and stock issued in acquisitions contributed significantly to the increase in common shares outstanding. Dividends declared on Preferred Stock totaled $20.7 million and $21.1 million for 1993 and 1992, respectively.\nThe Company implemented two separate Common Stock open market purchase programs during 1993. Beginning in April 1993, the Company commenced open market purchases through an independent agent to acquire Common Stock for issuance under its dividend reinvestment plan and stock option plans. On October 21, 1993, the Board authorized the acquisition of up to 2% of First Fidelity's outstanding Common Stock in any calendar year through open market or privately-negotiated transactions, which amount does not include purchases made in connection with Company employee or stockholder benefit plans. On November 18, 1993, the Board authorized the acquisition of up to an additional 1% of the Company's outstanding Common Stock during 1993. As of December 30, 1993, the Company had repurchased 2,383,451 shares of its Common Stock at an average price of $42.22 per share, which constitutes substantially all of the 3% authorized for purchase in 1993. All such acquired shares were reissued in connection with the Company's acquisition of Peoples.\nSecurities\nGeneral\nThe Company's securities portfolios are comprised of U.S. government and federal agency securities, the tax-exempt issues of states and municipalities, and equity and other securities. The portfolios generate substantial interest income and provide liquidity.\nThe Company adopted SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities\", as of December 31, 1993. Debt and equity securities are classified in one of three categories, and are accounted for as follows:\nSecurities are classified as securities held to maturity based on management's intent and the Company's ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts.\nSecurities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities, which are carried at market value. Realized gains and losses and gains and losses from marking the portfolio to market value are included in trading revenue.\nSecurities not classified as securities held to maturity or trading securities are classified as securities available for sale, and are stated at fair value. Unrealized gains and losses are excluded from earnings, and are reported as a separate component of stockholders' equity, net of taxes.\nManagement determines the appropriate classification of securities at the time of purchase. Securities classified as available for sale include securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital or other similar requirements. Such securities were accounted for at the lower of cost or market prior to the adoption of SFAS 115.\nAt December 31, 1993, securities held to maturity are comprised of debt obligations with a weighted average yield of 5.86% and a remaining weighted average life of 2.5 years.\nAt December 31, 1993, securities available for sale were primarily U.S. Treasury and Federal agencies securities having a weighted average yield of 5.36% and a remaining weighted average life of 1.6 years.\nThe adoption of SFAS 115 had no effect on the Company's net income or liquidity. Total stockholders' equity was increased by $27.3 million, net of taxes, at December 31, 1993 as a result of net unrealized gains on securities available for sale.\nSecurities Held to Maturity\nGross unrealized gains and losses in the securities held to maturity portfolio at December 31, 1993 were as follows:\nAt December 31, 1993, the securities held to maturity portfolio totaled $5.2 billion, a decrease of $335.8 million from December 31, 1992.\nSecurities Available for Sale\nGross unrealized gains and losses in the securities available for sale portfolio at December 31, 1993 were as follows:\nThe net unrealized gains were reported as a separate component of stockholders' equity, net of tax effect, at December 31, 1993. Securities available for sale totaled $2.7 billion at December 31, 1993 and $755.1 million at December 31, 1992.\nProceeds from sales of debt securities available for sale during 1993 were $458.3 million. Gains of $7.5 million and losses of $642 thousand were realized on these sales. In 1992, the sale of debt securities available for sale resulted in realized gains of $978 thousand and realized losses of $91 thousand. Proceeds from these sales were $37.4 million.\nMaturities\nThe following tables set forth certain information regarding First Fidelity's securities held to maturity and securities available for sale.\nSECURITIES HELD TO MATURITY -- BOOK VALUE AND MATURITY DISTRIBUTION(1)\n- ---------------\n(1) For 1992 and 1991, these securities were classified as securities at amortized cost.\n(2) Maturities of mortgage-backed securities are estimated based on projected cash flows, assuming no change in the current interest rate environment.\n(3) Detail not available for 1991 for certain categories of securities.\nSECURITIES AVAILABLE FOR SALE -- FAIR VALUE AND MATURITY DISTRIBUTION\n- ---------------\n(1) Maturities of mortgaged-backed securities are estimated based on projected cash flows, assuming no change in the current interest rate environment.\n(2) Consists entirely of equity securities.\nLoan Portfolio\nDetails regarding the Company's loan portfolio are presented below:\nLOANS OUTSTANDING\nLOANS OUTSTANDING -- MATURITY DISTRIBUTION(1)\n- ---------------\n(1) Excludes mortgage, installment and leasing loans.\nThe economy in First Fidelity's primary marketplace (New Jersey, eastern Pennsylvania, Connecticut and southern New York) is broad-based and diverse. The Company's loan portfolio reflects this diversity. Consumer loans constituted 50%, 49% and 42% as a percentage of total loans at December 31, 1993, 1992 and 1991, respectively. The remainder of the portfolio is predominantly domestic commercial loans and commercial real estate loans in First Fidelity's primary marketplace. Commercial lending activities are focused primarily on lending to middle market and small business corporate borrowers engaged in a variety of industries. Foreign loans are an insignificant portion of total loans.\nLoan demand in the Company's primary market area remained flat during most of 1993, with the exception of stronger demand for certain types of consumer loans, but signs of overall strengthening emerged toward the end of the year. The Company's total loans grew in 1993 by $3.0 billion to $21.4 billion, primarily as a result of acquisitions. The Company's commercial and financial loans increased $978 million during the year, while commercial mortgages increased by $531 million, or 18%.\nExpansion of the Company's consumer loan portfolio remains an important objective for First Fidelity. Progress toward this goal continued in 1993 as the Company increased loan originations in certain categories of consumer loans. Residential mortgage loans increased 38% to $4.9 billion at December 31, 1993. Home equity loans rose 22% to $1.5 billion at December 31, 1993. Automobile leases increased by 37% to $1.1 billion at December 31, 1993, reflecting the Company's marketing efforts in this area.\nForeign Assets\nFirst Fidelity's foreign loan portfolio was $112.4 million and $117.0 million at December 31, 1993 and 1992, respectively. At December 31, 1993, the Company had no outstandings to any single foreign country in excess of .75% of total assets, except for short-term eurodollar outstandings with banks in the United Kingdom of $333 million, or 1%, of total assets. At December 31, 1992, the Company had such outstandings of $509 million, or 2% of total assets, with French banks, and $476 million, or 2% of total assets, with United Kingdom banks.\nAsset Quality\nThe Company seeks to manage credit risk through diversification of the loan portfolio and the application of policies and procedures designed to foster sound underwriting and credit monitoring practices. However, as is the case with any banking organization, the level of credit risk is dependent in part upon local and national economic conditions that are beyond the Company's control. The chief credit officer is charged with monitoring asset quality, establishing credit policies and procedures, seeking the consistent application of these policies and procedures across the organization, and adjusting policies as appropriate for changes in market conditions.\nFirst Fidelity's loan portfolio is diversified by industry of borrower and type of loan, with limits on the size of loan to any single borrower. At December 31, 1993 and 1992, domestic commercial and financial loans represented 30% and 29% of the loan portfolio, respectively; installment loans were 22% and 26%, respectively; residential mortgages represented 23% and 19%, respectively; commercial mortgages were 16% in both years; construction\nloans were 2% and 3%, respectively; the leasing portfolio (consisting of equipment and automobile leases) was 6% in both years; and foreign loans represented 1% in both years.\nThe risk profile of the loan portfolio is impacted by many external trends and conditions. Among the more important economic factors which tend to reduce or increase the risk profile of the loan portfolio are changes in regional or local real estate values, employment levels and personal income levels. Changes in property and income tax rates, governmental actions such as spending cutbacks, and weakened market conditions are also important determinants of the risk inherent in lending by the Company.\nThe lending risk for commercial mortgage, real estate\/construction, commercial and financial, and equipment leasing loans is also influenced by factors such as the specific borrower's financial condition, the demand for office space, and the long-term success of companies involved in manufacturing and distribution which operate in the Company's primary marketplace.\nCertain of the Company's asset quality ratios are set forth below:\nASSET QUALITY RATIOS\n- --------------- (a) Non-performing loans and non-performing assets and ratios exclude loans classified as contractually past due 90 days or more but still accruing, assets subject to FDIC loss-sharing provisions, and assets classified as held for sale, which are included in other assets.\nThe ratios for \"Non-performing loans\/loans\" and \"Non-performing assets\/loans and other real estate owned\" improved in 1993. The improvement in these ratios reflects the Company's continuing workout and collection efforts, which include repayments, charge-offs, transfers of non-performing assets to \"assets held for sale\" and fewer additions to non-performing loans.\nTotal non-performing assets decreased to $494.7 million at December 31, 1993 from $695.7 million at December 31, 1992. Excluding non-performing assets related to 1993 acquisitions of $61.0 million at December 31, 1993 and including assets classified as held for sale of $88.4 million at December 31, 1993, total non-performing assets would have declined by $173.6 million from $695.7 million at December 31, 1992.\nThe commercial loan portfolio is monitored continuously, primarily by the review of risk ratings assigned to each commercial loan, which take into consideration both the borrower's fundamental condition and the specifics of each loan. These risk ratings provide the principal basis for managerial and accounting actions. It is the responsibility of lending groups to monitor these loans and to make adjustments as appropriate to the risk ratings. In addition, such loans are periodically examined by the Company's credit audit department, which is structured to be independent of both the lending and the credit policy and administration functions. The status of individual loans, portfolio segments, and the entire portfolio are monitored by credit policy officers and senior management on a continuous basis. This process is designed to assist the Company in taking appropriate corrective actions as early as possible.\nA quarterly reporting and review process is in place for monitoring those credits that have been identified as problematic or vulnerable in order to develop a corrective action program, to assess the Company's progress in working toward a solution, and to assist in determining an appropriate reserve for possible credit losses. A separate loan workout unit becomes involved in credits that have been identified as problems. The Company's loan review procedures are designed to reduce both non-performing assets and loan losses; however, such assets and losses are an\ninevitable element of a banking organization's provision of credit to its customers. The levels of such assets and losses are dependent in part on economic, legislative and regulatory factors that are beyond the Company's control.\nFor commercial loans, mortgage loans and leases, the necessity for charge-offs is determined on a case-by-case basis. Installment loans and credit card receivables are generally charged-off when principal or interest payments are in arrears for more than 120 and 180 days, respectively, except where the loan is well secured and in the process of collection.\nCommercial real estate lending is an integral part of the Company's middle market lending business, and continues to be a commercial credit product for First Fidelity. Commercial real estate loans (commercial mortgages and construction loans) comprised 18% of total loans at year-end, compared to 19% at December 31, 1992. First Fidelity's real estate lending policies are designed to take into consideration the cyclical nature of the real estate business and to define acceptable transactions specifically in terms of the borrower, collateral, documentation, loan structure and product.\nIn addition to internal processes, lending procedures and the loan portfolio are examined by several banking regulatory agencies as part of their supervisory activities. For First Fidelity, the most comprehensive of these is the examination by the OCC. Examinations by regulators are performed periodically. The Company's independent auditors also review the portfolio and lending procedures during their annual audit of the Company's financial statements.\nSegregated Assets\nOn October 2, 1992, in accordance with the agreement to acquire selected assets and liabilities of Howard, the Company entered into a loss-sharing arrangement with the FDIC. The Howard non-performing commercial mortgages, commercial real estate\/construction loans and commercial and financial loans (\"shared-loss loans\"), and any such Howard performing shared-loss loans that become non-performing through October 2, 1997, are considered \"segregated assets\", and are included in the \"other assets\" caption of the Consolidated Statements of Condition. Such segregated assets include non-accrual loans, foreclosed properties and in-substance foreclosures, net of a reserve for segregated assets, but exclude acquired consumer loans. Under the terms of the loss-sharing arrangement, the FDIC reimburses the Company for 80% of net charge-offs and reimbursable expenses associated with such shared-loss loans for a five year period. Under the terms of the loss-sharing arrangement, First Fidelity is obligated to pay the FDIC 80% of net recoveries on such assets during years six and seven after the acquisition. At the end of the seven year period, the FDIC is obligated to provide additional reimbursement to First Fidelity for losses so that, subject to certain conditions, First Fidelity bears only 5% of total losses with respect to such segregated assets over $130 million of net losses and associated expenses.\nIn addition to non-performing shared-loss loans reported as segregated assets, performing loans potentially subject to the loss-sharing arrangement with the FDIC at December 31, 1993 and 1992, respectively, totaled $324.1 million and $404.9 million of commercial mortgages, and $27.2 million and $62.0 million of commercial and financial loans. There were no construction loans in this category at December 31, 1993, and $8.8 million of such loans at December 31, 1992.\nAt December 31, 1993, segregated assets were $247.9 million, net of a $6.5 million reserve, compared to $293.8 million, net of a $16.2 million reserve at December 31, 1992. The reserve established by First Fidelity in 1992 with respect to its 20% loss exposure on the segregated assets was $25.0 million. First Fidelity's share of charge-offs on segregated assets was $10.6 million in 1993 and $8.8 million in 1992. Related recoveries in 1993 were $855 thousand. Net losses incurred through December 31, 1993 totaled $98.4 million. The Company's risk share was $17.5 million at December 31, 1993.\nAssets Held for Sale\nAs of September 30, 1993, the Company determined that it would pursue an accelerated disposition approach on certain of its non-performing assets and, accordingly, classified $91.0 million (net of market value adjustments) of assets as \"held for sale\", and included such assets in other assets. These assets consisted of $42.0 million of OREO, $35.3 million of non-performing loans and a $13.7 million performing loan. Related to this strategic decision, $48.8 million in write-downs were taken to record the assets held for sale at their estimated near-term\ndisposition values. During the fourth quarter, related primarily to the Peoples acquisition, the Company classified an additional $44.7 million of assets as \"held for sale\". During the fourth quarter of 1993, First Fidelity sold $47.3 million of assets held for sale, leaving a balance at December 31, 1993, of $88.4 million. The Company anticipates that substantially all such assets will be sold within 18 months of their reclassification. The decision to sell these assets reflected an improvement in market pricing.\nProvision and Reserve for Possible Credit Losses\nThe levels of the provision and reserve for possible credit losses are based on management's ongoing assessment of the Company's credit exposure and consideration of a number of relevant variables. These variables include prevailing and anticipated domestic and international economic conditions, assigned risk ratings on credit exposures, the diversification and size of the loan portfolio, the results of the most recent regulatory examinations available to the Company, the current and projected financial status and creditworthiness of borrowers, certain off balance sheet credit risks, the nature and level of non-performing assets and loans that have been identified as potential problems, the adequacy of collateral, past and expected loss experience, and other factors deemed relevant by management. The Company's risk rating system and the quarterly reporting process for problem and vulnerable credits are utilized by management in determining the adequacy of the Company's reserve for possible credit losses.\nThe following table sets forth information regarding the Company's provision and reserve for possible credit losses and charge-off experience:\nRECONCILIATION OF RESERVE FOR POSSIBLE CREDIT LOSSES\n- --------------- (1) As a result of a significant decrease in the level of foreign assets and substantial recoveries in its foreign portfolio, management made the indicated reallocations from the reserve for foreign loans to the general reserve. (2) Breakdown between categories of real estate loans is not available for 1989.\nThe continued decline in the provision for possible credit losses from 1991 through 1993 reflects management's evaluation of the adequacy of the level of the reserve for possible credit losses in light of, among other factors, improved asset quality trends, current economic conditions, the continued decline in non-performing loans and slightly lower levels of charge-offs. The reduction of the provision for possible credit losses contributed to the improvement in the Company's net income in 1993, 1992 and 1991.\nKey asset quality reserve ratios improved steadily over the three years ended December 31, 1991, 1992 and 1993. The ratio of the reserve for possible credit losses to non-performing loans was 85% for 1991, 121% for 1992 and 159% for 1993. The reserve for possible credit losses to non-performing assets ratio was 66% for 1991, 88% for 1992 and 122% for 1993. These ratios exclude loans classified as contractually past due 90 days or more but still accruing, assets subject to FDIC loss-sharing provisions, and assets classified as held for sale.\nThe reserve for possible credit losses was $602.2 million at December 31, 1993, and represented 2.82% of total loans, compared to $610.4 million and 3.32% of total loans at December 31, 1992. The Company believes that it has maintained the reserve for possible credit losses at an adequate level, although ultimately, the level of credit losses is dependent in part upon factors outside of management's control which may not be presently foreseeable.\nThe Company regards the reserve as a general reserve which is available to absorb losses from all loans. However, for the purpose of complying with disclosure requirements of the Securities and Exchange Commission, the table below presents an allocation of the reserve among various loan categories and sets forth the percentage of loans in each category to total loans. The allocation of the reserve as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions.\nALLOCATION OF RESERVE FOR POSSIBLE CREDIT LOSSES\n- ---------------\n(1) Breakdown among categories is not available for 1989.\nCharge-Offs\nFirst Fidelity's gross charge-offs in 1993 totaled $283.6 million, a decline of 4% from $295.3 million in 1992. The 1993 charge-offs included $42.8 million in connection with transfers to \"assets held for sale\". Charge-offs in 1992 were down 8% from $320.4 million in 1991. The current charge-off level reflects some stabilization in the business climate, which affects both business and consumers, and continued softness in the regional real estate market.\nReal estate-related charge-offs were $118.3 million in 1993, compared to $83.8 million in 1992. The increase in 1993 was the result of $37.7 million of charge-offs in connection with transfers to \"assets held for sale\".\nCharge-offs of commercial and financial loans, excluding those related to commercial real estate loans, were $100.8 million (including $5.1 million on loans transferred to assets held for sale), representing a $22.3 million decrease from 1992. Charge-offs unrelated to real estate were not concentrated in any industry, type of loan or type of borrower.\nInstallment loan charge-offs of $47.7 million were down $21.1 million from 1992, reflecting lower charge-offs in credit cards and other types of installment loans. Leasing charge-offs were $16.3 million in 1993, compared to $14.9 million in 1992.\nRecoveries\nRecoveries on charged-off commercial and financial loans were $15.8 million in 1993, compared to $18.6 million in the prior year. Real estate-related recoveries were $6.3 million in 1993 and $2.1 million in 1992. Installment loan recoveries were $17.8 million in 1993, compared to $22.5 million a year earlier.\nNon-Performing Assets\nNon-performing assets include those loans that are not accruing interest (non-accruing loans), loans that have been renegotiated due to a weakening in the financial position of the borrower (restructured loans) and OREO, which consists of real estate acquired upon foreclosure and in-substance foreclosures. A real estate loan is classified as an in-substance foreclosure when the borrower has little or no equity in the underlying property and the Company can reasonably expect repayment to come only from the operation or sale of the real estate.\nThe following table sets forth information regarding non-performing assets and accruing contractually past due loans.\nNON-PERFORMING ASSETS AND CONTRACTUALLY PAST DUE LOANS\n- ---------------\n(a) Non-performing assets exclude loans classified as contractually past due 90 days or more and still accruing, segregated shared-loss assets of $254.4 million in 1993 and $310.0 million in 1992, and assets held for sale of $88.4 million in 1993.\n(b) Accruing loans past due 90 days or more.\n(c) Breakdown among categories of contractually past due loans is not available for 1989.\nInterest income is not accrued on loans where interest or principal is 90 days or more past due, unless the loans are adequately secured and in the process of collection. Additionally, interest is not accrued on loans where management has determined that the borrowers may be unable to meet future contractual principal and\/or interest obligations, even though interest and principal payments may be current. When a loan is placed on non-accrual status, interest accruals cease and past due interest is reversed and charged against current income. Any interest payments subsequently received are credited to either principal or interest income, depending upon the financial condition of the borrower. Interest income is not accrued until the financial condition and payment record of the borrower once again warrant it. Interest on loans that have been restructured is accrued according to the restructured terms once regularity of payment is established and management has determined that the borrower is able to meet all recorded obligations.\nNon-performing assets were $494.7 million at December 31, 1993, compared to $695.7 million at December 31, 1992. The decline reflects the Company's continuing workout and collection efforts, which include\nrepayments, charge-offs, transfers of non-performing assets to \"assets held for sale\" and fewer additions to non-performing loans. Non-performing real estate loans declined $52.0 million, including a $107.0 million decline in connection with the assets held for sale reclassification ($72.4 million was transferred to assets held for sale, including certain non-performing loans acquired in connection with the Peoples, Northeast and Village transactions, and $34.6 million in related write-downs were taken). The level of non-accruing domestic commercial loans decreased $62.4 million from December 31, 1992 to December 31, 1993. The decline reflected the reclassification of $6.1 million to assets held for sale and $5.1 million in related write-downs. Restructured loans decreased $21.7 million to $13.9 million at December 31, 1993, due primarily to the return to accruing status of certain loans whose rates and terms are consistent with market rates and terms, and where a sufficient period of satisfactory performance by the borrower in accordance with the modified terms had occurred.\nInterest recognized as income on loans that were classified as non-accruing and restructured as of year-end totaled $3.1 million in 1993. Had payments on year-end non-accruing and restructured loans been made at the original contracted amounts and due dates, the Company would have recorded additional interest income of approximately $30.1 million in 1993.\nOREO decreased from $189.4 million at December 31, 1992 to $115.9 million at December 31, 1993. OREO obtained in 1993 acquisitions was $11.9 million at December 31, 1993. The decline reflected the reclassification of $46.9 million to assets held for sale and $9.7 million in related write-downs.\nPrior to transferring a real estate loan to OREO (due to actual foreclosure or in-substance foreclosure), it is written-down to the lower of cost or fair value. This write-down is charged to the reserve for possible credit losses. Subsequently, OREO is carried at the lower of fair value less estimated cost to sell or carrying value. An OREO reserve is maintained at a level sufficient to absorb unidentified declines in the fair value of all OREO properties between periodic appraisals and for estimated selling costs. The reserve and related provision for OREO were relatively unchanged in 1993 as compared to 1992. Charge-offs also include write-downs related to assets held for sale, reflecting management's plans to dispose of such assets rapidly. The following table sets forth information regarding the Company's reserve for OREO:\nAt December 31, 1993, loans that were 90 days or more past due but still accruing interest totaled $141.5 million, including $133.1 million of consumer loans, compared to $154.5 million at December 31, 1992, a decrease of $13.0 million, or 8%. The decrease was primarily the result of continuing workout and collection efforts. Management's determination regarding the accrual of interest on these loans is based on the availability and sufficiency of collateral and the status of collection efforts. Delays which the Company continues to experience in pursuing remedies through the court systems have had a significant impact on this loan category. In the present environment, certain of such loans could become non-performing assets or result in charge-offs in the future.\nWhile the Company believes it has responded appropriately to the current economic environment, management remains sensitive to the evolving economic situation and its potential impact on asset quality and the reserve for possible credit losses. In addition, regulatory agencies periodically review the level of the Company's reserve for possible credit losses. Such agencies could require the Company to increase or decrease the level of the reserve based on their interpretation of data available to them at the time of their examination.\nIn May, 1993, SFAS 114, \"Accounting by Creditors for Impairment of a Loan\", was issued. SFAS 114 requires that \"impaired\" loans be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Although management is continuing to review SFAS 114 and the expected changes to that standard, it does not currently expect that the adoption of SFAS 114, which is required for fiscal years beginning after December 15, 1994, will have a material effect on the Company's financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n(a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:\n(b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages:\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors First Fidelity Bancorporation\nWe have audited the accompanying consolidated statements of condition of First Fidelity Bancorporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of First Fidelity Bancorporation's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Fidelity Bancorporation and subsidiaries as of December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, First Fidelity Bancorporation changed its methods of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits, and certain investments in debt and equity securities.\n\/s\/ KPMG Peat Marwick\nJanuary 14, 1994, except for the sixth paragraph of Note 11 which is as of February 2, 1994 New York, New York\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CONDITION\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. ACCOUNTING POLICIES\nThe Consolidated Financial Statements of First Fidelity Bancorporation and Subsidiaries (collectively, the \"Company\" or \"First Fidelity\") have been prepared in conformity with generally accepted accounting principles and reporting practices applied in the banking industry. The consolidated financial statements include the accounts of First Fidelity Bancorporation and its subsidiaries, all of which are directly or indirectly wholly-owned. Significant intercompany balances and transactions have been eliminated in consolidation. The Company also presents herein condensed parent company only financial information regarding First Fidelity Bancorporation (the \"Parent Company\"). Prior period amounts are reclassified when necessary to conform with the current year's presentation. The following is a summary of significant accounting policies:\nSecurities Held to Maturity: Securities are classified as securities held to maturity based on management's intent and the Company's ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts. Purchase premiums and discounts are amortized over the life of the related security using a method which approximates the effective interest method.\nTrading Account Securities: Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are carried at market value. Realized gains and losses and gains and losses from marking the portfolio to market value are included in trading revenue.\nSecurities Available for Sale: At December 31, 1993, securities not classified as securities held to maturity or trading account securities are classified as securities available for sale, and are stated at fair value. Unrealized gains and losses are excluded from earnings, and are reported as a separate component of stockholders' equity, net of taxes. In 1992, these securities were stated at the lower of cost or market. Such securities include those that may be sold in response to changes in interest rates, changes in prepayment risk or other factors.\nNet securities transactions included in non-interest income consist of realized gains and losses on the sale of securities. Gains or losses on sale are recorded on the completed transaction basis and are computed under the identified certificate method.\nLoans: Loans are stated net of unearned income. Unearned income is recognized over the lives of the respective loans, principally on the effective interest method.\nIncome from direct financing leases is recorded over the life of the lease under the financing method of accounting, except for leveraged lease transactions. Income from leveraged lease transactions is recognized using a method which yields a level rate of return in relation to the Company's net investment in the lease. The investment includes the sum of aggregate rentals receivable and the estimated residual value of leased equipment, less deferred income and third party debt on leveraged leases.\nInterest income is not accrued on loans where interest or principal is 90 days or more past due, unless the loans are adequately secured and in the process of collection, or on loans where management has determined that the borrowers may be unable to meet contractual principal and\/or interest obligations. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Non-accrual loans are generally not returned to accruing status until principal and interest payments have been brought current and full collectibility is reasonably assured. Interest on loans that have been restructured is recognized according to the revised terms.\nLoan origination and commitment fees and certain related costs are deferred and amortized as an adjustment of loan yield in a manner which approximates the effective interest method.\nReserve for Possible Credit Losses: The level of the reserve for possible credit losses is based on management's ongoing assessment of the Company's credit exposure, in consideration of a number of relevant variables. These variables include prevailing and anticipated domestic and international economic conditions,\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nassigned risk ratings, the diversification and size of the loan portfolio, the results of the most recent regulatory examinations available to the Company, the current and projected financial status and creditworthiness of borrowers, various off balance-sheet credit risks, the nature and level of non-performing assets and loans that have been identified as potential problems, the adequacy of collateral, past and expected loss experience and other factors deemed relevant by management.\nFinancial Instruments: A financial instrument is defined as cash, evidence of ownership in an entity, or a contract that imposes an obligation on one entity and conveys a right to another for the exchange of cash or other financial instruments. In addition to the financial instruments shown in the Consolidated Statement of Condition, the Company enters into interest rate swaps, futures, caps and floors, primarily to manage interest rate exposure, and also enters into firm commitments to extend credit.\nHedges: In order to qualify for hedge accounting treatment, the item being hedged must expose the Company to interest rate risk. Interest rate swaps, futures, caps and floors which reduce exposure to interest rate risk associated with identifiable assets, liabilities, firm commitments or anticipated transactions are designated as hedges. Interest rate swaps which are hedges of other interest rate swaps (i.e., matched swaps) are held to maturity. Gains or losses on contracts designated as hedges are deferred and amortized to interest income or expense over the life of the related hedged asset, liability, firm commitment or anticipated transaction. The net settlement amount to be received or paid on contracts designated as hedges is accrued over the life of the contract and recognized as interest income or expense, respectively.\nTrading positions: Interest rate swaps, futures, caps, or floors not qualifying for hedge accounting treatment or used in trading activities, if any, are carried at market value, and realized and unrealized gains and losses are included in trading revenue.\nForeign Currency Translation and Exchange Contracts: Assets and liabilities of overseas offices are translated at current rates of exchange. Related income and expenses are translated at average rates of exchange in effect during the year. All foreign exchange positions are valued daily at prevailing market rates. Exchange adjustments, including unrealized gains or losses on unsettled forward contracts, are included in trading revenue.\nOther Real Estate Owned: Real estate acquired in partial or full satisfaction of loans and loans meeting the criteria of \"in-substance foreclosures\" are classified as Other Real Estate Owned (\"OREO\"). Prior to transferring a real estate loan to OREO (due to actual or in-substance foreclosure) it is written down to the lower of cost or fair value. This write down is charged to the reserve for possible credit losses. Subsequently, OREO is carried at the lower of fair value less estimated costs to sell or carrying value.\nPremises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Buildings and equipment are depreciated over their estimated useful lives. Leasehold improvements are amortized over the lesser of the term of the respective lease or the estimated useful life of the improvement.\nIncome Taxes: Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") 109, \"Accounting for Income Taxes\". Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets are recognized for future deductible temporary differences and tax loss and credit carryforwards if their realization is \"more likely than not\". Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nUnder Accounting Principles Board Opinion No. 11, which was applied by the Company in 1992 and prior years, deferred income taxes were recognized for income and expense items that were reported in different\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nyears for financial reporting purposes and income tax purposes, using the tax rate applicable in the year of the calculation. Under that method, deferred taxes were not adjusted for subsequent changes in tax rates.\nThe Parent Company's income taxes, as reflected in the Parent Company's Statement of Income, represent the taxes allocated to the Parent Company on the basis of its contribution to consolidated income.\nRetirement Benefits: The Company maintains self-administered, non-contributory defined benefit pension plans covering all employees who qualify as to age and length of service. Plan expense is based on actuarial computations of current and future benefits for employees and is included in salaries and benefits expense. In addition, the Company provides health care and life insurance benefits for qualifying employees. The related expense is based upon actuarial calculations and is recognized during the period over which such benefits are earned. Prior to 1993, the Company recognized health care and life insurance expenses on an \"as paid\" basis.\nEarnings per Share: Primary earnings per share is based on the weighted average number of common shares outstanding during each period, including the assumed exercise of dilutive stock options and warrants, using the treasury stock method. Primary earnings per share also reflects provisions for dividend requirements on all outstanding shares of the Company's Preferred Stock.\nFully diluted earnings per share is based on the weighted average number of common shares outstanding during each period, including the assumed conversion of convertible preferred stock into common stock and the assumed exercise of dilutive stock options and warrants, using the treasury stock method. Fully diluted earnings per share also reflects provisions for dividend requirements on non-convertible preferred stock.\nStatement of Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing time deposits, federal funds sold and securities purchased under agreements to resell, none having an original maturity of more than three months.\nExcess of Cost Over Net Assets Acquired: The excess of cost over the fair value of acquired net assets is included in other assets and is being amortized using the straight-line method over the estimated period of benefit.\nNOTE 2. CHANGES IN ACCOUNTING PRINCIPLES\nDuring 1993, First Fidelity changed its method of accounting for: (a) postretirement benefits other than pensions, as required by SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", (b) income taxes, as required by SFAS 109, \"Accounting for Income Taxes\", (c) postemployment benefits, as prescribed in SFAS 112, \"Employers' Accounting for Postemployment Benefits\" and (d) securities, as prescribed in SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities\".\nThe cumulative effect of changes in accounting principles, net of tax effect, in the Company's 1993 Consolidated Statement of Income consists of the following:\nThe Company recorded a cumulative one-time benefit of $63.1 million upon the adoption of SFAS 109. The major components of the deferred tax asset related to temporary differences created by the Reserve for Possible Credit Losses, alternative minimum tax credit carryforwards, and accrued postretirement benefits.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSFAS 106 requires accrual, during an employee's active years of service, of the expected costs of providing postretirement benefits (principally health care) to employees and their beneficiaries and dependents. Benefit levels and eligibility are based upon the employee's status (currently employed or retired), length of service, age at retirement and other factors. The majority of the costs of providing these benefits relate to current retirees and their beneficiaries. Through 1992, First Fidelity, like most other companies, recognized this expense on an \"as paid\" basis. As a result of this change in accounting principle, the Company recorded a one-time cumulative effect adjustment of $80.7 million ($53.3 million, net of tax effect), to recognize the accumulated postretirement benefit obligation at January 1, 1993.\nIn addition, as of January 1, 1993, the Company adopted SFAS 112, which requires employers to recognize any obligation to provide postemployment (as differentiated from postretirement) benefits (salary continuation, outplacement services, etc.) by accruing the estimated liability through a charge to expense. Upon adoption of SFAS 112, the Company's accumulated postemployment benefit obligation at January 1, 1993 of $11.3 million was recognized by a one-time cumulative effect adjustment of $7.4 million, net of tax effect, during 1993.\nThe Company adopted SFAS 115 as of December 31, 1993. Adoption of this standard resulted in an increase in the carrying value of \"Securities Available for Sale\" of $49.2 million and a decrease in the carrying value of \"Loans\" of $7.2 million, offset by increases in Retained Earnings of $27.3 million and the related deferred tax impact of $14.7 million.\nNOTE 3. PRINCIPAL ACQUISITIONS\nIn May 1993, the Company acquired $2.5 billion in assets and assumed $2.5 billion in liabilities of Northeast Bancorp, Inc. (\"Northeast\") and its subsidiaries for $27.2 million in an exchange of common stock. In connection with the acquisition, the Company also issued 3,284,207 shares of its Common Stock to Banco Santander, S.A. (\"Santander\") representing the exercise by Santander of warrants (\"Warrants\") to purchase 2,376,250 shares and the exercise by Santander of gross up rights to purchase an additional 907,957 shares (\"the Acquisition Gross Up Rights\") pursuant to the Investment Agreement, dated as of March 18, 1991 (the \"Investment Agreement\") between the Company and Santander. The acquisition has been accounted for as a purchase and, accordingly, the results of operations of Northeast have been included in the Company's consolidated financial statements from May 4, 1993.\nOn August 11, 1993, First Fidelity acquired Village Financial Services, Ltd. (\"Village\") and its 9 branch bank subsidiary, Village Bank, for $40.0 million in cash and $26.8 million of First Fidelity Common Stock. Village had $736 million in assets and $489 million in deposits at closing. In connection with the acquisition, the Company issued 893,956 shares of First Fidelity Common Stock to Santander pursuant to its exercise of Acquisition Gross Up Rights under the Investment Agreement. The acquisition has been accounted for as a purchase and, accordingly, the results of operations of Village have been included in the Company's consolidated financial statements from August 11, 1993.\nOn December 30, 1993, the Company acquired the 31 branch Peoples Westchester Savings Bank (\"Peoples\"), a savings bank operating in Westchester County, New York, for a combination of cash and Common Stock with an aggregate value of $234.9 million. At closing, Peoples had approximately $1.7 billion in assets and $1.5 billion in deposits. Substantially all of the 2,442,083 shares of Common Stock issued to Peoples stockholders in the acquisition came from Treasury Stock, all of which was acquired by First Fidelity late in 1993 through open market purchases. The acquisition has been accounted for as a purchase and, accordingly, the results of operations of Peoples have been included in the Company's consolidated financial statements from December 30, 1993.\nThe following required unaudited pro forma financial information presents the combined historical results of operations of First Fidelity, Northeast, Village and Peoples (the \"companies\") as if the acquisitions had all occurred as of January 1, 1993 and 1992, respectively, giving effect to purchase accounting adjustments. The results do not include certain non-recurring charges and credits directly attributable to such acquisitions. The pro forma financial\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\ninformation does not necessarily reflect the results of operations that would have been achieved had the companies actually combined at such dates.\nCOMBINED CONDENSED CONSOLIDATED PRO FORMA STATEMENTS OF INCOME (UNAUDITED)\nOn October 2, 1992, the Company acquired $2.7 billion in assets and assumed $3.1 billion in deposits and other liabilities of The Howard Savings Bank (\"Howard\"). The transaction was effected through an emergency purchase and assumption transaction pursuant to a Purchase and Assumption Agreement (the \"Agreement\"). The Company paid a premium of $73.5 million to the Federal Deposit Insurance Corporation (\"FDIC\") to acquire Howard. The underlying Agreement contained FDIC loss-sharing provisions with respect to approximately $860 million in commercial loans, commercial mortgages and certain other loans (the \"shared-loss loans\"). During the five-year term of the loss-sharing arrangement, the Company classifies non-accruing shared-loss loans as \"segregated assets\". See Note 9 presented herein.\nThe Howard acquisition was accounted for under the purchase method; accordingly, Howard's operations have been included in the Company's consolidated financial statements only since the date of acquisition.\nNOTE 4. CASH AND DUE FROM BANKS\nThe Company's banking subsidiaries are required to maintain reserve balances with Federal Reserve Banks. These balances totaled $333 million at December 31, 1993 and averaged approximately $398 million for the year ended December 31, 1993.\nNOTE 5. SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE\nThe Company adopted SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities\", as of December 31, 1993.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSecurities Held to Maturity\nSecurities held to maturity are stated at amortized cost, and at December 31, 1993 and 1992 consisted of the following:\nFederal agency securities consisted almost entirely of mortgage-backed securities (which included collateralized mortgage obligations and pass-through certificates) at December 31, 1993 and 1992, respectively. Other securities included mortgage-backed securities with book values of $442.8 million and $189.2 million and market values of $443.1 million and $192.7 million at December 31, 1993 and 1992, respectively.\nProceeds from sales of debt securities held as investments in 1992 were $134.5 million. Gains of $7.7 million and losses of $67 thousand were realized on such sales in 1992. Proceeds from sales of debt securities held as investments during 1991 were $1.7 billion. Gains of $63.9 million and losses of $429 thousand were realized on these sales in 1991.\nGross unrealized gains and losses in the securities held to maturity portfolio at December 31, 1993 were as follows:\nGross unrealized gains and losses in the securities held to maturity portfolio at December 31, 1992 were as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSecurities held to maturity aggregating approximately $2.6 billion at December 31, 1993 and $2.4 billion at December 31, 1992 were pledged, either under repurchase agreements or to secure public deposits.\nSecurities Available for Sale\nSecurities available for sale are stated at fair value, and at December 31, 1993 and 1992, respectively, consisted of the following:\nGross unrealized gains and losses in the securities available for sale portfolio at December 31, 1993 were as follows:\nConsistent with SFAS 115, the net unrealized gains were reported as a separate component of stockholders' equity, net of tax effect, at December 31, 1993.\nGross unrealized gains and losses in the securities available for sale portfolio at December 31, 1992 were as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nProceeds from the sale of debt securities available for sale during 1993 were $458.3 million. Gains of $7.5 million and losses of $642 thousand were realized on these sales. In 1992, the sale of such securities resulted in realized gains of $978 thousand and realized losses of $91 thousand. Proceeds from these sales were $37.4 million.\nMaturities\nExpected maturities of debt securities were as follows at December 31, 1993 (maturities of mortgage-backed securities and collateralized mortgage obligations are based upon estimated cash flows, assuming no change in the current interest rate environment):\nSecurities held to maturity:\nSecurities available for sale:\nNOTE 6. LOANS\nLoans at December 31, 1993 and 1992 consisted of the following:\nIncluded in loans at December 31, 1993 and 1992, were $351.3 million and $475.7 million, respectively, of acquired Howard shared-loss loans which, under the terms of the Agreement with the FDIC, are subject to FDIC\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nreimbursement for certain losses if they become non-performing before October 2, 1997. When such assets become non-performing, they are reclassified as \"segregated assets\" (see Note 9 herein).\nNon-accruing loans at December 31, 1993 and 1992 totaled $365.0 million and $470.7 million, respectively. Restructured loans totaled $13.9 million and $35.6 million at December 31, 1993 and 1992, respectively. Interest recognized as income on loans that were classified as non-accruing and restructured as of year-end totaled $3.1 million in 1993 and $2.4 million in 1992. Had payments on year-end non-accruing and restructured loans been made at the original contracted amounts and due dates, the Company would have recorded additional interest income of approximately $30.1 million in 1993 and $47.8 million in 1992.\nDuring 1993, $78.5 million of non-accruing loans (net of market value adjustments of $39.7 million taken against the reserve for possible credit losses) were transferred to the \"Assets Held for Sale\" portfolio (see Note 9).\nIn May, 1993, SFAS 114, \"Accounting by Creditors for Impairment of a Loan\", was issued. SFAS 114 requires that \"impaired\" loans be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Although management is continuing to review SFAS 114 and the expected changes to that standard, it does not currently expect that the adoption of SFAS 114, which is required for fiscal years beginning after December 15, 1994, will have a material effect on the Company's financial statements.\nNOTE 7. RESERVE FOR POSSIBLE CREDIT LOSSES\nChanges in the reserve for possible credit losses for 1993, 1992 and 1991 are shown below:\nNOTE 8. PREMISES AND EQUIPMENT\nPremises and equipment at December 31, 1993 and 1992 consisted of the following:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDepreciation and amortization expenses for 1993, 1992 and 1991 were $46.6 million, $47.9 million and $49.9 million, respectively.\nNOTE 9. OTHER ASSETS\nSegregated Assets\nSegregated assets consist of Howard shared-loss loans acquired October 2, 1992 (\"Bank Closing\") that were or have since become classified as restructured, non-accrual or OREO. Such assets at December 31, 1993 were $247.9 million, net of a $6.5 million reserve. The Company's share of charge-offs on such assets was $10.6 million in 1993, while recoveries were $855 thousand. Segregated assets at December 31, 1992 were $293.8 million, net of a $16.2 million reserve. The initial reserve of $25 million decreased by net charge-offs of $8.8 million in 1992 and $9.7 million in 1993.\nThe FDIC pays the Company 80 percent of all net charge-offs on acquired shared-loss loans, during the five-year period that commenced with Bank Closing. Charge-offs eligible for FDIC reimbursement include accrued interest as of October 2, 1992 and up to 90 days of additional accrued interest. Subsequent to a charge-off of a shared-loss loan, the FDIC also reimburses the Company for 80 percent of the aggregate amount of certain actual direct expenses incurred on such loans, on a prospective basis.\nDuring the sixth and seventh years following Bank Closing, the Company will pay the FDIC 80 percent of net recoveries of shared-loss loan charge-offs that occurred during the five years following Bank Closing.\nDuring the seven-year period following Bank Closing, the Company will pay the FDIC 80 percent of any recoveries on charge-offs of assets acquired that were effected by Howard prior to Bank Closing. Such payments will be reduced by 80 percent of certain related direct recovery expenses incurred by the Company during this same period.\nAfter the seven-year period following Bank Closing, the FDIC will pay the Company 15 percent of the excess over $130 million of the sum of net charge-offs incurred during the five-year period following Bank Closing, plus all reimbursable and recovery expenses for the seven-year period following Bank Closing, minus the aggregate amount of gross recoveries during the sixth and seventh years following Bank Closing.\nThe Company is generally required to exercise prudent stewardship over assets entitled to loss-sharing protection, in the same manner and to the same degree as any other Company asset.\nIntangible Assets\nUnamortized goodwill and identified intangibles were $458.3 million and $325.4 million at December 31, 1993 and 1992, respectively. These amounts are being amortized over the remaining period of expected benefit, which approximates 15 years on a weighted average basis. The amortization expense related to goodwill and identified intangibles was $31.7 million, $23.0 million and $19.5 million for 1993, 1992 and 1991, respectively.\nOther Real Estate Owned\nOREO consisted of foreclosed property of $103.3 million and \"in-substance foreclosures\" of $19.2 million, less a $6.6 million reserve, as of December 31, 1993. At December 31, 1992, OREO consisted of foreclosed property of $155.1 million and \"in-substance foreclosures\" of $40.1 million, less a $5.8 million reserve. During 1993, $46.9 million of OREO (net of market value adjustments of $6.6 million taken against the OREO reserve) was transferred to the \"Assets Held for Sale\" portfolio (see below).\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nChanges in the OREO reserve for 1993, 1992 and 1991 are shown below:\nAssets Held for Sale\nAssets held for sale totaled $88.4 million at December 31, 1993. Such assets consisted of $64.6 million of non-performing loans (including $56.4 million related to 1993 acquisitions) and $23.8 million of OREO (including $6.1 million related to 1993 acquisitions), and are carried at the lower of adjusted cost or fair value.\nNOTE 10. SHORT-TERM BORROWINGS\nShort-term borrowings at December 31, 1993 and 1992 consisted of the following:\nNOTE 11. LONG-TERM DEBT\nLong-term debt at December 31, 1993 and 1992 consisted of the following:\nThe 6.80%, 9 5\/8% and 9 3\/4% subordinated notes, the 8 1\/2% subordinated capital notes and the floating rate subordinated notes qualify as Tier II capital for regulatory purposes, subject to certain limitations.\nThe 6.80%, 9 5\/8% and 9 3\/4% subordinated notes are not redeemable prior to maturity and are subordinated in right of payment to all senior indebtedness of the Parent Company. Interest on the notes is payable semi-annually on various dates each year.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe 8 1\/2% subordinated capital notes are not redeemable prior to maturity and are subordinated to all indebtedness for borrowed money. At maturity, these notes are payable either in whole or in part in cash from the proceeds of the sale of Common Stock, perpetual preferred stock or other securities qualifying as primary capital securities designated for such purpose or in whole or in part by the exchange of such securities having a market value equal to the principal amount of the notes to be so exchanged. If the Company determines that the notes do not constitute \"primary capital\" or if the notes cease being treated as \"primary capital\" by the Federal Reserve Board, the Company will not exchange the notes for securities at maturity but instead will pay cash at 100% of the principal amount, plus accrued interest.\nThe floating rate subordinated note is a capital note bearing interest at 1\/4 of 1% per annum above the London Interbank Offered Rate (\"LIBOR\") for three-month eurodollar deposits. It is repayable using any combination of cash and certain nonvoting securities. Under certain circumstances, the Company may be obligated to repurchase the note prior to maturity using proceeds of a secondary offering of certain nonvoting securities. The note is redeemable prior to maturity at 100% of principal plus accrued interest if the Federal Reserve Board determines that the note will not be treated as \"primary capital\" and in certain other limited circumstances.\nThe Company redeemed $50 million of floating rate subordinated capital notes on July 16, 1993. The 11 1\/2% notes were redeemed at maturity. On May 15, 1993, the Company redeemed the 7 3\/4% capital debentures.\nOn February 2, 1994, the Company issued $200 million of floating rate senior notes, which mature August 2, 1996. The notes bear interest at .10% per annum above LIBOR for three-month eurodollar deposits. Such notes may not be redeemed prior to maturity.\nThe aggregate amounts of maturities for long-term debt as of December 31, 1993 are as follows:\nNOTE 12. STOCKHOLDERS' EQUITY\nPreferred Stock at December 31, 1993 and 1992 consisted of the following:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Series B Convertible Preferred Stock bears a cumulative annual dividend of $2.15 per share, votes as a single class with the Common Stock (each share of Series B Convertible Preferred Stock being entitled to .39 votes, subject to adjustment in certain events), has a liquidation preference of $25 per share, is redeemable in whole or in part at the Company's option at $25 per share plus accrued but unpaid dividends to the redemption date, and is convertible at any time at the option of the holder into .7801 of a share of Common Stock, subject to adjustment in the event of a merger, stock split, etc. Holders of Series B Convertible Preferred Stock are also entitled to vote as a class in certain limited circumstances.\nThe Series D Adjustable Rate Cumulative Preferred Stock is non-voting, subject to certain limited exceptions, has a liquidation preference of $100 per share, is redeemable in whole or in part at the option of the Company at a redemption price of $100 per share plus accrued but unpaid dividends to the redemption date, and cannot be converted into any other class of capital stock. It bears cumulative dividends at a rate (the \"applicable rate\") equal to .75% less than the highest of the three month U.S. Treasury Bill rate, the U.S. Treasury ten year constant maturity rate or the U.S. Treasury twenty year constant maturity rate (as defined), adjusted quarterly; however, in no event will the applicable rate be less than 6 1\/4% or more than 12 3\/4% per annum. For the quarter beginning January 1, 1994, the rate is 6.25%.\nThe Series F 10.64% Cumulative Preferred Stock (the \"Series F Preferred Stock\") is non-voting, subject to certain limitations and is not convertible into any other class of capital stock. The 75,000 outstanding shares of Series F Preferred Stock were issued in the form of 3,000,000 depositary shares, each of which represents a one-fortieth interest in a share of Series F Preferred Stock. Each depositary share bears a cumulative annual dividend of $2.66, has a liquidation preference of $25.00 and is redeemable in whole or part at the Company's option on or after July 1, 1996 at $25.00.\nWarrants for the Purchase of Common Stock\nPursuant to the Investment Agreement between the Company and Santander, on December 27, 1991, the Company issued Warrants for the purchase of 9,505,000 shares of Common Stock. At December 31, 1993, Warrants for the purchase of 4,752,500 shares of Common Stock were outstanding. The remaining Warrants are exercisable through December, 1995 at an exercise price of $25.50 per share, and are not transferable. In addition, pursuant to the Investment Agreement, the Company has granted Santander a number of rights, including the right to request the nomination of two directors to First Fidelity's Board of Directors, gross-up rights to acquire Common Stock at a price under market price under certain circumstances and registration rights.\nChanges in Number of Shares Outstanding\nDuring 1993, in conjunction with the Northeast and Village acquisitions, the Company issued 4,178,163 shares (2,376,250 shares from Warrants and 1,801,913 shares from the Acquisition Gross up Rights) of its Common Stock to Santander, pursuant to the exercise of a portion of the Warrants and Acquisition Gross Up Rights which Santander acquired in 1991. In addition, 3,605,606 shares of Common Stock were issued to former shareholders of Northeast, Village and Peoples, of which 1,222,155 shares were newly-issued and 2,383,451 shares were Treasury Stock acquired during the year. The Company acquired 370,394 shares of its Common Stock, in open market purchases through an independent agent, to be issued under the dividend reinvestment and stock option plans. During 1993, the Company issued 333,680 such shares from Treasury Stock and 374,868 shares of newly-issued Common Stock in connection with such plans. Also, 54,584 shares of Common Stock were issued as a result of conversions of 69,976 shares of Series B Convertible Preferred Stock.\nOn October 5, 1992, in conjunction with the Howard acquisition, the Company issued 2,376,250 shares of its Common Stock to Santander, pursuant to the exercise of a portion of the Warrants which Santander acquired in 1991. In addition, during 1992, the Company issued 1,390,392 shares of Common Stock through the dividend reinvestment and stock option plans and 2,010 shares of Common Stock as a result of conversions of 2,578 shares of Series B Convertible Preferred Stock.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nShare Purchase Rights Plan\nThe Company has in effect a preferred share purchase rights plan. The rights plan provides that each share of Common Stock has attached to it a right (each, a \"Right\", together, the \"Rights\") to purchase one one-hundredth of a share of Series E Junior Participating Preferred Stock, par value $1.00 per share (the \"Series E Preferred Stock\") at a price of $185 per one one-hundredth of a share of Series E Preferred Stock, subject to adjustment. In general, if a person or group (other than the Company, its subsidiaries, certain affiliates or any of the Company's employee benefit plans) acquires 10% or more of the Company's Common Stock (a \"10% Holder\"), stockholders (other than such 10% Holder) may exercise their Rights to purchase Common Stock having a market value equal to twice the exercise price of the Rights. If the Company is acquired in a merger, the Rights may be exercised to purchase common shares of the acquiring company at a similar discount. At any time after a person or group becomes a 10% Holder but prior to the acquisition by such 10% Holder of 50% or more of the outstanding Common Stock, First Fidelity's Board may elect to exchange the Rights (other than Rights owned by such 10% Holder which become void) for Common Stock or Series E Preferred Stock, at an exchange ratio of one share of Common Stock or one one-hundredth of a share of Series E Preferred Stock, per Right, subject to adjustment. The rights plan is designed to protect stockholders in the event of unsolicited offers or attempts to acquire the Company.\nCapital\nThe Parent Company and the Subsidiary Banks are required by various regulatory agencies to maintain minimum levels of capital. At December 31, 1993, the Company and its Subsidiary Banks exceeded all such minimum capital requirements. In connection with the acquisition of Howard, the Company agreed with the Office of the Comptroller of the Currency to maintain a minimum Tier I leverage ratio for First Fidelity Bank, N.A., New Jersey (\"FFB-NJ\") of 5.5% by December 31, 1992 and 6% by September 30, 1993. FFB-NJ's Tier I leverage ratio was 6.24% at December 31, 1992 and 6.97% at September 30, 1993. On January 11, 1994, FFB-NJ and First Fidelity Bank, N.A., Pennsylvania were combined into a new entity, First Fidelity Bank, N.A.\nDividends Declared\nDuring 1993, dividends declared with respect to the Company's Common Stock, Series B Convertible Preferred Stock, Series D Adjustable Rate Cumulative Preferred Stock and per depositary share with respect to the Series F Preferred Stock were $1.44, $2.15, $6.51, and $2.66, respectively.\nDividend Reinvestment Plan\nAt December 31, 1993, the Company had reserved 823,099 shares of its Common Stock for issuance under the Company's dividend reinvestment plan.\nDividend Restrictions\nDividends payable by the Company, its bank holding company subsidiaries and its banking subsidiaries are subject to various limitations imposed by statutes, regulations and policies adopted by bank regulatory agencies. Under current regulations regarding dividend availability, the Company's bank subsidiaries (other than FFB-NY), without prior approval of bank regulators, may declare dividends to the respective holding companies totaling approximately $281 million plus additional amounts equal to the net profits earned by the Company's bank subsidiaries for the period from January 1, 1994 through the date of declaration, less dividends declared during that period.\nTreasury Stock\nDuring 1992, the Company's Board of Directors authorized the purchase of up to 250,000 shares of Common Stock per quarter for reissuance under the Company's stock option plans, as well as the purchase by the Company on the open market of all shares of Common Stock issuable under the Company's Dividend Reinvestment Plan. Such\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\npurchases are made in the market by an independent agent from time to time, subject to market conditions. No such purchases were made in 1992. The Company held 36,714 shares of Treasury Stock, related to stock options, for such purposes on December 31, 1993.\nDuring 1993, the Company's Board of Directors authorized the purchase of up to 2% of its outstanding Common Stock in any calendar year. The purchases may be made from time to time in the open market or through privately-negotiated transactions, and acquired shares will be used for general corporate purposes, including acquisitions. It is anticipated that reacquired shares may be used in future acquisitions accounted for under the purchase method. This program was subsequently extended by the Company's Board of Directors for the purchase of up to 3% of the outstanding Common Stock for the 1993 calendar year.\nNOTE 13. BENEFIT PLANS\nPension Plans\nThe Company maintains self-administered, non-contributory defined benefit pension plans covering all employees who qualify as to age and length of service. Benefits are based on years of credited service, highest average compensation (as defined) and primary social security benefits. Qualified plans are funded in accordance with statutory and regulatory guidelines. Pension (benefit) expense for the years ended December 31, 1993, 1992 and 1991, for all qualified and unqualified plans, aggregated $(130,000), $(937,000) and $950,000, respectively.\nThe following table sets forth the plans' funded status and amounts recognized in the Company's consolidated financial statements at December 31, 1993 and 1992:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNet pension expense (benefit) for 1993, 1992 and 1991 included the following components:\nThe weighted average discount rate assumed in determining the actuarial present value of the projected benefit obligation was 7.5% at December 31, 1993 and 8.75% at December 31, 1992. The assumed rate of increase in future compensation levels was 4.0% at December 31, 1993 and 4.5% at December 31, 1992. The long-term expected rate of return on assets was 9.75% in 1993 and 10.25% in 1992. The change in the weighted average discount rate to 7.5% resulted in an increase in the actuarial present value of the projected benefit obligation of approximately $44.0 million. The change in the assumed rate of increase in future compensation levels to 4.0% resulted in a decrease in the actuarial present value of the projected benefit obligation of approximately $9.0 million.\nPostretirement Benefits\nThe Company sponsors postretirement benefit plans which provide medical and life insurance coverage to employees, depending upon the employee's status (currently retired or still employed), length of service, age at retirement and other factors.\nThe plans have no assets. The following table sets forth the plans' accumulated postretirement benefit obligation as of December 31, 1993, which represents the liability for accrued postretirement benefit cost:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe net periodic postretirement benefit cost for the year 1993 includes the following:\nFor measurement purposes, the 1993 health care cost trend rate is projected to be 13.5% for participants under 65 and 11% for participants over 65. These rates are assumed to trend downward to 5.5% for participants under 65 and 5% for participants over 65 by the year 2007 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of January 1, 1993 by $5.9 million (7%) and the aggregate of the service and interest cost components of net periodic retirement benefit cost for the year 1993 by $.6 million (8%). The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5%. The change in the weighted average discount rate from 8.75% resulted in an increase in the actuarial present value of the postretirement benefit obligation of approximately $19.2 million.\nThe Company's accumulated postretirement benefit obligation under SFAS 106 of approximately $81 million was recognized in the first quarter of 1993 by a one-time cumulative effect adjustment of $53.3 million, net of tax effect. In 1992 and 1991, the cost of providing postretirement benefits was recognized as such benefits were paid and totaled $5.8 million and $5.1 million, respectively.\nPostemployment Benefits\nThe Company's accumulated postemployment benefit obligation under SFAS 112 of $11.3 million was recognized in the first quarter of 1993 by a one-time cumulative effect adjustment of $7.4 million, net of tax effect. Exclusive of this one-time adjustment, the Company's annual postemployment benefit expense on an accrual basis was approximately $900 thousand for 1993, as compared to approximately $2 million in 1992 under the previous method. No funding is provided for postemployment benefits.\nSavings Plans\nThe Company maintains a savings plan under Section 401(k) of the Internal Revenue Code, which covers substantially all full-time employees after one year of continuous employment. Under the plan, employee contributions are partially matched by the Company. Such matching becomes vested when the employee reaches three years of credited service. Total savings plan expense was $12.0 million, $10.7 million and $10.3 million for 1993, 1992 and 1991, respectively.\nStock Option Plans\nThe Company maintains stock option plans, pursuant to which an aggregate of 7,775,454 shares of Common Stock have been authorized for issuance to certain key employees of the Company and its subsidiaries. The options granted under these plans are, in general, exercisable not earlier than one year after the date of grant, at a price equal to the fair market value of the Common Stock on the date of grant, and expire not more than ten years after the date of grant. There are also options outstanding under other plans, pursuant to which no further options may be granted. Vesting with respect to certain options granted to certain senior executive officers may be accelerated. In addition, the Company assumed certain stock options related to acquisitions during 1993.\nThe Company also maintains an employee stock purchase plan, under the terms of which 1,760,000 shares of Common Stock have been authorized for issuance. The plan's purchase period begins on July 1 and ends June 30 of the following year, during which options to purchase stock are offered to employees once a year. No individual\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nemployee may exercise options to acquire stock in any one year in excess of 10% of base compensation, or $20,000, whichever is less. The option price equals 90% of the market price of the Common Stock on the last day of the purchase period. The aggregate number of shares to be purchased in any given offering, which cannot be greater than 250,000, is determined by the amount contributed by the employees and the market price as of the last day of the purchase period.\nChanges in total options outstanding during 1993, 1992 and 1991 are as follows:\nCertain of the options assumed in the course of 1993 acquisitions (64,831 shares at December 31, 1993), when translated at the applicable exchange rate for First Fidelity Common Stock, result in an option price as high as $797. In order to provide more meaningful disclosure, such prices and shares have been omitted from the tabular presentation above.\nNOTE 14. OTHER INCOME AND EXPENSE\nIn 1993 and 1992, there were no individual items of income in excess of one percent of total income that were not separately disclosed in the Consolidated Statements of Income. In 1991, Other income included a gain on the\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nsale of Fidelcor Business Credit Corporation, a commercial finance subsidiary, of $30.7 million. Other expenses included FDIC premium expense of $63.2 million, $56.2 million and $48.5 million in 1993, 1992 and 1991, respectively; external data processing expense of $48.2 million, $47.0 million and $47.0 million in 1993, 1992 and 1991, respectively; communication expenses of $33.5 million, $33.1 million and $34.2 million in 1993, 1992 and 1991, respectively; total OREO expenses of $28.4 million and $29.9 million in 1993 and 1992, respectively; and amortization of goodwill and core deposit intangibles of $30.8 million in 1993.\nNOTE 15. INCOME TAXES\nIncome tax expense for 1993 was allocated as follows:\nIn addition, the tax effect of the cumulative effect of the change in accounting for certain investments in debt and equity securities under SFAS 115 was $14.7 million.\nIncome tax expense is comprised of the following:\nThe components of deferred income tax expense attributable to income from continuing operations for the year ended December 31, 1993 were as follows:\nThe components of deferred income tax for the years ended December 31, 1992 and 1991 were as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1993 were as follows:\nManagement has determined that, based upon recoverable taxes and projected levels of pretax income, realization of the deferred tax asset is more likely than not.\nThe total tax expense for 1993, 1992 and 1991 resulted in effective tax rates that differed from the applicable U.S. federal income tax rate. A reconciliation follows:\nAt December 31, 1993, for income tax purposes, the Company had alternative minimum tax credit carryforwards of approximately $9.2 million available to offset future income tax to the extent that it exceeds alternative minimum tax. These credits have an unlimited life. The Company had capital loss carryforwards at December 31, 1993 of $2.9 million which are available to offset future capital gains. Such losses expire on December 31, 1997, if not utilized by that date.\nNOTE 16. FINANCIAL INSTRUMENTS\nFinancial Instruments with Off Balance-Sheet Risk\nThe Company is a party to various financial instruments required in the normal course of business to meet the financing needs of its customers and to manage its exposure to changes in interest and foreign exchange rates. The contract or notional amounts of such instruments are not included in the Consolidated Statements of Condition at\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDecember 31, 1993 and 1992. Management does not expect any material losses from these transactions. The Company's involvement in such financial instruments at December 31, 1993 and 1992 is summarized as follows:\nThe amounts above indicate gross positions and do not reflect offsetting positions or participations to other financial institutions.\nThe Company uses the same credit policies in extending commitments, letters of credit and financial guarantees as it does for financial instruments recorded on the Consolidated Statements of Condition. The Company seeks to control its exposure to loss from these agreements through credit approval processes and monitoring procedures. Letters of credit and commitments to extend credit are generally issued for one year or less and may require payment of a fee. The total commitment amounts do not necessarily represent future cash disbursements, as many of the commitments expire without being drawn upon. The Company may require collateral in extending commitments, which may include cash, accounts receivable, securities, real or personal property, or other assets. For those commitments which require collateral, the value of the collateral generally equals or exceeds the amount of the commitment. Total standby letters of credit of $22.4 million and $20.9 million had been participated to other financial institutions at December 31, 1993 and 1992, respectively.\nThe Company enters into interest rate swap, cap and floor agreements primarily to hedge its interest rate exposure associated with various assets and liabilities and to meet the needs of its customers. Such instruments generally do not extend beyond five years, except those swaps related to hedging of the Company's long-term debt. The Company is exposed to losses from possible counterparty default in conjunction with movements in interest rates. The Company's risk of credit loss is limited to any amounts receivable, which constitute a small fraction of the contract or notional amounts above. At December 31, 1993, the Company had no deferred gains or losses recorded on the Consolidated Statement of Condition relating to terminated interest rate swaps. At December 31, 1993, the remaining terms to maturity of interest rate swaps ranged from four weeks to ten years.\nThe Company enters into foreign exchange, futures and forward contracts which generally extend from several days to two years for the future delivery of securities, money market instruments, or foreign currencies at specified prices. Risk arises from the possible inability of the counterparty to perform and from movements in interest rates, exchange rates or securities prices. The Company's risk of credit loss constitutes a small fraction of the contract or notional amounts above.\nConcentrations of Credit Risk of Financial Instruments\nThe Company extends credit in the normal course of business to its customers, the majority of whom operate or reside within the New Jersey\/eastern Pennsylvania\/Connecticut\/southern New York business areas. The ability of its customers to meet contractual obligations is, to some extent, dependent upon the economic conditions existing in this region.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIn addition, the Company had credit extensions (on and off balance-sheet) to certain groups which represented 5% or more of total credit extensions, at December 31, 1993 and 1992, respectively, as follows: consumers (including residential mortgages), 38% and 34%; U.S. government and agencies, 16% and 15%; commercial mortgages and commercial real estate, 11% and 10%; and depository institutions, 10% and 16%.\nNOTE 17. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company is required to disclose certain information about so-called \"fair values\" of financial instruments, as defined in SFAS 107.\nLimitations: Estimates of \"fair value\" are made at a specific point in time, based upon, where available, relevant market prices and information about the financial instrument. Such estimates do not include any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. For a substantial portion of the Company's financial instruments, no quoted market exists. Therefore, estimates of \"fair value\" are necessarily based on a number of significant assumptions (many of which involve events outside the control of management). Such assumptions include assessments of current economic conditions, perceived risks associated with these financial instruments and their counterparties, future expected loss experience and other factors. Given the uncertainties surrounding these assumptions, the reported \"fair values\" represent estimates only and, therefore, cannot be compared to the historical accounting model. Use of different assumptions or methodologies are likely to result in significantly different \"fair value\" estimates.\nThe estimated \"fair values\" presented neither include nor give effect to the values associated with the Company's banking, trust or other businesses, existing customer relationships, extensive branch banking network, property, equipment, goodwill or certain tax implications related to the realization of unrealized gains or losses. Also, the \"fair value\" of non-interest bearing demand deposits, savings and NOW accounts and money market deposit accounts is equal to the carrying amount because these deposits have no stated maturity. Obviously, this approach to estimating \"fair value\" excludes the significant benefit that results from the low-cost funding provided by such deposit liabilities, as compared to alternative sources of funding.\nThe following methods and assumptions were used to estimate the \"fair value\" of each major classification of financial instruments at December 31, 1993 and 1992:\nCash, short-term investments, and customers' acceptance liability: Current carrying amounts approximate estimated \"fair value\".\nSecurities: Current quoted market prices were used to determine \"fair value\".\nLoans: The \"fair value\" of residential mortgages was estimated based upon recent market prices of securitized receivables, adjusted for differences in loan characteristics. The \"fair value\" of certain installment loans (e.g., bankcard receivables) was estimated based upon recent market prices of sales of similar receivables. The \"fair value\" of non-accruing and restructured loans which are secured by real estate was estimated considering recent external appraisals of the underlying collateral and other factors. The \"fair value\" of all other loans was estimated using a method which approximates the effect of discounting the estimated future cash flows over the expected repayment periods using rates which consider credit risk, servicing costs and other relevant factors.\nDeposits with no stated maturity and short-term time deposits: Current carrying amounts approximate estimated \"fair value\".\nOther consumer time deposits: \"Fair value\" was estimated by discounting the contractual cash flows using current market rates offered in the Company's market area for deposits with comparable terms and maturities.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nShort-term borrowings and acceptances outstanding: Current carrying amounts approximate estimated \"fair value\".\nLong-term debt: Current quoted market prices were used to estimate \"fair value\".\nCommitments to extend credit and letters of credit: The majority of the Company's commitments to extend credit and letters of credit carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally unassignable by either the Company or the borrower, they only have value to the Company and the borrower. The estimated \"fair value\" approximates the recorded deferred fee amounts.\nOther Off Balance-Sheet Instruments: The estimated amounts that the Company would receive or pay, based upon current market rates or prices, to terminate such agreements was used to determine estimated \"fair value\". The \"fair value\" of interest rate swaps, forward and futures contracts at December 31, 1993 and 1992 was a net receivable of $126 million and $160 million, respectively, of which $3 million and $7 million, respectively, were recorded as a net receivable on the balance sheet.\nThe carrying amounts and estimated \"fair values\" of the Company's financial instruments were as follows at December 31, 1993 and 1992:\n- --------------- (A) Disclosure of the \"fair value\" of lease receivables is not required and has not been included above. The carrying amount of Net loans excludes $1.4 billion and $1.2 billion of lease receivables, $183 million and $173 million of related unearned income and allocated reserves of $29 million and $38 million at December 31, 1993 and 1992, respectively. The reserve for lease receivables has been allocated only to present the information above on a comparable basis. Additionally, the Company continues to pursue its contractual claims on loans which have been charged-off. The \"fair value\" of such contractual claims was not included in the estimate of \"fair value\".\nNOTE 18. OTHER COMMITMENTS AND CONTINGENCIES\nLegal Proceedings\nThe Company is a party (as plaintiff or defendant) to a number of lawsuits. While any litigation carries an element of uncertainty, management is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the liquidity, financial condition or results of operations of the Company.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOperating Leases\nAt December 31, 1993, the Company was obligated under non-cancelable operating leases for certain premises and equipment. Minimum rental expenses under these leases for the year 1994 and later are as follows:\nTotal rental expense under cancelable and non-cancelable operating leases for 1993, 1992 and 1991 was $36.4 million, $44.3 million and $41.6 million, respectively.\nLong-term Service Contract\nIn September, 1990, the Company entered into a contract with EDS under which EDS provides certain data processing services, manages the Company's data center operations and is integrating various application systems to produce unified Company-wide operating systems. The cost of the services is determined by volume considerations and an inflation factor, in addition to an agreed base rate.\nAcquisitions\nIn January, 1994, First Fidelity acquired Greenwich Financial Corporation and its 7 branch subsidiary, Greenwich Federal Savings and Loan Association (\"Greenwich Federal\"), for $41.9 million in cash. Greenwich Federal, which reported assets of $425 million and deposits of $255 million at December 31, 1993, operates in the Greenwich\/Stamford area of Fairfield County, Connecticut. The Company also entered into a definitive agreement to acquire First Inter-Bancorp Inc. and its 16 branch subsidiary, Mid-Hudson Savings Bank FSB (\"Mid-Hudson\"), for approximately $56 million in cash. Mid-Hudson, which operates throughout Dutchess, Ulster, Orange and Putnam Counties, New York, had approximately $522 million in assets and $460 million in deposits at December 31, 1993. The Company intends to merge Mid-Hudson's operations with those of First Fidelity Bank, N.A., New York (\"FFB-NY\"). The acquisition is subject to shareholder and regulatory approval.\nOn August 27, 1993, First Fidelity entered into a definitive agreement to acquire BankVest, Inc. and its 2 branch subsidiary, First Peoples National Bank of Edwardsville, Pennsylvania, for $19.6 million in cash. BankVest, Inc. reported assets of $101 million and deposits of $85 million at December 31, 1993. Completion of the acquisition is expected to occur by the end of the first quarter of 1994.\nOn October 27, 1993, the Company, through FFB-NY, entered into a definitive agreement to acquire The Savings Bank of Rockland County (\"Rockland\") for $5.9 million in cash. Rockland, which reported assets of $179 million and deposits of $168 million at December 31, 1993, has 4 offices, all in Rockland County, New York. The acquisition is expected to be completed during the second quarter of 1994.\nNOTE 19. RELATED PARTY TRANSACTIONS\nAt December 31, 1992, the Company had $15 million of time deposits with Santander, a principal stockholder of the Company. These deposits were eurodollar placements, at market terms. In addition, at December 31, 1993 and 1992, the Company had other balances with Santander, typical of and consistent with a correspondent banking relationship in the normal course of business.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nLoans to directors, executive officers and their associates, which are made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others, approximated $154 million at December 31, 1993 and $117 million at December 31, 1992. During 1993, there were increases of approximately $253 million and loan repayments of approximately $216 million on such loans.\nNOTE 20. CONDENSED FINANCIAL INFORMATION OF FIRST FIDELITY BANCORPORATION (PARENT COMPANY ONLY)\nCONDENSED BALANCE SHEETS (PARENT COMPANY ONLY)\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONDENSED STATEMENTS OF INCOME (PARENT COMPANY ONLY)\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)\nRegulatory Restrictions\nThe Federal Reserve Act limits extensions of credit that can be made from the Company's bank subsidiaries to any affiliate (with certain exceptions), including the Parent Company. Loans to any one affiliate may not exceed 10% of a bank subsidiary's capital and surplus, and loans to all affiliates may not exceed 20% of such bank subsidiary's capital and surplus. Additionally, such loans must be collateralized and must have terms comparable to those with unaffiliated companies.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nSUPPLEMENTARY DATA\nSUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\n- ---------------\n(A) Non-interest income less net securities transactions.\n(B) Net income.\n(C) Net income applicable to Common Stock.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nSUPPLEMENTARY DATA\nCOMPUTATION OF EARNINGS PER SHARE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS OF THE REGISTRANT\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders, provided, however, that such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Securities and Exchange Commission Regulation S-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report.\nFinancial statement schedules are not required under the related instructions of the Securities and Exchange Commission or are inapplicable and, therefore, have been omitted.\n(b) The following exhibits are incorporated by reference herein or annexed to this Annual Report:\n(c) Current Reports on Form 8-K during the quarter ended December 31, 1993.\nThe Company's Current Report on Form 8-K, dated May 4, 1993, filed with the Securities and Exchange Commission on November 11, 1993, reporting certain pro forma financial information relating to the acquisition of Northeast Bancorp, Inc.\nSIGNATURES\nPURSUANT 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, THIS 17TH DAY OF FEBRUARY, 1994.\nFIRST FIDELITY BANCORPORATION\nBy: ANTHONY P. TERRACCIANO Anthony P. Terracciano Chairman, President and Chief Executive Officer\nPURSUANT 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 AND ON THE DATES INDICATED.\nEXHIBIT INDEX","section_15":""}
{"filename":"783996_1993.txt","cik":"783996","year":"1993","section_1":"Item 1. Business\nGeneral\nMendik Real Estate Limited Partnership (the \"Partnership\" or \"Registrant\") is a New York limited partnership which was formed in October 1985 pursuant to an agreement of limited partnership (as amended, the \"Partnership Agreement\") for the purpose of acquiring, maintaining and operating income-producing commercial office buildings in the Greater New York Metropolitan Area. NY Real Estate Services 1 Inc., a Delaware corporation (\"NYRES1\") (formerly known as Hutton Real Estate Services XV, Inc.), and Mendik Corporation, a New York corporation (\"Mendik Corporation\"), are the general partners (together, the \"General Partners\") of the Registrant. (See Item 10.)\nCommencing May 7, 1986, the Partnership began offering up to a maximum of 1,000,000 units of limited partnership interest (the \"Units\") at $500 per Unit with a minimum required purchase of 10 Units or $5,000 (four Units for an Individual Retirement Account or Keogh Plan). Investors who purchased the Units (\"Investor Limited Partners\") are not required to make any further capital contributions to the Partnership. Upon completion of the offering on September 18, 1987 the Partnership had accepted subscriptions for 395,169 Units for gross aggregate cash proceeds to the Partnership of $197,584,500. Net proceeds to the Partnership after deducting selling commissions, organization expenses, and other expenses of the offering were approximately $172,766,598. These proceeds were used to: (i) repay the principal amount of and interest on interim financing obtained by the Partnership to fund the acquisition of a property located at 1351 Washington Boulevard, Stamford, Connecticut (the \"Stamford Property\"); (ii) acquire the leasehold interests in a property located on Mamaroneck Avenue in Harrison, New York (the \"Saxon Woods Corporate Center\") and in a property located at 330 West 34th Street, New York, New York (the \"34th Street Property\") and; (iii) acquire an approximate 60% interest in Two Park Company, the joint venture which owns a property located at Two Park Avenue, New York, New York (the \"Park Avenue Property\").\nThe Stamford Property, Saxon Woods Corporate Center, 34th Street Property and Park Avenue Property are each referred to as a \"Property\" and collectively referred to as the \"Properties.\" See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSaxon Woods Corporate Center\nValuation. The Partnership's investment in the leasehold interest in the Saxon Woods Corporate Center at acquisition was $20,664,379, excluding acquisition expenses of $536,454. The Property's appraised value as of January 21, 1986 was $22,000,000. The appraised value of the leasehold interest as of December 31, 1993 was $15,000,000, as compared to appraised values of $14,000,000 at December 31, 1992 and $12,000,000 at December 31, 1991.\nLocation. Saxon Woods Corporate Center is located on Mamaroneck Avenue in Harrison, New York, approximately 18 miles north of New York City in Westchester County. The office park is located near the Mamaroneck Avenue exit of Hutchinson River Parkway, approximately one mile north of Interstate 95, which is the major artery connecting New York City to Westchester County and Connecticut. Westchester County Airport is located approximately three miles north of the site.\nSite and Improvements. Saxon Woods Corporate Center consists of two five-story office buildings. The building at 550 Mamaroneck Avenue consists of approximately 112,000 net rentable square feet and the building at 600 Mamaroneck Avenue contains approximately 125,000 net rentable square feet, based on current standards of measurement. The buildings are situated on a 15.28 acre site, which provides ground-level parking for more than 800 cars.\nGround Lease. The parcel of land underlying each building is leased from an unaffiliated ground lessor pursuant to a ground lease which terminates in September 2027 and provides the Partnership with the option to renew for two 25-year periods and one 39-year period. Each ground lease provides for an annual net rental of $170,000, with an increase of $20,000 every five years commencing in January 1996.\nRenovations. During the period from 1986 through 1993, the Partnership expended approximately $8.9 million on capitalized renovations, including tenant improvement construction, funded from cash flow, Partnership reserves, and borrowings.\nFinancing. Through January 1994, the Partnership had borrowed approximately $4.7 million and made commitments to borrow an additional $362,000 under the $6.5 million non-recourse line of credit secured by the Partnership's leasehold interest in the Saxon Woods Corporate Center (the \"Saxon Woods Line of Credit\"). Reference is made to Note 6 to the Financial Statements, which is incorporated herein by reference thereto, for additional information regarding the Saxon Woods Line of Credit.\nLeasing. The Property's occupancy rates as of February 28, 1994, 1993 and 1992 were 75%, 67% and 42%, respectively. The vacancy rate in Westchester County, where the Saxon Woods Corporate Center is located, was 20.9% as of December 31, 1993, as compared to a vacancy rate of 15.1% at December 31, 1992. The Property's combined occupancy rate was lower than in the surrounding area primarily as a result of IBM's having vacated its more than 100,000 square feet of space in the Property (which constituted approximately 43% of the space in the Property) upon expiration of its lease in November 1988 in order to consolidate into other existing locations in Westchester County. This departure coincided with a severe and prolonged downturn in the Westchester County commercial real estate market. Although the Property's occupancy rate had risen since the departure of IBM, the Partnership experienced the loss of General Accident Insurance Company of America which vacated its 28,000 square feet in the Property (which constituted approximately 12% of the space in the Property) to relocate to the company's newly-constructed headquarters building upon expiration of its lease in July 1991. During 1993, utilizing funds available under the Saxon Woods Line of Credit, the Partnership entered into leasing transactions covering approximately 30,000 square feet at the Property including lease extensions and expansions by existing tenants. This activity is in addition to the leases for approximately 65,000 square feet that were signed during 1992. During 1994, the General Partners will continue to market the Property's available space to commercial office tenants and fund the costs of any additional leases utilizing proceeds from the Saxon Woods Line of Credit.\nStamford Property\nValuation. The Stamford Property was acquired by the Partnership for $31,250,000, excluding acquisition expenses of $313,125. The Property's appraised value as of October 17, 1985 was $34,000,000. The appraised value of the Property as of December 31, 1993 was $9,150,000, compared to appraised values of $10,600,000 as of December 31, 1992 and $14,100,000 as of December 31, 1991.\nLocation. The Stamford Property is located at 1351 Washington Boulevard in the northwestern section of downtown Stamford, Connecticut approximately one mile north of the Stamford railroad station and Interstate 95, which is the major east\/west freeway in the city, and 3.5 miles south of the Merritt Parkway, which bisects the city. In addition to fronting on Washington Boulevard, the Stamford Property is bounded by North Street, Franklin Street and Stanley Court. Stamford is located on the Long Island Sound in southwestern Connecticut, approximately 34 miles northeast of New York City.\nSite and Improvements. The office building and adjacent parking garage are located on a 1.73 acre parcel of land. The ten-story office building contains approximately 220,000 net rentable square feet, based on current standards of measurement. The above-ground parking garage provides over 550 parking spaces.\nRenovations. During the period from 1985 through 1993, the Partnership expended approximately $10 million on capitalized renovations, including tenant improvement construction, funded from cash flow, Partnership reserves, and borrowings.\nFinancing. Reference is made to Note 6 to the Financial Statements, which is incorporated herein by reference thereto, for information regarding the terms of the $12.5 million non-recourse first mortgage loan to which the Stamford Property is subject (the \"Stamford Loan\"). The Partnership failed to make full payment of debt service due on February 10, 1994 and March 10, 1994 with respect to the Stamford Loan. Consequently, the Partnership is in default under the terms of the Stamford Loan and the property's lender, New York Life Insurance Company (\"New York Life\"), may elect to exercise its remedies under the loan agreement including accelerating the maturity date of the principal balance of the loan and electing to foreclose on its mortgage. The General Partners are now seeking a short-term agreement from New York Life, pursuant to which New York Life would forbear from exercising its remedies under the mortgage and Mendik Realty Company, Inc. (\"Mendik Realty\") would continue to defer its management fees and leasing commissions with respect to the Property. The Partnership would then attempt to sell the Property during the forbearance period. However, in light of the fact that the appraised value of the Property at December 31, 1993 was less than the mortgage, and New York Life is unlikely to accept a pay off of its mortgage at a discount, it is unlikely that such a sale would result in any cash proceeds being available for distribution. If the Partnership were unable to sell the Property and pay off the Stamford Loan within the forbearance period, the Partnership would transfer the deed in lieu of a foreclosure in order to provide an orderly and efficient transfer of title to the Property to New York Life. See Item 7.\nLeasing. The Property's occupancy rates as of February 28, 1994, 1993 and 1992, were 57%, 60% and 60%, respectively. Fairfield County, where the Stamford Property is located, has suffered from one of the highest metropolitan area vacancy rates in the country over the past six years as the vacancy rate increased from 17% in 1986 to 24.2% as of December 31, 1992. As of December 31, 1993, the vacancy rate in Fairfield County had declined slightly to 21%. Major tenants at the Stamford Property include D&B Computing Services, Inc. (\"D&B\") which leases 43,100 square feet (20% of the total leasable area in the Property) under a lease that expired on December 31, 1993. Effective January 1, 1994, the Partnership signed a ten-year lease extension with D&B whereby D&B will remain a tenant in the property through December 31, 2003. However, the rental rate D&B is paying under the terms of the extension represents a substantial reduction in the rate paid previously, reflecting current market conditions in Stamford. The property's other major tenant is Automatic Data Processing, Inc. (\"ADP\") which leases 34,700 square feet (16% of the total leasable area in the Property) under a lease expiring June 30, 1994. ADP has subleased approximately two-thirds of its space in the Property. The Partnership has entered into negotiations with ADP regarding a possible extension of the lease covering its portion of the space. The Partnership has also begun discussions with certain of ADP's subtenants in connection with new leases to extend the subtenants' tenancy beyond the expiration of ADP's lease. Based on current market conditions, it is likely that any lease extensions or renewals will be at lower rates than the Partnership currently receives, further adversely affecting the revenue generated by the Property. Currently, a lease for one of ADP's subtenants that occupies 8,200 square feet is close to being completed.\nThe General Partners leasing strategy at the Property has been to market the Property's available space to potential tenants on an \"as is\" basis which would not require the Partnership to make additional investments for tenant improvement construction and would enable the Partnership to conserve its limited working capital reserves. The strategy was adopted recognizing that beginning in 1994, when the original modification was to expire, the Partnership would not have sufficient resources to meet its debt service payments and did not want to jeopardize any additional investment in the Property. Leases signed on an \"as is\" basis are likely to be at annual rental rates substantially below existing market rates. In addition, leasing space on an \"as is\" basis may have put and may continue to put the Partnership at a disadvantage compared to other landlords that provide allowances for tenant improvements. The occupancy rate at the Property, which is lower than that in the surrounding area, may have been and may continue to be adversely affected by the extremely competitive nature of the Stamford real estate market and the availability of space in newer buildings in the area as compared to the Partnership's older but renovated Property.\n34th Street Property\nValuation. The Partnership's investment in the leasehold interest in the 34th Street Property at acquisition was $34,883,132, excluding acquisition expenses of $728,268. The Property's appraised value as of November 1, 1986 was $39,000,000. The appraised value of the leasehold interest as of December 31, 1993 was $9,800,000 compared to appraised values of $12,500,000 at December 31, 1992 and $23,000,000 as of December 31, 1991.\nLocation. The 34th Street Property is located at 330 West 34th Street, New York, New York, which is between Eighth and Ninth Avenues in Manhattan's Penn Plaza district, five blocks west of the Empire State Building, one-half block west of Pennsylvania Station and three blocks east of the Jacob Javits Convention Center.\nThe Penn Plaza district is located in midtown Manhattan and comprises the seven-block area that surrounds Pennsylvania Station, New York City's largest transportation hub. Pennsylvania Station serves as the western terminus for the Long Island Railroad, the Manhattan terminal for the Amtrak rail system and the eastern terminus for the New Jersey Transit rail system. In addition, several major arteries of the New York City subway system have stops in and around Pennsylvania Station, providing access to passengers from the New York City boroughs of Brooklyn, Queens and the Bronx. Madison Square Garden, New York City's largest spectator arena, is located above Pennsylvania Station.\nSite and Improvements. The 34th Street Property consists of an 18-story structure and a two-story attached annex containing in the aggregate approximately 627,000 net rentable square feet, based on current standards of measurement. The 46,413 square foot site also includes an above-ground parking area containing 39 spaces that is currently leased to an independent garage operator.\nGround Lease. Per the terms of the ground lease agreement, the annual ground lease payment to the unaffiliated ground lessor for the parcel of land underlying the 34th Street Property increased from $1.25 million to $2.25 million effective January 1, 1992. Reference is made to Note 5 to the Financial Statements, which is incorporated herein by reference thereto, for additional information on the ground lease.\nRenovations. During the period from 1987 through 1993, the Partnership expended approximately $9.6 million on capitalized renovations, including tenant improvement construction, funded from cash flow, Partnership reserves, and borrowings.\nFinancing. On August 12, 1993, the Partnership entered into a modification of the 34th Street Line of Credit which will allow the Partnership to pay off the 34th Street Line of Credit at a substantial discount by payment of the sum of $6.5 million at any time through June 30, 1994. Should the Partnership be unable to pay off the 34th Street Line of Credit, the forbearance agreement provides that the Partnership will assign its leasehold interest to the Property to the lender, at the lender's election, in lieu of a foreclosure. Reference is made to Item 7 and Note 6 to the Financial Statements, which is incorporated herein by reference thereto, for additional information regarding the 34th Street Line of Credit.\nIn order further to supplement the Property's cash flow, beginning in January 1992, Mendik Realty agreed to defer its management fees of approximately $170,000 a year that would otherwise have been payable with respect to the 34th Street Property, although it had no obligation to do so. Pursuant to the forbearance agreement, these fees will continue to be deferred. The Partnership's obligation to pay the management fees deferred by Mendik Realty, will be on a non-recourse basis to the Partnership and will bear interest at a rate per annum equal to the prime rate of Morgan Guaranty Trust Company of New York less 1.25%. Principal and interest will be payable on December 31, 2025, or such earlier date on which the term of the Partnership terminates, subject to a mandatory prepayment from the net proceeds from the sale of any of the Properties, after repayment of all debt secured by the Property sold. In addition, Mendik Realty agreed to defer its leasing commission with respect to the long-term lease with the City of New York as discussed below and any further leasing commissions associated with additional leasing activity at the Property. See Item 7.\nLeasing. On February 17, 1993, the Partnership signed a long-term lease with the City of New York effective August 1, 1992 for approximately 300,000 square feet or approximately 48% of the Property's leasable area. The term of the lease is for eight years and six months expiring on February 28, 2001. The City has the right to terminate the lease without penalty provided the City gives the Partnership one year's notice of its intent to terminate the lease. The City will also be required to pay the Partnership for certain improvement costs as defined in the lease. The City will make annual base rental payments of approximately $5.4 million and will pay its proportionate share of increases in real estate taxes and operating expenses. Approximately $1.25 million has been spent by the Partnership for tenant improvement costs required under the terms of the lease. The funds utilized for such purpose had been held as security by the unaffiliated ground lessor.\nThe General Partners have been marketing the Property's remaining available space to light-industrial type tenants on an \"as is\" basis. Rental rates for light-industrial type tenants are substantially less than the rental rates received from commercial office tenants. Effective January 1, 1993, the Partnership signed a ten-year lease with Tiger Button Company, Inc. for approximately 25,000 square feet in the Property. In addition, effective July 1, 1993, the Partnership signed a nine and one-half year lease with G. Dinan & Co., Inc. for approximately 26,000 square feet. The General Partners believe that renting space on an \"as is\" basis to light-industrial type tenants may be an effective means to generate additional cash flow from the Property without requiring a significant current investment in tenant improvements. The Property's occupancy rates as of February 28, 1994, 1993 and 1992, were 61%, 57% and 50%, respectively. The Midtown West District, where the 34th Street Property is located has seen the vacancy rate for primary office space increase from 9.6% at December 31, 1987 to 16.2% at December 31, 1993. It should be noted that the Property's occupancy rate is not comparable with office buildings in the Midtown West District due to the Partnership's strategy of marketing space to light-industrial type tenants rather than commercial office tenants. However, the Property's occupancy rate continues to be below the average occupancy rate for office space in the area in which it is located primarily because of past uncertainty surrounding the City's tenancy, the character of the City's tenancy, the nature of the services the City provides, and the Partnership's strategy of conserving its limited resources.\nPark Avenue Property\nValuation. Two Park Company, the joint venture in which the Partnership has an approximate 60% interest, acquired the Park Avenue Property for $151,500,000. The Property's appraised value as of September 1, 1987 was $165,000,000. The appraised value of the Property as of December 31, 1993 was $115,000,000, compared to appraised values of $125,000,000 as of December 31, 1992 and $135,000,000 as of December 31, 1991. The Partnership's investment in its interest in Two Park Company at acquisition was $95,965,732, including $35,820,000 which represents the Partnership's share of first mortgage debt to which the Property was subject when the Partnership acquired its interest and excluding $1,722,532 of acquisition expenses. The appraised value of the Partnership's interest in the Property as of December 31, 1993 was $68,655,000, compared to appraised values of $74,625,000 as of December 31, 1992, $80,595,000 as of December 31, 1991 and $98,505,000 as of September 1, 1987.\nLocation. The Park Avenue Property is located at Two Park Avenue, New York, New York, on an approximately one-acre site that occupies the entire western frontage of Park Avenue between East 32nd and East 33rd Streets in midtown Manhattan. The Park Avenue Property is located four blocks east of Pennsylvania Station and nine blocks south of Grand Central Station, New York City's largest transportation hubs. Grand Central Station serves as the Manhattan terminal for the Metro North rail system. In addition to a subway stop located below the building, several major arteries for the New York City subway system have stops in and around Grand Central Station and Pennsylvania Station, providing access to passengers from the New York City boroughs of Brooklyn, Queens and the Bronx.\nSite and Improvements. The improvements to the Park Avenue Property consist of a 28-story office building that contains approximately 956,000 net rentable square feet, based on current standards of measurement. The building includes two lower levels consisting of a subway concourse, a small tenant garage containing approximately 43 spaces, rentable storage areas and mechanical facilities.\nRenovations. During the period from 1987 through 1993, a total of approximately $39.7 million was capitalized by Two Park Company on renovations.\nFinancing. Reference is made to Note 6 to the Financial Statements, which is incorporated herein by reference thereto, for information regarding the non-recourse first mortgage, non-recourse second mortgage and non-recourse third mortgage secured by the Park Avenue Property which aggregate $75 million.\nLeasing. The Property's occupancy rates as of February 28, 1994, 1993 and 1992, were 89%, 90% and 92%, respectively. The vacancy rate for primary office space in the Grand Central District of Midtown Manhattan, where the Park Avenue Property is located, has increased from 10.2% at December 31, 1987 to 18.4% at December 31, 1992. At December 31, 1993, the vacancy rate in the Grand Central District had declined slightly to 17.6%. During 1994, the General Partners will continue to market the Property's available space to commercial office tenants.\nMajor tenants at the Park Avenue Property are Times Mirror Magazines, Inc. and its affiliate Newsday, Inc. which, in the aggregate, lease 259,043 square feet (approximately 27% of the total leasable area in the Property) under two leases expiring on June 30, 2004 and National Benefit Life Insurance Company which leases 99,800 square feet (approximately 10% of the total leasable area in the Property) under a lease expiring on May 30, 1998. The base rental income under the leases with Times Mirror Magazines, Inc. and Newsday, Inc., and National Benefit Life Insurance Company represented approximately 18% and 8%, respectively, of the Partnership's consolidated rental income in 1993.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Partnership nor any of the Properties is currently subject to any material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1993, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters\nAs of December 31, 1993, there were 19,815 holders of Units. No public trading market has developed for the Units, and it is not anticipated that such a market will develop in the future. The transfer of Units is subject to significant restrictions, including the requirement that an Investor Limited Partner may transfer his Units only with the consent of the General Partners, which consent may be withheld in the sole and absolute discretion of the General Partners.\nDuring the first quarter of 1989, a decision was made by the General Partners to establish reserves in the amount of what would otherwise be Net Cash From Operations to help meet anticipated Partnership requirements. For the years ended December 31, 1993 and 1992, no distributions were paid to the Partners, and the Partnership does not contemplate making any distributions during 1994. See Item 7 of this Report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following financial data of the Partnership has been selected by the General Partners and derived from financial statements which have been audited by KPMG Peat Marwick, independent public accountants whose report thereon is included elsewhere herein. The information set forth below should be read in conjunction with the Partnership's financial statements and notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" also included elsewhere herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe commercial real estate market in the Greater New York Metropolitan Area remains weak. As vacancy rates have risen, increased competition among landlords has led to lower rents and increasingly generous tenant concession packages in the form of tenant improvements and free-rent periods. The significant cost of tenant improvements required to be funded under both new and renewal leases has sharply increased the demand for capital by landlords, including the Partnership. Expenditures for tenant improvements have contributed to the Partnership's reduced liquidity. In order to conserve the Partnership's limited resources, the General Partners have pursued a strategy intended to position each of the Partnership's four properties, to the extent possible, to meet its operating and other expenses as they come due using only the operating income generated by that Property, and, if necessary, proceeds from borrowings secured by such Property.\nDuring 1993, the Partnership funded operating costs, the cost of tenant improvements, leasing commissions, and building capital improvements from five sources: (i) positive cash flow generated by the approximately 60% joint venture interest in the Park Avenue Property and the Partnership's leasehold interest in the Saxon Woods Corporate Center, (ii) Partnership reserves, (iii) funds provided by certain unsecured loans and the deferral of property management fees by certain affiliates of the General Partners, (iv) additional borrowings from the $6.5 million Saxon Woods Line of Credit and (v) a portion of the $1.25 million security deposit maintained by the unaffiliated ground lessor for the 34th Street Property. It is expected that the availability of funds from certain of these sources will be reduced in the future.\nPark Avenue Property - Although the Partnership has continued to lease space at the Property, with the continuing softness in the real estate market, new and renewal leases generally have been signed at rental rates significantly less than the rental rates received on certain expiring leases. The Property's cash flow, however, is expected to remain stable for the foreseeable future because rental rate increases negotiated in leases signed in earlier years have offset the lower market rental rates reflected in the leases recently signed by the Partnership.\nAt December 31, 1993, the unrestricted cash balance at the Property was approximately $5 million over and above a reserve for real estate taxes. The Park Avenue Property currently generates, and is expected to generate in the future, sufficient revenue to cover operating expenses and debt service obligations. The indebtedness secured by the Park Avenue Property currently matures in 1998 (or 1996 at the option of the lender). The Partnership expects, as the maturity of the loan approaches, to commence negotiations to extend the existing loan or to seek refinancing. However, as a result of the current lack of liquidity in the financial marketplace, no assurances can be made that the Partnership will be able to extend with the existing lender or refinance with a new lender, on terms acceptable to the Partnership or at all.\nSaxon Woods Corporate Center - The Partnership expects that cash flow from the Saxon Woods Corporate Center will cover operating expenses and debt service obligations in 1994. Although the Saxon Woods Line of Credit is in the amount of up to $6.5 million, as a result of Section 13(d) (xviii) of the Partnership Agreement which prohibits the Partnership from incurring indebtedness secured by a Property in excess of 40% of the then-appraised value of such Property (or 40% of the value of such Property as determined by the lender as of the date of financing or refinancing, if such value is lower) (the \"Borrowing Limitation\"), the Partnership is permitted to borrow only $6 million based on the most recent appraisal of the Saxon Woods Corporate Center which as of December 31, 1993 was $15 million. The loan agreement provides that all available cash flow from the Property will be used for expenses incurred at the Property prior to borrowing any additional funds under the Saxon Woods Line of Credit. The General Partners expect that additional leasing activity, the costs of which partially will be funded by borrowing amounts remaining available under the Saxon Woods Line of Credit, may result in an increase in the appraised value of the Property thereby enabling the Partnership to borrow the additional amounts available under the Saxon Woods Line of Credit up to the full amount of $6.5 million. There can be no assurance that future appraisals will reflect an increase in the Property's value which would enable the Partnership to borrow additional funds. As of\nDecember 31, 1993, the Partnership had borrowed $4,542,677 under the Saxon Woods Line of Credit. In January 1994 the Partnership borrowed an additional $138,000 and had made commitments to borrow an additional $362,000 which would increase the total borrowings on the Saxon Woods Line of Credit to $5,042,677.\nThe indebtedness secured by the Saxon Woods Corporate Center currently matures in 1996. The Partnership expects, as the maturity of the loan approaches, to commence negotiations to extend the existing loan or to seek refinancing. However, as a result of the current lack of liquidity in the financial marketplace, no assurances can be made that the Partnership will be able to extend with the existing lender or refinance with a new lender, on terms acceptable to the Partnership or at all.\n34th Street Property - On February 17, 1993, the Partnership signed a long-term lease with the City of New York effective August 1, 1992 for approximately 300,000 square feet in the 34th Street Property. The City has the right to terminate the lease without penalty provided the City gives the Partnership one year's notice of its intent to terminate the lease. The City will also be required to pay the Partnership for certain improvement costs as defined in the lease. The terms of the lease call for the City to make annual base rental payments of approximately $5.4 million and pay its proportionate share of increases in real estate taxes and operating expenses. Per the terms of the lease, approximately $1.25 million is being spent by the Partnership for tenant improvements required under the terms of the lease. In order to fund the tenant improvements required by the City lease, the Partnership negotiated an agreement with the unaffiliated ground lessor pursuant to which the ground lessor agreed to make available the $1.25 million that was being held as security under the ground lease. As of December 31, 1993, virtually all of these funds had been spent. The ground lessor also agreed to waive the lease requirement that the Partnership deposit an additional $1 million as security with the ground lessor in connection with the increase in the annual ground rent in 1992 to $2.25 million.\nDuring 1992, the cash flow from the 34th Street Property did not cover its debt service obligations after payment of operating expenses, and it was not expected to meet its debt service obligations in 1993. As a result, in order to conserve the Partnership's limited working capital reserves and induce The First National Bank of Chicago (\"FNBC\"), the Property's lender, to modify the mortgage's terms, the Partnership suspended its interest payments to FNBC beginning in September 1992. On August 12, 1993, the Partnership entered into a forbearance agreement which modified the terms of the 34th Street Line of Credit. Pursuant to the forbearance agreement FNBC agreed to forbear through June 30, 1994 from exercising its remedies under the loan agreement as a result of the Partnership's failure to pay interest. The forbearance agreement will also allow the Partnership to pay off the 34th Street Line of Credit for $6.5 million at any time through June 30, 1994, a substantial discount to the 34th Street Line of Credit's current outstanding balance and below the Property's December 31, 1993 appraised value of $9.8 million. As of December 31, 1993, there was $15 million of principal and approximately $1.3 million of accrued interest outstanding on the 34th Street Line of Credit. Also through June 30, 1994, the Partnership will be permitted to make interest payments to FNBC only to the extent of available cash flow from the 34th Street Property. Since the forbearance agreement went into effect, the Partnership has not made any interest payments to FNBC. The General Partners are seeking to obtain either debt or equity financing even if such financing would entail the Partnership's transferring all or a portion of its interest in the Property to the party providing the financing. In the event the Partnership obtains from a third party an offer to provide financing of less than the $6.5 million required by FNBC, the Partnership would explore with FNBC a pay off at a further discount. Should the Partnership be unable to pay off the 34th Street Line of Credit by June 30, 1994, the forbearance agreement provides that the Partnership will assign its interest in the Property and in the ground lease to the Property to FNBC, at FNBC's election, in lieu of foreclosure. The forbearance agreement with FNBC provides the Partnership with an opportunity to pay off the 34th Street Line of Credit at a substantial discount while at the same time establishing a cost-effective means to ensure an orderly and efficient transfer of the Property to FNBC in the event the 34th Street Line of Credit cannot be paid off. The Partnership has no assurances that it will be able to obtain the financing necessary to pay off the 34th Street Line of Credit and any such pay off will depend on numerous factors including general market conditions. Chief among these is the fact that many traditional sources of real estate financing such as banks, insurance companies and pension funds have dramatically curtailed their investment in commercial office properties. Consequently, only a limited number of investors is likely to be available, further hampering the Partnership's ability to secure a refinancing. Should the Partnership be unable to complete a refinancing, it will likely result in the loss of the Partnership's investment in the Property.\nIn order to improve the 34th Street Property's cash flow, beginning in January 1992, Mendik Realty voluntarily agreed to defer its management fees of approximately $170,000 a year that would otherwise have been payable with respect to the 34th Street Property. In addition, Mendik Realty agreed to defer its leasing commission with respect to the signing of the long-term lease with the City of New York and any further leasing commissions associated with additional leasing activity at the Property. Both of these provisions will remain in effect pursuant to the terms of the forbearance agreement with FNBC.\nThe forbearance agreement requires the Partnership to deposit all receipts from the Property into a lockbox at FNBC. FNBC will approve all releases from the lockbox to fund Property costs. As of December 31, 1993, approximately $1 million was in the lockbox account maintained at FNBC which was utilized to fund real estate taxes due in January 1994.\nStamford Property - As described in Note 6 to the Financial Statements, the Partnership previously restructured the loan secured by the Stamford Property in 1991. As part of the terms of the restructured loan, Mendik Corporation and an affiliate of NYRES1 loaned $50,000 and $110,000, respectively, to the Partnership in each of 1991, 1992 and 1993. The loans were required to be deposited in an escrow account and may be used only to pay costs and expenses related to the Stamford Property. Mendik Realty also agreed to defer its management fees of approximately $70,000 a year in connection with the Stamford Property in each of calendar years 1991, 1992 and 1993.\nThe restructuring was intended to enable the Stamford Property to generate sufficient cash flow to meet its operating expenses and debt service obligations through 1993 without utilizing the Partnership's working capital reserves in the hope that the Stamford real estate market would recover and that, as leases at the Property expired, the Partnership would be able to enter into new or renewal leases at rental rates in excess of the rates being paid by existing tenants under current leases. However, the Stamford real estate market has continued to deteriorate resulting in a further erosion of market lease rates. While the cash flow from the Stamford Property, together with the loans by Mendik Corporation and an affiliate of NYRES1 and the management fee deferrals by Mendik Realty, were sufficient to cover the Property's operating expenses and debt service obligations in 1993, due to a decline in the Property's revenue following the extension of D&B's lease, the Partnership failed to make full payment of debt service due on February 10, 1994 and March 10, 1994 with respect to the Stamford Loan. In order to preserve its limited working capital reserves, the Partnership currently does not intend to fund any operating shortfalls out of reserves. As a result of the Partnership's failure to make these interest payments, the Partnership is in default under the terms of the Stamford Loan and the property's lender, New York Life Insurance Company (\"New York Life\"), may elect to exercise its remedies under the loan agreement including accelerating the maturity date of the principal balance of the loan and electing to foreclose on its mortgage. The General Partners are now seeking a short-term agreement from New York Life, pursuant to which New York Life would forbear from exercising its remedies under the Stamford Loan and Mendik Realty would continue to defer its management fees and leasing commissions with respect to the Property. The Partnership would then attempt to sell the Property during the forbearance period. However, in light of the fact that the appraised value of the Property at December 31, 1993 was less than the mortgage, and New York Life is unlikely to accept a pay off of its mortgage at a discount, it is unlikely that such a sale would result in any cash proceeds being available for distribution. If the Partnership were unable to sell the Property and pay off the Stamford Loan within the forbearance period, the Partnership would transfer the deed in lieu of a foreclosure in order to provide an orderly and efficient transfer of title to the Property to New York Life.\nDuring the latter part of 1992, the General Partners concluded that the Partnership may be unable to hold the 34th Street Property and the Stamford Property on a long-term basis. As a result, the Partnership determined to account for each Property as held for disposition. Accordingly, as of December 31, 1993, these Properties are being carried at the lower of their depreciated cost or estimated market value resulting in the Partnership's recording an unrealized loss of approximately $43.2 million in 1992 and an additional $4.2 million loss in 1993.\nCash Reserves - The Partnership's consolidated cash reserves decreased by $82,686 to $10,346,684 at December 31, 1993 from $10,429,370 at December 31, 1992. During 1993, approximately $2.8 million was expended for property improvements at the Park Avenue and 34th Street Properties, and Saxon Woods Corporate Center. These expenditures were offset by approximately $1.4 million in additional borrowings under the Saxon Woods Line of Credit and approximately $1.4 million of cash flow from operations which includes the release of the previously-restricted security deposit held by the 34th Street Property's unaffiliated ground lessor. In addition to the cash reserves, at December 31, 1993, the Partnership had $2,390,734 in restricted cash under various agreements including the FNBC lockbox required under the forbearance agreement. As a result of the additional borrowings under the Saxon Woods Line of Credit, mortgage notes payable increased from $105,654,502 at December 31, 1992 to $107,042,677 at December 31, 1993 on a consolidated basis.\nResults of Operations\n1993 vs. 1992 During the year ended December 31, 1993, the Partnership realized operating income before non-cash expenses, on a consolidated basis, of approximately $1,541,000 as compared to operating income of approximately $2,454,000 for the corresponding period in 1992.\nAs a result of the Partnership's decision to carry the 34th Street Property and Stamford Property at the lower of their depreciated cost or estimated market value, the Partnership recorded an unrealized loss on properties held for disposition of $4,240,608 and $43,166,559 for the years ended December 31, 1993 and 1992, respectively. Including the unrealized losses, the Partnership sustained a net loss after depreciation and amortization of $11,406,548 for the year ended December 31, 1993 as compared to $52,415,692, for 1992. If the Partnership had not recorded the unrealized losses in 1993 and 1992, the Partnership would have recorded losses of $7,165,940 and $9,249,133 for the years ended December 31, 1993 and 1992, respectively.\nConsolidated rental income for the year ended December 31, 1993 was $34,333,599 as compared with $34,094,669 for the corresponding period in 1992. Consolidated rental income remained stable from 1992 to 1993 as the income from the new leases signed in the Saxon Woods Corporate Center offset a decline in rental income from the Two Park Avenue Property that resulted from leases being renewed at the lower market rental rates. Consolidated interest income for 1993 was $282,740 as compared to $342,409 for the corresponding period in 1992. The decline is due to lower interest rates earned on the Partnership's cash balance and the Partnership's maintaining a lower average cash balance during 1993.\nConsolidated property operating expenses for 1993 increased slightly from 1992. Depreciation and amortization decreased in 1993 primarily due to the reduction in the carrying value of the 34th Street Property and Stamford Property effective December 31, 1992. Interest expense increased slightly during 1993 from the corresponding period in 1992 due to the increase in the principal balance outstanding under the Saxon Woods Line of Credit.\n1992 vs. 1991\nDuring 1992, the Partnership realized operating income before non-cash expenses, on a consolidated basis, of approximately $2,454,000 as compared to approximately $3,472,000 in 1991.\nAs a result of the Partnership's decision to carry the 34th Street Property and Stamford Property at the lower of their cost or market value, the Partnership recorded an unrealized loss on properties held for disposition of $43,166,559. Including the unrealized loss, the Partnership sustained a net loss after depreciation and amortization of $52,415,692 for the year ended December 31, 1992. If the Partnership had not recorded the unrealized loss, the Partnership would have recorded a net loss after depreciation and amortization of $9,249,133 for the year ended December 31, 1992 as compared to a net loss of $8,062,874 for the year ended December 31, 1991.\nConsolidated rental income for the year ended December 31, 1992 decreased by approximately 5% or $1,612,082 from the year ended December 31, 1991 primarily as a result of a decline in occupancy at the Park Avenue Property. Consolidated interest income for the year ended December 31, 1992 decreased by $268,988 from the year ended December 31, 1991 due to lower interest rates earned on the Partnership's cash balance and the Partnership's maintaining a lower average cash balance during 1992.\nConsolidated property operating expenses for the year ended December 31, 1992 were virtually unchanged from the year ended December 31, 1991. It should be noted that although the annual ground lease rent for the 34th Street Property increased by $1 million, pursuant to the terms of the Property's ground lease, such increase was more than offset by reductions in property maintenance expenses at the four Properties. Interest expense during 1992 was also virtually unchanged from 1991 due to a decrease in the interest rate on the 34th Street Line of Credit which was offset by an increase in the principal balance outstanding under the Saxon Woods Line of Credit. Consolidated general and administrative expenses decreased by $260,962 from 1991 to 1992 primarily due to reduced legal fees.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index of the Consolidated Financial Statements and Financial Statement Schedules at Item 14, filed as part of this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Partnership has no officers or directors. Mendik Corporation and NYRES1, as General Partners, jointly manage and control the affairs of the Partnership and have general responsibility and authority in all matters affecting its business.\nMendik Corporation\nMendik Corporation was incorporated under the laws of the State of New York on November 13, 1985. All of the capital stock of Mendik Corporation is owned by Bernard H. Mendik. Pursuant to Section 22(b) of the Partnership Agreement, Mr. Mendik has contributed to the capital of Mendik Corporation $2.5 million in the form of a demand promissory note, which represents the only substantial asset of Mendik Corporation. Mr. Mendik has a net worth in excess of such amount. Mendik Corporation maintains its principal office at 330 Madison Avenue, New York, New York 10017.\nThe executive officers and sole director of Mendik Corporation (none of whom has a family relationship with another) are:\nName \t\tAge \tOffice\nBernard H. Mendik 64 \tChairman and Director David R. Greenbaum 42\tPresident Christopher G. Bonk 39 \tSenior Vice President and Treasurer Michael M. Downey 52 \tSenior Vice President David L. Sims \t47 \tSenior Vice President Kevin R. Wang \t36 \tSenior Vice President John J. Silberstein 33 \tSenior Vice President and Secretary\nAll officers and directors of Mendik Corporation, except for John J. Silberstein, have been officers or directors of the corporation since its incorporation in November 1985. All officers of Mendik Corporation hold the same position in Mendik Realty.\nBernard H. Mendik has been an owner\/manager and developer of office and commercial properties since 1957. Mr. Mendik was named Chairman of Mendik Realty in 1990. Prior to his appointment as Chairman, Mr. Mendik had served as President of Mendik Realty since 1978.\nDavid R. Greenbaum was appointed President of Mendik Realty in 1990. Prior to his appointment as President, Mr. Greenbaum had served as Executive Vice President of Mendik Realty since 1982.\nChristopher G. Bonk has been with Mendik Realty since 1981, most recently as Senior Vice President and Treasurer.\nMichael M. Downey has been with Mendik Realty since 1978, most recently as Senior Vice President of Operations.\nDavid L. Sims has been with Mendik Realty since 1984, most recently as Senior Vice President of Leasing.\nKevin R. Wang has been with Mendik Realty since 1985, most recently as Senior Vice President of Leasing.\nJohn J. Silberstein has been with Mendik Realty since 1989, most recently as Senior Vice President and Secretary. Prior thereto, Mr. Silberstein had been associated with the law firm of Skadden, Arps, Slate, Meagher & Flom since 1986.\nNYRES1\nNYRES1 is a Delaware Corporation formed on September 9, 1985, and is an indirect wholly-owned subsidiary of Lehman Brothers, Inc. (\"Lehman\").\nOn July 31, 1993, Shearson Lehman Brothers, Inc. (\"Shearson\") sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the Partnership or the General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, effective October 22, 1993, Hutton Real Estate Services XV, Inc. changed its name to NY Real Estate Services 1 Inc. to delete any references to \"Hutton.\"\nPursuant to Section 22(b) of the Partnership Agreement, an affiliate of Lehman has contributed to the capital of NYRES1 $2.5 million in the form of a demand promissory note, which represents the only substantial asset of NYRES1. Such affiliate has a net worth in excess of such amount.\nCertain officers and directors of NYRES1 are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought the protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nThe executive officers and sole director of NYRES1 (none of whom has a family relationship with another) are:\nName \t\tAge \tOffice\nKenneth L. Zakin 46 \tDirector and President Mark Sawicki \t31 \tVice President and Chief Financial Officer\nKenneth L. Zakin has been an officer of NYRES1 since 1989. Mark Sawicki has been an officer of NYRES1 since October 1990.\nKenneth L. Zakin is a Senior Vice President of Lehman and has held such title since November 1988. He is currently a senior manager in Lehman's Capital Preservation and Restructuring (\"CPR\") Group and was formerly group head of the Commercial Property Division of Shearson Lehman Brothers' Direct Investment Management Group responsible for the management and restructuring of limited partnerships owning commercial properties throughout the United States. From January 1985 through November 1988, Mr. Zakin was a Vice President of Shearson Lehman Brothers Inc. Mr. Zakin is a member of the Bar of the State of New York and previously practiced as an attorney in New York City from 1973 to 1984 specializing in the financing, acquisition, disposition, syndication and restructuring of real estate transactions. Mr. Zakin is currently an associate member of the Urban Land Institute, a member of the New York District Council Advisory Services Committee, and is a Director of Lexington Corporate Properties, Inc. He received a Juris Doctor degree from St. John's University School of Law in 1973 and a B.A. degree from Syracuse University in 1969.\nMark Sawicki is a Vice President of Lehman and has been a member of the CPR Group since August 1988. Mr. Sawicki has been involved in the management, restructuring, and administration of real estate limited partnerships and has assisted in the budgeting, auditing, and portfolio review of the CPR Group. Prior to joining Lehman, Mr. Sawicki was a Senior Credit Analyst with Republic National Bank of New York where he was responsible for the credit review of Middle Market and Fortune 500 companies. Mr. Sawicki also worked in London with the accounting firm of Arthur Young as an auditor and as a junior consultant on a project for the National Health Service. Mr. Sawicki received his Bachelor's degree in 1985 from New York University, College of Business and Public Administration, with a concentration in Finance. He also completed the Diploma Program in Real Estate Investment Analysis at the Real Estate Institute of N.Y.U. in December 1991.\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither of the General Partners nor any of their officers or directors received any compensation from the Partnership. See Item 13 below of this Report with respect to certain transactions of the General Partners and their affiliates with the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 30, 1994, no person was known by the Partnership to be the beneficial owner of more than five percent of the Units.\nSet forth below is a chart indicating, as of March 30, 1994, the name and the amount and nature of beneficial ownership of Units held by the General Partners and officers and directors thereof. Only those General Partners and officers and directors thereof which beneficially own any Units are listed. No General Partner or any officer or director thereof, or the officers and directors of the General Partners as a group, beneficially owns in excess of 1% of the total number of Units outstanding.\nBeneficial Ownership of Units\nName of Beneficial Owner \t\tNumber of Units Owned\nBernard H. Mendik \t\t1,276 (1) David R. Greenbaum \t\t 485 (2) Kevin R. Wang\t\t\t 20 (3) Christopher G. Bonk \t\t 49 Michael M. Downey \t\t 33 David L. Sims \t\t\t 16 ----- The General Partners and all officers and directors thereof as a group (10 persons) \t\t1,879 (1)(2)(3) ===== _________________________\n(1) Includes 1,027 Units owned by Mr. Mendik, 200 Units held in trust for Mr. Mendik's children and 49 Units owned by Mendik Realty. Does not include 40 Units owned by Mr. Mendik's wife, as to which he disclaims beneficial ownership.\n(2) Includes 285 Units owned by Mr. Greenbaum and 200 Units owned by Mr. Greenbaum's wife.\n(3) Does not include four Units owned by Mr. Wang's wife, as to which he disclaims beneficial ownership.\nItem 13.","section_13":"Item 13. Certain Business Relationships and Related Transactions\nAs a result of the suspension of cash distributions, neither NYRES1 nor Mendik Corporation received Net Cash from Operations with respect to the year ended December 31, 1993. $57,032.50 of the Partnership's net loss for the 1993 fiscal year was allocated to each of NYRES1 and Mendik Corporation. For a description of the shares of Net Cash From Operations and Sale or Refinancing Proceeds (as defined in the Partnership Agreement) and the allocation of items of income and loss to which the General Partners, the special limited partner, and the Investor Limited Partners are respectively entitled, see Note 4 of Notes to Consolidated Financial Statements.\nPursuant to Section 12 of the Partnership Agreement, Mendik Realty has agreed to limit its payment of leasing commissions at any Property in any year to not more than 3% of the gross operating revenues of that Property in such year less leasing commissions paid to other brokers in connection with that Property in such year. Any excess will be deferred but is payable only if and to the extent such limit is not exceeded in the year paid. As of December 31, 1993, there was a contingent liability of approximately $316,337 to Mendik Realty as a result of leasing commissions earned in prior periods from the 34th Street Property and Park Avenue Property. There is no such contingent liability with respect to any of the other Properties. During 1993, the Partnership paid $454,373 to Mendik Realty, on a consolidated basis, in connection with leasing commissions earned in prior periods from the Park Avenue Property.\nTBC, a former affiliate of NYRES1, provides partnership accounting services and investor relations services to the Partnership. In May 1993, TBC was sold to Mellon Bank Corporation and is no longer an affiliate of NYRES1. During 1993, TBC earned from the Partnership $65,254 for such services and received reimbursement for out-of-pocket expenses of $981.\nB&B Park Avenue L.P., a limited partnership of which Mendik Corporation is a general partner, owns the remaining 40% interest in Two Park Company, the joint venture that owns the Park Avenue Property.\nMendik Realty, an affiliate of Mendik Corporation, receives fees for the management of the Partnership's Properties and is reimbursed for the cost of on-site building management staff. During 1993, Mendik Realty earned management fees of $700,725 from the Partnership and were reimbursed $527,019 for the cost of on-site building management salaries.\nDuring 1993, the General Partners or their affiliates made certain loans to the Partnership and Mendik Realty deferred certain management fees payable to it by the Partnership in connection with the Stamford Property and the 34th Street Property. During 1994, Mendik Realty will continue to defer fees and leasing commissions in connection with the Stamford Property and 34th Street Property. See the information under the captions \"Stamford Property\" and \"34th Street Property\" in Item 2 of this Report. See Note 8 of Notes to the Consolidated Financial Statements.\nBuilding Management Service Corporation (\"BMSC\"), an affiliate of Mendik Corporation, performs cleaning and related services for the properties at cost. As of January 1, 1993, Guard Management Service Corporation (\"GMSC\"), an affiliate of Mendik Corporation, began providing security services at the Park Avenue Property and Saxon Woods Corporate Center, which services will be provided by GMSC at cost. During 1993, GMSC and BMSC earned from the Partnership $4,581,196 for such services.\nSee Note 8 of Notes to Consolidated Financial Statements for additional information concerning amounts paid or accrued to the General Partners and their affiliates during the years ended December 31, 1993, 1992 and 1991 and all balances unpaid at December 31, 1993.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) (1),(2) See page 20.\n(3) See Index to Exhibits contained herein.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed in the fourth quarter of fiscal year 1993.\n(c) See Index to Exhibits contained herein.\n(d) See page 20.\nINDEX TO EXHIBITS\nExhibit No.\n3 (a) Amended and Restated Certificate and Agreement of Limited Partnership of the Partnership (included as Exhibit A to the Prospectus of Registrant dated April 7, 1986 included as Exhibit 28(b) to the 1986 Annual Report on Form 10-K of the Partnership and incorporated herein by reference thereto).\n(b) Amendments to Amended and Restated Certificate and Agreement of Limited Partnership of the Partnership (included as Exhibit A to the Prospectus Amendment of Registrant dated April 29, 1987 included as Exhibit 29(c) to the 1989 Annual Report on Form 10-K of the Partnership and incorporated herein by reference thereto).\n10 (a) Form of Property Management Agreement between the Partnership and Mendik Realty Company, Inc. (included as Exhibit 10(a) to Amendment No. 2 to the Registration Statement (Registration No. 33-01779) (the \"Registration Statement\") and incorporated herein by reference thereto).\n(b) James Felt Realty Services appraisal of the Stamford Property (included as Exhibit 10(b) to the Registration Statement and incorporated herein by reference thereto).\n(c) Contract of Sale, dated June 25, 1985, between 1351 Washington Blvd. Limited Partnership, Bernard H. Mendik and Hutton Real Estate Services XV, Inc. and related assignments (included as Exhibit 10(f) to Amendment No. 1 to the Registration Statement and incorporated herein by reference thereto).\n(d) Cushman & Wakefield, Inc. appraisal of Saxon Woods Corporate Center (included as Exhibit 10(g) to Amendment No. 2 to the Registration Statement and incorporated herein by reference thereto).\n(e) Copies of Ground Leases relating to Saxon Woods Corporate Center (included as Exhibit 10(h) to Amendment No. 2 to the Registration Statement and incorporated herein by reference thereto).\n(f) Memorandum of Contract, dated December 24, 1985, between The Prudential Insurance Company of America and 550\/600 Mamaroneck Company relating to the acquisition of Saxon Woods Corporate Center (included as Exhibit 10(i) to Amendment No. 2 to the Registration Statement and incorporated by reference thereto).\n(g) The Weitzman Group, Inc. appraisal of the 330 West 34th Street property (included as Exhibit 10(j) to Post-Effective Amendment No. 2 to the Registration Statement and incorporated herein by reference thereto).\n(h) Copy of Ground Lease relating to the 34th Street property (included as Exhibit 10(k) to Post-Effective Amendment No. 1 to the Registration Statement and incorporated herein by reference thereto).\n(i) Agreement of Assignment of Contract of Sale, dated September 25, 1986, between 330 West 34th Street Associates and M\/H 34th Street Associates (included as Exhibit 10(l) to Post-Effective Amendment No. 1 to the Registration Statement and incorporated herein by reference thereto).\n(j) Agreement, dated December 5, 1986, between Park Fee Associates, The Mendik Company, Chase Investors Management Corporation New York and M\/H Two Park Associates relating to the acquisition of the Park Avenue Property (included as Exhibit 10(m) to Post-Effective Amendment No. 1 to the Registration Statement and incorporated by reference thereto).\n(k) James Felt Realty Services appraisal of the Park Avenue Property (included as Exhibit 10(n) to Post-Effective Amendment No. 7 to the Registration Statement and incorporated herein by reference thereto).\nExhibit No.\n(l) Exhibits (l) through (aa) to the Partnership's Form 10-K for the fiscal year ended December 31, 1990 are incorporated herein by reference thereto.\n(m) Loan Agreement of $6,500,000 to Mendik Real Estate Limited Partnership from Friesch-Groningsche Hypotheekbank Realty Credit Corporation dated September 25, 1991 secured by the Saxon Woods Corporate Center (included as Exhibit 10(m) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(n) Appraisal of the 34th Street Property as of January 1992 by Cushman & Wakefield, Inc. (included as Exhibit 10(n) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(o) Letter Opinion of Value of the Park Avenue Property as of January 1992 by Cushman & Wakefield, Inc. (included as Exhibit 10(o) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(p) Letter Opinion of Value of the Stamford Property as of January 1992 by Cushman & Wakefield, Inc. (included as Exhibit 10(p) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(q) Letter Opinion of Value of the Saxon Woods Corporate Center as of January 1992 by Cushman & Wakefield, Inc. (included as Exhibit 10(q) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(r) Modification effective January 1, 1991 of the $12,500,000 first mortgage loan secured by the Stamford Property between New York Life Insurance Company and the Partnership (included as Exhibit 10(r) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(s) Reimbursement Agreement dated as of January 1, 1991 among the Partnership, Mendik Realty, Mendik Corporation and SLH Lending Corp. related to the deferral of management fees and loans made to the Partnership with respect to the Stamford Property (included as Exhibit 10(s) to the Partnership's Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto).\n(t) Agreement dated as of January 1, 1992 among the Partnership, Mendik Realty, Mendik Corporation and SLH Lending Corp. (included as Exhibit 10(a) to the Partnership's Form 10-Q for the quarter ended June 30, 1992 and incorporated herein by reference thereto).\n(u) Appraisal of the 34th Street Property as of January 1993 by Cushman & Wakefield, Inc. (included as Exhibit 10(u) to the Partnership's Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference thereto).\n(v) Letter Opinion of Value of the Park Avenue Property as of January 1993 by Cushman & Wakefield, Inc. (included as Exhibit 10(v) to the Partnership's Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference thereto).\n(w) Letter Opinion of Value of the Stamford Property as of January 1993 by Cushman & Wakefield, Inc. (included as Exhibit 10(w) to the Partnership's Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference thereto).\n(x) Letter Opinion of Value of the Saxon Woods Corporate Center as of January 1993 by Cushman & Wakefield, Inc. (included as Exhibit 10 (x) to the Partnership's Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference thereto).\nForm 10-K - Item 14 (a) (1) and (2)\nMENDIK REAL ESTATE LIMITED PARTNERSHIP\nINDEX OF THE CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Mendik Real Estate Limited Partnership and Consolidated Venture are included in Item 8:\nIndependent Auditors' Report \t\t\t\nConsolidated Balance Sheets December 31, 1993 and 1992\nConsolidated Statements of Operations for the years ended December 31, 1993, 1992 and 1991 \t\t\nConsolidated Statements of Changes in Partners' Capital (Deficit) for the years ended December 31, 1993, 1992 and 1991 \t\t\t\t\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991 \t\t\nNotes to Consolidated Financial Statements \t\nSchedule XI - Real Estate and accumulated depreciation\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted since (1) the information required is disclosed in the financial statements and the notes thereto; (2) the schedules are not required under the related instructions; or (3) the schedules are inapplicable.\nSIGNATURES\nPursuant 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.\nMENDIK REAL ESTATE LIMITED PARTNERSHIP\nBY: Mendik Corporation General Partner\nDate: March 30, 1994 \tBY: \ts\/David R. Greenbaum\/ \t\t\t\tName: David R. Greenbaum \t\t\t\tTitle: President\nBY: NY Real Estate Services 1 Inc. General Partner\nDate: March 30, 1994 \tBY: \ts\/Kenneth L. Zakin\/ \t\t\t\tName: Kenneth L. Zakin \t\t\t\tTitle: Director and President \t\t\t\t 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 in the capabilities and on the dates indicated.\nNY REAL ESTATE SERVICES 1 INC. A General Partner\nDate: March 30, 1994 \tBY: \ts\/Kenneth L. Zakin\/ \t\t\t\tName: Kenneth L. Zakin \t\t\t\tTitle: Director and President\nDate: March 30, 1994 \tBY: \ts\/Mark Sawicki\/ \t\t\t\tName: Mark Sawicki \t\t\t\tTitle: Vice President and \t\t\t\t\tChief Financial Officer\nPursuant 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 in the capabilities and on the dates indicated.\nMENDIK CORPORATION A General Partner\nDate: March 30, 1994 \tBY: \ts\/Bernard H. Mendik\/ \t\t\t\tName: Bernard H. Mendik \t\t\t\tTitle: Chairman and Director\nDate: March 30, 1994 \tBY: \ts\/David R. Greenbaum\/ \t\t\t\tName: David R. Greenbaum \t\t\t\tTitle: President\nDate: March 30, 1994 \tBY: \ts\/Christopher G. Bonk\/ \t\t\t\tName: Christopher G. Bonk \t\t\t\tTitle: Senior Vice President and Treasurer\nIndependent Auditors' Report\nThe Partners Mendik Real Estate Limited Partnership\nWe have audited the consolidated financial statements of Mendik Real Estate Limited Partnership and Consolidated Venture (a New York Limited Partnership) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mendik Real Estate Limited Partnership and Consolidated Venture at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK\nBoston, Massachusetts February 15, 1994\nNotes to Consolidated Financial Statements December 31, 1993, 1992 and 1991\n1. Organization\nMendik Real Estate Limited Partnership (the \"Partnership\") was organized as a limited partnership under the laws of the State of New York pursuant to a Certificate and Agreement of Limited Partnership dated and filed October 30, 1985 (the \"Partnership Agreement\") and subsequently amended and restated on February 25, 1986. The Partnership was formed for the purpose of acquiring, maintaining and operating income producing commercial office buildings in the Greater New York Metropolitan Area. The general partners of the Partnership are Mendik Corporation and NYRES1 (See below). The Partnership will continue until December 31, 2025, unless sooner terminated in accordance with the terms of the Partnership Agreement. The Partnership offered Class A units to taxable investors and Class B units to tax exempt investors.\nOn July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the general partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, effective October 22, 1993, Hutton Real Estate Services XV, Inc., a general partner, changed its name to NY Real Estate Services 1 Inc. (\"NYRES1\") to delete any reference to \"Hutton.\"\n2. Liquidity\nThe commercial real estate market in the Greater New York Metropolitan Area remains weak. As vacancy rates continue to rise, increased competition among landlords has led to lower rents and increasingly generous tenant concession packages in the form of tenant improvements and free-rent periods. The significant cost of tenant improvements required to be funded under both new and renewal leases has sharply increased the demand for capital by landlords, including the Partnership. Expenditures for tenant improvements have contributed to the Partnership's reduced liquidity. In order to conserve the Partnership's limited resources, the General Partners have pursued a strategy intended to position each of the Partnership's four properties, to the extent possible, to meet its operating and other expenses as they come due using only the operating income generated by that property, and if necessary, proceeds from borrowings secured by such property.\nDuring 1993, the Partnership funded operating costs, the cost of tenant improvements, leasing commissions and building capital improvements from five sources: (i) positive cash flow generated by the approximately 60% joint venture interest in the Park Avenue Property and the Partnership's leasehold interest in the Saxon Woods Corporate Center, (ii) Partnership reserves, (iii) funds provided by certain unsecured loans and the deferral of property management fees by certain affiliates of the General Partners, (iv) additional borrowings from the $6.5 million Saxon Woods Line of Credit and (v) a portion of the $1.25 million security deposit maintained by the unaffiliated ground lessor for the 330 West 34th Street Property. It is expected that the availability of funds from some of these sources will be reduced in the future.\nPark Avenue Property - Although the Partnership has continued to lease space at the Property, with the continuing softness in the real estate market, new and renewal leases generally have been signed at rental rates significantly less than the rental rates received on certain expiring leases. The Property's cash flow, however, is expected to remain stable for the foreseeable future because rental rate increases negotiated in leases signed in earlier years have offset the lower market rental rates reflected in the leases recently signed by the Partnership.\nAt December 31, 1993, the unrestricted cash balance at the Property was approximately $5 million over and above a reserve for real estate taxes. The Park Avenue Property currently generates, and is expected to generate in the future, sufficient revenue to cover operating expenses and debt service obligations. The indebtedness secured by the Park Avenue Property currently matures in 1998 (or 1996 at the option of the lender). The Partnership expects, as the maturity of the loan approaches, to commence negotiations to extend the existing loan or to seek refinancing. However, as a result of the current lack of liquidity in the financial marketplace, no assurances can be made that the Partnership will be able to extend with the existing lender or refinance with a new lender, on terms acceptable to the Partnership or at all.\nThe property was 89% and 90% occupied at December 31, 1993 and 1992, respectively.\nSaxon Woods Corporate Center - The Partnership expects that cash flow from the Saxon Woods Corporate Center will cover operating expenses and debt service obligations in 1994. Although the Saxon Woods Line of Credit is in the amount of up to $6.5 million, as a result of Section 13(d) (xviii) of the Partnership Agreement which prohibits the Partnership from incurring indebtedness secured by a Property in excess of 40% of the then-appraised value of such Property (or 40% of the value of such Property as determined by the lender as of the date of financing or refinancing, if such value is lower) (the \"Borrowing Limitation\"), the Partnership is permitted to borrow only $6 million based upon the most recent appraisal of the Saxon Woods Corporate Center which as of December 31, 1993 was $15 million. The loan agreement provides that all available cash flow from the Saxon Woods Corporate Center will be used for expenses incurred at the Saxon Woods Corporate Center prior to borrowing additional funds under the Saxon Woods Line of Credit. The General Partners expect that additional leasing activity, the costs of which will be partially funded by borrowing amounts remaining available under the Saxon Woods Line of Credit, may result in an increase in the appraised value of the Property thereby enabling the Partnership to borrow the additional amounts available under the Saxon Woods Line of Credit up to the full amount of $6.5 million. There can be no assurance that future appraisals will reflect an increase in the Property's value which would enable the Partnership to borrow additional funds. As of December 31, 1993, the Partnership had borrowed $4,542,677 under the Saxon Woods Line of Credit. In January 1994 the Partnership borrowed an additional $138,000 and had made commitments to borrow an additional $362,000 which would increase the total borrowings on the Saxon Woods Line of Credit to $5,042,677.\nThe indebtedness secured by the Saxon Woods Corporate Center currently matures in 1996. The Partnership expects, as the maturity of the loan approaches, to commence negotiations to extend the existing loan or to seek refinancing. However, as a result of the current lack of liquidity in the financial marketplace, no assurances can be made that the Partnership will be able to extend with the existing lender or refinance with a new lender, on terms acceptable to the Partnership or at all.\nThe property was 72% and 67% occupied at December 31, 1993 and 1992, respectively.\n34th Street Property - On February 17, 1993, the Partnership signed a long-term lease with the City of New York effective August 1, 1992 for approximately 300,000 square feet in the 34th Street Property. The terms of the lease call for the City to make annual base rental payments of approximately $5.4 million and pay its proportionate share of increases in real estate taxes and operating expenses. Approximately $1.25 million is being spent by the Partnership for tenant improvements under the terms of the lease. As of December 31, 1993 virtually all of these funds have been spent. In order to fund the tenant improvements required by the City lease, the Partnership negotiated an agreement with the unaffiliated ground lessor pursuant to which the ground lessor agreed to make available the $1.25 million that was being held as security under the ground lease. The ground lessor also agreed to waive the lease requirement that the Partnership deposit an additional $1 million as security with the ground lessor in connection with the increase in the annual ground rent in 1992 to $2.25 million.\nIn order to improve the 34th Street Property's cash flow, beginning in January 1992, Mendik Realty Company, Inc. (\"Mendik Realty\"), an affiliate of Mendik Corporation, voluntarily agreed to defer its management fees of approximately $170,000 a year that would otherwise have been payable with respect to the 34th Street Property. The Partnership's obligation to pay the management fees deferred by Mendik Realty, will be on a non-recourse basis to the Partnership and will bear interest at a rate per annum equal to the prime rate of Morgan Guaranty Trust Company of New York less 1.25%. Principal and interest will be payable on December 31, 2025, or such earlier date on which the term of the Partnership terminates, subject to a mandatory prepayment from the net proceeds from the sale of any of the Properties, after repayment of all debt secured by the Property sold. In addition, Mendik Realty agreed to defer its leasing commission in the amount of $153,182 with respect to the signing of the long-term lease with the City of New York and any further leasing commissions associated with additional leasing activity at the Property. Both of these provisions will remain in effect pursuant to the terms of the forbearance agreement with The First National Bank of Chicago (\"FNBC\") (see below). Additionally, the forbearance agreement gives FNBC control of the property's cash flow by requiring the Partnership to maintain a lockbox at FNBC. FNBC will approve all releases of funds from the lockbox. As of December 31, 1993, approximately $1 million was on deposit in the lockbox account maintained by FNBC.\nDuring 1992, the cash flow from the 34th Street Property did not cover its debt service obligations after payment of operating expenses, and it was not expected to meet its debt service obligations in 1993. As a result, in order to conserve the Partnership's limited working capital reserves and induce FNBC, the Property's lender, to modify the mortgage's terms, the Partnership suspended its interest payments to FNBC beginning in September 1992. On August 12, 1993, the Partnership entered into a forbearance agreement which modified the terms of the 34th Street Line of Credit. Pursuant to the forbearance agreement, FNBC agreed to forbear through June 30, 1994 from exercising its remedies under the loan agreement as a result of the Partnership's failure to pay interest. The forbearance agreement will also allow the Partnership to pay off the 34th Street Line of Credit for $6.5 million, a substantial discount to the current outstanding balance, at any time through June 30, 1994. As of December 31, 1993, there was $15 million of principal and approximately $1.3 million of accrued interest outstanding on the 34th Street Line of Credit. Also through June 30, 1994, the Partnership will be permitted to make interest payments to FNBC only to the extent of available cash flow from the 34th Street Property. Since the forbearance agreement went into effect, the Partnership has not made any interest payments to FNBC. The General Partners are seeking to obtain either debt or equity financing even if such financing would entail the Partnership's transferring all or a portion of its interest in the Property to the party providing the financing. In the event the Partnership obtains from a third party an offer to provide financing of less than the $6.5 million required by FNBC, the Partnership would explore with FNBC a pay off at a further discount. As of December 31, 1993, the 34th Street Property's appraised value was $9.8 million. Should the Partnership be unable to pay off the 34th Street Line of Credit by June 30, 1994, the forbearance agreement provides that the Partnership will assign its interest in the property and in the ground lease to the Property to FNBC, at FNBC's election, in lieu of foreclosure. The forbearance agreement with FNBC provides the Partnership with an opportunity to pay off the 34th Street Line of Credit at a substantial discount while at the same time establishing a cost-effective means to ensure an orderly and efficient transfer of the Property to FNBC in the event the 34th Street Line of Credit cannot be paid off. The Partnership has no assurances that it will be able to obtain the financing necessary to pay off the 34th Street Line of Credit and any such pay off will depend on numerous factors including general market conditions. Chief among these is the fact that many traditional sources of real estate financing such as banks, insurance companies and pension funds have dramatically curtailed their investment in commercial office properties. Consequently, only a limited number of investors is likely to be available, further hampering the Partnership's ability to secure a refinancing. Should the Partnership be unable to complete a refinancing, it might result in the loss of the Partnership's investment in the Property.\nThe property was 64% and 50% occupied at December 31, 1993 and 1992, respectively.\nStamford Property - The Partnership previously restructured the loan secured by the Stamford Property in 1991. As part of the terms of the restructured loan, Mendik Corporation and an affiliate of NYRES1 loaned in each of 1991, 1992 and 1993 $50,000 and $110,000, respectively, to the Partnership. The loans were required to be deposited in an escrow account and may be used only to pay costs and expenses related to the Stamford Property. Mendik Realty also agreed to defer its management fees of approximately $70,000 a year in connection with the Stamford Property in each of calendar years 1991, 1992 and 1993.\nThe restructuring was intended to enable the Stamford Property to generate sufficient cash flow to meet its operating expenses and debt service obligations through 1993 without utilizing the Partnership's working capital reserves in the hope that the Stamford real estate market would recover and that, as leases at the Property expired, the Partnership would be able to enter into new or renewal leases at rental rates in excess of the rates being paid by existing tenants under current leases. However, the Stamford real estate market has continued to deteriorate resulting in a further erosion of market lease rates. While the cash flow from the Stamford Property, together with the loans by Mendik Corporation and an affiliate of NYRES1 and the management fee deferrals by Mendik Realty, were sufficient to cover the Property's operating expenses and debt service obligations in 1993, due to a decline in the Property's revenue following the extension of D&B Computing Services, Inc.'s (\"D&B\") lease, the Partnership failed to make full payment of debt service due on February 10, 1994 and March 10, 1994 with respect to the Stamford Loan. In order to preserve its limited working capital reserves, the Partnership currently does not intend to fund any operating shortfalls out of reserves. As a result of the Partnership's failure to make these interest payments, the Partnership is in default under the terms of the Stamford Loan and the Property's lender, New York Life Insurance Company (\"New York Life\"), may elect to exercise its remedies under the loan agreement including accelerating the maturity date of the principal balance of the loan and electing to foreclose on its mortgage. The General Partners are now seeking a short-term agreement from New York Life, pursuant to which New York Life would forbear from exercising its remedies under the Stamford Loan and Mendik\nNet Loss Per Limited Partnership Unit. Net loss per limited partnership unit is based upon the limited partnership units outstanding during the year and the loss allocated to the limited partners in accordance with the terms of the Partnership Agreement.\n4. The Partnership Agreement\nThe Partnership Agreement provides that the net cash from operations, as defined, for each fiscal year will be distributed on a quarterly basis, 99% to the limited partners and 1% to the general partners (as defined) until each limited partner has received an amount equal to an 8% annual preferred return. The net cash from operations will then be distributed, 99% to the special limited partner, Bernard H. Mendik, and 1% to Mendik Corporation until the special limited partner has received his special preferred return (as defined). Thereafter, net cash from operations will be distributed 85% to the limited partners, 14% to the special limited partner and 1% to the general partners.\nNet proceeds from sales or refinancing will be distributed first to the limited partners until each limited partner has received an 8% cumulative annual return (as defined) and then an additional amount equal to his adjusted capital contribution (as defined). Second, the net proceeds from sale or refinancing will be distributed 99% to the special limited partner and 1% to the Mendik Corporation until the special limited partner has received any shortfall on his special cumulative return (as defined). Third, the net proceeds will be distributed to the general partners until the general partners have received their deferred incentive shares (as defined). Thereafter, net proceeds will be distributed 75% to the limited partners, 20.33% to the special limited partner and 4.67% to the general partners.\nTaxable income and all depreciation for any fiscal year shall be allocated in substantially the same manner as net cash from operations except that depreciation allocated to the limited partners will be allocated solely to the Class A units (for taxable investors). Tax losses for any fiscal year will generally be allocated to the limited partners and special limited partner to the extent of their positive capital accounts and then 99% to the limited partners and 1% to the general partners.\n5. Real Estate Investments\nThe major tenants described below represented 49% of the Partnership's rental income in 1993. See Note 2 for leasing activity.\nThe Stamford Property. In 1985, the Partnership acquired the Stamford Property, a ten-story office building containing approximately 220,000 net rentable square feet (based on current standards of measurement) and an attached parking garage located on 1351 Washington Blvd. in Stamford, Connecticut. The purchase price of the property was $31,250,000. The property was appraised at $9,150,000 at December 31, 1993 as compared to $10,600,000 at December 31, 1992.\nMajor tenants at the Stamford Property are Electronic Information Systems which leases 25,846 square feet (12% of the total leasable area in the property) under a lease expiring March 31, 1998, D&B which leases 43,100 square feet (20% of the total leasable area in the property) under a lease expiring December 31, 1993, Automatic Data Processing, Inc. (\"ADP\") which leases 34,700 square feet (16% of the total leasable area in the property) under a lease expiring June 30, 1994 and Wyatt Company, Inc. which leases, but does not occupy, 17,000 square feet (8% of the total leasable area in the property) under a lease expiring August 31, 1995. ADP has subleased approximately 69% of its space.\nThe Saxon Woods Corporate Center. In 1986, the Partnership acquired Saxon Woods Corporate Center, two office buildings located in Harrison, New York containing an aggregate of approximately 237,000 net rentable square feet (based on current standards of measurement), from an affiliate of the Partnership.\nThe property was purchased by the affiliate for the purpose of facilitating the acquisition by the Partnership. The purchase price of $21,282,805 was paid from the proceeds of the Partnership's offering and consisted of the purchase price to the affiliate plus the acquisition and closing costs and costs associated with carrying the property.\nThe buildings are situated on a 15.28 acre site which is subject to two ground leases, each of which terminates in September 2027 and provides the lessee with the option to renew for two 25-year periods and one 39-year period.\nEach ground lease provides for an annual net rental of $170,000 with an increase of $20,000 every five years, commencing January 1996. The property was appraised at $15,000,000 at December 31, 1993 as compared to $14,000,000 at December 31, 1992.\nMajor tenants at the Saxon Woods Corporate Center are Commodity Quotations which leases 24,540 square feet (10% of the total leasable area) under leases expiring October 31, 2001 and October 31, 1998. Commodity Quotations has the option to cancel the lease expiring October 31, 2001 at the end of the seventh year, October 23, 1998. Icon Capital Corp. leases 29,040 square feet (12% of the total leasable area) under a lease expiring November 30, 2004. Commodity Quotations and Icon Capital Corp represented approximately 13% and 16%, respectively, of the property's rental income in 1993.\nThe 34th Street Property. In 1987, the Partnership acquired the 34th Street Property, an eighteen-story office building containing approximately 627,000 net rentable square feet (based on current standards of measurement) from an affiliate of the Partnership. The building was purchased by the affiliate for the purpose of facilitating the acquisition by the Partnership. The purchase price of $35,611,400 consisted of the purchase price to the affiliate plus the acquisition and closing costs and costs associated with carrying the property. The building is situated on a 46,413 square foot site.\nThe parcel of land underlying the 34th Street Property is leased from an unaffiliated third party pursuant to a ground lease with an initial term ending on December 31, 1999 that provided for annual lease payments of $1.25 million through December 31, 1991 and requires annual lease payments of $2.25 million for the remaining eight years. The ground lease may be renewed at the option of the Partnership for successive terms of 21, 30, 30, 30 and 39 years at annual rentals, determined at the commencement of each renewal term, equal to 7% of the then-market value of the land considered as if vacant, unimproved and unencumbered, valued at the highest and best use under then-applicable zoning and other land use regulations as office, hotel or residential property, but in no event less than the higher of (i) $2.75 million or (ii) the base rent for any consecutive 12-month period during the then-preceding renewal term. The property was appraised at $9,800,000 at December 31, 1993. The appraised value at December 31, 1992 was $12,500,000.\nThe major tenant at the 34th Street property is the City which leases 300,000 square feet (48% of the total leasable area in the property) under a lease expiring February 28, 2001. The City has the option to terminate its lease without penalty effective anytime from March 31, 1993 to February 28, 2001 provided that the City gives the Partnership one year's notice of its intent to terminate the lease. The City will also be required to pay the Partnership for certain improvement costs as defined in accordance with the terms of the lease agreement. The City represented approximately 92% of the property's total revenue in 1993.\nThe Park Avenue Property. In 1987, the Partnership indirectly acquired from an affiliate an approximate 60% interest in a joint venture, Two Park Company, formed in 1986 for the purpose of acquiring and operating a parcel of land located at Two Park Avenue, New York, New York, together with the 28-story office building and related improvements located thereon containing approximately 956,000 net rentable square feet (based on current standards of measurement). The affiliate acquired such interest to facilitate the acquisition by the Partnership. Two Park Company acquired the Park Avenue Property in 1986 from an unaffiliated seller for approximately $151.5 million, $60 million of which was financed by a first mortgage loan. The Partnership acquired its interest by contributing $61,868,264 in cash, and assuming its share of the $60 million loan secured by a first mortgage on the property. The remaining approximate 40% interest in Two Park Company is owned by B & B Park Avenue L.P., an affiliate of Mendik Corporation. At December 31, 1993, the property was appraised at $115,000,000 ($125,000,000 at December 31, 1992), and the appraised value of the property net of the minority interest was $68,655,000 ($74,625,000 at December 31, 1992).\nMajor tenants at Two Park Avenue are Times Mirror Magazines, Inc. and its affiliate Newsday, Inc. which lease 262,774 square feet (28% of total leasable area in the property) under two leases expiring June 30, 2004 and National Benefit Life Insurance Company which leases 99,800 square feet (11% of total leasable area in the property) under a lease expiring May 30, 1998. Times Mirror Magazines, Inc. and its affiliate Newsday, Inc. and National Benefit Life Insurance Company represented 32% and 14%, respectively, of the property's total rental income in 1993.\n6. Mortgage and Notes Payable\nThe Partnership is currently only able to incur additional indebtedness secured by the Saxon Woods Property (See Note 2).\nThe Stamford Property The $12,500,000 non-recourse first mortgage loan is for a term of ten years and accrues interest at the rate of 10% per annum through December 10, 1993 and 10.3% thereafter (See below) (the \"Stamford Loan\"). While the $12,500,000 principal amount outstanding currently exceeds the Borrowing Limitation, it did not exceed the Borrowing Limitation when the loan was incurred. The loan was modified effective January 1, 1991. Prior to modification interest only was payable in monthly installments of $104,167 through July 10, 1991. Thereafter, constant monthly installments in the amount of $113,625 were to be applied first to the payment of interest, then the balance to the reduction of principal through the maturity date, July 10, 1996, at which time the balance of principal and any accrued interest was to be due and payable.\nUnder the terms of the loan modification one-half of the monthly interest payments due under the loan from January 10, 1991 to December 10, 1991 are deferred until July 10, 1996, the loan's maturity date, and bear interest at the rate of 10% per annum (collectively, the \"Deferred Interest\"). During the period from December 10, 1991 to December 10, 1993, monthly payments of interest only were due at the rate of 10% per annum on the principal balance of the note. In addition, principal amortization payments previously required to be paid commencing August 10, 1991 have been deferred until the maturity of the loan. Commencing December 10, 1993 through the maturity date of the loan, interest is payable on the principal balance of the loan and the Deferred Interest at the rate of 10.3% per annum. If the Partnership prepays the Deferred Interest in full, interest under the loan will be reduced to 10% per annum. Deferred interest payable at December 31, 1993 is $798,777.\nThe loan modification requires that in each of calendar years 1991, 1992 and 1993, (i) Mendik Corporation will lend the Partnership $50,000, (ii) an affiliate of NYRES1 will lend the Partnership $110,000, and (iii) Mendik Realty Company, Inc. will defer management fees of approximately $70,000 a year payable to it in connection with services performed at the Stamford Property.\nThe loans by Mendik Corporation and the affiliate of NYRES1 are required to be deposited in an escrow account and may be used only to pay building improvement costs, lease-up costs and operating expenses related to the Stamford Property. Accordingly, as of December 31, 1993, $281,071 is being held as restricted cash with respect to these loans and fees. The loans and management fee deferral by Mendik Corporation, Mendik Realty and the affiliate of NYRES1 are on a non-recourse basis and bear interest at the prime rate less 1.25%. Principal and interest is payable on December 31, 2025, or upon termination of the Partnership if earlier, subject to a mandatory prepayment from the net proceeds from the sale of any of the properties, after repayment of all debt secured by the property sold.\nThe Partnership failed to make full payment of debt service due on February 10, 1994 and March 10, 1994 with respect to the Stamford Loan due to a decline in the property's revenue following the extension of D&B's lease. As a result, the Partnership is in default under the terms of the Stamford Loan. The General Partners are currently attempting to negotiate a further modification of the property's loan, however, no agreement has been reached to date. It appears unlikely that such efforts will be successful. Should the Partnership be unable to secure a loan modification, the lender may elect to exercise its remedies under the loan agreement including accelerating the maturity date of the principal balance of the loan. Should title to the property ultimately be transferred to the lender, it would result in the loss of the Partnership's investment in the property.\nThe Saxon Woods Corporate Center. In September 1991, the Partnership established a non-recourse line of credit of $6,500,000 (the \"Saxon Woods line of credit\") secured by the Partnership's leasehold interest in the property located at 550\/600 Mamaroneck Avenue, Harrison, New York (the \"Saxon Woods Property\"). The Saxon Woods line of credit has a term of five (5) years, is secured by a first leasehold mortgage on the Saxon Woods Property and generally bears interest at the rate of 2.5% per annum in excess of the London Interbank Offered Rate (\"LIBOR\"). The interest rate was 5.875% at December 31, 1993. In addition, the Partnership is required to pay 1\/2% per annum on the undrawn balance of the Saxon Woods line of credit. As additional security for the repayment of the Saxon Woods line of credit, the Partnership deposited $500,000 with the lender, which deposit was used by the Partnership to pay operating expenses in connection with the Saxon Woods Property prior to borrowing any sums under the Saxon Woods line of credit for\noperating expenses. The Saxon Woods line of credit provides the partnership with a source of funds to pay for those improvements necessary to lease additional space at the property. In order to reduce the need for additional borrowings under the Saxon Woods line of credit, the Partnership has agreed to use all available cash flow from the Saxon Woods Property (which cash flow has been pledged to the lender) for all expenses incurred at the Saxon Woods Property prior to borrowing any additional funds under the Saxon Woods line of credit.\nBased on the current appraised value of the Saxon Woods Property, only $6,000,000 of the Saxon Woods line of credit is available to the Partnership due to the Borrowing Limitation. The General Partners believe that the Saxon Woods line of credit will provide the Partnership with a source of funds which should be sufficient to pay for those improvements necessary to lease additional space at the property and anticipated operating shortfalls. As of December 31, 1993, the Partnership had borrowed $4,542,677 under the Saxon Woods line of credit. In January 1994, the Partnership borrowed an additional $138,000 and have made commitments to borrow an additional $362,000. The General Partners expect that additional leasing activity, the costs of which will be covered by borrowings from the Saxon Woods Line of Credit, may result in a further increase in the appraised value of the property thereby enabling the Partnership to borrow the additional amounts available under the Saxon Woods Line of Credit up to the full amount of $6,500,000. The Partnership has the option to request an updated appraisal at any time; however, there can be no assurance that subsequent appraised values for the Property will continue to increase.\nThe Park Avenue Property. The $60,000,000 first mortgage is for a term of twelve years and accrues interest at the rate of 9.75% per annum. Interest only is payable in monthly installments until the maturity date (December 19, 1998) at which time the full amount of principal and any accrued interest shall be due and payable. On June 15, 1989, Two Park Company placed a second mortgage on the Park Avenue Property in the amount of $10,000,000. Interest only is payable in monthly installments at a rate of 10.791% through June 15, 1992 and thereafter at the rate of 10.625% through December 19, 1998 at which time the full amount of principal and any accrued interest shall be due and payable.\nOn December 26, 1990, Two Park Company placed a third mortgage on the Park Avenue Property in the amount of $5,000,000. Interest only is payable in monthly installments at a rate of 11.5% through its maturity date of December 19, 1998 at which time the full amount of principal and any accrued interest shall be due and payable. The lender has the right to accelerate the maturity date of the first, second and third mortgage loans (collectively the \"Park Avenue Loans\") to a date not earlier than December 19, 1996 upon at least 180 days prior notice.\nThe loans are being treated as one loan and at any time upon request of Two Park Company, the lender will combine and consolidate all of the loans to make a non-recourse first mortgage loan in the principal amount of $75,000,000. While the $75,000,000 principal outstanding currently exceeds the Borrowing Limitation, it did not exceed the Borrowing Limitation when the loans were incurred.\nThe 34th Street Property. On December 12, 1989, the Partnership entered into a loan agreement with First National Bank of Chicago (the \"Bank\"). The loan provides for a $30,000,000 credit facility in the form of a first mortgage secured by the Partnership's leasehold interest on the 34th Street Property (the \"34th Street line of credit\"). The lender agreed to advance amounts under the credit facility up to 40% of the lesser of the appraised value of the 34th Street Property or the value thereof as determined by the lender. The credit facility matures on May 31, 1997 and provided the Partnership with the flexibility to draw funds at 110 basis points over Libor, or 110 basis points over the Bank's C.D. rate or at the Bank's prime rate. If the net operating income (as defined) for the property is less than 115% of the projected debt service for the property for any six month period, the lender may increase the interest rate to 125 basis points over Libor or 125 basis points over the Bank's C.D. rate. As of December 31, 1993, the Partnership had $15,000,000 outstanding under the credit facility at Libor plus 1.25% per annum. The rate was fixed at 6.4375% for the period from March 20, 1992 to March 18, 1993. The interest rate for the period March 19, 1993 through December 31, 1993 was 6% (see below).\nOf the $30,000,000 maximum principal amount of the credit facility, up to $20,000,000 was permitted to be used by the Partnership for building improvements, tenant improvement allowances and leasing commissions relating to the 34th Street Property, as well as closing costs, interest reserves and mortgage recording tax reserves with respect to the\ncredit facility. The remaining $10,000,000, substantially all of which had been advanced by March 1991, was unrestricted and was allowed to be used by the Partnership for any purpose.\nAs of December 31, 1992, $15,000,000 had been advanced under the 34th Street line of credit. As a result of the default on the loan (See Note 2) and the decline in the appraised value of the 34th Street Property, the Partnership is currently prevented from borrowing any additional funds. While the $15,000,000 principal amount outstanding currently exceeds the Borrowing Limitation and the appraised value, it did not exceed the Borrowing Limitation when the loan was incurred.\nThe Partnership suspended its interest payments to the lender beginning with the September 1992 payment. On August 12, 1993, the Partnership entered into a forbearance agreement which modified the terms of the 34th Street Line of Credit with The First National Bank of Chicago (\"FNBC\"), under which $15 million of principal and approximately $1.3 million of accrued interest is outstanding at December 31, 1993. Pursuant to the forbearance agreement, FNBC agreed to forbear through June 30, 1994 from exercising its remedies under the loan agreement as a result of the Partnership's failure to pay interest. Subject to the terms of the forbearance agreement, the Partnership will have the ability to pay off the 34th Street Line of Credit for $6.5 million, a substantial discount to the current outstanding balance, at any time through June 30, 1994. Also through June 30, 1994, the Partnership will be permitted to make interest payments, based upon the Corporate Base Rate or the prime rate beginning March 19, 1993, to FNBC only to the extent of available cash flow from the 34th Street Property. No interest payments have been made by the Partnership since entering into the forbearance agreement. If the Partnership is not successful in obtaining the financing necessary to pay off the 34th Street Line of Credit by June 30, 1994, the Partnership has agreed to assign its interest in the property and in the ground lease to the Property to FNBC, at FNBC's election, in lieu of foreclosure. This agreement provides the Partnership with an opportunity to pay off the 34th Street Line of Credit at a substantial discount while at the same time establishing a cost-effective means to ensure an orderly and efficient transfer of the Property to FNBC in the event the 34th Street Line of Credit cannot be paid off. The Partnership has no assurances that it will be able to obtain the financing necessary to pay off the 34th Street Line of Credit and any such pay off will depend on numerous factors including general market conditions. Should the Partnership be unable to complete a refinancing, it might result in the loss of the Partnership's investment in the Property.\nThe deferral of management fees and leasing commissions by Mendik Realty will remain in effect pursuant to the terms of the forbearance agreement. Additionally, the forbearance agreement gives FNBC control of the property's cash flow by requiring the Partnership to maintain a lockbox at FNBC. FNBC will approve all releases of funds from the lockbox. As of December 31, 1993, approximately $1 million was on deposit in the lockbox account maintained by FNBC.\n7. Rental Income Under Operating Leases\n8. Transactions With General Partners and Affiliates\n10. Supplementary Information","section_15":""}
{"filename":"810316_1993.txt","cik":"810316","year":"1993","section_1":"Item 1. Business.\nDiamond Shamrock, Inc. (the \"Company\") is the leading independent refiner and marketer of petroleum products in the southwestern United States. The Company operates two crude oil refineries located in Texas and is engaged in the wholesale marketing of refined petroleum products in an eight state area. The Company sells gasoline and convenience merchandise through Company-operated retail outlets concentrated in Texas, Colorado, New Mexico, and Louisiana, and distributes gasolines through independently owned Diamond Shamrock branded outlets in Texas and nearby states. The Company also stores and markets natural gas liquids, and manufactures and markets certain petrochemicals.\nThe Company was incorporated in Delaware in February 1987 to hold all of the capital stock of Diamond Shamrock Refining and Marketing Company (\"DSRMC\"), a wholly owned subsidiary of Maxus Energy Corporation (formerly Diamond Shamrock Corporation) (\"Maxus\"). DSRMC had been operating all of Maxus' refining and marketing business since August 1983. The Company became a publicly owned corporation effective April 30, 1987 as a result of the distribution (the \"Spin- Off\") of its common stock, $.01 par value (the \"Common Stock\"), to the stockholders of Maxus. On February 1, 1990 the name of the Company was changed from Diamond Shamrock R&M, Inc. to Diamond Shamrock, Inc.\nOn December 27, 1993 DSRMC transferred all of the assets associated with its two refineries to Diamond Shamrock Refining Company, L.P., a Delaware limited partnership, which is also a wholly owned subsidiary of the Company, and the two refineries are now operated by that entity.\nA description of the general development and conduct of the business of the Company is set forth below. Consolidated financial information for the Company for the year ended December 31, 1993 and for certain prior years, including Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements, and Selected Financial Data, is attached to this report as Exhibits 13.1 and 13.2, and all such information is incorporated into this report by reference. Information concerning outside sales and operating revenues and operating profit for the Company and each of its business segments for the three years ended December 31, 1993, together with information concerning the identifiable assets of the various business segments as of December 31, 1991, 1992, and 1993, is set forth in Note 4 contained in Exhibit 13.2, which is incorporated herein by reference.\nRefining\nThe Company owns and operates two modern refineries strategically located near its key markets. The McKee Refinery, located near Amarillo, Texas, and the Three Rivers Refinery, located near San Antonio, Texas, have an aggregate refining capacity of approximately 195,000 barrels of crude oil per day (125,000 barrels at the McKee Refinery and 70,000 barrels at the Three Rivers Refinery). The Company operated its refineries at approximately 92% of capacity in 1993 and at levels in excess of 94% in each of the four years preceding 1993. Approximately 94% of the refinery outputs are high-value products, including gasoline, diesel, jet fuels, and liquified petroleum gases. The refineries also produce sulfur, sulfuric acid, ammonium thiosulfate, refinery grade propylene, fuel oil, asphalt, and carbon black oil.\nThe Company believes that it is at or near the top of its peer group in productivity, capacity utilization, and operational cost efficiency. The Company continually strives to increase its refinery efficiency, control costs, retain its competitive edge, and meet changing market demands.\nIn April 1990 the Company completed an upgrade of an existing 10,000 barrel per day reformer located at the McKee Refinery to a 25,000 barrel per day continuous catalyst regeneration unit. This unit has enabled the McKee Refinery to produce significantly more high octane gasolines.\nConstruction of a 30,000 barrel per day diesel desulfurization unit at the McKee Refinery was completed in August 1993. This unit enables the refinery to produce diesel fuel that meets the new federally mandated sulfur specifications which went into effect on October 1, 1993.\nThe completion of certain debottlenecking projects at the McKee Refinery during 1993 increased its refining capacity to approximately 125,000 barrels per day.\nAt the Three Rivers Refinery, construction was completed during 1993 on a 25,000 barrel per day hydrocracker, the expansion of a 10,000 barrel per day continuous regeneration reformer which was installed in 1991, and the expansion of a crude distillation unit which was installed in 1990. The Company also installed a new naptha hydrotreater, light ends unit, and quality-control lab in 1993. The completion of these projects enabled the Three Rivers Refinery to meet federally mandated diesel desulfurization requirements, expand crude oil throughput capacity to 70,000 barrels per day, provide additional octane producing capacity, increase gasoline production at the refinery by approximately 50%, and increase diesel production capacity by approximately 25%.\nThe Company owns a natural gas processing facility located at the McKee Refinery which ceased operating in early 1993. The facility had been operated under an agreement with Maxus entered into in connection with the Spin-Off. Maxus terminated the gas processing agreement as of January 1993 and operation of the facility was phased out. In 1992 this facility had a throughput of approximately 172 million cubic feet of natural gas per day, and recovered approximately 16,100 barrels per day of natural gas liquids. The Company has no present plans to operate the gas processing plant.\nSupply and Distribution\nBecause of the volatility of crude oil prices over recent years, the flexibility to supply the Company's refineries from a variety of sources is an essential part of being competitive. The Company's network of 2,112 miles of crude oil pipelines gives the Company the ability to acquire crude oil directly from producing leases, major domestic oil trading centers, or Gulf Coast ports, and to transport crude oil to the refineries at a competitive cost.\nThe McKee Refinery has access to crude oil from the Texas Panhandle, Oklahoma, southwestern Kansas, and eastern Colorado through approximately 2,023 miles of crude oil pipeline owned or leased (in whole or in part) by the Company. This refinery is also connected by common carrier pipelines to the major crude oil centers of Cushing, Oklahoma and Midland, Texas.\nIn September 1992 the Company completed a 270 mile crude oil pipeline from Wichita Falls, Texas to the McKee Refinery. This pipeline has an initial capacity of 50,000 barrels per day, and it delivered crude oil to the McKee Refinery at the rate of approximately 40,000 barrels per day during 1993. At Wichita Falls the pipeline has access to two major pipelines which transport crude oil from the Texas Gulf Coast into the Mid-Continent region, and to a third pipeline which transports crude oil from major West Texas oil fields.\nThe Three Rivers Refinery has access to crude oil production in South Texas, to West Texas Intermediate crude oil by common carrier pipeline, and to foreign crude oil from the Texas Gulf Coast near Corpus Christi through 89 miles of Company-owned crude oil pipelines connected to third party pipelines and terminals.\nAlthough both of its refineries primarily run \"sweet\" (low-sulfur content) crude, the Company has constructed \"sour\" (high-sulfur content) crude oil tanks at the McKee Refinery, and at the Dixon pump station southeast of the McKee Refinery so that, when economics dictate, a small percentage of sour crude oil can be blended with sweet crude oil for processing.\nThe crude oil requirements of the McKee Refinery are currently satisfied by purchases of domestic crude oil under short-term contracts. With completion of the Wichita Falls to McKee pipeline, this refinery now also has cost-effective access to foreign crude oil. In 1993 the crude oil requirements of the Three Rivers Refinery were supplied by foreign crude oil and by domestic crude oil under short-term contracts. Over 90% of the crude oil processed by the Three Rivers Refinery in 1993 was foreign crude oil, mostly from the North Sea. While the Company has no crude oil reserves and its operations could be adversely affected by fluctuations in availability of crude oil and other supplies, the Company believes that current domestic and foreign sources of crude oil will be sufficient to meet the Company's requirements for the foreseeable future.\nIn January 1994 the Company received a notice terminating the lease arrangement under which the Company currently has use of Fina's terminaling and storage facilities at Harbor Island, near Corpus Christi, Texas. That termination will become effective in January 1995. The Harbor Island facility is one of two crude oil terminaling and storage facilities through which the Company receives shipments of foreign crude oil for its Three Rivers Refinery. The Company is currently in the process of negotiating arrangements to either continue use of the Harbor Island facility or to secure the use of substitute facilities. The Company does not currently anticipate that the termination will have a material effect on its access to crude oil supplies for the Three Rivers Refinery.\nThe Company's refined products are distributed primarily through the Company's approximately 2,460 miles of refined products pipelines and its 15 terminals. The Company's refined products terminal near Dallas, the Southlake Terminal, also receives products from the Explorer Pipeline, a major common carrier of refined products from the Houston area. In late 1989 the Company completed a project to expand its Southlake products pipeline by 15% to 32,500 net barrels per day. In April 1990 the Company completed an expansion project for its Amarillo-Tucumcari-Albuquerque products pipeline. Pipeline capacity to Tucumcari was increased by over 50% to 8,963 net barrels per day, and pipeline capacity to Albuquerque was increased to 8,055 net barrels per day. On December 31, 1993, the Company completed the purchase of one-half of the total interest of Texaco Pipeline Inc. (which was approximately one-third) in the Amarillo- Tucumcari-Albuquerque products pipeline. The Company is currently in the process of again expanding the Amarillo-Tucumcari-Albuquerque products pipeline, to increase capacity by an additional 2,000 barrels per day, with completion anticipated in the second quarter of 1994.\nIn January 1991 the Company completed the construction of turbine fuel loading and measurement facilities at its Southlake Terminal. This facility enables the Company to transport turbine fuel produced at its McKee Refinery to the terminal, then by truck to Love Field in Dallas. The project also included a five mile pipeline connecting the new Southlake Terminal facilities directly to turbine fuel facilities servicing airlines at the Dallas-Fort Worth International Airport.\nIn October 1992 the Company commenced operation of its newly constructed refined products terminal near Laredo, Texas. The project included construction of a 100 mile refined products pipeline connecting the terminal to the Three Rivers Refinery. The new terminal enables the Company to deliver approximately 15,000 barrels per day of refined products to southwest Texas and adjacent market areas in Mexico.\nIn the second quarter of 1993 the Company commenced construction of a refined products pipeline from the McKee Refinery to the Colorado Springs, Colorado area. The project includes a 10-inch pipeline covering approximately 254 miles, and a terminal facility near Colorado Springs. The pipeline will have an initial capacity of 32,000 barrels per day. Completion is anticipated during the first quarter of 1994.\nIn August 1993 the Company connected its product pipeline running from the McKee Refinery to the Southlake Terminal to those of another gasoline refiner and marketer at Wichita Falls, Texas and at Southlake, Texas. The new connections will enable the Company to deliver an additional 2,500 barrels of gasoline per day from the McKee Refinery to Wichita Falls as part of a product exchange arrangement, and to deliver an additional 4,000 to 8,000 barrels of gasoline per day from the McKee Refinery to the Southlake Terminal for sale at a specified margin above the spot market price.\nIn December 1993 the Company announced a plan to construct a 400-mile, 10- inch pipeline from the McKee Refinery to El Paso, Texas, which will have an initial capacity of 32,000 barrels per day of refined products. The Company will also construct a new terminal at El Paso, with total associated storage capacity of 500,000 barrels. The new pipeline will give the Company the capability of delivering refined products from the McKee Refinery to the El Paso market and also give it the capability to deliver refined products to markets in Phoenix and Tucson, Arizona through a common carrier pipeline originating in El Paso. Completion of the new pipeline is anticipated by the end of the second quarter of 1995.\nThe Company has historically entered into product exchange and purchase agreements with unaffiliated companies. Exchange agreements provide for the delivery to unaffiliated companies of refined products at the Company's terminals in exchange for delivery of a similar amount of refined products to the Company by such unaffiliated companies at agreed locations. Purchase agreements involve the purchase by the Company of refined products from unaffiliated companies with delivery occurring at agreed locations. Such arrangements enable the Company to broaden its geographical distribution capabilities and supply markets not connected to its refined products pipeline system. Most of the Company's exchanges and purchase arrangements are long- standing arrangements, but generally can be terminated on 30 to 90 days notice. Some agreements have terms as long as five years. Products are currently received on exchange or by purchase through 49 terminals and distribution points throughout the Company's principal marketing areas.\nMarketing\nThe Company has a strong brand identification in much of its eight-state marketing area. The volume of gasoline the Company sells through its network of 776 Company-operated retail outlets is equal to approximately 47% of the gasoline the Company produces at its refineries. The volume of gasoline the Company sells to independent branded and unbranded jobbers, commercial, and end user accounts, and other marketers exceeds the remainder of the gasoline production at the Company's refineries. To the extent the Company's requirements exceed the production at its refineries, the balance is made up through spot market purchases of gasoline from other refiners.\nTotal motor fuel outlets at the dates indicated below were as follows:\nDecember 31, 1993 1992 1991\nCompany Owned and Operated 504 518 529\nCompany Leased and Operated 272 243 234\nTotal Company Operated 776 761 763\nJobber Operated 1,194 1,163 1,155\nTotal Motor Fuel Outlets 1,970 1,924 1,918\nAs of December 31, 1993, Company-operated retail outlets were located in Texas (622), Colorado (98), Louisiana (37), and New Mexico (19). Most of the Company's outlets are modern, attractive, high-volume gasoline\/convenience stores which sell, in addition to motor fuels, a variety of products such as groceries, health and beauty aids, fast foods, and beverages.\nThe Company plans to open between 25 and 30 new retail outlets during 1994.\nThe Company opened nine newly constructed retail outlets in 1993. In 1993 the Company also purchased 14 retail outlets in Albuquerque, New Mexico, and five retail outlets in El Paso, Texas, all of which were branded \"Vickers\", from Total Petroleum. These outlets have been reidentified under the Diamond Shamrock brand.\nIn 1992 the Company opened 12 newly constructed retail outlets. In 1991 the Company opened 22 newly constructed retail outlets and acquired an additional 89, including 24 stores in El Paso, Texas from National Convenience Stores, and 64 stores in the Dallas to San Antonio corridor from Strasburger Enterprises. During 1990 and 1989 the Company constructed 48 and 44 new retail units, respectively, and completely rebuilt a total of six outlets.\nThe Company has an on-going program to modernize and upgrade the retail outlets it operates. These efforts are designed to improve appearances and create a uniform look easily recognizable by customers. Exterior improvements generally include the installation of new price signs, lighting, and canopies over the gasoline pumping areas. The program also includes the installation of computer-controlled pumping equipment and the renovation of interiors.\nThe Company is continuing its program of closing and selling retail outlets which have marginal profitability or which are situated outside its principal marketing areas. During 1993 the Company closed 11 such outlets.\nAs of December 31, 1993 127 independent jobbers supplied 1,194 \"Diamond Shamrock\" branded retail outlets located in eight states. The Company enjoys long-term relationships with many of its jobbers. Representatives from 20 jobbers make up a Jobber Council that meets on a regular basis with the Company's management to communicate concerns, and to learn about opportunities and developments in the Company's marketing program.\nDuring the past five years the Company has made a number of significant improvements to its jobber assistance programs in an on-going effort to improve the quality of the \"Diamond Shamrock\" brand image. Under one program the Company sets aside an amount for each gallon of Diamond Shamrock branded motor fuels sold by the jobber, which the jobber may then use to help offset expenses for advertising, image improvements, and upgrading of equipment. In 1988 the Company doubled the amount of this per-gallon set aside, and in 1991 increased the amount again by 62.5%. Under another program, the jobber building incentive program, the Company offers financial incentives which may total in excess of $100,000 per site to encourage jobbers to build, refurbish, or rebuild outlets according to Diamond Shamrock plans and guidelines. In early 1993 the Company also implemented a program pursuant to which the Company assists jobbers in securing loans to construct units that meet Diamond Shamrock's plans and image requirements.\nIn July 1993 the Company formed a joint venture for the purpose of franchising the Company's \"Corner Store\" branded convenience stores in Mexico. The stores are operated in conjunction with Pemex gasoline outlets under the name \"Corner Store\", and are patterned after the Company's retail outlets in the United States. The Company anticipates that seven such stores will be open and operating under the franchise arrangement by the end of the first quarter of 1994.\nThe Company sells three grades of high-quality unleaded gasoline products, including mid and high octane grades, all of which contain a detergent package with a polymer additive. This additive package meets all the standard tests generally accepted by researchers and automobile manufacturers for today's more sophisticated engine technology.\nThe Company's competitive position is supported by its own credit card program, with approximately 509,000 active accounts. The Company offers a no fee credit card, and a prestige card marketed as the Diamond Shamrock Club Card which, for an annual fee, offers a debit function that earns an annual credit and certain other features. A credit card program designed especially for use by the operators of fleets of vehicles is also marketed by the Company. Over 61,000 vehicles are now in the program, and during 1993 gasoline sales (including sales by Diamond Shamrock branded jobbers) under the program averaged approximately 4.2 million gallons per month.\nThe Company currently utilizes electronic point of sales credit card processing (\"P.O.S.\") at all of its Company-operated stores, and since early 1990 all of its independent branded jobber outlets have also used the P.O.S. system. P.O.S. reduces transaction time at the retail outlet and lowers the Company's credit card program costs by reducing float, eliminating postage and insurance costs, and reducing bad debts.\nThe Company is in the process of installing a computer based, intelligent retail information system (\"IRIS\") at Company-operated stores. IRIS incorporates an enhanced P.O.S. system and will automate inventory control, pricing, and sales tracking. IRIS interfaces with the Company's continuous underground storage tank monitoring system now being installed. The Company is also installing pump-mounted credit card readers which will interface with IRIS at certain high-volume locations. At December 31, 1993 500 Company-operated stores had been equipped with the IRIS system. The IRIS system is projected to be in place at all Company-operated stores by the end of 1994 and is expected to increase customer convenience and merchandise sales volumes.\nIn connection with its credit card program, the Company developed a computer software system (the Retail Account Management System (\"RAMS\")) which it uses to process credit card transactions and to manage credit card accounts. In June 1989 the Company formed a new subsidiary, D-S Systems, Inc., to license the RAMS software to other proprietary credit card issuers, to process credit card transactions for such issuers, and provide such issuers with certain related services.\nThe \"Corner Store\" concept for the retail outlets that began in 1987 is intended to provide the customer with a message of convenience and friendly customer service. The Company also uses \"Corner Store\" to identify its newly expanded merchandise line. Customers now find a greater variety of merchandise and consistency of appearance from outlet to outlet.\nThe Company actively uses radio, television, newspaper, and billboard advertising to promote the Company and its products. These promotional efforts are facilitated by the concentration of a substantial portion of the Company's outlets in the Texas metropolitan areas of Austin, Corpus Christi, Dallas, El Paso, Fort Worth, Houston, and San Antonio, and in Denver and Colorado Springs, Colorado. The Company considers the \"Diamond Shamrock\" brand name and logo to be of significant importance to its business.\nIn addition to gasoline, the Company also markets an average of 43,774 barrels per day of diesel fuel to branded and non-branded customers, railroads, and large fleet accounts. Asphalt produced at the McKee Refinery is sold to local contractors, primarily to the roofing industry and for road construction. The Company also sells an average of 20,437 barrels per day of high quality jet fuel to commercial airlines and the United States military.\nAllied Businesses\nIn addition to its core refining and marketing businesses, the Company is engaged in several related businesses. In 1988 the Company established its Development and New Ventures group to develop these related businesses, and to explore opportunities for entry into additional fields where the Company has technical, operating, or management expertise. The more significant of these businesses and new ventures are described below.\nThe Company owns and operates large underground natural gas liquids and petrochemical storage and distribution facilities located on the Mont Belvieu salt dome, northeast of Houston. The Company's original facility provided approximately 37 million barrels of storage capacity in 14 wells. In September 1989 the Company acquired a similar facility, XRAL Storage, and Terminaling Company, which added 11 new underground storage wells and approximately 23 million barrels of additional storage capacity to the Company's existing facilities. The total permitted storage capacity of the facilities is currently approximately 76 million barrels. The two facilities are interconnected by pipeline and are utilized for storing and distributing ethane, ethane\/propane mix, propane, butane, and isobutane, as well as refinery, chemical, and polymer- grade propylene. The Mont Belvieu facilities receive products from the McKee Refinery through the Skelly-Belvieu pipeline (in which the Company owns a 50% interest), as well as through major pipelines coming from the Mid-Continent region, West Texas, and New Mexico. In 1993 an average of approximately 529,237 barrels per day of natural gas liquids and petrochemicals moved through the facilities, and was distributed via an extensive network of pipeline connections to various refineries and petrochemical complexes on the Texas and Louisiana Gulf Coasts, earning various storage and distribution fees for the Company.\nIn June 1990 the Company completed a propane\/propylene splitter plant located at the Company's Mont Belvieu hydrocarbon storage facility. A subsidiary of American PetroFina Inc. (\"Fina\") has a one-third interest in the plant. The plant is operated by the Company. Each of the Company and Fina pays its proportionate share of the costs and receive in kind its proportionate share of the products produced at the plant.\nWhen first completed the splitter was capable of producing 600 million pounds of polymer-grade propylene per year. Capacity has since been increased to 720 million pounds per year. Polymer-grade propylene is a feedstock used in the manufacture of plastics. This plant utilizes refinery-grade propylene produced by the Company's refineries and additional refinery-grade propylene purchased from other refiners for feedstock. The Company's storage facilities at Mont Belvieu are used to store both feedstock for the plant and polymer-grade propylene after it is produced. The product is distributed by pipeline to purchasers in the Houston ship channel area and for export. In 1993 the Company's share of production from the splitter totaled approximately 370 million pounds of polymer-grade propylene, and the Company was successful in marketing product in excess of that amount.\nIn December 1991 the Company entered into a joint venture to construct a petrochemical export terminal located on the Houston Ship Channel. The terminal was completed and commenced operation in August 1992. The terminal is connected by pipeline to the Company's propane\/propylene splitter plant and petrochemical storage facilities at Mont Belvieu. The terminal provides the Company with access to international petrochemical markets.\nIn late 1990 the Company repurchased an ammonia production facility located at the McKee Refinery, which had been sold by a predecessor of the Company in the late 1970's. In March 1991 the Company commenced operation of one of the two production units at the plant. In December 1991 the second unit commenced operation. During 1993 the plant produced approximately 359 tons per day of anhydrous ammonia which is marketed by the Company as a fertilizer.\nIn September 1991 the Company and Sol Petroleo, S.A. (\"Sol\"), an Argentine company headquartered in Buenos Aires, jointly acquired the oil and gas exploration and production interests of Occidental Petroleum in the Republic of Bolivia. The operation includes a 100% interest in the Porvenir Field in southeastern Bolivia which has daily sales of approximately 50 million cubic feet of gas and a 50% interest in the Madre de Dios concession in northern Bolivia. This operation is conducted by a staff located in Santa Cruz, Bolivia. In 1992 the Company exchanged a portion of its Bolivian interests for a minority interest in Sol, which owns a small solvents refinery located in Buenos Aires and markets gasoline under the \"Sol\" brand. The venture presently includes twenty branded retail outlets, eight operated by the venture and twelve operated by jobbers.\nIn late 1988 the Company formed a subsidiary to provide environmental testing services, primarily relating to underground petroleum product storage tanks. This subsidiary also designs and installs waste treatment systems and provides environmental services, including cleanup and disposal of industrial waste, tank cleaning, monitoring, site surveying, and record keeping.\nIn August 1989 the Company acquired the assets of an existing telephone services company to form a new subsidiary, North American InTeleCom, Inc. (\"NAI\"), to provide private pay telephone services and telephone services for correctional facilities. At the end of 1993 NAI operated inmate telephone systems in 63 correctional facilities capable of housing some 40,000 inmates and owned or managed approximately 6,900 private pay telephones.\nNAI is currently testing a software system for use by correctional facilities, which will monitor inmates' physical movements, inventories of supplies, and perform certain accounting functions with respect to telephone and commissary charges, trustee fund accounts, and various other inmate-related matters.\nOn March 27, 1992 the Company completed a sale of its wholly-owned subsidiary, Industrial Lubricants Co. (\"Industrial Lubricants\"), to Specialty Oil Company of Shreveport, Louisiana. Industrial Lubricants blends and packages motor oils and other lubricant products. It is also a distributor of a number of major brand motor oils and automotive products.\nCompetitive Considerations\nThe Company's two refineries and refined products pipelines and terminals network are strategically located to service its markets in the states in which the Diamond Shamrock brand is strongly represented. The Company consistently sells more refined products than its refineries produce, purchasing its additional requirements in the spot market. This strategy has enabled the Company to operate its refineries at high rates while allowing for incremental refinery capacity expansions to be quickly utilized upon completion.\nQuality products and a strong brand identification have positioned the Company as the third largest marketer of motor fuels in Texas, with a market share of over 10%, and have led to a growing wholesale and retail market presence for the Company in Colorado (particularly the Denver and Colorado Springs areas), Louisiana, and New Mexico.\nThe Company expects to continue to experience intense competition in all areas of its retail marketing business from major integrated oil and gas companies, and other independent refining and marketing concerns, as well as from national and regional convenience store chains that sell motor fuels. The Company believes that its products compare favorably as to price and quality with the products sold by its competitors.\nThe refining and marketing business has historically been volatile and highly competitive. A refiner's earnings are largely dependent upon its refining margin -- the difference between crude oil and other feedstock costs, and the prices it receives for refined products. In recent years crude oil costs have fluctuated substantially, as have prices of refined products. The industry also tends to be seasonal in that refining margins often begin to increase in the second quarter and decrease in the third quarter of the year, reflecting increased demand for gasoline and other refined products during the summer driving season.\nMany of the Company's competitors are large multi-national oil companies which, because of their diverse operations, may be better able to withstand volatile industry conditions.\nRegulatory Matters\nFederal, state, and local laws and regulations establishing various health and environmental quality standards affect nearly all of the operations of the Company. Included among such statutes are the Clean Air Act of 1955, as amended (\"CAA\"), including substantial amendments adopted in 1990 (the \"Clean Air Act Amendments\"), the Clean Water Act of 1977, as amended (\"CWA\"), the Resource Conservation and Recovery Act of 1976, as amended (\"RCRA\"), and the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"). Also significantly affecting the Company are the rules and regulations of the Occupational Safety and Health Administration (\"OSHA\").\nThe CAA requires the Company to meet certain air emission standards. The CWA requires the Company to obtain and comply with the terms of water discharge permits. The RCRA empowers the Environmental Protection Agency (\"EPA\") to regulate the treatment and disposal of industrial wastes and to regulate the use and operation of underground storage tanks. CERCLA requires notification to the National Response Center of releases of hazardous materials and provides a program to remediate hazardous releases at uncontrolled or abandoned hazardous waste sites. The Superfund Amendments and Reauthorization Act of 1986 (\"SARA\") is an extension of the CERCLA cleanup program. Title III of SARA, the Emergency Planning and Community Right to Know Act of 1986, relates to planning for hazardous material emergencies and provides for a community's right to know about the hazards of chemicals used or manufactured at industrial facilities. The OSHA rules and regulations call for the protection of workers, and provide for a worker's right to know about the hazards of chemicals used or produced at the Company's facilities.\nRegulations issued by the EPA in 1988 with respect to underground storage tanks require the Company, over a period of time of up to ten years, to install, where not already in place, spill prevention manholes, tank overfill protection devices, leak detection devices, and corrosion protection on all underground tanks and piping at retail gasoline outlets. The regulations also require periodic tightness testing of underground tanks and piping. Commencing in 1998, operators will be required under these regulations to install continuous monitoring systems for underground tanks.\nState and local regulations in parts of Texas, New Mexico, and Colorado require that only motor fuels containing higher than the normal levels of oxygen may be marketed in winter months. Such fuels are intended to reduce the amount of carbon monoxide in automobile emissions. The Clean Air Act Amendments required that beginning in November 1992 only oxygenated gasoline having a minimum oxygen content of 2.7% could be marketed in these areas. The level of oxygen in motor fuels is normally raised by the addition of methyl tertiary butyl ether (\"MTBE\"), ethanol, or tertiary amyl methyl ether (\"TAME\"). The Company produces some MTBE at its McKee Refinery and purchases the remainder of such blending components. If other areas currently not identified as severe carbon monoxide or ozone nonattainment areas elect to require the use of oxygenates or reformulated gasoline, the Company may be required to purchase additional blending components. To the extent that the Company is unable to pass along such compliance costs by raising motor fuel prices, the Company's profitability will be adversely affected.\nIn March 1989 the EPA issued Phase I of regulations under authority of the CAA requiring a reduction for the summer months in 1989 in the volatility of gasoline (\"RVP\") (the measure of the amount of light hydrocarbons contained in gasoline, such as normal butane, an octane booster). In June 1990 Phase II of these regulations were issued by the EPA which required further reductions in RVP beginning in May 1992. The Clean Air Act Amendments also established nationwide RVP standards which went into effect as of May 1992, but did not exceed the EPA's Phase II standards. Such regulations required reductions in RVP for gasolines produced at the McKee Refinery for distribution in the Denver and Dallas-Fort Worth markets, beginning May 1, 1992.\nThe Clean Air Act Amendments will impact the Company in the following areas: (i) starting in 1995, a \"reformulated\" gasoline (which would include content standards for oxygen, benzenes, and aromatics) is mandated in the nine worst ozone polluting cities, including Houston, Texas, and other cities may opt into the program, including Dallas and El Paso, Texas; (ii) \"Stage II\" hose and nozzle controls on gas pumps to capture fuel vapors in nonattainment areas, including Beaumont, Dallas, El Paso, Fort Worth and Houston, Texas; and (iii) more stringent refinery and petrochemical permitting requirements.\nIn addition EPA regulations required that after October 1, 1993 the sulfur contained in on-highway diesel fuel produced in the United States must be reduced. Construction of a desulfurization unit at the McKee Refinery and a hydrocracker unit at the Three Rivers Refinery enabled the Company to produce diesel fuel in compliance with such regulations.\nIt is expected that rules and regulations implementing the Clean Air Act Amendments and other federal, state, and local laws relating to health and environmental quality will continue to affect the operations of the Company. The Company cannot predict what health or environmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be administered or enforced with respect to products or activities of the Company. However, compliance with more stringent laws or regulations, as well as more expansive interpretation of existing laws and their more vigorous enforcement by the regulatory agencies could have an adverse effect on the operations of the Company and could require substantial additional expenditures by the Company, such as for the installation and operation of pollution control systems and equipment. Much of the capital spent by the Company for environmental compliance is integrally related to projects that increase refinery capacity or improve product mix, and the Company does not specifically identify capital expenditures related to such projects on the basis of environmental as opposed to economic purpose. However, with respect to capital expenditures budgeted primarily to produce federally-mandated fuels to comply with regulations related to air and water toxic emission levels and for remediation and compliance costs related to underground storage tanks, it is estimated that approximately $21.4 million was spent in 1993, $9.6 million in 1992 and $7.5 million in 1991. For 1994 the Company has budgeted approximately $10.0 million primarily related to environmental capital expenditures for the retail segment to comply with Stage II Vapor recovery requirements and underground storage tank regulations.\nThe Company has in effect policies, practices, and procedures in the areas of pollution control, product safety, and occupational health, the production, handling, storage, use, and transportation of refined petroleum products, and the storage, use, and disposal of hazardous materials to prevent an unreasonable risk of material environmental or other damage, and the material financial liability which could result from such events. However, some risk of environmental or other damage is inherent in the businesses of the Company, as it is with other companies engaged in similar businesses.\nEmployees\nThe Company employs approximately 6,300 people, about 600 of which are part-time employees. Approximately 315 hourly paid workers at the McKee Refinery are affiliated with the Oil, Chemical, and Atomic Workers International Union, AFL-CIO, with which the Company has a contract extending to April 1996. The Company considers its relationship with its employees to be good and has not experienced any organized work stoppage in over 30 years.\nCertain Transactions with Maxus\nIn connection with the Spin-Off in 1987, Maxus and the Company entered into an agreement (the \"Distribution Agreement\") which, among other things, provides that as between the Company and Maxus, the Company will be responsible for liabilities and other obligations relating principally to the Company's business and Maxus will be responsible for all other liabilities relating principally to Maxus' continuing and former businesses, subject to certain cost-sharing arrangements described below.\nThe Distribution Agreement provides for the sharing by Maxus and the Company of certain liabilities (other than product liability) relating to businesses discontinued or disposed of by Maxus prior to April 30, 1987. In substance, the cost of such liabilities will be borne one-third by the Company and two-thirds by Maxus until the Company's aggregate reimbursement share equals $85.0 million, and thereafter solely by Maxus.\nPayments with respect to the obligations to be shared pursuant to the Distribution Agreement are initially made by Maxus, and the Company is obligated to reimburse Maxus for the Company's share of such payments after receipt of Maxus' invoice accompanied by appropriate supporting data. In the fourth quarter of 1989 the Company recorded a non-cash charge as an extraordinary item in the amount of $32.0 million, after taxes, to establish a reserve for such obligations under the Distribution Agreement.\nDuring June 1993 the Emerging Issues Task Force (\"ETIF\") of the Financial Accounting Standards Board (\"FASB\") released the minutes of its May 20, 1993 meeting during which the ETIF announced a consensus with regard to certain issues of \"Accounting for Environmental Liabilities\" (Issue 93-5). The consensus effectively changes the criteria for determining when a liability may be recorded on a discounted method. Consequently, the Company changed the accounting method for recording the liability to reflect the entire unpaid amount rather than the discounted amount of the liability (See Note 3 to the Consolidated Financial Statements contained in Exhibit 13.1 to this report). Although some expenditures are still subject to audit, the Company has reimbursed Maxus for a total of $53.4 million as of December 31, 1993, including $11.3 million paid during 1993.\nPursuant to the Distribution Agreement, the Company will also reimburse Maxus for one-third of all payments made by Maxus after April 30, 1987 for providing certain medical and life insurance benefits with respect to persons who retired on or before the effective date of the Spin-Off. (See Note 6 to the Consolidated Financial Statements contained in Exhibit 13.1 to this report.) The actuarial cost of these expected payments under the Distribution Agreement has been recognized by the Company. (See Note 3 to the Consolidated Financial Statements contained in Exhibit 13.1 to this report.)\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe principal plants and properties used by the Company in its Refining and Wholesale segment are the McKee Refinery, the Three Rivers Refinery, the Company's crude oil and refined products pipelines, and products terminals. For a description of the foregoing, see \"Refining\", and \"Supply and Distribution\" in Item 1 above. The refineries are owned by the Company in fee. Of the Company's 2,112 miles of crude oil pipelines, 2,069 miles are owned in fee and 43 miles are leased under a long-term lease agreement expiring in 1999 which may be extended for up to 30 years. Of the Company's 2,460 miles of refined products pipelines, 364 miles are under a long term lease, and 2,096 miles are owned in fee. 614 miles of the Company's owned crude oil pipelines and 527 miles of its owned refined products pipelines are owned jointly with one or more other companies. The Company's interests in such pipelines are between 33% and 50%. Of the Company's 15 products terminals, 14 are owned in fee and one is leased under an agreement expiring in 1999 which may be renewed for 30 years. All of the terminals are 100% owned or leased by the Company except for one terminal which is owned 60% by the Company.\nThe principal properties used in the Company's Retail segment are 776 Company-operated retail outlets, 504 of which are owned in fee and 272 of which are leased. Of the leased outlets, 166 are currently leased to the Company pursuant to a lease facility entered into in 1992 (which replaced a lease facility with an affiliate of a major securities and money market firm). Financing for the lease facility was expanded by an additional $25 million in April 1993. The facility has an initial five year term which expires in 1997. After the initial five year term the Company may purchase the properties or renew the lease with the lessor's consent for an additional five year term or arrange for a sale of the outlets. (See Note 15 to the Consolidated Financial Statements contained in Exhibit 13.2 to this report.) For a description of the Company-operated retail outlets, see \"Marketing\" in Item 1 above.\nThe principal plants and properties used in the Company's Allied Businesses segment are the hydrocarbon storage facility at Mont Belvieu, which the Company owns, and the jointly-owned propane\/propylene splitter at Mont Belvieu. See Allied Businesses in Item 1 above.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn January 1994 a settlement was reached in a contemplated action by the District Attorney of Santa Clara County, California, against Autotronic Systems, Inc. for failure to expeditiously remediate groundwater contaminated by hydrocarbons at a former gasoline station site. Autotronic Systems, Inc. is a wholly-owned subsidiary of the Company. Autotronic Systems, Inc. agreed to pay a $100,000.00 fine of which $95,000.00 was abated against Autotronic Systems, Inc.'s future remediation expenses at the site. Settlement documents reflecting the fine's abatement and Autotronic Systems, Inc.'s agreement to remediate the site are currently being negotiated.\nThe Company is a party to a number of lawsuits which are ordinary routine litigation incidental to the Company's businesses, the outcomes of which are not expected to have a material adverse effect on the Company's operations or financial position. The Company is engaged in a number of environmental cleanup projects, mostly relating to retail gasoline outlets. While such cleanup projects are typically conducted under the supervision of a governmental authority, they do not involve proceedings seeking monetary sanctions from the Company and are not expected to be material to the Company's operations or financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nInapplicable.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe principal United States market on which the Common Stock is traded is the New York Stock Exchange. The high and low sales prices for the Common Stock for each full quarterly period during 1992 and 1993 as reported on the New York Stock Exchange Composite Tape, together with the amount of cash dividends paid per share of the Common Stock by calendar quarter, are contained in Exhibit 13.2 to this report, which information is incorporated herein by reference.\nThe approximate number of record holders of the Common Stock at March 1, 1994 was 21,241.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information required by this item appears in Exhibit 13.2 to this report, which information is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nThe information required by this item appears in Exhibit 13.1 to this report, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe information required by this item appears in Exhibit 13.2 to this report, which information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nInapplicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information required by this item with respect to the identity and business experience of the directors of the Company appears under the heading \"Election of Directors\" in the Company's definitive Proxy Statement for the 1994 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (the \"Commission\") pursuant to Regulation 14A (the \"Proxy Statement\"), which information is incorporated herein by reference.\nThe following information concerning the executive officers of the Company is as of March 1, 1994.\nRoger R. Hemminghaus, 57, is Chairman of the Board and President of the Company, and has served as the chief executive officer of the Company since April 1987.\nRobert C. Becker, 52, has served as Vice President and Treasurer of the Company since April 1987.\nTimothy J. Fretthold, 44, is Senior Vice President\/Group Executive and General Counsel of the Company. He served as a Group Vice President, and General Counsel of the Company from April 1987 to June 1989.\nGary E. Johnson, 58, has served as Vice President and Controller of the Company since April 1987.\nWilliam R. Klesse, 47, is Senior Vice President\/Group Executive of the Company. He served as Group Vice President - Development and New Ventures of the Company from May 1988 to June 1989. Mr. Klesse served as Group Vice President -Planning and Public Affairs of the Company from April 1987 through May 1988.\nJ. Robert Mehall, 51, is Senior Vice President\/Group Executive of the Company. He served as Group Vice President - Supply of the Company from April 1987 to June 1989.\nA. W. O'Donnell, 61, is Senior Vice President\/Group Executive of the Company. He served as Group Vice President - Marketing of the Company from April 1987 to June 1989.\nJ. E. Prater, 55, is Senior Vice President\/Group Executive of the Company. He served as Group Vice President - Refining of the Company from April 1987 to June 1989.\nOfficers are elected annually by the Board of Directors and may be removed at any time by the Board. There are no family relationships among the executive officers listed or the directors of the Company, and there are no arrangements or understandings pursuant to which any of the officers or directors were elected as such.\nInformation concerning compliance by the directors and executive officers of the Company with Section 16(a) of the Securities Exchange Act of 1934 appears under the heading \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive Proxy Statement for the 1994 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this item appears under the heading \"Compensation of Executive Officers\" in the Proxy Statement, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this item appears under the heading \"Beneficial Ownership of Securities\" in the Proxy Statement, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required by this item with respect to directors appears under the heading \"The Board of Directors and Its Committees - Certain Business Relationships\" in the Proxy Statement, which information is incorporated herein by reference.\nThe information required by this item with respect to executive officers appears under the heading \"Compensation of Executive Officers - Retirement and Other Compensation - Employee Stock Purchase Loan Program\" in the Proxy Statement, which information is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) Documents filed as part of this report:\n(1) Financial Statements\nThe following financial statements are attached hereto as Exhibit 13.2, and are incorporated herein by reference:\nConsolidated Statement of Operations for the three years ended December 31, 1993\nConsolidated Balance Sheet - December 31, 1993 and\nConsolidated Statement of Cash Flows for the three years ended December 31, 1993\nNotes to Consolidated Financial Statements\nSupplementary Financial Information\nThe Report of Independent Accountants relating to such financial statements is attached hereto as Exhibit 13.3, and is incorporated herein by reference.\nCondensed parent company financial information has been omitted, since the amount of restricted net assets of consolidated subsidiaries does not exceed 25% of total consolidated net assets. Also, footnote disclosure regarding restrictions on the ability of both consolidated and unconsolidated subsidiaries to transfer funds to the parent company has been omitted since the amount of such restrictions does not exceed 25% of total consolidated net assets.\n(2) Financial Statement Schedules.\nThe following report of independent accountants and financial statement schedules are also a part of this report:\nReport of Independent Accountants on Financial Statement Schedules\nSchedule V - Consolidated Properties and Equipment\nSchedule VI - Consolidated Accumulated Depreciation\nAll other schedules have been omitted because they are not applicable or the required information is shown in the Financial Statements or the Notes to Consolidated Financial Statements.\n(3) Exhibits.\nExhibit Filing No. Reference Description of Document\n3.1 * Certificate of Incorporation of the Company (Exhibit 3.1 to the Company's Form 10 Registration Statement No. 1-9409 (the \"Form 10\")).\n3.2 * Form of Certificates of Designations of Series A Junior Participating Preferred Stock (Exhibit 3 to the Company's Form 8-A Registration Statement dated March 6, 1990, filed under Commission File No. 1-9409 (the \"Form 8-A for Preferred Stock Purchase Rights\")).\n3.3 * Form of Certificate of Designations establishing 5% Cumulative Convertible Preferred Stock (filed as Exhibit 4.7 to the Company's Form S-3 Registration Statement dated August 6, 1993, under Commission file 33-67166, and incorporated herein by reference).\n3.4 * By-Laws of the Company (Exhibit 3.2 to the Form 10.\n4.1 * Certificate of Incorporation of the Company (Exhibit 3.1 to the Form 10).\n4.2 * By-Laws of the Company (Exhibit 3.2 to the Form 10).\n4.3 * Form of Common Stock Certificate (Exhibit 4.3 to the Form 10).\n4.4 * Form of Indenture between the Company and The First National Bank of Chicago (Exhibit 4.1 to the Company's Form S-1 Registration Statement No. 33-32024 (the \"Form S-1 for Medium-Term Notes\")).\n4.5 * Form of Right Certificate (Exhibit 1 to the Form 8-A for Preferred Stock Purchase Rights).\n4.6 * Rights Agreement between the Company and Ameritrust Company National Association (Exhibit 2 to the Form 8-A for Preferred Stock Purchase Rights).\n4.7 * Form of 9-3\/8% Note Due March 1, 2001 (Exhibit 4.1 to Form 8-K dated February 20, 1991, filed with the Commission on February 22, 1991).\n4.8 * Forms of Medium-Term Notes (Exhibit 4.2 to the Company's Form S-3 Registration Statement No. 33-588744).\n4.9 * Form of 8% Debenture due April 1, 2023 (Exhibit 4.1 to Form 8-K dated March 22, 1993, filed with the Commission on March 25, 1993).\n4.10 * 401(k) Retirement Savings Plan creating certain \"participation interests\" (Exhibit 4.1 to Form S-8 Registration Statement dated October 6, 1993, filed under Commission File No. 33-50573).\n4.11 * Form of Certificate of Designations establishing 5% Cumulative Convertible Preferred Stock (filed as Exhibit 4.7 to the Company's Form S-3 Registration Statement dated August 6, 1993, under Commission file file 33-67166, and incorporated herein by reference).\n4.12 + Form of 5% Cumulative Convertible Preferred Stock Certificate\n10.1 * Distribution Agreement between the Company and Maxus (Exhibit 10.1 to the Form 10).\n10.2 * Tax-Sharing Agreement between the Company and Maxus (Exhibit 10.2 to the Form 10).*\n10.3 * Credit Agreement I, dated as of April 14, 1987, as amended and restated through April 15, 1993, between the Company and certain banks (Exhibit 10.1 to the Company's report on Form 10-Q for the quarter ended June 30, 1993.)\n10.4 * Credit Agreement II, dated as of April 14, 1987, as amended and restated through April 15, 1993, between the Company and certain banks (Exhibit 10.2 to the Company's report on Form 10-Q for the quarter ended June 30, 1993).\n10.5 * Senior Subordinated Note Purchase Agreement, dated as of April 17, 1987, between the Company and certain purchasers (the \"Senior Subordinated Note Agreement\") (Exhibit 10.22 to the Form 10).\n10.6 * Amendment No. 1 to the Senior Subordinated Note Agreement, dated as of March 31, 1988 (Exhibit 19.5 to the Company's report on Form 10-Q for the quarter ended March 31, 1988).\n10.7 * Amendment No. 2 to the Senior Subordinated Note Agreement, dated as of July 12, 1989, between the Company and certain purchasers. (Exhibit 19.2 to the Company's report on Form 10-Q for the quarter ended June 30, 1989 (the \"June 30, 1989 10-Q\")).\n10.8 + Amendment No. 3 to the Senior Subordinated Note Agreement, dated as of December 6, 1993, between the Company and certain purchasers.\n10.9 # 9% Senior Note Purchase Agreement, dated as of June 4, 1987, between the Company and Prudential Insurance Company of America (the \"9% Senior Note Agreement\").\n10.10 # Amendment No. 1 to the 9% Senior Note Agreement, dated as of July 12, 1989.\n10.11 # Amendment No. 2 to the 9% Senior Note Agreement, dated as of December 6, 1993.\n10.12 # 8.35% Senior Note Purchase Agreement, dated as of December 1, 1988, between the Company and Prudential Insurance Company of America (the \"8.35% Senior Note Agreement\").\n10.13 # Amendment No. 1 to the 8.35% Senior Note Agreement, dated as of July 12, 1989.\n10.14 # Amendment No. 2 to the 8.35% Senior Note Agreement, dated as of December 6, 1993.\n10.15 # 8.77% Senior Note Agreement, dated as of April 20, 1989, between the Company and Prudential Insurance Company of America (the \"8.77% Senior Note Agreement\").\n10.16 # Amendment No. 1 to the 8.77% Senior Note Agreement, dated as of July 12, 1989.\n10.17 # Amendment No. 2 to the 8.77% Senior Note Agreement, dated as of December 6, 1993.\n10.18 * X Form of Indemnification Agreement between the Company and its directors and executive officers (Exhibit 19.6 to the Company's report on Form 10-Q for the quarter ended June 30, 1987 (the \"June 30, 1987 10-Q\")).\n10.19 * X Amended form of Employment Agreement between the Company and certain of its executive officers (Exhibit 19.2 to the Company's report on Form 10-Q for the quarter ended March 31, 1989).\n10.20 * X Deferred Compensation Plan for executives and directors of the Company, amended and restated as of January 1, 1989 (Exhibit 10.13 to the Company's report on Form 10-K for the year ended December 31, 1988 (the \"1988 Form 10-K\")).\n10.21 * X Supplemental Executive Retirement Plan of the\nCompany (the \"SERP\") (Exhibit 10.16 to the Form 10).\n10.22 * X First Amendment to the SERP (Exhibit 10.17 to the Form S-1 for Preferred Stock).\n10.23 * X Second Amendment to the SERP (Exhibit 10.21 to the 1989 Form 10-K).\n10.24 * X Performance Incentive Plan of the Company (Exhibit 10.19 to the Form 10).\n10.25 * X Excess Benefits Plan of the Company (Exhibit 19.5 to the June 30, 1987 Form 10-Q).\n10.26 * X 1987 Long-Term Incentive Plan of the Company (Annex A-1 to the Company's Form S-8 Registration Statement No. 33-15268).\n10.27 * X Amended Form of Non-Incentive Stock Option Agreement with Stock Appreciation Rights between the Company and certain officers (Exhibit 19.5 to the June 30, 1989 Form 10-Q).\n10.28 * X Amended Form of Restricted Stock Agreement between the Company and certain officers (Exhibit 19.6 to the June 30, 1989 Form 10-Q).\n10.29 * X Form of Disability Benefit Agreement between the Company and certain of its executive officers (Exhibit 10.21 to the Form S-1 for Preferred Stock).\n10.30 * X Form of Split Dollar Insurance Agreement between the Company and certain of its executive officers (Exhibit 10.20 to the 1988 Form 10-K).\n10.31 * X Form of Supplemental Death Benefit Agreement between the Company and certain of its executive officers (Exhibit 19.9 to the June 30, 1987 Form 10-Q).\n10.32 * X Form of Employee Stock Purchase Loan Agreement between the Company and certain of its executive officers and employees (Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.33 * X Amendment dated March 5, 1990 to the Employee Stock Purchase Loan Agreement (Exhibit 10.31 to the 1989 Form 10-K).\n10.34 * X Retirement Plan for Non-Employee Directors of the Company dated as of May 2, 1989 (Exhibit 19.7 to the June 30, 1989 Form 10-Q).\n10.35 * X Diamond Shamrock, Inc. Long-Term Incentive Plan (Exhibit 4.1 to the Company's Form S-8 Registration Statement No. 33-34306 filed on April 13, 1990).\n10.36 * X Form of Executive Officer's Restricted Stock Agreement between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plan. (Exhibit 19.3 to the Company's report on Form 10-Q for the quarter ended June 30, 1990 (the \"June 30, 1990 Form 10-Q\")).\n10.37 * X Form of Non-Incentive Stock Option Agreement with Stock Appreciation Rights between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plan. (Exhibit 19.4 to the June 30, 1990 Form 10-Q).\n10.38 * X Form of Executive Officer's Performance Restricted Stock Agreement between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long -Term Incentive Plan. (Exhibit 19.5 to the June 30, 1990 Form 10-Q).\n10.39 * X Form of Non-Incentive Stock Option Agreement between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plan (Exhibit 19.2 to the Company's report on Form 10-Q for the quarter ended September 30, 1991 (the \"September 30, 1991 Form 10-Q\").\n10.40 * X Form of Non-Incentive Stock Option Agreement With Reload between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plan (Exhibit 19.3 to the Company's report on Form 10-Q for the quarter ended September 30, 1991 (the \"September 30, 1991 Form 10-Q\").\n10.41 * X Form of Amendment to the Non-Incentive Stock Option Agreement with Stock Appreciation Rights and the Non -Incentive Stock Option Agreement with Reload, each between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plans (Exhibit 19.1 to the Company's report on Form 10-Q for the quarter ended March 31, 1992 (the \"March 31, 1992 Form 10-Q\").\n10.42 * X Form of Amendment to the Non-Incentive Stock Option Agreement between the Company and certain officers pursuant to the Diamond Shamrock, Inc. Long-Term Incentive Plan (Exhibit 19.2 to the March 31, 1992 Form 10-Q).\n10.43 * X Diamond Shamrock, Inc. Long-Term Incentive Plan, amended and restated as of May 5, 1992 (Exhibit 19.1 to the Company's report on Form 10-Q for the quarter ended June 30, 1992 (the \"June 30, 1992 Form 10-Q\").\n10.44 * X Form of Employee Stock Purchase Loan Agreement between the Company and certain of its executive officers and employees, amended and restated as of May 26, 1992 (Exhibit 19.2 to the June 30, 1992 Form 10-Q).\n10.45 * X Ground Lease Agreement between Brazos River Leasing, L.P. and DSRMC, dated as of April 23, 1993 (Exhibit 19.3 to the June 30, 1992 Form 10-Q).\n10.46 * First Amendment to Ground Lease Agreement between Brazos River Leasing, L.P. and Diamond Shamrock Refining and Marketing Company, dated as of August 1, 1992 (Exhibit 10.2 to the Company's report on Form 10-Q for the quarter ended, September 30, 1993).\n10.47 * Facilities Lease Agreement between Brazos River Leasing L.P. and DSRMC, dated as of April 23, 1992 (Exhibit 19.4 to the June 30, 1992 Form 10-Q).\n10.48 * First Amendment to Facilities Lease Agreement between Brazos River Leasing, L.P. and Diamond Shamrock Refining and Marketing Company, dated as of August 1, 1992. (Exhibit 10.3 to the Company's report on Form 10-Q for the quarter ended September 30, 1993 (the \"September 30, 1993 10-Q\").\n10.49 * Schedule Relating to Certain Lease Agreements (Exhibit 10.4 to the September 30, 1993 10-Q).\n10.50 * X Form of Excess Benefits Plan between the Company and certain officers, amended and restated as of December 1, 1992 (Exhibit 10.49 to the Company's report on Form 10-K for the year ended December 31, 1992 (the \"1992 10-K\")).\n10.51 * X Form of Disability Benefit Agreement between the Company and certain officers, amended and restated as of January 1, 1993 (Exhibit 10.50 to the 1992 10-K).\n10.52 * X Form of Deferred Compensation Plan between the Company and certain directors, officers and other employees of the Company, amended and restated as of January 1, 1993 (Exhibit 10.51 to the 1992 10-K).\n13.1 + Management's Discussion and Analysis of Financial Condition and Results of Operation from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n13.2 + Consolidated Financial Statements and Selected Financial Data from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n13.3 + Report of Independent Accountants from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n21.1 + Significant Subsidiaries of the Company.\n23.1 + Consent of Price Waterhouse.\n24.1 + Powers of Attorney of directors and officers of the\nCompany.\n- -------------------------- * Each document marked with an asterisk is incorporated herein by reference to the designated document previously filed with the Securities and Exchange Commission.\n# The Company hereby agrees pursuant to Item 601(b)(4)(III)(A) of Regulation S-K to furnish a copy of this agreement to the Securities and Exchange Commission upon request.\n+ Indicates a document filed with this report.\nX Indicates a document which constitutes an executive contract or compensation plan or arrangement. - ------------------------------\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by the Company during the fourth quarter of 1993.\nSIGNATURES\nPursuant 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.\nDIAMOND SHAMROCK, INC.\nBy \/s\/ R. R. HEMMINGHAUS* R. R. Hemminghaus, Chairman of the Board and President\nMarch 28, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant, and in the capacities, and on the dates indicated.\nSignature Title\n\/s\/ R. R. HEMMINGHAUS* R. R. Hemminghaus Chairman of the Board and President (Principal Executive Officer)\n\/s\/ ROBERT C. BECKER* Robert C. Becker Vice President and Treasurer (Principal Financial Officer)\n\/s\/ GARY E. JOHNSON* Gary E. Johnson Vice President and Controller (Principal Accounting Officer)\n\/s\/ B. CHARLES AMES* B. Charles Ames Director\n\/s\/ E. GLENN BIGGS* E. Glenn Biggs Director\n\/s\/ WILLIAM E. BRADFORD* William E. Bradford Director\n\/s\/ LAURO F. CAVAZOS* Lauro F. Cavazos Director\n\/s\/ W. H. CLARK* W. H. Clark Director\n\/s\/ WILLIAM L. FISHER* William L. Fisher Director\n\/s\/ WILLIAM S. McCONNOR* William S. McConnor Director\n\/s\/ BOB MARBUT* Bob Marbut Director\n\/s\/ KATHERINE D. ORTEGA* Katherine D. Ortega Director\n* The undersigned, by signing his name hereto, does hereby sign this report on Form 10-K pursuant to the Powers of Attorney executed on behalf of the above- named officers and directors of the registrant, and contemporaneously filed herewith with the Securities and Exchange Commission\n\/s\/ TODD WALKER Todd Walker Attorney-in-Fact\nMarch 28, 1994\nCONSOLIDATED FINANCIAL INFORMATION\nIndex\nFinancial Statement Schedules:\nReport of Independent Accountants on Financial Statement Schedules\nFor the three years ended December 31, 1993:\nConsolidated Properties and Equipment\nConsolidated Accumulated Depreciation and Depletion - Properties and Equipment\n(All other schedules have been omitted because they are not applicable or the required information is shown in the Financial Statements or the Notes to Consolidated Financial Statements.)\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Diamond Shamrock, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 25, 1994, which includes an explanatory paragraph with respect to the Company's changes in its methods of accounting for its long-term shared cost liability, postretirement benefits other than pensions, and income taxes, which is attached as Exhibit 13.3 to this Annual Report on Form 10-K, also includes an audit of the Financial Statement Schedules listed in Item 14(a)(2) hereof. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ Price Waterhouse\nPRICE WATERHOUSE\nSan Antonio, Texas February 25, 1994\nSCHEDULE V DIAMOND SHAMROCK, INC. CONSOLIDATED PROPERTIES AND EQUIPMENT Three Years Ended December 31, 1993 (dollars in millions)\nRefining & Retail Allied Wholesale Marketing Businesses Other Total\nBalance January 1, 1991 $ 615.5 $ 245.1 $ 195.2 $ 18.0 $ 1,073.8\nAdditions, at cost 80.1 65.6 21.2 13.2 180.1\nDisposals and transfers (2.6) (4.5) (4.7) 0.1 (11.7)\nBalance December 31, 1991 693.0 306.2 211.7 31.3 1,242.2\nAdditions, at cost 143.8 4.8 19.6 2.3 170.5\nDisposals and transfers 2.1 (4.3) (18.7) - (20.9)\nBalance December 31, 1992 838.9 306.7 212.6 33.6 1,391.8\nAdditions, at cost 100.1 26.5 4.4(1) 0.8 131.8\nDisposals and transfers 10.1 (6.7) (34.5) (0.5) (31.6)\nBalance December 31, 1993 $ 949.1 $ 326.5 $ 182.5 $ 33.9 $ 1,492.0\n(1) During 1993, the Company exchanged an undivided interest in certain properties and equipment for an equity ownership interest in a limited liability company. This transaction increased investments by $19.2 million, decreased properties and equipment by $22.0 million and decreased accumulated depreciation by $2.8 million in the Allied Businesses segment.\nSCHEDULE VI\nDIAMOND SHAMROCK, INC. CONSOLIDATED ACCUMULATED DEPRECIATION Three Years Ended December 31, 1993 (dollars in millions)\nRefining & Retail Allied Wholesale Marketing Businesses Other Total\nBalance January 1, 1991 $ 270.1 $ 63.6 $ 63.4 $ 7.8 $ 404.9 Additions charged against income 27.4 12.3 10.1 2.5 52.3 Disposals and transfers 0.5 (2.1) (3.6) (1.0) (6.2)\nBalance December 31, 1991 298.0 73.8 69.9 9.3 451.0 Additions charged against income 29.5 13.7 10.9 2.7 56.8 Disposals and transfers 0.7 (3.3) (3.5)* (1.5) (7.6)\nBalance December 31, 1993 $ 366.9 $ 96.6 $ 74.5 $ 12.9 $ 550.9\n*See footnote (1) to the preceding Schedule V \"Consolidated Properties and Equipment.\"\nThe provisions for depreciation were computed principally in accordance with the following methods and range of rates:\nMethod Rate\nBuildings and land improvements Straight line 3% to 5% Machinery and equipment Straight line 5% to 20% Furniture and fixtures Straight line 10% to 20% Automotive equipment Straight line 14% to 33% Leasehold improvements Straight line Lease terms\nINDEX TO EXHIBITS\nDIAMOND SHAMROCK, INC.\nFORM 10-K\nYEAR ENDED DECEMBER 31, 1993\nExhibit No.\n4.12 Form of 5% Cumulative Convertible Preferred Stock Certificate.\n10.8 Amendment No. 3 to Senior Subordinated Note Agreement, dated as of December 6, 1993, between the Company and certain purchasers.\n13.1 Management's Discussion and Analysis of Financial Condition and Results of Operation from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n13.2 Consolidated Financial Statements and Selected Financial Data from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n13.3 Report of Independent Accountants from the Company's Annual Report to Shareholders for the year ended December 31, 1993.\n21.1 Significant Subsidiaries of the Company.\n23.1 Consent of Price Waterhouse.\n24.1 Powers of Attorney of directors and officers of the Company.","section_15":""}
{"filename":"24058_1993.txt","cik":"24058","year":"1993","section_1":"ITEM 1. BUSINESS\nCONTINENTAL BANK CORPORATION\nContinental Bank Corporation (Continental) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, the principal asset of which is all of the outstanding stock of Continental Bank N.A. (Bank). Continental was incorporated in Delaware in November 1968, and the Bank became its subsidiary in March 1969. The Bank and its predecessors have been in business for more than 135 years. As the context requires, references to Continental in the remaining portion of Item 1 of this Form 10-K mean either Continental acting as a single entity or Continental acting through its direct or indirect subsidiaries.\nFor information on the proposed merger of Continental and BankAmerica Corporation (BankAmerica), see Note 1--Proposed Merger with BankAmerica--of Notes to Consolidated Financial Statements.\nContinental's strategic plan focuses on the needs of its business customers. Continental's business customer base consists principally of its longstanding corporate, institutional, and depository customers in the United States and abroad. Through its direct and indirect subsidiaries, Continental concentrates on four principal areas: corporate finance, specialized financial services, trading, and equity financing. Continental is both an originator of financial products to be issued or used by its customers and a distributor of financial products that investors may purchase or trade.\nAs an originator of financial products, Continental's objective is to provide corporations, governmental entities, and other depository institutions with funding capabilities. In distribution, the objective is to provide investors with securities and other investment vehicles, many of which are originated by the Bank, that will meet their investment objectives.\nContinental provides a broad range of deposit, credit, advisory, and related financial services to its business customers. These customers are provided a variety of capital funding alternatives, including syndicated and non-syndicated long-term debt, acquisition financing, secured business credit, and securitized financings. Continental also arranges private placements, lease financing, and commercial paper programs. Continental has a large domestic and international network of correspondent banking relationships and provides a wide variety of services for banks, including check clearing, transfer of funds, loan participations, and investment advice. Continental provides direct transactional\nassistance for its customers through cash management, investment advisory, securities transfer, custodial, corporate and pension trust, and similar types of operational services. Continental engages in market-making and risk-management activities in all U.S. and selected international capital markets to provide specialized services for its customers. Continental arranges financial transactions (including mergers, acquisitions, and divestitures) and distributes financial assets to third parties. Continental also provides foreign-exchange, money-market, interest-rate, and financial futures products and services.\nContinental's products and services are provided through a network of domestic and foreign subsidiaries, affiliates, branches, and representative offices in key capital markets worldwide. In 1993, approximately 97 percent of Continental's consolidated gross revenues, which are composed of interest revenue and fees, trading, and other revenues, was derived from the Bank. The Bank's commercial lending relationships currently generate the greatest percentage of corporate consolidated gross revenues. While Continental anticipates increased contributions from the operations of its other subsidiaries, the Bank is expected to continue to be the major source of Continental's consolidated gross revenues for the foreseeable future.\nContinental also owns directly or indirectly a small-business investment company and an equity-investment company. Other subsidiaries engage in asset-based financing and fiduciary and investment services.\nAs an extension of Continental's overall business focus, the Bank, from offices in Chicago, Los Angeles, Dallas, and Miami, concentrates on meeting the deposit, financing, investment, brokerage, and fiduciary needs of professionals, entrepreneurs, executives, and private investors. Fiduciary and investment services for these customers are also offered through Continental's subsidiary in Florida.\nContinental is a legal entity separate and distinct from the Bank and its other subsidiaries. Under federal law, there are various restrictions on the extent to which the Bank may finance or otherwise supply funds to Continental and its affiliates.\nSTATISTICAL INFORMATION\n(a) Taxable-equivalent adjustments are used in adjusting interest on tax-exempt assets (primarily state, county, and municipal securities) to a fully taxable basis. Such adjustments are based on the prevailing federal and state income tax rates. For 1993 and 1992 the adjustments amounted to $3 million and $4 million, respectively. (b) Average rate is computed using amounts rounded to thousands. (c) The principal amounts of cash-basis and renegotiated loans have been included in the average loan balances used to determine the rate earned on loans. Interest on cash-basis loans is included in revenue only to the extent that cash payments have been received, and is included for renegotiated loans at renegotiated rates. (d) Net interest margin is net interest revenue on a taxable- equivalent basis divided by average earning assets.\n(a) Taxable-equivalent adjustments are used in adjusting interest on tax-exempt assets (primarily state, county, and municipal securities) to a fully taxable basis. Such adjustments are based on the prevailing federal and state income tax rates. For 1991, the adjustments amounted to $7 million. (b) Average rate is computed using amounts rounded to thousands. (c) The principal amounts of cash-basis and renegotiated loans have been included in the average loan balances used to determine the rate earned on loans. Interest on cash-basis loans is included in revenue only to the extent that cash payments have been received, and is included for renegotiated loans at renegotiated rates. (d) Net interest margin is net interest revenue on a taxable- equivalent basis divided by average earning assets.\nSECURITIES\nLOANS\nThe tables for year-end and average loans for the last five years are presented in Note 6--Loans--of Notes to Consolidated Financial Statements on pages 71 through 73.\nNonperforming Loans\nThe discussion of and tables for nonperforming loans for the last five years are presented in Note 6--Loans--of Notes to Consolidated Financial Statements on pages 71 through 73. Information concerning Continental's interest-accrual policies for loans is presented in Note 2--Summary of Significant Accounting Policies--of Notes to Consolidated Financial Statements on pages 64 through 68.\nCREDIT ANALYSIS AND LOSS EXPERIENCE\nDiscussion of the reserve for credit losses is set forth on page 30 and pages 52 and 53 of Management's Discussion and Analysis, under the captions \"Provision for Credit Losses\" and \"Reserve for Credit Losses,\" respectively.\nThe following table presents an analysis of the changes in the foreign component of the reserve for credit losses for the five years ended December 31, 1993:\nDEPOSITS\nSHORT-TERM BORROWINGS\nFINANCIAL RATIOS\nFor purposes of computing these ratios, earnings represent income from continuing operations before income taxes after adding back fixed charges. Fixed charges represent interest and one-third of rents (the portion deemed representative of the interest factor). Preferred stock dividend requirements represent an amount equal to the pretax earnings required to meet applicable preferred stock dividend requirements.\nEarnings for 1991 were inadequate to cover fixed charges. The coverage deficiency for both fixed charges and combined fixed charges and preferred stock dividend requirements was $56 million.\nFOREIGN OUTSTANDINGS\nInformation concerning Continental's foreign outstandings is set forth on pages 53 through 55 of Management's Discussion and Analysis, under the caption \"Country Risk.\"\nLOAN CONCENTRATIONS\nA discussion addressing risk diversification is set forth on pages 40 through 53 of Management's Discussion and Analysis, under the caption \"Credit Risk Management.\"\nFOREIGN OPERATIONS\nInformation concerning Continental's foreign operations is presented in Note 22--Domestic and Foreign Operations--of Notes to Consolidated Financial Statements on pages 97 and 98.\nEMPLOYEES\nAs of December 31, 1993, Continental had (on a full-time-equivalent basis) 4,238 officers and employees, all but 32 of whom were employed by the Bank and its subsidiaries.\nCOMPETITION\nActive competition exists in local, regional, national, and\/or international markets in all principal business areas in which Continental is currently engaged, not only with other national and state banks but also with savings and loan institutions, finance companies, and other financial services companies.\nContinental competes principally through prices and the quality and nature of services offered. In attracting deposits, Continental's banking subsidiaries pay interest, subject to applicable government regulations, that reflects adjustments in the money markets. Continental's goal is to provide the best possible service for its customers, and in many business areas, including trust activities, correspondent banking, and international banking, service is a primary means of competition.\nMONETARY POLICY AND ECONOMIC CONDITIONS\nTwo key factors in the performance and profitability of bank holding companies are loan volume and the margin or spread between earning yields and interest rates paid to obtain lendable funds in worldwide money markets. Major influences on these factors are federal government policies, including those of the Federal Reserve Board (FRB). Designed to promote orderly economic growth and to control the growth of both money and credit, these policies influence financial and credit market conditions, and affect general interest-rate levels and the ability to lend. Thus, changes in these policies can significantly affect Continental's future business and earnings. Discussion and analysis of the economic environment and its impact on Continental's 1993 and future earnings is set forth on pages 25 through 57 of Management's Discussion and Analysis.\nSUPERVISION AND REGULATION\nIn addition to setting monetary policy, the FRB is the principal regulator of bank holding companies such as Continental. The Bank Holding Company Act of 1956, as amended, generally limits bank holding companies to activities that the FRB determines to be closely related to banking or managing or controlling banks. Under FRB policy, Continental is expected to act as a source of strength to its principal subsidiary, the Bank, and to commit resources in support of it.\nA bank holding company cannot acquire substantially all of the assets or control more than 5 percent of the voting shares of any commercial bank of which it is not already the majority shareholder without the approval of the FRB. Also, the FRB cannot approve any application to acquire shares of an additional commercial bank located outside the state in which a holding company's existing bank subsidiaries are located unless specifically authorized by the laws of the additional bank's state. Illinois has enacted a reciprocal national interstate banking statute, which became effective on December 1, 1990. The statute authorizes a bank holding company whose principal place of business is in another state to acquire control of an Illinois bank or bank holding company if the laws of the home state of the acquiring bank holding company authorize an Illinois bank holding company to acquire control of a bank or bank holding company in that state. The approval of the Illinois Commissioner of Banks and Trust Companies (Illinois Commissioner) is required to effect such an acquisition within Illinois.\nThe FRB has adopted risk-based capital guidelines for bank holding companies. The minimum ratio of qualifying total capital to risk-adjusted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8 percent. At least half of the total capital is to comprise common stock, retained earnings, and a limited amount of qualifying perpetual preferred stock, less disallowed intangibles, including goodwill (Tier 1 capital). The remainder may consist of subordinated debt, other preferred stock, and a limited amount of loan loss reserves (Tier 2 capital). In addition, the FRB has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets equal to between 3 percent and 5 percent. The FRB has not advised Continental of any specific minimum Tier 1 leverage ratio applicable to it. Information concerning Continental's capital ratios is set forth on pages 34 and 35 of Management's Discussion and Analysis, under the caption \"Capital.\"\nAs a national bank, the Bank is a regulated entity permitted to engage only in banking and activities incidental to banking. National banks are primarily regulated and examined by the Office of the Comptroller of the Currency (Comptroller). In addition, national banks are subject to certain regulations adopted by the FRB and the Federal Deposit Insurance Corporation (FDIC). Major matters regulated include loan limits, deposit reserves and insurance, interest rates, securities dealings, international operations, dividends, and transactions with affiliates. The Comptroller has adopted risk-based capital and minimum leverage ratio guidelines for national banks similar to those adopted by the FRB for bank holding companies. The Comptroller has not advised the Bank of any specific leverage ratio applicable to it. On December 31, 1993, the Bank's capital ratios exceeded those required under the Comptroller's guidelines.\nIn late 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) became law. The statute significantly revised key aspects of bank regulation. Many parts of the statute have delayed effective dates and provisions for phasing in certain new requirements. The federal bank regulatory agencies have adopted implementing regulations in many of the areas impacted, including ones relating to risk-based FDIC insurance assessments, brokered deposits, interbank liabilities, operational and managerial standards, and auditing requirements. FDICIA also requires those agencies to take \"prompt corrective action\" with respect to depository institutions that do not meet minimum regulatory capital requirements. The Bank presently exceeds all such requirements. FDICIA establishes five capital levels and imposes increasingly stringent limitations on banks that fall below the highest level. The federal bank regulatory agencies have issued various implementing regulations, certain of which are described below, and have others in the proposal stage, including one that would add an interest-rate-risk component to risk-based capital requirements. It is anticipated that FDICIA and the regulations issued thereunder will result in increased costs for the banking industry, including the Bank, due to higher\nFDIC insurance assessments and additional operating and reporting requirements. FDICIA and those regulations are not expected to have a material adverse effect on the Bank's present operations.\nThe Bank's deposits are insured by the FDIC. Pursuant to FDICIA, the FDIC has adopted an interim risk-based system for the payment of insurance premiums beginning in 1993 at rates ranging from $0.23 to $0.31 per $100 of deposits. A final risk-based system must be implemented under FDICIA by mid-1994.\nSubject to regulation by the FRB, banks and their Edge Act corporation subsidiaries which engage in international banking and finance may establish foreign branches. With FRB approval, Edge Act corporations may also establish United States branches and invest in the shares of financial companies whose transactions in the United States are solely and directly related to international business. Moreover, with FRB consent, bank holding companies and their nonbank subsidiaries may own or control the voting shares of any company in which an Edge Act corporation may invest and of certain other companies whose business is closely related to banking.\nOn February 8, 1994, the FRB terminated the agreement, dated as of July 26, 1984, between the FRB and Continental, under which Continental, in order to ease any liquidity pressures, was required to establish from time to time interim target levels of consolidated assets that could be funded on a sustainable basis.\nFederal law also places restrictions on extensions of credit by banks to their parent bank holding companies and, with some exceptions, other affiliates, on investments in stock or securities thereof, and on the taking of such stock or securities as collateral for loans.\nBanks and their affiliates are also subject to certain restrictions on the issuance, underwriting, public sale, and distribution of securities. Operations in countries other than the United States are subject to various restrictions and to the supervision of various regulatory authorities, under federal law and the laws of those countries.\nOn December 23, 1993, Continental filed with the Illinois Commissioner an Application For Approval to Convert From a National Bank to a State Bank. In connection therewith, Continental has pending applications with the FRB for approval of membership therein as an Illinois bank and with the Illinois Commissioner for authorization as a state bank to exercise trust powers.\nNote 10--Regulatory Matters--of Notes to Consolidated Financial Statements on pages 76 and 77 provides information on dividend restrictions on Continental and the Bank, and limitations on loans from Continental's bank subsidiaries to Continental and its affiliates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Bank's banking headquarters and Continental's principal offices are located at 231 South LaSalle Street, Chicago, Illinois, in a 23-story building owned by the Bank on land of which one-half is owned by the Bank and one-half is held under a lease expiring in 1996 (with an option to purchase for $23 million prior to lease expiration). Approximately 97 percent of the building is occupied by the Bank. Continental and certain other subsidiaries, including the Bank, own directly or beneficially other unimproved and improved land in Chicago and own or lease office space at various locations in the United States and in foreign countries. For information on properties leased by Continental, see Note 12--Lease and Other Commitments--of Notes to Consolidated Financial Statements on page 78.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation pertaining to legal matters is presented in Note 1--Proposed Merger with BankAmerica--and Note 24--Legal Proceedings--of Notes to Consolidated Financial Statements on pages 63 and 64 and page 102, respectively.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE CORPORATION\nContinental Bank Corporation\nThomas C. Theobald (56) (1987) Chairman\nWilliam M. Goodyear (45) (1991) Vice Chairman\nRichard L. Huber (57) (1990) Vice Chairman\nMichael J. Murray (49) (1991) Vice Chairman\nMichael E. O'Neill (47) (1993) Chief Financial Officer\nRoger H. Sherman (60) (1989) Executive Vice President\nRichard S. Brennan (55) (1982) General Counsel and Secretary, Partner in the law firm of Mayer, Brown & Platt\nJohn J. Higgins (50) (1985) Controller\nKurt P. Stocker (56) (1991) Chief Corporate Relations Officer\nJoseph V. Thompson (51) (1986) Chief Human Resources Officer\nThe parentheses enclose age, followed by the year in which the individual was initially classified as an executive officer of Continental for Securities and Exchange Commission reporting purposes. Each individual listed also serves as an executive officer of the Bank. Executive officers are appointed by the Board of Directors of Continental or the Bank to hold office until the first meeting of the Board of Directors after the annual meeting of stockholders next following appointment, and until a successor is qualified. They may be removed and replaced only by the Board of Directors of Continental or the Bank, and may be removed, with or without cause, at any time by a majority vote of the directors at the time in office. Under provisions of federal banking law, the initial appointment of an individual as an executive officer of Continental or the Bank presently requires the respective approval of the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency, and these regulatory authorities in certain circumstances can cause the suspension or removal of an executive officer.\nWith the exception of Messrs. Huber and O'Neill, all of the executive officers have served in an executive capacity with Continental, the Bank, or an affiliate of Continental for more than five years. Mr. Huber joined Continental in January 1990. Prior to joining Continental, he served as an executive vice president and head of the Capital Markets and Foreign Exchange Sector at Chase Manhattan Corporation in 1988 and 1989. Prior to that experience, he served in various executive capacities at Citicorp and Citibank since 1973. Mr. O'Neill first joined Continental in 1974 and held a number of international banking positions through the early 1980s. He remained with First Interstate Capital Markets as managing director and co-chief executive when it bought Continental's London-based merchant bank in 1984, but rejoined Continental in 1989 as a managing director in its mergers and acquisitions area. Mr. O'Neill was also responsible for long-term planning at Continental prior to his appointment as chief financial officer in July 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCOMMON STOCKHOLDERS\nThere were 9,709 holders of Continental Bank Corporation common stock on December 31, 1993.\nCOMMON STOCK LISTING\nContinental Bank Corporation common stock is traded on the New York, Midwest, Pacific, and London stock exchanges. Many newspapers quote the daily price per share of the common stock as reported on the New York Stock Exchange Composite Tape, using the abbreviation ContBkCp. The official trading symbol is CBK.\nDividends declared on Continental common stock were $0.60, $0.60, and $0.80 per share in 1993, 1992, and 1991, respectively. Information setting forth the high and low sales prices of Continental common stock during the past two years is presented in tabular form on page 23, under the caption \"Quarterly Financial Information.\"\nInformation setting forth restrictions on Continental's ability to pay dividends on its common stock is presented in Note 10--Regulatory Matters--of Notes to Consolidated Financial Statements on pages 76 and 77.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFourth-Quarter Summary\nContinental reported a $7 million, or 11 percent, increase in net income for the fourth quarter of 1993 over the 1992 period. The year-to-year improvement was due to higher revenues and the recognition of additional deferred tax benefits, partially offset by increases in operating expenses, including the costs of other nonperforming assets (ONPA).\nNet interest revenue fell $18 million from the 1992 fourth quarter, due to a narrower interest-rate spread and a lower level of average earnings assets. Fees, trading, and other revenues rose $46 million, or 34 percent, over the prior year's quarter, primarily due to a $24 million increase in revenues from equity investments and a $14 million rise in trading revenues.\nFourth-quarter 1993 operating expenses increased 20 percent from the 1992 quarter. Much of the increase was due to an $18 million rise in the net costs of ONPA, mainly foreclosure costs related to other real estate owned (OREO) properties. The remainder of the increase was largely attributable to higher incentive compensation, professional service, and insurance expenses.\nThe fourth-quarter provision for credit losses remained level with the same period last year. Fourth-quarter 1993 charge-offs rose $14 million, or 25 percent, from the same period last year, primarily due to higher write-downs in the residential real estate portfolio. Recoveries were down $5 million from last year's fourth quarter.\nNonperforming assets decreased $113 million from September 30, 1993. Nonperforming loans dropped significantly in all major categories, offset, in part, by a $22 million increase in ONPA.\nThe income tax credit of $7 million, compared with income tax expense of $4 million in the 1992 quarter, was due to the recognition of additional deferred tax benefits.\nSENSITIVITY TO INTEREST-RATE CHANGES\nThe relationships shown are for one day only, and significant changes can occur in the sensitivity relationships as a result of market forces and management decisions. Moreover, although certain assets and liabilities may by their contractual terms change their interest rates within a certain period, they will not necessarily change at the same time or to the same extent. The table includes the effect of off-balance-sheet instruments, such as financial futures contracts and interest-rate swaps.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's Discussion and Analysis uses the following abbreviations: Allocated transfer risk reserve--ATRR Federal Deposit Insurance Corporation--FDIC Highly leveraged transaction--HLT In-substance foreclosure--ISF Other nonperforming assets--ONPA Other real estate owned--OREO Statement of Financial Accounting Standards--SFAS\nOn January 28, 1994, Continental and BankAmerica announced that they had signed a definitive agreement for BankAmerica to acquire Continental in a transaction structured as a cash-election merger. Continental's financial condition on December 31, 1993, results of operation for the year then ended, and management's discussion thereof, do not give effect to any financial consequences of the proposed merger. For information on the proposed merger, see Note 1 to the financial statements.\nRESULTS OF OPERATIONS--1993 AND 1992\nContinental reported net income of $338 million, or $5.59 per common share, for 1993, compared with $222 million, or $3.44 per common share, for 1992. Excluding the $80 million effect of an accounting change for income taxes in 1993, net income was $258 million, or $4.12 per share. Revenues increased 15 percent in 1993 over the prior year, aided by higher trading profits and revenues from equity investments, partially offset by higher credit costs and operating expenses. The recognition of additional deferred tax benefits in 1993 also favorably impacted results.\nRevenues\nTotal revenues in 1993 increased $140 million from the 1992 level. With only a moderate demand for credit continuing during 1993, revenue growth was highly dependent on customer needs for other services. In this regard, fees, trading, and other revenues increased 35 percent over 1992 and more than offset the 5 percent decline in net interest revenue. Trading revenues more than tripled the 1992 level. Gains on loan sales increased 40 percent, and revenues from equity investments were up 32 percent from 1992.\nNet Interest Revenue\nNet interest revenue, the difference between interest revenue and interest expense, decreased 5 percent from the 1992 level. Net interest revenue is influenced by market interest rates; the level, composition, and repricing characteristics of earning assets and liabilities; loan fees; and the level of and interest collections on nonperforming loans. While Continental relies mainly on interest-bearing funds, it also maintains a considerable amount of interest-free funding, such as demand deposits and stockholders' equity. The level of and benefit from these interest-free funds significantly affect net interest revenue.\nNet interest revenue decreased $25 million in 1993, due to a $1 billion reduction in average earning assets, primarily loans, and a slight decline in the net interest margin. The lower level of earning assets caused $17 million of the decline in net interest revenue. The lower margin was due to a reduced benefit from interest-free funds in the lower interest-rate environment, partially offset by a $14 million increase in collections on nonperforming loans and a $7 million increase in loan fees.\nSee Consolidated Average Balance Sheet and Net Interest Revenue on pages 5 through 8 of Statistical Information for detail of annual average balance-sheet volumes with associated revenues and rates.\nFees, Trading, and Other Revenues\nAll categories of fees, trading, and other revenues showed increases in 1993 over 1992. Fees and commissions from the origination and distribution of loans and other assets, cash management services, and other service-related activities rose 3 percent in 1993. Fees and commissions provided more than 30 percent of Continental's non-interest revenue in each of the last five years.\nTrust income, derived primarily from portfolio management, fiduciary, and securities services, increased 5 percent in 1993. The trust business has been a reliable source of revenue, providing more than 15 percent of Continental's non-interest revenue in each of the last five years.\nContinental primarily engages in trading activities to serve customers' needs, buying and selling various types of securities, money market instruments, currencies, and derivative and other risk-management products. In 1993, these activities produced revenues of $102 million, $72 million more than 1992, primarily because of improved revenues from the origination of interest-rate-derivative transactions for customers and Continental's management of the resultant risk portfolio. Also contributing to the increase were significantly higher revenues from the trading of emerging markets debt.\nEquity investments, both domestic and foreign, have been important revenue providers for Continental and represent another avenue through which Continental profits by serving the financing\nneeds of its customers. Revenues from these investments have averaged more than $100 million per year over the last five years.\nThe major components of revenues from equity investments were as follows:\nRevenues from domestic equity investments were $150 million in 1993, up from $113 million in 1992, due to a $59 million increase in net unrealized gains, partially offset by a $22 million decrease in net gains on sales. A significant portion of unrealized gains recorded in 1993 is expected to be realized in the first quarter of 1994. Revenues from foreign equity investments increased to $48 million from $37 million in 1992, primarily due to a $15 million increase in net gains on sales, mainly from Latin American investments.\nDuring 1993, Continental invested directly in a wide variety of companies engaging in activities such as television broadcasting, publishing, healthcare, telecommunications, and financial services. Approximately 36 percent of the 1993 revenues was from ten investments in the telecommunications industry, both domestic and foreign. Revenues from investments in the financial services and apparel industries accounted for an additional 23 percent and 11 percent, respectively. No other industry accounted for more than 10 percent of the revenues. The adoption of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" at year-end 1993 resulted in a $45 million increase in the equity-investment portfolio. Under the standard, certain securities previously carried at lower of cost or market in this portfolio are required to be carried at fair value. The increase in value from adopting the standard had no effect on the income statement and is included, net of tax, in a separate component of stockholders' equity. See Note 5 to the financial statements for further discussion of equity investments.\nThe other revenue component of total revenues includes gains and losses from the translation of foreign-currency assets and liabilities, and a variety of other activities. In 1993, other revenues included gains on loan sales of $36 million, $7 million from the settlement of outstanding claims, and foreign-exchange translation losses attributable to Latin American operations of $4 million. In 1992, other revenues included gains on loan sales\nof $26 million, $8 million from the collection of claims retained from the sale of a business, and foreign-exchange translation losses of $21 million.\nBanking Product Revenues\nFour product categories form the core of Continental's business strategy: corporate finance; specialized financial services; trading; and equity financing. The amounts in the following table differ from those in similar revenue lines in the consolidated statement of operations, because Continental presents banking product revenues after allocating funding costs among product lines.\nCorporate Finance: Corporate finance revenues, which include revenues from lending, syndication, and distribution activities, rose slightly from the 1992 level. Lending revenues fell 5 percent due to a $1.3 billion decline in average loans, partially offset by higher cash collections on nonperforming loans and increased loan fees. Increased capital markets activity in 1993 produced higher syndication and distribution revenues from gains on Latin American debt sales and higher domestic transaction flow.\nSpecialized Financial Services: Cash management revenues increased 3 percent, primarily due to increased business volume. The $5 million drop in revenue from securities and clearing services reflected downward pricing pressure. Revenues from private banking, personal trust, and other activities, primarily deposit-related, fell 7 percent due to the lower value of interest-free funds in a lower interest-rate environment.\nTrading: Trading revenues rose $77 million due to increased revenues from secondary asset trading and growth in revenues from customer-driven activity in interest-rate derivative products. While achieving significant revenue growth year-to-year, this area is still viewed by management as one in which opportunities to expand business will continue. The key to continued growth lies in Continental's ability to provide financial products and services to assist customers in managing financial risk inherent to their businesses, and to deliver value to financial investors.\nEquity Financing: Revenues from equity financing increased 40 percent from the prior year to a record level of $182 million. In 1993, 55 percent of revenues from equity financing was from net gains on sales, dividends, and fees; the remaining 45 percent was from unrealized market appreciation. In 1992, 83 percent of revenues represented net gains on sales, dividends, and fees. Equity investments have consistently contributed to product revenues, averaging 14 percent of total banking product revenues over the past three years.\nAll Other Revenues: All other revenues consists of revenues from non-product-related activities, such as foreign-exchange translation. In 1993, all other revenues included $7 million from the settlement of outstanding claims and $4 million of foreign-exchange translation losses attributable to Latin American operations. In 1992, foreign-exchange translation losses amounted to $21 million; $8 million from the collections retained from the sale of a business was also included in all other revenues. Losses from write-downs of nonperforming assets acquired in connection with corporate finance activities are included in corporate finance product revenues.\nProvision for Credit Losses\nThe provision for credit losses totaled $181 million in 1993, compared with $125 million in 1992. See Reserve for Credit Losses on pages 52 and 53 for a discussion of reserve adequacy.\nOperating Expenses\nTotal operating expenses rose 14 percent in 1993. Excluding the net costs of ONPA of $68 million for 1993 and $13 million for 1992, operating expenses increased 5 percent over the 1992 level. On this basis, despite the increase in operating expenses, the efficiency ratio (operating expenses as a percentage of revenues) improved to 56 percent in 1993, compared with 61 percent in 1992.\nEmployee expenses increased $14 million year-to-year, primarily due to higher provisions for incentive compensation related to improved revenue levels. Increases in base salaries, as well as pension, medical, and other employee benefit expenses, also contributed to the 1993 rise. Partially offsetting these increases were reductions in contributions to the Employees Stock Ownership Plan and payroll tax expense. The increase in medical expense was related to the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nNet occupancy expense increased slightly in 1993, primarily due to higher expenses for the maintenance of banking premises. Other expenses rose 8 percent and included higher professional service fees, an increase in FDIC insurance premiums, and higher travel expense. Professional service fees increased $7 million, resulting from several marketing-related projects.\nNet costs of ONPA were $68 million in 1993, compared with $13 million in 1992. The increase was primarily due to write- downs and foreclosure costs related to OREO. Continental expects these costs in future periods to be below the 1993 level. For information about the components of net costs of ONPA, see Note 21 of the financial statements.\nIncome Taxes\nEffective January 1, 1993, Continental adopted SFAS No. 109, \"Accounting for Income Taxes,\" which resulted in the recognition of $354 million of deferred federal tax benefits, reduced by the establishment of a valuation allowance of $274 million. The net amount of $80 million is included in 1993 net income as the cumulative effect of a change in accounting principle.\nRealization of deferred tax benefits is dependent on Continental's ability to generate taxable income in the current and future years. The recognition of benefits in the financial statements is based upon projections by management of future operating income and the anticipated reversal of temporary differences that will result in taxable income. Projections of future earnings were based on adjusted historical earnings.\nContinental had taxable income and pretax book income for 1993 and the prior two years as follows:\nContinental recorded an income tax credit of $18 million in 1993, compared with income tax expense, primarily foreign taxes applicable to equity investment gains, of $20 million in 1992. The 1993 credit included the recognition of an additional $49 million of deferred federal tax benefits as a result of a decrease in the valuation allowance of $157 million, partially offset by a decrease in the gross deferred tax asset of $108 million.\nManagement increased its projection of future taxable income in view of Continental's 1993 earnings and, as a result, reduced the valuation allowance to $117 million as of December 31, 1993.\nIn order to fully realize the December 31, 1993, deferred tax asset of $129 million (without regard to a $19 million deferred tax liability resulting from the adoption of SFAS No. 115), Continental will need to generate future taxable income of approximately $369 million. Management believes that it is more likely than not that the required amount of taxable income will be realized. Management will periodically reconsider the assumptions utilized in the projection of future earnings, and, if current earnings and taxable income trends continue, additional tax benefits will be recognized through further reductions of the valuation allowance. See Note 20 to the financial statements for additional information on income taxes.\nDOMESTIC\/FOREIGN OPERATIONS\nContinental attributes assets and earnings to domestic and foreign operations based on the location of the principal obligor. The level of foreign assets increased in 1993 after years of decline principally due to the downsizing or closing of certain foreign operations and a reduction of Latin American exposure. The increase from year-end 1992 was primarily due to an increase in short-term assets in the Asia\/Pacific region.\nIncome from continuing operations attributable to foreign operations was $97 million in 1993, compared with $51 million in 1992. Latin America continued to be the principal contributor to foreign earnings. However, a $51 million increase in non- interest revenues, primarily from higher gains from equity investments, was almost entirely offset by lower net interest revenue and higher income taxes. Results improved in all other regions, except Asia\/Pacific where a decline in net interest revenue and an increase in operating expenses resulted in a $17 million drop in earnings. Domestic income from continuing operations amounted to $161 million in 1993, compared with $171 million in 1992.\nFor country risk information, see pages 53 through 55.\nBALANCE-SHEET ANALYSIS\nContinental's well-established distribution network enables it to meet customer needs by placing financial assets with a broad range of investors. This limits Continental's need to use its balance sheet, thereby maximizing risk-adjusted returns.\nAssets\nAlthough total assets increased only slightly from year-end 1992, the composition of total assets changed more significantly. As a result of the adoption of SFAS No. 115 on December 31, 1993, Continental transferred $665 million of securities from securities held for sale, $157 million from loans, and $98 million from trading account assets to securities available for sale. The recording of net unrealized gains on securities available for sale and equity investments increased those categories by $9 million and $45 million, respectively.\nContinental estimates that $7 billion of credit facilities (unused credit commitments and loans) were sold in 1993, excluding sales of short-term loans (for example, loan participation certificates).\nDeposits\nDeposits, the principal source of funds, totaled $13.5 billion on December 31, 1993, down $602 million from year-end 1992. Most of the reduction was in deposits in domestic offices, primarily interest-bearing. At year-end 1993, $3.7 billion of deposits had a remaining maturity of more than one year, compared with $4.4 billion the prior year. Such funds are considered to be term deposits and are included in Continental's term funding.\nThe Bank has issued certificates of deposit through securities brokers. At year-end 1993, these deposits totaled $4.3 billion. During 1993, Continental issued approximately $250 million of these deposits, with an average maturity of more than five years. These deposits allow Continental to obtain retail-priced term funding without incurring costs associated with a retail branch network.\nCapital\nMaintaining a strong capital base is a key component of a successful funding strategy and provides Continental with both the level of capital to prudently support the financial risks inherent in its businesses and the flexibility to take advantage of new business opportunities.\nContinental's objective is to maintain capital ratios in excess of the regulatory minimums through retention of earnings, asset management, and the issuance of qualifying debt. Despite an increase in risk-adjusted assets, the ratios of Tier 1 capital and total capital to risk-adjusted assets increased from year-end 1992, due to an increase in capital from retention of earnings. In addition, the $80 million net deferred tax benefit that was\nrecorded upon adoption of SFAS No. 109 was recognized for regulatory capital purposes. However, the purchase of treasury stock in 1993 reduced capital. The improvement in the leverage ratio resulted primarily from the increase in Tier 1 capital.\nThe adoption of SFAS No. 115 resulted in the recording of net appreciation on securities available for sale and certain equity investments of $35 million, net of income tax effect ($54 million on a pretax basis). The net appreciation is reported as a separate component of stockholders' equity. This portion of equity did not qualify as regulatory capital as of December 31, 1993.\nThe largest component of capital is stockholders' equity. The ratio of equity to assets was 8.5 percent at year-end 1993, an improvement from 7.5 percent at year-end 1992, primarily due to earnings retention.\nOFF-BALANCE-SHEET ACTIVITIES\nContinental engages in a variety of transactions with customers and for its own account which by their nature, are not recorded on the balance sheet. These transactions are in the form of contingent liabilities, including commitments to extend credit, contracts to purchase and sell foreign currencies, and derivative instruments. Some of these transactions are entered into to assist Continental and its customers to manage financial risks, while others are for Continental's proprietary trading purposes. The products most often involved in these transactions are derivative and credit-related.\nDerivative Products\nDerivative products involve the use of one or more of the following basic instruments: futures, forwards, swaps, and options. The financial risks inherent in these instruments may include interest-rate, foreign-currency, and other price risks.\nBasic derivative instruments may be combined to \"build\" other derivatives. For example, an interest-rate collar combines a sold option and a purchased option to provide protection for a range of interest-rate movements at a low cost. Financial instruments also may be combined to build other derivatives for the management of more than one financial risk. For example, a cross-currency interest-rate swap is designed to manage both interest-rate and foreign-currency risk. For more information about Continental's derivative products, see Note 14 to the financial statements.\nCredit-Related Products\nOff-balance-sheet credit-related products primarily include commitments to fund under various scenarios and conditions, such as a standby letter of credit. With this product, Continental's obligation is contingent in nature, and, therefore, a liability is not recorded on the balance sheet. However, if the standby letter of credit is expected to be funded and the customer is not expected to repay, then a loss must be recognized in the financial statements.\nThe credit risks inherent in credit-related products as well as any credit risk associated with derivative products are managed as part of the Bank's overall credit review process and are subject to the same credit policies and practices as a loan. These policies and procedures are discussed in greater detail in Credit Risk Management on pages 40 through 53.\nFINANCIAL RISK MANAGEMENT\nAs a provider of financial services, Continental is exposed to certain inherent risks and, to be successful, must actively manage these risks under dynamic conditions. Continental's Financial Risk Management Committee coordinates and oversees the application of financial risk-management policy and financial strategies. This committee reviews and analyzes Continental's balance-sheet management and financial-risk profile, including liquidity risk, interest-rate risk, trading risk, and foreign-currency risk, as well as risks related to new markets and new products.\nContinental utilizes derivatives to manage certain of its financial risks. These include interest-rate risk resulting from Continental's asset and liability structure, trading activities, foreign-currency exposure related to investments in foreign subsidiaries, and price risk associated with certain equity investments.\nLiquidity Management\nContinental's liquidity management balances the trade-off between financial flexibility and funding costs to provide adequate liquidity. Because of its business banking strategy, Continental's primary source of funds is the wholesale capital markets. Therefore, key elements of Continental's liquidity management policy include limiting the reliance on short-dated funding, establishing an appropriate level of medium- and long-term funding to provide stability, diversifying funding sources, and maintaining a liquidity cushion using readily marketable and\/or short-maturity assets. For a more detailed discussion of liquidity, see Funding Strategy below.\nIn 1993, Continental's net cash flow was $188 million, compared with $147 million in 1992. The net decrease in loans produced cash inflows of $167 million in 1993 and $1.269 billion in 1992. Issuance of long-term debt, net of repayments and retirements, provided $183 million of cash in 1993. However, in 1992, repayments and retirements exceeded proceeds from the issuance of long-term debt, resulting in a net cash outflow of $21 million. Proceeds from sales and maturities of securities held to maturity and sales of equity investments totaled $338 million in 1993 and $735 million in the prior year. During 1993, the purchase of securities held to maturity and equity investments totaled $514 million in 1993 and $685 million in the prior year.\nFunding Strategy\nContinental accesses various capital markets when they are economically attractive, while maintaining a balance among capital, term funding, and short-term funding. This strategy, in conjunction with its liquidity policy, is designed to mitigate any adverse impact on Continental when unfavorable conditions exist in capital markets.\nTerm Funding\nContinental considers term funding (funding with remaining maturities of more than one year) a key element of its liquidity management, especially due to the corporation's limited retail deposit base. Although most of Continental's term funding is fixed-rate, it has been converted to a floating-rate basis through the use of derivative products. In general, interest- rate risk on these funds is managed as part of Continental's overall interest-rate-sensitivity position.\nTerm funding decreased from $5.2 billion on December 31, 1992, to $4.8 billion on December 31, 1993, consistent with the $0.7 billion decline in loans. During 1993, Continental issued $1.0 billion of term liabilities with an average original maturity of 5.1 years, bringing the average remaining maturity of term funds to 3.4 years at year-end. The level of term funding in 1994 will be managed in accordance with changing\nconditions in capital markets and the size and composition of Continental's balance sheet. See Note 7 to the financial statements for additional information on long-term debt.\nShort-Term Funding\nShort-term obligations are used to fund short-term assets and a portion of longer-term assets. Short-term obligations include deposits with remaining maturities of less than one year, federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings. These obligations amounted to $14.6 billion at year-end 1993.\nInterest-Rate-Risk Management\nIn managing interest-rate risk, Continental recognizes that earnings and the market value of financial instruments are affected by movements in interest rates and the repricing characteristics of assets and liabilities. Interest-rate risk is managed on a macro, or enterprise, basis designed to achieve a level of interest-rate risk that mitigates and controls the conflicting risks of net-interest-revenue variability and variability in the market value of interest-sensitive assets and liabilities. Limits associated with interest-rate-risk management are approved and monitored by the Financial Risk Management Committee.\nAs described in Funding Strategy above, Continental strives to maintain sufficient term funding to limit its reliance on short- term, volatile funding. This funding strategy, designed to mitigate the impact of limited core deposits, creates interest- rate risk due to the overall short-term repricing nature of Continental's assets. As shown in Sensitivity to Interest-Rate Changes on page 24 of Selected Financial Data, off-balance-sheet products used for hedging purposes substantially reduce Continental's interest-rate risk. It can be misleading to view off-balance-sheet products (including derivatives) separately from the balance-sheet items to which they relate. What may appear to be a large off-balance-sheet exposure is in fact a hedge of a balance-sheet position, which, when viewed with the hedged item, actually minimizes risk. If the derivatives market did not exist, or were less liquid, other techniques would be used to manage Continental's interest-rate risk and funding.\nManagement of Trading and Other Financial Risks\nTrading Portfolio\nAs a financial intermediary, Continental provides various interest-rate, commodity, foreign-exchange, fixed-income, emerging-market, and other products to its customers through its marketing and distribution activities. Continental manages the risk exposures created by these activities through transactions involving cash instruments as well as derivative products. The risks inherent in the trading of these products are managed and controlled worldwide. The Financial Risk Management Committee establishes limits for trading activity with respect to each type\nof financial risk and business activity. The limits are based on Continental's current financial strategy and risk profile. Positions are monitored daily against those limits.\nForeign-Currency Exposure\nContinental is exposed to foreign-currency exchange-rate fluctuations through its trading activities, as well as through its investments in foreign subsidiaries and branches. Risk arising through trading activities is hedged as part of the overall management of Continental's trading portfolio. Continental's policy is to manage foreign-currency exposure from investments in foreign subsidiaries and branches through hedging where available and strategically appropriate.\nSecurities Available for Sale\nSecurities that are held for indefinite periods of time are classified as securities available for sale and carried at fair value, with unrealized appreciation or depreciation recognized in a component of stockholders' equity. This category includes securities that may be used as part of Continental's asset\/liability management strategy and that may be sold in response to changes in interest rates, prepayments, or similar factors.\nEquity Investments\nContinental has a well-diversified portfolio of equity investments which has been consistently profitable. This portfolio totaled $679 million on December 31, 1993. Approximately 24 percent of the portfolio at year-end was invested in foreign securities, primarily Latin American. The equity-investment portfolio has generated a steady revenue stream from realized gains on sales, unrealized market appreciation, and dividends.\nThe focus of Continental's domestic equity-investment portfolio is direct equity ownership in successful private businesses that need additional capital to expand and businesses in which experienced management maintains a substantial financial interest. Continental also acquires equity investments through debt-for-equity swaps, settlement of loans, and enhancements to lending agreements. In addition to direct equity ownership, investments in externally managed equity funds are an important part of Continental's equity portfolio strategy.\nContinental actively manages risks through established limits on the aggregate level of equity investments; the size of individual deals; and the number of investments within a single industry, an economically linked sector of the economy, or a geographic region. The portfolio is managed by proven, experienced professionals within Continental and through professionally managed funds externally. Continental manages market risk\nrelated to certain publicly traded equity investments held by its equity-investment companies. Derivatives are entered into to minimize volatility of earnings.\nCREDIT RISK MANAGEMENT\nContinental remains committed to a thorough, active credit management process which it views as essential to its success as a financial intermediary. Continental's worldwide credit approval and monitoring process is driven by the size and inherent risk of each transaction and exposure to any one customer, whether the customer is a borrower or counterparty. Extensive analysis and monitoring of the financial strength and structure of each transaction and customer is an integral part of these processes. Additionally, a process called watch-loan reporting serves as management's early-warning system, flagging potential problems early for senior management review and action, and includes scrutiny of collateral positions and values. Continental's credit portfolio, as discussed in this section, includes loans, OREO, all other nonperforming assets, and funded bankers' acceptances and is gross of unearned income and deferred fees.\nDiversification of risk and rigorous monitoring of composition are critical to maintaining a well-managed credit portfolio. Continental regularly monitors and actively manages the credit portfolio by customer diversification, industry diversification, and credit-quality measures. Management's analysis of each of its four portfolios--general corporate, commercial real estate, residential real estate, and Latin American--encompasses all of the foregoing elements of diversification. Continental's Credit Policy Committee is responsible for setting and maintaining credit standards and ensuring the overall quality of the credit portfolio.\nContinental also monitors credit exposure arising from off- balance-sheet financial instruments, mainly unused credit commitments, standby letters of credit, and interest-rate and other risk-management products. To manage and minimize credit risk, limits are established for each counterparty in derivative transactions. Additionally, master netting arrangements are entered into with counterparties whenever possible, and, where appropriate, collateral is required to further mitigate credit risk.\nIn the context of credit risk management, credit exposure from interest-rate and foreign-exchange products includes the estimated cost of replacing, at current market rates, all agreements that are favorable to Continental and an amount that represents the potential risk from market variability for all contracts. For additional information about concentrations in Continental's total credit exposure (excluding advised lines of credit), both balance-sheet and off-balance-sheet, see Note 15 to the financial statements.\nCustomer Diversification\nContinental monitors the size of credits in the portfolio to manage concentrations to single and related borrowers. The table below shows the distribution by size of Continental's worldwide portfolio to single borrowers.\nContinental's largest single loan, which was $200 million to a government-owned import\/export bank, represented about 28 percent of the maximum amount the Bank at year-end could lend to a single borrower. Only 20 other loans were $50 million or greater.\nOther than the three largest borrower groups, with outstandings of $264 million, $185 million, and $177 million, no related borrower group had outstandings greater than $100 million at year-end 1993.\nCredit exposure arising from off-balance-sheet financial instruments, excluding Latin America, included unused commitments and advised lines of credit totaling $18 billion on December 31, 1993. The largest such exposure was $153 million, with 17 others greater than $100 million; there were 66 between $50 million and $100 million, and 150 between $25 million and $50 million. Standby letters of credit totaled $2.7 billion on December 31, 1993. The two largest were $217 million to a large freight handling company and $184 million to a corporation that specializes in the purchase of receivables and other financial\nassets. Of the remaining standby letters of credit (aggregated by customer), only three were between $50 million and $100 million, and 14 were between $25 million and $50 million.\nIndustry Diversification\nContinental closely monitors the industry diversification of its portfolio across more than 50 industry segments. More information on industry diversification is in the portfolio discussions that follow and in Credit Portfolio Information on pages 47 through 52.\nCredit Quality\nAt year-end 1993, nonperforming assets were $495 million, or 41 percent lower than at year-end 1992. Nonperforming loans decreased $372 million, more than 53 percent, from December 31, 1992.\nFor more information about nonperforming assets, see Credit Portfolio Information on pages 47 through 52.\nNonperforming loans include loans for which interest is recorded only when it is received (cash basis) and loans that have been renegotiated, for which concessions have been granted due to the borrower's deteriorating financial condition. Continental generally places loans that are past-due 60 days or more on nonperforming status.\nThe combined costs of credit-loss provisions, forgone revenue on nonperforming loans, and ONPA costs were $301 million in 1993, compared with $196 million in 1992 and $444 million in 1991. These costs are expected to decline in 1994. See Operating\nExpenses on page 31 for further discussion of the net costs of ONPA. See Note 6 to the financial statements for the pretax impact of nonperforming loans on interest revenue.\nPrincipal and interest were contractually current for 30 percent of nonperforming loans on December 31, 1993. Nonperforming loans, excluding fully charged-off loans, were carried at 65 percent of the contractual balance. Supplemental Information on Nonperforming Loans in Credit Portfolio Information on pages 51 and 52 provides information on the degree of performance of Continental's nonperforming loans on December 31, 1993.\nGeneral Corporate Portfolio\nThe general corporate portfolio of $9.5 billion represented the largest portion, 80 percent, of the total credit portfolio on December 31, 1993, compared with $9.7 billion, or 77 percent, on December 31, 1992. This portfolio included $873 million of highly leveraged transactions, which represented approximately 9 percent of the general corporate portfolio at year-end 1993.\nContinental's corporate portfolio represents a cross-section of the U.S. economy. Customers range in size from small companies to the nation's largest corporations, and include individuals. Excluding financial institutions and Private Banking customers, about 60 percent are privately held. For more information on the general corporate portfolio, see the tables on pages 47 and 48 of Credit Portfolio Information.\nOn December 31, 1993, nonperforming assets in the general corporate portfolio totaled $199 million, or 2 percent of this portfolio, a decrease from $321 million, or 3 percent, at year- end 1992. There were 54 nonperforming general corporate assets at year-end 1993; the two largest amounted to $33 million and $21 million, and 29 were less than $0.5 million. At year-end 1992, the three largest nonperforming assets were $62 million, $56 million, and $21 million; 14 additional nonperforming assets were between $5 million and $20 million.\nNo single credit in the general corporate portfolio had outstandings of more than $100 million at year-end 1993. Three had outstandings between $75 million and $100 million; and 15 credits were between $50 million and $75 million. In total, all credits of more than $50 million represented only 12 percent of the general corporate portfolio. The largest industry concentrations for the general corporate credit portfolio were services, $703 million; brokerage firms, $671 million; fabricated metals, $550 million; and leasing--transportation, $523 million.\nHighly Leveraged Transactions\nContinental classifies a transaction as an HLT in accordance with the definition established jointly by federal bank regulatory agencies in February 1990.\nOn December 31, 1993, $62 million, or 7 percent, of HLT outstandings was nonperforming, a decline from $204 million, or 20 percent, at year-end 1992. See Reserve for Credit Losses on pages 52 and 53 for information on HLT charge-offs and recoveries.\nCommercial Real Estate Portfolio\nThe commercial real estate portfolio consists primarily of loans secured by retail facilities, offices, hotels, and industrial facilities. This portfolio declined $125 million from $1.165 billion on December 31, 1992, to $1.040 billion at year- end 1993, primarily due to payments by borrowers and $40 million of charge-offs and write-downs. The largest single credit amounted to $73 million at year-end 1993.\nOn December 31, 1993, mortgage credits were 57 percent of this portfolio, construction and development credits were 32 percent, and working capital loans were 11 percent. The largest geographic concentration was in Illinois, with 35 percent of the portfolio, followed by New England and California, each with 11 percent.\nOn December 31, 1993, $70 million, or 7 percent, of the commercial real estate portfolio was nonperforming, compared with $108 million, or 9 percent, at year-end 1992. There were 19 nonperforming commercial real estate credits at year-end 1993; the largest amounted to $13 million. This was the only nonperforming commercial real estate loan of more than $10 million. One OREO also was more than $10 million. See Reserve for Credit Losses on pages 52 and 53 for information on commercial real estate charge-offs and recoveries.\nAt year-end 1993, 54 percent of the nonperforming commercial real estate assets was mortgages, 40 percent was construction and development credits, and 6 percent was working capital credits.\nThe quality of the commercial real estate portfolio has been, and over the near term will continue to be, affected by fiscal and monetary policy, consumer confidence, appraised values during the current economic climate, the level of interest rates, and borrowers' liquidity problems.\nFor more information on Continental's commercial real estate portfolio, see pages 48 and 49 of Credit Portfolio Information.\nResidential Real Estate Portfolio\nThe residential real estate portfolio generally consists of credits to real estate developers for single-family homebuilding. Residential real estate outstandings declined $347 million to $676 million on December 31, 1993, from $1.0 billion at year-end 1992. Of this amount, California residential real estate amounted to $282 million at year-end 1993, down from $588 million at year-end 1992. On December 31, 1993, approximately 38 percent of the total portfolio outstandings represented mortgages, 26 percent was for construction, 19 percent for land development, 10 percent for land acquisition, and 7 percent for working capital loans.\nAt year-end 1993, the largest credit was $59 million, and seven other credits ranged from $15 million to $38 million.\nNonperforming assets in this portfolio decreased $93 million in 1993. On December 31, 1993, $203 million, or 30 percent, of the residential real estate portfolio was nonperforming, compared with $296 million, or 29 percent, at year-end 1992. There were 35 nonperforming residential real estate credits at year-end 1993; the largest was carried at $45 million. Only three nonperforming residential real estate loans and three OREO were more than $10 million at year-end 1993. At year-end 1993, all $101 million of residential OREO was ISFs, the largest relating to one borrower group, carried at $42 million, and with projects primarily in California. Land acquisition credits represented $13 million of OREO. See Reserve for Credit Losses on pages 52 and 53 for information on residential real estate charge-offs and recoveries.\nAs with the commercial real estate portfolio, the quality of the residential real estate portfolio has been, and over the near term will continue to be, affected by a variety of external factors.\nCalifornia Residential Real Estate\nCalifornia represented the largest geographic concentration of residential real estate exposure, with $282 million of outstandings and $176 million of nonperforming assets on December 31, 1993. The carrying value of nonperforming assets\nwas 35 percent at year-end 1993, 51 percent excluding working-capital loans. The largest credit was $49 million, and five others ranged from $15 million to $40 million; five of these six credits were nonperforming.\nFor more information on the residential real estate portfolio, see the tables on pages 49 and 50 of Credit Portfolio Information.\nLatin American Portfolio\nThe Latin American portfolio, before deduction of guarantees, totaled $721 million at year-end 1993. On December 31, 1993, with the adoption of SFAS No. 115, approximately $157 million of debt securities of Argentina, Mexico, and Venezuela was transferred from loans to securities available for sale. These outstandings are collateralized by U.S. Treasury obligations and are deemed to be securities under SFAS No. 115. In addition, in 1993, $58 million of loans to Brazil was transferred to trading account assets after charge-offs of $19 million against the ATRR. The decline in the portfolio due to these transfers was partially offset by a sharp increase in short-term, trade-related credits, primarily to Mexico.\nOn December 31, 1993, $23 million of Latin American assets was nonperforming, a decrease from $109 million at year-end 1992. See Country Risk on pages 53 through 55 for further discussion of countries experiencing liquidity problems. Amounts in that section differ from amounts in the table above because guarantees have been deducted and other financial instruments with transfer risk are included in Country Risk.\nCredit Portfolio Information\nThe following tables present additional information on Continental's credit portfolio:\nGeneral Corporate Portfolio\nOther nonperforming assets of $9 million at year-end 1993 and $15 million at year-end 1992 are included in the general corporate tables above.\nCommercial Real Estate Portfolio\nOther commercial real estate owned of $35 million at year-end 1993 and $48 million at year-end 1992 are included in the tables above.\nResidential Real Estate Portfolio\nOther residential real estate owned of $101 million at year-end 1993 and $66 million at year-end 1992 are included in the tables above.\nNonperforming Asset Information\nSupplemental Information on Nonperforming Loans: The following table provides information on the degree of performance of Continental's nonperforming loans on December 31, 1993. There can be no assurance, however, that individual borrowers will continue to perform. Also, performance characteristics can change significantly over time. Both book and contractual balances are presented; the difference represents charge-offs and the application of interest payments to principal. Amounts for fully charged-off loans are excluded.\nOn December 31, 1993, principal and interest were contractually current for 30 percent of nonperforming loans. As shown in the table, these loans were carried at 65 percent of the contractual balance.\nReserve for Credit Losses\nContinental has established a reserve for credit losses that in management's judgment is adequate to absorb probable losses inherent in the portfolio on December 31, 1993. The reserve, excluding the ATRR in 1992, is not allocated to specific credits.\nManagement's quarterly evaluation of the adequacy of the reserve for credit losses is based on a variety of factors, such as the credit quality and diversification of the credit portfolio, the risk characteristics of individual credits, and historical loss experience.\nContinental's ongoing approach to evaluating reserve adequacy consists of estimating the inherent losses in the credit portfolio using various tests that analyze the portfolios and evaluate the potential impact of other significant factors on the probable loss in the portfolio. The process for evaluating reserve adequacy is both quantitative and subjective, with significant quantitative analysis involved in both the derivation of historical loss experience and in the ongoing adequacy tests themselves. Consideration is also given to other more subjective factors, such as forecasted economic trends, that may influence the evaluation process. This overall analysis process provides the necessary and documented framework for evaluating reserve adequacy.\nThe foundation of Continental's methodology to determine reserve adequacy consists of four separate tests. Two multiple portfolio tests measure reserve adequacy through an assessment of portfolio risk based on internal credit risk ratings. The other two portfolio tests utilize single ratios to set minimum standards for the reserve. Each of the four tests embodies a different approach, the results of which provide multiple perspectives to the overall adequacy analysis and evaluation.\nThe reserve was $328 million, or 2.8 percent of total loans, on December 31, 1993, compared with $376 million, or 3.0 percent of total loans, at year-end 1992. The reserve for credit losses was 100 percent of nonperforming loans on December 31, 1993, compared with 54 percent at year-end 1992. There was no ATRR at year-end 1993; the ATRR was $21 million at year-end 1992.\nNet charge-offs were $222 million in 1993, compared with $158 million in 1992. The increase resulted primarily from higher charge-offs on loans to residential real estate developers in California, partially offset by net recoveries on Latin American loans and lower charge-offs on corporate and HLT loans.\nSee Analysis of Net Credit Loss Experience on page 12 of Credit Analysis and Loss Experience.\nCOUNTRY RISK\nContinental's foreign transactions present elements of risk beyond those associated with domestic business. There is the risk that borrowers within a country will default on their debt due to economic problems within the country. Another risk factor, transfer risk, occurs when there is a shortage of available non-local currency in the borrower's country with which to repay the credit.\nIn evaluating country risk, Continental's Country Risk Committee monitors such factors as the political, social, and economic conditions of the country. Management maintains country lending limits to control the total amount of credit extended to borrowers in individual countries.\nOn December 31, 1993, Continental's foreign-currency outstandings, which include loans, accrued interest, deposits with banks, acceptances, and securities, totaled $3.7 billion, compared with $3.1 billion at year-end 1992. Outstandings are reported net of legally binding third-party guarantees. These guarantees are considered outstandings of the country of the guarantor. Foreign-currency outstandings do not include local currency assets in excess of local currency liabilities.\nCountries with foreign-currency outstandings that were greater than 0.75 percent but less than 1 percent of total assets were as follows: On December 31, 1993--Venezuela, with an aggregate of $186 million; on December 31, 1992--Spain, Argentina, and Mexico, with an aggregate of $549 million; and on December 31, 1991-- Netherlands, Argentina, and Brazil, with an aggregate of $595 million.\nBrazil\nOn December 31, 1993, total outstandings to Brazil were $122 million, down $9 million from year-end 1992. Term outstandings declined $76 million to $9 million on December 31, 1993. This decline was mostly offset by an increase in short-term outstandings from $46 million at year-end 1992 to $113 million at year-end 1993, primarily due to the transfer of loans with a book value of $58 million (net of charge-offs of $19 million) to trading account assets. On December 31, 1993, Continental had no Brazilian nonperforming loans. Brazilian nonperforming loans totaled $85 million at year-end 1992.\nContinental received $7 million of cash payments for Brazil's past-due interest in 1993 and recognized the entire amount as interest revenue. At year-end, unrecognized past-due interest on Brazilian loans, including those held as trading account assets, amounted to $22 million.\nThe refinancing of Brazil's eligible debt and past-due interest is still pending. Under the agreements in principle between the Government of Brazil and the Bank Advisory Committee reached in July 1992, banks are to receive a combination of bonds and cash interest payments in settlement of Brazil's medium- and long-term debt and 1991 and 1992 past-due interest. Continental expects to receive these bonds and remaining cash payments in 1994.\nArgentina\nIn the first quarter of 1993, Continental sold its eligible Argentine debt with a book value of $17 million for approximately $41 million, resulting in recoveries of $24 million. In 1993, Continental converted all of its past-due Argentine interest claim to interest bonds with a face amount of $38 million and $5 million of cash payments for Argentine past-due interest. The cash was recognized as interest revenue, and the interest bonds were recorded at a nominal amount. During 1993, interest bonds with a face amount of $16 million were sold for approximately $14 million, which was recognized as gains on loan sales. On December 31, 1993, the remaining interest bonds, with a face value of $22 million, were written up, upon adoption of SFAS No. 115, to their market value of $19 million.\nRECENTLY ISSUED ACCOUNTING STANDARDS\nIn March 1992, the FASB issued Interpretation No. 39, \"Offsetting of Amounts Related to Certain Contracts.\" This interpretation requires assets or liabilities related to certain contracts, such as interest-rate swaps and foreign-exchange contracts, to be reported gross, rather than offset, in the balance sheet, unless certain conditions are met. Offsetting across product lines also will be acceptable under certain conditions. The new interpretation will be adopted on January 1, 1994, and the effect on Continental's total assets and liabilities is expected to be an increase of approximately 5 percent. There will be no material impact on the results of operations or on Continental's risk-based capital ratios. However, the regulatory leverage ratio is expected to decrease by less than 50 basis points.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This standard requires the cost of benefits provided to former or inactive employees after employment but before retirement to be accrued if certain conditions are met. Under current practice, employer costs are generally recognized as benefits are actually paid. The adoption of the new standard is required for years beginning after December 15, 1993. The effect of the standard on Continental is expected to be immaterial.\nIn May 1993, the FASB issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan.\" Adoption of this standard is required for fiscal years beginning after December 15, 1994. The standard requires that certain loans be identified as impaired whenever it is probable that a creditor will be unable to collect all amounts due according to contractual terms. The amount of impairment of these loans is then measured as the difference between the recorded loan balance and the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral. At adoption and each subsequent reporting date, the overall amount of measured impairment will be reported as a component of the reserve for\ncredit losses. The scope of SFAS No. 114 is limited to loans deemed impaired and does not include other components of the credit portfolio.\nSince the impact of the standard on Continental's financial statements will depend on the composition of the loan portfolio and level of the reserve for credit losses at the time of adoption, the future effect of adoption cannot be precisely determined at this time. To approximate the effect, however, the requirements of SFAS No. 114 were applied to the loan portfolio as of December 31, 1993. The resulting preliminary analysis indicated that adoption at year-end 1993 would not have affected the amount of the provision for credit losses and that the level of the reserve for credit losses would not have changed. More detailed information on the process used in determining the adequacy of the credit loss reserve is in Reserve for Credit Losses on pages 52 and 53.\nRESULTS OF OPERATIONS--1992 AND 1991\nContinental reported net income and income from continuing operations of $222 million, or $3.44 per common share, for 1992. In 1991, Continental reported a net loss of $76 million, or $2.08 per common share, and a loss from continuing operations of $73 million, or $2.03 per common share.\nNet interest revenue increased only $2 million in 1992, due to a number of significant, but offsetting, factors. As interest rates fell during the year, interest-bearing liabilities repriced faster than earning assets, causing the net interest-rate spread to widen and net interest revenue to increase by $86 million over 1991. Also, loan fees rose $8 million. However, the benefit derived from interest-free funds declined $52 million, again due to the lower interest-rate environment. In addition, a $2.7 billion decrease in average earning assets resulted in a $38 million decline in revenue.\nFees, trading, and other revenues in 1992 decreased slightly from the 1991 level. Fees and commissions from the origination and distribution of loans and other assets, cash management services, and other service-related activities rose 12 percent in 1992. Trading activities produced revenues of $30 million, 59 percent less than 1991, because of lower profits from risk-management products.\nRevenues from domestic equity investments were $113 million in 1992, up from $74 million in 1991, primarily due to higher gains on sales of companies in varied industries, such as hospital supply, manufacturing, insurance, and computer-related retail. Revenues from foreign equity investments decreased to $37 million from $57 million in 1991, due to lower sales and dividend levels.\nIn 1992, other revenues included gains on loan sales of $26 million, $8 million from the collection of claims retained from the sale of a business, and foreign-exchange translation losses of $21 million. In 1991, Continental incurred $14 million of foreign-exchange translation losses.\nThe provision for credit losses totaled $125 million in 1992, compared with $340 million in 1991 which included a special provision of $150 million and a $25 million provision to establish an ATRR against Brazilian loans. The 1992 total included a $1 million ATRR provision.\nOperating expenses fell $83 million in 1992 ($80 million, excluding the net costs of ONPA of $13 million in 1992 and $16 million in 1991). When restructuring provisions and the net costs of ONPA are excluded, operating expenses declined $40 million, or 6 percent. This drop reflected the benefits from the restructuring and other ongoing cost-control efforts. The net costs of ONPA primarily resulted from asset write-downs.\nThe year-end 1991 outsourcing of information technology services reduced employee and equipment expenses in 1992 and increased other expenses. This action, along with the outsourcing of the law function, resulted in an overall cost savings of approximately $16 million in 1992.\nStaff levels declined 8 percent, or 361 people, during 1992. This decline, along with the year-end 1991 staff reduction, contributed to a $54 million drop in salary and benefit expenses in 1992. The decrease was partially offset by an increase of $9 million in the provision for incentive compensation.\nNet occupancy expense decreased $6 million in 1992, primarily due to the corporate downsizing from the restructuring. Other expenses rose 19 percent in 1992, as professional service fees increased $38 million. This increase related primarily to the cost of the outsourced functions.\nIncome tax expense, primarily foreign taxes applicable to equity- investment gains, was $20 million, compared with $17 million in 1991. The 1992 income tax expense reflected the recognition of previously unrecognized U.S. federal income tax benefits of $77 million. In 1991, Continental recognized no federal income tax benefit for the loss recorded. On December 31, 1992, Continental's unrecognized federal income tax benefits, computed at a 34 percent rate, totaled approximately $354 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFINANCIAL STATEMENTS\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1--PROPOSED MERGER WITH BANKAMERICA\nOn January 28, 1994, Continental Bank Corporation (Continental) and BankAmerica Corporation (BankAmerica) announced that they had signed a definitive agreement for BankAmerica to acquire Continental for 21.25 million shares of BankAmerica common stock and $939 million in cash, subject to adjustment in certain circumstances. Based on BankAmerica's closing price on January 27, 1994, of $45.75 per share, the transaction was then valued at approximately $1.9 billion.\nThe transaction will be structured as a cash-election merger, in which Continental stockholders may elect to receive either all cash or all BankAmerica common stock. The merger is expected to be tax-free to the extent stock is received, but may become taxable in certain circumstances. The acquisition is expected to close in the third quarter of 1994 and is subject to completion of due diligence and approval by regulators and Continental stockholders.\nThe amount of BankAmerica stock to be issued in the merger is subject to adjustment pursuant to an exchange ratio, which is based on the average BankAmerica stock price during a ten-day period ending ten days prior to closing. The conversion of Continental shares into cash or BankAmerica stock is subject to the BankAmerica average stock price not being greater than $55.84 or less than $36.16. Continental has granted BankAmerica an option to purchase shares of Continental common stock representing 19.9% of its outstanding common shares, at a price of $37.50 per share. The option is exercisable in certain circumstances, including the purchase by a third party of more than 20% of Continental shares or Continental's completion of an alternative transaction with a third party at a higher price. In addition, if Continental enters into such an alternative transaction, it would be obligated to pay BankAmerica the greater of $60 million or 3% of the transaction's value.\nEach outstanding share of Continental Adjustable Rate Preferred Stock, Series 1 (Series 1 preferred stock) and Continental Adjustable Rate Preferred Stock, Series 2 (Series 2 preferred stock), except for shares of Continental Series 2 preferred stock as to which appraisal rights are perfected, will be converted into one share of BankAmerica Series 1 Preferred Stock and one share of BankAmerica Series 2 Preferred Stock, respectively. The BankAmerica Series 1 Preferred Stock and BankAmerica Series 2 Preferred Stock will have substantially the same terms as the Continental Series 1 preferred stock and Continental Series 2 preferred stock, respectively. For information on Continental's preferred stock, see Note 8.\nContinental's Board of Directors has unanimously approved the merger agreement and has agreed to recommend the transaction to Continental stockholders at a meeting to be held on May 23, 1994,\nfollowing the clearance of a proxy statement\/prospectus by the Securities and Exchange Commission. Continental has amended its stockholder rights plan as of January 27, 1994, so as to provide that (i) none of the approval, execution, or delivery of the merger agreement or the stock option agreement, the consummation of the merger, or the acquisition of shares of common stock pursuant to the stock option agreement will cause the rights issued thereunder to become exercisable and (ii) upon the consummation of the merger, the rights issued thereunder will expire. For information on Continental's stockholder rights plan, see Note 9.\nOn January 28, 1994, four lawsuits were filed in Delaware Chancery Court against Continental, Continental's directors, and BankAmerica Corporation. The lawsuits are entitled Alvin J. Slater v. Continental Bank Corporation, et al., C.A. No. 13362; Max Fecht, et al. v. Thomas C. Theobald, et al., C.A. No. 13363; John J. Nitti v. Thomas C. Theobald, et al., C.A. No 13364; and James M. Dupree v. Thomas A. Gildehaus, et al., C.A. No. 13365. In general, each lawsuit alleges that Continental's directors breached their fiduciary duties to the stockholders by agreeing to the merger of Continental with BankAmerica Corporation (Merger) at an allegedly inadequate price and without certain auction or open bidding procedures, and by agreeing to certain terms of the Merger that allegedly prevent or discourage additional potential acquirors from offering a higher price to Continental's stockholders than the price to be paid by BankAmerica. The Slater lawsuit further alleges that the directors breached their fiduciary duties by failing to appoint a committee of unaffiliated directors to consider the Merger. Each of the lawsuits seeks certification of a class action on behalf of Continental's stockholders. Each of the lawsuits, except the Slater lawsuit, seeks to enjoin the Merger. The Slater lawsuit seeks an injunction that would enjoin certain provisions of the Merger agreement and require Continental to solicit higher bids from additional potential acquirors. All four lawsuits also seek monetary damages in an unspecified amount. See Note 24 for discussion of management's assessment of the effect of these lawsuits.\nNOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accounting policies followed by Continental, Continental Bank N.A. (Bank), and their subsidiaries, and the methods of applying these policies, conform with generally accepted accounting principles and with prevailing practice within the banking industry. Policies materially affecting the determination of financial position, results of operations, or cash flows are summarized below.\nBasis of Presentation: Consolidated financial statements of Continental and the Bank include all majority-owned subsidiaries. Intercompany accounts and transactions are eliminated.\nBeginning in 1993, the net costs of other nonperforming assets (ONPA) were presented separately within operating expenses on the Consolidated Statement of Operations in order to highlight credit costs impacting Continental other than the provision for credit losses. Prior years were restated to conform. The components of net costs of ONPA are write-downs, gains and losses from sales, and net operating and direct legal expenses. ONPA comprises other real estate owned (OREO) and all other nonperforming assets, excluding loans.\nEffective January 1, 1993, Continental adopted prospectively Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This standard requires that the cost of benefits such as healthcare and life insurance provided to retirees be recognized over a prescribed period. Under this standard, calculation of reported expense is similar to the approach followed for pensions, which involves the use of actuarial assumptions regarding employee population and estimating the timing and amount of future benefit costs. See Note 18 for further information on postretirement benefits other than pensions.\nEffective January 1, 1993, Continental changed its method of accounting for income taxes to conform with SFAS No. 109, \"Accounting for Income Taxes.\" See Note 20 for further information on the accounting change, including the impact on Continental's financial statements.\nEffective December 31, 1993, Continental adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This standard establishes more stringent criteria for classifying investments as \"held-to-maturity\" and requires investments categorized as \"available-for-sale\" to be carried at fair value, with any net unrealized gains or losses reported in stockholders' equity, net of related taxes. Prior years have not been restated pursuant to SFAS No. 115. See Notes 4 and 5 for further information on debt securities and equity investments.\nIn accordance with a recent clarification by bank regulatory agencies and supplemental guidance by the Securities and Exchange Commission to the banking industry, Continental reclassified certain loans previously classified as in-substance foreclosures (ISFs) to nonperforming loans. These loans, which were included in OREO, were reclassified because Continental had not taken possession of the collateral at the reporting date and had no intent to do so. Prior periods have been restated to reflect this reclassification. These restatements did not change total nonperforming assets.\nDiscontinued Operations: In 1989, the Bank decided to sell its wholly owned subsidiary, First Options of Chicago, Inc. (First Options). The sale was completed in 1991. Prior to the sale, all revenues and expenses attributable to First Options were included in the statement of operations under the caption \"Loss from business held for sale, net of income tax benefits,\" and\nits net assets were included in other assets on the balance sheet. Except where indicated, footnote disclosures relate solely to continuing operations.\nSecurities and Trading Account Assets: Debt securities are classified as securities held to maturity only if there is intent and ability to hold until maturity. These debt securities are carried at amortized cost.\nPrior to the adoption of SFAS No. 115, certain debt securities that were held for indefinite periods of time were classified as securities held for sale and carried at the lower of cost or market value. After the adoption of SFAS No. 115, these securities are classified as securities available for sale and carried at fair value, with unrealized appreciation or depreciation recognized in \"Net unrealized security gains, net of income tax effect,\" a component of stockholders' equity. This category includes certain securities that may be used as part of Continental's asset\/liability management strategy and that may be sold in response to changes in interest rates, prepayments, or similar factors.\nThe gain or loss on the sale of debt securities is determined by using the specific identification method and is displayed as a separate line in the statement of operations. All debt securities are evaluated individually to determine if an \"other- than-temporary\" decline in value has occurred, with any such losses resulting in a direct write-down of the investment.\nAssets, predominately debt securities, are classified as trading account assets when purchased with the intent to profit from short-term market-price movements. Debt securities are carried at fair value unless they are traded in an illiquid market, in which case they are carried at the lower of cost or market. Other assets classified as trading account assets are carried at the lower of cost or market. A gain or loss on a trading account asset sale is determined by using the average cost method. Realized and unrealized gains and losses are included in trading revenues.\nTransfers of securities generally are not permitted between trading account assets, securities held to maturity, or securities available for sale.\nEquity Investments: Securities held by Continental's equity- investment subsidiaries are carried at fair value, with appreciation or depreciation recognized in revenues from equity investments. The fair value of publicly traded securities is based on quoted market prices, discounted where appropriate. Fair values for non-publicly traded securities are determined by management's estimates based on quoted market prices of similar securities, prior earnings, comparable investments, liquidity, percentage ownership, original cost, and other evidence. Management's valuations are approved by the boards of directors of the respective equity-investment subsidiaries.\nPrior to the adoption of SFAS No. 115, equity investments held by other subsidiaries were carried at the lower of cost or market. After adoption, investments held by these subsidiaries that have a readily determinable fair value are carried at such value, with unrealized appreciation or depreciation recognized in \"Net unrealized security gains, net of income tax effect.\" All other equity investments are carried at cost. The carrying value of equity investments held by these subsidiaries is reduced by \"other-than-temporary\" declines in value.\nInterest-Rate and Foreign-Exchange Products: Note 14 contains information about the accounting for interest-rate and foreign- exchange products.\nLoans: Loans, net of deferred origination fees, are generally carried at amortized cost. Fees received for the origination of loans are deferred and amortized to interest revenue over the life of the loan.\nCash-Basis Loans: The accrual of interest revenue is stopped when full or timely collection of scheduled payments becomes doubtful. All loans on which there is a default of scheduled principal or interest payments for a period of 60 days or more are placed on a cash basis, unless the loans are well secured and in the process of collection. Domestic loans that are 30 days past final maturity also are placed on a cash basis. Once a loan is placed on a cash basis, all accrued but uncollected revenue is reversed, with the reversal reported in current-period income.\nReserve for Credit Losses: The reserve for credit losses is available to absorb credit losses on loans and other credit and risk-management products. The level of the reserve is based upon management's review of the loan portfolio and other credit and risk-management products, historical credit loss experience, current economic and political conditions, and other pertinent factors that form a basis for determining the adequacy of the reserve for credit losses.\nOther Nonperforming Assets: ONPA includes OREO acquired for debts previously contracted, assets considered to be in-substance foreclosed for accounting purposes, and other assets acquired through settlement or foreclosure. An asset is deemed to have been in-substance foreclosed if the creditor receives physical possession of loan collateral, regardless of whether formal foreclosure has taken place. ONPA are carried at the lower of cost or fair value, less estimated costs to sell. ONPA write- downs at time of reclassification are charged to the reserve for credit losses. Subsequent write-downs, costs of maintaining these assets, and net gains or losses on sale are reported in other expenses.\nIncome Taxes: Continental and its U.S. subsidiaries file a consolidated federal income tax return, with each subsidiary recognizing and remitting to Continental its share of the current tax liability. Tax benefits of losses and tax credits are allocated to the subsidiary incurring such losses or\ngenerating such credits, only to the extent they reduce consolidated taxes payable. See page 32 of Management's Discussion and Analysis for discussion of the adoption of SFAS No. 109, \"Accounting for Income Taxes.\"\nNOTE 3--PLEDGED AND RESTRICTED ASSETS\nOn December 31, 1993 and 1992, certain securities and other assets totaling $2.286 billion and $1.830 billion, respectively, were pledged to secure government, public, and trust deposits, repurchase agreements for securities and loans, and Treasury tax and loan borrowings, as required by law.\nContinental maintained average deposits at Federal Reserve Banks of $103 million and $79 million during 1993 and 1992, respectively, to satisfy reserve requirements. These deposits are included in cash and non-interest-bearing deposits in the consolidated balance sheet.\nNOTE 4--SECURITIES\nEffective December 31, 1993, Continental adopted SFAS No. 115. See Note 2 for further information on accounting for securities.\nSecurities Held to Maturity: Book values, gross unrealized gains, gross unrealized losses, and fair values of securities held to maturity are shown below:\nThe amortized cost of securities held to maturity that were sold in 1993, 1992, and 1991 was $23 million, $251 million, and $871 million, respectively. Gross realized gains and losses on securities held to maturity were immaterial in 1993. In 1992, gross realized gains were $1 million and gross realized losses were $3 million, and, in 1991, $9 million and $2 million, respectively. Tax-exempt interest revenue on securities held to maturity was immaterial in 1993 and $2 million in 1992 and 1991.\nBook and fair values of securities held to maturity by maturity distribution are shown in the table below:\nSecurities Available for Sale: As a result of the adoption of SFAS No. 115 on December 31, 1993, Continental transferred securities amounting to $665 million from securities held for sale, $157 million from loans, and $98 million from trading account assets to securities available for sale.\nCost basis, gross unrealized gains, gross unrealized losses, and fair values of securities available for sale are shown below:\nFair values of securities available for sale by maturity distribution are shown in the table below:\n\"Net unrealized security gains, net of income tax effect\" includes net unrealized appreciation on securities available for sale and certain equity investments as discussed in Note 5. The amount attributable to securities available for sale was $6 million, net of related taxes of $3 million.\nSecurities Held for Sale: On December 31, 1992, Continental reclassified $495 million of securities held to maturity to securities held for sale. The write-down of these securities to the lower of cost or market resulted in a loss of $4 million, included in security losses on the consolidated statement of operations.\nBook values, gross unrealized gains, and fair values of securities held for sale are shown below:\nGross realized gains on securities held for sale in 1993 amounted to $5 million.\nNOTE 5--EQUITY INVESTMENTS\nEquity-investment securities are held by equity-investment subsidiaries and other subsidiaries and are considered to be available for sale.\nThe proceeds from sales of equity investments were $196 million, $191 million, and $156 million for 1993, 1992, and 1991, respectively. Gross unrealized gains were $108 million, $28 million, and $40 million in 1993, 1992, and 1991, respectively.\nThe following table shows the composition of the equity- investment portfolio:\nSee page 28 of Management's Discussion and Analysis for the composition of revenues from equity investments. The cost basis and gross unrealized gains of equity investments held by other subsidiaries and carried at fair value on December 31, 1993, were $24 million and $45 million, respectively.\n\"Net unrealized security gains, net of income tax effect\" includes net appreciation on equity investments held by other subsidiaries and carried at fair value and securities available for sale, as discussed in Note 4. The amount attributable to equity investments held by other subsidiaries was $29 million,\nnet of related taxes of $16 million. \"Net unrealized security gains, net of income tax effect\" does not include appreciation on investments held by Continental's equity-investment subsidiaries.\nNOTE 6--LOANS\nThe following table presents loans by type:\nNo single industry equalled or exceeded 10% of total loans at year-end 1993 or 1992.\nThe following table shows average loans by type:\nThe following table shows the amount of nonperforming loans at year-end for the past five years:\nLoans classified as performing that had scheduled principal or interest payments past due 60 days or more amounted to $4 million, $43 million, $16 million, $9 million, and $3 million on December 31, 1993, 1992, 1991, 1990, and 1989, respectively. Continental considered these loans to be well secured and in the process of collection.\nThe following table shows the pretax impact of nonperforming loans on interest revenue for the years 1989 through 1993. The negative impact on interest revenue in 1993 decreased from 1992, due to higher cash collections.\nFor a reconciliation of the reserve for credit losses for each of the last five years, see Analysis of Net Credit Loss Experience on page 12 of Credit Analysis and Loss Experience.\nSee Management's Discussion and Analysis for unaudited information on credit risk.\nNOTE 7--LONG-TERM DEBT\nLong-term notes at year-end 1993 and 1992 were as follows:\nThe interest rates on floating-rate notes are determined periodically pursuant to formulas based on certain money market rates, as specified in the agreements governing the issues. Terms of several of the note offerings restrict Continental's ability to dispose of shares of the capital stock of the Bank. None of the notes can be redeemed before maturity, except as noted below.\nThe subordinated notes due July 1, 2001, are redeemable, in whole or in part, at the option of the Bank at any time on or after July 1, 1998, at 100% of the principal amount thereof plus accrued interest to the date of redemption.\nIn February 1993, the Bank issued $100 million of 7 7\/8% subordinated notes due February 1, 2003. Interest on the notes is payable semiannually on February 1 and August 1 of each year.\nIn May 1993, Continental issued $150 million of floating-rate unsecured notes due May 18, 2000. Interest on these notes is payable quarterly. The per annum rate of interest is reset quarterly based on the greater of 4.5% or the three-month London Interbank Offered Rate plus 0.375%.\nIn August 1993, Continental issued $200 million of floating-rate Euronotes due August 19, 1998. Interest on these notes is payable quarterly. The notes are priced at 50 basis points above the three-month London Interbank Offered Rate and are callable after August 1995 at par.\nScheduled maturities and sinking fund requirements for all long-term debt for the years 1994 through 1998 aggregate $81 million, $156 million, $156 million, $5 million, and $200 million, respectively.\nNOTE 8--COMMON AND PREFERRED STOCK\nCommon Stock: From time to time, Continental has acquired shares of its common stock in the open market to be used in connection with employee benefit and compensation programs and for other corporate purposes. On December 31, 1993, 295,342 shares were carried at cost in other assets and deemed held on a temporary basis; 2,868,892 shares were carried at cost as treasury stock and recorded in a separate component of stockholders' equity.\nPreferred Stock: Continental has no obligation to repurchase or retire its Series 1 preferred stock or Series 2 preferred stock, but may at its option redeem this stock in whole or in part. The Series 1 preferred stock is redeemable at $50.00 per share. The Series 2 preferred stock is redeemable at $108 per share prior to August 16, 1999, and $100 per share on or after that date. The Series 2 preferred stock is traded in depositary shares, each depositary share representing a one-quarter fractional interest in a share. Both series of preferred stock have limited voting rights. They have no conversion or preemptive rights but have priority over common stock as to dividends and liquidation rights. The Series 1 preferred stock ranks on a parity with the Series 2 preferred stock as to dividends and liquidation rights.\nDividends on Series 1 and Series 2 preferred stock, payable quarterly, are cumulative and accrue at an adjustable rate determined each quarter. A factor is added to or subtracted from specified money market rates to determine the dividend rate. Information on preferred dividend rates is shown below:\nSee Note 1 for information on the impact the proposed merger of Continental and BankAmerica will have on preferred stock.\nNOTE 9--STOCKHOLDER RIGHTS PLAN\nOn July 22, 1991, Continental's Board of Directors (Board) adopted a Stockholder Rights Plan (Plan) which is designed to strengthen its ability to act for common stockholders in the event of an unsolicited bid to acquire control of the corporation. Each outstanding share of common stock is entitled to one right under the Plan. At present, each right, when exercisable, would entitle the holder (except the acquiring person or entity referred to below) to purchase from Continental\none one-hundredth of a share of Series 3 preferred stock, without par value, at a price of $55.00, subject to adjustment as provided in the Plan. If a person or entity becomes a 20% beneficial owner of Continental common stock, each holder of a right would be entitled to receive, in lieu of the Series 3 preferred stock, at the then current exercise price of the right, common stock (or, in certain circumstances, cash, property, or other securities of Continental) having a value equal to two times the exercise price.\nIn general, these rights become exercisable if another person or entity without Board approval acquires 20% or more of Continental's outstanding common stock or makes a tender offer for that amount of stock. The acquiring person or entity would not be entitled to exercise the rights. These rights expire at the earliest of July 22, 2001; upon redemption by Continental at a price of $0.01 per right; and, upon exchange of the rights in accordance with the Plan. The rights will cause substantial dilution to a person or entity attempting to acquire Continental without conditioning the offer on the rights' being redeemed or a substantial number of rights being acquired.\nIn connection with the proposed merger of Continental and BankAmerica, the Plan has been amended. See Note 1 for further information.\nNOTE 10--REGULATORY MATTERS\nDividend Restrictions: There are two provisions of the federal banking laws that may restrict the Bank's ability to pay dividends to its parent--Continental. One statutory provision requires that net profits then on hand (as determined under the statute) exceed bad debts (as therein defined) after the payment of any dividends. On December 31, 1993, the Bank's net profits then on hand exceeded its bad debts. The second statutory provision requires that dividends declared in any calendar year not exceed the Bank's net profits (as therein defined) for the current calendar year plus the retained net profits for the two preceding calendar years, unless approval of the Comptroller of the Currency (Comptroller) is obtained. Under the more restricting of the two provisions, the Bank had the ability to pay $405 million in dividends as of January 1, 1994, without obtaining the Comptroller's approval. The Bank paid $85 million of dividends during 1993.\nIn addition to the statutory restrictions set forth above, Continental may not declare or pay any dividends on its common stock while there is any dividend arrearage on any class or series of its capital stock ranking, as to dividends, ahead of its common stock. There are currently no dividend arrearages on any class of Continental's capital stock.\nThe Board of Governors of the Federal Reserve System (FRB) generally considers it to be an unsafe and unsound banking practice for a bank holding company to pay dividends except out of current operating earnings, although other factors such as overall capital adequacy, projected earnings, and the composition\nof such earnings may also be relevant in determining whether dividends should be paid. The Comptroller has a similar view with respect to the payment of dividends by a national bank.\nThe payment and amount of future dividends will depend upon the earnings and financial condition of Continental, restrictive covenants in its debt securities, and other factors, such as the views of the bank regulatory agencies.\nLoan Restrictions: The Federal Reserve Act (Act) places restrictions on loans by subsidiary banks to bank holding companies and other affiliates. Other than loans secured by U.S. Government securities or certain segregated deposits, the maximum amount of loans to any single affiliate may not exceed 10% of a bank's capital and surplus, as defined, less the amount of other transactions subject to the Act, and to all affiliates may not exceed 20% of the bank's capital and surplus, as defined, less the amount of other transactions subject to the Act. On December 31, 1993, the maximum amount of all loans that the Bank would be permitted to have outstanding to Continental was $283 million plus the amount of any loans secured by U.S. Government securities or certain segregated deposits.\nOther Regulatory Matters: The Bank is currently classified as \"well capitalized\" for purposes of the brokered deposit regulations issued by the Federal Deposit Insurance Corporation (FDIC) pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), and thus may solicit, accept, renew, and roll over brokered deposits without restrictions. The Bank continues to actively use brokered deposits.\nA bank's capital category for purposes of applying various FDICIA regulations may not necessarily be representative of its overall financial condition or prospects.\nNOTE 11--EARNINGS PER COMMON SHARE\nThe basis for the calculation of primary earnings per share for each of the last three years is presented below:\nThe earnings (loss) per common share was computed by dividing the net income (loss) applicable to common stock, which excludes the preferred dividend requirements, by the weighted average number of shares of Continental common stock outstanding and included common shares that would result from conversion of the Junior Perpetual Convertible Preference Stock, which was outstanding until June 1991. For 1993 and 1992, earnings per common share were computed using the treasury stock method. Under this method, common stock equivalents include shares that would result from the exercise of options reduced by the number of shares assumed to be repurchased from the proceeds received.\nNOTE 12--LEASE AND OTHER COMMITMENTS\nLease Commitments: Continental's obligations for future minimum lease payments and sublease rentals on operating leases were as follows:\nIn addition to the amounts set forth above, certain of the leases require payments by Continental for taxes, insurance, and maintenance. Rental expense included in operating expense in the consolidated statement of operations amounted to $16 million in 1993, $15 million in 1992, and $20 million in 1991.\nOther Commitments: In 1991, the Bank outsourced its information technology operation to Integrated Systems Solutions Corporation (ISSC), a subsidiary of International Business Machines Corporation. The Bank entered into a ten-year contract with ISSC, effective January 1, 1992, to obtain technology and development services. The Bank's cost for such services is estimated to be approximately $49 million per year, including core inflation coverage but subject to adjustments depending upon processing volumes. The contract is subject to termination upon the occurrence of certain conditions.\nNOTE 13--FAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires all entities to estimate the fair value of all assets, liabilities, and off-balance-sheet transactions that are financial instruments. While a significant part of Continental's activities falls under the definition of financial instruments, other balance-sheet items such as properties and\nequipment are not included, nor are intangibles such as the values of the core deposit base or various fee-based activities such as trust and cash management services.\nFair values are point-in-time estimates of the amount at which a financial instrument could be exchanged between a willing buyer and seller, other than in a forced or liquidation sale. These values can change significantly based on various factors, including market risk related to movements in prices, interest rates, or currency rates and credit risk related to the ability of customers to perform under the agreed terms of the contract. Additionally, fair values determined in accordance with SFAS No. 107 do not fully consider transaction costs, the impact of individual transactions on prices, management's intent regarding disposition, or even whether a willing buyer is available. Accordingly, management cannot provide any assurance that the estimated fair values presented below could actually be realized. The fair value estimates for financial instruments were determined as of December 31, 1993 and 1992, by application of the methods and significant assumptions described below.\nThe following methods and significant assumptions were used in determining fair value estimates:\nCash and Short-Term Investments: Interest-bearing balances were valued by discounting contractual cash flows, using market interest rates corresponding to the remaining term of the assets. The fair value of non-interest-bearing balances and acceptances approximated the carrying value because of their short tenor.\nTrading Account Assets, Securities, and Equity Investments: Values of debt and equity securities carried in the statement of condition at either market or fair value were determined as discussed in Note 2. For assets not carried at market or fair value, fair values were determined by management based on quoted market prices of the same or similar securities, prior earnings, comparable investments, liquidity, percentage ownership, and other evidence, as applicable. Purchased options carried as trading account assets were valued using appropriate pricing models.\nLoans: Fair value was determined by segmenting the portfolio into major groupings. The pricing of floating-rate performing loans was deemed to be substantially equivalent to terms offered by other lenders for similar credits, based on prior testing of the loan portfolio and assessment of current market conditions. Accordingly, no adjustment for pricing of this portfolio group was made. The interest-rate-risk component of performing loans, both floating- and fixed-rate, was valued by discounting contractual cash flows, using market interest rates corresponding to the remaining term or repricing period of the loans, as appropriate. Prepayments were not anticipated.\nNonperforming loans were valued either at traded prices, when available; at the present value of expected cash flows, discounted at rates commensurate with uncertainties of those estimated cash flows; or at an amount no greater than the appraised value of underlying collateral, as appropriate.\nIn addition to the credit risk considered by the valuation of nonperforming loans described above, the reserve for credit losses was considered a reasonable approximation, not only for loan credit risk, but also for other uncertainties in the entire credit portfolio, including obligations to extend credit and other off-balance-sheet transactions. Considering the reserve for credit losses in this manner is only one component in estimating the fair value of the loan portfolio. Its use in this context is not the same as an estimate of probable credit losses determined for financial statement reporting purposes.\nSince the methodology for valuing loans encompassed the pricing of the entire credit facility and consideration of the credit loss reserve, segregating amounts between loans and commitments was not feasible. However, a reasonable approximation of current values for unused credit commitments was the amount of net prepaid or accrued fees.\nDeposits and Short-Term Liabilities: Values were determined by discounting contractual cash flows, using current rates paid on obligations of similar remaining tenor. As indicated in the table, the unrecognized loss on interest-bearing deposits was significantly offset by unrecognized gains on related interest- rate hedges. Securities sold but not yet purchased were carried at fair value. The fair value of non-interest-bearing deposits\napproximated the carrying value because of their short tenors. A fair value for Continental's deposit-base intangible has not been estimated.\nLong-Term Debt: A fair value for long-term debt was determined by reference to current market prices for Continental's outstanding debt.\nOff-Balance-Sheet Financial Instruments: Exchange-traded instruments were valued using quoted market prices. Forward contracts were valued at the prices of comparable instruments. Other instruments, including swaps, forward-rate agreements, and options, were valued using appropriate pricing models.\nUnused credit commitments, primarily loan commitments and standby letters of credit, were determined to be priced substantially at current market levels for similar commitments. Accordingly, estimated fair value represents currently accrued fees charged for assuming these obligations. The fair value of letters of credit other than standby letters of credit was immaterial.\nNOTE 14--DERIVATIVE AND CREDIT-RELATED FINANCIAL INSTRUMENTS\nContinental incurs off-balance-sheet risk as a result of entering into derivative and credit-related financial instrument transactions. A loss may occur as a result of credit or market risk. Off-balance-sheet risk is the potential loss, assuming the worst case situation, attributable to these financial instruments that has not been recorded in the financial statements. It is not intended to represent expected losses.\nCredit risk is the possibility of a loss from the failure of another party to perform according to the terms of a contract. An example of a financial instrument that has off-balance-sheet credit risk is a standby letter of credit. Continental's obligation under a standby letter of credit is contingent in nature, and, therefore, a liability is not recorded on the balance sheet. However, if the standby letter of credit is expected to be funded and the customer is not expected to repay, then a loss must be recognized in the financial statements. Any such anticipated losses are determined based on expected net cash settlements and are covered by the reserve for credit losses. Contractual or notional amounts related to derivatives are used only as a base for calculating net cash settlements. Such amounts do not represent off-balance-sheet credit risk.\nMarket risk is the potential loss that may be incurred due to adverse shifts in either interest rates, foreign-exchange rates, or prices of equity, commodity, or other financial instruments. An example of a financial instrument with off-balance-sheet market risk is an interest-rate swap. An interest-rate-swap transaction in which one party receives cash based on a floating rate and pays cash based on a fixed rate will experience a loss in value in a falling interest-rate environment.\nDerivatives: Derivatives may be separated into four fundamental components that are linked to various types of financial risks. The four components are futures, forwards, swaps, and options. The financial risks include interest-rate, foreign-currency, and other price risks. Continental uses these instruments to manage its financial risk position, as well as to provide customers the tools to manage their risks.\nFutures and forward contracts are commitments to buy and sell a financial instrument at a specified future date for a specified price. Futures differ from forwards in that they are standardized, exchange-traded contracts that require that a specified level of cash be placed in a margin account for daily settlement purposes. Forwards, on the other hand, have customized terms and are generally transacted between two parties. As such, there is some amount of credit risk which varies with price movements.\nSwaps, primarily interest-rate, involve exchanges of fixed- for floating-rate payments calculated over a specified time on a specified notional amount. However, the exchange of one contract based on a floating-rate index for another contract based on a floating-rate index, as well as exchanges based on commodity- and equity-price movements, also may occur. As with forwards, swaps are contracts between two parties and, therefore, have associated credit risk. Swaps may be entered into under master netting arrangements; accordingly, periodic payments between counterparties are typically settled on a net basis over the life of the swap. For interest-rate swaps, notional amounts are used only for calculating settlements and are not exchanged. Collateralization and periodic settlements based on market value are sometimes utilized to reduce credit exposure.\nOptions convey to the holder the right, but not the obligation, to buy or sell a financial instrument at a specified price or exchange rate at or over a specified time period. Options may be entered into on an exchange or via the \"over the counter\" market. Options traded on exchanges have standardized terms, while non- exchange-traded options have customized terms and, like forwards and swaps, are generally transacted between two parties. Counterparty credit risk related to exchange-traded options is to the exchange. The buyer of a non-exchange-traded option is dependent on the seller or writer to honor the terms of the transaction and, as a result, assumes credit risk. This risk increases as the option value increases. In contrast, the writer is paid a premium for assuming the obligation for adverse market- risk movements over the life of the option.\nThe accounting for derivatives depends on the nature and purpose of the transaction. The fair value of derivatives entered into for trading purposes is recorded on the balance sheet in either other assets, other liabilities, or trading account assets. Changes in fair value are immediately recognized as trading revenue. Futures contracts and options that are exchange-traded instruments are valued using quoted market prices. Forward contracts, swaps, and options negotiated with individual\ncounterparties are valued using applicable pricing models. Currently, unrealized gains and losses on forward contracts and swaps are each reported net on the balance sheet. Beginning in 1994, in order to comply with a new accounting interpretation, Continental will net only forwards or swaps by counterparty provided a master netting arrangement exists with the counterparty.\nThe extent of Continental's involvement in derivative transactions for both hedging and trading purposes is represented by contractual or notional amounts. These amounts, summarized in the table below, serve as volume indicators only and do not represent the potential gain or loss from market or credit risk.\nTrading revenues in 1993 related to derivative products were primarily customer-driven and, by management's estimate, totaled $33 million.\nDerivatives Used as Hedges: The following table shows the notional amounts for derivatives that Continental used to manage its interest-rate risk. These amounts also are included in the table of contractual or notional amounts above.\nThe notional amounts of financial futures contracts displayed in the preceding table consist mostly of three-month contracts used to hedge longer-term deposits and loans, and, therefore, the volumes included can be misleading.\nInterest-rate swaps that qualify as hedges are accounted for on an accrual basis, with gains or losses recorded in interest revenue or interest expense, as appropriate. Futures contracts and terminated swaps that have been identified to function as a hedge or to adjust interest-rate risk must meet specific criteria. The realized gains or losses related to these hedges are deferred and amortized as interest revenue or interest expense over the life of the designated assets, liabilities, or anticipated transactions.\nAs shown in the following schedule, Continental's net interest revenue for 1993 was favorably impacted by hedging.\nIt is important to view the hedging results in conjunction with the related balance-sheet positions in order to determine the impact on net income of these associated items. The tables in Note 13 provides information about the deferred hedge gains or losses and the unrecognized gains or losses on the underlying assets or liabilities.\nThe net deferred gain related to futures hedging activity at year-end 1993 was $134 million, which generally will be amortized over the expected life of the underlying hedged assets or liabilities. Since this deferred amount includes the current value of open futures contracts, it is subject to change as interest rates move. Again, it is critical to view this amount in conjunction with the balance-sheet position being hedged. Note 13 provides more information on the relationship between hedges and the underlying risk positions.\nThe foreign-currency-hedge results (net of related income taxes attributable to forward contracts) associated with certain investments in foreign subsidiaries and branches are excluded from income and recorded as accumulated translation adjustments in stockholders' equity, unless the related investment is sold or substantially liquidated.\nCredit-Risk Exposure for Derivatives: The extent of Continental's credit-risk exposure for derivatives generally represents positions with a positive market value, in which cash\nhas not yet been received by Continental. In the case of forward and swap contracts, a positive market value may be reduced by unrealized losses on other contracts with the same counterparty, provided a master netting arrangement exists with that counterparty. Written options do not pose any credit risk to Continental because Continental is obligated to perform under the option contract, and the purchaser, therefore, has the credit risk.\nThe following table shows Continental's estimate of the credit- risk exposure from derivatives, including those used for hedging.\nThe fair value of collateral held related to derivative transactions was approximately $9 million on December 31, 1993. For an unaudited maturity distribution for derivative transactions as of December 31, 1993, see Sensitivity to Interest-Rate Changes on page 24 of Selected Financial Data.\nCredit-Related Financial Instruments: Credit-related financial instruments primarily include commitments to extend credit, standby letters of credit, and foreign-office guarantees.\nCommitments to extend credit are obligations to lend to a customer over a specified period. These agreements are typically contingent upon the customer's maintenance of certain credit standards during the commitment period.\nStandby letters of credit and guarantees are irrevocable commitments by Continental that generally guarantee the performance of a customer in arrangements with a third party.\nCredit-risk exposure for credit-related financial instruments is represented by the contractual amounts of these instruments. The following table summarizes Continental's credit-risk exposure related to these financial instruments:\nSince many of the above commitments are expected to expire without being drawn upon, or will be only partially used, the total commitments do not necessarily represent future cash requirements.\nContinental closely monitors the credit-risk exposure of these financial instruments as part of its credit review process. Collateral is required as deemed necessary by the creditworthiness of the counterparty. The nature of the collateral varies, but may include third-party letters of credit, securities issued by the U.S. Government and its agencies, inventory, receivables, equipment, and property. The collateral is reviewed periodically to determine its adequacy and ensure its existence. Some forms of collateral, such as cash equivalents and marketable securities in the possession of the Bank, are readily accessible. Other forms are not in the Bank's possession, but security agreements give the Bank rights with respect to the title and disposition of the collateral.\nIn the case of standby letters of credit, credit-risk exposure is further reduced by participations to third parties. The amount participated to third parties was $336 million and $310 million on December 31, 1993 and 1992, respectively.\nApproximately 87% of standby letters of credit and guarantees expire within one year, and nearly all within five years. The amount on December 31, 1993, included $312 million to support repayment of commercial paper and industrial revenue bonds.\nContinental earns fee revenue on the above credit-related products which it generally recognizes over the term of the credit-related financial instrument. The amount of such fee revenue recognized in 1993 was $66 million.\nNOTE 15--CONCENTRATIONS OF CREDIT RISK\nCredit concentrations exist if a number of counterparties are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be affected similarly by changes in economic or other conditions.\nSee Management's Discussion and Analysis for unaudited information on credit risk. This information includes size, industry, and geographic distributions of the credit portfolio (loans, other real estate owned, and other nonperforming assets). The table below shows Continental's credit-risk concentrations by type with respect to all financial instruments, balance-sheet and off-balance-sheet, except securities purchased under agreements to resell, customers' liability on acceptances, and over-the- counter foreign-exchange contracts:\nNOTE 16--EMPLOYEE STOCK PLANS\nContinental maintains an Employees Stock Ownership Plan (ESOP) that provides benefits to substantially all full-time U.S. employees. On December 31, 1993, the ESOP held 1,908,806 shares of Continental common stock, 344,302 shares of which were unallocated. All loans to the ESOP Trust have been recorded as a reduction of stockholders' equity.\nContinental contributed $4 million to the ESOP in 1993, all of which represented the compensation element. The 1992 and 1991 contributions were $10 million and $7 million, respectively ($9 million and $6 million, respectively, representing the compensation element). The contributions in 1992 and 1991 were net of $1 million of dividends on unallocated shares of common stock.\nContinental maintains a stock plan and a stock-equivalent plan for certain non-U.S.-paid employees. Expense recognized for both plans was less than $1 million in 1993, 1992, and 1991.\nContinental adopted a stock option plan during l979 and a combined stock option and restricted stock plan in l982. In April 1991, Continental's stockholders approved the 1991 Equity Performance Incentive Plan (1991 Plan). Under the 1991 Plan, officers and other key employees may receive awards consisting of options, stock appreciation rights, restricted stock, and restricted stock units. The 1991 Plan allows for a maximum of 3,500,000 shares of common stock to be issued. Awards generally are not assignable or transferable and may be exercised only by the participant.\nAuthorized shares of Continental common stock reserved for issuance to key personnel under the stock option plans amounted to 7 million and 8 million on December 31, 1993 and l992, respectively. Stock options expire ten years from the date of grant.\nData with respect to options are as follows:\nOptions for 763,621 shares were exercised during 1993. In 1992, 443,245 options were exercised. In 1991, no options were exercised.\nIn addition to the plans described above, Continental has granted stock options to three present or former members of executive management in conjunction with their employment, all of which are currently exercisable. The following table sets forth information with respect to these options:\nUnder the terms of the options granted in 1984, the optionees have the right to exercise the options in exchange for common stock or to surrender any of the options in return for a cash payment equal to the book value per share of common stock at the end of the preceding quarter less $26.00 per share. In addition, these optionees have until August 13, 1994, to require Continental to repurchase shares acquired through exercise of the options, at a price per share equal to the book value per share of common stock at the end of the preceding quarter less $8.00 per share.\nNOTE 17--PENSION PLAN\nContinental and certain subsidiaries have a noncontributory defined benefit pension plan covering substantially all full-time U.S. employees. The plan benefits are based on years of service and a final-pay formula. Continental's policy is to fund the plan in compliance with the Employee Retirement Income Security Act (ERISA).\nThe domestic pension expense for 1993 and 1991 was less than $1 million and $3 million, respectively; the domestic pension benefit for 1992 totaled $1 million. Continental did not contribute to the plan in any of the last three years, since the plan was overfunded for ERISA purposes.\nContinental recognized a curtailment gain of $9 million in 1991 as a result of the decrease in projected benefit obligations associated with the reduction in the total number of employees.\nThis gain is included as part of the provision for business restructuring in 1991.\nThe following table reconciles the domestic pension plan's funded status and the amounts recorded in Continental's consolidated balance sheet:\nThe following table shows the rates used in determining the actuarial present values of projected benefits and the expected long-term rate of return on plan assets:\nIn addition to considering borrowing rates, Continental's discount rate for 1993 was actuarially derived by comparing expected cash outflows under its pension plan to cash flows related to a hypothetical, but obtainable, bond portfolio of highly rated bonds which could be purchased to settle Continental's pension obligation.\nThe components of pension expense for each of the last three years are as follows:\nEmployees of certain foreign units of Continental participate in defined benefit or contributory pension plans established by those units; the pension expense related to these plans was not material in any of the last three years.\nNOTE 18--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nContinental and certain subsidiaries have a contributory postretirement healthcare plan covering substantially all salaried U.S. employees. Eligibility for plan benefits is based on a combination of age and length of service. Healthcare benefits are subject to limitations on both individual and total benefits available. Continental also has retained the right to amend the plan in the future. Continental provides postretirement life insurance only for retirees who retired by December 31, 1991, and certain key executives. Continental funds its portion of the postretirement benefits on a pay-as-you-go basis.\nThe following table presents the components of the accumulated postretirement benefit obligation as of December 31, 1993:\nThe following table shows the rates used in determining the actuarial present values of projected benefits:\nContinental's discount rate for postretirement benefits was derived using the same methodology as that used to determine the pension discount rate.\nA one-percentage point increase in the assumed medical trend and administration cost rates in each year would increase the accumulated postretirement benefit obligation on December 31, 1993, by approximately $8 million. The increase on the combined service and interest cost components of the 1993 annual postretirement benefit expense would have been approximately $1 million.\nThe components of postretirement benefit expense for 1993 are as follows:\nThe difference between the accrued postretirement benefit cost on December 31, 1993, and postretirement benefit expense for 1993 was expenses paid during the year.\nNOTE 19--OTHER EMPLOYEE BENEFITS\nEmployee Savings Plan: Continental maintains a savings incentive plan under Section 401(k) of the Internal Revenue Code, covering substantially all full-time U.S. employees. Under the plan, employee contributions are partially matched by Continental. Total savings plan expense amounted to $3 million, $2 million, and $3 million for 1993, 1992, and 1991, respectively.\nHealthcare and Life Insurance Benefits: Continental provides healthcare and life insurance benefits to certain active employees based on a combination of age and length of service. Healthcare benefits are subject to limitations on both individual and total benefits available. The amount charged to expense\nincludes healthcare benefits paid to participants, net of their contributions, and administrative costs. Life insurance premiums paid to insurance companies are recognized as an expense when paid. The expense for healthcare and life insurance benefits in 1993, 1992, and 1991, was $12 million, $12 million, and $13 million, respectively, for active employees.\nNOTE 20--INCOME TAXES\nIncome tax expense (credit) consisted of the following:\nThe components of and changes in the federal deferred tax asset were as follows:\nIn addition to the federal deferred tax asset shown above, Continental recorded a federal deferred tax liability of $19 million due to the adoption of SFAS No. 115. See Note 2 for further discussion of the adoption of SFAS No. 115.\nFor discussion of management's assessment of the valuation allowance, see Income Taxes on page 32 of Management's Discussion and Analysis.\nThe components of deferred income tax expense for 1992 and 1991 relate to the factors listed below:\nOn December 31, 1993, Continental had the following federal income tax carryforwards.\nIn addition to the federal tax benefits indicated in the table above, Continental has net operating loss carryforwards available in various state and foreign jurisdictions, none of which have been recognized for financial statement purposes.\nThe following table provides a reconciliation of income taxes on continuing operations included in the consolidated statement of operations to an income tax provision computed by applying the statutory federal corporate tax rate of 35% for 1993 and 34% for 1992 and 1991 to income (loss) before income taxes:\nThe effect of the change in federal income tax rates enacted as part of the Revenue Reconciliation Act of 1993 was an immaterial increase to net deferred tax benefits as of January 1, 1993.\nThe following table shows income (loss) from continuing operations before taxes from domestic and foreign operations. In this table, foreign operations include foreign branches and foreign subsidiaries only.\nNOTE 21--SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION\nOther revenues in the consolidated statement of operations included gains on loan sales and foreign-exchange translation losses. Gains on loan sales were $36 million in 1993, $26 million in 1992, and $3 million in 1991. Foreign-exchange translation losses totaled $4 million in 1993, $21 million in 1992, and $14 million in 1991.\nThe main components of other expenses included in the consolidated statement of operations are as follows:\nThe main components of net costs of ONPA included in the consolidated statement of operations are as follows:\nNOTE 22--DOMESTIC AND FOREIGN OPERATIONS\nDue to the nature of Continental's business, it is not possible to separate precisely domestic and foreign operations. Thus, subjective judgments related to the distribution of earning assets, revenues, and costs were used to derive operating results. Charges or credits for intercompany funding were based on the cost of selected short-term funds. Equity was allocated based on the level of total average assets. Gross expenses included interest expense and provisions for credit losses. Other operating expenses were allocated between regions for expenses incurred by one on behalf of another. Income taxes were adjusted for the difference between foreign and U.S. tax rates.\nThe general provision for credit losses was allocated on the basis of net charge-off experience and management's assessment of risk characteristics of the portfolio. In 1992 and 1991, the allocated transfer risk reserve was netted against assets of the Latin American\/Caribbean region. The information presented for foreign operations was based on the location of the principal obligor without regard to guarantors. Prior-year amounts have been restated to conform with the current year's presentation.\nNOTE 23--CONDENSED PARENT COMPANY STATEMENTS\nThe condensed balance sheet and statements of operations and cash flows for the parent company, Continental Bank Corporation, are as follows:\nNOTE 24--LEGAL PROCEEDINGS\nThe following consolidated civil action is a proceeding that primarily seeks monetary damages against the Bank. On September 25, 1984, two actions were instituted in Oklahoma entitled The First National Bank and Trust Company of Oklahoma City and Continental Illinois National Bank and Trust Company of Chicago v. Ray Bell, et al. (Bell Group), and The First National Bank and Trust Company of Oklahoma City and Continental Illinois National Bank and Trust Company of Chicago v. Atex Oil Company of Oklahoma, Inc., et al. (Bell Group), in which the Bank sought repayment of obligations due under various notes and guarantees. The Bell Group filed counterclaims against the Bank seeking $13 million in damages for alleged fraud and violations of both federal and Oklahoma securities laws. The FDIC was substituted for the Bank as plaintiff, and the actions were consolidated for trial in the United States District Court for the Western District of Oklahoma (the Bell action). The FDIC obtained summary judgment on its claim against the Bell Group, and thereafter the Bell Group amended their counterclaims to seek damages of approximately $52 million against the Bank. On April 4, 1988, the court entered judgment on the jury verdict in the amount of approximately $52 million in damages against the Bank. On April 24, 1990, the United States Court of Appeals for the Tenth Circuit reversed the judgment against the Bank based on common law fraud and violation of the federal securities laws, while affirming the jury verdict against the Bank for non- registration of a security under Oklahoma securities law and remanding the case for a redetermination of damages on that issue. The Bank became aware that certain members of the Bell Group purportedly assigned their rights to any judgment against the Bank to the FDIC. On June 6, 1991, following a bench trial, a federal judge issued an opinion that the Bell Group was not entitled to any damages against the Bank. On September 14, 1993, the United States Court of Appeals for the Tenth Circuit affirmed the District Court's findings in the Bell case that the Bell Group is not entitled to any damages against the Bank. On January 13, 1994, the plaintiffs filed a petition for a writ of certiorari in the Supreme Court of the United States.\nIn addition to these actions, Continental and certain subsidiaries, including the Bank, are defendants in various other lawsuits. It is the opinion of management that the ultimate resolution of the Bell action, the actions discussed in Note 1, and all other lawsuits will not have a material effect on the financial condition of Continental.\nMANAGEMENT REPORT\nManagement is responsible for the content of the Annual Report on Form 10-K, including the financial statements and related notes appearing on pages 58 through 102, and believes that the statements and notes have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and present fairly Continental Bank Corporation's financial condition and results of operations. Where amounts must be based on estimates and judgments, they represent the best estimates of management. All financial information appearing in the Annual Report on Form 10-K is consistent with that in the financial statements.\nThe accounting system and related internal accounting controls are designed to provide reasonable assurance that assets are safeguarded and that transactions are properly executed and recorded. Emphasis is placed on proper segregation of duties and authorities, the development and dissemination of written policies and procedures, and a comprehensive program of internal audits and management follow-up. Inherent limitations exist in any system of internal accounting controls based upon the recognition that the cost of control should not exceed the benefit derived. Recognizing this cost\/benefit relationship, the system provides reasonable assurance that material errors and irregularities are prevented or would be detected within a timely period by employees in the normal course of performing their assigned duties.\nThe financial statements have been audited by Price Waterhouse, independent accountants, who are responsible for conducting their audits in accordance with generally accepted auditing standards.\nThe Board of Directors pursues its oversight role for accounting and internal accounting control matters through an Audit Committee of the Board of Directors, composed entirely of outside directors. The Audit Committee meets periodically with management, internal auditors, and independent accountants. The independent accountants and internal auditors have full and free access to the Audit Committee, and meet with it privately as well as with management present to discuss internal control, accounting, and auditing matters.\nThomas C. Theobald Chairman\nMichael E. O'Neill Chief Financial Officer\nJohn J. Higgins Controller\nFebruary 28, 1994\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Continental Bank Corporation\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of changes in stockholders' equity, and of cash flows of Continental Bank Corporation and its subsidiaries, and the consolidated balance sheet of Continental Bank N.A. and its subsidiaries, present fairly, in all material respects, the financial position of Continental Bank Corporation and its subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, and the financial position of Continental Bank N.A. and its subsidiaries at December 31, 1993 and 1992, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Corporation's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Note 2 to the consolidated financial statements, the Corporation changed its method of accounting for postretirement benefits other than pensions, income taxes and certain investments in debt and equity securities in 1993.\nPRICE WATERHOUSE\nChicago, Illinois January 18, 1994, except as to Note 1, which is as of January 28, 1994.\nQuarterly financial information for the quarterly periods ended December 31, 1993 and 1992, is set forth in Item 6, under the caption \"Quarterly Financial Information\" and \"Fourth-Quarter Summary.\"\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information on directors of Continental set forth in Continental's Proxy Statement for its 1994 Annual Meeting, under the caption \"Election of Directors,\" is incorporated herein by reference. The information on executive officers of Continental is set forth in Item 4, under the caption \"Executive Officers of the Corporation.\"\nBOARD OF DIRECTORS\nContinental Bank Corporation and Continental Bank N.A.\nThomas C. Theobald Chairman 1\nBert A. Getz Chairman of the Board and President Globe Corporation (diversified investment company) 2\nThomas A. Gildehaus President and Chief Executive Officer UNR Industries, Inc. (holding company with businesses in metal fabrication) 2\nRobert B. Goergen Chairman of the Board and Chief Executive Officer Blyth Industries, Inc. (manufacturer of candles and various home accessories) 3,4\nWilliam M. Goodyear Vice Chairman\nRichard L. Huber Vice Chairman\nMiles L. Marsh Chairman and Chief Executive Officer Pet Incorporated (food products company) 4\nRoger H. Morley Business Consultant and Private Investor 2\nMichael J. Murray Vice Chairman\nLinda Johnson Rice President and Chief Operating Officer Johnson Publishing Company, Inc. (publisher of Ebony and other magazines) 3,4\nJohn M. Richman Of Counsel Wachtell, Lipton, Rosen & Katz (law firm) 1,3,4\nGordon I. Segal President and Chief Executive Officer Crate & Barrel (houseware retail company) 2\nJames L. Vincent Chairman of the Board of Directors and Chief Executive Officer Biogen, Inc. (biotechnology and pharmaceutical company) 4\n1 Member of Executive Committee 2 Member of Audit Committee 3 Member of Committee on Directors 4 Member of Human Resources Committee\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in Continental's Proxy Statement for its 1994 Annual Meeting, under the captions \"Election of Officers\" and \"Executive Officer Compensation,\" (other than the subsection titled \"Report of Human Resources Committee\") is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth in Continental's Proxy Statement for its 1994 Annual Meeting, under the caption \"Stock Ownership,\" is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth in Continental's Proxy Statement for its 1994 Annual Meeting, under the caption \"Certain Transactions,\" is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements\nThe following consolidated financial statements and schedules of Continental and its subsidiaries included in Continental's 1993 Annual Report to Stockholders are included in Item 8:\nFor Continental Bank Corporation and Subsidiaries: Consolidated Balance Sheet--December 31, 1993, and December 31, 1992 Consolidated Statement of Operations--Years ended December 31, 1993, December 31, 1992, and December 31, 1991 Consolidated Statement of Cash Flows--Years ended December 31, 1993, December 31, 1992, and December 31, 1991 Consolidated Statement of Changes in Stockholders' Equity--Years ended December 31, 1993, December 31, 1992, and December 31, 1991 For Continental Bank N.A.: Consolidated Balance Sheet--December 31, 1993, and December 31, 1992 Notes to Financial Statements\n(a)(2) Financial Statement Schedules\nAdditional statement schedules are omitted because they are not applicable, the data are not significant, or the required information is set forth in the consolidated financial statements or in the notes related thereto.\n(a)(3) Exhibits*\n(2)(1) Agreement and Plan of Merger, dated as of January 27, 1994, between Continental and BankAmerica Corporation. Incorporated by reference to Exhibit 2 to Continental's Current Report on Form 8-K, dated February 7, 1994, File No. 1-5872.\n(2)(2) Stock Option Agreement, dated as of January 27, 1994, between Continental and BankAmerica Corporation. Incorporated by reference to Exhibit 10 to Continental's Current Report on Form 8-K, dated February 7, 1994, File No. 1-5872.\n3(1) Continental's Certificate of Incorporation. Incorporated by reference to Exhibit 3(1) of Continental's 1989 Annual Report on Form 10-K, File No. 1-5872 ($16.00).\n3(2) Continental's Bylaws ($3.50).\n4(ii)(1) Indenture, dated as of October 1, l986, between Continental and Manufacturers Hanover Trust Company, as Trustee, relating to Continental's Floating Rate Notes due October 16, 1992; 9.125% Notes due October 15, 1993; 11.09% Notes due October 18, 1994; Floating Rate Notes due October 18, 1994; 9.75% Notes due March 15, 1995; 9 7\/8% Notes due June 15, 1996; and Floating Rate Notes due May 18, 2000. Incorporated by reference to Exhibit 4(ii)(2) of Continental's 1989 Annual Report on Form 10-K, File No. 1-5872. First Supplemental Indenture, dated as of April 1, 1989, to the Indenture dated as of October 1, 1986, between Continental and Manufacturers Hanover Trust Company. Incorporated by reference to Exhibit 4(b) to Continental's Registration Statement on Form S-3, File No. 33-27113 ($29.50).\n4(ii)(2) In accordance with Paragraph (b)(4)(iii) of Item 601 of Regulation S-K, Continental agrees to furnish to the Securities and Exchange Commission upon its request a copy of any instrument that defines the rights of holders of long-term debt of Continental. With the exception of the instrument filed as Exhibit 4(ii)(1) to this Annual Report on Form 10-K, no such instrument authorizes a total amount of securities in excess of 10% of the total assets of Continental on a consolidated basis.\n10(ii)(D) Copy of leases relating to land on which part of the Bank's banking headquarters is located. Incorporated by reference to Exhibit 10(ii)(D) of Continental's 1989 Annual Report on Form 10-K, File No. 1-5872 ($25.75).\n10(iii)(1) through 10(iii)(12) are management contracts or compensatory plans or arrangements.\n10(iii)(1) Continental's 1991 Equity Performance Incentive Plan. Incorporated by reference to Exhibit 10(iii)(1) of Continental's 1991 Annual Report on Form 10-K, File No. 1-5872 ($1.25).\n10(iii)(2) Continental's l982 Performance, Restricted Stock and Stock Option Plan. Incorporated by reference to Exhibit 10(iii)(1) of Continental's 1988 Annual Report on Form 10-K, File No. 1-5872 ($1.50).\n10(iii)(3) Continental's l979 Stock Option Plan. Incorporated by reference to Exhibit 10(c)(1) of Continental's l981 Annual Report and Form 10-K, File No. 1-5872 ($1.00).\n10(iii)(4) Continental's l974 Stock Option Plan. Incorporated by reference to Exhibit 10(c)(2) of Continental's l981 Annual Report and Form 10-K, File No. 1-5872 ($1.00).\n10(iii)(5) Continental Supplemental Pension Program. Incorporated by reference to Exhibit 10(iii)(4) of Continental's 1989 Annual Report on Form 10-K, File No. 1-5872 ($1.50).\n10(iii)(6) Continental's Senior Management Death Benefit Plan. Incorporated by reference to Exhibit 10(iii)(5) of Continental's 1986 Annual Report on Form 10-K, File No. 1-5872 ($2.50).\n10(iii)(7) Continental's Deferred Compensation Plan for Directors. Incorporated by reference to Exhibit 10(iii)(6) of Continental's 1988 Annual Report on Form 10-K, File No. 1-5872 ($1.25).\n10(iii)(8) Option Agreement, dated as of July 27, 1987, between Continental and Thomas C. Theobald. Incorporated by reference to Exhibit 10(iii)(8) of Continental's 1989 Annual Report on Form 10-K, File No. 1-5872 ($2.75).\n10(iii)(9) Continental's Management Incentive Plan. Incorporated by reference to Exhibit 10(iii)(9) of Continental's 1990 Annual Report on Form 10-K, File No. 1-5872 ($2.50).\n10(iii)(10) Continental's 1985 Long-Term Incentive Compensation Plan. Incorporated by reference to Exhibit 10(iii)(10) of Continental's 1985 Annual Report on Form 10-K, File No. 1-5872 ($2.50).\n10(iii)(11) Senior Executive Termination Agreement between Continental and Certain Executive Officers. Agreements in substantially the same form exist between Continental and W. M. Goodyear, J. J. Higgins, R. L. Huber, M. J. Murray, H. W. Rademacher, R. H. Sherman, K. P. Stocker, T. C. Theobald, and J. V. Thompson, all of which are dated as of January 1, 1992. Incorporated by reference to Exhibit 10(iii)(12) of Continental's 1991 Annual Report on Form 10-K, File No. 1-5872 ($3.75).\n10(iii)(12) Continental's Stock Plan for Directors, Amended and Restated, Effective January 1, 1993. Incorporated by reference to Exhibit 10(iii)(12) of Continental's 1992 Annual Report on Form 10-K, File No. 1-5872 ($1.75).\n(10)(iv)(13) Senior Executive Termination Agreement, dated as of July 26, 1993, between Continental and Michael E. O'Neill.\n11 Statement regarding computation of per share earnings ($0.25).\n12 Statements regarding computation of ratios ($0.25).\n21 Subsidiaries of Continental ($0.25).\n23 Consent of Price Waterhouse ($0.25).\n(b) Reports on Form 8-K.\nDuring the fourth quarter of 1993, Continental filed no Current Reports on Form 8-K.\n*Stockholders may obtain a copy of any exhibit by writing to Mr. John J. Higgins, Controller, Continental Bank Corporation, 231 South LaSalle Street, Chicago, Illinois 60697. All requests must be accompanied by a check or money order payable to Continental Bank Corporation in the amount indicated in the parentheses after the exhibit ordered. No payment is required for orders under $2.50.\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933 (the \"Act\"), the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8, Nos. 2-97669 (filed May 13, 1985) and 33-28458 (filed May 9, 1989):\nInsofar as indemnification for liabilities arising under the Act may be permitted to directors, officers, and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer, or controlling person of the registrant in the successful defense of any action, suit, or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nFebruary 28, 1994\nSIGNATURES\nPursuant 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.\nCONTINENTAL BANK CORPORATION\nby Richard S. Brennan Richard S. Brennan General Counsel and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the date indicated.\nThomas C. Theobald Miles L. Marsh Thomas C. Theobald Miles L. Marsh Chairman and Director Director\nMichael E. O'Neill Roger H. Morley Michael E. O'Neill Roger H. Morley Chief Financial Officer Director\nJohn J. Higgins Michael J. Murray John J. Higgins Michael J. Murray Controller and Vice Chairman and Director Principal Accounting Officer\nBert A. Getz Linda Johnson Rice Bert A. Getz Linda Johnson Rice Director Director\nThomas A. Gildehaus John M. Richman Thomas A. Gildehaus John M. Richman Director Director\nRobert B. Goergen Gordon I. Segal Robert B. Goergen Gordon I. Segal Director Director\nWilliam M. Goodyear James L. Vincent William M. Goodyear James L. Vincent Vice Chairman and Director Director\nRichard L. Huber Richard L. Huber Vice Chairman and Director","section_15":""}
{"filename":"203596_1993.txt","cik":"203596","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"761860_1993.txt","cik":"761860","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nIP Timberlands, Ltd. (the 'Registrant') is a Texas limited partnership formed by International Paper Company ('International Paper') to succeed to substantially all of International Paper's forest resources business. The Registrant's forest resources business includes the marketing and sale of forest products for use as sawlogs, poles and pulpwood. In addition, the Registrant may sell or exchange portions of its forestlands and may acquire additional properties for cash, additional units or other consideration.\nThe Registrant operates through IP Timberlands Operating Company, Ltd., a Texas limited partnership ('IPTO'), in which the Registrant holds a 99% limited partner's interest. IP Forest Resources Company ('IPFR'), a wholly owned subsidiary of International Paper, is the managing general partner of the Registrant and IPTO, and lnternational Paper is the special general partner of\nboth. A further discussion of the Registrant's organization appears on the inside front cover and page 14 of the Annual Report to Unitholders (the 'Annual Report'), which information is incorporated herein by reference.\nDESCRIPTION OF PRINCIPAL PRODUCTS\nThe Registrant's forestlands include merchantable forest products inventory, approximately 60% of which consists of commercial softwoods, principally Douglas fir in the Pacific Northwest, southern pine in the South, and spruce and fir in the Northeast. A variety of hardwoods account for the remaining 40% of the inventory.\nThe Registrant sells forest products to International Paper for use in its pulp mills and wood products plants and to third party customers.\nA discussion of the Registrant's harvest plan is presented on page 8 of the Annual Report, which information is incorporated herein by reference.\nCOMPETITION AND COSTS\nLog and wood fiber consuming facilities tend to purchase raw materials within relatively small geographic areas, generally within a 100-mile radius. Competitive factors within a market area generally include price, species, grade and proximity to wood-consuming facilities. The Registrant competes in the log and wood fiber market with numerous private industrial and nonindustrial forestland owners as well as with the U.S. government, principally the U.S. Forest Service and the Bureau of Land Management. Litigation involving endangered species and environmental concerns has caused a decline in government forest products sales volumes and market share in recent years and has resulted in additional demand and higher prices for private forestland owners.\nMany factors influence the Registrant's competitive position, including costs, prices, product quality and services.\nMARKETING\nConsistent with International Paper's experience prior to the contribution of its forestlands to the Registrant, the Registrant has annually sold forest products from its lands to more than 800 purchasers other than International Paper. No customer accounted for more than 10% of annual revenues for the years 1993 and 1991. In 1992, total revenues included $91 million in sales to a west coast forest products company due principally to bulk sales and forestland sales.\nDuring 1993, 1992 and 1991, International Paper's facilities consumed approximately 30%, 27% and 28%, respectively, of the logs and wood fiber harvested from the Registrant's forestlands, which represented approximately 12%, 10% and 11%, respectively, of its manufacturing facilities' requirements during such periods. International Paper does not anticipate any change in its policy of relying on the Registrant's forestlands as an important source of raw material for its manufacturing facilities, although it is unable to predict what\nportion of its requirements will be purchased from the Registrant in the future.\nIn addition to sales to International Paper for use in its manufacturing facilities, the Registrant sells trees to International Paper that are harvested and resold by International Paper to unaffiliated purchasers as logs, poles or pulpwood.\nAdditional information on marketing activities, including related parties and major customers, appears on pages 8 and 15 of the Annual Report, which information is incorporated herein by reference.\nENVIRONMENTAL PROTECTION\nManagement of the Registrant's forestlands to protect the environment is a continuing commitment of the Registrant. The Registrant expends considerable efforts to comply with regulatory requirements for the use of pesticides, protection of wetlands, and minimization of stream sedimentation and soil erosion. From time to time the Registrant volunteers to or may be required to clean up certain dump sites on its forestlands created by the general public. Environmental protection costs and capital expenditures have not been significant and are not expected to be significant in the future.\nEMPLOYEES\nThe Registrant does not have officers or directors. Instead, officers and directors of IPFR perform all management functions for the Registrant. In most respects, the Registrant conducts the business formerly conducted by the Forest Products Division of International Paper. Consequently, the employees of International Paper or its subsidiaries formerly assigned to such division continue to carry out the activities of the Registrant. These employees continue to be employees of International Paper and in some cases are employed solely for the conduct of the Registrant's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFORESTLANDS\nForestlands include approximately 5.5 million acres owned in fee (excluding any interest in underlying minerals) and approximately 507,000 acres held under long-term deeds and leases (terms of three years or longer). These forestlands are located in 14 states in three major regions of the United States. In the Pacific Northwest, forestlands are located in Oregon and Washington, including approximately 311,000 acres owned in fee and approximately 3,200 acres covered by deeds and leases. In the southern and southeastern United States, forestlands are located in seven states, including approximately 3,689,000 acres owned in fee and approximately 500,400 acres held under long-term deeds and leases. In the Northeast, forestlands are located in Maine, New York, Pennsylvania, Vermont and New Hampshire, including approximately 1,531,000 acres owned in fee and approximately 3,300 acres held under long-term deeds and leases. The deeds and leases held by the Registrant generally do not include deeds and leases on government lands in the western United States nor deeds and leases with terms of less than three years, which are generally managed by International Paper in connection with short-term wood procurement for its manufacturing facilities.\nCAPITAL INVESTMENTS\nDiscussion of the Registrant's capital investments can be found on pages 9 and 10 of the Annual Report, which information is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIPTO and International Paper are parties to two lawsuits involving long-term leases on approximately 212,000 acres of forestlands in Louisiana and Mississippi. Successors in interest to the original lessors are seeking to have the two leases terminated and IPTO enjoined from further operation on the land covered by the leases, as well as seeking approximately $52 million in alleged damages, plus alleged statutory and trebling penalties and punitive damages in excess of $450 million. A jury trial in the Louisiana state court case resulted in a verdict in favor of IPTO and International Paper on January 24, 1992. Appeals are pending.\nTrial in the Mississippi state court case has been stayed while the parties litigate certain issues relating to the purchase option exercise by IPTO. IPTO and International Paper plan to vigorously contest any remaining allegations.\nThe Registrant is a party to various legal proceedings incidental to its business. While any proceeding or litigation has an element of uncertainty, the Registrant believes that the outcome of any lawsuit or claim that is pending or threatened, or all of them combined, will not have a material adverse effect on its consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe market and cash distribution data on the Registrant's Class A Depositary Units are set forth below and on the inside front cover and page 18 of the Annual Report and are incorporated herein by reference.\nAs of March 25, 1994, there were 3,947 holders of record of the Registrant's Class A Depositary Units.\nSet forth below are the market price ranges for each quarter of 1993 and 1992 for the Class A Depositary Units on the New York Stock Exchange Composite Index.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for 1993, 1992 and 1991 is set forth on page 1 of the Annual Report and is incorporated herein by reference. Selected financial data for 1990 and 1989 is as follows (in thousands, except per unit data):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's review and comments on the consolidated financial statements are set forth on pages 8, 9 and 10 of the Annual Report and are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Registrant's consolidated financial statements, the notes thereto and the report of independent public accountants are set forth on pages 11 through 17 and 19 of the Annual Report and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of IPFR* and their business experiences are as set forth below:\n**WILLIAM M. ELLINGHAUS, 72, former President, Chief Operating Officer and\ndirector of American Telephone & Telegraph Company, having retired in 1984. He was Executive Vice Chairman of The New York Stock Exchange until 1986. He is a director of International Paper Company and Textron Inc.\nDirector since April 8, 1986.\nJOHN A. GEORGES, 63, Chairman and Chief Executive Officer of IPFR since 1985. He has been Chairman and Chief Executive Officer of International Paper Company since 1985. He was elected Chief Executive Officer of International Paper in 1984 and President in 1981. He is a director of International Paper Company, Ryder Systems, Inc., Scitex Corporation Ltd. and Warner-Lambert Company. He is a member of The Business Council and the Policy Committee of the Business Roundtable. He is a Board member of The Business Council of New York State, a member of the Trilateral Commission, the President's Advisory Committee for Trade Policy and Negotiations, and a trustee of Drexel University.\nDirector since January 8, 1985.\n**ARTHUR G. HANSEN, 69, Educational Consultant. He was Director of Research of the Hudson Institute from 1987 to 1988, Chancellor of the Texas A&M University System from 1982 to 1986, President of Purdue University from 1971 to 1982 and President of Georgia Institute of Technology from 1969 to 1971. He is a director of American Electric Power Company, Inc., The Interlake Corporation, International Paper Company and Navistar International Corporation. He is a member of the National Academy of Engineering, Chairman of the Corporation for Educational Technology and a fellow of the American Association for the Advancement of Science.\nDirector since February 1, 1990.\n**WILLIAM G. KUHNS, 72, former Chairman of General Public Utilities Corporation (a public utility holding company). He is a director of Ingersoll-Rand Company and International Paper Company.\nDirector since April 14, 1987.\n**JANE C. PFEIFFER, 61, Management Consultant. She is a director of Ashland Oil, Inc., International Paper Company, J.C. Penney Company, Inc. and The Mutual Life Insurance Company of New York. She is a trustee of the Conference Board, The University of Notre Dame, the Overseas Development Council and a member of The Council on Foreign Relations.\nDirector since January 13, 1988.\n- ------------------ * Managing General Partner of the Registrant. ** Member of the Audit Committee of IPFR. The Audit Committee reviews policies and practices of the Registrant dealing with various matters (including accounting and financial practices) as to which conflicts of interest with the special general partner may arise. The Audit Committee consists of nonemployee directors of IPFR.\nEXECUTIVE OFFICERS AS OF MARCH 31, 1994 INCLUDING NAME, AGE, OFFICES AND POSITIONS HELD*, AND BUSINESS EXPERIENCE DURING THE PAST FIVE YEARS\nEDWARD J. KOBACKER, 55, president since August, 1992. He was general manager and group executive of the kraft paper group of International Paper from 1987 to 1992, when he assumed his current position and was elected vice president and general manager--forest products of International Paper.\nFREDERICK L. BLEIER, 45, treasurer and controller since July, 1993; controller from 1991. He has been sector controller--forest products of International Paper since July, 1993. He was director-corporate accounting of International Paper from 1990 to 1993. He joined International Paper as manager-financial reporting in 1988.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe four nonemployee directors of IPFR receive a retainer of $7,000 per year plus a fee of $1,100 for each IPFR Board and committee meeting attended. These fees are paid by IPFR. The Registrant has no employees. All management and services are performed by International Paper on behalf of the Registrant. International Paper pays the personnel used in the Registrant's business with certain expenses reimbursed to it by the Registrant.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Registrant knows of no one owning beneficially more than five percent (5%) of the Registrant's Class A Depositary Units except International Paper, which owns approximately eighty-four percent (84%). The following table shows, as of March 25, 1994, the number of Class A Depositary Units in the Registrant beneficially owned (as defined by the Securities and Exchange Commission) or otherwise claimed by current IPFR directors and by all IPFR directors and executive officers as a group (if no name appears, no Class A Depositary Units are owned or claimed).\n- ------------------ (1) Ownership shown includes securities over which the individual has or shares, directly or indirectly, voting or investment powers, including units owned\nby a spouse or relatives and ownership by trusts for the benefit of such relatives, as required to be reported by the Securities and Exchange Commission. Certain individuals may disclaim beneficial ownership of some of these units, but they are included for the purpose of computing the holdings and the percentages of Class A Depositary Units owned.\nThe certificate of incorporation of IPFR ('IPFR Charter') provides for two classes of common stock: Class A Common Stock and Class B Common Stock, of which International Paper is the sole owner. The Class B Common Stock possesses exclusive voting rights and the holder or holders thereof are entitled to cumulative voting for the election of directors of IPFR. Except with respect to voting rights, the Class B Common Stock of IPFR is equal in all other respects to the Class A Common Stock of IPFR. However, the Class B Common Stock represents only .00005 of 1% of the total authorized Common Stock of IPFR, all of which has been issued and is outstanding.\nThe IPFR Charter further provides that in the event International Paper owns, or as a result of certain events would own, less than 50% of either the outstanding Class A Depositary Units or Class B Depositary Units, then - ------------------ * Officers of IPFR are elected to hold office until the next annual meeting of the board of directors and until election of successors, subject to removal by the board.\n(i) International Paper must sell all of the shares of Class B Common Stock to the directors of IPFR, on a pro rata basis, at a price equal to $100.00 per share in cash; (ii) any director who does not purchase his pro rata shares of Class B Common Stock must resign; and (iii) the directors of IPFR are then required, as soon as practicable but not later than the next annual meeting of stockholders of IPFR, to vote or cause their shares of Class B Common Stock to be voted to elect a Board of Directors of IPFR comprised entirely of persons who are not employees, officers, directors or affiliates of International Paper or of any affiliate of International Paper (other than IPFR). Each director of IPFR is further required to execute a voting trust agreement, pursuant to which the Class B Common Stock will be held and voted, and a stockholders agreement, pursuant to which transfer of ownership in the Class B Common Stock is restricted to persons who are directors of IPFR. In order to maintain the independence of IPFR's Board of Directors, the IPFR Charter further provides that (i) each director, upon resigning as a director of IPFR, must sell his shares of Class B Common Stock to IPFR, and (ii) each subsequent director elected to replace any director so resigning must similarly purchase shares of Class B Common Stock and enter into the voting trust agreement and stockholders agreement described above. International Paper believes that the foregoing arrangement for the possible ownership of the Class B Common Stock of IPFR assists in reducing the potential for conflicts of interests should International Paper's ownership of units decrease significantly.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nA description of certain relationships and related transactions is set forth on pages 14 through 17 of the Annual Report and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nEXHIBITS\n(13) 1993 Annual Report to Unitholders of the Registrant\n(24) Power of Attorney\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed by the Registrant for the fourth quarter of 1993.\nFINANCIAL STATEMENT SCHEDULES\nThe consolidated balance sheets as of December 31, 1993 and 1992, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1993, together with the report thereon of Arthur Andersen & Co., dated February 4, 1994, appearing on pages 11 through 17 and 19 of the Annual Report, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1, 2, 5 through 8, and 13, the Annual Report is not to be deemed filed as part of this report. The following additional financial data should be read in conjunction with the financial statements in the Annual Report. Schedules not included with this additional financial data have been omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto.\nADDITIONAL FINANCIAL DATA 1993, 1992 AND 1991\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTO THE PARTNERS OF IP TIMBERLANDS, LTD.:\nWe have audited in accordance with generally accepted auditing standards,\nthe consolidated financial statements included in IP Timberlands, Ltd.'s 1993 Annual Report to Unitholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 4, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Partnership's management and are presented for the purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nNew York, N. Y. February 4, 1994\nSCHEDULE II\nIP TIMBERLANDS, LTD. SCHEDULE II--AMOUNTS RECEIVABLE FROM RELATED PARTIES (IN THOUSANDS)\nFOR THE YEAR ENDED DECEMBER 31, 1993\nFOR THE YEAR ENDED DECEMBER 31, 1992\nFOR THE YEAR ENDED DECEMBER 31, 1991\n- ------------------ (a) Consists of notes with due dates of up to 90 days; weighted average interest rates of 3.5% at December 31, 1993, 3.68% at December 31, 1992, and 5.28% at December 31, 1991.\n(b) Consisted of notes with annual due dates through 1995; weighted average interest rates of 9.75% at December 31, 1990.\nSCHEDULE V\nIP TIMBERLANDS, LTD. SCHEDULE V--PROPERTY, PLANT AND EQUIPMENT (IN THOUSANDS)\nFOR THE YEAR ENDED DECEMBER 31, 1993\nFOR THE YEAR ENDED DECEMBER 31, 1992\nFOR THE YEAR ENDED DECEMBER 31, 1991\n- ------------------ (a) Represents depletion credited directly to the asset.\nSCHEDULE VI\nIP TIMBERLANDS, LTD. SCHEDULE VI--ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (IN THOUSANDS)\nFOR THE YEAR ENDED DECEMBER 31, 1993\nFOR THE YEAR ENDED DECEMBER 31, 1992\nFOR THE YEAR ENDED DECEMBER 31, 1991\nSIGNATURES\nPURSUANT 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.\nIP TIMBERLANDS, LTD.\nBy: IP Forest Resources Company (as managing general partner)\nBy: JAMES W. GUEDRY -------------------------------\nJAMES W. GUEDRY, VICE PRESIDENT AND SECRETARY\nMarch 30, 1994\nPURSUANT 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 AND ON THE DATES INDICATED:\n( IP TIMBERLANDS, LTD. LOGO )\nPRINTED ON HAMMERMILL PAPERS, ACCENT OPAQUE, 50 LBS. HAMMERMILL PAPERS IS A DIVISION OF INTERNATIONAL PAPER\nEXHIBIT INDEX\nExhibits Page No. -------- --------\n(13) 1993 Annual Report to Unitholders of the Registrant\n(24) Power of Attorney","section_15":""}
{"filename":"784681_1993.txt","cik":"784681","year":"1993","section_1":"Item 1. Business. 3\n2. Properties. 31\n3. Legal Proceedings. 31\n4. Submission of Matters to a Vote of Security Holders. 31\nPart II - -------- 5. Market for the Registrant's Common Equity and Related Stockholder Matters. 32\n6. Selected Financial Data. 33\n7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 35\n8. Consolidated Financial Statements. 50\n9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 87\nPart III - --------- 10. Directors and Executive Officers of the * Registrant.\n11. Executive Compensation. *\n12. Security Ownership of Certain Beneficial Owners and Management. *\n13. Certain Relationships and Related Transactions. *\nPart IV - -------- 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 87\n* These items are omitted because the registrant intends to file with the Securities and Exchange Commission, not later than 120 days after the close of its fiscal year, a definitive proxy statement or an amendment on Form 8 to this report containing the information required to be disclosed under Part III of Form 10-K.\n(2)\nPART I\nITEM 1. BUSINESS\nTHE COMPANY\nCablevision Systems Corporation, a Delaware corporation and its majority owned subsidiaries (the \"Company\") own and operate cable television systems in six states with approximately 1,379,000 subscribers at December 31, 1993. The Company also has ownership interests in and\/or manages other cable television systems which served an aggregate of approximately 853,000 subscribers at December 31, 1993 and has interests in companies that produce and distribute national and regional programming services and that provide advertising sales services for the cable television industry.\nCable television is a service that delivers multiple channels of television programming to subscribers who pay a monthly fee for the services they receive. Television and radio signals are received over-the-air or via satellite delivery by antennas, microwave relay stations and satellite earth stations and are modulated, amplified and distributed over a network of coaxial and fiber optic cable to the subscribers' television sets. Cable television systems typically are constructed and operated pursuant to non-exclusive franchises awarded by local governmental authorities for specified periods of time.\nThe Company's cable television systems offer varying levels of service which may include, among other programming, local broadcast network affiliates and independent television stations, satellite-delivered \"superstations\" such as WTBS (Atlanta), certain other news, information and entertainment channels such as Cable News Network (\"CNN\"), CNBC, ESPN and MTV: Music Television and certain premium services such as HBO, Showtime, The Movie Channel and Cinemax.\nThe Company's cable television revenues are derived principally from monthly fees paid by subscribers. In addition to recurring subscriber revenues, the Company derives revenues from installation charges, from the sales of pay-per-view movies and events, and from the sale of advertising time on advertiser supported programming. Certain services and equipment provided by substantially all of the Company's cable television systems are subject to regulation. See \"Business - Cable Television Operations - Regulation - 1992 Cable Act.\"\nFor financing purposes, the Company is structured as a restricted group, consisting of Cablevision Systems Corporation and certain of its subsidiaries (the \"Restricted Group\"), and an unrestricted group of subsidiaries, consisting primarily of V Cable, Inc. (\"V Cable\"), Cablevision of New York City (\"CNYC\"), Rainbow Programming Holdings, Inc. (\"Rainbow Programming\") and Rainbow Advertising Sales Corporation (\"Rainbow Advertising\"). In addition, the Company has an unrestricted group of investments, consisting of investments in A-R Cable Services, Inc. (\"A-R Cable\"), U.S. Cable Television Group, L.P. (\"U.S. Cable\"), Cablevision of Boston Limited\n(3)\nPartnership (\"Cablevision of Boston\"), Cablevision of Chicago and Cablevision of Newark.\nSee \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" for a discussion of the financing of the Company including a discussion of restrictions on investments by the Restricted Group.\nThe Company's consolidated cable television systems are concentrated in the New York City greater metropolitan area (80.9% of the Company's total subscribers) and the greater Cleveland metropolitan area (14.3% of total subscribers). The Company believes that its cable systems on Long Island comprise the largest group of contiguous cable television systems under common ownership in the United States (measured by number of subscribers).\nRECENT DEVELOPMENTS\nOn March 11, 1994, Cablevision of Cleveland, L.P. (\"Cablevision Cleveland\"), a partnership comprised of subsidiaries of the Company, purchased substantially all of the assets and assumed certain liabilities of North Coast Cable Limited Partnership, which operated a cable television system in Cleveland, Ohio. The purchase price aggregated $133.0 million which amount includes: (i) approximately $98.8 million paid in cash; (ii) $4.0 million paid in a short-term promissory note secured by a letter of credit; (iii) approximately $13.2 million paid by the surrender of the Company's 19% interest in North Coast and the satisfaction of certain management fees owed to the Company; and (iv) approximately $17.0 million paid by the assumption of certain capitalized lease obligations and certain other liabilities. The net cash purchase price of the acquisition was financed by borrowings under the Company's Credit Agreement (as hereinafter defined) and Cablevision Cleveland is part of the Restricted Group. At December 31, 1993 North Coast Cable served approximately 82,900 basic subscribers.\nThe partnership agreement relating to one of Rainbow Programming's businesses, American Movie Classics Company (\"AMCC\"), contains a provision allowing any partner to commence a buy-sell procedure by establishing a stated value for the AMCC partnership interests. On August 2, 1993, Rainbow Programming received a notice from the AMCC partner affiliated with Liberty Media Corporation initiating the buy-sell procedure and setting a stated value of $390 million for all the partnership interests in AMCC. The partnership agreement provides that the non-initiating partner has a period of 45 days from receipt of the buy-sell notice to elect to purchase the initiating partner's interest at the stated value or sell its interest at the stated value. On September 16, 1993, Rainbow Programming notified its partners in AMCC that it had elected to purchase Liberty Media's 50% interest in AMCC at the stated value. The Company anticipates that the transaction will be consummated in the second quarter of 1994.\nOn October 26, 1993, Cablevision MFR, Inc. (\"Cablevision MFR\"), a wholly-owned subsidiary of the Company, entered into agreements to purchase substantially all of the assets of Monmouth Cablevision Associates, L.P. (\"Monmouth Cablevision\"),\n(4)\nRiverview Cablevision Associates, L.P. (\"Riverview Cablevision\") and Framingham Cablevision Associates, L.P. (\"Framingham Cablevision\"), each a limited partnership operated by Sutton Capital Associates. Each of Monmouth Cablevision and Riverview Cablevision own and operate cable television systems in New Jersey. Framingham Cablevision owns and operates a cable television system in Massachusetts. It is anticipated that Cablevision MFR will be an unrestricted subsidiary of the Company.\nOn January 12, 1994 Cablevision MFR assigned its rights and obligations under its agreement to purchase the assets of Framingham Cablevision to Cablevision of Framingham Holdings, Inc. (\"CFHI\"), currently a wholly-owned subsidiary of the Company. The Company has entered into an agreement with Warburg, Pincus Investors, L.P. (\"Warburg Pincus\"), pursuant to which Warburg Pincus will (i) purchase 60% of the common stock of CFHI for cash and (ii) purchase preferred stock of CFHI, from time to time, for a purchase price sufficient to pay 70% of the interest and principal payments on the Framingham Cablevision promissory note described below. The Company agreed to purchase preferred stock of CFHI, from time to time, for a purchase price sufficient to pay 30% of the interest and principal payments on the Framingham Cablevision promissory note. Agreements between the Company and Warburg Pincus with respect to management of Framingham Cablevision and purchase and sale rights are substantially similar to those reached with respect to Warburg Pincus' investment in A-R Cable, which arrangements are described under \"Cable Television Operations - Other Cable Affiliates\" below.\nThe aggregate purchase price for the two New Jersey systems is expected to be $422.3 million. The Company expects that $244.6 million of such purchase price will be financed by senior credit facilities in newly formed unrestricted subsidiaries of the Company secured by the assets of the systems. The remaining $177.7 million of such purchase price will be paid by the issuance, by Cablevision MFR, of promissory notes due in 1998 and bearing interest at 6% until the third anniversary and 8% thereafter (increasing to 8% and 10%, respectively, if interest is paid in shares of the Company's Class A Common Stock). The purchase price for the Framingham Cablevision assets is expected to be $41.1. The Company expects that approximately $22.8 million of such purchase price will be financed by a senior credit facility of a wholly-owned subsidiary of CFHI secured by the assets of such system. Approximately $13.3 million of such purchase price will be paid by the issuance by CFHI of a promissory note issued on the same terms as the promissory note of Cablevision MFR described above. The remaining approximately $5.0 million will consist of a $1.0 million loan to CFHI from its stockholders and an approximate $4.0 million capital contribution to CFHI from its stockholders. Principal and interest on the notes, which may be paid, at the maker's election, in cash or in shares of the Company's Class A common stock, will be guaranteed by the Company. The Company's obligations under the guarantee will rank pari passu with the Company's public subordinated debt. Under the Company's senior credit facility, the Company is only permitted to pay such amount in common stock. In certain circumstances, Cablevision MFR or CFHI (as the case may be) may extend the maturity date of the promissory notes until 2003 for certain additional consideration.\n(5)\nConsummation of the transaction is subject to the receipt of necessary regulatory approvals and other customary closing conditions. There can be no assurance that this transaction will be successfully consummated. As of December 31, 1993, the two New Jersey systems served approximately 155,400 subscribers, in the aggregate, and Framingham Cablevision served approximately 16,200 subscribers.\nOn November 5, 1993, A-R Cable Partners, a partnership comprised of subsidiaries of the Company and E.M. Warburg, Pincus & Co., Inc., entered into an agreement to purchase certain assets of Nashoba Communications (\"Nashoba\"), a group of three limited partnerships which operate three cable television systems in Massachusetts. A-R Cable Partners is controlled in a manner substantially similar to the way A-R Cable Services, Inc. is controlled. The purchase price is $90.0 million, subject to certain adjustments, of which up to $55.0 million is expected to be provided by a senior credit facility provided to A-R Cable Partners secured by the assets of such system. The remainder will be provided by equity contributions from the partners in A-R Cable Partners. The Company will provide 30% of such equity through drawings under its senior credit facility. Consummation of the transaction is subject to regulatory approval, as well as other customary closing conditions. As of December 31, 1993, Nashoba served approximately 34,800 basic subscribers.\nOn March 31, 1994, the Company issued and sold 100,000 shares of a new series of preferred stock (the \"Preferred Shares\") to Toronto-Dominion Investments, Inc. in a private transaction. The Preferred Shares were sold for a purchase price of $1,000 per share and carry a liquidation preference of a like amount plus accrued and unpaid dividends. Dividends accrue at a floating rate of LIBOR plus 2.5 percent and are payable, at the Company's option, either in cash or in registered shares of Class A common stock with a value equalling 105 percent of the required dividend. Additional dividend payments may be required with respect to the availability of the dividend received deduction. The Preferred Shares are redeemable at any time at the option of the Company at par plus accrued and unpaid dividends to the redemption date and are convertible after March 31, 1995 into Class A common stock, at the option of the holder, at a conversion rate based on 95 percent of the average closing price of the Class A Common Stock for the twenty business days prior to conversion. Additionally, the holders of the Preferred Shares have the right to convert their shares in connection with certain change in control transactions (regardless of when they occur) into a number of shares of Class A Common Stock which would yield $100,000,000 based upon an auction process involving the Class A Common Stock issuable on such conversion or, at the holder's election, at a conversion rate based on 95 percent of the average closing price of the Class A Common Stock for the twenty business days prior to conversion. The Company has the right to suspend the conversion of the Preferred Shares from March 31, 1995 through March 31, 1997 as long as it is in compliance with its Restricted Group financial covenants and is current in dividend payments on the Preferred Shares.\nThe Preferred Shares are not transferrable except with the Company's consent, not to be unreasonably withheld. The Preferred Shares are exchangeable, at the option of the holder, into a separate series of preferred stock with terms substantially identical to the\n(6)\nPreferred Shares, except that such series (i) are not convertible into common stock or exchangeable for any other class of securities, and (ii) are freely transferable. The Company has granted registration rights with respect to the common stock issuable upon a conversion of the Preferred Shares and with respect to the series of preferred stock into which the Preferred Shares are exchangeable. Also, if the Company completes an offering on non-convertible, non-exchangeable shares of preferred stock, Preferred Shares, if not previously exchanged or converted, also may be converted into a new series of preferred stock having terms identical to or based upon the other series issued by the Company.\nThe Preferred Shares do not have voting rights, other than as required by law, except that (i) the vote of 60% of such shares is necessary to authorize the issuance of capital stock ranking senior to the Preferred Shares, or certain mergers or consolidations, in each case unless provision is made to redeem the Preferred Stock; (ii) if the Company misses four consecutive quarterly dividends in the Preferred Stock or in the event that certain covenants are breached, the holders of the Preferred Stock have the right to cause an increase in the size of the Company's Board of Directors and to elect one director during the continuation of such default in dividend payments or covenant breach. The Company also has the right to require conversion by the holders of the Preferred Shares in certain circumstances.\nOn February 22, 1994 the Federal Communications Commission (\"FCC\") ordered a further reduction in rates for the basic service tier in effect on September 30, 1992. See \"Cablevision Television Operations -- Regulation\", below.\n(7)\nCABLE TELEVISION OPERATIONS\nGENERAL.\nAs of December 31, 1993, the Company's consolidated cable television systems served approximately 1,379,000 subscribers in New York, Ohio, Connecticut, New Jersey, Michigan, and Massachusetts.\nThe following table sets forth certain statistical data regarding the Company's consolidated cable television operations (1):\n(8)\nThe following table sets forth certain statistical data regarding the Company's managed, unconsolidated cable television operations (1):\n(9)\nSUBSCRIBER RATES AND SERVICES; MARKETING AND SALES.\nThe Company's cable television systems offer a package of services, generally marketed as \"Family Cable\", which includes, among other programming, broadcast network local affiliates and independent television stations, satellite-delivered \"superstations\" and certain other news, information and entertainment channels such as CNN, CNBC, ESPN and MTV: Music Television. For additional charges, the Company's cable television systems provide certain premium services such as HBO, Showtime, The Movie Channel and Cinemax, which may be purchased either individually (in conjunction with Family Cable) or in combinations or in tiers.\nIn addition, the Company's cable television systems recently introduced a basic package which includes broadcast network local affiliates and public, educational or governmental channels and certain public leased access channels.\nThe Company offers premium services on an individual basis and as components of different \"tiers\". Successive tiers include additional premium services for additional charges that reflect discounts from the charges for such services if purchased individually. For example, in most of the Company's cable systems, subscribers may elect to purchase Family Cable plus one, two or three premium services with declining incremental costs for each successive tier. In addition, most systems offer a \"Rainbow\" package consisting of between five and seven premium services, and a \"Rainbow Gold\" package consisting of between eight and ten premium services.\nSince its existing cable television systems, other than the CNYC system, are substantially fully built, the Company's sales efforts are primarily directed toward increasing penetration and revenues in its franchise areas. The Company sells its cable television services through door-to-door selling supported by telemarketing, direct mail advertising, promotional campaigns and local media and newspaper advertising.\nCertain services and equipment provided by substantially all of the Company's cable television systems are subject to regulation. See \"Business -- Cable Television Operations -- Regulation -- 1992 Cable Act.\"\nSYSTEM CAPACITY.\nThe Company is engaged in an ongoing effort to upgrade the technical capabilities of its cable plant and to increase channel capacity for the delivery of additional programming and new services. The Company's cable television systems have a minimum capacity of 35 channels and 70% of its subscribers are currently served by systems having a capacity of at least 52 channels. As a result of currently ongoing upgrades, the Company expects that by December 1995 virtually all of its subscribers will be served by systems having a capacity of at least 52 channels and 66% by systems having a capacity of at least 77 channels. A substantial portion of the system upgrades either completed or underway will utilize fiber optic cable.\n(10)\nPROGRAMMING.\nAdequate programming is available to the Company from a variety of sources. Program suppliers' compensation is typically a fixed per subscriber monthly fee based, in most cases, either on the number of total subscribers of the cable systems of the Company and certain of its affiliates, or on the number of subscribers subscribing to the particular service. The Company's programming contracts are generally for a fixed period of time and are subject to negotiated renewal. The Company's cable programming costs have increased in recent years and are expected to continue to increase due to additional programming being provided to most subscribers, increased costs to produce or purchase cable programming and other factors. Management believes that the Company will continue to have access to programming services at reasonable price levels.\nFRANCHISES.\nThe Company's cable television systems are operated primarily under nonexclusive franchise agreements with local governmental franchising authorities, in some cases with the approval of state cable television authorities. Franchising authorities generally charge a fee of up to 5% based on a percentage of certain revenues of the franchisee. In 1993 franchise fee payments made by the Company aggregated approximately 3.9% of total revenues.\nThe Company's franchise agreements are generally for a term of ten to fifteen years from the date of grant, although recently renewals have often been for five to ten year terms. Some of the franchises grant the Company an option to renew. Except for the Company's franchise for the Town of Brookhaven, New York which expired in 1991, the expiration dates for the Company's ten largest franchises range from 1995 to 2001. In certain cases, including the Town of Brookhaven, the Company is operating under temporary licenses while negotiating renewal terms with the franchising authorities. Franchises usually require the consent of the franchising authority prior to the sale, assignment, transfer or change in ownership or operating control of the franchisee.\nThe Cable Communications Policy Act of 1984 (the \"1984 Cable Act\") and the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") provide significant procedural protections for cable operators seeking renewal of their franchises. See \"Business -- Cable Television Operations -- Regulation\". In connection with a renewal, a franchising authority may impose different and more stringent terms. The Company has never lost a franchise as a result of a failure to obtain a renewal.\n(11)\nCOMPETITION.\nThe Company's cable television systems generally compete with the direct reception of broadcast television signals by antenna and with other methods of delivering television signals to the home for a fee. The extent of such competition depends upon the number and quality of the signals available by direct antenna reception as compared to the number and quality of signals distributed by the cable system. The Company's cable television systems also compete to varying degrees with other communications and entertainment media, including movies, theater and other entertainment activities.\nThe 1984 Cable Act, Federal Communications Commission (\"FCC\") regulations and the 1982 federal court consent decree (the \"Modified Final Judgment\") that settled the 1974 antitrust suit against American Telephone & Telegraph Company regulate the provision of video programming and other information services by telephone companies. A federal district court in 1991 issued an opinion, upheld on appeal, lifting the Modified Final Judgment prohibition on the provision of information services by the seven Bell Operating Companies (\"BOCs\"), allowing the BOCs to acquire or construct cable television systems outside of their own service areas. Several BOCs have purchased or made investments in cable systems outside their service areas in reliance on this decision. The 1984 Cable Act codified FCC cross-ownership regulations which, in part, prohibit local exchange telephone companies, including the BOCs, from providing video programming directly to subscribers within their local exchange service areas, except in rural areas or by specific waiver of FCC rules. The statutory provision and corresponding FCC regulations are of particular competitive importance because these telephone companies already own much of the plant necessary for cable television operations, such as poles, underground conduit, associated rights-of-way and connections to the home.\nOne telephone company has been successful in a lawsuit in a Virginia federal court challenging the constitutionality of the existing statutory ban on unrestricted telephone company ownership of cable systems. The federal government has appealed this decision. The ruling applies to telephone company ownership of cable systems in one state in which the Company owns systems. Similar lawsuits have been filed in several other states in which the Company owns systems. Legislation to repeal this ban, subject to certain regulatory requirements, has been introduced in the U.S. Senate and House of Representatives; repeal has also been endorsed by the Clinton Administration. The bills would also, inter alia, preempt state and locally-imposed barriers to the provision of intrastate and interstate telecommunications services by the Company and other cable system operators in competition with local telephone companies.\nIn July 1992, the FCC voted to authorize additional competition to cable television by video programmers using broadband common carrier facilities constructed by telephone companies. The FCC allowed telephone companies to take ownership interests of up to 5% in such programmers. The FCC also reaffirmed an earlier holding, currently on appeal to a federal court, that programmers using such a telephone company-provided \"video dial tone\" system would not need to obtain a state or municipal franchise. Several telephone companies have sought approval from the FCC to build such \"video\n(12)\ndial tone\" systems. Such a system has been proposed in several communities in Connecticut in which the Company currently holds a cable franchise and approval of one such system has been granted in a franchise area adjoining a cable television system of the Company.\nCable television also competes with the home video industry. Owners of videocassette recorders are able to rent many of the same movies, special events and music videos that are available on certain premium services. The availability of videocassettes has affected the degree to which the Company is able to sell premium service units and pay-per-view offerings to some of its subscribers.\nMultipoint distribution services (\"MDS\"), which deliver premium television programming over microwave superhigh frequency channels received by subscribers with a special antenna, and multichannel multipoint distribution service (\"MMDS\"), which is capable of carrying four channels of television programming, also compete with certain services provided by the Company's cable television systems. By acquiring several MMDS licenses or subleasing from several MMDS operators and holders of other types of microwave licenses, a single entity can increase channel capacity to a level more competitive with cable systems. MDS and MMDS systems are not required to obtain a municipal franchise, are less capital intensive, require lower up-front capital expenditures and are subject to fewer local and FCC regulatory requirements than cable systems. The ability of MDS and MMDS systems to serve homes and to appeal to consumers is affected by their less extensive channel capacity and the need for unobstructed line of sight over-the-air transmission.\nSatellite master antenna systems (\"SMATV\") generally serve large multiple dwelling units. The FCC has preempted all state and local regulation of SMATV operations. SMATV is limited to the buildings within which the operator has received permission from the building owner to provide service. The FCC has recently streamlined its MDS regulations and opened substantially more microwave channels to MDS and SMATV operators, which could increase the strength of their competition with cable television systems.\nIn January 1993, the FCC proposed establishing a new local multipoint distribution service (\"LMDS\", sometimes referred to as \"cellular cable\") in the virtually unused 28 GHz band of the electromagnetic spectrum that could be used to offer multichannel video in competition with cable systems, as well as two-way communications services. The FCC has proposed issuing two LMDS licenses per market, using auctions or lotteries to select licensees. Suite 12 Group, the originator of this service, currently holds an experimental license and has constructed a video transmission service using the 28 GHz band in a portion of the Company's New York City service area.\nThe 1984 Cable Act specifically legalized, under certain circumstances, reception by private home earth stations of satellite-delivered cable programming services. By law, dish owners have the right to receive broadcast superstations and network affiliate\n(13)\ntransmissions in return for a compulsory copyright fee. Cable programmers have developed new marketing efforts to reach these viewers. Direct broadcast satellite (\"DBS\") systems currently permit satellite transmissions from the low-power C-Band to be received by antennae approximately 60 to 72 inches in diameter at the viewer's home. New higher power DBS systems providing transmissions over the Ku-Band will permit the use of smaller receiver antennae and thus may be more appealing to customers. A consortium of cable operators (other than the Company), formed PrimeStar, a joint venture to operate a medium power Ku-Band DBS system which began operations in 1990. In addition, other mid- and high-power DBS ventures have announced their intentions to begin operations during 1994. Both C-Band and Ku-Band DBS delivery of television signals are competitive alternatives to cable television.\nOther technologies supply services that may compete with certain services provided by cable television. These technologies include translator stations (which rebroadcast signals at different frequencies at lower power to improve reception) and low-power television stations (which operate on a single channel at power levels substantially below those of most conventional broadcasters and, therefore, reach a smaller service area).\nThe full extent to which developing media will compete with cable television systems may not be known for several years. There can be no assurance that existing, proposed or as yet undeveloped technologies will not become dominant in the future and render cable television systems less profitable or even obsolete. In particular, certain major telephone companies have demonstrated an interest in acquiring cable television systems or providing video services to the home through fiber optic technology. Changes in the laws and regulations mentioned above governing telephone companies could allow these companies in the future to provide information and entertainment services to the home.\nAlthough substantially all the Company's cable television franchises are non-exclusive, most franchising authorities have granted only one franchise in an area. Other cable television operators could receive franchises for areas in which the Company operates or a municipality could build a competing cable system. One company has applied for a franchise to build and operate a competing cable television system in several communities in Connecticut in which the Company currently holds a cable franchise. The state regulatory authority is currently conducting hearings on this application and a decision is expected during the second or third fiscal quarters of this year. The 1992 Cable Act described below prohibits municipalities from unreasonably refusing to grant competitive franchises and facilitates the franchising of second cable systems or municipally-owned cable systems. See \"Regulation -- 1992 Cable Act,\" below.\n(14)\nREGULATION.\n1984 CABLE ACT. In 1984, Congress enacted the 1984 Cable Act, which set uniform national guidelines for cable regulation under the Communications Act of 1934. While several of the provisions of the 1984 Cable Act have been amended or superseded by the 1992 Cable Act, described below, other provisions of the 1984 Act, including the principal provisions relating to the franchising of cable television systems, remain in place. The 1984 Cable Act authorizes states or localities to franchise cable television systems but sets limits on their franchising powers. It sets a ceiling on cable franchise fees of 5% of gross revenues and prohibits localities from requiring cable operators to carry specific programming services. The 1984 Cable Act protects cable operators seeking franchise renewals by limiting the factors a locality may consider and requiring a due process hearing before denial. The 1984 Cable Act does not, however, prevent another cable operator from being authorized to build a competing system. The 1992 Cable Act prohibits franchising authorities from granting exclusive cable franchises and from unreasonably refusing to award an additional competitive franchise.\nThe 1984 Cable Act allows localities to require free access to public, educational or governmental channels, but sets limits on the number of commercial leased access channels cable television operators must make available for potentially competitive services. The 1984 Cable Act prohibits obscene programming and requires the sale or lease of devices to block programming considered offensive.\n1992 CABLE ACT. On October 5, 1992, Congress enacted the 1992 Cable Act. The 1992 Cable Act represents a significant change in the regulatory framework under which cable television systems operate.\nAfter the effective date of the 1984 Cable Act, and prior to the enactment of the 1992 Cable Act, rates for cable services were unregulated for substantially all of the Company's systems. The 1992 Cable Act reintroduced rate regulation for certain services and equipment provided by most cable systems in the United States, including substantially all of the Company's systems. On April 1, 1993, the FCC adopted rules implementing the rate regulation provisions of the 1992 Cable Act.\nThe 1992 Cable Act requires each cable system to establish a basic service package consisting, at a minimum, of all local broadcast signals and all non-satellite delivered distant broadcast signals that the system wishes to carry, and all public, educational and governmental access programming. The rates for the basic service package are subject to regulation by local franchising authorities. Under the FCC's April 1, 1993 rate regulation rules, a cable operator whose per channel rates as of September 30, 1992 exceeded an FCC established benchmark was required to reduce its per channel rates for the basic service package by up to 10% unless it could justify higher rates on the basis of its costs. On February 22, 1994, after reconsideration, the FCC ordered a further reduction of 7% in rates for the basic service tier in effect on September 30, 1992, for an overall reduction of 17% from those rates. The amount of this 17% decrease that is below a new per channel benchmark need not be implemented pending\n(15)\ncompletion of FCC studies of the costs of below-benchmark cable systems. In the interim, however, the amount of the 17% decrease that is below this benchmark must be computed by the cable system and must be offset against otherwise allowable rate increases by these systems. Franchise authorities (local municipalities or state cable television regulators) are also empowered to regulate the rates charged for the installation and lease of the equipment used by subscribers to receive the basic service package (including a converter box, a remote control unit and, if requested by a subscriber, an addressable converter box or other equipment required to access programming offered on a per channel or per program basis), including equipment that may also be used to receive other packages of programming, and the installation and monthly use of connections for additional television sets. The FCC's rules require franchise authorities to regulate rates for equipment and connections for additional television sets on the basis of an actual cost formula developed by the FCC, plus a return of 11.25%. No additional charge is permitted for the delivery of service to additional sets unless the operator incurs additional programming costs in connection with the delivery of the regulated service to multiple sets.\nThe FCC may, in response to complaints by a subscriber, municipality or other governmental entity, reduce the rates for service packages other than the basic service package if it finds that such rates are unreasonable. Under the FCC's April 1, 1993 rules, a cable operator whose per channel rates for such service packages as of September 30, 1992, exceeded an FCC established benchmark was required to reduce its per channel rates for such packages by up to 10% unless it could justify higher rates on the basis of its costs. On February 22, 1994, the FCC also determined on reconsideration to authorize a further rate reduction of 7% applicable to FCC-regulated tiers, subject to the same interim constraints on further decreases in the basic tier rates below new benchmarks discussed above. The FCC will in response to complaints also regulate, on the basis of actual cost, the rates for equipment used only to receive these higher packages. Services offered on a per channel or per program basis or packages comprised only of services that are also available on a per channel or per program basis are not subject to rate regulation by either municipalities or the FCC. The FCC on February 22, 1994 adopted criteria to assess whether certain discounted packages of \"a la carte\" or per channel offerings should be regulated as a tier of services by the FCC, or treated as unregulated per channel offerings.\nThe regulations adopted by the FCC on April 1, 1993, including the original rate benchmarks, became effective on September 1, 1993. The new rate regulations adopted by the FCC on February 22, 1994, including the new benchmarks, are expected to become effective in May, 1994.\nThe FCC's rules provide that, unless a cable operator can justify higher rates on the basis of its costs, increases in the rates charged by the operator for the basic service package or any other regulated package of service may not exceed an inflation indexed amount, plus increases in certain costs beyond the cable operator's control, such as taxes, franchise fees and increased programming costs that exceed the inflation index. A cable operator may not pass through to subscribers any amounts paid by the operator on or before October 6, 1994, to broadcast stations for the retransmission of their\n(16)\nsignals. Increases in retransmission fees above those in effect on that day may be passed through to subscribers. As part of the implementation of its rate regulations, the FCC has frozen all cable service rates in effect on April 5, 1993 until May 15, 1994. Challenges to rates then in effect were required to be filed within six months from September 1, 1993.\nOn February 22, 1994, the FCC adopted guidelines for cost-of-service showings that establish a regulatory framework pursuant to which a cable television operator may attempt to justify rates in excess of the benchmarks. Such justification would be based upon (i) the operator's costs in operating a cable television system (including certain operating expenses, depreciation and taxes) and (ii) a return on the investment the operator has made to provide regulated cable television services in such system (such investment being referred to as its \"ratebase\", which includes working capital and certain costs associated with the construction of such system). The guidelines (1) create a rebuttable presumption that excludes from a cable television operator's ratebase any \"excess acquisition costs\" (equal to the excess of the purchase price for a cable television system over the original construction cost of such system, or its book value at the time of acquisition), (2) include in the rate base the costs associated with certain intangibles such as franchise rights and customer lists, (3) set a uniform rate of return for regulated cable television service of 11.25% after taxes, and (4) include a \"productivity offset feature\" that could reduce otherwise justifiable rate increases based on a claimed increase in a cable television system's operational efficiencies.\nUnder the 1992 Cable Act, systems may not require subscribers to purchase any service package other than the basic service package as a condition of access to video programming offered on a per channel or per program basis. Cable systems are allowed up to ten years to the extent necessary to implement the necessary technology to facilitate this access.\nIn addition, the 1992 Cable Act (i) requires cable programmers under certain circumstances to offer their programming to present and future competitors of cable television such as MMDS, SMATV and DBS, and prohibits new exclusive contracts with program suppliers without FCC approval, (ii) directs the FCC to set standards for limiting the number of channels that a cable television system operator could program with programming services controlled by such operator, (iii) bars municipalities from unreasonably refusing to grant additional competitive franchises, (iv) requires cable television operators to carry (\"Must Carry\") all local broadcast stations (including home shopping broadcast stations), or, at the option of a local broadcaster, to obtain the broadcaster's prior consent for retransmission of its signal (\"Retransmission Consent\"), (v) requires cable television operators to obtain the consent of any non-local broadcast station prior to retransmitting its signal, and (vi) regulates the ownership by cable operators of other media such as MMDS and SMATV. In connection with clause (ii) above concerning limitations on affiliated programming, the FCC has established a 40% limit on the number of channels of a cable television system that can be occupied by programming services in which the system operator has an attributable interest and a national limit of 30% on the number of households that any cable company can serve. In connection with clause (iv) above concerning\n(17)\nretransmission of a local broadcaster's signals, a substantial number of local broadcast stations are currently carried by the Company's systems and have elected to negotiate with the Company for Retransmission Consent. Although the Company has obtained Retransmission Consent agreements with all broadcast stations it currently carries, a number of these agreements are temporary in nature and the potential remains for discontinuation of carriage if an agreement is not ultimately reached.\nThe FCC has imposed new regulations under the 1992 Cable Act in the areas of customer service, technical standards, equal employment opportunity, privacy, rates for leased access channels, obscenity and indecency, and disposition of a customer's home wiring. The FCC has also issued a report to Congress on proposals for compatibility with other consumer electronic equipment such as \"cable ready\" television sets and videocassette recorders and has issued a notice of proposed rulemaking seeking comments on proposed equipment compatibility regulations.\nA number of lawsuits have been filed in federal court challenging the constitutionality of various provisions of the 1992 Cable Act. A challenge to the constitutionality of the 1992 Cable Act's Must Carry rules was denied by a federal court in April 1993. A stay of the rules pending an appeal to the United States Supreme Court was denied. Argument on those rules was heard by the United States Supreme Court in January 1994. Other lawsuits filed challenging the application of the Must Carry rules to particular cable television systems have been unsuccessful. Most other challenged provisions of the 1992 Cable Act have been upheld at the federal district court level, including provisions governing rate regulation and retransmission consent, but an appeal to the District of Columbia Court of Appeals of that decision has been filed. Other challenges to the FCC rate freeze and other provisions of the FCC's rate regulation scheme have been separately brought directly to the D.C. Circuit. The Company cannot predict the outcome of any of the foregoing litigation affecting the 1992 Cable Act.\nOTHER FCC REGULATION. In addition to the rules and regulations promulgated by the FCC under the 1984 Cable Act and the 1992 Cable Act, the FCC has promulgated other rules affecting the Company. FCC rules require that cable systems black out certain network and sports programming on imported distant broadcast signals upon request. The FCC also requires that cable systems delete syndicated programming carried on distant signals upon the request of any local station holding the exclusive right to broadcast the same program within the local television market and, in certain cases, upon the request of the copyright owner of such programs. These rules affect the diversity and cost of the Company's programming options for their cable systems.\nThe FCC has the authority to regulate utility company rates for cable rental of pole and conduit space. States can establish preemptive regulations in this area, and the states in which the Company's cable television systems operate have done so. The FCC's technical guidelines for signal leakage became substantially more stringent in 1990, requiring upgrading expenditures by the Company. Two-way radio stations, microwave-relay stations and satellite earth stations used by the Company's cable television systems are licensed by the FCC.\n(18)\nFEDERAL COPYRIGHT REGULATION. There are no restrictions on the number of distant broadcast television signals that cable television systems can import, but cable systems are required to pay copyright royalty fees to receive a compulsory license to carry them. The United States Copyright Office has increased the royalty fee from time to time. The FCC has recommended to Congress the abolition of the compulsory licenses for cable television carriage of broadcast signals. Any such action by Congress could adversely affect the Company's ability to obtain such programming and could increase the cost of such programming.\nCABLE TELEVISION CROSS-MEDIA OWNERSHIP LIMITATIONS. The 1984 Cable Act prohibits any person or entity from owning broadcast television and cable properties in the same market. The 1984 Cable Act also bars co-ownership of telephone companies and cable television systems operating in the same service areas, with limited exceptions for rural areas. The FCC may also expand the rural exemption for telephone companies offering cable service within their service areas. The FCC has modified its rule that formerly barred the commercial broadcasting networks (NBC, CBS and ABC) from owning cable television systems. The FCC rule does not allow the networks to acquire cable systems in markets in which they already own a broadcast station, and sets limitations on the percentage of homes that can be passed, both nationally and locally, by network-owned cable systems. There is no federal bar to newspaper ownership of cable television systems. The 1992 Cable Act imposed limits on new acquisitions of SMATV or MMDS systems by cable operators in their franchise areas. The Company does not have any prohibited cross-ownership interests.\nSTATE AND LOCAL REGULATION. Regulatory responsibility for essentially local aspects of the cable business such as franchisee selection, system design and construction, safety, and consumer services remains with either state or local officials and, in some jurisdictions, with both. The 1992 Cable Act expands the factors that a franchising authority can consider in deciding whether to renew a franchise and limits the damages for certain constitutional claims against franchising authorities for their franchising activities. New York law provides for comprehensive state-wide regulation, including approval of transfers of cable franchises and consumer protection legislation. State and local franchising jurisdiction is not unlimited, however, and must be exercised consistently with the provisions of the 1984 Cable Act and the 1992 Cable Act. Among the more significant restrictions that the Cable Act imposes on the regulatory jurisdiction of local franchising authorities is a 5% ceiling on franchise fees and mandatory renegotiation of certain franchise requirements if warranted by changed circumstances.\n(19)\nCONSOLIDATED CABLE AFFILIATES\nV CABLE. On December 31, 1992, the Company consummated a significant restructuring and reorganization involving its unrestricted subsidiary V Cable, U.S. Cable and General Electric Capital Corporation (\"GECC\"), V Cable's principal creditor (the \"V Cable Reorganization\"). In the V Cable Reorganization, V Cable acquired, for $20.0 million, a 20% partnership interest in U.S. Cable, and U.S. Cable acquired, for $3.0 million, a 19% non-voting interest in a newly incorporated subsidiary of V Cable (\"VC Holding\") that was formed to hold substantially all of V Cable's assets. As a result, V Cable now owns an effective 84.8% interest in VC Holding. GECC then provided new long-term credit facilities to each of V Cable, VC Holding and U.S. Cable. The debt of V Cable and VC Holding is guaranteed by, and secured by a pledge of all of the assets of, V Cable, VC Holding and each of their subsidiaries, including a pledge of all direct and indirect ownership interests in such subsidiaries. The debt of U.S. Cable is guaranteed by all subsidiaries of U.S. Cable, and secured by all the assets of each subsidiary of U.S. Cable; U.S. Cable's debt is also guaranteed (and cross-collateralized in most cases) by each of V Cable, VC Holding and each of their subsidiaries. All of the V Cable, VC Holding and U.S. Cable credit facilities are non-recourse to the Company other than with respect to the common stock of V Cable owned by the Company. The Company manages the U.S. Cable properties and the V Cable systems under management agreements that provide for cost reimbursement, including an allocation of overhead charges.\nIn connection with the V Cable Reorganization, V Cable will assume, on December 31, 1997, approximately $121.0 million face value of debt of U.S. Cable ($78.3 million present value as of December 31, 1993), which amount is subject to adjustment, upward or downward, depending on U.S. Cable's ratio of debt to cash flow (as defined) in 1997. Each year thereafter, until the final adjustment upon occurrence of an exchange described below, the amount of U.S. Cable debt assumed by V Cable may be similarly adjusted, upward or downward.\nV Cable has the option to exchange its interest in U.S. Cable for all of U.S. Cable's interest in VC Holding and thus recover full ownership of the V Cable systems from and after January 1, 1998. Upon such an exchange, the guarantee and cross collateralization by V Cable and VC Holding of any portion of the U.S. Cable senior credit facilities not assumed by V Cable would terminate. Such option may not be exercised prior to November 30, 2001 unless the U.S. Cable systems have been sold for a net purchase price sufficient to repay to GECC certain of the U.S. Cable loans not assumed by V Cable, as well as a fixed additional amount. In addition, V Cable may exercise the option prior to January 1, 1998 if the U.S. Cable systems have been sold, all outstanding indebtedness of V Cable, VC Holding and U.S. Cable to GECC (other than junior subordinated debt and certain other excluded indebtedness) is repaid, and an additional fixed amount is paid to GECC.\nThe Company accounts for its investment in U.S. Cable using the equity method of accounting.\n(20)\nCABLEVISION OF NEW YORK CITY. In July 1992, the Company acquired (the \"CNYC Acquisition\") substantially all of the remaining interests in Cablevision of New York City -- Phase I through Phase V (\"CNYC\"), the operator of a cable television system that is under development in The Bronx and parts of Brooklyn, New York. Prior to the CNYC Acquisition, the Company had a 15% interest in CNYC and Charles F. Dolan, the chief executive officer and principal shareholder of the Company, owned the remaining interests. Mr. Dolan remains a partner in CNYC, with a 1% interest and the right to certain preferential payments.\nCNYC holds franchises that permit construction of the franchised areas in specified phases. Construction of the systems in the Brooklyn and The Bronx franchises will take place in five and four phases, respectively. Construction of Phases I, II, III and IV in Brooklyn and Phases I, II and III in The Bronx has been substantially completed. Construction of Phase IV in The Bronx and Phase V in Brooklyn is scheduled to be substantially fully built by the end of 1995.\nUnder the agreement between the Company and Mr. Dolan, a new limited partnership (\"CNYC LP\") was formed and holds 99% of the partnership interests in CNYC. The remaining 1% interest in CNYC is owned by the existing corporate general partner, which is a wholly-owned subsidiary of the Company. The Company owns 99% of the partnership interests in CNYC LP and Mr. Dolan retains a 1% partnership interest in CNYC LP plus certain preferential rights. Mr. Dolan's preferential rights entitle him to an annual cash payment (the \"Annual Payment\") of 14% multiplied by the outstanding balance of his \"Minimum Payment\". The Minimum Payment is $40.0 million and is to be paid to Mr. Dolan prior to any distributions from CNYC LP to partners other than Mr. Dolan. In addition, Mr. Dolan has the right, exercisable on December 31, 1997, and as of the earlier of (1) December 31, 2000 and (2) December 31 of the first year after 1997 during which CNYC achieves an aggregate of 400,000 subscribers, to require the Company to purchase (Mr. Dolan's \"put\") his interest in CNYC LP. The Company has the right to require Mr. Dolan to sell his interest in CNYC LP to the Company (the Company's \"call\") during the three-year period commencing one year after the expiration of Mr. Dolan's second put. In the event of a put, Mr. Dolan will be entitled to receive from the Company the Minimum Payment, any accrued but unpaid Annual Payments, a guaranteed return on certain of his investments in CNYC LP and a Preferred Payment defined as a payment (not exceeding $150.0 million) equal to 40% of the Appraised Equity Value (as defined) of CNYC LP after making certain deductions including a deduction of a 25% compound annual return on approximately 85% of the Company's investments with respect to the construction of Phases III, IV and V of CNYC and 100% of certain of the Company's other investments in CNYC, including Mr. Dolan's Annual Payment. In the event the Company exercises its call, the purchase price will be computed on the same basis as for a put except that there will be no payment in respect of the Appraised Equity Value amount.\nThe Company has the right to make payment of the put or call exercise price in the form of shares of the Company's Class B Common Stock or, if Mr. Dolan so elects, Class A Common Stock, except that all Annual Payments must be paid in cash to the\n(21)\nextent permitted under the Company's Credit Agreement (as defined below). Under the Credit Agreement, the Company is currently prohibited from paying the put or call exercise price in cash and, accordingly, without the consent of the bank lenders, would be required to pay it in shares of the Company's Common Stock.\nThe Company has agreed to invest in CNYC LP sufficient funds to permit CNYC LP to make the required Annual Payments to Mr. Dolan and to make certain equity contributions to CNYC. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Restricted Group.\"\nThe subsidiaries of the Company that own all of the Company's interests in CNYC have succeeded to the rights and obligations of Mr. Dolan under a security agreement relating to CNYC's credit agreement and in connection therewith have pledged all of the Company's interests in CNYC and CNYC LP to secure the obligations to the bank lenders under the CNYC credit agreement. Recourse against these subsidiaries, which are members of the Restricted Group, is limited solely to the pledged interests in CNYC and CNYC LP.\nOTHER CABLE AFFILIATES\nA-R CABLE. On May 11, 1992, A-R Cable purchased approximately $237 million principal amount of its Senior Subordinated Deferred Interest Notes due December 30, 1997 (the \"A-R Cable Notes\") representing approximately 86.9% of the principal amount of A-R Cable Notes outstanding. Concurrent with the purchase of the A-R Cable Notes, Warburg, Pincus Investors, L.P. (\"Warburg Pincus\") purchased a new Series A Preferred Stock of A-R Cable for a cash investment of $105.0 million, and the Company purchased a new Series B Preferred Stock of A-R Cable for a cash investment of $45.0 million. The Company acquired the funds for its investment in A-R Cable through borrowings under the Company's credit agreement. In addition, GECC provided A-R Cable with an additional $70.0 million under a secured revolving credit line. The proceeds from the sale of the Series A and Series B Preferred Stock and the additional GECC loans were used to purchase the A-R Cable Notes.\nIn connection with Warburg Pincus' investment in A-R Cable, upon the receipt of certain franchise approvals, Warburg Pincus will be permitted to elect three of the six members of the A-R Cable board of directors, will have approval rights over certain major corporate decisions of A-R Cable and will be entitled to 60% of the vote on all matters on which holders of capital stock are entitled to vote (other than the election of directors). A wholly-owned subsidiary of the Company continues to own the common stock, as well as the Series B Preferred Stock, of A-R Cable and the Company continues to manage A-R Cable under a management agreement that provides for cost reimbursement, an allocation of overhead charges and a management fee of 3-1\/2% of gross receipts, as defined, with interest on unpaid annual amounts thereon at a rate of 10% per annum. The 3-1\/2% fee and interest thereon is payable by A-R Cable only after repayment in full of its senior debt and certain other obligations. Under certain circumstances, the fee is subject to reduction to 2-1\/2% of gross receipts.\n(22)\nAfter May 11, 1997, either Warburg Pincus or the Company may irrevocably cause the sale of A-R Cable, subject to certain conditions. In certain circumstances, Warburg Pincus may cause the sale of A-R Cable prior to that date. If Warburg Pincus initiates the sale, the Company will have the right to purchase A-R Cable through an appraisal procedure. The Company's purchase right may be forfeited in certain circumstances. Upon the sale of A-R Cable, the net sales proceeds, after repayment of all outstanding indebtedness and other liabilities, will be used as follows: first, to repay Warburg Pincus' original $105.0 million investment in the Series A Preferred Stock; second, to repay the Company's original investment of $45.0 million in the Series B Preferred Stock; third, to repay the accumulated unpaid dividends on the Series A Preferred Stock (19% annual rate); fourth, to repay the accumulated unpaid dividends on the Series B Preferred Stock (12% annual rate); fifth, to pay the Company for all accrued and unpaid management fees together with accrued but unpaid interest thereon; sixth, pro rata 60% to the Series A Preferred Stockholders, 4% to the Series B Preferred Stockholders and 36% to the common stockholder(s).\nAlso in connection with the purchase of the A-R Cable Notes, A-R Cable retired its previously outstanding preferred stock (undesignated as to series) which it had purchased from an affiliate for nominal consideration. In connection with the purchase of the preferred stock, a transaction fee agreement between A-R Cable and GECC was terminated and A-R Cable's obligations thereunder were extinguished.\nAs a result of the rights to which Warburg Pincus is entitled discussed above, the Company no longer has financial or voting control over A-R Cable's operations. Accordingly, the Company no longer consolidates the financial position or results of operations of A-R Cable. For reporting purposes, the deconsolidation of A-R Cable became effective on January 1, 1992 and the Company is accounting for its investment using the equity method of accounting.\nThe Company continues to guarantee the debt of A-R Cable to GECC under a limited recourse guarantee wherein recourse to the Company is limited solely to the common stock and Series B Preferred Stock of A-R Cable owned by a wholly-owned subsidiary of the Company.\nIn October and November 1992, A-R Cable repurchased approximately an aggregate $6.9 million principal amount of the A-R Cable Notes at an average price of $98.60 per $100 principal amount. The funds for such repurchase were obtained by additional borrowings under A-R Cable's secured revolving credit line. In February 1993, A-R Cable redeemed the remaining principal amount of A-R Cable Notes and accrued interest thereon in the aggregate amount of $29.3 million. The funds for such redemption were obtained from an additional revolving credit line provided by GECC.\nCABLEVISION OF BOSTON. Cablevision of Boston, a Massachusetts limited partnership, is engaged in the construction, ownership and operation of cable television systems in Boston and Brookline, Massachusetts. The Company had advanced net funds to Cablevision of Boston as of December 31, 1993 amounting to approximately $52.0 million. Due to uncertainties existing during 1985 (which subsequently were resolved),\n(23)\nthe Company wrote off for accounting purposes its entire investment in and advances to Cablevision of Boston of $34.5 million as of September 30, 1985. Subsequent to 1985, a subsidiary of the Company exchanged $45.7 million of advances, consisting of amounts previously written off of $34.5 million, interest of $3.2 million that had not been recognized for accounting purposes, and $8.0 million of subsequent advances, for $45.7 million of preferred equity in Cablevision of Boston. After this exchange, the Company advanced an additional $9.5 million to Cablevision of Boston; in addition, at December 31, 1993, $81.2 million of unpaid distributions had accrued on the Company's preferred equity. At December 31, 1993, as a result of the write-off referred to above and non-recognition for accounting purposes of the unpaid distributions, the Company's consolidated financial statements reflected $17.5 million due from Cablevision of Boston. The Company's preferred equity is subordinated to the indebtedness of Cablevision of Boston (including the Company's $9.5 million of advances not converted to preferred equity) and accrued but unpaid management fees due to a corporation owned by the managing general partner, which indebtedness and management fees aggregated approximately $92.2 million at December 31, 1993, and any working capital deficit incurred in the ordinary course of business.\nIn addition to the Company's preferred equity interest in Cablevision of Boston, the Company is a limited partner in Cablevision of Boston and currently holds a 7% prepayout interest and a 20.7% postpayout interest. Mr. Dolan holds directly or indirectly a 1% prepayout general partnership interest and a 23.5% postpayout general partnership interest in Cablevision of Boston. With respect to Cablevision of Boston, \"payout\" means the date on which the limited partners are distributed the amount of their original investment.\nCABLEVISION OF CHICAGO. Cablevision of Chicago owns cable television systems operating in the suburban Chicago area. The Company does not have a material ownership interest in Cablevision of Chicago but had loans and advances outstanding to Cablevision of Chicago in the amount of $12.4 million (plus $10.1 million in accrued interest which the Company has fully reserved) as of December 31, 1993, which loans and advances are subordinated to Cablevision of Chicago's senior credit facility. Mr. Dolan currently holds directly or indirectly an approximate 1% prepayout and a 32.7% postpayout general partnership interest in the cable television systems owned and operated by Cablevision of Chicago. With respect to Cablevision of Chicago, \"payout\" means the date on which the limited partners in Cablevision of Chicago are distributed the amount of their original investment, plus interest thereon, if applicable. In February, 1993 Cablevision of Chicago amended its credit facility, increasing the maximum amount available under such facility to $85.0 million and obtaining the ability to pay certain subordinated debt.\nCABLEVISION OF NEWARK. In April 1992, Cablevision of Newark, a partnership 25% owned and managed by the Company and 75% owned by an affiliate of Warburg Pincus, acquired cable television systems located in Newark and South Orange, New Jersey (\"Gateway Cable\") from Gilbert Media Associates, L.P. for a cash purchase price of approximately $76.5 million. The Company's total capital contributions to Cablevision of Newark were approximately $6.0 million. The Company manages the\n(24)\noperations of Cablevision of Newark for a fee equal to 3-1\/2% of gross receipts, as defined, plus reimbursement of certain costs and an allocation of certain selling, general and administrative expenses.\nU.S. CABLE. In connection with the V Cable Reorganization (see Note 2 of Notes to Consolidated Financial Statements), V Cable acquired for $20.0 million a 20% interest in U.S. Cable. The Company has managed the properties of U.S. Cable since June 1992 under management agreements that provide for cost reimbursement, including an allocation of overhead charges.\n(25)\nPROGRAMMING OPERATIONS\nGENERAL.\nThe Company conducts its programming activities through Rainbow Programming, its wholly owned subsidiary, and through subsidiaries of Rainbow Programming in partnership with certain unaffiliated entities, including National Broadcasting Company, Inc. (\"NBC\") and Liberty Media Corporation (\"Liberty\"). Rainbow Programming's businesses include eight regional SportsChannel services, two national entertainment services (American Movie Classics Company (\"AMCC\") and Bravo Network (\"Bravo\")), News 12 Long Island (a regional news service serving Long Island, New York) and the national backdrop sports services of Prime SportsChannel Networks (\"Prime SportsChannel\"). Rainbow Programming also owns an interest in Courtroom Television Network. Rainbow Programming's SportsChannel services provide regional sports programming to the New York, Philadelphia, New England, Chicago, Cincinnati, Cleveland, San Francisco and Florida areas. AMCC is a national program service featuring classic, unedited and non-colorized films from the 1930s through the 1970s. Bravo is a national program service offering international films and performing arts programs, including jazz, dance, classical music, opera and theatrical programs.\nRainbow Programming acts as managing partner for each of these programming businesses, other than Courtroom Television Network (which is managed by Time Warner), and reflects its share of the profits or losses in these businesses using the equity method of accounting. Rainbow Programming may from time to time sell equity interests in certain of these businesses, which sale(s) would reduce Rainbow Programming's ownership interests therein. Certain of Rainbow Programming's programming interests are held through Rainbow Program Enterprises (\"RPE\"), which is substantially wholly owned by Rainbow Programming.\nIn December 1992, Rainbow Programming, NBC and Liberty entered into an agreement to form Prime SportsChannel, a partnership to supply national sports programming, including live and taped sports events and sports news, to regional sports markets in the United States. The partnership, which is owned 50% by an affiliate of Liberty and 25% each by affiliates of Rainbow and NBC, delivers two national sports program services: Prime Network, consisting primarily of live and taped events, and SportsChannel America, featuring sports news and occasional events. In addition, an affiliate of Liberty concurrently acquired a one-third partnership interest in SportsChannel Prism Associates (\"Prism\"), which operates two regional sports and entertainment programming services in Philadelphia. Following this transaction, affiliates of Liberty, Rainbow Programming and NBC are equal one-third partners in Prism.\nIn January 1993, Liberty exercised the remainder of its option to purchase an additional 0.1% interest in SportsChannel Chicago Associates equally from both Rainbow Programming and NBC. Accordingly, Liberty now has a 50% ownership interest while Rainbow and NBC each have a 25% interest in the company.\n(26)\nAs previously announced, the Company is considering possible transactions that could result in Rainbow Programming, or another entity holding the Company's programming interests, becoming a publicly-held company, including a spin-off of all or a portion of Rainbow Programming or such entity to the Company's common stockholders.\nRainbow Programming and NBC formed a venture to exploit the pay-per-view television rights to the 1992 Summer Olympics. Rainbow Programming's share of the losses of the venture amounted to its maximum obligation of $50 million and this payment was made to NBC in January 1993.\nOn August 2, 1993, Rainbow Programming received a notice from the AMCC partner affiliated with Liberty Media Corporation initiating the buy-sell procedure and setting a stated value of $390 million for all the partnership interests in AMCC. The partnership agreement provides that the non-initiating partner has a period of 45 days from receipt of the buy-sell notice to elect to purchase the initiating partner's interest at the stated value or sell its interest at the stated value. On September 16, 1993, Rainbow Programming notified its partners in AMCC that it had elected to purchase Liberty Media's 50% interest in AMCC at the stated value. The Company anticipates that the transaction will be consummated in the second quarter of 1994.\nRainbow Programming's financing needs have been funded by the Restricted Group's investments in and advances to Rainbow Programming, by sales of equity interests in various programming businesses and, to a limited extent, through separate, external debt financing. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\".\nCOMPETITION.\nThere are numerous programming services with which Rainbow Programming competes for cable television system distribution and for subscribers, including network television, other national and regional cable services, independent broadcast television stations, television superstations, the home videocassette industry, and developing pay-per-view services. Rainbow Programming and the other programming services are competing for limited channel capacity and for inclusion in the basic service tier of the systems offering their programming services. Many of these program distributors are large, publicly-held companies which have greater financial resources than Rainbow Programming.\nRainbow Programming also competes for the availability of programming, through competition for telecast rights to films and competition for rights agreements with sports teams. The Company anticipates that such competition will increase as the number of programming distributors increases.\n(27)\nIn general, the programming services offered by Rainbow Programming compete with other forms of television-related services and entertainment media on the basis of the price of services, the variety and quality of programming offered and the effectiveness of Rainbow Programming's marketing efforts.\nREGULATION.\nCable television program distributors such as Rainbow Programming are not regulated by the FCC under the Communications Act of 1934. To the extent that regulations and laws, either presently in force or proposed, hinder or stimulate the growth of the cable television and satellite industries, the business of Rainbow Programming will be directly affected. As discussed above under \"Business - Cable Television Operations - Regulation\", the 1992 Cable Act limits in certain ways the Company's ability to freely manage the Rainbow Programming services or carry the Rainbow Programming services on their affiliates' systems or could impose other regulations on the Rainbow Programming companies.\nThe 1984 Cable Act prohibits localities from requiring carriage of specific programming services, providing a more open market for Rainbow Programming and other cable program distributors. The 1984 Cable Act limits the number of commercial leased access channels that a cable television operator must make available for potentially competitive services but the 1992 Cable Act empowers the FCC to set the rates and conditions for such leased access channels. The reimposition of the FCC's rules requiring blackout of syndicated programming on distant broadcast signals for which a local broadcasting station has an exclusive contract opened new channels for Rainbow Programming's services.\nSatellite common carriers, from whom Rainbow Programming and its affiliates obtain transponder channel time to distribute their programming, are directly regulated by the FCC. All common carriers must obtain from the FCC a certificate for the construction and operation of their interstate communications facilities. Satellite common carriers must also obtain FCC authorization to utilize satellite orbital slots assigned to the United States by the World Administrative Radio Conference. Such slots are finite in number, thus limiting the number of carriers that can provide satellite service and the number of channels available for program producers and distributors such as Rainbow Programming and its affiliates. Nevertheless, there are at present numerous competing satellite services that provide transponders for video services to the cable industry.\nAll common carriers must offer their communications service to Rainbow Programming and others on a nondiscriminatory basis (including by means of a lottery). A satellite carrier cannot unreasonably discriminate against any customer in its charges or conditions of carriage.\n(28)\nADVERTISING SERVICES\nRainbow Advertising represents certain of the Company's cable television systems in the sales of advertising time to regional and local advertisers. Rainbow Advertising also represents each of the SportsChannel regional programming services and the News 12 Long Island programming service in the sales of advertising time to national and regional advertisers. Rainbow Advertising represents cable television systems unaffiliated with the Company in the sales of spot advertising to national and regional advertisers. Rainbow Advertising also has contracted with certain unaffiliated cable television operators to act as their exclusive representative for the sales of advertising time to local advertisers.\nOTHER AFFILIATES\nATLANTIC PUBLISHING. Atlantic Cable Television Publishing Corporation (\"Atlantic Publishing\") holds a minority equity interest and a debt interest in a company that publishes a weekly cable television guide which is offered to the Company's subscribers and to other unaffiliated cable television operators. As of December 31, 1993, the Company had advanced an aggregate of approximately $18.3 million to Atlantic Publishing, of which approximately $0.7 million was advanced during 1992 and approximately $0.5 million was paid back during 1993. The Company has written off all of its advances to Atlantic Publishing other than $4.0 million. Atlantic Publishing is owned by a trust for certain Dolan family members; however, the Company has the option to purchase Atlantic Publishing for an amount equal to the owner's net investment therein plus interest. The current owner has made only a nominal investment in Atlantic Publishing to date.\nRADIO STATION WKNR. In 1990, the Company and a partner purchased Cleveland Radio Associates (\"WKNR\"), an AM radio station serving the Cleveland metropolitan area. The Company purchased its partner's interest and its total purchase price for its 100% interest in the radio station was $2.5 million. The Company has implemented a change for WKNR to an all-sports format. The Company purchased WKNR in order to explore possible synergies that may exist between radio and its cable television systems and regional sports channel service in the Cleveland market.\nEMPLOYEES AND LABOR RELATIONS\nAs of December 31, 1993, the Company had 3,197 full-time, 370 part-time and 69 temporary employees. During 1991, the International Brotherhood of Electrical Workers (\"IBEW\") conducted an organizing campaign among employees involved in the operation of News 12 Long Island. In connection with that campaign, the IBEW claimed that various unfair labor practices were committed. An NLRB administrative law judge found that News 12's downsizing of its work force in 1991 was based upon valid economic factors and was not an unfair labor practice. The IBEW intends to appeal this determination. The administrative law judge has also found that News 12 offered improper promises to certain employees and improper threats of retaliation to\n(29)\nothers. News 12 intends to appeal this determination. As of December 31, 1993, News 12 Long Island had 40 full-time, 7 part-time and 102 temporary employees.\nIn January 1993, IBEW Local 3 filed a Petition seeking to organize certain employees in CNYC's engineering department. At an election held on March 23, 1994, the employees voted not to be represented by the union. CNYC currently employs 642 employees of whom approximately 145 comprise the proposed bargaining unit.\nThere are no collective bargaining agreements with employees in effect, and the Company believes that its relations with its employees are satisfactory.\n(30)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company generally leases the real estate where its business offices, microwave receiving antennae, earth stations, transponders, microwave towers, warehouses, headend equipment, hub sites, program production studios and access studios are located. Significant leasehold properties include eleven business offices, comprising the Company's headquarters located in Woodbury, New York with approximately 248,000 square feet of space, and the headend sites. The Company believes its properties are adequate for its use.\nThe Company generally owns all assets (other than real property) related to the cable television operations of the Restricted Group, including its program production equipment, headend equipment (towers, antennae, electronic equipment and satellite earth stations), cable system plant (distribution equipment, amplifiers, subscriber drops and hardware), converters, test equipment, tools and maintenance equipment. Similarly, the unconsolidated entities managed by the Company generally own such assets related to their cable television operations. The Company generally leases its service and other vehicles.\nSubstantially all of the assets of the Restricted Group, CNYC, V Cable and VC Holding are pledged to secure borrowings under their respective credit agreements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is party to various lawsuits, some involving substantial amounts. Management does not believe that the resolution of such lawsuits will have a material adverse impact on the financial position of the Company. See Note 12 of Notes to Consolidated Financial Statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n(31)\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Class A Common Stock, par value $.01 per share (\"Class A Common Stock\"), is traded on the American Stock Exchange under the symbol \"CVC\". The following table sets forth the high and low sales prices for the last two years of Class A Common Stock as reported by the American Stock Exchange for the periods indicated.\nAs of March 15, 1994, there were 719 holders of record of Class A Common Stock.\nThere is no public trading market for the Company's Class B Common Stock, par value $.01 per share (\"Class B Common Stock\"). As of March 15, 1994, there were 23 holders of record of Class B Common Stock.\nDIVIDENDS. The Company has not paid any dividends on shares of Class A or Class B Common Stock. The Company intends to retain earnings to fund the growth of its business and does not anticipate paying any cash dividends on shares of Class A or Class B Common Stock in the foreseeable future.\nThe Company may pay cash dividends on its capital stock only from surplus as determined under Delaware law. Holders of Class A and Class B Common Stock are entitled to receive dividends equally on a per share basis if and when such dividends are declared by the Board of Directors of the Company from funds legally available therefor. No dividend may be declared or paid in cash or property on shares of either Class A or Class B Common Stock unless the same dividend is paid simultaneously on each share of the other class of common stock. In the case of any stock dividend, holders of Class A Common Stock are entitled to receive the same percentage dividend (payable in shares of Class A Common Stock) as the holders of Class B Common Stock receive (payable in shares of Class B Common Stock). In addition, the Company is restricted from paying dividends on its capital stock, other than the Company's 8% Series C Cumulative Preferred Stock, under the provisions of its debt agreements.\nUnder the most restrictive of these provisions, cash dividends could not be paid on Class A or Class B Common Stock at December 31, 1993. Dividends may not be paid in respect of shares of Class A or Class B Common Stock unless all dividends due and payable in respect of the preferred stock of the Company have been paid or provided for.\n(32)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL AND STATISTICAL DATA\nThe operating and balance sheet data included in the following selected financial data have been derived from the consolidated financial statements of the Company. Acquisitions made by the Company were accounted for under the purchase method of accounting and, accordingly, the acquisition costs were allocated to the net assets acquired based on their fair value, except for assets owned by Mr. Dolan or affiliates of Mr. Dolan which were recorded at historical cost. Acquisitions are reflected in operating, balance sheet and statistical data from the time of acquisition. The operating data for 1992 reflects the deconsolidation of the Company's A-R Cable subsidiary for reporting purposes, effective January 1, 1992. The selected financial data presented below should be read in conjunction with the financial statements of the Company and notes thereto included in Item 8 of this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION RECENT CABLE REGULATORY DEVELOPMENTS\nAs a result of the initial FCC rate regulations, significant rate reductions were required in a number of the Company's cable television systems. The Company estimates that rate changes and other adjustments, effective September 1, 1993, made in compliance with the initial FCC regulations, caused revenues and operating cash flow (operating profit before depreciation and amortization) to decline $14.9 million and $13.4 million, respectively, for the period from September 1, through December 31, 1993 from those that would have existed absent such adjustments. On February 22, 1994, the FCC ordered a further reduction in rates in effect on September 30, 1992 for the basic service tier. For a further description see Item 1 - \"Business - Cable Television Operations - Competition and Regulation\".\nThe Company is currently in the process of attempting to analyze the impact of the revised rate regulations announced by the FCC in February 1994. Because the Company has not yet had an opportunity to review the formal text of the revised regulations, it is not possible at this time to predict the ultimate financial impact of these rate regulations on the Company and its subsidiaries; however, the Company expects further rate reductions will be required in a number of its cable television systems.\nIn connection with the implementation of its revised rate structure resulting from the initial FCC rate regulation, the Company introduced a number of measures, including the provision of alternate service offerings and repackaging of certain services in order to mitigate the negative impact of FCC regulation on the Company's rate structure. Following the latest FCC rate regulation, the Company intends to introduce additional marketing measures. The Company is not able to predict fully the extent of the effect any of such measures will have in mitigating the impact of rate regulation.\nRECENT ACQUISITIONS AND RESTRUCTURINGS\nThe Company's high levels of interest expense and depreciation and amortization, largely associated with acquisitions made by the Company in the past, have had and will continue to have a negative impact on the reported results of the Company. Consequently, the Company expects to report substantial net losses for at least the next several years.\nFor a description of the Company's recent acquisitions and restructurings, see Item 1 - \"Business - Consolidated Cable Affiliates and Other Cable Affiliates\" and Note 2 of Notes to Consolidated Financial Statements. For a description of the Company's pending acquisitions see Item 1 - \"Business - Recent Developments\".\n(35)\nRESULTS OF OPERATIONS\nThe following table sets forth on a historical basis certain items related to operations as a percentage of net revenues for the periods indicated. The results of operations of CNYC are included in 1992 from the date of acquisition.\nCOMPARISON OF YEAR ENDED DECEMBER 31, 1993 VERSUS YEAR ENDED DECEMBER 31, 1992.\nNET REVENUES for the year ended December 31, 1993 increased $94.2 million (16%) as compared to net revenues for the prior year. Approximately $45.8 million (8%) of the increase is attributable to the CNYC Acquisition on July 10, 1992; approximately $37.1 million (6%) to internal growth of over 112,700 (9%) in the average number of subscribers during the year; and approximately $11.6 million (2%) resulted from an increase in other revenue sources such as advertising. These increases were offset slightly by a decrease of approximately $0.3 million attributable to decreased revenue per subscriber resulting primarily from compliance with FCC regulations. See \"Recent Cable Regulatory Developments\" above.\nTECHNICAL EXPENSES for 1993 increased $37.4 million (18%) over the 1992 amount. Approximately 11% of the 18% increase is attributable to the CNYC Acquisition (whose programming costs reflect high premium service penetration); the remaining\n(36)\n7% is attributable to increased costs directly associated with the growth in subscribers and revenues discussed above. As a percentage of net revenues, technical expenses increased less than 1% during 1993 as compared to 1992; excluding the effect of the CNYC Acquisition, such expenses would have remained relatively constant during 1993.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased $52.3 million (43%) for 1993 as compared to the 1992 level. Approximately 13% of this 43% increase is directly attributable to the CNYC Acquisition, 17% to expense adjustments related to an incentive stock plan and 13% to general cost increases, including higher administrative and sales and marketing costs (a portion of which was attributable to compliance with FCC regulation during the third quarter of 1993). As a percentage of net revenues, selling, general and administrative expenses increased 5%; excluding the effects of the CNYC Acquisition and the incentive stock plan expense adjustments, such expenses, as a percent of net revenues, would have decreased 1% during 1993.\nOPERATING CASH FLOW (operating profit before depreciation and amortization) increased $4.5 million (2%) to $252.2 million for 1993 from $247.7 million for 1992. A $7.8 million (3%) increase, attributable to the CNYC Acquisition, was partially offset by the combined effect of the revenue and expense changes, primarily the impact of the higher selling, general and administrative expenses, noted above.\nDEPRECIATION AND AMORTIZATION EXPENSE increased $26.4 million (16%) during 1993 as compared to the 1992 amount. The acquisition of CNYC contributed $8.6 million (5%) of this increase. The components of the remaining increase in depreciation and amortization of $17.8 million (11%) are as follows: Depreciation expense for the Company, excluding CNYC, increased $10.7 million during 1993 resulting primarily from depreciation charges on capital expenditures made during 1993 and 1992. Amortization expense, excluding CNYC, increased $7.1 million, reflecting an increase of $10.1 million due to the implementation of SFAS 109 during 1993 offset to some extent by a decrease of $3.0 million primarily due to certain intangible assets becoming fully amortized.\nNET INTEREST EXPENSE increased $36.9 million (19%) during 1993 compared to 1992. Approximately $3.7 million (2%) of the increase is attributable to the CNYC Acquisition. An increase of $18.2 million (9%) is due to the net effect of the repayment of bank debt, bearing lower average interest rates with the issuances of a series of senior subordinated debentures as well as to an increase in average debt levels in 1993. An additional $15.0 million (8%) increase resulted from V Cable's debt restructuring on December 31, 1992, primarily from amortization of deferred interest expense incurred in connection therewith.\nSHARE OF AFFILIATES' NET LOSSES of $61.0 million for 1993 and $47.3 million for 1992 consist primarily of the Company's share of A-R Cable's net losses ($56.4 million in 1993 and $30.3 million in 1992), the Company's net share of the profits and losses in certain programming businesses in which the Company has varying ownership interests, (amounting to an $8.8 million profit in 1993 and a $12.4 million loss in\n(37)\n1992) and the Company's share of the net losses of other entities, primarily U.S. Cable (in 1993) and Cablevision of Newark (in 1993 and 1992), which amounted to $13.4 million and $4.6 in 1993 and 1992, respectively.\nMINORITY INTEREST in 1993 represents U.S. Cable's share of the losses of VC Holding, limited to its $3.0 million investment. At December 31, 1992, as part of a restructuring and reorganization involving the Company's unrestricted subsidiary V Cable, V Cable acquired a 20% interest in U.S. Cable for $20 million, and U.S. Cable acquired a 19% interest in VC Holding (a subsidiary of V Cable formed to hold substantially all of V Cable's assets) for $3.0 million.\nOTHER ITEMS\nDuring 1993, net deferred financing charges of approximately $1.0 million associated with the reduction of the Company's credit facility with proceeds from the issuance of the Company's $150 million debentures in April, were written off.\nIn connection with the acquisition of CNYC, for the year ended December 31, 1993, the Company expensed $5.6 million representing the proportionate amount due with respect to the Annual Payment. For the year ended December 31, 1993, the Company has provided for an additional $22.7 million due Mr. Dolan in respect of the Preferred Payment that would be due him in the event he exercises his \"put\" as further described under \"Business - Cable Television Operations - Consolidated Cable Affiliates - Cablevision of New York City\". the additional provision is based on management's estimate of the Appraised Equity Value of the system at December 31, 1993 and has been charged to par value in excess of capital contributed in the accompanying consolidated financial statements. The total amount due Mr. Dolan as of December 31, 1993 in respect of the Preferred Payment amounted to $91.6 million, reflecting a reduction of $3.7 million in 1993 representing Mr. Dolan's obligation to reimburse the Company in connection with certain claims paid or owing by CNYC. See Note 2 of Notes to Consolidated Financial Statements.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued SFAS 115 \"Accounting for Certain Investments in Debt and Equity Securities\". SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values, other than those accounted for under the equity method or as investments in consolidated subsidiaries, and all investments in debt securities. SFAS 115 is effective for fiscal years beginning after December 15, 1993. The effect of initially adopting SFAS 115 will be reported in a manner similar to a cumulative effect of a change in accounting principle. Management of the Company believes that the implementation of SFAS 115 will not have a material effect on the financial position and results of operations of the Company.\nIn November 1992, the FASB issued SFAS No. 112 \"Employers Accounting for Postemployment Benefits\". This statement is effective for fiscal years beginning after December 15, 1993 and management of the Company believes that the implementation\n(38)\nof this statement will not have a significant impact on the results of operations or financial position of the Company.\nINFLATION. The effects of inflation on the Company's costs have generally been offset by increases in subscriber rates.\nCOMPARISON OF YEAR ENDED DECEMBER 31, 1992 VERSUS YEAR ENDED DECEMBER 31, 1991, AS ADJUSTED.\nAs a result of the A-R Cable Restructuring discussed above, effective January 1, 1992, the Company no longer consolidates the financial position and results of operations of A-R Cable, but rather is accounting for its investment in A-R Cable using the equity method of accounting. Accordingly, in order to provide comparability between the 1992 and 1991 periods presented, the following table reflects adjustments made to 1991 to deconsolidate and show on the equity basis the results of operations of A-R Cable for the year ended December 31, 1991. The results of operations of CNYC are included in 1992 from the date of acquisition. The following discussion and analysis of financial condition and results of operations refers to the adjusted results reflected in the table except as otherwise noted.\n(39)\nNET REVENUES for the year ended December 31, 1992 increased $69.4 million (14%) as compared to adjusted net revenues for the prior year. Approximately $35.8 million (7%) of the increase is attributable to the CNYC Acquisition on July 10, 1992; approximately $17.3 million (3%) to an increase of over 40,300 (3.8%) in the average number of subscribers during the year; approximately $9.3 million (2%) to increased revenue per subscriber resulting primarily from rate increases; and approximately $7.0 million (2%) resulted from an increase in non-recurring revenues such as advertising.\nTECHNICAL EXPENSES for 1992 increased $25.5 million (14%) over the adjusted 1991 amount. Approximately 10% of the increase is attributable to the CNYC Acquisition (whose programming costs reflect high premium service penetration) and 4% is attributable to increased costs directly associated with the other growth in revenues and subscribers discussed above, together with increased rates paid for certain programming services. As a percentage of net revenues, technical expenses remained relatively constant in 1992 as compared to 1991; excluding the effect of the CNYC Acquisition, such expenses would have declined 0.8% during 1992.\nSELLING, GENERAL AND ADMINISTRATIVE expenses increased $15.8 million (15%) for 1992 as compared to the adjusted 1991 level (11% of this increase is directly attributable to the CNYC Acquisition); excluding the effects of the CNYC Acquisition, such expenses would have increased approximately $3.7 million (4%), primarily due to general cost increases. As a percentage of net revenues, selling, general and administrative expenses remained relatively constant; excluding the effect of the CNYC Acquisition, such expenses would have declined 0.6%, as a percent of net revenues, during 1992.\nOPERATING CASH FLOW (operating profit before depreciation and amortization) increased $28.1 million (13%) to $247.7 million for 1992 from $219.6 million for 1991, as adjusted. Approximately $6.0 million (3%) of the increase is attributable to the CNYC Acquisition; the remaining $22.1 million (10%) increase is attributable to the combined effect of the revenue and expense increases noted above.\nDEPRECIATION AND AMORTIZATION EXPENSE increased $3.8 million (2%) during 1992 as compared to the adjusted 1991 amount. The acquisition of CNYC contributed an increase of $8.6 million (5%) in depreciation and amortization during 1992. Depreciation expense for the Company, excluding CNYC, increased $3.2 million (2%) during 1992 resulting from depreciation charges on capital expenditures made during 1992 and 1991. Amortization expense, excluding CNYC, decreased $8.0 million (5%) as the result of certain intangible assets becoming fully amortized during 1992 and 1991.\nNET INTEREST EXPENSE increased $5.6 million (3%) during 1992 compared to 1991, as adjusted. Interest expense increased by $11.4 million ($3.1 million (2%) attributable to the CNYC Acquisition; $6.9 million (4%) to increasing amortization of the original issue discount on the subordinated notes payable of V Cable; and $1.4 million (1%) to interest incurred on a special funding revolver). These increases were partially offset by a net reduction of approximately $5.8 million (4%) attributable primarily to lower average interest rates during 1992 on the Company's bank debt and on the term loans\n(40)\nof V Cable. Included in the calculation of the net $5.8 million reduction is $21.2 million of interest on the Company's $275 million 10-3\/4% Senior Subordinated Debentures issued in April 1992, the proceeds of which were used to repay bank debt, on which an estimated $17.8 million of interest would have been charged.\nSHARE OF AFFILIATES' NET LOSSES of $47.3 million for 1992 and $100.6 million for 1991, as adjusted, consist primarily of the Company's share of A-R Cable's net losses ($30.3 million in 1992 and $76.8 million in 1991, as adjusted), $12.3 million and $4.9 million due to the Company's share of losses in a regional sports programming business which was discontinued on December 31, 1992 and its net share of the profits and losses in other entities, primarily certain programming businesses in which the Company has varying ownership interests, which amounted to an aggregate net loss of $4.7 million and $18.9 million in 1992 and 1991, respectively.\nOTHER ITEMS\nDuring the year ended December 31, 1992, the Company recorded gains of $7.1 million on the sale of certain programming interests and $0.7 million on the sale of marketable securities. During 1991, the Company recorded gains on the sale of certain programming interests approximating $15.5 million, and on the sale of marketable securities approximating $5.8 million.\nIn 1992, the Company provided for the loss it incurred, $50.0 million, with respect to Rainbow Programming's agreement with NBC relating to the telecast of the 1992 Summer Olympics. This amount was paid in January 1993 with borrowings under the Company's Credit Agreement. See Note 8 of Notes to Consolidated Financial Statements.\nIn connection with the V Cable Reorganization described above, the Company recognized a loss on sale of preferred stock amounting to $20.0 million in the year ended December 31, 1992.\nThe cost of debt restructuring, for the year ended December 31, 1992 includes the write-off of deferred financing charges of approximately $4.8 million associated with that portion of bank debt that was repaid ($267 million) with the proceeds of the Company's 10-3\/4% subordinated debentures issued in April 1992. In addition, $7.5 million of deferred financing costs was written off in relation to the debt that V Cable carried before the V Cable Reorganization was consummated on December 31, 1992. See Item 1 - \"Business - Consolidated Cable Affiliates - V Cable\" and Note 2 of Notes to Consolidated Financial Statements.\nIn 1992, the Company provided an additional $5.7 million for settlement of claims and potential claims related to certain litigation that had been pending against Mr. Dolan and the Company, as described in Note 12 of Notes to Consolidated Financial Statements.\n(41)\nIn connection with the acquisition of CNYC, the Company provided for the $40.0 million minimum payment due Mr. Dolan and, for the year ended December 31, 1992, expensed $2.7 million representing the proportionate amount due with respect to the Annual Payment. As of December 31, 1992, the Company has provided for an additional $27.0 million due Mr. Dolan in respect of the Preferred Payment that would be due him in the event he exercises his \"put\" as further described under \"Business - Cable Television Operations - Consolidated Cable Affiliates - Cablevision of New York City\". The additional provision is based on management's estimate of the Appraised Equity Value of the system at December 31, 1992 and has been charged to par value in excess of capital contributed in the accompanying consolidated financial statements. See Note 2 of Notes to Consolidated Financial Statements.\nINFLATION. The effects of inflation on the Company's costs have generally been offset by increases in subscriber rates.\nLIQUIDITY AND CAPITAL RESOURCES\nFor financing purposes, the Company is structured as the Restricted Group, consisting of Cablevision Systems Corporation and certain of its subsidiaries and an unrestricted group of certain subsidiaries which includes V Cable (including VC Holding), CNYC, Rainbow Programming, WKNR and Rainbow Advertising. The Restricted Group, V Cable and CNYC are individually and separately financed. Equity funding for CNYC will, however, be provided by the Restricted Group. Rainbow Programming does not have external financing and its cash requirements have been financed to date by the Restricted Group, although one of the programming businesses in which Rainbow Programming invests has separate financing. WKNR and Rainbow Advertising do not have external financing and havebeen financed to date by the Restricted Group.\n(42)\nThe following table presents selected historical results of operations and other financial information related to the captioned groups or entities for the year ended December 31, 1993. (Rainbow Programming, Rainbow Advertising, and WKNR are included in \"Other Unrestricted Subsidiaries\").\n(43)\nAt December 31, 1993, the Company's consolidated debt was $2,235.5 million (excluding the Company's deficit investment in A-R Cable of $307.8 million), of which $833.0 million represented V Cable's debt and $220.7 million represented CNYC's debt including the $91.6 million obligation to a related party.\nRESTRICTED GROUP\nThe Company is party to a credit facility with a group of banks led by Toronto-Dominion (Texas) as agent, (the \"Credit Agreement\"). The maximum amount available to the Restricted Group under the Credit Agreement is $695.6 million with a final maturity at December 31, 2000. The facility consists of a $291.0 million term loan, which begins amortizing on a scheduled quarterly basis beginning December 31, 1993 with 68% being amortized by December 31, 1998; and a $404.6 million revolving loan with scheduled facility reductions starting on December 31, 1993 resulting in a 66.25% reduction by December 31, 1998. On March 18, 1994, the Restricted Group had outstanding bank borrowings of $427.0 million. An additional $18.4 million was reserved under the Credit Agreement for letters of credit issued on behalf of the Company.\nUnrestricted and undrawn funds available to the Restricted Group under the Credit Agreement amounted to approximately $250.2 million at March 18, 1994. The Credit Agreement contains certain financial covenants that may limit the Restricted Group's ability to utilize all of the undrawn funds available thereunder, including covenants requiring the Restricted Group to maintain certain financial ratios and restricting the permitted uses of borrowed funds.\nThe amount outstanding under a separate credit agreement for the Company's New Jersey subsidiary (\"CNJ\"), which is part of the Restricted Group, was $58.5 million as of March 18, 1994. The Company and CNJ are jointly and severally liable for this debt. On March 31, 1993, the CNJ revolving facility converted to an amortizing term loan. The CNJ facility began amortizing on a scheduled quarterly basis on June 30, 1993 with 68.25% being amortized by December 31, 1998.\nAs of March 18, 1994 the Company had entered into interest exchange (swap) agreements with several of its banks on a notional amount of $200.0 million, on which its pays a fixed rate of interest and receives a variable rate of interest for periods ranging from one to four years. The average effective annual interest rate on all bank debt outstanding at February 28, 1994 was approximately 8.2%.\nOn February 17, 1993, the Company issued $200.0 million of its 9-7\/8% senior subordinated debentures due 2013. The net proceeds of $193.1 million were initially used to repay borrowings under the Company's Credit Agreement. With respect to such issuance the Company had obtained the consent of its bank lenders to waive the provisions of the Credit Agreement that require the Company to reduce the facility by 50% of the gross proceeds of any debenture issue.\n(44)\nIn April 1993, the Company issued $150,000 of its 9-7\/8% senior subordinated debentures due 2023. Approximately $105.0 million of the net proceeds of $145.9 million was used to repay borrowings under the Credit Agreement. As a result of such issuance, the maximum amount available under the Credit Agreement was reduced by $75.0 million.\nThe Restricted Group made capital expenditures of $106.4 million during 1993 and $65.3 million in 1992, primarily in connection with system upgrades, the expansion of existing cable plant to pass additional homes and other general capital needs.\nThe cable systems located in New York State that are owned by the Restricted Group and VC Holding are subject to agreements (the \"New York Upgrade Agreements\") with the New York State Commission on Cable Television (the \"New York Cable Commission\"). The New York Upgrade Agreement applicable to the Restricted Group requires the substantial upgrade of its systems, ultimately to a 77 channel capacity by 1995-1996, subject to certain minor exceptions. As part of this planned upgrade of the Restricted Group's New York systems, the Company expects to use fiber optic cable extensively in its trunk and distribution networks. The Company believes that the remaining portion of the upgrade to 77 channels will cost up to an additional $80 million which would be spent during the period 1994 to 1996. In addition, the Company anticipates upgrading certain of its New York systems beyond the level required by the New York Upgrade Agreements along with upgrading certain other of its Restricted Group systems. The Company anticipates that the capital costs of these additional upgrades may be substantial.\nIn July 1992, the Company acquired substantially all of the remaining interests in CNYC. CNYC is separately financed by a $185 million bank credit agreement. Under an agreement with the City of New York, the Company undertook to make aggregate equity contributions in Phases III, IV and V of CNYC of $71.0 million or such lesser amount as the CNYC banks deem necessary. Recourse by the City of New York with respect to such obligation is limited to remedies available under the CNYC franchises. As of March 1, 1994, the Restricted Group had advanced $48.2 million of equity to CNYC and had the ability to invest the balance of the $71.0 million in CNYC. Under the CNYC purchase agreement, the Restricted Group has guaranteed an annual payment to Mr. Dolan of $5.6 million (the \"Annual Payment\" as defined) and a $40.0 million minimum payment (the \"Minimum Payment\", as defined). The Minimum Payment can be made in either cash or stock at the Company's option. Under its Credit Agreement, the Company is currently prohibited from paying the Minimum Payment and any amounts in respect of the Preferred Payment in cash. See Item 1 -- \"Business -- Consolidated Cable Affiliates -- Cablevision of New York City\".\nIn March 1994, the Company purchased the assets of North Coast Cable for an aggregate purchase price of $133 million. The Company's cash requirement for this acquisition amounted to approximately $98.8 million. The remainder of the purchase price was paid with distributions owed the Company with respect to its existing minority interest and accrued management fees owing from North Coast Cable, through the assumption of certain liabilities of North Coast Cable and certain other\n(45)\nadjustments. The net cash purchase price was provided by borrowings under the Restricted Group's Credit Agreement. See \"Business -- Recent Developments\".\nThe Company believes that, for the Restricted Group, and based upon a preliminary analysis of the impact of the revised FCC rate regulations referred to above, as announced by the FCC in February 1994, internally generated funds together with funds available under its existing Credit Agreement, as well as the proceeds from the issuance of the Preferred Shares, will be sufficient through December 31, 1995 (i) to meet its debt service requirements including its amortization requirements under the Credit Agreement, (ii) to fund its normal capital expenditures, including the required upgrades under the New York Upgrade Agreement, and (iii) to fund its anticipated investments, including its $75 million investment in Rainbow Programming in connection with Rainbow Programming's purchase of Liberty Media's 50% interest in AMCC, the $5.6 million annual payments to Charles Dolan in connection with the CNYC Acquisition and the equity requirements in connection with the build out of the CNYC cable systems.\nFurther acquisitions and other investments by the Company, if any, will be funded by undrawn borrowing capacity and by possible increases in the amount available under the Credit Agreement, additional borrowings from other sources, and\/or possible future sales of debt, equity or equity related securities.\nThe senior secured indebtedness incurred by A-R Cable and V Cable is guaranteed by the Restricted Group, but recourse against the Restricted Group is limited solely to the common stock of A-R Cable and of V Cable pledged to A-R Cable's and V Cable's senior secured lenders, respectively.\nUnder the terms of the agreement relating to Warburg Pincus' investment in A-R Cable, the Company pledged the stock of the subsidiary which owns all of the A-R Cable common stock and the A-R Cable Series B Preferred Stock as collateral for the Company's indemnification obligations under such agreement.\nUnder the terms of its Credit Agreement, as amended, the Company is permitted to make unspecified investments of up to $200 million, which include the Company's planned investment in Rainbow Programming, in the remaining equity contributions to CNYC and any equity contributions the Company may make to A-R Cable and V Cable.\nThe terms of the instruments governing A-R Cable's and V Cable's indebtedness prohibit transfer of funds (except for certain payments related to corporate overhead allocations by A-R Cable and V Cable and pursuant to an income tax allocation agreement with respect to V Cable) from A-R Cable and V Cable to the Restricted Group and are expected to prohibit such transfer of funds for the foreseeable future. Payments to the Restricted Group in respect of its investments in and advances to Cablevision of Chicago and Cablevision of Boston are also presently prohibited by the terms of those companies' applicable debt instruments and are expected to be prohibited for the foreseeable future. The Restricted Group does not expect that such\n(46)\nlimitations on transfer of funds or payments will have an adverse effect on the ability of the Company to meet its obligations.\nV CABLE\nThe new long-term credit facilities extended by GECC to V Cable and VC Holding in connection with the V Cable Reorganization refinanced all of V Cable's pre-existing debt on December 31, 1992. Under the credit agreement between V Cable and GECC (the \"V Cable Credit Agreement\"), GECC has provided a term loan (the \"V Cable Term Loan\") in the amount of $20.0 million to V Cable, which accretes interest at a rate of 10.62% compounded semi-annually until December 31, 1997 (the reset date) and is payable in full on December 31, 2001. In addition, GECC has extended to VC Holding a $505 million term loan (the \"Series A Term Loan), a $25 million revolving line of credit (the \"Revolving Line\") and a $202.6 million term loan (the \"Series B Term Loan\") all three of which comprise the VC Holding Credit Agreement. The Series A Term Loan and any amounts drawn under the Revolving Line pay current cash interest and mature on December 31, 2001. The Series B Term Loan does not pay cash interest but rather accretes interest at a rate of 10.62% compounded semi-annually until December 31, 1997 (the reset date) and is payable in full on December 31, 2001. On March 18, 1994 VC Holding had no outstanding borrowings under the Revolving Line but did have letters of credit issued approximating $2.0 million. Accordingly, unrestricted and undrawn funds under the VC Holding Revolving Line amounted to approximately $23.0 million on March 18, 1994.\nThe VC Holding Credit Agreement also provides for the assumption by VC Holding of certain loans of U.S. Cable, as described under Item 1 -- \"Business -- Consolidated Cable Affiliates -- V Cable\".\nThe outstanding principal amount of the V Cable Term Loan is payable in full, with accreted interest, at maturity on December 31, 2001. VC Holding is obligated to make principal payments on a portion of the Series A Term Loan beginning on June 30, 1997 totalling $18 million, $20 million, $30 million, $40 million and $56 million for the years ending December 31, 1997, 1998, 1999, 2000 and 2001, respectively. The remaining balance of the Series A Term Loan, as well as any amounts borrowed under the VC Holding Revolving Line, is due December 31, 2001. In addition, VC Holding and V Cable are required to apply all consolidated available cash flow (as defined), as well as the net proceeds of any disposition of assets, to the reduction of the VC Holding Term Loans and the V Cable Term Loan.\nV Cable made capital expenditures of approximately $20.3 million in 1993 and $17.6 million in 1992, primarily in connection with the expansion of existing cable plant to pass additional homes and for system upgrades and other general capital needs. The New York Upgrade Agreement applicable to V Cable requires the substantial upgrade of its systems in New York State, ultimately to a 77 channel capacity in 1995. In 1992 V Cable completed the first phase of this required upgrade, under which it expanded all of its New York cable systems to a 52 channel capacity. The Company\n(47)\nbelieves that the upgrade of V Cable's New York systems from 52 to 77 channels will cost up to an additional $9.9 million, which would be spent during 1994 and 1995.\nV Cable anticipates that its cash flow from operations and amounts available under the VC Holding Revolving Line will be sufficient to service its debt, to fund its capital expenditures and to meet its working capital requirements through 1995. However, after taking into account the anticipated reductions to regulated revenue arising from the latest round of FCC regulation, V Cable believes that it is likely that it will be unable to meet several of its financial covenants during such period. To remedy the anticipated covenant defaults, V Cable may request waivers and\/or amendments to its credit agreement and\/or seek equity contributions from the Restricted Group. There can be no assurance as to V Cable's ability to accomplish any of these alternatives or the terms or timing of such alternatives.\nCABLEVISION OF NEW YORK CITY\nCNYC is party to an $185 million credit facility with a group of banks led by the Chase Manhattan Bank, N.A. as agent (the \"CNYC Credit Agreement\") which is restricted to the construction and operating needs of Phases I through V in Brooklyn and The Bronx. In Brooklyn, CNYC has completed construction of Phases I through IV. In The Bronx, CNYC has completed construction of Phases I, II and III. For additional information concerning the CNYC acquisition, see Item I -- \"Business -- Consolidated Cable Affiliates -- Cablevision of New York City\" and Note 2 of Notes to Consolidated Financial Statements.\nAt March 18, 1994 CNYC had outstanding bank borrowings of $140.0 million and an additional $7.2 million was reserved under the CNYC Credit Agreement for letters of credit issued on behalf of CNYC. Unrestricted and undrawn funds available to CNYC under the most restrictive borrowing condition of the CNYC Credit Agreement amounted to approximately $37.6 million at March 18, 1994.\nAs of March 18, 1994, the Restricted Group had contributed $48.2 million. The CNYC Credit Agreement requires that the Restricted Group contribute $55 million of equity for Phases III and IV.\nCNYC made capital expenditures of approximately $86.7 million in 1993 and $31.1 million in 1992 (from the date of acquisition). At December 31, 1993, the cost to complete CNYC construction was estimated at $122.0 million. CNYC expects the remaining costs for all CNYC construction will be financed by the amounts available under the CNYC Credit Agreement, committed equity contributions and cash flow generated from operations. To eliminate the need for further equity contributions, CNYC expects to refinance the CNYC Credit Facility in 1994 to provide for additional amounts to complete construction.\nIf CNYC fails to complete construction of the systems after construction of Phase IV in The Bronx and Phase V in Brooklyn has commenced, the City of New York could\n(48)\n(among other remedies under the franchises) revoke the franchises, upon which CNYC would have 180 days to find a buyer for the system acceptable to the City.\nSubstantially all of the assets of the Phase Partnerships (as well as the interests in the Phase Partnerships held directly or indirectly by the Company and Mr. Dolan) are pledged to secure the obligations to the banks under the CNYC Credit Facility.\nThe Company is party to a management agreement with CNYC which requires the Company to provide management assistance to CNYC in exchange for 3-1\/2% of gross revenues, as defined, plus reimbursement of general and administrative expenses and overhead. Payment of the 3-1\/2% management fee is restricted under the CNYC Credit Facility, although a one time payment of $2.4 million was made to the Company in 1992 as permitted by the CNYC bank group. Unpaid management fees accrue interest at a rate equal to 2% above the average borrowing rate of CNYC under the CNYC Credit Agreement, compounded quarterly. As of December 31, 1993, CNYC owed the Company approximately $7.1 million for unpaid management fees and accrued interest thereon.\nRAINBOW PROGRAMMING\nRainbow Programming's financing needs have been funded by the Restricted Group's investments in and advances to Rainbow Programming, by sales of equity interests in the programming businesses and in the case of one of the programming businesses, through separate external debt financing. The Company expects that the future cash needs of Rainbow Programming's current programming partnerships will increasingly be met by internally generated funds, although certain of such partnerships will at least in the near future rely to some extent upon their partners (including Rainbow Programming) for certain cash needs. The partners' contributions may be supplemented through the sale of additional equity interests in, or through the incurrence of indebtedness by, such programming businesses.\nOn September 16, 1993 Rainbow Programming notified its partners in AMCC that it has elected to purchase Liberty Media's 50% interest in AMCC at the stated value. As described above, the Company anticipates that $75 million will be contributed to Rainbow Programming by the Company through drawings under its senior credit facility. Rainbow Programming has obtained an underwriting commitment from a commercial bank for the balance of the funds required. The Company anticipates that the transaction will be consummated in the second quarter of 1994.\n(49)\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS.\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage ---- Independent Auditors' Report . . . . . . . . . . . . . . . . . . 51\nConsolidated Balance Sheets -- December 31, 1993 and 1992. . . . 52\nConsolidated Statements of Operations -- years ended December 31, 1993, 1992 and 1991. . . . . . . . . . . . 54\nConsolidated Statements of Stockholders' Deficiency -- years ended December 31, 1993, 1992 and 1991. . . . . . . . . . . . 55\nConsolidated Statements of Cash Flows -- years ended December 31, 1993, 1992 and 1991. . . . . . . . . . . . . . . 56\nNotes to Consolidated Financial Statements . . . . . . . . . . . 58\n(50)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Cablevision Systems Corporation\nWe have audited the accompanying consolidated balance sheets of Cablevision Systems Corporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' deficiency and cash flows for each of the years in the three-year period ended December 31, 1993. In connection with our audits of the consolidated financial statements, we also audited the financial statement schedules as listed in Item 14(a)(2). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cablevision Systems Corporation and subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs described in Note 6 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", on a prospective basis in 1993.\n\/s\/ KPMG Peat Marwick ------------------------- KPMG Peat Marwick Jericho, New York March 4, 1994\n(51)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n(52)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n(53)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (Dollars in thousands except per share data)\nSee accompanying notes to consolidated financial statements.\n(54)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY Years Ended December 31, 1993, 1992 and 1991 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n(55)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992 and 1991 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n(56)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992 and 1991 (Dollars in thousands) (continued)\nSee accompanying notes to consolidated financial statements.\n(57)\nCABLEVISION SYSTEMS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Cablevision Systems Corporation and its majority owned subsidiaries (the \"Company\"). All significant intercompany transactions and balances have been eliminated in consolidation.\nREVENUE RECOGNITION\nThe Company recognizes revenues as cable television services are provided to subscribers.\nMARKETABLE SECURITIES\nMarketable securities are recorded at cost. At December 31, 1993 and 1992, the market value of such securities exceeded their cost by approximately $3,575 and $3,881, respectively.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including construction materials, are carried at cost, which includes all direct costs and certain indirect costs associated with the construction of cable television transmission and distribution systems, and the costs of new subscriber installations.\nDEFERRED FINANCING COSTS\nCosts incurred in obtaining debt are deferred and amortized, on the straight-line basis, over the life of the related debt.\nSUBSCRIBER LISTS, FRANCHISES, AND OTHER INTANGIBLE ASSETS\nSubscriber lists are amortized on the straight-line basis over varying periods (2 to 8 years) during which subscribers are expected to remain connected to the systems. Franchises are amortized on the straight-line basis over the average remaining terms (7 to 11 years) of the franchises. Other intangible assets are amortized on the straight-line basis over the periods benefited (2 to 20 years). Excess costs over fair value of net assets acquired are being amortized over periods ranging from 7 to 20 years on the straight line basis. The Company assesses the recoverability of such excess costs based upon undiscounted anticipated future cash flows of the businesses acquired.\n(58)\nINCOME TAXES\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which requires the liability method of accounting for deferred income taxes and permits the recognition of deferred tax assets, subject to an ongoing assessment of realizability. Adoption of SFAS 109 had no material impact on the operations of the Company.\nLOSS PER SHARE\nNet loss per common share is computed based on the average number of common shares outstanding after giving effect to dividend requirements on the Company's preferred stock. Common stock equivalents were not included in the computation as their effect would be to decrease net loss per share.\nCASH FLOWS\nFor purposes of the Consolidated Statements of Cash Flows, the Company considers short-term investments with a maturity at date of purchase of three months or less to be cash equivalents. The Company paid cash interest expense of approximately $173,073, $142,807 and $179,246 during 1993, 1992 and 1991, respectively. During 1993, 1992 and 1991, the Company's noncash investing and financing activities included capital lease obligations of $2,695, $5,953 and $760, respectively, incurred when the Company entered into leases for new equipment, preferred stock dividend requirements in 1991 of $3,579 and the present value of debt to be assumed by V Cable in 1997 of $70,238 recorded in 1992 (see Note 4).\nINVESTMENTS IN AND ADVANCES TO AFFILIATES\nThe Company accounts for its investments in affiliates using the equity method of accounting whereby the Company records its appropriate share of the net income or loss of the affiliate. The Company's advances to affiliates are carried at cost adjusted for any known diminution in value (see Note 8).\nNOTE 2. ACQUISITIONS, RESTRUCTURINGS AND DISPOSITIONS\n1993 ACQUISITIONS:\nIn December 1986, the Company had purchased substantially all the limited partnership interests in Cablevision of Connecticut. In November 1993, the Company purchased\n(59)\nthe remaining interests in exchange for 164,051 shares of the Company's Class A Common Stock which had a fair market value of approximately $10,725. Such amount was charged to excess cost over fair value of net assets acquired and will be amortized over the remaining original amortization period.\nIn November 1993, the Company purchased the business of CATV Enterprises, Inc. (\"CATV\") in Riverdale, The Bronx, New York following the expiration of CATV's temporary permit to operate its cable television system in Riverdale. The cost of $8,500 is included in excess cost over fair value of net assets acquired.\n1992 RESTRUCTURINGS:\nV CABLE, INC.\nOn December 31, 1992, the Company consummated a significant restructuring and reorganization (the \"V Cable Reorganization\") involving its subsidiary, V Cable, Inc. (\"V Cable\"), U.S. Cable Television Group, L.P. (\"U.S. Cable\") and General Electric Capital Corporation (\"GECC\"), V Cable's principal creditor. In the V Cable Reorganization, V Cable acquired a 20% interest in U.S. Cable for $20,000 and U.S. Cable acquired a 19% non-voting interest in a newly incorporated subsidiary of V Cable that holds substantially all of V Cable's assets (\"VC Holding\") for $3,000. As a result, V Cable now owns an effective 84.8% interest in VC Holding. GECC has provided new long-term credit facilities to each of V Cable, VC Holding and U.S. Cable, secured in each case by the assets of the borrower and in most cases cross-collateralized by the assets of the other two entities. The credit facilities are non-recourse to the Company other than with respect to the common stock of V Cable owned by the Company (see Note 4). The Company has management responsibility for the U.S. Cable properties, and for the V Cable systems. The Company accounts for its investment in U.S. Cable using the equity method of accounting and accordingly its share of losses in U.S. Cable for 1993 amounted to $8,566. Also in 1993, included in the accompanying consolidated statements of operations is U.S. Cable's share of losses in VC Holding, limited to its $3,000 investment described above.\nIn contemplation of the V Cable Reorganization, in May, 1992 GECC provided a $20,000 loan to V Cable, which lent the proceeds to one of its operating subsidiaries. Also in May, 1992, the operating subsidiary of V Cable paid GECC an aggregate of $20,000 in order to acquire all of the then outstanding shares of A-R Cable Services, Inc. (\"A-R Cable\") preferred stock from GECC and to obtain the termination of the transaction fee agreements between each of V Cable and A-R Cable, on the one hand, and GECC, on the other, pursuant to which GECC was entitled under certain circumstances to receive payments from V Cable and A-R Cable. On May 11, 1992, A-R Cable purchased, for a nominal amount, the shares of A-R Cable preferred stock held by the operating subsidiary of V Cable. For the purposes of these consolidated financial statements, the Company recognized a net loss of $20,000 on the purchase and retirement of the shares of A-R Cable's preferred stock.\n(60)\nIn consideration of V Cable's assumption of U.S. Cable debt in 1997 (see Note 4) and the cross-collateralization of U.S. Cable debt by V Cable and VC Holding, V Cable has the option to exchange its interest in U.S. Cable for all of U.S. Cable's interest in VC Holding and thus recover full ownership of the V Cable systems from and after January 1, 1998, subject to certain limitations. Upon such an exchange, the guarantee by V Cable and VC Holding of any portion of the U.S. Cable senior credit facilities not assumed by V Cable, as well as the guarantee and cross-collateralization by U.S. Cable of the V Cable and VC Holding credit facilities, would terminate.\nThe V Cable Reorganization resulted in significant changes to V Cable's debt levels and maturities. See Note 4.\nA-R CABLE. In May 1992 the Company and A-R Cable consummated a restructuring and refinancing transaction (the \"A-R Cable Restructuring\") that had the effect of retiring a substantial portion of A-R Cable's subordinated debt and reducing the Company's economic and voting interest in A-R Cable. Among other things, this transaction involved an additional $45,000 investment in A-R Cable by the Company to purchase a new Series B Preferred Stock, the purchase of a new Series A Preferred Stock in A-R Cable by Warburg Pincus Investors, L.P. (\"Warburg Pincus\") for $105,000, and GECC providing an additional $70,000 to A-R Cable under a secured revolving credit line. After the receipt of certain pending franchise approvals, the Company will have a 40% economic and voting interest in A-R Cable. As a result of the A-R Cable Restructuring, the Company no longer has financial or voting control over A-R Cable's operations. Accordingly the Company no longer consolidates the financial position or results of operations of A-R Cable. For reporting purposes, the deconsolidation of A-R Cable became effective on January 1, 1992 and the Company is accounting for its investment in A-R Cable using the equity method of accounting.\nIncluded in share of affiliates' net loss in the accompanying consolidated statements of operations for the year ended December 31, 1993 and 1992 is $56,420 and $30,326, respectively, representing A-R Cable's net loss plus dividend requirements for the Series A Preferred Stock of A-R Cable, which is not owned by the Company. The deficit investment in affiliate of $307,758 and $251,679, respectively, represents A-R Cable losses and external dividend requirements recorded by the Company in excess of amounts invested by the Company therein. At December 31, 1993 and 1992 and for the years then ended, A-R Cable's total assets, liabilities and net revenues amounted to $288,348 and $294,111; $650,099 and $594,294; $108,711 and $105,629, respectively.\n(61)\nThe Company continues to guarantee the debt of A-R Cable to GECC under a limited recourse guarantee wherein recourse to the Company is limited solely to the common and Series B Preferred Stock of A-R Cable owned by the Company.\nThe Company continues to manage A-R Cable under a management agreement that provides for cost reimbursement, an allocation of overhead charges and a management fee of 3-1\/2% of gross receipts, as defined, with interest on unpaid amounts thereon at a rate of 10% per annum. The 3-1\/2% fee and interest thereon is payable by A-R Cable only after repayment in full of its senior debt and certain other obligations. Under certain circumstances, the fee is subject to reduction to 2-1\/2% of gross receipts.\nAfter May 11, 1997, either Warburg Pincus or the Company may irrevocably cause the sale of A-R Cable, subject to certain conditions. In certain circumstances, Warburg Pincus may cause the sale of A-R Cable prior to that date. Upon the sale of A-R Cable, the net sales proceeds, after repayment of all outstanding indebtedness and other liabilities, will be used as follows: first, to repay Warburg Pincus' original $105,000 investment in the Series A Preferred Stock; second, to repay the Company's original investment of $45,000 in the Series B Preferred Stock; third, to repay the accumulated unpaid dividends on the Series A Preferred Stock (19% annual rate); fourth, to repay the accumulated unpaid dividends on the Series B Preferred Stock (12% annual rate); fifth, to pay the Company for all accrued and unpaid management fees together with accrued but unpaid interest thereon; sixth, pro rata 60% to the Series A Preferred Stockholders, 4% to the Series B Preferred Stockholders and 36% to the common stockholder(s).\n1992 ACQUISITION:\nIn July 1992, the Company acquired (the \"CNYC Acquisition\") substantially all of the remaining interests in Cablevision of New York City - Phase I through Phase V (collectively, \"CNYC\" or \"Phase Partnerships\"), the operator of a cable television system which is under development in The Bronx and parts of Brooklyn, New York. Prior to the CNYC Acquisition, the Company had a 15% interest in CNYC and Charles F. Dolan, the chief executive officer and principal shareholder of the Company, owned the remaining interests. Mr. Dolan remains a partner in CNYC with a 1% interest and the right to certain preferential payments.\nMr. Dolan's preferential rights entitle him to an annual cash payment (the \"Annual Payment\") of 14% multiplied by the outstanding balance of his \"Minimum Payment\". The Minimum Payment is $40,000 and is to be paid to Mr. Dolan prior to any distributions to partners other than Mr. Dolan. In addition, Mr. Dolan has the right, exercisable beginning on December 31, 1997 to require the Company to purchase his\n(62)\ninterest. Mr. Dolan would be entitled to receive from the Company the Minimum Payment, any accrued but unpaid Annual Payments, a guaranteed return on certain of his investments in CNYC and a Preferred Payment defined as a payment (not exceeding $150,000) equal to 40% of the Appraised Equity Value (as defined) of CNYC after making certain deductions.\nThe Company has accounted for the purchase of CNYC in a manner similar to a pooling of interests whereby the assets and liabilities of CNYC have been recorded at historical values and the excess of the purchase price over the book value of the net assets acquired, amounting to approximately $44,000, has been charged to par value in excess of capital contributed. The total assets and liabilities of CNYC at acquisition date amounted to $109,000 and $92,000, respectively. Based upon estimates for accounting purposes of the Appraised Equity Value of CNYC made by the Company at December 31, 1993 and 1992, approximately $22,700 and $27,000, respectively, was accrued as additional obligations to Mr. Dolan relating to the Company's purchase of CNYC, which have also been charged to par value in excess of capital contributed. The total amount owed to Mr. Dolan at December 31, 1993 of approximately $91,600 in respect of the Preferred Payment reflects a reduction of approximately $3,700 in 1993 representing Mr. Dolan's obligation to reimburse the Company in connection with certain claims paid or owed by CNYC.\nSALE OF PROGRAMMING INTERESTS:\nIn February 1991, Rainbow Programming Holdings, Inc. (\"RPH\"), a wholly-owned subsidiary of the Company, and certain majority-owned and wholly-owned subsidiaries of RPH (RPH and such subsidiaries are hereinafter referred to as \"Rainbow Programming\") transferred to NBC Cable Holding Inc. (\"NBC Cable\"), a subsidiary of the National Broadcasting Company, Inc. (\"NBC\") a 25% general partnership interest in the American Movie Classics Company (\"AMCC\") (reducing Rainbow Programming's interest in AMCC to a 25% general partnership interest). In connection with this transfer, Rainbow Programming received $15,407 and the Company recorded a gain of approximately $9,966.\nIn July 1991, Rainbow Programming consummated transactions with NBC, Tele-Communications, Inc. (\"TCI\") and Liberty Media Corporation (\"Liberty\"), relating to sports programming offered in the San Francisco Bay area, Florida and Chicago through SportsChannel regional cable sports networks. Viacom Inc. (\"Viacom\") is also a party to the San Francisco Bay area transaction. The agreements extend the carriage of Rainbow Programming's SportsChannel services on certain TCI and Viacom owned and operated cable systems in those areas. As part of the\n(63)\ntransactions, TCI acquired a 25% general partnership interest in SportsChannel Chicago (12.5% from each of Rainbow Programming and NBC Cable) plus an option to purchase an additional 25% interest for a total of $15,000 and Liberty acquired, for a nominal amount, a 50% general partnership interest (25% from each of Rainbow Programming and NBC Cable) in SportsChannel Pacific. In connection with these transactions the Company recorded a net gain of approximately $5,539.\nIn October 1992 and January 1993, TCI exercised its option to purchase from each of NBC Cable and Rainbow Programming an additional 12.5% of SportsChannel Chicago for an aggregate purchase price of approximately $15,000 plus approximately $1,600 in interest. In connection with this transaction, the Company recorded a net gain of approximately $7,100.\nThe partnership agreement relating to one of Rainbow Programming's businesses, American Movie Classics Company (\"AMCC\"), contains a provision allowing any partner to commence a buy-sell procedure by establishing a stated value for the AMCC partnership interests. On August 2, 1993, Rainbow Programming received a notice from the AMCC partner affiliated with Liberty Media Corporation initiating the buy-sell procedure and setting a stated value of $390 million for all the partnership interests in AMCC. The partnership agreement provides that the non-initiating partner has a period of 45 days from receipt of the buy-sell notice to elect to purchase the initiating partner's interest at the stated value or sell its interest at the stated value. On September 16, 1993, Rainbow Programming notified its partners in AMCC that it had elected to purchase Liberty Media's 50% interest in AMCC at the stated value. The Company anticipates that the transaction will be consummated in the second quarter of 1994.\n(64)\nNOTE 3. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of the following items, which are depreciated or amortized primarily on a straight-line basis over the estimated useful lives shown below:\nAt December 31, 1993 and l992, property, plant and equipment include approximately $7,714 and $7,879, respectively, of net assets recorded under capital leases.\nNOTE 4. DEBT\nBANK DEBT\nRESTRICTED GROUP\nThe Company is party to a credit agreement (the \"Credit Agreement\") in the amount of $695,625 with a group of banks led by Toronto Dominion (Texas), Inc., as agent. The total amount of bank debt outstanding at December 31, 1993 and 1992 was $292,556 and $524,810, respectively. As of December 31, 1993, approximately $19,384 was restricted for certain letters of credit issued for the Company. Undrawn\n(65)\nfunds available to the Company under the Credit Agreement amounted to approximately $385,241 at December 31, 1993. The Credit Agreement contains numerous covenants that may limit the Company's usage of and ability to utilize the undrawn amount of funds available thereunder.\nIn addition, the Company has a separate credit agreement with the banks that are parties to the Credit Agreement to finance the Company's New Jersey subsidiary (collectively with the Credit Agreement, the \"Credit Agreements\"), in the amount of $58,500. The amount outstanding at December 31, 1993 and 1992 amounted to $58,500 and $52,962, respectively. There were no additional funds available to the Company under this separate credit agreement at December 31, 1993.\nInterest on outstanding amounts may be paid, at the option of the Company, based on various formulas which relate to the prime rate, rates for certificates of deposit or other prescribed rates. In addition, the Company has entered into interest rate swap agreements with several banks on a notional amount of $275,000 as of December 31, 1993 whereby the Company pays a fixed rate of interest and receives a variable rate. Interest rates and terms vary in accordance with each of the agreements. As of December 31, 1993, the interest rate agreements expire at various times through 2000 and have a weighted average life of approximately two years. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. However, the Company does not anticipate nonperformance by the counterparties. The weighted average interest rate on all bank indebtedness was 8.9% and 8.2% on December 31, 1993 and 1992, respectively. The Company is also obligated to pay fees of 3\/8 of 1% per annum on the unused loan commitment and from 1-3\/8% to 1-5\/8% per annum on letters of credit issued under the Credit Agreement.\nBeginning in 1993, total commitments under the Credit Agreements decline on a scheduled quarterly basis with a final maturity in 2000. The Credit Agreements contain various restrictive covenants, among which are limitations on the amount of investments that may be made in affiliated entities and certain other subsidiaries, the maintenance of various financial ratios and tests, and limitations on various payments, including preferred dividends. The Company is restricted from paying any dividends on its common stock. The Company was in compliance with the covenants of its Credit Agreements at December 31, 1993.\nSubstantially all of the assets of the Company, (excluding the assets of V Cable, CNYC, Rainbow Programming, Rainbow Advertising Sales Corporation and certain other subsidiaries), amounting to approximately $1,255,600 at December 31, 1993, have been pledged to secure the borrowings under the Credit Agreements.\n(66)\nCNYC\nCNYC is party to a credit agreement, in the amount of $185,000 with a group of banks led by Chase Manhattan, N.A., as agent (the \"CNYC Credit Agreement\"). The amounts outstanding at December 31, 1993 and 1992 were $126,500 and $78,500, respectively. In addition CNYC has a $5,000 line of credit provided by the Bank of New York under which $2,523 and $0 was outstanding at December 31, 1993 and 1992, respectively. Available funds are limited by certain covenants of the CNYC Credit Agreement.\nInterest on outstanding amounts under the CNYC Credit Agreement, may be paid, at the option of the Company, based on various formulas which relate to the prime rate, rates for certificates of deposit or other prescribed rates. In addition, CNYC has entered into three interest rate swap agreements with several banks on a total notional amount of $35,000 whereby CNYC pays a fixed rate and receives a variable rate of interest. These agreements expire at various times through 1997. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements, however, the Company does not anticipate nonperformance by the counterparties. The weighted average interest rate on CNYC's bank indebtedness was 5.8% and 7.2%, respectively, on December 31, 1993 and 1992, respectively. CNYC is also obligated to pay fees on the unused portion of the loan commitment.\nOn December 31, 1994, borrowings under the CNYC Credit Agreement convert to a six year term facility in a maximum amount of $185,000. The balance thereafter declines on a scheduled quarterly basis with a final maturity at June 30, 2000.\nSubstantially all of the assets of CNYC, amounting to approximately $207,500 at December 31, 1993, have been pledged to secure the borrowings under the CNYC Credit Agreement.\nThe CNYC Credit Agreement contains various restrictive covenants, among which are the maintenance of various financial ratios and tests and limitations on various payments. CNYC was in compliance with all the covenants of the CNYC Credit Agreement at December 31, 1993.\nSENIOR SUBORDINATED DEBENTURES\nIn February 1993, the Company issued $200,000 face amount of its 9-7\/8% Senior Subordinated Debentures due 2013 (the \"2013 Debentures\"). Interest is payable on the 2013 Debentures semi-annually on February 15 and August 15. The 2013 Debentures\n(67)\nare redeemable, at the Company's option, on February 15, 2003, February 15, 2004, February 15, 2005 and February 15, 2006 at the redemption price of 104.80%, 103.60%, 102.40% and 101.20%, respectively, of the principal amount and thereafter at the redemption price of 100% of the principal amount, in each case together with accrued interest to the redemption date. The indenture under which the 2013 Debentures were issued contains various covenants, which are generally less restrictive than those contained in the Company's Credit Agreement, with which the Company was in compliance at December 31, 1993. The 2013 Debentures are not entitled to the benefits of a sinking fund. The net proceeds of approximately $193,150 were used to reduce bank borrowings.\nIn April 1993, the Company, through a private placement offering, issued $150,000 face amount of its 9-7\/8% Senior Subordinated Debentures due 2023 (the \"2023 Debentures\"). Interest is payable on the 2023 Debentures semi-annually on April 1 and October 1. The 2023 Debentures are redeemable, at the Company's option, on and after April 1, 2003 at the redemption price of 104.938% reducing ratably to 100% of the principal amount on and after April 1, 2010, in each case together with accrued interest to the redemption date. The indenture under which the 2023 Debentures were issued contains various covenants, which are generally less restrictive than those contained in the Company's Credit Agreement, with which the Company was in compliance at December 31, 1993. The 2023 Debentures are not entitled to the benefits of a sinking fund. Approximately $105,000 of the net proceeds of $145,896 were used to reduce bank borrowings. In connection with such repayment, the Company wrote off approximately $1,044 of deferred financing costs.\nIn August 1993, the Company consummated an exchange offer pursuant to which it exchanged $1 principal amount of its 9-7\/8% Senior Subordinated Debentures due April 1, 2023 (the \"New Debentures\") which have been registered under the Securities Act of 1933, as amended (the \"Securities Act\") for each $1 principal amount of the outstanding 2023 Debentures. The form and terms of the New Debentures are identical in all material respects to the form and terms of the 2023 Debentures except that the New Debentures have been registered under the Securities Act.\nIn April 1992, the Company completed a public offering of $275,000 of its 10-3\/4% Senior Subordinated Debentures due 2004 (the \"2004 Debentures\"). Interest is payable on the 2004 Debentures semi-annually on April 1 and October 1. The 2004 Debentures are redeemable, at the Company's option, on April 1, 1997 and April 1, 1998 at the redemption price of 103.071% and 101.536%, respectively, of the principal amount, and on April 1, 1999 and thereafter at the redemption price of 100% of the principal amount, in each case together with accrued interest to the redemption date. The Indenture under which the 2004 Debentures were issued contains various\n(68)\ncovenants, which are generally less restrictive than those contained in the Company's Credit Agreement, with which the Company was in compliance at December 31, 1993. The Indenture requires a sinking fund providing for the redemption on April 1, 2002 and April 1, 2003 of $68,750 principal amount of the 2004 Debentures, at a redemption price equal to 100% of the principal amount, plus accrued interest to the redemption date.\nThe net proceeds of approximately $267,000 from the offering were used to repay borrowings under the Company's Credit Agreement. In connection with such repayment, the Company wrote off approximately $4,783 of deferred financing costs.\nIn November 1988, the Company issued $200,000 face amount of its 12-1\/4% Senior Subordinated Reset Debentures due November 15, 2003 (the \"Reset Debentures\"). Interest is payable on the Reset Debentures semi-annually on May 15 and November 15. The Indenture under which the Reset Debentures were issued contains various restrictive covenants with which the Company was in compliance at December 31, 1993. The Reset Debentures are redeemable, at the Company's option, beginning on May 15, 1994 at the redemption price of 101.5% of the principal amount, and thereafter with the redemption price gradually lowered at six month intervals to 100% of the principal amount by November 15, 1995. The Company is required to redeem $20,000 principal amount of Reset Debentures on each of November 15, 2000 and 2001 and $40,000 on November 15, 2002. Effective on May 15, 1991, the interest rate on the Reset Debentures was reset to a rate of 14%. At December 31, 1993 and 1992 the balance outstanding was $199,321 and $199,247, respectively.\nSENIOR DEBT\nIn connection with the V Cable Reorganization, all of V Cable's senior and subordinated debt with GECC outstanding at December 31, 1992 was restructured. V Cable's Senior Subordinated Deferred Interest Notes (the \"V Cable Notes\") and its Junior Subordinated Note (the \"Junior Note\") were replaced with new long-term credit facilities provided by GECC to V Cable and VC Holding. Under the credit agreement between V Cable and GECC (the \"V Cable Credit Agreement\"), GECC has provided a term loan (the \"V Cable Term Loan\") in the amount of $20,000 to V Cable, which loan will accrete interest at a rate of 10.62% compounded semi-annually until December 31, 1997 (the reset date). In addition, GECC has extended to VC Holding a $505,000 term loan (the \"Series A Term Loan), a $25,000 revolving line of credit (the \"Revolving Line\") and a $202,554 term loan (the \"Series B Term Loan\"), all of which comprise the VC Holding Credit Agreement. Interest on the Series A Term Loan and on any amounts drawn under the Revolving Line of credit is payable currently.\n(69)\nInterest on the Series B Term Loan accretes at a rate of 10.62% compounded semi-annually until December 31, 1997 (the reset date) and is payable in full on December 31, 2001. At December 31, 1993 and 1992, amounts outstanding under the V Cable Term Loan, the Series A Term Loan, the Series B Term Loan and the Revolving Line were $22,187 and $20,000; $505,000 and $505,000; $221,373 and $199,554; and $6,000 and $4,000, respectively. Unrestricted and undrawn funds available to VC Holding at December 31, 1993 amounted to $17,221.\nApproximately $7,501 of deferred financing costs related to V Cable's debt prior to its restructuring with GECC were written off.\nInterest rates on $254,000 of the Series A Term Loan are fixed at 10.12% through December 31, 1997. The remaining $251,000 bears interest at rates based on either GECC's Index Rate (as defined) or LIBOR plus applicable percentages. Interest on any borrowings under the Revolving Line is paid based on either GECC's Index Rate (as defined) or LIBOR plus applicable percentages which vary depending upon certain prescribed financial ratios. Scheduled quarterly principal payments on the Series A Term Loan commence June 30, 1997 and continue through December 31, 2001.\nAlso in connection with the V Cable Reorganization, V Cable agreed to assume on December 31, 1997, approximately $121,000 of debt of U.S. Cable, which amount is subject to adjustment, upward or downward, depending on U.S. Cable's ratio of debt to cash flow (as defined) in 1997 and thereafter. Included in Senior Debt at December 31, 1993 is $78,306 which represents the present value of debt of U.S. Cable to be assumed in 1997. The difference of approximately $42,694 will be charged to interest expense during the period from January 1, 1994 to December 31, 1997. The effective interest rate on this debt is approximately 11%. This debt matures on December 31, 2001. Amortization of deferred interest expense in connection with the assumption of U.S. Cable's debt, which is being amortized on a straight line basis through December 31, 1997, amounted to $14,047 for 1993.\nThe debt of V Cable and VC Holding is guaranteed by, and secured by a pledge of all of the assets of, V Cable, VC Holding and each of their subsidiaries, including a pledge of all direct and indirect ownership interests in such subsidiaries. U.S. Cable's debt is also guaranteed and cross-collateralized by each of V Cable, VC Holding and each of their subsidiaries. All of the V Cable, VC Holding and U.S. Cable credit facilities are non-recourse to the Company other than with respect to the common stock of V Cable owned by the Company. Substantially all of the assets of V Cable, amounting to approximately $536,600 at December 31, 1993, have been pledged to secure borrowings under the V Cable and VC Holding Credit Agreements. At\n(70)\nDecember 31, 1993 V Cable's liabilities exceeded its assets by approximately $331,215.\nThe V Cable and VC Holding Credit Agreements contain various restrictive covenants, among which are the maintenance of certain financial ratios, limitations regarding certain transactions, prohibitions against the transfer of funds to the parent company (except for reimbursement of certain expenses), and limitations on levels of permitted capital expenditures. V Cable and VC Holding were in compliance with all of the covenants of their loan agreements at December 31, 1993.\nDue to anticipated reductions to regulated revenue arising from the latest round of FCC regulation, V Cable believes that it is likely that it will be unable to meet several of its financial covenants during 1994 and 1995. To remedy the anticipated covenant defaults, V Cable may request waivers and\/or amendments to its credit agreement and\/or seek equity contributions from the Company. There can be no assurance as to V Cable's ability to accomplish any of these alternatives or the terms or timing of such alternatives.\nSUMMARY OF FIVE YEAR DEBT MATURITIES\nTotal amounts payable by the Company and its subsidiaries (excluding V Cable and CNYC) under its various debt obligations, including capital leases, during the five years subsequent to December 31, 1993 amount to $20,035 in 1994, $36,828 in 1995, $54,838 in 1996, $57,344 in 1997 and $73,378 in 1998. Total amounts payable by V Cable and CNYC respectively, under their various debt obligations, including capital leases, during the five years subsequent to December 31, 1993 amount to $98 and $83 in 1994; $0 and $2,500 in 1995; $0 and $17,700 in 1996; $18,000 and $24,000 in 1997; and $20,000 and $31,600 in 1998.\nNOTE 5. PREFERRED STOCK\nThe holders of the Company's 8% Series C Cumulative Preferred Stock (\"Series C Preferred Stock\") may require the Company to redeem for cash at any time commencing December 31, 1997 all or a portion of the outstanding shares of the Series C Preferred Stock. The Company has the right, upon notice to the holders requesting redemption, to convert all or a part of such shares into shares of Class B Common Stock. If, in the future, holders require the Company to redeem their Series C Preferred Stock, it is the Company's intention to convert such shares into Class B Common Stock.\n(71)\nNOTE 6. INCOME TAXES\nThe Company and its majority-owned subsidiaries file consolidated federal income tax returns. At December 31, 1993 the Company had consolidated net operating loss carry forwards for tax purposes of approximately $713,934, which expires in 2001 to 2008.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which requires the liability method of accounting for deferred income taxes and permits the recognition of deferred tax assets, subject to an ongoing assessment of realizability.\nThe tax effects of temporary differences which give rise to significant portions of deferred tax assets or liabilities and the corresponding valuation allowance at December 31, 1993 are as follows:\nThe Company has provided a valuation allowance for the total amount of net deferred tax assets since realization of these assets was not assured due principally to the Company's history of operating losses. The amounts of net deferred tax assets and corresponding valuation allowance increased by $146,151 during the year ended December 31, 1993. Also, in connection with acquisitions made prior to 1993, the Company recorded certain fair value adjustments net of their tax effects. In accordance with SFAS 109, these assets have been adjusted to their remaining pre tax amounts. Accordingly, property, plant and equipment, franchises, and subscriber lists have been increased by $3,658, $38,470 and $20,892, respectively, with a corresponding decrease in excess costs over fair value of net assets acquired.\n(72)\nNOTE 7. OPERATING LEASES\nThe Company leases certain office, production and transmission facilities under terms of leases expiring at various dates through 2004. The leases generally provide for fixed annual rentals plus certain real estate taxes and other costs. Rent expense for the years ended December 31, 1993, 1992 and 1991 amounted to $10,849, $10,071 and $10,292, respectively.\nIn addition, the Company rents space on utility poles for its operations. The Company's pole rental agreements are for varying terms, and management anticipates renewals as they expire. Pole rental expense for the years ended December 31, 1993, 1992 and 1991 amounted to approximately $6,177, $5,042 and $5,458, respectively. The minimum future annual rentals for all operating leases during the next five years, including pole rentals from January 1, 1994 through December 31, 1998, and thereafter, at rates now in force are approximately: 1994, $14,748; 1995, $13,514; 1996, $12,316; 1997, $10,377, 1998, $9,535; thereafter, $9,912.\nNOTE 8. AFFILIATE TRANSACTIONS\nThe Company has affiliation agreements with certain cable television programming companies, varying ownership interests in which were held, directly or indirectly, by RPH during the three years ended December 31, 1993. RPH's investment in these programming companies is accounted for on the equity basis of accounting. Accordingly, the Company recorded income and (losses) of approximately $8,828, $(12,428) and $(20,290) in 1993, 1992 and 1991, respectively, representing its percentage interests in the results of operations of these programming companies. At December 31, 1993 and 1992, the Company's investment in these programming companies amounted to approximately $17,721 and $10,682, respectively, which exceeded the Company's underlying equity in the net assets of these companies by approximately $290 and $652, respectively. This excess has been classified as other intangible assets in the accompanying consolidated balance sheets. Costs incurred by the Company for programming services provided by these affiliates and included in technical expense for the years ended December 31, 1993, 1992 and 1991 amounted to approximately $26,732, $23,388 and $27,400, respectively. At December 31, 1993 and 1992, amounts due from certain of these programming affiliates aggregated $1,367 and $2,352, respectively, and are included in advances to affiliates. Also, at December 31, 1993 and 1992 amounts due to certain of these affiliates, primarily for programming services provided to the Company, aggregated $16,236 and $14,785, respectively, and are included in accounts payable to affiliates.\n(73)\nSummarized combined financial information relating to these programming companies at December 31, 1993, 1992 and 1991 and for the years then ended is as follows:\nNBC and RPH formed a partnership which distributed on a multi-channel, pay-per-view basis certain events of the 1992 Summer Olympics. This distribution was in addition to NBC's conventional broadcast network coverage of those games. Pursuant to the agreement, profits and losses from the broadcast network coverage and the pay-per-view coverage of the 1992 Summer Games were shared equally by NBC and RPH; however, RPH's liability under this agreement was limited to $50,000. The partnership paid its share of the loss ($50,000) in January 1993 with borrowings under the Credit Agreement.\nCablevision of Boston Limited Partnership (\"Cablevision Boston\") is a Massachusetts limited partnership in which Mr. Dolan is the general partner and in which the Company has certain direct and indirect partnership interests. The Company is a limited partner in Cablevision Boston and currently holds a 7% prepayout (prior to repayment of capital contributions to limited partners) interest and a 20.7% postpayout interest in Cablevision Boston.\nAs of December 31, 1993 and 1992, the Company's consolidated financial statements reflect advances ($8,000 of which were converted to Preferred Equity in Cablevision Boston) to Cablevision Boston of approximately $17,540 and $18,345, respectively. Such amounts are fully subordinated to certain of Cablevision Boston's obligations to other lenders aggregating approximately $68,250 and $71,250 plus accrued interest at December 31, 1993 and 1992, respectively.\nThe Company has also advanced funds to Cablevision of Chicago (\"Cablevision Chicago\"), an Illinois limited partnership and an affiliate whose general partner is Mr. Dolan. At December 31, 1993 and 1992 approximately $12,445 and $12,473, respectively, was owed the Company and is included in advances to affiliates in the accompanying consolidated balance sheets. Of the amount owed, approximately $12,314 principal amount is evidenced by a subordinated note bearing interest at the rate of 14% per annum, payable as to principal and interest, on demand. Repayment\n(74)\nof this subordinated note and accrued interest thereon is restricted until repayment of Cablevision Chicago's bank indebtedness.\nDuring 1993, 1992 and 1991, the Company made advances to or incurred costs on behalf of other affiliates engaged in providing cable television, cable television programming, and related services. Amounts due from these affiliates amounted to $6,805 and $8,262 at December 31, 1993 and 1992, respectively and are included in advances to affiliates.\nIn April 1992, Cablevision of Newark, a partnership 25% owned and managed by the Company and 75% owned by an affiliate of Warburg Pincus, acquired cable television systems located in Newark and South Orange, New Jersey from Gilbert Media Associates, L.P. (\"Gateway Cable\") for a purchase price of approximately $76,483. The Company's capital contributions to Cablevision of Newark amounted to approximately $6,000. The Company's share of the net losses of Cablevision of Newark amounted to $4,206 and $3,070 in 1993 and 1992. The Company manages the operations of Cablevision of Newark for a fee equal to 3-1\/2% of gross receipts, as defined, plus reimbursement of certain costs and an allocation of certain selling, general and administrative expenses. For 1993 and 1992, such management fees and expenses amounted to $1,632 and $1,526, respectively, of which $800 and $506 for 1993 and 1992, representing management fees, has been fully reserved by the Company.\nIn connection with the V Cable Reorganization (see Note 2), V Cable acquired for $20,000, a 20% interest in U.S. Cable. The Company has managed the properties of U.S. Cable, since June 1992, under management agreements that provide for cost reimbursement, including an allocation of overhead charges. For 1993 and 1992, such cost reimbursement amounted to $4,894 and $2,160, respectively, which included the allocation of overhead charges of $2,604 and $1,200, respectively.\nThe Company also manages A-R Cable under a management agreement that provides for cost reimbursement, an allocation of overhead charges and a management fee of 3-1\/2% of gross receipts, as defined, with interest on unpaid annual amounts thereon at a rate of 10% per annum beginning in 1993. Such management fees amounted to $3,801 and $2,383 for 1993 and 1992, respectively; interest thereon amounted to $244 for 1993. Management fees and interest thereon have been fully reserved by the Company.\nOn December 14, 1993, the Company purchased 50,000 shares of Class A Common Stock from John Tatta, a director of the Company and the Chairman of the Executive\n(75)\nCommittee, for $64.75 per share, the closing price of a share of Class A common stock on such date. These shares are being held as treasury stock.\nNOTE 9. PENSION PLANS\nThe Company maintains the CSSC Supplemental Benefit Plan (the \"Benefit Plan\") for the benefit of certain officers and employees of the Company. As part of the Benefit Plan, the Company established a nonqualified defined benefit pension plan, which provides that, upon attaining normal retirement age, a participant will receive a benefit equal to a specified percentage of the participant's average compensation, as defined. Participants vest in all components of the Benefit Plan 40% after four years of service and 10% for each additional year of service. Net periodic pension cost for the years indicated consisted of the following:\nThe following table sets forth the funded status of the Benefit Plan at December 31, 1993 and 1992:\nThe projected benefit obligation for the plan was determined using an assumed discount rate and assumed long range rate of return of 8% in 1993 and 1992. No assumed rate of salary increase was used to compute the projected benefit obligation, since substantially all participants are currently at their maximum benefit level.\n(76)\nIn addition, the Company accrues a liability in the amount of 7% of certain officers' and employees' compensation, as defined. Each year the Company also accrues for the benefit of these officers and employees interest on such amounts. The officer or employee will receive such amounts upon termination of employment. Such benefits will vest 40% after four years of service and 10% each additional year of service. The cost associated with this plan for the years ended December 31, 1993, 1992 and 1991 was approximately $497, $358 and $328, respectively.\nPrior to 1993 the Company, with other affiliates, maintained a defined contribution pension plan covering substantially all employees. The Company contributed 3% of eligible employees' annual compensation (as defined), and employees could voluntarily contribute up to 10% of their annual compensation. Employee contributions were fully vested. Employer contributions became vested in years three through seven.\nEffective January 1, 1993, the Board of Directors of the Company approved the adoption of an amended and restated Pension and 401(K) Savings Plan (the \"Plan\"), in part to permit employees of the Company and its affiliates to make contributions to the Plan on a pre-tax salary reduction basis in accordance with the provisions of Section 401(K) of the Internal Revenue Code, and to introduce new investment options under the Plan. The Company contributes 1-1\/2% of eligible employees' annual compensation, as defined, to the defined contribution portion of the Plan (the \"Pension Plan\") and an equivalent amount to the Section 401(K) portion of the Plan (the \"Savings Plan\"). Employees may voluntarily contribute up to 15% of eligible compensation, subject to certain restrictions, to the Savings Plan, with an additional matching contribution by the Company of 1\/4 of 1% for each 1% contributed by the employee, up to a maximum contribution by the Company of 1\/2 of 1% of eligible base pay. Employee contributions are fully vested as are employer base contributions to the Savings Plan. Employer contributions to the Pension Plan and matching contributions to the Savings Plan become vested in years three through seven.\nThe cost associated with these plans was approximately $2,905, $2,322 and $2,212 for the years ended December 31, 1993, 1992 and 1991, respectively.\nNOTE 10. STOCK BENEFIT PLANS\nIn June 1992, the Stockholders of the Company approved the Amended and Restated Employee Stock Plan (the \"Amended Plan\") which consolidated the Company's prior Stock Plan, Nonqualified Plan and Bonus Award Plan (the \"Prior Plans\"). Under the Amended Plan the Company is authorized to issue a maximum of 3,500,000 shares. The Company may grant incentive stock options, nonqualified stock options, restricted stock, conjunctive stock appreciation rights, stock grants and stock bonus awards. The\n(77)\nexercise price of stock options may not be less than the fair market value per share of class A common stock on the date the option is granted and expire no longer than ten years from date of grant. Conjunctive stock appreciation rights permit the employee to elect to receive payment in cash, either in lieu of the right to exercise such option, or in addition to the stock received upon the exercise of such option, equal to the difference between the fair market value of the stock as of the date the right is exercised, and the exercise price.\nUnder the Amended Plan, during 1993 the Company issued options to purchase 15,225 shares of class A common stock, stock appreciation rights related to 15,225 shares under option and stock awards of 10,225 common shares. The options and related conjunctive stock appreciation rights are exercisable at various prices ranging from $27.625 to $38.25 per share in 25% and 33% annual increments beginning from the date of grant. The stock awards vest 100% by May of 1996.\nUnder the Amended Plan, during 1992 the Company issued options to purchase 211,350 shares of class A common stock, stock appreciation rights related to 211,350 shares under option and stock awards of 211,350 common shares. The options and related conjunctive stock appreciation rights are exercisable at $27.625 per share in 25% annual increments beginning one year from the date of grant. The stock awards vest 100% four years from date of grant. Also, during 1992 the Company granted to certain employees conjunctive stock appreciation rights with respect to 472,500 shares under options granted in prior years under the Company's 1985 Employee Stock Plan. Those options are exercisable at prices ranging from $16.625 to $36.00 and vest at various times during the period from October 1992 through October 1996.\nUnder the Nonqualified Plan, nonqualified options to purchase 24,000 shares were granted in 1991 at an exercise price of $25.00 per share. These options are exercisable one-third per year beginning July 30, 1992.\nPursuant to a Bonus Award Plan (\"Bonus Plan\"), adopted in 1986, in 1990 the Company granted to fifteen employees the right to receive 118,900 shares of class A common stock or, at the election of the Stock Option Committee, cash equal to the product of such number of shares times the closing price of a share of Class A Common Stock at the time of issuance. In May 1992, in accordance with the provisions of the Bonus Plan, the Company paid in cash the value of 59,450 shares based on a market price of $28-6\/8, totalling $1,709. Rights to the remaining 59,450 shares vest on May 17, 1994. In addition, in 1990 the Company granted to seven employees the right to receive 111,180 shares of class A common stock or, at the\n(78)\nelection of the Stock Option Committee, cash equal to the product of such number of shares times the closing price of a share of class A common stock at the time of issuance. On March 28, 1991, in accordance with the provisions of the Bonus Plan, the Company paid in cash the value of 91,180 shares based on a market price of $24-5\/8, totalling $2,245. On December 31, 1992, the Company paid in cash the value of the remaining 20,000 shares based on a market price of $35 totalling $700.\nStock transactions under the Amended Plan and Prior Plans are as follows:\nOf the total shares awarded, 77,700 shares were restricted at December 31, 1993. Also at December 31, 1993, options for approximately 1,467,000 shares were exercisable. As a result of the stock awards, bonus awards and stock appreciation rights, the Company expensed approximately $28,234, $9,656 and $6,668 in 1993, 1992 and 1991, respectively.\nIn June, 1986, the Company adopted an Employee Stock Purchase Plan (the \"Purchase Plan\"). The Purchase Plan enabled employees of the Company and its subsidiaries to purchase class A common stock of the Company through payroll deductions of up to $1,250 each year per employee. The price to be paid for a share of stock was 85% of the market price on the last business day of each month. The discount increased to 20% after twelve months of continuous participation in the Purchase Plan and to 25%\n(79)\nafter twenty-four months of continuous participation. Under the Purchase Plan, employees purchased 26,499 and 34,757 shares during 1992 and 1991, respectively, for which, $796 and $842 was paid to the Company.\nIn connection with the adoption of the amended and restated Pension and 401(K) Savings Plan, the Company discontinued the Purchase Plan. (See Note 9.)\nNOTE 11. COMMITMENTS AND CONTINGENCIES\nCablevision Systems Service Corporation (\"CSSC\"), an affiliate of the Company, purchases a premium programming service from an unaffiliated program supplier. CSSC makes such service available to the Company and its affiliates at CSSC's cost in return for the Company's assumption of its proportionate share, based on subscriber usage, of CSSC's obligations under its agreement with such unaffiliated program supplier. The Company is contingently liable for approximately $13,399 through 1994 in respect of this agreement.\nThe Company, through Rainbow Programming, has entered into several contracts relating to cable television programming in the normal course of its business, including rights agreements with professional and other sports teams. These contracts typically require substantial payments over extended periods of time.\nMr. Dolan, the Company's chairman, has an employment agreement with the Company expiring in January 1995, with automatic renewals for successive one-year terms unless terminated by either party at least three months prior to the end of the then existing term. The agreement provides for a base salary of $400 per year payable to Mr. Dolan or, upon his death during the term of such agreement, a death benefit payment to his estate in an amount equal to the greater of one year's salary or one-half of the compensation that would have been payable to Mr. Dolan during the remaining term of such agreement.\nJohn Tatta, the Company's former president, has a three-year consulting agreement with the Company expiring in January 1995, which provides for a fee of $485 per year plus reimbursement of certain expenses payable to Mr. Tatta or, upon his death during the term of such agreement, a death benefit payable to his estate in an amount equal to the greater of one year's fee or one-half of the fee that would have been payable to him during the remaining term of such agreement.\n(80)\nIncome tax returns of the Company's predecessor entities are currently under examination for 1985 and prior years. The Internal Revenue Service has proposed adjustments which the Company intends to vigorously oppose through the IRS appeals process. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position.\nThe Company does not provide postretirement benefits to any of its employees.\nNOTE 12. LEGAL MATTERS\nDuring 1992, the Company recorded expenses of $5,655 in connection with the settlement of certain litigation pending against Mr. Dolan and the Company and other related matters. The litigation was based upon an alleged breach of fiduciary duty by Mr. Dolan, as the general partner of Cablevision Programming Investments and Rainbow Program Enterprises (\"RPE\"), involving the allocation of partnership profits from 1983 through 1986 and RPH's offer to purchase limited partnership interests in 1986. The amounts provided also include an estimated value of certain untendered interests in RPE based upon the values utilized in connection with the settlements relating to Cablevision Programming Investments.\nIn addition, the Company is party to various other lawsuits, some involving substantial amounts. Management does not believe that the resolution of these lawsuits will have a material adverse impact on the financial position of the Company.\nNOTE 13. ACQUISITION RELATED COSTS AND DEPOSITS\nIn March 1994, Cablevision of Cleveland, L.P. (\"Cablevision Cleveland\"), a partnership currently comprised of subsidiaries of the Company, purchased substantially all of the assets and assumed certain liabilities of North Coast Cable Limited Partnership (the \"North Coast Cable Acquisition\"), which operates a cable television system in Cleveland, Ohio. As of December 31, 1993, the Company made deposits and or incurred expenses in connection with the North Coast Cable Acquisition amounting to approximately $3,213 (see Note 15).\nOn October 26, 1993, Cablevision MFR, Inc. (\"Cablevision MFR\"), a wholly-owned subsidiary of the Company, entered into agreements to purchase substantially all of the assets of Monmouth Cablevision Associates, L.P. (\"Monmouth Cablevision\"), Riverview Cablevision Associates, L.P. (\"Riverview Cablevision\") and Framingham Cablevision Associates, L.P. (\"Framingham Cablevision\"), each a limited partnership operated by Sutton Capital Associates. Each of Monmouth Cablevision and Riverview\n(81)\nCablevision own and operate cable television systems in New Jersey. Framingham Cablevision owns and operates a cable television system in Massachusetts.\nOn January 12, 1994 Cablevision MFR assigned its rights and obligations under its agreement to purchase the assets of Framingham Cablevision to Cablevision of Framingham Holdings, Inc. (\"CFHI\"), currently a wholly-owned subsidiary of the Company. The Company has entered into an agreement with Warburg, Pincus Investors, L.P. (\"Warburg Pincus\"), pursuant to which Warburg Pincus will (i) purchase 60% of the common stock of CFHI for cash and (ii) purchase preferred stock of CFHI, from time to time, for a purchase price sufficient to pay 70% of the interest and principal payments on the Framingham Cablevision promissory note described below. The Company agreed to purchase preferred stock of CFHI, from time to time, for a purchase price sufficient to pay 30% of the interest and principal payments on the Framingham Cablevision promissory note. The aggregate purchase price for the two New Jersey systems is expected to be $422,300. The purchase price for the Framingham assets is expected to be $41,100. Consummation of the transaction is subject to the receipt of necessary regulatory approvals and other customary closing conditions. There can be no assurance that this transaction will be successfully consummated.\nAs of December 31, 1993, the Company made deposits and\/or incurred expenses in connection with the acquisition of these three systems amounting to approximately $10,796.\nOn November 5, 1993, A-R Cable Partners, a partnership comprised of subsidiaries of the Company and E. M. Warburg, Pincus & Co., Inc., entered into an agreement to purchase certain assets of Nashoba Communications (\"Nashoba\"), a group of three limited partnerships which operate three cable television systems in Massachusetts. A-R Cable Partners will be controlled in a manner substantially similar to the way A-R Cable Services, Inc. is controlled. The purchase price is $90,000, subject to certain adjustments, of which up to $55,000 is expected to be provided by separate financing. The remainder will be provided by equity contributions from the partners in A-R Cable Partners. The Company will provide 30% of such equity through drawings under its senior credit facility. The Company will account for its investment in Nashoba using the equity method of accounting. Consummation of the transaction is subject to regulatory approval, as well as other customary conditions. The Company currently anticipates consummation of this acquisition in the second quarter of 1994. As of December 31, 1993, the Company made deposits and\/or incurred expenses related to the Nashoba acquisition amounting to approximately $2,728.\n(82)\nNOTE 14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS\nCASH AND CASH EQUIVALENTS, TRADE ACCOUNTS RECEIVABLE, NOTES AND OTHER RECEIVABLES, ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND ACCOUNTS PAYABLE TO AFFILIATES\nThe carrying amount approximates fair value due to the short maturity of these instruments.\nMARKETABLE SECURITIES AND NOTES RECEIVABLE -- AFFILIATES\nThe fair value of the Company's marketable securities are based on quoted market prices. The fair value of notes receivable -- affiliates is based on current rates for notes with similar maturities.\nOTHER INVESTMENTS\nThe fair values of the Company's Other Investments are generally based on multiples of the investees' cash flow, after adjustment for net assets or liabilities.\nBANK DEBT, SENIOR TERM LOANS, SENIOR SUBORDINATED DEBENTURES, AND SUBORDINATED NOTES PAYABLE\nThe fair values of each of the Company's long-term debt instruments are based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.\nINTEREST RATE SWAP AGREEMENTS\nThe fair values of interest rate swap agreements are obtained from dealer quotes. These values represent the estimated amount the Company would receive or pay to terminate agreements, taking into consideration current interest rates and the current creditworthiness of the counterparties. The carrying amount represents accrued or deferred income arising from the unrecognized financial instruments.\nOBLIGATION TO RELATED PARTY\nThe fair values of Obligation to Related Party is estimated based on current rates for debt with similar maturities.\n(83)\nThe fair value of the Company's financial instruments are summarized as follows:\nFair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nNOTE 15. SUBSEQUENT EVENTS\nOn February 22, 1994, after reconsideration, the Federal Communications Commission (\"FCC\") ordered a further reduction in rates for the basic service tier in effect on September 30, 1992. As the formal text of these new regulations has not yet been released, the Company cannot yet determine the impact on its operations.\nIn March 1994, Cablevision Cleveland, a partnership comprised of subsidiaries of the Company, purchased substantially all of the assets and assumed certain liabilities of North Coast Cable Limited Partnership, which operated a cable television system in Cleveland, Ohio. The purchase price aggregated $133,000 which amount includes: (i) approximately $98,800 paid in cash; (ii) $4,000 paid in a short-term promissory note\n(84)\nsecured by a letter of credit; (iii) approximately $13,200 paid by the surrender of the Company's 19% interest in North Coast and the satisfaction of certain management fees owed to the Company; and (iv) approximately $17,000 to be paid by the assumption of certain capitalized lease obligations and certain other liabilities. The net cash purchase price of the acquisition was financed by borrowings under the Company's Credit Agreement and Cablevision Cleveland is part of the Restricted Group.\n(85)\nNOTE 16. INTERIM FINANCIAL INFORMATION (Unaudited)\nThe following is a summary of selected quarterly financial data for the fiscal years ended December 31, 1993 and 1992.\nThe operating data for the quarters ended March 31, and June 30, 1992 have been restated to reflect as of January 1, 1992 the deconsolidation of the Company's A-R Cable subsidiary for reporting purposes. The Company is accounting for its investment in A-R Cable using the equity method of accounting. Amounts previously reported in the Company's Form 10-Q for the quarter ended March 31, 1992 for net revenues, operating expenses and operating profit were $153,585, $138,072 and $15,513, respectively, and for the quarter ended June 30, 1992, $162,153, $140,563 and $21,590, respectively.\n(86)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nThe information called for by Item 10, Directors and Executive Officers of the Registrant, Item 11, Executive Compensation, Item 12, Security Ownership of Certain Beneficial Owners and Management and Item 13, Certain Relationships and Related Transactions, is hereby incorporated by reference to the Company's definitive proxy statement for its Annual Meeting of Shareholders anticipated to be held in June, 1994 or if such definitive proxy statement is not filed with the Commission prior to April 30, 1994, to an amendment to this report on Form 10-K filed under cover of Form 8.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n1. The financial statements as indicated in the index is set forth on page 50. 2. Financial Statement schedules:\nPage No. Schedules supporting consolidated financial statements: Schedule V - Property, Plant and Equipment 88 Schedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment 90 Schedule VIII - Valuation and Qualifying Accounts 92 Schedule X - Supplementary Income Statement Information 93\nSchedules other than those listed above have been omitted, since they are either not applicable, not required or the information is included elsewhere herein.\n3. Independent auditors report and accompanying financial statements of A-R Cable Services, Inc. are filed as part of this report on page 94. 4. The Index to Exhibits is on page 116.\n(b) Reports on Form 8-K:\nThere were no reports on Form 8-K filed during the last quarter of the fiscal period covered by this report.\n(87)\n(continued)\n(88)\nCABLEVISION SYSTEMS CORPORATION SCHEDULE V PROPERTY, PLANT AND EQUIPMENT (Dollars in thousands)\n(89)\nCABLEVISION SYSTEMS CORPORATION SCHEDULE VI ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (Dollars in thousands)\n(continued)\n(90)\nCABLEVISION SYSTEMS CORPORATION SCHEDULE VI ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (Dollars in thousands)\n(91)\nCABLEVISION SYSTEMS CORPORATION SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS (Dollars in thousands)\n(92)\nCABLEVISION SYSTEMS CORPORATION SCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION (Dollars in thousands)\n(93)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation)\nConsolidated Financial Statements\nDecember 31, 1993 and 1992\n(With Independent Auditors' Report Thereon)\n(94)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors A-R Cable Services, Inc.\nWe have audited the accompanying consolidated balance sheets of A-R Cable Services, Inc. (a wholly-owned subsidiary of Cablevision Systems Corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholder's deficiency and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of A-R Cable Services, Inc. and subsidiaries at December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs described in Note 7 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", on a prospective basis in 1993.\n\/s\/ KPMG PEAT MARWICK ------------------------ KPMG PEAT MARWICK\nJericho, New York March 4, 1994\n(95)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1993 AND 1992 (in thousands)\nSee accompanying notes to consolidated financial statements.\n(96)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1993 AND 1992 (in thousands)\nSee accompanying notes to consolidated financial statements.\n(97)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (in thousands)\nSee accompanying notes to consolidated financial statements.\n(98)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED STATEMENTS OF STOCKHOLDER'S DEFICIENCY YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (in thousands)\nSee accompanying notes to consolidated financial statements.\n(99)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (in thousands)\nSee accompanying notes to consolidated financial statements.\n(100)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (in thousands) (continued)\nSee accompanying notes to consolidated financial statements.\n(101)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1993, 1992 and 1991 (Dollars in thousands)\nNOTE 1. THE COMPANY\nA-R Cable Services, Inc. (\"A-R Cable\" or the \"Company\") became a wholly-owned subsidiary of Cablevision Systems Corporation (\"CSC\") on January 4, 1988 in accordance with the terms of a merger agreement dated July 15, 1987.\nNOTE 2. 1992 RESTRUCTURING\nOn May 11, 1992, the Company and CSC consummated a restructuring and refinancing transaction whereby the Company repurchased approximately $236,841 principal amount of Senior Subordinated Deferred Interest Notes (the \"A-R Cable Notes\"), representing approximately 86.9% principal amount of the A-R Cable Notes outstanding pursuant to the terms of a tender offer. In connection with the consummation of the tender offer, Warburg, Pincus Investors, L.P. (\"Warburg Pincus\") purchased a new Series A Preferred Stock of the Company for a cash investment of $105,000, and CSC purchased a new Series B Preferred Stock of the Company for a cash investment of $45,000. In addition, General Electric Capital Corporation (\"GECC\") provided the Company with an additional $70,000 under a secured revolving credit line. In connection with the investment by Warburg Pincus, the Company incurred costs of approximately $1,725.\nIn connection with Warburg Pincus' investment in the Company, upon the receipt of certain franchise approvals, Warburg Pincus will be permitted to elect three of the six members of the Company's board of directors, will have approval rights over certain major corporate decisions of the Company and will be entitled to 60% of the vote on all matters on which holders of capital stock are entitled to vote (other than the election of directors). CSC (through a wholly- owned subsidiary) continues to own the common stock, as well as the Series B Preferred Stock, and CSC continues to manage the Company under a management agreement that provides for cost reimbursement, an allocation of overhead charges and a management fee of 3-1\/2% of gross receipts, as defined, with interest on unpaid annual amounts thereon at a rate of 10% per annum. The 3-1\/2% fee is payable by the Company only after repayment in full of its senior debt and certain other obligations. Under certain circumstances, the fee is subject to reduction to 2-1\/2% of gross receipts.\nAfter May 11, 1997, either Warburg Pincus or CSC may irrevocably cause the sale of the Company, subject to certain conditions. In certain circumstances, Warburg Pincus may cause the sale of the Company prior to that date. If Warburg Pincus initiates the sale, CSC will have the right to purchase the Company through an appraisal procedure. CSC's purchase right may be forfeited in certain circumstances. Upon the sale of the\n(102)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nCompany, the net sales proceeds, after repayment of all outstanding indebtedness and other liabilities, will be used as follows: first, to repay Warburg Pincus' original $105,000 investment in the Series A Preferred Stock; second, to repay CSC's original investment of $45,000 in the Series B Preferred Stock; third, to repay the accumulated unpaid dividends on the Series A Preferred Stock (19% annual rate); fourth, to repay the accumulated unpaid dividends on the Series B Preferred Stock (12% annual rate); fifth, to pay CSC for all accrued and unpaid management fees together with accrued but unpaid interest thereon; sixth, pro rata 60% to the Series A Preferred Stockholders, 4% to the Series B Preferred Stockholders and 36% to the common stockholder(s).\nAlso in connection with the purchase of the A-R Cable Notes, the Company purchased from an affiliate, for nominal consideration, and retired its previously outstanding 1987 Cumulative Preferred Stock (\"1987 Preferred Stock\"). The affiliate had purchased the 1987 Preferred Stock from GECC. In connection with the purchase of the 1987 Preferred Stock, a transaction fee agreement between the Company and GECC was terminated and the Company's obligations thereunder were extinguished. The Company recognized a gain of $33,509 on its purchase of the 1987 Preferred Stock.\nIn October and November 1992, the Company repurchased approximately $6,900 principal amount of the A-R Cable Notes at an average price of $98.60 per $100 principal amount. The funds for such repurchase were obtained by additional borrowings under A-R Cable's secured revolving credit line. In connection with the purchase of A-R Cable Notes the Company incurred a loss of approximately $211.\nOn February 9, 1993, the Company redeemed all of its remaining outstanding A-R Cable Notes in the aggregate principal amount of $28,793 (plus accrued interest of $522) in accordance with the terms of the Indenture with respect to the A-R Cable Notes. In connection with this redemption the Company incurred a loss of approximately $390. The funds for such redemption were obtained from the proceeds of an additional $30,000 provided by GECC under the Company's secured revolving credit line.\nNOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements of the Company include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation.\n(103)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nREVENUE RECOGNITION\nThe Company recognizes revenues as cable television services are provided to subscribers.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including construction materials, are recorded at cost, which includes all direct costs and certain indirect costs associated with the construction of cable television transmission and distribution systems, and the costs of new subscriber installations.\nPlant and equipment are being depreciated over their estimated useful lives using the straight-line method for financial reporting purposes. Leasehold improvements are amortized over the shorter of their useful lives or the term of the related leases.\nDEFERRED FINANCING COSTS\nCosts incurred in obtaining debt are deferred and amortized on the straight-line basis over the life of the related debt.\nSUBSCRIBER LISTS, FRANCHISES, AND EXCESS COSTS OVER FAIR VALUE OF NET ASSETS ACQUIRED\nSubscriber lists are amortized on the straight-line basis over varying periods during which subscribers are expected to remain connected to the system (averaging approximately 8 years). Franchises are amortized on the straight-line basis over the average remaining term of the franchises (approximately 7 years). Excess costs over fair value of net assets acquired are being amortized over 20 years on the straight-line basis. The Company assesses the recoverability of such excess costs based upon undiscounted anticipated future cash flows of the businesses acquired.\nINCOME TAXES\nThe Company is not a member of the CSC consolidated group for federal tax purposes and, accordingly, files its federal income tax return on behalf of itself and its consolidated subsidiaries and not as part of a CSC consolidated group.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which requires the liability method of accounting for deferred income taxes and\n(104)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\npermits the recognition of deferred tax assets, subject to an ongoing assessment of realizability. Prior years' financial statements have not been restated to reflect the provisions of SFAS 109.\nCASH FLOWS\nFor purposes of the consolidated statements of cash flows, the Company considers short-term investments with a maturity at date of purchase of three months or less to be cash equivalents. The Company paid cash interest expense of approximately $25,030, $43,008 and $36,472 during the years ended December 31, 1993, 1992 and 1991, respectively. During 1993, 1992 and 1991 the Company's noncash investing and financing activities included capital lease obligations of $0, $65 and $259, respectively, incurred when the Company entered into leases for new equipment, and preferred stock dividend requirements of $29,510, $17,985 and $3,579, respectively.\nNOTE 4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of the following items which are depreciated over the estimated useful lives shown below:\nAt December 31, 1993 and 1992 property, plant and equipment include approximately $310, and $643, respectively, of net assets recorded under capital leases.\n(105)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nNOTE 5. DEBT\nSENIOR TERM LOAN\nThe Company's outstanding borrowings under its senior term loan and revolving lines of credit (the \"Senior Term Loan\") with GECC amounted to $397,500 at December 31, 1993 and 1992, respectively. The facility consists of a $285,000 senior term loan, $95,000 in special funding advances and a $45,000 revolving line of credit; all of the loans are non-amortizing and mature on December 30, 1997. Aggregate undrawn funds available under the revolving line of credit at December 31, 1993 amounted to approximately $27,500 of which $400 was restricted.\nInterest rates on the $397,500 of the Senior Term Loan, are at floating rates based on either GECC's LIBOR (as defined in the agreement) or Index Rate plus applicable percentages which vary depending upon certain prescribed financial ratios. Such floating rate approximated 6.8% at December 31, 1993. In addition, the Company entered into an interest rate cap agreement with a bank on a notional amount of $155,000 which limits the interest rate the Company will pay to 7.25% on the $155,000. The cap agreement terminates in May 1995. The Company is exposed to credit loss in the event of nonperformance by the other party to the cap agreement. However, the Company does not anticipate nonperformance by the counterparty.\nSubstantially all of the assets of the Company have been pledged to secure the borrowings under the Senior Term Loan agreement.\nThe Senior Term Loan agreement contains various restrictive covenants, among which are the maintenance of certain financial ratios, limitations regarding certain transactions by the Company, prohibitions against the transfer of funds to the parent company (except for reimbursement of certain expenses) and limitations on levels of permitted capital expenditures. The Company was in compliance with all of the covenants of its Senior Term Loan agreement at December 31, 1993.\nSUBORDINATED NOTES PAYABLE\nIn January 1988, the Company issued $125,000 ($272,533 face amount) of the A-R Cable Notes due December 30, 1997. No interest was payable on the A-R Cable Notes until June 30, 1993 at which time interest at 16-3\/4% per annum became payable. The original issue discount of $147,533 was being charged to operations over the period from January 1988 to December 1992. During 1992, the Company repurchased approximately $243,740 principal amount of the A-R Cable Notes (106)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\npursuant to the terms of a tender offer. In connection with the purchase of the A-R Cable Notes, the Company incurred a loss aggregating approximately $2,435.\nOn February 9, 1993, the Company redeemed all of its remaining outstanding A-R Cable Notes in the aggregate principal amount of $28,793 in accordance with the terms of the Indenture with respect to the A-R Cable Notes. The funds for such redemption were obtained from the proceeds of an additional $30,000 provided by GECC under the Company's secured revolving credit line.\nCAPITAL LEASES\nThe Company's minimum future obligations under capital leases as of December 31, 1993 are approximately as follows:\nNOTE 6. PREFERRED STOCK\nIn January, 1988, the Company issued and GECC purchased 200,000 shares of the 1987 Preferred Stock for a purchase price of $100 per share. The 1987 Preferred Stock bore cumulative annual dividends of $12 per share payable quarterly. Dividends on or before January 4, 1993 were payable in additional shares of preferred stock at a rate of one share per $100. The 1987 Preferred Stock was mandatorily redeemable, at a redemption price of $100 per share.\nIn connection with the purchase of the A-R Cable Notes, the Company purchased from an affiliate, (which in 1992 had purchased the 1987 Preferred Stock from GECC) for nominal consideration, and retired the 1987 Preferred Stock. The Company recognized a gain of $33,509 on its purchase of the 1987 Preferred Stock.\n(107)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nIn connection with the consummation of the tender offer, Warburg Pincus purchased a new Series A Preferred Stock of the Company for a cash investment of $105,000, and CSC purchased a new Series B Preferred Stock of the Company for a cash investment of $45,000. The Series A Preferred Stock is entitled to a 19% annual dividend. The Series B Preferred Stock is entitled to a 12% annual dividend. Dividends on the Series A and Series B Preferred Stock are not payable until the repayment in full of all outstanding indebtedness to GECC under the A-R Cable credit agreement.\nNOTE 7. INCOME TAXES\nAs a result of an Internal Revenue Service (\"IRS\") examination of the Company's predecessor's tax returns for the years 1981 to 1983, the Company accrued approximately $1,757 in 1991 representing amounts due for federal income taxes and interest thereon, in full settlement of that audit. The Company's tax returns for the years 1984 to 1989 have been examined by the IRS and certain issues related to the amortization of intangible assets are being appealed by the Company. Management believes that any settlement arising out of this examination will not have a material adverse effect on the financial position of the Company.\nAt December 31, 1993, the Company had a net operating loss carry forward for income tax purposes of approximately $206,752, which expires in the years 2003 to 2008. Due to the transaction on May 11, 1992, described in Note 2 above, the Company underwent an ownership change within the meaning of Internal Revenue Code Section 382. This would limit the amount of net operating loss carry forward from the period prior to the transaction which could be utilized to offset any taxable income in periods subsequent to the transaction. There is a pro rata allocation in the year that the ownership change occurs. Therefore, of the $206,752 of net operating loss carry forwards for tax purposes, $201,588 is restricted and $5,164 is currently available.\nUsage of the $201,588 net operating loss carry forward is limited to a fixed annual amount, calculated using the Federal long-term tax-exempt rate times the value of the Company prior to the ownership change. This amount is increased in any year in which the Company recognizes any built in gain from the sale of assets owned prior to the ownership change. Based on this formula, none of the $201,588 restricted net operating loss carry forwards would currently be available to the Company.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which requires the liability method of accounting for deferred income taxes and\n(108)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\npermits the recognition of deferred tax assets, subject to an ongoing assessment of realizability. Prior years' financial statements have not been restated to reflect the provisions of SFAS 109.\nThe tax effects of temporary differences which give rise to significant portions of deferred tax assets or liabilities and the corresponding valuation allowance at December 31, 1993 are as follows:\nThe Company has provided a valuation allowance of $61,683 for deferred tax assets since realization of these assets was not assured due to the Company's history of operating losses. The amounts of deferred tax assets and corresponding valuation allowance increased by $11,590 during the year ended December 31, 1993, principally due to a provision for potential state tax benefits. Also, in connection with the acquisition of the Company by CSC in January 1988, the Company recorded certain fair value adjustments net of their tax effects. In accordance with SFAS 109, these assets have been adjusted to their remaining pre tax amounts. Accordingly, property, plant and equipment, franchises, and subscriber lists have been increased by $68, $26,611 and $7,616, respectively. Amortization of these amounts in 1993 resulted in the recognition of income tax benefits of $14,168.\nNOTE 8. AFFILIATE TRANSACTIONS\nAs a result of the restructuring described in Note 2, the Company entered into a management agreement with CSC whereby the Company continues to be managed by CSC in exchange for a management fee of 3-1\/2% of gross receipts, as defined, and interest on unpaid annual amounts thereon at a rate of 10% per annum commencing (109)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nJanuary 1, 1993. Such management fees amounted to $3,801 and $2,383 for 1993 and 1992, respectively. Interest on such management fees amounted to $244 for 1993.\nThe Company is also charged for cost reimbursement and an allocation of certain selling, general and administrative expenses by CSC. For the years ended December 31, 1993, 1992 and 1991 these cost reimbursements and expense allocations approximated $3,373, $2,719, and $1,813, respectively. In accordance with certain restrictive covenants contained in its Senior Term Loan agreement, the Company may not pay in excess of the amounts permitted relating to the allocation of selling, general and administrative expenses, subject to certain escalation provisions, of corporate overhead expenses charged by CSC in any fiscal year. At December 31, 1993 and 1992, the total balance due CSC for management fees, cost reimbursement and expenses amounted to $7,191 and $2,899, respectively.\nCSC has interests in several companies engaged in providing cable television services and programming services to the cable television industry, including the Company. During 1993, 1992 and 1991, the Company was charged approximately $2,787, $2,690 and $3,127, respectively, by these companies for these services. The total amount due these companies at December 31, 1993 and 1992 was $602 and $794, respectively.\nCablevision Systems Services Corporation (\"CSSC\"), a company owned by CSC's chairman, Charles F. Dolan, entered into an agreement with a certain premium program service supplier allowing all cable systems managed by CSSC or CSC to offer that premium program service to their subscribers. The contract requires minimum annual payments escalating to approximately $13,399 in 1994. Each of the related cable systems offering this service, including the Company, pays its proportionate share of the minimum annual payment based on subscriber usage of the service. In 1993, 1992 and 1991, the Company was charged $949, $976 and $907, respectively, for such usage.\nNOTE 9. PENSION PLANS\nPrior to 1993 the Company was a participant, with other affiliates, in a defined contribution pension plan (the \"Pension Plan\") covering substantially all of its employees. The Company contributed three percent of each eligible employee's annual compensation, as defined, and employees could voluntarily contribute up to ten percent of their annual compensation.\nEffective January 1, 1993, the Board of Directors of CSC approved the adoption of an amended and restated Pension and 401(K) Savings Plan (the \"Plan\"), in part to permit\n(110)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nemployees of CSC and its affiliates to make contributions to the Plan on a pre-tax salary reduction basis in accordance with the provisions of Section 401(K) of the Internal Revenue Code, and to introduce new investment options under the Plan. The Company contributes 1-1\/2% of eligible employees' annual compensation, as defined, to the defined contribution portion of the Plan (the \"Pension Plan\") and an equivalent amount to the section 401(K) portion of the Plan (the \"Savings Plan\"). Employees may voluntarily contribute up to 15% of eligible compensation, subject to certain restrictions, to the Savings Plan, with an additional matching contribution by the Company of 1\/4 of 1% for each 1% contributed by the employee, up to a maximum contribution by the Company of 1\/2 of 1%. Employee contributions are fully vested as are employer base contributions to the Savings Plan. Employer contributions to the Pension Plan and matching contributions to the Savings Plan become vested in years three through seven. Total expense related to these plans for the years ended December 31, 1993, 1992 and 1991 was approximately $339, $234 and $235, respectively.\nThe Company does not provide any postretirement benefits to its employees.\nNOTE 10. OPERATING LEASES\nThe Company leases certain office, production, satellite transponder, and transmission facilities under terms of operating leases expiring at various dates through the year 2017. The leases generally provide for fixed annual rentals plus certain real estate taxes and other costs. Rent expense for the years ended December 31, 1993, 1992 and 1991, was approximately $842, $910 and $952, respectively.\nIn addition, the Company rents space on utility poles for its operations. The Company's pole rental agreements are for varying terms, and management anticipates renewals as they expire. Pole rental expense for the years ended December 31, 1993, 1992 and 1991 was approximately $1,507, $1,265 and $1,247, respectively.\nThe minimum future annual rentals for all operating leases, including pole rentals from January 1, 1994 through December 31, 1998, and thereafter, at rates now in force are approximately: 1994, $2,198; 1995, $2,188; 1996, $2,113; 1997, $1,785; 1998, $1,555; thereafter, $213.\n(111)\nA-R CABLE SERVICES, INC. AND SUBSIDIARIES (a wholly-owned subsidiary of Cablevision Systems Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (continued)\nNOTE 11. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS\nCASH AND CASH EQUIVALENTS, TRADE ACCOUNTS RECEIVABLE, NOTES AND OTHER RECEIVABLES, ACCOUNTS PAYABLE, ACCRUED LIABILITIES, ACCOUNTS PAYABLE TO AFFILIATES AND DUE TO PARENT\nThe carrying amount approximates fair value because of the short maturity of these instruments.\nSENIOR TERM LOAN\nThe fair values of the Company's long-term debt instruments are based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.\nINTEREST RATE CAP AGREEMENT\nThe fair value of the interest rate cap agreement is obtained from dealer quotes. This value represents the estimated amount the Company would receive or pay to terminate agreements, taking into consideration current interest rates and the current creditworthiness of the counterparties. The carrying amount represents a deferred expense arising from the unrecognized financial instrument.\nThe fair value of the Company's financial instruments are summarized as follows:\nFair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. (112)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 29th day of March, 1994.\nCablevision Systems Corporation\nBy: \/s\/ William J. Bell ------------------------- Name: William J. Bell Title: Vice Chairman\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Francis F. Randolph, Jr., Marc A. Lustgarten and Robert S. Lemle, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him in his name, place and stead, in any and all capacities, to sign this report, and file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons in the capacities and on the dates indicated.\n(113)\n(114)\nINDEX TO EXHIBITS\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n3.1 --Certificate of Incorporation of the Registrant (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 dated January 17, 1986, File No. 33-1936 (the \"S-1\"))\n3.1A --Amendment to Certificate of Incorporation and complete copy of amended and restated Certificate of Incorporation (incorporated herein by reference to Exhibits 3.1A(i) and 3.1A(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (the \"1989 10-K\"))\n3.1B --Certificate of Designations for the Series E Redeemable Exchangeable Convertible Preferred Stock\n3.1C --Certificate of Designations for the Series F Redeemable Preferred Stock\n3.2 --By-laws of the Registrant (incorporated herein by reference to Exhibit 3.2 to the S-1)\n3.2A --Amendment to By-laws and complete copy of amended and restated By-laws (incorporated herein by reference to Exhibit 3.2 to the 1989 10-K)\n3.2B --Amendment to By-laws and complete copy of amended and restated By-laws (incorporated herein by reference to Exhibit 3.2B to the Company's Annual Report on Form 10K for the fiscal year ended December 31, 1992 (the \"1992 10-K\").\n4.1 --Indenture dated as of November 10, 1988 relating to the Registrant's $200,000,000 Senior Subordinated Debentures due October 15, 2003 (incorporated herein by reference to Exhibit 4.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-9046 (the \"1988 10-K\").\n4.2 --Indenture dated as of April 1, 1992 relating to the Registrant's $275,000,000 10 3\/4% Senior Subordinated Debentures due April 1, 2004 (incorporated herein by reference to Exhibit 4.2 to the 1992 10-K).\n(115)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- ----\n4.3 --Indenture dated as of February 15, 1993 relating to the Registrant's $200,000,000 9 7\/8% Senior Subordinated Debentures due February 15, 2013 (incorporated herein by reference to Exhibit 4.3 to the 1992 10-K).\n10.1 --Registration Rights Agreement between Cablevision Systems Company and the Registrant (incorporated herein by reference to Exhibit 10.1 of the S-1).\n10.2 --Registration Rights Agreement between CSC Holdings Company and the Registrant (incorporated herein by reference to Exhibit 10.2 to the S-1)\n10.4 --Form of Right of First Refusal Agreement between Dolan and the Registrant (incorporated herein by reference to Exhibit 10.4 to the S-1)\n10.5 --Supplemental Benefit Plan of the Registrant (incorporated herein by reference to Exhibit 10.7 to the S-1)\n10.6 --Cablevision Money Purchase Pension Plan, and Trust Agreement dated as of December 1, 1983 between Cablevision Systems Development Company and Dolan and Tatta, as Trustees (incorporated herein by reference to Exhibit 10.8 to the S-1)\n10.6A --Amendment to the Cablevision Money Purchase Pension Plan adopted November 6, 1992 (incorporated herein by reference to Exhibit 10.6A to the 1992 10-K).\n10.7 --Employment Agreement between Charles F. Dolan and the Registrant dated January 27, 1986 (incorporate herein by reference to Exhibit 10.9 to the S-1)\n10.8 --Amended and Restated Agreement dated as of June 1, 1983 between SportsChannel Associates and Cablevision Systems Holdings Company (incorporated herein by reference to Exhibit 10.11 to the S-1)\n(116)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n10.9 --Assignment of Partnership Interest dated as of November 30, 1984 between Cablevision Systems Company, Cablevision Company and Cablevision of Boston Limited Partnership (incorporated herein by reference to Exhibit 10.15 to the S-1)\n10.10 --Promissory Note of Cablevision of Chicago dated November 30, 1984 payable to Cablevision Company (incorporated herein by reference to Exhibit 10.16 to the S-1)\n10.11 --Promissory Note of Cablevision of Chicago dated August 11, 1989 payable to Cablevision Systems Corporation (incorporated herein by reference to Exhibit 10.16A to the 1989 10-K)\n10.12 --Lease Agreement dated as of October 9, 1978 between Cablevision Systems Development Company and Industrial and Research Associates Co. and amendment dated June 21, 1985 between Industrial and Research Associates Co. and Cablevision Company (incorporated herein by reference to Exhibit 10.18 to the S-1)\n10.13 --Lease Agreement dated May 1, 1982 between Industrial and Research Associates Co. and Cablevision Systems Development Company (incorporated herein by reference to Exhibit 10.19 to the S-1)\n10.14 --Agreement of Sublease dated as of July 9, 1982 between Cablevision Systems Development Company and Ontel Corporation (incorporated herein by reference to Exhibit 10.20 to the S-1)\n10.15 --Agreement of Sublease dated as of June 21, 1985 between Grumman Data Systems Corporation and Cablevision Company (incorporated herein by reference to Exhibit 10.21 to the S-1)\n10.16 --Agreement dated as of June 21, 1985 between Industrial and Research Associates Co., Grumman Data Systems Corporation and Cablevision Company (incorporated herein by reference to Exhibit 10.22 to the S-1) (117)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------ ----------- ----\n10.17 --Lease Agreement dated as of June 21, 1985 between Industrial and Research Associates Co. and Cablevision Company (incorporated herein by reference to Exhibit 10.23 to the S-1)\n10.18 --Lease Agreement dated as of February 1, 1985 between Cablevision Company and County of Nassau (incorporated herein by reference to Exhibit 10.24 to the S-1)\n10.19 --Lease Agreement dated as of January 1, 1981 between Cablevision Systems Development Company and Precision Dynamics Corporation and amendment dated January 15, 1985 between Cablevision Company and Nineteen New York Properties Limited Partnership (incorporated herein by reference to Exhibit 10.25 to the S-1)\n10.20 --Option Certificate for 840,000 Shares Issued Pursuant to the 1986 Nonqualified Stock Option Plan of the Registrant (incorporated herein by reference to Exhibit 10.29 to the S-1)\n10.21 --Stock Purchase Agreement dated as of February 17, 1989 among the Registrant, Viacom, Inc. and Arsenal Holdings II, Inc. (incorporated herein by reference to Exhibit 10.29 to the 1988 10-K)\n10.23 --Acquisition Agreement, dated as of April 20, 1989, among Rainbow Programming Holdings, Inc., Rainbow Program Enterprises and SportsChannel America Holding Corporation, and National Broadcasting Company, Inc. and NBC Cable Holding, Inc. (incorporated herein by reference to Exhibit 2.1 to the Registrant's Report on Form 8-K under the Securities Exchange Act of 1934 dated April 20, 1989) (the \"April 1989 8-K\"))\n10.24 --Investment Agreement, dated as of April 20, 1989, among Rainbow Programming Holdings, Inc., CNBC Holding Corporation, National Broadcasting Company, Inc. and CNBC, Inc. (incorporated herein by reference to Exhibit 2.2 to the April 1989 8-K)\n(118)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ---------- ----------- ----\n10.25 --New Ventures Agreement, dated as of April 20, 1989, among the Registrant and certain of its subsidiaries, and National Broadcasting Company, Inc. and certain of its subsidiaries (incorporated herein by reference to Exhibit 2.3 to the April 1989 8-K)\n10.26 --Olympics Agreement, dated as of April 20, 1989, between Rainbow Programming Holdings, Inc., National Broadcasting Company, Inc. and Rainbow NBC Olympics Company (incorporated herein by reference to Exhibit 2.5 to the April 1989 8-K)\n10.27 --Agreement for Asset Trade, dated as of August 25, 1989 among CSC Acquisition Corporation, Times Mirror Cable Television of Long Island, Inc. and Time Mirror Cable Television of Haverhill, Inc. (incorporated herein by reference to Exhibit 10.40 to the 1990 10-K)\n10.29 --Letter Agreement dated as of December 19, 1991 among U.S. Cable Television Group, L.P., V Cable, Inc. and General Electric Capital Corporation (incorporated herein by reference to Exhibit 2(a) to the January 1992 8-K).\n10.30 --Letter Agreement dated as of December 19, 1991 among General Electric Capital Corporation, the Registrant and V Cable, Inc. (incorporated herein by reference to Exhibit 2(b) to the January 1992 8-K).\n10.31 --Amendment dated February 12, 1992 to Letter Agreement dated as of December 19, 1991 among General Electric Capital Corporation, the Registrant and V Cable, Inc. (incorporated herein by reference to Exhibit 2(b) to the March 1992 Form 8).\n10.32 --Purchase and Reorganization Agreement dated as of December 20, 1991 between the Registrant and Charles F. Dolan (incorporated herein by reference to Exhibit 2(c) to the January 1992 8-K).\n(119)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n10.33 --Amendment No. 1 dated as of March 28, 1992 to Purchase and Reorganization Agreement dated as of December 20, 1991 between the Registrant and Charles F. Dolan (incorporated herein by reference to Exhibit 2(g) to the March 1992 Form 8).\n10.34 --Letter Agreement dated February 12, 1992, among the Registrant, A-R Cable Services, Inc. and Warburg Pincus Investors, L.P. (incorporated herein by reference to Exhibit 28(a) to the Registrant's Current Report on Form 8-K under the Securities Exchange Act of 1934 dated February 21, 1992 (the \"February 1992 8-K\")).\n10.35 --Letter Agreement dated February 12, 1992 among the Registrant, A-R Cable Services, Inc. and General Electric Capital Corporation (incorporated herein by reference to Exhibit 28(b) to the February 1992 8-K).\n10.36 --Letter Agreement dated February 12, 1992 among the Registrant and A-R Cable Services, Inc. (incorporated herein by reference to Exhibit 28(b) to the February 1992 8-K).\n10.37 --Non-Competition Agreement, dated as of December 31, 1992, among V Cable, Inc., VC Holding, Inc. and the Registrant, for the benefit of V Cable, Inc., VC Holding, Inc. and General Electric Capital Corporation (incorporated herein by reference to Exhibit 10.37 to the 1992 10-K).\n10.38 --Non-Competition Agreement, dated as of December 31, 1992, between U.S. Cable Television Group, L.P. and the Registrant, for the benefit of U.S. Cable Television Group, L.P. and General Electric Capital Corporation (incorporated herein by reference to Exhibit 10.38 to the 1992 10-K).\n10.39 --CSC Nonrecourse Guaranty and Pledge Agreement, dated as of December 31, 1992, between the Registrant and General Electric Capital Corporation, as Agent for the Lenders (incorporated herein by reference to Exhibit 10.39 to the 1992 10-K). (120)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n10.40 --U.S. Cable Investment Agreement, dated as of June 30, 1992, among V Cable, Inc., V Cable GP, Inc., U.S. Cable Television Group, L.P. and U.S. Cable Partners (incorporated herein by reference to Exhibit 10.40 to the 1992 10-K).\n10.41 --Newco Investment Agreement, dated as of December 31, 1992, among VC Holding, Inc., V Cable, Inc. and U.S. Cable Television Group (incorporated herein by reference to Exhibit 10.41 to the 1992 10-K).\n10.42 --Senior Loan Agreement, dated as of December 31, 1992, among V Cable, Inc., the Lenders named therein and General Electric Capital Corporation, as Agent for the Lenders and as Lender (incorporated herein by reference to Exhibit 10.42 to the 1992 10-K).\n10.43 --Senior Loan Agreement, dated as of December 31, 1992, among U.S. Cable Television Group, L.P., the Lenders named therein and General Electric Capital Corporation, as Agent for the Lenders and as Lender (incorporated herein by reference to Exhibit 10.43 to the 1992 10-K).\n10.44 --Third Amended and Restated Credit Agreement dated as of June 24, 1992 (the \"Third Amended and Restated Credit Agreement\") among the Registrant, the Restricted Subsidiaries (as defined therein), the banks which are parties thereto and Toronto Dominion (Texas), Inc. as Agent and Bank of Montreal, Chicago Branch, The Bank of New York, The Bank of Nova Scotia, and The Canadian Imperial Bank of Commerce, as Co-Agents (incorporated herein by reference to Exhibit 10.44 to the 1992 10-K).\n10.44A --Amendment No. 1, dated as of August 4, 1992, to Third Amended and Restated Credit Agreement (incorporated herein by reference to Exhibit 10.44A to the 1992 10-K).\n10.44B --Amendment No. 2 and waiver, dated as of November 8, 1993 to the Third Amended and Restated Credit Agreement.\n(121)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n10.44C --Amendment No. 3 and waivers, dated as of March __, 1994 to the Third Amended and Restated Credit Agreement.\n10.46 --Cablevision Systems Corporation Amended and Restated Employee Stock Plan (incorporated herein by reference to Exhibit 10.46 to the 1992 10-K).\n10.47 --Cablevision Systems Corporation 401(K) Savings Plan (incorporated herein by reference to Exhibit 10.47 to the 1992 10-K).\n10.49 --Fourth Amended and Restated Credit Agreement, dated as of June 18, 1993, among Cablevision of New York City - Phase I L.P., Cablevision Systems New York City Corporation, Cablevision of New York City- Master L.P., each of the Banks signatory thereto, The Chase Manhattan Bank (National Associates) as Agent and The First National Bank of Chicago and CIBC, Inc. each as Co-Agent.\n10.50 --Asset Purchase Agreement, dated as of July 23, 1993, by and between Cablevision of Cleveland, L.P. and North Coast Cable Limited Partnership (incorporated herein by reference to Exhibit 10.50 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1993).\n10.51 --Master Agreement, dated as of October 26, 1993, between Cablevision MFR, Inc., Monmouth Cablevision Associates, Framingham Cablevision Associates and Riverview Cablevision Associates, L.P. (incorporated herein by reference to Exhibit 10.51 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1993 (the \"September 1993 10-Q\").\n10.52 --Asset Purchase Agreement, dated as of October 26, 1993, between Monmouth Cablevision Associates and Cablevision MFR, Inc. (incorporated herein by reference to Exhibit 10.52 to the September 1993 10-Q).\n(122)\nINDEX TO EXHIBITS (continued)\nEXHIBIT PAGE NO. DESCRIPTION NO. - ------- ----------- -----\n10.53 --Asset Purchase Agreement, dated as of October 26, 1993, between Framingham Cablevision Associates, Limited Partnership and Cablevision MFR, Inc. (incorporated herein by reference to Exhibit 10.53 to the September 1993 10-Q).\n10.54 --Asset Purchase Agreement, dated as of October 26, 1993 between Riverview Cablevision Associates, L.P. and Cablevision MFR, Inc. (incorporated herein by reference to Exhibit 10.54 to the September 1993 10-Q).\n10.55 --Asset Purchase Agreement among A-R Cable Partners, Nashoba Communications Limited Partnership, Nashoba Communications Limited Partnership No. 7 and Nashoba Communications of Belmont Limited Partnership dated as of November 5, 1993 (incorporated herein by reference to Exhibit 10.55 to the September 1993 10-Q).\n10.56 --Preferred Stock Purchase Agreement, dated as of March 30, 1994, by and among the Company and Toronto Dominion Investments, Inc.\n10.57 --Registration Rights Agreement, dated as of March 30, 1994, by and among the Company and Toronto Dominion Investments, Inc.\n22 --Subsidiaries of the Registrant\n23.1 --Consent of Independent Auditors\n28.1 --Form of Guarantee and Indemnification Agreement among Dolan, the Registrant and directors and officers of the Registrant (incorporated herein by reference to Exhibit 28 to the S-1)\n(123)","section_15":""}
{"filename":"764241_1993.txt","cik":"764241","year":"1993","section_1":"ITEM 1. BUSINESS\nNational City Bancshares, Inc., (hereinafter referred to as the Corporation), is an Indiana Corporation organized in 1985 to engage in the business of a bank holding company. Based in Evansville, Indiana, the Corporation has eleven wholly owned subsidiaries, ten commercial banks serving twenty towns and cities with a total of thirty banking centers and an insurance agency. Each subsidiary, its locations, number of offices, year founded and date of merger is shown below. In addition to these mergers, Chandler State Bank was acquired by the Corporation in August 1986 and merged into The National City Bank of Evansville in June 1987.\nThe Corporation's subsidiary banks provide a wide range of financial services to the communities they serve in southwestern Indiana, western Kentucky and southeastern Illinois. These services include various types of deposit accounts; safe deposit boxes; safekeeping of securities; automated teller machines; consumer, mortgage and commercial loans; mortgage loan sales and servicing; letters of credit; accounts receivable management (financing, accounting, billing and collecting); and complete personal and corporate trust services. All banks are members of the Federal Deposit Insurance Corporation.\nThe Corporation's nonbank subsidiary, Ayer-Wagoner-Deal Insurance Agency, Inc., operates as an insurance agency offering various insurance products through several insurance companies or underwriters and sells the following types of insurance: life, casualty, property, homeowners, business, disability and automobile.\nAt December 31, 1993, the Corporation and its subsidiaries had 388 full-time equivalent employees. The subsidiaries provide a wide range of employee benefits and consider employee relations to be excellent.\nCOMPETITION\nThe Corporation has active competition in all areas in which it presently engages in business. Each subsidiary bank competes for commercial and individual deposits and loans with commercial banks, savings and loan associations, credit unions connected with local businesses and other non-banking institutions. The Corporation's insurance agency competes with several other insurance agencies in Rockport, Indiana, and neighboring communities.\nFOREIGN OPERATIONS\nThe Corporation and its subsidiaries have no foreign branches or significant business with foreign obligers or depositors.\nREGULATION AND SUPERVISION\nThe Corporation, as a bank holding company registered under the Bank Holding Company Act of 1956, as amended (\"Act\"), is subject to regulation by the Board of Governors of the Federal Reserve System (\"Board\"). Under the Act, the Corporation is required to obtain the prior approval of the Board before acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank which is not already majority owned. In addition, the Corporation is prohibited under the Act, with certain exceptions, from acquiring direct or indirect ownership or control of 5% or more of the voting shares of any company which is not a bank. The Corporation may engage in, and may own shares of companies engaged in, certain activities found by the Board to be so closely related to banking as to be a proper incident thereto. The Act prohibits the acquisition by a bank holding company of shares of a bank located outside the state in which the operations of its banking subsidiaries are principally conducted,\nunless such an acquisition is specifically authorized by statute of the state in which the bank to be acquired is located. The Corporation is required by the Act to file annual reports of its operations with the Board and such additional information as they may require pursuant to the Act, and the Corporation and its subsidiaries are subject to examination by the Board. Further, under the Act and the regulations of the Board, the Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements with respect to any extension of credit or provision of property or services. The Board has adopted \"capital adequacy guidelines\" for its use in examining and supervising bank holding companies. A bank holding company's ability to pay dividends and expand its business through the acquisition of additional subsidiaries can be restricted if its capital falls below levels established by these guidelines.\nThe primary supervisory authority of The National City Bank of Evansville and The Peoples National Bank of Grayville is the Comptroller of the Currency, who regularly examines such areas as reserves, loans, investments, management practices and other aspects of bank operations. The Comptroller of the Currency has the authority to prevent a national bank from engaging in an unsafe or an unsound practice in conducting its business. The payment of dividends, depending upon the financial condition of a bank, could be deemed such a practice. In addition, both banks are members of, and subject to regulation by, the Federal Deposit Insurance Corporation.\nAs state banks, Poole Deposit Bank and Farmers State Bank are supervised and regulated by the Commonwealth of Kentucky Department of Financial Institutions. The Farmers and Merchants Bank, Lincolnland Bank, The Bank of Mitchell, Pike County Bank, The Spurgeon State Bank and The State Bank of Washington are supervised and regulated by the State of Indiana Department of Financial Institutions. In addition, all eight banks are members of, and subject to regulation by, the Federal Deposit Insurance Corporation.\nFederal and state banking laws and regulations govern, among other things, the scope of the bank's business, the investments it may make, the reserves against deposits it must maintain, loans the bank makes and collateral it takes, activities with respect to mergers and consolidations and the establishment of branches.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") was enacted on August 9, 1989, primarily in an attempt to address problems in the savings and loan industry. However, the Act has had a substantial effect on the environment in which commercial banks operate. The annual assessment rates for banks insured by the Federal Deposit Insurance Corporation were to increase from .083% of deposits to .12% in 1990, and to .15% in 1991. However, such rates were increased by the FDIC to .195% effective January 1, 1991 and .23% effective July 1, 1991.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted in 1991. Among other things, FDICIA, requires federal bank regulatory authorities to take \"prompt corrective action\" with respect to banks that do not meet minimum capital requirements. For these purposes, FDICIA established five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Corporation and each of the Corporation's Banks currently exceed the regulatory definition of a \"well capitalized\" financial institution.\nThe Ayer-Wagoner-Deal Insurance Agency, Inc. is regulated by the Indiana Department of Insurance.\nSTATISTICAL DISCLOSURE\nThe statistical disclosure on the Corporation and its subsidiaries, on a consolidated basis, included on pages 1, 3 through 13 and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, is hereby incorporated by reference herein.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe net investment of the Corporation and its subsidiaries in real estate and equipment at December 31, 1993, was $10,439,166. The Corporation's offices are located in a building owned by The National City Bank of Evansville (hereinafter referred to as the Bank), in which the Bank's main office is located. The main office of the Bank is located at 227 Main Street in downtown Evansville, Indiana. This building is owned in fee by the Bank. The other subsidiary banks, all branches and the insurance agency are located on premises either owned or leased. None of the property is subject to any major encumbrance.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1993, two matters were submitted to a vote of shareholders. On December 14, 1993, a special meeting of the shareholders was held to consider and take action on proposals to approve and adopt two Merger Agreements. The first Merger Agreement dated July 1, 1993, by and between the Corporation and Lincolnland Bancorp, Inc. (\"Lincolnland\") provided for, among other things, the merger of Lincolnland with and into the Corporation. This proposal was approved with 2,003,763.1085 shares voted affirmatively, 3,614.0000 negatively and 31,460.8022 abstaining. The second Merger Agreement dated June 25, 1993, by and between the Corporation and Sure Financial Corporation, (\"Sure\") provided for, among other things, the merger of Sure with and into the Corporation. This proposal was approved with 2,024,601.1085 shares voted affirmatively, 288,160.7531 negatively and 9,532.8022 abstaining. Both mergers were consummated December 17, 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nPages 1 and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, is hereby incorporated by reference herein. Dividends are restricted by earnings and the need to maintain adequate capital. Management intends to continue its current dividend policy subject to these restrictions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPage 1 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, is hereby incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nPages 1, 3 through 13 and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, are incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 15 through 30 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, are incorporated by reference herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Board of Directors approved the appointment of McGladrey & Pullen, Certified Public Accountants and Consultants, as independent accountants to audit the financial statements of the Corporation and its subsidiaries for the year 1993. Gaither Rutherford & Co., formerly Gaither Koewler Rohlfer Luckett & Co., (\"Gaither\") audited the books and records of the Corporation and its subsidiaries from 1985 through 1992. The Board of Directors had determined it to be in the best interest of the Corporation to change independent accountants for 1993. This change was ratified by the Corporation's shareholders at the 1993 annual meeting.\nThe financial statements provided by Gaither in 1992 and 1991 did not contain any adverse opinions or any disclaimers of opinions, nor were they qualified or modified as to uncertainty, audit scope or accounting reasons. Further, there have been no disagreements between Gaither and the Corporation.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Directors of the Corporation\nThis information under the heading \"Election of Directors and Information with Respect to Directors and Officers\" on pages 3 to 6 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 19, 1994, is hereby incorporated by reference herein.\n(b) Executive Officers of the Corporation\nThe Executive Officers of the Corporation, most of whom are also Executive Officers of The National City Bank of Evansville (hereinafter referred to as the Bank) are as follows:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information under the heading \"Compensation of Executive Officers\" on pages 7 through 11 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 19, 1994, is hereby incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under the heading \"Voting Securities\" on pages 1 through 3 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 19, 1994, is hereby incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under the heading \"Transactions with Management\" on page 11 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 19, 1994, is hereby incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS\nThe following consolidated financial statements of the Corporation and its subsidiaries, included on pages 15 through 30 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1993, are hereby incorporated by reference:\nIndependent Auditor's Report Consolidated Statements of Financial Position, at December 31, 1993 and 1992 Consolidated Statements of Income, years ended December 31, 1993, 1992 and 1991 Consolidated Statements of Shareholders' Equity, years ended December 31, 1993, 1992 and 1991 Consolidated Statements of Cash Flows, years ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements\nFINANCIAL STATEMENT SCHEDULES\nAll schedules are omitted because they are not applicable or not required or because the required information is included in the consolidated financial statements or related notes.\nEXHIBITS\nThe following exhibits are submitted herewith:\n3 - Articles of Incorporation, as amended 13 - Annual Report to Shareholders for the year ended December 31, 1993 (Incorporated by Reference) 22 - Subsidiaries of the Registrant 28 - Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 1994 (Incorporated by Reference)\nREPORTS ON FORM 8-K\nForm 8-K dated December 29, 1993, reported that on December 17, 1993, the Registrant completed its acquisition of Sure Financial Corporation (\"Sure\") and Lincolnland Bancorp, Inc. (\"Lincolnland\"). The transactions were structured as statutory mergers, pursuant to which each of Sure and Lincolnland were merged with and into National City Bancshares, Inc. Sure was a multibank holding company with approximately $130 million in assets and Lincolnland was a one-bank holding company with approximately $108 million in total assets. Shareholders of Lincolnland received shares of Registrant valued at $23.5 million and shareholders of Sure received shares of Registrant valued at $16 million in the transactions. The former subsidiaries of Lincolnland and Sure will be operated as wholly owned subsidiaries of Registrant. The consolidated entity will have approximately $711 million in total assets.\nIn other matters, Michael F. Elliott was appointed Executive Vice President of the Registrant on December 21, 1993. Mr. Elliott was President of Sure.\nSIGNATURES\nPursuant 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, on the dates indicated.\nNATIONAL CITY BANCSHARES, INC.\nBy \/s\/ JOHN D. LIPPERT 3\/15\/94 John D. Lippert Date Chairman of the Board and Chief Executive Officer\nBy \/s\/ ROBERT A. KEIL 3\/15\/94 Robert A. Keil Date President and Chief Financial Officer\nBy \/s\/ HAROLD A. MANN 3\/15\/94 Harold A. Mann Date Secretary and Treasurer (Chief Accounting Officer)\nPursuant 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 and on the dates indicated.\nDonald B. Cox Date Director\n\/s\/ SUSANNE R. EMGE 3\/15\/94 Mrs. N. Keith Emge Date Director\n\/s\/ MICHAEL D. GALLAGHER 3\/15\/94 Michael D. Gallagher Date Director\n\/s\/ DONALD G. HARRIS 3\/15\/94 Donald G. Harris Date Director\n\/s\/ ROBERT H. HARTMANN 3\/15\/94 Robert H. Hartmann Date Director\n\/s\/ C. MARK HUBBARD 3\/15\/94 C. Mark Hubbard Date Director\n\/s\/ EDGAR P. HUGHES 3\/15\/94 Edgar P. Hughes Date Director\n\/s\/ R. EUGENE JOHNSON 3\/15\/94 R. Eugene Johnson Date Director\n\/s\/ EDWIN F. KARGES, JR. 3\/15\/94 Edwin F. Karges, Jr. Date Director\n\/s\/ ROBERT A. KEIL 3\/15\/94 Robert A. Keil Date Director\n\/s\/ JOHN D. LIPPERT 3\/15\/94 John D. Lippert Date Director\n\/s\/ JOHN LEE NEWMAN 3\/15\/94 John Lee Newman Date Director\n\/s\/ RONALD G. REHERMAN 3\/15\/94 Ronald G. Reherman Date Director\nLaurence R. Steenberg Date Director\n\/s\/ C. WAYNE WORTHINGTON 3\/15\/94 C. Wayne Worthington Date Director\n\/s\/ GEORGE A. WRIGHT 3\/15\/94 George A. Wright Date Director\nEXHIBIT INDEX\nReg. S-K\nEXHIBIT NUMBER DESCRIPTION OF EXHIBIT\n3 Articles of Incorporation, as amended\n13 Annual Report to Shareholders for the year ended December 31, 1993\n22 Subisdiaries of the Registrant\n28 Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 1994","section_15":""}
{"filename":"825313_1993.txt","cik":"825313","year":"1993","section_1":"ITEM 1. BUSINESS\nGeneral The Partnership was formed in 1987 to succeed to the business of ACMC which began providing investment management services in 1971. On April 21, 1988 the business and substantially all of the operating assets of ACMC were conveyed to the Partnership in exchange for a 1% general partnership interest in the Partnership and 30,868,182 Units (adjusted to reflect the Partnership's two for one Unit split effective February 22, 1993). In December 1991 ACMC transferred its 1% general partnership interest in the Partnership to Alliance.\nOn February 10, 1993 the Partnership declared a two for one Unit split payable to Unitholders of record on February 22, 1993. All Unit and per Unit amounts in this Annual Report on Form 10-K have been adjusted where necessary to reflect the Unit split.\nIn July 1992 AXA acquired 49% of the issued and outstanding shares of the capital stock of ECI. ECI is a public company with shares traded on the New York Stock Exchange, Inc. (\"NYSE\"). ECI owns all of the shares of Equitable.\nAXA is a member of a group of companies (\"AXA Group\") that is the second largest insurance group in France and one of the largest insurance groups in Europe. Principally engaged in property and casualty insurance and life insurance in Europe and elsewhere in the world, the AXA Group is also involved in real estate operations and certain other financial services, including mutual fund management, lease financing services and brokerage services. Based on information provided by AXA, as of December 31, 1993, 42.7% of the voting shares (representing 54.8% of the voting power) of AXA were owned by Midi Participations, a French corporation that is a holding company. The voting shares of Midi Participations are in turn owned 60% by Finaxa, a French corporation that is a holding company, and 40% by subsidiaries of Assicurazioni Generali S.p.A., an Italian corporation (\"Generali\") (one of which, Belgica Insurance Holdings S.A., a Belgian corporation, owned 34.2%). As of December 31, 1993, 62.4% of the voting shares (representing 71.5% of the voting power) of Finaxa were owned by five French mutual insurance companies (\"Mutuelles AXA\") one of which, AXA Assurance I.A.R.D. Mutuelle, owned 31.6% of the voting shares (representing 45.5% of the voting power), and 27.1% of the voting shares (representing\n19.7% of the voting power) of Finaxa were owned by Compagnie Financiere de Paribas, a French financial institution engaged in banking and related activities (\"Paribas\"). Including the shares owned by Midi Participations, as of December 31, 1993, the Mutuelles AXA directly or indirectly owned 51.7% of the voting shares (representing 64.2% of the voting power) of AXA. In addition, certain subsidiaries of AXA own 0.3% of the shares of AXA which may not be voted. Acting as a group, the Mutuelles AXA control AXA, Midi Participations and Finaxa. The Mutuelles AXA have approximately 1.5 million policyholders.\nOn July 22, 1993 the business and substantially all of the assets of Equitable Capital Management Corporation (\"ECMC\") were transferred to the Partnership. The Partnership assumed substantially all of ECMC's liabilities and issued 12,500,000 Units (consisting of 12,400,000 Units and a newly created Class A Limited Partnership Interest convertible initially into 100,000 Units). The Partnership issued 11,800,000 of the Units and the Class A Limited Partnership Interest to ECMC. ECMC may receive additional Units valued at up to $25 million under a formula based on contingent incentive fees received by the Partnership prior to April 1, 1998. The remaining 600,000 Units were issued to certain ECMC employees at a substantial discount from market value. In addition, ACMC purchased 2,380,952 Units for $50 million in cash. ECMC and ACMC are wholly-owned subsidiaries of Equitable. As a result of this transaction Equitable's direct and indirect percentage ownership interest in the Units increased to approximately 63%. The transaction was accounted for in a manner similar to the pooling of interests method. Accordingly, all financial data for all periods presented, except as specifically stated herein, has been restated to include the results of operations of ECMC.\nOn March 7, 1994 the Partnership acquired the business of Shields Asset Management, Incorporated (\"Shields\") and its wholly-owned subsidiary, Regent Investor Services Incorporated (\"Regent\") for a purchase price of $70 million in cash. Shields and Regent are investment managers with client assets under management aggregating approximately $8 billion as of December 31, 1993. Shields' clients consist primarily of collectively bargained multiemployer retirement plan accounts. Regent's clients are primarily smaller retirement plan accounts and \"wrap-fee\" accounts of individuals maintained with third-party broker-dealers with whom Regent has entered into agreements under which Regent is one of several investment managers who may be selected by the client. In addition the Partnership issued 645,160 new Units to key employees of Shields and Regent in connection with their entering into long term employment agreements.\nThe Partnership, one of the nation's largest investment advisers, provides diversified investment management services both to institutional clients and, through various investment vehicles, to individual investors.\nThe Partnership's institutional account management business consists primarily of the active management of equity and fixed income accounts. The Partnership's institutional clients include corporate and public employee pension funds, the general and separate accounts of Equitable and its insurance company subsidiaries, endowment funds, and other domestic and foreign institutions. The Partnership's individual investor services, which developed as a diversification of its institutional investment management business, consist of the management, distribution and servicing of mutual funds and cash management products, including money market funds and deposit accounts.\nThe following tables provide a summary of assets under management and associated revenues:\nASSETS UNDER MANAGEMENT (in millions)\nREVENUES (in thousands)\nInstitutional Account Management\nThe Partnership provides investment management services to institutional clients. As of December 31, 1991, 1992, and 1993 institutional accounts (other than investment companies and deposit accounts) represented approximately 72%, 71%, and 68% respectively, of the total assets under management by the Partnership. The fees earned from the management of those accounts represented approximately 44%, 39% and 38% of the Partnership's revenues for 1991, 1992 and 1993, respectively.\nINSTITUTIONAL ACCOUNT ASSETS UNDER MANAGEMENT (in millions)\nREVENUES FROM INSTITUTIONAL ACCOUNT MANAGEMENT (in thousands)\nInvestment Management Services\nThe Partnership's institutional account management business consists primarily of the active management of equity accounts, balanced (equity and fixed income) accounts and fixed income accounts. The Partnership also provides active management for venture capital portfolios, and international (non-U.S.) and global (including U.S.) equity, balanced and fixed income portfolios. The Partnership provides \"passive\" management services for equity, fixed income and international accounts. As of December 31, 1993 the Partnership's accounts were managed by 81 portfolio managers with an average of 16 years of experience in the industry and 10 years of experience with the Partnership.\nEQUITY AND BALANCED ACCOUNTS. The Partnership's equity and balanced accounts contributed approximately 20%, 21% and 20% of the Partnership's total revenues for 1991, 1992 and 1993, respectively. Assets under management relating to active equity and balanced accounts grew from approximately $19.7 billion as of December 31, 1988 to approximately $33.9 billion as of December 31, 1993.\nThe Partnership has had a distinct and consistent style of equity investing that has remained essentially unchanged since its inception. The Partnership does not emphasize market timing as an investment tool but instead emphasizes long-term trends and objectives, generally remaining fully invested. The Partnership's strategy is to invest in the securities of companies experiencing growing earnings momentum. Consequently, the Partnership's client portfolios tend to include growth stocks. The result of these investment characteristics is that the Partnership's client portfolios tend to have, as compared to the average of companies comprising the Standard & Poor's Index of 500 Stocks (\"S&P 500\"), a greater market price volatility, a lower average yield, and a higher average price-earnings ratio.\nThe Partnership's principal method of securities evaluation is through fundamental analysis undertaken by its internal staff of full-time research analysts, supplemented by research undertaken by the Partnership's portfolio managers. The Partnership holds frequent investment strategy meetings in which senior management, portfolio managers and analysts establish the Partnership's firmwide investment strategy, including asset classes and mix, investment themes, and industry concentrations. The Partnership's portfolio managers then construct and maintain portfolios that adhere to each client's guidelines and conform to the Partnership's current investment strategy.\nThe Partnership's balanced accounts consist of an equity component and a fixed income component. Typically, from 50% to 75% of a balanced account is managed in the same manner as a separate equity account, while the remaining fixed income component is oriented toward capital preservation and income generation.\nFIXED INCOME ACCOUNTS. The Partnership's fixed income accounts contributed approximately 20%, 15% and 14% of the Partnership's total revenues for 1991, 1992 and 1993, respectively. Assets under management relating to active fixed income accounts decreased from approximately $30.9 billion as of December 31, 1988 to approximately $30.8 billion as of December 31, 1993.\nThe Partnership's fixed income management services include conventional actively managed bond portfolios in which portfolio maturity structures, market sector concentrations and other characteristics are actively shifted in anticipation of market changes. The fixed income services also include managing portfolios investing in foreign government securities and other foreign debt securities of high quality and short duration, utilizing currency cross hedging to manage currency risk. Sector concentrations and other portfolio characteristics are heavily committed to areas that the Partnership's portfolio managers believe have the best investment values. The Partnership also manages portfolios that are confined to investment in specialized areas of the fixed income markets, such as mortgage-backed securities and high yield bonds.\nAlliance Corporate Finance Group Incorporated (\"ACFG\"), a wholly-owned subsidiary of the Partnership, manages investments in private mezzanine financings and private investment limited partnerships. Private mezzanine financings are investments in the subordinated debt and\/or preferred stock portion of leveraged transactions (such as leveraged buy-outs, leveraged acquisitions and leveraged recapitalizations). Such investments may be coupled with a contingent interest component or investment in an equity participation, which provide the potential for capital appreciation.\nACFG uses a network of investment banks, commercial banks, other financial institutions and issuers to generate investment opportunities in the private placement market. This network permits ACFG to seek to manage risk through high selectivity and diversification strategies. ACFG also seeks to mitigate risk through an ongoing program of monitoring the performance of the companies in its portfolios. In addition, ACFG maintains a separate Investment Recovery Group responsible for maximizing the recovery of clients' investments in troubled companies.\nACFG manages two private investment funds designed for institutional investors, with an aggregate of approximately $986 million under management as of December 31, 1993. As of that date, Equitable and its insurance company subsidiaries had investments of approximately $329 million in these funds.\nThe Partnership manages two collateralized bond obligation funds whose pool of collateral debt securities consist primarily of privately-placed, fixed rate corporate debt securities acquired from Equitable and its affiliates. As of December 31, 1993 these funds had approximately $768 million under management. As of that date, Equitable and its insurance company subsidiaries had investments of approximately $374 million in these funds.\nACFG also manages two limited partnerships regulated as business development companies under the Investment Company Act of 1940 (\"Investment Company Act\") which invest primarily in private mezzanine financings. As of December 31, 1993 these funds had net assets of approximately $377 million.\nOTHER SERVICES. The Partnership's strategy in passive portfolio management is to provide customized portfolios to meet specialized client needs, such as a portfolio fitted to an index of small-capitalization stocks. In addition, the Partnership offers domestic and international indexation strategies, such as portfolios designed to match the performance characteristics of the S&P 500 and the Morgan Stanley Capital International Indices. The Partnership also offers a variety of structured fixed income portfolio applications, including immuniza- tion (designed to produce a compound rate of return over a specified time, irrespective of interest rate movements), dedication (designed to produce specific cash flows at specific times to fund known liabilities) and indexation (designed to replicate the return of a specified market index or benchmark). A subsidiary of the Partnership is the manager of four passive U.K. unit trusts which invest in small capitalization common stocks on a global basis. As of December 31, 1993, the Partnership managed approximately $13.0 billion in passive portfolios.\nSubsidiaries of the Partnership maintain offices in London, England and Tokyo, Japan which provide international and global investment management and advisory services to institutional and other clients, and in Melbourne, Australia and Vancouver, Canada, Toronto, Canada and Singapore which market investment management services.\nClients\nThe approximately 940 institutional accounts (other than investment companies) for which the Partnership acts as investment manager include corporate employee benefit plans, public employee retirement systems, the general and separate accounts of Equitable and its insurance company subsidiaries, endowment funds, foundations, foreign governments and financial and other institutions. Generally, the minimum size for a new separately managed account is $10 million.\nThe general and separate accounts of Equitable and its insurance company subsidiaries are the Partnership's largest institutional clients. As of December 31, 1993 these accounts, excluding investments made by these accounts in The Hudson River Trust (See \"Individual Investor Services - The Hudson River Trust\"), represented approximately 22.1% of total assets under management by the Partnership and approximately 12.4% of the Partnership's annual revenues for 1993.\nPrior to the acquisition of the business and substantially all of the assets of ECMC during 1993, corporate employee benefit plans (\"corporate plans\") constituted the largest segment of the Partnership's institutional clients. As of December 31, 1993, corporate plan accounts represented approximately 17% of total assets under management by the Partnership. Assets under management for other tax-exempt accounts, including public employee benefit funds organized by government agencies and municipalities, endowments, foundations and multi-em- ployer employee benefit plans, represented approximately 28% of total assets under management as of December 31, 1993.\nThe following table lists the Partnership's ten largest institutional clients, ranked in order of size of total assets under management as of December 31, 1993. Since the Partnership's fee schedules vary based on the type of account, the table does not reflect the ten largest revenue generating clients.\nClient or Sponsoring Employer Type of Account - ----------------------------- ---------------\nEquitable and its insurance company subsidiaries . . . . . . . . . . . . Equity, Fixed Income, Passive A Foreign Government Central Bank. . . . . . . Equity, Global Equity, Fixed Income, Global Fixed Income North Carolina Retirement System . . . . . . . Passive Equity, Equity, Global Equity BellSouth Corporation. . . . . . . . . . . . . Passive Equity State Board of Administration of Florida . . . Equity, Fixed Income Ford Motor Company . . . . . . . . . . . . . . Equity, Venture Capital Boeing Company . . . . . . . . . . . . . . . . Equity, Balanced Ontario Municipal Employees Retirement System . . . . . . . . . . . . . Passive Equity National Westminster Bancorp, Inc. . . . . . . Equity, Fixed Income Wyoming Retirement System. . . . . . . . . . . Balanced\nAs of December 31, 1993 these institutional clients accounted for approximately 43.0% of the Partnership's total assets under management. No single institutional client other than Equitable and its insurance company subsidiaries accounted for more than approximately 1.1% of the Partnership's total revenues for the year ended December 31, 1993.\nSince its inception, the Partnership has experienced periods when it gained significant numbers of new accounts or amounts of assets under management and periods when it lost significant accounts or assets under management. These fluctuations result from, among other things, the relative attractiveness of the Partnership's investment style or level of performance under prevailing market conditions, changes in the investment patterns of clients that dictate a shift in assets under management and other circumstances such as changes in the management or control of a client.\nInvestment Management Agreements and Fees\nThe Partnership's institutional accounts are managed pursuant to a written investment management agreement between the client and the Partnership, which usually is terminable at any time or upon relatively short notice by either party. In general, the Partnership's contracts may not be assigned without the consent of the client.\nIn providing investment management services to institutional clients, the Partnership is principally compensated on the basis of fees calculated as a percentage of assets under management. Fees are generally billed quarterly and are calculated on the net asset value of an account at the beginning or end of a quarter or on the average of such values during the quarter. As a result, fluctuations in the amount or value of assets under management are reflected in revenues from management fees within two calendar quarters.\nManagement fees paid on equity and balanced accounts are generally charged in accordance with a fee schedule that ranges from 0.75% (for the first $10 million in assets) to 0.25% (for assets over $60 million) per annum of assets under management. Fees for the management of fixed income portfolios generally are charged in accordance with lower fee schedules, while fees for passive equity portfolios typically are even lower. With respect to approximately 6.1% of assets under management, including certain of the portfolios of the clients listed in the table listing the Partnership's ten largest institutional clients, the Partnership charges performance-based fees, which consist of a relatively low base fee plus an additional fee based on a percentage of assets if invest- ment performance for the account exceeds certain benchmarks. No assurance can be given that such fee arrangements will not become more common in the investment management industry. Utilization of such fee arrangements by the Partnership on a broader basis could create greater fluctuations in the Partnership's revenues.\nACFG's fees for corporate finance activities generally involve the payment of a base management fee ranging from 0.10% to 1.00% of assets under management per annum. In some cases ACFG receives incentive fees generally equivalent\nto 20% of any gains in excess of a specified hurdle rate.\nIn connection with the investment advisory services provided to the general and separate accounts of Equitable and its insurance company subsidiaries the Partnership provides ancillary accounting, valuation, reporting, treasury and other services for regulatory purposes.\nMarketing\nThe Partnership's institutional products are marketed by marketing specialists assisted by portfolio managers. These marketing specialists solicit business on a full-time basis for the entire range of the Partnership's institutional account management services. Regional office personnel, including investment managers, participate directly in attracting business for their particular office and products. In addition, marketing specialists are dedicated to public retirement systems.\nIndividual Investor Services\nThe Partnership (i) manages and sponsors a broad range of open-end and closed-end mutual funds other than The Hudson River Trust (\"Alliance Mutual Funds\"), (ii) manages The Hudson River Trust which is the funding vehicle for the variable annuity insurance and variable life insurance products offered by Equitable and its insurance company subsidiaries, and (iii) provides cash management services (money market funds and federally insured deposit accounts) that are marketed to individual investors through broker-dealers and other financial intermediaries. The assets comprising all Alliance Mutual Funds, The Hudson River Trust and deposit accounts on December 31, 1993 amounted to approximately $37.4 billion held in more than 1,500,000 investor accounts. The assets of the Alliance Mutual Funds and The Hudson River Trust are managed by the same investment professionals who manage the Partnership's institutional client accounts.\nREVENUES FROM INDIVIDUAL INVESTOR SERVICES (in thousands)\nAlliance Mutual Funds\nThe Partnership has been managing mutual funds since 1971. Since then, the Partnership has sponsored open-end load mutual funds, closed-end mutual funds and offshore mutual funds. On December 31, 1993 the assets in the Alliance Mutual Funds totalled approximately $22.0 billion. Additional funds are under development.\nThe Hudson River Trust\nThe Hudson River Trust is the funding vehicle for the variable annuity insurance and variable life insurance products offered by Equitable and its insurance company subsidiaries. On December 31, 1993 the assets of the various portfolios of The Hudson River Trust were as follows:\nDISTRIBUTION. The Alliance Mutual Funds are distributed to individual investors through national and regional broker-dealers, insurance sales representatives, banks and other financial intermediaries. Alliance Fund Distributors, Inc. (\"AFD\"), a registered broker-dealer and a wholly-owned subsidiary of the Partnership, serves as the principal underwriter and distributor of the Alliance Mutual Funds registered under the Investment Company Act of 1940 as \"open-end\" investment companies (\"U.S. Funds\") and serves as the placing or distribution agent of the Alliance Mutual Funds not registered under the Investment Company Act (\"Offshore Funds\"). 63 sales representatives devote their time exclusively to promoting the sale of Alliance Mutual Fund shares by financial intermediaries.\nMany of the financial intermediaries that sell shares of Alliance Mutual Funds also offer shares of funds not managed by the Partnership and, in some cases, offer shares managed by their own affiliates.\nDuring 1993 the Partnership expanded its mutual fund distribution system (the \"System\") to include a third distribution option. The System permits open- end Alliance Mutual Funds to offer investors the option of purchasing shares (a) subject to a conventional front-end sales charge (\"Class A Shares\"), (b) without a front-end sales charge but subject to a contingent deferred sales charge payable by shareholders (\"CDSC\") and higher distribution fees and transfer agent costs payable by the Funds (\"Class B Shares\") or (c) without either a front-end sales charge or the CDSC but with higher distribution fees payable by the funds (\"Class C Shares\"). If a shareholder purchases Class A Shares, AFD compensates the financial intermediary distributing the Fund from a portion of the front-end sales charge paid by the shareholder at the time of each sale. If a shareholder purchases Class B Shares, AFD does not collect a front-end sales charge even though AFD is obligated to compensate the financial intermediary at the time of each sale. Payments made to financial intermediaries during 1993 in connection with the System, net of CDSC received, totalled approximately $75.3 million. Management of the Partnership believes AFD will recover the payments made to financial intermediaries from the higher distribution fees and CDSC it receives over periods not exceeding 5 1\/2 years. If a shareholder purchases Class C Shares, AFD does not collect a front-end sales charge or CDSC and does not compensate the financial intermediary at the time of sales but the entire amount of the distribution fees attributable to Class C Shares is paid to the financial intermediary. The rules of the National Association of Securities Dealers, Inc. effectively limit the aggregate of all front-end, deferred and asset-based sales charges paid to AFD with respect to any class of its shares by each open-end Alliance Mutual fund to 6.25% of cumulative gross sales of shares of that class, plus interest at the prime rate plus 1% per annum.\nThe open-end U.S. Funds and Offshore Funds have entered into agreements with AFD, under which AFD is paid a distribution services fee. The Partnership uses borrowings and its own resources to finance distribution of open-end Alliance Mutual Fund shares.\nThe selling and distribution agreements between AFD and the financial intermediaries that distribute Alliance Mutual Funds are terminable by either party upon notice (generally of not more than sixty days) and do not obligate the financial intermediary to sell any specific amount of fund shares. A small amount of mutual fund sales is made directly by AFD, in which case AFD retains the entire sales charge paid.\nDuring 1993 the ten largest dealers with which AFD had selling agreements were responsible for 72% of the total sales of Alliance Mutual Funds. Equico Securities, Inc. (\"Equico\"), a wholly-owned subsidiary of Equitable that utilizes members of Equitable's insurance agency sales force as its registered representatives, has entered into a selected dealer agreement with AFD and since 1986 has been responsible for a significant portion of total open-end mutual fund sales (8% in 1993). Equico is under no obligation to sell a specific amount of fund shares and also sells shares of mutual funds sponsored by organizations unaffiliated with Equitable.\nSubsidiaries of Merrill Lynch & Co., Inc. (collectively \"Merrill Lynch\") were responsible for approximately 26%, 21% and 35% of Alliance Mutual Fund sales in 1991, 1992 and 1993, respectively. Merrill Lynch is not under any obligation to sell a specific amount of Alliance Mutual Fund shares and also sells shares of mutual funds which it sponsors and which are sponsored by unaffiliated organizations.\nNo other dealer or agent has in any year since 1988 accounted for more than 10% of the sales of open-end Alliance Mutual Funds.\nBased on market data reported by the Investment Company Institute (December 1993), the Partnership's market share in the U.S. mutual fund industry is 1.32% of total industry assets and the Partnership accounted for 2.69% of total open-end and closed-end fund sales force-derived industry sales in the U.S. during 1993. While the performance of the Alliance Mutual Funds is a factor in the sale of their shares, there are other factors contributing to success in the mutual fund management business that are not present in the institutional account management business. These factors include the level and quality of shareholder services (see \"Shareholder and Administration Services\" below) and the amounts and types of distribution assistance and administrative services payments. The Partnership believes that its compensation programs with dealers and distributors are competitive with others in the industry.\nUnder current interpretations of the Glass-Steagall Act and other laws and regulations governing depository institutions, banks and certain of their affiliates generally are permitted to act as agent for their customers in connection with the purchase of mutual fund shares and to receive as compensation a portion of the sales charges paid with respect to such purchases. During 1993, banks and their affiliates accounted for approximately 19.7% of the sales of shares of open-end Alliance Mutual Funds.\nINVESTMENT MANAGEMENT AGREEMENTS AND FEES. Management fees from the Alliance Mutual Funds and The Hudson River Trust vary between .35% and 1.20% per annum of average net assets. As certain of the U.S. Funds have grown, fee schedules have been revised to provide lower incremental fees above certain levels. Fees paid by the U.S. Funds and The Hudson River Trust are fixed annually by negotiation between the Partnership and the board of directors or trustees of each U.S. Fund and The Hudson River Trust, including a majority of the disinterested directors or trustees. Changes in the fees must be approved by the shareholders of each U.S. Fund and The Hudson River Trust. In general, the investment management agreements of the U.S. Funds and The Hudson River Trust provide for termination at any time upon 60 days notice.\nInvestment management fees paid by Alliance Short-Term Multi-Market Trust represented approximately 9%, 10% and 5% of the Partnership's aggregate investment advisory fees in 1991, 1992 and 1993, respectively.\nUnder each investment management agreement with a U.S. Fund, the Partnership provides the U.S. Fund with investment management services, office space and order placement facilities and pays all compensation of directors or trustees and officers of the U.S. Fund who are affiliated persons of the Partnership. Each U.S. Fund pays all of its other expenses. If the expenses of a U.S. Fund exceed an expense limit established under the securities laws of any state in which shares of that U.S. Fund are qualified for sale or as prescribed in the U.S. Fund's investment management agreement, the Partnership absorbs such excess through a reduction in the advisory fee. Currently, the Partnership believes that California is the only state to impose such a limit. The expense ratios for the U.S. Funds during their most recent fiscal year ranged from 0.97% to 2.69%. In connection with newly organized U.S. Funds, the Partnership may also agree to reduce its fee or bear certain expenses to limit a fund's expenses during an initial period of operations. The Partnership does not expect, however, that state expense or voluntary limits, at current fee and expense levels, will have a significant effect on the results of its operations.\nCash Management Services\nThe Partnership provides individual cash management services through a product line comprising twelve money market fund portfolios and two types of brokered money market deposit accounts. Assets in these products as of December 31, 1993 totalled approximately $8.1 billion.\nThe Partnership also offers a managed assets program, which provides customers of participating broker-dealers with a Visa Card, access to automated teller machines and check writing privileges. The program is linked to the customer's chosen Alliance money market fund. The program serves to enhance relationships with broker-dealers and to attract and retain investments in the Alliance money market funds, as well as to generate fee income.\nUnder its investment management agreement with each money market fund, the Partnership is paid an investment management fee equal to 0.50% per annum of the fund's average net assets except for ACM Institutional Reserves which pays a fee between 0.20% and 0.45% of its average net assets. In the case of Alliance Capital Reserves, the fee is payable at lesser rates with respect to average net assets in excess of $1.25 billion. For its distribution and account maintenance services\nrendered in connection with the sale of money market deposit accounts, the Partnership receives fees from the participating banks that are based on outstanding account balances. Because the money market deposit account programs involve no investment management functions to be performed by the Partnership, the Partnership's costs of maintaining the account programs are less, on a relative basis, than its costs of managing the funds.\nMore than 95% of the assets invested in the Partnership's cash management programs are attributable to regional broker-dealers and other financial intermediaries, with the remainder coming directly from the public. Through active sales efforts, the Partnership has been able to increase the number of financial intermediaries that feature the Alliance line. On December 31, 1993 more than 400 financial intermediaries offered Alliance cash management services. The Partnership's money market fund market share (not including deposit products), as computed based on market data reported by the Investment Company Institute (November 1993), has increased from .82% of total money market fund industry assets at the end of 1987 to 1.33% at November 30, 1993.\nThe Partnership makes payments to financial intermediaries for distribution assistance and shareholder servicing and administration. The Alliance money market funds pay fees to the Partnership at annual rates of up to 0.25% of average daily net assets pursuant to \"Rule 12b-1\" distribution plans. Such payments are supplemented by the Partnership in making payments to intermediaries under the distribution assistance and shareholder servicing and administration program. During 1993 such supplemental payments totalled $22.1 million ($19.6 million in 1992). Nine employees of the Partnership devote their time exclusively to marketing the Partnership's cash management services.\nA principal risk to the Partnership's cash management services business is the acquisition of its participating intermediaries by companies that are competitors or that plan to enter the cash management services business. As of December 31, 1993 the five largest participating intermediaries were responsible for assets aggregating approximately $4.2 billion, or 51% of the Alliance cash management services total. Donaldson, Lufkin & Jenrette Securities Corporation (\"DLJ Securities Corporation\"), a subsidiary of Equitable, was one of these intermediaries.\nMany of the financial intermediaries whose customers utilize the Partnership's cash management services are broker-dealers whose customer accounts are carried, and whose securities transactions are cleared and settled, by the Pershing Division (\"Pershing\") of DLJ Securities Corporation. Pursuant to an agreement between Pershing and the Partnership, Pershing recommends to certain of its correspondent firms the use of Alliance money market funds and other cash management products. In return, Pershing is allocated a portion of the revenues derived by the Partnership from sales through such Pershing correspondents. During 1993 these payments to Pershing amounted to approxi- mately $2.9 million. As of December 31, 1993 DLJ Securities Corporation and these Pershing correspondents were responsible for approximately 38% of Alliance's total cash management assets. Pershing may terminate its agreement with the Partnership on 180 days' notice. If the agreement were terminated, Pershing would be under no obligation to recommend or in any way assist in the sale of Alliance cash management products and would be free to recommend or assist in the sale of competitive products.\nThe Alliance money market funds are investment companies registered under the Investment Company Act and are managed under the supervision of boards of directors or trustees, which include disinterested directors or trustees who must approve investment management agreements and certain other matters. The investment management agreements between the money market funds and the Partnership provide for an expense limitation of 1% per annum or less of average daily net assets. See \"Alliance Mutual Funds.\"\nShareholder and Administration Services\nAlliance Fund Services, Inc. (\"AFS\"), a wholly-owned subsidiary of the Partnership, provides registrar, dividend disbursing and transfer-agency related services for each U.S. Fund and provides servicing for each U.S. Fund's shareholder accounts. As of December 31, 1993 AFS employed approximately 257 people. AFS operates out of offices in Secaucus, New Jersey. Under each servicing agreement AFS receives a monthly fee. Each servicing agreement must be approved annually by the relevant U.S. Fund's board of directors or trustees, including a majority of the disinterested directors or trustees, and may be terminated by either party without penalty upon 60 days' notice.\nAlliance International Fund Services S.A. (\"AIFS\"), a wholly-owned subsidiary of the Partnership, is the registrar and transfer agent of substantially all of the Offshore Funds. As of December 31, 1993 AIFS employed approximately 4 people. AIFS operates out of its offices in Luxembourg. AIFS receives a monthly fee for its registrar and transfer agency\nservices. Each agreement between AIFS and an Offshore Fund may be terminated by either party upon 60 days' notice.\nThe Partnership expects to continue to devote substantial resources to shareholder servicing because of its importance in competing for assets invested in mutual funds and cash management services.\nIn addition, under most U.S. Fund investment management agreements, the U.S. Funds are authorized to utilize Partnership personnel to perform legal, clerical and accounting services not required to be provided by the Partnership. The payments therefore must be specifically approved in advance by the U.S. Fund's board of directors or trustees. Currently, the Partnership and AFS are accruing revenues for providing clerical and accounting services to such U.S. Funds at the rate of approximately $7.0 million per year.\nCompetition\nThe financial services industry is highly competitive and new entrants are continually attracted to it. No one or small number of competitors is dominant in the industry. The Partnership is subject to substantial competition in all aspects of its business. Pension fund, institutional and corporate assets are managed by investment management firms, broker-dealers, banks and insurance companies. Many of these financial institutions have substantially greater resources than the Partnership. The Partnership competes with other providers of institutional investment products and services primarily on the basis of the range of investment products offered, the investment performance of such products and the services provided to clients. Based on an annual survey conducted by PENSIONS & INVESTMENTS, as of January 1, 1993, prior to the acquisition of the business and assets of ECMC, the Partnership was ranked 10th out of 851 managers based on tax-exempt assets under management, 6th out of the 25 largest managers of active U.S. assets invested abroad, 5th out of the 25 largest managers of international index assets, 6th out of the 25 largest managers of domestic equity index funds and 10th out of the 25 largest managers of mortgage-backed securities.\nMany of the firms competing with the Partnership for institutional clients also offer mutual fund shares and cash management services to individual investors. Competitiveness in this area is chiefly a function of the range of mutual funds and cash management services offered, investment performance, the quality in servicing customer accounts and the capacity to provide financial incentives to intermediaries through distribution assistance and administrative services payments funded by \"Rule 12b-1\" distribution plans and the manager's own resources.\nCustody and Brokerage\nNeither the Partnership nor its subsidiaries maintains custody of client funds or securities, which is maintained by client-designated banks, trust companies, brokerage firms or other custodians. Custody of the assets of Alliance Mutual Funds, The Hudson River Trust and money market funds is main- tained by custodian banks and central securities depositories.\nThe Partnership generally has the discretion to select the brokers with whom orders for the purchase or sale of securities for client accounts are placed for execution. These brokers include those that have correspondent clearing arrangements with Pershing. Broker-dealers affiliated with Equitable are used to effect transactions for client accounts only if the use of the broker-dealers has been specifically authorized or directed by the client.\nRegulation\nThe Partnership, ACFG and Alliance are investment advisers registered under the Investment Advisers Act of 1940. Each U.S. Fund is registered with the Securities and Exchange Commission (\"SEC\") under the Investment Company Act and the shares of most are qualified for sale in all states in the United States and the District of Columbia, except for Funds offered only to residents of a particular state. AFS is registered with the SEC as a transfer agent and AFD is registered with the SEC as a broker-dealer. AFD is subject to minimum net capital requirements ($4.6 million at December 31, 1993) imposed by the SEC on registered broker-dealers and had aggregate regulatory net capital of $5.9 million at December 31, 1993.\nThe relationships of Equitable and its insurance company subsidiaries with the Partnership are subject to applicable provisions of the New York Insurance Law and regulations. Certain of the investment advisory agreements and ancillary administrative service agreements between Equitable and the insurance company subsidiaries and the Partnership are subject to disapproval by the New York Superintendent of Insurance within a prescribed notice period. Under the New York Insurance Law and regulations, the terms of these agreements are to be fair and equitable, charges or fees for services performed are to be reasonable, and certain other standards must be met. Fees must be determined either with reference to fees charged to other clients for similar services or, in certain cases, which include the ancillary service agreements, based on cost reimbursement.\nThe Partnership's assets under management and its revenues derived from the general accounts of Equitable and its insurance company subsidiaries are directly affected by the investment policies for the general accounts. Among the numerous factors influencing general account investment policies are regulatory factors, such as (i) laws and regulations that require diversification of the investment portfolios and limit the amount of investments in certain investment categories such as below investment grade fixed maturities, equity real estate and equity interests, (ii) statutory investment valuation reserves, and (iii) risk-based capital guidelines for life insurance companies approved by the National Association of Insurance Commissioners for implementation beginning with the 1993 statutory financial statements. Equitable is generally following a strategy of directing new general account investments into investment grade securities and reducing its portfolio of below investment grade fixed maturities and currently has a policy of not investing substantial new funds in equity interests. This has the effect of shifting general account assets managed by the Partnership into categories having lower management fees.\nAll aspects of the Partnership's business are subject to various federal and state laws and regulations and to the laws in the foreign countries in which the Partnership's subsidiaries conduct business. These laws and regulations are primarily intended to benefit clients and fund shareholders and generally grant supervisory agencies broad administrative powers, including the power to limit or restrict the carrying on of business for failure to comply with such laws and regulations. In such event, the possible sanctions which may be imposed include the suspension of individual employees, limitations on engaging in business for specific periods, the revocation of the registration as an investment adviser, censures and fines.\nEmployees\nAs of December 31, 1993 the Partnership and its subsidiaries employed 1,284 full-time employees, including 147 investment professionals, of whom 81 are portfolio managers, 58 are securities analysts, and 8 are order placement specialists. The average period of employment of these professionals with the Partnership is approximately 8 years and their average investment experience is approximately 14 years. The Partnership considers its employee relations to be good.\nService Marks\nThe Partnership has registered a number of service marks with the U.S. Patent and Trademark Office, including an \"A\" design logo and the combination of such logo and the words \"Alliance\" and \"Alliance Capital\". Each of these service marks was registered in 1986 and has a duration of 20 years from the date of registration (which is automatically renewable) provided the mark continues to be used during that time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership's principal executive offices at 1345 Avenue of the Americas, New York, New York are occupied pursuant to a lease which extends until 2009. The Partnership currently occupies approximately 186,000 square feet at this location and will lease approximately 15,500 square feet of additional space at this location during 1994. The Partnership also occupies approximately 51,200 square feet at 1285 Avenue of the Americas, New York, New York and approximately 80,000 square feet at 135 West 50th Street, New York, New York under leases expiring in 2001 and 1998, respectively. The Partnership and its subsidiaries, AFD and AFS, occupy approximately 67,000 square feet of space in Secaucus, New Jersey pursuant to a lease which extends until 2003. The Partnership leases substantially all of the furniture and office equipment at the New York and New Jersey offices.\nThe Partnership also leases space in California, Minnesota and Ohio, and its subsidiaries lease space in London, England, Tokyo, Japan, Melbourne, Australia, Vancouver, Canada, Toronto, Canada, Luxembourg and Singapore.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 22, 1993 substantially all of the assets of ECMC were transferred to the Partnership and certain of its wholly-owned subsidiaries pursuant to the Amended and Restated Transfer Agreement dated as of February 23, 1993, as amended and restated on May 28, 1993 (\"Transfer Agreement\"), among the Partnership, ECMC and Equitable Investment Corporation (\"EIC\"), a wholly-owned subsidiary of Equitable, in exchange for (i) 11,800,000 newly-issued Limited Partnership Interests\nwhich were immediately exchanged for 11,800,000 Units, (ii) a newly created Class A Limited Partnership Interest convertible initially into 100,000 Units, and (iii) the assumption by the Partnership and certain of its subsidiaries of certain liabilities of ECMC. The number of Units into which the Class A Limited Partnership Interest is convertible may increase based on the receipt of future contingent incentive fee income. The transfer of such assets and assumption of such liabilities are referred to herein as the \"Transfer\".\nOn or about June 8, 1993 a lawsuit was filed in the United States District Court of the Southern District of New York by the owner of an annuity contract issued by Equitable against ECMC, the Partnership, Equitable and The Hudson River Trust (PAUL D. WEXLER V. EQUITABLE CAPITAL MANAGEMENT CORPORATION, ET AL.). The Hudson River Trust is the funding vehicle for the variable annuity insurance and variable life insurance products offered by Equitable and The Equitable Variable Life Insurance Company. As of December 31, 1993 the Partnership managed approximately $7.2 billion in net assets invested in The Hudson River Trust. The lawsuit purports to be brought individually and derivatively on behalf of The Hudson River Trust which is an investment company with multiple portfolios registered under the Investment Company Act. The complaint alleges that the transfer to the Partnership of the investment advisory agreement for The Hudson River Trust imposes an unfair burden on The Hudson River Trust under Section 15(f) of the Investment Company Act. The complaint also appears to allege that the fees charged to The Hudson River Trust under the investment advisory agreement constitute excessive compensation for advisory services under Section 36(b) of the Investment Company Act. The complaint seeks a judgment declaring the Transfer to be null and void and terminating the investment advisory agreement between the Partnership and The Hudson River Trust. The complaint also seeks (apparently in the alternative) payment to The Hudson River Trust of certain amounts paid by the Partnership to ECMC pursuant to the Transfer Agreement and payment to The Hudson River Trust of the value of certain compensation arrangements entered into between the Partnership and certain employees of ECMC. On April 23, 1993 the shareholders of each of the portfolios constituting The Hudson River Trust voted to approve the new investment advisory agreement relating to each of the portfolios between the Partnership and The Hudson River Trust. The Partnership believes that the lawsuit is without merit and will vigorously defend against it.\nEIC has agreed to bear any legal and other costs of the Partnership relating to the defense or settlement of the lawsuit. In addition, since the investment advisory relationship with The Hudson River Trust was an important factor in the Partnership's decision to enter into the Transfer Agreement, ECMC, EIC and the Partnership have agreed in principle that ECMC or EIC will make a cash contribution to the Partnership in order to reflect lost value to the Partnership attributable to any loss in revenue resulting from a settlement of the lawsuit or a final, non-appealable judgment in favor of the plaintiff. In addition, if such a settlement or final, non-appealable judgment results in the termination of the Partnership's relationship with The Hudson River Trust, ECMC and EIC have agreed in principle that such cash contribution will also reflect any costs incurred by the Partnership relating to the termination of such relationship. Neither ECMC nor EIC will receive any Limited Partnership Interest or Units in return for such cash contribution.\nOn February 18, 1994 the Court ordered the complaint dismissed. Plaintiff has filed an appeal.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the fourth quarter of 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket for the Units\nThe Units are traded on the New York Stock Exchange (\"NYSE\"). The high and low sales prices on the NYSE during each quarter of the Partnership's two most recent fiscal years were as follows:\nOn February 10, 1993 the Partnership declared a two for one Unit split payable to Unitholders of record on February 22, 1993. The high and low sales prices above have been adjusted where necessary to reflect the Unit split.\nOn March 14, 1994 the closing price of the Units on the NYSE was $25.125. As of March 14, 1994 there were approximately 1,461 Unitholders of record.\nCash Distributions\nThe Partnership distributes on a quarterly basis all of its Available Cash Flow (as defined in the Partnership Agreement). During its two most recent fiscal years the Partnership made the following distributions of Available Cash Flow:\nOn February 10, 1993 the Partnership declared a two for one Unit split payable to Unitholders of record on February 22, 1993. The cash distribution per Unit amounts above have been adjusted where necessary to reflect the Unit split.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Selected Financial Data which appears on page 43 of the Alliance Capital Management L.P. 1993 Annual Report to Unitholders is incorporated by reference in this Annual Report on Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's Discussion and Analysis of Financial Condition and Results of Operations which appears on pages 44 through 52 of the Alliance Capital Management L.P. 1993 Annual Report to Unitholders is incorporated by reference in this Annual Report on Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of Alliance Capital Management L.P. and subsidiaries and the report thereon by KPMG Peat Marwick which appear on pages 53 through 69 of the Alliance Capital Management L.P. 1993 Annual Report to Unitholders are incorporated by reference in this Annual Report on Form 10-K. The financial statement schedule required by Regulation S-X is filed under Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nGeneral Partner\nThe Partnership's activities are managed and controlled by Alliance as General Partner and Unitholders do not have any rights to manage or control the Partnership. The General Partner has agreed that it will conduct no active business other than managing the Partnership, although it may make certain investments for its own account.\nThe General Partner does not receive any compensation from the Partnership for services rendered to the Partnership as General Partner. The General Partner holds a 1% general partnership interest in the Partnership. As of March 14, 1994 ACMC and ECMC, affiliates of the General Partner, held 45,371,500 Units (including 100,000 Units issuable upon conversion of the Class A Limited Partnership Interest).\nThe General Partner is reimbursed by the Partnership for all expenses incurred by it in carrying out its activities as General Partner, including compensation paid by the General Partner to its directors and officers (to the extent such persons are not compensated directly as employees of the Partnership) and the cost of directors and officers liability insurance obtained by the General Partner. The General Partner was not reimbursed for any such expenses in 1993 except for directors' fees.\nDirectors and Executive Officers of the General Partner\nThe directors and executive officers of the General Partner are as follows:\nName Age Position ---- --- --------\nDave H. Williams 61 Chairman of the Board, Chief Executive Officer and Director James M. Benson 47 Director Bruce W. Calvert 47 Director, Vice Chairman and Chief Investment Officer John D. Carifa 49 Director, President, Chief Operating Officer and Chief Financial Officer Henri de Castries 39 Director Christophe Dupont-Madinier 42 Director Alfred Harrison 56 Director and Vice Chairman Jean-Pierre Hellebuyck 46 Director Benjamin D. Holloway 69 Director Henri Hottinguer 59 Director Richard H. Jenrette 64 Director Joseph J. Melone 63 Director Brian S. O'Neil 41 Director Frank Savage 55 Director Peter G. Smith 52 Director Madelon DeVoe Talley 62 Director Reba W. Williams 57 Director David R. Brewer, Jr. 48 Senior Vice President and General Counsel Robert H. Joseph, Jr. 46 Senior Vice President-Finance and Chief Accounting Officer\nMr. Williams joined Alliance in 1977 and has been the Chairman of the Board and Chief Executive Officer since that time. He was elected a director of Equitable on March 21, 1991 and was elected to the ECI Board of Directors in July of 1992. ECI is a parent of the Partnership. Mr. Williams is the husband of Reba W. Williams.\nMr. Benson was elected a Director of Alliance in October 1993. He has been Senior Executive Vice President of ECI and President and Chief Operating Officer of Equitable since March 1994. He was a Senior Vice President of Equitable from March 1993 until March 1994. From January 1984 to March of 1993 he was President of Management Compensation Group. Mr. Benson is also a Director of Equitable, The Association for Advanced Underwriting, Health Plans, Inc., the California Special Olympics, The Joffrey Ballet and The African Wildlife Foundation. Equitable is a parent of the Partnership.\nMr. Calvert joined Alliance in 1973 as an equity portfolio manager and was elected Vice Chairman and Chief Investment Officer on May 3, 1993. From 1986 to 1993 he was an Executive Vice President and from 1981 to 1986 he was a Senior Vice President. He was elected a director of Alliance in 1992.\nMr. Carifa joined Alliance in 1971 and was elected President and Chief Operating Officer on May 3, 1993. He has been the Chief Financial Officer since 1973. He was an Executive Vice President from 1986 to 1993 and he was a Senior Vice President from 1980 to 1986. He was elected a director of Alliance in 1992.\nMr. de Castries was elected a Director of Alliance in October 1993. He has been Executive Vice President of AXA since 1993, previously serving as General Secretary of AXA from 1991 to 1993 and Central Director of Finances from 1989 to 1991. Mr. de Castries is Chairman of Compagnie Financiere de Paris, AXA Banque, Banque d'Orsay, Cecico Financement and Maeschaert Rouusselle. He also is a Director of Ateliers de Construction du Nord de la France, Cecico Location, Orsay Arbitrage, Financiere 78, France Telecom, La Paternelle Monegasque (Monaco), Equitable, Donaldson Lufkin & Jenrette, Inc. (\"DLJ\") and Equitable Real Estate Investment Management, Inc. Additionally, Mr. de Castries serves as a Representative of Compagnie Financiere de Paris on the Boards of Banque Eurofin and AXA Credit; AXA on the Boards of Investissement Finance et Developpement - I.F.D. and AXA Asset Management; and AXA Assurances Iard on the Board of Colisee Development. AXA and Equitable are parents of the Partnership.\nMr. DuPont-Madinier was elected a Director of Alliance in October 1992. He has been the Manager of AXA, International Division, since 1988. Mr. Dupont- Madinier is also director of Anglo Canada General Insurance Company, AXA Insurance Canada, AXA Assurances Canada, AXA Equity & Law UK, DLJ, Equitable Real Estate Investment Management and the chairman and director of AXA Insurance U.K. AXA is a parent of the Partnership.\nMr. Harrison joined Alliance in 1978 and was elected Vice Chairman on May 3, 1993. Mr. Harrison is in charge of the Partnership's Minneapolis office and is a senior portfolio manager. He was an Executive Vice President from 1986 to 1993 and a Senior Vice President from 1978 to 1986. He was a director from 1978 to 1987 and from February 23, 1988 until July 27, 1988. He was elected a director of Alliance in 1992.\nMr. Hellebuyck was elected a director of Alliance in October 1992. He has been the Chief Investment Officer of AXA since 1986. Mr. Hellebuyck is also a director of AXA Reassurance France, AXA Reinsurance UK Plc, AXA Reinsurance Company, Equity & Law Plc, Equity & Law Investment Managers Ltd., Equity & Law Fondsmanagement GmbH, Europhenix Management Company and Societe Des Bourses Francaises. AXA is a parent of the Partnership.\nMr. Holloway was elected a director of Alliance in November 1987. He is a consultant to Tishman\/Speyer, Edward J. Debartolo and The Continental Companies. From September 1988 until his retirement in March 1990, Mr. Holloway was a Vice Chairman of Equitable. He served as an Executive Vice President of Equitable from 1979 until 1988. Prior to his retirement he served as a director and officer of various Equitable subsidiaries and Mr. Holloway was also a director of DLJ until March 1990. Mr. Holloway is a director of Rockefeller Center Properties, Inc, Chairman of Duke University Management Corporation, the Cathedral of St. John the Divine Building and Conservation Fund and Touro National Heritage Trust and a Trustee of the Cathedral of St. John the Divine, Duke University and the American Academy in Rome (Emeritus).\nMr. Hottinguer was elected a director of Alliance in October 1992. He has been a partner of Hottinguer & Company since 1968. Mr. Hottinguer is also a President\/General Director of Banque Hottinguer and Societe Financiere Pour Le Financement De Bureaux Et D'usines - Sofibus, a Vice President, General Director and Administrator of Financiere Hottinguer, a Vice President\/Administrator of AXA International, an Administrator of Investissement Hottinguer S.A., AXA, AXA Assurances IARD, UNI Europe Assurances, ALPHA Assurances VIE and FINAXA, and the Controller of Didot Bottin, Caisee d'Escompte Du Midi and Financiere Provence de Participations - F.P.P. He serves as a General Director of Intercom and Sofides, he is a Permanent Representative of La Banque Hottinguer aupres de I.F.D., La Banque Hottinguer aupres de AXIVA, AXA aupres d'AXA Millesimes and Cie Financiere SGTE au sein de la Societe Schneider S.A., is the Associate Gerant of Hottinguer & Cie, and is a Vice President of Gaspee. In addition, he is the Chairman of the Board of Hottinguer Brothers and Co., Inc., a Director of the Helvetia Fund Inc. and DLJ, the President\/Counsel of AXA Belgium and AXA Industry S.A., the Administrator of Hestia Fund, ECU Invest, and Hottinguer Gestion and is a Member of Council of Surveillance d'EMBA N.V. AXA is a parent of the Partnership.\nMr. Jenrette was a director of Alliance from 1971 to 1985 and was reelected a director in November 1987. He is Chairman of the Board of Directors and Chief Executive Officer of ECI and Chairman of the Executive Committee of the Board of Directors of Equitable. He was Chairman of the Board of Directors of Equitable from July 1987 until March 1994 and has been a Director of Equitable since 1985 and Chairman, President and Chief Executive Officer of EIC since September 1988. He was Chief Investment Officer of Equitable from July 1986 until March 1991. Mr. Jenrette is also a director of Advanced Micro Devices and the New York Historical Society, Chairman of Historic Hudson Valley and Federal Hall Memorial Associates, a Trustee of Rockefeller Foundation and the University of North Carolina and a member of the Visiting Committee of the American Wing, Metropolitan Museum of Art and the Governor's Council on Hudson River Greenway. ECI and Equitable are parents of the Partnership.\nMr. Melone was elected a director of Alliance in January 1991. He is President and Chief Operating Officer of ECI and has been Chairman and Chief Executive Officer of Equitable since March 1994. He was President and Chief Executive Officer of Equitable from 1991 until March 1994. From 1984 to 1990, he was President of The Prudential Insurance Company of America. ECI and Equitable are parents of the Partnership.\nMr. O'Neil was elected a Director of Alliance in October 1993. He joined Equitable in 1988, serving as a Senior Vice President from February 1989 to April 1992 and was elected Executive Vice President and Chief Investment Officer in April 1992. In addition, Mr. O'Neil is President and Director of FHJV Holdings, Inc., Vice President and Director of The Equitable Variable Life Insurance Company, and Director of Equitable Real Estate Investment Management as well as The Equitable Foundation. Equitable is a parent of the Partnership.\nMr. Savage was elected a Director of Alliance in May 1993. He has been Chairman of ACFG, a subsidiary of the Partnership, since July 1993. Prior to this, he was with ECMC, serving as Vice Chairman from June 1989 to April 1992, and Chairman from April 1992 to July 1993. In addition, Mr. Savage is a Director of Lockheed Corporation and ARCO Chemical Corporation.\nMr. Smith was elected a Director of Alliance in July 1993. He has been a Managing Director of AXA Equity and Law, a subsidiary of AXA, since January 1991. Mr. Smith was also an Investment Manager with Equity and Law Life Assurance Society plc. from 1983 to 1991. AXA is a parent of the Partnership.\nMs. Talley was elected a Director of Alliance in October 1993. She was with Melhado Flynn from January 1987 to December 1989. Ms. Talley is a Governor of the National Association of Securities Dealers, Vice Chairman of the Board of W.P. Carey & Co. as well as a trustee of Smith Barney-Shearson's TRAK, Advisor Fund and Equity & Income Funds. In addition she serves as Director of Corporate Property Associates, Series 10-1 W.P. Carey Real Estate Limited Partnerships, Biocraft Labs, Schroeders Asian Growth Fund, the New York State Industrial Development Board, the New York State Common Retirement Fund and Global Asset Management Funds, Inc.\nMs. Williams was elected a Director of Alliance in October 1993. She is currently the Director of Special Projects of the Partnership. She serves on the boards of the India Liberalisation Fund, The Spain Fund, The Austria Fund, The Visiting Committee for Prints and Illustrated Books, The Board of The Spanish Institute (and its Art Advisory Committee), The Wolfsonian Foundation and The Exhibition Committee of The Equitable Gallery. Ms. Williams is the wife of Dave H. Williams.\nMr. Brewer joined Alliance in 1987 and has been Senior Vice President and General Counsel since 1991. From 1987 until 1990 Mr. Brewer was Vice President and Assistant General Counsel of Alliance.\nMr. Joseph joined Alliance in 1984 and has been Senior Vice President- Finance and Chief Accounting Officer since January 1994. He was Senior Vice President and Controller from 1989 until January 1994. From 1986 until 1989 Mr. Joseph was Vice President and Controller of Alliance and from 1984 to 1986 Mr. Joseph was a Vice President and the Controller of AFS, a subsidiary of the Partnership.\nCertain executive officers of Alliance are also directors or trustees and officers of various Alliance Mutual Funds and The Hudson River Trust and are directors and officers of certain of the Partnership's subsidiaries.\nUnder the terms of the Standstill Agreement dated as of July 18, 1991, as amended (\"Standstill Agreement\"), among ECI, Equitable and AXA, AXA or the Voting Trustees are entitled to nominate 49% of the members of the Board of Directors of the General Partner. See \"Item 12. Security Ownership of Certain Beneficial Owners and Management - Principal Security Holders\".\nAll directors of the General Partner hold office until the next annual meeting of the stockholder of the General Partner and until their successors are elected and qualified. All officers serve at the discretion of the General Partner's Board of Directors.\nThe General Partner has an Audit Committee composed of its independent directors Mr. Holloway and Ms. Talley. The Audit Committee reports to the Board of Directors with respect to the selection and terms of engagement of the Partnership's independent auditors and reviews various matters relating to the Partnership's accounting and auditing policies and procedures. The Audit Committee held four meetings in 1993.\nThe General Partner has a Board Compensation Committee composed of Messrs. Williams, Holloway and Jenrette. The Board Compensation Committee is responsible for compensation and compensation related matters, including, but not limited to, exclusive responsibility and authority for determining bonuses, contributions and awards under most employee incentive plans or arrangements, amending or terminating such plans or arrangements or any welfare benefit plan or arrangement or adopting any new incentive, fringe benefit or welfare benefit plan or arrangement. The Board Compensation Committee consults with a Management Compensation Committee consisting of Messrs. Williams, Calvert, Carifa and Harrison with respect to matters within its authority.\nThe General Partner pays directors who are not employees of the Partnership, Equitable or any affiliate of Equitable an annual retainer of $18,000 plus $1,000 per meeting attended of the Board of Directors and $500 per meeting of a committee of the Board of Directors not held in conjunction with a Board of Directors meeting. Other directors are not entitled to any additional compensation from the General Partner for their services as directors. The Board of Directors meets quarterly.\nSection 16(a) of the Securities Exchange Act of 1934 requires the General Partner's directors and executive officers, and persons who own more than 10% of the Units, to file with the SEC and NYSE initial reports of ownership and reports of changes in ownership of Units. To the best of the Partnership's knowledge, during the year ended December 31, 1993 all Section 16(a) filing requirements applicable to its executive officers, directors and 10% beneficial owners were complied with, except that initial reports of beneficial ownership on Form 3 were not filed on a timely basis on behalf of Mr. de Castries, Mr. Smith and Ms. Talley, directors of the General Partner, following their elections in 1993. None of them owned any Units then and none has acquired any Units.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following Summary Compensation Table sets forth all plan and non-plan compensation awarded to, earned by or paid to the Chairman of the Board and each of the four most highly compensated executive officers of the General Partner at the end of 1993:\nOn February 10, 1993 the Partnership declared a two-for-one Unit Split payable to Unitholders of record on February 22, 1993. All Unit amounts in Item 11 have been adjusted to reflect the Unit Split.\nCompensation Agreements with Certain Executive Officers\nIn connection with the transfer of ACMC's business to the Partnership on April 21, 1988 Messrs. Williams, Harrison, Carifa and Calvert entered into employment agreements with the Partnership. Each of these agreements provides for a base salary and bonus eligibility. The agreements with Messrs. Williams, Harrison, Carifa and Calvert expire on April 21, 1994, 1994, 1996 and 1996, respectively. The base salaries of Messrs. Williams, Harrison, Carifa, Calvert and Joseph are currently $225,000, $200,000, $200,000, $200,000 and $140,000 respectively. Each of these agreements provides that the employee will not engage in competitive practices with the Partnership, Alliance or its affiliates for the term of the agreement unless his employment is terminated by the Partnership other than for cause (as defined below), in which case the nature of the non-compete obligation is significantly relaxed and the term is shortened to the lesser of six months or the remaining employment term. Each of the agreements also restricts the disclosure of confidential information and extends broad indemnification rights, including all of the rights of an \"indemnified person\" under the Partnership Agreement.\nThe employment agreements provide that the Partnership may terminate employment for any reason, provided that if employment is terminated by the Partnership without cause (as defined), the employee will be entitled to receive his base salary under the agreement for the remaining term thereof and the benefits otherwise provided under the employee benefit plans in which he participates. If employment is terminated by the Partnership for cause or by reason of an employee's death or disability (based on a finding by the Board of Directors of the General Partner that the employee is physically or mentally incapacitated and has been unable for a period of six months to perform his duties by reason of that incapacity), the employee will not be entitled to receive any further salary beyond that payable for services to the date of termination. Cause is defined to include an employee's continuing willful failure to perform his duties, his gross negligence or malfeasance in the performance of his duties, his breach of a confidentiality or non-compete obligation, his commission of a felony, and various acts on the employee's part by reason of which the Board of Directors of the General Partner determines that the employee's continued employment would be seriously detrimental to the Partnership. Messrs. Williams, Harrison, Carifa and Calvert may terminate their respective employment agreements if their duties, status or title are changed to a lesser level or rank than that in effect on December 31, 1987. In such event, the terminating employee is treated as if the Partnership had terminated his employment other than for cause.\nThe employment agreements provide for discretionary bonus eligibility. Bonus amounts are fixed by the Board Compensation Committee after receiving recommendations from the Management Compensation Committee. The aggregate amount\navailable for bonuses and contributions and awards under various employee plans to all employees is based on the annual adjusted consolidated net operating earnings of the Partnership.\nIn connection with Equitable's 1985 acquisition of DLJ, the former parent of ACMC, ACMC entered into employment agreements with Messrs. Williams, Harrison, Carifa and Calvert. Each agreement provided for deferred compensation payable in stated monthly amounts for ten years commencing at age 65, or earlier in a reduced amount in the event of disability or death, if the individual involved so elects. The right to receive such deferred compensation is vested. Assuming payments commence at age 65, the annual amount of deferred compensation payable for ten years to Messrs. Williams, Harrison, Carifa and Calvert is $378,900, $328,332, $522,036 and $434,612, respectively. While the Partnership assumed responsibility for payment of these deferred compensation obligations, ACMC and Alliance are required, subject to certain limitations, to make capital contributions to the Partnership in an amount equal to the payments, and ACMC is also obligated to the employees for the payments. ACMC's obligations to make capital contributions to the Partnership are guaranteed, subject to certain limitations, by EIC, the parent of Alliance.\nEmployee Benefit Plans\nUNIT ACQUISITIONS. In 1988 the executive officers named in the Summary Compensation Table (\"Named Executive Officers\") acquired from ACMC, pursuant to Restricted Limited Partnership Units Acquisition Agreements (\"Restricted Units Agreements\"), an aggregate of 5,048,172 Restricted Units. Messrs. Williams, Harrison, Carifa, Calvert and Joseph acquired 1,583,756, 1,583,756, 929,868, 928,638 and 22,154 Restricted Units, respectively. The cost of the Restricted Units was either $0.50 or $1.00 per Restricted Unit. The price for the Restricted Units was paid either by a reduction of the Named Executive Officer's unvested account balance under the Partners Plan, in cash, or a combination thereof.\nEach Named Executive Officer has the right to vote his Restricted Units and to receive Partnership distributions made on the Restricted Units. All Restricted Units become nonforfeitable, i.e., vest, over periods of employment ending April 21, 1994 and in certain other situations as described below. 1,170,963, 1,170,963, 1,170,962 and 1,163,570 of the Restricted Units issued to the Named Executive Officers vested on April 21, 1990, April 21, 1991, April 21, 1992 and April 21, 1993, respectively. The remaining 371,714 unvested Restricted Units will vest on April 21, 1994. Unvested Restricted Units are not transferable. Cessation of employment with the Partnership during the vesting period will result in the automatic and immediate forfeiture to ACMC (or its designated affiliate) of unvested Restricted Units unless employment ceases as a result of the Named Executive Officer's disability (as defined), death or termination by the Partnership without cause (as defined). Under the definition of cause a resignation caused by reason of the Partnership's changing his duties, status or title to a lesser level or rank than that in effect on December 31, 1987, will result in the full vesting of the Restricted Units issued to Messrs. Williams, Harrison, Carifa and Calvert. Disability and cause for this purpose are defined in the same manner as in the employment agreements discussed above. See \"Compensation Agreements with Named Executive Officers.\"\n395,936, 395,936, 185,972, and 185,726 of the Restricted Units acquired by Messrs. Williams, Harrison, Carifa and Calvert, respectively, vested on April 21, 1993. The fair market value of these Restricted Units on the date of vesting is included in column (i) of the Summary Compensation Table.\nUNIT OPTION PLAN. Pursuant to the Partnership's Unit Option Plan key employees of the Partnership and its subsidiaries, other than Messrs. Williams, Harrison, Carifa and Calvert, may be granted options to purchase up to 4,923,076 Units. Options may be granted only to employees who the Board Compensation Committee of the General Partner, which administers the Plan, after obtaining recommendations from the Management Compensation Committee, determines materially contribute, or are expected to materially contribute, to the growth and profitability of the Partnership's business. The number of options to be granted to any employee is to be determined in the discretion of the Board Compensation Committee. Options may be granted with terms of up to ten years, and an employee's right to exercise each option will vest at a rate no faster than 20% per year commencing on the first anniversary of the date of grant. Each option will have an exercise price no less than the fair market value of the Units subject to option at the time the option is granted, payable in cash. Generally, options may only be exercisable while the optionee is employed by the Partnership. Options may not be granted under the Unit Option Plan after ten years from its adoption.\nDuring 1993 none of the Named Executive Officers were granted or awarded options under the Unit Option Plan by the Partnership or exercised any options granted under the Unit Option Plan. As of December 31, 1993 Mr. Joseph held options to purchase 70,000 Units. Options to purchase 38,000 of the Units are currently exercisable. As of December 31, 1993 the aggregate dollar value of Mr. Joseph's exercisable and unexercisable in-the-money options were $732,000 and $528,313, respectively.\n1993 UNIT OPTION PLAN. Pursuant to the Partnership's 1993 Unit Option Plan key employees of the Partnership and its\nsubsidiaries may be granted options to purchase Units. The aggregate number of Units that may be the subject of options granted or awarded under the 1993 Unit Option Plan, the Unit Bonus Plan and the Century Club Plan may not exceed 3,200,000 Units (\"Overall Limitation\"). In addition the maximum aggregate number of Units that may be the subject of options granted or awarded under the 1993 Unit Option Plan, the Unit Bonus Plan and the Century Club Plan in any of the years ended July 22, 1994, 1995, 1996 and 1997 may not exceed 800,000 Units (\"Annual Limitation\"). The maximum number of Units that may otherwise be the subject of options granted under the 1993 Unit Option Plan may be increased by the number of Units tendered to the Partnership by employees in payment of either the exercise price or withholding tax liabilities. Options may be granted only to employees who a committee of the General Partner consisting of Messrs. Jenrette and Holloway, which administers the Plan, after obtaining recommendations from the Management Compensation Committee, determines materially contribute, or are expected to materially contribute, to the growth and profitability of the Partnership's business. The number of options to be granted to any employee is to be determined in the discretion of the Board Compensation Committee. Options may be granted with terms of up to ten years, and an employee's right to exercise each option will vest at a rate no faster than 20% per year commencing on the first anniversary of the date of grant. Each option will have an exercise price no less than the fair market value of the Units subject to the option at the time the option is granted, payable in cash. Generally, options may only be exercisable while the optionee is employed by the Partnership or one of its subsidiaries. Options may not be granted under the 1993 Unit Option Plan after ten years from its adoption.\nNone of the Named Executive Officers has been granted or awarded options under the 1993 Unit Option Plan.\nPROFIT SHARING PLAN. The Partnership maintains a qualified defined contribution profit sharing plan covering most employees of the Partnership who have attained age 21 and completed one year of service. Annual contributions are determined by the Board of Directors in its sole discretion and are allocated among participants who are employed by a participating employer on the last business day of the calendar year involved by crediting each participant with the same proportion of the contribution as the participant's base compensation bears to the total base compensation of all participants. The plan provides for a 401(k) salary reduction election under which the Partnership may match a participant's election to reduce up to 5% of base salary. A partici- pant's interest in the plan is 100% vested after the participant has completed three years of service although account balances deriving from salary reductions are 100% vested at all times. The Partnership's contributions under the plan for a given year may not exceed 15% of the aggregate compensation paid to all participants for that year. Contributions to a participant's plan account (including contributions made by a participant) for a particular year may not exceed 25% of the participant's compensation for that year or $30,000, whichever is less. The amount of the benefits ultimately distributed to an employee is dependent on the investment performance of the employee's account under the plan. Distribution of vested account balances under the plan is made upon termination of employment either in a lump sum or in installments for a specific period of years. If a participant dies prior to termination of his employment, the entire value of his account is paid to the participant's beneficiary. For 1993, vested contributions to the plan for the accounts of Messrs. Williams, Harrison, Carifa, Calvert and Joseph were $26,250, $25,000, $25,000, $25,000 and $19,450, respectively. These amounts are included in column (i) of the Summary Compensation Table.\nPROFIT SHARING PLAN FOR FORMER ECMC EMPLOYEES. The Partnership maintains a qualified defined contribution profit sharing plan covering most former ECMC employees with vesting and benefit contribution allocation methods substantially equivalent to the profit sharing plan maintained by ECMC prior to the acquisition. The plan provides for a 401(k) salary reduction election under which a participant may reduce up to 12% of compensation and the Partnership must match the first 2 1\/2% of compensation so reduced in 1993 and 1994. A participant's entire interest in the plan is 100% vested at all times. The Partnership's contributions under the plan for a given year may not exceed 15% of the aggregate compensation paid to all participants for that year. Contributions to a participant's plan account (including contributions made by a participant) for a particular year may not exceed 25% of the participant's base compensation for that year or $30,000, whichever is less. The amount of the benefits ultimately distributed to an employee is dependent on the investment performance of the employee's account under the plan. Distribution of vested account balances under the plan is made upon termination of employment either in a lump sum or in installments for a specific period of years. If a participant dies prior to termination of his employment, the entire value of his account is paid to the participant's beneficiary.\nNone of the Named Executive Officers is a participant in this plan.\nRETIREMENT PLAN. The Partnership maintains a qualified, non-contributory, defined benefit retirement plan covering most employees of the Partnership who have completed one year of service and attained age 21. Employer contributions are determined by application of actuarial methods and assumptions to reflect the cost of benefits under the plan. Each participant's benefits are determined under a formula which takes into account years of credited service, the participant's average compensation over prescribed periods and Social Security covered compensation. The maximum annual benefit payable under the plan may not exceed the lesser of $100,000 or 100% of a participant's average aggregate compensation for the three consecutive years in which he received the highest aggregate compensation from the Partnership or such lower limit as may be imposed by the Internal Revenue Code on certain participants by reason of their coverage under another qualified plan maintained by the Partnership. A participant is fully vested after the completion of five years of service. The plan generally provides for payments to or on behalf of each vested employee upon such employee's retirement at the normal retirement age provided under the plan or later, although provision is made for payment of early retirement benefits on an actuarially reduced basis. Normal retirement age under the plan is 65. Death benefits are payable to the surviving spouse of an employee who dies with a vested benefit under the plan.\nThe table below sets forth with respect to the retirement plan the estimated annual straight life annuity benefits payable upon retirement at normal retirement age for employees with the remuneration and years of service indicated.\nAssuming they are employed by the Partnership until age 65, the credited years of service under the plan for Messrs. Williams, Harrison, Carifa, Calvert and Joseph would be 20, 24, 40, 38 and 28, respectively. Compensation on which plan benefits are based includes only base compensation and not bonuses, incentive compensation, profit-sharing plan contributions or deferred compensation. The compensation for calculation of plan benefits for these five individuals for 1993 is $225,000, $200,000, $200,000, $200,000 and $129,673, respectively.\nUNIT BONUS PLAN. Pursuant to the Partnership's Unit Bonus Plan the Board Compensation Committee may award Units to key employees of the Partnership and its subsidiaries in lieu of all or a portion of the cash bonus that they would otherwise receive. The aggregate number of Units that may be the subject of awards or grants under the Unit Bonus Plan, the 1993 Unit Option Plan and the Century Club Plan may not exceed the Overall Limitations and the maximum aggregate number of Units that may be the subject of awards or grants under the Unit Bonus Plan, the 1993 Unit Option Plan and the Century Club Plan in any of the years ended July 22, 1994, 1995, 1996 and 1997 may not exceed the Annual Limitation. Units that may otherwise be awarded under the Unit Bonus Plan may be increased by the number of Units tendered to the Partnership in payment of withholding tax liabilities in respect of Unit Bonus Plan awards. Units awarded under the Unit Bonus Plan may be vested or unvested (i.e., subject to forfeiture) at the time of award. Unvested Units will vest or become nonforfeitable in accordance with the conditions specified by the Board Compensation Committee at the time of award.\nNone of the Named Executive Officers has been awarded Units under the Unit Bonus Plan.\nCENTURY CLUB PLAN. Pursuant to the Partnership's Century Club Plan up to 200,000 Units may be awarded to employees of AFD or another subsidiary of the Partnership who attain certain sales targets or sales criteria determined by the Century Club Committee which consists of Messrs. John D. Carifa and Michael Laughlin, President and Executive Vice President of the General Partner, respectively. The maximum aggregate number of Units that may be awarded under the Century Club Plan, the 1993 Unit Option Plan and the Unit Bonus Plan may not exceed the Overall Limitation and the maximum aggregate number of Units that may be awarded under the Century Club Plan, the 1993 Unit Option Plan and the Unit Bonus Plan in any of the years ended July 22, 1994, 1995, 1996 and 1997 may not exceed that Annual Limitation. Units awarded under the Century Club Plan may be vested or unvested (i.e., subject to the forfeiture) at the time of award. Unvested Units will vest or become nonforfeitable in accordance with the conditions specified by the Century Club Committee at the time of award.\nNone of the Named Executive Officers has been awarded Units under the Century Club Plan.\nPARTNERS PLAN. Since 1983 a nonqualified, unfunded deferred compensation program known as the Partners Plan has been maintained under which certain key employees received incentive awards pursuant to a formula set each year by the Management Compensation Committee. No awards have been or will be made under the Partners Plan for any year after 1987. All awards are fully vested. Unless accelerated, award account balances generally are distributed upon resignation, retirement, disability or death. The Board of Directors of the General Partner has the right to accelerate vesting and make distributions of up to 90% of a participant's account balance if the key employee agrees to extend the term of his employment for a period of at least one year. Until distributed, the awards are credited with interest based on prevailing market rates plus, for the years prior to 1989, a premium if the Partnership's earnings growth rate exceeded certain levels. Interest credited during 1993 for the accounts of Messrs. Williams, Harrison, Carifa and Calvert was $7,323, $3,115, $2,863, and $2,526 respectively. These amounts are included in column (i) of the Summary Compensation Table. This amount is included in column (h) of the Summary Compensation Table.\nCAPITAL ACCUMULATION PLAN. Since 1985 a nonqualified, unfunded deferred compensation program known as the Capital Accumulation Plan has been maintained to provide retirement benefits for key employees and their beneficiaries which supplement their benefits under the Retirement Plan described above. Under this plan, at the end of 1985, 1986 and 1987, awards were made for each participant, selected on the basis of performance by the Management Compensation Committee, equal to a percentage of the participant's base salary and the participant's discretionary bonus for the year. The amount awarded was credited to the participant's account on the Partnership's books to which interest is thereafter credited, until distributed or forfeited, based on prevailing market rates. A participant's account balance vests based on the participant's years in the plan with no vesting for zero to four years of participation, 30% vesting after five to seven years with gradually increased vesting thereafter ranging to 87% after 35 years of participation and 100% vesting at age 65 or death. Upon termination of employment other than by reason of permanent disability or death, the participant's vested account balance is to be paid out in ten equal annual installments. In the event of permanent disability, the participant is to receive the higher of the vested balance at the time of disability or 50% of the total balance at the time of disability, in either case payable in ten equal annual installments. In the event of death, the participant's beneficiary is to receive the higher of (i) the participant's account balance paid in ten equal annual installments together with interest or (ii) annually 50% of the participant's total cash compensation for the year prior to the year of the participant's death payable until the participant would have attained age 65, but in no event for less than ten years.\nWhile the Partnership is responsible for the payment of all obligations under the plan, ACMC and Alliance are required, subject to certain limitations, to make capital contributions to the Partnership in an amount equal to the payments. ACMC's obligations are guaranteed, subject to certain limitations, by EIC. No additional awards will be made under this plan, but employees will continue to vest in their existing account balances and to be credited with interest at prevailing market rates on these balances. A participant's total cash compensation for 1987 increased by 5% per year, compounded annually, will be considered his total cash compensation for purposes of determining the amount of any death benefits payable in respect of the participant. The Board of Directors of the General Partner intends to cancel this plan if tax legislation is enacted which adversely affects certain benefits derived by ACMC from insurance on the lives of certain of the Partnership's employees purchased in connection with the plan. If the plan is cancelled, the Board of Directors of the General Partner may, at its option, either pay each participant his then vested account balance or continue to maintain the account balances for vesting and distribution as described above as if the plan had not terminated, provided that in such event no death benefit based on a participant's total cash compensation will be paid. The plan account balances which became vested during 1993 for the accounts of Messrs. Williams, Harrison, Carifa and Calvert were $30,011, $29,916, $17,658 and $18,423, respectively. These amounts are included in column (i) of the Summary Compensation Table.\nDEFERRAL PLAN. Under this plan, certain employees of the Partnership may elect to defer for at least one year the receipt of base or bonus compensation otherwise payable in a given year to January 31 of the year selected. Interest is credited at prevailing market rates on the amounts deferred under this plan until paid. In certain cases, 10% of a deferred amount is subject to forfeiture if the employee's employment terminates prior to the January 31 payment date for any reason other than death or disability. There was no compensation deferred from 1993 to a subsequent year for the Named Executive Officers. During 1993 there were no payments of previously deferred compensation to or interest credited on amounts deferred by any of the Named Executive Officers.\nDLJ PLANS. Prior to Equitable's 1985 acquisition of DLJ, certain employees of the Partnership participated in various DLJ employee benefit plans and arrangements. Since the acquisition, no employer contributions or awards have been made, nor in the future are any employer contributions or awards to be made, under these plans or arrangements for any employee of the Partnership. No deferral of compensation earned by any such employee for services rendered since the acquisition has been permitted under any such plan or arrangement. The Partnership has no liability for and will not bear the cost of any benefits under these plans and arrangements.\nIn 1983, DLJ adopted an Executive Supplemental Retirement Program under which certain employees of the Partnership deferred a portion of their 1983 compensation in return for which DLJ agreed to pay each of them a specified annual retirement benefit for 15 years beginning at age 65. Benefits are based upon the participant's age and the amount deferred and are calculated to yield an approximate 12.5% annual compound return. In the event of the participant's disability or death, an equal or lesser amount is to be paid to the participant or his beneficiary. After age 55, participants the sum of whose age and years of service equals 80 may elect to have their benefits begin in an actuarially reduced amount before age 65. DLJ has funded its obligation under the Program through the purchase of life insurance policies. The following table shows as to the Named Executive Officers who are participants in the Plan the estimated annual retirement benefit payable at age 65. Each of these individuals is fully vested in the applicable benefit.\nEstimated Annual Name Retirement Benefit ---- ------------------ Dave H. Williams $ 41,825 Alfred Harrison 50,246 John D. Carifa 114,597 Bruce W. Calvert 145,036\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Security Holders\nThe Partnership has no information that any person beneficially owns more than 5% of the outstanding Units except (i) ACMC and ECMC wholly-owned subsidiaries of ECI, and (ii) as reported on Schedule 13D, filed with the SEC by AXA and certain of its affiliates pursuant to the Securities Exchange Act of 1934. The following table and notes have been prepared in reliance upon such filing for the nature of ownership and an explanation of overlapping ownership.\n(1) For insurance regulatory purposes the shares of capital stock of ECI beneficially owned by AXA have been deposited into a voting trust which has an initial term of 10 years (\"Voting Trust\"). The Voting Trustees, who must be members of AXA's Conseil d'Administration (the body analogous to a U.S. corporation's board of directors), are Claude Bebear, Patrice Garnier and Henri de Clermont-Tonnerre. The Voting Trustees have agreed to exercise their voting rights to protect the legitimate economic interests of AXA, but with a view to ensuring that certain of the indirect minority shareholders of ECI do not exercise control over ECI or certain of its insurance subsidiaries. See \"Item 1. Business-General\".\n(2) The Voting Trustees may be deemed to be beneficial owners of all Units beneficially owned by AXA. In addition, the Mutuelles AXA, as a group, and each of Finaxa and Midi Participations may be deemed to be beneficial owners of all Units beneficially owned by AXA. By reason of the fact that the Voting Trustees are members of AXA's Conseil d'Administration and by virtue of the provisions of the Voting Trust Agreement, AXA may be deemed to have shared voting power with respect to the Units. Subject to the restrictions on the disposition of shares of the capital stock of ECI in the Standstill Agreement, AXA has the power to dispose or direct the disposition of all shares of the capital stock of ECI deposited in the Voting Trust. By reason of their relationship with AXA, the Mutuelles AXA, as a group, and each of Finaxa and Midi Participations may be deemed to share the power to vote or to direct the vote and to dispose or to direct the disposition of all the Units beneficially owned by AXA. The address of each of AXA, Midi Participations, Finaxa and the Voting Trustees is 23 Avenue Matignon, Paris, France. The addresses of the Mutuelles AXA are as follows: The address of each of AXA Assurances I.A.R.D. Mutuelle and AXA Assurances Vie Mutuelle is La Grande Arche, Paroi Nord, Paris La Defense, France; the address of each of Alpha Assurances Vie Mutuelle and Alpha Assurances I.A.R.D. Mutuelle is 100-101 Terrasse Boieldieu, Paris La Defense, France; and the address of Uni Europe Assurance Mutuelle is 24 Rue Drouot, Paris, France. See \"Item 1. Business-General\".\n(3) By reason of their relationship, AXA, the Voting Trustees, ECI, Equitable, ACMC, ECMC, the Mutuelles AXA, Finaxa and Midi Participations may be deemed to share the power to vote or to direct the vote or to dispose or direct the disposition of the 45,371,500 Units.\n(4) Includes 100,000 Units which are issuable upon conversion of the Class A Limited Partnership Interest.\nManagement\nThe following table shows, as of March 14, 1994, the beneficial ownership of Units by each director and each Named Executive Officer of the General Partner who owns more than 1% of the outstanding Units and by all directors and executive officers of the General Partner as a group:\nThe Partnership has no information that any director of the General Partner, any Named Executive Officer or the directors and executive officers of the General Partner as a group beneficially own any class of equity securities of any of the Partnership's parents or subsidiaries other than directors' qualifying shares except that (i) Mr. Williams has been granted options to purchase 100,000 shares of the common stock of ECI, (ii) Mr. Benson has been granted options to purchase 250,000 shares of the common stock of ECI, (iii) Mr. Calvert has been granted options to purchase 50,000 shares of the common stock of ECI, (iv) Mr. Carifa has been granted options to purchase 50,000 shares of the common stock of ECI, (v) Mr. de Castries has been granted options to purchase 15,000 shares of AXA, (vi) Mr. Dupont-Madinier has been granted options to purchase 7,938 AXA shares, (vii) Mr. Hellebuyck owns 1,125 shares of AXA and has been granted options to purchase 1,500 shares of AXA, (viii) Mr. Hottinguer owns 1,621 shares of AXA and 1,840 shares of Finaxa, (ix) Mr. Jenrette owns 85 shares of the common stock of ECI and has been granted options to purchase 600,000 shares of the common stock of ECI, (x) Mr. Melone owns 182 shares of the common stock of ECI and has been granted options to purchase 400,000 shares of the common stock of ECI, (xi) Mr. O'Neil owns 27 shares of the common stock of ECI and has been granted options to purchase 100,000 shares of the common stock of ECI, (xii) Mr. Savage owns 136 shares of the common stock of ECI, and (xiii) Mr. Smith has been granted options to purchase 1,000 shares of AXA.\nThe General Partner makes all decisions relating to the management of the Partnership. The General Partner has agreed that it will conduct no business other than managing the Partnership, although it may make certain investments for its own account. Conflicts of interest, however, could arise between the General Partner and the Unitholders.\nSection 17-403(b) of the Delaware Revised Uniform Limited Partnership Act (the \"Delaware Act\") states that, except as provided in the Delaware Act or the partnership agreement, a general partner of a limited partnership has the same liabilities to the partnership and to the limited partners as a general partner in a partnership without limited partners. While, under Delaware law, a general partner of a limited partnership is liable as a fiduciary to the other partners, the Agreement of Limited Partnership of Alliance Capital Management L.P. (As Amended and Restated)(\"Partnership Agreement\") sets forth a more limited standard of liability for the General Partner. The Partnership Agreement provides that the General Partner is not liable for monetary damages to the Partnership for errors in judgment or for breach of fiduciary duty (including breach of any duty of care or loyalty), unless it is established that the General Partner's action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the Partnership, with reckless disregard for the best interests of the Partnership or with actual bad faith on the part of the General Partner, or constituted actual fraud. Whenever the Partnership Agreement provides that the General Partner is permitted or required to make a decision (i) in its \"discretion,\" the General Partner is entitled to consider only such interests and factors as it desires and has no duty or obligation to consider any interest of or other factors affecting the Partnership or any Unitholder or (ii) in its \"good faith\" or under another express standard, the General Partner will act under that express standard and will not be subject to any other or different standard imposed by the Partnership Agreement or applicable law.\nIn addition, the Partnership Agreement grants broad rights of indemnification to the General Partner and its directors and affiliates and authorizes the Partnership to enter into indemnification agreements with the directors, officers, partners, employees and agents of the Partnership and its affiliates. The Partnership has granted broad rights of indemnification to officers of the General Partner and employees of the Partnership. In addition, the Partnership assumed indemnification obligations previously extended by Alliance to its directors, officers and employees. The foregoing indemnification provisions are not exclusive, and the Partnership is authorized to enter into additional indemnification arrangements. The Partnership has obtained directors and officers liability insurance.\nThe Partnership Agreement also allows transactions between the Partnership and the General Partner or its affiliates if the transactions are on terms determined by the General Partner to be comparable to (or more favorable to the Partnership than) those that would prevail with any unaffiliated party. The Partnership Agreement provides that those transactions are deemed to meet that standard if such transactions are approved by a majority of those directors of the General Partner who are not directors, officers or employees of any affiliate of the General Partner (other than the Partnership and its subsidiar- ies) or, if in the reasonable and good faith judgment of the General Partner, the transactions are on terms substantially comparable to (or more favorable to the Partnership than) those that would prevail in a transaction with an unaffiliated party.\nThe Partnership Agreement expressly permits all affiliates of the General Partner (including Equitable and its other subsidiaries) to compete, directly or indirectly, with the Partnership, to engage in any business or other activity and to exploit any opportunity, including those that may be available to the Partnership. Equitable and some of its subsidiaries currently compete with the Partnership. See \"Item 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCompetition\nAXA, Equitable and certain of their direct and indirect subsidiaries provide financial services, some of which are competitive with those offered by the Partnership. The Partnership Agreement specifically allows Equitable and its subsidiaries (other than the General Partner) to compete with the Partnership and to exploit opportunities that may be available to the Partnership. Equitable and certain of its subsidiaries have substantially greater financial resources than the Partnership or the General Partner.\nFinancial Services\nThe Partnership Agreement permits Equitable and its affiliates to provide services to the Partnership on terms comparable to (or more favorable to the Partnership than) those that would prevail in a transaction with an unaffiliated third party. The Partnership believes that its arrangements with Equitable and its affiliates are at least as favorable to the Partnership as could be obtained from an unaffiliated third party, based on its knowledge of and inquiry with respect to comparable arrangements with or between unaffiliated third parties.\nThe Partnership acts as the investment manager for the general and separate accounts of Equitable and its insurance company subsidiaries pursuant to investment advisory agreements. During 1993 the Partnership received approximately $55.4 million in fees pursuant to these agreements. In connection with the services provided under these agreements the Partnership provides ancillary accounting, valuation, reporting, treasury and other services for regulatory purposes under service agreements. During 1993 the Partnership received approximately $6.8 million in fees pursuant to these agreements. Equitable provides certain legal and other services to the Partnership relating to certain insurance and other regulatory aspects of the general and separate accounts of Equitable and its insurance company subsidiaries. During 1993 the Partnership paid approximately $1.4 million to Equitable for these services.\nDuring 1993 the Partnership paid Equitable approximately $8.3 million for certain services provided with respect to the marketing of the variable annuity insurance and variable life insurance products for which The Hudson River Trust is the funding vehicle.\nA life insurance subsidiary of Equitable has issued to ACMC life insurance policies on certain employees of the Partnership, the costs of which are to be borne by ACMC without reimbursement by the Partnership. During 1993 ACMC paid approximately $5.7 million in insurance premiums on these policies.\nThe Partnership and its employees are covered by various policies maintained by Equitable and its other subsidiaries. The amount of premiums for these group policies paid by the Partnership to Equitable was approximately $.2 million for 1993.\nThe Partnership provides investment management services to certain employee benefit plans of Equitable and DLJ. Advisory fees from these accounts totalled approximately $2.9 million for 1993 including $1.8 million from the separate accounts of Equitable.\nEquico was the Partnership's second largest distributor of load mutual funds in 1993 for which it received sales concessions from the Partnership on sales of $475 million. In 1993 Equico also distributed certain of the Partnership's cash management products. Equico received distribution payments totalling $3.0 million in 1993 for these services.\nDLJ Securities Corporation and Pershing distribute certain Alliance Mutual Funds and cash management products and receive sales concessions and distribution payments. In addition, the Partnership and Pershing have an agreement pursuant to which Pershing recommends to certain of its correspondent firms the use of Alliance cash management products for which Pershing is allo- cated a portion of the revenues derived by the Partnership from sales through the Pershing correspondents. Amounts paid by the Partnership to DLJ Securities Corporation, Pershing and Wood Struthers & Winthrop Management Corp., a subsidiary of DLJ, in connection with the above distribution services were $10.7 million in 1993. DLJ and its subsidiaries also provide the Partnership with brokerage and various other services, including clearing, investment banking, research, data processing and administrative services. Brokerage, the expense of which is borne by the Partnership's clients, aggregated approximately $0.1 million for 1993. During 1993, the Partnership paid $.2 million to DLJ and its subsidiaries for all such other services.\nPrior to the Partnership's acquisition of ECMC, during 1993 ECMC reimbursed Equitable in the amount of $9.9 million for rent and the use of certain services and facilities. ECMC also paid Equitable $1.9 million pursuant to a tax sharing arrangement. Subsequent to the Partnership's acquisition of ECMC during 1993 the Partnership reimbursed Equitable in the amount of $1.6 million for rent and the use of certain services and facilities.\nOther Transactions\nDuring 1993 the Partnership paid certain legal and other expenses incurred by Equitable and its insurance company subsidiaries relating to the general and separate accounts of Equitable and such subsidiaries for which it has been or will be fully reimbursed by Equitable. The largest amount of such indebtedness outstanding during 1993 was $1.2 million which represents the amount outstanding on December 31, 1993.\nEquitable and its affiliates are not obligated to provide funds to the Partnership, except for ACMC's and the General Partner's obligation to fund certain of the Partnership's deferred compensation and employee benefit plan obligations referred to under \"Compensation Agreements with Named Executive Officers\" and \"Capital Accumulation Plan\". The Partnership Agreement permits Equitable and its affiliates to lend funds to the Partnership at the lender's cost of funds.\nACMC and the General Partner are obligated, subject to certain limitations, to make capital contributions to the Partnership in an amount equal to the payments the Partnership is required to make as deferred compensation under the employment agreements entered into in connection with Equitable's 1985 acquisition of DLJ, as well as obligations of the Partnership to various employees and their beneficiaries under the Partnership's Capital Accumulation Plan. In 1993, ACMC made capital contributions to the Partnership of $.7 million. ACMC's obligations to make these contributions are guaranteed by EIC subject to certain limitations. All tax deductions with respect to these obligations, to the extent funded by ACMC, Alliance or EIC, will be allocated to ACMC or Alliance.\nReba W. Williams, the wife of Dave H. Williams, was employed by the Partnership during 1993 and received compensation in the amount of $102,000.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following is a list of the documents filed as a part of this annual report on Form 10-K:\nOther schedules are omitted because they are not applicable, or the required information is set forth in the financial statements or notes thereto.\n(b) REPORTS ON FORM 8-K.\nA report on Form 8-K dated November 17, 1993 was filed during the last quarter of 1993 reporting that the Partnership had entered into an Asset Purchase Agreement dated November 16, 1993 with Shields Asset Management, Incorporated (\"Shields\"), Regent Investor Services Incorporated (\"Regent\"), Furman Selz Holding Corporation and Xerox Financial Services, Inc. to acquire the business and substantially all of the assets of Shields and Regent.\n(c) Exhibits.\nThe following exhibits required to be filed by Item 601 of Regulation S-K are filed herewith or, in the case of Exhibits 10.54, 10.55, 10.56, 10.57, 10.58 and 13.5, incorporated by reference herein:\nEXHIBIT DESCRIPTION\n10.54 Amended and Restated Transfer Agreement among Alliance Capital Management L.P., Equitable Capital Management Corporation and Equitable Investment Corporation dated as of February 23, 1993 as amended and restated on May 28, 1993 (1) 10.55 Asset Purchase Agreement among Alliance Capital Management L.P., Shields Asset Management, Incorporated, Regent Investor Services Incorporated, Furman Selz Holding Corporation and Xerox Financial Services, Inc. dated November 16, 1993 (2) 10.56 Alliance Capital Management L.P. 1993 Unit Option Plan (3) 10.57 Alliance Capital Management L.P. Unit Bonus Plan (3) 10.58 Alliance Capital Management L.P. Century Club Plan (3) 13.5 Alliance Capital Management L.P. 1993 Annual Report to Unitholders (pages 43 through 69) 21.1 Subsidiaries of the Registrant 23.1 Consent of KPMG Peat Marwick 24.32 Power of Attorney by James M. Benson 24.33 Power of Attorney by Henri de Castries 24.34 Power of Attorney by Christophe Dupont-Madinier 24.35 Power of Attorney by Jean-Pierre Hellebuyck 24.36 Power of Attorney by Benjamin D. Holloway 24.37 Power of Attorney by Henri Hottinguer\n24.38 Power of Attorney by Richard H. Jenrette 24.39 Power of Attorney by Joseph J. Melone 24.40 Power of Attorney by Brian S. O'Neil 24.41 Power of Attorney by Peter G. Smith 24.42 Power of Attorney by Madelon DeVoe Talley\n(1) Filed as an Exhibit to the Registrant's Form 8-K dated August 10, 1993. (2) Filed as an Exhibit to the Registrant's Form 8-K dated November 17, 1993. (3) Filed as an Exhibit to the Registrant's Registration Statement on Form S-8 (File No. 33-65932) filed with the Securities and Exchange Commission on July 12, 1993.\nSIGNATURES\nPursuant 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.\nAlliance Capital Management L.P. By: Alliance Capital Management Corporation, General Partner Date: March 28, 1994 By: \/s\/Dave H. Williams ---------------------------- Dave H. Williams Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: March 28, 1994 \/s\/John D. Carifa ---------------------------- John D. Carifa President, Chief Operating Officer and Chief Financial Officer\nDate: March 28, 1994 \/s\/Robert H. Joseph, Jr. ---------------------------- Robert H. Joseph, Jr. Senior Vice President and Chief Accounting Officer\nDirectors \/s\/Dave H. Williams * - ---------------------------- ---------------------------- Dave H. Williams Benjamin D. Holloway Chairman and Director Director\n* * - ---------------------------- ---------------------------- James M. Benson Henri Hottinguer Director Director\n\/s\/Bruce W. Calvert * - ---------------------------- ---------------------------- Bruce W. Calvert Richard H. Jenrette Director Director\n\/s\/John D. Carifa * - ---------------------------- ---------------------------- John D. Carifa Joseph J. Melone Director Director\n* * - ---------------------------- ---------------------------- Henri de Castries Brian S. O'Neil Director Director\n* \/s\/Frank Savage - ---------------------------- ---------------------------- Christophe Dupont-Madinier Frank Savage Director Director\n\/s\/Alfred Harrison * - ---------------------------- ---------------------------- Alfred Harrison Peter Smith Director Director\n* * - ---------------------------- ---------------------------- Jean-Pierre Hellebuyck Madelon DeVoe Talley Director Director\n*By\/s\/David R. Brewer, Jr. \/s\/Reba W. Williams - ---------------------------- ----------------------------- David R. Brewer, Jr. Reba W. Williams (Attorney-in-Fact) Director\nAlliance Capital Management L.P. Schedule I - Marketable Securities December 31, 1993\nIndependent Auditors' Report\nThe General Partner and Unitholders Alliance Capital Management L.P.\nUnder date of January 27, 1994, except as to Note 12, which is as of March 7, 1994, we reported on the consolidated statements of financial condition of Alliance Capital Management L.P. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in partners' capital, and cash flows for the years ended December 31, 1993, 1992 and 1991, as contained in the 1993 Annual Report to Unitholders. These consolidated finan- cial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index (page 34). This financial statement schedule is the responsibility of Alliance Capital Management Corporation, General Partner. Our responsibility is to express an opinion on this financial statement schedule based on our 1993 audit.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK\nNew York, New York January 27, 1994, except as to Note 12, which is as of March 7, 1994","section_15":""}
{"filename":"775483_1993.txt","cik":"775483","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTHE COMPANY\nOn March 23, 1979, in the case of Van Vranken, et al. v. Atlantic Richfield, two California service station dealers purporting to represent a class of all resellers of gasoline, aviation fuels, butane and propane sued the Company in the United States District Court for the Northern District of California (Case No. C-79-0627-SW) for allegedly willfully violating the Department of Energy's (\"DOE\") 1973-1981 price regulations by unlawfully inflating its costs of crude oil eligible for recovery. On March 25, 1986, the District Court certified the plaintiffs as representatives of the class for purchases made between May 1, 1976 and January 28, 1981. On July 23, 1992, a jury found for the Company on the class' original claim, and for the class on three subsequent claims in the amount of $22.8 million, plus prejudgment interest. On October 22, 1992, the trial court ordered a formula for interest resulting in a total judgment of approximately $63 million. On September 30, 1993, the United States Court of Appeals for the Federal Circuit affirmed, without opinion, the trial court's judgment. The Company has sought reconsideration.\nOn June 7, 1989, the City of New York, the New York City Housing Authority and the New York City Health and Hospitals Corporation brought suit in the Supreme Court of the State of New York for the County of New York (Case No. 14365\/89) against six alleged former lead pigment manufacturers or their successors (including ARCO as successor to International Smelting and Refining Company (\"IS&R\"), a former subsidiary of The Anaconda Company), and the Lead Industries Association (\"LIA\"), a trade association. Plaintiffs seek to recover damages in excess of $50 million including (i) past and future costs of abating lead-based paint from housing owned by New York City and the New York City Housing Authority; (ii) other costs associated with dealing with the presence of lead-based paint in that housing and privately owned housing; and (iii) any amounts paid by the City or the Housing Authority to tenants because of injuries caused by the ingestion of lead-based paint. Plaintiffs also seek punitive damages and attorney fees. On January 7, 1991, defendant Eagle- Picher, one of the lead pigment manufacturers, filed for Chapter 11 bankruptcy protection in the Southern District of Ohio, for reasons unrelated to this litigation. As a result of the filing, all proceedings against Eagle-Picher have been stayed in this litigation. On December 23, 1991, the Court dismissed plaintiffs' claims of negligent product design, negligent failure to warn, and strict liability as time-barred under the applicable statute of limitation. The Court also ruled, however, that the plaintiffs' fraud and restitution claims were adequately pled and that more facts were needed to determine if the fraud claim was also time-barred. Interlocutory appeals were taken, and this decision was affirmed. On March 12, 1992, ARCO filed its answer to the complaint and its counterclaims against the City of New York and the New York City Housing Authority. On April 8, 1993, pursuant to stipulation by the parties, the trial court entered an order dismissing with prejudice plaintiffs' claims for indemnification arising from third-party personal injury claims resolved before March 15, 1993, and dismissing without prejudice claims for indemnification brought after that date. On September 3, 1993, plaintiffs filed an amended complaint adding American Cyanamid Company and Fuller-O'Brien Corporation as defendants.\nOn August 25, 1992, ARCO (as successor to IS&R) was added as a defendant to a purported class action suit pending in the Court of Common Pleas in Cuyahoga County (Cleveland), Ohio, Jackson, et al. v. The Glidden Company, et al. (Case No. 236835), that seeks on behalf of the three named plaintiffs, and all other persons similarly situated in the state of Ohio, money damages for injuries allegedly suffered from exposure to lead paint, punitive damages, and an order requiring defendants to remove and abate all lead paint applied to any building in Ohio. The suit names as defendants, in addition to ARCO, the LIA and 16 companies alleged to have participated in the manufacture and sale of lead pigments and paints and includes causes of action for strict product liability, negligence, breach of warranty, fraud, nuisance, restitution, negligent infliction of emotional distress, and enterprise, market share and alternative liability. On July 29, 1993, the Court entered an order granting defendants' motion to dismiss the complaint on the grounds that Ohio law does not recognize market share,\nenterprise or alternative liability causes of action in this case. On August 27, 1993, plaintiffs filed their notice of appeal.\nIn addition, the Company is a defendant in several lawsuits, brought by individuals that allege injury from exposure to lead paint. These cases, in the aggregate, are not material to the financial condition of the Company.\nOn July 5, 1990, an explosion and fire occurred at ARCO Chemical's Channelview, Texas plant. The incident resulted in the death of 17 people and in significant damage to the waste water treatment section of the plant, with some damage to the adjacent area providing utilities to the plant. Various lawsuits have been filed and claims made against ARCO Chemical for wrongful death, personal injury and property damage in connection with this incident, most of which have been resolved.\nENVIRONMENTAL PROCEEDINGS\nAs discussed under the caption \"Environmental Matters,\" ARCO is currently participating in environmental assessments and cleanups at numerous operating and non-operating sites under Superfund and comparable state laws, RCRA and other state and local laws and regulations, and pursuant to third party indemnification requests, and is the subject of material legal proceedings relating to certain of these sites. See \"Environmental Matters--Material Environmental Litigation.\" Set forth below is a description, in accordance with SEC rules, of certain fines and penalties imposed by governmental agencies in respect of environmental rules and regulations.\nIn September 1991, the California Department of Toxic Substances Control filed an administrative complaint against ARCO Products Company seeking a civil penalty of $137,500 for failure to comply with certain hazardous waste regulations. The alleged violations stem from sandblasting and related actions by subcontractors while performing work at the Los Angeles Refinery. In December 1991, an administrative law hearing was held on these alleged violations. The Administrative Law Judge proposed a reduced penalty of $62,000, and the matter has been settled on that basis.\nARCO Chemical has discovered that certain organic waste material is situated in the soil and ground water at portions of its Monaca, Pennsylvania (Beaver Valley) plant. ARCO Chemical has commenced a feasibility study to determine the technology required to remedy the conditions at the plant. Concurrently, ARCO Chemical is working with the Pennsylvania Department of Environmental Resources (\"DER\") to design a plan to remedy the conditions at the plant. ARCO Chemical has signed an agreement with Beazer East, Inc., the successor to Koppers Inc. (the previous owner of the Beaver Valley plant), whereby Beazer East, Inc. has agreed to pay for approximately 50 percent of the cost of the remediation. ARCO Chemical has agreed to pay to the Pennsylvania DER a fine in the amount of $300,000 in settlement for contamination of the ground water at the plant.\nIn August 1993, the City Prosecuting Attorney of Long Beach, California, filed a complaint against ARCO Terminal Services Corporation (\"ATSC\"), an ARCO subsidiary, alleging that ATSC illegally disposed of hazardous waste. A second complaint was filed against ATSC and Four Corners Pipe Line Company (\"FCPL\"), another ARCO subsidiary, alleging that ATSC and FCPL illegally disposed of hazardous waste. The allegations made in each complaint are not related. In December 1993, pursuant to the provisions of judicially approved Orders for Civil Compromise, the complaints were dismissed. Liability was not admitted with regard to any of the allegations raised in the complaints, but payments in the amount of $150,000 and $100,000 have been placed into escrow accounts to fund environmental training and the acquisition of various materials and equipment to be used for environmental purposes.\nIn addition to the matters reported herein, from time to time, certain of the Company's operating divisions and subsidiaries receive notices from federal, state or local governmental entities of alleged violations of environmental laws and regulations pertaining to, among other things, the disposal, emission and storage of chemical and petroleum substances, including hazardous wastes. Such alleged violations may become the subject of enforcement actions or other legal proceedings and may involve monetary sanctions of $100,000 or more (exclusive of interest and costs).\nOTHER LITIGATION\nThe Company and its subsidiaries are defendants in numerous suits in which they are not covered by insurance which involve smaller amounts than the matters described above. Although the legal responsibility and financial impact in respect to such litigation cannot be ascertained, it is not anticipated that these suits will result in the payment by the Company or its subsidiaries of monetary damages which in the aggregate would be material in relation to the net assets of the Company and its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of 1993.\n----------------\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the executive officers of Registrant as of February 28, 1994.\n- -------- (a) Division names used in the descriptions of business experience of executive officers of the Company are the names which were in effect at the time such officers held such positions. In some instances, divisions have been combined or reorganized and, accordingly, activities thereof are presently conducted under different division names.\n(b) The By-Laws of the Company provide that each officer shall hold office until the officer's successor is elected or appointed and qualified or until the officer's death, resignation or removal by the Board of Directors.\nDESCRIPTION OF CAPITAL STOCK\nThe following description of the Company's capital stock is included in order to facilitate incorporation by reference of such description in filings by the Company under the federal securities laws.\nCertain statements under this heading are summaries of provisions of the Certificate of Incorporation of ARCO, as adopted upon the reincorporation of the Company into a Delaware corporation on May 7, 1985, and do not purport to be complete. A copy of the Certificate of Incorporation, as amended through May 3, 1993, is filed as an exhibit hereto. The summaries make use of certain terms defined in the Certificate of Incorporation and are qualified in their entirety by reference thereto.\nThe term \"$3.00 Preference Stock\" refers to the Company's $3.00 Cumulative Convertible Preference Stock, par value $1 per share. The term \"$2.80 Preference Stock\" refers to the Company's $2.80 Cumulative Convertible Preference Stock, par value $1 per share. The term \"Preferred Stock\" refers to the Company's Preferred Stock, par value $.01 per share; this new class of Preferred Stock was authorized by stockholders on May 3, 1993. The term \"Common Stock\" refers to the Company's Common Stock, par value $2.50 per share.\nThe following is a summary of the capital stock of ARCO as of December 31, 1993.\n- --------\n* Excludes treasury stock.\nNew Class of Preferred Stock. Under the Certificate of Incorporation, as amended following approval by stockholders on May 3, 1993, the Board is authorized to issue, at any time or from time to time, one or more series of Preferred Stock at its discretion. In addition, the Board has the power to determine all designations, powers, preferences and the rights of such stock and any qualifications, limitations and restrictions, including but not limited to: (i) the designation of series and numbers of shares; (ii) the dividend rights, if any; (iii) the rights upon liquidation or distribution of the assets of the Company, if any; (iv) the conversion or exchange rights, if any; (v) the redemption provisions, if any; and (vi) the voting rights, if any.\nSo long as the Preference Stocks are outstanding, and only for that period of time, the rights of the Preferred Stock are subordinate to the rights of the holders of Preference Stocks.\nDividend Rights. Holders of $3.00 Preference Stock and holders of $2.80 Preference Stock are entitled to receive cumulative dividends at the annual rate of $3.00 per share and $2.80 per share, respectively, payable quarterly, before cash dividends are paid on the Preferred Stock, if any, and the Common Stock. Shares of $3.00 Preference Stock and shares of $2.80 Preference Stock rank on a parity as to dividends. After provision for payment in full of cumulative dividends on the outstanding $3.00 Preference and $2.80 Preference Stocks, and the payment in full of cumulative dividends on the outstanding Preferred Stock, if any, dividends may be paid on the Common Stock as the Board of Directors may deem advisable, within the limits and from the sources permitted by law.\nConversion Rights. Each share of $3.00 Preference Stock is convertible, at the option of the holder, into six and eight-tenths (6.8) shares of Common Stock of the Company at any time, and each share of $2.80 Preference Stock is convertible, at the option of the holder, into two and four-tenths (2.4) shares of Common Stock of the Company at any time. These conversion rates are subject to adjustment as set forth in the Certificate of Incorporation. Shares of Preferred Stock would be convertible, if at all, on such terms as were designated by the Board of Directors.\nVoting Rights. The holders of $3.00 Preference Stock are entitled to eight votes per share; holders of $2.80 Preference Stock are entitled to two votes per share; and holders of Common Stock are entitled to one vote per share. Holders of $3.00 Preference and $2.80 Preference Stocks are entitled to vote cumulatively for directors; holders of Common Stock have no cumulative voting rights. The $3.00 Preference, $2.80 Preference and Common Stocks vote together as one class, except as provided by law and except as to certain matters which require a vote by the holders of $3.00 Preference Stock or by the holders of $2.80 Preference Stock as a separate class as set forth below.\nThe Certificate of Incorporation provides that if the Company shall be in default with respect to dividends on the $3.00 Preference Stock in an amount equal to six quarterly dividends, the number of directors of the Company shall be increased by two at the first annual meeting thereafter, and at such meeting and at each subsequent annual meeting until all dividends on the $3.00 Preference Stock shall have been paid in full, the holders of the $3.00 Preference Stock shall have the right, voting as a class, to elect such two additional directors. The Certificate of Incorporation contains identical provisions with respect to the $2.80 Preference Stock.\nThe Certificate of Incorporation provides that the Company shall not, without the assent of the holders of two-thirds of the then outstanding shares of $3.00 Preference Stock, (a) change any of the terms of the $3.00 Preference Stock in any material respect adverse to the holders, or (b) authorize any prior ranking stock; and that the Company shall not, without the assent of the holders of a majority of the then outstanding shares of $3.00 Preference Stock, (1) authorize any additional $3.00 Preference Stock or stock on a parity with it; (2) sell, lease or convey all or substantially all of the property or business of the Company; or (3) become a party to a merger or consolidation unless the surviving or resulting corporation will have immediately after such merger or consolidation no stock either authorized or outstanding (except such stock of the Company as may have been authorized or outstanding immediately before such merger or consolidation of such stock of the surviving or resulting corporation as may be issued upon conversion thereof or in exchange therefor) ranking as to dividends or assets prior to or on a parity with the $3.00 Preference Stock or the stock of the surviving or resulting corporation issued upon conversion thereof or in exchange therefor. The Certificate of Incorporation contains identical provisions with respect to the $2.80 Preference Stock.\nThe holders of Preferred Stock, if any, would have such voting rights, if any, as were designated by the Board.\nRedemption Provisions. The $3.00 Preference Stock is redeemable at the option of the Company as a whole or in part at any time on at least thirty days' notice at $82 per share plus accrued dividends to the redemption date. The $2.80 Preference Stock is redeemable at the option of the Company as a whole or in part at any time on at least thirty days' notice at $70 per share plus accrued dividends to the redemption date. The holders of Preferred Stock, if any, would have such redemption provisions, if any, as were designated by the Board.\nLiquidation Rights. In the event of liquidation of the Company, the holders of $3.00 Preference Stock and holders of $2.80 Preference Stock will be entitled to receive, before any payment to holders of Common Stock, $80 per share and $70 per share, respectively, together in each case with accrued and unpaid dividends. Shares of $3.00 Preference Stock and shares of $2.80 Preference Stock will rank on a parity as to assets of the Company upon its liquidation. Subject to the rights of creditors and the holders of $3.00 Preference Stock and $2.80 Preference Stock, the holders of Common Stock are\nentitled pro rata to the assets of the Company upon its liquidation. The holders of Preferred Stock, if any, would have such liquidation rights, if any, as were designated by the Board.\nPreemptive Rights. No holders of shares of capital stock of the Company have or will have any preemptive rights to acquire any securities of the Company.\nLiability to Assessment. The shares of Common Stock are fully paid and non- assessable.\nProhibition of Greenmail. Article VII of the Certificate of Incorporation provides in general that any direct or indirect purchase by the Company of any of its voting stock (or rights to acquire voting stock) known to be beneficially owned by any person or group which holds more than 3 percent of a class of its voting stock and which has owned the securities being purchased for less than two years must be approved by the affirmative vote of at least 66 2\/3 percent of the votes entitled to be cast by the holders of the voting stock. Such approval shall not be required with respect to any purchase by the Company of such securities made (i) at or below fair market value (based on average New York Stock Exchange closing prices over the preceding 90 days) or (ii) as part of a Company tender offer or exchange offer made on the same terms to all holders of such securities and complying with the Securities Exchange Act of 1934 or (iii) in a Public Transaction (as defined).\nRights to Purchase Common Stock. On May 27, 1986, the Board of Directors of the Company declared a dividend distribution of one Right for each outstanding share of Common Stock to the stockholders of record on June 9, 1986 (the \"Record Date\"). Each Right entitles the registered holder to purchase from the Company one share of Common Stock at a price of $200 per share (the \"Purchase Price\"), subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement (the \"Rights Agreement\") between the Company and Morgan Guaranty Trust Company of New York, as Rights Agent (the \"Rights Agent\").\nThe Rights were issued on the Record Date. Thereafter, as long as the Rights are attached to the Common Stock, the Company will issue one Right with each share of Common Stock that shall become outstanding so that all such shares will have attached Rights.\nThe Rights are attached to all Common Stock certificates representing outstanding Common Stock, and no separate certificates evidencing Rights (\"Right Certificates\") have been distributed. Until the earlier to occur of (i) 10 days following a public announcement that a person or group of affiliated or associated persons acquired, or obtained the right to acquire, beneficial ownership of 20 percent or more of the outstanding shares of Common Stock (an \"Acquiring Person\") or (ii) 10 days following the earlier of the commencement of, or the announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 30 percent or more of the outstanding shares of Common Stock (the earlier of such dates described in (i) and (ii) above being called the \"Distribution Date\"), the Rights are evidenced by such Common Stock certificate with a copy of the Summary of Rights attached thereto. The date of announcement of the existence of an Acquiring Person referred to in clause (i) above is hereinafter referred to as the \"Shares Acquisition Date.\" The Rights Agreement provides that, until the Distribution Date, the Rights will be transferred with and only with the Common Stock. Until the Distribution Date (or earlier redemption or expiration of the Rights), Common Stock certificates issued after the Record Date upon transfer or issuance of Common Stock contain a notation incorporating the Rights Agreement by reference. Until the Distribution Date (or earlier redemption or expiration of the Rights), the surrender for transfer of any certificates evidencing Common Stock outstanding as of the Record Date, even without a copy of the Summary of Rights attached thereto, will also constitute the transfer of the Rights associated with the Common Stock represented by such certificate. As soon as practicable following the Distribution Date, Right Certificates will be mailed to holders of record of the Common Stock as of the close of business on the Distribution Date and such separate Right Certificates alone will evidence the Rights.\nThe Rights are not exercisable until the Distribution Date. The Rights will expire on June 9,1996, unless earlier redeemed by the Company as described below.\nThe Purchase Price payable, and the number of shares of Common Stock or other securities or property issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of the Common Stock, (ii) upon the grant to holders of the Common Stock of certain rights or warrants to subscribe for Common Stock or convertible securities at less than the current market price of the Common Stock or (iii) upon the distribution to holders of the Common Stock of evidences of indebtedness or assets (excluding regular periodic cash dividends out of earnings or retained earnings at a rate not in excess of 125 percent of the rate of the last cash dividend theretofore paid or dividends payable in Common Stock) or of subscription rights or warrants (other than those referred to above).\nIn the event that the Company were to be acquired in a merger or other business combination transaction, or more than 50 percent of its assets or earning power were sold, proper provision would be made so that each holder of a Right would thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times the exercise price of the Right. In the event that the Company were to be the surviving corporation in a merger with an Acquiring Person and its Common Stock were not changed or exchanged, or in the event that an Acquiring Person were to engage in one of a number of self- dealing transactions or certain other events occur while there is an Acquiring Person (e.g., a reverse stock split), as specified in the Rights Agreement, proper provision would be made so that each holder of a Right (except as provided below) would thereafter have the right to receive upon exercise that number of shares of Common Stock of the Company having a market value of two times the exercise price of the Right. Upon the occurrence of any of the events described in the preceding sentence, any Rights that are or were at any time on or after the earlier of (a) the Shares Acquisition Date and (b) the Distribution Date beneficially owned by an Acquiring Person will immediately become null and void, and no holder of such Rights will have any right with regard to such Rights from and after such occurrence.\nWith certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments require an adjustment of at least 1 percent in such Purchase Price. No fractional shares will be issued and in lieu thereof, an adjustment in cash will be made based on the market price of the Common Stock on the last trading date prior to the date of exercise.\nAt any time prior to the time that a person or group of affiliated or associated persons has acquired beneficial ownership of 20 percent or more of the outstanding Common Stock, the Company may redeem the Rights in whole, but not in part, at a price of $0.10 per Right (the \"Redemption Price\"). Immediately upon the action of the Board of Directors of the Company electing to redeem the Rights, the Company will make announcement thereof, and upon such election, the right to exercise the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price.\nUntil a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends.\nWhile the distribution of the Rights was not, and the issuance of Rights thereafter is not, taxable to plan participants or the Company, stockholders may recognize taxable income if the Rights become exercisable.\nThe terms of the Rights may be amended by the Board of Directors of the Company and the Rights Agent, provided that the amendment does not adversely affect the interests of the holders of Rights.\nThe Rights have certain antitakeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by its Board of Directors, except pursuant to an offer conditioned on a substantial number of Rights being acquired. The Rights should not interfere with any merger or other business combination approved by the Board of Directors at a time when the Rights are redeemable.\nA copy of the Rights Agreement is filed as an exhibit hereto. This summary description of the Rights is qualified in its entirety by reference thereto.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrices in the foregoing table are from the New York Stock Exchange composite tape. On February 28, 1994 the high price per share was $101 3\/8 and the low price per share was $100 5\/8.\nAs of December 31, 1993, the approximate number of holders of record of Common Stock of ARCO was 120,000. The principal markets in which ARCO's Common Stock is traded are listed on the cover page.\nThe quarterly dividend rate for Common Stock was increased to $1.375 per share in January 1991. On January 24, 1994, a dividend of $1.375 per share was declared on Common Stock, payable on March 15, 1994 to stockholders of record on February 18, 1994. Future cash dividends will depend on earnings, financial conditions and other factors; however, the Company presently expects that dividends will continue to be paid.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial information for ARCO:\n- -------- (1) See Note 2 of Notes to Consolidated Financial Statements regarding unusual items on page 42.\n(2) Includes after-tax gain of $634 million from sale of majority interest in Lyondell.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW OF 1993 RESULTS\nIn 1993, ARCO's net income was $269 million, or $1.66 per share. Operating results were lower compared to 1992. Operations in 1993 benefited from improved margins and higher gasoline sales volumes in ARCO's West Coast refining and marketing operations, higher coal sales volumes and higher natural gas prices. These benefits were more than offset by lower crude oil prices and volumes, lower natural gas volumes, higher exploration and selling, general and administrative expenses and lower after-tax earnings from transportation operations.\nThe 1993 results included net charges of $545 million after tax related to reorganization of ARCO's Lower 48 oil and gas operations, the impact of the federal corporate tax rate increase on deferred taxes, litigation issues, reserves for future environmental remediation and a loss on the sale of Brazilian marketing subsidiaries partially offset by gains from Lower 48 property sales.\nThe charges associated with the fourth quarter reorganization of ARCO's Lower 48 oil and gas operations were $450 million after tax. Included in those charges were unusual items of $659 million before tax, $404 million after tax, primarily related to writedowns for sale or other disposition of oil and gas properties and excess office space, in addition to workforce reductions. The incremental cash cost associated with these charges is approximately $60 million after tax.\nOVERVIEW OF 1992 RESULTS\nIn 1992, ARCO's net income was $801 million, or $4.96 per share. The improvement in operating results compared to 1991 reflected improved margins and higher sales volumes in refining and marketing operations, lower lease operating costs, higher sales volumes and margins in chemical operations and higher natural gas prices, partially offset by lower natural gas sales volumes. In addition, income from equity earnings, interest income and interest expense were lower in 1992.\nThe 1992 results included approximately $140 million after tax in net benefits primarily related to unusual items, partially offset by provisions for future environmental costs. Unusual items were $271 million before tax, $211 million after tax, and were comprised of a settlement on assets nationalized by Iran and recognition of a previously deferred portion of the gain from the 1989 sale of a majority interest in Lyondell Petrochemical Company (Lyondell), partially offset by a charge related to the withdrawal by ARCO Chemical Company (ARCO Chemical) from a South Korean joint venture.\nThe 1992 results also included a net after-tax charge of\n$392 million, or $2.43 per share, for the cumulative effect of adopting two new accounting standards related to non-pension postretirement benefits and income taxes.\nOVERVIEW OF 1991 RESULTS\nIn 1991, ARCO's net income was $709 million, or $4.39 per share. Results included net charges for unusual items of $503 million before tax, $312 million after tax, primarily related to personnel reductions, anticipated loss on property sales and property writedowns.\nRESULTS OF CONSOLIDATED OPERATIONS\nREVENUES\nSales and other operating revenues were $18.5 billion in 1993, $18.7 billion in 1992 and $18.2 billion in 1991. The decrease in revenues in 1993, compared to 1992, resulted from lower crude oil prices and volumes, lower natural gas volumes, decreased crude oil trading volumes and lower refined and chemical products prices, partially offset by increased natural gas marketing volumes and higher refined and chemical products sales volumes and natural gas prices.\nThe increase in revenues in 1992, compared to 1991, resulted from higher crude oil trading volumes, refined product prices and sales volumes, chemical product sales volumes and natural gas prices, partially offset by lower crude oil prices and natural gas volumes.\nIncome from equity investments was $40 million in 1993, $22 million in 1992 and $119 million in 1991. The increase in income from equity investments in 1993, compared to 1992, primarily reflected reduced losses from ARCO Chemical's equity affiliates. The lower income in 1992, compared to 1991, primarily resulted from a decline in earnings from Lyondell.\nOther revenues were $492 million in 1993, compared to $376 million in 1992 and $385 million in 1991. The increase in 1993 reflected higher gains on asset sales.\nEXPENSES\nTrade purchases were $7.2 billion in 1993, $7.3 billion in 1992 and $7.0 billion in 1991. The 1993 trade purchases decrease compared to 1992 reflected lower crude oil trading prices and volumes and lower purchased volumes of finished refined products and chemical feedstocks, partially offset by higher natural gas marketing volumes and prices. The trade purchases increase in 1992, compared to 1991, related primarily to higher crude oil trading volumes, partially offset by lower crude oil prices.\nOperating expenses were $3.3 billion in 1993, $3.2 billion in 1992 and $3.1 billion in 1991. In 1993, operating expenses were higher than in 1992 as a result of litigation-related accruals, higher compensation and contract personnel costs associated with downstream and coal operations and higher maintenance costs, including turnarounds at three chemical plants, partially offset by lower operating costs in oil and gas operations. In 1992, lower operating costs in oil and gas were offset by higher operating costs in chemical operations.\nExploration expenses were $667 million in 1993, $567 million in 1992 and $593 million in 1991. The increase in 1993, compared to 1992, reflected higher dry hole costs in Alaska and increased activity overseas, partially offset by decreased activity in the Lower 48.\nSelling, general and administrative expenses were $1.8 billion in 1993, $1.7 billion in 1992, and $1.8 billion in 1991. Increased expenses in 1993, compared to 1992, primarily resulted from higher compensation expense and higher delivery and advertising costs. The decrease in expenses in 1992, compared to 1991, primarily reflected lower insurance and pension costs.\nTaxes other than excise and income taxes were $1.1 billion in 1993, $1.2 billion in 1992, and $1.1 billion in 1991. The decrease in 1993 primarily resulted from lower production taxes related to lower crude oil prices and volumes. The increase in 1992 primarily resulted from an increase in the Brazilian value- added tax rate.\nExcise taxes were $1.3 billion in 1993, $1.2 billion in 1992 and $1.1 billion in 1991. The increase in 1993, compared to 1992, primarily resulted from the fourth quarter 1993 federal excise tax rate increase, the full-year effect in 1993 of increased state excise tax rates in 1992 and higher refined products sales volumes. The increase in 1992, compared to 1991, resulted from higher refined product sales volumes and increases in state excise tax rates in certain states in the fourth quarter of 1992.\nDepreciation, depletion and amortization was $1.7 billion in 1993, $1.8 billion in 1992 and $1.7 billion in 1991. The decrease in 1993, compared to 1992, resulted from\nthe sale of Lower 48 oil and gas properties, partially offset by a $73 million accrual for the plugging and abandonment of onshore wells. The increase in 1992, compared to 1991, included the startup of the new ARCO Chemical propylene oxide\/styrene monomer plant in Channelview, Texas and assets placed in service at the Corporation's two West Coast refineries.\nInterest expense was $715 million in 1993, $762 million in 1992 and $892 million in 1991. A decline in the weighted average interest rate on outstanding long- term debt in 1993 and 1992 is the primary cause of the lower interest expense compared to 1991.\nThe Corporation's effective tax rate was 51.6% in 1993, compared to 35.6% in 1992 and 36.2% in 1991. The higher effective tax rate in 1993 reflected increased taxes on foreign income and the effect of the 1993 federal tax rate increase on deferred taxes.\nRESULTS OF SEGMENT OPERATIONS\nOIL AND GAS\nARCO's worldwide oil and gas exploration and production operations earned $45 million after tax in 1993, versus $816 million after tax in 1992. The effect of lower crude oil prices and volumes and natural gas volumes and higher dry hole expense, partially offset by higher natural gas prices and lower depletion and lease operating costs, resulted in the lower earnings for 1993. The 1993 results included net charges of approximately $390 million after tax comprised of the previously discussed charges associated with the Lower 48 reorganization, the federal tax rate increase and other charges, partially offset by gains on property sales. Annual future cost savings associated with the Lower 48 reorganization are estimated to be approximately $100 million after tax. The 1992 results included a net benefit of $138 million after tax consisting of gains from the Iranian settlement, and gains from Lower 48 property sales, partially offset by charges associated with the downsizing of Lower 48 operations.\nARCO's oil and gas exploration and production operations earned $816 million after tax in 1992, up from $549 million after tax in 1991. The 1992 results reflected the effect of lower operating and exploration costs and higher natural gas prices, offset by lower natural gas sales volumes, compared to 1991. The 1991 results included approximately $170 million after tax in net charges related to personnel reductions and the anticipated loss on divestiture of properties in the Lower 48, partially offset by a benefit from the reduction in U.K. corporation tax rates.\nThe Corporation's domestic composite average price for crude oil was $11.67 per barrel in 1993, $12.92 per barrel in 1992 and $12.93 per barrel in 1991. Average domestic natural gas prices were $1.93 per thousand cubic feet in 1993, $1.65 per thousand cubic feet in 1992 and $1.54 per thousand cubic feet in 1991.\nWorldwide petroleum liquids production averaged 684,400 barrels per day in 1993, 738,200 barrels per day in 1992 and 744,200 barrels per day in 1991. Volumes decreased in 1993 as a result of Lower 48 property divestitures and natural field declines, partially offset by increased overseas production. Natural field decline in Alaska was partially offset by the September 1993 startup of the first phase of the second gas handling expansion facility (GHX-2) at Prudhoe Bay and new volumes which came on-stream from the Greater Point McIntyre area in October 1993. Worldwide production in 1992, compared to 1991, benefited from increased international volumes, although this was offset by natural field declines and Lower 48 property divestitures.\nARCO's share of production from its largest Alaskan field, Prudhoe Bay, was 250,800 barrels of petroleum liquids per day in 1993, compared to 270,500 barrels per day in 1992 and 281,700 barrels per day in 1991. The decline in 1993 and 1992, compared to 1991, primarily reflected natural field decline.\nARCO's share of petroleum liquids production from the Kuparuk River field was 151,500 barrels per day in 1993 compared to 150,800 barrels per day in 1992 and 140,300 barrels per day in 1991. The increase in 1992, compared to 1991, reflected the completion as of July 1, 1992 of a 24-month production payback of 9,000 barrels per day and improved field operations.\nLower 48 petroleum liquids production was 186,000 barrels per day in 1993, 221,600 barrels per day in 1992 and 227,900 barrels per day in 1991. Domestic natural gas production totaled 911 million cubic feet per day in\n1993, 1.2 billion cubic feet per day in 1992 and 1.4 billion cubic feet per day in 1991. The decreases in 1993 and 1992 production were primarily associated with the sale of Lower 48 properties and natural field declines.\nForeign petroleum liquids production averaged 79,700 barrels per day in 1993, 77,700 barrels per day in 1992 and 75,700 barrels per day in 1991. Foreign natural gas production increased to 321 million cubic feet per day in 1993 as a result of the first full year of production from the Pickerill field in the United Kingdom North Sea and new production from the Orwell and Murdoch fields in the U.K. North Sea and from the offshore Northwest Java Sea field in Indonesia, all of which began production in late 1993. The decrease in 1992 natural gas production to 240 million cubic feet per day from 261 million cubic feet per day in 1991, reflected primarily natural field decline in the United Kingdom.\nCOAL\nAfter-tax earnings from coal operations were $107 million in 1993, $83 million in 1992 and $33 million in 1991. The improvement in 1993 earnings reflected record sales volumes as a result of strong electric utility demand and reduced East Coast supply as a result of a mine workers strike. Australian mines also set production volumes and sales records for 1993. 1993 results included a benefit of approximately $10 million after tax associated with a change in the accrued estimated loss on the sale of the Coal Resources of Queensland (CRQ) mine, which was completed in January 1993. Included in the 1991 earnings were approximately $50 million in net after-tax charges primarily associated with a writedown of the CRQ mine, partially offset by gains from the sale of Venezuelan and other assets. Total worldwide coal shipments in 1993 were 47.7 million tons compared to 39.8 million tons in 1992 and 41.6 million tons in 1991.\nREFINING AND MARKETING\nAfter-tax earnings for refining and marketing operations were $307 million in 1993, $346 million in 1992 and $266 million in 1991. Earnings were lower in 1993, compared to 1992, because operating results were offset by a net charge of approximately $80 million after tax, comprised primarily of litigation-related accruals, the loss associated with the sale of the Brazilian marketing subsidiaries and the effect of the federal tax rate increase on deferred taxes. The improved earnings in 1992, compared to 1991, were the result of higher margins and sales volumes in the West Coast marketing area. The 1992 results included a charge of approximately $40 million after tax primarily for environmental costs related to previously divested operations. The 1991 earnings included approximately $10 million of net after-tax charges for personnel reductions, future environmental remediation primarily associated with previously divested properties and certain legal exposures, partially offset by benefits associated with accounting and tax adjustments related to Brazilian operations.\nWest Coast petroleum products sales totaled 481,500 barrels per day in 1993, 479,500 barrels per day in 1992 and 466,400 barrels per day in 1991. The higher level of sales in 1993, compared to 1992, resulted from increased demand. The higher level of sales in 1992, compared to 1991, resulted from increased market share. The marketing operations supplemented ARCO's production with third-party purchases in order to meet increased sales.\nTRANSPORTATION\nAfter-tax earnings for the transportation operations were $189 million in 1993, $239 million in 1992 and $212 million in 1991. The 1993 earnings were lower, compared to 1992, as a result of a lower Trans Alaska Pipeline System (TAPS) tariff, lower volumes and the effect of the federal tax rate increase on deferred taxes. In 1992, improved results from Lower 48 terminal and pipeline operations offset a decline in earnings from TAPS. The 1991 earnings included after-tax charges of approximately $30 million for personnel reduction costs and for settlement of the Kuparuk Pipeline tariff rate litigation.\nINTERMEDIATE CHEMICALS AND SPECIALTY PRODUCTS\nAfter-tax earnings for the intermediate chemicals and specialty products segment were $239 million in 1993, $210 million in 1992 and $192 million in 1991. The segment consists of ARCO Chemical, an 83.3 percent owned subsidiary of the Corporation. ARCO Chemical's reported net income in 1993 included a $10 million after-tax loss on early debt extinguishment and benefited from a lower effective income tax rate. The 1992\nresults included $56 million before tax for a charge resulting from ARCO Chemical's withdrawal from the YUKONG ARCO Chemical Ltd., joint venture in South Korea.\nIn 1993, increased sales volumes in ARCO Chemical's core products worldwide were offset by higher fixed costs associated with a new plant and maintenance expense resulting from turnarounds at three plants. Additional offsets included lower methyl tertiary butyl ether (MTBE) margins, primarily in Europe and lower overall propylene oxide (PO) and derivative margins as a result of lower margins for new products and continued weakness in the European economy.\nThe 1992 earnings improved, compared to 1991, as a result of higher sales volumes and margins. Sales volumes for all major product groups, including PO derivatives and MTBE, were higher in 1992 than 1991. PO margins were higher in 1992, primarily in Europe, reflecting a weaker dollar. MTBE sales volumes were higher in 1992, primarily in the U.S., as a result of higher demand from domestic gasoline refiners. MTBE margins were higher on average in 1992 in both the U.S. and Europe as a result of lower raw material costs.\nARCO Chemical's reported 1991 results included a $153 million before tax benefit from business interruption insurance related to a plant accident and to feedstock contamination at another plant in 1990. Also included in 1991 results were net pretax charges totaling $20 million reflecting personnel reductions and future environmental remediation costs, partially offset by a benefit related to a change in estimated accident charges.\nLYONDELL PETROCHEMICAL COMPANY\nARCO's 49.9 percent equity share of Lyondell's net income was $13 million for 1993, $8 million for 1992 and $111 million for 1991. Lyondell's results in 1993 improved as a result of higher margins attained through the processing of greater volumes of Venezuelan crude oil. Lyondell's 1992 earnings, compared to 1991, were lower as a result of lower olefins margins and volumes and reduced refining margins in the Gulf Coast.\nUNALLOCATED EXPENSES AND OTHER\nUnallocated expenses and other was a net after-tax expense of $140 million in 1993 and $60 million in 1991 compared to a net after-tax benefit of $25 million in 1992. The increase in unallocated expenses in 1993, compared to 1992, reflected the absence of a $111 million after-tax gain recognized in 1992, increased employee-related expenses, higher charges for future environmental remediation, and lower net investment income. In 1992, unallocated expenses and other included the recognition of a $111 million after-tax gain representing a previously deferred portion of the gain from the 1989 sale of a majority interest in Lyondell, partially offset by corporate staff expense and charges for future environmental remediation. The 1991 unallocated expenses and other included after-tax charges of $34 million for future environmental remediation and higher insurance costs.\nRECENT DEVELOPMENTS\nOn January 28, 1994, Vastar Resources, Inc. (Vastar), a wholly owned subsidiary of ARCO, filed a registration statement on Form S-1 with the Securities and Exchange Commission for the proposed sale of up to 17,250,000 shares of common stock to the public. ARCO intends to retain 80,000,001 shares, or 82.3 percent of Vastar's common stock. On December 7, 1993, Vastar borrowed $1.25 billion under a revolving credit agreement with a group of banks at an initial interest rate of 3.9 percent. The revolving line of credit is available until November 30, 1996.\nFINANCIAL POSITION AND LIQUIDITY\nCash flows from operating activities were $2.8 billion in 1993, $3.1 billion in 1992 and $3.0 billion in 1991. The net cash used in investing activities was $2.2 billion in 1993 and primarily included expenditures for additions to fixed assets (including dry hole costs) of $2.1 billion, proceeds from asset sales of $582 million and a net increase in short-term investments of $789 million. The net cash used in financing activities was $431 million in 1993 and primarily included repayments of long-term debt of $886 million, proceeds of $1.3 billion from the issuance of long-term debt and dividend payments of $879 million.\nCash and cash equivalents and short-term investments totaled $3.7 billion at year-end 1993 and short-term borrowings were $1.5 billion. Working capital was $1.1 billion higher at the end of 1993, reflecting an increase in\nshort-term investments and a decrease in long-term debt due within one year. At December 31, 1993, the Corporation had unused committed bank credit facilities totaling $3.2 billion. In addition, ARCO Chemical had unused bank credit facilities totaling $300 million.\nThe Corporation's 1994 capital spending program includes $1.9 billion for additions to fixed assets. Future capital expenditures remain subject to business conditions affecting the industry, particularly changes in price and demand for crude oil, natural gas and petroleum products. Changes in the tax laws, the imposition of and changes in federal and state clean air and clean fuel requirements, and other changes in environmental rules and regulations may also affect future capital expenditures.\nIt is expected that future cash requirements for capital expenditures, dividends and debt repayments will come from cash generated from operating activities, existing cash balances, and any asset sales and future financings.\nENVIRONMENTAL MATTERS\nDuring 1993, the Corporation charged to income $172 million before tax for environmental remediation costs and made related payments of $206 million. At December 31, 1993, the environmental remediation reserve totaled $648 million. The amount reserved represents an estimate of the undiscounted costs which the Corporation will incur to remediate sites with known contamination. In view of the uncertainties associated with estimating these costs, such as uncertainties with respect to the appropriate method for remediating contaminated sites, the extent of contamination at various sites, and the Corporation's ultimate share of costs at various sites, actual future costs could exceed the amount accrued by as much as $1 billion.\nAlthough the contingencies associated with environmental matters could result in significant expenses or judgments that, if aggregated and assumed to occur within a single fiscal year, would be material to the Corporation's results of operations, the likelihood of such occurrence is considered remote. On the basis of management's best assessment of the ultimate amount and timing of these events, such expenses or judgments are not expected to have a material adverse effect on the Corporation's consolidated financial position, stockholders' equity, liquidity or capital resources.\nIn addition to the provision for environmental remediation costs, $788 million has been accrued for the estimated cost, net of salvage value, of dismantling facilities as required by contract, regulation or law, and the estimated costs of restoration and reclamation of land associated with such facilities.\nFor further discussion of environmental matters see Note 12 of Notes to Consolidated Financial Statements.\nEFFECTS OF INFLATION\nWhile the annual rate of inflation remained moderate during the three-year period ended December 31, 1993, the Corporation continued to experience certain inflationary effects. The Corporation will achieve some benefits by using current, inflated dollars to satisfy its debt obligations and other monetary liabilities, because the Corporation's monetary assets are less than its monetary liabilities at December 31, 1993.\nBased on the age of the Corporation's property, plant and equipment, it is estimated that the replacement cost of those assets is greater than the historical cost reflected in the Corporation's financial statements. Accordingly, the Corporation's depreciation, depletion and amortization expense for the three years ended December 31, 1993, would be greater if the expense were stated on a current-cost basis.\nTo the extent that the Corporation uses the last-in, first-out (LIFO) inventory accounting method, the replacement cost of inventory is greater than the historical cost reflected on the Corporation's balance sheet, while the costs of products sold reflected in the Corporation's income statement approximate current cost.\nITEM 8.","section_7A":"","section_8":"ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nSchedules other than those listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the financial statements or related notes.\nFinancial statements with respect to unconsolidated subsidiaries and 50 percent owned companies are omitted per Rule 3-09(a) of Regulation S-X.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Atlantic Richfield Company\nWe have audited the accompanying consolidated balance sheets of Atlantic Richfield Company as of December 31, 1993 and 1992, and the related consolidated statements of income and retained earnings and cash flows for each of the three years in the period ended December 31, 1993 and the related financial statement schedules listed in the index on page 37 of this Form 10- K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Atlantic Richfield Company as of December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for income taxes, postretirement benefits other than pensions and postemployment benefits in 1992.\nCOOPERS & LYBRAND\nLos Angeles, California February 11, 1994\nCONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS ARCO\nSee Notes on pages 42 through 53.\nCONSOLIDATED BALANCE SHEET ARCO\nThe Corporation follows the successful efforts method of accounting for oil and gas producing activities.\nSee Notes on pages 42 through 53.\nCONSOLIDATED STATEMENT OF CASH FLOWS ARCO\n(a) Includes noncash unusual items of $659 and ($149) in 1993 and 1992, respectively. (b) Includes noncash unusual items of $476. See Notes on pages 42 through 53.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 Accounting Policies\nARCO's accounting policies conform to generally accepted accounting principles, including the \"successful efforts\" method of accounting for oil and gas producing activities.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of all subsidiaries, ventures and partnerships in which a controlling interest is held, including ARCO Chemical Company (ACC), of which ARCO owned 83.3 percent of the outstanding shares at December 31, 1993. ARCO also consolidates its interests in undivided interest pipeline companies and in oil and gas and coal mining joint ventures. ARCO uses the equity method of accounting for companies where its ownership is between 20 and 50 percent and for other ventures and partnerships in which less than a controlling interest is held.\nCash Equivalents; Short-Term Investments\nCash equivalents consist of highly liquid investments, such as time deposits, certificates of deposit and marketable securities other than equity securities, maturing within three months of purchase. Short-term investments consist of similar investments maturing in more than three months of purchase. Cash equivalents and short-term investments are stated at cost, which approximates market value.\nOil and Gas Unproved Property Costs\nUnproved property costs are capitalized and amortized on a composite basis, considering past success experience and average property life. In general, costs of properties surrendered or otherwise disposed of are charged to accumulated amortization. Costs of successful properties are transferred to developed properties.\nFixed Assets\nFixed assets are recorded at cost and are written off on either a unit-of- production method or a straight-line method based on the expected lives of individual assets or groups of assets.\nUpon disposal of assets depreciated on an individual basis, residual cost less salvage is included in current income. Upon disposal of assets depreciated on a group basis, unless unusual in nature or amount, residual cost less salvage is charged against accumulated depreciation.\nDismantlement, Restoration and Reclamation Costs\nThe estimated costs, net of salvage value, of dismantling facilities or projects with limited lives or facilities that are required to be dismantled by contract, regulation or law, and the estimated costs of restoration and reclamation associated with oil and gas and mining operations are accrued during production and classified as a long-term liability. Such costs are taken into account in determining the cost of production in all operations, except oil and gas production, in which case such costs are considered in determining depreciation, depletion and amortization.\nEnvironmental Remediation\nEnvironmental remediation costs are accrued as operating expenses based on the estimated timing and extent of remedial actions required by applicable governmental authorities, experience gained from similar sites on which remediation has been completed, and the amount of ARCO's liability in consideration of the proportional liability and financial wherewithal of other responsible parties. Estimated liabilities are not discounted to present value.\nReclassifications\nCertain previously reported amounts have been restated to conform to classifications adopted in 1993.\nNOTE 2 Unusual Items\nIn the fourth quarter of 1993, ARCO announced a reorganization of its Lower 48 oil and gas operations. ARCO provided as unusual items a pretax charge of $659 million, $404 million after tax, primarily related to the writedown for sale or other disposition of oil and gas properties and excess office space, in addition to workforce reductions.\nIn the fourth quarter of 1992, ARCO recognized a pretax benefit of $149 million from the settlement with Iran related to Corporation assets that had been nationalized in the late 1970s. In the second quarter of 1992, ARCO recognized a pretax benefit of $178 million related to a portion of the gain from the 1989 sale of a majority interest in Lyondell Petrochemical Company (Lyondell) which was previously deferred as the amount equal to ARCO's guarantee of notes associated with certain of Lyondell's manufacturing facilities. When Lyondell repaid the notes in 1992, ARCO was released from its guarantee and accordingly recognized the gain. In the second quarter of 1992, ARCO also recognized a pretax charge of $56 million resulting from ACC's withdrawal from the YUKONG ARCO Chemical Ltd. joint venture in Korea. The net benefit related to 1992 unusual items was $211 million after tax.\nIn 1991, ARCO announced a reorganization of its oil and gas operations in the Lower 48 states and a companywide workforce reduction. An estimated pretax charge of $281 million was provided as unusual items for the\ncost of these programs. ARCO also provided as unusual items a pretax charge of approximately $222 million for the anticipated loss on the sale of certain Lower 48 oil and gas properties and the writedown of certain coal assets. The net provision related to the above items was $312 million after tax.\nNOTE 3 Accounting Changes\nEffective January 1, 1992, ARCO implemented on the immediate recognition basis Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires accrual of the actuarially determined costs of postretirement benefits during the years that the employee renders the necessary service. ARCO's previous policy was to expense these costs when incurred.\nThe cumulative effect of adopting SFAS No. 106 as of January 1, 1992, resulted in a charge of $435 million, or $2.70 per share, to 1992 earnings, net of income tax effects of approximately $262 million.\nEffective January 1, 1992, ARCO adopted SFAS No. 109, \"Accounting for Income Taxes.\" The cumulative effect of the change on 1992 net income was a benefit of $43 million, or $0.27 per share. The effect of adopting SFAS Nos. 106 and 109 on 1992 net income, excluding the cumulative effect, was not material.\nEffective January 1, 1992, ARCO also adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The standard requires companies to accrue the cost of postemployment benefits either during the years that the employee renders the necessary service or at the date of the event giving rise to the benefit, depending upon whether certain conditions are met. The effect of adoption did not have a material impact on 1992 net income.\nNOTE 4 Segment Information\nARCO operates primarily in the Resources and Products segments. The Resources segment includes oil and gas operations, which comprise the exploration, development and production of petroleum, including petroleum liquids (crude oil, condensate and natural gas liquids) and natural gas; the purchase and sale of petroleum liquids and natural gas; and the mining and sale of coal. The Products segment includes the refining and transportation of petroleum and petroleum products; the marketing of petroleum products; and the manufacture and sale of intermediate chemicals and specialty products, including propylene oxide and derivatives, tertiary butyl alcohol, methyl tertiary butyl ether and styrene monomer.\nSegment information for the years ended December 31, 1993, 1992 and 1991 was as follows:\nIntersegment sales were made at prices approximating current market values. The amounts for intersegment sales included in sales and other operating revenues were as follows:\n(a) Net of minority interest of $(36), $(32), and $(31) in 1993, 1992 and 1991, respectively.\n(a) Excludes undeveloped leasehold amortization of $98, $110, and $113, respectively, included in exploration expense.\nForeign operations are conducted principally in the following geographic regions: Oil and gas--United Kingdom, Indonesia and Dubai; Coal--Australia; Intermediate chemicals and specialty products---Europe and Asia Pacific; Refining and marketing--Brazil (marketing only). The Brazilian operations were sold in December 1993.\n(a) Includes gain from settlement on assets nationalized by Iran (Note 2). (b) Includes losses of equity affiliates, principally Asian joint ventures, of $(2), $(18), and $(22), in 1993, 1992 and 1991, respectively. (c) Operations sold in December 1993.\nNOTE 5 Inventories\nInventories are recorded when purchased, produced or manufactured and are stated at the lower of cost or market. In 1993, approximately 88 percent of inventories excluding materials and supplies were determined by the last-in, first-out (LIFO) method. Materials and supplies and other non-LIFO inventories are determined predominantly on an average cost basis.\nTotal inventories at December 31, 1993 and 1992 comprised the following categories:\nThe excess of the current cost of inventories over book value was approximately $228 million and $285 million at December 31, 1993 and 1992, respectively.\nNOTE 6 Taxes\nTaxes other than excise and income taxes for the years ended December 31, 1993, 1992 and 1991 comprised the following:\nThe components of the provision for taxes on income for the years ended December 31, 1993, 1992 and 1991 were as follows:\nThe deferred tax benefit in 1993 and 1991 primarily resulted from book accruals associated with the reorganizations and workforce reductions.\nThe major components of the net deferred tax liability as of December 31, 1993 and 1992, and January 1, 1992 were as follows:\nARCO has foreign loss carryforwards of $227 million which begin expiring in 1994.\nThe domestic and foreign components of income before income taxes, minority interest and cumulative effect of changes in accounting principles, and a reconciliation of income tax expense with tax at the effective federal statutory rate for the years ended December 31, 1993, 1992 and 1991 were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7 Long-Term Debt\nLong-term debt at December 31, 1993 and 1992 comprised the following:\nMaturities and sinking fund obligations for the five years subsequent to December 31, 1993 are as follows (millions of dollars): 1994--$165; 1995--$632; 1996--$1,434; 1997--$269; 1998--$182. No material amounts of long-term debt are collateralized by Corporation assets.\nVastar Resources, Inc. (Vastar), a wholly owned subsidiary of ARCO, entered into a $1.25 billion unsecured, variable rate, revolving-term credit agreement. In December 1993, Vastar borrowed $1.25 billion principal amount at an initial interest rate of 3.9 percent. The agreement contains restrictions\nwhich, among other things, require Vastar to maintain certain financial ratios and restrict encumbrance of assets.\nNOTE 8 Bank Credit Facilities and Compensating Balances\nIn 1993, ARCO and certain wholly owned subsidiaries had committed bank credit facilities of approximately $3.2 billion, including a credit facility negotiated on behalf of a subsidiary that is denominated in pounds sterling. At December 31, 1993, there were no borrowings under these committed facilities.\nACC maintains two credit facilities under which it may borrow up to $300 million which are not guaranteed by ARCO. At December 31, 1993, there were no borrowings against the ACC credit facilities. The facilities replace a previous facility that effectively expired in December 1993.\nNotes payable on the balance sheet consist primarily of commercial paper issued to a variety of financial investors and institutions and any amounts outstanding under ARCO or ACC credit facilities.\nARCO has no requirements for compensating balances. ARCO does maintain balances for some of its banking services and products. Such balances are solely at ARCO's discretion, so that on any given date, none of ARCO's cash is restricted.\nAt December 31, 1993, ARCO had letters of credit outstanding totalling $305 million.\nNOTE 9 Interest Expense\nInterest expense for the years ended December 31, 1993, 1992 and 1991 was comprised of the following:\nNOTE 10 Foreign Currency Transaction Gains\nForeign exchange transactions, which relate primarily to Brazilian operations, resulted in net gains of $22 million, $1 million and $41 million in 1993, 1992 and 1991, respectively.\nNOTE 11 Fixed Assets\nProperty, plant and equipment, and related accumulated depreciation, depletion and amortization at December 31, 1993 and 1992 were as follows:\nExpenses for maintenance and repairs for 1993, 1992 and 1991 were $509 million, $513 million and $523 million, respectively.\nNOTE 12 Other Commitments and Contingencies\nARCO has commitments, including those related to the acquisition, construction and development of facilities, all made in the normal course of business.\nAt December 31, 1993 and 1992, there were contingent liabilities primarily with respect to guarantees of securities of other issuers of approximately $111 million and $100 million, respectively, of which approximately $41 million and $45 million, respectively, were indemnified.\nFollowing the March 1989 EXXON VALDEZ oil spill, Alyeska Pipeline Service Company (Alyeska) and Alyeska's owner companies were the subject of numerous lawsuits by the State of Alaska, the United States and private plaintiffs. ARCO Transportation Alaska, Inc. (ATA) owns approximately 21 percent of Alyeska. In July 1993, it was announced that Alyeska and its owner companies had agreed to pay $98 million in settlement of all but a handful of the lawsuits by private plaintiffs of which $20.9 million was ATA's share. At the October 1993 approval hearing on the settlement, the settlement was tentatively approved; however, there remain certain issues concerning claims that Exxon might assert against Alyeska and its owner companies that must be resolved before the settlement becomes final.\nARCO and former producers of lead pigments have been named as defendants in cases filed by a municipal housing authority, a purported class and several individuals seeking damages and injunctive relief as a consequence of the presence of lead-based paint in certain housing units.\nARCO and its subsidiary, Atlantic Richfield Hanford Company (ARHCO), and several other companies have been named as defendants in lawsuits filed on behalf of individual persons and a number of purported classes. These lawsuits arise out of radioactive and non-radioactive toxic and hazardous substances allegedly generated at the Hanford Nuclear Reservation in Richland, Washington (HNR). The claims against ARCO and ARHCO arise out of the performance by ARHCO of a contract with the Atomic Energy Commission to provide chemical processing, waste management and support services at HNR from 1967 to 1977. ARCO and ARHCO believe that, should either or both ultimately be held liable, they will be entitled to indemnification by the federal government as provided under the Price-Anderson Act, and pursuant to the terms of the contract between ARHCO and the Atomic Energy Commission.\nARCO is also the subject of or party to a number of pending or threatened legal actions for which the legal responsibility and financial impact cannot presently be ascertained. Although any ultimate liability arising from any of these suits, or from any of the proceedings described above, if aggregated and assumed to occur in a single fiscal year, would be material to ARCO's results of operations, the likelihood of such occurrence is considered remote. On the basis of management's best assessment of the ultimate amount and timing of these events, such expenses or judgments are not expected to have a material adverse effect on ARCO's consolidated financial position, stockholders' equity, liquidity or capital resources.\nARCO is subject to other loss contingencies pursuant to federal, state and local environmental laws and regulations. These include possible obligations to remove or mitigate the effects on the environment of the disposal or release of certain chemical, mineral and petroleum substances at various sites, including the restoration of natural resources located at these sites and damages for loss of use and non-use values. ARCO is currently participating in environmental assessments and cleanups under these laws at federal Superfund and state-managed sites, as well as other clean-up sites, including service stations, refineries, terminals, chemical facilities, third-party landfills, former nuclear processing facilities, and sites\nassociated with discontinued operations. ARCO may in the future be involved in additional environmental assessments and cleanups, including the restoration of natural resources and damages for loss of use and non-use values. The amount of such future costs is indeterminable due to such factors as the unknown nature and extent of contamination at many sites, the unknown timing, extent and method of the remedial actions which may be required and the determination of ARCO's liability in proportion to other responsible parties.\nARCO continues to estimate the amount of these costs in periodically establishing reserves based on progress made in determining the magnitude of remediation costs, experience gained from sites on which remediation has been completed, the timing and extent of remedial actions required by the applicable governmental authorities and an evaluation of the amount of ARCO's liability considered in light of the liability and financial wherewithal of the other responsible parties. At December 31, 1993, the reserve balance is $648 million. As the scope of ARCO's obligations becomes more clearly defined, there may be changes in these estimated costs, which might result in future charges against ARCO's earnings.\nARCO's reserve covers federal Superfund and state-managed sites as well as other clean-up sites, including service stations, refineries, terminals, chemical facilities, third-party landfills, former nuclear processing facilities and sites associated with discontinued operations. ARCO has been named a potentially responsible party (PRP) for 123 sites. The number of PRP sites in and of itself does not represent a relevant measure of liability, because the nature and extent of environmental concerns varies from site to site and ARCO's share of responsibility varies from sole responsibility to very little responsibility. ARCO reviews all of the PRP sites, along with other sites as to which no claims have been asserted, in estimating the amount of the reserve. ARCO's future costs at these sites could exceed the reserve by as much as $1 billion.\nApproximately half of the reserve related to sites associated with ARCO's discontinued operations, primarily mining activities in the states of Montana and Colorado. Another significant component related to currently and formerly owned chemical, nuclear processing, and refining and marketing facilities, and other sites which received wastes from these facilities. The remainder related to other sites with reserves ranging from $1 million to $10 million per site. No one site represents more than 15 percent of the total reserve. Substantially all amounts accrued in the reserve are expected to be paid out over the next five to six years.\nClaims for recovery of remediation costs already incurred and to be incurred in the future have been filed against various insurance companies and other third parties. None of these claims has been resolved. Due to the uncertainty as to ultimate recovery from these parties, ARCO has neither recorded any asset nor reduced any liability in anticipation of such recovery.\nEnvironmental loss contingencies also include claims for personal injuries allegedly caused by exposure to toxic materials manufactured or used by ARCO. Although these contingencies could result in significant expenses or judgments that, if aggregated and assumed to occur within a single fiscal year, would be material to ARCO's results of operations, the likelihood of such occurrence is considered remote. On the basis of management's best assessment of the ultimate amount and timing of these events, such expenses or judgments are not expected to have a material adverse effect on ARCO's consolidated financial position, stockholders' equity, liquidity or capital resources.\nThe operations and consolidated financial position of ARCO continue to be affected from time to time in varying degrees by domestic and foreign political developments as well as legislation, regulations and litigation pertaining to restrictions on production, imports and exports, tax increases, environmental regulations, cancellation of contract rights and expropriation of property. Both the likelihood of such occurrences and their overall effect on ARCO vary greatly and are not predictable.\nThese uncertainties are part of a number of items that ARCO has taken and will continue to take into account in periodically establishing reserves.\nNOTE 13 Retirement Plans\nARCO and its subsidiaries have defined benefit pension plans to provide pension benefits to substantially all employees. The benefits are based on years of service and the employee's compensation, primarily during the last three years of service. ARCO's funding policy is to make annual contributions as required by applicable regulations. ARCO charges pension costs as accrued, based on an actuarial valuation for each plan, and funds the plans through contributions to trust funds that are kept apart from Corporation funds.\nThe following table sets forth the plans' funded status and amounts recognized in the balance sheet at December 31, 1993 and 1992:\nPension costs related to ARCO-sponsored plans, on a pretax basis, including amortization of unfunded projected benefit obligations for the years ended December 31, 1993, 1992 and 1991 were as follows:\nIn addition to the pension (benefit) cost above, in 1993 and 1991 ARCO recorded $61 million and $103 million, respectively, before tax as additional pension expense in connection with the workforce reductions in those years.\nARCO's assumptions used as of December 31, 1993, 1992 and 1991 in determining the pension cost and pension liability shown above were as follows:\nNOTE 14 Other Postretirement Benefits\nARCO and its subsidiaries sponsor defined postretirement benefit plans to provide other postretirement benefits to substantially all employees who retire with ARCO having rendered the required years of service, along with their spouses and eligible dependents. Health care benefits are provided primarily through comprehensive indemnity plans. Currently, ARCO pays approximately 80 percent of the cost of such plans, but has the right to modify the cost-sharing provisions at any time. Life insurance benefits are based primarily on the employee's final compensation and are also partially paid for by retiree contributions, which vary based upon coverage chosen by the retiree.\nARCO's current policy is to fund the cost of postretirement health care and life insurance plans on a pay-as-you-go basis. Pursuant to Section 401(h) of the Internal Revenue Code of 1986, excess pension assets totalling $21 million were transferred from the pension plans to health care benefit accounts within the pension plans for reimbursement of 1992 retiree health care benefits.\nThe following table sets forth the plans' combined postretirement benefit liability as of December 31, 1993 and 1992:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nARCO charges postretirement benefit costs as accrued, based on actuarial calculations for each plan. Net annual postretirement benefit costs as of December 31, 1993 and 1992 included the following components:\nIn addition to the cost above, ARCO recorded $9 million as additional postretirement benefit expense in connection with the workforce reduction in 1993.\nFor the year ended December 31, 1991, ARCO recognized postretirement costs as incurred. Accordingly, the amount recognized as expense in prior years is not comparable.\nThe significant assumptions used in determining postretirement benefit cost and the accumulated postretirement benefit obligation were as follows:\nThe weighted average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care trend rate) for the health plans is 10 percent for 1993 to 1996, 8 percent for 1997 to 2001, and 6 percent thereafter. The effect of a one-percentage-point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of December 31, 1993, by approximately 10.5 percent, and the aggregate of the service and interest cost components of net annual postretirement benefit cost by approximately 11 percent.\nNOTE 15 Stockholders' Equity\nDetail of ARCO's capital stock as of December 31, 1993 and 1992 was as follows:\nThe changes in preference stocks outstanding were due solely to conversions. The $3.00 cumulative convertible preference stock is convertible into 6.8 shares of common stock. The $2.80 cumulative convertible preference stock is convertible into 2.4 shares of common stock. The common stock is subordinate to the preference stocks for dividends and assets. The $3.00 and $2.80 preference stocks may be redeemed at the option of ARCO for $82 and $70 per share, respectively.\nARCO has authorized 75,000,000 shares of preferred stock, $.01 par, of which none were issued or outstanding at December 31, 1993.\nBy stockholder approval, all of the Series B, 3.75 percent cumulative preferred stock, $100 par, of which none were issued and outstanding, was cancelled effective May 3, 1993.\nBy Board authorization, effective December 31, 1991, ARCO canceled 7 million shares of common stock held in treasury. As a result of this cancellation, common stock decreased by $17 million, capital in excess of par value of stock decreased by $30 million, and retained earnings decreased by $684 million in 1991.\nThe balance in ARCO's common stock at December 31, 1993, 1992 and 1991 was $402 million.\nDetail of changes in treasury stock in 1993, 1992 and 1991 was as follows:\nThe net decrease in capital in excess of par value of stock in 1993, 1992 and 1991 of $15 million, $12 million and $52 million, respectively, was due primarily to the conversion of preference stock to common stock and the cancellation of treasury stock in 1991.\nARCO's Certificate of Incorporation contains a provision restricting dividend payments; however, at December 31, 1993, retained earnings were free from such restriction. At December 31, 1993, shares of ARCO's authorized and unissued common stock were reserved as follows:\nUnder ARCO's incentive compensation plans, awards of ARCO's common stock may be made to officers, outside directors and key employees.\nNOTE 16 Earned per Share\nEarned per share is based on the average number of common shares outstanding during each period including common stock equivalents that consist of certain outstanding options and all outstanding convertible securities. The average shares used in the calculation of earned per share for the years ended December 31, 1993, 1992 and 1991 were 162.4 million, 161.5 million and 161.7 million, respectively.\nNOTE 17 Stock Options\nOptions to purchase shares of ARCO's common stock have been granted to executives, outside directors and key employees. These options become exercisable in varying installments and expire ten years after the date of grant. Transactions during 1993, 1992 and 1991 were as follows:\nNOTE 18 Supplemental Cash Flow Information\nThe following is supplemental cash flow information for the years ended December 31, 1993, 1992 and 1991:\nNOTE 19 Lease Commitments\nCommitments under capital financial leases are capitalized with the obligation recorded at the present value of future rental payments. The related assets are amortized on a straight-line basis.\nAt December 31, 1993, future minimum rental payments due under leases were as follows:\nMinimum future rental income under noncancelable subleases at December 31, 1993 amounted to $98 million.\nOperating lease net rental expense for the years ended December 31, 1993, 1992 and 1991 was as follows:\nNo restrictions on dividends or on additional debt or lease financing exist under ARCO's lease commitments. Under certain conditions, options and obligations exist to purchase certain leased properties.\nNOTE 20 Lyondell Petrochemical Company\nLyondell Petrochemical Company (Lyondell) is engaged in the manufacture, refining and marketing of basic commodity chemicals, including ethylene, propylene, methanol and aromatics, and petroleum products.\nAt December 31, 1993, ARCO owned 49.9 percent of Lyondell common stock outstanding; ARCO accounts for this investment on the equity method. The market value of ARCO's shares of Lyondell common stock, based on the closing quoted market price at December 31, 1993, was $848 million.\nSummarized financial information for Lyondell was as follows:\n(a) Includes $278, $329 and $526 of sales to ARCO in 1993, 1992 and 1991, respectively, which approximated 4%, 5% and 8% of ARCO's purchases in those years. (b) ARCO's investment in Lyondell comprises 49.9% of Lyondell's stockholders' deficit plus $72 of dividends received in excess of basis of investment.\nNOTE 21 Financial Instruments; Fair Value and Off-Balance-Sheet Risk\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nThe carrying amount of cash equivalents, short-term investments and notes payable approximates fair value because of the short maturity of those instruments.\nThe fair value of other investments and long-term receivables was estimated primarily based on quoted market prices for those or similar investments. At December 31, 1993 and 1992, the fair value of other investments and long-term receivables approximated carrying value.\nThe fair value of ARCO's long-term debt was estimated based on the quoted market prices for the same or similar issues or on the current rates offered to ARCO for debt of the same remaining maturities. At December 31, 1993 and 1992, the fair value of long-term debt, including long-term debt due within one year, was $8,307 million and $7,570 million, respectively.\nThe fair value of foreign currency forward contracts and derivatives was estimated by obtaining quotes from brokers. Fair value of these instruments at December 31, 1993 and 1992, approximated carrying value.\nAt December 31, 1993 and 1992, ARCO had foreign currency forward contracts and foreign cross-currency contracts outstanding, which mature at various dates, to reduce exposure to foreign currency exchange risk. The aggregate contract value of instruments used to buy U.S. dollars in exchange for Australian dollars was approximately $483 million and $367 million at December 31, 1993 and 1992, respectively. The aggregate contract value of instruments used to sell European currencies and Japanese yen in exchange for Deutsche marks, U.S. dollars and functional currencies of ARCO's European operations was approximately $24 million and $65 million at December 31, 1993 and 1992, respectively. Additionally, ARCO had outstanding foreign currency swaps which mature at various dates through 1994, to sell approximately 187 million French francs for $35 million at both December 31, 1993 and 1992.\nAt December 31, 1993 and 1992, approximately $355 million and $405 million, respectively, of the long-term debt was denominated in foreign currencies. To reduce the exposure to foreign currency fluctuations, ARCO entered into a swap agreement on an 18 billion yen debt issue due in 1996 which fixes the principal balance at $102 million with an effective rate of 8.14 percent. At December 31, 1993, ARCO had outstanding interest rate swaps on two loans totalling 300 million Dutch guilders due in 1997 (one loan for 150 million Dutch guilders in 1992). This effectively changed both loans' floating interest rates to fixed rates of 5.70 percent and 6.71 percent (9.69 percent in 1992).\nThe counterparties to these transactions are major international financial institutions; ARCO does not anticipate nonperformance by the counterparties.\nNOTE 22 Unaudited Quarterly Results\n(a) See Note 2. (b) The impact of cumulative effect of changes in accounting principles resulted in a net after-tax charge of ($392) million, or ($2.43) per share. (c) Includes $100 million benefit from reduced taxes resulting from adjustments for capital transactions and revisions of previously accrued taxes.\nSUPPLEMENTAL INFORMATION (UNAUDITED)\nOil and Gas Producing Activities\nThe Securities and Exchange Commission (SEC) defines proved oil and gas reserves as those estimated quantities of crude oil, natural gas, and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.\nARCO reports reserve estimates to various federal government agencies and commissions. These estimates may cover various regions of crude oil and natural gas classifications within the United States and may be subject to mandated definitions. There have been no reports of total ARCO reserve estimates furnished to federal government agencies or commissions which vary from those reported to the SEC since the beginning of the last fiscal year.\nEstimated quantities of ARCO's proved oil and gas reserves were as follows:\nThe changes in proved reserves for the years ended December 31, 1991, 1992 and 1993 were as follows:\nSignificant changes to proved oil and gas reserves during 1993 were due to the addition of reserves from the Sirasun gas discovery in Indonesia, the Mustang Island gas discovery offshore Gulf of Mexico and the sale of Lower 48 oil and gas properties.\nEstimates of petroleum reserves have been made by ARCO engineers. These estimates include reserves in which ARCO holds an economic interest under production-sharing and other types of operating agreements with foreign governments. These estimates do not include probable or possible reserves. Natural gas liquids comprise 12 percent of petroleum liquid proved reserves.\nThe sale of natural gas from the North Slope of Alaska, which is not used in providing fuel in North Slope operations or sold to others on the North Slope, is dependent upon construction of a natural gas transportation system or another marketing alternative. Such gas is not\nincluded in ARCO's reserves. There are currently several projects under consideration, including the Alaska Natural Gas Transportation System and the Trans Alaska Gas System. However, there are a number of regulatory, financial, legal and marketing questions regarding the projects that remain unresolved.\nARCO has studied various options for marketing North Slope gas over the past few years. However, ARCO Alaska believes that market conditions are not likely to permit implementation of any large gas sales project within the foreseeable future.\nThe aggregate amounts of capitalized costs relating to oil and gas producing activities and the related accumulated depreciation, depletion and amortization as of December 31, 1993, 1992 and 1991 were as follows:\nCosts, both capitalized and expensed, incurred in oil and gas producing activities during the three years ended December 31, 1993, 1992 and 1991 were as follows:\nResults of operations from oil and gas producing activities (including operating overhead) for the three years ended December 31, 1993, 1992 and 1991 were as follows:\nThe difference between the above results of operations for 1993, 1992 and 1991 and the amounts reported for after-tax oil and gas segment earnings in Note 4 of Notes to Consolidated Financial Statements is primarily marketing-related activities and the exclusion of gains\non property sales and unusual items related to the Lower 48 reorganization.\nInformation for 1992 and 1991 has been restated to conform to 1993 formats, primarily the reclassification of allocated overhead from production and exploration costs to other operating expenses and the removal of certain unusual items previously included.\nThe standardized measure of discounted estimated future net cash flows related to proved oil and gas reserves at December 31, 1993, 1992 and 1991 was as follows:\nPrimary changes in the standardized measure of discounted estimated future net cash flows for the years ended December 31, 1993, 1992 and 1991 were as follows:\nEstimated future cash inflows are computed by applying year-end prices of oil and gas to year-end quantities of proved reserves. Future price changes are considered only to the extent provided by contractual arrangements. Estimated future development and production costs are determined by estimating the expenditures to be incurred in developing and producing the proved oil and gas reserves at the end of the year, based on year-end costs and assuming continuation of existing economic conditions. Estimated future income tax expense is calculated by applying year-end statutory tax rates (adjusted for permanent differences and tax credits) to estimated future pretax net cash flows related to proved oil and gas reserves, less the tax basis of the properties involved.\nThese estimates are furnished and calculated in accordance with requirements of the Financial Accounting Standards Board and the SEC. Because of unpredictable variances in expenses and capital forecasts, crude oil and natural gas price changes, largely influenced and controlled by U.S. and foreign governmental actions, and the fact that the bases for such estimates vary significantly, management believes the usefulness of these projections is limited. Estimates of future net cash flows presented do not represent management's assessment of future profitability or future cash flow to ARCO. Management's investment and operating decisions are based on reserve estimates that include proved reserves prescribed by the SEC as well as probable reserves, and on different price and cost assumptions from those used here.\nIt should be recognized that applying current costs and prices and a 10 percent standard discount rate does not convey absolute value. The discounted amounts arrived at are only one measure of the value of proved reserves.\nRegarding the information on estimated reserve quantities and discounted future net cash flows, ARCO has no long-term supply contracts to purchase from foreign governments or any interest in equity affiliates involved in oil and gas producing activities.\nCoal Operations\nSupplemental operating statistics for the coal operations of ARCO for the three years ended December 31, 1993, 1992 and 1991 were as follows:\nThe significant change to reserves in 1992 was due to the acquisition of the West Black Thunder lease acreage.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding executive officers of the Company is included in Part I. For the other information called for by Items 10, 11, 12 and 13, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, to be held on May 2, 1994, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1993, and which is incorporated herein by reference, except for the material included under the captions \"Report of Compensation Committee\" and \"Performance Graph.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:\n1 AND 2. Financial Statements and Financial Statement Schedules: These documents are listed in the Index to Consolidated Financial Statements and Financial Statement Schedules.\n3. Exhibits:\n3.1 Certificate of Incorporation of Atlantic Richfield Company as amended through May 3,1993 filed herewith; proposed amendment to Certificate of Incorporation is included in Appendix A of Registrant's Proxy Statement dated March 14, 1994 (the \"1994 Proxy Statement\") filed with the Securities and Exchange Com- mission (the \"Commission\") under File No. 1-1196 and incorpo- rated herein by reference.\n3.2 By-Laws of Atlantic Richfield Company as amended through Janu- ary 23, 1989 filed herewith.\n4.1 Rights Agreement dated as of May 27, 1986 between the Company and Morgan Guaranty Trust Company of New York, as Rights Agent, filed as Exhibit 2.1 to the Company's Form 8-A filed with the Commission under File No. 1-1196 on June 3, 1986, and incorporated herein by reference.\n4.2 Indenture dated as of May 15, 1985 between the Company and The Chase Manhattan Bank, N.A., filed as Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the six months ended June 30, 1985, File No. 1-1196, and incorporated herein by reference.\n4.3 Indenture, dated as of January 1, 1992, between the Company and The Bank of New York, filed as an exhibit, bearing the same number, to the Company's Registration Statement on Form S-3 (No. 33-44925), filed with the Commission on January 6, 1992, and incorporated herein by reference.\n4.4 Instruments defining the rights of holders of long-term debt which is not registered under the Securities Exchange Act of 1934 are not filed because the total amount of securities authorized under any such instrument does not exceed 10 percent of the consolidated total assets of the Company. The Company agrees to furnish a copy of any such instrument to the Commis- sion upon request.\n10.1(a) Atlantic Richfield Company Supplementary Executive Retirement Plan, as adopted by the Board of Directors of the Company on March 26, 1990, and effective on October 1, 1990, filed as Ex- hibit 10.2 to the Company's Form 10-K Report for the year 1990, File No. 1-1196, and incorporated herein by reference.\n10.1(b) Amendment No. 1 to Atlantic Richfield Company Supplementary Executive Retirement Plan effective March 22, 1993, filed as Exhibit 10 to the Company's Form 10-Q Report for the quarterly period ended June 30, 1993, File No. 1-1196, and incorporated herein by reference.\n10.2(a) Atlantic Richfield Company Executive Deferral Plan, as adopted by the Board of Directors of the Company on March 26, 1990 and effective on October 1, 1990, filed as Exhibit 10.3 to the Company's Form 10-K Report for the year 1990, File No. 1-1196, and incorporated herein by reference.\n10.2(b) Amendment No. 1 to Atlantic Richfield Company Executive Defer- ral Plan effective July 27, 1992, filed as an exhibit, bearing the same number, to the Company's Form 10-K Report for the year 1992, File No. 1-1196, and incorporated herein by reference.\n10.3 Atlantic Richfield Executive Medical Insurance Plan-Summary Plan Description, as in effect January 1, 1994, filed herewith.\n10.4(a) Atlantic Richfield Company Executive Supplementary Savings Plan II, as amended, restated and effective on July 1, 1988, filed as Exhibit 10.6 to the Company's Form 10-K Report for the year 1988, File No. 1-1196, and incorporated herein by reference.\n10.4(b) Amendment No. 1 to Atlantic Richfield Company Executive Sup- plementary Savings Plan II as amended and effective on January 1, 1989, filed as Exhibit 10.6(b) to the Company's Form 10-K Report for the year 1989, File No. 1-1196, and incorporated herein by reference.\n10.5 Atlantic Richfield Company Policy on Financial Counseling and Individual Income Tax Service, as revised effective January 1, 1991, filed as Exhibit 10.6 to the Company's Form 10-K Report for the year 1990, File No. 1-1196, and incorporated herein by reference.\n10.6 Annual Incentive Plan, as adopted by the Board of Directors of the Company on November 26, 1984, and effective on that date, as amended through January 1, 1991, filed as Exhibit 10.7 to the Company's Form 10-K Report for the year 1990, File No. 1-1196, and incorporated herein by reference; proposed amendment to the Annual Incentive Plan is included in Appendix B of Reg-istrant's 1994 Proxy Statement filed with the Commission under File No. 1-1196 and incorporated herein by reference.\n10.7 Atlantic Richfield Company's 1985 Executive Long-Term Incen- tive Plan, as adopted by the Board of Directors of the Company on May 28, 1985, and effective on that date, as amended through February 24, 1992, filed as Exhibit 10.8 to the Company's Form 10-K Report for the year 1991, File No. 1-1196, and incorporated herein by reference, and as amended on Febru- ary 22, 1993 and effective on that date, filed as an exhibit bearing the same number, to the Company's 10-K Report for the year 1992, File No. 1-1196, and incorporated herein by reference.\n10.8 Atlantic Richfield Company Executive Life Insurance Plan--Sum- mary Plan Description, as in effect January 1, 1994, filed herewith.\n10.9 Atlantic Richfield Company Executive Long-Term Disability Plan--Summary Plan Description, as in effect January 1, 1994, filed herewith.\n10.10 Form of Indemnity Agreement adopted by the Board of Directors on January 26, 1987 and executed in February 1987 by the Com- pany and each of its directors and officers, included in Ex- hibit A to the 1987 Proxy Statement (filed with the Commission under File No. 1-1196) and incorporated herein by reference.\n10.11 Exchange Agreement between Tosco Corporation and Atlantic Richfield Company dated October 2, 1986, as amended by letter dated November 5, 1986, filed as Exhibit 10.14, to the Company's Form 10-K Report for the year 1986, File No. 1-1196, and incorporated herein by reference.\n10.12 Retirement Plan for Outside Directors effective October 1, 1990, as amended March 31, 1993, filed as Exhibit 10 to the Company's Form 10-Q Report for the quarterly period ended March 31, 1993, File No. 1-1196, and incorporated herein by reference.\n10.13(a) Stock Option Plan for Outside Directors effective December 17, 1990, filed as Exhibit 10.14 to the Company's Form 10-K Report for the year 1990, File No. 1-1196, and incorporated herein by reference.\n10.13(b) Amendment No. 1 to Stock Option Plan for Outside Directors effective June 22, 1992, filed as an exhibit, bearing the same number, to the Company's Form 10-K Report for the year 1992, File No. 1-1196, and incorporated herein by reference.\n10.14 Special Incentive Plan, as adopted by the Board of Directors of the Company on February 28, 1994, and effective on that date, is included in Appendix C of Registrant's Proxy State- ment filed with the Commission under File No. 1-1196 and in- corporated herein by reference.\n22 Subsidiaries of the Registrant.\n23 Consent of Coopers & Lybrand.\nCopies of exhibits will be furnished upon prepayment of 25 cents per page. Requests should be addressed to the Corporate Secretary.\n(b) REPORTS ON FORM 8-K:\nNo Current Reports on Form 8-K were filed during the quarter ended December 31, 1993, and thereafter through March 1, 1994.\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the following registration statements of Atlantic Richfield Company, Registration Statement on Form S-8 (No. 33-43830), Registration Statement on Form S-8 (No. 33-21558), Post- Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33- 21160), Post-Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33-23639), Post-Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33-21162), Post-Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33-21553), Post-Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33-23640), and Post-Effective Amendment No. 4 to Registration Statement on Form S-8 (No. 33-21552) of our report dated February 11, 1994, on our audits of the consolidated financial statements and financial statement schedules of Atlantic Richfield Company as of December 31, 1993 and 1992 and for each of the three years in the period ended December 31, 1993, which report is included in this Annual Report on Form 10-K.\nCOOPERS & LYBRAND\nLos Angeles, California March 1, 1994\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 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.\nATLANTIC RICHFIELD COMPANY\n\/s\/ Lodwrick M. Cook By ___________________________________ Lodwrick M. Cook Chairman of the Board and Chief Executive Officer\nFEBRUARY 28, 1994\nPURSUANT 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 AND ON THE DATES INDICATED.\nSIGNATURE TITLE DATE\n\/s\/ Lodwrick M. Cook Chairman of the February 28, 1994 - ------------------------------------- Board, Chief Lodwrick M. Cook Principal executive Executive Officer officer and Director\n\/s\/ Mike R. Bowlin President, Chief February 28, 1994 - ------------------------------------- Operating Officer Mike R. Bowlin and Director\n\/s\/ Ronald J. Arnault Executive Vice February 28, 1994 - ------------------------------------- President, Chief Ronald J. Arnault Principal Financial Officer financial officer and Director\n\/s\/ James A. Middleton Executive Vice February 28, 1994 - ------------------------------------- President and James A. Middleton Director\n\/s\/ William E. Wade, Jr. Executive Vice February 28, 1994 - ------------------------------------- President and William E. Wade, Jr. Director\nSIGNATURE TITLE DATE\n\/s\/ Frank D. Boren Director February 28, 1994 - ------------------------------------- Frank D. Boren\n\/s\/ Richard H. Deihl Director February 28, 1994 - ------------------------------------- Richard H. Deihl\n\/s\/ John Gavin Director February 28, 1994 - ------------------------------------- John Gavin\n\/s\/ Hanna H. Gray Director February 28, 1994 - ------------------------------------- Hanna H. Gray\n\/s\/ Philip M. Hawley Director February 28, 1994 - ------------------------------------- Philip M. Hawley\n\/s\/ William F. Kieschnick Director February 28, 1994 - ------------------------------------- William F. Kieschnick\n\/s\/ Kent Kresa Director February 28, 1994 - ------------------------------------- Kent Kresa\n\/s\/ David T. McLaughlin Director February 28, 1994 - ------------------------------------- David T. McLaughlin\n\/s\/ John B. Slaughter Director February 28, 1994 - ------------------------------------- John B. Slaughter\n\/s\/ Hicks B. Waldron Director February 28, 1994 - ------------------------------------- Hicks B. Waldron\n\/s\/ Henry Wendt Director February 28, 1994 - ------------------------------------- Henry Wendt\n\/s\/ Allan L. Comstock Vice President and February 28, 1994 - ------------------------------------- Controller Allan L. Comstock Principal accounting officer\nSCHEDULE V\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT\n(IN MILLIONS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n(See footnotes on following page.)\nSCHEDULE V (CONTINUED)\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT\n(IN MILLIONS OF DOLLARS)\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\n- -------- (a) Primarily the sale of various oil and gas properties.\n(b) Primarily dry hole costs charged to income.\n(c) Primarily an equity translation adjustment at December 31, 1992 and dry hole costs charged to income.\n(d) Primarily the reclassification of assets associated with the ARCO exploration and production technology division and dry hole costs charged to income.\n(e) Primarily the Union Carbide Chemicals and Plastics Company, Inc. assets transferred from deferred charges upon finalization of purchase.\n(f) Primarily the reclassification of assets associated with the ARCO exploration and production technology division.\nThe methods used in computing the annual provision for depreciation, depletion and amortization of property, plant and equipment are presented in Note 1 of Notes to Consolidated Financial Statements herein.\nSCHEDULE VI\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE VI--ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\n(IN MILLIONS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n(See footnotes on following page.)\nSCHEDULE VI (CONTINUED)\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE VI--ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\n(IN MILLIONS OF DOLLARS)\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\n- -------- (a) Primarily the sale of various oil and gas properties.\n(b) Primarily the writedown of various oil and gas properties and the Company's office building and parking structure in Dallas, Texas.\n(c) Primarily the reclassification of assets associated with the ARCO exploration and production technology division.\nSCHEDULE VIII\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS\n(IN MILLIONS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n(See footnotes on following page.)\nSCHEDULE VIII (CONTINUED)\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS\n(IN MILLIONS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- -------- (a) Write-off for uncollectible accounts, net of recoveries.\n(b) Primarily a reclassification of pension liability.\nSCHEDULE IX\nATLANTIC RICHFIELD COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE IX--SHORT-TERM BORROWINGS\n(DOLLARS IN MILLIONS)\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\n- -------- (a) The average amount outstanding equals the sum of the amounts outstanding at each month-end divided by twelve.\n(b) The weighted average interest rate equals the sum of each outstanding amount times its rate for each day in the period, divided by the total number of days in the period times the average amount outstanding during the period.","section_15":""}
{"filename":"96903_1993.txt","cik":"96903","year":"1993","section_1":"Item 1. Business.\n(a) General Development of Business\nTele-Communications, Inc. (\"TCI\" or the \"Company\", which terms, as used herein, include its consolidated subsidiaries unless the context indicates otherwise) was incorporated in Delaware on August 20, 1968. The Company and its predecessors have been engaged in the cable television business since the early 1950's.\nOn January 31, 1994, TCI announced that TCI and Liberty Media Corporation (\"Liberty\") had entered into a definitive agreement (the \"TCI\/Liberty Agreement\"), dated as of January 27, 1994 to combine the two companies. As previously announced, the transaction will be structured as a tax free exchange of Class A and Class B shares of both companies and preferred stock of Liberty for like shares of a newly formed holding company, TCI\/Liberty Holding Company (\"TCI\/Liberty\"). TCI shareholders will receive one share of TCI\/Liberty for each of their shares. Liberty common shareholders will receive 0.975 of a share of TCI\/Liberty for each of their common shares. The transaction is subject to the approval of both sets of shareholders as well as various regulatory approvals and other customary conditions. Subject to timely receipt of such approvals, which cannot be assured, it is anticipated the closing of such transaction will take place during 1994.\n(b) Financial Information about Industry Segments\nThe Company operates in the cable television industry. The Company sold its motion picture theatre business and certain theatre-related real estate assets in 1992. Amounts related to the motion picture theatre business and certain theatre-related real estate assets are discontinued operations and are set forth separately in the financial statements and related notes included in Part II of this Report.\nI-1 (c) Narrative Description of Business\nGeneral. Cable television systems receive video, audio and data signals transmitted by nearby television and radio broadcast stations, terrestrial microwave relay services and communications satellites. Such signals are then amplified and distributed by coaxial cable and optical fiber to the premises of customers who pay a fee for the service. In many cases, cable television systems also originate and distribute local programming.\nService Charges. The Company reconfigured its service offerings as contemplated by the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"). The Company offers a limited \"basic service\" (primarily comprised of local broadcast signals and public, educational and governmental access channels) and a broader \"expanded\" tier (primarily comprised of specialized programming services, in such areas as health, family entertainment, religion, news, weather, public affairs, education, shopping, sports and music). The monthly fee for \"basic\" generally ranges from $8.00 to $11.00, and the monthly service fee for the \"expanded\" tier generally ranges from $10.00 to $12.00. The Company offers \"premium services\" (referred to in the cable television industry as \"Pay-TV\" or \"pay-per-view\") to its customers. Such services consist principally of feature films, as well as live and taped sports events, concerts and other programming. The Company offers Pay-TV services for a monthly fee generally ranging from $12.00 to $14.00 per service, except for certain movie or sports services (such as various regional sports networks and certain pay-TV channels) and pay-per-view movies offered separately at $1.00 to $5.00 per month or per movie and certain pay-per- view events offered separately at $10.00 to $40.00 per event. Charges are usually discounted when multiple Pay-TV services are ordered. The Company does not generally require basic subscribers to \"buy-through\" the \"expanded\" service to receive a Pay-TV service in its systems.\nThe Company does not charge for additional outlets in a subscriber's home. As further enhancements to their cable services, customers may generally rent converters, with or without a remote control device, for a monthly charge ranging from $0.50 to $3.00 each, as well as purchase a channel guide for a monthly charge ranging from $0.85 to $2.00. Also a nonrecurring installation charge (which is based upon the newly regulated hourly service charges for each individual cable system) of up to $60.00 is usually charged.\nMonthly fees for basic and Pay-TV services to commercial customers vary widely depending on the nature and type of service. Except under the terms of certain contracts to provide service to commercial accounts, customers are free to discontinue service at any time without penalty. As noted below, the Company's service offerings and rates were affected by rate regulations issued by the Federal Communications Commission (\"FCC\") in the spring of 1993 and are expected to be further affected by revised regulations in 1994. See Federal Regulation below.\nI-2 Subscriber Data. TCI operates its cable television systems either directly through its regional operating divisions or indirectly through certain subsidiaries or affiliated companies. Basic and Pay-TV customers served by TCI and its consolidated subsidiaries are summarized as follows (amounts in millions):\n(1) In December of 1992, SCI Holdings, Inc. (\"SCI\") consummated a transaction (the \"Split-Off\") that resulted in the ownership of its cable television systems being split between its two stockholders, which stockholders were Comcast Corporation and the Company. The Split-Off was effected by the distribution of approximately 50% of the net assets of SCI to three holding companies formed by the Company (the \"Holding Companies\"). Immediately following the Split-Off, the Company owned a majority of the common stock of the Holding Companies. As such, the Company, which previously accounted for its investment in SCI using the equity method, now consolidates its investment in the Holding Companies. One of the Holding Companies, TKR Cable I, Inc., is managed through the Company's regional operating divisions.\n(2) Management of the remaining two Holding Companies was assumed by an affiliated company of TCI in December of 1992.\n(3) Management assumed by the Company's regional operating divisions in January of 1992.\nThis subscriber information does not include any amounts related to cable television systems in which the Company has an investment accounted for by the equity method or cost method. A basic customer may subscribe to one or more Pay-TV services and the number of Pay-TV subscribers reflected represents the total number of such subscriptions to Pay-TV services. TCI, its subsidiaries and affiliates operate cable television systems throughout the continental United States and Hawaii and, through certain joint ventures accounted for under the equity method, have cable television systems and investments in the United Kingdom and other parts of Europe.\nI-3 Programming. Generally, the Company does not currently produce any of the programming for the premium motion picture services or for the specialized basic cable television channels carried by its cable systems, but does hold interests in certain cable programming entities, including Turner Broadcasting System, Inc. (CNN, TBS and TNT), Liberty (Encore and certain regional sports networks), Discovery Communications, Inc. (Discovery Channel and The Learning Channel) and Reiss Media Enterprises, Inc. (Request-TV - a pay-per-view service provider).\nAdditionally, during 1993, Encore QE Programming Corp. (\"QEPC\"), a wholly-owned subsidiary of Encore Media Corporation (\"EMC\") entered into a limited partnership agreement with TCI STARZ, Inc. (\"TCIS\"), a wholly-owned subsidiary of TCI, for the purpose of developing, operating and distributing STARZ!, a first-run premium programming service launched in 1994. QEPC is the general partner and TCIS is the limited partner. Losses are allocated 1% to QEPC and 99% to TCIS. Profits are allocated 1% to QEPC and 99% to TCIS until certain defined criteria are met. Subsequently, profits are allocated 20% to QEPC and 80% to TCIS. TCIS has the option, exercisable at any time and without payment of additional consideration, to convert its limited partnership interest to an 80% general partnership interest with QEPC's partnership interest simultaneously converting to a 20% limited partnership interest. In addition, during specified periods commencing April 1999 and April 2001, respectively, QEPC may require TCIS to purchase, or TCIS may require QEPC to sell, the partnership interest of QEPC in the partnership for a formula-based price. EMC manages the service and has agreed to provide the limited partnership with certain programming under a programming agreement whereby the partnership will pay its pro rata share of the total costs incurred by EMC for such programming.\nThe Company has entered into a joint venture with Time Warner Entertainment Company, L.P. and Sega of America to produce and distribute The Sega Channel, which would provide 50 video games per month to subscribers, of which at least five would be educational in nature. The release pattern of such games would be similar to the film industry, with its traditional cycle of theatrical, pay-per-view, home video and Pay-TV. In the case of The Sega Channel, a minimum number of video games would be available soon after they are released for retail sale, but in limited form. Consumer testing of The Sega Channel will be conducted in 12 test markets beginning in April of 1994.\nOn February, 1994, United Artists European Holdings, Ltd. (\"UAEH\"), a wholly-owned subsidiary of the Company, merged all of the issued share capital and loan stock of each of the following of its wholly-owned subsidiaries into Flextech p.l.c. (\"Flextech\"), a United Kingdom cable programming corporation: Bravo Classic Movies Limited, United Artists Limited (Children's Channel), United Artists Investments Limited and United Artists Entertainment Limited (Programming) (collectively, \"The European Programming Assets\"). In addition to the European Programming Assets, UAEH agreed to make available to Flextech an additional (Sterling Pound) 36.5 million in working capital. The working capital will be provided as needed and will be used to fund Flextech's programming interests through the early stages of their development. Flextech's shares trade publicly on the Unlisted Securities Market of the London Stock Exchange. In the Merger, UAEH received 52,356,707 ordinary shares of Flextech stock, representing an approximate 60% interest in Flextech subsequent to the closing of the Merger.\nThe Company has entered into long-term agreements with certain of its program suppliers in order to obtain favorable rates for programming and to protect the Company from unforeseen future increases in the Company's cost of programming.\nLocal Franchises. Cable television systems generally are constructed and operated under the authority of nonexclusive permits or \"franchises\" granted by local and\/or state governmental authorities. Federal law, including the Cable Communications Policy Act of 1984 (the \"1984 Cable Act\") and the 1992 Cable Act, limits the power of the franchising authorities to impose certain conditions upon cable television operators as a condition of the granting or renewal of a franchise.\nI-4 Franchises contain varying provisions relating to construction and operation of cable television systems, such as time limitations on commencement and\/or completion of construction; quality of service, including (in certain circumstances) requirements as to the number of channels and broad categories of programming offered to subscribers; rate regulation; provision of service to certain institutions; provision of channels for public access and commercial leased-use; and maintenance of insurance and\/or indemnity bonds. The Company's franchises also typically provide for periodic payments of fees, generally ranging from 3% to 5% of revenue, to the governmental authority granting the franchise. Franchises usually require the consent of the franchising authority prior to a transfer of the franchise or a transfer or change in ownership or operating control of the franchisee.\nSubject to applicable law, a franchise may be terminated prior to its expiration date if the cable television operator fails to comply with the material terms and conditions thereof. Under the 1984 Cable Act, if a franchise is lawfully terminated, and if the franchising authority acquires ownership of the cable television system or effects a transfer of ownership to a third party, such acquisition or transfer must be at an equitable price or, in the case of a franchise existing on the effective date of the 1984 Cable Act, at a price determined in accordance with the terms of the franchise, if any.\nIn connection with a renewal of a franchise, the franchising authority may require the cable operator to comply with different and more stringent conditions than those originally imposed, subject to the provisions of the 1984 Cable Act and other applicable Federal, state and local law. The 1984 Cable Act, as supplemented by the renewal provisions of the 1992 Cable Act, establishes an orderly process for franchise renewal which protects cable operators against unfair denials of renewals when the operator's past performance and proposal for future performance meet the standards established by the 1984 Cable Act. The Company believes that its cable television systems generally have been operated in a manner which satisfies such standards and allows for the renewal of such franchises; however, there can be no assurance that the franchises for such systems will be successfully renewed as they expire.\nMost of the Company's present franchises had initial terms of approximately 10 to 15 years. The duration of the Company's outstanding franchises presently varies from a period of months to an indefinite period of time. Approximately 1,400 of the Company's franchises expire within the next five years. This represents approximately thirty-five percent of the franchises held by the Company and involves approximately 3.8 million basic subscribers.\nTechnological Changes. Cable operators have traditionally used coaxial cable for transmission of television signals to subscribers. Optical fiber is a technologically advanced transmission medium capable of carrying cable television signals via light waves generated by a laser. The Company is installing optical fiber in its cable systems at a rate such that in three years TCI anticipates that it will be serving the majority of its customers with state-of-the-art fiber optic cable systems. The systems, which facilitate digital transmission of television signals as discussed below, will have optical fiber to the neighborhood nodes with coaxial cable distribution downstream from that point.\nI-5 Compressed digital video technology converts as many as ten analog signals (now used to transmit video and voice) into a digital format and compresses such signals (which is accomplished primarily by eliminating the redundancies in television imagery) into the space normally occupied by one analog signal. The digitally compressed signal will be uplinked to a satellite, which will send the signal back down to a cable system's headend to be distributed, via optical fiber and coaxial cable, to the customers home. At the home, a set-top terminal will convert the digital channel back into analog channels that can be viewed on a normal television set. The Company is establishing a national center to uplink, encrypt and authorize the reception of compressed digital television services. The Company intends to begin offering such technology to its cable subscribers as the set-top terminals become available for distribution. The Company is currently negotiating with cable programmers to allow for the Company to digitize, encrypt and authorize their signals although there can be no assurance that the terms will be favorable to the Company.\nThe Company and Microsoft Corporation (\"Microsoft\") announced that they have agreed in principle to jointly conduct a technology trial and a market trial of various broadband interactive network services using upgraded TCI cable television systems and certain Microsoft computer systems to provide the services. The technology trial, which will be conducted among TCI and Microsoft employees in the greater Seattle area commencing in the fourth quarter of 1994, will test the reliability and scalability of Microsoft's software architecture for interactive broadband networking and its operating system software. The market trial will be conducted with TCI residential cable customers in the Seattle and Denver areas, commencing in 1995, and will test consumer reaction to and interaction with the system and service features.\nThe Company and three other cable operators own Teleport Communications Group, Inc. (\"Teleport\"). Teleport and its owners currently are negotiating with another cable operator the terms upon which it would acquire an interest in Teleport. Teleport provides local telecommunications services to businesses over fiber optic networks in 18 metropolitan areas throughout the United States, including New York and San Francisco.\nCompetition. Cable television competes for customers in local markets with other providers of entertainment, news and information. The competitors in these markets include broadcast television and radio, newspapers, magazines and other printed material, motion picture theatres, video cassettes and other sources of information and entertainment including directly competitive cable television operations. The passage of the 1992 Cable Act was designed to increase competition in the cable television industry.\nI-6 There are alternative methods of distribution of the same or similar video programming offered by cable television systems. Further, these technologies have been encouraged by Congress and the FCC to offer services in direct competition with existing cable systems. In addition to broadcast television stations, the Company competes in a variety of areas with other service providers that offer Pay-TV and other satellite-delivered programming to subscribers on a direct over-the-air basis. Multi-channel programming services are distributed by communications satellites directly to home satellite dishes (\"HSDs\"). Cable programmers have developed marketing efforts directed to HSD owners and numerous companies, including a subsidiary of the Company called Netlink USA (one of the larger distributors to HSD owners), make programming packages available to these viewers. The Company estimates that there are currently in excess of 3.5 million HSDs in the United States, most of which are in the 6 to 10 foot range. Medium power and higher power communications satellites (\"DBS\") using higher frequencies transmit signals that can be received by dish antennas much smaller in size. The Company has an interest in an entity, Primestar Partners, that distributes a multi-channel programming service via a medium power communications satellite to HSDs of approximately 3 feet in size. Such service currently serves an estimated 70,000 HSDs in the United States. Two other service providers plan to offer multi-channel programming services to HSDs in 1994 via a high power communications satellite that will require a dish antenna of only approximately 18 inches. Additionally, such DBS operators have acquired the right to distribute all of the significant cable television services. The Company's application for a license to launch and operate a high power direct broadcast satellite was granted by the FCC in 1992 and the satellite is currently under construction. Competition from both medium and high power DBS services could become substantial as developments in technology continue to increase satellite transmitter power, and decrease the cost and size of equipment needed to receive these transmission.\nDBS has advantages and disadvantages as an alternative means of distribution of video signals to the home. Among the advantages are that the capital investment (although initially high) for the satellite and uplinking segment of a DBS system is fixed and does not increase with the number of subscribers receiving satellite transmissions; that DBS is not currently subject to local regulation of service and prices or required to pay franchise fees; and that the capital costs for the ground segment of a DBS system (the reception equipment) are directly related to and limited by the number of service subscribers. DBS's disadvantages presently include the inability to tailor the programming package to the interests of different geographic markets, such as providing local news, other local origination services and local broadcast stations; signal reception being subject to line of sight angles; and intermittent interference from atmospheric conditions and terrestrially generated radio frequency noise. The effect of competition from these services cannot be predicted. The Company nonetheless assumes that such competition could be substantial in the near future.\nI-7 The 1984 Cable Act, FCC rules and the 1982 Federal court Consent Decree (which settled the 1974 antitrust suit against AT&T) prohibit telephone companies from providing video programming and other information services directly to subscribers in their telephone service areas (except in limited circumstances in rural areas). In Chesapeake & Potomac Telephone Company of Virginia v. United States, the United States District Court for the Eastern District of Virginia held on August 24, 1993 that the cross-entry prohibition in the 1984 Cable Act is unconstitutional as a violation of the telephone company's First Amendment right to free expression. The Court's decision has been appealed to the United States Court of Appeals for the Fourth Circuit. Since the Court rendered its decision, however, other telephone companies have filed a number of actions in courts throughout the United States, similarly seeking to invalidate the cross-entry prohibition. Certain proposals are also pending before the FCC and Congress which would eliminate or relax these restrictions on telephone companies. If the current cross-entry restrictions are removed or relaxed, the Company could face increased competition from telephone companies which, in most cases, have greater financial resources than the Company. Certain major telephone companies have announced plans to acquire cable television systems or provide video services to the home through fiber optic technology.\nThe FCC authorized the provision of so-called \"video-dialtone\" services by which independent video programmers may deliver services to the home over telephone-provided circuits, thereby by-passing the local cable system or other video provider. Under the FCC decision, which is now the subject of reconsideration and a federal appellate challenge, such services would require no local franchise agreement or payment to the city or local governmental authority. Although telephone companies providing \"video-dialtone\" under the existing rules are allowed only a limited financial interest in programming services and must limit their role largely to that of a traditional \"common carrier,\" the current status of these rules is uncertain under the Chesapeake & Potomac Telephone Company decision. Telephone companies have filed numerous applications with the FCC for authorization to construct video-dialtone systems and provide such services. This alternative means of distribution of video services to the consumer's home represents a direct competitive threat to the Company.\nAnother alternative method of distribution is the multi-channel multi-point distribution systems (\"MMDS\"), which deliver programming services over microwave channels received by subscribers with a special antenna. MMDS systems are less capital intensive, are not required to obtain local franchises or pay franchise fees, and are subject to fewer regulatory requirements than cable television systems. Although there are relatively few MMDS systems in the United States that are currently in operation or under construction, virtually all markets have been licensed or tentatively licensed. The FCC has taken a series of actions intended to facilitate the development of wireless cable systems as alternative means of distributing video programming, including reallocating the use of certain frequencies to these services and expanding the permissible use of certain channels reserved for educational purposes. The FCC's actions enable a single entity to develop an MMDS system with a potential of up to 35 channels, and thus compete more effectively with cable television. Developments in compression technology have significantly increased the number of channels that can be made available from other over-the-air technologies.\nI-8 Within the cable television industry, cable operators may compete with other cable operators or others seeking franchises for competing cable television systems at any time during the terms of existing franchises or upon expiration of such franchises in expectation that the existing franchise will not be renewed. The 1992 Cable Act promotes the granting of competitive franchises. An increasing number of cities are exploring the feasibility of owning their own cable systems in a manner similar to city-provided utility services. Currently one of the Company's franchises is being over built by a city and in another franchise the franchising authority granted a second cable franchise to a competing cable operator. The Company believes that this type of competitive threat may increase in the future.\nThe Company also competes with Master Antenna Television (\"MATV\") systems and Satellite MATV (\"SMATV\") systems, which provide multi-channel program services directly to hotel, motel, apartment, condominium and similar multi-unit complexes within a cable television system's franchise area, generally free of any regulation by state and local governmental authorities.\nIn addition to competition for subscribers, the cable television industry competes with broadcast television, radio, the print media and other sources of information and entertainment for advertising revenue. As the cable television industry has developed additional programming, its advertising revenue has increased. Cable operators sell advertising spots primarily to local and regional advertisers.\nThe Company has no basis upon which to estimate the number of cable television companies and other entities with which it competes or may potentially compete. There are a large number of individual and multiple system cable television operators in the United States but, measured by the number of basic subscribers, the Company is the largest provider of cable television services.\nThe full extent to which other media or home delivery services will compete with cable television systems may not be known for some time and there can be no assurance that existing, proposed or as yet undeveloped technologies will not become dominant in the future.\nRegulation and Legislation. The operation of cable television systems is extensively regulated through a combination of Federal legislation and FCC regulations, by some state governments and by most local government franchising authorities such as municipalities and counties. The regulation of cable television systems at the federal, state and local levels is subject to the political process and has been in constant flux over the past decade. This process continues in the context of legislative proposals for new laws and the adoption or deletion of administrative regulations and policies. Further material changes in the law and regulatory requirements must be anticipated and there can be no assurance that the Company's business will not adversely be affected by future legislation, new regulation or deregulation.\nI-9 Federal Regulation. The 1984 Cable Act established national policy and, in some cases, governing standards regarding the regulation of cable television in the areas of ownership (including the ownership of other media of mass communications), channel usage, franchising, subscriber charges and services, subscriber privacy, equal employment opportunity (\"EEO\"), technical standards and comprehensive reporting requirements. Among other things, the 1984 Cable Act (a) requires cable television systems with 36 or more \"activated\" channels to reserve a percentage of such channels for commercial use by unaffiliated third parties; (b) permits franchise authorities to require the cable operator to provide channel capacity, equipment and facilities for public, educational and governmental access; (c) limits the amount of fees required to be paid by the cable operator to franchise authorities to a maximum of 5% of annual gross revenues; and (d) regulates the revocation and renewal of franchises as described above.\nOn October 5, 1992, Congress enacted the 1992 Cable Act. The 1992 Cable Act greatly expands federal and local regulation of the cable television industry. Certain of the more significant areas of regulation imposed by the 1992 Cable Act are discussed below.\nRate Regulation. The FCC adopted certain rate regulations required by the 1992 Cable Act and imposed a moratorium on certain rate increases. Such rate regulations became effective on September 1, 1993. The rate increase moratorium, which began on April 5, 1993, continues in effect through May 15, 1994 for franchise areas not subject to regulation. As a result of such actions, the Company's basic and tier service rates and its equipment and installation charges (the \"Regulated Services\") are now under the jurisdiction of local franchising authorities and the FCC. Basic and tier service rates are evaluated against competitive benchmark rates as published by the FCC, and equipment and installation charges are based on actual costs. Any rates for Regulated Services that exceeded the benchmarks were reduced as required by the new rate regulations. The rate regulations do not apply to the relatively few systems which are subject to \"effective competition\" or to services offered on an individual service basis, such as premium movie and pay-per-view services. The Company's new rates for Regulated Services, which were implemented September 1, 1993, are subject to review by the FCC if a complaint has been filed or the appropriate local franchising authority if such authority has been certified.\nOn February 22, 1994, the FCC announced that it had adopted revised benchmark rate regulations pursuant to which those cable systems electing not to make a cost-of-service showing will be required to set their rates for Regulated Services at a level equal to the higher of the FCC's revised benchmark rates or the operator's September 30, 1992 rates minus 17 percent. Thus, the revised benchmarks may result in additional rate reductions of up to 7 percent beyond the maximum reductions established under the FCC's initial benchmark regulations. Although the text of the FCC's revised benchmark regulations has not been released, it is currently anticipated that the rules will take effect on or about May 15, 1994.\nThe FCC has indicated that certain systems with relatively low rates for Regulated Services (defined as systems whose rates would be below the benchmark after subtracting 17% from their September 30, 1992 rates), and systems owned by small operators (i.e. operators whose systems serve a total of 15,000 or fewer subscribers) will not be required immediately to reduce their regulated rates by the full 17 percent. However, to the extent that such systems do not reduce regulated rates by the full 17 percent, such lesser rate reductions will be offset against future inflation adjustments pending completion of additional cost studies by the FCC.\nThe FCC's benchmark rate regulations permit cable operators to adjust rates to account for inflation and increases in certain external costs, including increases in programming costs and compulsory copyright fees, to the extent such increases exceed the rate of inflation. However, these increases may be required to be offset by a productivity factor.\nI-10 The revised rules adopted by the FCC on February 22, 1994 also modify the regulation of packaged a-la-carte programming services. The FCC previously had indicated that a-la-carte services (i.e. program services which are available to subscribers on an individual basis rather than as part of a regulated service tier) could be packaged without being regulated under certain conditions. However, the FCC indicated that under its revised rules it will examine such \"packaged a la carte\" offerings on a case- by-case basis to determine whether they constitute evasions of its rate regulations.\nThe revised benchmark regulations also provide a mechanism for adjusting rates when regulated tiers are affected by channel additions or deletions. The FCC has indicated that cable operators adding or deleting channels on a regulated tier will be required to adjust the per-channel benchmark for that tier based on the number of channels offered after the addition or deletion. The FCC also stated that the additional programming costs resulting from channel additions will be accorded the same external treatment as other program cost increases, and that cable operators will be permitted to recover a mark-up on their programming expenses.\nOn February 22, 1994 the FCC also adopted interim \"cost-of-service\" rules governing attempts by cable operators to justify higher than benchmark rates based on unusually high costs. The FCC stated that under its interim cost-of-service rules, a cable operator may recover through rates for Regulated Services its normal operating expenses plus an interim rate of return equal to 11.25 percent, which rate may be subject to change in the future. However, the FCC has presumptively excluded from the rate-base acquisition costs above the book value of tangible assets and of allowable intangible assets at the time of acquisition, has declined to prescribe depreciation rates and has suggested that the rules will have limited usefulness for cable operators. The FCC also adopted rules governing transactions between cost-of-service regulated cable operators and their affiliates.\nThe texts of the FCC's revised benchmark and cost-of-service regulations have not been released. In addition, key portions of these regulations are subject to change during the course of ongoing rulemaking proceedings before the FCC. Further, the revised rate regulations have been challenged in court. However, based on the foregoing, the Company believes the new rate regulations will have a material adverse effect on its net earnings.\nThe FCC also announced it intends to adopt an experimental incentive plan which would provide cable operators with incentives to upgrade their systems and offer new services.\nI-11 Regulation of Carriage of Broadcast Stations. The 1992 Cable Act granted broadcasters a choice of \"must carry\" rights or \"retransmission consent\" rights. As of October of 1993, cable operators were required to secure permission from broadcasters that elected retransmission consent rights before retransmitting the broadcaster's signals. Established \"superstations\" were not granted such rights. Local and distant broadcasters can require cable operators to make payments as a condition to carriage of such broadcasters' station on a cable system. The 1992 Cable Act imposed obligations to carry \"local\" broadcast stations if such stations chose a \"must carry\" right as distinguished from the \"retransmission consent\" right described above. The rules adopted by the FCC provided for mandatory carriage by cable systems after September 1, 1993, of all local full-power commercial television broadcast signals (up to one-third of all channels) including the signals of stations carrying home-shopping programming, and, depending on a cable system's channel capacity, all non-commercial local television broadcast signals, or at the option of commercial broadcasters after October 6, 1993, the right to deny such carriage unless the broadcaster consented. Although similar \"must carry\" regulations adopted by the FCC have been held unconstitutional by federal appellate courts on two prior occasions and the Supreme Court declined review, the \"must carry\" provisions of the 1992 Cable Act were upheld by a three-judge panel of the United States District Court of Columbia in Turner Broadcasting System, Inc. v. FCC on April 8, 1993. The Supreme Court granted certiorari on September 28, 1993 to review the District Court's decision and oral argument was held on January 12, 1994. It is anticipated a decision will be issued later this year. The Company is currently retransmitting the signals of broadcasters who chose a \"must carry\" right and the signals of broadcasters electing negotiated \"retransmission consent\" rights.\nOwnership Regulations. The 1992 Cable Act required the FCC to (i) promulgate rules and regulations establishing reasonable limits on the number of cable subscribers which may be served by a multiple systems cable operator; (2) prescribe rules and regulations establishing reasonable limits on the number of channels on a cable system that will be allowed to carry programming in which the owner of such cable system has an attributable interest; and (3) consider the necessity and appropriateness of imposing limitations on the degree to which multichannel video programming distributors (including cable operators) may engage in the creation or production of video programming. On September 23, 1993, the FCC adopted regulations establishing a 30 percent limit on the number of homes passed nationwide that a cable operator may reach through cable systems in which it holds an attributable interest (attributable for these purposes if its ownership interest therein is five percent or greater or if there are any common directors) with an increase to 35 percent if the additional cable systems are minority controlled. However, the FCC stayed the effectiveness of its ownership limits pending the appeal of a September 16, 1993 decision by the United States District Court for the District of Columbia which, among other things, found unconstitutional the provision of the 1992 Cable Act requiring the FCC to establish such ownership limits. If the ownership limits are determined on appeal to be constitutional, they may affect the Company's ability to acquire interests in additional cable systems in the future.\nI-12 On September 23, 1993, the FCC also adopted regulations limiting carriage by a cable operator of national programming services in which that operator holds an attributable interest (using the same attribution standards as were adopted for its limits on the number of homes passed nationwide that a cable operator may reach through its cable systems) to 40 percent of the first 75 activated channels on each of the operator's systems. The rules provide for the use of two additional channels or a 45 percent limit whichever is greater, provided that the additional channels carry minority controlled programming services. The regulations also grandfather existing carriage arrangements which exceed the channel limits, but require new channel capacity to be devoted to unaffiliated programming services until the system achieves compliance with the regulations. Channels beyond the first 75 activated channels are not subject to such limitations, and the rules do not apply to local or regional programming services. These rules, which currently are subject to petitions for reconsideration pending before the FCC, may limit carriage of programming services in which the Company or Liberty has an interest on certain systems of cable operators affiliated with the Company.\nIn the same rulemaking, the FCC concluded that additional restrictions on the ability of multichannel distributors to engage in the creation or production of video programming presently are unwarranted.\nUnder the 1992 Cable Act and the FCC's regulations, cable operators may not hold a license for an MMDS nor acquire a SMATV system within the same geographic area in which it provides cable service. Additionally, cable operators are prohibited, subject to certain exceptions, from selling a cable system within 3 years of acquisition or construction of such cable system.\nBuy-through Prohibition. The 1992 Cable Act prohibits cable systems which have addressable converters or certain other security devices in place from requiring cable subscribers to purchase service tiers above basic as a condition to purchasing premium movie channels or pay-per-view. If cable systems do not have such security devices in place, they are given up to 10 years to comply. The Company has, however, generally complied with the provision in its systems, regardless of addressability.\nProgram Acquisition. On April 2, 1993, the FCC adopted regulations implementing the program access provisions of the 1992 Cable Act. Essentially, these regulations are designed to insure that video programming distributors competing with cable operators have access to cable television programming services at non-discriminatory prices and will limit unfair practices, programming contracts, and discriminatory contract terms (including excessive volume discounts).\nThe rules apply the prohibition against \"unfair\" practices to all programmers whether vertically integrated or not. If a vertically integrated program supplier is challenged for price discrimination, it must justify the price differential based on several factors. New exclusive contracts involving vertically integrated programmers will be prohibited in most cases unless the FCC first determines the contract serves the public interest. However, existing service contracts executed prior to June 1, 1990 granting exclusive rights will remain in effect. The FCC allowed a transition period until the fall of 1993 to bring other existing programming contracts into compliance with the regulations.\nCustomer Service\/Technical Standard. As required by the 1992 Cable Act, the FCC has adopted comprehensive regulations establishing minimum standards for customer service and technical system performance. Franchising authorities are allowed to enforce stricter customer service requirements than the FCC standards.\nI-13 The 1992 Cable Act contains numerous other regulatory provisions which together with the 1984 Cable Act create a comprehensive regulatory framework. Violation by a cable operator of the statutory provisions or the rules and regulations of the FCC can subject the operator to substantial monetary penalties and other significant sanctions such as suspension of licenses and authorizations, issuance of cease and desist orders and imposition of penalties that could be of severe consequence to the conduct of a cable operator's business.\nMany of the specific obligations imposed on the operation of cable television systems under these laws and regulations are complex, burdensome and increase the Company's costs of doing business. Numerous petitions have been filed with the FCC seeking reconsideration of various aspects of the regulations implementing the Cable Act. Petitions for judicial review of regulations adopted by the FCC, as well as other court challenges to the 1992 Cable Act and the FCC's regulations, also remain pending. The Company is uncertain how the courts and\/or FCC will ultimately rule or whether such rulings will materially change any existing rules or statutory requirements. Further, virtually all of these laws and regulations are subject to revision at the discretion of the appropriate governmental authority.\nThe Company has two-way communications stations, microwave relay stations and receive-only earth stations for reception of satellite signals, which are individually licensed by the FCC for a specific term. Such licenses are essential to the conduct of the Company's business and must periodically be renewed by the Company. No assurance can be given that such renewals will be granted by the FCC.\nPursuant to lease agreements with local public utilities, the cable facilities in most of the Company's cable television systems are generally attached to utility poles or are in underground ducts controlled by the utility owners. The rates and conditions imposed on the Company for such attachments or occupation of utility space are generally subject to regulation by the FCC or, in some instances, by state agencies, and are subject to change.\nCopyright Regulations. The Copyright Revision Act of 1976 (the \"Copyright Act\") provides cable television operators with a compulsory license for retransmission of broadcast television programming without having to negotiate with the stations or individual copyright owners for retransmission consent for the programming. However, see Regulation of Carriage of Broadcast Stations regarding the imposition of retransmission consent for broadcast stations. The availability of the compulsory license is conditioned upon the cable operators' compliance with applicable FCC regulations, certain reporting requirements and payment of appropriate license fees, including interest charges for late payments, pursuant to the schedule of fees established by the Copyright Act and regulations promulgated thereunder. The Copyright Act also empowers the Copyright Office to periodically review and adjust copyright royalty rates based on inflation and\/or petitions for adjustments due to modifications of FCC rules. The FCC has recommended to Congress the abolition of the compulsory license for cable television carriage of broadcast signals, a proposal that has received substantial support from members of Congress. Any material change in the existing statutory copyright scheme could significantly increase the costs of programming and could have an adverse effect on the business interests of the Company.\nI-14 State and Local Regulation. Cable television systems are generally licensed or \"franchised\" by local municipal or county governments and, in some cases, by centralized state authorities with such franchises being given for fixed periods of time subject to extension or renewal largely at the discretion of the issuing authority. The specific terms and conditions of such franchises vary significantly depending on the locality, population, competitive services, and a host of other factors. While this variance takes place even among systems of essentially the same size in the same state, franchises generally are comprehensive in nature and impose requirements on the cable operator relating to all aspects of cable service including franchise fees, technical requirements, channel capacity, consumer service standards, \"access\" channel and studio facilities, insurance and penalty provisions and the like. Local franchise authorities generally control the sale or transfer of cable systems to third parties and, although the 1992 Cable Act sought to limit such transfer review, the transfer process still affords local governmental officials some power to affect the disposition of the cable property as well as to obtain other concessions from the operator. The franchising process, like the federal regulatory climate, is highly politicized and no assurances can be given that the Company's franchises will be extended or renewed or that other problems will not be engendered at the local level. There appears to be a growing trend for local authorities to impose more stringent requirements on cable operators often increasing the costs of doing business. The 1984 Cable Act grants certain protective procedures in connection with renewal of cable franchises, which procedures were further clarified by the renewal provisions of the 1992 Cable Act.\nGENERAL\nLegislative, administrative and\/or judicial action may change all or portions of the foregoing statements relating to competition and regulation.\nThe Company has not expended material amounts during the last three fiscal years on research and development activities.\nThere is no one customer or affiliated group of customers to whom sales are made in an amount which exceeds 10% of the Company's consolidated revenue.\nCompliance with Federal, state and local provisions which have been enacted or adopted regulating the discharge of material into the environment or otherwise relating to the protection of the environment has had no material effect upon the capital expenditures, results of operations or competitive position of the Company.\nAt December 31, 1993, the Company had approximately 24,000 employees. Of these employees, approximately 500 were located in its corporate headquarters and most of the balance were located at the Company's various facilities in the communities in which the Company owns and\/or operates cable television systems.\n(d) Financial Information about Foreign & Domestic Operations and Export Sales\nThe Company has neither material foreign operations nor export sales.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company owns its executive offices in a suburb of Denver, Colorado. It leases most of its regional and local operating offices. The Company owns many of its head-end and antenna sites. Its physical cable television properties, which are located throughout the United States, consist of system components, motor vehicles, miscellaneous hardware, spare parts and other components.\nI-15 The Company's cable television facilities are, in the opinion of management, suitable and adequate by industry standards. Physical properties of the Company are not held subject to any major encumbrance.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material pending legal proceedings to which the Company is a party or to which any of its property is subject, except as follows:\nViacom International, Inc. v. Tele-Communications, Inc., Liberty Media Corporation, Satellite Services, Inc., Encore Media Corporation, NetLink USA, Comcast Corporation, and QVC Network, Inc. This suit was filed on September 23, 1993 in the United States District Court for the Southern District of New York, and the complaint was amended on November 9, 1993. The amended complaint alleges that the Company violated the antitrust laws of the United States and the State of New York, violated the 1992 Cable Act, breached an affiliation agreement, and tortiously interfered with the Viacom Inc.-Paramount Communications, Inc. (\"Paramount\") merger agreement and with plaintiff's prospective business advantage. The amended complaint further alleges that even if plaintiff is ultimately successful in its bid to acquire Paramount, its competitive position will still be diminished because the Company, through Liberty, will have forced plaintiff to expend additional financial resources to consummate the acquisition. Plaintiff is seeking permanent injunctive relief and actual and punitive or treble damages of an undisclosed amount. Plaintiff claims that the Company, along with Liberty, has conspired to use its monopoly power in cable television markets to weaken unaffiliated programmers and deny access to essential facilities necessary for distributing programming to cable television systems. Plaintiff also alleges that the Company has conspired to deny essential technology necessary for distributing programming to owners of home satellite dishes. Plaintiff claims that the Company is engaging in these alleged conspiracies in an attempt to monopolize alleged national markets for non-broadcast television programming and distribution. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nRanlee Communications, Inc. v. United Artists Telecommunications, Inc. and United Artists Communications, Inc. This matter was filed in the United States District Court for the Eastern District of New York in September of 1989. Plaintiff alleges that defendant United Artists Telecommunications, Inc., by and through its parent United Artists Communications, Inc., the predecessor company of UAE (now a wholly-owned subsidiary of TCI), entered into an agreement with plaintiff wherein plaintiff was engaged as a manager to order, install and supervise telephone switching systems throughout the United States, and to order, install and supervise pay telephones in the Greater New York Metropolitan area, and that the defendants did wrongfully and in bad faith terminate the contract. Plaintiff seeks damages in excess of $100 million. Discovery has been completed. The defendants have filed a motion for summary judgement which is pending. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nI-16 On November 10, 1992, a complaint, captionedThe City of Chicago Heights, Illinois and Walter J. Pietrucha v. Nick Lobue, et. al., was filed in the Circuit Court of Cook County, Illinois. The complaint named numerous defendants including former public officials of the City of Chicago Heights and various companies that entered into contracts with the City during the period from 1976 to 1991, and alleged that such contracts were procured or maintained in violation of Illinois state law through a series of bribes, kickbacks and breaches of fiduciary duties. With respect to the Company, the complaint alleged that an unidentified attorney obtained a 15-year cable television franchise for the City of Chicago Heights on behalf of a subsidiary of the Company in 1981 as a result of bribes and illegal kickbacks made to certain of the public officials named as defendants in the action. Effective December 30, 1993, a settlement agreement was executed which resolved all claims against the Company. Pursuant to that settlement agreement, plaintiffs' claims against the Company were dismissed with prejudice on January 27, 1994. This represents the final resolution of this matter and, accordingly, this case will not be reported in future filings.\nTyrone Belgrave, et al., vs. Tele-Communications, Inc., et al. On February 8, 1994, Tyrone Belgrave and 26 other current or former employees of United Cable Television of Baltimore Limited Partnership filed suit in the Circuit Court for Baltimore City against Tele-Communications, Inc., TCI East, Inc., UCTC of Baltimore, Inc., and United Cable Television of Baltimore Limited Partnership. The action alleges, inter alia, false imprisonment, assault, employment defamation, intentional infliction of emotional distress, invasion of privacy, wrongful discharge, and discrimination on the basis of race. The complaint also seeks divestiture of the Baltimore City cable franchise from the Company. Six counts in the complaint each seek compensatory damages of $1,000,000 per plaintiff, and punitive damages of $5,000,000 per plaintiff. Three other counts in the complaint each seek compensatory damages of $1,000,000 per plaintiff and punitive damages of $5,000,000 per plaintiff per defendant. The Company intends to contest the case. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nEuan Fannell v. Tele-Communications, Inc., et al. On February 8, 1994, Euan Fannell, the former general manager of UCTC of Baltimore, Inc. filed suit in the Circuit Court for Baltimore City against Tele-Communications, Inc., TCI East, Inc., UCTC of Baltimore, Inc., and United Cable Television of Baltimore Limited Partnership. The suit alleges, inter alia, employment defamation, intentional infliction of emotional distress, invasion of privacy, breach of contract, and discrimination on the basis of race. The complaint also seeks divestiture of the Baltimore City cable franchise of the Company. The plaintiff seeks $10,000,000 in compensatory damages and $50,000,000 in punitive damages with respect to the intentional infliction of emotional distress claim; and $10,000,000 in compensatory damages and $50,000,000 in punitive damages with respect to each of five other counts. The Company intends to contest the case. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nI-17 Leonie Palumbo, et al. v. Tele-Communications, Inc., et al. On February 8, 1994, Leonie Palumbo, a former employee of TCI East, Inc., filed a class action suit in the United States District Court for the District of Columbia against Tele-Communications, Inc., John Malone, and J.C. Sparkman. The action alleges, on behalf of a class of past, present and future black employees of the Company, and all past, present and future black applicants for employment with the Company, discrimination on the basis of race. The complaint seeks unspecified compensation and punitive damages as well as injunctive relief for these violations. The Company intends to contest the action. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nLes Dunnaville v. United Artists Cable, et al. On February 9, 1994, Les Dunnaville and Jay Sharrieff, former employees of United Cable Television of Baltimore Limited Partnership, filed an amended complaint in the Circuit Court for Baltimore City against United Cable Television of Baltimore Limited Partnership, TCI Cablevision of Maryland, Tele-Communications, Inc. and three company employees, Roy Harbert, Tony Peduto, and Richard Bushie (the suit was initially filed on December 3, 1993, but the parties agreed on December 30, 1993 that no responsive pleading would be due pending filing of an amended complaint). The action alleges, inter alia, intentional interference with contract, tortious interference with prospective advantage, defamation, false light, invasion of privacy, intentional infliction of emotional distress, civil conspiracy, violation of Maryland's Fair Employment Practices Law, and respondeat superior with respect to the individual defendants. Six counts in the complaint each seek compensatory damages of $1,000,000 and punitive damages of $1,000,000; the intentional infliction of emotional distress count seeks compensatory damages of $1,000,000 and punitive damages of $2,000,000; and the count which alleges violation of Maryland's Fair Employment Practices Law seeks damages of $500,000. The Company intends to contest the action. Based upon the facts available, management believes that, although no assurance can be given as to the outcome of this action, the ultimate disposition should not have a material adverse effect upon the financial condition of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nI-18\nPART II.\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nShares of the Company's Class A and Class B common stock are traded in the over-the-counter market on the Nasdaq National Market under the symbols TCOMA and TCOMB, respectively. The following table sets forth the range of high and low sales prices of shares of Class A and Class B common stock for the periods indicated as furnished by Nasdaq. The prices have been rounded up to the nearest eighth, and do not include retail markups, markdowns, or commissions.\nAs of January 31, 1994, there were 7,663 holders of record of the Company's Class A common stock and 692 holders of record of the Company's Class B common stock (which amounts do not include the number of shareholders whose shares are held of record by brokerage houses but include each brokerage house as one shareholder).\nThe Company has not paid cash dividends on its Class A or Class B common stock and has no present intention of so doing. Payment of cash dividends, if any, in the future will be determined by the Company's Board of Directors in light of the Company's earnings, financial condition and other relevant considerations. Certain loan agreements contain provisions that limit the amount of dividends, other than stock dividends, that the Company may pay (see note 6 to the consolidated financial statements). See also related discussion under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations.\nII-1 Item 6.","section_6":"Item 6. Selected Financial Data.\nThe following tables present selected information relating to the financial condition and results of operations of the Company for the past five years.\n(continued)\nII-2\n____________________\n*Restated and reclassified - see notes to consolidated financial statements included in Part II of this Report.\nII-3 Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nSummary of Operation\nThe following table sets forth, for the periods indicated, the percentage relationship that certain items bear to revenue and the percentage increase or decrease of the dollar amount of such items as compared to the prior period. This summary provides trend data relating to the Company's normal recurring operations. Other items of significance are discussed separately under the captions \"Other Income and Expense\", \"Income Taxes\" and \"Net Loss\" below. Amounts set forth below reflect the Company's motion picture theatre exhibition industry segment as discontinued operations. Additionally, amounts set forth below have been restated to reflect the Company's implementation of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement No. 109\").\nRevenue increased by approximately 16.2% from 1992 to 1993. Such increase was the result of an acquisition in late 1992 (10%), growth in subscriber levels within the Company's cable television systems (4%) and increases in prices charged for cable services (3%), net of a decrease in revenue (1%) due to rate reductions required by rate regulation implemented pursuant to the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"). Revenue increased 11.2% from 1991 to 1992. Approximately 3% to 5% of such increase resulted from growth in subscriber levels within the Company's cable television systems and additional services sold to existing customers and 5% to 7% resulted from increases in prices charged for cable services. In 1994, the Company anticipates that it will experience a decrease in the price charged for those services that are subject to rate regulation under the 1992 Cable Act. See related discussion below.\nOperating costs and expenses have historically remained relatively constant as a percentage of revenue. However, operating costs and expenses increased in 1993 primarily as a result of an acquisition in late 1992. Additionally, in 1993, the Company incurred certain one-time direct charges relating to the implementation of the new Federal Communications Commission (\"FCC\") regulations, as further described below. The Company made several separate grants (in 1992 and 1993) of stock options issued in tandem with stock appreciation rights. The Company recorded compensation relating to such stock appreciation rights of $31 million and $1 million in 1993 and 1992, respectively.\nII-4 In 1992, the Company experienced an improvement in its operating costs and expenses due primarily to certain efficiencies and cost savings arising from the integration of the operations and management of United Artists Entertainment Company (\"UAE\") upon TCI's acquisition in late 1991 of the remaining minority interests in the equity of UAE. Additionally, during 1992, the Company streamlined its operating structure through the consolidation of three of its regional operating divisions into two divisions. In connection with the consolidation of these divisional offices, the Company incurred restructuring charges of approximately $8 million which are reflected in the accompanying consolidated financial statements for the year ended December 31, 1992.\nThe Company cannot determine whether and to what extent increases in the cost of programming will effect its operating costs. Additionally, the Company cannot predict how these increases in the cost of programming will affect its revenue but intends to recover additional costs to the extent allowed by the FCC's rate regulations as described below.\nEffective April 1, 1993, based upon changes in FCC regulations, the Company revised its estimate of the useful lives of certain distribution equipment to correspond to the Company's anticipated remaining period of ownership of such equipment. The revision resulted in a decrease in net earnings of approximately $12 million (or $.03 per share) for the year ended December 31, 1993.\nOn October 5, 1992, Congress enacted the 1992 Cable Act. In 1993, the FCC adopted certain rate regulations required by the 1992 Cable Act and imposed a moratorium on certain rate increases. Such rate regulations became effective on September 1, 1993. The rate increase moratorium, which began on April 5, 1993, continues in effect through May 15, 1994 for franchise areas not subject to regulation. As a result of such actions, the Company's basic and tier service rates and its equipment and installation charges (the \"Regulated Services\") are subject to the jurisdiction of local franchising authorities and the FCC. Basic and tier service rates are evaluated against competitive benchmark rates as published by the FCC, and equipment and installation charges are based on actual costs. Any rates for Regulated Services that exceeded the benchmarks were reduced as required by the 1993 rate regulations. The rate regulations do not apply to the relatively few systems which are subject to \"effective competition\" or to services offered on an individual service basis, such as premium movie and pay-per-view services.\nThe Company's new rates for Regulated Services, which were implemented September 1, 1993, are subject to review by the FCC if a complaint has been filed or the appropriate local franchising authority if such authority has been certified. The Company estimated that, on an annualized basis, implementation of the 1993 rate regulations would result in a reduction to revenue ranging from $140 million to $160 million. The Company experienced a $44 million revenue reduction during the four months ended December 31, 1993 and incurred $21 million in one-time direct expenses in connection with the implementation of the FCC's regulations.\nII-5 On February 22, 1994, the FCC announced that it had adopted revised benchmark rate regulations which will apply to rates and charges for Regulated Services on and after the effective date of these rules. After its initial review of the effect of the FCC further rate reductions, the Company estimated that its revenue could be further decreased by approximately $144 million on an annualized basis. The estimate was based upon the FCC Executive Summary dated February 22, 1994 which stated that those cable television systems electing not to make a cost-of-service showing will be required to set their rates for Regulated Services at a level equal to the higher of the FCC's revised benchmark rates or the operator's September 30, 1992 rates minus 17 percent. Thus, the revised benchmarks may result in additional rate reductions of up to 7 percent beyond the maximum reductions established under the FCC's initial benchmark regulations. Although the text of the FCC's benchmark regulation has not been released, it is currently anticipated that the rules will take effect on or about May 15, 1994. The actual reduction in revenue may differ depending on the terms of the final regulations and the completion of a more detailed analysis of the new rate regulations and the Company's rates and services.\nThe estimated reductions in revenue resulting from the FCC's actions in 1993 and 1994 are prior to any possible mitigating factors (none of which is assured) such as (i) the provision of alternate service offerings (ii) the implementation of rate adjustments to non-regulated services and (iii) the utilization of cost-of-service methodologies, as described below.\nThe FCC's benchmark rate regulations permit cable operators to adjust rates to account for inflation and increases in certain external costs, including increases in programming costs and compulsory copyright fees, to the extent such increases exceed the rate of inflation. However, these increases may be required to be offset by a productivity factor.\nThe revised benchmark regulations also provide a mechanism for adjusting rates when regulated tiers are affected by channel additions or deletions. The FCC has indicated that cable operators adding or deleting channels on a regulated tier will be required to adjust the per-channel benchmark for that tier based on the number of channels offered after the addition or deletion. The FCC also stated that the additional programming costs resulting from channel additions will be accorded the same external treatment as other program cost increases, and that cable operators will be permitted to recover a mark-up on their programming expenses.\nOn February 22, 1994, the FCC also adopted interim \"cost-of-service\" rules governing attempts by cable operators to justify higher than benchmark rates based on unusually high costs. Under this methodology, cable operators may recover, through the rates they charge for Regulated Service, their normal operating expenses plus an interim rate of return of 11.25%, which rate may be subject to change in the future.\nBased on the foregoing, the Company believes that the 1993 and 1994 rate regulations will have a material adverse effect on its results of operations.\nOther Income and Expens\nThe Company's weighted average interest rate on borrowings was 7.2%, 7.6% and 9.0% during 1993, 1992 and 1991, respectively. At December 31, 1993, after considering the net effect of various interest rate hedge and exchange agreements (see note 6 to the consolidated financial statements) aggregating $1,322 million, the Company had $5,123 million (or 52%) of fixed-rate debt with a weighted average interest rate of 9.0% and $4,777 million (or 48%) of variable-rate debt with interest rates approximating the prime rate (6% at December 31, 1993).\nII-6 The Company is a partner in certain joint ventures that are currently operating and constructing cable television and telephone systems in the United Kingdom and other parts of Europe. These joint ventures, which are accounted for under the equity method, have generated losses of which the Company's share in 1993 and 1992 amounted to $47 million and $37 million, respectively, including $3 million and $6 million in 1993 and 1992, respectively, resulting from foreign currency transaction losses. In contrast to the Company's domestic operations, the Company's results of operations in the United Kingdom and Europe will continue to be subject to fluctuations in the applicable foreign currency exchange rates. At December 31, 1993, the Company's stockholders' equity includes a cumulative foreign currency translation loss of $29 million.\nThe Company sold certain investments and other assets for an aggregate net pre-tax gain of $42 million, $9 million and $43 million in 1993, 1992 and 1991, respectively.\nDuring 1993, 1992 and 1991, the Company recorded losses of $17 million, $67 million and $7 million, respectively, from early extinguishment of debt during such periods. Included in the 1992 amount was $52 million from the extinguishment of the SCI Holdings, Inc. (\"SCI\") indebtedness (see note 4 to the consolidated financial statements). There may be additional losses associated with early extinguishments of debt in the future.\nInterest and dividend income was $34 million, $69 million and $53 million in 1993, 1992 and 1991, respectively. Included in the 1992 and 1991 amounts was $30 million and $26 million, respectively, earned on the preferred stock investment that was repurchased by a subsidiary of SCI in 1992 (see note 4 to the consolidated financial statements). In connection with such repurchase, the Company received a premium amounting to $14 million which has been separately reflected in the accompanying consolidated statement of operations.\nIncome Taxes\nThe Company has adopted Statement No. 109. Statement No. 109 changed the Company's method of accounting for income taxes from the deferred method to the asset and liability method. The Company restated its financial statements for the years beginning January 1, 1986 through December 31, 1992. The effect of the implementation of Statement No. 109 at December 31, 1992 was a $2 million decrease in receivables, $48 million net increase in investments, $178 million net increase in property and equipment, $2,901 million net increase in franchise costs, $2 million increase in other assets, $34 million increase in other liabilities, $2,865 million increase in deferred taxes payable and $228 million decrease in accumulated deficit. Under Statement No. 109, the effect on deferred taxes of a change in tax rates is recognized in the consolidated statement of operations in the period that includes the enactment.\nNew tax legislation was enacted in the third quarter of 1993 which, among other matters, increased the corporate Federal income tax rate from 34% to 35%. The Company has reflected the tax rate change in its consolidated statements of operations in accordance with the treatment prescribed by Statement No. 109. Such tax rate change resulted in an increase of $76 million to the Company's income tax expense and deferred income tax liability.\nII-7 Net Loss\nThe Company's loss (before preferred stock dividends) of $7 million for the year ended December 31, 1993 represented a decrease of $14 million as compared to the Company's earnings from continuing operations of $7 million for the corresponding period of 1992. Such decline was due primarily to an increase in income tax expense arising from the aforementioned tax rate change enacted in the third quarter of 1993, an increase in compensation relating to stock appreciation rights and the reduction of interest and dividend income resulting from the disposition at the end of 1992 of a preferred stock investment, net of an increase in gain on disposition of assets, a reduction in loss from early extinguishment of debt and a reduction in minority interest in earnings of consolidated subsidiaries attributable to the repurchase of certain preferred stock of a consolidated subsidiary.\nThe Company's earnings from continuing operations (before preferred stock dividends) for 1992 of $7 million represented an improvement as compared to the Company's net loss from continuing operations of $78 million for the corresponding period of 1991 due primarily to improved operating results by the Company in its cable television business. Also, the general decline in interest rates had a positive impact on the Company's net results.\nOn March 28, 1991, the Company contributed its interests in certain of its cable television programming businesses and cable television systems to Liberty Media Corporation (\"Liberty\") in exchange for several different classes and series of preferred stock of Liberty. On that same date, Liberty issued shares of its common stock to TCI shareholders (certain of whom were TCI officers and directors) who tendered shares of TCI Class A and Class B common stock pursuant to an exchange offer (see note 3 to the accompanying consolidated financial statements). Due to the significant economic interest held by TCI through its ownership of Liberty preferred stock and Liberty common stock and other related party considerations, TCI has accounted for its investment in Liberty under the equity method. The Company does not recognize any income relating to dividends, including preferred stock dividends, and the Company has continued to record earnings or losses generated by the interests contributed to Liberty (by recognizing 100% of Liberty's earnings or losses before deducting preferred stock dividends). Consequently, the contribution of such assets to Liberty has had no effect on the net reported results of the Company. For a discussion of the proposed merger of Liberty and TCI, see Liquidity and Capital Resources below.\nOn May 12, 1992, the Company sold its motion picture theatre business and certain theatre-related real estate assets (see note 12 to the accompanying consolidated financial statements). Accordingly, the operations of the Company's motion picture theatre exhibition industry segment have been reclassified and reflected as \"discontinued operations\" in the accompanying consolidated financial statements.\nInflation has not had a significant impact on the Company's results of operations during the three-year period ended December 31, 1993.\nRecent Accounting Pronouncements\nIn November of 1992, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"Statement No. 112\"). As the Company's present accounting policies generally are in conformity with the provisions of Statement No. 112, the Company does not believe that Statement No. 112 will have a material effect on the Company. Statement No. 112 is effective for years beginning after December 31, 1994.\nII-8 In May 1993, the FASB issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"Statement No. 114\"). As the Company's present accounting policies generally are in conformity with the provisions of Statement No. 114, the Company does not expect that Statement No. 114 will have a material effect on the Company's consolidated financial statements. Statement No. 114 is effective for years beginning after December 15, 1994.\nIn May 1993, the FASB issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective for fiscal years beginning after December 15, 1993. Under the new rules, debt securities that the Company has both the positive intent and ability to hold to maturity are carried at amortized cost. Debt securities that the Company does not have the positive intent and ability to hold to maturity and all marketable equity securities are classified as available-for-sale or trading and carried at fair value. Unrealized holding gains and losses on securities classified as available- for sale are carried as a separate component of shareholders' equity. Unrealized holding gains and losses on securities classified as trading are reported in earnings.\nThe Company holds no material debt securities. Marketable equity securities are currently reported by the Company at the lower of cost or market (\"LOCOM\") and net unrealized losses are reported in earnings. The Company will apply the new rules starting in the first quarter of 1994. Application of the new rules will result in an estimated increase of approximately $300 million in stockholders' equity as of January 1 1994, representing the recognition of unrealized appreciation, net of taxes, for the Company's investment in equity securities determined to be available-for-sale, previously carried at LOCOM.\nLiquidity and Capital Resource\nOn January 31, 1994, TCI announced that TCI and Liberty had entered into a definitive agreement (the \"TCI\/Liberty Agreement\"), dated as of January 27, 1994 to combine the two companies. As previously announced, the transaction will be structured as a tax free exchange of Class A and Class B shares of both companies and preferred stock of Liberty for like shares of a newly formed holding company, TCI\/Liberty Holding Company (\"TCI\/Liberty\"). TCI shareholders will receive one share of TCI\/Liberty for each of their shares. Liberty common shareholders will receive 0.975 of a share of TCI\/Liberty for each of their common shares. The transaction is subject to the approval of both sets of shareholders as well as various regulatory approvals and other customary conditions. Subject to timely receipt of such approvals, which cannot be assured, it is anticipated the closing of such transaction will take place during 1994.\nThe Company generally finances acquisitions and capital expenditures through net cash provided by operating and financing activities. Although amounts expended for acquisitions and capital expenditures exceed net cash provided by operating activities, the borrowing capacity resulting from such acquisitions, construction and internal growth has been and is expected to continue to be adequate to fund the shortfall. See the Company's consolidated statements of cash flows included in the accompanying consolidated financial statements.\nII-9 The Company had approximately $1.4 billion in unused lines of credit at December 31, 1993, excluding amounts related to lines of credit which provide availability to support commercial paper. Although the Company was in compliance with the restrictive covenants contained in its credit facilities at said date, additional borrowings under the credit facilities are subject to the Company's continuing compliance with such restrictive covenants (which relate primarily to the maintenance of certain ratios of cash flow to total debt and cash flow to debt service, as defined). Based upon preliminary calculations, the Company believes that the aforementioned 1993 and 1994 rate regulations will not materially impact the availability under its lines of credit or its ability to repay indebtedness as it matures. See note 6 to the accompanying consolidated financial statements for additional information regarding the material terms of the Company's lines of credit.\nIn October of 1992, the Company received full investment grade status by all accredited rating agencies. Such ratings added to the Company's ability to sell publicly greater amounts of fixed-rate debt securities with longer maturities. The increased maturities of the debt securities sold by the Company and the use of the proceeds of such sales to decrease bank borrowings are expected to improve the Company's liquidity due to decreased principal payments required in the next five years.\nDuring the year ended December 31, 1993, the Company sold $3 billion of publicly-placed fixed-rate senior notes with interest rates ranging from 4.81% to 9.25% and maturity dates ranging from 1995 to 2023. The proceeds from the sale of these notes were used to repay variable-rate bank debt.\nOn October 28, 1993, the Company called for redemption all of its remaining Liquid Yield OptionTM Notes. In connection with such call for redemption, Notes aggregating $405 million were converted into 18,694,377 shares of Class A common stock and Notes aggregating less than $1 million were redeemed together with accrued interest to the redemption date. Prior to the aforementioned redemption, Notes aggregating $6 million were converted into 259,537 shares of TCI Class A common stock during 1993.\nOne measure of liquidity is commonly referred to as \"interest coverage.\" Interest coverage, which is measured by the ratio of operating income before depreciation, amortization and other non-cash operating expenses ($1,858 million, $1,637 million and $1,430 million in 1993, 1992 and 1991, respectively) to interest expense ($731 million, $718 million and $826 million in 1993, 1992 and 1991, respectively), is determined by reference to the consolidated statements of operations. The Company's interest coverage ratio was 254%, 228% and 173% for 1993, 1992 and 1991, respectively. Management of the Company believes that the foregoing interest coverage ratio is adequate in light of the consistency and nonseasonal nature of its cable television operations and the relative predictability of the Company's interest expense, more than half of which results from fixed rate indebtedness. The Company's improved operating results in 1993 and 1992 and a general decline in interest rates during 1992 led to an improvement in the Company's interest coverage ratio.\nAs security for borrowings under one of its credit facilities, the Company pledged a portion of the common stock it holds of Turner Broadcasting System, Inc. (\"TBS\") having a value of approximately $643 million at December 31, 1993. Borrowings under this credit facility (which amounted to $250 million at December 31, 1993) are due in August of 1994. On or before such date, the Company expects to repay these borrowings.\nII-10 Approximately thirty-five percent of the franchises held by the Company, involving approximately 3.8 million basic subscribers, expire within five years. There can be no assurance that the franchises for the Company's systems will be renewed as they expire although the Company believes that its cable television systems generally have been operated in a manner which satisfies the standards established by the Cable Communications Policy Act of 1984 for franchise renewal. However, in the event they are renewed, the Company cannot predict the impact of any new or different conditions that might be imposed by the franchising authorities in connection with such renewals.\nThe Company is upgrading and installing optical fiber in its cable systems at a rate such that in three years TCI anticipates that it will be serving the majority of its customers with state-of-the-art fiber optic cable systems. The Company made capital expenditures of $947 million in 1993 and the Company's capital budget for 1994 is $1.2 billion to provide for the continued rebuilding of its cable systems. The Company has suspended $500 million of its 1994 capital spending pending further clarification of the FCC's February 22, 1994 revised benchmark regulations and the FCC's announced intention to adopt an experimental incentive plan which would provide cable operators with incentives to upgrade their systems and offer new services.\nThe Company is obligated to pay fees for the license to exhibit certain qualifying films that are released theatrically by various motion picture studios from January 1, 1993 through December 31, 2002 (the \"Film License Obligations\"). The aggregate minimum liability under certain of the license agreements is approximately $105 million. The aggregate amount of the Film License Obligations under other license agreements is not currently estimable because such amount is dependent upon the number of qualifying films produced by the motion picture studios, the amount of United States theatrical film rentals for such qualifying films, and certain other factors. Nevertheless, the Company's aggregate payments under the Film License Obligations could prove to be significant.\nThe Company believes that it has complied in all material respects with the provisions of the 1992 Cable Act, including its rate setting provisions. However, the Company's rates for regulated services are subject to review. If, as a result of this process, a system cannot substantiate its rates, it could be required to retroactively reduce its rates to the appropriate benchmark and refund the excess portion of rates received since September 1, 1993. The amount of refunds, if any, which could be payable by the Company in the event that systems' rates are successfully challenged by franchising authorities is not currently estimable.\nThe Company's various partnerships and other affiliates accounted for under the equity method generally fund their acquisitions, required debt repayments and capital expenditures through borrowings under and refinancing of their own credit facilities (which are generally not guaranteed by the Company) and through net cash provided by their own operating activities.\nCertain subsidiaries' loan agreements contain restrictions regarding transfers of funds to the parent company in the form of loans, advances or cash dividends. The amount of net assets of such subsidiaries exceeds the Company's consolidated net assets. However, net cash provided by operating activities of other subsidiaries which are not restricted from making transfers to the parent company have been and are expected to continue to be sufficient to enable the parent company to meet its cash obligations.\nII-11 Management believes that net cash provided by operating activities, the Company's ability to obtain additional financing (including its available lines of credit and its access to public debt markets as an investment grade debt security issuer) and proceeds from disposition of assets will provide adequate sources of short-term and long-term liquidity in the future.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements of the Company are filed under this Item, beginning on Page II-13. The financial statement schedules required by Regulation S-X are filed under Item 14 of this Annual Report on Form 10-K.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nII-12 INDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Tele-Communications, Inc.:\nWe have audited the accompanying consolidated balance sheets of Tele-Communications, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tele-Communications, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in notes 1 and 10 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\n\/s\/ KPMG PEAT MARWICK KPMG Peat Marwick\nDenver, Colorado March 21, 1994\nII-13\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1993 and 1992\n*Reclassified and restated - see notes 1, 3 and 10.\n(continued)\nII-14 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets, continued\n*Restated and reclassified - see notes 1, 3 and 10.\nSee accompanying notes to consolidated financial statements.\nII-15 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Operations\nYears ended December 31, 1993, 1992 and 1991\n*Restated and reclassified - see notes 1, 3 and 10.\nSee accompanying notes to consolidated financial statements.\nII-16 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Stockholders' Equity\nYears ended December 31, 1993, 1992 and 1991\n*Restated - see notes 1, 3 and 10.\nSee accompanying notes to consolidated financial statements.\nII-17 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nYears ended December 31, 1993, 1992 and 1991\n(continued)\nII-18 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows, Continued\nYears ended December 31, 1993, 1992 and 1991\n*Restated and reclassified - see notes 1, 3 and 10.\nSee accompanying notes to consolidated financial statements.\nII-19\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1993, 1992 and 1991\n(1) Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Tele-Communications, Inc. and those of all majority-owned subsidiaries (\"TCI\" or the \"Company\"). All significant intercompany accounts and transactions have been eliminated in consolidation.\nRestated Financial Statements for Implementation of Statement of Financial Accounting Standards No. 109, \"Accounting fo Income Taxes\"\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (\"Statement No. 109\"), \"Accounting for Income Taxes\" and has applied the provisions of Statement No. 109 retroactively to January 1, 1986. The accompanying 1992 and 1991 consolidated financial statements and related notes have been restated to reflect the implementation of Statement No. 109. See note 10.\nReceivable\nReceivables are reflected net of an allowance for doubtful accounts. Such allowance at December 31, 1993 and 1992 was not material.\nInvestment\nInvestments in which the ownership interest is less than 20% are generally carried at cost. Investments in marketable equity securities are carried at the lower of aggregate cost or market and any declines in value which are other than temporary are reflected as a reduction in the Company's carrying value of such investment. For those investments in affiliates in which the Company's voting interest is 20% to 50%, the equity method of accounting is generally used. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company's share of the net earnings or losses of the affiliates as they occur rather than as dividends or other distributions are received, limited to the extent of the Company's investment in, advances to and guarantees for the investee. The Company's share of net earnings or losses of affiliates includes the amortization of purchase adjustments.\nProperty and Equipment\nProperty and equipment is stated at cost, including acquisition costs allocated to tangible assets acquired. Construction costs, including interest during construction and applicable overhead, are capitalized. During 1993, 1992 and 1991, interest capitalized was not material.\n(continued)\nII-20 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDepreciation is computed on a straight-line basis using estimated useful lives of 3 to 15 years for distribution systems and 3 to 40 years for support equipment and buildings. Beginning in April of 1993, based upon changes in FCC regulations, the Company revised its estimate of useful lives of certain distribution equipment to correspond to the Company's anticipated remaining period of ownership of such equipment. This revision resulted in a decrease to net earnings of approximately $12 million ($.03 per share) for the year ended December 31, 1993.\nRepairs and maintenance are charged to operations, and renewals and additions are capitalized. At the time of ordinary retirements, sales or other dispositions of property, the original cost and cost of removal of such property are charged to accumulated depreciation, and salvage, if any, is credited thereto. Gains or losses are only recognized in connection with the sales of properties in their entirety. However, recognition of gains on sales of properties to affiliates accounted for under the equity method is deferred in proportion to the Company's ownership interest in such affiliates.\nFranchise Costs\nFranchise costs include the difference between the cost of acquiring cable television systems and amounts assigned to their tangible assets. Such amounts are generally amortized on a straight-line basis over 40 years. Costs incurred by the Company in obtaining franchises are being amortized on a straight-line basis over the life of the franchise, generally 10 to 20 years.\nMinority Interests\nRecognition of minority interests' share of losses of consolidated subsidiaries is limited to the amount of such minority interests' allocable portion of the common equity of those consolidated subsidiaries. Further, the minority interests' share of losses is not recognized if the minority holders of common equity of consolidated subsidiaries have the right to cause the Company to repurchase such holders' common equity.\nIncluded in minority interests in equity of consolidated subsidiaries are $50 million and $46 million at December 31, 1993 and 1992, respectively, of preferred stocks (and accumulated dividends thereon) of certain subsidiaries. The current dividend requirements on these preferred stocks aggregate $6 million per annum and such dividend requirements are reflected as minority interests in the accompanying consolidated statements of operations.\nForeign Currency Translatio\nAll balance sheet accounts of foreign investments are translated at the current exchange rate as of the end of the accounting period. Statement of operations items are translated at average currency exchange rates. The resulting translation adjustment is recorded as a separate component of stockholders' equity.\n(continued)\nII-21 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nLoss Per Common Shares\nThe loss per common share for 1993, 1992 and 1991 was computed by dividing net loss by the weighted average number of common shares outstanding during such periods (432.6 million, 424.1 million and 359.9 million for 1993, 1992 and 1991, respectively). Common stock equivalents were not included in the computation of weighted average shares outstanding because their inclusion would be anti-dilutive.\nReclassification\nCertain amounts have been reclassified for comparability with the 1993 presentation.\n(2) Supplemental Disclosures to Consolidated Statements of Cash Flows\nCash paid for interest was $641 million, $689 million and $829 million for 1993, 1992 and 1991, respectively. Also, during these years, cash paid for income taxes was not material.\nSignificant noncash investing and financing activities are as follows:\nYears ended December 31, ------------------------ 1993 1992 1991 ---- ---- ---- amounts in millions Acquisitions: Fair value of assets acquired $ 172 1,231 1,877 Liabilities assumed, net of current assets (7) 21 (12) Deferred tax asset (liability) recorded in acquisitions (7) 7 (337) Minority interests in equity of acquired entities -- -- (3) Value of TCI preferred stock issued in acquisitions -- -- (115) Value of TCI common stock issued in acquisitions -- (3) (1,011) ------ ----- ------ Cash paid for acquisitions $ 158 1,256 399 ====== ===== ======\nValue of TCI Class A common stock issued as part of purchase price of equity investment $ -- 95 -- ====== ===== ======\nNote received upon disposition of assets $ -- 15 -- ====== ===== ======\nContribution of certain interests to Liberty in exchange for preferred stock (see note 3) $ -- -- 530 ====== ===== ======\nCommon stock received upon redemption of preferred stock of Liberty (see note 3) $ -- -- 91 ====== ===== ======\n(continued)\nII-22 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nYears ended December 31, ------------------------ 1993 1992 1991 ---- ---- ---- amounts in millions Receipt of notes receivable upon disposition of Liberty common stock and preferred stock (note 3) $ 182 -- -- ====== ===== =====\nNoncash capital contribution to Community Cable Television (\"CCT\") (note 3) $ 22 -- -- ====== ===== =====\nNoncash exchange of equity investment for consolidated subsidiary and equity investment $ 22 -- -- ====== ===== =====\nContribution of assets to an affiliate $ -- -- 108 ====== ===== =====\nEffect of foreign currency translation adjustment on book value of foreign equity investments $ 10 19 -- ====== ===== =====\nCommon stock issued upon conversion of notes (with accrued interest through conversion) $ 403 112 4 ====== ===== =====\nCommon stock surrendered in lieu of cash upon exercise of stock options $ 1 7 3 ====== ===== =====\nNote payable issued for repurchase of common stock $ -- -- 5 ====== ===== =====\nExchange of preferred stock investment for marketable equity securities $ -- -- 156 ====== ===== =====\nDeferred tax liability resulting from stock option deduction $ -- -- 7 ====== ===== =====\n(3) Investment in Liberty\nAs of January 27, 1994, TCI and Liberty entered into a definitive agreement to combine the two companies. The transaction will be structured as a tax free exchange of Class A and Class B shares of both companies and preferred stock of Liberty for like shares of a newly formed holding company, TCI\/Liberty Holding Company (\"TCI\/Liberty\"). TCI shareholders will receive one share of TCI\/Liberty for each of their shares. Liberty common shareholders will receive 0.975 of a share of TCI\/Liberty for each of their common shares. The transaction is subject to the approval of both sets of shareholders as well as various regulatory approvals and other customary conditions. Subject to timely receipt of such approvals, which cannot be assured, it is anticipated the closing of such transaction will take place during 1994.\n(continued)\nII-23 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nTCI owns 3,477,778 shares of Liberty Class A common stock (after giving effect to the repurchase by Liberty during the year ended December 31, 1993 of 927,900 shares of Class A common stock) and 55,070 shares of Liberty Class E, 6% Cumulative Redeemable Exchangeable Junior Preferred Stock received in January of 1993 upon conversion of the Liberty Class A Redeemable Convertible Preferred Stock. Such common shares represent less than 5% of the outstanding Class A common stock of Liberty.\nOf the remaining classes of preferred stock of Liberty held by the Company, one class entitles TCI to elect a number of members of Liberty's board of directors equal to no less than 11% of the total number of directors and another class is exchangeable for TCI common stock.\nDue to the significant economic interest held by TCI through its ownership of Liberty preferred stock and Liberty common stock and other related party considerations, TCI has accounted for its investment in Liberty under the equity method. Accordingly, the Company has not recognized any income relating to dividends, including preferred stock dividends, and the Company has continued to record the earnings or losses generated by the interests contributed to Liberty (by recognizing 100% of Liberty's earnings or losses before deducting preferred stock dividends).\nOn December 30, 1991, TCI Liberty, Inc. (\"TCIL\"), a wholly-owned subsidiary of TCI, entered into a Commercial Paper Purchase Agreement with Liberty whereby TCIL could from time to time sell short-term notes to Liberty from TCIL of up to an aggregate amount of $100 million. TCIL borrowed $22 million from Liberty on December 31, 1991, pursuant to the Commercial Paper Purchase Agreement. The full amount, including interest, was repaid on January 15, 1992. Interest rates on the short-term notes were determined by the parties by reference to prevailing money-market rates. This agreement was terminated on March 23, 1993.\nDuring 1992, the Company and Liberty formed Community Cable Television (\"CCT\"), a general partnership created for the purpose of acquiring and operating cable television systems with Tele-Communications of Colorado, Inc. (\"TCIC\"), an indirect wholly-owned subsidiary of TCI, owning a 49.999% interest and Liberty Cable Partner, Inc. (\"LCP\"), an indirect wholly-owned subsidiary of Liberty, owning a 50.001% interest.\nPursuant to an amendment to the CCT General Partnership Agreement (the \"Amendment\"), certain non-cash contributions previously made to CCT were rescinded, TCIC contributed to CCT a $10,590,000 promissory note of TCI Development Corporation (\"TCID\") as of the date of the originally contributed assets, LCP agreed to contribute its equity and debt interests in Daniels & Associates Partners Limited (\"DAPL\"), a general partner of Mile Hi Cablevision Associates, Ltd. (\"Mile Hi\"), to CCT immediately prior to the closing of the acquisition of Mile Hi described below which closed on March 15, 1993. TCIC also agreed to contribute, at the time of the contribution by LCP of its DAPL interests, a TCID promissory note in the amount of $66,900,000.\n(continued)\nII-24 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nOn March 12, 1993, the CCT General Partnership Agreement was further amended (the \"Second Amendment\"). Under the Second Amendment, LCP agreed to contribute its Mile Hi partnership interest but not a loan receivable from Mile Hi in the amount of $50 million (including accrued interest) (the \"Mile Hi Note\") (both of which it received upon the liquidation of DAPL on March 12, 1993 as described below) to CCT in exchange for 50.001% of a newly created Class B partnership interest in CCT. TCIC agreed to contribute a $21,795,000 promissory note from TCID in exchange for 49.999% of the Class B partnership interests in place of the $66,900,000 note which was to be contributed under the Amendment. On March 15, 1993, each party made its respective contribution required by the Second Amendment.\nOn June 3, 1993, Liberty and TCI completed the transactions contemplated by a recapitalization agreement (the \"Recapitalization Agreement\"). Pursuant to the Recapitalization Agreement, Liberty repurchased 927,900 shares of Liberty Class A common stock owned by TCI and repurchased all of the outstanding shares of the Liberty Class C Redeemable Exchangeable Preferred Stock. The total purchase price of $194 million was paid through the delivery of cash amounting to $12 million and promissory notes of Liberty in the aggregate principal amount of $182 million.\nIn connection with the Recapitalization Agreement, TCIC and LCP entered into an Option-Put Agreement (the \"Option-Put Agreement\"), which was amended on November 30, 1993. Under the amended Option-Put Agreement, between June 30, 1994 and September 28, 1994, and between January 1, 1996 and January 31, 1996, TCIC will have the option to purchase all of LCP's interest in CCT and the Mile Hi Note for an amount equal to $77 million plus interest accruing at the rate of 11.6% per annum on such amount from June 3, 1993. Between April 1, 1995 and June 29, 1995, and between January 1, 1997 and January 31, 1997, LCP will have the right to require TCIC to purchase LCP's interest in CCT and the Mile Hi Note for an amount equal to $77 million plus interest on such amount accruing at the rate of 11.6% per annum from June 3, 1993.\nUnder a separate agreement, on June 3, 1993, TCI Holdings, Inc. (\"TCIH\"), a wholly-owned subsidiary of TCI, purchased a 16% limited partnership interest in Intermedia Partners from LCP and all of LCP's interest in a special allocation of income and gain of $7 million under the partnership agreement of Intermedia Partners for a purchase price of approximately $9 million. TCIH also received an option to purchase LCP's remaining 6.37% limited partnership interest in Intermedia Partners prior to December 31, 1995 for a price equal to $4 million plus interest at 8% per annum from June 3, 1993.\n(continued)\nII-25 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nIn September of 1993, Encore QE Programming Corp. (\"QEPC\"), a wholly-owned subsidiary of Encore Media Corporation (\"EMC\"), a 90% owned subsidiary of Liberty, entered into a limited partnership agreement with TCI Starz, Inc. (\"TCIS\"), a wholly- owned subsidiary of TCI, for the purpose of developing, operating and distributing STARZ!, a first-run movie premium programming service launched in 1994. QEPC is the general partner and TCIS is the limited partner. Losses are allocated 1% to QEPC and 99% to TCIS. Profits are allocated 1% to QEPC and 99% to TCIS until certain defined criteria are met. Subsequently, profits are allocated 20% to QEPC and 80% to TCIS. TCIS has the option, exercisable at any time and without payment of additional consideration, to convert its limited partner interest to an 80% general partner interest with QEPC's partnership interest simultaneously converting to a 20% limited partnership interest. In addition, during specific periods commencing April 1999 and April 2001, respectively, QEPC may require TCIS to purchase, or TCIS may require QEPC to sell, the partnership interest of QEPC in the partnership for a formula-based price. EMC is paid a management fee equal to 20% of \"managed costs\" as defined, in order to manage the service. EMC manages the service and has agreed to provide the limited partnership with certain programming under a programming agreement whereby the partnership will pay its pro rata share of the total costs incurred by EMC for such programming. The Company accounts for the partnership as a consolidated subsidiary. (See note 11).\nOn March 15, 1993, Mile Hi Cable Partners, L.P. (\"New Mile Hi\") acquired all the general and limited interests in Mile Hi Cablevision Associates, Ltd. (\"Mile Hi\"), the owner of the cable television system serving Denver, Colorado. New Mile Hi is a limited partnership formed among CCT (78% limited partnership interest), Daniels Cablevision, Inc. (\"DCI\") (1% limited partner) and P & B Johnson Corp. (\"PBJC\") (21% general partnership interest), a corporation controlled by Robert L. Johnson, a member of Liberty's board of directors. As a result of the acquisition, New Mile Hi is a consolidated subsidiary of Liberty for financial reporting purposes.\nPrior to the acquisition, LCP indirectly owned a 32.175% interest in Mile Hi through its ownership of a limited partnership interest in DAPL, one of Mile Hi's general partners. The other partners in Mile Hi were Time Warner Entertainment Company, L.P., various individual investors and Mile Hi Cablevision, Inc., a corporation in which all the other partners in Mile Hi were the shareholders.\nDAPL was liquidated on March 12, 1993, at which time LCP received a liquidating distribution consisting of its proportionate interest in DAPL's partnership interest in Mile Hi, representing the aforementioned 32.175% interest in Mile Hi. The subsidiary of Liberty also received a note payable from Mile Hi in the approximate amount of $50 million (including accrued interest) (the \"Mile Hi Note\") in novation of a loan receivable from DAPL in an equal amount.\n(continued)\nII-26 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe total value of the acquisition was approximately $180 million. Of that amount, approximately $70 million was in the form of Mile Hi debt paid at the closing. Another $50 million was in the form of the Mile Hi Note, which debt was assumed by New Mile Hi and then by CCT. Of the remaining $60 million, approximately $40 million was paid in cash to partners in Mile Hi in exchange for their partnership interests. The remaining $20 million of interest in Mile Hi was acquired by New Mile Hi through the contribution by Liberty's subsidiary to CCT and by CCT to New Mile Hi of the 32.175% interest in Mile Hi received in the DAPL liquidation and by DCI's contribution to New Mile Hi of a 0.4% interest in Mile Hi.\nOf the estimated $110 million in cash required by New Mile Hi to complete the transaction, $105 million was loaned to New Mile Hi by CCT and $5 million was provided by PBJC as a capital contribution to New Mile Hi. Of the $5 million contributed by PBJC, approximately $4 million was provided by CCT through loans to Mr. Johnson and trusts for the benefit of his children. CCT funded its loans to New Mile Hi and the Johnson interests by drawing down $93 million under its revolving credit facility and by borrowing $16 million from TCIC in the form of a subordinated note.\nLiberty's investment in Mile Hi, which was previously accounted for under the cost method, was received from TCI in the March 28, 1991 transaction whereby TCI contributed its interests in certain programming businesses and cable television systems in exchange for several different classes and series of preferred stock of Liberty.\nLiberty adopted Statement No. 109 in 1993 and has applied the provisions of Statement No. 109 retroactively to March 28, 1991.\nDuring the year ended December 31, 1992, Liberty increased its economic and voting interest in Lenfest Communications, Inc. (\"LCI\") to 50% and, accordingly, adopted the equity method of accounting. Liberty's investment in LCI, which was previously accounted for under the cost method, was received from TCI in March of 1991. Additionally, LCI adopted Statement No. 109 in 1993 and has applied its provisions on a retroactive basis.\nAs a result of the aforementioned acquisition of Mile Hi and the implementation of Statement No. 109 by Liberty and LCI, the Company restated the carrying amount of its investment in Liberty preferred stock at December 31, 1992 through an increase of $19 million. Included in the restated balance is the recognition of previously reserved interest income on the Mile Hi Note. These restatements resulted in an increase of $6 million to the Company's results of operations for the year ended December 31, 1992, a decrease of $2 million for the year ended December 31, 1991 and an increase of $7 million for prior years.\n(continued)\nII-27 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nAlso, during the year ended December 31, 1992, Liberty increased its economic and voting interest in Columbia Associates, L.P. (\"Columbia\") to 39.609% and, accordingly, adopted the equity method of accounting. Liberty's investment in Columbia, which was previously accounted for under the cost method, was received from TCI in March of 1991.\nOn December 31, 1992, Liberty sold certain notes receivable of Intermedia Partners to TCI for $36,300,000 in cash.\nThe Company purchases sports and other programming from certain subsidiaries of Liberty. Charges to TCI (which are based upon customary rates charged to others) for such programming were $44 million, $44 million and $25 million for the years ended December 31, 1993 and 1992 and the period from March 29, 1991 through December 31, 1991 respectively. Such amounts are included in operating expenses in the accompanying consolidated statements of operations. Certain subsidiaries of Liberty purchase from TCI, at TCI's cost plus an administrative fee, certain pay television and other programming. In addition, a consolidated subsidiary of Liberty pays a commission to TCI for merchandise sales to customers who are subscribers of TCI's cable systems. Aggregate commission and charges for such programming were $11 million, $3 million and $2 million for the years ended December 31, 1993 and 1992 and the period from March 29, 1991 through December 31, 1991, respectively. Such amounts are recorded in revenue in the accompanying consolidated statements of operations.\nSummarized unaudited financial information of Liberty as of December 31, 1993 and 1992 and for the years ended December 31, 1993 and 1992 and the period from March 29, 1991 through December 31, 1991 is as follows:\nDecember 31, ------------ Consolidated Financial Position 1993 1992 ------------------------------- ---- ---- amounts in millions\nCash and cash equivalents $ 91 96 Investment in TCI common stock 104 104 Receivable from TCI -- 5 Other investments and related receivables 372 453 Other assets, net 870 172 ------ ----\nTotal assets $1,437 830 ====== ====\nDebt $ 446 167 Deferred income taxes 2 15 Other liabilities 307 54 Minority interests 175 10 Redeemable preferred stocks 155 155 Stockholders' equity 352 429 ------ ----\nTotal liabilities and stockholders' equity $1,437 830 ====== ====\n(continued)\nII-28 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nConsolidated Operations 1993 1992 1991 ----------------------- ---- ---- ---- amounts in millions Revenue $1,153 157 85 Operating expenses (1,105) (144) (74) Depreciation and amortization (49) (16) (10) ------ ----- ----\nOperating income (loss) (1) (3) 1\nInterest expense (31) (7) (5) Other, net 36 32 44 ------ ---- ----\nNet earnings $ 4 22 40 ====== ==== ====\n(4) Investments in Other Affiliates\nInvestments in affiliates, other than Liberty (see note 3), accounted for under the equity method, amounted to $567 million and $650 million at December 31, 1993 and 1992, respectively.\nOn December 2, 1992, SCI Holdings, Inc. (\"SCI\") consummated a transaction (the \"Split-Off\") that resulted in the ownership of its cable systems being split between its two stockholders, which stockholders were Comcast Corporation (\"Comcast\") and the Company. Prior to the Split-Off, the Company had an investment in the common stock of SCI and the preferred stock of its wholly-owned subsidiary, Storer Communications, Inc. (\"Storer\").\nThe Split-Off, which permitted refinancing of substantially all of the publicly held debt of SCI and the preferred stock of SCI's wholly-owned subsidiary, Storer, was effected by the distribution of approximately 50% of the net assets of SCI to three holding companies formed by the Company (the \"Holding Companies\").\nPrior to the Split-off, the Company contributed its SCI common stock to the Holding Companies in exchange for 100% of such Holding Companies' common stock. The amount of SCI common stock contributed to each of the Holding Companies was based upon the proportionate value of net assets to be received by each of the Holding Companies in the Split-Off. SCI then merged into Storer and the SCI common stock held by the Holding Companies was converted into Storer common stock.\n(continued)\nII-29 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nAlso prior to the Split-Off, (i) the Holding Companies incurred long-term debt aggregating approximately $1.1 billion and contributed substantially all of the resulting proceeds to Storer and (ii) a consolidated subsidiary of TCI redeemed approximately $476 million of its debt securities held by Storer with proceeds of its separate financing, and an affiliate of Comcast redeemed approximately $274 million of its debt securities held by Storer. In turn, Storer utilized substantially all of the proceeds of such contributions and redemptions to repurchase its preferred stock and extinguished all of its debt. The Company's share of Storer's loss on early extinguishment of debt was $52 million and such amount is included in loss on early extinguishment of debt in the accompanying consolidated statements of operations. Additionally, the Company received a premium, amounting to $14 million, on the repurchase of the Storer preferred stock. Such amount is reflected separately in the accompanying consolidated financial statements.\nIn the Split-Off, Storer redeemed its common stock held by the Holding Companies in exchange for 100% of the capital stock of certain operating subsidiaries of Storer.\nImmediately following the Split-Off, the Company owned a majority of the common stock of the Holding Companies and Comcast owned 100% of the common stock of Storer. As such, the Company, which previously accounted for its investment in SCI using the equity method, now consolidates its investment in the Holding Companies. The tangible assets of the Holding Companies were recorded at predecessor cost.\nIn connection with the Company's 1988 acquisition of an equity interest in SCI, a subsidiary of the Company issued certain debt and equity securities to Storer for $650 million. Such debt securities were redeemed and the equity securities were received by one of the Holding Companies in the Split-Off. Interest charges and preferred stock dividend requirements on these debt and equity securities, prior to the Split-Off, aggregated $81 million and $89 million for the period ended December 2, 1992 and the year ended December 31, 1991. The Company's share of losses of SCI, prior to the Split-Off for the period ended December 2, 1992 and the year ended December 31, 1991 amounted to $51 million and $54 million, as adjusted for the effect of interest and dividends accounted for by Storer as capital transactions due to their related party nature.\nThe Company had a management consulting agreement with Storer which provided for the operational management of certain of Storer's cable television systems by TCI. This agreement provided for a management fee based on 3.5% of the revenue of those cable television systems managed by the Company. The Company also entered into a programming service agreement with Storer whereby the Company, for a fee, managed Storer's purchases of programming. The total management fees under the consulting and programming service agreements, prior to the Split-Off, amounted to $7 million in each of the period from January 1 1992 through December 2, 1992 and the year ended December 31, 1991 (which amounts are recorded as a reduction of selling, general and administrative expenses in the accompanying consolidated statements of operations).\n(continued)\nII-30 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe Company is a partner in certain joint ventures, accounted for under the equity method, which have operations in the United Kingdom and other parts of Europe. These joint ventures, which are currently operating and constructing cable television and telephone systems, have generated losses to the Company in 1993 and 1992 amounting to $47 million and $37 million, including $3 million and $6 million in 1993 and 1992, respectively, resulting from foreign currency transaction losses.\nSummarized unaudited financial information for affiliates other than Liberty (including those contributed to Liberty through March 28, 1991), is as follows:\nDecember 31, ------------- 1993 1992 ---- ---- Combined Financial Position amounts in millions ---------------------------\nProperty and equipment, net $1,059 757 Franchise costs, net 266 211 Other assets, net 727 467 ------ ------\nTotal assets $2,052 1,435 ====== ======\nDebt $ 593 661 Due to TCI 78 71 Other liabilities 338 185 Owners' equity 1,043 518 ------ ------\nTotal liabilities and equity $2,052 1,435 ====== ======\nYears ended December 31, ------------------------ 1993 1992 1991 ---- ---- ---- Combined Operations amounts in millions -------------------\nRevenue $ 713 1,224 1,461 Operating expenses (648) (786) (993) Depreciation and amortization (127) (303) (329) ------ ------ ------\nOperating income (loss) (62) 135 139\nInterest expense (37) (295) (374) Other, net 98 (234) (47) ----- ------ ------\nNet loss $ (1) (394) (282) ====== ====== ======\nCertain of the Company's affiliates are general partnerships and any subsidiary of the Company that is a general partner in a general partnership is, as such, liable as a matter of partnership law for all debts (other than non-recourse debts) of that partnership in the event liabilities of that partnership were to exceed its assets.\n(continued)\nII-31 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(5) Investment in Turner Broadcasting System, Inc.\nIn 1987, the Company and several other cable television operators purchased shares of two classes of preferred stock of Turner Broadcasting System, Inc. (\"TBS\"). During 1991, TBS made an offer to exchange shares of one class of its preferred stock (and accrued dividends thereon) for shares of TBS common stock and, as a result, the Company received common shares valued at $178 million. Shares of the other class of preferred stock have voting rights and are convertible into shares of TBS common stock. The holders of those preferred shares, as a group, are entitled to elect seven of fifteen members of the board of directors of TBS, and the Company appoints three such representatives. However, voting control over TBS continues to be held by its chairman of the board and chief executive officer (an unrelated third party). The Company's total holdings of TBS common and preferred stocks represent an approximate 12% voting interest for those matters for which preferred and common stock vote as a single class.\nThe Company's investment in TBS common stock had an aggregate market value of $803 million and $628 million (which exceeded cost by $485 million and $310 million) at December 31, 1993 and 1992, respectively. In addition, the Company's investment in TBS preferred stock had an aggregate market value of $954 million and $746 million, based upon the common market value, (which exceeded cost by $781 million and $573 million) at December 31, 1993 and 1992, respectively.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective for fiscal years beginning after December 15, 1993. Under the new rules, debt securities that the Company has both the positive intent and ability to hold to maturity are carried at amortized cost. Debt securities that the Company does not have the positive intent and ability to hold to maturity and all marketable equity securities are classified as available-for-sale or trading and carried at fair value. Unrealized holding gains and losses on securities classified as available-for sale are carried as a separate component of shareholders' equity. Unrealized holding gains and losses on securities classified as trading are reported in earnings.\nThe Company holds no material debt securities. Marketable equity securities are currently reported by the Company at the lower of cost or market (\"LOCOM\") and net unrealized losses are reported in earnings. The Company will apply the new rules starting in the first quarter of 1994. Application of the new rules will result in an estimated increase of approximately $300 million in stockholders' equity as of January 1 1994, representing the recognition of unrealized appreciation, net of taxes, for the Company's investment in equity securities determined to be available-for-sale, previously carried at LOCOM.\n(continued)\nII-32 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(6) Debt\nDebt is summarized as follows:\nWeighted-average December 31, interest rate at ------------- December 31, 1993 1993 1992 ----------------- ---- ---- amounts in millions\nParent company debt: Senior notes 8.6% $ 5,052 1,960 Liquid Yield OptioTM Notes (a) -- 386\nBank credit facilities 6.0% 80 500 Commercial paper 4.1% 44 50 Other debt 2 1 ------ ----- 5,178 2,897\nDebt of subsidiaries: Bank credit facilities 4.6% 3,264 5,526 Commercial paper -- 12 Notes payable 10.3% 1,321 1,732 Convertible notes (b) 9.5% 47 48 Other debt 90 70 ------ ------\n$ 9,900 10,285 ======= ======\n(a) These subordinated notes, which were stated net of unamortized discount of $764 million at December 31, 1992, were issued through a public offering. On October 28, 1993, the Company called for redemption all of its remaining Liquid Yield OptionTM Notes. In connection with such call for redemption, Notes aggregating $405 million were converted into 18,694,377 shares of Class A common stock and Notes aggregating less than $1 million were redeemed together with accrued interest to the redemption date. Prior to the aforementioned redemption, Notes aggregating $6 million were converted into 259,537 shares of TCI Class A common stock during 1993.\n(b) These convertible notes, which are stated net of unamortized discount of $197 million and $201 million on December 31, 1993 and 1992, respectively, mature on December 18, 2021. The notes require (so long as conversion of the notes has not occurred) an annual interest payment through 2003 equal to 1.85% of the face amount of the notes. During the year ended December 31, 1993, certain of these notes were converted into 819,000 shares of Class A common stock. At December 31, 1993, the notes were convertible, at the option of the holders, into an aggregate of 41,060,990 shares of Class A common stock.\nDuring the year ended December 31, 1992, TCI called for redemption all of its 7% convertible subordinated debentures. Debentures aggregating $114 million were converted into 6,636,881 shares of Class A common stock and the remaining debentures were redeemed at 104.2% of the principal amount together with accrued interest to the redemption date.\n(continued)\nII-33 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe Company's bank credit facilities and various other debt instruments generally contain restrictive covenants which require, among other things, the maintenance of certain earnings, specified cash flow and financial ratios (primarily the ratios of cash flow to total debt and cash flow to debt service, as defined), and include certain limitations on indebtedness, investments, guarantees, dispositions, stock repurchases and dividend payments.\nAs security for borrowings under one of its credit facilities, the Company pledged a portion of the common stock (with a quoted market value of approximately $643 million at December 31, 1993) it holds of TBS.\nIn order to provide interest rate protection on a portion of its variable rate indebtedness, the Company has entered into various interest rate exchange agreements pursuant to which it pays fixed interest rates, ranging from 7.7% to 9.9%, on notional amounts of $608 million. The Company has also entered into various other exchange agreements, pursuant to which it pays variable interest rates on notional amounts of $2,275 million. The Company is exposed to credit losses for the periodic settlements of amounts due under these interest rate exchange agreements in the event of nonperformance by the other parties to the agreements. However, the Company does not anticipate nonperformance by the counterparties and, in any event, such amounts were not material at December 31, 1993.\nThe Company has also entered into various interest rate hedge agreements on notional amounts of $345 million which fix the maximum variable interest rates, at rates ranging from 10% to 11%. The term of such agreements is approximately two years.\nTCI and certain of its subsidiaries are required to maintain unused availability under bank credit facilities to the extent of outstanding commercial paper. Also, TCI and certain of its subsidiaries pay fees, ranging from 1\/4% to 1\/2% per annum, on the average unborrowed portion of the total amount available for borrowings under bank credit facilities.\nThe fair value of the Company's debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The fair value of debt, which has a carrying value of $9,900 million, was $10,572 million at December 31, 1993.\nThe fair value of the interest rate exchange agreements is the estimated amount that the Company would pay or receive to terminate the agreements at December 31, 1993, taking into consideration current interest rates and assuming the current creditworthiness of the counterparties. The Company would receive $13 million at December 31, 1993 upon termination of the agreements.\n(continued)\nII-34 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nAnnual maturities of debt for each of the next five years are as follows:\nParent Total ------ ----- amounts in millions\n1994 $ 69* 927* 1995 212 705 1996 210 993 1997 151 885 1998 349 799\n* Includes $44 million of commercial paper.\n(7) Redeemable Preferred Stocks\nDecember 31, ----------------- 1993 1992 ------ ------ amounts in millions\n12-7\/8% Cumulative Compounding Preferred Stock, Series A; issued and outstanding 4,772,394 shares in 1992 (a) $ -- 92 6-3\/4% Convertible Preferred Stock, Series B; issued and outstanding 6,201 shares at December 31, 1992 (b) -- 18 4-1\/2% Convertible Preferred Stock, Series C; issued and outstanding 6,201 shares at December 31, 1993 (b) 18 -- ---- ----\n$ 18 110 ==== ====\n(a) The 12-7\/8% Cumulative Compounding Preferred Stock was stated at its redemption value of $19.25 per share. Dividends were cumulative and accrued at 12-7\/8% of the redemption value. In October of 1992, the Company acquired and retired 250,000 shares of this preferred stock in the open market for a purchase price of $19.56 per share. All remaining outstanding shares of such preferred stock were redeemed on February 1, 1993 for a redemption price of $19.25 per share plus all unpaid dividends accrued thereon.\n(continued)\nII-35 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(b) The 4-1\/2% Convertible Preferred Stock is stated at its redemption value of $3,000 per share, and each share is convertible into 204 shares of TCI Class A common stock. In 1993, the Company designated this Series C Convertible Preferred Stock with all of the same attributes of the Series B Convertible Preferred Stock except that dividends on each share of the Series C stock accrued on a daily basis at the rate of 4- 1\/2% per annum instead of 6-3\/4% per annum, and such Series C stock was not subject to optional redemption by the Company until after January 10, 1994. During the year ended December 31, 1993, the shares so designated were exchanged for the existing Series B shares. Subsequent to December 31, 1993, all of the Series C shares were converted into 1,265,004 shares of TCI Class A common stock.\n(8) Stockholders' Equity\nCommon Stock\nThe Class A common stock has one vote per share and the Class B common stock has ten votes per share. Each share of Class B common stock is convertible, at the option of the holder, into one share of Class A common stock.\nEmployee Benefit Plans\nThe Company has an Employee Stock Purchase Plan (\"ESPP\") to provide employees an opportunity for ownership in the Company and to create a retirement fund. Terms of the ESPP provide for employees to contribute up to 10% of their compensation to a trust for investment in TCI common stock. The Company, by annual resolution of the Board of Directors, contributes up to 100% of the amount contributed by employees. Certain of the Company's subsidiaries have their own employee benefit plans. Contributions to all plans aggregated $16 million, $13 million and $12 million for 1993, 1992 and 1991, respectively.\n(continued)\nII-36 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nStock Options\nTwo officers (one of whom is also a director) each held an option to acquire 200,000 shares of Class A common stock at an adjusted purchase price of $10.00 per share. One of such officers received payment of $550,000 from the Company in December of 1991 upon cancellation of a portion of his option covering 100,000 shares. The amount paid was based on the then market value of Class A common stock of $15.50 per share. The same officer received payments of $512,500 and $569,000 from the Company (based on the then market value of Class A common stock of $20.25 and $21.375 per share) in July and December of 1992, respectively, in cancellation of the remainder of his option covering 100,000 shares of TCI Class A common stock. The other officer received payment of $2,276,000 from the Company in December of 1992 upon cancellation of his option covering 200,000 shares of TCI Class A common stock. The amount paid was based on the then market value of Class A common stock of $21.375 per share.\nThe Company had an Incentive Stock Option Plan (\"ISOP\") which has expired. Options granted under the ISOP (prior to its expiration) have an option price equal to the fair market value on the date of grant, are all currently exercisable and expire five years from the date of grant. Options to purchase 217,008 shares of TCI Class A common stock are outstanding at December 31, 1993, with a price of $17.25 per share. During the years ended December 31, 1993, 1992 and 1991, options to acquire 96,242, 321,406 and 78,642 shares, respectively were exercised at prices ranging from $10.00 to $17.25 per share and options for 25,000, 12,000 and 15,000 shares, respectively, were cancelled.\nTCI assumed certain stock options previously granted by UAE to certain of its employees. These options, which are currently exercisable, represent the right, as of December 31, 1993, to acquire 167,328 shares of TCI Class A common stock at adjusted purchase prices ranging from $8.83 to $18.63 per share. During the year ended December 31, 1993, no options were exercised or cancelled. No additional options may be granted by UAE.\n(continued)\nII-37 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe Company has adopted the 1992 Stock Incentive Plan (the \"Plan\"). The Plan provides for awards to be made with respect to a maximum of 10 million shares of Class A common stock. Awards may be made as grants of stock options, stock appreciation rights, restricted shares, stock units or any combination thereof. On November 11, 1992, stock options in tandem with stock appreciation rights to purchase 4,020,000 shares of Class A common stock were granted pursuant to the Plan to certain officers and other key employees at a purchase price of $16.75 per share. Such options become exercisable and vest evenly over five years, first became exercisable beginning November 11, 1993 and expire on November 11, 2002. During the year ended December 31, 1993, stock options covering 50,000 shares of Class A common stock were cancelled upon termination of employment. On October 12, 1993, stock options in tandem with stock appreciation rights to purchase 1,355,000 shares of TCI Class A common stock were granted pursuant to the Plan to certain officers and other key employees at a purchase price of $16.75 per share. On November 12, 1993, an additional grant of stock options in tandem with stock appreciation rights to purchase 600,000 shares of TCI Class A common stock were granted to two officers at a purchase price of $16.75 per share. Such options become exercisable and vest evenly over four years, first become exercisable beginning October 12, 1994 and expire on October 12, 2003. Separately from the Plan, an additional grant of stock options in tandem with stock appreciation rights to purchase 2,000,000 shares of TCI Class A common stock at a purchase price of $16.75 per share was made on November 12, 1993 to an individual who thereafter became a director of the Company. Twenty percent of such options vested and became exercisable immediately and the remainder become exercisable evenly over 4 years. The options expire October 12, 1998. Estimates of the compensation relating to these grants have been recorded through December 31, 1993, but are subject to future adjustment based upon market value and, ultimately, on the final determination of market value when the rights are exercised.\nTwo officers (who are also directors) each held an option, expiring December 31, 1991, to acquire 1,200,000 shares of Class B common stock at an adjusted purchase price of $1.10 per share. In June of 1991, one of the aforementioned officers exercised in full his option to acquire 1,200,000 shares of Class B common stock by delivery of 80,000 shares of Class B common stock valued at $16.50 per share and, on the same date, sold 400,000 of such option shares (at a price of $16.50 per share) to TCI for cash and a short-term note. In December of 1991, the other officer exercised his option to purchase 900,000 shares of Class B common stock by delivery of 63,871 shares of Class A common stock valued at $15.50 per share. Such officer agreed to forego exercising the balance of his option to purchase 300,000 shares of Class B common stock in exchange for the payment by the Company of $4,320,000 as compensation to be applied towards federal and state income taxes withheld by the Company for his account.\nOther\nThe excess of consideration received on debentures converted or options exercised over the par value of the stock issued is credited to additional paid-in capital.\n(continued)\nII-38 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nAt December 31, 1993, there were 50,635,330 Class A shares of TCI common stock reserved for issuance under exercise privileges related to options and convertible debt securities described in this note 8 and in notes 6 and 7. In addition, one share of Class A common stock is reserved for each share of Class B common stock.\n(9) Transactions with Officers and Directors\nOn December 10, 1992, pursuant to a restricted stock award agreement, an officer, who is also a director, of the Company was transferred the right, title and interest in and to 124.03 shares (having a liquidation value of $4 million) of the 12% Series B cumulative compounding preferred stock of WestMarc Communications, Inc. (a wholly-owned subsidiary of the Company) owned by the Company. Such preferred stock is subject to forfeiture in the event of certain circumstances from the date of grant through February 1, 2002, decreasing by 10% on February 1 of each year.\nOn December 14, 1992, an officer, who is also a director, sold 100,000 shares of Class B common stock to the Company for $2,138,000.\n(10) Income Taxes\nTCI files a consolidated Federal income tax return with all of its 80% or more owned subsidiaries. Consolidated subsidiaries in which the Company owns less than 80% each file a separate income tax return. TCI and such subsidiaries calculate their respective tax liabilities on a separate return basis which are combined in the accompanying consolidated financial statements.\nThe Financial Accounting Standards Board Statement No. 109 requires a change from the deferred method of accounting for income taxes of APB Opinion No. 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement No. 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under Statement No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nThe Company adopted Statement No. 109 in 1993 and has applied the provisions of Statement No. 109 retroactively to January 1, 1986. The Company restated its financial statements for the years beginning January 1, 1986 through December 31, 1992. The effect of the implementation of Statement No. 109 at December 31, 1992 was a $2 million decrease in receivables, $48 million net increase in investments, $178 million net increase in property and equipment, $2,901 million net increase in franchise costs, $2 million increase in other assets, $34 million increase in other liabilities, $2,865 million increase in deferred taxes payable and $228 million decrease in accumulated deficit.\n(continued)\nII-39 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe financial statements for the years ended December 31, 1992 and 1991 have been restated to comply with the provisions of Statement No. 109. The following summarizes the impact of applying Statement No. 109 on net loss and loss per common share for the years ended December 31, 1992 and 1991:\nDecember 31, -------------------- 1992 1991 ------- -------- amounts in millions\nNet loss as previously reported $ (34) (103) Effect of restatements: Liberty, including the effects of Mile Hi and LCI (note 3) 6 (2) Statement No. 109 20 8 ------- -------\nAs restated $ (8) (97) ======= =======\nPer share amounts as previously reported $ (.12) (.29) Effect of restatements: Liberty, including the effects of Mile Hi and LCI (note 3) .02 -- Statement No. 109 .05 .02 ------- -------\nAs restated $ (.05) (.27) ======= =======\nIncome tax benefit (expense) attributable to income or loss from continuing operations for the years ended December 31, 1993, 1992 and 1991 consists of:\nCurrent Deferred Total ------- -------- ------- amounts in millions\nYear ended December 31, 1993: Federal $ (14) (119) (133) State and local (15) (20) (35) ------- ------- -------\n$ (29) (139) (168) ======= ======= =======\nYear ended December 31, 1992: Federal $ -- (24) (24) State and local (10) (4) (14) ------- ------- -------\n$ (10) (28) (38) ======= ======= =======\nYear ended December 31, 1991: Federal $ (2) 33 31 State and local (7) 6 (1) ------- ------- -------\n$ (9) 39 30 ======= ======= =======\n(continued)\nII-40 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe significant components of deferred income tax benefit (expense) for the years ended December 31, 1993, 1992 and 1991 are as follows:\nYears ended December 31, ----------------------- 1993 1992 1991 ----- ------ ------ amounts in millions\nDeferred tax benefit (expense) (exclusive of effects of other components listed below) $ (63) (28) 39 Adjustment to deferred tax assets and liabilities for enacted change in tax rates (76) -- -- ----- ----- -----\n$(139) (28) 39 ===== ===== =====\nIncome tax benefit (expense) attributable to income or loss from continuing operations differs from the amounts computed by applying the Federal income tax rate of 35% in 1993 and 34% in 1992 and 1991 as a result of the following:\nYears ended December 31, ----------------------- 1993 1992 1991 ----- ------ ------ amounts in millions\nComputed \"expected\" tax benefit (expense) $ (56) (15) 37 Adjustment to deferred tax assets and liabilities for enacted change in Federal income tax rate (84) -- -- Dividends excluded for income tax purposes 4 10 13 Amortization not deductible for tax purposes (12) (8) (7) Minority interest in earnings of consolidated subsidiaries (1) (14) (13) Recognition of losses of consolidated partnership (8) -- -- State and local income taxes, net of Federal income tax benefit (23) (9) 1 Other 4 (2) (1) ------ ------ ------\n$ (168) (38) 30 ====== ====== ======\n(continued)\nII-41 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNote to Consolidated Financial Statements\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993 and 1992 are presented below:\nDecember 31, --------------------- 1993 1992 ------ ------ amounts in millions\nDeferred tax assets: Net operating loss carryforwards $ 590 665 Less - valuation allowance (90) (88) Investment tax credit carryforwards 140 140 Less - valuation allowance (36) (34) Alternative minimum tax credit carryforwards 19 11 Investments in affiliates, due principally to losses of affiliates recognized for financial statement purposes in excess of losses recognized for income tax purposes 266 321 Future deductible amounts principally due due to non-deductible accruals 27 19 Other 13 5 ------ ------\nNet deferred tax assets 929 1,039 ------ ------\nDeferred tax liabilities: Property and equipment, principally due to differences in depreciation 1,193 1,136 Franchise costs, principally due to differences in amortization 2,784 2,720 Investment in affiliates, due principally to undistributed earnings of affiliates 256 332 Other 6 15 ------ ------ Total gross deferred tax liabilities 4,239 4,203 ------ ------\nNet deferred tax liability $3,310 3,164 ====== ======\nThe valuation allowance for deferred tax assets as of December 31, 1993 was $126 million. Such balance increased by $4 million from December 31, 1992. Subsequently recognized tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 1993 will be recorded as reductions of franchise costs.\nAt December 31, 1993, the Company had net operating loss carryforwards for income tax purposes aggregating approximately $1,071 million of which, if not utilized to reduce taxable income in future periods, $8 million expires through 1998, $17 million in 2001, $76 million in 2002, $153 million in 2003, $132 million in 2004, $384 million in 2005 and $301 million in 2006. Certain subsidiaries of the Company had additional net operating loss carryforwards for income tax purposes aggregating approximately $368 million and these net operating losses are subject to certain rules limiting their usage.\n(continued)\nII-42 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nAt December 31, 1993, the Company had remaining available investment tax credits of approximately $85 million which, if not utilized to offset future Federal income taxes payable, expire at various dates through 2005. Certain subsidiaries of the Company had additional investment tax credit carryforwards aggregating approximately $55 million and these investment tax credit carryforwards are subject to certain rules limiting their usage.\nCertain of the Federal income tax returns of TCI and its subsidiaries which filed separate income tax returns are presently under examination by the Internal Revenue Service (\"IRS\") for the years 1979 through 1992. In the opinion of management, any additional tax liability, not previously provided for, resulting from these examinations, ultimately determined to be payable, should not have a material adverse effect on the consolidated financial position of the Company. The Company pursued a course of action on certain issues (primarily the deductibility of franchise cost amortization) the IRS had raised and such issues were argued before the United States Tax Court. During 1990, the Company received a favorable decision regarding these issues. The IRS appealed this decision but the Company prevailed in the appeal. The IRS may further appeal the decision to the Supreme Court until March 27, 1994.\nNew tax legislation was enacted in the third quarter of 1993 which, among other matters, increased the corporate Federal income tax rate from 34% to 35%. The Company has reflected the tax rate change in its consolidated statements of operations in accordance with the treatment prescribed by Statement No. 109. Such tax rate change resulted in an increase of $76 million to income tax expense and deferred income tax liability.\n(11) Commitments and Contingencies\nOn October 5, 1992, Congress enacted the 1992 Cable Act. In 1993, the FCC adopted certain rate regulations required by the 1992 Cable Act and imposed a moratorium on certain rate increases. Such rate regulations became effective on September 1, 1993. The rate increase moratorium, which began on April 5, 1993, continues in effect through May 15, 1994. As a result of such actions, the Company's basic and tier service rates and its equipment and installation charges (the \"Regulated Services\") are subject to the jurisdiction of local franchising authorities and the FCC. Basic and tier service rates are evaluated against competitive benchmark rates as published by the FCC, and equipment and installation charges are based on actual costs. Any rates for Regulated Services that exceeded the benchmarks were reduced as required by the 1993 rate regulations. The rate regulations do not apply to the relatively few systems which are subject to \"effective competition\" or to services offered on an individual service basis, such as premium movie and pay-per-view services. Subsequent to September 1, 1993, any cable system charging basic cable rates that exceed the FCC's benchmark rate may be required to substantiate its rates by demonstrating its cost of providing basic cable services to subscribers. If, as a result of this process, a system cannot substantiate its rates, it could be required to retroactively reduce its rates to the appropriate benchmark and refund the excess portion of rates received since September 1, 1993.\n(continued)\nII-43 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nThe Company believes that it has complied in all material respects with the provisions of the 1992 Cable Act, including its rate setting provisions. However, since the Company's rates for regulated services are subject to review, the Company may be subject to a refund liability. The amount of refunds, if any, which could be payable by the Company in the event that systems' rates are successfully challenged by franchising authorities is not currently estimable.\nIn connection with the acquisition from TCI of a 19.9% minority interest in Heritage Communications, Inc. (\"Heritage\") by Comcast, Comcast has the right, through December 31, 1994, to require TCI to purchase or cause to be purchased from Comcast all shares of Heritage directly or indirectly owned by Comcast for either cash or assets or, at TCI's election, shares of TCI common stock. The purchase price of the shares of Heritage directly or indirectly owned by Comcast will be determined by external appraisal.\nThe Company is obligated to pay fees for the license to exhibit certain qualifying films that are released theatrically by various motion picture studios from January 1, 1993 through December 31, 2002 (the \"Film License Obligations\"). The aggregate minimum liability under certain of the license agreements is approximately $105 million. The aggregate amount of the Film License Obligations under other license agreements is not currently estimable because such amount is dependent upon the number of qualifying films produced by the motion picture studios, the amount of United States theatrical film rentals for such qualifying films, and certain other factors. Nevertheless, the Company's aggregate payments under the Film License Obligations could prove to be significant.\nThe Company has guaranteed notes payable and other obligations of affiliated and other companies with outstanding balances of approximately $237 million at December 31, 1993.\nThe Company leases business offices, has entered into pole rental agreements and uses certain equipment under lease arrangements. Minimum rental expense under such arrangements, net of sublease rentals, amounted to $59 million, $57 million and $52 million for 1993, 1992 and 1991, respectively.\nFuture minimum lease payments under noncancellable operating leases for each of the next five years are summarized as follows (amounts in millions):\nIt is expected that, in the normal course of business, expiring leases will be renewed or replaced by leases on other properties; thus, it is anticipated that future minimum lease commitments will not be less than the amount shown for 1994.\n(continued)\nII-44 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(12) Discontinued Operations\nThe Company sold its motion picture theatre business and certain theatre-related real estate assets on May 12, 1992. The selling price (including liabilities assumed) was approximately $680 million. In connection with the disposition, the Company paid $92.5 million for certain preferred stock of the buyer. No gain or loss was recognized in connection with this transaction as the net assets of discontinued operations were reflected at their net realizable value.\nOperating results for the theatre operations for the period from January 1, 1992 through May 12, 1992 and the year ended December 31, 1991 are reported separately in the consolidated statements of operations under the caption \"Loss from discontinued operations\" and include:\n(continued)\nII-45 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(13) Quarterly Financial Information (Unaudited)\n(continued)\nII-46 TELE-COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\nII-47 PART III.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe following lists the directors and executive officers of TCI, their birth dates, a description of their business experience and positions held with the Company as of February 1, 1994. Directors are elected to staggered three-year terms with one-third elected annually. The date the present term of office expires for each director is the date of the Annual Meeting of the Company's stockholders held during the year footnoted opposite their names. All officers are appointed for an indefinite term, serving at the pleasure of the Board of Directors.\n(continued)\nIII-1\n_______________________________\n(1) Director's term expires in 1994. (2) Director's term expires in 1995. (3) Director's term expires in 1996.\n(continued)\nIII-2 In February of 1994, Paul J. O'Brien, a director of the Company since 1968, passed away. Mr. O'Brien was the publisher of the \"Salt Lake Tribune\" and Secretary, Treasurer and a director of Kearns-Tribune Corporation, a newspaper publishing concern. Mr. O'Brien was also Secretary of TCI since 1968.\nThere are no family relations, of first cousin or closer, among the above named individuals, by blood, marriage or adoption, except that Bob Magness and Kim Magness are father and son, respectively.\nDuring the past five years, none of the above persons have had any involvement in such legal proceedings as would be material to an evaluation of his ability or integrity.\nSection 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (\"SEC\"). Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on review of the copies of such forms furnished to the Company, or written representations that no Forms 5 were required, the Company believes that, during the year ended December 31, 1993, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with, except that one report, covering diminimus shareholdings, was incorrectly completed by Mr. Barry P. Marshall, Chief Operating Officer of TCI Cable Management Corporation and such filing was subsequently amended.\nIII-3 Item 11.","section_11":"Item 11. Executive Compensation.\n(a) Summary Compensation Table. The following table shows, for the years ended December 31, 1993, 1992 and 1991 all forms of compensation (other than Other Annual Compensation and All Other Compensation, amounts for which are only reported for the years ended December 31, 1993 and 1992), for the Chief Executive Officer and each of the four most highly compensated executive officers of the Company, whose total annual salary and bonus exceeded $100,000 for the year ended December 31, 1993:\n____________________\n(1) Includes deferred compensation of $150,000.\n(2) Includes deferred compensation of $188,000 and $31,333 in 1993 and 1992, respectively.\n(3) Includes deferred compensation of $250,000 and $41,667 in 1993 and 1992, respectively.\n(4) Includes amounts reimbursed during the year for the payment of taxes.\n(5) For additional information regarding this award, see Option\/SAR Grants Table below.\n(continued)\nIII-4 (6) On November 11, 1992, pursuant to the Company's 1992 Stock Incentive Plan (the \"Plan\"), certain executive officers and other key employees were granted 4,020,000 options in tandem with stock appreciation rights to acquire share of TCI Class A common stock at a purchase price of $16.75 per share. Such options vest and become exercisable evenly over 5 years, first became exercisable beginning on November 11, 1993 and expire on November 11, 2002. Notwithstanding the vesting schedule as set forth in the option agreement, the option shares shall become available for purchase if grantee's employment with the Company (a) shall terminate by reason of (i) termination by the Company without cause (ii) termination by grantee for good reason (as defined in the agreement) or (iii) disability, (b) shall terminate pursuant to provisions of a written employment agreement, if any, between the grantee and the Company which expressly permits the grantee to terminate such employment upon occurrence of specified events (other than the giving of notice and passage of time), or (c) if grantee dies while employed by the Company. Further, the option shares will become available for purchase in the event of an Approved Transaction, Board Change or Control Purchase (each as defined in the Plan), unless in the case of an Approved Transaction, the Compensation Committee under the circumstances specified in the Plan determines otherwise.\n(7) Includes dollar value of annual Company contributions to the TCI Employee Stock Purchase Plan (\"ESPP\") in which all named executive officers are fully vested. Directors who are not employees of the Company are ineligible to participate in the ESPP. The ESPP, a defined contribution plan, enables participating employees to acquire a proprietary interest in the Company and benefits upon retirement. Under the terms of the ESPP, employees are eligible for participation after one year of service. The ESPP's normal retirement age is 65 years. Participants may contribute up to 10% of their compensation and the Company (by annual resolution of the Board of Directors) may contribute up to 100% of the participants' contributions. The ESPP includes a salary deferral feature in respect of employee contributions. Forfeitures (due to participants' withdrawal prior to full vesting) are used to reduce the Company's otherwise determined contributions. Generally, participants acquire a vested right in TCI contributions as follows:\nParticipant contributions are fully vested. Although TCI has not expressed an intent to terminate the ESPP, it may do so at any time. The ESPP provides for full and immediate vesting of all participants rights upon termination.\n(8) Includes fees paid to directors for attendance at each meeting of the Board of Directors ($500 per meeting).\n(continued)\nIII-5 (b) Option\/SAR Grants Table. The following table shows all individual grants of stock options and stock appreciation rights (\"SARs\") granted to each of the named executive officers during the year ended December 31, 1993:\n_________________________\n(1) On October 12, 1993, pursuant to the Plan, certain executive officers and other key employees were granted 1,355,000 options in tandem with stock appreciation rights to acquire shares of TCI Class A common stock at a purchase price of $16.75 per share. On November 12, 1993, an additional grant of stock options in tandem with stock appreciation rights to purchase an aggregate of 600,000 shares of TCI Class A common stock was made to Messrs. Clouston and Vierra at a purchase price of $16.75 per share. Such options vest evenly over four years, become exercisable beginning on October 12, 1994 and expire on October 12, 2003. Notwithstanding the vesting schedule as set forth in the option agreement, the option shares shall become available for purchase if grantee's employment with the Company (a) shall terminate by reason of (i) termination by the Company without cause (ii) termination by the grantee for good reason (as defined in the agreement) or (iii) disability, (b) shall terminate pursuant to provisions of a written employment agreement, if any, between the grantee and the Company which expressly permits the grantee to terminate such employment upon occurrence of specified events (other than the giving of notice and passage of time), or (c) if grantee dies while employed by the Company. Further, the option shares will become available for purchase in the event of an Approved Transaction, Board Change or Control Purchase (each as defined in the Plan), unless in the case of an Approved Transaction, the Compensation Committee under the circumstances specified in the Plan determines otherwise.\n(2) Represents the closing market price per share of TCI Class A common stock on November 12, 1993.\n(3) The values shown are based on the Black-Scholes model and are stated in current annualized dollars on a present value basis. The key assumptions used in the model for purposes of this calculation include the following: (a) a 6.5% discount rate; (b) a volatility factor based upon the Company's historical trading pattern; (c) the 10-year option term; and (d) the closing price of the Company's common stock on March 18, 1994. The actual value an executive may realize will depend upon the extent to which the stock price exceeds the exercise price on the date the option is exercised. Accordingly, the value, if any, realized by an executive will not necessarily be the value determined by the model.\nIII-6 (c) Aggregated Option\/SAR Exercises and Fiscal Year-End Option\/SAR Value Table. The following table shows each exercise of stock options and SARs during the year ended December 31, 1993 by each of the named executive officers and the December 31, 1993 year-end value of unexercised options and SARs on an aggregated basis:\n(d) Compensation of directors. The standard arrangement by which the Company's directors are compensated for all services (including any amounts payable for committee participation or special assignments) as a director is as follows: each director receives a fee of $500 plus travel expenses for attendance at each meeting of the Board of Directors and each director who is not a full-time employee of TCI receives additional compensation of $30,000 per year.\nEffective on November 1, 1992, the Company created a deferred compensation plan for all non-employee directors. Each director may elect to defer receipt of all, but not less than all, of the annual compensation (excluding meeting fees and reimbursable expenses) payable to the director for serving on the Company's Board of Directors for each calendar year for which such deferral is elected. An election to defer may be made as to the compensation payable for a single calendar year or period of years. Any compensation deferred shall be credited to the director's account on the last day of the quarter for which compensation has accrued. Such deferred compensation will bear interest from the date credited to the date of payment at a rate of 8% per annum in 1993 and 120% of the applicable federal long-term rate thereafter, compounded annually.\n(continued)\nIII-7 A director may elect payment of deferred compensation to be made at a specified year in the future or upon termination of the director's service as director of the Company. Each director may elect payment in a lump sum, three substantially equal consecutive annual installments or five substantially equal consecutive annual installments. In the event that a director dies prior to payment of all the amounts payable pursuant to the plan, any amounts remaining in the director's deferred compensation account, together with accrued interest thereon, shall be paid to the director's designated beneficiary. Mr. Naify elected to defer his 1993 compensation and elected to defer his 1994 compensation under this plan.\nThere are no other arrangements whereby any of the Company's directors received compensation for services as a director during 1993 in addition to or in lieu of that specified by the aforedescribed standard arrangement.\n(e) Employment Contracts and Termination of Employment and Change of Control Arrangements. Effective November 1, 1992 the employment agreements between the Company and Mr. Magness and Dr. Malone, as amended, were further amended and restated. The term of each agreement is extended daily so that the remainder of the employment term shall at all times on and prior to the effective date of the termination of employment as provided by each agreement be five years. Dr. Malone's and Mr. Magness' employment agreements provide for annual salaries of $800,000. Additionally, these employment agreements provide for personal use of the Company's aircraft and flight crew, limited to an aggregate value of $35,000 per year.\nDr. Malone's employment agreement provides, among other things, for deferral of a portion (40% in 1993 and not in excess of 40% thereafter) of the monthly compensation payable to him. Pursuant to a letter agreement entered into between Dr. Malone and the Company subsequent to the date of his employment agreement, Dr. Malone deferred $150,000 in 1993 in lieu of 40% of his compensation for such year. The deferred amounts will be payable in monthly installments over a 20-year period commencing on the termination of Dr. Malone's employment, together with interest thereon at the rate of 8% per annum compounded annually from the date of deferral to the date of payment. The amendment also provides for the payment of certain benefits, discussed below. Dr. Malone's employment agreement provides that he will devote 80% of his business time to the Company.\nMr. Magness' and Dr. Malone's agreements described above also provide that upon termination of such executive's employment by the Company (other than for cause, as defined in the agreement), or if Bob Magness or Dr. Malone elects to terminate the agreement because of a change in control of the Company, all remaining compensation due under the agreement for the balance of the employment term shall be immediately due and payable.\nDr. Malone's and Mr. Magness' agreements provide that during their employment with the Company and for a period of two years following the effective date of their termination of employment with the Company, unless termination results from a change in control of the Company, they will not be connected with any entity in any manner, as defined in the agreement, which competes in a material respect with the business of the Company, except that Dr. Malone may serve as Chairman of the Board of Liberty. However, the agreements provide that both executives may own securities of any corporation listed on a national securities exchange or quoted in the Nasdaq System to the extent of an aggregate of 5% of the amount of such securities outstanding, but Dr. Malone and Mr. Magness may own securities of Liberty without regard to the aforementioned percentage limitation.\n(continued)\nIII-8 Dr. Malone's agreement also provides that in the event of termination of his employment with the Company, he will be entitled to receive 240 consecutive monthly payments of $15,000 (increased at the rate of 12% per annum compounded annually from January 1, 1988 to the date payment commences), the first of which will be payable on the first day of the month succeeding the termination of Dr. Malone's employment. In the event of Dr. Malone's death, his beneficiaries will be entitled to receive the foregoing monthly payments. The Company currently owns a whole-life insurance policy on Dr. Malone, the face value of which is sufficient to meet its obligation under the salary continuation arrangement. The premiums payable by the Company on such insurance policy are currently being funded through earnings on the policy. Dr. Malone has no interest in this policy.\nThe Company pays a portion of the annual premiums (equal to the \"PS-58\" costs) on three whole-life insurance policies of which Dr. Malone is the insured and trusts for the benefit of members of his family are the owners. The Company is the designated beneficiary of the proceeds of such policies less an amount equal to the greater of the cash surrender value thereof at the time of Dr. Malone's death and the amount of the premiums paid by the policy owners.\nEffective November 1, 1992, the Company entered into an employment agreement with Mr. Sparkman which will expire on December 31, 1997, providing for a salary of $738,000 per year. Mr. Sparkman's employment agreement provides for the deferral of approximately 25.47% of each monthly payment so as to result in the deferral of payment of Mr. Sparkman's salary at the rate of $188,000 per annum. The deferred amounts will be payable in monthly installments over a 120-month period commencing on the later of January 1, 1998 and the termination of Mr. Sparkman's full-time employment with the Company, together with interest thereon at the rate of 8% per annum compounded annually from the date of deferral to the payment date. Additionally, Mr. Sparkman's employment agreement provides for personal use of the Company's aircraft and flight crew, limited to an aggregate value of $35,000 per year.\nEffective November 1, 1992, the Company entered into an employment agreement with Mr. Vierra which will expire on December 31, 1997, providing for a salary of $650,000 per year. Mr. Vierra's employment agreement provides for the deferral of approximately 38.46% of each monthly payment so as to result in the deferral of payment of Mr. Vierra's salary at the rate of $250,000 per annum. The deferred amounts will be paid in monthly installments over a 240-month period commencing on the later of January 1, 1998 and the termination of Mr. Vierra's full-time employment with the Company, together with interest thereon at the rate of 8% per annum compounded annually from the date of deferral to the payment date. Additionally, Mr. Vierra's employment agreement provides for personal use of the Company's aircraft and flight crew, limited to an aggregate value of $35,000 per year.\nMessrs. Sparkman's and Vierra's employment agreements each provide that upon termination by the Company without cause, all remaining compensation due under such agreements for the balance of the employment term would become immediately due and payable to such executive. Upon the death of any such executive during the employment term, the Company will pay to such executive's beneficiaries a lump sum in an amount equal to the lesser of (i) the compensation due under such executive's employment agreement for the balance of the employment term and (ii) one year's compensation. In the event of such executive's disability, the Company will continue to pay such executive his annual salary as and when it would have otherwise become due until the first to occur of the end of the employment term or the date of such executive's death.\n(continued)\nIII-9 The Company will pay Mr. Sparkman 240 consecutive monthly payments of $6,250 (increased at the rate of 12% per annum compounded annually from January 1, 1988) commencing upon the termination of his employment. In the event Mr. Sparkman dies prior to the payment of all monthly payments, the remainder of such payments shall be made to Mr. Sparkman's designated beneficiaries. The Company owns a whole-life insurance policy on Mr. Sparkman, the face value of which is sufficient to meet its obligations under this salary continuation arrangement. The premiums payable by the Company on such insurance policy are currently being funded through earnings on the policies. Mr. Sparkman has no interest in this policy.\nDr. Malone and Mr. Sparkman each deferred a portion of their monthly compensation under their previous employment agreements. Such deferred compensation (together with interest thereon at the rate of 13% per annum compounded annually from the date of deferral to the date of payment) will continue to be payable under the terms of the previous agreements. The rate at which interest accrues on such previously deferred compensation was established in 1983 pursuant to such earlier agreements.\nMessrs. Sparkman's and Vierra's agreements provide that during their employment with the Company and for a period of two years following the effective date of their termination of employment with the Company, they will not be connected with any entity in any manner, as defined in the agreement, which competes in a material respect with the business of the Company. However, the agreements provide that such executives may own securities of any corporation listed on a national securities exchange or quoted in the NASDAQ System to the extent of an aggregate of 5% of the amount of such securities outstanding. If such executives terminate employment with the Company prior to the expiration of each respective employment term or if the Company terminates each executive's employment for cause, as defined in the agreements, then the noncompetition clause of the agreements shall apply to the longer of the previously described two year period or the period beginning on the effective date of termination of employment through December 31, 1997.\n(f) Additional information with respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions.\nThe members of the Company's compensation committee during 1993 were Messrs. Robert A. Naify and Paul J. O'Brien, both directors of the Company. Mr. O'Brien was also Secretary of the Company. Except as described above, neither Mr. Naify nor Mr. O'Brien are or were officers of the Company or any of its subsidiaries. However, Mr. Naify was the President and Co-Chief Executive Officer of UACI from 1971 to 1986, the year in which TCI acquired a majority interest in UACI. After the acquisition, Mr. Naify resigned, but by the terms of his 1983 employment agreement with UACI, he continued to be entitled to consulting payments of a fixed amount and certain fringe benefits from UACI and its successors through August of 1993. Following the death of Mr. O'Brien in 1994, Mr. Gallivan, a director of the Company, was appointed to fill the vacancy.\nIII-10 Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) Security ownership of certain beneficial owners. The following table sets forth information with respect to the ownership of shares of the Company's Class A and Class B common stock, as of February 1, 1994, by each person known to the Company to own beneficially more than 5% of either class based on 402,504,309 shares of Class A common stock and 47,258,787 shares of Class B common stock outstanding on that date. Shares issuable upon exercise or conversion of convertible securities are deemed to be outstanding for the purpose of computing the percentage of ownership and overall voting power of persons beneficially owning such convertible securities, but have not been deemed to be outstanding for the purpose of computing the percentage ownership or overall voting power of any other person. So far as is known to the Company, the persons indicated below have sole voting and investment power with respect to the shares indicated as owned by them except as otherwise stated in the notes to the table. The Class A common stock has one vote per share and the Class B common stock has ten votes per share.\n- --------------------\n* Less than one percent.\n(continued)\nIII-11 (1) Bob Magness, as executor of the Estate of Betsy Magness, is the beneficial owner of all shares of TCI Class A and Class B common stock held of record by the Estate of Betsy Magness. The number of shares in the table includes 2,105,332 shares of Class A and 6,346,212 shares of Class B common stock of which Bob Magness is beneficial owner as executor. The number of Class A and Class B shares shown as owned by Bob Magness in the table do not include the numbers of such shares owned by Liberty which are set forth separately. Mr. Magness, together with Dr. Malone, (each a director and executive officer of TCI) represent two out of the six members of Liberty's Board of Directors, and accordingly, each of them may be deemed to share voting and investment power over, and to be the beneficial owner of, the shares of the Company's Class A and Class B common stock owned by Liberty. See the table in Section (b) (Beneficial Ownership by Directors and Executive Officers) below and note 11 thereto. If all of the shares owned by Liberty were included in the numbers of shares owned by Mr. Magness, his percentage ownership of the Company's Class A common stock, Class B common stock and overall voting power would be 1.89%, 65.43% and 36.16%, respectively.\n(2) Assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1992 to acquire 1,000,000 shares of TCI Class A common stock. Options to acquire 200,000 shares of TCI Class A common stock are currently exercisable. See note 6 to the table in Item 11(a) for additional information.\n(3) Bob Magness and Kearns-Tribune Corporation (\"Kearns\") are parties to a buy-sell agreement, entered into in October of 1968, as amended, under which neither party may dispose of their shares without notification of the proposed sale to the other, who may then buy such shares at the offered price, sell all of their shares to the other at the offered price or exchange one of their Class A shares for each Class B share held by the other and purchase any remaining Class B shares at the offered price. There are certain exceptions, including transfers to specified persons or entities, certain public sales of Class A shares and exchanges of Class A shares for Class B shares.\n(4) Mr. Robert Naify received notes, which are currently convertible into 22,446,926 shares of TCI Class A common stock, as partial consideration for the sale to TCI of the stock owned by him in United Artists Communications, Inc. (\"UACI\"). Mr. Naify is also a co-trustee, along with Mr. Naify's brother, Marshall, and their sister, of a trust for the benefit of Marshall which holds additional notes convertible into 341,606 shares of TCI Class A common stock. The number of shares in the table assumes the conversion of these notes.\n(5) The number of shares in the table is based upon a Schedule 13G, dated February 9, 1994, filed by The Equitable Life Assurance Society of the United States which Schedule 13G reflects that said corporation has sole voting power over 15,277,835 shares and shared voting power over 772,431 shares of Class A common stock of the Company. No information is given in respect to voting power over the remaining shares.\n(6) The number of shares in the table is based upon a Schedule 13G, dated February 11, 1994, filed by The Capital Group, Inc. Certain operating subsidiaries of The Capital Group, Inc. exercised investment discretion over various institutional accounts which held as of December 31, 1993, 30,472,024 shares of TCI Class A common stock. Capital Guardian Trust Company, a bank, and one of such operating companies, exercised investment discretion over 3,892,102 of said shares. Capital Research and Management Company and Capital International, Ltd., registered investment advisors, and Capital International, S.A., another operating subsidiary, had investment discretion with respect to 26,246,100, 150,675 and 183,147 shares, respectively, of the above shares.\n(continued)\nIII-12 (7) Certain of the shares in the table are held pursuant to an escrow agreement which provides, among other things, for delivery of the deposited shares to TCI upon the exercise by TCI of certain exchange rights with respect to one of the classes of Liberty's preferred stock.\n(b) Security ownership of management. The following table sets forth information with respect to the ownership of shares of the Company's Class A and Class B common stock (other than directors' qualifying shares) as of February 1, 1994 by all directors and each of the named executive officers of the Company, other than those listed in the table in Item 12(a), and by all executive officers and directors of the Company as a group based on 402,504,309 shares of Class A common stock and 47,258,787 shares of Class B common stock outstanding on that date. Shares issuable upon exercise or conversion of convertible securities are deemed to be outstanding for the purpose of computing the percentage ownership and overall voting power of persons beneficially owning such convertible securities, but have not been deemed to be outstanding for the purpose of computing the percentage ownership or overall voting power of any other person. The number of Class A and Class B shares in the table include interests of the named directors or executive officers or of members of the group of directors and executive officers in shares held by the trustee of TCI's ESPP and shares held by the trustee of UAE's Employee Stock Ownership Plan for their respective accounts. So far as is known to the Company, the persons indicated below have sole voting and investment power with respect to the shares indicated as owned by them except as otherwise stated in the notes to the table and except for the shares held by the trustee of TCI's ESPP for the benefit of such person, which shares are voted at the discretion of the trustee.\n* Less than one percent. (continued)\nIII-13 (1) See notes 1 through 4 to the table in Item 12(a).\n(2) Assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1992 to acquire 1,000,000 shares of TCI Class A common stock. Options to acquire 200,000 shares of TCI Class A common stock are currently exercisable. See note 6 to the table in Item 11(a) for additional information.\n(3) The number of Class B shares in the table includes 634,800 shares held by Dr. Malone's wife, Mrs. Leslie Malone, but Dr. Malone has disclaimed any beneficial ownership of such shares. Pursuant to a letter agreement, dated June 17, 1988, Mr. Magness and Kearns each agreed with Dr. Malone that prior to making a disposition of a significant portion of their respective holdings of TCI Class B common stock, he or it would first offer Dr. Malone the opportunity to purchase such shares. See note 3 to the table in Item 12(a).\n(4) Assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1992 to acquire 100,000 shares of TCI Class A common stock. Options to acquire 20,000 shares of TCI Class A common stock are currently exercisable. See note 6 to the table in Item 11(a) for additional information.\n(5) Assumes the exercise in full of stock options, granted in August of 1990, to purchase an aggregate of 9,714 shares of TCI Class A common stock at an adjusted price of $10.30 per share. All such options are fully exercisable. Also assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1992 to acquire 100,000 shares of TCI Class A common stock. Options to acquire 20,000 shares of TCI Class A common stock are currently exercisable. See note 6 to the table in Item 11(a) for additional information. Also assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1993 to acquire 100,000 shares of TCI Class A common stock. None of these options are exercisable until October 12, 1994. See note 1 to the table in Item 11(b) for additional information.\n(6) Assumes the exercise in full of stock options granted in tandem with stock appreciation rights to acquire 2,000,000 shares of TCI Class A common stock. Options to acquire 400,000 shares are currently exercisable. See Item 13(a) for additional discussion.\n(7) Assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1992 to acquire 500,000 shares of TCI Class A common stock. Options to acquire 100,000 shares of TCI Class A common stock are currently exercisable. See note 6 to the table in Item 11(a) for additional information. Additionally, assumes the exercise in full of stock options granted in tandem with stock appreciation rights in November of 1993 to acquire 500,000 shares of TCI Class A common stock. None of the options are exercisable until October 12, 1994. See note 1 to the table in Item 11(b) for additional information.\n(continued)\nIII-14 (8) Certain executive officers of the Company (5 persons) hold options, which were granted in November of 1989, to purchase an aggregate of 43,000 shares of TCI Class A common stock at a purchase price of $17.25 per share. Certain executive officers and directors (11 persons including Messrs. Magness, Malone, Sparkman, Vierra and Clouston) hold stock options which were granted in tandem with stock appreciation rights in November of 1992, to acquire 3,325,000 shares of TCI Class A common stock at a purchase price of $16.75 per share. Options to acquire 665,000 of such shares are currently exercisable. Additional certain executive officers (8 persons including Messrs. Vierra and Clouston) hold stock options which were granted in tandem with stock appreciation rights in October and November of 1993 and become exercisable (as to 25% of the shares covered thereby) in October of 1994, to acquire 1,225,000 shares of TCI Class A common stock at a purchase price of $16.75 per share. Additionally, Mr. Vierra holds an option to acquire 9,714 shares of Class A common stock as described in note 5 above and Mr. Kern holds an option to acquire 2,000,000 shares of Class A common stock as described in note 6 above. The number of TCI Class A shares in the table assumes the exercise of these options.\n(9) The number of shares in the table does not include any shares held by Kearns, of which Mr. Gallivan is an officer.\n(10) The number of Class A and Class B shares shown in the table as owned by the directors and executive officers of the Company as a group include the numbers of such shares owned by Liberty, of which Messrs. Magness and Malone, each a director and an executive officer of the Company, are also directors and of which Dr. Malone is an officer. See the table in Item 12(a) and note 1 thereto. The numbers of Class A and Class B shares shown in the above table as owned by John Malone do not include the shares owned by Liberty although he may be deemed to share voting and investment power over, and to be the beneficial owner of, such shares. If all of the shares of the Company's Class A and Class B common stock owned by Liberty were included in the numbers of shares owned by Dr. Malone, the percentage ownership of the Company's Class A common stock, Class B common stock and voting power of Dr. Malone would 1.03%, 9.40% and 5.54%, respectively.\nNo equity securities in any subsidiary of the Company, other than directors' qualifying shares, are owned by any of the Company's executive officers or directors, except that Mr. Bob Magness, a director and an executive officer of the Company, owns 944 shares of WestMarc Series B cumulative compounding redeemable preferred stock, including 40 shares owned by KGBB, Inc. over which Bob Magness is deemed to have shared voting and investment power; Mr. Kim Magness, a director of the Company, owns 29 shares of WestMarc Series B cumulative compounding redeemable preferred stock (excluding his indirect interest in such shares owned by KGBB, Inc.); Dr. Malone, a director and an executive officer of the Company, owns, as trustee for his children, 68 shares of WestMarc Series B cumulative compounding redeemable preferred stock; Mr. Larry Romrell, an officer of the Company, owns 103 shares of WestMarc Series B cumulative compounding redeemable preferred stock and Mr. Jerome Kern, a director of the Company, owns 116 shares of WestMarc Series B cumulative compounding redeemable preferred stock, including 58 shares owned by his wife, Diane D. Kern, over which Mr. Kern is deemed to have beneficial ownership. Mr. Kern has disclaimed any beneficial ownership of such shares owned by Diane D. Kern. Mr. Donne Fisher, a director and executive officer of the Company, pursuant to a Restricted Stock Award Agreement dated December 10, 1992, was transferred the right, title and interest in and to 124.03 shares (having a liquidation value of $4 million) of WestMarc Series B cumulative compounding redeemable preferred stock owned by the Company. Such preferred stock held by Mr. Fisher is subject to forfeiture in the event of certain circumstances from the date of grant through February 1, 2002, decreasing by 10% on February 1 of each year.\n(continued)\nIII-15 (c) Change of control. The Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company except that on January 27, 1994 the Company and Liberty entered into a definitive agreement to combine the two companies as further described in Item 13","section_13":"Item 13. Certain Relationships and Related Transactions.\n(a) Transactions with management and others.\nAs of January 27, 1994, TCI and Liberty entered into a definitive agreement to combine the two companies. The transaction will be structured as a tax free exchange of Class A and Class B shares of both companies and preferred stock of Liberty for like shares of a newly formed holding company, TCI\/Liberty Holding Company (\"TCI\/Liberty\"). TCI shareholders will receive one share of TCI\/Liberty for each of their shares. Liberty common shareholders will receive 0.975 of a share of TCI\/Liberty for each of their common shares. The transaction is subject to the approval of both sets of shareholders as well as various regulatory approvals and other customary conditions. Subject to timely receipt of such approvals, which cannot be assured, it is anticipated the closing of such transaction will take place during 1994.\nDuring 1992, the Company and Liberty formed Community Cable Television (\"CCT\"), a general partnership created for the purpose of acquiring and operating cable television systems with Tele-Communications of Colorado, Inc. (\"TCIC\"), an indirect wholly-owned subsidiary of TCI, owning a 49.999% interest and Liberty Cable Partner, Inc. (\"LCP\"), an indirect wholly-owned subsidiary of Liberty, owning a 50.001% interest. Pursuant to a cable management agreement, a subsidiary of TCI provides management services for cable systems owned by CCT. The subsidiary receives a fee equal to 3% of the gross cable television revenue of CCT. In 1993, CCT paid $1,562,000 under the agreement.\nPursuant to an amendment to the CCT General Partnership Agreement (the \"Amendment\"), certain noncash contributions previously made to CCT were rescinded, TCIC contributed to CCT a $10,590,000 promissory note of TCI Development Corporation (\"TCID\") as of the date of the originally contributed assets, LCP agreed to contribute its equity and debt interests in Daniels & Associates Partners Limited (\"DAPL\"), a general partner of Mile Hi Cablevision Associates, Ltd. (\"Mile Hi\"), to CCT immediately prior to the closing of the acquisition of Mile Hi described below which closed on March 15, 1993, and TCIC agreed to contribute, at the time of the contribution by LCP of its DAPL interests, a TCID promissory note in the amount of $66,900,000.\nOn March 12, 1993, the CCT General Partnership Agreement was further amended (the \"Second Amendment\"). Under the Second Amendment, LCP agreed to contribute its Mile Hi partnership interest but not a loan receivable from Mile Hi in the amount of $50 million (including accrued interest) (the \"Mile Hi Note\") (both of which it received upon the liquidation of DAPL on March 12, 1993 as described below) to CCT in exchange for 50.001% of a newly created Class B partnership interest in CCT. TCIC agreed to contribute a $21,795,000 promissory note from TCID in exchange for 49.999% of the Class B partnership interests in place of the $66,900,000 note which was to be contributed under the Amendment. On March 15, 1993, each party made its respective contribution required by the Second Amendment.\n(continued)\nIII-16 On March 26, 1993, TCI Liberty, Inc. (\"TCIL\"), a wholly-owned subsidiary of TCI, TCIC and Liberty entered into a recapitalization agreement (the \"Recapitalization Agreement\"). Pursuant to the Recapitalization Agreement, on June 3, 1993, Liberty repurchased 927,900 shares of Liberty's Class A common stock owned by TCIL (sufficient to reduce TCIL's percentage ownership of Liberty's outstanding common stock by at least 20%), and repurchased all of the outstanding shares of Liberty's Class C Redeemable Exchangeable Preferred Stock (the \"Class C Preferred Stock\") from TCIL. The purchase price per share for the shares of Liberty's Class A common stock of $19.98 was equal to the average of the daily closing prices for the 10 trading days prior to signing of the Recapitalization Agreement and the daily closing prices for the 10 trading days prior to closing. The aggregate purchase price for the Class C Preferred Stock was $175,057,000 plus $337,500 ($22,500 per day from May 19, 1993 to the date of closing of the repurchase). The total purchase price for the shares of Class A common stock and Class C Preferred Stock was to be paid through the delivery of promissory notes of Liberty in the aggregate principal amount of $76,952,000, consisting of a $66,900,000 note and a $10,052,000 note (collectively, the \"Liberty Notes\"), and the balance in cash. The Liberty Notes, which were issued at the closing, bear interest at the rate of 11.6% per annum, are due on February 1, 1997 and are secured by a pledge of stock of LCP and certain other assets of LCP. However, on June 3, 1993, TCIL, TCIC and Liberty agreed that the balance of the purchase price which was to have been paid in cash would instead be payable by delivery of two promissory notes in the principal amount of $86,105,000 and $18,539,442, which bear interest at the rate of 6% per annum, and were to be due on December 31, 1993 (the \"6% Notes\"). In consideration for this amendment, Liberty agreed to transfer to TCIC its interest in \"TV Guide On Screen.\" On November 30, 1993, the parties agreed to extend the maturity of the 6% Notes to the earlier of June 30, 1994 or ten days following the termination of the aforementioned proposed business combination of TCI and Liberty. TCIL acquired the shares of Liberty's Class A common stock upon the conversion on January 15, 1993 of all of the outstanding shares (10,794 shares) of Liberty's Class A Redeemable Convertible Preferred Stock into 4,405,678 shares of Liberty's Class A common stock and 55,070 shares of Class E, 6% Cumulative Redeemable Exchangeable Junior Preferred Stock. Pursuant to the Recapitalization Agreement, TCIL, as the holder of Liberty's Class D Redeemable Voting Preferred Stock, gave its consent to an amendment to Liberty's Restated Certification of Incorporation that would reduce the number of Liberty's directors that the holders of such stock have the exclusive right to elect.\nIn connection with the Recapitalization Agreement, TCIC and LCP entered into an Option-Put Agreement (the \"Option-Put Agreement\"), which was amended on November 30, 1993. Under the amended Option-Put Agreement, between June 30, 1994 and September 28, 1994, and between January 1, 1996 and January 31, 1996, TCIC will have the option to purchase all of LCP's interest in CCT and the Mile Hi Note for an amount equal to $77.0 million plus interest accruing at the rate of 11.6% per annum on such amount from June 3, 1993. Between April 1, 1995 and June 29, 1995, and between January 1, 1997 and January 31, 1997, LCP will have the right to require TCIC to purchase LCP's interest in CCT and the Mile Hi Note for an amount equal to $77.0 million plus interest on such amount accruing at the rate of 11.6% per annum from June 3, 1993.\nUnder a separate agreement, on June 3, 1993, TCI Holdings, Inc. (\"TCIH\"), a wholly-owned subsidiary of TCI, purchased a 16% limited partnership interest in Intermedia Partners from LCP and all of LCP's interest in a special allocation of income and gain of $7 million under the partnership agreement of Intermedia Partners, for a purchase price of approximately $9 million. TCIH also received an option to purchase LCP's remaining 6.37% limited partnership interest in Intermedia Partners prior to December 31, 1995 for a price equal to approximately $4 million plus interest at 8% per annum from June 3, 1993.\n(continued)\nIII-17 On March 15, 1993, Mile Hi Cable Partners, L.P. (\"New Mile Hi\") acquired (the \"Acquisition\") all of the general and limited partnership interests in Mile Hi, the owner of the cable television system serving Denver, Colorado. New Mile Hi is a limited partnership formed among CCT (78% limited partnership interest), Daniels Communications, Inc. (\"DCI\") (1% limited partnership interest) and P & B Johnson Corp. (\"PBJC\") (21% general partnership interest), a corporation controlled by Robert L. Johnson, a member of Liberty's board of directors.\nPrior to the Acquisition, Liberty, through LCP, indirectly owned a 32.175% interest in Mile Hi through its ownership of a limited partnership interest in DAPL, one of Mile Hi's general partners. The other partners in Mile Hi were Time-Warner Entertainment Company, L.P., various individual investors and Mile Hi Cablevision, Inc., a corporation in which all the other partners in Mile Hi were the shareholders.\nDAPL was liquidated on March 12, 1993, at which time LCP received a liquidating distribution consisting of its proportionate interest in DAPL's partnership interest in Mile Hi, representing the 32.175% interest in Mile Hi. LCP also received the Mile Hi Note in the approximate amount of $50 million (including accrued interest) in novation of a loan receivable from DAPL in an equivalent amount.\nThe total value of the Acquisition was approximately $180 million. Of that amount, approximately $70 million was in the form of Mile Hi debt paid at the closing. Another $50 million was in the form of the Mile Hi Note, which debt was assumed by New Mile Hi and then by CCT. In connection with the foregoing assumption, the Mile Hi Note was restated on March 15, 1993 to reflect its principal amount as approximately $50 million which amount includes the interest that had accrued on the Mile Hi Note to such date. The Mile Hi Note, as restated, bears interest from March 15, 1993 at the rate of 8% per annum and principal and interest thereon is payable on January 1, 2000. Of the remaining $60 million, approximately $40 million was paid in cash to partners in Mile Hi in exchange for their partnership interests. The remaining $20 million of interest in Mile Hi was acquired by New Mile Hi through the contribution by Liberty's subsidiary to CCT and by CCT to New Mile Hi of the 32.175% interest in Mile Hi received in the DAPL liquidation and by DCI's contribution to New Mile Hi of a 0.4% interest in Mile Hi.\nOf the estimated $110 million in cash required by New Mile Hi to complete the transaction, $105 million was loaned to New Mile Hi by CCT and $5 million was provided by PBJC as a capital contribution to New Mile Hi. Of the $5 million contributed by PBJC, approximately $4 million was provided by CCT through loans to Mr. Johnson and trusts for the benefit of his children. CCT funded its loans to New Mile Hi and the Johnson interests by drawing down $93 million under its revolving credit facility and by borrowing $16 million from TCI in the form of a subordinated note which bears interest at the rate of 8% per annum and is payable in full on January 1, 2000.\nAt June 3, 1993, Liberty and TCI each had approximately $7,800,000 in outstanding loans to CCT. The loans are evidenced by promissory notes, bear interest at the rate of 12% per annum through December 31, 1992 and 8% per annum thereafter, and are due in full on January 1, 2000. On June 3, 1993, CCT prepaid approximately $3,000,000 to Liberty. The remaining indebtedness between CCT and each of Liberty and TCI will remain outstanding and will be repaid in the ordinary course out of cash flow or partnership borrowings, as permitted by the CCT revolving credit facility. Repayments of this indebtedness will be made in equal amounts between TCI and Liberty and prior to repayment of any advances made by TCI in connection with or subsequent to the closing of the Mile Hi Transaction. In the event that Liberty is no longer a partner, any remaining indebtedness outstanding to Liberty at such time will be repaid by CCT.\n(continued)\nIII-18 Satellite Services, Inc. (\"SSI\"), a wholly-owned subsidiary of TCI, purchases sports and other programming from certain subsidiaries and affiliates of Liberty. Charges to SSI (which are based upon customary rates charged to others) for such programming were $44,074,000 for 1993. Certain subsidiaries and affiliates of Liberty purchase, at TCI's cost plus in some cases an administrative fee of up to 10% of the rates actually charged, certain pay television and other programming through SSI. In addition, a consolidated subsidiary of Liberty pays a commission to TCI for merchandise sales to customers who are subscribers of TCI's cable systems. Aggregate commissions and charges for such programming were $10,650,000 for 1993.\nTCI and Liberty are parties to a services agreement pursuant to which TCI agreed to provide certain financial reporting, tax and other administrative services to Liberty. A subsidiary of Liberty also leases office space and satellite transponder facilities from TCI. Charges by TCI for such services and leases amounted to $1,407,000 for the year ended December 31, 1993.\nIn September, 1993, Encore QE Programming Corp. (\"QEPC\"), a wholly-owned subsidiary of Encore Media Corporation (\"EMC\"), a 90% owned subsidiary of Liberty, entered into a limited partnership agreement with TCI Starz, Inc. (\"TCIS\"), a wholly-owned subsidiary of TCI, for the purpose of developing, operating and distributing STARZ!, a first-run movie premium programming service launched in 1994. QEPC is the general partner and TCIS is the limited partner. Losses are allocated 1% to QEPC and 99% to TCIS. Profits are allocated 1% to QEPC and 99% to TCIS until certain defined criteria are met. Subsequently, profits are allocated 20% to QEPC and 80% to TCIS. TCIS has the option, exercisable at any time and without payment of additional consideration, to convert its limited partner interest to an 80% general partner interest with QEPC's partnership interest simultaneously converting to a 20% limited partnership interest. In addition, during specific periods commencing April 1999 and April 2001, respectively, QEPC may require TCIS to purchase, or TCIS may require QEPC to sell, the partnership interest of QEPC in the partnership for a formula- based price. EMC is paid a management fee equal to 20% of \"managed costs\" as defined, in order to manage the service. During 1993, EMC earned approximately $200,000 in management fees. EMC has agreed to provide the limited partnership with certain programming under a programming agreement whereby the partnership will pay its pro rata share of the total costs incurred by EMC for such programming. In December of 1993, this same limited partnership announced its intention to enter into a joint venture (the \"BET Venture\") with Black Entertainment Television Films, Inc. and Live Ventures, Inc. which would develop, produce and distribute motion pictures targeted primarily to minority audiences. Though no definitive agreement has been reached with respect to the BET Venture, under the proposed structure, each of the parties would own a one-third interest and agree to contribute up to $5 million as a capital contribution.\nDuring 1993, Peachtree Cable TV, Inc. (\"Peachtree\"), a Nevada corporation wholly owned by certain employees of TCI, including Messrs. Thomson, Schotters, Marshall and Bracken (executive officers of TCI), paid $73,553 in management fees to TCI for the operation and management of Peachtree's cable television systems.\nDuring 1993, Mr. Vierra, an executive officer of the Company, was a partner in United International Holdings, a Colorado general partnership (\"UIH\"). An affiliate of the Company and United International Holdings, Inc. (\"UIHI\"), formerly a subsidiary of UIH, each own a 50% partnership interest in United International investments (\"UII\"). On December 31, 1993, UIH was liquidated and all of the shares of UIHI owned by UIH were distributed to UIH's partners. After giving effect to the liquidation of UIH, Mr. Vierra's equity interest in UIHI is less than 5%. UII holds, among other assets, an interest in cable television systems in Israel. The Company, through an affiliate, has provided or has agreed to provide certain guarantees for the benefit of the cable systems in Israel, which guarantee obligations total $4,894,000.\n(continued)\nIII-19 The Company loaned to UIHI the sum of $1 million on June 18, 1992, in connection with UII's acquisition of an interest in a MMDS system being developed in Ireland. Such loan is secured by the MMDS system in Ireland and is due June 30, 1999. Subsequent to the closing, the Company also loaned to UII the sum of $975,000 on an unsecured basis. This note, which it was anticipated would be repaid out of the proceeds of the Malta refinancing (described below) matured on December 31, 1992 and has not yet been repaid in full. UIHI has claimed that, due to exchange losses, the note should be restated at a lesser principal amount. The Company has disputed that position, and the issue is currently under negotiation.\nOn March 5, 1993, UII acquired an interest in a cable television system in Malta (the \"Malta System\") from UIHI and its affiliates. In connection with that acquisition, the Company contributed capital of approximately $2 million to UII for the system in Malta and provided certain guarantees to lenders to the Malta System not to exceed (on a joint and several basis with UIHI) U.S. $5 million. The closing of the UII acquisition and related financing permitted UIHI to repay a bridge loan of $1.5 million which the Company had made to UIHI in 1992. The Company has released its security with respect to that bridge loan. Currently, the Company and UIHI are negotiating with lenders the terms of an additional guarantee requested by them for the Malta System, and the terms of inter-guarantor and inter-shareholder arrangements for reimbursement of any payments under such guarantee.\nAffiliates of the Company and UIHI have also formed a partnership for the joint management of the interests in Israel and Malta.\nThe Company is a partner in a partnership with a subsidiary of U S WEST, Inc. (\"U S WEST\"), which partnership is in turn a partner in a partnership, United Communications International (\"UCI\"), with UIHI. UIHI acquired its partnership interest in UCI from UIH in 1993. UCI's assets consist of cable television systems in Norway, Sweden and Hungary. The systems in Sweden and Norway were originally acquired by UIH or its affiliates from the Company in 1989 and 1990, respectively. The Company and U S WEST contributed funds, through the partnership formed by them in January of 1992, to UCI which in turn advanced funds to NorKabel A\/S (\"NorKabel\"), a Norwegian joint stock company and the holding company for the Norwegian cable interests, to enable NorKabel to repay a Keep Well loan previously made by the Company to NorKabel. UIHI and the Company are continuing to negotiate the amount of post-closing adjustments owed to the Company from the sale of the Swedish interests to UIHI in 1989.\nOn November 12, 1993, the Company granted stock options in tandem with stock appreciation rights to purchase 2,000,000 shares of TCI Class A common stock at a purchase price of $16.75 per share to Jerome H. Kern who, thereafter, became a director of the Company. Twenty percent of such options vested and became exercisable immediately and the remainder become exercisable evenly over 4 years. The options expire October 12, 1998.\nThe Company believes that the foregoing business dealings with management during 1993 were based upon terms no less advantageous to the Company than those which would be available in dealing with unaffiliated persons.\n(b) Certain business relationships\nMr. Jerome H. Kern, a director of TCI, is a partner with the law firm of Baker & Botts, L.L.P., the principal outside counsel for TCI.\nSee also Item 13(a) above.\n(continued)\nIII-20 (c) Indebtedness of management\nOn February 3, 1994, Dr. Malone, an executive officer and director of the Company, borrowed $310,000 from the Company. Such indebtedness bore interest at the Bank of New York prime rate. Dr. Malone repaid such indebtedness, including accrued interest amounting to $1,733, on March 10, 1994.\nSee also Item 13(a) above regarding indebtedness of UIH and Liberty and their respective subsidiaries to the Company.\nIII-21\nPART IV.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) (1) Financial Statements\nIncluded in Part II of this Report: Page No. -------- Independent Auditors' Report II-13\nConsolidated Balance Sheets, December 31, 1993 and 1992 II-14 to II-15\nConsolidated Statements of Operations, Years ended December 31, 1993, 1992 and 1991 II-16\nConsolidated Statements of Stockholders' Equity, Years ended December 31, 1993, 1992 and 1991 II-17\nConsolidated Statements of Cash Flows, Years ended December 31, 1993, 1992 and 1991 II-18 to II-19\nNotes to Consolidated Financial Statements, December 31, 1993, 1992 and 1991 II-20 to II-47\nIV-1 (a) (2) Financial Statement Schedules\nIncluded in Part IV of this Report:\n(i) Financial Statement Schedules required to be filed: Page No. -------- Independent Auditors' Report IV-8\nSchedule II - Amounts Receivable from Related Parties and Employees Other Than Related Parties, Years ended December 31, 1993, 1992 and 1991 IV-9\nSchedule III - Condensed Information as to the Financial Position of the Registrant, December 31, 1993 and 1992; Condensed Information as to the Operations and Cash Flows of the Registrant, Years ended December 31, 1993, 1992 and 1991 IV-10 to IV-12\nSchedule V - Property and Equipment, Years ended December 31, 1993, 1992 and 1991 IV-13\nSchedule VI - Accumulated Depreciation of Property and Equipment, Years ended December 31, 1993, 1992 and 1991 IV-14\nSchedule VII - Guarantees of Securities of Other Issuers, December 31, 1993 IV-15\nSchedule VIII - Valuation and Qualifying Accounts, Years ended December 31, 1993, 1992 and 1991 IV-16\nSchedule IX - Short-Term Borrowings, Years ended December 31, 1993, 1992 and 1991 IV-17\nSchedule X - Supplementary Statement of Operations Information, Years ended December 31, 1993, 1992 and 1991 IV-18\nAll other schedules have been omitted because they are not required or are not applicable, or the required information is set forth in the applicable financial statements or notes thereto.\nIV-2 (a) (3) Exhibits\nListed below are the exhibits which are filed as a part of this Report (according to the number assigned to them in Item 601 of Regulation S-K):\n3 - Articles of Incorporation and Bylaws:\nThe Restated Certificate of Incorporation, dated July 19, 1979, as amended on June 12, 1980, June 18, 1981, June 9, 1983, May 20, 1986, June 12, 1987, January 14, 1988, November 4, 1991, December 2, 1991, December 2, 1991, December 27, 1991, April 3, 1992, February 8, 1993, March 19, 1993 and July 23, 1993.\nThe Bylaws as Amended and Restated July 19, 1979, with amendments April 8, 1980 and October 29, 1987. Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987, as amended by Form 8 amendment dated June 16, 1988. (Commission File No. 0-5550)\n10 - Material Contracts:\nTele-Communications, Inc. 1992 Stock Incentive Option Plan.* Incorporated herein by reference to the Company's definitive Proxy Statement, dated May 21, 1992. (Commission File No. 0-5550)\nRestated and Amended Employment Agreement, dated as of November 1, 1992, between the Company and Bob Magness.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nRestated and Amended Employment Agreement, dated as of November 1, 1992, between the Company and John C. Malone.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of November 1, 1992, between Tele- Communications, Inc. and J. C. Sparkman.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of January 1, 1992, between Tele- Communications, Inc. and Donne F. Fisher.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nRestricted Stock Award Agreement, made as of December 10, 1992, among Tele-Communications, Inc., Donne F. Fisher and WestMarc Communications, Inc.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\n(continued)\nIV-3 Deferred Compensation Plan for Non-Employee Directors, effective on November 1, 1992.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of November 1, 1992 between Tele- Communications, Inc. and Fred A. Vierra.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of September 1, 1983, by and between United Artists Communications, Inc. and Robert A. Naify.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, as amended by Form 8 amendments dated April 7, 1992, April 14, 1992, October 26, 1992, October 27, 1992 and March 2, 1993.\nForm of 1992 Non-Qualifed Stock Option and Stock Appreciation Rights Agreement.*\nForm of 1993 Non-Qualified Stock Option and Stock Appreciation Rights Agreement.*\nNon-Qualifed Stock Option and Stock Appreciation Rights Agreement, dated as of November 12, 1993, by and between Tele-Communications, Inc. and Jerome H. Kern.*\nForm of Indemnification Agreement.*\nQualified Employee Stock Purchase Plan of Tele-Communications, Inc., as amended.* Incorporated herein by reference to the Tele-Communications, Inc. Registration Statement on Form S-8. (Commission File No. 33-59058)\nLetter Agreement dated September 16, 1992, among Tele-Communications, Inc., Time Warner Entertainment Company, L.P., Daniels Communications, Inc., Cablevision Equities III and Liberty of Denver, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated September 24, 1992. (Commission File No. 0-19036)\nLetter of Intent, dated September 16, 1992, among Robert L. Johnson, Tele-Communications, Inc., Liberty of Denver, Inc. and Daniels Communications, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated September 24, 1992. (Commission File No. 0-19036)\nCommunity Cable Television General Partnership Agreement, dated as of January 30, 1992, by and between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated January 12, 1993. (Commission File No. 0-19036)\n(continued)\nIV-4 10- Material Contracts, continued:\nAmendment to Community Cable Television General Partnership Agreement, dated as of December 29, 1992, by and between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated January 12, 1993. (Commission File No. 0-19036)\nSecond Amendment to Community Cable Television General Partnership Agreement, dated March 12, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nAgreement to Purchase and Sell Partnership Interests, dated as of January 29, 1993, among Mile Hi Cable Partners, L.P., Mile Hi Cablevision, Inc., Time Warner Entertainment Company, L.P., Daniels & Associates Partners Limited, Daniels Communications, Inc., Cablevision Associates, Ltd., and John Yelenick and Maria Garcia-Berry, as agents for the limited partners. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nLoan and Security Agreement, dated January 28, 1993, among Community Cable Television and Robert L. Johnson, the Paige Johnson Trust and the Brett Johnson Trust. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nAgreement of Limited Partnership, dated as of January 28, 1993 among P & B Johnson Corp., Community Cable Television and Daniels Communications, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nAssignment and Assumption Agreement, dated December 29, 1992, among Liberty Cable Partner, Inc., Community Cable Television and Intermedia Partners. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nAssignment and Assumption Agreement, dated December 29, 1992, among Liberty Cable Partner, Inc. Community Cable Television and Robin Cable Systems of Tucson. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nRecapitalization Agreement, dated March 26, 1993, among Liberty Media Corporation, TCI Liberty, Inc. and Tele-Communications of Colorado, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\n(continued)\nIV-5 10- Material Contracts, continued:\nAmendment to Recapitalization Agreement, dated June 3, 1993, between Liberty Media Corporation, TCI Liberty and Tele-Communications of Colorado, Inc. $18,539,442 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $66,900,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $10,052,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $86,105,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. Pledge and Security Agreement, dated June 3, 1993, between Liberty Cable Partner, Inc. and Tele-Communications of Colorado, Inc. Stock Pledge and Security Agreement, dated June 3, 1993, between Liberty Capital Corp. and Liberty Cable, Inc., and Tele-Communications of Colorado, Inc. Option-Put Agreement, dated June 3, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Assignment and Assumption Agreement, dated June 3, 1993, between Liberty Cable Partner, Inc. and TCI Holdings, Inc. Option Agreement dated June 3, 1993, between TCI Holdings, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated June 24, 1993 (Commission File No. 0-19036).\nModification of Promissory Note, dated November 30, 1993, between Liberty Media Corporation and Tele-Communications of Colorado, Inc. Modification of Promissory Note, dated November 30, 1993, between Liberty Media Corporation and TCI Liberty, Inc. Amendment to Option-Put Agreement, dated November 30, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-19036).\nAgreement Regarding Purchase and Sales of Partnership Interest, dated as of March 26, 1993, between Liberty Cable Partners, Inc. and TCI Holdings, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nStock Purchase Agreement, dated as of February 18, 1992, among Tele-Communications, Inc., United Artists Entertainment Company, United Artists Holdings, Inc., United Artists Theatre Holding Company, United Artists Cable Holdings, Inc., Oscar I Corporation and Oscar II Corporation. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated February 28, 1992.\n(continued)\nIV-6 Amendment Agreement and Supplement, dated as of May 12, 1992, by and among Tele-Communications, Inc., United Artists Entertainment Company, United Artists Holdings, Inc., United Artists Cable Holdings, Inc., United Artists Theatre Holding Company, Oscar I Corporation and Oscar II Corporation. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated May 19, 1992.\nDistribution Agreement, dated as of December 2, 1992, among Comcast Corporation, Comcast Storer, Inc., SCI Holdings, Inc., Storer Communications, Inc., certain subsidiaries of Storer, Tele-Communications, Inc., TCI Storer, Inc., TKR Storer Limited Partnership, TKR Cable I, Inc., TKR Cable II, Inc. and TKR Cable III, Inc. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nStandstill, Indemnification and Contribution Agreement, made as of November 30, 1992, by and among Tele-Communications, Inc., TCI Storer, Inc., TKR Storer Limited Partnership, Knight-Ridder Cablevision, Inc., Country Cable Co., and SCI Cable Partners. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nTax Sharing Agreement, dated as of December 2, 1992, by and among Storer Communications, Inc., TKR Cable I, Inc., TKR Cable II, Inc., TKR Cable III, Inc., Tele-Communications, Inc., Comcast Corporation and certain subsidiaries of Storer. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nAgreement and Plan of Merger, dated as of January 27, 1994, by and among Tele-Communications, Inc., Liberty Media Corporation, TCI\/Liberty Holding Company, TCI Mergeco, Inc. and Liberty Mergeco, Inc. Incorporated herein by reference to the Company's Current Report on Form 8-K dated February 15, 1994.\n21- Subsidiaries of the Registrant.\n23- Consent of KPMG Peat Marwick.\n*Constitutes management contract or compensatory arrangement.\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1993:\nItem Date of Report Reported Financial Statements Filed -------------- -------- -------------------------- October 26, 1993 Item 5 Liberty Media Corporation: Years ended December 31, 1992, nine months ended December 31, 1991, three months ended March 31, 1991 and year ended December 31, 1991 Six months ended June 30, 1993 and 1992 (unaudited)\nIV-7 INDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Tele-Communications, Inc.:\nUnder date of March 21, 1994, we reported on the consolidated balance sheets of Tele-Communications, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in notes 1 and 10 to the consolidated financial statements, the Company changed its method of accounting for income taxes.\n\/s\/ KPMG PEAT MARWICK KPMG Peat Marwick\nDenver, Colorado March 21, 1994\nIV-8 Schedule II\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nAmounts Receivable from Related Parties and Employees Other Than Related Parties\nYears ended December 31, 1993, 1992 and 1991\n(1) This note receivable is due in 2003 or upon sale of certain property and has no stated interest rate. Interest will be based upon appreciation of the underlying property.\nNote - Amounts include accrued interest on note receivable balances.\nIV-9 Schedule III Page 1 of 3\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nCondensed Information as to the Financial Position of the Registrant\nDecember 31, 1993 and 1992\n*Restated - see notes 1, 3 and 10 to consolidated financial statements.\nIV-10 Schedule III Page 2 of 3\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nCondensed Information as to the Operations of the Registrant\nYears ended December 31, 1993, 1992 and 1991\n*Restated - see notes 1, 3 and 10 to consolidated financial statements.\nIV-11 Schedule III Page 3 of 3\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nCondensed Information as to Cash Flows of the Registrant\nYears ended December 31, 1993, 1992 and 1991\nSee also note 2 to the consolidated financial statements.\nIV-12 Schedule V\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nProperty and Equipment\nYears ended December 31, 1993, 1992 and 1991\n*Restated and Reclassified - see notes 1 and 10 to consolidated financial statements.\nNote - Columns which would have been answered \"none\" have been omitted.\nIV-13 Schedule VI\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nAccumulated Depreciation of Property and Equipment\nYears ended December 31, 1993, 1992 and 1991\n*Restated and Reclassified - see notes 1 and 10 to consolidated financial statements.\n**Amount represents the historical accumulated depreciation of the Storer assets received by the Holding Companies in the Split-Off (see note 4 to the consolidated financial statements).\nIV-14 Schedule VII\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nGuarantees of Securities of Other Issuers\nDecember 31, 1993\nNote - Columns which would have been answered \"none\" have been omitted.\nIV-15 Schedule VIII\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts\nYears ended December 31, 1993, 1992 and 1991\n*Reclassified - see note 1 to consolidated financial statements.\nIV-16 Schedule IX\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nShort-Term Borrowings\nYears ended December 31, 1993, 1992 and 1991\nIV-17 Schedule X\nTELE-COMMUNICATIONS, INC. AND SUBSIDIARIES\nSupplementary Statement of Operations Information\nYears ended December 31, 1993, 1992 and 1991\n*Restated and Reclassified - see notes 1 and 10 to consolidated financial statements.\nIV-18\nSIGNATURES\nPursuant 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.\nTELE-COMMUNICATIONS, INC.\nBy \/s\/ JOHN C. MALONE ------------------------------- John C. Malone President and Chief Executive Officer\nDated: March 25, 1994\nPursuant 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 and on the date indicated.\nIV-19\nEXHIBIT INDEX\nListed below are the exhibits which are filed as a part of this Report (according to the number assigned to them in Item 601 of Regulation S-K):\n3 - Articles of Incorporation and Bylaws:\nThe Restated Certificate of Incorporation, dated July 19, 1979, as amended on June 12, 1980, June 18, 1981, June 9, 1983, May 20, 1986, June 12, 1987, January 14, 1988, November 4, 1991, December 2, 1991, December 2, 1991, December 27, 1991, April 3, 1992, February 8, 1993, March 19, 1993 and July 23, 1993.\nThe Bylaws as Amended and Restated July 19, 1979, with amendments April 8, 1980 and October 29, 1987. Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987, as amended by Form 8 amendment dated June 16, 1988. (Commission File No. 0-5550)\n10 - Material Contracts:\nTele-Communications, Inc. 1992 Stock Incentive Option Plan.* Incorporated herein by reference to the Company's definitive Proxy Statement, dated May 21, 1992. (Commission File No. 0-5550)\nRestated and Amended Employment Agreement, dated as of November 1, 1992, between the Company and Bob Magness.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nRestated and Amended Employment Agreement, dated as of November 1, 1992, between the Company and John C. Malone.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of November 1, 1992, between Tele-Communications, Inc. and J. C. Sparkman.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of January 1, 1992, between Tele-Communications, Inc. and Donne F. Fisher.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nRestricted Stock Award Agreement, made as of December 10, 1992, among Tele-Communications, Inc., Donne F. Fisher and WestMarc Communications, Inc.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992. Deferred Compensation Plan for Non-Employee Directors, effective on November 1, 1992.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of November 1, 1992 between Tele-Communications, Inc. and Fred A. Vierra.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, as amended by Form 10-K\/A (amendment #1) for the year ended December 31, 1992.\nEmployment Agreement, dated as of September 1, 1983, by and between United Artists Communications, Inc. and Robert A. Naify.* Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, as amended by Form 8 amendments dated April 7, 1992, April 14, 1992, October 26, 1992, October 27, 1992 and March 2, 1993.\nForm of 1992 Non-Qualifed Stock Option and Stock Appreciation Rights Agreement.*\nForm of 1993 Non-Qualified Stock Option and Stock Appreciation Rights Agreement.*\nNon-Qualifed Stock Option and Stock Appreciation Rights Agreement, dated as of November 12, 1993, by and between Tele-Communications, Inc. and Jerome H. Kern.*\nForm of Indemnification Agreement.*\nQualified Employee Stock Purchase Plan of Tele-Communications, Inc., as amended.* Incorporated herein by reference to the Tele-Communications, Inc. Registration Statement on Form S-8. (Commission File No. 33-59058)\nLetter Agreement dated September 16, 1992, among Tele-Communications, Inc., Time Warner Entertainment Company, L.P., Daniels Communications, Inc., Cablevision Equities III and Liberty of Denver, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated September 24, 1992. (Commission File No. 0-19036)\nLetter of Intent, dated September 16, 1992, among Robert L. Johnson, Tele-Communications, Inc., Liberty of Denver, Inc. and Daniels Communications, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated September 24, 1992. (Commission File No. 0-19036)\nCommunity Cable Television General Partnership Agreement, dated as of January 30, 1992, by and between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated January 12, 1993. (Commission File No. 0-19036) 10- Material Contracts, continued:\nAmendment to Community Cable Television General Partnership Agreement, dated as of December 29, 1992, by and between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated January 12, 1993. (Commission File No. 0-19036)\nSecond Amendment to Community Cable Television General Partnership Agreement, dated March 12, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nAgreement to Purchase and Sell Partnership Interests, dated as of January 29, 1993, among Mile Hi Cable Partners, L.P., Mile Hi Cablevision, Inc., Time Warner Entertainment Company, L.P., Daniels & Associates Partners Limited, Daniels Communications, Inc., Cablevision Associates, Ltd., and John Yelenick and Maria Garcia-Berry, as agents for the limited partners. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nLoan and Security Agreement, dated January 28, 1993, among Community Cable Television and Robert L. Johnson, the Paige Johnson Trust and the Brett Johnson Trust. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nAgreement of Limited Partnership, dated as of January 28, 1993 among P & B Johnson Corp., Community Cable Television and Daniels Communications, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated March 24, 1993. (Commission File No. 0-19036)\nAssignment and Assumption Agreement, dated December 29, 1992, among Liberty Cable Partner, Inc., Community Cable Television and Intermedia Partners. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nAssignment and Assumption Agreement, dated December 29, 1992, among Liberty Cable Partner, Inc. Community Cable Television and Robin Cable Systems of Tucson. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nRecapitalization Agreement, dated March 26, 1993, among Liberty Media Corporation, TCI Liberty, Inc. and Tele-Communications of Colorado, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\n10- Material Contracts, continued:\nAmendment to Recapitalization Agreement, dated June 3, 1993, between Liberty Media Corporation, TCI Liberty and Tele-Communications of Colorado, Inc. $18,539,442 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $66,900,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $10,052,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. $86,105,000 Promissory Note, dated June 3, 1993, from Liberty Media Corporation to Tele-Communications of Colorado, Inc. Pledge and Security Agreement, dated June 3, 1993, between Liberty Cable Partner, Inc. and Tele-Communications of Colorado, Inc. Stock Pledge and Security Agreement, dated June 3, 1993, between Liberty Capital Corp. and Liberty Cable, Inc., and Tele-Communications of Colorado, Inc. Option-Put Agreement, dated June 3, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Assignment and Assumption Agreement, dated June 3, 1993, between Liberty Cable Partner, Inc. and TCI Holdings, Inc. Option Agreement dated June 3, 1993, between TCI Holdings, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Current Report on Form 8-K, dated June 24, 1993 (Commission File No. 0-19036).\nModification of Promissory Note, dated November 30, 1993, between Liberty Media Corporation and Tele-Communications of Colorado, Inc. Modification of Promissory Note, dated November 30, 1993, between Liberty Media Corporation and TCI Liberty, Inc. Amendment to Option-Put Agreement, dated November 30, 1993, between Tele-Communications of Colorado, Inc. and Liberty Cable Partner, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-19036).\nAgreement Regarding Purchase and Sales of Partnership Interest, dated as of March 26, 1993, between Liberty Cable Partners, Inc. and TCI Holdings, Inc. Incorporated herein by reference to Liberty Media Corporation's Annual Report on Form 10-K for the year ended December 31, 1992. (Commission File No. 0-19036)\nStock Purchase Agreement, dated as of February 18, 1992, among Tele-Communications, Inc., United Artists Entertainment Company, United Artists Holdings, Inc., United Artists Theatre Holding Company, United Artists Cable Holdings, Inc., Oscar I Corporation and Oscar II Corporation. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated February 28, 1992. Amendment Agreement and Supplement, dated as of May 12, 1992, by and among Tele-Communications, Inc., United Artists Entertainment Company, United Artists Holdings, Inc., United Artists Cable Holdings, Inc., United Artists Theatre Holding Company, Oscar I Corporation and Oscar II Corporation. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated May 19, 1992.\nDistribution Agreement, dated as of December 2, 1992, among Comcast Corporation, Comcast Storer, Inc., SCI Holdings, Inc., Storer Communications, Inc., certain subsidiaries of Storer, Tele-Communications, Inc., TCI Storer, Inc., TKR Storer Limited Partnership, TKR Cable I, Inc., TKR Cable II, Inc. and TKR Cable III, Inc. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nStandstill, Indemnification and Contribution Agreement, made as of November 30, 1992, by and among Tele-Communications, Inc., TCI Storer, Inc., TKR Storer Limited Partnership, Knight-Ridder Cablevision, Inc., Country Cable Co., and SCI Cable Partners. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nTax Sharing Agreement, dated as of December 2, 1992, by and among Storer Communications, Inc., TKR Cable I, Inc., TKR Cable II, Inc., TKR Cable III, Inc., Tele-Communications, Inc., Comcast Corporation and certain subsidiaries of Storer. Incorporated herein by reference to the Tele-Communications, Inc. Current Report on Form 8-K, dated December 7, 1992.\nAgreement and Plan of Merger, dated as of January 27, 1994, by and among Tele-Communications, Inc., Liberty Media Corporation, TCI\/Liberty Holding Company, TCI Mergeco, Inc. and Liberty Mergeco, Inc. Incorporated herein by reference to the Company's Current Report on Form 8-K dated February 15, 1994.\n21- Subsidiaries of the Registrant.\n23- Consent of KPMG Peat Marwick.\n*Constitutes management contract or compensatory arrangement.","section_15":""}
{"filename":"37008_1993.txt","cik":"37008","year":"1993","section_1":"ITEM 1. BUSINESS.\nThe registrant is an unincorporated association in the form of a business trust organized in Ohio under a Declaration of Trust dated August 1, 1961, as amended from time to time through July 25, 1986 (the \"Declaration of Trust\"), which has as its principal investment policy the purchase of interests in real estate equities. The registrant qualifies as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code.\nIn order to encourage efficient operation and management of its property, and after receiving a ruling from the Internal Revenue Service with respect to the proposed form of organization and operation, the registrant, in 1971, caused a management company to be organized pursuant to the laws of the State of Delaware under the name First Union Management, Inc. (the \"Management Company\"), to lease property from the registrant and to operate such property for its own account as a separate taxable entity. The registrant presently net leases 30 of its properties to the Management Company. The shares of the Management Company are held in trust, with the shareholders of the registrant, as exist from time to time, as contingent beneficiaries. For financial reporting purposes, the financial statements of the Management Company are combined with those of the registrant.\nThe registrant owns regional enclosed shopping malls, large downtown office buildings and apartment complexes. Its portfolio is diversified by type of property, geographical location, tenant mix and rental market. As of December 31, 1993, the registrant owned (in fee or pursuant to long-term ground leases under which the registrant is lessee) seven office buildings, 15 shopping malls, 50% interests in two shopping malls, six apartment complexes, a 1,100-car parking garage, and a 300-car parking facility, as well as other miscellaneous properties (see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES -Continued\n======= =======\nITEM 2. PROPERTIES - Continued NOTES\n(1) The square footage shown represents gross leasable area for shopping malls and net rentable area for office buildings. The apartments are shown as number of units. The parking garage and parking facility are shown as number of parking spaces.\n(2) Occupancy rates shown are as of December 31, 1993, and are based on the total square feet at each property, except apartments which are based on the number of units.\n(3) The registrant obtained mortgages on the following properties subsequent to acquisition: Wyoming Valley Mall in the amount of $259,000 in 1982; Somerset Lakes Apartments in the amount of $12,000,000 in 1990; Meadows of Catalpa Apartments in the amount of $8,000,000 in 1992; Crossroads Shopping Center (St. Cloud, MN) in the amount of $35,000,000 in 1993; and Huntington Parking Garage in the amount of $9,300,000 in 1993.\n(4) This property has two mortgages. Interest rates are 9.75% and 9.5%. The mortgages mature in 2000 and 2005, respectively. The 9.75% mortgage, in the principal amount of $4,084,000, has a principal repayment for 1994 of $482,000. The 9.5% mortgage, in the principal amount of $182,000, has a principal repayment for 1994 of $10,000.\n(5) The total mall contains 656,000 square feet; the registrant owns 598,000 square feet, the balance being ground leased to Giant Eagle Markets, Inc. The occupancy rate at December 31, 1993 is non-inclusive of Wal-Mart which opened in January 1994. Wal-Mart is currently occupying 126,390 square feet, which increased total mall occupancy to 81% in January 1994.\n(6) The total mall contains 528,000 square feet; the registrant owns 429,000 square feet, the balance being separately ground leased to Boscov Depart- ment Store, Inc.\n(7) This property serves as collateral for borrowings in excess of $30 million on the registrant's $60 million five-year term loan.\n(8) The total mall contains 743,000 square feet; the registrant owns 636,000 square feet, the balance being separately owned by Target Stores.\n(9) The mortgage has a variable interest rate which was 5.63% at December 31, 1993. The interest is tied to LIBOR with a maximum rate of 9.5%. At maturity in 2003, a lump sum payment will be due of approximately $25,682,000.\n(10) The total mall contains 425,000 square feet; the registrant owns 328,000 square feet, the balance being separately owned by an unrelated third party with Sears, Roebuck and Co. as tenant.\n(11) The total mall contains 386,000 square feet; the registrant owns 291,000 square feet, the balance being separately owned by Montgomery Ward & Co., Incorporated.\n(12) Highly competitive market conditions have made leasing space difficult. The registrant continues to seek tenants and alternative retail strategies for this property.\nITEM 2. PROPERTIES - Continued\n(13) The total mall contains 434,000 square feet; the registrant owns 257,000 square feet, the balance being separately owned by Montgomery Ward Development Corporation.\n(14) The property was inundated by a flood which occurred in February 1986. The mall was subsequently rebuilt and re-opened in November 1986. In May 1992, a 60,000 square foot supermarket opened. Additionally, a temporary tenant occupied approximately 70,000 square feet as of December 31, 1993. The Trust is pursuing a mixed use strategy for this former retailing facility.\n(15) The total mall contains 418,000 square feet; the registrant owns 308,000 square feet, the balance being separately ground leased to Sears, Roebuck and Co.\n(16) This mortgage is interest only until maturity in December 1995.\n(17) This property has two mortgages. The interest rate on both mortgages is 10%. The mortgage in the principal amount of $8,000 fully amortizes through maturity in 1994. The mortgage in the principal amount of $2,225,000 is interest only and matures in 1998.\n(18) This property has two mortgages. Interest rates are 8.875% and 9.375%. The mortgages mature in 2005 and 2007, respectively. The 8.875% mortgage, in the principal amount of $930,000, has a principal repayment for 1994 of $51,000. The 9.375% mortgage, in the principal amount of $697,000, has a principal repayment for 1994 of $27,000.\n(19) This property has two mortgages. Interest rates are 8.50% and 9.25%, and both mature in 2000. The 8.50% mortgage, in the principal amount of $1,579,000, has a principal repayment for 1994 of $191,000. The 9.25% mortgage, in the principal amount of $1,345,000, has a principal repayment for 1994 of $105,000.\n(20) Represents a long-term leasehold estate interest which was capitalized in accordance with Statement of Financial Accounting Standards No. 13.\n(21) The registrant has ground leased the land until October 30, 2011, with seven 10-year renewal options.\nITEM 2. PROPERTIES - Continued\nAs of December 31, 1993, the registrant owned in fee its interests in Middletown Mall, Crossroads Center (St. Cloud, Minnesota), Wyoming Valley Mall, Mall 205, Crossroads Mall (Ft. Dodge, Iowa), Westgate Towne Centre, Mountaineer Mall, Plaza 205, Peach Tree Mall, Valley Mall, Fingerlakes Mall, Fairgrounds Square Mall, Wilkes Mall, 55 Public Square Building, Henry C. Beck Building, Landmark Towers, Ninth Street Plaza, Somerset Lakes Apartments, Meadows of Catalpa Apartments, Briarwood Apartments, Woodfield Gardens Apartments, Windgate Place Apartments, Walden Village Apartments, Land - Huntington Building, and the Parking Facility. The registrant holds a leasehold estate or estates, or a fee interest and one or more leasehold estates in North Valley Mall, Valley North Mall, Two Rivers Mall, Kandi Mall, Circle Tower Building, Rockwell Avenue Building, 300 Sixth Avenue Building and the Parking Garage.\nITEM 2. PROPERTIES -Continued RENTALS FROM NET LEASES\nThe following table sets forth the rentals payable to the registrant for the year ended December 31, 1993, under net leases of the properties indicated:\nITEM 2. PROPERTIES -Continued\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Trust has pursued legal action agaist the State of California associated with the 1986 flood of Peach Tree Mall. In September 1991, the court ruled in favor of the Trust on the liability portion of this inverse condemnation suit, which the State of California appealed. The Trust is proceeding with its damage claim. No recognition of potential income has been made in the accompanying financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nMARKET PRICE AND DIVIDEND RECORD.\n\"Market Price and Dividend Record\" presented on the inside front cover of registrant's 1993 Annual Report to Shareholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n\"Selected Financial Data\" presented on pages 18 and 19 of registrant's 1993 Annual Report to Shareholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" presented on pages 30 through 31 of registrant's 1993 Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS.\nThe \"Combined Balance Sheets\" as of December 31, 1993 and 1992, and the \"Combined Statements of Income, Combined Statements of Changes in Cash, Combined Statements of Shareholders' Equity\" for the years ended December 31, 1993, 1992 and 1991, of the registrant, \"Notes to Combined Financial Statements\" and \"Report of Independent Public Accountants\" are presented on pages 20 through 29 of registrant's 1993 Annual Report to Shareholders and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\n(a) DIRECTORS.\n\"Election of Trustees\" presented on pages 1 through 4 of registrant's 1994 Proxy Statement is incorporated herein by reference.\n(b) EXECUTIVE OFFICERS.\nThe above-named executive officers of the registrant hold office at the pleasure of the Trustees of the registrant, and until their successors are chosen and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\n\"Compensation of Trustees\" and \"Executive Compensation\", presented on page 4 and pages 7 through 10, respectively, of registrant's 1994 Proxy Statement are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n\"Security Ownership of Trustees, Officers and Others\" presented on page 6 of registrant's 1994 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\n(1) FINANCIAL STATEMENTS:\nCombined Balance Sheets - December 31, 1993 and 1992 (incorporated by reference to page 20 of registrant's 1993 Annual Report to Shareholders).\nCombined Statements of Income - For the Years Ended December 31, 1993, 1992 and 1991 (incorporated by reference to page 21 of registrant's 1993 Annual Report to Shareholders).\nCombined Statements of Changes in Cash - For the Years Ended December 31, 1993, 1992 and 1991 (incorporated by reference to page 22 of registrant's 1993 Annual Report to Shareholders).\nCombined Statements of Shareholders' Equity - For the Years Ended December 31, 1993, 1992 and 1991 (incorporated by reference to page 23 of registrant's 1993 Annual Report to Shareholders).\nNotes to Combined Financial Statements (incorporated by reference to pages 24 through 28 of registrant's 1993 Annual Report to Shareholders).\nReport of Independent Public Accountants (incorporated by reference to page 29 of registrant's 1993 Annual Report to Shareholders).\n(2) FINANCIAL STATEMENT SCHEDULES:\nReport of Independent Public Accountants on Financial Statement Schedules.\nSCHEDULE IX - Short-Term Borrowings.\nSCHEDULE XI - Real Estate and Accumulated Depreciation.\nSCHEDULE XII - Mortgage Loans on Real Estate.\nAll Schedules, other than IX, XI and XII, are omitted, as the information is not required or is otherwise furnished.\n(b) EXHIBITS.\nExhibit (10)(a) - Share Purchase Agreement dated as of December 31, 1983 between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 2-88719).\nExhibit (10)(b) - First Amendment to Share Purchase Agreement dated as of December 10, 1985 between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-2818).\nExhibit (10)(c) - Second Amendment to Share Purchase Agreement dated as of December 9, 1986 between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-11524).\nExhibit (10)(d) - Third Amendment to Share Purchase Agreement dated as of December 2, 1987 between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-19812).\nExhibit (10)(e) - Fourth Amendment to Share Purchase Agreement dated as of December 7, 1988, between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-26758).\nExhibit (10)(f) - Fifth Amendment to Share Purchase Agreement dated as of November 29, 1989, between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-33279).\nExhibit (10)(g) - Sixth Amendment to Share Purchase Agreement dated as of November 28, 1990, between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-38754).\nExhibit (10)(h) - Seventh Amendment to Share Purchase Agreement dated as of November 27, 1991, between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-45355).\nExhibit (10)(i) - Eighth Amendment to Share Purchase Agreement dated as of November 30, 1992, between registrant and First Union Management, Inc., (incorporated by reference to Registration Statement No. 33-57756).\nExhibit (11) - Statements Re: Computation of Per Share Earnings.\nExhibit (12) - Statements Re: Computation of Ratios.\nExhibit (13) - 1993 Annual Report to Shareholders.\nExhibit (23) - Consent of Independent Public Accountants.\nExhibit (24) - Powers of Attorney.\n(c) REPORTS ON FORM 8-K.\nNone.\nSIGNATURES\nPursuant 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.\nFIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS\nBy: \/S\/James C. Mastandrea _____________________________ James C. Mastandrea, Chairman, President and Chief Executive Officer\nMarch 21, 1994\nPursuant 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 and on the dates indicated.\nSIGNATURE TITLE DATE\nPrincipal Executive Officer Chairman, President March 21, 1994 and Chief Executive Officer \/S\/James C. Mastandrea ________________________ James C. Mastandrea\nPrincipal Financial Officer Executive Vice- March 21, 1994 President and Chief Financial Officer \/S\/Gregory D. Bruhn ________________________ Gregory D. Bruhn\nPrincipal Financial and Senior Vice President- March 21, 1994 Accounting Officer Controller\n\/S\/John J. Dee ________________________ John J. Dee\nTRUSTEES: ) DATE ) *Otes Bennett, Jr. ) ) *William E. Conway ) ) *Allen H. Ford ) ) *Russell R. Gifford ) ) March 21, 1994 *James C. Mastandrea ) ) ) ) ) *By: \/S\/Paul F. Levin ) _________________________________ ) Paul F. Levin, Attorney-in-fact )\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON\nFINANCIAL STATEMENT SCHEDULES\nTo First Union Real Estate Equity and Mortgage Investments:\nWe have audited in accordance with generally accepted auditing standards, the combined financial statements included in the registrant's 1993 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 1, 1994. Our audit was made for the purpose of forming an opinion on those combined statements taken as a whole. The schedules listed under Item 14(a)(2) on page 15 are the responsibility of management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic combined financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic combined financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nCleveland, Ohio, February 1, 1994.\nSCHEDULE IX -----------\nSHORT-TERM BORROWINGS --------------------- (IN THOUSANDS, EXCEPT PERCENTAGES)\nSCHEDULE XI -----------\nREAL ESTATE AND ACCUMULATED DEPRECIATION ---------------------------------------- AS OF DECEMBER 31, 1993 ----------------------- (IN THOUSANDS)\nSCHEDULE XI ----------- - Continued\nThe following is a reconciliation of real estate assets and accumulated depreciation for the years ended December 31, 1993, 1992 and 1991:\nSchedule XII\nMORTGAGE LOANS ON REAL ESTATE AS OF DECEMBER 31, 1993 (IN THOUSANDS, EXCEPT FOR PAYMENT TERMS AND FOOTNOTES)","section_15":""}
{"filename":"38321_1993.txt","cik":"38321","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS:\nFoster Wheeler Corporation was incorporated under the laws of the State of New York in 1900. Executive offices of Foster Wheeler Corporation are at Perryville Corporate Park, Clinton, New Jersey, 08809-4000 (Telephone (908) 730-4000). Except as the context otherwise requires, the term \"Foster Wheeler\" as used herein includes Foster Wheeler Corporation and its subsidiaries.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS:\nIncorporated by reference to Note 16 on page 35 in the Notes to Financial Statements in Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993.\nNARRATIVE DESCRIPTION OF BUSINESS:\nCommencing in 1993, the activities of the Corporation have been redefined to focus on three core business groups covering Engineering and Construction, Energy Equipment and Power Systems. Prior to 1993, the Industrial and Environmental Group was reported as a separate segment. Those companies previously reported within the Industrial and Environmental Group have been reclassified as follows: Glitsch International, Inc. is now considered part of the Energy Equipment Group; Thermacote Welco Company, which was sold in September 1993, Barsotti's Inc. and Ullrich Copper, Inc. are aggregated as part of Corporate and Financial Services. Certain reclassifications have been made to conform prior years' data to the current presentation. These reclassifications had no impact on the previously reported consolidated earnings of the Corporation.\nThe three business groups are: the Engineering and Construction Group that consists primarily of the design, engineering and construction of process plants and fired heaters for oil refineries, synthetic fuels, and chemical producers; the Energy Equipment Group that consists mainly of the design and fabrication of steam generators and condensers, and suppliers of mass-transfer equipment, tower packings and industrial wire mesh; and the Power Systems Group engaged in the owning, leasing to, or operation for third parties of solid waste-to-energy and cogeneration plants. Foster Wheeler markets its services and products through a staff of sales and marketing personnel and through a network of sales representatives. The businesses of its industry groups are not seasonal nor are they dependent on a single customer or a very few customers. No one customer accounts for 10 percent or more of Foster Wheeler's consolidated revenues, although in any given year one customer could contribute significantly to such revenues.\nThe materials used in Foster Wheeler's manufacturing and construction operations are obtained from both domestic and foreign sources. Materials, which consist mainly of steel products and manufactured items, are heavily dependent on foreign sources, particularly on overseas projects.\nGenerally, lead time for delivery of materials does not presently constitute a problem.\nFoster Wheeler owns and licenses patents, trademarks and know-how which are used in each of its industry groups. Such licenses, patents and trademarks are of varying durations. No industry group of the Corporation is materially dependent upon any particular or related group of patents, trademarks or licenses. Foster Wheeler has licensed companies throughout the world to manufacture marine and stationary steam generators and related equipment and certain of its other products. Principal licensees are in Japan, the Netherlands, Italy, Spain, Portugal, Norway and England.\nFor the most part, Foster Wheeler products are custom designed and manufactured and are not produced for inventory. As is the practice in the Engineering and Construction Group and Energy Equipment Group, customers often make a down payment at the time a contract is entered into, and continue to make progress payments until the contract is completed and the work has been accepted as meeting contract guarantees.\nThe Engineering and Construction Group backlog at the end of 1993 was $2.7 billion. Refinery upgrading and reconfiguration projects continue to be the major sources of new orders for the Group with strong markets in the Pacific Rim and the Middle East. The Energy Equipment Group backlog at the end of 1993 was $890.5 million.\nFoster Wheeler had a backlog of firm orders as of December 31, 1993 of $3,884,100,000 as compared to a backlog as of December 25, 1992 of $3,806,800,000. The elapsed time from the award of a contract to completion of performance may be up to four years. The amount of backlog at December 31, 1993 should not necessarily be considered indicative of Foster Wheeler's total revenues for 1994, since contracts may under certain circumstances be accelerated or delayed and new orders booked in 1994 may be billed during that year.\nThe backlog by major industry segments as of December 31, 1993 and December 25, 1992 is as follows:\nThe Power Systems projects consist of the following:\n* Includes Recycling.\nFor waste-to-energy (resource recovery) projects, generally, it takes approximately two to three years from award of a contract and the signing of a service agreement with a community to the beginning of construction.\nMany companies compete in the Engineering and Construction segment of Foster Wheeler's business. Management estimates, based on industrial publications, that it is among the ten largest of the many large and small companies engaged in the design and construction of petroleum refineries and chemical plants. In the manufacture of refinery and chemical plant equipment, neither Foster Wheeler nor any other single company contributes a large percentage of the total volume of such business.\nIn the Energy Equipment Group, Foster Wheeler competes in the United States with three major and a number of smaller manufacturers of coal, oil, and gas-fired steam generating equipment, and, based on a review of trade association materials, it is third largest in this area. Its two major competitors are Combustion Engineering, Inc., a wholly owned subsidiary of ABB Asea Brown Boveri, Ltd.; and Babcock and Wilcox Co., a wholly owned subsidiary of J. Ray McDermott & Co., Inc. It competes in the United States with seven or more manufacturers of condensers, feedwater heaters and heat transfer equipment, and is among the largest of these manufacturers.\nFor the most part, contracts are awarded on the basis of price, delivery, performance and service.\nFoster Wheeler is continually engaged in research and development efforts both in performance and analytical services on current projects and in development of new products and processes. During 1993, approximately $8,350,000, and in 1992 and 1991, $6,900,000 and $7,500,000, respectively, was spent on Foster Wheeler sponsored research activities. During the same periods, approximately $40,850,000, $32,300,000, and $27,200,000, respectively, was spent on customer sponsored research.\nFoster Wheeler and its domestic subsidiaries are subject to certain Federal, state and local environmental, occupation health and product safety laws. Foster Wheeler believes all its operations are in compliance with such laws and does not anticipate any material capital expenditures or adverse effect on earnings in maintaining compliance with such laws.\nFoster Wheeler had approximately 9,350 full-time employees on December 31, 1993. Following is a tabulation of the number of full-time employees of Foster Wheeler in each of its industry segments for the past three years:\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES:\nIncorporated by reference to Note 16 on page 35 in the Notes to Financial Statements in Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nCOMPANY AND (INDUSTRY SEGMENT*)\nCOMPANY AND (INDUSTRY SEGMENT*)\nCOMPANY AND (INDUSTRY SEGMENT*)\nCOMPANY AND (INDUSTRY SEGMENT*)\n(1) Portion leased or subleased to a responsible tenant. (2) Entire facility leased to a responsible tenant, with a portion being subleased back to Foster Wheeler subsidiaries. (3) 50% ownership interest.\nWith the exception of the New York Office of the Corporation, locations of less than 10,000 square feet are not listed. Except as noted above, the properties set forth are held in fee. All or part of listed locations may be leased or subleased to other affiliates. All properties are in good condition and adequate for their intended use.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIncorporated by reference to Note 12 on page 33 in the Notes to Financial Statements in Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNONE\nITEM 4(A) EXECUTIVE OFFICERS OF THE REGISTRANT\nIn accordance with General Instruction G (3) of Form 10-K information regarding executive officers is included in PART I.\nThe executive officers of Foster Wheeler, all of whom have held executive positions with Foster Wheeler or its subsidiaries for more than the past five years, except Messrs. Bartoli, O'Brien and Whittaker, are as follows:\nEach officer holds office for a term running until the Board of Directors meeting next following the Annual Meeting of Stockholders and until his\/her successor is elected and qualified. There are no family relationships between the officers listed above. There are no arrangements or understandings between any of the listed officers and any other person, pursuant to which he\/she was elected as an officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference to Note 11 on page 33 in Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993. The Corporation's common stock is traded on the New York Stock Exchange. The approximate number of stockholders of record as of December 31, 1993 was 8,008.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(In Thousands of Dollars, Except Per Share Data)\n(1) As of the beginning of 1992, the Corporation adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The effect of the accounting change at the beginning of 1992 was a charge to earnings of $91.3 million after tax and valuation allowance which amounted to $2.57 per share.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference to pages 18 to 22 in Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference to the following sections of Foster Wheeler's Annual Report to Stockholders for the year ended December 31, 1993:\nA. Consolidated Balance Sheet, December 31, 1993 and December 25, 1992 (page 23)\nB. Consolidated Statement of Earnings for the years ended December 31, 1993; December 25, 1992; and December 27, 1991 (page 24)\nC. Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 1993; December 25, 1992; and December 27, 1991 (page 25)\nD. Consolidated Statement of Cash Flows for the years ended December 31, 1993; December 25, 1992; and December 27, 1991 (page 26)\nE. Notes to Financial Statements (pages 27-35)\nF. Report of Independent Accountants (page 24)\nSchedules Required by Regulations S-X\nG. Schedule V, Land, Buildings and Equipment (page 23 of Form 10-K)\nH. Schedule VI, Accumulated Depreciation of Buildings and Equipment (page 24 of Form 10-K)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference to pages 2-4 of Foster Wheeler's Proxy Statement, dated March 18, 1994, for the Annual Meeting of Stockholders to be held April 25, 1994. Certain information regarding executive officers is included in Part I in accordance with General Instruction G (3) of Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference to pages 6-12 of Foster Wheeler's Proxy Statement, dated March 18, 1994, for the Annual Meeting of Stockholders to be held April 25, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to pages 2-4 of Foster Wheeler's Proxy Statement, dated March 18, 1994, for the Annual Meeting of Stockholders to be held April 25, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report:\n1 - Financial Statements\nThe index to Financial Statements is incorporated in this paragraph by reference to Item 8, page 14\n2 - Financial Statement Schedules\nSchedule V, Land, Buildings and Equipment, page 23\nSchedule VI, Accumulated Depreciation of Buildings and Equipment,\nAll other schedules and financial statements have been omitted because of the absence of conditions requiring them or because the required information is shown in the financial statements or the notes thereto.\n(b) Reports on Form 8-K:\nThe following reports on Form 8-K have been filed during the period September 25 through December 31, 1993:\nNone\n3 - The following Exhibits are required by Item 601 of Regulation S-K and by paragraph (c) of Item 14 of Form 10-K:\n(2) Not applicable\n(3) By-Laws of Registrant as amended through February 22, 1994 and filed as part of this report.\n(4) Not applicable\n(9) Not applicable\n(10) Not applicable\n(11) Not applicable\n(12) Not applicable\n(13) Except for those portions thereof which are expressly incorporated by reference in this filing, the Financial Section of the Annual Report to Stockholders of Foster Wheeler Corporation (pages 17-35) for the fiscal year ended December 31, 1993 is furnished for the information of the Commission and is not deemed \"filed\" as part of this filing.\n(18) Not applicable\n(21) Subsidiaries of the registrant (pages 18 and 19)\n(22) Not applicable\n(23) See consent of Independent Accountants (page 21)\n(24) Not applicable\n(27) Not applicable\n(28) Not applicable\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 2-91384 (filed May 29, 1984), 33-34694 (filed May 2, 1990) and 33-40878 (filed May 29, 1991):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nEXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT FOSTER WHEELER CORPORATION (PARENT) PRINCIPAL CONSOLIDATED, WHOLLY OWNED SUBSIDIARIES (DIRECTLY OR INDIRECTLY) Listed by Jurisdiction of Organization\nPRINCIPAL AFFILIATED COMPANIES (PERCENT DIRECTLY OR INDIRECTLY OWNED BY FOSTER WHEELER CORPORATION)\nCOLUMBIA Foster Wheeler Andina, S.A., Bogota (19%)\nITALY F.FW Fiatavio Foster Wheeler Per L'Energia, S.p.A., Milan (40%) Software Technology, S.p.A., Milan (90%)\nNIGERIA Foster Wheeler (Nigeria) Ltd., Lagos (60%)\nTURKEY Birlesik Insaat ve Muhendislik, A.S., Istanbul (51%)\nA copy of the By-Laws of the Corporation, as amended through February 22, 1994, is available upon request to the Office of the Secretary, Foster Wheeler Corporation, Perryville Corporate Park, Clinton, New Jersey 08809-4000.\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of Foster Wheeler Corporation on Form S-8 (File No.'s 2- 91384, 33-34694 and 33-40878) of our report dated February 14, 1994, on our audits of the consolidated financial statements of Foster Wheeler Corporation and Subsidiaries as of December 31, 1993 and December 25, 1992, and for each of the three years in the period ended December 31, 1993, which report is incorporated by reference in this Annual Report on Form 10-K.\nCoopers & Lybrand\nNew York, New York March 25, 1994\nREPORT OF INDEPENDENT ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nOur report on the consolidated financial statements of Foster Wheeler Corporation and Subsidiaries has been incorporated by reference in this Form 10-K from page 24 of the 1993 Annual Report to Stockholders of Foster Wheeler Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 15 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCoopers & Lybrand\nNew York, New York February 14, 1994\nFOSTER WHEELER CORPORATION AND SUBSIDIARIES SCHEDULE V LAND, BUILDINGS AND EQUIPMENT THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS OF DOLLARS)\n(a) Exchange translation adjustment. (b) Primarily waste-to-energy and cogeneration facilities under construction by the Power Systems Group.\nFOSTER WHEELER CORPORATION AND SUBSIDIARIES SCHEDULE VI ACCUMULATED DEPRECIATION OF BUILDINGS AND EQUIPMENT THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS OF DOLLARS)\n(a) Exchange translation adjustment.\nSIGNATURES\nPursuant 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.\nFOSTER WHEELER CORPORATION (Registrant)\nDated March 25, 1994 By \/s\/ Jack E. Deones -------------------- ------------------------------ Jack E. Deones Vice President and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed, as of March 25, 1994, by the following persons on behalf of the registrant, in the capacities indicated.\nSignature Title --------- -----\n\/s\/ Louis E. Azzato Director and Chairman --------------------------- Louis E. Azzato (Principal Executive Officer)\n\/s\/ Richard J. Swift Director and President --------------------------- Richard J. Swift (Principal Operating Officer)\n\/s\/ David J. Roberts Executive Vice President - Finance --------------------------- David J. Roberts (Principal Financial Officer)\n\/s\/ George S. White Vice President and Controller --------------------------- George S. White (Principal Accounting Officer)\n\/s\/ Harold E. Kennedy Director and Vice Chairman --------------------------- Harold E. Kennedy\n\/s\/ Leland E. Boren Director --------------------------- Leland E. Boren\nDirector --------------------------- Martha J. Clark\n\/s\/ Kenneth A. DeGhetto Director --------------------------- Kenneth A. DeGhetto\nSignature Title --------- -----\n\/s\/ E. James Ferland Director --------------------------- E. James Ferland\n\/s\/ John A. Hinds Director --------------------------- John A. Hinds\n\/s\/ Joseph J. Melone Director --------------------------- Joseph J. Melone\n\/s\/ Frank E. Perkins Director --------------------------- Frank E. Perkins\n\/s\/ John Timko, Jr. Director --------------------------- John Timko, Jr.\n\/s\/ Charles Y. C. Tse Director --------------------------- Charles Y. C. Tse\n\/s\/ Robert Van Buren Director -------------------------- Robert Van Buren\nEXHIBIT INDEX\nEXHIBIT NUMBER DESCRIPTION ------- ----------- (2) Not applicable\n(3) By-Laws of Registrant as amended through February 22, 1994 and filed as part of this report.\n(4) Not applicable\n(9) Not applicable\n(10) Not applicable\n(11) Not applicable\n(12) Not applicable\n(13) Except for those portions thereof which are expressly incorporated by reference in this filing, the Financial Section of the Annual Report to Stockholders of Foster Wheeler Corporation (pages 17-35) for the fiscal year ended December 31, 1993 is furnished for the information of the Commission and is not deemed \"filed\" as part of this filing.\n(18) Not applicable\n(21) Subsidiaries of the registrant (pages 18 and 19)\n(22) Not applicable\n(23) See consent of Independent Accountants (page 21)\n(24) Not applicable\n(27) Not applicable\n(28) Not applicable","section_15":""}
{"filename":"200155_1993.txt","cik":"200155","year":"1993","section_1":"ITEM 1. BUSINESS.\nINTRODUCTION\nColorado is a Delaware corporation organized in 1927. All of Colorado's outstanding common stock is owned by Coastal Natural Gas, which is a wholly- owned subsidiary of Coastal. Colorado owns and operates an interstate natural gas pipeline system and also has gas and oil exploration and production operations. At December 31, 1993, the Company had 1,129 employees.\nThe revenues and operating profit of the Company by industry segment for each of the three years in the period ended December 31, 1993, and the related identifiable assets as of December 31, 1993, 1992 and 1991, are set forth in Note 12 of Notes to Consolidated Financial Statements included herein.\nNATURAL GAS SYSTEM\nOPERATIONS\nGENERAL\nThe Company is involved in all phases of the production, gathering, processing, transportation, storage and sale of natural gas. Colorado purchases and produces natural gas and makes sales of such gas principally to local gas distribution companies for resale. Separately, Colorado contracts to gather, process, transport and store natural gas owned by third parties.\nColorado's gas transmission system extends from gas production areas in the Texas Panhandle, western Oklahoma and western Kansas, northwesterly through eastern Colorado to the Denver area, and from production areas in Montana, Wyoming and Utah, southeasterly to the Denver area. The Company's gas gathering and processing facilities are located throughout the production areas adjacent to its transmission system. Most of the Company's gathering facilities connect directly to its transmission system, but some gathering systems are connected to other pipelines. The Company also has certain gathering facilities located in New Mexico. Colorado owns four underground gas storage fields; three located in Colorado, and one in Kansas.\nThe Company's principal pipeline facilities at December 31, 1993 consisted of 6,347 miles of pipeline and 65 compressor stations with approximately 346,000 installed horsepower. At December 31, 1993, the design peak day delivery capacity of the transmission system was approximately 2.0 Bcf per day. The underground storage facilities have a working capacity of approximately 29 Bcf per year and a peak day delivery capacity of approximately 769 MMcf.\nGAS SALES, STORAGE AND TRANSPORTATION\nBeginning in October, 1993, Colorado implemented Order 636 on its system and as required by the Order, Colorado's gas sales are now made at \"upstream\" locations (typically the wellhead). Colorado's gas sales contracts extend through September 30, 1996, but provide for reduced customer purchases to be made each year. Under Order 636, Colorado's certificate to sell gas for resale allows sales to be made at negotiated prices and not at prices established by FERC. Colorado is also authorized to abandon all sales for resale at such time as the contracts expire and without prior FERC approval.\nEffective October 1, 1993, Colorado formed an unincorporated Merchant Division to conduct most of the Company's sales activity in the Order 636 environment. The gas sales volumes reported include those sales which continue to be made by Colorado together with those of its Merchant Division.\nEffective October 1, 1993, Colorado assigned an undivided interest in a portion of its company-owned leases (representing approximately 20% of Company owned reserves) to a new subsidiary. The subsidiary has entered into a contract to sell the production to the Company's Merchant Division, which utilizes the gas primarily for its sales to Colorado's traditional customers. The reserve volumes reported represent those interests retained by Colorado together with those assigned to the new subsidiary.\nGas sales revenues were $223 million in 1993, compared to $261 million in 1992. This decrease is due largely to the fact that prior to the mandated restructuring under Order 636 the costs of providing gathering, storage and transportation services for sales customers were recovered as part of the total resale rate and were classified as part of gas sales revenue. Subsequent to restructuring, these costs are now recovered under separate rates for each service.\nColorado has engaged in \"open access\" transportation and storage of gas owned by third parties for several years. In addition, prior to October 1, 1993, Colorado provided storage and transportation services as part of its \"bundled\" sales service. As a result of Order 636, the Company has \"unbundled\" these services from its sales services and will continue to provide these services to third parties under individual contracts. Such services will be at negotiated rates that are within minimum and maximum levels established by the FERC. Also, pursuant to Order 636, the Company, on September 30, 1993, sold all of its working gas except for 3.8 Bcf which it retained for operational needs.\nColorado's deliveries for the years 1993, 1992 and 1991 are as follows:\nGAS GATHERING AND PROCESSING\nPrior to Order 636, the Company gathered and processed gas incident to its \"bundled\" sales service (which also included storage and transportation activities). However, in compliance with the FERC mandated restructuring, Colorado now provides gathering and processing services on an \"unbundled\" or stand-alone basis. The Company contracts for these services under terms which are negotiated. With respect to gathering, the Company is limited to charging rates which are between minimum and maximum levels approved by FERC. Processing terms are not subject to FERC approval, but Colorado is required to provide \"open access\" to its processing facilities.\nColorado has 2,994 miles of gathering lines and 110,500 horsepower of compression in its gathering operations. Colorado owns and operates six gas processing plants which recovered approximately 86 million gallons of liquid hydrocarbons in 1993, compared to 77 million gallons in 1992 and 61 million gallons in 1991, and 4,400 long tons of sulfur in 1993 and 3,600 long tons in both 1992 and 1991. Additionally, in 1993, Colorado processed approximately 12 million gallons of liquid hydrocarbons owned by others compared to 10 million in 1992 and 11 million in 1991. These plants, with a total operating capacity of approximately 697 MMcf daily, recover mainly propane, butanes, natural gasoline, sulfur and other by-products, which are sold to refineries, chemical plants and other customers.\nCOMPETITION\nColorado has historically competed with interstate and intrastate pipeline companies in the sale, storage and transportation of gas and with independent producers, brokers, marketers and other pipelines in the gathering, processing and sale of gas within its service areas. On October 1, 1993, the Company implemented Order 636 on its system. Order 636 also mandated implementation of capacity release and secondary delivery point options allowing a pipeline's firm transportation customers to compete with the pipeline for interruptible transportation, which\nmay result in reduced interruptible transportation revenue of pipelines. Additional information on this subject is included under \"Regulations Affecting Gas System\" included herein.\nNatural gas competes with other forms of energy available to customers, primarily on the basis of price. These competitive forms of energy include electricity, coal, propane and fuel oils. Changes in the availability or price of natural gas or other forms of energy, as well as changes in business conditions, conservation, legislation or governmental regulations, capability to convert to alternate fuels, changes in rate structure, taxes and other factors may affect the demand for natural gas in the areas served by Colorado.\nGAS SYSTEM RESERVES AND AVAILABILITY\nGENERAL\nThe following information about gas system reserves of Colorado and the current and future availability of these reserves is based on data as of December 31, 1993, 1992 and 1991, prepared by Huddleston, Colorado's independent engineers. Based on annual requirements of 109 Bcf, the Company's reserve life index at January 1, 1994 is approximately 12 years. See a further discussion of estimated future sales requirements under \"Gas System Reserves and Availability - - Availability\" included herein.\nRESERVES\nThe table below presents the independent engineers' estimates of the Company's gas system reserves as of December 31, 1993, 1992 and 1991 (Bcf):\nThe estimates of controlled gas reserves include: (a) quantities economically recoverable over the productive life of existing wells and quantities estimated to be recoverable in the future, either from completions in other productive zones of existing wells or from additional wells to be drilled in proven reservoirs currently covered by existing gas purchase contracts and (b) reserves attributable to gas in storage fields. The independent engineers' estimates of reserves are based upon new analyses or upon a review of earlier analyses updated by production and field performance.\nAt December 31, 1993, Colorado maintained under its own account 3 Bcf of natural gas in underground working storage for system balancing and no-notice storage services. The Company has an additional 38 Bcf of base gas in its four owned storage fields.\nAVAILABILITY\nThe table below presents the independent engineers' estimates of the Company's aggregate daily volumes of gas available for sale for the next three years (MMcf):\nThe independent engineers' estimates of the current availability of gas from Colorado's existing controlled gas reserves exceed the anticipated total requirements for 1994 of 272 MMcf per day. The availability of future gas volumes for years 1995 and 1996, including those available volumes from the future development of the non-producing and undeveloped reserves, is greater than the future total requirements of 227 MMcf per day averaged over that time period. Future requirements have been estimated utilizing the projected effects of Order 636 on future sales. Over the remaining life of Colorado's current gas sales contracts (most of which expire October 1, 1996), it is expected that customers will continue to reduce their contractual sales entitlements pursuant to the provisions of Order 636. At this time, however, the magnitude of those conversions cannot be estimated with reasonable certainty. See a further discussion under \"Regulations Affecting Gas System\" included herein.\nThe independent engineers' estimates of gas available for sale in future years are not firm, unconditional projections, but are calculations based on reviews of historical data and estimates of the future availability of gas from contracted gas reserves. In preparing the estimates of gas available for sale, the independent engineers assumed pipeline availability at levels similar to 1993 purchases and did not make projections as to the volumes of gas which Colorado may temporarily release from contract as being in excess of its purchase requirements.\nColorado's ability to supply gas on a daily and annual basis to meet the demands of its customers is subject to limiting factors in addition to the quantities of gas available for sale. Such factors include, but are not limited to, conservation, regulations by governmental agencies, a producer's right to exercise prudent control of operations and maintenance of wells or leases, mechanical operation of equipment, weather, the ability of wells to deliver gas of pipeline quality and pressure, new production technology, unpredictable declines of production, varying peakload demands, availability of alternate fuels, gas storage capacity and pipeline capacity in particular areas.\nRESERVES DEDICATED TO A PARTICULAR CUSTOMER\nColorado is committed to provide gas to Mesa Operating Company, formerly Mesa Operating Limited Partnership (\"Mesa\"), a customer, from specific owned gas reserves in the West Panhandle Field of Texas. Production from this area contributed approximately 46% of Colorado's total supply in 1993. Approximately 68% of those volumes were delivered to Mesa. Under an agreement which was effective January 1, 1991, as amended, Colorado has the right to take a cumulative 23% of the total net production from such reserves for its customers other than Mesa.\nRECONCILIATION WITH FERC FORM 15 REPORT\nThe FERC Form 15 Annual Report of Gas Supplies is no longer required pursuant to FERC Order No. 554 issued July 13, 1993.\nREGULATIONS AFFECTING GAS SYSTEM\nGENERAL\nUnder the NGA, the FERC has jurisdiction over Colorado as to rates and charges for the transportation and storage of natural gas and the construction of new facilities, extension or abandonment of service and facilities, accounts and records, depreciation and amortization policies and certain other matters. In addition, FERC has certificate authority over gas sales for resale in interstate commerce, but under Order 636, had determined that it will not regulate sales rates. Additionally, FERC has asserted rate-regulation (but not certificate regulation) over gathering. Colorado is challenging the FERC's assertion of rate jurisdiction over gathering, but has agreed in a settlement that for three years beginning October 1, 1993, Colorado will post in its tariff the minimum and maximum gathering rates which will be established and approved by FERC. Colorado, where required, holds certificates of public convenience and necessity issued by the FERC covering its jurisdictional facilities, activities and services.\nColorado is also subject to regulation with respect to safety requirements in the design, construction, operation and maintenance of its interstate gas transmission and storage facilities by the Department of Transportation. Operations on United States government land are regulated by the Department of the Interior.\nFERC Order Nos. 500 and 528 allowed regulated pipelines, including Colorado, to recover, through a fixed charge, from 25% to 50% of the cost of payments made to producers to extinguish outstanding claims under existing gas purchase contracts or to secure reformation of existing contracts. Fixed charges are paid by pipeline sales customers without regard to volumes of gas purchased. Under this election, however, an amount equivalent to the amount included in the fixed charge must be borne by the pipeline. Colorado has incurred costs related to contract reformation and settlements of take-or-pay claims, a portion of which have been recovered under Order Nos. 500 and 528.\nOn April 8, 1992, the FERC issued Order No. 636 (\"Order 636\"), which required significant changes in the services provided by interstate natural gas pipelines. The Company and numerous other parties have sought judicial review of aspects of Order 636.\nOn July 2, 1993, the Company submitted to the FERC an unanimous offer of settlement which resolved all the Order 636 restructuring issues which had been raised in its restructuring proceedings. That settlement was ultimately approved (except for minor issues), and the Company's restructured services became effective October 1, 1993. Under that settlement, Colorado has \"unbundled\" its gas sales from its other services. Separate gathering, transportation, storage, no notice transportation and storage and other services are available on a \"stand-alone\" basis to any customers desiring them. Colorado's Order 636 transition costs are not expected to be material and are expected to be recovered through Colorado's rates.\nRATE MATTERS\nUnder the NGA, Colorado continues to be required to file with the FERC to establish or adjust certain of its service rates. The FERC may also initiate proceedings to determine whether Colorado's rates are \"just and reasonable.\"\nOn March 31, 1993, the Company filed at FERC to increase its rates by approximately $26.5 million annually. Such rates (adjusted to reflect the Company's Order 636 program) became effective subject to refund on October 1, 1993.\nCertain regulatory issues remain unresolved among Colorado, its customers, its suppliers, and the FERC. The Company has made provisions which represent management's assessment of the ultimate resolution of these issues. While Colorado estimates the provisions to be adequate to cover potential adverse rulings on these and other issues, it cannot estimate when each of these issues will be resolved.\nGAS AND OIL EXPLORATION AND PRODUCTION\nThe Company has domestic gas and oil production operations. The gas is delivered primarily to Colorado's interstate gas pipeline system while the crude oil and condensate are sold at the wellhead to oil purchasing companies at prevailing market prices. The production of gas and oil is subject to regulation in states in which the Company operates.\nThe following table shows gas, oil and condensate production volumes of the Company, including quantities attributable to its natural gas system, for the three years ended December 31, 1993:\nThe following table summarizes sales price and unit cost information of the Company's exploration and production operations for the three years ended December 31, 1993:\nAt December 31, 1993, the gas and oil properties of the Company included leasehold interests covering 475,622 acres (357,281 net acres), of which 388,012 acres (323,262 net acres) were producing and 87,610 acres (34,019 net acres) were undeveloped. The net producing acreage, held by production, is concentrated principally in Texas (77%), Oklahoma (9%), Wyoming (6%) and Utah (6%). The net undeveloped acreage, not held by production, is principally in Wyoming (42%), Colorado (20%) and Montana (22%).\nThe Company drilled 22 gross (12.53 net) gas wells, 39 gross (34.41 net) gas wells and 24 gross (21.52 net) gas wells in 1993, 1992 and 1991, respectively.\nInformation on Company-owned reserves of oil and gas is included herein under \"Supplemental Information on Oil and Gas Producing Activities (Unaudited)\" in Item 14(a)1 included herein.\nENVIRONMENTAL\nThe Company's operations are subject to extensive federal, state and local environmental laws and regulations which may affect such operations and costs as a result of their effect on the construction and maintenance of its pipeline facilities as well as its gas and oil exploration and production operations. Appropriate governmental authorities may enforce the laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties and remediation requirements. Compliance with all applicable environmental protection laws is not expected to have a material adverse impact on the Company's liquidity or financial position. Future information and developments will require the Company to continually reassess the expected impact of all applicable environmental laws.\nThe Comprehensive Environmental Response, Compensation and Liability Act, also known as \"Superfund\", as reauthorized, imposes liability, without regard to fault or the legality of the original act, for disposal of a \"hazardous substance.\" The Company is not presently, and has not been in the past, a potentially responsible party in any \"Superfund\" waste disposal sites. There are additional areas of environmental remediation responsibilities which may fall upon the Company.\nOTHER DEVELOPMENTS\nColorado owns approximately 20% of Natural Fuels Corporation (\"NFC\") which is headquartered in Denver, Colorado. NFC's business is to develop compressed natural gas (\"CNG\") as an alternative vehicular fuel. Major services provided by NFC include vehicle conversions to CNG, fuel sales, CNG equipment sales, maintenance services, and training. Besides operating a full service conversion center which converts vehicles to CNG, NFC has installed 44 stations in Colorado, 26 of which are open to the public. NFC, in joint partnership with Total Petroleum, installs natural gas refueling facilities at selected Total Petroleum stores along the Colorado Front Range. This project is one of the largest public fueling station development commitments in the United States. As of January 1994, seven\nstations were operational and one was under construction. Also, Colorado is a co-sponsor in the testing of two Colorado Springs buses that are powered by dual-fueled engines modified to run on up to 90% natural gas.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation on properties of Colorado is included in Item 1, \"Business,\" included herein.\nThe real property owned by the Company in fee consists principally of sites for compressor and metering stations and microwave and terminal facilities. With respect to the four owned storage fields, the Company holds title to gas storage rights representing ownership of, or has long-term leases on, various subsurface strata and surface rights and also holds certain additional mineral rights. Under the NGA, the Company may acquire by the exercise of the right of eminent domain, through proceedings in United States District Courts or in state courts, necessary rights-of-way to construct, operate and maintain pipelines and necessary land or other property for compressor and other stations and equipment necessary to the operation of pipelines.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn December 1992, certain of Colorado's natural gas lessors in the West Panhandle Field filed a complaint in the U.S. District Court for the Northern District of Texas, claiming underpayment, breach of fiduciary duty, fraud and negligent misrepresentation. Management believes that Colorado has numerous defenses to the lessors' claims, including (i) that the royalties were properly paid, (ii) that the majority of the claims were released by written agreement, and (iii) that the majority of the claims are barred by the statute of limitations.\nOther lawsuits and other proceedings which have arisen in the ordinary course of business are pending or threatened against Colorado or its subsidiaries.\nAlthough no assurances can be given and no determination can be made at this time as to the outcome of any particular lawsuit or proceeding, the Company believes there are meritorious defenses to substantially all of the above claims and that any liability which may finally be determined should not have a material adverse effect on the Company's consolidated financial position. Additional information regarding legal proceedings is set forth in Notes 3 and 10 of Notes to Consolidated Financial Statements included herein.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll common stock of Colorado is owned by Coastal Natural Gas.\nCertain preferred stock resolutions restrict the payment of dividends on common stock. Under the most restrictive of these provisions, approximately $311.5 million was available for dividends on the common stock of the Company at December 31, 1993. Additional information relating to dividends is set forth under the \"Statement of Consolidated Retained Earnings and Additional Paid-In Capital\" included herein.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data (in thousands of dollars) is derived from the Consolidated Financial Statements included herein and Item 6 of the Company's Annual Report on Form 10-K for the year ended December 31, 1992. The Notes to Consolidated Financial Statements included herein contain information relating to this data.\nAll of the outstanding common stock of Colorado is owned by Coastal Natural Gas; therefore, earnings and cash dividends per common share have no significance and are not presented.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Management's Discussion and Analysis of Financial Condition and Results of Operations is presented on pages through herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Financial Statements and Supplementary Data required hereunder are included in this Annual Report as set forth in Item 14(a) herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe directors and executive officers of Colorado as of March 16, 1994, were as follows:\nThe above named persons bear no family relationship to each other. Their respective terms of office expire coincident with Colorado's Annual Meeting of the Sole Stockholder and Annual Meeting of the Board of Directors to be held in May 1994. Each of the directors and officers named above have been officers or employees of Colorado, ANR Pipeline and\/or Coastal for five years or more except for the following:\nMr. Anderson was elected to the Board of Directors of Colorado in April 1989. He is a General Partner of Anderson Development Associates.\nMr. Coffin was elected a Vice President of Colorado in June 1990. Before joining the Company, he practiced law with the Denver law firms of Holland & Hart from 1986 to 1988 and Brownstein Hyatt Farber & Madden from 1988 to 1990. Prior thereto, he served as Deputy Administrative Assistant to a United States congressman.\nMr. Gillet was elected Vice President of Colorado in July 1993. Prior thereto he served as Vice President of ANR Pipeline Company from 1985 to 1991 and as a Vice President of Coastal States Management Corporation since 1983.\nMr. King was elected to Colorado's Board of Directors in April 1989. Prior thereto, he served in various executive capacities with the Company.\nMr. Ogden was elected to the Board of Directors of Colorado in April 1989. He has been President and General Manager of KCNC-TV, Denver, Colorado since 1983.\nMr. Powers was elected to Colorado's Board of Directors in April 1989. He served as a Colorado State Senator from 1978 through 1988. He currently is a member of the Board of Directors of the Vail National Bank and President of Hanover Realty Corporation.\nMr. Sparger was elected a Vice President of Colorado in June 1992. Before joining the Company, he served in various capacities with Transcontinental Gas Pipe Line Corporation since 1967.\nMr. Tutt was elected to the Board of Directors of Colorado in April 1989. He is Chairman of the Olympic Festival Committee, Chairman Emeritus of the Colorado Springs Sports Corporation, Vice Chairman of the United States Space Foundation and a member of the Boards of Directors of Norwest Bank of Colorado and US West Communications\/Colorado. He has also been past President of the Broadmoor Management Company and past Vice President of the United States Olympic Committee.\nMr. Zuckweiler was elected a Vice President of Colorado in August 1991. He held the position of Director, Transportation and Exchange for the Company from July 1981 to September 1988, at which time he was elected Assistant Vice President.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nColorado is an indirectly wholly-owned subsidiary of Coastal. Information concerning the cash compensation and certain other compensation of directors and officers of Coastal is contained in this section.\nThe following table sets forth information for the fiscal years ended December 31, 1993, 1992 and 1991 as to cash compensation paid by Coastal and its subsidiaries, as well as certain other compensation paid or accrued for those years, to Coastal's Chief Executive Office (\"CEO\") and its four most highly compensated executive officers other than the CEO (the \"Named Executive Officers\"). The table also sets forth the cash compensation paid to James R. Paul, CEO through July 20, 1993, including Long Term Incentive Plan (\"LTIP\") cash compensation.\nSUMMARY COMPENSATION TABLE\n\/(1)\/ Does not include the value of perquisites and other personal benefits because the aggregate amount of such compensation, if any, does not exceed the lesser of $50,000 or 10 percent of annual salary and bonus for any named individual.\n(2) Due to Coastal's practice of paying bi-weekly, there is one extra pay period reflected in the 1992 salary. Normally there are 26 pay periods, but approximately once every 11 years there are 27 pay periods; 1992 was such a year.\n(3) The bonuses shown in the table represent the amount awarded for performance in the year indicated. With the exception of Mr. Burrow, bonuses for 1993 will not be finalized until after preliminary results for the 1994 first quarter are known. These bonuses will be reported in the Coastal Proxy Statement for the 1995 Annual Meeting. Mr. Burrow's bonus was paid in full in 1993. Bonuses for 1992 were paid or are payable in equal installments over a three-year period, provided the employee is still employed on the anniversary date of the award. The 1991 bonuses were payable in equal installments in 1992 and 1993.\n(4) The options do not carry any stock appreciation rights.\n(5) All Other Compensation for 1993 consists of: (i) directors' fees paid by Coastal, ANR and Colorado (O. S. Wyatt, Jr. $66,375; David A. Arledge $18,000; James R. Paul $51,625; James F. Cordes $66,375; Sam F. Willson, Jr. $-0-; and Harold Burrow $56,624); (ii) cash payments for relinquishing certain stock appreciation rights (O. S. Wyatt, Jr. $ -0-; David A. Arledge $5,625; James R. Paul $9,375; James F. Cordes $3,750; Sam F. Willson, Jr. $1,875; and Harold Burrow $-0-); (iii) Coastal contributions to the Coastal Thrift Plan (O. S. Wyatt, Jr. $15,000; David A. Arledge $15,000; James R. Paul $15,000; James F. Cordes $15,000; Sam F. Willson, Jr. $15,000; and Harold Burrow $15,000); and (iv) certain payments in lieu of Thrift Plan contributions (O. S. Wyatt, Jr. $56,690; David A. Arledge $21,417; James R. Paul $-0-; James F. Cordes $29,664; Sam F. Willson, Jr. $11,725; and Harold Burrow $8,409).\nMr. Cordes is employed pursuant to a five-year employment contract expiring in 1995, which provides that if he is terminated for a reason not permitted by the employment contract, he will be entitled to receive for the remainder of the term the salary, employee benefits, perquisites, salary increases, bonuses and other incentive compensation which he would have received had he not been terminated. Such reasons are a significant change in title, duties, authorities or reporting responsibilities, a reduction in salary or benefits or a move of the location of his office to a location not acceptable to him.\nSTOCK OPTIONS\nThe following table sets forth information with respect to stock options granted on November 4, 1993 and December 8, 1993 for the fiscal year ended December 31, 1993 to the Named Executive Officers.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR (1993)\n(1) Options expire ten years from the date of issuance and are granted at the fair market value of the Common Stock of Coastal on the date of grant. Options granted on November 4, 1993 vested in full immediately. Options granted on December 8, 1993, vest in full on the second anniversary of the date of grant.\n(2) Granted November 4, 1993 as a one-time grant for relinquishment of directors fees.\n(3) Granted December 8, 1993.\n(4) The options do not carry any stock appreciation rights. The option information included in the table does not include grants made on March 4, 1993 for the fiscal year ended December 31, 1992 which (except for Mr. Willson) were reported in the Coastal 1993 Proxy Statement. These grants were at $26.06 per share as follows: O. S. Wyatt, Jr. -0-; David A. Arledge 35,000 shares; James R. Paul 40,000 shares; James F. Cordes 25,000 shares; Sam F. Willson, Jr. 15,000 shares; and Harold Burrow -0-.\n(5) Based on the Black-Scholes option pricing model expressed as a ratio (.425 for options granted on November 4, 1993; .399 for options granted on December 8, 1993) x exercise price x number of shares. The actual value, if any, an executive may realize will depend on the excess of the stock price over the exercise price on the date the option is exercised, so that there is no assurance the value realized by an executive will be at or near the value estimated by the Black-Scholes model. The estimated values under that model are based on assumptions that include (i) a stock price volatility of .2786, calculated using monthly stock prices for the three years prior to the grant date, (ii) an interest rate of 6.10%, (iii) a dividend yield of 1.44% and (iv) an option exercise term of ten years. No adjustments were made for the non-transferability of the options or to reflect any risk of forfeiture prior to vesting. The Securities and Exchange Commission requires disclosure of the potential realizable value or present value of each grant. The Company's use of the Black-Scholes model to indicate the present value of each grant is not an endorsement of this valuation, which is based on certain assumptions, including the assumption that the option will be held for the full ten-year term prior to exercise. Studies conducted by the Company's independent consultants indicate that options are usually exercised before the end of the full ten-year term.\nOPTION\/SAR EXERCISES AND HOLDINGS\nThe following table sets forth information with respect to the Named Executive Officers, concerning the exercise of options during the last fiscal year and unexercised options and SARs held as of the fiscal year (\"FY\") ended December 31, 1993.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES (1993)\n(1) $-based on the market price of $28.00 at December 31, 1993.\nPENSION PLAN\nThe following table shows for illustration purposes the estimated annual benefits payable under the Pension Plan and Coastal's Replacement Pension Plan described below upon retirement at age 65 based on the compensation and years of credited service indicated.\nPENSION PLAN TABLE\n(A) Compensation covered under the Pension Plan for Employees of Coastal and the Coastal Replacement Pension Plan generally includes only base salary and is limited to $235,840 for 1993.\n(B) At December 31, 1993 each of the individuals named in the Summary Compensation Table had covered salary of $235,840 and the following years of credited service: Mr. Wyatt, 38 years; Mr. Arledge, 13 years; Mr. Paul, 20 years; Mr. Cordes, 16 years; Mr. Willson, 21 years; and Mr. Burrow, 19 years.\n(C) The normal form of retirement income is a straight life annuity. Benefits payable under the Pension Plan are subject to offset by 1.5% of applicable monthly social security benefits multiplied by the number of years of credited service (up to 33 1\/3 years).\nThe Employee Retirement Income Security Act of 1974, as amended by subsequent legislation, limits the retirement benefits payable under the tax-qualified Pension Plan. Where this occurs, Coastal will provide to certain executives, including persons named in the Summary Compensation Table, additional nonqualified retirement benefits under a Coastal Replacement Pension Plan. These benefits, plus payments under the Pension Plan, will not exceed the maximum amount which Coastal would have been required to provide under the Pension Plan before application of the legislative limitations, and are reflected in the above table.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Security ownership of certain beneficial owners.\nThe following is information, as of March 16, 1994, on each person known or believed by Colorado to be the beneficial owner of 5% or more of any class of its voting securities:\n(b) Security ownership of management.\nColorado is an indirectly wholly-owned subsidiary of Coastal. Information concerning the security ownership of certain beneficial owners and management of Coastal is contained in this section.\nThe total number of shares of stock of Coastal outstanding as of March 16, 1994 is 112,832,796: consisting of 64,403 shares of $1.19 Cumulative Convertible Preferred Stock, Series A (the \"Series A Preferred Stock\"), 87,398 shares of $1.83 Cumulative Convertible Preferred Stock, Series B (the \"Series B Preferred Stock\"), 35,252 shares of $5.00 Cumulative Convertible Preferred Stock, Series C (the \"Series C Preferred Stock\"), and 8,000,000 non-voting shares of $2.125 Cumulative Preferred Stock, Series H (the \"Series H Preferred Stock\"), 104,218,335 shares of Common Stock, and 427,408 shares of Class A Common Stock.\nEach voting share of Common Stock or Preferred Stock entitles the holder to one vote with respect to all matters to come before a shareholders' meeting while each share of Class A Common Stock entitles the holder to 100 votes. However, 25% of Coastal's directors standing for election at each annual meeting will be determined solely by holders of the Common Stock and voting Preferred Stock voting as a class.\nThe following table sets forth information, as of March 16, 1994, with respect to each person known or believed by Coastal to be the beneficial owner, who has or shares voting and\/or investment power (other than as set forth below), of more than five percent (5%) of any class of its voting securities.\n_____________________\n(1) Class includes presently exercisable stock options held by directors and executive officers.\n(2) Includes 7,354 shares of Class A Common Stock owned by the spouse and a son of Mr. Wyatt, as to which shares beneficial ownership is disclaimed.\n(3) The Trustee\/Custodian is the record owner of these shares; and also is the record owner of 969 shares of the Series B Preferred Stock, each of which is convertible into 3.6125 shares of Common Stock and 0.1 share of Class A Common Stock. Voting instructions are requested from each participant in the Thrift Plan and ESOP and from the trustees under a Pension Trust. Absent voting instructions, the Trustee is permitted to vote Thrift Plan shares on any matter, but has no authority to vote ESOP shares or Pension Plan shares. Nor does the Trustee\/Custodian have any authority to dispose of shares except pursuant to instructions of the administrator of the Thrift Plan and ESOP or pursuant to instructions from the trustees under the Pension Trust.\n(4) Members of the DeZurik family acquired the Series C Preferred Stock in connection with a 1972 Agreement of Merger involving the acquisition of Colorado, a subsidiary of Coastal.\nThe following table sets forth information, as of March 16, 1994, regarding each of the then current directors, including Class II directors standing for election, and all directors and executive officers as a group. Each director has furnished the information with respect to age, principal occupation and ownership of shares of stock of Coastal. As of such date, Messrs. Bissell, Burrow, Chapin, Cordes, Gates and Katzin were the Class I directors whose terms expire in 1996; Messrs. Arledge, Brundrett, Wooddy and Wyatt were the Class II directors whose terms expire in 1994; and Messrs. Buck, Johnson, Marshall and McDade were the Class III directors whose terms expire in 1995.\n* Less than one percent unless otherwise indicated. Class includes outstanding shares and presently exercisable stock options held by directors and executive officers. Excluding presently exercisable stock options, directors and executive officers as a group would own 187,501 shares of Class A Common Stock, which would constitute 43.9% of the shares of such class.\n(1) Except for the shares referred to in Notes 2 and 3 below, and the shares represented by presently exercisable stock options, the holders are believed by Coastal to have sole voting and investment power as to the shares indicated. Amounts include shares in Coastal ESOP and Thrift plans, and presently exercisable stock options held by Messrs. Burrow (14,189 shares of Common Stock), Arledge (140,960 shares of Common Stock and 13,412 shares of Class A Common Stock), Cordes (89,786 shares of Common Stock), and Johnson (60,415 shares of Common Stock).\n(2) Includes shares owned by the spouse and a son of Mr. Wyatt (266,295 shares of Common Stock and 7,354 shares of Class A Common Stock), by the spouse of Mr. Burrow (5,000 shares of Common Stock), by the spouse of Mr. Chapin (1,000 shares of Common Stock) and by the spouse of Mr. Katzin (928 shares of Common Stock), as to which shares beneficial ownership is disclaimed; also includes shares owned by the estate of the late Mrs. Marshall (4,362 shares of Common Stock and 100 shares of Class A Common Stock).\n(3) Includes presently exercisable stock options to purchase 629,038 shares of Common Stock and 14,628 shares of Class A Common Stock; also includes 280,239 shares of Common Stock and 7,354 shares of Class A Common Stock owned by spouses and children, as to which shares beneficial ownership is disclaimed; also includes 4,362 shares of Common Stock and 100 shares of Class A Common Stock owned by the estate named in Note 2 above. In addition, one executive officer owns 8 shares of Series B Preferred Stock, each of which is convertible into 3.6125 shares of Common Stock and 0.1 share of Class A Common Stock.\nNo incumbent director is related by blood, marriage or adoption to another director or to any executive officer of Coastal or its subsidiaries or affiliates.\nExcept as hereafter indicated, the above table includes the principal occupation of each of the directors during the past five years. The listed executive officers have held various executive positions with Coastal, ANR, ANR Pipeline and\/or Colorado during the five-year period.\nMr. Bissell is a member of the Boards of Directors of Old Kent Financial Corporation and Batts Inc.\nMr. Cordes is a member of the Boards of Directors of Comerica Inc. and Royal Group, Inc.\nMr. Katzin is a member of the Board of Directors of Qualcomm Incorporated.\nMr. Marshall is a member of the Boards of Directors of Missouri-Kansas-Texas Railroad Company and Presidio Oil Company.\nMr. McDade is a trial lawyer and the founding senior partner of the Houston law firm of McDade & Fogler. Prior to forming McDade & Fogler he was a senior partner in the Houston law firm of Fulbright & Jaworski.\nMessrs. Arledge, Burrow, Cordes and Wyatt are directors of Colorado. Mr. Cordes is a director of ANR Pipeline. Both of these subsidiaries of Coastal are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\").\n(c) Coastal knows of no arrangement which may, at a subsequent date, result in a change in control of Coastal.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a) Transactions with management and others.\nColorado participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing total borrowings from outside sources. At December 31, 1993 the Company had advanced $107.5 million to an associated company at a market rate of interest. Such amount is repayable on demand.\nAdditional information called for by this item is set forth under Item 11, \"Executive Compensation\" and Notes 9 and 13 of Notes to Consolidated Financial Statements included herein.\n(b) Certain business relationships.\nNone.\n(c) Indebtedness of management.\nNone.\n(d) Transactions with promoters.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this Annual Report or incorporated herein by reference:\n1. Financial Statements and Supplemental Information.\nThe following Consolidated Financial Statements of Colorado and Subsidiaries and Supplemental Information are included in response to Item 8 hereof on the attached pages as indicated:\n2. Financial Statement Schedules.\nThe following schedules of Colorado and Subsidiaries are included on the attached pages as indicated:\nSchedules other than those referred to above are omitted as not applicable or not required, or the required information is shown in the Consolidated Financial Statements or Notes thereto.\n3. Exhibits.\n(3.1)+ Certificate of Incorporation of the Company (Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1980).\n(3.2)+ By-laws of the Company (Filed as Module CIGBY-LAWS on March 29, 1994).\n(3.3)+ Certificate of Amendment of Certification of Incorporation of the Company (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989).\n(4) With respect to instruments defining the rights of holders of long-term debt, the Company will furnish to the Securities and Exchange Commission any such document on request.\n(21)* Subsidiaries of the Company.\n(24)* Power of Attorney (included on signature pages herein).\nNote:\n+ Indicates documents incorporated by reference from the prior filing indicated.\n* Indicates documents filed herewith.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the quarter ended December 31, 1993.\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby appoints David A. Arledge, Dan A. Homec and Austin M. O'Toole and each of them, any one of whom may act without the joinder of the others, as his attorney-in-fact to sign on his behalf and in the capacity stated below and to file all amendments to this Annual Report on Form 10-K, which amendment or amendments may make such changes and additions thereto as such attorney-in-fact may deem necessary or appropriate.\nSIGNATURES\nPursuant 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.\nCOLORADO INTERSTATE GAS COMPANY (Registrant)\nBy: JON R. WHITNEY ------------------------------ Jon R. Whitney President March 29, 1994\nPursuant 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 and on the dates indicated.\nBy: HAROLD BURROW ------------------------------ Harold Burrow Chairman of the Board March 29, 1994\nBy: JON R. WHITNEY ------------------------------ Jon R. Whitney President, Chief Executive Officer and Director March 29, 1994\nBy: DAVID A. ARLEDGE ------------------------------ David A. Arledge Principal Financial Officer and Director March 29, 1994\nBy: DAN A. HOMEC ------------------------------ Dan A. Homec Principal Accounting Officer March 29, 1994\n* * *\nBy: RICHARD L. ANDERSON By: ROGER L. OGDEN ------------------------------ ------------------------------ Richard L. Anderson Roger L. Ogden Director Director March 29, 1994 March 29, 1994\nBy: JAMES F. CORDES By: PAUL W. POWERS ------------------------------ ------------------------------ James F. Cordes Paul W. Powers Director Director March 29, 1994 March 29, 1994\nBy: By: WILLIAM B. TUTT ------------------------------ ------------------------------ Peter J. King, Jr. William B. Tutt Director Director March , 1994 March 29, 1994\nBy: REBECCA H. NOECKER By: ------------------------------ ------------------------------ Rebecca H. Noecker O. S. Wyatt, Jr. Director Director March 29, 1994 March , 1994 ---\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Notes to Consolidated Financial Statements contain information that is pertinent to the following analysis.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company uses the following consolidated ratios to measure liquidity and ability to meet future funding needs and debt service requirements.\nThe Company's primary needs for cash are capital expenditures and debt service requirements. Capital expenditures, debt retirements and other cash needs in each of the years 1991 through 1993 and the sources of capital used to finance these expenditures are summarized in the Statement of Consolidated Cash Flows. Management believes the Company's stable financial position and earnings capability will enable it to continue to generate and obtain capital for financing needs in the foreseeable future.\nCash flow from operating activities amounted to $77.6 million in 1993 and $169.1 million in 1992. Prepayments for gas supply and settlement of natural gas contract disputes required investments of $7.1 million in 1993 and $2.4 million in 1992. Liquidity needs were met in 1993 by internally generated funds and a $249.7 million repayment of a note due from an associated company.\nThe Company has adopted a guideline capital expenditure budget of approximately $51.6 million for 1994, a decrease from the capital additions of $72.4 million in 1993. The anticipated decrease in 1994 is the result of a $19.0 million decrease for natural gas projects and a $1.8 million decrease for exploration and production projects. Alternatives to finance capital expenditures and other cash needs are primarily limited by the terms of a Coastal Natural Gas debt instrument. As of December 31, 1993, the Company and certain affiliates could incur approximately $916.8 million of additional indebtedness. For the Company and such affiliates to incur indebtedness for borrowed money in excess of $916.8 million, approximately $400 million of indebtedness under this agreement would need to be retired.\nThe Company participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing borrowings from outside sources. At December 31, 1993, the Company had advanced $107.5 million to an associated company at a market rate of interest. Such amount is repayable on demand.\nThe Company is responding to the extensive changes in the natural gas industry by continuing to take steps to operate its facilities at their maximum efficient capacity, renegotiating many gas purchase contracts to lower its cost of gas and reduce take-or-pay obligations, pursuing innovative marketing strategies and applying strict cost-cutting measures.\nIn 1993, the Company adopted changes in accounting for postretirement benefits as required by FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" See Note 8 of Notes to Consolidated Financial Statements.\nIn 1994, the Company adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This standard covers the accounting for estimated costs of benefits provided to former or inactive employees before their retirement. The effect of this new standard is not expected to have a significant effect on the Company's results of operations or financial position.\nOrder 636, issued in 1992, required significant changes in natural gas pipeline services. See Note 10 of Notes to Consolidated Financial Statements.\nThe Company's operations are subject to extensive federal, state and local environmental laws and regulations which may affect such operations and costs as a result of their effect on the construction and maintenance of its pipeline facilities as well as its gas and oil exploration and production operations. Appropriate governmental authorities may enforce laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties and remediation requirements. Compliance with all applicable environmental protection laws is not expected to have a material adverse impact on the Company's liquidity or financial position. Future information and developments will require the Company to continually reassess the expected impact of all applicable environmental laws.\nThe Comprehensive Environmental Response, Compensation and Liability Act, also known as \"Superfund\", as reauthorized, imposes liability, without regard to fault or the legality of the original act, for disposal of a \"hazardous substance.\" The Company is not presently, and has not been in the past, a potentially responsible party in any \"Superfund\" waste disposal sites. There are additional areas of environmental remediation responsibilities which may fall upon the Company.\nRESULTS OF OPERATIONS\nOPERATING REVENUES\nThe following table reflects the increase (decrease) in operating revenues experienced by segment during the past two years (millions of dollars):\nNATURAL GAS\n1993 Versus 1992. Revenues from natural gas operations increased in 1993 due to the $35 million sale of storage gas inventory pursuant to the implementation of Order 636, increased transportation and gathering revenues of $34 million and increased extracted products revenue of $4 million offset by lower sales prices of $23 million and decreased sales volumes for $15 million.\n1992 Versus 1991. Revenues from natural gas operations increased in 1992 as a result of higher sales volumes for a $10 million increase, a net $16 million increase related to decreased reservations and an outstanding rate related matter and increased transportation and gathering revenues of $5 million offset by lower sales prices of $1 million and other decreases of $3 million.\nThe daily average volumes of natural gas sold were 272 MMcf, 287 MMcf and 278 MMcf for 1993, 1992 and 1991, respectively. However, over the remaining life of Colorado's current gas sales contracts (most of which expire October 1, 1996), it is expected that customers will reduce their contractual sales entitlement pursuant to the provisions of Order 636. At this time, however, the magnitude of those conversions cannot be estimated with reasonable certainty. Transportation volumes increased by 16% in 1993 over the 1992 level and are expected to increase slightly in 1994.\nEXPLORATION AND PRODUCTION\n1993 Versus 1992. Revenues from exploration and production increased in 1993 as natural gas volumes generated a $4 million increase and natural gas prices increased by $1 million, partially offset by decreases of $1 million.\n1992 Versus 1991. Revenues from exploration and production increased in 1992 as natural gas volumes generated a $2 million increase. The prices for natural gas also increased slightly.\nOTHER INCOME - NET\nThe decreases in 1993 and 1992 reflect changes in interest income, primarily from loans to affiliated companies.\nCOST OF GAS SOLD\n1993 Versus 1992. The increase in 1993 was due primarily to increased transportation, gathering and exchange gas costs of $17 million and storage gas costs associated with the sale of storage gas inventory pursuant to Order 636, net of injection\/withdrawals in the amount of $11 million, partially offset by other increases and decreases of $1 million.\n1992 Versus 1991. The increase in 1992 was due primarily to higher average gas purchase rates for $11 million and an increase of $11 million for storage gas due to larger withdrawal levels partially offset by decreased gas purchase volumes for $10 million and other decreases of $2 million.\nOPERATION AND MAINTENANCE\n1993 Versus 1992. Operation and maintenance expenses increased in 1993 due primarily to increased property and production taxes of $3 million, increased professional services of $2 million, increased gas used costs of $2 million and other increases of $1 million.\n1992 Versus 1991. Operation and maintenance expenses increased in 1992 due primarily to an $8 million increase for gas and gas liquids handling and other increases of $2 million.\nDEPRECIATION, DEPLETION AND AMORTIZATION\n1993 Versus 1992. Depreciation, depletion and amortization increased $8 million in 1993 due primarily to an increase in the natural gas segment's depreciable plant and increased production volumes in the exploration and production segment.\n1992 Versus 1991. Depreciation, depletion and amortization increased $4 million in 1992 due primarily to an increase in the natural gas segment's depreciable plant and increased production volumes in the exploration and production segment.\nOPERATING PROFIT\nThe following table reflects the increase (decrease) in operating profit experienced by segment during the past two years (millions of dollars):\nNATURAL GAS\n1993 Versus 1992. The natural gas segment's operating profit decrease in 1993 is due to increased gas related costs of $27 million, increased operation and maintenance expenses of $6 million, increased depreciation, depletion and amortization expenses of $6 million and other increases of $3 million partially offset by increased operating revenues of $35 million.\n1992 Versus 1991. The natural gas segment's operating profit increase in 1992 is due to increased operating revenues of $27 million partially offset by increased gas related costs of $12 million, increased operation and maintenance expenses of $9 million and increased depreciation, depletion and amortization expenses of $3 million.\nEXPLORATION AND PRODUCTION\n1993 Versus 1992. The exploration and production segment's operating profit was unchanged from 1992 as increased revenues of $4 million were offset by increases of $2 million for operation and maintenance expenses and $2 million for depreciation, depletion and amortization.\n1992 Versus 1991. The exploration and production segment's operating profit was unchanged from 1991 as increased revenues of $2 million were offset by increases of $1 million for operation and maintenance expenses and $1 million for depreciation, depletion and amortization.\nINTEREST EXPENSE\nThe slight decrease in 1993 is primarily due to lower average debt outstanding partially offset by increases in other financial expenses. The decrease in 1992 is primarily due to decreased interest expense related to rate refund provisions and lower average debt outstanding.\nTAXES ON INCOME\nIncome taxes fluctuated primarily as a result of changing levels of income before taxes and changes in the effective income tax rate. The effective federal income tax rate for the Company was 32% in 1993, 32% in 1992 and 33% in 1991.\nThe Omnibus Budget Reconciliation Act of 1993 enacted in August 1993 included, among other things, an increase in the corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. In September 1993, the Company recorded a change in its deferred income tax balances reflecting this change in corporate federal income tax rates. The cumulative impact of the tax rate increase did not materially affect the Company's consolidated earnings and financial position. The Company has mitigated the impact of this tax rate increase in its rates effective October 1, 1993, subject to refund.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Colorado Interstate Gas Company Colorado Springs, Colorado\nWe have audited the accompanying consolidated balance sheets of Colorado Interstate Gas Company (a wholly-owned subsidiary of The Coastal Corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings, retained earnings and additional paid-in capital and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Colorado Interstate Gas Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 8 to the consolidated financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106.\nDELOITTE & TOUCHE\nDenver, Colorado February 3, 1994\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Thousands of Dollars)\nSee Notes to Consolidated Financial Statements.\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Thousands of Dollars)\nSee Notes to Consolidated Financial Statements.\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED EARNINGS (Thousands of Dollars)\nSTATEMENT OF CONSOLIDATED RETAINED EARNINGS AND ADDITIONAL PAID-IN CAPITAL (Thousands of Dollars)\nSee Notes to Consolidated Financial Statements.\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (Thousands of Dollars)\nSee Notes to Consolidated Financial Statements.\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\n- - Basis of Presentation\nColorado is a subsidiary of Coastal Natural Gas, a wholly-owned subsidiary of Coastal. The stock of the Company was contributed by Coastal to Coastal Natural Gas effective April 30, 1982. The financial statements presented herewith are presented on the basis of historical cost and do not reflect the basis of cost to Coastal Natural Gas.\nThe Company is regulated by and subject to the regulations and accounting procedures of the FERC. Colorado meets the criteria and, accordingly, follows the reporting and accounting requirements of FAS No. 71 for regulated enterprises.\n- - Principles of Consolidation\nThe Consolidated Financial Statements include the accounts of the Company and its subsidiaries after eliminating all significant intercompany transactions. The equity method of accounting is used for investments in which the Company has approximately 20% interests and exercises significant influence.\n- - Statement of Cash Flows\nFor purposes of this Statement, cash equivalents include time deposits, certificates of deposit and all highly liquid instruments with original maturities of three months or less. The Company made cash payments for interest, net of amounts capitalized, of $20.3 million, $20.7 million and $29.4 million in 1993, 1992 and 1991, respectively. Cash payments for income taxes amounted to $40.5 million, $22.5 million and $49.6 million in 1993, 1992 and 1991, respectively.\n- - Inventories\nMaterials and supplies inventories are carried principally at average cost. Gas stored underground is carried at last-in, first-out cost (\"LIFO\"), and the current portion is included under the caption \"Current portion of gas stored underground and prepaid expenses.\" At December 31, 1993 there was no current gas stored underground and the carrying value of current gas stored underground was $25.9 million at December 31, 1992. Pursuant to FERC Order 636, on September 30, 1993, the Company sold all of its working gas except for 3.8 Bcf which it was allowed to retain for operational needs. The excess of replacement cost over the carrying value of gas in underground storage carried by the LIFO method, including long-term amounts which are classified as Plant, Property and Equipment, was $52.6 million and $47.8 million at December 31, 1993 and 1992, respectively.\n- - Plant, Property and Equipment\nProperty additions and betterments are capitalized at cost. In accordance with accounting requirements of the FERC, an allowance for equity and borrowed funds used during construction is included in the cost of property additions and betterments. This cost amounted to $1.2 million, $2.4 million and $.7 million in 1993, 1992 and 1991, respectively. All costs incurred in the acquisition, exploration and development of gas and oil properties, including unproductive wells, are capitalized under the full-cost method of accounting.\nThe Company generally provides for depreciation on a straight-line basis, although the unit-of-production method is used for depreciation, depletion and amortization of certain natural gas properties. The average amortization rate per equivalent unit of a thousand cubic feet of gas production for oil and gas properties was $1.00 for the years 1993, 1992 and 1991.\nThe cost of minor property units replaced or retired, net of salvage, is credited to plant accounts and charged to accumulated depreciation, depletion and amortization. Since provisions for depreciation, depletion and amortization expense are made on a composite basis, no adjustments to accumulated depreciation, depletion and amortization are made in connection with retirements or other dispositions occurring in the ordinary course of business. Gain or loss on sales of major property units is credited or charged to income.\n- - Income Taxes\nThe Company follows the liability method of accounting for deferred federal income taxes as required by the provisions of FAS 109 \"Accounting for Income Taxes.\" The Company is a member of a consolidated group which files a consolidated federal income tax return. Members of the consolidated group with taxable income are charged with the amount of income taxes as if they filed separate federal income tax returns, and members providing deductions and credits which result in income tax savings are allocated credits for such savings.\n- - Gain or Loss on Reacquired Debt\nAs required by the FERC, gain or loss on reacquired debt is deferred and amortized over the remaining life of the related long-term indebtedness.\n- - Revenue Recognition\nThe Company recognizes revenues for the sale of their products in the period of delivery. Revenue for services are recognized in the period the services are provided.\n- - Reclassification of Prior Period Statements\nCertain minor reclassifications of prior period statements have been made to conform with current reporting practices. The effect of the reclassifications was not material to the Company's consolidated results of operations or financial position.\nBalances at December 31 were as follows (thousands of dollars):\nThe 9.875% Notes due in 1998 were redeemed in part through the exercise of the doubling option on the annual installment due date of October 1, 1993, and in part through an early redemption at a premium on October 6, 1993. The $8.4 million previously outstanding on the 9% Notes due 1994 were redeemed through the exercise of a doubling option on the November 1, 1993 installment due date.\nThe 10% Series debentures, due 2005, are not redeemable prior to maturity and have no sinking fund provisions.\nThere are no maturities of long-term debt in the next five years.\nAlternatives to finance capital expenditures and other cash needs are primarily limited by the terms of a Coastal Natural Gas debt instrument. As of December 31, 1993, the Company and certain affiliates could incur approximately $916.8 million of additional indebtedness. For the Company and such affiliates to incur indebtedness for borrowed money in excess of $916.8 million, approximately $400 million of indebtedness under this agreement would need to be retired.\n3. Take-or-Pay Obligations\nThe Consolidated Balance Sheet includes assets of $13.2 million and $22.3 million at December 31, 1993 and 1992, respectively, relating to prepayments for gas under gas purchase contracts with producers and settlement payment amounts relative to the restructuring of gas purchase contracts as negotiated with producers. As a result of the implementation of Order 636 on October 1, 1993 (see Note 10 of Notes to Consolidated Financial Statements),\nfuture gas sales will be made at negotiated prices and will not be subject to regulatory price controls. This will not affect the recoverability or the results of pending take-or-pay litigation or any take-or-pay or contractual reformation settlements that the Company may achieve with respect to periods before October 1, 1993. A portion of the costs associated with take-or-pay incurred prior to October 1, 1993, may continue to be recovered pursuant to FERC's Order No. 528.\nA few producers have instituted litigation arising out of take-or-pay claims against the Company. In the Company's experience, producers' claims are generally vastly overstated and do not consider all adjustments provided for in the contract or allowed by law. The Company has resolved the majority of the exposure with its suppliers for approximately 11% of the amounts claimed. At December 31, 1993, the Company estimated that unresolved asserted and unasserted producers' claims amounted to approximately $22.9 million. The remaining disputes will be settled where possible and litigated if settlement is not possible.\nAt December 31, 1993, the Company was committed to make future purchases under certain take-or-pay contracts with fixed, minimum or escalating price provisions. Based on contracts in effect at that date, and before considering reductions provided in the contracts or applicable law, such commitments are estimated to be $1.2 million, $1.0 million, $1.0 million, $.9 million and $.8 million for the years 1994-1998, respectively, and $4.8 million thereafter. Such commitments have not been adjusted for all amounts which may be assigned or released, or for the results of future litigation or negotiation with producers.\nThe Company has made provisions, which it believes are adequate, for payments to producers that may be required for settlement of take-or-pay claims and restructuring of future contractual commitments. In determining the net loss relating to such provisions, the Company has also made accruals for the estimated portion of such payments which would be recoverable pursuant to FERC approved settlements with customers.\n4. Common Stock and Other Stockholders' Equity\nAll of the Company's common stock is owned by Coastal Natural Gas.\nCertain provisions of the preferred stock resolutions restrict the payment of dividends on common stock; however, all $311.5 million of retained earnings were available for dividends on the common stock of the Company at December 31, 1993.\n5. Mandatory Redemption Preferred Stock\nThe Company's Mandatory Redemption Preferred Stock consists of the following:\n5.50% Cumulative Preferred Stock (Third Series) - Of the 150,000 shares authorized and issued, 5,560 were outstanding as of December 31, 1993. The shares are callable at the option of the Company at a price of $100 per share. The sinking fund requirements have annual provisions which will retire all shares of this series on or before July 1, 1997.\nRequired share redemptions during the remaining years are:\nThe outstanding series of the Company's Mandatory Redemption Preferred Stock is a $100 par value, cumulative, non-convertible and non-voting issue. If at any time dividends on the Mandatory Redemption Preferred Stock shall be in arrears in an amount equal to six quarterly dividends, holders of the Mandatory Redemption Preferred Stock, voting as a class, will have the right to elect not less than one-fourth of the Company's Board of Directors until all accrued and unpaid dividends on the Mandatory Redemption Preferred Stock are paid in full. In addition, if at any time dividends shall be in arrears in an aggregate amount equal to eight full quarterly dividends, holders of these securities, voting as a class, will have the right to elect such number of Directors as shall be necessary to constitute a minimum majority of the Board of Directors until all accrued and unpaid dividends on the Mandatory Redemption Preferred Stock are paid in full.\n6. Fair Value of Financial Instruments\nThe estimated fair value amounts of the Company's financial instruments have been determined by the Company, using appropriate market information and valuation methodologies. Considerable judgment is required to develop the estimates of fair value, thus, the estimates provided herein are not necessarily indicative of the amounts that could be realized in a current market exchange.\nThe carrying values of cash and the note receivable from affiliate are reasonable estimates of their fair values. The estimated value of the Company's long-term debt and mandatory redemption preferred stock is based on interest rates at December 31, 1993 and 1992, respectively, for new issues with similar remaining maturities.\n7. Taxes On Income\nProvisions for income taxes are composed of the following (thousands of dollars):\nThe Company and the Internal Revenue Service (\"IRS\") Appeals Office have concluded a tentative settlement of all contested adjustments to federal income tax returns filed for the years 1982 through 1984. The settlement is in the process of being finalized. The Company's federal income tax returns filed for the years 1985 through 1987 have been examined by the IRS, and the Company has received notice of proposed adjustments to the returns for each of those years. The Company currently is contesting certain of these adjustments with the IRS Appeals Office. Examinations of the Company's federal income tax returns for 1988, 1989 and 1990 are currently in progress. It is the opinion of management that adequate provisions for federal income taxes have been reflected in the consolidated financial statements.\nProvisions for federal income taxes were different from the amount computed by applying the statutory United States federal income tax rate to earnings before tax. The reasons for these differences are (thousands of dollars):\nDeferred tax liabilities (assets) which are recognized for the estimated future tax effects attributable to temporary differences are (thousands of dollars):\nThe Omnibus Budget Reconciliation Act of 1993 enacted in August 1993 included, among other things, an increase in the corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. In September 1993, the Company recorded a change in its deferred income tax balances reflecting this change in corporate federal income tax rates. The cumulative impact of the tax rate increase did not materially affect the Company's consolidated earnings and financial position. The Company has mitigated the impact of this tax rate increase in its rates effective October 1, 1993, subject to refund.\n8. Benefit Plans\nThe Company participates in the non-contributory pension plan of Coastal (the \"Plan\") which covers substantially all employees. The Plan provides benefits based on final average monthly compensation and years of service. As of December 31, 1993, the Plan did not have an unfunded accumulated benefit obligation. Colorado made no contributions to the Plan for 1993, 1992 or 1991. Assets of the Plan are not segregated or restricted by participating subsidiaries and pension obligations for Company employees would remain the obligation of the Plan if the Company were to withdraw.\nThe Company also makes contributions to a thrift plan, which is a trusteed, voluntary and contributory plan for eligible employees of the Company. The Company's contributions, which match the contributions made by employees, amounted to approximately $2.8 million for 1993 and $2.6 million for each of 1992 and 1991.\n- - Postretirement\/Postemployment Benefits Other Than Pensions\nThe Company provides certain health care and life insurance benefits for retired employees. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"). FAS 106 requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. The Company previously expensed\nthe cost of these benefits, which are principally health care, as claims were incurred. FAS 106 allows recognition of the cumulative effect of the liability in the year of the adoption or the amortization of the obligation over a period of up to twenty years. The Company has elected to recognize the initial postretirement benefit obligation of approximately $18.2 million over a period of twenty years. The impact on the Company's results of operations for the nine months ended September 30, 1993 of $1.8 million has been deferred and will be amortized over three years consistent with rates effective October 1, 1993, subject to refund. The impact on the Company's results of operations for three months ended December 31, 1993 was approximately $.8 million.\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 16.0% in 1993, declining gradually to 7.0% by the year 2004. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 and net postretirement health care cost by approximately 4.29%. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.25%.\nThe Company adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits\" effective January 1, 1994. This standard covers the accounting for estimated costs of benefits provided to former or inactive employees before their retirement. The effect of the new standard will not have a material effect on the Company's results of operations or financial position.\n9. Commitments\nThe Company and its subsidiary had rental expense of approximately $9.0 million, $9.7 million and $8.3 million in 1993, 1992 and 1991, respectively (excluding leases covering natural resources). The aggregate minimum lease payments under existing noncapitalized long-term leases are estimated to be $5.9 million, $3.1 million, $2.2 million, $.3 million and $.2 million for the years 1994-1998, respectively, and $1.1 million thereafter.\nThe Company has executed a service agreement with WIC, an affiliate, providing for the availability of pipeline transportation capacity through January 1, 2004. Under the service agreement, the Company is required to make minimum payments on a monthly basis. The estimated amounts of minimum annual payments are as follows (thousands of dollars):\nThe Company made minimum payments of approximately $3.6 million under this agreement in 1993. The Company has and will continue to pay additional amounts based on the actual quantities shipped.\n10. Litigation and Regulatory Matters\n- - Litigation\nIn December 1992, certain of Colorado's natural gas lessors in the West Panhandle Field filed a complaint in the U.S. District Court for the Northern District of Texas, claiming underpayment, breach of fiduciary duty, fraud and negligent misrepresentation. Management believes that Colorado has numerous defenses to the lessors' claims, including (i) that the royalties were properly paid, (ii) that the majority of the claims were released by written agreement, and (iii) that the majority of the claims are barred by the statute of limitations.\nOther lawsuits and other proceedings which have arisen in the ordinary course of business are pending or threatened against the Company or its subsidiaries.\nAlthough no assurances can be given and no determination can be made at this time as to the outcome of any particular lawsuit or proceeding, the Company believes there are meritorious defenses to substantially all of the above claims and that any liability which may finally be determined should not have a material adverse effect on the Company's consolidated financial position.\n- - Rate Matters\nOn April 8, 1992, the FERC issued Order No. 636 (\"Order 636\"), which required significant changes in the services provided by interstate natural gas pipelines. The Company and numerous other parties have sought judicial review of aspects of Order 636.\nOn July 2, 1993, the Company submitted to the FERC an unanimous offer of settlement which resolved all the Order 636 restructuring issues which had been raised in its restructuring proceedings. That settlement was ultimately approved (except for minor issues), and the Company's restructured services became effective October 1, 1993.\nEffective October 1, 1993, Colorado has separated all of its services and separately contracts for each service on a stand-alone or \"unbundled\" basis. Gathering, storage and transportation services are provided at negotiated rates established between minimum and maximum levels approved by FERC, while gas processing rates are not subject to FERC regulations.\nEffective October 1, 1993, Colorado formed an unincorporated Merchant Division to conduct most of the Company's sales activity in the Order 636 environment. The gas sales volumes reported include those sales which continue to be made by Colorado together with those of its Merchant Division.\nColorado's gas sales contracts extend through September 30, 1996, but provide for reduced customer purchases to be made each year. Under Order 636, Colorado's certificate to sell gas for resale allows sales to be made at negotiated prices and not at prices established by FERC. Colorado is also authorized to abandon all sales for resale at such time as the contracts expire and without prior FERC approval.\nOn March 31, 1993, the Company filed at FERC to increase its rates by approximately $26.5 million annually. Such rates (adjusted to reflect the Company's Order 636 program) became effective subject to refund on October 1, 1993.\nThe Company is regulated by the FERC. Certain rate issues remain unresolved between the Company, its customers, its suppliers, and the FERC. The Company has made provisions which represent management's assessment of the ultimate resolution of these issues. While the Company estimates the provisions to be adequate to cover potential adverse rulings on these issues, it cannot estimate when each of these issues will be resolved.\n11. Quarterly Results of Operations (Unaudited)\nThe results of operations by quarter for the years ended December 31, 1993 and 1992 were (thousands of dollars):\n12. Segment Reporting\nNatural gas system operations and gas and oil exploration and production are the two segments of the Company's operations.\nNatural gas system operations involve the production, purchase, gathering, storage, transportation and sale of natural gas, principally to and for public utilities, industrial customers, other pipelines, and other gas customers, as well as the operation of natural gas liquids extraction plants.\nGas and oil exploration and production operations involve primarily the development and production of natural gas, crude oil, condensate and natural gas liquids.\nOperating revenues by segment include both sales to unaffiliated customers, as reported in the Company's statement of consolidated earnings, and intersegment sales, which are accounted for on the basis of contract, current market, or internally established transfer prices. The intersegment sales are from the exploration and production segment to the natural gas segment.\nOperating profit is total revenues less interest income from affiliates and operating expenses. Operating expenses exclude income taxes, corporate general and administrative expenses and interest.\nIdentifiable assets by segment are those assets that are used in the Company's operations in each segment.\nThe Company's operating revenues and operating profit for the years ended December 31, 1993, 1992 and 1991, and identifiable assets as of December 31, 1993, 1992 and 1991, by segment, are shown below (thousands of dollars):\nCapital expenditures and depreciation, depletion and amortization expense by segment for the years ended December 31, 1993, 1992 and 1991, were (thousands of dollars):\nRevenues from sales and transportation of natural gas to individual customers amounting to 10% or more of the Company's consolidated revenues were as indicated below (thousands of dollars):\nRevenues from sales and transportation of natural gas to any other single customer did not amount to 10% or more of the Company's consolidated revenues for the years ended December 31, 1993, 1992 and 1991, respectively. The Company does not have any foreign operations.\nGas sales from the Company's transmission system are made primarily to public utilities which resell the gas to residential, commercial and industrial customers and to end-users in Colorado and southeastern Wyoming. Deliveries from the Company's field system are made to markets in the Texas Panhandle region. Transportation services are provided for brokers, producers, marketers, distributors, end-users and other pipelines. The Company extends credit for sales and transportation services provided to certain qualifying companies.\n13. Transactions with Affiliates\nThe Statement of Consolidated Earnings includes the following major transactions with affiliates (thousands of dollars):\n- ----------------------------\n\/1\/ The 1991 and 1992 amounts were immaterial.\n\/2\/ The 1991 Gathering, Transportation and Compression amount for WIC includes the result of a transportation rate refund in the amount of $15.6 million, inclusive of interest, for the period June 1, 1985 through August 31, 1991.\nServices provided by the Company at cost for affiliated companies were $7.9 million for 1993, $8.1 million for 1992 and $4.4 million for 1991. Services provided by affiliated companies for the Company at cost were $8.1 million for 1993, $7.9 million for 1992 and $7.3 million for 1991. The services provided by the Company to affiliates, and by affiliates to the Company, primarily reflect the allocation of costs relating to the sharing\/operating of facilities and general and administrative functions. Such costs are allocated to the Company using a three factor formula consisting of revenue, property and payroll, or other methods which have been applied on a reasonable and consistent basis.\nIn 1989, the Company entered into two separate five-year lease agreements with ANR Western Storage Company, an affiliate, for the rental of certain pipeline facilities. Rental expense of approximately $1.5 million for 1993 and $1.6 million was recorded in both 1992 and 1991, in conjunction with the terms of the lease agreements.\nIn 1992, the Company entered into a five-year lease agreement with ANR Production Company, an affiliate, for the rental of certain pipeline facilities. Rental expense of approximately $.2 million was recorded in 1993 and 1992 in conjunction with the terms of the lease agreement.\nThe Company participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing total borrowings from outside sources. At December 31, 1993, the Company had advanced $107.5 million to an associated company at a market rate of interest. Such amount is repayable on demand.\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)\nReserves, capitalized costs, costs incurred in oil and gas acquisition, exploration and development activities, results of operations and the standardized measure of discounted future net cash flows are presented for the exploration and production segment. Natural gas systems reserves and the related standardized measure of discounted future net cash flows are presented separately for natural gas operations. All reserves are located in the United States. Most of the Company-owned gas reserves are dedicated to Colorado's system.\nChanges in proved reserves since the end of 1990 are shown in the following table:\nTotal proved reserves for natural gas systems exclude storage gas and liquids volumes. The natural gas systems storage gas volumes are 41,012, 55,284 and 57,346 MMcf and storage liquids volumes are approximately 150, 159 and 207 thousand barrels at December 31, 1993, 1992 and 1991, respectively.\nThe 1991 \"Revisions of previous estimates and other\" for Colorado's company- owned reserves of natural gas are related to the Company's independent engineers' interpretation of an agreement, effective January 1, 1991, as amended, between Colorado and Mesa Operating Company, formerly Mesa Operating Limited Partnership, which is discussed under Item 1, \"Business - Gas System Reserves and Availability-Reserves Dedicated to a Particular Customer\" herein. Such revisions are not due to any change in gross reserve estimates for the affected properties.\nCAPITALIZED COSTS RELATING TO EXPLORATION AND PRODUCTION ACTIVITIES\n(thousands of dollars)\nAs described in Note 1 of Notes to Consolidated Financial Statements, the Company follows the full-cost method of accounting for oil and gas properties.\nCOSTS INCURRED IN OIL AND GAS ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES (thousands of dollars)\nProperty acquisition costs consist of amounts paid for unproved reserves.\nRESULTS OF OPERATIONS FOR EXPLORATION AND PRODUCTION ACTIVITIES (thousands of dollars)\nThe average amortization rate per equivalent Mcf was $1.00 in 1993, 1992 and 1991.\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVE QUANTITIES\nFuture cash inflows from the sale of proved reserves and estimated production and development costs, as calculated by the Company's independent engineers, are discounted at 10% after they are reduced by the Company's estimate for future income taxes. The calculations are based on year-end prices and costs, statutory tax rates and nonconventional fuel source tax credits that relate to existing proved oil and gas reserves in which the Company has mineral interests.\nThe standardized measure is not intended to represent the market value of reserves and, in view of the uncertainties involved in the reserve estimation process, including the instability of energy markets, may be subject to future revisions (thousands of dollars):\nPrincipal sources of change in the standardized measure of discounted future net cash flows during each year are as follows (thousands of dollars):\nNone of the amounts include any value for storage gas and liquids which were approximately 41 Bcf and 150 thousand barrels, respectively, at the end of 1993.\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (Thousands of Dollars)\n- ----------------------------\n1 The note receivable is a promissory note due from an affiliate on demand and bears a market rate of interest.\nS-1\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES SCHEDULE V - PLANT, PROPERTY AND EQUIPMENT (Thousands of Dollars)\n- --------------- (A) Reclassifications and other miscellaneous adjustments. (B) Amortization of exploration cost charged to income.\nThe Company generally provides for depreciation on a straight-line basis, although the unit-of-production method is used for depreciation, depletion and amortization of gas and oil properties. The depreciation rates for production and gathering, products extraction, storage, and transmission plant are 1.55%, 3.85%, 2.90% and 2.60%, respectively.\nS-2\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PLANT, PROPERTY AND EQUIPMENT (Thousands of Dollars)\n- ---------------\n(A) Charged to clearing and other accounts. (B) Reclassification and other miscellaneous adjustments.\nS-3\nCOLORADO INTERSTATE GAS COMPANY AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION (Thousands of Dollars)\n- --------------------------------- \/1\/ Amounts are not presented as such amounts are less than 1% of revenues. \/2\/ Production taxes for exploration and production operations are charged against operating revenues.\nS-4\nEXHIBIT INDEX\nExhibit Number Document - ------ ------------------------------------------------------------------------\n(3.1)+ Certificate of Incorporation of the Company (Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1980).\n(3.2)+ By-laws of the Company (Filed as Module CIGBY-LAWS on March 29, 1994).\n(3.3)+ Certificate of Amendment of Certification of Incorporation of the Company (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989).\n(4) With respect to instruments defining the rights of holders of long-term debt, the Company will furnish to the Securities and Exchange Commission any such document on request.\n(21)* Subsidiaries of the Company.\n(24)* Power of Attorney (included on signature pages herein).\n__________________________________\nNote: + Indicates documents incorporated by reference from prior filing indicated. * Indicates documents filed herewith.","section_15":""}
{"filename":"45333_1993.txt","cik":"45333","year":"1993","section_1":"ITEM 1. BUSINESS GENERAL Handy & Harman (hereinafter \"H&H\" or the \"Company\"), was incorporated in the State of New York in 1905 as the successor to a partnership which commenced business in 1867. Unless the context indicates otherwise, the terms, \"H&H\" and the \"Com- pany\", refer to Handy & Harman and its consolidated subsidiaries. Historically, until commencing a diversification program in 1966, the Company was engaged primarily in the manufacture of silver and gold alloys in mill forms and the refining of precious metals from jewelry and industrial scrap. The Company's markets were largely among silversmiths and manufacturing jewelers, users of silver brazing alloys, and manufacturers who required silver and gold primarily for the properties of those metals. As part of these precious metals operations, the Company still publishes a daily New York price for its purchases of silver and gold and now also publishes a daily price for its fabricated silver and gold. The silver price is recognized, relied on and used by others throughout the world. Further, the review entitled \"The Silver Market\", published annually by the Company since 1916, is widely distributed in trade and financial centers in this country and abroad.\nThe diversification program has added lines of precious metals products and various specialty manufacturing operations, including stainless steel and specialty metal alloy products, for industrial users in a wide range of applications which include the electrical, electronic, automotive original equipment, office equipment, oil and other energy-related, refrigeration, utility, telecommunications and medical industries. The Company's business segments are (a) manufacturing and selling precious metals products and providing refining services; (b) manufacturing and selling products for the original equipment automotive industry; (c) manufacturing and selling of non-precious metal wire and tubing products; and (d) manufacturing and selling other specialty products. Three-year financial data for the Company's business segments appear under the caption \"The Company's Business\" on pages 18 and 19 of the Handy & Harman 1993 Annual Report to Shareholders (hereinafter referred to as the \"Annual Report\") and are incorporated by reference herein. One customer of the Automotive Original Equipment Group represented 10.7%, 11.3%, and 10.5% of consolidated sales and service revenues for 1993, 1992 and 1991, respectively. Export sales and revenues are not significant in the total sales and revenues of any of the Company's business segments. In June 1991 the Company announced a major restructur- ing program designed to strengthen the Company's balance sheet by reducing debt and interest expense, to provide a sound basis for improved profitability and to allow management to concentrate on\nthose businesses which have demonstrated potential for above average growth. The program called for divestiture of six businesses deemed to be non-core operations that no longer fit within the Company's long-term strategies. The six discontinued businesses were those involved in the manufacture of automotive replacement parts, proprietary chemicals, metal powders, pressur- ized vessels, coldheaded parts and specialized platinum group metals refinings and products. See Notes 1 and 10 to the Consol- idated Financial Statements included in the Annual Report and Management's Discussion and Analysis on page 21 of the Annual Report.\nPRECIOUS METALS PRODUCTS AND REFINING SERVICES The operational structure of the parent company's precious metals activities consists of two distinct profit centers: Products Operations and Refining Operations. Both of these profit centers and the activities of other precious metals subsidiaries are included in the following discussion of the precious metals segment of the Company's business. Within the precious metals segment of the Company's business, two principal classes of products are manufactured: wire products and rolled products. The table on page 19 of the Annual Report, showing percentages of gross shipments of these classes of precious metals products which contributed 10% or more to total sales and revenues, is incorporated herein by reference.\nIn the following discussion of the Company's precious metals products, the term \"karat\" refers to the amount of gold in a gold alloy. Pure gold is 24-karat, and karat golds generally range between 10-karat (41.6%) and 18-karat (75%). The usual alloy metals are silver, copper, nickel and zinc. By varying the other elements in the alloy, karat golds may be fabricated in a number of colors including white, green, yellow and red. Sterling silver is an alloy of silver, which contains a minimum of 92.5% pure silver. The Company's profits from the products manufactured in this segment are derived from the \"value added\" of processing and fabricating, not from the purchase and resale, of precious metals. In accordance with general practice in the industry, prices to customers are a composite of two factors, namely, (1) the value of the precious metal content of the product plus (2) an amount referred to as \"fabrication values\" to cover the cost of base metals, labor, overhead, financing and profit. Wire Products - In the manufacture of the Company's wire products, precious metal alloys are cast, extruded and then drawn into wire. The Company's precious metal wire products con- sist of karat golds, sterling and other alloys of silver, and other precious metal alloys in drawn and coiled wire and rod forms of differing diameters, ranging from .007 of an inch to .25 of an inch. The Company also manufactures Easy Flo(R), Sil- Fos(R) and other silver brazing alloys in wire form for making permanent, strong, leak-tight joints of the metals joined.\nBrazing alloy wire is also sold in preformed rings and special shapes. The Company's precious metal alloy wire products are marketed for electrical conductive and contact applications in a wide variety of industries, including the aerospace, electronics and appliance industries. Manufacturing jewelers use the Com- pany's precious metal wire in a wide range of production applica- tions, including, for example, necklaces, bracelets, earring parts and pins and clips. Rolled Products - The Company's rolled products are manufactured from karat golds, sterling and lesser alloys of silver, and alloys of other precious metals in sheets, strips and bars of varying thicknesses, widths and lengths. These precious metal rolled products range in standard thickness from foils .0005 of an inch thick to strips or bars .375 of an inch thick, and in standard widths from strips .125 of an inch wide to fifteen inches wide. Rolled products are shipped in lengths up to many hundred feet. The Company's rolled products include precious metals bonded with other metals in bimetallic and tri- metallic strips which provide more versatile industrial applica- tions at a lower cost than would be possible if a solid precious metal or a precious metal alloy were used. Because of the physical properties of precious metals and precious metal alloys, the Company's rolled products have a wide variety of applications by the Company's industrial cus- tomers. The Company's rolled products are sold to silversmiths for use as anodes in plating operations and for flatware and\nhollowware, to manufacturing jewelers for a variety of jewelry, to mints and others for coins, commemorative medals and ingots, to manufacturers of electrical and electronic devices for elec- trical contacts and circuitry, to the nuclear power industry for control assemblies, to the defense industry as foil for batter- ies, and to the aerospace industry for use in guidance systems. Powder Products - The Company produced a variety of precious metal powders and flakes which it sold under various names, including Silpowder(R) and Silflake(R), for use in the production of electronic parts and in powder metal contacts, batteries, conductive coatings and other electrical applications. It produced a line of silver oxide powders for use in chemical silver alumina catalysts and in button batteries. The Company sold this business in 1992 and effectively exited the business in December 1992. However, it continues to produce silver\/tin alloy powders for use in dental applications and silver\/copper alloy powders, sold under the names Easy-Flo(R) and Sil-Fos(R), for use in industrial brazing applications. Other Precious Metals Products - The Company produces grain beads of various precious metal alloys by melting the metal and then pouring it through water. Grain beads are distinguished from the Company's precious metal powders, which are not as coarse and are produced by atomization spraying. The major grain product is karat gold grain produced in a number of colors, including white, green, yellow and red. The Company also produces grain in various silver and other gold alloys.\nElectronic parts are selectively electroplated in order to deposit gold, silver, palladium, and various base metals on such parts for applications in computer connectors, semi-conductor devices and telecommunication equipment. Refining Services - The Company recovers precious metals from waste and scrap generated by users of the Company's precious metals products and other industrial users of precious metals, from metal-bearing objects delivered for that purpose by non-manufacturing refining customers, and from high grade mining concentrates and bullion. The Company receives a fee for this service. After controlled sampling, assaying, weighing, deter- mination of values and settlement with the customer, the Company purchases for its own use the precious metal resulting from such refining, or, upon request by the customer, returns an equivalent amount of metal to the customer. Raw Materials - The raw materials for the Company's precious metals products consist principally of silver, gold, copper, cadmium, zinc, nickel, tin, and the platinum group metals in various forms. Gold and silver constitute the major portion of the value of the raw materials involved. In addition, the Company buys waste and scrap containing precious metals for recycling and refining, as described above. The Company purchases all of its precious metals at free market prices from either refining customers, primary producers or bullion dealers. Over the past several years, the prices of gold and silver have been subject to fluctuations, and are expected to continue to be\naffected by world market conditions; however, the Company has not experienced any problem in obtaining the necessary quantities of raw materials required for this segment. In the normal course of business, the Company receives precious metals from suppliers and customers. These metals are returnable in fabricated or commercial bar form under agreed upon terms. Since precious metals are fungible, the Company does not physically segregate supplier and customer metals from its own inventories. Therefore, to the extent that supplier or customer metals are used by the Company, the amount of inventory which the Company must own is reduced. All raw materials used in this segment are readily available from several sources. For a discussion of the Company's inventory purchasing and pricing, and of the Company's practices to eliminate the economic risk of precious metal price fluctuations, see \"The Company's Business\" on page 18 of the Annual Report. Working Capital Items - The Company maintains a con- stant level of inventory of fine and fabricated precious metals in various stages of processing and\/or refining for customer delivery requirements and for a continuous supply of raw mate- rials. Such inventories are carried under the Last-In, First- Out (LIFO) method of accounting. The LIFO carrying values are substantially less than the market values of the inventories. In the Notes to Consolidated Financial Statements, commencing on page 28 of the Annual Report, see Note 7 for a comparison of the cost and market values of the Company's precious metals invento-\nries at December 31, 1992 and December 31, 1993 and see Note 2 for a discussion of the effects of fluctuations in precious metals prices on the Company's credit requirements. Both Notes are incorporated by reference herein. Product Development, Patents and Trademarks - While the Company holds a number of patents and trademarks related to its precious metals products and processes, and is licensed under others, the precious metals business, as a whole, is not depen- dent upon such patents. The Company's trademarks are registered in the United States and in several foreign countries. The Com- pany maintains a technical laboratory and staff in connection with its precious metals operations and a portion of the work of that staff is devoted to metallurgical products and development. Distribution Facilities - The Company distributes precious metals products directly to customers from its plants and service branches, except that certain products, primarily brazing alloys, are distributed through independent distributors throughout the United States and Canada. The Company has a marketing organization trained to service its customers and dealers, to solicit orders for its precious metal and related products, and to obtain refining business. This organization markets all of the Company's refining services and precious metals products and provides special technical assistance with respect to precious metals through product engineers and other technical personnel. The Company maintains customer service and sales offices at its various manufacturing and processing plants\nand in Los Angeles and Chicago. It also has warehouse facilities to support sales and distribution at each of its manufacturing and processing plants and in Chicago and Los Angeles. Competition - The Company is one of the leading fab- ricators and refiners of precious metals. The Company currently sells its precious metal fabricated products to approximately 5,000 customers throughout the United States and Canada. Al- though there are no companies in the precious metals field whose operations exactly parallel those of H&H in every area, there are a number of competitors in each of the classes of the Company's precious metals products. Many of these competitors also carry on activities in other product lines in which the Company is not involved. Competition is based on quality, service and price, each of which is of equal importance.\nMANUFACTURING OF AUTOMOTIVE ORIGINAL EQUIPMENT Through Handy & Harman Automotive Group, Inc. (the \"Automotive Group\"), a subsidiary, the Company manufactures a wide variety of parts, components and assemblies for the North American domestic automobile original equipment manufacturers (the OEM market).\nThe Automotive Group produces a wide variety of tubular parts for the OEM market from steel, stainless steel and other metals. Formed and brazed tubing parts made from stainless and carbon steel and various other metals are produced as air pipes,\nbrake and fuel lines, components of fuel delivery systems, and other tubing parts. The Automotive Group also produces small diameter cables and a variety of control assemblies for automotive applications, including parking brake cables, speedometer cables, various transmission cables and other mechanical assemblies, made from steel and other materials. In addition, the Automotive Group produces plastic parts, tubing, fuel lines, plastic component manifolds and assemblies for the OEM market. Raw Materials - The raw materials used in this segment include stainless and carbon steels, tin, zinc, nickel and various plastic compositions. Raw materials are purchased at open market prices principally from domestic suppliers. The Automotive Group has not experienced any problem in obtaining sufficient quantities of raw materials. Competition - There are many companies, domestic and foreign, which manufacture products of the type manufactured by the Automotive Group. Some are larger than the Company and many are larger than the Automotive Group's operation with which they compete. Competition is based to a great extent on price, quality, service and new product introduction. The domestic automobile industry has traditionally engineered and manufactured in its own plants a high percentage of the parts used in assem- bling its automobiles. In recent years the industry has begun to purchase more parts and assemblies from outside suppliers such as the Automotive Group. Although this trend continued during 1993 there can be no assurance that it will do so in the future.\nEqually as important is the industry trend to use outside suppliers to participate in the engineering and designing of some parts and assemblies. Research and Development Center - The Automotive Group operates a Research and Development Center in Auburn Hills, Michigan. The Center contains approximately 40,000 square feet of floor space and \"state-of-the-art\" equipment, including chassis rolls, dynamometers, vibration equipment and flow testing equipment. A number of highly-qualified personnel currently are employed at the Center which also houses automotive administrative and sales personnel. They offer the capability to design, fabricate and test complete fuel and cable control systems; to support the Automotive Group and other units of the Company in the design, fabrication and testing of automotive components; and to assist in the design and development of new components and systems for automotive purposes. Distribution - Essentially all of the Automotive Group's original equipment products is sold directly to the major domestic automobile companies through its sales and marketing employees.\nMANUFACTURING OF WIRE AND TUBING PRODUCTS The Company, through several subsidiaries, manufactures a wide variety of non-precious metal wire and tubing products. Small diameter precision drawn tubing fabricated from stainless steel, nickel alloy and carbon and alloy steel is produced in\nmany sizes and shapes to critical specifications for use in the semi-conductor, aircraft, petrochemical, automotive, appliance, refrigeration and instrumentation industries. Additionally, tubular product is manufactured for the medical industry for use as implants, surgical supplies and instrumentation. Stainless steel wire products are redrawn from rods for such diverse applications as bearings, brushes, cable lashing, hose reinforcement, nails, knitted mesh, wire cloth, air bags and antennas in the aerospace, automotive, chemical, communications, marine, medical, petrochemical and other industries. Raw Materials - The raw materials used in this segment include stainless and carbon steels, nickel alloys and a variety of high performance alloys. The Company purchases all such raw materials at open market prices from domestic and foreign suppli- ers. The Company has not experienced any problem in obtaining the necessary quantities of raw materials. Prices and availabil- ity, particularly of raw materials purchased from foreign suppli- ers, will be affected by world market conditions and governmental policies. Competition - There are many companies, domestic and foreign which manufacture wire and tubing products of the types manufactured by this segment. Competition is based on quality, service, price and new product introduction, each of which is of equal importance. Distribution - Most of the products manufactured by this segment are sold directly to customers through Company\nsalesmen; however, some are sold through manufacturer's represen- tatives and through distributors.\nMANUFACTURING OF OTHER SPECIALTY PRODUCTS Other Company subsidiaries manufacture a large number of other specialty products for industrial use. Plastic and steel fittings and connections, plastic pipe and non-ferrous thermite welding powders are produced for the natural gas, electrical and water distribution industries. In 1993 the Company sold its business which used powdered metals to make custom-molded structural parts and assemblies from ferrous and non-ferrous powdered metals for components and assemblies for office products, business machines, hand-held power tools, hydraulic motors and pumps and lawn and garden equipment. Also in 1993, the Company sold the large industrial heat exchanger business which made packaged power units for oil and gas, construction, agricultural and the skiing industries. Distribution - Most of the Company's specialty prod- ucts comprising this segment are sold directly to customers through Company salesmen, although some are sold by agents and manufacturer's representatives. In particular, gas distribution supplies and fittings, thermite welding powders and certain other products are sold primarily through manufacturer's representa- tives to the ultimate users, although some sales also are made by manufacturer's representatives to distributors.\nRaw Materials - The raw materials used in this segment include various steel alloys, copper, tin, zinc, nickel and various plastic compositions. The Company purchases all such raw materials at open market prices primarily from domestic suppliers. The Company has not experienced any problem in obtaining the necessary quantities of raw materials. Prices and availability, particularly as to raw materials purchased from foreign suppliers, will continue to be affected by world market conditions and governmental policies. Competition - There are many companies, domestic and foreign, which manufacture products of the type manufactured by this segment. Some are larger than the Company, and many are larger than the Company's operations with which they compete. Competition in portions of this segment's business is based primarily on price, and significant competition has come from lower-priced foreign imports. Competition is otherwise generally based on quality, service and price, each of which is of equal importance.\nGOVERNMENT REGULATION During the last fiscal year, the Company spent or committed approximately $2,700,000 in complying with federal, state and local occupational safety and health, environmental control and equal employment opportunity laws and regulations. These expenditures included monies spent by the Company in the clean-up of hazardous wastes and toxic substances under Federal,\nState and local laws and regulations relating to protection of the environment. Like many other large domestic manufacturing concerns, the Company's operations may affect the environment. These operations may produce, process, and dispose of materials and waste products which, under certain conditions, are toxic or hazardous under such environmental laws and regulations. The Company expects to make comparable expenditures and commitments during the current fiscal year, provided that no further changes are made in such laws and regulations or in their application. Such expenditures are not material to the competitive position or financial condition of the Company; however, such laws and regulations may require capital expenditures not now contemplated and may result in increased operating costs. See Item 3 Legal Proceedings.\nENERGY The Company requires significant amounts of electrici- ty, natural gas, fuel oil and propane to operate its facilities. The Company has few contracts covering natural gas or electrici- ty, but has some one-year contracts for the delivery of fuel oil and\/or propane at some facilities. These contracts are the result of competitive bidding. In an attempt to minimize the effects of any fuel shortages, the Company has made a number of process and equipment changes to allow use of alternate fuels in key processes, and the Company has equipped certain plants with alternate fuel reserves\nintended to reduce any curtailment upon a local shortage. A general and continuing shortage of such fuels, however, or a government allocation of supplies resulting in a general reduc- tion in fuel supplies, could cause some curtailment of produc- tion.\nEMPLOYEES The Company had 4,246 employees on December 31, 1993. Of these, approximately 35% are covered by collective bargaining agreements which expire at various times during the next three years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company has 32 operating plants in the United States, Canada, Mexico, England, Brazil (50% owned) and Singapore (50% owned) with a total area of approximately 2,500,000 square feet, including warehouse, office and laboratory space, but not including the plants used by the Brazil or Singapore operations and by the discontinued operations described in Notes 1 and 10 to the Consolidated Financial Statements included in the Annual Report. The Company owns or leases sales, service and warehouse facilities at 4 other locations in the United States and Canada, which, with the Company's executive and general offices, have a total area of approximately 115,000 square feet. The Company considers its manufacturing plants and service facilities to be well maintained and efficiently\nequipped, and therefore suitable for the work being done. Theproductive capacity and extent of utilization of the Company'sfacilities is dependent in some cases on general business condi-tions and in other cases on the seasonality of the utilization ofits products. Productivity can be expanded readily to meet additional demands. A description of the Company's principal plants by industry segment is as follows: Precious Metals The Company's principal precious metal products and refining services operations are conducted in Fairfield and South Windsor, Connecticut; Attleboro, Massachusetts; and East Providence, Rhode Island. Other precious metal operations are conducted in Phoenix, Arizona; North Attleboro, Massachusetts; Cudahy, Wisconsin; Indianapolis, Indiana; Toronto, Canada and Singapore (50% owned). The Company owns all these operating plants in fee. Automotive Original Equipment The headquarters of Handy & Harman Automotive Group, Inc. is located in Auburn Hills, Michigan in the same building as the sales offices and the Engineering Research and Development Center. Manufacturing facilities are in Dover and Archbold, Ohio; Kendallville and Angola, Indiana; and Martinsburg, West Virginia. All of this segment's operating plants are owned in fee. The Auburn Hills building is leased. The Automotive Group\nalso has operated in Mexico through a \"maquiladora\" arrangement and now has \"National Supplier Status.\" Wire and Tubing The headquarters of the wire portion of this segment is in Cockeysville, Maryland and the headquarters of the tubing portion of this segment is in Norristown, Pennsylvania. Manufacturing facilities are located in Cockeysville, Maryland; Norristown, Pennsylvania; Willingboro and Middlesex, New Jersey; Oriskany, New York; Camden, Delaware; Evansville, Indiana; Salto, Sao Paulo, Brazil; Retford, Notts. and Liversedge, Yorkshire, England. All these plants are owned in fee except the Retford and Salto plants which are leased. Other Specialty Products The principal facilities currently engaged in the Company's other specialty products businesses are located in Tulsa and Broken Arrow, Oklahoma; and Bolton, England. The Oklahoma plants are owned in fee while the Bolton plant is leased. Company's Offices The Company's executive offices are in New York, New York and occupy 17,000 square feet under a lease. The Company has leased approximately 30,000 square feet in Rye, New York, for its general offices and approximately 8,500 square feet in New York, New York for its Corporate MIS Center.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS There are no pending legal proceedings to which the Company or any of its subsidiaries is a party or which any of their property is the subject, other than ordinary, routine litigation incidental to the business, none of which individually or in the aggregate is material to the business or financial condition of the Company, except as follows: Palmer Well Fields On February 25, 1991 the Massachusetts Department of Environmental Protection (\"MDEP\") filed a lien against the property owned by Pal-Rath Realty, Inc. (a subsidiary of the Company formerly named Rathbone Corporation) which is located in Palmer, Massachusetts and is leased to Rathbone Realty, Inc. whose affiliated corporation purchased the business and assets of Pal-Rath Realty (other than the real estate) in May 1988. The lien is for a claim in the amount of $1,131,105.31 for expenses allegedly incurred in connection with the Palmer Well Fields known as the Galaxy Well Field and Gravel Pack Well No. 2. A claim has also been made against a neighboring industry and a lien similarly filed against that industry's property. The MDEP has not allocated the alleged liability between Pal-Rath and the other industry. In June 1987, the Massachusetts Department of Environmental Quality Engineering (now called the Massachusetts Department of Environmental Protection) had issued a Notice of Responsibility to Rathbone (now Pal-Rath) relating to alleged contami-\nnation of the Palmer Well Fields by Rathbone. Rathbone responded to that letter and has from time to time assisted the MDEP and also conducted an extensive investigation of the Rathbone proper- ty. In November 1990 the MDEP had issued a letter requesting submittal of good faith offers by Pal-Rath and its neighbor to pay past costs and to conduct further work. In January 1991 Pal-Rath responded that the MDEP's request for money was not supported by the law or the facts and that it would not pay past costs but would conduct or assist in further work. Discussions were continuing when the MDEP filed its liens. Agreement has been reached to submit the matter to non-binding mediation before the Massachusetts Office of Dispute Resolutions. The mediation proceedings are continuing. Although the final outcome of this matter cannot be assured, the Company believes that it will not have a materially adverse affect on the financial position of the Company. Montvale, New Jersey Facility On April 13, 1993, the Borough of Park Ridge, New Jersey sued Handy & Harman Electronic Materials Corporation, a subsidiary (\"HHEM\"), and Handy & Harman, in the Superior Court of New Jersey, Law Division, Bergen County, asserting that a chemical used at a formerly owned facility in Montvale, New Jersey, an adjoining municipality, had migrated and entered a drinking water supply of Park Ridge. Park Ridge seeks reimbursement of $2,190,437 expended in the construction and operation of water treatment equipment for wells alleged to have been\ncontaminated from the Montvale facility, and of $1,255,582 for future expenditures over a 20-year period. The lawsuit includes as additional defendants the prior owner and operator of the Montvale facility, and a vendor of the chemical involved. Evidence exists that contamination existed at Park Ridge prior to HHEM's ownership of the site and that there are other sources of the contamination of the Park Ridge wells. HHEM has worked with the New Jersey Department of Environmental Protection and Energy to investigate and implement a remedy for conditions at the site; and Park Ridge has requested the assistance of the New Jersey DEPE to investigate whether there is a connection between the contamination at the site and at the Park Ridge wells. HHEM is negotiating with Park Ridge and the other defendants to agree on a settlement of all outstanding issues. Although the final outcome of this matter cannot be assured, the Company believes that it will not have a materially adverse affect on the financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None during the fourth quarter of the year ended December 31, 1993.\nEXECUTIVE OFFICERS OF THE COMPANY As of March 30, 1994, the executive officers of the Company, their ages, their present positions and offices, and\ntheir recent business experience and employment, are as follows: Richard N. Daniel - Age 58; Chairman (since 1988) and Chief Executive Officer of the Company (since 1983); a Director (since 1974).\nFrank E. Grzelecki - Age 56; President and Chief Operating Officer of the Company (since 1992); prior thereto Vice Chairman of the Board (since 1989); a Director (since 1988); prior thereto a Management Consultant (since 1986);\nPaul E. Dixon - Age 49; Vice President, General Counsel and Secretary (since 1993); prior thereto Vice President and General Counsel (since 1992); prior thereto Senior Vice President and General Counsel of Warnaco Group (since prior to 1989).\nRichard P. Schneider - Age 47; Vice President-Corporate Development (since 1993); prior thereto Vice President-Corporate Development of Sequa Corporation (a diversified manufacturing company) (since prior to 1989).\nDennis C. Kelly - Age 42; Controller (since 1993) of the Company; prior thereto Assistant Controller (since 1989); and prior thereto Director of Internal Audit (since 1985).\nJames S. McElya - Age 46; Group Vice President (since 1992); prior thereto President of Handy & Harman Automotive Group, Inc. (since 1987), a subsidiary.\nJohn M. McLoone - Age 51; Vice President - Financial Services (since 1992); prior thereto Group Vice President, Information Technologies for W. R. Grace & Co. (a multinational company) (since prior to 1989).\nStephen B. Mudd - Age 62; Vice President (since 1983) and Treasurer (since 1977).\nRobert M. Thompson - Age 61; Group Vice President (since 1984); prior thereto President of Handy & Harman Tube Company, Inc. (1976 to 1984), a subsidiary. There are no family relationships between any of the executive officers. The regular term of office for all executive officers is one year, beginning on May 1. There are no arrangements or understandings between any of the executive officers and any other person pursuant to which such officer was elected to be an officer.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The information for this Item is incorporated by reference to the section entitled \"Stock Trading and Dividends\" on page 19 of the Annual Report and to Note 5 of the Notes to Consolidated Financial Statements included in the Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA The information for this Item is incorporated by reference to the section entitled \"Five Year Selected Financial Data\" on page 20 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information for this Item is incorporated by reference to the section entitled \"Management's Discussion and Analysis\" on pages 21 and 22 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information for this Item is incorporated by reference to the Consolidated Financial Statements contained on pages 23 through 26 of the Annual Report and by reference to the Summary of Significant Accounting Policies contained on page 27 of the Annual Report and the Notes to Consolidated Financial Statements commencing on page 28 of the Annual Report and by\nreference to the Independent Auditors' Report set forth on page 34 of the Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable.\nPART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information for this Item is incorporated by reference to the section entitled \"Election of Directors,\" on pages 2 and 3 of the Company's Proxy Statement, dated March 30, 1994 (the \"Proxy Statement\"), for the 1994 Annual Meeting of Shareholders, and by reference to the item captioned \"Executive Officers of the Company\" at the end of Part I of this Annual Report on Form 10-K. No person who was during the 1993 fiscal year a director, officer or beneficial owner of more than ten percent of any class of equity securities of the registrant failed to file on a timely basis reports required by Section 16(a) of the Exchange Act of 1934, as amended.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information for this Item is incorporated by reference to the sections entitled \"Executive Compensation,\" \"Base Salaries,\" \"Annual Incentive Awards for 1993,\" \"Stock Options,\" \"Long-Term Incentive Plan,\" \"Compensation Committee\nReport on Executive Compensation,\" \"Pensions,\" \"Compensation of Directors,\" \"Employment Contracts and Termination of Employment and Change-in- Control Agreements\" on pages 4 to 10 of the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information for this Item is incorporated by reference to the sections entitled \"Voting Rights and Principal Holders Thereof\" and \"Election of Directors\" on page 1 and pages 2 and 3, respectively, of the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information for this Item is incorporated by reference to the section entitled \"Election of Directors\" on pages 2 and 3 of the Proxy Statement.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents Filed as a Part of This Report 1. Financial Statements The Consolidated Financial Statements, the Summary of Significant Accounting Policies and Notes to Consolidated Finan- cial Statements, the Independent Auditors' Report thereon and the items of Supplementary Information incorporated by reference in\nPart II, Item 8 of this Report are set forth at the respective pages of the Annual Report indicated in the list contained on page 17 of the Annual Report, which list is incorporated herein by reference to the Annual Report. 2. Financial Statement Schedules The following Financial Statement Schedules are filed as a part of this Report, beginning herein at the respective pages indicated: (i) Report and Consent of Independent Auditors (page ). (ii) Schedule V - Property, Plant and Equipment (page S-1). (iii) Schedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment (page S-2). (iv) Schedule VIII - Valuation and Qualifying Accounts and Reserves (page S-3). (v) Schedule X - Supplementary Income Statement Information (page S-4). All other Schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto. 3. Exhibits Required To Be Filed The following exhibits required to be filed as part of this Report have been included: (3) Certificate of Incorporation and By-Laws.\n(a) The Restated Certificate of Incorporation of Handy & Harman (Filed as Exhibit 3(a) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (b) The By-Laws as amended (Filed as Exhibit 3(b) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference). (4) Instruments defining the rights of security holders, including indentures. (a) Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent (Filed as Exhibit 4(a) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (b) Short Term Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemi- cal Bank, as Co-Agents and The Bank of Nova Scotia, as the Administrative Agent (Filed as Ex- hibit 4(b) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference).\n(c) Amendment to Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent (filed as Exhibit 4(e) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference). (d) Amendment to Short Term Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia, as the Administrative Agent (filed as Exhibit 4(d) to the Company's Annual Report on Form 10- K and incorporated herein by reference). (e) Amendment to Revolving Credit Agreement dated February 4, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent. (f) Amendment to Short Term Revolving Credit Agreement dated February 4, 1993 among the Company, certain financial institutions as lenders, The Bank of\nNova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and the Bank of Nova Scotia, as the Administrative Agent. (g) Amendment to Revolving Credit Agreement dated July 1, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent. (h) Amendment to Short Term Revolving Credit Agreement dated July 1, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and the Bank of Nova Scotia, as the Administrative Agent. No other required to be filed. The Company agrees to furnish to the Securities and Exchange Commission upon its request therefor a copy of each instrument omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. (10) Material contracts. (a) 1982 Stock Option Plan (Filed as Exhibit 1 to the Company's Registration Statement on Form S-8 (Registration No. 2-78264) under the Securities Act of 1933 and incorporated herein by reference).\n(b) Amendment to 1982 Stock Option Plan approved in December 1988 (Filed as Exhibit 10(a) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (c) Management Incentive Plan, as amended February 26, 1981 (Filed as Exhibit 10(b) to the Company's 1980 Annual Report on Form 10-K and incorporated herein by reference thereto). (d) Amendment to Management Incentive Plan approved in December 1988 (Filed as Exhibit 10(d) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (e) Amendment to Management Incentive Plan approved in October 1991 (Filed as Exhibit 10(e) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (f) Deferred Fee Plan For Directors, as amended February 26, 1981 (Filed as Exhibit 10(c) to the Company's 1980 Annual Report on Form 10-K and incorporated herein by reference thereto). (g) Form of Executive Agreement entered into with the Company's executive officers in September 1986 (Filed as Exhibit 10(d) to the Company's 1986 Annual Report on Form 10-K and incorporated herein by reference thereto).\n(h) Amendment to Executive Agreement approved in December 1988 (Filed as Exhibit 10(b) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (i) 1988 Long-Term Incentive Plan (Filed as Exhibit 10(h) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference). (j) Amendment to 1988 Long-Term Incentive Plan approved in December 1988 (Filed as Exhibit 10(c) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (k) Amendment to 1988 Long-Term Incentive Plan approved in June 1989 (Filed as Exhibit 10(j) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (l) Agreement dated as of May 1, 1989 between the Company and R. N. Daniel (Filed as Exhibit 10(k) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (m) Amendment to Agreement between the Company and R. N. Daniel approved by the Company on May 11, 1993. (n) Supplemental Executive Retirement Plan approved by the Company in September, 1989 (Filed as Exhibit 10(l) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference).\n(o) Outside Directors Stock Option Plan (Filed as Exhibit 10(m) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference. (p) Amended and Restated Joint Venture Agreement dated as of June 1, 1990 by and between Allen Heat Transfer Products Inc. and Handy & Harman Radiator Corporation (Filed as Exhibit (2) to the Company's Report on Form 8-K for June 1990 and incorporated herein by reference). (q) Handy & Harman Long-Term Incentive Stock Option Plan (Filed as Exhibit 10(p) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (r) Handy & Harman Supplemental Executive Plan (Filed as Exhibit 10(q) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference). (11) Statement re computation of per share earnings. Incorporated by reference to item (g) of Summary of Significant Accounting Policies on page 27 of the Annual Report. (13) Pages 17 through 34 of the Company's Annual Report to Shareholders for 1993. Except for those portions which are expressly incorporated by reference in this Annual Report on Form 10-K, this exhibit is furnished for the information of the\nCommission and is not deemed to be filed as part of this Annual Report on Form 10-K. (22) List of Subsidiaries of the Company is filed as Exhibit 22 to this Annual Report on Form 10-K. (24) Report and Consent of Independent Auditors. Included as part of the Report and Consent of Independent Auditors on page filed with the Financial Statement Schedules as part of this Annual Report on Form 10-K pursuant to Part IV hereof and incorporated herein by reference thereto. (b) Reports on Form 8-K The Company did not file a Report on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1993. For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby under- takes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 2-78264 (filed July 1, 1982), 33-37919 (filed November 21, 1990) 33-43709 (filed October 31, 1991): Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange\nCommission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the regis- trant in the successful defense of any action, suit or proceed- ing) is asserted by such director, officer or controlling person in connection with the securities being registered, the regis- trant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnifica- tion by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Handy & Harman has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHANDY & HARMAN\nDated: March 24, 1994 By \/s\/ R. N. Daniel ---------------------- R.N. Daniel\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company, in the capacities and on the respective dates indicated.\nREPORT AND CONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Handy & Harman:\nUnder the date of February 18, 1994 we reported on the consolidated balance sheet of Handy & Harman and Subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 Annual Report to Shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year 1993. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules on pages S-1, S-2, S-3 and S-4. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statement schedules based on our audits.\nIn our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nWe also consent to the incorporation by reference in the Registration Statements on Form S-8 (Registration Nos. 2-78264, 33-37919 and 33-43709) of Handy & Harman of our report dated February 18, 1994.\nKPMG PEAT MARWICK\nNew York, New York March 24, 1994 HANDY & HARMAN AND SUBSIDIARIES S-1 SCHEDULE V PROPERTY, PLANT AND EQUIPMENT (Thousands of Dollars)\n(a) Amounts represent transfers to depreciable assets in excess of new construction in progress. (b) The translation adjustment results from restating the property, plant and equipment of the Company's Canadian and British subsidiaries in U.S. dollars. (c) Amounts represent reclass of discontinued operations property, plant and equipment. (d) Amounts represent reclass of discontinued operations property, plant and equipment and contribution of machinery and equipment to Joint Venture. (e) Amounts include reclass of machinery and equipment to assets held for resale.\nNote: The depreciation and amortization policy is to provide for retirement of property at the end of its estimated useful life, determined as follows:\nHANDY & HARMAN AND SUBSIDIARIES S-2 SCHEDULE VI ACCUMULATED DEPRECIATION, DEPLETION, AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (Thousands of Dollars)\n(a) The translation adjustment results from restating the accumulated depreciation of the Company's Canadian and British subsidiaries in U.S. dollars. (b) Amounts represent reclass for discontinued operations property, plant and equipment. (c) Amounts represent reclass for discontinued operations property, plant and equipment and contribution of machinery and equipment to Joint Venture. (d) Amounts include reclass of machinery and equipment to assets held for resale. HANDY & HARMAN AND SUBSIDIARIES S-3\nSCHEDULE VIII\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES (Thousands of Dollars)\n(1) 1,530 of the provision for doubtful accounts was part of continuing operations' reserve for restructuring, nonrecurring and unusual charges.\n(b) Items determined to be uncollectible, less recovery of amounts reviously written off.\n(c) $1,165 of allowance for doubtful accounts receivable reclassed to current assets of discontinued operations. HANDY & HARMAN AND SUBSIDIARIES S-4 SCHEDULE X\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nThree Years Ended December 31, 1993\n(Thousands of Dollars)\nEXHIBIT INDEX\nExhibit Number Description ------- -----------\n(3) Certificate of Incorporation and By-Laws. (a) The Restated Certificate of Incorporation of Handy & Harman (Filed as Exhibit 3(a) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (b) The By-Laws as amended (Filed as Exhibit 3(b) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference). (4) Instruments defining the rights of security holders, including indentures. (a) Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent (Filed as Exhibit 4(a) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (b) Short Term Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemi- cal Bank, as Co-Agents and The Bank of Nova Scotia, as the Administrative Agent (Filed as Ex- hibit 4(b) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (c) Amendment to Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent (filed as Exhibit 4(e) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference). (d) Amendment to Short Term Revolving Credit Agreement dated as of March 16, 1992 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia, as the Administrative Agent (filed as Exhibit 4(d) to the Company's Annual Report on Form 10- K and incorporated herein by reference). (e) Amendment to Revolving Credit Agreement dated February 4, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent. (f) Amendment to Short Term Revolving Credit Agreement dated February 4, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and the Bank of Nova Scotia, as the Administrative Agent. (g) Amendment to Revolving Credit Agreement dated July 1, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and The Bank of Nova Scotia as the Administrative Agent. (h) Amendment to Short Term Revolving Credit Agreement dated July 1, 1993 among the Company, certain financial institutions as lenders, The Bank of Nova Scotia, The Chase Manhattan Bank, N.A. and Chemical Bank, as Co-Agents and the Bank of Nova Scotia, as the Administrative Agent. No other required to be filed. The Company agrees to furnish to the Securities and Exchange Commission upon its request therefor a copy of each instrument omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K.\n(10) Material contracts. (a) 1982 Stock Option Plan (Filed as Exhibit 1 to the Company's Registration Statement on Form S-8 (Registration No. 2-78264) under the Securities Act of 1933 and incorporated herein by reference). (b) Amendment to 1982 Stock Option Plan approved in December 1988 (Filed as Exhibit 10(a) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (c) Management Incentive Plan, as amended February 26, 1981 (Filed as Exhibit 10(b) to the Company's 1980 Annual Report on Form 10-K and incorporated herein by reference thereto). (d) Amendment to Management Incentive Plan approved in December 1988 (Filed as Exhibit 10(d) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (e) Amendment to Management Incentive Plan approved in October 1991 (Filed as Exhibit 10(e) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (f) Deferred Fee Plan For Directors, as amended February 26, 1981 (Filed as Exhibit 10(c) to the Company's 1980 Annual Report on Form 10-K and incorporated herein by reference thereto). (g) Form of Executive Agreement entered into with the Company's executive officers in September 1986 (Filed as Exhibit 10(d) to the Company's 1986 Annual Report on Form 10-K and incorporated herein by reference thereto). (h) Amendment to Executive Agreement approved in December 1988 (Filed as Exhibit 10(b) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (i) 1988 Long-Term Incentive Plan (Filed as Exhibit 10(h) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference). (j) Amendment to 1988 Long-Term Incentive Plan approved in December 1988 (Filed as Exhibit 10(c) to the Company's Report on Form 8-K for December 1988 and incorporated herein by reference). (k) Amendment to 1988 Long-Term Incentive Plan approved in June 1989 (Filed as Exhibit 10(j) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (l) Agreement dated as of May 1, 1989 between the Company and R. N. Daniel (Filed as Exhibit 10(k) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (m) Amendment to Agreement between the Company and R. N. Daniel approved by the Company on May 11, 1993. (n) Supplemental Executive Retirement Plan approved by the Company in September, 1989 (Filed as Exhibit 10(l) to the Company's 1989 Annual Report on Form 10-K and incorporated herein by reference). (o) Outside Directors Stock Option Plan (Filed as Exhibit 10(m) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference. (p) Amended and Restated Joint Venture Agreement dated as of June 1, 1990 by and between Allen Heat Transfer Products Inc. and Handy & Harman Radiator Corporation (Filed as Exhibit (2) to the Company's Report on Form 8-K for June 1990 and incorporated herein by reference). (q) Handy & Harman Long-Term Incentive Stock Option Plan (Filed as Exhibit 10(p) to the Company's 1991 Annual Report on Form 10-K and incorporated herein by reference). (r) Handy & Harman Supplemental Executive Plan (Filed as Exhibit 10(q) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference).\n(11) Statement re computation of per share earnings. Incorporated by reference to item (g) of Summary of Significant Accounting Policies on page 27 of the Annual Report. (13) Pages 17 through 34 of the Company's Annual Report to Shareholders for 1993. Except for those portions which are expressly incorporated by reference in this Annual Report on Form 10-K, this exhibit is furnished for the information of the Commission and is not deemed to be filed as part of this Annual Report on Form 10-K. (22) List of Subsidiaries of the Company is filed as Exhibit 22 to this Annual Report on Form 10-K. (24) Report and Consent of Independent Auditors. Included as part of the Report and Consent of Independent Auditors on page filed with the Financial Statement Schedules as part of this Annual Report on Form 10-K pursuant to Part IV hereof and incorporated herein by reference thereto.","section_15":""}
{"filename":"20290_1993.txt","cik":"20290","year":"1993","section_1":"Item 1. Business--Registrant (CG&E and Subsidiaries) - ------- --------------------------------------------\nGeneral - -------\nCG&E and its subsidiary companies, The Union Light, Heat and Power Company (Union Light), Miami Power Corporation, The West Harrison Gas and Electric Company, and Lawrenceburg Gas Company, operate in contiguous territories. Tri-State Improvement Company is a wholly-owned real estate development company. CGE Corp, a wholly-owned non-regulated subsidiary of CG&E formed in 1994, serves as the parent company of two non-utility subsidiaries, Enertech Associates International Inc., which provides energy related services, and CG&E Resource Marketing, Inc., which provides gas marketing services. All of the companies are managed by substantially the same officers.\nCG&E and its subsidiaries are primarily engaged in providing electric and gas service in the southwestern portion of Ohio and adjacent areas in Kentucky and Indiana. The area served with electricity or gas, or both, covers approximately 3,000 square miles with an estimated population of 1.8 million and includes the cities of Cincinnati and Middletown in Ohio, Covington and Newport in Kentucky, and Lawrenceburg in Indiana. The area is, for the most part, heavily populated and highly industrialized. The industrial activities are diversified and include the manufacturing or processing of iron and steel, machinery and machine tools, non-ferrous metals, jet engines, transportation equipment, fabricated metal products, industrial chemicals, soaps and detergents, food and beverage products, paper and printing, electrical machinery, rubber and plastic products, and petroleum refining and related products.\nMerger Agreement - ----------------\nIn December 1992, CG&E, PSI Resources, Inc. (PSI) and PSI Energy, Inc., PSI's principal subsidiary, an Indiana electric utility (PSI Energy), entered into an agreement which, as subsequently amended (the Merger Agreement) provides for the merger of PSI into a newly formed corporation named CINergy Corp. (CINergy) and the merger of a newly formed subsidiary of CINergy into CG&E. For 1993, PSI had operating revenues of $1.1 billion and earnings on common shares of $96.4 million. As a result of the merger, holders of CG&E Common Stock and PSI Common Stock will become the holders of CINergy Common Stock. CINergy will become a holding company required to be registered under the Public Utility Holding Company Act of 1935 (PUHCA) with two operating subsidiaries, CG&E and PSI Energy. Union Light will remain a subsidiary of CG&E. Under the Merger Agreement, each share of CG&E Common Stock will be converted into the right to receive one share of CINergy Common Stock. Each share of PSI Common Stock will be converted into the right to receive that number of shares of CINergy Common Stock obtained by dividing $30.69 by the\naverage closing price of CG&E Common Stock for the 15 consecutive trading days preceding the fifth trading day prior to the merger; provided that, if the actual quotient obtained thereby is less than .909, the quotient shall be .909, and if the actual quotient obtained thereby is more than 1.023, the quotient shall be 1.023. At December 31, 1993, CG&E and PSI had 88.1 million and 57.0 million common shares outstanding, respectively.\nThe merger will be accounted for as a \"pooling of interests\", and it is anticipated that the transaction will be completed in the third quarter of 1994. The merger is subject to approval by the Securities and Exchange Commission (SEC) and the Federal Energy Regulatory Commission (FERC). Shareholders of both companies approved the merger in November 1993.\nFERC issued conditional approval of the CINergy merger in August 1993, but several intervenors, including The Public Utilities Commission of Ohio (PUCO) and the Kentucky Public Service Commission (KPSC), filed for rehearing of that order. On January 12, 1994, FERC withdrew its conditional approval of the merger and ordered the setting of FERC-sponsored settlement procedures to be held.\nOn March 4, 1994, CG&E reached a settlement agreement with the PUCO and the Ohio Office of Consumers' Counsel (OCC) on merger issues identified by FERC. On March 2, PSI Energy and Indiana's consumer representatives had reached a similar agreement. Both settlement agreements have been filed with FERC. These documents address, among other things, the coordination of state and federal regulation and the commitment that neither CG&E nor PSI electric base rates, nor CG&E's gas base rates, will rise because of the merger, except to reflect any effects that may result from the divestiture of CG&E's gas operations if ordered by the SEC in accordance with the requirements of PUHCA discussed below.\nCG&E also filed with FERC a unilateral offer of settlement addressing all issues raised in the KPSC's application for rehearing with FERC. Although it is the belief of CG&E and PSI that no state utility commissions have jurisdiction over approval of the proposed merger, an application has been filed with the KPSC to comply with the Staff of the KPSC's position that the KPSC's authorization is required for the indirect acquisition of control of CG&E's Kentucky subsidiary, The Union Light, Heat and Power Company, by CINergy. As part of the settlement offer, Union Light will agree not to increase gas base rates as a result of the merger except to reflect any effects that may result from the divestiture of Union Light's gas operations discussed below.\nAlso included in the filings with FERC were settlement agreements with the city of Hamilton, Ohio, and the Wabash Valley Power Association in Indiana. These agreements resolve issues related to the transmission of power in Ohio and Indiana.\nIf the settlement agreements filed with FERC are not acceptable, FERC could set issues for hearing. If a hearing is held by FERC, consummation of the merger would likely be extended beyond the third quarter of 1994.\nCG&E and PSI also submitted to FERC the operating agreement among CINergy Services, Inc., a subsidiary of CINergy, and CG&E and PSI Energy that provides for the coordinated planning and operation of the electric generation and transmission and other facilities of CG&E and PSI as an integrated utility system. It also establishes a framework for the equitable sharing of the benefits and costs of such coordinated operations between CG&E and PSI. The parties to the Ohio and Indiana FERC settlements have agreed to support or not oppose the operating agreement, and the settlements are conditioned upon FERC approving the filed operating agreement without material changes.\nCG&E's filing with FERC also references a separate agreement among CG&E, the Staff of the PUCO, the OCC, and other parties settling issues raised by a November 1993 ruling of the Supreme Court of Ohio on the phased-in electric rate increase ordered by the PUCO in May 1992. The agreement includes a moratorium on increases in base electric rates prior to January 1, 1999 (except under certain circumstances), authorization for CG&E to retain all non-fuel merger savings until 1999, and a commitment by the PUCO that it will support CG&E's efforts to retain CG&E's gas operations in its PUHCA filing with the SEC (see below). Reference is made to \"Rate Matters\" for additional information.\nPUHCA imposes restrictions on the operations of registered holding company systems. Among these are requirements that securities issuances, sales and acquisitions of utility assets or of securities of utility companies and acquisitions of interests in any other business be approved by the SEC. PUHCA also limits the ability of registered holding companies to engage in non-utility ventures and regulates holding company system service companies and the rendering of services by holding company affiliates to the system s utilities. The SEC has interpreted the PUHCA to preclude registered holding companies, with some exceptions, from owning both electric and gas utility systems. The SEC may require that CG&E divest its gas properties within a reasonable time after the merger in order to approve the merger as it has done in many cases involving the acquisition by a holding company of a combination gas and electric company. In some cases, the SEC has allowed the retention of the gas properties or deferred the question of divestiture for a substantial period of time. In those cases in which divestiture has taken place, the SEC usually has allowed companies sufficient time to accomplish the divestiture in a manner that protects shareholder value. CG&E believes good arguments exist to allow retention of the gas assets, and CG&E will request that it be allowed to do so.\nDiscussions contained in the following pages of this Report, except where noted, pertain to CG&E and its subsidiary companies, and projections or estimates contained therein do not reflect the pending merger.\nGeneral Problems of the Industry - --------------------------------\nCG&E is experiencing, or may experience in the future, certain problems which are general to the utility industry, including increased costs of complying with evolving environmental regulations, uncertainty regarding adequate and timely rate treatment for operating expenses and costs incurred in constructing facilities, uncertainty as to the deregulation of the utility industry (primarily resulting from the Energy Policy Act of 1992 (Energy Act)), uncertainties in the gas industry resulting from FERC Order 636, difficulty in accurately forecasting demand for utility service, and the effects of customer conservation practices on gas and electric usage. Reference is made to \"Electric Operations and Fuel Supply\" and \"Gas Operations and Gas Supply\" herein regarding the Energy Act and FERC Order 636, respectively.\nConstruction Program and Capital Requirements - ---------------------------------------------\nA comparison of actual and estimated construction programs, including allowance for funds used during construction, for CG&E and its subsidiaries for the years 1993-1998 is set forth below. These estimates are under continuing review and subject to adjustment.\nDuring 1994-1998, long-term debt of CG&E and its subsidiaries will mature or be subject to mandatory redemption as follows: $.3 million in 1994 and $130 million in 1997. For information relating to the redemption of preferred stock, see Note 4 to the Consolidated Financial Statements.\nCG&E, The Dayton Power and Light Company (DP&L), and Columbus Southern Power Company (Columbus) have constructed electric generating units and related transmission facilities on varying common ownership bases as set forth in Note 10 to the Consolidated Financial Statements. Agreements among CG&E, DP&L, and Columbus obligate each company, severally and not jointly, to pay the cost of constructing and operating only its ownership share of commonly owned electric facilities. Each of the three companies is paying its share of the cost of operating commonly owned facilities.\nReference is made to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Environmental Matters\" herein for information as to estimated capital expenditures relating to compliance with the Clean Air Act Amendments of 1990.\nElectric Operations and Fuel Supply - -----------------------------------\nDuring 1993, almost all of the electricity generated by units owned by CG&E or in which it has an ownership interest was produced by coal-fired generating units. Those units generate most of the electric requirements of CG&E and its subsidiaries. A new all-time electric system peak load of 4,493,000 Kw was set on July 28, 1993. This was 8.0% greater than the previous record of 4,161,000 Kw set in 1991. For the next five years (1994-1998) peak demands are expected to increase at an average annual rate of 1.8%. CG&E's presently installed summer net generating capability is 5,120,750 Kw, consisting of 1,884,400 Kw of capacity which it solely owns, and 3,236,350 Kw of capacity which is its interest in units commonly owned with Columbus and\/or DP&L. In addition, CG&E, DP&L, and Columbus have a commonly owned transmission network, and CG&E has interconnections with other utilities for the purchase, sale, and interchange of electricity.\nCG&E and East Kentucky Power Cooperative, Inc. have an agreement for the interchange of electric power, subject to availability, during certain times of the year through March 2000. Under the agreement, CG&E, a summer peaking company, has the right to obtain up to 150 megawatts of electricity through March 31, 1997 and up to 50 megawatts from April 1, 1997 through March 31, 2000 from East Kentucky Power during the months of June, July and August. East Kentucky Power, a winter peaking company, has the right to receive up to 150 megawatts through March 31, 1997 and up to 50 megawatts from April 1, 1997 through March 31, 2000 from CG&E in December, January and February.\nCG&E currently attempts to maintain its coal inventory at a supply of approximately 50 days. On December 31, 1993, based on an estimated daily burn, the coal reserve for the four coal-burning stations (W. C. Beckjord, East Bend, Miami Fort and Zimmer Stations) operated by CG&E represented a 49-day supply. Based upon information received from DP&L and Columbus, the reserve at Stuart and Killen Stations (operated by DP&L) represented a 52-day supply, and the reserve at Conesville Station (operated by Columbus) represented a 107-day supply.\nThe coal requirements for generating units operated by CG&E (including commonly owned units) were approximately 9.1 million tons in 1993, and are estimated to be 9.8 million tons in 1994. The coal required for units commonly owned with and operated by DP&L or Columbus is obtained by them.\nA major portion of the coal required by CG&E is obtained through contract purchases, with the remaining requirements purchased on the spot market. The prices to be paid by CG&E under its contracts are subject to adjustment to reflect suppliers' costs and certain other factors, and the contracts may be terminated by virtue of certain provisions pertaining to coal quality. The coal delivered under these contracts is primarily from mines located in Ohio, Kentucky, West Virginia and Pennsylvania. CG&E intends to continue purchasing a portion of its coal requirements on the spot market.\nCG&E believes that it will be able to obtain sufficient coal to meet its generating requirements. The average sulfur content of coal to be supplied to CG&E under its present contracts will permit compliance with the current Federal sulfur dioxide plan for Ohio (see \"Environmental Matters--Air Quality\"). CG&E is unable to predict the extent to which coal availability and price may ultimately be affected by future environmental requirements, although CG&E expects the cost of coal to rise in the long run as the supply of more accessible and higher-grade coal diminishes and as mining, transportation, and other related costs continue an upward trend.\nThe Energy Policy Act of 1992 addresses several matters affecting electric utilities including mandated open access to the electric transmission system and greater encouragement of independent power production and cogeneration. Although CG&E cannot predict the long-term consequences the Energy Act will have, CG&E intends to aggressively pursue the opportunities presented by the Act.\nAdministrative rules of the PUCO on integrated resource planning (IRP) require electric utilities to show that least-cost options are pursued when planning for future load growth. The primary emphasis of IRP is on procedures for the evaluation of long-term electric forecasts and the integration of demand and supply alternatives for meeting future electric needs. In February 1994, the PUCO approved CG&E's 1992 Electric Long-Term Forecast Report, which included its IRP.\nIn December 1992, the PUCO issued proposed rules to establish competitive bidding for new power capacity additions and transmission access. The proposed rules purport to require open access to the intrastate transmission grid for winning bidders for that amount of capacity offered by the winning bidders. While bidding is not mandatory, if a utility decides not to conduct a competitive bidding to meet additional capacity needs, the utility must demonstrate that, in developing its IRP, it considered all reasonable and practical resource options. CG&E is awaiting the issuance of final rules to determine the effect, if any, on its electric operations.\nGas Operations and Gas Supply - -----------------------------\nIn 1992, FERC issued Order 636 which restructures the relationships between interstate gas pipeline companies and their customers for gas sales and transportation services. Order 636 has changed the way CG&E and Union Light purchase gas supplies and contract for transportation and storage services. CG&E and Union Light have contracts that provide adequate supply and storage capacity, including transportation services, to meet normal demand, as well as unanticipated load swings. CG&E and Union Light expect to purchase approximately 5% of their annual firm gas requirements on the spot market.\nOrder 636 also allows pipelines to recover transition costs they incur in complying with the Order from customers, including CG&E and Union Light. An agreement between CG&E and residential and industrial customer groups regarding recovery of these transition costs has been submitted to the PUCO for approval. The KPSC has issued an order which allows Union Light to recover these transition costs through its purchased gas adjustment clause. Order 636 transition costs are not expected to significantly impact the Company.\nCG&E and Union Light each have an approved rate structure for the transportation of gas which contributes in making gas prices competitive with alternate fuels. CG&E and Union Light are transporting gas for more than 90 large-volume customers. Without these programs, CG&E and Union Light would have lost many of these customers to alternate fuels. CG&E and Union Light can either transport gas purchased by its customers for a transportation charge, or buy spot market gas which is then sold to customers at a rate competitive with alternate fuels.\nDue to extremely cold weather, an all-time record for 24-hour gas sendout was set on January 18, 1994. Gas customers consumed 1 million dekatherms, 8% higher than the previous record which was set in 1972.\nRegulation - ----------\nCG&E is a public utility under the laws of Ohio and is subject to regulation as to intrastate electric and gas rates and other matters by the PUCO. Rates within municipalities are subject to original regulation by the municipalities. As to intrastate rates and other matters, Union Light is regulated by the KPSC, and The West Harrison Gas and Electric Company and Lawrenceburg Gas Company by the Indiana Utility Regulatory Commission. The Ohio Power Siting Board, a division of the PUCO, has jurisdiction over the location, construction, and initial operation of new electric generating facilities, and certain electric and gas transmission lines, of the capacities presently utilized by CG&E.\nCG&E, Union Light, and Miami Power Corporation are subject to rate regulation under Part II of the Federal Power Act, principally as to CG&E's wholesale of electricity to Union Light. Transportation of gas between CG&E and Union Light is subject to regulation under the Natural Gas Act.\nCG&E and its utility subsidiaries follow the Uniform Systems of Accounts prescribed by FERC.\nCG&E is exempt from the Public Utility Holding Company Act of 1935 (PUHCA) (except Section 9(a)(2)) by virtue of having filed an exemption statement with the SEC. CINergy plans to file for registered holding company status under PUHCA (see \"Merger Agreement\").\nSee also \"Environmental Matters\".\nRate Matters - ------------\nIn April 1991, CG&E filed a request with The Public Utilities Commission of Ohio (PUCO) to increase electric rates by approximately $200 million annually. The primary reason for the request was recovery of costs associated with Zimmer Station.\nIn a 1992 rate decision, the PUCO authorized CG&E to increase electric revenues by $116.4 million to be phased in over a three-year period through annual increases of $37.8 million, $38.8 million and $39.8 million in the first, second and third years, respectively. The PUCO also disallowed from rate base approximately $230 million, representing costs related to Zimmer Station for nuclear fuel, nuclear wind-down activities during the conversion to a coal-fired facility and a portion of the allowance for funds used during construction (AFC) accrued by CG&E on Zimmer.\nIn August 1992, CG&E filed an appeal with the Supreme Court of Ohio to overturn the rate order issued by the PUCO including the rate base disallowances. In the appeal, CG&E stated that the PUCO did not have authority to order a phased-in rate increase and erroneously determined the amount of CG&E's required cash working capital.\nOn November 3, 1993, the Supreme Court of Ohio issued its decision on CG&E's appeal. The Court ruled that the PUCO does not have the authority to order a phase-in of amounts granted in a rate proceeding and remanded the case to the PUCO to set rates that provide the gross annual revenues determined in accordance with Ohio statutes. The Court also said the PUCO must provide a mechanism by which CG&E may recover costs already deferred under the phase-in plan through the date of the order on remand. At December 31, 1993, CG&E had deferred $70 million of costs, net of taxes, related to the phase-in plan. On the other issues, the Court ruled in favor of the PUCO, stating the PUCO properly determined CG&E's cash working capital allowance and properly excluded costs related to nuclear fuel, nuclear wind-down activities, and AFC from rate base. As a result of the Supreme Court decision, CG&E wrote off Zimmer Station costs of approximately $223 million, net of tax, in November 1993.\nIn March 1994, CG&E negotiated a settlement agreement with the PUCO Staff, the Ohio Office of Consumers' Counsel and other intervenors to address the November 1993 ruling by the Supreme Court of Ohio. As part of the agreement, CG&E has agreed not to seek early implementation of the third phase of the 1992 rate increase, which means the $39.8 million increase will take effect in May 1994 as originally scheduled. CG&E also agreed that it would not seek accelerated recovery of deferrals related to the phase-in plan. These deferrals will be recovered over the remaining seven year period contemplated in the 1992 PUCO order. In addition, if the merger with PSI is consummated, CG&E has agreed not to increase base electric rates prior to January 1, 1999, except for increases in taxes, changes in federal or state environmental laws, PUCO actions affecting electric utilities in general and financial emergencies.\nThe settlement agreement also permits CG&E to retain all non-fuel savings from the merger until 1999 and calls for merger-related transaction costs, or any other accounting deferrals, to be amortized over a period ending by January 1, 1999.\nOther provisions of the agreement are: (i) if the merger is not completed, CG&E can raise electric rates in May 1995 by $21 million to provide accelerated recovery of phase-in deferrals; (ii) the PUCO and OCC will have access to information about CINergy and affiliated companies; (iii) the PUCO will support, before the Securities and Exchange Commission, CG&E's efforts to retain its gas operations and other parties will not oppose efforts to retain the gas properties; and (iv) contracts of CG&E with affiliated companies under the merger that are to be filed with the Securities and Exchange Commission must first be filed with the PUCO for its review and copies provided to the OCC.\nIn September 1992, CG&E filed applications with the PUCO requesting increases in annual electric and gas revenues of approximately $86 million and $35 million, respectively. In August 1993, the PUCO approved a stipulation providing for annual increases of approximately $41 million (5%) in electric revenues and $19 million (6%) in gas revenues effective immediately. As part of the stipulation, CG&E agreed, among other things, not to increase electric or gas base rates prior to June 1, 1995. This would not include rate filings made under certain circumstances, such as to address financial emergencies or to reflect any savings associated with the prospective merger with PSI Resources, Inc. (see Note 9 to the Consolidated Financial Statements).\nIn September 1992, Union Light filed a request with the KPSC to increase annual gas revenues by approximately $9 million. Orders issued in mid-1993 by the KPSC authorized Union Light to increase annual gas revenues by $4.2 million.\nOhio's rate base law prescribes the net original cost method of determining rate base. The law permits the PUCO, at its discretion, to allow normalization of accounting for income taxes and to include in rate base construction work in progress (CWIP) on projects at least 75% complete, in an amount up to 10% of the rate base excluding CWIP. The amount of air pollution control construction, together with any other allowance for CWIP, allowed in rate base may not exceed 20% of the rate base excluding CWIP. Rate increases requested under the law will be permitted to go into effect, subject to refund, nine months after the date of filing. The law prohibits a utility from filing an application for a rate increase if it has another pending. Revenues collected after 18 months from the date of filing, without a final order of the PUCO, will not be subject to refund. The law also provides for a Consumers' Counsel to participate in rate cases before the PUCO on behalf of residential consumers.\nIn accordance with rules established by the PUCO, CG&E is permitted to make changes in the electric fuel adjustment charge every six months, following hearings by the PUCO. The rules also require reconciliation of over- or under-recovery of fuel costs and annual audits of the application of the adjustment charge and fuel procurement practices. Rules pertaining to purchased gas costs permit quarterly adjustments, reconciliation of over- or under-recovery of gas costs, and require annual hearings and audits. In conjunction with these rules, CG&E expenses the cost of fuel used to generate electricity and purchased gas costs as recovered through revenue and defers the portion of these costs recoverable or refundable in future periods.\nRules established by the KPSC pertaining to Union Light's electric fuel adjustment clause provide for public hearings at six-month intervals to review past calculations, reconciliation of over- or under-recovery of fuel costs, and a public hearing every two years to review the application of the adjustment charge and fuel procurement practices. In accordance with a purchased gas adjustment clause approved by the KPSC, Union Light is permitted to make quarterly adjustments in gas costs and reconciliation of over- or under-recovery of gas costs. In conjunction with these rules, Union Light expenses the costs of gas and electricity purchased as recovered through revenue and defers the portion of these costs recoverable or refundable in future periods.\nEnvironmental Matters - ---------------------\nGENERAL\nCG&E and its subsidiaries are subject to regulation by various Federal, state, and local authorities relative to air and water quality, solid and hazardous waste disposal, and other environmental matters. During 1993, CG&E's capital expenditures for pollution control facilities, including those commonly owned with Columbus and\/or DP&L, amounted to $26 million. During the year 1994, CG&E expects to spend $21 million for pollution control facilities. CG&E is expected to incur other substantial capital expenditures and operating costs relating to efforts to comply with environmental statutes and regulations as described below, but it is not able to estimate the expenditures and costs which would be necessary to meet environmental requirements imposed in the future by governmental authorities or to estimate the effect of delays that may result from rigid application of existing standards.\nCG&E's inability to comply with potential environmental regulations and more rigid enforcement policies with respect to existing standards and regulations could cause substantial capital expenditures in addition to those included in its construction program, and increase the cost per Kwh of generation by reducing the amount of electricity available for delivery or by necessitating increased fuel and\/or operating and capital costs, and may cause serious fuel supply problems for CG&E, or require it to cease operating a portion of its generating facilities.\nPursuant to Federal law, the Director of the Ohio Environmental Protection Agency (Ohio EPA) administers regulations prescribing air and water quality standards, and regulations pertaining to solid waste, and is generally empowered by Ohio environmental laws to issue construction and operating permits and variances for facilities which may contribute to air pollution and to issue similar permits for facilities which discharge pollutants into the waters of the state as well as permits for the disposal of solid waste. The Secretary of the Natural Resources and Environmental Protection Cabinet (NREPC) exercises similar functions in Kentucky.\nAIR QUALITY\nPursuant to the Federal Clean Air Act (Air Act), the U.S. Environmental Protection Agency (U.S. EPA) promulgated national ambient air quality standards for specified pollutants, including particulate matter, sulfur dioxide, and nitrogen oxide. The Air Act places primary responsibility on the states to develop implementation plans which include emission controls and other methods to attain those standards. All implementation plans are subject to approval by the U.S. EPA. The Ohio and Kentucky implementation plans are fully enforceable by those states and, to the extent approved by the U.S. EPA, are also enforceable by it.\nThe U.S. EPA has promulgated various regulations under the Air Act. Included are regulations dealing with significant deterioration of air quality, imposition of more stringent control standards on new emission sources, and construction of new sources in areas presently not meeting ambient air quality standards. For facilities found to be in violation of an applicable implementation plan, the Air Act provides for civil penalties of up to $25,000 per day and criminal penalties. Noncompliance penalties are also provided for and are generally based on the economic savings resulting from a failure to comply with applicable emission limitations.\nIn 1990, the Air Act was amended by adding numerous requirements including provisions pertaining to the nonattainment, hazardous air pollutant, permitting, and enforcement programs. A new acid deposition (\"acid rain\") program in the law governs emission of nitrogen oxides and establishes a cap on sulfur dioxide emissions. The Air Act requires a 10 million ton per year reduction nationwide in sulfur dioxide emissions by the year 2000, and nationwide reductions in nitrogen oxide emissions of approximately two million tons per year. The impact of these changes to the Air Act on CG&E will depend upon regulations which remain to be promulgated by the U.S. EPA. However, as a result of compliance, CG&E's operating and capital costs will increase.\nAIR ACT COMPLIANCE. In June 1992, CG&E submitted its strategy for complying with the acid rain provision of the Air Act to the PUCO, as part of its Electric Long-Term Forecast Report (Electric LTFR). An Order approving CG&E's Electric LTFR was issued by the PUCO in February 1994. In a separate PUCO filing, CG&E requested approval of its plan for compliance with Phase I of the Air Act. Approval of the compliance plan by the PUCO is needed so that the costs of compliance can be recovered through rates. In February 1994, the PUCO approved the compliance plan submitted in a stipulation and recommendation. The PUCO emphasized that the approval did not limit their authority to review CG&E's costs of compliance, and also indicated that it intended to use the approved compliance plan as a baseline to measure the effects of the proposed merger of CG&E and PSI.\nCG&E's compliance strategy is a flexible program, which will allow utilization of the emission allowance trading market as it develops and will take full advantage of CG&E's existing sulfur dioxide removal equipment. To comply with the new sulfur dioxide requirements, CG&E will increase the amount of sulfur dioxide being removed by one of its existing scrubbers and will use coal with a lower sulfur content at some of its generating stations. In addition, CG&E will rely on demand side management and energy conservation programs to reduce electric usage and demand. Reductions in nitrogen oxide emissions will be achieved by installing low nitrogen oxide burners on certain boilers. Emission monitors will be installed to continuously monitor sulfur dioxide and nitrogen oxide emissions.\nCG&E presently estimates that capital expenditures needed to comply with the Air Act will be between $125 million and $150 million through the year 2000. The construction program discussed in \"Construction Program and Capital Requirements\" herein reflects expenditures of $73 million over the next five years in order to comply with the Air Act. In addition, operating costs will also increase. These estimates are under continuing review and subject to adjustment based on such things as a change in regulatory requirements or a change in compliance strategy.\nSULFUR DIOXIDE STANDARDS. The U.S. EPA has approved portions of the Ohio EPA sulfur dioxide plan applicable to CG&E. CG&E believes that the units operated by it in Ohio are in compliance with applicable existing sulfur dioxide regulations. CG&E also believes that East Bend Unit 2 is operating in compliance with applicable existing Federal and Kentucky regulations.\nIn December 1988, the U.S. EPA notified the State of Ohio that the portion of its state implementation plan (SIP) dealing with sulfur dioxide emission limitations for Hamilton County (in southwestern Ohio) was deficient and required the Ohio EPA to develop a new SIP with revised emission limitations. The notice affects industrial and utility sources. The Ohio EPA adopted a rule that required CG&E to construct a new smoke stack for two units at CG&E's Miami Fort Generating Station, located in southwestern Hamilton County.\nIn a separate action, the U.S. EPA, in January 1991, requested that Hamilton and Butler Counties be redesignated nonattainment areas for sulfur dioxide. The State of Ohio provided a response to the U.S. EPA stating that Hamilton County should not be redesignated to nonattainment. The U.S. EPA has not taken final action on the redesignation. This action by the U.S. EPA could lead to the need for significant emission reductions at CG&E's Miami Fort Generating Station and possibly at certain peaking facilities, in addition to the new smoke stack mentioned above.\nIn August 1985, CG&E, as part of an industry group, filed a Petition for Review in the U.S. Court of Appeals for the District of Columbia Circuit and, in September 1985, filed a Petition for Reconsideration with the U.S. EPA, regarding final regulations promulgated in June 1985 which relate to the height of smokestacks at power plants. In January 1988, the Court of Appeals issued its decision upholding certain provisions and remanding others to the U.S. EPA for further rulemaking. CG&E believes that the Miami Fort Station will not be affected by the regulations. CG&E has been informed by Columbus that Conesville Unit 4 may be affected by the regulations. CG&E owns an undivided 40% interest in Unit 4. CG&E has been informed by DP&L that the Ohio EPA has determined that Killen Station will not be affected by the regulations, but that the U.S. EPA has not made its determination. CG&E owns an undivided 33% interest in Killen Station. CG&E, Columbus, and DP&L are not able to state the ultimate impact of the regulations or of the Court of Appeals' remand.\nSTATE IMPLEMENTATION PLANS. Ohio has adopted its SIP applicable to the units operated by CG&E in Ohio, portions of which have been approved by the U.S. EPA. The Ohio implementation plan requires CG&E to obtain permits from the Ohio EPA for operation of present generating facilities and for construction and operation of new facilities.\nKentucky has adopted, and the U.S. EPA has approved, its SIP which contains emission limitations and licensing requirements which are substantially similar to U.S. EPA regulations.\nAs a result of the Air Act discussed above, prior to 1995, CG&E will need to obtain an acid rain permit for those Phase I units operated by it which will be affected by the acid rain provisions of the Air Act. This permit will be issued by the U.S. EPA until Ohio and Kentucky are authorized by the U.S. EPA to issue these permits. CG&E has complied with the application procedures for the acid rain permits for the units. It has received some of the permits and is awaiting action on the remaining applications.\nCG&E has applied for or obtained all other state and federal environmental permits for all generating units operated by it.\nPARTICULATE MATTER STANDARDS. CG&E believes that existing generating units operated by it in Ohio are in compliance with applicable Federal and state standards for emission of particulate matter. East Bend Unit 2, located in Kentucky, is in compliance with applicable Federal and state standards, except for opacity standards, for which an application for a variance has been filed and is still pending.\nWATER QUALITY\nUnder the Water Act, effluent limitations requiring application of the best available technology economically achievable are to be applied, and those limitations require that no pollutants be discharged if the U.S. EPA finds elimination of such discharges is technologically and economically achievable. In 1987, the Water Act was amended to prohibit issuance of permits with less stringent effluent limitations and to increase civil and criminal penalties for violations. The Water Act provides for penalties of up to $25,000 per day for each discharge violation. CG&E believes that it is in compliance with applicable provisions of the Water Act.\nSOLID AND HAZARDOUS WASTE\nThe Resource Conservation and Recovery Act (RCRA) and the Hazardous and Solid Waste Amendments of 1984 (Amendments), which substantially expand Federal enforcement for violations of RCRA, provide for maximum corporate fines of $1 million. The Amendments provide for a deferral of the identification as a hazardous waste of high volume solid wastes of the type generated at CG&E's electric generating stations, such as fly ash, bottom ash, boiler slag, and flue gas emission control waste. In August 1993, the U.S. EPA made the regulatory determination that these generating station products should not be regulated under RCRA. Additional waste streams are under study and a determination is expected by 1998. The Amendments also provide that the states may adopt regulations governing the treatment, processing, and storage of hazardous wastes which are more stringent than the Federal regulations. RCRA Amendment provisions include a regulatory program for performance standards for new underground storage tanks as well as standards covering leak detection, leak prevention and corrective action for both new and existing underground storage tanks.\nThe Comprehensive Environmental Response Compensation and Liability Act (CERCLA) expanded reporting and liability requirements covering the release of hazardous substances into the environment. Some of these substances, including polychlorinated biphenyls (PCBs), a substance regulated under the Toxic Substances Control Act, are contained in certain equipment currently used by CG&E and its subsidiaries. CG&E cannot predict the occurrence and effect of a release of such substances.\nCERCLA provides, among other things, for a trust fund, drawn from industry and Federal appropriations, to finance clean up and containment efforts of improperly managed hazardous waste sites. Under CERCLA, and other laws, responsible parties may be strictly, and jointly and severally, liable for money expended by the government to take necessary corrective action at such sites.\nIn October 1986, the Superfund Amendments and Reauthorization Act of 1986 (SARA) was signed into law. SARA significantly amended CERCLA and established programs dealing with emergency preparedness and community right-to-know, leaking underground storage tanks, and other matters. SARA provides for a significant increase in CERCLA funding, adopts strict cleanup standards and schedules, places limitations on the timing and scope of court review of government cleanup decisions, authorizes state and citizen participation in cleanup plans, enforcement actions, and court proceedings, including provision for citizens' suits against both private and public entities to enforce CERCLA's requirements, expands liability provisions, and increases civil and criminal penalties for violations of CERCLA.\nIn June 1991, CG&E was notified by the U.S. EPA that, in accordance with CERCLA, the U.S. EPA alleges that CG&E is a Potentially Responsible Party (PRP) liable for cleanup of the United Scrap Lead site in Troy, Ohio. CG&E was one of approximately 200 companies so notified. CG&E believes it is not a PRP and should not be responsible for cleanup of the site. Under CERCLA, CG&E could be jointly and severally liable for costs incurred in cleaning the site, estimated by the U.S. EPA to be $27 million.\nEmployee Relations - ------------------\nCG&E and its subsidiaries presently have about 5,000 employees, of whom about 3,300 belong to bargaining units. Approximately 1,600 employees are represented by the International Brotherhood of Electrical Workers (IBEW), 500 by the United Steelworkers of America (USWA) and 1,200 by the Independent Utilities Union (IUU).\nThe collective bargaining agreements with the IBEW and the USWA expire on April 1, 1994 and May 15, 1994, respectively. The three year agreement with the IUU, which expires in March 1995, has a wage reopener for the third year of the contract. Negotiations with the IBEW and IUU are presently under way.\nExecutive Officers of the Registrant - ------------------------------------ Term Name Position Age Began - ---- -------- --- -----\nJackson H. Randolph Chairman of the Board, 5\/19\/93 President and Chief Executive Officer 63 10\/ 1\/86 C. Robert Everman Senior Vice-President--Finance 57 2\/ 1\/87 Robert P. Wiwi Senior Vice-President--Customer and Corporate Services 52 2\/ 1\/87 Donald R. Blum Secretary 62 4\/26\/78 Terry E. Bruck Vice-President--Electric Operations 48 4\/21\/88 Daniel R. Herche Controller 47 2\/ 1\/87 Donald I. Marshall Vice-President--Rates and Economic Research 47 4\/17\/91 James J. Mayer Vice-President and 9\/18\/91 General Counsel 55 1\/ 1\/86 Stephen G. Salay Vice-President--Electric Production and Fuel Supply 57 4\/21\/88 William L. Sheafer Treasurer 50 2\/ 1\/87 George H. Stinson Vice-President--Gas Operations 48 1\/16\/91 W. Denis Waymire Vice-President--Marketing and Customer Relations 61 10\/ 1\/89\nAll of the executive officers of CG&E have been actively engaged in the business of the Company for more than the past five years. Officers are elected annually for a term of one year. The present terms end May 18, 1994.\nUnder the Amended and Restated Agreement and Plan of Reorganization (the Merger Agreement) by and among CG&E, PSI Resources, Inc., PSI Energy, Inc., CINergy Corp. and CINergy Sub, Inc., dated as of December 11, 1992, as amended on July 2, 1993 and as of September 10, 1993, Jackson H. Randolph will be entitled to serve as chief executive officer (CEO) of CINergy until November 30, 1995 and Chairman of CINergy until November 30, 2000. James E. Rogers, Jr., the current Chairman and CEO of PSI Resources, Inc. and Chairman, CEO and President of PSI Energy, Inc., will be entitled to serve as Vice Chairman of the Board, President and Chief Operating Officer of CINergy until November 30, 1995, at which time he will be entitled to assume the additional role of CEO. Reference is made to \"Merger Agreement\" herein for information on the proposed merger.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------- ----------\nCG&E wholly owns two of four steam electric generating units and six combustion turbine units with a combined net capability of 395,800 Kw at Miami Fort Station, located in Ohio. This station is on the Ohio River and is about 20 miles west of the center of Cincinnati. CG&E has an undivided interest in the third and fourth units, commonly owned units, at this station with CG&E's share of net capability being 320,000 Kw each.\nCG&E wholly owns five of six steam electric generating units and four combustion turbine units with a combined net capability of 890,400 Kw at the Walter C. Beckjord Station, located in Ohio. This station is on the Ohio River and is about 20 miles southeast of the center of Cincinnati. CG&E has an undivided interest in the sixth unit, a commonly owned unit, at this station with CG&E's share of net capability being 155,250 Kw.\nCG&E wholly owns six combustion turbine electric generating units with a combined net capability of 462,000 Kw at Woodsdale Generating Station, located in Ohio. This station is in Butler County and is about 24 miles north of the center of Cincinnati.\nCG&E has undivided interests in four commonly owned steam electric generating units at the J. M. Stuart Station, located in Ohio, with CG&E's share of net capability being 912,600 Kw. This station is on the Ohio River near Aberdeen, Ohio and is about 65 miles southeast of the center of Cincinnati.\nCG&E has an undivided interest in a commonly owned steam electric generating unit at the Conesville Station, located in Ohio, with CG&E's share of net capability being 312,000 Kw. This station is located on the Muskingum River and is about 60 miles east of Columbus, Ohio.\nCG&E has an undivided interest in a commonly owned steam electric generating unit at the East Bend Station, located in Kentucky, with CG&E's share of net capability being 414,000 Kw. This station is on the Ohio River and is about 40 miles southwest of the center of Cincinnati.\nCG&E has an undivided interest in a commonly owned steam electric generating unit at the Killen Station, located in Ohio, with CG&E's share of net capability being 198,000 Kw. This station is on the Ohio River and is about 80 miles southeast of the center of Cincinnati.\nCG&E has an undivided interest in a commonly owned steam electric generating unit at the Wm. H. Zimmer Generating Station, located in Ohio, with CG&E's share of net capability being 604,500 Kw. This station is located on the Ohio River near Moscow, Ohio and is about 25 miles southeast of the center of Cincinnati.\nCG&E wholly owns a combustion turbine electric generating station, Dicks Creek Station, with a net capability of 136,200 Kw. This station is located in the City of Middletown, Ohio.\nCG&E's presently installed summer net generating capability is 5,120,750 Kw.\nCG&E owns an overhead electric transmission system, an underground electric transmission system and an electric distribution system in Cincinnati, and other incorporated communities and adjacent rural territory within all or parts of the Counties of Hamilton, Butler, Warren, Clermont, Preble, Montgomery, Clinton, Highland, Adams, and Brown, in southwestern Ohio. In addition, CG&E, Columbus, and DP&L have a commonly owned transmission network. CG&E also owns electric transmission lines within the Counties of Boone, Kenton, Pendleton, and Campbell, in northern Kentucky.\nCG&E owns a 7,000,000 gallon capacity underground cavern located in the Village of Monroe, Ohio, for the storage of liquid propane and a related vaporization and mixing plant, located in Middletown, Ohio, and an 8,000,000 gallon capacity underground cavern for the storage of liquid propane and a related vaporization and mixing plant located in the City of Cincinnati, which are used primarily to augment CG&E's supply of natural gas during periods of peak demand and emergencies. CG&E has gas distribution systems in Cincinnati, Middletown, and other incorporated communities and in contiguous rural territory within all or parts of the Counties of Hamilton, Butler, Warren, Clermont, Clinton, Montgomery, Brown, and Adams, in southwestern Ohio.\nUnion Light, a subsidiary, owns an electric transmission system and an electric distribution system in Covington, Newport, and other smaller communities and in adjacent rural territory within all or parts of the Counties of Kenton, Campbell, Boone, Grant, and Pendleton, in Kentucky. Union Light owns a gas distribution system in Covington, Newport, and other smaller communities and in adjacent rural territory within all or parts of the Counties of Kenton, Campbell, Boone, Grant, Gallatin, and Pendleton, in Kentucky. Union Light owns a 7,000,000 gallon capacity underground cavern for the storage of liquid propane and a related vaporization and mixing plant and feeder lines, located in Kenton County, Kentucky near the Kentucky-Ohio line and adjacent to one of the gas lines that transports natural gas to CG&E. The cavern and vaporization and mixing plant are used primarily to augment CG&E's and Union Light's supply of natural gas during periods of peak demand and emergencies.\nLawrenceburg Gas Company, a subsidiary, owns a gas distribution system in and around Lawrenceburg, Greendale, Brookville, Rising Sun, Cedar Grove, and West Harrison, Indiana, which are adjacent to the western part of CG&E's service area. Lawrenceburg Gas is connected with and sells gas at wholesale to the City of Aurora, Indiana, and also is connected within Indiana with the lines of Texas Gas Transmission Corporation and Texas Eastern Transmission Corporation.\nThe West Harrison Gas and Electric Company, a subsidiary, renders electric service in a small community in Indiana adjacent to CG&E's service area. Miami Power Corporation, a subsidiary, owns 40 miles of 138,000 volt transmission line connecting the lines of Louisville Gas and Electric Company with those of CG&E. Tri-State Improvement Company is a wholly-owned real estate development company.\nUnder the terms of the respective mortgage indentures securing first mortgage bonds issued by CG&E and its subsidiaries, substantially all property is subject to a direct first mortgage lien.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------- -----------------\nIn March 1993, two purported class action suits were filed with the Superior Court for Hendricks County in the State of Indiana, in which PSI and 13 directors of PSI and PSI Energy were named as defendants. The complaints alleged, among other things, that the directors breached their fiduciary duties in connection with the Merger Agreement, the PSI Stock Option Agreement and the PSI Rights Agreement and sought, among other things, to enjoin the merger and to require that an auction for PSI be held. Four other purported class action suits were filed in the U.S. District Court for the Southern District of Indiana making substantially similar allegations, including alleged violations of federal securities laws. Three of these suits named CG&E and CINergy as defendants in addition to the defendants named in the state actions above.\nIn April 1993, the U.S. District Court for the Southern District of Indiana, with respect to discovery and injunctive relief, ordered five of the pending suits to be consolidated. One of the purported class action suits filed in Hendricks County was not included in the U.S. District Court's order of consolidation. In May 1993, the Shareholder Plaintiffs filed a Unified Complaint in the Consolidated Action alleging, among other things, that the PSI directors breached their fiduciary duties in connection with the merger and the PSI Rights Agreement, violated the federal securities laws and further alleging that PSI failed to hold its annual meeting of shareholders and sought, among other things, to enjoin the merger. The Consolidated Action alleged that CG&E was a primary violator and aider and abettor of the foregoing allegations.\nIn early 1994, the parties agreed to a Stipulation and Agreement of Dismissal of the Consolidated action and the one remaining suit filed in the Superior Court for Hendricks County. By the terms of the Stipulation and Agreement of Dismissal the parties agreed that since 1) the Annual Meeting of PSI stockholders was held in accordance with the orders of the U.S. District Court for the Southern District of Indiana; 2) the supplemental disclosure was made by PSI in accordance with the district court's order in August 1993; 3) PSI's nominees were elected to the Board of Directors; and 4) both PSI shareholders and CG&E shareholders have approved the merger, all class members have received all the meaningful relief they could have received through the litigation and that some or all of the claims are now moot and no longer meritorious.\nThe parties also agreed to jointly move the court for an entry 1) of a Final Order certifying the Consolidated Action as a class action on behalf of the Class for the purpose of consideration of the Final Order; 2) dismissing the Consolidated Action and remaining state action with prejudice; and 3) settling all claims between the parties except that the U.S. District Court for the Southern District of Indiana and the Superior Court for Hendricks\nCounty reserve jurisdiction to hold a hearing on the application by the Shareholder Plaintiffs for attorney fees and expenses without waiving any rights of the defendants to appeal. The Agreement of Dismissal also provides that should the court find upon plaintiff's application that attorney fees and expenses are recoverable by the Shareholder Plaintiffs, such fees and expenses shall be paid by PSI. The parties are currently awaiting a ruling from the District Court.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------- ---------------------------------------------------\n(a) A special meeting of shareholders of The Cincinnati Gas & Electric Company was held on November 16, 1993.\n(c) At the meeting, the shareholders adopted the Amended and Restated Agreement and Plan of Reorganization dated as of December 11, 1992, as amended and restated on July 2, 1993 and as of September 10, 1993 (as amended and restated, the \"Merger Agreement\"), as set forth in its entirety in the Joint Proxy Statement\/Prospectus dated October 8, 1993. Of the 87,654,430 common shares outstanding and entitled to vote at the meeting, 75,051,985 common shares were for the adoption of the Merger Agreement, 1,123,450 against, 1,138,032 abstentions and 5,367,016 broker nonvotes.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related - ------- ------------------------------------------------- Stockholder Matters -------------------\nCG&E's common stock is listed on the New York, Cincinnati, Chicago, and Pacific Stock Exchanges.\nThe table below sets forth the high and low sale prices as reported on the New York Stock Exchange-Composite and dividend information for CG&E's common stock.\nAs of December 31, 1993, CG&E had approximately 58,000 common shareholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------- -----------------------\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial - ------- ------------------------------------------------- Condition and Results of Operations -----------------------------------\nRESULTS OF OPERATIONS - ---------------------\nEarnings - --------\nThe Company incurred a loss in 1993 of $.39 per common share. The write-off of a portion of Zimmer Station, discussed below, reduced 1993 earnings per common share by $2.55. Without the write-off, earnings per share would have been $2.16, compared to $2.04 in 1992. Earnings for 1993 were positively affected by gas and electric rate increases received in 1992 and 1993, higher electric sales volumes, higher gas sales and transportation volumes and continued cost control efforts.\nOperating Revenues - ------------------\nElectric operating revenues increased $123 million in 1993 over 1992, as a result of electric rate increases granted by regulatory bodies in 1992 and 1993, and an increase in total electric sales volumes of 5.3%. In 1992, electric operating revenues increased $12 million due to rate increases granted by regulatory bodies, partially offset by a 1.4% decrease in retail\nelectric kwh sales due to mild weather. Electric operating revenues increased $27 million in 1991 primarily as a result of a 7.8% increase in retail electric sales volumes.\nGas operating revenues increased $75 million in 1993. The increase resulted from gas rate increases granted by regulatory bodies in 1993, a 7.2% increase in total volumes of gas sold and transported, and the operation of adjustment clauses reflecting an increase in the average cost of gas purchased. Gas operating revenues increased $23 million in 1992 due to a 7.3% increase in total volumes sold and transported and to the operation of adjustment clauses reflecting an increase in the average cost of gas purchased. The $53 million increase in gas operating revenues for 1991 was the result of an 8.9% increase in total volumes sold and transported and rate increases granted by regulatory bodies.\nOperating Expenses - ------------------\nGas purchased expense for 1993 increased $53 million as a result of an increase in the average cost per Mcf purchased of 17.5% and an increase in volumes purchased of 4.7%. For 1992, gas purchased expense increased $16 million as a result of an increase in volumes purchased of 1.7% and an increase in the average cost per Mcf purchased of 5.9%. Gas purchased expense increased $8 million in 1991 primarily as a result of a 3.3% increase in volumes purchased.\nFuel used in electric production increased $12 million in 1993 due to a 6.2% increase in the amount of electricity generated. Fuel used in electric production decreased $10 million in 1992 due to a 4.0% decrease in the cost of fuel per kwh generated. In 1991, fuel used in electric production decreased $6 million due to a 2.6% decrease in the amount of electricity generated.\nThe $15 million increase in other operation expense for 1993 was due to a number of factors, including wage increases, the adoption of two accounting standards involving postemployment and postretirement benefits, and increases in gas production expenses. For information on new accounting standards, see \"Future Outlook\" herein. The $22 million increase in other operation expense for 1991 was due to a number of factors, including wage increases, increases in gas and electric distribution expenses, and operating costs associated with Zimmer Station which were not being recovered in rates charged to customers.\nMaintenance expense decreased $16 million in 1992 primarily due to decreased maintenance on electric generating units and gas and electric distribution facilities.\nDepreciation expense increased $11 million in 1993 primarily due to a full year's effect of the first five units of Woodsdale Station being placed in commercial operation in 1992, and from the sixth unit being placed in commercial operation during 1993. Depreciation expense increased $10 million in 1992 primarily due to a full year's effect of Zimmer Station being placed in commercial operation in March 1991, and from the first five units at Woodsdale being placed in commercial operation in 1992. In 1991, depreciation\nexpense increased $37 million primarily due to an increase in depreciable plant resulting from Zimmer Station being placed in commercial operation.\nPost-in-service deferred operating expenses (net) of $6 million and $28 million in 1993 and 1992, respectively, reflect deferral of depreciation, operation and maintenance expenses (exclusive of fuel costs), and property taxes related to the first five units of Woodsdale Station between the time the units began commercial operation and the effective date of new rates which reflect these costs, in accordance with a stipulation approved by The Public Utilities Commission of Ohio (PUCO) in August 1993. Post-in-service deferred operating expenses in 1992 also reflect deferral of depreciation, operation and maintenance expenses (exclusive of fuel costs), and property taxes related to Zimmer Station from January 1992 through May 1992, the effective date of new rates which reflected Zimmer Station costs. In accordance with a May 1992 rate order, CG&E began amortizing the deferred expenses associated with Zimmer Station over a 10-year period. CG&E began amortizing the deferred Woodsdale expenses over a 10-year period in accordance with the stipulation approved by the PUCO in August 1993.\nPhase-in deferred depreciation was $8 million for each of 1993 and 1992 as a result of a PUCO ordered phase-in plan, in which rates charged to customers in the early years of the plan are less than that required to fully recover the depreciation expenses related to Zimmer Station (see \"Future Outlook\" herein).\nTaxes other than income taxes increased $9 million in 1993, $24 million in 1992 and $11 million in 1991 primarily due to increased property taxes resulting from a greater investment in taxable property (including Zimmer and Woodsdale Stations) and higher property tax rates in 1992 and 1991.\nOther Income and Deductions - ---------------------------\nAllowance for funds used during construction (AFC) decreased $11 million for 1993 primarily due to a decrease in construction work in progress associated with the sixth unit of Woodsdale Station being placed in commercial operation in 1993 and the first five units of Woodsdale being placed in commercial operation during 1992. AFC decreased $51 million for 1992 and $68 million in 1991 due to decreases in construction work in progress associated with Zimmer Station being placed in commercial operation in March 1991 and the commercial operation of the first five units of Woodsdale Station in 1992.\nPost-in-service carrying costs decreased $25 million in 1993 and $13 million in 1992 as a result of discontinuing the accrual of carrying costs on Zimmer Station when it was reflected in rates in May 1992. Post-in-service carrying costs for 1993 and 1992 also reflect the accrual of carrying costs on the first five units of Woodsdale Station between the time they began commercial operation and the effective date of new rates approved by the PUCO in August 1993 which reflect Woodsdale Station. Post-in-service carrying costs were $50 million for 1991 as a result of accruing carrying costs on Zimmer Station after it began commercial operation, in accordance with an order of the PUCO. In accordance with the stipulation approved by the PUCO in\nAugust 1993, CG&E began amortizing the post-in-service carrying costs on Zimmer and a portion of the carrying costs on Woodsdale over the useful life of the applicable plant.\nPhase-in deferred return was $35 million for 1993 and $27 million for 1992 as a result of the PUCO ordered phase-in plan, in which rates charged to customers in the early years of the plan will be less than that required to provide the authorized return on investment (see \"Future Outlook\" herein).\nIn November 1993, CG&E wrote off costs associated with Zimmer Station of approximately $223 million, net of taxes. The write-off represents amounts disallowed from rate base by the PUCO in its May 1992 rate order. CG&E had appealed the rate order to the Supreme Court of Ohio; however, in November 1993, the Supreme Court upheld the PUCO on the issue of the disallowance, ruling that the PUCO properly excluded costs related to nuclear fuel, nuclear wind-down activities and AFC from CG&E's rate base.\nOther (net) decreased $10 million in 1993 due to a number of factors, including costs associated with IPALCO Enterprises, Inc.'s intervention in the proposed merger between CG&E and PSI Resources.\nInterest on long-term debt increased $8 million in 1992 and $18 million in 1991 due to the issuance of additional first mortgage bonds.\nOther interest decreased $12 million for 1992 primarily due to interest accrued in 1991 on an Internal Revenue Service settlement regarding the timing of the tax deduction on the 1985 abandonment of facilities not used in the conversion of Zimmer Station.\nFUTURE OUTLOOK - --------------\nMerger Agreement - ----------------\nCG&E has entered into a merger agreement with PSI Resources, Inc., whose principal subsidiary is an Indiana electric utility with a service area contiguous to that of CG&E. Under the merger agreement, CG&E and PSI will become subsidiaries of a newly formed corporation named CINergy Corp., which will be a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA). In order to effect the merger, each share of CG&E common stock will be converted into one share of CINergy common stock, and each share of PSI common stock will be converted into that number of shares of CINergy common stock obtained by dividing $30.69 by the average closing price of CG&E common stock for the 15 trading days preceding the fifth day prior to consummation of the merger, provided that the number of shares of CINergy stock to be exchanged for each share of PSI will be no greater than 1.023 and no less than .909. At December 31, 1993, CG&E and PSI had 88.1 million and 57.0 million common shares outstanding, respectively. The merger will be accounted for as a \"pooling-of-interests\", and will be tax-free for shareholders.\nThe merger is subject to approval by the Securities and Exchange Commission (SEC) and the Federal Energy Regulatory Commission (FERC). Shareholders of each company have already approved the CINergy merger at special meetings held in November 1993.\nFERC issued conditional approval of the CINergy merger in August 1993, but several intervenors, including The Public Utilities Commission of Ohio (PUCO) and the Kentucky Public Service Commission (KPSC), filed for rehearing of that order. On January 12, 1994, FERC withdrew its conditional approval of the merger and ordered the setting of FERC-sponsored settlement procedures to be held.\nOn March 4, 1994, CG&E reached a settlement agreement with the PUCO and the Ohio Office of Consumers' Counsel (OCC) on merger issues identified by FERC. On March 2, PSI Energy and Indiana's consumer representatives had reached a similar agreement. Both settlement agreements have been filed with FERC. These documents address, among other things, the coordination of state and federal regulation and the commitment that neither CG&E nor PSI electric base rates, nor CG&E's gas base rates, will rise because of the merger, except to reflect any effects that may result from the divestiture of CG&E's gas operations if ordered by the SEC in accordance with the requirements of PUHCA discussed below.\nCG&E also filed with FERC a unilateral offer of settlement addressing all issues raised in the KPSC's application for rehearing with FERC. Although it is the belief of CG&E and PSI that no state utility commissions have jurisdiction over approval of the proposed merger, an application has been filed with the KPSC to comply with the Staff of the KPSC's position that the KPSC's authorization is required for the indirect acquisition of control of CG&E's Kentucky subsidiary, The Union Light, Heat and Power Company, by CINergy. As part of the settlement offer, Union Light will agree not to increase gas base rates as a result of the merger except to reflect any effects that may result from the divestiture of Union Light's gas operations discussed below.\nAlso included in the filings with FERC were settlement agreements with the city of Hamilton, Ohio, and the Wabash Valley Power Association in Indiana. These agreements resolve issues related to the transmission of power in Ohio and Indiana.\nIf the settlement agreements filed with FERC are not acceptable, FERC could set issues for hearing. If a hearing is held by FERC, consummation of the merger would likely be extended beyond the third quarter of 1994.\nCG&E and PSI also submitted to FERC the operating agreement among CINergy Services, Inc., a subsidiary of CINergy, and CG&E and PSI Energy that provides for the coordinated planning and operation of the electric generation and transmission and other facilities of CG&E and PSI as an integrated utility system. It also establishes a framework for the equitable sharing of the benefits and costs of such coordinated operations between CG&E and PSI. The parties to the Ohio and Indiana FERC settlements have agreed to support or not oppose the operating agreement, and the settlements are conditioned upon FERC approving the filed operating agreement without material changes.\nCG&E's filing with FERC also references a separate agreement among CG&E, the Staff of the PUCO, the OCC, and other parties settling issues raised by a November 1993 ruling of the Supreme Court of Ohio on the phased-in electric rate increase ordered by the PUCO in May 1992. The agreement includes a moratorium on increases in base electric rates prior to January 1, 1999 (except under certain circumstances), authorization for CG&E to retain all non-fuel merger savings until 1999, and a commitment by the PUCO that it will support CG&E's efforts to retain CG&E's gas operations in its PUHCA filing with the SEC (see below). Reference is made to \"Rate Matters\" for additional information.\nPUHCA imposes restrictions on the operations of registered holding company systems. Among these are requirements that securities issuances, sales and acquisitions of utility assets or of securities of utility companies and acquisitions of interests in any other business be approved by the SEC. PUHCA also limits the ability of registered holding companies to engage in non-utility ventures and regulates the rendering of services by holding company affiliates to the system's utilities. PUHCA has been interpreted to preclude the ownership of both electric and gas utility systems. As a result, the SEC may require divestiture of the Company's gas properties within a reasonable time after the merger. CG&E believes good arguments exist to allow retention of its gas assets and will request that it be allowed to do so.\nOriginally, the merger agreement provided that CG&E and PSI would be merged into CINergy as an Ohio corporation. Under this structure CG&E and PSI would have become operating divisions of CINergy, ceasing to exist as separate corporations, and CINergy would not have been subject to the restrictions imposed by PUHCA. However, The Indiana Utility Regulatory Commission (IURC) dismissed PSI's application for approval of the transfer of its license or property to a non-Indiana corporation. The IURC's decision has been appealed and the original merger structure could be reinstated if the appeal is successful.\nUnless otherwise noted, the following discussion pertains solely to CG&E and its subsidiary companies, and any projections or estimates contained therein do not reflect the pending merger.\nCapital Requirements - --------------------\nFor 1994, construction expenditures are estimated to be $192 million, including $5 million of AFC, and over the next five years, (1994-1998), construction expenditures are estimated to be $1,343 million, including $54 million of AFC. These estimates are under continuing review and subject to adjustment. Also during the next five years, a total of $142 million will be required for the redemption of long-term debt and cumulative preferred stock.\nIncluded in CG&E's five-year construction program is $566 million for electric production projects, $91 million for electric transmission facilities, $379 million in electric distribution expenditures and $224 million in gas distribution expenditures. Of the projected expenditures,\nabout $248 million is associated with construction of additional baseload and peaking capacity, some of which will be deferred under the CINergy merger.\nCapital Resources - -----------------\nInternally generated funds provided 85% of the amount needed for construction during 1993. Over the past five years, internally generated funds provided 47% of the amount needed for construction. For the next five years (1994-1998), CG&E expects funds from operations to provide a greater portion of the amount needed for construction expenditures than in the prior five-year period, primarily as a result of decreased construction requirements and the recovery through rates of CG&E's investment in Zimmer and Woodsdale Stations.\nCG&E contemplates future debt and equity financings in the capital markets and the issuance of additional shares of common stock through its employee stock purchase plans and Dividend Reinvestment and Stock Purchase Plan. Short-term indebtedness will be used to supplement internal sources of funds for the interim financing of the construction program. The Company may continue to sell additional securities, from time to time, beyond what is needed for capital requirements to allow the early refinancing of existing securities. For information regarding the refinancing of long-term debt, see Note 2 to the Consolidated Financial Statements.\nUnder the terms of CG&E's first mortgage indenture, at December 31, 1993, CG&E would have been able to issue approximately $900 million of additional first mortgage bonds at current interest rates.\nAs a result of the write-off of a portion of Zimmer Station in November 1993, CG&E will have inadequate coverage to meet the requirements of its articles of incorporation for issuing additional shares of preferred stock from March 1994 to late December 1994.\nCG&E has a $200 million bank revolving credit agreement that will expire in September 1996. The agreement provides a back-up source of funds for CG&E's commercial paper program. CG&E has not made any borrowings under this agreement.\nCG&E and its subsidiaries had lines of credit at December 31, 1993, of $123 million, of which $102 million remained unused. CG&E and its subsidiaries are currently authorized to have a maximum of $235 million of short-term notes outstanding.\nCurrent credit ratings for the Companies securities are provided in the following table.\nCG&E's securities have been placed on credit watch by Standard & Poor s and Duff & Phelps for a possible upgrade upon consummation of the merger with PSI.\nRate Matters - ------------\nOver the past two years, the Company has received a number of electric and gas rate increases that will positively impact future earnings. The primary reasons for the electric rate increases were recovery of CG&E's investment in Zimmer Station, Woodsdale Station and other facilities used to serve customers. The gas rate increases reflect investments in new and replacement gas mains and facilities. As part of an August 1993 stipulation, CG&E has agreed not to increase electric or gas base rates prior to June 1, 1995, excluding rate filings made under certain circumstances, such as to address financial emergencies or to reflect savings associated with the merger with PSI.\nIn August 1993, the PUCO approved a stipulation authorizing CG&E to increase annual electric revenues by $41.1 million and increase annual gas revenues by $19.1 million. In May 1992, the PUCO authorized CG&E to increase electric revenues by $116.4 million to be phased in over a three-year period through annual increases beginning each May of $37.8 million in 1992, $38.8 million in 1993 and $39.8 million in 1994.\nIn response to an appeal by CG&E of the PUCO's May 1992 rate order, the Supreme Court of Ohio ruled, in November 1993, that the PUCO did not have authority to order the phased-in rate increase, and remanded the case to the PUCO to set rates that provide the gross annual revenues determined in accordance with Ohio statutes. The Court also said the PUCO must provide a mechanism which allows CG&E to recover costs being deferred under the phase-in plan through the date of the order on remand. At December 31, 1993, CG&E had deferred $70 million of costs, net of taxes, related to the phase-in plan.\nIn March 1994, CG&E negotiated a settlement agreement with the PUCO Staff, the Ohio Office of Consumers' Counsel and other intervenors to address the November 1993 ruling by the Supreme Court of Ohio. As part of the agreement, CG&E has agreed not to seek early implementation of the third phase of the May 1992 rate increase, which means the $39.8 million increase will\ntake effect in May 1994 as originally scheduled. CG&E also agreed that it would not seek accelerated recovery of deferrals related to the phase-in plan. These deferrals will be recovered over the remaining seven year period contemplated in the May 1992 PUCO order. In addition, if the merger with PSI is consummated, CG&E has agreed not to increase base electric rates prior to January 1, 1999, except for increases in taxes, changes in federal or state environmental laws, PUCO actions affecting electric utilities in general and financial emergencies.\nThe settlement agreement also permits CG&E to retain all non-fuel savings from the merger until 1999 and calls for merger-related transaction costs, or any other accounting deferrals, to be amortized over a period ending by January 1, 1999.\nOther provisions of the agreement are: (i) if the merger is not completed, CG&E can raise electric rates in May 1995 by $21 million to provide accelerated recovery of phase-in deferrals; (ii) the PUCO and OCC will have access to information about CINergy and affiliated companies; (iii) the PUCO will support, before the Securities and Exchange Commission, CG&E's efforts to retain its gas operations and other parties will not oppose efforts to retain the gas properties; and (iv) contracts of CG&E with affiliated companies under the merger that are to be filed with the Securities and Exchange Commission must first be filed with the PUCO for its review and copies provided to the OCC.\nRegulation and Legislation - --------------------------\nCG&E presently estimates that capital expenditures needed to comply with the Clean Air Act Amendments of 1990 (Air Act) will be between $125 million and $150 million through the year 2000. The construction program discussed under \"Capital Requirements\" includes expenditures of $73 million over the next five years in order to comply with the Air Act. Compliance with the Air Act also will increase operating costs. CG&E expects that its cost of compliance with the Air Act will be recoverable through rates.\nIn April 1992, FERC issued Order 636 which restructures the relationships between interstate gas pipelines and their customers for gas sales and transportation services. Order 636 will result in changes in the way CG&E and Union Light purchase gas supplies and contract for transportation and storage services, and will result in increased risks in managing the ability to meet demand.\nOrder 636 also allows pipelines to recover transition costs they incur in complying with the Order from customers, including CG&E and Union Light. An agreement between CG&E and residential and industrial customer groups regarding recovery of these transition costs has been submitted to the PUCO for approval. Order 636 transition costs are not expected to significantly impact the Company.\nThe Energy Policy Act of 1992 addresses several matters affecting electric utilities including mandated open access to the electric transmission system and greater encouragement of independent power production and\ncogeneration. Although CG&E cannot predict the long-term consequences the Energy Act will have, the Company intends to aggressively pursue the opportunities presented by the Act.\nEnvironmental Issues - --------------------\nThe United States Environmental Protection Agency (U.S. EPA) alleges that CG&E is a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) liable for cleanup of the United Scrap Lead site in Troy, Ohio. CG&E was one of approximately 200 companies so named. CG&E believes it is not a PRP and should not be responsible for cleanup of the site. Under CERCLA, CG&E could be jointly and severally liable for costs incurred in cleaning the site, estimated by the U.S. EPA to be $27 million.\nAccounting Standards - --------------------\nIn recent years several new accounting standards have been issued by the Financial Accounting Standards Board. While the impact on earnings and cash flow associated with the new standards has been relatively minor, these accounting changes do affect the recognition and presentation of amounts reported in the Company's financial statements. For information in addition to that provided below on recently adopted accounting standards, see Note 1 to the Consolidated Financial Statements.\nIn 1993, CG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106). SFAS No. 106 requires the accrual of the expected cost of providing postretirement benefits other than pensions to an employee and the employee's covered dependents during the employee's active working career. SFAS No. 106 also requires the recognition of the actuarially determined total postretirement benefit obligation earned by existing retirees. In August 1993, the PUCO, under whose jurisdiction the majority of these costs fall, authorized CG&E to begin recovering SFAS No. 106 costs. The adoption of SFAS No. 106 did not have a material effect on results of operations.\nAlso in 1993, CG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). SFAS No. 109 requires deferred tax recognition for all temporary differences in accordance with the liability method, requires that deferred tax liabilities and assets be adjusted for enacted changes in tax laws or rates and prohibits net-of-tax accounting and reporting. The Company believes it is probable that the net future increases in income taxes payable will be recovered from customers through future rates and, accordingly, has recorded a net regulatory asset at December 31, 1993. Adoption of SFAS No. 109 had no impact on results of operations.\nIn 1993, CG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 112, \"Employers Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires the accrual of the cost of\ncertain postemployment benefits provided to former or inactive employees. The adoption of SFAS No. 112 did not have a material effect on results of operations.\nInflation - --------- Over the past several years, the rate of inflation has been relatively low. The Company believes that the recent inflation rates do not materially affect its results of operations or financial condition. However, under existing regulatory practice, only the historical cost of plant is recoverable from customers. As a result, cash flows designed to provide recovery of historical plant costs may not be adequate to replace plant in future years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ------- -------------------------------------------\nThe Cincinnati Gas & Electric Company And Subsidiary Companies\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CG&E and its subsidiaries follow the Uniform Systems of Accounts prescribed by the Federal Energy Regulatory Commission (FERC), and are subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\". The more significant accounting policies are summarized below:\nPRINCIPLES OF CONSOLIDATION. All subsidiaries of CG&E are included in the consolidated statements. Intercompany items and transactions have been eliminated.\nUTILITY PLANT. Property, plant and equipment is stated at the original cost of construction, which includes payroll and related costs such as taxes, pensions and other fringe benefits, general and administrative costs, and an allowance for funds used during construction.\nREVENUES AND FUEL. CG&E and its subsidiaries recognize revenues for gas and electric service rendered during the month, which includes revenue for sales unbilled at the end of each month. CG&E and The Union Light, Heat and Power Company (Union Light) expense the costs of gas and electricity purchased and the cost of fuel used in electric production as recovered through revenues and defer the portion of these costs recoverable or refundable in future periods.\nDEPRECIATION AND MAINTENANCE. The Companies determine their provision for depreciation using the straight-line method and by the application of rates to various classes of property, plant and equipment. The rates are based on periodic studies of the estimated service lives and net cost of removal of the properties. The percentages of the annual provisions for depreciation to the weighted average of depreciable property during the three years ended December 31, 1993, were equivalent to:\n1993 1992 1991 ------------------------\nElectric . . . . 2.9 2.9 3.0 Gas . . . . . . 2.7 2.6 2.6 Common . . . . . 4.0 3.1 3.1\nIn a May 1992 rate order, The Public Utilities Commission of Ohio (PUCO) authorized changes in depreciation accrual rates on CG&E's electric and common plant. The changes resulted in an annual decrease in depreciation expense of about $9 million.\nExpenditures for maintenance and repairs of units of property, including renewals of minor items, are charged to the appropriate maintenance expense accounts. A betterment or replacement of a unit of property is accounted for as an addition and retirement of property, plant and equipment. At the time of such a retirement, the accumulated provision for depreciation is charged with\nthe original cost of the property retired and also for the net cost of removal.\nINCOME TAXES. For income tax purposes, CG&E and its subsidiaries use liberalized depreciation methods and deduct removal costs as incurred. Consistent with regulatory treatment, CG&E and its subsidiaries currently provide for deferred taxes arising from the use of liberalized depreciation for operations regulated by state utility commissions, and for income tax deferrals on all timing differences for operations regulated by FERC. Although CG&E does not provide for deferred taxes resulting from the use of liberalized depreciation for property additions subject to PUCO jurisdiction made prior to October 1978, CG&E is allowed to collect through rates the income taxes payable in the future as a result of using liberalized depreciation for such property.\nCG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), in 1993. SFAS No. 109 requires deferred tax recognition for all temporary differences in accordance with the liability method, requires that deferred tax liabilities and assets be adjusted for enacted changes in tax laws or rates and prohibits net-of-tax accounting and reporting. The Company believes it is probable that the net future increases in income taxes payable will be recovered from customers through future rates and, accordingly, has recorded a net regulatory asset at December 31, 1993. Adoption of SFAS No. 109 had no impact on results of operations.\nThe following are the tax effects of temporary differences resulting in deferred tax assets and liabilities:\nThe following table reconciles the change in the net deferred tax liability to the deferred income tax expense included in the accompanying Consolidated Statement of Income for the year ended December 31, 1993:\nIn August 1993, President Clinton signed into law the Omnibus Budget Reconciliation Act of 1993. Among the Act's provisions is an increase in the corporate Federal income tax rate from 34% to 35%, retroactive to January 1, 1993. Under SFAS No. 109, the increase in the tax rate has resulted in an increase in the net deferred tax liability and in income tax related regulatory assets. In the above table, this increase in regulatory assets has been included in \"Change in amounts due from customers - income taxes\". The increase in the Federal income tax rate has not had a material impact on the Company's results of operations.\nRETIREMENT INCOME PLANS. CG&E and its subsidiaries have trusteed non-contributory retirement income plans covering substantially all regular employees. The benefits are based on the employee's compensation, years of service, and age at retirement. The Companies funding policy is to contribute annually to the plans an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes.\nThe plans funded status and amounts recognized on the Consolidated Balance Sheet for the years 1993 and 1992 are presented below:\nDuring 1992, the Company recorded $28.4 million of accrued pension cost in accordance with Statement of Financial Accounting Standards No. 88, \"Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits\". This amount represented the costs associated with additional benefits extended in connection with an early retirement program and workforce reduction discussed below.\nThe following assumptions were used in accounting for pensions:\nNet pension cost for the years 1993, 1992 and 1991 included the following components:\nEARLY RETIREMENT PROGRAM AND WORKFORCE REDUCTIONS. As a result of unfavorable rate orders received in 1992, CG&E and its subsidiaries eliminated approximately 900 regular, temporary and contract positions. The workforce reduction was accomplished through a voluntary early retirement program and involuntary separations. At December 31, 1992, the accrued liability associated with the workforce reduction was $30.4 million (including $28.4 million of additional pension benefits discussed above). In accordance with a stipulation approved by the PUCO in August 1993, CG&E is recovering the majority of these costs through rates over a period of three years. The balance of unrecovered costs at December 31, 1993, totaled $27.2 million, and is reflected in \"Other Assets--Other\" on the Consolidated Balance Sheet.\nPOSTRETIREMENT BENEFITS. Effective January 1, 1993, CG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106). SFAS No. 106 requires the accrual of the expected cost of providing postretirement benefits other than pensions to an employee and the employee s covered dependents during the employee's active working career. SFAS No. 106 also requires the recognition of the actuarially determined total postretirement benefit obligation earned by existing retirees. CG&E offers health care and life insurance benefits which are subject to SFAS No. 106.\nLife insurance benefits are fully paid by the Company for qualified employees. Eligibility to receive postretirement coverage is limited to those employees who had participated in the plans and earned the right to postretirement benefits prior to January 1, 1991.\nIn 1988, CG&E and its subsidiaries recognized the actuarially determined accumulated benefit obligation for postretirement life insurance benefits earned by retirees. The accumulated benefit obligation for active employees is being amortized over 15 years, the employees estimated remaining service lives. The accounting for postretirement life insurance benefits is not impacted by the adoption of SFAS No. 106.\nPostretirement health care benefits are subject to deductibles, copayment provisions and other limitations. Retirees can participate in health care plans by paying 100% of the group coverage premium. Prior to the adoption of SFAS No. 106, the cost of postretirement health care benefits was expensed by the Companies as paid. Beginning in 1993, the Companies began recognizing the accumulated postretirement benefit obligation over 20 years in accordance with SFAS No. 106.\nThe PUCO, under whose jurisdiction the majority of SFAS No. 106 costs fall, authorized CG&E to begin recovering these costs in September 1993. The adoption of SFAS No. 106 did not have a material effect on results of operations.\nThe net periodic postretirement cost for the Companies postretirement benefit plans for 1993 are presented below:\nThe Companies accumulated postretirement benefit obligation and accrued postretirement benefit cost under the plans at December 31, 1993 are as follows:\nThe following assumptions were used to determine the accumulated postretirement benefit obligation:\nIncreasing the assumed medical care cost trend rates by one percentage point in each year would increase the estimated accumulated postretirement benefit obligation as of December 31, 1993 by $10.5 million and the net periodic postretirement cost by $1.2 million. No funding has been established by the Companies for postretirement benefits.\nPOSTEMPLOYMENT BENEFITS. In 1993, CG&E and its subsidiaries adopted Statement of Financial Accounting Standards No. 112, \"Employers Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires the accrual of the cost of certain postemployment benefits provided to former or inactive employees. The adoption of SFAS No. 112 did not have a material effect on results of operations.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION. The applicable regulatory uniform systems of accounts define \"allowance for funds used during construction\" (AFC) as including \"the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used.\" This amount of AFC constitutes an actual cost of construction and, under established regulatory rate practices, a return on and\nrecovery of such costs heretofore has been permitted in determining the rates charged for utility services.\nFor 1993, 1992 and 1991, AFC was accrued at average pre-tax rates of 8.33%, 10.18% and 10.38%, respectively, compounded semi-annually. AFC was accrued at an average net-of-tax rate of 10.25% compounded semi-annually for 1991 on construction projects that commenced before December 31, 1982 (primarily Zimmer Station). AFC represents non-cash earnings and, as a result, does not affect current cash flow.\nPHASE-IN DEFERRED DEPRECIATION AND DEFERRED RETURN. In a 1992 rate order, the PUCO authorized CG&E an annual increase in electric revenues of approximately $116.4 million, to be phased in over a three-year period under a plan that met the requirements of Statement of Financial Accounting Standards No. 92, \"Regulated Enterprises - Accounting for Phase-in Plans\". The phase-in plan was designed so that the three rate increases will provide revenues sufficient to recover all operating expenses and provide a fair rate of return on plant investment. In the first three years of the phase-in plan ordered by the PUCO, rates charged to customers do not fully recover depreciation expense and return on shareholders investment. This deficiency is being capitalized on the Consolidated Balance Sheet and will be recovered over a 10-year period. Beginning in the fourth year, the revenue levels authorized pursuant to the phase-in plan are designed to be sufficient to recover that period's operating expenses, a fair return on the unrecovered investment, and amortization of deferred depreciation and deferred return recorded during the first three years of the plan. Under the rate order, the amount of deferred depreciation and deferred return, including carrying costs on the deferrals, estimated to be recorded in 1994 totaled approximately $15 million, net of tax, in addition to the $70 million already deferred. For information on the recovery of phase-in deferrals, the write-off of a portion of Zimmer Station and other matters related to the phased-in rate increase, see Note 5.\nPOST-IN-SERVICE DEFERRED OPERATING EXPENSES AND CARRYING COSTS. In accordance with an order of the PUCO, CG&E capitalized carrying costs for Zimmer Station from the time it was placed in service in March 1991 until the effective date of new rates authorized by the PUCO's 1992 rate order which reflected Zimmer Station. CG&E began recovering these carrying costs over the useful life of Zimmer Station in accordance with a stipulation approved by the PUCO in August 1993 (see Note 5 herein). At December 31, 1993, the unamortized amount of post-in-service carrying costs associated with Zimmer Station was $102.7 million and is reflected in \"Other Assets--Post-in-service carrying costs and deferred operating expenses\" on the Consolidated Balance Sheet.\nEffective in January 1992, the PUCO, at CG&E's request, authorized the Company to defer Zimmer Station depreciation, operation and maintenance expenses (exclusive of fuel costs) and property taxes, which were not being recovered in rates charged to customers. The PUCO also authorized CG&E to accrue carrying costs on the deferred expenses. In its 1992 rate order, the PUCO authorized CG&E to begin recovering these deferred expenses and associated carrying costs over a 10-year period. At December 31, 1993, the unamortized amount of post-in-service deferred operating expenses associated with Zimmer Station was $18.7 million and is reflected in \"Other Assets--\nPost-in-service carrying costs and deferred operating expenses\" on the Consolidated Balance Sheet.\nIn May 1992, the first three units at the Woodsdale Generating Station began commercial operation and, in July 1992, two additional units were declared operational. In accordance with an order issued by the PUCO, CG&E capitalized carrying costs on the first five units at Woodsdale Station and deferred depreciation, operation and maintenance expenses (exclusive of fuel costs) and property taxes from the time these units were placed in service until the effective date of new rates approved by the PUCO in August 1993 which reflected the Woodsdale units. CG&E began recovering a portion of carrying costs over the useful life of Woodsdale Station and the deferred expenses over a 10-year period in accordance with the stipulation approved by the PUCO in August 1993 (see Note 5 herein). At December 31, 1993, unamortized carrying costs and deferred expenses associated with Woodsdale Station were $19.2 million and $14.0 million, respectively, and are reflected in \"Other Assets--Post-in-service carrying costs and deferred operating expenses\" on the Consolidated Balance Sheet.\nSTATEMENT OF CASH FLOWS. For purposes of the Statement of Cash Flows, CG&E and its subsidiaries consider short-term investments having maturities of three months or less at time of purchase to be cash equivalents.\nThe cash amounts of interest (net of allowance for borrowed funds used during construction) and income taxes paid by CG&E and its subsidiaries in 1993, 1992 and 1991 are as follows:\n1993 1992 1991 -------- -------- -------- Interest (000).............. $151,867 $151,821 $142,269 Income taxes (000).......... $53,786 $26,021 $46,573\n(2) LONG-TERM DEBT: Under the terms of the respective mortgage indentures securing first mortgage bonds issued by CG&E and its subsidiaries, substantially all property is subject to a direct first mortgage lien.\nImprovement and sinking fund provisions contained in the indentures applicable to the First Mortgage Bonds of CG&E issued prior to 1980, and of Union Light issued prior to 1981, require deposits with the Trustee, on or before April 30 of each year, of amounts in cash and\/or principal amount of bonds equal to 1% ($4,300,000) of the principal amount of bonds of the applicable series originally outstanding less certain designated retirements.\nIn lieu of such cash deposits or delivery of bonds and as permitted under the terms of the indentures, historically the companies have followed the practice of pledging unfunded property additions to the extent of 166 2\/3% of the annual sinking fund requirements.\nOver the next five years, long-term debt of CG&E and its subsidiaries will mature or be subject to mandatory redemption as follows: $.3 million in 1994 and $130.0 million in 1997.\nIn November 1993, CG&E redeemed $280 million principal amount of First Mortgage Bonds, consisting of the 8 3\/4% Series due 1996, 9.15% Series due 2004 and 9 1\/4% Series due 2016. Reacquisition expenses associated with the extinguishment of these First Mortgage Bonds are reflected in \"Other Assets - Other\" on the Consolidated Balance Sheet ($9.5 million as of December 31, 1993) and, consistent with past regulatory treatment, are being amortized over a period of 12 years. The total balance of reacquisition expenses associated with early retirements of long-term debt reflected in \"Other Assets - Other\" on the Consolidated Balance Sheet at December 31, 1993, is $27.4 million.\nIn January 1994, the Company issued $94.7 million principal amount of pollution control revenue refunding bonds at interest rates of 5.45% and 5 1\/2%, the proceeds from which were used to refund six different series of pollution control revenue bonds with interest rates ranging from 6.70% to 9 5\/8%.\nIn February 1994, the Company issued $220 million principal amount of first mortgage bonds with interest rates of 5.80% and 6.45%, the proceeds from which will be used to refund $210 million principal amount of First Mortgage Bonds, consisting of the 8 5\/8% Series due 2000, 8.55% Series due 2006 and 9 1\/8% Series due 2008.\n(3) COMMON STOCK: On December 2, 1992, a three-for-two stock split in the form of a stock dividend was paid to shareholders of record November 2, 1992, at which time there were 57,338,284 shares of common stock outstanding. The split was accomplished through a reduction in additional paid-in capital and an increase in common shares. In connection with the split, fractional interests totalling 4,438 shares were retired for cash. The accompanying consolidated financial statements have been retroactively adjusted to reflect the split.\nCG&E issued authorized but previously unissued shares of Common Stock as follows:\nPursuant to a Shareholders Rights Plan adopted by CG&E in 1992, one right is presently attached to and trading with each share of outstanding CG&E common stock. The rights will be exercisable, if not otherwise approved by the Board of Directors, only if a person or group becomes the beneficial owner of 20% or more of CG&E's common stock, commences a tender or exchange offer for 25% or more of the common stock, or is declared an Adverse Person by the Board of Directors.\n(4) CUMULATIVE PREFERRED STOCK: Under CG&E's Articles of Incorporation, the Company presently is authorized to issue a maximum of 6,000,000 shares of preferred stock at a par value of $100 per share.\nThe Cumulative Preferred Stock, 9.15% Series is subject to mandatory redemption each July 1, beginning in 1996, in an amount sufficient to retire 25,000 shares, and the 7 3\/8% Series is subject to mandatory redemption each August 1, beginning in 1998, in an amount sufficient to retire 40,000 shares, each at $100 per share, plus accrued dividends. For both series, CG&E has the noncumulative option to redeem up to a like amount of additional shares in each year. CG&E has the option to satisfy the mandatory redemption requirements in whole or in part by crediting shares acquired by CG&E. To the extent CG&E does not satisfy its mandatory sinking fund obligation in any year, such obligation must be satisfied in the succeeding year or years. If CG&E is in arrears in the redemption pursuant to the mandatory sinking fund requirement, CG&E shall not purchase or otherwise acquire for value, or pay dividends on, Common Stock.\nThe Cumulative Preferred Stock, 7 7\/8% Series is subject to mandatory redemption on January 1, 2004, at $100 per share plus accrued dividends to the redemption date.\nOn February 25, 1994, CG&E gave notice to the holders of the Cumulative Preferred Stock, 9.28% Series of its intention to redeem all outstanding shares at $101 per share, on April 1, 1994.\n(5) RATES: In April 1991, CG&E filed a request with the PUCO to increase electric rates by approximately $200 million annually. The primary reason for the request was recovery of costs associated with Zimmer Station.\nIn a 1992 rate decision, the PUCO authorized CG&E to increase electric revenues by $116.4 million to be phased in over a three-year period through annual increases of $37.8 million, $38.8 million and $39.8 million in the first, second and third years, respectively. The PUCO also disallowed from rate base approximately $230 million, representing costs related to Zimmer Station for nuclear fuel, nuclear wind-down activities during the conversion to a coal-fired facility and a portion of the AFC accrued by CG&E on Zimmer.\nIn August 1992, CG&E filed an appeal with the Supreme Court of Ohio to overturn the rate order issued by the PUCO including the rate base disallowances. In the appeal, CG&E stated that the PUCO did not have authority to order a phased-in rate increase and erroneously determined the amount of CG&E's required cash working capital.\nOn November 3, 1993, the Supreme Court of Ohio issued its decision on CG&E's appeal. The Court ruled that the PUCO does not have the authority to order a phase-in of amounts granted in a rate proceeding and remanded the case to the PUCO to set rates that provide the gross annual revenues determined in accordance with Ohio statutes. The Court also said the PUCO must provide a mechanism by which CG&E may recover costs already deferred under the phase-in plan through the date of the order on remand. At December 31, 1993, CG&E had deferred $70 million of costs, net of taxes, related to the phase-in plan. On the other issues, the Court ruled in favor of the PUCO, stating the PUCO\nproperly determined CG&E's cash working capital allowance and properly excluded costs related to nuclear fuel, nuclear wind-down activities, and AFC from rate base. As a result of the Supreme Court decision, CG&E wrote off Zimmer Station costs of approximately $223 million, net of taxes, in November 1993.\nIn March 1994, CG&E negotiated a settlement agreement with the PUCO Staff, the Ohio Office of Consumers' Counsel and other intervenors to address the November 1993 ruling by the Supreme Court of Ohio. As part of the agreement, CG&E has agreed not to seek early implementation of the third phase of the 1992 rate increase, which means the $39.8 million increase will take effect in May 1994 as originally scheduled. CG&E also agreed that it would not seek accelerated recovery of deferrals related to the phase-in plan. These deferrals will be recovered over the remaining seven year period contemplated in the 1992 PUCO order. In addition, if the merger with PSI is consummated, CG&E has agreed not to increase base electric rates prior to January 1, 1999, except for increases in taxes, changes in federal or state environmental laws, PUCO actions affecting electric utilities in general and financial emergencies.\nThe settlement agreement also permits CG&E to retain all non-fuel savings from the merger until 1999 and calls for merger-related transaction costs, or any other accounting deferrals, to be amortized over a period ending by January 1, 1999.\nOther provisions of the agreement are: (i) if the merger is not completed, CG&E can raise electric rates in May 1995 by $21 million to provide accelerated recovery of phase-in deferrals; (ii) the PUCO and OCC will have access to information about CINergy and affiliated companies; (iii) the PUCO will support, before the Securities and Exchange Commission, CG&E's efforts to retain its gas operations and other parties will not oppose efforts to retain the gas properties; and (iv) contracts of CG&E with affiliated companies under the merger that are to be filed with the Securities and Exchange Commission must first be filed with the PUCO for its review and copies provided to the OCC.\nIn September 1992, CG&E filed applications with the PUCO requesting increases in annual electric and gas revenues of approximately $86 million and $35 million, respectively. In August 1993, the PUCO approved a stipulation providing for annual increases of approximately $41 million (5%) in electric revenues and $19 million (6%) in gas revenues effective immediately. As part of the stipulation, CG&E agreed, among other things, not to increase electric or gas base rates prior to June 1, 1995. This would not include rate filings made under certain circumstances, such as to address financial emergencies or to reflect any savings associated with the prospective merger with PSI Resources, Inc. (see Note 9).\nIn September 1992, Union Light filed a request with the Kentucky Public Service Commission (KPSC) to increase annual gas revenues by approximately $9 million. Orders issued in mid-1993 by the KPSC authorized Union Light to increase annual gas revenues by $4.2 million.\n(6) BANK LINES OF CREDIT AND REVOLVING CREDIT AGREEMENT: At December 31, 1993, CG&E and its subsidiaries had lines of credit totaling $123.4 million, which were maintained by compensating balances and\/or fees. Unused lines of credit at December 31, 1993, totaled $102.4 million (generally subject to withdrawal by the banks). Substantially all of the cash balances of CG&E and its subsidiaries are maintained to compensate the respective banks for banking services and to obtain lines of credit; however, CG&E and its subsidiaries have the right of withdrawal of such funds. The maximum amount of outstanding short-term notes payable, including commercial paper, authorized by the PUCO to be incurred by CG&E at any time through June 30, 1994 is $200 million and, in addition, FERC authorized Union Light to issue a maximum of $35 million of short-term notes payable through December 31, 1994.\nCG&E has a bank revolving credit agreement providing for borrowings of up to $200 million through September 1, 1996. At the option of CG&E, interest rates on borrowings under the agreement may be based upon the prevailing prime rate or certain other interest measurements. CG&E must pay a commitment fee of 3\/16% on the total amount of the credit agreement. CG&E has not made any borrowings under this agreement.\n(7) LEASES: CG&E and its subsidiaries have entered into operating leases covering various facilities and properties, including office space, and computer, communications and miscellaneous equipment. Rental payments for operating leases are primarily charged to operating expenses. Total rental payments for all operating leases were $21,756,000, $22,882,000 and $20,984,000 for the years 1993, 1992 and 1991, respectively. Future minimum lease payments required by CG&E and its subsidiaries under such operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1993 were as follows:\n(8) FAIR VALUE OF FINANCIAL INSTRUMENTS: The Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (SFAS No. 107), requires disclosure of the estimated fair value of certain financial instruments of the Company. This information does not purport to be a valuation of the Company as a whole.\nThe following methods and assumptions were used to estimate the fair value of each major class of financial instrument of CG&E and its subsidiaries as required by SFAS No. 107:\nCash, Notes Payable, Accounts Receivable and Accounts Payable. The carrying amount as reflected on the Consolidated Balance Sheet approximates the fair value of these instruments due to the short period to maturity.\nLong-Term Debt. The aggregate fair values for the first mortgage bonds and other long-term debt of CG&E and its subsidiaries are based on the present value of future cash flows. The discount rates used approximate the incremental borrowing costs for similar instruments. Certain notes payable have been excluded due to immateriality.\nCumulative Preferred Stock. The aggregate fair value for CG&E's preferred stock is based on the latest closing prices quoted on the New York Stock Exchange for each series.\nThe estimated fair values of long-term debt and preferred stock at December 31, 1993 and 1992, are as follows:\n(9) COMMITMENTS AND CONTINGENCIES: In December 1992, CG&E, PSI Resources, Inc. (PSI) and PSI Energy, Inc., PSI's principal subsidiary, an Indiana electric utility (PSI Energy), entered into an agreement which, as subsequently amended (the Merger Agreement) provides for the merger of PSI into a newly formed corporation named CINergy Corp. (CINergy) and the merger of a newly formed subsidiary of CINergy into CG&E. For 1993, PSI had operating revenues of $1.1 billion and earnings on common shares of $96.4 million. As a result of the merger, holders of CG&E Common Stock and PSI Common Stock will become the holders of CINergy Common Stock. CINergy will become a holding company required to be registered under the Public Utility Holding Company Act of 1935 (PUHCA) with two operating subsidiaries, CG&E and PSI Energy. Union Light will remain a subsidiary of CG&E. Under the Merger Agreement, each share of CG&E Common Stock will be converted into the right to receive one share of CINergy Common Stock. Each share of PSI Common Stock will be converted into the right to receive that number of shares of CINergy Common Stock obtained by dividing $30.69 by the average closing price of CG&E Common Stock for the 15 consecutive trading days preceding the fifth trading day prior to the merger; provided that, if the actual quotient obtained thereby is less than .909, the quotient shall be .909, and if the actual quotient obtained thereby is more than 1.023, the quotient shall be 1.023.\nThe merger will be accounted for as a \"pooling of interests\", and it is anticipated that the transaction will be completed in the third quarter of 1994. The merger is subject to approval by the Securities and Exchange Commission (SEC) and FERC. Shareholders of both companies approved the merger in November 1993.\nFERC issued conditional approval of the CINergy merger in August 1993, but several intervenors, including The Public Utilities Commission of Ohio (PUCO) and the Kentucky Public Service Commission (KPSC), filed for rehearing of that order. On January 12, 1994, FERC withdrew its conditional approval of the merger and ordered the setting of FERC-sponsored settlement procedures to be held.\nOn March 4, 1994, CG&E reached a settlement agreement with the PUCO and the Ohio Office of Consumers' Counsel (OCC) on merger issues identified by FERC. On March 2, PSI Energy and Indiana's consumer representatives had reached a similar agreement. Both settlement agreements have been filed with FERC. These documents address, among other things, the coordination of state and federal regulation and the commitment that neither CG&E nor PSI electric base rates, nor CG&E's gas base rates, will rise because of the merger, except to reflect any effects that may result from the divestiture of CG&E's gas operations if ordered by the SEC in accordance with the requirements of PUHCA discussed below.\nCG&E also filed with FERC a unilateral offer of settlement addressing all issues raised in the KPSC's application for rehearing with FERC. Although it is the belief of CG&E and PSI that no state utility commissions have jurisdiction over approval of the proposed merger, an application has been filed with the KPSC to comply with the Staff of the KPSC's position that the KPSC's authorization is required for the indirect acquisition of control of CG&E's Kentucky subsidiary, The Union Light, Heat and Power Company, by CINergy. As part of the settlement offer, Union Light will agree not to increase gas base rates as a result of the merger except to reflect any effects that may result from the divestiture of Union Light's gas operations discussed below.\nAlso included in the filings with FERC were settlement agreements with the city of Hamilton, Ohio, and the Wabash Valley Power Association in Indiana. These agreements resolve issues related to the transmission of power in Ohio and Indiana.\nIf the settlement agreements filed with FERC are not acceptable, FERC could set issues for hearing. If a hearing is held by FERC, consummation of the merger would likely be extended beyond the third quarter of 1994.\nCG&E and PSI also submitted to FERC the operating agreement among CINergy Services, Inc., a subsidiary of CINergy, and CG&E and PSI Energy that provides for the coordinated planning and operation of the electric generation and transmission and other facilities of CG&E and PSI as an integrated utility system. It also establishes a framework for the equitable sharing of the benefits and costs of such coordinated operations between CG&E and PSI. The parties to the Ohio and Indiana FERC settlements have agreed to support or not oppose the operating agreement, and the settlements are conditioned upon FERC approving the filed operating agreement without material changes.\nCG&E's filing with FERC also references a separate agreement among CG&E, the Staff of the PUCO, the OCC, and other parties settling issues raised by a November 1993 ruling of the Supreme Court of Ohio on the phased-in electric rate increase ordered by the PUCO in May 1992. The agreement includes a moratorium on increases in base electric rates prior to January 1, 1999 (except under certain circumstances), authorization for CG&E to retain all non-fuel merger savings until 1999, and a commitment by the PUCO that it will support CG&E's efforts to retain CG&E's gas operations in its PUHCA filing with the SEC (see below). Reference is made to Note 5 for additional information.\nPUHCA imposes restrictions on the operations of registered holding company systems. Among these are requirements that securities issuances, sales and acquisitions of utility assets or of securities of utility companies and acquisitions of interests in any other business be approved by the SEC. PUHCA also limits the ability of registered holding companies to engage in non-utility ventures and regulates holding company system service companies and the rendering of services by holding company affiliates to the system s utilities. The SEC has interpreted the PUHCA to preclude registered holding companies, with some exceptions, from owning both electric and gas utility systems. The SEC may require that CG&E divest its gas properties within a reasonable time after the merger in order to approve the merger as it has done in many cases involving the acquisition by a holding company of a combination gas and electric company. In some cases, the SEC has allowed the retention of the gas properties or deferred the question of divestiture for a substantial period of time. In those cases in which divestiture has taken place, the SEC usually has allowed companies sufficient time to accomplish the divestiture in a manner that protects shareholder value. CG&E believes good arguments exist to allow retention of the gas assets, and CG&E will request that it be allowed to do so.\nCG&E and its subsidiaries are subject to regulation by various Federal, state and local authorities relative to air and water quality, solid and hazardous waste disposal, and other environmental matters. Compliance programs necessary to meet existing and future environmental laws and regulations will increase the cost of utility service. Capital expenditures related to environmental compliance are included in the Companies estimated construction programs (see \"Construction Program and Capital Requirements\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" herein) and are expected to be recoverable through rates.\nIn April 1992, FERC issued Order 636 which restructures the relationships between interstate gas pipelines and their customers for gas sales and transportation services. Order 636 will result in changes in the way CG&E and Union Light purchase gas supplies and contract for transportation and storage services, and will result in increased risks in managing the ability to meet demand.\nOrder 636 also allows pipelines to recover transition costs they incur in complying with the Order from customers, including CG&E and Union Light. An agreement between CG&E and residential and industrial customer groups regarding recovery of these transition costs has been submitted to the PUCO for approval. Order 636 transition costs are not expected to significantly impact the Company.\nThe United States Environmental Protection Agency (U.S. EPA) alleges that CG&E is a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) liable for cleanup of the United Scrap Lead site in Troy, Ohio. CG&E was one of approximately 200 companies so named. CG&E believes it is not a PRP and should not be responsible for cleanup of the site. Under CERCLA, CG&E could be jointly and severally liable for costs incurred in cleaning the site, estimated by the U.S. EPA to be $27 million.\n(10) COMMON OWNERSHIP OF ELECTRIC UTILITY PLANT: CG&E, Columbus Southern Power Company, and The Dayton Power and Light Company have constructed electric generating units and related transmission facilities on varying common ownership bases as follows:\n(11) UNAUDITED QUARTERLY FINANCIAL DATA (THOUSANDS):\n(12) FINANCIAL INFORMATION BY BUSINESS SEGMENTS (THOUSANDS):\n(13) UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION: The following pro forma condensed consolidated financial information combines the historical consolidated statements of income and consolidated balance sheets of CG&E and PSI after giving effect to the merger. The unaudited Pro Forma Condensed Consolidated Statements of Income for each of the three years ended December 31, 1993, give effect to the merger as if it had occurred at January 1, 1991. The unaudited Pro Forma Condensed Consolidated Balance Sheet at December 31, 1993, gives effect to the merger as if it had occurred at December 31, 1993. These statements are prepared on the basis of accounting for the merger as a pooling of interests and are based on the assumptions set forth in the notes thereto. In addition, the following pro forma condensed consolidated financial information should be read in conjunction with the historical consolidated financial statements and related notes thereto of CG&E and PSI. The following information is not necessarily indicative of the operating results or financial position that would have occurred had the merger been consummated at the beginning of the periods, or on the date, for which the merger is being given effect, nor is it necessarily indicative of future operating results or financial position.\nPro Forma Condensed Consolidated Statements of Income (in millions, except per share amounts):\nPro Forma Condensed Consolidated Balance Sheet (in millions):\nNotes to Pro Forma Condensed Consolidated Financial Information:\n(1) Outstanding shares of CG&E common stock have been restated for a 3-for-2 stock split paid in the form of a dividend in December 1992. (2) The Pro Forma Condensed Consolidated Statements of Income reflect the conversion of each share of CG&E common stock outstanding into one share of CINergy common stock and each share of PSI common stock outstanding into (a) .909 share and (b) 1.023 shares of CINergy common stock. The actual PSI conversion ratio may be lower than 1.023 or higher than .909 depending upon the closing sales price of CG&E common stock during a period prior to the consummation of the merger. (3) The pro forma \"Common stock\" and \"Paid-in capital\" amounts reflected in the Pro Forma Condensed Consolidated Balance Sheet are based on the conversion of each share of CG&E common stock outstanding into one share of CINergy common stock ($.01 par value) and each share of PSI common stock outstanding into 1.023 shares of CINergy common stock ($.01 par value). Any PSI conversion ratio lower than 1.023 would result in a reallocation of amounts between \"Common stock\" and \"Paid-in capital\". However, any such reallocation would have no effect on \"Total common stock equity\". (4) Intercompany transactions (including purchased and exchanged power transactions) between CG&E and PSI during the periods presented were not material and accordingly no pro forma adjustments were made to eliminate such transactions. (5) Transaction costs, estimated to be approximately $47 million, are being deferred by CG&E and PSI. In a settlement agreement filed with the PUCO, CG&E has agreed to, among other things, amortize its portion of merger-related transaction costs over a period ending by January 1, 1999. CG&E will also be permitted to retain all of its non-fuel savings from the merger until 1999. For additional information on the settlement agreement, see Note 5 to the Consolidated Financial Statements. PSI's portion of the costs are being deferred for post- merger recovery through customer rates.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo The Cincinnati Gas & Electric Company:\nWe have audited the accompanying consolidated balance sheet and schedules of common shareholders' equity and cumulative preferred shares and long-term debt of THE CINCINNATI GAS & ELECTRIC COMPANY (an Ohio Corporation) and its subsidiary companies as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in common shareholders' equity and cash flows and schedule of taxes for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Cincinnati Gas & Electric Company and its subsidiary companies as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs explained in Note 1 to the consolidated financial statements, the Company changed its methods of accounting for income taxes, postretirement health care benefits and postemployment benefits effective January 1,1993.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules listed in Item 14 are presented for purposes of complying with the Securities and Exchange Commission's Rules and Regulations under the Securities Exchange Act of 1934 and are not a required part of the basic financial statements. The supplemental schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nCincinnati, Ohio, January 24, 1994.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ------- --------------------------------------------------------------- Financial Disclosure --------------------\nNot Applicable.\nPART III\nItems 10., 11., 12. and 13. - ---------------------------\nThe information required by Items 11, 12, and 13 will be included in CG&E's definitive proxy statement which will be filed with the Securities and Exchange Commission in connection with the 1994 Annual meeting of Shareholders and is incorporated herein by reference. The information regarding executive officers of CG&E, called for by Item 10, is furnished in Part I of this Annual Report.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------- ----------------------------------------------------------------\n(a) Listed below are all financial statements, schedules, and exhibits attached hereto, incorporated herein, and filed as a part of this Annual Report.\n(1) Consolidated Financial Statements:\nReport of Independent Public Accountants\nConsolidated Balance Sheet, December 31, 1993 and 1992\nConsolidated Statement of Income for the three years ended December 31, 1993\nConsolidated Statement of Cash Flows for the three years ended December 31, 1993\nConsolidated Statement of Changes In Common Shareholders' Equity for the three years ended December 31, 1993\nSchedule of Common Shareholders' Equity and Cumulative Preferred Shares, December 31, 1993 and 1992\nSchedule of Long-Term Debt, December 31, 1993 and 1992\nSchedule of Taxes for the three years ended December 31, 1993\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedules:\n#Schedule V -- Property, Plant and Equipment (1993, 1992 and 1991)\n#Schedule VI -- Accumulated Provisions for Depreciation (1993, 1992 and 1991)\n#Schedule VIII -- Other Accumulated Provisions (1993, 1992 and 1991)\n#Schedule IX -- Short-Term Borrowings (1993, 1992 and 1991)\n(3) Exhibits:\nExhibit No. ------- *2-A-1 -- Amended and Restated Agreement and Plan of Reorganization by and among CG&E, PSI Resources, Inc., PSI Energy, Inc., CINergy Corp. and CINergy Sub, Inc., dated as of December 11, 1992, as amended on July 2, 1993 and as of September 10, 1993 (filed as Annex A to Amendment No. 3 to Registration Statement No. 33-59964 on Form S-4) *2-A-2 -- Form of CG&E Stock Option Agreement by and between CG&E and PSI Resources, Inc. dated December 11, 1992 (filed as Exhibit 28 to Form 8-K dated December 11, 1992) *2-A-3 -- Form of PSI Stock Option Agreement by and among CG&E, PSI Resources, Inc. and PSI Energy, Inc. dated December 11, 1992 (filed as Exhibit 28 to Form 8-K dated December 11, 1992) 3-A-1 -- Copy of Amended Articles of Incorporation of CG&E effective January 24, 1994 *3-B -- Copy of Regulations of CG&E as amended, adopted by shareholders April 16, 1987 (filed as Exhibit 3-B to Form 10-Q for the quarter ended March 31, 1987) *4-A-1 -- Copy of Indenture between CG&E and The Bank of New York dated as of August 1, 1936 (filed as Exhibit B-2 to Registration Statement No. 2-2374) *4-A-2 -- Copy of Tenth Supplemental Indenture between CG&E and The Bank of New York dated as of July 1, 1967 (filed as Exhibit 2-B-11 to Registration Statement No. 2-26549) *4-A-3 -- Copy of Eleventh Supplemental Indenture between CG&E and The Bank of New York dated as of May 1, 1969 (filed as Exhibit 2-B-12 to Registration Statement No. 2-32063) *4-A-4 -- Copy of Twelfth Supplemental Indenture between CG&E and The Bank of New York dated as of December 1, 1970 (filed as Exhibit 2-B-13 to Registration Statement No. 2-38551)\n*4-A-5 -- Copy of Thirteenth Supplemental Indenture between CG&E and The Bank of New York dated as of November 1, 1971 (filed as Exhibit 2-B-14 to Registration Statement No. 2-41974) *4-A-6 -- Copy of Fourteenth Supplemental Indenture between CG&E and The Bank of New York dated as of November 2, 1972 (filed as Exhibit 2-B-15 to Registration Statement No. 2-60961) *4-A-7 -- Copy of Fifteenth Supplemental Indenture between CG&E and The Bank of New York dated as of August 1, 1973 (filed as Exhibit 2-B-16 to Registration Statement No. 2-60961) *4-A-8 -- Copy of Eighteenth Supplemental Indenture between CG&E and The Bank of New York dated as of October 15, 1976 (filed as Exhibit 2-B-19 to Registration Statement No. 2-57243) *4-A-9 -- Copy of Nineteenth Supplemental Indenture between CG&E and The Bank of New York dated as of April 15, 1978 (filed as Exhibit 1 to Form 10-Q for the quarter ended June 30, 1978) *4-A-10 -- Copy of Twenty-fifth Supplemental Indenture between CG&E and The Bank of New York dated as of December 1, 1985 (filed as Exhibit 4-A-20 to Form 10-K for the year ended December 31, 1985) *4-A-11 -- Copy of Twenty-ninth Supplemental Indenture between CG&E and The Bank of New York dated as of June 15, 1989 (filed as Exhibit 4-A to Form 10-Q for the quarter ended June 30, 1989) *4-A-12 -- Copy of Thirtieth Supplemental Indenture between CG&E and The Bank of New York dated as of May 1, 1990 (filed as Exhibit 4-A to Form 10-Q for the quarter ended June 30, 1990) *4-A-13 -- Copy of Thirty-first Supplemental Indenture between CG&E and The Bank of New York dated as of December 1, 1990 (filed as Exhibit 4-A-21 to Form 10-K for the year ended December 31, 1990) *4-A-14 -- Copy of Thirty-second Supplemental Indenture between CG&E and The Bank of New York dated as of December 15, 1991 (filed as Exhibit 4-A-29 to Registration Statement No. 33-45115 of CG&E) *4-A-15 -- Copy of Thirty-third Supplemental Indenture between CG&E and The Bank of New York dated as of September 1, 1992 (filed as Exhibit 4-A-30 to Registration Statement No. 33-53578 of CG&E) *4-A-16 -- Copy of Thirty-fourth Supplemental Indenture between CG&E and The Bank of New York dated as of October 1, 1993 (filed as Exhibit 4-A to Form 10-Q for the quarter ended September 30, 1993) *4-A-17 -- Copy of Thirty-fifth Supplemental Indenture between CG&E and The Bank of New York dated as of January 1, 1994 (filed as Exhibit 4-A-32 to Registration Statement No. 33-52335 of CG&E)\n*4-A-18 -- Copy of Thirty-sixth Supplemental Indenture between CG&E and The Bank of New York dated as of February 15, 1994 (filed as Exhibit 4-A-33 to Registration Statement No. 33-52335 of CG&E) *4-A-19 -- Copy of Loan Agreement between CG&E and County of Boone, Kentucky dated as of February 1, 1985 (filed as Exhibit 4-A-26 to 1984 Form 10-K of CG&E) *4-A-20 -- Copy of Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of December 1, 1985 (filed as Exhibit 4-A-28 to Form 10-K for the year ended December 31, 1985) *4-A-21 -- Copy of Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of December 1, 1985 (filed as Exhibit 4-A-29 to Form 10-K for the year ended December 31, 1985) *4-A-22 -- Copy of Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of December 1, 1985 (filed as Exhibit 4-A-30 to Form 10-K for the year ended December 31, 1985) *4-A-23 -- Copy of Repayment Agreement between CG&E and The Dayton Power and Light Company dated as of December 23, 1992 (filed as Exhibit 4-A-29 to Form 10-K for the year ended December 31, 1992) 4-A-24 -- Copy of Loan Agreement between CG&E and State of Ohio Water Development Authority dated as of January 1, 4-A-25 -- Copy of Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of January 1, 1994 4-A-26 -- Copy of Loan Agreement between CG&E and County of Boone, Kentucky dated as of January 1, 1994 *4-B-1 -- Copy of First Mortgage between Union Light and The Bank of New York dated as of February 1, 1949 (filed as Exhibit 7 to Registration Statement No. 2-7793) *4-B-2 -- Copy of Fifth Supplemental Indenture between Union Light and The Bank of New York dated as of January 1, 1967 (filed as Exhibit 2-C-6 to Registration Statement No. 2-60961 of CG&E) *4-B-3 -- Copy of Seventh Supplemental Indenture between Union Light and The Bank of New York dated as of October 1, 1973 (filed as Exhibit 2-C-7 to Registration Statement No. 2-60961 of CG&E) *4-B-4 -- Copy of Eighth Supplemental Indenture between Union Light and The Bank of New York dated as of December 1, 1978 (filed as Exhibit 2-C-8 to Registration Statement No. 2-63591 of CG&E) *4-B-5 -- Copy of Tenth Supplemental Indenture between Union Light and The Bank of New York dated as of July 1, 1989 (filed as Exhibit 4-B to Form 10-Q of CG&E for the quarter ended June 30, 1989)\n*4-B-6 -- Copy of Eleventh Supplemental Indenture between Union Light and The Bank of New York dated as of June 1, 1990 (filed as Exhibit 4-B to Form 10-Q of CG&E for the quarter ended June 30, 1990) *4-B-7 -- Copy of Twelfth Supplemental Indenture between Union Light and The Bank of New York dated as of November 15, 1990 (filed as Exhibit 4-B-8 to Form 10-K for the year ended December 31, 1990) *4-B-8 -- Copy of Thirteenth Supplemental Indenture between Union Light and The Bank of New York dated as of August 1, 1992 (filed as Exhibit 4-B-9 to Form 10-K for the year ended December 31, 1992) *4-C -- Rights Agreement between The Cincinnati Gas & Electric Company and The Fifth Third Bank, as Rights Agent, dated as of July 15, 1992 (filed as Exhibit 4 to Form 8-K dated June 17, 1992) *10-A-1 -- Copy of Deferred Compensation Agreement between Jackson H. Randolph and CG&E dated January 1, 1992 (filed as Exhibit 10-B-1 to Form 10-K for the year ended December 31, 1992) *10-A-2 -- Copy of Supplemental Executive Retirement Income Plan between CG&E and certain executive officers (filed as Exhibit 10-B-4 to 1988 Form 10-K of CG&E) *10-A-3 -- Copy of Amendment to Supplemental Executive Retirement Income Plan between CG&E and certain executive officers (filed as Exhibit 10-B-3 to Form 10-K for the year ended December 31, 1992) *10-A-4 -- Copy of Key Employee Annual Incentive Plan offered by CG&E to executive officers and other key employees (filed as Exhibit 10-B-5 to 1988 Form 10-K of CG&E) *10-A-5 -- Copy of Executive Severance Agreement between CG&E and each of its executive officers (filed as Exhibit 10-B- 6 to 1989 Form 10-K of CG&E) *10-A-6 -- Copy of Amendment to Executive Severance Agreement between CG&E and each of its executive officers (filed as Exhibit 10-B-6 to Form 10-K for the year ended December 31, 1992) *10-A-7 -- Copy of Employment Agreement by and among CG&E, CINergy Corp., PSI Resources, Inc., PSI Energy, Inc. and Jackson H. Randolph dated December 11, 1992 (filed as Exhibit 10-B-7 to Form 10-K for the year ended December 31, 1992) *10-A-8 -- Copy of Employment Agreement by and among PSI Resources, Inc., PSI Energy, Inc., CG&E, CINergy Corp. and James E. Rogers, Jr., dated December 11, 1992 (filed as Exhibit 10-B-8 to Form 10-K for the year ended December 31, 1992) 21 -- Not applicable 23 -- Consent of Independent Public Accountants dated as of March 15, 1994\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1993:\nDate of Report Item Reported -------------- -------------\nOctober 20, 1993 Item 7. Financial Statements and Exhibits October 26, 1993 Item 5. Other Events Item 7. Financial Statements and Exhibits - ----------------- # All schedules, other than Schedules V, VI, VIII, and IX, are omitted as the information is not required or is otherwise furnished, per Title 17, Section 210.5-04, CFR.\n* The exhibits with an asterisk have been filed with the Securities and Exchange Commission and are incorporated herein by reference.\nSIGNATURES\nPursuant 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, on this 15th day of March, 1994.\nTHE CINCINNATI GAS & ELECTRIC COMPANY\nBy Jackson H. Randolph ------------------------------------- (Jackson H. Randolph, Chairman of the Board, President and Chief Executive Officer)\nPursuant 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 and on the dates indicated.\n(i) Principal Executive Officer:\nChairman of the Board, President and Chief Executive Officer Jackson H. Randolph and Director March 15, 1994 - ------------------------------- (Jackson H. Randolph)\n(ii) Principal Financial Officer:\nSenior Vice-President-- C. R. Everman Finance and Director March 15, 1994 - ------------------------------- (C. Robert Everman)\n(iii) Principal Accounting Officer:\nDaniel R. Herche Controller March 15, 1994 - ------------------------------- (Daniel R. Herche)\n(iv) A Majority of the Board of Directors:\nNeil A. Armstrong Director March 15, 1994 - ------------------------------- (Neil A. Armstrong)\nOliver W. Birckhead Director March 15, 1994 - ------------------------------- (Oliver W. Birckhead)\nClement L. Buenger Director March 15, 1994 - ------------------------------- (Clement L. Buenger)\nGeorge C. Juilfs Director March 15, 1994 - ------------------------------- (George C. Juilfs)\nThomas E. Petry Director March 15, 1994 - ------------------------------- (Thomas E. Petry)\nDirector March 15, 1994 - ------------------------------- (Jane L. Rees)\nJohn J. Schiff, Jr. Director March 15, 1994 - ------------------------------- (John J. Schiff, Jr.)\nDudley S. Taft Director March 15, 1994 - ------------------------------- (Dudley S. Taft)\nOliver W. Waddell Director March 15, 1994 - ------------------------------- (Oliver W. Waddell)","section_15":""}
{"filename":"315256_1993.txt","cik":"315256","year":"1993","section_1":"ITEM 1. BUSINESS\nTHE NORTHEAST UTILITIES SYSTEM\nNortheast Utilities (NU) is the parent company of the Northeast Utilities system (the System). It is not itself an operating company. Through four of NU's wholly-owned subsidiaries (The Connecticut Light and Power Company [CL&P], Public Service Company of New Hampshire [PSNH], Western Massachusetts Electric Company [WMECO] and Holyoke Water Power Company [HWP]), the System furnishes electric service in Connecticut, New Hampshire and western Massachusetts. In addition to their retail electric service, CL&P, PSNH, WMECO and HWP (including its wholly-owned subsidiary Holyoke Power and Electric Company) together furnish firm wholesale electric service to eight municipalities and utilities. The System companies also supply other wholesale electric services to various municipalities and other utilities. NU serves about 30 percent of New England's electric needs and is one of the 20 largest electric utility systems in the country.\nNU acquired PSNH, the largest electric utility in New Hampshire, in June 1992. PSNH was in bankruptcy reorganization proceedings from January 1988 to May 1991, when it emerged from bankruptcy in the first step of an NU- sponsored two-step plan of reorganization. NU's acquisition of PSNH was the second step of the reorganization plan. On October 1, 1993, the Bankruptcy Court in New Hampshire formally terminated the bankruptcy proceeding. See Item 3, Legal Proceedings. PSNH continues to operate its core electric utility business, but pursuant to the reorganization plan, PSNH transferred its 35.6 percent interest in the Seabrook nuclear generating facility (Seabrook) in Seabrook, New Hampshire to North Atlantic Energy Corporation (NAEC), a special purpose subsidiary of NU which sells the capacity and output of that unit to PSNH under two life-of-unit, full cost recovery contracts. In June 1992, NU's subsidiary North Atlantic Energy Service Corporation (North Atlantic) assumed operational responsibility for Seabrook. Before that, Seabrook had been operated by a division of PSNH.\nOther wholly-owned subsidiaries of NU provide support services for the System companies and, in some cases, for other New England utilities. Northeast Utilities Service Company (NUSCO or the Service Company) provides centralized accounting, administrative, data processing, engineering, financial, legal, operational, planning, purchasing and other services to the System companies. Northeast Nuclear Energy Company (NNECO) acts as agent for the System companies and other New England utilities in operating nuclear generating facilities in Connecticut. North Atlantic acts as agent for the System companies and other New England utilities in operating Seabrook. Two other subsidiaries construct, acquire or lease some of the property and facilities used by the System companies.\nNU has two other principal subsidiaries, Charter Oak Energy, Inc. (Charter Oak) and HEC Inc. (HEC), which have non-utility businesses. Directly and through subsidiaries, Charter Oak develops and invests in cogeneration, small power production and independent power production facilities. HEC provides energy management services for commercial, industrial and institutional electric customers. See \"Non-Utility Businesses.\"\nCOMPETITION AND MARKETING\nCompetition within the electric utility industry is increasing. In response, NU has developed, and is continuing to develop, a number of initiatives to retain and continue to serve its existing customers and to expand its retail and wholesale customer base. These initiatives are aimed at keeping customers from either leaving NU's retail service territory or replacing NU's electric service with alternative energy sources and at attracting new customers. Management believes that CL&P, PSNH and WMECO must continue to be responsive to their business customers, in particular, in dealing with the price of electricity and to recognize that many business customers have alternatives such as fuel switching, relocation and self- generation if the price of electricity is not competitive.\nA System-wide emphasis on improved customer service is a central focus of the reorganization of NU that became effective on January 1, 1994. The reorganization entails realignment of the System into two new core business groups. The first core business group, the energy resources group, is devoted to energy resource acquisition and wholesale marketing and focuses on nuclear, fossil and hydroelectric generation, wholesale power marketing and new business development. The second core business group, the retail business group, oversees all customer service, transmission and distribution operations and retail marketing in Connecticut, New Hampshire and Massachusetts. These two core business groups are served by various support functions known collectively as the corporate center. In connection with NU's reorganization, the System has begun a corporate reengineering process which should help it to identify opportunities to become more competitive while improving customer service and maintaining a high level of operational performance.\nECONOMIC DEVELOPMENT\nThe cost of doing business, including the price of electricity, is higher in the System's service area, and the Northeast generally, than in most other parts of the country. Relatively high state and local taxes, labor costs and other costs of doing business in New England also contribute to competitive disadvantages for many industrial and commercial customers of CL&P, PSNH and WMECO. These disadvantages have aggravated the pressures on business customers in the current weakened regional economy. As a result, state and local governments in the region frequently offer incentives to attract new business development to, and to expand existing businesses within, their states. Since 1991, CL&P and WMECO have worked actively with state and local economic development authorities to package incentives for a variety of prospective or expanding customers. These economic development packages typically include both electric rate discounts and incentive payments for energy efficient construction, as well as technical support and energy conservation services.\nIn general, electric rate discounts are phased out over varying periods generally not in excess of ten years. From September 1991 through March 1, 1994, economic development rate agreements had been reached with approximately 45 industrial and commercial customers in the three states served by the System, including 38 customers in CL&P's service territory, one customer in PSNH's service territory and six customers in WMECO's service territory.\nAs an adjunct to their economic development efforts, CL&P and WMECO have also developed programs which provide incentives to customers planning to construct or significantly renovate commercial or industrial buildings within the System's service territory. Approximately 40 percent of all such construction qualifies for incentive payments for the installation or retrofitting of energy-efficient equipment designed to result in permanent savings for the customer in addition to any savings that result from the rate discounts.\nThe business expansion-related rate agreements cover small-to- medium-sized industrial companies and a few medium-sized commercial business relocations. In all cases where economic development rates are in effect, the additional load and associated revenues, even though received under discounted rates, result in a net benefit to the System by making a contribution towards the System's fixed costs. During 1993, 28 customers were on economic development rate riders, including 24 CL&P customers and four WMECO customers. The net benefit to the System during 1993 as a result of these agreements was approximately $300,000.\nBUSINESS RETENTION\/BUSINESS RECOVERY\nFrom 1983 through 1989, the System's retail kilowatt-hour sales grew by an annual average rate of 3.8 percent. Since the end of 1989, retail sales have been level, except for the addition of PSNH's electric load as a result of NU's acquisition of PSNH, effective in June 1992. The leveling effect has resulted in part from the System's conservation and load management (C&LM) efforts, but is largely due to the region's persistent weak economy. Management expects a modest improvement in the economy in 1994 and moderate electric sales growth is anticipated.\nTo spur economic activity, NU's subsidiaries have worked in concert with state and local authorities to retain businesses that are considering relocating outside of the NU service territory. C&LM incentives are used with temporary rate reductions to produce both short-term and long-term cost savings for customers. These reductions are generally limited to five years but may be for as long as ten years. As of the end of 1993, 25 System customers received such reductions, including 19 CL&P customers, two PSNH customers and five WMECO customers. These customers in the aggregate represented less than 0.5 percent of System revenues.\nThe NU operating subsidiaries also offer rate reductions to business entities that can demonstrate that they are encountering financial problems threatening their viability but have reasonable prospects for improvement. These \"business recovery\" reductions can be brief in duration, sometimes lasting only a few months, or may extend for up to five years. From the time these rates became available in late 1991 through the end of 1993, 23 CL&P customers, two PSNH customers and eight WMECO customers have been granted such rate reductions. The CL&P customers provided approximately $10 million in annual revenues; the PSNH customers provided approximately $10 million in annual revenues and the WMECO customers provided approximately $1.5 million in annual revenues.\nThe bulk of the cost of the presently estimated discounts has been anticipated in base rates. The cost of the C&LM program is also collected from ratepayers.\nCOMPETITIVE GENERATION\nA growing source of competition in the electric utility industry comes from companies that are marketing co-generation systems, primarily to those customers who can use both the electricity and the steam created by such systems. See \"Regulatory and Environmental Matters - Public Utility Regulation.\" For instance, the Pratt & Whitney Aircraft Division of United Technologies Corporation, the System's largest industrial customer, put into service a 25-megawatt generating system in January 1993, reducing CL&P's industrial sales by approximately 1.5 percent, or $8 million, during 1993. While only a few other such systems have been installed in the System's service territory to date, the extent of growth of further self-generation cannot be predicted.\nTo help convince retail customers not to generate their own power, CL&P, PSNH and WMECO have offered a competitive generation rate or special rate contracts that typically provide for up to ten years of rate reductions in return for a commitment not to self-generate. Two of CL&P's largest customers, together accounting for approximately $12 million of annual revenues in 1993, are operating under these arrangements. The New Hampshire Public Utilities Commission (NHPUC) also approved a special PSNH rate available for operators of sawmills to help prevent those customers from installing diesel generation. Altogether, approximately 28 System customers were on some type of competitive generation rate or special contract at the end of 1993, consisting of two CL&P customers, 20 PSNH customers and six WMECO customers. The PSNH customers provided approximately $3 million in annual revenues and the WMECO customers provided approximately $1.5 million in annual revenues.\nOverall, all types of flexible rate riders and special contracts offered by the System have preserved System revenues of approximately $50 million. As each subsidiary intensifies its efforts to retain existing customers and gain new customers, the number of customers covered under such flexible rates, and the number and amount of overall discounts, are expected to rise moderately over the next few years.\nRETAIL WHEELING\nIn principle, retail wheeling would enable a retail customer to select an electricity supplier and force the local electric utility to transmit the power to the customer's site. While wholesale wheeling was mandated by the Energy Policy Act of 1992 (Energy Policy Act) under certain circumstances, retail wheeling is generally not required in any of the System's jurisdictions. See \"Regulatory and Environmental Matters - Public Utility Regulation.\" In Connecticut, the Department of Public Utility Control (DPUC) has begun an investigation into the desirability of retail wheeling; a similar DPUC study undertaken in 1987 concluded that full-scale ail wheeling was not in the public interest at that time. See \"Rates-Connecticut Retail Rates.\"\nIn New Hampshire, there have been no legislative proposals on full- scale retail wheeling to date.\nIn Massachusetts, bills being reviewed by legislative committees could permit limited retail wheeling in economically distressed areas and to municipal and state-owned facilities.\nFUEL SWITCHING\/ELECTROTECHNOLOGIES\nA customer's ability to switch to or from electricity as an energy source for heating, cooling or industrial processes (fuel switching) will continue to provide the System with both opportunities and risks over the coming years.\nWhile it is an important load, residential electric space heating makes up only five percent of the System's retail sales. In Connecticut and Massachusetts, the risk of fuel switching among residential customers is concentrated in the area of electric to natural gas conversions with lesser risks of oil and propane conversions, while in New Hampshire, conversions to oil and propane are more common. During 1993, approximately three percent of WMECO and PSNH space heating customers converted their heating systems from electric resistance or baseboard heating. Conversion activity in CL&P's service territory was minimal during 1993 and the net number of electric space heating customers in CL&P's territory increased during 1993. Since 1992, space heating conversions on the System have not represented more than a 0.1 percent loss of annual retail sales. Nonetheless, the System operating companies have implemented a number of programs to mitigate these losses. In New Hampshire, a new thermal energy storage program is being reviewed for approval by the NHPUC. In Connecticut and Massachusetts, programs are in place to encourage the use of ground source and advanced air-to-air heat pumps in both new and existing construction. In addition, in 1993 WMECO lowered rates for its electric space heating cusomters by approximately five percent with permission from the Massachusetts Department of Public Utilities (DPU) to address the competitive threat. Because of these programs and other initiatives, NU forecasts a continued increase in the net number of electric space heating customers.\nWith respect to residential sales, central air conditioning continues to become more common in the System's service territory. The System has also begun to test the use of electric vehicles in all three of its service territories and is working to promote the manufacture of electric vehicles and their components in the System's service area. The System's energy conservation programs which target electric heat and hot water customers can be effective in lowering electric bills substantially. In 1993, the System embarked upon two aggressive field testing programs involving heat pumps to provide residential heating, cooling and hot water heating in cost effective ways. These programs, in Massachusetts and at Heritage Village in Southbury, Connecticut, are intended to demonstrate that the combination of cost effective conservation and the use of heat pumps will provide lower cost heating, cooling and water heating than other available fuels.\nThe System also faces commercial load loss because of fuel switching, such as in the area of electrically heated commercial buildings. Additionally, natural gas distribution companies have been actively marketing gas-fired chillers to commercial and industrial customers. Electric space and hot water heating and air conditioning have come under increasing pressure in recent years from aggressive campaigns by natural gas distribution companies seeking to add new customers. In Connecticut and Massachusetts, NU's subsidiaries have initiated market driven heating, ventilating and air-conditioning (HVAC) incentive programs, which include some design assistance, to promote efficient, nonchlorofluorocarbon refrigerant electric chillers.\nIn response to the threat of load loss due to alternative fuel sources, the System's marketing and customer service staff works proactively to compare relative costs of alternative fuels. In most instances, accurate cost comparisons and energy conservation programs allow the System to preserve most of each customer's load by assisting the customer to achieve a more efficient use of its electric energy.\nWHOLESALE MARKETING\nIn general and subject to existing contractual restrictions, the System's wholesale customers, both within and outside the System's retail service area, are free to select any supplier they choose. NU's subsidiaries do not have an exclusive franchise right to serve such customers. Thus, the wholesale segment of the System's business is highly competitive.\nAs a result of very limited load growth throughout the Northeast in the past five years and the operation of several new generating plants, competition has grown, and a seller's market for electricity has turned into a buyer's market. Of the approximately 2,000 - 3,000 megawatts of surplus capacity in New England, the System's total is approximately 1,000 megawatts.\nThe prices the System has been able to receive for new wholesale contracts have generally been far lower than the prices prevalent in recent years.\nNevertheless, in 1993, the System sold a monthly average of 350 megawatts on a daily and short-term basis and 1,150 megawatts under preexisting long-term commitments of capacity to over 20 utilities throughout the Northeast. These sales resulted in approximately $150 million of capacity revenues. The majority of these revenues have been recognized in System company base rates.\nIn addition, System companies entered into approximately 11 long- term sales contracts in 1993 with both new and existing customers. These contracts are expected to increase sales by a yearly average of 60 megawatts from late 1993 through 2005. The new wholesale customers include the municipal electric systems in Georgetown, Middletown, South Hadley, Princeton, Danvers, Littleton and Mansfield, all in Massachusetts. Including these new sales, the System currently has capacity sales commitments with other New England utilities to sell an aggregate 4,000 megawatt-years of capacity from 1994 through 2008. The net benefits after costs from these sales are estimated at approximately $550 million over the remaining life of the contracts. Most of these benefits will be realized over the next few years. In addition, a contract for the sale of approximately 450 megawatt- years to the municipal electric system in Madison, Maine has been signed and is awaiting certain approvals. For information on competitive pressures affecting wholesale transmission, see \"Electric Operations - Generation and Transmission.\"\nOver the next five years, intense competition in the Northeast market is expected to continue as new generating facilities, located for the most part outside the System's retail service areas and contracted to sell to others, become operational. See \"Regulatory and Environmental Matters - Public Utility Regulation.\" This increase in power supply sources could put further downward pressure on prices, but the potential price decreases may be somewhat offset by an improvement in the region's economy and the retirement of a number of the region's existing generating plants. See \"Electric Operations - Generation and Transmission.\"\nSUMMARY\nTo date, the System has not been materially affected by competition, and it does not foresee substantial adverse effect in the near future unless the current regulatory structure or practice is substantially altered. The rate, service, business development and conservation initiatives described above, portions of which are funded in base rates, plus other cost containment efforts described below, have been adequate to date in retaining customers, preventing fuel switching and attracting new customers at a level sufficient to maintain the System's revenue and profit base and should have significant positive effects in the next few years. As noted above, however, the DPUC has begun a retail wheeling investigation in Connecticut, and its outcome is uncertain at this time. In Massachusetts, retail wheeling legislation is under consideration. To date, no such initiatives are underway in New Hampshire. NU's subsidiaries benefit from a diverse retail base, and the System has no significant dependance on any one customer or industry. The System's extensive transmission facilities and diversified generating capacity position it to be a strong factor in the regional wholesale power market for the foreseeable future. The System's wholesale power business should further cushion the financial effects of competitive inroads within its service area. The System believes that the corporate reengineering process initiated in early 1994 and structural reorganization effective January 1, 1994 should better position it to compete in the retail and wholesale electric businesses in the future.\nRATES\nCONNECTICUT RETAIL RATES\nGENERAL\nCL&P's retail electric rate schedules are subject to the jurisdiction of the DPUC. Connecticut law provides that increased rates may not be put into effect without the prior approval of the DPUC, which has 150 days to act upon a proposed rate increase, with one 30-day extension possible. If the DPUC does not act within that period, the proposed rates may be put into effect subject to refund.\nConnecticut law authorizes the DPUC to order a rate reduction before holding a full-scale rate proceeding if it finds that (i) a utility's earnings exceed authorized levels by one percentage point or more for six consecutive months, (ii) tax law changes significantly increase the utility's profits, or (iii) the utility may be collecting rates that are more than just and reasonable. The law requires the DPUC to give notice to the utility and any customers affected by the interim decrease. The utility would be afforded a hearing. If final rates set after a full rate proceeding or court appeal are higher, customers would be surcharged to make up the difference.\n1992-1993 CL&P RETAIL RATE CASE\nIn December 1992, CL&P filed an application for rate relief with the DPUC. The updated request sought to increase CL&P's revenues by $344 million or 15.4 percent in total over three years. That increase incorporated requested annual increases of $130 million, $104 million and $110 million starting in May 1993. As an alternative to the multi-year plan, CL&P also proposed a one-time increase totaling about $280 million, or 13.9 percent.\nOn June 16, 1993, the DPUC issued a decision (Decision) approving the multi-year plan and providing for annual rate increases of $46.0 million, or 2.01 percent, in July 1993, $47.1 million, or 2.04 percent, in July 1994 and $48.2 million, or 2.06 percent, in July 1995. The total increase granted of $141.3 million, or 6.11 percent, is approximately 42 percent of CL&P's updated request.\nIn light of the State of Connecticut's concern over economic development and industrial and commercial rates, one important aspect of the Decision was that industrial and manufacturing rates will rise only about 1.1 percent anually over the three-year period.\nOther significant aspects of the Decision include the reduction of CL&P's return on equity (ROE) from 12.9 percent (CL&P had sought to continue its ROE at that level) to 11.5 percent for the first year of the multi-year plan, 11.6 percent for the second year and 11.7 percent for the third year; recognition in CL&P's rates, by 1998, of non-pension, post-retirement benefit cost accruals required under Statement of Financial Accounting Standards (SFAS) No. 106; the identification of $49 million of prior fuel overrecoveries and the use of that amount to offset a similar amount of the unrecovered balance in CL&P's generation utilization adjustment clause (GUAC); the reduction of CL&P's projected operating and maintenance expense for contingency funding by approximately $53.6 million spread over three years; and the deferral of cogeneration expenses projected for 1994 and 1995 and the future recovery of those deferred amounts (approximately $63 million in total) plus carrying costs over five years beginning July 1, 1996.\nThe Decision also required CL&P to allocate to customers $10 million of after tax earnings from a $47.7 million property tax accounting change made in the first quarter of 1993. CL&P recorded this $10 million adjustment as a reduction to second quarter net income.\nOn August 2, 1993, two appeals were filed from the Decision. CL&P filed an appeal on four issues. The second appeal was filed by the Connecticut Office of Consumer Counsel (OCC) and the City of Hartford, challenging the legality of the multi-year plan approved by the DPUC. The two appeals were consolidated. CL&P moved to dismiss the appeal by the City of Hartford and the OCC on jurisdictional grounds. Oral arguments were held on October 15, 1993 and February 14, 1994 on CL&P's motion to dismiss the appeals challenging the multi-year rate plan. It is not known when a decision on CL&P's motion will be issued. In addition, the Court rejected (without prejudice to renewal) the City of Hartford's and the OCC's motion to stay implementation of the second and third year of the rate plan pending the outcome of their appeal. The City of Hartford and the OCC could renew a request for a stay following the outcome of their appeal.\nCL&P ADJUSTMENT CLAUSES\nCL&P has a fossil fuel adjustment clause and a GUAC applicable to its retail electric rates. In Connecticut, the DPUC is required to approve each month the charges or credits proposed for the following month under the fossil fuel adjustment clause. These charges and credits are designed to recover or refund changes in purchased power (energy) and fossil fuel prices from those set in base rates. Monthly fossil fuel charges or credits are also subject to review and appropriate adjustment by the DPUC each quarter after full public hearings. The Connecticut clause allows CL&P to recover substantially all prudently incurred fossil fuel expenses.\nCL&P's current retail electric base rate schedules assume that the nuclear units in which CL&P has entitlements will operate at a 72 percent composite capacity factor. The GUAC levels the effect on rates of fuel costs incurred or avoided due to variations in nuclear generation above and below that performance level. When actual nuclear performance is above the specified level, net fuel costs are lower than the costs reflected in base rates, and when nuclear performance is below the specified level, net fuel costs are higher than the costs reflected in base rates. At the end of a twelve-month period ending July 31 of each year, with DPUC approval, these net variations from the costs reflected in base rates are generally refunded to or collected from customers over the subsequent eleven-month period beginning September 1. This clause, however, does not permit automatic collection from customers to the extent the capacity factor is less than 55 percent for the twelve-month period. When and to the extent the annual nuclear capacity factor is less than 55 percent, it is necessary for CL&P to apply to the DPUC for permission to recover the additional fuel expense.\nIn the Decision, the DPUC disallowed recovery of $41.5 million, the GUAC deferral balance associated with operation at a nuclear capacity factor below 55 percent during the 12-month GUAC period ending July 31, 1992. In the same Decision, the DPUC also disallowed $7.5 million of the $96 million deferral balance, representing operation at a nuclear capacity factor above 55 percent for that period, which had already been approved for collection from customers through December 31, 1993. The reason given for the disallowances was CL&P's $49 million overrecovery of fuel costs through base rates and the fuel adjustment clauses for the period August 1991 to July 1992.\nThe Decision also cut short the previously allowed recovery of $96 million in GUAC deferrals by four months. The DPUC ordered the remaining unrecovered GUAC balance of $24.6 million to be \"trued-up\" against the deferral for the 1992-93 GUAC year. As result of two previous prudence decisions imposing disallowances for outages at the nuclear unit (CY) operated by the Connecticut Yankee Atomic Power Company (CYAPC) and Millstone I, the DPUC also ordered CL&P to refund to customers a total of $5.1 million in the GUAC billing period beginning September 1, 1993.\nIn the most recent GUAC period, which ended July 31, 1993, the actual level of nuclear generating performance was 72.6 percent, resulting in a GUAC deferral of $4.0 million to be credited to customers beginning in September 1993. The GUAC rate filed by CL&P for the September 1993 - August 1994 GUAC billing period had five components: the $7.5 million disallowance from the rate case, the $5.1 million of prudence disallowances, the $4.0 million credit deferral for the most recent GUAC period, and the $24.6 million debit of previously unrecovered GUAC deferrals, for a total of $7.9 million.\nOn September 1, 1993, the DPUC issued an interim order setting a GUAC rate of zero beginning September 1, 1993, subject to a proceeding to consider further CL&P's GUAC rate for the period September 1, 1993 to July 31, 1994. On January 5, 1994, the DPUC issued a decision fixing the GUAC rate at zero through August 31, 1994 and disallowing recovery of $7.9 million through the GUAC. The disallowance was based on a comparison of fuel revenues with fuel expenses, in the August 1992 - July 1993 period. On January 24, 1994, CL&P requested the DPUC to clarify its January 5, 1994 decision with respect to future application of the GUAC. Based on management's interpretation of the January 5, 1994 decision, CL&P does not expect that any future DPUC review using this methodology will have a material adverse impact on its future earnings. On March 4, 1994, CL&P appealed the January 5 GUAC decision to Connecticut Superior Court.\nFor the 1984-1991 GUAC periods, CL&P refunded more than $112 million to its customers through the GUAC mechanism. For the five months ended December 31, 1993, the composite nuclear generation capacity factor was 66.7 percent. For the full twelve-month period ending July 31, 1994, the factor is projected to be approximately 74.7 percent.\nThe DPUC has opened a docket to review the prudence of the 1992 outage related to the Millstone 2 steam generator replacement project. Discovery and filing of testimony is expected to continue through May 1994 and hearings, if required, will be held in the summer of 1994.\nCL&P incurred approximately $88 million in replacement power costs associated with Millstone outages that occurred during the period October 1990 - February 1992. These outages were the subject of several separate prudence reviews conducted by the DPUC, three of which are either on appeal or still pending at the DPUC.\nOn May 19, 1993, the DPUC issued a final decision allowing recovery of costs related to the July 1991 shutdown of Millstone 3 caused by mussel- fouling of the heat exchangers. Approximately $0.9 million of replacement power costs are at issue. The OCC has appealed that decision to the Connecticut Superior Court.\nOn September 1, 1993, the DPUC issued a final decision in the prudence investigation of outages at all four Connecticut nuclear plants resulting from an erosion\/corrosion-induced pipe rupture at Millstone 2 on November 6, 1991. The decision concluded that CL&P's management of its erosion\/corrosion program was reasonable and prudent and that expenses incurred as a result of the outages, which total approximately $65 million ($51 million of which represents replacement power costs) for CL&P, should be allowed. The OCC has also appealed this decision to the Connecticut Superior Court.\nThe third ongoing prudence investigation involves a Millstone 3 outage caused by repairs to the service water piping in the fall of 1991. The OCC's witness filed testimony that, as a result of the DPUC's decision finding that the concurrent mussel-fouling outage was prudent, and the fact that the mussel-fouling outage continued at least as long as the service water outage, there was no economic impact on ratepayers from the service water outage. On September 23, 1993, the DPUC suspended the service water docket pending the outcome of OCC's appeal of the decision on the mussel- fouling outage. Approximately $26 million of replacement power costs are at issue. For further information on the shutdowns of Millstone units currently under review by the DPUC, see \"Electric Operations -- Nuclear Generation -- Millstone Units.\"\nSome portion of the replacement power costs reflected in the three Millstone outages, as to which the DPUC has not completed its review or as to which the DPUC's decision has been appealed, may be disallowed. However, management believes that its actions with respect to these outages have been prudent, and it does not expect the outcome of the prudence reviews to result in material disallowances.\nCL&P has recognized that it will not recover in rates approximately $9.4 million in replacement power costs resulting from two other shutdowns at Millstone 1: one related to the unit's licensed operators failing requalification exams and the other related to seaweed blockage at the intake structure.\nCL&P owns 34.5 percent of the common stock of CYAPC, a regional nuclear generating company. During the 1987-1988 refueling outage, repairs were made to CY's thermal shield. During an extended 1989-1990 refueling outage, the thermal shield was removed due to continued degradation.\nThe DPUC reviewed these outages. In a report issued in 1990, the DPUC's auditors concluded that the actions of CYAPC's personnel and its contractors were reasonable with respect to the thermal shield's repair and removal. However, the auditors also concluded that the failure to clean the entire refueling cavity during the 1987-1988 outage was the most likely cause of debris left in the cavity that subsequently resulted in the additional damage that was repaired during the 1989-1990 outage.\nIn October 1992, the DPUC disallowed CL&P's recovery of $3 million in replacement power costs and $230,000 of related operating and maintenance costs resulting from CY's 1989-1990 extended outage. CL&P appealed the DPUC's decision. On December 2, 1993, the Connecticut Superior Court issued a decision reversing the DPUC, in part, and upholding it in part. The court ruled in favor of CL&P by reversing the $230,000 disallowance and in favor of the DPUC by upholding the $3 million disallowance of replacement power costs.\nThe partial reversal in favor of CL&P was based on the principle of federal preemption and is an important legal precedent for future CYAPC matters.\nCONSERVATION AND LOAD MANAGEMENT\nCL&P participates in a collaborative process for the development and implementation of C&LM programs for its residential, commercial and industrial customers.\nIn September 1992, the DPUC approved a Conservation Adjustment Mechanism (CAM) that allows CL&P to recover C&LM costs to the extent not recovered through current base rates. The CAM authorized continued recovery of C&LM costs over a ten-year period with a return on the unrecovered costs. In December 1992, CL&P filed an application with the DPUC for approval of budgeted C&LM expenditures for 1993 of $47.5 million and a proposed CAM for 1993. On April 14, 1993, the DPUC issued an order approving a new CAM rate, which allows CL&P to recover $24 million of its budgeted $47 million C&LM expenditures during 1993 and associated true-ups of past C&LM expenditures. The order also provided that any unrecovered expenditures would be recovered over eight years. CL&P's actual 1993 C&LM expenditures were approximately $42.8 million. The unrecovered C&LM costs at December 31, 1993 excluding carrying costs were $116.2 million.\nOn December 30, 1993, CL&P and the other participants in the collaborative process filed an offer of settlement with the DPUC regarding CL&P's 1994 C&LM expenditures, program designs, performance incentive and lost fixed cost revenue recovery. The settlement proposed a budget level of $39 million for 1994 C&LM and a reduction in the amortization period for new expenditures from eight to 3.85 years. CL&P expects additional 1994 C&LM expenditures of approximately $1 million for state facilities. The DPUC began hearings on the proposed settlement during March 1994.\nNEW HAMPSHIRE RETAIL RATES\nRATE AGREEMENT AND FPPAC\nNU acquired PSNH, the largest electric utility in New Hampshire, in June 1992. See \"The Northeast Utilities System.\" PSNH's 1989 Rate Agreement (Rate Agreement) provides the financial basis for the plan under which PSNH was reorganized and became an NU subsidiary. The Rate Agreement sets out a comprehensive plan of retail rates for PSNH, providing for seven base rate increases of 5.5 percent per year and a comprehensive fuel and purchased power adjustment clause (FPPAC). The first of these base retail rate increases was put into effect in January 1990. The second rate increase took place on May 16, 1991, when PSNH reorganized as an interim, stand-alone company; the third rate increase occurred on June 1, 1992, just before NU's acquisition of PSNH; and the fourth rate increase went into effect on June 1, 1993. The remaining three increases are to be placed in effect by the NHPUC annually beginning June 1, 1994, concurrently with a semi-annual adjustment in the FPPAC.\nThe Rate Agreement also provides for the recovery by PSNH through rates of a regulatory asset, which is the aggregate value placed by PSNH's reorganization plan on PSNH's assets in excess of the net book value of PSNH's non-Seabrook assets and the value assigned to Seabrook. In accordance with the Rate Agreement, approximately $265 million of the remaining regulatory asset is scheduled to be amortized and recovered through rates by 1998, and the remaining amount, approximately $504 million, is scheduled to be amortized and recovered through rates by 2011. PSNH is entitled to a return each year on the unamortized portion of the asset. The unrecovered balance of the regulatory asset at December 31, 1993 was approximately $769.5 million. In order to provide protection from significant variations from the costs assumed in the base rates over the period of the seven base rate increases (Fixed Rate Period), the Rate Agreement established a return on equity (ROE) collar to prevent PSNH from earning an ROE in excess of an upper limit or below a lower limit. To date, PSNH's ROE has been within the limits of the ROE collar.\nThe FPPAC provides for the recovery or refund by PSNH, for the ten- year period beginning on May 16, 1991, of the difference between the actual prudent energy and purchased power costs and the costs included in base rates. The rate is calculated for a six-month period based on forecasted data and is reconciled to actual data in subsequent FPPAC billing periods. PSNH costs included in the FPPAC calculation are the cost of fuel used at its generating plants and purchased power, energy savings and support payments associated with PSNH's participation in the Hydro-Quebec arrangements, the Seabrook Power Contract costs billed to PSNH from NAEC, NEPOOL Interchange expense and savings, fifty percent of the joint dispatch energy expense savings resulting from the combination of PSNH and the System companies as a single pool participant, purchased capacity costs associated with other System power and unit contract capacity purchases excluding the Yankee nuclear companies and the cost to amortize capital expenditures for, and to operate, environmental or safety backfits or fuel switching. The FPPAC also provides for the recovery of a portion of the payments made currently to qualifying facilities and a portion of the costs associated with the PSNH buyback of the New Hampshire Electric Cooperative, Inc. (NHEC) entitlement in Seabrook. For information on NHEC's 1991 filing for bankruptcy and its subsequent reorganization, see \"Rates - Wholesale Rates.\" The balance of the current payments to qualifying facilities, representing a part of the payments made currently to eight specific small power producers (SPPs), are deferred each year and amortized and recovered over the succeeding ten years.\nA portion of the current payments to NHEC is also deferred and will be recovered either through the FPPAC during the fixed rate period or through base rates after the fixed rate period. Recovery of the NHEC deferral through the FPPAC occurs only if the FPPAC rate is negative; in such instance, deferred NHEC costs would be recovered to the extent required to bring the FPPAC rate to zero. From June to November 1992, the FPPAC rate, which would otherwise have been negative, was set at zero, and some NHEC deferrals were amortized. The operation of the FPPAC during this period resulted in an overrecovery, which was also netted against NHEC deferrals in December 1992 and March 1993. As of December 31, 1993, SPP and NHEC deferrals totaled approximately $107.6 and $14.8 million, respectively.\nUnder the Rate Agreement, PSNH has an obligation to use its best efforts to renegotiate the purchase power arrangements with 13 specified SPPs that were selling their output to PSNH under long term rate orders. Agreements have been reached with all five of the hydroelectric facilities under which the rates PSNH pays for their output would be reduced but the term of years for sales from the hydro producers would be extended by five years. The NHPUC held a hearing concerning these agreements on February 25, 1994. PSNH has also reached agreements with three of the eight wood-fired qualifying facilities with long term rate orders. Under each agreement, PSNH would pay each operator a lump sum in exchange for canceling the operator's right to sell its output to PSNH under rate orders. The total payment to the three operators would be approximately $91.8 million (covering approximately 35 MW of capacity). The three wood operators' agreements will be considered in hearings before the NHPUC in late spring 1994. PSNH is unable to predict if any or all of these agreements will be consummated.\nAlthough the Rate Agreement provides an unusually high degree of certainty about PSNH's future retail rates, it also entails a risk if sales are lower than anticipated, as they were in 1991 and 1992, or if PSNH should experience unexpected increases in its costs other than those for fuel and purchased power, since PSNH has agreed that it will not seek additional rate relief before 1997, except in limited circumstances. Even if allowed under the Rate Agreement, any additional increases above 5.5 percent per year are subject to political and economic pressures that tend to limit overall retail rate increases, including FPPAC increases.\nIn accordance with the Rate Agreement, PSNH increased its average retail electric rates by about 4.5 percent in June 1993 and by 1.8 percent on December 1, 1993. The 4.5 percent increase in June resulted from the combined effect of decreasing to $.00110 per kilowatthour the FPPAC charge at the same time that (1) the fourth of the seven increases in base electric rates of 5.5 percent and (2) a temporary increase associated with recently enacted legislation associated with the settlement of the Seabrook tax suit described below took effect. The decrease in the FPPAC charge also reflected lower costs paid by PSNH through the Seabrook Power Contract for Seabrook property tax imposed on NAEC. The December 1993 increase resulted from an increase in the FPPAC rate.\nIn its decision on the June 1, 1993 increase, the NHPUC disallowed replacement power costs for three Seabrook outages totalling about $0.4 million. On August 16, 1993, the NHPUC affirmed its decision to disallow that amount. In the August 16 decision, the NHPUC also rejected a request by the New Hampshire Office of Consumer Advocate (OCA) to allow access to certain confidential, self-critical documents generated at Seabrook station by plant personnel following outages and power reductions. PSNH has been providing summary analyses of the circumstances surrounding outages; however, it declined to provide the original self-critical documents in an effort to maintain an atmosphere in which employees would be encouraged to report and comment on all possible problems. The OCA filed an appeal of the NHPUC's decision on its request for access to these documents with the New Hampshire Supreme Court on November 16, 1993. On February 8, 1994, the court accepted the appeal.\nOn September 14, 1993, PSNH filed a request for an increase in its FPPAC rate for the period December 1, 1993 through May 31, 1994. The increase of one percent of the average retail rate was expected to produce less than the revenues necessary to cover PSNH's FPPAC costs over these six months, a period during which Seabrook will undergo a two-month refueling outage. PSNH waived its right to immediate collection and proposed to defer about $13 million of FPPAC costs for later collection in order to limit its total rate increases for 1993 to 5.5 percent. Hearings on the FPPAC rate request were held on November 9 and 10, 1993. On November 29, 1993, the NHPUC approved a higher FPPAC rate than the rate requested by PSNH. The increase was 1.8 percent higher than rates previously in effect and allowed PSNH to recover a deferral of $10.5 million over a twelve month period beginning June 1, 1994, which ends prior to the next scheduled Seabrook refueling outage.\nIn its June 1992 decision concerning PSNH's FPPAC rate, the NHPUC had determined that PSNH should not be entitled to recover approximately $1.3 million with respect to wholesale power agreements with two New England utilities. Also, the NHPUC had questioned the prudence of a series of short term contractual agreements (SWAP Agreements) for energy and capacity exchanges entered into between the System and PSNH prior to the merger and the allocation of savings resulting from the SWAP Agreements. In November 1992, PSNH entered into proposed settlements with the NHPUC staff and the OCA to settle these issues. The settlements proposed disallowances of approximately $500,000 for the two wholesale power agreements and $250,000 for the SWAP Agreements. On March 23, 1993, the NHPUC approved the settlements.\nSETTLEMENT OF THE SEABROOK TAX SUIT\nOn April 16, 1993, the Governor of New Hampshire signed into law legislation that implemented the settlement of a suit concerning property tax on Seabrook station (the Seabrook Tax) that was filed with the United States Supreme Court by Attorneys General of Connecticut, Massachusetts and Rhode Island. The legislation made various changes to New Hampshire tax laws, resulting in taxes of approximately $5.8 million to be paid by NU on a consolidated basis in each of 1993 and 1994 and $3.0 million in 1995, a reduction from the $9.5 million paid by NU on a consolidated basis in 1992. Of such amounts to be paid, CL&P's portion will be approximately $0.6 million in each of 1993 and 1994 and approximately $0.3 million in 1995 and NAEC's portion will be approximately $5.2 million in each of 1993 and 1994 and approximately $2.7 million in 1995.\nMEMORANDUM OF UNDERSTANDING\nOn May 6, 1993, PSNH, NAEC, NUSCO and the Attorney General of the State of New Hampshire entered into a Memorandum of Understanding (Memorandum) relating to certain issues which had arisen under the Rate Agreement. In part, the issues addressed relate to the enactment of the legislation implementing the settlement of the Seabrook Tax lawsuit. Pursuant to the Memorandum, tax changes imposed by the legislation will not increase PSNH's overall ratepayer charges, but will be reflected in PSNH rates pursuant to the Rate Agreement through offsetting adjustments to PSNH's base rates and FPPAC charges. On June 1, 1993, PSNH put into effect a temporary increase of $0.00074 per kilowatthour in base rates designed to recover the increased costs associated with the enactment of the legislation.\nA corresponding decrease in the FPPAC costs collected after June 1, 1993 offset the base rate increase. The FPPAC decrease reflected the reduction of the Seabrook property tax resulting from the legislation.\nThe Memorandum also addresses the implementation of new accounting standards imposed by SFAS 106 and SFAS 109. The Memorandum establishes the method of accounting under SFAS 106 for employees' post-retirement benefits other than pensions for PSNH ratemaking purposes. Under SFAS 109, companies may recognize as a deferred tax asset the value of certain tax attributes. The Memorandum provides for the establishment of a regulatory liability attributable to significant net operating loss carryforwards and establishes that such liability should be amortized over a six-year period beginning on May 1, 1993.\nOther provisions of the Memorandum cover:\nNAEC's acquisition of the Vermont Electric Generation and Transmission Cooperative's (VEG&T) 0.41259% interest in Seabrook for approximately $6.4 million and NAEC's sale of the output to PSNH. All necessary regulatory approvals for NAEC's acquisition have been received and NAEC acquired VEG&T's interest on February 15, 1994. The Rate Agreement will be amended to ensure that this acquisition will not impact PSNH rates during the fixed rate period.\nThe Rate Agreement's ROE collar floor provisions were amended to provide for the adjustment by PSNH of its revenue received from James River Corporation and Wausau Papers of New Hampshire by the amount of the demand charge discount previously approved by the NHPUC.\nThe Rate Agreement was also amended to provide that any adjustments to the amount of PSNH's liability under the Seabrook Power Contract to reimburse NAEC for payments to the Seabrook Nuclear Decommissioning Financing Fund (a fund administered by the State of New Hampshire to finance decommissioning of Seabrook) will be recovered through adjustments to PSNH's base rates; however, such adjustments will not be subject to the annual 5.5 percent increases established under the Rate Agreement. See \"Electric Operations - Nuclear Generation - Decommissioning\" for further information on decommissioning costs for Seabrook station and other nuclear units that the System owns or participates in.\nOn May 11, 1993, PSNH and the State of New Hampshire filed a petition with the NHPUC seeking approval of the Memorandum. As required for implementation, PSNH's lenders approved the Memorandum. The NHPUC hearing on the petition seeking approval of the Memorandum and a request to make the June 1, 1993, temporary base rate increase permanent was held on December 2, 1993. PSNH entered into a stipulation with the NHPUC staff and the OCA which modified the Memorandum slightly, clarifying terms of the NAEC power contract applicable to the VEG&T interest in Seabrook. The NHPUC approved the Memorandum as modified by the stipulation, the permanent base rate increase and the Third Amendment to the Rate Agreement on January 3, 1994.\nAs a result of the approval of the Memorandum, PSNH's earnings in 1993 increased by $10 million. The cumulative impact of the issues resolved by the Memorandum is not expected to have a significant impact on PSNH's future earnings.\nSEABROOK POWER CONTRACT\nPSNH and NAEC entered into the Seabrook Power Contract (Contract) on June 5, 1992. Under the terms of the Contract, PSNH is obligated to purchase NAEC's initial 35.56942% ownership share of the capacity and output of Seabrook 1 for the term of Seabrook's NRC operating license and to pay NAEC's \"cost of service\" during this period, whether or not Seabrook 1 continues to operate. NAEC's cost of service includes all of its prudently incurred Seabrook-related costs, including maintenance and operation expenses, cost of fuel, depreciation of NAEC's recoverable investment in Seabrook 1 and a phased-in return on that investment. The payments by PSNH to NAEC under the Contract constitute purchased power costs for purposes of the FPPAC and are recovered from customers under the Rate Agreement. Decommissioning costs are separately collected by PSNH in its base rates. See \"Rates - New Hampshire Retail Rates - Rate Agreement and FPPAC\" for information relating to the Rate Agreement.\nIf Seabrook 1 is retired prior to the expiration of the Nuclear Regulatory Commission (NRC) operating license term, NAEC will continue to be entitled under the Contract to recover its remaining Seabrook investment and a return of that investment and its other Seabrook-related costs for 39 years, less the period during which Seabrook 1 has operated. At December 31, 1993, NAEC's net utility plant investment in Seabrook 1 was $732 million.\nThe Contract provides that NAEC's return on its \"allowed investment\" in Seabrook 1 (its investment in working capital, fuel, capital additions after the date of commercial operation of Seabrook 1 and a portion of the initial investment) is calculated based on NAEC's actual capitalization from time to time over the term of the Contract, its actual debt and preferred equity costs, and a common equity cost of 12.53 percent for the first ten years of the Contract, and thereafter at an equity rate of return to be fixed in a filing with the FERC. The portion of the initial investment which is included in the \"allowed investment\" was 20 percent for the twelve months commencing May 16, 1991, increasing by 20 percent in the second year and by 15 percent in each of the next four years, resulting in 100 percent in the sixth and each succeeding year. As of December 31, 1993, 55 percent of the investment was included in rates.\nNAEC is entitled to earn a deferred return on the portion of the initial investment not yet phased into rates. The deferred return on the excluded portion of the initial investment will be recovered, together with a return on it, beginning in the first year after PSNH's Fixed Rate Period, and will be fully recovered prior to the tenth anniversary of PSNH's reorganization date.\nEffective February 15, 1994, NAEC also owns the 0.41259% share of capacity and output of Seabrook it purchased from VEG&T. NAEC sells that share to PSNH under an agreement that has been approved by FERC and is substantially similar to the Contract; however, the agreement does not provide for a phase-in of allowed investment and associated deferrals of capital recovery.\nMASSACHUSETTS RETAIL RATES\nGENERAL\nWMECO's retail electric rate schedules are subject to the jurisdiction of the DPU. The rates charged under HWP's contracts with industrial customers are not subject to the ratemaking jurisdiction of any state or federal regulatory agency. Massachusetts law allows the DPU to suspend a proposed rate increase for up to six months. If the DPU does not act within the suspension period, the proposed rates may be put into effect.\nUnder present rate-making standards, the DPU allows few adjustments to historic test year expenses to reflect the conditions anticipated by a company during the first year amended rate schedules are to be in effect. The principal adjustments that are permitted are inflation adjustments to historic test year non-fuel operation and maintenance expenses. Rate base is based on test year-end levels, and capital structure is based on test year-end levels adjusted for known and measurable changes. Current DPU practices permit WMECO to normalize most income tax timing differences.\nIn Holyoke, Massachusetts, where HWP and Holyoke Gas and Electric Department, a municipal utility, operate side-by-side, approximately 30 HWP industrial customers sought bids as a group in 1993 for future electric service. HWP retained the load and has a 10-year contract, at substantially lower rates than in the past, to supply the group.\nWMECO REGULATORY ACTIVITY\nIn December 1991, WMECO filed an application with the DPU for a retail rate increase of approximately $36 million or 9.1 percent. In April 1992, WMECO and the Massachusetts Attorney General filed a partial settlement agreement for approval by the DPU. Also in April 1992, a settlement agreement on WMECO's C&LM program budget was filed with the DPU jointly by WMECO, the Massachusetts Attorney General, Massachusetts Division of Energy Resources (DOER), the Conservation Law Foundation, Inc. (CLF) and the DPU's Settlement Intervention Staff. The settlement agreement covered WMECO's C&LM program through 1993 and included an annual budget of $17 million for both years. The parties also agreed that all expenditures and other charges relating to C&LM would be collected through a conservation charge (CC).\nIn May 1992, the DPU accepted the WMECO retail rate case and the C&LM settlement agreements. As a result, WMECO's annual retail rates increased by $12 million, or three percent, on July 1, 1992, and by a further $11 million, or 2.7 percent, on July 1, 1993. In June 1992, the DPU resolved the remaining issues in the rate case filed in December 1991, when it issued an order on WMECO's rate design. The DPU order required the first and second year base revenue increases to be allocated so that all classes contribute the same percentage increase.\nIn July 1992, the DPU approved an amended settlement agreement for 1992 and 1993 C&LM programs that established a CC that promoted rate stability by spreading the costs and subsequent recovery of 1992 and 1993 C&LM programs over the 18-month period from July 1, 1992 through December 31, 1993. The CC includes incremental C&LM program costs above or below base rate recovery levels, C&LM fixed cost recovery adjustments, and the provision for a C&LM incentive mechanism. In January 1993, WMECO filed with the DPU a request to reduce the CC rate by an aggregate of $3 million in 1993. On February 5, 1993, the DPU directed WMECO to file a revised CC to be effective on March 1, 1993 based on actual 1992 expenditures and the preapproved 1993 budget. The DPU approved the new CC on February 26, 1993. A motion for reconsideration was filed by certain of the parties to the original settlement. The DPU rejected that motion on July 9, 1993. WMECO filed for approval of a new CC on February 2, 1994. The DPU held a hearing on the proposed new CC on February 18, 1994.\nIn October 1992, the DPU approved an Integrated Resource Management (IRM) settlement agreement that had been proposed by WMECO, the Attorney General, CLF, DOER and the Massachusetts Public Interest Research Group (MASSPIRG) concerning WMECO's IRM. The settlement required WMECO to submit its C&LM programs for 1994, 1995 and a portion of 1996 for approval by the DPU prior to October 1993, and to file its next IRM draft initial filing on January 3, 1994. The settlement also requires WMECO to prepare a competitive resource solicitation at least six months before its C&LM filing for any new C&LM programs it proposes.\nOn March 16, 1993 WMECO filed a motion with the DPU to request authority to eliminate the separate (and higher) rates for residential electric heating customers by placing those customers on the same rates as the residential non-electric heating customers. WMECO proposed this change in order to be more competitive and to stem its losses of electric heating customers. On April 30, 1993, the DPU denied WMECO's request to eliminate the separate rates for residential electric heating customers but reduced the customer and energy charges for the electric heating customers to equal the comparable charges for non-electric heating customers.\nIn November 1993, WMECO submitted its C&LM filing required in the settlement of the IRM proceeding, along with a settlement offer from WMECO, the Attorney General, DOER, CLF and MASSPIRG. The settlement offer incorporated preapproved C&LM funding levels for 1994 and 1995 of $14.2 million and $15.8 million, respectively. The settlement also provides for the recovery of lost fixed revenue and a bonus incentive if certain implementation objectives are met. On January 21, 1994, the DPU approved the settlement.\nOn January 3, 1994, WMECO submitted its next draft initial IRM filing required by the October 1992 settlement to the DPU. The filing indicates the System does not need additional resources until at least the year 2007 and, therefore, WMECO does not intend to issue any solicitation for additional resources anytime in the foreseeable future. WMECO is presently participating in settlement discussions concerning this IRM filing. Should no settlement be reached, WMECO is scheduled to submit its initial IRM filing to the DPU in April 1994.\nWMECO ADJUSTMENT CLAUSE\nIn Massachusetts, all fuel costs are collected on a current basis by means of a forecasted quarterly fuel clause. The DPU must hold public hearings before permitting quarterly adjustments in WMECO's retail fuel adjustment clause. In addition to energy costs, the fuel adjustment clause includes capacity and transmission charges and credits that result from short-term transactions with other utilities and from the operation of the Northeast Utilities Generation and Transmission Agreement (NUG&T). The NUG&T is the FERC-approved contract among the System operating companies, other than PSNH, that provides for the sharing among the companies of system-wide costs of generation and transmission and serves as the basis for planning and operating the System's bulk power supply system on a unified basis.\nMassachusetts law establishes an annual performance program related to fuel procurement and use, and requires the DPU to review generating unit performance and related fuel costs if a utility fails to meet the fuel procurement and use performance goals set for that utility. Goals are established for equivalent availability factor, availability factor, capacity factor, forced outage rate and heat rate. Fuel clause revenues collected in Massachusetts are subject to potential refund, pending the DPU's examination of the actual performance of WMECO's generating units.\nCurrently pending before the DPU are investigations into the performance of WMECO's generating units for the 12-month periods ending May 31, 1992 and May 31, 1993. The DPU held a hearing on February 1, 1994 on WMECO's non-nuclear performance for the 12-month period ending May 31, 1992. Except for the order concerning CYAPC discussed below, the DPU has completed investigations of, but not yet issued decisions reviewing WMECO's actual generating unit performance for the program years between June 1987 and May 1991.\nThe DPU has consistently set performance goals for generating units that are not wholly-owned and operated by the company whose goals are being set. The DPU has found that possession of a minority ownership interest in a generating plant does not relieve a company of its responsibilities for the prudent operation of that plant. Accordingly, the DPU has established goals, as discussed above, for the three Millstone units and for the three regional nuclear generating units (the Yankee plants) in which WMECO has minority ownership interests.\nThe total amount of WMECO retail replacement power costs attributable to the major outages in the 1991 performance year -- the Millstone 3 July 1991 outage (mussel-fouling and service water), the Millstone 1 October 1991 outage (operator requalification examinations) and the November 1991 outages to perform pipe inspections, analysis and repair -- is approximately $17 million. In December 1992, WMECO notified the DPU that it will forego recovery of $1.2 million in replacement power costs associated with the October 1991 Millstone 1 operator requalification examination outage. The total amount of WMECO retail replacement power costs attributable to outages in the 1992-1993 performance year is approximately $17 million. Management believes that some portion of these replacement power costs may be subject to refund upon completion of the DPU's performance program reviews. However, management believes that its actions with respect to these outages have been prudent and does not expect the outcome of the DPU review to have a material adverse impact on WMECO's future earnings.\nIn September 1992, the DPU issued a partial order pertaining to CY's extended 1989-1990 refueling outage (discussed above), disallowing the recovery of $0.6 million of incremental replacement power costs that could be attributable to the outage. WMECO filed a motion for reconsideration with the DPU in the same month, which motion is pending before the DPU.\nWHOLESALE RATES\nCL&P currently furnishes firm wholesale electric service to one Connecticut municipal electric system. PSNH serves NHEC, three New Hampshire municipal electric systems and one investor-owned utility in Vermont. HWP and its wholly-owned subsidiary, Holyoke Power and Electric Company, serve one Massachusetts municipal electric system. WMECO serves one New York investor-owned electric utility. The System's 1993 firm wholesale load was approximately 275 megawatts (MW). In 1993, firm wholesale electric service accounted for approximately 2.5 percent of the System's consolidated electric operating revenues (approximately 1.2 percent of CL&P's operating revenue, 6.0 percent of PSNH's operating revenue, 0.1 percent of WMECO's operating revenue and 21.5 percent of HWP's operating revenue).\nNHEC, PSNH's largest customer, representing 5.9 percent of its revenues for 1993, filed a petition for reorganization in 1991 under Chapter 11 of the United States Bankruptcy Code. A plan of reorganization for NHEC, which was confirmed by the Bankruptcy Court in March 1992 and became effective on December 1, 1993, resolves a series of disputes between PSNH and NHEC and provides for PSNH to continue to serve NHEC. The contract covering this continued service has been filed with and accepted by FERC.\nIn addition to firm service, the System engages in numerous other bulk supply transactions that reduce retail customer costs, at rates that are subject to FERC jurisdiction, and it transmits power for other utilities at FERC-regulated rates. See \"Electric Operations - Generation and Transmission\" for further information on those bulk supply transactions and for information on pending FERC proceedings relating to transmission service. All of the wholesale electric transactions of CL&P, PSNH, WMECO, NAEC and HWP are subject to the jurisdiction of the FERC.\nFor a discussion of certain FERC-regulated sales of power by CL&P, PSNH, WMECO and HWP to other utilities, see \"Electric Operations -- Distribution and Load.\" For a discussion of sales of power by NAEC to PSNH, see \"Rates - Seabrook Power Contract.\" For a discussion of the effects of competition on the System, see \"Competition and Marketing.\"\nRESOURCE PLANS\nCONSTRUCTION\nThe System's construction program expenditures, including allowance for funds used during construction (AFUDC), in the period 1994 through 1998 are estimated to be as follows:\n1994 1995 1996 1997 1998 (Millions of Dollars) PRODUCTION CL&P . . . . . $ 60.9 $54.5 $44.3 $41.5 $39.6 PSNH . . . . . 10.5 7.0 13.3 8.7 15.8 WMECO . . . . 17.3 13.5 10.1 9.3 17.4 NAEC . . . . . 8.2 8.5 8.3 7.0 5.8 Other . . . . 16.2 3.0 2.0 0.7 0.5 System Total . 113.1 86.5 78.0 67.2 79.1\nSUBSTATIONS AND TRANSMISSION LINES CL&P . . . . . 12.2 9.4 11.6 12.3 14.6 PSNH . . . . . 3.0 6.9 9.9 6.1 6.7 WMECO. . . . . 0.8 0.4 0.5 0.8 1.3 NAEC . . . . . 0.0 0.0 0.0 0.0 0.0 Other . . . . 0.0 0.0 0.0 0.0 0.0 System Total 16.0 16.7 22.0 19.2 22.6\nDISTRIBUTION OPERATIONS CL&P . . . . . 76.1 78.8 80.9 84.1 85.5 PSNH . . . . . 22.0 11.7 10.6 14.5 14.2 WMECO. . . . . 17.4 19.3 17.3 17.2 18.7 NAEC . . . . . 0.0 0.0 0.0 0.0 0.0 Other . . . . 0.4 0.2 0.2 0.2 0.2 System Total 115.9 110.0 109.0 116.0 118.6\nGENERAL CL&P . . . . . 8.6 8.8 7.2 5.8 5.1 PSNH . . . . . 2.0 3.3 1.9 2.4 2.0 WMECO . . . . 2.0 2.1 1.9 1.5 1.3 NAEC . . . . . 0.0 0.0 0.0 0.0 0.0 Other . . . . 9.9 7.4 7.8 9.8 9.8 System Total 22.5 21.6 18.8 19.5 18.2\nTOTAL CONSTRUCTION CL&P . . . . . 157.8 151.5 144.0 143.7 144.8 PSNH . . . . . 37.5 28.9 35.7 31.7 38.7 WMECO . . . . 37.5 35.3 29.8 28.8 38.7 NAEC . . . . . 8.2 8.5 8.3 7.0 5.8 Other . . . . 26.5 10.6 10.0 10.7 10.5 System Total $267.5 $234.8 $227.8 $221.9 $238.5\nThe construction program data shown above include all anticipated capital costs necessary for committed projects and for those reasonably expected to become committed, regardless of whether the need for the project arises from environmental compliance, nuclear safety, improved reliability or other causes.\nThe construction program data shown above generally include the anticipated capital costs necessary for fossil generating units to operate at least until their scheduled retirement dates. Whether a unit will be operated beyond its scheduled retirement date, be deactivated or be retired on or before its scheduled retirement date is regularly evaluated in light of the System's needs for resources at the time, the cost and availability of alternatives, and the costs and benefits of operating the unit compared with the costs and benefits of retiring the unit. Retirement of certain of the units could, in turn, require substantial compensating expenditures for other parts of the System's bulk power supply system. Those compensating capital expenditures have not been fully identified or evaluated and are not included in the table.\nFUTURE NEEDS\nThe System's integrated demand and supply planning process is the means by which the System periodically updates its long-range resource needs. The current resource plan identifies a need for new resources beginning in 2007.\nBecause New England and the System have surplus generating capacity and are forecasting low load growth over the next several years, the System has no current plans to construct or to contract for any new generating units. Additional capacity beyond 2007, the projected System year of need, can come from a variety of sources. The design and implementation of new C&LM programs, the timely development of economic, reliable and efficient qualifying cogeneration and small power production facilities (QFs) or independent power producer (IPP) capacity through state-sanctioned resource acquisition processes, economic utility-sponsored generating resources (including the possibility of repowering retired power plants) and purchases from other utilities will all receive consideration in the System's integrated resource planning process.\nWith respect to demand-side management measures, the System's long- term plans rely, in part, on encouraging additional C&LM by customers. These measures, including installations to date, are projected to lower the System summer peak load in 2007 by over 1000 MW. In addition, System companies have long-term arrangements to purchase the output from QFs and IPPs under federal and state laws, regulations and orders mandating such purchases. CL&P's, PSNH's and WMECO's plans anticipate the development of QFs and IPPs supplying 710 MW of firm capacity by 1995, of which approximately 695 MW was operational in 1993. See \"New Hampshire Retail Rates -- Rate Agreement and FPPAC\" for information concerning PSNH's efforts to renegotiate its agreements with thirteen QFs.\nCL&P and WMECO filed applications with the U.S. Environmental Protection Agency to receive 203 SO2 allowances for C&LM activity as authorized by the Clean Air Act Amendments. See \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\"\nThe DPUC has issued regulations establishing competitive bidding systems for future purchases by Connecticut electric utilities from QFs and IPPs and from C&LM vendors. The regulations also implement a state law which provides that a utility may seek a premium of between one and five percentage points above its most recently authorized rate of return for each multi-year C&LM program requiring capital investment by the utility. In April 1993, CL&P submitted its eighth annual filing to the DPUC on private power production, C&LM, projected avoided costs and related matters. CL&P stated that the\nSystem's existing and committed resources are expected to be sufficient to meet System capacity requirements until 2007, and therefore, CL&P did not solicit new capacity from QFs or C&LM vendors in 1993. In December 1993, the DPUC issued its final decision approving CL&P's avoided cost estimates as filed.\nIn 1993, regulatory preapproval was obtained for all 1993 C&LM expenditures in each of the three retail jurisdictions. In addition, the DPUC authorized a maximum of 3 percent premium rate of return (after tax) on CL&P C&LM investment in 1993. WMECO is currently projected to earn $1.2 million of incentive (after tax) based on 1993 program savings. See \"Rates - Connecticut Retail Rates - Conservation and Load Management\" and \"Rates - Massachusetts Retail Rates -WMECO Regulatory Activity\" for information about rate treatment of C&LM costs.\nIn 1988, the DPU adopted regulations requiring preapproval of Massachusetts utilities' major investments in electric generating facilities, including life extensions. In 1990, the DPU adopted new IRM regulations, which established procedures by which additional resources are planned, solicited and processed to provide for reliable electric service in a least- cost manner. The regulations provide a mechanism for preapproval (rather than after-the-fact review) of utility plant construction, procurement of non-utility generation (QFs and IPPs), and C&LM programs. The regulations specifically require that environmental externalities be considered in the evaluation of resource alternatives.\nIn January 1994, WMECO filed its initial draft IRM filing, stating that WMECO's year of need is estimated to be 2007, and that no new capacity need be solicited at this time. WMECO is presently in settlement discussions. See \"Rates-Massachusetts Retail Rates - WMECO Regulatory Activity\" for further information relating to WMECO C&LM issues.\nIn 1993, the NHPUC approved a settlement agreement related to PSNH's 1992 least cost planning filing, which defers various planning issues to PSNH's April 1, 1994 filing.\nIn addition to the contributions from C&LM, QFs and IPPs, the System's long-term resource plan includes consideration of continued operation of certain of the System's fossil generating units beyond their current book retirement dates to the extent that it is economic, and possibly repowering certain of the System's older fossil plants. Continued operation of existing fossil units past their book retirement dates (and replacing certain critically located peaking units if they fail) is expected by 2007 to provide approximately 1,400 MW of resources that would otherwise have been retired. Repowering of some of the System's retired generating plants could make available an additional 900 MW of capacity. The capacity could be brought on line in various increments timed with the year of need. The System's need for new resources may be affected by any additional retirements of the System's existing generating units.\nThe System companies periodically study the economics of their generating units as part of their overall resource planning process. In 1992, the DPUC ordered CL&P to submit economic analyses of the continued operation of 11 fossil steam units by April 1, 1993, and of Millstone Units 1 and 2 and CY, of which the System companies own 49 percent) by April 1, 1994. In 1993, the DPUC reviewed the continued unit operation (CUO) studies submitted by CL&P for the eleven fossil units in Connecticut and\nMassachusetts in its annual review of Integrated Resource Planning. The DPUC concluded that a decision was inappropriate at that time and that it would review the issue again in its management audit of CL&P and in CL&P's 1994 integrated resource planning docket. For Millstone 1 and 2 and CY, the CUO studies are in progress. Preliminary indications are that the operation of the units continues to be economic for customers. Final analyses for CY and the Millstone units will be filed with the DPUC in 1994.\nFor planning and budgetary purposes, the System assumes that CL&P's Montville Station (497.5 MW) will be deactivated from November 1994 through October 1998. A final decision is expected to be made in 1994. Since reactivation is expected to occur in 1998, the System year of need of 2007 is unaffected. The System year of need of 2007 assumes PSNH's Merrimack 2 continues to operate. However, Merrimack 2's continued operation is in question because Merrimack 2 produces significant NOx emissions. The concern has been raised as to whether the emissions can be lowered to acceptable levels in the short and long term. In 1993, PSNH worked successfully with local, state and federal interests to arrive at a solution for Merrimack 2 NOx compliance by 1995, while deferring a decision on continued unit operation beyond 1999 to the future. For information regarding the agreement concerning NOX emissions at the Merrimack units, see \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\"\nSee \"Regulatory and Environmental Matters -- NRC Nuclear Plant Licensing\" for further information on the NRC rule on nuclear plant operating license renewal and information on the expiration dates of the operating licenses of the nuclear plants in which System companies have interests. Before the System can make any decisions about whether license extensions for any of its nuclear units are feasible, detailed technical and economic studies will be needed.\nFINANCING PROGRAM\n1993 FINANCINGS\nIn January 1993, WMECO issued $60 million in principal amount of 6 7\/8 percent first mortgage bonds due in 2000. In July 1993, CL&P issued $200 million and $100 million, respectively, of 5 3\/4 percent and 7 1\/2 percent first mortgage bonds due in 2000 and 2023, respectively. In December 1993, CL&P issued $125 million of 7 3\/8 percent first mortgage bonds due in 2025. The proceeds from the foregoing issues were used to redeem outstanding bonds with interest rates ranging from 8 3\/4 percent to 9 3\/4 percent.\nIn October 1993, CL&P issued $80 million of 5.30 percent preferred stock, $50 par value. The proceeds of this issuance, together with $30 million of short-term debt, were used to redeem $110 million of preferred stock with dividend rates ranging from 7.6 percent to 9.1 percent.\nIn September 1993, the Connecticut Development Authority (CDA) issued, on behalf of CL&P, two tax-exempt variable rate pollution control revenue bonds (PCRBs) in the amounts of $245.5 million and $70 million, respectively. At the same time, the CDA issued, on behalf of WMECO, $53.8 million of tax-exempt variable rate PCRBs. The proceeds of these issues were used to redeem like amounts of tax-exempt PCRBs having less favorable structures. These refinancings will result in savings from the extension of maturities, the redemption of two issues of fixed-rate bonds with proceeds of the issuance of variable-rate bonds, the improved credit ratings of new supporting letter of credit banks and associated administrative savings. In December 1993, the New Hampshire Business Finance Authority (BFA) issued, on behalf of PSNH, $44.8 million of tax-exempt variable rate PCRBs. The proceeds of this issue were used to redeem a like amount of taxable PCRBs. Taxable BFA bonds issued on behalf of PSNH in the amount of $109.2 million are outstanding and may be refinanced with tax-exempt bonds upon the receipt of an allocation of the state's private activity volume allocation.\nIn January 1993, CL&P, PSNH and WMECO purchased $340 million, $75 million and $52 million, respectively, of three-year variable rate debt caps. The caps were purchased to hedge the interest rate risk of the companies' respective variable rate PCRBs and were sized to approximate each respective company's then-current tax-exempt variable rate PCRB issuances. If the interest rate, based on the J. J. Kenny index, exceeds 4.5 percent (the strike rate), each company will receive payments under the terms of its respective interest rate cap agreement. In June 1993, PSNH purchased a $50 million six-month interest rate cap, a $50 million 12 month cap and a $100 million 18 month cap to hedge its interest rate exposure on its variable rate term note. The six-month and 12 month caps have a strike rate of 4.5 percent and the 18 month cap has a strike rate of 5.0 percent, all based on 90 day LIBOR. These caps were sized to approximate portions of a PSNH term note which has a quarterly sinking fund of $23.5 million.\nIn February 1993, NU, CL&P, WMECO and the Niantic Bay Fuel Trust (NBFT) began a co-managed commercial paper program with two commercial paper dealers. Prior to this time, each company's commercial paper program was managed by one commercial paper dealer. The co-managed program was implemented to promote competition between commercial paper dealers, to increase the investor universe and to increase the range of maturities available to the issuers. On December 31, 1993, $113.0 million commercial paper was outstanding under these programs.\nIn December 1993, NNECO issued $25 million of 7.17 percent unsecured amortizing notes maturing in 2019. The proceeds of this issuance are being used to finance the construction of a new building at Millstone station to house various administrative and technical support functions.\nFINANCING NUCLEAR FUEL\nThe System requires nuclear fuel for the three Millstone units and for Seabrook 1. The requirements for the Millstone 1, Millstone 2 and CL&P's and WMECO's share of the Millstone 3 units are financed through a third party trust financing arrangement described below. All nuclear fuel for NAEC's and CL&P's shares of Seabrook 1 and PSNH's share of Millstone 3 is owned and financed directly by the respective companies. For the period 1994 through 1998, NAEC's and CL&P's shares of the cost of nuclear fuel for Seabrook 1 are estimated at $56.8 million and $6.4 million, respectively, excluding AFUDC. For the same period, PSNH's share of the cost of nuclear fuel for Millstone 3 is estimated at $6 million, excluding AFUDC.\nIn 1982, CL&P and WMECO entered into arrangements under which NBFT owns and finances the nuclear fuel for Millstone 1 and 2 and CL&P's and WMECO's share of the nuclear fuel for Millstone 3. NBFT finances the fuel from the time uranium is acquired, during the off-site processing stages and through its use in the units' reactors. NBFT obtains funds from bank loans, the sale of commercial paper and the sale of intermediate term notes. The fuel is leased to CL&P and WMECO by the trust while it is used in the reactors, and ownership of the fuel is transferred to CL&P and WMECO when it is permanently discharged from the reactors. CL&P and WMECO are severally obligated to make quarterly lease payments, to pay all expenses incurred by NBFT in connection with the fuel and the financing arrangements, to purchase the fuel under certain circumstances and to indemnify all the parties to the transactions.\nThe trust arrangements presently allow up to $530 million to be financed by NBFT with bank loans and commercial paper (up to $230 million) and with intermediate term notes (up to $300 million). The arrangements with the banks are in effect until February 19, 1996, and can be extended for an additional three years if the parties so agree. On December 31, 1993, NBFT had $80 million of intermediate term notes and $113 million of commercial paper outstanding.\nAs of December 31, 1993, NBFT's investment in nuclear fuel, net of the fourth quarter 1993 lease payment made on January 31, 1994, for all three Millstone units was $172.1 million, as follows:\nTotal CL&P WMECO System\n(Millions of Dollars)\nIn process.......... $20.3 $4.7 $25.0 In stock............ 8.0 1.9 9.9 In reactor.......... 111.2 26.0 137.2 Total.......... $139.5 $32.6 $172.1\nFor the period 1994 through 1998, CL&P and WMECO's share of the cost of nuclear fuel for the three Millstone units that will be acquired through NBFT will be $313.5 million and $73.2 million, respectively, excluding AFUDC.\nNuclear fuel costs and a provision for spent fuel disposal costs are being recovered through rates as the fuel is consumed in reactors.\n1994 FINANCING REQUIREMENTS\nIn addition to financing the construction requirements described under \"Resource Plans - Construction,\" the System companies are obligated to meet $1,373.8 million of long-term debt maturities and cash sinking fund requirements and $76.4 million of preferred stock cash sinking fund requirements in 1994 through 1998. In 1994, long-term debt maturity and cash sinking fund requirements will be $295.3 million, consisting of $182 million of long-term debt maturities and $7 million of debt cash sinking fund requirements to be met by CL&P, $94 million of cash sinking fund requirements to be met by PSNH, $1.5 million of cash sinking funds to be met by WMECO and $10.7 million of cash sinking fund requirements to be met by other subsidiaries. These figures do not include $125 million of long-term debt redeemed by CL&P on January 7, 1994 with the proceeds of its issuance of $125 million mortgage bonds in December 1993. See \"Financing Program - 1993 Financings.\"\nSee \"Electric Operations -- Nuclear Generation -- Operations -- Seabrook\" for information on CL&P's commitment to advance funds to cover payments that a 12 percent Seabrook owner might be unable to pay with respect to Seabrook project costs.\nThe System's aggregate capital requirements for 1994, exclusive of requirements under NBFT, are as follows:\nTotal CL&P PSNH WMECO NAEC Other System (Millions of Dollars) Construction (including AFUDC)..... $157.8 $37.5 $37.5 $ 8.2 $26.5 $267.5 Nuclear Fuel (excluding AFUDC). (.3) 1.8 (.2) 5.8 - 7.1 Maturities......... 182.0 - - - - 182.0 Cash Sinking Funds. 7.0 94.0 1.5 - 10.7 113.2 Total.......... $346.5 $133.3 $38.8 $14.0 $37.2 $569.8\n1994 FINANCING PLANS\nThe System companies, other than CL&P, currently expect to finance their 1994 requirements through internally generated funds. CL&P may issue up to $200 million of long-term debt, primarily to finance maturing securities. This estimate excludes the nuclear fuel requirements financed through the NBFT. See \"Financing Nuclear Fuel\" above for information on the NBFT. In addition to financing their 1994 requirements, the System companies intend, if market conditions permit, to continue to refinance a portion of their outstanding long-term debt and preferred stock, if that can be done at a lower effective cost.\nOn February 17, 1994, CL&P issued $140 million in principal amount of 5 1\/2 percent first mortgage bonds due in 1999 and $140 million in principal amount of 6 1\/2 percent first mortgage bonds due in 2004. The net proceeds were used to redeem higher cost first mortgage bonds.\nOn March 8, 1994, WMECO contracted to issue $40 million principal amount of 6 1\/4 percent first mortgage bonds due in 1999 and $50 million in principal amount of 7 3\/4 percent first mortgage bonds due in 2024. The net proceeds will be used to redeem higher cost first mortgage bonds.\nFINANCING LIMITATIONS\nThe amounts of short-term borrowings that may be incurred by NU, CL&P, PSNH, WMECO, HWP, NAEC, NNECO, The Rocky River Realty Company (RRR), The Quinnehtuk Company (Quinnehtuk) (RRR and Quinnehtuk are real estate subsidiaries), and HEC are subject to periodic approval by the SEC under the Public Utility Holding Company Act of 1935 (1935 Act).\nThe following table shows the amount of short-term borrowings authorized by the SEC for each company and the amounts of outstanding short term debt of those companies at the end of 1993.\nMaximum Authorized Short-Term Debt Short-Term Debt Outstanding at 12\/31\/93* (Millions of Dollars) NU.................. $ 175.0 $ 72.5 CL&P ............... 375.0 96.2 PSNH ............... 125.0 2.5 WMECO............... 75.0 6.0 HWP................. 8.0 - NAEC................ 50.0 - NNECO............... 65.0 - RRR................. 25.0 16.5 Quinnehtuk.......... 8.0 4.3 HEC................. 11.0 2.9 ______ $200.9 _________________ * This column includes borrowings of various System companies from NU and other System companies through the Northeast Utilities System Money Pool (Money Pool). Total System short term indebtedness to unaffiliated lenders was $173.5 million at December 31, 1993.\nThe supplemental indentures under which NU issued $175 million in principal amount of 8.58 percent amortizing notes in December 1991 and $75 million in principal amount of 8.38 percent amortizing notes in March 1992 contain restrictions on dispositions of certain System companies' stock, limitations of liens on NU assets and restrictions on distributions on and acquisitions of NU stock. Under these provisions, neither NU, CL&P, PSNH nor WMECO may dispose of voting stock of CL&P, PSNH or WMECO other than to NU or another System company, except that CL&P may sell voting stock for cash to third persons if so ordered by a regulatory agency so long as the amount sold is not more than 19 percent of CL&P's voting stock after the sale. The restrictions also generally prohibit NU from pledging voting stock of CL&P, PSNH or WMECO or granting liens on its other assets in amounts greater than five percent of the total common equity of NU. As of March 1, 1994, no NU debt was secured by liens on NU assets. Finally, NU may not declare or make distributions on its capital stock, acquire its capital stock (or rights thereto), or permit a System company to do the same, at times when there is an Event of Default under the supplemental indentures under which the amortizing notes were issued.\nThe charters of CL&P and WMECO contain preferred stock provisions restricting the amount of short term or other unsecured borrowings those companies may incur. As of December 31, 1993, CL&P's charter would permit CL&P to incur an additional $570 million of unsecured debt and WMECO's charter would permit it to incur an additional $141.1 million of unsecured debt.\nIn connection with NU's acquisition of PSNH, certain financial conditions intended to prevent NU from relying on CL&P resources if the PSNH acquisition strains NU's financial condition were imposed by the DPUC. The principal conditions provide for a DPUC review if CL&P's common equity falls to 36 percent or below, require NU to obtain DPUC approval to secure NU financings with CL&P stock or assets, and obligate NU to use its best efforts to sell CL&P preferred or common stock to the public if NU cannot meet CL&P's need for equity capital. At December 31, 1993, CL&P's common equity ratio was 39.1 percent.\nWhile not directly restricting the amount of short-term debt that CL&P, WMECO, RRR, NNECO and NU may incur, credit agreements to which CL&P, WMECO, HWP, RRR, NNECO and NU are parties provide that the lenders are not required to make additional loans, or that the maturity of indebtedness can be accelerated, if NU (on a consolidated basis) does not meet a common equity ratio that requires, in effect, that the NU consolidated common equity (as defined) be at least 27 percent for three consecutive quarters. At December 31, 1993, NU's common equity ratio was 30.9 percent. Credit agreements to which PSNH is a party forbid its incurrence of additional debt unless it is able to demonstrate, on a pro forma basis for the prior quarter and going forward, that its equity ratio (as defined) will be at least 21 percent of total capitalization (as defined) through June 30, 1994, 23 percent through June 30, 1995 and 25 percent thereafter. In addition, PSNH must demonstrate that its ratio of operating income to interest expense will be at least 1.5 to 1 for each period of four fiscal quarters ending after June 30, 1993 through June 30, 1994 and 1.75 to 1 thereafter. At December 31, 1993, PSNH's common equity ratio was 28.2 percent and its operating income to interest expense ratio was 2.27 to 1.\nSee \"Short-Term Debt\" in the notes to NU's, CL&P's, PSNH's and WMECO's financial statements for information about credit lines available to System companies.\nThe indentures securing the outstanding first mortgage bonds of CL&P, PSNH, WMECO and NAEC provide that additional bonds may not be issued, except for certain refunding purposes, unless earnings (as defined in each indenture, and before income taxes, and, in the case of PSNH, without deducting the amortization of PSNH's regulatory asset) are at least twice the pro forma annual interest charges on outstanding bonds and certain prior lien obligations and the bonds to be issued.\nThe preferred stock provisions of CL&P's, WMECO's and PSNH's charters also prohibit the issuance of additional preferred stock (except for refinancing purposes) unless income before interest charges (as defined and after income taxes and depreciation) is at least 1.5 times the pro forma annual interest charges on indebtedness and the annual dividend requirements on preferred stock that will be outstanding after the additional stock is issued.\nBeginning with the dividends paid on NU common shares by NU in June 1990, NU's Dividend Reinvestment Plan (DRP) was amended to authorize the dividends and optional cash purchases of participating shareholders to be reinvested in NU common shares purchased either in the open market or directly from NU. NU received approximately $42.4 million in 1991 and approximately $35.6 million in 1992 of new common shareholders' equity from the reinvestment of dividends and voluntary cash investments. No funds have been raised by NU through DRP since August 1992, when management ended direct purchases and caused shares to be purchased for DRP participants in the open market.\nAs part of the PSNH acquisition in June 1992, NU issued warrants for the purchase of NU common stock at a price of $24 per share. In 1993, NU received $8.3 million from the exercise of these warrants. As of December 31, 1993, warrants for 7,975,516 shares of NU common stock remained unexercised.\nNU is dependent on the earnings of, and dividends received from, its subsidiaries to meet its own financial requirements, including the payment of dividends on NU common shares. At the current indicated annual dividend of $1.76 per share, NU's aggregate annual dividends on common shares outstanding at December 31, 1993, including unallocated shares held by the ESOP trust, would be approximately $236.2 million. Dividends are payable on common shares only if, and in the amounts, declared by the NU Board of Trustees. SEC rules under the 1935 Act require that dividends on NU's shares be based on the amounts of dividends received from subsidiaries, not on the undistributed retained earnings of subsidiaries. The SEC's order approving NU's acquisition of PSNH under the 1935 Act approved NU's request for a waiver of this requirement through June 1997. PSNH and NAEC were effectively prohibited from paying dividends to NU through May 1993. Through the remainder of 1993, PSNH and NAEC did not pay dividends to permit them to build up the common equity portion of their capitalizations. Until PSNH and NAEC can begin to fund a part of NU's dividend requirements, NU expects to fund that portion of its dividend requirements with the proceeds of borrowings.\nThe supplemental indentures under which CL&P's and WMECO's first mortgage bonds and the indenture under which PSNH's first mortgage bonds have been issued limit the amount of cash dividends and other distributions these subsidiaries can make to NU out of their retained earnings. As of December 31, 1993, CL&P had $210.6 million, WMECO had $26.5 million and PSNH had $60.8 million of unrestricted retained earnings. PSNH's preferred stock provisions also limit the amount of cash dividends and other distributions PSNH can make to NU if after taking the dividend or other distribution into account, PSNH's common stock equity is less than 25 percent of total capitalization. The indenture under which NAEC's Series A Bonds have been issued also limits the amount of cash dividends or distributions NAEC can make to NU to retained earnings plus $10 million. At December 31, 1993, $48.7 million was available to be paid under this provision.\nPSNH's credit agreements prohibit PSNH from declaring or paying any cash dividends or distributions on any of its capital stock, except for dividends on the preferred stock, unless minimum interest coverage and common equity ratio tests are satisfied.\nCertain subsidiaries of NU established the Money Pool to provide a more effective use of the cash resources of the System, and to reduce outside short term borrowings. The Service Company administers the Money Pool as agent for the participating companies. Short term borrowing needs of the participating companies (except NU) are first met with available funds of other member companies, including funds borrowed by NU from third parties. NU may lend to, but not borrow from, the Money Pool. Investing and borrowing subsidiaries receive or pay interest based on the average daily Federal Funds rate, except that borrowings based on loans from NU bear interest at NU cost. Funds may be withdrawn or repaid to the Money Pool at any time without prior notice.\nELECTRIC OPERATIONS\nDISTRIBUTION AND LOAD\nThe System operating companies own and operate a fully-integrated electric utility business. The System operating companies' retail electric service territories cover approximately 11,335 square miles (4,400 in CL&P's service area, 5,445 in PSNH's service area and 1,490 in WMECO's service area) and have an estimated total population of approximately 3.7 million (2.5 million in Connecticut, 780,000 in New Hampshire and 450,000 in Massachusetts). The companies furnish retail electric service in 149, 198 and 59 cities and towns in Connecticut, New Hampshire and Massachusetts, respectively. In December 1993, CL&P furnished retail electric service to approximately 1.085 million customers in Connecticut, PSNH provided retail electric service to approximately 397,000 customers in New Hampshire and WMECO served approximately 193,000 retail electric customers in Massachusetts. HWP serves approximately 25 customers in a portion of the town of Holyoke, Massachusetts.\nThe following table shows the sources of 1993 electric revenues based on categories of customers:\nCL&P PSNH WMECO NAEC Total System\nResidential........... 39% 35% 38% - 39% Commercial............ 33 17 30 - 29 Industrial ........... 14 28 20 - 18 Wholesale* ........... 11 17 8 100% 11 Other ................ 3 3 4 - 3 ____ ____ ____ ____ ____ Total ................ 100% 100% 100% 100% 100%\n______________________ * Includes capacity sales.\nNAEC's 1993 electric revenues were derived entirely from sales to PSNH under the Seabrook Power Contract. See \"Rates - Seabrook Power Contract\" for a discussion of the contract.\nThrough December 31, 1993, the all-time maximum demand on the System was 6,191 MW, which occurred on July 8, 1993. At the time of the peak, the System's generating capacity, including capacity purchases, was 8,965 MW. The System was also selling approximately 1,431 MW of capacity to other utilities at that time.\nIn 1993, System energy requirements were met 62 percent by nuclear units, nine percent by oil burning units, 10 percent by coal burning units, three percent by hydroelectric units, two percent by natural gas burning units and 14 percent by cogenerators and small power producers. By comparison, in 1992 the System's energy requirements were met 48 percent by nuclear units, 24 percent by oil burning units, 10 percent by coal burning units, four percent by hydroelectric units, one percent by natural gas burning units and 13 percent by cogenerators and small power producers. See \"Electric Operations-Generation and Transmission\" for further information.\nThe actual changes in kWh sales for the last two years and the forecasted sales growth estimates for the 10-year period 1993 through 2003, in each case exclusive of bulk power sales, for the System, CL&P, PSNH and WMECO are set forth below:\n1993 over 1992 over Forecast 1993-2003 (under) 1992 (under) 1991 Compound Rate of Growth\nSystem......... 10.9%(1) 15.3%(1) 1.4% CL&P........... (0.3)% 0.2% 1.3% PSNH........... 1.0% 1.1% 1.7% WMECO....... 0.1% (1.6)% 1.1% ___________________ (1) The percent increase in System 1992 sales over 1991 sales and 1993 sales over 1992 sales is due to the inclusion of PSNH sales beginning in June 1992.\nIn 1990, FERC required the reclassification of bulk power sales from \"purchased power\" to \"sales for resale\" for the 1990 and later reporting years. Bulk power sales are not included in the development of any long-term forecasted growth rates. The actual changes in kWh sales for the last two years, adjusted for bulk power sales (by adding back the bulk power sales), for the System, CL&P, PSNH and WMECO are set forth below:\n1993 over (under) 1992 1992 over (under) 1991 System ................... 11.8%(1) 19.7%(1) CL&P ..................... 1.2% 3.3% PSNH ..................... (9.3)% 6.7% WMECO .................... 13.5% 9.9%\n__________________ (1) System sales percentages reflect the inclusion of PSNH sales beginning in June 1992.\nDespite a warmer than normal summer that added to cooling requirements, sales showed negligible growth in 1993. Widespread economic recovery throughout the System's service territory did not occur in 1993, but there were mixed pockets of regional economic growth aided by very favorable interest rates. Curtailments in defense spending continue to affect the Connecticut, New Hampshire and western Massachusetts economies, which are heavily dependent on defense-related industries. Competition in various forms may also adversely affect the projected growth rate of sales over the next ten years. Where energy costs are a significant part of operating expenses, business customers may turn to self-generation, switch fuel sources, or relocate to other states and countries which have aggressive programs to attract new businesses. For further information on the effect of competition on sales growth rates, see \"Marketing and Competition.\"\nThe forecasted load growth for the System as a whole is significantly below historic rates in part because of forecasted savings from NU-sponsored C&LM programs, which are designed to minimize operating expenses for System customers and postpone the need for new capacity on the System. The forecasted ten-year growth rate of System sales would be approximately 1.8 percent instead of 1.4 percent if the System did not pursue C&LM savings. See \"Resource Plans - Future Needs\" for an estimate of the impact of C&LM programs on the System's need for new generating resources and for information about C&LM cost impacts and cost recovery. See \"Rates - Connecticut Retail Rates\" and \"Rates - Massachusetts Retail Rates\" for information about rate treatment of C&LM costs.\nWith the System's generating capacity of 8,268 MW as of January 1, 1994 (including the net of capacity sales to and purchases from other utilities, and approximately 690 MW of capacity to be purchased from QFs and IPPs under existing contracts and contracts under negotiation), the System expects to meet its projected annual peak load growth of 1.3 percent reliably until at least the year 2007.\nThe availability of new resources and reduced demand for electricity have combined to place the System and most other New England electric utilities in a surplus capacity situation. The principal resource changes were Seabrook 1's commercial operation, the full operation of the second phase of the Hydro-Quebec project, and increased availability of power from QF and IPP projects. As a consequence, the competition from capacity-long utilities as sellers and the loss of utilities that are no longer capacity- short as buyers have adversely affected the System companies' efforts to sell additional surplus capacity at the price levels that prevailed in the late 1980s. Taking into account projected load growth for the System and committed capacity sales, but not taking into account future potential capacity sales to other utilities that are not subject to firm commitments, the System's surplus capacity is expected to be approximately 1,000 MW in 1994.\nFor further information on the effect of competition on sales of surplus capacity, see \"Competition and Marketing.\"\nThe System operating companies operate and dispatch their generation as provided in the New England Power Pool (NEPOOL) Agreement. In 1993, the peak demand on the NEPOOL system was 19,570 MW, which occurred in July, above the 1992 peak load of 18,853 MW in January of that year. NEPOOL has projected that there will be an increase in demand in 1994 and estimates that the summer 1994 peak load could reach 19,800 MW. NEPOOL projects that sufficient capacity will be available to meet this anticipated demand.\nGENERATION AND TRANSMISSION\nThe System operating companies and most other New England utilities with electric generating facilities are parties to the NEPOOL Agreement. Under the NEPOOL Agreement, the region's generation and transmission facilities are planned and operated as part of the regional New England bulk power system. System transmission lines form part of the New England transmission system linking System generating plants with one another and with the facilities of other utilities in the northeastern United States and Canada. The generating facilities of all NEPOOL participants are dispatched as a single system through the New England Power Exchange, a central dispatch facility. The NEPOOL Agreement provides for a determination of the generating capacity responsibilities of participants and certain transmission rights and responsibilities. Pool dispatch results in substantial purchases and sales of electric energy by pool participants, including the System companies, at prices determined in accordance with the NEPOOL Agreement.\nThe System operating companies, except PSNH, pool their electric production costs and the costs of their principal transmission facilities under the NUG&T agreement. In addition, a ten-year agreement between PSNH and CL&P, WMECO and HWP provides for a sharing of the capability responsibility savings and energy expense savings resulting from a single system dispatch.\nIn connection with NU's acquisition of PSNH, the System proposed a comprehensive plan for opening up a transmission corridor between northern and southern New England for use in \"wheeling\" power of other utilities. The plan was designed to accomplish a level of access to transmission resources of the PSNH and New England Electric System (NEES) systems that could formerly be accomplished only after a series of multilateral negotiations. The plan includes provisions to (i) make 452 MW of long term transmission service available across the PSNH system from Maine to Massachusetts, Rhode Island, Connecticut and Vermont at embedded cost rates, (ii) make 200 MW of long term transmission service available by NEES for those utilities requiring deliveries across NEES's system in order to make use of access to the PSNH system, and (iii) construct new facilities as needed to expand the corridor from Maine to Massachusetts, if the cost of expansion is supported and if regulatory approvals for the expansion are received. Further, NU committed to make access to the combined NU-PSNH transmission system available for third-party wheeling transactions whenever capacity is available, and to expand the system when expansion is feasible. The principal constraints are that NU and PSNH have reserved a priority on the use of their transmission systems to serve the reliability needs of their own native load customers, and the commitment to expand would be subject to obtaining all necessary approvals. This plan became effective in October 1992, subject to the outcome of a hearing ordered by FERC in this proceeding, and the Commission's final decision in the compliance phase of the merger proceeding discussed below. NU and NEES filed offers of settlement in this proceeding in May and June 1993, respectively, and the Presiding Administrative Law Judge certified both settlement offers to the Commission in July 1993. The only contested issue was the refund and surcharge provision that was included in both offers of settlement. The Commission has not yet acted on these settlement offers.\nThese commitments, and the entire issue of access to the NU and PSNH transmission systems by other utilities and non-utility generators, were the subject of extensive controversy in New England. On January 29, 1992, FERC issued a decision approving the acquisition and allowing NU and PSNH customers to be held harmless if other utilities and non-utility generators need to use the NU-PSNH transmission to buy or sell electricity. In accordance with the January 29 decision, on April 23, 1992 and August 4, 1992, NU made compliance filings, including transmission tariffs implementing the FERC's conditions. All tariffs have been accepted by FERC and were effective as of the merger date. FERC has issued summary determinations (without hearing) and NU has filed for rehearing of FERC's compliance tariff order in an effort to reinstate the originally proposed rates. FERC has not yet acted on NU's rehearing petition.\nFERC's approval of NU's acquisition of PSNH was appealed to the United States Court of Appeals for the First Circuit. On May 19, 1993, the First Circuit Court affirmed FERC's decision approving the merger but remanded to FERC one issue brought by NU related to FERC's ability to change the terms of the Seabrook Power Contract. FERC filed for en banc (full court) review by the First Circuit Court on the Seabrook Power Contract issue, which was denied. No petitions for review were filed in the U.S. Supreme Court, therefore, the First Circuit Court's decision is final. FERC has yet to initiate any proceeding on the court's remand, which would address whether FERC could modify the Seabrook Power Contract under a more stringent \"public interest standard.\"\nOn December 21, 1993, NU filed an appeal in the United States Court of Appeals for the District of Columbia Circuit of a FERC order directing NU to put itself on its own transmission tariffs in connection with all NU sales of wholesale power. NU had committed, as part of the PSNH merger, to place itself on its tariff when it was competing with other wholesale power suppliers to make a sale in order to \"level the playing field.\" In its order, FERC expanded NU's merger commitment to include all transactions, regardless of whether or not NU's competitors need to use the NU transmission system.\nThe controversy about the terms on which wheeling transactions are to be effected in New England has stimulated a series of negotiations among utilities, regulators and non-utility generators, directed at the possible development of new regional transmission arrangements. While an original draft regional transmission arrangement was not supported by all parties, there have been negotiations on a less comprehensive arrangement. Any arrangement would be subject to approval by NEPOOL members and FERC.\nHYDRO-QUEBEC\nAlong with other New England utility companies, CL&P, PSNH, WMECO and HWP is each a participant in agreements to finance, construct, and operate the United States portion of direct current transmission circuits between New England and Quebec, Canada. The project was built in two phases, and now provides 2,000 MW of rated transfer capacity with Canadian facilities constructed and owned by Hydro-Quebec, a Canadian utility system. Phase 1, which entered into commercial operation in 1986, initially provided 690 MW of North-South transfer capacity. In Phase 2, the transmission line was extended to a new converter station in eastern Massachusetts. Phase 2 entered into full operation in 1991. The actual transfers over the interconnection to date have averaged in the 1,400 to 1,800 MW range.\nThe interconnection permits a reduction in oil consumption in New England and has the potential to produce cost savings to customers through the purchase of power from Hydro-Quebec's hydroelectric generating facilities. The interconnection also reduces the level of reserves New England utilities must carry to assure that pool reliability criteria are met.\nThe System companies are obligated to pay 34.22 percent of the annual costs of the Phase 1 facilities and 32.78 percent of the annual cost of the Phase 2 facilities. They are entitled, on the basis of a composite of these percentages, to use the capacity of the facilities for their own transactions and to share in the savings from pool energy transactions with Hydro-Quebec. The Phase 1 total project cost was $141 million and the Phase 2 total project cost was approximately $495 million. Phase 2 was constructed and is owned and operated by two companies in which NU has a 22.66 percent equity ownership interest. As an equity participant, NU guarantees certain obligations in connection with the debt financing of certain other participants that have lower credit ratings, and it receives compensation for such undertakings.\nWhen the Phase 2 facilities became fully operational in 1991, a contract covering the purchase by the New England utilities of 70 terawatthours of energy from Hydro-Quebec over a period of approximately ten years came into effect. While transactions under this contract are expected to constitute the principal use of the interconnection during the 1990s, the interconnection is also available for other energy transactions and for the \"banking\" of energy in Canada during off-peak hours in New England, with equivalent amounts of energy available to New England during peak hours.\nFOSSIL FUELS\nOIL\nThe System's residual oil-fired generation stations used approximately 5.89 million barrels of oil in 1993. The System obtained the majority of its oil requirements in 1993 through contracts with three large, independent oil companies. Those contracts allow for some spot purchases when market conditions warrant, but spot purchases represented less than 15 percent of the System's fuel oil purchases in 1993. The contracts expire annually or biennially.\nThe average 1993 price paid for fuel oil used for electric generation was approximately $14 per barrel, which was the same as the average 1992 price. No. 6 fuel oil prices were high during the first quarter of 1993 due to increased demand and firm crude oil prices. Fuel oil prices declined slightly during the second and third quarters, weakened in the fourth quarter due to weak crude prices associated with OPEC over-production and then firmed in the first quarter of 1994 due to severe weather in the Northeast. On February 1, 1994, the weighted average price being paid for the System's fuel oil had increased to $17 per barrel.\nThe System-wide fuel oil storage capacity is approximately 2.5 million barrels. In 1993, inventories were maintained at levels between 40 - 60 percent of capacity. This inventory constitutes approximately 13 days of full load operation.\nGAS\nCurrently, three system generating units, PSNH's Newington unit, WMECO's West Springfield Unit 3 and CL&P's Montville 5, can burn either residual oil or natural gas as economics dictate. The System is currently in the process of converting CL&P's Devon Units 7 & 8 into oil and gas dual-fuel generating units. Devon Unit 8's boiler conversion, which gave it gas burning capability, was completed in December 1993. Devon Unit 7's boiler conversion is scheduled for completion during its upcoming April 1994 outage. The System plans to have both units operational by the end of July 1994.\nAnnual gas consumption depends on factors such as oil prices, gas prices and unit availability. In 1993, gas was used sparingly at the System's dual-fuel units because of the attractiveness of oil prices relative to those for natural gas. CL&P, PSNH and WMECO all have contracts with the local gas distribution companies where the Montville, Newington and West Springfield units are located, under which natural gas is made available by those companies on an interruptible basis. While WMECO and PSNH meet all of their gas supply needs for the West Springfield and Newington units through purchases from the local gas distribution company, CL&P can supply its Montville unit either by purchasing gas from the local gas distribution company at a DPUC-approved rate or by purchasing gas directly from producers or brokers and transporting that gas through the interstate pipeline system and the local gas distribution system. In 1993, all of the gas burned at Montville Unit 5 was purchased from a local gas distribution company. It is expected that gas for the Devon units will be purchased directly from producers or brokers on an interruptible basis and transported through the interstate pipeline system and the local gas distribution company.\nThe System expects that interruptible natural gas will continue to be available for its dual-fuel electric generating units and will continue to supplement fuel oil requirements. The Iroquois Gas Transportation System, which became fully operational in November 1992, is expected to increase New England's gas supplies by at least 35 percent by November 1994. The increased availability of gas may make the option of converting other oil- burning electric generating units to gas on an interruptible dual-fuel basis more attractive to the System.\nCOAL\nCurrently, coal is purchased for HWP's Mt. Tom Station and for PSNH's Merrimack Units 1 and 2 and its coal-oil Schiller Units 4, 5 and 6. Mt. Tom Station received approximately 314,000 tons of coal in 1993 at an average delivered coal price of $ 43.40 per ton, which is down from the average 1992 coal price of $44.25 per ton. In 1993, HWP extended an existing contract for the majority of the coal to be supplied to Mt. Tom Station. This contract provides the System with assurance of coal supply and the flexibility to purchase some coal on the spot market. In the future, the System will evaluate whether to continue to purchase coal by contract or return to the spot market.\nThe coal inventory for Mt. Tom Station varies between a minimum level of 30 days fuel and a maximum of approximately 100 days fuel. Typically, the higher level is achieved in December, when deliveries are suspended for the winter. The stockpile provides the plant's operating fuel until deliveries are resumed in March. Because of changes in federal and state air quality requirements, by 1995 HWP will need to change the kinds of coal that it purchases for use at Mt. Tom Station. The potential impact of changing air quality requirements on coal supplies is being evaluated, and HWP is testing various types of coal to meet these requirements. See \"Regulatory and Environmental Matters - Environmental Regulation-Air Quality Requirements.\"\nIn December 1991, PSNH executed a contract for the purchase of up to 100 percent of the coal requirements for PSNH's Merrimack Units 1 and 2 through December 31, 1993. This contract has been extended through December 31, 1994. Under this agreement, PSNH may also purchase coal on the spot market. In 1993, Merrimack Station received approximately 1.1 million tons of coal. The average delivered coal price in 1993 was $43.00 per ton. The coal inventory at Merrimack Station varies between a minimum of 60 days and a maximum of 90 days of fuel.\nSchiller Units 4, 5 and 6, PSNH's dual-fuel coal and oil fired units, are dispatched on the most economical fuel in accordance with the provisions of the NEPOOL Agreement. Schiller Station consumed approximately 236,000 tons of coal in 1993 at an average delivered price of $39.40 per ton. Schiller's 1993 coal requirements were fulfilled through three primary contracts, pursuant to which 77 percent was provided by foreign suppliers and the remaining 23 percent by a domestic supplier.\nFOSSIL PLANT RETIREMENTS\nIn 1991, the System retired seven of the System's oldest, least used, and most costly oil-fired steam generating units. In 1992, five oil-burning combustion turbines were retired. The decision to retire these units reflected both the surplus of generating capacity in New England and the System's continuing efforts to reduce operation and maintenance costs. There were no significant fossil plant retirements in 1993, but the System's plan calls for deactivating, by the end of 1994 Montville Units 5 and 6, which have a capacity of 82 MW and 410 MW, respectively. A final decision on the future of these units will be made following the completion of further economic evaluations and consideration of possible alternatives.\nNUCLEAR GENERATION\nGENERAL\nThe System companies have interests in seven operating nuclear units: Millstone 1, 2 and 3, Seabrook 1 and three other units owned by regional nuclear generating companies (the Yankee companies). System companies operate the three Millstone units, Seabrook 1 and CY. The System companies also have interests in the owned by the Yankee Atomic Electric Company (Yankee Rowe), which was permanently removed from service in 1992.\nCL&P and WMECO own 100 percent of Millstone 1 and 2 as tenants in common. Their respective ownership interests are 81 percent and 19 percent.\nCL&P, PSNH and WMECO have agreements with other New England utilities covering their joint ownership as tenants in common of Millstone 3. CL&P's ownership interest in the unit is 52.9330 percent (608 MW), PSNH's ownership interest in the unit is 2.8475 percent (32.7 MW) and WMECO's interest is 12.2385 percent (140.6 MW). NAEC and CL&P are parties to an agreement, similar to the Millstone 3 agreements, with respect to their 35.98201 percent (413.8 MW) and 4.05985 percent (46.7 MW) interests, respectively, in Seabrook. The agreements all provide for pro rata sharing of the construction and operating costs and the electrical output of each unit by the owners, as well as associated transmission costs.\nCL&P, PSNH, WMECO and other New England electric utilities are the stockholders of the Yankee companies. Each Yankee company owns a single nuclear generating unit. The stockholder-sponsors of a Yankee company are responsible for proportional shares of the operating costs of the Yankee company and are entitled to proportional shares of the electrical output. The relative rights and obligations with respect to the Yankee companies are approximately proportional to the stockholders' percentage stock holdings, but vary slightly to reflect arrangements under which non-stockholder electric utilities have contractual rights to some of the output of particular units. The Yankee companies and CL&P's, PSNH's and WMECO's stock ownership percentages and approximate MW entitlements in each are set forth below:\nCL&P PSNH WMECO System % MW % MW % MW % MW\nConnecticut Yankee Atomic Power Company (CYAPC) ...... 34.5 204 5.0 29 9.5 56 49.0 289 Maine Yankee Atomic Power Company (MYAPC) ............ 12.0 95 5.0 39 3.0 24 20.0 158 Vermont Yankee Nuclear Power Corporation (VYNPC)... 9.5 44 4.0 19 2.5 12 16.0 75 Yankee Atomic Electric Company (YAEC)* ............ 24.5 - 7.0 - 7.0 - 38.5 -\n_____________________________ * See \"Yankee Units\" for information about the permanent shutdown of the unit owned and operated by YAEC.\nCL&P, PSNH and WMECO are obligated to provide their percentages of any additional equity capital necessary for the Yankee companies. CL&P, PSNH and WMECO believe that the Yankee companies, excluding YAEC, will require additional external financing in the next several years to finance construction expenditures and nuclear fuel and for other purposes. Although the ways in which each Yankee company will attempt to finance these expenditures have not been determined, CL&P, PSNH and WMECO could be asked to provide direct or indirect financial support for one or more Yankee companies.\nOPERATIONS\nCapacity factor is a ratio that compares a unit's actual generating output for a period with the unit's maximum potential output. In 1993, the nuclear units in which the System companies have entitlements achieved an actual composite (weighted by entitlement) capacity factor of 79.9 percent. The five nuclear units operated by the System had a composite capacity factor of 80.3 percent based on normal winter claimed capability. The average capacity factor for operating nuclear units in the United States was 73.2 percent for January through September 1993 and 80.4 percent for the five System nuclear units operated in 1993, in each case using the design electrical rating method rather than normal winter claimed capability.\nWhen the nuclear units in which they have interests are out of service, CL&P, PSNH and WMECO need to generate and\/or purchase replacement power. Recovery of prudently incurred replacement power costs is permitted, with limitations, through the GUAC for CL&P, through a retail fuel adjustment clause for WMECO and through a comprehensive fuel and purchased power adjustment clause (FPPAC) for PSNH. For the status of regulatory and legal proceedings related to recovery of replacement power costs for the 1990-1993 period, see \"Rates - Connecticut Retail Rates,\" \"Rates-Massachusetts Retail Rates\" and \"Rates - New Hampshire Retail Rates.\"\nMILLSTONE UNITS\nThe 1993 overall performance of the three nuclear electric generating units located at Millstone station and operated by the System was substantially better than in 1992. For the twelve months ended December 31, 1993, the three units' composite capacity factor was 79.3 percent, compared with a composite capacity factor of 53.1 percent for the twelve months ended December 31, 1992 and 38.4 percent for the same period in 1991.\nIn 1993 Millstone 1 operated at a 92.4 percent capacity factor with no extended outages. The unit began a planned refueling and maintenance outage on January 15, 1994 that is expected to last seventy-one days. Major work includes replacement of the main condenser tubes and installation of a new low pressure turbine. These modifications are intended to reduce the number of unplanned outages and improve the overall plant efficiency.\nIn 1993 Millstone 2 operated at a 82.5 percent capacity factor. On January 13, 1993, the plant returned to service following a refueling outage that commenced on May 29, 1992. During that outage, both steam generators were replaced. The DPUC has opened a docket to review CL&P's performance in replacing Millstone 2's steam generators. See \"Rates-Connecticut Retail Rates\" for further information on the steam generator replacement docket. In addition to several short outages during 1993, Millstone 2 was shut down for two unplanned outages of significant duration. The first such outage began on August 5, 1993, to replace a leaking primary system valve. That outage lasted ten days. For more information on this outage, see \"Electric Operations - Nuclear Generation - Operations - NRC Regulation.\" The second significant unplanned outage lasted twenty-six days, commencing on September 15, 1993, and was necessary to upgrade the motor-operated feedwater isolation valves. Millstone 2 is scheduled to begin a refueling and maintenance outage on July 30, 1994. The outage is currently planned for a 63-day duration. Major work activities will include a reactor vessel in-service inspection, erosion\/corrosion piping inspections, motor-operated valve testing and service water piping replacement.\nIn 1993 Millstone 3 operated at a 64.8 percent capacity factor. The unit began a refueling and maintenance outage on July 31, 1993 and completed it in 99 days. During the outage two significant issues were identified and resolved. Each of these issues resulted in an outage extension beyond original plans. The first issue required replacement of all four reactor coolant pumps due to concerns over turning vane cap screw and locking cup integrity. The second issue related to problems identified during inspection and testing of the supplementary leak collection and release system (SLCRS) and the auxiliary building ventilation system (ABVS), which provide secondary protection against radiological releases to the atmosphere. For more information on this issue, see \"Electric Operations - Nuclear Generation - Operations - NRC Regulation.\" Resolution of these problems necessitated various modifications to these systems. No refueling or maintenance outages are planned for Millstone 3 during 1994. NUCLEAR PERFORMANCE IMPROVEMENT INITIATIVES\nThe System's nuclear organization is taking major steps to correct identified performance weaknesses. For instance, on a 1992 to 1995 cumulative basis, NU anticipates total expenditures of approximately $2.3 billion for operation and maintenance and $440 million in capital improvements for the five plants that it operates.\nIn addition, the comprehensive Performance Enhancement Program (PEP), authorized in 1992, continues to be one of the major initiatives that the nuclear organization is implementing to improve its overall performance. The program, in conjunction with other actions to address the long-term performance of the nuclear group, is designed to correct the root causes of the declining performance trend noted in the early 1990's. The PEP is organized into four major areas of activities, each focusing on a particular aspect of nuclear operations. The areas are management practices, programs and processes, performance assessments and functional programs. These areas were established based on an internal self-assessment completed in 1992. Detailed action plans have been prepared to address the specific activities. At the end of 1992, six of the forty-two action plans were completed and validated. An additional fourteen action plans were completed in 1993 and are awaiting validation. Seven action plans are to be completed in 1994, leaving fifteen action plans to complete during the remainder of the program. The 1993 PEP budget was $32.9 million.\nThe System also announced a major reorganization of its Connecticut-based nuclear organization on November 8, 1993. The primary focus was realignment of engineering services along unit lines. The changes also included the appointment of a new senior vice president for Millstone station, some management consolidation, and a reorganization of the nuclear plant maintenance staff. See \"Employees.\" In addition, most of the nuclear support staff currently located in Berlin, Connecticut will be centralized at the generating stations by the summer of 1994. To support these efforts, the System is constructing a five-story office building at Millstone station. This building will replace several temporary modular buildings and will house most of the nuclear technical support staff that is now located at various System locations. The prudence of this construction project is the subject of an ongoing inquiry by the DPUC.\nSEABROOK\nIn 1993 Seabrook 1 operated at a capacity factor of 89.8 percent. The unit is currently in an 18-month operating cycle that began in November 1992.\nThe unit is scheduled to begin a 57-day refueling and maintenance outage on April 16, 1994. During this outage, the main plant computer will be replaced.\nCL&P, PSNH and NAEC could be affected by the ability of other Seabrook joint owners to fund their share of Seabrook costs. Great Bay Power Corporation (GBPC), a former subsidiary of Eastern Utilities Associates and owner of 12.13 percent of Seabrook, has been in bankruptcy since February 1991. The Bankruptcy Court confirmed GBPC's reorganization plan on March 5, 1993 and approvals are required from NRC, FERC and NHPUC to consummate the plan. CL&P has committed to advance GBPC up to $12 million, secured by a high priority lien on GBPC's share of Seabrook, to cover GBPC's shortfalls in funding its share of the operation of Seabrook through June 30, 1994. As of March 1, 1994, CL&P was lending approximately $2 million to GBPC under this arrangement. GBPC has advised CL&P that it expects to consummate its reorganization plan, emerge from bankruptcy and repay CL&P for all advances by June 30, 1994. CL&P is unable to predict what impact, if any, failure of the reorganization plan to become effective will have on the operating license for Seabrook or what actions CL&P and the other joint owners of the unit may be required to take.\nOn May 6, 1991, NHEC, PSNH's largest customer and one of the joint owners of Seabrook, filed a petition for reorganization under Chapter 11 of the Federal Bankruptcy Code. The plan of reorganization for NHEC was confirmed by the United States Bankruptcy Court on March 20, 1992 and wholesale power arrangements were accepted by FERC on July 22, 1992. On October 5, 1992, the NHPUC released an order approving NHEC's plan of reorganization. Under the plan of reorganization, NHEC will remain a customer of PSNH. The plan also provides that PSNH will purchase the capacity and energy of NHEC's 2.2 percent ownership interest in Seabrook 1 and pay all of NHEC's Seabrook costs for a ten-year period, which began July 1, 1990. On December 1, 1993, the United States Bankruptcy Court for the District of New Hampshire declared the NHEC reorganization plan effective as of that date. See \"Rates--Wholesale Rates\" for further information on the bankruptcy and subsequent reorganization of NHEC.\nAt certain times, VEG&T failed to pay its share of Seabrook costs. Certain joint owners, including PSNH and CL&P, provided funds against future payments due from VEG&T to assure that funds were available to meet its ownership share of Seabrook costs. PSNH initially participated in such payments, but ceased providing such funds in January 1988, when it commenced bankruptcy proceedings under Chapter 11 of the Bankruptcy Code. The total amount contributed by PSNH until then was $976,000. The total amount contributed by CL&P was $265,000.\nAs part of an agreement to resolve issues raised during the bankruptcy of PSNH, PSNH agreed that it or its designee would purchase the VEG&T 0.41259 percent interest in Seabrook for approximately $6.4 million. NAEC, the current owner of PSNH's ownership share in Seabrook, agreed to purchase the interest and to enter into a separate power contract with PSNH, under which PSNH would be obligated to buy from NAEC all of the capacity and output of Seabrook attributable to such interest for a period equal to the length of the NRC full power operating license for Seabrook. On January 7, 1994, the NRC approved the transfer of VEG&T's ownership share of Seabrook to NAEC. All other regulatory approvals for NAEC's purchase were received and the acquisition became effective on February 15, 1994. In settlement of their claims against VEG&T for advances, PSNH and CL&P received payment of the amounts advanced, $1.78 million and $390,000, respectively, out of proceeds of the sale, with interest thereon, for the period each advance was outstanding at the prime rate. See \"Rates-New Hampshire Retail Rates-Memorandum of Understanding\" and \"Rates-New Hampshire Retail Rates-Seabrook Power Contract\" for further information on NAEC's acquisition of VEG&T's share of Seabrook.\nIn 1989, as part of a comprehensive settlement of Seabrook issues, PSNH agreed to make certain payments totaling $16 million to Massachusetts Municipal Wholesale Electric Company during the first eight years of Seabrook operation. As of December 31, 1993, PSNH had made approximately $7.2 million of these payments.\nYANKEE UNITS\nCY, the nuclear unit owned by MYAPC (MY) and the nuclear unit owned by VYAPC (VY) operated in 1993 at capacity factors of 73.1 percent, 74.3 percent and 74.1 percent, respectively, based on normal winter claimed capability. Yankee Rowe has not operated since October 1991.\nCY. As of December 31, 1993, CY, since it began commercial operation in 1968, had generated over 99 billion kWh (gross) of electricity, making it one of the most productive nuclear generating units in the United States.\nThe unit completed, on schedule, a 66-day refueling and maintenance outage that began on May 15, 1993. The second reload of fuel clad with zircalloy was installed during this outage to replace the stainless steel clad fuel. There is one more phase to this upgrade project that, when completed, will make the operation of the reactor core more economical by allowing longer operating cycles. CY's next refueling and maintenance outage is scheduled to begin on November 12, 1994 and is expected to last 54 days. Major work activities will include auxiliary feedwater system modifications and motor-operated valve testing. The start date and length of this refueling outage may be impacted by an unplanned shutdown which occurred on February 12, 1994, when the plant was required to come off line to address integrity concerns in the safety-related service water system. CYAPC is reviewing the scope of work required and schedule for returning the unit to service from the unplanned outage.\nIn October 1992, CYAPC filed an application with the FERC for wholesale rate relief. CYAPC requested the increase to become effective on January 1, 1993. The filing requested an increase in estimated decommissioning cost collections from $130 million to $309.1 million (in July 1992 dollars) and also proposed to adjust decommissioning accruals automatically on an annual basis beginning January 1, 1993. In December 1992, FERC accepted CYAPC's increased rates for filing, to become effective on June 1, 1993, subject to refund, and rejected the proposal to automatically adjust decommissioning accruals. A settlement between all the parties was reached in 1992 and was accepted by FERC in 1993. This included an accrual level for decommissioning of $294.2 million in 1992 dollars and an automatic increase of 5.5% annually in the decommissioning accrual for each of the next five years.\nMY. MY began a refueling and maintenance outage on July 31, 1993 and completed it in 75 days. During the outage, repairs were made to the reactor vessel thermal shield.\nVY. VY began a refueling and maintenance outage on August 27, 1993, and completed it in 59 days, including recovery from a dropped fuel bundle that suspended fuel movement for approximately 20 days.\nYankee Rowe. In February 1992, YAEC's owners voted to shut down Yankee Rowe permanently and to begin preparations for an orderly decommissioning of the facility. The decision to close the generating plant eight years before the end of its operating license was based on an economic evaluation of the cost of a proposed safety review, the reduced demand for electricity in New England, the price of alternative energy sources and uncertainty about the regulatory requirements that the unit would need to meet in order to restart.\nSee \"Electric Operations-Nuclear Generation-Operations-Decommissioning\" for information on YAEC's filing with FERC to collect for shutdown and decommissioning costs and the recovery of the remaining investment in the Yankee Rowe plant.\nThe power contracts between CL&P, PSNH and WMECO and YAEC permit YAEC to recover from each its proportional share of these costs from CL&P, PSNH and WMECO. Management believes that, although Yankee Rowe was shut down eight years before the end of the unit's current license, CL&P, PSNH and WMECO will recover their investments in YAEC, along with any other costs associated with the shutdown and decommissioning of Yankee Rowe. Accordingly,\nthe System has recognized these costs as a regulatory asset on its consolidated balance sheet and as a corresponding obligation to YAEC.\nNRC REGULATION\nAs holders of licenses to operate nuclear reactors, CL&P, PSNH, WMECO, NAEC, North Atlantic, NNECO and the Yankee companies are subject to the jurisdiction of the NRC. The NRC has broad jurisdiction over the design, construction and operation of nuclear generating stations, including matters of public health and safety, financial qualifications, antitrust considerations and environmental impact.\nIn its latest Systematic Assessment of Licensee Performance Report (SALP report) issued on October 19, 1993, the NRC gave the three Millstone nuclear plants a Category 1 rating in the area of radiological controls and a Category 2 rating in five of the seven areas rated: plant operations, maintenance\/surveillance, emergency preparedness, security and engineering\/technical support. The Millstone units received a Category 3 rating in the area of safety assessment\/quality verification. Category 1 indicates \"a superior level of performance,\" Category 2 indicates \"a good level of performance\" and Category 3 denotes \"an acceptable level of performance.\" The evaluation covered plant activities for the period February 16, 1992 through April 3, 1993. Management expects to continue to improve performance, thereby raising these scores.\nThe NRC issued its latest SALP report for Seabrook 1 on November 18, 1993. The report covered the interval from March 1, 1992 through August 28, 1993. This report reflects the recent revisions to the SALP program in which the number of functional evaluation areas has been reduced from seven to four: plant operations, maintenance, engineering and plant support. The evaluation rated Seabrook 1 a Category 1 in the engineering and plant support areas. In the areas of plant operations and maintenance, the unit was rated a Category 2.\nThe NRC issued its latest SALP report for CY on May 21, 1993. The report covered the interval from July 14, 1991 through January 9, 1993. This evaluation recognized the superior performance of CY by awarding the unit a Category 1 in six of the seven areas rated: plant operations, emergency preparedness, security, engineering\/technical support, safety assessment\/quality verification and radiological controls. In the final area, maintenance\/surveillance, CY was rated as a Category 2.\nDespite the overall improved performance of the Millstone units, there were a number of regulatory enforcement actions taken by the NRC in 1993. On May 4, 1993, the NRC issued to NNECO a Notice of Violation (NOV) identifying two potential violations. The first violation concerned NRC findings that a former employee was subjected to harassment and intimidation in 1989 for raising a nuclear safety concern and that senior management was not effective in dealing with the situation. The second violation involved NRC concerns that an employee may have deliberately delayed the processing of a contemplated substantial safety hazard evaluation conducted to fulfill the requirements of federal law. Following NNECO's response to the NOV, the NRC withdrew the second violation. To resolve this matter, NNECO paid a fine of $100,000 in connection with the first violation.\nOn August 5, 1993, Millstone Unit 2 was shut down by plant personnel after extensive efforts to repair a leaking primary system valve proved unsuccessful, and a sudden increase in the leak rate was experienced. Following replacement of the damaged valve, the unit was returned to service on August 16, 1993. Recognizing the seriousness of this event and the potentially severe consequences of the failed repair efforts, NNECO performed a detailed evaluation of this event to consider potential deficiencies and identify the actions needed to prevent recurrence. The NRC also conducted a special investigation of this event and on September 22, 1993, identified to NNECO three apparent violations, related to work control planning and implementation, which were being considered for escalated enforcement. On December 3, 1993, the NRC informed NNECO that it was imposing a civil penalty of $237,500 for the three violations. NNECO has since paid the fine.\nOn September 10, 1993, NNECO was informed by the NRC that, as a result of an investigation by the NRC Office of Investigation and a routine safety inspection of the Millstone Unit 1 nuclear power plant, two apparent violations arising from 1989 events were being considered for possible civil monetary penalties. The first issue concerned the alleged failure to initiate and perform a required engineering analysis to determine the operability of safety-related system in a timely manner. The second issue relates to allegations that the engineer who identified the system as being potentially inoperable was harassed and discriminated against in retaliation for the findings of his technical evaluations. These matters were investigated between early 1992 and June 1993 by a grand jury acting under the direction of the U.S. Attorney's Office in Bridgeport, Connecticut. The U.S. Attorney's office issued a letter on June 30, 1993, stating that no prosecutorial action would be initiated. On March 17, 1994, the NRC informed NNECO that further enforcement action with respect to this matter was not planned, because their review had determined that there was insufficient evidence to support the apparent violations.\nOn September 20, 1993, the NRC issued to NNECO an NOV concerning two violations at the Millstone Station identified during its evaluation of the licensed operator requalification training (LORT) program. The first violation concerned an inspection finding that various licensed operators at Millstone 1 and 2 did not fully complete the LORT program for the 1991 and 1992 training periods. The second violation cited the failure of NNECO's internal nuclear review board to perform comprehensive audits of the training, retaining, requalification, and performance of the operations staff at Millstone 2 and 3. NNECO chose not to contest the violations nor the imposition of a $50,000 civil penalty.\nOn December 15, 1993, the NRC issued an inspection report concerning the SLCRS and ABVS systems deficiencies that were identified during the 1993 Millstone 3 refueling outage. The report identified two apparent violations that are being considered for escalated enforcement. The apparent violations involve the inability of the systems to provide the necessary drawdown of secondary containment following a postulated accident and NNECO's failure to fully resolve these problems earlier, as a result of previous similar violations identified in September 1992. On March 11, 1994, the NRC notified NNECO that it proposed to impose a civil penalty of $50,000 in respect of these violations. NNECO has 30 days to respond to the NRC.\nIn January 1994, the NRC issued a report finding that the overall Millstone 1 operator requalification training program was satisfactory. The NRC had previously found the program to be unsatisfactory. The recent conclusion was based on the results of a number of NRC inspections and the operator examinations conducted in September 1993. The NRC reviewed NNECO's corrective actions and determined that all actions necessary to obtain and maintain a satisfactory requalification training program had been completed and verified.\nINDUSTRY-WIDE NUCLEAR ISSUES\nThe NRC regularly conducts generic reviews of technical and other issues, a number of which may affect the nuclear plants in which System companies have interests. Issues currently under review include individual plant examination programs to evaluate the likelihood and effects of severe accidents at operating nuclear plants, pipe crack phenomena, post-accident measures for controlling hydrogen, reactor vessel embrittlement, upgrading of emergency response facilities and communications, the ability of plants to cope with a total loss of power, emergency response planning, fitness for duty policies, operator requalification training, reactor containment suitability, maintenance adequacy, motor-operated valve testing, design basis reconstitution, diesel generator reliability, life extension, equipment procurement, electrical distribution system adequacy, reactor coolant pump seal integrity, plant risk during shutdown and low power operation, technical specification improvements, accident management, component aging, steam generator degradation phenomena, service water system adequacy, seismic qualification of equipment and other issues. At present, the outcome of the NRC's reviews of these and other technical issues, and the ways in which the different nuclear plants in which System companies have interests may be affected, cannot be determined. The cost of complying with any new requirements that may result from these reviews cannot be estimated at this time, but such costs could be substantial. Further, the NRC is currently evaluating a staff report on the reporting of nuclear safety concerns, which may result in changes in the way such concerns are addressed. The NRC has authorized the conduct of various regulatory activities designed to lower costs to its licensees while maintaining or improving public safety.\nPublic controversy concerning nuclear power could affect the nuclear units in which System companies have ownership interests. Over the past decade, proposals to force the premature shutdown of nuclear units have become issues of serious and recurring attention in Maine, Massachusetts, Vermont and New Hampshire. States' efforts to deal with the siting of low level radioactive waste repositories have also stimulated negative reactions in communities being considered for those facilities. The continuing controversy about nuclear power may affect the cost of operating the nuclear units in which System companies have interests.\nWhile much of the public policy debate about nuclear power has been critical in the past, some trends in the energy environment have stimulated renewed support for nuclear power in the northeastern United States. Among these trends are the growing national environmental concerns and legislation about acid rain, air quality and global warming associated with fossil fuels.\nThese concerns particularly affect the densely populated areas in the Northeast, downwind of coal-burning regions like the Midwest and mid-Atlantic states. In addition, at times when the price and availability of fuel oil have been volatile, the System's commitment to nuclear power has allowed it to minimize the oil-related rise in customers' bills. While the public controversy about nuclear power is not expected to disappear, recent trends suggest a more balanced public policy debate about the impacts of fossil fuel generation as well.\nNUCLEAR INSURANCE\nThe NRC's nuclear property insurance rule requires nuclear plant licensees to obtain a minimum of $1.06 billion in insurance coverage. The\nrule requires that, although such policies may provide traditional property coverage, proceeds from the policy following an accident in which estimated stabilization and decontamination expenses exceed $100 million will first be applied to pay such expenses. The insurance carried by the licensees of the Millstone units, Seabrook 1, CY, MY and VY meets the requirements of this rule. YAEC has obtained an exemption for the Yankee Rowe plant from the $1.06 billion requirement and currently carries $25 million of insurance that otherwise meets the requirements of the rule.\nThe Price-Anderson Act currently limits public liability from a single incident at a nuclear power plant to $9.4 billion. The first $200 million of liability would be provided by purchasing the maximum amount of commercially available insurance. Additional coverage of up to $8.8 billion would be provided by an assessment of $75.5 million per incident, levied on each of the 116 United States nuclear units that are currently subject to the secondary financial protection program, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. In addition, if the sum of all public liability claims and legal costs arising from any nuclear incident exceeds the maximum amount of financial protection, each reactor operator can be assessed an additional five percent, up to $3.8 million or $437.9 million in total for all 116 reactors. The maximum assessment is to be adjusted for inflation at least every five years.\nBased on CL&P's, PSNH's and WMECO's ownership interests in the three Millstone units and CL&P's and NAEC's interests in Seabrook 1, the System's current maximum direct liability would be $244.2 million per incident. In addition, through CL&P's, PSNH's and WMECO's power purchase contracts with the four Yankee regional nuclear electric generating companies, the System would be responsible for up to an additional $97.9 million per incident. These payments would be limited to a maximum in any year of $43.2 million per incident.\nInsurance has been purchased from Nuclear Electric Insurance Limited (NEIL) to cover: (1) certain extra costs incurred in obtaining replacement power during prolonged accidental outages with respect to CL&P's and WMECO's ownership interests in Millstone 1, 2, 3, and CY, CL&P's ownership interest in Seabrook, and PSNH's Seabrook Power Contract with NAEC; and (2) the cost of repair, replacement, or decontamination or premature decommissioning of utility property resulting from insured occurrences with respect to CL&P's ownership interests in Millstone 1, 2, 3, CY, MY, VY, and Seabrook 1; WMECO's ownership interests in Millstone 1, 2, 3, CY, MY, and VY; PSNH's ownership interest in Millstone 3, CY, MY and VY; and NAEC's ownership interest in Seabrook 1. All companies insured with NEIL are subject to retroactive assessments if losses exceed the accumulated funds available to NEIL. The maximum potential assessments against CL&P, PSNH, WMECO, and NAEC with respect to losses arising during current policy years are approximately $13.9 million under the replacement power policies and $29.9 million under the property damage, decontamination, and decommissioning policies. Although CL&P, PSNH, WMECO, and NAEC have purchased the limits of coverage currently available from the conventional nuclear insurance pools, the cost of a nuclear incident could exceed available insurance proceeds.\nInsurance has been purchased from American Nuclear Insurers\/Mutual Atomic Energy Liability Underwriters, aggregating $200 million on an industry basis, for coverage of worker claims. All companies insured under this coverage are subject to retrospective assessments of $3.2 million per reactor. The maximum potential assessments against CL&P, PSNH, WMECO, and NAEC with respect to losses arising during the current policy period are approximately $13.9 million.\nCYAPC expects that it will receive an insurance recovery for costs related to the CY thermal shield repair which occurred during the 1987 outage, and the removal which occurred during the 1989 outage, but the amount and time of payment are not certain. See \"Rates-Connecticut Retail Rates-Adjustment Clauses.\"\nNUCLEAR FUEL\nThe supply of nuclear fuel for the System's existing units requires the procurement of uranium concentrates, followed by the conversion, enrichment and fabrication of the uranium into fuel assemblies suitable for use in the System's units. These materials and services are available from a number of domestic and foreign sources. The System companies have predominantly relied on long term contracts with both domestic and foreign suppliers, supplemented with short term contracts and market purchases, to satisfy the units' requirements. Although the System has increased the use of foreign suppliers, domestic suppliers still provide the majority of the materials and services. The System companies have maintained diversified sources of supply, relying on no single source of supply for any one component of the fuel cycle, with the exception of enrichment services of which the majority of the System companies' requirements are provided under a long term contract with the U.S. Enrichment Corporation, a wholly-owned government corporation, established on July 1, 1993, in accordance with the Energy Policy Act and the successor to the U.S. DOE Uranium Enrichment Enterprise. The System expects that uranium concentrates and related services for the units operated by the System and for the other units in which the System companies are participating, that are not covered by existing contracts, will be available for the foreseeable future on reasonable terms and prices.\nAs a result of the Energy Policy Act, the U.S. utility industry is required to pay to the DOE, via a special assessment for the costs of the decontamination and decommissioning of uranium enrichment plants operated by the DOE, $150 million each U.S. Government fiscal year for 15 years beginning in 1993. Each domestic utility will make a payment proportioned on its past purchases from the DOE's Uranium Enrichment Enterprise. Each year, the DOE will adjust the annual assessment using the Consumer Price Index. The Energy Policy Act provides that the assessments are to be treated as reasonable and necessary current costs of fuel, which costs shall be fully recoverable in rates in all jurisdictions. The System's total share of the estimated assessment was approximately $56.7 million. Management believes that the DOE assessments against CL&P, WMECO, PSNH and NAEC will be recoverable in future rates. Accordingly, each of these companies has recognized these costs as regulatory asset, with corresponding obligation on its balance sheet.\nCosts associated with nuclear plant operations include amounts for disposal of nuclear wastes, including spent fuel, and for the ultimate decommissioning of the plants. The System companies include in their nuclear fuel expense spent fuel disposal costs accepted by the DPUC, the NHPUC and the DPU in rate case or fuel adjustment decisions. Spent fuel disposal costs are also reflected in wholesale charges. Such provisions include amortization and recovery in rates of previously unrecovered disposal costs of accumulated spent nuclear fuel.\nHIGH-LEVEL RADIOACTIVE WASTES\nUnder the Nuclear Waste Policy Act of 1982, the DOE is required to design, license, construct and operate a permanent repository for high level\nradioactive wastes and spent nuclear fuel. The act requires the DOE to provide, beginning in 1998, for the disposal of spent nuclear fuel and high level radioactive waste from commercial nuclear plants through contracts with the owners and generators of such waste. The System companies have entered into such contracts with the DOE with respect to Millstone 1, 2 and 3 and Seabrook 1, and have been advised that the Yankee companies have entered into similar contracts.\nThe DOE has established disposal fees to be paid to the federal government by electric utilities owning or operating nuclear generating units. The System companies have been paying for such services for fuel burned starting in April 1983 on a quarterly basis since July 1983 in accordance with the contracts; the DPUC, the NHPUC and the DPU permit the fee to be recovered through rates.\nThe disposal fee for fuel burned before April 1983 (previously burned fuel) is determined in accordance with a fee structure based on fuel burnup. Under the contract payment option selected, the System companies anticipate making payment to the DOE for disposal of previously burned fuel just before the first delivery of spent fuel to the DOE. That payment obligation is not a funded obligation. The liability under the selected payment option for previously burned fuel, including interest, through December 31, 1993, and the amounts recovered through rates for previously burned fuel through the end of 1993 for Millstone 1 and 2, are as follows:\nPreviously Burned Fuel Liability, Amounts Recovered for Previously Including Interest, Thru 12\/31\/93 Burned Fuel Thru 12\/31\/93 (Millions)\nCL&P $136.1 $134.5 WMECO 31.9 32.3 Total $168.0 $166.8\nBecause Millstone 3 and Seabrook 1 went into service after 1983, there is no previously burned fuel liability for those units.\nIn return for payment of the fees prescribed by the Nuclear Waste Policy Act, the federal government is to take title to and dispose of the utilities' high level wastes and spent nuclear fuel beginning no later than 1998. Until the federal government begins receiving such materials, operating nuclear generating plants will need to retain high-level wastes and spent fuel on-site or make some other provisions for their storage. With the addition of new storage racks or through fuel consolidation, storage facilities for Millstone 3 and CY are expected to be adequate for the projected life of the units. With the storage facilities for Millstone 1 and 2 are expected to be adequate (maintaining the capacity to accommodate a full-core discharge from the reactor) until 2000. Fuel consolidation, which has been licensed for Millstone 2, could provide adequate storage capability for the projected lives of Millstone 1 and 2. In addition, other licensed technologies, such as dry storage casks or on-site transfers, are being considered to accommodate spent fuel storage requirements. With the addition of new racks, Seabrook 1 is expected to have spent fuel storage capacity until at least 2010.\nUnder the terms of a license amendment approved by the NRC in 1984, MY's present storage capacity of the spent fuel pool at the unit will be reached in 1999, and after 1996 the available capacity of the pool will not accommodate a full-core removal. After consideration of available technologies, MYAPC elected to provide additional capacity by replacing the fuel racks in the spent fuel pool at the unit and, on January 25, 1993, filed with the NRC seeking authorization to implement the plan. MYAPC believes that the replacement of the fuel racks, if approved, will provide adequate storage capacity through the unit's licensed operating life. While no intervention has occurred, MYAPC cannot predict with certainty whether the NRC authorization will be granted or whether or to what extent the storage capacity limitation at the unit will affect the operation of the unit or the future cost of disposal.\nUnder the terms of a license amendment approved by the NRC in 1991, the storage capacity of the spent fuel pool at VY is expected to be reached in 2003, and the available capacity of the pool is not expected to be able to accommodate a full-core removal after 1998.\nBecause the Yankee Rowe plant was permanently shut down effective February 26, 1992, YAEC is planning to construct a temporary facility to store the spent nuclear fuel produced by the Yankee Rowe plant over its operating lifetime until that fuel is removed by the DOE. See \"Electric Operations - Nuclear Generation - Decommissioning\" for further information on the closing and decommissioning of Yankee Rowe.\nLOW-LEVEL RADIOACTIVE WASTES\nDisposal costs for low-level radioactive wastes (LLRW) have continued to rise in recent years despite significant reductions in volume. Approximately $7.65 million was spent on LLRW disposal for the Millstone units and CY in 1993.\nIn accordance with the provisions of the federal Low-Level Radioactive Waste Policy Act of 1980, as amended (the Waste Policy Act), on December 31, 1992 the disposal site at Beatty, Nevada closed, and the Richland, Washington facility closed to disposal of LLRW from outside its compact region. During 1992, the Barnwell, South Carolina site announced its intention to remain open for disposal of out-of-region LLRW until June 30, 1994. In November 1992, the Northeast Compact commission entered into an agreement with the Southeast Interstate Low-Level Radioactive Waste Management Compact (the Southeast Compact) commission providing for continued access to the Barnwell facility until June 30, 1994 by Connecticut LLRW generators, and the System agreed to pay, in addition to disposal fees, an access fee of $220 per cubic foot, with a minimum of $4.73 million, for the right to dispose of LLRW at Barnwell during this period.\nThe Connecticut Hazardous Waste Management Service (the Service), a state quasi-public corporation, is charged with coordinating the establishment of a facility for disposal of LLRW originating in Connecticut. In June 1991, the Service announced that it had selected three potential sites in north-central Connecticut for further study. The Service's announcement provoked intense controversy in the affected municipalities and resulted in legislative action to stop the selection process. On February 1, 1993, the Service presented the legislature with a new site selection plan under which communities are urged to volunteer a site for a facility in return for financial and other incentives. The volunteer process is being continued in 1994. The Service's activities in this regard are funded by assessments on Connecticut's LLRW generators. The System was assessed approximately $1.8 million for the state's 1992-1993 fiscal year. Due to the change to a volunteer process, there was no assessment for the 1993-1994 fiscal year and the state projects no assessment for the 1994-1995 and 1995-1996 fiscal years.\nThe System has plans to acquire or construct additional LLRW storage capacity at the Millstone and CY sites to provide for temporary storage of LLRW should that become necessary. The System can manage its Connecticut LLRW by volume reduction, storage or shipment at least through 1999. Management cannot predict whether and when a disposal site will be designated in Connecticut.\nSince January 1, 1989, the State of New Hampshire has been barred from shipping Seabrook LLRW to the operating disposal facilities in South Carolina, Nevada and Washington for failure to meet the milestones required by the Waste Policy Act. Seabrook 1 has never shipped LLRW but has capacity to store at least five years' worth of the LLRW generated on-site, with the capability to expand this on-site capacity if necessary. The Seabrook station accrued approximately $1.3 million in off-site disposal costs in 1993. New Hampshire is pursuing options for out-of-state disposal of LLRW generated at Seabrook.\nMassachusetts and Vermont have arranged for continued access to the Barnwell facility until mid-1994 for the nuclear waste generators in their states. YAEC is currently disposing of its LLRW at the Barnwell facility. MY has been storing its LLRW on-site since January 1993. VY and MY each has on-site storage capacity for at least five years' production of LLRW from its respective plants. Maine and Vermont are in the process of finalizing an agreement with the state of Texas to provide access to a facility that will be developed in that state.\nDECOMMISSIONING\nThe System's most recent comprehensive site-specific updates of the decommissioning costs for each of the three Millstone units were completed in 1992 and for Seabrook was completed in 1991. The recommended decommissioning method reflected in the cost estimates continues to be immediate and complete dismantlement of those units at their retirement. The table below sets forth the estimated Millstone and Seabrook decommissioning costs for the System companies. The estimates are based on the latest site studies, escalated to December 31, 1993 dollars, and include costs allocable to NAEC's share of Seabrook recently acquired from VEG&T.\nCL&P PSNH WMECO NAEC NU System (Millions) Millstone 1 $312.5 $ - $ 73.3 $ - $385.8 Millstone 2 251.0 - 58.9 - $309.9 Millstone 3 223.0 12.0 51.6 - 286.6 Seabrook 1 14.9 - - 131.7 146.6 Total $801.4 $12.0 $183.8 $131.7 $1,128.9\nPursuant to Connecticut law, CL&P has periodically filed plans with the DPUC for financing the decommissioning of the three Millstone units. In 1986, the DPUC approved the establishment of separate external trusts for the currently tax-deductible portions of decommissioning expense accruals for Millstone 1 and 2 and for all expense accruals for Millstone 3. In its 1993 CL&P multi-year rate case decision, the DPUC allowed CL&P's full decommissioning estimate for the three Millstone units to be collected from customers. This estimate includes an approximately 16 percent contingency factor for each unit. The estimated aggregate cost of decommissioning the Millstone units is $1.1 billion in December 1993 dollars.\nWMECO has established independent trusts to hold all decommissioning expense collections from customers. In its 1990 WMECO multi-year rate case decision, the DPU allowed WMECO's decommissioning estimate for the three Millstone units ($840 million in December 1990 dollars) to be collected from customers. Due to the settlement in the 1992 WMECO rate case, the aggregate decommissioning estimate for the three Millstone units remains unchanged.\nThe decommissioning cost estimates for the Millstone units are reviewed and updated regularly to reflect inflation and changes in decommissioning requirements and technology. Changes in requirements or technology, or adoption of a decommissioning method other than immediate dismantlement, could change these estimates. CL&P, PSNH and WMECO attempt to recover sufficient amounts through their allowed rates to cover their expected decommissioning costs. Only the portion of currently estimated total decommissioning costs that has been accepted by regulatory agencies is reflected in rates of the System companies. Although allowances for decommissioning have increased significantly in recent years, ratepayers in future years will need to increase their payments to offset the effects of any insufficient rate recoveries in previous years.\nNew Hampshire enacted a law in 1981 requiring the creation of a state-managed fund to finance decommissioning of any units in that state. In 1992, the New Hampshire Nuclear Decommissioning Financing Committee (NDFC) established approximately $323 million (in 1991 dollars) as the decommissioning cost estimate for immediate and complete dismantlement of Seabrook 1 upon its retirement. On March 10, 1993, FERC approved this estimate. The estimated total decommissioning cost for Seabrook 1 is $366 million in December 1993 dollars.\nThe NHPUC is authorized to permit the utilities subject to its jurisdiction that own an interest in Seabrook 1 to recover from their customers on a per-kilowatt-hour basis amounts paid into the decommissioning fund over a period of years. NAEC's costs for decommissioning are billed by it to PSNH and recovered by PSNH under the Rate Agreement. Under the Rate Agreement, PSNH is entitled to a base rate increase to recover increased decommissioning costs. See \"Rates - New Hampshire Retail Rates\" for further information on the Rate Agreement.\nNorth Atlantic submitted its annual update of the 1991 Decommissioning Study and Funding Schedule to the NDFC on March 31, 1993. It included an updated estimate for the prompt removal and dismantling of Seabrook station in 2026 at the end of licensed life and a review of the assumptions on inflation and rate-of-return on fund investments used to develop the joint owner contribution schedule. North Atlantic concluded that the 1991 estimate, escalated in accordance with these assumptions to 1993 dollars, is still valid. Although a schedule has not been set by the NDFC, public hearings on the decommissioning estimate and funding schedule will probably be held in the third quarter of 1994.\nThe new Investment Guidelines for the Seabrook Nuclear Decommissioning Financing Fund, which were approved by the New Hampshire State Treasurer and would have gone into effect on November 1, 1993, have been put on hold by a recent decision of FERC. The October 20, 1993 FERC order effectively reinstated the so-called \"black lung\" investment restrictions on decommissioning funds subject to its jurisdiction, although Congress, in the Energy Policy Act, had repealed the IRS regulation which mandated them. Under these restrictions, investments are limited to public debt securities that are fully backed by the U.S. government, tax exempt obligations of state or local governments and time deposits with a bank or insured credit union. The new guidelines would allow equity holdings by the joint owners of Seabrook, beginning with a limit of 10 percent in 1994 and gradually increasing to a limit of 40 percent in 1997. The strategies also call for a gradual reduction in the equity position as the plant approaches the end of its licensed life. Implementation of new investment guidelines for the Millstone units and CY have also been delayed because of the FERC decision. The System is party to petitions filed with FERC in November 1993, seeking reconsideration of the FERC decision.\nAs of December 31, 1993, the balances (at cost) in the external decommissioning trust funds were as follows:\nMillstone 1 Millstone 2 Millstone 3 Seabrook 1 (Millions of Dollars)\nCL&P........... $70.4 $45.5 $30.9 $ .9 PSNH........... * * 1.5 * WMECO.......... 24.0 16.5 8.6 * NAEC........... * * * 7.9 _____ _____ _____ ____ Total........ $94.4 $62.0 $41.0 $8.8\n*PSNH has no ownership interest in the Millstone 1 and 2 units. WMECO has no ownership interest in Seabrook 1. NAEC's only ownership interest is in Seabrook 1.\nYAEC, MYAPC, VYNPC and CYAPC are all collecting revenues for decommissioning from their power purchasers. The table below sets forth the estimated decommissioning costs of the Yankee units for the System companies.\nThe estimates are based on the latest site studies, escalated to December 31, 1993 dollars. For information on the equity ownership of the System companies in each of the Yankee units, see \"Electric Operations - Nuclear Generation - General.\"\nCL&P PSNH WMECO NU System (Millions)\nCY $117.3 $17.0 $32.3 $166.6 MY 38.8 16.2 9.7 64.7 VY * * * * Yankee Rowe 68.7 19.6 19.6 107.9 ______ _____ _____ ______ Total $255.3 $65.6 $69.6 $390.5\n*VYNPC is currently reestimating the cost of decommissioning VY. Based on recent estimates for comparable units, the projected cost is expected to fall into the $300 - $350 million range. The System's share of these costs is expected to be between $48 million and $56 million. The results of the VYNPC study are expected to be available in the spring of 1994.\nIn June 1992, YAEC filed a rate filing to obtain FERC authorization for an increase in rates to cover the costs of closing and decommissioning the Yankee Rowe plant and for the recovery of the remaining investment in the unit over the remaining period of its NRC operating license. At December 31, 1993, the System's share of these estimated costs was approximately $132.8 million. A settlement agreement among YAEC, the FERC staff and intervenors to the FERC proceeding addressing all issues has been filed with and accepted by FERC. YAEC has submitted its decommissioning plan to the NRC for approval.\nDue to the unexpected continued availability of the low level waste disposal facility in Barnwell, South Carolina, YAEC requested NRC permission to use decommissioning funds prior to final NRC approval of the complete plan. On April 16, 1993, the NRC approved YAEC's request to use funds for removal of the steam generators, pressurizer and reactor internals. By December 31, 1993, all major components were successfully disposed of at Barnwell and only a small number of internals shipments remain to be made.\nYAEC will continue its dismantling of the plant in 1994. The NRC's review of the decommissioning plan is expected to be completed by December\n31, 1994 at which time YAEC will, depending upon the availability of a low level waste site, move to completely dismantle the facility.\nCYAPC accrues decommissioning costs on the basis of immediate dismantlement at retirement. The most current estimated decommissioning cost, based on a 1992 study, is approximately $339.9 million in year-end 1993 dollars. As a result of a 1987 study approved by FERC, CYAPC has been accruing expenses based on an estimated decommissioning level of $130 million. On October 30, 1992, CYAPC filed with FERC a proposed change in rates to recover the increase in estimated decommissioning costs. On May 11, 1993, FERC approved a settlement agreement allowing a decommissioning estimate of $294.2 million (in July 1992 dollars) to be recovered in rates effective June 1, 1993. See \"Electric Operations - Nuclear Generation - Operations - Yankee Units.\"\nIn 1984, CYAPC established an independent irrevocable decommissioning trust fund, which was modified for tax purposes in 1987 to create two trusts.\nEach month, CYAPC's sponsors are billed for their proportionate share of decommissioning expense as allowed by FERC and payments are made directly to the trust. The combined balance of the trusts at December 31, 1993 was $137.8 million. The trust balances must be used exclusively to discharge decommissioning costs as incurred.\nMYAPC estimates the cost of decommissioning MY at $323.7 million in December 31, 1993 dollars based on a study completed in July 1993.\nNON-UTILITY BUSINESSES\nGENERAL\nIn addition to its core electric utility businesses in Connecticut, New Hampshire and Massachusetts, in recent years the System has begun a diversification of its business activities into two energy-related fields: private power development and energy management services.\nPRIVATE POWER DEVELOPMENT\nIn 1988, NU organized a new subsidiary corporation, Charter Oak, through which the System participates as a developer and investor in domestic and international private power projects. With the passage of the Energy Policy Act, Charter Oak can invest in cogeneration and small power production (SPP) facilities anywhere in the world. This legislation also expands Charter Oak's permissible involvement in exempt wholesale generators (EWGs) to include development, construction and ownership. Management currently does not permit Charter Oak to invest in facilities which are located within the System service territory or to sell its electric output to any of the System electric utility companies. For a discussion of certain highlights of the Energy Policy Act relating to EWGs, see \"Regulatory and Environmental Matters - - Public Utility Regulation.\" Under the Public Utility Regulatory Policies Act of 1978 (PURPA), as a subsidiary of an electric utility holding company, Charter Oak is effectively limited to no more than 50 percent ownership in a QF within the United States. To work within this constraint, Charter Oak has made strategic alliances with several experienced developers to pursue development opportunities. Through these relationships, Charter Oak is pursuing development opportunities nationwide and internationally.\nAlthough Charter Oak has no full-time employees, eight NUSCO employees are dedicated to Charter Oak activities on a full-time basis. Other NUSCO employees provide services as required.\nCharter Oak owns, through a wholly-owned special purpose subsidiary, a ten percent equity interest in a 220 MW natural gas-fired combined cycle cogeneration QF in Texas which provides steam to Campbell Soup Company's Paris, Texas manufacturing facility and electricity to Texas Utilities Electric Company. Charter Oak also owns 56 MW of the 1,875 MW Teesside natural gas-fired cogeneration facility in the United Kingdom. Charter Oak is pursuing other project development opportunities in both the domestic and international markets with a combined capacity over 1,000 MW. Charter Oak is currently participating in the development stage of projects in Texas, the West Coast, the Midwest, Latin America and the Pacific Rim.\nNU's total investment in Charter Oak was approximately $23.0 million as of December 31, 1993. NU, Charter Oak and its subsidiary, Charter Oak Energy Development, have received approval from the SEC to increase NU's authorized investment in Charter Oak to up to $100 million and to increase Charter Oak's authorized investment in COE Development to up to $100 million for preliminary development activities in QFs, IPPs, EWGs and foreign utility companies.\nENERGY MANAGEMENT SERVICES\nIn 1990, NU organized a new subsidiary corporation, HEC, which acquired substantially all of the assets and personnel of an existing, non-affiliated energy management services company. In general, the energy management services that HEC provides are performed for customers pursuant to contracts to reduce the customers' overall energy consumption and reduce energy costs and\/or conserve energy resources. HEC also provides demand side management consulting services to utilities. HEC's energy management and consulting services are directed primarily to the commercial, industrial and institutional markets and utilities in New England and New York, although the SEC's order under the 1935 Act that authorized NU to operate HEC also permits HEC to serve customers outside that area, so long as over half of its revenues are attributable to customers in New England and New York.\nNU's initial equity investment in HEC was approximately $4 million and NU has made additional capital contributions of approximately $300,000 through March 1, 1994. Under the SEC order authorizing HEC's participation in the Money Pool, HEC may borrow up to $11 million from the Money Pool. At December 31, 1993, HEC had $2.9 million outstanding from its borrowings from the Money Pool.\nREGULATORY AND ENVIRONMENTAL MATTERS\nPUBLIC UTILITY REGULATION\nNU is registered with the SEC as an electric utility holding company under the 1935 Act. Under the 1935 Act, the SEC has jurisdiction over NU and its subsidiaries with respect to, among other things, securities issues, sales and acquisitions of securities and utility assets, intercompany loans, services performed by and for associated companies, accounts and records, involvement in non-utility operations and dividends.\nThe Energy Policy Act amended the 1935 Act to give registered holding companies, like NU, broadened authority to invest in small power production facilities qualifying under PURPA and to own a new class of IPPs known as EWGs. An EWG is an entity exclusively in the business of owning and\/or operating generating facilities that sell electricity at wholesale. EWGs are exempt from most regulation under the 1935 Act. A registered holding company may also invest in foreign utility companies with SEC approval. EWGs, however, are subject to state regulation with respect to siting and financial regulation to prevent cross-subsidies and self-dealing among utilities and affiliated EWGs.\nThe Energy Policy Act also amended the Federal Power Act to authorize FERC to order wholesale transmission wheeling services, including the enlargement of transmission capacity necessary to provide such services, unless such transmission would unreasonably impair the reliability of the electric systems affected or the utility ordered to provide transmission is unable to obtain necessary governmental approvals or property rights. Rates for transmission ordered under the Energy Policy Act are to be designed to protect the wheeling utilities' existing customers. FERC's authority to order wheeling does not extend to retail wheeling, and FERC may not issue a wheeling order that is inconsistent with state franchise laws.\nCL&P is subject to regulation by the DPUC, which has jurisdiction over, among other things, retail rates, accounting procedures, certain dispositions of property and plant, mergers and consolidations, securities issues, standards of service, management efficiency and construction and operation of generation, transmission and distribution facilities. Because of their ownership interests in the Millstone units, PSNH and WMECO are also subject to the jurisdiction of the DPUC with respect to their activities in Connecticut and their securities issues.\nPSNH and NAEC are subject to regulation by the NHPUC, which has jurisdiction over retail rates, accounting procedures, certain dispositions of property and plant, quality of service, securities issues, acquisitions of securities of other utilities, mortgages of property, declaration of dividends, contracts with affiliates, management efficiency, construction and operation of generation, transmission and distribution facilities, integrated resource planning and other matters. Although the Seabrook Power Contract between PSNH and NAEC is a wholesale contract subject to the jurisdiction of FERC, pursuant to the terms of the Rate Agreement, the NHPUC has the right to review the prudence of costs incurred by NAEC to determine whether they should be passed on to ratepayers through FPPAC, and the NHPUC and the State of New Hampshire have additional rights and limited jurisdiction over certain other Seabrook Power Contract issues.\nNU and its subsidiaries are subject to the general supervision of the NHPUC with respect to all dealings with PSNH and NAEC. Based upon PSNH's ownership of generating and transmission facilities in Maine and transmission and hydroelectric facilities in Vermont, PSNH is also subject to limited regulatory jurisdiction in those states.\nWMECO is subject to regulation by the DPU, which has jurisdiction over retail rates, accounting procedures, quality of service, contracts for the purchase of electricity, mergers, securities issues and other matters. The DPU has adopted regulations that provide for DPU preapproval of utility plant construction, procurement of non-utility generation (QFs and IPPs), and C&LM programs. HWP is subject to regulation by the DPU with respect to certain contracts and quality of service. NU and its subsidiaries are subject to the general supervision of the DPU with respect to all dealings with WMECO and HWP.\nCL&P is subject to the jurisdiction of the NHPUC for limited purposes in connection with its ownership interest in Seabrook.\nCL&P, PSNH, WMECO, NAEC and HWP are public utilities under Part II of the Federal Power Act and are subject to regulation by the FERC with respect to, among other things, interconnection and coordination of facilities, wholesale rates and accounting procedures.\nThe System incurs substantial capital expenditures and operating expenses to identify and comply with environmental, energy, licensing and other regulatory requirements, including those described in the following subsections, and it expects to incur additional costs to satisfy further requirements in these and other areas of regulation. Because of the continually changing nature of regulations affecting the System, the total amount of these costs is not determinable.\nThe System has active auditing programs addressing a variety of legal and regulatory areas, including an environmental auditing program. To the extent it is determined that a System operation or facility is not in full compliance with applicable environmental or other laws or regulations, the System attempts to resolve non-compliance through the auditing response process or other management processes. Compliance with existing and proposed regulations also affects the time needed to complete new facilities or to modify present facilities, and it affects System companies' rates, sales, revenues and net income, all in ways that may be substantial but are not readily calculable.\nNRC NUCLEAR PLANT LICENSING\nThe operators of the Millstone 1, 2 and 3 units, the CY, MY and VY and Seabrook 1 all have full term full power operating licenses from the NRC. The following table sets forth the current license expiration dates for each unit:\nOperating License Unit Expiration Date (*)\nMillstone 1 October 6, 2010 Millstone 2 July 31, 2015 Millstone 3 November 25, 2025 Seabrook 1 October 17, 2026 CY June 29, 2007 MY October 21, 2008 VY March 21, 2012 _________________________ (*) For all units except Seabrook 1 and MY, the current operating license expires 40 years from the date the operating licensee was issued. The Seabrook license expires 40 years from the date on which the NRC issued a license for the unit to load nuclear fuel, which was about 3 1\/2 years before the full power operating license was issued. MY's operating license expires 40 years from the date the construction license was issued, which was about four years before the operating license was issued. The System will determine at the appropriate time whether to seek to recapture these periods and add them to the operating license terms for those units.\nYAEC had been working with the NRC on a preliminary analysis to extend the license expiration date for Yankee Rowe from 2000 to 2020, but that effort was suspended when the unit was shut down for evaluation. YAEC received a \"possession only\" license from the NRC in August 1992. See \"Electric Operations - Nuclear Generation - Operations - Yankee Units\" for further information on the decision to shut down the Yankee Rowe unit permanently.\nCurrently the NRC issues 40-year operating licenses to nuclear units. In December 1991, the NRC issued a final rule that establishes the requirements that must be met by an applicant for renewal of a nuclear power plant operating license, the information that must be submitted to the NRC for review, so that the agency can determine whether those requirements have in fact been met, and the application procedures that must be used to obtain an extension of a nuclear plant operating license beyond 40 years. A renewal license may be granted for not more than 20 years beyond the current licensed life. The licensing requirements for a nuclear plant during the renewal term will consist of the plant's current licensing requirements and new commitments to monitor, manage, and correct age-related degradation of plant systems, structures, and components that is unique to the license renewal term but will not encompass the higher licensing standards imposed on new plants. An opportunity for a formal public hearing is provided to permit interested persons to raise contentions on the adequacy of the renewal applicant's proposals to address age-related degradation and compliance with applicable requirements relating to an environmental impact statement. The NRC rule was challenged on antitrust grounds and upheld in the District of Columbia Court of Appeals.\nENVIRONMENTAL REGULATION\nGENERAL\nThe National Environmental Policy Act (NEPA) requires that detailed statements of the environmental effects of major federal actions be prepared by federal agencies. Major federal actions can include licenses or permits issued to the System by FERC, NRC and other federal agencies for construction or operation of generation and transmission facilities. NEPA requires that federal licensing agencies make an independent evaluation of the alternatives and environmental impacts of the proposed actions.\nUnder Connecticut law, major generation or transmission facilities may not be constructed or significantly modified without a certificate of environmental compatibility and public need from the Connecticut Siting Council (CSC). After public hearings, CSC may issue the certificate, which addresses the public need for the facility and probable environmental impact of the facility and may impose specific conditions for protection of the environment.\nIn New Hampshire, construction of major new generation or transmission facilities, or sizeable additions to existing facilities, requires a certificate of site and facility from the New Hampshire Site Evaluation Committee (NHSEC) and NHPUC under the state's energy facility siting law. In addition to review by all state agencies having jurisdiction over any aspect of the construction or operation of the proposed facility, the law requires full review by NHSEC of the environmental impact of the proposed site or route after allowing for public comment and conducting public hearings. Issuance of a certificate requires, among other findings, a finding that the proposed site and facility will not have an unreasonable adverse effect on environmental values.\nMassachusetts law requires all state agencies to determine the environmental impact of any projects proposed by private companies requiring state permits, or involving state funding or participation. Massachusetts state agencies are required to make a finding that all feasible measures have been taken to avoid or minimize the environmental impact of the project. In certain instances, Massachusetts law also requires the preparation and dissemination, among various state agencies, of an environmental impact report for the proposed project. Major generation or transmission facilities may not be constructed or significantly modified without approval by the Massachusetts Energy Facilities Siting Board; new transmission facilities also require approval by the DPU.\nThe System anticipates that additional environmental legislation will be seriously considered by Congress and state legislatures in the coming years. The issues of global warming, air pollution, hazardous waste handling and disposal and water pollution control are receiving a significant amount of public and political attention and are likely areas for federal or state legislative activity in the near future. Until and unless any such legislation is enacted and implementing regulations are issued, the effects on the System cannot be determined. Compliance with environmental laws and regulations, particularly air and water pollution control requirements, may limit operations or require substantial investments in new equipment at existing facilities. Such laws and regulations may also require substantial investments that are not included in the estimated construction budget set forth herein. See \"Resource Plans\" for a discussion of the System's construction plans.\nSURFACE WATER QUALITY REQUIREMENTS\nThe federal Clean Water Act (CWA) provides that every \"point source\" discharger of pollutants into navigable waters must obtain a National Pollutant Discharge Elimination System (NPDES) permit from EPA specifying the allowable quantity and characteristics of its effluent. To obtain an NPDES permit, a discharger must meet technology-based and biologically-based effluent standards and must also demonstrate that its effluent will not cause a violation of established standards for the quality of the receiving waters. Connecticut, Massachusetts and New Hampshire regulations contain similar permit requirements and these states can impose more stringent requirements.\nAll of the System's steam-electric generating plants have NPDES permits in effect. Any of the permits may be reopened to incorporate more stringent regulations adopted by EPA or state environmental agencies. Compliance with NPDES and state water discharge permit requirements has necessitated substantial expenditures and may require further expenditures because of additional requirements that could be imposed in the future.\nThe CWA requires EPA and state permitting authorities to approve the cooling water intake structure design and thermal discharge of steam-electric generating plants. All System steam-electric plants have received these approvals. In the renewed discharge permit for the three Millstone nuclear units, issued in 1992, CDEP included a condition requiring a feasibility study of various structural or operational modifications of the cooling water intake system to reduce the entrainment of winter flounder larvae. This study was submitted to CDEP in January 1993 and includes analyses of the costs and benefits of each alternative considered. The costs ranged from $1.8 million to $519 million. The study concluded that the substantial incremental costs of each of the alternatives studied are not justified by the small benefits to the winter flounder population. In a letter dated January 14, 1994, CDEP approved the report requiring only that Millstone station continue efforts to schedule refueling outages to coincide with the period of high winter flounder larvae abundance and that the station continue to monitor the Niantic River winter flounder population in accordance with existing NPDES permit conditions.\nMerrimack station's NHDES discharge permit requires site work to isolate adjacent wetlands from the station's waste water system. Plans have been approved by the New Hampshire Department of Environmental Services (NHDES), and PSNH is now preparing a permit application to begin construction. The new permit may require PSNH to perform further biological studies because significant numbers of migratory fish are being restored to lower reaches of the Merrimack River. Should the studies indicate that Merrimack Station's once-through cooling system interferes with the establishment of a balanced aquatic community, PSNH could be required to construct a partially enclosed cooling water system for Merrimack station. The amount of capital expenditures relating to the foregoing cannot be determined at this time. However, if such expenditures were to be required, they would likely be substantial and a reduction of Merrimack station's net generation capability could result.\nThe ultimate cost impact of the CWA and state water quality regulations on the System cannot be estimated because of uncertainties such as the impact of changes to the effluent guidelines or water quality standards. Additional modifications, in some cases extensive and involving substantial cost, may ultimately be required for some or all of the System's generating facilities.\nIn response to several major oil spills in recent years, Congress passed the Oil Pollution Act of 1990 (OPA 90). OPA 90 sets out the requirements for facility response plans and periodic inspections of spill response equipment at certain facilities. The requirements apply to facilities that can cause substantial harm or significant and substantial harm to the environment by discharging oil or hazardous substances into the navigable waters of the United States and adjoining shorelines. Pursuant to OPA 90, EPA has authority to regulate non-transportation-related fixed onshore facilities and the Coast Guard has the authority to regulate transportation-related onshore facilities.\nResponse plans were filed for all System facilities believed to be subject to this requirement. EPA and the Coast Guard have reviewed these plans and accepted the information provided in them as certification of contracted resources for response to a worst case discharge. The Coast Guard expects to complete its review process by February 17, 1995, and EPA by August 18, 1995. Both agencies have authorized continued operation pending final plan approval.\nOPA 90 includes limits on the liability that may be imposed on persons deemed responsible for release of oil. The limits do not apply to oil spills caused by negligence or violation of laws or regulations. OPA 90 also does not preempt state laws regarding liability for oil spills. In general, the laws of the states in which the System owns facilities and through which the System transports oil could be interpreted to impose strict liability for the cost of remediating releases of oil and for damages caused by releases. The System and its principal oil transporter currently carry a total of $890 million in insurance coverage for oil spills.\nAIR QUALITY REQUIREMENTS\nUnder the federal Clean Air Act, EPA has promulgated national ambient air quality standards for certain air pollutants, including sulfur dioxide, particulate matter, nitrogen oxides and ozone. EPA has approved a Connecticut implementation plan prepared by CDEP, a New Hampshire plan prepared by NHDES and a Massachusetts plan prepared by MDEP for the achievement and maintenance of these standards. The Connecticut, New Hampshire and Massachusetts plans impose limits on the amounts of various airborne pollutants that can be emitted from utility boilers.\nUnder the Clean Air Act, emissions from new or substantially modified sources are limited by new source performance standards and very strict technology-based emission limits.\nThe Clean Air Act Amendments of 1990 (CAAA) made extensive revisions and additions to the Clean Air Act and imposed many stringent new requirements on air emissions sources. The CAAA contains provisions further regulating emissions of sulfur dioxide (SO2) and nitrogen oxides (NOX) for the purpose of controlling acid rain, toxic air pollutants and other pollutants, requiring installation of continuous emissions monitors (CEMs) and expanding permitting provisions.\nExisting and additional federal and state air quality regulations could hinder or possibly preclude the construction of new, or modification of existing, fossil units in the System's service area, could raise the capital and operating cost of existing units, and may affect the operations of the System's work centers and other facilities. The ultimate cost impact of these requirements on the System cannot be estimated because of uncertainties about how EPA and the states will implement various requirements of the CAAA.\nNOX. The CAAA identifies NOX emissions as a precursor of ambient ozone for the northeastern region of the United States, much of which is in violation of the ambient air quality standard for ozone. Pursuant to the CAAA, Connecticut, New Hampshire and Massachusetts must implement plans to address ozone nonattainment. Probable actions include additional NOX controls that could impose costs on the System's generating units. The capital cost to comply with 1995's anticipated Phase I requirements is expected to approximate $10 million for CL&P, $11 million for PSNH, $1 million for WMECO and $3 million for HWP, while compliance costs for Phase II, effective in 1999, could be substantially higher depending on the level of NOX reductions required. Costs for meeting the 1999 NOX emission reduction requirements cannot be estimated at this time.\nConnecticut and New Hampshire have not as yet issued final regulations to implement NOX reduction requirements, although both have previously indicated that they will attempt to achieve NOX reduction requirements at the lowest possible costs. The System companies are in the process of reviewing compliance strategies and costs and of providing input to state environmental regulators. Massachusetts issued final NOX Reasonably Available Control Technology (RACT) rules in September, 1993.\nIn December 1993, PSNH reached a revised agreement regarding NOX emissions with various environmental groups and the New Hampshire Business and Industrial Association. The agreement has been submitted to the New Hampshire Air Resources Division (NHARD) in the form of proposed regulations.\nThe agreement provides for aggressive unit specific NOX emission rate limits for PSNH's generating facilities, effective May 31, 1995. The agreement no longer requires a PSNH commitment to retire or repower Merrimack Unit 2 by May 15, 1999, however more stringent emission rate limits equivalent to the range of 0.1 to 0.4 pounds of NOX per million Btu are required for the unit by that date.\nPSNH recently received an amendment to its Permit to Operate for Merrimack Unit 1 from NHARD to allow the testing of wood chips as a fuel. Testing has begun and if it is successful it may assist PSNH in compliance with the CAAA.\nSO2. The CAAA mandates reductions in sulfur dioxide (SO2) emissions to control acid rain. These reductions are to occur in two phases. First, high SO2 emitting plants are required to reduce their emissions beginning January 1, 1995. The only System units subject to the Phase I reduction requirements are PSNH's Merrimack Units 1 and 2. Management plans to meet the requirements of both Phase I and Phase II by burning low sulfur fuels and substituting (i.e. adding) Newington and Mt. Tom stations as Phase I units, if allowed by EPA regulations.\nOn January 1, 2000, the start of Phase II, a nationwide cap of 8.9 million tons per year of utility SO2 emissions will be imposed and existing units will be granted allowances to emit SO2. These allowances are freely tradable. One allowance entitles a source to emit one ton of SO2 in a year. No unit may emit more SO2 in a particular year than the amount for which it has allowances. The System expects to be allocated allowances by EPA that substantially exceed its expected SO2 emissions for 2000 and subsequent years. In 1993, the System agreed to donate, subject to regulatory approval, 10,000 of its surplus SO2 allowances to the American Lung Association thereby effectively preventing 10,000 tons of SO2 from being emitted into the atmosphere. The System expects to be able to sell some of its surplus allowances. The price of allowances depends on the market. The amount of surplus allowances and the allocation of the revenues received from such sales between ratepayers and shareholders have not been determined.\nOn February 15, 1993, as required by the CAAA, PSNH filed Phase I Acid Rain Permit Applications for Merrimack Station. In addition, as allowed by the CAAA, PSNH designated its Newington station unit, and HWP designated its Mt. Tom unit, as conditional Phase I substitution units. EPA is currently reviewing whether it will accept Newington and Mt. Tom as substitution units and the number of allowances each will be awarded. All Phase I units, including substitution units accepted by EPA, will be allocated SO2 allowances for the period 1995-1999.\nOn December 31, 1992, pursuant to Connecticut Public Act 92-106, CL&P filed a report with the Energy and Public Utilities Committee of the Connecticut General Assembly and the DPUC describing its plan for allocation of revenues from sale of SO2 allowances. CL&P proposed that its shareholders receive 20 percent of the proceeds from sales of allowances to compensate for the risks they have taken to reduce CL&P's SO2 emissions and to provide appropriate incentive to CL&P to sell allowances at the maximum price. In 1993 the DPUC approved a proposal by The United Illuminating Company (UI) to grant an option to another utility for the purchase of SO2 allowances, and ruled that shareholders would receive 15 percent of the proceeds from the eventual sale. The DPUC opened a docket and held hearings to review the reports filed by CL&P and UI. This review is addressing development of a policy on allocation between shareholders and ratepayers of SO2 allowance proceeds as well as CL&P's allowance donation.\nCDEP's air quality regulations permit CL&P to burn 1.0 percent sulfur oil at oil-fired generating stations in Connecticut, except that 0.5 percent sulfur oil must be burned at Middletown station. Current CDEP policy requires CL&P to use 0.5 percent or lower sulfur oil when replacing older (1.0 percent sulfur oil fueled) plant auxiliary boilers needed for unit start-up and plant space heating. The regulations also permit the burning of coal with a sulfur content of up to 0.7 percent at CL&P's plants, or up to 1.0 percent if a special permit is obtained.\nNew Hampshire air quality regulations permit PSNH to emit 55,150 tons of SO2 annually. The New Hampshire acid rain control law required a 25 percent reduction in SO2 emissions from the 1979-1982 baseline emissions at PSNH's units, which has been achieved. Compliance with New Hampshire's acid rain control law has brought PSNH very close to compliance with the SO2 emission limits of Phase I of the CAAA. PSNH may need to install additional pollution control equipment or use fuel with lower sulfur content in order to meet the requirements of the CAAA.\nThe EPA has issued an order requiring modeling of the impact on ambient air quality of SO2 emissions from Merrimack Station. Work on this study has begun and the final results of the modeling are expected to be available in mid-1995. If the modeling study indicates that compliance with the primary ambient air quality standards for SO2 is not being achieved, additional control strategies, possibly including the addition of emission control devices or a higher stack, will be required. Management cannot at this time predict the results of the modeling or estimate the cost of any additional control strategies that may be required.\nThe Massachusetts air quality regulations permit HWP to burn 1.5 percent sulfur coal with an ash content up to 9 percent at Mt. Tom Station. Coal with a higher ash content can be burned with MDEP approval. Mt. Tom Station is required to reduce sulfur emissions to the equivalent of 1.0 percent sulfur oil if certain air quality monitors show levels of SO2 approaching ambient air quality limits. WMECO's West Springfield station currently burns 1.0 percent sulfur oil or natural gas.\nThe Massachusetts acid rain control law requires MDEP to adopt regulations to limit future sulfur dioxide emissions. These regulations limit the allowable SO2 emissions from utility power plants and other major fuel burning sources to 1.2 pounds per million BTUs averaged over all of the System's Massachusetts plants, effective January 1, 1995. The System's generating plants in Massachusetts on average emit approximately 1.9 pounds of SO2 per million BTUs. The System expects to meet the new sulfur dioxide limitation by using natural gas and lower sulfur oil and coal in its plants. The System could incur additional costs for the lower sulfur fuels it may burn to meet the requirements of this legislation.\nUnder the existing fuel adjustment clauses in Connecticut, New Hampshire and Massachusetts, the System would be able to recover the additional fuel costs of compliance with the CAAA and state laws from its customers. Management does not believe that the acid rain provisions of the CAAA will have a significant impact on the System's overall costs or rates due to the very strict limits on SO2 emissions already imposed by Connecticut, New Hampshire and Massachusetts and on NOX limitations imposed by Connecticut and New Hampshire.\nEPA, Connecticut, New Hampshire and Massachusetts regulations also include other air quality standards, emission standards and monitoring, and testing and reporting requirements that apply to the System's generating stations. They require that new or modified fossil fuel-fired electric generating units operate within stringent emission limits.\nAir Toxics. Title III of the CAAA imposes new stringent discharge limitations on hazardous air pollutants. EPA is required to study toxic emissions and mercury emissions from power plants. Pending completion of these studies, power plants are exempt from the hazardous air pollutant requirements. Should EPA or Congress determine that power plant emissions must be controlled to the same extent as emissions from other sources under Title III, the System could be required to make substantial capital expenditures to upgrade or replace pollution control equipment, but the amount of these expenditures cannot be readily estimated.\nConnecticut and New Hampshire have enacted, and Massachusetts is considering, toxic air pollution regulations limiting emissions of numerous substances that may extend beyond those regulated under federal law.\nTOXIC SUBSTANCES AND HAZARDOUS WASTE REGULATIONS\nPCBs. Under the federal Toxic Substances Control Act of 1976 (TSCA), EPA has issued regulations that control the use and disposal of polychlorinated biphenyls (PCBs). PCBs had been widely used as insulating fluids in many electric utility transformers and capacitors before TSCA prohibited any further manufacture of such PCB equipment. System companies have taken numerous steps to comply with these regulations and have incurred increased costs for disposal of used fluids and equipment that are subject to the regulations. One disposal measure involves the System's burning of some waste oil with a low level of PCB contamination (up to 500 parts per million (ppm)) as supplemental fuel at CL&P's Middletown station Unit 3. EPA and CDEP have approved this disposal method.\nIn general, the System sends fluids with concentrations of PCBs equal to or higher than 500 ppm but lower than 8,500 ppm to an unaffiliated company to dispose of using a chemical treatment process. Electrical capacitors that contain PCB fluid are sent offsite to dispose of through burning in high temperature incinerators approved by EPA. Currently, there are only four such approved incinerators operating in the United States, which has resulted in a sharp rise in the price of disposal through these facilities. The System disposes of solid wastes containing PCBs in secure chemical waste landfills. In 1993, the System incurred costs of approximately $450,000 for disposal of materials at these facilities.\nAsbestos. Federal, Connecticut, New Hampshire and Massachusetts asbestos regulations have required the System to expend significant sums on removal of asbestos including measures to protect the health of workers and the general public and to properly dispose of asbestos wastes. Areas of the System currently undergoing removal of asbestos include nuclear, fossil\/hydro production, transmission and distribution and facilities operations. The System expects to expend approximately $3.4 million in 1994 on the removal of asbestos in nuclear units, fossil and hydro generating stations and buildings. Even greater costs are likely to be incurred annually in the future if federal and state asbestos regulations become more stringent and the System's need to remove asbestos grows.\nRCRA. Under the federal Resource Conservation and Recovery Act of 1976, as amended (RCRA), the generation, transportation, treatment, storage and disposal of hazardous wastes are subject to EPA regulations. Connecticut, New Hampshire and Massachusetts have adopted state regulations that parallel RCRA regulations but in some cases are more stringent. A change in interpretation of RCRA by EPA now requires that nuclear facilities obtain EPA permits to handle radioactive wastes that are also hazardous under RCRA (so-called mixed wastes). The notifications and applications required by these regulations have been made by all units to which these regulations apply. The procedures by which System companies handle, store, treat and dispose of hazardous wastes are regularly revised, where necessary, to comply with these regulations.\nCL&P has discontinued operation of surface impoundments in its four Connecticut wastewater treatment facilities used to treat hazardous waste. This is because CL&P was unable to obtain variances from EPA to exempt the facilities from the double lining requirement under the 1984 RCRA amendments.\nCL&P has constructed replacement above-ground concrete tanks at an estimated cost of approximately $22 million. It is expected that in early 1994, EPA and DEP will approve clean closure for CL&P's Montville Station's impoundment. Accordingly, CL&P will no longer be required to maintain liability insurance or financial assurance for closure and post-closure for this former impoundment site. EPA's final approval of the closure of the remaining three surface impoundments is pending. The System estimates that it will incur approximately $2 million in costs of monitoring and closure of the container storage areas for these sites in the future, but the ultimate amount will depend on EPA's final disposition.\nUnderground Storage Tanks. Federal and state regulations regulate underground tanks storing petroleum products or hazardous substances. The System has about 130 underground storage tanks that are used primarily for gasoline, diesel, house-heating and fuel oil. To reduce its environmental and financial liabilities, the System has begun implementing a policy calling for the permanent removal of all non-essential underground vehicle fueling tanks. Costs for this program are not substantial.\nHazardous Waste Liability. As many other industrial companies have done in the past, System companies have disposed of residues from operations by depositing or burying such materials on-site or disposing of them at off-site landfills or facilities. Typical materials disposed of include coal gasification waste and oils that might contain PCBs. In recent years it has been determined that deposited or buried wastes, under certain circumstances, could cause groundwater contamination or other environmental harm. The System continues to evaluate the environmental impact of its former disposal practices. Under federal and state law, government agencies and private parties can attempt to impose liability on System companies for such past disposal.\nUnder the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, commonly known as Superfund, EPA has the authority to clean up hazardous waste sites and to impose the cleanup costs on parties deemed responsible for the hazardous waste activities on the sites. Responsible parties include the current owner of a site, past owners of a site at the time of waste disposal, waste transporters and waste generators. It is EPA's position that all responsible parties are jointly and severally liable, so that any single responsible party can be required to pay the entire costs of cleaning up the site. As a practical matter, however, the costs of cleanup are usually allocated by agreement of the parties, or by the courts on an equitable basis among the parties deemed responsible, and several recent federal appellate court decisions have rejected EPA's position on strict joint and several liability. Superfund also contains provisions that require System companies to report releases of specified quantities of hazardous materials and require notification of known hazardous waste disposal sites. Management believes that the System companies are in compliance with these reporting and notification requirements.\nThe System is or has recently been involved in eight Superfund sites. Three of these sites are in Connecticut, one is in Kentucky, one is in West Virginia and three are in New Hampshire. The level of study of each site and the information about the waste contributed to the site by the System and other parties differs from site to site. Where reliable information is available that permits the System to make a reasonable estimate of the expected total costs of remedial action and\/or the System's likely share of remediation costs for a particular site, those cost estimates are provided below. All cost estimates were made, in accordance with Financial Accounting Standards Board Statement No. 5, where remediation costs were probable and reasonably estimable. Any estimated costs disclosed for cleaning up the sites discussed below were determined without consideration of possible recoveries from third parties, including insurance recoveries. Where the System has not accrued a liability, the costs either were not material or there was insufficient information to accurately assess the System's exposure.\nAt two Connecticut sites, the Beacon Heights and Laurel Park landfills, the major parties formed coalitions to clean the sites and settled their suits with EPA and CDEP. The coalitions then attempted to join as defendants a large number of potential contributors, including \"Northeast Utilities (Connecticut Light and Power).\" Litigation on both sites was consolidated in a single case in the federal district court. In January 1993, Judge Dorsey denied the motion of the Laurel Park Coalition to join NU (CL&P). In December 1993, Judge Dorsey dismissed the claims of Beacon Heights Coalition against many of the defendants and directed the coalition to indicate which remaining defendants it intended to pursue claims against. In January 1994, the Beacon Heights Coalition filed a response listing NU (CL&P) as a defendant they would not continue to pursue. As a result of Judge Dorsey's rulings and the coalition's actions, it is not likely that CL&P will incur any cleanup costs for these sites.\nIn June, 1993, EPA notified the System that it was a Potentially Responsible Party (PRP) at the Solvents Recovery Service of New England site in Southington, Connecticut. PSNH is a de minimis PRP at this site and does not expect its cost to be substantial.\nAt the Maxey Flats nuclear waste disposal site in Fleming County, Kentucky, EPA has issued a notice of potential liability to NNECO and CYAPC. The System had sent a substantial volume of LLRW from Millstone 1, Millstone 2 and CY to this site. CL&P and WMECO had previously recorded a liability for future remediation costs for this site based on System estimates. To date, the costs have not been material with respect to their earnings or financial positions.\nIn September 1991, EPA issued its record of decision for the Maxey Flats nuclear waste disposal site. The EPA-approved remedy requires pumping and treatment of leachate, installing of an initial cap, allowing materials in the trenches to settle and ultimately constructing a permanent cap. EPA estimated that the cost of the remedy is approximately $33.5 million. Based on that estimate and the volume contributed, the System's share would be approximately $0.5 million. However, the System believes that the cost of the remedy could be substantially higher. The System estimates that its total cost for cleanup could be approximately $1-$2 million. EPA provided an opportunity for PRPs, including certain System companies, to enter into a consent decree with EPA under which each PRP would reimburse EPA for its past costs and would undertake remedial action at the site or pay the costs of EPA undertaking remedial action.\nOn October 20, 1992, PRPs that are members of the Maxey Flats PRP Steering Committee, including System companies, and several federal government agencies, including DOE and the Department of Defense, made a settlement offer to EPA involving a commitment to perform a substantial portion of the remedial work required by EPA in its record of decision. On that same date, the Commonwealth of Kentucky made a settlement offer. EPA rejected the settlement offers in December 1992, but gave the parties an additional 60 days to make a \"good faith\" offer. On March 16, 1993, the PRP Steering Committee and the federal government agencies made a revised offer to EPA. Since then all parties have been actively involved in settlement negotiations.\nPSNH has settled with EPA and other PRPs at sites in West Virginia and Kingston, New Hampshire. PSNH paid approximately $33,700 to cash out of these sites.\nPSNH has committed approximately $280,000 as its share of the costs to clean up municipal landfills in Dover and North Hampton, New Hampshire. Some additional costs may be incurred at these sites but they are not expected to be significant.\nOther New Hampshire sites include municipal landfills in Somersworth and Peterborough, and the Dover Point site owned by PSNH in Dover, New Hampshire.\nPSNH's liability at the landfills is not expected to be significant and its liability at the Dover Point site cannot be estimated at this time.\nPSNH contacted NHDES in December 1993 concerning possible coal tar contamination in the headwater of Lake Winnipesaukee near an area where PSNH formerly owned and operated a coal gasification plant which was sold in 1945. PSNH agreed to conduct an historical review and provide a report to NHDES in February 1994. PSNH, along with two other identified PRPs, most likely will be conducting a site investigation in the spring of 1994.\nIn 1987, CDEP published a list of 567 hazardous waste disposal sites in Connecticut. The System owns two sites on this list. The System has spent approximately $0.5 million to date completing investigations at these sites. Both sites were formerly used by CL&P predecessor companies for the manufacture of coal gas (also known as town gas sites) from the late 1800s to the 1950s. This process resulted in the production of coal tar residues, which, when not sold for roofing or road construction, were frequently deposited on or near the production facilities. Site investigations are being carried out to gain an understanding of the environmental and health risks of these sites. Should future site remediation become necessary, the level of cleanup will be established in cooperation with CDEP. Connecticut is currently developing cleanup standards and guidelines for soil and groundwater.\nOne of the sites is a 25.8 acre site located in the south end of Stamford, Connecticut. Site investigations have located coal tar deposits covering approximately 5.5 acres and having a volume of approximately 45,000 cubic yards. A final risk assessment report for the site was completed in January 1994. Several remedial options are currently being evaluated to clean up the site; however, CL&P is focusing on institutional and engineering controls, such as capping and paving, which would reduce the potential health risks and secure the site. The estimated costs of institutional controls range from $2 million to $3 million.\nAs part of the 1989 divestiture of CL&P's gas business, site investigations were performed for properties that were transferred to Yankee Gas Services Company (Yankee Gas). As a result of those investigations, ten properties were identified for which negative declarations under the Property Transfer Act could not be filed. A negative declaration is a statement that there has been no discharge of hazardous wastes at the site, or that if there was such a discharge, it has been cleaned up or determined to pose no threat to health, safety or the environment and is being managed lawfully. Of the ten sites, CL&P agreed to accept liability for required cleanup for the three sites it retained. At one location, CL&P and Yankee Gas share the site and any liability for any required cleanup. Yankee Gas accepted liability for any required cleanup of the other sites. CL&P and Yankee Gas will share the costs of cleanup of sites formerly used in CL&P's gas business but not currently owned by either of them.\nIn Massachusetts, System companies have been designated by MDEP as PRPs for ten sites under MDEP's hazardous waste and spill remediation program. The System does not expect that its share of the remaining remediation costs for any of these sites will be material. At some of these sites, the System is responsible for only a small portion or none of the hazardous wastes. For some of these and for other sites, the total remediation costs are not expected to be material. At one of the sites, the System has spent approximately $2 million for cleanup and it expects to incur approximately $250,000 for the remaining remediation costs.\nHWP has been identified by MDEP as a PRP in a coal tar site in Holyoke, Massachusetts. HWP owned and operated the Holyoke Gas Works from 1859 to 1902. It was sold to the city of Holyoke and operated by its Gas and Electric Department (HG&E) from 1902 to 1951. Currently, one third of the two acre property is owned by HG&E, with the remaining portion owned by a construction company. The site is located on the west side of Holyoke, adjacent to the Connecticut River and immediately downstream of HWP's Hadley Falls Station. MDEP has classified both the land and river deposit areas as Tier I priority waste disposal sites. Due to the presence of tar patches in the vicinity of the spawning habitat of the shortnose sturgeon (SNS) - an endangered species - the National Oceanographic and Atmospheric Administration (NOAA) and National Marine Fisheries Service have taken an active role in overseeing site activities. Although HWP denies that it is a PRP, it has cooperated with the agencies in investigating this problem. Both MDEP and NOAA have indicated they may require the removal of tar deposits from the vicinity of the SNS spawning habitat. To date, HWP has spent approximately $200,000 for river studies and construction costs for an oil containment boom to prevent leaching hydrocarbons from entering the Hadley Falls tailrace and the Connecticut River.\nThe System has received other claims from government agencies and third parties for the cost of remediating sites not currently owned by the System but affected by past System disposal activities and expects to receive more such claims in the future. The System expects that the costs of resolving claims for remediating sites about which it has been notified will not be material, but cannot estimate the costs with respect to sites about which it has not been notified. If the System, regulatory agencies or courts determine that remedial actions must be taken in relation to past disposal practices on property owned or used for disposal by the System in the past, the System could incur substantial costs.\nELECTRIC AND MAGNETIC FIELDS\nIn recent years, published reports have discussed the possibility of adverse health effects from electric and magnetic fields (EMF) associated with electric transmission and distribution facilities and appliances and wiring in buildings and homes. On the basis of scientific reviews of these reports conducted by various state, federal and international panels, management does not believe that a causal relationship has been established or that significant capital expenditures are appropriate to minimize unsubstantiated risks. The System supports further research into the subject and is participating in the funding of the National EMF Research and Public Information Dissemination Program and other industry-sponsored studies. If further investigation were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems, the industry could be faced with the difficult problem of delivering reliable electric service in a cost-effective manner while managing EMF exposures. In addition, if the courts were to conclude that individuals have been harmed and that utilities are liable for damages, the potential monetary exposure for all utilities, including the System companies, could be enormous. Without definitive scientific evidence of a causal relationship between EMF and health effects, and without reliable information about the kinds of changes in utilities' transmission and distribution systems that might be needed to address the problem, if one is found, no estimates of the cost impacts of remedial actions and liability awards are available.\nEpidemiological studies, rather than laboratory studies, have been primarily responsible for increased scientific interest in and public concern over EMF exposures in the past decade. New epidemiological study results from international researchers were released and publicized in late-1992 and in 1993, but these only added to a picture of inconsistency from previous studies. Researchers from Sweden and Denmark concluded that their statistical results support the hypothesis that EMF may be a causative factor in certain types of cancer (although they disagreed on which types), while researchers from Finland and Greece found no evidence to support such a hypothesis. These researchers, as well as scientific review panels considering all significant EMF epidemiological and laboratory research to date, all agree that current information remains inconclusive, inconsistent and insufficient for risk assessment of EMF exposures. NU is closely monitoring research and government policy developments.\nIn 1993, there were several notable events on the federal government level regarding EMF. The EPA has indefinitely postponed completion of a report on EMF, citing as its reasons high costs and the unlikelihood of shedding new light on the issue. Instead, it now plans to issue a 30-page \"summary of science\" in early 1994. In a related development, the Department of Energy has initiated a scientific review of EMF research by the National Academy of Sciences. Also on the federal level, the National EMF Research and Public Information Dissemination Program (created by the Energy Policy Act) moved forward in 1993 by establishing a federal interagency committee and an advisory committee, and by soliciting the required non-federal matching funds (through The Edison Electric Institute, NU will be making a voluntary contribution of approximately $62,000 for each year of the five-year program).\nThe Connecticut Interagency EMF Task Force (Task Force) provided reports to the state legislature in March 1993 and in January 1994. The Task Force recognizes and supports the need for more research, and has suggested a policy of \"voluntary exposure control,\" which involves providing people with information to enable them to make individual decisions about EMF exposure. Neither the Task Force, nor any Connecticut state agency, has recommended changes to the existing electrical supply system. Finally, the Connecticut Siting Council adopted a set of EMF \"best management practices\" in February 1993, which must now be considered in the justification, siting and design of new transmission lines and substations. EMF has become increasingly important as a factor in facility siting decisions in many states.\nSeveral bills were introduced in Massachusetts in January 1993, and were last reported to be pending before various legislative committees. It is not known whether there will be further action on the bills, which would require certain disclosures to real estate purchasers and utility employees, a scientific literature review, establishment of a fund to reduce certain field exposures, identification of schools and day care centers within 500 feet of transmission lines and development of EMF regulations. No action was taken on EMF bills previously pending in 1992.\nCL&P has been the focus of media reports charging that EMF associated with a CL&P substation and related distribution lines in Guilford, Connecticut, is linked with various cancers and other illnesses in several nearby residents. See Item 3, Legal Proceedings, for information about two suits brought by plaintiffs who now live or formerly lived near that substation.\nFERC HYDRO PROJECT LICENSING\nFederal Power Act licenses may be issued for hydroelectric projects for terms of up to 50 years as determined by FERC. Any hydroelectric project so licensed is subject to recapture by the United States for licensing to others after expiration of the license upon payment to the licensee of the lesser of fair value or the net investment in the project plus severance damages less certain amounts earned by the licensee in excess of a reasonable rate of return. Licenses are customarily conditioned on the licensee's development of recreational and other non-power uses at each licensed project. Conditions may be imposed with respect to low flow augmentation of streams and fish passage facilities.\nOn September 28, 1993, the United States Fish and Wildlife Service (FWS) was petitioned to list the anadromous Atlantic salmon (Salmo salar) as an endangered species in the United States. After a 90-day review, the petition was found to be complete and was accepted. The National Marine Fisheries Service and FWS were given joint jurisdiction over this petition. Within the next 12 months, these agencies will decide if the petition is warranted. If salmon are listed as an endangered species, the System may be required to take a number of actions including increasing spillage over some dams during the salmon migration period resulting in loss of generation capacity at the affected hydroelectric facilities; modifying spillways to accommodate safe fish passage; curtailing pumping at Northfield Mountain during the salmon migration period; improving upstream and downstream passage facilities at all hydroelectric dams on the Connecticut and Merrimack Rivers; and modifying intake structures and curtailing operations during salmon migration periods at certain of the System's thermal structures. Although these are all possible implications of a listing, the System cannot estimate the impact on System facilities at this time.\nThe System is continuing to conduct studies on the Connecticut River in fulfillment of the Memorandum of Agreement (MOA) concerning downstream passage of anadromous fishes (Atlantic salmon, American shad and blueback herring). The MOA was signed by the System and the Connecticut River Atlantic Salmon Commission and its member agencies in 1990. The System conducted studies in 1991 and 1992 of the entrainment of salmon smolts and juvenile shad and herring in water pumped to the upper reservoir of the Northfield Mountain Pumped Storage Project. Studies of entrainment of shad and herring indicated that Northfield's impact on these species is low, and further studies have not been conducted.\nStudies of salmon smolts, however, indicated the potential for unacceptable losses of smolts due to entrainment, but the results also indicated that firm conclusions could not be drawn. Accordingly, the System conducted a more definitive study indicating that about 10 percent of the 1993 smolt run was entrained at Northfield. The System will continue to pursue practical techniques to reduce salmon smolt entrainment at Northfield and has agreed to alter its 1994 maintenance schedule to reduce the amount of time when all four pump\/turbine units will be pumping simultaneously during the smolt migration period. Should the system be unable to reduce smolt entrainment through operational changes or practical exclusion techniques, substantial additional costs are possible. The total cost cannot be determined at this time.\nThe System operating companies hold licenses granted under Part I of the Federal Power Act for the operation and maintenance of thirteen existing hydroelectric projects, four of which are in Massachusetts (Northfield, Turners Falls, Gardners Falls and Holyoke [river and canal units]), three of which are in Connecticut (Scotland, Housatonic [encompassing Bulls Bridge, Rocky River, Shepaug and Stevenson] and Falls Village) and six of which are in New Hampshire (Merrimack [encompassing Garvins Falls, Hooksett and Amoskeag], Smith, Ayers Island, Eastman Falls, Canaan and Gorham).\nIn 1992, FERC issued orders exempting from licensing WMECO's four Chicopee River projects: Dwight, Indian Orchard, Putts Bridge and Red Bridge. To date, FERC has not claimed jurisdiction over CL&P's Bantam, Robertsville, Taftville and Tunnel Projects or PSNH's Jackman project.\nFour of the System's FERC licenses expired at the end of 1993 (Gardners Falls, Ayers Island, Gorham and Smith). Relicensing efforts have been under way for these projects for several years. As no third parties have filed competing license applications with FERC for these projects, it is highly likely that FERC will grant renewal licenses for these projects to the System.\nHowever, certain operating, environmental and\/or recreational conditions may be placed on these licenses. Because FERC was unable to complete its relicensing process prior to the December 31, 1993 expiration of these licenses, under the provision of section 15 of the Federal Power Act, FERC has issued one-year extensions to each of these licensees. FERC will continue to issue annual licenses until it completes the relicensing process.\nEMPLOYEES\nAs of December 31, 1993, the System companies had approximately 9,697 full and part time employees on their payrolls, of which approximately 2,697 were employed by CL&P, approximately 1,452 by PSNH, approximately 656 by WMECO, approximately 119 by HWP, approximately 1,252 by NNECO, approximately 2,584 by NUSCO and approximately 937 by North Atlantic. NU and NAEC have no employees. Approximately 2,242 employees of CL&P, PSNH, WMECO and HWP are covered by union agreements, which expire between October 1994 and May 1996. Certain employees of North Atlantic negotiated a union contract in 1993.\nOn August 3, 1993, the System announced that it intended to reduce its total workforce by 600 to 700 positions and offered a voluntary early retirement program to about 800 eligible employees. The program was available generally to all nonbargaining unit employees of NU's subsidiaries, NUSCO, CL&P, WMECO, HWP, PSNH and NAESCO, who would be at least age 55 with ten years of service as of November 1, 1993. Most nuclear-related job classifications at NUSCO and NAESCO were not eligible. The program enhanced pension benefits by adding an additional three years to age and service for the purpose of calculating pension benefits and early retirement reduction factors, as well as providing a supplemental payment to employees who retired prior to becoming eligible for social security benefits. Each program participant has retired or will retire on a date to be established by the employer between November 1, 1993 and November 1, 1994. A similar program was offered to approximately 300 bargaining unit employees working for System companies and 12 employees of NEPOOL\/NEPEX. The workforce reduction affected approximately 811 employees, of which 498 individuals accepted the early retirement program and another 313 individuals who were involuntarily terminated. Involuntarily terminated employees were eligible to receive a lump sum severance payment of up to a maximum of 52 weeks salary, depending on years of credited service. In addition, as part of the System's reorganization of its Connecticut-based nuclear organization, 32 employees were involuntarily terminated through January 12, 1994. For more information on the reorganization see \"Nuclear Generation - Operations - Nuclear Performance Improvement Initiatives.\" The total cost of the workforce reduction program and the nuclear reorganization was approximately $38 million, including pension, severance and other benefits.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe physical properties of the System are owned or leased by subsidiaries of NU. CL&P's principal plants and other properties are located either on land which is owned in fee or on land, as to which CL&P owns perpetual occupancy rights adequate to exclude all parties except possibly state and federal governments, which has been reclaimed and filled pursuant to permits issued by the United States Army Corps of Engineers. The principal properties of PSNH are held by it in fee. In addition, PSNH leases space in an office building under a 30-year lease expiring in 2002. WMECO's principal plants and a major portion of its other properties are owned in fee, although one hydroelectric plant is leased. NAEC owns a 35.98201 percent interest in Seabrook 1, and approximately 719 acres of exclusion area land located around the unit. In addition, CL&P, PSNH, and WMECO have certain substation equipment, data processing equipment, nuclear fuel, nuclear control room simulators, vehicles, and office space that are leased. With few exceptions, the System's companies' lines are located on or under streets or highways, or on properties either owned, leased, or in which the company has appropriate rights, easements, or permits from the owners.\nCL&P's properties are subject to the liens of CL&P's first mortgage indenture and, with respect to properties formerly owned by The Hartford Electric Light Company (HELCO), to the lien of HELCO's first mortgage indenture. PSNH's properties are subject to the lien of its first mortgage indenture. In addition, PSNH's outstanding term loan and revolving credit agreement borrowings are secured by a second lien, junior to the lien of the first mortgage indenture, on PSNH property located in New Hampshire. WMECO's properties are subject to the lien of its first mortgage indenture. NAEC's First Mortgage Bond are secured by a lien on the Seabrook 1 interest described above, and all rights of NAEC under the Seabrook Power Contract. In addition, CL&P's and WMECO's interests in Millstone 1 are subject to second liens for the benefit of lenders under agreements related to pollution control revenue bonds. Various ones of these properties are also subject to minor encumbrances which do not substantially impair the usefulness of the properties to the owning company.\nThe System companies' properties are well maintained and are in good operating condition.\nNotes:\n1. Until 1991, awards under the short-term programs of the Northeast tilities Executive Incentive Compensation Program (EICP) were made in restricted stock. In 1991, the Northeast Utilities Executive Incentive Plan (EIP) was adopted, which did not require restricted stock awards. Awards under the 1991 and 1992 short-term programs under the EIP were paid in 1992 and 1993, respectively, in the form of unrestricted stock and, in accordance with the requirements of the SEC, are included as \"bonus\" in the years earned.\n2. The five executive officers listed in the table above each received an award of restricted stock in May, 1991 (which vested in January, 1993), under the EICP. The number of shares in each such award is shown below. All restricted stock awards under the EICP vested prior to December 31, 1993.\nName Shares\nB. M. Fox 1,807 W. B. Ellis 2,585 J. F. Opeka 1,349 R. E. Busch 1,090 J. P. Cagnetta 847\n3. \"All Other Compensation\" consists of employer matching contributions under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan (401(k) Plan), generally available to all eligible employees. In 1993, the employer match for non-union employees was 100 percent of the first three percent of compensation contributed on a before-tax basis.\n4. Awards under the short-term program of the EIP have typically been made by NU's Committee on Organization, Compensation and Board Affairs in April each year. Based on preliminary estimates of corporate performance, and assuming that the individual performance levels of Messrs. Opeka, Busch and Cagnetta approximate those of other system officers, it is estimated that the five executive officers listed in the table above would receive the following awards: Mr. Fox - $180,780; Mr. Ellis - $160,693; Mr. Busch - $64,946; Mr. Opeka - $64,946; and Dr. Cagnetta - $43,828.\n5. Mr. Fox served as President and Chief Operating Officer of CL&P, NAEC and WMECO and Vice Chairman and Chief Operating Officers of PSNH until July 1, 1993, when he became President and Chief Executive Officer of CL&P, NAEC and WMECO and Vice Chairman and Chief Executive Officer of PSNH. Mr. Ellis served as Chairman and Chief Executive Officer of these companies until July 1, 1993, when he became Chairman. Amounts listed in the \"Long Term Incentive Program\" column of the Summary Compensation Table for 1993 were received by these individuals prior to their change in responsibilities. $267,500 of Mr. Ellis's 1993 salary was paid prior to July 1, 1993, while he was Chief Executive Officer, and $253,750 was paid after July 1, 1993. $217,500 of Mr. Fox's 1993 salary was paid prior to July 1, 1993, and $261,275 was paid after Mr. Fox became Chief Executive Officer on July 1, 1993.\nPENSION BENEFITS\nThe following table shows the estimated annual retirement benefits payable to an executive officer of NU, CL&P, WMECO, PSNH and NAEC upon retirement, assuming that retirement occurs at age 65 and that the officer is at that time not only eligible for a pension benefit under the Northeast Utilities Service Company Retirement Plan (the Retirement Plan) but also eligible for the \"make-whole benefit\" and the \"target benefit\" under the Supplemental Executive Retirement Plan for Officers of Northeast Utilities System Companies (the Supplemental Plan). The Supplemental Plan is a non-qualified pension plan providing supplemental retirement income to System officers. The \"make-whole benefit\" under the Supplemental Plan makes up for benefits lost through application of certain tax code limitations on the benefits that may be provided under the Retirement Plan, and is available to all officers. The \"target benefit\" further supplements these benefits and is available to officers at the Senior Vice President level and higher who are selected by the NU Board of Trustees to participate in the target benefit and who remain in the employ of NU companies until at least age 60 (unless the NU Board of Trustees sets an earlier age). Each of the executive officers of NU, CL&P, WMECO, PSNH and NAEC named in the summary compensation table above is currently eligible for a target benefit. If an executive officer were not eligible for a target benefit at the time of retirement, a lower level of retirement benefits would be paid.\nThe benefits presented are based on a straight life annuity beginning at age 65 and do not take into account any reduction for joint and survivorship annuity payments.\nYears of Credited Service Final Average ------------------------------------------------------ Compensation 15 20 25 30 35 - ------------------ ------------------------------------------------------ $ 125,000 $ 45,000 $ 60,000 $ 75,000 $ 75,000 $ 75,000 $ 150,000 $ 54,000 $ 72,000 $ 90,000 $ 90,000 $ 90,000 $ 175,000 $ 63,000 $ 84,000 $105,000 $105,000 $105,000 $ 200,000 $ 72,000 $ 96,000 $120,000 $120,000 $120,000 $ 225,000 $ 81,000 $108,000 $135,000 $135,000 $135,000 $ 250,000 $ 90,000 $120,000 $150,000 $150,000 $150,000 $ 300,000 $108,000 $144,000 $180,000 $180,000 $180,000 $ 350,000 $126,000 $168,000 $210,000 $210,000 $210,000 $ 400,000 $144,000 $192,000 $240,000 $240,000 $240,000 $ 450,000 $162,000 $216,000 $270,000 $270,000 $270,000 $ 500,000 $180,000 $240,000 $300,000 $300,000 $300,000 $ 600,000 $216,000 $288,000 $360,000 $360,000 $360,000 $ 700,000 $252,000 $336,000 $420,000 $420,000 $420,000 $ 800,000 $288,000 $384,000 $480,000 $480,000 $480,000\nFinal average compensation for purposes of calculating the \"target benefit\" is the highest average annual compensation of the participant during any 36 consecutive months compensation was earned. Compensation taken into account under the \"target benefit\" described above includes salary, bonus, restricted stock awards, and long-term incentive payouts shown in the Summary Compensation Table above, but does not include employer matching contributions under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan (401(k)) Plan. In the event that an officer's employment terminates because of disability, the retirement benefits shown above would be offset by the amount of any disability benefits payable to the recipient that are attributable to contributions made by NU and its subsidiaries under long term disability plans and policies.\nAs of December 31, 1993, the five executive officers named in the Summary Compensation Table above had the following years of credited service for retirement compensation purposes: Mr. Fox - 29, Mr. Ellis - 17, Mr. Opeka - 23, Mr. Busch - 20 and Dr. Cagnetta - 21. Assuming that retirement were to occur at age 65 for these officers, retirement would occur with 43, 29, 35, 38 and 25 years of credited service, respectively.\nNU has entered into agreements with Messrs. Ellis and Fox to provide for an orderly management succession. The agreement with Mr. Ellis calls for him to work with the NU Board of Trustees and Mr. Fox to effect the orderly transition of his responsibilities to Mr. Fox. In accordance with the agreement, Mr. Ellis stepped down as Chief Executive Officer of NU, CL&P, WMECO, PSNH and NAEC as of July 1, 1993. The agreement anticipates his retirement as of August 1, 1995.\nThe agreement provides that, upon his retirement, Mr. Ellis will be entitled to receive from NU and its subsidiaries a target benefit under the Supplemental Plan. His target benefit will be based on the greater of his actual final average compensation or an amount determined as if his salary had increased each year since 1991 at a rate equal to the average rate of the increases of all other target benefit participants and as if he had received incentive awards each year based on this modified salary, but with the same performance as the Chief Executive Officer at the time. The agreement also provides specified death and disability benefits for the period before Mr. Ellis's 1995 retirement.\nThe agreement with Mr. Fox states that if he is terminated as Chief Executive Officer without cause, he will be entitled to specified severance pay and benefits. Those benefits consist primarily of (i) two years' base pay, medical, dental and life insurance benefits, (ii) a supplemental retirement benefit equal to the difference between the target benefit he would be entitled to receive if he had reached the age of 55 on the termination date and the actual target benefit to which he is entitled as of the termination date, and (iii) a target benefit under the Supplemental Plan, notwithstanding that he might not have reached age 60 on the termination date and notwithstanding other forfeiture provisions of that plan. The agreement also provides specified death and disability benefits. The agreement terminates two years after NU gives Mr. Fox a notice of termination, but no earlier than the date he becomes 55.\nThe agreements do not address the officers' normal compensation and benefits, which are to be determined by NU's Committee on Organization, Compensation and Board Affairs and the NU Board of Trustees in accordance with their customary practices.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nNU.\nIncorporated herein by reference are pages 5 through 12 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1994 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO and NAEC.\nAs of February 28, 1994, the Directors of CL&P, PSNH, WMECO and NAEC, beneficially owned the following number of shares of each class of equity securities of NU. No equity securities of CL&P, PSNH or WMECO are owned by the Directors and Executive Officers.\nCL&P, PSNH, WMECO, and NAEC DIRECTORS AND NAMED EXECUTIVE OFFICERS\nAmount and Nature of Title Of Name of Beneficial Percent of Class Beneficial Owner Ownership (1) Class (2)\nNU Common Robert G. Abair (3) (621) 4,271 shares NU Common Robert E. Busch (772) 6,054 shares NU Common John P. Cagnetta (4) (581) 3,979 shares NU Common John C. Collins (5) 0 shares NU Common William B. Ellis (6) (1,259) 14,837 shares NU Common Ted C. Feigenbaum(7) 151 shares NU Common Bernard M. Fox (8) (1,072) 17,428 shares NU Common William T. Frain, Jr. 885 shares NU Common Cheryl W. Grise (221) 1,349 shares NU Common John B. Keane (9) (368) 1,146 shares NU Common Francis L. Kinney (10) (303) 3,781 shares NU Common Gerald Letendre (5) 0 shares NU Common Hugh C. MacKenzie (4)(11) (779) 4,277 shares NU Common Jane E. Newman (5) 0 shares NU Common Dale F. Nitzschke (5) 0 shares NU Common John W. Noyes (658) 2,789 shares NU Common John F. Opeka (4)(12) (1,075) 16,463 shares NU Common Robert P. Wax (5) (651) 1,436 shares\nAmount beneficially owned by Directors and Executive Officers as a group - CL&P (7,709) 77,259 shares - PSNH (6,790) 69,299 shares - WMECO (7,709) 77,259 shares - NAEC (7,088) 73,139 shares\n(1) Unless otherwise noted, each Director and Executive Officer of CL&P, PSNH, WMECO and NAEC has sole voting and investment power with respect to the listed shares. The numbers in parentheses reflect the number of shares owned by each Director and Executive Officer under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan (401(k) Plan), as to which the Officer has no investment power.\n(2) As of February 28, 1994 there were 134,208,461 common shares of NU outstanding. The percentage of such shares beneficially owned by any Director or Executive Officer, or by all Directors and Executive Officers of CL&P, PSNH, WMECO and NAEC as a group, does not exceed one percent.\n(3) Mr. Abair is a Director of CL&P and WMECO only.\n(4) Mr. Opeka and Dr. Cagnetta are not officers of PSNH, but each in his capacity as an officer (with the stated title) of NUSCO, an affiliate of PSNH, performs policy-making functions for PSNH.\n(5) Messrs. Collins, Letendre, Nitzschke and Wax and Ms. Newman areDirectors of PSNH only.\n(6) Mr. Ellis shares voting and investment power with his wife for 1,117 shares.\n(7) Mr. Feigenbaum is a Director and an Executive Officer of NAEC only.\n(8) Mr. Fox shares voting and investment power with his wife for 3,031 of these shares. In addition, Mr. Fox's wife has sole voting and investment power for 140 shares, as to which Mr. Fox disclaims beneficial ownership.\n(9) Mr. Keane is a Director of CL&P, WMECO and NAEC only.\n(10) Mr. Kinney shares voting and investment power with his wife for 2,155 shares.\n(11) Mr. MacKenzie shares voting and investment power with his wife for 1,259 shares.\n(12) Mr. Opeka shares voting and investment power with his wife for 1,718 shares.\nItem 13. Certain Relationships and Related Transactions\nNU.\nIncorporated herein by reference is page 14 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1994 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO and NAEC.\nNo relationships or transactions that would be described in response to this item exist now or existed during 1993 with respect to CL&P, PSNH, WMECO and NAEC.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements:\nThe Report of Independent Public Accountants and financial statements of NU, CL&P, PSNH, WMECO, and NAEC are hereby incorporated by reference and made a part of this report (see \"Item 8. Financial Statements and Supplementary Data\").\nReports of Independent Public Accountants on Schedules S-1\nConsents of Independent Public Accountants S-3\n2. Schedules:\nFinancial Statement Schedules for NU (Parent), NU and Subsidiaries, CL&P, PSNH, WMECO, and NAEC are listed in the Index to Financial Statement Schedules S-5\n3. Exhibits Index E-1\n(b) Reports on Form 8-K:\nDuring the fourth quarter of 1993, the companies filed Form 8-Ks dated December 2, 1993 disclosing the following:\no On December 2, 1993, the Northeast Utilities system announced a reorganization of its corporate structure.\no On December 3, 1993, NNECO was informed by the NRC that it was being assessed a civil penalty in response to repair activities at Millstone 2.\nIn addition, the Form 8-K dated December 2, 1993 which was filed by PSNH also discussed the following:\no On June 8, 1992, PSNH changed its independent public accountant.\nNORTHEAST UTILITIES\nSIGNATURES\nPursuant 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.\nNORTHEAST UTILITIES ------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------------- William B. Ellis Chairman of the Board\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Trustee and Chairman \/s\/ William B. Ellis - -------------- of the Board ------------------------- William B. Ellis\nMarch 18, 1994 Trustee, President \/s\/ Bernard M. Fox - -------------- and Chief Executive ------------------------- Officer Bernard M. Fox\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President and Chief ------------------------- Financial Officer Robert E. Busch\nMarch 18, 1994 Vice President and \/s\/ John B. Keane - -------------- Treasurer ------------------------- John B. Keane\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller ------------------------- John W. Noyes\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Trustee \/s\/ Cotton Mather Cleveland - -------------- --------------------------- Cotton Mather Cleveland\nMarch 18, 1994 Trustee \/s\/ George David - -------------- --------------------------- George David\nMarch 18, 1994 Trustee \/s\/ Donald J. Donahue - -------------- --------------------------- Donald J. Donahue\nMarch 18, 1994 Trustee \/s\/ Eugene D. Jones - -------------- --------------------------- Eugene D. Jones\nMarch 18, 1994 Trustee \/s\/ Elizabeth T. Kennan - -------------- --------------------------- Elizabeth T. Kennan\nTrustee - -------------- --------------------------- Denham C. Lunt, Jr.\nMarch 18, 1994 Trustee \/s\/ William J. Pape II - -------------- --------------------------- William J. Pape II\nMarch 18, 1994 Trustee \/s\/ Robert E. Patricelli - -------------- --------------------------- Robert E. Patricelli\nTrustee - -------------- --------------------------- Norman C. Rasmussen\nTrustee - -------------- --------------------------- John F. Swope\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES\nPursuant 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.\nTHE CONNECTICUT LIGHT AND POWER COMPANY --------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman and \/s\/ Bernard M. Fox - -------------- Director -------------------------- Bernard M. Fox\nMarch 18, 1994 President and Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\n- ------------------- Director -------------------------- Robert G. Abair\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - ------------------- -------------------------- John P. Cagnetta\nMarch 18, 1994 Director \/s\/ William T. Frain, Jr. - ------------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - ------------------- ----------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - ------------------- ----------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ John F. Opeka - ------------------- ----------------------- John F. Opeka\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES\nPursuant 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.\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE --------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- ------------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman, Chief \/s\/ Bernard M. Fox - -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 18, 1994 President, Chief \/s\/ William T. Frain, Jr. - -------------- Operating Officer -------------------------- and Director William T. Frain, Jr.\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Director \/s\/ John C. Collins - ------------------- -------------------------- John C. Collins\nMarch 18, 1994 Director \/s\/ Gerald Letendre - ------------------- -------------------------- Gerald Letendre\nMarch 18, 1994 Director \/s\/ Hugh C. MacKenzie - ------------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Director \/s\/ Jane E. Newman - ------------------- -------------------------- Jane E. Newman\nMarch 18, 1994 Director \/s\/ Dale S. Nitzschke - ------------------- -------------------------- Dale S. Nitzschke\nMarch 18, 1994 Director \/s\/ Robert P. Wax - ------------------- -------------------------- Robert P. Wax\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant 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.\nWESTERN MASSACHUSETTS ELECTRIC COMPANY -------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- -------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman and \/s\/ Bernard M. Fox - -------------- Director -------------------------- Bernard M. Fox\nMarch 18, 1994 President and Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\n- ------------------- Director -------------------------- Robert G. Abair\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - ------------------- -------------------------- John P. Cagnetta\nMarch 18, 1994 Director \/s\/ William T. Frain, Jr. - ------------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - ------------------- ----------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - ------------------- ----------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ John F. Opeka - ------------------- ----------------------- John F. Opeka\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES\nPursuant 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.\nNORTH ATLANTIC ENERGY CORPORATION --------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman, Chief \/s\/ Bernard M. Fox - -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 18, 1994 President, Chief \/s\/ Robert E. Busch - -------------- Operating Officer -------------------------- and Director Robert E. Busch\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - -------------- -------------------------- John P. Cagnetta\n- -------------- Director -------------------------- Ted C. Feigenbaum\nMarch 18, 1994 Director \/s\/ William T. Frain. Jr. - -------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - -------------- -------------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - -------------- -------------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Director \/s\/ John F. Opeka - -------------- -------------------------- John F. Opeka\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Northeast Utilities' annual report to shareholders and The Connecticut Light and Power Company's, Western Massachusetts Electric Company's, North Atlantic Energy Corporation's, and Public Service Company of New Hampshire's annual reports, incorporated by reference in this Form 10-K, and have issued our reports thereon dated February 18, 1994. Our reports on the financial statements include an explanatory paragraph with respect to the change in methods of accounting for property taxes, postretirement benefits other than pensions, income taxes, and employee stock ownership plans, as applicable to each company, as explained in Note 1 to the related company's financial statements. Our audits were made for the purpose of forming an opinion on each company's statements taken as a whole. The schedules listed in the index to financial statement schedules are the responsibility of each company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of each company's basic financial statements. The schedules have been subjected to the auditing procedures applied in the audits of each company's basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to each company's basic financial statements taken as a whole.\n\/s\/ ARTHUR ANDERSEN & CO.\nARTHUR ANDERSEN & CO.\nHartford, Connecticut February 18, 1994\nS-1\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES\nThe Board of Directors Public Service Company of New Hampshire:\nUnder date of February 7, 1992, we reported on the balance sheet and statement of capitalization of Public Service Company of New Hampshire as of December 31, 1991 (not presented in the 1993 annual report to stockholders) and the related statements of income, cash flows and common stock equity for the periods January 1, 1991 to May 15, 1991 and May 16, 1991 to December 31, 1991, as contained in the annual report to stockholders of Public Service Company for the year 1993. These financial statements and our report thereon are incorporated by reference herein. In connection with our audits of the aforementioned financial statements, we have also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsiblity is to express an opinion on these financial statement schedules based on our audit.\nIn our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nBoston, Massachusetts February 7, 1992\nS-2\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference of our reports in this Form 10-K, into previously filed Registration Statement No. 33-13444, No. 33-46291 , No. 33-59430, and No. 33-50853 of The Connecticut Light and Power Company, No. 33-34886, No. 33-51185 and No. 33-25619 of Western Massachusetts Electric Company, and No. 33-34622 and No. 33-40156 of Northeast Utilities.\n\/s\/ ARTHUR ANDERSEN & CO.\nARTHUR ANDERSEN & CO.\nHartford, Connecticut March 18, 1994\nS-3\nINDEPENDENT AUDITORS' CONSENT\nThe Board of Directors Public Service Company of New Hampshire:\nWe consent to the use of our reports included or incorporated by reference herein.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nBoston, Massaschusetts March 18, 1994\nS-4\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page - -------- ----\nIII. Financial Information of Registrant:\nNortheast Utilities (Parent) Balance Sheets 1993 and 1992 S-7\nNortheast Utilities (Parent) Statements of Income 1993, 1992, and 1991 S-8\nNortheast Utilities (Parent) Statements of Cash Flows 1993, 1992, and 1991 S-9\nV. Utility Plant 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-10 -- S-12 The Connecticut Light and Power Company S-13 -- S-15 Public Service Company of New Hampshire S-16 -- S-20 Western Massachusetts Electric Company S-21 -- S-23 North Atlantic Energy Corporation S-24 -- S-25\nV. Nuclear Fuel 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-26 -- S-28 The Connecticut Light and Power Company S-29 -- S-31 Public Service Company of New Hampshire S-32 -- S-36 Western Massachusetts Electric Company S-37 -- S-39 North Atlantic Energy Corporation S-40 -- S-41\nVI. Accumulated Provision for Depreciation of Utility Plant 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-42 -- S-44 The Connecticut Light and Power Company S-45 Public Service Company of New Hampshire S-46 -- S-48 Western Massachusetts Electric Company S-49 North Atlantic Energy Corporation S-50\nVIII. Valuation and Qualifying Accounts and Reserves 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-51 -- S-53 The Connecticut Light and Power Company S-54 -- S-56 Public Service Company of New Hampshire S-57 -- S-61 Western Massachusetts Electric Company S-62 -- S-64\nS-5\nSchedule Page - -------- ----\nIX. Short-Term Borrowings 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-65 The Connecticut Light and Power Company S-66 Public Service Company of New Hampshire S-67 Western Massachusetts Electric Company S-68 North Atlantic Energy Corporation S-69\nX. Supplementary Income Statement Information 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-70 The Connecticut Light and Power Company S-71 Public Service Company of New Hampshire S-72 Western Massachusetts Electric Company S-73 North Atlantic Energy Corporation S-74\nAll other schedules of the companies' for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted.\nS-6\nSCHEDULE III NORTHEAST UTILITIES (PARENT) ---------------------------- FINANCIAL INFORMATION OF REGISTRANT ----------------------------------- BALANCE SHEETS -------------- AT DECEMBER 31, 1993 AND 1992 ------------------------------ (Thousands of Dollars)\nS-7\nSCHEDULE III NORTHEAST UTILITIES (PARENT) ---------------------------- FINANCIAL INFORMATION OF REGISTRANT ----------------------------------- STATEMENTS OF INCOME -------------------- YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 --------------------------------------------- (Thousands of Dollars Except Share Information)\nS-8\nSCHEDULE III NORTHEAST UTILITIES (PARENT) FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 (Thousands of Dollars)\nS-9\nS-10\nS-11\nS-12\nS-13\nS-14\nS-15\nS-16\nS-17\nS-18\nS-19\nS-20\nS-21\nS-22\nS-23\nS-24\nS-25\nS-26\nS-27\nS-28\nS-29\nS-30\nS-31\nS-32\nS-33\nS-34\nS-35\nS-36\nS-37\nS-38\nS-39\nS-40\nS-41\nS-42\nS-43\nS-44\nS-45\nS-46\nS-47\nS-48\nS-49\nS-50\nS-51\nS-52\nS-53\nS-54\nS-55\nS-56\nS-57\nS-58\nS-59\nS-60\nS-61\nS-62\nS-63\nS-64\nS-65\nS-66\nS-67\nS-68\nS-69\nS-70\nS-71\nS-72\nS-73\nS-74\nEXHIBIT INDEX\nEach document described below is incorporated by reference to the files of the Securities and Exchange Commission, unless the reference to the document is marked as follows:\n* - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Reports on Form 10-K for CL&P, PSNH, WMECO and NAEC.\n# - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for CL&P.\n@ - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for PSNH.\n** - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for WMECO.\n## - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for NAEC.\nExhibit Number Description\n3 Articles of Incorporation and By-Laws\n3.1 Northeast Utilities\n3.1.1 Declaration of Trust of NU, as amended through May 24, 1988. (Exhibit 3.1.1, 1988 NU Form 10-K, File No. 1-5324)\n3.2 The Connecticut Light and Power Company\n# 3.2.1 Certificate of Incorporation of CL&P, restated to March 22, 1994.\n# 3.2.2 By-laws of CL&P, as amended to March 1, 1982.\n3.3 Public Service Company of New Hampshire\n@ 3.3.1 Articles of Incorporation, as amended to May 16, 1991.\n@ 3.3.2 By-laws of PSNH, as amended to November 1, 1993.\n3.4 Western Massachusetts Electric Company\n3.4.1 Certificate of Organization of WMECO, as amended, to August 31, 1954. (Exhibit 3.1, File No. 2-11114)\n3.4.2 Amendments to Certificate of Organization of WMECO of May 19, 1966 and of December 5, 1967. (Exhibit 3.2, File No. 2-30534)\nE-1\n3.4.3 Articles of Amendment dated December 9, 1981. (Exhibit 3.1.2, 1981 WMECO Form 10-K, File No. 0-7624)\n3.4.4 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated December 16, 1981. (Exhibit 3.1.3, 1981 WMECO Form 10-K, File No. 0-7624)\n3.4.5 Articles of Amendment dated April 7, 1983. (Exhibit 3.3.5, 1983 NU Form 10-K, File No. 1-5324)\n3.4.6 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated April 12, 1983. (Exhibit 3.3.6, 1983 NU Form 10-K, File No. 1-5324)\n3.4.7 Articles of Amendment dated January 29, 1987. (Exhibit 3.3.7, 1986 NU Form 10-K, File No. 1-5324)\n3.4.8 Articles of Amendment dated February 11, 1987. (Exhibit 3.3.8, 1986 NU Form 10-K, File No. 1-5324)\n3.4.9 Articles of Amendment dated February 19, 1988. (Exhibit 3.3.9, 1987 NU Form 10-K, File No. 1-5324)\n3.4.10 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated February 23, 1988. (Exhibit 3.3.10, 1987 NU Form 10-K, File No. 1-5324)\n** 3.4.11 By-laws of WMECO, as amended to February 24, 1988.\n3.5 North Atlantic Energy Corporation\n## 3.5.1 Articles of Incorporation of NAEC dated September 20, 1991.\n## 3.5.2 Articles of Amendment dated October 16, 1991 and June 2, 1992 to Articles of Incorporation of NAEC.\n## 3.5.3 By-laws of NAEC, as amended to November 8, 1993.\n4 Instruments defining the rights of security holders, including indentures\n4.1 Northeast Utilities\n4.1.1 Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with respect to the issuance of Debt Securities. (Exhibit 4.1.1, 1991 NU Form 10-K, File No. 1-5324)\n4.1.2 First Supplemental Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with respect to the issuance of Series A Notes. (Exhibit 4.1.2, 1991 NU Form 10-K, File No. 1-5324)\n4.1.3 Second Supplemental Indenture dated as of March 1, 1992 between Northeast Utilities and IBJ Schroder Bank & Trust Company with respect to the issuance of 8.38% Amortizing Notes. (Exhibit 4.1.3, 1992 NU Form 10-K, File No. 1-5324)\nE-2 4.1.4 Warrant Agreement dated as of June 5, 1992 between Northeast Utilities and the Service Company. (Exhibit 4.1.4, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.1 Additional Warrant Agent Agreement dated as of June 5, 1992 between Northeast Utilities and State Street Bank and Trust Company. (Exhibit 4.1.4.1, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.2 Exchange and Disbursing Agent Agreement dated as of June 5, 1992 among Northeast Utilities, Public Service Company of New Hampshire and State Street Bank and Trust Company. (Exhibit 4.1.4.2, 1992 NU Form 10-K, File No. 1-5324)\n4.1.5 Credit Agreements among CL&P, NU, WMECO, NUSCO (as Agent) and 19 Commercial Banks dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.38, 1992 NU Form U5S, File No. 30-246)\n4.1.6 Credit Agreements among CL&P, WMECO, NU, Holyoke Water Power Company, RRR, NNECO and NUSCO (as Agent) dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.39, 1992 NU Form U5S, File No. 30-246)\n4.2 The Connecticut Light and Power Company\n4.2.1 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, Trustee, dated as of May 1, 1921. (Composite including all twenty-four amendments to May 1, 1967.) (Exhibit 4.1.1, 1989 NU Form 10-K, File No. 1-5324)\nSupplemental Indentures to the Composite May 1, 1921 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, dated as of:\n4.2.2 April 1, 1967. (Exhibit 4.16, File No. 2-60806)\n4.2.3 January 1, 1968. (Exhibit 4.18, File No. 2-60806)\n4.2.4 December 1, 1969. (Exhibit 4.20, File No. 2-60806)\n4.2.5 June 30, 1982. (Exhibit 4.33, File No. 2-79235)\n4.2.6 June 1, 1989. (Exhibit 4.1.24, 1989 NU Form 10-K, File No. 1-5324)\n4.2.7 September 1, 1989. (Exhibit 4.1.25, 1989 NU Form 10-K, File No. 1-5324)\n4.2.8 December 1, 1989. (Exhibit 4.1.26, 1989 NU Form 10-K, File No. 1-5324)\n4.2.9 April 1, 1992. (Exhibit 4.30, File No. 33-59430)\n4.2.10 July 1, 1992. (Exhibit 4.31, File No. 33-59430)\nE-3 4.2.11 October 1, 1992. (Exhibit 4.32, File No. 33-59430)\n4.2.12 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.13 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n# 4.2.14 December 1, 1993.\n# 4.2.15 February 1, 1994.\n# 4.2.16 February 1, 1994.\n4.2.17 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1986. (Exhibit C.1.47, 1986 NU Form U5S, File No. 30-246)\n4.2.18 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of October 1, 1988. (Exhibit C.1.55, 1988 NU Form U5S, File No. 30-246)\n4.2.19 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1989. (Exhibit C.1.39, 1989 NU Form U5S, File No. 30-246)\n4.2.20 Loan and Trust Agreement among Business Finance Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1992. (Exhibit C.2.33, 1992 NU Form U5S, File No. 30-246)\n# 4.2.21 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.22 Series B (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.23 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.24 Series B (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n4.3 Public Service Company of New Hampshire\n4.3.1 First Mortgage Indenture dated as of August 15, 1978 between PSNH and First Fidelity Bank, National Association, New Jersey, Trustee, (Composite including all amendments to May 16, 1991). (Exhibit 4.4.1, 1992 NU Form 10-K, File No. 1- 5324)\nE-4 4.3.1.1 Tenth Supplemental Indenture dated as of May 1, 1991 between PSNH and First Fidelity Bank, National Association. (Exhibit 4.1, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392).\n4.3.2 Revolving Credit Agreement dated as May 1, 1991. (Exhibit 4.12, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.3 Term Credit Agreement dated as of May 1, 1991. (Exhibit 4.11, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.4 Series A (Tax Exempt New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.2, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.5 Series B (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.3, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.6 Series C (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.4, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.7 Series D (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.5, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.7.1 First Supplement to Series D (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1992. (Exhibit 4.4.5.1, 1992 NU Form 10-K, File No. 1-5324)\n4.3.8 Series E (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.6, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n@ 4.3.8.1 First Supplement to Series E (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1993.\n@ 4.3.9 Series D (May 1, 1991 Taxable New Issue and December 1, 1992 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of October 1, 1992.\n@ 4.3.9.1 Amended and Restated Letter of Credit dated December 17, 1992.\n4.3.10 Series E (May 1, 1991 Taxable New Issue and December 1, 1993 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of May 1, 1991. (Exhibit 4.8, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\nE-5 @ 4.3.10.1 Amended and Restated Letter of Credit dated December 15, 1993.\n4.4 Western Massachusetts Electric Company\n** 4.4.1 First Mortgage Indenture and Deed of Trust between WMECO and Old Colony Trust Company, Trustee, dated as of August 1, 1954.\nSupplemental Indentures thereto dated as of:\n4.4.2 March 1, 1967. (Exhibit 2.5, File No. 2-68808)\n4.4.3 March 1, 1968. (Exhibit 2.6, File No. 2-68808)\n4.4.4 December 1, 1968. (Exhibit 2.7, File No. 2-68808)\n4.4.5 July 1, 1972. (Exhibit 2.9, File No. 2-68808)\n4.4.6 May 1, 1986. (Exhibit 4.3.18, 1986 NU Form 10-K, File No. 1-5324)\n4.4.7 December 1, 1988. (Exhibit 4.3.20, 1988 NU Form 10-K, File No. 1-5324.)\n4.4.8 September 1, 1990. (Exhibit 4.3.15, 1990 NU Form 10-K, File No. 1-5324.)\n4.4.9 December 1, 1992. (Exhibit 4.15, File No. 33-55772)\n4.4.10 January 1, 1993. (Exhibit 4.5.13, 1992 NU Form 10-K, File No. 1-5324)\n** 4.4.11 March 1, 1994.\n** 4.4.12 March 1, 1994.\n** 4.4.13 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and WMECO (Pollution Control Bonds) dated as of September 1, 1993.\n** 4.4.14 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n4.5 North Atlantic Energy Corporation\n4.5.1 First Mortgage Indenture and Deed of Trust between NAEC and United States Trust Company of New York, Trustee, dated as of June 1, 1992. (Exhibit 4.6.1, 1992 NU Form 10-K, File No. 1-5324)\n4.5.2 Note Indenture dated as of May 15, 1991. (Exhibit 4.10, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\nE-6 4.5.3 First Supplemental Indenture dated as of June 5, 1992 between NAEC, PSNH and United States Trust Company of New York, Trustee. (Exhibit 4.6.3, 1992 NU Form 10-K, File No. 1-5324)\n10 Material Contracts\n10.1 Stockholder Agreement dated as of July 1, 1964 among the stockholders of Connecticut Yankee Atomic Power Company (CYAPC). (Exhibit 13.1, File No. 2-22958)\n10.2 Form of Power Contract dated as of July 1, 1964 between CYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 13.2, File No. 2-22958)\n10.2.1 Form of Additional Power Contract dated as of April 30, 1984, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.4, 1984 NU Form 10-K, File No. 1-5324)\n10.2.2 Form of 1987 Supplementary Power Contract dated as of April 1, 1987, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.6, 1987 NU Form 10-K, File No. 1-5324)\n10.3 Capital Funds Agreement dated as of September 1, 1964 between CYAPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 13.3, File No. 2-22958)\n#@** 10.4 Stockholder Agreement dated December 10, 1958 between Yankee Atomic Electric Company (YAEC) and CL&P, HELCO, PSNH and WMECO.\n10.5 Form of Amendment No. 3, dated as of April 1, 1985, to Power Contract between YAEC and each of CL&P, PSNH and WMECO, including a composite restatement of original Power Contract dated June 30, 1959 and Amendment No. 1 dated April 1, 1975 and Amendment No. 2 dated October 1, 1980. (Exhibit 10.5, 1988 NU Form 10-K, File No. 1-5324.)\n10.5.1 Form of Amendment No. 4 to Power Contract, dated May 6, 1988, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.1, 1989 NU Form 10-K, File No. 1-5324)\n10.5.2 Form of Amendment No. 5 to Power Contract, dated June 26, 1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.2, 1989 NU Form 10-K, File No. 1-5324)\n10.5.3 Form of Amendment No. 6 to Power Contract, dated July 1, 1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.3, 1989 NU Form 10-K, File No. 1-5324)\n#@** 10.5.4 Form of Amendment No. 7 to Power Contract, dated February 1, 1992, between YAEC and each of CL&P, PSNH and WMECO.\n10.6 Stockholder Agreement dated as of May 20, 1968 among stockholders of MYAPC. (Exhibit 4.15, File No. 2-30018)\n10.7 Form of Power Contract dated as of May 20, 1968 between MYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.14, File No. 2-30018)\nE-7 #@** 10.7.1 Form of Amendment No. 1 to Power Contract dated as of March 1, 1983 between MYAPC and each of CL&P, PSNH and WMECO.\n#@** 10.7.2 Form of Amendment No. 2 to Power Contract dated as of January 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.7.3 Form of Amendment No. 3 to Power Contract dated as of October 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.3, 1985 NU Form 10-K, File No. 1-5324)\n#@** 10.7.4 Form of Additional Power Contract dated as of February 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.8 Capital Funds Agreement dated as of May 20, 1968 between Maine Yankee Atomic Power Company (MYAPC) and CL&P, PSNH, HELCO and WMECO. (Exhibit 4.13, File No. 2-30018)\n10.8.1 Amendment No. 1 to Capital Funds Agreement, dated as of August 1, 1985, between MYAPC, CL&P, PSNH and WMECO. (Exhibit 10.6.1, 1985 NU Form 10-K, File No. 1-5324)\n10.9 Sponsor Agreement dated as of August 1, 1968 among the sponsors of VYNPC. (Exhibit 4.16, File No. 2-30285)\n10.10 Form of Power Contract dated as of February 1, 1968 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.18, File No. 2-30018)\n10.10.1 Form of Amendment to Power Contract dated as of June 1, 1972 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 5.22, File No. 2-47038)\n#@** 10.10.2 Form of Second Amendment to Power Contract dated as of April 15, 1983 between VYNPC and each of CL&P, PSNH and WMECO.\n10.10.3 Form of Third Amendment to Power Contract dated as of April 24, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.3, 1986 NU Form 10-K, File No. 1-5324)\n10.10.4 Form of Fourth Amendment to Power Contract dated as of June 1, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.4, 1986 NU Form 10-K, File No. 1-5324)\n10.10.5 Form of Fifth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.5, 1990 NU Form 10-K, File No. 1-5324)\n10.10.6 Form of Sixth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.6, 1990 NU Form 10-K, File No. 1-5324)\nE-8 10.10.7 Form of Seventh Amendment to Power Contract dated as of June 15, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.7, 1990 NU Form 10-K, File No. 1-5324)\n10.10.8 Form of Eighth Amendment to Power Contract dated as of December 1, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.8, 1990 NU Form 10-K, File No. 1-5324)\n#@** 10.10.9 Form of Additional Power Contract dated as of February 1, 1984 between VYNPC and each of CL&P, PSNH and WMECO.\n10.11 Capital Funds Agreement dated as of February 1, 1968 between Vermont Yankee Nuclear Power Corporation (VYNPC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.16, File No. 2-30018)\n10.11.1 Form of First Amendment to Capital Funds Agreement dated as of March 12, 1968 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.17, File No. 2-30018)\n#@** 10.11.2 Form of Second Amendment to Capital Funds Agreement dated as of September 1, 1993 between VYNPC and CL&P, HELCO, PSNH and WMECO.\n10.12 Amended and Restated Millstone Plant Agreement dated as of December 1, 1984 by and among CL&P, WMECO and Northeast Nuclear Energy Company (NNECO). (Exhibit 10.17, 1985 NU Form 10-K, File No. 1-5324)\n10.13 Sharing Agreement dated as of September 1, 1973 with respect to 1979 Connecticut nuclear generating unit (Millstone 3). (Exhibit 6.43, File No. 2-50142)\n10.13.1 Amendment dated August 1, 1974 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 5.45, File No. 2-52392)\n10.13.2 Amendment dated December 15, 1975 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 7.47, File No. 2-60806)\n10.13.3 Amendment dated April 1, 1986 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 10.17.3, 1990 NU Form 10-K, File No. 1-5324)\n10.14 Agreement dated July 19, 1990, among NAESCO and Seabrook Joint owners with respect to operation of Seabrook. (Exhibit 10.53, 1990 NU Form 10-K, File No. 1-5324)\n10.15 Sharing Agreement between CL&P, WMECO, HP&E, HWP and PSNH dated as of June 1, 1992. (Exhibit 10.17, 1992 NU Form 10- K, File No. 1-5324)\n10.16 Form of Seabrook Power Contract between PSNH and NAEC, as amended and restated. (Exhibit 10.45, NU 1992 Form 10-K, File No. 1-5324)\nE-9 10.17 Agreement for joint ownership, construction and operation of New Hampshire nuclear generating units dated as of May 1, 1973. (Exhibit 13-57, File No. 2-48966)\n10.17.1 Amendments to Exhibit 10.17 dated May 24, 1974, June 21, 1974 and September 25, 1974. (Exhibit 5.15, File No. 2-51999)\n10.17.2 Amendments to Exhibit 10.17 dated October 25, 1974 and January 31, 1975. (Exhibit 5.23, File No. 2-54646)\n10.17.3 Sixth Amendment to Exhibit 10.17 dated as of April 18, 1979. (Exhibit 5.4.3, File No. 2-64294)\n10.17.4 Seventh Amendment to Exhibit 10.17 dated as of April 18, 1979. (Exhibit 5.4.4, File No. 2-64294)\n10.17.5 Eighth Amendment to Exhibit 10.17 dated as of April 25, 1979. (Exhibit 5.4.5, File No. 2-64815)\n10.17.6 Ninth Amendment to Exhibit 10.17 dated as of June 8, 1979. (Exhibit 5.4.6, File No. 2-64815)\n10.17.7 Tenth Amendment to Exhibit 10.17 dated as of October 10, 1979. (Exhibit 5.4.2, File No. 2-66334)\n10.17.8 Eleventh Amendment to Exhibit 10.17 dated as of December 15, 1979. (Exhibit 5.4.8, File No. 2-66492)\n10.17.9 Twelfth Amendment to Exhibit 10.17 dated as of June 16, 1980. (Exhibit 5.4.9, File No. 2-68168)\n10.17.10 Thirteenth Amendment to Exhibit 10.17 dated as of December 31, 1980. (Exhibit 10.6, File No. 2-70579)\n* 10.17.11 Fourteenth Amendment to Exhibit 10.17 dated as of June 1, 1982.\n10.17.12 Fifteenth Amendment to Exhibit 10.17 dated as of April 27, 1984. (Exhibit 10.14.12, 1984 NU Form 10-K, File No. 1-5324)\n10.17.13 Sixteenth Amendment to Exhibit 10.17 dated as of June 15, 1984. (Exhibit 10.14.13, 1984 NU Form 10-K, File No. 1-5324)\n10.17.14 Seventeenth Amendment to Exhibit 10.17 dated as of March 8, 1985. (Exhibit 10.13.14, 1985 NU Form 10-K, File No. 1-5324)\n10.17.15 Eighteenth Amendment to Exhibit 10.17 dated as of March 14, 1986. (Exhibit 10.13.15, 1986 NU Form 10-K, File No. 1-5324)\n10.17.16 Nineteenth Amendment to Exhibit 10.17 dated as of May 1, 1986. (Exhibit 10.13.16, 1986 NU Form 10-K, File No. 1-5324)\nE-10 10.17.17 Twentieth Amendment to Exhibit 10.17 dated as of July 15, 1986. (Exhibit 10.13.17, 1986 NU Form 10-K, File No. 1-5324)\n10.17.18 Twenty-first Amendment to Exhibit 10.17 dated as of November 12, 1987. (Exhibit 10.13.18, 1987 NU Form 10-K, File No. 1-5324)\n10.17.19 Twenty-second Amendment to Exhibit 10.17 dated as of January 13, 1989. (Exhibit 10.13.19, 1989 NU Form 10-K, File No. 1-5324)\n10.17.20 Twenty-third Amendment to Exhibit 10.17 dated as of November 1, 1990. (Exhibit 10.13.20, 1990 NU Form 10- K, File No. 1-5324)\n10.17.21 Memorandum of Understanding dated November 7, 1988 between PSNH and Massachusetts Municipal Wholesale Electric Company (Exhibit 10.17, PSNH 1989 Form 10-K, File No. 1-6392)\n10.17.22 Agreement of Settlement among Joint Owners dated as of January 13, 1989. (Exhibit 10.13.21, 1988 NU Form 10- K, File No. 1-5324)\n10.17.22.1 Supplement to Settlement Agreement, dated as of February 7, 1989, between PSNH and Central Maine Power Company. (Exhibit 10.18.1, PSNH 1989 Form 10-K, File No. 1-6392)\n10.18 Amended and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1, 1990. (Exhibit 10.4.7, File No. 33-35312)\n10.18.1 Form of First Amendment to Exhibit 10.18. (Exhibit 10.4.8, File No. 33-35312)\n* 10.18.2 Form (Composite) of Second Amendment to Exhibit 10.18.\n10.19 Agreement dated November 1, 1974 for Joint Ownership, Construction and Operation of William F. Wyman Unit No. 4 among PSNH, Central Maine Power Company and other utilities. (Exhibit 5.16 , File No. 2-52900)\n10.19.1 Amendment to Exhibit 10.19 dated June 30, 1975. (Exhibit 5.48, File No. 2-55458)\n10.19.2 Amendment to Exhibit 10.19 dated as of August 16, 1976. (Exhibit 5.19, File No. 2-58251)\n10.19.3 Amendment to Exhibit 10.19 dated as of December 31, 1978. (Exhibit 5.10.3, File No. 2-64294)\n#** 10.20 Form of Service Contract dated as of July 1, 1966 between each of NU, CL&P and WMECO and the Service Company.\n10.20.1 Service Contract dated as of June 5, 1992 between PSNH and the Service Company. (Exhibit 10.12.4, 1992 NU Form 10-K, File No. 1-5324)\nE-11 10.20.2 Service Contract dated as of June 5, 1992 between NAEC and the Service Company. (Exhibit 10.12.5, 1992 NU Form 10-K, File No. 1-5324)\n* 10.20.3 Form of Annual Renewal of Service Contract.\n10.21 Memorandum of Understanding between CL&P, HELCO, Holyoke Power and Electric Company (HP&E), Holyoke Water Power Company (HWP) and WMECO dated as of June 1, 1970 with respect to pooling of generation and transmission. (Exhibit 13.32, File No. 2-38177)\n#** 10.21.1 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of February 2, 1982 with respect to pooling of generation and transmission.\n10.22 New England Power Pool Agreement effective as of November 1, 1971, as amended to November 1, 1988. (Exhibit 10.15, 1988 NU Form 10-K, File No. 1-5324.)\n10.22.1 Twenty-sixth Amendment to Exhibit 10.22 dated as of March 15, 1989. (Exhibit 10.15.1, 1990 NU Form 10-K, File No. 1-5324)\n10.22.2 Twenty-seventh Amendment to Exhibit 10.22 dated as of October 1, 1990. (Exhibit 10.15.2, 1991 NU Form 10-K, File No. 1-5324)\n10.22.3 Twenty-eighth Amendment to Exhibit 10.22 dated as of September 15, 1992. (Exhibit 10.18.3, 1992 NU Form 10-K, File No. 1-5324)\n* 10.22.4 Twenty-ninth Amendment to Exhibit 10.22 dated as of May 1, 1993.\n10.23 Agreements among New England Utilities with respect to the Hydro-Quebec interconnection projects. (See Exhibits 10(u) and 10(v); 10(w), 10(x), and 10(y), 1990 and 1988, respectively, Form 10-K of New England Electric System, File No. 1-3446.)\n10.24 Trust Agreement dated February 11, 1992, between State Street Bank and Trust Company of Connecticut, as Trustor, and Bankers Trust Company, as Trustee, and CL&P and WMECO, with respect to NBFT. (Exhibit 10.23, 1991 NU Form 10-K, File No. 1-5324)\n10.24.1 Nuclear Fuel Lease Agreement dated as of February 11, 1992, between Bankers Trust Company, Trustee, as Lessor, and CL&P and WMECO, as Lessees. (Exhibit 10.23.1, 1991 NU Form 10-K, File No. 1-5324)\n10.25 Simulator Financing Lease Agreement, dated as of February 1, 1985, by and between ComPlan and NNECO. (Exhibit 10.52, 1985 NU Form 10-K, File No. 1-5324)\nE-12 10.26 Simulator Financing Lease Agreement, dated as of May 2, 1985, by and between The Prudential Insurance Company of America and NNECO. (Exhibit 10.53, 1985 NU Form 10-K, File No. 1-5324)\n10.27 Lease dated as of April 14, 1992 between The Rocky River Realty Company (RRR) and Northeast Utilities Service Company (NUSCO) with respect to the Berlin, Connecticut headquarters (office lease). (Exhibit 10.29, 1992 NU Form 10-K, File No. 1-5324)\n10.27.1 Lease date as of April 14, 1992 between RRR and NUSCO with respect to the Berlin, Connecticut headquarters (project lease). (Exhibit 10.29.1, 1992 NU Form 10-K, File No. 1-5324)\n* 10.28 Millstone Technical Building Note Agreement dated as of December 21, 1993 between, by and between The Prudential Insurance Company of America and NNECO.\n10.29 Lease and Agreement, dated as of December 15, 1988, by and between WMECO and Bank of New England, N.A., with BNE Realty Leasing Corporation of North Carolina. (Exhibit 10.63, 1988 NU Form 10-K, File No. 1-5324.)\n10.30 Note Agreement dated April 14, 1992, by and between The Rocky River Realty Company (RRR) and Purchasers named therein (Connecticut General Life Insurance Company, Life Insurance Company of North America, INA Life Insurance Company of New York, Life Insurance Company of Georgia), with respect to RRR's sale of $15 million of guaranteed senior secured notes due 2007 and $28 million of guaranteed senior secured notes due 2017. (Exhibit 10.52, 1992 NU Form 10-K, File No. 1-5324)\n10.30.1 Note Guaranty dated April 14, 1992 by Northeast Utilities pursuant to Note Agreement dated April 14, 1992 between RRR and Note Purchasers, for the benefit of The Connecticut National Bank as Trustee, the Purchasers and the owners of the notes. (Exhibit 10.52.1, 1992 NU Form 10-K, File No. 1-5324)\n10.30.2 Assignment of Leases, Rents and Profits, Security Agreement and Negative Pledge, dated as of April 14, 1992 among RRR, NUSCO and The Connecticut National Bank as Trustee, securing notes sold by RRR pursuant to April 14, 1992 Note Agreement. (Exhibit 10.52.2, 1992 NU Form 10-K, File No. 1-5324)\n10.31 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 1 decommissioning costs. (Exhibit 10.80, 1986 NU Form 10-K, File No. 1-5324)\n10.31.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.41.1, 1992 NU Form 10-K, File No. 1-5324)\nE-13\n10.32 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 2 decommissioning costs. (Exhibit 10.81, 1986 NU Form 10-K, File No. 1-5324)\n10.32.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.42.1, 1992 NU Form 10-K, File No. 1-5324)\n10.33 Master Trust Agreement dated as of April 23, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 3 decommissioning costs. (Exhibit 10.82, 1986 NU Form 10-K, File No. 1-5324)\n10.33.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.43.1, 1992 NU Form 10-K, File No. 1-5324)\n10.34 NU Executive Incentive Plan, effective as of January 1, 1991. (Exhibit 10.44, NU 1991 Form 10-K, File No. 1-5324)\n10.35 Supplemental Executive Retirement Plan for Officers of NU System Companies, Amended and Restated effective as of January 1, 1992. (Exhibit 10.45.1, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n* 10.35.1 Amendment 1 to Exhibit 10.35, effective as of August 1, 1993.\n* 10.35.2 Amendment 2 to Exhibit 10.35, effective as of January 1, 1994.\n10.36 Loan Agreement dated as of December 2, 1991, by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $175 million to an ESOP Trust. (Exhibit 10.46, NU 1991 Form 10-K, File No. 1-5324)\n* 10.36.1 First Amendment to Exhibit 10.36 dated February 7, 1992.\n10.36.2 Loan Agreement dated as of March 19, 1992 by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $75 million to the ESOP Trust. (Exhibit 10.49.1, 1992 NU Form 10-K, File No. 1-5324)\n* 10.36.3 Second Amendment to Exhibit 10.36 dated April 9, 1992.\n10.37 Management Succession Agreement. (Exhibit 10.47, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n10.38 Employment Agreement. (Exhibit 10.48, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n13 Annual Report to Security Holders (Each of the Annual Reports is filed only with the Form 10-K of that respective registrant.)\nE-14 * 13.1 Portions of the Annual Report to Security Holders of NU (pages 17 - 54) that have been incorporated by reference into this Form 10-K.\n13.2 Annual Report of CL&P.\n13.3 Annual Report of WMECO.\n13.4 Annual Report of PSNH.\n13.5 Annual Report of NAEC.\n21 Subsidiaries of the Registrant (Exhibit 22, 1992 NU Form 10-K, File 1-5324)\nE-15","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNU.\nIncorporated herein by reference are pages 5 through 12 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1994 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO and NAEC.\nAs of February 28, 1994, the Directors of CL&P, PSNH, WMECO and NAEC, beneficially owned the following number of shares of each class of equity securities of NU. No equity securities of CL&P, PSNH or WMECO are owned by the Directors and Executive Officers.\nCL&P, PSNH, WMECO, and NAEC DIRECTORS AND NAMED EXECUTIVE OFFICERS\nAmount and Nature of Title Of Name of Beneficial Percent of Class Beneficial Owner Ownership (1) Class (2)\nNU Common Robert G. Abair (3) (621) 4,271 shares NU Common Robert E. Busch (772) 6,054 shares NU Common John P. Cagnetta (4) (581) 3,979 shares NU Common John C. Collins (5) 0 shares NU Common William B. Ellis (6) (1,259) 14,837 shares NU Common Ted C. Feigenbaum(7) 151 shares NU Common Bernard M. Fox (8) (1,072) 17,428 shares NU Common William T. Frain, Jr. 885 shares NU Common Cheryl W. Grise (221) 1,349 shares NU Common John B. Keane (9) (368) 1,146 shares NU Common Francis L. Kinney (10) (303) 3,781 shares NU Common Gerald Letendre (5) 0 shares NU Common Hugh C. MacKenzie (4)(11) (779) 4,277 shares NU Common Jane E. Newman (5) 0 shares NU Common Dale F. Nitzschke (5) 0 shares NU Common John W. Noyes (658) 2,789 shares NU Common John F. Opeka (4)(12) (1,075) 16,463 shares NU Common Robert P. Wax (5) (651) 1,436 shares\nAmount beneficially owned by Directors and Executive Officers as a group - CL&P (7,709) 77,259 shares - PSNH (6,790) 69,299 shares - WMECO (7,709) 77,259 shares - NAEC (7,088) 73,139 shares\n(1) Unless otherwise noted, each Director and Executive Officer of CL&P, PSNH, WMECO and NAEC has sole voting and investment power with respect to the listed shares. The numbers in parentheses reflect the number of shares owned by each Director and Executive Officer under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan (401(k) Plan), as to which the Officer has no investment power.\n(2) As of February 28, 1994 there were 134,208,461 common shares of NU outstanding. The percentage of such shares beneficially owned by any Director or Executive Officer, or by all Directors and Executive Officers of CL&P, PSNH, WMECO and NAEC as a group, does not exceed one percent.\n(3) Mr. Abair is a Director of CL&P and WMECO only.\n(4) Mr. Opeka and Dr. Cagnetta are not officers of PSNH, but each in his capacity as an officer (with the stated title) of NUSCO, an affiliate of PSNH, performs policy-making functions for PSNH.\n(5) Messrs. Collins, Letendre, Nitzschke and Wax and Ms. Newman areDirectors of PSNH only.\n(6) Mr. Ellis shares voting and investment power with his wife for 1,117 shares.\n(7) Mr. Feigenbaum is a Director and an Executive Officer of NAEC only.\n(8) Mr. Fox shares voting and investment power with his wife for 3,031 of these shares. In addition, Mr. Fox's wife has sole voting and investment power for 140 shares, as to which Mr. Fox disclaims beneficial ownership.\n(9) Mr. Keane is a Director of CL&P, WMECO and NAEC only.\n(10) Mr. Kinney shares voting and investment power with his wife for 2,155 shares.\n(11) Mr. MacKenzie shares voting and investment power with his wife for 1,259 shares.\n(12) Mr. Opeka shares voting and investment power with his wife for 1,718 shares.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNU.\nIncorporated herein by reference is page 14 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1994 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO and NAEC.\nNo relationships or transactions that would be described in response to this item exist now or existed during 1993 with respect to CL&P, PSNH, WMECO and NAEC.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements:\nThe Report of Independent Public Accountants and financial statements of NU, CL&P, PSNH, WMECO, and NAEC are hereby incorporated by reference and made a part of this report (see \"Item 8. Financial Statements and Supplementary Data\").\nReports of Independent Public Accountants on Schedules S-1\nConsents of Independent Public Accountants S-3\n2. Schedules:\nFinancial Statement Schedules for NU (Parent), NU and Subsidiaries, CL&P, PSNH, WMECO, and NAEC are listed in the Index to Financial Statement Schedules S-5\n3. Exhibits Index E-1\n(b) Reports on Form 8-K:\nDuring the fourth quarter of 1993, the companies filed Form 8-Ks dated December 2, 1993 disclosing the following:\no On December 2, 1993, the Northeast Utilities system announced a reorganization of its corporate structure.\no On December 3, 1993, NNECO was informed by the NRC that it was being assessed a civil penalty in response to repair activities at Millstone 2.\nIn addition, the Form 8-K dated December 2, 1993 which was filed by PSNH also discussed the following:\no On June 8, 1992, PSNH changed its independent public accountant.\nNORTHEAST UTILITIES\nSIGNATURES\nPursuant 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.\nNORTHEAST UTILITIES ------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------------- William B. Ellis Chairman of the Board\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Trustee and Chairman \/s\/ William B. Ellis - -------------- of the Board ------------------------- William B. Ellis\nMarch 18, 1994 Trustee, President \/s\/ Bernard M. Fox - -------------- and Chief Executive ------------------------- Officer Bernard M. Fox\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President and Chief ------------------------- Financial Officer Robert E. Busch\nMarch 18, 1994 Vice President and \/s\/ John B. Keane - -------------- Treasurer ------------------------- John B. Keane\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller ------------------------- John W. Noyes\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Trustee \/s\/ Cotton Mather Cleveland - -------------- --------------------------- Cotton Mather Cleveland\nMarch 18, 1994 Trustee \/s\/ George David - -------------- --------------------------- George David\nMarch 18, 1994 Trustee \/s\/ Donald J. Donahue - -------------- --------------------------- Donald J. Donahue\nMarch 18, 1994 Trustee \/s\/ Eugene D. Jones - -------------- --------------------------- Eugene D. Jones\nMarch 18, 1994 Trustee \/s\/ Elizabeth T. Kennan - -------------- --------------------------- Elizabeth T. Kennan\nTrustee - -------------- --------------------------- Denham C. Lunt, Jr.\nMarch 18, 1994 Trustee \/s\/ William J. Pape II - -------------- --------------------------- William J. Pape II\nMarch 18, 1994 Trustee \/s\/ Robert E. Patricelli - -------------- --------------------------- Robert E. Patricelli\nTrustee - -------------- --------------------------- Norman C. Rasmussen\nTrustee - -------------- --------------------------- John F. Swope\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES\nPursuant 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.\nTHE CONNECTICUT LIGHT AND POWER COMPANY --------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman and \/s\/ Bernard M. Fox - -------------- Director -------------------------- Bernard M. Fox\nMarch 18, 1994 President and Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\n- ------------------- Director -------------------------- Robert G. Abair\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - ------------------- -------------------------- John P. Cagnetta\nMarch 18, 1994 Director \/s\/ William T. Frain, Jr. - ------------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - ------------------- ----------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - ------------------- ----------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ John F. Opeka - ------------------- ----------------------- John F. Opeka\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES\nPursuant 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.\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE --------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- ------------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman, Chief \/s\/ Bernard M. Fox - -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 18, 1994 President, Chief \/s\/ William T. Frain, Jr. - -------------- Operating Officer -------------------------- and Director William T. Frain, Jr.\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Director \/s\/ John C. Collins - ------------------- -------------------------- John C. Collins\nMarch 18, 1994 Director \/s\/ Gerald Letendre - ------------------- -------------------------- Gerald Letendre\nMarch 18, 1994 Director \/s\/ Hugh C. MacKenzie - ------------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Director \/s\/ Jane E. Newman - ------------------- -------------------------- Jane E. Newman\nMarch 18, 1994 Director \/s\/ Dale S. Nitzschke - ------------------- -------------------------- Dale S. Nitzschke\nMarch 18, 1994 Director \/s\/ Robert P. Wax - ------------------- -------------------------- Robert P. Wax\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant 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.\nWESTERN MASSACHUSETTS ELECTRIC COMPANY -------------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- -------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman and \/s\/ Bernard M. Fox - -------------- Director -------------------------- Bernard M. Fox\nMarch 18, 1994 President and Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Executive Vice \/s\/ Robert E. Busch - -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\n- ------------------- Director -------------------------- Robert G. Abair\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - ------------------- -------------------------- John P. Cagnetta\nMarch 18, 1994 Director \/s\/ William T. Frain, Jr. - ------------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - ------------------- ----------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - ------------------- ----------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ John F. Opeka - ------------------- ----------------------- John F. Opeka\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES\nPursuant 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.\nNORTH ATLANTIC ENERGY CORPORATION --------------------------------- (Registrant)\nDate: March 18, 1994 By \/s\/ William B. Ellis -------------- --------------------- William B. Ellis Chairman\nPursuant 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 and on the dates indicated.\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Chairman and Director \/s\/ William B. Ellis - -------------- -------------------------- William B. Ellis\nMarch 18, 1994 Vice Chairman, Chief \/s\/ Bernard M. Fox - -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 18, 1994 President, Chief \/s\/ Robert E. Busch - -------------- Operating Officer -------------------------- and Director Robert E. Busch\nMarch 18, 1994 Vice President and \/s\/ John W. Noyes - -------------- Controller -------------------------- John W. Noyes\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 18, 1994 Director \/s\/ John P. Cagnetta - -------------- -------------------------- John P. Cagnetta\n- -------------- Director -------------------------- Ted C. Feigenbaum\nMarch 18, 1994 Director \/s\/ William T. Frain. Jr. - -------------- -------------------------- William T. Frain, Jr.\nMarch 18, 1994 Director \/s\/ Cheryl W. Grise - -------------- -------------------------- Cheryl W. Grise\nMarch 18, 1994 Director \/s\/ John B. Keane - -------------- -------------------------- John B. Keane\nMarch 18, 1994 Director \/s\/ Hugh C. MacKenzie - -------------- -------------------------- Hugh C. MacKenzie\nMarch 18, 1994 Director \/s\/ John F. Opeka - -------------- -------------------------- John F. Opeka\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Northeast Utilities' annual report to shareholders and The Connecticut Light and Power Company's, Western Massachusetts Electric Company's, North Atlantic Energy Corporation's, and Public Service Company of New Hampshire's annual reports, incorporated by reference in this Form 10-K, and have issued our reports thereon dated February 18, 1994. Our reports on the financial statements include an explanatory paragraph with respect to the change in methods of accounting for property taxes, postretirement benefits other than pensions, income taxes, and employee stock ownership plans, as applicable to each company, as explained in Note 1 to the related company's financial statements. Our audits were made for the purpose of forming an opinion on each company's statements taken as a whole. The schedules listed in the index to financial statement schedules are the responsibility of each company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of each company's basic financial statements. The schedules have been subjected to the auditing procedures applied in the audits of each company's basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to each company's basic financial statements taken as a whole.\n\/s\/ ARTHUR ANDERSEN & CO.\nARTHUR ANDERSEN & CO.\nHartford, Connecticut February 18, 1994\nS-1\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES\nThe Board of Directors Public Service Company of New Hampshire:\nUnder date of February 7, 1992, we reported on the balance sheet and statement of capitalization of Public Service Company of New Hampshire as of December 31, 1991 (not presented in the 1993 annual report to stockholders) and the related statements of income, cash flows and common stock equity for the periods January 1, 1991 to May 15, 1991 and May 16, 1991 to December 31, 1991, as contained in the annual report to stockholders of Public Service Company for the year 1993. These financial statements and our report thereon are incorporated by reference herein. In connection with our audits of the aforementioned financial statements, we have also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsiblity is to express an opinion on these financial statement schedules based on our audit.\nIn our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nBoston, Massachusetts February 7, 1992\nS-2\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference of our reports in this Form 10-K, into previously filed Registration Statement No. 33-13444, No. 33-46291 , No. 33-59430, and No. 33-50853 of The Connecticut Light and Power Company, No. 33-34886, No. 33-51185 and No. 33-25619 of Western Massachusetts Electric Company, and No. 33-34622 and No. 33-40156 of Northeast Utilities.\n\/s\/ ARTHUR ANDERSEN & CO.\nARTHUR ANDERSEN & CO.\nHartford, Connecticut March 18, 1994\nS-3\nINDEPENDENT AUDITORS' CONSENT\nThe Board of Directors Public Service Company of New Hampshire:\nWe consent to the use of our reports included or incorporated by reference herein.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nBoston, Massaschusetts March 18, 1994\nS-4\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page - -------- ----\nIII. Financial Information of Registrant:\nNortheast Utilities (Parent) Balance Sheets 1993 and 1992 S-7\nNortheast Utilities (Parent) Statements of Income 1993, 1992, and 1991 S-8\nNortheast Utilities (Parent) Statements of Cash Flows 1993, 1992, and 1991 S-9\nV. Utility Plant 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-10 -- S-12 The Connecticut Light and Power Company S-13 -- S-15 Public Service Company of New Hampshire S-16 -- S-20 Western Massachusetts Electric Company S-21 -- S-23 North Atlantic Energy Corporation S-24 -- S-25\nV. Nuclear Fuel 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-26 -- S-28 The Connecticut Light and Power Company S-29 -- S-31 Public Service Company of New Hampshire S-32 -- S-36 Western Massachusetts Electric Company S-37 -- S-39 North Atlantic Energy Corporation S-40 -- S-41\nVI. Accumulated Provision for Depreciation of Utility Plant 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-42 -- S-44 The Connecticut Light and Power Company S-45 Public Service Company of New Hampshire S-46 -- S-48 Western Massachusetts Electric Company S-49 North Atlantic Energy Corporation S-50\nVIII. Valuation and Qualifying Accounts and Reserves 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-51 -- S-53 The Connecticut Light and Power Company S-54 -- S-56 Public Service Company of New Hampshire S-57 -- S-61 Western Massachusetts Electric Company S-62 -- S-64\nS-5\nSchedule Page - -------- ----\nIX. Short-Term Borrowings 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-65 The Connecticut Light and Power Company S-66 Public Service Company of New Hampshire S-67 Western Massachusetts Electric Company S-68 North Atlantic Energy Corporation S-69\nX. Supplementary Income Statement Information 1993, 1992, and 1991:\nNortheast Utilities and Subsidiaries S-70 The Connecticut Light and Power Company S-71 Public Service Company of New Hampshire S-72 Western Massachusetts Electric Company S-73 North Atlantic Energy Corporation S-74\nAll other schedules of the companies' for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted.\nS-6\nSCHEDULE III NORTHEAST UTILITIES (PARENT) ---------------------------- FINANCIAL INFORMATION OF REGISTRANT ----------------------------------- BALANCE SHEETS -------------- AT DECEMBER 31, 1993 AND 1992 ------------------------------ (Thousands of Dollars)\nS-7\nSCHEDULE III NORTHEAST UTILITIES (PARENT) ---------------------------- FINANCIAL INFORMATION OF REGISTRANT ----------------------------------- STATEMENTS OF INCOME -------------------- YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 --------------------------------------------- (Thousands of Dollars Except Share Information)\nS-8\nSCHEDULE III NORTHEAST UTILITIES (PARENT) FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 (Thousands of Dollars)\nS-9\nS-10\nS-11\nS-12\nS-13\nS-14\nS-15\nS-16\nS-17\nS-18\nS-19\nS-20\nS-21\nS-22\nS-23\nS-24\nS-25\nS-26\nS-27\nS-28\nS-29\nS-30\nS-31\nS-32\nS-33\nS-34\nS-35\nS-36\nS-37\nS-38\nS-39\nS-40\nS-41\nS-42\nS-43\nS-44\nS-45\nS-46\nS-47\nS-48\nS-49\nS-50\nS-51\nS-52\nS-53\nS-54\nS-55\nS-56\nS-57\nS-58\nS-59\nS-60\nS-61\nS-62\nS-63\nS-64\nS-65\nS-66\nS-67\nS-68\nS-69\nS-70\nS-71\nS-72\nS-73\nS-74\nEXHIBIT INDEX\nEach document described below is incorporated by reference to the files of the Securities and Exchange Commission, unless the reference to the document is marked as follows:\n* - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Reports on Form 10-K for CL&P, PSNH, WMECO and NAEC.\n# - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for CL&P.\n@ - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for PSNH.\n** - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 NU Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for WMECO.\n## - Filed with the 1993 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1993 Form 10-K, File No. 1-5324 into the 1993 Annual Report on Form 10-K for NAEC.\nExhibit Number Description\n3 Articles of Incorporation and By-Laws\n3.1 Northeast Utilities\n3.1.1 Declaration of Trust of NU, as amended through May 24, 1988. (Exhibit 3.1.1, 1988 NU Form 10-K, File No. 1-5324)\n3.2 The Connecticut Light and Power Company\n# 3.2.1 Certificate of Incorporation of CL&P, restated to March 22, 1994.\n# 3.2.2 By-laws of CL&P, as amended to March 1, 1982.\n3.3 Public Service Company of New Hampshire\n@ 3.3.1 Articles of Incorporation, as amended to May 16, 1991.\n@ 3.3.2 By-laws of PSNH, as amended to November 1, 1993.\n3.4 Western Massachusetts Electric Company\n3.4.1 Certificate of Organization of WMECO, as amended, to August 31, 1954. (Exhibit 3.1, File No. 2-11114)\n3.4.2 Amendments to Certificate of Organization of WMECO of May 19, 1966 and of December 5, 1967. (Exhibit 3.2, File No. 2-30534)\nE-1\n3.4.3 Articles of Amendment dated December 9, 1981. (Exhibit 3.1.2, 1981 WMECO Form 10-K, File No. 0-7624)\n3.4.4 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated December 16, 1981. (Exhibit 3.1.3, 1981 WMECO Form 10-K, File No. 0-7624)\n3.4.5 Articles of Amendment dated April 7, 1983. (Exhibit 3.3.5, 1983 NU Form 10-K, File No. 1-5324)\n3.4.6 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated April 12, 1983. (Exhibit 3.3.6, 1983 NU Form 10-K, File No. 1-5324)\n3.4.7 Articles of Amendment dated January 29, 1987. (Exhibit 3.3.7, 1986 NU Form 10-K, File No. 1-5324)\n3.4.8 Articles of Amendment dated February 11, 1987. (Exhibit 3.3.8, 1986 NU Form 10-K, File No. 1-5324)\n3.4.9 Articles of Amendment dated February 19, 1988. (Exhibit 3.3.9, 1987 NU Form 10-K, File No. 1-5324)\n3.4.10 Certificate of Vote of Directors Establishing a Series of a Class of Stock, dated February 23, 1988. (Exhibit 3.3.10, 1987 NU Form 10-K, File No. 1-5324)\n** 3.4.11 By-laws of WMECO, as amended to February 24, 1988.\n3.5 North Atlantic Energy Corporation\n## 3.5.1 Articles of Incorporation of NAEC dated September 20, 1991.\n## 3.5.2 Articles of Amendment dated October 16, 1991 and June 2, 1992 to Articles of Incorporation of NAEC.\n## 3.5.3 By-laws of NAEC, as amended to November 8, 1993.\n4 Instruments defining the rights of security holders, including indentures\n4.1 Northeast Utilities\n4.1.1 Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with respect to the issuance of Debt Securities. (Exhibit 4.1.1, 1991 NU Form 10-K, File No. 1-5324)\n4.1.2 First Supplemental Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with respect to the issuance of Series A Notes. (Exhibit 4.1.2, 1991 NU Form 10-K, File No. 1-5324)\n4.1.3 Second Supplemental Indenture dated as of March 1, 1992 between Northeast Utilities and IBJ Schroder Bank & Trust Company with respect to the issuance of 8.38% Amortizing Notes. (Exhibit 4.1.3, 1992 NU Form 10-K, File No. 1-5324)\nE-2 4.1.4 Warrant Agreement dated as of June 5, 1992 between Northeast Utilities and the Service Company. (Exhibit 4.1.4, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.1 Additional Warrant Agent Agreement dated as of June 5, 1992 between Northeast Utilities and State Street Bank and Trust Company. (Exhibit 4.1.4.1, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.2 Exchange and Disbursing Agent Agreement dated as of June 5, 1992 among Northeast Utilities, Public Service Company of New Hampshire and State Street Bank and Trust Company. (Exhibit 4.1.4.2, 1992 NU Form 10-K, File No. 1-5324)\n4.1.5 Credit Agreements among CL&P, NU, WMECO, NUSCO (as Agent) and 19 Commercial Banks dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.38, 1992 NU Form U5S, File No. 30-246)\n4.1.6 Credit Agreements among CL&P, WMECO, NU, Holyoke Water Power Company, RRR, NNECO and NUSCO (as Agent) dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.39, 1992 NU Form U5S, File No. 30-246)\n4.2 The Connecticut Light and Power Company\n4.2.1 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, Trustee, dated as of May 1, 1921. (Composite including all twenty-four amendments to May 1, 1967.) (Exhibit 4.1.1, 1989 NU Form 10-K, File No. 1-5324)\nSupplemental Indentures to the Composite May 1, 1921 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, dated as of:\n4.2.2 April 1, 1967. (Exhibit 4.16, File No. 2-60806)\n4.2.3 January 1, 1968. (Exhibit 4.18, File No. 2-60806)\n4.2.4 December 1, 1969. (Exhibit 4.20, File No. 2-60806)\n4.2.5 June 30, 1982. (Exhibit 4.33, File No. 2-79235)\n4.2.6 June 1, 1989. (Exhibit 4.1.24, 1989 NU Form 10-K, File No. 1-5324)\n4.2.7 September 1, 1989. (Exhibit 4.1.25, 1989 NU Form 10-K, File No. 1-5324)\n4.2.8 December 1, 1989. (Exhibit 4.1.26, 1989 NU Form 10-K, File No. 1-5324)\n4.2.9 April 1, 1992. (Exhibit 4.30, File No. 33-59430)\n4.2.10 July 1, 1992. (Exhibit 4.31, File No. 33-59430)\nE-3 4.2.11 October 1, 1992. (Exhibit 4.32, File No. 33-59430)\n4.2.12 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.13 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n# 4.2.14 December 1, 1993.\n# 4.2.15 February 1, 1994.\n# 4.2.16 February 1, 1994.\n4.2.17 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1986. (Exhibit C.1.47, 1986 NU Form U5S, File No. 30-246)\n4.2.18 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of October 1, 1988. (Exhibit C.1.55, 1988 NU Form U5S, File No. 30-246)\n4.2.19 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1989. (Exhibit C.1.39, 1989 NU Form U5S, File No. 30-246)\n4.2.20 Loan and Trust Agreement among Business Finance Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1992. (Exhibit C.2.33, 1992 NU Form U5S, File No. 30-246)\n# 4.2.21 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.22 Series B (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.23 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n# 4.2.24 Series B (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n4.3 Public Service Company of New Hampshire\n4.3.1 First Mortgage Indenture dated as of August 15, 1978 between PSNH and First Fidelity Bank, National Association, New Jersey, Trustee, (Composite including all amendments to May 16, 1991). (Exhibit 4.4.1, 1992 NU Form 10-K, File No. 1- 5324)\nE-4 4.3.1.1 Tenth Supplemental Indenture dated as of May 1, 1991 between PSNH and First Fidelity Bank, National Association. (Exhibit 4.1, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392).\n4.3.2 Revolving Credit Agreement dated as May 1, 1991. (Exhibit 4.12, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.3 Term Credit Agreement dated as of May 1, 1991. (Exhibit 4.11, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.4 Series A (Tax Exempt New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.2, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.5 Series B (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.3, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.6 Series C (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.4, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.7 Series D (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.5, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.7.1 First Supplement to Series D (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1992. (Exhibit 4.4.5.1, 1992 NU Form 10-K, File No. 1-5324)\n4.3.8 Series E (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.6, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n@ 4.3.8.1 First Supplement to Series E (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1993.\n@ 4.3.9 Series D (May 1, 1991 Taxable New Issue and December 1, 1992 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of October 1, 1992.\n@ 4.3.9.1 Amended and Restated Letter of Credit dated December 17, 1992.\n4.3.10 Series E (May 1, 1991 Taxable New Issue and December 1, 1993 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of May 1, 1991. (Exhibit 4.8, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\nE-5 @ 4.3.10.1 Amended and Restated Letter of Credit dated December 15, 1993.\n4.4 Western Massachusetts Electric Company\n** 4.4.1 First Mortgage Indenture and Deed of Trust between WMECO and Old Colony Trust Company, Trustee, dated as of August 1, 1954.\nSupplemental Indentures thereto dated as of:\n4.4.2 March 1, 1967. (Exhibit 2.5, File No. 2-68808)\n4.4.3 March 1, 1968. (Exhibit 2.6, File No. 2-68808)\n4.4.4 December 1, 1968. (Exhibit 2.7, File No. 2-68808)\n4.4.5 July 1, 1972. (Exhibit 2.9, File No. 2-68808)\n4.4.6 May 1, 1986. (Exhibit 4.3.18, 1986 NU Form 10-K, File No. 1-5324)\n4.4.7 December 1, 1988. (Exhibit 4.3.20, 1988 NU Form 10-K, File No. 1-5324.)\n4.4.8 September 1, 1990. (Exhibit 4.3.15, 1990 NU Form 10-K, File No. 1-5324.)\n4.4.9 December 1, 1992. (Exhibit 4.15, File No. 33-55772)\n4.4.10 January 1, 1993. (Exhibit 4.5.13, 1992 NU Form 10-K, File No. 1-5324)\n** 4.4.11 March 1, 1994.\n** 4.4.12 March 1, 1994.\n** 4.4.13 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and WMECO (Pollution Control Bonds) dated as of September 1, 1993.\n** 4.4.14 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993.\n4.5 North Atlantic Energy Corporation\n4.5.1 First Mortgage Indenture and Deed of Trust between NAEC and United States Trust Company of New York, Trustee, dated as of June 1, 1992. (Exhibit 4.6.1, 1992 NU Form 10-K, File No. 1-5324)\n4.5.2 Note Indenture dated as of May 15, 1991. (Exhibit 4.10, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\nE-6 4.5.3 First Supplemental Indenture dated as of June 5, 1992 between NAEC, PSNH and United States Trust Company of New York, Trustee. (Exhibit 4.6.3, 1992 NU Form 10-K, File No. 1-5324)\n10 Material Contracts\n10.1 Stockholder Agreement dated as of July 1, 1964 among the stockholders of Connecticut Yankee Atomic Power Company (CYAPC). (Exhibit 13.1, File No. 2-22958)\n10.2 Form of Power Contract dated as of July 1, 1964 between CYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 13.2, File No. 2-22958)\n10.2.1 Form of Additional Power Contract dated as of April 30, 1984, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.4, 1984 NU Form 10-K, File No. 1-5324)\n10.2.2 Form of 1987 Supplementary Power Contract dated as of April 1, 1987, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.6, 1987 NU Form 10-K, File No. 1-5324)\n10.3 Capital Funds Agreement dated as of September 1, 1964 between CYAPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 13.3, File No. 2-22958)\n#@** 10.4 Stockholder Agreement dated December 10, 1958 between Yankee Atomic Electric Company (YAEC) and CL&P, HELCO, PSNH and WMECO.\n10.5 Form of Amendment No. 3, dated as of April 1, 1985, to Power Contract between YAEC and each of CL&P, PSNH and WMECO, including a composite restatement of original Power Contract dated June 30, 1959 and Amendment No. 1 dated April 1, 1975 and Amendment No. 2 dated October 1, 1980. (Exhibit 10.5, 1988 NU Form 10-K, File No. 1-5324.)\n10.5.1 Form of Amendment No. 4 to Power Contract, dated May 6, 1988, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.1, 1989 NU Form 10-K, File No. 1-5324)\n10.5.2 Form of Amendment No. 5 to Power Contract, dated June 26, 1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.2, 1989 NU Form 10-K, File No. 1-5324)\n10.5.3 Form of Amendment No. 6 to Power Contract, dated July 1, 1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.3, 1989 NU Form 10-K, File No. 1-5324)\n#@** 10.5.4 Form of Amendment No. 7 to Power Contract, dated February 1, 1992, between YAEC and each of CL&P, PSNH and WMECO.\n10.6 Stockholder Agreement dated as of May 20, 1968 among stockholders of MYAPC. (Exhibit 4.15, File No. 2-30018)\n10.7 Form of Power Contract dated as of May 20, 1968 between MYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.14, File No. 2-30018)\nE-7 #@** 10.7.1 Form of Amendment No. 1 to Power Contract dated as of March 1, 1983 between MYAPC and each of CL&P, PSNH and WMECO.\n#@** 10.7.2 Form of Amendment No. 2 to Power Contract dated as of January 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.7.3 Form of Amendment No. 3 to Power Contract dated as of October 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.3, 1985 NU Form 10-K, File No. 1-5324)\n#@** 10.7.4 Form of Additional Power Contract dated as of February 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.8 Capital Funds Agreement dated as of May 20, 1968 between Maine Yankee Atomic Power Company (MYAPC) and CL&P, PSNH, HELCO and WMECO. (Exhibit 4.13, File No. 2-30018)\n10.8.1 Amendment No. 1 to Capital Funds Agreement, dated as of August 1, 1985, between MYAPC, CL&P, PSNH and WMECO. (Exhibit 10.6.1, 1985 NU Form 10-K, File No. 1-5324)\n10.9 Sponsor Agreement dated as of August 1, 1968 among the sponsors of VYNPC. (Exhibit 4.16, File No. 2-30285)\n10.10 Form of Power Contract dated as of February 1, 1968 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.18, File No. 2-30018)\n10.10.1 Form of Amendment to Power Contract dated as of June 1, 1972 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 5.22, File No. 2-47038)\n#@** 10.10.2 Form of Second Amendment to Power Contract dated as of April 15, 1983 between VYNPC and each of CL&P, PSNH and WMECO.\n10.10.3 Form of Third Amendment to Power Contract dated as of April 24, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.3, 1986 NU Form 10-K, File No. 1-5324)\n10.10.4 Form of Fourth Amendment to Power Contract dated as of June 1, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.4, 1986 NU Form 10-K, File No. 1-5324)\n10.10.5 Form of Fifth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.5, 1990 NU Form 10-K, File No. 1-5324)\n10.10.6 Form of Sixth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.6, 1990 NU Form 10-K, File No. 1-5324)\nE-8 10.10.7 Form of Seventh Amendment to Power Contract dated as of June 15, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.7, 1990 NU Form 10-K, File No. 1-5324)\n10.10.8 Form of Eighth Amendment to Power Contract dated as of December 1, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.8, 1990 NU Form 10-K, File No. 1-5324)\n#@** 10.10.9 Form of Additional Power Contract dated as of February 1, 1984 between VYNPC and each of CL&P, PSNH and WMECO.\n10.11 Capital Funds Agreement dated as of February 1, 1968 between Vermont Yankee Nuclear Power Corporation (VYNPC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.16, File No. 2-30018)\n10.11.1 Form of First Amendment to Capital Funds Agreement dated as of March 12, 1968 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.17, File No. 2-30018)\n#@** 10.11.2 Form of Second Amendment to Capital Funds Agreement dated as of September 1, 1993 between VYNPC and CL&P, HELCO, PSNH and WMECO.\n10.12 Amended and Restated Millstone Plant Agreement dated as of December 1, 1984 by and among CL&P, WMECO and Northeast Nuclear Energy Company (NNECO). (Exhibit 10.17, 1985 NU Form 10-K, File No. 1-5324)\n10.13 Sharing Agreement dated as of September 1, 1973 with respect to 1979 Connecticut nuclear generating unit (Millstone 3). (Exhibit 6.43, File No. 2-50142)\n10.13.1 Amendment dated August 1, 1974 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 5.45, File No. 2-52392)\n10.13.2 Amendment dated December 15, 1975 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 7.47, File No. 2-60806)\n10.13.3 Amendment dated April 1, 1986 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 10.17.3, 1990 NU Form 10-K, File No. 1-5324)\n10.14 Agreement dated July 19, 1990, among NAESCO and Seabrook Joint owners with respect to operation of Seabrook. (Exhibit 10.53, 1990 NU Form 10-K, File No. 1-5324)\n10.15 Sharing Agreement between CL&P, WMECO, HP&E, HWP and PSNH dated as of June 1, 1992. (Exhibit 10.17, 1992 NU Form 10- K, File No. 1-5324)\n10.16 Form of Seabrook Power Contract between PSNH and NAEC, as amended and restated. (Exhibit 10.45, NU 1992 Form 10-K, File No. 1-5324)\nE-9 10.17 Agreement for joint ownership, construction and operation of New Hampshire nuclear generating units dated as of May 1, 1973. (Exhibit 13-57, File No. 2-48966)\n10.17.1 Amendments to Exhibit 10.17 dated May 24, 1974, June 21, 1974 and September 25, 1974. (Exhibit 5.15, File No. 2-51999)\n10.17.2 Amendments to Exhibit 10.17 dated October 25, 1974 and January 31, 1975. (Exhibit 5.23, File No. 2-54646)\n10.17.3 Sixth Amendment to Exhibit 10.17 dated as of April 18, 1979. (Exhibit 5.4.3, File No. 2-64294)\n10.17.4 Seventh Amendment to Exhibit 10.17 dated as of April 18, 1979. (Exhibit 5.4.4, File No. 2-64294)\n10.17.5 Eighth Amendment to Exhibit 10.17 dated as of April 25, 1979. (Exhibit 5.4.5, File No. 2-64815)\n10.17.6 Ninth Amendment to Exhibit 10.17 dated as of June 8, 1979. (Exhibit 5.4.6, File No. 2-64815)\n10.17.7 Tenth Amendment to Exhibit 10.17 dated as of October 10, 1979. (Exhibit 5.4.2, File No. 2-66334)\n10.17.8 Eleventh Amendment to Exhibit 10.17 dated as of December 15, 1979. (Exhibit 5.4.8, File No. 2-66492)\n10.17.9 Twelfth Amendment to Exhibit 10.17 dated as of June 16, 1980. (Exhibit 5.4.9, File No. 2-68168)\n10.17.10 Thirteenth Amendment to Exhibit 10.17 dated as of December 31, 1980. (Exhibit 10.6, File No. 2-70579)\n* 10.17.11 Fourteenth Amendment to Exhibit 10.17 dated as of June 1, 1982.\n10.17.12 Fifteenth Amendment to Exhibit 10.17 dated as of April 27, 1984. (Exhibit 10.14.12, 1984 NU Form 10-K, File No. 1-5324)\n10.17.13 Sixteenth Amendment to Exhibit 10.17 dated as of June 15, 1984. (Exhibit 10.14.13, 1984 NU Form 10-K, File No. 1-5324)\n10.17.14 Seventeenth Amendment to Exhibit 10.17 dated as of March 8, 1985. (Exhibit 10.13.14, 1985 NU Form 10-K, File No. 1-5324)\n10.17.15 Eighteenth Amendment to Exhibit 10.17 dated as of March 14, 1986. (Exhibit 10.13.15, 1986 NU Form 10-K, File No. 1-5324)\n10.17.16 Nineteenth Amendment to Exhibit 10.17 dated as of May 1, 1986. (Exhibit 10.13.16, 1986 NU Form 10-K, File No. 1-5324)\nE-10 10.17.17 Twentieth Amendment to Exhibit 10.17 dated as of July 15, 1986. (Exhibit 10.13.17, 1986 NU Form 10-K, File No. 1-5324)\n10.17.18 Twenty-first Amendment to Exhibit 10.17 dated as of November 12, 1987. (Exhibit 10.13.18, 1987 NU Form 10-K, File No. 1-5324)\n10.17.19 Twenty-second Amendment to Exhibit 10.17 dated as of January 13, 1989. (Exhibit 10.13.19, 1989 NU Form 10-K, File No. 1-5324)\n10.17.20 Twenty-third Amendment to Exhibit 10.17 dated as of November 1, 1990. (Exhibit 10.13.20, 1990 NU Form 10- K, File No. 1-5324)\n10.17.21 Memorandum of Understanding dated November 7, 1988 between PSNH and Massachusetts Municipal Wholesale Electric Company (Exhibit 10.17, PSNH 1989 Form 10-K, File No. 1-6392)\n10.17.22 Agreement of Settlement among Joint Owners dated as of January 13, 1989. (Exhibit 10.13.21, 1988 NU Form 10- K, File No. 1-5324)\n10.17.22.1 Supplement to Settlement Agreement, dated as of February 7, 1989, between PSNH and Central Maine Power Company. (Exhibit 10.18.1, PSNH 1989 Form 10-K, File No. 1-6392)\n10.18 Amended and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1, 1990. (Exhibit 10.4.7, File No. 33-35312)\n10.18.1 Form of First Amendment to Exhibit 10.18. (Exhibit 10.4.8, File No. 33-35312)\n* 10.18.2 Form (Composite) of Second Amendment to Exhibit 10.18.\n10.19 Agreement dated November 1, 1974 for Joint Ownership, Construction and Operation of William F. Wyman Unit No. 4 among PSNH, Central Maine Power Company and other utilities. (Exhibit 5.16 , File No. 2-52900)\n10.19.1 Amendment to Exhibit 10.19 dated June 30, 1975. (Exhibit 5.48, File No. 2-55458)\n10.19.2 Amendment to Exhibit 10.19 dated as of August 16, 1976. (Exhibit 5.19, File No. 2-58251)\n10.19.3 Amendment to Exhibit 10.19 dated as of December 31, 1978. (Exhibit 5.10.3, File No. 2-64294)\n#** 10.20 Form of Service Contract dated as of July 1, 1966 between each of NU, CL&P and WMECO and the Service Company.\n10.20.1 Service Contract dated as of June 5, 1992 between PSNH and the Service Company. (Exhibit 10.12.4, 1992 NU Form 10-K, File No. 1-5324)\nE-11 10.20.2 Service Contract dated as of June 5, 1992 between NAEC and the Service Company. (Exhibit 10.12.5, 1992 NU Form 10-K, File No. 1-5324)\n* 10.20.3 Form of Annual Renewal of Service Contract.\n10.21 Memorandum of Understanding between CL&P, HELCO, Holyoke Power and Electric Company (HP&E), Holyoke Water Power Company (HWP) and WMECO dated as of June 1, 1970 with respect to pooling of generation and transmission. (Exhibit 13.32, File No. 2-38177)\n#** 10.21.1 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of February 2, 1982 with respect to pooling of generation and transmission.\n10.22 New England Power Pool Agreement effective as of November 1, 1971, as amended to November 1, 1988. (Exhibit 10.15, 1988 NU Form 10-K, File No. 1-5324.)\n10.22.1 Twenty-sixth Amendment to Exhibit 10.22 dated as of March 15, 1989. (Exhibit 10.15.1, 1990 NU Form 10-K, File No. 1-5324)\n10.22.2 Twenty-seventh Amendment to Exhibit 10.22 dated as of October 1, 1990. (Exhibit 10.15.2, 1991 NU Form 10-K, File No. 1-5324)\n10.22.3 Twenty-eighth Amendment to Exhibit 10.22 dated as of September 15, 1992. (Exhibit 10.18.3, 1992 NU Form 10-K, File No. 1-5324)\n* 10.22.4 Twenty-ninth Amendment to Exhibit 10.22 dated as of May 1, 1993.\n10.23 Agreements among New England Utilities with respect to the Hydro-Quebec interconnection projects. (See Exhibits 10(u) and 10(v); 10(w), 10(x), and 10(y), 1990 and 1988, respectively, Form 10-K of New England Electric System, File No. 1-3446.)\n10.24 Trust Agreement dated February 11, 1992, between State Street Bank and Trust Company of Connecticut, as Trustor, and Bankers Trust Company, as Trustee, and CL&P and WMECO, with respect to NBFT. (Exhibit 10.23, 1991 NU Form 10-K, File No. 1-5324)\n10.24.1 Nuclear Fuel Lease Agreement dated as of February 11, 1992, between Bankers Trust Company, Trustee, as Lessor, and CL&P and WMECO, as Lessees. (Exhibit 10.23.1, 1991 NU Form 10-K, File No. 1-5324)\n10.25 Simulator Financing Lease Agreement, dated as of February 1, 1985, by and between ComPlan and NNECO. (Exhibit 10.52, 1985 NU Form 10-K, File No. 1-5324)\nE-12 10.26 Simulator Financing Lease Agreement, dated as of May 2, 1985, by and between The Prudential Insurance Company of America and NNECO. (Exhibit 10.53, 1985 NU Form 10-K, File No. 1-5324)\n10.27 Lease dated as of April 14, 1992 between The Rocky River Realty Company (RRR) and Northeast Utilities Service Company (NUSCO) with respect to the Berlin, Connecticut headquarters (office lease). (Exhibit 10.29, 1992 NU Form 10-K, File No. 1-5324)\n10.27.1 Lease date as of April 14, 1992 between RRR and NUSCO with respect to the Berlin, Connecticut headquarters (project lease). (Exhibit 10.29.1, 1992 NU Form 10-K, File No. 1-5324)\n* 10.28 Millstone Technical Building Note Agreement dated as of December 21, 1993 between, by and between The Prudential Insurance Company of America and NNECO.\n10.29 Lease and Agreement, dated as of December 15, 1988, by and between WMECO and Bank of New England, N.A., with BNE Realty Leasing Corporation of North Carolina. (Exhibit 10.63, 1988 NU Form 10-K, File No. 1-5324.)\n10.30 Note Agreement dated April 14, 1992, by and between The Rocky River Realty Company (RRR) and Purchasers named therein (Connecticut General Life Insurance Company, Life Insurance Company of North America, INA Life Insurance Company of New York, Life Insurance Company of Georgia), with respect to RRR's sale of $15 million of guaranteed senior secured notes due 2007 and $28 million of guaranteed senior secured notes due 2017. (Exhibit 10.52, 1992 NU Form 10-K, File No. 1-5324)\n10.30.1 Note Guaranty dated April 14, 1992 by Northeast Utilities pursuant to Note Agreement dated April 14, 1992 between RRR and Note Purchasers, for the benefit of The Connecticut National Bank as Trustee, the Purchasers and the owners of the notes. (Exhibit 10.52.1, 1992 NU Form 10-K, File No. 1-5324)\n10.30.2 Assignment of Leases, Rents and Profits, Security Agreement and Negative Pledge, dated as of April 14, 1992 among RRR, NUSCO and The Connecticut National Bank as Trustee, securing notes sold by RRR pursuant to April 14, 1992 Note Agreement. (Exhibit 10.52.2, 1992 NU Form 10-K, File No. 1-5324)\n10.31 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 1 decommissioning costs. (Exhibit 10.80, 1986 NU Form 10-K, File No. 1-5324)\n10.31.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.41.1, 1992 NU Form 10-K, File No. 1-5324)\nE-13\n10.32 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 2 decommissioning costs. (Exhibit 10.81, 1986 NU Form 10-K, File No. 1-5324)\n10.32.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.42.1, 1992 NU Form 10-K, File No. 1-5324)\n10.33 Master Trust Agreement dated as of April 23, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 3 decommissioning costs. (Exhibit 10.82, 1986 NU Form 10-K, File No. 1-5324)\n10.33.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.43.1, 1992 NU Form 10-K, File No. 1-5324)\n10.34 NU Executive Incentive Plan, effective as of January 1, 1991. (Exhibit 10.44, NU 1991 Form 10-K, File No. 1-5324)\n10.35 Supplemental Executive Retirement Plan for Officers of NU System Companies, Amended and Restated effective as of January 1, 1992. (Exhibit 10.45.1, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n* 10.35.1 Amendment 1 to Exhibit 10.35, effective as of August 1, 1993.\n* 10.35.2 Amendment 2 to Exhibit 10.35, effective as of January 1, 1994.\n10.36 Loan Agreement dated as of December 2, 1991, by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $175 million to an ESOP Trust. (Exhibit 10.46, NU 1991 Form 10-K, File No. 1-5324)\n* 10.36.1 First Amendment to Exhibit 10.36 dated February 7, 1992.\n10.36.2 Loan Agreement dated as of March 19, 1992 by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $75 million to the ESOP Trust. (Exhibit 10.49.1, 1992 NU Form 10-K, File No. 1-5324)\n* 10.36.3 Second Amendment to Exhibit 10.36 dated April 9, 1992.\n10.37 Management Succession Agreement. (Exhibit 10.47, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n10.38 Employment Agreement. (Exhibit 10.48, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n13 Annual Report to Security Holders (Each of the Annual Reports is filed only with the Form 10-K of that respective registrant.)\nE-14 * 13.1 Portions of the Annual Report to Security Holders of NU (pages 17 - 54) that have been incorporated by reference into this Form 10-K.\n13.2 Annual Report of CL&P.\n13.3 Annual Report of WMECO.\n13.4 Annual Report of PSNH.\n13.5 Annual Report of NAEC.\n21 Subsidiaries of the Registrant (Exhibit 22, 1992 NU Form 10-K, File 1-5324)\nE-15","section_15":""}
{"filename":"822043_1993.txt","cik":"822043","year":"1993","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nMcClatchy Newspapers, Inc. and subsidiaries (the Company), originally incorporated in California in 1930 and reincorporated in Delaware on August 7, 1987, owns and publishes 20 newspapers in California, Washington, Alaska and South Carolina, ranging from large daily newspapers serving metropolitan areas to non-daily newspapers serving small communities. For the year ended December 31, 1993 the Company had average paid daily circulation of 815,000, Sunday 962,100 and nondaily circulation 31,700.\nEach of the Company's newspapers is semiautonomous in its business and editorial operations so as to meet most effectively the needs of the communities it serves. Publishers, editors and general managers of the newspapers make the day-to-day decisions and within limits are responsible for their own budgeting and planning. Policies on such matters as the amount and type of capital expenditures, key personnel changes, and strategic planning and operating budgets including wage and pricing matters, are approved or established by the Company's senior management or Board of Directors.\nThe Company's overall strategy is to concentrate on developing its newspapers and smaller related businesses. Each of its seven major daily newspapers has the largest circulation of any newspaper servicing its particular metropolitan area. The Company believes that this circulation advantage is of primary importance in attracting advertising, the principal source of revenues for the Company. Advertising revenues approximated 78% of consolidated revenues in both 1993 and 1992. Circulation revenues approximated 19% of consolidated revenues in 1993 and 18% in 1992.\nThe northern California economy, home to three of the Company's larger newspapers, slowed in 1991 and continues to be affected by the economic downturn, albeit not as severely as the downturn in the southern half of the state. The decline in the Company's combined linage was offset by increases in advertising rates resulting in advertising revenue growth of 1.3%. The Company continued to show growth in average paid circulation in 1993. See the following discussion of individual newspapers and Part II, Item 7 for further elaboration of the impact of these trends on the Company's business.\nThe Company's newspaper business is somewhat seasonal, with peak revenues and profits generally occurring in the second and fourth quarters of each year as a result of increased advertising activity during the Easter holiday and spring advertising season, and Thanksgiving and Christmas periods. The first quarter is historically the weakest quarter for revenues and profits.\nOther businesses owned by the Company include Legi-Tech, an on-line computer service which provides information to clients on legislative activity in the California and New York state legislatures and in the United States Congress and McClatchy Printing Co., a commercial printing operation, located in Clovis, California. In 1993 the Company expanded Big Valley, a previously West Coast based distributor of preprinted advertising inserts, to a national operation under a newly formed subsidiary, The Newspaper Network, Inc. Revenues, operating income and assets for each of these businesses are less than 10% of total consolidated revenues, operating income and assets of the Company. In addition, the Company is a partner (13.5% interest) in Ponderay Newsprint Company, a general partnership that constructed and now operates a newsprint mill in Washington state.\nThe Company also distributes information by electronic technology. The Company believes that individual newspapers, as primary information providers in their respective markets, will play a pivotal role in the potential growth of this segment in the industry.\nTHE SACRAMENTO BEE\nThe Sacramento Bee, the Company's largest newspaper, is a morning newspaper serving the California state capital and its metropolitan area. Based on the Company's records, The Sacramento Bee's average paid circulation was approximately 271,700 daily and 341,000 Sunday in 1993 compared to 266,900 daily and 337,900 Sunday in 1992.\nUntil October 1993 The Sacramento Bee's principal direct newspaper competitor was the Sacramento Union, a morning daily and Sunday newspaper. In October 1993 the Union became a thrice-weekly newspaper and in January 1994 ceased publications.\nThe suggested home delivery price for The Sacramento Bee is $10.75 per month. The newsstand price is $0.50 for the daily paper and $1.25 for the Sunday paper. As of December 31, 1993, approximately 86% of the daily and 79% of the Sunday circulation was home delivered.\nThe Sacramento Bee's advertising linage for the years ended December 31, 1993 and 1992 is set forth in the following table.\nNet revenues of The Sacramento Bee were $165,322,000 in 1993 and $168,486,000 in 1992.\nTHE FRESNO BEE\nThe Fresno Bee is a morning newspaper serving the Fresno, California metropolitan area. Based on the Company's records, The Fresno Bee's average paid circulation was approximately 149,900 daily and 186,800 Sunday compared to 146,800 daily and 183,100 Sunday in 1992.\nAmong the small newspapers which compete with The Fresno Bee is the Clovis Independent, a Company-owned weekly newspaper with about 4,000 circulation. As of December 31, 1993, approximately 89% of The Fresno Bee's daily and 85% of the Sunday circulation was home delivered. The suggested home delivery price is $10.50 per month. The newsstand price is $0.50 for the daily paper and $1.25 for the Sunday paper.\nThe Fresno Bee's advertising linage for the years ended December 31, 1993 and 1992 is set forth in the following table.\nNet revenues of The Fresno Bee were $79,072,000 in 1993 and $77,153,000 in 1992.\nTHE MODESTO BEE\nThe Modesto Bee is a morning newspaper serving the Modesto, California metropolitan area. Based on the Company's records, The Modesto Bee's average paid circulation was approximately 83,000 daily and 91,900 Sunday in 1993 compared to 82,500 daily and 91,700 Sunday in 1992.\nThe Modesto Bee competes with small daily and weekly newspapers in its market area. The suggested home delivery price is $10.50 per month. The newsstand price is $0.50 for the daily paper and $1.25 for the Sunday paper. As of December 31, 1993, approximately 89% of the daily and 86% of the Sunday circulation was home delivered.\nThe Modesto Bee's advertising linage for the years ended December 31, 1993 and 1992 is set forth in the following table.\nNet revenues of The Modesto Bee were $42,925,000 in 1993 and $43,662,000 in 1992.\nTHE NEWS TRIBUNE\nThe News Tribune, a morning newspaper, primarily serves the Tacoma, Washington metropolitan area. Based on the Company's records, the average paid circulation of the News Tribune was approximately 128,600 daily and 147,800 Sunday in 1993 compared to 126,900 daily and 144,500 Sunday in 1992.\nTacoma is approximately 30 miles south of Seattle. The News Tribune competes in the northern most fringes of its market with the major Seattle daily newspapers. Among the small newspapers which compete with The News Tribune is the Pierce County Herald a Company-owned twice-weekly newspaper with about 8,800 circulation. The suggested home delivery price of The News Tribune is $10.00 per month. The newsstand price of The News Tribune is $0.35 for the daily paper and $1.25 for the Sunday paper. As of December 31, 1993 approximately 83% of the daily and 81% of the Sunday circulation was home delivered.\nThe News Tribune's advertising linage for the years ended December 31, 1993 and 1992 is set forth in the following table.\nNet revenues of The News Tribune were $64,324,000 in 1993 and $61,647,000 in 1992.\nANCHORAGE DAILY NEWS\nThe Anchorage Daily News, a morning newspaper, is Alaska's largest newspaper. The Anchorage Daily News circulates throughout the state of Alaska but its primary circulation is concentrated in the south central region of the state comprised of metropolitan Anchorage, the Kenai Peninsula and the Matanuska-Susitna Valley.\nThe suggested home delivery price of the Anchorage Daily News is $9.50 per month for city delivery. The newsstand price of the Anchorage Daily News is $0.50 for the daily paper and $1.00 for the Sunday paper. As of December 31, 1993 approximately 72% of the daily and 63% of the Sunday circulation was home delivered.\nThe Anchorage Daily News' principal direct competitor was the Anchorage Times. In June 1992, the Anchorage Times ceased publication and the Company purchased certain of its operating assets. Based on the Company's records, the Daily News' average paid circulation was approximately 73,400 daily and 97,100 Sunday in 1993 compared to 72,000 daily and 94,900 Sunday in 1992.\nComparative amounts of linage for the years ended December 31, 1993 and 1992 are set forth in the following table.\nNet revenues of the Anchorage Daily News were $41,923,000 in 1993 and $36,648,000 in 1992.\nTRI-CITY HERALD\nThe Tri-City Herald is a morning newspaper serving the Tri-Cities of Richland, Kennewick and Pasco in southeastern Washington. Efforts to diversify the economic base of the area, which has depended in the past on energy development and agriculture, are having a positive impact in the Tri-Cities. The Tri-Cities economy benefitted in 1993 by the Department of Energy's efforts to clean up nuclear waste at nearby Hanford Nuclear reservation. Over the last several years the clean-up activity has contributed to revenue growth at the Tri-City Herald.\nBased on the Company's records, the Tri-City Herald's average paid circulation was approximately 38,600 daily and 41,900 Sunday in 1993 compared to 37,300 daily and 40,400 Sunday in 1992.\nThe suggested home delivery price of the Tri-City Herald is $9.50 per month while the newsstand price for its daily paper is $0.50 and the newsstand price for its Sunday paper is $1.25. As of December 31, 1993, approximately 92% of the daily and 90% of the Sunday circulation was home delivered.\nThe Tri-City Herald's advertising linage for the years ended December 31, 1993 and 1992 is set forth in the following table.\nNet revenues of the Tri-City Herald were $15,626,000 in 1993 and $14,089,000 in 1992.\nTHE (ROCK HILL) HERALD\nThe Herald is a morning newspaper serving Rock Hill and surrounding communities in York County, South Carolina. Rock Hill is a community approximately 25 miles southwest of Charlotte, North Carolina. The Herald's average paid circulation as reported by the Company was 31,000 daily and 30,700 Sunday in 1993 compared to 30,400 daily and 29,800 Sunday in 1992.\nThe Herald's main competitor is a zoned edition of the Charlotte Observer, whose circulation in the Herald's primary circulation area as reported by ABC was 10,752 daily and 13,894 Sunday as of March 31, 1993 compared to 11,049 daily and 13,955 Sunday as of March 31, 1992. The Herald also competes with the Yorkville Enquirer and the Clover Herald, weekly newspapers, and the Lake Wylie Magazine, a monthly magazine, all company-owned publications. The newsstand prices for the Herald are $0.25 daily and $0.75 Sunday and the suggested home delivery price is $7.50 per month. As of December 31, 1993, approximately 81% of the daily and 82% of the Sunday circulation was home delivered.\nAccording to the Herald's records, advertising linage for the years ended December 31, 1993 and 1992 were as follows:\nNet revenues of the Herald were $9,514,000 in 1993 and $8,723,000 in 1992.\nOTHER NEWSPAPERS\nDuring 1993 the Company published five small daily and eight nondaily community newspapers (including the previously mentioned weekly newspapers).\nThe (Ellensburg) Daily Record in Central Washington, was purchased in September 1992. The Daily Record is an evening newspaper, published Monday through Saturday, with about 5,500 paid circulation.\nThe other four daily newspapers include two in South Carolina, the Island Packet on Hilton Head Island and the Beaufort Gazette in Beaufort; and two in California, The Dispatch in Gilroy and the Free Lance in Hollister. Combined average daily circulation for these four newspapers according to Company records was 33,200 in 1993 compared to 32,300 in 1992. Average Sunday circulation at the two South Carolina newspapers was 24,900 in 1993 compared to 23,600 in 1992.\nThe eight nondaily newspapers are generally published weekly or twice-weekly. Four of the newspapers are located in California, three in South Carolina and one in Washington state. Combined average circulation for this group according to Company records was 31,700 at December 31, 1993.\nRAW MATERIALS\nIn 1993 the Company consumed approximately 137,000 metric tons of newsprint compared to 138,000 metric tons in 1992. The Company currently obtains its supply of newsprint from a number of suppliers, both foreign and domestic, under long-term contracts.\nNewsprint costs accounted for approximately 15.1% of operating expenses in 1993. Management believes its newsprint sources of supply under existing arrangements are adequate for its anticipated needs. Weak demand for newsprint resulting from lower newspaper advertising caused a weakening in newsprint prices in 1992 which persisted in 1993. A substantial increase in the price of newsprint would adversely affect the operating results of the Company to the extent that it was not offset by advertising and circulation volume and\/or rate increases.\nThe Company, through a wholly-owned subsidiary, Newsprint Ventures, Inc. and four other publishers and a Canadian newsprint manufacturer are partners in Ponderay Newsprint Company, a general partnership formed to construct and operate a newsprint mill located sixty miles northeast of Spokane, Washington. The mill became operational in late 1989 and has a production capacity in excess of 200,000 metric tons annually. The publisher partners have committed to take 126,000 metric tons of this anticipated production on a \"take-if-tendered\" basis with the balance to be sold on the open market. The Company's annual commitment is 28,400 metric tons. See Part II, Items 7 and 8 for further discussion of the impact of this investment on the Company's business.\nCOMPETITION\nThe Company faces competition for advertising revenues from television, radio and direct mail programs, suburban neighborhood and national newspapers and other publications. The Company's daily newspaper competitor in Sacramento, California, the Sacramento Union, ceased publication in January 1994. The Company's primary competitor in Anchorage, the Anchorage Times, ceased operations in June 1992. Competition for advertising is based upon circulation levels, readership demographics, price and advertiser results, while competition for circulation is generally based upon the content, journalistic quality and price of the newspaper. The Company's major daily newspapers are well ahead of their newspaper competitors in both advertising linage and general circulation in all of their markets.\nEMPLOYEES -- LABOR\nAs of December 31, 1993, the Company had 6,304 employees, of whom approximately 13% were represented by unions. Following the expiration of contracts with certain unions at The Sacramento Bee, The Fresno Bee and The Modesto Bee, negotiations between the newspapers and the affected unions (which represent approximately 10% of these newspapers' employees) reached an impasse. In early 1987, final offers were \"posted\" to the unions at the Sacramento and Fresno Bees. In 1990, a final offer to the union at The Modesto Bee was posted. It is under these posted conditions that such union employees have been working. Negotiations have been resumed with the unions at the Sacramento and Fresno Bees. At The News Tribune\nin Tacoma, Washington negotiations between the newspaper and one union representing about 6% of The News Tribune's employees reached an impasse and these employees are working under posted conditions.\nWhile the Company's newspapers have not had a strike since 1978 and they do not currently anticipate a strike occurring, the Company cannot preclude the possibility that a strike may occur at one or more of its newspapers. The Company believes that, in the event of a newspaper strike, the affected newspaper would be able to continue to publish and deliver to subscribers, a capability which is critical to retaining revenues from advertising and circulation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of the Company are located at 2100 \"Q\" Street, Sacramento, California. The general character, location and approximate size of the principal physical properties used by the Company at December 31, 1993, are set forth below.\nThe Company believes that its current facilities are adequate to meet the present and immediately foreseeable needs of its newspapers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company becomes involved from time to time in claims and lawsuits incidental to the ordinary course of its business, including such matters as libel, invasion of privacy and wrongful termination actions, and complaints alleging discrimination. In addition, the Company is involved from time to time in governmental and administrative proceedings concerning labor, environmental and other claims. Management believes that the outcome of pending claims or proceedings will not have a material adverse effect upon the Company's consolidated results of operations or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMcClatchy Newspapers, Inc. Class A Common Stock is listed on the New York Stock Exchange (NYSE symbol -- MNI). Class A stock is also traded on the Midwest Stock Exchange and the Pacific Stock Exchange. The Company's Class B stock is not publicly traded. The following table lists dividends paid on Common Stock and the prices of the Company's Class A Common Stock as reported by these exchanges for 1993 and 1992:\nThe Board of Directors does not anticipate reducing the present level of quarterly dividend payments. However, the payment and amount of future dividends remain within the discretion of the Company's Board of Directors and will depend upon the Company's future earnings, financial condition and requirements, and other factors considered relevant by the Board of Directors.\nThe number of record holders of Class A and Class B Common Stock at February 8, 1994 was approximately 1,337 and 24, respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR FINANCIAL SUMMARY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nResults for 1992 include a $2.6 million pre-tax change related to an early retirement program. This summary should be read in conjunction with the consolidated financial statements and notes thereto.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRECENT EVENTS\nThe recessionary economy of Northern California continued in 1993, resulting in a slowdown in advertising revenues at The Sacramento Bee and The Modesto Bee. Stronger revenue performances at The Fresno Bee, the Anchorage Daily News and newspapers in Washington state and South Carolina offset the lower revenues in Sacramento and Modesto. Net income also benefitted from continued low newsprint prices and cost controls.\nIn June 1992 the Anchorage Daily News became the sole metropolitan daily newspaper in Anchorage when the competing newspaper (the Anchorage Times) closed. As a result, revenues increased from $31.1 million in 1991 to $36.6 million in 1992, and $41.9 million in 1993, allowing the Daily News to become profitable for the first time under Company ownership in 1993.\nOn August 2, 1993 new federal tax laws raised the corporate income tax rate from 34% to 35% retroactive to January 1, 1993, and made other changes to the deductibility of certain expenses. The liability method of income tax accounting required that the Company revalue accumulated deferred taxes, and taxes on earnings through the first half of 1993 to reflect the higher rate. Accordingly, the Company increased its tax provision by $1,088,000 or four cents per share in the third quarter of 1993 for these retroactive adjustments.\nRESULTS OF OPERATIONS\n1993 COMPARED TO 1992\nNet income increased 6.6% to $31.8 million as strong performances at The Fresno Bee and newspapers in Washington and South Carolina offset weaker results at the Sacramento and Modesto Bees. Income also benefitted from improved operating results at the Anchorage Daily News since the closure of the Anchorage Times, stringent cost controls at all of the Company's newspapers and a second year of low newsprint prices.\nNet revenues increased 2.0% to $449.1 million compared to $440.2 million in 1992. Advertising rate increases at most of the Company's newspapers offset the impact of lower volumes resulting in a 1.3% increase in consolidated advertising revenues. While overall advertising volumes were down, gains were reported at The Fresno Bee, the Tri-City Herald and The (Rock Hill) Herald. In general, higher retail advertising linage was offset by declines in national and classified linage.\nAt the Company's seven largest daily newspapers, full run \"run-of-press\" (ROP) linage, which is found in the body of the newspaper and accounts for the majority of advertising revenues, declined 3.1%. Part-run ROP linage, found in zoned editions of the newspaper which are targeted to specific areas of a community, declined 4.6%. These declines were partially offset by gains in advertising in total market coverage products (delivered to nonsubscribers of the newspapers) of 18.5% and a 5.9% increase in the number of preprinted advertisements inserted into the daily newspapers. Advertising volume in McClatchy's 13 other newspapers increased 3.3%.\nCirculation revenue increased 4.2% as the combined number of daily and Sunday subscribers increased 1.9% and 1.8%, respectively (average paid circulation). With a slower economy impacting many of the Company's newspaper readers, most of McClatchy's metropolitan newspapers opted to forego circulation rate increases in 1993. The Anchorage Daily News and The (Rock Hill) Herald increased home-delivery rates modestly in April and September, respectively.\nOther revenues increased $985,000 or 6.9% due principally to an increase in commercial printing at McClatchy Printing Company in Clovis, California.\nOperating expenses were held to a 1.5% increase over 1992 and were up 2.2% after excluding a $2.6 million charge in 1992 for the early retirement program at the Sacramento and Modesto Bees. Excluding the early retirement charge, compensation costs increased 1.5% reflecting a 2.1% increase in salaries and a nominal decline in the cost of employee benefits. The increase in salaries generally reflects wage rate increases of 2% to 3%, partially offset by lower headcounts. Newsprint and supplements and other operating expenses increased 2.2%, and reflect low newsprint prices, generally low inflation and the impact of cost control programs at all of the Company's newspapers. Depreciation and amortization was up 6.0% due primarily to the installation of new mailroom equipment at The Sacramento Bee and presses at The (Tacoma) News Tribune.\nNonoperating expense declined $1.5 million primarily due to lower interest expense as the Company repaid its bank debt, and higher investment income on cash equivalents.\nThe Company's tax rate was 46.0% compared to 44.4% in 1992. The increase in this rate primarily relates to new federal tax legislation which raised the corporate tax rate from 34% to 35%, retroactive to January 1, 1993.\n1992 COMPARED TO 1991\nImproved operating results at the Anchorage Daily News and The News Tribune, lower newsprint prices and company-wide cost controls were the major contributors to a 25.7% increase in net income. The Daily News and The News Tribune led the Company in both revenue and operating income growth.\nNet revenues increased 3.1% to $440.2 million compared to $426.8 million in 1991. This growth reflects circulation and advertising rate increases, and, to a lesser extent, a rebound in subscriber and advertising volumes in the second half of 1992.\nAdvertising revenues were up 2.4% to $345.6 million. Advertising rates were increased at a number of the larger metropolitan dailies in the first quarter of 1992. The Anchorage Daily News implemented an additional advertising rate increase in August 1992 because of its significant growth in circulation after the Anchorage Times' closure.\nAdvertising volumes were generally flat for the year. Lower advertising linage in the California markets was offset by gains at other newspapers. At the Company's seven largest newspapers, full run ROP linage was even with 1991 levels. Gains in retail linage were offset by losses in classified and national advertising. Part run ROP linage grew 0.2% while linage in TMC products declined 11.1% at these newspapers. The number of preprinted inserts delivered in the seven largest newspapers grew 3.8%. Linage at McClatchy's 13 other newspapers declined 0.7%.\nThe Anchorage Daily News also led the Company in subscriber and circulation revenue growth. The Daily News' average daily paid circulation for the year ended December 31, 1992 grew to approximately 72,000 from 60,800 in 1991 and Sunday was 94,900 versus 81,600.\nCompany-wide, the number of subscribers grew 2.1% for average daily paid circulation (1.4% excluding The (Ellensburg) Daily Record purchased in 1992) and 1.8% on Sunday. Nondaily subscribers increased 3.1%. This growth in subscribers, coupled with selective home delivery and single-copy rate increases, resulted in a 7.4% gain in circulation revenues to $80.3 million.\nOperating expenses were held to a 0.2% increase over 1991 despite the recognition of a $2.6 million charge for an early retirement program. Excluding the early retirement charge, compensation costs were up 4.2%, reflecting a 3.6% increase in salaries and a 6.6% increase in fringe benefits. These increases reflect wage increases of 2% to 4% and higher retirement and other fringe benefits. Newsprint and supplements costs declined $15.1 million or 20.2% due mostly to lower newsprint prices precipitated by a lack of advertising demand. Depreciation and amortization was up 12.1% reflecting primarily a full year of depreciation on The Fresno Bee's expanded plant and new presses and amortization of intangibles purchased during the year. Other operating expenses were held to a 1.9% increase through company-wide cost control programs.\nWhile the Ponderay Newsprint Company continues to be one of the more efficient and low cost producers of newsprint, the Company's share of losses from this joint venture increased due to lower newsprint prices. Other nonoperating expenses declined because 1991 included an adjustment related to the destruction of a rental property.\nThe effective tax rate increased to 44.4% from 43.7% in 1991. A reconciliation of the effective tax rates is included in note 5 to the consolidated financial statements.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company generated $90.7 million of cash from operations in 1993 and has generated $228.5 million over the last three years. The principal uses of cash have been to repay bank debt incurred to purchase the South Carolina based newspapers and to invest in capital expenditures. Cash has also been used to fund its Ponderay newsprint mill investment and to pay dividends. With all bank debt now repaid, the Company has invested its excess cash in high quality commercial paper and government securities. At year end cash and cash equivalents totalled $42.3 million.\nWith the ongoing recession in Northern California, the Company deferred some of its planned capital expenditures in 1992 and 1993. Nonetheless, a total of $35.9 million was expended in 1993 for projects and equipment to improve productivity and keep pace with circulation growth. Capital expenditures over the last three years have totalled $106.9 million and planned expenditures in 1994 are estimated to be $38.3 million.\nThe Company has a 13.5% interest in the Ponderay Newsprint Company, a general partnership formed to construct and operate a newsprint mill near Spokane, Washington. The mill began operating in December 1989. The Company's share of the mill's operating losses over the last three years equaled $17.0 million. The Company contributed $12.4 million to fund its share of the mill's cash needs over this period. Ponderay is expected to incur losses over the next several years assuming newsprint prices remain depressed and the Company presently intends when necessary, to, contribute funds to help finance its share of these losses. See note 3 to the consolidated financial statements.\nDuring 1993 the Company terminated its bank line of credit and now has only an outstanding letter of credit for $5.9 million. Management is of the opinion that operating cash flow is adequate to meet the liquidity needs of the Company, including currently planned capital expenditures and other investments.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED BALANCE SHEET (IN THOUSANDS)\nASSETS\nSee notes to consolidated financial statements.\nLIABILITIES AND STOCKHOLDERS' EQUITY\nCONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nMcClatchy Newspapers, Inc. and its subsidiaries (\"the Company\") are engaged primarily in the publication of newspapers.\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany items and transactions have been eliminated.\nRevenue recognition -- Advertising revenues are recorded when the advertisement is placed in the newspaper and circulation revenues are recorded as newspapers are delivered over the subscription term. Unearned revenues represent prepaid circulation subscriptions.\nCash equivalents are highly liquid investments with maturities of three months or less when acquired.\nConcentrations of credit risks -- Financial instruments which potentially subject the Company to concentrations of credit risks are principally cash and cash equivalents and trade accounts receivables. Cash and cash equivalents are placed with various high-credit-quality institutions and are currently invested in the highest rated commercial paper and government securities. Accounts receivable are with customers located primarily in the immediate area of each city of publication. The Company routinely assesses the financial strength of significant customers and this assessment, combined with the large number and geographic diversity of its customers, limits the Company's concentration of risk with respect to trade accounts receivable.\nInventories are stated at the lower of cost (based principally on the last-in, first-out method) or current market value. If the first-in, first-out method of inventory accounting had been used, inventories would have increased by $1,460,000 at December 31, 1993 and $1,124,000 at December 31, 1992.\nProperty, plant and equipment are stated at cost. Major renewals and betterments, as well as interest incurred during construction, are capitalized. Such interest aggregated $5,000 in 1993, $376,000 in 1992 and $2,715,000 in 1991.\nDepreciation is computed generally on a straight-line basis over estimated useful lives of:\n- 10 to 60 years for buildings\n- 9 to 20 years for presses\n- 3 to 10 years for other equipment\nIntangibles consist of the unamortized excess of the cost of acquiring newspaper operations over the fair market values of the newspapers' tangible assets at the date of purchase. Identifiable intangible assets, consisting primarily of lists of advertisers and subscribers, covenants not to compete and commercial printing contracts, are amortized over periods ranging from three to twenty-five years. The excess of purchase prices over identifiable assets is amortized over forty years. Management periodically evaluates the recoverability of intangible assets by reviewing the current and projected profitability of its newspaper operations.\nDeferred income taxes result from temporary differences between amounts reported for financial and income tax reporting purposes. See note 2.\nEarnings per share are based upon the weighted average number of outstanding shares of common stock and common stock equivalents (stock options -- see note 10). Prior to 1992 shares issued excluded 750,000 Class B shares which were held in a trust in which the Company had a vested income and remainder interest. Upon the dissolution of the trust in 1992 the shares were returned to the Company and included in treasury stock at no cost. These shares have been excluded from weighted average shares outstanding for all periods.\n2. CUMULATIVE EFFECTS OF ACCOUNTING CHANGES\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". Under SFAS 109, deferred income tax assets and liabilities reflect the future tax consequences, based on enacted tax laws, of temporary differences between\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfinancial and tax reporting existing at the balance sheet date. The actual effects of tax law changes are recognized when enacted. Prior to SFAS 109, deferred income taxes were determined using tax rates in effect when differences relating to revenues and expenses arose between financial and tax reporting. The cumulative effect of this change reduced deferred tax liabilities and increased 1992 net income by $4,286,000 or $.15 per share. This change had no significant effect on the income tax provision for 1992, and when considered with the other change described below, did not have a material impact on net earnings in 1992.\nThe Company also adopted the provisions of SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1992. The Statement requires the accrual of postretirement health care and life insurance benefits over employees' service periods rather than expensing these costs on a pay-as-you-go basis. The cumulative effect of this change increased long-term obligations by $7,592,000, decreased deferred income tax liabilities by $2,965,000 and reduced 1992 net income by $4,627,000 or $.16 per share.\n3. INVESTMENT IN NEWSPRINT MILL PARTNERSHIP\nA wholly-owned subsidiary of the Company owns a 13.5% interest in Ponderay Newsprint Company (\"Ponderay\"), a general partnership formed to construct and operate a newsprint mill in the State of Washington. The Company guarantees $16,875,000 of bank debt provided by a consortium of 11 foreign and domestic banks to construct the mill.\nAt December 31, 1993, Ponderay borrowings bore interest at rates averaging 7.27%. The debt is due in quarterly installments through March 1, 2001 and is collateralized by the assets of Ponderay. The debt is subject to certain restrictive covenants regarding contractual obligations of Ponderay and its partners. The Company has committed to take 28,400 metric tons of annual production on a \"take-if-tendered\" basis until the debt is repaid. The Company purchased $12,079,000, $12,700,000 and $16,526,000 of newsprint from Ponderay in 1993, 1992 and 1991, respectively.\nSummarized financial data for the years ended December 31, 1993, 1992 and 1991 for Ponderay's operations are as follows (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM OBLIGATIONS\nLong-term obligations consist of (in thousands):\nLong-term obligations mature as follows (in thousands):\nThe Company's cash reserves and expected cash flows are sufficient for its near term needs. Accordingly, the Company terminated its bank credit agreement at the end of 1993. The Company has an outstanding letter of credit for $5,860,000.\nOther long-term obligations consist primarily of deferred compensation and supplemental retirement benefits.\n5. INCOME TAX PROVISIONS\nOn January 1, 1992 the Company adopted SFAS 109. The impact of this change is discussed in note 2.\nIncome tax provisions consist of (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDeferred income tax provisions result from (in thousands):\nThe effective tax rate and the statutory federal income tax rate are reconciled as follows:\nOn August 2, 1993 new federal tax legislation was enacted which, among other things, increased the federal corporate tax rate to 35% from 34%, retroactive to January 1, 1993. The liability method of accounting for taxes requires that the effect of this rate increase on current and cumulative deferred taxes be reflected in the period in which the law was enacted. Accordingly, the Company recorded an adjustment of $1,088,000 in the third quarter. Of this amount, $239,000 related to higher taxes on earnings through June 30, 1993 and $849,000 was required to revalue deferred taxes at January 1, 1993.\nThe components of deferred tax liabilities (benefits) recorded in the Company's Consolidated Balance Sheet on December 31, 1993 and 1992 are (in thousands):\nThe tax asset above for deferred compensation includes $2,965,000 in 1992 which was allocated to the cumulative effect of adopting a change in the method of accounting for postretirement benefits as discussed in note 2.\nSee note 9 for a discussion of tax assessments.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. INTANGIBLES\nIntangibles consist of (in thousands):\n7. EMPLOYEE BENEFITS\nEarly retirement charge:\nIn September 1992, the Sacramento and Modesto Bees made available an early retirement program to certain employees. The program ended in October 1992 with 66 employees accepting early retirement. Accordingly, the Company recorded a pretax charge of $2,593,000 in the fourth quarter of 1992.\nRetirement plans:\nThe Company has a defined benefit pension plan (the \"retirement plan\") for a majority of its employees. Benefits are based on years of service and compensation. Contributions to the plan are made by the Company in amounts deemed necessary to provide benefits. Plan assets consist primarily of investments in marketable securities including common stocks, bonds and U.S. government obligations, and other interest bearing accounts.\nThe Company also has a supplemental retirement plan to provide key employees with additional retirement benefits. The terms of the plan are generally the same as those of the retirement plan, except that the supplemental retirement plan is limited to key employees and benefits under it are reduced by benefits received under the retirement plan. The accrued pension obligation for the supplemental retirement plan is included in other long-term obligations.\nThe elements of pension costs are as follows (in thousands):\nAssumptions used for accounting for defined benefit plans were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe plans' funded status and amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1993 and 1992 are as follows (in thousands):\nIn 1992, the Company settled pension obligations for future benefits due to employees who retired prior to January 1, 1989 by converting pension assets totalling approximately $22,300,000 to purchased annuities. The Company recognized a pretax gain of $794,000 on the settlement of these obligations.\nThe Company has a Deferred Compensation and Investment Plan (401(k) plan) which enables qualified employees to voluntarily defer compensation. Company contributions to the 401(k) plan were $3,751,000 in 1993, $3,455,000 in 1992 and $2,987,000 in 1991.\nPOSTRETIREMENT BENEFITS:\nThe Company also provides or subsidizes certain retiree health care and life insurance benefits. On January 1, 1992 the Company began accruing the cost of these benefits over employee's service periods instead of recording them on a pay-as-you-go basis. The impact of this change is discussed in note 2.\nThe elements of postretirement expenses are as follows (in thousands):\nAssumptions used for accounting for postretirement benefits were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe plan's funded status and amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1993 and 1992 are as follows (in thousands):\nThe medical care cost trend rates are expected to decline to about 5.8% by the year 2003. A 1.0% increase in the assumed health care cost trend rate would have increased the APBO by 3.0%, the annual service cost by 13.0% and the annual interest cost by 4.0%.\n8. CASH FLOW INFORMATION\nCash provided or used by operations was affected by changes in certain current assets and liabilities, net of the effects of acquired newspaper operations, as follows (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. COMMITMENTS AND CONTINGENCIES\nSee note 3 for a discussion of the Company's commitments to Ponderay Newsprint Company.\nThe Company and its subsidiaries rent certain facilities and equipment under operating leases expiring at various dates through December 31, 1999. Total rental expense amounted to $1,618,000 in 1993, $1,596,000 in 1992 and $1,649,000 in 1991. Minimum rental commitments under operating leases with noncancelable terms in excess of one year are (in thousands):\nState and federal taxing authorities have audited the Company's tax returns for 1982-1987, and have made assessments or proposed adjustments primarily related to the deduction of certain intangible assets and deductions related to discontinued and other non-newspaper operations. The total amount of the proposed adjustments, including interest thereon, is approximately $25,000,000 at December 31, 1993. The Company is protesting the adjustments through the appropriate authorities. While this process is expected to extend over several years and additional assessments for like issues are expected to be forthcoming, the Company believes these adjustments will be reduced in the appeals processes. Pending final resolution of these matters, the Company has deposited, with the applicable tax authorities, a total of $12,592,000 to stop interest accrual on a portion of the adjustments and included this amount in other assets at December 31, 1993. In the opinion of management, adequate provision has been made for any taxes and interest resulting from these assessments and the ultimate outcome of these matters will not have a material adverse effect on the Company's consolidated results of operation or financial position.\nThere are libel and other legal actions that have arisen in the ordinary course of business and are pending against the Company. Management believes, after reviewing such actions with counsel, that the outcome of pending actions will not have a material adverse effect on the Company's consolidated results of operations or financial position.\n10. COMMON STOCK AND STOCK PLANS\nThe Company's Class A and Class B common stock participate equally in dividends. Holders of Class B common stock are entitled to one vote per share and to elect as a class 75% of the Board of Directors, rounded down to the nearest whole number. Holders of Class A common stock are entitled to one-tenth of a vote per share and to elect as a class 25% of the Board of Directors, rounded up to the nearest whole number. Class B common stock is convertible at the option of the holder into Class A common stock on a share-for-share basis.\nPrior to 1992, shares issued excluded 750,000 Class B shares which were held in a trust in which the Company had a vested income and remainder interest. Upon dissolution of the trust in 1992, the shares were returned to the Company and included in treasury stock.\nThe Company's Amended Employee Stock Purchase Plan (the \"Purchase Plan\") reserved 1,500,000 shares of Class A common stock for issuance to employees. Eligible employees may purchase shares at 85% of \"fair market value\" (as defined) through payroll deductions. The Purchase Plan can be automatically terminated by the Company at any time. As of December 31, 1993, 385,518 shares of Class A common stock have been issued under the Purchase Plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company's 1987 Stock Option Plan (the \"Employee Plan\"), as amended, reserved 600,000 shares of Class A common stock for issuance to key employees. Options are granted at the market price of the Class A common stock on the date of the grant. The options vest in installments over four years, and once vested are exercisable up to ten years from the date of award. Although the Plan permits the Company, at its sole discretion, to settle unexercised options by granting stock appreciation rights (SARS), the Company does not intend to avail itself of this alternative except in limited circumstances.\nIn July 1990, the Company adopted a stock option plan for outside (nonemployee) directors (the \"Directors' Plan\") providing for the issuance of up to 150,000 shares of Class A common stock. Under the Directors' Plan each outside director is granted an option at fair market value at the conclusion of each regular annual meeting of stockholders for 1,500 shares. Terms of the Directors' Plan are similar to the terms of the Employee Plan. Outstanding options are summarized as follows:\nIn the Employee Plan, there are 220,925 options exercisable as of December 31, 1993. In January 1994, the Company granted 104,500 options to employees using substantially all shares reserved in the plan. In the Directors' Plan 15,750 shares were exercisable at December 31, 1993 and 108,000 available for future awards.\nOn January 26, 1994 the Board of Directors adopted the 1994 Employee Stock Option Plan, subject to stockholder approval, reserving 650,000 Class A shares for issuance to key employees. The terms of this plan are substantially the same as the terms of the Employee Plan and no shares have been granted under the new plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe Company's business is somewhat seasonal, with peak revenues and profits generally occurring in the second and fourth quarters of each year as a result of increased advertising activity during the spring holiday and Christmas periods. The first quarter is historically the weakest quarter for revenues and profits. The Company's quarterly results are summarized as follows (in thousands, except per share amounts):\nSee notes 5 and 7 for discussions of charges recorded in the third quarter of 1993 and fourth quarter of 1992 for tax and early retirement expenses, respectively.\nINDEPENDENT AUDITOR'S REPORT\nMcClatchy Newspapers, Inc.:\nWe have audited the accompanying consolidated balance sheets of McClatchy Newspapers, Inc. and its subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a)(2). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of McClatchy Newspapers, Inc. and its subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in note 2 to the consolidated financial statements, in 1992 the Company changed its method of accounting for income taxes to conform to Statement of Financial Accounting Standards (SFAS) No. 109 and changed its method of accounting for postretirement health care and life insurance benefits to conform to SFAS No. 106.\nSacramento, California February 1, 1994\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nBiographical information for Class A Directors, Class B Directors and executive officers contained under the captions \"Nominees for Class A Directors\", \"Nominees for Class B Directors\" and \"Other Executive Officers\" under the heading \"Election of Directors\" in the definitive Proxy Statement for the Company's 1994 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained under the heading \"Compensation\" in the definitive Proxy Statement for the Company's 1994 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained under the heading \"Stock Ownership\" in the definitive Proxy Statement for the Company's 1994 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) Financial statements and independent auditor's report on pages 12 through 27.\nConsolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Cash Flows Consolidated Statement of Stockholders' Equity Notes to Consolidated Financial Statements Independent Auditor's Report\n(2) Financial statement schedules for the years ended December 31, 1993, 1992 and 1991 on pages 33 through 36. All schedules, other than those listed below, are omitted as not applicable under the rules of Regulation S-X:\nSchedule V, Property, plant and equipment Schedule VI, Accumulated depreciation of property, plant and equipment Schedule VIII, Valuation and qualifying accounts Schedule X, Supplementary income statement information\n(3) Exhibits\n(b) Reports on Form 8-K\nNot applicable.\nSIGNATURES\nPursuant 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 on March 1, 1994.\nMcCLATCHY NEWSPAPERS, INC.\nBy JAMES B. McCLATCHY* -------------------------------- James B. McClatchy Chairman of the Board\n*By: JAMES P. SMITH -------------------------------- (James P. Smith, Attorney-in-Fact)\nPursuant 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 and on the dates indicated.\nSCHEDULE V\nMCCLATCHY NEWSPAPERS, INC. AND SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\n- ---------------\n(1) Additions attributable to acquisitions including The (Ellensburg) Daily Record in September 1992.\nSCHEDULE VI\nMCCLATCHY NEWSPAPERS, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nSCHEDULE VIII\nMCCLATCHY NEWSPAPERS, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\n- ---------------\n(1) Amounts written off net of bad debt recoveries.\nSCHEDULE X\nMCCLATCHY NEWSPAPERS, INC. AND SUBSIDIARIES\nSUPPLEMENTAL INCOME STATEMENT INFORMATION\nFOR THE THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nINDEX OF EXHIBITS\n- ---------------\n* Incorporated by reference","section_15":""}
{"filename":"804752_1993.txt","cik":"804752","year":"1993","section_1":"Item 1. Business.\nForum Retirement Partners, L.P. (the \"Partnership\") was formed in 1986 to own retirement communities (\"RCs\") originally developed or acquired by Forum Group, Inc., (\"Forum Group\"), a corporation which is a substantial equity owner of the Partnership and the parent corporation of Forum Retirement, Inc., the general partner of the Partnership (the \"General Partner\").\nPartnership Recapitalization. On October 6, 1993, the Partnership entered into an agreement (the \"Recapitalization Agreement\") with Forum Group pursuant to which the Partnership issued 6.5 million depositary units representing limited partners' interests in the Partnership (\"Preferred Depositary Units\" or \"Units\") to a subsidiary of Forum Group (\"Forum A\/H\"), and Forum A\/H made a capital contribution to the Partnership of $13.0 million in the aggregate, or $2.00 per unit. The proceeds were used to prepay a portion of the Partnership's bank debt scheduled to mature on December 31, 1993 (the \"Bank Credit Facility\").\nOn December 28, 1993, the Partnership entered into a loan agreement with Nomura Asset Capital Corporation (\"Nomura\") pursuant to which Nomura provided approximately $50,700,000 in new financing (the \"Nomura Loan\"). The proceeds of the Nomura Loan were used to prepay the remaining balances due under the Bank Credit Facility and under the Partnership's split coupon first mortgage notes due July 1, 1996 (the \"Split Coupon Notes\"), to pay fees and expenses related to the financing and to fund reserves. The Nomura Loan is secured by first priority mortgages on the Partnership's nine RCs and by security interests in substantially all of the Partnership's other assets. For a description of the principal terms of the Nomura Loan, see Note (4) of Notes to Consolidated Financial Statements under Item 8.\nPursuant to the Recapitalization Agreement, and to afford holders of Preferred Depositary Units the opportunity to avoid the dilution resulting from the issuance of the Preferred Depositary Units to Forum A\/H, on January 10, 1994 the Partnership commenced a subscription offering pursuant to which holders of Preferred Depositary Units of record as of the close of business on October 18, 1993 (other than Forum Group and its affiliates) were permitted to purchase .07398342 of a Preferred Depositary Unit for each Preferred Depositary Unit held by them on October 18, 1993 at a purchase price of $2.00 per Unit. 1,994,189 Preferred Depositary Units were issued in the subscription offering, which expired on February 25, 1994. In accordance with the Recapitalization Agreement, the Partnership used the $3,988,398 of proceeds of the subscription offering to repurchase 1,994,189 Preferred Depositary Units from Forum A\/H at a purchase price of $2.00 per unit. Following the repurchase transaction, Forum Group beneficially owned 43.2% of the outstanding Units, including its 1.0% General Partner's interest.\nFor additional information relating to the 1993 recapitalization and subscription offering, see the disclosures contained under the following captions in the Subscription Offering Prospectus (which disclosures are incorporated herein by this reference): \"Prospectus Summary\" (at pp. 4-10), \"The Recapitalization\" (at pp. 16-18), \"Cash Distribution Policy\" (at pp. 23-24) and \"The Subscription Offering\" (at pp. 24-27).\nForum Group Reorganization and Recapitalization. On February 19, 1991, Forum Group and 12 of its affiliates (not including the Partnership or the General Partner) voluntarily commenced proceedings under chapter 11 of the United States Bankruptcy Code (the \"Reorganization Proceedings\") in the United States Bankruptcy Court for the Southern District of Indiana, Indianapolis Division (the \"Bankruptcy Court\"). In the course of the Reorganization Proceedings, Forum Group rejected the lease agreement (the \"Lincoln Heights Lease\") between Forum Retirement Operations, L.P., an affiliated operating partnership of the\nPartnership (\"Operations\"), as lessor, and Forum Group, as lessee, covering The Forum at Lincoln Heights, an RC in San Antonio, Texas (\"Forum\/Lincoln Heights\"). On February 5, 1993, the matter was settled pursuant to an agreement (the \"Settlement Agreement\") whereby (i) Operations received from Forum Group $125,000 and 63,612 shares of reorganized Forum Group's common stock, and (ii) Forum Group agreed to provide the Partnership certain general and administrative services for compensation in the amount of $180,000 per year.\nForum Group was recapitalized in June 1993 in a series of transactions pursuant to which an investor group (the \"FGI Investor Group\") obtained beneficial ownership of a majority of Forum Group's capital stock. Following the recapitalization of Forum Group, the Board of Directors of the General Partner was reconstituted. See \"Item 3 -- Legal Proceedings\" for a discussion of certain litigation challenging the constitution of the Board of Directors of the General Partner and the management agreement entered into in 1986 in connection with the formation of the Partnership.\nPursuant to agreements entered into in connection with Forum Group's 1993 recapitalization, on July 27, 1993, the FGI Investor Group offered to purchase all outstanding shares of Forum Group common stock for $3.62 per share. Pursuant to that offer, Operations tendered the shares of Forum Group common stock which it had received pursuant to the Settlement Agreement and received $230,275 therefor.\nThe Board of Directors of the General Partner intends to consider, among other alternatives, the possible expansion of certain of its existing RCs to add additional capacity on land already owned by the Partnership in an effort further to increase the Partnership's levels of operating income overall by adding capacity to existing facilities without having to incur substantial land acquisition and common area build-out costs. Preliminary evaluations indicate that it may be feasible from an engineering standpoint to add an aggregate of up to approximately 500 additional independent living, assisted living and nursing care units to existing RCs, yielding favorable returns to the Partnership. However, any major expansion or other capital improvement program could require that the Partnership obtain additional financing and would affect the Partnership's levels of distributable cash, if any. Furthermore, such expansions may require additional regulatory approvals and the modifications of the Nomura Loan. The Board of Directors also presently intends to consider other alternative applications of the Partnership's cash on hand and from operations (if any), including distributions to Unitholders, repurchases of Units, establishment of reserves, and other capital expenditures. There can be no assurance that the Partnership will adopt or be able successfully to implement any major expansion or other capital improvement program, as to the timing thereof or as to the effect thereof on the Partnership's financial position.\nSee \"Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Partnership (through an operating partnership) owns RCs in Delaware (4), Florida, New Mexico, South Carolina and Texas (2) (collectively, the \"Properties\"). All of the Properties are managed by Forum Group pursuant to a management agreement entered into in 1986 in connection with the formation of the Partnership under which Forum Group acts as manager (the \"Management Agreement\").\nExcept as described below, each Property contains an independent living component and a nursing component, and each Property except Millcroft, Myrtle Beach Manor and Shipley Manor also includes an assisted living component. One Property (Foulk Manor) consists of an assisted living component and a nursing component, and does not contain an independent living component.\nIndependent living components contain a variety of accommodations, together with amenities such as dining facilities, lounges, and game and craft rooms. All residents of the independent living components are provided security, meals,\nand housekeeping and linen service. Routine healthcare service is available upon demand 24 hours a day from an on-site nursing staff, and each independent living unit is equipped with an emergency call system. The independent living components of the Properties consist of apartments, villas and, in the case of Foulk Manor North, condominiums. Independent living unit residency fees presently range from $999 to $3,960 per month, depending on the size of accommodations. Each apartment and villa resident enters into a residency agreement that may be terminated by the resident on short notice. Although there can be no assurance that available independent living units will be reoccupied as residency agreements expire or are terminated, since 1988 at least 80% of the residents of the apartments and villas have renewed their residency agreements from year to year. All residents of the independent living components of the Properties are assured space in the assisted living (if any) and nursing components should the need therefor arise.\nNursing components provide residents a full range of nursing care. Residents have private or semiprivate rooms, and share communal dining and social facilities. In most instances, each resident of the independent living component of a Property is entitled to care in the assisted living (if any) or nursing component at no extra charge for up to a specific number of days annually or an aggregate of a specified number of days during the resident's lifetime. After utilizing this accrued time, the resident pays for both independent living occupancy, and assisted living or nursing care, until cancelling one or the other. The charge for a private nursing room presently ranges from $67 to $160 per day.\nAssisted living components provide residents a semistructured environment that encourages independent living. Residents have private or semiprivate suites, eat meals in a private dining room, and are provided the added services of scheduled activities, housekeeping and linen service, preventive health surveillance, periodic health monitoring, assistance with activities of daily living and emergency care. The charge for a private assisted living suite presently ranges from $46 to $125 per day.\nThe Properties provide ancillary healthcare services, including the operation of an adult day care center on the premises of one RC, and the placement of private duty registered nurses, licensed practical nurses and nursing technicians.\nThe following table indicates the name and location, current capacity, average occupancy rate for each of the last five years and average effective annual fees\/charges per unit\/suite\/bed for each of the last five years for each Property:\nMortgages\nThe Properties are subject to first mortgages securing outstandings under the Nomura Loan. The current principal amount outstanding under the Nomura Loan is approximately $50,700,000, and borrowings under the Nomura Loan bear interest at 9.93% per annum (assuming a servicing cost of 0.2% per annum). See Item 1, \"Business\", and Note 4 of Notes to Consolidated Financial Statements filed under Item 8 for additional information regarding the Nomura Loan.\nDepreciation\nThe following table indicates, with respect to each component of each Property upon which depreciation is taken, the federal tax basis, rate, method and life claimed with respect to such component for purposes of depreciation:\nReal Estate Taxes\nThe following table indicates, with respect to each Property, the assessed value, real estate tax rate and annual real estate taxes for 1993:\nSources of Payment\nThe independent and assisted living components (if any) of the Properties receive direct payment for resident occupancy solely on a private pay basis. The nursing components of the Properties receive payment for resident care directly on a private pay basis, including payment from private health insurance, and from governmental reimbursement programs such as the federal Medicare program for certain elderly and disabled residents, and state Medicaid programs for certain medically indigent residents. The following table indicates the approximate percentages of operating revenues for each of the last five years derived by the Partnership from private sources, and Medicare and Medicaid:\nIndependent and Assisted Living Components --------------- Source 1993 1992 1991 1990 1989 ------------ -------------------------------- Private 100% 100% 100% 100% 100% Medicare and Medicaid -0- -0- -0- -0- -0- -------------------------------- Total 100% 100% 100% 100% 100% ================================\nNursing Components ------------------ 1993 1992 1991 1990 1989 -------------------------------- Private 69% 72% 77% 73% 78% Medicare and Medicaid 31% 28% 23% 27% 22% -------------------------------- Total 100% 100% 100% 100% 100% ================================\nTotal RCs --------- 1993 1992 1991 1990 1989 -------------------------------- Private 85% 86% 89% 87% 91% Medicare and Medicaid 15% 14% 11% 13% 9% -------------------------------- Total 100% 100% 100% 100% 100% ================================\nMost private insurance carriers reimburse their policyholders, or make direct payment to facilities, for covered services at rates established by the facilities. Where applicable, the resident is responsible for any difference between the insurance proceeds and the total charges. In certain states, Blue Cross plans pay for covered services at rates negotiated with facilities. In other states, Blue Cross plans are administered under contracts with facilities providing for payment under formulae based on the cost of services. The Medicare program also makes payment under a cost-based reimbursement formula. Under the Medicaid program, each state is responsible for developing and administering its own reimbursement formula.\nWithin the statutory framework of the Medicare and Medicaid programs, there are substantial areas subject to administrative rulings, interpretations and discretion which affect payment made under those programs. In addition, the federal and state governments might reduce the funds available under those programs in the future or require more stringent utilization of healthcare facilities. Those measures could adversely affect the Partnership's future revenues and, therefore, the value of the Properties.\nAt any given time, there are numerous federal and state legislative proposals relating to the funding and reimbursement of healthcare costs. It is difficult to predict whether those proposals will be adopted or the form in which they might be adopted. In January, 1993, President Clinton established the Task Force on National Health Care Reform (the \"Task Force\"). The Task Force was charged with preparing health care reform legislation to be presented to Congress. Among the stated concerns considered by the Task Force were the means to control or reduce public and private spending on health care, to reform the payment methodology for healthcare goods and services by both the public (Medicare and Medicaid) and private sectors and to provide universal access to health care. The Task Force has presented its report and recommendations to the Administration, and the Administration has recently proposed legislation to Congress. The Partnership cannot predict the effect the Task\nForce's report and recommendations or the proposed legislation may have on its business, and no assurance can be given that any such report and recommendations or the proposed legislation will not have a material adverse effect on the Partnership. Various other legislative and industry groups are studying numerous healthcare issues, including access, delivery and financing of long-term health care, and at any given time there are numerous federal and state legislative proposals relating to the funding and reimbursement of healthcare costs. It is difficult to predict whether these proposals will be adopted or the form in which they might be adopted, and no assurance can be given that any such legislation, if adopted, would not have a material effect on the Partnership.\nRegulation and Other Factors\nHealthcare facility operations are subject to federal, state and local government regulations. Facilities are subject to periodic inspection by state licensing agencies to determine whether the standards necessary for continued licensure are maintained. In granting and renewing licenses, the state agencies consider, among other things, buildings, furniture and equipment; qualifications of administrative personnel and staff; quality of care; and compliance with laws and regulations relating to operation of facilities. State licensure of a nursing facility is a prerequisite to certification for participation in the Medicare and Medicaid programs. Requirements for licensure of assisted living components are generally less comprehensive and stringent than requirements for licensure of nursing facilities. Most states do not have licensure requirements for the independent living components of RCs. The Properties are presently in substantial compliance with all applicable federal, state and local regulations with respect to licensure requirements. However, because those requirements are subject to change, there can be no assurance that the Properties will be able to maintain their licenses upon a change in standards, and future changes in those standards could necessitate substantial expenditures by the Partnership to comply therewith.\nCompetition\nThe Properties compete with long-term healthcare facilities of varying similarity in the respective geographical market areas in which the Properties are located. Competing facilities are operated on a national, regional and local basis by religious groups and other nonprofit organizations, as well as by private operators, some of which have substantially greater resources than the Partnership. The independent living components of the Properties face competition from all the various types of residential opportunities available to the elderly. However, the number of RCs that offer on-premises healthcare services is limited. The assisted living and nursing components of the Properties compete with other assisted living and nursing facilities, and, to a lesser extent, with general hospitals. Because the target market segment of the Properties (i.e., full-service RCs) is relatively narrow, the risk of competition may be higher than with some other types of RCs. Additionally, the Properties may be subject to competition from new RCs, and assisted living and nursing facilities, developed in close proximity to them.\nSignificant competitive factors for attracting residents to the independent living components of the Properties include price, physical appearance, and amenities and services offered. Additional competitive factors for attracting residents to the assisted living and nursing components of the Properties include quality of care, reputation, physician and nursing services available, and family preferences. The Partnership believes that its RCs rate high in each of these categories, except that its RCs are generally more expensive than competing facilities. The assisted living and nursing components of the Properties are designed to supplement, not to compete with, healthcare services provided by general hospitals.\nInsurance\nThe Partnership maintains professional liability, comprehensive general liability and other typical insurance coverage on all its RCs. The Partnership believes that its insurance is adequate in amount and coverage.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOn January 24, 1994, the Russell F. Knapp Revokable Trust (the \"Plaintiff\"), filed a complaint (the \"Complaint\") in the United States District Court for the Northern District of Iowa against the General Partner alleging breach of the Partnership Agreement, breach of fiduciary duty, fraud and civil conspiracy. On March 17, 1994, the Plaintiff amended the Complaint, adding Forum Group as a defendant. The Complaint alleges, among other things, that the Plaintiff holds a substantial number of Units, that the Board of Directors of the General Partner is not comprised of a majority of independent directors, as required by the Partnership Agreement and as allegedly represented in the Partnership's 1986 Prospectus for its initial public offering and that the General Partner's Board of Directors has approved and\/or acquiesced in 8% management fees being charged by Forum Group under the Management Agreement. The Complaint further alleges that the \"industry standard\" for such fees is 4% thereby resulting in an \"overcharge\" to the Partnership estimated by the Plaintiff at $1.8 million per annum, beginning in 1994. The Plaintiff is seeking the restoration of certain former directors to the Board of Directors of the General Partner and the removal of certain other directors from that Board, an injunction prohibiting the payment of 8% management fees and unspecified compensatory and punitive damages.\nThe General Partner believes that the allegations in the Complaint are without merit and intends vigorously to defend against this litigation.\nPursuant to the Management Agreement, management fees payable to Forum Group for periods from the formation of the Partnership in 1986 to December 31, 1993 were deferred. Such deferred fees will become payable only if certain conditions occur. Under the terms of the Management Agreement entered into in connection with the formation of the Partnership in 1986, and as disclosed in the Partnership's 1986 Prospectus, Forum Group's management fees for periods after December 31, 1993 will not be deferred. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for further discussion of the Management Agreement.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted during 1993 to a vote of security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for Partnership's Common Equity and Related Stockholder Matters.\n(a) Market Information. The principal United States market in which Units are being traded is the American Stock Exchange (symbol:FRL).\nThe high and low sales prices for Units for each full quarterly period within the two most recent fiscal years, as reported in the consolidated transaction reporting system, were as follows:\n1993 HIGH LOW ---- ---- --- Quarter ended March 31, 1993 1 11\/16 Quarter ended June 30, 1993 2-1\/16 1 Quarter ended September 30, 1993 2 1-1\/8 Quarter ended December 31, 1993 3-1\/16 1-3\/4\n---- Quarter ended March 31, 1992 15\/16 3\/8 Quarter ended June 30, 1992 13\/16 3\/8 Quarter ended September 30, 1992 5\/8 5\/16 Quarter ended December 31, 1992 7\/8 1\/4\n(b) Holders. The approximate number of record holders of Units as of March 15, 1994, was 1,143.\n(c) Dividends. The Partnership has not made any distributions on Preferred Depositary Units for 1993, 1992 and 1991. However, with the continued improvements in the Partnership's operating results and the completion of the Recapitalization in the fourth quarter of 1993, the Partnership presently expects to have positive cash flow commencing in 1994. There necessarily can be no assurance that operating results will continue to improve or as to whether or when, or at what levels, any future cash distributions to holders of Units will be made. See \"Cash Distribution Policy\": (at pp. 23-24) in the Subscription Offering Prospectus (which disclosure is incorporated herein by this reference) for a discussion of the Partnership's cash distribution policy; and \"Item 1 -- Expansion of RCs\" for a discussion of possible cash needs for expansions of the Partnership's RCs.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations.\nIntroduction. At December 31, 1993, the Partnership owned nine RCs, all of which were managed by Forum Group. Operating revenues and operating income (operating revenues less operating expenses) for the year then ended, on a comparable RC basis, were $4,355,000 (11%) and $2,794,000 (32%), respectively, higher than 1992. Combined occupancy at December 31, 1993, was 94%, compared to 90% at December 31, 1992.\nThe year ended December 31, 1993 produced a net loss of $4,679,000 compared to a net loss of $6,112,000 for 1992. The loss for the year ended December 31, 1993 includes an extraordinary charge in the amount of $2,917,000 related to the early extinguishment of debt.\nOn March 26, 1992, the Partnership sold the business and substantially all of the assets of The Lafayette\/Philadelphia, an RC located in Philadelphia, Pennsylvania (\"The Lafayette\"), for $17,000,000. Approximately $16,000,000 of the proceeds were used to repay a portion of the indebtedness under the Partnership's then-outstanding Split Coupon Notes.\nThe Partnership has incurred net losses consistently since its formation in 1986. However, the Partnership's operating results improved substantially in 1993 compared to 1992. Excluding the effects of the sale of The Lafayette in the first quarter of 1992 and the effects of the write-off of deferred financing costs in connection with the Partnership's recapitalization on refinancing described below and certain other fees and expenses and reserves relating thereto, in 1993 the Partnership's RCs' operating revenues increased 11% over operating revenue for the comparable period in 1992 and the Partnership's net operating income (operating revenues less operating expenses) for 1993 was 32% higher than its net operating income for 1992.\nThe improvement in operating revenue was attributable both to improved occupancy rates for the Partnership's RCs during 1993\nand to increases in the amount of revenue generated per occupied unit. Average occupancy of the Properties for 1993 was 91.1% as compared to average occupancy of 85.9% for 1992, and average revenue per occupied unit for the same periods has improved from $26,052 to $27,156. Because many of the Partnership's operating expenses are fixed, a substantial portion of incremental revenues generated by improvements in occupancy are expected to flow- through to increase the Partnership's net operating income. In light of the large and growing segment of the U.S. population which is 75 years of age and older and the low levels of construction of new RCs and other competitive properties during the 1990's compared to the high levels of RC and other real estate construction and development in the 1980's, management of the Partnership presently expects the recent increases in occupancy levels and billing rates and, therefore, in net operating income, to be sustainable, although there necessarily can be no assurance with respect thereto.\nManagement of the Partnership is implementing various systems designed to control and, in some instances, decrease operating expenses. In addition, as discussed below, on December 28, 1993, the Partnership refinanced its long-term indebtedness on terms that reduce the Partnership's overall level of indebtedness and total required debt service payments during the term of the new loan. However, pursuant to the terms of the Management Agreement between the Partnership and Forum Group, management fees (based on the Partnership's gross operating revenues) payable to Forum Group for all periods from the formation of the Partnership in 1986 to December 31, 1993 have been deferred. Management fees payable for periods after December 31, 1993 will not be deferred.\nThe Partnership has not made any distributions on Preferred Depositary Units for 1993, 1992 and 1991. However, with the continued improvements in the Partnership's operating results and the completion of the Refinancing in the fourth quarter of 1993, the Partnership presently expects to have positive cash flow commencing in 1994. There necessarily can be no assurance that operating results will continue to improve or as to whether or when, or at what levels, any distributions will be made. As discussed above, the Board of Directors of the General Partner intends to consider the possible expansion of certain of its RCs as well as other alterations intended to increase the Partnership's levels of operating income. Implementation of this strategy may affect the Partnership's levels of distributable cash, if any. See \"Item 1 - Business\" for a discussion of alternative strategies which the Board of Directors of the General Partner intends to consider.\nOperating Revenues. Operating revenues for the year ended December 31, 1993 increased by $2,149,000 (5%) compared to operating revenues for 1992. Operating revenues for the year ended December 31, 1992 included $2,206,000 from the operation of The Lafayette. The remaining change (increase of $4,355,000) is primarily attributable to increases in occupancy, residency fees and charges.\nOperating revenues for the year ended December 31, 1992 decreased by $577,000 (1%) compared to operating revenues for 1991. Operating revenues for the year ended December 31, 1991, did not include $1,423,000 from the operation of Forum\/Lincoln Heights through April 30, 1991. Operating revenues for the years ended December 31, 1991, and December 31, 1992, included $8,440,000 and $2,206,000, respectively, from the operation of The Lafayette. After adjusting for these inter-period inconsistencies in the Partnership's RC portfolio by adding Forum\/Lincoln Heights' 1991 operating revenue and deleting The Lafayette's operating revenue for both 1991 and 1992, the remaining change (increase of $4,234,000) is primarily attributable to increases in occupancy, residency fees and charges.\nA change in the estimate of amounts reimbursable by third party payors from prior years resulted in the recognition of $379,000 of additional operating revenues in the year ended December 31, 1993.\nOperating Expenses. Operating expenses, including management fees and depreciation for the year ended December 31, 1993 decreased by $760,000 (2%) compared to 1992. Those expenses for the year ended December 31, 1992 included $2,286,000 from the operation of The Lafayette. The remaining change (increase of $1,526,000) is primarily attributable to increases in occupancy combined with normal inflationary increases in other operating expenses.\nOperating expenses, including management fees and depreciation, for the year ended December 31, 1992 decreased by $2,400,000 (6%) compared to operating expenses for 1991. For the year ended December 31, 1991, those expenses did not include $1,318,000 from the operation of Forum\/Lincoln Heights through April 30, 1991. Those expenses for the years ended December 31, 1991, and December 31, 1992, included $8,251,000 and $2,286,000, respectively, from the operation of The Lafayette. After adjusting for these inter-period inconsistencies in the Partnership's RC portfolio by adding Forum\/Lincoln Heights' 1991 operating expenses and deleting The Lafayette's operating expenses for both 1991 and 1992, the remaining change (increase of $2,049,000) is primarily attributable to increases in occupancy combined with normal inflationary increases in other operating expenses.\nPursuant to the terms of the Management Agreement as in effect since the Partnership's formation in 1986, management fees (based on the Partnership's gross operating revenues) payable to Forum Group for all periods prior to 1994 have been deferred. Such fees accruing after January 1, 1994 will not be deferred. The deferred management fees were expensed in the Partnership's statements of operations and reflected on a deferred basis in the Partnership's balance sheets for the relevant periods. Accordingly, except for variations in management fees payable resulting from variations in revenue levels, the commencement of the current payment of such fees for periods after January 1, 1994 will not affect the Partnership's operating or net income as compared to prior periods, although it will affect the Partnership's cash position.\nInterest Expense. Total interest expense for the year ended December 31, 1993 decreased by $1,404,000 compared to total interest expense for 1992, due principally to a reduction in the principal amount of long-term debt.\nTotal interest expense for the year ended December 31, 1992, decreased by $1,385,000 compared to total interest expense for 1991, due principally to (i) a reduction in long-term debt as a result of the sale of The Lafayette and (ii) lower interest rates during 1992.\nIncome Taxes. The Omnibus Budget Reconciliation Act of 1987 provides that certain publicly traded partnerships will be treated as corporations for federal income tax purposes. A grandfather provision delays corporate tax status until 1998 for publicly-traded partnerships in existence prior to December 18, 1987. On August 8, 1988, the General Partner was authorized by the limited partners to do all things deemed necessary or desirable to insure that the Partnership is not treated as a corporation for federal income tax purposes. Alternatives available to avoid corporate taxation after 1998 include: (i) selling or otherwise disposing of all or substantially all of the Partnership's assets pursuant to a plan of liquidation, (ii) converting the Partnership into a real estate investment trust or other type of legal entity, and (iii) restructuring the Partnership to qualify as a partnership primarily with passive rental income. While the Partnership presently intends to avoid being taxed as a corporation for federal income tax purposes, there can be no assurance that it will be successful.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Implementation of that Statement has not had a material effect on the Partnership.\nFinancial Condition\nRecapitalization. Pursuant to the Recapitalization Agreement, $13 million of additional equity was provided to the Partnership by a subsidiary of Forum Group which purchased 6.5 million Units at a price of $2.00 per Unit. That additional equity, together with the Nomura Loan (described below), allowed the Partnership to refinance its indebtedness.\nAs required by the Recapitalization Agreement, the Partnership made a subscription offering whereby Unitholders of record as of October 18, 1993 (other than Forum Group and its affiliates) had the right to acquire additional Units at $2.00 per Unit, the same price paid by the Forum Group subsidiary in order to avoid dilution to their ownership interests caused by the recapitalization. As a result of the subscription offering, subscriptions were received for 1,994,189 Units, the proceeds which were used to repurchase 1,994,189 Units from the Forum Group subsidiary at the same price paid by that subsidiary. Forum Group's percentage ownership in the Partnership is now approximately 43.2%, including the 1% General Partner's interest which it beneficially owns.\nLiquidity and Capital Resources. On December 28, 1993, the Partnership entered into a loan agreement with Nomura for $50,700,000 in new financing. The Nomura Loan bears interest at the rate of 9.93% per annum (assuming a 0.20% servicing fee), is amortized over a 20-year period and matures on January 1, 2001. The proceeds of the Nomura Loan were used to repay in full (i) the approximately $9.5 million remaining principal balance of the debt under the Bank Credit Facility, which would have matured on December 31, 1993 and (ii) approximately $34.1 million aggregate principal amount of the Split Coupon Notes, which would have matured June 30, 1996, and to pay related fees and expenses.\nAs discussed above, the discontinuation of the deferral of management fees commencing on January 1, 1994 will affect the Partnership's cash position. Deferred management fees are payable to Forum Group out of proceeds of sales and refinancings after making distributions of those proceeds in an amount sufficient (i) to meet limited partners' tax liabilities, (ii) to repay limited partners' capital contributions, and (iii) to pay a 12% cumulative, simple annual return on limited partners' unrecovered capital contributions. Deferred management fees become immediately due and payable in the event that the Management Agreement is terminated, which may occur under certain conditions, including if Forum Retirement, Inc. is removed as the General Partner of the Partnership and 80% in interest of the limited partners vote to terminate such agreement. The Partnership is unable to determine when or if deferred management fees will be paid.\nFor additional discussion of the Management Agreement, see. \"Management Agreement\" of the Subscription Offering Prospectus (at pp. 33-35).\nOperating activities provided $1,841,000 less cash during the year ended December 31, 1993 than during 1992. Normal operating activities provided $48,000 less $1,889,000 used to pay real estate taxes and accrued interest during December, 1993 in connection with the refinancing discussed above.\nInvesting activities provided $17,092,000 less cash during the year ended December 31, 1993 than during 1992, due principally to the sale of The Lafayette.\nFinancing activities used $15,908,000 less cash during the year ended December 31, 1993 than during 1992, due principally to the application of the net proceeds of the sale of The Lafayette to pay principal of the Split Coupon Notes.\nInflation. Management does not believe that inflation has had a material effect on net operating income. To the extent possible, increased costs are recovered through increased residency fees and charges. Marketing efforts are being continued to improve move-ins and overall occupancy rates.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe following consolidated financial statements are filed under this Item:\nPage(s)\nIndependent Auditors' Report..................................17 Consolidated Balance Sheets - December 31, 1993 and 1992.....18 Consolidated Statements of Operations - Years ended December 31, 1993, 1992 and 1991................19 Consolidated Statements of Partners' Equity - Years ended December 31, 1993, 1992 and 1991....20 Consolidated Statements of Cash Flows - Years ended December 31, 1993, 1992 and 1991................21 Notes to Consolidated Financial Statements...............22 - 26\nIndependent Auditors' Report - ----------------------------\nThe Partners Forum Retirement Partners, L.P.:\nWe have audited the accompanying consolidated balance sheets of Forum Retirement Partners, L.P. and subsidiary partnerships as of December 31, 1993 and 1992 and the related consolidated statements of operations, partners' equity and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Forum Retirement Partners, L.P. and subsidiary partnerships as of December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.\nKPMG Peat Marwick Indianapolis, Indiana February 1, 1994\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nConsolidated Balance Sheets December 31, 1993 and 1992 (in thousands)\nAssets 1993 1992 ------ ---- ---- Property and equipment: Land $ 14,572 14,501 Buildings 96,473 95,680 Furniture and equipment 7,739 7,393 ------- ------- 118,784 117,574 Less accumulated depreciation 20,519 17,163 ------- ------- Net property and equipment 98,265 100,411\nCash and cash equivalents 4,700 4,888 Accounts receivable, less allowance for doubtful accounts of $126 and $86 2,274 707 Amounts receivable from parent of general partner - 225 Restricted cash 1,719 1,893 Deferred financing costs, net of accumulated amortization of $2,186 in 1992 2,339 943 Other assets 1,183 700 ------- ------- $ 110,480 109,767 ======= ======= Liabilities and Partners' Equity -------------------------------- Long-term debt, including $773 and $24,975 due within one year 50,707 59,045 Accounts payable and accrued expenses 3,402 5,539 Amounts due to parent of general partner 638 1,286 Deferred management fees due to parent of general partner 15,780 12,264 Resident deposits 1,341 1,211 ------- ------- Total liabilities 71,868 79,345 ------- ------- General partner's equity in subsidiary partnerships 226 235 ------- ------- Partners' equity: General partner 490 409 Limited partners (15,285 and 8,785 units issued and outstanding) 37,896 29,778 ------- ------- Total partners' equity 38,386 30,187 ------- ------- $ 110,480 109,767 ======= ======= See accompanying Notes to Consolidated Financial Statements.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nConsolidated Statements of Operations Years ended December 31, 1993, 1992 and 1991 (in thousands except per unit amounts)\n1993 1992 1991 ---- ---- ---- Revenues: Operating revenues $ 43,797 41,648 42,225 Rental income from parent of general partner - - 588 Other income 379 302 288 ------ ------ ------ Total revenues 44,176 41,950 43,101 ------ ------ ------ Costs and expenses: Operating expenses 32,969 33,873 35,595 Management fees to parent of general partner 3,516 3,337 3,391 Depreciation 3,356 3,391 4,035 Interest, including amounts to parent of general partner of $50, $68 and $77 6,106 7,510 8,895 Reduction in carrying value of properties - - 14,850 ------ ------ ------ Total costs and expenses 45,947 48,111 66,766 ------ ------ ------ Loss before general partner's interest in loss of subsidiary partnerships and extraordinary charge 1,771 6,161 23,665\nGeneral partner's interest in loss of subsidiary partnerships 9 49 234 ------ ------ ------ Loss before extraordinary charge 1,762 6,112 23,431\nExtraordinary charge - early extinguishment of debt 2,917 - - ------ ------ ------ Net loss 4,679 6,112 23,431\nGeneral partner's interest in net loss 47 61 234 ------ ------ ------ Limited partners' interest in net loss $ 4,632 6,051 23,197 ====== ====== ====== Average number of units outstanding 10,317 8,785 8,785 ====== ====== ====== Loss per unit: Loss before extraordinary charge $ 0.17 0.69 2.64 Extraordinary charge 0.28 - - ---- ---- ---- Net loss $ 0.45 0.69 2.64 ==== ==== ====\nSee accompanying Notes to Consolidated Financial Statements.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nConsolidated Statements of Partners' Equity Years ended December 31, 1993, 1992 and 1991 (in thousands)\nGeneral Limited partner partners ------- -------- Balances at January 1, 1991 $ 704 59,026\nNet loss (234) (23,197) ----- ------- Balances at December 31, 1991 470 35,829\nNet loss (61) (6,051) ----- ------- Balances at December 31, 1992 409 29,778\nCapital contributions from issuance of 6,500 units, net of offering costs of $253 128 12,750\nNet loss (47) (4,632) ----- ------- Balances at December 31, 1993 $ 490 37,896 ===== =======\nAccumulated balances: Capital contributions 1,173 116,279 Offering expenses (3) (6,625) Cash distributions (255) (29,679) Accumulated losses (425) (42,079) ----- ------- Balances at December 31, 1993 $ 490 37,896 ===== =======\nSee accompanying Notes to Consolidated Financial Statements.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nConsolidated Statements of Cash Flows Years ended December 31, 1993, 1992 and 1991 (in thousands)\n1993 1992 1991 ---- ---- ---- Cash flows from operating activities: Net loss $ (4,679) (6,112)(23,431) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property and equipment 3,356 3,391 4,035 Amortization of deferred financing costs 479 339 517 Amortization of discount on long-term debt - 1,433 2,629 Extraordinary charge 2,917 - - Deferred management fees due to parent of general partner 3,516 3,337 3,391 Reduction in carrying value of properties - - 14,850 Accrued revenues and expenses, net (4,210) 1,125 1,929 Other 121 (172) (124) ------ ------ ------ Net cash provided by operating activities 1,500 3,341 3,796 ------ ------ ------ Cash flows from investing activities: Additions to property and equipment (1,210) (813) (1,232) Proceeds from sale of retirement community - 16,695 - ------ ------ ------ Net cash provided (used) by investing activities (1,210) 15,882 (1,232) ------ ------ ------ Cash flows from financing activities: Reduction of long-term debt (59,260)(17,134) (341) Proceeds from long-term debt 50,707 - 850 Yield maintenance premium and other expenses in connection with refinancing (2,602) - - Deferred financing costs (2,436) (95) (14) Capital contributions, net 12,939 - - Payment of deferred purchase price to parent of general partner - - (620) Cash distributions to partners - - (799) Net decrease (increase) in restricted cash 174 843 (550) ------ ------ ------ Net cash used by financing activities (478)(16,386) (1,474) ------ ------ ------ Net increase (decrease) in cash and cash equivalents (188) 2,837 1,090\nCash and cash equivalents at beginning of year 4,888 2,051 961 ------ ------ ------ Cash and cash equivalents at end of year $ 4,700 4,888 2,051 ====== ====== ====== See accompanying Notes to Consolidated Financial Statements.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nNotes to Consolidated Financial Statements December 31, 1993 and 1992\n(1)Summary of Significant Accounting Policies ------------------------------------------ Organization ------------ Forum Retirement Partners, L.P. and a subsidiary partnership (the \"Partnership\") own nine retirement communities (\"RCs\") which were acquired from Forum Group, Inc. (\"Forum Group\"). Forum Group was engaged to manage, and continues to manage, the RCs for the Partnership.\nThe general partner of the Partnership, a wholly owned subsidiary of Forum Group, receives 1% of all distributions of net cash flow until the limited partners receive cumulative distributions equal to a 12% cumulative annual return on the initial offering price. Thereafter, the general partner is to receive 30% of all distributions of net cash flow.\nOn February 19, 1991, Forum Group commenced reorganization proceedings under Chapter 11 of the United States Bankruptcy Code, and on April 2, 1992, Forum Group's plan of reorganization was confirmed by the Bankruptcy Court. In February 1993, the Partnership and Forum Group entered into a settlement agreement disposing of certain claims which arose during the reorganization proceedings. As part of that settlement, the Partnership received a cash payment of $125,000 and 63,612 shares of Forum Group common stock which were sold in August 1993 for $230,000, resulting in a gain of $130,000.\nTo facilitate the refinancing of its long-term debt, the Partnership and Forum Group entered into a Recapitalization Agreement (the \"Recapitalization Agreement\") in October 1993, which provided for, among other things, an immediate infusion of $13 million of equity into the Partnership by a wholly- owned subsidiary of Forum Group. The Partnership applied the $13 million of proceeds to the partial prepayment of the outstanding principal balance of the secured bank credit agreement that was to mature on December 31, 1993. In order to repay the remaining amount due on the secured bank credit agreement and other indebtedness of the Partnership, on December 28, 1993, the Partnership obtained $50.7 million in new mortgage financing (see note 4).\nIn order that the other limited partners' interests are not diluted as a result of the Recapitalization Agreement, in January 1994, the Partnership offered all of the other limited partners the right to purchase 0.74 of a Partnership unit for each unit owned on October 18, 1993, at $2.00 per unit. Proceeds from the exercise of these rights are to be used to repurchase units from the wholly owned subsidiary of Forum Group at $2.00 per unit.\nPrinciples of Consolidation --------------------------- The consolidated financial statements include the accounts of the Partnership and its affiliated operating partnership in which the Partnership has a 99% limited partner's interest. The effects of all significant intercompany accounts and transactions have been eliminated in consolidation.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nNotes to Consolidated Financial Statements\nProperty and Equipment ---------------------- Property and equipment are carried at cost. Depreciation is computed on the straight-line method at rates calculated to amortize the costs over the estimated useful lives of the related assets.\nDeferred Costs -------------- Costs incurred in connection with the initial occupancy of independent living components of RCs are amortized on the straight-line method over the first 12 months after opening the RC, the term of the initial independent living residents' contracts. Financing costs are amortized to interest expense on the straight-line method over the term of the related loan agreement.\nOperating Revenues ------------------ Routine service revenues are generated from monthly charges for independent living units and daily charges for assisted living suites and nursing beds, and are recognized monthly based on the terms of the residents' agreements. Advance payments received for services are deferred until the services are provided. Ancillary service revenues are generated on a \"fee for service\" basis for supplementary items requested by residents, and are recognized as the services are provided.\nOperating revenues include amounts estimated by management to be reimbursable by Medicare, Medicaid and other cost-based programs. Cost-based reimbursements are subject to audit by agencies administering the programs, and provisions are made for potential adjustments that may result. To the extent those provisions vary from settlements, revenues are charged or credited when the adjustments become final. A change in the estimate of amounts reimbursable by third party payors from prior years resulted in the recognition of $379,000 of additional operating revenues in the year ended December 31, 1993.\nRental income from leased RCs is recognized as income over the terms of the leases on the straight-line method.\nIncome Taxes ------------ As partnerships, the allocated share of income or loss for the year is includable in the income tax returns of the partners; accordingly, income taxes are not reflected in the accompanying consolidated financial statements.\nThe tax basis of the Partnership's property and equipment is approximately $11,000,000 less than the basis reported for financial statement purposes, primarily due to the carryover tax basis of the affiliated operating partnerships and differences in tax reporting methods.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nNotes to Consolidated Financial Statements\nPer Unit Data ------------- The net loss per unit is based on the limited partners' interest in the net loss divided by the average number of limited partner units outstanding.\n(2)Cash ---- Restricted cash includes required property, working capital and other reserves amounting to $612,000 and $855,000 at December 31, 1993 and 1992, respectively, and residents' deposits of $1,107,000 and $1,038,000 at December 31, 1993 and 1992, respectively.\nCash and cash equivalents include cash and highly liquid investments with a maturity of three months or less.\n(3)Reduction in Carrying Value of Properties ----------------------------------------- On March 26, 1992, the Partnership sold a RC to an unrelated third party for $17,000,000. Based on the expected sales proceeds, a reduction of $4,850,000 in carrying value of the property was recorded during 1991. Proceeds from the sale were used to prepay a portion of the split coupon mortgage notes (see note 4).\nDue to difficulties in real estate markets and related factors, the Partnership had not achieved the occupancy and revenue levels that were expected at several of its RCs and, accordingly, management believed that the carrying values of those RC's as of December 31, 1991 would not be recovered. Based on management's evaluation of market conditions at that time, a reduction in the carrying value of its properties of $10,000,000 was recorded as of December 31, 1991. The methodology used to estimate the ultimate recovery value of the properties was an income approach which estimated the annual operating cash flow at the end of a six-year holding period, after estimated annual capital expenditures of $100,000 per facility and management fees of 2% of gross revenues, based on the Partnership's 1992 and 1993 operating budgets. Estimates of annual revenue and expense increases thereafter ranged from 4.5% to 4.75% and 1% to 3.5%, respectively. Capitalization rates ranging from 9% to 11% were used to estimate the value of the properties at the end of the six-year period.\nThe method used for estimating property values requires sensitive assumptions regarding future operations and economic conditions. The inability to achieve the estimated operating cash flows used in estimating the property values could have a material effect on the ultimate recoverability of the property values. Based on its current expectations and operating budgets, management does not believe that an additional reduction in the carrying values of the RCs is necessary at December 31, 1993 or 1992. However, additional reductions in value may be necessary in the future if the cash flow assumptions are not achieved or market conditions decline.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nNotes to Consolidated Financial Statements\n(4)Long-term Debt -------------- Long-term debt at December 31 is summarized as follows:\n1993 1992 ---- ---- Mortgage loan $ 50,707,000 - Split coupon mortgage notes - 34,070,000 Bank credit facility - 24,975,000 ---------- ---------- $ 50,707,000 59,045,000 ========== ==========\nOn December 28, 1993, the Partnership entered into a new mortgage loan agreement and used the proceeds to retire the split coupon mortgage notes and the outstanding balance at that date of $9.5 million on the bank credit facility, and to pay the related fees, yield maintenance premium and expenses. The new loan requires monthly payments of principal (based on a 20-year amortization) and interest at 9.93% (assuming servicing costs of 0.20%) to maturity on January 1, 2001. The loan agreement prohibits prepayment for three years and requires payment of a yield maintenance premium, as defined, if prepaid thereafter. Additional principal payments are required if the debt service coverage ratio, as defined, is below specified levels. The loan is secured by all of the Partnership's RCs. Scheduled principal payments on the mortgage loan as of December 31, 1993, are $773,000 in 1994, $927,000 in 1995, $1,023,000 in 1996, $1,129,000 in 1997 and $1,247,000 in 1998.\nThe split coupon mortgage notes were repaid on December 28, 1993 and upon prepayment, these notes required payment of a yield maintenance premium of $2,142,000 which is included in extraordinary charge in the accompanying consolidated statements of operations. The split coupon mortgage notes, as restructured in March 1992, included prohibition of cash distributions and required the maintenance of cash escrow and reserve funds. Base interest rates ranged from 7.75% to 9.25%, payable monthly, and additional interest rates ranged from 2.25% to 3.00%, payable monthly from net operating cash flow for the previous month, as defined, or upon maturity on June 30, 1996, for an effective rate of 11.46%. Prior to this restructuring, the split coupon mortgage notes, which were issued with a principal amount of $51,000,000 at a discount, had an effective interest rate of 11.75%. Interest payments of $255,000 were due monthly at 6% per annum through July 1992, with principal and interest payments of $527,000 due monthly at 11.75% thereafter to maturity on July 1, 1996.\nThe outstanding principal balance under the bank credit facility was repaid and the agreement terminated on December 28, 1993. In March 1992, the maturity of the bank credit facility was extended to March 31, 1993. In March 1993, maturity was extended to December 31, 1993. Interest was payable quarterly through March 1993, and monthly thereafter, at the bank's reference rate plus 2%.\nAmounts due to parent of general partner include long-term debt of $632,000 and $848,000 at December 31, 1993 and 1992, respectively, with a blended interest rate of 7.2% and maturities in varying amounts through January 31, 2004.\nFORUM RETIREMENT PARTNERS, L.P. AND SUBSIDIARY PARTNERSHIPS\nNotes to Consolidated Financial Statements\nInterest paid during 1993, 1992 and 1991 totaled $5,872,000, $6,732,000 and $5,795,000, respectively.\n(5)Leases ------ The Partnership leased an RC to Forum Group under a net operating lease originally scheduled to expire on September 30, 1991. In conjunction with Forum Group's reorganization proceeding, on May 1, 1991, Forum Group rejected this lease, and the RC became subject to the management agreement (see note 6). Rental income under the lease totaled $588,000 in 1991. Through May 1, 1991, Forum Group was responsible for all operating expenses of the leased RC.\n(6)Commitments and Contingencies ----------------------------- In connection with the formation of the Partnership, the Partnership entered into a long-term management agreement with Forum Group which requires fees of 8% of gross operating revenues. Through December 31, 1993, the agreement provides for the deferral of payment of the fees if net cash flow is not adequate to make certain distributions to limited partners. Since cash flow has not been adequate to make the distributions, all management fees earned since formation of the Partnership have been deferred. The Partnership also reimbursed Forum Group for general and administrative costs incurred on behalf of the Partnership, which amounted to $180,000, $176,000 and $195,000 in 1993, 1992 and 1991, respectively.\nOn January 24, 1994, the Russell F. Knapp Revokable Trust (the \"Plaintiff\"), filed a complaint (the \"Complaint\") in the United States District Court for the Northern District of Iowa against the Partnership's general partner alleging breach of the partnership agreement, breach of fiduciary duty, fraud and civil conspiracy. The Complaint alleges, among other things, that the Plaintiff holds a substantial number of Units, that the Board of Directors of the general partner is not comprised of a majority of independent directors, as allegedly required by the partnership agreement and as represented in the 1986 Prospectus for the Partnership's initial public offering, and that the general partner's Board of Directors has approved and\/or acquiesced in 8% management fees being charged by Forum Group under the management agreement. The Complaint further alleges that the \"industry standard\" for such fees is 4% thereby resulting in an \"overcharge\" to the Partnership estimated by the Plaintiff at $1.8 million per annum, beginning in 1994. The Plaintiff is seeking the restoration of certain former directors to the Board of Directors of the general partner and the removal of certain other directors from that Board, an injunction prohibiting the payment of 8% management fees and unspecified compensatory and punitive damages. The general partner believes that the allegations in the Complaint are without merit and intends vigorously to defend against this litigation.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNo reportable change in or disagreement with accountants has taken place during the Partnership's two most recent fiscal years or any subsequent interim period.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership.\nThe following table lists the names and ages of all current directors and executive officers of the General Partner; all positions and offices with the General Partner held by each such person; each such person's term of office as a director or an executive officer, and the period during which he has served as such; and each such person's business experience for the past five years. The directors of the General Partner serve as such until their successors are elected. See \"Item 3 -- Legal Proceedings\" for a discussion of certain litigation challenging the constitution of the Board of Directors of the General Partner and the Management Agreement entered into in 1986 in connection with the formation of the Partnership. The executive officers of the General Partner serve at the pleasure of the Board of Directors of the General Partner.\nName, Principal Occupation Served and Business Experience Since Age ----------------------- ----- --- Directors:\nDonald J. McNamara 1993 40 Chairman of the Board and President of the General Partner; Chairman and Co-Chief Executive Officer of The Hampstead Group since 1988; director of La Quinta Motor Inns, Inc. since 1992.\nJohn F. Sexton 1993 61 Chairman, Evans-McKinsey Company, since 1993, theretofore Senior Vice President of Finance, Lomas Financial Corporation since prior to 1989; director of Turtle Creek National Bank since prior to 1989; director of Forecast Homes since 1992; director of American Hotels and Realty Corp. since prior to 1989.\nJames C. Leslie 1993 37 Executive Vice President - Financial Services and director of The Staubach Company since 1992 and director since prior to 1989; President and director of Wolverine Holding Company since prior to 1989.\nNon-Director Officers:\nPaul A. Shively 1986 51 Vice President, Treasurer and Chief Financial Officer of the General Partner; Senior Vice President, Treasurer and Chief Financial Officer of Forum Group since prior to 1989; director and Secretary of Capital Industries, Inc., since prior to 1989; director of Forum Group, 1988-1992.\nJohn H. Sharpe 1993 44 Secretary and General Counsel of the General Partner; Vice President, Secretary and General Counsel of Forum Group since 1992; formerly Assistant General Counsel of Forum Group since prior to 1989.\nOn March 9, 1993 David K. Easlick and John R. Wood resigned as directors of the General Partner and Donald D. Gilligan, Everett A. Sisson and Kenneth P. Williamson joined the board of directors of the General Partner. Following the recapitalization of Forum Group, Messrs. Gilligan, Shively, Sisson and Williamson resigned as directors and Messrs. McNamara, Sexton and Harry J. Kloosterman became directors. James C. Leslie and John W. Kneen became directors on August 4, 1993. Messrs. Kloosterman and Kneen resigned as directors on September 7, 1993. See Item 3 of Part I for a discussion of certain litigation challenging the constitution of the Board of Directors of the General Partner.\nItem 11.","section_11":"Item 11. Executive Compensation.\nNo cash compensation is paid to any officer of the General Partner for services rendered in any capacity to the Partnership and its affiliated operating partnerships.\nEach independent director of the General Partner is compensated for all services as a director at the rate of $18,000 per year, payable quarterly in advance, plus $1,500 for each board or committee meeting attended in person and $1,000 per meeting attended telephonically. Each other director of the General Partner is compensated for all services as a director at the rate of $15,000 per year, payable quarterly in advance.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) Security Ownership of Certain Beneficial Owners. The following table shows the numbers and percentages of Units owned beneficially on March 15, 1994, by any person known to the Partnership to be the beneficial owner of more than 5% of the issued and outstanding Units. Each person has sole voting and investment power as to the Units beneficially owned by that person.\nUnits ----- Amount and Name and Nature of Percent Address of Beneficial of Beneficial Owner Ownership Total ---------------- ---------- -------\nForum Group, Inc. 6,446,079 42.2% 8900 Keystone Crossing, Suite 200 Post Office Box 40498 Indianapolis, Indiana 46240-0498\nHatton Hall Associates 824,670* 5.4% 9560 Wilshire Boulevard, Suite 301 Beverly Hills, California\n* This information is based upon the most recent Statement on Schedule 13D received by the Partnership from Hatton Hall Associates. However, the Partnership has received reports of the results of the subscription offering indicating that, following the exercise of its subscription rights, Hatton Hall Associates owned 1,150,068 Units or 7.52% of Units outstanding as of March 11, 1994.\nIn an affidavit dated March 17, 1994, Russell K. Knapp stated that, as of March 1, 1994 the \"Knapp Family\" owned 846,000 Units. That amount equals 5.06% of the 15,285,248 Units outstanding as of March 11, 1994. The most recent Statement on Schedule 13D received by the Partnership from the Russell F. Knapp Family Group (Post Office Box 1326, Cedar Rapids, Iowa 52046), which was filed on or about April 13, 1993, reported that as of March 31, 1993 the Russell F. Knapp Family Group owned 444,568 Units. The Partnership does not presently know the actual level of beneficial ownership of the Partnership of Mr. Knapp or, if applicable, any group of which he is a member.\nNone of the directors or officers of the General Partner beneficially owns any Units, except insofar as they may be deemed beneficially to own Units owned by Forum or its affiliates.\nChanges in Control. There are no arrangements, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership. See \"Item 1 -- Business\" in respect to the acquisition of majority ownership in Forum Group by the Investor Group and related transactions.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nApart from (i) the transactions contemplated by the Management Agreement, (ii) the reimbursement of Forum Group for direct expenses incurred on behalf of the Partnership and office expenses, salaries, compensation expenses, administrative expenses and other expenses necessary or appropriate to the conduct of the business of, and allocable to, the Partnership pursuant to the Settlement Agreement (totalling $180,000 for the Partnership's last fiscal year), (iii) the Recapitalization Agreement and the transactions contemplated thereby, including the reimbursement of Forum Group for certain fees and expenses incurred with respect to the Recapitalization Agreement (totalling $131,952), there is no transaction, or series of similar transactions, since the beginning of the Partnership's last fiscal year, or any currently proposed transaction, or series of similar transactions, to which the Partnership or any of its affiliated operating partnerships was or is to be party, in which the amount involved exceeds $60,000 and in which (i) any director or executive officer of the General Partner or Forum\nGroup, (ii) any nominee for election as a director of the General Partner or Forum Group, (iii) any security holder known to the registrant to own of record or beneficially more than 5% of any class of the registrant's voting securities, or (iv) any member of the immediate family of any of the foregoing persons, had, or will have, a direct or indirect material interest. At December 31, 1993, deferred management fees due Forum Group under the Management Agreement totalled approximately $15,780,000. See Item 1 - \"Partnership Recapitalization: and Item 7 of Part I of this Report for a discussion of the Management Agreement between the Partnership and Forum Group.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) Documents Filed as Part of Report. The following documents are filed as a part of this report:\n1. Financial statements:\nThe following consolidated financial statements of the Partnership and its affiliated operating partnerships are filed under Item 8 of this report:\nPage(s) ------- Independent Auditors' Report..............................17 Consolidated Balance Sheets - December 31, 1993 and 1992....................................................18 Consolidated Statements of Operations Years ended December 31, 1993, 1992 and 1991............19 Consolidated Statements of Partners' Equity - Years ended December 31, 1993, 1992 and 1991...20 Consolidated Statements of Cash Flows - Years ended December 31, 1993, 1992 and 1991............21 Notes to Consolidated Financial Statements...........22 - 26\n2. Financial statement schedules:\nThe following other financial statements and financial statement schedules are filed pursuant to this item:\nPage(s) ------- Independent Auditors' Report.............................F-1 Schedule V - Property, Plant and Equipment...............F-2 Schedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment......F-3 Schedule VIII - Valuation and Qualifying Accounts........F-4 Schedule X - Supplementary Income Statement Information..F-5\nAll other schedules for which provision is made in Regulation S-X are not required under the related instructions or are inapplicable, and have therefore been omitted.\n3. Exhibits: Page ---- Exhibit 2(1): Option Agreement (MLP), dated December 29, 1986, by and among Forum Group, the Partnership and Operations (incorporated by reference to Exhibit 2(1) to Registration Statement Number 33-71498 dated November 10, 1993 (the \"1993 Form S-2\"))....................................N\/A\nExhibit 2(2): Recapitalization Agreement, dated October 6, 1993, between Forum Group and the Partnership (incorporated by reference to Exhibit 10(1) to Partnership Current Report on Form 8-K, dated October 12, 1993 (the \"October 1993 Form 8-K\")).....N\/A\nExhibit 2(3): Letter Agreement, dated December 14, 1993, by and among Forum Group, Forum A\/H and the Partnership (incorporated by reference to Exhibit 2(3) of Amendment No. 1 to the 1993 Form S-2, dated December 21, 1993 (\"1993 Amendment No. 1\"))...............N\/A\nExhibit 4(1): Amended and Restated Agreement of Limited Partnership, dated as of December 29, 1986, of the Partnership, as amended (incorporated by reference to Exhibit 4(1) to the 1993 Form S-2)............................................N\/A\nExhibit 10(1): Management Agreement (MLP), dated as of December 31, 1986, by and among the Partnership, Forum Retirement Operations, L.P., Forum Health Partners I-A, L.P., Foulk Manor Associates, L.P. and Forum Group (the \"Management Agreement\") (incorporated by reference to Exhibit 10(1) to the 1993 Form S-2)...............................N\/A\nExhibit 10(2): First Amendment to Management Agreement, dated as of September 20, 1986 (incorporated by reference to Exhibit 10(2) to the 1993 Form S-2).......N\/A\nExhibit 10(3): Second Amendment to Management Agreement, dated as of September 20, 1989 (incorporated by reference to Exhibit 10(3) to the 1993 Form S-2).......N\/A\nExhibit 10(4): Third Amendment to Management Agreement, dated as of May 27, 1992 (incorporated by reference to Exhibit 10(4) to the 1993 Form S-2)..........N\/A\nExhibit 10(5) Fourth Amendment to Management Agreement, dated as of November 9, 1993 (incorporated by reference to Exhibit 10(5) to the 1993 Form S-2).......N\/A\nExhibit 10(6): Depositary Agreement, dated as of December 29, 1986, by and among the Partnership, the General Partner, limited partners and assignees holding depository receipts and Manufacturers Hanover Trust Company (\"Manufacturers\") (incorporated by reference to Exhibit 10(6) to the 1993 Form S-2).......N\/A\nExhibit 10(7): Assignment of Depositary Agreement from Manufacturers to American Stock & Trust Company, dated January 1, 1992 (incorporated by reference to Exhibit 10(7) of Amendment No. 2 to the 1993 Form S-2, dated January 5, 1994 (\"1993 Amendment No. 2\")..................................N\/A\nExhibit 10(8): Loan Agreement, dated as of December 28, 1993, by and among FRP Financing Limited, L.P., Nomura Asset Capital Corporation and Bankers Trust Company (incorporated by reference to Exhibit 10(8) to 1993 Amendment No. 2)..........................................N\/A\nExhibit 11: Computation of Net Loss Per Unit.........E-1 and E-2\nExhibit 22: Subsidiaries of the Partnership..............E-3\nExhibit 28(1): Prospectus dated January 10, 1994, as supplemented on February 3, 1994, relating to a subscription offering by the Partnership filed with the Commission as part of Registration Statement Number 33-71498 on November 10, 1993, as amended in Part I.........................................N\/A\nReports on Form 8-K. No reports on Form 8-K were filed by the Partnership during the last quarter of the fiscal year covered by this report.\nSIGNATURES\nPursuant 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.\nFORUM RETIREMENT PARTNERS, L.P., a Delaware limited partnership\nBy: Forum Retirement, Inc., General Partner\nBy:\/s\/Paul A. Shively ------------------ Paul A. Shively, Vice President and Treasurer\nDate: March 29, 1994\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby authorizes Paul A. Shively and John H. Sharpe, and each of them, to file one or more amendments to this report, which amendments may make changes in this report as any of them deems appropriate, and each person whose signature appears below hereby appoints Paul A. Shively and John H. Sharpe, and each of them, as attorney-in-fact to execute in his name and on his behalf individually, and in each capacity stated below, any amendments to this report.\n____________\nPursuant 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 and on the dates indicated.\nSignature Title Date --------- ----- ---- (1) Principal Executive Financial and Accounting Officer of General Partner:\n\/s\/Paul A. Shively Vice President, March 29, 1994 ------------------ Treasurer and Paul A. Shively Chief Financial Officer S-1\n(2) A Majority of the Board of Directors of General Partner:\n\/s\/Donald J. McNamara Director March 29, 1994 --------------------- Donald J. McNamara\n\/s\/ James C. Leslie Director March 29, 1994 ------------------- James C. Leslie\n\/s\/ John F. Sexton Director March 29, 1994 ------------------ John F. Sexton S-2\nIndependent Auditors' Report - ----------------------------\nThe Partners Forum Retirement Partners, L.P.:\nUnder date of February 1, 1994, we reported on the consolidated balance sheets of Forum Retirement Partners, L.P. and subsidiary partnerships as of December 31, 1993 and 1992 and the related consolidated statements of operations, partners' equity and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick Indianapolis, Indiana February 1, 1994\nE-1\nE-2\nExhibit 22 ----------\nSubsidiaries of Forum Retirement Partners, L.P. -----------------------------------------------\nState of Name Organization ---- ------------\n1. Forum Health Partners I-A, L.P. (99%-owned) Delaware\n2. Forum Retirement Operations, L.P. (99%-owned) Delaware\n3. Foulk Manor Associates, L.P. (99%-owned) Delaware\nE-3","section_15":""}
{"filename":"9435_1993.txt","cik":"9435","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSeveral purported derivative actions against Bally and certain of its current and former directors, originally filed in December 1990 and January 1991, have been consolidated under the caption \"In re: Bally Manufacturing Corporation Shareholders Litigation in the Court of Chancery of the State of Delaware, New Castle County.\" The consolidated complaint alleges, among other things, breach of fiduciary duty, corporate mismanagement, and waste of corporate assets in connection with certain actions including, among other things, payment of compensation, certain acquisitions by Bally, the dissemination of allegedly materially false and misleading information, the proposed restructuring of Bally's debt, and a subsidiary's allegedly discriminatory practices. The plaintiffs seek, among other things: (i) injunctions against payment of certain termination compensation benefits and implementation of the proposed restructuring plan, (ii) rescission of consummated transactions and a declaration that the complained of transactions are null and void, (iii) an accounting by individual defendants of damages to Bally and benefits received by such defendants, (iv) the appointment of a representative to negotiate on behalf of the stockholders in connection with any proposed restructuring, and (v) costs and disbursements, including a\n- --------------------------------------------------------------------------------\nreasonable allowance for the fees and expenses of plaintiffs' attorneys, accountants and experts.\nIn January 1992, a purported holder of Bally's Grand, Inc.'s bonds filed an action in the United States District Court for the Central District of California entitled \"Nehus v. Bally Manufacturing Corporation, et al.\" against Bally, Bally's Grand, Inc. and certain of Bally's current and former officers and directors. The complaint alleged, among other things, that defendants violated the federal securities laws and the California Corporation Code, made intentional misrepresentations and breached their fiduciary obligations to plaintiff in connection with a purported exchange of Bally's Grand, Inc.'s bonds. In December 1992, the claims against former officers and a former director were dismissed for failure to effect proper service and in July 1993, Bally and Bally's Grand, Inc. settled the alleged claims against them.\nThe Internal Revenue Service (\"IRS\") has completed an audit of the federal income tax returns of certain of the Company's fitness center subsidiaries for periods ending on the day these subsidiaries were acquired. Among other things, the IRS is asserting that these subsidiaries owe additional taxes of approximately $32 million and substantial amounts of interest with respect to issues arising pursuant to the Company's election in 1983 to treat the purchases of stock of these subsidiaries as if they were purchases of assets. The Company vigorously opposes the IRS' assertions and has filed petitions in the United States Tax Court contesting the IRS' proposed deficiencies with respect to these issues. This matter has been docketed for trial in October 1994, however, a resolution may occur sooner if the Company and the IRS resolve all or some of these issues by stipulation or otherwise. Based on the information presently available, there can be no assurance of the outcome of this matter. However, in the opinion of management, payment, if any, to the IRS of amounts which may be ultimately deemed owing will not have a material adverse effect on the Company's consolidated financial position or results of operations, since the Company believes that it has adequately provided deferred and current taxes related to this matter, although it could, though it is not expected to, have a material adverse effect on the Company's liquidity.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nItem 4 is inapplicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nArthur M. Goldberg was elected Chairman of the Board of Directors and Chief Executive Officer of the Company in October 1990 and President of the Company in January 1993. He is also Chairman of the Company's Executive Committee. In June 1993, he was elected Chairman of the Board of Directors, President and Chief Executive Officer of Casino Holdings. Since January 1993, Mr. Goldberg has been Chairman of the Board of Directors and Chief Executive Officer of both Bally's Park Place, Inc. and GNAC. He has also served as Chief Executive Officer of Bally's Tunica, Inc. since April 1993 and as a director of Bally's Health & Tennis since 1990. Mr. Goldberg was elected Chairman of the Board of Directors and President of Bally's Grand, Inc. in August 1992, and its Chief Executive Officer in September 1992. Since 1990, he has been Chairman of the Board of Directors, Chief Executive Officer and President of Di Giorgio Corporation, a food distributor. Mr. Goldberg is also Managing Partner of Arveron Investments L.P. and a director of First Fidelity Bancorp. From 1985 to 1989, he was Chief Executive Officer, President and a director of International Controls Corporation, a manufacturing and engineering company. Mr. Goldberg is 52 years of age.\nLee S. Hillman was elected Vice President, Chief Financial Officer and Treasurer of the Company in November 1991 and Executive Vice President in August 1992. He has been an Executive Vice President, Chief Financial Officer and a director of Casino Holdings since June 1993. Mr. Hillman has served as a director of Bally's Park Place, Inc. since January 1993 and a director of GNAC since February 1993. He has also been Chief Financial Officer of Bally's Tunica, Inc. since April 1993 and Vice President -- Administration of Bally's Grand, Inc. since August 1993. In addition, he has served as Senior Vice President of Bally's Health & Tennis since April 1991, Chief Financial Officer of that company since January 1992, one of its directors since September 1992 and its Treasurer since October 1992. From October 1989 to April 1991, he was a partner with the accounting firm of Ernst & Young. From 1987 to October 1989, he was a\n- --------------------------------------------------------------------------------\nprincipal with the accounting firm of Arthur Young & Company, a predecessor to Ernst & Young. Mr. Hillman is 38 years of age.\nRobert G. Conover was elected Vice President, Management Information Systems and Chief Information Officer of the Company in December 1992. He has been Senior Vice President, Management Information Systems of Casino Holdings since June 1993 and Senior Vice President of GNOC, CORP. (a subsidiary of GNAC) since 1987. Mr. Conover was elected a Senior Vice President of Bally's Park Place, Inc. in January 1993 and for approximately ten years prior thereto, he was a Vice President of that company. Mr. Conover has also been President of the Bally Systems division of Gaming since October 1990. From January 1987 to September 1992, he was Vice President, Management Information Systems of Bally's Grand, Inc. Mr. Conover is 48 years of age.\nJohn W. Dwyer was elected Corporate Controller of the Company in June 1992 and Vice President in December 1992. He has been a Vice President and Controller of Casino Holdings since June 1993. From October 1989 to June 1992, he was a partner with the accounting firm of Ernst & Young. From 1986 to October 1989, Mr. Dwyer was a partner with the accounting firm of Arthur Young & Company, a predecessor to Ernst & Young. Mr. Dwyer is 41 years of age.\nHarold Morgan was elected Vice President, Human Resources of the Company in December 1992. Since August 1991, he has been employed by Bally's Health & Tennis and was elected a Vice President of that company in January 1992. From 1985 until August 1991, Mr. Morgan was Director of Employee and Labor Relations of the Hyatt Corporation. Mr. Morgan is 37 years of age.\nBernard J. Murphy was elected Vice President, Corporate Affairs and Governmental Relations of the Company in November 1991. From March 1991 to November 1991, Mr. Murphy was employed as an executive of Bally and since March 1991, he has been a Senior Vice President of Bally's Health & Tennis. For 20 years prior to 1990, he had been with the Federal Bureau of Investigation. Mr. Murphy is 47 years of age.\nJerry W. Thornburg was elected Vice President, Audit of the Company in July 1993. For approximately five years prior thereto, he was Director of Internal Audit of the Company. Mr. Thornburg is 50 years of age.\nCarol Stone DePaul was elected Secretary of the Company in December 1992. She has been a Vice President and Secretary of Casino Holdings since June 1993. For more than four years prior to December 1992, she was Assistant Secretary of the Company and a member of its law department. Ms. DePaul is 37 years of age.\n------------------------------------\nWallace R. Barr was elected President and a director of Bally's Park Place, Inc. in February 1993 and has served as its Chief Operating Officer since January 1993. He has also been an Executive Vice President, Chief Operating Officer and a director of Casino Holdings since June 1993 and President of Bally's Tunica, Inc. since April 1993. Mr. Barr was a Senior Vice President of GNAC from June 1991 to February 1993, has served that company as its Chief Operating Officer since January 1993 and has been its President and a director since February 1993. From March 1984 to June 1991, he served as Senior Vice President -- Operations of Bally's Park Place, Inc. and from January 1987 to September 1992, he was Senior Vice President and Treasurer of Bally's Grand, Inc. Mr. Barr is 48 years of age.\nMichael G. Lucci, Sr. was elected President of Bally's Health & Tennis in April 1993 and Chief Operating Officer in October 1992. He has been a director of Bally's Health & Tennis since September 1992. From 1991 to April 1993, he served as Executive Vice President of Bally's Health & Tennis and supervised the eastern region of that company for more than two years prior to 1991. Mr. Lucci is 54 years of age.\n- -------------------------------------------------------------------------------- PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nBally Common Stock, par value $.66 2\/3 per share (the \"Common Stock\"), is traded on the New York Stock Exchange and Chicago Stock Exchange. The Company suspended cash dividend payments on the Common Stock beginning with the fourth quarter of 1990. The high and low quarterly sales prices on the New York Stock Exchange for the past two years are as follows:\nThe number of record holders of the Common Stock at March 24, 1994 was 16,555.\nFor restrictions on the ability of Bally's subsidiaries to pay dividends, see Liquidity and Capital Resources in Item 7 of this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- ---------------\nNote:\nDuring 1993, Casino Holdings and another subsidiary of Bally acquired approximately 5.2 million shares (approximately 50% of the shares presently outstanding) of reorganized Bally's Grand, Inc. common stock. Bally's Grand, Inc. has been consolidated since December 1, 1993 as a result of Bally's controlling interest. Prior to December 1, 1993, Bally's investment in Bally's Grand, Inc. was principally recorded on the equity method of accounting. See Notes to consolidated financial statements -- Acquisition of Bally's Grand, Inc. for additional information.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nIn late 1992, after completing a major restructuring effort which began in October 1990, the Company began actively pursuing new casino gaming projects. In April 1993, Casino Holdings was formed as a holding company for Bally's Park Place, Inc. and for acquiring and developing gaming operations, including those in newly emerging gaming jurisdictions. In June 1993, Casino Holdings completed a private placement of $220.0 million principal amount of Senior Discount Notes and received net proceeds therefrom of approximately $127.9 million which\n- --------------------------------------------------------------------------------\nhave been and are being used to: (i) construct and equip Bally's Tunica (which commenced operations in December 1993), (ii) acquire a significant equity interest in Bally's Las Vegas (which caused its consolidation effective December 1, 1993), (iii) fund initial payments for construction of a riverboat (including dockside improvements) for eventual operation in New Orleans, (iv) fund an option agreement to acquire certain riverfront property in Philadelphia for the purpose of developing a dockside gaming facility if gaming were to be legalized in Pennsylvania and (v) pursue other gaming opportunities.\nRESULTS OF OPERATIONS Revenues and operating income (loss) from continuing operations are as follows (in millions):\n1993 VERSUS 1992\nCASINOS\nRevenues of the Company's casinos for 1993 were $619.2 million compared to $552.8 million for 1992, an increase of $66.4 million (12%). Operating income for 1993 was $104.4 million compared to $92.0 million for 1992, an increase of $12.4 million (13%).\nATLANTIC CITY. Revenues of Bally's Park Place for 1993 were $352.8 million compared to $331.1 million for 1992, an increase of $21.7 million (7%). Casino revenues for 1993 were $297.7 million compared to $278.0 million for 1992, an increase of $19.7 million (7%). Slot revenues, which include the discontinuation of certain progressive slot jackpots, increased $14.7 million (8%) due to an 11% increase in slot handle (volume) offset, in part, by a decline in the slot win percentage from 9.9% in 1992 to 9.6% in 1993. Bally's Park Place added 112 slot machines (a 6% increase) during 1993. Slot revenues represented 69% of Bally's Park Place's casino revenues in 1993 compared to 68% in 1992. Table game revenues, excluding poker, increased $2.4 million (3%) from 1992 primarily due to a 6% increase in the drop (amount wagered) offset, in part, by a decline in the hold percentage from 17.0% in 1992 to 16.5% in 1993. Bally's Park Place's poker operations, which commenced in July 1993, contributed $2.6 million to its casino revenues. Rooms revenue increased $1.3 million (5%) due to an increase in rooms occupied in 1993 compared to 1992 offset, in part, by a reduction in the average room rate. Food and beverage revenue remained essentially unchanged. Interest income declined $.9 million from 1992 due to the elimination of an intercompany loan. Operating income for 1993 was $85.8 million compared to $62.7 million in 1992, an increase of $23.1 million (37%), due to the aforementioned increase in revenues and, to a lesser extent, to a $1.4 million (1%) decrease in operating expenses. Operating expenses decreased due to a 10% reduction in selling, general and administrative expenses (due in part to a reduction in costs associated with a management restructuring) which was offset, in part, by increased marketing and promotional costs and food and beverage expenses.\nIn July 1993, The Grand introduced a comprehensive marketing program designed to emphasize the first-class nature of the facility, personalized service provided to guests, frequent special events and entertainment offered. The Grand has directed its marketing efforts toward\n- --------------------------------------------------------------------------------\nexpanding its domestic customer base and attracting international gaming patrons. To attract and retain these gaming patrons, The Grand is providing increased complimentary services (room, food, beverage and entertainment), increased promotional expenses (customer transportation, gifts and coin giveaways) and frequent special events. Revenues of The Grand for 1993 were $239.8 million compared to $223.7 million for 1992, an increase of $16.1 million (7%). Casino revenues for 1993 were $216.3 million compared to $199.6 million in 1992, an increase of $16.7 million (8%). Table game revenues increased $13.3 million (18%) due primarily to a 19% increase in the drop. Slot revenues increased $3.4 million (3%). Slot revenues include approximately $1.2 million and $1.9 million from the discontinuation of certain progressive slot jackpots in 1993 and 1992, respectively. Excluding these adjustments, slot revenues increased $4.1 million (3%) due to a 9% increase in slot handle offset, in part, by a decline in the slot win percentage from 10.0% in 1992 to 9.5% in 1993. The Grand added 28 slot machines (a 2% increase) during 1993. Slot revenues represented 60% of The Grand's casino revenues in 1993 compared to 63% in 1992. Rooms revenue decreased $1.5 million (22%) due primarily to a reduction in the average room rate. Food and beverage revenue remained essentially unchanged. Other revenues increased $.9 million from 1992 due principally to an adjustment to the reserve for unclaimed gaming chips and tokens in 1993. Operating income for 1993 was $21.7 million compared to $30.6 million in 1992, a decrease of $8.9 million (29%), as the aforementioned increase in revenues was more than offset by a $25.0 million (13%) increase in operating expenses. Operating expenses increased primarily due to the increase in casino volume and the increased marketing efforts described above which increased the cost of providing complimentary services, promotional expenses and special events, payroll and payroll-related expenses and state gaming taxes. Management of The Grand believes the initial costs of the comprehensive marketing program are proportionately greater during implementation and, because the incremental revenues generally trail such costs, the marketing program had an adverse effect on operating results for 1993.\nAtlantic City city-wide casino revenues for all operators in 1993, excluding poker and horse race simulcasting, increased approximately 2% from 1992, which was primarily attributable to a 5% increase in slot revenues offset, in part, by a 3% decrease in table game revenues. Atlantic City's 1993 results were negatively impacted by severe weather conditions that hampered attendance on several weekends in the first quarter. The number of slot machines in Atlantic City increased approximately 8% during 1993 while the number of Atlantic City table games, excluding poker tables, declined approximately 1%. Slot revenues in 1993 represented 67% of total gaming revenues in Atlantic City compared to 66% in 1992. Changes in gaming regulations, including modifications allowing more slot machines on existing casino floor space and permitting unrestricted 24-hour gaming effective July 1992, have aided Atlantic City slot revenue growth. In addition to the ongoing slot revenue trend, the introduction in the second quarter of 1993 of poker and horse race simulcasting has also improved the Atlantic City gaming climate. The Company's competitors in Atlantic City intensified their promotional slot marketing efforts during 1992 to expand their share of slot revenues and this trend continued through 1993. The Company believes it is well-positioned to compete for its share of casino revenues by continuing to offer promotional slot and table game programs and special events at Bally's Park Place and through the comprehensive marketing program at The Grand. However, the Company believes that as a result of the aggressive competition for slot patrons, the slot win percentage will continue to be subject to competitive pressure and may further decline.\nLAS VEGAS. As described previously, Bally's Grand, Inc. has been consolidated since December 1, 1993. Revenues of Bally's Grand, Inc. for December 1993 were $21.1 million. Casino revenues were $12.2 million, which primarily consisted of table game revenues of $6.7 million and slot revenues of $5.0 million. Rooms revenues were $2.9 million and food and beverage revenues were $2.8 million. Other revenues were $3.1 million and primarily resulted from entertainment. Operating income for December 1993 was $1.0 million.\nTUNICA. Revenues of Bally's Tunica, which included 24 days of operations in December 1993, were $4.2 million and included casino revenues of $4.0 million (slot revenues were $2.7 million and table game revenues were $1.3 million).\n- --------------------------------------------------------------------------------\nOperating loss for Bally's Tunica was $1.7 million, principally resulting from the amortization of $3.1 million of pre-opening costs ($3.1 million is also being amortized in the first quarter of 1994).\nFITNESS CENTERS\nIn late 1991, the Company implemented a value pricing strategy which lowered the average selling price of membership contracts thereby lowering the monthly payment for financed memberships. This strategy was designed to improve the collection experience on financed memberships. In addition, commencing at the end of the third quarter of 1992, the Company implemented programs designed to increase its emphasis on the sale of financed contracts with payments made by direct bank account electronic funds transfer (\"EFT\") and automatic credit card payment plans by adjusting sales commission and member incentive levels. This was done to further improve the Company's collection experience on financed membership contracts based on Company studies which indicated better collection experience for financed memberships sold under these plans compared to those sold with standard coupon book payment plans. While these changes were intended to reduce the Company's exposure to risks associated with collection of financed membership contracts, the emphasis on EFT and credit card payment programs negatively affected the number of new memberships sold. In April 1993, the Company reduced the average selling price of membership contracts even further in an attempt to increase unit volume. Management now believes that the selling price decreases implemented in April 1993 were greater than required and such price decreases did not measurably increase the number of new memberships sold. Therefore, in mid-October 1993, the Company began increasing prices modestly, which has continued into 1994. Management believes that increased prices have not resulted in significant reductions in unit sales volume or exposure to higher collection risk because the prices of the Company's memberships are comparable to or less than its competitors and significantly less than memberships sold by the Company prior to the implementation of the value pricing strategy in 1991. These price increases coupled with the changes in selling methods and cost reduction programs implemented in the last fifteen months are intended to improve the Company's operating results.\nRevenues for 1993 were $694.8 million compared to $741.9 million in 1992, a decrease of $47.1 million (6%). Revenues in 1992 included a gain of $3.9 million on the retirement of a portion of Bally's Health & Tennis' public debt acquired for sinking fund purposes. Excluding this gain, revenues decreased $43.2 million (6%). Revenues for the same fitness centers selling memberships throughout both years decreased $88.4 million (12%), which management believes was principally due to the changes in its sales and pricing policies described above. Revenues from new fitness centers opened during 1993 or 1992 were $45.2 million. The number of fitness centers selling memberships increased from 331 at December 31, 1992 to 339 at December 31, 1993. New membership revenues decreased $31.5 million (6%) in 1993 due to a 5% decline in the average selling price and a 4% decrease in unit volume. Management believes that unit volume has been and continues to be affected by the weak retail economy, increased competition and prevailing general economic uncertainties. Dues and renewals increased $23.3 million (16%) in 1993 due to the continuing emphasis on memberships requiring the payment of monthly dues beginning in the first month of membership and an improvement in member retention rates. Finance charges earned decreased $12.4 million (22%) due principally to a decrease in installment contracts receivable due to lower sales volume and, to a lesser extent, a lower effective interest rate on installment contracts receivable. Deferred revenues earned during 1993 decreased $22.8 million from 1992 due to an increase in the liability for membership services at December 31, 1993 as compared to December 31, 1992 and 1991.\nOperating income for 1993 decreased $22.4 million from 1992. Excluding the aforementioned gain on debt, operating income was $.8 million for 1993 compared to $19.3 million in 1992, a decline of $18.5 million. Excluding the provision for doubtful receivables, operating expenses increased $19.0 million (3%) in 1993 from 1992 primarily due to $26.8 million of costs related to new clubs partially offset by a $9.4 million decrease in costs related to the same fitness centers selling memberships in both years. This decrease was primarily due to reductions in payroll, commissions and employee benefits as\n- --------------------------------------------------------------------------------\na function of the aforementioned decline in sales and as a result of the continuation of cost reduction programs. As a percentage of revenues (excluding the gain on debt), these operating expenses were 82% in 1992 and 89% in 1993. The provision for doubtful receivables for 1993 was $72.5 million compared to $116.2 million in 1992, a decrease of $43.7 million (38%). The provision for doubtful receivables as a percentage of net financed sales was reduced from 39% in 1992 to 26% in 1993, which reflects expected improvement in the collectibility of memberships sold during 1993 due to increased emphasis on EFT and automatic credit card payment programs and lower prices as described above.\nCORPORATE\nRevenues for 1993 were $8.0 million compared to $2.5 million in 1992, an increase of $5.5 million. The increase was due principally to the forgiveness of a tax liability of $1.7 million previously owed to Gaming, the billing of $1.7 million additional insurance costs to subsidiaries and an increase in interest income and other revenues from subsidiaries of $2.0 million.\nOperating income for 1993 was $2.3 million compared to an operating loss of $4.2 million in 1992, an improvement of $6.5 million. Results in 1993, as compared to 1992, were positively impacted by the aforementioned revenue items totalling $5.4 million and a $1.1 million reversal of a tax accrual no longer deemed necessary. The allocation of corporate overhead (including executive salaries and benefits, public company reporting costs and other corporate headquarters' costs) to subsidiaries remained essentially unchanged. Allocations for 1993 and 1992 were, and management expects allocations in subsequent years will be, based upon similar cost categories and allocation methods subject to changes in circumstances which may warrant modifications.\nINTEREST EXPENSE\nInterest expense, net of capitalized interest, was $129.8 million in 1993 compared to $126.1 million in 1992. The increase of $3.7 million (3%) was due principally to higher average levels of debt in 1993 due, in part, to the issuance of the Senior Discount Notes in June 1993 offset, in part, by the reversal in 1993 of a $2.0 million interest reserve no longer necessary and interest in 1992 on accrued but unpaid interest for debt in default (which did not occur in 1993).\nINCOME TAXES\nEffective rates of the income tax benefit were 20% in 1993 and 39% in 1992. The 1993 income tax rate differed from the U.S. statutory tax rate (35%) due principally to nondeductible goodwill amortization and state income taxes, partially offset by adjustments of prior years' taxes. In addition, the income tax benefit for 1993 was reduced by $1.7 million as a result of applying the change in the U.S. statutory tax rate from 34% to 35% to deferred tax balances. The 1992 income tax rate differed from the U.S. statutory tax rate (34%) due principally to adjustments of prior years' taxes, partially offset by nondeductible amortization and depreciation and state income taxes. A reconciliation of the income tax benefit with amounts determined by applying the U.S. statutory tax rate to loss from continuing operations before income taxes and minority interests is included in Notes to consolidated financial statements -- Income taxes.\nEffective January 1, 1993, the Company changed its method of accounting for income taxes as required by Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 retains the requirement to record deferred income taxes for temporary differences that are reported in different years for financial reporting and for tax purposes; however, the methodology for calculating and recording deferred income taxes has changed. Under the liability method adopted by SFAS No. 109, deferred tax liabilities or assets are computed using the tax rates expected to be in effect when the temporary differences reverse. Also, requirements for recognition of deferred tax assets and operating loss and tax credit carryforwards were liberalized by requiring their recognition when and to the extent that their realization is deemed to be more likely than not. As permitted by SFAS No. 109, the Company elected to use the cumulative effect approach rather than to restate the consolidated financial statements of any prior years to apply the provisions of SFAS No. 109. The cumulative effect on prior years of this change in accounting for income taxes as of January 1, 1993 was a charge of $28.2 million ($.61 per share). The effect of this change in accounting for income taxes on the income tax benefit for 1993 was to reduce the income tax benefit by $1.7 million as a result of\n- --------------------------------------------------------------------------------\napplying the change in the U.S. statutory tax rate described above.\nIn 1992, the Company utilized tax loss carryforwards to offset taxable income principally arising from the sale of Gaming common stock in July 1992 and the related tax benefit of $10.6 million was reflected as an extraordinary credit.\n1992 VERSUS 1991\nCASINOS\nRevenues of the Company's Atlantic City casino hotels for 1992 were $552.8 million compared to $536.2 million for 1991, an increase of $16.6 million (3%). Operating income for 1992 was $92.0 million compared to $83.3 million for 1991, an increase of $8.7 million (10%).\nRevenues of Bally's Park Place for 1992 were $331.1 million compared to $322.8 million for 1991, an increase of $8.3 million (3%). Casino revenues increased $12.3 million (5%), with slot revenues increasing $15.0 million (9%) as a result of a 13% increase in the slot handle, partially offset by a 4% decline in the win percentage from 10.3% in 1991 to 9.9% in 1992. Table game revenues decreased $2.7 million (3%) as a result of a decline in the table game drop of $21.6 million (4%), partially offset by an improvement in the hold percentage from 16.8% in 1991 to 17.0% in 1992. Bally's Park Place increased its number of slot machines by 119 machines (7%) since December 1991. Slot revenues in 1992 represented 68% of casino revenues compared to 66% in 1991. All other operating revenues were essentially unchanged. Interest income from Bally in 1992 was $.8 million compared to $4.2 million in 1991. This decrease was primarily due to the declaration as a dividend to Bally by Bally's Park Place of an amount totalling $50.0 million formerly classified as a demand note receivable and the discontinuation of interest payments on such note effective April 1, 1992. Operating income for 1992 was $62.7 million compared to $54.4 million for 1991, an increase of $8.3 million (15%) due primarily to the increase in revenues. Operating expenses include charges for Bally overhead expenses allocated to Bally's Park Place of $3.7 million and $1.0 million in 1992 and 1991, respectively. Operating income was adversely impacted in 1992 by the aforementioned decrease in interest income and increase in the allocation of overhead expenses from Bally. In 1991, operating income was adversely impacted by a $3.5 million charge related to the closing and demolition of an ancillary motel property operated by Bally's Park Place and a $2.0 million charge for the estimated cost of settling certain liabilities.\nRevenues of The Grand for 1992 were $223.7 million compared to $215.2 million for 1991, an increase of $8.5 million (4%). Casino revenues increased $8.0 million (4%), with slot revenues increasing $9.7 million (8%), which was attributable to increased slot volume and the positive impact of discontinuation of certain progressive slot jackpots and the reversal of related reserves in 1992. Table game revenues decreased $1.7 million (2%) as a result of a decline of $21.6 million (5%) in the table game drop partially offset by an improvement in the hold percentage from 16.0% in 1991 to 16.4% in 1992. During the first half of 1992, The Grand increased its number of slot machines by 86 machines (6%) and expanded its slot marketing efforts. Slot revenues in 1992 represented 63% of casino revenues compared to 61% in 1991. All other revenues were essentially unchanged. Operating income for 1992 was $30.6 million compared to $29.8 million for 1991, an increase of $.8 million (3%), due to the increase in revenues offset, in part, by a $7.7 million (4%) increase in operating expenses. The operating expense increase includes additional spending in 1992 of $2.6 million in conjunction with intensified slot marketing efforts and $1.8 million of additional selling, general and administrative expenses. Operating expenses include charges for Bally overhead expenses allocated to The Grand of $2.2 million and $.7 million in 1992 and 1991, respectively.\nAtlantic City city-wide casino revenues for all operators in 1992 increased approximately 8% from 1991, which was negatively impacted in the first quarter by the Persian Gulf war. The increase was due to a 14% increase in slot revenues, partially offset by a 3% decrease in table game revenues. Slot revenues for 1992 represented 66% of total gaming revenue in Atlantic City compared to 62% in 1991. During 1992, the Company's competitors in Atlantic City intensified their promotional slot marketing efforts to expand their share of slot revenues. Additionally, changes in gaming regulations, including modifications allowing more slot machines in existing casino floor space and permitting unrestricted 24-hour gaming effective\n- --------------------------------------------------------------------------------\nJuly 1992, have aided Atlantic City slot revenue growth. Management believes, however, that a weak economy in the northeastern United States during 1992 and 1991 and the increased competitive pressure had a negative impact on the operating results of the Company's Atlantic City casino hotels.\nFITNESS CENTERS\nRevenues for 1992 were $741.9 million compared to $720.4 million for 1991, an increase of $21.5 million (3%). Revenues for 1992 and 1991 include gains of $3.9 million and $10.8 million, respectively, on the retirement of Bally's Health & Tennis' public debt acquired for sinking fund purposes. Excluding these gains, revenues increased $28.4 million (4%) of which $10.7 million related to 19 fitness centers acquired in September 1992. The remaining increase of $17.7 million was due principally to the same fitness centers selling memberships throughout both years. New membership revenues increased $8.2 million (2%) in 1992 due to a 31% increase in the number of new memberships sold offset, in part, by a 22% decline in the average selling price which reflects the value pricing strategy implemented by the Company in the second half of 1991. Dues and renewals increased $20.9 million (17%) in 1992 due to the continued emphasis on memberships requiring the payment of monthly dues beginning in the first month of membership, a practice which began in mid-1991. Finance charges earned decreased 10% from $62.8 million in 1991 to $56.8 million in 1992 due principally to a decrease in net installment contracts receivable and, to a lesser extent, a lower effective interest rate on installment contracts receivable.\nManagement believes that the weak economy had a negative effect on revenues in both years and that the Persian Gulf war and unfavorable publicity regarding Bally's financial condition negatively affected revenues in 1991. New membership sales in the second half of 1992 were negatively affected by the introduction of new selling practices and incentive compensation programs emphasizing EFT and automatic credit card charge payment plans for sales of financed memberships. The emphasis on EFT and credit card payment plans was intended to improve the Company's collection experience on financed membership contracts based on Company studies which indicate better collection experience for financed memberships sold with EFT or credit card payment plans compared to those sold with standard coupon book payment plans. It has been the Company's experience that new membership sales are adversely affected when significant changes in sales and commission programs are implemented. EFT and credit card sales as a percentage of total financed sales increased commencing in the third quarter and were approximately 50% of sales initiated during the fourth quarter of 1992. For the previous six quarters, such sales accounted for approximately 25% of financed sales.\nOperating income for 1992 was $23.2 million compared to an operating loss of $4.4 million in 1991. Excluding the aforementioned gains on debt, operating income was $19.3 million for 1992 compared to an operating loss of $15.2 million in 1991, an improvement of $34.5 million. This improvement was due primarily to the aforementioned revenue increase and a decrease of $5.8 million (5%) in the provision for doubtful receivables. Excluding the provision for doubtful receivables, operating expenses increased $.3 million in 1992 from 1991, due to a $2.3 million increase in the cost of membership services partially offset by a $1.4 million decrease in selling and promotion expenses. As a percentage of revenues (excluding the gains on debt), these operating expenses declined to 82% in 1992 from 85% in 1991. The provision for doubtful receivables as a percentage of net financed sales was 39% in both years.\nCORPORATE\nRevenues for 1992 were $2.5 million compared to $8.0 million in 1991, a decrease of $5.5 million. The decrease was due principally to lower gains on the purchase of debt for sinking fund purposes in 1992 ($.6 million compared to $5.5 million in 1991) and reductions in interest and other income from subsidiaries in 1992 ($.1 million compared to $1.4 million in 1991), partially offset by foreign currency transaction losses of $1.2 million in 1991.\nOperating loss for 1992 was $4.2 million compared to $14.4 million in 1991, an improvement of $10.2 million. Excluding the gains on the purchase of debt securities, the reductions in income from subsidiaries and the foreign currency transaction losses, the year-to-year improvement was $15.2 million. Operating results in 1992 were positively impacted by an\n- --------------------------------------------------------------------------------\n$8.6 million reduction in general and administrative expenses, a $3.0 million reduction in restructuring costs, the elimination of litigation accruals totalling $2.7 million relating to matters which were favorably settled and a $1.0 million commission on the July 1992 sale by Bally's Grand, Inc. of the casino resort complex formerly known as \"Bally's Reno.\" Allocations of corporate overhead to subsidiaries remained essentially unchanged.\nINTEREST EXPENSE\nInterest expense, net of capitalized interest, was $126.1 million in 1992 compared to $158.5 million in 1991. The decrease of $32.4 million (20%) was due principally to lower average levels of debt and, to a lesser extent, lower average interest rates and a decline in the amount of interest provided on prior years' income tax matters.\nINCOME TAXES\nEffective rates of the income tax benefit were 39% in 1992 and 31% in 1991. The 1992 income tax rate differed from the U.S. statutory tax rate (34%) due principally to adjustments of prior years' taxes, partially offset by nondeductible amortization and depreciation and state income taxes. The 1991 income tax rate differed from the U.S. statutory tax rate (34%) due principally to nondeductible amortization and depreciation. A reconciliation of the income tax benefit with amounts determined by applying the U.S. statutory tax rate to loss from continuing operations before income taxes and minority interests is included in Notes to consolidated financial statements -- Income taxes.\nIn 1992, the Company utilized tax loss carryforwards to offset taxable income principally arising from the sale of Gaming common stock in July 1992 and the related tax benefit of $10.6 million was reflected as an extraordinary credit.\nLIQUIDITY AND CAPITAL RESOURCES\nPARENT COMPANY\nBally is a holding company without operations of its own. Nevertheless, Bally has certain cash obligations that must be satisfied by obtaining cash from its subsidiaries or disposing of or leveraging certain assets. Bally's corporate cash operating costs, net of allocations to its subsidiaries, are expected to be less than $3 million in 1994. Bally has debt service and preferred stock dividend cash requirements of approximately $20 million in 1994. Cash requirements for Bally in 1994 may also include income tax payments which management estimates to be approximately $36 million, net of amounts to be collected from subsidiaries pursuant to tax sharing agreements.\nSources of cash available to Bally are generally limited to existing cash balances ($43.5 million at December 31, 1993), dividends, management fees or cost allocations to subsidiaries, capital transactions and asset sales. Each of Bally's principal operating subsidiaries presently have debt covenants which limit the payment of dividends to Bally and the redemption of stock owned by Bally. Under the terms of the Senior Discount Notes, an amount equal to certain dividends paid pursuant to a net income test by Bally's Park Place, Inc. to Casino Holdings may be declared as a dividend by Casino Holdings and paid to Bally. In 1993, $16.7 million in dividends were paid by Bally's Park Place, Inc. to Casino Holdings and by Casino Holdings to Bally. Additional dividends may be available from Casino Holdings and are generally limited to 50% of its consolidated net income exclusive of income attributable to Bally's Park Place, Inc. Pursuant to the terms of GNAC's 10 5\/8% First Mortgage Notes due 2003 (the \"10 5\/8% Notes\") and its credit agreement, GNAC paid dividends to Bally of $7.5 million in 1993. GNAC is not expected to be able to pay dividends to Bally in 1994. Bally's Health & Tennis, which paid a $15 million dividend to Bally in January 1993, is not expected to be able to pay dividends in 1994. In addition, Casino Holdings has an obligation to Bally of approximately $18.3 million to be paid in 1994 for shares of Bally's Grand, Inc. common stock purchased from Bally during 1993. Bally believes that it will be able to satisfy its cash needs throughout 1994, but remains dependent upon the ability of subsidiaries to pay dividends and allocations to meet its cash requirements in the future.\nSUBSIDIARIES\nCASINO HOLDINGS\nCASINO HOLDINGS. Casino Holdings is a holding company without operations of its own and relies on obtaining cash from its subsidiaries to meet its cash obligations. Casino Holdings has no scheduled interest or principal payments on the Senior Discount Notes until 1998, but expects to incur substantial costs in the pursuit of new gaming ventures. The proceeds from the Senior Discount Notes have been and are being used to:\n- --------------------------------------------------------------------------------\n(i) construct and equip Bally's Tunica, (ii) acquire a significant equity interest in Bally's Las Vegas, (iii) fund initial payments for construction of a riverboat (including dockside improvements) for eventual operation in New Orleans, (iv) fund an option agreement to acquire certain riverfront property in Philadelphia for the purpose of developing a dockside gaming facility if gaming were to be legalized in Pennsylvania and (v) pursue other gaming opportunities. To the extent Casino Holdings requires additional funds for existing ventures or to develop new ventures, Casino Holdings expects that it will be able to obtain financing for a significant portion of the total development costs of new gaming ventures from a combination of third party sources, including banks, suppliers and debt markets.\nSources of cash available to Casino Holdings are generally limited to existing cash balances ($25.4 million at December 31, 1993) and loan repayments, dividends and management fees from subsidiaries. Bally's Park Place, Inc. and Bally's Grand, Inc. are both limited with respect to amounts which may be paid as dividends to Casino Holdings under the terms of their respective public debt indentures. In March 1994, Bally's Park Place, Inc. paid a $30 million dividend to Casino Holdings from a portion of the proceeds of the sale of its 9 1\/4% First Mortgage Notes due 2004 (the \"9 1\/4% Notes\"), which is not available to be paid by Casino Holdings to Bally. Bally's Grand, Inc. is not expected to pay dividends or make any other distributions on its common stock to Casino Holdings in 1994. Bally's Tunica, which commenced operations in December 1993, is expected to generate a significant amount of unrestricted cash flows in 1994 which will be used to reduce an advance from Casino Holdings. The New Orleans project is not expected to commence operations until February 1995. Although Casino Holdings believes it will be able to satisfy its cash needs throughout 1994, Casino Holdings remains dependent upon the ability of its subsidiaries to generate cash to repay advances and pay dividends.\nBALLY'S PARK PLACE, INC. In March 1994, a subsidiary of Bally's Park Place, Inc. issued $425 million principal amount of the 9 1\/4% Notes. The net proceeds from the sale of the 9 1\/4% Notes were used to purchase and retire certain of its 11 7\/8% First Mortgage Notes due 1999 (the \"11 7\/8% Notes\"), defease the remaining 11 7\/8% Notes at a price of 104.45% of their principal amount plus accrued interest through the redemption date, thereby satisfying all obligations thereunder, and pay a $30 million dividend to Casino Holdings. In connection with the sale of the 9 1\/4% Notes, Bally's Park Place terminated its existing credit facility and entered into an agreement for a new $50 million revolving credit facility which expires on December 31, 1996.\nAs adjusted for the refinancing described above, Bally's Park Place, Inc. has no scheduled principal payments under its public indebtedness until 2004, and its scheduled principal payments under other indebtedness outstanding at December 31, 1993 are not significant. Management expects to make capital expenditures of approximately $18 million in 1994. As of December 31, 1993, after giving effect to the new credit facility, Bally's Park Place, Inc. had unused lines of credit totalling $48 million. The Company believes that Bally's Park Place, Inc. will be able to satisfy its debt service and capital expenditure requirements in 1994 out of cash flow from operations.\nBALLY'S GRAND, INC. In December 1993, Bally's Grand, Inc. issued $315 million principal amount of 10 3\/8% First Mortgage Notes due 2003 (the \"10 3\/8% Notes\"). Bally's Grand, Inc. used a substantial portion of the net proceeds from the sale of the 10 3\/8% Notes to redeem $252.5 million principal amount of its 12% First Mortgage Notes due 2001 (the \"12% Notes\") at a price of 103% of their principal amount plus accrued interest, thereby satisfying all obligations thereunder, and to pay approximately $9 million to Bally under a tax sharing agreement between Bally's Grand, Inc. and Bally, which amount became due and payable in connection with the redemption of the 12% Notes. The remaining proceeds are primarily being used for capital expenditures.\nBally's Grand, Inc. has no scheduled principal payments on its indebtedness outstanding at December 31, 1993 until 2003, however, it expects to make several major capital improvements during 1994 and 1995. Bally's Las Vegas has commenced the construction of improvements to its frontage area along the Strip (with completion expected in mid-1994) and has formed a joint venture with a subsidiary of\n- --------------------------------------------------------------------------------\nMGM Grand, Inc. to construct and operate a monorail that will transport passengers between Bally's Las Vegas and The MGM Grand Hotel and Theme Park (with completion expected in mid-1995). These capital improvement projects are expected to cost Bally's Las Vegas approximately $28 million and are intended to increase traffic into its casino. Other major capital projects currently anticipated to commence in 1994 include the renovation of the south tower rooms and corridors, the retail shopping arcade and other common areas which, with other capital expenditures required to maintain Bally's Las Vegas, are estimated to cost approximately $26 million. The Company believes that Bally's Grand, Inc. will be able to satisfy its debt service and capital expenditure requirements in 1994 out of existing cash balances ($97 million at December 31, 1993) and cash flow from operations.\nBALLY'S TUNICA. Construction of Bally's Tunica was completed in early November and operations commenced in December 1993. The total cost to construct and equip Bally's Tunica was approximately $39 million, which was advanced by Casino Holdings and is being repaid out of available cash flow. Bally's Tunica may seek third party financing to enable it to repay part or all of Casino Holdings' advance to Bally's Tunica. However, there can be no assurance that third party financing will be available on terms favorable to Bally's Tunica. Bally's Tunica expects capital expenditures during 1994 to be insignificant.\nOTHER. A subsidiary of Casino Holdings owns a 45% interest in Belle of Orleans, L.L.C. (\"Belle\"). In June 1993, Belle received a Certificate of Preliminary Approval from the Louisiana Riverboat Gaming Commission to commence construction of a riverboat casino facility (including dockside improvements) for operation in New Orleans, Louisiana. In March 1994, the Louisiana Riverboat Gaming Commission awarded Belle a permanent operating license. In August 1993, the Casino Holdings subsidiary entered into a formal operating agreement for the capitalization and development of Belle. Simultaneously, Casino Holdings and Belle entered into a management agreement with a term of five years and an option for a second five-year term granting responsibility for the development and management of Belle to Casino Holdings. Casino Holdings will receive management fees based on a percentage of the earnings of Belle. Construction of the riverboat commenced in January 1994 and operations are expected to begin in February 1995. Management estimates that as much as $75 million will be needed to develop Belle, and anticipates the cost will be funded either through third party financing (there can be no assurance that third party financing will be available on terms favorable to Belle) or by Casino Holdings, though not required to be.\nAnother subsidiary of Casino Holdings has entered into an option agreement to acquire a 31-acre site along the Delaware River in Philadelphia for the purpose of developing a dockside gaming facility (the \"Philadelphia Venture\") if gaming were to be legalized in Pennsylvania. The site includes a 550 foot pier and is easily accessed by three ramps off of a major highway nearby. Pursuant to the terms of the agreement, Casino Holdings has agreed to pay $10 million, consisting of an initial cash payment of $5 million (paid in 1993) and $5 million payable over the next three years. These payments are due whether or not gaming is legalized in Pennsylvania. Additionally, in the event Casino Holdings elects to take title to the property, it will be required to deliver the balance of the purchase price in the form of a pre-payable, non-recourse note for approximately $55 million (including interest) at the closing of the transaction, which is payable in various installments over the five-year period subsequent to the closing of the transaction. Assuming legalization, the closing of the transaction is scheduled for January 1997, unless accelerated by Casino Holdings. Certain of Casino Holdings' obligations under the agreement are guaranteed by Bally.\nTHE GRAND\nThe Grand has no scheduled principal payments on its indebtedness outstanding at December 31, 1993 until 2003. Management expects to make capital expenditures of approximately $15 million in 1994. As of December 31, 1993, The Grand had unused lines of credit totalling $20 million. The Company believes that The Grand will be able to satisfy its debt service and capital expenditure requirements in 1994 out of cash flow from operations.\n- --------------------------------------------------------------------------------\nBALLY'S HEALTH & TENNIS\nBally's Health & Tennis has no scheduled principal payments of public indebtedness until 2003. The Bally's Health & Tennis revolving credit agreement has scheduled reductions of availability totalling $20 million in 1994, however, as of December 31, 1993, $26.6 million of borrowing capacity was available under the credit line. Management expects to make capital expenditures of approximately $30 million in 1994 which will be used primarily for maintaining and refurbishing its present fitness centers, leasehold improvements for 11 planned new fitness centers and acquisition of new fitness equipment. The Company believes that Bally's Health & Tennis will be able to satisfy its debt service and capital expenditure requirements in 1994 out of cash flow from operations.\nThe Bally's Health & Tennis revolving credit agreement requires maintenance by Bally's Health & Tennis of certain financial ratios. Certain provisions of the revolving credit agreement applicable to those financial ratios were amended as of September 30, 1993. Although Bally's Health & Tennis was in compliance with these financial ratio requirements as of December 31, 1993, there can be no assurance that it will not be necessary in the future to amend the financial ratio requirements and, if necessary, that such amendments will be obtained.\nTAX MATTER\nThe IRS has completed an audit of the federal income tax returns of certain of the Company's fitness center subsidiaries for periods ending on the day these subsidiaries were acquired. Among other things, the IRS is asserting that these subsidiaries owe additional taxes of approximately $32 million and substantial amounts of interest with respect to issues arising pursuant to the Company's election in 1983 to treat the purchases of stock of these subsidiaries as if they were purchases of assets. The Company vigorously opposes the IRS' assertions and has filed petitions in the United States Tax Court contesting the IRS' proposed deficiencies with respect to these issues. This matter has been docketed for trial in October 1994, however, a resolution may occur sooner if the Company and the IRS resolve all or some of these issues by stipulation or otherwise. Based on the information presently available, there can be no assurance of the outcome of this matter. However, in the opinion of management, payment, if any, to the IRS of amounts which may be ultimately deemed owing will not have a material adverse effect on the Company's consolidated financial position or results of operations, since the Company believes that it has adequately provided deferred and current taxes related to this matter, although it could, though it is not expected to, have a material adverse effect on the Company's liquidity.\n(This page intentionally left blank)\n- --------------------------------------------------------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX\n- --------------------------------------------------------------------------------\nREPORT OF INDEPENDENT AUDITORS\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS BALLY MANUFACTURING CORPORATION\nWe have audited the accompanying consolidated balance sheet of Bally Manufacturing Corporation as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bally Manufacturing Corporation at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in the \"Summary of significant accounting policies -- Income taxes\" note to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes.\nERNST & YOUNG\nChicago, Illinois February 25, 1994, except for the seventh paragraph of the \"Long-term debt\" note, as to which the date is March 8, 1994\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION CONSOLIDATED BALANCE SHEET\nSee accompanying notes.\n- --------------------------------------------------------------------------------\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS\nSee accompanying notes.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nSee accompanying notes.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Bally Manufacturing Corporation (\"Bally\") and the subsidiaries which it controls (collectively, the \"Company\").\nCertain reclassifications have been made to prior years' financial statements to conform with the 1993 presentation.\nCASH EQUIVALENTS\nThe Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value due to the short maturity of those instruments.\nPROPERTY AND EQUIPMENT\nDepreciation of property and equipment is provided principally on the straight-line method over the estimated economic lives of the related assets and the terms of the applicable leases for leasehold improvements. Depreciation expense was $96,945, $91,564 and $88,765 for 1993, 1992 and 1991, respectively.\nDEFERRED FINANCE COSTS\nDeferred finance costs associated with the Company's debt are being amortized over the terms of the related debt using the bonds outstanding method. Included in \"Other assets\" at December 31, 1993 and 1992 were deferred finance costs of $40,995 and $14,823, respectively, net of accumulated amortization of $12,646 and $11,564, respectively.\nPRE-OPENING COSTS\nPersonnel, marketing and other operating costs incurred that are directly associated with the opening of new casinos are capitalized as pre-opening costs and amortized to expense over the first two calendar quarters of operations. During 1993, pre-opening costs of $6,105 were capitalized, of which $3,052 were amortized.\nINTANGIBLE ASSETS\nIntangible assets consist principally of cost in excess of net assets of acquired businesses (goodwill) and are being amortized on the straight-line method over periods ranging up to forty years from dates of acquisition.\nBally periodically evaluates whether the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. Bally has reviewed and expects to continue to evaluate the goodwill related to its casino and fitness center operations. Based on present operations and strategic plans, Bally believes that no impairment of goodwill has occurred. However, if future operations do not perform as expected, or if Bally's strategic plans for its businesses were to change and independent measures of value reflecting such changed plans indicated an impairment of goodwill, a reduction for impairment may be required.\nREVENUE RECOGNITION\nCasinos\nCasino revenues consist of the net win from gaming activities, which is the difference between gaming wins and losses. Operating revenues exclude the retail value of complimentary food, beverages and hotel services furnished to customers, which were $71,261, $69,177 and $65,061 for 1993, 1992 and 1991, respectively. The estimated costs of providing such complimentary services, which are classified as casino expenses through interdepartment allocations from the departments granting the services, are as follows:\nFitness centers\nThe Company's fitness centers primarily offer a dues membership, which permits members, after paying initial membership fees, to continue membership on a month-to-month basis as long as monthly dues payments are made. Revenues related to dues memberships recorded at the time of sale are limited to the portion allocable to the initial membership fee. Dues memberships also require that monthly payments be made for services provided at which time the revenue is recorded.\nA substantial portion of new membership revenues are collected in installments over periods ranging up to three years. Installment\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\ncontracts bear interest at, or are adjusted for financial accounting purposes at the time the contracts are issued to, rates for comparable consumer financing contracts. Unearned finance charges are amortized over the term of the contracts on the sum-of-the-months-digits method which approximates the interest method.\nMemberships with initial terms of up to three years can also be paid in full. Revenues related to these memberships include both an initial membership fee, which is recorded as revenue at the time of sale, and an annual service fee. The service fee portion of such memberships is recorded as deferred revenues and is realized over the term of the memberships. Prepaid dues and renewals revenues are recorded in a similar manner. This policy approximates the \"selling and service\" method, which provides for a profit being reported for both the selling and service functions.\nINCOME TAXES\nEffective January 1, 1993, the Company changed its method of accounting for income taxes as required by Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 retains the requirement to record deferred income taxes for temporary differences that are reported in different years for financial reporting and for tax purposes; however, the methodology for calculating and recording deferred income taxes has changed. Under the liability method adopted by SFAS No. 109, deferred tax liabilities or assets are computed using the tax rates expected to be in effect when the temporary differences reverse. Also, requirements for recognition of deferred tax assets and operating loss and tax credit carryforwards were liberalized by requiring their recognition when and to the extent that their realization is deemed to be more likely than not. As permitted by SFAS No. 109, the Company elected to use the cumulative effect approach rather than to restate the consolidated financial statements of any prior years to apply the provisions of SFAS No. 109. The cumulative effect on prior years of this change in accounting for income taxes as of January 1, 1993 was a charge of $28,197 ($.61 per share). The effect of this change in accounting for income taxes on the income tax benefit for 1993 was to reduce the income tax benefit by $1,684 as a result of applying the change in the U.S. statutory tax rate from 34% to 35% to deferred tax balances.\nOPERATING COSTS AND EXPENSES -- OTHER, NET\nOperating costs and expenses -- other, net represents: (i) for 1993, the amortization of pre-opening costs totalling $3,052 associated with Bally's Saloon and Gambling Hall dockside gaming facility in Tunica, Mississippi (\"Bally's Tunica\") which commenced operations in December 1993, (ii) for 1992, the elimination of litigation accruals totalling $2,738 relating to matters which were favorably settled and a $1,000 commission on the July 1992 sale by Bally's Grand, Inc. of the casino resort complex formerly known as \"Bally's Reno\" offset by $3,722 of professional fees related to the Company's reorganization and (iii) for 1991, $6,760 of similar professional fees.\nEXTRAORDINARY ITEMS\nIn 1993, three of the Company's subsidiaries completed refinancings of their debt which, in the aggregate, resulted in an extraordinary loss of $8,490, net of income taxes of $5,092 and minority interests of $412. See \"Long-term debt.\"\nIn 1992, the Company utilized tax loss carryforwards to offset taxable income principally arising from the sale of Bally Gaming International, Inc. (\"Gaming\") common stock in July 1992 and the related tax benefit of $10,605 has been reflected as an extraordinary credit. See \"Discontinued operations.\" Also in 1992, the Company purchased $11,471 principal amount of public debt securities of Bally not related to sinking fund requirements for 952,697 shares of Bally Common Stock, par value $.66 2\/3 per share (\"Common Stock\") and $7,900 in cash, which resulted in an extraordinary gain of $612, net of income taxes of $329.\nIn 1991, the Company purchased $157,255 principal amount of public debt securities of Bally and a subsidiary not related to sinking fund requirements for 3,639,000 shares of Common Stock, $33,707 in cash and substantially all of the purchaser's debt securities received by the Company in conjunction with the sale of Life Fitness, Inc. See \"Discontinued operations.\" These purchases resulted in an extraordinary gain of $56,053, net of income taxes of $27,039 and other related costs.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nEARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE\nEarnings (loss) per common and common equivalent share is computed by dividing net income (loss) applicable to common stock by the weighted average number of shares of common stock and common stock equivalents outstanding during each year (46,558,856 in 1993, 41,110,353 in 1992 and 33,872,044 in 1991). Common stock equivalents, which represent the dilutive effect of the assumed exercise of certain outstanding stock options, increased the weighted average number of shares outstanding by 1,645,348 in 1992. The assumed exercise of outstanding stock options was not applicable in 1993 (due to losses) and not significant in 1991.\nACQUISITION OF BALLY'S GRAND, INC.\nOn August 20, 1993 (the \"Effective Date\"), the Fifth Amended Plan of Reorganization (the \"Chapter 11 Plan\") of Bally's Grand, Inc. (a company originally acquired by Bally in 1986 which owns and operates the casino resort in Las Vegas, Nevada known as \"Bally's Las Vegas\") became effective and Bally's Grand, Inc. emerged from bankruptcy. For almost two years prior thereto, Bally's Grand, Inc. operated its business and managed its properties as a debtor-in-possession under chapter 11 of title 11 of the United States Code (the \"Bankruptcy Code\"). On the Effective Date, Bally relinquished all of its equity interest in Bally's Grand, Inc. and Bally's net intercompany receivable from Bally's Grand, Inc. was cancelled and extinguished. Bally's investment in and advances to Bally's Grand, Inc. were written down to zero in 1990. Also, Bally did not provide any type of guarantee or commitment to Bally's Grand, Inc. nor did it assume any other obligation of Bally's Grand, Inc. in connection with the Chapter 11 Plan. Accordingly, the Company did not reflect any equity in earnings of Bally's Grand, Inc. for the period from January 1, 1991 through the Effective Date.\nDuring 1993, Bally's Casino Holdings, Inc. (\"Casino Holdings\") and another subsidiary of Bally acquired approximately 5.2 million shares (approximately 50% of the shares presently outstanding) of reorganized Bally's Grand, Inc. common stock in several transactions in exchange for $41,714 in cash and 1,752,400 shares of Gaming common stock. The acquisitions of Bally's Grand, Inc. common stock have been recorded using the purchase method of accounting, and the excess of the purchase price over the estimated fair value of net assets acquired of $19,354 is being amortized using the straight-line method over 20 years. Bally's Grand, Inc. has been consolidated since December 1, 1993 as a result of Bally's controlling interest. From September 29, 1993 (the date a cumulative 20% equity interest in reorganized Bally's Grand, Inc. was attained) through November 30, 1993, Bally's investment in Bally's Grand, Inc. was recorded on the equity method of accounting. The equity in earnings of reorganized Bally's Grand, Inc. recognized during that period was $786.\nCertain employees of Bally and certain of its subsidiaries are involved in the management and operations of Bally's Grand, Inc. For services provided to Bally's Grand, Inc. prior to the Effective Date, Bally was paid $1,427, $2,247 and $3,640 during 1993, 1992 and 1991, respectively. Following the Effective Date, such services, among other things, are provided to reorganized Bally's Grand, Inc. under a management agreement pursuant to which a subsidiary of Bally receives $3,000 annually.\nThe following unaudited pro forma summary consolidated results of operations of the Company for 1993 and 1992 were prepared to give effect to the acquisition of the controlling interest in reorganized Bally's Grand, Inc. as if the acquisition had occurred as of the beginning of each of the years presented. These pro forma results have been prepared for comparative purposes only and do not purport to present what the Company's results of operations would actually have been if the acquisition had in fact occurred at such dates or to project the Company's results of operations for any future year. In addition, the pro forma summary consolidated results of operations of the Company include adjustments to the historical results of operations of Bally's Grand, Inc. which principally reflect: (i) the elimination of the operating results of Bally's Reno, (ii) the elimination of the reorganization items of Bally's Grand, Inc., (iii) the effects of transactions related to the reorganization of Bally's Grand, Inc. pursuant to the Chapter 11 Plan, (iv) the effects of the adoption of \"fresh-start reporting\" and\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\n(v) the income tax effects of the pro forma adjustments. The pro forma summary consolidated results of operations are based upon available information and upon certain assumptions that management believes are reasonable.\nRECEIVABLES\nThe carrying amount of the Company's receivables at December 31, 1993 and 1992 approximates fair value. The fair value of fitness center installment contracts is based on discounted cash flow analyses, using interest rates in effect at the end of the year comparable to similar consumer financing contracts. The fair value of other receivables approximates their carrying amount.\nACCRUED LIABILITIES\nLONG-TERM DEBT\nThe carrying amounts of the Company's long-term debt at December 31, 1993 and 1992 are as follows:\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nThe indentures for Bally's debt do not contain cross-default provisions. However, the indentures and credit agreements related to the indebtedness of certain of Bally's subsidiaries require, among other things, that these subsidiaries maintain certain financial ratios and restrict the amount of additional indebtedness that can be incurred. Bally has not guaranteed the payment of principal or interest under the publicly traded debt securities and credit agreements of its subsidiaries.\nThe Bally 6% Convertible Subordinated Debentures due 1998 (the \"6% Debentures\") require annual sinking fund payments of $2,587 through 1997, which will retire 75% of these debentures prior to maturity. The Company may redeem these debentures at any time, in whole or in part, without premium. At any time prior to maturity or redemption, these debentures are convertible into Common Stock (current conversion price of $28.99 per share, subject to adjustment for certain subsequent changes in the Company's capitalization). In 1993, the Company purchased $2,587 principal amount of these debentures to satisfy the 1993 sinking fund requirement, which resulted in a pre-tax gain of $495 (included in \"Other revenues\").\nThe Bally 10% Convertible Subordinated Debentures due 2006 (the \"10% Debentures\") require annual sinking fund payments of $5,000 through 2005, which will retire 75% of these debentures prior to maturity. The Company may redeem these debentures at any time, in whole or in part, with premiums ranging from 1.96% at December 31, 1993 to zero in December 1996 and thereafter. At any time prior to maturity or redemption, these debentures are convertible into Common Stock (current conversion price of $32.68 per share, subject to adjustment for certain subsequent changes in the Company's capitalization). In 1993, the Company purchased $617 principal amount of these debentures to satisfy the remaining 1993 sinking fund requirement, which resulted in a pre-tax gain of $101 (included in \"Other revenues\").\nThe payment of the 6% Debentures and 10% Debentures is subordinated to the prior payment, in full, of all senior indebtedness of Bally, as defined (approximately $20,190 at December 31, 1993). In addition, almost all of the Company's business is conducted through subsidiaries and claims of creditors of subsidiaries are effectively senior to these debentures.\nIn June 1993, Casino Holdings issued $220,000 principal amount of Senior Discount Notes due 1998 (the \"Senior Discount Notes\") at a discount to yield an interest rate of 10 1\/2%. The Senior Discount Notes are not subject to any sinking fund requirement, but may be redeemed at any time, in whole or in part, at their accreted value plus a \"make-whole premium,\" as defined. In addition, on or before June 15, 1996, a portion of the Senior Discount Notes may be redeemed with premiums ranging from 8.0% of the accreted value prior to June 15, 1994 to 4.8% of the accreted value on June 15, 1996 out of the proceeds of an initial public offering by Casino Holdings if such offering were to occur, provided that at least $154,000 principal amount of the Senior Discount Notes remains outstanding after the redemption. The net proceeds from the issuance of the Senior Discount Notes were approximately $127,900, which have been and are being used to: (i) construct and equip Bally's Tunica, (ii) acquire a significant equity interest in Bally's Las Vegas, (iii) fund initial payments for construction of a riverboat (including dockside improvements) for eventual operation in New Orleans, Louisiana, (iv) fund an option agreement to acquire certain riverfront property in Philadelphia for the purpose of developing a dockside gaming facility if gaming were to be legalized in Pennsylvania and (v) pursue other gaming opportunities. The Senior Discount Notes are effectively subordinated to all liabilities of Casino Holdings' subsidiaries, which were $779,585 at December 31, 1993.\nOn March 8, 1994, a subsidiary of Bally's Park Place, Inc. (\"Bally's Park Place\") issued $425,000 principal amount of 9 1\/4% First Mortgage Notes due 2004 (the \"9 1\/4% Notes\"). The 9 1\/4% Notes are not subject to any sinking fund requirement, but may be redeemed beginning March 1999, in whole or in part, with premiums ranging from 4.5% in 1999 to zero in 2002 and thereafter. In addition, on or before March 15, 1997, a portion of the 9 1\/4% Notes may be redeemed at a premium of 9.25% out of the proceeds of one or more public equity offerings by Bally's Park Place or Casino Holdings if such offerings were to occur, provided that at least $100,000 principal amount of the 9 1\/4% Notes remains outstanding after the redemption. The\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\n9 1\/4% Notes are secured by a first mortgage on and security interest in substantially all property and equipment at Bally's Park Place, which had a net book value of $486,498 at December 31, 1993. Bally's Park Place used the net proceeds from the sale of the 9 1\/4% Notes to purchase and retire certain of its 11 7\/8% First Mortgage Notes due 1999 (the \"11 7\/8% Notes\"), defease the remaining 11 7\/8% Notes at a price of 104.45% of their principal amount plus accrued interest through the redemption date, thereby satisfying all obligations thereunder, and pay a $30,000 dividend to Casino Holdings. The retirement and defeasance of the 11 7\/8% Notes results in an extraordinary loss in the first quarter of 1994 of approximately $20,500, net of income taxes of approximately $14,300. In connection with the sale of the 9 1\/4% Notes, Bally's Park Place terminated its existing credit facility and entered into an agreement for a new $50,000 revolving credit facility which expires on December 31, 1996, at which time all amounts outstanding become due. The new credit facility provides for interest on borrowings payable, at Bally's Park Place's option, at the agent bank's prime rate or the LIBOR rate plus 2%, each of which increases as the balance outstanding increases. The rate of interest on borrowings was previously based upon the agent bank's prime rate or certain other short-term rates (6% at December 31, 1993). Bally's Park Place pays a fee of 1\/2% on the unused commitment. The new credit facility is secured by a pari passu lien on the collateral securing the 9 1\/4% Notes.\nIn March 1993, a subsidiary of GNAC, CORP. (which owns and operates the casino resort in Atlantic City known as \"The Grand\") issued $275,000 principal amount of 10 5\/8% First Mortgage Notes due 2003 (the \"10 5\/8% Notes\") at a discount to yield an interest rate of 10 3\/4%. The 10 5\/8% Notes are not subject to any sinking fund requirement, but may be redeemed beginning April 1998, in whole or in part, with premiums ranging from 5.25% in 1998 to zero in 2001 and thereafter. The 10 5\/8% Notes are secured by a first mortgage on and security interest in substantially all property and equipment of GNAC, CORP., which had a net book value of $280,960 at December 31, 1993. GNAC, CORP. used the net proceeds from the sale of the 10 5\/8% Notes, together with the collection of certain funds on deposit with Bally's Park Place, to redeem its 13 1\/4% Mortgage-Backed Notes due 1995 (the \"13 1\/4% Notes\") at a price of 102.94% of their principal amount plus accrued interest, thereby satisfying all obligations thereunder. The redemption of the 13 1\/4% Notes resulted in an extraordinary loss of $2,091, net of income taxes of $1,405. During April 1993, GNAC, CORP. entered into an agreement with two banks for a $20,000 revolving credit facility. This credit facility has a term of two years, provides for interest on borrowings at the rate of 1% above the banks' stated prime rates and is secured by a pari passu lien on the collateral securing the 10 5\/8% Notes. GNAC, CORP. pays a fee of 1\/2% on the unused commitment.\nIn December 1993, Bally's Grand, Inc. issued $315,000 principal amount of 10 3\/8% First Mortgage Notes due 2003 (the \"10 3\/8% Notes\"). The 10 3\/8% Notes are not subject to any sinking fund requirement, but may be redeemed beginning December 1998, in whole or in part, with premiums ranging from 5.19% in 1998 to zero in 2001 and thereafter. In addition, on or before December 15, 1996, a portion of the 10 3\/8% Notes may be redeemed at a premium of 9.375% out of the proceeds of one or more public equity offerings by Bally's Grand, Inc. if such offerings were to occur, provided that at least $100,000 principal amount of the 10 3\/8% Notes remains outstanding after the redemption. The 10 3\/8% Notes are secured by a first priority lien on the fee interests in the approximately thirty-acre site comprising Bally's Las Vegas and by a security interest in certain personal property of Bally's Grand, Inc., which together had a net book value of $331,448 at December 31, 1993. Bally's Grand, Inc. used a substantial portion of the net proceeds from the issuance of the 10 3\/8% Notes to redeem its 12% First Mortgage Notes due 2001 (the \"12% Notes\") at a price of 103% of their principal amount plus accrued interest, thereby satisfying all obligations thereunder, and to pay approximately $9,000 to Bally under a tax sharing agreement between Bally's Grand, Inc. and Bally, which amount became due and payable in connection with the redemption of the 12% Notes. The remaining proceeds are primarily being used for capital expenditures. The redemption of the 12% Notes resulted in an extraordinary loss of $400, net of income taxes of $438 and minority interests of $412.\nThe Bally's Health & Tennis Corporation (\"Bally's Health & Tennis\") revolving credit agreement,\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nwhich was amended in January 1993, provides for borrowings of up to $107,500 and letters of credit up to $20,000 at December 31, 1993. The commitment under the revolving credit facility is reduced by $5,000 during each quarter of 1994 and by increasing amounts thereafter through December 31, 1997. The rate of interest on the borrowings (blended rate of 6 3\/4% at December 31, 1993) is at Bally's Health & Tennis' option, based upon either the agent bank's prime rate plus 1 3\/4% or the Euro-dollar rate plus 3 1\/4%. Bally's Health & Tennis pays an annual fee of 1\/2% on the unused commitment. Outstanding letters of credit as of December 31, 1993 totalled $11,370, for which Bally's Health & Tennis pays an annual fee of 1 3\/4% on outstanding letters of credit and a fee of 1\/2% on the unused commitment. The revolving credit agreement is secured by substantially all real and personal property of Bally's Health & Tennis, which had a net book value of $759,848 at December 31, 1993, and a pledge of the stock of Bally's Health & Tennis. The Bally's Health & Tennis revolving credit agreement requires maintenance by Bally's Health & Tennis of certain financial ratios. Certain provisions of the revolving credit agreement applicable to those financial ratios were amended as of September 30, 1993. Although Bally's Health & Tennis was in compliance with these financial ratio requirements as of December 31, 1993, there can be no assurance that it will not be necessary in the future to amend the financial ratio requirements and, if necessary, that such amendments will be obtained.\nAlso in January 1993, Bally's Health & Tennis issued $200,000 principal amount of 13% Senior Subordinated Notes due 2003 (the \"13% Notes\"). The 13% Notes are not subject to any sinking fund requirement, but may be redeemed beginning January 1998, in whole or in part, with premiums ranging from 6.5% in 1998 to zero in 2000 and thereafter. The payment of the 13% Notes is subordinated to the prior payment in full of all senior indebtedness of Bally's Health & Tennis, as defined ($124,463 at December 31, 1993). Bally's Health & Tennis used the net proceeds from the sale of the 13% Notes to prepay $101,500 of indebtedness under the Bally's Health & Tennis revolving credit agreement, redeem $69,505 principal amount of its 13 5\/8% Senior Subordinated Debentures due 1997 (the \"13 5\/8% Debentures\") at a price of 105.71% of their principal amount plus accrued interest, thereby satisfying all obligations thereunder, and pay a $15,000 dividend to Bally. The redemption of the 13 5\/8% Debentures and the amendment to the revolving credit agreement resulted in an extraordinary loss of $5,999, net of income taxes of $3,249.\nOther secured and unsecured obligations are payable through 2018 and are collateralized by land, buildings and equipment which have a net book value of $43,395 at December 31, 1993. Interest rates averaged 8% at December 31, 1993.\nDIVIDEND RESTRICTIONS\nEach of Bally's principal subsidiaries presently have debt covenants which limit the payment of dividends to Bally. Under the terms of the Senior Discount Notes, an amount equal to certain dividends paid pursuant to a net income test by Bally's Park Place to Casino Holdings may be declared as a dividend by Casino Holdings and paid to Bally. In February 1994, Bally's Park Place declared and paid a $595 dividend (amount of unrestricted retained earnings at December 31, 1993) to Casino Holdings which subsequently declared and paid a dividend in the same amount to Bally. In addition, Bally's Park Place paid a $30,000 dividend to Casino Holdings from a portion of the proceeds of the sale of the 9 1\/4% Notes in March 1994, which is not available to be paid by Casino Holdings to Bally. In connection with the sale of the 9 1\/4% Notes, the New Jersey Casino Control Commission (the \"New Jersey Commission\") requires, among other things, that the payment of certain dividends by Bally's Park Place to Casino Holdings which are not based on net income receive prior approval from the New Jersey Commission. GNAC, CORP. and Bally's Health & Tennis are not expected to be able to pay dividends to Bally in 1994. Also, the terms of the 10 3\/8% Notes limit the ability of Bally's Grand, Inc. to pay dividends, and no dividends are expected to be paid in 1994.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nAnnual maturities\nAggregate annual maturities of long-term debt for the five years after December 31, 1993 (adjusted for the Bally's Park Place refinancing described above) are as follows:\nFair value\nThe fair value of the Company's long-term debt at December 31, 1993 and 1992 was $1,520,926 and $1,013,552, respectively. The fair value of publicly traded debt securities is based on quoted market prices. The fair value of borrowings under revolving credit agreements and of other secured and unsecured obligations approximates their carrying amount.\nINCOME TAXES\nThe income tax benefit applicable to loss from continuing operations before income taxes and minority interests consists of the following:\nDeferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1993 and January 1, 1993, along with their classification, are as follows:\nBased on federal income tax returns as filed, as adjusted for certain agreements with the Internal Revenue Service (\"IRS\"), the Company had federal net operating loss carryforwards of approximately $185,000, which expire in 2006, and Alternative Minimum Tax (\"AMT\") credits of approximately $41,000, which have no expiration. The Company also has substantial state tax loss carryforwards which begin to expire in 1994 and fully expire in 2008. Because of complex issues involved in the Company's tax situation and the Company's present expectations of ultimate settlements with the IRS, the Company has provided a valuation allowance for substantially all of the federal and state tax loss carryforwards and a portion of its AMT credits.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nThe deferred income tax provision (benefit) applicable to loss from continuing operations before income taxes and minority interests for 1992 and 1991 arises from the tax effect of timing differences as follows:\nA reconciliation of the income tax benefit with amounts determined by applying the U.S. statutory tax rate to loss from continuing operations before income taxes and minority interests is as follows:\nThe IRS has completed an audit of the federal income tax returns of certain of the Company's fitness center subsidiaries for periods ending on the day these subsidiaries were acquired. Among other things, the IRS is asserting that these subsidiaries owe additional taxes of approximately $32,000 and substantial amounts of interest with respect to issues arising pursuant to the Company's election in 1983 to treat the purchases of stock of these subsidiaries as if they were purchases of assets. The Company vigorously opposes the IRS' assertions and has filed petitions in the United States Tax Court contesting the IRS' proposed deficiencies with respect to these issues. This matter has been docketed for trial in October 1994; however, a resolution may occur sooner if the Company and the IRS resolve all or some of these issues by stipulation or otherwise. Based on the information presently available, there can be no assurance of the outcome of this matter. However, in the opinion of management, payment, if any, to the IRS of amounts which may be ultimately deemed owing will not have a material adverse effect on the Company's consolidated financial position or results of operations, since the Company believes that it has adequately provided deferred and current taxes related to this matter, although it could, though it is not expected to, have a material adverse effect on the Company's liquidity.\nSTOCKHOLDERS' EQUITY\nPreferred stock\nThe Series B Junior Participating Preferred Stock, par value $1 per share (the \"Series B Junior Stock\"), if issued, will have a minimum preferential quarterly dividend of $5 per share, but will be entitled to an aggregate dividend of 100 times the dividend declared on shares of Common Stock. Each share of Series B Junior Stock will have 100 votes, voting together with Common Stock, except as Delaware law may otherwise provide. In the event of liquidation, the holders of Series B Junior Stock will receive a preferred liquidation payment of $100 per share, but will be entitled to receive an aggregate liquidation payment equal to 100 times the payment made per share of Common Stock.\nThe Series D Convertible Exchangeable Preferred Stock, par value $1 per share (the \"Preferred Stock\"), with a face value of $34,725 as of December 31, 1993, bears a dividend rate of 8%. The holders of Preferred Stock do not have voting rights, except that the holders would have the right to elect two additional directors of Bally if dividends on the Preferred Stock are in arrears\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nin an amount equal to at least six quarterly dividends and except as Delaware law may otherwise provide. The Preferred Stock is redeemable, in whole or in part, at the option of Bally at $51.60 per share as of December 31, 1993, declining each February 1 in equal annual amounts to $50 per share on and after February 1, 1997, in each case plus accrued and unpaid dividends. The Preferred Stock is convertible into Common Stock at a price of $25 per share, equivalent to a conversion rate of two shares of Common Stock for each share of Preferred Stock, subject to adjustment. The Preferred Stock is exchangeable at the option of Bally, in whole but not in part, on any dividend payment date for 8% Convertible Subordinated Debentures due February 1, 2007. In the event of liquidation, the holders of the Preferred Stock will receive a preferred liquidation payment of $50 per share, plus an amount equal to any dividends accrued and unpaid to the payment date, before any distribution is made to holders of junior securities.\nCOMMON STOCK\nAt December 31, 1993, shares of Common Stock were reserved for future issuance as follows:\nSTOCK PLANS, AWARDS AND RIGHTS\nINCENTIVE PLANS\nIn May 1989, the stockholders approved the 1989 Incentive Plan of Bally (the \"1989 Plan\") for officers and key employees that provides for the grant of stock options, stock appreciation rights (\"SARs\"), stock depreciation rights (\"SDRs\") and restricted stock (collectively \"Awards\"). In June 1992, the stockholders approved an increase in the number of shares of Common Stock available for issuance under the 1989 Plan from 2,500,000 shares to 4,000,000 shares. Amendments to the 1989 Plan increasing the aggregate number of shares of common stock which may be sold or delivered under the 1989 Plan from 4,000,000 to 6,022,000 shares and limiting the number of stock options, stock appreciation rights or stock options in tandem with stock appreciation rights that may be granted during any one calendar year to certain executive officers of the Company are subject to stockholder approval in 1994. No Awards may be granted after March 9, 1999.\nThe 1989 Plan provides for granting incentive as well as non-qualified stock options. Generally, non-qualified stock options will be granted with an option price equal to the fair market value of the stock at the date of grant. Incentive stock options must be granted at not less than the fair market value of the stock at the date of grant. Option grants generally become exercisable in three equal annual installments commencing one year after the date of grant, but the Compensation and Stock Option Committee of the Board (\"Compensation Committee\"), in its discretion, may alter such terms.\nSARs are rights granted to an officer or key employee to receive shares of stock and\/or cash in an amount equal to the excess of the fair market value of the stock on the date the SARs are exercised over the fair market value of the stock on the date the SARs were granted or, at the discretion of the Compensation Committee, the date the option was granted, if granted in tandem with an option granted on a different date. Upon exercise of stock appreciation rights, the optionee surrenders the related option in exchange for payment, in cash, of the excess of the fair market value on the date of surrender over the option price.\nSDRs are rights granted to an officer or key employee in conjunction with an option to receive a payment of stock and\/or cash equal to the excess, if any, of the option price of stock acquired on the exercise of the related option over the greater of: (i) the fair market value of the stock, as of the date six months and one day after the option was exercised (or such other date as the Compensation Committee, in its discretion, shall determine), or (ii) if such stock was sold prior to such date, the gross sale proceeds from the sale of such stock. Stock options, SARs and SDRs granted under the 1989\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nPlan may be exercisable for a term of not more than ten years after the date of grant. At December 31, 1993, no SDRs had been granted and Bally has no current intention of granting SDRs under the 1989 Plan.\nRestricted stock awards are rights granted to an employee to receive shares of stock without payment but subject to forfeiture and other restrictions as set forth in the 1989 Plan. Generally, the restricted stock awarded, and the right to vote such stock or to receive dividends thereon, may not be sold, exchanged or otherwise disposed of during the restricted period. Except as otherwise determined by the Compensation Committee, the restrictions and risks of forfeiture will, after one year from the date of grant, lapse as to not more than 20% of the stock originally awarded, after two years lapse as to an aggregate of not more than 40% of the stock originally awarded, and after three years shall lapse as to all the stock originally awarded. There have been no restricted stock awards granted under this plan since 1989 and there are no shares outstanding with restrictions under this plan at December 31, 1993.\nIn October 1993, the Board of Directors of the Company adopted, subject to stockholder approval in 1994, the 1993 Non-Employee Directors' Stock Option Plan of Bally Manufacturing Corporation (the \"1993 Plan\"). The 1993 Plan provides for the grant of non-qualified stock options to purchase an aggregate of 120,000 shares of Common Stock to directors of the Company who are not officers or key employees of Bally or any of its subsidiaries. Under this plan, stock options are granted with an option price equal to the fair market value of the stock on the date of grant. Option grants generally become exercisable in three equal annual installments commencing one year after the date of grant, with such options expiring ten years after the date of grant. No options may be granted under this plan after October 13, 1998.\nThe Company also has a non-qualified and incentive stock option and stock appreciation rights plan for officers and key employees (the \"1985 Plan\") which has been terminated except as to options and stock appreciation rights outstanding, all of which are vested.\nA summary of 1993 stock option activity under the 1989 Plan, the 1993 Plan and the 1985 Plan is as follows:\nAt December 31, 1993, options on 2,296,018 shares were exercisable and 1,103,459 shares and 80,000 shares were reserved for future grants under the 1989 Plan and 1993 Plan, respectively. Outstanding options at December 31, 1993 expire between 1994 and 2003. Included in the stock options outstanding at December 31, 1993 are options for 1,416,666 shares (options for 250,000 shares were exercised during 1993) comprising non-qualified stock options the Company granted in 1991 to two executives to each purchase 1,000,000 shares of Common Stock at an exercise price of $2 per share less than the fair market value of Common Stock at the date of grant. The awards also provided for accelerated vesting under certain circumstances. During the first quarter of 1993, the required circumstances were met, and the related compensation expense, which was being amortized over the three-year vesting period of the awards, was fully expensed.\nIn December 1993, Bally's Board of Directors adopted, subject to stockholder approval in 1994, the Bally's Employee Stock Purchase Plan (the \"Stock Purchase Plan\"). The Stock Purchase Plan provides for the purchase of an aggregate of 200,000 shares of Common Stock by eligible employees (as defined) electing to participate in the plan. The stock can generally be purchased every six months at a price equal to the lesser of: (i) 85% of the fair market value of the stock on the date when a particular offering begins or (ii) 85% of the fair market value of the stock on the date when a particular offering terminates. On each offering made under the Stock Purchase Plan, each eligible employee electing to\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nparticipate in the Stock Purchase Plan will automatically be granted shares of Common Stock equal to the number of full shares which may be purchased from the employee's elected payroll deduction, with a maximum payroll deduction equal to 10% of eligible compensation, as defined. Assuming stockholder approval, the first offering under this plan commences on July 1, 1994 and the last offering terminates on June 30, 2004.\nAWARDS OF SUBSIDIARY STOCK\nDuring 1993, 600,000 shares of reorganized Bally's Grand, Inc. common stock were awarded to certain employees of Bally's Grand, Inc. (300,000 shares) and certain executive officers of Bally who also serve as executive officers of Bally's Grand, Inc. (300,000 shares) pursuant to the Bally's Grand, Inc. 1993 Incentive Stock Plan. The shares awarded to employees of Bally's Grand, Inc. are subject to forfeiture if the employee's employment by Bally's Grand, Inc. is terminated and are subject to restrictions which lapse as to approximately one-third of the shares awarded on each of December 31, 1993, 1994 and 1995 and the fair value of such shares on the date of award is being charged to expense over such period. The shares awarded to executive officers of Bally were not subject to restrictions and, accordingly, the fair value of the awards was expensed in 1993. In December 1993, the executive officers of Bally sold the shares of Bally's Grand, Inc. common stock awarded to them to a subsidiary of Bally at the fair market value of the shares at the date of sale.\nRIGHTS TO PURCHASE PREFERRED STOCK\nOne preferred stock purchase right is attributable to each outstanding share of Common Stock. Under certain conditions, each right may be exercised to purchase for $60 one 1\/100th of a share of Series B Junior Stock. The rights are not exercisable or transferable apart from the stock until the occurrence of one of the following: (i) ten days after the date (\"Stock Acquisition Date\") of a public announcement by a person or a group of beneficial ownership of 20% or more of Common Stock (an \"Acquiring Person\"), (ii) ten business days after a public announcement by a person or group of a tender offer for 30% or more of Common Stock, or (iii) the occurrence of a Flip-In Event. A Flip-In Event is any of: (i) a final court or administrative order finding that a person or group having beneficial ownership of 10% or more of Common Stock (a \"10% Stockholder\") has violated Nevada or New Jersey gaming, casino or similar laws in connection with such 10% Stockholder's interest in the Company, (ii) the failure of a 10% Stockholder to eliminate or reduce to an acceptable level its beneficial ownership of Common Stock within 20 days after a final court or administrative order finding that such 10% Stockholder is unsuitable or unqualified to hold its interest in the Company, (iii) the acquisition by a person or group of 20% or more of Common Stock without having obtained prior Nevada Gaming Commission approval to acquire control of the Company, and (iv) the consummation of certain \"self-dealing\" transactions between an Acquiring Person and the Company, including a merger with an Acquiring Person in which Bally is the surviving corporation and Common Stock is not changed or exchanged. Upon the occurrence of a Flip-In Event, each right, other than those held by the Acquiring Person or 10% Stockholder causing such occurrence, will entitle the holder to purchase shares of Common Stock or, in certain cases, other assets or securities of the Company having a value of $120 for $60. In the event that the Company is acquired in a merger or other business combination transaction (other than a merger with an Acquiring Person in which the Company is the surviving corporation and Common Stock is not changed or exchanged) or 50% or more of the Company's assets or earning power is sold or transferred, each holder of a right shall have the right to receive, upon exercise, common stock of the acquiring company having a calculated value equal to twice the purchase price of the right. The rights, which do not have voting privileges, are subject to adjustment to prevent dilution, expire on December 4, 1996 and may be redeemed by the Company at a price of five cents per right at any time until 20 days (subject to extension by the Board) following the Stock Acquisition Date.\nEMPLOYEE BENEFIT PLANS\nBally and certain subsidiaries sponsor employee savings plans which cover certain full-time employees and which are considered part of the Company's overall retirement program. Pursuant to these savings plans, participating employees may contribute (defer) a percent of eligible\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\ncompensation. Employee contributions to the savings plans, up to certain limits, are partially matched by the Company. The expense applicable to continuing operations for the Company's savings plans and a profit-sharing plan which was terminated on January 1, 1993 was $5,243, $3,724 and $5,082 for 1993, 1992 and 1991, respectively.\nIn addition, Bally and Bally's Park Place have noncontributory supplemental executive retirement plans for certain key executives. Normal retirement under these plans is age 60 to 65 and participants receive benefits based on years of service and compensation. Pension costs of these plans are unfunded except for one executive's benefits which are funded through annual contributions to a trust. Net periodic pension cost for these plans was $4,482, $1,627 and $6,664 for 1993, 1992 and 1991, respectively. The accrued pension liability related to the unfunded supplemental executive retirement plans in the consolidated balance sheet (principally classified as long-term) was $9,994 and $6,890 at December 31, 1993 and 1992, respectively. The weighted average discount rate and rate of increase in future compensation levels used in determining actuarial present value of the projected benefit obligations were 6.1% and 6.0% in 1993, 8.1% and 6.0% in 1992 and 8.3% and 5.5% in 1991.\nIn 1991, Bally's Park Place and one of its executives entered into an agreement to terminate the executive's participation in a noncontributory supplemental executive retirement plan sponsored by the subsidiary. Pursuant to this agreement, the subsidiary agreed to pay the executive $27,600 over five years. The subsidiary recorded the settlement in an amount equal to the net present value of the required payments. No charge against operations in 1991 was required, as the subsidiary had fully accrued in prior years the value of this settlement as part of its pension liability. The net present value of the remaining payments under this termination agreement was $16,042 at December 31, 1992. On January 8, 1993, Bally and Bally's Park Place entered into a retirement and separation agreement with this executive which, among other things, reduced the remaining amount payable under the termination agreement to $13,500, which Bally's Park Place paid on such date.\nCertain employees of the Company's casinos are covered by union-sponsored, collectively bargained, multiemployer defined benefit pension plans. The contributions and charges to expense for these plans were $1,314, $942 and $915 in 1993, 1992 and 1991, respectively.\nCOMMITMENTS AND CONTINGENCIES\nLEASES\nMinimum future rent payments totalling $918,254 under commitments for noncancellable operating leases with initial terms in excess of one year in effect at December 31, 1993, principally for fitness center facilities, are payable $77,874, $76,204, $73,493, $72,017 and $70,073 in 1994 through 1998 and $548,593 thereafter. Rent expense was $80,514, $74,891 and $74,046 for 1993, 1992 and 1991, respectively.\nLITIGATION\nSeveral purported derivative actions originally filed against Bally and certain of its current and former directors and officers have been consolidated. The consolidated complaint seeks, among other things, unspecified damages and compensatory and punitive damages and costs in connection with allegations of breach of fiduciary duty, corporate mismanagement, and waste of corporate assets in connection with certain actions including, among others, payment of compensation, certain acquisitions by Bally, the dissemination of allegedly materially false and misleading information, the proposed restructuring of debt, and a subsidiary's allegedly discriminatory practices. The Company is also involved in various other matters of litigation as both plaintiff and defendant. Management believes, based upon the advice of its counsel, that the ultimate disposition of these matters will not have a materially adverse effect on the Company's consolidated financial statements.\nDISCONTINUED OPERATIONS\nIn September 1993, the Company disposed of its remaining 1,752,400 shares of Gaming common stock pursuant to stock exchange agreements. This disposition, including the recognition of previously deferred cumulative translation adjustment credits of $2,506, resulted in a net gain of $6,215, including an income tax benefit of $1,452. The income tax benefit resulted from the utilization of tax loss carryforwards to offset taxable income arising from this disposition of\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\nGaming common stock, and is included in income from discontinued operations. In 1992 and 1991, the Company sold 4,547,600 shares and 3,000,000 shares, respectively, of Gaming common stock it owned in public offerings and received net proceeds of $51,243 and $33,300, respectively, which, including the recognition of previously deferred cumulative translation adjustment credits of $7,922 and $4,263, respectively, resulted in a net gain of $6,706 and $5,219, respectively, net of income taxes of $8,529 and $3,807, respectively, and other related costs. As a result of the Company's disposal of its investment in Gaming, the consolidated financial statements reflect Gaming as a discontinued operation. Income from discontinued operations in 1992 and 1991 also includes equity in earnings of Gaming of $2,879 and $4,644, respectively. Gaming's revenues in 1992 and 1991 were $163,781 and $153,648, respectively.\nAlso in 1991, the Company sold the assets of its Life Fitness, Inc. computerized fitness equipment business and Scientific Games, Inc. lottery business in separate transactions for a total consideration of approximately $100,000, of which approximately $69,500 was paid in cash and the remainder was paid in the form of a new issue of one of the purchaser's debt securities. These sales resulted in a net gain of $18,010, net of income taxes of $18,172 and other related costs. The Company subsequently exchanged substantially all of the purchaser's debt securities received by the Company in connection with one of the sales and 800,000 shares of Common Stock with a third party for approximately $48,400 principal amount of public debt securities of Bally and one of its subsidiaries that were held by the third party, which resulted in an extraordinary gain of $10,800, net of income taxes of $4,800 and other related costs. See \"Extraordinary items.\" The income from operations of these businesses has also been reflected as discontinued operations in the consolidated financial statements. Sales and income from operations of these businesses totalled $126,481 and $5,290 (after income taxes of $4,297), respectively, prior to their disposal dates in 1991.\nINDUSTRY SEGMENTS\nThe Company operates in two segments: (i) Casinos -- includes the operation of two casino hotels in Atlantic City, New Jersey, a casino resort in Las Vegas, Nevada and a dockside gaming facility in Tunica, Mississippi; and (ii) Fitness centers -- includes the operation of 339 fitness centers. Revenues and assets of operations outside the United States are insignificant.\nDuring 1991, Bally began allocating its corporate overhead (including executive salaries and benefits, public company reporting costs and other corporate headquarters' costs) to its subsidiaries. Bally's method for allocating costs to its subsidiaries is designed to apportion its costs to its subsidiaries based upon many subjective factors including size of operations and extent of Bally's oversight requirements. The allocations by Bally to its subsidiaries for 1993, 1992 and 1991 totalled $8,732, $9,591 and $9,175, respectively.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (ALL DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SUPPLEMENTARY DATA QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)\n- ---------------\nNOTES:\n1. The quarterly consolidated financial information reflects Bally Gaming International, Inc. (\"Gaming\") as a discontinued operation as a result of the Company's disposition of its remaining investment in September 1993.\n2. Income from continuing operations for the quarters ended March 31 and June 30, 1993 includes gains of $.2 million and $.2 million, respectively, resulting from market purchases of the Company's public debt for sinking fund requirements.\n3. Loss from continuing operations for the quarter ended September 30, 1993 includes a charge of $1.7 million ($.04 per share) as a result of applying the change in the U.S. statutory tax rate from 34% to 35% to deferred tax balances.\n4. Loss from continuing operations for the quarter ended December 31, 1993 includes a charge of $1.9 million ($.04 per share) for the amortization of pre-opening costs associated with Bally's Saloon and Gambling Hall which commenced operations in December 1993.\n5. Income from discontinued operations for the quarter ended September 30, 1993 represents a gain from the sale of Gaming common stock.\n6. The extraordinary losses for the quarters ended March 31 and December 31, 1993 are due to early redemptions of debt.\n7. The cumulative effect on prior years of change in accounting for income taxes for the quarter ended March 31, 1993 is a result of the Company changing its method of accounting for income taxes (effective January 1, 1993) as required by Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" As permitted by SFAS No. 109, the Company elected to use the cumulative effect approach rather than to restate the financial statements of any prior years to apply the provisions of SFAS No. 109.\n8. Income from continuing operations for the quarters ended March 31 and September 30, 1992 includes gains of $2.5 million ($.07 per share) and $.4 million ($.01 per share), respectively, resulting from market purchases of the Company's public debt for sinking fund requirements.\n9. Income (loss) from continuing operations for the quarters ended March 31 and December 31, 1992 includes the elimination of litigation accruals relating to matters which were favorably settled amounting to $1.0 million ($.03 per share) and $1.2 million ($.03 per share), respectively.\n- --------------------------------------------------------------------------------\n10. Income from continuing operations for the quarter ended September 30, 1992 includes charges for professional fees related to the Company's reorganization of $3.2 million ($.08 per share) offset, in part, by a commission on the July 1992 sale by Bally's Grand, Inc. of the casino resort complex formerly known as \"Bally's Reno\" of $.7 million ($.02 per share).\n11. Income from discontinued operations for the quarter ended September 30, 1992 includes a gain of $6.7 million ($.17 per share) from the sale of Gaming common stock.\n12. The extraordinary gain for the quarter ended March 31, 1992 relates to the extinguishment of debt as a result of market purchases of the Company's public debt.\n13. The extraordinary gains for the quarters ended September 30, 1992 and December 31, 1992 represent credits for the utilization of tax loss carryforwards.\n14. The Company's operations are subject to seasonal factors.\n- --------------------------------------------------------------------------------\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nItem 9 is inapplicable.\nPART III\nPart III, except for certain information relating to Executive Officers included in Part I, is omitted inasmuch as the Company intends to file with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 31, 1993 a definitive proxy statement containing such information pursuant to Regulation 14A of the Securities Exchange Act of 1934 and such information shall be deemed to be incorporated herein by reference from the date of filing such document.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES\n(A) 1. INDEX TO FINANCIAL STATEMENTS\n(A) 2. INDEX TO FINANCIAL STATEMENT SCHEDULES\nAll other schedules specified under Regulation S-X are omitted because they are not applicable, not required under the instructions or all information required is set forth in the Notes to consolidated financial statements.\n- --------------------------------------------------------------------------------\n(A) 3. INDEX TO EXHIBITS\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\n- --------------- * Incorporated herein by reference as indicated.\n- --------------------------------------------------------------------------------\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALLY MANUFACTURING CORPORATION\nDated: March 21, 1994 By \/s\/ ARTHUR M. GOLDBERG ------------------------------------ Arthur M. Goldberg Chairman of the Board, Chief Executive Officer and President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. This Annual Report may be signed in multiple identical counterparts all of which, taken together, shall constitute a single document.\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTE:\nAmounts are exclusive of accrued interest.\nS-1\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET (PARENT COMPANY ONLY) DECEMBER 31, 1993 AND 1992 (ALL DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nSee accompanying notes.\nS-2\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED) CONDENSED STATEMENT OF OPERATIONS (PARENT COMPANY ONLY) YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\nSee accompanying notes.\nS-3\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE III--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) CONDENSED STATEMENT OF CASH FLOWS (PARENT COMPANY ONLY) YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\nSee accompanying notes.\nS-4\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE III--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) NOTES TO CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) (ALL DOLLAR AMOUNTS IN THOUSANDS)\nBASIS OF PRESENTATION\nThe accompanying condensed financial information of Bally Manufacturing Corporation (\"Bally\") includes the accounts of Bally, and on an equity basis, the subsidiaries which it controls. The accompanying condensed financial information should be read in conjunction with the consolidated financial statements of Bally.\nLONG-TERM DEBT\nScheduled annual maturities of long-term debt for the five years after December 31, 1993 are $7,587, $7,587, $7,587, $7,587 and $13,621.\nS-5\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE V -- PROPERTY AND EQUIPMENT YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTES: (a) Other changes include $372,792 and $4,289 arising from acquisitions of businesses in 1993 and 1992, respectively, an adjustment of $16,061 due to temporary differences resulting from the implementation of SFAS No. 109 in 1993 and reclassifications between categories in each of the years.\n(b) Depreciable lives are equal to the estimated economic lives of the related assets and the terms of the applicable leases for leasehold improvements. Depreciation is provided principally on the straight-line method over depreciable lives ranging from two to forty years.\nS-6\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTE:\nOther changes include $3,876 arising from the acquisition of a business in 1993, $2,342 due to temporary differences resulting from the implementation of SFAS No. 109 in 1993 and reclassifications between categories in each of the years.\nS-7\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTES:\n(a) Additions charged to accounts other than costs and expenses consist of the following:\n(b) Deductions include write-offs of uncollectible amounts, net of recoveries. In addition, for 1992 the allowance for doubtful receivables and cancellations also includes reclassifications of amounts ($7,040) previously reported as unearned finance charges that represent the portion of balances estimated to be related to uncollectible amounts.\nS-8\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE IX--SHORT-TERM BORROWINGS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTE:\nThe average amount outstanding during 1992 and 1991 was computed by averaging the month-end balances during the year. The weighted average interest rate during 1992 and 1991 was computed by dividing interest expense by the weighted average amount of short-term borrowings outstanding.\nS-9\n- -------------------------------------------------------------------------------- BALLY MANUFACTURING CORPORATION SCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (ALL DOLLAR AMOUNTS IN THOUSANDS)\n- ---------------\nNOTE:\nRoyalties are not shown as they are less than one percent of consolidated revenues in all years presented.\nS-10","section_15":""}
{"filename":"96277_1993.txt","cik":"96277","year":"1993","section_1":"Item 1. Business - ------ --------\nGeneral - -------\nTambrands Inc. (the \"Company\") has been manufacturing and marketing menstrual tampons, which are sold under the trademark TAMPAX(R), since 1936. It is the leading manufacturer and marketer of tampons in the world. The Company operates in one business segment, personal care products. In recent years, the Company has focused on its core TAMPAX tampon business worldwide and has been expanding its international operations. The Company has manufacturing operations in eight countries. In 1993, TAMPAX tampons were sold in over 150 countries.\nThe Company has subsidiaries operating in Brazil, Canada, the Czech Republic, France, Ireland, Mexico, Poland, Russia, South Africa, Switzerland, Ukraine, the United Kingdom and Venezuela. The Company also has an 80% interest in a joint venture in the People's Republic of China.\nThe Company was incorporated under the laws of the State of Delaware in 1936. The Company's principal executive offices are located at 777 Westchester Avenue, White Plains, New York 10604 (telephone number 914-696-6000).\nRecent Developments - -------------------\nIn June 1989, the Company adopted a new corporate strategy of concentrating on the Company's core TAMPAX tampon business. As part of this strategy, the Company announced in December 1989 a major restructuring program designed to reduce costs and improve performance. The restructuring program has included sales of the Company's businesses that were not supportive of the Company's core activities, reductions in workforce and consolidation of certain administrative, manufacturing and research and development facilities in the United States, Canada and Europe. This program has been virtually completed.\nIn December 1991, the Company announced a program to restructure its worldwide manufacturing operations to improve efficiency and reduce costs. The program includes workforce reductions and consolidation of facilities. The program has been virtually completed, and has included the sale of non-core businesses in Brazil and Mexico and the closing of manufacturing plants in Canada and the United States.\nIn June 1993, the Company announced that it would provide a $30 million charge ($20 million after-tax) to provide for restructuring of manufacturing and administrative operations and the cost of management changes, including the adoption of a\nconsolidated international management strategy. The program includes workforce reductions and consolidation of facilities.\nIn order to implement these restructuring programs, the number of manufacturing plants has been reduced by approximately 50% and the Company has sold (i) its cosmetics, diagnostics and MAXITHINS(R) pad and panty shield businesses; (ii) its headquarters in Lake Success, New York; (iii) its non- tampon businesses in Spain, which included sanitary pads, disposable diapers and other baby products; (iv) its interest in a joint venture in Turkey, which primarily produced sanitary pads and diapers; (v) its disposable diaper and external pad businesses in Brazil; and (vi) its alcohol, cotton, baby wipes and external pad businesses in Mexico.\nThe Company currently is engaged in an ongoing program of substantially upgrading production equipment at its remaining manufacturing facilities through further automation and computerization. The Company's 1993 capital spending programs were related to investments in equipment to improve product quality and productivity, modernize facilities and reduce costs. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" contained in item 7 of Part II hereof.\nIn June 1989, the Company initiated a stock repurchase program. As of December 31, 1993, the Company had spent approximately $365 million to purchase approximately 5.9 million shares of its Common Stock under four repurchase programs. The Company was authorized as of December 31, 1993 to purchase 2.02 million additional shares. The Company is continuing its repurchases as conditions warrant.\nIn 1992, the Company established a commercial paper program under which it may borrow up to $150 million for general corporate purposes. At December 31, 1993, $48 million was outstanding under this program. In addition, in 1993, the Company established a $150 million Medium-Term Note program. At December 31, 1993, $30 million was outstanding under this program.\nOn June 1, 1993, Martin F. C. Emmett resigned from his position as Chairman and Chief Executive Officer. Howard B. Wentz, Jr. replaced Mr. Emmett as the Chairman of the Board of Directors and, pending the appointment of a Chief Executive Officer, is performing the duties of Chief Executive Officer. Certain other changes in senior management also occurred in mid-1993. The Company is currently in the process of evaluating candidates for the position of Chief Executive Officer.\nProducts - --------\nMenstrual tampons represent virtually all of the Company's sales. The Company's largest selling tampon is the TAMPAX\nflushable applicator tampon, which first became commercially available in 1936. The Company also manufactures and sells (i) TAMPAX tampons with plastic applicators in the United States; (ii) TAMPAX COMPAK(R) tampons, with a compact all-plastic applicator, in the United States, Canada, France, the United Kingdom and other countries in Europe; and (iii) TAMPAX comfort shaped flushable applicator tampons, with an all-paper rounded-end applicator and a slimmer design than the Company's standard product, in the United States, Canada, Australia, parts of Europe and several other countries.\nIn 1993, the Company introduced nationally in Canada the new TAMPAX SATIN TOUCH\/TM\/ tampon. This tampon offers the ease and comfort of a plastic applicator but has an all-paper applicator that is flushable and biodegradable. In 1993, the Company introduced nationally its new TAMPAX TAMPETS(R) non- applicator tampon in Ireland. The Company also introduced this tampon in test market in the United Kingdom in 1993 and plans to introduce this tampon nationally in the United Kingdom in 1994. The Company continues to evaluate the possible introduction of these and other products in additional markets.\nMarketing and Sales - -------------------\nMarketing operations are conducted either directly by the Company and its subsidiaries and joint venture, or by independent brokers or sales agents and distributors. Sales are made directly to drug, grocery, variety and discount stores and other comparable outlets, as well as to wholesalers and distributors in those trades. No single customer (including distributors) of the Company and its subsidiaries and joint venture accounted for 10% or more of total net sales in 1993. A small number of significant customers have highly leveraged capital structures, making them particularly sensitive to adverse market interest rate changes and other economic variables. This situation has not significantly affected the Company in prior years.\nSubstantially all sales involve extensions of credit. Credit terms generally are consistent with terms typically extended under local industry practices. Default rates by the Company's customers in the United States have been at or below industry averages, based on information from the Credit Research Foundation.\nIn the United States, the Company's internal sales management group directly handles sales to certain large customer accounts. These sales have been increasing as a percentage of total sales. Other sales in the United States and sales in Belgium, Canada, France and the Netherlands are handled through independent sales brokers, who also may sell other branded consumer products but generally do not carry products that compete with the products of the Company and its subsidiaries. Sales are conducted in the Czech\nRepublic, Poland, Russia, Ukraine and the United Kingdom by the Company's subsidiaries and in the People's Republic of China by its joint venture. Sales are conducted in other countries through independent distributors and agents.\nDuring 1993, retailers in the United States and Europe and distributors in Europe continued to reduce their inventories of TAMPAX tampons, as part of an industry-wide trend to reduce consumer goods inventory levels. This inventory reduction adversely affected the Company's 1993 financial results. This inventory reduction trend has continued in the first quarter of 1994 and the Company believes that the trend will continue. However, the rate of inventory reduction in future periods is expected to be significantly less than the rate of reduction experienced in 1993.\nMedia advertising is important to the overall success of the TAMPAX tampon brand. In the United States, Canada and Europe, the Company focuses its advertising on women aged 12-34, using a variety of media, including television and print advertisements. The Company increased its advertising and promotional spending substantially in the second half of 1993, in the face of a significant decline in the Company's market share of the tampon category in the United States in the first half of 1993 and a decline in the tampon share of the sanitary protection category in Europe in 1992 and 1993. The advertising and promotional spending is being concentrated in the Company's five largest markets (the United States, the United Kingdom, Canada, France and Spain) and in the four international markets believed to have the greatest development potential (CIS, principally Russia and Ukraine, Mexico, China and Brazil).\nThe Company also seeks to attract and retain customers through its teen education program, which is designed to help female teenagers understand the various forms of sanitary protection and promotes trial usage of TAMPAX tampons.\nCompetition - -----------\nHighly competitive conditions prevail in the feminine protec-tion industry for external pads and menstrual tampons, which are directly competitive in both performance and price, the principal methods of competition.\nIn the United States, there are four other manufacturers whose sales, directly or through subsidiaries, are significant in the total sanitary protection market: Johnson & Johnson, Kimberly-Clark Corporation, Playtex Family Products Corporation and The Procter & Gamble Company. Each of these corporations manufactures and sells external pads or menstrual tampons or both. Each makes and sells products other than external pads and tampons, and the total sales\nof all products by and the capitalization of each of Johnson & Johnson, Kimberly-Clark and Procter & Gamble are substantially greater than the total sales and capitalization of the Company. These factors may be helpful to the respective competitive positions of these companies in the feminine protection industry. Substantially all of the tampons manufactured by the above-mentioned four companies are sold under these companies' brand names. In addition, there is a small but growing private label segment of the industry. Management believes that the TAMPAX tampon's leading market share position in the U.S. tampon category (approximately 50.3% in dollars and 53.7% in units for the year 1993, according to Information Resources, Inc.) and strong brand loyalty among consumers (as verified by household panel data obtained by Nielsen Marketing Research), are positive factors in the Company's ability to compete in the feminine protection industry. During 1993, the level of competitive activity increased in the United States, particularly in the area of price discounting.\nHighly competitive conditions prevail in virtually all foreign markets. Competition tends to be fragmented and regional in nature in most of those markets, but tampons produced by, or under license from, Johnson & Johnson, and external pads produced by Procter & Gamble, are sold in many of the foreign markets where the Company does business. Competitive activity intensified in Europe in 1993. This activity included the introduction and aggressive marketing of several new external pad products.\nManagement expects that highly competitive conditions will continue in 1994, including price discounting, new product introductions and continued growth in private label tampons.\nRaw Materials - -------------\nThe principal raw materials used in the Company's business are cotton and rayon for tampons, paper and plastic for tampon applicators, and paperboard for cartons and containers. Most of these raw materials are readily available in the market from many sources.\nTrademarks and Patents - ----------------------\nThe Company, directly or through its subsidiaries, owns a number of trademarks, trademark registrations and trademark applications in the United States and other countries, which, in the opinion of management, are significant. The Company's trademark registrations vary in duration and are typically renewable by the Company. Certain features of TAMPAX tampons are the subject of U.S. and foreign patents or patent applications owned by the Company. In management's opinion, certain of these patents are significant. The duration of the Company's patents ranges from 5 to 19 years (i.e., the patents have ---- expiration dates\nranging from the year 1999 to the year 2013).\nResearch and Development - ------------------------\nThe Company maintains a research and development laboratory at its facilities in each of Palmer, Massachusetts and Havant, England. The Company's research and development expenditures have approximated 2% of net sales in each of the past three years. Management believes that developing better protecting and more comfortable and convenient products, and products which are environmentally sound, is important to maintaining the Company's competitive position. Research is directed toward these goals.\nEmployees - ---------\nAs part of the restructuring program announced in 1989, the staff of the Company's headquarters and North American Division has been reduced substantially. The sale of non-core businesses also has reduced the number of employees. Additional headcount reductions have occurred and will occur as a result of the restructuring programs announced in 1991 and 1993. At December 31, 1993, the Company and its consolidated subsidiaries employed approximately 3,600 persons, including 900 employees in the People's Republic of China, Russia and Ukraine.\nForeign and Domestic Operations; Export Sales - ---------------------------------------------\nThe information regarding foreign and domestic operations of the Company and its subsidiaries set forth on page 38 under the caption \"Segment and Geographic Information\" in the Notes to Consolidated Financial Statements is incorporated herein by reference.\nOver the past three years, sales by the Company's foreign operations accounted for approximately one-half of total unit sales.\nIn 1993, sales between geographic areas and export sales of the Company were not significant.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------ ----------\nDomestic Properties - -------------------\nAs part of its worldwide manufacturing restructuring program, during 1993, the Company's Palmer, Massachusetts manufacturing plant was converted to a facility for testing new equipment and developing new products. The Company has consolidated its U.S. manufacturing operations in its three other U.S. plants, located in Auburn, Maine; Claremont, New Hampshire; and Rutland, Vermont.\nTechnical and research and development operations are conducted at the Company's Technical Center, also located in Palmer, Massachusetts. This facility is a testing center for the application of advanced manufacturing technology to the Company's products. The Company owns each of these plants and the Technical Center. The Company leases headquarters office space in White Plains, New York.\nThe Company's production machinery and equipment and the properties owned by it described above are held free and clear of encumbrances.\nDuring the last fiscal year, the Company's domestic plants were suitable and adequate for the Company's requirements. The Company's domestic plants operate principally on a three-shift basis, and have sufficient additional capacity to satisfy the foreseeable requirements of the Company.\nForeign Properties - ------------------\nThe Company's foreign subsidiaries own and operate manufacturing plants in France, Ireland, Russia, South Africa, Ukraine and the United Kingdom. The Company's joint venture in the People's Republic of China has contractual rights to use a manufacturing plant there. The Company's foreign subsidiaries lease office space in Brazil, Canada, France, Mexico, Switzerland, Venezuela and in several other countries. The Company's subsidiary in the United Kingdom leases office space there for the Company's international headquarters.\nIn 1993, as part of the Company's worldwide manufacturing restructuring program, the Company determined to effect a restructuring of the manufacturing operations conducted at the plant owned by its subsidiary in France. All European production of COMPAK tampons now will be concentrated at the French plant, and production of other tampons will be consolidated in the Company's other European plants. As part of the restructuring program, the Company also decided in 1993 to close the tampon manufacturing plant in Mexico leased by a subsidiary. The Mexican manufacturing operations are being consolidated in the Company's U.S. plants.\nThe production machinery and equipment and properties owned by the Company's foreign subsidiaries described above are held free and clear of encumbrances.\nDuring the last fiscal year, the Company's foreign facilities were suitable and adequate for the Company's requirements. In general, the Company's foreign manufacturing facilities operate on a two- or three-shift basis, and have sufficient additional capacity to satisfy the foreseeable requirements of the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------ -----------------\nThe Company or a subsidiary is a defendant in a small number of pending product liability lawsuits based on allegations that toxic shock syndrome (\"TSS\") was contracted through the use of tampons. A small number of pre-suit claims involving similar allegations have also been asserted. The damages alleged vary from case to case and often include claims for punitive damages.\nThe Company and certain of its present and former officers have been named as defendants in certain shareholder lawsuits that have been filed in the United States District Court for the Southern District of New York and that have been consolidated under the caption In Re Tambrands Inc. Securities Litigation. The ------------------------------------------ consolidated lawsuit purports to be a federal securities fraud class action on behalf of all purchasers of the Company's common stock during the period December 14, 1992 through June 2, 1993. The complaint alleges that the Company's disclosures during the alleged class period contained material misstatements and omissions concerning its anticipated future earnings. The complaint seeks an unspecified amount of damages on behalf of the purported class.\nThe Company is a nominal defendant in three purported shareholder derivative lawsuits that have been filed in the Supreme Court of the State of New York for Westchester County and that have been consolidated into a single action. Named collectively in the consolidated complaint as individual defendants are the Company's directors (and certain of its former directors) and two of its former officers. The complaint alleges that the officer-defendants exposed the Company to liability in the purported shareholder class action described in the preceding paragraph and misappropriated corporate opportunities by trading in the Company's stock on the basis of nonpublic information. One of the former officers is also alleged to have received improper reimbursements from the Company for alleged personal expenses. The director-defendants are alleged to have acquiesced in the aforesaid alleged violations. The complaint seeks to recover on behalf of the Company an unspecified amount of damages from the individual defendants. No relief is sought against the Company.\nThe Company is involved in certain other legal proceedings incidental to the normal conduct of its business.\nWhile it is not feasible to predict the outcome of these legal proceedings and claims with certainty, management is of the belief that any ultimate liabilities for damages either are covered by insurance, are provided for in the Company's financial statements or, to the extent not so covered or provided for, should not individually or in the aggregate have a material adverse effect on the Company's financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------ ---------------------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant - ------------------------------------\nThe names and ages of all executive officers of the Company, the current office held by each, and the period during which each has served as such are set forth in the following table:\nEach executive officer is appointed by the Board of Directors to serve until the first meeting of directors following the annual meeting of shareholders of the Company. Except as indicated in the footnotes below, the principal occupation and employment during the past five years of each of the above-named executive officers have been as an officer or other member of management of the Company or one or more of its subsidiaries.\n(1) Mr. Chapman has served as an officer of the Company since August 1989. From prior to March 1989 until August 1989, he was employed by The Spectrum Group, Inc. (an investment company) as Vice President.\n(2) Mr. Wainick has served as an officer of the Company since June 1990. From prior to March 1989 until June 1990, he was employed by Binney & Smith, Inc. (a manufacturer of arts and crafts\nsupplies), a subsidiary of Hallmark Cards, Inc., as Director of Technical Development.\n(3) Mr. Wentz is a non-employee director of the Corporation and has been Chairman of the Board and has performed the duties of the Chief Executive Officer of the Corporation since June 2, 1993. Mr. Wentz has served as Chairman of the Board of ESSTAR Incorporated (a manufacturer of portable electric tools and architectural hardware) since July 1989. From prior to March 1989 until June 1989, he served as Chairman, President and Chief Executive Officer of Amstar Corporation (a diversified manufacturer).\n(4) Mr. Wright has served as an officer of the Company since August 1989. From prior to March 1989 until August 1989, he was employed by International Nabisco Brands as Senior Vice President-Finance.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related - ------ ------------------------------------------------- Shareholder Matters -------------------\nThe Company's Common Stock is traded on the New York and Pacific Stock Exchanges. The following table provides quarterly dividend and Common Stock price range information for the years 1992 and 1993:\n(a) Reflects trading on the New York Stock Exchange. (b) Dividends of $0.42 per share declared in the third quarter were paid in December 1993.\nAs of March 15, 1994, there were 7,001 holders of record of the Company's Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------ -----------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K under the caption \"Selected Financial Data\" appearing on page 25 and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of - ------ -------------------------------------------------- Operations and Financial Condition ----------------------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K under the caption \"Management's Discussion and Analysis\" beginning on page 26 and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ------ -------------------------------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K as indicated in the \"Index to Financial Information\" appearing on page 24 and is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on - ------ ------------------------------------------------ Accounting and Financial Disclosure -----------------------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - ------- --------------------------------------------------\nThe information relating to nominees for election as directors of the Company set forth under the caption \"Election of Directors\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 26, 1994 is incorporated herein by reference.\nMr. Brian Healey is currently a director of the Company, but he is retiring from the Board of Directors, and he is not a nominee for election as a director at the annual meeting of shareholders to be held on April 26, 1994. Mr. Healey has been a Principal of Brian Healey & Associates, Victoria, Australia (a business consulting firm), since before March 1989. He has been a director of the Company since 1992 and is 60 years old.\nThe information on executive officers set forth under the caption \"Executive Officers of the Registrant\" beginning on page 9 is incorporated herein by reference.\nThe information relating to compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, set forth under the caption \"Executive Compensation and Other Information - Other Information\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 26, 1994 is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation - ------- ----------------------\nThe information regarding executive compensation set forth under the captions \"Information Regarding the Board of Directors -\nCompensation of Directors,\" \"Executive Compensation and Other Information\" and \"Proposal to Approve Amendment to the 1992 Directors Stock Incentive Plan\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 26, 1994 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and - ------- ---------------------------------------------------- Management ----------\nThe information regarding the security ownership of certain beneficial owners and management set forth under the caption \"Security Ownership by Management and Others\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 26, 1994 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - ------- ----------------------------------------------\nThe information pertaining to certain relationships and related transactions set forth under the captions \"Information Regarding the Board of Directors - Compensation of Directors\" and \"Executive Compensation and Other Information - Other Information\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 26, 1994 is incorporated herein by reference. The services performed for the Company by Doherty, Wallace, Pillsbury & Murphy, P.C. were on terms no less favorable to the Company than if such services had been provided by unaffiliated parties.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, - ------- ---------------------------------------- and Reports on Form 8-K -----------------------\n(a) Documents filed as part of this report\n1. Financial Statements\nThe list of financial statements set forth under the caption \"Index to Financial Information\" on page 24 is incorporated herein by reference.\n2. Financial Statement Schedules\nThe list of financial statement schedules set forth under the caption \"Index to Financial Information\" on page 24 is incorporated herein by reference. All other schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or related notes.\n3. Exhibits\nExhibit Number Description ------- -----------\n3(1) Certificate of Incorporation of the Company, as amended through April 28, 1987, filed April 30, 1987 as Exhibit 4(a) to the Company's Form S-8 Registration Statement (Reg. No. 33-13902), incorporated herein by reference.\n3(2) Certificate of Amendment of Certificate of Incorporation of the Company, dated April 24, 1990, filed May 15, 1990 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1990, incorporated herein by reference.\n3(3) Certificate of Amendment of Certificate of Incorporation of the Company, dated April 28, 1992, filed May 15, 1992 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1992, incorporated herein by reference.\n3(4) By-Laws of the Company, as amended, filed herewith.\n4(1) Description of the rights of security holders set forth in the Certificate of Incorporation of the Company, as amended through April 28, 1987, filed April 30, 1987 as Exhibit 4(a) to the Company's Form S-8 Registration Statement (Reg. No. 33-13902), incorporated herein by reference.\n4(2) Description of the rights of security holders set forth in the Certificate of Amendment of Certificate of Incorporation of the Company, dated April 28, 1992, filed May 15, 1992 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1992, incorporated herein by reference.\n4(3) Rights Agreement, dated as of October 24, 1989, between the Company and First Chicago Trust Company of New York, which includes the Form of Right Certificate as Exhibit A and the Summary of Rights to Purchase Common Shares as Exhibit B, filed October 27, 1989 as Exhibit 1 to the Company's Form 8-A Registration Statement,\nincorporated herein by reference.\n4(4)(a) Indenture dated as of December 1, 1993 between the Company and Citibank, N.A., as trustee, relating to the Company's Medium- Term Note Program, filed herewith.\n4(4)(b) Form of Floating Rate Debt Security, filed December 16, 1993 as Exhibit 4-a to the Company's Report on Form 8-K, incorporated herein by reference.\n4(4)(c) Form of Fixed Rate Debt Security, filed December 16, 1993 as Exhibit 4-b to the Company's Report on Form 8-K, incorporated herein by reference.\nManagement Contracts and Compensatory Plans and Arrangements (Exhibits 10(1) - 10(21)) -----------------------\n10(1)(a) 1981 Long Term Incentive Plan, as amended through November 4, 1988, filed as Exhibit 10(1)(a) to the Company's Report on Form 10-K for the year 1988, incorporated herein by reference.\n10(1)(b) Amendment to 1981 Long Term Incentive Plan, dated as of February 27, 1990, filed as Exhibit 10(1)(b) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(1)(c) Amendment to 1981 Long Term Incentive Plan, effective as of June 25, 1991, filed as Exhibit 10(1)(c) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(1)(d) Amendment to 1981 Long Term Incentive Plan, effective as of June 23, 1992, filed as Exhibit 10(1)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(1)(e) Amendment to 1981 Long Term Incentive Plan, effective as of February 23, 1993, filed as Exhibit 10(1)(e) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(1)(f) Addendum to 1981 Long Term Incentive Plan, filed April 30, 1987 as Exhibit 28(a) to the\nCompany's Form S-8 Registration Statement (Reg. No. 33-13902), incorporated herein by reference.\n10(2)(a) 1981 Incentive Stock Option Plan, as amended through April 30, 1987, filed April 30, 1987 as Exhibit 28(a) to the Company's Form S-8 Registration Statement (Reg. No. 33- 13902), incorporated herein by reference.\n10(2)(b) Amendment to 1981 Incentive Stock Option Plan, dated as of February 27, 1990, filed as Exhibit 10(2)(b) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(2)(c) Amendment to 1981 Incentive Stock Option Plan, effective as of June 23, 1992, filed as Exhibit 10(2)(c) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(2)(d) Amendment to 1981 Incentive Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(2)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(a) 1991 Stock Option Plan, filed as Exhibit 10(3) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(3)(b) First Amendment to 1991 Stock Option Plan, effective as of July 1, 1991, filed as Exhibit 10(3)(b) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(3)(c) Second Amendment to 1991 Stock Option Plan, effective as of July 1, 1991, filed as Exhibit 10(3)(c) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(3)(d) Third Amendment to 1991 Stock Option Plan, effective as of June 23, 1992, filed as Exhibit 10(3)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(e) Fourth Amendment to 1991 Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(3)(e) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(f) Fifth Amendment to 1991 Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(3)(f) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(g) Addendum to 1991 Stock Option Plan, filed as Exhibit 10(3)(g) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(h) Sixth Amendment to 1991 Stock Option Plan, effective as of February 1, 1994, filed herewith.\n10(4)(a) 1989 Restricted Stock Plan, as amended through December 31, 1990, filed as Exhibit 10(4) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(4)(b) Amendment to 1989 Restricted Stock Plan, effective as of February 23, 1993, filed as Exhibit 10(4)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(5)(a) Supplemental Executive Retirement Plan, effective July 1, 1986, as amended and restated effective July 1, 1994, filed herewith.\n10(5)(b) Resolutions of the Compensation Committee of the Board of Directors of the Company with respect to certain benefits under the Supplemental Executive Retirement Plan, adopted on February 11, 1993, filed as Exhibit 10(5)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(6) Trust Agreement between the Company and The Northern Trust Company, dated as of October 31, 1988, filed as Exhibit 10(6) to the Company's Report on Form 10-K for the year 1988, incorporated herein by reference.\n10(7) Pension Plan for Non-Employee Directors, filed as Exhibit 10(10) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(8)(a) 1992 Directors Stock Incentive Plan, filed as Exhibit 10(11) to the Company's Report on Form 10-K for the year 1991, incorporated herein by\nreference.\n10(8)(b) First Amendment to 1992 Directors Stock Incentive Plan, effective as of August 18, 1992, filed as Exhibit 10(8)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(8)(c) Second Amendment to 1992 Directors Stock Incentive Plan, effective as of February 23, 1993, filed as Exhibit 10(8)(c) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(8)(d) Third Amendment to the 1992 Directors Stock Incentive Plan, effective as of August 24, 1993, filed as Exhibit 10(3) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(8)(e) Fourth Amendment to 1992 Directors Stock Incentive Plan, effective as of March 1, 1994 (subject to shareholder approval at the annual meeting of shareholders to be held on April 26, 1994), filed herewith.\n10(9)(a) Amended and Restated Employment Protection Agreement between the Company and Mr. Martin F.C. Emmett, dated as of October 16, 1990, filed as Exhibit 10(11)(a) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(9)(b) Employment Protection Agreement between the Company and Mr. Charles J. Chapman, dated as of August 23, 1989, and First Amendment to Employment Protection Agreement between the Company and Mr. Charles J. Chapman, dated as of October 16, 1990, filed as Exhibit 10(11)(b) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference;\n10(9)(c) Employment Protection Agreement between the Company and Mr. Alain Strasser, dated as of November 15, 1989, and First Amendment to Employment Protection Agreement between the Company and Mr. Alain Strasser, dated as of October 16, 1990, filed as Exhibit 10(11)(e) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference;\n10(9)(d) Employment Protection Agreement between the Company and Mr. Raymond F. Wright, dated as of August 23, 1989, and First Amendment to Employment Protection Agreement between the Company and Mr. Raymond F. Wright, dated as of October 16, 1990, filed as Exhibit 10(11)(c) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference;\n10(9)(e) Employment Protection Agreement between the Company and Ms. Helen G. Goodman, dated as of December 1, 1989, and First Amendment to Employment Protection Agreement between the Company and Ms. Helen G. Goodman, dated as of October 16, 1990, filed herewith;\nThe Company has agreements similar to the agreements listed as Exhibits 10(9)(b), 10(9)(c), 10(9)(d) and 10(9)(e) with its other executive officers.\n10(10) Letter Agreement between the Company and Mr. Martin F.C. Emmett, dated October 16, 1990, filed as Exhibit 10(12) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(11) Amended and Restated Stock Option Agreement between the Company and Mr. Martin F.C. Emmett, dated October 16, 1990, filed as Exhibit 10(13) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(12) Consulting Agreements between the Company and Mr. Brian Healey, dated July 1, 1989, filed as Exhibit 10(12) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(13) Executive Severance Program of the Company, filed as Exhibit 10(15) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(14) Annual Incentive Plan of the Company, filed as Exhibit 10(6) to the Company's Report on Form 10-K for the year 1984, incorporated herein by reference.\n10(15) Summary of supplemental pension plan of Tambrands France S.A., filed as Exhibit 10(16) to the Company's Report on Form 10-K for the\nyear 1992, incorporated herein by reference.\n10(16) Summary of Revision to Non-Employee Director Cash Compensation, approved August 24, 1993, filed as Exhibit 10(1) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(17) Amended and Restated Letter Agreement between the Company and Mr. Howard B. Wentz, Jr., dated August 24, 1993, filed as Exhibit 10(2) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(18) Letter Agreement between the Company and Mr. James G. Mitchell, dated June 30, 1993, and amendment thereto, dated October 13, 1993, filed as Exhibit 10(5) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(19) Letter Agreement between the Company and Mr. Constantin B. Ohanian, dated August 18, 1993, filed as Exhibit 10(6) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(20) Severance Agreement between the Company and Mr. Martin F. C. Emmett, dated July 21, 1993, filed as Exhibit 10(4) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(21) Retirement Agreement between the Company and Mr. Charles J. Chapman, dated as of February 28, 1994, filed herewith.\n10(22)(a) Commercial Paper Dealer Agreement between the Company and Merrill Lynch Money Markets, Inc., dated November 18, 1992, filed as Exhibit 10(15)(a) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(22)(b) Letter Agreement between the Company and The First National Bank of Chicago, dated as of November 18, 1992, filed as Exhibit 10(15)(b)\nto the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(22)(c) Credit Agreement by and among the Company, the signatory banks thereto and The Bank of New York, as agent, dated as of October 16, 1992, filed as Exhibit 10(15)(c) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n12 Computation of Ratio of Earnings to Fixed Charges, filed herewith.\n21 Subsidiaries of the Company, filed herewith.\n23 Independent Auditors' Consent, filed herewith.\n24 Powers of attorney, filed herewith.\n99 Trust Agreement, dated as of November 1, 1991, between the Company and Manufacturers Hanover Trust Company, as trustee under the Tambrands Inc. Savings Plan, filed as Exhibit 28 to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n(b) Reports on Form 8-K\nThe Company filed a Report under Item 5 of Form 8-K on December 16, 1993 in order to file the forms of Floating Rate Debt Security and Fixed Rate Debt Security to be used in connection with the Company's Medium- Term Note Program.\nTAMPAX, COMPAK, SATIN TOUCH and TAMPETS are trademarks of Tambrands Inc.\nSIGNATURES ----------\nPursuant 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.\nTAMBRANDS INC.\nDate: March 28, 1994 By \/s\/ HOWARD B. WENTZ, JR. ----------------------------- Howard B. Wentz, Jr. Chairman\nPursuant 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 and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ HOWARD B. WENTZ, JR. Chairman and March 28, 1994 - ---------------------------- Director (Principal HOWARD B. WENTZ, JR. Executive Officer)\n\/s\/ RAYMOND F. WRIGHT Senior Vice President- March 28, 1994 - ---------------------------- Chief Financial RAYMOND F. WRIGHT Officer (Principal Financial Officer and Principal Accounting Officer)\n* Director March 28, 1994 - ---------------------------- LILYAN H. AFFINITO\n\/s\/ CHARLES J. CHAPMAN Executive Vice March 28, 1994 - ---------------------------- President and CHARLES J. CHAPMAN President, North America and Director\n* Director March 28, 1994 - ---------------------------- PAUL S. DOHERTY\n* Director March 28, 1994 - ---------------------------- FLOYD HALL\n* Director March 28, 1994 - ---------------------------- BRIAN HEALEY\nSignature Title Date --------- ----- ----\n* Director March 28, 1994 - --------------------------- ROBERT P. KILEY\n* Director March 28, 1994 - --------------------------- JOHN LOUDON\n* Director March 28, 1994 - --------------------------- RUTH M. MANTON\n* Director March 28, 1994 - --------------------------- JOHN A. MEYERS\n* Director March 28, 1994 - --------------------------- H.L. TOWER\n* Director March 28, 1994 - --------------------------- ROBERT M. WILLIAMS\n* By \/s\/ HOWARD B. WENTZ, JR. --------------------------- Howard B. Wentz, Jr. Attorney-in-Fact\nINDEX TO FINANCIAL INFORMATION ------------------------------\nPage Reference --------- Selected Financial Data................................. 25\nManagement's Discussion and Analysis of Results of Operations and Financial Condition........... 26\nFinancial Statements:\nConsolidated Statements of Earnings for the years ended December 31, 1993, 1992 and 1991................. 28\nConsolidated Statements of Retained Earnings for the years ended December 31, 1993, 1992 and 1991................. 28\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991................. 29\nConsolidated Balance Sheets as of December 31, 1993 and 1992....................... 30\nNotes to Consolidated Financial Statements....................................... 31\nIndependent Auditors' Report on Consolidated Financial Statements................ 39\nFinancial Statement Schedules:\nV Property, Plant and Equipment.............. 40\nVI Accumulated Depreciation of Property, Plant and Equipment.............. 43\nVIII Reserves................................... 46\nIX Short-Term Borrowings...................... 47\nX Supplementary Income Statement Information................................ 50\nIndependent Auditors' Report on Financial Statement Schedules.................... 51\nSupplementary Financial Information and Quarterly Data for the years ended December 31, 1993 and 1992................. 52\nPer share amounts have been restated to reflect a two-for-one stock split effected in the form of a 100% stock dividend in December 1990. (a) Net of Restructuring and other charges which reduced Net earnings by $20,273, $23,477 and $65,692 in 1993, 1991 and 1989, respectively.\nMANAGEMENT'S DISCUSSION AND ANALYSIS\nResults of Operations\n1993 VS. 1992 Consolidated Net sales for 1993 were $611.5 million, a decrease of 10.6% from 1992. The decrease is the result of lower unit sales in the USA and Europe, unfavorable foreign exchange rates in Europe and the elimination of non-core products. Volume shortfalls in 1993 were principally caused by a continuing trend by US retailers and European distributors to reduce consumer goods inventory levels. The decline was partially offset by favorable pricing adjustments associated with the European restaging in 1992.\nGross profit as a percent of Net sales was 67% for 1993, up from 66.7% in 1992. This increase is attributable to elimination of lower-margin sales of divested products and worldwide manufacturing efficiencies, partially offset by the impact of lower sales volume.\nIn 1993, the Company provided $30.0 million for restructuring of manufacturing and administrative operations and the cost of management changes including the adoption of a consolidated international management strategy. The anticipated annual savings of approximately $20.0 million resulting from work force reductions and worldwide manufacturing restructuring are expected to be fully realized by 1995.\nOperating income was $116.3 million in 1993, down $78.4 million from 1992. In addition to the restructuring charge of $30.0 million, the decline in Operating income is primarily due to lower Net sales. Marketing, selling and distribution expenses increased 4.4% over 1992. The Company raised its level of advertising and promotional spending to support the Tampax brand in the face of increased competition and to regain market share in the second half of 1993. The increase in brand support was partially offset by reductions in the other components of Marketing, selling and distribution as well as lower administrative spending in 1993. These reductions were the result of the continuing program to reduce overhead expenses.\nInterest, net and other improved by $5.2 million primarily due to net gains on foreign exchange contracts in the current year, somewhat mitigated by interest expense on increased borrowings.\nThe effective tax rate for 1993, exclusive of the restructuring charge, was 36.8%, compared to 36.2% in 1992.\nOUTLOOK The Company believes that the recent trend by retailers and distributors to reduce inventories and the related adverse impact on shipments will continue in future periods. However, the rate of inventory reduction in future periods is expected to be significantly less than the rate of reduction experienced in 1993. The Company intends to continue in 1994 the increased advertising and promotional activities in the USA and Europe to provide support for the Tampax brand.\n1992 VS. 1991 Consolidated Net sales for 1992 were $684.1 million, an increase of 4% over 1991. The increase was due primarily to pricing adjustments associated with the restaging programs in North America and Europe, partially offset by elimination of non-core sanitary pad and disposable diaper products and lower restaged volume in Europe, but aided somewhat by favorable foreign exchange rates in Europe.\nGross profit as a percent of sales in 1992 improved by 3.4 percentage points over 1991, to 66.7%, reflecting the successful North American restaging implemented in the third quarter of 1991, the European restaging of 1992, elimination of non-core products and worldwide manufacturing efficiencies.\nOperating income rose 21% in 1992 compared to 1991 exclusive of the restructuring charge. Marketing, selling and distribution expenses in the USA decreased in 1992 compared to the prior year's unusually high levels incurred to support the 1991 restaging. This reduction was offset by promotional spending to support the European restaging program and heavy planned advertising and education expenditures designed to build the Tampax franchise worldwide. Operating margins continued to rise in 1992 as marketing and promotional spending normalized and the benefit of the worldwide restaging program was felt.\nInterest, net and other declined significantly in 1992 compared to 1991 due to reductions in cash and marketable securities balances combined with interest expense on increased Short-term borrowings as a result of the Company's share buyback program.\nThe effective tax rate for 1992 was 36.2%, compared to 36.8% in 1991, exclusive of the restructuring charge.\nFinancial Condition\nCASH FLOWS FROM OPERATING ACTIVITIES 1993 Cash flows from operating activities amounted to $128.7 million versus $95.8 million in 1992. The reduction in Net earnings was more than offset by the 1993 restructuring charge, the cumulative effect of accounting change, and an improvement in working capital. Over the past three years, Cash flows from operating activities totaled $331.9 million. These funds were used for the repurchase of Common Stock for treasury purposes, payment of dividends and capital expenditures.\nCAPITAL EXPENDITURES The 1993 capital spending programs relate to investments in equipment to improve product quality and productivity, modernize production facilities and reduce costs. Over the past three years, the Company has spent $145.4 million on capital improvements. Capital expenditures in 1994 are expected to be somewhat below 1993 levels.\nLIQUIDITY AND CAPITAL RESOURCES During 1993, the Company continued to utilize its strong debt rating and a favorable financial climate to take advantage of low US interest rates through short-term bank credit lines and a commercial paper program. Additionally, to provide financial flexibility, the Company established a $150 million Medium-Term Note facility and accessed the debt market in December 1993 by issuing $30 million of these notes.\nCash flows from operations and the ability to borrow from a variety of sources will provide the Company with the liquidity to continue the investments necessary to meet the Company's long-term strategic goals.\nThe Company also utilizes cash resources to enhance shareholder value through the payment of dividends and its stock repurchase program. In 1993, the Company paid record cash dividends of $60.1 million. This is the 42nd consecutive year of higher annual dividend payments. During the year, Tambrands spent $57.9 million in its Common Stock repurchase program. Since 1989, a total of 5,901,900 shares have been purchased. The Company will continue the share repurchase program as conditions warrant.\nCONSOLIDATED STATEMENTS OF EARNINGS Tambrands Inc. and subsidiaries\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Tambrands Inc. and subsidiaries\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS Tambrands Inc. and subsidiaries\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Tambrands Inc. and subsidiaries (dollar amounts in thousands, except per share amounts)\nAccounting Policies The consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. Where alternatives exist, the choices selected are described below.\nCONSOLIDATION The 1993 consolidated financial statements include the accounts of Tambrands Inc. and all majority owned subsidiaries (the \"Company\"). Prior to 1993, businesses in China, Russia and Ukraine were accounted for under the cost method and carried as Investments in Affiliates. The financial results and positions of these businesses were consolidated in 1993. The effect of consolidation of these subsidiaries is not material to the financial statements as a whole; therefore, prior years have not been restated.\nFOREIGN CURRENCY TRANSLATION For subsidiaries not located in highly inflationary economies, gains or losses resulting from the translation of subsidiary companies' assets and liabilities denominated in foreign currencies are shown as a separate component of Shareholders' Equity.\nFor subsidiaries operating in highly inflationary economies, working capital items are translated using current rates of exchange with adjustments included in Operating income.\nCASH EQUIVALENTS Highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.\nMARKETABLE SECURITIES Marketable securities, comprised of corporate obligations, are stated at cost, which approximates market.\nINVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the LIFO method for all domestic inventories. All other inventories are stated at FIFO.\nDEPRECIATION Depreciation is computed on the straight-line and accelerated methods over the useful lives of the assets.\nBRANDS, TRADEMARKS, PATENTS AND OTHER INTANGIBLE ASSETS Intangible assets are amortized on a straight-line basis over periods not exceeding 40 years.\nINCOME TAXES In 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which requires a provision for deferred taxes for differences between the financial statement and tax bases of assets and liabilities. Prior to 1992, deferred income taxes were provided on timing differences between financial and income tax reporting methods.\nProvision has not been made for income taxes on foreign subsidiaries' unremitted earnings to the extent that such earnings have been reinvested in the business; any United States income taxes payable on the distribution of available earnings should generally be offset by credits for foreign taxes paid.\nRECLASSIFICATIONS Certain reclassifications have been made to prior years' financial statements to conform to the 1993 presentation.\nBalance Sheet Components The components of certain balance sheet accounts at December 31 are as follows:\nStatement of Earnings Information\nBenefit Plans\nThe Company maintains several non-contributory pension plans covering domestic and foreign employees who meet certain minimum service and age requirements and provides supplemental non-qualified retirement benefits to non-employee directors, certain officers and key employees. Pensions are based upon earnings of covered employees during their periods of credited service. The Company's funding policy for its pensions is to make the annual contributions required by applicable regulations.\nThe following table sets forth the funded status of the plans and the amounts recognized in the accompanying financial statements.\nAt December 31, 1993 and 1992, the accumulated benefit obligation of the domestic plans exceeded plan assets by $10,251 and $4,400, respectively.\nThe net cost of pensions included in the Statements of Earnings consists of:\nIn 1993 and 1992, the discount rate used to determine the projected benefit obligation for the domestic plans was 7.5% and the rate of increase in future compensation was 6%. For the international plans, the discount rate used to determine the projected benefit obligation was 8% in 1993 and ranged from 8.5% to 9% in 1992, and the rate of increase in future compensation ranged from 5.5% to 6.5% and 5.5% to 7% in 1993 and 1992, respectively. Expected long-term rates of return on plan assets ranged from 8.5% to 9.25% in 1993 and 8.4% to 9% in 1992. Prior service costs arising from plan amendments are amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under each plan.\nAs of January 1, 1993, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" recognizing a pre-tax charge to earnings of $16,000, amounting to $10,252 or $.27 per share after tax. In 1992, the Company recognized the full amount of its estimated accumulated postretirement benefit obligation in accordance with the provisions of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The pre-tax charge to 1992 earnings was $1,627 with a net earnings effect of $1,009 or $.03 per share. The after-tax amounts of these accounting changes have been reflected in the 1993 and 1992 Statements of Earnings as a cumulative effect of accounting change. The incremental annual cost of accounting for postretirement and postemployment benefits under the new accounting methods is not material. The actuarial assumptions used to measure the cost of postretirement benefits are consistent with those used to measure the cost of the pension plans.\nThe Company also sponsors a defined contribution 401(k) savings plan available to domestic employees who meet certain minimum age and service requirements. The plan, which is funded principally with the Company's Common Stock, includes provision for a discretionary contribution by the Company of up to 2% of each employee's covered earnings based on Company performance.\nIncome Taxes Provision for income taxes for the years ended December 31 has been made as follows:\nChanges in deferred taxes are due primarily to the restructuring provisions established in 1993, 1991 and 1989 and \"safe harbor\" leases entered into in 1981 and 1982.\nThe difference between the Company's effective tax rate and the statutory federal rate is principally due to state income taxes and the restructuring and other charges.\nDuring 1993 and 1992, Shareholders' Equity was credited for $1,330 and $2,336, respectively, relating to compensation expense for tax purposes in excess of the amounts recognized for financial reporting purposes.\nIn 1992, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" The adoption of the statement did not have a material effect on Net earnings. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nThe components of the net deferred tax asset (liability) for the years ended December 31 are as follows:\nRestructuring and Other Charges\nIn 1991, the Company announced a program to restructure its worldwide manufacturing operations to improve efficiency and reduce costs and its intention to exit the sanitary pad and diaper businesses in Brazil. As a result, the Company recorded a $30,348 ($23,477 after tax) restructuring charge. In 1993, the Company announced further restructuring as its previous investments in technology will enable it to operate with reduced manufacturing and administrative overhead and number of employees. The Company provided $30,042, or $20,273 after tax, for this restructuring and the cost of management changes including the adoption of a consolidated international management strategy. The provision includes the costs associated with salary and benefit continuation due to work force reductions and the revaluation and consolidation of certain manufacturing and office facilities.\nCommitments and Contingencies\nThe Company's lease of its headquarters in White Plains, New York and European headquarters in the United Kingdom are non-cancelable operating leases. Certain computers and related equipment are held under capital leases.\nFuture minimum lease payments under operating leases with terms in excess of one year amount to $4,593 in 1994, $4,088 in 1995, $3,560 in 1996, $3,221 in 1997 and $3,021 in 1998. Rent expense in 1993, 1992 and 1991 amounted\nto $5,027, $4,031 and $4,204, respectively. Future minimum lease payments under capital leases with terms in excess of one year amount to approximately $550 in both 1994 and 1995; no capital leases extend beyond 1995.\nThe Company has been named in product liability litigation and claims arising from the alleged association of tampons with Toxic Shock Syndrome. The cases seek compensatory and punitive damages in various amounts.\nThe Company and certain of its present and former officers have been named as defendants in certain shareholder lawsuits now consolidated into one action. The consolidated lawsuit purports to be a federal securities fraud class action on behalf of all purchasers of the Company's Common Stock during the period December 14, 1992 through June 2, 1993. The complaint alleges that the Company's disclosures during the alleged class period contained material misstatements and omissions concerning its anticipated future earnings. The complaint seeks an unspecified amount of damages on behalf of the purported class.\nThe Company is a nominal defendant in three purported shareholder derivative lawsuits that have been consolidated into a single action. Named in the consolidated complaint as individual defendants are the Company's directors (and certain of its former directors) and two of its former officers. The complaint alleges that, among other things, the officer-defendants exposed the Company to liability in the purported shareholder class action described in the preceding paragraph. The director-defendants are alleged to have acquiesced in the alleged violations. The complaint seeks to recover on behalf of the Company an unspecified amount of damages from the individual defendants. No relief is sought against the Company.\nWhile it is not feasible to predict the outcome of these legal proceedings and claims with certainty, management is of the belief that any ultimate liabilities for damages either are covered by insurance or should not have a material adverse effect on the Company's financial position.\nBorrowings\nThe Company's Short-term borrowings consist of unsecured commercial paper and notes payable bearing interest at prevailing market rates and supported by bank lines of credit amounting to $161,000 at December 31, 1993 and 1992. Commercial paper borrowings at December 31, 1993 and 1992 were $48,425 and $79,135 at average annual interest rates of 3.4% and 4%, respectively, with maturities in the first quarter of the subsequent year. Notes payable at December 31, 1993 and 1992 totaled $15,943 and $1,025 at average annual rates of 4.3% and 7%, respectively. Commitment fees to secure the lines of credit are not material.\nIn 1993, the Company established a $150,000 Medium-Term Note facility and issued $30,000 of these unsecured notes at interest rates ranging from 5.525% to 5.58% maturing in January 1999.\nThe terms of the borrowing facilities include various covenants which provide, among other things, for limitations on liens and the maintenance of a minimum debt service ratio. The Company was in compliance with such covenants at December 31, 1993.\nFinancial Instruments\nThe Company minimizes its exposure to foreign currency fluctuation through the use of forward exchange contracts and options. Realized and unrealized gains and losses on hedging contracts designated as hedges of foreign currency transactions are deferred and recognized in the Statement of Earnings in the same period as the underlying transactions. All other realized and unrealized gains and losses are recognized in the current period. At December 31, 1993 and 1992, the Company had forward exchange contracts outstanding with face values of $50,627 and $24,038, respectively, the carrying value of which approximated market. The contracts mature in less than one year. The estimated fair value of Medium-Term Notes payable at December 31, 1993 approximated their carrying value of $30,000.\nShareholders' Equity COMMON STOCK In 1992, the Company increased the number of authorized shares of Common Stock from 150 million to 300 million. Changes in outstanding shares for the years ended December 31 are as follows:\nThe Company has stock option plans which provide for the granting of options to directors, officers and key employees to purchase shares of its Common Stock within ten years at prices equal to the fair market value on the date of grant.\nActivity for the years 1993, 1992 and 1991 is as follows:\nAt December 31, 1993 and 1992, respectively, there were 1,137,470 and 616,003 shares exercisable at average prices of $51.18 and $42.45 and there were 2,741,522 and 337,887 shares available for granting options.\nUNAMORTIZED VALUE OF RESTRICTED STOCK AND PENSION COSTS Changes in the unamortized value of restricted stock represent charges for the market value of grants made during the year offset by periodic amortization. Such net charges amounted to ($577), ($442) and $827 for the years ended December 31, 1993, 1992 and 1991, respectively. In 1993, an excess pension liability adjustment amounting to $1,263, net of tax benefits, was charged to Shareholders' Equity.\nCUMULATIVE FOREIGN CURRENCY TRANSLATION ADJUSTMENT Amounts charged to Shareholders' Equity were $10,073, $19,804 and $1,014 for the years ended December 31, 1993, 1992 and 1991, respectively.\nSegment and Geographic Information\nThe Company operates in one industry segment, personal care products. The Company markets these products around the world. Sales are made and credit is granted to drug, grocery, variety and discount stores and other comparable outlets as well as to wholesalers and distributors in those trades. A small number of significant customers are financed through highly leveraged capital structures, making them particularly sensitive to market interest rate changes and other economic variables.\nInformation about the Company's operations in different geographic areas follows:\nCertain overhead costs are allocated to the geographic areas based on the anticipated benefit to be derived by the area.\nNet current assets of consolidated subsidiaries operating outside of the United States and the total net assets of such subsidiaries were as follows:\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Tambrands Inc.:\nWe have audited the accompanying consolidated balance sheets of Tambrands Inc. and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of earnings, retained earnings and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tambrands Inc. and subsidiaries as of December 31, 1993 and 1992 and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in the notes to the consolidated financial statements, the Company changed its method for accounting for postemployment benefits in 1993 and for postretirement benefits in 1992.\nKPMG PEAT MARWICK Stamford, Connecticut January 25, 1994\nSchedule V - Page 1 -------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nProperty, Plant and Equipment\nYear Ended December 31, 1993\n(dollars in thousands)\n(a) Includes assets of previously unconsolidated subsidiaries of $9,780.\nSchedule V - Page 2 -------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nProperty, Plant and Equipment\nYear Ended December 31, 1992\n(dollars in thousands)\n(a) Includes assets of subsidiary acquired of $1,259.\nSchedule V - Page 3 -------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nProperty, Plant and Equipment\nYear Ended December 31, 1991\n(dollars in thousands)\n(a) Includes capital leases of $525.\nSchedule VI - Page 1 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nAccumulated Depreciation of Property, Plant and Equipment\nYear Ended December 31, 1993\n(dollars in thousands)\n(a) Includes accumulated and current year depreciation of previously unconsolidated subsidiaries amounting to $2,916.\nSchedule VI - Page 2 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nAccumulated Depreciation of Property, Plant and Equipment\nYear Ended December 31, 1992\n(dollars in thousands)\nSchedule VI - Page 3 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nAccumulated Depreciation of Property, Plant and Equipment\nYear Ended December 31, 1991\n(dollars in thousands)\nSchedule VIII -------------\nTAMBRANDS INC. AND SUBSIDIARIES\nReserves\nYears Ended December 31, 1993, 1992 and 1991\n(dollars in thousands)\nSchedule IX - Page 1 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nShort-Term Borrowings\nDecember 31, 1993\n(dollars in thousands)\nSchedule IX - Page 2 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nShort-Term Borrowings\nDecember 31, 1992\n(dollars in thousands)\n(a) Commercial paper was outstanding only in the month of December. Average outstanding for the month was $50,287.\nSchedule IX - Page 3 --------------------\nTAMBRANDS INC. AND SUBSIDIARIES\nShort-Term Borrowings\nDecember 31, 1991\n(dollars in thousands)\n(a) Loans outstanding in hyperinflationary countries. (b) Nominal rate excluding devaluation.\nSchedule X ----------\nTAMBRANDS INC. AND SUBSIDIARIES\nSupplementary Income Statement Information\nYears Ended December 31, 1993, 1992 and 1991\n(dollars in thousands)\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Shareholders Tambrands Inc.:\nUnder date of January 25, 1994, we reported on the consolidated balance sheets of Tambrands Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings, retained earnings and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the annual report on Form 10-K for the year 1993. Our report refers to a change in accounting for postemployment benefits in 1993 and postretirement benefits in 1992. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in Item 14(a)2 of the annual report on Form 10-K for the year 1993. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK\nStamford, Connecticut January 25, 1994\nSupplementary Financial Information and Quarterly Data -----------------------------------\nQUARTERLY DATA (unaudited)\n(a) Results have been adversely affected by the restructuring and other charges as described in the notes to the consolidated financial statements.\nIndex to Exhibits -----------------\nThe Company will furnish a copy of any exhibit to a shareholder requesting such exhibit in writing upon payment by the shareholder of a fee representing the Company's reasonable expenses in furnishing such exhibit.","section_15":""}
{"filename":"58492_1993.txt","cik":"58492","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS. The Company was incorporated in 1901 as the successor to a partnership formed in 1883 at Carthage, Missouri. That partnership was a pioneer in the manufacture and sale of steel coil bedsprings. Products produced and sold for the furnishings industry constitute the largest portion of the Company's business. These include primarily components used by companies making furniture and bedding for homes, offices and institutions. Also in the furnishings area, the Company produces and sells some finished furniture and carpet cushioning materials. In addition, a group of diversified products is produced and sold. The Company believes it is the largest producer of a diverse range of furniture and bedding components in the United States. The term \"Company,\" unless the context requires otherwise, refers to Leggett & Platt, Incorporated and its majority owned subsidiaries.\nThe Company completed several acquisitions during 1993, primarily businesses engaged in manufacturing components for the furnishings industry and raw materials used by the Company in the manufacture of its products.\nIn September 1993 the Company acquired Hanes Holding Company (\"Hanes\"), headquartered in Winston-Salem, North Carolina. Hanes is a converter and distributor of woven and nonwoven construction fabrics, primarily in the furnishings industry. Hanes also is a commission dye\/finisher of nonfashion fabrics for the furnishings and apparel industries. Immediately following the Company's acquisition of Hanes, the Company (through Hanes) completed the acquisition of VWR Textiles & Supplies, Inc., which converts and distributes woven and nonwoven construction fabrics and manufactures other soft goods components for sale to manufacturers of furniture and bedding.\nAlso, in September 1993 the Company acquired full ownership of several wire drawing mills which had been previously jointly owned.\nFor further information concerning acquisitions reference is made to Note B of the Notes to Consolidated Financial Statements.\nPRODUCTS AND MARKET. The Company is engaged primarily in the manufacture and distribution of components used by companies that manufacture furniture and bedding for homes, offices and institutions. Manufacturers of finished furniture and bedding use many component parts which can be standardized and more efficiently produced in volumes beyond the individual needs of most such manufacturers. It is this market for component parts which the Company serves through its furniture and bedding component product lines.\nThe Company's components customers manufacture bedding (mattresses and boxsprings), upholstered furniture and other finished products for sale to wholesalers, retailers, institutions and others. Historically, the furnishings industry has been highly fragmented and included many relatively small companies, widely dispersed geographically. Although there has been a trend toward consolidation in the furnishings industry, the industry as a whole remains fragmented to a substantial degree.\nThe Company's component products are sold and distributed primarily through the Company's sales personnel.\nIn addition to components, the Company manufactures and sells finished products for the furnishings industry. These finished products include sleep-related finished furniture and carpet cushioning materials. Some of the finished furniture products are sold to bedding and furniture manufacturers which resell the finished furniture under their own labels to wholesalers or retailers. Certain finished furniture such as bed frames, fashion beds, daybeds and other select items are also sold by the Company directly to retailers. The Company's carpet cushioning materials are sold primarily to floor covering distributors with some direct contract sales.\nThe following list is representative of the principal products produced by the Company in the furnishings industry:\nBEDDING COMPONENTS Lectro-LOK-R-, Web-LOK-TM-, LOK-Fast-TM-, Flex-Deck-TM-, and Semiflex-TM- boxspring components Edge and corner stabilizer spring supports Foam and fiber cushioning materials Gribetz computerized single needle (Class V) and multi-needle chain stitch (Class I-IV) quilting machinery, material handling systems, panel cutters, tape edge and border serging machines Hanes construction fabrics Mira-Coil-R-, Super-Lastic-R-, Lura-Flex-TM-, Hinge Flex-TM-, and Ever-Flex-TM- innerspring assemblies for mattresses Mounted and crated boxsprings and foundation units Nova-Bond-R- and other insulator pads for mattresses and boxsprings Perm-A-Lator-R-, Plasteel-R-, Posturizer-TM-, Flexnet-TM- and other mattress insulators Spring and basic wire Synthetic, wool, cotton, and silk cushioning materials Wood frames and dimension lumber for boxspring frames FINISHED PRODUCTS Bed frames Bunk beds made of wood and steel Daybeds made of brass and wood Electric beds Genuine Brass, Lustre Brass-R- and other metal fashion beds and headboards Pedestal bed bases DURAPLUSH-TM-, Permaloom-R- and other carpet cushioning materials Rollaway beds Trundle beds Wood headboards FURNITURE COMPONENTS Chair controls, casters and other components for office furniture ClassicTouch-TM- and Modular Wallhugger-R- mechanisms for motion upholstered groups Coil-Flex-TM- and ModuCoil-R- spring assemblies for upholstered furniture Components for office panel systems Die cast aluminum, fabricated steel, and injection molded plastic bases for office furniture and dinettes Flex-Cord-R- paper covered wire Hanes construction fabrics Mechanisms for adjustable height work tables MPI\/No-Sag-R- and other foam cushioning No-Sag-R- seating systems and clips Metal bed rails for bedroom suites Molded plastic recliner handles and other plastic furniture components No-Sag-R- rocker springs Perm-A-Lator-R- wire seating insulators Perma-eze-R- seat and back springs PETCO weltcord and furniture edgings Ring-Flex-R- polyethylene foam edgings SOFA PLUS-TM-, MAX-R-, and Classic-TM- Series sofa sleeper mechanisms Spring wire Swivel, rocker and glider components for motion furniture Synthetic fiber, densified fiber batting, seat pads and other cushioning materials System Seating-TM-, Seat Pleaser-R- and other furniture coils and accessories Tackit-TM- tackstrips Wallhugger-R- and Concept-TM- mechanisms for reclining chairs Webline-TM- seating systems Welded steel tubing\nOutside the furnishings industry, the Company produces and sells for home, industrial and commercial uses a diversified line of components and other products made principally from steel, steel wire, aluminum, plastics, textile fibers and woven and nonwoven fabrics. The Company's diversified products require manufacturing technologies similar to those used in making furniture and bedding components and certain raw materials which the Company produces for its own use.\nThe following list is representative of the Company's principal diversified products:\nDIVERSIFIED PRODUCTS Aluminum die cast custom products and aluminum ingot Cyclo-Index-R- motion controls for manufacturing equipment Flex-O-Lators-R- and No-Sag-R- automotive seat suspension systems Gribetz single needle quilters, multi-needle chain stitch quilters, and panel cutters Hanes industrial and apparel fabrics Industrial wire Injection molded plastic products Mechanical springs Metal and wire shelving for utility vehicles and consumer products Point-of-purchase display racks Sound insulation materials Specialty foam products Textile fiber wiping cloths and other products Welded steel tubing\nThe table below sets out further information concerning sales of each class of the Company's products:\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SUMMARY OF SALES 1993-1988\nReference is also made to Note I of the Notes to Consolidated Financial Statements for further segment information.\nThe Company's international division is involved primarily in the sale of machinery and equipment designed to manufacture the Company's Mira-Coil-R- (Continuous Coil) innersprings and certain other spring products and the licensing of patents owned and presently maintained by the Company in a number of foreign countries. The Company also sells quilting machines and similar equipment and certain other component products in some foreign countries. Foreign sales are a minor portion of the Company's business.\nCUSTOMERS. The Company has several thousand customers, most of which are engaged in manufacturing finished bedding and furniture products. None of the Company's customers account for as much as 10% of sales and, in management's opinion, the loss of any single customer would not have a material adverse effect on the Company's business as a whole.\nSOURCES OF RAW MATERIALS. Steel rod (from which steel wire is drawn) and coil steel are the Company's most important raw materials. Other raw materials used by the Company include aluminum ingot, aluminum scrap, angle steel, sheet steel, various woods, textile scrap, foam chemicals, foam scrap, woven and nonwoven fabrics and plastic.\nSubstantially all of the Company's requirements for steel wire, an important component in many of the Company's products, are supplied by Company-owned wire drawing mills. A substantial portion of the steel rod used by these wire drawing mills is purchased pursuant to a rod supply agreement with a major steel rod producer. The Company also produces, at various locations, for its own consumption and for sale to customers not affiliated with the Company, slit coil steel, welded steel tubing, textile fibers, dimension lumber and aluminum ingot.\nNumerous supply sources for the raw materials used by the Company are available. The Company did not experience any significant shortages of raw materials during the past year.\nPATENTS: RESEARCH AND DEVELOPMENT. The Company holds numerous patents concerning its various product lines. No single patent or group of patents is material to the Company's business as a whole. The Company's more significant trademarks include those listed with the Company's principal products.\nThe Company maintains research, engineering and testing centers at Carthage, Missouri, and also does research and development work at several of its other facilities. The Company is unable to precisely calculate the cost of research and development since the personnel involved in product and machinery development also spend portions of their time in other areas. However, the Company believes that the cost of research and development approximated $5 million in each of the last three years.\nEMPLOYEES. The Company has approximately 13,000 employees of whom approximately 10,000 are engaged in production. Approximately 40% of the Company's production employees are represented by labor unions.\nThe Company did not experience any material work stoppage related to the negotiation of contracts with labor unions during 1993. Management is not aware of any circumstance which is likely to result in a material work stoppage related to the negotiations of any contracts expiring during 1994.\nCOMPETITION. The markets for components and other products the Company produces are highly competitive in all aspects. There are numerous companies offering products which compete with those products offered by the Company. The Company believes it is the largest supplier in the United States of a diverse range of furniture and bedding components to the furnishings industry.\nGOVERNMENT REGULATION. The Company's various operations are subject to federal, state, and local laws and regulations related to the protection of the environment, worker safety, and other matters. Environmental regulations include those relating to air and water emissions, underground storage tanks, waste handling, and the like. While the Company cannot forecast policies that may be adopted by various regulatory agencies, management believes that compliance with these various laws and regulations will not have a material adverse effect on the consolidated financial condition or results of operations of the Company. From time to time, the Company is involved in proceedings, or takes remedial or other actions, relating to environmental matters. In one instance, the United States Environmental Protection Agency (\"EPA\") has directed one of the Company's subsidiaries to investigate potential releases into the environment and, if necessary, to perform corrective action. The subsidiary appealed the EPA's action. On February 4, 1994, the EPA Environmental Appeals Board\nremanded the matter to the EPA for further proceedings. One-half of any costs associated with any such investigation or corrective action would be reimbursed to the Company under a contractual obligation of a former joint owner of the subsidiary. The outcome of this matter cannot be reasonably predicted. Accordingly, no provision for the cost of performing any required investigation and corrective action has been recorded on the books of the Company. Management believes the cost to perform any investigation and corrective action, if eventually required, will not have a material adverse effect on the consolidated financial condition or results of operations of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns or leases approximately 150 facilities throughout the United States and Canada. Its corporate headquarters is located in Carthage, Missouri. The Company's most important physical properties are its owned or leased manufacturing plants. Such plants include five wire drawing mills in Missouri, Florida, Kentucky, Indiana and Massachusetts; welded steel tubing mills in Mississippi and Tennessee; and an aluminum smelting plant in Alabama. All of these mills manufacture some products which are either transferred to and used by the Company's other manufacturing plants, or are sold to others. Other major manufacturing plants are located in Alabama, Arkansas, California, Georgia, Illinois, Indiana, Kentucky, Massachusetts, Michigan, Mississippi, Missouri, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Wisconsin, and Canada. In addition, the Company owns or leases a large number of other facilities located in approximately 30 states utilized mainly for assembly, warehousing and distribution of Company products.\nMost of the Company's major manufacturing plants are owned by the Company or are held under operating leases. Leases expire at various dates through 2010. For additional information regarding lease obligations, reference is made to Note E of the Notes to Consolidated Financial Statements.\nThe Company's machinery, equipment and buildings are maintained in good condition and are suitable for its current operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in numerous ordinary, routine workers' compensation, product liability, vehicle accident, employment termination, and other claims and legal proceedings, the resolution of which Management believes will not have a material adverse effect on the consolidated financial condition or results of operations of the Company.\nThe Company is presently party to a small number of proceedings in which a governmental authority is a party and which involve provisions enacted regulating the discharge of materials into the environment. These proceedings deal primarily with waste disposal site remediation. Management believes that potential monetary sanctions, if imposed in any or all of these proceedings, or any capital expenditures or operating expenses attributable to these proceedings, will not have a material adverse effect on the consolidated financial condition or results of operations of the Company. The EPA has alleged that two of the Company's facilities in Grafton, Wisconsin violated wastewater pretreatment requirements under the Clean Water Act. No action is pending. The EPA has not requested any specific relief, but has indicated it intends to bring an action. Management believes the cost to resolve this matter will not have a material adverse effect on the consolidated financial condition or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nLeggett & Platt's common stock is listed on The New York and Pacific Stock Exchanges with the trading symbol LEG. The table below highlights quarterly and annual stock market information for the last two years.\nPrice and volume data reflect composite transactions and closing prices as reported daily by The Wall Street Journal adjusted, as appropriate, for a 2-for-1 stock split on June 15, 1992.\nAt February 25, 1994 the Company had approximately 6,969 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company's previously issued financial statements have been restated to reflect pooling of interests acquisitions. Therefore, the following discussion and analysis reflects the Company's capital resources and liquidity and results of operations as restated for these acquisitions.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's financial position reflects several important principles and guidelines of management's capital policy. These include management's belief that corporate liquidity must always be adequate to support the Company's projected internal growth rate. At the same time, liquidity must assure management that the Company will be able to withstand any amount of financial adversity that can reasonably be anticipated. Management also intends to direct capital to strategic acquisitions and other investments that provide additional opportunities for expansion and enhanced profitability.\nFinancial planning to meet these needs reflects management's belief that the Company should never be forced to expand its capital resources, whether debt or equity, at a time not of its choosing. Management also believes that financial flexibility is more important than maximization of earnings through excessive leverage.\nThe Company's primary source of capital to meet these objectives is from internally generated funds. Operating activities provided $349.1 million in cash during the last three years. An additional $3.5 million in cash was generated from the issuance of the Company's common stock. Cash dividends paid on the stock were $57.2 million and repurchases of stock for the Company's treasury totaled $3.2 million during the three year period.\nManagement continuously provides for available credit in excess of the Company's worst-case projections. Policy guidelines provide that long-term debt, composed of two \"layers\", will normally be maintained in a range of 30% to 40% of total capitalization. Obligations having scheduled maturities are the base \"layer\" of debt capital. At the end of 1993, these obligations totaled $122.3 million, consisting primarily of privately placed institutional loans and tax-exempt industrial development bonds. At the end of 1992, debt with scheduled maturities totaled $112.5 million, which was down from $135.4 million a year earlier.\nNear the end of the third quarter of 1993, the Company issued $50 million in unsecured privately placed debt under a medium-term note program. These notes were issued with average lives of approximately nine years and fixed interest rates averaging 5.8%. Debt of a company acquired in a September pooling of interests transaction was repaid with the majority of the proceeds from these notes. In 1992, the Company also issued approximately $26 million of medium-term notes near the beginning of the fourth quarter. These notes were issued with average lives of approximately five years and fixed interest rates averaging 6.15%. Proceeds from the notes issued in 1992 were used to repay debt outstanding under the Company's revolving bank credit agreements.\nStandard & Poor's and Moody's, the nations two leading debt rating agencies, both increased their ratings of the Company's senior debt in July 1992. Standard & Poor's increased its rating to A- from BBB+, and Moody's increased its rating to A3 from Baa1. In March 1992, substantially all of the $40 million of 6 1\/2% convertible subordinated debentures, which had been outstanding at the end of 1991, were converted into 2.1 million shares of the Company's common stock. The resulting increase in shareholders' equity enhanced the Company's flexibility in capital management and increased yearly after-tax cash flow by approximately $.7 million.\nThe Company's second \"layer\" of debt capital consists of revolving credit agreements with six banks. Over the years, management has renegotiated these bank credit agreements to keep pace with the Company's projected growth and to maintain a highly flexible source of debt capital. When utilized, the credit under these agreements is a long-term obligation. At the same time, however, the credit is available for short-term borrowings and repayments. In 1993, there was $43.5 million in revolving debt outstanding at the end of the year, up from $35.4 million in 1992. At the end of 1991, $97.3 million in revolving debt was outstanding. The 1993 increase in revolving debt reflected a portion of funds borrowed to finance cash acquisitions in the third quarter. In the fourth quarter of 1993 and prior to recent acquisitions, revolving bank debt was reduced with internally generated funds. Additional details of long-term debt outstanding, including scheduled maturities and the revolving credit, are discussed in Note D of the Notes to Consolidated Financial Statements.\nNet capital investments to modernize and expand manufacturing capacity internally totaled $109.0 million in the last three years. During this period, acquisitions accounted for by the purchase method of accounting involved a net cash investment of $93.3 million, plus an assumption of $5.7 million in long-term debt of the acquired businesses. In addition, the Company issued 1.8 million shares of common stock in three acquisitions accounted for as poolings of interests during this period.\nThe largest acquisitions were completed during the third quarter of 1993. On September 1, the Company acquired Hanes Holding Company for 1.6 million shares of common stock, in a pooling of interests, and purchased VWR Textiles & Supplies, Inc. (through Hanes) for $26 million in cash. The Company also purchased full ownership of several wire drawing mills, which previously had been jointly owned. This transaction involved $33 million, plus the assumption of $3.6 million in long-term debt. Additional details of acquisitions are discussed in Note B of the Notes to Consolidated Financial Statements.\nThe following table shows, in millions, the Company's capitalization at the end of the three most recent years. It also shows the amount of additional capital available through the revolving bank credit agreements and the Company's commercial paper program. The amount of cash and cash equivalents is also shown.\nThe Company has the additional availability of short-term uncommitted credit from several banks. However, there was no short-term debt outstanding at the end of any of the last three years. The Company has substantial capital resources to support additional capital investments at or above recent levels.\nWorking capital increased $32.5 million in the last three years. To gain additional flexibility in capital management and to improve the rate of return on shareholders' equity, the Company continuously seeks efficient use of working capital. The following table shows the annual turnover on average year-end working capital, trade receivables and inventories.\nFuture commitments under lease obligations are described in Note E and contingent obligations in connection with environmental matters are discussed in Note J of the Notes to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nThe results of operations during the last three years reflect various elements of the Company's long-term growth strategy, along with general trends in the economy and the furnishings industry. The Company's growth strategy continues to include both internal programs and acquisitions, which broaden product lines and provide for increased market penetration and operating efficiencies. With a continuing emphasis on the development of new and improved products and advancements in production technology, the Company is able to consistently offer high quality products, competitively priced.\nTrends in the general economy were favorable during the last two years. Economic growth increased in the fourth quarter of 1993, following more modest growth during most of the year. Consumer confidence also improved near the end of the year, and final demand for durable goods, including furniture and bedding, generally remained stronger than the demand for non-durable goods. Consumers reacted favorably to lower long-term interest rates and increased availability of credit. In 1992, a post-election recovery in consumer confidence quickly led to increased consumer spending and accelerated growth in the economy. However, compared with previous first year recoveries from recessionary lows, economic improvement was modest during most of 1992. During 1991, the economy began to recover from recessionary lows early in the year, when the war in the Middle East ended and consumer confidence temporarily improved. Consumer confidence soon turned back down and the pace of overall business remained depressed at the end of 1991.\nDemand in the furnishings industry followed a pattern similar to the general economy during the last three years. Annual growth in retail sales and manufacturers' shipments of bedding and furniture was somewhat stronger in 1993 than in 1992. Increased consumer spending near the end of the last two years helped offset some of the seasonal slowdown in demand for bedding, furniture and other furnishings the industry normally experiences. In 1991, industry sales and shipments reached recessionary lows in the first quarter, and recovered slowly during the remainder of the year.\nManagement is anticipating further modest growth in the economy and the markets the Company serves in 1994. Severe winter weather and the California earthquake have impacted overall business activity at the beginning of the year, in several parts of the country. However, these are temporary adversities. Management is cautious in its outlook for business generally, primarily because of concerns about higher income tax rates, proposals for governmental health care programs, and inflationary trends.\nInflation in the United States generally remained modest during the last three years. However, the Company experienced renewed inflation in prices for raw materials, principally steel and wire, throughout 1993. Modest price increases were implemented on some Company products during the second and third quarters of 1993 to help offset earlier cost increases and the renewed inflation in prices for raw materials. However, some of this inflation has not yet been reflected in the Company's selling prices. Therefore, the Company is continuing to experience cost\/price pressures in affected product lines. In 1992, the Company was able to refrain from raising prices, as previously weaker economic conditions had reduced inflation for most raw materials. During 1991, the Company implemented modest price increases on some products in the second quarter. Prices for urethane foam products were raised more than others, in response to the 1990 acceleration in prices for petrochemicals.\nThe Company's consolidated net sales in 1991 were modestly reduced after the mid-year divestiture of certain urethane foam operations. At the same time, the Company's profitability improved through the partial elimination of the operating losses these operations experienced in 1990. The operating results of the Company's restructured Fashion Bed Group, which manufactures sleep-related finished furniture, also began to improve near the end of 1992. In 1993, the Company's overall profitability reflected improved efficiencies in the remaining foam operations. The Fashion Bed Group also attained improved efficiencies in 1993, but continues to perform below management's expectations.\nThe Company's consolidated net sales in 1993 increased 16% over the prior year. Excluding acquisitions accounted for as purchases, sales increased 10%, reflecting higher unit volumes and modestly higher prices on some products. In 1992, consolidated net sales increased 8% over 1991, due almost entirely to higher unit volumes. Sales, excluding purchase acquisitions and divestitures, also increased 8% in 1992.\nThe following table shows various measures of earnings as a percentage of sales for the last three years. It also shows the effective income tax rate and the coverage of interest expense by pre-tax earnings plus interest.\nThe Company's profit margins, like sales, continued to improve since 1991. In 1993, the gross profit margin was substantially unchanged from 1992. Operating efficiencies resulting from increased sales and production, cost cutting, and constant attention to cost containment were largely offset by inflation in prices for some key raw materials. Reflecting this inflation, LIFO expense reduced the gross profit margin by 0.2% in 1993. This experience was in contrast to the previous two years, when LIFO income slightly increased gross profit margins. The replacement cost of the LIFO inventory is discussed in Note A of the Notes to Consolidated Financial Statements.\nThe 1993 pre-tax profit margin increased to 9.2% of sales. This improvement primarily reflected a 0.7% reduction in selling, distribution and administrative expenses, as a percentage of sales. Increased efficiencies and reduced bad debt expense contributed to the improvement in operating expense ratios. These factors and a slight increase in other income more than offset one time charges related to recent acquisitions and the Company's implementation of new accounting statements issued by the Financial Accounting Standards Board. The new accounting statements are mentioned separately at the end of this discussion, and in Note A of the Notes to Consolidated Financial Statements.\nInterest expense, as a percentage of sales, was reduced 0.4% in 1993 and further improved the pre-tax profit margin. Reduced debt outstanding (before recent acquisitions) and lower interest rates were reflected in this improvement.\nThe effective income tax rate was 39.1% in 1993, up from 38.5% in 1992. In the third quarter of 1993, corporate federal income tax rates were increased from 34% to 35%, retroactive to January 1, 1993. Additional details of income taxes for the last three years are discussed in Note H of the Notes to Consolidated Financial Statements.\nIn 1992, the gross profit margin increased to 22.8% of sales. This 1.4% increase over 1991 primarily reflected an improvement in operating efficiencies and earlier cost cutting at many locations.\nThe 1992 pre-tax profit margin increased to 8.1% of sales. In addition to the improvement in the gross profit margin, the pre-tax margin benefitted from a 0.7% reduction in selling, distribution and administrative expenses, as a percentage of sales. Improved operating efficiencies and reduced bad debt expense were reflected in the lower 1992 operating expense ratios.\nInterest expense, as a percentage of sales, was reduced 0.6% in 1992 and further improved the pre-tax profit margin. Reduced debt outstanding and lower interest rates both contributed to this improvement, which was partially offset by an increase in other deductions, net of other income. The 1992 earnings contribution from associated (50% owned) companies was down modestly from 1991.\nSTATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ADOPTED\nThe Company adopted three accounting statements in 1993 issued by the Financial Accounting Standards Board. The new statements included Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions;\" SFAS No. 109, \"Accounting for Income Taxes;\" and SFAS No. 112, \"Employers' Accounting for Postemployment\nBenefits.\" The Company fully expensed any previously unrecorded liabilities related to these accounting statements in 1993. The Company's financial statements, contrary to those of many other companies, have not been impacted in any significant way by the implementation of the new accounting rules. All new accounting statements issued by the Financial Accounting Standards Board that could impact the Company were fully implemented by the end of 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements and supplementary data included in this Report begin on page 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Reference is made to the sections entitled \"Election of Directors\" and \"Compliance With Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 11, 1994, said section being incorporated by reference, for a description of the directors of the Company.\nThe following table sets forth the names, ages and positions of all executive officers of the Company. Executive officers are elected annually by the Board of Directors at the first meeting of directors following the Annual Meeting of Shareholders.\nThe description of the executive officers of the Company is as follows:\nSubject to the employment agreements and severance benefit agreements listed as Exhibits to this Report, officers serve at the pleasure of the Board of Directors.\nHarry M. Cornell, Jr. has served as the Company's Chief Executive Officer, Chairman of the Board and Chairman of the Board's Executive Committee for more than the last five years.\nFelix E. Wright was elected President in 1985 and has served as Chief Operating Officer since 1979.\nRoger D. Gladden was elected Senior Vice President in 1992. Mr. Gladden has been President -- Commercial Products Group since 1984 and previously served as Vice President -- Administration.\nMichael A. Glauber was elected Senior Vice President, Finance and Administration in 1990. Mr. Glauber was elected Vice President -- Finance in 1979 and Vice President -- Finance and Treasurer in 1980.\nDavid S. Haffner was elected Senior Vice President and President -- Furniture and Automotive Components Group in 1992. Mr. Haffner was appointed President -- Furniture Components Group in 1985 and was elected Vice President of the Company in 1985.\nRobert A. Jefferies, Jr. was elected Senior Vice President, Mergers, Acquisitions and Strategic Planning in 1990. Mr. Jefferies formerly served as Vice President and the Senior Vice President, General Counsel and Secretary of the Company from 1977 through 1992.\nDuane W. Potter was elected Vice President in 1978 and Senior Vice President in 1983. Mr. Potter has been President -- Bedding Components Group since 1985.\nThomas D. Sherman, prior to joining the Company on January 1, 1993, served as Vice President, General Counsel and Secretary to Coca-Cola Enterprises Inc. and engaged in the private practice of law.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation and Related Matters\" in the Company's definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 11, 1994, is incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section entitled \"Ownership of Common Stock\" in the Company's definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 11, 1994, is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe subsection entitled \"Related Transactions\" of the section entitled \"Executive Compensation and Related Matters\" in the Company's definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 11, 1994 is incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n1. FINANCIAL STATEMENTS\nThe Financial Statements listed below are included in this Report:\n- Consolidated Statements of Earnings for each of the years in the three year period ended December 31, 1993\n- Consolidated Balance Sheets at December 31, 1993 and 1992\n- Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three year period ended December 31, 1993\n- Consolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1993\n- Notes to Consolidated Financial Statements\n- Report of Independent Accountants\n2. FINANCIAL STATEMENT SCHEDULES\nReports of Independent Accountants on Financial Statement Schedules\nSchedules (at December 31, 1993 and 1992, and for each of the years in the three year period ended December 31, 1993)\nAll other information schedules have been omitted as the required information is inapplicable, not required, or the information is included in the financial statements or notes thereto.\n3. EXHIBITS -- See Exhibit Index.\n4. REPORTS ON FORM 8-K FILED DURING THE LAST QUARTER OF 1993: None.\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES\nQUARTERLY SUMMARY OF EARNINGS\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS\nYEAR ENDED DECEMBER 31\nThe accompanying notes are an integral part of these financial statements.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nDECEMBER 31 ASSETS\nThe accompanying notes are an integral part of these financial statements.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(DOLLAR AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) DECEMBER 31, 1993, 1992 AND 1991\nA -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Leggett & Platt, Incorporated and its majority-owned subsidiaries (the Company). The Company's previously issued financial statements have been restated to reflect pooling of interests acquisitions as discussed in Note B. All significant intercompany transactions and accounts have been eliminated in consolidation.\nCASH EQUIVALENTS: Cash equivalents include cash in excess of daily requirements which is invested in various financial instruments with maturities of three months or less.\nINVENTORIES: All inventories are stated at the lower of cost or market. Cost includes materials, labor and production overhead. Cost is determined by the last-in, first-out (LIFO) method for approximately 70% of the inventories at December 31, 1993 and 1992. The first-in, first-out (FIFO) method is used for the remainder. The FIFO cost of inventories at December 31, 1993 and 1992 approximated replacement cost.\nDEPRECIATION AND AMORTIZATION: Property, plant and equipment and other intangibles are depreciated or amortized over their estimated lives, principally by the straight-line method. Accelerated methods are used for tax purposes. The excess cost of purchased companies over net assets acquired is amortized by the straight-line method over forty years.\nCOMPUTATIONS OF EARNINGS PER SHARE: Earnings per share is based on the weighted average number of common and common equivalent shares outstanding. Common stock equivalents result from the assumed issuance of shares under stock option plans.\nCONCENTRATION OF CREDIT RISK: The Company specializes in manufacturing, marketing and distributing components and other related products for the furnishings industry and diversified markets. The Company performs ongoing credit evaluations of its customers' financial conditions and, generally, requires no collateral from its customers, some of which are highly leveraged. The Company maintains allowances for potential credit losses and such losses generally have been within management's expectations.\nFAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying value of the Company's financial instruments approximates market value.\nACCOUNTING STANDARDS ADOPTED: During 1993, the Company adopted three new statements issued by the Financial Accounting Standards Board. These statements were: 1) Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions;\" 2) SFAS No. 109, \"Accounting for Income Taxes;\" and 3) SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The adoption of these statements did not have a material effect on the Company's financial position or results of operations.\nRECLASSIFICATIONS: Certain reclassifications have been made to the prior years' consolidated financial statements to conform to the 1993 presentation.\nB -- ACQUISITIONS In September 1993, the Company issued 1,579,354 shares of common stock to acquire Hanes Holding Company (Hanes) in a transaction accounted for as a pooling of interests. Options to purchase an additional 45,743 shares of common stock were also extended by the Company in substitution for previously existing options. Hanes' business consists of converting and distributing woven and nonwoven construction fabrics, primarily in the furnishings industry. In addition, Hanes is a\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nB -- ACQUISITIONS (CONTINUED) commission dye\/finisher of non-fashion fabrics for the furnishings and apparel industries. In another pooling of interests transaction, the Company issued 68,788 shares of common stock to acquire a company whose business is manufacturing furniture components for the furnishings industry. Previously issued financial statements have been restated to reflect the poolings. Separate results of operations for the years ended December 31, 1993, 1992 and 1991 are as follows:\nIn September 1993, the Company acquired VWR Textiles & Supplies, Inc. (through Hanes) which converts and distributes construction fabrics and manufactures and distributes other soft goods components to the furnishings industry. The purchase price of this acquisition was approximately $26.0. Also in 1993, the Company acquired full ownership of several wire drawing mills which previously had been jointly owned. This transaction involved $33.0 in cash and the assumption of approximately $3.6 of long term debt. In addition, the Company acquired several smaller companies during 1993 which primarily manufacture and distribute products to the furnishings industry. The following unaudited pro forma information shows the results of operations for the years ended December 31, 1993 and 1992 as though the 1993 acquisitions accounted for as purchases had occurred on January 1 of each year presented. These pro forma amounts reflect purchase accounting adjustments, interest on incremental borrowings and the tax effects thereof. This pro forma financial information is not necessarily indicative of either results of operations that would have occurred had the purchases been made on January 1 of each year or of future results of the combined companies.\nDuring 1992, the Company acquired the assets of one small company that primarily manufactures bedding and furniture components for the furnishings industry. The purchase price of this acquisition was approximately $5.8. Assuming this acquisition had occurred at the beginning of the year, it would not have had a material impact on net sales, net earnings or earnings per share.\nAlso during 1992, the Company acquired a business accounted for as a pooling of interests. The business primarily manufactures bedding and furniture components for the furnishings industry. In exchange for all of the outstanding capital stock of the business, the Company issued 100,903 shares of its common stock. The Company elected not to restate prior year's financial statements as the effect was immaterial.\nDuring 1991, the Company acquired the assets of two small companies that primarily manufacture bedding and furniture components for the furnishings industry. The purchase price of these acquisitions was approximately $10.0. Assuming these acquisitions had occurred at the beginning of the year, they would not have had a material impact on net sales, net earnings or earnings per share.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nB -- ACQUISITIONS (CONTINUED) The above acquisitions, except for the 1993 and 1992 poolings, have been accounted for as purchases, and, where applicable, the excess of the total acquisition cost over the fair value of the net assets acquired is being amortized by the straight-line method over forty years. The results of operations of these companies since the dates of acquisition have been included in the consolidated financial statements.\nThe purchase prices as originally reported represent the initial amounts of cash and common stock of the Company issued at the time of the acquisitions. Some purchase agreements also contain provisions for additional payments if certain minimum earnings requirements are met. All such provisions expired during 1993. Amounts earned under the terms of the agreements are recorded as increases in the excess of the total acquisition cost over the fair value of the net assets acquired. Such additional payments were approximately $6.4 and $2.7 during 1993 and 1992, respectively.\nC -- ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities at December 31 consist of the following:\nD -- LONG-TERM DEBT Long-term debt at December 31 consists of the following:\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nD -- LONG-TERM DEBT (CONTINUED) The revolving credit agreements provide for a maximum line of credit of $160.0. For any revolving credit agreement, the Company may elect to pay interest based on 1) the bank's base lending rate, 2) LIBOR, 3) an adjusted certificate of deposit rate, or 4) the money market rate, as specified in the revolving agreements. Any outstanding balances at the end of the third year of the revolving credit agreements may be converted into term loans payable in ten equal semi-annual installments. Commitment fees during the revolving agreement period are 3\/16 of 1% per annum of the unused credit line, payable on a quarterly basis.\nThe revolving credit agreements and certain other long-term debt contain restrictive covenants which, among other restrictions, limit the amount of additional debt, require working capital to be maintained at specified amounts and restrict payments of dividends. Unrestricted retained earnings available for dividends at December 31, 1993 were approximately $137.1.\nMaturities of long-term debt for each of the five years following 1993 are:\nE -- LEASE OBLIGATIONS The Company conducts certain of its operations in leased premises and also leases most of its automotive and trucking equipment and some other assets. Terms of the leases, including purchase options, renewals and maintenance costs, vary by lease. Total rental expense entering into the determination of results of operations was approximately $17.4, $16.8 and $17.0 for the years ended December 31, 1993, 1992 and 1991, respectively. Future minimum rental commitments for all long-term noncancelable operating leases are as follows:\nThe above lease obligations expire at various dates through 2010. Certain leases contain renewal and\/or purchase options. Aggregate rental commitments above include renewal amounts where it is the intention of the Company to renew the lease.\nF -- CAPITAL STOCK At December 31, 1993, the Company had 1,724,973 common shares authorized for issuance under stock option plans. All options are granted at not less than quoted market value on the date of grant and generally become exercisable in varying installments, beginning 6 to 18 months after the date of grant.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nF -- CAPITAL STOCK (CONTINUED) Other data regarding the Company's stock options is summarized below:\nThe Company has also authorized shares for issuance in connection with certain employee stock benefit plans discussed in Note G.\nIn 1989, the Company declared a dividend distribution of one preferred stock purchase right (a Right) for each share of common stock. The Rights are attached to and traded with the Company's common stock. The Rights may only become exercisable under certain circumstances involving actual or potential acquisitions of the Company's common stock. Depending upon the circumstances, if the Rights become exercisable, the holder may be entitled to purchase shares of Series A junior preferred stock of the Company, shares of the Company's common stock or shares of common stock of the acquiring entity. The Rights remain in existence until February 15, 1999, unless they are exercised, exchanged or redeemed at an earlier date.\nOn May 12, 1993 the Company's shareholders approved an amendment to the Company's Restated Articles of Incorporation increasing authorized Common Stock to 300,000,000 shares from 100,000,000 shares and reducing the par value of Common Stock to $.01 from $1.00. The amendment provided that the stated capital of the Company would not be affected as of the date of the amendment. Accordingly, stated capital of the Company exceeds the amount reported as common stock in the financial statements by approximately $39.0.\nG -- EMPLOYEE BENEFIT PLANS The Company sponsors contributory and non-contributory pension and retirement plans. Substantially all employees, other than union employees covered by multiemployer plans under collective bargaining agreements, are eligible to participate in the plans. Retirement benefits under the contributory plans are based on career average earnings. Retirement benefits under the non-contributory plans are based on years of service, employees' average compensation and social security benefits. It is the Company's policy to fund actuarially determined costs as accrued.\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nG -- EMPLOYEE BENEFIT PLANS (CONTINUED) Information at December 31, 1993, 1992 and 1991 as to the funded status of Company sponsored defined benefit plans, net pension income from the plans for the years then ended and weighted average assumptions used in the calculations are as follows:\nPlan assets are invested in a diversified portfolio of equity, debt and government securities, including 294,000 shares of the Company's common stock at December 31, 1993.\nContributions to union sponsored, multiemployer pension plans were $.2, $.2 and $.4 in 1993, 1992 and 1991, respectively. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. As of 1993, the actuarially computed values of vested benefits for these plans were equal to or less than the net assets of the plans. Therefore, the Company would have no withdrawal liability. However, the Company has no present intention of withdrawing from any of these plans, nor has the Company been informed that there is any intention to terminate such plans.\nNet pension income (expense), including Company sponsored defined benefit plans, multiemployer plans and other plans, was $.7, $.8 and $(.4) in 1993, 1992 and 1991, respectively.\nThe Company also has a contributory stock purchase\/stock bonus plan (SPSB Plan), a non-qualified executive stock purchase program (ESPP) and an employees' discount stock plan (DSP). The SPSB Plan provides Company pre-tax contributions of 50% of the amount of employee contributions. The ESPP provides cash payments of 50% of the employees' contributions, along with an additional payment to assist employees in paying taxes on the cash payments. These contributions to the ESPP are invested in the Company's common stock through the DSP. In addition, the Company matches its\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nG -- EMPLOYEE BENEFIT PLANS (CONTINUED) contributions when certain profitability levels, as defined in the SPSB Plan and the ESPP, have been attained. The Company's total contributions to the SPSB Plan and the ESPP were $2.5, $2.2 and $2.0 for 1993, 1992 and 1991, respectively.\nUnder the DSP, eligible employees may purchase a maximum of 4,000,000 shares of Company common stock. The purchase price per share is 85% of the closing market price on the last business day of each month. Shares purchased under the DSP were 181,306, 237,713 and 267,212 during 1993, 1992 and 1991, respectively. Purchase prices ranged from $12 to $43 per share. Since inception of the DSP in 1982, a total of 2,120,413 shares have been purchased by employees.\nH -- INCOME TAXES The components of earnings before income taxes are as follows:\nIncome tax expense is comprised of the following components:\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The major temporary differences that give rise to deferred tax assets or liabilities at December 31, 1993 and 1992 are as follows:\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nH -- INCOME TAXES (CONTINUED) Deferred tax assets and liabilities included in the consolidated balance sheets are as follows:\nIncome tax expense, as a percentage of earnings before income taxes, differs from the statutory federal income tax rate as follows:\nTax benefits of approximately $2.0 associated with the Company's restructuring charge were not recognized during 1990. These tax benefits became available during 1992 and were recognized accordingly.\nI -- INDUSTRY SEGMENT INFORMATION The Company's operations principally consist of the manufacturing of components and related finished products for the furnishings industry. In addition, the Company supplies a diversified group of industries with products which are similar in manufacturing technology to its furnishings operations. Other than furnishings, no industry segment is significant.\nThe Company's products are sold primarily through its own sales personnel to customers in all states of the United States. Foreign sales are a minor portion of the Company's business. No single customer accounts for as much as 10% of sales.\nOperating profit is determined by deducting from net sales the cost of goods sold and the selling, distribution, administrative and other expenses attributable to the segment operations. Corporate expenses not allocated to the segments include corporate general and administrative expenses, interest expense and certain other income and deduction items which are incidental to the Company's operations. Capital expenditures, as defined herein, include amounts relating to acquisitions as well as internal expenditures. The identifiable assets of industry segments are those used in the Company's\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nI -- INDUSTRY SEGMENT INFORMATION (CONTINUED) operations of each segment. Corporate identifiable assets include cash, land, buildings and equipment used in conjunction with corporate activities, and sundry assets. Financial information by segment is as follows:\nJ -- CONTINGENCIES From time to time, the Company is involved in proceedings related to environmental matters. In one instance, the United States Environmental Protection Agency (\"EPA\") has directed one of the Company's subsidiaries to investigate potential releases into the environment and, if necessary, to perform corrective action. The subsidiary appealed the EPA's action and the outcome cannot be reasonably predicted. Costs to perform the actions directed by the EPA, if the outcome is unfavorable, cannot be reasonably estimated. One-half of any such costs would be reimbursed to the Company under a contractual obligation of a former joint owner of the subsidiary. No provision for costs of performing investigation and corrective action, if ultimately required, have been recorded in the Company's financial statements. If any such investigation and corrective action is required, management believes the possibility of incurring unreimbursed costs, with a material adverse effect on the Company's consolidated financial condition or results of operations, is remote.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Leggett & Platt, Incorporated:\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Leggett & Platt, Incorporated and its subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE\nSt. Louis, Missouri February 17, 1994\nSIGNATURES\nPursuant 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.\nDated: March 28, 1994\nLEGGETT & PLATT, INCORPORATED\nBy: ____\/s\/__HARRY M. CORNELL, JR.____ Harry M. Cornell, Jr. CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER\nPursuant 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 and on the dates indicated.\nEXHIBIT INDEX\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Leggett & Platt, Incorporated:\nOur audits of the consolidated financial statements referred to in our report dated February 17, 1994, appearing on page 29 of Leggett & Platt, Incorporated's Annual Report on Form 10-K for the year ended December 31, 1993, also included an audit of the Financial Statement Schedules listed in Item 14 - 2 in Part IV of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE\nSt. Louis, Missouri February 17, 1994\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT YEAR ENDED DECEMBER 31, 1993 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT YEAR ENDED DECEMBER 31, 1992 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT YEAR ENDED DECEMBER 31, 1991 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYEAR ENDED DECEMBER 31, 1993 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYEAR ENDED DECEMBER 31, 1992 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEAR ENDED DECEMBER 31, 1991 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE YEARS ENDED DECEMBER 31, 1993 (AMOUNTS IN MILLIONS)\nLEGGETT & PLATT, INCORPORATED AND SUBSIDIARIES SCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE THREE YEARS ENDED DECEMBER 31, 1993 (AMOUNTS IN MILLIONS)","section_15":""}
{"filename":"724176_1993.txt","cik":"724176","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSee the heading \"Health, Safety and Environmental Controls\" under \"Items 1 and 2. Business and Properties.\" of this report for a description of certain legal proceedings, which description is incorporated herein by reference.\nThe Company is involved in various other legal proceedings incidental to its business, the outcome of any of which should not have a material adverse effect on its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.\nInapplicable.\nExecutive Officers of the Company\nThe following table sets forth certain information as of March 1, 1994 concerning the executive officers of the Company.\nOfficers are elected annually by the Board of Directors and may be removed at any time by the Board. There are no family relationships among the executive officers listed and there are no arrangements or understandings pursuant to which any of them were elected as officers. Each of the officers named above has been employed by the Company during the last five years with responsibilities of the general nature indicated by his title, except as set forth below.\nMr. Forrest joined the Company in 1992 as special assistant to the Chairman and later that year was elected Vice Chairman and Chief Operating Officer. Prior to 1992, he was with Shell U.S.A. for more than five years, last serving as President of its subsidiary, Pecten International Company.\nMr. Crowell joined the Company in 1976 as a geophysicist. Since such time, he has held various positions with the Company, including Senior Vice President, North American Exploration and Production, and Vice President, Administration. Mr. Crowell was named Senior Vice President, Operations, in 1992.\nMr. Pasley joined the Company in 1984 as Associate Director of Investor Relations. Since such time, he has held various positions with the Company, including Director of Communications, Vice President, Human Resources and Senior Vice President, International. Mr. Pasley was named Senior Vice President, Operations, in 1992.\nMr. Ardila was elected Vice President, Exploration, in October 1993. Mr. Ardila joined the Company in 1979 as a Senior Geologist in Jakarta and has held various positions with the Company since such time, including Exploration Manager in Indonesia and Exploration Manager, Latin America and Far East, in Dallas. His present position pertains to the Company's South American exploration efforts.\nMr. Barron was elected Vice President, Treasurer and Chief Financial Officer of the Company in 1991. Mr. Barron joined Natomas Company in 1982 as a Project Manager. Natomas Company was acquired by the Company in 1983 and Mr. Barron has held various positions with the Company, including Director of Strategic Planning and Assistant Treasurer, since such time.\nMr. Blankenship was elected Vice President, Hydrocarbon Marketing, in April 1993. Mr. Blankenship joined Natomas Company in 1983 as Senior Manager of Research. Natomas Company was acquired by the Company in the same year and Mr. Blankenship has held various positions with the Company, including Vice President, Economics and Contracts, since such time.\nMr. Gentry was elected Vice President, Human Resources and General Services, in 1991. Mr. Gentry joined the Company in 1975 and has held various positions with the Company, including Associate Director of Management Information Systems Operations, Assistant Treasurer and General Manager of Human Resources, since such time.\nMr. Vandenberg joined the Company in 1990 as Production Engineer in Jakarta, Indonesia. He served as Production and Acquisition Manager for Kilroy Company of Texas from 1988 to 1990. Mr. Vandenberg was elected Vice President, Engineering and Development, in 1992.\nMr. Rietman retires in March 1994.\nA new organizational structure will become effective March 31, 1994. The position of Vice Chairman will be eliminated and Mr. Forrest will become Senior Vice President, Business Development. Mr. Crowell will become Senior Vice President, Producing Operations and Mr. Pasley will become Senior Vice President, Finance and Administration and Chief Financial Officer. After the restructuring becomes effective, Messrs. Barron, Brown, Gentry and Middlebrook will be the only other Vice Presidents.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe principal United States market on which the Common Stock is traded is the New York Stock Exchange. The Common Stock is also listed and traded on the Pacific Stock Exchange, the Basel Stock Exchange (Switzerland), the Geneva Stock Exchange (Switzerland) and the Zurich Stock Exchange (Switzerland). The high and low sales prices for the Common Stock for each full quarterly period during 1993 and 1992 as reported on the New York Stock Exchange Composite Tape are set forth on page 58 of the Company's 1993 Annual Report to Stockholders, which information is incorporated herein by reference.\nThe approximate number of record holders of Common Stock at December 31, 1993 was 35,619.\nThe Company paid no dividends on its Common Stock during 1993 and 1992. Cash flows are currently being dedicated to exploration and development projects rather than to the payment of dividends on Common Stock. The Company intends to continue paying regular quarterly dividends on its $4.00 Cumulative Convertible Preferred Stock, $9.75 Cumulative Convertible Preferred Stock and $2.50 Cumulative Preferred Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item appears on page 57 of the Company's 1993 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by this item appears on pages 26 through 32 of the Company's 1993 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item appears on pages 33 through 49 and pages 52 through 59 of the Company's 1993 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nInapplicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nWith the exception of the information provided below as to Darrell L. Black, the information required by this item with respect to the directors of the Company appears on pages 2 through 6 of the definitive proxy statement of the Company relating to the Company's 1994 Annual Meeting of Stockholders filed with the Securities and Exchange Commission pursuant to Regulation 14A, under the captions \"Nominees for Election at Annual Meeting,\" \"Present Directors Whose Terms Continue After Annual Meeting,\" and \"Director Proposed By Prudential\" which information is incorporated herein by reference. Darrell L. Black, aged 70, has served as a director of the Company since 1989. His current term expires on the date of the Company's annual meeting, May 11, 1994, and Mr. Black will retire as a director of the Company as of such date pursuant to the Board's retirement policy that a director shall not be nominated or stand for reelection to the Board after age 70. Information concerning the Company's executive officers is set forth under the caption \"Executive Officers of the Company\" in Part I above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item appears under the captions \"Director Compensation,\" \"Executive Officer Compensation,\" and \"Termination of Employment and Change In Control Arrangements\" in the definitive proxy statement of the Company relating to the Company's 1994 Annual Meeting of Stockholders filed with the Securities and Exchange Commission pursuant to Regulation 14A, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this item appears under the caption \"Beneficial Ownership of Securities\" in the definitive proxy statement of the Company relating to the Company's 1994 Annual Meeting of Stockholders filed with the Securities and Exchange Commission pursuant to Regulation 14A, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this item appears under the caption \"Certain Transactions and Relationships\" in the definitive proxy statement of the Company relating to the Company's 1994 Annual Meeting of Stockholders filed with the Securities and Exchange Commission pursuant to Regulation 14A, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of this report:\n(1) Financial Statements--The following financial statements have been incorporated by reference to pages 33 through 49 and pages 52 through 59 of the Company's 1993 Annual Report to Stockholders:\nConsolidated Statement of Operations for the three years ended December 31, 1993.\nConsolidated Balance Sheet at December 31, 1993 and 1992.\nConsolidated Statement of Cash Flows for the three years ended December 31, 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Accountants.\nSupplementary Financial Information (unaudited).\nQuarterly Data (unaudited).\n(2) Financial Statement Schedules.\nSchedule V--Consolidated Properties and Equipment.\nSchedule VI--Consolidated Accumulated Depreciation and Depletion.\nReport of Independent Accountants on Financial Statement Schedules.\nAll other schedules have been omitted because they are not applicable or the required information is shown in the Financial Statements or the Financial Summary.\nCondensed parent company financial information has been omitted, since the amount of restricted net assets of consolidated subsidiaries does not exceed 25% of total consolidated net assets. Also, footnote disclosure regarding restrictions on the ability of both consolidated and unconsolidated subsidiaries to transfer funds to the parent company has been omitted since the amount of such restrictions does not exceed 25% of total consolidated net assets.\nThe Company has computed the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividends for the year ended December 31, 1993 to be 1.50 and less than one, respectively, on a consolidated basis. Earnings were inadequate to cover combined fixed charges and preferred stock dividends for such year by $7.8 million. For the purposes of these computations, earnings consist of income before income taxes and fixed charges (excluding interest capitalized, net of amortization). Fixed charges represent interest incurred, amortization of debt expense and that portion of rental expense deemed to be the equivalent of interest.\n(3) Exhibits.\nEach document marked by an asterisk is incorporated herein by reference to the designated document previously filed with the Securities and Exchange Commission (the \"Commission\"). Each of Exhibits Nos. 10.1 through 10.17 is a management contract or compensatory plan, contract or arrangement required to be filed as an exhibit hereto by Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K.\nSCHEDULE V\nMAXUS ENERGY CORPORATION CONSOLIDATED PROPERTIES AND EQUIPMENT\nTHREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN MILLIONS)\nSCHEDULE VI\nMAXUS ENERGY CORPORATION CONSOLIDATED ACCUMULATED DEPRECIATION AND DEPLETION\nTHREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN MILLIONS)\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Maxus Energy Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 22, 1994 appearing on page 51 of the 1993 Annual Report to Stockholders of Maxus Energy Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14 (a)(2) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE\nDallas, Texas February 22, 1994\nSIGNATURES\nPURSUANT 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.\nMaxus Energy Corporation\nC. L. BLACKBURN By __________________________________ C. L. Blackburn Chairman, President and Chief Executive Officer\nMarch 25, 1994\nPursuant 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 and on the date indicated.\nSIGNATURE TITLE\nC. L. BLACKBURN* Chairman, President and Chief _____________________________________ Executive Officer C. L. Blackburn\nM. J. BARRON* Vice President, Treasurer and Chief _____________________________________ Financial Officer (Principal M. J. Barron Financial Officer)\nG. R. BROWN* Vice President and Controller _____________________________________ (Principal Accounting Officer) G. R. Brown\nJ. DAVID BARNES* Director _____________________________________ J. David Barnes\nDARRELL L. BLACK* Director _____________________________________ Darrell L. Black\nB. CLARK BURCHFIEL* Director _____________________________________ B. Clark Burchfiel\nSIGNATURE TITLE\nBRUCE B. DICE* Director _____________________________________ Bruce B. Dice\nM. C. FORREST* Director _____________________________________ M. C. Forrest\nCHARLES W. HALL* Director _____________________________________ Charles W. Hall\nRAYMOND A. HAY* Director _____________________________________ Raymond A. Hay\nGEORGE L. JACKSON* Director _____________________________________ George L. Jackson\nJOHN T. KIMBELL* Director _____________________________________ John T. Kimbell\nRICHARD W. MURPHY* Director _____________________________________ Richard W. Murphy\nW. THOMAS YORK* Director _____________________________________ W. Thomas York\nLynne P. Ciuba, by signing her name hereto, does hereby sign this report on Form 10-K on behalf of each of the above-named officers and directors of the registrant pursuant to a power of attorney executed by each of such officers and directors.\nLYNNE P. CIUBA *By _________________________________ Lynne P. Ciuba Attorney-in-fact March 25, 1994\nExhibit Index (exhibits filed herewith)\n10.10 -Amendment effective as of January 1, 1994 to the Employee Shareholding and Investment Supplemental Benefits Plan of the Company.\n10.17 -Deferred Compensation Plan for Executives of the Company, effective September 28, 1993.\n12.1 -Statement re Computation of Ratios.\n13.1 -Pages 25 through 59 of the 1993 Annual Report to Stockholders of the Company (such pages are incorporated by reference and are identified by reference to page numbers in the text of this report on Form 10-K).\n21.1 -List of Subsidiaries of the Company.\n23.1 -Consent of Independent Accountants.\n24.1 -Powers of Attorney of directors and officers of the Company.","section_15":""}
{"filename":"773468_1993.txt","cik":"773468","year":"1993","section_1":"ITEM 1. BUSINESS - ------- --------\nGENERAL\nCountrywide Mortgage Investments, Inc. (\"CMI\" or the \"Company\") was incorporated in the State of Maryland on July 16, 1985 and reincorporated in the State of Delaware on March 6, 1987. The Company has elected to be taxed as a real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986, as amended (the \"Code\"). As a result of this election, the Company will not, with certain limited exceptions, be taxed at the corporate level on the net income distributed to the Company's stockholders.\nHistorically, the Company has been a long-term investor in single-family, first- lien, residential mortgage loans and in mortgage securities representing interests in such loans (the \"CMO portfolio\"). Under its new operating plan commenced in 1993, the Company conducts mortgage conduit activities through a newly formed subsidiary, Countrywide Mortgage Conduit, Inc. (\"CMC\"), which is not a qualified REIT subsidiary and which is subject to applicable federal and state income taxes. See \"Certain Federal Income Tax Considerations.\" As part of its new operating plan, the Company also conducts warehouse lending operations which provide short-term revolving financing to certain mortgage bankers.\nMORTGAGE CONDUIT OPERATIONS\nOn October 22, 1992, the Company's Board of Directors approved a new operating plan, implementation of which was begun in the first quarter of 1993. Under the new plan, the Company established CMC, which principally operates as a jumbo and nonconforming mortgage loan conduit. As a jumbo mortgage loan conduit, CMC is an intermediary between the originators of mortgage loans which have outstanding principal balances in excess of the guidelines of the government and government sponsored enterprises that guarantee mortgage-backed securities (\"jumbo mortgage loans\") and permanent investors in mortgage-backed securities secured by or representing an ownership interest in such mortgage loans. Sellers generally retain the rights to service the mortgage loans purchased by the Company. The Company's principal sources of income from its mortgage conduit operations are gains recognized on the sale of mortgage loans, the net spread between interest earned on mortgage loans owned by the Company and the interest costs associated with the borrowings used to finance such loans pending their securitization and the net interest earned on its long-term investment portfolio.\nProduction - ----------\nThe Company's mortgage conduit operations are designed to attract both large and small sellers of jumbo mortgage loans by offering a variety of pricing and loan underwriting methods designed to be responsive to such sellers' needs. The Company focuses on sellers that originate loans in regions of the United States with generally higher property values and mortgage balances.\nThe Company has established three loan underwriting methods designed to be responsive to the needs of jumbo mortgage loan sellers. The Company's first method is designed to serve sellers who generally obtain mortgage pool insurance commitments in connection with the origination of their loans. The Company does not perform a full underwriting review of such mortgage loans but instead relies on the credit review and analysis of the mortgage pool insurer and its own follow-up quality control procedures. The second method established by the Company offers a delegated underwriting program for those loan sellers who meet higher financial and performance criteria than those applicable to sellers generally. Under the delegated underwriting program, loans are underwritten in accordance with the Company's guidelines by the seller and purchased on the basis of the seller's financial strength, historical loan quality and other qualifications. A sample of such loans is subsequently reviewed by the Company in accordance with its expanded quality control guidelines. Finally, sellers may submit to the Company loans for which there is no pool insurance commitment to be underwritten in accordance with the Company's guidelines. Under all three methods, loans are purchased by the Company only after completion of a legal documentation and eligibility criteria review. See \"Underwriting and Quality Control.\"\nPurchase Commitments - --------------------\nMaster Commitments. As part of its marketing strategy, the Company establishes mortgage loan purchase commitments (\"Master Commitments\") with sellers that, subject to certain conditions, obligate the seller to sell and the Company to purchase a specified dollar amount of nonconforming mortgage loans over a period generally ranging from three months to one year. The terms of each Master Commitment specify whether a seller may sell loans to the Company on a mandatory, best efforts or optional basis, or a combination thereof. Master Commitments do not obligate the Company to purchase loans at a specific price but rather provide the seller with a future outlet for the sale of its originated loans based on the Company's quoted prices at the time of purchase. Master Commitments specify the types of mortgage loans the seller is entitled to sell to the Company and generally range from $10 million to $500 million in aggregate committed principal amount.\nBulk and Other Commitments. The Company also acquires mortgage loans from sellers that are not purchased pursuant to Master Commitments. These purchases may be made on a bulk or individual commitment basis. Bulk commitments obligate the seller to sell and the Company to purchase a specific group of loans, generally ranging from $1 million to $50 million in aggregate committed principal amount, at set prices on specific dates. Bulk commitments enable the Company to acquire substantial quantities of loans on a more immediate basis.\nUnderwriting and Quality Control - --------------------------------\nPurchase Guidelines. The Company has developed comprehensive purchase guidelines for its acquisition of mortgage loans. Subject to certain exceptions, each loan purchased must conform to the Company's loan eligibility requirements specified in its Seller\/Servicer Guide with respect to, among other things, loan amount, type of property, loan-to-value ratio, type and amount of insurance, credit history of the borrower, income ratios, sources of funds, appraisal and loan documentation. The Company also performs a legal documentation review prior to the purchase of any loan. For loans with mortgage pool insurance commitments, the Company does not perform a full underwriting review prior to purchase but instead relies on the credit review and analysis performed by the mortgage pool insurer and its own post-purchase quality control review. In contrast, for mortgage loans that have not been underwritten for mortgage pool insurance and are not part of the delegated underwriting program, the Company performs a full credit review and analysis to ensure compliance with its loan eligibility requirements. This review specifically includes, among other things, an analysis of the underlying property and associated appraisal and an examination of the credit, employment and income history of the borrower. For loans purchased pursuant to the delegated underwriting program, the Company relies on the credit review performed by the seller and its own follow-up quality control procedures.\nQuality Control. Ongoing quality control reviews are conducted by the Company to ensure that the mortgage loans purchased meet the Company's quality standards. The type and extent of the quality control review will depend on the nature of the seller and the characteristics of the loans. Loans acquired under the delegated underwriting program are subject to a pre-purchase legal documentation review of, among other things, the promissory note, deed of trust or mortgage and title policy. The Company also conducts a full post-purchase underwriting review of 50% of the loans purchased during the first two months of a seller's participation in the delegated underwriting program to ensure ongoing compliance with the Company's guidelines. The percentage of loans fully reviewed is thereafter reduced bimonthly to 20% after six months and maintained at this level throughout the seller's participation in the delegated underwriting program. The Company reviews on a post-purchase basis approximately 10% of all loans submitted to the Company with mortgage pool insurance commitments or underwritten by the Company for compliance with the Company's guidelines. In addition, a higher percentage of mortgage loans with certain specified characteristics are reviewed by the Company either before or after their purchase.\nIn performing a quality control review on a loan, the Company analyzes the underlying property and associated appraisal and examines the credit, employment and income history of the borrower. In addition, all documents submitted in connection with the loan including insurance policies, appraisals, credit records, title policies, deeds of trust and promissory notes are examined for compliance with the Company's underwriting guidelines. Furthermore, the Company reverifies the employment, income and source of funds documentation of each borrower and obtains a new credit report and independent appraisal with respect to approximately 10% of the reviewed loan sample.\nMortgage Loans Acquired - -----------------------\nSubstantially all of the mortgage loans purchased through the Company's mortgage conduit operations are nonconforming mortgage loans. Nonconforming mortgage loans are loans which do not qualify for purchase by the Federal Home Loan Mortgage Corporation (\"FHLMC\") or the Federal National Mortgage Association (\"FNMA\") or for inclusion in a loan guarantee program sponsored by the Government National Mortgage Association (\"GNMA\"). Nonconforming mortgage loans generally consist of jumbo mortgage loans or loans which are not originated in accordance with other agency criteria. Currently, the maximum principal balance for a conforming loan is $203,150. The Company generally purchases jumbo mortgage loans with original principal balances of up to $1 million. The Company's loan purchase activities focus on those regions of the country where higher volumes of jumbo mortgage loans are originated, including California, Connecticut, Florida, Hawaii, Illinois, Maryland, Michigan, New Jersey, New York, Ohio, Texas, Virginia, Washington and Washington, D.C. The Company's highest concentration of jumbo mortgage loans relates to properties in California because of the generally higher property values and mortgage loan balances prevalent there. Mortgage loans secured by California properties have accounted for approximately 69% of the mortgage loans purchased in 1993.\nMortgage loans acquired by the Company are secured by first liens on single (one-to-four) family residential properties with either fixed or adjustable interest rates. Fixed-rate mortgage loans accounted for over 90% of the mortgage loans purchased by the Company in 1993 primarily because of the desire of borrowers to lock in the low rates of interest prevailing in 1993. The Company anticipates that its adjustable-rate mortgage loan purchase volume as a percent of total loans purchased will grow as interest rates rise.\nThe Company also purchases adjustable rate mortgage (\"ARM\") loans which provide the borrower with the option to convert to a fixed rate of interest in the future. Although the Company sells or securitizes these ARM loans in connection with its mortgage conduit operations, it generally is obligated to repurchase the fixed-rate loans resulting from any such conversion. The Company generally has the right to require repurchase of any such converted mortgage loan by the servicer or seller of such loans.\nSeller Eligibility Requirements - ---------------------------------\nThe mortgage loans acquired pursuant to the Company's mortgage conduit operations are originated by various sellers, including savings and loan associations, banks, mortgage bankers and other mortgage lenders. Sellers are required to meet certain regulatory, financial, insurance and performance requirements established by the Company before they are eligible to participate in the Company's mortgage loan purchase program and must submit to periodic reviews by the Company to ensure continued compliance with these requirements. The Company's current criteria for seller participation generally include a tangible net worth of at least $1 million, a servicing portfolio of at least $25 million and loan production aggregating at least $50 million during the last three years. In addition, sellers are required to have comprehensive loan origination quality control procedures. In connection with their qualification, each seller enters into an agreement that provides for recourse by the Company against the seller in the event of any material breach of a representation or warranty made by the seller with respect to mortgage loans sold to the Company or any fraud or misrepresentation during the mortgage loan origination process.\nServicing Retention - ---------------------\nSellers of mortgage loans to the Company are generally expected to retain the rights to service the mortgage loans purchased by the Company. Servicing includes collecting and remitting loan payments, making required advances, accounting for principal and interest, holding escrow or impound funds for payment of taxes and insurance, if applicable, making required inspections of the mortgaged property, contacting delinquent borrowers and supervising foreclosures and property dispositions in the event of unremedied defaults in accordance with the Company's guidelines. The servicer receives fees generally ranging from 1\/4% to 1\/2% per annum on the declining principal balances of the loans serviced. Under certain circumstances, sellers have the right to require the Company to purchase such servicing rights at a previously determined price. If a seller\/servicer breaches certain of its representations and warranties made to the Company, the Company may terminate the servicing rights of such seller\/servicer and assign such servicing rights to another servicer.\nSale of Loans - -------------\nThe Company, similar to other mortgage conduits, customarily sells all loans that it purchases. When a sufficient volume of mortgage loans with similar characteristics has been accumulated, generally $100 million to $500 million, the loans are securitized through the issuance of mortgage-backed securities in the form of real estate mortgage investment conduits (\"REMICs\") or collateralized mortgage obligations (\"CMOs\") or resold in bulk whole loan sales. The length of time between the Company's commitment to purchase a mortgage loan and when it sells or securitizes such mortgage loan generally ranges from ten to 90 days depending on certain factors, including the length of the purchase commitment period and the securitization process.\nThe Company's decision to form REMICs or CMOs or to sell the loans in bulk is influenced by a variety of factors. REMIC transactions are generally accounted for as sales of the mortgage loans and can eliminate or minimize any long-term residual investment in the loans. REMIC securities consist of one or more classes of \"regular interests\" and a single class of \"residual interest.\" The regular interests are tailored to the needs of investors and may be issued in multiple classes with varying maturities, average lives and interest rates. These regular interests are predominately senior securities but, in conjunction with providing credit enhancement, may be subordinated to the rights of other regular interests. The residual interest represents the remainder of the cash flows from the mortgage loans (including, in some instances, reinvestment income) over the amounts required to be distributed to the regular interests. In some cases, the regular interests may be structured so that there is no significant residual cash flow, thereby allowing the Company to sell its entire interest in the mortgage loans. As a result, in some cases the capital originally invested in the mortgage loans by the Company may be redeployed in the mortgage conduit operations. The Company generally retains any residual interests for investment. Management believes that because of the current low level of interest rates, investments in residual interest or \"excess master servicing fees\" are prudent, and if interest rates rise, the income from investments will mitigate declines in income that may occur in the Company's purchase operations.\nAs an alternative to REMIC sales, the Company may issue CMOs to finance mortgage loans to maturity. For accounting and tax purposes, the mortgage loans financed through the issuance of CMOs are treated as assets of the Company and the CMOs are treated as debt of the Company. The Company earns the net interest spread between the interest income on the mortgage loans and the interest and other expenses associated with the CMO financing. The net interest spread is directly impacted by the levels of prepayment of the underlying mortgage loans. The Company is required to retain a residual interest in its issued CMOs.\nSubstantially all of the Company's loans and mortgaged-backed securities (\"MBS\") are sold at prices that are determined based on the cash market for MBS. As such, the Company's interest-rate risk is directly correlated to the risk that the price of MBS changes between the date on which a loan is purchased by the Company and the date on which the mortgage loan is settled with the ultimate investor. In addition, the Company is exposed to the risk that the value of the loans that it has committed to purchase, but has not yet closed, will decline between the commitment date and the date of the settlement with the investor.\nIn order to offset the risk that a change in interest rates will result in a decrease in the value of the Company's current mortgage loan inventory, or its commitments to purchase mortgage loans (\"Committed Pipeline\") the Company enters into hedging transactions. The Company's hedging policies generally require that all of its inventory of loans and the expected portion of its Committed Pipeline that may close be hedged with forward contracts for the delivery of MBS or whole loans. The Company hedges its inventory and Committed Pipeline of mortgage loans by using whole-loan sale commitments to ultimate buyers, by using temporary \"cross hedges\" with sales of government sponsored MBS since such loans are ultimately sold based on a market spread to MBS or by selling forward private label MBS. As such, the Company is not exposed to significant risk nor will it derive any benefit from changes in interest rates on the price of the inventory net of gains or losses of associated hedge positions. The correlation between the price performance of the hedge instruments and the inventory being hedged is generally high due to the similarity of the asset and the related hedge instrument. The Company is exposed to interest-rate risk to the extent that the portion of loans from the Committed Pipeline that\nactually closes at the committed price is less than the portion expected to close in the event of a decline in rates and such decline in closings is not covered by options to purchase MBS needed to replace the loans in process that do not close at their committed price. The Company determines the portion of its Committed Pipeline that it will hedge based on numerous factors, including the composition of the Company's Committed Pipeline, the portion of such Committed Pipeline likely to close, the timing of such closings and anticipated changes in interest rates.\nMaster Loan Servicing - ---------------------\nThe Company acts as master servicer with respect to the mortgage loans it sells. Master servicing includes collecting loan payments from seller\/servicers of loans and remitting loan payments, less master servicing fees and other fees, to trustees. In addition, as master servicer, the Company monitors compliance with its servicing guidelines and is required to perform, or to contract with a third party to perform, all obligations not adequately performed by any servicer.\nIn connection with REMIC issuances, the Company master services on a non- recourse basis substantially all of the mortgage loans it purchases. Each series of mortgage-backed securities is typically fully payable from the mortgage assets underlying such series and the recourse of investors is limited to those assets and any credit enhancement features, such as insurance. Generally, any losses in excess of the credit enhancement obtained is borne by the security holders. Except in the case of a breach of the standard representations and warranties made by the Company when mortgage loans are securitized, the securities are non-recourse to the Company. Typically, the Company has recourse to the sellers of loans for any such breaches.\nFinancing of Mortgage Conduit Operations - ----------------------------------------\nThe Company's principal financing needs are the financing of loan purchase activities and the investment in excess master servicing rights. To meet these needs, the Company currently relies on reverse-repurchase agreements collateralized by mortgage loans held for sale and cash flow from operations. In addition, in 1993 the Company has relied on proceeds from public offerings of common stock. For further information on the material terms of the borrowings utilized by the Company to finance its inventory of mortgage loans and mortgage- backed securities, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.\" The Company continues to investigate and pursue alternative and supplementary methods to finance its operations through the public and private capital markets.\nWAREHOUSE LENDING\nAs part of its new operating plan, the Company engages in warehouse lending operations for small-and medium-size mortgage bankers. Warehouse lending facilities typically provide short-term revolving financing to mortgage bankers to finance mortgage loans during the time from the closing of the loan until its settlement with an investor. The Company's warehouse lending program offers warehouse lending facilities up to a maximum aggregate amount of $20 million to mortgage bankers who have a minimum audited net worth of $300,000 subject to a maximum debt-to-adjusted-net-worth ratio of 20 to 1. The specific terms of any warehouse line of credit, including the amount, are determined based upon the financial strength, historical performance and other qualifications of the mortgage banker. All such lines of credit are subject to the prior approval of a credit committee comprised of senior officers and directors of the Company. The Company finances this program through a combination of reverse repurchase agreements and equity. The Company has a committed one-year reverse repurchase agreement facility with an investment bank in an aggregate amount of up to $100 million for this warehouse lending program.\nAs a warehouse lender the Company is a secured creditor of the mortgage bankers to which it extends credit and is subject to the risks inherent in that status, including the risks of borrower default and bankruptcy.\nHISTORICAL OPERATIONS\nIn contrast to the Company's new mortgage conduit and warehouse lending operations, which establish the Company as a niche mortgage banker and lender to mortgage companies, the Company historically has been a long-term investor in single-family, first-lien, residential mortgage loans and in mortgage securities representing interests in such loans. The Company's mortgage investment portfolio consisted primarily of fixed-rate mortgage pass-through certificates issued by FHLMC or FNMA (\"Agency Securities\") and jumbo mortgage loans. The principal source of earnings for the Company historically has been interest income generated from investments in such mortgage loans and mortgage-backed securities, net of the interest expense on the CMOs or reverse-repurchase agreements used to finance such mortgage investments. In 1987, the Company began to invest in Agency Securities representing undivided interests in pools of adjustable-rate mortgages (\"Agency ARMs\") purchased through various broker- dealers and financed primarily through reverse repurchase agreements. During 1992, the Company sold substantially all of its portfolio of Agency ARMs, resulting in a gain of approximately $9.0 million and the remainder of such portfolio was sold during the first quarter of 1993 at its approximate carrying value. At December 31, 1993, the Company's assets included approximately $402.5 million of fixed-rate jumbo mortgage loans and Agency Securities which were pledged to secure outstanding CMOs issued by the Company's subsidiaries.\nDuring 1993, long-term interest rates, including mortgage rates, fell to their lowest levels in over twenty years. The collateral for CMOs experienced substantial prepayments, resulting in significantly decreased net earnings and, as mortgage loan premiums, original issue discount and bond issuance costs were required to be amortized, losses on the portfolio. If prepayments continue at high levels, the performance of this CMO portfolio will continue to be adversely impacted. Regardless of the level of interest rates or prepayments, the Company anticipates no significant earnings from this CMO portfolio. Any continued negative performance of this CMO portfolio will continue to adversely impact the earnings of the Company to the extent of its investment in such portfolio.\nCERTAIN FEDERAL INCOME TAX CONSIDERATIONS\nGeneral Considerations - ----------------------\nThe Company has elected to be taxed as a REIT under the Code and intends to continue to do so. CMC, which operates the Company's mortgage conduit operations and is included in the Company's consolidated financial statements, is not a qualified REIT subsidiary. Consequently, CMC is subject to applicable federal and state income taxes. The Company will include in taxable income amounts earned by CMC only when CMC remits its after-tax earnings by dividend to the Company.\nThe Company's election to be treated as a REIT will be terminated automatically if the Company fails to meet the requirements of the REIT provisions of the Code. Qualification as a REIT requires that the Company satisfy a variety of tests relating to its income, assets, distribution and ownership. Although the Company believes it has operated and intends to continue to operate in such a manner as to qualify as a REIT, no assurance can be given that the Company will in fact continue to so qualify. If the Company fails to qualify as a REIT in any taxable year, it would be subject to federal corporate income tax (including any alternative minimum tax) on its taxable income at regular corporate rates, and distributions to its stockholders would not be deductible by the Company. In that event, the Company would not be eligible again to elect REIT status until the fifth taxable year which begins after the year for which the Company's election was terminated unless certain relief provisions apply. The Company may also voluntarily revoke its election, although it has no intention of doing so, in which event the Company would be prohibited, without exception, from electing REIT status for the year to which the revocation relates and the following four taxable years.\nDistributions to stockholders of the Company with respect to any year in which the Company fails to qualify would not be deductible by the Company nor would they be required to be made. In such event, to the extent of current and accumulated earnings and profits, any distributions to stockholders would be taxable as ordinary income and, subject to certain limitations in the Code, eligible for the dividends-received deduction for corporations. Failure to qualify would reduce the amount of after-tax earnings available for distribution to stockholders and could result in the Company incurring substantial indebtedness (to the extent borrowings are\nfeasible), or disposing of substantial investments, in order to pay the resulting taxes or, at the discretion of the Company, to maintain the level of the Company's distributions to its stockholders.\nExcess Inclusion - ----------------\nA portion of the Company's assets may be in the form of CMO residual interests. In general, CMOs are debt instruments secured by fixed pools of mortgage instruments in which investors hold multiple classes of interest. Part or all of the income derived by the Company from a residual interest of a CMO issued by the Company or a qualified real estate investment trust subsidiary after December 31, 1991, pursuant to regulations yet to be published, may be \"excess inclusion\" income. Such excess inclusion income generally is subject to federal income tax in all events. If the Company pays any dividends to its shareholders that are attributable to excess inclusion income, the shareholders who receive such dividends generally will be subject to the same tax consequences that would apply if they derived excess inclusion income from a direct investment in a CMO residual interest. Excess inclusion income allocable to a shareholder may not be offset by current deductions or net operating losses of such shareholder. Moreover, such excess inclusion income constitutes unrelated business taxable income for tax-exempt entities (including employee benefit plans) and would be subject to a tax on any excess inclusion income that would be allocable to a \"disqualified organization\" holding its shares. The Company's bylaws provide that disqualified organizations are ineligible to hold the Company's shares.\nCOMPETITION\nIn purchasing mortgage loans and issuing mortgage-backed securities, the Company competes with established mortgage conduit programs, investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, other lenders and other entities purchasing mortgage assets, many of which have greater financial resources than the Company. Mortgage-backed securities issued through the Company's mortgage conduit operations face competition from other investment opportunities available to prospective investors.\nFNMA and FHLMC are not permitted to purchase mortgage loans with original principal balances above $203,150 (effective January 1, 1993). If this dollar limitation increases, FNMA and FHLMC may be able to purchase a greater percentage of the loans in the secondary market than they currently acquire, and the Company's ability to maintain or increase its current acquisition levels could be adversely affected.\nThe Company also faces competition in its warehouse lending operations from banks and other warehouse lenders, including investment banks and other financial institutions who offer warehouse financing through the use of reverse- repurchase agreements.\nRELATIONSHIPS WITH COUNTRYWIDE ENTITIES\nThe Company has entered into an agreement with Countrywide Asset Management Corporation (\"CAMC\") to advise the Company on various facets of its business and manage its operations, subject to supervision by the Company's Board of Directors. The Manager has entered into a subcontract with its affiliate, Countrywide Funding Corporation (\"CFC\"), to perform such services for the Company as the Manager deems necessary.\nThe Company and Countrywide Credit Industries, Inc. (\"CCI\") are both publicly traded companies whose shares of common stock are listed on the New York Stock Exchange. The Company has utilized the mortgage banking experience, management expertise and resources of CCI, CAMC and CFC in conducting its new mortgage conduit operations. CAMC and CFC are both wholly-owned subsidiaries of CCI. CCI, directly or indirectly, owns approximately 3.50% of the common stock of the Company. In addition, a number of directors and officers of the Company also serve as directors and\/or officers of CCI, CAMC and\/or CFC. See \"Directors and Executive Officers of the Registrant.\" CAMC serves as the manager of the Company and employs the personnel who conduct the Company's mortgage conduit, warehouse lending and other operations. The Company also has a $10 million line of credit from CFC, and the Company may utilize CFC as a resource for loan servicing, technology, information services and loan production. CFC owns all of the voting common stock of CMC, and the Company owns all of the preferred stock of CMC.\nWith a view toward protecting the interests of the Company's stockholders, the Bylaws of the Company provide that a majority of the Board of Directors (and a majority of each committee of the Board of Directors) must not be \"Affiliates\" of CAMC, as that term is defined in the Bylaws, and that the investment policies of the Company must be reviewed annually by a majority of these Unaffiliated Directors. Moreover, approval of the management agreement requires the affirmative vote of a majority of the Unaffiliated Directors, and a majority of such Unaffiliated Directors may terminate the management agreement with CAMC at any time upon 60 days' notice.\nEMPLOYEES\nAll employees and operating management of the conduit are presently employees of CAMC, a CCI subsidiary and manager of CMI. As of December 31, 1993, CAMC had 60 employees dedicated to the Company's mortgage conduit, warehouse lending and other operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe primary executive and administrative offices of the Company and its subsidiaries are located at 35 North Lake Avenue, Pasadena, California, and consist of approximately 9,500 square feet. The principal lease covering such space expires in the year 2001. The Company leases office space consisting of approximately 2,500 square feet for its warehouse lending operations in another building in the Pasadena area. This lease commenced February 15, 1994 and expires February 15, 1999. In addition the Company leases office space throughout the country for marketing its conduit and warehouse lending operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nA special meeting of the Company's stockholders was held on December 9, 1993 to vote on a proposal to amend the Company's Certificate of Incorporation to increase the number of authorized shares of common stock from 30,000,000 to 60,000,000 shares. The votes cast on this proposal were as follows: 22,231,995 For; 546,514 Against; 138,623 Abstain; and 0 Broker Non-vote.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S STOCK AND RELATED SECURITY HOLDER MATTERS - ------- ------------------------------------------------------------------\nThe Company's Common Stock became listed on the New York Stock Exchange in November 1986 (Symbol: CWM).\nThe following table sets forth the high and low closing prices for the Common Stock of the Company (as reported by NYSE), for the years ended December 31, 1993 and 1992 and cash dividends declared for earnings of the periods as indicated:\nAs of March 23, 1994, the Company's Common Stock was held by 1,774 stockholders of record.\nFor each of the years ended December 31, 1993 and 1992, the Company declared quarterly cash dividends for earnings of the periods aggregating $.48 per share. On January 27, 1994, the Company declared a cash dividend for the fourth quarter of 1993 of $.12 per share paid March 1, 1994 to shareholders of record on February 7, 1994.\nThe Company maintains a dividend reinvestment plan for stockholders who wish to reinvest their cash dividends in additional shares of Common Stock. The dividend reinvestment plan currently provides for the purchase of additional shares of Common Stock on the open market for the accounts of its participants.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (Dollar amounts in thousands, except per share data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nGENERAL\nDuring the first quarter of 1993, the Company commenced operations of a mortgage loan conduit, under which the Company purchases mortgage loans from eligible sellers who generally retain the servicing rights. These activities are primarily conducted through the Company's taxable subsidiary, Countrywide Mortgage Conduit, Inc. (\"CMC\"). The Company generally purchases mortgage loans originated in regions of the country with higher volumes of jumbo and non- conforming mortgage loans, including California. As the mortgage loans are accumulated, they are generally financed through short-term borrowing sources such as reverse-repurchase agreements. When a sufficient volume of mortgage loans with similar characteristics has been accumulated, the loans are securitized through the issuance of mortgage-backed securities in the form of real estate mortgage investment conduits (\"REMICs\") or collateralized mortgage obligations (\"CMOs\") or resold in bulk whole loan sales. The Company's principal sources of revenue from its new mortgage conduit operations are the net interest income earned from holding the mortgage loans during the accumulation phase and gains or losses on the REMIC or whole loan sale transactions. Alternatively, if the Company elects to invest in the mortgage loans on a long-term basis using financing provided by CMOs, the Company recognizes a net yield on these investments over time. In addition, the Company earns fee income and net interest income through its warehouse lending program which provides warehouse lines of credit to third party mortgage loan originators.\nHistorically, the Company's principal source of earnings has been net interest income generated from its mortgage portfolio which was primarily financed through the issuance of CMOs (the \"CMO Portfolio\"). The amount of net interest earned on the CMO Portfolio is directly affected by the rate of principal repayment (including prepayments) of the related mortgage loans as discussed below.\nDuring 1993, low mortgage interest rates resulted in continued high prepayment rates which adversely impacted the net interest income earned on the CMO Portfolio. When prevailing mortgage interest rates are low relative to interest rates of existing mortgage loans, prepayments on the existing mortgage loans generally tend to increase as mortgagors refinance their loans. The cash flow generated by these prepayments is used to repay the CMOs collateralized by these mortgage loans. The substantial prepayments experienced by the CMO Portfolio resulted in a negative cash flow and since mortgage loan premiums, original issue discount and bond issuance costs were also required to be amortized, net interest expense was ultimately realized on the portfolio. Continued negative performance of the CMO Portfolio will adversely impact the future earnings of the Company. Although higher interest rates may decrease prepayments and mitigate the negative impact on the Company's earnings from its CMO Portfolio, higher interest rates may otherwise adversely affect the Company's new mortgage conduit and warehouse lending operations.\nHistorically, the Company also earned net interest income on its investments in adjustable-rate mortgage-backed securities (\"ARM Porfolio\") financed with reverse-repurchase agreements. The Company began accumulating adjustable-rate mortgage assets in 1987 due to the attractive returns and earnings profile of these investments. As interest rates declined in 1992, the Company partially offset the declining earnings performance of its CMO Portfolio by selling substantially all of its investments in the ARM Portfolio at a gain of $7.8 million. During the first quarter of 1993, the Company sold its remaining adjustable-rate mortgage assets for an amount that approximated book value. The sales of adjustable-rate mortgage assets were also designed to provide capital for the Company's new mortgage loan conduit and warehouse lending operations.\nFINANCIAL CONDITION\nCONDUIT AND WAREHOUSE LENDING OPERATIONS: Through its mortgage loan conduit operations, the Company purchases jumbo and other nonconforming loans from mortgage bankers and other financial institutions which generally retain the mortgage loan servicing rights. During 1993, the Company purchased $3.5 billion of such mortgage loans, which were financed on an interim basis using equity and short-term borrowings in the form of reverse-repurchase agreements. In general, the Company sells the loans in the form of REMICs or whole loan sales or alternatively, invests in the loans on a long-term basis using financing provided by CMOs. During 1993, the Company sold $2.3 billion of mortgage loans through the issuance of REMIC securities and the sale of whole loans. In addition, the Company issued two new series of CMOs in 1993 totalling $240.2 million (see discussion below). At December 31, 1993, the Company was committed to sell approximately $680.0 million of mortgage loans in connection with the issuance of REMIC securities and the sale of whole loans in the first quarter of 1994.\nThe Company's warehouse lending program provides secured short-term revolving financing to small- and medium-size mortgage bankers to finance mortgage loans from the closing of the loan until it is sold to a permanent investor. At December 31, 1993, the Company had extended lines of credit under this program in the aggregate amount of $206.0 million, of which $92.1 million was outstanding. Reverse-repurchase agreements associated with the financing of warehouse lines of credit and mortgage loans held for sale totaled $806.6 million at December 31, 1993.\nCMO PORTFOLIO: As of December 31, 1993, the CMO Portfolio was comprised of 15 series of CMOs issued from the Company's inception through 1990 (\"Pre-1993 CMO Portfolio\"). In 1993, two new series of CMOs were issued in connection with the Company's new mortgage conduit operation. Disclosures relative to the CMO Portfolio include both groups of CMOs.\nCollateral for CMOs decreased from $620.4 million at December 31, 1992 to $402.5 million at December 31, 1993. This decrease of $217.9 million included a redemption of $34.0 million and repayments (including prepayments and premium and discount amortization) of $405.7 million offset by additions of $248.2 million of collateral related to the issuance of two new series of CMOs. The decrease was also due to decreases in guaranteed investment contracts (\"GICs\") held by trustees and accrued interest receivable of $22.9 million and $3.5 million respectively. The Company's CMOs outstanding decreased to $365.9 million at December 31, 1993 from $571.9 million at December 31, 1992. This decrease of $206.0 million resulted from the redemption of two series of CMOs totaling $32.6 million and principal payments (including discount amortization) on CMOs of $411.3 million, partially offset by the issuance of two series of CMOs totaling $240.2 million. The decrease also resulted from a decrease in accrued interest payable on CMOs of $2.3 million.\nWhen interest rates decline, prepayments on the underlying mortgage loans generally tend to increase as mortgagors refinance their existing loans. The cash flow generated by these unanticipated prepayments is ultimately used by the Company to repay the CMOs since they are collateralized by these mortgages. When interest rates decline and prepayments increase, the net yield achieved from the Company's net investment in the CMO Portfolio is adversely impacted due to factors which are explained below.\nRESULTS OF OPERATIONS 1993 COMPARED TO 1992\nNET EARNINGS: The Company's net earnings were $2.5 million or $0.13 per share, based on 18,578,307 weighted average shares outstanding for 1993 compared to $5.0 million or $0.36 per share, based on 13,978,683 weighted average shares outstanding for 1992. The decrease in net earnings of $2.5 million was due to a decrease in earnings of $17.1 million associated with the Pre-1993 CMO Portfolio and the ARM Portfolio, offset by an increase in earnings of $14.2 million associated with the Company's new mortgage conduit and warehouse lending operations. In addition, the Company's fixed organizational expenses decreased by $358,000.\nThe decrease in net earnings on the Pre-1993 CMO and ARM Portfolios was primarily due to decreases in net interest income and in gains of approximately $12.8 million and $7.8 million, respectively, associated with the sale of substantially all of the Company's investment in adjustable-rate mortgage-backed securities in 1992. These decreases were offset by increases associated with the decrease in net interest expense on the Pre-1993 CMO Portfolio of $3.4 million. In addition, gains decreased by $283,000 related to the redemption of one CMO series in 1992 and two CMO series in 1993. The earnings associated with the operation of the Company's new mortgage loan conduit and warehouse lending program were primarily due to interest income, net of interest expense and net master servicing expense, of $10.1 million, gains of $8.4 million and expenses of $2.5 million. A provision for income taxes of $1.8 million for 1993 has been made as the earnings of CMC are subject to state and federal income tax. CMC, the Company's taxable subsidiary, was formed in 1993, therefore no such provision was made in 1992.\nThe net earnings of the Company for 1993 do not include certain personnel and other operating expenses totaling $900,000 which have been absorbed by Countrywide Asset Management Corporation, the Manager of the Company, under the terms of its Management Agreement. The Company began paying all expenses of its new operations in June 1993.\nINTEREST INCOME: Total interest income was $73.4 million for 1993 and $106.1 million for 1992. Interest income on collateral for CMOs was $41.7 million and $68.7 million for 1993 and 1992, respectively. The decline was attributable to a decrease in the average aggregate principal amount of collateral for CMOs outstanding, from $847.7 million for 1992 to $550.5 million for 1993, combined with a decrease in the effective yield earned on the collateral from 8.10% in 1992 to 7.57% in 1993. The decrease in the average balance of collateral for CMOs and the effective interest yield earned thereon was due to the continued low interest rate environment experienced in 1993 which resulted in significant prepayment activity. The rate of prepayments (including repayments) was 50% in 1993 compared to 42% in 1992. In a declining interest rate environment, loans with higher interest rates prepay faster than loans with lower interest rates, resulting in a lower overall effective yield. In addition, the interest income was reduced on collateral for CMOs by the amortization of premiums paid in connection with acquiring the portfolio, a delay in the receipt of prepayments and temporary investment in lower yielding short-term investments (GICs) until such amounts were used to repay CMOs.\nInterest income earned on mortgage loans held for sale and revolving warehouse lines of credit was $29.1 million and $1.9 million, respectively, for 1993. The weighted average principal balance of mortgage loans held for sale and revolving warehouse lines of credit approximated $401.1 million and $25.3 million, respectively, for 1993 and earned interest at an effective yield of approximately 7.25% and 7.67%, respectively. These operations commenced in 1993, therefore there was no such income in 1992.\nInterest income on adjustable-rate mortgage securities amounted to $674,000 for 1993 and $37.4 million for 1992. The decrease resulted from the liquidation of these securities which was completed in the first quarter of 1993. The net proceeds from the sale of these securities were deployed in the new mortgage loan conduit and warehouse lending operations.\nINTEREST EXPENSE: For 1993 and 1992, total interest expense was $69.3 million and $107.5 million, respectively. Interest expense on CMOs was $55.0 million and $83.6 million for 1993 and 1992, respectively. This decrease was primarily attributable to a decrease in average aggregate CMOs outstanding from $813.6 million for 1992 to $516.2 million for 1993, partically offset by an increase in the weighted average cost of CMOs from 10.27% in 1992 to 10.65% in 1993. The decrease in the average balance of CMOs was directly related to the prepayment activity on collateral for CMOs discussed above. The prepayments are ultimately used to repay the related CMOs. In general, the class of each series of CMO with the shortest maturity receives all principal payments until it is repaid in full. After the first class is retired, the second class will receive all principal payments until retired and so forth. Substantially all CMO bonds were structured with the shortest maturity class generally having the lowest interest rate and interest rates increasing as the maturity of the class increased. Therefore, prepayments generally must be applied to the class with the lowest interest rate, resulting in repayment of CMO classes with relatively low interest rates and increasing the weighted average interest rate of the remaining outstanding CMOs.\nInterest expense on reverse-repurchase agreements financing mortgage loans held for sale and revolving warehouse lines of credit was $14.3 million or 3.89% of the average balance outstanding for 1993. Interest expense on reverse-repurchase agreements financing the Company's investment in its adjustable-rate mortgage portfolio was $24.0 million or 4.15% of the average balance outstanding for 1992.\nMASTER SERVICING EXPENSE, NET: During 1993, as a result of the new mortgage conduit operations, the Company began earning master servicing fee income. At December 31, 1993, the Company master serviced loans with principal balances aggregating $3.0 billion. The growth in the Company's master servicing portfolio during 1993 was the result of loan production volume from the Company's new conduit operations, partially offset by prepayments of mortgage loans. The weighted average interest rate of the mortgage loans in the Company's master servicing portfolio at December 31, 1993 was 7.21%. It is the Company's strategy to build and retain its master servicing portfolio because of the returns the Company can earn from such investment and because the Company believes that master servicing income is countercyclical to loan production income. In periods of rising interest rates, prepayments tend to decline and income from the master servicing portfolio should increase. In periods of decreasing interest rates, prepayments tend to increase. To mitigate the effect on earnings of higher amortization (which is deducted from master servicing income) resulting from increased prepayment activity, the Company purchases call options that increase in value when interest rates decline.\nSALARIES AND RELATED EXPENSES: Salaries and related expenses were $1.8 million for 1993. The Company incurred no salaries and related expense in 1992. This increase was associated with the implementation of the Company's new mortgage conduit and warehouse lending operations. As of December 31, 1993, the Manager employed approximately 60 employees on behalf of the conduit whereas in the prior year there were approximately two. Prior to 1993, personnel costs were minimal due to the passive nature of operations and were absorbed by the Company as a component of the management fee.\nGENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses for 1993 and 1992 were $2.4 million and $1.6 million, respectively. This increase was primarily attributed to costs related to the new mortgage conduit and warehouse lending operations. The Company anticipates that expenses will continue to increase as the new operations expand and develop.\nIncluded in the above amounts are approximately $358,000 and $437,000 attributable to the administration of CMOs for 1993 and 1992, respectively.\nMANAGEMENT FEES: For 1993, management fees were $400,000 compared to $997,000 for 1992. The decrease was primarily due to a decrease in the base management fee. In addition, included in management fees for 1992 were $254,000 in fees associated with the management of the CMO Portfolio. There were no such fees in 1993 due to a change in the Management Agreement. Under the agreement with the Company's Manager, management fees were waived for 1993. Accordingly, such fees are reflected as an expense and a corresponding capital contribution in the accompanying financial statements.\nRESULTS OF OPERATIONS 1992 COMPARED TO 1991\nNET EARNINGS: The Company's net earnings were $5.0 million or $0.36 per share, based on 13,978,683 weighted average shares outstanding for 1992 compared to net earnings of $10.9 million or $0.78 per share, based on 13,924,326 weighted average shares outstanding for 1991. Earnings for 1992 reflected net interest expense of $1.4 million and a gain on sale of investments in mortgage loans of $9.0 million compared to net interest income of $13.2 million and a gain on sale of investments of mortgage loans of $735,000 for the prior year.\nAs a result of higher than anticipated prepayment rates in 1992, net interest income on the CMO Portfolio decreased $15.0 million. Included in net interest expense is amortization of purchase premiums, relating to the collateral for the CMOs, and amortization of deferred bond issuance costs and original issue discounts, related to the costs associated with the issuance of CMOs. The amount of amorization recorded in 1992 exceeded the amount recorded in 1991 by $7.9 million. This decrease in net interest income was offset by gains of $1.1 million primarily associated with a redemption of a CMO series and a $7.1 million increase in gains on the sale of the ARM Portfolio. General and administrative expenses increased $121,000 and management fees decreased $625,000 from 1991 to 1992. As a consequence, net earnings for 1992 decreased by $5.9 million from the prior year.\nINTEREST INCOME: Total interest income amounted to $106.1 million for 1992 and $148.6 million for 1991. Interest income on collateral for CMOs was $68.7 million and $106.9 million for 1992 and 1991, respectively. The decline was primarily attributable to a decrease in the average aggregate principal amount of collateral for CMOs outstanding from $1.2 billion for 1991 to $847.7 million for 1992 combined with a decrease in the weighted average effective yield earned from 9.00% in 1991 to 8.10% in 1992. The decrease in the average balance of collateral for CMOs and the effective interest yield earned thereon is due to the low interest rate environment experienced in 1992 resulting in significant prepayment activity (including repayments) which totaled 42% in 1992 compared to 17% in 1991. In a declining interest rate environment, loans with higher interest rates prepay faster than loans with lower interest rates resulting in a lower overall effective yield. In addition, the interest income on collateral for CMOs was reduced by the amortization of premiums paid in connection with acquiring the portfolio, a delay in the receipt of prepayments, and temporary investment in lower yielding short-term investments (GICs) until such amounts were used to repay CMOs.\nInterest income on the ARM Portfolio totaled $37.4 million and $41.8 million for 1992 and 1991, respectively. Although the average aggregate principal amount of the ARM Portfolio increased from $522.8 million for 1991 to $597.9 million for 1992, the weighted average yield on such investments decreased from 7.99% for 1991 to 6.25% for 1992. This decline in weighted average yield was primarily attributable to the effect of declining interest rates on the Company's ARM Portfolio.\nINTEREST EXPENSE: Total interest expense was $107.5 million and $135.4 million for 1992 and 1991, respectively. Interest expense on CMOs was $83.6 million and $106.7 million for 1992 and 1991, respectively. This decrease was primarily attributable to a decrease in average aggregate CMOs outstanding from $1.1 billion for 1991 to $813.6 million for 1992. The weighted average cost of CMOs increased from 9.47% for 1991 to 10.27% for 1992. The decrease in the average balance on CMOs is directly related to the prepayment activity of collateral for CMOs discussed above. The decrease in the weighted average cost of CMOs is attributed to factors previously discussed (see Results of Operations 1993 Compared to 1992).\nInterest expense on reverse-repurchase agreements amounted to $24.0 million and $28.7 million for 1992 and 1991, respectively. This decrease of $4.7 million was attributable to the decrease in the weighted average interest rate paid on such borrowings from 5.92% in 1991 to 4.15% in 1992. The effect of the decrease in the weighted average interest rate was offset by an increase in the average aggregate outstanding amounts of borrowings from $485.3 million in 1991 to $577.4 million for 1992.\nGENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses were $1.6 million and $1.5 million for 1992 and 1991, respectively. Of these amounts, approximately $437,000 and $457,000, respectively, were attributable to the administration of CMOs. The increase in general and administrative expenses was primarily due to increased insurance and franchise tax expenses.\nMANAGEMENT FEES: Management fees for 1992 and 1991 were $997,000 and $1.6 million, respectively. Management fees paid for the management of collateral for CMOs amounted to $254,000 and $360,000 for the same periods. This decrease was a result of the decline in the average aggregate principal balance of invested assets primarily due to principal prepayments. Management fees for the other mortgage portfolio decreased $519,000 from $1.3 million for 1991 to $743,000 for 1992, primarily due to a decrease in the base management fee rate on assets not pledged to secure CMOs.\nLIQUIDITY AND CAPITAL RESOURCES\nHistorically, the Company has used proceeds from the issuance of CMOs, uncommitted reverse-repurchase agreements, other borrowings and proceeds from the issuance of common stock to meet its working capital needs. In connection with its new mortgage conduit operations, the Company has begun to issue REMIC securities through CMC to help meet such needs. The Company may also borrow collateral or funds from Countrywide Funding Corporation (\"CFC\") to meet collateral maintenance requirements under reverse-repurchase agreements or margin calls on forward securities sales. These borrowings are made pursuant to a $10 million, one-year, unsecured line of credit which expires on September 30, 1994, subject to extension by CFC and the Company. As of December 31, 1993, the Company had no outstanding borrowings under this agreement. The Company has established a committed reverse-repurchase facility in the aggregate amount of up to $100 million for its mortgage conduit operations that expires in April 1994 and an additional facility in the aggregate amount of up to $100 million for its warehouse lending program that expires in September 1994. The Company also has obtained credit approval from the same lender to enter into additional reverse-repurchase agreements, associated with the mortgage conduit operations, under which individual transactions and their terms will be subject to agreement by the parties based upon market conditions at the time of each transaction. The maximum balance outstanding during the year was $1.1 billion and as of December 31, 1993, the Company had entered into reverse-repurchase agreements aggregating $806.6 million. In February 1994, the Company signed a commitment letter for a master repurchase agreement to provide a committed short-term credit line in the amount of $500.0 million and an addition $300.0 million on an uncommitted basis. The agreement expires in January 1996. The Company, to the extent permitted by its by-laws, may issue other debt securities or incur other types of indebtedness from time to time.\nThe collateral maintenance requirements under reverse-repurchase agreements could adversely affect the Company's liquidity in the event of a significant decrease in the market value of the mortgage loans financed under reverse- repurchase agreements. However, the Company has implemented a hedging strategy for its mortgage portfolio which to some extent may mitigate this adverse effect.\nDuring 1993, the Company increased its capital resources through the issuance of 18,040,097 shares of common stock with net proceeds of $136.9 million. The REIT provisions of the Internal Revenue Code require the Company to distribute to shareholders substantially all of its income, thereby restricting its ability to retain earnings.\nManagement believes that the cash flow from operations and the current and potential financing arrangements are sufficient to meet current liquidity requirements.\nINFLATION\nInterest rates often increase during periods of high inflation. Higher interest rates may depress the market value of the Company's investment portfolio if the yield on such investments does not keep pace with increases in interest rates. As a result of decreased market values it could be necessary for the Company to borrow additional funds and pledge additional assets to maintain financing for investments that have not been financed to maturity through the issuance of CMOs or other debt securities. Increases in short-term borrowing rates relative to rates earned on investments that have not been financed to maturity through the issuance of CMOs or other debt securities may also adversely affect the Company's earnings. However, the Company has implemented a hedging strategy which may mitigate this adverse effect. In addition, high levels of interest rates tend to decrease the rate at which mortgage investments prepay. A decrease in the rate of prepayments may lengthen the estimated average lives for the underlying mortgages for master servicing fees receivable and for classes of the CMOs issued by the Company and may result in higher residual cash flows from the CMOs than would otherwise have been obtained. However, higher interest rates may otherwise adversely affect the Company's new mortgage conduit and warehouse lending operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA - ------- ------------------------------------------\nThe information called for by this item 8 is hereby incorporated by reference to the Company's Consolidated Financial Statements and Report of Certified Public Accountants beginning at Page of this Form 10-K.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------- ----------------------------------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------- --------------------------------------------------\nThe information required by this Item 10 as to directors and executive officers of the Company is hereby incorporated by reference to the Company's definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.\nThe directors and principal executive officers of CAMC, the Company's Manager, are:\n* The above are also directors and\/or officers of the Company. A description of their backgrounds is hereby incorporated by reference to the Company's definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year\nJeffrey F. Butler joined CCI in 1985 and became the Chief Information Officer in 1989 and Managing Director--Chief Information Officer in May 1991. He became a director of CAMC in 1993.\nRalph S. Mozilo joined CFC in 1971 and is Executive Vice President of Underwriting and Compliance for CFC. He became a director of CAMC in 1993.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nThe information required by this Item 11 is hereby incorporated by reference to the Company's definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS - -------- ----------------------------------------------- AND MANAGEMENT --------------\nThe information required by this Item 12 is hereby incorporated by reference to the Company's definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nThe information required by this Item 13 is hereby incorporated by reference to the Company's definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES - -------- --------------------------------------- AND REPORTS ON FORM 8-K -----------------------\n(a)(1) and (2) - Financial Statements and Schedules\nThe information called for by this section of Item 14 is set forth in the Index to Financial Statements and Schedules at page of this Form 10-K.\n(3) - Exhibits\nExhibit No. Description - ------- ----------- 3.1 Certificate of Incorporation for the Company, as amended.\n3.2* Bylaws of the Company as amended (incorporated by reference to Exhibit 4.2 to the Company's Form 10-Q, for the quarter ended June 30, 1993).\n4.1* Indenture (the \"Indenture\"), dated as of December 1, 1985, between Countrywide Mortgage Obligations, Inc. (\"CMO, Inc.\") and Bankers Trust Company, as Trustee (\"BTC\") (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on January 24, 1986).\n4.2* Series A Supplement, dated as of December 1, 1985, to the Indenture (incorporated by reference to Exhibit 4.2 to CMO, Inc.'s Form 8-K filed with the SEC on January 24, 1986).\n4.3* Series B Supplement, dated as of February 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on March 31, 1986).\n4.4* Series C Supplement, dated as of April 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.4 to CMO, Inc.'s Amendment No. 1 to S-11 Registration Statement (No. 33-3274) filed with the SEC on May 13, 1986).\n4.5* Series D Supplement, dated as of May 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.5 to the Company's S-11 Registration Statement (No. 33-6787) filed with the SEC on June 26, 1986).\n4.6* Series E Supplement, dated as of June 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.6 to the Company's Amendment No. 1 to S-11 Registration Statement (No. 33-6787) filed with the SEC on July 30, 1986).\n4.7* Series F Supplement, dated as of August 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on August 14, 1986).\n4.8* Series G Supplement, dated as of August 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.8 to CMO, Inc.'s S-11 Registration Statement (No.33-8705) filed with the SEC on September 12, 1986).\n4.9* Series H Supplement, dated as of September 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.1 to CMO, Inc's Form 8-K filed with the SEC on October 7, 1986).\n4.10* Series I Supplement, dated as of October 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.11 to CMO, Inc.'s Amendment No. 1 to S-11 Registration Statement (No. 33-8705) filed with the SEC on October 27, 1986).\n4.11* Series J Supplement, dated as of October 15, 1986, to the Indenture (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on November 12, 1986).\n4.12* Series K Supplement, dated as of December 1, 1986, to the Indenture (incorporated by reference to 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on March 16, 1987).\n4.13* Series L Supplement, dated as of December 1, 1986, to the Indenture (incorporated by reference to Exhibit 4.2 to CMO, Inc.'s Form 8-K filed with the SEC on March 16, 1987).\n4.14* Series M Supplement, dated as of January 1, 1987, to the Indenture (incorporated by reference to Exhibit 4.3 to CMO, Inc.'s Form 8-K filed with the SEC on March 16, 1987).\n4.15* Indenture (the \"SPNB Indenture\"), dated as of December 1, 1986, between CMO, Inc. and Security Pacific National Bank, as Trustee (\"SPNB\") (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on January 9, 1987).\n4.16* Series W-1 Supplement, dated as of December 1, 1986, to the SPNB Indenture (incorporated by reference to Exhibit 4.2 to CMO, Inc.'s Form 8-K filed with the SEC on January 9, 1987).\n4.17* Series N Supplement, dated as of February 1, 1987, to the SPNB Indenture (incorporated by reference to Exhibit 4.1 to CMO, Inc.'s Form 8-K filed with the SEC on March 16, 1987).\n4.18* Indenture, dated as of February 1, 1987, between Countrywide Mortgage Trust 1987-I (the \"1987-I Trust\") and SPNB (incorporated by reference to Exhibit 4.18 to the Company's Form 10-K for the year ended December 31, 1986).\n4.19* Indenture, dated as of June 1, 1987, between Countrywide Mortgage Trust 1987-II (the \"1987-II Trust\") and SPNB (incorporated by reference to Exhibit 4.19 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n4.20* Indenture Supplement, dated as of September 1, 1987, among Countrywide Mortgage Obligations III, Inc. (\"CMO III, Inc.\"), CMO, Inc. and BTC (incorporated by reference to Exhibit 4.1 to CMO III, Inc.'s Form 8-K filed with the SEC on October 9, 1987).\n4.21* Indenture Supplement, dated as of September 1,1987, among CMO III, Inc., CMO, Inc. and SPNB (incorporated by reference to Exhibit 4.2 to CMO III, Inc.'s. Form 8-K filed with the SEC on October 9, 1987).\n4.22* Indenture dated as of November 20, 1990, between the Countrywide Cash Flow Bond Trust (\"CCFBT\") and BTC (incorporated by referenced to Exhibit 4.22 to the Company's Form 10-K for the year ended December 31, 1990).\n4.23* Indenture dated as of March 30, 1993 between Countrywide Mortgage Trust 1993-I (the \"1993-I Trust\") and State Street Bank and Trust Company (the \"Bond Trustee\") (incorporated by reference to Exhibit 4.1 to the Company's 10-Q for the quarter ended March 31, 1993).\n4.24* Indenture dated as of April 14, 1993 between Countrywide Mortgage Trust 1993-II (the \"1993-II Trust\") and the Bond Trustee (incorporated by reference to Exhibit 4.2 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.1* 1993 Amended and Extended Management Agreement, dated as of May 15, 1993, between the Company and Countrywide Asset Management Corporation (the \"Manager\") (incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 3 to S-3 Registration Statement (No.33-63034) filed with the SEC on July 16, 1993).\n10.2* 1987 Amended and Restated Servicing Agreement, dated as of May 15, 1987, between the Company and Countrywide Funding Corporation (\"CFC\") (incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q filed for the quarter ended June 30, 1987).\n10.3* 1993 Amended and Extended Loan Purchase and Administrative Services Agreement, dated as of May 15, 1993, between the Company and CFC (incorporated by reference to Exhibit 10.9 to the Company's 10-Q for the quarter ended June 30, 1993).\n10.4* 1988 Amended and Restated Submanagement Agreement, dated as of May 15, 1988, between CFC and the Manager (incorporated by reference to Exhibit 10.4 to the Company's Form 10-Q for the quarter ended March 31, 1988).\n10.5* 1985 Stock Option Plan adopted August 26, 1985, as amended February 12, 1987 (incorporated by reference to Exhibit 10.6 to the Company's Form 10-K for the year ended December 31, 1986).\n10.6* Form of Indemnity Agreement between the Company and the Company's directors and officers (incorporated by reference to Exhibit 10.5 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.7* Form of Guaranty of Indemnity Agreement made by Countrywide Credit Industries, Inc. (\"Countrywide Credit\") to the Company and the Company's directors and officers (incorporated by reference to Exhibit 10.6 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.9* Servicing Agreement, dated as of November 15, 1986, among CMO, Inc. SPNB and CFC (incorporated by reference to Exhibit 10.1 to CMO, Inc.'s Form 8-K filed with the SEC on January 9, 1987).\n10.10* Deposit Trust Agreement (the \"1987-I Deposit Trust Agreement\"), dated January 16, 1987, between Countrywide Mortgage Obligations II, Inc. (\"CMO II, Inc.\") and Wilmington Trust Company, as Owner Trustee of the 1987-I Trust (incorporated by reference to Exhibit 10.15 to the Company's Form 10-K for the year ended December 31, 1986).\n10.11* Management Agreement, dated as of February 1, 1987, between Wilmington Trust Company, as Owner Trustee of the 1987-I Trust, and the Manager (incorporated by reference to Exhibit 10.17 to the Company's Form 10-K for the year ended December 31, 1986).\n10.12* Servicing Agreement, dated as of February 1, 1987, among the 1987-I Trust, SPNB and CFC (incorporated by reference to Exhibit 10.18 to the Company's Form 10-K filed for the year ended December 31, 1985).\n10.13* Agreement between CMO, II, Inc. and the Company, dated as of February 1, 1987, regarding certain bankruptcy matters (incorporated by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 31, 1986).\n10.14* Agreement among CMO II, Inc., the Manager and CFC, dated as of February 1, 1987, regarding certain bankruptcy matters (incorporated by reference to Exhibit 10.20 to the Company's Form 10-K for the year ended December 31, 1986).\n10.15* Term Revolving Loan Agreement, dated March 30, 1987, between the Company and Citicorp Real Estate, Inc. (incorporated by reference to Exhibit 10.21 to the Company's Form 10-K for the year ended December 31, 1986).\n10.16* Deposit Trust Agreement (the \"1987-II Deposit Trust Agreement\"), dated as of April 29, 1987, between CMO II, Inc. and Wilmington Trust Company, as Owner Trustee of the 1987-II Trust (incorporated by reference to Exhibit 10.7 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.17* First Amendment to 1987-II Deposit Trust Agreement, dated as of May 29, 1987, between CMO II, Inc. and Wilmington Trust Company, as Owner Trustee of the 1987-II Trust (incorporated by reference to Exhibit 10.8 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.18* Guaranty, dated as of May 29, 1987, by the Company of obligations of CMO II, Inc. under the 1987-II Deposit Trust Agreement, as amended (incorporated by reference to Exhibit 10.9 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.19* Management Agreement, dated as of June 1, 1987, between Wilmington Trust Company, as Owner Trustee of the 1987-II Trust, and the Manager (incorporated by reference to Exhibit 10.10 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.20* Servicing Agreement, dated as of June 1, 1987, among the 1987-II Trust, SPNB and CFC (incorporated by reference to Exhibit 10.11 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.21* Transfer Agreement, dated as of May 1, 1987, among the Company, CMO II, Inc. and CMO III, Inc. (incorporated by reference to Exhibit 10.12 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.22* Guaranty, dated as of May 1, 1987, by the Company of obligations of CMO III, Inc. under the 1987-I Deposit Trust Agreement (incorporated by reference to Exhibit 10.13 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.23* Amended and Restated Security Agreement, dated as of July 15, 1987, between the Company and Citicorp Real Estate, Inc. (incorporated by reference to Exhibit 10.14 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.24* Assignment of Servicing Rights, dated as of July 15, 1987, among the Company, CFC and Citicorp Real Estate, Inc. (incorporated by reference to Exhibit 10.15 to the Company's Form 10-Q for the quarter ended June 30, 1987).\n10.25* Agreement of Merger, dated as of September 11, 1987, between CMO, Inc. and CMO III, Inc. (incorporated by reference to Exhibit 2 to CMO III, Inc.'s Form 8-K filed with the SEC on October 9, 1987).\n10.26* Amendment to Term Revolving Loan Agreement between the Company and Citicorp Real Estate, Inc. dated June 22, 1988. (incorporated by reference to Exhibit 10.26 to the Form S-11 filed with the SEC on June 24, 1988).\n10.27* Credit Agreement, dated as of September 30, 1993, between the Company and CFC (incorporated by reference to Exhibit 10.1 to the Company's 10-Q for the quarter ended September 30, 1993).\n10.28* Agreement between the Company and CFC dated December 1, 1988 (incorporated by reference to Exhibit 10.28 to the Company's Form 10-K for the year ended December 31, 1988).\n10.29* 1985 Stock Option Plan adopted August 26, 1985, as amended February 12, 1987 and as further amended on February 15, 1989 (incorporated by reference to Exhibit 10.30 to the Company's Form 10-K for the year ended December 31, 1989).\n10.30* Second Amendment to Term Revolving Loan Agreement between the Company and Citicorp Real Estate, Inc., dated as of December 26, 1990 (incorporated by reference to Exhibit 10.30 to the Company's Form 10-K for the year ended December 31, 1990).\n10.31* Trust Agreement, dated as of November 20, 1990, between CMO III, Inc. and Wilmington Trust Company relating to the CCFBT (the \"CCFBT Trust Agreement\") (incorporated by reference to Exhibit 10.31 to the Company's Form 10-K for the year ended December 31, 1990).\n10.32* Guaranty, dated as of November 20, 1990, by the Company of obligations of CMO III, Inc. under the CCFBT Trust Agreement (incorporated by reference to Exhibit 10.32 to the Company's Form 10-K for the year ended December 31, 1990).\n10.33* Management Agreement, dated as of November 20, 1990, between CCFBT and the Manager (incorporated by reference to Exhibit 10.33 to the Company's Form 10-K for the year ended December 31, 1990).\n10.34* Amendment, dated as of November 21, 1990, to the 1990 Amended and Extended Management Agreement between the Company and the Manager (incorporated by reference to Exhibit 10.34 to the Company's Form 10-K for the year ended December 31, 1990).\n10.35* Assignment Agreement, dated as of November 21, 1990, between CMO III, Inc. and CCFBT (incorporated by reference to Exhibit 10.35 to the Company's Form 10-K for the year ended December 31, 1990).\n10.36* Deposit Trust Agreement dated as of March 24, 1993 between Countrywide Mortgage Obligations II, Inc. and Wilmington Trust Company (incorporated by reference to Exhibit 10.1 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.37* Master Servicing Agreement dated as of March 30, 1993 by and among the 1993-I Trust, the Company and the Bond Trustee (incorporated by reference to Exhibit 10.2 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.38* Servicing Agreement dated as of March 30, 1993 by and among the 1993-I Trust, Countrywide Funding Corporation and the Bond Trustee (incorporated by reference to Exhibit 10.3 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.39* Management Agreement, dated as of March 30, 1993 between Countrywide Asset Management Corporation and the 1993-I Trust (incorporated by reference to Exhibit 10.4 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.40* First Amendment dated as of March 30, 1993 to Agreement between Countrywide Mortgage Obligations II, Inc. and the Company (incorporated by reference to Exhibit 10.5 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.41* First Amendment dated as of March 30, 1993 to Agreement between Countrywide Mortgage Obligations II, Inc., Countrywide Asset Management Corporation and Countrywide Funding Corporation (incorporated by reference to Exhibit 10.6 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.42* Deposit Trust Agreement dated as of April 7, 1993 between Countrywide Mortgage Obligations II, Inc. and Wilmington Trust Company (incorporated by reference to Exhibit 10.7 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.43* Master Servicing Agreement dated as of April 14, 1993 by and among the 1993-II Trust, the Company and the Bond Trustee (incorporated by reference to Exhibit 10.8 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.44* Servicing Agreement dated as of April 14, 1993 by and among the 1993-II Trust, Countrywide Funding Corporation and the Bond Trustee (incorporated by reference to Exhibit 10.9 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.45* Management Agreement, dated as of April 14, 1993 between Countrywide Asset Management Corporation and the 1993-II Trust (incorporated by reference to Exhibit 10.10 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.46* First Amendment to Deposit Trust Agreement dated as of April 13, 1993 between Countrywide Mortgage Obligations II, Inc. and Wilmington Trust Company, as Owner Trustee (incorporated by reference to Exhibit 10.11 to the Company's 10-Q for the quarter ended March 31, 1993).\n10.47* Contribution and Mortgage Loan Acquisition Agreement dated as of April 19, 1993 between the Company and Countrywide Funding Corporation (incorporated by reference to Exhibit 10.2 to the Company's Amendment No. 3 to S-3 Registration Statement (No. 33-63034) filed with the SEC on July 16, 1993).\n10.48* First Amendment to Deposit Trust Agreement dated as of April 16, 1993 between Countrywide Mortgage Obligations II, Inc. and Wilmington Trust Company (incorporated by reference to Exhibit 10.8 to the Company's 10-Q for the quarter ended June 30, 1993).\n10.49* 1993 Amended and Extended Loan Purchase and Administrative Services Agreement dated as of May 15, 1993 between the Company and Countrywide Funding Corporation (incorporated by reference to Exhibit 10.9 to the Company's 10-Q for the quarter ended June 30, 1993).\n10.50* Custody Agreement dated as of April 5, 1993 among the Company, Merrill Lynch Mortgage Capital, Inc. and State Street Bank and Trust Company of California, N.A., Custodian (incorporated by reference to Exhibit 10.10 to the Company's 10-Q for the quarter ended June 30, 1993).\n10.51* Master Repurchase Agreement dated as of April 5, 1993 between the Company and Merrill Lynch Mortgage Capital, Inc. (incorporated by reference to Exhibit 10.11 to the Company's 10-Q for the quarter ended June 30, 1993).\n10.52 Master Repurchase Agreement dated October 1, 1993 between the Company and Merrill Lynch Mortgage Capital, Inc.\n22.1 List of Subsidiaries.\n23.1 Consent of Grant Thornton.\n*Incorporated by reference.\n(B) - REPORTS ON FORM 8-K\nNone.\nSIGNATURES\nPursuant 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, in the City of Pasadena, State of California, on March 28, 1994.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC.\nBY: DAVID S. LOEB __________________________________ David S. Loeb Chairman of the Board of Directors and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nCONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nDecember 31, 1993, 1992 and 1991\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES December 31, 1993, 1992, 1991\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Shareholders Countrywide Mortgage Investments, Inc.\nWe have audited the accompanying consolidated balance sheets of Countrywide Mortgage Investments, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Countrywide Mortgage Investments, Inc. and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nGRANT THORNTON\nLos Angeles, California February 28, 1994\nCountrywide Mortgage Investments, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands)\nThe accompanying notes are an integral part of these statements.\nCountrywide Mortgage Investments, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (Dollar amounts in thousands, except per share data)\nThe accompanying notes are an integral part of these statements.\nCountrywide Mortgage Investments, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollar amounts in thousands, except share data)\nThe accompanying notes are an integral part of these statements.\nCountrywide Mortgage Investments, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands)\nThe accompanying notes are an integral part of these statements.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE A - NEW OPERATIONS\nHistorically, the Company's principal source of earnings has been net interest income generated from mortgage investments which were primarily financed through the issuance of collateralized mortgage obligations (\"CMOs\"). During the first quarter of 1993, the Company commenced operations of its mortgage loan conduit, Countrywide Mortgage Conduit, Inc. (\"CMC\"), and its warehouse lending program which provides warehouse loans to third-party mortgage loan originators.\nUnder its conduit operations, the Company purchases jumbo and nonconforming mortgage loans from eligible sellers who generally retain the servicing rights. The Company generally purchases mortgage loans in regions with higher volumes of jumbo and nonconforming mortgage loans, including California. As the mortgage loans are accumulated, they are generally financed through short-term borrowing sources such as reverse-repurchase agreements. When a sufficient volume of mortgage loans with similar characteristics has been accumulated, they are securitized through the issuance of mortgage-backed securities in the form of Real Estate Mortgage Investment Conduits (\"REMICs\") or CMOs or resold in bulk whole loan sales. The Company's principal sources of revenue from its new mortgage conduit business strategy are the net interest income earned from holding the mortgage loans during the accumulation phase and gains or losses on the REMIC or whole loan sale transactions. If the Company elects to invest in the mortgage loans on a long-term basis using financing provided by CMOs, the Company may also recognize a net yield on these investments over time. In addition, the Company earns fee income and net interest income through its warehouse lending program which provides warehouse loans to third-party mortgage loan originators.\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n1. Basis of Presentation\nThe consolidated financial statements include the accounts of Countrywide Mortgage Investments, Inc. and its subsidiaries (\"CMI\" or the \"Company\"). All material intercompany balances and transactions have been eliminated in consolidation.\nCertain amounts for 1992 and 1991 have been reclassified to conform to the 1993 presentation.\n2. Income Taxes\nThe Company intends to operate so as to continue to qualify as a real estate investment trust (REIT) under the requirements of the Internal Revenue Code. Requirements for qualification as a REIT include various restrictions on ownership of its stock, requirements concerning distribution of taxable income and certain restrictions on the nature of assets and sources of income. A REIT must distribute at least 95% of its taxable income to its shareholders, the distribution of which may extend until timely filing of its tax return in its subsequent taxable year. Qualifying distributions of its taxable income are deductible by a REIT in computing its taxable income. Accordingly, no provision for income taxes has been made for the parent company and its qualified REIT subsidiaries. If in any tax year the Company should not qualify as a REIT, it would be taxed as a corporation and distributions to the shareholders would not be deductible in computing taxable income. If the Company would fail to quality as a REIT in any tax year, it would not be permitted to qualify for that year and the succeeding four years.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nThe provision for income taxes in the accompanying financial statements is computed using the liability method and relates only to the earnings of CMC, a taxable corporation that is consolidated with CMI for financial reporting purposes but is not consolidated for income tax purposes. Taxable earnings of CMC are subject to state and federal income taxes at the applicable statutory rates.\n3. Collateral for CMOs\nCollateral for CMOs consists of mortgage loans and mortgage-backed securities and is carried at the outstanding principal balances net of unamortized purchase discounts or premiums. Also included in collateral for CMOs are guaranteed investment contracts (\"GICs\") held by trustees and accrued interest receivable related to such collateral.\n4. Mortgage Loans Held for Sale\nMortgage loans held for sale are carried at the lower of cost or market, which is computed by the aggregate method (unrealized losses are offset by unrealized gains). The cost of mortgage loans is adjusted by gains and losses generated from corresponding hedging transactions entered into to protect the inventory value from increases in interest rates. Hedge positions are also used to protect the pipeline of loan purchases in process from changes in interest rates. Gains and losses resulting from changes in the market value of the inventory, pipeline and open hedge positions are netted. Any net gain that results is deferred; any net loss that results is recognized when incurred. Hedging gains and losses realized during the commitment and warehousing period related to the pipeline and mortgage loans held for sale are deferred. Hedging losses are recognized currently if deferring such losses would result in mortgage loans held for sale and the pipeline being valued in excess of their estimated net realizable value.\n5. Master Servicing Fees Receivable\nThe Company sells substantially all of the mortgage loans it purchases and retains the master servicing rights thereto. These master servicing rights entitle the Company to a future stream of cash flows based on the outstanding principal balance of the mortgage loans and the related contractual master service fees. The sales price of the loans and the resulting gain or loss on sale are adjusted to provide for the recognition of a normal master service fee rate over the estimated servicing lives of the loans. The adjustment results in a receivable that is realized through receipt of excess master servicing fees over time. Master servicing fees receivable are amortized into income over the lives of the underlying mortgages using the effective yield method adjusted for the effects of prepayments. The Company intends to hold the master servicing fees receivable for investment.\nTo protect the value of the master servicing fees receivable from the effects of increased prepayment activity, the Company purchases options on mortgage-backed securities that increase in value when interest rates decline. Options are reflected in other assets at their estimated market value. The cost of option fees is charged to expense over the contractual life of the options. Option gains are applied first to offset amortization due to impairment caused by increasing the projected prepayment speed (\"Incremental Amortization\").\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\n6. Revenue Recognition\nInterest is recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectable. Premiums paid and discounts obtained on collateral for CMOs are amortized to interest income over the estimated life of the mortgage loans using the interest method with effect given to principal reductions. Premiums paid and discounts obtained on mortgage loans held for sale are deferred as an adjustment to the carrying value of the loans until the loans are sold. CMO discounts or premiums are amortized to interest expense using the interest method with effect given to principal reductions.\nSubstantially all commitment fees collected are refunded as commitments are fulfilled. Such fees, with respect to expired unfilled commitments, are credited to income at the time of expiration.\n7. Collaterized Mortgage Obligations (CMOs) and Deferred Issuance Costs\nCollateralized mortgage obligations are carried at their outstanding principal balances net of unamortized original issue discounts or premiums. Also included in CMOs is accrued interest payable on such obligations. Issuance costs have been deferred and are amortized to expense over the estimated life of the CMOs using the straight-line method with effect given to principal reductions. Unamortized deferred issuance costs are included in other assets in the consolidated balance sheets.\n8. Earnings Per Share\nEarnings per share are computed on the basis of the weighted average number of common shares outstanding for the year which were 18,578,307, 13,978,683 and 13,924,326 for 1993, 1992 and 1991, respectively. The effect on earnings per share resulting from dilution upon exercise of stock options is not material in any year and is therefore not presented. Of the total dividends per share paid in 1993 and 1992, approximately $0.45 and $0.00, respectively, represented return of capital.\n9. Fair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires that the Company disclose estimated fair values for its financial instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nFair values of revolving warehouse lines of credit, cash, master servicing fees receivable, other assets, reverse-repurchase agreements and accounts payable and accrued liabilities are not separately disclosed as such values approximate carrying amounts because of the short term to maturity or nature of the underlying asset or liability.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE C - COLLATERAL FOR CMOS\nCollateral for CMOs consists of fixed-rate mortgage loans secured by first liens (enforceable through foreclosure proceedings) on one-to-four family residential real estate and mortgage- backed securities. During the year ended December 31, 1993, the Company pledged approximately $248.2 million of mortgage loans as collateral for two new series of CMOs.\nAll principal and interest on the collateral is remitted to a trustee and, together with any reinvestment income earned thereon, is available for payment on the CMOs. Generally, any default of a mortgage loan which is the basis for a foreclosure action is covered (up to an aggregate benefit limit) under a pool insurance policy provided by a private mortgage insurer. Furthermore, the Company's mortgage-backed securities are guaranteed as to the repayment of principal and interest of the underlying mortgages by the Federal Home Loan Mortgage Corporation. The maximum amount of credit risk related to the Company's investment in mortgage loans is represented by the outstanding principal balance of the mortgage loans plus accrued interest.\nCollateral for CMOs is summarized as follows: (Dollar amounts in thousands)\nThe mortgage loans and mortgage-backed securities, together with GICs, which are all held by trustees, collateralized 17 series of CMOs at December 31, 1993. A time lag of 24 to 45 days exists from the date the underlying mortgage is prepaid to the date the Company actually receives the cash related to the prepayment. During this interim period, the Company does not earn interest income on the portion of the mortgage loan or mortgage-backed security that has been prepaid. The weighted average coupon on collateral for CMOs, net of the related servicing fees, was 8.88% at December 31, 1993.\nAs of December 31, 1993 and 1992, the aggregate market value of collateral for CMOs was estimated to be $413.0 million and $638.2 million, respectively. This estimate was determined based upon quoted market prices from dealers and brokers for securities backed by similar types of loans. Collateral for CMOs cannot be sold until the related obligations mature or are otherwise paid or redeemed. As a consequence, the aggregate market values indicated above may not be realizable. As a REIT, the Company's ability to sell these assets for gain also is subject to restrictions under the Internal Revenue Code and any such sale may result in substantial additional tax liability.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE D - MORTGAGE LOANS HELD FOR SALE\nSubstantially all of the mortgage loans purchased through the Company's mortgage conduit operations are fixed-rate and adjustable-rate nonconforming mortgage loans secured by first liens on single (one-to-four) family residential properties. Approximately 69% of the properties collateralizing mortgage loans held for sale at December 31, 1993 were located in California.\nIn 1993, the Company purchased mortgage loans with an aggregate principal balance of $3.5 billion and sold mortgage loans in the form of REMIC securities, CMOs or bulk whole loan sales with an aggregate principal balance of $2.5 billion. In connection with the issuance of these securities, the Company retained master servicing rights with a carrying value of $45.2 million at December 31, 1993. The Company recognized gains on these securitizations in 1993 totaling $8.2 million, net of related costs.\nMortgage loans held for sale are carried at the lower of cost or estimated market value determined on an aggregate basis. At December 31, 1993, these investments had an approximate market value of $872.5 million and a cost of $873.8 million.\nNOTE E - COLLATERALIZED MORTGAGE OBLIGATIONS\nCollateralized mortgage obligations are secured by a pledge of mortgage loans, mortgage-backed securities or residual cash flows from such loans or securities. As required by the indentures relating to the CMOs, the pledged collateral is in the custody of a trustee. The trustee also held investments in GICs amounting to $21.7 million and $44.6 million as of December 31, 1993 and 1992, respectively, as additional collateral which is legally restricted to use in servicing the CMOs. The trustee collects principal and interest payments on the underlying collateral, reinvests such amounts in the GICs and makes corresponding principal and interest payments on the CMOs to the bondholders.\nIn general, each series of CMOs consists of various classes which are retired in order of maturity, with the shortest maturity class receiving all principal payments until it is paid in full. After the first class is fully retired, the second class will receive principal until retired and so forth. Each series is also subject to redemption according to specific terms of the respective indentures. As a result, the actual maturity of any class of a CMO series is likely to occur earlier than its stated maturity.\nInterest is payable monthly or quarterly, as applicable in accordance with the respective indenture, for all classes other than deferred interest classes. Interest on deferred interest classes is accrued and added to the principal balance and will not be paid until all other classes in the series have been paid in full. The weighted average coupon on CMOs was 8.43% at December 31, 1993.\nThe Company's investment in CMO residuals amounted to $40.2 million and $51.8 million at December 31, 1993 and 1992, respectively.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE E - COLLATERALIZED MORTGAGE OBLIGATIONS - CONTINUED\nCMOs are summarized as follows: (Dollar amounts in thousands)\nDuring 1993, the Company redeemed two series of CMOs (the \"Series\"), in accordance with the terms of the indentures governing the Series. The mortgage- backed securities that collateralized the Series were sold and the Company recognized a gain of $917,000. Additionally, in March 1993 and April 1993, the Company issued two new series of CMO's with a total initial balance of $240.2 million.\nThe estimated fair value of CMOs at December 31, 1993 and 1992 was $393.4 million and $604.0 million, respectively. This estimate was determined based upon quoted market prices from dealers and brokers for securities backed by similar types of loans.\nNOTE F - REVERSE-REPURCHASE AGREEMENTS\nDuring April 1993, the Company entered into a $100.0 million reverse-repurchase agreement, which expires in April 1994, to provide the Company with a committed revolving credit facility to finance mortgage loans held for sale. The Company also has obtained credit approval from the same lender to enter into additional reverse-repurchase agreements, associated with the mortgage conduit operation under which individual transactions and their terms will be subject to agreement by the parties based upon market conditions at the time of each transaction. The maximum balance outstanding during the year was $1.1 billion and the balance outstanding at December 31, 1993 totaled $779.2 million. These facilities are secured by such loans which the Company ultimately sells in the form of REMIC securities or whole loans. Mortgage loans held for sale securing this facility totaled $793.1 million at December 31, 1993. Adjustable-rate mortgage-backed securities totaling $23.3 million were pledged as collateral for reverse- repurchase agreements at December 31, 1992.\nDuring September 1993, the Company entered into an additional $100.0 million reverse-repurchase agreement, which expires in September 1994, to provide the Company with a committed revolving credit facility to be used to finance the Company's warehouse lending program. The balance outstanding at December 31, 1993 totaled $27.4 million. The facility is secured by mortgage loans originated by small- and medium-size mortgage bankers to which the Company advances funds for the period from the closing of the loans until the loans are purchased by a permanent investor.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE F - REVERSE-REPURCHASE AGREEMENTS - CONTINUED\nAt December 31, 1993, the outstanding reverse-repurchase transactions had maturities of less than five days with interest at rates indexed to the London Interbank Offered Rates (\"LIBOR\"). At December 31, 1993, the Company was in compliance with all representations, warranties and covenants of its reverse- repurchase agreements.\nNOTE G - INCOME TAXES\nDeferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. As of December 31, 1993, the components of the Company's deferred tax liability consisted of approximately $6.1 million related to the excess of carrying value assigned to its master servicing fee receivable for financial reporting purposes over the tax value of the asset reduced by approximately $4.3 million of future benefit to be derived from a net operating loss carryforward for tax purposes of approximately $10.7 million, which expires in 2008.\nThe provision for income tax expense for the year ended December 31, 1993 consists of deferred taxes of $1.3 million and $476,000 for federal and state income tax purposes, respectively. The effective income tax rate included in the Company's financial statements of 41.9% differs from the applicable federal statutory income tax rate of 34.0% because of state tax expense of 7.2% and other items which aggregate 0.7%.\nNOTE H - COMMITMENTS AND CONTINGENCIES\nFinncial Instruments With Off-Balance Sheet Risk. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business through the production and sale of mortgage loans and the management of interest-rate risk. These instruments include master servicing fees receivable and short-term commitments to extend credit and purchase and sell loans. The instruments involve, to varying degrees, elements of credit and interest-rate risk. The Company is exposed to credit loss in the event of nonperformance by the counterparties to the various agreements. However, the Company does not anticipate nonperformance by the counterparties. As discussed below, the Company's exposure to credit risk with respect to the master servicing portfolio in the event of nonperformance by the mortgagor is limited due to the non- recourse nature of the loans in the servicing portfolio. The Company's exposure to credit risk in the event of default by the counterparty is the difference between the contract price and the current market price. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.\nMaster Loan Servicing. As of December 31, 1993, the Company was master servicing loans totaling $2.1 billion associated with mortgage-backed securities and whole loans securitizing REMICs, whole loans and CMOs. The Company was master servicing $869.7 million associated with mortgage loans held for sale.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED\nIn connection with REMIC issuances, each series of mortgage-backed securities is typically fully payable from the mortgage assets underlying such series and the recourse of investors is limited to those assets and any credit enhancement features, such as insurance. Generally, any losses in excess of the credit enhancement obtained is borne by the security holders. Except in the case of a breach of the standard representations and warranties made by the Company when mortgage loans are securitized, the securities are non-recourse to the Company. Typically, the Company has recourse to the sellers of such loans for any breaches of similar representations and warranties made by the sellers.\nProperties securing mortgage loans in the Company's master servicing portfolio are geographically dispersed throughout the United States. As of December 31, 1993, approximately 64% of mortgage loans in the Company's master servicing portfolio were secured by properties located in California. No other state contained more than 6% of the properties securing mortgage loans.\nCommitments to Purchase Loans. As of December 31, 1993, the Company had entered into commitments to purchase mortgage loans totaling $618.6 million subject to funding of such loans by various mortgage bankers and other financial institutions. After purchase and sale of the mortgage loans, the Company's exposure to credit loss in the event of nonperformance by the mortgagor is limited as described above. The fair value of commitments to purchase loans is estimated to be ($290,000) at December 31, 1993. This estimate is based upon the difference between the current value of similar loans and the price at which the Company has committed to purchase the loans.\nCommitments to Sell Loans. As of December 31, 1993, the Company had open commitments amounting to approximately $680.0 million to sell mortgage loans in the first quarter of 1994. These commitments are utilized in delivering mortgage loans held for sale and are considered in the valuation of the mortgage loan inventory. The fair value of commitments to sell loans was estimated to be $1.4 million as of December 31, 1993. This estimate is based upon the difference between the settlement values of those commitments and the quoted market values of the underlying securities.\nRevolving Warehouse Lines of Credit Commitments. The Company's warehouse lending program provides secured short-term revolving financing to small- and medium-size mortgage bankers to finance mortgage loans from the closing of the loans until sold to permanent investors. At December 31, 1993, the Company had extended lines of credit under this program in the aggregate amount of $206.0 million, of which $92.1 million was outstanding.\nNOTE I - SHAREHOLDERS' EQUITY\nThe Company issued 10,215,000 shares of common stock in July 1993. Net proceeds of this offering amounted to $74.1 million and were used to expand the Company's mortgage conduit and warehouse lending operations.\nIn December 1993, the Company's shareholders approved an increase in the number of authorized shares of common stock of the Company from 30,000,000 to 60,000,000. Subsequently, the Company issued 7,666,300 shares of common stock. Net proceeds of this offering amounted to $62.0 million and will be used to expand the Company's mortgage conduit operations and other aspects of its new business plan.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE J - STOCK OPTION PLAN\nThe 1985 Stock Option Plan provides for the issuance of non-qualified and incentive stock options to purchase up to 1,090,000 shares of the Company's common stock. Options granted to date are at a per share exercise price equal to the average of the high and low sales prices per share of the Company's common stock on the date of grant. Options granted are exercisable one year from the date of grant and generally terminate five years from the date of grant.\nAs of December 31, 1993, options to purchase 346,875 shares were exercisable and 47,750 shares were reserved for future grants. Stock option transactions for the three years ended December 31, 1993, 1992 and 1991 are summarized as follows:\nTwo members of the Company's Board of Directors exercised options totaling 126,125 shares during the year ended December 31, 1993. The exercise of these options was financed through the Company. At December 31, 1993 and 1992, the total principal balances of notes receivable relating to the 1993 and prior option exercises by Directors were $1.5 million and $1.1 million respectively; the notes are secured by the common stock issued, have maturities of up to five years and bear interest rates ranging from 4.17% to 7.70% at December 31, 1993.\nNOTE K - RELATED PARTY TRANSACTIONS\nThe Company has entered into an agreement (the \"Management Agreement\") with Countrywide Asset Management Corporation (the \"Manager\") to advise the Company on various facets of its business and manage its operations, subject to supervision by the Company's Board of Directors. The Manager has entered into a subcontract with its affiliate, Countrywide Funding Corporation (\"CFC\"), to perform such services for the Company as the Manager deems necessary.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE K - RELATED PARTY TRANSACTION (CONTINUED)\nFor performing these services, the Manager receives a base management fee of 1\/8 of 1% per annum of average invested assets not pledged to secure CMOs. The Manager also receives a subsidiary management fee equal to 3\/8 of 1% per annum of the average amounts outstanding under warehouse lines of credit. In addition, the Manager receives incentive compensation equal to 25% of the amount by which the Company's annualized return on equity exceeds the ten-year U.S. Treasury Rate plus 2%. The Manager waived all fees pursuant to the above for 1993. Such amounts are reflected as an expense and a corresponding capital contribution in the accompanying financial statements. In addition, in 1993 the Manager absorbed $900,000 of operating expenses incurred in connection with its duties under the Management Agreement. The Company began paying all expenses of the new operations in June 1993. The Manager earned management fees totaling $997,000 and $1.6 million, for the years ended December 31, 1992 and 1991, respectively. The Management Agreement is renewable annually and expires May 15, 1994.\nDuring 1993, the Company purchased approximately $415.0 million in nonconforming mortgage loans from CFC. In addition, as of December 31, 1993, CFC was subservicing approximately $72.7 million in mortgage loans associated with purchased servicing rights.\nIn 1987 and 1993, the Company entered into servicing agreements appointing CFC as servicer of pools of mortgage loans collaterizing five series of CMOs with outstanding balances of approximately $154.2 million at December 31, 1993. CFC is entitled to an annual fee of up to 0.32% of the aggregate unpaid principal balance of the pledged mortgage loans. Servicing fees received by CFC under such agreements were approximately $1.1 million, $290,000 and $462,000 in 1993, 1992 and 1991, respectively.\nCFC has extended the Company a $10.0 million line of credit bearing interest at prime and maturing September 30, 1994. At December 31, 1993, there was no outstanding amount under the agreement.\nThe Manager and CFC are wholly-owned subsidiaries of Countrywide Credit Industries, Inc. (\"CCI\"), a diversified financial services company whose shares of common stock are traded on the New York Stock Exchange. CCI owned 1,100,000 shares or 3.44% of the Company's common stock at December 31, 1993. The Manager owned 20,000 shares of the Company's common stock, which was purchased at inception.\nNOTE L - SUBSEQUENT EVENT\nOn January 27, 1994, the Board of Directors declared a $0.12 cash dividend to be paid on March 1, 1994 to shareholders of record on February 7, 1994.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE M - QUARTERLY FINANCIAL DATA - UNAUDITED\nSelected quarterly financial data follows:\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\n(Dollar amounts in thousands)\n(1) The notes receivable are secured by Common Stock of the Company, have interest rates of up to 7.70% per annum as of December 31, 1993 and have original maturities of five years. Cash dividends on the Common Stock pledged for these notes are used first to pay accrued interest and second to reduce the outstanding principal of the notes.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)\nBALANCE SHEETS (Dollar amounts in thousands)\n- ------------------- (1) The Company has received cash dividends from its subsidiaries of $9,858 and $8,803 for the years ended December 31, 1993 and 1992, respectively.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) (Continued)\nSTATEMENTS OF EARNINGS (Dollar amounts in thousands)\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) (Continued)\nSTATEMENTS OF CASH FLOWS (Dollar amounts in thousands)\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\n(Dollar amounts in thousands)\n- ------------------------- (1) Calculation of average amount outstanding during the period based upon the monthly weighted average principal balance of borrowings.\n(2) Calculation of weighted average interest rate during the period based upon the monthly weighted average principal balance of borrowings divided into total interest charges on such borrowings.\nCOUNTRYWIDE MORTGAGE INVESTMENTS, INC. AND SUBSIDIARIES SCHEDULE XII - MORTGAGE LOANS ON REAL ESTATE\n(Dollar amounts in thousands)\nDecember 31, 1993\n- -------------------- (1) All mortgage loans are fixed or adjustable-rate, conventional mortgage loans secured by single (one-to-four) family residential properties with initial maturities of 15 to 30 years. (2) Total mortgage loans comprised of $870,140 of mortgage loans held for sale and $154,152 of whole loans pledged as collateral for CMOs. (3) Information with respect to the geographic breakdown of first mortgages on single family residential housing as of December 31, 1993 is as follows: California 70% with no other state comprising more than 14%. (4) The aggregate cost for federal income tax purposes is $1,029,457. (5) Interest earned on mortgages by range of carrying amounts is not reasonably obtainable. (6) $ 415.0 million of mortgage loans purchased during 1993 were acquired from CFC, an affiliate of the Company's Manager. (7) $5.8 million of the total principal amount of loans subject to delinquent principal or interest is related to Pre-1993 CMOs. (8) Of the total amount of mortgages being foreclosed, $606 is related to Pre- 1993 CMOs and $255 is related to CMOs issued in 1993. Generally, any default of a mortgage loan which is the basis of a foreclosure action is covered (up to an aggregate benefit limit) under a pool insurance policy provided by a private mortgage insurer.","section_15":""}
{"filename":"55454_1993.txt","cik":"55454","year":"1993","section_1":"ITEM 1. BUSINESS\n1. General\nKerr Group, Inc. (the \"Registrant\"), a Delaware corporation which was founded in 1903, currently operates in two business segments: the Plastic Products segment and the Consumer Products segment.\nOperations in the Plastic Products segment include the manufacture and sale of a variety of plastic products, including child- resistant closures, tamper-evident closures, prescription packaging products, jars, other closures and containers and the sale of glass prescription products (the \"Plastic Products Business\"). Operations in the Consumer Products segment include the manufacture and sale of caps and lids and the sale of glass jars and a line of pickling spice and pectin products for home canning (the \"Home Canning Supplies Business\"), which together with the sale of other related products, including iced tea tumblers and beverage mugs, constitutes the \"Consumer Products Business.\" The Plastic Products Business and the Consumer Products Business are referred to herein as \"Continuing Businesses\".\na. Principal Products and Markets; Sales and Customers\nThe Plastic Products segment accounted for approximately 77% of the Registrant's total net sales in 1993. Plastic closures of the Plastic Products Segment are sold to customers in the pharmaceutical, food, distilled spirits, toiletries and cosmetics and household chemical industries. Plastic and glass prescription products are sold to drug wholesalers, drug chains and independent pharmacists. Plastic bottles and jars are sold to customers in the pharmaceutical and toiletries and cosmetics industries. Plastic products are sold nationally, principally by the Registrant's sales force.\nThe Consumer Products Business accounted for approximately 23% of the Registrant's total net sales in 1993. The Home Canning Supplies Business represents substantially all of the Consumer Products Business. The Consumer Products Business sells its products primarily through food brokers to grocery retailers, food wholesalers and mass merchandisers.\nNo customer accounted for more than 10% of the Registrant's net sales in 1993.\nb. Competition\nCompetition in the markets in which the Plastic Products Business operates is highly fragmented and the Registrant has a number of large competitors with respect to its Plastic Products Business who compete for sales on the basis of price, service and quality of product. The Registrant believes that it is one of the three largest manufacturers of child-resistant plastic closures. The Registrant has one major competitor in the prescription products business, who has substantially larger market share than the Registrant. The Registrant also believes it is the largest manufacturer of plastic closures incorporating a tamper-evident feature for the liquor market and that it is one of the leading suppliers of single and double walled jars to the personal care and cosmetic markets.\nThe Registrant's one major competitor in the Home Canning Supplies Business is Alltrista Corporation. The Registrant believes it has a significant share of the market for home canning caps, lids and jars.\nc. Backlog\nThe Registrant does not believe that recorded sales backlog is a significant factor in its business.\nd. Raw Materials and Supplies; Fuel and Energy Matters\nThe primary raw materials used by the Registrant's Plastic Products Business are resins. The Registrant has historically been able to obtain adequate supplies of these items from a number of sources. However, since resins are derived from petroleum or fossil fuel, shortages of petroleum or fossil fuel could affect the supply of resins. From time to time, the Registrant has experienced increases in the cost of resins. To the extent that the Registrant is unable to reflect such price increases in the price for products manufactured by it, increases in the cost of resins could have a significant impact on the\nresults of the Registrant's operations. Currently, a majority of the sales of Plastic Products are made pursuant to agreements that provide for increases in the cost of resin to be passed on to the customer.\nThe Registrant purchases glass jars for its Home Canning Business from a single supplier under a multi-year contract. The Registrant believes that it could obtain adequate supplies of glass jars from alternate sources at reasonable prices if its current supply was interrupted. In addition to glass jars, the primary raw material used by the Registrant's Home Canning Supplies Business in the manufacture of its caps and lids is tin-plate. During 1993, the Registrant was able to obtain adequate supplies of these items from a number of sources.\ne. Product Development, Engineering, Patents and Licensing\nThe Registrant carries on a product development and engineering program with respect to its Plastic Products Business. Expenditures for such programs during the years ended December 31, 1993, 1992 and 1991 were approximately $2,000,000, $1,400,000 and $1,300,000, respectively.\nAlthough the Registrant owns a number of United States patents, including patents for its tamper-evident closures and certain of its child-resistant closures, it is of the opinion that no one or combination of these patents is of material importance to its business. The Registrant has granted licenses on some of its patents, although the income from these sources is not material.\nf. Environmental Matters; Legislation\nSeveral states have enacted recycling laws which require consumers to recycle certain items including containers. These mandatory recycling laws are not expected to have an adverse effect on the Registrant's business.\nThe Registrant is subject to laws and regulations governing the protection of the environment, disposal of waste, discharges into water and emissions into the atmosphere. The Registrant's expenditures for environmental control equipment in each of the last three years have not been material and the standards required by such regulations have not significantly affected the Registrant's operations.\ng. Employees\nAs of December 31, 1993, the Registrant had approximately 1,100 employees, of which approximately 280 were office, supervisory and sales personnel.\nh. Seasonality\nThe Registrant's sales and earnings are usually higher in the second and third calendar quarters and lower in the first and fourth calendar quarters. Most of the sales by the Home Canning Supplies Business occur in the second and third calendar quarters. In addition, substantially all returns of home canning supplies occur in the fourth calendar quarter of each year. Because of the foregoing factors, the Registrant generally records a low level of profitability in the first and fourth calendar quarters. Demand for home canning supplies is adversely affected by poor crop growing conditions, such as occurred in 1993.\nThe Registrant's Home Canning Supplies Business normally manufactures its inventory of caps and lids in anticipation of expected orders, and, consistent with practice followed in the industry, grants extended payment terms to home canning customers and accepts the return of unsold home canning merchandise in the fourth calendar quarter of each year.\ni. Working Capital\nIn general, the working capital practices followed by the Registrant are typical of the businesses in which it operates. The seasonal nature of the Registrant's Home Canning Supplies Business requires periodic short-term borrowing by the Registrant.\nAs of December 31, 1993, the Registrant had two unsecured $6,000,000 lines of credit with two banks to provide for the seasonal working capital needs of the Company. One of the lines of credit is committed through October 28, 1994 with borrowings to bear interest at either the prime rate of the lender or, alternatively, Eurodollar rate plus 2%. In addition, a facility fee of 0.5% per annum is charged on the unused amount of the commitment. The other line of credit is committed through September 30, 1994 with borrowings to bear interest at the prime rate of the lender. A facility fee of 0.75% per annum is charged on the total amount of this commitment. The lines of credit provide the Registrant with a source of working capital which the\nRegistrant believes will be sufficient to meet its anticipated needs.\n2. The Discontinued Businesses\na. The Metal Crown Business\nOn December 11, 1992, the Registrant sold substantially all of its assets (the \"Sale of the Metal Crown Assets\") relating to the manufacture and sale of metal crowns for beer and beverage bottles (the \"Metal Crown Business\") to Crown Cork & Seal Company, Inc. (\"Crown Cork\") pursuant to the terms of an asset purchase agreement for approximately $7,200,000 in cash. Included among the assets of the Metal Crown Business sold to Crown Cork were essentially all of the assets of the Registrant's Arlington, Texas plant. The Sale of the Metal Crown Assets was more fully described in the Registrant's Current Report on Form 8-K dated December 11, 1992 filed with the Securities and Exchange Commission.\nAs a result of the Sale of the Metal Crown Assets, the Registrant no longer operates its Metal Crown Business.\nb. The Commercial Glass Container Business\nOn February 28, 1992, the Registrant consummated the sale of substantially all of its assets (the \"Sale of the Glass Container Assets\") relating to the manufacture and sale of glass containers (the \"Commercial Glass Container Business\") to Ball Corporation pursuant to the terms of an asset purchase agreement for approximately $68,000,000 in cash. The Sale of the Glass Container Assets was more fully described in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (the \"1991 10-K\").\nAs a result of the Sale of the Glass Container Assets, the Registrant no longer operates its Commercial Glass Container Business.\n3. Segment Information\nThe Registrant's 1993 Annual Report to Stockholders contains on pages 29 and 30 additional financial information regarding each of the Registrant's two industry segments for each of the last three fiscal years required by Item 1 and such information is incorporated herein by reference. The Registrant's 1993 Annual Report to Stockholders contains on\npages 34 through 36 Management's Discussion and Analysis of Financial Condition and Results of Operations and such information is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant's manufacturing activities with respect to its Continuing Businesses are conducted at the five facilities described in the following table.\nThe Lancaster, Pennsylvania and Ahoskie, North Carolina facilities are owned by the Registrant. The Chicago, Illinois; Jackson, Tennessee and the Santa Fe Springs, California facilities are leased by the Registrant.\nThe Registrant's principal executive offices are located at 1840 Century Park East, Los Angeles, California 90067, in approximately 26,000 square feet of leased space. In addition, the Registrant rents three area sales offices and one warehouse.\nDuring 1994, the Registrant will relocate its home canning cap and lid manufacturing operations from Chicago, Illinois to a new, leased 168,000 square foot manufacturing\nfacility in Jackson, Tennessee and permanently cease operations in its leased facility in Chicago.\nIn the opinion of the Registrant's management, its manufacturing facilities are suitable and adequate for the purposes for which they are being used.\nThe Registrant owns land and buildings used in connection with a former glass container manufacturing plant that are being held for sale. In addition, pursuant to a sublease dated January 6, 1992, Fluidmaster, Inc., a California corporation, subleases a 28,000 square foot manufacturing facility located in Santa Fe Springs, California from a wholly-owned subsidiary of the Registrant. Prior to 1992, the Registrant manufactured custom molded plastic parts at this facility.\nIn 1993, the Registrant's plastic products manufacturing facilities operated at approximately 83% of capacity, and the home canning cap and lid manufacturing facility operated at approximately 76% of capacity.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs the Registrant reported in its Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, in February 1986, the Registrant was advised by the United States Environmental Protection Agency (\"EPA\") that Phoenix Closures, Inc. (\"Phoenix\") was one of several companies which disposed of wastes at the American Chemical Services (\"ACS\") site located near Griffith, Indiana. The EPA indicated that the wastes were disposed of by Phoenix's Chicago plant between 1955 and 1975. The Registrant has advised the EPA that it did not lease the Chicago plant during the period from 1955 to 1975. The Registrant has also advised Phoenix of its responsibilities with respect to environmental matters, including the environmental matters at the ACS site, under the lease relating to the Chicago plant.\nAs the Registrant reported in its Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, in March 1986, the Registrant and other parties were designated by the EPA as potentially responsible parties (\"PRPs\") responsible for the cleanup of certain hazardous wastes that have been disposed of at the Wayne Waste Oil (\"WWO\") site located near Columbia City, Indiana. In October 1986, the Registrant and other PRPs entered into a Consent Order with the EPA which allowed the PRPs to\ncomplete a Remedial Investigation and Feasibility Study (\"RI\/FS\") for the WWO site. In March 1990, the EPA issued a Record of Decision (\"ROD\") for the site. The ROD documents the EPA's cleanup plan for the site, which includes capping the former municipal landfill, groundwater extraction and treatment, and soil vapor extraction. On July 20, 1992, a Consent Decree between the EPA and the PRPs at the site was entered in the United States District Court for the Northern District of Indiana, captioned United States v. Active Products Corp., No.-00247. Based upon the Registrant's percentage share of the total amount of wastes disposed of at the WWO site, the Registrant estimates its share of the costs under the Consent Decree will be approximately $109,000. A reserve has been established for such costs.\nAs the Registrant reported in its Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, on April 12, 1990, the State of New Jersey, Department of Environmental Protection and Energy (\"NJDEPE\"), filed a lawsuit in the United States District Court for the District of New Jersey against the Registrant, among others, entitled State of New Jersey, Department of Environmental Protection v. Gloucester Environmental Management Services, Inc., et al., No. 84-0152 (D.N.J.). The suit alleges that the Registrant was a \"generator\" of hazardous wastes and other hazardous substances which were disposed of at the Gloucester Environmental Management Services, Inc. (\"GEMS\") facility in the Township of Gloucester. The suit seeks cleanup costs, compensatory and treble damages, and a declaration that the Registrant and others are responsible for NJDEPE's past and future response costs at the GEMS site. On March 27, 1990, NJDEPE issued a Directive to the Registrant and other parties pursuant to the New Jersey Spill Compensation and Control Act, N.J.S.A. 58:10-23.11 et seq. Pursuant to the Directive, the Registrant and other parties have been ordered to undertake the second phase of remedial action at the site, including the construction and operation of a groundwater treatment system and operation of the remedial action performed in the first phase, and to reimburse NJDEPE's alleged past and future response costs. The estimated cost of second phase remedial action related to the GEMS site is approximately $20 million. The amount that the NJDEPE is seeking as reimbursement for past costs and damages is approximately $10 million. Notwithstanding the issuance of the Directive by the NJDEPE, the Registrant believes that it has no material liability with respect to the GEMS site because the only reason it has been named as a defendant (there are over 550 named defendants) is that a transporter that was used by the Registrant\nis known to have disposed of waste at the site. However, there is no evidence that any waste disposed of at the site by such transporter was waste of the Registrant and the Registrant has a motion for summary judgment pending in which it seeks dismissal from the case on these grounds. If such motion is granted, the Registrant would have a good faith basis to not comply with the Directive. The Registrant does not believe that any of its waste was disposed of at the site. One of the Registrant's insurance carriers has agreed to defend the current lawsuit and has funded the Registrant's participation in settlement efforts, which may result in the Registrant's dismissal from the lawsuit for a payment of approximately $100,000. Participation in the settlement will not be considered an admission of liability for the disposal of waste at the site. A reserve has been established for such costs.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names, ages, positions and offices held, and a brief account of the business experience during the past five years of each executive officer of the Registrant.\nBusiness Experience\nRoger W. Norian has served in an executive capacity with the Registrant for more than the past five years.\nNorman N. Broadhurst joined the Registrant in 1988 as Senior Vice President, General Manager, Consumer Products. Prior to that time he was President and Chief Operating Officer of the Famous Amos Chocolate Chip Cookie Corporation and Vice President, Marketing, Beatrice Companies, Inc.\nRobert S. Reeves has served in an executive capacity with the Registrant for more than the past five years.\nD. Gordon Strickland has served in an executive capacity with the Registrant for more than the past five years.\nJ. Stephen Grassbaugh has served in an executive capacity with the Registrant for more than the past five years.\nJohn F. Thelen joined the Registrant in 1993 as Vice President, Employee Relations. Prior to that time he was Vice President, Compensation, Benefits and Human Resource Information Systems of Mattel, Inc.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Registrant's Annual Report to Stockholders for the year ended December 31, 1993, contains on page 12 the information required by Item 5 of Form 10-K and such information is incorporated herein by this reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1993, contains on pages 32 and 33 the information required by Item 6 of Form 10-K and such information is incorporated herein by this reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1993, contains on pages 34 through 36 the information required by Item 7 of Form 10-K and such information is incorporated herein by this reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1993, contains on pages 12 through 31 the information required by Item 8 of Form 10-K and such information is incorporated herein by this reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain of the information required by Item 10 of Form 10-K is included in a separate item captioned \"Executive Officers of the Registrant\" in Part I of this Form 10-K. With respect to reports required to be filed pursuant to Section 16(a) of the Securities Exchange Act of 1934 regarding the Registrant's common stock, par value $.50 per share, the Registrant believes that, based solely on a review by the Registrant of copies of such reports received by it, during its fiscal year 1993, all filing requirements of Section 16(a) with respect to its common stock were complied with.\nThe Registrant's Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on April 26, 1994 contains on pages 2 through 6 the remaining information required by Item 10 of Form 10-K and such information is incorporated herein by this reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Registrant's Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on April 26, 1994 contains on pages 7 through 10 the information required by Item 11 of Form 10-K, and such information is incorporated herein by this reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Registrant's Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on April 26, 1994 contains on pages 2 through 4 the information required by Item 12 of Form 10-K, and such information is incorporated herein by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Registrant's Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on April 26, 1994 contains on page 12 the information required by Item 13 of Form 10-K, and such information is incorporated herein by this reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. (i) Financial Statements\nThe Financial Statements and related financial data contained in the Registrant's Annual Report to Stockholders for the year ended December 31, 1993, on pages 13 through 33 thereof and the Independent Auditors' Report on page 12 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1993, are incorporated herein by reference. With the exception of information specifically incorporated by reference, however, the Registrant's Annual Report to Stockholders for the year ended December 31, 1993 is not to be deemed filed as a part of this report.\nConsolidated Financial Statements:\nConsolidated Statements of Earnings (Loss) for the years ended December 31, 1993, 1992 and 1991.\nConsolidated Balance Sheets as of December 31, 1993 and 1992.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991.\nConsolidated Statements of Common Stockholders' Equity for the years ended December 31, 1993, 1992 and 1991.\nNotes to Consolidated Financial Statements.\nIn addition to such Consolidated Financial Statements and Independent Auditors' Report, the following are included herein:\nIndependent Auditors' Report on Supporting Schedules, page 21.\nSchedules for the three years ended December 31, 1993:\nAll other Schedules have been omitted as inapplicable, or not required, or because the required information is included in the Consolidated Financial Statements or the notes thereto.\n(ii) Exhibits\nThe Registrant has no additional long-term debt instruments in which the total amount of securities authorized\nunder any instrument exceeds 10% of total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant hereby agrees to furnish a copy of any such long-term debt instrument upon the request of the Securities and Exchange Commission.\nb. Reports on Form 8-K\nOn October 19, 1993, the Registrant filed a Form 8-K Current Report announcing its intention to call for redemption on December 15, 1993 all of the Registrant's outstanding 13% Subordinated Notes Due December 15, 1996.\nSIGNATURES\nPursuant 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.\nKERR GROUP, INC.\nBy: Roger W. Norian ------------------------------- Roger W. Norian, Chairman President and Chief Executive Officer\nDated: March 29, 1994 Los Angeles, California\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nINDEPENDENT AUDITOR'S REPORT\nTo the Stockholders and Board of Directors of Kerr Group, Inc.:\nUnder date of February 23, 1994, we reported on the consolidated balance sheets of Kerr Group, Inc. as of December 31, 1993 and 1992, and the related consolidated statements of earnings (loss), common stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related supplementary financial statement schedules as listed in Item 14a(i). These supplementary financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these supplementary financial statement schedules based on our audits.\nIn our opinion, such supplementary financial statement schedules, when considered in relation to the basic consolidated financial statement taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick\nLos Angeles, California February 23, 1994\nSCHEDULE II\nKERR GROUP, INC.\nAmounts Receivable From Related Parties and Underwriters, Promoters and Employees Other Than Related Parties\nThree years ended December 31, 1993 (in thousands)\n(a) Includes both note receivable and related accrued interest. The loan accrued interest at an annual rate of 9.23%. On February 28, 1992, $400,000 of remaining principal and $128,319 of related accrued interest was forgiven by the Registrant.\n(b) Consists of two loans dated January 16, 1990 and June 11, 1991 in the original amount of $30,000 and $100,000, respectively, and related accrued interest. The principal of the loan dated January 16, 1990 is to be paid in six equal annual installments in 1991 through 1996, however, on January 1, 1992, $15,000 of principal was forgiven by the Registrant. This loan bears interest at 6% annually and accrued interest is paid annually. The principal and related accrued interest of the loan dated June 11, 1990 is to be paid in 1996. This loan bears interest at 7.76% per annum.\nSCHEDULE V\nKERR GROUP, INC.\nProperty, Plant and Equipment\nThree years ended December 31, 1993 (in thousands)\n1.) Amounts for property, plant and equipment presented in the table above are related to continuing operations only. Property, plant and equipment associated with the Commercial Glass Container Business and Metal Crown Business of the Registrant in 1991 and 1992 has been reported as a component of net non-current assets related to discontinued operations in the Registrant's Consolidated Balance Sheets.\n2.) As to Column E, which is omitted, the answers are \"None\".\nSCHEDULE VI\nKERR GROUP, INC.\nAccumulated Depreciation and Amortization of Property, Plant and Equipment\nThree years ended December 31, 1993 (in thousands)\n1.) Amounts for accumulated depreciation and amortization of property, plant and equipment presented in the table above are related to continuing operations only. Accumulated depreciation and amortization of property, plant and equipment associated with the Commercial Glass Container Business and Metal Crown Business of the Registrant in 1991 and 1992 has been reported as a component of net non- current assets related to discontinued operations in the Registrant's Consolidated Balance Sheets.\n2.) See note 1 of notes to Consolidated Financial Statements for description of the Registrant's depreciation policy.\n3.) As to Column E, which is omitted, the answers are \"None\".\nSCHEDULE VIII\nKERR GROUP, INC.\nValuation and Qualifying Accounts\nThree years ended December 31, 1993 (in thousands)\nNote: Allowance for doubtful accounts presented in the table above is related to continuing operations only. Allowance for doubtful accounts associated with the Commercial Glass Container Business and Metal Crown Business of the Registrant in 1991 and 1992 has been reported as a component of net current assets related to discontinued operations in the Registrant's Consolidated Balance Sheets.\n(a) These deductions represent uncollectible amounts charged against the reserve.\nSCHEDULE X\nKERR GROUP, INC.\nSupplementary Income Statement Information\nThree years ended December 31, 1993 (in thousands)\nNote: Income statement information presented in the table above are for the Registrant's continuing operations.\n* Less than 1% of annual net sales from continuing operations.\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\nKERR GROUP, INC.\nFORM 10-K for year ended December 31, 1993\nINDEX TO EXHIBITS FILED SEPARATELY WITH FORM 10-K","section_15":""}
{"filename":"63908_1993.txt","cik":"63908","year":"1993","section_1":"Item 1. Business\nMcDonald's Corporation, the registrant, together with its subsidiaries, is referred to herein as the \"Company\".\n(a) General development of business\nThere have been no significant changes to the Company's corporate structure during 1993, nor material changes in the Company's method of conducting business.\n(b) Financial information about industry segments\nIndustry segment data for the years ended December 31, 1993, 1992 and 1991 is included in Part II, item 8, pages 33 and 41 of this Form 10-K.\n(c) Narrative description of business\nGeneral\nThe Company develops, operates, franchises and services a worldwide system of restaurants which prepare, assemble, package and sell a limited menu of value-priced foods. These restaurants are operated by the Company or, under the terms of franchise arrangements, by franchisees who are independent third parties, or by affiliates operating under joint-venture agreements between the Company and local businesspeople.\nThe Company's franchising program assures consistency and quality. The Company is selective in granting franchises and is not in the practice of franchising to investor groups or passive investors. Under the conventional franchise arrangement, franchisees supply capital - initially, by purchasing equipment, signs, seating, and decor, and over the long term, by reinvesting in the business. The Company shares the investment by owning or leasing the land and building; franchisees then contribute to the Company's revenues through payment of rent and service fees based upon a percent of sales, with specified minimum payments. Generally, the conventional franchise arrangement lasts 20 years and franchising practices are consistent throughout the world. Further discussion regarding site selection is included in Part 1, item 2, page 6 of this Form 10-K.\nTraining begins at the restaurant with one-on-one instruction and videotapes. Aspiring restaurant managers progress through a development program of classes in basic and intermediate operations, management and equipment. Assistant managers are eligible to attend the advanced operations and management class at one of the five Hamburger University (H.U.) campuses in the U.S., Germany, England, Japan or Australia. The curriculum at H.U. concentrates on skills and practices essential to delivering customer satisfaction and running a restaurant business.\nThe Company's global brand is well-known. Marketing and promotional activities are designed to nurture this brand image and differentiate the Company from competitors by focusing on value and customer satisfaction. Funding for promotions is handled at the local restaurant level; funding for regional and national efforts is handled through advertising cooperatives. Franchised, Company-operated and affiliated restaurants throughout the world make voluntary contributions to cooperatives which purchase media. Production costs for certain advertising efforts are borne by the Company.\nProducts\nMcDonald's restaurants offer a substantially uniform menu consisting of hamburgers and cheeseburgers, including the Big Mac and Quarter Pounder with Cheese sandwiches, the Filet-O-Fish, McGrilled Chicken and McChicken sandwiches, french fries, Chicken McNuggets, salads, low fat shakes, sundaes and cones made with low fat frozen yogurt, pies, cookies and a limited number of soft drinks and other beverages. In addition, the restaurants sell a variety of products during limited promotional time periods. McDonald's restaurants operating in the United States are open during breakfast hours and offer a full breakfast menu including the Egg McMuffin and the Sausage McMuffin with Egg sandwiches, hotcakes and sausage; three varieties of biscuit sandwiches; Apple-Bran muffins; and cereals. McDonald's restaurants in many countries around the world offer many of these same products as well as other products and limited breakfast menus. The Company tests new products on an ongoing basis.\nThe Company, its franchisees and affiliates purchase food products and packaging from numerous independent suppliers. Quality specifications for both raw and cooked food products are established and strictly enforced. Alternative sources of these items are generally available. Quality assurance labs in the U.S., Europe and the Pacific work to ensure that the Company's high standards are consistently met. The quality assurance process involves ongoing testing and on-site inspections of suppliers' facilities. Independently owned and operated distribution centers distribute products and supplies to most McDonald's restaurants. The restaurants then prepare, assemble and package these products using specially designed production techniques and equipment to obtain uniform standards of quality.\nTrademarks and patents\nThe Company has registered trademarks and service marks, some of which, including \"McDonald's\", \"Ronald McDonald\" and other related marks, are of material importance to the Company's business. The Company also has certain patents on restaurant equipment which, while valuable, are not material to its business.\nSeasonal operations\nThe Company does not consider its operations to be seasonal to any material degree.\nWorking capital practices\nInformation about the Company's working capital practices is incorporated herein by reference to Management's Discussion and Analysis of the Company's financial position and the consolidated statement of cash flows for the years ended December 31, 1993, 1992 and 1991 in Part II, item 7, pages 26 through 28, and Part II, item 8 page 35 of this Form 10-K.\nCustomers\nThe Company's business is not dependent upon a single customer or small group of customers.\nBacklog\nCompany-operated restaurants have no backlog orders.\nGovernment contracts\nNo material portion of the business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. government.\nCompetition\nMcDonald's restaurants compete with international, national, regional, and local retailers of food products. The Company competes on the basis of price and service and by offering quality food products. The Company's competition in the broadest perspective includes restaurants, quick-service eating establishments, pizza parlors, coffee shops, street vendors, convenience food stores, delicatessens, and supermarket freezers.\nIn the U.S., about 372,000 restaurants generate nearly $213 billion in annual sales. McDonald's accounts for about 2.5% of those restaurants and approximately 6.7% of those sales. No reasonable estimate can be made of the number of competitors outside of the U.S.; however, the Company's business in foreign markets continues to grow.\nResearch and development\nThe Company operates research and development facilities in Illinois. While research and development activities are important to the Company's business, these expenditures are not material. Independent suppliers also conduct research activities for the benefit of the McDonald's System, which includes franchisees and suppliers, as well as McDonald's, its subsidiaries and joint ventures.\nEnvironmental matters\nThe Company is not aware of any federal, state or local environmental laws or regulations which will materially affect its earnings or competitive position, or result in material capital expenditures; however, the Company cannot predict the effect on its operations of possible future environmental legislation or regulations. During 1993, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.\nNumber of employees\nDuring 1993, the Company's average number of employees was approximately 167,000.\n(d) Financial information about foreign and domestic operations\nFinancial information about foreign and domestic markets is incorporated herein by reference from selected Financial Data, Management's Discussion and Analysis and Segment and Geographic Information in Part II, item 6, page 10, Part II, item 7, pages 11 through 29 and Part II, item 8, page 41, respectively, of this Form 10-K.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company identifies and develops sites that offer convenience to customers and provide for long-term sales and profit potential. To assess potential, the Company analyzes traffic and walking patterns, census data, school enrollments and other relevant data. The Company's experience and access to advanced technology aids in evaluating this information. In order to control occupancy costs and rights, the Company owns restaurant sites and buildings where feasible and where it is not practical, secures long-term leases. Restaurant profitability for both the Company and franchisees is important; therefore, ongoing efforts are made to lower average development costs through construction and design efficiencies and by leveraging the Company's global sourcing system. Additional information about the Company's properties is incorporated herein by reference to Management's Discussion and Analysis and the related financial statements with footnotes in Part II, item 7, pages 11 through 29 and Part II, item 8, pages 34, 35, 37, 38, 42, 46 and 47, respectively, of this Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company has pending a number of lawsuits which have been filed from time to time in various jurisdictions. These lawsuits cover a broad variety of allegations spanning the Company's entire business. The following is a brief description of the more significant of these categories of lawsuits and government regulations.\nFranchising\nA substantial number of McDonald's restaurants are franchised to independent businesspeople operating under arrangements with the Company. In the course of the franchise relationship, occasional disputes arise between the Company and its franchisees relating to a broad range of subjects including, without limitation, quality, service and cleanliness issues, contentions regarding grants or terminations of franchises, franchisee claims for additional franchises or rewrites of franchises, and delinquent payments.\nSuppliers\nThe Company and its affiliates and subsidiaries do not supply, with minor exceptions outside of the United States, food, paper, or related items to any McDonald's restaurants. The Company relies upon independent suppliers which are required to meet and maintain the Company's standards and specifications. There are a number of such suppliers worldwide and on occasion disputes arise between the Company and its suppliers on a number of issues including, by way of example, compliance with product specifications and McDonald's business relationship with suppliers.\nEmployees\nThousands of persons are employed by the Company and in restaurants owned and operated by subsidiaries of the Company. In addition, thousands of persons, from time to time, seek employment in such restaurants. In the ordinary course of business, disputes arise regarding hiring, firing and promotion practices.\nCustomers\nMcDonald's restaurants serve a large cross-section of the public and in the course of serving so many people, disputes arise as to products, service, accidents and other matters typical of an extensive restaurant business such as that of the Company.\nTrademarks\nMcDonald's has registered trademarks and service marks, some of which are of material importance to the Company's business. From time to time, the Company may become involved in litigation to defend and protect its use of such registered marks.\nGovernment Regulations\nLocal, state and federal governments have adopted laws and regulations involving various aspects of the restaurant business, including, but not limited to, franchising, health, environment, zoning and employment. The Company does not believe that it is in violation of any existing statutory or administrative rules, but it cannot predict the effect on its operations from promulgation of additional requirements in the future.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Shareholders None.\nExecutive Officers of the Registrant\nAll of the executive officers of McDonald's Corporation as of March 1, 1994 are shown below. Each of the executive officers has been continuously employed by the Company for at least five years and has a term of office until the May 1994 Board of Directors' meeting.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters\nThe Company's common stock trades under the symbol MCD and is listed on the following stock exchanges in the United States: New York, Chicago and Pacific.\nThe common stock price range on the New York Stock Exchange composite tape has been as follows:\n--------------------------------------------------------- Quarter 1993 1992 --------------------------------------------------------- First $54 1\/4 - 46 3\/4 $45 - 38 3\/8 Second $53 1\/2 - 45 1\/2 $47 1\/2 - 39 3\/8 Third $55 5\/8 - 48 1\/4 $47 1\/4 - 41 1\/8 Fourth $59 1\/8 - 51 1\/4 $50 3\/8 - 40 7\/8 --------------------------------------------------------- Year $59 1\/8 - 45 1\/2 $50 3\/8 - 38 3\/8 ---------------------------------------------------------\nThe approximate number of shareholders of record and beneficial owners of the Company's common stock as of December 31, 1993 was estimated to be 459,000.\nGiven the Company's returns on equity and assets, the Company's management believes it is prudent to reinvest a significant portion of earnings back into the business. The Company has paid 72 consecutive quarterly dividends on common stock and has increased the per share amount 19 times since the first dividend was paid in 1976. Additional dividend increases will be considered after reviewing returns to shareholders, profitability expectations and financing needs.\nDividends per common share for the years ended December 31, 1993 and 1992 are incorporated herein by reference from Part II, item 8, page 33.\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n----------------------------------------------------------------------- CONSOLIDATED OPERATING RESULTS ----------------------------------------------------------------------- INCREASES (DECREASES) IN OPERATING RESULTS OVER PRIOR YEAR ----------------------------------------------------------------------- (Dollars rounded to millions, 1993 1992 except per common share data) Amount % Amount % ----------------------------------------------------------------------- SYSTEMWIDE SALES $1,702 8 $1,957 10 ----------------------------------------------------------------------- REVENUES Sales by Company-operated restaurants $ 55 1 $ 194 4 Revenues from franchised restaurants 220 11 244 14 ----------------------------------------------------------------------- TOTAL REVENUES 275 4 438 7 ----------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants 38 1 97 2 Franchised restaurants 32 9 42 14 General, administrative and selling expenses 81 9 66 8 Other operating (income) expense--net 2 (3) 50 (44) ----------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 153 3 255 5 ----------------------------------------------------------------------- OPERATING INCOME 122 7 183 11 ----------------------------------------------------------------------- Interest expense (58) (15) (18) (5) Nonoperating income (expense)--net 48 N\/M (52) N\/M ----------------------------------------------------------------------- INCOME BEFORE PROVISION FOR INCOME TAXES 228 16 149 11 ----------------------------------------------------------------------- Provision for income taxes 104 21 50 11 ----------------------------------------------------------------------- NET INCOME $ 124 13 $ 99 12 ======================================================================= NET INCOME PER COMMON SHARE $ .31 12 $ .25 11 -----------------------------------------------------------------------\nN\/M - Not Meaningful\nSYSTEMWIDE SALES AND RESTAURANTS Systemwide sales are comprised of sales by restaurants operated by the Company, franchisees and affiliates operating under joint-venture agreements between McDonald's and local businesspeople. The 1993 increase was due to new restaurant expansion and higher sales at existing restaurants worldwide, offset in part by weaker foreign currencies and one less day in 1993 since 1992 was a leap year. The 1992 increase was due to new restaurant expansion, higher sales at existing restaurants and stronger foreign currencies. Sales by Company-operated restaurants grew at a slower rate than Systemwide sales in 1993 and 1992. The slower rate of growth in 1993 occurred primarily because weaker foreign currencies had a greater impact on sales by Company-operated restaurants than on Systemwide sales, combined with an increasing global base of franchised restaurants from expansion. The slower rate of growth in 1992 reflected the franchising of certain Company-operated businesses. Average sales by restaurants open at least one year were $1,768,000 in 1993, which was $35,000 higher than in 1992. Average sales both in the U.S. and outside of the U.S. improved due to the value program and various promotional efforts. Expansion has continued at an accelerated pace as 900 restaurants were added in 1993, compared with 675 in 1992 and 615 in 1991. Restaurants opened during the year (excluding satellite locations) contributed $572 million to Systemwide sales in 1993, $478 million in 1992 and $460 million in 1991. McDonald's plans to add between 900 and 1,200 restaurants (excluding satellite locations) around the world in 1994 and in each of the next several years. The mix of net additions will remain the same -- approximately one-third in the U.S. and two-thirds in markets outside of the U.S. Our global expansion plan also includes satellites -- sites that leverage the infrastructure of existing restaurants, either by using their storage capability or by drawing on their management talent and labor pool. At year-end 1993, 170 satellites were operating around the world. In addition, we expect to add several hundred satellite locations around the world each year.\nTOTAL REVENUES Total revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates, based upon a percent of sales with specified minimum payments. The minimum franchise fee generally has been 12% of sales for new U.S. franchise arrangements since 1987. Higher fees are charged for sites that require a higher investment on the part of the Company. Fees paid by franchisees outside of the U.S. vary according to local business conditions. These fees, together with occupancy and operating rights, are stipulated in franchise arrangements that generally have 20-year terms. Revenues grow as restaurants are added and as existing restaurants build sales. Menu price adjustments affect revenues as well as sales; however, different pricing structures, new products, promotions, and product mix variations make it impractical to quantify the impact for the System.\nThe rates of increases in total revenues for 1993 and 1992 were less than the rates of increases in Systemwide sales. In 1993, this reflected weaker foreign currencies which had a greater impact on revenues than on Systemwide sales and the increasing global base of franchised restaurants, occurring primarily from expansion. In 1992, the franchising of certain Company-operated restaurant businesses primarily in the U.S. and Canada affected the rate of increase. Growth rates in sales by Company-operated restaurants and revenues from franchised restaurants varied because of expansion and changes in ownership and because sales by Company-operated restaurants were impacted to a greater degree by changing foreign currencies than were revenues. In 1993, about 53% of sales by Company-operated restaurants were outside of the U.S., compared with 33% of revenues from franchised restaurants.\nRESTAURANT MARGINS Company-operated restaurant margins were 19.2% of sales in 1993, compared with 19.1% in 1992 and 17.9% in 1991. As a percent of sales, food and paper costs increased, while occupancy, other operating and payroll costs declined in 1993. All costs as a percent of sales declined in 1992. Franchised restaurant margins were 83.1% of applicable revenues for 1993, compared with 82.8% in 1992 and 1991. Franchised margins include revenues and expenses associated with restaurants operating under business facilities lease arrangements. Under these arrangements, the Company leases the businesses -- including equipment -- to franchisees who have options to purchase the businesses. While higher fees are charged under these arrangements, margins are generally lower because of equipment depreciation. When these purchase options are exercised, the resulting gains compensate the Company for lower margins prior to exercise and are included in other operating (income) expense--net. At year-end 1993, 544 restaurants were operating under such arrangements, compared with 583 and 584 at year-end 1992 and 1991, respectively.\nGENERAL, ADMINISTRATIVE AND SELLING EXPENSES The 1993 increase was due primarily to higher employee costs associated with expansion and key priorities, partially offset by weaker foreign currencies. The 1992 increase was due to higher employee costs associated with expansion, partially offset by a reduction in U.S. marketing costs associated with the value program. These expenses as a percent of Systemwide sales have remained relatively constant over the past five years, and were 4.0% in 1993 and 3.9% in 1992.\nOTHER OPERATING (INCOME) EXPENSE--NET This category is comprised primarily of gains on sales of restaurant businesses, equity in earnings of unconsolidated affiliates, and net gains or losses from property dispositions. The 1993 and 1992 amounts were relatively constant, reflecting greater income from affiliates and gains on sales of restaurant businesses in 1993, offset by the favorable settlement of a sales tax case in Brazil in 1992. Major factors contributing to the 1992 decrease included lower affiliate results due to 1991 gains from property dispositions and lower operating results in Japan, lower gains on sales of restaurant businesses, and greater losses on property dispositions, partially offset by the favorable settlement of a sales tax case in Brazil in 1992. Gains on sales of restaurant businesses include gains from exercises of purchase options by franchisees operating under business facilities lease arrangements and from sales of Company-operated restaurants. As a franchisor, McDonald's purchases and sells businesses in transactions with franchisees and affiliates in an ongoing effort to achieve the optimal ownership mix in each market. These transactions and the resulting gains are integral to franchising, and are appropriately recorded in operating income. Equity in earnings of unconsolidated affiliates is reported after interest expense and income taxes, except for U.S. partnerships that are reported before income taxes. The Company actively participates in, but does not control, these businesses. Net gains or losses from property dispositions result from disposal of excess properties that occur because of closings, relocations and other transactions.\nOPERATING INCOME The 1993 and 1992 increases reflected better results from combined restaurant margins, partially offset by higher general, administrative and selling expenses. Additionally, 1993 was impacted by weaker foreign currencies, while 1992 was impacted by lower income from other operating transactions and stronger foreign currencies.\nINTEREST EXPENSE The 1993 and 1992 decreases were primarily due to lower average debt balances and lower average interest rates; 1993 also was impacted by weaker foreign currencies. The trends have been positively affected by the fact that cash provided by operations exceeded capital expenditures in each of the last three years.\nNONOPERATING INCOME (EXPENSE)--NET This category includes interest income, gains and losses related to investments and financings, as well as miscellaneous income and expense. The 1993 increase reflected $9 million in gains related to debt extinguishments and $29 million in charges related to various early redemptions of high-coupon, U.S. Dollar debt in 1992.\nPROVISION FOR INCOME TAXES The effective tax rate increased to 35.4% for 1993, compared with 33.8% for 1992 and 1991, primarily as a result of new U.S. tax legislation enacted in the third quarter of 1993 and lower foreign tax benefits. The full-year impact of the U.S. tax law changes on the 1993 income tax provision was approximately $20 million. Of this amount, the retroactive impact was $15 million, comprised of nearly $14 million attributable to a one-time, noncash revaluation of deferred tax liabilities, and $1 million related to periods prior to the third quarter. The Company expects its 1994 effective income tax rate to be in the 35.5% to 36.0% range. Consolidated net deferred tax liabilities included tax assets of $148 million, net of valuation allowance, in 1993 and 1992. Substantially all of the tax assets arose from profitable markets and the majority is expected to be realized in future U.S. income tax returns.\nNET INCOME AND NET INCOME PER COMMON SHARE Net income and net income per common share increased 13 and 12 percent, respectively, in 1993. These increases were negatively affected by weaker foreign currencies and the new U.S. tax legislation.\n---------------------------------------------------------------- NET INCOME (Dollars in NET INCOME PER millions) COMMON SHARE ---------------------------------------------------------------- AMOUNT % AMOUNT % ---------------------------------------------------------------- 1993 AS REPORTED $1,083 13 $2.91 12 Impact of changing foreign currencies 32 .09 Retroactive impact of U.S. tax law changes 15 .04 ---------------------------------------------------------------- 1993 AS ADJUSTED $1,130 18 $3.04 17 ================================================================\nIMPACT OF CHANGING FOREIGN CURRENCIES Changing foreign currencies do impact reported results from time to time, but McDonald's manages foreign currencies to mitigate business risk and the reporting impact. As previously noted, weaker foreign currencies had a significant negative impact on 1993 results, while stronger foreign currencies had a positive impact in 1992. Further discussion of our approach to managing changing foreign currencies can be found on pages 26 through 28 in Financings and Total Shareholders' Equity.\n----------------------------------------------------------------------- Impact of changing foreign currencies 1993 ----------------------------------------------------------------------- Reported Adjusted ----------------------------------------------------------------------- (Dollars in millions) Amount % Amount % ----------------------------------------------------------------------- Systemwide sales $23,587 8 $23,993 10 Revenues 7,408 4 7,721 8 Operating income 1,984 7 2,051 10 Net income 1,083 13 1,114 16 ----------------------------------------------------------------------- ----------------------------------------------------------------------- Systemwide sales $21,885 10 $21,717 9 Revenues 7,133 7 7,116 6 Operating income 1,862 11 1,846 10 Net income 959 12 953 11 -----------------------------------------------------------------------\n------------------------------------------------------------------------ U.S. OPERATIONS ------------------------------------------------------------------------\nSALES The 1993 and 1992 increases were due to higher sales and transaction counts at existing restaurants and expansion. Sales and transaction counts in 1993 were positively driven by the emphasis on value and customer satisfaction in the form of Extra-Value Meals, Happy Meals, \"2 for $2\" offers and the Burger of the Month program; as well as the NBA Fantasy Pack Trading Card, Happy Birthday Big Mac, Jurassic Park, Double Plays and Holiday Video promotions.\n------------------------------------------------------------------------ Five Ten years years (In millions of dollars) 1993 1992 1991 ago ago ------------------------------------------------------------------------ Operated by franchisees $11,435 $10,615 $ 9,873 $ 8,574 $5,322 Operated by the Company 2,420 2,353 2,410 2,629 1,716 Operated by affiliates 331 275 236 177 31 ------------------------------------------------------------------------ U.S. sales $14,186 $13,243 $12,519 $11,380 $7,069 ========================================================================\nRESTAURANTS There were 324 restaurants added in the U.S. in 1993, representing 36% of Systemwide additions, compared with 195 additions and 29% in 1992, and 340 additions and 56% five years ago. McDonald's expects to boost U.S. expansion in 1994 and in each of the next several years by adding between 300 and 400 restaurants, exclusive of satellites.\n------------------------------------------------------------------------ Five Ten years years 1993 1992 1991 ago ago ------------------------------------------------------------------------ Operated by franchisees 7,628 7,375 7,149 6,017 4,791 Operated by the Company 1,433 1,395 1,446 1,758 1,430 Operated by affiliates 222 189 169 132 30 ------------------------------------------------------------------------ U.S. restaurants 9,283 8,959 8,764 7,907 6,251 ========================================================================\nRestaurants operated by franchisees and affiliates represented 85% of U.S. restaurants at year-end 1993, compared with 78% five years ago. During the period 1989 through 1991, the Company franchised certain restaurants it previously operated, while continuing to own or control the land and buildings. The restaurants that had been franchised either were generating weak operating results, not building sales as expected, or located in outlying markets. The franchising of these businesses accomplished several objectives. On-site, entrepreneurial owners with an equity stake in the business improved operations, sales and profits; and franchising of these restaurants also improved consolidated profits.\nOPERATING RESULTS ------------------------------------------------------------------------ (In millions of dollars) 1993 1992 1991 1990 1989 ------------------------------------------------------------------------ REVENUES Sales by Company- operated restaurants $2,420 $2,353 $2,410 $2,655 $2,728 Revenues from franchised restaurants 1,511 1,396 1,300 1,216 1,159 ------------------------------------------------------------------------ TOTAL REVENUES 3,931 3,749 3,710 3,871 3,887 ------------------------------------------------------------------------ OPERATING COSTS AND EXPENSES Company-operated restaurants 1,977 1,920 2,000 2,221 2,250 Franchised restaurants 247 235 217 202 180 General, administrative and selling expenses 638 566 549 511 490 Other operating (income) expense--net (18) (13) (56) (49) (22) ------------------------------------------------------------------------ TOTAL OPERATING COSTS AND EXPENSES 2,844 2,708 2,710 2,885 2,898 ------------------------------------------------------------------------ U.S. OPERATING INCOME $1,087 $1,041 $1,000 $ 986 $ 989 ========================================================================\nU.S. revenues were positively impacted by strong sales and expansion in 1993 and 1992, and negatively affected by the franchising of certain Company-operated restaurant businesses in 1992, 1991 and 1990. U.S. Company-operated margins increased $11 million or 3% in 1993. These margins were 18.3% of sales in 1993, compared with 18.4% in 1992 and 17.0% in 1991. U.S. franchised margins rose $102 million or 9% in 1993, reflecting sales improvement and expansion. These margins were 83.6% of applicable revenues in 1993, compared with 83.2% in 1992 and 83.3% in 1991. While it is difficult to assess the potential effects of federal and state legislation in the U.S. that may impact the industry, the Company believes it can maintain operating margins within the same range of the past ten years by continuing to build sales and reduce costs. U.S. operating income rose $46 million or 4% in 1993 and was 55% of consolidated operating income, compared with 56% in 1992. This increase resulted primarily from higher combined restaurant margins, partially offset by higher general, administrative and selling expenses in the form of higher employee costs and other expenditures to support our global strategies and strengthen our competencies. The 1992 increase was driven by strong sales and combined restaurant margins, partially offset by lower gains on sales of restaurant businesses in 1992 and a gain on the sale of real estate by a U.S. affiliate in 1991. Operating income included $348 million of depreciation and amortization in 1993, compared with $330 million in 1992 and $325 million in 1991.\nASSETS AND CAPITAL EXPENDITURES\n------------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 1990 1989 ------------------------------------------------------------------------- New restaurants $ 332 $ 196 $ 214 $ 446 $ 490 Existing restaurants 122 125 151 249 283 Other properties 130 76 45 51 74 ------------------------------------------------------------------------- U.S. capital expenditures $ 584 $ 397 $ 410 $ 746 $ 847 ========================================================================= U.S. assets $6,385 $6,410 $6,154 $6,060 $5,646 -------------------------------------------------------------------------\nU.S. assets decreased $25 million or .4% in 1993, due to the utilization of year-end 1992 cash balances. At year-end 1993, 53% of consolidated assets were located in the U.S., compared with 55% at year-end 1992. Capital expenditures increased $187 million or 47% in 1993, and represented 44% of consolidated capital expenditures, compared with 60% five years ago. The amounts excluded expenditures made by franchisees such as their initial investments in equipment, signs, seating and decor and over the long term, ongoing reinvestment in their businesses. New restaurant expenditures increased $136 million or 69% because of accelerated expansion, tempered by lower average development costs. Expenditures for existing restaurants included modifications to achieve higher levels of customer satisfaction and implementation of technology to improve service and food quality. The decline over time highlighted aggressive reinvestment in prior years. Rebuilding and relocating restaurants has generated additional sales, reflecting our ability to adjust to changing demographics, traffic patterns and market opportunities. More than $35 million was spent for these investments in 1993 and $291 million over the past five years. The rise in other property expenditures was attributable to the further testing of Leaps & Bounds, a family play center concept.\n------------------------------------------------------------------------- (In thousands of dollars) 1993 1992 1991 1990 1989 ------------------------------------------------------------------------- Land $ 328 $ 361 $ 433 $ 433 $ 472 Building 482 515 608 720 682 Equipment 317 361 362 403 416 ------------------------------------------------------------------------- U.S. average costs $1,127 $1,237 $1,403 $1,556 $1,570 =========================================================================\nAverage land costs declined as a result of the implementation of low-cost building designs, which require smaller parcels, and a softer real estate market. Average building costs decreased due to low-cost building designs and construction efficiencies. Low-cost building designs comprised nearly 80% of 1993 openings, compared with 60% in 1992. Average equipment costs decreased due to standardization and global sourcing. McDonald's intends to pursue ongoing development cost reductions by taking further advantage of standardization, global sourcing and economies of scale.\nThe Company continues to emphasize restaurant property ownership. Real estate ownership yields long-term benefits, including the ability to fix occupancy costs. In addition to purchasing new properties, previously leased properties are acquired. The Company owned 68% of U.S. sites at year-end 1993, the same as five years ago.\n---------------------------------------------------------------------- OPERATIONS OUTSIDE OF THE U.S. ----------------------------------------------------------------------\nSALES The 1993 and 1992 increases were due to expansion and higher sales at existing restaurants; however, 1993 was impacted by weaker foreign currencies, most notably the European currencies along with the Canadian and Australian Dollars. On the other hand, 1992 benefited from stronger foreign currencies in the form of the Japanese Yen, Deutsche Mark and French Franc. Strong operating results have been achieved in the past several years despite weak economies in several countries, particularly Canada, England and Japan.\n---------------------------------------------------------------------- Five Ten years years (In millions of dollars) 1993 1992 1991 ago ago ---------------------------------------------------------------------- Operated by franchisees $4,321 $3,859 $3,085 $1,850 $ 607 Operated by the Company 2,737 2,750 2,499 1,567 581 Operated by affiliates 2,343 2,033 1,825 1,267 430 ---------------------------------------------------------------------- Sales outside of the U.S. $9,401 $8,642 $7,409 $4,684 $1,618 ======================================================================\nEuropean sales rose because of accelerated expansion and higher sales at existing restaurants, partially offset by weaker foreign currencies. Asia\/Pacific sales grew because of expansion coupled with the favorable impact of a stronger Japanese Yen. Latin American sales increased because of expansion and higher sales at existing restaurants. Canadian sales were negatively impacted by the weaker currency, partially offset by higher sales at existing restaurants and expansion. In 1993, four of the six largest markets outside of the U.S. -- France, Germany, Australia and England -- reported double digit sales increases on a local currency basis. Other markets -- including Argentina, Austria, Belgium, Brazil, Canada, Denmark, Hong Kong, Hungary, Italy, Malaysia, Netherlands, New Zealand, Norway, Panama, Puerto Rico, Scotland, Singapore, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey and Wales -- delivered excellent results on a local currency basis.\nRESTAURANTS During the past five years, 60% of Systemwide additions have been outside of the U.S. Of the 576 restaurants added in 1993, 54% were in the six largest markets, compared with 57% in 1992 and 63% in 1991. This continued relative decline was indicative of the growing importance of emerging markets. McDonald's expects to boost expansion outside of the U.S. in 1994 and in each of the next several years by adding between 600 and 800 restaurants, exclusive of satellites.\n----------------------------------------------------------------------- Five Ten years years 1993 1992 1991 ago ago ----------------------------------------------------------------------- Operated by franchisees 2,204 1,862 1,586 1,093 580 Operated by the Company 1,266 1,156 1,101 842 519 Operated by affiliates 1,240 1,116 967 671 428 ----------------------------------------------------------------------- Restaurants outside of the U.S. 4,710 4,134 3,654 2,606 1,527 =======================================================================\nAbout 82% of Company-operated restaurants outside of the U.S. were in England, Canada, Germany, Australia, Hong Kong and France. About 71% of franchised restaurants outside of the U.S. were in Canada, Germany, Australia, France, Japan and the Netherlands. Restaurants operated by affiliates were principally located in Japan and other Asia\/Pacific countries.\nOPERATING RESULTS ----------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 1990 1989 ----------------------------------------------------------------------- REVENUES Sales by Company- operated restaurants $2,737 $2,750 $2,499 $2,364 $1,873 Revenues from franchised restaurants 740 634 486 405 306 ----------------------------------------------------------------------- TOTAL REVENUES 3,477 3,384 2,985 2,769 2,179 ----------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants 2,188 2,206 2,029 1,915 1,528 Franchised restaurants 133 114 90 77 61 General, administrative and selling expenses 303 295 246 213 166 Other operating (income) expense--net (44) (51) (58) (46) (25) ----------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 2,580 2,564 2,307 2,159 1,730 ----------------------------------------------------------------------- OPERATING INCOME OUTSIDE OF THE U.S. $ 897 $ 820 $ 678 $ 610 $ 449 =======================================================================\nThe 1993 and 1992 revenue and operating income increases reflected accelerated expansion and better performance despite weak economies in several major markets. Changing foreign currencies had a negative effect in 1993 and a positive one in 1992 on these increases.\nCompany-operated and franchised dollar margins were negatively impacted by weaker foreign currencies. Company-operated margins increased $6 million or 1% in 1993. These margins improved to 20.1% of sales in 1993, compared with 19.8% in 1992 and 18.8% in 1991. Franchised margins grew $86 million or 17% in 1993. These margins were 82.0% of applicable revenues in 1993, compared with 82.1% in 1992 and 81.5% in 1991. The 1993 and 1992 increases in general, administrative and selling expenses were due primarily to higher employee costs associated with expansion, partially offset by weaker foreign currencies in 1993. Other operating income decreased in 1993 due to the favorable settlement of a sales tax case in Brazil in 1992, offset somewhat by 1993 increases in gains on sales of restaurant businesses and greater affiliate earnings. Other operating income decreased in 1992 due to lower affiliate results and lower gains on sales of restaurant businesses, offset somewhat by the favorable settlement of a sales tax case in Brazil. Operations outside of the U.S. continued to contribute greater amounts to consolidated results as shown below: --------------------------------------------------------------------- (As a percent of consolidated) 1993 1992 1991 1990 1989 --------------------------------------------------------------------- Systemwide sales 40 39 37 35 31 Total revenues 47 47 45 42 36 Operating income 45 44 40 38 31 Restaurant margins Company-operated 55 56 53 51 42 Franchised 32 31 27 24 20 Systemwide restaurants 34 32 29 27 26 Assets 47 45 46 43 38 ---------------------------------------------------------------------\nThe Europe\/Africa\/Middle East segment accounted for 64% of revenues and 61% of operating income outside of the U.S. in 1993, growing $49 and $64 million, respectively. Germany, England and France accounted for 85% of this segment's operating income, compared with 90% in 1992. The 1993 increases were primarily due to strong operating results in Germany and France, as well as many emerging markets, offset by weaker foreign currencies. England's operating income decrease was due to the significant impact of the weaker currency. The majority of the 1992 revenue and operating income increases were generated by Germany, France and England. Asia\/Pacific revenues grew $60 million and operating income increased $27 million in 1993; 82% of the operating income was contributed by Australia, Japan and Hong Kong. The 1993 increases were attributable to expansion and developing economies in many Asia\/Pacific markets, with the exception of Japan which continues to suffer from a weak economy. In 1992, stronger operations in Australia, and better results in Hong Kong and Singapore improved operating income, while earnings from Japan were affected by the economy. Latin American revenues grew $22 million, while operating income decreased $12 million in 1993. The 1993 increase in revenues was primarily a function of expansion, while the decrease in operating income reflected the favorable settlement of a sales tax case in Brazil in 1992, partially offset by better results in Argentina. Brazil was affected by a weak economy in 1993 and 1992.\nCanadian revenues decreased $37 million due to a weaker Canadian Dollar in 1993. Operating income decreased $2 million, reflecting the weaker currency and a decrease in other operating income, partially offset by better Company-operated margins. Revenues decreased in 1992 due to the franchising of certain restaurant businesses and the weaker currency, while operating income declined due to lower gains on sales of restaurant businesses and the weaker currency.\nASSETS AND CAPITAL EXPENDITURES Assets outside of the U.S. rose $379 million or 7% in 1993; the effects of expansion were partially offset by weaker foreign currencies. At year-end 1993, about 47% of consolidated assets were located outside of the U.S.; 64% of these assets were located in England, France, Germany, Canada and Australia.\n----------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 1990 1989 ----------------------------------------------------------------------- New restaurants $ 609 $ 603 $ 612 $ 639 $ 486 Existing restaurants 94 91 94 126 148 Other properties 55 47 39 74 64 ----------------------------------------------------------------------- Capital expenditures outside of the U.S. $ 758 $ 741 $ 745 $ 839 $ 698 ======================================================================= Assets outside of the U.S. $5,650 $5,271 $5,195 $4,608 $3,529 -----------------------------------------------------------------------\nIn the past five years, nearly $3.8 billion has been invested outside of the U.S.; in 1993, capital expenditures rose in all geographic segments except Canada. Weaker foreign currencies negatively impacted Europe, Asia\/Pacific and Canada. Approximately 72% of capital expenditures outside of the U.S. were invested in Europe -- primarily in Germany, France and England. In general, average development costs for new restaurants for the five largest, majority-owned markets -- Australia, Canada, England, France and Germany -- were nearly double the U.S. average; such costs accommodate higher sales volumes and transaction counts. Even so, 1993 average development costs have decreased approximately one-third since 1991 in these markets. Over the past two years, average development costs have decreased due to construction and design efficiencies, standardization, global sourcing and changes in the mix of openings, and because of weaker foreign currencies in 1993. Expenditures for existing restaurants included seating and decor upgrades, and equipment required for new products and operating efficiencies. The majority of these expenditures were in Europe. Expenditures for other properties were principally for office facilities.\nAs in the U.S., business outside of the U.S. emphasizes restaurant property ownership. However, various laws and regulations make property acquisition and ownership much more difficult than in the U.S. Ownership is obtained when practical; otherwise, long-term leases are an alternative. In addition, certain markets have laws and customs that offer stronger tenancy rights than are available in the U.S. The Company and affiliates owned 36% of sites outside of the U.S. at year-end 1993, compared with 35% five years ago.\nCapital expenditures made by affiliates -- which were not included in consolidated amounts -- were $207 million in 1993, compared with $206 million in 1992. The majority of the 1993 expenditures were for development in Japan, Argentina and Russia. Included in the amounts for Russia were costs for constructing an office building which is leased primarily to third parties.\n----------------------------------------------------------------------- FINANCIAL POSITION -----------------------------------------------------------------------\nTOTAL ASSETS AND CAPITAL EXPENDITURES Total assets grew $354 million or 3% in 1993; net property and equipment represented 84% of total assets and rose $484 million. Capital expenditures increased $204 million or 18%, reflecting higher expansion, partially offset by lower average development costs and weaker foreign currencies.\nCASH PROVIDED BY OPERATIONS Cash provided by operations increased $254 million or 18% in 1993, and was relatively flat in 1992 mainly due to $159 million in payments related to various prior years' tax matters. Together with other sources of cash such as borrowings, cash provided by operations was used primarily for capital expenditures, debt repayments, share repurchase and dividends. For the third straight year, cash provided by operations exceeded capital expenditures. While cash generated is significant relative to cash required, the Company also has the ability to meet short-term needs through commercial paper borrowings and line of credit agreements. Accordingly, a relatively low current ratio has been purposefully maintained; it was .60 at year-end 1993. The Company believes that cash flow measures are meaningful indicators of growth and financial strength, when evaluated in the context of absolute dollars, uses and consistency. Over the past five years, cash flow coverage has improved significantly. Cash provided by operations is expected to cover capital expenditures over the next several years, even as expansion continues to accelerate.\n----------------------------------------------------------------------- (Dollars in millions) 1993 1992 1991 1990 1989 ----------------------------------------------------------------------- Cash provided by operations $1,680 $1,426 $1,423 $1,301 $1,246 Cash provided by operations minus capital expenditures $ 363 $ 339 $ 294 $ (270) $ (309) Cash provided by operations as a percent of capital expenditures 128 131 126 83 80 Cash provided by operations as a percent of total debt 45 37 31 27 31 -----------------------------------------------------------------------\nFINANCINGS The Company strives to minimize interest expense and the impact of changing foreign currencies, while maintaining the capacity to meet increasing growth requirements. To accomplish these objectives, McDonald's generally finances long-term assets with long-term debt in the currencies in which the assets are denominated, while remaining flexible to take advantage of changing foreign currencies and interest rates.\nOver the years, major capital markets and various techniques have been utilized to meet financing requirements and reduce interest expense. Currency exchange agreements have been employed in conjunction with borrowings to obtain desired currencies at attractive rates. Interest-rate exchange agreements and interest-rate caps have been used to effectively convert fixed-rate to floating-rate debt, or vice versa, and to limit interest expense. Foreign-denominated debt has been used to lessen the impact of changing foreign currencies on net income and shareholders' equity. Total foreign-denominated debt, including the effects of currency exchange agreements, was $3.1 and $2.7 billion at year-end 1993 and 1992, respectively. The Company manages its debt portfolio, including the use of derivatives, in order to respond to changes in interest rates and foreign currencies. Accordingly, the Company periodically retires, redeems, and repurchases debt, and terminates exchange agreements. While changing foreign currencies affect reported results, the Company actively hedges the seven currencies that have significant potential impact in order to minimize the cash exposure of royalty and other payments received in the U.S. in foreign currencies. In addition, McDonald's restaurants primarily purchase goods and services in local currencies resulting in natural hedges; McDonald's typically finances in local currencies creating economic hedges; and the Company's foreign currency exposure is diversified within a basket of currencies, as opposed to one or several.\n----------------------------------------------------------------------- (Includes the net asset positions of currency exchange agreements) 1993 1992 1991 1990 1989 ----------------------------------------------------------------------- Fixed-rate debt as a percent of total debt at year end 77 75 78 78 76 Weighted average annual interest rate 9.1 9.3 9.4 9.4 9.4 Foreign-denominated debt as a percent of total debt at year end 86 72 61 60 59 -----------------------------------------------------------------------\nMoody's and Standard & Poor's have rated McDonald's debt Aa2 and AA, respectively, since 1982. Duff & Phelps began rating the debt in 1990, and currently rates it AA+. The Company has not experienced, nor does it expect to experience, difficulty in obtaining financing or in refinancing existing debt. The Company had $1.7 billion under line of credit agreements and $685 million under previously filed shelf registrations available at year-end 1993 for future debt issuance. Although McDonald's prefers to own real estate, leases are an alternative financing method. As in the past, some new properties will be leased. Such leases frequently include renewal and\/or purchase options. In the past five years, McDonald's has leased properties related to 41% of U.S. openings and 67% of openings outside of the U.S.\nDuring the past three years, the Company has improved its balance sheet by reducing leverage while simultaneously increasing expansion and repurchasing shares. Total debt as a percent of total capitalization -- defined as total debt and total shareholders' equity -- was 37% at year-end 1993, compared with 40% and 49% at year- end 1992 and 1991, respectively.\nTOTAL SHAREHOLDERS' EQUITY Total shareholders' equity rose $382 million and represented 52% of total assets at year-end 1993. One technique used to enhance common shareholder value is share repurchase through excess cash flow or debt capacity, while maintaining a strong equity base for future expansion. At year-end 1993, the market value of shares repurchased by the Company and recorded as common stock in treasury was $3.5 billion. In conjunction with efforts to enhance common shareholder value, the Company recently announced its intention to purchase up to $1 billion of its common stock within the next three years, primarily from excess cash flow. In 1993, the Company completed a $700 million common share repurchase program begun in 1992. In order to lower the cost of equity capital, the Company issued $500 million of Series E 7.72% Cumulative Preferred Stock in 1992; at the same time, the Board of Directors authorized a $500 million common share repurchase program and the use of derivatives. Subsequently, the Board authorized an additional $200 million expenditure for share repurchase in 1993. Weaker foreign currencies reduced shareholders' equity by $65 million in 1993; however, financing foreign-denominated assets with foreign-denominated debt tempered the effect. At year-end 1993, foreign-denominated assets not entirely financed with the related foreign-denominated debt were primarily located in England, Canada, Australia, France and Germany.\nRETURNS Return on average assets is computed using income before provision for income taxes, preferred dividends and interest expense. Net income, less preferred stock dividends (net of tax in 1993 and 1992), is used to calculate return on average common equity. Month-end balances are used to compute both average assets and average common equity.\n---------------------------------------------------------------------- 1993 1992 1991 1990 1989 ---------------------------------------------------------------------- Return on average assets 17.1 16.1 15.8 16.7 17.3 Return on average common equity 19.0 18.2 19.1 20.7 20.5 ----------------------------------------------------------------------\nThe 1993 and 1992 improvements in return on average assets reflected better global operating results and a slower rate of asset growth. The 1993 improvement in return on average common equity reflected higher levels of share repurchase, whereas declines in 1992 and 1991 resulted from lower levels of share repurchase as excess cash flow was used to reduce debt. In recent years, returns were affected by soft economies in the U.S. and certain markets outside of the U.S. Also influencing these returns were expansion outside of the U.S. and, prior to 1991, escalating development costs and higher reinvestment.\nEFFECTS OF CHANGING PRICES--INFLATION McDonald's has demonstrated an ability to manage inflationary cost increases effectively. Rapid inventory turnover, the ability to adjust prices, substantial property holdings--many of which are at fixed costs and partially financed by debt made cheaper by inflation-- and cost controls have enabled McDonald's to mitigate the effects of inflation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage Reference ---------\nManagement's Report 31\nReport of independent auditors 32\nConsolidated statement of income for each of the three years in the period ended December 31, 1993 33\nConsolidated balance sheet at December 31, 1993 and 1992 34\nConsolidated statement of cash flows for each of the three years in the period ended December 31, 1993 35\nConsolidated statement of shareholders' equity for each of the three years in the period ended December 31, 1993 36\nNotes to consolidated financial statements (Financial comments) 37-50\nQuarterly Results (unaudited) 51\nMANAGEMENT'S REPORT\nManagement is responsible for the preparation and integrity of the consolidated financial statements and Financial Comments appearing in this annual report. The financial statements were prepared in accordance with generally accepted accounting principles and include certain amounts based on management's best estimates and judgments. Other financial information presented in the annual report is consistent with the financial statements. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded, and that transactions are executed as authorized and are recorded and reported properly. This system of controls is based upon written policies and procedures, appropriate divisions of responsibility and authority, careful selection and training of personnel and utilization of an internal audit program. Policies and procedures prescribe that the Company and all employees are to maintain the highest ethical standards and that business practices throughout the world are to be conducted in a manner which is above reproach. Ernst & Young, independent auditors, has audited the Company's financial statements and their report is presented herein. The Board of Directors has an Audit Committee composed entirely of outside Directors. Ernst & Young has direct access to the Audit Committee and periodically meets with the Committee to discuss accounting, auditing and financial reporting matters.\nMcDONALD'S CORPORATION Oak Brook, Illinois January 27, 1994\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders McDonald's Corporation Oak Brook, Illinois\nWe have audited the accompanying consolidated balance sheet of McDonald's Corporation as of December 31, 1993 and 1992, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of McDonald's Corporation management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of McDonald's Corporation at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nERNST & YOUNG Chicago, Illinois January 27, 1994\nMCDONALD'S CORPORATION FINANCIAL COMMENTS\n-------------------------------------------------------------------- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -------------------------------------------------------------------- CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries. Investments in 50% or less owned affiliates are carried at equity in the companies' net assets.\nFOREIGN CURRENCY TRANSLATION The functional currency of each operation outside of the U.S., except for those located in hyperinflationary countries, is the respective local currency.\nINCOME TAXES In 1992, the Company adopted Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes. The effects were not material, as the Company had previously adopted Statement No. 96.\nPROPERTY AND EQUIPMENT Property and equipment are stated at cost with depreciation and amortization provided on the straight-line method over the following estimated useful lives: buildings--up to 40 years; leasehold improvements--lesser of useful lives of assets or lease terms including option periods; and equipment--3 to 12 years.\nINTANGIBLE ASSETS Intangible assets consist primarily of franchise rights reacquired from franchisees and affiliates, and are amortized on the straight- line method over an average life of 29 years.\nFINANCIAL INSTRUMENTS Non-U.S. Dollar financing transactions generally are effective as hedges of long-term investments in the corresponding currency. Interest-rate exchange agreements are designated and generally are effective as hedges of the Company's interest-rate exposures. The carrying amounts for cash and equivalents and notes receivable approximated fair value. For noninterest-bearing security deposits by franchisees, no fair value was provided as these deposits are an integral part of the overall franchise arrangements.\nSTATEMENT OF CASH FLOWS The Company considers all highly liquid investments with short-term maturity dates to be cash equivalents. The impact of changing foreign currencies on cash and equivalents was not material.\n---------------------------------------------------------------------- NUMBER OF RESTAURANTS IN OPERATION ---------------------------------------------------------------------- 1993 1992 1991 1990 ---------------------------------------------------------------------- Operated by franchisees 9,288 8,654 8,151 7,578 Operated under business facilities lease arrangements 544 583 584 553 Operated by the Company 2,699 2,551 2,547 2,643 Operated by 50% or less owned affiliates 1,462 1,305 1,136 1,029 ---------------------------------------------------------------------- Systemwide restaurants 13,993 13,093 12,418 11,803 ====================================================================== Franchisees operating under business facilities lease arrangements have options to purchase the businesses. The results of operations of restaurant businesses purchased and sold in transactions with franchisees and affiliates were not material to the consolidated financial statements for periods prior to purchase and sale.\n---------------------------------------------------------------------- OTHER OPERATING (INCOME) EXPENSE--NET ---------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 ---------------------------------------------------------------------- Gains on sales of restaurant businesses $(48.2) $(43.1) $ (64.0) Equity in earnings of unconsolidated affiliates (34.6) (29.5) (57.5) Net losses from property dispositions 15.5 18.1 9.9 Other--net 5.3 (9.5) (2.2) ---------------------------------------------------------------------- Other operating (income) expense--net $(62.0) $(64.0) $(113.8) ====================================================================== Gains on sales of restaurant businesses are recognized as income when the sales are consummated and other stipulated conditions are met. Proceeds from certain sales of restaurant businesses and property include notes receivable.\n--------------------------------------------------------------------- INCOME TAXES --------------------------------------------------------------------- Income before provision for income taxes and the provision for income taxes, classified by source of income, were as follows: --------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 --------------------------------------------------------------------- U.S. $ 986.0 $ 873.3 $ 847.3 Outside of the U.S. 689.7 574.8 452.1 --------------------------------------------------------------------- Income before provision for income taxes $1,675.7 $1,448.1 $1,299.4 ===================================================================== U.S. $ 391.9 $ 316.8 $ 312.6 Outside of the U.S. 201.3 172.7 127.2 --------------------------------------------------------------------- Provision for income taxes $ 593.2 $ 489.5 $ 439.8 =====================================================================\nIncome before provision for income taxes outside of the U.S. and the related provision for income taxes reflect fees received in the U.S. from operations outside of the U.S. Income before provision for income taxes in the U.S. and the related provision for income taxes reflect interest received in the U.S. from operations outside of the U.S. The provision for income taxes, classified by the timing and location of payment, consisted of:\n------------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 ------------------------------------------------------------------------- Current U.S. federal $331.6 $256.8 $230.8 U.S. state 62.0 56.3 45.3 Outside of the U.S. 147.2 154.0 99.0 ------------------------------------------------------------------------- 540.8 467.1 375.1 ------------------------------------------------------------------------- Deferred U.S. federal 21.9 (10.3) 46.9 U.S. state 3.4 4.0 8.2 Outside of the U.S. 27.1 28.7 9.6 ------------------------------------------------------------------------- 52.4 22.4 64.7 ------------------------------------------------------------------------- Provision for income taxes $593.2 $489.5 $439.8 =========================================================================\nIncluded in the 1993 deferred tax provision were $14.0 million attributable to a one-time, noncash revaluation of deferred tax liabilities resulting from the increase in the statutory U.S. federal income tax rate. Net deferred tax liabilities were comprised of:\n------------------------------------------------------------------------- (In millions of dollars) December 31, 1993 1992 ------------------------------------------------------------------------- Property and equipment basis differences $786.1 $738.2 Other 175.4 154.8 ------------------------------------------------------------------------- Total deferred tax liabilities 961.5 893.0 ------------------------------------------------------------------------- Deferred tax assets before valuation allowance (1) (192.8) (183.8) Valuation allowance 44.5 35.7 ------------------------------------------------------------------------- Net deferred tax liabilities (2) $813.2 $744.9 ========================================================================= (1) Includes loss carryforwards: 1993--$46.7 million; 1992--$44.4 million. (2) Net of assets recorded in current income taxes: 1993--$22.1 million; 1992--$3.7 million.\nReconciliations of the statutory U.S. federal income tax rates to the effective income tax rates are shown in the following table.\n-------------------------------------------------------------------- 1993 1992 1991 -------------------------------------------------------------------- Statutory federal income tax rates 35.0% 34.0% 34.0% State income taxes, net of related federal income tax benefit 2.5 2.7 2.7 Other (2.1) (2.9) (2.9) -------------------------------------------------------------------- Effective income tax rates 35.4% 33.8% 33.8% ====================================================================\nU.S. income and foreign withholding taxes have not been provided on $760.8 million of undistributed earnings of certain subsidiaries and affiliates outside of the U.S. at December 31, 1993. These earnings are considered to be permanently invested in the businesses and, under the tax laws, are not subject to taxes until distributed as dividends. If these earnings were not considered permanently invested, no additional taxes would be provided due to the overall higher tax rates in markets outside of the U.S. and the ability to recover withholding taxes as foreign tax credits in the U.S.\n---------------------------------------------------------------------- SEGMENT AND GEOGRAPHIC INFORMATION ---------------------------------------------------------------------- The Company operates exclusively in the foodservice industry. Substantially all revenues result from the sale of menu products at restaurants operated by the Company, franchisees or affiliates. Operating income includes the Company's share of operating results of affiliates. All intercompany revenues and expenses are eliminated in computing revenues and operating income. Fees received in the U.S. from subsidiaries outside of the U.S. were: 1993--$202.8 million; 1992--$187.8 million; 1991--$153.1 million.\n---------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 ---------------------------------------------------------------------- U.S. $3,931.2 $3,749.4 $3,710.2 Europe\/Africa\/Middle East 2,235.9 2,187.0 1,806.0 Canada 557.8 595.1 629.5 Asia\/Pacific 494.4 434.6 392.5 Latin America 188.8 167.2 156.8 ---------------------------------------------------------------------- Total revenues $7,408.1 $7,133.3 $6,695.0 ======================================================================\nU.S. $1,087.1 $1,041.6 $1,000.4 Europe\/Africa\/Middle East 547.5 484.0 361.3 Canada 111.2 113.5 120.7 Asia\/Pacific 190.6 163.2 157.2 Latin America 47.6 59.3 38.9 ---------------------------------------------------------------------- Operating income $1,984.0 1,861.6 1,678.5 ======================================================================\nU.S. $6,385.4 $6,410.6 $6,154.3 Europe\/Africa\/Middle East 3,473.2 3,290.9 3,316.1 Canada 562.5 587.4 618.2 Asia\/Pacific 1,103.2 980.3 925.0 Latin America 510.9 412.0 335.5 ---------------------------------------------------------------------- Total assets $12,035.2 $11,681.2 $11,349.1 ======================================================================\n------------------------------------------------------------------------ PROPERTY AND EQUIPMENT ------------------------------------------------------------------------ (In millions of dollars) December 31, 1993 1992 ------------------------------------------------------------------------ Land $2,587.2 $2,440.0 Buildings and improvements on owned land 5,209.4 4,906.0 Buildings and improvements on leased land 3,673.0 3,423.7 Equipment, signs and seating 1,545.4 1,467.2 Other 444.0 421.1 ------------------------------------------------------------------------ 13,459.0 12,658.0 ------------------------------------------------------------------------ Accumulated depreciation and amortization (3,377.6) (3,060.6) ------------------------------------------------------------------------ Net property and equipment $10,081.4 $9,597.4 ========================================================================\nDepreciation and amortization were: 1993--$492.8 million; 1992--$492.9 million; 1991--$456.9 million. Contractual obligations for the acquisition and construction of property amounted to $193.1 million at December 31, 1993.\n------------------------------------------------------------------------ DEBT FINANCING ------------------------------------------------------------------------ LINE OF CREDIT AGREEMENTS The Company has a long-term line of credit agreement for $700.0 million, which remained unused at December 31, 1993, and which continues indefinitely unless terminated by the participating banks upon advance notice of at least 18 months. Each borrowing under the agreement bears interest at one of several specified floating rates, to be selected by the Company at the time of borrowing. The agreement provides for fees of .15 of 1% per annum on the unused portion of the commitment. In addition, certain subsidiaries outside of the U.S. had unused lines of credit totaling $1.0 billion at December 31, 1993; these were principally short-term and denominated in various currencies at local market rates of interest.\nEXCHANGE AGREEMENTS The Company uses derivatives and has entered into agreements for the exchange of various currencies. Certain of these agreements also provide for the periodic exchange of interest payments. These agreements, as well as additional interest-rate exchange agreements, expire through 2003 and provide for an effective right of offset; therefore, the related receivable and liability are offset in the financial statements. The counterparties to these exchange agreements consist of a diverse group of financial institutions. The Company continually monitors its positions and the credit ratings of its counterparties, and adjusts positions as appropriate. The Company also had short-term forward foreign exchange contracts outstanding at December 31, 1993, with a U.S. Dollar equivalent of $83.4 million in various currencies, primarily the Japanese Yen, Deutsche Mark and British Pound Sterling.\nAGGREGATE MATURITIES Included in the 1995 maturities are $700.0 million of notes maturing within one year, as 1995 is the earliest time at which the banks can terminate the line of credit agreement, which supports the classification in long-term debt. Under certain agreements, the Company has the option to retire debt prior to maturity, either at par or at a premium over par. During 1993, $264.5 million was retired prior to maturity.\nGUARANTEES Included in total debt at December 31, 1993, were $171.3 million of 7.60% ESOP Notes Series A and $89.0 million of 7.23% ESOP Notes Series B issued by the Leveraged Employee Stock Ownership Plan (LESOP), with payments through 2004 and 2006, respectively, which are guaranteed by the Company. Interest rates on the notes were adjusted due to U.S. tax law changes in 1993. The Company has agreed to repurchase the notes upon the occurrence of certain events. The Company also has guaranteed certain foreign affiliate loans of $154.7 million at December 31, 1993. The Company also was a general partner in 48 domestic partnerships with total assets of $174.3 million and total liabilities of $95.8 million at December 31, 1993.\nFAIR VALUES The carrying amounts for notes payable and short-term forward foreign exchange contracts approximated fair value at December 31, 1993. The fair value of the remaining debt obligations (excluding capital leases), including the net effects of currency and interest-rate exchange agreements, was estimated using quoted market prices, various pricing models or discounted cash flow analyses. At December 31, 1993, the fair value of these obligations, which were primarily used to finance property and equipment, was $3.7 billion, compared to a carrying value of $3.4 billion. The Company currently has no plans to retire any of these obligations prior to maturity. The Company believes that the fair value of total assets is higher than their carrying value.\nDEBT OBLIGATIONS\n------------------------------------------------------------------- OTHER LONG-TERM LIABILITIES AND MINORITY INTERESTS ------------------------------------------------------------------- (In millions of dollars) December 31, 1993 1992 ------------------------------------------------------------------- Security deposits by franchisees $121.4 $116.6 Preferred interests in consolidated subsidiaries 106.7 12.8 Minority interests in consolidated subsidiaries 38.2 32.1 Other 68.1 63.7 ------------------------------------------------------------------- Other long-term liabilities and minority interests $334.4 $225.2 ===================================================================\nIn 1993, a Company subsidiary issued 50 million British Pounds Sterling (U.S. $74.0 million at December 31, 1993) of 5.91% Series A Preferred Stock which, unless redeemed earlier at the Company's option, must be redeemed on February 19, 1998. Also, another subsidiary issued additional preferred stock. All of the preferred stock of this subsidiary has a dividend rate adjusted annually (8.2% at December 31, 1993) and is redeemable at the option of the holder at a current redemption price of $32.7 million. Both of these issues were reflected in preferred interests in consolidated subsidiaries. Included in other was the $100.00 per share redemption value of 181,868 shares of 5% Series D Preferred Stock issued in connection with the Company's 1991 increase in ownership of its Hawaii affiliate. This stock, which carries one vote per share, must be redeemed on the occurrence of specified events.\n--------------------------------------------------------------------- LEASING ARRANGEMENTS --------------------------------------------------------------------- At December 31, 1993, the Company was lessee at 2,294 restaurant locations under ground leases (the Company leases land and constructs and owns buildings) and at 2,305 locations under improved leases (lessor owns land and buildings). Land and building lease terms are generally for 20 to 25 years and, in many cases, provide for rent escalations and one or more five-year renewal options with certain leases providing purchase options. The Company is generally obligated for the related occupancy costs that include property taxes, insurance and maintenance. In addition, the Company is lessee under noncancelable leases covering offices and vehicles. Future minimum payments required under operating leases with initial terms of one year or more after December 31, 1993, are:\n------------------------------------------------------------ (In millions of dollars) Restaurant Other Total ------------------------------------------------------------ 1994 $ 277.0 $ 34.7 $ 311.7 1995 266.7 33.3 300.0 1996 255.7 31.5 287.2 1997 242.4 28.4 270.8 1998 227.2 25.8 253.0 Thereafter 2,334.1 165.0 2,499.1 ------------------------------------------------------------ Total minimum payments $3,603.1 $318.7 $3,921.8 ============================================================\nRent expense was: 1993--$339.0 million; 1992--$320.2 million; 1991-$283.6 million. Included in these amounts were percentage rents based on sales by the related restaurants in excess of minimum rents stipulated in certain lease agreements: 1993--$29.0 million; 1992--$26.1 million; 1991--$26.3 million.\n---------------------------------------------------------------------- FRANCHISE ARRANGEMENTS ---------------------------------------------------------------------- Franchise arrangements, with franchisees who operate in various geographic locations, generally provide for initial fees and continuing payments to the Company based upon a percentage of sales, with minimum rent payments. Among other things, franchisees are provided the use of restaurant facilities, generally for a period of 20 years. They are required to pay related occupancy costs that include property taxes, insurance, maintenance and a refundable, noninterest-bearing security deposit. On a limited basis, the Company receives notes from franchisees. Generally the notes are secured by interests in restaurant equipment and franchises.\n---------------------------------------------------------------------- (In millions of dollars) 1993 1992 1991 ---------------------------------------------------------------------- Minimum rents Owned sites $ 573.6 $ 538.7 $ 494.5 Leased sites 381.7 353.3 303.7 ---------------------------------------------------------------------- 955.3 892.0 798.2 ---------------------------------------------------------------------- Percentage fees 1,272.1 1,120.6 970.4 Initial fees 23.5 18.2 17.9 ---------------------------------------------------------------------- Revenues from franchised restaurants $2,250.9 $2,030.8 $1,786.5 ======================================================================\nFuture minimum payments based on minimum rents specified under franchise arrangements after December 31, 1993, are:\n---------------------------------------------------------------------- Owned Leased (In millions of dollars) sites sites Total ---------------------------------------------------------------------- 1994 $ 618.4 $ 404.7 $ 1,023.1 1995 607.4 390.3 997.7 1996 593.2 375.9 969.1 1997 579.5 365.2 944.7 1998 567.3 353.2 920.5 Thereafter 5,309.1 3,406.6 8,715.7 ---------------------------------------------------------------------- Total minimum payments $8,274.9 $5,295.9 $13,570.8 ======================================================================\nAt December 31, 1993, net property and equipment under franchise arrangements totaled $5.9 billion (including land of $1.8 billion), after deducting accumulated depreciation and amortization of $1.7 billion.\n---------------------------------------------------------------------- PROFIT SHARING PROGRAM ---------------------------------------------------------------------- The Company has a program for U.S. employees which includes profit sharing, 401(k) (McDESOP), and leveraged employee stock ownership features. McDESOP allows employees to invest in McDonald's common stock by making contributions that are partially matched by the Company. Assets of the profit sharing plan can be invested in McDonald's common stock, or among several other alternatives. Certain subsidiaries outside of the U.S. also offer profit sharing, stock purchase or other similar benefit plans. Total U.S. program costs were: 1993--$47.1 million; 1992--$38.8 million; 1991--$46.4 million. Total plan costs outside of the U.S. were: 1993--$13.0 million; 1992-- $14.0 million; 1991--$9.8 million. The Company does not provide any other postretirement benefits, and postemployment benefits were immaterial.\n---------------------------------------------------------------------- STOCK OPTIONS ---------------------------------------------------------------------- Under the 1992 Stock Ownership Incentive and the 1975 Stock Ownership Option Plans, options to purchase common stock are granted at prices not less than fair market value of the stock on date of grant. Substantially all of these options become exercisable in four equal biennial installments, commencing one year from date of grant, and expire ten years from date of grant. At December 31, 1993, 41.5 million shares of common stock were reserved for issuance under both plans.\n----------------------------------------------------------------------- (In millions, except per common share data) 1993 1992 1991 ----------------------------------------------------------------------- Options outstanding at January 1 25.1 23.7 21.6 Options granted 6.0 5.8 5.5 Options exercised (2.7) (3.8) (2.6) Options forfeited (.9) (.6) (.8) ----------------------------------------------------------------------- Options outstanding at December 31 27.5 25.1 23.7 ======================================================================= Options exercisable at December 31 8.8 7.7 7.8 Common shares reserved for future grants at December 31 14.0 19.1 6.3 Option prices per common share Exercised during the year $ 9 to $48 $9 to $45 $6 to $34 Outstanding at year end $10 to $56 $9 to $48 $9 to $34 -----------------------------------------------------------------------\n---------------------------------------------------------------------- CAPITAL STOCK ---------------------------------------------------------------------- PER COMMON SHARE INFORMATION Income used in the computation of per common share information was reduced by preferred stock cash dividends (net of tax benefits in 1993 and 1992) and divided by the weighted average shares of common stock outstanding during each year: 1993--355.9 million; 1992--363.2 million; 1991--358.1 million. The effect of potentially dilutive securities was not material.\nPREFERRED STOCK In December 1992, the Company issued $500.0 million of Series E 7.72% Cumulative Preferred Stock; 10,000 preferred shares are equivalent to 20.0 million depositary shares having a liquidation preference of $25.00 per depositary share. Each preferred share is entitled to one vote under certain circumstances, and is redeemable at the option of the Company beginning on December 3, 1997, at its liquidation preference plus accrued and unpaid dividends. In September 1989 and April 1991, the Company sold $200.0 million of Series B and $100.0 million of Series C ESOP Convertible Preferred Stock, respectively, to the LESOP. The LESOP financed the purchase by issuing notes that are guaranteed by the Company and are included in long-term debt, with an offsetting reduction in shareholders' equity. Each preferred share has a liquidation preference of $28.75 and $33.125, respectively, and is convertible into a minimum of .7692 and .8 common share (conversion rate), respectively. Upon termination, employees are guaranteed a minimum value payable in common shares equal to the greater of the conversion rate; the fair market value of their preferred shares; or the liquidation preference plus accrued dividends, not to exceed one common share. Each preferred share is entitled to one vote and is redeemable at the option of the Company three years after issuance and, under certain circumstances, is redeemable prior to that date. In 1992, 4.1 million Series B shares were converted into 3.2 million common shares.\nCOMMON EQUITY PUT OPTIONS In December 1992, the Company sold 2.0 million common equity put options. At December 31, 1992, the $94.0 million exercise price of these options was classified in common equity put options and the related offset was recorded in common stock in treasury, net of premiums received. In April 1993, these options expired unexercised. In April 1993, the Company also sold 1.0 million common equity put options which expired unexercised in July 1993.\nSHAREHOLDER RIGHTS PLAN In December 1988, the Company declared a dividend of one Preferred Share Purchase Right (Right) on each outstanding share of common stock. Under certain conditions, each Right may be exercised to purchase one two-hundredth of a share of Series A Junior Participating Preferred Stock (the economic equivalent of one common share) at an exercise price of $125.00 (which may be adjusted under certain circumstances), and is transferable apart from the common stock ten days following a public announcement that a person or group has acquired beneficial ownership of 20% or more of the outstanding common shares, or ten business days following the commencement or announcement of an intention to make a tender or exchange offer, resulting in beneficial ownership by a person or group of 20% or more of the outstanding common shares. If a person or group acquires 20% or more of the outstanding common shares, or if the Company is acquired in a merger or other business combination transaction, each Right will entitle the holder, other than such person or group, to purchase at the then current exercise price, stock of the Company or the acquiring company having a market value of twice the exercise price. Each Right is nonvoting and expires on December 28, 1998, unless redeemed by the Company, at a price of $.005, at any time prior to the public announcement that a person or group has acquired beneficial ownership of 20% or more of the outstanding common shares. At December 31, 1993, 2.1 million shares of the Series A Junior Participating Preferred Stock were reserved for issuance under this plan.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation regarding directors is incorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after December 31, 1993.\nOn December 1, 1993, Donald R. Keough, Chairman of Allen & Company, Inc., was appointed to the Company's Board of Directors.\nInformation regarding all of the Company's executive officers is included in Part I.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after December 31, 1993.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after December 31, 1993.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after December 31, 1993.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Financial statements Consolidated financial statements filed as part of this report are listed under Part II, Item 8 of this Form 10-K. 2. Financial statement schedules The financial schedules listed in the accompanying index to consolidated financial statement schedules are filed as part of this report. 3. Exhibits\n(3) Restated Certificate of Incorporation, dated as of February 2, 1993, incorporated herein by reference from Exhibit (3) of Form 10-K dated December 31, 1992. By-laws incorporated herein by reference from Exhibit 3 of Form 10-K dated December 31, 1991.\n(4) Instruments defining the rights of security holders, including indentures (A):\n(a) Debt Securities. Indenture dated as of March 1, 1987 incorporated herein by reference from Exhibit 4(a) of Form S-3 Registration Statement, SEC file no. 33-12364.\n(i) Supplemental Indenture No. 5 incorporated herein by reference from Exhibit (4) of Form 8-K dated January 23, 1989.\n(ii) 9-3\/4% Notes due 1999. Supplemental Indenture No. 6 incorporated herein by reference from Exhibit (4) of Form 8-K dated January 23, 1989.\n(iii) Medium-Term Notes, Series B, due from nine months to 30 years from Date of Issue. Supplemental Indenture No. 12 incorporated herein by reference from Exhibit (4) of Form 8-K dated August 18, 1989 and Forms of Medium-Term Notes, Series B, incorporated herein by reference from Exhibit (4)(b) of Form 8-K dated September 14, 1989.\n(iv) 9-3\/8% Notes due 1997. Form of Supplemental Indenture No. 14 incorporated herein by reference from Exhibit (4) of Form 10-K for the year ended December 31, 1989.\n(v) Medium-Term Notes, Series C, due from nine months to 30 years from Date of Issue. Form of Supplemental Indenture No. 15 incorporated herein by reference from Exhibit 4(b) of Form S-3 Registration Statement, SEC file no. 33-34762 dated May 14, 1990.\n(vi) Medium-Term Notes, Series C, due from nine months\/184 days to 30 years from Date of Issue. Amended and restated Supplemental Indenture No. 16 incorporated herein by reference from Exhibit (4) of Form 10-Q for the period ended March 31, 1991.\n(vii) 8-7\/8% Debentures due 2011. Supplemental Indenture No. 17 incorporated herein by reference from Exhibit (4) of Form 8-K dated April 22, 1991.\n(viii)Medium-Term Notes, Series D, due from nine months\/184 days to 60 years from Date of Issue. Supplemental Indenture No. 18 incorporated herein by reference from Exhibit 4(b) of Form S-3 Registration Statement, SEC file no. 33-42642 dated September 10, 1991.\n(ix) 7-3\/8% Notes due July 15, 2002. Form of Supplemental Indenture No. 19 incorporated herein by reference from Exhibit (4) of Form 8-K dated July 10, 1992.\n(x) 6-3\/4% Notes due February 15, 2003. Form of Supplemental Indenture No. 20 incorporated herein by reference from Exhibit (4) of Form 8-K dated March 1, 1993.\n(xi) 7-3\/8% Debentures due July 15, 2033. Form of Supplemental Indenture No. 21 incorporated herein by reference from Exhibit (4)(a)of Form 8-K dated July 15, 1993.\n(b) Form of Deposit Agreement dated as of November 25, 1992 by and between McDonald's Corporation, First Chicago Trust Company of New York, as Depositary, and the Holders from time to time of the Depositary Receipts.\n(c) Rights Agreement dated as of December 13, 1988 between McDonald's Corporation and The First National Bank of Chicago, incorporated herein by reference from Exhibit 1 of Form 8-K dated December 23, 1988.\n(i) Amendment No. 1 to Rights Agreement incorporated herein by reference from Exhibit 1 of Form 8-K dated May 25, 1989.\n(ii) Amendment No. 2 to Rights Agreement incorporated herein by reference from Exhibit 1 of Form 8-K dated July 25, 1990.\n(d) Indenture and Supplemental Indenture No. 1 dated as of September 8, 1989, between McDonald's Matching and Deferred Stock Ownership Trust, McDonald's Corporation and Pittsburgh National Bank in connection with SEC Registration Statement Nos. 33-28684 and 33-28684-01, incorporated herein by reference from Exhibit (4)(a) of Form 8-K dated September 14, 1989.\n(e) Form of Supplemental Indenture No. 2 dated as of April 1, 1991, supplemental to the Indenture between McDonald's Matching and Deferred Stock Ownership Trust, McDonald's Corporation and Pittsburgh National Bank in connection with SEC Registration Statement Nos. 33-28684 and 33-28684-01, incorporated herein by reference from Exhibit (4)(c) of Form 8-K dated March 22, 1991.\n(10) Material Contracts\n(a) Material contract between McDonald's Corporation and Joan B. Kroc, incorporated herein by reference from Exhibit (10) of Form 10-K for the year ended December 31, 1984.\n(b) Director's Deferred Compensation Plan, incorporated herein by reference from Exhibit (10)(b)of Form 10-K for the year ended December 31, 1992*.\n(c) Profit Sharing Program, as amended, McDonald's Supplemental Employee Benefit Equalization Plan, McDonald's Profit Sharing Program Equalization Plan and McDonald's 1989 Equalization Plan, incorporated by reference from Form 10-K\/A dated May 4, 1993, Amendment No. 1 to Form 10-K for the year ended December 31, 1992*.\n(i) Amendment No. 1 to McDonald's 1989 Equalization Plan, incorporated herein by reference from Form 10-Q for the period ended June 30, 1993.\n(ii) Amendment No. 2 to McDonald's 1989 Equalization Plan, attached hereto as an Exhibit.\n(iii)Amendment No. 1 to McDonald's Supplemental Employee Benefit Equalization Plan, attached hereto as an Exhibit.\n(iv) Amendment No. 2 to McDonald's Supplemental Employee Equalization Plan, attached hereto as an Exhibit.\n(v) Amendment No. 5 to the Profit Sharing Program, as amended, attached hereto as an Exhibit.\nAmendment No. 6 to the Profit Sharing Program, as (vi) amended, attached hereto as an Exhibit.\n(d) 1975 Stock Ownership Option Plan, incorporated herein by reference from Exhibit (10)(d) of Form 10-K for the year ended December 31, 1992*.\n(e) Stock Sharing Plan, incorporated herein by reference from Exhibit (10)(e) of Form 10-K for the year ended December 31, 1992*.\n(f) 1992 Stock Ownership Incentive Plan, incorporated herein by reference from exhibit pages 20-34 of McDonald's 1992 Proxy Statement and Notice of 1992 Annual Meeting of Shareholders dated April 10, 1992*.\n(g) McDonald's Corporation Deferred Incentive Plan, incorporated herein by reference from Exhibit(10) of Form 10-Q for the period ended September 30, 1993*.\n(11) Statement re: Computation of per share earnings.\n(12) Statement re: Computation of ratios.\n(21) Subsidiaries of the registrant.\n(23) Consent of independent auditors.\n-------------------- * Denotes compensatory plan.\n(A) Other instruments defining the rights of holders of long-term debt of the registrant and all of its subsidiaries for which consolidated financial statements are required to be filed and which are not required to be registered with the Securities and Exchange Commission, are not included herein as the securities authorized under these instruments, individually, do not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. An agreement to furnish a copy of any such instruments to the Securities and Exchange Commission upon request has been filed with the Commission.\n(b) Reports on Form 8-K\nThe following reports on Form 8-K were filed for the last quarter covered by this report, and subsequently up to March 29, 1994.\nFinancial Statements Date of Report Item Number required to be filed -------------- ----------- -------------------- November 22, 1993 Item 7 No January 18, 1994 Item 7 No\nMcDONALD'S CORPORATION\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\n(Item 14)\n(a) The following documents are filed as part of this report:\nPage 1. Financial Statement Schedules Reference\nReport of Independent Auditors 58\nConsolidated schedules for the years ended December 31, 1993, 1992 and 1991:\nV - Property and equipment 59\nVI - Accumulated depreciation and amortization of property and equipment 60\nIX - Short-term borrowings 62\nX - Supplementary income statement information 63\nConsolidated schedule at December 31, 1993:\nVII - Guarantees of securities of other issuers 61\nAll other schedules have been omitted as the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nWe have audited the consolidated financial statements of McDonald's Corporation as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated January 27, 1994 (included elsewhere in this Annual Report on Form 10-K). Our audits also included the consolidated financial statement schedules of McDonald's Corporation listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.\nIn our opinion, the consolidated financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nErnst & Young\nChicago, Illinois January 27, 1994\nMcDonald's Corporation Exhibit Index (Item 14)\nAmendment No. 2 to McDonald's 1989 Equalization Plan\nAmendment No. 1 to McDonald's Supplemental Employee Benefit Equalization Plan\nAmendment No. 2 to McDonald's Supplemental Employee Benefit Equalization Plan\nAmendment No. 5 to the Profit Sharing Program\nAmendment No. 6 to the Profit Sharing Program\nStatement re: Computation of per share earnings\nStatement re: Computation of ratios\nSubsidiaries of the registrant\nConsent of independent auditors\nSIGNATURES\nPursuant 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.\nMcDONALD'S CORPORATION (Registrant) By Jack M. Greenberg ---------------------- Jack M. Greenberg Vice Chairman, Chief Financial Officer March 29, 1994\nPursuant 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 and on the dates indicated:\nSignature Title Date --------- ----- ----\n------------------------- Director Hall Adams, Jr.\nRobert M. Beavers, Jr. ------------------------- Senior Vice President March 29, 1994 Robert M. Beavers, Jr. and Director\nJames R. Cantalupo ------------------------- President and Chief Executive March 29, 1994 James R. Cantalupo Officer-International and Director\nMichael L. Conley ------------------------- Senior Vice President, March 29, 1994 Michael L. Conley Controller\nGordon C. Gray ------------------------- Director March 29, 1994 Gordon C. Gray\nJack M. Greenberg ------------------------- Vice Chairman, March 29, 1994 Jack M. Greenberg Chief Financial Officer and Director\n------------------------- Director Donald R. Keough\nSignature Title Date --------- ----- ----\nDonald G. Lubin ------------------------- Director March 29, 1994 Donald G. Lubin\n------------------------- Director Andrew J. McKenna\nMichael R. Quinlan ------------------------- Chairman, Chief Executive March 29, 1994 Michael R. Quinlan Officer and Director\nEdward H. Rensi ------------------------- President and Chief Executive March 29, 1994 Edward H. Rensi Officer-U.S.A. and Director\n------------------------- Director Terry Savage\nPaul D. Schrage ------------------------- Senior Executive Vice March 29, 1994 Paul D. Schrage President, Chief Marketing Officer and Director\n------------------------- Director Ballard F. Smith\n------------------------- Director Roger W. Stone\nRobert N. Thurston ------------------------- Director March 29, 1994 Robert N. Thurston\nFred L. Turner ------------------------- Senior Chairman and Director March 29, 1994 Fred L. Turner\nB. Blair Vedder, Jr. ------------------------- Director March 29, 1994 B. Blair Vedder, Jr.","section_15":""}
{"filename":"33656_1993.txt","cik":"33656","year":"1993","section_1":"Item 1. BUSINESS DESCRIPTION OF BUSINESS Ethyl Corporation (the \"Company\") is a major producer of per- formance chemicals including fuel and lubricant additives, brominated flame retardants, polymer intermediates and catalysts, detergent intermediates, agricultural chemical intermediates, pharmaceutical intermediates, electronic materials, and bromine chemicals. The Company also owns Whitby, Inc. (\"Whitby\"), which in turn owns Whitby Pharmaceuticals, Inc. (\"Whitby Pharmaceuticals\"), which markets pharmaceutical products that are contract manufactured for it. Incorporated in Virginia in 1887, the Company employs approximately 5,500 people. The following discussion of the Company's businesses as of December 31, 1993, should be read in conjunction with the information contained in the \"1993 Financial Review\" section of Ethyl's Annual Report as of December 31, 1993, referred to in Item 7 below.\nChemicals The Company conducts its worldwide chemicals operations through the Petroleum Additives Division, which includes fuel additives and lubricant additives, and the Chemicals Businesses, which consist of three divisions - -- Olefins and Derivatives, Bromine Chemicals and Specialty Chemicals, which includes Electronic Materials. The Chemicals Businesses manufacture a broad range of chemicals, most of which are additives to or intermediates for detergents, plastics and elastomers, agricultural pesticides and herbicides, pharmaceuticals and electronic semiconductors. Most sales of the Chemicals Businesses products are made directly to manufacturers of such products, including chemical and\npolymer companies, pharmaceutical companies, and detergent manufacturers in the United States and throughout the world. The Petroleum Additives Division manufactures a broad range of additives for motor fuels and lubricating oils. Most sales of fuel additives for gasoline, diesel fuels and heating oils are sold directly to petroleum refiners and marketers, terminals and blenders, while lubricant additive packages are sold directly to companies producing finished oils and fluids in the United States and throughout the world. The Company produces a majority of its products in the United States and also has major production facilities in Belgium, Canada and France. The processes and technology for most of these products were developed in the Company's research and development laboratories. The Company's divisions operate in a highly competitive environment. Some market areas involve a significant number of competitors, while others involve only a few. The competitors are both larger and smaller than the Company in terms of resources and market shares. Competition in connection with all of the Company's products requires continuing investments in research and development of new products or leading technologies, in continuing product and process improvements and in providing specialized customer services. Principal Olefins and Derivatives products include linear alpha olefins and synthetic primary alcohols used as intermediates in the manufacture of detergents, plasticizers, polymers, synthetic lubricants and lubricant additives; poly alpha olefins used in the formulation of synthetic lubricants and personal-care products; and zeolite A, which is used as a builder in detergent formulations. Also produced are tertiary amines for disinfectants and sanitizers and alkenyl succinic anhydride for paper sizing.\nBromine Chemicals products include brominated flame retardants for use in polymers, clear brine fluids for use in oil and gas well drilling and completion, and bromine-containing chemicals used in water purification, in soil fumigation and as chemical intermediates; and organic and inorganic brominated compounds used as pharmaceutical, photographic and agrichemical intermediates; and also high-purity caustic potash and potassium carbonate used in the glass, chemical and food industries. Specialty Chemicals include the active ingredient in ibuprofen pain relievers; aluminum alkyl polymerization co-catalysts, high-molecular-weight phenolic antioxidants for polymers, ortho-alkylated phenols, diamines and anilines used as polymer additive intermediates; polymer modifiers; herbicide intermediates; organophosphorus intermediates used in insecticides; and Electronic Materials. Electronic materials primarily include polycrystalline silicon, which is produced in the Company's polysilicon production facility by a unique process developed by the Company. The same polysilicon plant also produces silane gas. These products are used in the semiconductor industry. Products of the Petroleum Additives Division include additives for gasoline and diesel fuels, additives for passenger-car and diesel crankcase lubricants, gear lubricants, transmission fluids and hydraulic fluids, as well as railroad-engine oil additives. Gasoline fuel additive products include lead and manganese antiknock compounds to increase octane and prevent power loss due to early or late combustion (engine knock); hindered phenolic antioxidants to prevent thermal degradation during storage and transport; corrosion inhibitors to prevent fuel storage and pumping system failures; detergent\npackages to keep carbon deposits from forming on fuel injectors, intake valves or carburetors and in combustion chambers; and dyes to provide color differentiation. Lead antiknock compounds, which are sold worldwide by the Petroleum Additives Division to petroleum refiners, remain one of the Company's largest product lines. The Company estimates that it accounts for approximately one-third of the total worldwide sales of lead antiknock compounds. For a number of years, lead antiknock compounds have been subject to regulations restricting the amount of the product that can be used in gasoline in the United States. Similar restrictions have been in effect in Canada since 1990. The North American market for these products in motor vehicles has effectively been eliminated, but the market for their use in piston aircraft and certain other applications has remained at about the same level for years and is expected to remain stable. As the Company has forecasted and planned, the market for these products in other major markets, particularly Western Europe, continues to decline as the use of unleaded gasoline grows. The contribution of lead antiknock compounds to the Company's net sales has declined to about 13% in 1993 from about 16% in 1992 and about 19% in 1991. The lead antiknock profit contribution to the Company's operating profit, excluding allocation of corporate expenses, is estimated to have been 49% in 1993, 50% in 1992 and 44% in 1991. Excluding the costs related to the planned cessation of lead antiknock compound production at the Company's Canadian plant, the 1993 lead antiknock profit contribution would have been about 52%. In recent years, the Company has been able to offset a continuing decline in shipments of lead antiknock compounds with higher margins due primarily to significant increases in selling\nprices. Any further decline in the use of lead antiknocks would adversely affect such sales and profit contributions unless the Company can offset such declines with increased market share and\/or higher selling prices. The Company currently produces some of its lead antiknock compounds in its subsidiary's Canadian plant and obtains additional quantities under a supply agreement with E.I. DuPont de Nemours & Company. On January 11, 1994, the Company announced an agreement with The Associated Octel Company Limited (\"Octel\") of London under which Octel has agreed to allocate a portion of its production capacity of lead antiknock compounds to the Company for sale and distribution through the Company's worldwide network. Ethyl also announced that its Canadian subsidiary would cease production of lead antiknock compounds by March 31, 1994. The agreement continues so long as the Company determines that a market continues to exist for lead antiknock compounds. Under the agreement with Octel, the Company has the right to purchase from Octel antiknock compounds which the Company estimates will be sufficient to cover its needs in any contract year. Purchases are at a fixed initial price per pound with periodic escalations and adjustments.\nIn addition to the supply agreement, Octel and the Company have agreed that the Company will assume the distribution for Octel of any of its lead antiknock compounds that are shipped in bulk. The Company believes the agreements with Octel will assure it of an ongoing efficient source of supply for lead antiknock compounds as the worldwide demand for these products continues to decline. It does not anticipate that the cessation of its Canadian antiknock operations and the entry into the Octel supply agreement will adversely affect its relations with its customers, nor will these changes have a material effect on its future\nresults of operations. The Company and Octel will continue to compete vigorously in sales and marketing of lead antiknock compounds. The Company also sells manganese-based antiknock compounds, HiTEC(R) 3000 (MMT), which are used in unleaded gasoline in Canada. The Company conducted extensive testing of this product prior to filing a request in 1990 for a fuel-additive waiver from the United States Environmental Protection Agency (the \"EPA\") required to begin marketing the additive for use in unleaded gasoline in the United States. The Company voluntarily withdrew its waiver application in November 1990 after public hearings and detailed exchanges of information with the EPA, when the EPA raised several health and environmental questions near the end of the 180-day statutory review period. The Company continued testing and filed a new waiver request in July 1991, followed by additional public hearings and detailed exchanges of information with the EPA. In January 1992, the EPA denied the Company's application for a waiver. An appeal was filed with the United States Court of Appeals for the District of Columbia Circuit contesting the EPA's denial of the application for a waiver for the use of the additive in unleaded gasoline. In April 1993, the Court remanded the case to the EPA for reconsideration within 180 days of its denial of the Company's waiver application, directing the EPA to consider new evidence and make a new decision. On November 30, 1993, the EPA determined that emissions data contained in the Company's application satisfy all Clean Air Act standards, but reported that it was not able to complete its assessment of the overall public health implications of manganese. The Company and the EPA mutually\nagreed to an 180-day extension, until May 29, 1994, to resolve this last remaining issue. The Petroleum Additives Division also produces diesel fuel additive products, including cetane improvers for consistent combustion and power delivery; amine stabilizers and hindered phenolic antioxidants to prevent degradation during storage and transport; cold flow improvers to enhance fuel pumping under cold-weather conditions; detergent packages to keep carbon deposits from forming on fuel injectors and in combustion chambers; dyes for fuel identification and leak detection; lubricity agents; and a conductivity modifier to neutralize static charge build-up in fuel and products for home heating oils. The division's lubricant additive products include (i) engine oil additive packages for passenger car motor oils for gasoline engines, heavy- duty diesel oils for diesel powered vehicles, diesel oils for locomotive, marine and stationary power engines and oils for two-cycle engines, (ii) specialty additive packages for automatic transmission fluids, automotive and industrial gear oils, hydraulic fluids and industrial oils, and (iii) components for engine oil and specialty additive packages such as antioxidants to resist high-temperature degradation, antiwear agents to protect metal surfaces from abrasion, detergents to prevent carbon and varnish deposits from forming on engine parts, dispersants to keep engine parts clean by suspending insoluble products of fuel combustion and oil oxidation, friction reducers to facilitate movement, pour point depressants to enable oils to flow at cold temperatures, corrosion inhibitors to protect metal parts, and viscosity-index improvers to control oils' rate of flow at low and high temperatures.\nMajor raw materials used by the Company's operating chemical divisions include ethylene, polybutene, process oil, aluminum and sodium and lead metals, 2-ethyl- 1-hexanol, isobutylene, and phenol and bisphenol-A, as well as electricity and natural gas as fuels, which are purchased or provided under contracts at prices the Company believes are competitive. The Company also produces bromine from extensive brine reserves in Arkansas. With separate, sharpened focus on two distinctly different businesses the Chemicals Businesses and Petroleum Additives--Ethyl took steps in 1993 to reorganize the Baton Rouge-based Chemicals Businesses while continuing to consolidate the Petroleum Additives Division's administrative, sales and research activities in Richmond, Virginia. The February 8, 1993, acquisition of Potasse et Produits Chimiques added organic and inorganic brominated compounds and high-purity caustic potash and potassium carbonate product lines to the Company's existing businesses. Recent developments include economic recovery for Ethyl's poly alpha olefins businesses which began in late 1993, supported by the recent introduction by several major U.S. oil companies of full or partially synthetic passenger car motor oils requiring the use of poly alpha olefins.\nIn 1993, new zeolite A capacity was added at the Houston Plant to support the product's continued market penetration as an environmentally accepted replacement for phosphate builders in laundry detergents. A line of polydecene emollients developed for nonoily personal-care end uses was commercialized and R&D developed new applications in detergents, stabilizers and cleansers for Ethyl's patented ADMOX(R) brand of low-water amine oxide.\nCommercialization of SAYTEX(R) 8010 flame retardant was accomplished in early 1993 followed by the successful start-up later in the year of a new production facility in Magnolia, Arkansas. The first commercial plant for SAYTEX(R) BT-93W flame retardant is scheduled for start-up in early 1994 in Magnolia. Also, in response to worldwide market demand for SAYTEX RB-100(R) flame retardant, used primarily in printed circuit boards, a multimillion-dollar investment program to increase capacity and improve quality has been completed at Magnolia. The Company is actively targeting the development of S(+)-ibuprofen (an enhanced version of ibuprofen). Construction of a new facility was completed in the fourth quarter of 1993 and is in the start-up phase. A plant expansion to increase production capability of ibuprofen also is in progress. All of these facilities are located at the Orangeburg, South Carolina plant. The late December 1992 acquisition of the marketing and sales activities of a lubricant additives business in Japan following the June 1992 acquisition of the petroleum additives products and technologies of Amoco Petroleum Additives Company and their subsequent integration into the Company's product lines also were part of a major ongoing effort to expand and improve the product lines and geographic coverage of the Petroleum Additives Division. As part of the consolidation of the Petroleum Additives Division, construction continues on a major Petroleum Additives research complex in Richmond, scheduled for completion in mid-1994. The market for lubricant additives has been experiencing significant changes as a result of market and regulatory demands. The demands for better fuel economy, reduced emissions and cleaner oils have led to new equipment design and more stringent performance requirements. Such requirements mean reformulation of\nmany products, new product development and more product qualification tests. To maintain and enhance a responsive worldwide product supply network for its petroleum additives, Ethyl is partially replacing the manufacturing capacity of products produced under contract for Ethyl by Amoco Petroleum Additives Company through June of 1995, and expanding capacity for other products. Ethyl has had a supply arrangement with Amoco since mid-1992, when it acquired Amoco's petroleum additives business. The new, more efficient facilities are scheduled for start-up, primarily in 1995, at Houston, Texas; Sauget, Illinois; Feluy, Belgium; and Natchez, Mississippi.\nPharmaceuticals Whitby offers a complete line of hydrocodone-based analgesic products, including LORTAB(R) products; VICON(R) products, which include prescription and over-the-counter vitamin and mineral products; and THEO- 24(R) products, which consist of a series of varying dosage bronchodilators. Other products include WINSOR(R) brand prescription dosage ibuprofen and over-the-counter products. Third-party manufacturers inspected by the United States Food and Drug Administration formulate and produce Whitby's products according to Whitby's specifications. Whitby sells its products to wholesalers, large pharmacy chains and institutional purchasers such as hospital chains and health maintenance organizations. In 1993, Whitby launched three new products: Duratuss(TM) prescription tablets for coughs and colds, Duratuss HD Elixir(TM) for the same indications, and a 400 mg product extension to its Theo-24 series of\nrespiratory products. In December 1993, Ethyl decided to discontinue pharmaceutical research projects previously conducted by Whitby Research, Inc., a subsidiary of Whitby. This will allow Whitby to focus on the acquisition of new products through purchase, license or strategic alliance. Whitby will also conduct, through a network of outside contract organizations, drug-development work on projects driven by the marketing group.\nResearch and Patents The Company spent approximately $76 million, $74 million and $69 million in 1993, 1992 and 1991, respectively, on research and development, which amounts qualified under the technical accounting definition of research and development. Total R&D and technical services support spending for 1993 was some $126 million, including $50 million related to technical services support to customers, testing of existing products, cost reduction, quality improvement and environmental studies. Substantially all of such activities were sponsored by the Company. Most research and development was related to the Company's chemical operations, but a portion was related to design and development of new drug molecules by Whitby Research prior to the decision to discontinue pharmaceutical research in December 1993. The Company owns more than 2200 active United States and foreign patents, including 113 U.S. patents and 178 foreign patents issued in 1993. Some of these patents are licensed to others. In addition, rights under the patents and inventions of others have been acquired by the Company through licenses. The Company's patent position is actively being managed and is deemed by it to be adequate for the conduct of its business.\nEnvironmental Requirements The Company is subject to Federal, state and local requirements regulating the handling, manufacture or use of materials (some of which are classified as hazardous or toxic by one or more regulatory agencies), the discharge of materials into the environment and the protection of the environment. It is the Company's policy to comply with these requirements and to provide workplaces for employees that are safe, healthy and environmentally sound and that will not adversely affect the safety, health or environment of communities in which the Company does business. The Company believes that as a general matter its policies, practices and procedures are properly designed to prevent any unreasonable risk of environmental damage, and of resulting financial liability, in connection with its business. The Clean Air Act Amendments of 1990 (\"the Amendments\") became Federal law on November 15, 1990. Because the EPA and the states are still in the process of completing and implementing definitive regulations, interpreting the Amendments and establishing detailed requirements, the Company is unable at this time to make any detailed assessment of the effect of the Amendments on its earnings or operations. Among other environmental requirements, the Company is subject to the Federal Comprehensive Environmental Response, Compensation and Liability Act (\"Superfund\"), and similar state laws, under which the Company has been designated as a potentially responsible party (\"PRP\") which may be liable for a share of the costs associated with cleaning up various hazardous waste sites, some of which are on the EPA's Superfund national priority list. Although, under some court interpretations of these laws, a PRP might have to bear more than its proportional share of the\ncleanup costs if appropriate contributions from other PRPs are not able to be obtained, the Company has been able to demonstrate it is only a de minimis participant at all but a few of the sites. Also, the Company has settled or resolved actions related to certain sites and generally has not had to bear significantly more than its proportional share in multiparty situations. Further, almost all of the sites represent environmental issues that are quite mature and that have been investigated, studied and in many cases settled. In de minimis PRP matters, the Company's policy generally is to negotiate a consent decree and to pay any apportioned settlement, enabling the Company to be effectively relieved of any further liability as a PRP, except for remote contingencies. In other than de minimis PRP matters, the Company's records indicate that unresolved exposures are expected to be immaterial. Because the Company's management has been actively involved in evaluating environmental matters, the Company is able to conclude that the outstanding environmental liabilities for unresolved PRP sites for which the Company would not be a de minimis participant should not be material. Compliance with government pollution-abatement and safety regulations usually increases operating costs and requires remediation costs and investment of capital that in some cases produces no monetary return. Operating and remediation costs charged to expense were $61 million in 1993 versus $51 million in 1992 and $38 million in 1991 (excluding depreciation of previous capital expenditures) and are expected to be somewhat higher in the next few years than in the past. Capital expenditures for pollution-abatement and safety projects, including such costs that are included in other projects, were about $30 million, $29 million and $25 million in 1993, 1992 and 1991, respectively. For each of the next few years, capital expenditures for these types of projects are likely\nto increase somewhat from current levels. Management's estimates of the effects of compliance with governmental pollution-abatement and safety regulations are subject to (i) the possibility of changes in the applicable statutes and regulations or in judicial or administrative construction of such statutes and regulations, and (ii) uncertainty as to whether anticipated solutions to pollution problems will be successful, or whether additional expenditures may prove necessary.\nFINANCIAL INFORMATION AS TO INDUSTRY SEGMENTS AND GEOGRAPHIC AREAS\nThe Company's remaining operations are substantially all in the Chemicals Industry. Geographic area information for the Company's operations for the three years ended December 31, 1993, is presented in the Annual Report on pages 26 and 27 (and the related notes on page 28) and is incorporated herein by reference.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nFinancial information about the Company's foreign and domestic operations and export sales for the three years ended December 31, 1993, is set forth in the Annual Report on pages 26 and 27 and in Notes 1, 3, 12, 14 and 15 of the Notes to the Financial Statements on pages 35, 36, 38, 39, 40, 41 and 42 and is incorporated herein by reference. See also information as to the Company's foreign lead antiknock compounds business under \"DESCRIPTION OF BUSINESS - Chemicals\" above. Domestic export sales to non-affiliates may be made worldwide but are made primarily in the Far East, Latin America and Europe. Foreign unaffiliated sales are made primarily in Europe, Canada, the Far East and the Middle East.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The following is a brief description of the principal plants and related facilities of the Company, all of which are owned except as stated below.\nLOCATION PRINCIPAL OPERATIONS Baton Rouge, Louisiana Research and product-development (2 facilities) activities\nBracknell, Berkshire, Research and testing activities England\nDeer Park, Texas (leased land) Production of poly alpha olefins\nElk Grove Village, Illinois Research and product-development (leased) activities\nFeluy, Belgium Production of aluminum alkyls, orthoalkylated anilines and phenols, lubricant additives, poly alpha olefins and linear alpha olefins\nHouston, Texas Production of aluminum alkyls, synthetic primary alcohols, linear alpha olefins, lubricant additive dispersants and blends, alkenyl succinic anhydride, orthoalkylated anilines and phenols, polycrystalline silicon, high-purity silane, zeolite A and other chemicals; research activities\nLouvain-la-Neuve, Belgium Research and customer technical service activities\nMagnolia, Arkansas Production of flame retardants, bromine, (2 facilities) ethylene dibromide, vinyl bromide, several inorganic bromides, agricultural chemical intermediates, tertiary amines, and polyimide foam; research activities\nNatchez, Mississippi Production of lubricant additives including mainly detergents\nOrangeburg, South Carolina Production of specialty chemicals, including pharmaceutical intermediates; and fuel additives, including antioxidants, diesel fuel cetane improver and manganese antiknocks; and orthoalkylated phenols, polymer modifiers and performance polymers; research activities\nSt. Louis, Missouri Research and product-development activities\nSarnia, Ontario, Canada Production of lead antiknock compounds1, lubricant additives, cold flow improvers and diesel fuel cetane improver\nSauget, Illinois Production of lubricant additives, including detergents, dispersants, antioxidants, antiwear agents, crankcase packages, transmission and gear packages and friction reducers\nThann, France Production of organic and inorganic brominated pharmaceutical, photographic and agrochemical intermediates, high- purity caustic potash and potassium carbonate; product development activities\n1 The Company will cease production of lead antiknock compounds by March 31, 1994.\nThe Company believes that its plants, including approved expansions, are more than adequate at projected sales levels. The Company currently has excess capacity in linear and poly alpha olefins and polysilicon. Operating rates of certain other plants vary with product mix and normal seasonal sales swings. The Company believes that its plants generally are well maintained and in good operating condition.\nThe Company owns its corporate headquarters offices in Richmond, Virginia, and its regional offices in Bracknell, Berkshire, England. The Company leases its executive offices in New York, New York, and Baton Rouge, Louisiana, and its regional offices in Brussels, Belgium; Mississauga, Ontario, Canada; Singapore; and Tokyo, Japan, as well as various sales and other offices. Whitby leases office space in Richmond, Virginia. The Company's research laboratory at Louvain-la-Neuve, Belgium, was completed in mid-1993. The Company also began construction in late 1992 of a $70-million lubricant and fuel additives research and product-development facility in Richmond, Virginia, scheduled for start-up in the summer of 1994. At that time, research and product-development activities at St. Louis, Missouri, will be phased out. All expenses in connection with the discontinuance of the St. Louis operations have been fully provided for. The Company is partially replacing the manufacturing capacity of Amoco's Wood River, Illinois, lubricant and fuel additives plant from which the Company currently is receiving product under a supply agreement. The new, more efficient facilities are scheduled for start-up in 1995 at Houston, Texas; Sauget, Illinois; Feluy, Belgium; and Natchez, Mississippi. The Company is obtaining lubricant additives, including crankcase packages and certain components, under a long-term supply agreement with a subsidiary of Mitsubishi Kasei Corporation from its petroleum additives plant in Yokkaichi, Japan. The Company also has a long-term services agreement for research and product development and customer technical services activities at the research facility associated with the petroleum additives plant in Yokkaichi, Japan.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS The Company and its subsidiaries are involved from time to time in legal proceedings of types regarded as common in the Company's businesses, particularly administrative or judicial proceedings seeking remediation under environmental laws, such as Superfund, and products liability litigation. A 1992 products liability suit is pending in a Minnesota state court against the Company, another chemical company, and the owner and leasing agent of a residence in Minneapolis at which two children are claimed to have been injured by ingesting soil and dust containing lead from peeling paint and automotive emissions. In recent years, many suits have been brought against paint manufacturers and landlords alleging personal injury caused by ingesting lead from paint found in paint chips, dirt and dust. Like these suits, the Minnesota suit just mentioned involves alleged injury from paint lead in chips, dirt and dust, but also involves alleged injury from gasoline lead in dirt and dust, as well. The Company believes the Minnesota suit is without merit with respect to the Company, but since the suit partially rests on a theory of harm to children from eating dirt containing automotive lead emissions, the Company is vigorously defending it. While it is not possible to predict or determine the outcome of the proceedings presently pending, in the Company's opinion they will not ultimately result in any liability that would have a material adverse effect upon the results of operations or financial condition of the Company and its subsidiaries on a consolidated basis.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company will be requesting that shareholders approve increasing the number of shares issuable pursuant to the stock option plan by 5.9 million shares.\nADDITIONAL INFORMATION - EXECUTIVE OFFICERS OF THE COMPANY The names and ages of all executive officers of the Company, as of March 25, 1994, are set forth on the following pages. The term of office of each such officer is until the meeting of the Board of Directors following the next annual shareholders meeting (April 28, 1994). All of such officers have been employed by the Company for at least the last five years, with the exception of Thomas E. Gottwald, who rejoined the Company August 1, 1991, following two years as General Manager of Tredegar Film Products, a division of Tredegar Industries, Inc., which was spun off to Ethyl shareholders in mid-1989, following assignments with Ethyl in Corporate Business Development and Strategic Planning.\nName Age Office *Bruce C. Gottwald 60 Chairman of the Board and of the Executive Committee, Chief Executive Officer, Director\n*Floyd D. Gottwald, Jr. 71 Vice Chairman of the Board, Director\n*Charles B. Walker 55 Vice Chairman of the Board, Chief Financial Officer and Treasurer, Director\n*Thomas E. Gottwald 33 President and Chief Operating Officer, Director\n*William M. Gottwald, MD 46 Senior Vice President and President of Whitby, Director\nE. Whitehead Elmore 55 Special Counsel to the Company's Executive Committee and Corporate Secretary\nSampson H. Bass, Jr. 64 Vice President - Secretary to the Executive Committee\nDavid A. Fiorenza 44 Vice President - Finance and Controller\nC. S. Warren Huang 44 Vice President - Research and Development\nDonald R. Lynam 55 Vice President - Air Conservation\nSteven M. Mayer 51 Vice President and General Counsel\nIan A. Nimmo 52 Vice President - Lubricant Additives\nHenry C. Page, Jr. 55 Vice President - Human Resources\nNewton A. Perry 51 Vice President - Fuel Additives\nA. Prescott Rowe 56 Vice President - External Affairs\n*Member of the Executive Committee\nFloyd D. Gottwald, Jr., and Bruce C. Gottwald are brothers. William M. Gottwald, MD, is a son of Floyd D. Gottwald, Jr. Thomas E. Gottwald is a son of Bruce C. Gottwald.\nCertain Agreements Between Albemarle and Ethyl The Chemicals Businesses have in the past engaged in numerous transactions with the Ethyl Businesses. Such transactions have included, among other things, the provision of various types of financial support by the Company. Although the Company will continue to provide certain support services to Albemarle and Albemarle will provide certain support services to the Company for a limited period of time, most of such services are expected ultimately to be discontinued. In addition to these services, for a more extended period of time, Albemarle will provide services to the Company at Orangeburg, South Carolina, and Feluy, Belgium, and Albemarle and the Company will exchange services at Houston, Texas.\nOrangeburg, South Carolina Agreements The Orangeburg, South Carolina plant consists of facilities for the production of petroleum additives and specialty chemicals. After the Distribution, Albemarle will operate for the Company the facilities that produce petroleum additives (the \"Orangeburg Additives Facility\") for a period of ten years, with an option by the Company to extend for an additional ten years. The operating agreement relating to the Orangeburg Additives Facility (the \"Orangeburg Operating Agreement\") provides that Albemarle will produce certain petroleum additive products meeting the Company's specifications and provide certain services and utilities customarily used by or reasonably necessary to maintain the Orangeburg Additives Facility in accordance with design capacity. At its option and upon 180 days' notice, the Company may assume responsibility for the operation of the Orangeburg Additives Facility, in which event Albemarle would continue to provide certain services and utilities for that facility.\nThe Company will reimburse Albemarle for certain costs specified in the Orangeburg Operating Agreement and will pay to Albemarle a monthly operating fee based on a percentage of such reimbursable costs. Albemarle will produce under a supply contract MMT for the Company in facilities owned by Albemarle. Albemarle also will be licensed by the Company, subject to certain restrictions, to produce and sell MMT for its own account to the extent of any excess not set aside for the Company under the supply contract. Albemarle will own the land on which the Orangeburg Additives Facility is located. In conjunction with Albemarle's operation of the Orangeburg Additives Facility for the Company, Albemarle will lease the land to the Company for a period of ten years, with an option by the Company to extend for an additional ten years. Albemarle and the Company will have a separate blending services agreement (the \"Orangeburg Blending Agreement\"), pursuant to which Albemarle will provide storage, blending and packaging services to the Company in connection with the operation of the Orangeburg Additives Facility. The term of the Orangeburg Blending Agreement will be for ten years, and the Company will have the option to extend for an additional ten years. Pursuant to the Orangeburg Blending Agreement, the Company will reimburse Albemarle for specified costs associated with the blending operations and will pay to Albemarle a monthly operating fee based on a percentage of such reimbursable costs. Pursuant to an antioxidant supply agreement, Albemarle will produce antioxidants for the Company at the Orangeburg plant. The Company will reimburse Albemarle for specified production costs and pay a monthly fee. The antioxidant supply agreement will be for ten years, and the Company will have the option to extend for an additional ten years.\nHouston, Texas Agreement The Houston, Texas plant consists of facilities for the production of petroleum additives, olefins and derivatives and specialty chemicals. After the Distribution, the Company will own the petroleum additives facility at the Houston plant (the \"Houston Additives Facilities\"), and Albemarle will own the facilities that produce olefins and derivatives and specialty chemicals. Albemarle and the Company will have a reciprocal agreement (the \"Houston Services Agreement\"), with respect to the operation of the Company's Houston Additives Facilities and Albemarle's chemical operations adjoining the Houston Additives Facilities. Pursuant to the Houston Services Agreement, the Company will provide to Albemarle certain services and utilities related to Albemarle's chemicals operations in Houston, while Albemarle will provide to the Company certain services and utilities related to the Company's petroleum additives operations in Houston. The term of the Houston Services Agreement is ten years, but any party receiving services and utilities may terminate one or more of such services or utilities upon giving 60 days' notice to the other party or may terminate all of such services and utilities upon giving 180 days' notice to the other party. Each party also has the right to extend for an additional ten years the Houston Services Agreement with respect to the services and utilities that it is receiving. Each party providing services will receive from the other party reimbursement of specified costs and a monthly service fee based on a percentage of such reimbursable costs.\nFeluy, Belgium Agreement The Feluy, Belgium plant consists of facilities for the production of petroleum additives, olefins and derivatives and specialty chemicals. After the Distribution, the Company will own and operate the petroleum additives facility at the Feluy, Belgium plant (the \"Feluy Additives Facility\"), and Albemarle will own the facilities that produce olefins and derivatives and specialty chemicals at the Feluy plant. Albemarle and the Company will have an agreement (the \"Feluy Services Agreement\"), with respect to the operation of the Company's Feluy Additives Facility. Pursuant to the Feluy Services Agreement, Albemarle will provide to the Company certain services and utilities related to the Company's petroleum additives operation in Feluy. The term of the Feluy Services Agreement is ten years, but the Company may terminate one or more of such services or utilities upon giving 60 days' notice to Albemarle or may terminate all of such services and utilities upon giving 180 days' notice to Albemarle. The Company also has the right to extend the Feluy Services Agreement for an additional ten years. Albemarle will receive from the Company reimbursement of specified costs and a monthly service fee based on a percentage of such reimbursable costs.\nIndemnification and Tax-Sharing Agreements Pursuant to an indemnification agreement between the Company and Albemarle, the Company will indemnify Albemarle for losses to Albemarle after the Distribution Date resulting from the conduct of the Ethyl Businesses, including environmental liabilities, before and after the Distribution Date, and Albemarle will indemnify the Company for losses to the Company after the Distribution Date resulting from the conduct of the\nChemicals Businesses, including environmental liabilities, before and after the Distribution Date. Tax liabilities, and related indemnification, are covered under a tax sharing agreement. Under that agreement the Company will be responsible for the taxes of the Ethyl Businesses and the Chemicals Businesses for periods prior to the Distribution, except with respect to taxes attributable to subsidiaries of the Company that will become subsidiaries of Albemarle in connection with the Distribution. Albemarle will be responsible for the taxes of the Chemicals Businesses for post-Distribution periods.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information contained on page 29 of the Annual Report under the captions \"Dividend Information & Equity Per Common Share\" and \"Market Prices of Common Stock & Shareholder Data\" and on pages 36 to 38 of the Annual Report in Notes 1, 10 and 11 of the Notes to Financial Statements is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA The information for the five years ended December 31, 1993, contained in the Five-Year Summary on pages 14 and 15 of the Annual Report is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe textual and tabular information concerning the years 1993, 1992 and 1991 contained in the \"1993 Financial Review\" section on pages 16 through 27 of the Annual Report (and the related notes on page 28) are incorporated herein by reference.\nAdditional information on restructuring costs from that included in the Annual Report is as follows: The major components of the $36.1 million in special charges in 1993 ($22.4 million after income taxes) included $14.2 million related to ceasing production at the Canadian lead antiknock facility of which $11.4 million was a noncash write-down of the remaining book value of the assets (which will reduce annual depreciation and amortization by about $1.5 million per year), $8.3 million for relocation of employees and other restructuring costs, $6.0 million covering manpower reductions of 55 employees and other costs in connection with discontinuing pharmaceutical research projects at Whitby Research, Inc., as well as $7.6 million for work force reductions of about 165 chemicals and corporate employees in the U.S. and Europe.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements contained on pages 30 through 34, the Notes to Financial Statements contained on pages 35 through 45, the Report of Independent Accountants on page 46 and the information under the caption \"Selected Quarterly Financial Data (Unaudited)\" on page 28 of the Annual Report are incorporated herein by reference.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Inapplicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained in the Proxy Statement under the caption \"Election of Directors\" concerning directors and persons nominated to become directors of the Company is incorporated herein by reference. See \"Additional Information -- Executive Officers of the Company\" at the end of Part I above for information about the executive officers of the Company.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The information contained in the Proxy Statement under the caption \"Compensation of Executive Officers and Directors\" concerning executive compensation is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained in the Proxy Statement under the caption \"Stock Ownership\" is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained in the Proxy Statement under the caption \"Election of Directors,\" specifically in the last several paragraphs of such section, is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) The following consolidated financial statements of the registrant included on pages 30 to 46 in the Annual Report are incorporated herein by reference in Item 8:\nConsolidated balance sheets as of December 31, 1993 and December 31,\nConsolidated statements of income, shareholders' equity and cash flows for the years ended December 31, 1993, 1992, and 1991\nNotes to financial statements\nReport of Independent Accountants\n(a) (2) See Index to Financial Statement Schedules of registrant and its consolidated subsidiaries at.\n(a) (3) Exhibits\nThe following documents are filed as exhibits to this Form 10-K pursuant to Item 601 of Regulation S-K:\n3.1 Restated Articles of Incorporation of the registrant (filed as Exhibit 3.1 to the registrant's Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference thereto).\n3.2 By-laws of the registrant.\n4.1 $500 million Credit Agreement, dated as of February 16, 1994.\n4.2 Indenture, dated as of June 15, 1985 (filed as Exhibit 4 to the registrant's Registration Statement on Form S-3 filed on June 27, 1985, and incorporated herein by reference thereto), as supplemented by the First Supplemental Indenture dated as of June 15, 1986 (filed as Exhibit 4.2 to the registrant's Registration Statement on Form S-3 filed on June 12, 1986, and incorporated herein by reference\nthereto), and the Prospectus Supplement, dated as of September 16, 1988, setting the terms for the public sale of $200,000,000 aggregate principal amount of its 9.8% Notes due September 15, 1998 (filed on September 16, 1988, and incorporated herein by reference thereto).\n10.1 Bonus Plan of the registrant (filed as Exhibit 10.1 to the registrant's Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference thereto).\n10.2 Incentive Stock Option Plan of the registrant (filed as Exhibit 10.2 to the registrant's Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference thereto).\n10.3 Non-Employee Directors' Stock Acquisition Plan (filed as Exhibit A to the registrant's Proxy Statement for Annual Meeting of Shareholders filed on March 17, 1993, and incorporated herein by reference thereto).\n10.4 Excess Benefit Plan of the registrant (filed as Exhibit 10.4 to the registrant's Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference thereto).\n10.5 Supply Agreement, dated as of December 22, 1993, between Ethyl Corporation and the Associated Octel Company Limited (filed as Exhibit 99 on the Registrant's Report on Form 8-K filed on February 17, 1994, and incorporated herein by reference thereto).\n11 Computation of Earnings Per Share.\n13 The registrant's Annual Report to Shareholders for the year ended December 31, 1993 (note 1).\n22 List of subsidiaries of the registrant.\n23 Consent of Independent Certified Public Accountants.\n__________________________\nNote 1. With the exception of the information incorporated in this Form 10-K by reference thereto, the Annual Report shall not be deemed \"filed\" as part of this Form 10-K.\n28 Trust Agreement Between Ethyl Corporation and NationsBank of Virginia, N.A. (filed as Exhibit 28 to the registrant's Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference thereto).\n99 Form 8-K filed on February 25, 1994.\n(b) Form 8-K as filed with the Commission on February 25, 1994.\n(c) Exhibits - The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules - The response to this portion of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPursuant 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.\nETHYL CORPORATION (Registrant)\nBy: \/s\/ Bruce C Gottwald Bruce C. Gottwald, Chairman of the Board\nDated: March 25, 1994\nPursuant 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 as of March 25, 1994.\nSignature Title\n\/s\/ Bruce C Gottwald Chairman of the Board, (Bruce C. Gottwald) Chairman of the Executive Committee, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Charles B Walker Vice Chairman of the Board, (Charles B. Walker) Treasurer, Chief Financial Officer and Director (Principal Financial Officer)\nSignature Title\n\/s\/ David A. Fiorenza Vice President - Finance and (David A. Fiorenza) Controller (Principal Accounting Officer)\n\/s\/ L B Andrew Director (Lloyd B. Andrew)\n\/s\/ Joseph C. Carter Jr Director (Joseph C. Carter, Jr.)\n\/s\/ Ronald V. Dolan Director (Ronald V. Dolan)\n\/s\/ Floyd D Gottwald Jr Vice Chairman of the Board (Floyd D. Gottwald, Jr.) and Director\n\/s\/ Bruce C. Gottwald Jr. Director (Bruce C. Gottwald, Jr.)\n\/s\/ Thomas E Gottwald President and Director (Thomas E. Gottwald)\n\/s\/ William M Gottwald Senior Vice President (William M. Gottwald) and Director\nSignature Title\n\/s\/ Gilbert M Grosvenor Director (Gilbert M. Grosvenor)\n\/s\/ Andre B. Lacy Director (Andre B. Lacy)\n\/s\/ Emmett J. Rice Director (Emmett J. Rice)\nINDEX TO FINANCIAL STATEMENT SCHEDULES OF REGISTRANT AND SUBSIDIARIES\nPages\nReport of Independent Accountants on Financial Statement Schedules\nETHYL CORPORATION AND SUBSIDIARIES\nSchedules:\nV - Property, Plant and Equipment for the years ended December 31, 1993, 1992 and 1991\nVI - Accumulated Depreciation, Depletion and Amortization of Property, Plant & Equipment for the years ended December 31, 1993, 1992 and 1991\nX - Supplementary income statement information for the years ended December 31, 1993, 1992 and 1991\nSchedules other than those listed above are omitted as the information is either not applicable, not required or has been furnished in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Ethyl Corporation\nOur report on the consolidated financial statements of Ethyl Corporation and Subsidiaries has been incorporated by reference in this Form 10-k from page 46 46 of the 1993 Annual Report to Shareholders of Ethyl Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand COOPERS & LYBRAND\nRichmond, Virginia January 31, 1994\nETHYL CORPORATION AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION for the years ended December 31, 1993, 1992, and 1991 ( In Thousands )\nCol. A Col. B Item Charged to Costs and Expenses 1993 1992 1991 ---- ---- ---- Maintenance and repairs: $96,851 $83,463 $80,991 ======= ======= =======\nAmortization of intangible assets, taxes, other than payroll and income taxes, royalties and advertising costs are less than one percent of revenue as reported in the related income statements for 1993, 1992 and 1991.\nEXHIBIT INDEX\nNumber and Name of Exhibit Page Number\n3.1 Restated Articles of Incorporated by reference - Incorporation see Page 34\n3.2 By-laws Pages 46 through 75\n4.1 $500 million Credit Agreement, Pages 76 through 185 dated as of February 16, 1994\n4.2 1988 $200,000,000 Debt Incorporated by reference - Offering see Page 35\n10.1 Bonus Plan Incorporated by reference - see Page 35\n10.2 Incentive Stock Option Incorporated by reference - Plan see Page 35\n10.3 Non-Employee Directors' Stock Incorporated by reference - Acquisition Plan see Page 35\n10.4 Excess Benefit Plan Incorporated by reference see Page 35\n10.5 Supply Agreement between Ethyl Incorporated by reference Corporation and Associated see Page 35 Octel Company\n11 Computation of Earnings Page 186 Per Share\n13 Annual Report Pages 187 through 238\n22 List of Subsidiaries Pages 239\n23 Consent of Independent Page 240 Certified Public Accountants\n28 Trust Agreement Incorporated by reference - see Page 36\n99 Form 8K filed on February 25, 1994 Pages 241 through 261","section_15":""}
{"filename":"813672_1993.txt","cik":"813672","year":"1993","section_1":"ITEM 1. BUSINESS\nCadence Design Systems, Inc. (\"Cadence\" or the \"Company\") develops, markets, and supports electronic design automation (\"EDA\") software products that automate, enhance and accelerate the design and verification of integrated circuits (\"ICs\") and electronic systems. Cadence's product lines are composed of suites of software packages or tools, integrated through Cadence's proprietary software architecture.\nCadence was formed as a result of the merger of SDA Systems, Inc. (\"SDA\") into ECAD, Inc. (\"ECAD\") in May 1988. ECAD commenced operations in 1982. SDA commenced operations in 1983. The Company's name was changed to Cadence Design Systems, Inc. in June 1988. In March 1989, Cadence acquired Tangent Systems Corporation (\"Tangent\"). In December 1989, Cadence merged with Gateway Design Automation Corporation (\"Gateway\"), a leading EDA supplier of digital logic simulation software. In July 1990 Cadence merged with Automated Systems, Inc. (\"ASI\"), a company that marketed products and services related to the design and manufacture of electronic printed circuit boards (\"PCBs\") to the aerospace, defense, computer and telecommunications industries. In December 1991 Cadence merged with Valid Logic Systems Incorporated (\"Valid\"), a company that developed and supported EDA software used to design electronic systems, PCBs and applications for electronic product designs involving advanced packaging technology such as hybrids and multi-chip modules (\"MCMs\"). In June 1993 Cadence acquired the business and certain assets of Comdisco Systems, Inc. (\"Comdisco\") a subsidiary of Comdisco, Inc. Comdisco develops, markets and supports digital signal processing software products in the electronic systems applications area. In December 1993 the Company sold its ASI division and reported the operating results of ASI as discontinued operations for all prior years.\nValid had acquired two companies by merger in February 1989: Integrated Measurements Systems, Inc. (\"IMS\"), a company that manufactured and marketed verification systems used in testing prototype application specific integrated circuits (\"ASICs\"), and Analog Design Tools, Inc. (\"ADT\"), a supplier of computer-aided engineering (\"CAE\") software for the design of analog electronic circuits.\nTHE ELECTRONIC PRODUCT DEVELOPMENT CYCLE\nELECTRONIC DESIGN AUTOMATION EDA refers to the use of engineering software to design electronic circuits and systems. A critical and enabling technology for the global electronics industry, EDA allows engineers to develop complex and high quality electronic products within accelerated time-to-market schedules. EDA software is one of the key forces driving electronics innovation and production. Virtually all complex computer, telecommunication, aerospace and semiconductor projects depend on advanced EDA solutions to handle the large amounts of data associated with these designs. In addition, the short product life cycles of consumer electronics products depend on the accelerated design schedules that EDA software allows. EDA software can literally cut months from a production schedule, allowing design teams to complete projects in a timeframe that would be impossible if done manually. Electronics manufacturing has a synergistic relationship with EDA. Without EDA simulation software to verify design performance, the design quality required for profitable high volume production of ICs and PCBs would be compromised. EDA technology has also enabled the quick production time and enormous market growth of semi-custom circuits and subsystems such as ASICs, Programmable Logic Devices (\"PLDs\"), Field Programmable Gate Arrays (\"FPGAs\") and MCMs. EDA systems address two major functions in the electronic product development cycle: electrical design, often referred to as CAE, and physical design, often referred to as computer-aided design (\"CAD\"). Together, CAE and CAD address the major phases in the design of electronic systems, PCBs, MCMs, ASICs, PLDs, FPGAs and full-custom ICs.\nCAE DESIGN PROCESSES The electrical design process involves design description, model development and simulation of the design's behavior and timing performance. Additional design automation technologies, such as architectural design and logic and test synthesis, can simplify the design entry process; IC floorplanning can provide greater accuracy in simulation. Design description (called design entry, design capture or schematic capture) is the first step in the electronic design process. To handle the complexity of large designs, design entry often consists of several levels of design description. At the highest level of abstraction, a design can be expressed in a behavioral description, a convention that allows engineers to describe large and complex designs quickly. Behavioral design description typically involves the use of equations, or a special design description language called a Hardware Description Language (\"HDL\"). For digital designs, the most common HDLs are Verilog(R) HDL, a language developed by Cadence that is now in the public domain, and VHDL, a language standardized and backed by the U.S. Department of Defense and supported by Cadence as well as many other EDA vendors. A similar standard is emerging for analog design. Cadence is developing an analog hardware description language (\"AHDL\") which it will seek to make an industry-standard. Much as a sketch is detailed into a blueprint before building a house, behavioral descriptions must be detailed into lower-level descriptions (also called structural designs) before the IC or PCB can be manufactured. This process can be done manually, or in an automated fashion using a process called logic synthesis and a software tool such as the Cadence Synergy(TM) synthesizer. In structural design, the engineer specifically defines components, their interconnections, and associated physical properties. This description can be the text file produced by logic synthesis, or a graphical drawing called a schematic. In structural design, critical design time is saved by pulling components from an electronic library and including them in the design, rather than recreating symbols and data for each design. A database, containing the design's electrical characteristics, interconnections and specific design rules, is automatically created and used as the foundation for subsequent design steps. Simulation is used to verify the design electronically before it is manufactured, enabling engineers to explore design alternatives quickly and to catch costly design errors before the design is manufactured. Simulation can be performed with different levels of design description: behavioral, structural and mixed-level. These levels allow designers to test their design concept, actual structure and performance, and a combination of concept and structure. A key element in the simulation process is the use of component libraries containing software models of commonly used parts. These are either developed and supplied by Cadence, or are provided by third-parties such as ASIC vendors or independent modeling companies that have certified their libraries for use with Cadence's simulation products.\nWhen the functionality and timing are determined to be correct, the engineer generates a netlist. A netlist is a non-graphic description, in list form, of all design components and interconnects. The netlist is the link between the CAE design environment and the CAD process.\nCAD DESIGN PROCESSES An electronic product's physical design process varies depending on whether the final product is a full-custom IC, an ASIC or a PCB. However, the physical design process typically includes the placement of devices or components, electrical routing or wiring between those devices and components, analysis of the layout to check for compliance with design rules and performance specifications and the generation of data for use in manufacturing and test activities.\nIf the design is a full custom IC, the process includes chip-level architectural design, creation of cells and blocks, floorplanning, placement, routing and compaction of the cells\/blocks, analysis of conformance to electrical and physical design rules, analysis of wire lengths, load factors and timing performance, and generation of mask data for chip fabrication. If the design is produced as a PCB or MCM incorporating off-the-shelf components, full custom ICs and\/or ASICs, physical design typically includes floorplanning and pre-placement of critical components, automatic or interactive component placement, analysis of thermal conditions and high-frequency transmission line characteristics, analysis of testability and generation of test documentation, pre-manufacturing clean-up or \"glossing\" of the board design, and generation of a wide range of manufacturing data and artwork.\nCADENCE'S EDA PRODUCT FAMILY\nCadence's full line of integrated EDA software solutions has been developed to support engineers at two levels. At one level, individual engineers need solutions to solve their specific design needs. A second level is to support teams of engineers working on larger projects. These engineers need to share information across the entire company and can do so effectively with a variety of solutions from Cadence.\nCadence offers a full line of integrated EDA solutions for three basic design areas: IC design for digital, analog and mixed-signal devices; system design for both digital and analog systems; and ASIC design, particularly for high-performance sub-micron ASICs.\nThese three areas include solutions for the electrical and physical design of all types of systems, subsystems, and ICs, including PCBs, MCMs, hybrids, ASICs, PLDs, FPGAs, and full custom and semi-custom ICs.\nThe major advantages of Cadence products are in the areas of design methodologies and integration of electrical and physical design tools. Cadence's commitment to industry standard hardware platforms, operating systems and networking protocols allows users to configure an open design environment tailored to their specific needs. As design needs grow, the Cadence design environment can be expanded to include additional Cadence tools or third-party tools. Customizing environments can be handled through Cadence's Spectrum Services Group, responsible for working with customers to define and implement design environments optimized for customer project or product needs.\nPRODUCT STRATEGY AND PRODUCTS Cadence's goal is to provide technology that accelerates the creation of innovative electronic products, enabling designers to bring complex products to market quickly and reliably. To meet this goal consistently, Cadence has adopted the following core product strategies: o Focus development efforts on collapsing the most complex and time-consuming aspects of the design process o Provide full integration of leading-edge tools into a unified environment o Deliver solutions that combine software tools and advanced design methodologies to streamline the overall design process\nCORE PRODUCT TECHNOLOGY Cadence believes that within its integrated solutions approach, customers still demand high performance point tools for certain functions. By focusing technology development efforts to address the most complex and time-consuming aspects of the design process, Cadence has delivered a suite of individual design tools that has become well known in the industry. These tools, which address all major areas of the design process, include: o Allegro(TM) and Prance-XL(TM) for board and MCM layout, along with integrated layout analysis tools, DF\/SigNoise(TM), DF\/Thermax(TM), and DF\/Viable(TM) o Analog Artist(TM) and Analog Workbench(TM) for analog IC and system design, respectively o Composer(TM) and Concept(TM) design entry environments o Design Framework II(TM) framework technology o Dracula(R) and Diva(TM) for verification o Gate Ensemble(TM), Cell Ensemble(TM) and Block Ensemble(TM) for place and route o Preview(TM) for ASIC and IC floorplanning o Profile(TM) analog behavioral language o Spectre(TM), Cadence Spice(TM) and SpicePlus(TM) for analog simulation o Synergy(TM) family for circuit synthesis and optimization o Verilog-XL(TM) and Leapfrog(TM) VHDL for top-down digital simulation o Virtuoso(TM) products for custom IC layout and library development\nOPEN ENVIRONMENT Cadence pioneered the ability to link and manage a variety of design tools under a consistent graphical user interface with the introduction of its Design Framework(TM) in 1985. In 1990 Cadence delivered Design Framework II, so that designers can work with multiple tools more efficiently. Through its communication and design management features, Design Framework II also improves project and data management, critical for today's large designs and design teams. Design Framework II gives users an easy-to-use EDA software system, which can easily be customized, combined with third party tools, and ported to new computer platforms as they become available. Cadence's software operates on industry standard workstations from Digital Equipment Corporation, Hewlett-Packard\/Apollo, International Business Machines Corporation and Sun Microsystems, Inc. Cadence believes that it is well positioned to port its systems quickly to other UNIX-based workstations that may gain broad customer acceptance in the future. The CAD Framework Initiative (CFI), a standards committee comprised of EDA vendors and customers, has developed a reference architecture as an initial step towards a universal framework definition. As a founding member, Cadence works closely with CFI to develop this standard, and is advancing Design Framework II to adhere to CFI's evolving guidelines.\nINTEGRATED DESIGN SOLUTIONS Cadence offers a full line of EDA software combined with framework technology and advanced design methodologies to provide complete EDA solutions that enhance productivity. IC DESIGN Cadence's products have been used in every major electronic product design ranging from microprocessors that are at the heart of personal computers and workstations, to mixed signal chips that are driving the telecommunications and networking industries. Cadence's IC solutions feature proven tools for custom library development and editing, automated custom design, advanced digital and analog simulation, and IC physical verification. Building on this full-line of IC tools, Cadence offers complete, front-to-back solutions for designing digital, analog, mixed-signal and microwave ICs. These solutions streamline the design of complex chips and help design teams get to market with innovative, high quality products. For each step in the IC design process Cadence provides a complete design environment to meet individual design tasks. Cadence's solution includes the Virtuoso(TM) product family of custom layout tools supporting polygon layout, symbolic layout and layout synthesis; the Ensemble(TM) product family providing automatic place and route for both ASIC and custom cell-based design styles; Chip Assembly Solution for multi-layered block placement and routing; the Diva(TM) product family of interactive verification tools; and the DRACULA product family of physical verification tools. For analog designers, Cadence offers complete front-to-back solutions for analog, mixed-signal and microwave circuits. The Analog Artist for IC design provides advanced simulation, layout and verification, featuring products like the Profile(TM) behavioral modeling and simulation software and the Spectre(TM) high-speed circuit simulator. This solution supports design teams with productive tools for fast, early evaluation of design alternatives on complex analog designs, allowing teams to manage the critical interdependencies between electrical design and physical layout. Cadence's front-to-back IC solution includes a unique timing-driven design methodology to minimize costly downstream iterations. All tools, from synthesis and simulation to floorplanning and place and route, share critical timing information to maintain consistency and ensure that key performance requirements are met. SYSTEM DESIGN Cadence provides complete front-to-back digital and analog system design solutions built around the Concept design entry system; the Verilog-XL and Leapfrog VHDL simulators; and the Allegro PCB\/MCM physical design system.\nAllegro, one of the industry's most comprehensive and production-proven systems design environments includes: the DF\/Viable(TM) reliability analyzer, the DF\/SigNoise(TM) and signal integrity analysis modules, the DF\/Thermax(R) thermal analysis software, and the Prance- XL(TM) routers. For analog board and system design, Cadence provides the Analog Workbench, for top-down, front-to-back analog design. The Analog Workbench provides simulation tools, integrated physical layout, extensive analog model libraries and advanced analysis tools for tasks such as thermal analysis and post-layout simulation with extracted temperatures. Cadence's system design tools, combined with design methodologies such as rules-driven design and correct-by-design, allow engineers to shorten design cycles and improve the product quality of high-speed PCBs, MCMs, hybrids and multiwire boards. With Cadence's solutions, important design or technology considerations are defined in advance and are automatically checked and enforced throughout the design process to shorten design cycles and optimize designs for performance, quality and cost. For additional accuracy, flexibility and overall process control, Cadence's unique \"synchronized\" library approach and in-process analysis tools cover electrical, thermal, reliability, testability, manufacturing and design management constraints. ASIC DESIGN Cadence helped pioneer the use of top-down design by ASIC designers with its Verilog-XL simulator and Verilog(R) HDL design language. Building on what is now the most broadly used top-down method in the industry, Cadence offers a complete and production- proven top-down design system. Included is a flexible environment with Composer(TM) mixed-level design entry using either Verilog HDL or VHDL; large-capacity, high- performance logic synthesis and optimization with the Synergy and Optimizer(TM) synthesis software; fully integrated mixed-level logic simulation with Verilog-XL(TM) and Leapfrog(TM) VHDL verification tools; and the Preview(TM) floorplanner that enable the sharing of consistent timing data from design entry through place and route. Completing the ASIC design process is Cadence's Gate Ensemble place and route system. A new series of design-for-test tools, offering advanced test synthesis and test pattern generation capabilities, helps to shorten ASIC design cycles and improve yields. In addition, Cadence's extensive list of over 185 ASIC libraries and endorsements from major ASIC vendors help ensure a production path for the most complex, leading-edge ASIC designs.\nMARKETING AND CUSTOMERS CUSTOMERS AND MARKETING STRATEGY Cadence's customers and target markets include computer manufacturers, consumer electronics companies, defense electronics companies, merchant semiconductor manufacturers, ASIC foundries and telecommunications companies. In addition, Cadence licenses its products to international distributors in certain countries (see \"International Sales\" below in this \"Business\" section). In 1993, 1992 and 1991 one customer, Cadence's distributor in Japan, Innotech Corporation (\"Innotech\"), accounted for 13%, 14% and 13% of total revenue, respectively.\nCadence's principal marketing objectives are: o Offer high quality, complete and integrated design solutions o Provide best-in-class technologies in critical design areas o Deliver a standards-driven, open design environment o Utilize Cadence's worldwide resources to solve customers' complex design challenges and serve global customers\nCUSTOMER SUPPORT Cadence's support group helps tailor new tools to a customer's existing design environment, train designers on how to best utilize their EDA software and provide ongoing software updates to enhance product capabilities. The backbone of the global customer support process is the customer response center program. These centers give Cadence customers worldwide access to solution and product experts. A dedicated team of application engineers is\navailable to address customer applications issues as well as provide links between customers and Cadence's product developers.\nCADENCE SPECTRUM SERVICES Customizing design automation systems can require a major time and resource investment from the customer. Spectrum Services provides a structured consultative approach to analyzing the design process. After an extensive review of a customer's business and technical objectives and design processes, a comprehensive plan is developed for an advanced custom design environment. By integrating Cadence's solutions with the customer's software tools and third-party and custom-designed tools and augmenting the software with expert advice on streamlining the design process, customers benefit from a custom optimized design environment.\nCUSTOMER PARTNERSHIPS Cadence has established close working relationships with a number of semiconductor manufacturers and electronic systems companies based on a business partnership model that has become a central business model for the Company. To ensure that research and development activities are properly prioritized, and also that finished products meet customers' needs, major new product developments begin after collaboration with a Cadence customer\/partner. There are presently several variations of Cadence partnerships: four groups of technology partnerships (involving Cadence's IC, HDL, Systems Design and Systems Physical Design Groups, respectively) and a fifth group that focuses on development of specific products (\"Product Development Partnerships\").\nThese technology partnerships allow Cadence to work with customers' designers in defining and developing state-of-the-art solutions for current and emerging design approaches. Through an engineer exchange program, customers will often work on-site at Cadence facilities, giving Cadence valuable insight into customer product planning. Product Development Partnerships are generally directed at the development and refinement of specific tools.\nINDUSTRY ALLIANCES Cadence cooperates with other design automation vendors to deliver full-scope technology to its customers. Through Cadence's Connections(TM) Program, participating companies can integrate their products and technologies more easily into Cadence's design framework. This provides customers with the flexibility to mix and match third-party and proprietary tools to specifically meet their design automation needs. Today over 70 companies have integrated their tools into Cadence's design framework.\nUNIVERSITY SOFTWARE PROGRAM Cadence supports EDA research by sharing its design automation technology and expertise with universities. More than 500 universities worldwide participate, including the University of California at Berkeley, Duke University, the Massachusetts Institute of Technology and Stanford University.\nSALES\nAs of December 31, 1993, Cadence had 796 employees engaged in field sales and sales support, representing approximately 32% of its total employees. Cadence's sales people present Cadence and its products for licensing to prospective customers, while applications engineers provide technical pre-sales as well as post-sales support. Due to the complexity of EDA products, the selling cycle is generally long, with three to six months being typical. Activities during this sales cycle typically consist of a technical presentation, a product demonstration, a design benchmark and often, an on-site customer evaluation of Cadence software.\nNORTH AMERICAN SALES In the domestic market Cadence uses a direct sales force, utilizing both sales people and applications engineers in each territory to license its products. As of December 31, 1993, Cadence had 419 regional sales people and applications engineers licensing and supporting Cadence's products in the United States and Canada. Cadence maintains domestic sales and support offices at various locations across the United States.\nINTERNATIONAL SALES In Europe and Asia Cadence markets and supports its products primarily through 12 majority owned subsidiaries, which, as of December 31, 1993, employed 86 salespeople and 291 other sales and support personnel.\nCadence licenses its products in Japan through three distributors: Innotech, Kanematsu Electronics and Sony Tektronics. Cadence's systems products are marketed in Japan through a wholly-owned subsidiary and, until 1992, through a distributor, CIC, Inc. In March 1992 Cadence reached an agreement to acquire CIC, Inc. and consolidated its systems product marketing in Japan utilizing its subsidiary in Japan, Cadence Design Systems K.K. (\"Cadence K.K.\").\nCadence also serves its international customers through a manufacturer's representative in Europe, European Silicon Structures B.V. (\"ES2\"). The Company also uses distributors in various countries. In Singapore, Hong Kong, Brazil, Australia, India and The People's Republic of China, Cadence uses CAD\/CAM Systems, Modern Devices Ltd., Quick Chip Eng. E. Projectos Ltd., Cadence Design Systems Pty Ltd., Wipro Information Technology and IMAG Industries, Inc. and ReMA Ltd., respectively, as its distributors.\nRevenue from international sources was $183.6 million, $215.4 million and $197.6 million or approximately 50%, 51% and 52% of total revenue for the years ended December 31, 1993, 1992 and 1991, respectively.\nPrices for international customers are quoted from an international price list. The list is maintained in U.S. dollars but reflects the higher cost of doing business outside the United States. International customers are invoiced in U.S. dollars using current exchange rates or the local currency. In light of the large portion of Cadence's revenue derived from international sales, if the dollar strengthens in relation to the Japanese yen or certain European currencies, Cadence's revenue from international sales may be adversely affected. Cadence enters into forward exchange contracts to reduce the impact of foreign currency fluctuations resulting from transaction gains and losses. Cadence is required to have United States Department of Commerce export licenses for shipment of its products outside the United States. Although to date Cadence has not encountered any material difficulty in obtaining these licenses, any difficulty in obtaining necessary export licenses in the future could have an adverse effect on revenue.\nForeign subsidiaries' marketing and support expenses are incurred in local currency and license fees paid by the subsidiaries to Cadence are paid in local currency or U.S. dollars. Cadence is subject to the currency conversion risks inherent in international transactions. It is Cadence's policy to manage and minimize its foreign exchange risks.\nSERVICE AND SUPPORT\nSTANDARD SERVICE AND SUPPORT Cadence believes that customer support is a key factor in successfully marketing EDA products and generating repeat orders. A majority of Cadence's customers have purchased one-year renewable maintenance contracts.\nProduct maintenance contracts entitle the customers to product updates, documentation and ongoing support. Cadence tracks all service reports using an on-line database that provides a mechanism for tracking progress in solving any reported problem from first report to final software solution.\nENHANCED SERVICE AND SUPPORT Installing a new design automation system, tailoring it to a customer's design environment and training designers in the efficient use of this new system requires a major time and resource investment from the customer. In response to customer requests, Cadence has developed an enhanced consulting service capability. The Cadence consulting services team is a group of Cadence employees whose services can be retained by customers to provide a wide range of engineering activities from specialized training to custom programming projects or contract design. These services are intended to assist customers in becoming productive quickly through use of Cadence's products, thereby improving customer satisfaction and increasing the likelihood of follow-on sales.\nPRODUCT DEVELOPMENT AND ENGINEERING\nAs of December 31, 1993, Cadence's product development was performed by 750 employees, 476 employees located at its research and development facilities in San Jose, Foster City, Santa Cruz and San Diego, California, 106 employees in Chelmsford, Massachusetts, 59 employees in India, 13 employees in Taiwan, 15 employees in Lawrence, Kansas, 2 employees in Ohio and 5 employees in Albany, New York. The development group includes experts in database structures and industry specific algorithm technology. In June 1990, the Company entered into a joint venture (\"EuCAD\") as majority owner with ES2. During 1992, the Company acquired the minority interest in the joint venture. EuCAD has 26 employees in the U.K. and 3 employees in France and specializes in research and development activities in the EDA and ASIC design markets. The Company also has 45 employees in Beaverton, Oregon at its IMS subsidiary.\nFor the years ended December 31, 1993, 1992 and 1991 Cadence's research and development expenses were approximately $84.3 million, $81.2 million and $84.3 million (before capitalizing approximately $15.2 million, $14.7 million and $16.2 million of software development costs in 1993, 1992 and 1991), respectively. Cadence began capitalizing certain of its software development costs in 1986 in accordance with Statement of Financial Accounting Standards No. 86. See Note 3 of Notes to Consolidated Financial Statements at December 31, 1993 for a more complete description of Cadence's capitalization of certain software development costs.\nCertain faculty members from the University of California at Berkeley, considered to be a leading university for IC design software research, have served as consultants to Cadence since its inception. These consultants have helped Cadence to stay abreast of the latest developments and directions in the rapidly changing IC design software industry.\nCOMPETITION\nCadence competes with a number of companies in each of Cadence's tool categories, as well as with internal CAD development groups of potential customers. The EDA software industry is characterized by rapid technological change and is intensely competitive. In Cadence's opinion, the principal competitive factors in its markets include performance, ease of use, breadth of tool offering, open system architecture, software portability, pre-sales and post-sales support and price.\nPROPRIETARY RIGHTS\nCadence relies principally upon a combination of copyright and trade secret laws and license agreements to protect Cadence's proprietary interest in its products. Cadence's products are generally licensed to end users pursuant to a license agreement that restricts the use of the products to the customer's internal purposes. Cadence protects the source code version of its products as a trade secret and as an unpublished copyrighted work. Cadence has made portions of its source code available to certain customers under very limited circumstances, subject to confidentiality, use and other restrictions. Despite these precautions, it may be possible for third parties to copy aspects of Cadence's products or to obtain and use information that Cadence regards as proprietary without authorization. In addition, effective copyright and trade secret protection for software products may be unavailable in certain foreign countries.\nCadence believes that patent, trade secret and copyright protection are less significant to Cadence's success than factors such as the knowledge, ability and experience of Cadence's personnel, new product development, frequent product enhancements, name recognition and ongoing reliable product maintenance. Cadence does not believe that its products or processes infringe on existing proprietary rights of others.\nDRACULA(R), Verilog(R), Prance(R), Verifault-XL(R) and Thermax(R) are registered trademarks of Cadence and substantially all of the other Cadence product and product family names used herein are trademarks of Cadence.\nMANUFACTURING AND BACKLOG\nCadence's software production operations consist of configuring the proper version of a product, recording it on magnetic tape or other recording media and producing user manuals and other documentation. Shipments are generally made within two weeks of receiving an order. In light of the short time between order and shipment of Cadence's products, Cadence generally has relatively little backlog at any given date.\nCadence's product line includes a series of design verification systems offered by IMS. Logic Master is a family of design verification systems designed to work with most computer systems, workstations, or terminals to receive and execute test commands and report the results of test procedures. These systems are designed to match varying customer requirements. Generally, they differ from one another as to speed, size of the device to be verified, flexibility in the number and variety of applications in which a system can be used and price.\nEMPLOYEES\nAs of December 31, 1993, Cadence employed 2,476 persons, including 1,449 in sales, marketing, support and manufacturing activities, 750 in product development and 277 in management, administration and finance. Of these employees, 1,949 were located in the United States and 527 were located in 15 other countries. None of Cadence's employees are represented by a labor union and Cadence has experienced no work stoppages. Cadence believes that its employee relations are good.\nCompetition in recruiting of personnel in the software industry is intense. Cadence believes that its future success will depend in part on its continued ability to recruit and retain highly skilled management, marketing and technical personnel.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nCadence leases approximately 692,000 square feet of facilities comprised of four buildings located at 535-575 River Oaks Parkway (the \"555 Facility\"), three buildings at Seely Road and three buildings at Plumeria Drive in San Jose, California for an annual rental of approximately $10,600,000. Cadence also leases approximately 100,000 square feet of facilities in Chelmsford, Massachusetts at an annual rate of approximately $450,000. Cadence leases additional facilities for its sales offices in the United States and various foreign countries, and research and development facilities in San Diego, Foster City and Santa Cruz, California, Lawrence, Kansas, Albany, New York, United Kingdom, France, Taiwan and India at an aggregate annual rental of approximately $7,000,000.\nCadence leases design center facilities in Blue Bell, Pennsylvania and Torrance, California, of approximately 11,700 and 13,700 square feet, respectively, at a combined annual rate of approximately $500,000. Cadence has contracted for the early termination of the Torrance facility lease and expects this transaction will close by April 1994 for approximately $600,000. In connection with its sales of ASI, Cadence has entered into a sublease agreement with ASI for the rental of the Blue Bell facility.\nCadence also leases approximately 75,000 square feet in a building in Beaverton, Oregon, at a current annual rental of approximately $540,000, which houses manufacturing, engineering, marketing and administrative operations for its IMS subsidiary.\nDuring June 1989 Cadence acquired a 49% interest as a limited partner in a real estate partnership. Also in 1989, the Company signed agreements to lease the four buildings of the 555 Facility from the limited partnership that is the owner of the 555 Facility for a period of ten years. During June 1991 the Company acquired a 46.5% interest as a limited partner in an additional real estate partnership, and signed agreements to lease upon completion of construction three buildings proximate to the 555 Facility in San Jose, California from the limited partnership for a period of fifteen years, which commenced during the second quarter of 1992. During June 1991 the Company acquired an 80% interest in a third real estate partnership which has purchased land for future expansion. This third partnership is consolidated in the accompanying financial statements. In March 1994 the Company acquired all third-party interests in two real estate partnerships in which it is a 46.5% and 80% limited partner, respectively, for approximately $9 million in cash and the assumption of a secured construction loan of approximately $23.5 million. The Company expects it will refinance the construction loan with permanent financing when it comes due in June 1994, although it may elect to pay off the construction loan with its cash reserves.\nCadence believes that these facilities are adequate for its current needs and that suitable additional or substitute space will be available as needed to accommodate expansion of Cadence's operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nStockholder class action lawsuits were filed against the Company and certain of its officers and directors in the United States District Court for the Northern District of California, San Jose Division, on April 8 and 9, 1991. The suits were subsequently consolidated into a single lawsuit and the class period changed to include purchasers of the Company's common stock during the period from October 18, 1990 through April 3, 1991. The lawsuit alleges violation of certain federal securities laws by maintaining artificially high market prices for the Company's common stock through alleged misrepresentations and nondisclosures regarding the Company's financial condition. The plaintiff in the suit seeks compensatory damages unspecified in amount. On June 2, 1993 the District Court granted in part and denied in part the Company's motion to dismiss the complaint in the class action originally filed in April 1991. The effect of the ruling was to limit the class period to include purchasers of the Company's common stock between January 29, 1991 and April 3, 1991. Trial of this matter is scheduled to commence on August 8, 1994. The Company is vigorously defending against the litigation.\nOn March 23, 1993 a separate class action lawsuit was filed against the Company and certain of its directors and officers in the United States District Court, Northern District of California, San Jose Division. Two additional complaints, identical to the complaint filed on March 23, 1993 except for the identities of the plaintiffs, were filed later in March and in April 1993. All three complaints were consolidated into a single lawsuit which seeks unspecified damages on behalf of all purchasers of the Company's common stock between October 12, 1992 and March 19, 1993. The lawsuit alleges violation of certain federal securities laws by maintaining artificially high market prices for the Company's common stock through alleged misrepresentations and nondisclosures regarding the Company's financial condition. On November 18, 1993, the District Court granted the Company's motion to dismiss the 1993 complaint. The effect of the ruling was to dismiss the complaint except as to a statement allegedly made on January 28, 1993, but plaintiffs were granted leave to further amend their complaint. The Company is vigorously defending against the litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNONE\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive corporate officers of Cadence are as follows:\nExecutive corporate officers are appointed by the Board of Directors and serve at the discretion of the Board.\nJOSEPH B. COSTELLO was appointed as President and a director of Cadence in May 1988 and as Chief Executive Officer in June 1988 . He is also a director of Oracle Corporation, Microelectronics and Computer Technology Corporation and Pano Corporation Display Systems.\nDR. LEONARD Y.W. LIU was appointed to serve on the Board in June 1989. Dr. Liu was appointed as Chief Operating Officer of the Company in February 1993. From April 1989 until March 1992, Dr. Liu was Chairman and Chief Executive Officer of Acer America Corporation and President of Acer, Inc., two personal computer suppliers. From 1969 until 1989, Dr. Liu held various technical and general management positions at IBM Corporation, most recently Manager of its Santa Teresa Laboratory. Dr. Liu is a director of Pano Corporation Display Systems, Network Application Technology, Omni Science Corporation and CIMIC Corporation.\nW. DOUGLAS HAJJAR was Chief Executive Officer and a director of Valid from May 1987 and Chairman of the Board of Valid from February 1988 until Valid's merger with and into Cadence in December 1991, at which time he was appointed as Vice Chairman and a director of Cadence. He also served as President of Valid from February 1987 to September 1989 and as Chief Financial Officer from May 1987 until August 1989. Mr. Hajjar was Chairman of the Board, President and Chief Executive Officer of Telesis, a manufacturer of EDA workstations and related software, from 1985 until the acquisition of Telesis by Valid in 1987. Mr. Hajjar is a director of Control Data Corporation, Frame Technology and Lasersight, Inc.\nH. RAYMOND BINGHAM joined Cadence in June 1993 as Executive Vice President and Chief Financial Officer. From June 1985 to May 1993 he served as Executive Vice President and Chief Financial Officer of Red Lion Hotels and Inns, which owns and operates a chain of 54 hotels. From 1981 to 1985 Mr. Bingham was the Managing Director of Agrico Overseas Investment Company, a subsidiary of the Williams Companies and was responsibile for developing and managing international manufacturing joint ventures.\nM. ROBERT LEACH joined Cadence in June 1993 as Senior Vice President of Consulting. From September 1981 to June 1993 Mr. Leach served as a partner in the worldwide electronics industry consulting practice for Andersen Consulting.\nSCOTT W. SHERWOOD joined Cadence in July 1990 as Vice President Human Resources and was appointed Senior Vice President, Human Resources in February 1992. From 1983 to 1990, he was Vice President Human Resources of Mead Data Central, a division of Mead Corporation and provider of information services to the legal community.\nJAMES E. SOLOMON, a founder of SDA, served as its Chief Executive Officer from its inception in July 1983 to May 1988 and as its President from July 1983 to March 1987, at which time he was appointed Chairman of the Board. He became a director of Cadence in 1988 and was Co-Chairman of Cadence's Board of Directors from May 1988 until May 1989. He was appointed President of the Company's Analog Division in December 1988, Senior Vice President of the IC Design Group of Cadence in February 1993 and Vice President and Principal Technologist in February 1994.\nDOUGLAS J. MCCUTCHEON joined Cadence in January 1991 as its Director, Financial Planning and Analysis, and in July 1991 became its Vice President, Corporate Finance. From November 1989 to November 1990, Mr. McCutcheon was President of Toshiba America Medical Credit, Inc., the wholly-owned captive financing subsidiary of Toshiba America Medical Systems, Inc., which sells and provides maintenance services for diagnostic and therapeutic medical systems. From November 1980 to November 1989, Mr. McCutcheon held various positions with Diasonics, Inc., a medical equipment company, most recently as Vice President and Treasurer.\nWILLIAM PORTER joined Cadence in February 1994 as Vice President, Corporate Controller and Assistant Secretary. From September 1988 to February 1994 Mr. Porter served as Technical Accounting and Reporting Manager and most recently as Controller of Cupertino Operations with Apple Computer Corporation, a worldwide manufacturer of computer equipment. From 1976 until 1988 Mr. Porter held various positions with Arthur Andersen & Co., most recently as a Senior Audit Manager.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock was traded on the NASDAQ National Market System under the NASDAQ symbol ECAD from the Company's initial public offering at $7.83 per share on June 10, 1987 until June 1, 1988 when it began trading under the NASDAQ symbol CDNC. Since September 17, 1990 the Company's Common Stock has traded on the New York Stock Exchange under the symbol CDN. The Company has not paid cash dividends in the past and none are planned to be paid in the future. As of December 31, 1993, the Company had approximately 2,400 stockholders of record.\nThe following table sets forth the high and low bid prices for the Common Stock for each calendar quarter in the two year period ended December 31, 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFor the years ended December 31, (In thousands, except per share amounts)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCadence (the \"Company\") designs, develops, markets and supports electronic design automation (\"EDA\") software products primarily used to automate, enhance and accelerate the design, verification and testing of integrated circuits, electronic systems and printed circuit boards (\"PCBs\").\nIn December 1991 the Company merged with Valid Logic Systems Incorporated (\"Valid\"). Valid commenced operations in 1981 and was involved in the development, marketing and support of EDA products primarily used to design electronic systems and PCBs. The merger was accounted for by the pooling of interests method and all financial information prior to the merger has been restated to combine the results of the Company and Valid. In connection with the merger, the Company recorded $49.9 million of restructuring costs and $1.7 million of merger costs in the fourth quarter of 1991.\nIn June 1993 the Company acquired the business and certain assets of Comdisco Systems, Inc. (\"Comdisco\"), a subsidiary of Comdisco, Inc. Comdisco develops, markets and supports digital signal processing software products in the electronic systems applications area. The acquisition was accounted for as a purchase. Accordingly, the results of Comdisco from the date of the acquisition forward have been recorded in the Company's consolidated financial statements.\nIn December 1993 the Company sold its Automated Systems (\"ASI\") division. ASI manufactures and provides design services for complex printed circuit boards. The operating results of ASI have been reported as discontinued operations in the consolidated statements of income for all years presented.\nResults of Operations\nThe following table sets forth for the years indicated (a) the percentage of total revenue represented by each item reflected in the Company's consolidated statements of income and (b) the percentage increase (decrease) in each such item from the prior year.\n* Not meaningful (1) The Company capitalizes software development costs in accordance with SFAS No. 86. Total research and development expenses incurred prior to capitalization represented 23%, 19% and 22% of total revenue for 1993, 1992 and 1991, respectively. The percentage change from 1992 to 1993 and from 1991 to 1992 was an increase of 4% and a decrease of 4%, respectively, on a pre-capitalization basis.\nRevenue\nTotal revenue was approximately $368.6 million, $418.7 million and $379.5 million for the years ended December 31, 1993, 1992 and 1991, respectively. Total revenue decreased approximately $50.1 million for the year ended December 31, 1993 as compared to the prior year and increased approximately $39.2 million in 1992 as compared to 1991. The decrease in total revenue in 1993 was primarily due to a $74.0 million decrease in product revenue due to weak economic conditions in certain areas and lower sales volume for the Company's products, as well as a shift in the Company's systems product strategy. This decrease in product revenue was offset somewhat by the acquisition of Comdisco. While product revenue decreased in 1993, maintenance revenue increased by $23.9 million due to increased focus on customer renewals, combined with a larger customer base. The growth in total revenue in 1992 compared to 1991 was comprised of $22.9 million in product revenue due to increased demand for the Company's products, including the new Valid products as a result of the merger, and improved economic conditions in 1992 as compared to 1991, and a $16.3 million increase in maintenance revenue.\nMaintenance revenue continued to increase each year as the Company's installed base of products has increased, growing by approximately $23.9 million in 1993 compared to 1992 and by approximately $16.3 million in 1992 compared to 1991. As a percentage of total revenue, maintenance revenue has grown over the last three years from approximately 23% to approximately 35% of total revenue. The increase in maintenance revenue as a percentage of total revenue is due in part to the Company's continued effort toward obtaining customer renewals of maintenance coverage as well as the decrease in total product revenue in 1993.\nRevenue from international sources was approximately $183.6 million, $215.4 million and $197.6 million or 50%, 51% and 52% of total revenue for each of the three years ended December 31, 1993, 1992 and 1991, respectively. The decrease in 1993 was principally related to decreased sales volume in Japan. It is anticipated that international revenue will continue to constitute a significant portion of total revenue. International revenues are subject to certain additional risks normally associated with international operations, including, among others, adoption and expansion of government trade restrictions, currency conversion risks, limitations on repatriation of earnings and reduced protection of intellectual property rights. Due to the continuing adverse business conditions in Japan, the Company has experienced and can expect to experience a reduced level of activity from this important market. A continued low level or further reduction of orders from Japan could have a material adverse impact on the Company's results of operations.\nCost of Revenue\nTotal cost of revenue was approximately $89.4 million, $94.0 million and $87.6 million for the years ended December 31, 1993, 1992 and 1991, respectively. Total cost of revenue decreased $4.6 million in 1993 compared to 1992 and increased $6.4 million in 1992 compared to 1991. The decrease in 1993 consisted of a $2.5 million decrease in product cost of revenue due to the decrease in product revenue and related costs, reduced costs due to restructure actions including related headcount reductions as well as the discontinuance in 1992 of sales of third- party hardware. This decrease was slightly offset by an increase in cost of product associated with the newly acquired Comdisco operations and a $4.0 million increase in amortization of software development costs, purchased software and other intangibles. Cost of maintenance also decreased $2.1 million in 1993 as compared to 1992 even though revenue increased due to the streamlining of the maintenance renewal process which includes a more cost-effective update program and lower cost media. The increase in total cost of revenue in 1992 as compared to 1991 consisted of an $11.7 million increase in cost of product, which was offset by a $5.4 million decrease in cost of maintenance. The increase in cost of product was primarily due to an increase in royalties of approximately $2.4 million and other related software product costs. The increase in software costs in 1992 was primarily a result of the expansion-related increase in personnel and capital expenditures in the Company's operations departments, which include software tape duplication, technical documentation and support, training and consulting services. The decrease in cost of maintenance in 1992 was primarily due to post-merger restructure and efficiencies, including the reduction of personnel and other duplicate costs in 1992 due to the merger of the Company with Valid, streamlining of the maintenance renewal process and a decrease in hardware maintenance contracts and costs related to Valid. As a percentage of total\nrevenue, cost of maintenance revenue has remained in the range of approximately 4% to 6% and cost of product revenue has been at approximately 17% to 20%.\nGross Margin\nGross margin was 76%, 78% and 77% for the years ended December 31, 1993, 1992 and 1991, respectively.\nMarketing and Sales\nMarketing and sales expenses increased $1.2 million in 1993 compared to 1992 and $11.8 million in 1992 compared to 1991. The increase in 1993 is primarily due to increased costs associated with the acquired Comdisco operations. This increase was partially offset by reduced costs related to restructure actions, including headcount reduction. The increase in 1992 was due to the establishment and continued growth of foreign subsidiaries and domestic field offices, and increased personnel and related expenses. As a result of the merger with Valid, there were a number of duplicate sales locations which were consolidated during 1992. Notwithstanding this, during 1992 the Company continued to focus on expanding its selling efforts. The costs associated with the consolidation of sales offices were included in the restructuring costs recorded in 1991. Marketing and sales expenses have increased as a percentage of revenue from 39% in 1991 to 43% in 1993. The higher percentage in 1993 is due primarily to the decrease in total revenue in 1993.\nResearch and Development\nTotal research and development expenditures incurred prior to capitalization of software development costs increased 4% in 1993 as compared to 1992 and decreased 4% in 1992 as compared to 1991, an increase of approximately $3.1 million and a decrease of approximately $3.2 million, respectively. The increase in 1993 is primarily due to increased expenses due to the addition of Comdisco's operations. The decrease in total research and development expenditures in 1992 compared to 1991 is due primarily to post-merger restructure and efficiencies, including the reduction of personnel and other duplicate costs in 1992 related to the merger with Valid. Prior to the deduction for capitalization of software development costs, research and development expenses comprised approximately 23%, 19% and 22% of total revenue or approximately $84.3 million, $81.2 million and $84.3 million for the years 1993, 1992 and 1991, respectively. The increase as a percentage of revenue in 1993 is primarily due to the decrease in total revenue in 1993 as compared to 1992. The decrease as a percentage of revenue in 1992 as compared to 1991 is due primarily to the elimination of duplicate costs in 1992 as a result of the merger with Valid. The Company capitalized approximately $15.2 million, $14.7 million and $16.2 million of software development costs in the years 1993, 1992 and 1991, respectively, which represented approximately 18%, 18% and 19% of total research and development expenditures made in those years. The amount of capitalized software development costs in any given period may vary depending on the exact nature of the development performed.\nGeneral and Administrative\nGeneral and administrative expenses increased approximately $4.9 million in 1993 compared to 1992 and decreased approximately $2.2 million in 1992 compared to 1991. The increase in 1993 is due to the addition of Comdisco's operations, increased bad debt expense due to the write-off of uncollectible accounts, increased professional services and employee-related expenses. The decrease in 1992 was due primarily to the result of post-merger efficiencies, including the reduction of personnel and related expenses and duplicate facilities in 1992 as a result of the merger with Valid. As a percentage of total revenue, general and administrative expenses have been in the range of approximately 8% to 10%. The higher percentage in 1993 is partially due to the decrease in total revenue in 1993.\nRestructuring Costs\nIn March 1993 the Company recorded restructuring costs of $13.5 million associated with a planned restructure of certain areas of sales, operations and administration due to business conditions. The restructuring charge primarily reflects costs associated with excess facilities, the write-off of software development costs and purchased software and intangibles and employee terminations resulting from lower revenue levels.\nIn the fourth quarter of 1991 the Company recorded restructuring costs of approximately $49.9 million associated with the merger of Valid with the Company. This amount included accruals for severance and payroll-related payments, costs of closing excess or duplicate facilities and write-offs of equipment, other assets and capitalized software development costs due to the overlap of products.\nOther Income and Expense\nInterest income was $3.2 million, $3.6 million and $6.2 million for the years ended December 31, 1993, 1992 and 1991, respectively. The decrease in interest income in 1993 and 1992 was primarily due to a decrease in interest rates which in 1992 was combined with a $20.7 million decrease in cash and cash investments and short-term investments. Interest expense was $.7 million, $.9 million and $2.6 million for the years ended December 31, 1993, 1992 and 1991, respectively. The decrease in 1993 as compared to 1992 is due to a decrease in capital lease borrowings and other debt obligations. The decrease of $1.8 million in 1992 as compared to 1991 was due to the repayment of $18.5 million in notes payable to banks in 1991. In addition, the Company incurred approximately $1.7 million of merger costs in the fourth quarter of 1991 related to the merger of the Company and Valid.\nProvision for Income Taxes\nThrough December 31, 1992, the Company accounted for income taxes pursuant to Statement of Financial Accounting Standards (\"SFAS\") No. 96. Effective January 1, 1993, the Company retroactively adopted SFAS No. 109, \"Accounting for Income Taxes.\" This pronouncement requires, among other things, recognition of future tax benefits, measured by enacted tax rates, attributable to (a) deductible temporary differences between the financial statement and income tax basis of assets and (b) liabilities and tax net operating loss carryforwards, to the extent that realization of such benefits is more likely than not. The adoption of this accounting pronouncement did not have a material impact on amounts reported in prior years' financial statements.\nAs of December 31, 1993 the Company had gross deferred tax assets of approximately $67.0 million against which the Company has recorded a valuation allowance of $54.6 million, resulting in a net deferred tax asset of $12.4 million. A significant portion of the net operating loss and credit carryforwards which created the deferred tax asset were generated by Valid prior to its merger with the Company and by restructure charges recorded as a result of the merger. Management has determined, based on the Company's history of prior operating earnings and its expectations for future years, that the recorded net deferred tax asset is realizable. However, no assurances can be given that sufficient taxable income will be generated in future years for the utilization of the net deferred tax asset.\nThe Company's tax provision for 1993 was zero as a result of the operating loss in 1993 and the recording of the benefit of certain foreign withholding and income taxes.\nIn 1992 the Company's effective tax rate was 19%. This rate reflects the utilization of foreign tax credits, Valid's net operating losses and temporary items generated in prior years but benefited currently.\nThe Company provided for income taxes in 1991 even though the Company reflected a pretax loss. This provision was primarily attributable to restructuring costs and foreign tax credits that the Company was not fully able to benefit for financial statement purposes.\nNet Income (Loss) From Continuing Operations\nThe net loss from continuing operations for 1993 was $.6 million as compared with net income of $55.1 million in 1992 and net loss of $17.1 million in 1991. The net loss from continuing operations in 1993 was due to a decrease in product revenue and $13.5 million recorded for restructuring costs. The net income in 1992 compared to the net loss in 1991 was partially due to increased revenue in 1992. Net income from continuing operations was also favorably impacted by the post-merger restructure and efficiencies, including the reduction of personnel and other duplicate costs in 1992 related to the merger with Valid. The fourth quarter of 1991 also included $49.9 million of restructuring costs and $1.7 million of merger costs associated with the merger of the Company and Valid.\nDiscontinued Operations\nAs previously discussed, the Company sold its ASI division in December 1993 and restated the financial information of prior periods to report discontinued operations of ASI as a separate line item in the consolidated statements of income. The discontinued operations resulted in a loss of $12.2 million, income of $.3 million and a loss of $5.3 million for the years ended December 31, 1993, 1992 and 1991, respectively. The loss for 1993 includes $6.0 million recorded as a loss on disposal, which represents the loss on the sale of the net assets as well as amounts accrued for estimated costs to be incurred in connection with the disposal. In addition, the 1993 loss includes $6.2 million for ASI's operating loss.\nQuarterly Results of Operations\nThe following table sets forth selected unaudited quarterly financial information for the Company's last eight quarters. This unaudited information has been prepared on the same basis as the audited information and in management's opinion reflects all adjustments (which include only normal recurring adjustments) necessary for the fair presentation of the information for the periods presented. Based on the Company's operating history and factors that may cause fluctuations in the quarterly results, quarter-to-quarter comparisons should not be relied upon as indicators of future performance. Although the Company's revenues are not generally seasonal in nature, the Company from time to time has experienced decreases in first quarter revenue versus the preceding fourth quarter which is believed to result primarily from the capital purchase cycle of the Company's customers.\nThe Company's operating expenses are partially based on its expectations of future revenue. The Company's results of operations may be adversely affected if revenue does not materialize in a period as expected. Since expense levels are usually committed in advance of revenues and because only a small portion of expenses vary with revenue, the Company's net income may be impacted significantly by lower revenue. In addition, the Company's results of operations for a particular quarter or quarters could be materially adversely affected by the ultimate resolution of the disputes and litigation matters discussed in Note 9 of Notes to Consolidated Financial Statements.\nThe Company's revenue decreased in each quarter in 1993 as compared to the same quarter in the prior year. This decrease was due to weak economic conditions and reduced demand for the Company's products as well as a shift in the Company's system product strategy. In addition, the first quarter of 1993 included approximately $13.5 million of restructuring costs related to the Company's planned restructure.\nThe amounts in the table above reflect the results of the Company restated to reflect the sale of ASI in the fourth quarter of 1993 and reclassification of its operations to discontinued operations.\nThe following table represents quarterly information as previously reported for the Company.\nInflation To date, the Company's operations have not been impacted significantly by inflation.\nLiquidity and Capital Resources\nThe Company raised approximately $10.8 million, $13.8 million and $14.9 million through the sale of common stock pursuant to employee benefit plans in 1993, 1992 and 1991, respectively. The Company purchased $52.2 million of treasury stock and repurchased $10.8 million and $1.8 million of common stock for the years ended December 31, 1993, 1992 and 1991, respectively. In addition, the Company realized approximately $90.7 million, $40.4 million and $74.7 million in cash provided by operations in 1993, 1992 and 1991, respectively. The Company's principal investing activities consist of the purchase of property, plant and equipment and the capitalization of software development costs, which in total were $34.5 million, $45.7 million and $44.6 million for the years ended December 31, 1993, 1992 and 1991, respectively. In addition, the other major component of investing activities is the change in short-term investments.\nWorking capital at December 31, 1993 was $105.0 million compared with $153.3 million at December 31, 1992 and $119.0 million at December 31, 1991. The decrease in 1993 as compared to 1992 was primarily due to a decrease of $30.9 million in accounts receivable primarily due to lower revenue, a $12.8 million increase in deferred revenue and a $7.3 million increase in accrued liabilities related to restructuring accruals recorded in 1993. The increase in 1992 as compared with 1991 was primarily due to a $17.0 million increase in accounts receivable due to higher revenue, a $21.4 million decrease in accrued liabilities related to restructuring accruals recorded in 1991 associated with the Company's merger with Valid and an $11.9 million decrease in deferred revenue. These increases were offset by a decrease of $20.7 million in cash and cash investments and short-term investments.\nLong-term obligations decreased $1.7 million in 1993 as compared to 1992 due to a decrease in capital lease borrowings and increased $1.9 million in 1992 as compared to 1991 due to an increase in capital lease borrowings and other debt obligations. At December 31, 1993 the Company had available $15.0 million under equipment lease lines for future capital expenditures and $17.5 million under two bank lines, which had not been drawn upon at December 31, 1993 (see Notes 7 and 8 of Notes to Consolidated Financial Statements for further discussion).\nAnticipated cash requirements in 1994 are payments related to the purchase of treasury stock, contemplated additions of capital equipment and restructure costs accrued at December 31, 1993. Prior to 1993, the Company authorized the repurchase of up to 2.8 million shares of common stock in the open market over the next several years to satisfy its estimated requirements for shares to be issued under its employee stock option and stock purchase plans. In April 1993 the Company authorized the repurchase of an additional 4.0 million shares of common stock from time to time in the open market. In total, as of December 31, 1993, approximately 5.5 million shares had been repurchased. In addition, in February 1994 the Company authorized the repurchase of an additional 2.9 million shares. In March 1994 the Company acquired all third-party interests in two real estate partnerships in which it is a 46.5% and 80% limited partner for approximately $9 million in cash and the assumption of a secured construction loan of approximately $23.5 million. The Company leases buildings from one of the limited partnerships and the second limited partnership owns unencumbered land adjacent to the leased property (see Note 3 of Notes to Consolidated Financial Statements). The Company expects it will refinance the construction loan with permanent financing when it comes due in June 1994, although it may elect to pay off the construction loan with its cash reserves. The Company anticipates that current cash balances, cash flow from operations and unused balances on capital lease lines and lines of credit will be sufficient to meet its working capital and capital expenditure requirements for at least the next year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe quarterly supplementary data is included as part of Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The financial statements required by this item are submitted as a separate section of this Form 10-K. See Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot required pursuant to Instruction 1 to Item 304 of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by Item 10 as to directors is incorporated by reference from the section entitled \"Election of Directors\" in the Company's Proxy Statement for its annual stockholders' meeting to be held May 17, 1994. The information required by this Item as to executive officers is included in Part I under \"Executive Officers of the Registrant.\"\nPursuant to Item 405 of Regulation S-K, the Company has reviewed all Forms 3, 4 and 5 required to be filed with respect to 1993 and has determined that there are no delinquencies in filing reports required by Section 16(a) of the Exchange Act for 1993 or prior years at the time of the filing of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated by reference from the Company's Proxy Statement for its annual stockholders' meeting to be held May 17, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 is incorporated by reference from the Company's Proxy Statement for its annual stockholders' meeting to be held May 17, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated by reference from the Company's Proxy Statement for its annual stockholders' meeting to be held May 17, 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K _ PAGE\n(a)1. Financial Statements\n(a)2. Financial Statement Schedules\nAll other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto.\n(a)3. Exhibits\nThe following exhibits are filed herewith:\nEXHIBIT NUMBER EXHIBIT TITLE\nEXHIBIT NUMBER EXHIBIT TITLE\nEXHIBIT NUMBER EXHIBIT TITLE\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Cadence Design Systems, Inc.:\nWe have audited the accompanying consolidated balance sheets of Cadence Design Systems, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the financial statements of Valid Logic Systems Incorporated, a company acquired during 1991 in a transaction accounted for as a pooling of interests, as discussed in Note 1. Such statements are included in the consolidated financial statements of Cadence Design Systems, Inc. and reflect total revenues of 40 percent of the consolidated total for the year ended December 31, 1991. These statements were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to amounts included for Valid Logic Systems Incorporated, is based solely upon the report of the other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Cadence Design Systems, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in Item 14. (a) 2. are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co. San Jose, California Arthur Andersen & Co. January 26, 1994\nINDEPENDENT AUDITORS' REPORT\nCadence Design Systems, Inc. San Jose, California\nWe have audited the consolidated statements of operations, stockholders' equity, and cash flows of Valid Logic Systems Incorporated (a wholly- owned subsidiary of Cadence Design Systems, Inc.) and subsidiaries for the year ended December 31, 1991. These financial statements (which are not presented separately herein) are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Valid Logic Systems Incorporated and subsidiaries for the year ended December 31, 1991 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche DELOITTE & TOUCHE\nSan Jose, California January 27, 1992\nCADENCE DESIGN SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1993 AND 1992 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nASSETS\nThe accompanying notes are an integral part of these balance sheets.\nCADENCE DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements\nCADENCE DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nCADENCE DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nCADENCE DESIGN SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. ORGANIZATION OF THE COMPANY\nCadence Design Systems, Inc. (the \"Company\") develops, markets and supports computer-aided design software products that automate, enhance and accelerate the design, verification and testing of integrated circuits and complex electronic circuits and systems.\nIn December 1991 the Company acquired all of the outstanding common and preferred stock of Valid Logic Systems Incorporated (\"Valid\") in exchange for approximately 10,816,000 shares of the Company's common stock and 86,133 shares of the Company's preferred stock. Valid was involved in the design, development, marketing and support of electronic design automation software products primarily used to design electronic systems and printed circuit boards (\"PCBs\"). In connection with the merger, each share of Valid common and preferred stock was converted into .323 shares of the Company's common and preferred stock, respectively. The Company also issued approximately 199,000 shares of common stock in exchange for an outstanding warrant to purchase common stock of Valid. The Company also assumed Valid's outstanding stock options and all other outstanding warrants. Each such option and warrant to purchase one share of Valid common stock was converted into an option and warrant, respectively, to purchase .323 shares of the Company's common stock. The merger was accounted for as a pooling of interests and, accordingly, the financial statements for periods prior to the merger have been restated to include the results of Valid.\nIn June 1993 the Company acquired the business and certain assets of Comdisco Systems, Inc. (\"Comdisco\"), a subsidiary of Comdisco, Inc. in exchange for 1,050,000 shares of the Company's common stock and a warrant to purchase 1,300,000 shares of the Company's common stock. The acquisition was accounted for as a purchase. Accordingly, the results of Comdisco from the date of acquisition forward have been recorded in the Company's consolidated financial statements. Comparative pro forma financial information has not been presented as the results of operations for Comdisco are not material to the Company's consolidated financial statements for 1993, 1992 and 1991. The acquisition costs of $10,903,000 include amounts paid for the net tangible assets of Comdisco and purchased software and other intangibles.\n2. DISCONTINUED OPERATIONS\nIn December 1993 the Company sold its Automated Systems (\"ASI\") division. ASI was sold for a nominal amount of cash and future royalties amounting to 5% of gross revenues of ASI for the period from January 1, 1994 through December 31, 2003, up to maximum royalties of $12,000,000. The royalties will be recorded in future periods as earned. The sale of ASI resulted in a loss on disposal of $6.0 million (the income tax effect of which was not material). This loss includes the loss on the sale of the net assets, as well as amounts accrued for estimated costs to be incurred in connection with the disposal. As of December 31, 1993, the Company has recorded $1.4 million in accrued liabilities and $2.0 million in other noncurrent liabilities for liabilities associated with the discontinued division. The operating results of the discontinued division have been reported as discontinued operations in the consolidated statements of income for all years presented. The prior year balance sheet has also been adjusted to reflect the net current assets of ASI as of December 31, 1992 of $4.8 million as a single line item in other current assets and to reflect the net noncurrent assets of $3.0 million as a single line item in other assets. There were no remaining assets related to ASI on the Company's balance sheet as of December 31, 1993. Revenue of the discontinued division was $11,165,000, $15,776,000 and $12,079,000 for the years ending December 31, 1993, 1992 and 1991, respectively.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries after elimination of intercompany accounts and transactions. The ownership interest of minority participants in subsidiaries that are not wholly owned was approximately $725,000 and $946,000 at December 31, 1993 and 1992, respectively, and is included in other noncurrent liabilities in the accompanying balance sheets. Minority interest income was approximately $134,000 and $196,000 and minority interest expense was $268,000 for the years ended December 31, 1993, 1992 and 1991, respectively, and is included in other income and expense in the accompanying statements of income.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is stated at cost. Depreciation and amortization are provided over the following estimated useful lives, by the straight-line method.\nCASH AND CASH INVESTMENTS\nFor purposes of the statements of cash flows, the Company considers all commercial paper, medium-term notes, bankers' acceptances, certificates of deposit, municipal bonds, Euro certificates of deposit and money market accounts with an original maturity of ninety days or less to be cash and cash investments.\nSHORT-TERM INVESTMENTS\nShort-term investments are stated at cost, which approximates market value, and consist principally of Euro certificates of deposit, medium-term notes, money market accounts, commercial paper, bankers' acceptances and certificates of deposit with an original maturity of greater than ninety days that the Company intends to sell within one year.\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out method) or market. Cost includes labor, material and manufacturing overhead. Inventories include testing equipment and accelerators.\nInventories consisted of the following (in thousands):\nREAL ESTATE PARTNERSHIPS\nDuring 1989 and 1991 the Company acquired a 49% and 46.5% interest as a limited partner in two real estate partnerships and signed agreements to lease buildings from the limited partnerships. Both of the above commitments are included in future operating lease commitments in Note 7. The investment in these partnerships of approximately $5.2 million at December 31, 1993 and 1992 is included in other assets in the accompanying balance sheets. The Company accounts for these investments under the equity method of accounting. During June 1991 the Company acquired an 80% interest in a third real estate partnership which has purchased land for future expansion. This partnership is consolidated in the accompanying financial statements.\nREVENUE RECOGNITION\nProduct revenue consists principally of revenue earned under software license agreements. Revenue earned under license agreements to end users is generally recognized when a customer purchase order has been received, the software has been shipped, the Company has a right to invoice the customer and there are no significant obligations remaining. Design services revenue and test equipment revenue are recognized upon delivery of the final design or shipment of the test equipment. Nonrefundable revenue earned under guaranteed revenue commitments from products relicensed through OEMs, system integrators and software value-added relicensors is recognized at the latter of the beginning of the commitment period or shipment of the initial product master. Additional revenue under these agreements is recognized at the time such amounts are reported to the Company.\nMaintenance revenue consists of fees for providing system updates, user documentation and technical support for software products. Maintenance revenue is recognized ratably over the term of the agreement.\nIn 1993, 1992 and 1991 one customer (a distributor) accounted for 13%, 14% and 13% of total revenue, respectively.\nSOFTWARE DEVELOPMENT COSTS\nThe Company capitalizes internally generated software development costs in compliance with Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.\" Capitalization of software development costs begins upon the establishment of technological feasibility for the product. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenue, estimated economic life and changes in software and hardware technology. Software development costs capitalized were $15,207,000, $14,741,000 and $16,188,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nAmortization of capitalized software development costs begins when the products are available for general release to customers and is generally computed on a straight-line basis over the remaining estimated economic life of the product (three to five years). Amortization, which is included in cost of revenue in the accompanying statements of income, amounted to $13,065,000, $11,043,000 and $11,904,000 for the years ended December 31, 1993, 1992 and 1991, respectively. The Company wrote off $1,495,000 of capitalized software in 1993 for projects discontinued during the year. In connection with the merger with Valid, the Company also wrote off $2,794,000 and $10,896,000 of capitalized software in 1992 and 1991, respectively, due to an overlap of products.\nPURCHASED SOFTWARE AND INTANGIBLES\nPurchased software and intangibles are stated at cost less accumulated amortization. Amortization is generally computed on a straight-line basis over the remaining estimated economic life of the underlying product (two to seven years). The cost and related accumulated amortization of purchased software and intangibles were as follows (in thousands):\nINCOME TAXES\nThrough December 31, 1992 the Company accounted for income taxes pursuant to Statement of Financial Accounting Standards (\"SFAS\") No. 96, \"Accounting for Income Taxes.\" Effective January 1, 1993 the Company retroactively adopted the provisions of SFAS No.109, \"Accounting for Income Taxes.\" This statement provides for a liability approach under which deferred income taxes are provided based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. The adoption of this accounting pronouncement did not have a material impact on the prior years' financial statements (see Note 11).\nFOREIGN CURRENCY TRANSLATION\nAs of December 31, 1991 the functional currency of certain of the Company's foreign subsidiaries was the U.S. dollar, whereas the functional currency of the former Valid subsidiaries was the local currency. During 1992, the Company made certain changes in the manner in which the subsidiaries' operations were conducted to conform more closely to the Valid business model. Accordingly, the functional currency of the U.S. dollar foreign subsidiaries was changed to the respective local currency effective for the first quarter of 1992. Gains and losses resulting from the translation of the financial statements for the subsidiaries are reported as a separate component of stockholders' equity.\nMERGER COSTS\nTotal costs incurred by the Company and Valid in 1991 in connection with the merger of the two companies were $1,660,000. These costs, consisting primarily of legal, accounting and other related expenses, were charged to operations in the fourth quarter of 1991.\nNET INCOME (LOSS) PER SHARE\nNet income per share for each period is calculated by dividing net income attributable to common stockholders by the weighted average number of common stock and common stock equivalents outstanding during the period. Common stock equivalents consist of dilutive shares issuable upon the exercise of outstanding common stock options and warrants and the conversion of Series A-1 preferred stock. Net loss per share is calculated by dividing net loss attributable to common stockholders by the weighted average number of common shares. Fully diluted net income (loss) per share is substantially the same as primary net income (loss) per share.\nSUPPLEMENTAL STATEMENTS OF CASH FLOWS DISCLOSURES\nCash paid for interest and income taxes, including foreign withholding taxes, was as follows (in thousands):\nDISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES\nNotes payable and capital lease obligations incurred for property, plant and equipment placed into service in 1993, 1992 and 1991 were $4,441,000, $5,498,000 and $2,195,000, respectively.\nAs discussed in Note 1, in June 1993 the Company acquired the business and certain assets of Comdisco in exchange for 1,050,000 shares of the Company's common stock and a warrant to purchase 1,300,000 shares of the Company's common stock. The cost in excess of net assets acquired was $6,500,000 which is being amortized over seven years and is included in purchased software and intangibles in the accompanying balance sheet. The accumulated amortization as of December 31, 1993 was approximately $436,000. In connection with the acquisition, net assets acquired were as follows (in thousands):\nIn March 1992 the Company acquired a distributorship in Japan, which, as its sole operation, had distributed the Company's system products. As part of this transaction, the Company paid approximately $400,000 in cash and issued a note for $3,100,000 in exchange for stock and a consulting agreement. This acquisition was accounted for as a purchase. The cost in excess of the net assets acquired was approximately $5.2 million which is being amortized over five years and is included in other assets in the accompanying balance sheets. The accumulated amortization as of December 31, 1993 and 1992 was approximately $2,079,000 and $854,000, respectively.\nDuring 1992 all of the Company's outstanding Series A-1 preferred stock was converted to approximately 861,000 shares of the Company's common stock.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.\nThe carrying amount of cash and cash investments and short-term investments is a reasonable estimate of fair value because of the short maturity of those instruments.\nThe fair value of the Company's long-term obligations, excluding capital leases, is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The carrying amount of the Company's long-term debt at December 31, 1993 approximates its fair value.\nThe Company enters into forward exchange contracts to reduce the impact of foreign currency fluctuations on those accounts that give rise to transaction gains or losses. As of December 31, 1993 the Company had entered into forward exchange contracts in the amount of $33,058,000, maturing January 31, 1994. The fair value of foreign currency contracts is estimated by obtaining quotes from banks. The market value was approximately the same as the carrying value as of December 31, 1993.\nCONCENTRATION OF CREDIT RISK\nFinancial instruments which may potentially subject the Company to concentrations of credit risk consist principally of cash and cash investments, short-term investments and accounts receivable. The Company's investment policy limits investments to short-term, low-risk instruments. Concentration of credit risk related to accounts receivable is limited due to the varied customers comprising the Company's customer base and their dispersion across geographies.\nRESTRUCTURING COSTS\nIn March 1993 the Company recorded restructuring costs of $13,450,000 associated with a planned restructure of certain areas of sales, operations and administration due to business conditions. The restructuring charge primarily reflects costs associated with excess facilities, the write-off of software development costs and purchased software and intangibles and employee terminations resulting from the change in product strategy and lower revenue levels.\nIn December 1991 the Company recorded restructuring costs of $49,901,000 associated with the merger of Valid with the Company. This amount included approximately $5,530,000 for excess fixed assets and other assets, $13,385,000 for severance and payroll-related payments, $16,475,000 for closing of excess and duplicate facilities, $10,896,000 for write-offs of capitalized software due to overlap of products and $3,615,000 for other items.\nPOST RETIREMENT BENEFITS\nStatement of Financial Accounting Standards No. 106, \"Accounting for Post Retirement Benefits other than Pensions,\" which was effective for the Company in fiscal 1993, has no effect on the Company as the Company has not offered such post retirement benefits.\nINVESTMENTS IN DEBT AND EQUITY SECURITIES\nStatement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which will be effective for the Company in fiscal 1994, is not expected to have a material impact on the Company.\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of (in thousands):\nThe cost of equipment, furniture and fixtures under capital leases included in property, plant and equipment at December 31, 1993 and 1992 was $22,178,000 and $25,622,000, respectively. Accumulated amortization of the leased equipment, furniture and fixtures at such dates was $16,199,000 and $19,568,000, respectively.\n5. ACCRUED LIABILITIES\nAccrued liabilities consisted of (in thousands):\nAccrued merger and restructuring costs consist principally of severance obligations and the current portion of lease obligations for closing of excess facilities.\n6. LONG-TERM OBLIGATIONS\nLong-term obligations consisted of (in thousands):\nAt December 31, 1993 future principal payments on long-term obligations, excluding capital lease obligations, were $620,000 for each of the years ending December 31, 1994, 1995 and 1996, respectively.\n7. LEASES\nFacilities and equipment are leased under various capital and operating leases expiring on different dates through the year 2008. Certain of these leases contain renewal options. The terms of several of the facilities agreements, accounted for as operating leases, provide for the deferral of several months' rental payments or scheduled rent increases. Rental expense under these agreements is recognized on a straight-line basis. Rental expense was approximately $19,983,000, $21,287,000 and $16,798,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nIn connection with the merger with Valid and planned restructure, the Company has closed certain excess and duplicate facilities. Accordingly, the Company has accrued for estimated future minimum rent and maintenance costs related to these facilities. Total costs accrued at December 31, 1993 were $8,557,000, of which $1,193,000 is included in accrued liabilities and $7,364,000 is included in lease liabilities in the accompanying balance sheet.\nIn connection with the disposition of ASI, the Company has accrued for estimated future rent on facilities not assumed by the purchaser. Total costs accrued at December 31, 1993 were $1,911,000, of which $102,000 is included in accrued liabilities and $1,809,000 is included in other noncurrent liabilities in the accompanying balance sheet.\nAt December 31, 1993 future minimum lease payments under capital and operating leases and the present value of the capital lease payments were as follows (in thousands):\nAs of December 31, 1993 the Company had $15.0 million available for future borrowings under capital lease agreements which expire in September 1994.\n8. LINES OF CREDIT\nThe Company has unsecured lines of credit with two banks allowing for combined maximum borrowings of $17,500,000 in the form of (a) domestic rate revolving loans with interest at the banks' prime lending rate, (b) Eurodollar rate loans with interest that exceeds three- quarters of one percent of the banks' current Eurodollar rate quoted for the same amount and maturity, or (c) issuances of letters of credit. There were no outstanding borrowings at December 31, 1993 or 1992 under these agreements. Certain financial covenants and restrictions are included in these agreements. As a result of its treasury stock purchase activity during 1993, the Company was not in compliance with certain covenants related to one of its lines of credit, with a borrowing amount of $10,000,000, as of December 31, 1993. The Company subsequently obtained a waiver of the noncompliance from the bank. These lines of credit will expire in May 1994 and June 1994.\n9. COMMITMENTS AND CONTINGENCIES\nThe Company has entered into an executive compensation agreement with one of its executive officers. This agreement provides severance benefits to the executive in the event that within 120 days before or two years after any change in control, or sale of all or substantially all assets of the Company, the executive's employment is terminated by the Company or the executive, in circumstances described in the agreement. The severance benefits are a cash payment of two times the executive's base salary, plus accelerated vesting of all outstanding stock options.\nThe Company assumed as part of the ASI acquisition an agreement dated April 22, 1985 under which the Company is obligated to pay to a former ASI officer a monthly annuity for a fifteen-year period after his retirement date or a lump sum payment subject to the terms of the agreement. The Company has accrued an amount equal to the present value of the estimated future payments at the eligible retirement date. Such accrual amount is included in accrued liabilities in the accompanying balance sheet.\nThe Company is involved in various disputes and litigation matters which have arisen in the ordinary course of business. These include disputes and lawsuits related to intellectual property, contract law and employee relations matters and the stockholder class action lawsuits described below, which allege violation of certain federal securities laws by maintaining artificially high market prices for the Company's common stock through alleged misrepresentations and nondisclosures regarding the Company's financial condition.\nStockholder class action lawsuits were filed against the Company and certain of its officers and directors in the United States District Court for the Northern District of California, San Jose Division, on April 8 and 9, 1991. The suits were subsequently consolidated into a single lawsuit and the class period changed to include purchasers of the Company's common stock during the period from October 18, 1990 through April 3, 1991. The plaintiff in the suit seeks compensatory damages unspecified in amount. On June 2, 1993 the District Court granted in part and denied in part the Company's motion to dismiss the Complaint in the class action originally filed in April 1991. The effect of the ruling was to limit the class period to include purchasers of the Company's common stock between January 29, 1991 and April 3, 1991. Trial of this matter is scheduled to commence on August 8, 1994. The Company is vigorously defending against the litigation.\nOn March 23, 1993 a separate class action lawsuit was filed against the Company and certain of its directors and officers in the United States District Court, Northern District of California, San Jose Division. Two additional complaints, identical to the complaint filed on March 23, 1993 except for the identities of the plaintiffs, were filed later in March and in April 1993. All three complaints were consolidated into a single lawsuit which seeks unspecified damages on behalf of all purchasers of the Company's common stock between October 12, 1992 and March 19, 1993. On November 18, 1993, the District Court granted the Company's motion to dismiss the 1993 complaint. The effect of the ruling was to dismiss the complaint except as to a statement allegedly made on January 28, 1993, but plaintiffs were granted leave to further amend their complaint. The Company is vigorously defending against the litigation.\nManagement believes that the ultimate resolution of the disputes and litigation matters discussed above will not have a material adverse impact on the Company's financial position or results of operations.\n10. STOCKHOLDERS' EQUITY\nREDEEMABLE CONVERTIBLE PREFERRED STOCK\nThe Company has 2,000,000 shares of authorized and unissued preferred stock at $.01 par value per share. At December 31, 1993 and 1992 there were no shares of preferred stock outstanding.\nIn 1990 a corporation acquired a minority interest in Valid through an initial investment of $10,998,000, in exchange for 86,133 shares of newly issued Series A-1 voting, convertible preferred stock, convertible into 861,330 common shares, at a purchase price equivalent to $13.00 per common share. All of the preferred stock was converted to common stock during 1992. In 1990 the corporation also purchased, for $1,187,500, a warrant to acquire up to 4,750,000 shares of Valid's common stock. This warrant was exchanged for approximately 199,000 shares of common stock upon the merger of Valid with the Company.\nEach share of Series A-1 preferred stock was entitled to receive cumulative annual dividends. The dividends were payable in cash. In 1992 and 1991 the Company recorded $559,000 and $1,344,000, respectively, for dividends paid to the corporation.\nEMPLOYEE STOCK OPTION PLANS\nThe Company's Employee Stock Option Plan (the \"Plan\") provides for employees to be granted options to purchase up to 13,637,800 shares of common stock. The Plan provides for the issuance of either incentive or nonqualified options at an exercise price not less than fair market value of the stock on the date of grant. Options granted under the Plan become exercisable over periods of one to four years and expire five to ten years from the date of grant. At December 31, 1993 options to purchase 8,320,101 shares were outstanding under the Plan, of which options for 1,317,646 shares were exercisable at prices ranging from $2.00 to $28.75. Options to purchase 1,284,864 shares were available for future grant under the Plan. During 1993 holders of the Company's options were given the opportunity to exchange previously granted stock options for new common stock options exercisable at $8.81 per share, the fair market value of the common stock on the date of exchange. Under the terms of the new options, one-third of the shares vest one year from the date of grant and the remaining shares vest in 24 equal monthly installments. Options to purchase 4,856,026 shares were exchanged. Options to purchase 4,032,835 shares of common stock have been exercised as of December 31, 1993.\nDuring 1993 the Company adopted a Non-Statutory Stock Option Plan (the \"Non-Statutory Plan\"). The Company has reserved 2,500,000 shares of common stock for issuance under the Non-Statutory Plan. Since directors and officers of the Company are not eligible to receive options under the Non-Statutory Plan, stockholder approval is not required nor will it be sought. Options granted under the Non-Statutory Plan become exercisable over a four-year period, with one-fourth of the shares vesting one year from the vesting commencement date and the remaining shares vesting in 36 equal monthly installments. The Non-Statutory options generally expire ten years from the date of grant. At December 31, 1993 options to purchase 1,230,225 shares were outstanding, none of which were exercisable. Options to purchase 1,269,775 shares were available for future grant under the Non-Statutory Plan.\nSTOCK OPTION PLANS - COMPANIES ACQUIRED\nThe Company has reserved a total of 1,313,996 shares of its authorized common stock for issuance upon the exercise of options granted to former employees of companies acquired (the \"Acquired Options\"). The Acquired Options were assumed by the Company outside the Plan, but all are administered as if assumed under the Plan. All of the Acquired Options have been adjusted to effectuate the conversion under the terms of the Agreements and Plans of Reorganization between the Company and the companies acquired. The Acquired Options generally become exercisable over a four-year period and generally expire either five or ten years from the date of grant. At December 31, 1993 Acquired Options to purchase a total of 1,313,996 shares were outstanding, of which 1,128,756 were exercisable at prices ranging from $.41 to $21.52. No additional options will be granted under any of the acquired companies' plans.\nCombined activity with respect to the Employee Stock Option Plans and Stock Option Plans - Companies Acquired was as follows:\nOPTION AGREEMENTS\nThe Company occasionally has issued options outside of the Plan. As of December 31, 1993 options to purchase 70,313 shares were outstanding under these agreements, of which 21,250 were exercisable at prices ranging from $18.25 to $20.94 per share.\nDIRECTORS STOCK OPTION PLANS\nThe Company's Board of Directors has adopted the 1988 and 1993 Directors Stock Option Plans (the \"Directors Plans\") in the indicated years. The Company has reserved 445,000 shares of common stock for issuance under the Directors Plans. The Directors Plans provide for the issuance of nonqualified stock options to nonemployee directors of the Company with an exercise price equal to the fair market value of the common stock on date of grant. Options granted under the Directors Plans have a term of up to ten years and vest one-third one year from the date of grant and two-thirds ratably over the subsequent two years. As of December 31, 1993 options to purchase 265,000 shares of common stock at $9.31 to $29.88 per share were outstanding under the Directors Plans, of which options for 99,717 shares were exercisable at prices ranging from $16.25 to $29.88 per share. Options to purchase 87,223 shares are available for future grant under the Directors Plans. Options to purchase 92,777 shares of common stock have been exercised as of December 31, 1993 under the Directors Plans. No additional options will be granted under the 1988 Directors Plan.\nEMPLOYEE STOCK PURCHASE PLANS\nThe Company has reserved 1,500,000 shares of common stock for issuance under the 1990 Employee Stock Purchase Plan (the \"ESPP\"). Under the ESPP the Company's employees may purchase shares of common stock at a price per share that is 85% of the lesser of the fair market value as of the beginning or the end of the semiannual option periods. In addition, Valid had a similar plan for which shares were approved for issuance in 1983. For the years ended December 31, 1993, 1992 and 1991 shares issued under the combined plans were 487,941, 324,183 and 286,586, respectively. As of December 31, 1993, 449,668 shares were available for future purchase under the ESPP. No additional shares will be issued under the Valid stock purchase plan.\nWARRANT\nIn connection with the purchase of Comdisco, the Company issued a warrant to purchase 1,300,000 shares of the Company's common stock at $14.50 per share. The warrant expires in June 2003 and can be exercised at any time in increments of not less than 50,000 shares. The warrant was valued at approximately $1,847,000 which was included as part of the total purchase price of Comdisco.\nRESERVED FOR FUTURE ISSUANCE\nAs of December 31, 1993 the Company has reserved the following shares of authorized but unissued common stock for future issuance:\nSTOCKHOLDER RIGHTS PLAN\nDuring 1989 the Company adopted a Stockholder Rights Plan. As part of this plan the Company's Board of Directors declared a dividend of one Common Share Purchase Right (the \"Right\") for each share of the Company's common stock outstanding on July 20, 1989. The Board also authorized the issuance of one such Right for each share of the Company's common stock issued after July 20, 1989 until the occurrence of certain events.\nEach Right entitles the holder thereof to purchase one share of the Company's common stock for $100, subject to adjustment in certain events. The Rights are not exercisable until the occurrence of certain events related to a person acquiring, or announcing the intention to acquire, 20% or more of the Company's common stock. Upon such acquisition, each Right (other than those held by the acquiring person) will be exercisable for that number of shares of the Company's common stock having a market value of two times the exercise price of the Right. If the Company subsequently enters into certain business combinations, each Right (other than those held by the acquiring person) will be exercisable for that number of shares of common stock of the other party to the business combination having a market value of two times the exercise price of the Right. The Rights currently trade with the Company's common stock. The Rights are subject to redemption at the option of the Board of Directors at a price of $.01 per Right until the occurrence of certain events, and are exchangeable for the Company's common stock, at the discretion of the Board of Directors, under certain circumstances. The Rights expire on May 30, 1999.\n11. INCOME TAXES\nThrough December 31, 1992 the Company accounted for income taxes pursuant to Statement of Financial Accounting Standards (\"SFAS\") No. 96, \"Accounting for Income Taxes.\" Effective January 1, 1993 the Company retroactively adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes.\" The adoption of this accounting pronouncement did not have a material impact on amounts reported in prior years' financial statements.\nThe provision for income taxes for the year ended December 31, consisted of the following components (in thousands):\nIncome (loss) from continuing operations before income taxes for the years ended December 31, 1993, 1992 and 1991 included income (loss) of $9,166,000, $5,478,000 and $(4,493,000), respectively, from the Company's foreign subsidiaries.\nThe provision for income taxes at December 31, differs from the amount estimated by applying the statutory federal income tax rate to income (loss) from continuing operations before taxes as follows (in thousands):\nThe components of deferred tax assets and liabilities consisted of the following (in thousands):\nThe deferred assets which will affect equity or intangibles and which will not be available to offset future provisions for income taxes are stated in the above table as \"Valuation allowance-equity\/intangibles.\" The net operating losses will expire at various dates from 1998 through the year 2006 and tax credit carry forwards will expire at various dates from 1997 through the year 2008.\n12. RELATED PARTY TRANSACTIONS\nDuring 1993 a customer of the Company entered into a consulting joint venture with the Company. Revenue related to this customer was approximately $5,928,000 for the year ended December 31, 1993. Outstanding trade accounts receivable from this related party were $2,268,000 at December 31, 1993.\nA minority interest participant in a subsidiary of the Company is also a major customer of the Company. Revenue related to this customer (a distributor) was approximately $48,655,000, $57,133,000 and $49,672,000 for the years ended December 31, 1993, 1992 and 1991, respectively. Outstanding trade accounts receivable from this related party were approximately $10,304,000 and $17,021,000 as of December 31, 1993 and 1992, respectively.\nDuring 1990 a customer of the Company entered into a research and development joint venture with the Company. During 1992 the Company acquired the minority interest in the joint venture. Revenue related to this customer was approximately $777,000 and $1,276,000 for the years ended December 31, 1992 and 1991, respectively. There were no accounts receivable outstanding for this customer at December 31, 1992.\n13. OPERATIONS BY GEOGRAPHIC AREA\nThe Company operates primarily in one industry segment -- the development and marketing of computer-aided design software. The Company's products have been marketed internationally through distributors and through the Company's subsidiaries in Europe, Japan and the Far East. Intercompany revenue results from licenses that are based on a percentage of the subsidiaries' revenue from unaffiliated customers. The following table presents a summary of operations by geographic area (in thousands):\n(1) Domestic operations revenue includes export revenue of approximately $10,137,000, $11,500,000 and $4,900,000 to Europe for the years ended December 31, 1993, 1992 and 1991, respectively, and approximately $48,971,000, $75,400,000 and $71,700,000 to Asia\/Pacific for the years ended December 31, 1993, 1992 and 1991, respectively.\nSCHEDULE VIII\nCADENCE DESIGN SYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)\n(1) Uncollectible accounts written-off (2) Inventory costs written-off (3) Incurred severance and facilities costs relating to the Company's restructuring and a reclassification of $3,500 and $13,135 in 1993 and 1991, respectively, from accrued operating lease obligations to lease liabilities. (4) Reflects a reclassification of $2,009 from accrued liabilities to other noncurrent liabilities.\nSCHEDULE IX\nCADENCE DESIGN SYSTEMS, INC. SHORT-TERM BORROWINGS (DOLLARS IN THOUSANDS)\n(1) Computed by dividing the average month-end balance (2) Computed by averaging month-end balance interest rates\nSCHEDULE X\nCADENCE DESIGN SYSTEMS, INC. SUPPLEMENTARY INCOME STATEMENT INFORMATION (IN THOUSANDS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Cadence Design Systems, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, March 30, 1994.\nCADENCE DESIGN SYSTEMS, INC.\n\/s\/ Joseph B. Costello --------------------------------- Joseph B. Costello President & Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capabilities and on the date indicated.\nINDEX TO EXHIBITS\nINDEX TO EXHIBITS\nINDEX TO EXHIBITS\nINDEX TO EXHIBITS","section_15":""}
{"filename":"793952_1993.txt","cik":"793952","year":"1993","section_1":"Item 1. Business ---------------- Summary -------\nHarley-Davidson, Inc. (the \"Company\") was incorporated in 1981, at which time it purchased the Harley-Davidson Motorcycle Business from AMF Incorporated (currently doing business as Minstar) in a management buyout. In 1986, the Company became publicly held. The Company operates in two segments: Motorcycles and Related Products and Transportation Vehicles.\nThe Company's Motorcycles and Related Products segment designs, manufactures and sells primarily heavyweight (engine displacement of 751cc or above) touring and custom motorcycles and a broad range of related products which include motorcycle parts and accessories and riding apparel. The Company, which is the only major American motorcycle manufacturer, has held the largest share of the United States heavyweight motorcycle market since 1986. The Company generally holds much smaller market shares in international markets.\nThe Transportation Vehicles segment consists entirely of the Company's wholly owned subsidiary Holiday Rambler Corporation and its subsidiaries (\"Holiday Rambler\"). Holiday Rambler manufactures recreational vehicles, principally motorhomes and travel trailers, and specialized commercial vehicles. Holiday Rambler was acquired by the Company in December 1986. Holiday Rambler's Recreational Vehicle division competes primarily in the mid to premium segment of the recreational vehicle market. Holiday Rambler's commercial vehicles (marketed under the Utilimaster(R) brand name), which include walk-in vans and parcel delivery trucks, are built for a diverse range of specialized commercial uses. Holiday Rambler's Commercial Vehicle division is one of a small number of commercial vehicle manufacturers with the resources to satisfy the volume requirements and specialized needs of fleet customers.\nRevenue, operating profit (loss) and identifiable assets attributable to each of the Company's segments are as follows (in thousands): - -------------------------------------------------------------------------------\n*Includes $57.0 million charge related primarily to the write-off of goodwill. - --------------------------------------------------------------------------------\nThe heavyweight motorcycle market continued to expand in 1993. The recreational vehicle industry also reported volume increases during 1993, primarily in the middle to low price segments of the market. The Recreational Vehicles division generally targets its products toward the middle to upper price segment of the market.\nQuarterly revenue and operating income (loss) (in thousands), by segment, and motorcycle shipment information, are as follows:\nMOTORCYCLES AND RELATED PRODUCTS\nThe primary business of the Motorcycles and Related Products segment is to produce and sell premium heavyweight motorcycles. The Company's motorcycle products emphasize traditional styling, design simplicity, durability, ease of service and evolutionary change. Studies by the Company indicate that the typical Harley-Davidson(R) motorcycle owner is a male in his late-thirties, with a household income of approximately $53,700, who purchases a motorcycle for recreational purposes rather than to provide transportation and who is an experienced motorcycle rider. Approximately two-thirds of the Company's sales are to buyers with at least one year of higher education beyond high school.\nThe heavyweight class of motorcycles is comprised of four types: standard, which emphasizes simplicity and cost; performance, which emphasizes racing and speed; touring, which emphasizes comfort and amenities for long-distance travel; and custom, which emphasizes styling and individual owner customization. Touring and custom models are the primary class of heavyweight motorcycle the Company manufactures. The Company presently manufactures and sells 18 models of touring and custom heavyweight motorcycles, with suggested retail prices ranging from approximately $5,000 to $16,200. The touring segment of the heavyweight market was pioneered by the Company and includes motorcycles equipped for long-distance touring with fairings, windshields, saddlebags and Tour Paks(R). The custom segment of the market includes motorcycles featuring the distinctive styling associated with certain classic Harley-Davidson motorcycles. These motorcycles are highly customized through the use of trim and accessories. The Company's motorcycles are based on variations of five basic chassis designs and are powered by one of three air cooled, twin cylinder engines of \"V\" configuration which have displacements of 883cc, 1200cc and 1340cc. The Company manufactures its own engines and frames.\nDuring 1993, the Company acquired a 49 percent interest in Buell Motorcycle Company (Buell), a manufacturer of performance motorcycles. This investment in Buell offers the Company the possibility of gradually gaining entry into select niches within the performance motorcycle market. Buell will begin the distribution of a limited number of Buell motorcycles during 1994 to select dealers within the Company's dealer network.\nAlthough there are some accessory differences between the Company's top-of-the line touring motorcycles and those of its competitors', suggested retail prices are generally comparable. The top of the Company's custom product line is typically priced at approximately twice that of its competitors' custom motorcycles. The custom portion of the product line represents the Company's highest unit volumes and continues to command a price premium because of its features, styling and high resale value. The Company's smallest displacement custom motorcycle (the 883cc Sportster(R)) is directly price competitive with competitors' comparable motorcycles. The Company's surveys of retail purchasers indicate that, historically, over three-quarters of the purchasers of its Sportster model have come from competitive-brand motorcycles or are people new to the sport of motorcycling. Since 1988, the Company's research has consistently shown a repurchase intent in excess of 92% on the part of purchasers of its motorcycles, and the Company expects to see sales of its 883cc Sportster model partially translated into sales of its higher-priced products in the normal two to three year ownership cycle. Domestically, motorcycle sales generated 51.4%, 52.8% and 50.6% of revenues in the Motorcycles and Related Products segment during 1993, 1992 and 1991, respectively.\nThe major product categories for the Motorcycle Parts and Accessories business are replacement parts, mechanical accessories, rider accessories (MotorClothes(R) and collectibles) and specially formulated oil and other lubricants. The Company's replacement parts include original equipment\nparts, generally made in the United States, and a less expensive line of imported parts introduced in 1983 to compete against foreign-sourced aftermarket suppliers. Domestic motorcycle parts and accessories sales comprised 17.4%, 15.3% and 14.9% of net sales in the Motorcycles and Related Products segment in 1993, 1992 and 1991, respectively. Net sales from domestic motorcycle parts and accessories have grown 77% over the last three years (since 1990).\nThe Company also provides a variety of services to its dealers and retail customers including service training schools, delivery of its motorcycles, motorcycling vacations, memberships in an owners club and customized software packages for dealers. The Company has had recent success under a program emphasizing modern store design and display techniques in the merchandising of parts and accessories by its dealers. Currently, 307 domestic and 75 international dealerships have completed store design renovation projects.\nLicensing. In recent years, the Company has endeavored to create an awareness of the brand among the nonriding public by licensing its trademark \"Harley- Davidson(R)\" and numerous related trademarks owned by the Company. The Company currently has licensed the production and sale of a broad range of consumer items, including t-shirts and other clothing, jewelry, small leather goods and numerous other products and is expanding its licensing activity in the toy category. Although the majority of licensing activity occurs in the U.S., the Company has expanded into international markets.\nThis licensing activity provides the Company with a valuable source of advertising. Licensing also has proven to be an effective means for enhancing the Company's image with consumers and provides an important tool for policing the unauthorized use of the Company's trademarks thereby protecting the brand and its use by authorized motorcycle dealers. Royalty revenues from licensing accounted for approximately 1% of the net sales from the Motorcycles and Related Products segment during each of the three years in the period ended December 31, 1993. While royalty revenues from licensing activities are small, the profitability of this business is relatively high.\nMarketing and Distribution. The Company's basic channel of United States distribution for its motorcycles and related products consists of approximately 600 independently owned full-service dealerships. With respect to sales of new motorcycles, approximately 75% of the dealerships sell Harley- Davidson motorcycles exclusively. All dealerships carry the Company's replacement parts and aftermarket accessories and perform servicing of Harley- Davidson motorcycle products.\nThe Company's marketing efforts are divided among dealer promotions, customer events, magazine and direct mail advertising, public relations, and cooperative programs with Harley-Davidson dealers. The Company also sponsors racing activities and special promotional events and participates in all major motorcycle consumer shows and rallies. In an effort to encourage Harley- Davidson owners to become more actively involved in the sport of motorcycling, the Company formed a riders club in 1983. The Harley Owners Group(R), or \"HOG(R)\" currently has approximately 250,000 members worldwide and is the industry's largest company-sponsored enthusiast organization. In addition, since 1980 the Company has been a national sponsor of the Muscular Dystrophy Association. In 1984, the Company became the first motorcycle manufacturer to use a national program of demonstration rides. The Company's expenditures on domestic marketing and advertising were approximately $53.8 million, $45.2 million and $36.1 million during 1993, 1992 and 1991, respectively.\nRetail Customer and Dealer Financing. Among the factors affecting the volume of the Company's motorcycle sales are the availability and cost of credit to both retail purchasers and Harley-Davidson dealers.\nOn January 5, 1993, the Company invested $10 million for a 49% interest in Eagle Credit Corporation (\"Eagle\"). Eagle was formed to provide a source for wholesale and retail motorcycle financing to dealers and customers, respectively. Also on January 5, 1993, Eagle assumed the motorcycle floor- plans and parts and accessories arrangements previously held by ITT Commercial Finance Corp. Eagle has initiated programs that have allowed it to offer retail financing opportunities to the Company's domestic motorcycle customers. In addition, Eagle has established a proprietary credit card for use in the Company's independent dealerships.\nA majority of dealer purchases of the Company's motorcycles are financed by Eagle. Under the terms of the Company's agreement with Eagle, participating dealers finance with Eagle 100% of the motorcycle invoice price. The Company has agreed to indemnify Eagle for certain losses that might be incurred by Eagle upon the sale or disposition of motorcycles repossessed by Eagle. Historically, the Company has experienced insignificant losses under this program.\nThe Company encourages its motorcycle dealers to purchase and maintain adequate inventories of the Company's parts and accessories during the winter months in anticipation of the Christmas and spring selling season by offering its dealers special discounts and delayed billing terms. Under this program, payments to Eagle by dealers are due on June 1. The Company enters into an annual trade acceptance agreement with Eagle to provide the Company with the ability to sell its receivables from dealers. Under the terms of the agreement, the Company receives cash from Eagle in the amount of 100% of certain eligible accounts receivable at the time of sale to the dealer. On June 1 of each year, the date by which payments to Eagle are due from dealers, the Company is obligated to repurchase all unpaid balances from Eagle. Historically, the Company has experienced insignificant losses under this program.\nInternational Sales. International sales were $263 million, $240 million and $205 million, accounting for approximately 28%, 29% and 29% of net sales of the Motorcycles and Related Products segment, during 1993, 1992 and 1991, respectively. The Company believes that the international heavyweight market is growing and is significantly larger than the U.S. heavyweight market. The Company estimates, using data reasonably available to the Company, that it holds an average market share of approximately 14% in the heavyweight export markets in which it competes.\nThe Company has wholly owned subsidiaries located in Germany, Japan and the United Kingdom. The German subsidiary also serves Austria and France. The combined foreign subsidiaries have a network of 129 dealers of which approximately 44% sell the Company's motorcycles exclusively. Distribution through these subsidiaries allows the Company flexibility in responding to changing economic conditions in a variety of foreign markets. Elsewhere, sales are managed through 16 distributors in 14 countries. These distributors service approximately 251 additional dealers, of which approximately 92% sell Harley-Davidson motorcycles exclusively. The Company has representatives in 5 additional countries who primarily seek fleet sales and parts orders. Japan, Germany, Canada and France, in that order, represent the Company's largest export markets and account for approximately 63% of export sales. See Note 11 to the consolidated financial statements for additional information regarding foreign operations.\nCompetition. The U.S. and international heavyweight motorcycle markets are highly competitive. The Company's major competitors generally have financial and marketing resources which are substantially greater than those of the Company. The Company's principal competitors have larger overall sales volumes and are more diversified than the Company. The Company believes that the heavyweight motorcycle market is the most profitable segment of the U.S. motorcycle market.\nDuring 1993, the heavyweight segment represented 34% of the total U.S. motorcycle market in terms of new units registered.\nThe Company first began to experience significant competition in the domestic heavyweight motorcycle market from Japanese manufacturers in the early 1970's, and prior to 1984, the Company's U.S. market share declined almost continuously. Domestically, the Company competes in the touring and custom segments of the heavyweight motorcycle market, which together accounted for 75%, 73% and 72% of total heavyweight retail unit sales in the U.S. during 1993, 1992 and 1991, respectively. The custom and touring motorcycles are generally the most expensive and most profitable vehicles in the market.\nFor the last 8 years, the Company has led the industry in domestic sales of heavyweight motorcycles. The Company has increased its share of the heavyweight market from 22% in 1983 to 58% in 1993.\nShares of U.S. Heavyweight Motorcycle Market* (Above 750cc Engine Displacement)\n* Information in this report regarding motorcycle registrations and market shares has been derived from data published by R.L. Polk & Co.\nOn a worldwide basis, the Company measures its market share using the heavyweight classification. Although definitive market share information does not exist for many of the smaller foreign markets, the Company estimates its worldwide competitive position, using data reasonably available to the Company, to be as follows:\n- --------------------------------------------------------------------------------\nWorldwide Heavyweight Motorcycle Registration Data (Above 750cc Engine Displacement)\n(1) Includes the United States and Canada (2) Includes Austria, Belgium, France, Germany, Italy, Netherlands, Spain, Switzerland and United Kingdom. (3) Data for Queensland, Northern Territory and South Australia not available prior to 1993. - -------------------------------------------------------------------------------\nCompetition in the heavyweight motorcycle market is based upon a number of factors, including price, quality, reliability, styling, product features and warranties. The Company emphasizes quality, reliability and styling in its products and offers warranties which are generally comparable to those of its competitors. In general, resale prices of Harley-Davidson motorcycles, as a percentage of price when new, are significantly higher than resale prices of motorcycles sold by the Company's competitors.\nAlthough domestic heavyweight registrations increased 17% and 14% during 1993 and 1992, respectively, the Company expects only modest market growth in the future. The Company's ability to maintain its current domestic sales levels will depend primarily on its ability to maintain or increase its share of the market.\nMotorcycle Manufacturing. Since 1982, in an effort to achieve cost and quality parity with its competitors, the Company has incorporated manufacturing techniques to continuously improve its operations. These techniques, which include employee involvement, just-in-time inventory principles and statistical process control, have significantly improved quality, productivity and asset utilization.\nThe Company's use of just-in-time inventory principles allows it to minimize its inventories of raw materials and work in process, as well as scrap and rework costs. This system also allows quicker reaction to engineering design changes, quality improvements and market demands. The Company has trained the majority of its manufacturing employees in problem solving and statistical methods.\nDuring 1993, the Company completed a comprehensive motorcycle manufacturing strategy designed to, among other things, achieve the goal of a 100,000 units per year production rate in 1996. The Company began implementing the strategy in 1993 and estimates that it will be completed during 1996. The strategy calls for the enhancement of the Motorcycle division's ability to increase capacity, adjust to changes in the market place and further improve quality while reducing costs. The strategy calls for the achievement of the increased capacity within the existing facilities (with minor additions) without a significant change in personnel.\nRaw Material and Purchased Components. The Company has endeavored to establish with its suppliers long-term informal \"partnership\" relationships, directly assisting them in the implementation of the manufacturing techniques employed by the Company through training sessions and plant evaluations. In furtherance of the Company's \"partnership\" philosophy, the Company reduced the number of its manufacturing suppliers in recent years and is conducting more business with suppliers that have implemented these same manufacturing techniques in their manufacturing operations.\nThe Company purchases all of its raw material, principally steel and aluminum castings, forgings, sheet and bars, and certain motorcycle components, including carburetors, batteries, tires, seats, electrical components and instruments. Certain of these components are secured from one of a limited number of suppliers. Interruptions from certain of these suppliers could adversely affect the Company's production pending the establishment of substitute supply arrangements. The Company anticipates no significant difficulties in obtaining raw materials or components for which it relies upon a limited source of supply.\nResearch and Development. The Company believes that research and development is a significant factor in the Company's ability to continuously improve its competitive position. The Motorcycles and Related Products segment incurred research and development expenses of approximately $19.3 million, $14.6 million and $8.0 million during 1993, 1992 and 1991, respectively.\nPatents and Trademarks. The Company owns certain patents which relate to its motorcycles and related products and processes for their production. The Company believes that the loss of any of its patents would not have a material effect upon its business.\nTrademarks are important to the Company's motorcycle business and licensing activities. The Company has a vigorous program of trademark registration and enforcement to prevent the unauthorized use of its trademarks, strengthen the value of its trademarks and improve its image and customer goodwill. The Company believes that its \"Harley-Davidson(R)\" registered United States trademark is its most significant trademark. The Company's Bar and Shield design is also highly recognizable by the general public. Additionally, the Company has numerous other registered trademarks, trade names and logos, both in the United States and abroad. The Company has used the \"Harley-Davidson\" trademark continuously since 1903.\nSeasonality. The Company, in general, does not experience seasonal fluctuations in production. This is primarily the result of a strong demand for the Company's motorcycles and related products, as well as the availability of floor plan financing arrangements for its independent dealers. Floor plan financing allows many dealers to build their inventory levels in anticipation of the spring and summer selling seasons.\nRegulation. Both federal and state authorities have various environmental control requirements relating to air, water and noise pollution which affect the business and operations of the Company.\nThe Company endeavors to ensure that its facilities and products comply with all applicable environmental regulations and standards.\nTo ensure compliance with lower European Union noise standards (80dba), which are scheduled to take effect in calendar year 1994, the Company began a product development program during late 1990. Most of the design changes related to this program will be incorporated into the 1995 model year motorcycles (production beginning in July 1994). While these models are subject to European Union Certification procedures, testing performed by the Company to date indicates that the design changes will bring 1995 model year motorcycles within the required limits. Near the end of the decade, there may be a further reduction of European Union noise standards (to 77dba). Accordingly, the Company anticipates that it will continue to incur some level of research and development costs related to this matter over the next several years.\nThe Company's motorcycles are subject to certification by the U.S. Environmental Protection Agency (EPA) for compliance with applicable emissions and noise standards and by the State of California Air Resources Board (ARB) with respect to the ARB's more stringent emissions standards. The Company's motorcycle products have been certified to comply fully with all such applicable standards. The Company's motorcycles are subject to additional ARB tailpipe and evaporation emissions standards requiring that unique vehicles be built for sale exclusively in California.\nThe Company, as a manufacturer of motorcycle products, is subject to the National Traffic and Motor Vehicle Safety Act (Safety Act), which is administered by the National Highway Traffic Safety Administration (NHTSA). The Company has acknowledged to NHTSA that its motorcycle products comply fully with all applicable federal motor vehicle safety standards and related regulations.\nIn accordance with NHTSA policies the Company has from time to time initiated certain voluntary recalls. During the last three years, the Company has initiated 11 voluntary recalls at a total cost of approximately $7.8 million. The Company fully reserves for all estimated costs associated with recalls in the period that they are announced.\nFederal, state, and local authorities have adopted various control standards relating to air, water and noise pollution which affect the business and operations of the Motorcycles and Related Product segment. Management does not anticipate that any of these standards will have a materially adverse impact on its capital expenditures, earnings, or competitive position.\nEmployees. As of December 31, 1993, the Motorcycles and Related Products segment had approximately 4,100 employees. Production workers at the motorcycle manufacturing facilities in Wauwatosa and Tomahawk, Wisconsin, are represented principally by the United Paperworkers International Union (UPIU) of the AFL-CIO, as well as the International Association of Machinist and Aerospace Workers (IAM). Production workers at the motorcycle manufacturing facility in York, Pennsylvania, are represented principally by the IAM. The current collective bargaining agreement with the UPIU as been extended to expire on April 11, 1994. The collective bargaining agreement with the Wisconsin-IAM will expire on March 2, 1997, and the collective bargaining agreement with the Pennsylvania-IAM will expire on February 2, 1997.\nTRANSPORTATION VEHICLES\nRecreational Vehicles ---------------------\nThe Recreational Vehicle division's motorhomes and travel trailers are designed to appeal to people interested in travel and outdoor recreational activities. These recreational vehicles are distinct from mobile homes, which are manufactured housing designed for permanent and semipermanent dwelling.\nPrincipal types of recreational vehicles produced by the Recreational Vehicle division include Class A or \"conventional\" motorhomes, Class C or \"mini\" motorhomes (discontinued with the 1994 model year), and travel trailers. Recreational vehicle classifications are based upon standards established by the Recreation Vehicle Industry Association (RVIA).\nA motorhome is a self-powered vehicle built on a motor vehicle chassis. The interior typically includes a driver's area, kitchen, bathroom, dining, and sleeping areas. Motorhomes are self-contained, with their own lighting, heating, cooking, refrigeration, sewage holding and water storage facilities so that they can be lived in without being attached to utilities. As such, they generally qualify as second homes for income tax purposes. Although they generally are not designed to provide complete facilities for permanent or semipermanent living, motorhomes do provide comfortable living facilities for short periods of time.\nClass A motorhomes are constructed on medium-duty truck chassis, which are purchased with engine and drive train components. The living area and driver's compartment are designed, manufactured, and installed by the Recreational Vehicle division.\nTravel trailers are non-motorized vehicles which are designed to be towed by passenger automobiles, pick-up trucks, sport utility vehicles or vans. They are otherwise similar to motorhomes in features and use. The Company produces both \"conventional\" and \"fifth wheel\" travel trailers. Conventional travel trailers are towed by means of a bumper or frame hitch attached to the towing vehicle. Fifth wheel trailers, designed to be towed by pick-up trucks, are constructed with a raised forward section that is attached to the bed area of the pick-up truck. This design allows a bi-level floor plan and additional living space.\nThe Company's premium lines of recreational vehicles are marketed under the Navigator(R) and Imperial(TM) brand names. Models in these lines are manufactured with premium quality materials and components, including entertainment centers, solid oak cabinetry and brass fixtures, and may be equipped with luxury features such as microwave-convection ovens, washer\/dryers and built-in vacuum cleaner systems. These models are generally purchased by persons who previously have owned recreational vehicles. The Navigator is a bus-style motorhome that carries a suggested retail price of $193,000 to $220,000. In the Company's Imperial line, suggested retail prices of motorhomes generally range between $108,000 and $183,000, while travel trailers retail between $38,200 and $67,000.\nThe Company also produces motorhomes under the Aluma-Lite(R) brand name, and travel trailers under the Aluma-Lite and Free Spirit(R) brand names, for the mid-range market. These models are produced with fewer standard features than the Navigator or Imperial. Suggested retail prices for the Aluma-Lite motorhome range between $68,000 and $123,000 while Aluma-Lite and Free Spirit travel trailers range between $18,000 and $58,000. Also in the mid-range market, the Company produces Endeavor(R) and Vacationer(R) motorhome models. Suggested retail prices in these lines range between $50,000 and $112,000.\nHoliday Rambler continues to emphasize product development. Its major thrust is threefold: to develop competitive floorplans; to update existing models; and to bring innovation into the product line along with increased quality. In achieving these goals, Holiday Rambler does not plan to vary from its traditional aluminum frame construction or stray from its existing product boundaries.\nThe following table presents information regarding wholesale sales of the Company's recreational vehicles during the periods indicated:\n- --------------------------------------------------------------------------------\nWholesale Recreational Vehicle Sales\nIn addition to wholesale sales of the recreational vehicle products shown above, sales by the Recreational Vehicle division also include retail sales by its wholly owned Holiday World(R) stores, discussed below.\nThe Recreational Vehicle division's sales (including retail, wholesale and other sales) were $192.7 million, $202.1 million and $170.6 million in 1993, 1992 and 1991, respectively. Sales of the Recreational Vehicle division accounted for 67.8%, 71.6% and 71.7% of the Transportation Vehicles segment's revenues for the years ended December 31, 1993, 1992 and 1991, respectively.\nCompetition and Other Business Considerations - The recreational vehicle market is highly competitive with a number of other manufacturers selling products in competition with the Company. Competition is based upon price, design, quality and service. The Company believes that it provides service comparable to that provided by its competitors and that the design and quality of its products compare favorably with similarly priced products of its competitors.\nThe Company believes that the primary external factors affecting the recreational vehicle industry are the consumer's perception of the health of the economy, interest rates, availability of retail financing and the availability of gasoline.\nFifteen manufacturers accounted for approximately 82% of total units sold during 1993 in the recreational vehicle market classifications in which the Recreational Vehicle division competes. The remaining units included products manufactured by approximately fifty additional manufacturers. During 1993, Fleetwood Enterprises, Inc. (Fleetwood) accounted for approximately 34% and 26% of the Class A and Travel Trailer markets, respectively. During the same period, the Company's shares of the Class A and Travel Trailer markets were 4.8% and 2.4%, respectively. The Company ranks fourth in Class A market share and ninth in Travel Trailer market share.\nAs a result of the Company's emphasis on sales of premium vehicles, the Company's market share in the premium market is significantly higher than its share of the overall market. While definitive market share statistics with respect to this market do not exist, the Company believes that its Recreational Vehicle division is one of the largest producers of premium recreational vehicles. The largest manufacturer in the recreational vehicle industry, Fleetwood, does not have significant market share in the premium segment. Although the Company manufactures Class A motorhomes and travel trailers with lower prices, the Recreational Vehicle division's strategy in manufacturing recreational vehicles outside of the premium market is to offer a broad range of recreational vehicles to purchasers who may subsequently purchase premium recreational vehicles.\nMarketing and Distribution - The Recreational Vehicle division markets its recreational vehicle products through a network of approximately 150 dealers located throughout the continental United States, including fourteen company- owned Holiday World dealers. Holiday World dealers also stock previously owned vehicles and new recreational vehicles manufactured by certain of Holiday Rambler's competitors. The Holiday World dealers provide Holiday Rambler with valuable knowledge regarding consumer preferences and information regarding products of its competitors, as well as other marketing information. Holiday Rambler's sales and service agreements require dealers to maintain a service department and a supply of recreational vehicle parts, supplies and accessories. These agreements are subject to renewal on an annual basis.\nHoliday Rambler's new owner questionnaires indicate that approximately 68% of purchasers of Holiday Rambler's new recreational vehicles are 56 years or older, a growing segment of the U.S. population.\nCustomer loyalty is reinforced by Holiday Rambler's sponsorship of the Holiday Rambler Recreational Vehicle Club, Inc., a not-for-profit Indiana corporation. The club is open only to owners of Holiday Rambler's recreational vehicles and has approximately 11,600 members. The club holds 31 club-sponsored rallies and caravans each year and is provided with administrative and promotional assistance by Holiday Rambler. Holiday Rambler receives valuable feedback from its customers at these events.\nHoliday Rambler is focusing its marketing effort to be more responsive to its customers' needs. During 1993, Holiday Rambler replaced or filled several key positions including that of the chief operating officer and the vice presidents of sales, marketing and engineering. The Company believes that these positions are vital to the success of the Transportation Vehicles segment's strategies surrounding the renewed customer focus.\nDealer Financing - Substantially all of the Recreational Vehicle division's recreational vehicle sales to dealers are made on terms requiring payment within ten days of the dealer's receipt of the unit. Most dealers are financed under \"floor plan\" arrangements with banks or finance companies under which the lender advances all, or substantially all, of the purchase price of the vehicle being purchased. The loan is collateralized by a lien on the vehicle. In certain instances, consistent with industry practice, Holiday Rambler has entered into repurchase agreements with these lenders which provide that, in the event of default by the dealer in repaying the loan, Holiday Rambler will either repay the loan or repurchase the financed vehicles. In general, the repurchase agreements provide that, for up to twelve months after a unit is financed, Holiday Rambler will repurchase the unit upon a determination by the lender to repossess the unit. Holiday Rambler's loss exposure on repurchase is limited to the difference between the net realized resale value of the vehicle and the amount required to be paid the lending institution at the time of repurchase. On January 5, 1993, Eagle purchased the Notes Payable obligations (floor plan financing) of the Company's wholly owned Holiday World Stores. For further\ninformation on dealer financing programs, see Notes 5 and 7 to the 1993 consolidated financial statements.\nCommercial Vehicles -------------------\nThe Company, through its Utilimaster Corporation subsidiary (Utilimaster), builds truck bodies for specialized commercial uses. Sales of the Company's commercial vehicles and truck bodies accounted for 27.8%, 24.0% and 23.4% of the Transportation Vehicles segment's revenues in 1993, 1992 and 1991, respectively.\nUtilimaster currently installs the truck bodies on chassis of various sizes supplied by third parties. The truck bodies are offered in aluminum or fiberglass reinforced plywood (FRP) construction and are available in lengths of 9 to 28 feet. The Company's products (excluding chassis) range in price from $2,600 to $34,000 although special service vehicles can sell as high as $60,000.\nThe principal types of commercial bodies are as follows:\nParcel Delivery Vans - Aluminum or FRP parcel delivery van bodies are installed on chopped van chassis supplied by the major Detroit truck manufacturers. These parcel delivery van bodies that are manufactured by the Company range in length from 10 to 16 feet and are primarily used for local delivery of parcels, freight and perishables.\nStandard Walk-In Vans - Utilimaster manufactures its standard walk-in vans (step-vans) on a truck chassis supplied with engine and drive train components, but without a cab. The Company fabricates the driver's compartment and body using aluminum panels. Uses for these vans include the distribution of food products and small packages.\nTruck Bodies - Utilimaster's truck bodies are typically fabricated up to 28 feet in length with prepainted aluminum or FRP panels, aerodynamic front and side corners, hardwood floors, and various door configurations to accommodate end-user loading and unloading requirements. These products are used for diversified dry freight transportation. The Company installs its truck bodies on chassis supplied with a finished cab.\nMobile Rescue and Special Use Emergency Vehicles - Utilimaster builds a variety of high cube and walk-in specialty use vehicles for the fire and rescue industry. These vehicles range in lengths from 10 to 22 feet and usually require extensive customization to meet the needs of the local emergency agencies.\nAeromate(R) - The Aeromate was developed for customers needing a mid-size delivery vehicle that offered maneuverability, front-wheel drive, fuel efficiency, a large cargo area and driver comfort, features not available from production vans and larger delivery vans. Its six-cylinder engine, automatic transmission and drive train are purchased from a third party in the automotive industry and retrofitted to the Company-built chassis. The all-aluminum truck body can hold 317 cubic feet of cargo, weighing up to one ton.\nMarketing and Distribution - Utilimaster markets its commercial vehicles and bodies directly to 450 fleet accounts and to single commercial vehicle purchasers through a network of 900 automobile and truck dealers. This network is distinct from the Company's recreational vehicle dealer network. The Company does not provide financing to these dealers or fleet accounts. For Aeromate dealers, the\nCompany makes financing available through lenders with which the Company has repurchase agreements.\nCompetition - While the Commercial Vehicle division experiences some competition from the large automotive manufacturers, which traditionally have offered a narrow selection of standardized commercial vehicle body options for their truck chassis, its principal competition is from a small number of manufacturers with the resources to satisfy the volume requirements and specialized needs of commercial vehicle fleet customers. These manufacturers include Grumman Corp., Union City Body Company, Inc., and Supreme Corp. Competition among manufacturers is based upon price, quality, and responsiveness to customer requirements both in design and timing of delivery. Sales of commercial vehicles to fleet customers generally are either the result of direct competition with other manufacturers or a competitive bidding process. Because of the specialized needs of each customer, the relative importance of each individual factor varies from customer to customer. The Company believes that it has been able to compete successfully on the basis of all of these factors.\nOther Products --------------\nThe Transportation Vehicles segment's Creative Dimensions division produces a broad line of contemporary office furniture. Creative Dimensions products are marketed through a network of approximately 750 office suppliers and designers nationwide. The Transportation Vehicles segment's Nappanee Wood Products division is a custom cabinetmaker which produces high quality, solid wood cabinets and wood components primarily for the Company's recreational vehicles. The Transportation Vehicles segment's B & B Molders division designs and manufactures a diverse range of custom or standard tooling and injection molded plastic pieces.\nOther products accounted for 4.4%, 4.4% and 4.9% of the Transportation Vehicles segment revenues for the years ended December 31, 1993, 1992 and 1991, respectively.\nAll Divisions -------------\nProduction. Holiday Rambler's products are built utilizing an assembly line process. Holiday Rambler has designed and built its own fabricating and assembly equipment for the majority of its manufacturing processes. Holiday Rambler believes that the manufacturing systems and technology enables it to produce high quality products on an efficient basis. In addition to assembling its products and installing various options and accessories, Holiday Rambler manufactures a majority of its plastic components and other installed products, such as draperies, bathtubs, holding tanks, wheel covers, and wiring harnesses.\nHoliday Rambler currently operates one production shift. Capacity increases can be achieved at relatively low cost on the existing shifts, largely by increasing the number of production employees, or by adding a shift. Holiday Rambler's plant facilities can be easily expanded, contracted, or converted to reflect changing product demand.\nThe manufacturing processes, facilities, and equipment used to make Holiday Rambler's recreational vehicles and commercial vehicles are similar and, in most respects, interchangeable. The required employee skills are applicable to the production of either type of vehicle. As a result, the Company has the flexibility to shift employees and resources in order to meet changing demands in its markets. A portion of production employees' compensation consists of production group incentives, which can permit an employee to increase his total compensation by increasing productivity and meeting quality standards.\nProduction Materials. The principal raw materials and other components used in the production of recreational and commercial vehicles are purchased from third parties. With the exception of the chassis, these materials, including aluminum, plywood, lumber, plastic and fiberglass, are generally available from numerous sources.\nHoliday Rambler obtains its chassis from several automobile or truck manufacturers under either consignment agreements or secured financing agreements with interest subsidies by the manufacturers. Subject to certain time limitations, Holiday Rambler pays for a recreational vehicle chassis upon making an alteration or addition to the chassis. Upon sale of a recreational vehicle to a dealer, Holiday Rambler invoices the purchasing dealer for the completed vehicle, including the chassis.\nThe agreements relating to commercial vehicle chassis contemplate that Holiday Rambler will make alterations or additions to a chassis upon the order of dealers affiliated with the chassis manufacturer. In this situation, Holiday Rambler delivers completed vehicles to the purchasing dealer and invoices the dealer for Holiday Rambler's additions and alterations only. The dealer is invoiced for the chassis directly by the chassis manufacturer (which has reacquired title to the chassis from Holiday Rambler under an interest subsidized secured financing arrangement). The commercial vehicle chassis agreements also permit Holiday Rambler to purchase the chassis from the manufacturer through an affiliated dealer, in which case Holiday Rambler takes title, and is obligated to pay for the chassis.\nHoliday Rambler's Class A motorhomes are generally built on Chevrolet, Ford and Spartan chassis, and its commercial vehicles are generally built on GM and Ford chassis. If any of these manufacturers were to cease manufacturing or otherwise reduce the availability of these chassis, the business of Holiday Rambler could be adversely affected, although Class A chassis supplied by Oshkosh Truck Corporation could lessen the impact. In general, Holiday Rambler has not experienced any substantial shortages of raw materials or components. However, the industry has occasionally experienced short-term chassis shortages.\nPatents and Trademarks. The Transportation Vehicles segment owns various patents and know-how which relate to its recreational vehicles and other products and the processes for their production. The Company believes that the loss of any of these patents would not have a material effect upon its business.\nTrademarks are important to the Transportation Vehicles segment's recreational and commercial vehicle business. The Transportation Vehicles segment's Holiday Rambler(R) trademark is its most significant trademark. Additionally, the Transportation Vehicle segment has numerous other valuable registered trademarks, trade names, and logos used in its business.\nSeasonality. The recreational vehicle market is generally subject to seasonal fluctuations. Retail sales are generally stronger during the spring and late summer months. The availability of retail floor plan financing to the Recreational Vehicle division's independent dealers, as well as the use of specialized sales programs during the winter months, help to mitigate some of the effects of seasonality on the Recreational Vehicle division's production schedule.\nRegulation. The manufacture, distribution, and sale of the Transportation Vehicle segment's vehicles are subject to governmental regulations in the United States at the federal, state, and local levels. The most extensive regulations are promulgated under the Safety Act which, among other things, enables the NHTSA to require a manufacturer to remedy vehicles containing \"defects related to motor vehicle safety\" or vehicles which fail to conform to all applicable federal motor vehicle safety standards. Pursuant to the Safety Act and related regulations, the Transportation Vehicles segment from time to\ntime has initiated voluntary recalls of its recreational and commercial vehicles. Since the beginning of 1990, recalls by the Transportation Vehicles segment initiated under the Safety Act, all of which have been voluntary, have involved an aggregate cost to the Company of approximately $3.8 million.\nFederal, state, and local authorities have adopted various control standards relating to air, water and noise pollution which affect the business and operations of the Transportation Vehicle segment. Management does not anticipate that any of these standards will have a materially adverse impact on its capital expenditures, earnings, or competitive position.\nEmployees. As of December 31, 1993, the Transportation Vehicles segment employed approximately 1,900 people. None of the segment's personnel are represented by labor unions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ------------------\nThe following is a summary of the principal properties of the Company as of March 17, 1994.\nMotorcycles and Related Products Segment ----------------------------------------\nThe Motorcycles and Related Products segment has three facilities that perform manufacturing operations: Wauwatosa, Wisconsin, a suburb of Milwaukee (motorcycle power train production); Tomahawk, Wisconsin (fiberglass parts production and painting); and York, Pennsylvania (motorcycle parts fabrication, painting and assembly).\nThe results of a comprehensive manufacturing strategy completed by the Company during 1993 indicated that generally the size of the existing facilities with minor additions would be adequate to meet its current goal of being able to produce 100,000 motorcycles, annually, in 1996.\nTransportation Vehicles Segment - -------------------------------\nThe Transportation Vehicles segment's units are manufactured in approximately 30 separate buildings. Additionally, the Segment owns 20 buildings used for administrative, storage, and other purposes. Substantially all of the facilities are located on three sites at or near the Transportation Vehicles segment's corporate headquarters in Wakarusa, Indiana. The Company owns all of the production facilities and the underlying parcels of land. Because recreational and commercial vehicles are produced largely through a labor- intensive assembly process, the facilities do not house extensive capital equipment. The Transportation Vehicles segment's present facilities are generally adequate for their current intended use. Capacity increases may be achieved at a relatively low cost, largely by adding production employees.\nItem 3.","section_3":"Item 3. Legal proceedings --------------------------\nThe Company is involved with government agencies in various environmental matters, including a matter involving soil and groundwater contamination at its York, Pennsylvania facility (the Facility). The Facility was formerly used by the U.S. Navy and AMF (the predecessor corporation of Minstar). The Company purchased the facility from AMF in 1981. Although the Company is not certain as to the extent of the environmental contamination at the Facility, it is working with the Pennsylvania Department of Environmental Resources. The Company is currently pursuing cost recovery litigation against the Navy and believes that the Navy, by virtue of its ownership and operation of the Facility, will ultimately be responsible for a substantial portion of the environmental remediation costs at the Facility. In addition, in March 1991 the Company entered into a settlement agreement with Minstar related to certain indemnification obligations assumed by Minstar in connection with the Company's purchase of the Facility. Pursuant to this settlement, Minstar is obligated to reimburse the Company for a portion of its investigation and remediation costs at the Facility. Although substantial uncertainty exists concerning the nature and scope of the environmental remediation that will ultimately be required at the Facility, based on preliminary information currently available to the Company and taking into account the Company's estimate of the probable liability of the Navy, and the settlement agreement with Minstar, the Company estimates that it will incur approximately $4 million of additional remediation and related costs at the Facility. The Company has established reserves for this amount. The Company has also put certain of its insurance carriers on notice that it intends to make claims relating to the environmental contamination at the Facility. However, the Company is currently unable to determine the probable amount of recovery available, if any, under insurance policies.\nThe Company self-insures its product liability loss exposure. The Company accrues for claim exposures which are probable of occurrence and reasonably estimable.\nItem 4.","section_4":"Item 4. Submission of matters to a vote of security holders\nNo matters were submitted to a vote of stockholders of the Company in the fourth quarter of 1993.\nExecutive officers of the registrant ------------------------------------\nThe following sets forth, as of March 17, 1994, the name, age and business experience for the last five years of each of the executive officers of Harley-Davidson.\nExecutive Officers ------------------\nAll of these individuals have been employed by the Company in an executive capacity for more than five years, except C. William Gray and Martin R. Snoey.\nMr. Gray has been Vice President of Human Resources for the Motorcycle Division since joining the Company in 1990. Prior to that time, he was Senior Vice President, Human Resources for Champion International Corp., a manufacturer of paper products, and from 1986 to 1988 Vice President, Human\nResources and Vice President, Strategic Planning for B. F. Goodrich Company, a leading manufacturer serving the chemical and aerospace industries.\nMr. Snoey has been President and Chief Operating Officer of Holiday Rambler Corporation since joining the Company in January 1993. Prior to that time he held, from January 1992 to December 1992, a general management consulting agreement with Precision Castparts Corporation, a specialty manufacturer supplying the transportation industry. From July 1989 to March 1991 he was the President and CEO of Geostar Corporation, an entrepreneurial, global satellite communications company, serving the transportation industry. In February 1991, Geostar Corporation filed a voluntary Chapter 11 bankruptcy petition. From March 1984 to July 1989, he was an executive with the Kenworth Truck Division of PACCAR, Inc., a leading manufacturer of transportation equipment, where his last position was General Manager for U.S. Operations.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Harley-Davidson, Inc. common stock and related stockholder matters\nHarley-Davidson, Inc., common stock is traded on the New York Stock Exchange. The high and low market prices for the common stock, reported as New York Stock Exchange Composite Transactions, were as follows:\nPrior to the declaration of its first quarterly dividends during 1993, the Company had not paid cash dividends on its common stock.\nAs of March 17, 1994, there were approximately 19,300 shareholders of record of Harley-Davidson, Inc. common stock.\n*Includes a $57.0 million charge related primarily to the write-off of goodwill at the Transportation Vehicles segment (Holiday Rambler).\nItem 7.","section_6":"","section_7":"Item 7. Management's discussion and analysis of financial condition and results of operations\nOVERALL The Company's Motorcycles and Related Products segment was responsible for virtually all of the growth in 1993 revenue and earnings. Demand for the segment's motorcycles continued to exceed supply during 1993 and its parts and accessories business generated a 27.8% revenue increase over 1992. The motorcycle business also significantly benefitted from a more predictable and efficient manufacturing process.\nThe Transportation Vehicles segment, in total, recorded disappointing results in 1993. The segment's Recreational Vehicles business did not participate, to the extent of other recreational vehicles manufacturers, in the industry recovery. During the fourth quarter of 1993, the Company determined that an impairment of goodwill related to the Transportation Vehicles segment had occurred, and accordingly, recorded a $57.0 million ($1.46 per share) write- off of goodwill and certain other assets.\nIn addition to the goodwill write-off, the Company changed its methods of accounting both for postretirement health care benefits and for income taxes during 1993, resulting in a $30.3 million ($0.80 per share) charge to earnings, net of tax. Excluding the effect of the goodwill write-off and accounting changes, the Company would have reported earnings during 1993 of $74.1 million ($1.95 per share) compared to $53.8 million ($1.50 per share) during 1992.\nRESULTS OF OPERATIONS 1993 COMPARED TO 1992\nMOTORCYCLE UNIT SHIPMENTS AND CONSOLIDATED NET SALES\nThe Company reported record consolidated revenue during 1993 of $1.2 billion compared to $1.1 billion during 1992. The Motorcycles and Related Products segment was responsible for virtually all of the change in consolidated revenue as the result of increases in both motorcycle unit shipments and parts and accessories sales.\nDuring 1992, the motorcycle production schedule began the year at 280 units per day and increased throughout the year to a scheduled rate of 345 units per day in December. The scheduled motorcycle production rate remained steady at 345-350 units per day throughout 1993. Accordingly, the Company reported only a 6.8% increase in unit shipments compared to 1992.\nIn October 1993, the Company announced that it would increase its scheduled production rate to 365 units per day beginning January 3, 1994. Since the beginning of 1994, that rate has been exceeded several times. The Company may increase the rate during 1994 if the current production conditions continue.\nYear-end data indicate that the domestic (United States) motorcycle market continued to grow throughout 1993. Compared to 1992, industry registrations of heavyweight (engine displacements in excess of 750cc) motorcycles were up 17.4% (data provided by R.L. Polk). The Company ended 1993 with a market share of 58.4% compared to 60.4% in 1992. This decrease is primarily a reflection of the Company's constrained capacity in a growing motorcycle market. Demand for the Company's motorcycles continues to exceed supply with nearly all of the Company's independent domestic dealers reporting retail orders on their remaining 1994 model year motorcycle allocations (production through June, 1994).\nIn total, international demand remains strong. Export revenues totaled $262.8 million during 1993, an increase of approximately $23.4 million (9.8%) over 1992. The Company exported approximately 30% of motorcycle units in both 1993 and 1992 and expects to maintain approximately the same percentage during 1994. The Company distributes approximately one-half of exported units through its wholly owned subsidiaries in Germany, Japan and England, which allows the Company flexibility in responding to changing economic conditions in a variety of foreign markets. While definitive market share information does not exist in many foreign countries, the Company believes that it generally holds an approximate 14% overall market share in the foreign markets in which it competes.\nParts and accessories revenues exceeded management's expectations during 1993, increasing 27.8% over 1992. Fourth quarter results were especially strong, with revenues increasing 39.7% compared to the same period in 1992. Several factors including media exposure surrounding the Company's 90th anniversary celebration in June 1993, the popularity of the MotorClothes line and a strong holiday selling season contributed to the growth. While pleased with the results, the Company does not believe that the parts and accessories business growth will continue at these rates.\nThe Transportation Vehicles segment's Recreational Vehicle division did not realize the same level of improvement as the overall recreational vehicle industry. During 1993, industry registrations increased 13.1% overall, while the division's wholesale unit shipments decreased in both \"Class A\" (motorized) and towable (fifth wheel and travel trailers) product lines compared to 1992. The division's 1993 market shares for Class A motorhomes and towables were 4.8% and 2.3%, respectively, compared to 5.3% and 2.9% during 1992. Much of the industry improvement (especially with respect to travel trailers) has occurred in the lower end of the market, where the division generally does not compete.\nDuring 1993, the division added several employees from outside of the organization to fill key leadership positions in product development, marketing and sales areas. In addition, the Company replaced, in January 1993, the President and Chief Operating Officer position of the Transportation Vehicles segment. The entire leadership group at the Recreational Vehicles division has renewed their focus on providing more customer responsive products to the marketplace.\nA 16.2% revenue increase in the Commercial Vehicles division was primarily the result of large fleet contracts completed during 1993. Although it is too early to determine whether the Commercial Vehicles division will be able to match its success in 1994, its ability to attract large fleet contracts in a competitive market positions it well for future growth.\nCONSOLIDATED GROSS PROFIT (Dollars in Millions)\nThe $40.8 million increase in consolidated gross profit was generated entirely by the Motorcycles and Related Products segment. Volume increases in both motorcycle units and parts and accessories provided the majority of the increase. The improvement in gross profit as a percent of sales reflects, primarily, efficiencies realized in the manufacturing process. Motorcycle volume increases realized during 1992 resulted in substantial overtime and caused significant manufacturing inefficiencies. Accordingly, the manufacturing focus in 1993 was on process improvement rather than on dramatic production increases. The result was a more predictable manufacturing process, a substantial decrease in overtime and an efficient transition to production of 1994 models. The improvement in gross profit percentage occurred despite a shift in mix toward lower-margin Sportster models. Approximately 27% of 1993 motorcycle unit shipments were Sportster models compared to approximately 23% during 1992. The Company's long-term goal is a product mix consisting of approximately 25% Sportsters. The Company currently anticipates that approximately 28% of calendar 1994 production will consist of the Sportster models.\nGross profit at the Transportation Vehicles segment decreased slightly during 1993. Volume decreases in the Recreational Vehicles division were largely offset by volume increases in the Commercial Vehicles division. However, most of the volume increase at the Commercial Vehicles division was the result of fleet contracts which generally carry lower margins.\nCONSOLIDATED OPERATING EXPENSES (Dollars in Millions)\nThe Motorcycles and Related Products segment's operating expenses increased approximately 5.5% during 1993, although 1992's operating expenses included a $5.5 million charge in the Motorcycle division related to two voluntary recalls. In general, the increase in operating expense was the result of spending required to support the growing business, including international operations. Other areas of increase in 1993 include incentive compensation and engineering costs, while areas of decrease included product liability and warranty costs.\nDuring the fourth quarter of 1993, the Company recorded a $57.0 million charge to operations related to its Transportation Vehicles segment. $53.5 million ($1.41 per share) of the charge related to nondeductible goodwill associated with the Company's purchase of Holiday Rambler Corporation during 1986. Since the acquisition, the markets in which the Transportation Vehicles segment operates have become increasingly competitive, and the segment itself did not react appropriately to changes in market conditions, resulting in lower profit than initially anticipated. The Company considered these and other factors in concluding that an impairment of the goodwill asset had\noccurred. The Company measured the impairment by discounting estimated future cash flows of the Transportation Vehicles segment over the remaining goodwill amortization period, using a targeted cost of capital discount rate. In addition, the Company recorded a $3.5 million pretax ($0.05 per share) restructuring charge related to strategic decisions made with respect to certain operating units of the Transportation Vehicles segment.\nExcluding the effect of the goodwill and restructuring charge, the Transportation Vehicles segment recorded a $3.4 million (7.6%) increase in operating expenses related primarily to increased marketing costs, rising fringe benefit costs and incremental costs generated by two new Holiday World retail showroom and service centers. 1993 operating expenses included goodwill amortization of $2.2 million. Although the segment will not incur goodwill amortization during 1994, it expects operating costs in the areas of marketing, engineering and research and development to more than offset any reduction related to the elimination of goodwill amortization.\nCONSOLIDATED OTHER EXPENSES\nConsolidated other expense decreased $3.2 million during 1993 compared to 1992, primarily as the result of approximately $3.7 million related to foreign exchange gain recognized during 1993. In addition, the third quarter of 1992 included an unusual $1.9 million product recall in the Recreational Vehicles division related to units that had been produced eight to ten years earlier, prior to the purchase of Holiday Rambler Corporation by the Company. During the fourth quarter of 1993, the Company accrued $2.0 million toward the initial funding of the Harley-Davidson Foundation. The Foundation was established to administer the Company's charitable contributions.\nCONSOLIDATED NET INTEREST EXPENSE\nConsolidated net interest expense of $0.8 million decreased $4.1 million (83.1%) compared to 1992. The conversion of the Company's 7 1\/4% convertible subordinated debentures during the fourth quarter of 1992 and generally lower short-term debt levels were the primary factors in the decrease of consolidated interest expense.\nCONSOLIDATED INCOME TAXES\nThe Company's effective tax rate during 1993 was 72.3% due primarily to the effect of a $53.5 million nondeductible goodwill write-off during 1993. Excluding the effect of the write-off, the Company's effective tax rate would have been 40.0% compared to 39.0% during 1992.\n1992 COMPARED TO 1991\nMOTORCYCLE UNIT SHIPMENTS AND CONSOLIDATED NET SALES\nThe Company reported worldwide net sales during 1992 of $1.1 billion. Worldwide motorcycle demand continued to outpace production during 1992 and net sales at the Transportation Vehicles segment increased $44.5 million (18.7%) related primarily to an increase in volume in the Recreational Vehicle division.\nTotal 1992 shipments included additional motorcycles shipped from planned year-end inventories, similar to the year ago quarter. This resulted in a shift of 1,400 units, intended for the first quarter of 1993, into the fourth quarter of 1992.\nThe Company held approximately 60% of the heavyweight segment of the domestic motorcycle market during 1992 and 1991. United States market registrations of heavyweight motorcycles increased approximately 12,100 units (16%) during 1992. Although definitive market share information does not exist for many of the smaller foreign markets, the Company estimates that it holds an average market share of approximately 13% in the heavyweight segment of the foreign markets in which it competes.\nTotal export revenues in the Motorcycles and Related Products segment increased 16.6% to $239.5 million during 1992. Revenue from export motorcycle sales and parts and accessories sales increased 17.1% and 13.5%, respectively, during 1992, despite reported consumer concerns regarding worldwide economic conditions. Over the past three years approximately 30-31% of all motorcycle unit production has been allocated and shipped to non domestic markets.\nWorldwide, the motorcycle parts and accessories business reported a 19.5% revenue increase over 1991. The MotorClothes line of rider accessories increased $15.3 million (approximately 45%) during the same period. The MotorClothes line has begun to attract \"non-traditional\" customers and is increasing floor traffic at dealerships. Margins on the MotorClothes line are slightly lower than the margins generated by the other major parts and accessories lines.\nMotorcycle production during a normal eight-hour day increased to 345 units by the end of 1992, compared to 280 units in January, 1992. The production ramp- up required additional overtime during 1992 to achieve the schedule.\nThe Transportation Vehicles segment reported a $44.5 million (18.7%) revenue increase compared to 1991. The Recreational Vehicle division provided the majority of the increase. Improvements in market conditions, as well as introductions of several new products during the year contributed to the Recreational Vehicle division's revenue increase. The division began shipping the new \"bus style\"\nNavigator motorhome at the end of the second quarter which generated the division's largest single source of revenue increase during 1992. Revenue also benefited from a $16.6 million increase in total sales at the division's 12 retail Holiday World stores. Approximately $9.4 million of this increase was the result of two new retail Holiday World stores, in California, which opened at the beginning of 1992.\nThe Commercial Vehicle division reported a $12.2 million (21.9%) improvement in revenue over the prior year. This increase was primarily the result of additional volume from progress on two large fleet contracts awarded in 1991. During the second half of 1992, the Commercial Vehicle division was awarded two additional fleet contracts totaling approximately $17 million. Production on these contracts began during the first quarter of 1993.\nCONSOLIDATED GROSS PROFIT (Dollars in Millions)\nThe Motorcycles and Related Products segment reported a $48.8 million (24.2%) increase in gross profit compared to 1991. Motorcycle volume increases accounted for approximately one-half of the change. Improvement in the gross profit percentage was primarily the result of a shift in motorcycle mix toward higher margin custom units. The shift in product mix accounted for approximately one-third of the segment's increase in gross profit. Gross margins during both 1992 and 1991 were negatively impacted by costs associated with a number of manufacturing issues. These issues included the production ramp-up process and paint facility transition during 1991 and 1992, and inefficiencies caused by a two week work stoppage and voluntary brake recall in 1991.\nThe Transportation Vehicles segment reported a $13.9 million (42.8%) increase in gross profit compared to 1991. The gross profit percentage for the segment improved to 16.4% during 1992 from 13.6% in 1991. Gross profit in the Recreational Vehicle division showed improvement due, in part, to the introduction of the Navigator motorhome. The division also benefited from a shift in product mix within the towable lines toward higher margin fifth wheel products. The gross profit percentage at the Commercial Vehicle division increased during 1992, due to higher sales volume and lower warranty costs.\nCONSOLIDATED OPERATING EXPENSES (Dollars in Millions)\nThe entire increase in operating expenses during 1992 occurred in the Motorcycles and Related Products segment. Significant financial resources were allocated in 1992 to both supporting increased sales levels over 1991 and preparing for additional revenue advances in the future. Operating cost increases occurred in almost every area, but more significantly in marketing and employee services and training areas. Additionally, the engineering group continued its on-going effort to meet more stringent motorcycle noise regulations which take effect as early as 1994 in the European Community,\nand also concentrated on new product development programs. In total, engineering costs increased approximately $6 million in 1992 compared to 1991. Another area of increase related to two voluntary motorcycle recalls totaling $5.5 million, initiated in the fourth quarter of 1992.\nThe Transportation Vehicles segment reduced its operating expenses during 1992 by 3.5%, despite an 18.7% increase in revenues. This reduction occurred primarily in the Commercial Vehicle division where operating costs were decreased by approximately $1.1 million in several areas, including promotion, research and development, and employment.\nCONSOLIDATED OTHER EXPENSES Consolidated other expenses in 1992 include a $1.9 million charge related to a voluntary product recall announced in September at the Recreational Vehicle division. This unusual recall covered units produced eight to ten years earlier, prior to the purchase of Holiday Rambler Corporation by Harley- Davidson, Inc.\nCONSOLIDATED NET INTEREST EXPENSE Consolidated net interest expense of $5.9 million during 1992 decreased $2.4 million (29.0%) compared to 1991. Lower short-term borrowings during 1992, combined with the retirement of the remaining $7.8 million of Holiday Rambler 12 1\/2% subordinated notes during May 1992, were the primary factors in the decrease. Interest expense in 1991 was reported net of capitalized interest incurred during the construction of the paint facility in York, Pennsylvania. No interest was capitalized during 1992. During December 1992, the remaining $36.3 million of Harley-Davidson, Inc. 7 1\/4% convertible subordinated debentures outstanding were converted into shares of the Company's common stock.\nCONSOLIDATED INCOME TAXES The Company's consolidated effective tax rate of 39.0% compares to an effective rate of 36.4% during 1991. The 1991 effective rate was impacted by the settlement of various tax matters with the Internal Revenue Service related to the final audit of prior tax years.\nOTHER MATTERS\nACCOUNTING CHANGES On January 1, 1993, the Company adopted the provisions of Statements of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" and No. 109 \"Accounting for Income Taxes.\" The adoption of SFAS No. 106 resulted in the recognition of a $32.1 million charge (net of tax) representing the cumulative effect of adopting the standard. The adoption of the standard resulted in additional expense to continuing operations of approximately $4.6 million during 1993.\nThe adoption of SFAS No. 109 resulted in the recognition of a cumulative effect adjustment of $1.8 million. Other than the cumulative effect adjustment recorded on January 1, 1993, the adoption of SFAS No. 109 had no significant effect on 1993 earnings. Virtually all of the adjustment relates to the accounting treatment applied to inventory balances at the date of the Company's initial purchase in 1981 as required under the then current provisions of Accounting Principles Board Opinions No. 11 and No. 16. In addition to the effect on earnings of adopting SFAS No. 109, the standard resulted in a $7.7 million valuation increase in inventory and a related $5.9 million short-term deferred tax liability.\nIn considering the necessity of establishing a valuation allowance on deferred tax assets, management considered: the levels of taxes paid in prior years that would be available for carryback; its ability to offset reversing deferred tax assets against reversing deferred tax liabilities; and, the Company's prospects for future earnings. Accordingly, it is the opinion of management that it is more likely than\nnot that the gross deferred tax assets included in the consolidated balance sheet at December 31, 1993 will be realized in their entirety. It is the intent of management to evaluate the realizability of deferred tax assets on a quarterly basis.\nThe adoption of these standards had no impact on cash flows.\nMANUFACTURING STRATEGY\nDuring the third quarter of 1993, the Company announced that its Board of Directors approved a comprehensive manufacturing strategy designed to, among other things, achieve the goal of a 100,000 units-per-year production rate in 1996. The strategy calls for the enhancement of the Motorcycle division's ability to increase capacity, adjust to changes in the marketplace and further improve quality while reducing costs. The strategy calls for the achievement of the increased capacity within the existing facilities (with minor additions) without a significant change in personnel.\nENVIRONMENTAL MATTERS The Company's policy is to comply with applicable environmental laws and regulations. The Company has a compliance program in place to monitor, and report on, environmental issues. The Company is currently involved with its former parent (Minstar) and the U.S. Navy in cost recovery litigation surrounding the remediation of the Company's manufacturing facility in York, PA. The Company currently estimates that it will be responsible for approximately $4 million related to the remediation of the York facility. The Company has established reserves for this amount.\nRecurring costs associated with managing hazardous substances and pollution in on-going operations are not material.\nThe Company regularly invests in equipment to support and improve its various manufacturing processes. While the Company considers environmental matters in capital expenditure decisions, and while some capital expenditures also act to improve environmental compliance, only a small portion of the Company's annual capital expenditures relate to equipment which has the sole purpose of environmental compliance. During 1993, the Company spent approximately $1 million on equipment used to limit hazardous substances\/ pollutants. The Company anticipates that capital expenditures for these matters during 1994 will approximate $2 million. The Company does not expect that expenditures related to environmental matters will have a material effect on future operating results or cash flows.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company recorded cash flows from operating activities of $96.2 million in 1993 compared to $87.9 million during 1992. Earnings before the noncash effects of the goodwill write-off and accounting changes added approximately $21 million to 1993 cash flow from operating activities compared to 1992. Decreases in Motorcycles and Related Products segment receivable balances occurred primarily as the result of a reduced shipping schedule near the close of the fourth quarter of 1993 compared to 1992. FIFO inventories in the Motorcycles and Related Products segment increased $24 million related primarily to the timing of motorcycle shipments to its foreign subsidiaries and to volume related increases in its Parts and Accessories business. The Transportation Vehicles segment reported a $16 million inventory increase related primarily to the advance receipt of chassis for first quarter 1994 orders at the Commercial Vehicles division and to additional recreational vehicles at two new Holiday World retail locations. As mentioned earlier, the adoption of SFAS No. 109 also had the effect of increasing inventory balances by approximately $7.7 million.\nInvesting activities utilized approximately $67.0 million during 1993. Capital expenditures amounted to $55.2 million and $47.2 million during 1993 and 1992, respectively. The Company anticipates 1994 capital expenditures will approximate $80-$90 million. As discussed earlier, the Company's Board of Directors approved a manufacturing strategy plan during the third quarter of 1993. The Company estimates the cost of capital expenditures for new initiatives under this plan will be approximately $80 million through 1996, with $5.0 million incurred in 1993. This estimate is in addition to capital expenditures to maintain existing equipment and for new product development. The Company anticipates funding all capital expenditures with internally generated funds.\nOn January 5, 1993, the Company invested $10.0 million for a noncontrolling interest in Eagle Credit Corporation (Eagle). The Company accounts for its investment in Eagle using the equity method. Eagle was formed primarily to provide wholesale and retail financing to the Company's dealer networks and customers. Upon completion of its capitalization on January 5, 1993, Eagle purchased all of Holiday Rambler's floor plan obligations (Notes payable) from a third party finance company. Eagle also began providing wholesale financing to the Motorcycle division's independent dealers, on that date, by purchasing a wholesale motorcycle floor plan financing portfolio from the third party finance company.\nThe Company currently has nominal levels of long-term debt and has available lines of credit of approximately $44 million, of which approximately $40 million remained available at year-end.\nThe Company's Board of Directors declared two quarterly cash dividends of $.06 each during 1993. On February 6, 1994, the Company's Board of Directors declared a cash dividend of $.06 per share payable February 28, 1994 to shareholders of record February 14.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated financial statements and supplementary data ------- --------------------------------------------------------\nREPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Harley-Davidson, Inc.\nWe have audited the accompanying consolidated balance sheets of Harley- Davidson, Inc. as of December 31, 1993 and 1992, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the index at item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harley-Davidson, Inc. at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in notes 6 and 9 to the consolidated financial statements, effective January 1, 1993, the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nERNST & YOUNG\nMilwaukee, Wisconsin January 28, 1994\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 1993, 1992 and 1991 (In thousands, except per share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992 (In thousands, except share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1993, 1992 and 1991 (In thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years ended December 31, 1993, 1992 and 1991 (In thousands, except share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year ended December 31, 1993\n1. Summary of significant accounting policies\nPrinciples of consolidation - The consolidated financial statements include the accounts of Harley-Davidson, Inc. and all of its wholly owned subsidiaries (the Company), including the accounts of Holiday Rambler Corporation (Holiday Rambler). All significant intercompany accounts and transactions are eliminated.\nThe Company has investments in certain entities which are accounted for using the equity method. Accordingly, the Company's share of the net earnings (losses) of these entities is included in consolidated net income (loss).\nCash and cash equivalents - The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nInventories - Inventories are valued at the lower of cost or market. Motorcycle and new transportation vehicle inventories located in the United States are valued using the last-in, first-out (LIFO) method. Other inventories, $26.5 million in 1993 and $16.4 million in 1992, are valued at the lower of cost or market using the first-in, first-out (FIFO) method.\nDepreciation - Depreciation of plant and equipment is determined on the straight-line basis over the estimated useful lives of the assets. Accelerated methods are used for income tax purposes.\nProduct warranty - Product warranty costs are charged to operations based upon the estimated warranty cost per unit sold.\nGoodwill - Goodwill represented the excess of the purchase price over the fair value of tangible net assets acquired. Goodwill was amortized principally over 25 years using the straight-line method. Accumulated amortization was $18.3 million at December 31, 1992. See footnote 2.\nResearch and development expenses - Research and development expenses were approximately $22.7 million, $17.6 million and $11.1 million for 1993, 1992 and 1991, respectively.\nEnvironmental - The Company accrues for environmental loss contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company does not use discounting in determining its environmental liabilities.\nEarnings (loss) per share - Earnings (loss) per common share assuming no dilution is calculated by dividing elements of net income (loss) by the weighted average number of common shares outstanding during the period, as adjusted for the stock split described in Note 10. The weighted average number of common shares outstanding during 1993, 1992 and 1991 were 38.0 million, 35.9 million and 35.6 million, respectively.\nEarnings (loss) per common share assuming full dilution include shares generated by the assumed conversion of convertible debt at the beginning of the period as well as the dilutive effect of stock options. 1992 net income has been adjusted (for purposes of this calculation) to reflect the interest savings of approximately $1.6 million (net of tax) associated with the assumed conversion. Shares used in computing earnings per common share assuming full dilution during 1992 were 38.3 million. Neither stock options nor convertible debt were materially dilutive, alone or in combination, during 1993 or 1991.\n2. Goodwill and restructuring charges\nDuring the fourth quarter of 1993, the Company recorded a $53.5 million nondeductible charge to operations resulting from the write-off of the remaining goodwill associated with the Company's purchase of Holiday Rambler in 1986. Since 1986, the markets in which Holiday Rambler operates have become increasingly competitive, resulting in lower profitability than initially anticipated. The Company considered these factors, as well as estimated future operating results, during the fourth quarter in concluding that an impairment had occurred. The Company measured the impairment and, based on the results of that measurement, recorded a $53.5 million charge against earnings. In measuring the impairment, the Company calculated the discounted value of estimated Holiday Rambler cash flows, over the approximate remaining goodwill amortization period, using a targeted cost of capital discount rate.\nIn addition, the Company recorded a pretax restructuring charge of approximately $3.5 million related to strategic decisions made with respect to certain operating units of Holiday Rambler.\nGoodwill and restructuring charges, in total, had the effect of reducing 1993 earnings per share by $1.46.\n3. Additional balance sheet and cash flows information\nAccounts receivable consist of the following:\nDomestic motorcycle and transportation vehicle sales are generally floor planned by the purchasing dealers. Foreign motorcycle sales are sold on open account except for sales to European distributors, which are typically backed by letters of credit.\n3. Additional balance sheet and cash flows information (continued) ---------------------------------------------------------------\nThe allowance for doubtful accounts deducted from accounts receivable was $1.8 million and $1.6 million at December 31, 1993 and 1992, respectively.\nAdoption of Financial Accounting Standard No. 109, \"Accounting for Income Taxes,\" resulted in a $7.7 million increase in the Company's LIFO inventory valuation. The increase was the result of breaking out the effect of an imbedded deferred tax liability, as required by the standard.\n3. Additional balance sheet and cash flows information (continued) ---------------------------------------------------------------\nSupplemental cash flow information is as follows:\nCash paid during the period for interest and income taxes is as follows:\nIn December 1992, the Company issued approximately 1.8 million shares of its common stock in exchange for the remaining $36.3 million of Harley-Davidson, Inc. 7-1\/4% convertible subordinated debentures.\nDuring 1991, the Company incurred $9.4 million of interest expense of which approximately $1.1 million was capitalized. No interest was capitalized in 1993 or 1992.\n4. Investments -----------\nOn January 5, 1993, the Company invested $10.0 million for a 49% interest in Eagle Credit Corporation (Eagle). Eagle was formed to provide wholesale and retail financing to the Company's dealer networks and customers. Upon the completion of its capitalization on January 5, 1993, Eagle purchased all of Holiday Rambler's floor plan obligations (Notes payable) from a third party finance company. Eagle also began providing wholesale financing to the Company's independent dealers, on that date, by purchasing a wholesale motorcycle floor plan financing portfolio from the third party finance company.\nThe Company accounts for this and another investment using the equity method. As of December 31, 1993, the Company's carrying value of its investments in these unconsolidated affiliates totaled $8.9 million which is included in other assets. In addition, accounts receivable includes a $9.4 million amount due from Eagle.\n5. Notes payable -------------\nNotes payable represent, primarily, floor plan obligations of Holiday Rambler which are secured by specific units held for sale (approximately $17 million of the finished goods inventory at December 31, 1993).\nAs of December 31, 1993, the Company had unsecured lines of credit available totaling approximately $44.0 million, of which approximately $40.0 million remained available.\n6. Income taxes ------------\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" which became effective for fiscal years beginning after December 15, 1992. The Company adopted this standard on a prospective basis effective January 1, 1993. The adoption resulted in additional income of $1.8 million related primarily to the accounting treatment applied to inventory LIFO reserves calculated at the date of the Company's initial purchase in 1981 as required under the then current provisions of Accounting Principles Board Opinion Nos. 11 and 16.\nDetails of income before provision for income taxes are as follows:\n6. Income taxes (continued) ------------------------\nThe provision for income taxes differs from the amount which would be provided by applying the statutory U.S. corporate income tax rate of 35%, 34% and 34% during 1993, 1992 and 1991, respectively, due to the following items:\nDeferred income taxes result from temporary differences between the recognition of revenues and expenses for financial statements and income tax returns. The principal components of the Company's deferred tax assets and liabilities as of December 31, 1993 include the following:\nThe deferred tax provision for 1992 and 1991 resulted principally from accelerated depreciation ($1.3 million and $1.7 million, respectively), warranty accrual increases ($3.6 million and $1.4 million, respectively), product liability accrual increase ($2.2 million during 1991) a lawsuit judgement ($2.7 million during 1992) and foreign tax credits ($1.5 million during 1991).\n7. Commitments and contingencies -----------------------------\nThe Company is involved with government agencies in various environmental matters, including a matter involving soil and groundwater contamination at its York, Pennsylvania facility (the Facility). The Facility was formerly used by the U.S. Navy and AMF (the predecessor corporation of Minstar). The Company purchased the facility from AMF in 1981. Although the Company is not certain as to the extent of the environmental contamination at the Facility, it is working with the Pennsylvania Department of Environmental Resources. The Company is currently pursuing cost recovery litigation against the Navy and believes that the Navy, by virtue of its ownership and operation of the Facility, will ultimately be responsible for a substantial portion of the environmental remediation costs at the Facility. In addition, in March 1991 the Company entered into a settlement agreement with Minstar related to certain indemnification obligations assumed by Minstar in connection with the Company's purchase of the Facility. Pursuant to this settlement, Minstar is obligated to reimburse the Company for a portion of its investigation and remediation costs at the Facility. Although substantial uncertainty exists concerning the nature and scope of the environmental remediation that will ultimately be required at the Facility, based on preliminary information currently available to the Company and taking into account the Company's estimate of the probable liability of the Navy, and the settlement agreement with Minstar, the Company estimates that it will incur approximately $4 million of additional remediation and related costs at the Facility. The Company has established reserves for this amount. The Company has also put certain of its insurance carriers on notice that it intends to make claims relating to the environmental contamination at the Facility. However, the Company is currently unable to determine the probable amount of recovery available, if any, under insurance policies.\nThe Company self-insures its product liability loss exposure. The Company accrues for claim exposures which are probable of occurrence and can be reasonably estimated.\nThe Company enters into forward exchange contracts to hedge against sales transactions denominated principally in European currencies. At December 31, 1993, the Company had forward exchange contracts that required it to convert these foreign currencies, at a variety of rates, into U.S. Dollars or German Deutsche Marks. These contracts represent a combined U.S. dollar equivalent commitment of approximately $45.5 million. The contracts mature at various dates through August, 1994. Unrealized gains and losses associated with these contracts are deferred and accounted for as part of the hedged transaction. At December 31, 1993 and 1992, these contracts had a fair value (deferred contract gains) of approximately $1.0 million and $1.6 million, respectively, based on published exchange rates.\nAt December 31, 1993, the Motorcycles and Related Products segment (the Motorcycle segment) and the Transportation Vehicles segment (the Transportation segment) estimated that they were contingently liable under repurchase agreements for a maximum of $31.8 million and $31.7 million, respectively, to lending institutions that provide wholesale floor plan financing to their dealers. These agreements are customary in both the motorcycle and recreational vehicle industry. The Company's loss exposure on repurchase is limited to the difference between the resale value of the vehicle and the amount required to be paid the lending institution at the time of repurchase.\nThe Motorcycle segment has a trade acceptance agreement with Eagle (see note 4) which expires on June 1, 1994, and is subject to annual renewal. Under the terms of the agreement, the Motorcycle segment receives cash from Eagle in the amount of 100% of certain eligible accounts receivable at the time of sale. On June 1, 1994, the Motorcycle segment is obligated to repurchase all unpaid balances from Eagle. At December 31, 1993, trade acceptances of $15.4 million were subject to this agreement. The Company has not incurred any material losses from the foregoing repurchase agreements and currently anticipates no material losses.\n7. Contingencies and commitments (continued) -----------------------------------------\nAt December 31, 1993, the Company was contingently liable for $13.0 million related to letters of credit. The letters of credit typically act as a guarantee of payment to certain third parties in accordance with specified terms and conditions.\n8. Employee benefit plans ----------------------\nThe Company has several noncontributory defined benefit pension plans or profit sharing plans covering substantially all employees of the Motorcycle segment. The Company's policy with respect to the pension plans is to fund pension benefits to the extent contributions are deductible for tax purposes.\nThe following data is provided for the pension plans for the years indicated:\n8. Employee benefit plans (continued)\nReconciliation of funded status\nIn 1993, the Company elected to change the measurement date for pension plan assets and liabilities from December 31 to September 30. The change in measurement date had no effect on 1993, or prior years', pension expense.\nThe provisions of Financial Accounting Standards Board Statement No. 87, \"Employers' Accounting for Pensions,\" require the recognition of an additional minimum liability and related intangible asset to the extent that accumulated benefits exceed plan assets. At December 31, 1993, the Company recorded an adjustment of $2.6 million which was required to reflect the Company's minimum pension liability. The Company recorded an intangible asset in the same amount.\n8. Employee benefit plans (continued)\nCertain of the Company's plans relating to hourly employees were amended during 1993, 1992 and 1991 to increase the scheduled benefits.\nThe Company also has thrift incentive plans for both salaried and hourly Motorcycle segment employees. The Company accrued for a matching contribution to the plan during 1993 of $1.2 million. The Company did not contribute to these plans in 1992 or 1991. Employees can make voluntary contributions in accordance with the provisions of their respective plan, which includes a 401(k) tax deferral option.\nThe Transportation segment has a defined contribution employee benefit plan which covers substantially all full-time employees. The plan is funded partly by employee wage deferrals in accordance with section 401(k) of the Internal Revenue Code. The Transportation segment accrued for a discretionary matching contribution of $0.4 million during 1992. The Company did not contribute to this plan in 1993 or 1991.\n9. Postretirement health care benefits\nThe Company has several postretirement health care benefit plans covering substantially all employees of the Motorcycle segment. Employees are eligible to receive benefits upon attaining age 55 after rendering at least 10 years of service to the Company.\nOn January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires companies to accrue the cost of postretirement benefits during the employees' active service period. The Company elected to immediately recognize the accumulated postretirement benefit obligation upon adoption of SFAS 106. The Company recorded an accumulated obligation of $32.1 million, net of tax. In prior years, the Company accounted for postretirement benefits on a cash basis.\nThe Company uses September 30 as the measurement date for valuing its postretirement health care obligation.\nThe Company's postretirement health care plans are currently funded as claims are submitted ($1.6 million in 1993). Some of the plans require employee contributions to offset benefit costs. The status of the plans at December 31, 1993 was as follows (in thousands):\nAccumulated postretirement benefit obligation:\n9. Postretirement health care benefits (continued) -----------------------------------------------\nThe net periodic postretirement benefit cost for the year ended December 31, 1993 includes the following (in thousands):\nService cost - benefits earned during the year $1,967 Interest cost on projected benefit obligation 4,277 ------ Net periodic postretirement benefit cost $6,244\nThe weighted average health care cost trend rate used in determining the accumulated postretirement benefit obligation of the health care plans was 15%. The per capita health care cost rate was assumed to decrease gradually to 6% for 1999 and remain at that level thereafter. This assumption can have a significant effect on the amounts reported. If the weighted average health care cost trend rate were to increase by 1%, the accumulated postretirement benefit obligation as of January 1, 1994 and aggregate of service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1994 would increase by $7.1 million and $1.1 million, respectively. The weighted average discount rate used to determine the accumulated postretirement benefit obligation of the health care plan as of September 30, 1993 was 7.75%. The Company used a weighted average discount rate of 8.5% in establishing the transition obligation at January 1, 1993.\nPretax postretirement benefits expense was $1.6 million and $1.9 million for the years ended December 31, 1992 and 1991, respectively.\n10. Capital stock -------------\nOn May 9, 1992, shareholders approved an increase in the number of authorized shares of common stock from 25 million to 100 million. Upon approval, the Company's Board of Directors declared a two-for-one stock split effected in the form of a dividend to shareholders of record on June 5, 1992, payable on June 26, 1992.\nStock options, and all other agreements payable in the Company's common stock, have been amended to reflect the split. An amount equal to the par value of the shares issued has been transferred from additional paid-in capital to the common stock account. All references to number of shares, except shares authorized, in the notes to the consolidated financial statements have been adjusted to reflect the stock split on a retroactive basis.\nOn May 9, 1992, the shareholders also approved an increase in the number of authorized Series A Junior Participating preferred stock (Preferred Stock) from 1 million to 2 million. The Preferred Stock has a par value of $1 per share. Each share of Preferred Stock is entitled to receive, when as and if declared, a quarterly dividend in an amount equal to the greater of $1 per share or 100 times the dividends declared on the Company's common stock. Each preferred share is entitled to 100 votes. In the event of liquidation, the holders of the Preferred Stock will be entitled to receive a liquidation payment in the amount equal to the greater of $1 per share or 100 times the payment made per share of common stock.\nThe Company has reserved 1 million shares of Preferred Stock for issuance in connection with Preferred Stock Purchase Rights (Rights). Each of the Rights entitles a stockholder to buy one one-hundredth of a newly issued share of the Company's Preferred Stock at an exercise price of $50. The Rights are only exercisable upon certain changes in Company ownership as defined by the Rights Agreement.\n10. Capital stock (continued) -------------------------\nThe Company has a restricted stock plan in which plan participants are entitled to cash dividends and voting rights on their respective shares. Restrictions generally limit the sale or transfer of shares during a restricted period, not exceeding eight years. Participants may vest in certain amounts of the restricted stock upon death, disability or retirement as described in the plan.\nUnearned compensation was charged for the market value of the restricted shares on the date of grant and is being amortized over the restricted period. The unamortized unearned compensation value is shown as a reduction of stockholders' equity in the accompanying consolidated balance sheets.\nInformation with respect to restricted stock outstanding is as follows:\nExpense in 1993, 1992, and 1991 associated with the restricted stock plan was $.4 million, $.9 million and $1.1 million, respectively.\nThe Company has Stock Option Plans under which the Board of Directors may grant to employees of the Company nonqualified stock options with or without appreciation rights. The options may be exercised one year after the date of grant, not to exceed 25 percent of the shares in the first year with an additional 25 percent to be exercisable in each of the three following years. The options expire ten years from the date of grant. The maximum number of shares of common stock available for grants under such plans are 3.0 million at December 31, 1993 of which 1.0 million shares remain available for future grants. The exercise price of outstanding options at December 31, 1993 ranged from $2.95 to $37.13. A summary of option activity is as follows:\nHistorically, the Company granted stock options in December of each year. In order to review all elements of compensation at the same time, the Human Resources Committee of the Board of Directors decided in February 1993 to consider annual stock option grants in February of each year, beginning with February 1994. Stock options issued during 1993 represent grants to certain new executives.\n11. Business segments and foreign operations\n(a) Business segments\nThe Company operates in two business segments: Motorcycles and Related Products and Transportation Vehicles.\nInformation by industry segment is set forth below (in thousands):\n(1) Includes a $57.0 million charge related primarily to the write-off of goodwill in 1993.\nThere were no sales between business segments for the years ended December 31, 1993, 1992 or 1991.\n11. Business segments and foreign operations (continued) --------------------------------------------------------\n(b) Foreign operations ------------------\nIncluded in the consolidated financial statements are the following amounts relating to foreign affiliates:\nExport sales of domestic subsidiaries to nonaffiliated customers were $117.6 million, $106.9 million and $105.7 million in 1993, 1992 and 1991, respectively.\nSUPPLEMENTARY DATA\nQuarterly financial data (unaudited) (In millions, except per share data)\n(a) 1993 fourth quarter results include a $57.0 million charge related primarily to the write-off of goodwill, which reduced earnings per share by $1.46.\n(b) Earnings (loss) per common share assuming full dilution generally includes the dilutive effect of outstanding stock options. During the first and fourth quarters of 1993, the effect of stock options was antidilutive, and therefore, was excluded from the calculations.\nItem 9.","section_9":"Item 9. Changes in and disagreements with accountants on accounting and ------- --------------------------------------------------------------- financial disclosure --------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and executive officers of the registrant ------- --------------------------------------------------\nInformation with respect to the Directors of the registrant will be included in the Company's definitive proxy statement for the 1994 annual meeting of shareholders (the \"Proxy Statement\"), which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1993, and is hereby incorporated by reference to such Proxy Statement.\nItem 11.","section_11":"Item 11. Executive compensation ------- ----------------------\nThis information will be included in the Proxy Statement, which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1993, and is hereby incorporated by reference to such Proxy Statement.\nItem 12.","section_12":"Item 12. Security ownership of certain beneficial owners and management ------- --------------------------------------------------------------\nThis information will be included in the Proxy Statement, which will be filed within 120 days after the close of Harley-Davidson's fiscal year ended December 31, 1993, and is hereby incorporated by reference to such Proxy Statement.\nItem 13.","section_13":"Item 13. Certain relationships and related transactions ------- ----------------------------------------------\nThis information will be included in the Proxy Statement, which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1993, and is hereby incorporated by reference to such Proxy Statement.\nItem 14.","section_14":"Item 14. Exhibits, financial statement schedules, and reports on Form 8-K ------- ----------------------------------------------------------------\n(A) 1. Financial statements - The financial statements listed in the -------------------- accompanying Index to Consolidated Financial Statements and Financial Statement Schedules are filed as part of this annual report and such Index to Consolidated Financial Statements and Financial Statement Schedules is incorporated herein by reference.\n2. Financial statement schedules - The financial statement ----------------------------- schedules listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules are filed as part of this annual report and such Index to Consolidated Financial Statements and Financial Statement Schedules is incorporated herein by reference.\n3. Exhibits - The exhibits listed on the accompanying List of -------- Exhibits are filed as part of this annual report and such List of Exhibits is incorporated herein by reference.\n(B) Reports on Form 8-K ------------------- The Company filed a current report on Form 8-K on December 20, 1993 to report under Item 5 the write down of goodwill and certain other assets in its Holiday Rambler Corporation subsidiary.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ AND FINANCIAL STATEMENT SCHEDULES ---------------------------------\n[Item 14(A) 1 and 2]\nAll other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements and notes thereto.\nLIST OF EXHIBITS ---------------- [Item 14(A)(3)]\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nLIST OF EXHIBITS ---------------- [Item 14(A)(3)]\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nSchedule V ----------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED PROPERTY, PLANT, AND EQUIPMENT Years ended December 31, 1993, 1992 and 1991 (In thousands)\n(1) Includes approximately $12.3 million during 1991 related to a new paint facility in York, PA.\nSchedule VI -----------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT, AND EQUIPMENT Years ended December 31, 1993, 1992 and 1991 (In thousands)\nDepreciation of property, plant and equipment is determined on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives used in computing depreciation are as follows:\nSchedule VIII -------------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1993, 1992 and 1991 (In thousands)\nReceivables - Allowance for doubtful accounts:\n(1)Represents amounts written off to the reserve, net of recoveries.\n(2)Stated in last-in, first-out (LIFO) cost.\nSchedule IX -----------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED SHORT-TERM BORROWINGS\nYears ended December 31, 1993, 1992 and 1991 (In thousands, except weighted average interest rates)\n(1) Floorplan obligations are secured by specific inventory units.\n(2) Notes payable to bank represent borrowings under lines of credit.\n(3) Computed by averaging the month-end balances during the year.\n(4) Computed by dividing the interest expense by the average amount outstanding during the period.\nSchedule X ----------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED SUPPLEMENTARY INCOME STATEMENT INFORMATION Years ended December 31, 1993, 1992 and 1991\nAmounts for depreciation and amortization of intangible assets, taxes, other than payroll and income taxes, and royalties are not presented as such amounts are less than 1% of net revenues or such information is included in the consolidated financial statements or the notes thereto.\nSIGNATURES ----------\nPursuant 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, on March 28, 1994.\nHARLEY-DAVIDSON, INC.\nBy: \/S\/ Richard F. Teerlink ------------------------------------------- Richard F. Teerlink President, Chief Executive Officer (Principal executive officer) and Director\nPursuant 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 March 28, 1994.\nName Title ---- -----\n\/S\/ Richard F. Teerlink President, Chief Executive Officer --------------------------------- Richard F. Teerlink (Principal executive officer) and Director\n\/S\/ James L. Ziemer Vice-President and Chief Financial Officer --------------------------------- James L. Ziemer (Principal financial officer)\n\/S\/ James M. Brostowitz Vice-President\/Controller (Principal --------------------------------- James M. Brostowitz accounting officer and Treasurer)\n\/S\/ Vaughn L. Beals Chairman and Director ---------------------------------- Vaughn L. Beals, Jr.\n\/S\/ Barry K. Allen Director ---------------------------------- Barry K. Allen\n\/S\/ William F. Andrews Director ---------------------------------- William F. Andrews\n\/S\/ Fred L. Brengel Director ---------------------------------- Fred L. Brengel\n\/S\/ Richard J. Hermon-Taylor Director ---------------------------------- Richard J. Hermon-Taylor\n\/S\/ Donald A. James Director ---------------------------------- Donald A. James\n\/S\/ Richard G. LeFauve Director ---------------------------------- Richard G. LeFauve\n\/S\/ James A. Norling Director ---------------------------------- James A. Norling\n\/S\/ William B. Potter Director ---------------------------------- William B. Potter\nINDEX TO EXHIBITS ----------------- [Item 14(A)(3)]\nExhibit No. Description Page - ----------- ----------- ----\n3.1 Restated Articles of Incorporation of the Registrant (incorporated herein by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form 8-B dated June 24, 1991 (File No. 1-10793 (the \"Form 8-B\")).\n3.2 By-Laws of the Registrant (incorporated herein by reference to Exhibit 3.2 to the Form 8-B).\n3.3 Form of Certificate of Designation relating to Series A Junior Participating Preferred Stock (incorporated herein by reference to Exhibit 3.3 to the Form 8-B).\n4.6 Form of Rights Agreement between Harley-Davidson, Inc. and Firstar Trust Company (incorporated herein by reference to Exhibit 4.6 to the Registrants' Quarterly Report on Form 10-Q for the period ended September 30, 1990 (File No. 1-9183)).\n4.6(a) First Amendment to Rights Agreement, dated as of June 21, 1991, (incorporated herein by reference to Exhibit 4.8 to the Form 8-B).\n10.1* Form of Employment Agreement for Executive Officers (incorporated by reference from Exhibit 10.1 to the Registrant's Registration Statement on Form S-1 (File No. 33-5871)).\n10.2(a)* 1986 Stock Option Plan of the Registrant (incorporated by reference from Exhibit 10.9 to the Registrant's Registration Statement on Form S-1 (File No. 33-5871)).\n10.2(b)* 1988 Stock Option Plan of the Registrant (incorporated by reference to Annex A to the Registrants' 1988 Proxy Statement (File No. 1-9183)).\n10.2(c)* 1990 Stock Option Plan of the Registrant (incorporated by reference to Annex A to the Registrants' 1989 Proxy Statement (File No. 1-9183)).\n10.2(d)* Form of Stock Option Agreement for use under the Harley-Davidson, Inc. 1986 Stock Option Plan (incorporated herein by reference from Exhibit 4.1(c) to the Registrant's registration statement on Form S-8 (File No. 33-33449)).\n10.2(e)* Form of Stock Option Agreement for use under the Harley-Davidson, Inc. 1988 Stock Option Plan (incorporated herein by reference from Exhibit 4.1(e) to the Registrant's registration statement on Form S-8 (File No. 33-33449)).\n10.2(f)* Form of Stock Option Agreement for use under the Harley-Davidson, Inc. 1990 Stock Option Plan (incorporated herein by reference from Exhibit 10 to the Registrants' Quarterly Report on Form 10-Q for the period ended September 26, 1993 (File No. 1-9183)).\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nINDEX TO EXHIBITS ----------------- [Item 14(A)(3)]\nExhibit No. Description Page - ----------- ----------- ----\n10.3(a) Ford Authorized Converter Pool Agreement between Ford Motor Company and Holiday Rambler Corporation dated June 11, 1990 (incorporated herein by reference to Exhibit 10.27(a) to Holiday Rambler's Quarterly Report on Form 10-Q for the period ending September 30, 1990 (File No. 33-12743)). (Replaces Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987).\n10.3(b) First Amendment to the Ford Authorized Converter Pool Agreement between Ford Motor Company and Holiday Rambler Corporation dated July 1, 1990 (incorporated herein by reference from Exhibit 10.27(b) to Holiday Rambler's Quarterly Report on Form 10-Q for the period ended September 30, 1990 (File No. 33-12743)).\n10.4* Consulting Agreement, dated May 19, 1989 between the Registrant and Vaughn L. Beals, Jr. (incorporated herein by reference from Exhibit 10.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.5(a)* Restated Long-Term Incentive Plan II, as amended, of the Registrant (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.5(b)* Growth Unit Cancellation Agreement of the Registrant (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.6* Form of Transition Agreement for Executive Officers (other than Mr. Teerlink) (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.7* Transition Agreement, dated October 22, 1989 between the Registrant and Richard F. Teerlink (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.8* Harley-Davidson, Inc. Deferred Compensation Plan 68\n10.9* Description of supplemental executive retirement benefits. 79\n10.10* Form of Split Dollar Life Insurance Agreement. 80\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nINDEX TO EXHIBITS ----------------- [Item 14(A)(3)]\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nExhibit 10.8\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nConcept Harley-Davidson, Inc. created this Plan, effective as of October 1, 1988, to assist eligible employees in deferring income until their retirement, death, or other termination of employment.\nAdministrator The Vice President--Human Resources of Harley-Davidson, Inc. is the Administrator for employees of Harley-Davidson, Inc. participating in the Plan. If the Administrator is also a participant, then the Chief Executive Officer of Harley- Davidson, Inc. is the Administrator as to that person.\nEligibility Participation in the Plan is limited to a select group of management or highly compensated employees. These employees are defined as persons whose combined base salary, target bonus potential, and restricted stock awards are equal to or greater than $100,000. The Administrator determines eligibility and may increase the entry level compensation requirement if necessary to assure that the Plan continues to be exempt from the eligibility, vesting, and funding requirements of the Employee Retirement Income Security Act of 1974, as amended.\nParticipation Eligible persons must complete Deferred Compensation Requirements Agreements in order to participate. Agreements completed by newly-eligible participants within 30 days of becoming eligible will be effective either immediately, or as of a later designated date, but only as to compensation payable after the date of the Agreement.\n--An eligible person may complete more than one Deferred Compensation Agreement. Each Participation Agreement will be treated as a separate program under the Plan and the person completing an additional Agreement will be treated as a newly- eligible participant as to each Agreement.\n--A person who ceases to be eligible has no further right to complete additional Deferred Compensation Agreements. Agreements in effect at the time eligibility is lost will remain in effect subject to the terms of the Plan.\n--The Administrator makes all final decisions regarding eligibility and compliance with the participation requirements.\nCompensation Each Participation Agreement must designate either a flat Deferral dollar amount of deferral or a percentage amount of deferral, and whether the amount is to be deducted from salary or bonus, or from both. Each Agreement shall also specify the time period during which the deferral is to take place. The Company will make the\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\ncorresponding reductions in compensation and credit the Deferred Benefit Account of the participant.\nMinimum and Each Deferred Compensation Agreement must provide for an Maximum aggregate deferral that is not less than $21,000 over 7 Deferrals years from the effective date of the Agreement. Only whole percentages may be elected as percentage deferrals. The Administrator may adjust this minimum and establish and\/or revise maximums in the Administrator's discretion.\nDeferral A participant's deferral election is irrevocable except for Elections are Hardship. The Administrator, in his or her discretion, upon Irrevocable demonstration of Hardship, which is substantial financial Except for need by a participant due to family health, education, or Hardship housing needs, may permit reduction of the participant's compensation deferral election for subsequent years. A request for change must be submitted in writing, with evidence of Hardship, to the Administrator before January 1 of the year in which the requested reduction is to take effect. If the request for change is approved it shall be effective for all future periods of deferral. The participant's benefits under the Plan will be adjusted to reflect the reduced deferral. The method of adjustment is as described and illustrated in Schedule A to the Plan.\nMakeup of A participant whose deferral has been reduced for Hardship may Deferrals elect, prior to termination of employment to reinstate his Reduced or her original deferral by paying to the Company the for Hardship difference between the reduced deferrals actually paid and the originally scheduled amount as described in the participant's original Deferred Compensation Agreement.\nEffect of All deferral elections under the Plan shall automatically Change of terminate as of the last day of the month preceding the Control Event occurrence of a Change of Control Event. The benefits of each on Deferral participant affected by the automatic termination of deferrals will be adjusted to reflect the reduced deferral. The method of adjustment is as described and illustrated in Schedule A to the Plan. The definition of Change of Control Event is as set forth in Schedule B to the Plan, which shall be revised from time to time, by the Administrator, to reflect the same definition of this term used by Harley-Davidson, Inc. for its general corporate purposes.\nDeferred The Company will establish on its books a Deferred Benefit Benefit Account for each Plan participant. Account\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\n--Deferred compensation shall be credited to this Account as of the last day of the month in which the participant would otherwise have received the compensation.\n--As of the last day of each month interest at the Plan's Interest Yield will be credited to the account. Interest will be calculated by applying the Interest Yield to the balances of the Account on such date including contributions or distributions to be credited or deducted on that date.\n--Distributions shall be charged to this Account as they are made.\nThe Company may deduct from non-deferred compensation any taxes it is required to withhold on deferred amounts.\nSpecial 401(k) The Company will also credit to the Deferred Benefit Account Matching Con- of each participant a Company matching contribution in the tribution same relative amount and in the same manner as is made to the Supplement participant's IRC 401(k) plan account on amounts the participant has elected to defer under that Plan. This credit will be made as of the last day of the month in which the Company matching contribution is deposited to the IRC 401(k) plan for a year. The credit, and the earnings attributed to it, are subject to the rules of the IRC 401(k) plan only as to vesting. Such amount shall not be deemed to be a Company matching contribution to the IRC 401(k) plan for any nondiscrimination testing purposes. A participant will not, under any circumstances, be credited with an aggregate Company matching amount under this Plan and the IRC 401(k) plan that is larger than the rate of matching applicable for the year under the IRC 401(k) plan multiplied by 6% of the participant's current and deferred compensation for such year.\nNo Trust A participant's Deferred Benefit Account is a means of Fund Created measuring the value of the participant's deferred compensation. The Account does not create a trust fund of any kind. Any assets earmarked by the Company to pay benefits under this Plan do at all times remain in the Company. A participant has no property interest in specific assets of the Company because of the Plan. The rights of the participant, a beneficiary, or an estate to benefits under the Plan shall be solely those of an unsecured creditor of the Company.\nStatement Following the close of each year the Administrator will of Account provide statements of account to each participant.\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nInterest Interest Yield means, for each 12 consecutive calendar months Yield ending after September 1, the Moody's Long Term Bond Rate in effect on such September 1 (or the last business day immediately preceding such date if it is a Saturday, Sunday, or holiday) divided by 12.\nPayment of Upon a participant's termination of employment, for any reason Benefits other than death, the Company will pay to the participant, as Other Than compensation for prior services, an amount equal to the Upon Death participant's Deferred Benefit Account measured as of the last day of the month in which employment terminated.\nBenefits Upon the death of a participant prior to termination of Upon Death employment, and before any periodic payments have started, Before the Company will pay to the participant's Designated Termination Beneficiary as compensation for services rendered prior to of Employment the date of death, a pre-retirement benefit that is equal to the participant's Deferred Benefit Account measured as of the last day of the month coincident with or immediately following the date of death or, if greater, a pre-retirement benefit determined as follows:\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS - -----------------------------------------\nExample:\nParticipant age 49 elects to defer $10,000 for 7 years\nStated Deferral ($10,000) x Deferral Period (7) = Total Deferral ($70,000)\nTotal Deferral ($70,000) x Deferral Commitment Multiple (4.2) = Total Benefit Commitment ($294,000)\nTotal deferral commitment ($294,000) divided by number of years pre-retirement benefit promised (10) = $29,400\/year for 10 years\nWhere the compensation deferred includes bonus or other non-periodic compensation, the \"Deferral Commitment\" applicable to such non-periodic\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\ncompensation shall be based on the average amount of such bonus or other non-periodic compensation during the 3 consecutive calendar years immediately preceding the date of death during which the participant was an eligible person. If a participant has been an eligible person for fewer than 3 consecutive calendar years immediately preceding the date of death, the \"Deferral Commitment\" applicable to such non-periodic compensation shall be based on the person's average amount of such bonus or other non-periodic compensation during his completed calendar years as an eligible person.\nIf there is a reduction in the deferral amount or a premature distribution due to Hardship, the Administrator will advise the participant as to the corresponding effect on the participant's pre-retirement benefit. If a participant has made more than one deferral commitment, the participant's pre-retirement benefit will be separately determined for each commitment.\nA special rule applies, however, for any participant who is not insurable for a death benefit larger than the \"guaranteed issue\" amount available to the Company at standard rates when the participant completes a Deferred Compensation Agreement. In that case, the affected participant's pre-retirement benefit will be limited to the greater of (i) the balance in the participant's Deferred Benefit Account, or (ii) the amount of death benefit able to be insured by the Company at standard rates at the time the participant completed his or her Deferred Compensation Agreement.\nExample:\nAssume that the maximum guaranteed issue life insurance available to the Company is $600,000 per person.\nAssume that an \"uninsurable at standard rates\" 45-year old participant elects to defer $100,000 over 7 years.\nThe participant's formula pre-retirement benefit of $700,000 is not available because of the lack of insurability.\nInstead, the participant's pre-retirement benefit is $600,000 divided by 10 years, or $60,000 per year for 10 years. (Of course, in the event that the participant's Deferred Benefit Account paid over 10 years would produce a larger benefit, that larger amount would then be paid.)\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nForms of -------- Benefit ------- Payment: --------\n--Termination ----------- of Employment Unless a participant elects an alternative benefit payment ------------- period as part of the participant's Deferred Compensation At or After Agreement, a participant will receive payment of his or her ----------- benefits upon termination of employment at or after age 55 in Age 55 annual installments of the Deferred Benefit Account, -------- commencing within 30 days of the date of termination of employment, over not more than 10 years, as determined by the Administrator. At the time a participant completes a Deferred Compensation Agreement the participant is entitled to select the number of years over which benefits are to be paid to the participant, up to a maximum of 15 years. The payment period selected shall not thereafter be subject to change by the participant. The amount to be distributed annually is determined by multiplying the aggregate balance of the participant's Account by a fraction, the numerator of which is one (1) and the denominator of which is the number of years remaining for the payments to be made (e.g., 1\/10, 1\/9, 1\/8, etc.). Additional earnings are to be credited to the Account during the installment payment period in the same way that earnings are credited while the participant is employed.\n--Other Termina- A participant whose benefit is payable for a reason other -------------- than retirement or death will receive payment in a single tions of lump sum amount within 30 days following termination of -------- employment. Employment ---------- Except Due ---------- to Death --------\n--Pre-retirement If a participant's Deferred Benefit Account is to be paid as -------------- the participant's pre-retirement benefit, payment will be Benefit made in 10 approximately level annual installments ------- (calculated by the Administrator using reasonable earnings assumptions) commencing within 30 days of the date of death. Additional earnings are to be credited to the Account during the installment payment period in the same way earnings are credited while a participant is employed. If a participant's pre-retirement benefit is the formula amount, described earlier in the Plan, payment of the formula amount will be made in 10 equal annual installments commencing within 30 days of the date of death. No additional earnings are credited during the installment payment period when the death benefit amount is determined by the Plan formula.\nDesignated All payments by the Company will be made to the participant, ---------- if living. If the participant has died, then any payment Beneficiary under the Plan will be made to the Designated Beneficiary ----------- of the participant. If a beneficiary dies before receiving all payments due, the remaining payments will be made to the beneficiary's estate. All beneficiary designations must be made in writing and acknowledged by the\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nAdministrator. If there is no beneficiary designation in force when Plan benefits become payable to a beneficiary, the deemed beneficiary shall be the participant's spouse, or if no spouse is then living, the participant's estate.\nHardship The Administrator may, in his or her sole discretion, upon the -------- finding that the participant has suffered a Hardship, Payments distribute to the participant any portion of the participant's -------- Deferred Benefit Account as of such date.\nAssignment No participant or beneficiary may assign the right to receive ---------- benefits under the Plan.\nNot An Employ- This Plan may not be construed as giving any person right to -------------- be retained as an employee of the Company. ment Contract -------------\nEffect on The Company will supplement the defined benefit pension --------- benefit that may be provided to each participant under the Pension Company's pension plan with an amount equal to the pension ------- benefit that would have been earned by the participant on the Benefits amount of compensation deferred by the participant under this -------- Plan, had such amount been received as compensation by the participant rather than deferred. Such amount is subject to all pension plan rules and regulations regarding determination of amount, vesting, method of payment, and so forth. Under no circumstance will this provision be construed to permit payment to a participant of an aggregate pension benefit, including this supplemental pension benefit, that is larger than the pension benefit the participant otherwise would have received if there had been no deferral election under this Plan.\nTaxes The Company will withhold from all benefit payments all ----- required taxes.\nAmendment and Harley-Davidson, Inc. may, at any time, amend the Plan by ------------- action of the Board of Directors of the Company, or by the Termination Human Resources Committee of the Board. The Company may, at any time, terminate the Plan as to its employees. The Company may not, however, reduce any benefit payment to a participant based on deferrals already made, without the participant's consent. Plan amendments adopted pursuant to this section shall govern all Deferred Compensation Agreements and Deferred Benefit Accounts uniformly except to the extent otherwise specifically provided by such amendment.\nConstruction The Plan is to be construed under the laws of the State of ------------ Wisconsin.\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nBinding This Plan is binding upon the Company and participants and ------- their respective successors, assigns, heirs, executors, and Agreement beneficiaries. ---------\n(Rev. 11\/18\/93 - g)\nHARLEY-DAVIDSON, INC.\nDEFERRED COMPENSATION PLAN SPECIFICATIONS -----------------------------------------\nSCHEDULE A ---------- Assumptions:\nX is healthy and under age 45. X elects to defer $10,000\/year for 7 years. X's pre-retirement benefit is $10,000 x 7 years = $ 70,000 Times Deferral Commitment Multiple x 5 -------- Pre-retirement Benefit $350,000\nFurther Assume:\nAfter 4 years of deferral X stops contributing either because of hardship or change of control event.\nX's adjusted pre-retirement benefit is based on his actual deferrals: $10,000 x 4 years = $ 40,000 Times Deferral Multiple Commitment x 5 --------\nPre-retirement Benefit $200,000\nFurther Assume:\nAfter 4 years of deferral X did not stop all deferrals but had them reduced by one-half due to hardship.\nX's adjusted pre-retirement benefit is based on his actual deferrals: $5,000 x 7 years = $ 35,000 x 5 -------- $175,000\nPLUS\n$5,000 x 4 years = $ 20,000 x 5 -------- $100,000\nTotal Adjusted Pre-retirement Benefit $275,000 ========\nSCHEDULE B ----------\nChange of Control Event means any one of the following:\n(a) Continuing directors no longer constitute at least 2\/3 of the directors of Harley-Davidson, Inc. (the \"Corporation\");\n(b) Any person or group of persons (as defined in Rule 13d-5 under the Securities Exchange Act of 1934), together with its affiliates, become the beneficial owner, directly or indirectly, of 20% of the Corporation's then outstanding Common Stock or 20% or more of the voting power of the Corporation's then outstanding securities entitled generally to vote for the election of the Corporation's directors;\n(c) The approval by the Corporation's stockholders of the merger or consolidation of the Corporation with any other corporation, the sale of substantially all of the assets of the Corporation or the liquidation or dissolution, of the Corporation, unless, in the case of a merger or consolidation, the then continuing directors in office immediately prior to such merger or consolidation will constitute at least 2\/3 of the directors of the surviving corporation of such merger or consolidation and any parent (as such term is defined in Rule 12b-1 under the Securities Exchange Act of 1934) of such corporation; or\n(d) At least 2\/3 of the then continuing directors in office immediately prior to any other action proposed to be taken by the Corporation's stockholders or by the Corporation's Board of Directors determines that such proposed action, if taken, would constitute a change of control of the Corporation and such action is taken.\nDESCRIPTION OF SUPPLEMENTAL EXECUTIVE RETIREMENT BENEFITS Exhibit 10.9\nThe Board of Directors of the Company has established certain supplemental retirement arrangements for certain executive officers of the Company. Pursuant to these arrangements, (1) the Company will pay executive officers amounts that would have been payable under the Retirement Annuity Plan for Salaried Employees of Harley-Davidson, Inc. (the \"Salaried Plan\") but for limitations imposed by the Internal Revenue Code, (2) if Messrs. Teerlink, Bleustein, Gelb, Gray and Ziemer retire at or after age 55 with 15 years of service, they will be entitled to receive a yearly retirement benefit payment equal to 35% of their final average earnings at age 55 increasing in equal increments to 50% of final average earnings at age 62, reduced by the amount of any Company pension or other defined benefit plan payments and by the amount of certain social security benefits, and (3) Messrs. Teerlink and Gelb have been credited with 5 and 6 additional years of service for purposes of the Salaried Plan and the above supplemental retirement arrangements.\nExhibit 10.10\nFORM OF SPLIT DOLLAR LIFE INSURANCE AGREEMENT (The Plan) --------------------------------------------------------\nTHIS AGREEMENT is entered into this ______, by and between HARLEY-DAVIDSON, INC., a Wisconsin Corporation (\"Company\") and ____, residing at ________ (the \"Executive\").\nWHEREAS, the Company has agreed to provide certain life insurance benefits to the Executive equal to three times the Executive's Base Compensation, as defined herein; and\nWHEREAS, the Company heretofore has provided such life insurance benefits through group term life insurance; and\nWHEREAS, all parties believe that it is in their best interests to replace such term insurance Policy with both a term and a whole life policy on the Executive's life; and\nWHEREAS, the parties believe that it is in the best interest of the Executive to be able to name the beneficiary under the Policy with respect to the insurance proceeds as described herein, but to vest all other incidents of ownership of the Policy in the Company.\nNOW, THEREFORE, IT IS AGREED AS FOLLOWS:\nSECTION 1. POLICY ------------------\nEffective _____, the Company shall procure policies (the \"Policy\") on the life of the Executive.\nSECTION 2. EXECUTIVE'S RIGHTS ------------------------------\nThe Executive's rights under the Policy shall be limited to the right to have his beneficiary(ies) (or estate, if there is no effective designation of beneficiary(ies) as of the date of his death) to receive a specified portion of the proceeds thereof upon the Executive's death and the right to designate and change the direct and contingent beneficiary(ies) with respect to each such specified portion of the proceeds, subject to the terms of the Policy. The rights of the Executive hereunder may not be assigned or alienated, except with the prior written consent of the Company.\nThe amount of such specified portion of the proceeds shall be equal to three times the Executive's Annual Base Salary (excluding bonus).\nSECTION 3. RIGHTS AND OBLIGATIONS OF COMPANY ---------------------------------------------\nExcept as provided in Section 2 hereof, the Company shall be the owner of the Policy and shall possess all of the rights in and under such Policy. Such rights shall include, but shall not be limited to, the right with respect to the split dollar policy, to apply Policy dividends in the manner determined by the Company, the right to borrow against the cash value of the Policy, the right to assign, pledge, transfer or exchange the Policy, and the right to receive any proceeds under the Policy in excess of those described in Section 2 hereof; provided, however, that in no event may the exercise of any such rights by the Company impair the benefits due to the Executive under Section 2, except with prior written consent of the Executive or except as otherwise provided in this Agreement.\nThe Company shall pay each premium under the Policy as it becomes due.\nSECTION 4. TAXES -----------------\nThe Company shall \"gross up\" the pay of the Executive in respect of each calendar year or partial calendar year during which this Agreement is in effect, by the amount of any federal or state income taxes required to be paid by the Executive by the reason of the current economic benefit derived by him under the Policy pursuant to Section 2, hereof.\nExcept as provided in the foregoing paragraph, the Company shall have no responsibility or liability for any estate or other taxes that may become due as a consequence of the Executive's rights under this Agreement or the Policy.\nSECTION 5. TERM OF AGREEMENT -----------------------------\nThis Agreement may be terminated without any liability to the Company by the Executive Committee of the Motorcycle Division of Harley-Davidson (the \"Committee\") at any time in its sole discretion. Unless so terminated by the Committee, or unless extended by mutual written agreement of the parties hereto, this Agreement shall remain in force so long as the Executive remains employed with the Company including all subsidiaries of Harley-Davidson, Inc. Upon Termination of employment, all rights of the Executive under Section 2 and under the Policy shall cease. Notwithstanding the foregoing, the Company, in its sole discretion (but subject to any applicable terms of the Policy), may offer the Executive the right to purchase the Policy upon the termination of this Agreement, at a price determined by the Company.\nSECTION 6. AMENDMENT AND TERMINATION -------------------------------------\nThis Agreement may only be amended in writing, signed by the Executive and an officer of the Company other than the Executive. This Agreement may be terminated at any time without liability by either party and without the consent of the other, by giving 30 days advance written notice thereof.\nSECTION 7. NOTICES -------------------\nAny notice hereunder shall be in writing and hand delivered or mailed, postage pre-paid, certified or registered mail, return receipt requested. Any notice that is mailed from the Company to the Executive shall be mailed to the address set forth above or to the most recent home address of the executive that is on file with the Company. The Executive shall promptly notify the Company of any change of address. Any notice that is mailed from the Executive to the Company shall be mailed to the Vice President, Human Resources, Harley-Davidson, Inc., 3700 West Juneau Avenue, Milwaukee, Wisconsin 53208.\nSECTION 8. ENTIRE UNDERSTANDING --------------------------------\nThis Agreement contains the entire understanding of the parties with regard to the subject matter, and the parties acknowledge that there are no representations, warranties or covenants of either party, express or implied, except as expressly set forth herein.\nSECTION 9. BINDING EFFECT --------------------------\nThis Agreement shall bind in benefit the parties hereto in their successors and assigns.\nSECTION 10. WAIVERS --------------------\nThe failure of either party to complain of any act or omission on the part of the other party or any waiver, express or implied, of any breach of any of the provisions of this Agreement, shall not be deemed a waiver of the party's right to complain of any subsequent act, omission or breach.\nSECTION 11. SEVERABILITY -------------------------\nThe invalidity of any provision of this Agreement, as determined by a court of competent jurisdiction, shall in no way affect any other provision of this Agreement as long as the performance by either party of its obligations under this Agreement is not eliminated by such determination.\nSECTION 12. RATIFICATION -------------------------\nNothing contained in this Agreement shall be construed as an employment agreement between Harley-Davidson, Inc. and the Executive. Therefore, nothing contained in the Plan or otherwise shall interfere with or limit in any respect whatsoever, the right of the Company or any subsidiary, branch, affiliate or division thereof to terminate the employment of any participant in this Plan, for any reason and at any time, nor confer upon any Plan participant any right to continue in the employ of the Company or any subsidiary, branch, affiliate or division thereof.\nSECTION 13. DUPLICATE ORIGINALS --------------------------------\nThis Agreement shall be executed in duplicate, and both copies of the Agreement shall be deemed originals.\nSECTION 14. GOVERNING LAW --------------------------\nThis Agreement shall be governed by and construed in accordance with the laws of the State of Wisconsin.\nIN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written.\nHarley-Davidson, Inc. By:\n-------------------------------------------- OFFICER\/ TITLE\n-------------------------------------------- EXECUTIVE\nExhibit 11\nHARLEY-DAVIDSON, INC.\nCOMPUTATION OF EARNINGS PER COMMON SHARE ASSUMING NO DILUTION (Unaudited)\n(In thousands, except per share amounts)\nHARLEY-DAVIDSON, INC.\nCOMPUTATION OF EARNINGS PER COMMON SHARE ASSUMING FULL DILUTION (Unaudited) (In thousands, except per share amounts)\n* Earnings (loss) per common share assuming full dilution generally includes the dilutive effect of outstanding stock options. During 1993, the effect of stock options had an antidilutive effect and, accordingly, was excluded from the calculations.\nExhibit 22 ----------\nHARLEY-DAVIDSON, INC.\nSUBSIDIARIES\nExhibit 23\nConsent of Ernst & Young, Independent Auditors\nWe consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-33449, No. 33-35311, and No. 33-48581) pertaining to (a) the Harley-Davidson, Inc. 1986 Stock Option Plan and the Harley-Davidson, Inc. 1988 Stock Option Plan; (b) the Harley-Davidson, Inc. Thrift Incentive Plan for Salaried Employees, the Harley-Davidson, Inc. Thrift Incentive Plan for Milwaukee and Tomahawk Hourly Bargaining Unit Employees, and the Holiday Rambler Corporation Employees Retirement Plan; and (c) the Harley-Davidson, Inc. 1990 Stock Option Plan of our report dated January 28, 1994, with respect to the consolidated financial statements and schedules of Harley-Davidson, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1993.\nERNST & YOUNG\nMilwaukee, Wisconsin March 29, 1994","section_15":""}
{"filename":"49573_1993.txt","cik":"49573","year":"1993","section_1":"Item 1. Business.\nGENERAL\nWhitman Corporation (\"Whitman\") is engaged in three distinct businesses: Pepsi-Cola and other non-alcoholic beverage products, Midas automotive services, and Hussmann refrigeration systems and equipment.\nPrior to 1968, Whitman's only substantial business was the Illinois Central Railroad. Between 1968 and 1986, Whitman effected a series of acquisitions aimed at diversifying beyond the railroad business, including Pepsi-Cola General Bottlers in 1970 and Midas in 1972. In 1978, Pet Incorporated, together with its subsidiary Hussmann, was acquired as a part of this diversification program. In 1987, Whitman began a program of strategic restructuring designed to transform itself into an enterprise more focused on consumer goods and services. In 1988, Whitman sold its Pneumo Abex Corporation aerospace and defense subsidiary, and in January, 1989, spun off its railroad operations to its shareholders. On April 1, 1991, Whitman spun off its Pet subsidiary (excluding its Hussmann subsidiary) to its shareholders. After the Pet spin-off, the principal operating companies of Whitman were Pepsi-Cola General Bottlers, Inc. (\"Pepsi General\"), Midas International Corporation (\"Midas\") and Hussmann Corporation (\"Hussmann\").\nWhitman incorporates by reference the information under the captions \"Discontinued Operations\" and \"Segment Reporting\" which constitute notes 2 and 12, respectively, to the financial statements included in Whitman's 1993 Annual Report to Shareholders.\nPEPSI GENERAL\nPepsi-Cola General Bottlers produces and distributes soft drinks and non-alcoholic beverages, under exclusive franchises, in 12 states in the Midwest and Southeast - a market of approximately 25 million people. It is the largest independent Pepsi bottler in the U.S., accounting for about 12 percent of all Pepsi-Cola products sold in the U.S. each year. Pepsi General products outsell all other soft drink brands in its major markets.\nIn 1993, approximately 88 percent of Pepsi General's volume was from Pepsi-Cola products, including: Pepsi, Diet Pepsi, Caffeine Free Pepsi, Mountain Dew, Slice, Crystal Pepsi, and All-Sport. Other soft drink brands, including Dr. Pepper, Seven-Up, Hawaiian Punch, Dad's Root Beer, Canada Dry, Ocean Spray, and Lipton's Tea, account for the remaining 12 percent. Diet products account for slightly more than 27 percent of total case sales. Three-quarters of all case goods are cans, and 24 percent are non-returnable bottles.\nHistorically, volume growth in the soft drink industry has come from supermarkets, where competition is intense. Pepsi General's focus has been to grow case volume and improve margins by focusing on other, higher margin distribution channels, including convenience stores, gas stations, food service and vending machines. In 1993, almost 50 percent of Pepsi General's sales were through these other more profitable channels.\nThe majority of Pepsi General's products are distributed by route sales people to retail outlets by truck. Currently, Pepsi General operates more than 1,200 routes. Over the past few years, Pepsi General has been expanding Pepsi Express, its bulk distribution system for large customers, for a substantial improvement in productivity. In addition, Pepsi General has pioneered the use of hand-held computers for route sales people. This system enables Pepsi General to process sales and orders more efficiently, better control inventories and discounts, and handle a wider range of products more productively.\nPepsi General owns, leases, or sells the vending machines which dispense its soft drink products in factories, offices, schools, stores, gasoline stations and other locations. Pepsi General's business is seasonal and weather conditions have a significant effect on sales.\nOne of Pepsi General's long-term strategic goals is to transform itself from a carbonated soft drink company to a total beverage company and to continue to grow faster than the industry. In 1993, Pepsi General took a major step towards fulfilling this goal by introducing more new product lines and brands than it had in the previous 20 years. They include: Lipton Original Tea, a fresh brewed tea, Lipton Brisk, Ocean Spray juice drinks, All-Sport, an isotonic drink, Crystal Pepsi, and Caffeine Free Mountain Dew.\nPepsi General's franchises grant it the exclusive right to produce and sell the products and use the related trade names and trademarks in the franchised territories. The franchises require Pepsi General, among other things, to purchase its concentrate requirements solely from the franchisor, at prices established by the franchisor, and to promote diligently the sale and distribution of the franchised products. Packaging materials (bottles, bottle caps, cans, cartons, cases) are obtained from manufacturers approved by the franchisor and other items are purchased in the general market. The franchises are for an indefinite term and are subject to termination upon failure to comply with the provisions of the franchise agreement.\nCompetition among soft drinks of all kinds, and particularly in the principal cola drink market (approximately 70% of all soft drinks sold in the United States are colas), is intense and focuses on price to retail outlets. Despite fluctuations in the prices of high fructose corn sweeteners and materials used in soft drink packaging, Pepsi General has not experienced difficulty in obtaining such items. It is the practice of Pepsi General to protect the availability and pricing of its sweetener requirements through commitments from suppliers for future delivery at the lower of market or guaranteed ceiling prices.\nMIDAS\nMidas operates the world's largest franchised dealer network specializing in under-the-car services - a $12 billion market. Midas dealers service exhaust systems, brakes, and steering-suspension systems. Many shops also offer oil changes. It is the market leader with an estimated 18 percent of the U.S. exhaust market, 12 percent of the brake market, and 4 percent of the steering and suspension market. In 1993, Midas shops replaced more than four million exhaust systems, serviced over two million brake systems, and continued to expand in the steering- suspension business. In 1993, exhaust service represented less than 50 percent of Midas' retail sales. Midas continues to test other automotive related services.\nThe United States is Midas' largest market, with 1,838 shops at the end of 1993. Midas is the only national company in its industry, with at least one shop in every county in the U.S. with a vehicle population of more than 25,000 cars and light trucks. Midas also has 239 shops in Canada, 215 in France, 36 in Belgium, 28 in Spain, 139 in Australia, and 30 in other countries.\nMidas manufactures automotive aftermarket products at four facilities in the United States. It is the third largest manufacturer of automotive aftermarket exhaust systems in the U.S. It manufactures nearly 1,800 different types of mufflers which will fit nearly 96 percent of the cars and light trucks - both foreign and domestic - on the road today in the U.S. It also distributes brake and ride control components to its dealers.\nIn the United States, Midas has the capacity to meet the demands of the market with its extensive network of shops. To maximize that presence, Midas reorganized and decentralized its field operations in 1993. It put more people in the field to work with franchises and shifted its focus from national to regional marketing programs.\nMidas continues to expand in markets outside the U.S. With 286 shops in Europe, Midas is building on its established operations in France and Belgium, while it continues to expand its newer operations in Spain. Midas has also signed master franchise agreements in Mexico and in the Middle East.\nThe principal source of Midas' revenue is derived from its network of franchised and company-owned and operated retail shops. Midas collects an initial franchise fee and receives yearly royalties based upon the franchisee's gross revenues. In addition, Midas generates revenues from the sale of manufactured mufflers and tubing, and from the resale of purchased parts (primarily brakes, shocks and front-end alignment components) to its franchisees. Midas also sells its manufactured exhaust system parts under other brand names to automotive parts distributors, jobbers and automobile accessory stores and its fabricated tube-bending equipment to jobbers and retail installers.\nThe raw materials and supplies used in Midas products are purchased from many suppliers and the company is not dependent upon any single source for any of its raw materials or supplies.\nCompetition in the automotive replacement parts business is intensive at both the wholesale and retail levels. Service, convenience, price, and warranties are the primary competitive factors. Midas' warranty of mufflers, brakes and shocks is particularly important to its marketing program. Competitors include automotive service centers of retail chain stores, muffler shops, automotive dealers, gasoline stations and independent repair shops. HUSSMANN\nHussmann Corporation produces merchandising and refrigeration systems for the world's food industry. Products include refrigerated display cases, commercial industrial refrigeration systems, storage coolers, bottle coolers, walk-in coolers, and HVAC equipment. Hussmann is the market leader in North America, and has substantial operations in the United Kingdom.\nThe supermarket equipment industry in the United States, Hussmann's core business, represents an $800 million market. The United States customer base is comprised of approximately 13,000 independent and 18,000 chain- owned supermarkets, plus over 52,000 other grocery stores. Every year, approximately 4,000 stores purchase refrigeration equipment for either new store openings or remodelings. Historically, Hussmann's business has been divided approximately equally between new store activity and the remodeling of existing stores. With the weak U.S. economy, about 45 percent of Hussmann's business has been new store openings, and 55 percent remodelings.\nThe convenience store specialty equipment industry in the U.S. represents a market of over $300 million per year, serving approximately 71,000 stores. Hussmann maintains separate sales and manufacturing operations for this industry.\nNorth American commercial industrial refrigeration represents a market of nearly $500 million. Hussmann manufactures unit coolers, condensing units, and air-cooled condenser products for this market.\nMexico is Hussmann's second largest profit center. It has two manufacturing operations, and uses both a direct sales force, and a network of 150 independent dealers and distributors to bring its products to the Mexican market. A large portion of Mexico's business is in equipment for the soft drink and brewery industries. Hussmann's Canadian operations consist of three manufacturing plants and a network of company-owned branches and independent distributors.\nIn the United Kingdom, Hussmann has a manufacturing plant located in Glasgow, Scotland, and a network of sales, service, and installation depots located throughout the country. Hussmann's branch service and distribution network in the United Kingdom is at least twice the size of its nearest competitor.\nIn the Far East, Hussmann has a joint venture with a distributor in Singapore who sells, services, and distributes Hussmann products throughout the Southern Pacific Rim region. Hussmann also has distributor agreements in Japan, Taiwan, New Zealand, Korea, Argentina, Columbia, El Salvador and Costa Rica and licensees in Thailand and New Zealand.\nIn 1993, Hussmann introduced Protocol, a unique refrigeration system which is CFC and HCFC free, and less expensive to install and operate than conventional systems. Hussmann has exclusive use of the Protocol compressor technology through 1994.\nOne of Hussmann's greatest strength's is its research and development center where Protocol was developed. It is the only R&D center of its kind in the industry. It allows Hussmann to work closely with chemical companies and compressor, valve and controls manufacturers to create the new generations of cases and systems.\nThe dollar amount of firm backlog at December 31, 1993 was $146.9 million, compared with $142.3 million in 1992. Substantially all such backlog is expected to be filled within one year.\nHussmann products are marketed internationally by both company sales personnel and independent distributors. The principal competitive factors in the sale of Hussmann products are price, variety, quality and technology, particularly energy conservation. The raw materials and supplies used in Hussmann products are purchased from many suppliers and Hussmann is not dependent upon any single source for any of its raw materials or supplies.\nEMPLOYEES\nWhitman employed 14,868 persons worldwide as of December 31, 1993. Whitman regards its employee relations as generally satisfactory.\nENVIRONMENTAL MATTERS\nWhitman maintains a continuous program to facilitate compliance with federal, state and local laws and regulations relating to the discharge or emission of materials into, and other laws and regulations relating to the protection of, the environment. The capital costs of such compliance, including the costs of the modification of existing plants and the installation of new manufacturing processes incorporating pollution control technology, are not material.\nHussmann, together with numerous other defendants, has been named as a potentially responsible party (\"PRP\")in two state actions under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\") involving off-site waste disposal. Neither of these matters is expected to involve any significant expense to Hussmann. Whitman's remaining two operating companies, Midas and Pepsi General, are not parties to any environmental litigation. Pepsi General has been notified that it is a de minimus participant at six Superfund sites. Midas has been named a PRP at one Superfund site where its participation is also expected to be at the de minimus level.\nUnder the agreement pursuant to which Whitman sold Pneumo Abex Corporation in 1988 and a subsequent settlement agreement entered into with Pneumo Abex in September, 1991, Whitman has assumed indemnification obligations for certain environmental liabilities of Pneumo Abex, net of any insurance recoveries. Pneumo Abex is subject to a number of federal, state and local environmental cleanup proceedings, including proceedings under CERCLA at off-site locations involving other major corporations which have also been named as PRPs. Pneumo Abex is also subject to private claims and several lawsuits for remediation of properties currently or previously owned by Pneumo Abex, and Whitman is subject to one such suit.\nThere is significant uncertainty in assessing the total cost of remediating a given site and in determining any individual party's share in that cost. This is due to the fact that the Pneumo Abex liabilities are at different stages in terms of their ultimate resolution, and any assessment and determination are inherently speculative, depending upon a number of variables beyond the control of any party. Additionally, the settlement of governmental proceedings or private claims for remediation invariably involves negotiations within broad cost ranges of possible remediation alternatives. Furthermore, there are significant timing considerations in that a portion of the expense involved and any resulting obligation of Whitman to indemnify Pneumo Abex may not be incurred for a number of years.\nOn September 30, 1992, the United States Environmental Protection Agency issued a Record of Decision (\"ROD\") under the provisions of CERCLA setting forth the scope of expected remedial action at a Pneumo Abex facility in Portsmouth, Virginia. The original cost estimate to implement the ROD was $28.9 million and has since been revised to $31.9 million. Whitman management is optimistic that ongoing negotiations with the EPA will result in less costly remedial action. Although Pneumo Abex was originally the only named PRP, the EPA has identified 13 additional PRPs, most of which are believed to be financially viable and which may be held responsible for a portion of such costs.\nManagement believes that potential insurance recoveries may defray a portion of the expenses involved in meeting Pneumo Abex environmental liabilities. On November 20, 1992, Jensen-Kelley Corporation, a Pneumo- Abex subsidiary, Pneumo Abex and certain other of its affiliates, and Whitman and certain of its affiliates, filed a lawsuit against numerous insurance companies in the Superior Court of California, Los Angeles County, seeking damages and declaratory relief for insurance coverage and defense costs for environmental claims. Whitman is unable to predict the outcome of this litigation.\nIn the opinion of management, and based upon information currently available, Whitman believes that the eventual resolution of these claims and litigation, considering amounts already accrued but excluding potential insurance recoveries, will not have a material adverse effect on Whitman's financial condition or the results of operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nPepsi General's facilities include five bottling plants, three combination bottling canning plants and three canning plants. In addition, Pepsi General has 58 distribution warehouses and one storage warehouse. Approximately 14 percent of Pepsi General's production is from leased facilities. Midas operates four manufacturing plants in the United States. Of the plants, three are owned and one is leased. In addition, Midas maintains 12 warehouses in the United States and five warehouses in Canada, of which two are owned and 15 are leased. At December 31, 1993, Midas operated 120 Midas Muffler Shops in the United States, 33 Midas Muffler Shops in Canada and 174 Midas Muffler Shops in six other foreign countries. Hussmann operates 9 owned and 8 leased manufacturing facilities in the United States, Canada, Mexico, and the United Kingdom. There are six owned and 44 leased branch facilities in the United States, Canada, Mexico, Hungary and the United Kingdom which sell, install and maintain Hussmann products.\nAll facilities are adequately equipped and maintained and capacity is considered to be adequate for current needs.\nIn addition, Whitman engages in a variety of industrial, commercial and residential real estate activities in the United States.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nWhitman and its subsidiaries are defendants in numerous lawsuits, none of which will, in the opinion of Whitman's counsel, have a material adverse effect on Whitman's financial position.\nSee also \"Environmental Matters\", above.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nWhitman incorporates by reference the information contained under the heading \"Securities Data\" in Whitman's 1993 Annual Report to Shareholders (Exhibit 13). There were 21,607 shareholders of record at December 31, 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nWhitman incorporates by reference the information contained under the heading \"Six-Year Summary of Operations\" in Whitman's 1993 Annual Report to Shareholders (Exhibit 13).\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nWhitman incorporates by reference the information contained under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Whitman's 1993 Annual Report to Shareholders (Exhibit 13).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nWhitman incorporates by reference the information contained under the headings \"Financial Statements\", \"Notes to Consolidated Financial Statements\" and \"Independent Auditors' Report\" in Whitman's 1993 Annual Report to Shareholders (Exhibit 13).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nWhitman incorporates by reference the information contained under the caption \"Election of Directors\" in its definitive proxy statement dated March 18, 1994, filed pursuant to Section 14 (a) of the Securities Exchange Act of 1934, as amended.\nThe executive officers of Whitman and their ages as of March 1, 1994 were as follows:\nAge Position\nBruce S. Chelberg 59 Chairman and Chief Executive Officer Thomas L. Bindley 50 Executive Vice President Frank T. Westover 55 Senior Vice President-Controller Lawrence J. Pilon 45 Senior Vice President-Human Resources Gerald A. McGuire 62 Corporate Vice President; President and Chief Executive Officer, Pepsi-Cola General Bottlers, Inc. John R. Moore 58 Corporate Vice President; President and Chief Executive Officer, Midas International Corporation J. Larry Vowell 53 Corporate Vice President; President and Chief Executive Officer, Hussmann Corporation Charles H. Connolly 59 Vice President-Corporate Affairs and Investor Relations William B. Moore 52 Vice President, Secretary and General Counsel\nExcept as described in the following paragraphs or as incorporated by reference to the Registrant's definitive proxy statement, all the executive officers of Whitman have held positions which are the same or which involve substantially similar functions as indicated above during the past five years.\nMr. Chelberg was elected Chairman and Chief Executive Officer in May, 1992. Prior to that, Mr. Chelberg served as Executive Vice President of the Company since 1985. Mr. Bindley joined Whitman Corporation as Executive Vice President in April, 1992. Prior to joining Whitman Corporation, Mr. Bindley served as Executive Vice President of Square D Corporation from August, 1986 through September, 1991. Mr. Pilon joined Whitman Corporation as Senior Vice President in February, 1994. Prior to joining Whitman Corporation, Mr. Pilon served as Vice President-Human Resources and Secretary of National Intergroup, Inc. from June, 1986 to January, 1994. Mr. Vowell was elected President and Chief Executive Officer of Hussmann Corporation in January, 1991. Prior to that, Mr. Vowell served as President and Chief Operating Officer of Hussmann U.S. operations since March, 1990; Senior Vice President and General Manager of Marketing from July, 1989; and President of the Convenience and Specialty Group from 1987.\nItem 11.","section_11":"Item 11. Executive Compensation.\nWhitman incorporates by reference the information contained under the caption \"Executive Compensation\" and the last two paragraphs under the caption \"General Information\" in its definitive proxy statement dated March 18, 1994, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nWhitman incorporates by reference the information contained under the captions \"Principal Shareholders\" and \"Securities Ownership of Directors and Executive Officers\" in its definitive proxy statement dated March 18, 1994, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNone.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) See Index to Financial Statements on page and Exhibit Index. (b) Through December 31, 1993, no reports on Form 8-K were filed subsequent to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\nSIGNATURES\nPursuant 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 on the 18th day of March, 1994.\nWHITMAN CORPORATION\nBy: \/s\/ Frank T. Westover ----------------------------------- Frank T. Westover Senior Vice President-Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on the 18th day of March, 1994.\nSignature Title\n*Bruce S. Chelberg Chairman and Chief Executive Officer and - ------------------------ Director BRUCE S. CHELBERG (principal executive officer)\n*Thomas L. Bindley Executive Vice President - ------------------------ (principal financial officer) THOMAS L. BINDLEY\n\/s\/ Frank T. Westover Senior Vice President-Controller - ------------------------ (principal accounting officer) FRANK T. WESTOVER\n*Richard G. Cline Director - ------------------------ RICHARD G. CLINE\n*James W. Cozad Director - ------------------------ JAMES W. COZAD\n*Pierre S. du Pont IV Director - ------------------------ PIERRE S. du PONT IV *By: \/s\/ FRANK T. WESTOVER *Archie R. Dykes Director ---------------------- - ------------------------ Frank T. Westover ARCHIE R. DYKES Attorney-in-Fact March 18, 1994 *Helen Galland Director - ------------------------ HELEN GALLAND\nDirector - ------------------------ C. JACKSON GRAYSON, JR.\nDirector - ------------------------ DONALD P. JACOBS\n*Charles S. Locke Director - ------------------------ CHARLES S. LOCKE\n*Harry A. Merlo - ------------------------ Director HARRY A. MERLO\nWHITMAN CORPORATION AND SUBSIDIARIES\nForm 10-K\nFinancial Statements Submitted in Response to Item 14(a)\nYear Ended December 31, 1993\nWHITMAN CORPORATION AND SUBSIDIARIES\nThe consolidated financial statements, together with the related notes and the report thereon of KPMG Peat Marwick, dated January 13, 1994, appearing in Whitman's 1993 Annual Report to Shareholders (Exhibit 13), are hereby incorporated by reference and made a part hereof.\nIndependent Auditors' Report on Financial Statement Schedules and Consent\nFinancial Statement Schedules:\nSchedule V Property, plant and equipment\nSchedule VI Accumulated depreciation and amortization of property,plant and equipment\nSchedule VIII Valuation and qualifying accounts\nSchedule X Supplementary income statement information\nSchedules not included have been omitted because they are not applicable or the required information is shown in the financial statements or related notes.\nINDEPENDENT AUDITORS'REPORT ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders of Whitman Corporation:\nUnder the date of January 13, 1994, we reported on the consolidated balance sheets of Whitman Corporation and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 Annual Report to Shareholders of Whitman Corporation. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG PEAT MARWICK\nKPMG Peat Marwick Chicago, Illinois January 13, 1994\nINDEPENDENT AUDITORS' CONSENT\nThe Board of Directors and Shareholders of Whitman Corporation:\nWe consent to incorporation by reference in Registration Statements Nos. 33-28238 and 33-65006 on Form S-8 and No. 33-50109 on Form S-3 of Whitman Corporation of our reports dated January 13, 1994, relating to the consolidated balance sheets of Whitman Corporation and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of income, shareholders' equity, cash flows and related financial statement schedules for each of the years in the three-year period ended December 31, 1993, which reports appear in or are incorporated by reference in the December 31, 1993 annual report on Form 10-K of Whitman Corporation. Our report refers to a change in the method of accounting for postretirement benefits other than pensions.\n\/s\/ KPMG PEAT MARWICK\nKPMG Peat Marwick Chicago, Illinois March 18, 1994\nSCHEDULE V WHITMAN CORPORATION AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT Year Ended December 31, 1993 (in Millions)\nOther Balance at Changes Balance Beginning Additions Retire- Add at End Classification of Period at Cost ments (Deduct) of Period - -------------- --------- --------- --------- --------- --------- Land $ 58.8 $ 2.9 $ 1.5 $ (0.3) $ 59.9 Buildings 291.2 12.6 5.1 (0.6) 298.1 Machinery & Equip. 706.3 70.7 25.3 (2.8) 748.9 -------- ------ ------ ------ -------- Total $1,056.3 $ 86.2 $ 31.9 $ (3.7)(a) $1,106.9 ======== ====== ====== ====== ========\n(a) Consists of cumulative translation adjustments.\nYear Ended December 31, 1992\nOther Balance at Changes Balance Beginning Additions Retire- Add at End Classification of Period at Cost ments (Deduct) of Period - -------------- --------- --------- --------- --------- --------- Land $ 55.9 $ 3.8 $ 0.6 $ (0.3) $ 58.8 Buildings 287.9 10.9 3.3 (4.3) 291.2 Machinery & Equip. 671.5 63.6 20.4 (8.4) 706.3 -------- ------ ------ ------ -------- Total $1,015.3 $ 78.3 $ 24.3 $(13.0)(a) $1,056.3 ======== ====== ====== ====== ========\n(a) Consists of cumulative translation adjustments.\nYear Ended December 31, 1991\nOther Balance at Changes Balance Beginning Additions Retire- Add at End Classification of Period at Cost ments (Deduct) of Period - -------------- --------- --------- --------- --------- --------- Land $ 55.0 $ 2.2 $ 0.8 $ (0.5) $ 55.9 Buildings 287.5 11.8 5.7 (5.7) 287.9 Machinery & Equip. 642.2 64.8 28.9 (6.6) 671.5 -------- ------ ------ ------ -------- Total $ 984.7 $ 78.8 $ 35.4 $(12.8)(a) $1,015.3 ======== ====== ====== ====== ========\n(a) Includes $6.8 million of cumulative translation adjustments and $6.0 million of property transferred to Pet Incorporated in the April 1, 1991 spin-off.\nSCHEDULE VI\nWHITMAN CORPORATION AND SUBSIDIARIES ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT Year Ended December 31, 1993 (in Millions)\nAdditions Other Balance at Charged to Changes Balance Beginning Costs and Retire- Add at End Classification of Period Expenses ments (Deduct) of Period - -------------- --------- --------- --------- --------- --------- Buildings $ 90.7 $ 10.4 $ 2.4 $ (0.3) $ 98.4 Machinery & Equip. 389.5 68.0 21.6 (0.2) 435.7 -------- ------ ------ ------ -------- Total $ 480.2 $ 78.4 $ 24.0 $ (0.5)(a) $ 534.1 ======== ====== ====== ====== ========\n(a) Consists of cumulative translation adjustments.\nYear Ended December 31, 1992\nAdditions Other Balance at Charged to Changes Balance Beginning Costs and Retire- Add at End Classification of Period Expenses ments (Deduct) of Period - -------------- --------- --------- --------- --------- --------- Buildings $ 84.0 $ 10.6 $ 2.2 $ (1.7) $ 90.7 Machinery & Equip. 341.7 65.6 13.5 (4.3) 389.5 -------- ------ ------ ------ -------- Total $ 425.7 $ 76.2 $ 15.7 $ (6.0)(a) $ 480.2 ======== ====== ====== ====== ========\n(a) Consists of cumulative translation adjustments.\nYear Ended December 31, 1991\nAdditions Other Balance at Charged to Changes Balance Beginning Costs and Retire- Add at End Classification of Period Expenses ments (Deduct) of Period - -------------- --------- --------- --------- --------- ---------\nBuildings $ 77.4 $ 10.3 $ 2.0 $ (1.7) $ 84.0 Machinery & Equip. 307.9 58.6 19.8 (5.0) 341.7 -------- ------ ------ ------ -------- Total $ 385.3 $ 68.9 $ 21.8 $ (6.7)(a) $ 425.7 ======== ====== ====== ====== ========\n(a) Includes $3.2 million of cumulative translation adjustments and $3.5 million of reserves on property transferred to Pet Incorporated in the April 1, 1991 spin-off.\nSCHEDULE VIII\nWHITMAN CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS Year Ended December 31, 1993 (in Millions)\nAdditions -------------------- Balance at Charged to Charged Balance Beginning Costs and to Other at End Classification of Period Expenses Accounts Deductions of Period - -------------- --------- --------- --------- --------- --------- Intangible assets $90.4 $ 17.1 $ -- $ (0.8)(a) $ 106.7 ====== ====== ====== ====== =======\n(a) Comprised of cumulative translation adjustments and adjustments to purchase accounting for prior-year acquisitions.\nYear Ended December 31, 1992\nAdditions -------------------- Balance at Charged to Charged Balance Beginning Costs and to Other at End Classification of Period Expenses Accounts Deductions of Period - -------------- --------- --------- --------- --------- --------- Intangible assets $74.5 $ 17.3 $ -- $ (1.4)(a) $ 90.4 ====== ====== ====== ====== =======\n(a) Consists of cumulative translation adjustments.\nYear Ended December 31, 1991\nAdditions -------------------- Balance at Charged to Charged Balance Beginning Costs and to Other at End Classification of Period Expenses Accounts Deductions of Period - -------------- --------- --------- --------- --------- ---------- Intangible Assets $58.8 $ 17.5 $ -- $ (1.8)(a) $74.5 ====== ====== ====== ====== ======\n(a) Includes $1.1 million of fully amortized intangibles removed from reserve and $0.7 million of cumulative translation adjustments.\nSCHEDULE X\nWHITMAN CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INCOME STATEMENT INFORMATION (in Millions)\nCharged to Costs and Expenses for Year Ended December 31 -------------------------------------- 1993 1992 1991 -------- -------- -------- Maintenance and repairs $ 42.8 $ 41.4 $ 40.4 Advertising costs 41.1 38.2 37.4\nEXHIBIT INDEX\nNo.* Description of Exhibit - -------- ----------------------------------------------------------------\n(3)a+ Certificate of Incorporation as Restated April 30, 1987, and subsequently amended through June 24, 1992. (3)b@ By-Laws, as Amended July 17, 1989. (4)a# Indenture dated as of January 15, 1993, between Whitman Corporation and The First National Bank of Chicago, Trustee. (4)b# Form of 7-1 2% Note due February 1, 2003, issued pursuant to the Indenture filed as Exhibit (4)a to the Whitman Corporation 1992 Annual Report on Form 10-K. (4)c Form of Medium-Term Note, Series A, issued pursuant to the Indenture dated January 15, 1993 filed as Exhibit 4(a) to the Whitman Corporation 1992 Annual Report on Form 10-K. (4)d Form of 6-1 2% Note due February 1, 2006, issued pursuant to the Indenture dated January 15, 1993 filed as Exhibit 4(a) to the Whitman Corporation 1992 Annual Report on Form 10-K. (10)a# **1982 Stock Option, Restricted Stock Award and Performance Award Plan (as amended through June 16, 1989). (10)b# **Amendment No. 2 to 1982 Stock Option, Restricted Stock Award and Performance Award Plan made as of September 1, 1992. (10)c# **Form of Nonqualified Stock Option Agreement. (10)d# **Amendment to 1982 Stock Option, Stock Award and Performance Award Plan made as of February 19, 1993. (10)e# **Form of Severance Compensation and Change in Control Agreement dated as of March 17, 1989. (10)f# **Form of Amendment to Severance Compensation and Change in Control Agreement dated July 1, 1992. (10)g# **Management Incentive Compensation Plan. (10)h# **Long Term Performance Compensation Program. (10)i **Whitman Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1991 and December 31, 1993. (10)j **Hussmann Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1991 and December 31, 1993. (10)k **Midas International Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1991 and December 31, 1993. (10)l **Pepsi-Cola General Bottlers, Inc. Executive Retirement Plan, as Amended and Restated Effective January 1, 1991 and December 31, 1993. (10)m# **Deferred Compensation Plan for Directors, as Amended November 18, 1988. (10)n# **Director Emeritus Program, as amended through February 16, 1990. (10)o **Whitman Corporation Retirement Savings Plan, as Amended and Restated Effective January 1, 1994. (10)p **Form of Restricted Stock Award Agreement. (12) Statement of Calculation of Ratio of Earnings to Fixed Charges. (13) 1993 Annual Report to Shareholders (only the portions incorporated by reference are included in this Exhibit) (21) Subsidiaries of the Registrant. (24) Powers of Attorney.\nExhibit Reference Explanations - ------------------------------\n* References are to Exhibit Table, Item 601 of Regulation S-K. ** Exhibit constitutes a management contract or compensatory plan, contract or arrangement described under Item 601(b)(10)(iii)(A) of Regulation S-K. + Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 as Exhibit 3. @ Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 as Exhibit 3. # Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 under the indicated Exhibit number.","section_15":""}
{"filename":"49146_1993.txt","cik":"49146","year":"1993","section_1":"Item 1. Business\nGeneral\nHunt Manufacturing Co. and its subsidiaries (herein called the \"Company\", unless the context indicates otherwise) are primarily engaged in the manufacture and distribution of office products and art\/craft products which the Company markets worldwide.\nBusiness Segments\nThe following table sets forth the Company's net sales and operating profit by business segment for the last three fiscal years:\n1993 1992 1991 -------- -------- -------- (In thousands) Net Sales: Office products....... $142,462 $126,101 $120,103 Art\/Craft products.... 113,688 108,828 108,519 -------- -------- -------- Total........... $256,150 $234,929 $228,622 ======== ======== ========\nOperating Profit: Office products....... $ 11,411 $ 8,541 $ 6,369 Art\/Craft products.... 18,832 18,516 17,618 -------- -------- -------- Total........... $ 30,243 $ 27,057 $ 23,987 ======== ======== ======== - ------------- See Items 6 and 7 herein and Note 15 to Consolidated Financial Statements herein for further information concerning the Company's business segments (including information concerning identifiable assets).\nOffice Products\nThe Company has three major classes of office products: mechanical and electromechanical products; office furniture and related products; and desktop accessory products. The amounts and percentages of net sales of these product classes for the last three fiscal years were as follows:\n1993 1992 1991 -------------- --------------- --------------- (Dollars in thousands) Product Class: Mechanical and Electromechanical.... $ 70,047 49% $ 62,323 49% $ 57,592 48% Office furniture....... 44,233 31 37,271 30 36,526 30 Desktop accessories.... 28,182 20 26,507 21 25,985 22 ------- --- -------- --- -------- --- Total.............. $142,462 100% $126,101 100% $120,103 100% ======== === ======== === ======== ===\nThe Company's mechanical and electromechanical office products consist of a variety of items sold under the Company's BOSTON brand, including manual and electric pencil sharpeners; paper punches; paper trimmers and paper shredders; electric letter openers; spring clips used to hold sheets of paper; manual and electronic staplers; electric air cleaners and other related products. The Company's specialty office furniture and related products are designed primarily to meet specific needs created by new office technologies and are sold under the BEVIS brand name. These products include conference, computer, utility and folding tables; office chairs; bookcases and screen panels; metal and wood workstations for computer terminals, personal computers, word processors, printers and other similar electronic office equipment; and home\/office furniture. The Company's desktop accessory products consist of an array of items marketed under its LIT-NING brand, including metal horizontal and vertical files, letter trays, desk organizers and paper sorting racks. Also included in desktop accessory products are a broad range of products that support the use of computers such as computer diskette storage devices, printer stands, mouse pads, and surge suppressors which are marketed under the MEDIAMATE brand name.\nThe Company consistently has sought to expand its office products business through internal product development, the acquisition of distribution rights to products which complement or extend the Company's established lines, the acquisition of complementary businesses and through increased distribution of its office products to the general consumer. Examples of new office product introductions by the Company in recent years are BOSTON brand electronic staplers, various models of air cleaners, automatic personal paper shredder, and desk-top laminators; BEVIS UNIWORX, BEVIS ULTRAWORX and BEVIS MEGAWORX lines of modular offices furniture systems; BEVIS STACKAWAYS stackable chairs; MEDIAMATE LASERRAK printer stands; MEDIAMATE FASTRAC mouse pads; MEDIAMATE multi-media storage files and MEDIAMATE POWER TAMER surge suppressors.\nThere are three major and generally distinct domestic markets for the Company's office products: commercial offices, home offices and the gen- eral consumer. The commercial line of the Company's office products is distributed primarily through a network of office supply wholesalers and dealers and office product superstores. Sales to the home office and the general consumer include mechanical and electromechanical products which are sold through large retail outlets, such as office superstores, drug and food chain stores, variety stores, discount chains, catalog showrooms and membership chains. The consumer market has increased significantly over the last few years primarily due to the dramatic growth of office superstores. A more limited line of products is sold to schools through specialized school supply distributors.\nArt\/Craft Products\nThe Company manufactures and distributes three major classes of art\/craft products: mounting and laminating products; art supplies; and hobby\/craft products. The amounts and percentages of net sales of these three product classes for the last three fiscal years were as follows:\n1993 1992 1991 ------------- ------------- ------------- (Dollars in thousands) Product Class: Mounting and laminating.... $ 68,734 61% $ 63,475 58% $ 61,851 57% Art supplies... 27,569 24 29,134 27 29,569 27 Hobby\/craft.... 17,385 15 16,219 15 17,099 16 -------- --- --------- --- --------- --- Total......... $113,688 100% $108,828 100% $108,519 100% ======== === ======== === ======== ===\nThe Company's mounting and laminating products are used largely by picture framers, graphic artists, display designers and photo laboratories, and include a range of BIENFANG foam boards; TECHMOUNT dry mount adhesive products; pressure sensitive and dry mount adhesive products sold under the SEAL and ADEMCO-SEAL brands, as well as under the COLORMOUNT, SEALEZE and PRINT GUARD brand names; an array of mounting and laminating equipment sold under the CLEAR TECH, SEALEZE, and IMAGE SERIES brand names; and specialty tapes and films supplied under various private brands. The Company's art supply products are used primarily by commercial and amateur artists, and include commercial and fine art papers which the Company converts, finishes and sells under its BIENFANG brand; various types of X-ACTO brand knives and blades; SPEEDBALL paint markers and acrylic and water-color paints; and CONTE(1) pastels, crayons and related drawing products, for which the Company is the exclusive United States and Canadian distributor. The Company's hobby\/craft products generally are used by hobbyists and craft enthusiasts and include SPEEDBALL print-making products; ACCENT MATS beveled-edge picture framing mats; SPEEDBALL ELEGANT WRITERS and PANACHE calligraphy products; and X-ACTO brand tools and kits.\nThe Company consistently has sought to expand its art\/craft business primarily through acquisitions of complementary businesses and of distribution rights to complementary products manufactured by others, through internal product development, and through increased distribution of its art\/craft products to the general consumer. Major art\/craft products introduced during\n- ------------ (1). Trademark of Conte S.A.\nthe last several fiscal years include BIENFANG colored foam board, as well as SINGLE STEP adhesive coated BIENFANG foam board; BIENFANG project display board; PANACHE calligraphy products; SPEEDBALL FABRIC PAINTERS non-toxic pen- type acrylic-based paint markers; TECHMOUNT dry mount adhesive products; CLEAR TECH pouch laminators; IMAGE SERIES large format laminators; CLEAR GUARD protective adhesive film; THERMASHIELD laminating film, and X-ACTO board cutter, self healing mats, hobby rulers and rotary cutters. The acquisition of the Graphic Arts Group from Bunzl plc during fiscal 1990 has significantly expanded the number of the Company's mounting and laminating products and enhanced the Company's position in the framing and photomounting markets. In 1993, the Company acquired IMAGE TECHNOLOGIES, Inc., a start-up company engaged in the development and production of large format laminators, which has allowed the Company to broaden its distribution into the digital imaging market. BIENFANG foam board has been particularly important, as it has allowed the Company to penetrate the picture framing and sign and display exhibit markets, yet it also holds wide appeal to the traditional customer groups in art supply and hobby\/craft markets. The success of foam board has been attributable, in significant part, to the Company's ability to offer the end-user a variety of value-added foam board products, such as colored or adhesive coated foam board.\nTraditionally, the Company's art\/craft products have been distributed primarily through wholesalers (framing, photomounting, art and hobby), dealers (specialized art supply and hobby\/craft stores), general consumer-oriented retail outlets (primarily office product superstores and chain stores), industrial concerns (photo labs, screen printers) and through specialized school supply distributors. Over the last several years, consumer-oriented retail outlets have become an increasingly important distribution channel for the Company's art\/craft products.\nSales and Marketing\nGeneral\nThe Company has over 15,000 active customers, the ten largest of which (three being office product superstore chains) accounted for approximately 37% of its sales in fiscal 1993. The largest single customer accounted for approximately 7% of sales for that year. There is a continuing trend toward consolidation of wholesalers, dealers and superstores, resulting in an increasing percentage of the Company's sales being attributable to a smaller number of customers. See Item 7 of this report.\nBecause most of the Company's sales are made from inventory, the Company customarily operates without a material backlog. The Company's sales generally are not subject to significant seasonal fluctuations. See Note 14 to Consolidated Financial Statements herein.\nDomestic Operations\nDomestic marketing of the Company's office products and art\/craft products is effected principally through six separate sales forces, one each for office products, furniture, computer accessory products, art\/craft products, photomounting and mass market. The combined sales forces are comprised of over 30 Company salespeople and over 300 independent manufacturers' representatives.\nThe Company maintains domestic distribution centers in Florence, Kentucky; Florence, Alabama; and Laredo, Texas, for office products; Naugatuck, Connecticut; and Cottage Grove, Wisconsin, for art\/craft products; and in Statesville, North Carolina, for both office and art\/craft products.\nForeign Operations\nThe Company distributes its products in more than 60 foreign markets through its own sales force of seven area sales managers and 18 salespersons, and through over 40 independent sales agents and over 150 distributors.\nSales of office products and art\/craft products represented approximately 47% and 53%, respectively, of the Company's export sales in fiscal 1993, with electrical and mechanical pencil sharpeners, paper punches, staplers, X-ACTO brand knives and blades, BIENFANG paper and foam board products and pressure sensitive and dry mount adhesive products accounting for the major portion of these sales. Sales from foreign operations were attributable to the Graphic Arts Group acquired in 1990 and included mounting and laminating products, as well as specialty tapes and films. See Note 15 to Consolidated Financial Statements herein for further information concerning the Company's foreign operations.\nThe Company maintains distribution centers in Ontario, Canada; Basildon, England; and in Kornwestheim, Germany.\nForeign operations are subject to the usual risks of doing business abroad, particularly currency fluctuations and foreign exchange controls. See also Note 1 to Consolidated Financial Statements herein for information concerning hedging.\nManufacturing and Production\nThe Company's operations include manufacturing and converting of products, as well as purchasing and assembly of various component parts. Excluding products for which it acts as a distributor, the vast majority of the Company's sales are of products which are either manufactured, converted or assembled by it. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company presently maintains its principal executive offices at 230 South Broad Street, Philadelphia, PA 19102 in approximately 35,000 square feet of leased space under a lease expiring in 1994.\nThe following table sets forth information with respect to certain of the other facilities of the Company:\n(1) During fiscal 1992, the Company transferred the manufacturing (but not the warehouse and distribution) function of this facility to Florence, Kentucky, in connection with the relocation and consolidation of its LIT-NING operations. See Note 2 to Consolidated Financial Statements herein for additional information. Recently, the Company decided to transfer the remaining warehouse and distribution function of this facility to Florence, Kentucky, during fiscal 1994.\n(2) The construction and expansion of this facility was financed by the issuance of industrial revenue bonds by the City of Florence, Kentucky. The City retains title to the property and leases it to the Company for rental payments equal to principal and interest payments on the bonds. The Company has the option, subject to certain conditions, to purchase the property. During fiscal 1989 two of the three bond issues relating to this financing matured. The third bond issue matured in fiscal 1993. In each instance, the Company exercised its option to continue to lease from the City, at a nominal consideration, the properties associated with the respective bond issues for a period of ten years. See Notes 6 and 11 to Consolidated Financial Statements herein for information concerning indebtedness and capital lease obligations relating to various of the Company's facilities.\n(3) A portion of this facility was financed by the issuance of industrial revenue bonds by the City of Florence, Alabama, which are collateralized by a plant facility and certain equipment.\n(4) A portion of this facility was financed by the issuance of industrial revenue bonds by the Iredell County Industrial Facilities and Pollution Control Financing Authority. The Authority retains title to the property and leases it to the Company for rental payments equal to principal and interest payments on the bonds. The Company has the option, subject to certain conditions, to purchase the property.\nAt present, the Company's facilities generally are believed to be adequately utilized and suitable for the Company's present needs, except for one warehouse facility that has excess capacity which the Company has successfully subleased.\nItem 3.","section_3":"Item 3. Pending Legal Proceedings\nThere currently are no material pending legal proceedings (within the meaning of the Form 10-K Instructions), other than routine litigation incidental to the business of the Company, to which the Company is a party or to which any of its property is subject. See Note 11 to Consolidated Financial Statements herein and Item 1 - - \"Environmental Matters\" herein.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of the security holders of the Company during the fourth quarter of the fiscal year covered by this report.\nAdditional Information\nThe following information is furnished in this Part I pursuant to Instruction 3 to Item 401(b) of Regulation S-K:\nExecutive Officers of the Company\nName Age Position ---- --- -------- Ronald J. Naples 48 Chairman of the Board and Chief Executive Officer\nRobert B. Fritsch 62 President and Chief Operating Officer\nJohn W. Carney 50 Vice President, Human Resources\nWilliam E. Chandler 50 Senior Vice President, Finance (Chief Financial Officer), and Secretary\nRoy M. Delizia 50 Vice President, Corporate Planning and Development\nSpencer W. O'Meara 47 Vice President and General Manager\nW. Ernest Precious 52 Vice President and General Manager\nRobert K. Scribner 47 Vice President and General Manager\nEugene A. Stiefel 46 Vice President, Information Services\nThe executive officers of the Company customarily are elected annually by the Board of Directors to serve, at the pleasure of the Board, for a period of one year or until their successors are elected. All of the executive officers of the Company, except for Messrs. Chandler, Scribner, Delizia and Stiefel have served in varying executive capacities with the Company for over five years.\nMr. Chandler was elected an executive officer of the Company in February 1993. He joined the Company in September 1992 after three years at Bally Manufacturing Corporation during which he held positions as Acting Chief Financial Officer and Vice President, Financial Operations and Controller. Prior to that, he served for three years at Household Manufacturing, Inc. as Senior Vice President of Finance, Treasurer and Chief Financial Officer.\nMr. Scribner was elected an executive officer of the Company in December 1990. He joined the Company in December 1986 as Vice President, Sales and Marketing, Office Products.\nMessrs. Delizia and Stiefel were elected executive officers of the Company in April 1993. Mr. Delizia joined the Company in October 1983 and has served as Vice President, Corporate Development and Planning since 1987. Mr. Stiefel joined the Company in February 1985 and has served as Vice President, Information Services since 1987.\n------------------------------------------\nFor the purposes of calculating the aggregate market value of the shares of common stock of the Company held by nonaffiliates, as shown on the cover page of this report, it has been assumed that all the outstanding shares were held by nonaffiliates except for the shares held by directors and officers of the Company. However, this should not be deemed to constitute an admission that all directors and officers of the Company are, in fact, affiliates of the Company, or that there are not other persons who may be deemed to be affiliates of the Company. Further information concerning shareholdings of officers, directors and principal shareholders is included in the Company's definitive proxy statement filed or to be filed with the Securities and Exchange Commission.\n-----------------------------------------\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\n(a) The Company's common stock is traded on the New York Stock Exchange (trading symbol \"HUN\"). The following table sets forth the high and low quarterly sales prices of the Company's common stock during the two most recent fiscal years (all as reported by The Wall Street Journal):\nFiscal Quarter -------------------------------------------- First Second Third Fourth ----- ------ ----- ------ High $15 1\/4 $16 1\/4 $16 1\/4 $16 3\/8 Low 12 3\/4 13 5\/8 13 1\/4 15 1\/4\nFiscal Quarter -------------------------------------------- First Second Third Fourth ----- ------ ----- ------ High $17 1\/8 $16 7\/8 $16 1\/8 $14 3\/8 Low 13 5\/8 14 1\/8 12 1\/4 11 1\/4\nSee Note 10 to Consolidated Financial Statements herein for information concerning certain Rights which were distributed by the Company to shareholders in 1990 and which currently are deemed to be attached to the Company's common stock.\n(b) As of February 1, 1994, there were approximately 1,200 record holders of the Company's common stock, which number does not include shareholders whose shares were held in nominee name.\n(c) During the past two fiscal years, the Company has paid regular quarterly cash dividends on its common stock at the following rates per share: 1993 - $.0875 per quarter and 1992 - $.085 per quarter.\nCertain of the Company's credit agreements contain restrictions on the Company's present and future ability to pay dividends. See Note 6 to Consolidated Financial Statements herein.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table contains selected financial data for each of the Company's last five fiscal years. This data should be read in conjunction with the Company's Consolidated Financial Statements (and related notes) appearing elsewhere in this report and with Item 7","section_7":"Item 7 of this report.\nYear Ended -------------------------------------------------------- Nov. 28, Nov. 29, Dec. 1, Dec. 2, Dec. 3, 1993 1992 1991(1) 1990(2) 1989(3) ------- ------- ------- ------- ------- (In thousands, except per share data)\nNet Sales $256,150 $234,929 $228,622 $220,099 $203,444\nNet Income 14,928 13,302 9,586 12,011 18,804\nNet Income Per Share(4) .93 .83 .60 .75 1.17\nTotal Assets 156,317 144,170 151,824 154,361 127,947\nLong-Term Debt 3,003 6,160 17,271 26,498 9,674\nCash Dividends Per Share(4) .35 .34 .32 .31 .27\n- ----------------------- (1) In the fourth quarter of fiscal 1991, the Company recorded a charge to net income of approximately $2.7 million, or $.17 per share, for anticipated costs relating to the relocation and consolidation of certain manufacturing and distribution operations. See Note 2 to Consolidated Financial Statements herein.\n(2) The Company acquired the Graphic Arts Group from Bunzl plc on May 4, 1990. In addition, in the fourth quarter of fiscal 1990, the Company recorded a charge to net income of approximately $1 million, or $.06 per share, relating to the discontinuance of certain products.\n(3) The Company acquired the Data Products Division of Amaray International Corporation on June 23, 1989.\n(4) Adjusted for stock splits.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFinancial Condition\nThe Company improved its already strong financial condition in fiscal 1993, with net cash flow provided by operating activities increasing to $23.2 million from $20.4 million and $19.9 million in fiscal 1992 and 1991, respectively. These fiscal 1993 net cash flows were more than sufficient to fund additions to property, plant and equipment of $10.3 million, to pay cash dividends of $5.6 million and to reduce debt by $1.2 million. The percentage of debt to equity was reduced to 5.3% at the end of fiscal 1993 from 6.9% and 18.1% at the end of fiscal 1992 and 1991, respectively.\nWorking capital increased to $47.1 million at November 28, 1993 from $45.5 million at November 29, 1992 as a net result of an $8.5 million increase in current assets, partially offset by a $6.9 million increase in current liabilities. The increase in current assets was primarily due to a $4.8 million increase in cash and cash equivalents, as well as to a $3 million increase in inventories. Higher inventories were largely the result of new products introduced in fiscal 1993, as well as higher anticipated sales volume. Accounts receivable turnover improved in fiscal 1993, and the balance of past due accounts was reduced significantly. The increase in current liabilities was principally the result of higher accounts payable (up $2.8 million), accrued salaries, wages and commissions (up $2.0 million) and current portion of long-term debt balance (up $1.9 million). The accounts payable increase was due to timing of and payment for raw materials received near the end of the fiscal year. The increase in accrued salaries, wages and commissions was primarily due to higher management incentive compensation accrued for fiscal 1993.\nManagement expects that expenditures for additions to property, plant and equipment to increase capacity and productivity in fiscal 1994 will approximate the level expended for such purposes in fiscal 1993.\nThe Company currently has line-of-credit agreements with three banks providing for borrowing capacity totaling $45 million. There were no borrowings under these line-of-credit agreements at the end of fiscal 1993. Management believes that funds generated from operations combined with existing credit agreements are sufficient to meet currently anticipated working capital and other capital and financing requirements. If additional resources are needed, management believes that the Company could obtain funds at competitive costs.\nResults of Operations\nComparison of Fiscal 1993 vs. 1992\nNet Sales and Earnings. Net sales of $256.2 million for fiscal 1993 increased 9% from $234.9 million in fiscal 1992 due primarily to higher unit volume largely attributable to new products. Average selling prices decreased approximately 3% in fiscal 1993 from fiscal 1992 prices due to continuing competitive pressures discussed below and to foreign currency exchange rate changes of approximately 1%.\nOffice products sales increased 13% in fiscal 1993 to $142.5 million from $126.1 million in fiscal 1992. This increase was led by higher sales of office furniture products, which were up 18.7%, primarily due to broadened distribution for these products gained in fiscal 1993. Mechanical and electromechanical products sales grew by 12.4% in fiscal 1993 due, in large part, to higher sales of Boston brand products, and desktop accessory products were up 6.3% attributable principally to new products, particularly MediaMate brand computer-related accessories. Export sales of office products increased 5.2% in fiscal 1993 largely as a result of higher sales in Canada.\nArt\/craft products sales of $113.7 million for fiscal 1993 increased 4.5% from fiscal 1992 sales of $108.8 million. This increase was the net result of higher sales of mounting and laminating products (up 8.3%) and hobby\/craft products (up 7.2%), partially offset by lower sales of art supplies (down 5.4%). The mounting and laminating sales increase was principally attributable to higher sales of Seal brand laminating equipment. The hobby\/craft products sales increase was largely due to higher sales of X-Acto brand knife and tool kits. The decrease in sales of art supplies was attributable primarily to lower sales of Bienfang brand art paper products. Export sales of art\/craft products were essentially unchanged in fiscal 1993, and foreign sales decreased 11.3% primarily due to a decrease in the value of the British pound sterling. Excluding the effect of exchange rate changes, foreign sales increased 3.2% in fiscal 1993.\nNet income of $14.9 million for fiscal 1993 grew 12.2% from fiscal 1992 net income of $13.3 million, and earnings per share increased to $.93 in fiscal 1993 from $.83 reported for fiscal 1992. Higher sales volume and lower interest expense were significant factors leading to the earnings increase.\nIn December 1993 the Company was selected by Schwan-STABILO, a prominent manufacturer based in Germany, to be the exclusive distributor in the U. S. of its STABILO(R) BOSS(R) fluorescent highlighting markers and a wide range of other products for the office, art and graphics markets. The purchase of inventories and commencement of distribution is expected to take place at the end of the first quarter of fiscal 1994.\nGross Profit. The Company's gross profit margin decreased to 40.1% of net sales in fiscal 1993 from 40.7% in 1992. The domestic gross profit margin decreased to 40.3% from 41%, and the foreign gross profit margin decreased to 26.7% from 28.6% in 1993 and 1992, respectively. The overall decrease was attributable to lower selling prices which were largely offset by lower raw material costs, the favorable effect of higher sales volume leveraging relatively fixed manufacturing overhead costs and lower employee fringe benefit expenses. Management expects the pressure on selling prices to continue due to the competitive environment for many of the Company's products, and also expects upward pressure on costs for certain raw material commodities, such as wood and steel, due to market conditions. Management plans to continue to seek productivity and operating process improvements and further cost reductions for other materials to offset these pressures.\nSelling, Shipping, Administrative and General Expenses. Selling and shipping expenses, as a percentage of net sales, were reduced to 20.6% in fiscal 1993 from 21.1% in fiscal 1992 primarily as a result of lower sales force commission expenses due, in part, to changes in customer sales mix.\nAdministrative and general expenses increased to $25.4 million in fiscal 1993 from $23.1 million in fiscal 1992 primarily as a result of higher management incentive compensation expenses and higher management consulting fees.\nInterest Expense. Interest expense was reduced to $.2 million in fiscal 1993 from $1.1 million in fiscal 1992 due principally to debt reduction at the end of fiscal 1992 and in fiscal 1993, as well as to an increase in capitalized interest in fiscal 1993 related to additions to property, plant and equipment.\nProvision for Income Taxes. The Company's effective tax rate decreased to 37.9% in fiscal 1993 from 38.4% in fiscal 1992 as a net result of losses incurred by the European operations in fiscal 1992 which did not generate offsetting tax benefits, partially offset by an increase in the U. S. statutory corporate tax rate in fiscal 1993 from 34% to 35% retroactive to January 1, 1993.\nEnvironmental Matters. The Company is involved on a continuing basis in monitoring its compliance with environmental laws and in making capital and operating improvements necessary to comply with existing and anticipated environmental requirements. Despite its efforts, the Company has been cited for occasional violations or alleged violations of environmental laws or permits. Expenses incurred by the Company to date relating to violations of and compliance with environmental laws and permits have not been material. While it is impossible to predict with certainty, management currently does not foresee such expenses in the future as having a material effect on the Company's business, results of operations or financial condition (see Note 11 of the Notes to Consolidated Financial Statements).\nComparison of Fiscal 1992 vs. 1991\nNet Sales and Earnings. Net sales increased 2.8% to $234.9 million in fiscal 1992 from $228.6 million in fiscal 1991. This increase was largely the result of higher unit volume, as selling prices were essentially unchanged in fiscal 1992 from those in fiscal 1991.\nOffice products sales of $126.1 million for fiscal 1992 increased 5% from the $120.1 million for fiscal 1991. The increase was led by higher sales of mechanical and electro-mechanical products, which grew by 8.2%, while desktop accessory and office furniture products grew by 2%. The growth in sales of mechanical and electromechanical products was primarily due to higher sales of Boston brand products. Export sales of office products increased 5.8% in fiscal 1992.\nArt\/craft products sales of $108.8 million in fiscal 1992 were essentially unchanged from those in fiscal 1991 as a net result of higher sales of mounting and laminating products (up 2.6%), offset by lower sales of hobby\/craft products (down 5.1%) and art supplies (down 1.5%). The decrease in sales of hobby\/craft products was due, in large part, to lower sales of X-Acto brand knife and tool kits. Export sales of art\/craft products decreased 1.3% in fiscal 1992 and foreign sales decreased 7.2%. The foreign sales decrease was attributable, in significant part, to the unfavorable economic environment in the United Kingdom.\nNet income of $13.3 million and earnings per share of $.83 for fiscal 1992 increased by more than 38% from net income of $9.6 million, or $.60 per share for fiscal 1991. The 1991 results included an after-tax provision of $2.7 million, or $.17 per share, for the relocation and consolidation of the Company's Lit-Ning office products operations in California and distribution operations in the United Kingdom. Excluding this provision, net income and earnings per share increased approximately 8% in fiscal 1992 on a comparable basis with fiscal 1991 results.\nGross Profit. The Company's gross profit was 40.7% of net sales in fiscal 1992, which approximated the fiscal 1991 percentage. This was largely the net result of higher gross profit percentages generated by the Company's foreign operations, partially offset by lower gross profit percentages for the domestic operations. The gross profit percentage increase for the Company's foreign operations, which improved to 28.6% in fiscal 1992 from 21.1% in fiscal 1991, was due to a decrease in 1992 in write-offs of excess inventories incurred by the United Kingdom operations as compared to 1991. These higher write-offs, which depressed fiscal 1991 gross profits for the foreign operations, related principally to inventories of laminating equipment determined to be excess or obsolete. The gross profit percentage decrease for the U. S. operations, which declined to 41% in fiscal 1992 from 42.2% in fiscal 1991, was attributable to several factors, including higher raw material costs and employee fringe benefit expenses, particularly health care and workers' compensation insurance. These higher costs were not able to be offset by higher selling prices because of the competitive environment in the distribution channels for certain of the Company's products, particularly office products and certain mounting and laminating products.\nSelling, Shipping, Administrative and General Expenses. Selling and shipping expenses, as a percentage of net sales, increased to 21.1% in fiscal 1992 from 20.4% in fiscal 1991, largely due to higher sales promotional allowances, freight costs and new product development and packaging expenses.\nAdministrative and general expenses were reduced 1.7% in fiscal 1992 to $23.1 million from $23.5 million in fiscal 1991, which was principally attributable to lower consulting fees and reductions in management incentive compensation.\nInterest Expense. Interest expense was reduced to $1.1 million in fiscal 1992 from $2.1 million in fiscal 1991 due primarily to reduction of long-term debt at the end of fiscal 1991 and during fiscal 1992 and, to a lesser extent, to lower interest rates.\nProvision for Income Taxes. The Company's effective tax rate decreased to 38.4% in fiscal 1992 from 44% in fiscal 1991 attributable, in large part, to a reduction in losses incurred by the European operations which did not generate current offsetting tax benefits.\nNew Accounting Standards\nStatement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" will require the calculation of deferred income taxes using the asset and liability method, which includes a requirement for adjustment of deferred tax balances for income tax rate changes. Future years' net income will be subject to increased volatility depending upon the frequency of tax rate changes. The Company will adopt the provisions of SFAS No. 109 in the first quarter of fiscal 1994, and the cumulative effect of this change of accounting principle for income taxes is expected to increase fiscal 1994 earnings per share by approximately $.05.\nSFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pension,\" requires accrual accounting for all postretirement benefits other than pensions. When adopted in fiscal 1994, based on the Company's current fringe benefit policies, the requirements of SFAS No. 106 are expected to have no impact on the results of operations or financial condition of the Company.\nSFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" requires the accrual of postemployment benefits if the obligation is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment of the benefits is probable and the amount of the benefits can be reasonably estimated. When adopted in fiscal year 1995, the Company currently does not believe SFAS No. 112 will have a material effect on the results of its operations or financial condition.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial statements and supplementary financial information specified by this Item, together with the report of Coopers & Lybrand thereon, are presented following Item 14 of this report.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNot applicable.\nPART III\nIncorporated by Reference\nThe information called for by Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12 \"Security Ownership of Certain Beneficial Owners and Management\" and Item 13","section_13":"Item 13 \"Certain Relationships and Related Transactions\" is incorporated herein by reference to the Company's definitive proxy statement for its Annual Meeting of Shareholders scheduled to be held April 13, 1994, which definitive proxy statement is expected to be filed with the Commission not later than 120 days after the end of the fiscal year to which this report relates.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents Filed as a part of the Report\n1. Financial Statements: -------------------- Pages ------ Report of Independent Accountants\nConsolidated Statements of Income for the fiscal years 1993, 1992 and 1991\nConsolidated Balance Sheets, November 28, 1993 and November 29, 1992\nConsolidated Statements of Stockholders' Equity for the fiscal years 1993, 1992 and 1991\nConsolidated Statements of Cash Flows for the fiscal years 1993, 1992 and 1991\nNotes to Consolidated Financial -22 Statements\n2. Financial Statement Schedules: ----------------------------- II. Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other Than Related Parties for the fiscal years 1993, 1992, and 1991\nV. Property, Plant and Equip- ment for the fiscal years 1993, 1992 and 1991\nVI. Accumulated Depreciation and Amortization of Property, Plant and Equipment for the fiscal years 1993, 1992 and 1991\nVIII. Valuation and Qualifying Accounts for the fiscal years 1993, 1992 and 1991\nX. Supplementary Income State- ment Information for the fiscal years 1993, 1992 and 1991\nAll other schedules not listed above have been omitted, since they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto.\nIndividual financial statements of the Company have been omitted, since the Company is primarily an operating company and any subsidiary companies included in the consolidated financial statements are directly or indirectly wholly-owned and are not indebted to any person, other than the parent or the consolidated subsidiaries, in an amount which is material in relation to total consolidated assets at the date of the latest balance sheet filed, except indebtedness incurred in the ordinary course of business which is not overdue and which matures in one year.\n3. Exhibits:\n(3) Articles of incorporation and bylaws:\n(a) Restated Articles of Incorporation, as amended (composite) (incorp. by ref. to Ex. 4(a) to Reg. Stmt. No. 33-6359 on Form S-8).\n(b) By-laws, as amended (incorp. by ref. to Ex. 4(b) to fiscal 1990 Form 10-K).\n(4) Instruments, defining rights of security holders, including indentures:\n(a) Credit Agreement dated as of October 2, 1990, between the Company and The Chase Manhattan Bank, N.A. (incorporated by reference to Ex. 4.1 to third quarter fiscal 1990 Form 10-Q).\n(b) Credit Agreement dated as of October 2, 1990, between the Company and Mellon Bank (East) PSFS, N.A. (incorp. by ref. to Ex. 4.2 to third quarter fiscal 1990 Form 10-Q).\n(c) Credit Agreement dated as of October 2, 1990, between the Company and Philadelphia National Bank, incorporated as CoreStates Bank, N.A. (incorp. by ref. to Ex. 4.3 to third quarter fiscal 1990 Form 10-Q).\n(d) Rights Agreement dated as of August 8, 1990 (including as Exhibit A thereto the Designation of Powers, Preferences, Rights and Qualifications of Preferred Stock), between the Company and Mellon Bank (East), N.A., as original Rights Agent (incorp. by\nref. to Ex. 4.1 to August, 1990 Form 8-K) and Assignment and Assumption Agreement dated December 2, 1991, with American Stock Transfer and Trust Company, as successor Rights Agent (incorp. by ref. to Ex. 4(d) to fiscal 1991 Form 10-K).\nMiscellaneous long-term debt instruments and credit facility agreements of the Company, under which the underlying authorized debt is equal to less than 10% of the total assets of the Company and its subsidiaries on a consolidated basis, may not be filed as exhibits to this report. The Company agrees to furnish to the Commission, upon request, copies of any such unfiled instruments.*\n(10) Material contracts:\n(a) Lease Agreement dated June 1, 1979 between the Iredell County Industrial Facilities and Pollution Control Financing Authority and the Company (incorp. by ref. to Ex. 10(d) to fiscal 1988 Form 10-K).\n(b) 1978 Stock Option Plan, as amended, of the Company (incorp. by ref. to Ex. 28(a) to Reg. Stat. No. 33-25947 on Form S-8).**\n(c) 1983 Stock Option and Stock Grant Plan, as amended, of the Company (incorp. by. ref. to Ex. 10(c) to fiscal 1992 Form 10-K).**\n(d) 1993 Stock Option and Stock Grant Plan of the Company (incorp. by ref. to Ex. 10(d) to fiscal 1992 Form 10-K).**\n(e) 1988 Long-Term Incentive Compensation Plan of the Company (incorp. by ref. to Appendix to 1988 Proxy Statement).**\n(f) 1994 Non-Employee Directors' Stock Option Plan (filed herewith).**\n(g) Loan and Security Agreement dated January 31, 1984, as amended, between the Company and Ronald J. Naples (incorp. by ref. to Ex. 10(h) to fiscal 1988 Form 10-K).**\n(h) Loan and Security Agreement dated April 20, 1988 between the Company and Robert B. Fritsch (incorp. by ref. to Ex. 10(i) to fiscal 1988 Form 10-K).**\n(i) (1) Form of Change in Control Agreement between the Company and various officers of the Company (incorp. by ref. to Ex. 10(h) to fiscal 1992 Form 10-K) and (2) list of executive officers who are parties (filed herewith)**\n(j) Employment-Severance Agreement between the Company and William E. Chandler (filed herewith).**\n(k) (1) Supplemental Executive Benefits Plan of the Company, effective April 16, 1992, and (2) related Amended and Restated Trust Agreement, effective February 17, 1993 (incorp. by ref. to Ex. 10(j) to fiscal 1992 Form 10-K).**\n(l) Master Agreement dated May 3, 1990 between the Company and Bunzl Public Limited Company (incorp. by ref. to Ex. 2(a) to May 1990 Form 8-K).\n(m) Stock Acquisition Agreement dated May 3, 1990 between Seal Purchase Corp. and Bunzl Graphic Arts, Inc. relating to Seal (incorp. by ref. to Ex 2(b) to May 1990 Form 8-K).\n(11) Statement re: computation of per share earnings (filed herewith).\n(21) Subsidiaries (filed herewith).\n(23) Consent of Coopers & Lybrand to incorporation by reference, in Registration Statement No.s 33-70660, 33-25947, 33-6359 and 2-83144 on Form S-8, of their report on the consolidated financial statements and schedules included in this report (filed herewith).\n- --------------- * Reference also is made to (i) Articles 5th, 6th, 7th and 8th of the Company's composite Articles of Incorporation (Ex. 3(a) to this report), and (ii) to Sections 1, 7 and 8 of the Company's By-laws (Ex. 3 (b) to this report).\n** Indicates a management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K\nThe Company did not file any reports on Form 8-K during the last quarter of the fiscal year covered by this report.\n---------------------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Stockholders and the Board of Directors of Hunt Manufacturing Co.:\nWe have audited the accompanying consolidated financial statements and the financial statement schedules of Hunt Manufacturing Co. and Subsidiaries as listed in the index on pages 22 and 23 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hunt Manufacturing Co. and Subsidiaries as of November 28, 1993 and November 29, 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended November 28, 1993 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND\n2400 Eleven Penn Center Philadelphia, Pennsylvania January 17, 1994\nHUNT MANUFACTURING CO. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME for the fiscal years 1993, 1992 and 1991 (In thousands except per share amounts)\n1993 1992 1991 -------- -------- --------\nNet sales $256,150 $234,929 $228,622\nCost of sales 153,353 139,366 135,887 -------- -------- --------\nGross profit 102,797 95,563 92,735\nSelling and shipping expenses 52,831 49,605 46,560 Administrative and general expenses 25,405 23,064 23,466 Provision for relocation and consolidation of operations - - 3,644 -------- -------- --------\nIncome from operations 24,561 22,894 19,065\nInterest expense (less $283, $50 and $121 capitalized in 1993, 1992 and 1991, respectively) (242) (1,073) (2,098)\nInterest income 190 422 630\nOther expense, net (471) (634) (479) --------- -------- ---------\nIncome before income taxes 24,038 21,609 17,118\nProvision for income taxes 9,110 8,307 7,532 --------- -------- --------\nNet Income $ 14,928 $ 13,302 $ 9,586 ========= ======== ========\nAverage shares of common stock outstanding 16,107 16,104 16,080 ========= ======== ========\nEarnings per common share $ .93 $ .83 $ .60 ========= ======== ========\nSee accompanying notes to consolidated financial statements.\nHUNT MANUFACTURING CO. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS November 28, 1993 and November 29, 1992 (In thousands except share and per share amounts)\nSee accompanying notes to consolidated financial statements.\nHUNT MANUFACTURING CO. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY for the fiscal years 1993, 1992 and 1991 (in thousands except share and per share amounts)\nSee accompanying notes to consolidated financial statements.\nHUNT MANUFACTURING CO. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the fiscal years 1993, 1992 and 1991 (in thousands)\nSee accompanying notes to consolidated financial statements.\nHUNT MANUFACTURING CO. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share and per share amounts)\n1. Summary of Significant Accounting Policies: ------------------------------------------ Basis of Consolidation: ---------------------- The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned.\nFiscal Year: ----------- The Company's fiscal year ends on the Sunday nearest the end of November. Fiscal year 1993 ended November 28, 1993; fiscal year 1992 ended November 29, 1992; and fiscal year 1991 ended December 1, 1991. All three fiscal years are comprised of 52 weeks.\nCash Equivalents: ---------------- The Company considers all highly liquid temporary cash investments purchased with a maturity of three months or less to be cash equivalents.\nInventories: ----------- Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for approximately half of the inventories and by the first-in, first-out (FIFO) method for the remainder. The Company uses the FIFO method of inventory valuation for certain acquired businesses because the related products and operations are separate and distinct from the Company's other businesses.\nProperty, Plant and Equipment: ----------------------------- Expenditures for additions and improvements to property, plant and equipment are capitalized, and normal repairs and maintenance are charged to expense as incurred. The related cost and accumulated depreciation of depreciable assets disposed of are eliminated from the accounts, and any profit or loss is reflected in other expense, net.\nExcess of Acquisition Cost Over Net Assets Acquired: --------------------------------------------------- Excess of acquisition cost over net assets acquired relates principally to the Company's acquisitions of X-Acto (1981), Bevis Custom Tables, Inc. (1985), and the Graphic Arts Group of Bunzl plc (1990) and is amortized on a straight-line basis over periods ranging from 20 to 40 years. The Company's policy is to record an impairment loss against the net unamortized excess of acquisition cost over net assets acquired in the period when it is determined that the carrying amount of the net assets may not be recoverable. This determination includes evaluation of factors such as current market value, future asset utilization, business climate and future cash flows expected to result from the use of the net assets.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n1. Summary of Significant Accounting Policies, continued: ------------------------------------------- Depreciation and Amortization: ----------------------------- Depreciation for financial reporting purposes is computed by the straight- line method. Depreciation for tax purposes is computed principally using accelerated methods. The costs of intangible assets are amortized on a straight-line basis over their respective estimated useful lives, ranging from five to thirty years. Amortization of assets under capital leases which contain purchase options is provided over the assets' useful lives. Other capital leases are amortized over the terms of the related leases or asset lives, if shorter.\nCurrency Translation: -------------------- The assets and liabilities of subsidiaries having a functional currency other than the U.S. dollar are translated at the fiscal year-end exchange rate, while elements of the income statement are translated at the weighted average exchange rate for the fiscal year. The cumulative translation adjustment is recorded as a separate component of stockholders' equity. Gains and losses on foreign currency transactions are included in the determination of net income as other expense, net. Such gains and losses are not material for any of the years presented.\nIncome Taxes: ------------ Taxes on income are calculated under the deferred method pursuant to Accounting Principles Board Opinion No. 11. Generally, the deferred method recognizes income taxes on financial statement income, and the tax effect of differences between financial income and taxable income is deferred at tax rates in effect during the period. Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" will require the calculation of deferred income taxes using the asset and liability method, which includes a requirement for adjustment of deferred tax balances for income tax rate changes. Future years' net income will be subject to increased volatility depending upon the frequency of tax rate changes. The Company will adopt the provisions of SFAS No. 109 in the first quarter of fiscal 1994, and the cumulative effect of this change of accounting principle for income taxes is expected to increase fiscal 1994 earnings per share by approximately $.05.\nHedging: ------- The Company enters into forward exchange contracts to hedge foreign currency transactions on a continuing basis for periods generally consistent with its committed exposure. Cash flows from hedges are classified in the statement of cash flows in the same category as the item being hedged.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n1. Summary of Significant Accounting Policies, continued: -------------------------------------------- Earnings Per Share: ------------------ Earnings per share are calculated based on the weighted average number of common shares outstanding. The effect of outstanding stock options and stock grants is not material and has not been included in the calculation.\nEmployee Benefit Plans: ---------------------- The Company and its subsidiaries have non-contributory, defined benefit pension plans covering the majority of their employees. It is the Company's policy to fund pension contributions in accordance with the requirements of the Employee Retirement Income Security Act of 1974. The benefit formula used to determine pension costs is the final-average-pay method.\nSFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" requires accrual accounting for all postretirement benefits other than pensions. When adopted in fiscal year 1994, based on the Company's current fringe benefit policies, the requirements of SFAS No. 106 are expected to have no impact on the results of operations or financial condition of the Company.\nSFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" requires the accrual of postemployment benefits if the obligation is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment of the benefits is probable and the amount of the benefits can be reasonably estimated. When adopted in fiscal year 1995, the Company currently does not believe SFAS No. 112 will have a material effect on the results of its operations or financial condition.\n2. Provision for Relocation and Consolidation of Operations: -------------------------------------------------------- In the fourth quarter of fiscal year 1991, the Company recorded a provision of $3.6 million (approximately $2.7 million after income taxes, or $.17 per share) relating to the Company's decision to relocate and consolidate certain operations. The pre-tax charge was comprised of a $2.7 million provision for anticipated costs relating to the relocation and consolidation of a Lit-Ning office products operation in California and a $.9 million provision for the relocation and consolidation of distribution operations in the United Kingdom. The provision included recognition of future lease obligations, write-off of property, plant and equipment, relocation costs, employee severance costs and other related costs.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n3. Inventories: ----------- The classification of inventories at the end of fiscal years 1993 and 1992 is as follows: 1993 1992 ---- ---- Finished goods $13,094 $11,554 Work in process 5,289 4,463 Raw materials 9,577 8,990 ------- ------- $27,960 $25,007 ======= =======\nInventories determined under the LIFO method were $13,299 and $13,120 at November 28, 1993 and November 29, 1992, respectively. The current replacement cost for these inventories exceeded the LIFO cost by $5,569 and $6,237 at November 28, 1993 and November 29, 1992, respectively.\nInventory reductions in fiscal years 1993 and 1992 resulted in a liquidation of certain LIFO inventories carried at lower costs prevailing in prior years. The effect of these reductions was to increase net income by $101, or $.01 per share, and $262, or $.02 per share, in fiscal years 1993 and 1992, respectively.\n4. Property, Plant and Equipment: ----------------------------- Property, plant and equipment at the end of fiscal years 1993 and 1992 is as follows: 1993 1992 ---- ---- Land and land improvements $ 3,698 $ 3,701 Buildings 17,434 16,779 Machinery and equipment 61,718 58,242 Leasehold improvements 661 706 Construction in progress 5,439 2,412 ------- ------- 88,950 81,840 Less accumulated depreciation and amortization 42,333 39,185 ------- ------- $46,617 $42,655 ======= =======\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n5. Intangible Assets: ----------------- Intangible assets at the end of fiscal years 1993 and 1992 are as follows:\n1993 1992 ---- ---- Covenants not to compete $11,643 $11,545 Customer lists 1,510 1,510 Patents 1,533 1,528 Trademarks 1,400 1,411 Licensing agreements 1,154 1,154 Other 1,751 1,782 ------- ------- 18,991 18,930 Less accumulated amortization 9,026 7,756 ------- ------- $ 9,965 $11,174 ======= ======= 6. Debt: ---- Credit Agreements and Lines of Credit: ------------------------------------- At November 28, 1993, the Company had revolving credit agreements with three banks that provide for unsecured borrowings up to $45 million which expire October 2, 1995. There were no borrowings under these agreements at November 28, 1993. Amounts borrowed under these agreements would be converted to term loans upon expiration of the revolving credit termination dates. Principal payments would be made in quarterly installments beginning January 2, 1996 through October 2, 1999. Interest on borrowings under these agreements are at varying rates based, at the Company's option, on the banks' prime rate, certificate of deposit rate, or money market rate, the London Interbank Offering Rate, or the as offered rate. None of these agreements have compensating balance requirements. Commitment fees of 1\/8 of 1% are payable under these agreements.\nLong-Term Debt: -------------- Long-term debt at the end of fiscal years 1993 and 1992 is as follows:\n1993 1992 ---- ---- Term loan (a) $1,875 $2,813 Capitalized lease obligations (see Note 11) 2,000 2,100 Industrial development revenue bonds (b) 1,559 1,559 Industrial development revenue bonds (c) 700 820 Other 27 78 ------ ------ 6,161 7,370 Less current portion 3,158 1,210 ------ ------ $3,003 $6,160 ====== ======\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\nDebt, continued: ---- (a) The principal of this term loan is payable in equal quarterly installments of $234.4 through September 29, 1995. Interest on the borrowing is payable quarterly at a rate of 10.93% per annum on the outstanding principal amount of the loan.\n(b) These bonds bear interest (3.9% at November 28, 1993) at 65% of the lending bank's average daily prime rate and are payable on June 15, 1994.\n(c) These bonds bear interest (4.536% at November 28, 1993) at 75.6% of the lending bank's average daily prime rate. One bond with a principal balance of $575 at November 28, 1993 is payable on May 1, 1994. The other bond with a principal balance of $125 is payable in semiannual installments of $60 on November 1, 1994 and May 1, 1995 and one payment of $5 on November 1, 1995. Both bonds are collateralized by a plant facility and certain equipment.\nThe terms of certain financing agreements contain, among other provisions, requirements for maintaining certain working capital and other financial ratios, and restrictions on incurring additional indebtedness and obligate the Company to equally and ratably collateralize the indebtedness undersuch agreements if the Company grants or assumes certain liens on its assets. Under the most restrictive covenants, dividends and purchases of capital stock of the Company may not exceed, on a cumulative basis, 75% of the cumulative net income of the Company at any time during the period beginning November 28, 1983. As of November 28, 1993, $46 million was available to the Company under this provision for future cash dividends and future purchases of its own capital stock. In addition, as of November 28, 1993, the Company exceeded its minimum tangible net worth requirement of $59 million by $30.2 million.\nThe capitalized lease obligations are collateralized by the property, plant and equipment described in Note 11.\nAggregate annual maturities for all long-term debt, including the capitalized leases, for each of the four fiscal years subsequent to November 27, 1994 are as follows:\n1995 - $1,353 1996 - 370 1997 - 400 1998 - 425 7. Income Taxes: ------------ Income before provision for income taxes consists of the following:\n1993 1992 1991 ---- ---- ---- Domestic $21,758 $20,341 $16,982 Foreign 2,280 1,268 136 ------- ------- ------- $24,038 $21,609 $17,118 ======= ======= =======\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n7. Income Taxes, continued: ------------ The provision for income taxes consists of the following: 1993 1992 1991 ---- ---- ---- Currently payable: Federal $8,406 $6,694 $7,162 State 877 815 800 Foreign 283 159 221 ------ ------ ------ 9,566 7,668 8,183 Deferred (456) 639 (651) ------ ------ ------ $9,110 $8,307 $7,532 ====== ====== ====== Deferred income taxes relate to the following timing differences between amounts reported for financial accounting and income tax purposes: 1993 1992 1991 ---- ---- ---- Depreciation $ 53 $ 119 $ 197 Provision for relocation and consolidation of operations 61 622 (975) Other, net (570) (102) 127 ----- ----- ----- $(456) $ 639 $(651) ===== ===== =====\nThe following is a reconciliation of the statutory federal income tax rate with the Company's effective income tax rate: 1993 1992 1991 ---- ---- ---- Statutory federal rate 34.9% 34.0% 34.0% State income taxes, net of federal tax benefit 2.2 2.6 2.5 Losses of foreign subsidiaries with no current offsetting tax benefit (including a provision for relocation and consolidation of foreign operations of 1.8% in 1991) - 1.0 6.0 Other, net .8 .8 1.5 ---- ---- ---- Effective tax rate 37.9% 38.4% 44.0% ==== ==== ==== As of November 28, 1993, the Company had a foreign net operating loss carry-forward for financial reporting purposes of approximately $3.5 million, the benefit of which has not been reflected in the financial statements. For tax return purposes, the Company has available approximately $2.4 million of foreign tax operating loss carryforwards which may be carried forward indefinitely, approximately $1 million of which were acquired in connection with business acquisitions. The use of foreign tax operating loss carryforwards acquired in connection with business acquisitions is subject to approval by the foreign taxing authorities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n8. Employee Benefit Plans: ---------------------- Pension Plans: ------------- Net pension costs for fiscal years 1993, 1992 and 1991 consist of the following components: 1993 1992 1991 ---- ---- ---- Service cost-benefits earned during the period $1,580 $1,595 $1,379 Interest cost on projected benefit obligation 1,852 1,672 1,415 Actual return on plan assets (1,863) (1,692) (3,342)\nNet amortization and deferral 107 184 2,133 ------ ------ ------ Net pension costs $1,676 $1,759 $1,585 ====== ====== ====== Net amortization and deferral consists of the deferral of the excess of actual return on assets over estimated return and amortization of the net unrecognized transition asset on a straight-line basis, principally over 15 years.\nThe funded status of the Company's pension plans at September 30, 1993 and 1992 (dates of actuarial valuations) is as follows: ----------------------- Overfunded Underfunded 1992 ---------- ----------- ---- Plan assets at fair value $24,327 $ 660 $22,356 ------- ------- ------- Actuarial present value of benefit obligations: Vested 19,139 1,718 15,626 Non-vested 390 249 1,739 ------- ------- ------- Accumulated benefit obligation 19,529 1,967 17,365 Effect of increase in compensation 7,288 875 6,973 ------- ------- ------- Projected benefit obligation 26,817 2,842 24,338 ------- ------- ------- Projected benefit obligation in excess of plan assets (2,490) (2,182) (1,982) Unrecognized net loss 2,612 486 731 Unrecognized transition asset (1,890) (22) (2,127) Unrecognized prior service cost 857 1,218 2,255 ------- ------- ------- Pension liability $ (911) $ (500) $(1,123) ======= ======= ======= The increase in the projected benefit obligation in fiscal 1993 was due primarily to a decrease in the discount rate assumption. Plan assets consist principally of common stocks and U.S. Government Agency obligations. Pension costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year. Significant assumptions at year- end include:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n8. Employee Benefit Plans, continued: ---------------------- Pension Plans: ------------- 1993 1992 1991 ---- ---- ---- Discount rate 7.00% 7.75% 8.00% Rate of increase in compensation levels 6.00% 6.00% 6.00% Expected long-term rate of return on plan assets 7.50% 7.50% 7.50%\nSupplemental Executive Retirement Plan: -------------------------------------- In 1992 the Company instituted a nonqualified, Supplemental Executive Retirement Plan covering all officers. Expenses of $331 and $325 in fiscal years 1993 and 1992, respectively, relating to this plan were actuarially determined and are included in the pension costs described above.\nEmployee Savings Plan: --------------------- The Company has a defined contribution 401(k) plan available to all nonunion employees in the U.S. Contributions to the 401(k) plan by the Company were $379, $300 and $260 for fiscal years 1993, 1992 and 1991, respectively.\n9. Stock Options, Stock Grant, Long-Term Incentive Compensation and Bonus Plans: -------------------------------------- In 1993 the Company adopted with shareholders' approval the 1993 Stock Option and Stock Grant Plan, which is intended to replace the expired 1983 Stock Option and Stock Grant Plan. The 1993 plan authorized the issuance of up to 1,750,000 common shares, of which up to 525,000 common shares may be issued in the form of stock grants. The terms of the 1993 plan are essentially similar to the terms of the 1983 plan described below. No options were granted under this plan in fiscal year 1993.\nThe Company's 1983 Stock Option and Stock Grant Plan and the 1978 Stock Option Plan expired by their terms in February 1993 and November 1988, respectively, and, while incentive stock options granted under them remain outstanding, no further options may be granted under these plans.\nUnder the 1983 plan, common shares were authorized for the granting of incentive stock options, nonqualified stock options and stock grants to key employees, provided that stock grants may be made for no more than 373,125 common shares. The option price of options granted under the plan may not be less than the market value of the shares at the date granted. Options may be granted for terms of between two and ten years and generally become exercisable not less than one year following the date of grant. Stock grants under this plan are subject to a vesting period or periods of between one and five years from the date of grant. Common shares were not actually issued to a grantee until such shares have vested under the plan. The plan also provided for the payment of an annual cash bonus to recipients of stock grants in an amount equal to the cash dividends which would have been received had the shares not yet vested\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n9. Stock Options, Stock Grant, Long-Term Incentive Compensation and Bonus Plans, continued: -------------------------------------- under the grant been actually held by the recipients. During fiscal 1987, the Company made a stock grant in the amount of 22,500 common shares to a key employee. By its terms, this grant vested in four equal installments of 5,625 shares each on April 22 of each year through 1991. The charge to administrative and general expenses, including the cash bonus, with respect to stock grants under the plan amounted to $28 in fiscal year 1991.\nUnder the 1978 plan, options for 632,813 common shares were authorized for the granting of options to key employees at option prices not less than the market value of the common shares at the date of grant. Options granted under this plan have terms of not more than ten years and generally become exercisable not less than one year following the date of grant.\nPayment upon exercise of stock options under the 1993, 1983 and 1978 plans may be by cash and\/or by the Company's common stock in an amount equivalent to the market value of the stock at the date exercised.\nA summary of options under the Company's stock option plans is as follows:\n1983 Plan 1978 Plan --------------- ------------- 1993 1992 1993 1992 ---- ---- ---- ---- Outstanding, beginning of year 756,486 644,558 3,493 3,493 Options granted 148,200 132,850 - - Options exercised (at an average price per share of $10.47, $7.77 and $6.22, respectively) (102,282) (17,022) (855) - Options terminated (23,400) (3,900) - - ------- ------- ----- ----- Outstanding, end of year 779,004 756,486 2,638 3,493 ======= ======= ===== ===== Average option price per share $13.43 $13.21 $10.58 $9.52 Outstanding exercisable options 506,754 511,526 2,638 3,493\nShares reserved for future stock options and grants - 259,932 - -\nIn 1991 there were 22,429 and 2,193 options exercised at average prices of $8.52 and $6.22 relating to the 1983 and 1978 plans, respectively.\nThe Company's 1988 Long-Term Incentive Compensation Plan provides for the granting to management-level employees of long-term incentive awards, which are payable in cash and\/or by the Company's common stock at the end of a designated performance period of from two to five years, based upon the degree of attainment of pre-established performance standards during the performance period. A maximum of 180,000 shares are authorized for issuance under this plan. As of the end of fiscal 1993, an aggregate of 48,966 shares have been earned under this plan (13,394, 4,300 and 8,127\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n9. Stock Options, Stock Grant, Long-Term Incentive Compensation and Bonus Plans, continued: -------------------------------------- shares in 1993, 1992 and 1991, respectively, and 23,145 shares in all previous years), and an aggregate of 50,587 shares were subject to outstanding unvested grants. There is no stated limitation on the aggregate amount of cash payable under this plan, but the maximum amount (in cash and\/or shares) which may be paid to a participant under all long-term incentive awards under the plan with respect to the same performance period may not exceed 125% of the participant's base salary in effect at the time the award initially was made. The charge to administrative and general expenses relating to this plan was $563, $88 and $228 in fiscal years 1993, 1992 and 1991, respectively.\n10. Shareholders' Rights Plan: ------------------------- During fiscal 1990 the Company adopted a Shareholders' Rights Agreement and declared a dividend of one right (a \"Right\") for each outstanding share of the Company's common shares held of record as of the close of business on August 22, 1990. The Rights initially are deemed to be attached to the common stock and detach and become exercisable only if (with certain exceptions and limitations) a person or group attempts to obtain beneficial ownership of 15% or more of the Company's common shares or is determined to be an \"adverse person\" by the Board of Directors of the Company. Each Right, if and when it becomes exercisable, initially will entitle holders of the Company's common shares to purchase one one-thousandth of a share of Junior Participating Preferred Shares (Series A, of which 50,000 shares currently are authorized for issuance) for $60, subject to adjustment. The Rights will convert into the right to purchase common shares or other securities or property of the Company or an acquiring company in certain other potential or actual takeover situations. The Rights are redeemable by the Company at $.01 per Right in certain circumstances and expire, unless earlier exercised or redeemed, on December 31, 2000.\n11. Commitments and Contingencies: ----------------------------- Leases: ------ Capitalized lease obligations (see Note 6) represent amounts payable under leases which are, in substance, installment purchases. Property, plant and equipment includes the following assets under capital leases:\n1993 1992 ---- ---- Land $ 314 $ 314 Buildings 2,632 2,632 Machinery and equipment 1,009 1,009 Accumulated depreciation (2,639) (2,531) ------- ------- $ 1,316 $ 1,424 ======= ======= The Company has the option to purchase the above assets at any time during the term of the leases for amounts sufficient to redeem and retire the underlying lessor debt obligations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n11. Commitments and Contingencies, continued: ----------------------------- Leases, continued: ------ The minimum rental commitments under all noncancellable leases as of November 28, 1993 are as follows:\nFiscal Operating Capitalized Period Leases Leases ------ --------- ---------- 1994 $ 3,539 $ 150 1995 2,779 562 1996 1,809 480 1997 1,406 448 1998 1,325 491 Thereafter 7,163 489 ------- ----- Minimum lease payments $18,021 2,620 ======= ===== Less interest 620 Present value of ------ minimum lease payments $2,000 ====== Rent expense, including related real estate taxes charged to operations, amounted to $4,217, $4,076 and $4,047 for fiscal years 1993, 1992 and 1991, respectively.\nContingencies: ------------- The Company has employment\/severance (change in control) agreements with its officers, as well as a severance policy covering Company employees generally. Under such agreements and policy, severance payments and benefits would become payable in the event of specified terminations of employment following a change in control (as defined) of the Company. In the event of a change in control of the Company and subsequent termination of all employees, the maximum contingent severance liability would have been approximately $14.3 million at November 28, 1993.\nPrior to the acquisition of the Graphic Arts Group by the Company from Bunzl plc in May 1990, it was discovered that some hazardous waste materials had been stored on the premises of one of the Graphic Arts Group companies, Seal, located in Naugatuck, Connecticut. In compliance with applicable state law, this environmental condition was reported to the Connecticut Department of Environmental Protection by Bunzl. Seal, which is now a subsidiary of the Company, may be partially responsible under law for the environmental conditions on the premises and any liabilities resulting therefrom. However, in connection with the Company's acquisition of Seal, Bunzl agreed to take responsibility for correcting such environmental conditions and, for a period of seven years, to indemnify Seal and the Company for such resulting liabilities, subject to certain limitations. Management believes that this contingency will not have a material effect on the Company's results of operations or financial condition.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n11. Commitments and Contingencies, continued: ----------------------------- Contingencies, continued: ------------- The Company is also involved on a continuing basis in monitoring its compliance with environmental laws and in making capital and operating improvements necessary to comply with existing and anticipated environmental requirements. Despite its efforts, the Company has been cited for occasional violations or alleged violations of environmental laws or permits. Expenses incurred by the Company to date relating to violations of and compliance with environmental laws and permits have not been material. While it is impossible to predict with certainty, management currently does not foresee such expense in the future as having a material effect on the Company's business, results of operations or financial condition.\nThere are other contingent liabilities with respect to product warranties, legal proceedings and other matters occurring in the normal course of business. In the opinion of management, all such matters are adequately covered by insurance or by accruals, and if not so covered, are without merit or are of such kind, or involve such amounts, as would not have significant effect on the financial condition or results of operations of the Company, if disposed of unfavorably.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n12. Research and Development: ------------------------ Research and development expenses were approximately $1,657, $1,519, and $1,153 in fiscal years 1993, 1992 and 1991, respectively.\n13. Cash Flow Information: --------------------- Cash payments for interest and income taxes (net of refunds) were as follows: 1993 1992 1991 ---- ---- ---- Interest paid $ 580 $ 863 $1,889 Income taxes 8,761 5,987 7,170\n14. Quarterly Financial Data (unaudited): ------------------------------------ Results of operations for each of the quarters during fiscal years 1993 and 1992 are as follows: ---- First Second Third Fourth Total ----- ------ ----- ------ ----- Net sales $57,117 $60,825 $65,021 $73,187 $256,150 Gross profit 22,465 24,701 25,702 29,929 102,797 Net income 2,533 3,544 3,856 4,995 14,928 Net income per share .16 .22 .24 .31 .93\n---- First Second Third Fourth Total ----- ------ ----- ------ ----- Net sales $53,016 $56,982 $61,795 $63,136 $234,929 Gross profit 21,275 23,037 24,940 26,311 95,563 Net income 2,191 3,219 3,854 4,038 13,302 Net income per share .14 .20 .24 .25 .83\n15. Industry Segment Information: ---------------------------- The Company operates in two industry segments, Office Products and Art\/Craft Products. Total export sales aggregated $21,580 in fiscal 1993, $20,919 in fiscal 1992 and $20,534 in fiscal 1991 of which $11,619, $10,981 and $11,074 in fiscal years 1993, 1992 and 1991, respectively, were made in Canada.\nOperating profits include all revenues and expenses of the reportable segment except for general corporate expenses, interest expense, interest income, other expenses, other income and income taxes.\nIdentifiable assets are those assets used in the operations of each business segment. Corporate assets include cash and miscellaneous other assets not identifiable with any particular segment. Capital additions include amounts related to acquisitions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n15. Industry Segment Information, continued: ---------------------------- Office Art\/Craft Corp. Fiscal Year 1993 Products Products Assets Consolidated ---------------- -------- -------- ------ ------------ Net sales $142,462 $113,688 $256,150 ======== ======== ======== Operating profit $ 11,411 $ 18,832 $ 30,243 ======== ======== General corporate (5,682) Interest expense (242) Interest income 190 Other expense, net (471) Income before income -------- taxes $ 24,038 ======== Identifiable assets $ 74,098 $ 67,619 $ 14,600 $156,317 ======== ======== ======== ======== Capital additions $ 5,559 $ 4,082 $ 698 $ 10,339 ======== ======== ======== ======== Depreciation and amortization $ 3,898 $ 3,234 $ 532 $ 7,664 ======== ======== ======== ========\nOffice Art\/Craft Corp. Fiscal Year 1992 Products Products Assets Consolidated ---------------- -------- -------- ------ ------------ Net sales $126,101 $108,828 $234,929 ======== ======== ======== Operating profit $ 8,541 $ 18,516 $ 27,057 ======== ======== General corporate (4,163) Interest expense (1,073) Interest income 422 Other expense, net (634) Income before income -------- taxes $ 21,609 ======== Identifiable assets $ 69,894 $ 64,715 $ 9,561 $144,170 ======== ======== ======== ======== Capital additions $ 3,666 $ 1,813 $ 523 $ 6,002 ======== ======== ======== ======== Depreciation and amortization $ 3,552 $ 3,521 $ 485 $ 7,558 ======== ======== ======== ========\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n15. Industry Segment Information, continued: ---------------------------- Office Art\/Craft Corp. Fiscal Year 1991 Products Products Assets Consolidated ---------------- -------- -------- ------ ------------ Net sales $120,103 $108,519 $228,622 ======== ======== ======== Operating profit* $ 6,369 $ 17,618 $ 23,987 ======== ======== General corporate (4,922) Interest expense (2,098) Interest income 630 Other expense, net (479) Income before income -------- taxes $ 17,118 ======== Identifiable assets $ 71,960 $ 68,292 $11,572 $151,824 ======== ======== ======== ======== Capital additions $ 2,736 $ 1,875 $ 338 $ 4,949 ======== ======== ======== ======== Depreciation and amortization $ 3,528 $ 3,494 $ 445 $ 7,467 ======== ======== ======== ======== * Includes the provision for relocation and consolidation of operations which reduced the office products operating profit by $3.2 million and art\/craft products operating profit by $.4 million.\nThe Company's operations by geographical areas for fiscal years 1993, 1992 and 1991 are presented below. Intercompany sales to affiliates represent products which are transferred between geographic areas on a basis intended to reflect as nearly as possible the market value of the products. Intercompany sales between areas were not material in fiscal year 1991.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n15. Industry Segment Information, continued: ----------------------------\nFiscal Year 1991 North America Europe Corporate Consolidated ------------- ------ --------- ------------ Net sales $210,687 $17,935 $228,622 ======== ======= ======== Operating profit (loss)* $ 26,786 $(2,799) $ 23,987 ======== ======= ======== Identifiable assets $117,791 $22,461 $11,572 $151,824 ======== ======= ======= ======== * Includes the provision for relocation and consolidation of operations which reduced operating profit in North America by $2.7 million and in Europe by $.9 million.\n16. Financial Instruments: --------------------- Off-Balance Sheet Risk: ---------------------- The Company had $992 in forward exchange contracts outstanding as of November 28, 1993 to hedge accounts receivable denominated in Canadian dollars. No forward exchange contracts were outstanding as of November 29, 1992. The forward exchange contracts generally have maturities which do not exceed six months and require the Company to exchange Canadian dollars for U.S. dollars at maturity at rates agreed to at the inception of the contracts. Letters of credit are issued by the Company during the ordinary course of business through major domestic banks as required by certain vendor contracts. As of November 28, 1993 and November 29, 1992, the Company had outstanding letters of credit for $511 and $1,426, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands except share and per share amounts)\n16. Financial Instruments, continued: --------------------- Concentrations of Credit Risk: ----------------------------- Financial instruments which potentially subject the Company to concentration of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments ($7.3 million and $4.5 million at November 28, 1993 and November 29, 1992, respectively) with quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across many different industries and geographies. Generally, the Company does not require collateral or other security to support customer receivables.\nFair Value: ---------- The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and cash equivalents - ------------------------- The carrying amount approximates fair value because of the short maturity of these instruments.\nDebt (excluding capital lease obligations) - ------------------------------------------ The fair value of the Company's debt is estimated based on the current rates offered to the Company for debt of the same remaining maturities.\nForward exchange contracts - -------------------------- The fair value of forward exchange contracts (used for hedging purposes) approximates fair value because of the short maturity of these instruments.\nThe estimated fair values of the Company's financial instruments at November 28, 1993 are as follows:\nCarrying Fair Amount Value -------- ----- Cash and cash equivalents $10,778 $10,778 Debt (excluding capital lease obligations) 4,161 4,324 Forward exchange contracts 992 992\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nHUNT MANUFACTURING CO.\nDated: February 22, 1994 By: \/s\/ Ronald J. Naples -------------------------- Ronald J. Naples Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on behalf of the registrant and in the capacities and on the dates indicated:\n\/s\/ Ronald J. Naples - ------------------------------ February 22, 1994 Ronald J. Naples Chairman of the Board and Chief Executive Officer\n\/s\/ William E. Chandler - ------------------------------ February 22, 1994 William E. Chandler Senior Vice President, Finance (Principal Financial and Accounting Officer)\n\/s\/ Vincent G. Bell, Jr. - ------------------------------ February 22, 1994 Vincent G. Bell, Jr. Director\n\/s\/ Jack Farber - ------------------------------ February 22, 1994 Jack Farber Director\n\/s\/ Robert B. Fritsch - ------------------------------ February 22, 1994 Robert B. Fritsch Director\n\/s\/ William F. Hamilton, Ph.D. - ------------------------------ February 22, 1994 William F. Hamilton, Ph.D. Director\n\/s\/ Mary R. Henderson - ------------------------------ February 22, 1994 Mary R. (Nina) Henderson Director\n\/s\/ Gordon A. MacInnes, Jr. - ------------------------------ February 16, 1994 Gordon A. MacInnes, Jr. Director\n\/s\/ Wilson D. McElhinny - ------------------------------ Wilson D. McElhinny February 22, 1994 Director\n\/s\/ Robert H. Rock - ------------------------------ February 22, 1994 Robert H. Rock Director\n\/s\/ Roderic H. Ross - ------------------------------ February 22, 1994 Roderic H. Ross Director\n- ------------------------------ February , 1994 Victoria B. Vallely Director","section_15":""}
{"filename":"36204_1993.txt","cik":"36204","year":"1993","section_1":"Item 1 Description of Business\nGeneral First Commerce Corporation (FCC) is a multi-bank holding company with five wholly-owned bank subsidiaries in Louisiana: First National Bank of Commerce (FNBC) in New Orleans, City National Bank of Baton Rouge (CNB), Rapides Bank & Trust Company in Alexandria (RB&T), The First National Bank of Lafayette (FNBL) and The First National Bank of Lake Charles (FNBLC). Effective January 1, 1994, First Acadiana National Bancshares, Inc. (FANB), the parent company of First Acadiana National Bank was acquired by FCC for 1,290,145 shares of common stock. First Acadiana National Bank was merged with FNBL. The acquisition was accounted for as a pooling-of-interests. The five banks accounted for 99.3% of the assets of FCC at December 31, 1993 and substantially all of the net income for 1993. The banks offer customary services of banks of similar size and similar markets, including numerous types of interest- bearing and noninterest-bearing deposit accounts, commercial and installment loans, trust services, correspondent banking services and safe deposit facilities. For further discussion of FCC's operations, see the Financial Review section of FCC's 1993 Annual Report, which is incorporated by reference into Item 7 of this Annual Report on Form 10-K. During 1993, FCC or its bank subsidiaries owned seven bank- related subsidiaries: First Commerce Investment Services, Inc. (FCIS), Baronne Street Properties, Inc. (BSP), KNW, Ltd. (KNW), DLC, Ltd. (DLC), First Commerce Community Development Corporation (FCCDC), First Commerce Service Corporation (FCSC) and New Orleans Bancshares, Inc. (NOBS). FCIS is a discount brokerage subsidiary, which was organized under the rules of the Securities and Exchange Commission in 1985 and is a member of the National Association of Securities Dealers, Inc. (NASD). BSP is a 1% general partner and FNBC is a 99% limited partner in DLC and KNW, Louisiana Partnerships in Commendam, created to manage and sell foreclosed property. FCIS and BSP are both subsidiaries of FNBC. In 1992, FCCDC was organized as a Louisiana non-profit organization under the policy guidelines established by the OCC for community development corporations. First Commerce developed this corporation to assist low-to-moderate income individuals to buy homes. Each of the five subsidiary banks of FCC owns 20% of FCCDC's outstanding common stock. FCSC performs services such as audit, credit review, data processing, accounting, financial reporting and other services for all other subsidiaries of FCC. NOBS is an inactive company, organized in 1983 to hold the name \"New Orleans Bancshares.\"\nRegulation Like other bank holding companies in Louisiana, FCC is subject to regulation by the Louisiana Commissioner of Financial Institutions and the Federal Reserve Board. Under the terms of the Bank Holding Company Act of 1956 (the \"Act\"), as amended, FCC is restricted to only banking or bank-related activities specifically allowed by the Act or the Federal Reserve Board. The Act requires FCC to file required reports with the Federal Reserve Board. Each of FCC's subsidiary banks is a member of the Federal Reserve System and is subject to regulation by the Federal Reserve Board and the FDIC. The four national bank subsidiaries are also subject to regulation and supervision by the Comptroller of the Currency, while the state-chartered bank subsidiary is subject to regulation and supervision by the Louisiana Commissioner of Financial Institutions.\nPayment of Dividends The primary source of funds for the dividends paid by FCC to its stockholders and debt service obligations is the dividends it receives from the bank subsidiaries. The payment of dividends by FCC's national banks is regulated by the Comptroller of the Currency. The payment of dividends by FCC's state bank is regulated by the Louisiana Commissioner of Financial Institutions and the Federal Reserve Board. Prior approval must be obtained from the appropriate regulatory authorities before dividends can be paid if the amount of defined capital, surplus and retained earnings is below defined regulatory limits. Additionally, the bank subsidiaries may not pay dividends in excess of their retained net profits (net income less dividends for the current and prior two years) without prior regulatory approval. Under certain circumstances, regulatory authorities may prohibit the payment of dividends by a bank or its parent holding company. See Note 16 of Notes to Consolidated Financial Statements, which is incorporated by reference into Item 8 of this Annual Report on Form 10-K.\nBorrowings by the Company Federal law prohibits FCC from borrowing from its bank subsidiaries, unless the borrowings are secured by specified amounts and types of collateral. Additionally, such secured loans are generally limited to 10% of each subsidiary bank's capital and surplus and, in the aggregate with respect to FCC and all of its subsidiaries, to 20% of each subsidiary bank's capital and surplus. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nCompany Support of Bank Subsidiaries The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") contains a \"cross-guarantee\" provision which could result in any insured depository institution owned by FCC (i.e., any bank subsidiary) being assessed for losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other depository institution owned by FCC. In addition, under Federal Reserve Board policy, FCC is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each such bank in circumstances in which such bank might need such outside support. The Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"1991 Act\") provides, among other things, that undercapitalized institutions, as defined by regulatory authorities, must submit recapitalization plans, and a parent company of such an institution must either (i) guarantee the institution's compliance with the capital plan, up to an amount equal to the lesser of five percent of the institution's assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan, or (ii) suffer certain adverse consequences such as a prohibition of dividends by the parent company to its shareholders.\nAnnual Insurance Assessment FCC's bank subsidiaries are subject to deposit insurance assessment by the FDIC. These assessments have been rising in recent years and could increase still further in the future.\nPrompt Corrective Action The 1991 Act and implementing regulations classify banks into five categories generally relating to their regulatory capital ratios and institutes a system of supervisory actions indexed to particular classification. Generally, banks that are classified as \"well capitalized\" or \"adequately capitalized\" are not subject to the supervisory actions specified in the 1991 Act for prompt corrective action, but may be restricted from taking certain actions that would lower their classification. Banks classified as \"undercapitalized\", \"significantly undercapitalized\" or \"critically undercapitalized\" are subject to restrictions and supervisory actions of increasing stringency based on the level of classification. Under the present regulation, all five of FCC's Banks are \"well-capitalized\". While such a classification would exclude the Banks from the restrictions and actions envisioned by the prompt corrective action provisions of the 1991 Act, the regulatory agencies have broad powers under other provisions of federal law that would permit them to place restrictions on the Banks or take other supervisory action regardless of such classification.\nOther Provisions of 1991 Act In general, the 1991 Act subjected banks and bank holding companies to significantly increased regulation and supervision. Other significant provisions of the 1991 Act require the federal regulators to draft non-capital regulatory measures to assure bank safety, including underwriting standards and minimum earnings levels. The legislation further requires regulators to perform annual on-site bank examinations, places limits on real estate lending and tightens audit requirements. The 1991 Act and implementing regulations also impose disclosure requirements relating to fees charged and interest paid on checking and deposit accounts.\nMiscellaneous Federal and Louisiana law provide for the enforcement of any pro rata assessment of stockholders of a bank to cover impairment of capital stock by sale, to the extent necessary, of the stock of any assessed stockholder failing to pay the assessment. FCC, as the stockholder of its bank subsidiaries, is subject to these provisions.\nFCIS is registered as a broker-dealer under the Securities Exchange Act of 1934, as amended, and is subject to regulation by the Securities and Exchange Commission and the Louisiana Commissioner of Securities. FCIS is a member of the NASD and, as such, is required to belong to the Securities Investor Protection Corporation, to which FCIS must pay an annual assessment.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties\nFCC's executive offices are located in leased facilities in the Central Business District of New Orleans. Through its subsidiaries, FCC also owns or leases its principal banking facilities and offices in New Orleans, Baton Rouge, Alexandria, Lafayette and Lake Charles. Of the 108 banking offices open at the end of 1993, 65 are owned and 43 are leased. FCSC performs data processing services for FCC and each of its subsidiaries in a facility in the Metropolitan New Orleans area, which is owned by FCSC. Management considers all properties owned or leased to be suitable and adequate for their intended purposes and considers the leases to be fair and reasonable. For additional information concerning premises and information concerning FCC's obligations under long-term leases, see Note 9 of Notes to Consolidated Financial Statements, which is incorporated by reference into Item 8 of this Annual Report on Form 10-K.\nItem 3","section_3":"Item 3 Legal Proceedings\nFCC and its subsidiaries have been named as defendants in various legal actions arising from normal business activities in which damages of various amounts are claimed. The amount, if any, of ultimate liability with respect to such matters cannot be determined. However, after consulting with legal counsel, management believes any such liability will not have a material effect on FCC's consolidated financial condition.\nItem 10.\nExecutive Officers of the Registrant Ian Arnof, 54--President, Chief Executive Officer and Director of FCC since 1983. Amos T. Beason, 53--Executive Vice President and Chief Investment Officer of FCC since 1988. R. Jeffrey Brooks, 45--Executive Vice President and Director of Strategic Support of FCC since 1993; President and Chief Operating Officer of FNBL from 1992 to 1993; Senior Vice President and Bankcard Group Manager of FNBC from 1986 to 1992. Thomas L. Callicutt, Jr., 46--Senior Vice President, Controller and Principal Accounting Officer of FCC since 1987. Michael A. Flick, 45--Executive Vice President of FCC since 1985; Chief Credit Policy Officer of FCC since 1985; Chief Financial Officer from 1988 to 1992; Secretary to the Board of Directors since 1987. Howard C. Gaines, 53--Chairman and Chief Executive Officer of FNBC since 1988. Thomas C. Jaeger, 43--Senior Vice President and Chief Internal Auditor of FCC since 1989. Mr. Jaeger served as Senior Vice President and Chief Financial Officer of FNBC from 1987 to 1989. David B. Kelso, 41--Executive Vice President and Chief Financial Officer of FCC since 1992. Prior to joining FCC, Mr. Kelso was a consultant with the MAC Group in Washington, D.C. for more than five years. Ashton J. Ryan, Jr., 46--President and Chief Operating Officer of FNBC since 1991. Senior Executive Vice President of FCC since 1993. From 1981 to 1991, Mr. Ryan was a partner with Arthur Andersen & Co., CPAs, New Orleans, Louisiana. Joseph V. Wilson III, 44--Senior Executive Vice President of FCC since 1993; Executive Vice President of FCC from 1989 to 1992; Executive Vice President--Retail Group of FNBC from 1984 to 1989.\nItem 14. (a) 3. Exhibits\n3.1 Amended and Restated Articles of Incorporation of First Commerce Corporation.\n3.2 Amended By-laws of First Commerce Corporation.\n4.1 Indenture between First Commerce Corporation and Republic Bank Dallas, N.A., Trustee, including the form of 12 3\/4% Convertible Debenture due 2000, Series A included as Exhibit 4.1 to First Commerce Corporation's Annual Report on Form 10-K for the year ended December 31, 1985 and incorporated herein by reference.\n4.2 Indenture between First Commerce Corporation and Republic Bank Dallas, N.A., Trustee, including the form of 12 3\/4% Convertible Debenture due 2000, Series B included as Exhibit 4.2 to First Commerce Corporation's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference.\n10.1 Amendments numbered 8 and 9 to First Commerce Corporation 1985 Stock Option Plan and Form of Nonqualified Stock Option Ageerement, included as Exhibit 4-C and 4-D to First Commerce Corporation's Registration Statement (Registration No. 2-97152) on Form S-8, and incorporated herein by reference.\n10.2 Amended First Commerce Corporation 1992 Stock Incentive Plan, Form of Nonqualified Stock Option Agreement and Form of Restricted Stock Agreement.\n10.3 Amended First Commerce Corporation Supplemental Tax-Deferred Savings Plan.\n10.4 First Commerce Corporation's Sharemax Corporate Incentive Plan.\n10.5 First Commerce Corporation's Chief Executive Officer Sharemax Plan.\n11 Statement Re: Computation of Earnings Per Share.\n13 First Commerce Corporation's 1993 Annual Report to Stockholders.\n21 Subsidiaries of First Commerce Corporation.\n23 Consent of Arthur Andersen & Co.\nSIGNATURES\nPursuant 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.\nFirst Commerce Corporation (Registrant)\nBy \/s\/ Thomas L. Callicutt, Jr. Thomas L. Callicutt, Jr. Senior Vice President, Controller and Principal Accounting Officer\nDate March 24, 1994\nPursuant 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 on the dates indicated.","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10.\nExecutive Officers of the Registrant Ian Arnof, 54--President, Chief Executive Officer and Director of FCC since 1983. Amos T. Beason, 53--Executive Vice President and Chief Investment Officer of FCC since 1988. R. Jeffrey Brooks, 45--Executive Vice President and Director of Strategic Support of FCC since 1993; President and Chief Operating Officer of FNBL from 1992 to 1993; Senior Vice President and Bankcard Group Manager of FNBC from 1986 to 1992. Thomas L. Callicutt, Jr., 46--Senior Vice President, Controller and Principal Accounting Officer of FCC since 1987. Michael A. Flick, 45--Executive Vice President of FCC since 1985; Chief Credit Policy Officer of FCC since 1985; Chief Financial Officer from 1988 to 1992; Secretary to the Board of Directors since 1987. Howard C. Gaines, 53--Chairman and Chief Executive Officer of FNBC since 1988. Thomas C. Jaeger, 43--Senior Vice President and Chief Internal Auditor of FCC since 1989. Mr. Jaeger served as Senior Vice President and Chief Financial Officer of FNBC from 1987 to 1989. David B. Kelso, 41--Executive Vice President and Chief Financial Officer of FCC since 1992. Prior to joining FCC, Mr. Kelso was a consultant with the MAC Group in Washington, D.C. for more than five years. Ashton J. Ryan, Jr., 46--President and Chief Operating Officer of FNBC since 1991. Senior Executive Vice President of FCC since 1993. From 1981 to 1991, Mr. Ryan was a partner with Arthur Andersen & Co., CPAs, New Orleans, Louisiana. Joseph V. Wilson III, 44--Senior Executive Vice President of FCC since 1993; Executive Vice President of FCC from 1989 to 1992; Executive Vice President--Retail Group of FNBC from 1984 to 1989.\nItem 14.","section_11":"","section_12":"","section_13":"","section_14":"Item 14. (a) 3. Exhibits\n3.1 Amended and Restated Articles of Incorporation of First Commerce Corporation.\n3.2 Amended By-laws of First Commerce Corporation.\n4.1 Indenture between First Commerce Corporation and Republic Bank Dallas, N.A., Trustee, including the form of 12 3\/4% Convertible Debenture due 2000, Series A included as Exhibit 4.1 to First Commerce Corporation's Annual Report on Form 10-K for the year ended December 31, 1985 and incorporated herein by reference.\n4.2 Indenture between First Commerce Corporation and Republic Bank Dallas, N.A., Trustee, including the form of 12 3\/4% Convertible Debenture due 2000, Series B included as Exhibit 4.2 to First Commerce Corporation's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference.\n10.1 Amendments numbered 8 and 9 to First Commerce Corporation 1985 Stock Option Plan and Form of Nonqualified Stock Option Ageerement, included as Exhibit 4-C and 4-D to First Commerce Corporation's Registration Statement (Registration No. 2-97152) on Form S-8, and incorporated herein by reference.\n10.2 Amended First Commerce Corporation 1992 Stock Incentive Plan, Form of Nonqualified Stock Option Agreement and Form of Restricted Stock Agreement.\n10.3 Amended First Commerce Corporation Supplemental Tax-Deferred Savings Plan.\n10.4 First Commerce Corporation's Sharemax Corporate Incentive Plan.\n10.5 First Commerce Corporation's Chief Executive Officer Sharemax Plan.\n11 Statement Re: Computation of Earnings Per Share.\n13 First Commerce Corporation's 1993 Annual Report to Stockholders.\n21 Subsidiaries of First Commerce Corporation.\n23 Consent of Arthur Andersen & Co.\nSIGNATURES\nPursuant 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.\nFirst Commerce Corporation (Registrant)\nBy \/s\/ Thomas L. Callicutt, Jr. Thomas L. Callicutt, Jr. Senior Vice President, Controller and Principal Accounting Officer\nDate March 24, 1994\nPursuant 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 on the dates indicated.","section_15":""}
{"filename":"49816_1993.txt","cik":"49816","year":"1993","section_1":"Item 1. Business\nIllinois Power Company (the \"Company\") was incorporated under the laws of the State of Illinois on May 25, 1923. It is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the State of Illinois.\nOn February 9, 1994, the stockholders of the Company approved, by a favorable vote of 57,647,534 shares or 70.14% of the total shares outstanding, an agreement and plan of merger for creation of a holding company. The holding company will be named Illinova Corporation. Documents have been filed relating to the formation of a holding company with the Illinois Commerce Commission (ICC), the Federal Energy Regulatory Commission (FERC), the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act and the Nuclear Regulatory Commission (NRC). In January 1994, the NRC gave its consent to the restructuring. The applications filed with the FERC, the SEC, and the ICC are currently pending. The holding company formation is not subject to ICC approval; however, the ICC must approve the agreement under which the Company may provide services and facilities to the holding company and affiliates.\nThe territory served by the Company comprises substantial areas in northern, central and southern Illinois, including the following larger communities (1990 Federal Census data):\nThe Company holds franchises in all of the 310 incorporated municipalities in which it furnishes retail electric service and in all of the 257 incorporated municipalities in which it furnishes retail gas service.\nTotal operating revenues, including interchange sales, of the Company for the past three years by classes of service were as follows:\n- 5 -\nOperating income before income taxes for the past three years by classes of service were as follows:\nIdentifiable assets for the past three years by classes of service were as follows:\nAt December 31, 1993, the Company had 4,540 employees.\nElectric Business\nOverview\nThe Company supplies electric service at retail to an estimated aggregate population of 1,265,000 in 310 incorporated municipalities, adjacent suburban and rural areas, and numerous unincorporated communities. Electric service at wholesale is supplied for resale to one electric utility and to the Illinois Municipal Electric Agency (IMEA) as agent for 11 municipalities. The Company also has a power coordination agreement with Soyland Power Cooperative, Inc. (Soyland). See the sub-caption \"Power Coordination Agreement With Soyland\" hereunder for additional information. In 1993, the Company provided interchange power to 13 utilities for resale.\nThe Company's highest system peak hourly demand (native load) in 1993 was 3,415,000 kilowatts on August 26, 1993. This 1993 peak load compares with the Company's historical high of 3,508,000 kilowatts in 1988.\nThe Company owns and operates electric generating facilities having a net summer capability of 4,416,000 kilowatts. The major electric generating stations are Clinton power station (Clinton) (933,000 kilowatts, of which 810,000 kilowatts of capability are owned by the Company and 123,000 kilowatts of capability are owned by Soyland), Baldwin (1,740,000 kilowatts), Havana (666,000 kilowatts), Wood River (603,000 kilowatts), Hennepin (286,000 kilowatts) and Vermilion (165,000 kilowatts). The other generating facilities owned by the Company consist of gas turbine units at three locations which provide peaking service and have an aggregate capability of 146,000 kilowatts. Havana Units 1-5 (238,000 killowatts) and Wood River Units 1-3 (139,000 kilowatts) are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice.\nThe Company owns 20% of the capital stock of Electric Energy, Inc. (EEI), an Illinois corporation, which was organized to own and operate a steam electric generating station and related transmission facilities near Joppa, Illinois to supply electric energy to the Department of Energy (DOE) for its project near Paducah, Kentucky. Under a power supply agreement with EEI, the Company has the right to purchase 5.0% of the annual output of the Joppa facility. The Company has the flexibility to schedule the capacity in varying amounts ranging from a nominal 51,000 kilowatts for 52 weeks up to a maximum of 203,000 kilowatts for approximately\n- 6 -\n13 weeks. The Company must schedule its annual capacity entitlement by August 1 of the preceding year, and availability of the scheduled capacity is subject to certain other limitations related to scheduling considerations of the other co-owners of the Joppa facility and the DOE, and unit outages (if any).\nThe Company is a participant, together with Union Electric Company and Central Illinois Public Service Company, in the Illinois-Missouri Power Pool which was formed in 1952. The Pool operates under an Interconnection Agreement which provides for the interconnection of transmission lines and contains provisions for the coordination of generating equipment maintenance schedules, inter-company sales of firm and non-firm power, and the maintaining of minimum capacity reserves by each participant equal to the greater of 15% of its peak demand, one-half of its largest unit, or one-half of its largest non-firm purchase.\nThe Company, Central Illinois Public Service Company and Union Electric Company have a contract with Tennessee Valley Authority (TVA) providing for the interconnection of the TVA system with those of the three companies to exchange economy and emergency power and for other working arrangements.\nThe Company also has interconnections with Indiana-Michigan Power Company, Commonwealth Edison Company, Central Illinois Light Company, Iowa-Illinois Gas & Electric Company, Kentucky Utilities Company, Southern Illinois Power Cooperative, Soyland Power Cooperative, Inc. and the City of Springfield, Illinois for various interchanges, emergency services and other working arrangements.\nThe Company is also a member of the Mid-America Interconnected Network, which is one of nine regional reliability councils established to coordinate plans and operations of member companies regionally and nationally.\nPower Coordination Agreement With Soyland\nUnder the provisions of a Power Coordination Agreement (PCA) between Soyland and the Company dated October 5, 1984, as amended, the Company is required to provide Soyland with 8.0% (288 megawatts) of electrical capacity from its fossil-fueled generating plants through 1994. This requirement will increase to 12% in 1995 and each year thereafter until the agreement expires or is terminated. This is in addition to the capacity Soyland receives as an owner of Clinton. The Company is compensated with capacity charges and for energy costs and variable operating expenses. The Company transmits energy for Soyland through the Company's transmission and subtransmission systems. Under provisions of the PCA, Soyland has the option of participating financially in major capital expenditures at the fossil-fueled plants, such as those needed for Clean Air Act compliance, to the extent of its capacity entitlement and with each party bearing its own direct capital costs, or having the costs treated as plant additions and billed to Soyland in accordance with other billing provisions of the PCA. See the sub-caption \"Clean Air Act\" on page 20, under \"Environmental Matters\" for further discussion. At any time after December 31, 2004, either the Company or Soyland can terminate the PCA by giving not less than seven years' prior written notice to the other party. The party to whom termination notice has been given may designate an earlier effective date of termination which shall be not less than twelve months after receiving notice. The revenues received from the power supplied to Soyland under the PCA are classified as operating revenues. In 1993, Soyland supplied electricity to 21 distribution cooperative members who served approximately 150,000 rural customers in 69 Illinois counties.\n- 7 -\nFuel Supply\nThe Company used coal to generate 70.2% of the electricity produced during the year ended December 31, 1993, with nuclear, oil, and gas contributing 28.4%, 0.4%, and 1.0%, respectively. The respective average costs of these fuels per million Btu during 1993 were: Coal $1.50, Nuclear $.90, Oil $3.40 and Gas $2.60 for a weighted average cost of $1.34. The weighted average cost of all fuels per million Btu during the years 1992 and 1991 was $1.33 and $1.37, respectively. High-sulfur coal mined in Illinois, Indiana and Kentucky provided 44.7%, 17.2% and 4.1%, respectively, of the coal delivered to the Company's electric generating stations in 1993. In addition, the Company received low-sulfur coal from Kentucky, Colorado, West Virginia, Wyoming, Montana, Tennessee, Utah and Illinois.\nThe average cost of primary fuel consumed at the Company's generating stations during the periods indicated was as follows:\nThe Company's rate schedules contain provisions for passing along to its electric customers increases or decreases in the cost of fuels used in its generating stations. See the information under the captions Revenue and Energy Cost of \"Note 1 - Summary of Significant Accounting Policies\" on page 33 of the Illinois Power Company 1993 Annual Report which is incorporated herein by reference and the sub-caption \"1987 Uniform Fuel Adjustment Clause Reconciliation\" on page 14 for additional information.\nReference is made to the sub-caption \"Environmental Matters\" hereunder for information regarding pollution control matters relating to the Company's fuel supply.\nCoal - As shown below, the Company presently has contracts with expiration dates ranging from 1994 to 2004 which will provide about 41 million tons of coal. Based upon projected 1994 usage of approximately 6.6 million tons, this is equivalent to about 6.2 years of consumption.\nLonger-term contracts with Peabody Coal Company (Peabody) and Arch Coal Sales Company, Inc. (Arch) in effect in 1993 provide for price renegotiations related to current market prices. In 1993, as hereinafter described, the Company negotiated contract amendments with each of these suppliers lowering the cost of their coal. These amendments provide for future price adjustments based on specified benchmarks. The shorter-term contracts with Northern Coal Company, CONSOL, Inc. and Golden Oak Mining Co. contain specified annual prices for each year in the contract term. The Company will be evaluating replacement coal supply alternatives to the CONSOL, Inc. contract at Wood River and the Northern Coal Company contract at Vermilion. Final decisions on both are expected by the end of the third quarter of 1994. Total contract purchases will range between 5.4 million to 5.7 million tons of coal in 1994.\n- 8 -\nThe sources and quantities of coal supplies, contract expiration dates, weighted average cost of coal purchases and anticipated sulfur contents are summarized in the following table:\n* High-sulfur content classified as 2.5 percent or greater.\n(a) The Company has a contract with Peabody to purchase, in total, 2,500,000 tons per year at Baldwin and Hennepin. The Company has also agreed to purchase and Peabody has agreed to supply through 1995 all coal needs above the Arch and Peabody contract quantities at Baldwin and Hennepin.\n(b) This contract will supply 2,065,500 tons per year.\n(c) This contract will supply 500,000 tons in 1994.\n(d) This contract will supply 200,000 to 250,000 tons per year.\n(e) This contract provides for delivery of 150,000 to 360,000 tons in 1994.\nSee the sub-caption \"Environmental Matters\" hereunder for additional information regarding the supply of coal at the Baldwin power station.\nWhen the Company's needs exceed contracted quantities, coal is purchased on the spot market. Spot purchases in 1993 represented about 12% of the Company's total coal purchases. The delivered cost of coal purchased on a spot basis during the year varied between $26.47 per ton, or $1.27 per million Btu, and $50.11 per ton, or $2.01 per million Btu. The Company anticipates that the spot market will continue to be a favorable supplemental source of supply for the next few years, and the Company will have adequate supplies of coal. The coal inventory at December 31, 1993 represented a 25 day supply based on the Company's average daily burn projection for 1994.\nIn December 1992, the Company filed a complaint in the U. S. District Court in St. Louis, Missouri, against Peabody, in which the Company sought declaratory judgment and injunctive relief with respect to its contractual rights to test burn and use coal from other suppliers in order to achieve compliance with the Clean Air Act if to do otherwise would expose the Company to higher costs.\n- 9 -\nIn January 1993, the Company filed a complaint in the U. S. District Court in St. Louis, Missouri against Arch seeking a declaratory judgment to enforce provisions in the coal supply contracts with Arch which permit the Company under certain circumstances to negotiate or arbitrate lower coal prices and if coal is available from other suppliers at substantially lower cost, to terminate the contracts on one year's notice. In February 1993, Arch and two subsidiaries filed suit against the Company in Perry County, Illinois, seeking a declaratory judgment, specific performance and other relief related to the Company's rights to declare force majeure and limit its coal purchases under the existing contracts, State law, and the Clean Air Act, and its declaration of certain force majeure events in prior years. In accordance with agreements-in-principle executed by the Company with each of these suppliers, all litigation was temporarily placed on hold, and deadlines for responses extended, to allow the parties to conclude negotiation of terms under which the Company may continue to purchase coal,through amendments to the existing contracts, on a cost- competitive basis, during the Phase I compliance period of the Clean Air Act Amendments.\nFinal agreements were executed with both Arch and Peabody in 1993. In accordance with those agreements, all of the above-described litigation will be dismissed with prejudice.\nOil - The Havana power station (five units totaling 238,000 kilowatts), is the Company's only station which utilizes fuel oil for the generation of electric energy. These units are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice.\nGas - Three generating units (totaling 139,000 kilowatts) at the Wood River power station and two combustion peaking plants, Stallings (75,000 kilowatts) and Oglesby (60,000 kilowatts), are fueled with natural gas. The three units at Wood River are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice. These units have the capability of burning either natural gas or distillate fuel oil. Natural gas is also used in start-up and as a secondary boiler fuel for two generating units (totaling 286,000 kilowatts) at the Hennepin power station and as a secondary boiler fuel for one generating unit (totaling 92,000 kilowatts) at the Wood River power station. Natural gas is also used as start-up fuel for one additional unit at the Wood River power station. The Company anticipates that adequate supplies of gas for these uses will be available for the foreseeable future. See the sub-caption \"Gas Business\" hereunder.\nNuclear - The Company leases nuclear fuel from Illinois Power Fuel Company (Fuel Company). The Fuel Company, which is 50% owned by the Company, was formed in 1981, for the purpose of leasing nuclear fuel to the Company for Clinton. Lease payments are equal to the Fuel Company's cost of fuel as consumed (including related financing and administrative costs). This lease is recorded as a capitalized lease on the Company's books. As of December 31, 1993, the Fuel Company had an investment in nuclear fuel of approximately $129 million. The Company is obligated to make subordinated loans to the Fuel Company at any time the obligations of the Fuel Company which are due and payable exceed the funds available to the Fuel Company. At December 31, 1993 the Company had no outstanding loans to the Fuel Company.\nAt December 31, 1993, the Company's net investment in nuclear fuel consisted of $22 million of Uranium 308. This inventory represents fuel to be used in connection with the fifth reload of Clinton which is scheduled to commence in March 1995. The unamortized investment of the nuclear fuel assemblies in the reactor was $106 million.\nThe Company signed two contracts in 1988 for the supply of uranium concentrates beginning in 1991. One contract is with U. S. Energy\/Crested Corporation and the other contract is with Cameco, a Canadian corpora- tion. Each of the two contracts is for 1,179,240 lbs. of uranium\n- 10 -\nconcentrates, with deliveries from 1991 to 1997. The contracts contain an option for an additional 479,440 lbs. of uranium concentrates for delivery through 2000. Each of the two contracts is to provide an estimated 35% of Clinton's fuel requirements, but each contract contains provisions permitting the Company to purchase 50-60% of Clinton's fuel requirements in certain years through the spot market. The decision to utilize these provisions is made the year before each delivery and depends on the estimated price and availability from the spot market versus the estimated contract prices. During 1993, all nuclear fuel purchases were settled in United States dollars.\nIn October 1993, the Company filed suit in U.S. District Court, Central District of Illinois, Danville, seeking a declaration that the Company's termination of one of these uranium supply contracts is permitted by the terms of the contract. Defendants in the lawsuit are U.S. Energy Corporation, Crested Corporation, U. S. Energy\/Crested Corporation, Cycle Resources Investment Corporation, Sheep Mountain Partners, Nulux Nukem Luxemburg GMBH, and Dresdner Bank. The defendants are joint ventures, partnerships, and domestic and foreign corporations who are either original parties or parties by assignment to the contract. The Company purchased approximately half of its uranium concentrates supply under this contract, which the Company terminated shortly before filing this action. If the contract termination is upheld, the Company does not anticipate having difficulty in replacing the contract at significantly lower fuel prices. The defendants have filed responses including affirma- tive defenses and breach of contract claims. A motion for change of venue filed by certain of the defendants has been denied, and the case is proceeding.\nConversion services for the period 1991-2001 are contracted with Sequoyah Fuels. Sequoyah Fuels closed its Oklahoma conversion plant in 1992 and has joined with Allied Chemical Company to form a new marketing company named CoverDyn. All conversion services will be performed at Allied's Metropolis, Illinois facility, but Sequoyah Fuels will retain the contract with the Company. The Company has a Utility Services contract for uranium enrichment requirements with the DOE which provides 70% of the enrichment requirements of Clinton through September 1999. The remaining 30% has been contracted with the DOE through its incentive pricing plan through September 1995, and an amendment was signed in 1993 which covers the remaining 30% through 1999. This amendment allows the Company to either purchase the enrichment services at the DOE's incentive price or provide electricity at DOE's Paducah, Kentucky enrichment plant, an agreed exchange rate. In addition, legislation was passed to create a new private government corporation, the United States Enrichment Corporation (USEC), for enrichment services. All of the DOE's assets including all contracts were transferred to the USEC as of July 1993.\nA contract with General Electric Company provides fuel fabrication requirements for the initial core and 2,196 fuel bundles (approximately 11 reloads through 2004). In 1993, an amendment was signed with the General Electric Company to add 1,472 fuel bundles to the contract and to change the existing price as well as some other terms and conditions. The additional 1,472 fuel bundles are expected to cover fuel fabrication requirements through 2017.\nBeyond the stated commitments, the Company may enter into additional contracts for uranium concentrates, conversion to uranium hexafluoride, enrichment and fabrication.\nCurrently, no plants for commercial reprocessing of spent nuclear fuel are in operation in the U.S., and reprocessing cannot commence until appropriate licenses are issued by the NRC. Clinton has on-site high density storage capability which will provide spent nuclear fuel storage capacity to meet requirements until the year 2004. Various governmental agencies are currently reviewing the environmental impact of nuclear fuel reprocessing and waste management. The Nuclear Waste Policy Act of\n- 11 -\n1982 was enacted to establish a government policy with respect to disposal of spent nuclear fuel and high-level radioactive waste. The Company signed a contract for disposal of spent nuclear fuel and\/or high-level radioactive waste on July 6, 1984 with the DOE. Under the contract, the Company is required to pay the DOE one mill (one-tenth of a cent) per net kilowatt-hour (one dollar per MWH) of electricity generated and sold. The Company is recovering this amount through rates. The federal government is required to have a repository in place to accept spent nuclear fuel by January 31, 1998; however, current federal government schedules indicate the year 2010 for the acceptance of the first spent nuclear fuel. The Company expects that it will be able to meet interim storage requirements through 2009 on-site using existing in-core pool facilities.\nUnder the Energy Policy Act of 1992, the Company is responsible for a portion of the cost to decontaminate and decommission the DOE's uranium enrichment facilities. Each utility will be assessed an annual fee for a period of fifteen years based on quantities purchased from the DOE facilities prior to passage of the Act. During 1992 the Company recorded an estimated liability of $10.5 million, which was revised to $7.2 million in 1993. At December 31, 1993, the Company has a remaining liability of $6.7 million representing future assessments. The Company is recovering these costs, as amortized, through its fuel adjustment clause.\nConstruction Program\nThe cost, including allowance for funds used during construction (AFUDC), of the Company's construction program during 1994 and during the period January 1, 1994 to December 31, 1998 is estimated as follows:\nHistoric gas purchases are shown in the following table. The source labeled \"Other\" below represents purchases from small natural gas fields in Illinois.\nThe Company's present estimated supplies of gas from pipelines and its own storage are sufficient to serve all of its existing firm loads, and to provide best efforts service to interruptible loads. Gas service to interruptible customers was interrupted on six occasions for a total of 622 hours during the year 1993. On these occasions, storage service was made available in lieu of curtailment. Gas service continues to be available to all applicants on a current basis.\nDuring 1993, the Company completed the Hillsboro Storage Field expansion project at a cost of approximately $56 million. The project included construction of a 62 mile pipeline from Hillsboro to the Decatur area, as well as additional facilities in the Metro-East area. The expansion increased total gas storage capacity by 42 percent and allows the Company to take maximum advantage of lower summer spot market prices, to reduce pipeline contract demand charges and to increase supplier price competition in the St. Louis Metro-East area. Nine new injection-withdrawal wells and two additional compressor units have been constructed to increase the storage capacity of the Hillsboro Field. Injection rates were tripled and delivery\/withdrawal rates were increased 150 percent to better meet winter peak demand.\nEnvironmental Matters\nThe Company is subject to regulation by certain federal and Illinois authorities with respect to environmental matters and may in the future become subject to additional regulation by such authorities or by other federal, state and local governmental bodies. Existing regulations affecting the Company are principally related to air and water quality, hazardous wastes and toxic substances.\n- 19 -\nAir Quality\nPursuant to the Federal Clean Air Act (Act), the United States Environmental Protection Agency (USEPA) has established ambient air quality standards for air pollutants which in its judgment have an adverse effect on public health or welfare. The Act requires each state to adopt laws and regulations, subject to USEPA approval, designed to achieve such standards. Pursuant to the Illinois Environmental Protection Act, the Illinois Pollution Control Board (Board) adopted and, along with the Illinois Environmental Protection Agency (IEPA), is enforcing a comprehensive set of air pollution control regulations which include emission limitations and permitting, monitoring, and reporting requirements. These regulations have, with some modifications, received USEPA approval and are enforceable by both the Illinois and federal agencies.\nThe air pollution regulations of the Board impose limitations on emissions of particulate, sulfur dioxide, nitrogen oxides, and various other pollutants. Enforcement of emission limitations is accomplished in part through the regulatory permitting process. To construct a facility which will produce regulated emissions, a construction permit must be obtained, usually on the basis of the design being sufficient to permit operation within applicable emission limitations. Upon completion of construction, an operating permit for the facility must be obtained. Operating permits are granted for various periods, usually within a range from two to five years. The initial granting or subsequent renewal of operating permits is based upon a demonstration that the facility operates within prescribed limitations on emissions. The Company's practice is to obtain an operating permit for each source of regulated emissions. Presently, it has a total of approximately 100 permits for emission sources at its power stations and other facilities, expiring at various times. In addition to having the requisite operating permits, each source of regulated emissions must be operated within the regulatory limitations on emissions. Verification of such compliance is usually accomplished by reports to regulatory authorities and inspections by such authorities.\nJointly, the Company and IEPA petitioned the Board to adopt a regulatory amendment providing for a site-specific sulfur dioxide limitation applicable to the Baldwin power station. The Board granted that relief in 1979 and amended it in 1983 to satisfy certain concerns raised by USEPA. In October 1983, the amendment, with supporting information, was submitted to USEPA for approval as part of the State Implementation Plan (SIP). On March 5, 1990, USEPA approved the Baldwin SIP allowing the use of local coal up to full capacity of the Baldwin power station.\nIn addition to the sulfur dioxide emission limitations for existing facilities, both the USEPA and the State of Illinois adopted New Source Performance Standards (NSPS) applicable to coal-fired generating units limiting emissions to 1.2 pounds of sulfur dioxide per million Btu of heat input. This standard is applicable to the Company's Unit 6 at the Havana power station. The federal NSPS also limits nitrogen oxides, opacity and particulate emissions and imposes certain monitoring requirements. In 1977 and 1990 the Act was amended and, as a result, USEPA has adopted more stringent emission standards for new sources. These standards would apply to any new plant constructed by the Company.\nClean Air Act\nOn November 15, 1990, the U. S. Congress passed the Clean Air Act Amendments (Amendments). The Amendments create new programs to control acid rain, protect stratospheric ozone and require permits for most air pollution sources. The Amendments also modify the existing hazardous air pollutant program and impose new air quality requirements on sources in areas which do not meet the ambient air quality standards.\n- 20 -\nAs the regulations implementing the Amendments are developed, the Company will develop and implement plans to maintain compliance with any new air pollutant restrictions.\nIn August 1992, the Company announced that it had suspended construction of two scrubbers at the Baldwin power station, on which the Company has expended approximately $34.6 million. After suspending scrubber construction, the Company reconsidered its alternatives for complying with Phase I of the 1990 Clean Air Act Amendments. In March, the Company announced its compliance plan for Phase I (1995-1999) of the Clean Air Act.\nTo meet the Phase I sulfur dioxide requirements of the acid rain provisions of the Clean Air Act, the Company will purchase sulfur dioxide emission allowances while continuing the use of high-sulfur Illinois coal. An emission allowance is the authorization by the USEPA to emit one ton of sulfur dioxide. The Company has already contracted to purchase approximately 430,000 of the approximately 550,000 emission allowances it expects to need to acquire from outside sources for Phase I compliance purposes. In 1993 the Illinois General Assembly passed and the governor signed legislation authorizing the ICC to permit expenditures and revenues from emission allowance purchases and sales to be reflected in rates charged to customers through the fuel adjustment clause as a cost of fuel. On February 18, 1994, the Company filed with the ICC revised fuel adjustment clause tariffs providing for recovery of expenses and revenues from emission allowances. On March 16, 1994, the ICC suspended this filing for investigation pursuant to the provisions of the Illinois Public Utilities Act. In addition, on March 9, 1994, the ICC initiated a rule-making proceeding to consider changes to its Uniform Fuel Adjustment Clause regulation to conform to the 1993 legislation.\nThe Company's compliance plan will defer, until at least 2000, any need for scrubbers or other capital projects associated with sulfur dioxide emission reductions. Additional actions will be required by the Company to achieve compliance with the Phase II sulfur dioxide and nitrogen-oxide emission requirements of the Clean Air Act.\nTo achieve compliance with the Phase I nitrogen-oxide emission reduction requirements of the acid rain provision of the Clean Air Act, the Company is installing low-nitrogen-oxide burners at two generating units. The estimated capital cost for these burners is $13 million. Additional capital expenditures are anticipated prior to 2000 to comply with the Phase II nitrogen-oxide requirements, as well as potential requirements to further reduce nitrogen-oxide emissions in the St. Louis metropolitan area. The Company is also proceeding with installation of continuous emission monitoring systems at its major generating stations, as required by the acid rain provisions of the Clean Air Act. The estimated capital cost for these monitoring systems is $17 million. The Company has expended approximately $9 million through 1993 on continuous emission monitoring systems.\nIn July 1993, the Alliance for Clean Coal (Alliance), a coalition of Western coal producers and railroads, filed suit against the ICC in the U.S. District Court in Chicago. The Alliance sought a declaration that the Illinois statute regarding the filing with and approval by the ICC of utility Clean Air Act compliance plans is unconstitutional. In September 1993, the ICC issued an order pursuant to this statute approving the Company's compliance plan for Phase I. In December 1993, the U.S. District Court issued an opinion and an order in Alliance for Clean Coal vs. Ellen Craig, et al. declaring the statute unconstitutional. The order prohibits the ICC from enforcing the statute, and declares void compliance plans prepared and approved in reliance on the statute. The Company is of the belief that no regulatory approval is now required of its Clean Air Act compliance plan, and has determined to go forward with the plan it has adopted for Phase I. The ICC has appealed the District Court decision to the U.S. Court of Appeals.\n- 21 -\nGas Manufacturing Sites\nThe Company, through its predecessor companies, is identified on a State of Illinois list as the responsible party for potential environmental impairment at 25 former manufactured-gas plant sites. The Company is investigating each site to determine (1) the type and amount of residues present; (2) whether the residues constitute environment or health risks and, if present, the extent of those risks; and (3) whether the Company has any responsibility for remedial action. Because of the unknown and unique characteristics of each site (such as amount and type of residues present, physical characteristics of the site and the environmental risk) and uncertain regulatory requirements, the Company is not able to determine its ultimate liability for the investigation and remediation of the 25 sites. However, at December 31, 1993, the Company has estimated and recorded a minimum liability of $35 million, which is an increase of $10 million from 1992. This adjustment to the liability was made because the Company can better define the extent of contamination due to ongoing monitoring. In 1993, the Company spent approximately $1.5 million for investi- gation and remediation activities. The Company is unable to determine at this time what portion of these costs, if any, will be eligible for recovery from insurance carriers or other potentially responsible parties. In addition, the Company is unable to determine the time frame over which these costs may be paid out. The Company has also recorded a regulatory asset in the amount of $36 million, reflecting management's expectation that investigation and remediation costs for the manufactured-gas plant sites will be recovered from customers.\nIn September 1992, the ICC issued a generic order addressing the recoverability of costs incurred by utilities in cleaning up coal-tar deposits resulting from the operation and retirement of former manufactured-gas plant sites. The ICC order concluded that utilities will be allowed to collect from customers their prudently incurred costs paid to third parties over a five-year period with no recovery from customers of carrying costs on the unrecovered balance. Based on the ICC's ruling that carrying costs on unrecovered cleanup costs will not be allowed, the Company and other utilities appealed the ICC order to the Illinois Appellate Court, Third District. Other parties also filed appeals of the ICC order, contesting the ICC's ruling that cleanup costs may be recovered from customers and that those costs may be recovered through a tariff rider. In December 1993, the Appellate Court issued its opinion affirming the ICC's order in all respects. In February 1993, an intervenor filed a petition for leave to appeal the Appellate Court decision with the Illinois Supreme Court. In April 1993, the ICC approved tariffs filed by the Company that provide for recovery of such costs that fall within the guidelines of the ICC's September 1992 Order and were incurred by the Company subsequent to January 1, 1993. The Company is also pursuing recovery of cleanup costs from its insurance carriers.\nWater Quality\nThe Federal Water Pollution Control Act Amendments of 1972 require that National Pollutant Discharge Elimination System permits be obtained from USEPA (or, when delegated, from individual state pollution control agencies) for any discharge into navigable waters. Such discharges are required to conform with the standards, including thermal, established by USEPA and also with applicable state standards.\nEnforcement of discharge limitations is accomplished in part through the regulatory permitting process similar to that described previously under \"Air Quality\". Presently, the Company has approximately two dozen permits for discharges at its power stations and other facilities, which must be periodically renewed.\n- 22 -\nIn addition to obtaining such permits, each source of regulated discharges must be operated within the limitations prescribed by applicable regulations. Verification of such compliance is usually accomplished by monitoring results reported to regulatory authorities and inspections by such authorities.\nThe Baldwin permit was reissued during the fourth quarter of 1993 and is due for renewal in the fourth quarter of 1997. The Hennepin NPDES permit was reissued in 1992 and is due for renewal in the third quarter of 1997. The Clinton permit was reissued in 1990 and is due for renewal in the second quarter of 1995. The Vermilion, Wood River and Havana permits were reissued in 1991. These permits are due for renewal in the fourth quarter of 1995.\nOperations at the Vermilion Plant (Plant) may be affected by allegations that continued discharge of certain levels of effluents from the ash pond at the Plant into the Middle Fork of the Vermilion River violates state water quality standards. Although both the Illinois Environmental Protection Agency and the Illinois Department of Conservation have supported the Company's position that current effluent discharge limitations, applied to the Plant since these standards first were adopted, continue to be appropriate, both the Illinois Pollution Control Board, in a 1993 decision currently under appeal by the Company, and a citizens group have challenged the Company's ability to continue to discharge these effluents at current levels, and the citizens group has notified the Company that it may bring suit against the Company and the United States and Illinois Environmental Protection Agencies to prevent such discharges. The Company is investigating compliance options to determine the least cost response should the most restrictive limitations be imposed and believes that it can avoid any material adverse impact on financial condition and operations.\nOther Issues\nHazardous and nonhazardous wastes generated by the Company must be managed in accordance with federal regulations under the Toxic Substances Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, and the Resource Conservation and Recovery Act (RCRA) and additional state regulations promulgated under both RCRA and state law. Regulations promulgated in 1988 under RCRA govern the Company's use of underground storage tanks. The use, storage, and disposal of certain toxic substances, such as polychlorinated biphenyls (PCB's) in electrical equipment, are regulated under the Toxic Substances Control Act. Hazardous substances used by the Company are subject to reporting requirements under the Community-Right-To-Know Act. The State of Illinois has been delegated authority for enforcement of these regulations under the Illinois Environ- mental Protection Act and state statutes. These requirements impose certain monitoring, recordkeeping, reporting, and operational requirements which the Company has implemented or is implementing to assure compliance. The Company does not anticipate that compliance will have a material adverse effect on its financial position or results of operations.\nBetween June 1983 and January 1985, the Company shipped various materials containing PCB's to the Martha C. Rose Chemicals, Inc. (Rose) facility in Holden, Missouri for proper treatment and disposal. Rose, pursuant to permits issued by USEPA, had undertaken to dispose of PCB materials for the Company and others, but failed in part to do so. As a result of such failure, PCB materials were being stored at the facility. In 1986, the Company joined with a number of other generators to efficiently and economically cleanup the facility. The Steering Committee, consisting of the Company and 15 other entities has received USEPA's approval to implement the Remedial Design Work Plan (Plan). All work is scheduled for completion by December, 1994. The Steering Committee is required to monitor the site for a minimum of five years after completion of the Plan. At the present time, the Company does not believe its ratable share of potential liability related to the cost of future activities at the Rose site will have a material adverse effect on its financial condition or results of\n- 23 -\noperations. The Company, along with fourteen other steering committee members, reached a settlement with all but one of the non- participating potentially liable entities to recover their ratable share of these costs.\nElectric and Magnetic Fields\nThe possibility that exposure to electric and magnetic fields emanating from power lines, household appliances and other electric sources may result in adverse health effects has been a subject of increased public, governmental and media attention. Lawsuits have been filed against several utilities seeking recovery for personal injury or loss of property values allegedly resulting from EMF emanating from power lines or substations, or to have such facilities relocated. A considerable amount of scientific research has been conducted on this topic without definitive results. Research is continuing to resolve scientific uncertainties. It is too soon to tell what, if any, impact these actions may have on the Company's financial position and results of operation.\nEnvironmental Expenditures\nOperating expenses for environmentally-related activities in 1993 were approximately $50 million (including the incremental costs of alternative fuels to meet environmental requirements). The Company's accumulated capital expenditures (including AFUDC) for environmental protection programs since 1969 have reached approximately $780 million. This accumulated amount of capital expenditures through 1993 has been reduced to reflect a pro rata share of the disallowance of Clinton plant costs.\nResearch and Development\nThe Company's research and development expenditures during 1993, 1992 and 1991 were approximately $6.4 million, $3.7 million and $7.3 million, respectively. The increased research and development costs in 1993 are primarily due to increased dues to the Electric Power Research Institute and increased alternate fuel testing at the Baldwin Power Station. The higher 1991 amount was due to incremental coal transportation costs associated with test burns of western low-sulfur coal at Baldwin, Hennepin and Havana power stations.\nRegulation\nUnder the Illinois Public Utilities Act, the ICC has broad powers of supervision and regulation with respect to the rates and charges of the Company, its services and facilities, extensions or abandonment of service, classification of accounts, valuation and depreciation of property, issuance of securities, and various other matters. The Illinois Public Utilities Act was amended effective January 1, 1986 to include certain provisions specifying criteria for the inclusion of utility plant investment in rate base. These provisions state in substance that the ICC shall include in a utility's rate base only the value of its investment which is both prudently incurred and used and useful in providing service to customers; that no new electric generating plant or significant addition to existing facilities shall be included in rate base unless the ICC determines that such plant or facility is reasonable in cost, prudent and used and useful in providing utility service to customers; and that the ICC is empowered to determine whether a utility's generating capacity is in excess of that reasonably necessary to provide adequate and reliable service and to make appropriate and equitable adjustments to rates upon a finding of excess capacity, provided that any such determination and adjustment with respect to generating capacity existing or under construction prior to January 1, 1986 shall be limited to the determination and adjustment, if any, appropriate under the law then in effect.\n- 24 -\nThe Company is exempt from all the provisions of the Public Utility Holding Company Act of 1935 except Section 9(a)(2) thereof. That section requires approval of the Securities and Exchange Commission prior to certain acquisitions by the Company of any securities of other public utility companies or public utility holding companies.\nThe Company is subject to regulation under the Federal Power Act by the FERC as to rates and charges in connection with the transmission of electric energy in interstate commerce and the sale of such energy at wholesale in interstate commerce, the issuance of debt securities maturing in not more than 12 months, accounting and depreciation policies, and certain other matters.\nThe FERC has declared the Company exempt from the Natural Gas Act and the orders, rules, and regulations of the Commission thereunder.\nThe Company is subject to the jurisdiction of the NRC with respect to Clinton. NRC regulations control the granting of permits and licenses for the construction and operation of nuclear power stations and subject such stations to continuing review and regulation. Additionally, the NRC review and regulatory process covers decommissioning, radioactive waste, environmental and radiological aspects of such stations. In general, the NRC continues to propose new and revised rules relating to the operations and maintenance aspects of nuclear facilities. It is unclear whether such proposed rules will be adopted and what effect, if any, such adoption will have on the Company.\nThe Company is subject to the jurisdiction of the Illinois Department of Nuclear Safety (IDNS) with respect to Clinton. IDNS and the NRC entered a memorandum of understanding which allows IDNS to review and regulate nuclear safety matters at state nuclear facilities. The IDNS review and regulatory process covers radiation safety, environmental safety, emergency preparedness and emergency response. IDNS continues to propose new and revised state administrative code through legislative approval. It is unclear if such proposed rules will be adopted and what effect, if any, such adoption will have on the Company. However, the NRC has the final authority over such nuclear facilities.\n- 25 -\nThe present term of office of each of the above executive officers extends to the first meeting of the Company's Board of Directors after the Annual Election of Directors. There are no family relationships among the executive officers and directors of the Company.\nEach of the above executive officers, except for Ms. Stetzner, Dr. Dreyer and Mr. Schultz, has been employed by the Company for more than five years in executive or management positions. Prior to election to the positions shown above, the following executive officers held the following positions since January 1, 1989.\nMr. Haab was elected Chairman in June 1991. Prior to being elected Chief Executive Office in April 1991 and President in April 1989, he was Executive Vice President and Senior Vice President.\nMr. Altenbaumer was elected Senior Vice President and Chief Financial Officer in June 1992. Prior to being elected Vice President, Chief Financial Officer and Controller in June 1990, he was Controller and Treasurer.\nMr. Lang was elected Senior Vice President in June 1992. He joined the Company as Vice President in July 1986.\nMr. Perry was elected Senior Vice President in June 1992. Prior to being elected Vice President in December 1989, he was Assistant Vice President and Manager of Nuclear Program Coordination at Clinton.\nMr. Cook was elected Vice President in June 1992. He previously held the positions of Manager of Clinton Power Station and Manager of Nuclear Planning and Support.\nMr. Smith's employment with the Company ended on December 31, 1993.\nMs. Stetzner was elected Vice President, General Counsel and Corporate Secretary in February 1993. Prior to joining the Company as General Counsel and Corporate Secretary in 1989, she was Associate General Counsel with Burlington Northern Railroad Company.\nMr. Dreyer joined the Company as Controller in June 1992. He previously was a Senior Audit Manager with Price Waterhouse.\nMr. Schultz was elected Treasurer in July 1989. He previously was Director of Planning and Programming at Clinton.\nOperating Statistics\nThe information under the captions \"Selected Statistics\" on page 48 of the Illinois Power Company 1993 Annual Report is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns and operates electric generating stations at Havana, Wood River, Hennepin, Baldwin, and near Danville, Illinois (designated as the Vermilion station), totaling 3,460,000 kilowatts of net summer capability. The Company has an ownership in the Clinton power station (Clinton) of 86.8% and Soyland Power Cooperative, Inc. owns the remaining 13.2%. The\n- 26 -\nCompany's portion of net summer output capability of Clinton is 810,000 kilowatts. The Company also owns other gas turbine generating facilities, at three locations, with an aggregate capability of 146,000 kilowatts.\nThe Company owns an interconnected electric transmission system of approximately 2,800 circuit miles, operating from 69,000 to 345,000 volts and a distribution system which includes about 36,900 circuit miles of overhead and underground lines.\nAll outstanding first mortgage bonds issued under the Mortgage and Deed of Trust dated November 1, 1943 are secured by a first mortgage lien on substantially all of the fixed property, franchises and rights of the Company with certain exceptions expressly provided in the mortgage securing the bonds. All outstanding New Mortgage Bonds issued under the General Mortgage and Deed of Trust dated November 1, 1992, are secured by a lien on the Company's properties used in the generation, purchase, transmission, distribution and sale of electricity and gas, which lien is junior to the lien of the Mortgage and Deed of Trust dated November 1, 1943.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFuel and Purchased Gas Adjustment Clauses\nThe ICC holds annual public hearings to determine whether each utility's fuel adjustment clause and purchased gas adjustment clause reflect actual costs of fuel and gas prudently purchased and to reconcile amounts collected with actual costs, with the possibility of surcharges or refunds to reflect amounts under-collected or over-collected. See \"1987 Uniform Fuel Adjustment Clause Reconciliation\" reported under \"Clinton Power Station\" in Item 1 for information regarding a February 1992 order from the ICC.\nEnvironmental\nSee \"Environmental Matters\" reported under Item 1 for information regarding legal proceedings concerning environmental matters.\nPeabody Coal Company and Arch Coal Sales Company, Inc.\nSee \"Coal\" reported under \"Fuel Supply\" in Item 1 for information regarding certain legal proceedings relating to the Clean Air Act.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe Company did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1993. At a special meeting of shareholders held on February 9, 1994, the Company's shareholders approved an agreement and plan of merger providing for the creation of a new holding company. See \"Business\" under Item 1 for a description of the holding company formation.\n- 27 -\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe information under the caption \"Quarterly Financial Information and Common Stock Data (Unaudited)\" on page 46 of the Illinois Power Company 1993 Annual Report is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information under the caption \"Selected Financial Data\" on page 47 of the Illinois Power Company 1993 Annual Report is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information under the caption \"Management's Discussion and Analysis\" on pages 18 through 25 of the Illinois Power Company 1993 Annual Report is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements on pages 27 through 46 and Report of Independent Accountants on page 26 of the Illinois Power Company 1993 Annual Report are incorporated herein by reference. With the exception of the aformentioned information and the information incorporated in Items 5, 6, 7, and 8, the Illinois Power Company 1993 Annual Report is not to be deemed filed as part of this Form 10-K Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information relating to directors is set forth in Part III of this Annual Report on Form 10-K. The information relating to executive officers is set forth in Part I of this Annual Report on Form 10-K.\n- 28 -\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth a summary of the compensation of the Chief Executive Officer and the four other most highly compensated executive officers of the Company for the years indicated.\n- 29 -\nA)The amounts shown in this column are the cash award portion of grants made to these individuals under the Executive Incentive Compensation Plan, including amounts deferred under the Executive Deferred Compensation Plan. See Plan description in footnote (B) below.\nB)This table sets forth stock unit awards for 1993 under the Company's Executive Incentive Compensation Plan. One-half of each year's award under this plan is converted into stock units representing shares of the Company's Common Stock based on the closing price of the Common Stock on the last trading day of the award year. The other one-half of the award is paid to the recipient in cash in the following year and is included in the Summary Compensation Table as Bonus paid in the award year. Stock units awarded in a given year, together with cash representing the accumulated dividend equivalents on those stock units, become fully vested after a three-year holding period. Stock units are converted into cash and paid based on the closing price of the Common Stock on the first trading day of the distribution year. Participants (or beneficiaries of deceased participants) whose employment is terminated by retirement on or after age 55, disability or death receive the present value of all unpaid awards on of such termination. Participants whose employment is terminated for reasons other than retirement, disability or death forfeit all unvested awards. In the event of a termination of employment within two years after a change in control of the Company (as defined in the Employee Retention Agreement described below), without good cause or by any participant with good reason, all awards of the participant become fully vested and payable. As of December 31, 1993, named executive officers were credited with the following total aggregate number of unvested stock units under the Executive Incentive Compensation Plan since its inception, valued on the basis of the closing price of the Company's Common Stock on December 31, 1993: Mr. Haab, 3,374 units valued at $74,650; Mr. Wells, 1,992 units valued at $44,083; Mr. Lang, 1,557 units valued at $34,454. Mr. Perry, 1,528 units valued at $33,813; Mr. Altenbaumer, 1,319 units valued at $29,200. Although stock units have been rounded, valuation is based on total stock units, including partial shares.\nC)The amounts shown in this column are Company contributions under the Incentive Savings Plan (including the market value of shares and sale of electricity and gas, which lien is junior to the lien of the Mortgage and Deed of Trust dated November 1, 1943).\n- 31 -\nThe following tables summarize grants during 1993 of stock options under the Company's 1992 Long Term Inc. Compensation Plan and awards outstanding at year end for the individuals named in the Summary Compensation Table. No options were exercisable or exercised during 1993.\na)Each option becomes exercisable on March 31, 1997. In addition to the specified expiration date, the grant expires on the first anniversary of the recipient's death and\/or the 90th day following retirement, and is not exercisable in the event recipient's employment terminates. In the event of a public tender for all or a portion of the stock, or if a proposal to merge or consolidate the Company with another company is submitted to the shareholders for a vote, the Compensation and Nominating Committee may declare the option immediately exercisable.\nb)These options have been valued using the Black-Scholes option pricing model. Disclosure of the grant date present value, using the Black-Scholes model or potential realizable value assuming 5% and 10% annualized growth rates, is mandated; however, the Company does not necessarily view the Black-Scholes pricing methodology, or any other methodology, as a valid or accurate means of valuing stock option grants. The Company elected to use the standard Black-Scholes model, which uses the following factors: fair market value of share at grant; option exercise price; term of the option; current yield of the stock; risk-free interest rate; volatility of the stock. The fair market value of the stock on June 9, 1993 was $24.25; the exercise price of the options is $24.25; and the term option is ten years. The annual dividend rate on the Company's Common Stock on June 9, 1993 was $0.80 for a yield of 3.3 percent. The risk-free interest rate used was 5.96 percent, based on the ten-year U.S. Treasury bond yield on May 14, 1993. The volatility of the stock used was .245. This figure is based on the absolute volatility (annualized standard deviation of the logarithms of the prior stock performance) for the 36-month period ending March, 1993. This is a relatively high volatility for an electric utility due, in part, to the Company's nuclear plant construction cost recovery disallowances, related write-offs, and temporary suspension of common stock dividend payments during this period. The value thus determined, $6.76 share, was not discounted.\n- 31 -\nAggregated Option and Fiscal Year-End Option Value Table\nPension Benefits\nThe Company maintains a Retirement Income Plan for Salaried Employees (the \"Plan\") providing pension for all eligible salaried employees of the Company. In addition to the Plan, the Company also maintains a nonqualified Supplemental Retirement Income Plan for Salaried Employees of Illinois Power Company (the \"Supplemental Plan\") that covers all elected officers eligible to participate in the Plan and provides for payments from general funds of the Company of any monthly retirement income not payable under the Plan because of benefit limits imposed by law or because of certain Plan rules limiting the amount of credited service accrued by a participant.\nThe following table shows the estimated annual pension benefits on a straight life annuity basis payable upon retirement based on specified annual average earnings and years of credited service classifications, assuming continuation of the Plan and Supplemental Plan and employment until age 65. This table does not show, but any actual pension benefit payments would be subject to, the Social Security offset.\n- 32 -\nThe earnings used in determining pension benefits under the Plan are the participants' regular base compensation, as set forth under salaries in the compensation table.\nAt December 31, 1993, for purposes of both the Plan and the Supplemental Plan, Messrs. Haab, Wells, Altenbaumer, Lang and Perry had completed 28, 30, 21, 7 and 9 years of credited service, respectively.\nEmployee Retention Agreements\nThe Company has entered into Employee Retention Agreements with each of its executive officers. Under each of these agreements, the officer would be entitled to receive a lump sum cash payment if his or her employment were terminated by the Company without good cause or voluntarily by the officer for good reason within two years following a change in control of the Company (as defined in the Agreement). The amount of the lump sum payment would be equal to (1) 36 months' salary at the greater of the officer's salary rate in effect on the date the change in control occurred or the salary rate in effect on the date the change in the officer's employment with the Company terminated; plus (2) three times the largest bonus earned by the officer during the three calendar years preceding termination of employment. Under the agreement, the officer would continue, after any such termination of employment, to participate in and receive benefits under other benefit plans of the Company. Such coverage would continue for 36 months following termination of employment, or, if earlier, until the officer reached age 65 or was employed by another employer; provided that, if the officer was 50 years of age or older at the time of such termination, then coverage under health, life insurance and similar welfare plans would continue until the officer became 55 years of age, at which time he or she would be eligible to receive the type of coverage extended to employees of the Company who elect early retirement.\n- 33 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following are the only holders known by the Company to be the beneficial owners of more than five percent of any class of the Company's outstanding stock.\n1) According to its Form 4 filing, American Express Company and its Subsidiaries beneficially own 303,245 shares of Serial Preferred Stock, without par value, as of February 18, 1994, as to which beneficial ownership is disclaimed, with sole power to vote and dispose of all shares. American Express Company was late in filing a Statement of Changes in Beneficial Ownership relating to a redemption by the Company of certain shares of serial preferred stock without par value.\n2) According to its Schedule 13G filing dated February 11, 1994, American General Corporation and Subsidiaries beneficially own 242,000 shares of Serial Preferred Stock, $50 par value (consisting of 211,100 shares of 8.00% Cumulative Preferred Stock, and 30,900 shares of 8.24% Cumulative Preferred Stock), and have shared power to vote or direct voting and shared power to dispose or direct disposition of all of such shares.\n3) According to its Schedule 13G filing dated February 11, 1994, FMR Corp. owns 7,026,460 shares of Common Stock, with sole power to vote or direct the vote of 1,022,800 shares and sole power to dispose or direct the disposition of all shares.\n4) According to its Schedule 13G filing dated February 10, 1994, Mellon Bank Corporation and Subsidiaries beneficially own 5,363,000 shares of Common Stock, with sole power to vote 3,786,000 shares, shared power to vote 202,000 shares, sole power to dispose of 4,355,000 shares and shared power to dispose of 1,008,000 shares.\n- 34 -\nThe names of the Board of Directors and certain information, including their principal occupation during the last five years and ownership of securities of the Company, with respect to each are shown below:\n(1) Member of the Finance Committee.\n(2) Member of the Audit Committee.\n(3) Member of the Compensation and Nominating Committee.\n(4) Member of the Corporate Strategy Committee.\n(5) Member of the Nuclear Operations Committee.\n(6) Includes 3,929 and 6,354 shares held in the accounts of Messrs. Haab and Wells, respectively, under the Company's Incentive Savings Plan.\n- 37 -\n(7) Includes 5,540 shares to which Mr. Hansen is entitled through the Company's Deferred Compensation Plan for Certain Directors.\n(8) In addition to the shares shown, Mr. Perkins, as trustee of The Putnam Funds, has shared voting and investment power over 443,000 shares of Common Stock, as to which he disclaims beneficial ownership.\n(9) Mr. Powers'wife owns 1,200 shares of Preferred Stock, as to which he does not disclaim beneficial ownership.\n(10) Includes 1,000 and 1,932 shares held by wives of Messrs. Wells and Zimmerman, respectively.\nThe Chief Executive Officer and four other most highly paid executive officers beneficially own the following shares of equity securities of the Company:\nExcept as indicated above, no director or any executive officer owns any other equity securities of the Company. No director or executive officer owns as much as one percent of the Common Stock. All executive officers and directors as a group own 78,751 shares of the Common Stock (less than one percent). The nature of beneficial ownership for shares shown, unless otherwise indicated, is sole voting and investment power.\nDirectors of the Company who are not salaried officers (\"Outside Directors\") receive a retainer fee of $18,000 per year. Outside Directors who also chair Board committees receive an additional $2,000 per year retainer. Outside Directors receive a grant of 600 shares of the Company's Common Stock on the date of each Annual Shareholders Meeting, representing payment in lieu of attendance-based fees for all Board and Committee meetings to be held during the subsequent one-year period. Outside Directors elected to the Board between Annual Shareholders Meetings are paid $850 for each Board and Committee meeting attended prior to the first Annual Shareholders Meeting after their election to the Board. The Company has a Retirement Plan for Outside Directors. Under this plan, each Outside Director who has attained age 65 and has served on the Board for a period of 60 or more consecutive months is eligible for annual retirement benefits at the rate of the annual retainer fee in effect when the director retires. These benefits, at the discretion of the Board, may be extended to Outside Directors who have attained the age of 65 but not served on the Board for the specified period. The benefits are payable for a number of months equal to the number of months of Board service, subject to a maximum of 120 months, and cease upon the death of the retired Outside Director.\nPursuant to the Company's Deferred Compensation Plan for Certain Directors, any director who is not a salaried officer or employee of the Company may elect to defer all or any portion of his or her fees until termination of\n- 38 -\nhis or her services as a director. Such deferred dollar amounts are converted into stock units representing shares of the Company's Common Stock with the value of each stock unit based upon the last reported sales price of such stock at the end of each calendar quarter. Additional credits are made to the participating director's account in dollar amounts equal to the dividends paid on the Common Stock which the director would have received if the director had been the record owner of the shares represented by stock units, and are converted into additional stock units. Upon termination of a participating director's services as a director, payment of his or her deferred fees is made in shares of Common Stock in an amount equal to the aggregate number of stock units credited to his or her account. Such payment is made in such number of annual installments as the Company may determine beginning in the year following the year of termination.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone.\n- 39 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of this report. (1) Financial Statements: Page in Annual Report to Stockholders*\nReport of Independent Accountants 26 Statements of Income for the three years ended December 31, 1993 27 Balance Sheets at December 31, 1993 and 1992 28 Statements of Cash Flows for the three years ended December 31, 1993 29 Statements of Retained Earnings (Deficit) for the three years ended December 31, 1993 29 Statements of Preferred and Preference Stock at December 31, 1993 and 1992 30 Statements of Long-Term Debt at December 31, 1993 and 1992 31 Notes to Financial Statements 32 - 46\nPage in Form 10-K\n(2) Financial Statement Schedules:\nReport of Independent Accountants on Financial Statement Schedules 43 V Utility 44 - 46 VI Accumulated Depreciation 47 - 49 VIII Valuation and Qualifying Accounts 50 - 52 X Supplementary Income Statement Information 53\n* Incorporated by reference from the indicated pages of the 1993 Annual Report.\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n- 40 -\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued)\n(3) Exhibits\nThe exhibits filed with the Form 10-K are listed in the Exhibit Index located elsewhere herein. All management contracts and compen- satory plans or arrangements set forth in such list are marked with a ~.\n(b) Reports on Form 8-K since September 30, 1993:\nA Current Report on Form 8-K, dated October 15, 1993, was filed reporting under Item 5, Other Events.\nA Current Report on Form 8-K, dated February 9, 1994, was filed reporting under Item 5, Other Events.\n- 41 -\nSIGNATURES\nPursuant 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.\nILLINOIS POWER COMPANY (REGISTRANT)\nBy Larry D. Haab Larry D. Haab, Chairman, President and Chief Executive Officer\nDate: March 30, 1994\nPursuant 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 on the dates indicated.\nSignature Title Date\nLarry D. Haab Chairman,President, Chief Larry D. Haab Executive Officer and Director (Principal Executive Officer)\nLarry F. Altenbaumer Senior Vice President Larry F. Altenbaumer and Chief Financial Officer Principal Financial Officer)\nAlec G. Dreyer Controller Alec G. Dreyer (Principal Accounting Officer)\nRichard R. Berry Richard R. Berry\nGrover J. Hansen\nDonald E. Lasater Donald E. Lasater\nDonald S. Perkins March 30, 1994 Donald S. Perkins\nRobert M. Powers Robert M. Powers\nWalter D. Scott Walter D. Scott Director\nRonald L. Thompson Ronald L. Thompson\nWalter M. Vannoy Walter M. Vannoy\nMarilou von Ferstel Marilou von Ferstel\nCharles W. Wells Charles W. Wells\nJohn D. Zeglis John D. Zeglis\nVernon K. Zimmerman Vernon K. Zimmerman\n- 42 -\nReport of Independent Accountants on Financial Statement Schedules\nTo the Board of Directors of Illinois Power Company\nOur audits of the financial statements referred to in our report dated February 9, 1994, appearing on page 26 of the 1993 Annual Report to Stockholders of Illinois Power Company (which report and financial statements are incorporated by reference in this Annual Report on Form 10-K), also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements.\nAs discussed in Note 1 to the financial statements, the Company changed its method of accounting for income taxes.\n\\S\\ Price Waterhouse\nPRICE WATERHOUSE One Boatmen's Plaza St. Louis, Missouri\nFebruary 9, 1994\n- 43 -\n( ) Credit (1) Gross-up to Plant ($162 million - Electric and $.9 million - Gas) for Net-of-Tax AFUDC in accordance with FAS 109. (2) Transfer of ($2.7 million) from Gas Stored Underground (Noncurrent) to Underground Storage at the Hillsboro Storage Field. (3) Transfer of $3.7 million from Inventory to Gas Stored Underground (Noncurrent) at the Hillsboro Storage Field. (4) Transfer between accounts - Clinton Unitization [Nuclear - ($7.8 million), Transmission - $9.7 million, General Plant - ($1.9 million)] (5) Includes ($11.6 million) deferred Clinton costs. (6) Includes ($1 million) capital lease property.\n- 44 -\n( ) Credit (1) Transfer of $21.7 million from CWIP to Plant held for future use due to suspended scrubber project. (2) Transfer of $2.2 million to Plant held for future use and $.5 million to Non-utility property from Production ($2.4 million) and Transmission Plan ($.3 million). (3) Transfer of $2.3 million from Gas stored underground (noncurrent) to Underground storage at the Hillsboro Storage Field. (4) Transfer of $4.5 million from Inventory to Gas stored underground (noncurrent) at the Hillsboro Storage Field.\n- 45 -\n( ) Credit (1) Reflects acquisition of capital lease property - computers and computer equipment - and their subsequent amortization. (2) Transfer of $2.2 million from Gas stored underground (noncurrent) to Underground storage at the Hillsboro Storage Field. (3) Transfer of $3.8 million from Inventory to Gas stored underground (noncurrent) at the Hillsboro Storage Field.\n- 46 -\n( ) Credit (1) Includes Depreciation Reserve of $38.8 million (Electric) and $.7 million (Gas) associated with FAS 109 compliance. (2) Includes $1.8 million associated with write-off of deferred Clinton costs. (3) Includes provision of approximately $.5 million for transportation equipment harged to clearing accounts. (4) Includes provision of approximately $.9 million for transportation equipment charged to clearing accounts. (5) Transfer of $1.9 million in Accumulated Provision associated with reclassification of the Danville Propane Plant to Account 105 and $.6 million associated with Galesburg Propane Plant transfer to Account 121.\n- 47 -\n( ) Credit\n- 48 -\n( ) Credit - 49 -\n- 50 -\n(1) Includes $2.5 million reduction to the reserve for uncollectible accounts.\n- 51 -\n- 52 -\n- 53 -\n- 54 -\n- 55 -\n- 56 -\n- 57 -\n- 58 -\n- 59 -\n- 60 -\n- 61 -\n- 62 -\nExhibit 3(g)\nExtract From Minutes of a Meeting of the Board of Directors of Illinois Power Company Held June 9, 1993\nRESOLVED, that pursuant to the authority vested in the Board of Directors under the terms and provisions of Article V of the Restated Articles of Incorporation of the Company, there is hereby established, as a series of the authorized Serial Preferred Stock, $50 par value, of the Company, a series to be known and designated as 7.75% Cumulative Preferred Stock (such series being herein called the \"New Preferred Stock\"), the relative rights and preferences of which, in addition to those applicable to all Serial Preferred Stock as class, as stated in said Article V, are hereby fixed and determined as follows:\n(a) The number of shares constituting the new Preferred Stock shall be 870,000.\n(b) The annual dividend rate on the New Preferred Stock shall be $3.875 per share in cash, and no more, and the date from which dividends on all shares of the New Preferred Stock issued prior to the record date for the first dividend payment on the new Preferred Stock shall be cumulative shall be the date of issue thereof.\n(c) The New Preferred Stock is not redeemable prior to July 1, 2003. On or after July 1, 2003, the new Preferred Stock shall be redeemable, in whole or in part, at the option of the Company. The redemption price for the New Preferred Stock (exclusive of accrued and unpaid dividends), to be paid in cash, shall be $50 per share.\n(d) The amount payable to the holders of the New Preferred Stock upon voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company or upon any distribution of its capital shall be at the rate of $50 per share in cash (exclusive of accrued and unpaid dividends).\nRESOLVED, that in light of the possibility that the Company's balance of retained earnings may become negative as a result of recording additional losses due to adverse decisions with respect to the Illinois Commerce Commission's August 7, 1992 rate order on appeal, there be and hereby is declared out of retained earnings of the Company a $.4317 per share dividend on the New Preferred Stock, when and if such New Preferred Stock is issued, payable on August 1, 1993, and a $.96875 per share payable dividend on the New Preferred Stock, payable on each of November 1, 1993, February 1, 1994 and May 1, 1994, to holders of record at the close of business on the applicable record dates in proportion to their respective holdings; provided, however, that payment is contingent on satisfaction, at the\n- 63 -\ntime of payment, of the financial tests set forth in the Illinois Commerce Commission Order dated March 24, 1993 in Docket 92- 0415 authorizing payment of dividends on the Company's outstanding Preferred and Common Stock in the event that the Company's retained earnings are insufficient to pay such dividends with respect to the aggregate amount of dividends on outstanding Preferred Stock and Common Stock to be paid at each payment date, including the dividends declared hereby and payment being otherwise lawful at the time made; and provided further, that if any such payment of dividends on new Preferred Stock cannot be made on each respective dividend payment date set forth above, then the payment of each such dividend shall be deferred until the earliest date on which such dividends may be paid, and in the event of such deferral, any payment in arrears shall be made to holders of record on the applicable record date which is related to the scheduled dividend payment date on which payment is made.\nI, LEAH MANNING STETZNER, Vice President, General Counsel and Corporate Secretary of ILLINOIS POWER COMPANY, do hereby certify that the foregoing is a true and correct copy of a certain resolution duly adopted by the Board of Directors of said Company at a meeting of said Board duly convened and held on the 9th day of June, 1993 at which meeting a quorum of said Board was present and voting throughout, and that said resolution has not been altered or amended and is in full force and effect on the date hereof.\nIN WITNESS WHEREOF, I have hereunto set my hand and affixed the corporate seal of said Illinois Power Company this 9th day of June, 1993.\nSecretary\n- 64 -\nExhibit 4(hh)\nILLINOIS POWER COMPANY\nTO\nHARRIS TRUST AND SAVINGS BANK,\nas Trustee\nSUPPLEMENTAL INDENTURE\nDated February 1, 1994\nTO\nMortgage and Deed of Trust\nDated November 1, 1943\n- 65 -\nSupplemental Indenture, dated the first day of February, Nineteen hundred and ninety-four (1994) (hereinafter referred to as the \"Supplemental Indenture\"), made by and between ILLINOIS POWER COMPANY, a corporation organized and existing under the laws of the State of Illinois (hereinafter called the \"Company\"), party of the first part, and HARRIS TRUST AND SAVINGS BANK, a corporation organized and existing under the laws of the State of Illinois (hereinafter called the \"Trustee\"), as a Trustee under the mortgage and Deed of Trust dated November 1, 1943, hereinafter mentioned, party of the second part;\nWHEREAS, the Company has heretofore executed and delivered its Mortgage and Deed of Trust dated November 1, 1943 (hereinafter referred to as the \"Original Indenture\"), to the Trustee, for the security of the First Mortgage Bonds of the Company issued and to be issued thereunder (hereinafter called the \"Bonds\"); and\nWHEREAS, pursuant to the terms and provisions of the Original Indenture there were created and authorized by various Supplemental Indentures First Mortgage Bonds of various series, including a series known as First Mortgage Bonds, Pollution Control Series K (\"Pollution Control Series K Bonds\") which was created and authorized by Supplemental Indenture No. 1 dated June 1, 1992 (\"Supplemental Indenture No. 1 of June 1, 1992\") and\nWHEREAS, the Pollution Control Series K Bonds were duly issued under and secured by the Indenture and Supplemental Indenture No. 1 of June 1, 1992 in the aggregate principal amount of $35,615,000, bearing interest at a rate of seven and three-tenths per cent (7.30%) per annum; and\nWHEREAS, the Company deems it advisable that Supplemental Indenture No. 1 of June 1, 1992 be amended as herein provided, and the holder of the outstanding Pollution Control Series K Bonds has duly consented to this amendment and the execution of this Supplemental Indenture and has delivered to the Trustee an instrument duly setting forth such consent;\nWHEREAS, the Company, in the exercise of the powers and authority conferred upon and reserved to it under the provisions of the Original Indenture, and pursuant to appropriate resolutions of the Board of Directors, has duly resolved and determined to make, execute and deliver to the Trustee a Supplemental Indenture in the form hereof for the purposes herein provided; and\nWHEREAS, all conditions and requirements necessary to make this Supplemental Indenture a valid, binding and legal instrument have been done, performed and fulfilled and the execution and delivery hereof have been in all respects duly authorized;\n- 66 -\nNOW, THEREFORE, THIS INDENTURE WITNESSETH:\nTHAT Illinois Power Company, in consideration of the purchase and ownership from time to time of the Bonds and the service by the Trustee, and its successors, under the Original Indenture and of One Dollar to it duly paid by the Trustee at or before the ensealing and delivery of these presents, the receipt whereof is hereby acknowledged, hereby covenants and agrees to and with the Trustee and its successors in the trust under the Original Indenture, for the benefit of those who shall hold the Bonds and coupons, if any, appertaining thereto, as follows:\nARTICLE I.\nAMENDMENT TO SUPPLEMENTAL INDENTURE NO. 1 OF JUNE 1, 1992.\nSECTION 1. Wherever in Supplemental Indenture No. 1 of June 1, 1992 reference is made to interest on the Pollution Control Series K Bonds at the rate of seven and tree-tenths per cent (7.30%) per annum, Supplemental Indenture No. 1 of June 1, 1992 is hereby amended to read \"five and seven- tenths per cent (5.70%)\" in lieu of \"seven and three-tenths per cent (7.30%)\" in each and every place where the term \"seven and three-tenths per cent (7.30%)\" shall occur.\nARTICLE II.\nMISCELLANEOUS PROVISIONS.\nSECTION 1. Except as amended by this Supplemental Indenture, all of the provisions of the Indenture and Supplemental Indenture No. 1 of June 1, 1992 shall remain in full force and effect, and from and after the effective date of this Supplemental Indenture shall be deemed to have been amended as herein set forth.\nSECTION 2. This Supplemental Indenture may be simultaneously executed in any number of counterparts, each of which when so executed shall be deemed to be an original; but such counterparts shall together constitute but one and the same instrument.\nIN WITNESS WHEREOF, said Illinois Power Company has caused this Supplemental Indenture to be executed on its behalf by its Chairman and President, one of its Executive Vice Presidents, one of its Senior Vice Presidents or one of its Vice Presidents and its corporate seal to be hereto affixed and said seal and this Indenture to be attested by its Secretary or one of its Assistant Secretaries; and said Harris Trust and Savings Bank, in evidence of its\n- 67 -\nacceptance of the trust hereby created, has caused this Indenture to be executed on its behalf by its President or one of its Vice Presidents and its corporate seal to be hereto affixed and said seal and this Indenture to be attested by its secretary or one of its Assistant Secretaries; all as of the first day of February, one thousand nine hundred and ninety-four.\nILLINOIS POWER COMPANY\n(CORPORATE SEAL) BY__\\s\\ LARRY F. ALTENBAUMER Senior Vice President and Chief Financial Officer\nATTEST:\n__\\s\\__Gary B. Pasek _________ Assistant Secretary\nHARRIS TRUST AND SAVINGS BANK, Trustee\n(CORPORATE SEAL) BY__\\s\\_J. Bartoline_______________ Vice President\nATTEST:\n__\\s\\_D. G. Donovan_______\n- 68 -\nSTATE OF ILLINOIS ) SS.: COUNTY OF MACON )\nBE IT REMEMBERED, that on this 27th day of January, 1994, before me, the undersigned Anita F. Ricker, a Notary public within and for the County and State aforesaid, personally came L. F. Altenbaumer, Senior Vice President and Chief Financial Officer, and G. B. Pasek, Assistant Secretary, of Illinois Power Company, a corporation duly organized, incorporated and existing under the laws of the State of Illinois, who are personally known to me to be such officers, and who are personally know to me to be the same persons who executed as such officers the within instrument of writing, and such persons duly acknowledged that they signed, sealed and delivered the said instrument as their free and voluntary act as such Vice President and Assistant Secretary, respectively, and as the free and voluntary act of said Illinois Power Company for uses and purposes therein set forth.\nIN WITNESS WHEREOF, I have hereunto subscribed my name and affixed my official seal on the day and year last above written.\n__\\s\\ Anita S. Ricker___\nNotary Public, Macon County, Illinois\nMy Commission Expires on June 28, 1997.\n(NOTARIAL SEAL)\nSTATE OF ILLINOIS ) SS.: COUNTY OF COOK )\nBE IT REMEMBERED, that on this 26th day of January, 1994, before me, the undersigned Marianne Cody, a Notary Public within and for the County and State aforesaid, personally came J. Bartolini, Vice President, and D. G. Donovan, Assistant Secretary, of Harris Trust and Savings Bank, a corporation duly organized, incorporated and existing under the laws of the State of Illinois, who are personally known to me to be the same persons who executed as such officers the within instrument of writing, and such persons duly acknowledged that they signed, sealed and delivered the said instrument as their free and voluntary act as such Vice President and Assistant Secretary, respectively, and as the free and voluntary act of said Harris Trust and Savings Bank for the uses and purposes therein set forth.\n- 69 -\nIN WITNESS WHEREOF, I have hereunto subscribed my name and affixed my official seal on the day and year last above written.\n_______\\s\\ Marianne Cody______________ Notary Public, Cook County, Illinois\nMy Commission Expires on May 29, 1997.\n(NOTARIAL SEAL)\nReturn to: This Instrument was prepared by\nILLINOIS POWER COMPANY SCHIFF, HARDIN & WAITE Real Estate Dept. 7200 Sears Tower 500 S. 27th Street Chicago, IL 60606 Decatur, IL 62525\n- 70 -\nExhibit 10(h)\nILLINOIS POWER COMPANY STOCK PLAN FOR OUTSIDE DIRECTORS As Amended and Restated April 9, 1992 And As Further Amended April 14, 1993\n1. HISTORY AND PURPOSE\nThe Stock Plan for Outside Directors (the \"Plan\") was established by Illinois Power Company (The \"Company\") to increase the stock ownership interests of directors in the Company and thereby provide further incentive to directors to work toward the long-term best interests of the Company and its shareholders. The following provisions constitute an amendment, restatement and continuation of the Plan as in effect immediately prior to April 9, 1992, the \"Effective Date\" of the Plan as set forth herein.\n2. ELIGIBILITY\nOnly outside directors of the Company (i.e., directors who are not officers or employees of the Company or any of its subsidiaries or affiliates) are eligible to participate in the Plan.\n3. GRANT OF STOCK\nEach outside director elected to the Board of Directors of the Company (the \"Board\") at each annual shareholders meeting of the Company (beginning with the 1993 annual shareholders meeting) shall receive 600 shares of common stock of the Company as soon as practicable after such meeting.\nSuch shares shall be obtained from one or both of the following sources:\n(a) Shares may be purchased on the open market for the accounts of directors by a broker selected by the chief financial officer of the Company, or his delegate. If shares are obtained in accordance with this paragraph 3(a), they shall be transferred directly to the director, and shall not be transferred to or held by the Company. The cost of obtaining such shares shall be paid by the Company.\n- 71 -\n(b) Treasury shares may be used, to the extent permitted by applicable law.\nThe shares so transferred represent payment for all Board and committee meetings to be held during the one- year period prior to the next annual shareholders meeting. Nothing in this paragraph 3 shall be construed to prevent the Board from awarding cash meeting fees to any outside director, which cash fees shall be in addition to the amounts granted to the outside directors in accordance with the other provisions of this paragraph 3.\nOutside directors elected to the Board between annual shareholders meetings shall be paid in cash for attendance at meetings prior to the first annual shareholders meeting after their election to the Board.\n4. ADJUSTMENT TO SHARES\nIn the event of any change in the outstanding shares of the common stock of the Company by reason of any stock dividend, split, reverse split, spin-off, recapitalization, merger, consolidation, combination, exchange of shares or other similar change, the number of shares of stock to be awarded to each director under the Plan shall be equitably adjusted by the Board.\n5. AMENDMENT\nThe Plan may be amended by the Board, except that, to the extent necessary to comply with Rule 16b- 3(c)(2)(ii), issued pursuant to the Securities Exchange Act of 1934, the provisions of the Plan may not be amended more than once in any six month period, other than to comport with changes in the Employee Retirement Income Security Act of 1974, as amended, or the Internal Revenue Code, as amended, and applicable regulations thereunder.\n- 72 -\nExhibt 10(1)\nILLINOIS POWER COMPANY EXECUTIVE DEFERRED COMPENSATION PLAN\n- 73 -\n- 74 -\n- 75 -\nILLINOIS POWER COMPANY EXECUTIVE DEFERRED COMPENSATION PLAN\nGeneral\n.1. Purpose. Illinois Power Company Executive Deferred Compensation Plan (the \"Plan\") has been established by Illinois Power Company (the \"Company\") so that it, and each of the Related Companies which, with the consent of the Company, adopts the Plan may provide its eligible key management employees with an opportunity to build additional financial security, thereby aiding such companies in attracting and retaining employees of exceptional ability.\n.2. Effective Date. The \"Effective Date\" of the Plan is December 8, 1993. No deferrals of Compensation shall be permitted under the Plan for any Plan Year with respect to Compensation otherwise payable by any Employer during that year unless the Employer has specifically adopted the Plan with respect to such year.\n.3. Related Companies and Employers. The term \"Related Company\" means any company during any period in which it owns at least fifty percent of the voting power of all classes of stock of the Company entitled to vote, and any company during any period in which at least fifty percent of the voting power of all classes entitled to vote is owned, directly or indirectly, by the Company or by any other company that is a Related Company by reason of its ownership of stock of the Company. The Company and each Related Company that adopts the Plan for the benefit of its eligible employees are referred to below collectively as the \"Employers\" and individually as an \"Employer\".\n.4. Administration. The authority to control and manage the operation and administration of the Plan shall be vested in the Compensation and Nominating Committee (the \"Committee\") of the Board of Directors of the Company. In controlling and managing the operation and administration of the Plan, the Committee shall have the rights, powers and duties set forth in Section 7.\n.5. Plan Year. The term \"Plan Year\" means the calendar year.\n.6. Applicable Laws. The Plan shall be construed and administered in accordance with the laws of the State of Illinois\n- 76 -\nto the extent that such laws are not preempted by the laws of the United States of America.\n.7. Gender and Number. Where the context admits, words in any gender shall include any other gender, words in the singular shall include the plural and the plural shall include the singular.\n.8. Notices. Any notice or document required to be filed with the Plan Administrator or the Committee under the Plan will be properly filed if delivered or mailed by registered mail, postage prepaid, to the Plan Administrator, in care of the Company, at its principal executive offices. The Plan Administrator may, by advance written notice to affected persons, revise such notice procedure from time to time. Any notice required under the Plan may be waived by the person entitled to notice.\n.9. Form and Time of Elections. Unless otherwise specified herein, each election required or permitted to be made by any Participant or other person entitled to benefits under the Plan, and any permitted modification or revocation thereof, shall be in writing filed with the Plan Administrator at such times, in such form, and subject to such restrictions and limitations as the Plan Administrator shall require.\n.10. Benefits Under Qualified Plans. Compensation of any Participant that is deferred under the Plan, and benefits payable under the Plan, shall be disregarded for purposes of determining the benefits under the Illinois Power Company Incentive Savings Plan (the \"Savings Plan\"), the Illinois Power Company Retirement Income Plan for Salaried Employees, and any other plan that is intended to be qualified under section 401(a) of the Internal Revenue Code of 1986.\n.11. Evidence. Evidence required of anyone under the Plan may be by certificate, affidavit, document or other information which the person acting on it considers pertinent and reliable, and signed, made or presented by the proper party or parties.\n.12. Action by Employers. Any action required or permitted to be taken by any Employer shall be by resolution of its Board of Directors, or by a duly authorized officer of the Employer.\n.13. Defined Terms. Terms used frequently with the same meaning are indicated by initial capital letters, and are defined\n- 77 -\nthroughout the Plan. Appendix A contains an alphabetical listing of such terms and the locations in which they are defined.\nParticipation\n.1. Participant. Any individual who is an Eligible Employee for any Plan Year shall be eligible to participate in the Plan for the Plan Year, subject to the terms of the Plan. For purposes of the Plan, the term \"Eligible Employee\" for any Plan Year shall mean any employee of the Company who is an elected officer of the Company for that Plan Year.\n.2. Deferral Election. An Eligible Employee shall participate in the Plan by electing to defer payment of a portion of his Compensation pursuant to the terms of a \"Deferral Election\". An individual's Deferral Election shall be subject to the following:\n(a) An individual who, prior to the beginning of any Plan Year, satisfies the requirements of an Eligible Employee for the Plan Year, shall be eligible to file a Deferral Election with respect to his Compensation for that Plan Year. Such Deferral Election shall be filed before the first day of that year (or at such earlier time as may be established by the Committee).\n(b) An individual who, prior to the beginning of any Plan Year, has not satisfied the requirements of an Eligible Employee for the Plan Year, but who becomes an Eligible Employee during the Plan Year, shall be eligible to file a Deferral Election with respect to his Compensation for that Plan Year, subject to the limits of paragraph 2.2(d). Such Deferral Election shall be filed within thirty days (or such shorter period as may be specified by the Committee) after he first becomes an Eligible Employee for the year.\n(c) If the Plan first becomes effective with respect to the employees of any Employer during any Plan Year, and an employee of that Employer becomes an Eligible Employee on the date the Plan becomes effective, such employee shall be eligible to file a Deferral Election with respect to Compensation for that Plan Year, subject to the limits of paragraph 2.2(d). Such Deferral\n- 78 -\nElection shall be filed within thirty days (or such shorter period as may be specified by the Committee) after the date the Plan becomes effective.\n(d) To the extent elected by a Participant, and subject to the terms of the Plan, a Participant's Deferral Election for any Plan Year shall apply to his Compensation for that Plan Year. The terms of a Deferral Election shall be subject to any conditions and limitations that may be imposed by the Committee. Except as otherwise provided in this subsection 2.2, a Deferral Election shall be irrevocable for the Plan Year to which it applies. In no event may a Deferral Election cover Compensation earned prior to the date the election is completed and filed in accordance with the Plan.\n(e) The Committee may revoke an individual's Deferral Election as of the date on which the individual ceases to be an Eligible Employee.\n(f) Each Deferral Election shall be revoked as of the date on which a Change in Control occurs, and no new Deferral Election shall be accepted for any date after the date of a Change in Control.\n(g) Subject to the terms of the Plan, the Participant shall specify, as part of his Deferral Election, and in accordance with subsection 4.2, the time and form of distribution of the amounts deferred pursuant to such election.\n.3. Compensation. For purposes of the Plan, a Participant's \"Compensation\" from any Employer for any Plan Year means any short-term incentive payable to him under the Illinois Power Company Executive Incentive Compensation Plan for that year (regardless of whether it is otherwise payable to him during that year or during a later year).\n.4. Plan Not Contract of Employment. The Plan does not constitute a contract of employment, and participation in the Plan will not give any employee the right to be retained in the employ of any Employer nor any right or claim to any benefit under the Plan, unless such right or claim has specifically accrued under the terms of the Plan.\n- 79 -\nPlan Accounting\n.1. Accounts. The Plan Administrator shall establish an Account for each Plan Year for each Participant who has filed a Deferral Election. If a Participant is employed by more than one Employer in any Plan Year, and his Compensation otherwise payable from such Employers is reduced pursuant to the Plan, a separate Account shall be established for the Participant with respect to the Compensation for the Plan Year from each such Employer.\n.2. Adjustment of Accounts. Each Account shall be adjusted in accordance with this Section 3 in a uniform, non- discriminatory manner, as of such periodic \"Accounting Dates\" as may be determined by the Plan Administrator from time to time (which Accounting Dates shall be not less frequent than quarterly). As of each Accounting Date, the balance of each Account shall be adjusted as follows:\n(a) first, charge to the Account balance the amount of any distributions under the Plan with respect to that Account that have not previously been charged;\n(b) then, adjust the Account balance for the applicable Investment Return Rate(s); and\n(c) then, credit to the Account balance the amount to be credited to that Account in accordance with subsection 3.3 that have not previously been credited.\n.3. Crediting Under Deferral Election. The balance of a Participant's Account for any Plan Year shall be credited, in accordance with the provisions of paragraph 3.2(c), with the amount by which his Compensation for the year is reduced pursuant to a Deferral Election. Such crediting shall occur as of the date on which such Compensation would otherwise have been paid to the Participant by the Employer were it not for the reduction made pursuant to the Deferral Election or, if such date is not an Accounting Date, as of the first Accounting Date occurring thereafter.\n.4. Investment Return Rates. The \"Investment Return Rate(s)\" with respect to the Account(s), or portions of the Account(s), of any Participant for any period shall be the Investment Return\n- 80 -\nRate(s) elected by the individual from among the following alternatives in accordance with subsection 3.5:\n(a) The Investment Return Rates described in paragraph 3.6(b), provided that no Investment Return Rate based on stock or other securities of the Company shall be offered under this paragraph 3.6(a).\n(b) The return from such other investment alternatives (if any) for that period which, in the discretion of the Committee, are offered from time to time under this paragraph 3.4(b).\nSubject to the provisions of subsection 3.6, and any other applicable provisions of the Plan, the Committee may eliminate any Investment Return Rate alternative at any time; provided, however, that the Company may not retroactively eliminate any Investment Return Rate alternative.\n.5. Employee Selection of Investment Return Rate. Subject to the terms of the Plan, a Participant may elect the Investment Return Rate(s) that will apply to all of his Accounts for any Plan Year, by filing an election with the Plan Administrator as to such Investment Return Rate(s), subject to the following:\n(a) if the Investment Return Rate(s) being selected is for the first year in which an Eligible Employee participates in the Plan, the election as to Investment Return Rate(s) must be filed by the due date for filing the Participant's Deferral Election for that year, or at such earlier time as may be established by the Plan Administrator; and\n(b) in all other cases, the election must be filed prior to the beginning of such Plan Year, or at such earlier time as may be established by the Plan Administrator.\nThe same Investment Return Rate(s) shall apply to all Accounts of a Participant for any Plan Year. To the extent permitted by the Committee, the Participant may elect to have different Investment Return Rates apply to different portions of his Account balances for any Plan Year.\n.6. Protected Investment Return Rates. At all times the Plan is in effect, the Plan shall provide that the Investment Return\n- 81 -\nRate(s) offered to each Participant shall include the Investment Return Rate described in paragraph 3.6(a), or each of the Investment Return Rates described in paragraph 3.6(b).\n(a) The Investment Return Rate described in this paragraph 3.6(a) for any period shall be the sum of: (i) the short-term borrowing rate for the Company for the period, plus (ii) 2.0 percentage points.\n(b) The Investment Return Rates described in this paragraph 3.6(b) for any period shall be each of the respective rates of investment return provided by each of the investment funds available under the Savings Plan for that period, subject to the following:\n(i) The rate of investment return with respect to the Company Stock Fund under the Savings Plan (or any investment fund based primarily on the return on stock or other securities of the Company, or any successor to the Company) need not be included as an Investment Return Rate under this Plan.\n(ii) The net investment return provided by an investment fund under the Savings Plan shall be the rate determined after reduction for any investment management fee or other, similar administrative fee or charge, to the extent that such fee or charge is applied under the Savings Plan in determining the net investment return of such fund.\n(iii) The net investment return from an investment fund under the Savings Plan shall not be reduced to reflect income taxes paid or payable with respect to such return; provided, however, that if, after the Effective Date, there is a material change in the applicable income tax laws, the rate of investment return may be adjusted by the Company to reflect income taxes to the extent that the Company reasonably determines such adjustment is necessary to preserve the benefit of the Plan, as originally established, for the Participants and the Company.\n(iv) The Investment Return Rates offered pursuant to this paragraph 3.6(b) shall be revised from time\n- 82 -\nto time to reflect changes in the investment funds offered under the Savings Plan; provided, however, that the recognition (with respect to this Plan) of any such changes in the investment funds offered by the Savings Plan may, in the discretion of the Company, be delayed for up to twelve months after such change is effective under the Savings Plan.\nNothing in this subsection 3.6 shall be construed to require the Plan to permit a Participant to select between the Investment Return Rate described in paragraph 3.6(a), and the Investment Return Rates described in paragraph 3.6(b), with respect to the same period.\nDistributions\n.1. General. Subject to this Section 4 and Section 5 (relating to change in control), the balance of a Participant's Account with respect to any year shall be distributed in accordance with the Participant's Deferral Election applicable to that Account. In no event shall the amount distributed with respect to any Participant's Account as of any date exceed the amount of the Account balance as of that date.\n.2. Distribution Election. A Participant's Deferral Election for any year shall specify the manner (including the time and form of distribution) in which the Account attributable to such election shall be distributed, subject to such restrictions and limitations as may be imposed by the Committee.\n.3. Unforeseeable Emergency. Prior to the date otherwise scheduled for distribution of his benefits under the Plan, upon a showing of an unforeseeable emergency, a Participant may elect to accelerate payment of an amount not exceeding the lesser of (a) the amount necessary to meet the emergency or (b) the sum of his Account balance(s) under the Plan. For purposes of the Plan, the term \"unforeseeable emergency\" shall mean an unanticipated emergency that is caused by an event beyond the control of the Participant (or the control of the beneficiary, if the amount is payable to a beneficiary) and that would result in severe financial hardship to the individual if early withdrawal were not permitted. The determination of \"unforeseeable emergency\" shall\n- 83 -\nbe made by the Plan Administrator, based on such information as the Plan Administrator shall deem to be necessary.\n.4. Sale of Business. If all or a substantial portion of the assets and business of an Employer (the \"Selling Employer\") is sold or otherwise transferred to a company (the \"Purchaser\") that is not a Related Company (a \"Sale Transaction\"), and in connection with the Sale Transaction, any Participant is employed by the Purchaser, then the Selling Employer may, in its sole discretion, discharge all obligation to the Participant by accelerating the date on which the Participant's Plan benefits are payable; provided, however, that any such acceleration shall be effective only if (i) the payment is made not later than 180 days following the date of the Sale Transaction, and (ii) the lump sum payable in settlement of the Employer's obligations to the Participant under the Plan is equal to 100% of the Participant's Account balances as of the date of payment.\n.5. Designation of Beneficiary. Each Participant from time to time, by signing a form furnished by the Plan Administrator, may designate any legal or natural person or persons (who may be designated contingently or successively) to whom his benefits under the Plan are to be paid if he dies before he receives all of his benefits. A beneficiary designation form will be effective only when the signed form is filed with the Plan Administrator while the Participant is alive and will cancel all beneficiary designation forms filed earlier. Except as otherwise specifically provided in this subsection 4.5, if a deceased Participant failed to designate a beneficiary as provided above, or if the designated beneficiary of a deceased Participant dies before him or before complete payment of the Participant's benefits, his benefits shall be paid to the legal representative or representatives of the estate of the last to die of the Participant and his designated beneficiary.\n.6. Distributions to Disabled Persons. Notwithstanding the provisions of this Section 4, if, in the Plan Administrator's opinion, a Participant or beneficiary is under a legal disability or is in any way incapacitated so as to be unable to manage his financial affairs, the Plan Administrator may direct that payment be made to a relative or friend of such person for his benefit until claim is made by a conservator or other person legally charged with the care of his person or his estate, and such payment shall be in lieu of any such payment to such Participant or beneficiary. Thereafter, any benefits under the Plan to which such Participant or beneficiary is entitled shall be paid to such\n- 84 -\nconservator or other person legally charged with the care of his person or his estate.\n.7. Benefits May Not be Assigned. Neither the Participant nor any other person shall have any voluntary or involuntary right to commute, sell, assign, pledge, anticipate, mortgage or otherwise encumber, transfer, hypothecate or convey in advance of actual receipt the amounts, if any, payable hereunder, or any part hereof, which are expressly declared to be unassignable and non-transferable. No part of the amounts payable shall be, prior to actual payment, subject to seizure or sequestration for payment of any debts, judgements, alimony or separate maintenance owed by the Participant or any other person, or be transferred by operation of law in the event of the Participant's or any other person's bankruptcy or insolvency.\n.8. Offset. Notwithstanding the provisions of subsection 4.7, if, at the time payments are to be made under the Plan, the Participant or beneficiary or both are indebted or obligated to any Employer or Related Company, then the payments remaining to be made to the Participant or the beneficiary or both may, at the discretion of the Plan Administrator, be reduced by the amount of such indebtedness, or obligation, provided, however, that an election by the Plan Administrator not to reduce any such payment shall not constitute a waiver of the claim for such indebtedness or obligation.\nChange in Control\n.1. Distribution on Change in Control. Upon the occurrence of a Change in Control, each Participant shall receive a lump sum distribution equal to 100% of the Participant's Account balances determined as of the date of the Change in Control. Such distributions shall be made to Participants regardless of any elections that may otherwise be applicable to them under the Plan, and shall be made as soon as practicable after the date of such Change in Control, but in no event later than 15 days after the occurrence of such Change in Control. Payments under this subsection 5.1 shall be in lieu of any amounts that would otherwise be payable after the date as of which the Participant's Account balance is determined for purposes of payment under this subsection.\n- 85 -\n.2. Change in Control Definition. For purposes of the Plan, a \"Change in Control\" will be deemed to occur on the earliest of the existence of one of the following and the receipt of all necessary regulatory approvals therefor:\n(a) the acquisition by an entity, person or group (including all Affiliates or Associates of such entity, person or group) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of capital stock of the Company entitled to exercise more than 20% of the outstanding voting power of all capital stock of the Company (\"Voting Power\");\n(b) the effective time of (i) a merger or consolidation of the Company with one or more other corporations as a result of which the holders of the outstanding Voting Power of the Company immediately prior to such merger or consolidation (other than the surviving or resulting corporation or any Affiliate or Associate thereof) hold less than 80% of the Voting Power of the surviving or resulting corporation, (ii) a transfer of a majority of the Voting Power other than to an entity of which the Company owns at least 80% of the Voting Power, or (iii) a transfer (other than a sale\/leaseback transaction) of a Substantial Portion of the Property of the Company other than to an entity of which the Company owns at least 80% of the Voting Power unless, within ten (10) days after such transfer of Property, the Board of Directors of the Company as constituted immediately before such transfer determines that such transfer shall not be a Change in Control hereunder; or\n(c) the election to the Board of Directors of the Company, of directors constituting a majority of the number of the directors in office unless such directors were recommended for election by the existing Board of Directors.\nFor purposes of this subsection 5.2, (A) the term \"Affiliate\" or \"Associate\" shall have the meaning set forth in Rule 12b-2 under the Securities Exchange Act of 1934; and (B) the term \"Substantial Portion of the Property of the Company\" shall mean 80% of the aggregate book value of the assets of the Company and its Affiliates and Associates as set forth in the most recent balance sheet of the Company, prepared on a consolidated basis, by its regularly employed, independent public accountants.\n- 86 -\nSource of Benefit Payments\n.1. Liability for Benefit Payments. Subject to the provisions of this Section 6, an Employer shall be liable for payment of benefits under the Plan with respect to any Participant to the extent that such benefits are attributable to the deferral of Compensation otherwise payable by that Employer to the Participant. Any disputes relating to liability of Employers for benefit payments shall be resolved by the Committee.\n.2. No Guarantee. Neither a Participant nor any other person shall, by reason of the Plan, acquire any right in or title to any assets, funds or property of the Employers whatsoever, including, without limitation, any specific funds, assets, or other property which the Employers, in their sole discretion, may set aside in anticipation of a liability under the Plan. A Participant shall have only a contractual right to the amounts, if any, payable under the Plan, unsecured by any assets of the Employers. Nothing contained in the Plan shall constitute a guarantee by any of the Employers that the assets of the Employers shall be sufficient to pay any benefits to any person.\n.3. Transfer to Related Employer. If a Participant leaves the employ of an Employer (the \"Original Employer\") and becomes the employee of another Employer or a Related Company (the \"New Employer\") then, with the consent of the Original Employer and the New Employer, but without the consent of the Participant, the liability of the Original Employer to the Participant under the Plan may be transferred to the New Employer. In the event of such transfer:\n(a) The Original Employer shall thereafter have no obligation to the Participant under the Plan.\n(b) The New Employer's rights and obligations with respect to the Participant shall be governed by the terms of the Plan, with the New Employer substituted for the Original Employer under the Plan with respect to the obligation to pay benefits to the Participant.\n- 87 -\nThe New Employer shall not be required to give effect to the Participant's Deferral Election with respect to remuneration earned at the New Employer.\nCommittee\n.1. Powers of Committee. Responsibility for the day-to- day administration of the Plan shall be vested in the Plan Administrator, which shall be the Committee. The authority to control and manage all other aspects of the operation and administration of the Plan shall also be vested in the Committee. The Committee is authorized to interpret the Plan, to establish, amend, and rescind any rules and regulations relating to the Plan, and to determine the terms and provisions of any agreements made pursuant to the Plan, and to make all other determinations that may be necessary or advisable for the administration of the Plan. Except as otherwise specifically provided by the Plan, any determinations to be made by the Committee under the Plan shall be decided by the Committee in its sole discretion. Any interpretation of the Plan by the Committee and any decision made by it under the Plan is final and binding on all persons.\n.2. Delegation by Committee. The Committee may allocate all or any portion of its responsibilities and powers to any one or more of its members and may delegate all or any part of its responsibilities and powers to any person or persons selected by it. Any such allocation or delegation may be revoked at any time. Until the Committee takes action to the contrary:\n(a) The chief executive officer of the Company shall be delegated the power and responsibility to take all actions assigned to or permitted to be taken by the Committee under Section 2, Section 3, and Section 4 (other than the powers and responsibility of the Plan Administrator).\n(b) The powers and responsibilities of the Plan Administrator shall be delegated to the Employee Services Department of the Company, subject to such direction as may be provided to the Employee Services Department from\n- 88 -\ntime to time by the Committee and the chief executive officer of the Company.\n.3. Information to be Furnished to Committee. The Employers and Related Companies shall furnish the Committee with such data and information as may be required for it to discharge its duties. The records of the Employers and Related Companies as to an employee's or Participant's employment, termination of employment, leave of absence, reemployment and Compensation shall be conclusive on all persons unless determined to be incorrect. Participants and other persons entitled to benefits under the Plan must furnish the Committee such evidence, data or information as the Committee considers desirable to carry out the Plan.\n.4. Liability and Indemnification of Committee. No member or authorized delegate of the Committee shall be liable to any person for any action taken or omitted in connection with the administration of the Plan unless attributable to his own fraud or willful misconduct; nor shall the Employers be liable to any person for any such action unless attributable to fraud or willful misconduct on the part of a director or employee of the Employers. The Committee, the individual members thereof, and persons acting as the authorized delegates of the Committee under the Plan, shall be indemnified by the Employers against any and all liabilities, losses, costs and expenses (including legal fees and expenses) of whatsoever kind and nature which may be imposed on, incurred by or asserted against the Committee or its members or authorized delegates by reason of the performance of a Committee function if the Committee or its members or authorized delegates did not act dishonestly or in willful violation of the law or regulation under which such liability, loss, cost or expense arises. This indemnification shall not duplicate but may supplement any coverage available under any applicable insurance.\nAmendment and Termination\nThe Committee may, at any time, amend or terminate the Plan, subject to the following:\n(a) Subject to the following provisions of this Section 8, no amendment or termination may materially adversely affect the rights of any Participant or beneficiary under the Plan.\n- 89 -\n(b) The Committee may revoke the right to defer Compensation under the Plan; provided, however, that no such revocation shall apply to the Compensation of any Participant to the extent that the revocation is adopted by the Committee after the date the Compensation is otherwise required to be credited to the Participant's Account under the Plan.\n(c) The Committee may amend the Plan to eliminate any Investment Return alternative; provided, however, that the Plan may not be amended to retroactively eliminate any Investment Return alternative, and further provided that the provisions of subsection 3.6 (relating to Protected Investment Return Rates) may not be amended or otherwise modified to materially adversely affect any Participant's rights under that subsection without the express written consent of such Participant.\n(d) The Plan may not be amended to delay the date on which benefits are otherwise payable under the Plan without the consent of each affected Participant. The Committee may amend the Plan to accelerate the date on which Plan benefits are otherwise payable under the Plan; provided, however, that any such amendment (and any termination of the Plan having the effect of such acceleration) shall be effective only if the acceleration results in payment of a lump sum of all benefits for all Participants at substantially the same time; and further provided that the lump sum payable in settlement of each Employer's obligations to each Participant under the Plan shall be equal to 100% of each Participant's Account balances as of the date of payment.\n(e) Notwithstanding any other provision of the Plan to the contrary, the Committee may not delegate its rights and responsibilities under this Section 8; provided, however, that, the Board of Directors of the Company may, from time to time, substitute itself, or another committee of the Board of Directors of the Company, for the Compensation and Nominating Committee under this Section 8.\n- 90 -\n- 91 -\n* Earnings are inadequate to cover fixed charges. Additional earnings of $374,958, $68,033 and 36,891 for 1989, 1990, and 1993, respectively, are required to attain a one-to-one ratio of Earnings to Fixed Charges. ** Supplemental ratio of earnings to fixed charges presented to exclude Disallowed Clinton plant costs.\n- 92 -\nExhibit 13\nIllinois Power Company 1993 Annual Report\nThe Illinois Power Company 1993 Annual Report was filed with the Securities and Exchange Commission.\nREFERENCE: IPWR10EX13\n- 93-124 -\n- 125 -\nEXHIBIT 23\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-22068), the Registration Statement on Form S-8 (No. 33-60278), and the Registration Statement on Form S-8 (No. 33-66124), and in the Prospectuses constituting part of the Registration Statement on Form S-3 (No. 33-50173), the Registration Statement on Form S-3 (No. 33-52048), the Registration Statement on Form S-3 (No. 33-62506), and the Registration Statement on Form S-3 (No. 33-25699) of Illinois Power Company of our report dated February 9, 1994, appearing on page 26 of the Annual Report to Stockholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules, which appears on page 43 of this Form 10-K.\n\\s\\ Price Waterhouse\nPRICE WATERHOUSE March 25, 1994\n- 126 -","section_15":""}
{"filename":"201533_1993.txt","cik":"201533","year":"1993","section_1":"ITEM 1. BUSINESS.\nGENERAL\nCMS Energy\nCMS Energy, incorporated in Michigan in 1987, is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the largest subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to end- users, and 4) transmission and storage of natural gas. For further information about subsidiary operations, see Item 1. BUSINESS. SUBSIDIARIES. CMS Energy is exempt from registration under PUHCA, see Item 1. BUSINESS. CMS ENERGY AND CONSUMERS REGULATION.\nCMS Energy's consolidated operating revenue in 1993 was derived approximately 61 percent from sales of electric energy, approximately 37 percent from sale, transportation and storage of natural gas, and approximately 2 percent from oil and gas exploration and production activities. Consumers' consolidated operations in the electric and gas businesses account for the major share of CMS Energy's total assets, revenue and income. CMS Energy's share of unconsolidated non-utility electric generation and gas transmission revenue for 1993 was $337 million.\nConsumers\nConsumers was incorporated in Michigan in 1968 and is the successor to a corporation of the same name which was organized in Maine in 1910 and which did business in Michigan from 1915 to 1968.\nConsumers is a public utility serving almost 6 million of Michigan's 9 million residents in 67 of the 68 counties in Michigan's Lower Peninsula. Industries in Consumers' service area include automotive, metal, chemical, food and wood products and a diversified group of other industries. Consumers' consolidated operating revenue in 1993 was derived approximately 64 percent from its electric business and approximately 36 percent from its gas business. Consumers' retail rates and certain other aspects of its business are subject to the jurisdiction of the MPSC. Consumers has five direct subsidiaries. For further information about subsidiary operations, see Item 1. BUSINESS. SUBSIDIARIES.\nBUSINESS SEGMENTS\nCMS Energy conducts its principal operations through the following five business segments: electric utility operations; gas utility operations; oil and gas exploration and production operations; independent power production; and gas transmission and marketing. Consumers or subsidiaries of Consumers are engaged in two segments: electric operations and gas operations. Consumers' electric and gas businesses are regulated utility operations.\nConsumers Electric Utility Operations Consumers generates, purchases, transmits and distributes electricity and renders electric service in 61 of the 68 counties in the Lower Peninsula of Michigan. Prin- cipal cities served include Battle Creek, Flint, Grand Rapids, Jackson, Kalamazoo, Muskegon, Saginaw and Wyoming.\nConsumers Gas Utility Operations Consumers purchases, transports, stores, and distributes gas and renders gas service in 40 of the 68 counties in the Lower Peninsula of Michigan. Principal cities served include Bay City, Flint, Jackson, Kalamazoo, Lansing, Pontiac and Saginaw, as well as the suburban Detroit area. Consumers' wholly owned subsidiary, Michigan Gas Storage, is engaged in the transportation and storage of natural gas in interstate commerce.\nCMS Enterprises CMS Generation Independent Power Production CMS Generation, a wholly owned subsidiary of Enterprises, invests in, develops, converts and\/or constructs and operates non-utility power generation plants both domestically and internationally. CMS Generation currently has ownership in- terests in power plants in Michigan, Cali- fornia, Connecticut, New York and Argentina.\nCMS Enterprises NOMECO Oil and Gas Exploration and Production NOMECO, a wholly owned subsidiary of Enterprises, and subsidiaries of NOMECO are engaged in the exploration for and production of oil and natural gas in Michigan and 12 other states, the Gulf of Mexico, Australia, Colombia, Ecuador, Equatorial Guinea, New Zealand, Papua New Guinea, Thailand and Yemen. NOMECO has 11 active wholly owned subsidiaries which are engaged in the exploration, development and operation of oil and gas interests and rights.\nCMS Enterprises Gas Transmission and Storage Enterprises has two subsidiaries which participate in non-utility natural gas businesses, including transportation, treating, storage and marketing.\nFINANCIAL INFORMATION\nCMS Energy\nFor information with respect to operating revenue, net operating income (loss) and assets and liabilities attributable to all of CMS Energy's business segments, refer to its Consolidated Financial Statements and to the Notes to Consolidated Financial Statements for the year ended December 31, 1993, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is incorporated herein by reference.\nConsumers\nFor information with respect to the operating revenue, net operating income (loss) and assets and liabilities attributable only to Consumers' business segments, refer to its Consolidated Financial Statements and to the Notes to Consolidated Financial Statements for the year ended Decem- ber 31, 1993, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is incorporated herein by reference.\nEMPLOYEES\nCMS Energy\nAs of February 28, 1994, CMS Energy and its subsidiaries had 9,874 full- time employees and 294 part-time employees for a total of 10,168 employees.\nConsumers\nAs of February 28, 1994, Consumers and its subsidiaries had 9,434 full- time employees and 277 part-time employees for a total of 9,711 employees. This total includes 4,212 full-time operating, maintenance and construction employees of Consumers who are represented by the Union. A new collective bargaining agreement was negotiated between Consumers and the Union which became effective on June 1, 1992 and, by its terms, will continue in full force and effect until June 1, 1995.\nSIGNIFICANT DEVELOPMENTS CONCERNING MCV COST RECOVERY ISSUES\nThe MCV Partnership was formed in January 1987 by subsidiaries of Consumers and Dow to convert a portion of Consumers' abandoned Midland Nuclear Plant into a natural gas-fueled, combined cycle cogeneration facility. The MCV Facility has been certified as a Qualifying Facility under PURPA. CMS Energy, certain other affiliates and the other partners in the MCV Partnership made certain contingent undertakings related to the MCV Partnership's sale and leaseback transaction. These included, but were not limited to, indemnifications related to tax matters and a commitment to extend a $10 million standby working capital facility to the MCV Partnership. In addition, CMS Energy and certain of its affiliates undertook certain indemnifications related to environmental matters regarding the site. Consumers' current interests in the MCV Partnership and the MCV Facility are discussed more fully in Note 3 of the Notes to Consolidated Financial Statements.\nIn 1987, Consumers signed a PPA with the MCV Partnership for the purchase of up to 1,240 megawatts of capacity for a 35-year period beginning with the MCV Facility's commercial operation in March 1990. Consumers' cost recovery from its electric customers for the amount of capacity purchased by Consumers from the MCV Partnership, the price paid by Consumers for that capacity and associated energy, and the method of rate recovery for those purchases had been at issue before the MPSC and the Michigan appellate courts since Consumers' first attempt to recover those costs in its annual power supply cost recovery proceedings. Because the MPSC consistently denied Consumers full recovery of the costs it incurred for its purchases from the MCV Partnership, Consumers incurred significant ongoing annual losses. On March 31, 1993, the MPSC issued an Opinion and Order on a Revised Settlement Proposal, which had been submitted by Consumers, CMS Energy, the MPSC Staff, and ten qualifying facility developers, approving it with certain modifications. For a discussion of the Revised Settlement Proposal as approved by the MPSC's March 31, 1993 Order, see Note 3 of the Notes to Consolidated Financial Statements, which is incorporated by reference herein. With Consumers' acceptance of the MPSC's decision on the Revised Settlement Proposal, the uncertainties surrounding Consumers' cost recoveries related to its purchases from the MCV Partnership were resolved to a sufficient degree that Consumers effected a quasi-reorganization as of December 31, 1992 in which Consumers' accumulated deficit was eliminated against other paid-in capital. Following this quasi-reorganization Consumers resumed paying dividends in 1993. The quasi-reorganization is more fully described in Note 7 of the Notes to Consolidated Financial Statements.\nA dispute has arisen between the MCV Partnership and Consumers relating to the impact of the order on the fixed energy charge payment, currently approx- imately 7 percent of the charges for capacity and energy, called for in the PPA and Consumers' ability to exercise its rights under the regulatory out provision based on the issuance of the Settlement Order. In accordance with the dispute resolution provisions set out in the PPA, an arbitrator acceptable to both parties has been selected and the arbitration of this dispute has commenced. Consumers is unable to predict the outcome of such arbitration proceedings or of any possible settlement of the issues underlying this dispute. On March 4, 1994, the lessors of the MCV Facility filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of the arbitration between the MCV Partnership and Consumers. While CMS Energy and Consumers believe this lawsuit to be without merit, they are unable to predict the outcome of this action. For a discussion of the arbitration proceedings and the lawsuit filed by the lessors, see Note 3 of the Notes to Consolidated Financial Statements and Item 3. LEGAL PROCEEDINGS, which are incorporated by reference herein.\nCONSUMERS ELECTRIC UTILITY OPERATIONS\nConsumers had approximately 1.5 million electric customers at December 31, 1993. Electric system energy sales by Consumers in 1993 totaled 31.66 billion kWh, a 3.8 percent increase from 1992. Electric operating revenue in 1993 was $2.077 billion, an increase of 11.5 percent from 1992. A peak demand of 6,226 MW was achieved in August 1993, representing an increase of 4.8 percent from the peak achieved in 1992 predominantly as a result of warmer than normal weather and improved industrial sales. Consumers' reserve margin was approximately 21 percent in 1993 and 19 percent in 1992, based on weather adjusted peaks.\nIncluding the Ludington pumped storage facility, in which it has a 51 percent ownership and capacity entitlement, Consumers owns and operates 28 electric generating plants with an aggregate net demonstrated capability available to Consumers, as of 1993 for summer conditions, of 6,299 MW. See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nCHARACTER OF OWNERSHIP\nThe principal properties of CMS Energy and its subsidiaries are owned in fee, except that most electric lines and gas mains are located, pursuant to ease- ments and other rights, in public roads or on land owned by others. The statements under this item as to ownership of properties are made without regard to tax and assessment liens, judgments, easements, rights of way, contracts, reservations, exceptions, conditions, immaterial liens and encum- brances, and other outstanding rights. None of these outstanding rights impairs the usefulness of such properties.\nSubstantially all of Consumers' properties are subject to the lien of its First Mortgage Bond Indenture.\nCONSUMERS ELECTRIC UTILITY PROPERTIES\nConsumers' electric generating system consists of five fossil-fueled plants, two nuclear plants, one pumped storage hydroelectric facility, seven gas combustion turbine plants and 13 hydroelectric plants.\nConsumers' electric transmission and distribution lines owned and in service are as follows:\nStructure Sub-Surface (Miles) (Miles)\nTransmission 345,000 volt 1,137 - 138,000 volt 3,246 4 120,000 volt 19 - 46,000 volt 4,066 9 23,000 volt 31 7 ------ ----- Total transmission 8,499 20\nDistribution (2,400-24,900 volt) 50,359 4,756 ------ ----- Total transmission and distribution 58,858 4,776 ====== ===== Consumers owns substations having an aggregate transformer capacity of 36,249,290 kilovoltamperes.\nCONSUMERS GAS UTILITY PROPERTIES\nConsumers' gas distribution and transmission system consists of 20,768 miles of distribution mains and 1,084 miles of transmission lines throughout the Lower Peninsula of Michigan. Consumers owns and operates five compressor stations with a total of 116,070 installed horsepower.\nConsumers' gas storage fields, listed below, have an aggregate certified storage capacity of 241.5 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nOverisel Allegan and Ottawa Counties 64.0 Salem Allegan and Ottawa Counties 35.0 Ira St Clair County 7.5 Lenox Macomb County 3.5 Ray Macomb County 66.0 Northville Oakland, Washtenaw and Wayne Counties 25.8 Puttygut St Clair County 16.6 Four Corners St Clair County 3.8 Swan Creek St Clair County .6 Hessen St Clair County 18.0 Lyon - 34 Oakland County .7\nMichigan Gas Storage owns and operates two compressor stations with a total of 46,600 installed horsepower. Its transmission system consists of 547 miles of pipelines within the Lower Peninsula of Michigan.\nMichigan Gas Storage's gas storage fields, listed below, have an aggregate certified storage capacity of 117 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nWinterfield Osceola and Clare Counties 75.0 Cranberry Lake Clare and Missaukee Counties 30.0 Riverside Missaukee County 12.0\nConsumers' gas properties also include the Marysville gas reforming plant, located in Marysville, Michigan. Huron entered into a partnership with PanCanadian Petroleum Company and CanStates Investments to use the expanded capacity of the underground caverns at the Marysville plant for commercial storage of liquid hydrocarbons. On February 1, 1994 PanCanadian Petroleum Company purchased CanStates Investments. In addition, Consumers and Novacor Hydrocarbons, Inc. are partners in a partnership to use certain hydrocarbon fractionation facilities at the plant.\nCMS ENERGY OIL AND GAS EXPLORATION AND PRODUCTION PROPERTIES\nNOMECO has carried on a domestic oil and gas exploration program since 1967. In 1976, NOMECO entered its first venture outside the United States.\nNet oil and gas production by NOMECO for the years 1991 through 1993 is shown in the following table.\nThousands of barrels of oil and millions of cubic feet of gas, except for reserves\n1993 1992 1991\nNatural gas (a) 18,487 17,578 14,714 Oil and condensate (a) 1,716 1,417 1,260 Plant products (a) 186 291 283 Average daily production (b) Oil 5.6 4.9 4.1 Gas 62.3 59.2 50.5\nReserves to annual production ratio Oil (MMbbls) 19.1 22.6 21.9 Gas (bcf) 10.9 11.8 13.0\n(a) Revenue interest to NOMECO (b) NOMECO working interest (includes NOMECO's share of royalties)\nThe following table shows NOMECO's undeveloped net acres of oil and gas leasehold interests at December 31.\nNet Acres 1993 1992\nMichigan 77,672 120,740 Louisiana (a) 37,295 39,226 Texas (a) 8,083 10,411 North Dakota 5,635 - Indiana 5,034 715 Other states 2,184 2,581 ------- --------- Total domestic 135,903 173,673 ------- --------- Thailand 188,000 188,000 Yemen 120,563 - Papua New Guinea 96,825 63,220 Equatorial Guinea 83,334 83,334 Ecuador 69,160 69,160 New Zealand 602 1,544 China (b) - 589,334 ------- --------- Total international 558,484 994,592 ------- --------- Total 694,387 1,168,265 ======= ========= (a) Includes offshore acreage.\n(b) Acreage excluded at year-end 1993 as part of an agreement with the state oil company to discontinue its current exploration program because it has been unsuccessful.\nCONSUMERS OTHER PROPERTIES\nCMS Midland owns a 49 percent interest in the MCV Partnership which was formed to construct and operate the MCV Facility. The MCV Facility has been sold to five owner trusts and leased back to the MCV Partnership. CMS Holdings is a limited partner in the FMLP, which is a beneficiary of one of these trusts. CMS Holdings' indirect beneficial interest in the MCV Facility is 35 percent.\nConsumers owns fee title to 1,140 acres of land in the City and Township of Midland, Midland County, Michigan, occupied by the MCV Facility. The land is leased to the owners of the MCV Facility by five separate leases, each leasing an undivided interest and in the aggregate totaling 100 percent, for an initial term ending December 31, 2035 with possible renewal terms to June 15, 2090.\nConsumers owns or leases three principal General Office buildings in Jackson, Michigan and 53 Regional and other field offices at various locations in Michigan's Lower Peninsula. Of these, two of the General Office buildings and eleven of the Regional and other field offices are leased. Also owned are miscellaneous parcels of real estate not now used in utility operations.\nCMS ENERGY OTHER PROPERTIES\nVarious subsidiaries of CMS Generation own interests in independent power plants, including a 50 percent partnership interest in a 30 MW wood waste- fueled power plant near Susanville, California; a 50 percent partnership interest in a 54 MW coal and wood waste-fueled power plant in Filer City, Michigan; a 50 percent partnership interest in a 34 MW wood waste-fueled power plant in Grayling Township, Michigan; a 50 percent interest in a 26 MW tire burning power plant near Sterling, Connecticut; a 50 percent interest in a wood waste-fueled power plant in Lyons Falls, New York; an 18.6 percent interest in a consortium which owns an 88 percent interest in a 50 MW fossil-fueled plant in San Nicolas, Argentina; a 25 percent interest in a consortium which owns a 59 percent interest in two hydroelectric power plants, with a total of 1,320 MW of capacity, on the Limay River in western Argentina; and a 50 percent ownership interest in a 18 MW wood waste-fueled power plant near Chateaugay, New York.\nCMS Gas Transmission owns a 75 percent interest in a general partnership which owns and operates a 25-mile, 16-inch natural gas transmission pipeline in Jackson and Ingham Counties, Michigan; owns a 24 percent limited partnership interest in the Saginaw Bay Area Limited Partnership which owns 125 miles of 10-inch and 16-inch natural gas transmission pipeline in north-central Michigan; owns a 44 percent limited partnership interest in a partnership that owns certain pipelines of 20 and 12 miles interconnected to the Saginaw Bay Area Limited Partnership facilities; owns a 60 percent interest in a partnership that owns and operates a natural gas treating plant in Otsego County, Michigan; and owns 100 percent interest in 41 miles of gas transmission pipeline in Otsego and Montmorency Counties, Michigan.\nCMS Energy, through certain subsidiaries owns approximately 6,000 acres of undeveloped land in Benzie and Manistee Counties, Michigan, approximately 53 acres of undeveloped land in Muskegon County, Michigan, and approximately 300 acres in undeveloped land in Emmet County, Michigan.\nCONSUMERS CAPITAL EXPENDITURES\nCapital expenditures during 1993 for Consumers and its subsidiaries totaled $509 million for capital additions and $52 million for demand-side management programs. These capital additions include approximately $31 million for environmental protection additions. Of the $509 million, $265 million was incurred for electric utility additions, $126 million for gas utility additions, $58 million for capital leases (see Note 14 to Consumers' Consolidated Financial Statements incorporated by reference herein), and $60 million for other additions and capital investments.\nIn 1994, capital expenditures are estimated to be $513 million for capital additions and $40 million for demand-side management programs. These capital addition estimates include approximately $48 million related to environmental protection additions. Of the $513 million, $290 million will be incurred for electric utility additions, $98 million for gas utility additions, $73 million for capital leases, and $52 million for other additions and capital investments.\nCMS ENERGY CAPITAL EXPENDITURES\nCapital expenditures during 1993 for CMS Energy and its subsidiaries totaled $714 million for capital additions and $52 million for demand-side management programs. These capital additions include approximately $31 million for environmental protection additions. Of the $714 million, $509 million was incurred by Consumers as discussed above. The remaining $205 million in capital additions include $81 million for oil and gas exploration, $110 million for independent power production and $14 million for gas transmission and marketing.\nIn 1994, capital expenditures are estimated to be $752 million for capital additions and $40 million for demand-side management programs. This capital addition estimate includes approximately $48 million related to environmental protection additions. Of the $752 million, $513 million will be incurred by Consumers as discussed above. The remaining $239 million in capital additions will be incurred as follows: $117 million for oil and gas exploration, $84 million for independent power production and $38 million for gas transmission and marketing.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nConsumers and some of its subsidiaries and affiliates are parties to certain routine lawsuits and administrative proceedings incidental to their businesses involving, for example, claims for personal injury and property damage, contractual matters, income taxes, and rates and licensing. Reference is made to the Notes to the Consolidated Financial Statements included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters.\nThe Attorney General, ABATE, and the MPSC Staff typically intervene in MPSC proceedings concerning Consumers. Unless otherwise noted below, these parties have intervened in such proceedings. For many years, almost every significant MPSC order affecting Consumers has been appealed. Appeals from such MPSC orders are pending in the Michigan Court of Appeals and the Michigan Supreme Court. Consumers is vigorously pursuing these matters. Under Michigan civil procedure, parties may file a claim of appeal with the Michigan Court of Appeals which serves as a notice of appeal. The grounds on which the appeal is being made are not set forth until a later date when the parties file their briefs.\n1. Electric Rate Case Proceedings\nA. Appeal of MPSC Orders Related to the Abandoned Midland Nuclear Plant Investment\nIn November 1983, Consumers filed an electric rate case with the MPSC which sought recovery of its investment in the abandoned portion of the Midland nuclear plant. This case was separated into two phases in September 1984: a financial stabilization phase, MPSC Case No. U-7830, Step 3A, and a prudence phase, MPSC Case No. U-7830, Step 3B. Numerous orders were issued in these cases, including one issued in 1985 in the financial stabilization phase which contained certain conditions to Consumers' receiving financial stabilization rate relief.\nOn May 7, 1991, the MPSC issued final orders in both Step 3A and Step 3B proceedings in which, among other things, the MPSC ruled that Consumers could recover approximately $760 million of the $2.1 billion of abandoned Midland investment. Consumers, as well as the Attorney General and ABATE, among others, filed applications for rehearing with the MPSC of the May 7 Orders in Step 3A and Step 3B. which were all denied by the MPSC. Several parties, including Consumers, have appealed the MPSC determinations in these orders to the Court of Appeals. The Attorney General and ABATE primarily disagree with the standard used by the MPSC to determine the amount of investment that is recoverable by Consumers from its electric customers, contending that recovery should not be allowed for utility assets that have not been placed in service. Consumers disagrees with the date the MPSC determined it would have been prudent for Consumers to abandon construction of the Midland nuclear facility and the reduction in recoverable investment that resulted from this determination. All briefs have been filed in these appeals. Oral argument has not yet been scheduled on the Step 3B appeals; oral argument was held on the Step 3A appeal in December 1993.\nB. Appeal of 1991 General Electric Rate Case Order\nOn May 7, 1991, the MPSC issued an order in Case No. U-9346, a general electric rate case the MPSC ordered Consumers to file in response to a complaint filed by ABATE. On July 1, 1991, the MPSC issued another order in this proceeding modifying the May 7 Order. These orders, together with the other orders discussed in paragraph A above, reduced Consumers' electric retail rates by an annual amount of approximately $73 million.\nCertain aspects of the May 7, 1991 and July 1, 1991 electric rate case orders were appealed by the Attorney General, ABATE, and the Michigan Association of Home Builders. The appeals of the Attorney General and the Michigan Association of Home Builders have both been dismissed. ABATE's appeal, which primarily seeks a reduction in the rates authorized by the MPSC, remains pending. Briefs have been filed in the ABATE appeal and oral argument was held in December 1993.\nC. 1993 Electric Rate Case\nOn May 10, 1993, Consumers filed an application with the MPSC seeking an increase in its base electric rates (MPSC Case No. U-10335). As a result of the new statutory federal tax rate and interest rate savings resulting from the refinancing of certain long-term debt, Consumers subsequently revised its requested electric rate increase to approximately $133 million in 1994 while its requested electric rate increase for 1995 remained at $38 million. In their initial brief, the MPSC Staff recommended approximately $98 million in annual rate relief beginning in 1994. The MPSC Staff also recommended a lower return on electric common equity (11.75 percent compared with Consumers' proposal of 13.25 percent), and using a projected actual equity ratio in the projected capitalization structure rather than a target ratio. The MPSC Staff did not support Consumers' request for additional rate relief for 1995 as part of this proceeding, but did support Consumers' rate design proposal to significantly reduce the level of cross-subsidization of residential customers' rates by commercial and industrial customers.\nA PFD was issued in this case on March 4, 1994. In the PFD the ALJ recommended a rate increase in 1994 of approximately $83 million with no incremental increase in 1995 to be granted as part of this proceeding. The ALJ adopted MPSC Staff's recommendation of an 11.75 percent return on common equity and the use of 1994 projected actual capital structure rather than the target structure proposed by Consumers. The PFD rejected a proposal made by Consumers through which returns above the authorized level would be shared with customers, but recommended the implementation of a performance incentive proposal Consumers had initially proposed with some modifications. The PFD also recommended the adoption of the cross- subsidization reduction proposed by Consumers modified so that subsidization would be immediately reduced by 50 percent in 1994 rates rather than the phased-in 20 percent per year over a three year period reduction proposed by Consumers.\nExceptions to the PFD are due March 18 with replies to exceptions due April 1. The PFD is not binding on the MPSC. An order of the MPSC will be issued sometime thereafter.\nD. 1986 Proceedings - Palisades Outages\nThe Palisades nuclear plant was out of service for maintenance from May 1986 until April 1987. In the 1986 PSCR reconciliation case decided December 22, 1988, the MPSC disallowed recovery of $22.4 million of replacement power costs associated with the 1986 portion of this outage and refunds to the customers were made. In an appeal filed in 1989 and now pending decision by the Court of Appeals, Consumers is challenging the adequacy of the MPSC's findings supporting the disallowance. Oral arguments were held in December 1993 and in March 1994 the Court of Appeals affirmed the MPSC order in a per curiam opinion.\n2. Settlement Proposals Relating to Consumers' Purchases from the MCV Partnership\nOn March 31, 1993, the MPSC issued the Settlement Order which approved with modifications the Revised Settlement Proposal filed by Consumers, the MPSC Staff and 10 small power and cogeneration developers. The scope of the Settlement Order included three major components: 1) treatment of cost recovery issues regarding the PPA, 2) resolution of PURPA issues raised by certain developers of Qualifying Facilities that had wanted contracts with Consumers, and 3) resolution of the remand to the MPSC ordered by the Court of Appeals in the Capacity Charge Order. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. On May 26, 1993, the MPSC denied petitions filed by the Attorney General, ABATE, MMCG and a small project developer which requested a rehearing of the Settlement Order by the MPSC. ABATE and the Attorney General have filed claims of appeal of the Settlement Order and the May 26, 1993 MPSC order with the Court of Appeals. Briefs have been filed with the Court of Appeals on this matter but oral argument has not yet been scheduled. In their respective briefs in opposition to the Settlement Order, ABATE and the Attorney General essentially reiterate the arguments they made before the MPSC in their petitions for rehearing. The substance of ABATE's and the Attorney General's arguments is that the MPSC exceeded its authority in approving the Revised Settlement Proposal as modified by the Settlement Order and the rates established thereby are not just and reasonable and lack evidentiary support. ABATE and the Attorney General also contend that the MPSC's procedures for the hearing on the Revised Settlement Order violated due process and denied ABATE and the Attorney General a fair hearing. In defense of the Settlement Order, the Independent Cogenerators, Consumers and the MPSC argue in their respective briefs to the Court of Appeals that the determinations of the MPSC in the Settlement Order are lawful and reasonable and that the Attorney General and ABATE have failed to meet the statutory burden of proof minimally necessary for the Court of Appeals to find otherwise.\nIn accordance with the terms of the Settlement Order, appeals of MPSC orders relating to MCV cost recovery issues in Consumers' 1990, 1991 and 1992 PSCR cases that had been pending before the Court of Appeals and the Michigan Supreme Court have been withdrawn.\n3. MPSC Case No. U-10029 - Intrastate Gas Supply\nIn November 1991, Consumers filed with the MPSC Case No. U-10029 seeking several kinds of relief with respect to a contract with one of Consumers' intrastate gas suppliers, North Michigan, including lowering a contract price. North Michigan filed an objection with the MPSC and in July 1992 filed a collateral case in Federal Court seeking an injunction to block the MPSC case. On April 8, 1993, the Federal Court dismissed Northern Michigan's suit. An appeal of the Federal Court's decision is pending in the U.S. Sixth Circuit Court of Appeals.\nOn February 8, 1993, the MPSC issued an order granting Consumers' request to lower the price to be paid North Michigan under its contract. In March 1993, North Michigan filed an appeal of the MPSC's February 8, 1993 order with the Court of Appeals. In July 1993, consistent with the MPSC's February 8, 1993 Order, Consumers notified North Michigan that it planned to terminate the contract in November 1993. In early October 1993, North Michigan sought to have the Court of Appeals stay Consumers' cancellation of the contract. The Court of Appeals denied this request in late October 1993 and Consumers terminated its contract with North Michigan effective November 1, 1993. If the MPSC order is overturned, Consumers would have to pay North Michigan higher contract costs for purchases in 1993 which may not be authorized by the MPSC for recovery from Consumers' customers. Should North Michigan obtain a favorable decision on all of the issues on appeal, including Consumers' termination of the contract in 1993, Consumers' total remaining exposure would be $24 million, for which Consumers previously accrued a loss. Consumers cannot predict the outcome of this appeal.\n4. Palisades Plant - Spent Nuclear Fuel Storage\nIn April 1993, the NRC amended its regulations, effective May 7, 1993, to approve the design of the dry spent fuel storage casks to be used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of February, 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals related to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. As of mid-August 1993, Consumers has loaded two dry storage casks with spent nuclear fuel and expects to load additional casks in 1994 prior to Palisades' 1995 refueling outage.\n5. CMS Energy's Exemption Under the Public Utility Holding Company Act of 1935\nCMS Energy is exempt from registration under PUHCA. In December 1991, the Attorney General and the MMCG filed a request with the SEC for the revocation of CMS Energy's exemption. In January 1992, CMS Energy responded to the revocation request affirming its position that it is entitled to the exemption. In April 1992, the MPSC filed a statement with the SEC that recommended that the SEC impose nine conditions on CMS Energy's exemption. The suggested conditions would (1) preclude CMS Energy's making non-utility investments without prior SEC approval; (2) prohibit CMS Energy's subsidiaries from making any upstream loans without prior SEC approval; (3) prohibit CMS Energy from pledging Consumers' assets as security without prior SEC approval; (4) prohibit the sale or transfer of utility securities or assets by CMS Energy without SEC concurrence; (5) prevent Consumers paying other than \"normal\" dividend; (6) require that all contracts and leases over $500,000 annual cost be filed with the SEC and MPSC; (7) require that access to the books and records of CMS Energy, its affiliates and their joint ventures, be provided to the SEC and the MPSC; (8) establish complaint procedures, with penalty provisions for addressing challenges to CMS Energy's compliance with the conditions; and (9) require that all pleadings filed with the SEC relating to the conditions be served contemporaneously on the MPSC. On July 9, 1993, the Attorney General submitted to the SEC a response to the MPSC's statement opposing the MPSC's recommendations and reiterating his argument that CMS Energy should not be allowed an exemption under PUHCA. On July 12, 1993, the MMCG submitted to the SEC a reply to CMS Energy's January 1992 response to the revocation request. On September 30, 1993, CMS Energy responded to the Attorney General's and the MMCG's July submissions. CMS Energy also contemporaneously submitted comments on the MPSC's April 1992 statement. In its response to the Attorney General and MMCG, CMS Energy again refuted the allegations made by the Attorney General and MMCG regarding CMS Energy's exemption, noting in particular that the matters complained of by the Attorney General and MMCG have all been addressed and resolved in proceedings before other regulatory and judicial authorities, primarily at the State level, with the Attorney General and MMCG participating. In its comments on the MPSC's April 1992 statement, CMS Energy updated events from the time the MPSC statement was filed during which the substantive issues underlying the MPSC's recommendations were resolved.\nShould the SEC revoke CMS Energy's current exemption from registration under PUHCA, CMS Energy could either become a registered holding company or be granted a new exemption, possibly subject to conditions similar to those recommended by the MPSC. Registration under PUHCA could require divestment by CMS Energy of either its gas utility or electric utility business by some future date following registration. As a registered company, CMS Energy could also be precluded from engaging in businesses that are not functionally related to its utility operations; in addition, SEC approval would be required for the issuance of securities by CMS Energy and its subsidiaries. If divestiture of Consumers' gas utility or its electric utility business ultimately were required, the effect on Consumers and CMS Energy would depend on the method of divestitures and the extent of the proceeds received, which cannot now be predicted.\nCMS Energy is vigorously contesting the revocation request and believes it will maintain the exemption. There has been no action taken by the SEC on this matter.\n6. Ludington Pumped Storage Plant\nIn September 1993, the Court of Appeals overturned the dismissal of a lawsuit filed by the Attorney General in September 1986 seeking damages from Consumers and Detroit Edison for alleged injuries to fishing resources due to the operation of the jointly owned Ludington Pumped Storage Plant. In his 1986 complaint, the Attorney General had sought $147.9 million (including interest) in damages for past injuries and approximately $89,000 per day for future damages, subject to adjustment based on the adequacy of the barrier net installed at the plant and other changed conditions. In a second lawsuit, filed in 1987, the Attorney General had also sought to have the plant's bottom lands lease agreement with the State declared void. The Court of Appeals' September 1993 ruling upheld the lower court's dismissal relating to the breach of claim, but would allow the Attorney General to continue his lawsuit for damages against Consumers and Detroit Edison, limiting the recovery of potential damages to those occurring not more than 3 years before filing the lawsuit in 1986. On October 14, 1993, the Court of Appeals made minor modifications to its opinion. Consumers and Detroit Edison have filed an application for leave to appeal with the Michigan Supreme Court seeking a reversal of the September 1993 Court of Appeals' Order and have the trial court's dismissal of the damages claim affirmed. The Attorney General filed a brief in opposition to Consumers' and Detroit Edison's application and also filed an application with the Michigan Supreme Court seeking reversal of the Court of Appeals' rulings as to the lease claims and the statute of limitations holding. The decision to grant or deny these applications is pending at the Michigan Supreme Court.\n7. Stray Voltage Lawsuit\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. On October 27, 1993, a complaint seeking certification as a class action suit was filed against Consumers in a local circuit court. The complaint alleged that in excess of a billion dollars of damages, primarily related to production by certain livestock owned by the purported class, were being incurred as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and has vigorously opposed the certification of the class and this suit. On March 11, 1994, the court decided to deny class certification for this complaint and to dismiss, subject to refiling as separate suits, the October lawsuit with respect to all but one of the named plaintiffs.\n8. Gas Supplier Dispute\nOn September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers, who have their contract price tied to the price Consumers pays Trunkline, have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers. To date, four suppliers have filed lawsuits, one in Canada, making these charges and seeking open pricing and\/or renegotiation of the pricing provision for their contracts, and also seeking damages for breach of contract. Consumers is disputing these claims and has sought declaratory and other relief on this issue in Michigan courts against nine suppliers. Certain of the suppliers also allege that, absent successful renegotiation, they have the right to terminate their supply contracts with Consumers and have involved the MCV Partnership in the litigation claiming termination rights with respect to the MCV Partnership's supply contracts that were negotiated during the same period. Consumers has reached an agreement in principle to settle with three of the suppliers. Consumers cannot predict the outcome of this matter.\nAdditionally, three of these direct gas suppliers of Consumers made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\n9. Arbitration Proceedings Between Consumers and the MCV Partnership\nA dispute has arisen between the MCV Partnership and Consumers relating to the impact of the Settlement Order on the fixed energy charge payment called for in the PPA and Consumers' ability to exercise its rights under the regulatory out provision based on the issuance of the Settlement Order. In accordance with the dispute resolution provisions set out in the PPA, an arbitrator acceptable to both parties has been selected and the arbitration of this dispute has commenced. Consumers is unable to predict the outcome of such arbitration proceedings or of any possible settlement of the issues underlying this dispute. The lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or fraudulent misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\n10. 1991 Gas Rate Settlement\nOn December 19, 1991, the MPSC approved a settlement in Case No. U-10037 concerning Consumers' gas rates which had been entered into by Consumers and the MPSC Staff. The settlement provides that Consumers is required to make certain expenditures for gas operation and maintenance activities in 1992, and provides for refunds if these expenditure levels are not met, or if Consumers' gas earnings exceed certain levels. Both the Attorney General and ABATE opposed approval of the settlement agreement and ABATE sought rehearing of the December 19, 1991 Order. On April 15, 1992, the MPSC denied the rehearing request. Both ABATE and the Attorney General have appealed the MPSC's order. On March 10, 1994, the Court of Appeals issued a per curiam opinion affirming the MPSC order.\n11. Investigative Demand\nOn July 17, 1991, the Attorney General served a civil investigative demand upon Consumers and CMS Energy indicating that the Attorney General was investigating \"possible violations\" of the Michigan Antitrust Reform Act by CMS Energy and Consumers and certain of their affiliates, primarily in connection with potential acquisitions and dealings with electric generating companies including the MCV Partnership. CMS Energy and Consumers do not believe any violations of such Act have occurred. The Attorney General has not taken any action on this matter since 1991 and Consumers and CMS Energy believe that this investigation is no longer being pursued.\n12. Environmental Matters\nOn September 23, 1993, the EPA filed an administrative complaint against Consumers under Superfund and the Emergency Planning and Community Right-to-Know Act. The complaint alleges, after release of a certain hazardous substance at its J. H. Campbell coal-fired electric generating plant, that Consumers did not immediately notify the appropriate governmental authorities of the release as soon as Consumers had knowledge of the release. The complaint proposes penalties aggregating $100,000. Consumers is disputing these allegations.\nIn addition, Consumers is subject to various federal, state and local laws and regulations relating to the environment. Consumers has been named as a party to several actions involving environmental issues. However, based on its present knowledge and subject to future legal and factual developments, CMS Energy and Consumers believe that it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition. See Item 1. BUSINESS. CONSUMERS AND CMS ENERGY ENVIRONMENTAL COMPLIANCE.\n13. Retail Wheeling Proceedings\nIn September 1992, in response to an application filed by ABATE, the MPSC issued an order commencing a joint contested case proceeding to consider experimental wheeling tariffs for Consumers and Detroit Edison. ABATE's proposal is that for an experimental period of five years utility customers with maximum demands of 5,000 kW or more be eligible for the retail wheeling tariff. Under the proposal, 60 megawatts of Consumers' load and 90 MW of Detroit Edison's load would be subject to displacement by retail wheeling. Consumers and Detroit Edison each opposed the proposed experimental retail wheeling tariff while the MPSC Staff cited concerns with the impact of the retail wheeling proposals on utility planning and procurement practices as well as regarding certain jurisdictional issues. In the PFD issued in August 1993, the ALJ determined that the MPSC could not order utilities to provide retail wheeling services and expressed concern regarding the proper pricing for this service should a utility voluntarily agree to provide the service.\n14. Wholesale Wheeling Proceedings\nConsumers has an approved open-access interconnection service schedule on file with the FERC for wholesale wheeling transactions. In 1992, Consumers also filed a separate but complementary open-access transmission tariff that would make both firm and non-firm transmission service available to eligible power generators, including investor-owned utilities, facilities that meet the ownership and technical requirements under PURPA, independent power producers, municipal and cooperative utilities. The FERC accepted the filing, effective May 2, 1992, subject to refund, and ordered a hearing before an ALJ. In September 1993, the ALJ issued an initial decision that would compel reductions of the tariff rates ranging from 25 percent to 65 percent. On November 1, 1993, Consumers filed exceptions with the FERC seeking reversal of the rate reductions proposed in the ALJ's initial decision. As of December 31, 1993, the amount of firm transmission service currently subject to the tariff is 23 MW.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nCMS Energy\nNone in the fourth quarter of 1993 for CMS Energy.\nConsumers\nNone in the fourth quarter of 1993 for Consumers. However, at a special meeting held on January 31, 1994, the shareholders of Consumers approved the creation of a new class of stock, Class A preferred stock. The stock vote taken on the matter was as follows:\nFor Against Abstain Total --- ------- ------- -----\nCommon and Preferred Stock 84,611,652 103,849 38,072 84,753,573\nPreferred Stock 502,863 103,849 38,072 644,784\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR CMS ENERGY'S AND CONSUMERS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nCMS Energy\nMarket prices for CMS Energy's common stock and related security holder matters are contained herein in Item 8, CMS Energy's Quarterly Financial and Common Stock Information, which is incorporated by reference herein. Number of common shareholders at February 28, 1994 was 66,250.\nConsumers\nConsumers' common stock is privately held by its parent, CMS Energy, and does not trade in the public market. In May, August, November and December 1993, Consumers paid $57 million, $21.5 million, $33.5 million and $21 million cash dividends, respectively, on its common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nCMS Energy\nSelected financial information is contained in Item 8, CMS Energy's Selected Financial Information which is incorporated by reference herein.\nConsumers\nSelected financial information is contained in Item 8, Consumers' Selected Financial Information which is incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nCMS Energy\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, CMS Energy's Management's Discussion and Analysis which is incorporated by reference herein.\nConsumers\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, Consumers' Management's Discussion and Analysis which is incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Financial Statements:\nCMS Energy Page\nSelected Financial Information 51 Management's Discussion and Analysis 53 Consolidated Statements of Income 64 Consolidated Statements of Cash Flows 65 Consolidated Balance Sheets 66 Consolidated Statements of Long-Term Debt 68 Consolidated Statements of Preferred Stock 69 Consolidated Statements of Common Stockholders' Equity 70 Notes to Consolidated Financial Statements 71 Report of Independent Public Accountants 96 Quarterly Financial and Common Stock Information 97\nConsumers Page\nSelected Financial Information 101 Management's Discussion and Analysis 102 Consolidated Statements of Income 112 Consolidated Statements of Cash Flows 113 Consolidated Balance Sheets 114 Consolidated Statements of Long-Term Debt 116 Consolidated Statements of Preferred Stock 117 Consolidated Statements of Common Stockholder's Equity 118 Notes to Consolidated Financial Statements 119 Report of Independent Public Accountants 142 Quarterly Financial Information 143\nCMS Energy Corporation\n1993 Financial Statements\n(This page intentionally left blank)\nCMS Energy Corporation Management's Discussion and Analysis\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to utility, commercial and industrial customers, and 4) storage and transmission of natural gas.\nConsolidated 1993 Earnings\nConsolidated net income for 1993 totaled $155 million or $1.90 per share, compared to net losses of $297 million or $3.72 per share in 1992 and $276 million or $3.44 per share in 1991. The increased net income reflects the Settlement Order related to power purchases from the MCV Partnership. Earnings also reflect record-setting utility electric sales and gas deliveries and additional earnings from the growth of non-utility businesses.\nCash Position, Financing and Investing\nCMS Energy's primary ongoing source of operating cash is dividends from its principal subsidiaries. Consumers effected a quasi-reorganization as of December 31, 1992, which allowed it to resume paying common dividends (see Note 7 to the Consolidated Financial Statements). Consumers paid $133 million in common dividends in 1993 and declared a $16 million common dividend in January 1994 from 1993 earnings. CMS Energy also received cash dividends of $11 million from its non-utility subsidiaries. CMS Energy paid $49 million in cash dividends to common shareholders compared to $38 million in 1992. The $11 million increase reflects an annual increase of $.24 per share commencing third quarter 1993.\nCMS Energy's consolidated cash requirements are met by its operating and financing activities. In 1993 and 1992, CMS Energy's consolidated cash inflow from operations was derived mainly from Consumers' sale and transportation of natural gas and its sale and transmission of electrici- ty, and from NOMECO's sale of oil and natural gas. Consolidated cash from operations for 1993 primarily reflects Consumers' record-setting electric sales and gas deliveries and reduced after-tax cash shortfalls resulting from Consumers' purchases of power from the MCV Partnership.\nDuring 1992, CMS Energy's cash from operations decreased as compared to 1991 primarily due to higher operational expenditures and reduced electric rates. In 1991, CMS Energy generated cash primarily from its consolidated operating and investing activities, including $859 million of net proceeds from the sale of a majority of the MCV Bonds.\nOver the last three years, CMS Energy has used its consolidated cash to fund its extensive utility construction expenditures, to improve the reliability of its utility transmission and distribution systems and to expand its non-utility businesses. It also has used its cash to retire portions of long-term securities and to pay cash dividends.\nFinancing Activities\nIn October 1993, CMS Energy issued 4.6 million shares of common stock at a price of $26 5\/8. The net proceeds of $119 million were used to reduce existing debt and for general corporate purposes. During 1993, Consumers significantly reduced its future interest charges by retiring approximately $51 million of high-cost outstanding debt and refinancing approximately $573 million of other debt at lower interest rates. In November 1993, NOMECO amended the terms of its loan agreement and increased the amount to $110 million. For further information, see Note 7.\nInvesting Activities\nCapital expenditures (excluding assets placed under capital leases of $58 million), deferred DSM costs and investments in unconsolidated subsidiaries totaled $708 million for 1993 as compared to $525 million in 1992. CMS Energy's expenditures for its utility, independent power production, oil and gas exploration and production, and gas transmission and marketing business segments were $503 million, $110 million, $81 million and $14 million, respectively.\nIn December 1993, Consumers sold $309 million of MCV Bonds it held and used the net proceeds to temporarily reduce short-term borrowings and ultimately plans to reduce long-term debt and to finance its construction program.\nOutlook\nCMS Energy estimates that capital expenditures, including DSM, new lease commitments and investments in unconsolidated subsidiaries, will total approximately $2.2 billion over the next three years.\nIn Millions Years Ended December 31 1994 1995 1996 ---- ---- ---- Electric and gas utility $553 $461 $471 Oil and gas exploration and production 117 90 100 Independent power production 84 99 98 Gas transmission and marketing 38 40 45 ---- ---- ---- $792 $690 $714 ==== ==== ====\nCMS Energy is required to redeem or retire approximately $796 million of long-term debt during 1994 through 1996. Cash generated by operations is expected to satisfy a substantial portion of these capital expenditures and debt retirements. Additionally, CMS Energy will evaluate the capital markets in 1994 as a source of financing its subsidiaries' investing activities.\nCMS Energy filed a shelf registration statement with the SEC in January 1994 covering the issuance of up to $250 million of unsecured debt securities. The net proceeds will be used to reduce the amount of CMS Energy Notes outstanding and for general corporate purposes. In October 1993, Consumers received MPSC authorization and is proceeding to issue $200 million of preferred stock in 1994.\nConsumers has several other available sources of credit including unsecured, committed lines of credit totaling $165 million and a $470 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1994. Consumers uses short-term borrowings to finance working capital, seasonal fuel inventory, and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. As of December 31, 1993 and 1992, receivables sold totaled $285 million and $225 million, respectively. On February 15, 1993, Consumers increased the level of receivables sold to $335 million. In February 1994, Consumers called or redeemed approximately $101 million of first mortgage bonds (see Note 7).\nElectric Utility Operations\nComparative Results of Operations\nElectric Pretax Operating Income: The improvement in 1993 pretax operating income compared to 1992 reflects an increase of $126 million relating to the resolution of the recoverability of MCV power purchase costs under the PPA and increased electric system sales of $45 million, partially offset by higher costs to improve system reliability. The 1992 decrease of $66 million from the 1991 level primarily resulted from an increased emphasis on system reliability improvements and decreased electric rates resulting from the full-year impact of a mid-1991 rate decrease.\nElectric Sales: Electric system sales in 1993 totaled a record 31.7 billion kWh, a 3.8 percent increase from 1992 levels. In 1993, residential and commercial sales increased 3.4 percent and 3.0 percent, respectively, while industrial sales increased 6.5 percent. Growth in the industrial sector was the strongest in the auto-related segments of fabricated and primary metals and transportation equipment. Electric system sales in 1992 totaled 30.5 billion kWh, essentially unchanged from the 1991 levels.\nPower Costs: Power costs for 1993 totaled $908 million, a $31 million increase from the corresponding 1992 period. This increase primarily reflects greater power purchases from outside sources to meet increased sales demand and to supplement decreased generation at Palisades due to an extended outage. Power costs for 1992 totaled $877 million, a $17 million decrease as compared to 1991.\nOperation and Maintenance: Increases in other operation and maintenance expense for 1993 and 1992 reflected increased expenditures to improve electric system reliability.\nDepreciation: The increased depreciation for 1993 reflects additional capital investments in plant. The 1992 increase resulted from higher depreciation rates, increased amortization of abandoned nuclear investment and increased nuclear plant decommissioning expense.\nElectric Utility Rates\nPower Purchases from the MCV Partnership: Consumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1993 1994 thereafter - ---- ----- ----- ---------- MW 1,023 1,132 1,240\nSince 1990, recovering capacity and fixed-energy costs for power purchased from the MCV Partnership has been a significant issue. Effective January 1, 1993, the Settlement Order allowed Consumers to recover from electric retail customers substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership, significantly reducing the amount of future underrecoveries for these power costs. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nPrior to the Settlement Order, Consumers had recorded losses for underrecoveries from 1990 through 1992. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order, based on management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. The after-tax expense for the time value of money for the $343 million loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. If Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Estimates for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Expected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level.\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. As of December 31, 1993, these amounts total $26 million. Although Consumers intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action. For further information regarding power purchases from the MCV Partnership, see Note 3.\nPSCR Matters: Consumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage and any associated delays. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies.\nElectric Rate Case: Consumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. In March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported a performance incentive which Consumers also supported. For further information, see Note 4.\nElectric Conservation Efforts\nIn October 1993, Consumers completed the customer participation portion of several incentive-based DSM programs which were designed to encourage the efficient use of energy, primarily through conservation measures. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on electric common equity may be adjusted either upward by up to one percent or downward by up to two percent, for one year following reconciliation hearings with the MPSC. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives (see Note 4).\nElectric Capital Expenditures\nCMS Energy estimates capital expenditures, including DSM and new lease commitments, related to its electric utility operations of $396 million for 1994, $324 million for 1995 and $332 million for 1996.\nElectric Environmental Matters and Health Concerns\nThe 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions will require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nIn 1990, the State of Michigan passed amendments to the Environmental Response Act, under which Consumers expects that it will ultimately incur costs at a number of sites, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. CMS Energy and Consumers believe costs incurred for both investigation and any required remedial actions would be recoverable from electric utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers and CMS Energy believe that it is unlikely that their liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on their financial positions or results of operations.\nElectric Outlook\nConsumers expects economic growth, competitive rates and other factors to increase the demand for electricity within its service territory by approximately 1.8 percent per year over the next five years. For the near term, Consumers currently plans a reserve margin of 20 percent and expects to fill the additional capacity required through long- and short-term power purchases. Long-term purchased power will likely be obtained through a competitive bidding solicitation process utilizing the framework established by the MPSC in 1992. Capacity from the MCV Facility above the levels authorized by the MPSC may be offered by Consumers in connection with the solicitation.\nA recent NRC review of Consumers' performance at Palisades showed a decline in performance. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. To provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management which is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nConsumers is currently collecting $45 million annually from electric retail customers for the future decommissioning of its two nuclear plants. Consumers believes these amounts will be adequate to meet current decommissioning cost estimates. For further information regarding nuclear decommissioning, see Note 2.\nConsumers' on-site storage pool at Palisades is at capacity, and it is unlikely that the DOE will begin accepting any spent nuclear fuel by the originally scheduled date in 1998. Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary storage. Several appeals relating to NRC approval of the casks are now pending at the U.S. Sixth Circuit Court of Appeals. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers has experienced an increase in complaints in 1993 relating primarily to the effect of so-called stray voltage on certain livestock. A complaint seeking certification as a class action suit has been filed against Consumers alleging significant damages, primarily related to certain livestock, which Consumers believes to be without merit (see Note 12).\nSome of Consumers' larger industrial customers are exploring the possibility of constructing and operating their own on-site generating facilities. Consumers is actively working with these customers to develop rate and service alternatives that are competitive with self-generation options. Although Consumers' electric rates are competitive with other regional utilities, Consumers has on file with the FERC two open access interconnection tariffs which could have the effect of increasing competition for wholesale customers. As part of its current electric rate case, Consumers has requested that the MPSC reduce the level of rate subsidization of residential customers by commercial and industrial customers so as to further improve rate competitiveness for its largest customers.\nThe MPSC has completed a hearing on a proposal by ABATE to create an experimental retail wheeling tariff. Certain other parties have proposals in support of retail wheeling under development. In August 1993, an ALJ recommended that the MPSC reject the proposed experiment. An MPSC order is expected early in 1994.\nGas Utility Operations\nComparative Results of Operations\nGas Pretax Operating Income: For 1993, pretax operating income increased $38 million compared to 1992, reflecting higher gas deliveries (both sales and transportation volumes) and more favorable regulatory recovery of gas costs related to transportation. During 1992, gas pretax operating income increased $45 million from the 1991 level, essentially for many of the same reasons as the current period.\nGas Deliveries: Gas sales and gas transported in 1993 totaled 410.6 bcf, a 6.9 percent increase from 1992. In 1992, gas sales and gas transported totaled 384.1 bcf, a 6.1 percent increase from 1991 deliveries.\nGas Utility Rates\nConsumers currently plans to file a request in 1994 with the MPSC to increase its gas rates. The request would include, among other things, costs for postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. A final order should be received approximately nine to twelve months after the request is filed.\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. The Trunkline contract covers gas deliveries through October 1994 and is at a price reduced in September 1993. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims.\nIn 1992, the FERC issued Order 636, which makes a number of significant changes to the structure of the services provided by interstate natural gas pipelines to be implemented by the 1993-94 winter heating season. Consumers is a significant purchaser of gas from an interstate pipeline (Trunkline) and is a major transportation customer of a number of pipelines. Management believes that Consumers will recover any transition costs it may incur and such restructuring will not have a significant impact on its financial position or results of operations.\nIn July 1993, Michigan Gas Storage submitted a notice of rate change with the FERC to revise its operation and maintenance expenses for 1993 and update plant costs to reflect the addition of approximately $27 million of new plant additions in 1993 and began collecting the revised rates subject to refund and a hearing in February 1994. Hearings or settlement conferences will follow. For further information regarding gas utility rates, see Note 4.\nGas Capital Expenditures\nCMS Energy estimates capital expenditures, including new lease commitments, related to its gas utility operations of $99 million for 1994, $88 million for 1995 and $81 million for 1996.\nGas Environmental Matters\nUnder the Environmental Response Act, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation\/feasibility studies for three of these sites. Work plans for remedial investigation\/feasibility studies for four other sites have also been prepared. The DNR has approved two of the three plans for remedial investigation\/feasibility studies submitted and is currently reviewing the one remaining. Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation\/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation\/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study, which may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. CMS Energy and Consumers believe costs incurred for both investigation and any required remedial actions would be recoverable from gas utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nGas Outlook\nIn 1993, Consumers purchased approximately 85 percent of its required gas supply under long-term contracts, and the balance on the spot market. Trunkline supplied approximately 41 percent of the total requirement. Consumers expects gas supply reliability to be ensured through long-term supply contracts, with purchases in the short-term spot market when economically beneficial. Management believes that Consumers' ability to purchase gas during the off-season and store it in its extensive underground storage facilities will continue to help provide customers with low-cost, competitive gas rates.\nConsumers anticipates growth in gas deliveries of approximately 0.6 percent per year over the next five years. Management believes that environmental benefits, along with the federal requirements included in the Energy Act, create an opportunity for growth in the natural gas vehicle industry.\nOil and Gas Exploration and Production\nPretax Operating Income\n1993 pretax operating income decreased $4 million from 1992, primarily reflecting lower average market prices for oil and $10 million of international write-offs, partially offset by higher gas and oil sales volumes and higher average market prices for gas. 1992 pretax operating income decreased $7 million from 1991, primarily due to lower average market prices for oil, partially offset by increased oil and gas sales volumes.\nCapital Expenditures\nDuring 1993, CMS Energy's oil and gas exploration and production capital expenditures were $81 million. Most expenditures were made to develop existing proven reserves -- oil reserves in Ecuador which will start production in 1994 and Antrim Shale gas in northern Michigan.\nCMS Energy currently plans to invest $307 million over the next three years in its oil and gas exploration and production operations. These anticipated capital expenditures primarily reflect continued development of Ecuador oil and Antrim Shale gas and reserve acquisitions. International focus will remain on Latin America and the Pacific Rim region.\nIndependent Power Production\nPretax Operating Income\n1993 pretax operating income increased $21 million, primarily reflecting the addition of new electric generating capacity and improved equity earnings and operating efficiencies. CMS Energy's ownership share of sales and revenues increased 24 percent and 18 percent, respectively, over the prior year.\nCapital Expenditures\nIn 1993, capital expenditures were $110 million, including investments in unconsolidated subsidiaries. These expenditures were primarily used to obtain ownership interests in an additional 309 MW of owned operating capacity or a 40 percent increase from December 31, 1992.\nIn April 1993, CMS Generation acquired a 50 percent interest in the Lyonsdale cogeneration plant, a 19 MW power plant in upstate New York. CMS Generation has invested $9 million in the project and additional investments relating to this project are expected to be immaterial.\nIn May 1993, a consortium including CMS Generation purchased an 88 percent share in the 650 MW San Nicolas power plant near Buenos Aires, Argentina. As of December 31, 1993, CMS Generation's share of the consortium is 18.6 percent and it has provided notice to exercise its option to increase its share to 21 percent. The plant sells power under long-term contracts to two utilities and Argentina's electric grid system. CMS Generation has invested $21 million in the partnership through December 31, 1993 and plans to invest approximately $3 million in 1994 in exercising its option.\nIn June 1993, CMS Generation was involved in the formation of Scudder Latin American Trust for Independent Power as a lead partner. The fund, which has investment commitments of $25 million from each of the four lead partners, will invest in electric generation and infrastructure resulting from the development of new power generating capacity. CMS Generation has contributed $.5 million through December 31, 1993 and estimates contributions of up to $11 million in 1994.\nIn July 1993, an investment company including CMS Generation S. A. acquired the rights to a 59 percent ownership interest in two hydroelectric power plants on the Limay River in western Argentina. These plants have a total generating capacity of 1,320 MW. The remaining interest in the project is to be held 39 percent by the Argentine provincial government and 2 percent by the plant employees. CMS Generation S.A. has a 25 percent ownership interest in the investment company. The investment company secured a 30-year concession under a government privatization program and in August 1993, began operating these power plants. CMS Generation S.A. entered into letter of credit agreements to support the acquisition. As of December 31, 1993, CMS Energy had approximately $41 million of guarantees relating to this agreement which were reduced to less than $15 million in January 1994. CMS Generation has invested $64 million in equity and loans and plans to invest up to an additional $2 million in 1994.\nCMS Generation has a 50 percent ownership interest and has invested, through the Oxford\/CMS Development Limited Partnership, $7 million in the Exeter waste tire-fueled\/electric generation facility near Sterling, Connecticut. Based on a financial restructuring completed in 1993, CMS Generation may be obligated to invest up to an additional $2 million. The 26.5 MW Exeter facility has a capacity of processing 10 million waste tires per year and sells its capacity and energy to Connecticut Light and Power Company under a long-term agreement.\nEffective November 1, 1993, CMS Generation acquired a 50 percent ownership interest in an 18 MW wood waste-fueled electric generation facility located near Chateaugay, New York for approximately $5 million and became the operator March 1, 1994. The facility sells its entire electric output to New York State Electric and Gas Corporation under a long-term power purchase agreement. CMS Generation expects no additional investment relating to this project.\nCMS Energy currently plans to invest $281 million relating to its independent power production operations over the next three years, primarily in domestic and international subsidiaries and partnerships. CMS Generation is involved with partnerships that have signed power contracts to construct power plant facilities capable of producing a total of 885 MW of operating capacity in Michigan, Tamil Nadu, India, and two projects in Batangas, Philippines. CMS Generation will also pursue acquisitions in Latin America, southern Asia and the Pacific Rim region.\nGas Transmission and Marketing\nPretax Operating Income\n1993 pretax operating income increased $2 million over 1992, reflecting earnings growth from existing and new gas transportation projects and increased natural gas marketed. In 1993, 60 bcf was marketed compared to 45 bcf in 1992.\nCapital Expenditures\nDuring 1993, CMS Energy's non-utility gas companies made capital expenditures of $14 million and formed two marketing partnerships which will provide natural gas marketing services throughout the Appalachian region of the United States and in Chicago and northern Illinois.\nIn November 1993, CMS Gas Transmission acquired an existing $4 million gas gathering system in the Antrim Shale region of Michigan's Lower Peninsula, which was placed into service in December 1993. CMS Gas Transmission began an $11 million expansion of its carbon dioxide processing facility, with completion expected in March 1994. In December 1993, they signed a letter of intent to invest $18 million to acquire 50 percent ownership in an existing 5 bcf high deliverability salt cavern storage facility on the Gulf Coast of Texas.\nCMS Energy currently plans to invest $123 million over the next three years relating to its non-utility gas operations. These investments would reflect the significant expansion of certain northern Michigan gas pipeline and carbon dioxide removal plant facilities. It will continue to pursue development of natural gas storage, gas gathering and pipeline operations both domestically and internationally and work toward the development of a Midwest \"market center\" for natural gas through strategic alliances and asset acquisition and development.\nOther\nOther Income: The 1993 other income level reflects lower Midland-related losses than experienced in 1992. The 1992 loss included a $343 million charge related to the Settlement Order. The 1991 loss included $294 million related to an MPSC order received in 1991 that allowed Consumers to recover only $760 million of remaining abandoned Midland investment.\nFixed Charges: Fixed charges for 1993 increased $22 million from 1992 and primarily reflect debt outstanding with higher rates of interest in 1993. The significant decrease in fixed charges in 1992 from 1991 primarily reflects Consumers' program aimed at significantly reducing its debt and the refinancing of debt at lower interest rates.\nPublic Utility Holding Company Act Exemption: CMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. On April 15, 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nCMS Energy Corporation Notes to Consolidated Financial Statements\n1: Corporate Structure\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to utility, commercial and industrial customers, and 4) transmission and storage of natural gas.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation\nThe consolidated financial statements include CMS Energy, Consumers and Enterprises and their wholly owned subsidiaries. CMS Energy eliminates all material transactions between its consolidated companies. CMS Energy uses the equity method of accounting for investments in its companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating revenue. For the years ended December 31, 1993, 1992 and 1991 equity earnings (losses) were $17 million, $(6) million, and $(8) million, respectively.\nGas Inventory\nConsumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion\nProperty repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. In May 1991, the MPSC approved an increase of approximately $15 million annually in Consumers' electric and common utility plant depreciation rates. The composite depreciation rate for electric utility property was 3.4 percent for 1993 and 1992 and 3.3 percent for 1991. The composite rate for gas utility plant was 4.4 percent for 1993 and 4.3 percent for 1992 and 1991.\nNOMECO follows the full-cost method of accounting and, accordingly, capitalizes its exploration and development costs, including the cost of non-productive drilling and surrendered acreage, on a country-by-country basis. The capitalized costs in each cost center are being amortized on an overall units-of-production method based on total estimated proven oil and gas reserves.\nThe composite rates for Consumers' common property, NOMECO's other property, and other property of CMS Energy and its subsidiaries were 4.5 percent in 1993, 4.7 percent in 1992 and 4.1 percent in 1991.\nNew Accounting Standards\nIn November 1992, the FASB issued SFAS 112, Employers' Accounting for Postemployment Benefits, which CMS Energy adopted January 1, 1994. CMS Energy pays for several postemployment benefits, the most significant being workers compensation. Because CMS Energy's postemployment benefit plans do not vest or accumulate, the standard did not materially impact CMS Energy's financial position or results of operations. For new accounting standards related to financial instruments, see Note 8.\nNuclear Fuel, Decommissioning and Other Nuclear Matters\nConsumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities under various payment options. However, in a statement released February 17, 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. The DOE is exploring options to offset the costs incurred by nuclear utilities in continuing to store spent nuclear fuel on site. For fuel burned after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers it through electric rates and remits it to the DOE quarterly. Consumers has elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983 until the spent fuel is delivered to the DOE. As of December 31, 1993, Consumers has recorded a liability to the DOE of $90 million, including interest, to dispose of spent nuclear fuel burned before April 7, 1983. Consumers has been recovering through electric rates the amount of this liability, excluding a portion of interest. Consumers' liability to the DOE becomes due when the DOE takes possession of Consumers' spent nuclear fuel, which was originally scheduled to occur in 1998.\nIn April 1993, the NRC approved the design of the dry spent fuel storage casks now being used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of mid- February 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals relating to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. Consumers loaded two dry storage casks with spent nuclear fuel in 1993 and expects to load additional casks in 1994 prior to Palisades' 1995 refueling. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers currently estimates decommissioning costs (decontamination and dismantlement) of $208 million and $399 million, in 1993 dollars, for the Big Rock Point and Palisades nuclear plants, respectively. At December 31, 1993, Consumers had recorded $171 million of decommissioning costs and classified the obligation as accumulated depreciation. In January 1987, Consumers began collecting estimated costs to decommission its two nuclear plants through a monthly surcharge to electric customers which currently totals $45 million annually. Consumers expects to file updated decommissioning estimates with the MPSC on or before March 31, 1995. Amounts collected from electric retail customers are deposited in trust. Trust earnings are recorded as an investment with a corresponding credit included in accumulated depreciation. The total amount of the trust will be available for decommissioning Big Rock Point and Palisades at the end of their respective license periods in 2000 and 2007. Consumers believes the amounts being collected are adequate to meet its currently estimated decommissioning costs and current NRC requirements.\nIn November 1993, Palisades returned to service following a planned refueling and maintenance outage that had been extended due to several unanticipated repairs. The results of an NRC review of Consumers' performance at Palisades published shortly thereafter showed a decline in performance ratings for the plant. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. In order to provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management. The evaluation is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nPlateau Resources Ltd.\nIn August 1993, Consumers sold its ownership interest in Plateau to U. S. Energy Corp. As a result of the sale, approximately $14 million of Plateau's cash and cash equivalents, other assets and liabilities, including certain future decommissioning, environmental and other contingent liabilities were transferred to U. S. Energy Corp. In view of prior write-offs, this transaction did not result in any material gains or additional losses.\nReclassifications\nCMS Energy and the MCV Partnership (see Note 16) have reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect the net losses for the years presented.\nRelated-Party Transactions\nIn 1993, 1992, and 1991, Consumers purchased $52 million, $36 million and $26 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Affiliates of CMS Energy sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $27 million, $21 million and $19 million for 1993, 1992 and 1991, respectively. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 16. Other related-party transactions are immaterial.\nRevenue and Fuel Costs\nConsumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers also accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until Consumers bills these unrecovered costs or refunds the excess recoveries to customers after reconciliation hearings conducted before the MPSC.\nUtility Regulation\nConsumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther\nFor significant accounting policies regarding cash equivalents, see Note 14; for income taxes, see Note 5; and for pensions and other postretirement benefits, see Note 10.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to supply electricity and steam to The Dow Chemical Company and to sell electricity to Consumers for a 35-year period beginning in March 1990. At December 31, 1993, Consumers, through its subsidiaries, held the following assets related to the MCV: 1) CMS Midland owned a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings held through the FMLP a 35 percent lessor interest in the MCV Facility. In late 1993, Consumers sold its remaining $309 million investment in the MCV Bonds.\nPower Purchases from the MCV Partnership\nConsumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1991 1992 1993 1994 thereafter - ---- ----- ----- ----- ----- ---------- MW 806 915 1,023 1,132 1,240\nDuring 1992 and 1991, the MPSC only allowed Consumers to recover costs of power purchased from the MCV Partnership based on delivered energy at rates less than Consumers paid for 840 MW in 1992 and 806 MW in 1991. As a result, Consumers recorded after-tax losses of $86 million in 1992 and $124 million in 1991.\nOn March 31, 1993, the MPSC approved, with modifications, the Revised Settlement Proposal which had been co-sponsored by Consumers, the MPSC staff and 10 small power and cogeneration developers. These parties accepted the Settlement Order and the MCV Partnership confirmed that it did not object to its terms. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nThe Settlement Order determined the cost of power purchased from the MCV Partnership that Consumers can recover from its electric retail customers and will significantly reduce the amount of future underrecoveries for these power costs. Effective January 1, 1993, the Settlement Order allowed Consumers to recover substantially all of the payments for its on- going purchase of 915 MW of contract capacity from the MCV Partnership. Capacity and energy purchases from the MCV Partnership above the 915 MW level can be competitively bid into Consumers' next solicitation for power or, if necessary, utilized for current power needs with a prudency review and a pricing recovery determination in annual PSCR cases. In either instance, the MPSC would determine the levels of recovery from customers for the power purchased. The Settlement Order also provides Consumers the right to remarket all of the remaining capacity to third parties. The PPA requires Consumers to pay a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge based primarily on Consumers' average cost of coal consumed. The Settlement Order provided Consumers two options for the recovery that could be used for capacity charges paid to the MCV Partnership. Under the option selected, Consumers is scheduling deliveries of energy from the MCV Partnership whenever it has energy available up to hourly availability limits, or \"caps,\" for the 915 MW of capacity authorized for recovery in the Settlement Order. Consumers can recover an average 3.62 cents per kWh capacity charge and the prescribed energy charges associated with the scheduled deliveries within the caps, whether or not those deliveries are scheduled on an economic basis. Through December 31, 1997, there is no cap applied during on-peak hours to Consumers' recovery for the purchase of capacity made available within the 915 MW authorized. Recovery for purchases during off-peak hours is capped at 80 percent in 1993, 82 percent in 1994 and 1995, 84 percent in 1996 and 1997, increasing to 88.7 percent in 1998 and thereafter at which time the 88.7 percent cap is applicable during all hours. For all economic energy deliveries above the caps to 915 MW, the option also allows Consumers to recover 1\/2 cent per kWh capacity payment in addition to the corresponding energy charge.\nIn December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss included management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. Because the calculation of the 1992 loss depended in part upon estimates of future unregulated sales of energy to third parties, a more conservative or risk-free investment rate of 7 percent was used to calculate $188 million of the total $343 million after-tax loss. The remaining portion of the loss was calculated using an 8.5 percent discount rate reflecting Consumers' incremental borrowing rate as required by SFAS 90, Regulated Enterprises- Accounting for Abandonments and Disallowances of Plant Costs. The after- tax expense for the time value of money for the loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries, including fixed energy charges, associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. However, if Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Consumers' estimates of its future after-tax cash underrecoveries and possible additional losses for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level.\nThe undiscounted, after-tax amount of the $343 million loss was $789 million. At December 31, 1993, the after-tax present value of the Settlement Order liability had been reduced to $307 million, which reflects after-tax cash underrecoveries related to capacity totaling $(54) million, after-tax accretion expense of $23 million and a $(5) million adjustment due to the 1993 corporate tax rate change (see Note 5).\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. In connection with the MPSC's approval of the Revised Settlement Proposal, Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership even though Consumers may not be recovering these costs. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. Although Consumers believes its position on arbitration is sound and intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. As of December 31, 1993, approximately $20 million has been escrowed by Consumers and is included in Consumers' temporary cash investments. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\nPSCR Matters: Consistent with the terms of the Settlement Order, Consumers has withdrawn its appeals of various MPSC orders issued in connection with the 1992, 1991 and 1990 PSCR cases. Consumers also agreed not to appeal any MCV-related issues raised in future orders for these plan cases and related reconciliations to the extent those issues are resolved by the Settlement Order. Consumers made refunds, including interest, of $69 million in 1993 and $29 million in 1992 to customers for overrecoveries in connection with the 1991 and 1990 PSCR reconciliation cases, respectively. These amounts were included in losses recorded prior to 1993. In 1992, Consumers recovered MCV power purchase costs consistent with the MPSC's 1992 plan case order, and does not anticipate that any MCV-related refunds will be required.\n4: Rate Matters\nElectric Rate Case\nConsumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. Consumers' request included increased future expenditures primarily related to capital additions, DSM programs, operation and maintenance, higher depreciation and postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. The filing also proposed experimental incentive provisions that would either reward or penalize Consumers, based on its operating performance. In addition, Consumers would share any returns above its MPSC-authorized level with customers in exchange for the ability to earn not lower than one percentage point below its authorized level.\nIn March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported the performance incentive but not the shared return mechanism discussed above.\nAbandoned Midland Project: In July 1984, Consumers abandoned construction of its unfinished nuclear power plant located in Midland, Michigan, and subsequently took a series of write-downs. In May 1991, Consumers began collecting $35 million pretax annually for the next 10 years and is amortizing the assets against current income over the recovery period using an interest method. Amortization for 1993, 1992 and 1991 was $28 million, $28 million and $18 million, respectively.\nConsumers was not permitted to earn a return on the portion of the abandoned Midland investment for which the MPSC was allowing recovery. Therefore, under SFAS 90, the recorded losses described above included amounts that reduced the recoverable asset to the present value of future recoveries. During the remaining recovery period, part of the prior losses will be reversed to adjust the unrecovered asset to its present value and is reflected as accretion income. An after-tax total of approximately $35 million of the prior losses remains to be included in accretion income through April 2001. Several parties, including the Attorney General, have filed claims of appeal with the Court of Appeals regarding MPSC orders issued in May and July 1991 that specified the recovery of abandoned investment.\nElectric DSM: As a result of settlement discussions regarding DSM and an MPSC order in July 1991, Consumers agreed to spend $65 million over two years on DSM programs. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent. This adjustment, if implemented, would be applied to Consumers' retail electric tariff rates and be in effect for one year following reconciliation hearings with the MPSC that are expected to be initiated in the first quarter of 1994. The estimated revenue effects of the potential adjustment range from an $11 million increase to a $22 million decrease. Consumers believes it will receive an increase on its return on common equity.\nOn October 1, 1993, Consumers completed the customer participation portion of these programs and as part of its current electric rate case has requested MPSC authorization to continue certain programs in 1994. Consumers has also requested recovery of DSM expenditures which exceeded the $65 million level. Consumers is deferring program costs and amortizing the costs over the period these costs are being recovered from its customers in accordance with an accounting order issued by the MPSC in September 1992. The unamortized balance of deferred costs at December 31, 1993 and 1992 was $71 million and $25 million, respectively.\nPSCR Issues\nConsumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage. Any finding of delay due to imprudence could result in disallowances of a portion of replacement power costs. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies. As of December 31, 1993, Consumers' remaining estimated liability was approximately $34 million. Consumers has a regulatory asset of $34 million for the expected recovery of this amount in electric rates. GCR Issues\nIn connection with its 1991 GCR reconciliation case, Consumers refunded $36 million, including interest, to its firm sales and transportation rate customers in April 1992. Consumers accrued the full amount for this refund in 1991.\nThe MPSC issued an order during 1993 that approved an interim settlement agreement for the 12 months ended March 31, 1993. As a result of the settlement, Consumers refunded in August 1993, to its GCR and transportation customers, approximately $22 million, including interest. Consumers previously accrued amounts sufficient for this refund.\nThe MPSC, in a February 1993 order, provided that the price payable to certain intrastate gas producers by Consumers be reduced prospectively. As a result, Consumers was not allowed to recover approximately $13 million of costs incurred prior to February 8, 1993. In 1991, Consumers accrued a loss sufficient for this issue. Future disallowances are not anticipated, unless the remaining appeals filed by the intrastate producers are successful.\nIn 1992, the FERC approved a settlement involving Consumers, Trunkline and certain other parties, which resolved numerous claims and proceedings concerning Trunkline liquified natural gas costs. The settlement represents significant gas cost savings for Consumers and its customers in future years. As part of the settlement, Consumers will not incur any transition costs from Trunkline as a result of FERC Order 636. In November 1992, Consumers had recorded a liability and regulatory asset for the principal amount of payments to Trunkline over a five-year period and a regulatory asset. On May 11, 1993, the MPSC approved a separate settlement agreement that provides Consumers with full recovery of these costs over a five-year period. At December 31, 1993, Consumers' remaining liability and regulatory asset was $116 million.\nOther\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. On September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements. The current contract covers gas deliveries through October 1994 and is at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims. Additionally, three of these direct gas suppliers of Consumers have made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on the financial statements.\n5: Income Taxes\nCMS Energy and its subsidiaries (including Consumers) file a consolidated federal income tax return. Income taxes are generally allocated to each subsidiary based on each subsidiary's separate taxable income. In 1992, CMS Energy implemented SFAS 109, Accounting for Income Taxes. Deferred tax assets and liabilities are classified as current or noncurrent based on the classification of the related asset or liability, for all temporary differences. Consumers began practicing full deferred tax accounting for temporary differences arising after January 1, 1993 as authorized by a generic MPSC order. The generic order reduces the amount of regulatory assets and liabilities that otherwise could have arisen in future periods by allowing Consumers to reflect the income statement effect in the period temporary differences arise.\nCMS Energy uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. The AMT requires taxpayers to perform a second separate federal tax calculation based on a flat rate applied to a broader tax base. AMT is the amount by which this \"broader-based\" tax exceeds regular tax. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 increased the statutory federal tax rate from 34 percent to 35 percent effective January 1, 1993. The cumulative effect of this tax rate change has been reflected in CMS Energy's financial statements.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1993 1992 1991(a) - ----------------------- ------- ------ -------- Current federal income taxes $ 19 $ 39 $ 13 Deferred income taxes 67 (177) (143) Deferred income taxes - tax rate change (1) - - Deferred ITC, net (10) (8) 36 ------- ------ ------ $ 75 $(146) $ (94) ======= ====== ======\nOperating $ 92 $ 22 $ 25 Other (17) (168) (119) ------- ------ ------ $ 75 $(146) $ (94) ======= ====== ======\n(a) The 1991 provision for income taxes was before an extraordinary item that had related deferred income taxes of approximately $7 million.\nThe principal components of CMS Energy's deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1993 1992 - ----------- ------- -------- Property $(580) $ (521) Unconsolidated investments (194) (128) Postretirement benefits (Note 10) (180) (167) Abandoned Midland project (Note 4) (57) (60) Employee benefit obligations (includes postretirement benefits of $182 and $168) (Note 10) 204 189 MCV power purchases - settlement (Note 3) 165 177 AMT carryforward 110 83 ITC carryforward (expires 2005) 48 52 Other (8) 5 ------- -------- $ (492) $ (370) ======== ========\nGross deferred tax liabilities $(1,571) $(1,416) Gross deferred tax assets 1,079 1,046 -------- -------- $ (492) $ (370) ======== ========\nThe actual income tax expense (benefit) differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1993 1992 1991 ------- ------- ------- Net income (loss) before preferred dividends and extraordinary item $ 166 $(286) $(252) Income tax expense (benefit) 75 (146) (94) ------- ------- ------- 241 (432) (346) Statutory federal income tax rate x 35% x 34% x 34% -------- ------- ------- Expected income tax expense (benefit) 84 (147) (118) Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 35 Differences in book and tax depreciation not previously deferred 6 9 8 ITC amortization and utilization (12) (11) (9) Other, net (8) (2) (10) ------- ------- ------- $ 75 $ (146) $(94) ======= ======= =======\n6: Short-Term Financings\nConsumers has authorization from the FERC to issue or guarantee up to $900 million of short-term debt through December 31, 1994. Consumers has a $470 million facility that is used to finance seasonal working capital requirements and unsecured, committed lines of credit aggregating $165 million. As of December 31, 1993, $235 million and $24 million were outstanding at weighted average interest rates of 4.0 percent and 3.9 percent, respectively. Further, Consumers has an established $500 million trade receivables purchase and sale program. As of December 31, 1993 and 1992, receivables sold under the agreement totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\n7: Capitalization\nCMS Energy\nCapital Stock: CMS Energy's Articles permit it to issue up to 250 million shares of common stock at $.01 par value and up to 5 million shares of preferred stock at $.01 par value. Under its two and one-half year Secured Credit Facility and Indenture pursuant to which the Notes are issued, CMS Energy is permitted to pay as dividends on its common stock an amount not to exceed the total of its net income and any proceeds received from the issuance or sale of common stock as defined in the Indentures and $40 million, provided there exists no event of default under the terms of the Secured Credit Facility or Indentures. The same formula applies to limits available to repurchase or reacquire CMS Energy stock for either the payment of dividends or repurchase of stock. In October 1993, CMS Energy issued an additional 4.6 million shares of common stock at a price of $26 5\/8. The net proceeds of $119 million were used to reduce existing debt and for general corporate purposes.\nLong-Term Debt: In October 1992, CMS Energy received proceeds of $130 million and $219 million from the issuance of Series A and Series B Notes, respectively. Interest will accrue and increase the principal to the face value of $172 million for the Series A Notes and $294 million for the Series B Notes through October 1, 1995. After such date, interest will be paid semi-annually commencing April 1, 1996, at a rate of 9.5 percent per annum for the Series A Notes and 9.875 percent per annum for the Series B Notes. In November 1992, CMS Energy entered into a $220 million Secured Credit Facility. As of December 31, 1993, $18 million was outstanding at a weighted average interest rate of 5.7 percent. The Notes and Secured Credit Facility are secured by a pledge of stock of Consumers, Enterprises, and NOMECO. Additionally, under the terms of the Secured Credit Facility, CMS Energy may only have outstanding, at any one time, an aggregate of $130 million of unsecured debt except for debt issued to refinance existing debt. The establishment of the Secured Credit Facility and the proceeds from the Notes, net of underwriting expenses, were used to retire the $410 million one-year secured revolving credit facility.\nCMS Energy filed a shelf registration statement with the SEC in January 1994 covering the issuance of up to $250 million of unsecured debt securities. The net proceeds will be used to reduce the amount of CMS Energy Notes outstanding and for general corporate purposes. The unsecured debt securities may be offered from time to time on terms to be determined at the time of the sale.\nConsumers\nCapital Stock: As of December 31, 1992, Consumers effected a quasi- reorganization, an elective accounting procedure in which Consumers' accumulated deficit of $574 million was eliminated against other paid-in capital. This action had no effect on CMS Energy's consolidated financial statements. As a result of the quasi-reorganization and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends in 1993 and also declared from 1993 earnings a $16 million common stock dividend in January 1994. Consumers has authorization from the MPSC and is proceeding to issue $200 million of preferred stock in 1994.\nFirst Mortgage Bonds: Consumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, Articles and the need for regulatory approvals in compliance with appropriate state and federal law. In September 1993, Consumers issued, with MPSC approval, $300 million of 6 3\/8 percent first mortgage bonds, due 2003 and $300 million of 7 3\/8 percent first mortgage bonds, due 2023. Consumers used the net proceeds from the bond issuance to refund approximately $515 million of higher interest first mortgage bonds and the balance to reduce short-term borrowings. Unamortized debt costs, premiums and discounts and call premiums on the refunded debt totaling approximately $18 million were deferred under SFAS 71, and are being amortized over the lives of the new debt.\nIn February 1994, Consumers issued a call for redemption totaling approximately $10 million. Consumers also fully redeemed two issues of first mortgage bonds totaling approximately $91 million. These redemptions completed Consumers' commitment to the MPSC, under the 1993 authorization to issue first mortgage bonds, to refinance certain long- term debt.\nLong-Term Bank Debt: Under its long-term credit agreement at December 31, 1993, Consumers was required to make 10 remaining quarterly principal payments of approximately $47 million. As of December 31, 1993, the outstanding balance under this credit agreement totaled $469 million with a weighted average interest rate of 4.0 percent. In January 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on the latest maturing $250 million of the then remaining $500 million obligation under its long-term credit agreement.\nOther: Consumers has a total of $131 million of PCRBs outstanding with a weighted average interest rate of 4.2 percent as of December 31, 1993. Consumers classifies $101 million of PCRBs as long-term because it can refinance these amounts through irrevocable letters of credit expiring after one year.\nIn June 1993, Consumers entered into loan agreements in connection with the issuance of approximately $28 million of adjustable rate demand limited obligation refunding revenue bonds, due 2010, which are secured by an irrevocable letter of credit expiring in 1996. These bonds bear an initial interest rate of 2.65 percent. Consumers also entered into loan agreements in connection with the issuance of $30 million of 5.8 percent limited obligation refunding revenue bonds, due 2010, secured by a financial guaranty insurance policy and certain first mortgage bonds of Consumers. Proceeds of these issues were used to redeem on August 1, 1993 in advance of their maturities, approximately $58 million of outstanding PCRBs.\nNOMECO\nAs of December 31, 1993, NOMECO had total debt outstanding of $122 million. Senior serial notes amounting to $45 million with a weighted average interest rate of 9.4 percent are outstanding from a private placement. In November 1993, NOMECO amended the terms of its revolving credit agreement and increased the amount to $110 million. At December 31, 1993, $72 million was outstanding at a weighted average interest rate of 4.7 percent. NOMECO also has $5 million outstanding under other credit agreements.\nEnterprises\nAs of December 31, 1993, MOAPA had $22 million of Clark County, Nevada, tax-exempt bonds outstanding with an interest rate of 3.35%. These bonds are backed by a letter of credit guaranteed by CMS Energy. If the letter of credit is not extended past its current expiration date of June 1, 1994, the bonds could be redeemed with the funds held in a trust account. These funds are invested in certificates of deposits and included in other noncurrent assets. The bonds were issued in 1990 for the purpose of providing partial funding for the development of a tires-to-energy solid waste disposal and resource recovery facility. In December 1993, the Nevada Public Service Commission rejected the power purchase agreement between MOAPA and the Nevada Power Company and subsequently rejected MOAPA's motion for rehearing.\n8: Financial Instruments\nCash, short-term investments and current liabilities approximate their fair value due to the short-term nature of those instruments. The estimated fair value of long-term investments is based on quoted market prices where available. When specific market prices do not exist for an instrument, the fair value is based on quoted market prices of similar investments or other valuation techniques. All long-term investments in financial instruments approximate fair value. The carrying amount of long-term debt was $2.4 billion and $2.7 billion and the fair value of long-term debt was $2.6 billion and $2.8 million as of December 31, 1993 and 1992, respectively. Although the current fair value of the long-term debt, which is based on calculations made by debt pricing specialists, may be greater than the current carrying amount, settlement of the reported debt is generally not expected until maturity. The fair value of CMS Energy's off-balance sheet financial instruments is based on the amount estimated to terminate or settle the obligation. The fair value of interest rate swap agreements was $6 million and $1 million and guarantees\/letters of credit was $96 million and $56 million as of December 31, 1993 and 1992, respectively (see Notes 7 and 12).\nOn January 1, 1994, CMS Energy adopted SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, requiring accounting for investments in debt securities to be held to maturity at amortized cost; otherwise debt and marketable equity securities would be recorded at fair value, with any unrealized gains or losses included in earnings if the security is held for trading purposes or as a separate component of shareholders' equity if the security is available for sale. The implementation of this standard did not materially impact CMS Energy's financial position or results of operations.\nIn May 1993, the FASB issued SFAS 114, Accounting by Creditors for Impairment of a Loan, effective in 1995, requiring certain loans that are determined to be impaired be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of any collateral for a secured loan. CMS Energy does not believe this standard will have a material impact on its financial position or results of operations.\n9: Executive Incentive Compensation\nUnder CMS Energy's Performance Incentive Stock Plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. The plan reserves for award not more than 2 percent of CMS Energy's common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. As of December 31, 1993, awards of up to 447,686 shares of common stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Performance criteria were added in 1990 based on CMS Energy's total return to shareholders. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, remains in effect until all authorized options are granted or September 25, 1995. As of December 31, 1993, options for 43,000 shares remained to be granted.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted under the Performance Incentive Stock Plan and options granted under both plans follows:\nRestricted Stock Options ---------- ---------------------------- Number Number Price of Shares of Shares per Share ----------- --------- --------------- Outstanding at January 1, 1991 212,500 1,162,216 $ 7.13 - $34.25 Granted 97,000 194,000 $ 21.13 - $21.13 Exercised or Issued (34,437) (65,125) $ 7.13 - $16.00 --------- ---------- --------------- Outstanding at December 31, 1991 275,063 1,291,091 $ 7.13 - $34.25 Granted 101,000 215,000 $ 17.13 - $18.00 Exercised or Issued (37,422) (21,000) $ 13.00 - $16.00 Canceled (15,375) (50,000) $ 20.50 - $33.88 --------- ---------- --------------- Outstanding at December 31, 1992 323,266 1,435,091 $ 7.13 - $34.25 Granted 132,000 249,000 $ 25.13 - $26.25 Exercised or Issued (54,938) (152,125) $ 7.13 - $21.13 Canceled (84,141) (33,000) $ 20.50 - $33.88 --------- ---------- ---------------\nOutstanding at December 31, 1993 316,187 1,498,966 $ 7.13 - $34.25 ========= ========== ===============\n10: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions\nCMS Energy and its subsidiaries adopted SFAS 106 effective as of the beginning of 1992. The standard required CMS Energy to change its accounting for the cost of health care and life insurance benefits that are provided to retirees from a pay-as-you-go (cash) method to a full accrual method. CMS Energy's non-utility subsidiaries expensed their accumulated transition obligation liability. The amount of such transition obligation is not material to the presentation of the consolidated financial statements or significant to CMS Energy's total transition obligation. Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates.\nBoth the MPSC and FERC have generally adopted SFAS 106 costs for ratemaking purposes provided costs recovered through rates are placed in external funds until they are needed to pay benefits. The MPSC's generic order allows utilities three years to seek recovery of costs and provides for recovery from customers of any deferred costs incurred prior to the beginning of rate recovery of such costs. Consumers anticipates recovering its regulatory asset within 20 years. As discussed in Note 4, Consumers has requested recovery of the portion of these costs allocated to the electric business. In late 1994, Consumers plans to request recovery of the gas utility portion of these costs. CMS Energy plans to fund the benefits using external Voluntary Employee Beneficiary Associations. Funding of the health care benefits would begin when Consumers' rate recovery based on SFAS 106 begins. A portion of the life insurance benefits have previously been funded.\nAs of December 31, 1993, the actuary assumed that retiree health care costs increased 10.5 percent in 1994, then decreased gradually to 5.5 percent in 2000 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $75 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1993 by $9 million.\nFor the years ended December 31, 1993 and 1992, the weighted average discount rate was 7.25 percent and 8 percent, respectively, and the expected long-term rate of return on plan assets was 8.5 percent. Net periodic postretirement benefit cost for health care benefits and life insurance benefits was $51 million in 1993 and $50 million in 1992. The 1993 and 1992 cost was comprised of $13 million and $11 million for service plus $38 million and $39 million for interest, respectively.\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1993 1992 ------- ------- Actuarial present value of estimated benefits Retirees $ 282 $ 265 Eligible for retirement 54 50 Active (upon retirement) 190 177 ------- ------- Accumulated postretirement benefit obligation 526 492 Plan assets (premium deposit fund) at fair value 4 4 ------- ------- Projected postretirement benefit obligation in excess of plan assets (522) (488) Unrecognized prior service cost (39) (39) Unrecognized net loss 41 33 ------- ------- Recorded liability $(520) $(494) ======= =======\nCMS Energy's postretirement health care plan is unfunded; the accumulated postretirement benefit obligation for that plan is $514 million and $482 million at December 31, 1993 and 1992, respectively. Consumers' regulatory asset is $510 million and $485 million at December 31, 1993 and 1992, respectively.\nSupplemental Executive Retirement Plan\nCertain management employees qualify under the SERP. Benefits are based on the employee's service and earnings as defined in the SERP. In 1988, a trust from which SERP benefits are paid was established and funded. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in Consumers' consolidated assets. As of December 31, 1993 and 1992, trust assets at cost (which approximates market) were $18 million and $16 million, respectively, and were classified as other non-current assets.\nDefined Benefit Pension Plan\nA trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan is fully funded, no contributions were made for plan years 1991 through 1993.\nYears Ended December 31 1993 1992 1991 - ----------------------- ----- ----- ----- Discount rate 7.25% 8.5% 8.5% Rate of compensation increase 4.5% 5.5% 5.5% Expected long-term rate of return on assets 8.75% 8.75% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Service cost $ 19 $ 19 $ 18 Interest cost 50 48 48 Actual return on plan assets (92) (36) (88) Net amortization and deferral 34 (20) 29 ------ ------ ------ Net periodic pension cost $ 11 $ 11 $ 7 ====== ====== ======\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP -------------- ------------- 1993 1992 1993 1992 ----- ----- ----- -----\nActuarial present value of estimated benefits Vested $ 471 $ 349 $ 16 $ 11 Non-vested 56 49 - - ----- ----- ----- ----- Accumulated benefit obligation 527 398 16 11 Provision for future pay increases 138 177 8 6 ----- ----- ----- ----- Projected benefit obligation 665 575 24 17 Plan assets (primarily stocks and bonds, including $87 in 1993 and $64 in 1992 in common stock of CMS Energy) at fair value 692 631 - - ----- ----- ----- ----- Projected benefit obligation less than (in excess of) plan assets 27 56 (24) (17) Unrecognized net (gain) loss from experience different than assumed (56) (76) 7 2 Unrecognized prior service cost 45 49 1 1 Unrecognized net transition (asset) obligation (44) (49) 1 1 Adjustment to recognize minimum liability - - (1) - ----- ----- ----- ----- Recorded liability $ (28) $ (20) $ (16) $ (13) ====== ====== ====== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\nIn 1991, certain eligible employees accepted early retirement incentives. The incentives consisted of lump-sum cash payments and increased pension payments. The pretax cost of the incentives was $25 million. Also in 1991, portions of the projected benefit obligation were settled which resulted in a pretax gain of $25 million that offset the early retirement costs.\n11: Leases\nCMS Energy, Consumers, and Enterprises lease various assets, including vehicles, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement was extended an additional year and is now scheduled to expire in November 1995. The maximum amount of nuclear fuel that can be leased increased from $55 million to $70 million. Consumers further increased this amount in early 1994 to $80 million. The lease provides for an additional one-year extension upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $57 million as of December 31, 1993. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under CMS Energy's non-cancelable leases at December 31, 1993, were:\nIn Millions Capital Operating Leases Leases ------- --------- 1994 $ 43 $ 9 1995 64 8 1996 16 3 1997 15 3 1998 13 3 1999 and thereafter 26 22 ----- ----- Total minimum lease payments 177 $ 48 ===== Less imputed interest 27 ----- Present value of net minimum lease payments 150 Less current portion 35 ----- Non-current portion (a) $115 =====\n(a) In January 1994, Consumers amended its nuclear fuel lease to include fuel previously owned at Big Rock Point. This is estimated to increase the non-current portion of capital leases by approximately $6 million. Consumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1993, 1992 and 1991, were $18 million, $15 million and $15 million, respectively.\nCapital lease expenses for the years ended December 31, 1993, 1992 and 1991 were $34 million, $47 million and $51 million, respectively. Included in these amounts for the years ended 1993, 1992 and 1991, are nuclear fuel lease expenses of $13 million, $17 million and $24 million, respectively.\n12: Commitments, Contingencies and Other\nLudington Pumped Storage Plant Litigation\nIn 1986, the Attorney General filed a lawsuit on behalf of the State of Michigan in the Circuit Court of Ingham County, seeking damages from Consumers and Detroit Edison for alleged injuries to fishery resources because of the operation of the Ludington Pumped Storage Plant. The state sought $148 million (including $16 million of interest) for past injuries and $89,000 per day for future injuries, with the latter amount to be adjusted upon installation of \"adequate\" fish barriers and other changed conditions.\nIn 1987, the Attorney General filed a second lawsuit alleging that Consumers and Detroit Edison have breached a bottomlands lease agreement with the state and asked that the lease be declared void. This complaint was consolidated with the suit described in the preceding paragraph. In 1990, both of the lawsuits were dismissed on the basis of federal preemption. In 1993, the Court of Appeals overturned the dismissal, as to damages, effectively allowing the state to continue its damages lawsuit against Consumers and Detroit Edison, but generally affirmed the lower court's ruling as to the breach of lease claim. The Court of Appeals' ruling also limited any potential damages to those occurring no earlier than 1983. Consumers, Detroit Edison and the Attorney General have filed an application for leave to appeal with the Michigan Supreme Court. Consumers and Detroit Edison are seeking to have the trial court's dismissal of the damages claim affirmed.\nEach year since 1989, Consumers and Detroit Edison have complied with FERC orders by installing a seasonal barrier net from April to October at the Ludington plant site. The FERC is now considering whether the barrier net (along with other actions by Consumers, including contributions to state fish-stocking programs) would be a satisfactory permanent solution.\nEnvironmental Matters\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers and CMS Energy believe that it is unlikely that their liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on their financial positions or results of operations.\nThe State of Michigan in 1990 passed amendments to the Environmental Response Act that established a state program similar to the federal Superfund law, though broader in scope. Under this law, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation\/feasibility studies for three of these sites. Work plans for remedial investigation\/feasibility studies for four other sites have also been prepared. The purpose of a remedial investigation\/feasibility study is to define the nature and extent of contamination at a site and to determine which of several possible remedial action alternatives, including no action, may be required under the Environmental Response Act. The DNR has approved two of the three plans for remedial investigation\/feasibility studies submitted and is currently reviewing the one remaining. The cost to conduct one of the approved studies will be approximately $250,000 based on bids received. Although the actual cost of conducting the remaining two remedial investigation\/feasibility studies will not be known until bids are received from contractors, Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation\/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation\/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study. Based on Consumers' knowledge of other utility remedial actions, remediation costs for Consumers for these sites may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. The MPSC stated the length of the period may be reviewed from time to time, but any revisions would be prospective. Consumers and CMS Energy believe costs incurred for both investigation and any required remedial actions would be recoverable from utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nIncluded in the 1990 amendments to the federal Clean Air Act are provisions that limit emissions of sulfur dioxide and nitrogen oxides and require enhanced emissions monitoring. All of Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in 2000. Beginning in 1995, certain coal-fueled generating units will receive emissions allowances (all of Consumers' coal units will receive allowances beginning in 2000). Based on projected emissions from these units, Consumers expects to have excess allowances which may be sold or saved for future use.\nThe Clean Air Act's provisions require Consumers to make capital expenditures estimated to total $74 million through 1999 for completed, in-process and possible modifications at coal-fired units based on existing and proposed regulations. Management believes that Consumers' annual operating costs will not be materially affected.\nThe EPA has asked a number of utilities in the Great Lakes area to voluntarily retire certain equipment containing specific levels of polychlorinated biphenyls. Consumers believes that it is largely in compliance with the EPA's petition. Consumers is continuing to study the request and has been granted an extension for responding until March 30, 1994.\nCapital Expenditures\nCMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries, DSM and new lease commitments, of $792 million for 1994, $690 million for 1995 and $714 million for 1996.\nPublic Utility Holding Company Act Exemption\nCMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. In 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nOther\nAs of December 31, 1993, CMS Energy and Enterprises have guaranteed up to $90 million in contingent obligations of unconsolidated affiliates of Enterprises' subsidiaries.\nNOMECO has hedged its gas supply obligations in the years 2001 through 2006 by purchasing the economic equivalent of 10,000 MMBtu per day at a fixed, escalated price starting at $2.82 per MMBtu in 2001. The settlement periods are each a one-year period ending December 31, 2001 through 2006 on 3.65 MMBtu. If the \"floating price,\" essentially the then current Gulf Coast spot price, for a period is higher than the \"fixed price,\" the seller pays NOMECO the difference, and vice versa. If a party's exposure at any time exceeds $2 million, that party is required to obtain a letter of credit in favor of the other party for the excess over $2 million, to a maximum of $10 million. At December 31, 1993, the seller had arranged a letter of credit in NOMECO's favor for $10 million. NOMECO also periodically enters into oil and gas price hedging arrangements to mitigate its exposure to price fluctuations on the sale of crude oil and natural gas. As of December 31, 1993, the fair value of these hedge arrangements was not material.\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment, can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. A complaint seeking certification as a class action suit was filed against Consumers in a local county circuit court in 1993. The complaint alleges the existence of a purported class that has incurred damages of up to $1 billion, primarily to certain livestock owned by the purported class, as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and intends to vigorously oppose the certification of the class and this suit.\nIn addition to the matters disclosed in these notes, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nThe ultimate effect of the proceedings discussed in this note is not expected to have a material impact on CMS Energy's financial position or results of operations.\n13: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1993 1992 - ----------- ---- ---- Net investment Ludington - 51% $114 $112 Campbell Unit 3 - 93.3% 349 360 Transmission lines - various 32 33\nAccumulated depreciation Ludington $ 74 $ 71 Campbell Unit 3 210 199 Transmission lines 11 10\n14: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1993 1992 1991 ------ ------ ------ Cash transactions Interest paid (net of amounts capitalized) $193 $203 $325 Income taxes paid (net of refunds) 32 19 21\nNon-cash transactions Nuclear fuel placed under capital lease $ 28 $ 30 $ 6 Other assets placed under capital leases 30 39 21 Capital leases refinanced 42 - - Assumption of debt - 15 -\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1993 1992 1991 ------ ------ ------ Sale of receivables, net $ 60 $ 25 $ - Accounts receivable 22 6 118 Accrued revenue (48) 88 7 Accrued refunds (48) (143) 102 Inventories (32) 23 (8) Accounts payable (31) 20 (70) Tax Reform Act refund reserve - - (77) Other current assets and liabilities, net (19) 46 (20) Non-current deferred amounts, net 9 (28) 108 ------ ------ ------ $ (87) $ 37 $ 160 ======= ====== ======\n15: Reportable Segments\nCMS Energy operates principally in the following five business segments: electric utility, gas utility, oil and gas exploration and production, independent power production, and gas transmission and marketing.\nThe Consolidated Statements of Income show operating revenue and pretax operating income by business segment. Other segment information follows:\nIn Millions Years Ended December 31 1993 1992 1991 --------- -------- ------ Depreciation, depletion and amortization Electric utility $ 241 $ 230 $ 172 Gas utility 73 76 70 Oil and gas exploration and production 45 38 33 Independent power production 2 2 2 Gas transmission and marketing 1 1 - Other 3 1 6 -------- ------- -------- $ 365 $ 348 $ 283 ======== ======= ========\nIdentifiable assets Electric utility (a) $ 4,027 $3,812 $3,399 Gas utility 1,443 1,387 1,186 Oil and gas exploration and production 398 364 334 Independent power production 488 333 321 Gas transmission and marketing 75 60 45 Other 533 892 909 --------- ------- ------- $ 6,964 $6,848 $6,194 ========= ======= =======\nCapital expenditures (b)(c)(d) Electric utility (e) $ 365 $ 353 $ 213 Gas utility 127 86 61 Oil and gas exploration and production 81 68 71 Independent power production 110 12 18 Gas transmission and marketing 14 6 17 Other 69 69 33 --------- ------- ------- $ 766 $ 594 $ 413 ========= ======= =======\n(a) Includes abandoned Midland investment of $162 million, $175 million and $287 million for 1993, 1992 and 1991, respectively.\n(b) Includes capital leases for nuclear fuel and other assets (see Note 14).\n(c) Includes equity investments in unconsolidated partnerships of $108 million for 1993, $12 million for 1992 and $33 million for 1991.\n(d) Certain prior year amounts have been adjusted for comparative purposes.\n(e) Includes DSM costs of $52 million for 1993 and $26 million for 1992.\n16: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1993 obligation to purchase electricity from the MCV Partnership was approximately 14 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership is shown below:\nStatements of Income In Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Operating revenue (a) $ 548 $ 488 $ 425 Operating expenses 362 315 278 ------ ------ ------ Operating income 186 173 147 Other expense, net (189) (190) (186) ------ ------ ------ Net loss $ (3) $ (17) $ (39) ====== ====== ======\nBalance Sheets In Millions December 31 1993 1992 - ----------- ------ ------ Assets Current assets (a) $ 181 $ 165 Property, plant and equipment, net 2,073 2,124 Other assets 146 147 ------ ------ $2,400 $2,436 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 198 $ 189 Long-term debt and other non-current liabilities (b) 2,147 2,189 Partners' equity (c) 55 58 ------ ------ $2,400 $2,436 ====== ======\n(a) Revenue from Consumers totaled $505 million, $444 million and $384 million for 1993, 1992 and 1991, respectively. As of December 31, 1993, 1992 and 1991, $44 million, $38 million and $33 million, respectively, were receivable from Consumers.\n(b) FMLP is a beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP (see Note 3). At December 31, 1993 and 1992, lease obligations of $1.7 billion were owed to the owner trust of which FMLP is the sole beneficiary. CMS Holdings' share of the interest and principal portion for the 1993 lease payments was $63 million and $16 million, respectively, and for the 1992 lease payments was $65 million and $12 million, respectively. The lease payments service $1.2 billion and $1.3 billion in non-recourse debt outstanding as of December 31, 1993 and 1992, respectively, of the owner-trust whose beneficiary is FMLP. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1993 and 1992, the owner-trust whose beneficiary is FMLP made debt payments of $172 million and $166 million, respectively, which included $10 million and $8 million principal and $25 million and $26 million interest, respectively, on the MCV Bonds held by MEC Development Corporation during part of 1991 and by Consumers through December 1993.\n(c) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of long-term debt and preferred stock of CMS ENERGY CORPORATION (a Michigan corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CMS Energy Corporation and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes. Additionally, as discussed in Note 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\n(This page intentionally left blank)\nConsumers Power Company\n1993 Financial Statements\n(This page intentionally left blank)\nConsumers Power Company Management's Discussion and Analysis\nConsumers is a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry.\nConsolidated 1993 Earnings\nConsolidated net income after dividends on preferred stock totaled $187 million in 1993, compared to net losses of $255 million in 1992 and $260 million in 1991. The increased net income reflects the Settlement Order related to power purchases from the MCV Partnership. Earnings also reflect record setting electric sales and gas deliveries.\nCash Position, Financing and Investing\nConsumers' operating cash requirements are met by its operating and financing activities. In 1993 and 1992, Consumers' cash from operations mainly resulted from its sale and transportation of natural gas and its sale and transmission of electricity. Cash from operations for 1993 primarily reflects record-setting electric sales and gas deliveries and reduced after-tax cash shortfalls resulting from Consumers' purchases of power from the MCV Partnership.\nDuring 1992, Consumers' cash from operations increased as compared to 1991 primarily due to lower interest charges resulting from reduced levels of debt, partially offset by higher operating expenditures and reduced electric rates. In 1991, Consumers generated cash primarily from its consolidated operating and investing activities, including $859 million of net proceeds from the sale of a majority of the MCV Bonds.\nOver the last three years, Consumers has used its cash primarily to fund its extensive construction expenditures and to improve the reliability of its transmission and distribution systems. Consumers has also used its cash to retire portions of long-term debt and to pay cash dividends.\nFinancing Activities\nAs a result of the 1992 quasi-reorganization (see Note 7 to the Consolidated Financial Statements), and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends during 1993 and declared a $16 million common stock dividend in January 1994 from 1993 earnings.\nDuring 1993, Consumers significantly reduced its future interest charges by retiring approximately $51 million of high-cost outstanding debt and refinancing approximately $573 million of other debt at lower interest rates. For further information, see Note 7.\nInvesting Activities\nCapital expenditures (excluding assets placed under capital leases of $58 million) and deferred demand-side management costs totaled $503 million in 1993 as compared to $437 million in 1992. These amounts primarily represent capital investments in Consumers' electric and gas utility segments. In December 1993, Consumers sold $309 million of MCV Bonds it held and used the net proceeds to temporarily reduce short-term borrowings and ultimately plans to reduce long-term debt and to finance its construction program.\nOutlook\nConsumers estimates that capital expenditures, including demand-side management and new lease commitments, related to its electric and gas utility operations will total approximately $1.5 billion over the next three years. In Millions Years Ended December 31 1994 1995 1996 ---- ---- ----\nConsumers Construction (including DSM) $474 $425 $391 Nuclear fuel lease 46 4 45 Capital leases other than nuclear fuel 27 27 28 Michigan Gas Storage 6 5 7 ---- ---- ---- $553 $461 $471 ==== ==== ====\nConsumers is required to redeem or retire approximately $741 million of long-term debt during 1994 through 1996. Cash generated by operations is expected to satisfy a substantial portion of these capital expenditures and debt retirements.\nConsumers has several other available sources of credit including unsecured, committed lines of credit totaling $165 million and a $470 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1994. Consumers uses short-term borrowings to finance working capital, seasonal fuel inventory and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. As of December 31, 1993 and 1992, receivables sold totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\nIn October 1993, Consumers received MPSC authorization and is proceeding to issue $200 million of preferred stock in 1994. In February 1994, Consumers called or redeemed approximately $101 million of first mortgage bonds.\nAt December 31, 1993, Consumers' capital structure consisted of approximately 32 percent common equity, 4 percent preferred stock, and 64 percent long- and short-term debt (including capital leases and notes payable). Consumers' long term goal is to achieve and maintain a capital structure consisting of approximately 37 percent common equity, 8 percent preferred stock and 55 percent debt. Management expects to achieve this structure through debt reductions, accumulated earnings, the issuance of new preferred stock and equity investments from CMS Energy.\nElectric Utility Operations\nComparative Results of Operations\nElectric Pretax Operating Income: The improvement in 1993 pretax operating income compared to 1992 reflects an increase of $126 million relating to the resolution of the recoverability of MCV power purchase costs under the PPA and increased electric system sales of $45 million, partially offset by higher costs to improve system reliability. The 1992 decrease of $66 million from the 1991 level primarily resulted from an increased emphasis on system reliability improvements and decreased electric rates resulting from the full-year impact of a mid-1991 rate decrease.\nIn Millions 1993 1992 Over Over (Under) (Under) 1992 1991 ------ ------\nSales growth $ 34 $ 11 Weather 11 (16) Resolution of MCV power cost issues 126 - Other regulatory issues 5 (13) O&M, general taxes and depreciation (a) (44) (48) ----- ----- Total change $132 $(66) ===== =====\n(a) Largely caused by Consumers' system reliability improvement program.\nElectric Sales: Electric system sales in 1993 totaled a record 31.7 billion kWh, a 3.8 percent increase from 1992 levels. In 1993, residential and commercial sales increased 3.4 percent and 3.0 percent, respectively, while industrial sales increased 6.5 percent. Growth in the industrial sector was the strongest in the auto-related segments of fabricated and primary metals and transportation equipment. Electric system sales in 1992 totaled 30.5 billion kWh, essentially unchanged from the 1991 levels.\nElectric Sales Millions of kWh 1993 1992 1991 ------ ------ ------\nResidential 10,066 9,733 9,997 Commercial 8,909 8,652 8,692 Industrial 11,541 10,831 10,692 Sales for resale 1,142 1,292 1,311 ------ ------ ------ System sales (a) 31,658 30,508 30,692 ====== ====== ======\nTotal customers (000) 1,526 1,506 1,492 ====== ====== ======\n(a) Excludes intersystem exchanges of power with other utilities through joint dispatching for the economic benefit of customers. The level of intersystem sales has been essentially unchanged during each of the last three years.\nPower Costs: Power costs for 1993 totaled $908 million, a $31 million increase from the corresponding 1992 period. This increase primarily reflects greater power purchases from outside sources to meet increased sales demand and to supplement decreased generation at Palisades due to an extended outage. Power costs for 1992 totaled $877 million, a $17 million decrease as compared to 1991.\nOperation and Maintenance: Increases in other operation and maintenance expense for 1993 and 1992 reflected increased expenditures to improve electric system reliability.\nDepreciation: The increased depreciation for 1993 reflects additional capital investments in plant. The 1992 increase resulted from higher depreciation rates, increased amortization of abandoned nuclear investment and increased nuclear plant decommissioning expense.\nElectric Utility Rates\nPower Purchases from the MCV Partnership: Consumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1993 1994 thereafter - ---- ----- ----- ---------- MW 1,023 1,132 1,240\nSince 1990, recovering capacity and fixed-energy costs for power purchased from the MCV Partnership has been a significant issue. Effective January 1, 1993, the Settlement Order allowed Consumers to recover from electric retail customers substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership, significantly reducing the amount of future underrecoveries for these power costs. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nPrior to the Settlement Order, Consumers had recorded losses for underrecoveries from 1990 through 1992. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order, based on management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. The after-tax expense for the time value of money for the $343 million loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. If Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Estimates for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. As of December 31, 1993, these amounts total $26 million. Although Consumers intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action. For further information regarding power purchases from the MCV Partnership, see Note 3.\nPSCR Matters: Consumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage and any associated delays. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies.\nElectric Rate Case: Consumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. In March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported a performance incentive which Consumers also supported. For further information, see Note 4.\nElectric Conservation Efforts\nIn October 1993, Consumers completed the customer participation portion of several incentive-based demand-side management programs which were designed to encourage the efficient use of energy, primarily through conservation measures. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on electric common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent, for one year following reconciliation hearings with the MPSC. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives. For further information, see Note 4.\nElectric Capital Expenditures\nConsumers estimates capital expenditures, including demand-side management and new lease commitments, related to its electric utility operations of $396 million for 1994, $324 million for 1995 and $332 million for 1996.\nElectric Environmental Matters and Health Concerns\nThe 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions will require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nIn 1990, the State of Michigan passed amendments to the Environmental Response Act, under which Consumers expects that it will ultimately incur costs at a number of sites, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from its electric customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers believes that it is unlikely that its liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position or results of operations.\nElectric Outlook\nConsumers expects economic growth, competitive rates and other factors to increase the demand for electricity within its service territory by approximately 1.8 percent per year over the next five years. For the near term, Consumers currently plans a reserve margin of 20 percent and expects to fill the additional capacity required through long- and short-term power purchases. Long-term purchased power will likely be obtained through a competitive bidding solicitation process utilizing the framework established by the MPSC in 1992. Capacity from the MCV Facility above the levels authorized by the MPSC may be offered by Consumers in connection with the solicitation.\nA recent NRC review of Consumers' performance at Palisades showed a decline in performance. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. To provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management which is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nConsumers is currently collecting $45 million annually from electric retail customers for the future decommissioning of its two nuclear plants. Consumers believes these amounts will be adequate to meet current decommissioning cost estimates. For further information regarding nuclear decommissioning, see Note 2.\nConsumers' on-site storage pool at Palisades is at capacity, and it is unlikely that the DOE will begin accepting any spent nuclear fuel by the originally scheduled date in 1998. Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary storage. Several appeals relating to NRC approval of the casks are now pending at the U.S. Sixth Circuit Court of Appeals. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers has experienced an increase in complaints in 1993 relating primarily to the effect of so-called stray voltage on certain livestock. A complaint seeking certification as a class action suit has been filed against Consumers alleging significant damages, primarily related to certain livestock, which Consumers believes to be without merit (see Note 12).\nSome of Consumers' larger industrial customers are exploring the possibility of constructing and operating their own on-site generating facilities. Consumers is actively working with these customers to develop rate and service alternatives that are competitive with self-generation options. Although Consumers' electric rates are competitive with other regional utilities, Consumers has on file with the FERC two open access interconnection tariffs which could have the effect of increasing competition for wholesale customers. As part of its current electric rate case, Consumers has requested that the MPSC reduce the level of rate subsidization of residential customers by commercial and industrial customers so as to further improve rate competitiveness for its largest customers.\nThe MPSC has completed a hearing on a proposal by ABATE to create an experimental retail wheeling tariff. Certain other parties have proposals in support of retail wheeling under development. In August 1993, an ALJ recommended that the MPSC reject the proposed experiment. An MPSC order is expected early in 1994.\nGas Utility Operations\nComparative Results of Operations\nGas Pretax Operating Income: For 1993, pretax operating income increased $37 million compared to 1992, reflecting higher gas deliveries (both sales and transportation volumes) and more favorable regulatory recovery of gas costs related to transportation. During 1992, gas pretax operating income increased $45 million from the 1991 level, essentially for many of the same reasons as the current period.\nIn Millions 1993 1992 Over Over (Under) (Under) 1992 1991 ------ ------\nSales growth $ 7 $ 14 Weather 10 6 Regulatory recovery of gas cost 12 48 O&M, general taxes and depreciation 8 (23) ------ ------ Total change $ 37 $ 45 ====== ======\nGas Deliveries: Gas sales and gas transported in 1993 totaled 410.6 bcf, a 6.9 percent increase from 1992. In 1992, gas sales and gas transported totaled 384.1 bcf, a 6.1 percent increase from 1991 deliveries.\nGas Deliveries Bcf 1993 1992 1991 ----- ----- -----\nResidential 174.9 166.7 157.2 Commercial 55.9 53.4 50.2 Industrial 13.9 13.5 14.5 Other .2 .2 .2 ----- ----- ----- Gas sales 244.9 233.8 222.1 Transportation deliveries 70.5 66.4 61.5 Transportation for MCV 73.4 63.5 55.0 Off-system transportation service 21.8 20.4 23.4 ----- ----- ----- Total deliveries 410.6 384.1 362.0 ===== ===== =====\nTotal customers (000) 1,423 1,402 1,382 ===== ===== =====\nGas Utility Rates\nConsumers currently plans to file a request in 1994 with the MPSC to increase its gas rates. The request would include, among other things, costs for postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. A final order should be received approximately nine to twelve months after the request is filed.\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. The Trunkline contract covers gas deliveries through October 1994 and is at a price reduced in September 1993. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims.\nIn 1992, the FERC issued Order 636, which makes a number of significant changes to the structure of the services provided by interstate natural gas pipelines to be implemented by the 1993-94 winter heating season. Consumers is a significant purchaser of gas from an interstate pipeline (Trunkline) and is a major transportation customer of a number of pipelines. Management believes that Consumers will recover any transition costs it may incur and such restructuring will not have a significant impact on its financial position or results of operations.\nIn July 1993, Michigan Gas Storage submitted a notice of rate change with the FERC to revise its operation and maintenance expenses for 1993 and update plant costs to reflect the addition of approximately $27 million of new plant additions in 1993 and began collecting the revised rates subject to refund and a hearing in February 1994. Hearings or settlement conferences will follow. For further information regarding gas utility rates, see Note 4.\nGas Capital Expenditures\nConsumers estimates capital expenditures, including new lease commitments, related to its gas utility operations of $99 million for 1994, $88 million for 1995 and $81 million for 1996.\nGas Environmental Matters\nUnder the Environmental Response Act, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation\/feasibility studies for three of these sites. Work plans for remedial investigation\/feasibility studies for four other sites have also been prepared. The DNR has approved two of the three plans for remedial investigation\/feasibility studies submitted and is currently reviewing the one remaining. Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation\/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation\/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study, which may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from gas utility customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nGas Outlook\nIn 1993, Consumers purchased approximately 85 percent of its required gas supply under long-term contracts, and the balance on the spot market. Trunkline supplied approximately 41 percent of the total requirement. Consumers expects gas supply reliability to be ensured through long-term supply contracts, with purchases in the short-term spot market when economically beneficial. Management believes that Consumers' ability to purchase gas during the off-season and store it in its extensive underground storage facilities will continue to help provide customers with low-cost, competitive gas rates.\nConsumers anticipates growth in gas deliveries of approximately 0.6 percent per year over the next five years. Management believes that environmental benefits, along with the federal requirements included in the Energy Act, create an opportunity for growth in the natural gas vehicle industry.\nOther\nOther Income: The 1993 other income level reflects lower Midland-related losses than experienced in 1992. The 1992 loss included a $343 million charge related to the Settlement Order. The 1991 loss included $294 million, related to an MPSC order received in 1991 that allowed Consumers to recover only $760 million of remaining abandoned Midland investment, and a $92 million loss related to the cancellation of the CMS Debentures.\nPublic Utility Holding Company Act Exemption: CMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. On April 15, 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nConsumers Power Company Notes to Consolidated Financial Statements\n1: Corporate Structure\nConsumers is a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation\nThe consolidated financial statements include Consumers and its wholly owned subsidiaries. Consumers eliminates all material transactions between its consolidated companies. Consumers uses the equity method of accounting for investments in its companies and partnerships where it has more than a 20 percent but less than a majority ownership interest.\nGas Inventory\nConsumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion\nProperty repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. In May 1991, the MPSC approved an increase of approximately $15 million annually in Consumers' electric and common utility plant depreciation rates. The composite depreciation rate for electric utility property was 3.4 percent for 1993 and 1992 and 3.3 percent for 1991. The composite rate for gas utility plant was 4.4 percent for 1993 and 4.3 percent for 1992 and 1991. The composite rate for other plant and property was 4.7 percent for 1993, 5.8 percent for 1992 and 3.7 percent for 1991.\nNew Accounting Standards\nIn November 1992, the FASB issued SFAS 112, Employers' Accounting for Postemployment Benefits, which Consumers adopted January 1, 1994. Consumers pays for several postemployment benefits, the most significant being workers compensation. Because Consumers' postemployment benefit plans do not vest or accumulate, the standard did not materially impact Consumers' financial position or results of operations. For new accounting standards related to financial instruments, see Note 8.\nNuclear Fuel, Decommissioning and Other Nuclear Matters\nConsumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities under various payment options. However, in a statement released February 17, 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. The DOE is exploring options to offset the costs incurred by nuclear utilities in continuing to store spent nuclear fuel on site. For fuel burned after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers it through electric rates and remits it to the DOE quarterly. Consumers has elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983 until the spent fuel is delivered to the DOE. As of December 31, 1993, Consumers has recorded a liability to the DOE of $90 million, including interest, to dispose of spent nuclear fuel burned before April 7, 1983. Consumers has been recovering through electric rates the amount of this liability, excluding a portion of interest. Consumers' liability to the DOE becomes due when the DOE takes possession of Consumers' spent nuclear fuel, which was originally scheduled to occur in 1998.\nIn April 1993, the NRC approved the design of the dry spent fuel storage casks now being used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of mid-February 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals relating to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. Consumers loaded two dry storage casks with spent nuclear fuel in 1993 and expects to load additional casks in 1994 prior to Palisades' 1995 refueling. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers currently estimates decommissioning costs (decontamination and dismantlement) of $208 million and $399 million, in 1993 dollars, for the Big Rock Point and Palisades nuclear plants, respectively. At December 31, 1993, Consumers had recorded $171 million of decommissioning costs and classified the obligation as accumulated depreciation. In January 1987, Consumers began collecting estimated costs to decommission its two nuclear plants through a monthly surcharge to electric customers which currently totals $45 million annually. Consumers expects to file updated decommissioning estimates with the MPSC on or before March 31, 1995. Amounts collected from electric retail customers are deposited in trust. Trust earnings are recorded as an investment with a corresponding credit included in accumulated depreciation. The total amount of the trust will be available for decommissioning Big Rock Point and Palisades at the end of their respective license periods in 2000 and 2007. Consumers believes the amounts being collected are adequate to meet its currently estimated decommissioning costs and current NRC requirements.\nIn November 1993, Palisades returned to service following a planned refueling and maintenance outage that had been extended due to several unanticipated repairs. The results of an NRC review of Consumers' performance at Palisades published shortly thereafter showed a decline in performance ratings for the plant. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. In order to provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management. The evaluation is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nPlateau Resources Ltd.\nIn August 1993, Consumers sold its ownership interest in Plateau to U. S. Energy Corp. As a result of the sale, approximately $14 million of Plateau's cash and cash equivalents, other assets and liabilities, including certain future decommissioning, environmental and other contingent liabilities were transferred to U. S. Energy Corp. In view of prior write-offs, this transaction did not result in any material gains or additional losses.\nReclassifications\nConsumers and the MCV Partnership (see Note 17) have reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect the net losses for the years presented.\nRevenue and Fuel Costs\nConsumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers also accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until Consumers bills these unrecovered costs or refunds the excess recoveries to customers after reconciliation hearings conducted before the MPSC.\nUtility Regulation\nConsumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther\nFor significant accounting policies regarding cash equivalents, see Note 14; for income taxes, see Note 5; and for pensions and other postretirement benefits, see Note 10.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to supply electricity and steam to The Dow Chemical Company and to sell electricity to Consumers for a 35-year period beginning in March 1990. At December 31, 1993, Consumers, through its subsidiaries, held the following assets related to the MCV: 1) CMS Midland owned a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings held through the FMLP a 35 percent lessor interest in the MCV Facility. In late 1993, Consumers sold its remaining $309 million investment in the MCV Bonds.\nPower Purchases from the MCV Partnership\nConsumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1991 1992 1993 1994 thereafter - ---- ----- ----- ----- ----- ---------- MW 806 915 1,023 1,132 1,240\nDuring 1992 and 1991, the MPSC only allowed Consumers to recover costs of power purchased from the MCV Partnership based on delivered energy at rates less than Consumers paid for 840 MW in 1992 and 806 MW in 1991. As a result, Consumers recorded after-tax losses of $86 million in 1992 and $124 million in 1991.\nOn March 31, 1993, the MPSC approved, with modifications, the Revised Settlement Proposal which had been co-sponsored by Consumers, the MPSC staff and 10 small power and cogeneration developers. These parties accepted the Settlement Order and the MCV Partnership confirmed that it did not object to its terms. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nThe Settlement Order determined the cost of power purchased from the MCV Partnership that Consumers can recover from its electric retail customers and will significantly reduce the amount of future underrecoveries for these power costs. Effective January 1, 1993, the Settlement Order allowed Consumers to recover substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership. Capacity and energy purchases from the MCV Partnership above the 915 MW level can be competitively bid into Consumers' next solicitation for power or, if necessary, utilized for current power needs with a prudency review and a pricing recovery determination in annual PSCR cases. In either instance, the MPSC would determine the levels of recovery from customers for the power purchased. The Settlement Order also provides Consumers the right to remarket all of the remaining capacity to third parties.\nThe PPA requires Consumers to pay a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge based primarily on Consumers' average cost of coal consumed. The Settlement Order provided Consumers two options for the recovery that could be used for capacity charges paid to the MCV Partnership. Under the option selected, Consumers is scheduling deliveries of energy from the MCV Partnership whenever it has energy available up to hourly availability limits, or \"caps,\" for the 915 MW of capacity authorized for recovery in the Settlement Order. Consumers can recover an average 3.62 cents per kWh capacity charge and the prescribed energy charges associated with the scheduled deliveries within the caps, whether or not those deliveries are scheduled on an economic basis. Through December 31, 1997, there is no cap applied during on-peak hours to Consumers' recovery for the purchase of capacity made available within the 915 MW authorized. Recovery for purchases during off-peak hours is capped at 80 percent in 1993, 82 percent in 1994 and 1995, 84 percent in 1996 and 1997, increasing to 88.7 percent in 1998 and thereafter at which time the 88.7 percent cap is applicable during all hours. For all economic energy deliveries above the caps to 915 MW, the option also allows Consumers to recover 1\/2 cent per kWh capacity payment in addition to the corresponding energy charge.\nIn December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss included management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. Because the calculation of the 1992 loss depended in part upon estimates of future unregulated sales of energy to third parties, a more conservative or risk-free investment rate of 7 percent was used to calculate $188 million of the total $343 million after-tax loss. The remaining portion of the loss was calculated using an 8.5 percent discount rate reflecting Consumers' incremental borrowing rate as required by SFAS 90, Regulated Enterprises- Accounting for Abandonments and Disallowances of Plant Costs. The after- tax expense for the time value of money for the loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries, including fixed energy charges, associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. However, if Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Consumers' estimates of its future after-tax cash underrecoveries and possible additional losses for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level\nThe undiscounted, after-tax amount of the $343 million loss was $789 million. At December 31, 1993, the after-tax present value of the Settlement Order liability had been reduced to $307 million, which reflects after-tax cash underrecoveries related to capacity totaling $(54) million, after-tax accretion expense of $23 million and a $(5) million adjustment due to the 1993 corporate tax rate change (see Note 5).\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. In connection with the MPSC's approval of the Revised Settlement Proposal, Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership even though Consumers may not be recovering these costs. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. Although Consumers believes its position on arbitration is sound and intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. As of December 31, 1993, approximately $20 million has been escrowed by Consumers and is included in Consumers' temporary cash investments. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\nPSCR Matters: Consistent with the terms of the Settlement Order, Consumers has withdrawn its appeals of various MPSC orders issued in connection with the 1992, 1991 and 1990 PSCR cases. Consumers also agreed not to appeal any MCV-related issues raised in future orders for these plan cases and related reconciliations to the extent those issues are resolved by the Settlement Order. Consumers made refunds, including interest, of $69 million in 1993 and $29 million in 1992 to customers for overrecoveries in connection with the 1991 and 1990 PSCR reconciliation cases, respectively. These amounts were included in losses recorded prior to 1993. In 1992, Consumers recovered MCV power purchase costs consistent with the MPSC's 1992 plan case order, and does not anticipate that any MCV-related refunds will be required.\n4: Rate Matters\nElectric Rate Case\nConsumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. Consumers' request included increased future expenditures primarily related to capital additions, demand-side management programs, operation and maintenance, higher depreciation and postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. The filing also proposed experimental incentive provisions that would either reward or penalize Consumers, based on its operating performance. In addition, Consumers would share any returns above its MPSC-authorized level with customers in exchange for the ability to earn not lower than one percentage point below its authorized level.\nIn March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported the performance incentive but not the shared return mechanism discussed above.\nAbandoned Midland Project: In July 1984, Consumers abandoned construction of its unfinished nuclear power plant located in Midland, Michigan, and subsequently took a series of write-downs. In May 1991, Consumers began collecting $35 million pretax annually for the next 10 years and is amortizing the assets against current income over the recovery period using an interest method. Amortization for 1993, 1992 and 1991 was $28 million, $28 million and $18 million, respectively.\nConsumers was not permitted to earn a return on the portion of the abandoned Midland investment for which the MPSC was allowing recovery. Therefore, under SFAS 90, the recorded losses described above included amounts that reduced the recoverable asset to the present value of future recoveries. During the remaining recovery period, part of the prior losses will be reversed to adjust the unrecovered asset to its present value. and is reflected as accretion income. An after-tax total of approximately $35 million of the prior losses remains to be included in accretion income through April 2001. Several parties, including the Attorney General, have filed claims of appeal with the Court of Appeals regarding MPSC orders issued in May and July 1991 that specified the recovery of abandoned investment.\nElectric Demand-side Management: As a result of settlement discussions regarding demand-side management and an MPSC order in July 1991, Consumers agreed to spend $65 million over two years on demand-side management programs. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent. This adjustment, if implemented, would be applied to Consumers' retail electric tariff rates and be in effect for one year following reconciliation hearings with the MPSC that are expected to be initiated in the first quarter of 1994. The estimated revenue effects of the potential adjustment range from an $11 million increase to a $22 million decrease. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives.\nOn October 1, 1993, Consumers completed the customer participation portion of these programs and as part of its current electric rate case has requested MPSC authorization to continue certain programs in 1994. Consumers has also requested recovery of demand-side management expenditures which exceeded the $65 million level. Consumers is deferring program costs and amortizing the costs over the period these costs are being recovered from its customers in accordance with an accounting order issued by the MPSC in September 1992. The unamortized balance of deferred costs at December 31, 1993 and 1992 was $71 million and $25 million, respectively.\nPSCR Issues\nConsumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage. Any finding of delay due to imprudence could result in disallowances of a portion of replacement power costs. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies. As of December 31, 1993, Consumers' remaining estimated liability was approximately $34 million. Consumers has a regulatory asset of $34 million for the expected recovery of this amount in electric rates. GCR Issues\nIn connection with its 1991 GCR reconciliation case, Consumers refunded $36 million, including interest, to its firm sales and transportation rate customers in April 1992. Consumers accrued the full amount for this refund in 1991.\nThe MPSC issued an order during 1993 that approved an interim settlement agreement for the 12 months ended March 31, 1993. As a result of the settlement, Consumers refunded in August 1993, to its GCR and transportation customers, approximately $22 million, including interest. Consumers previously accrued amounts sufficient for this refund.\nThe MPSC, in a February 1993 order, provided that the price payable to certain intrastate gas producers by Consumers be reduced prospectively. As a result, Consumers was not allowed to recover approximately $13 million of costs incurred prior to February 8, 1993. In 1991, Consumers accrued a loss sufficient for this issue. Future disallowances are not anticipated, unless the remaining appeals filed by the intrastate producers are successful.\nIn 1992, the FERC approved a settlement involving Consumers, Trunkline and certain other parties, which resolved numerous claims and proceedings concerning Trunkline liquified natural gas costs. The settlement represents significant gas cost savings for Consumers and its customers in future years. As part of the settlement, Consumers will not incur any transition costs from Trunkline as a result of FERC Order 636. In November 1992, Consumers had recorded a liability and regulatory asset for the principal amount of payments to Trunkline over a five-year period and a regulatory asset. On May 11, 1993, the MPSC approved a separate settlement agreement that provides Consumers with full recovery of these costs over a five-year period. At December 31, 1993, Consumers' remaining liability and regulatory asset was $116 million.\nOther\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. On September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements. The current contract covers gas deliveries through October 1994 and is at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims. Additionally, three of these direct gas suppliers of Consumers have made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on the financial statements.\n5: Income Taxes\nConsumers and its subsidiaries file a consolidated federal income tax return with CMS Energy. Income taxes are generally allocated to each company based on each company's separate taxable income. Consumers' accrued federal income tax benefits from CMS Energy were $49 million and $3 million as of December 31, 1993 and 1992, respectively. In 1992, Consumers implemented SFAS 109, Accounting for Income Taxes. Deferred tax assets and liabilities are classified as current or noncurrent based on the classification of the related asset or liability, for all temporary differences. Consumers began practicing full deferred tax accounting for temporary differences arising after January 1, 1993, as authorized by a generic MPSC order. The generic order reduces the amount of regulatory assets and liabilities that otherwise could have arisen in future periods by allowing Consumers to reflect the income statement effect in the period temporary differences arise.\nConsumers uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. The AMT requires taxpayers to perform a second separate federal tax calculation based on a flat rate applied to a broader tax base. AMT is the amount by which this \"broader-based\" tax exceeds regular tax. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 increased the statutory federal tax rate from 34 percent to 35 percent effective January 1, 1993. The cumulative effect of this tax rate change has been reflected in Consumers' financial statements.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1993 1992 1991(a) - ----------------------- ------- ------ -------- Current federal income taxes $ 41 $ 52 $ 58 Deferred income taxes 61 (172) (166) Deferred income taxes - tax rate change (2) - - Deferred ITC, net (9) (7) 33 ------- ------ ------ $ 91 $(127) $(75) ======= ====== ======\nOperating $ 116 $ 51 $ 48 Other (25) (178) (123) ------- ------ ------ $ 91 $(127) $(75) ======= ====== ======\n(a) The 1991 provision for income taxes was before an extraordinary item that had related deferred income taxes of approximately $7 million.\nThe principal components of Consumers' deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1993 1992 - ----------- ------- -------- Property $ (518) $ (458) Unconsolidated investments (184) (129) Postretirement benefits (Note 10) (178) (165) Abandoned Midland project (Note 4) (57) (60) Employee benefit obligations (includes postretirement benefits of $178 and $165) (Note 10) 200 186 MCV power purchases - settlement (Note 3) 165 177 AMT carryforward 64 51 ITC carryforward (expires 2005) 48 49 Other (8) (4) ------- -------- $ (468) $ (353) ======= ========\nGross deferred tax liabilities $(1,319) $(1,228) Gross deferred tax assets 851 875 -------- -------- $ (468) $ (353) ======== ========\nThe actual income tax expense (benefit) differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1993 1992 1991 ------- ------- ------- Net income (loss) before extraordinary item $ 198 $(244) $(235) Income tax expense (benefit) 91 (127) (75) ------- ------- ------- 289 (371) (310) Statutory federal income tax rate x 35% x 34% x 34% -------- ------- ------- Expected income tax expense (benefit) 101 (126) (105) Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 35 Differences in book and tax depreciation not previously deferred 6 9 8 ITC amortization and utilization (10) (10) (7) Affiliated companies' dividends (6) (5) (5) Other, net (5) - (1) ------- ------- ------- $ 91 $(127) $ (75) ======= ======= =======\n6: Short-Term Financings\nConsumers has authorization from the FERC to issue or guarantee up to $900 million of short-term debt through December 31, 1994. Consumers has a $470 million facility that is used to finance seasonal working capital requirements and unsecured, committed lines of credit aggregating $165 million. As of December 31, 1993, $235 million and $24 million were outstanding at weighted average interest rates of 4.0 percent and 3.9 percent, respectively. Further, Consumers has an established $500 million trade receivables purchase and sale program. As of December 31, 1993 and 1992, receivables sold under the agreement totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\n7: Capitalization\nCapital Stock\nAs of December 31, 1992, Consumers effected a quasi-reorganization, an elective accounting procedure in which Consumers' accumulated deficit of $574 million was eliminated against other paid-in capital. The fair values of Consumers' assets and liabilities at the date of the quasi- reorganization were determined by management to approximate their carrying values and no material adjustments to the historical bases were made. This action was approved by Consumers' Board of Directors and did not require shareholder approval. As a result of the quasi-reorganization and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends in 1993 and also declared from 1993 earnings a $16 million common stock dividend in January 1994. Consumers has authorization from the MPSC and is proceeding to issue $200 million of preferred stock in 1994.\nFirst Mortgage Bonds\nConsumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, Articles and the need for regulatory approvals in compliance with appropriate state and federal law. In September 1993, Consumers issued, with MPSC approval, $300 million of 6 3\/8 percent first mortgage bonds, due 2003 and $300 million of 7 3\/8 percent first mortgage bonds, due 2023. Consumers used the net proceeds from the bond issuance to refund approximately $515 million of higher interest first mortgage bonds and the balance to reduce short-term borrowings. Unamortized debt costs, premiums and discounts and call premiums on the refunded debt totaling approximately $18 million were deferred under SFAS 71, and are being amortized over the lives of the new debt.\nIn February 1994, Consumers issued a call for redemption totaling approximately $10 million. Consumers also fully redeemed two issues of first mortgage bonds totaling approximately $91 million. These redemptions completed Consumers' commitment to the MPSC, under the 1993 authorization to issue first mortgage bonds, to refinance certain long- term debt.\nLong-Term Bank Debt\nUnder its long-term credit agreement at December 31, 1993, Consumers was required to make 10 remaining quarterly principal payments of approximately $47 million. As of December 31, 1993, the outstanding balance under this credit agreement totaled $469 million with a weighted average interest rate of 4.0 percent. In January 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on the latest maturing $250 million of the then remaining $500 million obligation under its long-term credit agreement.\nOther\nConsumers has a total of $131 million of PCRBs outstanding with a weighted average interest rate of 4.2 percent as of December 31, 1993. Consumers classifies $101 million of PCRBs as long-term because it can refinance these amounts through irrevocable letters of credit expiring after one year.\nIn June 1993, Consumers entered into loan agreements in connection with the issuance of approximately $28 million of adjustable rate demand limited obligation refunding revenue bonds, due 2010, which are secured by an irrevocable letter of credit expiring in 1996. These bonds bear an initial interest rate of 2.65 percent. Consumers also entered into loan agreements in connection with the issuance of $30 million of 5.8 percent limited obligation refunding revenue bonds, due 2010, secured by a financial guaranty insurance policy and certain first mortgage bonds of Consumers. Proceeds of these issues were used to redeem on August 1, 1993 in advance of their maturities, approximately $58 million of outstanding PCRBs.\n8: Financial Instruments\nCash, short-term investments and current liabilities approximate their fair value due to the short-term nature of those instruments. The estimated fair value of long-term investments is based on quoted market prices where available. When specific market prices do not exist for an instrument, the fair value is based on quoted market prices of similar investments or other valuation techniques. All long-term investments in financial instruments, except as shown below, approximate fair value. Although the current fair value of the long-term debt, which is based on calculations made by debt pricing specialists, may be greater than the current carrying amount, settlement of the reported debt is generally not expected until maturity. The estimated fair values of Consumers' financial instruments are as follows:\nIn Millions Years Ended December 31 1993 1992 - ----------------------- ----------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Value\nInvestment in stock of affiliates $ 291 $ 323 $ 291 $ 303 Long-term debt 1,839 1,984 2,079 2,123\nThe fair value of Consumers' off-balance sheet financial instruments is based on the amount estimated to terminate or settle the obligation:\nIn Millions Years Ended December 31 1993 1992 ---------- ---------- Fair Value Fair Value\nInterest rate swaps (Note 7) $ 5 $ - Guarantees 7 7\nOn January 1, 1994, Consumers adopted SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, requiring accounting for investments in debt securities to be held to maturity at amortized cost; otherwise debt and marketable equity securities would be recorded at fair value, with any unrealized gains or losses included in earnings if the security is held for trading purposes or as a separate component of shareholders' equity if the security is available for sale. The implementation resulted in an increase in assets of $30 million in January 1994 with a corresponding increase in stockholders' equity of $20 million, net of tax.\nIn May 1993, the FASB issued SFAS 114, Accounting by Creditors for Impairment of a Loan, effective in 1995, requiring certain loans that are determined to be impaired be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of any collateral for a secured loan. Consumers does not believe this standard will have a material impact on its financial position or results of operations.\n9: Executive Incentive Compensation\nConsumers participates in CMS Energy's Performance Incentive Stock Plan. Under the plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. The plan reserves for award not more than 2 percent of CMS Energy's common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. As of December 31, 1993, awards of up to 447,686 shares of common stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Performance criteria were added in 1990 based on CMS Energy's total return to shareholders. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, remains in effect until all authorized options are granted or September 25, 1995. As of December 31, 1993, options for 43,000 shares remained to be granted.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted under the Performance Incentive Stock Plan and options granted under both plans follows. The number of shares presented also includes shares for employees of CMS Energy and non-utility affiliates.\nRestricted Stock Options ---------- ---------------------------- Number Number Price of Shares of Shares per Share ----------- --------- --------------- Outstanding at January 1, 1991 212,500 1,162,216 $ 7.13 - $34.25 Granted 97,000 194,000 $ 21.13 - $21.13 Exercised or Issued (34,437) (65,125) $ 7.13 - $16.00 --------- ---------- --------------- Outstanding at December 31, 1991 275,063 1,291,091 $ 7.13 - $34.25 Granted 101,000 215,000 $ 17.13 - $18.00 Exercised or Issued (37,422) (21,000) $ 13.00 - $16.00 Canceled (15,375) (50,000) $ 20.50 - $33.88 --------- ---------- --------------- Outstanding at December 31, 1992 323,266 1,435,091 $ 7.13 - $34.25 Granted 132,000 249,000 $ 25.13 - $26.25 Exercised or Issued (54,938) (152,125) $ 7.13 - $21.13 Canceled (84,141) (33,000) $ 20.50 - $33.88 --------- ---------- ---------------\nOutstanding at December 31, 1993 316,187 1,498,966 $ 7.13 - $34.25 ========= ========== ===============\n10: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions\nConsumers adopted SFAS 106 effective as of the beginning of 1992. The standard required Consumers to change its accounting for the cost of health care and life insurance benefits that are provided to retirees from a pay-as-you-go (cash) method to a full accrual method. Accordingly, Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates.\nBoth the MPSC and FERC have generally adopted SFAS 106 costs for ratemaking purposes provided costs recovered through rates are placed in external funds until they are needed to pay benefits. The MPSC's generic order allows utilities three years to seek recovery of costs and provides for recovery from customers of any deferred costs incurred prior to the beginning of rate recovery of such costs. Consumers anticipates recovering its regulatory asset within 20 years. As discussed in Note 4, Consumers has requested recovery of the portion of these costs allocated to the electric business. In late 1994, Consumers plans to request recovery of the gas utility portion of these costs. Consumers plans to fund the benefits using external Voluntary Employee Beneficiary Associations. Funding of the health care benefits would begin when Consumers' rate recovery based on SFAS 106 begins. A portion of the life insurance benefits have previously been funded.\nAs of December 31, 1993, the actuary assumed that retiree health care costs increased 10.5 percent in 1994 then decreased gradually to 5.5 percent in 2000 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $75 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1993 by $9 million.\nFor the years ended December 31, 1993 and 1992, the weighted average discount rate was 7.25 percent and 8 percent, respectively, and the expected long-term rate of return on plan assets was 8.5 percent. Net periodic postretirement benefit cost for health care benefits and life insurance benefits was $51 million in 1993 and $49 million in 1992. The 1993 and 1992 cost was comprised of $13 million and $10 million for service plus $38 million and $39 million for interest, respectively.\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1993 1992 ------- ------- Actuarial present value of estimated benefits Retirees $ 281 $ 264 Eligible for retirement 54 50 Active (upon retirement) 187 175 ------- ------- Accumulated postretirement benefit obligation 522 489 Plan assets (premium deposit fund) at fair value 4 4 ------- ------- Projected postretirement benefit obligation in excess of plan assets (518) (485) Unrecognized net loss from experience different than assumed 8 - ------- ------- Recorded liability and regulatory asset $ (510) $ (485) ======= =======\nConsumers' postretirement health care plan is unfunded; the accumulated postretirement benefit obligation for that plan is $510 million and $478 million at December 31, 1993 and 1992, respectively.\nSupplemental Executive Retirement Plan\nCertain management employees qualify under the SERP. Benefits are based on the employee's service and earnings as defined in the SERP. In 1988, a trust from which SERP benefits are paid was established and funded. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in Consumers' consolidated assets. As of December 31, 1993 and 1992, trust assets at cost (which approximates market) were $16 million and $14 million, respectively, and were classified as other non-current assets.\nDefined Benefit Pension Plan\nA trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan is fully funded, no contributions were made for plan years 1991 through 1993. Amounts presented for the Pension Plan include amounts for CMS Energy and non-utility affiliates, which are not distinguishable from nor are they significant when compared with the plan's total amounts.\nYears Ended December 31 1993 1992 1991 - ----------------------- ----- ----- ----- Discount rate 7.25% 8.5% 8.5% Rate of compensation increase 4.5% 5.5% 5.5% Expected long-term rate of return on assets 8.75% 8.75% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1993 1992 1991 ----- ----- ----- Service cost $ 19 $ 19 $ 18 Interest cost 49 47 48 Actual return on plan assets (92) (36) (88) Net amortization and deferral 34 (20) 28 ----- ----- ----- Net periodic pension cost $ 10 $ 10 $ 6 ===== ===== =====\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP ------------- ------------- 1993 1992 1993 1992 ----- ----- ----- ----- Actuarial present value of estimated benefits Vested $ 471 $ 349 $ 12 $ 10 Non-vested 56 49 - - ------ ------ ----- ----- Accumulated benefit obligation 527 398 12 10 Provision for future pay increases 138 177 5 5 ------ ------ ----- ----- Projected benefit obligation 665 575 17 15 Plan assets (primarily stocks and bonds,including $87 in 1993 and $64 in 1992 in common stock of CMS Energy) at fair value 692 631 - - ------ ------ ----- ----- Projected benefit obligation less than (in excess of) plan assets 27 56 (17) (15) Unrecognized net (gain) loss from experience different than assumed (56) (76) 5 2 Unrecognized prior service cost 45 49 - 1 Unrecognized net transition (asset) obligation (44) (49) 1 1 ------ ------ ------ ----- Recorded liability $ (28) $ (20) $ (11) $(11) ====== ====== ====== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\nIn 1991, certain eligible employees accepted early retirement incentives. The incentives consisted of lump-sum cash payments and increased pension payments. The pretax cost of the incentives was $25 million. Also in 1991, portions of the projected benefit obligation were settled which resulted in a pretax gain of $25 million that offset the early retirement costs.\n11: Leases\nConsumers leases various assets, including vehicles, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement was extended an additional year and is now scheduled to expire in November 1995. The maximum amount of nuclear fuel that can be leased increased from $55 million to $70 million. Consumers further increased this amount in early 1994 to $80 million. The lease provides for an additional one-year extension upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $57 million as of December 31, 1993. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under Consumers' non-cancelable leases at December 31, 1993, were:\nIn Millions Capital Operating Leases Leases ------- --------- 1994 $ 40 $ 7 1995 57 6 1996 16 2 1997 15 2 1998 13 2 1999 and thereafter 26 21 ----- ----- Total minimum lease payments 167 $ 40 ===== Less imputed interest 27 -----\nPresent value of net minimum lease payments 140 Less current portion 34 -----\nNon-current portion (a) $106 =====\n(a) In January 1994, Consumers amended its nuclear fuel lease to include fuel previously owned at Big Rock Point. This is estimated to increase the non-current portion of capital leases by approximately $6 million.\nConsumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1993, 1992 and 1991, were $8 million, $12 million and $12 million, respectively.\nCapital lease expenses for the years ended December 31, 1993, 1992 and 1991 were $32 million, $44 million and $48 million, respectively. Included in these amounts for the years ended 1993, 1992 and 1991, are nuclear fuel lease expenses of $13 million, $17 million and $24 million, respectively.\n12: Commitments and Contingencies\nLudington Pumped Storage Plant Litigation\nIn 1986, the Attorney General filed a lawsuit on behalf of the State of Michigan in the Circuit Court of Ingham County, seeking damages from Consumers and Detroit Edison for alleged injuries to fishery resources because of the operation of the Ludington Pumped Storage Plant. The state sought $148 million (including $16 million of interest) for past injuries and $89,000 per day for future injuries, with the latter amount to be adjusted upon installation of \"adequate\" fish barriers and other changed conditions.\nIn 1987, the Attorney General filed a second lawsuit alleging that Consumers and Detroit Edison have breached a bottomlands lease agreement with the state and asked that the lease be declared void. This complaint was consolidated with the suit described in the preceding paragraph. In 1990, both of the lawsuits were dismissed on the basis of federal preemption. In 1993, the Court of Appeals overturned the dismissal, as to damages, effectively allowing the state to continue its damages lawsuit against Consumers and Detroit Edison, but generally affirmed the lower court's ruling as to the breach of lease claim. The Court of Appeals' ruling also limited any potential damages to those occurring no earlier than 1983. Consumers, Detroit Edison and the Attorney General have filed an application for leave to appeal with the Michigan Supreme Court. Consumers and Detroit Edison are seeking to have the trial court's dismissal of the damages claim affirmed.\nEach year since 1989, Consumers and Detroit Edison have complied with FERC orders by installing a seasonal barrier net from April to October at the Ludington plant site. The FERC is now considering whether the barrier net (along with other actions by Consumers, including contributions to state fish-stocking programs) would be a satisfactory permanent solution.\nEnvironmental Matters\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers believes that it is unlikely that its liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position or results of operations.\nThe State of Michigan in 1990 passed amendments to the Environmental Response Act that established a state program similar to the federal Superfund law, though broader in scope. Under this law, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation\/feasibility studies for three of these sites. Work plans for remedial investigation\/feasibility studies for four other sites have also been prepared. The purpose of a remedial investigation\/feasibility study is to define the nature and extent of contamination at a site and to determine which of several possible remedial action alternatives, including no action, may be required under the Environmental Response Act. The DNR has approved two of the three plans for remedial investigation\/feasibility studies submitted and is currently reviewing the one remaining. The cost to conduct one of the approved studies will be approximately $250,000 based on bids received. Although the actual cost of conducting the remaining two remedial investigation\/feasibility studies will not be known until bids are received from contractors, Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation\/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation\/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study. Based on Consumers' knowledge of other utility remedial actions, remediation costs for Consumers for these sites may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. The MPSC stated the length of the period may be reviewed from time to time, but any revisions would be prospective. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from its customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nIncluded in the 1990 amendments to the federal Clean Air Act are provisions that limit emissions of sulfur dioxide and nitrogen oxides and require enhanced emissions monitoring. All of Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in 2000. Beginning in 1995, certain coal-fueled generating units will receive emissions allowances (all of Consumers' coal units will receive allowances beginning in 2000). Based on projected emissions from these units, Consumers expects to have excess allowances which may be sold or saved for future use.\nThe Clean Air Act's provisions require Consumers to make capital expenditures estimated to total $74 million through 1999 for completed, in-process and possible modifications at coal-fired units based on existing and proposed regulations. Management believes that Consumers' annual operating costs will not be materially affected.\nThe EPA has asked a number of utilities in the Great Lakes area to voluntarily retire certain equipment containing specific levels of polychlorinated biphenyls. Consumers believes that it is largely in compliance with the EPA's petition. Consumers is continuing to study the request and has been granted an extension for responding until March 30, 1994.\nCapital Expenditures\nConsumers estimates capital expenditures, including demand-side management and new lease commitments, of $553 million for 1994, $461 million for 1995 and $471 million for 1996.\nPublic Utility Holding Company Act Exemption\nCMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. In 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nOther\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment, can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. A complaint seeking certification as a class action suit was filed against Consumers in a local county circuit court in 1993. The complaint alleges the existence of a purported class that has incurred damages of up to $1 billion, primarily to certain livestock owned by the purported class, as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and intends to vigorously oppose the certification of the class and this suit.\nIn addition to the matters disclosed in these notes, Consumers and certain of its subsidiaries are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nThe ultimate effect of the proceedings discussed in this note is not expected to have a material impact on Consumers' financial position or results of operations.\n13: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for the jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1993 1992 - ----------- ---- ---- Net investment Ludington - 51% $114 $112 Campbell Unit 3 - 93.3% 349 360 Transmission lines - various 32 33\nAccumulated depreciation Ludington $ 74 $ 71 Campbell Unit 3 210 199 Transmission lines 11 10\n14: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1993 1992 1991 ------ ------ ------ Cash transactions Interest paid (net of amounts capitalized) $177 $176 $308 Income taxes paid (net of refunds) 90 6 30\nNon-cash transactions Nuclear fuel placed under capital lease $ 28 $ 30 $ 6 Other assets placed under capital leases 30 39 21 Capital leases refinanced 42 - - Assumption of debt - 15 - Return of Midland related assets (Note 16) - - (92) Increased value of investment in Enterprises' preferred stock (Note 16) - - 100\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1993 1992 1991 ------ ------ ------ Sale of receivables, net $ 60 $ 25 $ - Accounts receivable 19 30 66 Accrued revenue (48) 91 7 Inventories (32) 24 (8) Accounts payable (25) 21 (83) Accrued refunds (48) (143) 102 Tax Reform Act refund reserve - - (77) Other current assets and liabilities, net (59) 38 (56) Non-current deferred amounts, net 8 (36) 170 ------ ------ ----- $(125) $ 50 $ 121 ======= ====== ======\n15: Reportable Segments\nThe Consolidated Statements of Income show operating revenue and pretax operating income by segments. These amounts include earnings (losses) from investments accounted for by the equity method of $6 million, $(10) million and $(2) million for 1993, 1992 and 1991, respectively. Other segment information follows:\nIn Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Depreciation, depletion and amortization Electric $ 241 $ 230 $ 172 Gas 73 76 70 Other 2 1 - ------ ------ ------ $ 316 $ 307 $ 242 ====== ====== ======\nIdentifiable assets Electric (a) $4,027 $3,812 $3,399 Gas 1,443 1,387 1,186 Other (b) 1,081 1,397 1,401 ------ ------ ------ $6,551 $6,596 $5,986 ====== ====== ======\nCapital expenditures (c) Electric (d) $ 365 $ 353 $ 213 Gas 127 86 61 Other 69 67 32 ------ ------ ------ $ 561 $ 506 $ 306 ====== ====== ======\n(a) Includes abandoned Midland investment of $162 million, $175 million and $287 million for 1993, 1992 and 1991, respectively.\n(b) Reclassified 1992 and 1991 to include independent power production, which is no longer significant enough for Consumers to report separately. Also, other was reduced by the sale of $309 million of MCV Bonds (see Note 3).\n(c) Includes capital leases for nuclear fuel and other assets (see Note 14).\n(d) Includes DSM costs of $52 million for 1993 and $26 million for 1992.\n16: Related-Party Transactions\nConsumers has an investment of $250 million in 10 shares of the preferred stock of Enterprises, an affiliate company of Consumers. Prior to a 1991 amendment to Enterprises' Articles, it was to have redeemed on July 1, 1991 and in each of the next four years, two shares of its preferred stock held by Consumers at a redemption price equal to $25 million per share. Because of the amendment, the dividend rate increased and the first mandatory redemption date became August 1, 1997. The asset value and other paid-in capital of Consumers were increased $100 million as a result of the amendment. In addition, Consumers has an investment in approximately 3 million shares of CMS Energy common stock totaling $42 million at December 31, 1993. As a result of these two investments, Consumers received dividends on affiliates' common and preferred stock totaling $16 million in 1993 and 1992 and $13 million in 1991.\nIn March 1990, Consumers' subsidiary, MGL and Consumers' parent, CMS Energy, entered into an agreement where MGL exchanged its investment in several subsidiaries that held Midland-related assets for CMS Debentures issued by CMS Energy. Consumers recorded the earnings on the CMS Debentures as income from contractual arrangements. In December 1991, the subsidiaries were returned to Consumers and the CMS Debentures were cancelled to comply with various regulatory and court orders. On July 27, 1991, Consumers stopped recording income on the CMS Debentures when it became probable the return would be required. The return resulted in a net after-tax loss of approximately $92 million because the book value of the subsidiaries was less than the CMS Debentures' book value.\nConsumers purchases a portion of its gas from an affiliate, NOMECO. The amounts of purchases for the years ended 1993, 1992 and 1991 were $3 million, $3 million and $20 million, respectively. In 1993, 1992 and 1991, Consumers purchased $52 million, $36 million and $26 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Consumers and its subsidiaries sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $14 million for 1993, 1992 and 1991, respectively. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 17. Other related-party transactions are immaterial.\n17: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1993 obligation to purchase electricity from the MCV Partnership was approximately 14 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership is shown below:\nStatements of Income In Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Operating revenue (a) $ 548 $ 488 $ 425 Operating expenses 362 315 278 ------ ------ ------ Operating income 186 173 147 Other expense, net (189) (190) (186) ------ ------ ------ Net loss $ (3) $ (17) $ (39) ====== ====== ======\nBalance Sheets In Millions December 31 1993 1992 - ----------- ------ ------ Assets Current assets (a) $ 181 $ 165 Property, plant and equipment, net 2,073 2,124 Other assets 146 147 ------ ------ $2,400 $2,436 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 198 $ 189 Long-term debt and other non-current liabilities (b) 2,147 2,189 Partners' equity (c) 55 58 ------ ------ $2,400 $2,436 ====== ======\n(a) Revenue from Consumers totaled $505 million, $444 million and $384 million for 1993, 1992 and 1991, respectively. As of December 31, 1993, 1992 and 1991, $44 million, $38 million and $33 million, respectively, were receivable from Consumers.\n(b) FMLP is a beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP (see Note 3). At December 31, 1993 and 1992, lease obligations of $1.7 billion were owed to the owner trust of which FMLP is the sole beneficiary. CMS Holdings' share of the interest and principal portion for the 1993 lease payments was $63 million and $16 million, respectively, and for the 1992 lease payments was $65 million and $12 million, respectively. The lease payments service $1.2 billion and $1.3 billion in non-recourse debt outstanding as of December 31, 1993 and 1992, respectively, of the owner-trust whose beneficiary is FMLP. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1993 and 1992, the owner-trust whose beneficiary is FMLP made debt payments of $172 million and $166 million, respectively, which included $10 million and $8 million principal and $25 million and $26 million interest, respectively, on the MCV Bonds held by MEC Development Corporation during part of 1991 and by Consumers through December 1993.\n(c) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of long-term debt and preferred stock of CONSUMERS POWER COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy Corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumers Power Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes. As discussed in Note 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions. Additionally, as discussed in Note 7 to the consolidated financial statements, the Company effected a quasi-reorganization on December 31, 1992.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nCMS Energy\nNone for CMS Energy.\nConsumers\nNone for Consumers. PART III (ITEMS 10., 11., 12. and 13.) CMS Energy\nCMS Energy's definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.","section_9A":"","section_9B":"","section_10":"Item 10.\nConsumers\nConsumers' definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.\nPART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent reports dated September 29, 1993, as amended by Form 8-K\/A, Amendment No. 1, dated October 22, 1993, and dated December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and current reports dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent reports dated September 21, 1993 and December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Articles of Incorporation of CMS Energy Corporation, as Amended. (Designated in CMS Energy Corporation's Form S-8 dated June 30, 1989, File No 1-9513, as Exhibit (4).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation.\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company.\n(3)(d) - Copy of By-Laws of Consumers Power Company.\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind\/Dated as of File Reference Exhibit ------------------- ---------------- -------\n44th 11\/15\/79 Reg No 2-65973 (b)(1)-7 45th 01\/15\/80 Reg No 2-68900 (b)(1)-5 46th 01\/15\/80 Reg No 2-69704 (4)(b) 47th 06\/15\/80 Form 10-K for year end Dec 31, 1980, File No 1-5611 (4)(b) 48th 03\/15\/81 Reg No 2-73741 (4)(b) 49th 11\/01\/81 Reg No 2-75542 (4)(b) 50th 03\/01\/82 Form 10-K for year end Dec 31, 1981, File No 1-5611 (4)(b) 51st 08\/10\/82 Reg No 2-78842 (4)(f) 52nd 08\/31\/82 Reg No 2-79390 (4)(f) 53rd 12\/01\/82 Reg No 2-81077 (4)(f) 54th 05\/01\/83 Reg No 2-84172 (4)(e) 55th 09\/15\/83 Reg No 2-86751 (4)(e) 56th 10\/15\/83 Reg No 2-87735 (4)(e) 57th 03\/01\/84 Reg No 2-89215 (4)(e) 58th 07\/16\/84 Form 10-Q for quarter ended June 30, 1984, File No 1-5611 (4)(f) 59th 10\/01\/84 Reg No 2-93438 (4)(c) 60th 06\/01\/85 Form 10-Q for quarter ended June 30, 1985, File No 1-5611 (4)(f) 61st 10\/15\/86 Reg No 33-9732 (4)(e) 63rd 04\/15\/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(f) 64th 06\/15\/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(g) 65th 02\/15\/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 66th 04\/15\/88 Form 10-Q for quarter ended March 31, 1988 File No 1-5611 (4)(d) 67th 11\/15\/89 Reg No 33-31866 (4)(d) 68th 06\/15\/93 Reg No 33-41126 (4)(c) 69th 09\/15\/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(5)-(9) - Not applicable.\n(10)(a) - Credit Agreement dated as of May 1, 1989 among Consumers Power Company, the Co-Managers, as defined therein, the Banks, as defined therein, the Lenders, as defined therein, and Citibank, NA, as Agent, and the Exhibits thereto. (Designated in Consumers Power Company's Form 10-Q for the quarter ended March 31, 1989, File No 1-5611, as Exhibit (19).)\nLetter amendment dated as of December 11, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 30, 1991, File No. 1-5611, as Exhibit (3)(d).)\n(10)(b) (CMS ONLY) - Amended and Restated Credit Agreement dated as of November 30, 1992 as Amended and Restated as of October 15, 1993, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent and the Operational Agent, all as defined therein, and the Exhibits thereto.\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment contract effective as of March 1, 1987 among CMS Energy Corporation, Consumers Power Company and S. Kinnie Smith, Jr. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1987, File No 1-5611, as Exhibit (10)(g).)\n(10)(e) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No 1-5611, as Exhibit (10)(i).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(f).)\n(10)(g) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(h) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(f).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(j) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(h).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994.\n(10)(n) - Consumers Power Company's Annual Executive Incentive Compensation Plan effective February 1993, as amended March 1994.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990.\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.13.)\nAmendment No 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.5.)\nAmendment No 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.6.)\nAmendment No 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.7.)\nAmendment No 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U- 10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24) - Powers of Attorney.\n(25)-(28) - Not applicable.\n*Five copies of this exhibit have been signed by, or on behalf of, each of five Owner Participants. With regard to each of the agreements, each copy is substantially identical in all material respects except as to the parties thereto. Therefore, pursuant to Instruction 2, Item 601(a) of Regulation S-K, CMS Energy Corporation and Consumers Power Company are filing a copy of only one such document.\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nSchedule Page\nV Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 154 Consumers Power Company 157\nVI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 160 Consumers Power Company 163\nVIII Valuation and Qualifying Accounts and Reserves 1993, 1992 and 1991: CMS Energy Corporation 166 Consumers Power Company 167\nIX Short-Term Borrowings 1993, 1992 and 1991: CMS Energy Corporation 168 Consumers Power Company 169\nX Supplementary Income Statement Information 1993, 1992 and 1991: CMS Energy Corporation 170 Consumers Power Company 171\nReport of Independent Public Accountants CMS Energy Corporation 172 Consumers Power Company 173\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. ---------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 18th day of March 1994.\nSignature Title - -------------------------------------- -----------------------------------\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director - ------------------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President, Controller P. D. Hopper and Chief Accounting Officer - ------------------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n* By Thomas A. McNish ------------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 18th day of March 1994.\nSignature Title - ------------------------------------- -----------------------------------\n(i) Principal executive officer:\nPresident and Michael G. Morris Chief Executive Officer - ------------------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller - ------------------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nWilliam T. McCormick, Jr. Director - ------------------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n*By Thomas A. McNish -------------------------------- Thomas A. McNish, Attorney-in-Fact","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent reports dated September 29, 1993, as amended by Form 8-K\/A, Amendment No. 1, dated October 22, 1993, and dated December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and current reports dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent reports dated September 21, 1993 and December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Articles of Incorporation of CMS Energy Corporation, as Amended. (Designated in CMS Energy Corporation's Form S-8 dated June 30, 1989, File No 1-9513, as Exhibit (4).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation.\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company.\n(3)(d) - Copy of By-Laws of Consumers Power Company.\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind\/Dated as of File Reference Exhibit ------------------- ---------------- -------\n44th 11\/15\/79 Reg No 2-65973 (b)(1)-7 45th 01\/15\/80 Reg No 2-68900 (b)(1)-5 46th 01\/15\/80 Reg No 2-69704 (4)(b) 47th 06\/15\/80 Form 10-K for year end Dec 31, 1980, File No 1-5611 (4)(b) 48th 03\/15\/81 Reg No 2-73741 (4)(b) 49th 11\/01\/81 Reg No 2-75542 (4)(b) 50th 03\/01\/82 Form 10-K for year end Dec 31, 1981, File No 1-5611 (4)(b) 51st 08\/10\/82 Reg No 2-78842 (4)(f) 52nd 08\/31\/82 Reg No 2-79390 (4)(f) 53rd 12\/01\/82 Reg No 2-81077 (4)(f) 54th 05\/01\/83 Reg No 2-84172 (4)(e) 55th 09\/15\/83 Reg No 2-86751 (4)(e) 56th 10\/15\/83 Reg No 2-87735 (4)(e) 57th 03\/01\/84 Reg No 2-89215 (4)(e) 58th 07\/16\/84 Form 10-Q for quarter ended June 30, 1984, File No 1-5611 (4)(f) 59th 10\/01\/84 Reg No 2-93438 (4)(c) 60th 06\/01\/85 Form 10-Q for quarter ended June 30, 1985, File No 1-5611 (4)(f) 61st 10\/15\/86 Reg No 33-9732 (4)(e) 63rd 04\/15\/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(f) 64th 06\/15\/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(g) 65th 02\/15\/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 66th 04\/15\/88 Form 10-Q for quarter ended March 31, 1988 File No 1-5611 (4)(d) 67th 11\/15\/89 Reg No 33-31866 (4)(d) 68th 06\/15\/93 Reg No 33-41126 (4)(c) 69th 09\/15\/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(5)-(9) - Not applicable.\n(10)(a) - Credit Agreement dated as of May 1, 1989 among Consumers Power Company, the Co-Managers, as defined therein, the Banks, as defined therein, the Lenders, as defined therein, and Citibank, NA, as Agent, and the Exhibits thereto. (Designated in Consumers Power Company's Form 10-Q for the quarter ended March 31, 1989, File No 1-5611, as Exhibit (19).)\nLetter amendment dated as of December 11, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 30, 1991, File No. 1-5611, as Exhibit (3)(d).)\n(10)(b) (CMS ONLY) - Amended and Restated Credit Agreement dated as of November 30, 1992 as Amended and Restated as of October 15, 1993, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent and the Operational Agent, all as defined therein, and the Exhibits thereto.\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment contract effective as of March 1, 1987 among CMS Energy Corporation, Consumers Power Company and S. Kinnie Smith, Jr. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1987, File No 1-5611, as Exhibit (10)(g).)\n(10)(e) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No 1-5611, as Exhibit (10)(i).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(f).)\n(10)(g) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(h) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(f).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(j) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(h).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994.\n(10)(n) - Consumers Power Company's Annual Executive Incentive Compensation Plan effective February 1993, as amended March 1994.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990.\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.13.)\nAmendment No 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.5.)\nAmendment No 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.6.)\nAmendment No 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.7.)\nAmendment No 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U- 10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24) - Powers of Attorney.\n(25)-(28) - Not applicable.\n*Five copies of this exhibit have been signed by, or on behalf of, each of five Owner Participants. With regard to each of the agreements, each copy is substantially identical in all material respects except as to the parties thereto. Therefore, pursuant to Instruction 2, Item 601(a) of Regulation S-K, CMS Energy Corporation and Consumers Power Company are filing a copy of only one such document.\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nSchedule Page\nV Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 154 Consumers Power Company 157\nVI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 160 Consumers Power Company 163\nVIII Valuation and Qualifying Accounts and Reserves 1993, 1992 and 1991: CMS Energy Corporation 166 Consumers Power Company 167\nIX Short-Term Borrowings 1993, 1992 and 1991: CMS Energy Corporation 168 Consumers Power Company 169\nX Supplementary Income Statement Information 1993, 1992 and 1991: CMS Energy Corporation 170 Consumers Power Company 171\nReport of Independent Public Accountants CMS Energy Corporation 172 Consumers Power Company 173\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. ---------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 18th day of March 1994.\nSignature Title - -------------------------------------- -----------------------------------\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director - ------------------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President, Controller P. D. Hopper and Chief Accounting Officer - ------------------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n* By Thomas A. McNish ------------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 18th day of March 1994.\nSignature Title - ------------------------------------- -----------------------------------\n(i) Principal executive officer:\nPresident and Michael G. Morris Chief Executive Officer - ------------------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller - ------------------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nWilliam T. McCormick, Jr. Director - ------------------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n*By Thomas A. McNish -------------------------------- Thomas A. McNish, Attorney-in-Fact","section_15":""}
{"filename":"770975_1993.txt","cik":"770975","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nFirst Republic Bancorp Inc. (\"First Republic\" and with its subsidiaries, the \"Company\") is a financial services holding company operating in California and Nevada. First Republic conducts its business primarily through a California- chartered, FDIC-insured, thrift and loan subsidiary, First Republic Thrift & Loan (\"First Thrift\"), and also a Nevada-chartered, FDIC-insured thrift and loan subsidiary, First Republic Savings Bank (together the \"Thrifts\") and a real estate loan origination subsidiary in Las Vegas, Nevada. The Company operates both as an originator of loans for its balance sheet and as a mortgage company, originating, holding or selling, and servicing mortgage loans.\nThe Company is engaged in originating real estate secured loans for retention in the portfolios of the Thrifts. In addition, the Company operates as a mortgage banking company originating mortgage loans for sale to institutional investors in the secondary market. The Company also generates fee income by servicing mortgage loans for such institutional investors and other third parties. First Thrift's depository activities and advances from the Federal Home Loan Bank (the \"FHLB\") are its principal source of funds with loan principal repayments, sales of loans and capital contributions and advances from First Republic as supplemental sources. The Company's deposit gathering activities are conducted in the San Francisco Bay Area, Los Angeles, and San Diego County, California and its lending activities are concentrated in the San Francisco, Los Angeles and Las Vegas areas. The San Francisco Bay Area, Los Angeles and San Diego County are among the wealthiest areas in California as measured by average housing costs and income per family. Las Vegas has been growing rapidly and has experienced significant inward migration as well as internal business growth.\nOn December 10, 1993, First Republic acquired First Republic Savings Bank (formerly Silver State Thrift and Loan), when all of its outstanding common stock was acquired for a total purchase price of $1,414,000 in cash. As a result of this acquisition, accounted for as a purchase transaction, the Company has recorded goodwill of $105,000 at December 31, 1993. At the date of acquisition, First Republic Savings Bank's assets consisted primarily of cash of $684,000 and loans of $1,416,000 and its deposits were $762,000. On January 18, 1994, this entity relocated to Las Vegas, Nevada and was renamed First Republic Savings Bank.\nLENDING ACTIVITIES\nThe Company's loan portfolio primarily consists of loans secured by single family residences, multifamily buildings and seasoned commercial real estate properties. Currently, the Company's strategy is to focus on the origination of single family and multifamily mortgage loans and to limit the origination of commercial mortgage loans. A substantial portion of single family loans is originated for sale in the secondary market, whereas historically a small percentage of apartment and commercial loans has been sold. From its inception in 1985 through December 31, 1993, the Company originated approximately $3.6 billion of loans, of which approximately $1.5 billion were sold to investors.\nThe Company has emphasized the retention of adjustable rate mortgages (\"ARMs\") in its loan portfolio. At December 31, 1993, over 87% of the Company's loans were adjustable rate or were due within one year. If interest rates rise, payments on ARMs increase, which may be financially burdensome to some borrowers. Subject to market conditions, however, the Company's ARMs generally provide for a life cap that is 5% to 6% above the initial interest rate as well as periodic caps on the rates to which an ARM can increase from its initial interest rate, thereby protecting borrowers from unlimited interest rate increases. Also, the ARMs offered by the Company often carry fixed rates of interest during the initial three-, six- or twelve-month periods which are below the rate determined by the index at the time of origination plus the contractual margin. Certain ARMs contain provisions for the negative amortization of principal in the event that the\namount of interest and principal due is greater than the required monthly payment. The amount of any shortfall is added to the principal balance of the loan to be repaid through future monthly payments, which could cause increases in the amount of principal owed by the borrower from that which was originally advanced. At December 31, 1993, the amount of loans with the potential for negative amortization held by the Company was approximately 4.8% of total loans and the amount of loans which had experienced increases in principal balance was approximately 0.5% of total loans.\nThe Company focuses on originating loans secured by a limited number of property types, located in specific geographic areas. The Company's loans are of sufficient average size to justify executive management's involvement in most transactions. The Company's executive loan committee reviews all loan applications and approves all lending decisions. Substantially all properties are visited by the originating loan officer, and generally, an additional visit is made by one of the members of the Executive Loan Committee, either the President, the Executive Vice President, or another Vice President who is an underwriting officer prior to loan closing. Approximately 80% of the Company's loans are secured by properties located within 20 miles of one of the Company's offices.\nThe Company utilizes third-party appraisers for appraising the properties on which it makes loans. These appraisers are chosen from a small group of appraisers approved by the Company for specific types of properties and geographic areas. In the case of single family home loans in excess of $1,500,000, two appraisals are generally required and the Company utilizes the lower of the two appraised values for underwriting purposes. The Company's focus on loans secured by a limited number of property types located in specific geographic areas enables management to maintain a continually updated knowledge of collateral values in the areas in which the Company operates. The Company's policy generally is not to exceed an 80% loan-to-value ratio on single family loans without mortgage insurance. The Company applies stricter loan-to-value ratios as the size of the loan increases. Under the Company's policies, an appraisal is obtained on all multifamily and commercial loans and the loan-to-value ratios generally do not exceed 75% for multifamily loans and 70% for commercial real estate loans.\nThe Company applies its collection policies uniformly to both its portfolio loans and loans serviced for others. It is the Company's policy to discuss each loan with one or more past due payments at a weekly meeting of all lending personnel. The Company has policies requiring rapid notification of delinquency and the prompt initiation of collection actions. The Company primarily utilizes loan officers and senior management in its collection activities in order to maximize attention and efficiency.\nIn 1992, the Company implemented procedures requiring annual or more frequent asset reviews of its multifamily and commercial real estate loans. As part of these asset review procedures, recent financial statements on the property and\/or borrower are analyzed to determine the current level of occupancy, revenues and expenses as well as to investigate any deterioration in the value of the real estate collateral or in the borrower's financial condition since origination or the last review. Upon completion, an evaluation or grade is assigned to each loan. These asset review procedures provide management with additional information for assessing its asset quality.\nAlso, since September 1992, the Company has maintained an insurance policy to cover a portion of the risk of loss that might result from earthquake damage to properties securing real estate mortgage loans in its loan portfolio. Under a policy extending until August 1994, the Company is self-insuring for the first $12,500,000 of any loss as a result of damages to underlying collateral and the insurance policy covers up to an additional $8,000,000. In connection with obtaining this insurance coverage, the Company was assisted by an engineering consulting firm which analyzed the location and construction attributes of certain of the properties that secure the Company's loans. For additional information regarding the effect of the January 17, 1994 earthquake on the Company's loans in the Los Angeles area, see \"Asset Quality--Event Subsequent to December 31, 1993.\"\nAt December 31, 1993, single family real estate secured loans, including home equity loans, represented $608,489,000, or 48% of the Company's loan portfolio. Approximately 72% of these loans were in the San Francisco Bay Area, and approximately 22% were in the Los Angeles area. The Company's strategy has\nbeen to lend to borrowers who are successful professionals, business executives, or entrepreneurs and who are buying or refinancing homes in metropolitan communities. Many of the borrowers have high liquidity and substantial net worths, and are not first-time home buyers. These are loans secured by single family detached homes, condominiums, cooperative apartments, and two-to-four unit properties. At December 31, 1993, the average single family loan amount was approximately $613,000 and the approximate average loan- to-value ratio was 65%, using appraised values at the time of loan origination and current loan balances outstanding.\nDue to the Company's focus on upper-end home mortgage loans, the number of single family loans originated is limited (approximately 1,450 for 1993), allowing the loan officers and executive management to apply the Company's underwriting criteria to each loan. Repeat customers or their direct referrals account for the most important source of the loans originated by the Company.\nAt December 31, 1993, loans secured by multifamily properties totaled $387,757,000, or 31% of the Company's loan portfolio. The loans are predominantly on older buildings in the urban neighborhoods of San Francisco and Los Angeles. Approximately 39% of the properties securing the Company's multifamily loans were in the San Francisco Bay Area, approximately 27% were in Los Angeles County, approximately 6% were in other California areas and approximately 28% were in Clark County (Las Vegas). The buildings are generally seasoned operating properties with proven occupancy, rental rates and expense levels. The neighborhoods tend to be densely populated; the properties are generally close to employment opportunities; and rent levels are generally low to moderate. Typically, the borrowers are property owners who are experienced at operating such type of buildings. At December 31, 1993, the average multifamily mortgage loan size was approximately $1,212,000 and the approximate loan-to-value ratio was 64%, using appraised values at the time of origination and current loan balances outstanding.\nThe Company actively engaged in commercial real estate lending from its formation in 1985; however, from May 1992 through December 31, 1993, in response to economic conditions, the Company entered into a limited number of commitments to make new commercial real estate loans. The Company has not made and does not make commercial real estate construction and development loans. The real estate securing the Company's existing commercial real estate loans includes a wide variety of property types, such as office buildings, smaller shopping centers, owner-user office\/warehouses, residential hotels, motels, mixed-use residential\/commercial, and retail properties. At the time of loan closing, the properties are generally completed and occupied. They are generally older properties located in metropolitan areas with approximately 74% in the San Francisco Bay Area, approximately 13% in Los Angeles County, approximately 4% in other California areas and approximately 7% in Las Vegas. At December 31, 1993, the average loan size was less than $1,000,000 and the approximate average loan-to-value ratio was 56%, using appraised values at the time of loan origination and current balances outstanding. The total amount of such loans outstanding on December 31, 1993, was $229,914,000, or 18% of the Company's loan portfolio, compared to $204,611,000, or 19% at December 31, 1992.\nSince May 1990, the Company has originated construction loans secured by single family and multifamily residential properties and permanent mortgage loans primarily secured by multifamily and single family properties in the Las Vegas, Nevada vicinity. In 1993, such loan originations were approximately $146,200,000 and approximately $102,400,000 of such loans were repaid, compared to approximately $128,100,000 of loan originations and $73,300,000 of such loans that were repaid in 1992. Generally, residential construction loans are short-term in nature and are repaid upon completion or ultimate sale of the properties. At December 31, 1993, the outstanding balance of the Company's construction loans was $20,219,000, or 2% of total loans. Construction loans are made only in Las Vegas by an experienced lending team. As a method for limiting this type of business, the Company's Board of Directors has approved a current limit of $78,710,000 of total commitments on single family for sale tracts and a maximum outstanding balance of $3,500,000 at any time per development. Total outstanding single family construction loans on 38 separate projects were $14,512,000 at December 31, 1993 with total additional committed loan amounts of $25,896,000. The Company also has loans to four separate borrowers on four separate multifamily properties\nunder construction in Las Vegas totalling $5,707,000 and has issued permanent take-out commitments of up to $20,770,000 on these multifamily projects, conditioned upon the completion of construction, satisfactory occupancy and rental rates, and certain other requirements.\nFor construction loans, a voucher system is used for all disbursements. For each disbursement, an independent inspection service is utilized to report the progress and percentage of completion of the project. In addition to these inspections, regular biweekly inspections of all projects are performed by senior management of First Republic Savings Bank. Checks are made payable to the various subcontractors and material suppliers, after they have waived their labor and\/or material lien release rights. The request for payment, via vouchers, is compared to the individual line item in the approved construction budget to ensure that the disbursements do not exceed the percentage of completion as reported by a third party inspection service. All vouchers must be approved by management prior to being processed for payment.\nIn 1991, the Company began purchasing seasoned performing multifamily and commercial real estate loans. Such loans met the Company's normal underwriting standards, were generally located in the Company's primary lending areas, and were purchased at a discount to their face value. Prior to the purchase of these loans, management conducted a property visit and applied the Company's underwriting procedures as if a new loan were being originated. The Company purchased loans totalling $70,307,000 in 1991, $12,342,000 in the first quarter of 1992, including some single family real estate loans, and $5,440,000 in 1993. The Company currently has no specific plans to make additional purchases of loans, but may do so in the future if attractive opportunities are presented.\nSince 1989, First Thrift has offered a home equity line of credit program, with loans secured by first or second deeds of trust on owner-occupied primary residences. At December 31, 1993, the outstanding balance due under home equity lines of credit was $31,213,000 and the unused remaining balance was $39,243,000. These loans carry interest rates which vary with the prime rate and may be drawn down and repaid during the first 10 years, after which the outstanding balance converts to a fully-amortizing loan for the next 15 years.\nCommercial business loans are generally secured by a mix of real estate, equipment, inventory and receivables, are primarily adjustable rate in nature, and are typically made to small businesses. These loans generally have maturities of 60 months. The yields on these small business loans are typically greater than the yields on real estate secured loans, and the difference in such yields reflects a marketplace assessment of the relative risks to the lender associated with each type of loan. At December 31, 1993, the Company had approximately 139 commercial business loans with an aggregate balance of $8,346,000, which accounted for less than 1% of the Company's loan portfolio. Additionally, certain of the Company's deposit customers have obtained loans which are fully secured by their thrift certificate balances. These loans totalled $812,000 at December 31, 1993.\nThe following table presents an analysis of the Company's loan portfolio at December 31, 1993 by property type and geographic location. The table does not include amounts which the Company is committed to lend but which are undisbursed.\n- -------- (1) Includes equity lines of credit secured by single family residences and single family loans held for sale.\nMORTGAGE BANKING OPERATIONS\nIn addition to originating loans for its own portfolio, the Company participates in secondary mortgage market activities by selling whole loans and participations in loans to FNMA and FHLMC and various institutional purchasers such as insurance companies, mortgage conduits and savings and loan associations. Mortgage banking operations are conducted primarily by First Thrift, and to a lesser extent, by First Republic Mortgage, Inc. Secondary market sales allow the Company to make loans during periods when deposit flows decline, or are not otherwise available, and at times when customers prefer loans with long-term fixed interest rates which the Company does not choose to retain in its loan portfolio.\nThe following table sets forth the amount of loans originated and purchased by the Company and the amount of loans sold to institutional investors in the secondary market.\nThe secondary market for mortgage-backed loans is comprised of institutional investors who purchase loans meeting certain underwriting specifications with respect to loan-to-value ratios, maturities and yields. Subject to market conditions, the Company tailors certain real estate loan programs to meet the specifications of particular institutional investors. The Company retains a portion of the loan origination fee (points) paid by the borrower and receives annual servicing fees as compensation for retaining responsibility for the servicing of all loans sold to institutional investors. See \"--Loan Servicing.\" The sale of substantially all loans to institutional investors is nonrecourse to the Company; however, the Company has on one occasion retained a subordinated interest in loans sold to an institutional investor of which at December 31, 1993, $431,000 remained outstanding. From its inception, through December 31, 1993, the Company has sold approximately $1.5 billion of loans to investors, substantially all nonrecourse, and has retained the servicing on all such loans except for a limited amount of FHA\/VA loans sold servicing released.\nThe Company sold loans to six institutional investors in 1991, to ten institutional investors in 1992 and to eight institutional investors in 1993. The terms and conditions under which such sales are made depend upon, among other things, the specific requirements of each institutional investor, the type of loan, the interest rate environment and the Company's relationship with the institutional investor. The majority of the Company's sales of multifamily and commercial real estate loans have been made pursuant to individually negotiated whole loan or participation sales agreements for individual loans or for a package of such loans. In the case of single family residential loans, the Company obtains in advance formal commitments under which the investors are committed to purchase up to a specific dollar amount of whole loans over a specified period of time. The terms of the commitments vary with each institutional investor and generally range from two months to one year. The fees paid for such commitments also vary with each investor and by the length of such commitment. Informal commitments are normal in the industry for multifamily and commercial loans, although the Company did not sell any new loans secured by multifamily or commercial properties in 1993 or 1992. Management expects to enter into additional formal and informal commitments in the future as it develops working relationships with additional institutional investors; however, an unstable interest rate environment could make it difficult for the Company to obtain commitments for the sale of loans with acceptable terms on a timely basis. Loans are classified as held for sale when the Company is waiting for purchase by an investor under a flow program or is negotiating for the sale of specific loans which meet selected criteria to a specific investor.\nUnderwriting criteria established by investors in adjustable and fixed rate single family residential loans generally include the following: maturities of 15 to 30 years, a loan-to-value ratio no greater than 90% (which percentage generally decreases as the size of the loan increases and is limited to 80% unless there is mortgage insurance on the loan), the liquidity of the borrower's other assets and the borrower's ability to service the debt out of income. Interest rates on adjustable rate loans are adjusted semiannually or annually primarily on the basis of either the One-Year Treasury Constant Maturity Index or the Eleventh District Federal Home Loan Bank Board Cost of Funds Index. Some loans may be fixed for an initial period of up to several years and become adjustable thereafter. Except for the amount of the loan, the underwriting standards of the investors generally conform to certain requirements established by the Federal National Mortgage Association (\"FNMA\") or the Federal Home Loan Mortgage Corporation (\"FHLMC\"). Underwriting criteria established by investors in multifamily and commercial real estate loans generally include the following: maturities of 10 to 30 years, with a 25 to 30 year amortization schedule, a loan-to-value ratio no greater than 75% and a debt coverage ratio (based on the property's cash flow) of 1-to-1. Loans sold in the secondary market are generally secured by a first deed of trust.\nLOAN SERVICING\nThe Company has retained the servicing on all non-government loans sold to institutional investors, thereby generating ongoing servicing revenues. Also, in 1990 and, to a lesser extent, in 1991, it purchased mortgage servicing rights on the open market. The Company's mortgage servicing portfolio was $814.5 million and $781.6 million at December 31, 1993 and 1992, respectively. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, holding escrow (impound) funds for payment of taxes and insurance, making inspections as required of the mortgaged property, collecting amounts due from delinquent mortgagors, supervising foreclosures in the event of unremedied defaults and generally administering the loans for the investors to whom they have been sold. Management believes that the quality of its loan servicing capability is a factor which permits it to sell its loans in the secondary market and to purchase servicing rights at competitive prices.\nThe Company receives fees for servicing mortgage loans, ranging generally from 0.125% to 1.25% per annum on the declining principal balances of the loans. The average service fee collected by the Company was 0.38% for 1993, 0.41% for 1992 and 0.42% for 1991. Servicing fees are collected and retained by the Company out of monthly mortgage payments. The Company's servicing portfolio is subject to reduction by reason of normal amortization and prepayment or liquidation of outstanding loans. A significant portion of the loans serviced by the Company have outstanding balances of greater than $200,000, and at December 31, 1993 approximately 55% were adjustable rate mortgages. The weighted-average mortgage loan note rate of the Company's servicing portfolio at December 31, 1993 was 6.54% for ARMs and 7.90% for fixed rate loans. Many of the existing servicing programs provide for full payments of principal and interest to be remitted by the Company, as servicer, to the investor, whether or not received from the borrower. Upon ultimate collection, including the sale of foreclosed property, the Company is entitled to recover any such advances plus late charges prior to payment to the investor.\nThe Company accounts for revenue from the sale of loans where servicing is retained in conformity with the requirements of Statement of Financial Accounting Standards No. 65. Gains and losses are recognized at the time of sale by comparing sales price with carrying value. A premium results when the interest rate on the loan, adjusted for a normal service fee, exceeds the pass- through yield to the buyer. Premiums are calculated as the present value of excess service fees expected to be collected in future periods and are amortized over the estimated life of the loans, based on market factors, including estimated prepayments. The Company adjusts the premium on the sale of loans on a quarterly basis to reflect actual prepayments on the underlying loan portfolio. At December 31, 1993, this asset (reported as \"premium on sale of loans\" and included in the Company's balance sheet as \"Other Assets\") was $903,000 as compared to $1,454,000 at December 31, 1992.\n\"Purchased servicing rights\" represent the carrying cost of bulk purchases of servicing rights and are also included in the Company's balance sheet as \"Other Assets.\" These carrying costs are amortized in proportion to, and over the period of, estimated net servicing income. No significant servicing rights were purchased in bulk prior to June 1990. Servicing rights on $443,000,000 of loans were purchased at a cost of $4,417,000 in early 1991 and the last half of 1990. No servicing rights were purchased in 1993 or 1992. At purchase, the underlying loans had an average balance of approximately $200,000, and approximately 75% carried fixed interest rates averaging 10.2%. The purchases were made to expand the Company's portfolio of loans serviced for others, allowing the more effective use of the existing servicing capacity and resulting in increased efficiency on a per loan basis. In order to hedge against the possible loss of servicing income that might result from a more rapid than anticipated prepayment of the underlying loans in the event of a significant decline in interest rates from purchase until May 1993, the Company purchased call options on $20 million of ten-year U.S. Treasury Notes, which became more valuable in a declining interest rate environment. At December 31, 1993 and 1992, the carrying cost of purchase servicing rights, net of amortization, was $251,000 and $1,502,000, respectively. Amortization of the carrying value of premium on sale of loans and the carrying cost on purchased servicing rights totalled $1,753,000 in 1993, $1,960,000 in 1992 and $1,820,000 in 1991.\nA declining and relatively low interest rate environment has existed for most of 1992 and 1993. When interest rates are low, the rate at which mortgage loans are prepaid tends to increase as borrowers refinance fixed rate loans to lower rates or convert from adjustable rate to fixed rate loans. Low rates also increase housing affordability, stimulating purchases by first time home buyers and trade up transactions by existing homeowners. The level and value of the Company's loan servicing portfolio, including purchased servicing rights, have been adversely affected by low mortgage interest rates, leading to higher loan prepayments and lower income generated from the Company's loan servicing portfolio. This negative effect on the Company's income has been offset somewhat by a rise in origination and servicing income attributable to new loan originations, which have increased during the recent period of low mortgage interest rates. From 1991 to 1993, the Company closed its loan servicing hedge position, resulting in total gains of approximately $1,200,000 which were used by the Company to reduce the recorded value of its purchased servicing rights. In addition, the Company has amortized, as a reduction of servicing fee revenues, the cost of purchased servicing rights at a rate generally consistent with the actual repayment experience. The Company believes its carrying basis of $251,000 has been reduced to a modest amount, which approximates the market value of such rights. See \"--Asset and Liability Management.\"\nThe following table sets forth the dollar amounts of the Company's mortgage loan servicing portfolio at the dates indicated, the portion of the Company's loan servicing portfolio resulting from loan originations and purchases, respectively, and the carrying value as a percentage of loans serviced. Although the Company intends to continue to increase the size of its servicing portfolio, such growth will depend on market conditions including the future level of loan originations, sales and prepayments.\nINVESTMENTS\nThe Company purchases short-term money market instruments as well as U.S. Government securities and other mortgage-backed securities (\"MBS\") in order to maintain a reserve of liquid assets to meet liquidity requirements and as alternative investments to loans. The Company has generated agency MBS by originating qualifying adjustable rate mortgage loans for sale to the agencies and pooling such loans into securities. At December 31, 1993, the Company's investment portfolio included the following securities in the proportions listed: U.S. Government--30%; agency MBS 16%; and other MBS--53%.\nAt December 31, 1993, the Company's investment portfolio totalled $84,208,000 (6% of total assets) as compared to $40,638,000 (3% of total assets) at December 31, 1992. The securities in the Company's investment portfolio at December 31, 1993 had maturities ranging from seven months to twenty-nine years. As of December 31, 1993, the market value of securities in the portfolio were $855,000 above cost consisting of total gross unrealized gains of $731,000 on U.S. Government securities, gross unrealized gains of $266,000 on agency MBS and gross unrealized losses of $16,000 and $155,000 on agency MBS and other MBS, respectively.\nThe following summarizes by category the carrying value and approximate market value of investment securities at the dates indicated:\n- -------- (1) As of December 31, 1991 the Company reclassified a $6,000,000 nonaccruing investment as a nonaccruing commercial real estate loan participation. The Company sold that asset in May 1992 and recorded a loss of $2,220,000.\nAt December 31, 1993, the Company's intent is to hold all investments other than the one corporate bond owned until maturity and management believes that the Company has the ability to do so. The following table summarizes the maturities of the Company's investment securities and their weighted average yields at December 31, 1993:\n- -------- (1) Represents one nonaccruing asset.\nAt December 31, 1993, all of the investment securities were due in one year or were adjustable, with rates which were generally subject to change monthly, quarterly or semiannually and varied according to several interest rate indices. Yields have been calculated by dividing the projected interest income at current interest rates, including discount or premium, by the carrying value. Most of the securities having maturities exceeding 10 years are adjustable U.S. Government guaranteed loan pools, agency MBS and other MBS which, as a class, have actual maturities substantially shorter than their face maturities. At December 31, 1993, the net book value of the Company's securities of an unsecured, below investment grade nature was $361,000.\nAt December 31, 1993, First Thrift owned redeemable FHLB stock having a par value of $22,927,000. At December 31, 1993, no other asset and no investment in the Company's portfolio had an aggregate book value exceeding 10% of stockholders' equity.\nFUNDING SOURCES\nThe Thrifts obtain funds from depositors by offering passbook accounts and term investment certificates or term deposits. The Thrifts' accounts are federally insured by the FDIC up to the legal maximum. First Thrift has typically offered somewhat higher interest rates to its depositors than do most full service financial institutions. At the same time, it minimizes the cost of maintaining these accounts by not offering transaction accounts or high operating cost services such as checking, safe deposit boxes, money orders, ATM access and other traditional retail services. This limited product operation results in substantial cost savings which more than exceed the differential interest rates paid. The Thrifts effect deposit withdrawals by issuing checks rather than disbursing cash, which minimizes operating costs associated with handling and storing cash, of which it does none. In addition, the Thrifts do not actively solicit deposit accounts of less than $5,000.\nThe Thrifts advertise in local newspapers to attract deposits; and since 1988, First Thrift has performed a limited direct telephone solicitation of potential institutional depositors such as credit unions, small commercial banks, and pension plans. At December 31, 1993, no individual depositor represents 0.7% or more of First Thrift's deposits.\nPrior to mid-1992, First Thrift utilized certificates with a balance of $100,000 or more, generally having maturities in excess of six months, to fund a portion of its assets. Existing bank regulations define brokered deposits, jumbo certificates and borrowings with a maturity of less than one year as \"volatile liabilities.\" Volatile liabilities are compared to cash, short-term investment and investments which mature within one year (\"liquid assets\") to calculate the volatile liability \"dependency ratio,\" a measure of regulatory liquidity. The level of such liquid assets should generally be higher in comparison with volatile liabilities if a financial institution has large negotiable liabilities like checking accounts, substantial future lending or off-balance sheet commitments, or a history of significant asset growth.\nIn the last six months of 1992 and continuing throughout 1993, First Thrift significantly altered its volatile liability dependency ratio by maintaining a higher level of cash and investments relative to its short-term borrowings and a reduced level of larger certificates. At December 31, 1993, First Thrift's cash and investments exceeded its volatile liabilities by $64,573,000. First Thrift has adopted a policy to discontinue accepting most larger certificates and, upon maturity, to return a portion or all of the funds on existing larger certificates. At year end 1993, First Thrift had not accepted brokered deposits for more than four years and the balance of $989,000 of brokered deposits at December 31, 1993, represented less than 0.2% of total deposits. Management does not plan to renew such deposits upon their scheduled maturity. At December 31, 1993, First Thrift's time certificates $100,000 or more totalled $44,847,000 of which $31,653,000, or 70.6%, were from retail consumer depositors. At December 31, 1993, First Republic Savings Bank had one time certificate over $100,000, totalling $112,000. For First Thrift, average maturity of all time certificates was 8.8 months and the average certificate amount per depositor was approximately $42,000 at December 31, 1993.\nThe following table shows the maturity of the Thrifts' certificates of $100,000 or more at December 31, 1993.\nFirst Thrift also utilizes term FHLB advances and, to a lesser extent, bank lines of credit as funding sources. Since August 1990, the Company has utilized term FHLB advances as an alternative to deposit gathering to fund its assets. FHLB advances must be collateralized by the pledging of mortgage loans which are assets of First Thrift. At December 31, 1993, total FHLB advances outstanding were $468,530,000. Of this amount, $414,530,000, or 88%, had an original maturity of 10 years or longer. Of the remaining, $10,000,000 was repaid in January 1994 and $44,000,000 was due between one and two years. The longer-term advances provide the Company with a stable and well-matched funding source for assets with longer lives. See \"--Asset and Liability Management.\"\nFirst Republic Savings Bank will apply for FHLB membership in 1994 and, if approved, it is expected that term adjustable rate advances will be used to fund a portion of its assets.\nThe following table sets forth certain information with respect to the Company's short-term borrowings at the dates indicated.\n- -------- (1) The amounts shown at the dates indicated are not necessarily reflective of the Company's activity in short-term borrowings during the periods. (2) See Note 7 of Notes to Consolidated Financial Statements for a discussion of general terms relating to repurchase agreements.\nASSET AND LIABILITY MANAGEMENT\nManagement seeks to manage its asset and liability portfolios to help reduce any adverse impact on the Company's net interest income caused by fluctuating interest rates. To achieve this objective, the Company's strategy is to manage the rate sensitivity and maturity balance of its interest-earning assets and interest-bearing liabilities by emphasizing the origination and retention of adjustable interest rate or short-term fixed rate loans and the matching of adjustable rate repricings with short- and intermediate-term investment certificates and adjustable rate borrowings. The Company has established a program to obtain deposits by offering six month to five-year term investment certificates for the purpose of providing funds for adjustable rate mortgage loans with repricing periods of six months or more and for other matching term maturities.\nThe following table summarizes the differences between the Company's maturing or rate adjusting assets and liabilities at December 31, 1993. Generally, an excess of maturing or rate adjusting assets over maturing or rate adjusting liabilities during a given period will serve to enhance earnings in a rising rate environment and inhibit earnings when rates decline; this is the Company's cumulative position as of December 31, 1993 for the six month and twelve month categories in accordance with its policy of having more assets than liabilities reprice for these periods. Conversely, when maturing or rate adjusting liabilities exceed maturing or rate adjusting assets during a given period, a rising rate environment generally will inhibit earnings and declining rates will serve to enhance earnings. The table illustrates projected maturities or interest rate adjustments based upon the contractual maturities or adjustment dates at December 31, 1993.\nASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY MATURING OR ADJUSTING DURING PERIODS SUBSEQUENT TO DECEMBER 31, 1993\n- -------- (1) Adjustable rate loans consist principally of real estate secured loans with a maximum term of 30 years. Such loans are generally adjustable semiannually based upon changes in the One Year Treasury Constant Maturity Index, the Federal Reserve's Six Month CD Index, or the FHLB 11th District Cost of Funds Index, subject generally to a maximum increase of 2% annually and 5% over the lifetime of the loan. (2) Passbook maturities and rate adjustments are allocated based upon management's experience of historical interest rate volatility and passbook erosion rates. However, all passbook accounts are contractually subject to immediate withdrawal.\nIn evaluating the Company's exposure to interest rate risk, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or periods to reprice, they may react differently to changes in market interest rates. Additionally, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates on a short- term basis and over the life of the asset. The Company considers the anticipated effects of these various factors in implementing its interest rate risk management activities, including the utilization of interest rate caps.\nFirst Thrift has entered into interest rate cap transactions in the aggregate notional principal amount of $945,000,000 which terminate in periods ranging from March 1994 through September 2000. Under the terms of these transactions, which have been entered into with nine different commercial or investment banking institutions or their affiliates, First Thrift will be reimbursed quarterly for increases in the London Inter-Bank Offer Rate (\"LIBOR\") for any quarter during the term of the applicable transaction in which such rate exceeds a rate ranging from 9% to 13% as established for the applicable transaction. The interest rate cap transactions are intended to act as hedges for the interest rate risk created by restrictions on the maximum yield of certain variable rate loans and investment securities held by First Thrift which may, therefore, at times be exposed to the effect of unrestricted increases in the rates paid on the liabilities which fund these assets. The cost of these interest rate cap transactions is amortized over their lives and totalled $850,000 in 1993, $672,000 in 1992 and $539,000 in 1991. Although these costs reduce current earnings, the Company believes that the cost is justified by the protection these interest rate cap transactions provide against increased interest rates. Additionally, $37,400,000 of First Thrift's advances with the FHLB contain interest rate caps of 12% as part of the borrowing agreement. The effect of these interest rate cap transactions is not factored into the determination of interest rate adjustments provided in the table above.\nThe Company has entered into interest rate swaps with the FHLB for $45,000,000 of FHLB advances and with an investment banking firm for $20,000,000 of FHLB advances to convert the fixed rate on long-term FHLB advances to semi-annual adjustable liabilities. Under these swaps, the Company has collected and recorded as a reduction in interest expense on borrowings $3,151,000 in 1993, $2,562,000 in 1992 and $1,227,000 in 1991. The availability of long-term, adjustable rate FHLB advances, with a weighted average maturity of 12 years at December 31, 1993, reduces the repricing volatility in the Company's balance sheet and the Company's dependence upon retail deposits, which generally have a shorter maturity than the contractual life of mortgage loans. The Company will continue to consider the utilization of FHLB advances as an integral part of its asset and liability management program. Additionally, in January 1992, the Company entered into $50,000,000 of interest rate swaps with the FHLB and a commercial bank to fix the cost of certain adjustable rate borrowings at an average rate of 4.90% for a period which ended in July 1993. Under these swaps, the Company paid and recorded as an increase in interest expense on borrowings $442,000 in 1993 and $501,000 in 1992. The Company is exposed to credit and market losses if the counterparties to its interest rate cap and swap agreements fail to perform; however, the Company does not anticipate such nonperformance.\nFIRST REPUBLIC AND SUBSIDIARIES\nFirst Republic was incorporated in February 1985. First Republic, which owns all of the capital stock of First Thrift, First Republic Savings Bank, and First Republic Mortgage, Inc., provides executive management to each of its subsidiaries and formulates and directs the implementation of an integrated business strategy for the Company. First Republic is also directly engaged in the mortgage lending, originating and servicing businesses.\nIn June 1985, First Republic purchased all of the outstanding capital stock of an inactive California-chartered thrift and loan company which had begun operations in California in 1953. Upon its acquisition by First Republic, the company was renamed First Republic Thrift & Loan.\nOn December 31, 1985, First Republic acquired, for $1.00, all of the outstanding capital stock of a California-chartered thrift and loan company, which was subsequently named First Republic Thrift & Loan of San Diego. At the time of the acquisition, First Republic Thrift & Loan of San Diego was operating at a loss, had a regulatory capital deficiency of approximately $3,000,000 and had a significant amount of delinquent net receivables. On December 31, 1991, pursuant to regulatory approval obtained from the FDIC and the Commissioner of Corporations of the State of California, the Company effected a combination of its two California thrifts by the merger of First Republic Thrift & Loan of San Diego into First Republic Thrift & Loan.\nIn December 1993, First Republic acquired in a purchase transaction all of the common stock in a Nevada state chartered thrift and loan. Upon approval by federal and state regulatory agencies, this institution was relocated to Las Vegas, Nevada in January 1994 and renamed First Republic Savings Bank. The purpose of this acquisition was to enable the Company to gather deposits in the Las Vegas, Nevada area and to continue its lending activities under a full service financial institution. In January 1994, the employees responsible for construction and income property lending were transferred to First Republic Savings Bank. It is expected that upon approval by FHA\/VA and other governmental agencies, all permanent single family lending and related employees will be transferred from First Republic Mortgage Inc. to First Republic Savings Bank.\nIn May 1990, First Republic established a wholly-owned mortgage originating subsidiary, First Republic Mortgage, Inc., which commenced operations from its office in Las Vegas. Until January 1994, First Republic Mortgage, Inc. originated construction loans for First Thrift on low- and moderate-income single family homes and multifamily units and originated permanent mortgage loans on low- and moderate-income multifamily units and on commercial real estate properties, all of which properties are located in and proximate to Las Vegas. It continues to be an approved FHA-insured and VA guaranteed lender for permanent mortgage loans on single family homes. Upon receipt of all governmental agency approvals, First Republic intends to transfer in 1994 the remaining employees of First Republic Mortgage Inc. to First Republic Savings Bank and, ultimately, to dissolve First Republic Mortgage Inc.\nCOMPETITION\nThe Company faces strong competition both in the attraction of deposits and in the making of real estate secured loans. The Company competes for deposits and loans by advertising, by offering competitive interest rates and by seeking to provide a higher level of personal service than is generally offered by larger competitors. The Company does not have a significant market share of the deposit-taking or lending activities in the areas in which it conducts operations.\nManagement believes that its most direct competition for deposits comes from savings and loan associations, other thrift and loan companies, commercial banks and credit unions. The Company's cost of funds fluctuates with market interest rates and also has been affected by higher rates being offered by certain institutions. During certain interest rate environments, additional significant competition for deposits may be expected to arise from corporate and governmental debt securities as well as money market mutual funds.\nThe Company's competition in making loans comes principally from savings and loan associations, mortgage companies, other thrift and loan companies, commercial banks, and, to a lesser degree, credit unions and insurance companies. Aggressive pricing policies of the Company's competitors, especially during a declining period of mortgage loan originations could in the future result in a decrease in the Company's mortgage loan origination volume and\/or a decrease in the profitability of the Company's loan originations. Many of the nation's largest savings and loan associations, mortgage companies and commercial banks have a significant number of branch offices in the areas in which the Company operates. Increased competition for mortgage loans from larger institutional lenders may result in a decrease in the Company's mortgage loan originations. The Company competes for loans principally through the quality of service it provides to\nborrowers, real estate brokers and loan agents, while maintaining competitive interest rates, loan fees and other loan terms.\nREGULATION\nThe Thrifts are subject to regulation, supervision and examination under both federal and state law. First Thrift is subject to supervision and regulation by the Commissioner of Corporations of the State of California (the \"California Commissioner\") and, as a member institution, by the FDIC. First Republic Savings Bank is subject to supervision and regulation by the Commissioner, Financial Institutions Division, Department of Commerce, State of Nevada (the \"Nevada Commissioner\") and, as a member institution, by the FDIC. Neither First Republic, nor the Thrifts are regulated or supervised by the Office of Thrift Supervision, which regulates savings and loan institutions. First Republic is not directly regulated or supervised by the California Commissioner, the Nevada Commissioner, the FDIC, the Federal Reserve Board or any other bank regulatory authority, except with respect to the general regulatory and enforcement authority of the California Commissioner, the Nevada Commissioner and the FDIC over transactions and dealings between First Republic and the Thrifts, and except with respect to both the specific limitations regarding ownership of the capital stock of the parent company of any thrift and the specific limitations regarding the payment of dividends from the Thrifts discussed below. Future federal legislation could cause First Republic to become subject to direct federal regulatory oversight; however, the full impact of any such legislation and subsequent regulation cannot be predicted.\nCalifornia Law\nThe thrift and loan business conducted by First Thrift is governed by the California Industrial Loan law and the rules and regulations of the California Commissioner which, among other things, regulate in certain limited circumstances the maximum interest rates payable on certain thrift deposits as well as the collateral requirements and maximum maturities of the various types of loans that are permitted to be made by California-chartered industrial loan companies, i.e., thrift and loan companies or thrifts.\nSubject to restrictions imposed by applicable California law, First Thrift is permitted to make secured and unsecured consumer and non-consumer loans. The maximum term for repayment of loans made by thrift and loan companies range up to 40 years and 30 days depending upon collateral and priority of secured position, except that loans with repayment terms in excess of 30 years and 30 days may not in the aggregate exceed 5% of total outstanding loans and obligations of the thrift. Although secured loans may generally be repayable in unequal periodic payments during their respective terms, consumer loans secured by real property with terms in excess of three years must be repayable in substantially equal periodic payments unless such loans are covered under the Garn-St. Germain Depository Institutions Act of 1982 which applies primarily to single family residential loans.\nLoans made to persons who reside outside California or who do not have a place of business in California are limited to a maximum 30% of a thrift and loan's portfolio; however, effective January 1, 1994, this limitation ceased to apply to loans (i) made to purchase or refinance single family or multifamily residential property, (ii) that are saleable in the secondary market, evidenced by a commitment therefor, and (iii) that are owned by the thrift for 90 days or less.\nEffective January 1, 1994, upon application to and approval by the California Commissioner, thrifts may operate loan production offices outside California, subject to certain conditions as may be imposed by the California Commissioner.\nCalifornia law contains extensive requirements for the diversification of the loan portfolios of thrift and loan companies. A thrift and loan with outstanding investment certificates may not, among other things: (i) place more than 25% of its loans or other obligations in loans or obligations which are secured only partially, but not primarily, by real property; (ii) may not make any one loan secured primarily by improved real property that exceeds 20% of its paid-up and unimpaired capital stock and surplus not available for\ndividends; (iii) may not lend an amount in excess of 5% of its paid-up and unimpaired capital stock and surplus not available for dividends upon the security of the stock of any one corporation; (iv) may not make loans to, or hold the obligations of, any one person as primary obligor in an aggregate principal amount exceeding 20% of its paid-up and unimpaired capital stock and surplus not available for dividends; and (v) may have no more than 70% of its total assets in loans which have remaining terms to maturity in excess of seven years and are secured solely or primarily by real property. After January 1, 1994, any loan guaranteed or insured by a federal or state agency is deemed to have a term less than seven years. At December 31, 1993, First Thrift satisfied all of these requirements. Management believes that First Thrift can maintain compliance with these statutory requirements by managing the mix of its assets and loans without any material adverse impact on earnings or liquidity.\nUnder California law, a thrift and loan generally may not make any loan to, or hold an obligation of, any of its directors or officers, except in specified cases and subject to regulation by the California Commissioner. In addition, a thrift and loan may not make any loan to, or hold an obligation of, any of its shareholders or any shareholder of its holding company or affiliates, except that this prohibition does not apply to persons who own less than 10% of the stock of a holding company or affiliate which is listed on a national securities exchange, such as First Republic. Any person who wishes to acquire 10% or more of the capital stock of a California thrift and loan company or 10% or more of the voting capital stock or other securities giving control over management of its parent company must obtain the prior written approval of the California Commissioner. If a stockholder failed to obtain the required approval and engaged in a proxy contest in opposition to management of First Republic, First Republic might seek to utilize the provisions of California law described above to invalidate that stockholder's votes. It is not certain that such an attempt by First Republic would be successful under California law.\nA thrift is subject to certain leverage limitations that are not generally applicable to commercial banks or savings and loan associations. In particular, thrifts which have been in operation in excess of 60 months may, with written approval of the California Commissioner, have outstanding at any time investment certificates not to exceed 20 times paid-up and unimpaired capital and surplus. Increases in leverage under California law must also meet specified minimum standards for liquidity reserves in cash, loan loss reserves, minimum capital stock levels and minimum unimpaired paid-in surplus levels. First Thrift satisfied all of these standards at December 31, 1993. Thrift and loan companies are not permitted to borrow, except by the sale of investment or thrift certificates, in an amount exceeding 300% of outstanding capital stock, surplus and undivided profits, without the California Commissioner's prior consent. All sums borrowed in excess of 150% of outstanding capital stock, surplus and undivided profits must be unsecured borrowings or, if secured, approved in advance by the California Commissioner, and be included as investment or thrift certificates for purposes of computing the above ratios; however, collateralized FHLB advances are excluded for this test of secured borrowings and are not specifically limited by California law.\nUnder California law, thrift and loan companies are generally limited to investments which are legal investments for California commercial banks. In general, California commercial banks are prohibited from investing an amount exceeding 15% of shareholders' equity in the securities of any one issuer, except for specified obligations of the United States, California and local governments and agencies. A thrift and loan company may acquire real property only in satisfaction of debts previously contracted, pursuant to certain foreclosure transactions or as may be necessary as premises for the transaction of its business, in which case such investment is limited to one-third of a thrift and loan's paid in capital stock and surplus not available for dividends. The Thrifts are also governed by various state and federal consumer protection laws including Truth in Lending, Truth in Saving and the Real Estate Settlement Procedures Act.\nEffective January 1, 1991, the California Industrial Loan Law allowed a thrift to increase its secondary capital by issuing interest-bearing capital notes in the form of subordinated notes and debentures. Such notes are not deposits and are not insured by the FDIC or any other governmental agency, generally are required to have an initial maturity of at least seven years, and are subordinated to deposit holders, general creditors and secured creditors of the issuing thrift.\nNevada Law\nThe Nevada Thrift Companies Act (\"Nevada Act\") governs the licensing and regulations of Nevada thrift companies in much the manner the California Industrial Loan Law does for California thrift and loan companies. The Nevada Commissioner is charged with the supervision and regulation of First Republic Savings Bank (\"FRSB\"). The Nevada Commissioner approved the change of name from Silver State Thrift and Loan to FRSB concurrently with the approval of the acquisition of FRSB by the Company in 1993.\nUnder the Nevada Act, there is no interest rate limitation on loans; however any loan in excess of $50,000 must be secured by collateral having a market value of at least 115 percent of the amount due. The net amount of advance on loans secured by deposits may not exceed 90 percent of the amount of said deposit collateral. There are no terms or amortization restrictions on loans. FRSB is required to invest its funds as set forth in the Nevada Act and in investments which are legal investments for banks and savings associations subject to any limitation under federal law (See--\"Federal Law\"). Secured loans to one person as primary obligor may not exceed 25 percent of capital and surplus and, except as to limitations on loans to one borrower, loans secured by real or personal property, may be made to any person without regard to the location or nature of the collateral.\nSubstantially as under the California Industrial Loan Law for California thrift and loan companies, the Nevada Act restricts transactions with officers, directors and shareholders as well as transactions with regard to holding, developing and carrying real property.\nIn 1985, the Nevada Act was amended to prohibit issuance of thrift certificates and required insurance for deposits. Therefore, FRSB accepts deposits rather than issuing investment certificates. However, by order of the Nevada Commissioner when FRSB was acquired by the Company, FRSB is not authorized to accept demand deposits. The total number of deposits which FRSB may accept is governed by limits which may be imposed by the Federal Deposit Insurance Corporation (\"FDIC\").\nUnder the Nevada Act, changes in stock ownership of a thrift company require notifications to the Nevada Commissioner if ownership of 5 percent or more of the outstanding voting stock changes. Additionally, if 25 percent or more thereof changes ownership or there is a change in control resulting from a change in ownership, then an approval must be first obtained from the Nevada Commissioner.\nIn addition to remedies available to the FDIC, the Nevada Commissioner may take possession of a thrift company if certain conditions exist.\nFederal Law\nThe Thrifts' deposits are insured by the FDIC to the full extent permissible by law. As an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises the operations of institutions to which it provides deposit insurance. The Thrifts are subject to the rules and regulations of the FDIC to the same extent as other financial institutions which are insured by that entity. The approval of the FDIC is required prior to any merger, consolidation or change in control, or the establishment or relocation of any branch office of the Thrifts. This supervision and regulation is intended primarily for the protection of the depositors and to ensure services for the public's convenience and advantage.\nOn August 6, 1992, First Thrift entered into a Memorandum of Understanding (the \"Memorandum\") with the FDIC regarding certain concerns arising out of the FDIC's 1992 examination of First Thrift, primarily related to the rapid loan growth of First Thrift. First Thrift agreed to limit its net loan growth, excluding loans held for resale in the secondary markets, to not more than 2.5% in any one calendar quarter, beginning with the quarter that began on October 1, 1992, to enhance certain operating policies and\nprocedures, including its internal asset review practice, and to provide certain reports to the FDIC. In May 1993, the FDIC rescinded in full the Memorandum.\nIn the last half of 1992 and in 1993, the Company took actions to meet the requirements of the Memorandum. The Company has always functioned partially as a balance sheet lender and partially as a mortgage banker, which sells loans to investors and retains servicing. An increased emphasis was placed on mortgage banking activity, continuing a trend already begun in early 1992. In 1992, the Company shifted its new loan originations primarily towards single family mortgages at a time when demand for loans in the secondary market was high. In 1992, the Company sold $373,551,000 of loans to secondary market investors, including $132,974,000 of adjustable rate mortgages which generally met the Company's underwriting and pricing criteria for retention on its balance sheet. In 1993, the Company sold $425,475,000 of loans, including $85,822,000 of ARMs.\nFirst Thrift also took steps to enhance its compliance and loan administration functions, including the annual revision of its policies and procedures, the hiring or reallocation of personnel, and the implementation of a more systematic loan review function.\nPursuant to FDIC regulations, at least 30 days prior to embarking on any special funding arrangement designed to increase assets of an insured institution by more than 7.5% in any consecutive three month period, notice must be given to the FDIC. A special funding arrangement means a specific effort to increase assets through solicitation and acceptance of fully insured deposits from or through brokers or affiliates, outside an institution's normal traffic area, or secured or unsecured borrowings (other than through repurchase agreements). If a thrift is determined to be undercapitalized, other restrictions apply to its asset growth. Previously, the Company has given notice of its intent to increase assets in excess of 7.5% during the following three months. The FDIC has acknowledged these notices without objection. If additional notices are required for subsequent periods, there can be no assurance that future approval from the FDIC will be obtained. Objection by the FDIC could lead to the requirement that the thrifts limit future asset growth.\nIn 1989, the FDIC and the other Federal regulatory agencies adopted final risk-based capital adequacy standards applicable to financial institutions like the thrifts whose deposits are insured by the FDIC and bank holding companies. These guidelines provide a measure of capital adequacy and are intended to reflect the degree of risk associated with both onand off-balance sheet items, including residential loans sold with recourse, legally binding loan commitments and standby letters of credit. Under these regulations, financial institutions are required to maintain capital to support activities which in the past did not require capital. Unlike the Thrifts, at the present time First Republic is not directly regulated by any bank regulatory agency and is not subject to any minimum capital requirements. If First Republic were to become subject to direct federal regulatory oversight, there can be no assurance that First Republic's existing senior subordinated debentures would be considered as Tier 2 capital.\nA financial institution's risk-based capital ratio is calculated by dividing its qualifying capital by its risk-weighted assets. Commencing December 31, 1992, financial institutions generally are expected to meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least 50% of qualifying total capital must be in the form of core capital (Tier 1)-- common stock, noncumulative perpetual preferred stock, minority interests in equity capital accounts of consolidated subsidiaries and allowed mortgage servicing rights less all intangible assets other than allowed mortgage servicing rights. Supplementary capital (Tier 2) consists of the allowance for loan losses up to 1.25% of risk-weighted assets, cumulative preferred stock, term preferred stock, hybrid capital instruments and term subordinated debt. The maximum amount of Tier 2 capital that may be recognized for risk-based capital purposes is limited to 100% of Tier 1 capital (after any deductions for disallowed intangibles). The aggregate amount of term subordinated debt and intermediate term preferred stock that may be treated as Tier 2 capital is limited to 50% of Tier 1 capital. Certain other limitations and restrictions apply as well. At December 31, 1993, the Tier 2 capital of First Thrift consisted of $15,000,000 of capital notes issued to First Republic and its allowance for loan losses.\nThe following table presents First Thrift's regulatory capital position at December, 1993 under the risk-based capital guidelines:\nThe FDIC has adopted a 3% minimum leverage ratio that is intended to supplement risk- based capital requirements and to ensure that all financial institutions, even those that invest predominantly in low risk assets, continue to maintain a minimum level of core capital. The FDIC adopted final regulations, applicable to First Thrift as of April 10, 1991, which provide that a financial institution's minimum leverage ratio is determined by dividing its Tier 1 capital by its quarterly average total assets, less intangibles not includable in Tier 1 capital.\nThe leverage ratio represents a minimum standard affecting the ability of financial institutions, including First Thrift, to increase assets and liabilities without increasing capital proportionately. The following table presents First Thrift's leverage ratio at December 31, 1993:\nSubsequent to the acquisition of First Republic Savings Bank and prior to December 31, 1993, First Republic contributed additional capital, resulting in Tier 1 and total capital of that entity equaling $5.1 million on a total asset base of $5.9 million. At December 31, 1993, the capital ratios of First Republic Savings Bank exceed all requirements.\nUnder FDIC regulations, First Thrift has been required to pay annual insurance premiums of 23 cents per $100 of eligible domestic deposits from July 1, 1991 until December 31, 1992, at which time the premium rate of 23 cents per $100 became a minimum rate. The rate at which the Thrifts will be required to pay insurance premiums to the FDIC for the first six months of 1994 will be the minimum rate. The FDIC has the authority to assess additional premiums to cover losses and expenses associated with insuring deposits maintained at financial institutions. See \"--Federal Deposit Insurance Reform.\"\nIn addition, subject to certain exceptions, under federal law no person, acting directly or indirectly or through or in concert with one or more persons, may acquire control of any insured depository institution such as the Company, unless the FDIC has been given 60 days' prior written notice of the proposed\nacquisition and within that time period the FDIC has not issued a notice disapproving the proposed acquisition, or extended the period of time during which a disapproval may be issued. For purposes of these provisions, \"control\" is defined as the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of an insured depository institution. The purchase, assignment, transfer, pledge, or other disposition of voting stock through which any person will acquire ownership, control, or the power to vote 10% or more of a class of voting securities of the Company would be presumed to be an acquisition of control. An acquiring person may request an opportunity to contest any such presumption of control. No assurance can be given that the FDIC would not disapprove a notice of proposed acquisition as described above.\nThe Competitive Equality Banking Act of 1989 (\"CEBA\") subjects certain previously unregulated companies to regulations as bank holding companies by expanding the definition of the term \"bank\" in the Bank Holding Company Act of 1956. First Republic is, however, exempt from regulation as a bank holding company and will remain so, while the Thrifts continue to fit within one or more exceptions to the term \"bank\" as defined by CEBA. The Thrifts currently have no plans to engage in any operational practice that would cause them to fall outside one or more exceptions to the term \"bank\" as defined by CEBA. The Thrifts may cease to comply with those exceptions if they engage in certain operational practices, including accepting demand deposit accounts. Because of these limitations, the Thrifts currently offer only passbook accounts and term investment certificates or deposits and do not offer checking accounts. CEBA does provide that First Republic and its affiliates will be treated as if First Republic were a bank holding company for the limited purposes of applying certain restrictions on loans to insiders and anti-tying provisions.\nLIMITATIONS ON DIVIDENDS\nUnder California law, a thrift is not permitted to declare dividends on its capital stock unless it has at least $750,000 of unimpaired capital plus additional capital of $50,000 for each branch office maintained. In addition, no distribution of dividends is permitted unless: (i) such distribution would not exceed a thrift's retained earnings, (ii) any payment would not result in a violation of the approved minimum capital to thrift and loan investment certificates ratio and (iii) after giving effect to the distribution, either (y) the sum of a thrift's assets (net of goodwill, capitalized research and development expenses and deferred charges) would be not less than 125% of its liabilities (net of deferred taxes, income and other credits), or (z) current assets would be not less than current liabilities (except that if a thrift's average earnings before taxes for the last two years had been less than average interest expenses, current assets must be not less than 125% of current liabilities).\nIn addition, a thrift is prohibited from paying dividends from that portion of capital which its board of directors has declared restricted for dividend payment purposes. The amount of restricted capital maintained by a thrift provides the basis for establishing the maximum amount that a thrift may lend to one single borrower. Accordingly, a thrift typically restricts as much capital as necessary to achieve its desired loan to one borrower limit, which in turn restricts the funds available for the payment of dividends. Exclusive of any other limitations which may apply, at December 31, 1993, First Thrift could have paid additional dividends aggregating approximately $9,400,000.\nUnder regulations issued by the Nevada Commissioner, a Nevada thrift company may not pay dividends from its capital surplus account. Dividends may only be payable from undivided profits. Once funds have been credited to the capital surplus account, those funds may not be transferred unless (1) such transfer represents payment for the redemption of shares and (2) the Nevada Commissioner has acquiesced to the transfer in writing. Further no dividends may be declared or paid if such would reduce the undivided profits account below 10 percent of the balance in the capital stock account. Dividend payment authority is subject to a thirft being current on payments to holders of debt securities and payments of interest on deposits.\nAs a matter of practice, the FDIC customarily advises insured institutions that the payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory\naction. As a result of this policy, the Thrifts may find it difficult to pay dividends out of retained earnings from historical periods prior to the most recent fiscal year or to take advantage of earnings generated by extraordinary items. Under the Financial Institutions Supervisory Act and FIRREA, federal regulators also have authority to prohibit financial institutions from engaging in business practices which are considered to be unsafe or unsound. It is possible, depending upon the financial condition of the Thrifts and other factors, that such regulators could assert that the payment of dividends in some circumstances might constitute unsafe or unsound practices and prohibit payment of dividends even though technically permissible.\nFederal Deposit Insurance Reform\nAs a consequence of the extensive regulation of commercial banking activities in the United States, the business of the Company is particularly susceptible to being affected by enactment of federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities, or enhancing the competitive position of other financial institutions. In response to various business failures in the savings and loan industry and more recently in the banking industry, in December 1991, Congress enacted and the President signed significant banking legislation entitled the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"). FDICIA substantially revises the bank regulatory and funding provisions of the Federal Deposit Insurance Act and makes revisions to several other federal banking statutes.\nAmong other things, FDICIA provides increased funding for the Bank Insurance Fund (the \"BIF\") of the FDIC, primarily by increasing the authority of the FDIC to borrow from the United States Treasury Department. It also provides for expanded regulation of depository institutions and their affiliates. A significant portion of the borrowings would be repaid by insurance premiums assessed on BIF members, including the Company. In addition, FDICIA generally mandates that the FDIC achieve a ratio of reserves to insured deposits of 1.25% within the next 15 years, also to be financed by insurance premiums. The result of these provisions could be a significant increase in the assessment rate on deposits of BIF members. FDICIA also provides authority for special assessments against insured deposits. No assurance can be given at this time as to what the future level of premiums will be.\nAs required by FDICIA, the FDIC adopted a transitional risk-based assessment system for deposit insurance premiums effective January 1, 1993. Under this system, depository institutions will be charged anywhere from 23 cents to 31 cents for every $100 in insured domestic deposits, based on such institutions' capital levels and supervisory ratings. The FDIC adopted amendments to this assessment system which become effective with the assessment period commencing January 1, 1994 which makes limited changes to the transitional risk-based system. FDICIA prohibits assessment rates from falling below the current annual assessment rate of 23 cents per $100 of eligible deposits if the FDIC has outstanding borrowings from the United States Treasury Department or the 1.25% designated reserve ratio has not been met. The ultimate effect of this risk- based assessment system cannot be determined until the permanent system becomes effective in 1994.\nFDICIA also requires the federal banking agencies to revise their risk-based capital guidelines to take into account interest-rate risk, concentration of credit risk, and the risks associated with nontraditional activities. It also requires the guidelines to reflect the actual performance and expected risk of loss on multifamily mortgages. Effective December 31, 1993, the risk based capital rules were revised to allow certain multifamily loans for BIF members to be included in the 50% risk weighted category instead of the 100% risk weighted category. In order to qualify for this lower category, multifamily loans must meet certain eligibility criteria, including (i) being a first lien; (ii) having a loan-to-value ratio below 75% for adjustable rate mortgages and a debt coverage ratio of at least 1.15 times; (iii) having a minimum original maturity of seven years and a maximum amortization period of 30 years; and (iv) have a history of timely payments for at least one year and not currently be on nonaccrual or past due 90 days or more. The effect on the Company and First Thrift of these new guidelines was to reduce total risk adjusted assets by approximately $65 million at December 31, 1993 and to increase their total capital ratios by approximately 1.06% and 0.89%,\nrespectively. The ultimate effect of the remaining FDICIA risk-based capital provisions cannot be determined until implementing regulations are adopted.\nFDICIA requires the federal banking regulators to take \"prompt corrective action\" with respect to depository institutions that do not meet minimum capital requirements. In response to this requirement, the FDIC adopted final rules based upon FDICIA's five capital tiers. The FDIC's rules provide that an institution is \"well capitalized\" if its risk-based capital ratio is 10% or greater; its Tier 1 risk-based capital ratio is 6% or greater; its leverage ratio is 5% or greater; and the institution is not subject to a capital directive. A depository institution is \"adequately capitalized\" if its risk- based capital ratio is 8% or greater; its Tier 1 risk-based capital ratio is 4% or greater; and its leverage ratio is 4% or greater (3% or greater for the highest rated institutions). An institution is considered \"undercapitalized\" if its risk-based capital ratio is less than 8%; its Tier 1 risk-based capital ratio is less than 4%, or its leverage ratio is 4% or less (less than 3% for the highest rated institutions). An institution is \"significantly undercapitalized\" if its risk-based capital ratio is less than 6%; its Tier 1 risk-based capital ratio is less than 3%; or its leverage ratio is less than 3%. An institution is deemed to be \"critically undercapitalized\" if its ratio of tangible equity (Tier 1 capital) to total assets is equal to or less than 2%. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it engages in unsafe or unsound banking practices. Under this standard, First Thrift and First Republic Savings Bank are \"well capitalized\" at December 31, 1993.\nNo sanctions apply to institutions which are \"well\" or \"adequately\" capitalized under the prompt corrective action requirements. Undercapitalized institutions are required to submit a capital restoration plan for improving capital. In order to be accepted, such plan must include a financial guaranty from each company having control of such under capitalized institution that the institution will comply with the capital plan until the institution has been adequately capitalized on average during each of four consecutive calendar quarters. If such a guarantee were deemed to be a commitment to maintain capital under the Federal Bankruptcy Code, a claim for a subsequent breach of the obligations under such guarantee in a bankruptcy proceeding involving the holding company would be entitled to a priority over third party general unsecured creditors of the holding company. Undercapitalized institutions are prohibited from making capital distributions or paying management fees to controlling persons; may be subject to growth limitations; and acquisitions, branching and entering into new lines of business are restricted. Finally, the institution's regulatory agency has discretion to impose certain of the restrictions generally applicable to significantly undercapitalized institutions.\nIn the event an institution is deemed to be significantly undercapitalized, it may be required to: sell stock; merge or be acquired; restrict transactions with affiliates; restrict interest rates paid; restrict growth; restrict compensation to officers; divest a subsidiary; or dismiss specified directors or officers. If the institution is a bank holding company, it may be prohibited from making any capital distributions without prior approval of the Federal Reserve Board and may be required to divest a subsidiary. A critically undercapitalized institution is generally prohibited from making payments on subordinated debt and may not, without the approval of the FDIC, enter into a material transaction other than in the ordinary course of business; engage in any covered transaction (as defined in Section 23 A (b) of the Federal Reserve Act); or pay excessive compensation or bonuses. Critically undercapitalized institutions are subject to appointment of a receiver or conservator.\nFDICIA also restricts the acceptance of brokered deposits by certain insured depository institutions and contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts.\nFDICIA contains numerous other provisions, including reporting, examination and auditing requirements, termination of the \"too big to fail\" doctrine except in special cases, limitations on the FDIC's payment of deposits at foreign branches, and revised regulatory standards for, among other things, real estate lending and capital adequacy.\nImplementation of the various provisions of FDICIA are subject to the adoption of regulations by the various banking agencies or to certain phase-in periods. The FDIC is the federal banking agency which\nregulates the Thrifts. The effect of FDICIA on the Company cannot be determined until complete implementing regulations are adopted.\nFDICIA also contains provisions which: (i) require that a receiver or conservator be appointed immediately for an institution whose tangible capital falls below certain levels; (ii) increase assessments for deposit insurance premiums; (iii) require the FDIC to establish a risk- based assessment system for insurance premiums; (iv) require federal banking agencies to revise their risk-based capital guidelines to take into account interest rate risk, concentration of credit risk and the risk associated with non-traditional activities; (v) give the FDIC the right to examine bank affiliates such as First Republic and make assessments for the cost of such examination; and (vi) limit the availability of brokered deposits. The effectiveness of this statute is subject to adoption of implementing regulations which are being issued on a timely basis as required by FDICIA.\nEMPLOYEES\nAs of December 31, 1993, the Company had 148 full-time employees. Management believes that its relations with employees are satisfactory. The Company is not a party to any collective bargaining agreement.\nSTATISTICAL DISCLOSURE REGARDING THE BUSINESS OF THE COMPANY\nThe following statistical data relating to the Company's operations should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes to Consolidated Financial Statements. Average balances are determined on a daily basis.\nDISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND DIFFERENTIALS\nThe following table presents for the periods indicated the distribution of consolidated average assets, liabilities and stockholders' equity as well as the total dollar amounts of interest income from average interest-earning assets and the resultant yields, and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and in rates. Nonaccrual loans are included in the calculation of the average balances of loans and interest not accrued is excluded. Beginning with the purchase of tax exempt securities in 1989, the yield on short-term investments has been adjusted upward to reflect the effects of certain income thereon which is exempt from federal income tax, assuming an effective rate of 34% prior to 1993 and 35% for 1993.\n- -------- (1) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (2) Net interest margin is computed by dividing net interest income by total average earning assets.\nRate and Volume Variances\nNet interest income is affected by changes in volume and changes in rates. Volume changes are caused by differences in the level of interest-earning assets and interest-bearing liabilities. Rate changes result from differences in yields earned on assets and rates paid on liabilities.\nThe following table sets forth, for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates. Where significant, the changes in interest due to both volume and rate have been allocated to the changes due to volume and rate in proportion to the relationship of absolute dollar amounts in each. Tax-exempt income from short- term investments is presented on a tax-equivalent basis.\nTypes of Loans\nThe following table sets forth by category the total loan portfolio of the Company at the dates indicated:\nThe following table shows the maturity distribution of the Company's real estate construction loans and commercial business loans outstanding as of December 31, 1993, which, based on remaining scheduled repayments of principal, were due within the periods indicated. All such loans are adjustable rate in nature.\nASSET QUALITY\nThe Company places an asset on nonaccrual status when one of the following events occurs: any installment of principal or interest is over 90 days past due (except for single family loans which are well secured and in the process of collection), management determines the ultimate collection of principal or interest to be unlikely, management deems a loan to be an in- substance foreclosure, or the Company takes possession of the collateral. Real estate collateral obtained by the Company or deemed to be foreclosed in substance is collectively referred to as \"REO.\"\nSince the inception of operations in 1985 through December 31, 1993, the Company has originated approximately $3.6 billion of loans both for sale and retention in its loan portfolio, on which the Company has experienced $14.6 million of losses, primarily as a result of the economic recession which has affected the California economy commencing in late 1990 and continue in parts of the state through 1993. Currently management of the Company believes that the adverse effects of the recession are substantially diminished in the San Francisco Bay Area, while the effects of the recession are more severe on the Company's loans in the Los Angeles area. The Company's loss experience since inception represents an aggregate total of 0.40% of loans originated in over eight years. The Company has experienced a higher level of chargeoffs during 1991, 1992 and 1993 in connection with the resolution of delinquent loans and sale of REO than in prior years. The ratio of the Company's net loan chargeoffs to average loans was 0.30% for 1991, 0.74% for 1992 and 0.44% for 1993. The Company recorded REO costs and losses related to the disposition of delinquent loans totaling $3,477,000 in 1993; such costs increased from $309,000 in 1992 and $330,000 in 1991 because substantially all of these costs were reflected as chargeoffs against the Company's loss reserves prior to 1993.\nThe Company's general policy is to attempt to resolve problem assets quickly and to sell such problem assets when acquired as rapidly as possible at prices available in the prevailing market. The following table presents nonaccruing loans and investments, REO, restructured performing loans and accruing single family loans more than 90 days past due at the dates indicated.\nIn February 1993, the Company restructured the terms of a $6,258,000 first trust deed loan secured by a 208 unit multifamily complex in Los Angeles. This loan was made by the Company in connection with the REO sale of the property by the Company to the borrower in March 1992 for $7,000,000. In order to facilitate the stabilization of the occupancy level at monthly rents appropriate for long-term tenants, the Company agreed to reduce the interest rate on its adjustable rate loan for a two year period. At December 31, 1993, there were no other loans that constituted troubled debt restructurings as defined in Statement of Financial Accounting Standards No. 15. The Company resolves problem assets by restructuring a loan when it determines the benefits of such a workout exeed the value of any concessions granted, it believes the borrower is committed to the terms of the new loan and it believes a successful outcome is likely.\nThe following table provides certain information with respect to the Company's reserve position and provisions for losses as well as chargeoff and recovery activity.\nAll chargeoff and recovery transactions during 1989 in the table above resulted only from loans acquired in a transaction occurring in 1985.\nThe Company's reserve for possible losses is maintained at a level estimated by management to be adequate to provide for losses that can be reasonably anticipated based upon specific conditions as determined by management, historical loan loss experience, the results of the Company's ongoing loan grading process, the amount of past due and nonperforming loans, observations of auditors, legal requirements, recommendations or requirements of regulatory authorities, prevailing economic conditions and other factors. These factors are essentially judgmental and may not be reduced to a mathematical formula. As a percentage of nonaccruing loans, the reserve for possible losses was 109% at December 31, 1993 and 133% at December 31, 1992. While this ratio declined, management considers the $12,657,000 reserve at December 31, 1993 to be adequate as an allowance against foreseeable losses in the loan portfolio. Management's continuing evaluation of the loan portfolio and assessment of economic conditions will dictate future reserve levels.\nThe adequacy of the Company's total reserves is reviewed quarterly. Management closely monitors all past due loans in assessing the adequacy of its total reserves. In addition, the Company has instituted procedures for reviewing and grading all of the larger income property loans in its portfolio on at least an annual basis. Based upon that continuing review and grading process, among other factors, the Company will determine appropriate levels of total reserves in response to its assessment of the potential risk of loss inherent in its loan portfolio. Management currently anticipates that it will continue to provide additional recession reserves so long as, in its judgement, the effects of the recessionary conditions on its assets continue. When management determines that the effects of the recessionary conditions have diminished, management currently anticipates that it would reduce or eliminate such future provisions to the recession reserve, although the Company may continue to maintain total reserves at a level higher than existed prior to this recession. Management does not intend to increase earnings in future periods by reversing amounts in the recession reserve.\nThe following table sets forth management's historical allocation of the reserve for possible losses by loan category and the percentage of loans in each category to total loans at the dates indicated:\nAt December 31, 1993, management had allocated from its recession reserve $2,600,000 to the multifamily loan category and $1,300,000 to the commercial real estate loan category, based upon management's estimate of the risk of loss inherent in its nonaccruing or other possible problem loans in those categories. The allocation of such reserve will change whenever management determines that the risk characteristics of its assets or specific assets have changed. The amount available for future chargeoffs that might occur within a particular category is not limited to the amount allocated to that category, since the allowance is a general reserve available for all loans in the Company's portfolio. In addition, the amounts so allocated by category may not be indicative of future chargeoff trends.\nEvent Subsequent to December 31, 1993\nOn January 17, 1994, the greater Los Angeles area experienced an earthquake which caused significant damage to the freeway system and real estate throughout the area. Some of the Company's borrowers were adversely affected by this event, with direct property damage or loss of tenants, or are expected to be affected in the future as a result of lower rental revenues or further economic difficulties. First Republic is currently working with those borrowers who have been identified to assist them with obtaining available disaster relief funding or to assist them by modifying the terms of loans. Such loan modifications may defer the timing of payments, reduce the rate of interest collected or possibly lower the principal balance. As of March 18, 1994, approximately $35 million of the Company's loans, secured primarily by larger multifamily properties, appeared to be adversely impacted by the earthquake. Based upon the Company's best estimate as of such\ndate of damage or related economic impact to borrowers and their properties, a special loan valuation reserve of $4,000,000 will be provided in the quarter ended March 31, 1994. Because of this earthquake, management of the Company expects the level of loan delinquencies and REO to increase during 1994 as problems related to this natural disaster are addressed and resolved.\nFINANCIAL RATIOS\nThe following table shows certain key financial ratios for the Company for the periods indicated.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFirst Republic does not own any real property. In 1990, First Republic entered into a 10-year lease, with three 5-year options to extend, for headquarters space at 388 Market Street, mezzanine floor, in the San Francisco financial district. Management believes that the Company's current and planned facilities are adequate for its current level of operations.\nFirst Republic's subsidiaries lease offices at the following locations, with terms expiring at dates ranging from April 1994 to December 2002:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere is no pending proceeding, other than ordinary routine litigation incidental to the Company's business, to which the Company is a party or to which any of its property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThis information is incorporated by reference to page 44 of the Company's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThis information is incorporated by reference to the inside front cover of the Company's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis information is incorporated by reference to pages 34 through 41 of the Company's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThis information is incorporated by reference to pages 20 through 33 and to page 44 of the Company's Annual Report to Stockholders for the year ended December 31, 1993.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThere have been no changes in or disagreements with Accountants during the Company's two most recent fiscal years.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe following table sets forth the directors and executive officers of First Republic and certain pertinent information about them.\n- -------- (1) Member of the Executive Committee.\n(2) Member of the Compensation Committee.\n(3) Member of the Audit Committee.\nThe directors of First Republic serve three-year terms. The terms are staggered to provide for the election of approximately one-third of the Board members each year. Each director (except Mr. Cox-Johnson who was elected in October 1986 and Ms. August who was elected in April 1988) has served in such capacity since the inception of First Republic. Messrs. Walther and Herbert have served as officers of First Republic since its inception. Ms. August has served as an officer since July 1985 and as a director since April of 1988, while Ms. Moulds has served as an officer since June 1985. Mr. Newton became an officer of First Republic in August 1988 and Ms. Coulston became an officer in 1990.\nThe backgrounds of the directors and executive officers of First Republic are as follows:\nRoger O. Walther is Chairman of the Board of Directors and a director of First Republic serving until 1994. Mr. Walther is Chairman and Chief Executive Officer of ELS Educational Services, Inc., the largest teacher of English as a second language in the United States. He is a director of Charles Schwab & Co., Inc. From 1980 to 1984, Mr. Walther served as Chairman of the Board of San Francisco Bancorp. He is a graduate of the United States Coast Guard Academy, B.S. 1958, and the Wharton School, University of Pennsylvania, M.B.A. 1961 and is a member of the Graduate Executive Board of the Wharton School.\nJames H. Herbert, II is President, Chief Executive Officer and a director of First Republic, serving until 1994, and has held such positions since First Republic's inception in 1985. From 1980 to July 1985, Mr. Herbert was President, Chief Executive Officer and a director of San Francisco Bancorp, as well as Chairman of the Board of its operating subsidiaries in California, Utah and Nevada. He is a past president of, a director of and a Legislative Committee member of the California Association of Thrift and Loan Companies and is on the California Commissioner of Corporations' Industrial Loan Law Advisory Committee. He is a graduate of Babson College, B.S., 1966, and New York University, M.B.A., 1969.\nKatherine August is Executive Vice President and a director of First Republic serving until 1995. She joined the Company in June 1985 as Vice President and Chief Financial Officer. From 1982 to 1985, she was Senior Vice President and Chief Financial Officer at PMI Mortgage Insurance Co., a subsidiary of Sears\/Allstate. She is a graduate of Goucher College, A.B., 1969, and Stanford University, M.B.A., 1975.\nWillis H. Newton, Jr. has been Senior Vice President and Chief Financial Officer of First Republic since August 1988. From 1985 to August 1988, he was Vice President and Controller of Homestead Financial Corporation. He is a graduate of Dartmouth College, B.A., 1971 and Stanford University, M.B.A., 1976. Mr. Newton is a Certified Public Accountant.\nLinda G. Moulds is Vice President, Secretary and Controller of First Republic, serving with the Company since inception. From 1980 to July 1985, Ms. Moulds was Secretary and Controller of San Francisco Bancorp and a director of First United. She is a graduate of Temple University B.S., 1971.\nChristina L. Coulston has been Vice President, Loan Administration at First Republic since July 1989. From 1985 to June 1989, she was in charge of the loan servicing function for Atlantic Financial Savings. She is a graduate of Oregon State University B.S., 1969.\nEdward J. Dobranski joined the company in August 1992 as Corporate Counsel and was appointed a Vice President in 1993. He also serves as the Company's Compliance Officer and Community Reinvestment Officer. From 1990 to 1992, Mr. Dobranski was Of Counsel at Jackson Cole & Black in San Francisco, specializing in banking, real estate and corporate law, and from 1987 to 1990 he was a partner in the San Francisco office of Rose Wachtell & Gilbert. Mr. Dobranski is a graduate of Coe College--Iowa, B.A. 1972 and Creighton University-- Nebraska, J.D. 1975.\nDavid B. Lichtman was appointed Vice President, Credit Administration, in January 1994. Mr. Lichtman served as a loan processor with First Thrift from 1986 to 1990, as a loan officer with First Republic Mortgage Inc. from 1990 through 1991, and as a credit officer with First Thrift from 1992 through December 1993. Mr. Lichtman is a graduate of Vassar College, B.A. 1985 and the University of California, Berkeley, M.B.A. 1990.\nRichard M. Cox-Johnson is a director of First Republic serving until 1996. Mr. Cox-Johnson is a director of Premier Consolidated Oilfields PLC and Marine and General Mutual Life Assurance Society. He is a graduate of Oxford University 1955.\nKenneth W. Dougherty is a director of First Republic serving until 1996. He was President of Gill & Duffus International Inc. from November 1981 to May 1984, and was an executive of Farr Man & Co., Inc. prior to that, serving as President of that corporation from 1978 to 1981. Both Gill & Duffus and Farr Man & Co. are international commodity trading companies. He was a director of San Francisco Bancorp from 1982 to 1984. Mr. Dougherty is a graduate of the University of Pennsylvania, B.A. 1948.\nFrank J. Fahrenkopf, Jr., is a director of First Republic serving until 1996. Since 1985, Mr. Fahrenkopf has been a partner in the Washington, D.C. law firm of Hogan & Hartson. From January 1983 until January 1989, he was Chairman of the Republican National Committee. Mr. Fahrenkopf is a graduate of the University of Nevada-Reno, B.A. 1962, and the University of California- Berkeley, L.L.B. 1965.\nL. Martin Gibbs is a director of First Republic serving until 1995. Mr. Gibbs has been a partner with the law firm of Rogers & Wells, counsel to the Company, since November 1987. For the five years prior to\njoining Rogers & Wells, Mr. Gibbs was the President and sole stockholder of a professional corporation which was a partner in the law firm of Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey (\"Finley Kumble\"). Finley Kumble rendered legal services to the Company from 1985 to 1987. He is a graduate of Brown University, B.A. 1959 and Columbia University, J.D. 1962.\nJames F. Joy is a director of First Republic serving until 1994. Mr. Joy is Director--European Business Development--CVC Capital Partners-Europe, and a non-executive director of Sylvania Lighting International. Formerly, he was Chairman of Real Estate Research Corporation, President of Stanger Joy Associates, financial consultants, and Vice-President--Corporate Finance at Thomson McKinnon Securities, Inc. In May 1989, Mr. Joy filed a petition under Chapter 11 of the U.S. Bankruptcy Code and in 1990, on consent of all parties, the court dismissed the case. He is a graduate of Trinity College, B.S. 1959, B.S.E.E. 1960 and New York University, M.B.A. 1964.\nJohn F. Mangan is a director of First Republic serving until 1995. Mr. Mangan is an investor and was previously President of Prudential-Bache Capital Partners, Inc. (a wholly owned subsidiary of Prudential-Bache Securities, Inc.). Prior to that, he was the managing general partner of Rose Investment Company, a venture capital partnership. Mr. Mangan was a member of the New York Stock Exchange for over 13 years and was previously vice president and a partner of Pershing & Co., Inc. He has been a director of Noel Group, Inc., New York, N.Y., and the Hutton-Deutsch Collection Ltd., London. Mr. Mangan is a graduate of the University of Pennsylvania, B.A. 1959.\nBarrant V. Merrill is a director of First Republic serving until 1994. Mr. Merrill has been Managing Partner of Sun Valley Partners, a private investment company, since July 1982. From 1984 until January 1989, he was a general partner of Dakota Partners, a private investment partnership. From 1980 to 1984, Mr. Merrill was a director of San Francisco Bancorp. From 1978 until 1982, he was Chairman of Pershing & Co. Inc., a division of Donaldson, Lufkin & Jenrette. Mr. Merrill is a graduate of Cornell University, B.A. 1953.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information is incorporated by reference to the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is incorporated by reference to the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information is incorporated by reference to the Company's definitive proxy statement under the caption \"Executive Compensation\" to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 10-K\n(a) Financial Statements and Schedules.\nThe following financial statements are contained in registrant's 1993 Annual Report to Stockholders and are incorporated in this Report on Form 10-K by this reference:\nAll schedules are omitted as not applicable.\n(b) Reports on Form 8-K.\nThe Company filed a report dated October 20, 1993 on Form 8-K reporting the Company's earnings for the quarter and nine months ended September 30, 1993.\nThe Company filed a report dated February 7, 1994 on Form 8-K reporting the Company's earnings for the quarter and year ended December 31, 1993, and the declaration of a 3% stock dividend to stockholders of record on February 18, 1994.\nThe Company filed a report dated March 18, 1994 on Form 8-K reporting the impact on the Company's earnings from the January 17, 1994 earthquake in the Los Angeles, California area.\n(c) Exhibits.\nNOTE: Exhibits marked with a plus sign (+) are incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 33-4608); Exhibits marked with two plus signs (++) are incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1987; Exhibits marked with three plus signs (+++) are incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 33-18963); Exhibits marked with a diamond (q) are incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1988; Exhibits marked with two diamonds (qq) are incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1989; Exhibits marked with three diamonds (qqq) are incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1990; Exhibits marked with two asterisks (**) are incorporated by reference to Registrant's Registration Statement on Form S-2 (No. 33-40182); Exhibits marked with three asterisks (***) are incorporated by reference to Registrant's Registration Statement on Form S-2 (No. 33-42426); Exhibits marked with one pound sign (#) are incorporated by reference to Registrant's Registration Statement on Form S-2 (No. 33-43858); Exhibits marked with two pound signs (##) are incorporated by reference to the Registrant's Registration Statement on Form S-2 (No. 33- 45435). Exhibits marked with three pound signs (###) are incorporated by reference to the Registrant's Registration Statement on Form S- 2 (No. 33-54136). Exhibits marked with four pound signs (####) are incorporated by reference to Registrant's Form 10-K for the year ended December 31, 1992. Exhibits marked with one dagger (-) are incorporated by reference to the Registrant's Registration Statement on Form S-3 (No. 33-60958). Exhibits marked with two daggers (--) are incorporated by reference to the Registrant's Registration Statement on Form S-3 (No. 33-66336). Each such Exhibit had the number in parentheses immediately following the description of the Exhibit herein.\nSIGNATURES\nPURSUANT 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.\nFirst Republic Bancorp Inc.\n\/s\/ Willis H. Newton, Jr. By:__________________________________ Willis H. Newton, Jr. Senior Vice President and Chief Financial Officer\nMarch 30, 1994\nPURSUANT 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 AND ON THE DATES INDICATED.\nFIRST REPUBLIC BANCORP INC. 1993 ANNUAL REPORT EDGAR VERSION\nDESCRIPTION OF PHOTOS AND GRAPHS\nCOVER PAGE: Photos are presented of landmarks in the Company's four geographical operating markets -San Francisco, San Diego and Los Angeles, California and Las Vegas, Nevada.\nINSIDE FRONT COVER: Three graphs are presented as follows, left to right: 1) Net income for the last five years in millions of dollars, as included in the table above. 2) Total assets in millions of dollars as presented in the table above. 3) Total capital in millions of dollars for the past five years, which was $52 million at the end of 1989, $62 million at the end of 1990, $104 million at the end of 1991, $160 million at the end of 1992 and $179 million at the end of 1993.\nPAGE 2: A bar chart is presented, representing the tangible book value per share of the Company's common stock for the past five years, which was $7.11 at the end of 1989, $7.71 at the end of 1990, $9.59 at the end of 1991, $11.94 at the end of 1992 and $13.58 at the end of 1993. This chart represents a plus 16% per annum rate of growth for the past five years.\nPAGE 3: A photo is presented of the Company's President and Chief Executive Officer and the Company's Chairman of the Board of Directors.\nPAGE 5: A bar chart is presented, representing the Company's return on equity as a percent of average equity for the past five years, which was 4.7% for 1989, 12.8% for 1990, 17.2% for 1991, 14.1% for 1992 and 12.7% for 1993.\nPAGE 6: A bar chart is presented, representing the Company's risk adjusted capital ratios in comparison with the minimum required amount. First Republic is shown as having 17.6% total risk adjusted capital, compared to 8.0% required.\nPAGE 7: A photo is presented, representing a street scene in the Chinatown District of San Francisco, California, where the Company maintains a branch, plus a smaller picture of a depositor, Dr. Godwin S. Wong, who was quoted on page 6 and materials used in the retail deposit gathering function of the Company.\nFirst Republic Bancorp Inc. 1993 Annual Report Edgar Version PAGE 8 AND CARRY OVER TO PAGE 9: A photo appears here of the Company's Vice President of Savings and some of her customers. Additionally, small photos of the three of the Company's branch locations are included.\nPAGE 10: A bar chart appears, representing loans originated in dollars (millions) for the last five years, which were $324 million in 1989, $341 million in 1990, $445 million in 1991, $826 million in 1992 and $945 million 1993.\nPAGE 11: A photo appears, representing one of the Company's mortgage loan borrowers, Mr. Barry Bonds of the San Francisco Giants baseball team, who was quoted on page 10. Mr. Bonds appears in his home. Additionally, there is a smaller photo of Mr. Bonds on a baseball card and a mortgage loan advertisement for the Company.\nPAGE 12: A bar chart appears here, representing the Company's loan service for others in dollars (million) at the end of the last five years, which was $426 million at the end of 1989, $797 million at the end of 1990, $795 million at the end of 1991, $782 million at the end of 1992 and $814 million at the end of 1993.\nPAGE 13: Photo appears on page 13 with carryover to page 12. One of the Company's borrowers, Mr. Lenore Conroy, is pictured in front of her home with the family dog. Additionally, small photos appear of her husband and author, Mr. Pat Conroy, and the cover of his novel, The Prince of Tides.\nPAGE 14: A pie chart appears, representing the composition of the Company's loan portfolio at December 31, 1993, which was 48% secured by single family residences, 31% secured by multifamily properties, 18% secured by commercial real estate properties and 3% related to other types of loans.\nPAGE 15: A photo appears of a single family residential housing tract under construction, along with a smaller photo of a family of one of the Company's borrowers who is quoted on page 14. Additionally, there is a photo representing an advertisement by Federal National Mortgage Association.\nFirst Republic Bancorp Inc. 1993 Annual Report Edgar Version PAGE 16: A photo appears here and carries over to page 17, depicting one of the Company's borrowers in front of his low to moderate income apartment building with several of his tenants. Additionally, smaller photos are presented of the property and the First Republic Thrift & Loan Fair Lending Statement.\nPAGE 17: A pie chart appears, representing the Company's residential loan profile by housing units. 63% of the Company's loans are located in low to moderate income census tracts, as measured by housing units, while 37% of the Company's loans are located in all other census tracts.\nPAGE 18: A bar chart appears, which represents the total loans in dollars (millions) at the end of the last five years, which was $409 million at the end of 1989, $601 million at the end of 1990, $872 million at the end of 1991, $1.068 billion at the end of 1992 and $1.256 billion at the end of 1993.\nPAGE 19: A photo appears here of a historic landmark building in San Francisco called The Flood Building. This property was renovated with the assistance of First Republic. Also included are small photos representing newspaper articles on the renovation and the owner-developer, Mr. James C. Flood, at the ribbon cutting ceremony with the mayor of San Francisco, Mr. Frank Jordan.\nPAGE 42: A photo appears here depicting the Company's Board of Directors as described in the caption below the photo, in front of a single family home in the process of construction by one of the Company's borrowers.\nPAGE 44: Three bar charts are presented, representing the following: 1. The left chart represents average assets per employee in dollars (millions) for the last five years, which were $6.0 million for 1989, $7.1 million for 1990, $8.3 million for 1991, $9.6 million for 1992 and $9.8 million for 1993. 2. The middle chart represents net income earned per employee in dollars (thousands), which was $15,000 for 1989, $44,000 for 1990, $79,000 for 1991, $101,000 for 1992, and $94,000 for 1993.\nFirst Republic Bancorp Inc. 1993 Annual Report Edgar Version 3. The right-hand chart represents the Company's trend in general and administrative expenses as a percent of average assets, which was 1.67% in 1989, 1.49% in 1990, 1.44% in 1991, 1.30% in 1992 and 1.33% in 1993.","section_15":""}
{"filename":"59229_1993.txt","cik":"59229","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Registrant, The Liberty Corporation (\"the Company\") is a holding company engaged through its subsidiaries primarily in the insurance and broadcasting businesses. The Company's primary insurance subsidiaries are Liberty Life Insurance Company (\"Liberty Life\"), Pierce National Life Insurance Company (\"Pierce National\") and, as of late February 1994, North American National Corporation (\"North American\") and American Funeral Assurance Company (\"American Funeral\"). North American's insurance subsidiaries are Pan Western Life Insurance Company, Brookings International Life Insurance Company and Howard Life Insurance Company. Together, these insurance subsidiaries offer a diverse portfolio of individual life and health insurance products. In 1991, the Company organized Liberty Insurance Services Corporation (\"Liberty Insurance Services\") to provide home office support services for unaffiliated life and health insurance companies, as well as for the Company's insurance subsidiaries. Other subsidiaries of the Company provide investment advisory services to the Company's insurance subsidiaries and unaffiliated insurance companies, and property development and management services to the Company. The Company's broadcasting subsidiary, Cosmos Broadcasting Corporation (\"Cosmos\"), currently owns and operates seven network affiliated television stations, six of which were ranked No. 1 in their markets in the November 1993 Nielsen ratings for sign-on to sign-off.\nSTRATEGY; RECENT DEVELOPMENTS\nThe Company's principal strategy is to grow internally and through insurance acquisitions, while maintaining its emphasis on cost controls. Management believes that the continuing consolidation in the life insurance industry presents attractive opportunities for the Company to acquire insurance companies and blocks of business that complement or fit with the Company's existing marketing divisions and product lines. As summarized in the table on the following page, the Company completed two such acquisitions in 1991, two acquisitions in 1992, one acquisition in 1993 and two acquisitions thus far in 1994, in addition to one pending acquisition which is subject to shareholder approval and other conditions.\nThe Company's acquisition strategy has focused on both the home service and pre-need businesses. Home service business represents the Company's primary core business, whereas the pre-need business is a relatively new line of business for the Company. The Company largely entered the pre-need business with the acquisition of Pierce National in July 1992. Pierce National is a major provider of pre-need life insurance, a product which pre-funds funeral services. The Company believes that the pre-need business has favorable demographics which can provide attractive future premium and earnings growth.\nRecent and Pending Insurance Acquisitions\n(1) Represents amount of annualized premiums acquired at the time of acquisition. (2) Net of annual premiums associated with western portion of Kentucky Central block of business, which the Company sold in December 1991. (3) Represents amount of annual premiums reported by the selling company in its 1992 annual financial statements filed under applicable statutory requirements. See \"Additional Information Regarding Recent and Pending Acquisitions\" for information regarding the relative profitability and other factors affecting the value of these annual premiums.\nADDITIONAL INFORMATION REGARDING RECENT AND PENDING ACQUISITIONS. The Company's very recent acquisitions of North American National Corporation and American Funeral Assurance Company in addition to its 1993 acquisition of the business of Estate Assurance Company, expand significantly the Company's pre-need life insurance business that is presently conducted primarily through Pierce National. The Company believes that its combined pre-need operation is the second largest distributor of pre-need insurance in the U.S. The Company is in the process of studying marketing territories and product lines of Pierce National and the recent pre-need acquisitions with the objective of developing an optimal strategy to grow its pre-need business. While no final plans are formalized, it is anticipated that there will be a realignment of territories and product lines and consolidation of corporate entities.\nNORTH AMERICAN. North American was acquired by the Company on February 23, 1994. A wholly owned subsidiary of the Company merged into North American, and the shareholders of North American received $14.75 in cash for each outstanding share of North American, which resulted in approximately $51.9 million in cash being paid by the Company in this transaction. Prior to its acquisition by the Company, North American was a publicly held holding company with three principal insurance subsidiaries --- Pan-Western Life Insurance Company (\"Pan-Western\"), Brookings International Life Insurance Company (\"Brookings\") and Howard Life Insurance Company (\"Howard Life\"). North American, through its subsidiaries, provides several types of individual insurance, the most significant of which are ordinary life insurance and accident and health insurance. Pan-Western is licensed to transact most types of insurance customarily written by life insurers, but principally writes ordinary whole life insurance. Insurance providing funding for pre-arranged funeral contracts and pre-funded funeral benefits presently constitutes 21% of the total insurance in force of Pan-Western and, in fiscal year 1993, contributed approximately 71% of its premium revenues. Pan-Western actively writes insurance in Illinois, Indiana, Iowa, Maryland, Ohio and Pennsylvania, and is licensed in twelve additional states. However, Ohio accounted for approximately 50% of Pan-Western's premium volume (gross) during 1993. Pan-Western has under contract approximately 500 independent agents, who may represent more than one insurer. Brookings, a wholly-owned subsidiary of Pan-Western, is licensed to transact all types of insurance normally written by life insurers, but a significant, although decreasing, amount of Brookings' insurance in force consists of Student Modified Life Insurance Policies written on the lives of students, which are modified whole-life policies providing for lower premium rates until the insured obtains a specific age and providing for normal whole-life rates thereafter. In addition to student life insurance, Brookings writes ordinary whole life insurance on the lives of adults and other term life insurance and accident and health insurance. Brookings also markets in Nebraska, North Dakota and South Dakota certain ordinary whole life insurance products that provide pre-funded funeral benefits and funding for pre-arranged funeral contracts. Such policies presently constitute 19% of the total insurance in force of Brookings and, in fiscal year 1993, constituted approximately 85% of its premium revenues. Brookings is licensed to transact insurance in 12 states, although most insurance written by Brookings is produced in South Dakota, the state of its domicile. Brookings is affiliated with approximately 100 independent agents and brokers who may represent more than one insurer. Howard Life is a Colorado life insurer that was acquired by Pan-Western in February 1993. Howard Life, which primarily writes pre-need life insurance, is licensed to transact insurance in 21 states. Howard Life is in the process of being consolidated with one of the Company's other pre-need insurance subsidiaries.\nAMERICAN FUNERAL. On February 24, 1994, the Company acquired American Funeral Assurance Company (\"American\") in a transaction in which a newly created, wholly owned subsidiary of the Company merged into American. The merger consideration was paid with a combination of cash and Preferred Stock 1994-B Series of the Company, having an aggregate value of approximately $28.1 million. American will further expand the Company's pre-need life insurance business. American Funeral is headquartered in Amory, Mississippi, and offers a portfolio of whole life, term, limited pay life, single premium and industrial life insurance plans, primarily to provide funding for funeral expenses. American also writes a small amount of accident and health insurance. In the past three years, American has increased its focus on writing ordinary life insurance and has reduced the amount of industrial life insurance written. During the three year period prior to 1993, American experienced significant increases in the sale of single premium, three and five year excess interest and annuity products used to fund the expenses of specific pre-arranged funerals, in contrast to insurance which is available to apply against expenses of funerals that are not pre-arranged. American is licensed in 26 states, but approximately 71% of premiums written in 1993 were derived from Mississippi, Illinois, Indiana, Kentucky and Tennessee. American markets its insurance products through a field force of approximately 2,700 agents, who work for or in connection with approximately 2,250\nfuneral homes.\nSTATE NATIONAL. On June 24, 1993, the Company announced the execution of a letter of intent to acquire State National Capital Corporation and its subsidiaries (\"State National\") in a transaction in which State National will be merged into the Company. On February 25, 1994, the Company signed a merger agreement with State National which provided a merger consideration consisting of a combination of cash, Preferred Stock 1994-A Series of the Company and Common Stock of the Company, having an aggregate value of approximately $27.5 million. The State National transaction is subject to approval by the shareholders of State National, regulatory approval and certain other conditions. State National will further expand the Company's home service business in Louisiana and will complement the similar business being conducted by the Company through Magnolia Life, which was acquired in October 1992. State National is the parent company of State National Life Insurance Company (\"State National Life\"), Delta National Life Insurance Company, State National Title Guaranty Company, State National Fire Insurance Company, State National Mortgage Company and several small subsidiaries. State National's principal insurance subsidiary is State National Life. State National Life' business is concentrated primarily in the industrial and ordinary life markets -- primarily home service insurance which is sold by agents who periodically visit the homes and businesses of policyholders to collect premiums on a monthly basis. Individual life insurance comprised 78% of State National Life's total premium income in 1993. Individual annuities, group life and accident and health insurance premiums accounted for the remainder of its premium income. State National Life had $409,286,169 of life insurance in force net of reinsurance at December 31, 1993. State National Life is licensed in Louisiana and Mississippi, but derived 100% of its premium income in 1993 from Louisiana.\nSTRATEGY FOR COST SAVINGS AND GROWTH. The Company's strategy is to realize cost savings as result of (i) the economies of scale inherent in increased volumes, (ii) productivity increases through continued implementation of appropriate technology, and (iii) continued consolidation and streamlining of the administrative functions for both existing operations and acquired businesses. There can be no assurance that significant cost savings will be achieved.\nKey elements of the Company's strategy for internal growth include (i) coinsuring its General Agency universal life business and redeploying the related capital to higher margin lines, in particular, the home service business that accounts for a predominant portion of the Company's business, (ii) applying the Company's expertise in marketing to the pre-need life insurance market, (iii) utilizing the Company's expertise in home office support and its related investments in technology by offering a full range of home office support services to unaffiliated life and health insurance companies through Liberty Insurance Services, and (iv) using the continued cash flow from Cosmos to support the growth of the Insurance Group. See \"Business - Insurance Operations -- Liberty Insurance Services.\"\nAlthough the Company believes that the insurance segment currently provides more attractive opportunities for acquisitions and achievement of economies of scale, the Company remains committed to its broadcasting business.\nINSURANCE OPERATIONS\nLIBERTY LIFE. Liberty Life is a stock life insurance company engaged in the business of writing a broad range of individual life insurance policies and accident and health insurance policies. Liberty Life is ranked 112th, based on ordinary life insurance in force among approximately 1,100 United States life insurance companies, according to the rankings provided by A.M. Best Company in their \"Best's Insurance Management Reports\" (Release No. 25, June 21, 1993). Although Liberty Life is licensed in forty-nine states, and the District of Columbia, its focus has been the Southeast and Midwest. It derived the largest percentages of its premium income in 1993 from South Carolina (31%), North Carolina (22%), Louisiana (6%) and Ohio (4%). The Company believes that Liberty Life is the largest provider of home service business in the Carolinas. In October 1992, the Company acquired Magnolia Life, headquartered in Lake Charles, Louisiana, which expanded the Company's home service business by generating additional premiums and extending the territory. Because the acquisition of Magnolia Life was not considered significant for financial reporting purposes and because the integration of the business of Magnolia Life into Liberty Life is almost completed, the operations and business of Magnolia Life are not discussed separately but have been integrated into the discussion of Liberty Life.\nLife insurance and annuity premiums contributed 79% of Liberty Life's total premiums\nin 1993, 78% in 1992 and 79% in 1991; accident and health insurance premiums contributed the remainder.\nLiberty Life markets its insurance products through three divisions, Home Service, Mortgage Protection and General Agency Marketing, each of which represents a different distribution channel.\nHOME SERVICE DIVISION. The Home Service Division is Liberty Life's largest division, contributing 69% of Liberty Life's premiums in 1993. Home Service agents of Liberty Life sell primarily individual life, including universal life and interest-sensitive whole life products, as well as health insurance. As of December 1993 the Company had approximately 1,605 agents and managers in this division, which is almost double the number in 1986, operating out of 62 district offices. These agents periodically visit the insureds' homes and businesses to collect premiums. Although the Company has broadened this division's area of concentration beyond the Carolinas, principally through strategic acquisitions, the Company has maintained a regional focus for its home service business on the Southeast and Midwest.\nMORTGAGE PROTECTION DIVISION. The Mortgage Protection Division is the second largest of Liberty Life's divisions, contributing 27% of Liberty Life's premiums in 1993. The Mortgage Protection Division primarily sells decreasing term life insurance designed to extinguish the unpaid portion of a residential mortgage upon the death of the insured. This division also sells accidental death, disability income and credit life insurance. A staff of full-time representatives and independent brokers offer these products through more than 1,000 financial institutions located throughout the United States. The Company supports the marketing of these products through direct mail and phone solicitations.\nGENERAL AGENCY MARKETING DIVISION. The General Agency Marketing Division sells individual universal life, as well as term life and interest-sensitive life insurance through independent agents. At December 31, 1993, the General Agency Marketing Division had 1000 agents contracted to sell products. It is the smallest of Liberty Life's marketing divisions, contributing 3% of Liberty Life's premiums in 1993.\nAt December 31, 1993, Liberty Life had 582 employees in its home office who perform administrative and clerical duties.\nPIERCE NATIONAL. In July 1992, the Company acquired Pierce National, a major provider of pre-need life insurance, a product which pre-funds funeral services. Pierce National, a stock life insurance company, is domiciled in California, but its principal executive offices are in Greenville, South Carolina. Pierce National's policies consist primarily of ordinary life insurance policies for which the premiums are paid in a single payment at the outset or primarily over a three, five or ten-year period. In April 1993, Pierce National acquired through reinsurance all of the ordinary life insurance, representing pre-need life insurance, of Estate Assurance Company, effective as of January 1, 1993.\nPierce National is currently licensed in 37 states, the District of Columbia, and ten Canadian provinces. Pierce National also has licensing applications pending in 4 additional states and one Canadian province. Pierce National plans to seek licensure in the majority of the remaining states by the end of 1994. Pierce National derived the largest percentages of its premium income for 1993 from Canada (30%) and California (33%).\nAt December 31, 1993, Pierce National had 20 employees in its home office who perform administrative and clerical duties. Policy administration is carried out by Liberty Insurance Services who employs approximately 60 people in this area.\nPREMIUM BREAKDOWN. The following table sets forth the insurance premiums and policy charges of each of Liberty Life's marketing and distribution divisions for the indicated periods and of Pierce National since its acquisition by the Company in July 1992.\n(1) Decline reflects the ceding through reinsurance of 80% of this division's net premiums at December 31, 1991.\n(2) Represents premiums from date of acquisition on July 1, 1992.\n(3) Increase reflects, in part, the acquisition of Estate Assurance Company's insurance in force in April 1993.\nUNDERWRITING PRACTICES. Liberty Life's underwriting practices for ordinary life insurance require medical examinations for applicants over age 60 or for policies in excess of certain prescribed face amounts. Approximately 83% of non-home service life insurance policies issued in 1993 were issued without medical examinations. In accordance with the general practice in the life insurance industry, Liberty Life writes life insurance on substandard risks at increased premium rates. Generally, home service life insurance for non-universal life products is written for amounts under $5,000 and typically no medical examination is required. Mortgage protection life insurance is usually written without medical examination. Substantially all of Pierce National's policies are written for amounts under $5,000, and no medical examination is required unless the applicant requests a preferred rate.\nREINSURANCE. The Company's insurance subsidiaries use reinsurance in two distinct ways: first, as a risk management tool in the normal course of business and second, in isolated strategic transactions to effectively buy or sell blocks of in force business. The Company's insurance subsidiaries remain contingently liable with respect to reinsurance ceded should any reinsurer be unable to meet the obligations assumed by it. As a result of its reinsurance transactions, the Company's insurance subsidiaries remain contingently liable on $4.8 billion (24%) of its total $20.2 billion life insurance in force at December 31, 1993.\nFor the years ended December 31, 1993, 1992 and 1991, the Insurance Group had ceded life insurance premiums of $26.1 million, $28.3 million and $5.5 million, respectively. Accident and Health premiums ceded for the Insurance Group made up the remainder of ceded premiums which were $3.5 million, $3.0 million, and $2.6 million for the years ended December 31, 1993, 1992, and 1991, respectively.\nRISK MANAGEMENT REINSURANCE TRANSACTIONS. Liberty Life reinsures with other insurance companies portions of the life insurance it writes in order to limit its exposure on large or substandard risks. The maximum amount of life insurance that Liberty Life will retain on any life is $300,000, plus an additional $50,000 in the event of accidental death. This maximum is reduced for higher ages and for special classes of risks. The maximum amount of life insurance that Pierce National will retain on any life is $50,000. Insurance in excess of the retention limit is either automatically ceded under reinsurance agreements or is reinsured on an individually agreed basis with other insurance companies. Liberty Life has ceded a significant portion of its risks on accidental death and disability coverage to other insurance companies. Liberty Life and Pierce National also have coverage for catastrophic accidents. At December 31, 1993, Liberty Life and Pierce National had ceded in the normal course of business portions of their risks to a number of other insurance companies.\nSTRATEGIC REINSURANCE TRANSACTIONS. At December 31, 1991, 80% or $3.2 billion face amount of Liberty Life's General Agency Marketing Division net insurance in force was coinsured with Life Reassurance Corporation (\"Life Re\"). The agreement with Life Re also provides for the coinsurance of 50% of this division's new insurance issued after 1991. The total face value of amounts ceded to Life Re at December 31, 1993 was $3 billion. In connection with this transaction, Liberty Life transferred into trust accounts assets supporting the statutory reserves with respect to the ceded policies. The Company's investment advisory subsidiary manages the trust portfolio, and the trust agreements impose asset quality requirements on investments. The Company believes that the overall credit quality of the assets held in each asset trust account is as high as that in the asset portfolio owned directly by the Company. Liberty Life's interest in the Life Reassurance trust accounts is shown as other invested assets in the consolidated balance sheet. The transfer of the reserves and the related assets and the receipt of a ceding commission from this transaction provided the Company with additional statutory capital which was redeployed to expand higher margin lines.\nIn order to facilitate the 1991 acquisition through reinsurance of the Kentucky Central block of business, Liberty Life coinsured 50% of its home service traditional life insurance business with Lincoln National Life Reinsurance Insurance Company. The Lincoln National reinsurance has been accounted for under generally accepted accounting principles as financial reinsurance, and no reserve reduction has been taken for the business ceded nor have the related assets been removed from the consolidated balance sheet. The reinsurance contract contains an escrow agreement that requires assets equal to the reserves reinsured, as determined under statutory accounting principles, be held in escrow for the benefit of this block of business.\nThe Company uses assumption reinsurance to effectively acquire blocks of in force business by acting as the \"reinsurer\" for other insurance companies. For instance, the Company acquired the Kentucky Central, Integon and Estate Assurance blocks in this manner.\nOPERATIONS. The administrative functions of underwriting and issuing new policies, and the ongoing servicing and claims settlement of in force policies, are centralized at the home office of Liberty Life and Pierce National in Greenville, South Carolina. In acquiring additional blocks of insurance business, the Company's strategy is to integrate the administrative functions into its existing operations, either directly or through Liberty Services, as soon as practical after the effective date of the acquisition. The Company believes that this centralization permits economies of scale and promotes greater cost efficiencies. The administrative operations of both Pierce National and Magnolia were moved to Greenville during the first three months of ownership. The Magnolia business has been fully integrated into Liberty Life's policy administration system for its home service business. In contrast, Pierce National's pre-need business is serviced by Liberty Insurance Services and is in the process of being converted onto a new system. As indicated earlier, however, the Company plans to evaluate appropriate ways to consolidate the pre-need business presently conducted through Pierce National with the pre-need business acquired through the Company's recent acquisitions of North American and American Funeral. See \"the Company Business - Strategy; Recent Developments.\"\nThe Company's Insurance Group services approximately 2.7 million policies representing $23.4 billion of life insurance in force, including policies representing approximately $15.4 billion of insurance in force for which Liberty Life and Pierce National are primarily liable and $8.0 billion of insurance for which others are primarily liable, either because of reinsurance or because Liberty Services contracted to service the policies of others without any assumption of the underlying liability. Approximately 166,405 policies representing $3.4 million of life insurance in force were issued during 1993. The Company intends to continue its focus on reducing the unit costs of administrative services by increasing the volume of business through acquisitions of blocks of business similar in nature to its existing business, by internal growth in those businesses, and by investing in up-to-date technology to further improve efficiency in its operations.\nDuring the past five years the Company has made $20.0 million of capital expenditures net of amortization for new technology designed to handle increasing volumes of the insurance business, while controlling operating costs associated with the Company's insurance operations. In addition to the Company's internal efforts, since March 1989 the Company has worked closely with Policy Management Systems Corporation (\"PMSC\") in developing a new fully integrated policy administration system. The first stage has been completed and will be integrated into operations in 1994. During the third quarter of 1993, PMSC completed a significant acquisition of a full line of life insurance software. The Company's contractual agreement with PMSC\nprovides a long term relationship including access to all life insurance related software available from PMSC, both existing products and those enhanced and\/or acquired in the future. The Company plans to utilize PMSC's recently acquired software in completing its new policy administration system. The Company expects to benefit from this new system not only by increasing the productivity of its own insurance subsidiaries, but also by using this system when offering home office services to non-affiliated life insurance companies on a fee basis through Liberty Services.\nLIBERTY INSURANCE SERVICES. Consistent with the Company's strategy of leveraging its existing capital and technical expertise, the Company organized Liberty Insurance Services in 1991 to provide a wide range of home office support services to unaffiliated life and health insurance companies on a fee basis, as well as to the Company's insurance subsidiaries. These services include underwriting, preparation of policies, accounting, customer service and claims processing and adjudication and can be tailored to support the special features of insurance products offered by other companies that desire these services. The Company's strategy is to target (i) insurance companies that have closed blocks of business that are expensive to administer, (ii) insurance companies that have start-up or new product lines requiring new support levels, (iii) small to midsize insurance companies that cannot justify large investments in home office technology, and (iv) insurance companies acquired by financial investors lacking experience in providing home office support. Liberty Insurance Services believes that its economies of scale will permit its customers to reduce their home office support costs and focus resources on marketing their insurance products. Although Liberty Insurance Services is still in the development stage and the revenues generated to date have not been material, the Company believes that Liberty Insurance Services has significant growth potential. Liberty Insurance Services has 271 employees who provide services to the Company's insurance subsidiaries as well as to its outside clients.\nINSURANCE COMPETITION. The Company's Insurance Group competes with approximately 2,300 United States and Canadian insurance companies, some of which have greater financial resources, broader product lines and larger staffs. In addition, banks and savings and loan associations in some jurisdictions compete with the Company's Insurance Group for sales of life insurance products, and the Insurance Group competes with banks, investment advisors, mutual funds and other financial entities to attract investment funds generally.\nCompetition in the home service business is largely regional or local, largely dependent on the quality of the local management, and is less price competitive than other insurance markets. The home service business involves frequent contacts by agents with their customers. Liberty emphasizes to its agents the importance of taking advantage of these contacts to establish personal relationships which the Company believes add stability to its home service business.\nThe Company believes that competition in the pre-need market is national and intends to expand the market of its pre-need business. The Company intends to capitalize on its affinity marketing expertise gained in the mortgage protection insurance business by targeting national chains of funeral homes and by supplementing this effort with direct marketing and telemarketing campaigns.\nThe Company currently believes that it ranks second nationally in mortgage protection insurance with an estimated 15% market share. Slightly over 70% of the mortgage protection market share is believed to be held by four companies and 33% of the market is held by the market leader. For both the Company and the mortgage protection industry generally, falling interest rates which have fueled mortgage refinancing have adversely affected persistency of existing business, as well as new sales.\nThe Company has a very small presence in the general agency universal life business. This is an extremely competitive line of business where economies of scale are key to success.\nINSURANCE REGULATION. Like other insurance companies, the Company's insurance subsidiaries are subject to regulation and supervision by the state or other insurance department of each jurisdiction in which they are licensed to do business. These supervisory agencies have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of agents, the approval of policy forms, reserve requirements and the form and content of required financial statements. As to its investments, each of the Company's insurance subsidiaries must meet the standards and tests established by NAIC and, in particular, the investment laws and regulations of the states in which each subsidiary is domiciled. The\ninsurance companies are also subject to laws in most states that require solvent life insurance companies to pay guaranty fund assessments to protect the interests of policyholders of insolvent life insurance companies.\nIn December 1991, the NAIC adopted two new reserve requirements (the Asset Valuation Reserve or \"AVR\" and the Interest Maintenance Reserve or \"IMR\") to replace the former Mandatory Securities Valuation Reserve or \"MSVR.\" These reserves are generally required by state insurance regulatory authorities to be established as a liability on a life insurer's statutory financial statements beginning with the 1992 annual statement, but do not affect financial statements of the Company prepared in accordance with generally accepted accounting principles. AVR establishes a statutory reserve for mortgage loans, equity real estate and joint ventures, as well as for the types of investments (fixed maturities and common and preferred stock) that have been subject to the MSVR. AVR generally captures all realized and unrealized gains and losses on such assets, other than those resulting from changes in interest rates. IMR captures the net gains or losses that are realized upon the sale of fixed income securities (bonds, preferred stocks, mortgage-backed securities and mortgage loans) and that result from changes in the overall level of interest rates, and amortizes these net realized gains or losses into income over the remaining life of each investment sold, thus limiting the ability of an insurer to enhance statutory surplus by taking gains on fixed income securities. The implementation of the IMR and AVR has not had a material impact on the Company's insurance subsidiaries' surplus nor Liberty Life's ability to pay dividends to the Company.\nIn recent years the NAIC has approved and recommended to the states for adoption and implementation several regulatory initiatives designed to decrease the risk of insolvency of insurance companies in general. These initiatives include the implementation of a risk-based capital formula for determining adequate levels of capital and surplus and further restrictions on an insurance company's payment of dividends to its shareholders. To date, South Carolina has not adopted the NAIC risk-based capital model act; however, effective October 1, 1993, it does require prior notice to the South Carolina Commissioner of dividend distributions to shareholders, and permits the Commissioner to disapprove or limit the dividend within 30 days of notice if the dividend or distribution is deemed an unreasonable strain on surplus. The NAIC risk-based capital model act or similar initiatives may be adopted by South Carolina or the various states in which Liberty Life and the Company's other insurance subsidiaries are licensed, but the ultimate content and timing of any statutes and regulations adopted by the states cannot be determined at this time.\nUnder the NAIC's risk-based capital initiatives, insurance companies must calculate and report information under a risk-based capital formula, beginning with their year-end 1993 statutory financial statement. This information is intended to permit insurance regulators to identify and require remedial action for inadequately capitalized insurance companies, but is not designed to rank adequately capitalized companies. The NAIC initiatives provide for four levels of potential involvement by state regulators for inadequately capitalized insurance companies, ranging from regulatory control of the insurance company to a requirement for the insurance company to submit a plan to improve its capital. Implementation of the substantive regulatory authority contemplated by this NAIC initiative depends on adoption by the states of the NAIC Model Act on risk-based capital requirements. The NAIC has determined to deny accreditation to state insurance regulatory authorities in states failing to adopt this risk-based capital Model Act by January 1, 1996. Based on statutory financial statements at December 31, 1993, Liberty Life and Pierce National are more than adequately capitalized under the formula.\nAnother NAIC Model Act limits dividends that may be paid in any calendar year without regulatory approval to the lesser of (i) 10% of the insurer's statutory surplus at the prior year-end, or (ii) the statutory net gain from operations of the insurer (excluding realized capital gains and losses) for the prior calendar year. The NAIC has determined that it will not grant accreditation to any state insurance regulatory authority in a state that has not enacted statutes \"substantially similar\" to the NAIC Model Act regulating the payment of dividends by insurers. The South Carolina statutes applicable to Liberty Life do not conform to the NAIC Model Act (South Carolina limits dividends to the greater of 10% of statutory surplus or gain from operations) and the legislature of South Carolina may consider legislation to bring South Carolina laws into substantial compliance with the NAIC Model Act.\nUnder current South Carolina law, without prior approval from the South Carolina Commissioner of Insurance, dividend payments from Liberty Life to the Company are limited to the greater of the prior year's statutory gain from operations or 10% of the prior year's statutory surplus. This resulted in a maximum allowable dividend in\n1993 of $23.2 million without approval from the South Carolina Insurance Commissioner. Actual dividends paid by Liberty Life were $12.8 million in 1993, $8.4 million in 1992 and $22.7 million in 1991. If South Carolina were to adopt the NAIC Model Act, there can be no assurance the Company can obtain approval to pay dividends in excess of the statutory maximum, but the Company has been successful in the past in obtaining such approvals.\nIn accordance with the rules and practices of the NAIC and in accordance with state law, every insurance company is examined generally once each three years by examiners from its state of domicile and from several of the other states where it is licensed to do business. Liberty Life and Pierce National's most recent examinations were for the period ending December 31, 1990. All states and jurisdictions (including the Canadian provinces where Pierce National is also licensed) have their own statutes and regulations, which vary in certain respects. However, the NAIC Model Act and regulations have tended to make the various states' regulation more uniform. Pierce National has agreed with several states to not pay dividends until after 1995.\nThe Office of the Superintendent of Financial Institutions - Canada, and the Canadian provinces regulate and supervise the Canadian operations of Pierce National in the same manner as the NAIC and the states. Separate financial statements are required to meet the Canadian regulatory requirements and a separate examination is conducted by the Canadian regulatory agencies.\nThe Company's insurance subsidiaries are also subject to regulation as an insurance holding company system under statutes which have been enacted in their states of domicile and other states in which they are licensed to do business. Pursuant to these statutes, Liberty Life and Pierce National are required to file an annual registration statement with the Office of the Commissioner of Insurance and to report all material changes or transactions. In addition, these statutes restrict the ability of any person to acquire control (generally presumed at 10% or more) of the outstanding voting securities of the Company without prior regulatory approval.\nBROADCASTING OPERATIONS\nCosmos currently owns and operates the following television stations, six of which were ranked No. 1 in their market by the November 1993 Nielsen ratings for sign-on to sign-off:\nCosmos has approximately 617 full-time employees and 80 part-time employees.\nNETWORK AFFILIATES. All of Cosmos' stations are affiliated with one of the major networks - NBC, ABC, CBS. The affiliation contracts provide that the network will offer to the affiliated station a variety of network programs, both sponsored and unsponsored, for which the station has the right of first refusal against any other television station located in its community. The station has the right to reject or accept the programs offered by the network and also has the right to broadcast programs either produced by the station or acquired from other sources. The major networks provide their affiliated stations with programming and sell the programs, or commercial time during the programs, to national advertisers. Each affiliate is compensated by its network for carrying the network's programs. That compensation is based on the local market rating strength of the affiliate and the audience it helps bring to the network programs. The major networks typically provide programming for approximately 90 hours of the approximately 135 hours per week broadcast by their affiliated stations.\nThe NBC affiliation contracts with each of Cosmos' NBC affiliated stations have been continuously in effect for over thirty-eight years. Cosmos' CBS affiliation contract and ABC affiliation contract have each been continuously in effect for approximately thirty years.\nSOURCES OF COSMOS' TELEVISION OPERATING REVENUES. The following table shows the approximate percentage of Cosmos' gross television operating revenues by source excluding other income for the three years ended December 31, 1993:\nLocal and regional advertising is sold by station's own sales representatives to local and other non-national advertisers or agencies. Generally these contracts are short-term, although occasionally longer-term packages will be sold. National spot advertising (generally a series of spot announcements between programs or within the station's own programs) is sold by the station or its sales representatives directly to agencies representing national advertisers. Most of these national sales contracts are also short-term, often covering spot campaigns running for thirteen weeks or less. Network compensation is paid by the network to its affiliated stations for broadcasting network programs that include advertising sold by the network to agencies representing national advertisers. Political advertising is generated by national and local elections, which is by definition very cyclical.\nA television station's rates are primarily determined by the estimated number of television homes it can provide for an advertiser's message. The estimates of the total number of television homes in the market and of the station's share of those homes is based on the AC Nielsen industry wide television rating service. The demographic make-up of the viewing audience is equally important to advertisers. Twenty-five to fifty-four year old and eighteen to forty-nine year old adults are the demographics most desired by advertisers. A station's rate card for national and local advertisers takes into account, in addition to audience delivered, such variables as the length of the commercial announcements and the quantity purchased. The payments by a network to an affiliated station are largely determined by the total homes delivered, the relative preference of the station among the viewers in the market area and other factors related to management and ownership.\nTELEVISION BROADCASTING COMPETITION. The television broadcasting industry competes with other leisure time activities for the time of viewers and with all other advertising media for advertising dollars. Within its coverage area a television station competes with other stations and with other advertising media serving the same area. The outcome of the competition among stations for advertising dollars in a market depends principally on share of audience, advertising rates and the effectiveness of the sales effort.\nCosmos believes that each of its stations has a strong competitive position in its local market, enabling it to deliver a high percentage of the local television audience to local advertisers. Cosmos' commitment to local news programming, combined with syndicated programming, are important elements in maintaining Cosmos' current market positions.\nAnother source of competition is cable television, which brings additional television programming, including pay cable (HBO, Showtime, Movie Channel, etc.), into subscribers' homes in a television station's service area. Cable television competes for the station's viewing audience and, on a more modest scale, its advertising.\nFederal law now requires that cable operators negotiate with television operators for the right to carry a station's signal (programs) on cable systems. Cosmos recently used this \"retransmission consent\" negotiation to forge long term partnerships with cable operators with the purpose of developing secondary revenue streams from programs and services specifically produced for cable. Cosmos also recently formed CableVantage Inc., a marketing company designed to assist local cable operators in the sale of commercial time available in cable network programs.\nSubscription Television, an over-the-air pay television service, and Multipoint Distribution Service, a microwave-distributed pay television service, also compete for television audiences. In addition, licenses are now being granted for Multichannel Multipoint Distribution Service. None of these services has significantly fractionalized the audiences of commercial television stations.\nThe use of home video recording and playback (VCR) equipment is growing and provides another element of competition for television audiences.\nTwo television broadcast services are still in the developmental stage. Low power television, sometimes referred to as \"neighborhood TV,\" is authorized to operate in a limited coverage area. Authorizations are being granted by the FCC on a lottery basis. A second developmental service is direct broadcast satellite which transmits television signals from satellite transponders to parabolic antennae. Neither of these new services has shown the potential for significant effects on commercial television broadcasting.\nFEDERAL REGULATION OF BROADCASTING. Cosmos' broadcasting operations are subject to the jurisdiction of the FCC under the Communications Act. The Communications Act empowers the FCC, among other things, to issue, revoke or modify broadcasting licenses; to assign frequency bands; to determine the location of stations; to regulate the apparatus used by stations; to establish areas to be served; to adopt such regulations as may be necessary to carry out the provisions of the Communications Act and to impose certain penalties for violation of such regulations.\nTelevision broadcasting licenses may be granted for a maximum term of five years and, upon application, and in the absence of a conflicting application or a petition to deny which raises a substantial and material issue of relevant fact (which would require the FCC to hold a hearing) or adverse findings as to the licensee's qualifications, are usually renewed without hearing by the FCC for additional five year terms. Cosmos' renewal applications have always been granted without hearing for the full term. The Communications Act prohibits the transfer of a license or the transfer of control or other change in control of a licensee without prior approval of the FCC. The Hipp family is considered to have de facto control over Cosmos, and any action that would change such control would require prior approval of the FCC.\nUnder FCC regulations governing multiple ownership, a license to operate a television station generally will not be granted to any person (or persons under common control) if such person directly or indirectly holds a significant interest in (i) another radio or television station, with an overlapping service area, (ii) more than 12 television stations or (iii) less than 12 television stations if their audience coverage exceeds 25% of total United States households. FCC regulations also limit ownership of television stations by those having interests in cable television systems and daily newspapers serving the same service area as the television stations. The rules provide that each case will be considered on the basis of its particular facts. During 1994, legislation is expected which will remove many of the ownership restrictions now encumbering broadcasters. Congress has publicly stated that broadcasters need regulatory relief in order to effectively compete in the multi-channel environment of the future commonly referred to as the \"electronic information superhighway\".\nThere are additional FCC Regulations and Policies, and regulations and policies of other federal agencies, principally the Federal Trade Commission, regulating network\/affiliate relations, political broadcasts, children's programming, advertising practices, equal employment opportunity, carriage of television signals by CATV systems, application and reporting procedures and other areas affecting the business and operations of television stations.\nINVESTMENTS AND INVESTMENT POLICY\nThe Company derives a substantial portion of its total revenues from investment income. Invested assets are held primarily through Liberty Life and Pierce National, although the parent company and its real estate subsidiary held $49.8 million (59%) of the $84.5 million of the consolidated investment real estate portfolio at December 31, 1993. The Company's investment advisory subsidiary manages securities and non-real estate related assets for the Company and its subsidiaries, while the Company's property development and management subsidiary manages all investment real estate assets and the mortgage loan portfolio for the Company and its subsidiaries.\nAll investments made for the Company are governed by the general requirements and guidelines established and approved by the Company's Investment Committee and by qualitative and quantitative limits prescribed by applicable insurance laws and regulations. The Committee, comprised of seven senior officers of the Company and appropriate subsidiaries, meets monthly to set and review investment policy and to approve current investment plans.\nThe Company follows a value-oriented investment philosophy in which purchases are generally made with the intention of holding securities to maturity. Investment philosophy is focused on the intermediate to longer-term horizon and is not oriented towards trading. As market relationships change and individual securities become increasingly over or undervalued, securities may be sold prior to maturity and replaced with similar securities. In addition, the Company attempts to minimize liquidity risk by using an integrated asset\/liability matching process. As an additional risk control measure, the Company's investment strategy focuses on diversity through a relatively large number of smaller investments in contrast to larger, more concentrated investments. As of December 31, 1993, the Company's invested assets had an aggregate book value of $1.4 billion.\nBONDS. As of December 31, 1993, bonds comprised 59% ($797.4 million) of the Company's invested assets and had a weighted average credit rating of AA. As of December 31, 1993, publicly traded bonds comprised 93% of the total bond portfolio. The Company's emphasis on call protection as part of its investment strategy makes its portfolio less vulnerable to prepayments which reduce portfolio yield during low interest rate environments. However, due to historically low interest rates, the Company experienced a significant amount of prepayments during 1993, which have accordingly been reinvested at lower interest rates causing downward pressure on investment income. A continuation of low interest rates can be expected to result in a continued high level of prepayments in the future.\nEQUITY SECURITIES. As of December 31, 1993, approximately 1.5% ($20.3 million) of the Company's invested assets were common stocks and 8% ($108.4 million) were preferred stocks. Common stocks and nonredeemable preferred stocks are carried on the Company's balance sheet at market if owned by the Company's insurance subsidiaries and at the lower of cost or market if owned by the parent company or one of its non-insurance subsidiaries. As of December 31, 1993, all of the Company's common stock and nonredeemable preferred stock were held by Liberty Life and Pierce National. Redeemable preferred stocks are carried at amortized cost which includes write-downs for impaired value where appropriate. At December 31, 1993, redeemable preferred stock represented 4.4% ($60.3 million) of the Company's investment portfolio.\nMORTGAGES. As of December 31, 1993, mortgage loans comprised 12.2% ($165.8 million) of the Company's invested assets. Mortgage loans on real estate are carried at amortized cost which include valuation adjustments for impaired value where appropriate. As of December 31, 1993, 1.59% of the Company's mortgage loan portfolio was more than 60 days delinquent, compared to the industry average of 4.54% at December 31, 1993 (as reported in the American Council of Life Insurance's \"Investment Bulletin\" dated March 1, 1994). It is the Company's policy to stop accruing mortgage loan interest income for financial statement purposes once a loan is more than 90 days past due. At that time the accrued interest on the loan is deducted from income.\nREAL ESTATE. As of December 31, 1993, 6.2% ($84.5 million) of the Company's invested assets were real estate. Liberty Life holds 41% ($34.7 million) of the real estate portfolio and the remainder is held by the parent company and its real estate subsidiary. The Company's real estate assets are comprised primarily of residential land development, business parks, business property rentals and shopping centers. Residential land development is partially developed and undeveloped properties zoned residential that are sold to home builders. Business parks are partially developed and undeveloped properties zoned for business use that are primarily sold to various industrial, manufacturing, and office users. The Company records gains (losses) on the sale of residential land development and business parks as operating income. Business property rentals and shopping centers are leased to commercial and rental tenants, respectively, and gains (losses) from sales of such properties are recorded as investment gains (losses). The Company's real estate investment properties are carried at cost less accumulated depreciation and valuation adjustments for impaired value where appropriate.\nThe Company's methodology for determining impairment of a property begins with an annual review of estimated value for each property in the portfolio. This process uses a discounted cash flow method to value partially developed land for resale, a combination of comparable tract sales and discounted cash flow to value undeveloped land and capitalization rates relative to net operating cash flow for developed properties. As of December 31, 1993, the Company does not believe that the values of these properties have been impaired from their carrying values.\nEXECUTIVE OFFICERS\nThe following is a list of the Executive Officers of the Registrant indicating their age and certain biographical data.\nFRANCIS M. HIPP, Age 83 (1) Chairman of the Board of Liberty since 1967\nW. HAYNE HIPP, Age 54 (1) Chairman of the Board of Liberty Life from January 1, 1979 - February 9, 1988; September 18, 1989 - present Chairman of the Board of Cosmos - May 1, 1989 - February 18, 1992 President and Chief Executive Officer of Liberty since September, 1981\nMARTHA G. WILLIAMS, Age 51 Vice President, General Counsel & Secretary of Liberty since January, 1982 Vice President, General Counsel & Secretary of Liberty Life since January, 1982 Secretary and Counsel of Cosmos since February 11, 1982\nBARRY L. EDWARDS, Age 46 Vice President and Treasurer of Liberty since January 1, 1979 Treasurer of Cosmos since January 22, 1979\nM. PORTER B. ROSE, Age 52 President, Liberty Investment Group, Inc. since March 24, 1992 Chairman, Liberty Capital Advisors, Inc. since January 1, 1987 Chairman, Liberty Properties Group, Inc. since January 1, 1987\nJENNIE M. JOHNSON, Age 47 Vice President, Planning, of Liberty since February 1, 1986\nWILLIAM S. KLECKLEY, Age 50 Vice President & Controller of Liberty since July 26, 1993\nRALPH L. OGDEN, Age 52 President of Liberty Life since February 9, 1988 Executive Vice President of Liberty Life November 28, 1983 - February 9, 1988\nJAMES M. KEELOR, Age 51 President of Cosmos since February 18, 1992 Vice President, Operations, of Cosmos from December, 1989 to February 18, 1992 Vice President & General Manager of WDSU-TV from January, 1987 to December, 1989\n(1) W. Hayne Hipp is the son of Francis M. Hipp.\nOTHER BUSINESS\nIn addition to the operating subsidiaries, the Company has other minor organizations. These include the Company's administrative staff, an investment advisory company, a property development & management company and transportation operations. There are approximately 102 full-time employees in these areas.\nRESEARCH ACTIVITIES\nThe Company and its subsidiaries do not have a formal program of research on new or improved products. As a part of its operation, each company continues to seek improved methods and products. No material amounts were spent in this area during 1993.\nINDUSTRY SEGMENT DATA\nInformation concerning the Company's industry segments is contained in Selected Financial Data on page 37 of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on page 183 of this report and is incorporated in this Item 1 by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMAIN OFFICES. The main office of the Company, Liberty Life and Cosmos is located on a 30-acre tract in Greenville, S. C. and consists of three buildings totalling approximately 360,000 square feet plus parking. The main office facilities are owned by the Company and Liberty Life, a wholly owned subsidiary of the Company. Liberty Life also owns three branch office buildings located in various cities in South Carolina and Kentucky and leases branch office space in various cities. Leases are normally made for terms of one to ten years.\nCosmos owns its television broadcast studios, office buildings and transmitter sites in Columbia, SC; Montgomery, AL; Toledo, OH; Louisville, KY; Evansville, IN; Jonesboro, AR; and Lake Charles, LA.\nThe following properties are owned by the Company or a wholly owned subsidiary.\nINDUSTRIAL PROPERTY\nOFFICE & OTHER BUILDINGS\nRESIDENTIAL LAND\nSHOPPING CENTERS\nTIMBER TRACTS\nUNDEVELOPED LAND\nPark Avenue Associates, Inc., a wholly owned subsidiary of Liberty Life, has a 60% interest as General Partner of Tanyard Creek Partnership. The partnership owns a 49,500 square foot office building.\nGreensboro Holdings, Inc., a wholly owned subsidiary of Liberty Life, owns the mortgage loans which funded the sales of a hotel and a parking deck in Greensboro, NC.\nPROPOSED ACQUISITION OF ADDITIONAL INVESTMENT PROPERTIES. In March 1994, the Company finalized an agreement to purchase a portion of the real estate assets of SCANA Development Corporation, a subsidiary of SCANA Corporation, for approximately $50 million in cash. This transaction is expected to close in April and May 1994, and will significantly increase the real estate portfolio of the Company.\nThe properties to be purchased from SCANA are located primarily in South Carolina and include residential, commercial and industrial projects, which are similar to the Company's existing real estate investments throughout the Southeast. The properties to be purchased include residential projects under development, undeveloped land held for future development, income producing commercial properties consisting of shopping centers and office buildings, undeveloped land intended for possible development and\/or sale, and of land to be developed as business parks.\n(A)(1) AND (2). LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of The Liberty Corporation and Subsidiaries are included in the Company's Annual Report to Shareholders for the year ended December 31, 1993, filed as Exhibit 13 to this report and incorporated in Item 8","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"14930_1993.txt","cik":"14930","year":"1993","section_1":"Item 1. Business\nBrunswick Corporation (the \"Company\") is organized into seven divisions with operations in two industry segments: Marine and Recreation. Segment information is contained in Note 8 on page 32.\nMarine\nThe Marine industry segment consists of the Mercury Marine Division, which manufactures and sells marine propulsion systems, and the US Marine, Sea Ray and Fishing Boat Divisions, which manufacture and sell pleasure and fishing boats. The Company believes it has the largest dollar volume of sales of recreational marine engines and pleasure boats in the world.\nThe Mercury Marine Division manufactures and sells Mercury, Mariner and Force outboard motors, MerCruiser gasoline and diesel inboard and stern drive engines, and the Sport-Jet 90 water-jet system. Outboard motors are sold through marine dealers for pleasure craft and commercial use and to the Company's US Marine, Sea Ray and Fishing Boat Divisions. The MerCruiser engines and the water-jet systems are sold principally to boatbuilders, including the Company's US Marine, Sea Ray and Fishing Boat Divisions.\nThe Mercury Marine Division also manufactures and sells replacement parts for engines and outboard motors and marine accessories, including steering systems, instruments, controls, propellers, service aids and marine lubricants. These products are marketed through marinas, dealers and boatbuilders under the Quicksilver brand name.\nMercury Marine products are manufactured in North America and Europe for global distribution. International assembly facilities are located in Belgium and Mexico, and offshore distribution centers are in Belgium, Japan and Australia. Trademarks for Mercury Marine products include MerCruiser, Mercury, Mariner, Force and Quicksilver.\nThe US Marine Division builds and sells several brands of fiberglass pleasure and fishing boats, ranging in size from 14 to 47 feet. Bayliner is the Division's oldest and most well known brand, with offerings that include jet powered boats, family runabouts, cabin cruisers, sport fishing boats and luxury motor yachts. Other brands include Maxum (runabouts and cabin cruisers) and Robalo (sport fishing boats).\nThe US Marine Division is vertically integrated, producing many of the parts and accessories which make up the boats. Escort boat trailers are also produced by the Division and sold with smaller boats as part of boat-motor-trailer packages. Outboard motors and stern drive and inboard engines are purchased from the Mercury Marine Division.\nThe US Marine Division's boats, Escort boat trailers, and parts and accessories are sold through dealers. Trademarks for US Marine products include Bayliner, Maxum, Cobra, Quantum, Robalo, Ciera, Trophy, Jazz, Escort and US Marine.\nThe Sea Ray Division builds and sells Sea Ray fiberglass boats from 13 to 65 feet in length, including luxury motor yachts, cabin cruisers, sport fishing boats, sport boats, runabouts, water skiing boats, and jet powered boats. Sea Ray boats use and are sold with outboard motors, stern drive engines and gasoline or diesel inboard engines. The Division purchases its outboard motors and most of its stern drive and gasoline inboard engines from the Mercury Marine Division.\nSea Ray boats are sold through dealers under the Sea Ray, Laguna, Ski Ray and Sea Rayder trademarks.\nThe Fishing Boat Division manufactures and sells fiberglass and aluminum boats for the sport fishing and recreational boating markets. Some of these boats are equipped with Mercury, Mariner or Force outboard motors at the factory and are sold in boat-motor-trailer packages by marine dealers. The Fishing Boat Division's boats are sold through dealers under the Astro, Fisher, MonArk, Procraft, Starcraft, and Spectrum trademarks.\nThe Company has an interest in Tracker Marine, L.P., a limited partnership, which manufactures and markets boats, motors, trailers and accessories. The Company has various agreements with Tracker Marine, L.P., including contracts to supply outboard motors, trolling motors and various other Brunswick products for Tracker Marine boats.\nThe Company's Marine segment sales to unaffiliated customers include sales of the following principal products for the three years ended December 31, 1993, 1992, and 1991:\nBoat sales include the value of engines when such engines are sold as a component of a finished boat. Engine sales include sales to boat manufacturers which are not Company-owned, marine dealers and others, when the engine is not sold with a Company-manufactured boat.\nRecreation\nThere are three divisions in the Recreation industry segment: Zebco, Brunswick, and Brunswick Recreation Centers.\nThe Zebco Division manufactures, assembles, purchases and sells fishing reels, rods, reel\/rod combinations, and accessories. The Division also manufactures and sells electric trolling motors for fishermen and for use by boat manufacturers, including Marine segment operations.\nThe Brunswick Division manufactures and sells products for the bowling industry, including bowling lanes, automatic pinsetters, ball returns, computerized scoring equipment and business systems, and BowlerVision, a computer software bowling system which allows pins to be set up in a variety of configurations, creating new games for bowlers to play. BowlerVision also is able to analyze and display ball path, ball speed and entry angle. In addition, the Division manufactures and sells seating and locker units for bowling centers; bowling pins, lane finishes and supplies; and bowling balls and bags.\nThe Brunswick Division also manufactures and sells golf club shafts and golf bags and sells billiards tables which are manufactured for the Company to its specifications.\nThe Brunswick Division has a 50% interest in Nippon Brunswick K. K., which sells bowling equipment and operates bowling centers in Japan. In 1993, the Division entered into a joint venture to build, own and operate bowling centers in Brazil and a joint venture to build, own and operate bowling centers and to sell bowling equipment in Thailand. The Division also entered into a joint venture to build, own and operate recreation centers containing the Q-Zar laser tag game and to sell Q-Zar laser tag equipment in Brazil and Mexico. The Division also has the rights to sell Q-Zar laser game equipment in Korea.\nThe Brunswick Recreation Centers Division operates 126 recreation centers worldwide. Recreation centers are bowling centers which offer, in varying degrees depending on size and location, the following additional activities and services: billiards and other family games, children's playrooms, restaurants and cocktail lounges. The Company owns most of its recreation centers.\nIn 1993, the Division also opened three Circus World Pizza facilities which contain children's play and entertainment areas and restaurants which serve pizza. The Company intends to open seven Circus World Pizza facilities in 1994.\nAmong the Company's trademarks in the recreation field are Zebco, Quantum, Pro Staff, Classic and Martin fishing equipment, MotorGuide, Stealth and Thruster electric trolling motors, Brunswick Recreation Centers, Circus World Pizza, Leiserv, Brunswick, AS-90, Armor Plate 3000, Anvilane, BallWall, Guardian, Perry-Austen, Rhino, GS-10, Systems 2000, BowlerVision and Colorvision bowling equipment, and Brunswick Golf and Precision FM golf club shafts. Browning S.A. has licensed the Zebco Division to manufacture and sell Browning fishing equipment. Recreation products are distributed, mainly under these trademarks, to mass merchants, distributors, dealers, bowling centers, and retailers by the Company's salesmen and manufacturers' representatives and to the recreation centers operated by the Company. Recreation products are distributed worldwide from regional warehouses, sales offices and factory stocks of merchandise.\nDiscontinued operations\nThe Company has announced its intention to divest its Technical Group, and the businesses in the Technical Group are considered and have been accounted for as discontinued operations.\nThe Technical Group manufactures and sells composite structures for aircraft, helicopters, spacecraft, propulsion systems, missiles, ships, automobiles, trucks, buses, oil and gas wells and offshore platforms; radomes; space qualified products including fire detection systems, filters and extendable robotic arms; camouflage; infrared optical surveillance systems; tactical weapons; flight decoys and target training systems; relocatable and mobile shelter systems; and chemical protective detectors\/alarms. These products are sold to the U.S. Department of Defense; major defense prime contractors; electronics, aerospace and commercial aircraft manufacturers; and machinery, automotive and oil and gas manufacturers and distributors.\nRaw materials\nMany different raw materials are purchased from various sources. At the present time, no critical raw material shortages are anticipated in either of the Company's industry segments. General Motors Corporation is a significant supplier of the gasoline engines used to manufacture the Company's gasoline stern drives.\nPatents, trademarks and licenses\nThe Company has and continues to obtain patent rights, consisting of patents and patent licenses, covering certain features of the Company's products and processes. The Company's patents, by law, have a limited life, and rights expire periodically.\nIn the Marine segment, patent rights principally relate to boats and features of outboard motors and inboard-outboard drives including die-cast powerheads, cooling and exhaust systems, drive train, clutch and gearshift mechanisms, boat\/engine mountings, shock absorbing tilt mechanisms, ignition systems, propellers, spark plugs, and fuel and oil injection systems.\nIn the Recreation segment, patent rights principally relate to computerized bowling scorers and business systems, bowling lanes and related equipment, lightweight golf club shafts, game tables, fishing reels and electric trolling motors.\nAlthough the Company has important patent and patent license positions, the Company believes that its performance is mainly dependent upon its engineering, manufacturing, and marketing capabilities.\nThe Company has many trademarks associated with its various divisions and applied to its products. Many of these trademarks are well known to the public and are considered valuable assets of the Company. Significant trademarks are listed on pages 1-4 herein.\nSeasonality of business\nThe Company's overall business is not seasonal. Demand in the marine business is typically strongest in the first half of the year, when for the past several years between 50 and 60 percent of that segment's annual sales have been recorded. In the recreation segment, slightly more than 50 percent of the segment's annual sales are recorded in the second half of the year.\nOrder backlog\nOrder backlog is not considered to be a significant factor in the businesses of the Company, except for bowling capital equipment. The backlog of bowling capital equipment at December 31, 1993 was $47 million, and the Company expects to fill all of such orders during 1994. The backlog of bowling capital equipment at December 31, 1992 was $61 million.\nCompetitive conditions and position\nThe Company believes that it has a reputation for quality in its highly competitive lines of business. The Company competes in its various markets by utilizing efficient production techniques and innovative marketing, advertising and sales efforts, and by providing high quality products at competitive prices.\nStrong competition exists with respect to each of the Company's product groups, but no single manufacturer competes with the Company in all product groups. In each product area, competitors range in size from large, highly diversified companies to small producers. The following paragraphs summarize what the Company believes its position is in each area.\nMarine. The Company believes it has the largest dollar volume of sales of recreational marine engines and of pleasure boats in the world. The domestic marine engine market includes relatively few major competitors. There are 10-12 competitors in outboard engine markets worldwide, and foreign competition continues in the domestic marine engine market. The marine engine markets are experiencing pricing pressures. The marine accessories business is highly competitive.\nThere are many manufacturers of pleasure and fishing boats, and consequently, this business is highly competitive. The Company competes on the basis of quality, value, performance, durability, styling and price. Demand for pleasure and fishing boats and marine engines is dependent on a number of factors, including economic conditions, the availability of fuel and marine dockage and, to some extent, prevailing interest rates and consumer confidence in spending discretionary dollars.\nRecreation. The Company competes directly with many manufacturers of recreation products. In view of the diversity of its recreation products, the Company cannot identify the number of its competitors. The Company believes, however, that in the United States, it is one of the largest manufacturers of bowling equipment and fishing reels.\nCertain bowling equipment, such as BowlerVision, automatic scorers and computerized management systems, represents innovative developments in the market. For other recreation products, competitive emphasis is placed on pricing and the ability to meet delivery and performance requirements.\nThe Company maintains a number of specialized sales forces that sell equipment to distributors and dealers and also, in some cases, to retail outlets.\nThe Company operates 126 recreation centers worldwide. Each center competes directly with centers owned by other parties in its immediate geographic area; so, competitive emphasis is placed on customer service, quality facilities and personnel, prices and promotional programs.\nResearch and development\nCompany-sponsored research activities, relating to the development of new products or to the improvement of existing products, are shown below:\nNumber of employees\nThe number of employees at December 31, 1993 is shown below by industry segment:\nMarine 11,300 Recreation 6,500 Corporate 200\n18,000\nThere are approximately 800 employees in the Recreation segment and 2,200 employees in the Marine segment who are represented by labor unions. The Company believes that relations with the labor unions are good.\nEnvironmental requirements\nThe Company is involved in certain legal and administrative proceedings under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 and other federal and state legislation governing the generation and disposition of certain hazardous wastes. These proceedings, which involve both on and off site waste disposal, in many instances seek compensation from the Company as a waste generator under Superfund legislation which authorizes action regardless of fault, legality of original disposition or ownership of a disposal site. The Company believes that it has established adequate reserves to cover all known claims.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's headquarters are located in Lake Forest, Illinois. The Company has numerous manufacturing plants, distribution warehouses, sales offices and test sites. Research and development facilities are division-related, and most are located at individual manufacturing sites.\nThe Company's plants are deemed to be suitable and adequate for the Company's present needs. The Company believes that all of its properties are well maintained and in good operating condition. Most plants and warehouses are of modern, single-story construction, providing efficient manufacturing and distribution operations.\nThe Company's plants currently are operating at approximately 65% of capacity, excluding the 15 closed plants in the Marine segment. Twelve of these closed plants are being offered for sale. The other three closed plants are not being offered for sale, but the Company has no plans to reopen them in the near future.\nThe Company's headquarters and all of its principal plants are owned by the Company. Some bowling recreation centers, three small plants, two test facilities and an overseas distribution center are leased.\nThe Company's primary facilities are in the following locations:\nMercury Marine Division\nFond du Lac, Oshkosh and Milwaukee, Wisconsin; Stillwater, Oklahoma; St. Cloud, Florida; Juarez, Mexico; and Petit Rechain, Belgium.\nUS Marine Division\nArlington and Spokane, Washington; Roseburg, Oregon; Miami and Claremore, Oklahoma; Pipestone, Minnesota; Cumberland and Salisbury, Maryland; Dandridge, Tennessee; Valdosta, Georgia; Tallahassee, Florida; and Lincoln, Alabama.\nSea Ray Division\nKnoxville and Vonore, Tennessee; Merritt Island, Sykes Creek and Palm Coast, Florida; Phoenix, Arizona; and Cork, Ireland.\nFishing Boat Division\nTopeka and Nappanee, Indiana; West Point, Mississippi; and Murfreesboro, Tennessee.\nZebco Division\nTulsa, Oklahoma; and Starkville, Mississippi.\nBrunswick Recreation Centers\nDeerfield, Illinois headquarters; 126 bowling centers in the United States, Canada and Europe; and Circus World Pizza theme restaurants in the United States.\nBrunswick Division\nMuskegon, Michigan; Eminence, Kentucky; Bristol, Wisconsin; Torrington, Connecticut; Des Moines, Iowa; Stockach, Germany; and Kettering, England.\nItem 3.","section_3":"Item 3. Legal Proceedings\nGenmar Industries, Inc. v. Brunswick Corporation, et al. Genmar Industries brought an action against the Company and certain of its subsidiaries in the United States District Court for the District of Minnesota on June 23, 1992, alleging that the Company (i) has monopolized or attempted to monopolize the sale of recreational marine engines and boats through its acquisition of Bayliner Marine Corporation and Ray Industries, Inc. in 1986; its acquisition of four smaller fishing boat builders in 1988; its 1990 acquisition of Kiekhaefer Aeromarine, Inc., a supplier of high performance propulsion units to the marine engine industry and the owner of certain patents for recreational marine engine components; and its agreement in 1992 to form a partnership with Tracker Marine Corporation for the manufacture and marketing of recreational marine engines and power boats; (ii) has unlawfully coerced purchasers to buy the Company's boats by charging higher prices for its engines sold separately than for its engines sold with its boats, thereby inducing purchasers to buy its boats in addition to its engines; (iii) has breached its agreement to offer Genmar the lowest possible price made available to other recreational marine engine purchasers for the same quantity of engines purchased; (iv) has not dealt in good faith with Genmar by, among other things, communicating to Genmar dealers that Genmar is experiencing purported financial difficulties; and, (v) by virtue of the foregoing, has interfered with Genmar's existing and prospective business relationships. Genmar has asked that the Company be required to divest its boat manufacturing business, be enjoined from continuing its partnership with Tracker Marine, and pay damages, including treble damages under the antitrust laws. The Company believes, based upon its assessment of the complaint and in consultation with counsel, that this litigation is without merit and intends to defend itself vigorously. Parties to this suit have exchanged written discovery and have begun depositions.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nExecutive Officers of the Company\nThe Company's executive officers are listed in the following table:\nOfficer Present Position Age\nJ. F. Reichert Chairman of the Board 63 and Chief Executive Officer J. P. Reilly President and Chief 50 Operating Officer J. M. Charvat Executive Vice President 63 J. W. Dawson Vice President and Zebco 59 Division President F. J. Florjancic, Jr. Vice President and Brunswick 47 Division President W. R. McManaman Vice President-Finance 46 D. M. Yaconetti Vice President Adminis- 47 tration and Secretary T. K. Erwin Controller 44 R. T. McNaney General Counsel 59 R. S. O'Brien Treasurer 44 W. J. Barrington Sea Ray Division President 43 A. D. Fogel BRC Division President 58 J. W. Hoag US Marine Division 54 President D. D. Jones Mercury Marine Division 50 President J. A. Schenk Corporate Director of 51 Planning and Development R. C. Sigrist Technical Group President 60\nThere are no family relationships among these officers. The term of office of all elected officers expires April 27, 1994. The Division Presidents are appointed from time to time at the discretion of the Chief Executive Officer.\nJack F. Reichert has been Chairman of the Board since 1983 and Chief Executive Officer since 1982. He was President from 1977 to 1993.\nJohn P. Reilly has been President and Chief Operating Officer since 1993. From 1984 to 1993 he was President of Tenneco Inc.'s Automotive Division, a manufacturer of automotive mufflers, shocks and brake components.\nJohn M. Charvat has been Executive Vice President of the Company since 1989. He was Vice President of the Company from 1986 to 1989 and Zebco Division President from 1977 to 1989.\nJim W. Dawson has been Vice President of the Company since 1994 and Zebco Division President since 1989. From 1981 to 1989 he was Senior Vice President of Zebco\/Motor Guide Technical Operations, responsible for manufacturing, research and development, distribution, and consumer service.\nFrederick J. Florjancic, Jr. has been Vice President of the Company and President of the Brunswick Division since 1988.\nWilliam R. McManaman has been Vice President-Finance since 1988.\nDianne M. Yaconetti has been Vice President-Administration since 1988, Corporate Secretary since 1986 and Manager of the Office of the Chairman since 1985.\nThomas K. Erwin has been Controller since 1988.\nRobert T. McNaney has been General Counsel since 1985.\nRichard S. O'Brien has been Treasurer since 1988.\nWilliam J. Barrington has been Sea Ray Division President and President of Ray Industries, Inc. (\"Ray\") since 1989. From 1985 to 1989 he was Vice President-Finance and Treasurer of Ray.\nArnold D. Fogel has been Brunswick Recreation Centers Division President since 1984.\nJames W. Hoag has been US Marine Division President since 1989. From 1988 to 1989 he was Executive Vice President of the US Marine Division.\nDavid D. Jones has been Mercury Marine Division President since 1989. From 1985 to 1989 he was General Manager of US Marine Power.\nJames A. Schenk has been Corporate Director of Planning and Development since 1988.\nRobert C. Sigrist has been President of the Technical Group (known as the Defense Division prior to 1991) since 1988.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock is traded on the New York, Chicago, Pacific, London, and Tokyo Stock Exchanges. Quarterly information with respect to the high and low sales prices for the common stock and the dividends declared on the common stock is set forth in Note 21 on page 54. As of December 31, 1993, there were approximately 27,900 shareholders of record of the Company's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNet sales, net earnings, earnings per common share, cash dividends declared per common share, total assets, and long-term debt are shown in the Five Year Financial Summary on page 57.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nManagement's Discussion and Analysis is presented on pages 19 to 23.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Company's Consolidated Financial Statements are set forth on pages 24 to 26 and are listed in the index on page 18.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation with respect to the directors of the Company is set forth on pages 2 and 3 of the Company's definitive Proxy Statement dated March 25, 1994 (the \"Proxy Statement\") for the Annual Meeting of Stockholders to be held on April 27, 1994, and is hereby incorporated by reference. The Company's executive officers are listed herein on pages 10-11.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation with respect to executive compensation is set forth on pages 5, 13-15 and 17-20 of the Proxy Statement and is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation with respect to the securities of the Company owned by the directors and certain officers of the Company, by the directors and officers of the Company as a group and by the only persons known to the Company to own beneficially more than 5% of the outstanding voting securities of the Company is set forth on pages 6 and 7 of the Proxy Statement, and such information is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone. Part IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\na) Financial Statements and Exhibits\nFinancial Statements\nFinancial statements and schedules are incorporated in this Annual Report on Form 10-K, as indicated in the index on page 18.\nExhibits\n3.1 Restated Certificate of Incorporation of the Company filed as Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1987, and hereby incorporated by reference.\n3.2 By-Laws of the Company.\n4.1 Indenture dated as of March 15, 1987, between the Company and Continental Illinois National Bank and Trust Company of Chicago filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1987, and hereby incorporated by reference.\n4.2 Form of 8-1\/8% Notes of the Company Due April 1, 1997, filed as Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1987, and hereby incorporated by reference.\n4.3 Officers' Certificate setting forth terms of the Company's $125,000,000 principal amount 7-3\/8% Debentures due September 1, 2023.\n4.4 The Company's Agreement to furnish additional debt instruments upon request by the Securities and Exchange Commission filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for 1980, and hereby incorporated by reference.\n4.5 Rights Agreement dated as of March 15, 1986, between the Company and Harris Trust and Savings Bank filed as Exhibit 4.14 to the Company's Annual Report on Form 10-K for 1985, and hereby incorporated by reference.\n4.6 Amendment dated April 3, 1989, to Rights Agreement between the Company and Harris Trust and Savings Bank filed as Exhibit 2 to the Company's Current Report on Form 8-K dated April 10, 1989, and hereby incorporated by reference.\n10.1* Third Amended and Restated Employment Agreement entered as of December 30, 1986, between the Company and Jack F. Reichert filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for 1986 and hereby incorporated by reference.\n10.2* Amendment dated October 24, 1989, to Employment Agreement by and between the Company and Jack F. Reichert filed as Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 and hereby incorporated by reference.\n10.3* Supplemental Agreement to Employment Agreement dated December 30, 1986, by and between the Company and Jack F. Reichert filed as Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989, and hereby incorporated by reference.\n10.4* Amendment dated February 12, 1991 to Employment Agreement by and between the Company and Jack F. Reichert filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for 1990 and hereby incorporated by reference.\n10.5* Amendment dated March 20, 1992 to Employment Agreement by and between the Company and Jack F. Reichert filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for 1992 and hereby incorporated by reference.\n10.6* Amendment dated December 15, 1992 to Employment Agreement by and between the Company and Jack F. Reichert filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for 1992 and hereby incorporated by reference.\n10.7* Employment Agreement dated as of June 1, 1989 by and between the Company and John M. Charvat filed as Exhibit 19.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989, and hereby incorporated by reference.\n10.8* Amendment dated as of December 15, 1992 to Employment Agreement by and between the Company and John M. Charvat filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for 1992 and hereby incorporated by reference.\n10.9* Supplemental Pension Plan filed as Exhibit 19.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and hereby incorporated by reference.\n10.10* Form of Employment Agreement by and between the Company and each of T. K. Erwin, W. R. McManaman, R. T. McNaney, R. S. O'Brien, J. A. Schenk, D. M. Yaconetti, W. J. Barrington, J. W. Dawson, F. J. Florjancic, Jr., A. D. Fogel, J. W. Hoag, D. D. Jones, and R. C. Sigrist filed as Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and hereby incorporated by reference.\n10.11* Amendment to Form of Employment Agreement filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for 1992 and hereby incorporated by reference.\n10.12* Form of Insurance Policy issued for the life of each of the Company's officers, together with the specifications for each of these policies, filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for l980 and hereby incorporated by reference. The Company pays the premiums for these policies and will recover these premiums, with some exceptions, from the policy proceeds.\n10.13* Insurance policy issued by The Prudential Insurance Company of America insuring all of the Company's officers and certain other senior management employees for medical expenses filed as Exhibit 10.23 to the Company's Annual Report on Form 10-K for 1980 and hereby incorporated by reference.\n10.14* Form of Indemnification Agreement by and between the Company and each of M. J. Callahan, J. P. Diesel, D. E. Guinn, L. Herzel, G. D. Kennedy, B. K. Koken, J. W. Lorsch, B. M. Musham, R. N. Rasmus, and R. W. Schipke filed as Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986, and hereby incorporated by reference.\n10.15* Indemnification Agreement dated September 16, 1986, by and between the Company and J. F. Reichert filed as Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986, and hereby incorporated by reference.\n10.16* Form of Indemnification Agreement by and between the Company and each of J. M. Charvat, T. K. Erwin, F. J. Florjancic, Jr., W. R. McManaman, R. T. McNaney, R. S. O'Brien, J. A. Schenk, and D. M. Yaconetti\nfiled as Exhibit 19.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986, and hereby incorporated by reference.\n10.17* Employment Agreement dated October 1, 1993 by and between the Company and John P. Reilly.\n10.18* Indemnification Agreement dated October 26, 1993 by and between the Company and John P. Reilly.\n10.19* 1991 Stock Plan filed as Exhibit A to the Company's definitive Proxy Statement dated March 21, 1991 for the Annual Meeting of Stockholders on April 24, 1991 and hereby incorporated by reference.\n10.20* Change In Control Severance Plan filed as Exhibit 10.22 to the Company's Annual Report on Form 10-K for 1989 and hereby incorporated by reference.\n10.21* Brunswick Performance Plan for 1993 filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for 1992 and hereby incorporated by reference.\n10.22* Brunswick Performance Plan for 1994.\n10.23* Brunswick Strategic Incentive Plan.\n10.24* 1988 Stock Plan for Non-Employee Directors filed as Exhibit B to the Company's definitive Proxy Statement dated March 10, 1988 for the Annual Meeting of Stockholders on April 27, 1988 and hereby incorporated by reference.\n10.25* 1994 Stock Option Plan for Non-Employee Directors filed as Exhibit A to the Company's definitive Proxy Statement dated March 25, 1994 for the Annual Meeting of Stockholders on April 27, 1994 and hereby incorporated by reference.\n22.1 Subsidiaries of the Company.\n25.1 Powers of Attorney.\nb) Reports on Form 8-K\nThe Company filed no reports on Form 8-K during the three months ended December 31, 1993.\n*Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of this Report.\nSignatures\nPursuant 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.\nBrunswick Corporation\nMarch 28, 1994 By \/s\/ Thomas K. Erwin Thomas K. Erwin, Controller\nPursuant 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 and on the dates indicated.\nName Title\nJack F. Reichert Chairman of the Board, Chief Executive Officer (Principal Executive Officer) and Director\nJohn P. Reilly President, Chief Operating Officer and Director\nWilliam R. McManaman Vice President-Finance (Principal Financial Officer)\nThomas K. Erwin Controller (Principal Accounting Officer)\nMichael J. Callahan Director\nJohn P. Diesel Director\nDonald E. Guinn Director\nLeo Herzel Director\nGeorge D. Kennedy Director\nBernd K. Koken Director\nJay W. Lorsch Director\nBettye Martin Musham Director\nRobert N. Rasmus Director\nRoger W. Schipke Director\nThomas K. Erwin, pursuant to a Power of Attorney (executed by each of the officers and directors listed above and filed with the Securities and Exchange Commission, Washington, D.C.), by signing his name hereto does hereby sign and execute this report of Brunswick Corporation on behalf of each of the officers and directors named above in the capacities in which the names of each appear above.\nMarch 28, 1994 \/s\/ Thomas K. Erwin Thomas K. Erwin\nBrunswick Corporation Index to Financial Statements and Schedules\nPage\nConsolidated Financial Statements\nManagement's Discussion and Analysis 19 to 23\nStatements of Results of Operations 1993, 1992 and 1991 24\nBalance Sheets December 31, 1993 and 1992 25\nStatements of Cash Flows 1993, 1992 and 1991 26\nNotes to Financial Statements 1993, 1992 and 1991 27 to 54\nReport of Management 55\nReport of Independent Public Accountants 55,56\nFive Year Financial Summary 57\nSchedules\nConsent of Independent Public Accountants 58\nI- Marketable Securities 1993 59\nV- Property 1993, 1992 and 1991 60\nVI- Accumulated Depreciation 1993, 1992 and 1991 61\nVIII- Valuation and Qualifying Accounts 1993, 1992 and 1991 62\nX- Supplementary Income Statement Information 1993, 1992 and 1991 62\nAll other schedules are not submitted because they are not applicable or not required or because the required information is included in the consolidated financial statements or in the notes thereto. These notes should be read in conjunction with these schedules.\nThe separate financial statements of Brunswick Corporation (the parent company Registrant) are omitted because consolidated financial statements of Brunswick Corporation and its subsidiaries are included. The parent company is primarily an operating company, and all consolidated subsidiaries are wholly owned and do not have any indebtedness (which is not guaranteed by the parent company) to any person other than the parent or the consolidated subsidiaries in an amount that is material in relation to consolidated assets.\nBrunswick Corporation Management's Discussion and Analysis\nCash Flow, Liquidity and Capital Resources\nNet cash provided by operating activities increased $19.9 million in 1993 to $188.9 million from the $169.0 million reported in 1992. The increase resulted primarily from a $14.8 million improvement in earnings from continuing operations. Income taxes payable increased and deferred items, primarily income taxes, decreased as a result of the Company's January 1994 agreement with the U.S. Internal Revenue Service regarding the IRS examination of the Company for the years 1985 and 1986, as discussed in Note 15 to the consolidated financial statements. Charges in both years for the cumulative effect of changes in accounting principles and estimated losses on the divestiture of the Company's Technical Group did not involve cash expenditures.\nThe net cash used for investing activities decreased $39.8 million to $97.1 million in 1993 from the $136.9 million in 1992. The primary reason for the decrease was reduced payments for businesses acquired.\nNet cash used for financing activities was $38.5 million in 1993 compared to net cash provided by financing activities of $61.3 million in 1992. The 1993 financing activities included payment of long-term debt of $117.3 million, primarily for the redemption of the Company's 9.875% sinking fund debentures, as well as net proceeds of $122.9 million from the issuance of 7.375% debentures due in 2023. The 1992 financing activities included net proceeds of $104.5 million received from the sale of 6.5 million shares of common stock.\nWorking capital at December 31, 1993, was $347.8 million compared to $362.0 million at December 31, 1992. The Company's current ratio was 1.6 to 1 at December 31, 1993, and 1.7 to 1 at December 31, 1992.\nThe Company's long-term financing was primarily comprised of 30-year debentures, 10-year unsecured notes, loans secured by mortgages on property and the guarantee of $78.0 million of debt of the Brunswick Employee Stock Ownership Plan (ESOP). The form and timing of all financing is determined by the prevailing securities markets, the Company's capital requirements and its financial position. At December 31, 1993, the Company had unused short-term and long-term credit agreements totaling $400 million with a group of banks. The\nCompany's debt-to-capitalization ratio increased to 29.5% at December 31, 1993, from 28.0% at the end of 1992. Total debt increased $15.9 million to $336.4 million at December 31, 1993, from the $320.5 million at December 31, 1992.\nCapital expenditures, excluding acquisitions, were $95.8 million, $88.6 million and $74.7 million in 1993, 1992 and 1991, respectively. The Company continues to make capital expenditures which offer increased production efficiencies and improved product quality. The Company believes that existing cash balances and future operating results, supplemented when necessary with short and\/or long-term borrowings, will continue to provide the financial resources necessary for capital expenditures and working capital requirements.\nResults of Operations - 1993 vs 1992\nNet Sales\nThe Company's consolidated net sales for 1993 increased 7% to $2.21 billion from the $2.06 billion reported for 1992. Increases in both the Marine and Recreation segments contributed to this improvement.\nThe Marine segment's 1993 net sales increased 4% to $1.57 billion from $1.52 billion in 1992. Domestic sales of engines and boats increased 14% over the prior year, while international sales declined approximately 20% as major European and Asian markets continue to experience recessions. Price increases accounted for 2.5% of the 4% increase with the other 1.5% attributable to increased volume and mix changes. Unit sales of boats to dealers were slightly lower than dealers' retail sales in 1993 and, therefore, dealer inventories continue to remain at relatively low levels.\nThe Recreation segment's 1993 net sales increased 17% to $635.6 million from $543.3 million in 1992. The Brunswick Division sales increased 29% as international demand for capital equipment continued to increase, as did domestic demand for consumer products, supplies and parts. Zebco Division sales increased 15% due to domestic volume increases and the full year effect of a 1992 fourth quarter acquisition. The Brunswick Recreation Centers (BRC) Division sales were flat in 1993 compared to 1992 as price increases, which were limited by competitive pressures, offset slight lineage declines.\nOperating Earnings\nThe consolidated operating earnings increased $20.0 million to $99.8 million in 1993 from the $79.8 million reported for 1992. Both the Marine and Recreation segments contributed to this increase.\nThe Marine segment's operating earnings for 1993 rose 25% to $53.7 million from the $43.0 million in 1992. The previously discussed sales increase and the continuation of cost reduction programs begun four years ago, when the marine industry downturn began, contributed to the operating results improvement.\nThe Recreation segment's operating earnings were $80.0 million for 1993 compared to $65.2 million in 1992. The Brunswick Division benefited from the previously discussed sales increases which were partly offset by start-up costs associated with manufacturing its new composite golf shaft and plant rearrangement expenses in the golf unit. The Zebco Division operating earnings increased in line with the Division's sales increase. The BRC Division's operating earnings for 1993 declined from 1992 levels largely due to start-up costs for its Circus World Pizza operations.\nInterest and Other Items, Net\nInterest expense declined to $27.2 million in 1993 from $29.9 million in 1992. The decline resulted primarily from lower levels of ESOP and other debt and the net reduction in interest expense from the redemption of the 9.875% sinking fund debentures on August 9, 1993, and the sale of 7.375% debentures on August 25, 1993. Interest income and other items, net increased to $13.9 million in 1993 from $12.1 million in 1992, primarily due to increased equity in earnings of unconsolidated affiliates.\nIncome Taxes\nIn 1993, the Company recorded a tax provision of $32.0 million compared with a tax provision of $22.3 million in 1992. The effective tax rate for 1993 of 37% compares to 36% for 1992. The increase in the effective tax rate results primarily from an increase in the effective foreign tax rate which was offset by a net benefit from a change in the Federal statutory income tax rate. In January 1994, the Company reached an agreement with the U.S. Internal Revenue Service regarding its examination of the Company for the years 1985 and 1986. See Note 15 for additional discussion.\nResults of Operations - 1992 vs. 1991\nNet Sales\nThe Company's consolidated net sales for 1992 increased 12% to $2.06 billion from the $1.84 billion reported for 1991. Increases in both the Marine and Recreation segments accounted for this improvement.\nThe Marine segment's 1992 net sales of $1.52 billion were 11% above the $1.37 billion reported in 1991. Increased domestic demand for engines and boats resulted in the first year-to-year improvement since the marine industry downturn began in 1988, but the recession that affected domestic markets has spread to major European and Asian markets. Unit sales improved more than the sales increase in dollars as the strongest improvements were in the areas of fishing boats and outboard motors, which are typically in the lower price range of the products in the segment. Sales of boats to dealers were approximately even with retail sales in 1992, so dealer inventories remained at relatively low levels. In anticipation of a stronger spring selling season in 1993, dealers increased their engine inventories, primarily outboards, over the levels of the prior year.\nThe Recreation segment's 1992 net sales increased 15% to $543.3 million from $472.7 million in 1991. Each of the three Divisions in the segment reported increases. The Zebco Division experienced an increase of 29% as a result of increased volume to major retailers. The Brunswick Recreation Centers (BRC) Division increase of 3% resulted primarily from higher demand by value conscious consumers. The Brunswick Division net sales increased 14% on continued increases in international demand for capital equipment.\nOperating Earnings\nThe consolidated operating earnings of $79.8 million in 1992 compares to an operating loss of $18.4 million in 1991. The 1991 operating results include a $38.0 million provision for litigation matters, of which $30.0 million is included in the Marine segment.\nThe Marine segment's operating earnings for 1992 of $43.0 million compared to an operating loss of $30.5 million in 1991 which included the $30.0 million litigation provision. The previously discussed sales increases and the benefits of cost reduction programs, which included production consolidations and plant closings, begun three years ago when the marine industry downturn began, contributed to the operating results improvement.\nThe Recreation segment's operating earnings were $65.2 million for 1992 compared to $52.5 million in 1991. This increase resulted from higher operating earnings at the Zebco and Brunswick Divisions because of their sales increases and lower warranty costs in the Brunswick Division. The BRC Division's operating earnings were flat with the prior year, despite the small sales increase, because of pricing pressures on open (non-league) bowling.\nInterest and Other Items, Net\nInterest expense declined to $29.9 million in 1992 from $32.0 million in 1991. The Company utilized no commercial paper borrowings in 1992, resulting in a reduction of interest expense of $3.0 million. This reduction was partially offset by interest expense of $0.9 million on a foreign borrowing made in the fourth quarter of 1991. Interest income and other items, net increased to $12.1 million in 1992 from $9.9 million in 1991 primarily due to increased equity in earnings of unconsolidated affiliates.\nIncome Taxes\nIn 1992, the Company recorded a tax provision of $22.3 million compared with a tax benefit of $5.5 million in 1991. The effective tax rate in 1992 of 36% compares to a benefit rate of 13.6% in 1991. The 1991 benefit rate of 13.6% is below the statutory rate primarily due to the inability to utilize $9.3 million of foreign tax credits in the calculation of the consolidated tax provision.\nBrunswick Corporation Consolidated Statements of Results Of Operations For the Years Ended December 31, (in millions, except per share data)\nBrunswick Corporation Consolidated Balance Sheets As of December 31, (in millions, except per share data)\nConsolidated Statements Of Cash Flows For the Years ended December 31, (in millions)\nBrunswick Corporation Notes to Consolidated Financial Statements December 31, 1993, 1992 and 1991\n1. Significant Accounting Policies\nRestatement. The Company's consolidated financial statements have been restated to segregate the results of operations and net assets of the Company's discontinued Technical segment.\nIn addition, certain previously reported amounts have been reclassified to conform with year-end 1993 presentations.\nPrinciples of consolidation. The Company's consolidated financial statements include the accounts of its significant domestic and foreign subsidiaries, after eliminating transactions between Brunswick Corporation and such subsidiaries. Investments in certain affiliates, including some majority-owned subsidiaries which are immaterial, are reported using the equity method. Cash and cash equivalents. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less from the time of purchase to be cash equivalents.\nInventories. Approximately fifty percent of the Company's inventories are valued at the lower of first-in, first-out (FIFO) cost or market (replacement cost or net realizable value). All other inventories are valued at last-in, first-out (LIFO) cost, which is not in excess of market. Inventory cost includes material, labor and manufacturing overhead. Property. Property, including major improvements, is recorded at cost. The costs of maintenance and repairs are charged against results of operations as incurred.\nDepreciation is charged against results of operations over the estimated service lives of the related assets. Improvements to leased property are amortized over the life of the lease or the life of the improvement, whichever is shorter. For financial reporting purposes, the Company principally uses the straight-line method of depreciation. For tax purposes, the Company generally uses accelerated methods where permitted.\nSales and retirements of depreciable property are recorded by removing the related cost and accumulated depreciation from the accounts. Gains or losses on sales and retirements of property are reflected in results of operations.\nIntangibles. The costs of dealer networks, trademarks and other intangible assets are amortized over their expected useful lives using the straight-line method. Accumulated amortization was $253.2 million and $278.3 million at December 31, 1993 and 1992, respectively. The decline resulted primarily from fully amortized intangible assets of $60.6 million being written off. The excess of cost over net assets of businesses acquired is being amortized using the straight-line method, principally over 40 years. Accumulated amortization was $25.2 million and $21.7 million at December 31, 1993 and 1992, respectively. Subsequent to acquisition, the Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of its intangible assets may warrant revision or that the remaining balance of such assets may not be recoverable. When factors indicate that such assets should be evaluated for possible impairment, the Company uses an estimate of the related business segment's undiscounted cash flows or, in the case of goodwill, undiscounted operating earnings, over the remaining life of the asset in measuring whether the asset is recoverable.\nIncome taxes. Statement of Financial Accounting Standards No. 109 (SFAS No. 109), \"Accounting for Income Taxes\", was issued by the Financial Accounting Standards Board (FASB) in February 1992, effective for fiscal years beginning after December 15, 1992, with earlier adoption encouraged. The Company elected to adopt SFAS No. 109 as of January 1, 1992. The adoption of SFAS No. 109 changed the Company's method of accounting for income taxes from the deferred method (under APB No. 11) to an asset and liability approach. Previously, the Company deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax bases of assets and liabilities.\nRetirement plans. The Company accrues the cost of pension and retirement plans which cover substantially all employees. Pension costs, which are primarily computed using the projected unit credit method, are generally funded based on the minimum required contribution under the Employee Retirement Income Security Act of 1974 for the Company's domestic pension plans and in accordance with local laws and income tax regulations for foreign plans. During 1993, the Company contributed $19.0 million in excess of the required minimum funding for its domestic pension plans.\n2. Earnings (loss) Per Common Share\nEarnings (loss) per common share are based on the weighted average number of common and common equivalent shares outstanding during each period. Such average shares were 95.3 million, 92.7 million and 88.4 million for 1993, 1992 and 1991, respectively.\n3. Inventories\nAt December 31, 1993 and 1992, $133.7 million and $111.1 million, respectively, of inventories were valued using the LIFO method. If the FIFO method of inventory accounting had been used by the Company for inventories valued at LIFO, inventories at December 31 would have been $73.9 million and $71.2 million higher than reported for 1993 and 1992, respectively. The FIFO cost of inventories at these dates approximated replacement cost or net realizable value.\nInventories at December 31 consisted of the following:\n4. Investments\nOn April 14, 1992, the Company acquired a significant minority interest in Tracker Marine, L.P., a limited partnership, which manufactures and markets boats, trailers and accessories. The Company also entered into various other agreements, including contracts to supply outboard motors, trolling motors and various other Brunswick products for Tracker boats. The Company's total payments relating to these transactions were $25 million.\n5. Discontinued Operations\nIn February 1993, the Company's Board of Directors approved plans to divest the Technical Group, the only remaining business in the Company's Technical segment. A $26.0 million estimated loss ($42.0 million pretax) on the divestiture of the Technical Group and for certain other expenses of the previously divested Technical businesses was recorded in 1992. In 1993, the Company recorded an additional $12.2 million estimated loss ($20.0 million pretax) on the divestiture of the Technical Group which reflects the offers for that operation which the Company is reviewing.\nThe net sales and earnings from discontinued operations for each of the three years in the period ended December 31, 1993, were as follows:\nOperating losses of discontinued operations for 1993 have been charged against the reserve established in 1992.\n6. Acquisitions\nIn 1993, the Company purchased the assets of three companies. The consideration for these acquisitions totaled $2.1 million in cash.\nIn October 1992, the Company purchased certain assets of three companies in the United States and Europe, which comprised the Fishing Division of Browning, a line of fishing rods and reels. The consideration for these assets consisted of cash of $17.9 million and assumed liabilities of $2.1 million. The Company also purchased certain assets of another company for $1.9 million in cash in 1992.\nIn 1991, the Company purchased the assets of four companies. The consideration for these acquisitions totaled $1.8 million in cash.\nThe effect of the aforementioned acquisitions, which were accounted for as purchases, was not significant to the Company's consolidated results of operations in the year of acquisition.\n7. Commitments and Contingent Liabilities\nIt is customary within the marine industry for manufacturers to enter into product repurchase agreements with financial institutions that provide financing to marine dealers. The Company has entered into agreements which provide for the repurchase of its products from a financial institution in the event of repossession upon a dealer's default. Most of these agreements contain provisions which limit the Company's annual repurchase obligation. The Company accrues for the cost and losses that are anticipated in connection with\nexpected repurchases. Such losses are mitigated by the Company's resale of repurchased products. Repurchases and losses incurred under these agreements have not and are not expected to have a significant impact on the Company's results of operations. The maximum potential repurchase commitments at December 31, 1993 and 1992, were approximately $124.0 million and $136.0 million, respectively.\nThe Company also has various agreements with financial institutions that provide limited recourse on marine and bowling capital equipment sales. The maximum potential recourse liabilities outstanding under these programs were approximately $45.0 million and $40.0 million at December 31, 1993 and 1992, respectively. Recourse losses have not and are not expected to have a significant impact on the Company's results of operations.\nThe Company had outstanding standby letters of credit and financial guarantees of approximately $19.0 million and $34.0 million at December 31, 1993 and 1992, respectively, representing conditional commitments whereby the Company guarantees performance to a third party. The majority of these commitments are standby letters of credit which guarantee premium payment under certain of the Company's insurance programs.\nThe Company enters into interest rate swap agreements in connection with the management of its assets and liabilities and interest rate exposure. The differential to be paid or received is recognized over the lives of the agreements. These agreements are entered into to reduce the impact of changes in interest rates on the Company's investments and borrowings. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. The Company regularly monitors its positions and the credit ratings of these counterparties and considers the risk of default to be remote. At December 31, 1993 and 1992, the Company had an outstanding floating-to-floating interest rate swap agreement with a notional principal amount of $260.0 million that terminates in September 2003. The interest rate on this agreement is set on a semi-annual basis in arrears, the first such setting took place in March 1992. The Company also has entered into fixed-to-floating interest rate swap agreements through October 1996 on $200.0 million of its fixed-rate debt. The floating interest rates are set on a semi-annual basis. The first such setting took place in October 1993. The cost exposure of the interest rate swaps, which represents the net cost to terminate these agreements, is not material to the Company.\nThe Company also enters into forward exchange contracts to hedge the U.S. dollar exposure of its foreign operations. Realized and unrealized gains and losses on contracts are recognized and included in net income.\nAt December 31, 1993, the Company had contracted to exchange 1,057.2 million Belgian francs for $29.2 million during 1994. Had this contract been entered into on December 31, 1993, the Company would have to exchange 1,057.2 million Belgian francs for $29.8 million. A loss of $0.6 million has been included in net income. At December 31, 1992, the Company had contracted to exchange 46.8 million Deutsche marks for $29.2 million during 1993. Had this contract been entered into on December 31, 1992, the Company would have to exchange 46.8 million Deutsche marks for $28.4 million.\n8. Segment Information\nNet sales to customers include immaterial amounts sold to unconsolidated affiliates. Sales between domestic and foreign operations generally are priced with reference to prevailing market prices.\nOperating earnings of segments do not include the expenses of corporate administration, other expenses and income of a nonoperating nature, and provisions for income taxes.\nThe 1991 operating loss of the Marine segment includes litigation charges of $30.0 million. The 1991 Corporate expenses include litigation charges of $8.0 million.\nCorporate assets consist primarily of cash and marketable securities, prepaid income taxes and investments in unconsolidated affiliates.\nThe Company's export sales to unaffiliated customers for the three years ended December 31, 1993, 1992 and 1991 were $181.4 million, $218.2 million and $256.2 million, respectively.\n9. Accrued Expenses\nAccrued expenses at December 31 were as follows:\n10. Debt\nShort-term debt at December 31 consisted of the following:\nLong-term debt at December 31 consisted of the following:\nScheduled maturities 1995 $ 25.8 1996 6.1 1997 106.3 1998 10.8 Thereafter 175.5\n$ 324.5\nOn November 8, 1993, the Company and seventeen banks entered into a short-term credit agreement for $100 million and a long-term credit agreement for $300 million with termination dates of November 7, 1994, and December 31, 1996, respectively. With mutual agreement between the Company and the banks, the Company may extend both agreements. The short-term credit agreement may be extended each 364 day anniversary, but not beyond December 31, 1996. The long-term credit agreement contains two one-year extension options with the extension requests permitted on the first and second anniversaries.\nUnder terms of the new agreements, the Company has multiple borrowing options, including borrowing at a corporate base rate, as announced by The First National Bank of Chicago, or a rate tied to the Eurodollar rate. Currently, the Company must pay a facility fee of 0.1875% per annum on the short-term agreement and 0.25% per annum on the long-term agreement.\nUnder the agreements, the Company is subject to interest coverage, net worth and leverage tests, as well as a restriction on secured debt, as defined.\nOn the interest coverage test, the Company is required to maintain a ratio of consolidated income before interest and taxes, as defined, to consolidated interest expense of not less than 2.0 to 1.0 on a cumulative twelve-month basis. This ratio, on a cumulative twelve-month basis, was 3.7 to 1.0 at December 31, 1993. The leverage ratio of consolidated total debt to capitalization, as defined, may not exceed 0.55 to 1.00, and at December 31, 1993, this ratio was 0.30 to 1.00. The Company also is required to maintain shareholders' equity of at least $711.6 million at December 31, 1993. The required level of shareholders' equity at December 31 of each subsequent year is increased by 50% of net earnings for that year. The Company has complied with this limitation and the secured debt limitation as of December 31, 1993. There were no borrowings under the credit agreements at December 31, 1993.\nOn August 9, 1993, the $100 million 9.875% sinking fund debentures were redeemed by the Company at 105.704% of the principal amount of the debentures plus accrued interest to the redemption date. Proceeds of the Company's common stock offering in May 1992 of $104.5 million, and cash from operations were used to redeem the debentures. The Company recorded an after-tax extraordinary loss of $4.6 million ($7.4 million pretax) relating to this transaction during the third quarter of 1993. On August 25, 1993, the Company sold $125 million of 7.375% debentures maturing on September 1, 2023. The proceeds will be used for general corporate purposes.\nOn February 27, 1990, the Brunswick Employee Stock Ownership Plan (ESOP) sold $96.7 million principal amount of notes bearing interest at the rate of 8.2% per annum, which were guaranteed by the Company and are payable in semi-annual installments of interest and principal ending in 2004. The interest rate on these notes was reduced to 8.13% per annum, effective as of January 1, 1993, as a result of the change in tax law passed by the U.S. Congress in August 1993. Company contributions to the ESOP along with dividends paid on shares purchased with ESOP debt proceeds are used to service the ESOP debt. Under the terms of the ESOP debt agreement, future changes in tax law could cause the interest rate on the debt to vary within the range of 6.8% to 10.3%.\nThe carrying amounts for the short-term debt and current maturities of long-term debt approximate their fair value because of the short maturity of these instruments. The fair value of the long-term debt is $318.2 million and $316.3 million, respectively, versus carrying amounts of $324.5 million and $304.5 million, respectively, at December 31, 1993 and 1992. The fair value is based on quoted market prices where available or discounted cash flows using market rates available for similar debt of the same remaining maturities.\n11. Consolidated Common Shareholders' Equity (in millions, except per share data)\n12. Litigation\nThe Company is subject to certain legal proceedings and claims which have arisen in the ordinary course of its business and have not been finally adjudicated. In 1993, 1992 and 1991, the Company recorded pretax provisions of $18.2 million, $4.8 million and $38.0 million ($11.2 million, $3.1 million and $23.6 million after-tax), respectively, for litigation matters. In light of existing reserves, the Company's litigation and environmental claims, including those discussed below, when finally resolved, will not, in the opinion of management, have a material adverse effect on the Company's consolidated financial position and results of operations.\nThe Company is involved in certain legal and administrative proceedings under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 and other federal and state legislation governing the generation and disposition of certain hazardous wastes. These proceedings, which involve both on and off site waste disposal, in many instances seek compensation from the Company as a waste generator under Superfund legislation which authorizes action regardless of fault, legality of original disposition or ownership of a disposal site.\nIn June 1992, Genmar Industries brought an action against the Company and certain of its subsidiaries in the United States District Court for the District of Minnesota, alleging that the Company (i) has monopolized or attempted to monopolize the sale of recreational marine engines and boats, (ii) has unlawfully coerced engine purchasers to buy the Company's boats, (iii) has breached its contract with Genmar, (iv) has not dealt in good faith with Genmar, and (v) has interfered with Genmar's existing and prospective business relationships. Genmar has asked that the Company be required to divest its boat manufacturing business, be enjoined from continuing its partnership with Tracker Marine, and pay damages, including treble damages under the antitrust laws. The Company believes, based upon its assessment of the complaint and in consultation with counsel, that this litigation is without merit and intends to defend itself vigorously. Parties to this suit have exchanged written discovery and have begun depositions.\nThe Federal Trade Commission is conducting an investigation of whether the formation or operations of Tracker Marine, L.P. and the Company's contracts with Tracker Marine, L.P. violate antitrust laws. The Company has received and responded to a subpoena seeking information relating to the Company's outboard motor sales. The Company understands that other marine companies have received similar subpoenas from the Federal Trade Commission.\nIn August 1988, certain plaintiffs brought an action against the Company in the United States District Court in Los Angeles, California alleging violations of the federal antitrust laws arising out of their planned construction of a bowling center and asserting three claims under state law principles. On May 3, 1991, a jury returned a verdict against the Company in the amount of $5.1 million in actual damages and in the amount of one dollar in punitive damages. Pursuant to federal antitrust laws, plaintiffs' antitrust damages were trebled to $15.3 million. The plaintiff was also entitled to legal fees and costs totalling $1.4 million plus interest at the rate of 6.04% per annum on both the damage award and the attorney fees and costs. On October 13, 1993, the United States Court of Appeals reversed the District Court's judgment and directed that judgment be entered in favor of the Company.\n13. Stock Plans and Management Compensation\nOn April 24, 1991, shareholders of the Company approved the 1991 Stock Plan (Plan) to succeed the 1984 Restricted Stock Plan and the 1971 Stock Plan. Under this Plan, the Company may grant non-qualified stock options, incentive stock options, stock appreciation rights and restricted stock and other various types of awards to executives and other management employees of the Company. The Plan provides for the issuance of a maximum of 5,000,000 shares of common stock of the Company which may be authorized but unissued shares or treasury shares. No grants or awards were made under this Plan during 1991.\nDuring 1993 and 1992, non-qualified stock options were awarded to 413 and 420, respectively, executives and management employees of the Company. Under the terms of the Plan, the option price per share may not be less than 100% of the fair market value on the date of grant. The stock options are exercisable over a period of time determined by the Compensation Committee of the Board of Directors. In the event of a change in control as defined below, the option holder may exercise all unexercised options until the earlier of the stated expiration date or two years following termination of employment. At December 31, 1993, 263,110 shares were exercisable under outstanding options at a weighted average option price of $14.0077 per share.\nIn addition to stock options, restricted shares were also awarded during 1993 and 1992 to seventeen and sixteen senior executives of the Company, respectively. Restrictions will lapse on a portion of these shares four years from the date of grant and after five years on the remaining shares. As the restrictions lapse, the shares awarded are transferred to the employees. According to the terms of this grant, a participant may elect within 90 days of\na change in control to terminate the restricted period for all shares awarded to him. Charges against earnings from continuing operations for the compensation element of the Plan were $0.3 million and $0.2 million for 1993 and 1992, respectively.\nStock option and restricted stock activities including discontinued operations are as follows:\nSelected management employees, including employees of its discontinued operations, have received shares of the Company's common stock under the 1984 Restricted Stock Plan (1984 Plan). Under the 1984 Plan, 1,367,232 shares, net of canceled shares, have been awarded. No award has been made since 1991 and no further awards will be made under the 1984 Plan. After a restricted period of one to three years, the shares awarded are transferred to the employees. At that time, the employees may also receive a cash award if certain performance standards, as established by the Compensation Committee of the Board of Directors, have been met.\nThe 1984 Plan provides that, within 90 days after a change in control of the Company, a participant may elect to terminate the restricted period on shares of common stock awarded under the 1984 Plan. A \"change in control of the Company\" occurs when 1) any person is or becomes a beneficial owner directly or indirectly of 30% or more of the combined voting power of the Company, 2) individuals nominated by the Board of Directors for election as directors do not constitute a majority of the Board of Directors after such election, or 3) a tender offer is made for the Company's stock, involving a control block, which is not negotiated and approved by the Board of Directors.\nThe 1984 Plan also provides that the Compensation Committee may at any time reduce the restricted period for restricted stock of any participant or group of participants to a minimum of one year. Charges against earnings (loss) from continuing operations for the compensation element of the 1984 Plan were $0.7 million, $1.4 million, and $1.9 million for 1993, 1992 and 1991, respectively.\nUnder the 1971 Stock Plan (1971 Plan), certain other management employees were granted shares of the Company's common stock at no cost during 1988 through 1991. There have been no grants since 1991 and there will be no further grants under the 1971 Plan. The shares awarded or purchased under the 1971 Plan are subject to restrictions which lapse ratably over a period of one to five years. The shares will be released at the time of a change in control of the Company or on a date selected by the Compensation Committee. Charges against earnings (loss) from continuing operations for the compensation element of the 1971 Plan were $0.4 million in 1993, $0.6 million in 1992 and $1.0 million in 1991.\nThe Company has employment agreements with certain executive officers that become operative only upon a change in control of the Company, as defined above. In 1989, the Company established a severance plan for all other salaried employees of the Company which also only becomes operative upon a change in control of the Company. Compensation which might be payable under these agreements and the severance plan has not been accrued in the consolidated financial statements as a change in control has not occurred.\nUnder the Brunswick Employee Stock Ownership Plan (ESOP), the Company may make annual contributions to a trust for the benefit of eligible domestic employees in the form of either cash or common shares of the Company. In April 1989, the Company's Board of Directors approved an amendment to the ESOP that permits the ESOP to borrow funds to acquire the Company's common shares. Subsequent to that amendment, the ESOP obtained a bridge loan of $100 million and purchased from the Company 5,095,542 shares (ESOP Shares) of the Company's common stock at a price of $19.625 per share. The bridge loan was repaid with notes sold on February 27, 1990. The debt of the ESOP is guaranteed by the Company and is recorded in the Company's consolidated financial statements.\nThe ESOP Shares are maintained in a Suspense Account until released and allocated to participants' accounts. The release of shares from the Suspense Account is determined by multiplying the number of shares in the Suspense Account by the ratio of debt service payments (principal plus interest) made by the ESOP during the year to the sum of the debt service payments made by the\nESOP in the current year plus the debt service payments to be made by the ESOP in future years. Allocation of released shares to participants' accounts is done at the discretion of the Compensation Committee of the Board of Directors. The shares released from the Suspense Account were 327,900 in 1993 and 1992 and 327,899 in 1991 leaving 3,442,948 shares in the Suspense Account at December 31, 1993.\nThe expense recorded by the Company since 1989 is based on cash contributed or committed to be contributed by the Company to the ESOP during the year. Unamortized ESOP expense is reduced as the Company recognizes compensation expense (excluding the impact of dividends on ESOP Shares).\nIn 1993, 1992 and 1991, the ESOP made debt service payments totaling $11.2 million which were funded by Company contributions of $9.0 million and dividends received on ESOP shares of $2.2 million in each of the three years. The Company, including discontinued operations, recognized expense of $9.0 million in 1993, 1992 and 1991 ($5.5 million, $5.9 million and $5.6 million after-tax) of which $6.6 million, $7.0 million and $7.3 million, respectively, were recorded as interest expense and $2.4 million, $2.0 million and $1.7 million, respectively, were recorded as compensation expense.\n14. Retirement and Employee Benefit Costs\nThe Company has pension and retirement plans covering substantially all of its employees, including certain employees in foreign countries.\nPension cost of continuing operations for all plans was $7.3 million, $3.6 million and $6.2 million in 1993, 1992 and 1991, respectively. Plan benefits are based on years of service, and for some plans, the average compensation prior to retirement. Plan assets generally consist of debt and equity securities, real estate and investments in insurance contracts.\nPension costs for 1993, 1992 and 1991, determined in accordance with the Financial Accounting Standards Board Statement No. 87, \"Employers' Accounting for Pensions\" (SFAS No. 87), included the following components:\nThe funded status of the plans accounted for in accordance with SFAS No. 87 and the amounts recognized in the Company's balance sheets at December 31 were as follows:\nThe projected benefit obligations were determined primarily using assumed weighted average discount rates of 7.5% in 1993 and 8.5% in 1992, and an assumed compensation increase of 5.5% in 1993 and 1992. The assumed weighted average long-term rate of return on plan assets was primarily 9% in 1993 and 1992.\nThe unrecognized asset or liability at the initial adoption of SFAS No. 87 is being amortized on a straight-line basis over 10 years for the Company's domestic plans and over the average remaining service period of plan participants for the Company's foreign plans. The unrecognized prior service cost is being amortized on a straight-line basis over the average remaining service period of plan participants.\nTwo of the Company's salaried pension plans provide that in the event of a termination, merger or transfer of assets of the plans during the five years following a change in control of the Company occurring on or before March 1, 1996, benefits would be increased so that there would be no excess net assets. The Company's supplemental pension plan provides for a lump sum payout to plan participants of the present value of accumulated benefits upon a change in control of the Company. For a definition of \"change in control of the Company\" refer to Note 13.\nThe Company has an unfunded retirement plan which provides for payments to retired directors. This plan is accounted for as a deferred compensation arrangement and resulted in charges to net earnings (loss) of $0.2 million in 1993 and 1992 and $0.1 million in 1991.\nSea Ray employees participate in a noncontributory employee stock ownership and profit sharing plan, under which the Company makes annual cash contributions to a trust for the benefit of eligible employees. The charges to net earnings (loss) for this plan were $1.3 million, $1.4 million and $1.2 million in 1993, 1992 and 1991, respectively.\nCertain employees participate in a profit sharing plan to which the Company makes cash contributions. Participants become vested in the contributions after they are employed for a specified period. This plan resulted in charges to net earnings (loss) of $2.2 million, $2.1 million and $1.5 million in 1993, 1992 and 1991, respectively.\nThe Brunswick Retirement Savings Plan for salaried and certain hourly employees, including discontinued operations, allows participants to make contributions via payroll deductions pursuant to section 401(k) of the Internal Revenue Code. Effective January 1, 1991, the Company makes a minimum matching contribution of 5% of a participant's pretax contributions limited to 6%of their salary. The Company may increase the matching percentage to 30% of the participant's pretax contributions. The Company made 10% matching contributions in 1993 and 1992, and the minimum 5% matching contribution in 1991. The Company's contribution is made in common stock of the Company. In 1993 and 1992, the net charge to continuing operations for matching contributions was $0.5 million and $0.4 million in 1991.\nIn addition to providing benefits to present employees, the Company currently provides certain health care and life insurance benefits for eligible retired employees. Employees may become eligible for those benefits if they have fulfilled specific age and service requirements. The Company monitors the cost of these plans, and has, from time to time, changed the benefits provided under these plans. The plans contain requirements for retiree contributions generally based on years of service as well as other cost sharing features such as deductibles and copayments. The Company reserves the right to make additional changes or terminate these benefits in the future. The Company's plans are not funded; claims are paid as incurred.\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106), for its domestic unfunded postretirement health care and life insurance programs. SFAS No. 106 requires the cost of postretirement benefits to be accrued during the service lives of employees. As 1991 costs were recognized as expense when the claims were paid by the Company, postretirement benefit cost is not comparable with 1993 and 1992. The cumulative effect on years prior to 1992 of adopting SFAS No. 106 on an immediate recognition basis, including discontinued operations, was to decrease net earnings by $38.3 million. The Company had previously recognized approximately $9.6 million of its accumulated postretirement benefit obligation primarily in conjunction with the disposition of the non-Defense businesses of the Technical segment. Postretirement benefit cost was $6.4 million, $6.7 million and $1.4 million in 1993, 1992, and 1991, respectively.\nNet periodic postretirement benefit cost of continuing operations for 1993 and 1992 included the following components:\nThe amounts recognized in the Company's balance sheets at December 31 were as follows:\nThe accumulated postretirement benefit obligation was determined using weighted average discount rates of 7.5% in 1993 and 8.5% in 1992, and an assumed compensation increase of 5.5% in 1993 and 1992. The health care cost trend rates were assumed to be 12% and 10% in 1994 for pre-65 and post-65 benefits, respectively, gradually declining to 5% after eight years and four years, respectively, and remaining at that level thereafter. The health care cost trend rates were assumed to be 15%, and 10% in 1993 for pre-65 and post-65 benefits, respectively, gradually declining to 6% after ten years and seven years, respectively, and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, a 1% increase in the health care trend rate would increase the accumulated postretirement benefit obligation by $7.9 million at December 31, 1993 and the net periodic cost by $1.0 million for the year.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment\nBenefits\" (SFAS No. 112), for employees' disability benefits. SFAS No. 112 requires the accrual method for recognizing the cost of postemployment benefits. The cumulative effect on prior years of adopting SFAS No. 112, including discontinued operations, was to decrease net earnings by $14.6 million. The effect of this change on 1993 consolidated results of operations was not material.\n15. Income Taxes\nThe sources of earnings (loss) before income taxes are presented as follows:\nThe income tax provision (benefit) consisted of the following:\nTemporary differences and carryforwards which give rise to deferred tax assets and liabilities at December 31 are as follows:\nThe valuation allowance relates to deferred tax assets established under SFAS No. 109 for capital loss carryforwards of $3.1 million, and foreign tax credit carryforwards of $2.7 million. These unutilized loss and credit carryforwards, which will expire in 1996, will be carried forward to future years for possible utilization. No benefit for these carryforwards has been recognized in the financial statements. No other valuation allowances were deemed necessary, as all deductible temporary differences will be utilized either by carryback to prior years' taxable income, charges against reversals of future taxable temporary differences, or charges against expected future taxable income other than reversals. The change in the valuation allowance from 1992 to 1993 is primarily due to the utilization of foreign tax credit carryforwards which reduced income tax expense for the current year.\nDuring 1991, deferred income taxes were provided for timing differences in the recognition of revenue and expenses for tax and financial statement purposes. The deferred tax provision (benefit) consisted of the following:\n(in millions) U.S. Federal Litigation and claims $ (11.8) Restructuring charge 4.9 Employee benefits (1.8) Bad debts (0.1) Product warranty (0.5) Dealer allowances and discounts (2.0) Inventory 0.8 State and local taxes 2.5 Sales of businesses 2.2 Insurance (2.3) Depreciation and amortization (0.6) Other 0.5\n(8.2) Foreign 0.4\nTotal deferred tax (benefit) $ (7.8)\nDeferred taxes have been provided, as required, on the undistributed earnings of foreign subsidiaries and unconsolidated affiliates.\nThe difference between the actual income tax provision and the tax provision (benefit) computed by applying the statutory Federal income tax rate to earnings (loss) before taxes is attributable to the following:\nIn January 1994, the Company reached an agreement with the U.S. Internal Revenue Service regarding its examination of the Company for the years 1985 and 1986. The issues of this examination dealt primarily with the deductibility of approximately $500 million of acquired intangible assets, which the IRS proposed to reclassify to non-deductible intangible assets. Under the terms of the agreement, the IRS has agreed to allow amortization deductions for virtually all of the acquired intangible assets, and the Company has agreed to increase the amortizable lives of most of the acquired intangible assets.\nThe revised lives create a temporary difference which results in an initial obligation by the Company to pay the IRS approximately $55 million, representing taxes and interest net of taxes for the years 1986 through 1993. This initial $55 million obligation will subsequently be reduced by the future tax benefits of the temporary difference created by the agreement. Since the interest will be charged to existing reserves and the taxes paid represent temporary differences which create, and have been recorded as, deferred tax assets, this agreement will have no impact on the Company's consolidated results of operations.\n16. Translation of Foreign Currencies\nMost of the Company's foreign entities use the local currency as the functional currency and translate all assets and liabilities at year-end exchange rates, all income and expense accounts at average rates and record adjustments resulting from the translation in a separate component of common shareholders' equity. The following is an analysis of the cumulative translation adjustments reflected in common shareholders' equity:\nThe remaining foreign entities translate monetary assets and liabilities at year-end exchange rates and inventories, property and nonmonetary assets and liabilities at historical rates. Income and expense accounts are translated at the average rates in effect during the year, except that depreciation and cost of sales are translated at historical rates. Adjustments resulting from the translation of these entities are included in the results of operations. Gains and losses resulting from transactions of the Company and its subsidiaries which are made in currencies different from their own are included in income as they occur. Currency losses of $1.0 million and $5.1 million were recorded in 1993 and 1992, respectively, and a gain of $3.2 million was recorded in 1991.\n17. Leases\nThe Company has various lease agreements for offices, branches, factories, distribution and service facilities, certain Company-operated bowling centers, and certain personal property. These obligations extend through 2032.\nMost leases contain renewal options and some contain purchase options. Many leases for Company-operated bowling centers contain escalation clauses, and many provide for contingent rentals based on percentages of gross revenue. No leases contain restrictions on the Company's activities concerning dividends, additional debt or further leasing.\nRent expense consisted of the following:\nFuture minimum rental payments at December 31, 1993, under agreements classified as operating leases with noncancelable terms in excess of one year, are as follows: (in millions) 1994 $ 3.2 1995 2.5 1996 1.7 1997 1.6 1998 1.3 Thereafter 2.7\nFuture minimum operating lease rental payments (not reduced by minimum sublease rentals of $1.3 million) $ 13.0\n18. Technological Expenditures\nTechnological expenditures consisted of the following:\n19. Preferred Share Purchase Rights\nIn March 1986, the Company's Board of Directors declared a dividend of one Preferred Share Purchase Right (Right) on each outstanding share of the Company's common stock. After the two-for-one stock split distributed on June 9, 1987, under certain conditions, each holder of Rights may purchase one one-hundredth share of a new series of junior participating preferred stock at an exercise price of $100 for each two Rights held.\nThe Preferred Share Purchase Rights become exercisable at the earlier of (1) a public announcement that a person or group acquired or obtained the right to acquire 15% or more of the Company's common stock or (2) ten days after commencement or public announcement of an offer for more than 15% of the Company's common stock. After a person or group acquires 15% or more of the common stock of the Company, other shareholders may purchase additional shares of the Company at fifty percent of the current market price. These Rights may cause substantial ownership dilution to a person or group who attempts to acquire the Company without approval of the Company's Board of Directors.\nThe Rights, which do not have any voting rights, expire on March 31, 1996, and may be redeemed by the Company at a price of $.025 per Right at any time prior to a person's or group's acquisition of 15% or more of the Company's common stock. The new series of preferred stock that may be purchased upon exercise of the Rights may not be redeemed and may be subordinate to other series of the Company's preferred stock designated in the future. A Right also will be issued with each share of the Company's common stock that becomes outstanding prior to the time the Rights become exercisable or expire.\nIn the event that the Company is acquired in a merger or other business combination transaction, provision will be made so that each holder of Rights will be entitled to buy the number of shares of common stock of the surviving company, which at the time of such transaction would have a market value of two times the exercise price of the Rights.\n20. Unconsolidated Affiliates and Subsidiaries\nThe Company has certain unconsolidated foreign and domestic affiliates that are accounted for on the equity method.\nSummary financial information of the unconsolidated affiliates is presented below:\n21. Quarterly Data (unaudited)\nReport of Management\nThe Company maintains accounting and related internal control systems which are intended to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce records necessary for the preparation of financial information. There are limits inherent in all systems of internal control, and the cost of the systems should not exceed the expected benefits. Through the use of a program of internal audits and through discussions with and recommendations from its independent public accountants, the Company periodically reviews these systems and controls and compliance therewith.\nThe Audit Committee of the Board of Directors, comprised entirely of nonemployee directors, meets regularly with management, the internal auditors, and the independent public accountants to review the results of their work and to satisfy itself that their responsibilities are being properly discharged. The internal auditors and independent public accountants have full and free access to the Audit Committee and have discussions regarding appropriate matters, with and without management present.\nThe primary responsibility for the integrity of financial information rests with management. Certain valuations contained herein result, of necessity, from estimates and judgments of management. The accompanying consolidated financial statements, notes thereto, and other related information were prepared in conformity with generally accepted accounting principles applied on a consistent basis.\nReport of Independent Public Accountants To the Shareholders of Brunswick Corporation:\nWe have audited the accompanying consolidated balance sheets of Brunswick Corporation(a Delaware Corporation) and Subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of results of operations, and cash flows for each of three years ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Brunswick Corporation and Subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 14 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postemployment benefits, and effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules listed in the preceding index are the responsibility of the company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nArthur Andersen & Co.\nChicago, Illinois, February 6, 1994\nBrunswick Corporation Five Year Financial Summary\nConsent of Independent Public Accountants\nAs independent public accountants, we hereby consent to the incorporation of our report dated February 6, 1994, included in this Form 10-K, into the Company's previously filed registration statements on Form S-8 (File No. 33-4683), Form S-3 (File No. 33-61512) and Form S-8 (File No. 33-55022).\nArthur Andersen & Co.\nChicago, Illinois, March 28, 1994\nBrunswick Corporation Schedule I - Marketable Securities and Other Investments\nBrunswick Corporation Schedule V - Property\nBrunswick Corporation Schedule VI - Accumulated Depreciation\nBrunswick Corporation Schedule VIII - Valuation and Qualifying Accounts\nSchedule X - Supplementary Income Statement Information","section_15":""}
{"filename":"27673_1993.txt","cik":"27673","year":"1993","section_1":"ITEM 1. BUSINESS.\nTHE COMPANY\nThe principal business of John Deere Capital Corporation (Capital Corporation) is the purchasing and financing of retail installment sales and loan contracts (retail notes) from the equipment sales branches in the United States operated by Deere & Company and its wholly-owned subsidiaries (collectively called John Deere). These notes are acquired by the sales branches through John Deere retail dealers in the United States and originate in connection with retail sales by dealers of new John Deere agricultural equipment, industrial equipment and lawn and grounds care equipment, as well as used equipment. The Capital Corporation and its subsidiaries also purchase and finance retail notes unrelated to John Deere equipment, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine mortgage service companies (recreational product retail notes). The Capital Corporation and its subsidiaries also lease John Deere equipment to retail customers, finance and service unsecured revolving charge accounts acquired from merchants in the agricultural, lawn and grounds care and marine retail markets, and provide wholesale financing for recreational vehicles and John Deere engine inventories held by dealers of those products.\nThe Capital Corporation and its subsidiaries: Deere Credit, Inc., Farm Plan Corporation, Deere Credit Services, Inc. and John Deere Receivables, Inc. are collectively called the Company. John Deere Credit Company, a wholly-owned finance holding subsidiary of Deere & Company, is the parent of the Capital Corporation.\nRetail notes, revolving charge accounts, financing leases and wholesale notes receivable are collectively called \"Receivables.\" Receivables and operating leases are collectively called \"Receivables and Leases.\"\nThe Capital Corporation was incorporated under the laws of Delaware and commenced operations in 1958. At January 1, 1994, the Company had 852 full- and part-time employees.\nBUSINESS OF JOHN DEERE\nJohn Deere's operations are categorized into five business segments:\nJohn Deere's worldwide AGRICULTURAL EQUIPMENT segment manufactures and distributes a full range of equipment used in commercial farming -- including tractors; tillage, soil preparation, planting and harvesting machinery; and crop handling equipment.\nJohn Deere's worldwide INDUSTRIAL EQUIPMENT segment manufactures and distributes a broad range of machines used in construction, earthmoving and forestry -- including backhoe loaders; crawler dozers and loaders; four-wheel-drive\nloaders; scrapers; motor graders; excavators; and log skidders. This segment also includes the manufacture and distribution of engines and drivetrain components for the original equipment manufacturer (OEM) market.\nJohn Deere's worldwide LAWN AND GROUNDS CARE EQUIPMENT segment manufactures and distributes equipment for commercial and residential uses - including small tractors for lawn, garden and utility purposes; riding and walk-behind mowers; golf course equipment; utility transport vehicles; snowblowers; and other outdoor power products.\nThe products produced by the equipment segments are marketed primarily through independent retail dealer networks.\nThe CREDIT segment includes the operations of the Company (described herein), the Company's parent, John Deere Credit Company, and John Deere Finance Limited, which primarily purchases and finances retail notes from John Deere's equipment sales branches in Canada.\nThe INSURANCE AND HEALTH CARE segment issues policies in the United States and Canada primarily for: a general line of property and casualty insurance to John Deere and non-Deere dealers and to the general public; group life and group accident and health insurance for employees of participating John Deere dealers; group life and group accident and health insurance for employees of John Deere; life and annuity products to the general public and credit physical damage insurance in connection with certain retail sales of John Deere products financed by the credit subsidiaries. This segment also provides health management programs and related administrative services in the United States to corporate customers and employees of John Deere.\nJohn Deere's total worldwide net sales and revenues in 1993 and 1992, which include net sales of agricultural equipment, industrial equipment and lawn and grounds care equipment and revenues from credit, insurance and health care operations, were as follows: total net sales and revenues, $7.8 billion and $7.0 billion; total sales of equipment, $6.5 billion and $5.7 billion; agricultural equipment sales, $4.1 billion and $3.8 billion; industrial equipment sales, $1.3 billion and $1.0 billion; and lawn and grounds care equipment sales, $1.1 billion and $.9 billion, respectively. John Deere believes that its worldwide sales of agricultural equipment during recent years have been greater than those of any other business enterprise. It also believes that it is an important provider of most of the types of industrial equipment that it markets and a leader in some size ranges. John Deere also believes that it is the largest manufacturer of lawn and garden tractors and provides the broadest line of grounds care equipment in North America.\nJohn Deere's 1993 worldwide income before the effects of special items (accounting changes, restructuring charges and the new United States tax law) was $286 million compared with $37 million in 1992. Additional information concerning the special items is presented in the Deere & Company Annual Report on Form 10-K for the fiscal year ended October 31, 1993. John Deere's improved 1993 results were mainly attributable to North American equipment operations. Sales and production volumes in\nNorth America were higher this year in response to increased retail demand. Price realization also improved in all of John Deere's North American equipment businesses compared with 1992 as sales incentive cost levels were significantly lower. Also, North American productivity continued to improve during 1993. Additionally, income of John Deere's financial services subsidiaries was significantly higher in 1993 compared with 1992. After the effects of restructuring charges, the incremental expenses from the accounting changes and the tax rate change, John Deere's worldwide income in 1993 was $184 million. John Deere incurred a worldwide net loss in 1993 of $921 million after all of the special items, including the cumulative effect of the accounting changes.\nNorth American agricultural economic conditions were generally more favorable in 1993 than in 1992. Although flooding and excessively wet conditions in certain areas of the Midwest and drought conditions in parts of the Southeast resulted in an estimated 31 percent decrease in corn production and a 16 percent decline in soybean production in 1993, United States farm net cash income is expected to achieve a record level in 1993. The lower production caused grain prices to rise above 1992 levels. Livestock producers enjoyed favorable prices and profit margins during 1993 and farmers boosted their cash flow by selling inventories accumulated from record corn and soybean yields in 1992. Additionally, direct government payments to farmers are expected to increase in 1993, aiding farmers most heavily impacted by this year's flooding. Uncertainties over the passage of a new investment tax credit were resolved in 1993 as the anticipated tax credit was not included in the final tax legislation. Consequently, many United States farmers who had delayed making purchases in 1992 bought equipment this year. Sales in Canada were boosted by a special 13-month investment tax credit in effect from December 1992 to December 1993. As a result of these developments, North American retail sales of John Deere agricultural equipment were considerably higher in 1993 compared with last year.\nThe North American general economy continued its slow expansion in 1993. In the United States, housing starts increased about five percent during the year with second-half strength overcoming a very sluggish first half. Real public construction was up slightly from the previous year's level while nonresidential construction was flat. However, the cumulative effects of the rebound in economic activity were felt in 1993, as housing starts were up more than 25 percent from their 1991 level and real public construction was nine percent larger. North American retail sales of industrial and construction machinery for both the industry and John Deere rose significantly in 1993.\nConsumer spending for durable goods rose briskly in 1993, and North American retail sales of John Deere lawn and grounds care equipment increased significantly. Sales were also supported by favorable moisture conditions over most areas throughout the prime selling season. However, dry conditions did emerge in portions of the Southeast and Northeast which impeded some late season buying activity.\nIndustry retail sales of agricultural equipment in overseas markets in general remained relatively weak during 1993. However, overseas retail sales of John Deere agricultural equipment were higher in 1993 than in 1992, reflecting good acceptance of John Deere's new tractors and combines. Despite recessionary conditions prevailing in most European markets and in Japan, overseas retail sales of John Deere lawn and\ngrounds care equipment continued to expand in 1993. Overseas industrial and construction equipment markets were relatively flat in 1993 compared with 1992.\nRELATIONSHIPS OF THE COMPANY WITH JOHN DEERE\nThe operations and results of the Company are affected by its relationships with John Deere, including, among other things, the terms on which the Company acquires Receivables and Leases and borrows funds from John Deere, the reimbursement for waiver and low-rate finance programs from John Deere and the payment to John Deere for various expenses applicable to the Company's operations. In addition, the Capital Corporation and John Deere have joint access to all of the Capital Corporation's bank lines of credit.\nThe Company's acquisition of Receivables and Leases is largely dependent upon the level of retail sales and leases of John Deere products. The level of John Deere retail sales and leases is responsive to a variety of economic, financial, climatic and other factors which influence demand for its products. Since 1986, the Company has also been providing retail sales financing through dealers of certain unrelated manufacturers of recreational vehicles and recreational marine products. The net balance of recreational product retail notes outstanding under these arrangements at October 31, 1993 totaled $804 million.\nThe Company bears all of the credit risk (net of recovery from withholdings from certain John Deere dealers and Farm Plan merchants) associated with its holding of Receivables and Leases, and performs all servicing and collection functions. The Company compensates John Deere for originating retail notes and leases on John Deere products or through John Deere dealers. John Deere is also reimbursed for staff and other administrative services at estimated cost, and for credit lines provided to the Company based on utilization of those lines.\nThe terms of retail notes and the basis on which the Company acquires retail notes from John Deere are governed by agreements with the sales branches, terminable by either the sales branches or the Company on 30 days notice. As provided in these agreements, the Company sets its terms and conditions for purchasing the retail notes from the sales branches. Under these agreements, the sales branches are not obligated to sell retail notes to the Company, and the Company is obligated to purchase retail notes from the sales branches only if the notes comply with the terms and conditions set by the Company.\nThe terms of retail notes and the basis on which the sales branches acquire retail notes from the dealers are governed by agreements with the independent John Deere dealers, terminable at will by either the dealers or the sales branches. In acquiring the retail notes from dealers, the terms and conditions, as set forth in agreements with the dealers, conform with the terms and conditions adopted by the Company in determining the acceptability of retail notes to be purchased from the sales branches. The dealers are not obligated to send retail notes to the sales branches, and the sales branches are not obligated to accept retail notes from the dealers. In practice, retail notes are acquired from dealers only if the terms of the notes and the creditworthiness of the customers are\nacceptable to the Company for purchase of the notes from the sales branches. The Company acts on behalf of both itself and the sales branches in determining the acceptability of the notes and in acquiring acceptable notes from dealers.\nThe terms of leases, and the basis on which the Company enters into such leases with retail customers through John Deere dealers, are governed by agreements between dealers and the Company. Leases are accepted based on the lessees' creditworthiness, the anticipated residual values of the equipment and the intended uses of the equipment.\nDeere & Company has expressed an intention of conducting its business with the Company on such terms that the Company's consolidated ratio of earnings before fixed charges to fixed charges will not be less than 1.05 to 1 for any fiscal quarter. For 1993, the ratio was 1.99 to 1 (excluding the effects of accounting changes) and for 1992, it was 1.74 to 1. For additional information concerning these accounting changes, see note 1 to the consolidated financial statements. This arrangement is not intended to make Deere & Company responsible for the payment of obligations of the Company.\nDESCRIPTION OF RECEIVABLES AND LEASES\nReceivables and Leases arise mainly from the retail sale or lease (including the sale to John Deere dealers for rental to users) of John Deere products, used equipment accepted in trade for them, and equipment of unrelated manufacturers, and also include revolving charge accounts receivable and wholesale notes receivable. The great majority derive from retail sales and leases of agricultural equipment, industrial equipment and lawn and grounds care equipment sold by John Deere dealers. The Company also offers financing to recreational product customers through the secured retail financing of recreational vehicles and recreational marine products. The Company also offers Farm Plan revolving charge accounts which are used primarily by agri-businesses to finance customer purchases, as well as credit cards which are used primarily by retail customers to finance purchases of John Deere lawn and grounds care equipment and marine equipment. Retail notes provide for retention by John Deere or the Company of security interests under certain statutes, including the Uniform Commercial Code or comparable state statutes, certain Federal statutes, and state motor vehicle laws. See notes 1 and 2 to the consolidated financial statements.\nRecreational product retail notes conform to industry standards different from those for John Deere retail notes and often have smaller down payments and longer repayment terms. In addition, the volumes, margins, and collectibility of recreational product retail notes are affected by different economic, marketing and competitive factors and cycles, such as fluctuations in fuel prices and recreational spending patterns, than those affecting retail notes arising from the sale of John Deere equipment. Recreational product retail notes are acquired from more than 1,400 recreational vehicle dealers throughout the United States, representing a variety of manufacturers, and from approximately 900 marine product dealers.\nReceivables and Leases are eligible for acceptance if they conform to prescribed finance and lease plan terms. Guidelines relating to down payments and contract terms\non retail notes and leases are described in note 2 to the consolidated financial statements.\nThe John Deere Credit Revolving Plan is used primarily by retail customers of John Deere dealers to finance purchases of John Deere lawn and grounds care equipment. Additionally, through its Farm Plan credit product, the Company finances revolving charge accounts offered by approximately 2,100 participating agri-businesses in the 48 contiguous states to their retail customers for the purchase of goods and services. Farm Plan account holders consist mainly of farmers purchasing equipment parts and service at implement dealerships. Farm Plan revolving charge accounts are also used by customers patronizing other agribusinesses, including farm supply, feed and seed, parts supply, bulk fuel, building supply and veterinarians. John Deere Marine Finance is used by the Company's marine customers to finance the purchase of marine related products. See notes 1 and 2 to the consolidated financial statements under \"Revolving Charge Accounts Receivable.\"\nThe Company finances recreational vehicle inventories and John Deere engines for approximately 300 dealers. A portion of the wholesale financing provided by the Company is with dealers from whom it also purchases recreational product retail notes. See notes 1 and 2 to the consolidated financial statements under \"Wholesale Receivables.\"\nThe Company requires that theft and physical damage insurance be carried on all equipment leased or securing retail notes. The customer may, at his own expense, have the Company purchase this insurance or obtain it from other sources. Theft and physical damage insurance is also required on wholesale notes and can be purchased through the Company or from other sources. If the customer elects to purchase theft and physical damage insurance through the Company, the Company purchases it from insurance subsidiaries of Deere & Company. Insurance is not required for revolving charge accounts.\nIn some circumstances, Receivables and Leases may be accepted and acquired even though they do not conform in all respects to the established guidelines. Acceptability and servicing of retail notes, wholesale notes and leases, according to the finance plans and retail terms, including any waiver of conformity with such plans and terms, is determined by Company personnel. Officers of the Company are responsible for reviewing the performance of the Company in accepting and collecting retail notes, wholesale notes and leases. The Company normally makes all routine collections, compromises, settlements and repossessions on Receivables and Leases.\nFINANCE RATES ON RETAIL NOTES\nAs of October 31, 1993, approximately 57 percent of the net dollar value of retail notes held by the Company bore a variable finance rate. Recreational product retail notes are primarily fixed-rate notes.\nA portion of the finance income earned by the Company arises from retail sales of John Deere equipment sold in advance of the season of use or in other sales promotions\nby John Deere on which finance charges are waived by John Deere for a period from the date of sale to a specified subsequent date. Some low-rate financing programs are also offered by John Deere. The Company receives compensation from John Deere approximately equal to the normal net finance charge on retail notes for periods during which finance charges have been waived or reduced. The portions of the Company's finance income earned that were received from John Deere on retail notes containing waiver of finance charges or reduced rates was 19 percent in 1993 and 17 percent in 1992.\nRECEIVABLES AND LEASES ACQUIRED AND HELD\nReceivable and Lease acquisitions during the fiscal years ended and amounts held at October 31, 1993 and 1992 were as follows in millions of dollars:\nJohn Deere equipment note acquisitions were slightly lower in the current year due primarily to a larger volume of cash purchases by John Deere customers and a more competitive agricultural financing environment. Lower acquisitions of agricultural and lawn and grounds care equipment notes were partially offset by higher acquisitions of industrial equipment notes. Acquisitions of recreational product retail notes were 20 percent lower in the current year due to a more competitive market for recreational product financing.\nThe Company's business is somewhat seasonal, with overall acquisitions of credit receivables traditionally higher in the second half of the fiscal year than in the first half, and overall collections of credit receivables traditionally somewhat higher in the first six months than in the last half of the fiscal year.\nFrom time to time, the Capital Corporation sells retail notes to other financial institutions and in the public market. The Capital Corporation received net proceeds from such sales of John Deere retail notes of $1.143 billion in 1993 and $683 million in 1992. The net unpaid balance of all retail notes previously sold was $1.394 billion at October 31, 1993 and $688 million at October 31, 1992. For additional information on the terms, conditions, recourse and accounting for such sales, see note 2 to the consolidated financial statements.\nAVERAGE ORIGINAL TERM AND AVERAGE LIFE OF RETAIL NOTES AND LEASES\nThe following table shows the estimated average original term in months (based on dollar amounts) for retail notes and leases acquired by the Company during 1993 and 1992:\nBecause of prepayments, the average actual life of retail notes is considerably shorter than the average original term. The following table shows the estimated average life in months (based on dollar amounts) for John Deere retail notes and leases liquidated in 1993 and 1992:\nDEPOSITS WITHHELD ON RECEIVABLES AND LEASES\nGenerally, the Company has limited recourse against certain John Deere dealers on retail notes and leases and against certain Farm Plan merchants on revolving charge account balances acquired from or through those dealers and merchants. For these John Deere dealers and Farm Plan merchants, separate withholding accounts are maintained by the Company. The total amount of deposits withheld from John Deere dealers and Farm Plan merchants totaled $104.9 million and $100.7 million at October 31, 1993 and 1992, respectively. Of this amount, deposits withheld from Farm Plan merchants totaled $.4 million at October 31, 1993 and $ .8 million at October 31, 1992. Credit losses are charged against these withheld deposits. To the extent that a loss cannot be absorbed by the deposit withheld from the dealer or merchant from which the retail note, lease or Farm Plan account was acquired, it is charged against the Company's allowance for credit losses. Beginning in January 1992, all industrial equipment retail notes have been accepted on a non-recourse basis, and the withholding of dealer deposits on those notes ceased. See note 1 to the consolidated financial statements.\nThe Company does not withhold deposits on recreational product retail notes, credit card receivables, or wholesale notes acquired. However, an\nallowance for credit losses has been established by the Company in an amount considered to be appropriate in relation to the Receivables and Leases outstanding. In addition, for wholesale notes relating to recreational vehicles, there are agreements with the recreational vehicle manufacturers for the repurchase of new inventories held by dealers. For additional information on credit losses and deposits withheld on Receivables and Leases, see note 3 to the consolidated financial statements.\nDELINQUENCIES AND LOSSES\nRETAIL NOTES. The following table shows unpaid installments 60 days or more past due on retail notes held by the Company and the total unpaid balances on the retail notes with such delinquencies, on the basis of retail note terms in effect at the indicated dates, in millions of dollars and as a percentage of retail notes at face value held by the Company at such dates:\nThe following table shows losses on retail notes in millions of dollars (after charges to withheld dealer deposits) and as a percentage of retail notes liquidated:\nThe decrease in losses in 1993 and 1992 related mainly to lower write-offs of recreational product retail notes, primarily as a result of the development and use of more selective credit criteria over the past few years, and lower write-offs of John Deere industrial equipment retail notes. The losses incurred in 1991 related primarily to recreational product retail notes, resulting from recessionary pressures and lower resale values of repossessed equipment. Write-offs of recreational product retail notes totaled $16.9 million in 1993 compared with $24.2 million in 1992 and $33.3 million in 1991.\nREVOLVING CHARGE ACCOUNTS. The following table shows revolving charge account payments 60 days or more past due in millions of dollars and as a percentage of total revolving charge accounts receivable:\nThe following table shows losses on revolving charge accounts in millions of dollars and as a percentage of revolving charge amounts liquidated:\nLosses declined in 1993 and 1992 for both Farm Plan and the John Deere Credit Revolving Plan reflecting improvements in the Company's overall collection procedures and improved economic conditions. The losses incurred in 1991 were due primarily to general recessionary conditions in the economy.\nLEASES. The following table shows finance and operating lease payments 60 days or more past due in millions of dollars and as a percent of the total lease payments receivable:\nThe following table shows losses absorbed by the Company, in millions of dollars and as a percent of total lease proceeds, on terminated financing and operating leases (after charges to withheld dealer deposits). Total lease proceeds include collections from regularly scheduled lease payments and proceeds from the disposal of equipment.\nThe decline in 1993 losses resulted from improvements in the Company's overall collection procedures and improved economic conditions. The decline in 1992 losses resulted from a more seasoned and smaller lease portfolio. The losses incurred in 1991 related primarily to the overall recessionary environment.\nWHOLESALE NOTES. The following table shows wholesale note payments 60 days or more past due in millions of dollars and as a percentage of wholesale notes receivable:\nThe following table shows wholesale note losses in millions of dollars and as a percentage of wholesale note amounts liquidated:\nThe losses in 1993 and 1991 resulted primarily from relatively large losses incurred with two recreational vehicle dealers, one in each of those years.\nCOMPETITION\nThe businesses in which the Company is engaged are highly competitive. The Company competes for customers based upon customer service and finance rates (or time-price differentials) charged. The proportion of John Deere equipment retail sales and leases financed by the Company is influenced by conditions prevailing in the agricultural equipment, industrial equipment and lawn and grounds care equipment industries, in the financial markets, and in business generally. A significant portion of such retail sales during 1993 were financed by the Company. A substantial part of the retail sales and leases eligible for financing by the Company is financed by others, including banks and other finance and leasing companies.\nThe Company attempts to emphasize convenient service to retail customers and to offer terms desired in its specialized markets such as seasonal installment schedules of repayment and rental. The Company's sales and loan finance rates, time-price differentials and lease rental rates are believed to be in the range of those of sales finance and leasing companies generally, although not as low as those of some banks and other lenders and lessors.\nREGULATION\nIn a number of states, the maximum finance rate or time-price differential on retail notes is limited by state law. The present state limitations have not, thus far, significantly limited the Company's variable-rate finance charges, which are determined in relation to a base rate quoted by a bank, nor the fixed-rate finance charges established by the Company. However, if interest rate levels should increase, maximum state rates or time-price differentials could affect the Company by preventing the variable rates on outstanding variable-rate retail notes from increasing above the maximum state rate or time-price differential, and\/or by limiting the fixed rates or time-price differentials on new notes. In some states, the Company may be able to qualify new retail notes for a higher maximum limit by using retail installment sales contracts (rather than loan contracts) or by using fixed-rate rather than variable-rate contracts.\nIn addition to rate regulation, various state and federal laws and regulations apply to some Receivables and Leases, principally retail notes for goods sold for personal, family or household use and to Farm Plan and John Deere revolving charge accounts receivable for such goods. To date, such laws and regulations have not had a significant, adverse effect on the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's properties principally consist of office equipment and leased office space in Reno, Nevada; West Des Moines, Iowa; Moline, Illinois; Madison, Wisconsin; and Ft. Lauderdale, Florida.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is subject to various unresolved legal actions which arise in the normal course of its business. The most prevalent of such actions relates to state and federal regulations concerning retail credit. There are various claims and pending actions against the Company with respect to commercial and consumer financing matters. These matters include lawsuits pending in federal and state courts in Texas alleging that certain of the Company's retail finance contracts for recreational vehicles and boats violate certain technical provisions of Texas consumer credit statutes dealing with maximum rates, licensing and disclosures. The plaintiffs in Texas claim they are entitled to common law and statutory damages and penalties. On November 6, 1992, the federal District Court certified a federal class action under Rule 23(b)(3) of the Federal Rules of Civil Procedure in an action brought by Russell Durrett, individually and on behalf of others, against John Deere Company (filed in state court on February 19, 1992 and removed on February 26, 1992 to the United States District Court for the Northern District of Texas, Dallas Division). On October 12, 1993, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992, the 281st District Court for Harris County, Texas, certified a class under Rules 42(b)(1)(A), 42(b)(1)(B) and 42(b)(2) of the Texas Rules of Civil Procedure, of all persons who opt out of the federal class action. The Company believes that it has substantial defenses and intends to defend the actions vigorously. Although it is not possible to predict the outcome of these unresolved legal actions, and the amounts of claimed damages and penalties are large, the Company believes that these unresolved legal actions will not have a material adverse effect on its consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOmitted pursuant to instruction J(2).\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll of the Capital Corporation's common stock is owned by John Deere Credit Company, a finance holding company that is wholly-owned by Deere & Company.\nIn 1993, the Capital Corporation paid a cash dividend to John Deere Credit Company of $82 million, which in turn paid an $82 million cash dividend to Deere & Company. Similarly during 1992, the Capital Corporation paid a $70 million dividend. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nOmitted pursuant to instruction J(2).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1993 COMPARED WITH 1992\nTotal acquisitions of Receivables and Leases by the Company increased five percent during 1993 compared with acquisitions in 1992. The higher acquisitions this year resulted from an increased volume of John Deere leases, revolving charge accounts and wholesale receivables, which more than offset lower acquisitions of retail notes. Receivables and Leases held by the Company at October 31, 1993 totaled $3.437 billion compared with $4.060 billion one year ago. This decrease resulted from sales of retail notes during 1993. Receivables and Leases administered, which include retail notes previously sold but still administered, amounted to $4.873 billion at the end of 1993 compared with $4.796 billion at October 31, 1992.\nDuring 1993, net retail notes (face value less unearned finance income) acquired by the Company decreased three percent compared with 1992. Net retail note acquisitions totaled $2.136 billion during 1993 compared with 1992 acquisitions of $2.207 billion. Acquisitions of recreational product retail notes accounted for nine percent of total note acquisitions in 1993 and 11 percent in 1992.\nNet retail note acquisitions from John Deere decreased by $22 million in 1993, due primarily to a larger volume of cash purchases by John Deere customers and a more competitive agricultural financing environment. Lower acquisitions of agricultural and lawn and grounds care equipment notes were partially offset by higher acquisitions of industrial equipment notes. Note acquisitions in 1993 from John Deere continued to represent a significant proportion of the total United States retail sales of John Deere equipment.\nNet acquisitions of recreational product retail notes, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of several unrelated manufacturers, were $202 million in 1993 compared with $251 million in 1992. This decline was due mainly to a more competitive market for recreational product financing and more selective acquisition criteria.\nAt October 31, 1993, the net amount of retail notes held by the Company was $2.792 billion compared to $3.509 billion last year. Included in these amounts were recreational product notes of $804 million in 1993 and $870 million in 1992. The net balance of John Deere retail notes decreased from $2.639 billion at October 31, 1992 to $1.988 billion at the end of 1993, even though net retail\nnotes acquired exceeded collections. This decrease resulted primarily from the sale of retail notes during 1993. The Company periodically sells retail notes as one of several funding techniques. In 1993 and in 1992, the Company received net proceeds of $1.143 billion and $455 million, respectively, from the sale of retail notes to limited-purpose business trusts which utilized the notes as collateral for the issuance of asset backed securities to the public. During 1992, the Company also sold retail notes to other financial institutions receiving proceeds of $228 million. The net balance of retail notes administered by the Company, which include retail notes previously sold, amounted to $4.185 billion at 31 October 1993, compared with $4.197 billion at 31 October 1992. The net balance of retail notes previously sold was $1.394 billion at October 31, 1993 compared with $688 million at October 31, 1992. Additional sales of retail notes are expected to be made in the future. On October 31, 1993, the Company was contingently liable for recourse in the maximum amount of $108 million on retail notes sold.\nRetail notes bearing variable finance rates totaled 57 percent of the total retail note portfolio at October 31, 1993 compared with 54 percent one year earlier. The Company actively manages the increased interest rate risk posed by fixed-rate retail notes through the issuance of fixed-rate borrowings and the use of financial instruments such as interest rate swaps and interest rate caps. See \"Capital Resources and Liquidity\" on pages 22 through 24.\nAt the end of fiscal 1993, revolving charge accounts receivable totaled $331 million, an increase of 24 percent compared with $268 million at October 31, 1992. The balance at October 31, 1993 included $147 million of John Deere Credit Revolving Plan receivables (including a small balance of marine finance receivables) and $184 million of Farm Plan receivables compared with $114 million and $154 million, respectively, at October 31, 1992. The John Deere Credit Revolving Plan, which was introduced in 1993, contains terms that increase the maximum amount financed, offer more attractive financing conditions and provide more flexible payment terms. Revolving charge account acquisitions increased 23 percent in 1993 compared with last year.\nThe portfolio of net financing leases totaled $85 million at both October 31, 1993 and October 31, 1992. The net investment in operating leases was $119 million and $85 million at the end of 1993 and 1992, respectively. Overall, lease acquisitions increased 84 percent in 1993 primarily due to a new lease program applicable to some models of John Deere tractors. In addition, $19 million of municipal leases were sold to Deere & Company during 1993 compared with $21 million sold last year. At October 31, 1993, the net unpaid balance of leases sold to John Deere was $43 million compared with $48 million at October 31, 1992.\nWholesale notes on recreational vehicle and John Deere engine inventories totaled $110 million at October 31, 1993 compared with $112 million at October 31, 1992.\nTotal Receivable and Lease amounts 60 days or more past due were $12.7 million at October 31, 1993 compared with $14.6 million at October 31, 1992.\nThese past-due amounts represented .30 percent of the face value of Receivables and Leases held at October 31, 1993 and .29 percent at October 31, 1992. The total face amount of retail notes held with any installment 60 days or more past due was $42.3 million at October 31, 1993 compared with $55.6 million one year earlier. The amount of retail note installments 60 days or more past due was $7.0 million at both October 31, 1993 and October 31, 1992. These past-due installments represented .19 percent of the unpaid face value of retail notes at October 31, 1993 and .15 percent at October 31, 1992.\nThe total balance of revolving charge accounts receivable 60 days or more past due was $5.3 million at October 31, 1993 compared with $6.4 million at October 31, 1992. These past due amounts represented 1.6 and 2.4 percent of the revolving charge accounts receivable held at each of those respective dates. The total balance of financing and operating lease payments 60 days or more past due was $0.5 million at October 31, 1993 compared with $1.2 million at October 31, 1992. These past-due installments represented .3 percent of the total lease payments receivable at October 31, 1993 and .8 percent at October 31, 1992.\nAt October 31, 1993, the Company's allowance for credit losses, totaled $77 million and represented 2.3 percent of the total net Receivables and Leases financed compared with $83 million and 2.0 percent, respectively, one year earlier. Deposits withheld from dealers and merchants, which are available for potential credit losses, totaled $105 million at October 31, 1993 compared with $101 million one year earlier.\nThe Capital Corporation's consolidated income for the fiscal year ended October 31, 1993, before the cumulative effect of adopting new accounting standards related to postretirement and postemployment benefits, was $111.0 million compared with 1992 net income of $95.0 million. The ratio of earnings before fixed charges to fixed charges was 1.99 to 1 (excluding the effects of accounting changes) for 1993 compared with 1.74 to 1 last year. The improvement in net income resulted primarily from higher securitization and servicing fee income from retail notes previously sold, lower credit losses, higher financing margins, and increased gains from the sale of retail notes, which more than offset the effects of a lower balance of Receivables and Leases financed. Net income totaled $107.2 million in 1993, including the cumulative effect of adopting FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and FASB Statement No. 112, Employers' Accounting for Postemployment Benefits.\nTotal revenues decreased one percent during 1993 to $466 million compared with $471 million in 1992. The average balance of total net Receivables and Leases financed was seven percent lower in 1993 compared with last year due primarily to the sale of receivables during 1993. Revenues were also affected by the lower level of interest rates and the corresponding lower finance charges earned in 1993 compared with last year. These decreases in revenues were partially offset by higher securitization and servicing fee income from retail notes previously sold. However, borrowing rates were also lower this year resulting in the slightly improved financing margins. The lower borrowing rates and decrease\nin average borrowings this year resulted in an 11 percent decrease in interest expense, which totalled $168 million in 1993 compared with $189 million last year. Average borrowings were $3.127 billion in 1993, a seven percent decline from last year's average borrowings of $3.379 billion. The weighted average annual interest rate incurred on all interest-bearing borrowings this year declined to 5.1 percent from 5.4 percent in 1992.\nFinance income earned on retail notes was $314 million this year compared with $356 million in 1992, a decrease of 12 percent. The average balance of the net retail note portfolio financed during 1993 was 10 percent lower than during 1992.\nRevenues earned on revolving charge accounts amounted to $54 million in 1993, a 14 percent increase over revenues of $47 million earned during 1992. This increase was primarily due to a 20 percent increase in the average balance of Farm Plan receivables financed and a 15 percent increase in the average balance of John Deere Credit Revolving Plan receivables financed in 1993 compared with 1992.\nThe average net investment in financing and operating leases decreased by two percent in 1993 compared with 1992. However, total lease revenues increased eight percent to $39.6 million in 1993 compared with $36.8 million in 1992. Lease revenues were favorably affected in 1993 by a significant increase in rentals earned on operating leases.\nThe net gain on retail notes sold totaled $15.6 million during 1993 compared with $8.5 million for 1992. The Company received proceeds from the sale of retail notes in the amount of $1.143 billion during 1993 and $683 million in 1992. Securitization and servicing fee income totaled $22.3 million in 1993 compared with $1.1 million during 1992. Securitization and servicing fee income relates to retail notes sold to limited-purpose business trusts and includes the amortization of present value receivable amounts from the trusts established at the time of sale and reimbursed administrative expenses received from the trusts. The amount of securitization and servicing fee income was small in 1992 because the first retail note sale to a trust occurred near the end of that year.\nAdministrative and operating expenses increased 18 percent to $75 million in 1993 compared with $63 million in 1992. These expenses increased primarily due to higher employment costs and legal expenses. The Company incurred additional costs associated with efforts relating to future growth and improving the quality of the portfolio.\nThe provision for credit losses declined to $28 million in 1993 from $48 million last year mainly as a result of improved credit experience resulting in lower Receivable and Lease write-offs. The decline in write-offs related particularly to recreational product retail notes and John Deere industrial equipment retail notes.\nACCOUNTING CHANGES\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Prior quarters of 1993 were restated as required by this Statement. This Statement generally requires the accrual of retiree health care and other postretirement benefits during employees' years of active service. The Company elected to recognize the pretax transition obligation of $5.4 million ($3.6 million net of deferred income taxes) as a one-time charge to earnings in the current year. This obligation represents the portion of future retiree benefit costs related to service already rendered by both active and retired employees up to November 1, 1992. The 1993 postretirement benefits expense and related disclosures have been determined according to the provisions of FASB Statement No. 106. For years prior to 1993, postretirement benefits were generally included in costs as covered expenses were actually incurred. The adoption of FASB Statement No. 106 resulted in an incremental pretax expense of $.2 million compared with the expense determined under the previous accounting principle. This increase in the current year expense is in addition to the previously mentioned one-time charge relating to the transition obligation.\nIn the fourth quarter of 1993, the Company also adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. This Statement requires the accrual of certain benefits provided to former or inactive employees after employment but before retirement during employees' years of active service. The Company previously accrued certain disability related benefits when the disability occurred. Results for the first quarter of 1993 were restated for the cumulative pretax charge resulting from this change in accounting as of November 1, 1992 which totaled $.3 million ($.2 million net of deferred income taxes). The adoption of FASB Statement No. 112 had an immaterial effect on 1993 expenses.\n1992 COMPARED WITH 1991\nTotal acquisitions of Receivables and Leases by the Company decreased three percent during 1992 compared with acquisitions in 1991. Receivables and Leases held by the Company at October 31, 1992 totaled $4.060 billion compared with $4.398 billion one year ago. This decrease resulted from sales of retail notes during 1992. Receivables and Leases administered, which include retail notes previously sold but still administered, amounted to $4.796 billion at the end of 1992 compared with $4.693 billion at October 31, 1991.\nDuring 1992, the volume of net retail notes acquired by the Company decreased eight percent compared with 1991. Net retail note acquisitions totaled $2.207 billion during 1992 compared with 1991 acquisitions of $2.400 billion. Acquisitions of recreational product retail notes accounted for 11 percent of total note acquisitions in 1992 and 13 percent in 1991.\nNet retail note acquisitions from John Deere decreased by $142 million in 1992, due primarily to a decrease in retail sales of John Deere agricultural equipment. Acquisitions of industrial equipment retail notes also were lower in 1992 while lawn and grounds care equipment note acquisitions were significantly higher due mainly to finance waiver programs on lawn and garden tractors. Note acquisitions in 1992 from John Deere continued to represent a significant proportion of the total United States retail sales of John Deere equipment.\nNet acquisitions of recreational product retail notes were $251 million in 1992 compared with $301 million in 1991. This decline was due mainly to a more competitive financing environment and the development of more selective retail note acquisition criteria by the Company over the past few years.\nAt October 31, 1992, 1991 and 1990, the net amount of retail notes held by the Company was $3.509 billion, $3.854 billion and $3.074 billion, respectively. Included in these amounts were non-Deere notes of $870 million, $888 million and $773 million at those respective dates. The net balance of John Deere retail notes decreased from $2.966 billion at October 31, 1991 to $2.639 billion at the end of 1992. John Deere retail notes totaled $2.301 billion at the end of 1990. The decrease in 1992 resulted primarily from the sale of retail notes. During 1992, the Company sold retail notes to other financial institutions and the public, receiving net proceeds of $683 million. Notes were not sold in 1991. At October 31, 1992, 1991 and 1990, the net unpaid balance of retail notes sold was $688 million, $242 million and $521 million, respectively. Additional sales of retail notes are expected to be made in the future.\nRetail notes bearing variable finance rates totaled 54 percent of the total retail note portfolio at October 31, 1992 compared with 56 percent one year earlier.\nRevolving charge accounts receivable totaled $268 million at October 31, 1992 compared with $240 million one year earlier. The increase in the outstanding balance at October 31, 1992 was due mainly to an increase in Farm Plan volume. The October 31, 1992 balance of revolving charge accounts receivable includes $114 million of credit card receivables and $154 million of Farm Plan receivables, compared with $112 million and $128 million, respectively, at October 31, 1991.\nAt October 31, 1992, the net investment in financing and operating leases on John Deere equipment was $170 million compared with $213 million at October 31, 1991. Lease acquisitions declined 27 percent in 1992 compared with 1991 due to a decrease in agricultural lease activity and competitive pressures. Lease liquidations during 1992 exceeded acquisitions, as the high lease acceptances of several years ago continued to mature. Also, $21 million net value of municipal leases were sold to John Deere during 1992 compared with $27 million sold in 1991. At October 31, 1992, the net unpaid balance of leases sold to John Deere was $48 million compared with $53 million at October 31, 1991.\nWholesale notes receivable totaled $112 million at October 31, 1992 compared with $91 million at October 31, 1991, as wholesale note acquisitions increased 37 percent in 1992.\nTotal Receivable and Lease amounts 60 days or more past due were $14.6 million at October 31, 1992 compared with $27.1 million at October 31, 1991. These past due amounts represented .29 percent of the face value of Receivables and Leases held at October 31, 1992 and .49 percent at October 31, 1991. The total face amount of retail notes held with any installment 60 days or more past due was $55.6 million at October 31, 1992 compared with $108.0 million one year earlier. The amount of retail note installments 60 days or more past due was $7.0 million at October 31, 1992, a decrease of 60 percent compared with $17.5 million at October 31, 1991. These past-due installments represented .15 percent of the unpaid face value of retail notes held at October 31, 1992 and .35 percent at October 31, 1991.\nThe total balance of revolving charge accounts receivable 60 days or more past due was $6.4 million at October 31, 1992 compared with $8.5 million at October 31, 1991. These past due amounts represented 2.4 and 3.5 percent of the revolving charge accounts receivable held at each of those respective dates. The total balance of financing and operating lease payments 60 days or more past due was $1.2 million at October 31, 1992 compared with $1.0 million at October 31, 1991. These past-due installments represented .8 percent of the total lease payments receivable at October 31, 1992 and .5 percent at October 31, 1991.\nAt October 31, 1992, the Company's allowance for credit losses totaled $83 million and represented 2.0 percent of the total net Receivables and Leases financed compared with $78 million and 1.8 percent at October 31, 1991. Deposits withheld from dealers and merchants amounted to $101 million at October 31, 1992 compared with $99 million one year earlier.\nNet income in 1992 totaled $95.0 million, an increase of 30 percent compared with 1991 income of $73.0 million. The ratio of earnings before fixed charges to fixed charges was 1.74 to 1 for 1992 compared with 1.48 to 1 in 1991. The improvement in net income in 1992 resulted primarily from a higher average volume of Receivables and Leases financed and improved credit loss experience. Results in 1992 also benefited from after-tax income of $5.6 million from sales of retail notes.\nThe average balance of total net Receivables and Leases financed was seven percent higher in 1992 compared with 1991, although the year-end balance was lower due to the sale of a substantial amount of retail notes in October 1992. However, total revenues decreased three percent to $471 million in 1992 compared with $487 million in 1991, as the average yield earned on the portfolio was lower this year. While revenues were affected by the lower level of interest rates and correspondingly lower finance charges earned in 1992 compared with last year, borrowing costs were also lower this year. Interest expense totaled $189 million in 1992, a decrease of 17 percent compared with $228 million in 1991. Total\naverage borrowings were $3.379 billion in 1992, an 11 percent increase over fiscal year 1991 average borrowings of $3.053 billion. The weighted average interest rate incurred on all interest-bearing borrowings during 1992 declined to 5.4 percent from 7.2 percent in 1991.\nFinance income earned on retail notes was $356 million this year compared with $383 million in 1991, a decrease of seven percent. The average balance of the net retail note portfolio financed during 1992 was seven percent higher than during 1991.\nRevenues earned on revolving charge accounts amounted to $47 million in 1992, an 11 percent increase over revenues of $43 million earned during 1991. This increase was primarily due to a 17 percent increase in the average balance of Farm Plan receivables financed and a 10 percent increase in the average balance of credit card receivables financed in 1992 compared with 1991.\nThe average net investment in financing and operating leases decreased by 13 percent in 1992 compared with 1991. In addition, total lease revenues decreased slightly to $36.8 million in 1992 compared with $36.9 million in 1991. Lease revenues were favorably affected in 1992 by a significant increase in rentals earned on operating leases.\nAdministrative and operating expenses for 1992 were $63 million, an increase of eight percent compared with $59 million for 1991. These expenses increased primarily due to the costs associated with the larger average portfolio financed.\nThe provision for credit losses decreased to $48 million in 1992 from $66 million in 1991 mainly as a result of improved credit experience resulting in lower Receivable and Lease write-offs. The most significant decline in write-offs related to recreational product notes, resulting primarily from more selective note acquisition criteria used by the Company. Write-offs of recreational product notes totaled $24.2 million in 1992 compared with $33.3 million in 1991.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company relies on its ability to raise substantial amounts of funds to finance its Receivable and Lease portfolios. The Company's primary sources of funds for this purpose are a combination of borrowings and equity capital. Additionally, the Company periodically sells substantial amounts of retail notes in the public market. The Company's ability to obtain funds is affected by its debt ratings, which are closely related to the outlook for and the financial condition of Deere & Company, and the nature and availability of support facilities, such as its lines of credit. For information regarding Deere & Company and its business, see Exhibit 99.1.\nThe Company's ability to meet its debt obligations is supported in a number of ways as described below. All commercial paper issued is backed by bank credit lines. The assets of the Company are self-liquidating in nature. A strong\nequity position is available to absorb unusual losses on these assets. Liquidity is also provided by the Company's ability to sell or \"securitize\" these assets. Asset-liability risk is also actively managed to minimize exposure to interest rate fluctuations.\nThe Company's business is somewhat seasonal, with overall acquisitions of Receivables and Leases traditionally higher in the second half of the fiscal year than in the first half, and overall collections of Receivables and Leases traditionally somewhat higher in the first six months than in the last half of the fiscal year.\nThe Company's cash flows from operating activities were $157 million in 1993. See \"Statement of Consolidated Cash Flows\" on page 34. Net cash provided by investing activities totaled $477 million in 1993, primarily due to net proceeds of $1.143 billion received from the securitization and sale of receivables in the public market, which was partially offset by funds used for Receivable and Lease acquisitions which exceeded collections by $698 million in 1993. Collections of receivables in 1993 were slightly lower than last year, due primarily to the lower retail note portfolio financed in 1993. The aggregate cash provided by operating and investing activities was used for financing activities and a $74 million increase in cash and cash equivalents. Cash used for financing activities totaled $561 million in 1993, representing a net decrease in outside borrowings of $853 million and the payment of an $82 million dividend to Deere & Company which were partially offset by a $374 million increase in payables to Deere & Company.\nOver the past three years, operating activities have provided $453 million in cash. Proceeds from the sale of receivables and an increase in payables to Deere & Company provided $1.893 and $423 million, respectively, during the same period. These amounts were used mainly to fund Receivable and Lease acquisitions which exceeded collections by $2.101 billion, a decrease of $438 million in net outside borrowings, $202 million in dividends and an increase in cash and cash equivalents of $67 million.\nIn common with other large finance and credit companies, the Company actively manages the relationship of the types and amounts of its funding sources to its Receivable and Lease portfolios in an effort to diminish risk due to interest rate and currency fluctuations, while responding to favorable competitive and financing opportunities. Accordingly, from time to time, the Company enters into interest rate swap and interest rate cap agreements to hedge its interest rate exposure in amounts corresponding to a portion of its borrowings. See notes 4 and 5 to the consolidated financial statements for further details. The credit and market risks under these agreements are not considered to be significant.\nTotal indebtedness amounted to $2.777 billion at October 31, 1993 compared with $3.256 billion at October 31, 1992. Total short-term indebtedness amounted to $1.299 billion at October 31, 1993 compared with $2.017 billion at October 31, 1992. See note 4 to the consolidated financial statements. Total long-term indebtedness amounted to $1.478 billion at October 31, 1993 and $1.239 billion at October 31, 1992. See note 5 to the consolidated financial statements. The\ndecrease in total indebtedness at October 31, 1993 compared with October 31, 1992 was due primarily to the decline in Receivables and Leases financed. The ratio of total interest-bearing debt to stockholder's equity was 3.8 to 1 and 4.6 to 1 at October 31, 1993 and October 31, 1992, respectively.\nIn 1993, the Company issued $150 million of 5% notes due in 1995 and $200 million of 4-5\/8% notes due in 1996. The Company also retired $150 million of 7.40% notes due in 1993, $125 million of 9.0% debentures due in 1993 and $47 million of 7-1\/2% debentures due in 1998. In November 1993, the Capital Corporation announced that on January 4, 1994 it will redeem the $40 million balance of outstanding 9.35% subordinated debentures due 2003. Additional information on these borrowings is included in the discussion of \"Long-Term Borrowings\" on page 41.\nDuring 1993, the Capital Corporation issued $337 million and retired $176 million of medium-term notes. At October 31, 1993, $737 million of medium-term notes were outstanding having original maturity dates of between one and seven years and interest rates that ranged from 3.4 percent to 9.5 percent.\nAt October 31, 1993, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $3.025 billion. Included in the total credit lines were three long-term credit agreement commitments totaling $3.016 billion. At October 31, 1993, $2.265 billion of the lines of credit were unused. For the purpose of computing unused credit lines, the aggregate of total short-term borrowings, excluding the current portion of long-term borrowings, of the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada) were considered to constitute utilization. Annual facility fees on the credit agreements are paid by Deere & Company and a portion is charged to the Capital Corporation based on utilization.\nIn 1993, the Capital Corporation paid a dividend of $82 million to John Deere Credit Company, which, in turn, paid an $82 million dividend to Deere & Company. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee accompanying table of contents of financial statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nOmitted pursuant to instruction J(2).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nOmitted pursuant to instruction J(2).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nOmitted pursuant to instruction J(2).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nOmitted pursuant to instruction J(2).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) Financial Statements\n(2) Financial Statement Schedules\nSee the table of contents to financial statements and schedules immediately preceding the financial statements and schedules to consolidated financial statements.\n(3) Exhibits\nSee the index to exhibits immediately preceding the exhibits filed with this report.\n(b) Reports on Form 8-K\nCurrent Report on Form 8-K dated August 24, 1993 (Items 5 and 7).\nCurrent Report on Form 8-K dated August 4, 1993 (Items 5 and 7).\n(THIS PAGE INTENTIONALLY LEFT BLANK)\nSIGNATURES\nPursuant 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.\nJOHN DEERE CAPITAL CORPORATION\nBy: \/s\/ Hans W. Becherer ---------------------- Hans W. Becherer, Chairman Date: 24 January 1994\nPursuant 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 and on the date indicated.\nSignature Title Date ----------- ----- ----\n\/s\/ Hans W. Becherer Director, Chairman and Principal ) -------------------- Executive Officer ) Hans W. Becherer ) ) \/s\/ J. Michael Dunn Director ) -------------------- ) J. Michael Dunn ) ) \/s\/ J. W. England Director, Vice President and ) ------------------- Principal Accounting Officer ) J. W. England ) ) \/s\/ B. L. Hardiek Director ) ------------------- ) B. L. Hardiek ) ) \/s\/ B. C. Harpole Director ) ------------------- ) B. C. Harpole ) ) \/s\/ D. E. Hoffmann Director ) ------------------- ) D. E. Hoffmann ) ) \/s\/ J. K. Lawson Director ) 24 January 1994 ------------------- J. K. Lawson\n\/s\/ Pierre E. Leroy Director ) - -------------------- ) Pierre E. Leroy ) ) \/s\/ M. P. Orr Director and President ) - -------------------- ) M. P. Orr ) ) \/s\/ E. L. Schotanus Director, Vice President and ) 24 January 1994 - -------------------- Principal Financial Officer ) E. L. Schotanus ) ) \/s\/ D. H. Stowe, Jr. Director ) - -------------------- ) D. H. Stowe, Jr. ) ) \/s\/ S. E. Warren Director ) - -------------------- ) S. E. Warren )\n[LOGO]\nINDEPENDENT AUDITORS' REPORT\nJohn Deere Capital Corporation:\nWe have audited the accompanying consolidated balance sheets of John Deere Capital Corporation and subsidiaries as of October 31, 1993 and 1992 and the related statements of consolidated income and retained earnings and of consolidated cash flows for each of the three years in the period ended October 31, 1993. Our audits also included the financial statement schedules listed in the Table of Contents on page 31. These financial statements and financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of John Deere Capital Corporation and subsidiaries at October 31, 1993 and 1992 and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, effective November 1, 1992 the company changed its method of accounting for postretirement benefits other than pensions.\nDELOITTE & TOUCHE\nDecember 10, 1993\n[LOGO]\nFINANCIAL STATEMENTS: Page ----\nJohn Deere Capital Corporation and Subsidiaries (consolidated):\nStatement of Consolidated Income and Retained Earnings for the Years Ended October 31, 1993, 1992 and 1991...............32\nConsolidated Balance Sheet, October 31, 1993 and 1992...........33\nStatement of Consolidated Cash Flows for the Years Ended October 31, 1993, 1992 and 1991...............................34\nNotes to Consolidated Financial Statements......................35\nFINANCIAL STATEMENT SCHEDULES:\nSchedule VIII - Valuation and Qualifying Accounts for the Years Ended October 31, 1993, 1992 and 1991...................46\nSchedule IX - Short-term Borrowings for the Years Ended October 31, 1993, 1992 and 1991...............................47\nSCHEDULES OMITTED\nThe following schedules are omitted because of the absence of the conditions under which they are required:\nI, II, III, IV, V, VI, VII, X, XI, XII, XIII and XIV.\nSTATEMENT OF CONSOLIDATED INCOME AND RETAINED EARNINGS\nCONSOLIDATED BALANCE SHEET\nSTATEMENT OF CONSOLIDATED CASH FLOWS\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCORPORATE ORGANIZATION\nJohn Deere Capital Corporation (Capital Corporation) is a wholly-owned subsidiary of John Deere Credit Company, a finance holding company which is wholly-owned by Deere & Company. The Capital Corporation and its subsidiaries, Deere Credit Services, Inc. (DCS), Farm Plan Corporation (FPC), Deere Credit, Inc. (DCI), and John Deere Receivables, Inc. (JDRI), are collectively called the Company. Deere & Company with its other wholly-owned subsidiaries are collectively called John Deere.\nRetail notes, revolving charge accounts, financing leases and wholesale notes receivable are collectively called \"receivables.\" Receivables and operating leases are collectively called \"receivables and leases.\"\nThe risk of credit losses applicable to John Deere retail notes and leases, net of recovery from withholdings from John Deere dealers, is borne by the Company. John Deere is compensated by the Company at a rate of 2.9 percent or less of the finance income earned, depending on prevailing bank interest rate levels, for originating retail notes on John Deere products. John Deere is reimbursed by the Company for staff support and other administrative services at estimated cost, and for credit lines provided by Deere & Company based on utilization of the lines. John Deere is compensated for originating leases on John Deere products and is reimbursed for staff support in a manner similar to the procedures for retail notes.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the financial statements of the Capital Corporation and its subsidiaries, all of which are wholly-owned.\nACCOUNTING CHANGES\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Prior quarters of 1993 were restated as required by this Statement. This Statement generally requires the accrual of retiree health care and other postretirement benefits during employees' years of active service. The Company elected to recognize the pretax transition obligation of $5.4 million ($3.6 million net of deferred income taxes) as a one-time charge to earnings in the current year. This obligation represents the portion of future retiree benefit costs related to service already rendered by both active and retired employees up to November 1, 1992. The 1993 postretirement benefits expense and related disclosures have been determined according to the provisions of FASB Statement No. 106. For years prior to 1993, postretirement benefits were generally included in costs as covered expenses were actually incurred. The adoption of FASB Statement No. 106 resulted in an incremental pretax expense of $.2 million compared with the expense determined under the previous accounting principle. This increase in the current year expense is in addition to the previously mentioned one-time charge relating to the transition obligation.\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. This Statement requires the accrual of certain benefits provided to former or inactive employees after employment but before retirement during employees' years of active service. The Company previously accrued certain disability related benefits when the disability occurred. Results for the first quarter of 1993 were restated for the cumulative pretax charge resulting from this change in accounting as of November 1, 1992 which totaled $.3 million ($.2 million net of deferred income taxes). The adoption of FASB Statement No. 112 had an immaterial effect on 1993 expenses.\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 107, Disclosures about Fair Values of Financial Instruments. Disclosures of the fair values of financial instruments which do not approximate the carrying values in the financial statements are included in the appropriate financial statement notes. Fair values of other financial instruments approximate the carrying amounts because of the short maturities or current market interest rates of those instruments.\nIn the second quarter of 1992, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. See note 10 for further information.\nRETAIL NOTES RECEIVABLE\nThe Company purchases and finances retail notes from John Deere's agricultural equipment, industrial equipment and lawn and grounds care equipment sales branches in the United States. The notes are acquired by the sales branches through John Deere retail dealers and principally originate in connection with retail sales by dealers of new John Deere equipment and used equipment. The Company also purchases and finances retail\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nnotes unrelated to John Deere equipment, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine mortgage service companies (recreational product retail notes).\nFinance income included in the face amount of retail notes is amortized into income over the lives of the notes on the effective-yield basis. Unearned finance income on variable-rate notes is adjusted monthly based on fluctuations in the base rate of a specified bank.\nCosts incurred in the acquisition of retail notes are deferred and amortized into income over the expected lives of the notes on the effective-yield basis.\nA portion of the finance income earned by the Company arises from retail sales of John Deere equipment sold in advance of the season of use or in other sales promotions by John Deere on which finance charges are waived by John Deere for a period from the date of sale to a specified subsequent date. Some low-rate financing programs are also offered by John Deere. The Company receives compensation from John Deere approximately equal to the normal net finance charge on retail notes for periods during which finance charges have been waived or reduced. The portions of the Company's finance income earned that were received from John Deere on retail notes containing waiver of finance charges or reduced rates were 19 percent in 1993, 17 percent in 1992 and 20 percent in 1991.\nA deposit equal to one percent of the face amount of John Deere agricultural and lawn and grounds care equipment retail notes originating from each dealer is withheld from that dealer and recorded by the Company. Any subsequent retail note losses are charged against the withheld deposits. To the extent that a loss on a retail note cannot be absorbed by deposits withheld from the dealer from which the retail note was acquired, it is charged against the Company's allowance for credit losses. At the end of each calendar year, the balance of each dealer's withholding account in excess of a specified percent (currently 3 percent) of the total balance outstanding on retail notes originating with that dealer is remitted to the dealer, and any negative balance in the dealer withholding account is written off and absorbed by the Company's allowance for credit losses.\nAll John Deere industrial equipment retail notes are currently acquired on a non-recourse basis and there is no withholding of dealer deposits on those notes. This procedure originated in January 1992. Industrial notes acquired prior to January 1992 remain subject to the agricultural and lawn and grounds care equipment procedures, noted in the above paragraph, until the notes are paid in full, or the withholding accounts are depleted. Because of this change, the allowance for credit losses was increased to compensate for the additional credit risk. The Company does not withhold deposits on recreational product retail notes.\nThe Company requires that theft and physical damage insurance be carried on all equipment leased or securing retail notes. The customer may, at his own expense, have the Company purchase this insurance or obtain it from other sources. Theft and physical damage insurance is also required on wholesale notes and can be purchased through the Company or from other sources. Insurance is not required on revolving charge accounts.\nGenerally, when an account becomes 120 days delinquent, accrual of finance income is suspended, the collateral is repossessed or the account is designated for litigation, and the estimated uncollectible amount, after charging the dealer's withholding account, if any, is written off to the allowance for credit losses.\nREVOLVING CHARGE ACCOUNTS RECEIVABLE\nRevolving charge account income is generated primarily by two revolving credit products: Farm Plan and the John Deere Credit Revolving Plan.\nFarm Plan is primarily used by agri-businesses to finance customer purchases, such as parts and service labor, which would otherwise be carried by the merchants as accounts receivable. Farm Plan income includes a discount paid by merchants for the purchase of customer accounts and finance charges paid by customers on their outstanding revolving charge account balances. Merchant recourse and a merchant reserve are established on some receivables purchased.\nThe John Deere Credit Revolving Plan is used primarily by retail customers of John Deere dealers to finance lawn and grounds care equipment. Income includes a discount paid by dealers on most transactions and finance charges paid by customers on their outstanding account balances.\nAccrual of revolving charge account income is suspended generally when an account becomes 120 days delinquent. Accounts are deemed to be uncollectible and written off to the allowance for credit losses when delinquency reaches 180 days for a Farm Plan account and 150 days for John Deere Credit Revolving Plan accounts.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDIRECT FINANCING LEASES AND EQUIPMENT ON OPERATING LEASES\nThe Company leases John Deere agricultural equipment, industrial equipment and lawn and grounds care equipment directly to retail customers.\nAt the time of accepting a lease that qualifies as a direct financing lease under FASB Statement No. 13, the Company records the gross amount of lease payments receivable, estimated residual value of the leased equipment for non-purchase option leases and unearned lease income. The unearned lease income is equal to the excess of the gross lease receivable plus the estimated residual value over the cost of the equipment. The unearned lease income is recognized as revenue over the lease term on the effective-yield method.\nLeases that do not meet the criteria for direct financing leases as outlined by FASB Statement No. 13 are accounted for as operating leases. Rental payments applicable to equipment on operating leases are recorded as income on a straight-line method over the lease terms. Operating lease assets are recorded at cost and depreciated on a straight-line method over the terms of the leases.\nLease acquisition costs are accounted for in a manner similar to the procedures for retail notes.\nDeposits withheld from John Deere dealers and related losses on leases are handled in a manner similar to the procedures for retail notes. In addition, a lease payment discount program, allowing reduced payments over the term of the lease, is administered in a manner similar to finance waiver on retail notes.\nEquipment returned to the Company upon termination of leases and held for subsequent sale or lease is recorded at the estimated wholesale market value of the equipment.\nGenerally, when an account becomes 120 days delinquent, accrual of lease revenue is suspended, the equipment is repossessed or the account is designated for litigation and the estimated uncollectible amount, after charging the dealer's withholding account, if any, is written off to the allowance for credit losses.\nWHOLESALE RECEIVABLES\nThe Company finances recreational vehicle inventory and John Deere engines held by dealers of those products. Wholesale finance income is recognized monthly based on the daily balance of wholesale receivables outstanding and the applicable effective interest rate. Interest rates vary with a prevailing bank base rate, the type of equipment financed and the balance outstanding. Wholesale receivables are secured by the recreational vehicle and engine inventories financed. Although amounts are not withheld from dealers to cover uncollectible receivables, there are repurchase agreements with manufacturers for new inventories held by dealers. Generally, when an account becomes 60 days delinquent, accrual of finance income is suspended, the collateral is repossessed and the estimated uncollectible amount is written off to the allowance for credit losses.\nOTHER RECEIVABLES\nDuring 1993 and 1992, the Company sold retail notes to limited-purpose business trusts, which utilized the notes as collateral for the issuance of asset backed securities to the public. At the time of the sales, \"other receivables\" from the trusts were recorded at net present value. The receivables relate to deposits made pursuant to recourse provisions and other payments to be received under the sales agreements. The receivables will be amortized to their value at maturity using the interest method. The Company is also compensated by the trusts for certain expenses incurred in the administration of these receivables. Securitization and servicing fee income includes both the amortization of the above receivables and reimbursed administrative expenses.\nCONCENTRATION OF CREDIT RISK\nReceivables and leases have significant concentrations of credit risk in the agricultural, industrial, lawn and grounds care, and recreational product business sectors as shown in note 2, \"Receivables and Leases.\" On a geographic basis, there is not a disproportionate concentration of credit risk in any area of the United States. The Company retains as collateral a security interest in the equipment associated with receivables and leases other than revolving charge accounts.\nRECLASSIFICATIONS\nCertain amounts for 1991 and 1992 have been reclassified to conform with 1993 financial statement presentations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2 RECEIVABLES AND LEASES\nRETAIL NOTES RECEIVABLE\nRetail notes receivable by product category at October 31 in millions of dollars follow:\nDuring 1993, the average effective yield on retail notes held by the Company was approximately 9.8 percent compared with 10.1 percent in 1992. Retail notes acquired by the Company during the year ended October 31, 1993 had an estimated average original term (based on dollar amounts) of 67 months. During 1992 and 1991, the estimated average original term was 68 and 66 months, respectively. Historically, because of prepayments, the average actual life of retail notes has been considerably shorter than the average original term. During 1993, the Company received net proceeds of $1.143 billion from the sale of retail notes to limited-purpose business trusts, which utilized the notes as collateral for the issuance of asset backed securities to the public. During 1992, the Company received net proceeds of $683 million from the sale of retail notes. At October 31, 1993 and 1992, the net balance of all retail notes previously sold by the Company was $1.394 billion and $688 million, respectively. Additional sales of retail notes are expected to be made in the future. The Company recognizes any gain or loss at the time of the sale of retail notes. The sale price of retail notes sold to financial institutions is subject to subsequent monthly adjustments to reflect changes in short-term interest rates and variations in timing between actual and anticipated collections. The Company acts as agent for the buyers in collection and administration of all the notes it has sold and was contingently liable for recourse in the maximum amount of $108 million and $67 million at October 31, 1993 and 1992, respectively. All retail notes sold are collateralized by security agreements on the related machinery sold to the customers. There is a minimal amount of market risk due to monthly adjustments to the sale price of a small portion of the retail notes. There is no anticipated credit risk related to the nonperformance by the counterparties.\nREVOLVING CHARGE ACCOUNTS RECEIVABLE Revolving charge accounts receivable at October 31, 1993 totaled $331 million compared with $268 million at October 31, 1992. Account holders may pay the account balance in full at any time, or make payments over a number of months according to a payment schedule. A minimum amount is due each month from customers selecting the revolving payment option.\nFINANCING LEASES RECEIVABLE Financing leases receivable by product category at October\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n31 are as follows in millions of dollars:\nResidual values represent the amounts estimated to be recoverable at maturity from disposition of the leased equipment under non-purchase option financing leases. Initial lease terms for financing leases range from 12 months to 72 months. Payments on financing leases receivable at October 31 are scheduled as follows in millions of dollars:\nThe Company sold $19 million of municipal leases to Deere & Company in 1993 compared with $21 million in 1992. At October 31, 1993, the net balance of leases sold was $43 million compared with $48 million at October 31, 1992. Additional sales of leases may be made in the future.\nWHOLESALE RECEIVABLES Wholesale receivables at October 31, 1993 totaled $110 million compared with $112 million at October 31, 1992.\nMaturities range from 12 to 24 months, with scheduled principal reductions from invoice date to maturity.\nEQUIPMENT ON OPERATING LEASES The cost of equipment on operating leases by product category at October 31 follows in millions of dollars:\nInitial lease terms for equipment on operating leases range from 12 months to 72 months. Rental payments for equipment on operating leases at October 31 are scheduled as follows in millions of dollars:\nFAIR VALUE At October 31, 1993, the estimated fair value of total net receivables and leases was $3.516 billion compared with the carrying value of $3.436 billion. The fair values of fixed-rate retail notes and financing leases were based on the discounted values of their related cash flows at current market interest rates. The fair values of variable-rate retail notes, revolving charge accounts and wholesale notes approximate the carrying amounts.\nNOTE 3 ALLOWANCE FOR CREDIT LOSSES\nAllowances for credit losses on receivables and leases are maintained in amounts considered to be appropriate in relation to the receivables and leases outstanding based on estimated collectibility and collection experience.\nAn analysis of the allowance for credit losses on total receivables and losses follows in millions of dollars:\nThe allowance for credit losses represented 2.3 percent, 2.0 percent and 1.8 percent of receivables and leases outstanding at October 31, 1993, 1992 and 1991, respectively. In addition, the Company had $105 million, $101 million and $99 million at October 31, 1993, 1992 and 1991, respectively, of deposits withheld from John Deere dealers and Farm Plan merchants available for certain potential credit losses originating from those dealers and merchants. The lower provisions in 1993 and 1992 resulted from a decrease in write-offs of uncollectible receivables and leases, particularly recreational product retail notes. The decrease in write-offs of recreational product notes resulted primarily from the development of more selective recreational product retail note acquisition criteria by the Company over the past few years and improved collection effectiveness.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 4 SHORT-TERM BORROWINGS\nOn October 31, 1993, short-term borrowings were $1.299 billion, $454 million of which was commercial paper. Short-term borrowings were $2.017 billion one year ago, $1.487 billion of which was commercial paper. Original maturities of commercial paper outstanding on October 31, 1993 ranged up to 244 days. The weighted average remaining term of commercial paper outstanding on October 31, 1993 was approximately 71 days. The Capital Corporation's short-term debt also includes amounts borrowed from Deere & Company, which totaled $439.5 million at October 31, 1993. The Capital Corporation pays a market rate of interest to Deere & Company based on the average outstanding borrowings each month. The weighted average interest rates on all short-term borrowings, excluding current maturities of long-term borrowings, for 1993, 1992 and 1991 were 4.0 percent, 5.0 percent and 6.9 percent, respectively.\nAt October 31, 1993, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $3.025 billion. Included in the total credit lines are three long-term credit agreements expiring on various dates through March 1996 for an aggregate maximum amount of $3.016 billion. At October 31, 1993, $2.265 billion of the lines of credit were unused. For the purpose of computing unused credit lines, the aggregate of total short-term borrowings, excluding the current portion of long-term borrowings, of the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada) were considered to constitute utilization. Annual facility fees on the credit agreements are paid by Deere & Company and charged to the Capital Corporation based on utilization.\nAt October 31, 1993, the Capital Corporation had no borrowings outstanding under the credit agreements. These agreements require the Capital Corporation to maintain its consolidated ratio of earnings before fixed charges to fixed charges at no less than 1.05 to 1 for each fiscal quarter. In addition, the Capital Corporation's ratio of senior debt to total stockholder's equity plus subordinated debt may not be more than 8 to 1 at the end of any fiscal quarter. For purposes of these calculations, \"earnings\" consist of income before income taxes to which are added fixed charges. \"Fixed charges\" consist of interest on indebtedness, amortization of debt discount and expense, an estimated amount of rental expense under capitalized leases which is deemed to be representative of the interest factor and rental expense under operating leases. \"Senior debt\" consists of the Company's total interest-bearing obligations, excluding subordinated debt, but including borrowings from Deere & Company. The Company's ratio of earnings to fixed charges was 1.99 to 1 (excluding the effect of the accounting changes), 1.74 to 1 and 1.48 to 1 in 1993, 1992 and 1991, respectively. The Company's ratio of senior debt to total stockholder's equity plus subordinated debt was 2.2 to 1 at October 31, 1993 compared with 2.7 to 1 at October 31, 1992.\nIn common with other large finance and credit companies, the Company actively manages the relationship of the types and amounts of its funding sources to its receivable and lease portfolios in an effort to diminish risk due to interest rate and currency fluctuations, while responding to favorable competitive and financing opportunities. Accordingly, from time to time, the Company has entered into interest rate swap and interest rate cap agreements to hedge its interest rate exposure in amounts corresponding to a portion of its short-term borrowings. At October 31, 1993 and 1992, the total notional principal amounts of interest rate swap agreements were $510 million and $150 million having rates of 3.6 to 9.6 percent terminating in up to 28 months and 14 months, respectively. The total notional principal amounts of interest rate cap agreements at October 31, 1993 and 1992 were $44 million and $105 million having capped rates of 8.0 percent to 9.0 percent terminating in up to 15 months and 28 months, respectively. The differential to be paid or received on all swap and cap agreements is accrued as interest rates change and is recognized over the lives of the agreements. The credit and market risk under these agreements is not considered to be significant. The estimated fair value and carrying value of these interest rate swap and cap agreements were not significant at October 31, 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 5 LONG-TERM BORROWINGS\nLong-term borrowings of the Capital Corporation at October 31 consisted of the following in millions of dollars:\nIn 1993, the Capital Corporation issued $150 million of 5% notes due in 1995 and $200 million of 4-5\/8% notes due in 1996. The Capital Corporation also retired $150 million of 7.4% notes due in 1993, $125 million of 9.0% debentures due in 1993 and $47 million of 7-1\/2% debentures due in 1998. During 1993, the Capital Corporation issued $337 million and retired $176 million of medium-term notes. In November 1993, the Capital Corporation announced that on January 4, 1994 it will redeem the $40 million balance of outstanding 9.35% subordinated debentures due 2003.\nThe Capital Corporation has entered into interest rate swap agreements with independent parties that change the effective rate of interest on certain long-term borrowings to a variable rate based on specified United States commercial paper rate indices. The table reflects the effective year-end variable interest rates relating to these swap agreements. The notional principal amounts and maturity dates of these swap agreements are the same as the principal amounts and maturities of the related borrowings. In addition, the Capital Corporation has interest rate swap agreements corresponding to a portion of its fixed rate long-term borrowings. At October 31, 1993, the total notional principal amount of these interest rate swap agreements was $347 million, having variable rates of 3.4 percent to 3.8 percent, terminating in up to 40 months. The Capital Corporation also has interest rate swap and cap agreements associated with medium-term notes. The table reflects the interest rates relating to these swap and cap agreements. At October 31, 1993 and 1992, the total notional principal amounts of these swap agreements were $138 million and $110 million, terminating in up to 42 months and 54 months, respectively. At October 31, 1993 and 1992, the total notional principal amounts of these cap agreements were $25 million and $125 million, terminating in up to 22 months and 34 months, respectively. A Swiss franc to United States dollar currency swap agreement is also associated with the Swiss franc bonds in the table. The credit and market risk under these agreements is not considered to be significant.\nAt October 31, 1993, the total estimated fair value of the Company's total long-term borrowings was $1.496 billion. The corresponding carrying amount of total long-term borrowings was $1.478 billion. Fair values of long-term borrowings with fixed rates were based on a discounted cash flow model. Fair values of long-term borrowings, which have been swapped to current variable interest rates, approximate their carrying amounts. The estimated fair value and carrying value of the Company's interest rate swap and cap agreements associated with medium-term notes were not significant at October 31, 1993.\nThe approximate amounts of long-term borrowings maturing and sinking fund payments required in each of the next five years, in millions of dollars, are as follows: 1994-$405, 1995-$633, 1996-$262, 1997-$309, 1998-$11.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 FIXED CHARGE COVERAGE\nDeere & Company has expressed an intention of conducting its business with the Company on such terms that the Company's consolidated ratio of earnings before fixed charges to fixed charges will not be less than 1.05 to 1 for each fiscal quarter. Financial support was not provided in 1993, 1992 or 1991, as the ratios were 1.99 to 1 (excluding the effect of the accounting changes), 1.74 to 1, and 1.48 to 1, respectively. This arrangement is not intended to make Deere & Company responsible for the payment of obligations of the Company.\nNOTE 7 COMMON STOCK\nAll of the Company's common stock is owned by John Deere Credit Company, a wholly-owned finance holding subsidiary of Deere & Company. No shares of common stock of the Company were reserved for officers or employees or for options, warrants, conversions or other rights at October 31, 1993 or 1992.\nNOTE 8 DIVIDENDS\nIn October 1993, the Capital Corporation paid a cash dividend to John Deere Credit Company of $82 million, which in turn paid an $82 million cash dividend to Deere & Company. Similarly, during 1992, the Capital Corporation paid a $70 million dividend. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nNOTE 9 PENSION AND OTHER RETIREMENT BENEFITS\nThe Company participates in the Deere & Company salaried pension plan, which is a defined benefit plan in which benefits are based primarily on years of service and employees' compensation near retirement. This plan is funded according to the 1974 Employee Retirement Income Security Act (ERISA) and income tax regulations. Plan assets consist primarily of common stocks, common trust funds, government securities and corporate debt securities. Pension expense is actuarially determined based on the Company's employees included in the plan. The Company's pension expense amounted to $1.5 million in 1993, $1.0 million in 1992 and was negligible in prior years. Further disclosure for the plan is included in the Deere & Company 1993 annual report pension note.\nDuring the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Additional information is presented in the \"Summary of Significant Accounting Policies\" on page 35, and the \"Quarterly Data (unaudited)\" on page 45.\nThe Company generally provides defined benefit health care and life insurance plans for retired employees. Health care and life insurance benefits expense is actuarially determined based on the Company's employees included in the plans and amounted to $.6 million in 1993. The 1992 and 1991 expenses were negligible as determined under the previous accounting principle.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10 INCOME TAXES\nTAXES ON INCOME AND INCOME TAX CREDITS The taxable income of the Company is included in the consolidated United States income tax return of Deere & Company. Provisions for income taxes are made generally as if the Capital Corporation and each of its subsidiaries filed separate income tax returns.\nDEFERRED INCOME TAXES In 1992, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. There was no cumulative effect of adoption or current effect on continuing operations mainly because the Company had previously adopted FASB Statement No. 96, Accounting for Income Taxes, in 1988. Deferred income taxes arise because there are certain items that are treated differently for financial accounting than for income tax reporting purposes. An analysis of deferred income tax assets and liabilities at October 31 in millions of dollars follows:\nThe provision for income taxes consisted of the following in millions of dollars:\nThe Omnibus Budget Reconciliation Act of 1993, which enacted an increase in the United States federal statutory income tax rate effective January 1, 1993, was signed into law during the fourth quarter of 1993. In accordance with FASB Statement No. 109, Accounting for Income Taxes, deferred tax assets and liabilities as of the enactment date were revalued during the fourth quarter of 1993 using the new rate of 35 percent. This resulted in a credit of $.7 million to the provision for income taxes.\nEFFECTIVE INCOME TAX PROVISION A comparison of the statutory and effective income tax provisions of the Company and reasons for related differences follow in millions of dollars:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11 CASH FLOW INFORMATION\nFor purposes of the statement of consolidated cash flows, the Company considers investments with original maturities of three months or less to be cash equivalents. Substantially all of the Company's short-term borrowings mature within three months or less.\nCash payments by the Company for interest incurred on borrowings in 1993, 1992 and 1991 were $134.8 million, $172.6 million and $215.9 million, respectively. Cash payments for income taxes during these same periods were $54.9 million, $53.0 million and $53.3 million, respectively.\nNOTE 12 LEGAL PROCEEDINGS\nThe Company is subject to various unresolved legal actions which arise in the normal course of its business. The most prevalent of such actions relates to state and federal regulations concerning retail credit. There are various claims and pending actions against the Company with respect to commercial and consumer financing matters. These matters include lawsuits pending in federal and state courts in Texas alleging that certain of the Company's retail finance contracts for recreational vehicles and boats violate certain technical provisions of Texas consumer credit statutes dealing with maximum rates, licensing and disclosures. The plaintiffs in Texas claim they are entitled to common law and statutory damages and penalties. On November 6, 1992 the federal District Court certified a federal class action under Rule 23 (b) (3) of the Federal Rules of Civil Procedure in an action brought by Russell Durrett, individually and on behalf of others, against John Deere Company (filed in state court on February 19, 1992 and removed on February 26, 1992 to the United States District Court for the Northern District of Texas, Dallas Division). On October 12, 1993, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992, the 281st District Court for Harris County, Texas, certified a class under Rules 42 (b) (1) (A), 42 (b) (1) (B) and 42 (b) (2) of the Texas Rules of Civil Procedure, of all persons who opt out of the federal class action. The Company believes that it has substantial defenses and intends to defend the actions vigorously. Although it is not possible to predict the outcome of these unresolved legal actions, and the amounts of claimed damages and penalties are large, the Company believes that these unresolved legal actions will not have a material adverse effect on its consolidated financial position.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13 QUARTERLY DATA (UNAUDITED)\nSupplemental consolidated quarterly information for the Company follows in millions of dollars:\nSchedule VIII\nJOHN DEERE CAPITAL CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED OCTOBER 31, 1993, 1992 AND 1991 (in thousands of dollars)\nSchedule IX\nSHORT-TERM BORROWINGS FOR THE YEARS ENDED OCTOBER 31, 1993, 1992 AND 1991 (in thousands of dollars)\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nINDEX TO EXHIBITS\nPage No. -------\n3.1 Certificate of Incorporation, as amended 50\n3.2 By-laws, as amended 57\n4.1 Credit agreements among registrant, Deere & Company, various financial institutions, and Chemical Bank and Deutsche Bank, as Managing Agents, dated as of December 15, 1993. 64\n4.2 Revolving evergreen facility linked credit agreement among registrant, Deere & Company and a number of banks dated as of March 26, 1993 (Exhibit 4.2 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n4.3 Form of certificate for common stock (Exhibit 4.3 to Form 10-Q of the registrant for the quarter ended April 30, 1993*)\n4.4 Indenture dated as of February 15, 1991 between registrant and Citibank, N.A., as Trustee (Exhibit 4.5 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\nCertain instruments relating to long-term debt constituting less than 10% of the registrant's total assets, are not filed as exhibits herewith pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. The registrant will file copies of such instruments upon request of the Commission.\n9. Not applicable.\n10.1 Agreement dated May 11, 1993 between registrant and Deere & Company concerning agricultural retail notes (Exhibit 10.1 to Form 10-Q of registrant for the quarter ended April 30, 1993*).\n10.2 Agreement dated May 11, 1993 between registrant and Deere & Company concerning lawn and grounds care retail notes (Exhibit 10.2 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.3 Agreement dated May 11, 1993 between registrant and John Deere Industrial Equipment Company concerning industrial retail notes (Exhibit 10.3 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.4 Agreement dated January 26, 1983 between registrant and Deere & Company relating to agreements with United States sales branches on retail notes (Exhibit 10.4 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.5 Insurance policy no. CL-001 of Sierra General Life Insurance Company providing insurance on lives of purchasers of certain equipment financed with receivables (Exhibit 10.5 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n11. Not applicable.\n12. Statement of computation of the ratio of earnings before fixed charges to fixed charges for each of the five years in the period ended October 31, 1993. 321\n13. Not applicable\n16. Not applicable\n18. Not applicable\n21. Omitted pursuant to instruction J(2)\n22. Not applicable\n23. Consent of Deloitte & Touche 322\n24. Not applicable\n27. Not applicable\n28. Not applicable\n99.1 Parts I and II of the Deere & Company Form 10-K for the fiscal year ended October 31, 1993.*\n- ----------------------------- * Incorporated by reference. Copies of these exhibits are available from the Company upon request.","section_15":""}
{"filename":"5272_1993.txt","cik":"5272","year":"1993","section_1":"ITEM 1. BUSINESS\nAmerican International Group, Inc. (\"AIG\"), a Delaware corporation, is a holding company which through its subsidiaries is primarily engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG's primary activities include both general and life insurance operations. The principal insurance company subsidiaries are American Home Assurance Company (\"American Home\"), National Union Fire Insurance Company of Pittsburgh, Pa. (\"National Union\"), New Hampshire Insurance Company (\"New Hampshire\"), Lexington Insurance Company (\"Lexington\"), American International Underwriters Overseas, Ltd. (\"AIUO\"), American Life Insurance Company (\"ALICO\"), American International Assurance Company, Limited (\"AIA\"), Nan Shan Insurance Company, Ltd. (\"Nan Shan\"), The Philippine American Life Insurance Company (\"PHILAM\"), American International Reinsurance Company, Ltd. and United Guaranty Residential Insurance Company. Other significant activities are financial services and agency and service fee operations. For information on AIG's business segments, see Note 19 of Notes to Financial Statements.\nAll per share information herein gives retroactive effect to all stock dividends and stock splits. As of January 31, 1994, beneficial ownership of approximately 15.9 percent, 3.7 percent and 2.4 percent of AIG's Common Stock, $2.50 par value (\"Common Stock\"), was held by Starr International Company, Inc. (\"SICO\"), The Starr Foundation and C. V. Starr & Co., Inc. (\"Starr\"), respectively.\nAt December 31, 1993, AIG and its subsidiaries had approximately 33,000 employees.\nThe following table shows the general development of the business of AIG on a consolidated basis, the contributions made to AIG's consolidated revenues and operating income and the assets held, in the periods indicated by its general insurance, life insurance, agency and service fee and financial services operations, equity in income of minority-owned reinsurance companies and realized capital gains. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 1 and 19 of Notes to Financial Statements.)\n(a) Adjusted underwriting profit (loss) is statutory underwriting income (loss) adjusted primarily for changes in deferral of acquisition costs. This adjustment is necessary to present the financial statements in accordance with generally accepted accounting principles.\n(b) Represents the sum of general net premiums earned, life premium income, agency commissions, management and other fees, net investment income, financial services commissions, transaction and other fees, equity in income of minority-owned reinsurance operations and realized capital gains.\nThe following table shows identifiable assets, revenues and income derived from operations in the United States and Canada and from operations in other countries for the year ended December 31, 1993. (See also Note 19 of Notes to Financial Statements.)\nGENERAL INSURANCE OPERATIONS\nAIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. One or more of these companies is licensed to write substantially all of these lines in all states of the United States and in more than 100 foreign countries.\nAIG's business derived from brokers in the United States and Canada is conducted through its domestic brokerage division, consisting of American Home, National Union, Lexington and certain other insurance company subsidiaries of AIG. Also included are the operations of New Hampshire and its subsidiaries, which were restructured in 1992, thus completing the withdrawal of these companies from an agency production system. New Hampshire is now integrated into this division as the AIG company focusing specifically on providing AIG products and services through brokers to middle market companies.\nThe domestic brokerage division accepts business mainly from insurance brokers, enabling selection of specialized markets and retention of underwriting control. Any licensed broker is able to submit business to these companies without the traditional agent-company contractual relationship, but such broker usually has no authority to commit the companies to accept a risk.\nIn addition to writing substantially all classes of business insurance, including large commercial or industrial property insurance, excess liability, inland marine, workers' compensation and excess and umbrella coverages, the domestic brokerage division offers many specialized forms of insurance such as directors and officers liability, difference-in-conditions, kidnap-ransom, export credit and political risk, and various types of professional errors and omissions coverages. Lexington writes surplus lines, those risks for which conventional insurance companies do not readily provide insurance coverage, either because of complexity or because the coverage does not lend itself to conventional contracts.\nAudubon Insurance Company and its subsidiaries (\"Audubon\") conduct agency marketing of personal and small commercial coverages in certain Southern and Western States.\nIn early 1994, AIG announced that it was considering the sale of Audubon, since its agency operations do not have a strategic fit with AIG's brokerage operations.\nAmerican International Insurance Company (\"AIIC\") engages in mass marketing of personal lines coverages. Since 1992, AIIC increased its participation in non-standard auto business in urban markets.\nThe business of United Guaranty Corporation (\"UGC\") and its subsidiaries is also included in the domestic operations of AIG. The principal business of the UGC subsidiaries is the writing of residential mortgage loan insurance, which is guaranty insurance on conventional first mortgage loans on single-family dwellings and condominiums. Such insurance protects lenders against loss if borrowers default. UGC subsidiaries also write commercial mortgage loan insurance covering first mortgage loans on commercial real estate, home equity and property improvement loan insurance on loans to finance residential property improvements, alterations and repairs and for other purposes not necessarily related to real estate, and rent guaranty insurance on commercial and industrial real estate.\nAIG's foreign general insurance business comprises primarily risks underwritten through American International Underwriters (\"AIU\"), a marketing unit consisting of wholly owned agencies and insurance companies. It also includes business written by foreign-based insurance subsidiaries of AIUO for their own accounts. In general, the same types of policies and marketing methods, with certain refinements for local laws, customs and needs, are used in these foreign operations as have been described above in connection with the domestic operations.\nDuring 1993 domestic general and foreign general insurance business accounted for 69.9 percent and 30.1 percent, respectively, of AIG's net premiums written.\nAIG's general insurance company subsidiaries worldwide operate primarily by underwriting and accepting any size risk for their direct account and securing reinsurance on that portion of the risk in excess of the limit which they wish to retain. This operating policy differs from that of many insurance companies which will underwrite only up to their net retention limit, thereby requiring the broker or agent to secure commitments from other underwriters for the remainder of the gross risk amount.\nThe following table summarizes general insurance premiums written and earned:\nThe utilization of reinsurance is closely monitored by an internal reinsurance security committee, consisting of members of AIG's Senior Management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 5 of Notes to Financial Statements.)\nAIG is well diversified both in terms of lines of business and geographic locations. Of the general insurance lines of business, workers' compensation was approximately 18 percent of AIG's net premiums written. This line is well diversified geographically and is generally written on a retrospectively rated basis which reduces its exposure to material uncertainty or risks.\nNotwithstanding the above, the majority of AIG's insurance business is in the casualty classes, which tend to involve longer periods of time for the reporting and settling of claims. This may increase the risk and uncertainty with respect to AIG's loss reserve development. (See also the Discussion and Analysis of Consolidated Net Loss and Loss Expense Reserve Development and Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nThe following table is a summary of the general insurance operations, including statutory ratios, by major operating category for the year ended December 31, 1993. (See also Note 19(b) of Notes to Financial Statements.)\n(a) Including workers' compensation and retrospectively rated risks. (b) Including involuntary pools. (c) Including mass marketing and specialty programs.\nStatutory loss and expense ratios of AIG's consolidated general insurance operations are set forth in the following table. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\n* Source: Best's Aggregates & Averages (Stock insurance companies, after dividends to policyholders). The ratio for 1993 reflects estimated results provided by Conning & Company.\nDuring 1993, of the direct general insurance premiums written (gross premiums less return premiums and cancellations, excluding reinsurance assumed and before deducting reinsurance ceded), 10.0 percent and 10.6 percent were written in California and New York, respectively (no other state accounted for more than 5 percent of such premiums).\nThere was no significant adverse effect on AIG's results of operations from the economic environments in any one state, country or geographic region for the year ended December 31, 1993. During that year, 32.2 percent of general insurance premiums were written outside of the United States and Canada.\nDISCUSSION AND ANALYSIS OF CONSOLIDATED NET LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT\nThe reserve for net losses and loss expenses is exclusive of applicable reinsurance and represents the accumulation of estimates for reported losses (\"case basis reserves\") and provisions for losses incurred but not reported (\"IBNR\"). AIG does not discount its loss reserves other than for very minor amounts related to certain workers' compensation claims.\nLoss reserves established with respect to foreign business are set and monitored in terms of the respective local or functional currency. Therefore, no assumption is included for changes in currency rates. (See also Note 1(t) of Notes to Financial Statements.) Losses and loss expenses are charged to income as incurred.\nManagement continually reviews the adequacy of established loss reserves through the utilization of a number of analytical reserve development techniques (discussed below). Through the use of these techniques, management is able to monitor the adequacy of its established reserves, including the appropriate assumptions for inflation. Also, through reactions to the emergence of specific development patterns, such as case reserve redundancies or deficiencies and IBNR emergence, management is able to currently determine any required adjustments. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nThe \"Analysis of Consolidated Net Loss and Loss Expense Reserve Development\", which follows, presents the development of net loss and loss expense reserves for calendar years 1983 through 1993. The upper half of the table shows the cumulative amounts paid during successive years related to the opening loss reserves. For example, with respect to the net loss and loss expense reserve of $2,800.1 million as of December 31, 1983, by the end of 1993 (ten years later) $2,998.3 million had actually been paid in settlement of these net loss reserves. In addition, as reflected in the lower section of the table, the original reserve of $2,800.1 million was reestimated to be $3,361.5 million at December 31, 1993. This increase from the original estimate would generally be a combination of a number of factors, including reserves being settled for larger amounts than originally estimated. The original estimates will also be increased or decreased as more information becomes known about the individual claims and overall claim frequency and severity patterns. The redundancy (deficiency) depicted in the table, for any particular calendar year, shows the aggregate change in estimates over the period of years subsequent to the calendar year reflected at the top of the respective column heading. For example, the deficiency of $50.2 million at December 31, 1993 related to December 31, 1992 net loss and loss expense reserves of $16,756.8 million represents the cumulative amount by which reserves for 1992 and prior years have developed deficiently during 1993.\nANALYSIS OF CONSOLIDATED NET LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT\nThe trend depicted in the latest development year in the reestimated liability portion of the \"Analysis of Consolidated Net Loss and Loss Expense Reserve Development\" table indicates that the overall position of AIG's 1992 and prior reserves one year later is fairly comparable to the trends reflected in recent years. The variations in development from original reserves in the later years of the table are relatively insignificant both in terms of aggregate amounts and as a percentage of the initial reserve balances.\n* Does not include the effects of foreign exchange adjustments as described above, which are reflected in the table on page 5.\nApproximately 50 percent of the net loss and loss expense reserves are paid out within two years of the date incurred. The remaining net loss and loss expense reserves, particularly those associated with the casualty lines of business, may extend to 20 years or more.\nFor further discussion regarding net reserves for losses and loss expenses, see Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe reserve for losses and loss expenses as reported in AIG's Consolidated Balance Sheet at December 31, 1993, differs from the total reserve reported in the Annual Statements filed with state insurance departments and, where appropriate, with foreign regulatory authorities. The difference at December 31, 1993 is primarily because of minor discounting on certain workers' compensation claims, estimates for unrecoverable reinsurance and additional reserves relating to certain foreign operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nThe reserve for gross loss and loss expenses is prior to reinsurance and represents the accumulation for reported losses and IBNR. Management reviews the adequacy of established gross loss reserves in a manner as previously described for net loss reserves.\nThe \"Analysis of Consolidated Gross Loss and Loss Expense Reserve Development\", which follows, presents the development of gross loss and loss expense reserves for calendar years 1992 and 1993. As with the net loss and loss expense reserve development, the deficiency of $96.6 million is relatively insignificant both in terms of an aggregate amount and as a percentage of the initial reserve balance.\nLIFE INSURANCE OPERATIONS\nAIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. One or more of these subsidiaries is licensed to write life insurance in all states in the United States and in over 70 foreign countries. Traditional products consist of individual and group life, annuity, and accident and health policies. Financial and investment products consist of single premium annuity, variable annuities, guaranteed investment contracts and universal life. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nIn the United States, AIG has four domestic life subsidiaries: American International Life Assurance Company of New York, AIG Life Insurance Company, Delaware American Life Insurance Company, and Pacific Union Assurance Company. These companies utilize multiple distribution channels including brokerage and career and general agents to offer primarily financial and investment products and specialty forms of accident and health coverage for individuals and groups, including employee benefit plans. The domestic life business comprised 4.7 percent of total life premium income in 1993.\nLife insurance operations in foreign countries comprised 95.3 percent of life premium income in 1993 and accounted for 94.4 percent of operating income. AIG operates overseas through two main subsidiary companies, ALICO and AIA. AIA operates primarily in Hong Kong, Singapore, Malaysia and Thailand. Although ALICO is incorporated in Delaware, all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in approximately 50 countries located in Europe, Africa, Latin America, the Middle East, and the Far East, with Japan being the largest territory.\nTraditional life insurance products such as whole life and endowment continue to be significant in the overseas companies, especially in Southeast Asia, while a mixture of traditional, accident and health and financial products are sold in Japan.\nIn addition to ALICO and AIA, AIG also has subsidiary operations in Taiwan (Nan Shan), Switzerland (Ticino Societa d'Assicurazioni Sulla Vita), Puerto Rico (AIG Life Insurance Company of Puerto Rico) and the Philippines (PHILAM), and conducts life insurance business through AIUO subsidiary companies in certain countries in Central and South America.\nThe foreign life companies have over 96,000 career agents and sell their products largely to indigenous persons in local currencies. In addition to the agency outlets, these companies also distribute their products through direct marketing channels, such as mass marketing, and through brokers and other distribution outlets such as financial institutions.\nThe following table summarizes the life insurance operating results for the year ended December 31, 1993. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\n(a) Including income related to investment type products. (b) Including $114.05 billion of whole life insurance and endowments. (c) Not applicable.\nINSURANCE INVESTMENT OPERATIONS\nA significant portion of AIG's general and life operating revenues are derived from AIG's insurance investment operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 2, 8 and 19 of Notes to Financial Statements.)\nThe following table is a summary of the composition of AIG's insurance invested assets by insurance segment, including investment income due and accrued and real estate, at December 31, 1993:\nThe following table summarizes the investment results of the general insurance operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 8 of Notes to Financial Statements.)\n(a) Including investment income due and accrued. (b) Net investment income is after deduction of investment expenses and excludes realized capital gains. (c) Net investment income divided by the annual average sum of cash and invested assets. (d) Net investment income divided by the annual average invested assets.\nThe following table summarizes the investment results of the life insurance operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 8 of Notes to Financial Statements.)\n(a) Including investment income due and accrued and real estate. (b) Net investment income is after deduction of investment expenses and excludes realized capital gains (losses). (c) Calculated on the basis of the formula prescribed by the National Association of Insurance Commissioners.\nAIG's worldwide insurance investment policy places primary emphasis on investments in high quality, fixed income securities in all of its portfolios and, to a lesser extent, investments in marketable common stocks in order to preserve policyholders' surplus and generate net investment income. The ability to implement this policy is somewhat limited in certain territories as there may be a lack of qualified long term investments or investment restrictions may be imposed by the local regulatory authorities. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nAGENCY AND SERVICE FEE OPERATIONS\nAIG's agency and service fee operations contribute to AIG earnings through fees as agents and managers, the premiums they generate for AIG's insurance companies and the revenues they produce from technical and support service activities.\nSeveral AIG companies act as managing general agents for both AIG subsidiaries and non-affiliated insurance companies, accepting liability on risks and actively managing the business produced. These general agencies deal directly with the producing agents and brokers, exercise full underwriting control, issue policies, collect premiums, arrange reinsurance, perform accounting, actuarial and safety and loss control services, adjust and pay losses and claims, and settle net balances with the represented companies. In some cases, they also maintain their own and the represented companies' authority to do business in the jurisdictions in which they operate.\nAgency and service fee operations are conducted primarily through AIG Risk Management, Inc., which provides risk management services to independent insurance agents, brokers and their customers on a worldwide basis and AIG Aviation Inc., which sells aviation insurance.\nFINANCIAL SERVICES OPERATIONS\nAIG operations which contribute to financial services income include primarily A.I. Credit Corp. (\"AICCO\"), AIG Financial Products Corp. and its subsidiary companies (\"AIGFP\"), AIG Trading Group Inc. and its subsidiaries (\"AIGTG\"), International Lease Finance Corporation (\"ILFC\") and UeberseeBank, AG. AICCO's business is principally in premium financing. During the year ended December 31, 1993, AICCO financed gross property and casualty premiums exceeding $2.1 billion. AIGFP structures borrowings through guaranteed investment agreements and engages in other complex financial transactions, including interest rate and currency swaps. AIGTG engages in various commodities trading, foreign exchange trading and market making activities. ILFC is engaged primarily in the acquisition of new and used commercial jet aircraft and the leasing and remarketing of such aircraft to airlines around the world. UeberseeBank, AG operates as a Swiss bank. AIG Funding, Inc. provides funding for various AIG subsidiaries. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 9 and 11 of Notes to Financial Statements.)\nThe following table is a summary of the composition of AIG's financial services invested assets and liabilities at December 31, 1993. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1 of Notes to Financial Statements.)\nOther financial services activities include AIG's 30 percent interest in AB Asesores CFMB, S.L., a Spanish brokerage, investment banking and private investment management firm, and certain investment management and venture capital operations in various overseas financial services sectors.\nOTHER OPERATIONS\nAIG Global Investors, Inc. and AIG Investment Corporation and its subsidiaries manage the investment portfolios of various AIG subsidiaries. Other smaller subsidiaries provide insurance-related services such as adjusting claims and marketing specialized products. AIG has several other relatively small subsidiaries which carry on various businesses. Mt. Mansfield Company, Inc. owns and operates the ski slopes, lifts, school and an inn located at Stowe, Vermont.\nADDITIONAL INVESTMENTS\nAs of March 15, 1994, AIG holds a 46.5 percent interest in Transatlantic Holdings, Inc., a reinsurance holding company, and a 19.9 percent interest in Richmond Insurance Company, Ltd., a reinsurer. (See also Note 1(n) of Notes to Financial Statements.) During 1992, AIG acquired a 20 percent interest through a purchase of preferred stock in The Robert Plan Corporation, a leading servicer and underwriter of private passenger and commercial automobile insurance in urban markets. During 1993, AIG acquired a 23.1 percent interest in Kroll Associates, an international investigation and consulting firm; AIG holds a 23.9 percent interest in SELIC Holdings, Ltd., an insurance holding company and a 24.4 percent interest in IPC Holding, Ltd., a reinsurance holding company.\nLOCATIONS OF CERTAIN ASSETS\nAs of December 31, 1993, approximately 36 percent of the consolidated assets of AIG were located in foreign countries (other than Canada), including $164.7 million and $814.0 million of cash and securities, respectively, on deposit with foreign regulatory authorities. Foreign operations and assets held abroad may be adversely affected by political developments in foreign countries, including such possibilities as tax changes, nationalization and changes in regulatory policy, as well as by consequence of hostilities and unrest. The risks of such occurrences and their overall effect upon AIG vary from country to country and cannot easily be predicted. If expropriation or nationalization does occur, AIG's policy is to take all appropriate measures to seek recovery of such assets. Certain of the countries in which AIG's business is conducted have currency restrictions which generally cause a delay in a company's ability to repatriate assets and profits. (See also Notes 1(t), 2 and 19(d) of Notes to Financial Statements.)\nINSURANCE REGULATION AND COMPETITION\nCertain states require registration and periodic reporting by insurance companies which are licensed in such states and are controlled by other corporations. Applicable legislation typically requires periodic disclosure concerning the corporation which controls the registered insurer and the other companies in the holding company system and prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system. AIG's subsidiaries are registered under such legislation in those states which have such requirements. (See also Note 10(b) of Notes to Financial Statements.)\nAIG's insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, the licensing of insurers and their agents, the nature of and limitations on investments, restrictions on the size of risks which may be insured under a single policy, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than security holders. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nRisk Based Capital (RBC) is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized general and life insurance companies may be identified.\nThe RBC formula develops a risk adjusted target level of statutory surplus by applying certain factors to various asset, premium and reserve items. Higher factors are applied to more risky items and lower factors are applied to less risky items. Thus, the target level of statutory surplus varies not only as a result of the insurer's size, but also on the risk profile of the insurer's operations.\nThe RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control.\nTo the extent that any of AIG's insurance entities would fall below prescribed levels of surplus, it would be AIG's intention to infuse necessary capital to support that entity.\nEach of AIG's domestic, general and life insurer's statutory surplus exceeds the risk based capital requirements as of December 31, 1993.\nA substantial portion of AIG's general insurance business and a majority of its life insurance business is carried on in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to AIG subsidiaries are subject to modification or revocation by such authorities, and AIU or other AIG subsidiaries could be prevented from conducting business in certain of the jurisdictions where they currently operate. In the past, AIU has been allowed to modify its operations to conform with new licensing requirements in most jurisdictions.\nIn addition to licensing requirements, AIG's foreign operations are also regulated in various jurisdictions with respect to currency, policy language and terms, amount and type of security deposits, amount and type of reserves, amount and type of local investment and the share of profits to be returned to policyholders on participating policies. Some foreign countries regulate rates in various types of policies. Certain countries have established reinsurance institutions, wholly or partially owned by the state, to which admitted insurers are obligated to cede a portion of their business on terms which do not always allow foreign insurers, including AIG, full compensation. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets.\nThe insurance industry is highly competitive. Within the United States, AIG's general insurance subsidiaries compete with approximately 3,100 other stock companies, specialty insurance organizations, mutual companies and other underwriting organizations. AIG's life insurance companies compete in the United States with some 1,300 other companies. Overseas, AIG subsidiaries compete for business with foreign insurance operations of the larger U.S. insurers and local companies in particular areas in which they are active.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAIG and its subsidiaries operate from approximately 250 offices in the United States, 5 offices in Canada and numerous offices in other foreign countries. The offices in Manchester, New Hampshire; Springfield, Illinois; Houston, Texas; Atlanta, Georgia; Baton Rouge, Louisiana; Wilmington, Delaware; Hato Rey, Puerto Rico; San Diego, California; Greensboro, North Carolina; Livingston and Morris County, New Jersey; 70 Pine Street, 99 John Street and 72 Wall Street in New York City; and offices in approximately 30 foreign countries including Bermuda, Hong Kong, the Philippines, Japan, England, Singapore, Taiwan and Thailand are located in buildings owned by AIG and its subsidiaries. The remainder of the office space utilized by AIG subsidiaries is leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material adverse effect on its financial condition. (See also the Discussion and Analysis of Consolidated Net Loss and Loss Expense Reserve Development and Management's Discussion and Analysis of Financial Condition and Results of Operations.)\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1993.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is certain information concerning the directors and executive officers of AIG. All directors are elected at the annual meeting of shareholders. All officers serve at the pleasure of the Board of Directors, but subject to the foregoing, are elected for terms of one year expiring in May of each year.\n* Member of Executive Committee.\nExcept as hereinafter noted, each of the directors who is also an executive officer of AIG and each of the other executive officers has, for more than five years, occupied an executive position with AIG or companies that are now its subsidiaries, or with Starr. Jeffrey W. Greenberg is the son of M.R. Greenberg. There are no other arrangements or understandings between any director or officer and any other person pursuant to which the director or officer was elected to such position. Mr. Lewis was Assistant General Manager for North America, Chief Credit Officer, and senior executive responsible for risk and exposure management of ING Bank in New York, the bank division of Internationale Nederlanden Group from 1988 until joining AIG in October, 1993. Mr. O'Kulich was president of Maccabees Life & Annuity Company from 1982 to July 31, 1989 and was self employed from August, 1989 until joining AIG in May, 1990. Mr. Sabatacakis was Managing Director and head of the Capital Markets and Treasury Group of Chemical Banking Corporation prior to joining AIG in February, 1992. From January, 1988 until joining AIG in October, 1989, Mr. Wooster headed his own corporate communications and investor relations firm, Wooster Communications, in New York. Prior to that, he was President of The Hannaford Company, a Washington-based public relations and public affairs firm.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\n(a) The table below shows the high and low closing sales prices per share of AIG's common stock, as reported on the New York Stock Exchange Composite Tape, for each quarter of 1993 and 1992. All prices are as reported by the National Quotation Bureau, Incorporated.\n(b) In 1993, AIG paid a quarterly dividend of 9.3 cents in March and June and 10.0 cents in September and December for a total cash payment of 38.6 cents per share of common stock. In 1992, AIG paid a quarterly dividend of 8.3 cents in March and June and 9.3 cents in September and December for a total cash payment of 35.2 cents per share of common stock. These amounts reflect the adjustment for a 50 percent common stock split in the form of a common stock dividend paid July 30, 1993. Subject to the dividend preference of any of AIG's serial preferred stock which may be outstanding, the holders of shares of common stock are entitled to receive such dividends as may be declared by the Board of Directors from funds legally available therefor. During 1992, serial preferred stock consisted of 750 shares of Series M-1 Preferred Stock and 750 shares of Series M-2 Preferred Stock. AIG redeemed the Series M-1 on April 2, 1993 and the Series M-2 on March 5, 1993 at a price of $100,000 per share plus accrued dividends.\nSee Note 10(b) of Notes to Financial Statements for a discussion of certain restrictions on the payment of dividends to AIG by some of its insurance subsidiaries.\n(c) The approximate number of holders of Common Stock as of January 31, 1994, based upon the number of record holders, was 14,700.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nAMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA\nThe following Selected Consolidated Financial Data is presented in accordance with generally accepted accounting principles. This data should be read in conjunction with the financial statements and accompanying notes included elsewhere herein.\n(a) Represents the sum of general net premiums earned, life premium income, agency commissions, management and other fees, net investment income, financial services commissions, transaction and other fees, equity in income of minority-owned reinsurance operations and realized capital gains. (See also tables under Item 1, \"Business\".) (b) Including commercial paper and excluding that portion of long-term debt maturing in less than one year.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOPERATIONAL REVIEW\nGENERAL INSURANCE OPERATIONS\nIn AIG's general insurance operations, 1993 net premiums written and net premiums earned increased 9.7 percent and 3.9 percent, respectively, from those of 1992. In 1992, net premiums written decreased 0.1 percent and net premiums earned increased 1.2 percent when compared to 1991. In 1991, declines occurred in both net premiums written of 1.3 percent and net premiums earned of 0.5 percent when compared to 1990.\nThe growth in net premiums written in 1993 over 1992 resulted from a mix of several factors. AIG achieved general price increases in domestic commercial property and some specialty casualty markets while overseas, price and volume increases were realized. During 1992 and 1991, the slowing of growth in net premiums written was due in part to the competitive pricing environment in the property-casualty industry in the United States, particularly in commercial lines. In addition, AIG had withdrawn from certain classes of business, primarily agency lines and certain segments of workers' compensation business, because returns on allocated capital or equity were deemed unacceptable. The estimated impact of AIG's strategy when comparing results for 1992 to those of 1991 was to reduce net premiums written by approximately $680 million, following a similar reduction of approximately $330 million in 1991.\nNet premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes the deferred earnings which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period.\nAdjusted underwriting profit or loss (operating income less net investment income and realized capital gains) represents statutory underwriting profit or loss adjusted primarily for changes in the deferral of acquisition costs. (See also Note 4 of Notes to Financial Statements.) The adjusted underwriting profit in 1993 was $10.4 million compared to adjusted underwriting losses of $195.1 million recorded in 1992 and $4.8 million in 1991.\nThe statutory general insurance ratios were as follows:\nThe gross and net impacts of the catastrophe losses during 1993 were approximately $134 million and $70 million, respectively. This was significantly below the approximately $567 million and $192 million in gross and net catastrophe losses, respectively, recorded in 1992, which included the three major storms Andrew, Iniki and Omar. Losses of $99 million and $68 million, respectively, were recorded in 1991. If the catastrophes were excluded from the losses incurred in each period, the pro forma statutory general insurance ratios would be as follows:\nThe maintenance of the statutory combined ratio in all three years at a level approximating 100 is a result of AIG's emphasis on maintaining its underwriting discipline within the continued overall competitiveness of the domestic market environment as well as AIG's expense control.\nAIG's operations are negatively impacted under guarantee fund assessment laws which exist in most states. As a result of operating in a state which has guarantee fund assessment laws, a solvent insurance company may be assessed for certain obligations arising from the insolvencies of other insurance companies which operated in that state. AIG generally records these assessments upon notice. Additionally, certain states permit at least a portion of the assessed amount to be used as a credit against a company's future premium tax liabilities. Therefore, the ultimate net assessment cannot reasonably be estimated. The guarantee fund assessments net of credits for 1993, 1992 and 1991 were $14.1 million, $27.7 million and $37.9 million, respectively. Also, AIG is required to participate in various involuntary pools (principally workers' compensation business) which provide insurance coverage for those not able to obtain such coverage in the voluntary markets. This participation is also recorded upon notification, as these amounts cannot reasonably be estimated.\nAt December 31, 1993, general insurance reserves for losses and loss expenses (loss reserves) amounted to $30.05 billion, an increase of $1.89 billion or 6.7 percent over the prior year end. General insurance net loss reserves represent the accumulation of estimates of ultimate losses, including provisions for losses incurred but not reported (IBNR), and loss expenses, reduced by reinsurance recoverable net of an allowance for unrecoverable reinsurance and very minor amounts of discounting related to certain workers' compensation claims. The net loss reserves increased $800.2 million or 4.8 percent to $17.56 billion. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and\nupdated. Any adjustments resulting therefrom are reflected in operating income currently. It is management's belief that the general insurance net loss reserves are adequate to cover all general insurance net losses and loss expenses as at December 31, 1993. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on such future results of operations.\nAIG's reinsurance recoverable results from its reinsurance arrangements. These arrangements do not relieve AIG from its direct obligation to its insureds. Thus, a contingent liability of approximately $12 billion existed at December 31, 1993 with respect to general reinsurance reserves for loss and loss expenses ceded (reinsurance recoverable) to the extent that reinsurers are unable to meet their obligations assumed under the reinsurance agreements. However, AIG holds substantial collateral as security under related reinsurance agreements in the form of funds, securities and\/or irrevocable letters of credit which can be drawn on for amounts that remain unpaid beyond specified time periods. Although a provision is recorded for estimated unrecoverable reinsurance, AIG has been largely successful in prior recovery efforts. (See also Note 5 of Notes to Financial Statements.)\nAIG enters into certain intercompany reinsurance transactions for both its general and life operations. AIG enters these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among various legal entities. These reinsurance agreements have been approved by the appropriate regulatory authorities. All material intercompany transactions have been eliminated in consolidation.\nIn a very broad sense, the general loss reserves can be categorized into two distinct groups: one group being long tail casualty lines of business; the other being short tail lines of business consisting principally of property lines and including certain classes of casualty lines.\nEstimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. In the more recent accident years of long tail casualty lines there is limited statistical credibility in reported net losses. That is, a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. A relatively high proportion of net losses would therefore be IBNR.\nA variety of actuarial methods and assumptions are normally employed to estimate net losses for long tail casualty lines. These methods ordinarily involve the use of loss trend factors intended to reflect the estimated annual growth in loss costs from one accident year to the next. Loss trend factors reflect many items including changes in claims handling, exposure and policy forms and current and future estimates of inflation and social inflation. Thus, many factors are implicitly considered in estimating the year to year growth in loss costs. Therefore, AIG's carried net long tail loss reserves are judgmentally set as well as tested for reasonableness using the most appropriate loss trend factors for each class of business. In the evaluation of AIG's net loss reserves, loss trend factors have ranged from 7 percent to 22 percent of average loss costs, depending on the particular class and nature of the business involved. For the majority of long tail casualty lines, net loss trend factors approximating 10 percent were employed. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience.\nEstimation of net losses for short tail business is less complex than for long tail casualty lines. Loss cost trends for many property lines can generally be assumed to be similar to the growth in exposure of such lines. For example, if the fire insurance coverage remained proportional to the actual value of the property, the growth in property's exposure to fire loss can be approximated by the amount of insurance purchased.\nFor other property and short tail casualty lines, the loss trend is implicitly assumed to grow at the rate that reported net losses grow from one year to the next. The concerns noted above for longer tail casualty lines with respect to the limited statistical credibility of reported net losses generally do not apply to shorter tail lines.\nAIG continues to receive indemnity claims asserting injuries from toxic waste, hazardous substances, asbestos and other environmental pollutants and alleged damages to cover the clean-up costs of hazardous waste dump sites (environmental claims). The vast majority of these environmental claims emanate from policies written in 1984 and prior years. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage. AIG has established a special environmental claims unit which investigates and adjusts all such claims.\nEstimation of environmental claims loss reserves is a difficult process. These environmental claims cannot be estimated by conventional reserving techniques as previously described. Quantitative techniques frequently have to be supplemented by subjective considerations including managerial judgment. Significant factors which affect the trends which influence the development of environmental claims are the inconsistent court resolutions, the broadening of the intent of the policies and scope of coverage and the increasing number of new claims. The case law that has emerged can be characterized as still being in its infancy and the likelihood of any firm direction in the near future is very small. Additionally, the exposure for cleanup costs of hazardous waste dump sites involves coverage issues such as allocation of responsibility among potentially responsible parties and the government's refusal to release parties. The cleanup cost exposure may significantly change if the Congressional reauthorization of Superfund in 1994 is dramatically changed thereby reducing or increasing litigation and cleanup costs.\nIn the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. If the courts continue in the future to expand the intent of the policies and the scope of the coverage as they have in the past, additional liabilities would emerge for amounts in excess of the current reserves held. This emergence cannot now be reasonably estimated, but could have a material impact on AIG's future operating results and financial condition. The reserves carried for these claims as at December 31, 1993 are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG's net exposure retained relative to the gross exposure written was lower in those years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. (See the previous discussion on reinsurance collectibility herein.)\nThe gross and net IBNR included in the reserve for loss and loss expenses at December 31, 1993 for environmental claims approximated $245 million and $85 million, respectively; for 1992, $225 million and $75 million, respectively; for 1991, $210 million and $60 million, respectively. Most of the claims included in the following table relate to policies written in 1984 and prior years.\nThe majority of AIG's exposures for environmental claims are excess casualty coverages, not primary coverages. Thus, the litigation costs are treated in the same manner as indemnity reserves. That is, litigation expenses are included within the limits of the liability AIG incurs. Individual significant claim liabilities, where future litigation costs are reasonably determinable, are established on a case basis.\nA summary of reserve activity, including estimates for applicable IBNR, relating to environmental claims at December 31, 1993, 1992 and 1991 is as follows:\nGeneral insurance net investment income in 1993 was $1.34 billion, an increase of 7.1 percent from 1992. In 1992, net investment income increased 7.6 percent to $1.25 billion from the $1.16 billion earned in 1991. The growth in net investment income in each of the three years was primarily attributable to new cash flow for investment. The new cash flow was generated from net general insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. The decline in the rate of growth is a reflection of the general worldwide downward trend in interest rates. (See also the discussion under \"Liquidity\" herein.)\nGeneral insurance realized capital gains were $65.3 million in 1993, $67.1 million in 1992 and $89.3 million in 1991. These realized gains resulted from the ongoing management of the general insurance investment portfolios within the overall objectives of the general insurance operations and arose primarily from the disposition of equity securities and fixed maturities, including redemptions of fixed maturities.\nGeneral insurance operating income in 1993 was $1.42 billion, an increase of 26.0 percent when compared to $1.12 billion in 1992. The 1992 results reflect a decrease of 9.9 percent from 1991. The 1992 operating results were significantly impacted by the aforementioned catastrophes. The contribution of general insurance operating income to income before income taxes and the cumulative effect of accounting changes was 54.4 percent in 1993 compared to 52.6 percent in 1992 and 61.7 percent in 1991. The changes in the contribution percentages were due to the aforementioned factors and, in 1992 and 1991, the growth of the financial services operations relative to general insurance operating income.\nA year to year comparison of operating income is significantly influenced by the catastrophe losses in any one year as well as the volatility from one year to the next in realized capital gains. Adjusting each year to exclude the effects of both catastrophe losses and realized capital gains, operating income would have increased by 13.9 percent in 1993, 1.7 percent in 1992 and 5.1 percent in 1991. The increase in the growth rate of 1993 over 1992 after the aforementioned adjustments was a result of the increased net investment income as previously discussed and improvement in underwriting results. The decline in the growth rate in 1992 as compared to 1991 is primarily a result of the higher level of incurred losses and the general downward trend in interest rates, as discussed above.\nLIFE INSURANCE OPERATIONS\nAIG's life insurance operations continued to show growth as a result of overseas operations, particularly in Asia. AIG's life premium income of $5.75 billion in 1993 represented an 18.4\npercent increase from the prior year. This compares with increases of 19.6 percent and 16.7 percent in 1992 and 1991, respectively. The foreign ordinary life products were the major contributor to premium growth in all three years. In 1993, foreign life operations produced 95.3 percent of the life premium income and 94.4 percent of the operating income. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)\nTraditional life insurance products such as whole life and endowment continue to be significant in the overseas companies, especially in Southeast Asia, while a mixture of traditional, accident and health and financial products are being sold in Japan.\nThe risks associated with the traditional and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is investment risk.\nUnderwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately $1 million of coverage by using yearly renewable term reinsurance. The life insurance operations have not entered into assumption reinsurance transactions or surplus relief transactions during the three year period ended December 31, 1993. (See also Note 5 of Notes to Financial Statements.)\nThe investment risk represents the exposure to loss resulting from the cash flows from the invested assets, primarily long-term fixed rate investments, being less than the cash flows required to meet the obligations of the expected policy and contract liabilities and the necessary return on investments.\nTo minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to determine if a liquidity excess or deficit is perceived to exist. If a rebalancing of the invested assets to the policy and contract claims became necessary and did not occur, a demand could be placed upon liquidity. (See also the discussion under \"Liquidity\" herein.)\nThe asset-liability relationship is appropriately managed in AIG's foreign operations, even though certain territories lack qualified long term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of such policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the investments may be at a yield below that of the interest required for the accretion of the policy liabilities. In Japan, the average duration of the investment portfolio is 5.3 years, while the related policy liabilities are estimated to be 7.4 years. To maintain an adequate yield to match the interest required over the duration of the liabilities, constant management focus is required to reinvest the proceeds of the maturing securities without sacrificing investment quality. To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and support of any operational shortfall through its international financial network. Domestically, the asset-liability matching process is appropriately functioning as there are investments available to match the duration and the required yield. (See also the discussion under \"Liquidity\" herein.)\nAIG uses asset-liability matching as a management tool to determine the composition of the invested assets and marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in an unmatched position due to anticipated interest rate or other economic changes.\nLife insurance net investment income increased 14.1 percent to $1.50 billion in 1993 compared to increases of 15.3 percent and 16.6 percent in 1992 and 1991, respectively. The growth in net investment income in each of the three years was primarily attributable to new cash flow for investment. The new cash flow was generated from net life insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. The decline in the rate of growth is a reflection of the general worldwide downward trend in interest rates. (See also the discussion under \"Liquidity\" herein.)\nLife insurance realized capital gains were $54.6 million in 1993, $43.3 million in 1992 and $23.2 million in 1991. These realized gains resulted from the ongoing management of the life insurance investment portfolios within the overall objectives of the life insurance operations and arose primarily from the redemption of fixed maturities and, to a smaller extent, from the disposition of equity securities.\nLife insurance operating income in 1993 increased 17.1 percent to $781.6 million compared to increases of 18.8 percent and 21.4 percent in 1992 and 1991, respectively. Excluding realized capital gains from life insurance operating income, the percent increases would be 16.5 percent, 15.9 percent and 14.8 percent in 1993, 1992 and 1991, respectively. The contribution of life insurance operating income to income before income taxes and the cumulative effect of accounting changes amounted to 30.0 percent in 1993 compared to 31.2 percent in 1992 and 27.8 percent in 1991.\nAGENCY AND SERVICE FEE OPERATIONS\nAgency and service fee operating income in 1993 increased 14.6 percent to $60.2 million compared to an increase of 13.8 percent in 1992 and an increase of 26.0 percent in 1991. The increases in operating income in all three years resulted from the growth of risk management services. Agency and service fee operating income contributed 2.3 percent to AIG's income before income taxes and the cumulative effect of accounting changes in 1993 compared to 2.5 percent in 1992 and 2.3 percent in 1991.\nFINANCIAL SERVICES OPERATIONS\nFinancial services operating income amounted to $390.0 million in 1993, an increase of 12.6 percent. This compares with operating income in 1992 and 1991 of $346.4 million and $222.2 million, respectively, or increases of 55.9 percent and 67.7 percent in 1992 and 1991, respectively. The financial services operating income in 1993 increased over that of 1992 as a result of increases in the operating income of International Lease Finance Corporation (ILFC) and AIG Trading Group Inc. and its subsidiaries (AIGTG). The financial services operating income in 1992 increased over that of 1991 as a result of increases in the operating income of AIG Financial Products Corp. and its subsidiaries (AIGFP), ILFC and AIGTG. The primary reason for the increase in financial services operating income in 1991 was the inclusion of twelve months results of operations of ILFC and AIGTG.\nThrough AIGFP and AIGTG, AIG participates in the derivatives market, which has expanded significantly during the past several years. Derivative products typically take the form of futures, forward, swap and option contracts and derive their values from underlying interest rate, foreign exchange, equity or commodity instruments. End users find derivatives to be a cost effective approach to managing market risks associated with traditional on-balance sheet financial instruments. As a dealer of derivative contracts, AIG typically acts as a counterparty to end users or other dealers. Consequently, AIG may build up substantial positions in derivatives which are managed by taking offsetting positions in other derivatives, commodities or financial instruments. AIG's counterparties include financial services companies, governmental units, banks and industrial companies. In considering AIG's derivative activities, it is also important to note that all significant derivative activities are conducted through AIGFP and AIGTG and that AIG's other units, including its insurance subsidiaries, are not significant end users of derivative products.\nAlthough the notional amounts of derivatives are not recorded on the balance sheet, dealer or principal-related derivatives are carried at their estimated fair values. Substantially all of AIG's derivative positions at December 31, 1993 were dealer or principal-related and thus accounted for in that manner. The notional amounts used to express the extent of AIG's involvement in derivatives transactions do not represent a quantification of the market or credit risks of the positions. The notional amounts represent the amounts used to calculate contractual cash flows to be exchanged and are generally not actually paid or received, except for certain contracts such as currency swaps and foreign exchange forwards. Furthermore, other factors such as offsetting transactions, master netting agreements and collateral must all be thoroughly considered in any measurement of risk.\nThe market risk of derivatives arises principally from the potential for changes in volatility, interest rates, foreign exchange rates, and equity and commodity prices. The credit risk of derivatives arises from the potential for a counterparty to default on its contractual obligations. Credit risk exists at a particular point in time when a derivative has a positive market value. Derivatives, other than options, may be in an unrealized gain or unrealized loss position depending on market rates and contract terms. Purchased options contracts with positive market values have credit risk.\nAIGFP conducts, primarily as principal, an interest rate, currency, equity and commodity derivative products business. AIGFP also enters into long dated forward foreign exchange, option, synthetic security, liquidity facility and investment contract transactions.\nAIGFP generally manages its exposures by taking offsetting positions, including swaps, options, bonds, forwards or futures contracts. AIGFP manages its credit risk by internally evaluating the creditworthiness of counterparties and consulting with widely accepted credit rating services. In addition, AIGFP enters into master netting agreements, which incorporate the right of set-off to provide for the net settlement of covered contracts with the same counterparty, in the event of default or other cancellation of the agreement. Also, AIGFP requires collateral on certain transactions based on the credit worthiness of the counterparty.\nAIGFP monitors and controls its risk exposure on a daily basis through financial, credit and legal reporting systems and, accordingly, has in place effective procedures for evaluating and limiting the credit and market risks to which it is subject. Management is not aware of any potential counterparty defaults as of December 31, 1993.\nRevenues generated by AIGFP for 1993 were primarily comprised of interest rate swaps activity, which represented over 50 percent of total AIGFP revenues.\nIn August of 1993, the chief executive officer and minority shareholder of AIGFP left the company and a new management team was put in place. A full and satisfactory settlement was reached between AIG and the former minority shareholder. Most members of AIGFP's core group central to the AIGFP operation have remained at the company.\nDuring 1993, certain investments held by AIGFP experienced financial difficulties and suffered significant rating downgrades. The pretax impact on AIG of the estimated other than temporary impairment in value of these investments was $215 million. As is AIG's policy in such situations where credit ratings have deteriorated significantly, these impairments have been appropriately recognized by charges to income of $104 million in 1993 and $111 million prior to 1993. The charge for the aforementioned impairments relates to investments made before the new management team was in place. Based on the latest information available, AIG believes that no further significant impairments exist.\nAIGTG engages as principal in trading activities in certain foreign exchange, precious and base metals, petroleum and petroleum products and natural gas markets. AIGTG is exposed to risk of loss through the potential non-performance of a counterparty on its contractual obligations (credit risk) and through the potential for changes in value due to fluctuations in interest and foreign exchange rates and in prices of commodities (market risk). Generally, AIGTG manages its credit risk through credit reviews, transaction limits and\/or margin requirements. AIGTG manages the market risk of its various positions and transactions through offsetting transactions such as purchasing and selling options and forward and futures contracts.\nRevenues generated by AIGTG for 1993 were primarily comprised of foreign exchange activities, which represented over 60 percent of total AIGTG revenues.\nILFC primarily engages in the acquisition of new and used commercial jet aircraft and the leasing and sale of such aircraft to airlines around the world. In addition, ILFC is engaged in the remarketing of commercial jets for airlines and financial institutions. ILFC is exposed to loss through non-performance of aircraft lessees and through owning and committing to purchase aircraft which it would be unable to lease. ILFC manages its lessee non-performance exposure through credit reviews and security deposit requirements. At December 31, 1993, only one of 230 aircraft owned was not leased. This aircraft is being converted for freighter service. Currently, 76.5 percent of the fleet is leased to foreign carriers.\nSee also the discussions under \"Capital Resources\" and \"Liquidity\" herein and Notes 1, 9, 11 and 16 of Notes to Financial Statements.\nFinancial services operating income represented 15.0 percent of AIG's income before income taxes and the cumulative effect of accounting changes in 1993. This compares to 16.2 percent and 11.0 percent in 1992 and 1991, respectively.\nOTHER OPERATIONS\nIn 1993, AIG's equity in income of minority-owned reinsurance operations was $39.6 million compared to $27.9 million in 1992 and $28.8 million in 1991. The equity interest in reinsurance companies, which includes two equity operations which commenced business during 1993, represented 1.5 percent of income before income taxes and the cumulative effect of accounting changes in 1993, compared to 1.3 percent in 1992 and 1.4 percent in 1991.\nOther realized capital losses amounted to $12.7 million, $11.3 million and $14.1 million in 1993, 1992 and 1991, respectively.\nOther income (deductions)-net includes AIG's equity in certain minor majority-owned subsidiaries and certain partially-owned companies, minority interest in certain consolidated companies, realized foreign exchange transaction gains and losses in substantially all currencies and unrealized gains and losses in hyperinflationary currencies, as well as the income and expenses of the parent holding company and other miscellaneous income and expenses. In 1993, net deductions amounted to $73.8 million. In both 1992 and 1991, net deductions amounted to $70.2 million.\nIncome before income taxes and the cumulative effect of accounting changes amounted to $2.60 billion in 1993 and $2.14 billion in 1992. Income before income taxes was $2.02 billion in 1991.\nIn 1993, AIG recorded a provision for income taxes of $683.0 million compared to the provisions of $512.0 million and $469.6 million in 1992 and 1991, respectively. These provisions represent effective tax rates of 26.3 percent, 24.0 percent and 23.2 percent in the same respective years. The most significant cause for the increase in the effective tax rate for 1993 was the Omnibus Budget Reconciliation Act of 1993 (the Act). Among other things, the Act increased the corporate tax rate to 35 percent from 34 percent, effective January 1, 1993. Additionally, the effective tax rate was influenced by higher state and local income taxes.\nThe increase in the effective tax rate for 1992 resulted from the adoption of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (FASB 109). That is, fresh start adjustments resulting from loss reserve discounting and salvage recoveries are no longer recognized periodically. The provision for income taxes in 1991 reflects a benefit of approximately $28 million relating to the fresh start adjustment. (See Note 3 of Notes to Financial Statements.)\nIncome before the cumulative effect of accounting changes amounted to $1.92 billion in 1993, $1.63 billion in 1992 and $1.55 billion in 1991. The increases in net income over the three year period resulted from those factors described above.\nAt January 1, 1993, AIG's equity in income of minority-owned reinsurance operations was positively impacted by the cumulative effect of accounting changes on such operations from the adoption of FASB 109, which was partially offset by the adoption of Statement of Financial Accounting Standards No. 106\n\"Employer's Accounting for Postretirement Benefits Other than Pension Plans\" (FASB 106). AIG's equity in the cumulative effect of such accounting changes was a net benefit of $20.7 million.\nAIG had adopted FASB 106 and FASB 109 effective as at January 1, 1992 recording a cumulative effect net benefit of $31.9 million. The pretax cumulative charge of adopting FASB 106 was $83.1 million and the net of tax cumulative charge was $54.8 million. The cumulative effect of adopting FASB 109 was a benefit of $86.7 million.\nNet income amounted to $1.94 billion in 1993, $1.66 billion in 1992 and $1.55 billion in 1991. The increases in net income over the three year period resulted from those factors described above.\nCAPITAL RESOURCES\nAt December 31, 1993, AIG had total capital funds of $15.22 billion and total borrowings of $15.69 billion.\nTotal borrowings at December 31, 1993 and 1992 were as follows:\n* AIG does not guarantee or support these borrowings.\nSee also Note 9 of Notes to Financial Statements.\nGIAs serve as the source of proceeds for AIGFP's investments in a diversified portfolio of securities. (See also the discussions under \"Operational Review\" and \"Liquidity\" herein and Notes 1, 9 and 11 of Notes to Financial Statements.)\nAIG Funding, Inc. intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of commercial paper is subject to the approval of AIG's Board of Directors. ILFC, A.I. Credit Corp. (AICCO) and AIGFP issue commercial paper for the funding of their own operations. AIG does not guarantee AICCO's or ILFC's commercial paper. However, AIG has entered into an agreement in support of AICCO's commercial paper. AIG guarantees AIGFP's commercial paper. (See Note 9 of Notes to Financial Statements.)\nILFC primarily uses the proceeds of its borrowings to acquire new and used commercial jet aircraft to lease and\/or remarket to airlines around the world. During 1993, ILFC increased the aggregate principal amount outstanding of its medium term and term notes to $4.30 billion at December 31, 1993, a net increase of $1.08 billion from 1992. At December 31, 1993, ILFC had $1 billion in aggregate principal amount of debt securities registered for issuance from time to time. (See also the discussions under \"Operational Review\" and \"Liquidity\" herein and Notes 1, 9 and 16 of Notes to Financial Statements.)\nILFC sold $100 million of Market Auction Preferred Stock in each of November 1993 and December 1992.\nDuring 1993, AIG issued $125.0 million in aggregate principal amount of medium term notes. The proceeds of these notes were used for general corporate purposes. During 1993, $67.0 million of previously issued notes matured. At December 31, 1993, AIG had $247.0 million in aggregate principal amount of debt securities registered for issuance from time to time. (See also Note 9 of Notes to Financial Statements.)\nAIG's capital funds have increased $2.44 billion in 1993. Unrealized appreciation of investments, net of taxes, increased $792.8 million, primarily as a result of the general market trends worldwide, particularly overseas, and to a lesser extent, the adoption of Financial Accounting Standards No. 115 \"Accounting for Certain Debt and Equity Securities\" (FASB 115). Unrealized appreciation of investments, net of taxes, will now be subject to increased volatility resulting from the changes in the market value of bonds available for sale. (See also the discussion under \"Accounting Standards\" herein.) The cumulative translation adjustment loss, net of taxes, increased $14.3 million, and retained earnings increased $1.81 billion, resulting from net income less dividends.\nDuring 1993, preferred stock issued and outstanding decreased $7,500 and additional paid-in capital declined approximately $150 million due to the redemption of Series M-1 and M-2 Exchangeable Money Market Cumulative Serial Preferred Stock. Common stock increased by $281.2 million\nand additional paid-in capital decreased by that amount as a result of a common stock split in the form of a 50 percent stock dividend paid July 30, 1993. (See also Note 10 of Notes to Financial Statements.)\nPayments of dividends to AIG by its insurance subsidiaries are subject to certain restrictions imposed by statutory authorities. AIG has in the past reinvested most of its unrestricted earnings in its operations and believes such continued reinvestment in the future will be adequate to meet any foreseeable capital needs. However, AIG may choose from time to time to raise additional funds through the issuance of additional securities. At December 31, 1993 there were no significant statutory or regulatory issues which would impair AIG's financial condition or results of operations. (See also the discussion under \"Liquidity\" herein and Note 10 of Notes to Financial Statements.)\nLIQUIDITY\nAt December 31, 1993, AIG's consolidated invested assets included approximately $5.23 billion of cash and short-term investments. Consolidated net cash provided from operating activities in 1993 amounted to approximately $6.47 billion.\nManagement believes that AIG's liquid assets, its net cash provided by operations, and access to the capital markets will enable it to meet any foreseeable cash requirements.\nAIG's liquidity is primarily derived from the operating cash flows of its general and life insurance operations.\nThe liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance pretax operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $5.7 billion in pretax operating cash flow during 1993. The underwriting cash flow approximated $2.8 billion in 1993. Underwriting cash flow represents periodic premium collections and paid loss recoveries less reinsurance premiums, losses, benefits, and acquisition and operating expenses paid. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance operations generated approximately $2.9 billion in investment income cash flow during 1993. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains.\nThe combined insurance pretax operating cash flow coupled with the cash and short-term investments of $4.70 billion provided the insurance operations with a significant amount of liquidity. This liquidity is available to purchase high quality and diversified fixed income securities and to a lesser extent marketable equity securities and to provide mortgage loans on real estate, policy and collateral and guaranteed loans. With this liquidity coupled with proceeds of approximately $11 billion from the maturities, sales and redemptions of fixed income securities and from the sales of marketable equity securities, AIG purchased approximately $15 billion of fixed income securities and marketable equity securities.\nThe following table is a summary of the composition of AIG's invested assets, including investment income due and accrued and real estate, at December 31, 1993:\nThe following table is a summary of the composition of AIG's insurance invested assets by insurance segment, including investment income due and accrued and real estate, at December 31, 1993:\nWith respect to bonds, AIG's strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and\/or country concentrations.\nApproximately two-thirds of the fixed maturity investments are domestic securities. Approximately 43 percent of such domestic securities were rated AAA and approximately 2 percent were below investment grade.\nA significant portion of the foreign insurance fixed income portfolio is rated by Moody's, Standard & Poor's (S&P) or similar foreign services. However, credit quality rating services similar to the aforementioned rating agencies are not available in all overseas locations. Thus, AIG annually reviews the credit quality of the nonrated fixed income investments, including mortgages, in its foreign portfolio. AIG applies a scale similar to that of Moody's and S&P to the rating of these securities. Coupling the ratings of this internal review with those of the independent agencies indicates that approximately 49 percent of the foreign fixed income investments were rated AAA and approximately one percent were deemed below investment grade at December 31, 1993.\nAlthough AIG's fixed income insurance portfolios contain minor amounts of securities below investment grade, potentially any fixed income security is subject to downgrade for a variety of reasons subsequent to any balance sheet date.\nApproximately 6 percent of the fixed maturities portfolio are Collateralized Mortgage Obligations (CMOs). All the CMOs are investment grade and nearly all the CMOs are backed by various U.S. government agencies. Thus, credit risk is minimal. There are no interest only or principal only CMOs. CMOs are exposed to interest rate risk as the duration and ultimate realized yield would be affected by the accelerated prepayments of the underlying mortgages.\nWhen permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from currency risk and interest rate risk, AIG and its insurance subsidiaries consider entering into derivative transactions. To date, such activities have been insignificant.\nShort-term investments represent amounts invested in various internal and external money market funds, time deposits and cash.\nMortgage loans on real estate, policy, collateral and guaranteed loans comprise 6.2 percent of AIG's insurance invested assets at December 31, 1993. AIG's insurance holdings of real estate mortgages amounted to $1.31 billion of which 36.4 percent was domestic. At December 31, 1993, no domestic mortgages and only a nominal amount of foreign mortgages were in default. At December 31, 1993, AIG's insurance holdings of collateral loans amounted to $482.4 million, all of which were foreign. It is AIG's practice to maintain a maximum loan to value ratio of 75 percent.\nAIG's real estate investment properties are primarily occupied by AIG's various operations. The current market value of these properties considerably exceeds their carrying value.\nThere exist in certain jurisdictions significant regulatory and\/or foreign governmental barriers which may not permit the immediate free flow of funds between insurance subsidiaries or from the insurance subsidiaries to AIG parent. These barriers generally cause only minor delays in the outward remittance of the funds.\nThe following table is a summary of the composition of AIG's financial services invested assets, including real estate, at December 31, 1993:\nAs previously discussed, the cash for the purchase of flight equipment is derived primarily from the proceeds of ILFC's debt financing. The primary sources for the repayment of this debt and the interest expense thereon are the lease receipts received and proceeds from the sale of flight equipment. During 1993, ILFC obtained net financing of $1.59 billion for the acquisition of flight equipment costing $2.41 billion. Additional funds were provided by the proceeds from the issuance of its preferred stock and the disposal of flight equipment.\nAt December 31, 1993, ILFC had committed to purchase 227 aircraft deliverable from 1994 through 1999 at an estimated aggregate purchase price of $12.9 billion and had options to purchase an additional 58 aircraft deliverable through 1999 at an estimated aggregate exercisable price of $3.4 billion. As of March 1, 1994, ILFC has entered into leases, letters of intent to lease or is in various stages of negotiation for 52 of 56 aircraft to be delivered in 1994 and 40 of 171 aircraft to be delivered subsequent to 1994. ILFC will be required to find customers for any aircraft presently on order and any new aircraft to be ordered, and it must arrange financing for portions of the purchase price of such equipment. ILFC has been successful to date both in placing its new aircraft on lease or sales contract and obtaining adequate financing.\nSecurities available for sale, and securities purchased under agreements to resell are primarily purchased with the proceeds of AIGFP's GIA financings. The securities purchased involve varying degrees of credit risk. The average credit rating of AIGFP's securities available for sale at December 31, 1993 was AA. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP generally takes possession of securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring customer credit exposure and requiring additional collateral to be deposited when deemed necessary.\nAIGFP for its own account enters into interest rate, currency, equity and commodity swaps and forward commitments. AIGFP evaluates the credit worthiness of its counter-parties by internal credit evaluation and consultation with widely accepted credit-rating services. The average credit rating of AIGFP's counterparties as a whole, as measured by AIGFP, was AA-- at December 31, 1993. Swaps, options and forward transactions are carried at estimated fair value based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates, as applicable, with the resulting unrealized gains or losses reflected in the current period's income. These values are also reviewed by reference to the market levels at which AIGFP hedges its transactions, and are adjusted as deemed appropriate by management. The recorded values may be different than the values that might be realized if AIGFP were to sell or close out the transactions because of limited liquidity for these instruments.\nAIGTG acts as principal in certain foreign exchange, precious and base metals, petroleum and petroleum products and natural gas trading activities. AIGTG owns and may maintain substantially hedged inventories in the commodities in which it trades. AIGTG supports its trading activities largely through payables to securities brokers and dealers, securities sold under agreements to repurchase and spot commodities sold but not yet purchased. Thus, AIGTG's liquidity is provided through its high volume and rapid turnover activities in trading, market making and hedging. AIGTG uses derivatives to hedge various trading positions and transactions from adverse movement in interest rates, exchange rates and commodity prices.\nRECENT DEVELOPMENTS\nIn 1989, the National Association of Insurance Commissioners (NAIC) adopted the \"NAIC Solvency Policing Agenda for 1990\". Included in this agenda was the development of Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company's statutory surplus to the risk inherent in its overall operations. AIG believes that the development of RBC standards is a positive step for the insurance industry but further believes the standards in their present form may lead to an inefficient deployment of industry capital. As experience is gained with the application of RBC standards, it is likely that adjustments to the formula will be made.\nStandards for the life RBC formula and a model act have been approved by regulators and were effective with the 1993 statutory financial statements. At December 31, 1993, the adjusted capital of each of AIG's four domestic life companies exceeded each of their RBC standards by multiples ranging from two to more than four.\nRBC standards for property and casualty insurers were finalized in principle in December 1993 and will be effective with the 1994 statutory financial statements to be filed in 1995. Applying these RBC standards to AIG's domestic general operations at December 31, 1993 reveals that the capital of each of the domestic general insurance companies exceeds the RBC requirements. Additionally, no AIG company is on any regulatory or similar \"watch list\".\nIn 1992, domestic life insurance companies were required for regulatory purposes to fully adopt two investment reserves, the Asset Valuation Reserve (AVR) and the Interest Maintenance Reserve (IMR). The AVR is formula based and applies to all invested assets which are subject to either credit or market risk. The IMR defers realized capital gains and losses on the sale of fixed maturities and mortgage loans. The realized gains and losses are subsequently amortized into investment income over the original term of the disposed assets. The impact of these reserves on the separately reported statutory income of certain domestic life companies was significant in 1993. However, there was no impact on AIG's 1993 GAAP consolidated life insurance operating income presented herein.\nIn January 1994, the Los Angeles area of California suffered severe damage as a result of an earthquake. The impact of the insured losses on AIG's 1994 results of operations is currently estimated to be approximately $55 million net of reinsurance recoverable of approximately $95 million.\nACCOUNTING STANDARDS\nStandards adopted during 1993:\nAt January 1, 1993, AIG adopted Statement of Financial Accounting Standards No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\" (FASB 113). This statement specifies the accounting for the reinsuring (ceding) of insurance contracts and, effective in the first quarter of 1993, eliminates the reporting of assets and liabilities net of the effects of reinsurance. As required by FASB 113, the reserve for losses and loss expenses, the reserve for unearned premiums and future policy benefits for life and accident and health insurance contracts have been presented gross of ceded reinsurance in the accompanying December 31, 1993 balance sheet. A reinsurance asset was established to include the aforementioned ceded reinsurance balances. The balance sheet at December 31,\n1992 has been appropriately reclassified to reflect the new presentation. FASB 113 also establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance ceded and prescribes accounting and reporting standards for the contract. There has been no material effect on AIG's general or life insurance operating income as a result of the adoption of FASB 113. (See also Note 5 of Notes to Financial Statements.)\nIn May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (FASB 115), and AIG adopted this standard at December 31, 1993. The pretax increase in carrying value of bonds available for sale as a result of marking to market was $919.3 million. The portion which inured to the benefit of policyholders was $511.8 million, which has been recorded as a component of future policy benefits for life and accident and health insurance contracts. Thus, the unrealized appreciation of investments increased $251.0 million, net of taxes of $156.5 million.\nFASB 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Those investments are to be classified in three categories and accounted for as follows:\no Where an enterprise has the positive intent and ability to hold debt securities to maturity, those securities are deemed to be held to maturity securities and reported at amortized cost.\no Where an enterprise purchases debt and equity securities principally for the purpose of selling them in the near term, those securities are deemed to be trading securities and are reported at fair value, with the unrealized gains and losses included in operating income.\no Where debt and equity securities are not reported either as held to maturity securities or trading securities, those securities are deemed to be available for sale securities and reported at fair value, with unrealized gains and losses excluded from operating income and reported in a separate component of shareholders' equity.\nThis statement has significantly changed and narrowed the meaning of the held to maturity category from previous generally accepted accounting principles. (See also Notes 1(c) and 8 of Notes to Financial Statements.)\nDuring 1993, the Emerging Issues Task Force (EITF) of FASB adopted an accounting rule \"Accounting for Multiple-Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises\" (EITF Issue No. 93-6). This rule encompasses any multiyear retrospectively rated contract requiring that insurers recognize as assets the reinsurer's obligations, and that ceding insurers accrue liabilities for the contract obligations. AIG has analyzed the aspects of this accounting rule and determined that there was no significant impact on AIG's results of operations or financial condition.\nStandards to be adopted in the future:\nIn March 1992, FASB issued Interpretation No. 39 \"Offsetting of Amounts Related to Certain Contracts\" (Interpretation), which is effective for fiscal years beginning after December 15, 1993. The Interpretation requires that unrealized gains and losses on swaps, forwards, options and similar contracts be recognized as assets and liabilities, whereas AIG's current policy is to record such unrealized gains and losses on a net basis in the consolidated balance sheet. The Interpretation allows the netting of such unrealized gains and losses with the same counterparty when they are included under a master netting arrangement with the counterparty and the contracts are reported at market value.\nAlthough there will be no effect on AIG's operating income upon the adoption of the Interpretation, AIG will be required to present certain of its financial services assets and liabilities on a gross basis, thus increasing both assets and liabilities in the consolidated balance sheet. The effect of presenting these assets and liabilities on a gross basis on AIG's consolidated balance sheet will not be significant.\nIn November of 1992, FASB issued Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Post-employment Benefits\" (FASB 112). FASB 112 establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. FASB 112 is effective for the 1994 financial statements and will have no material effect on AIG's results of operations or financial condition.\nIn May 1993, FASB issued Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" (FASB 114). FASB 114 addresses the accounting by all creditors for impairment of certain loans. The impaired loans are to be measured at the present value of all expected future cash flows. The present value may be determined by discounting the expected future cash flows at the loan's effective rate or valued at the loan's observable market price or valued at the fair value of the collateral if the loan is collateral dependent. This methodology is not expected to produce a material effect on AIG's results of operations or financial condition.\nFASB 114 will be effective for the 1995 financial statements. AIG does not anticipate adoption prior to the effective date.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nAMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Shareholders American International Group, Inc.\nWe have audited the consolidated financial statements of American International Group, Inc. and subsidiaries listed in the index on page 26 of this Form 10-K. These financial statements and the financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American International Group, Inc. and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 1(w) to the financial statements, the Company changed its method of accounting for investments in certain fixed maturity securities in 1993, and in 1992 for income taxes and postretirement benefits other than pensions.\nCOOPERS & LYBRAND\nNew York, New York February 24, 1994.\nSee Accompanying Notes to Financial Statements.\nSee Accompanying Notes to Financial Statements.\nSee Accompanying Notes to Financial Statements.\nSee Accompanying Notes to Financial Statements.\nSee Accompanying Notes to Financial Statements.\nSee Accompanying Notes to Financial Statements.\nNOTES TO FINANCIAL STATEMENTS American International Group, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of American International Group, Inc. and all significant subsidiaries (AIG). All material intercompany accounts and transactions have been eliminated.\n(B) BASIS OF PRESENTATION: The accompanying financial statements have been prepared on the basis of generally accepted accounting principles. Certain accounts have been reclassified in the 1992 and 1991 financial statements to conform to their 1993 presentation.\nGeneral Insurance Operations: Premiums are earned primarily on a pro rata basis over the term of the related coverage. The reserve for unearned premiums represents the portion of net premiums written relating to the unexpired terms of coverage.\nAcquisition costs are deferred and amortized over the period in which the related premiums are earned. Investment income is not anticipated in the deferral of acquisition costs (see Note 4).\nLosses and loss expenses are charged to income as incurred. The reserve for losses and loss expenses represents the accumulation of estimates for reported losses and includes provisions for losses incurred but not reported. AIG does not discount its loss reserves, other than for very minor amounts related to certain workers' compensation claims. The methods of determining such estimates and establishing resulting reserves, including amounts relating to reserves for estimated unrecoverable reinsurance, are continually reviewed and updated. Adjustments resulting therefrom are reflected in income currently.\nLife Insurance Operations: Premiums for traditional life insurance products are generally recognized as revenues over the premium paying period of the related policies. Benefits and expenses are provided against such revenues to recognize profits over the estimated life of the policies. Revenues for universal life and investment-type products consist of policy charges for the cost of insurance, administration, and surrenders during the period. Expenses include interest credited to policy account balances and benefit payments made in excess of policy account balances. Investment income reflects certain minor amounts of realized capital gains where the gains are deemed to be an inherent element in pricing certain life products in some foreign countries.\nPolicy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Deferred policy acquisition costs and policy initiation costs related to universal life and investment-type products are amortized in relation to expected gross profits over the life of the policies (see Note 4).\nThe liabilities for future policy benefits and policyholders' contract deposits are established using assumptions described in Note 6.\nFinancial Services Operations: AIG conducts, primarily as principal, an interest rate, currency, equity and commodity derivative products business. It also enters into long dated forward foreign exchange, option, synthetic security, liquidity facility and investment contract transactions. In the course of conducting its business, AIG also engages in a variety of other related transactions.\nAIG engages as principal in trading activities in certain foreign exchange, precious and base metals, petroleum and petroleum products and natural gas markets. AIG owns and maintains substantial inventories in the commodities in which it trades. Substantially all spot commodities are hedged by futures and forward contracts to minimize exposure to market risk. Additionally, AIG acts as an adviser in evaluating and subsequently customizing specific programs for customers to manage their foreign exchange exposure.\nAIG, as lessor, leases flight equipment principally under operating leases. Accordingly, income is reported over the life of the lease as rentals become receivable under the provisions of the lease or, in the case of leases with varying payments, under the straight-line method over the noncancelable term of the lease. In certain cases, leases provide for additional amounts contingent on usage. AIG also is a marketer of flight equipment and marketing revenues from such operations consist of net gains on sales of flight equipment, commissions and net gains on dispositions of leased flight equipment.\n(C) INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES: Bonds and preferred stocks held to maturity, both of which are principally owned by the insurance subsidiaries, are carried at amortized cost where AIG has the ability and positive intent to hold these securities until maturity. Where AIG may not have the positive intent to hold these securities until maturity, those bonds are considered to be available for sale and carried at market values. Included in the bonds available for sale are collateralized mortgage obligations (CMOs). Premiums and discounts arising from the purchase of CMOs are treated as yield adjustments. Bond trading securities are carried at market value, as it is AIG's intention to sell these securities in the near term. Common and preferred stocks available for sale are carried at market value.\nUnrealized gains and losses from investments in available for sale securities are reflected in capital funds, net of any related deferred income taxes. Changes in unrealized gains and losses from investments in trading securities are reflected in income currently.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nRealized capital gains and losses are determined principally by specific identification. Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge would be reflected in income for the difference between carrying value and estimated net realizable value.\n(D) MORTGAGE LOANS ON REAL ESTATE, POLICY AND COLLATERAL LOANS: Mortgage loans on real estate, policy loans and collateral loans are carried at unpaid principal balances.\n(E) FLIGHT EQUIPMENT: Flight equipment is stated at cost. Major additions and modifications are capitalized. Normal maintenance and repairs, airframe and engine overhauls and compliance with return conditions of flight equipment on lease are provided by and paid for by the lessee. Under the provisions of most leases for certain airframe and engine overhauls, the lessee is reimbursed for costs incurred up to but not exceeding contingent rentals paid to AIG by the lessee. AIG provides a charge to income for such reimbursements based upon the hours utilized during the period and the expected reimbursement during the life of the lease. Depreciation and amortization are computed on the straight-line basis to a residual value of approximately 15 percent over the estimated useful lives of the related assets but not exceeding 25 years. This caption also includes deposits for aircraft to be purchased.\nAt the time the assets are retired or disposed of, the cost and associated accumulated depreciation and amortization are removed from the related accounts and the difference, net of proceeds, is recorded as a gain or loss.\n(F) SECURITIES AVAILABLE FOR SALE, AT MARKET VALUE: These securities are held to meet long term investment objectives and are accounted for as available for sale. In 1992 these securities were carried at amortized cost.\n(G) TRADING SECURITIES, AT MARKET VALUE: Trading securities are held to meet short term investment objectives, including hedging securities. These securities are carried at market value and are recorded on a trade date basis. The unrealized gains and losses are reflected in income currently.\n(H) SPOT COMMODITIES, AT MARKET VALUE: Spot commodities, which include commodities and foreign currency options, are valued at market and are recorded on a trade date basis. The unrealized gains and losses are reflected in income currently. Substantially all spot commodities are hedged by futures and forward contracts. These contracts are valued at market and are recorded as contractual commitments on a trade basis. The unrealized gains and losses on open contracts are reflected in income currently.\n(I) NET UNREALIZED GAIN ON INTEREST RATE AND CURRENCY SWAPS, OPTIONS AND FORWARD TRANSACTIONS: Swaps, options and forward transactions are accounted for as contractual commitments recorded on a trade date basis and are carried at estimated fair value based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates, as applicable, with the resulting unrealized gains or losses reflected in the current period's income. These values are also reviewed by reference to the market levels at which AIG hedges its transactions, and are adjusted, as deemed appropriate by management. The recorded values may be different than the values that might be realized if AIG were to sell or close out the transactions because of limited liquidity for these instruments. AIGmanages its economic risk with a variety of transactions, including swaps, options, bonds, forwards or futures contracts and other transactions as appropriate.\n(J) RECEIVABLES FROM AND PAYABLES TO SECURITIES BROKERS AND DEALERS: Receivables from and payables to securities brokers and dealers include balances due from and due to clearing brokers and exchanges and receivables from and payables to counterparties which relate to unrealized gains and losses on open forward settlement contracts and next day settlements on securities and swap payments.\n(K) SECURITIES PURCHASED (SOLD) UNDER AGREEMENTS TO RESELL (REPURCHASE), AT CONTRACT VALUE: Purchases of securities under agreements to resell and sales of securities under agreements to repurchase are accounted for as collateralized transactions and are recorded at their contracted resale or repurchase amounts, plus accrued interest. Generally, it is AIG's policy to take possession of securities purchased under agreements to resell.\nAIG minimizes the credit risk that counterparties to transactions might be unable to fulfill their contractual obligations by monitoring customer credit exposure and collateral value and generally requiring additional collateral to be deposited with AIG when deemed necessary.\n(L) OTHER INVESTED ASSETS: Other invested assets consist primarily of investments in joint ventures and partnerships and other investments not classified elsewhere herein. The joint ventures and partnerships are carried at equity or cost depending on the nature of the invested asset and the ownership percentage thereof. Other investments are carried at cost or market depending upon the nature of the underlying assets. Unrealized gains and losses from the revaluation of those investments carried at market are reflected in capital funds, net of any related taxes.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\n(M) REINSURANCE ASSETS: Reinsurance assets include the balances due from other insurance companies under the terms of AIG's reinsurance arrangements for paid and unpaid losses and loss expenses, unearned reinsurance premium ceded and for future policy benefits for life and accident and health insurance contracts and benefits paid. It also includes funds held under reinsurance treaties.\n(N) INVESTMENTS IN PARTIALLY-OWNED COMPANIES: The equity method of accounting is used for AIG's investment in companies in which AIG's ownership interest approximates twenty but is not greater than fifty percent (minority-owned companies). Equity in income of minority-owned reinsurance operations is presented separately in the consolidated statement of income. Equity in realized capital gains of such companies is included in other realized capital gains (losses). Equity in net income of other unconsolidated companies is principally included in other income (deductions)-net. At December 31, 1993, AIG's significant investments in partially-owned companies included its 45.4 percent interest in Transatlantic Holdings, Inc. (Transatlantic), which derives a substantial portion of its assumed reinsurance from AIG subsidiaries; its 19.9 percent interest in Richmond Insurance Company; its 23.9 percent interest in SELIC Holdings, Ltd; and its 24.4 percent interest in IPC Holdings, Ltd. This balance sheet caption also includes investments in less significant partially-owned companies and in certain minor majority-owned subsidiaries. At December 31, 1993, the market value of AIG's investment in Transatlantic exceeded its carrying value by approximately $193.1 million.\n(O) REAL ESTATE AND OTHER FIXED ASSETS: The costs of buildings and furniture and equipment are depreciated principally on a straight-line basis over their estimated useful lives (maximum of 40 years for buildings and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterments are capitalized and depreciated.\n(P) SEPARATE AND VARIABLE ACCOUNTS: Separate and variable accounts represent funds for which investment income and investment gains and losses accrue directly to the policyholders. Each account has specific investment objectives, and the assets are carried at market value. The assets of each account are legally segregated and are not subject to claims which arise out of any other business of AIG.\n(Q) SECURITIES SOLD BUT NOT YET PURCHASED, PRINCIPALLY OBLIGATIONS OF THE U.S. GOVERNMENT AND GOVERNMENT AGENCIES, AT MARKET VALUE: Securities sold but not yet purchased represent sales of securities not owned at the time of sale. These obligations are recorded on a trade date basis and are carried at current market values. The unrealized gains and losses are reflected in income currently.\n(R) SPOT COMMODITIES SOLD BUT NOT YET PURCHASED, AT MARKET VALUE: Spot commodities sold but not yet purchased represent sales of commodities not owned at the time of sale. These obligations are recorded on a trade date basis and are carried at market values based upon current commodity prices. The unrealized gains and losses are reflected in income currently.\n(S) PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANY: Preferred shareholders' equity in subsidiary company relates to outstanding market auction preferred stock of International Lease Finance Corporation (ILFC), a wholly owned subsidiary of AIG.\n(T) TRANSLATION OF FOREIGN CURRENCIES: Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 \"Foreign Currency Translation\" (FASB 52). Under FASB 52, functional currency assets and liabilities are translated into U.S. dollars generally using current rates of exchange and the related translation adjustments are recorded as a separate component of capital funds. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates. The adjustments resulting from translation of financial statements of foreign entities operating in highly inflationary economies are recorded in income. Exchange gains and losses resulting from foreign currency transactions are also recorded in income.\n(U) INCOME TAXES: Deferred federal and foreign income taxes are provided for temporary differences for the expected future tax consequences of events that have been recognized in AIG's financial statements or tax returns.\n(V) EARNINGS PER SHARE: Earnings per common share are based on the weighted average number of common shares outstanding, retroactively adjusted to reflect all stock dividends and stock splits. The effect of all other common stock equivalents is not significant for any period presented.\n(W) ACCOUNTING STANDARDS: (i) Standards Adopted in 1993: At January 1, 1993, AIG adopted Statement of Accounting Standards No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\" (FASB 113). This statement specifies the accounting for the reinsuring (ceding) of insurance contracts and, effective in the first quarter of 1993, eliminates the reporting of assets and liabilities net of the effects of reinsurance. As required by FASB 113, the reserve for losses and loss expenses, reserve for unearned premiums and future policy benefits for life and accident and health insurance contracts have been presented gross of ceded reinsurance. A reinsurance asset was established to include the aforementioned ceded reinsurance balances. The balance sheet at December 31, 1992 has been appropriately reclassified to reflect the new presentation.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nFASB 113 also establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance ceded and prescribes accounting and reporting standards for the contract. There has been no material effect on AIG's general or life insurance operating income as a result of the adoption of FASB 113.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Accounting Standards No. 115 \"Accounting for Certain Investments on Debt and Equity Securities\" (FASB 115) and AIG adopted this standard at December 31, 1993. The pretax increase in carrying value of bonds available for sale as a result of marking to market was $919.3 million. The portion which inured to the benefit of policyholders was $511.8 million, which has been recorded as a component of future policy benefits for life and accident and health insurance contracts. Thus, the unrealized appreciation of investments increased $251.0 million, net of taxes of $156.5 million.\nFASB 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Those investments are to be classified in three categories and accounted for as follows:\no Where an enterprise has the positive intent and ability to hold debt securities to maturity, those securities are deemed to be held to maturity securities and reported at amortized cost.\no Where an enterprise purchases debt and equity securities principally for the purpose of selling them in the near term, those securities are deemed to be trading securities and are reported at fair value, with the unrealized gains and losses included in operating income.\no Where debt and equity securities are not reported either as held to maturity securities or trading securities, those securities are deemed to be available for sale securities and reported at fair value, with unrealized gains and losses excluded from operating income and reported in a separate component of shareholders' equity.\nThis statement has significantly changed and narrowed the meaning of the held to maturity category from previous generally accepted accounting principles.\nDuring 1993, the Emerging Issues Task Force (EITF) of the FASB adopted an accounting rule \"Accounting for Multiple-Year Retrospectively Rated Contract by Ceding and Assuming Enterprises\" (EITF Issue No. 93-6). This rule encompasses any multiyear retrospectively rated contract requiring that insurers recognize as assets the reinsurer's obligations, and that ceding insurers accrue liabilities for the contract obligations. AIG has analyzed the aspects of this accounting rule and determined that there was no significant impact on AIG's results of operations or financial condition.\n(ii) Standards Adopted Prior to 1993: In 1990, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (FASB 106). FASB 106 establishes accounting for postretirement benefits, principally postretirement health care and life insurance benefits. It requires accrual accounting for postretirement benefits during the years that an employee renders services. FASB 106 has been adopted effective January 1, 1992. The consolidated transition liability was approximately $83.1 million, including minor amounts for certain foreign plans. The transition liability was recognized immediately at adoption as a change in accounting principle. The cumulative effect of the adoption of FASB 106 was a charge of $54.8 million, net of a tax benefit of $28.3 million.\nIn 1992, FASB issued Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (FASB 109). FASB 109's objectives are to recognize (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for expected future tax consequences of events that have been recognized in the financial statements or tax returns. The measurement of a deferred tax asset is subject to the expectation of future realization. AIG adopted FASB 109, effective January 1, 1992. The cumulative effect of adopting FASB 109 was a benefit of $86.7 million.\n(iii) Standards to Be Adopted: In March, 1992, FASB issued Interpretation No. 39 \"Offsetting of Amounts Related to Certain Contracts\" (Interpretation), which is effective for fiscal years beginning after December 15, 1993. The Interpretation requires that unrealized gains and losses on swaps, forwards, options and similar contracts be recognized as assets and liabilities, whereas AIG's current policy is to record such unrealized gains and losses on a net basis in the consolidated balance sheet. The Interpretation allows the netting of such unrealized gains and losses with the same counterparty when they are included under a master netting arrangement with the counterparty and the contracts are reported at market value.\nAlthough there will be no effect on AIG's operating income upon the adoption of the Interpretation, AIG will be required to present certain of its financial services assets and liabilities on a gross basis, thus increasing both assets and liabilities in the consolidated balance sheet. The effect of presenting these assets and liabilities on a gross basis on AIG's consolidated balance sheet will not be significant.\nIn November of 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Postemployment Benefits\" (FASB 112). FASB 112 establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. FASB 112 is effective for the 1994 financial statements. There will be no material effect on AIG's results of operations or financial condition.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nIn May 1993, FASB issued Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" (FASB 114). FASB 114 addresses the accounting by all creditors for impairment of certain loans. The impaired loans are to be measured at the present value of all expected future cash flows. The present value may be determined by discounting the expected future cash flows at the loan's effective rate or valued at the loan's observable market price or valued at the fair value of the collateral if the loan is collateral dependent. This methodology is not expected to produce a material effect on AIG's results of operations or financial condition.\nFASB 114 will be effective for the 1995 financial statements. AIG does not anticipate adoption prior to the effective date.\n2. FOREIGN OPERATIONS\nCertain subsidiaries operate solely outside of the United States. Their assets and liabilities are located principally in the countries where the insurance risks are written and\/or investment and noninsurance related operations are located. In addition, certain of AIG's domestic subsidiaries have branch and\/or subsidiary operations and substantial assets and liabilities in foreign countries. Certain countries have restrictions on the conversions of funds which generally cause a delay in the outward remittance of such funds. Approximately 36 percent of consolidated assets at both December 31, 1993 and 1992, and 50 percent, 47 percent and 43 percent of revenues for the years ended December 31, 1993, 1992 and 1991, respectively, were located in or derived from foreign countries (other than Canada). (See Note 19.)\n3. FEDERAL INCOME TAXES\n(a) AIG and its domestic subsidiaries file a consolidated U.S. Federal income tax return. Revenue Agent's Reports assessing additional taxes for the years 1985 and 1986 have been issued and Letters of Protest contesting the assessments have been filed with the Internal Revenue Service. It is management's belief that there are substantial arguments in support of the positions taken by AIG in its Letters of Protest. Management also believes that the final result of these examinations will be immaterial to the financial statements.\nForeign income not expected to be taxed in the United States has arisen because AIG's foreign subsidiaries were generally not subject to U.S. income taxes on income earned prior to January 1, 1987. Such income would become subject to U.S. income taxes at current tax rates if remitted to the United States or if other events occur which would make these amounts currently taxable. The cumulative amount of undistributed earnings of AIG's foreign subsidiaries currently not subject to U.S. income taxes was approximately $2.2 billion at December 31, 1993. The unrecognized deferred tax liability has not been determined as it is not practicable. Management presently has no intention of subjecting these accumulated earnings to material U.S. income taxes and no provision has been made in the accompanying financial statements for such taxes.\nThe Tax Reform Act of 1986 (the 1986 Act) required that, for tax purposes, AIG recalculate its property and casualty loss reserves to a discounted basis as of December 31, 1986. The discount of these loss reserves was the \"Fresh Start\" adjustment and any current tax benefit was deferred and amortizable over future periods. Effective January 1, 1992, the remaining future tax effect of this Fresh Start adjustment was recognized as a component of deferred taxes receivable. Prior to January 1, 1992, this adjustment was amortized into subsequent years' income, giving rise to a current tax benefit only. For 1991, this tax benefit approximated $16,000,000.\nIncome taxes paid in 1993, 1992 and 1991 amounted to $466,600,000, $328,900,000 and $376,800,000, respectively.\nThe Consolidated Omnibus Budget Reconciliation Act of 1990 (the 1990 Act) requires that life insurers capitalize and amortize policy acquisition expenses that relate to specified insurance contracts. This provision has no significant effect on current income taxes or future net income of AIG. The 1990 Act also requires that property and casualty insurers, for tax purposes, reduce the effects of the discounted loss and loss expenses reserve change by a discounted estimate of recoveries from the salvage and subrogation of claims. The tax effect applicable to 87 percent of the discounted December 31, 1989 anticipated recovery balance was a Fresh Start benefit to be amortized over four years. Thus, the provision for income taxes in 1991 reflects benefits of approximately $12,000,000. Effective January 1, 1992, a deferred tax receivable was recognized for the remainder of the discounted recoveries from salvage and subrogation.\nThe Omnibus Budget Reconciliation Act of 1993 (the 1993 Act) increased the highest tax rate on corporations to 35 percent for 1993. The 1993 Act requires securities dealers to recognize for tax purposes the mark-to-market gain or loss on certain securities. The adjustment from this change in accounting method must be phased into taxable income over five years beginning in 1993. The 1993 Act also disallows several items as expenses beginning in 1994. None of these items will have a significant effect on AIG's net income or financial condition. However, it is expected that income taxes paid will increase as a result of such changes.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n3. FEDERAL INCOME TAXES (continued)\n(b) The U.S. Federal income tax rate is 35 percent for 1993 and 34 percent for 1992 and 1991. Actual tax expense on income differs from the \"expected\" amount computed by applying the Federal income tax rate because of the following:\n(a) See discussion in Note 3(a). (b) Including U.S. tax on foreign income.\n(c) The components of the net deferred tax liability as of December 31, 1993 and December 31, 1992 were as follows:\n(d) Under APB 11, deferred income tax expenses or benefits resulted from timing differences in the recognition of revenues and expenses for tax and financial statement purposes.\nThe sources of these differences and the tax effect of each are summarized as follows:\n* 1993 and 1992 information is not required under FASB 109.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n4. DEFERRED POLICY ACQUISITION COSTS\nThe following reflects the policy acquisition costs deferred for amortization against future income and the related amortization charged to income for general and life insurance operations, excluding certain amounts deferred and amortized in the same period:\n5. REINSURANCE\nIn the ordinary course of business, AIG's general and life insurance companies cede reinsurance to other insurance companies in order to provide greater diversification of its business and limit its potential for losses arising from large risks.\nGeneral reinsurance is effected under reinsurance treaties and by negotiation on individual risks. Certain of these reinsurance arrangements consist of excess of loss contracts which protect AIG against losses over stipulated amounts. Amounts recoverable from general reinsurers are estimated in a manner consistent with the claims liabilities associated with the reinsurance and presented as a component of reinsurance assets.\nAIG life companies limit exposure to loss on any single life. For ordinary insurance, AIG retains a maximum of approximately $1,000,000 of coverage per individual life. There are smaller retentions for other lines of business. Life reinsurance is effected principally under yearly renewable term treaties. Amounts recoverable from life reinsurers are estimated in a manner consistent with the assumptions used for the underlying policy benefits and are presented as a component of reinsurance assets.\nGeneral insurance premiums written and earned were comprised of the following:\nIn the normal course of their operations, certain AIG subsidiaries are provided reinsurance coverages from AIG's minority-owned reinsurance companies. During 1993, 1992 and 1991, the premiums written which were ceded to Transatlantic amounted to $238,100,000, $210,700,000 and $257,700,000, respectively.\nFor the years ended December 31, 1993 and 1992, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $4.45 billion and $4.19 billion, respectively.\nLife insurance net premium income was comprised of the following:\nLife insurance recoveries, which reduced death and other benefits, approximated $169.8 million and $125.0 million respectively, for each of the years ended December 31, 1993 and 1992.\nAIG's reinsurance arrangements do not relieve AIG from its direct obligation to its insureds. Thus, a contingent liability exists with respect to both general and life reinsurance ceded to the extent that any reinsurer is unable to meet the obligations\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n5. REINSURANCE (continued)\nassumed under the reinsurance agreements. AIG holds substantial collateral as security under related reinsurance agreements in the form of funds, securities and\/or letters of credit. A provision has been recorded for estimated unrecoverable reinsurance. AIG has been largely successful in prior recovery efforts.\nAIG evaluates the financial condition of its reinsurers by an internal reinsurance security committee consisting of members of AIG's Senior Management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract.\nLife insurance ceded to other insurance companies was as follows:\nLife insurance assumed represented 1 percent of gross life insurance in-force at December 31, 1993, and 2 percent for both 1992 and 1991, and 0.1 percent, 0.2 percent and 0.3 percent of gross premium income for each of the periods ended December 31, 1993, 1992 and 1991, respectively.\nA reconciliation of the Balance Sheet at December 31, 1992 reflecting the adoption of FASB 113 is as follows:\nSupplemental information for gross loss and benefit reserves net of ceded reinsurance at December 31, 1993 is as follows:\n6. FUTURE LIFE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS\n(a) The analysis of the future policy benefits and policyholders' contract deposits liabilities as at December 31, 1993 follows:\n(b) Long duration contract liabilities included in future policy benefits, as presented in the table above, result from traditional life products. Short duration contract liabilities are primarily accident and health products. These long duration products generally have fixed cash values and there are no surrender charges. The liability for future life policy benefits has been established based upon the following assumptions:\n(i) Interest rates (exclusive of immediate\/terminal funding annuities), which vary by territory, year of issuance and products, range from 2.2 percent to 12.0 percent within the first 20 years. Interest rates on immediate\/terminal funding annuities are at a maximum of 13.3 percent and grade to not greater than 7.5 percent.\n(ii) Mortality and surrender rates are based upon actual experience by geographical area modified to allow for variations in policy form. The weighted average lapse rate, including surrenders, for individual and group life approximated 9 percent.\n(iii) The portion of net income and unrealized appreciation (depreciation) of investments that can inure to the benefit of AIG is limited in some cases by the insurance contracts and by the local insurance regulations of the countries in which the policies are in force. All net income and unrealized appreciation (depreciation) of investments in excess of these limits have been included in the reserve for future policy benefits in the consolidated balance sheet.\n(iv) Participating life business represented approximately 29 percent of the gross insurance in-force at December 31, 1993 and 48 percent of gross premium income in 1993. The amount of dividends to be paid is determined annually by the Boards of Directors. Anticipated dividends are considered as a planned contractual benefit in computing the value of future policy benefits and are provided ratably over the premium-paying period of the contracts.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n6. FUTURE LIFE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS (continued)\n(c) The liability for policyholders' contract deposits has been established based on the following assumptions:\n(i) Interest rates credited on deferred annuities vary by year of issuance and range from 8.2 percent to 4.8 percent. Credited interest rate guarantees are generally for a period of one year. Withdrawal charges generally range from 6 percent to 10 percent grading to 0 percent over a period of 7 to 10 years.\n(ii) Domestically, GICs have market value withdrawal provisions for any funds withdrawn other than benefit responsive payments. Interest rates credited generally range from 4.8 percent to 9.2 percent and maturities range from 2 to 7 years. Overseas, primarily in the United Kingdom, GIC type contracts are credited at rates ranging from 4.0 percent to 9.0 percent with maturities generally being 1 to 2 years. Contracts in other foreign locations have interest rates, maturities and withdrawal charges based upon local economic and regulatory conditions.\n(d) Experience adjustments, relating to future policy benefits and policyholders' contract deposits, vary according to the type of contract and the territory in which the policy is in force. In general terms, investments, mortality and morbidity results may be passed through by experience credits or as an adjustment to the premium mechanism, subject to local regulatory guidance.\n7. STATUTORY FINANCIAL DATA\nStatutory surplus and net income for general insurance and life insurance operations as reported to regulatory authorities were as follows:\nAIG's insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulators. The differences between statutory financial statements and financial statements prepared in accordance with generally accepted accounting principles (GAAP) vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect the change in the market value of the bonds available for sale, deferred policy acquisition costs and deferred income taxes.\n8. INVESTMENT INFORMATION\n(A) STATUTORY DEPOSITS: Cash in the amount of $165,111,000 and $84,763,000 and securities with a carrying value of $2,787,900,000 and $2,372,400,000 were deposited by AIG's subsidiaries under requirements of regulatory authorities as of December 31, 1993 and 1992 respectively.\n(B) NET INVESTMENT INCOME: An analysis of the net investment income from the general and life insurance operations follows:\n(C) INVESTMENT GAINS AND LOSSES: The realized capital gains and change in unrealized appreciation of investments for 1993, 1992 and 1991 were as follows:\n* A majority of the gains realized resulted from sales of bonds carried at market value.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n8. INVESTMENT INFORMATION (continued)\nDuring 1993, 1992 and 1991, gross gains of $99,162,000, $87,776,000 and $79,315,000, respectively and gross losses of $43,094,000, $35,635,000 and $62,797,000, respectively were realized on dispositions of fixed maturities carried at amortized cost.\n(D) MARKET VALUE OF FIXED MATURITIES AND UNREALIZED APPRECIATION OF INVESTMENTS: At December 31, 1993, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $906,400,000 and gross losses of approximately $246,400,000.\nAt December 31, 1992, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $423,100,000 and gross losses of approximately $308,200,000.\nThe deferred tax payable related to the net unrealized appreciation of investments was $404,264,000 at December 31, 1993 and $69,769,000 at December 31, 1992.\nThe amortized cost and estimated market value of investments in fixed maturities carried at amortized cost at December 31, 1993 and December 31, 1992 were as follows:\n(a) Including U.S. Government agencies and authorities. (b) Including municipalities and political subdivisions.\nThe amortized cost and estimated market value of bonds available for sale and carried at market value at December 31, 1993 were as follows:\n(a) Including U.S. Government agencies and authorities. (b) Including municipalities and political subdivisions.\nThe amortized cost and estimated market values of fixed maturities held to maturity and of fixed maturities available for sale at December 31, 1993, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.\n(E) CMOs: CMOs, held by AIG's domestic life companies, are principally U.S. government and government agency backed and AAA rated securities. These represent 95 percent of the CMOs held. Whole loans represent 5 percent of the CMOs held and are investment grade. These CMOs are held by AIG's domestic life company which operates overseas.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n8. INVESTMENT INFORMATION (continued)\nAt December 31, 1993 and 1992, the market value of the CMO portfolio was $1.8 billion and $1.6 billion, respectively; the estimated amortized cost was approximately $1.7 billion in 1993 and $1.5 billion in 1992. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 1993.\nThe distribution of the CMOs at December 31, 1993 and 1992 was as follows:\nAt December 31, 1993, the gross weighted average coupon of this portfolio was 8.8 percent. The gross weighted average life of this portfolio was 6.5 years.\n(F) FIXED MATURITIES BELOW INVESTMENT GRADE: At December 31, 1993, the fixed maturities held by AIG that were below investment grade were insignificant.\n(G) During 1993, certain investments held by AIGFP experienced financial difficulties and suffered rating downgrades. The pretax impact on AIG of the estimated other than temporary impairment in value of these investments was $215 million. As is AIG's policy in such situations where credit ratings have deteriorated significantly, these impairments have been appropriately recognized by charges to income of $104 million in 1993 and $111 million prior to 1993.\n(H) At December 31, 1993, non-income producing assets were insignificant.\n9. DEBT OUTSTANDING\nAt December 31, 1993, AIG had the following debt outstanding:\n*At December 31, 1993, borrowings not guaranteed by AIG were $5,942,961.\n(A) COMMERCIAL PAPER: At December 31, 1993, the commercial paper issued and outstanding was as follows:\n*Reflects the nominal Deutschemark rate available at December 31, 1993. Economically, this rate is reduced by various hedging transactions to an effective rate approximating those presented above.\nCommercial paper issued by Funding and AIGFP is guaranteed by AIG. AIG has entered into an agreement in support of AICCO's commercial paper.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n9. DEBT OUTSTANDING (continued)\n(B) BORROWINGS UNDER OBLIGATIONS OF GUARANTEED INVESTMENT AGREEMENTS: Borrowings under obligations of guaranteed investment agreements, which are guaranteed by AIG, are recorded on the basis of proceeds received. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings range from 3.3 percent to 9.8 percent.\nPayments due under these investment agreements in each of the next five years ending December 31, and the periods thereafter based on the earliest call dates, were as follows:\nAt December 31, 1993, the market value of securities pledged as collateral with respect to these obligations approximated $976 million.\n(C) MEDIUM TERM NOTES PAYABLE:\n(i) Medium Term Notes Payable Issued by AIG: AIG's Medium Term Notes are unsecured obligations which may not be redeemed by AIG prior to maturity and bear interest at either fixed rates set by AIG at issuance or variable rates determined by reference to an interest rate or other formula.\nAn analysis of the Medium Term Notes for the year ended December 31, 1993 is as follows:\nThe interest rates on this debt range from 3.13 percent to 8.45 percent. To the extent deemed appropriate, AIG enters into swap transactions to reduce its effective borrowing rate.\nAt December 31, 1993, the maturity schedule for AIG's outstanding Medium Term Notes was as follows:\nAt December 31, 1993, AIG had $247,000,000 principal amount of Series D Medium Term Notes registered and available for issuance from time to time.\n(ii) Medium Term Notes Payable Issued by ILFC: ILFC's Medium Term Notes are unsecured obligations which may not be redeemed by ILFC prior to maturity and bear interest at fixed rates set by ILFC at issuance.\nAs of December 31, 1993, notes in aggregate principal amount of $1,753,685,000 were outstanding with maturity dates varying from 1994 to 2003 at interest rates ranging from 3.57 percent to 10.25 percent. These notes provide for a single principal payment at the maturity of each note.\nAt December 31, 1993, the maturity schedule for ILFC's outstanding Medium Term Notes was as follows:\n(D) NOTES AND BONDS PAYABLE:\n(i) Zero Coupon Notes: On October 1, 1984, AIG issued Eurodollar zero coupon notes in the aggregate principal amount at stated maturity of $750,000,000. The notes were offered at 12 percent of principal amount at stated maturity, bear no interest and are due August 15, 2004. The net proceeds to AIG from the issuance were $85,625,000. The notes are redeemable at any time in whole or in part at the option of AIG at 100 percent of their principal amount at stated maturity. The notes are also redeemable at the option of AIG or bearer notes may be redeemed at the option of the holder in the event of certain changes involving taxation in the United States at prices ranging from 30.92 percent currently, to 89.88 percent after August\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n9. DEBT OUTSTANDING (continued)\n15, 2003, of the principal amount at stated maturity together with accrued amortization of original issue discount from the preceding August 15. During 1993, no notes were repurchased. During 1992, AIG repurchased notes with a face value of $17,500,000, realizing a loss of $2,126,000. At December 31, 1993, the notes outstanding have a face value of $189,200,000, an unamortized discount of $130,084,000 and a net book value of $59,116,000. The amortization of the original issue discount is recorded as interest expense.\n(ii) Italian Lire Bonds: In December, 1991, AIG issued unsecured bonds denominated in Italian Lire. The principal amount of Italian Lire 200 billion matures December 4, 2001 and accrues interest at a rate of 11.7 percent which is paid annually. These bonds are not redeemable prior to maturity, except in the event of certain changes involving taxation in the United States or the imposition of certain certification, identification or reporting requirements.\nSimultaneous with the issuance of this debt, AIG entered into a swap transaction which effectively converted AIG's net interest expense to a U.S. dollar liability of approximately 7.9 percent, which requires the payment of proceeds at maturity of approximately $159 million in exchange for Italian Lire 200 billion and interest thereon.\n(iii) Term Notes Issued by ILFC: ILFC has issued unsecured obligations which may not be redeemed prior to maturity. $200,000,000 of such term notes are at floating interest rates and the remainder are at fixed rates.\nAs of December 31, 1993, notes in aggregate principal amount of $2,550,000,000 were outstanding with maturity dates varying from 1994 to 2001 and interest rates ranging from 3.56 percent to 8.88 percent. These notes provide for a single principal payment at maturity.\nAt December 31, 1993, the maturity schedule for ILFC's Term Notes was as follows:\nAIG does not guarantee any of the debt obligations of ILFC.\n(E) LOANS AND MORTGAGES PAYABLE: Loans and mortgages payable at December 31, 1993 consisted of the following:\n(F) INTEREST EXPENSE FOR ALL INDEBTEDNESS: Total interest expense for all indebtedness, net of capitalized interest, aggregated $1,103,955,000 in 1993, $1,128,007,000 in 1992 and $871,036,000 in 1991. Interest expense paid approximated $1,017,066,000 in 1993, $1,051,976,000 in 1992 and $797,000,000 in 1991.\n10. CAPITAL FUNDS\n(a) At December 31, 1993, there were 6,000,000 shares of AIG's $5 par value serial preferred stock authorized, issuable in series. AIG redeemed the Exchangeable Money Market Cumulative Serial Preferred(TM) Stock, Series M-1 on April 2, 1993 and the Exchangeable Money Market Cumulative Serial Preferred Stock, Series M-2 (Series M-1 and M-2 together, MMP(TM)), on March 5, 1993 at a price of $100,000 per share plus accrued dividends.\nDuring 1993, 1992 and 1991, dividends paid on the MMP aggregated $1,043,000, $4,471,000 and $7,262,000, respectively.\n(b) AIG parent depends on its subsidiaries for cash flow in the form of loans, advances and dividends. Some AIG subsidiaries, namely those in the insurance business, are subject to regulatory restrictions on the amount of dividends which can be remitted to AIG parent. These restrictions vary by state. For example, unless permitted by the New York Superintendent of Insurance, general insurance companies domiciled in New York may not pay dividends to shareholders which in any twelve month period exceed the lesser of 10 percent of the company's statutory policyholders' surplus or 100 percent of its \"adjusted net investment income\", as defined. Generally, less severe restrictions applicable to both general and life insurance companies exist in most of the other states in which AIG's insurance subsidiaries are domiciled. Certain foreign jurisdictions have restrictions which generally cause only a temporary delay in the remittance of dividends. There are also various local restrictions limiting cash loans and advances to AIG by its subsidiaries. Largely as a result of the restrictions, approximately 53 percent of consolidated capital funds were restricted from immediate transfer to AIG parent at December 31, 1993.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n10. CAPITAL FUNDS (continued)\n(c) The common stock activity for the three years ended December 31, 1993 was as follows:\n* Shares issued to AIG and subsidiaries as part of stock split effected as dividend.\nCommon stock increased and additional paid-in capital decreased $281.2 million as a result of a common stock split in the form of a 50 percent stock dividend paid July 30, 1993 to holders of record July 2, 1993.\n11. COMMITMENTS AND CONTINGENT LIABILITIES\nIn the normal course of business, various commitments and contingent liabilities are entered into by AIG and certain of its subsidiaries. In addition, AIG guarantees various obligations of certain subsidiaries.\nCommitments to extend credit are agreements to lend subject to certain conditions. These commitments generally have fixed expiration dates or termination clauses and typically require payment of a fee. At December 31, 1993 and 1992, these commitments, made principally by AIG Capital Corp., approximated $140,700,000 and $167,300,000 respectively. AIG uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. AIG evaluates each counterparty's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by AIG upon extension of credit, is based on management's credit evaluation of the counterparty.\nAIG and certain of its subsidiaries become parties to financial instruments with off-balance-sheet risk as a result of trading activities and to reduce currency, interest rate, equity and commodity exposures. To the extent those instruments are carried at their estimated fair value, the elements of currency, interest rate, equity and commodity risks are reflected in the consolidated balance sheet. In addition, these instruments involve, to varying degrees, elements of credit risk not explicitly recognized in the consolidated balance sheet. Collateral is required, at the discretion of AIG, on certain transactions based on the creditworthiness of the counterparty.\nAIGFP becomes party to off-balance-sheet financial instruments in the normal course of its business and to reduce its currency, interest rate, equity and commodity exposures.\nForward and future contracts are contracts for delivery of foreign currencies, commodities, securities, equity indexes or money market instruments in which the seller\/purchaser agrees to make\/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise as a result of deviations in current market conditions from contracted levels and the potential inability of counterparties to meet the terms of their contracts. The notional amounts for each AIGFP contract are converted to five-year equivalent amounts, a measurement used to standardize the various maturities within the portfolio. At December 31, 1993, the notional principal amount of forward contracts entered into by AIGFP, expressed in five-year equivalent amounts, approximated $247 million. The contractual amounts of futures commitments to purchase and commitments to sell approximated $25.5 billion and $4.6 billion, respectively.\nAs a writer of options, AIGFP generally receives a premium at the outset and then follows a policy of minimizing interest rate, commodity, equity and currency risks underlying the option. At December 31, 1993, the notional principal amount of interest rate, commodity, equity and currency options written, expressed in five-year equivalent amounts, approximated $813 million.\nAIGFP, for its own account, enters into interest rate, currency, equity and commodity swaps and forward commitments. Interest rate swap and swaption transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. AIGFP typically becomes a principal in the exchange of interest payments between the parties and, therefore, may be exposed to loss, if counterparties default. Currency, equity and commodity swaps are similar to interest rate swaps, but may involve the exchange of principal amounts at the beginning and end of the transaction. At December 31, 1993, the notional principal amount of the sum of the swap pays and receives expressed in five-year equivalent amounts, approximated $118 billion, primarily related to interest rate swaps ($90 billion). Assuming simultaneous nonperformance by all counterparties on all contracts potentially subject to a loss, the maximum potential loss, based on the cost of replacement at market rates prevailing at December 31, 1993, approximated $5.4 billion.\nAIGFP evaluates the creditworthiness of its counterparties by internally evaluating counterparties by individual credits and consulting with widely accepted credit-rating services. The average credit rating of AIGFP's counterparties as a whole (as measured by AIGFP) is equivalent to AA-. The maximum potential loss will increase or decrease during the life of the swaps and forward commitments as a function of maturity and market conditions.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n11. COMMITMENTS AND CONTINGENT LIABILITIES (continued)\nAt December 31, 1993, the breakdown by industry of maximum potential loss was as follows:\nAIGFP has entered into commitments to provide liquidity for certain insured variable rate bonds issued by municipal entities. The bond agreements allow the holder, in certain circumstances, to tender the bonds to the issuer at par value. In the event a remarketing agent of the issuer is unable to resell such bonds, AIGFP would be obligated to purchase the bonds at par value. AIGFP would receive interest on any bonds purchased at rates above the then prevailing market rates. These liquidity facilities aggregated $685 million at December 31, 1993 and extend through December 31, 1997. In management's opinion, it is unlikely that AIGFP will become obligated to purchase any bonds pursuant to the liquidity facilities.\nSecurities sold, but not yet purchased represent obligations of AIGFP to deliver specified securities at their contracted prices, and thereby create a liability to repurchase the securities in the market at prevailing prices.\nAIGFP monitors and controls its risk exposure on a daily basis through financial, credit and legal reporting systems and, accordingly, believes that it has in place effective procedures for evaluating and limiting the credit and market risks to which it is subject. Management is not aware of any potential counterparty defaults as of December 31, 1993.\nAIG has issued an unconditional guarantee with respect to the prompt payment, when due, of all present and future obligations and liabilities of AIGFP arising from transactions entered into by AIGFP.\nAIG Trading Group Inc. and its subsidiaries (AIGTG) becomes party to off-balance sheet financial instruments in the normal course of its business and to reduce its currency, interest rate and commodity exposures.\nForward and futures contracts are contracts for delivery of foreign currencies or money market instruments in which the seller\/purchaser agrees to make\/take delivery at a specified future date of a specified instrument at a specified price or yield. Risks arise as a result of movements in current markets from contracted levels and the potential inability of counterparties to meet the terms of their contracts. At December 31, 1993, the notional principal amount of open purchase and sale forward and futures contracts of AIGTG approximated $101 billion. The notional or contractual amounts used to summarize the volume of financial instruments do not represent the amount of financial instruments subject to off-balance sheet risks. Assuming simultaneous nonperformance by all counterparties on all contracts of AIGTG potentially subject to loss, the maximum potential loss, based on the cost of replacement at market rates prevailing at December 31, 1993, approximated $800 million.\nAs a writer of foreign exchange options, AIGTG generally receives a premium at the outset and then follows a policy of minimizing the currency risk underlying the option. At December 31, 1993, the notional principal amount of foreign currency options written approximated $15 billion.\nAIGTG limits its risks by holding offsetting positions. In addition, AIGTG monitors and controls its risk exposures through various monitoring systems which evaluate AIGTG's market and credit risks, and through credit approvals and limits. At December 31, 1993, AIGTG did not have a significant concentration of credit risk from either an individual counterparty or group of counterparties.\nAt December 31, 1993, ILFC had committed to purchase 227 aircraft deliverable from 1994 through 1999 at an estimated aggregate purchase price of $12.9 billion. Concurrently, at December 31, 1993, ILFC had options to purchase 58 aircraft deliverable through 1999 at an estimated aggregate purchase price of $3.4 billion. ILFC will be required to find customers for any new aircraft ordered and arrange financing for portions of the purchase price of such equipment.\nAIG does not anticipate any losses in connection with the aforementioned activities that would have a material effect on its financial condition or results of operations.\nAIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material effect on its operating results and financial condition.\nAIG continues to receive indemnity claims asserting injuries from toxic waste, hazardous substances, asbestos and other environmental pollutants and alleged damages to cover the clean-up costs of hazardous waste dump sites (environmental claims). Estimation of environmental claims loss reserves is a difficult process, as these claims, which emanate from policies written in 1984 and prior years, cannot be estimated by conventional reserving techniques. Environmental claims development is affected by factors such as inconsistent court resolutions, the broadening of the intent of policies and scope\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n11. COMMITMENTS AND CONTINGENT LIABILITIES (continued)\nof coverage and increasing number of new claims. AIGand other industry members have and will continue to litigate the broadening judicial interpretation of policy coverage and the liability issues. If the courts continue in the future to expand the intent of the policies and the scope of the coverage, as they have in the past, additional liabilities would emerge for amounts in excess of reserves held. This emergence cannot now be reasonably estimated, but could have a material impact on AIG's future operating results and financial condition. The reserves carried for these claims as at December 31, 1993 ($1.48 billion gross; $368.3 million net) are believed to be adequate as these reserves are based on known facts and current law. Furthermore, as AIG's net exposure retained relative to the gross exposure written was lower in those years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves.\n12. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFinancial Accounting Standards Board Statement No. 107 \"Disclosures about Fair Value of Financial Instruments\" (FASB 107) requires disclosure of fair value information about financial instruments for which it is practicable to estimate such fair value. These financial instruments may or may not be recognized in the consolidated balance sheet. In the measurement of the fair value of certain of the financial instruments, quoted market prices were not available and other valuation techniques were utilized. These derived fair value estimates are significantly affected by the assumptions used. FASB 107 excludes certain financial instruments, including those related to insurance contracts.\nThe following methods and assumptions were used by AIG in estimating the fair value of the financial instruments presented:\nCash and short-term investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values.\nFixed maturity securities: Fair values for fixed maturity securities carried at amortized cost or at market value were generally based upon quoted market prices. For certain fixed maturity securities for which market prices were not readily available, fair values were estimated using values obtained from independent pricing services. No other fair valuation techniques were applied to these bonds as AIG believes it would have to expend excessive costs for the benefits derived.\nEquity securities: Fair values for equity securities were based upon quoted market prices.\nMortgage loans on real estate, policy and collateral loans: Where practical, the fair values of loans on real estate and collateral loans were estimated using discounted cash flow calculations based upon AIG's current incremental lending rates for similar type loans. The fair values of the policy loans were not calculated as AIG believes it would have to expend excessive costs for the benefits derived.\nSecurities held for investment: Fair values for securities held for investment carried at amortized cost were based upon quoted market prices. For securities for which market prices were not readily available, fair values were estimated using quoted market prices of comparable investments.\nReceivables from and payables to securities brokers and dealers: Fair values for receivables from and payables to securities brokers and dealers approximate the carrying values presented in the consolidated balance sheet.\nSecurities available for sale: Fair values for securities available for sale and related hedges were based on quoted market prices. For securities and related hedges for which market prices were not readily available, fair values were estimated using quoted market prices of comparable investments.\nTrading securities: Fair values for trading securities were based on current market value where available. For securities for which market values were not readily available, fair values were estimated using quoted market prices of comparable investments.\nSpot commodities: Fair values for spot commodities, which include options, were based on current market prices.\nNet unrealized gains on interest rate and currency swaps, options and forward transactions: Fair values for swaps, options and forward transactions were based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates, as applicable.\nSecurities purchased (sold) under agreements to resell (repurchase), at contract value: As these securities (obligations) are short-term in nature, the contract values approximate fair values.\nOther invested assets: For assets for which market prices were not readily available, fair valuation techniques were not applied as AIG believes it would have to expend excessive costs for the benefits derived.\nPolicyholders' contract deposits: Fair values of policyholder contract deposits were estimated using discounted cash flow calculations based upon interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued.\nGIAs: Fair values of AIG's obligations under investment type agreements were estimated using discounted cash flow calculations based on interest rates currently being offered for similar agreements with maturities consistent with those remaining for the agreements being valued. Additionally, AIG follows a policy of minimizing interest rate risks associated with GIAs by entering into swap transactions. The unrealized gains for transactions related to GIAs were $526.3 million at December 31, 1993.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n12. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)\nSecurities sold but not yet purchased, principally obligations of the U.S. Government and Government agencies: The carrying amounts for these financial instruments approximate fair values.\nSpot commodities sold but not yet purchased: The carrying amounts for these financial instruments approximate fair values.\nDeposits due to banks and other depositors: To the extent certain amounts are not demand deposits or certificates of deposit which mature in more than one year, fair values were not calculated as AIG believes it would have to expend excessive costs for the benefits derived.\nCommercial paper: The carrying amount of AIG's commercial paper borrowings approximates fair value.\nNotes, bonds, loans and mortgages payable: Where practical, the fair values of these obligations were estimated using discounted cash flow calculations based upon AIG's current incremental borrowing rates for similar types of borrowings with maturities consistent with those remaining for the debt being valued.\nThe carrying values and fair values of AIG's financial instruments at December 31, 1993 and December 31, 1992 were as follows:\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n12. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)\nOff-balance sheet financial instruments: Financial instruments which are not currently recognized in the consolidated balance sheet of AIG are principally commitments to extend credit and financial guarantees. The unrecognized fair values of these instruments represent fees currently charged to enter into similar agreements, taking into account the remaining terms of the current agreements and the counterparties' credit standings. No valuation was made as AIG believes it would have to expend excessive costs for the benefits derived.\n13. STOCK PURCHASE PLAN\nAIG's 1984 employee stock purchase plan was adopted at the 1984 shareholders' meeting and became effective as of July 1, 1984. Eligible employees receive privileges to purchase up to an aggregate of 1,312,500 shares of AIG common stock, at a price equal to 85 percent of the fair market value on the date of grant of the purchase privilege.\nPurchase privileges are granted annually and are limited to the number of whole shares that can be purchased by an amount equal to 5 percent of an employee's annual salary or $3,750, whichever is less.\nAs of December 31, 1993, there were 84,055 shares of common stock subscribed to at a weighted average price of $75.97 per share pursuant to grants of privileges under the 1984 plan. There were 93,447 shares, 92,220 shares and 122,072 shares issued under the 1984 plan at weighted average prices of $54.46, $49.66 and $41.33 for the years ended December 31, 1993, 1992 and 1991, respectively. The excess of the proceeds over the par value or cost of the common stock issued was credited to additional paid-in capital. There were 352,040 shares available for the grant of future purchase privileges under the 1984 plan at December 31, 1993.\n14. STOCK OPTIONS\nOn December 19, 1991, the AIG Board of Directors adopted a 1991 employee stock option plan, which provides that options to purchase a maximum of 3,000,000 shares of common stock could be granted to officers and other key employees at prices not less than fair market value at the date of grant. Both the 1991 plan, and the options with respect to 74,925 shares granted thereunder on December 19, 1991, were approved by shareholders at the 1992 Annual Meeting. At December 31, 1993, 2,108,950 shares were reserved for future grants under the 1991 plan. As of March 18, 1992, no further options could be granted under the 1987 plan, but outstanding options granted under the 1987 plan and the previously superceded 1982 plan continue in force until exercise or expiration. At December 31, 1993, there were 2,622,259 shares reserved for issuance under the 1991, 1987 and 1982 plans.\nUnder each plan, 25 percent of the options granted become exercisable on the anniversary of the date of grant in each of the four years following that grant and all options expire 10 years from the date of the grant. As of December 31, 1993, outstanding options granted with respect to 1,981,273shares qualified for Incentive Stock Option treatment under the Economic Recovery Tax Act of 1981.\nAdditional information with respect to the AIG plans at December 31, 1993 was as follows:\n15. EMPLOYEE BENEFITS\n(a) Employees of AIG, its subsidiaries and certain affiliated companies, including employees in foreign countries, are generally covered under various funded and insured pension plans. Eligibility for participation in the various plans is based on either completion of a specified period of continuous service or date of hire, subject to age limitation. While benefits vary, they are usually based on the employees' years of credited service and average compensation in the three years preceding retirement.\nAIG's U.S. retirement plan is a qualified, noncontributory, defined benefit plan. All qualified employees who have attained age 21 and completed six months of continuous service are eligible to participate in this plan. An employee with 5 or more years of service is entitled to pension benefits beginning at\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n15. EMPLOYEE BENEFITS (continued)\nnormal retirement at age 65. Benefits are based upon a percentage of average final compensation multiplied by years of credited service commencing April 1, 1985 and limited to 44 years of credited service. The average final compensation is subject to certain limitations. Annual funding requirements are determined based on the \"projected unit credit\" cost method which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service.\nAIG has adopted a Supplemental Executive Retirement Program (Supplemental Plan) to provide additional retirement benefits to designated executives and key employees. Under the Supplemental Plan, the annual benefit, not to exceed 60 percent of average final compensation, accrues at a percentage of average final pay multiplied for each year of credited service reduced by any benefits from the current and any predecessor retirement plans, Social Security, if any, and from any qualified pension plan of prior employers. Effective January 1, 1991, the Supplemental Plan also provides a benefit equal to the reduc-tion in benefits payable under the AIG retirement plan as a result of Federal limitations on benefits payable thereunder. Currently, the Supplemental Plan is unfunded.\nEligibility for participation in the various non-U.S. retirement plans is either based on completion of a specified period of continuous service or date of hire, subject to age limitation. While benefits vary, they are generally based on the employees' years of credited service and average compensation in the years preceding retirement.\nAssumptions associated with the projected benefit obligation and expected long-term rate of return on plan assets at December 31, 1993 were as follows:\n* The ranges for the non-U.S. plans reflect the local socioeconomic environments in which AIG operates.\nThe following table sets forth the funded status of the various pension plans and the amounts recognized in the accompanying consolidated balance sheet as of December 31, 1993 and 1992:\n* Plan assets are invested primarily in fixed-income securities and listed stocks.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n15. EMPLOYEE BENEFITS (continued)\nNet pension cost for the years ended December 31, 1993, 1992 and 1991 included the following components:\n* Net pension expense included $20,999, $13,478 and $13,433 related to non-U.S. plans for 1993, 1992 and 1991, respectively.\n(b) AIG sponsors a voluntary savings plan for domestic employees (a 401(k) plan), which provides for salary reduction contributions by employees and matching contributions by AIG of up to 2 percent of annual salary.\n(c) In addition to AIG's defined benefit pension plan, AIG and its subsidiaries provide a postretirement benefit program for medical care and life insurance, domestically and in certain foreign countries. Eligibility in the various plans is generally based upon completion of a specified period of eligible service and reaching a specified age. Benefits vary by geographic location.\nAIG's U.S. postretirement medical and life insurance benefits are based upon the employee reaching age 55 with 10 years of service to be eligible for an immediate benefit from the U.S. retirement plan. Retirees and their dependents who were age 65 by May 1, 1989 participate in the medical plan at no cost. All other retirees and dependents over age 65 pay 50 percent of the premium that is paid by current active employees. Retirees under age 65 pay the full active premium and covered dependents pay twice the active employee amounts. Contri-butions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance and Medicare coordination and a lifetime maximum benefit of $1,000,000. The maximum life insurance benefit prior to age 70 is $32,500, with a maximum of $25,000 thereafter.\nEffective January 1, 1993, both plans' provisions were amended. Employees who retire on or after January 1, 1993 will be required to pay the actual cost of the medical benefits reduced by a credit which is based upon age and years of serv- ice at retirement. The life insurance benefit will vary by age at retirement from $5,000 for retirement at ages 55 through 59 to $15,000 for retirement at ages 65 and over.\nAIG adopted FASB 106 effective January 1, 1992. Prior to adoption, AIG expensed these postretirement benefits on a pay-as-you-go basis. The cumulative effect of the accounting change relative to the adoption of FASB 106 was $54.8 million, net of tax.\nAssumptions associated with the accrued postretirement benefit liability at December 31, 1993 were as follows:\n* The Medical trend rate grades downward from years 1 through 8 domestically and years 1 through 9 for the foreign benefits. The trend rates remain level thereafter.\nThe following table sets forth the liability for the accrued postretirement benefits of the various plans, and amounts recognized in the accompanying consolidated balance sheet as of December 31, 1993 and 1992. These plans are not funded currently.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n15. EMPLOYEE BENEFITS (continued)\nThe net periodic postretirement costs for the years ended December 31, 1993 and 1992 included the following components:\nThe medical trend rate assumptions have a significant effect on the amounts reported. Increasing each trend rate by 1 percent in each year would increase the accumulated post-retirement benefit obligations as of December 31, 1993 by $5.0 million and the aggregate service and interest cost components of the periodic postretirement benefit costs for 1993 by $468,000.\nDuring 1991, AIG recognized the cost of providing current medical and life insurance benefits by recording the annual insurance premiums as an expense. During 1991 these costs approximated $32,000,000. The cost of providing these benefits for retirees was not separable from the cost of providing benefits for active employees prior to 1992.\n16. LEASES\n(a) AIG and its subsidiaries occupy leased space in many locations under various long-term leases and have entered into various leases covering the long-term use of data processing equipment. At December 31, 1993, the future minimum lease payments under operating leases were as follows:\nRent expense approximated $200,500,000, $199,200,000, and $199,400,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\n(b) Minimum future rental income on noncancelable operating leases of flight equipment which have been delivered at December 31, 1993 was as follows:\nFlight equipment is leased, under operating leases, for periods ranging from one to twelve years.\n17. OWNERSHIP AND TRANSACTIONS WITH RELATED PARTIES\n(A) OWNERSHIP: The directors and officers of AIG, the directors and holders of common stock of C. V. Starr & Co., Inc. (Starr), a private holding company, The Starr Foundation, Starr International Company, Inc. (SICO), a private holding company, and Starr own or otherwise control approximately 29 percent of the voting stock of AIG. Six directors of AIG also serve as directors of Starr and SICO.\n(B) TRANSACTIONS WITH RELATED PARTIES: During the ordinary course of business, AIG and its subsidiaries pay commissions to Starr and its subsidiaries for the production and management of insurance business. Net commission payments to Starr aggregated approximately $25,800,000 in 1993, $21,200,000 in 1992 and $19,600,000 in 1991, from which Starr is required to pay commissions due originating brokers and its operating expenses. AIG also received approximately $11,800,000 in 1993, $11,500,000 in 1992 and $10,500,000 in 1991 from Starr and paid approximately $60,000 in 1993 and $50,000 in 1992 and 1991 to Starr as reimbursement for services provided at cost. AIG also received approximately $600,000 in 1993 and $800,000 in 1992 and 1991 from SICO and paid approximately $1,100,000 in 1993, $900,000 in 1992 and $800,000 in 1991 to SICO as reimbursement for services rendered at cost. AIG also paid to SICO $3,400,000 in 1993, $3,800,000 in 1992 and $4,700,000 in 1991 in rental fees.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n18. SUMMARY OF QUARTERLY FINANCIAL INFORMATION- UNAUDITED\nThe following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1993 and 1992 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown.\n(a) Represents a net benefit for the cumulative effect of the adoption of accounting pronouncements related to postretirement benefits (FASB 106) and income taxes (FASB 109) by minority-owned reinsurance operations in 1993 and by AIG in 1992.\n19. SEGMENT INFORMATION\n(a) AIG's operations are conducted principally through five business segments. These segments and their respective operations are as follows:\nParent - AIG parent is a holding company owning directly or indirectly all of the capital stock of certain insurance, insurance related and financial services companies in both the United States and abroad.\nGeneral Insurance - AIG's general insurance operations are multiple line property and casualty companies writing substantially all lines of insurance other than title insurance. The general insurance operations also include mortgage guaranty insurance operations.\nLife Insurance - AIG's life insurance operations offer a broad line of individual and group life, annuity and accident and health policies.\nAgency and Service Fee - AIG's agency operations are engaged in the production and management of various types of insurance for affiliated and non-affiliated companies.\nFinancial Services - AIG's financial services operations engage in diversified financial services for affiliated and non-affiliated companies. Such operations include, but are not limited to, short-term cash management and financing, premium financing, interest rate, currency, equity and commodity derivative products business, various commodities trading and market making activities, banking services and operations and leasing and remarketing of flight equipment.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n19. SEGMENT INFORMATION (continued)\nThe following table is a summary of the operations by major operating segments for the years ended December 31, 1993, 1992 and 1991:\n(a) Including other operations and other income (deductions) -net, which are not deemed to be reportable segments. (b) Including realized capital gains attributable to the segments. (c) Substantially dividend income from subsidiaries. (d) Relating primarily to ILFC. (e) Assets as at December 31, 1993 and 1992 have been adjusted to conform to the requirements of FASB 113.\nNOTES TO FINANCIAL STATEMENTS (continued) American International Group, Inc. and Subsidiaries\n19. SEGMENT INFORMATION (continued)\n(b) The following table is a summary of AIG's general insurance operations by major operating category for the years ended December 31, 1993, 1992 and 1991:\n(a) Including workers' compensation and retrospectively rated risks. (b) Including involuntary pools. (c) Including mass marketing and specialty programs.\n(c) AIG's individual life insurance and group life insurance portfolio accounted for 64 percent, 67 percent and 71 percent of AIG's consolidated life insurance operating income before realized capital gains or losses for the years ended December 31, 1993, 1992 and 1991, respectively. For those years, 97 percent, 98 percent and 99 percent, respectively, of consolidated life operating income before realized capital gains or losses was derived from foreign operations.\n(d) A substantial portion of AIG's business is conducted in countries other than the United States and Canada. The following table is a summary of AIG's business by geographic segments. Allocations have been made on the basis of location of operations and assets.\n(a) Including general insurance operations in Canada. (b) Revenues are derived from revenues of the general, life, agency and service fee and financial services operations, equity in income of minority-owned reinsurance operations and realized capital gains attributable to the segments. (c) Assets as at December 31, 1993 and 1992 have been adjusted to conform to the requirements of FASB 113.\nAmerican International Group, Inc. and Subsidiaries\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in or disagreements with accountants on accounting and financial disclosure within the twenty-four months ending December 31, 1993.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nExcept for the information provided in Part I under the heading \"Directors and Executive Officers of the Registrant\", this item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A.\nITEM 11.","section_11":"ITEM 11.EXECUTIVE COMPENSATION\nThis item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A.\nITEM 12.","section_12":"ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A.\nITEM 13.","section_13":"ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A.\nPART IV\nITEM 14.","section_14":"ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) FINANCIAL STATEMENTS AND EXHIBITS. 1. Financial Statements and Schedules. See accompanying Index to Financial Statements. 2. Exhibits. 3-- Articles of Incorporation and By-Laws. 10-- Material Contracts. 11-- Computation of Earnings Per Share for the Years Ended December 31, 1993, 1992, 1991, 1990 and 1989. 12-- Computation of Ratios of Earnings to Fixed Charges for the Years Ended December 31, 1993, 1992, 1991, 1990 and 1989. 21-- Subsidiaries of Registrant. 23-- Consent of Coopers & Lybrand. 24-- Power of Attorney. 28-- Information from Statutory Schedule P. 99-- Undertakings.\n(B) REPORTS ON FORM 8-K.\nThere have been no reports on Form 8-K filed during the quarter ended December 31, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the issuer has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York and State of New York, on the 30th day of March, 1994.\nAMERICAN INTERNATIONAL GROUP, INC. By \/s\/ M. R. Greenberg -------------------------------- (M. R. Greenberg, Chairman)\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed below by the following persons in the capacities indicated on the 30th day of March, 1994 and each of the undersigned persons, in any capacity, hereby severally constitutes M.R. Greenberg, Edward E. Matthews and Howard I. Smith and each of them, singularly, his true and lawful attorney with full power to them and each of them to sign for him, and in his name and in the capacities indicated below, this Annual Report on Form 10-K and any and all amendments thereto.\nII-1 SIGNATURES--(CONTINUED)\nII-2 EXHIBIT INDEX\nII-3\nII-4\nII-5","section_15":""}
{"filename":"790523_1993.txt","cik":"790523","year":"1993","section_1":"Item 1. BUSINESS\nPRODUCTS AND SERVICES\nIWC Resources Corporation (Resources or, together with its subsidiaries, the Company) is a holding company which owns and operates seven subsidiaries, including three waterworks systems which supply water for residential, commercial, and industrial uses and for fire protection service in Indianapolis, Indiana and surrounding areas. The territory served by the three utilities covers an area of approximately 185 square miles and includes areas in Marion, Hancock, Hamilton, Hendricks, and Boone counties.\nAt year end, Indianapolis Water Company (IWC) was providing service to 219,600 customers. Harbour Water Corporation (Harbour), in the Morse Reservoir area of Hamilton County, was serving 2,309 customers. Zionsville Water Corporation (Zionsville), located northwest of Indianapolis, was serving 2,233 customers.\nIn addition to the three water utilities, Resources has four other wholly owned subsidiaries, IWC Services, Inc., Utility Data Corporation, Waterway Holdings, Inc., and SM&P Conduit Co., Inc. IWC Services, Inc. offers water-related services to contractors and other water and wastewater utilities. Utility Data Corporation provides customer billing, customer relations, and data processing services to the Company's water utilities, the city of Indianapolis sewer operations, and to several other unaffiliated utilities. The Company, principally through Waterway Holdings, Inc., owns approximately 360 acres of real estate located primarily in the Geist Reservoir area that it intends to sell or develop in the future. SM&P Conduit Co., Inc., which was acquired in June 1993, provides underground facility locating services for utility companies including electric, telephone, gas, cable television, water and sewer utilities.\nIn November 1993, a subsidiary of the Company became majority partner in White River Environmental Partnership (Partnership). In December 1993, the Partnership was awarded a five-year contract by the city of Indianapolis to manage and operate its two Advanced Wastewater Treatment plants commencing January 30, 1994. At December 31, 1993, this Partnership was still in the development stage and had no significant assets.\nThe Company's majority-owned subsidiary, L&K Noe Pin-Point Boring, Inc., which provided directional boring services, was liquidated in 1993.\nThe Company continues to explore the possibility of involving itself in other water utilities and utility-related activities through the acquisition or formation of additional subsidiaries. However, the Company does not intend to enter into any business that would impair the Company's primary commitment to maintain and develop its water utilities to meet the current and future needs of their customers.\nINDUSTRY SEGMENT FINANCIAL INFORMATION\nThe Company's operations include two business segments: regulated water utilities and unregulated utility-related services. The water utilities segment includes the operations of the Company's three water utility subsidiaries. The utility-related services segment provides utility line locating services, data processing and billing and payment processing, and other utility-related services to both unaffiliated utilities and to the Company's water utilities. The discussion of segment information, including selected financial data included on pages 31 through 32 of the 1993 Annual Report under \"Segment Information\", is incorporated herein by reference.\nSECURITIES AND RATE REGULATION\nThe utility subsidiaries of the Company are subject to regulation by the Indiana Utility Regulatory Commission (Commission) which has jurisdiction over rates, standards of service, accounting procedures, issuance of securities and related matters. The Commission consists of five Commissioners, appointed by the Governor of Indiana from a list of persons selected by a 7-member nominating committee whose members are: appointed by the Governor (3); and the majority (2) and minority (2) leaders of the Indiana House and Senate. Decisions of the Commission are appealable directly to the Indiana Court of Appeals.\nSecurities. The issuance of securities by Resources is not subject to approval by the Commission. The issuance of securities by, and changes in the equity capital of, the Company's utility subsidiaries, including IWC, must be approved.\nWater Rates. Rates charged by the Company for water service are approved by the Commission. It is the Company's policy to seek rate relief when necessary to maintain its service and financial soundness. The Company is not permitted to submit petitions for general rate relief more frequently than every fifteen months and the Commission is not required to act upon petitions within any particular time period.\nRate Case. On May 17, 1993, Indianapolis Water Company and Zionsville Water Corporation, both wholly owned subsidiaries of the Company, filed a petition with the Commission for approval of a merger of the two companies and a new schedule of rates and charges applicable to their interconnected systems. The increase in combined revenues sought by the companies is approximately $8.9 million, or 14%. This request for new rates includes the increased costs associated with adoption of accrual accounting for postretirement benefits other than pensions. On November 10, 1993, the Utility Consumer Counselor, representing ratepayers, prefiled its testimony and exhibits in the case, the effect of which, if adopted by the Commission, would result in a decrease in current rates of approximately $4.6 million, or 7.2%. Hearings before the Commission were concluded in December 1993, and the Company anticipates a final order in the second quarter of 1994.\nCOMPETITIVE CONDITIONS\nThe Company conducts its water utility operations, subject to regulation by the Commission, under indeterminate permit and related franchise rights, all of which may be revoked for cause. Under such permit and franchise rights, the Company may lay, maintain and operate its mains and conduits in public streets and ways throughout the area which it serves. Although the permit and franchise rights granted to the Company are not exclusive, other than private wells, there are presently no other significant competitors operating within most of the Company's service area, and the Company does not anticipate that any significant general competition will develop within the area. As the Indianapolis metropolitan area has expanded to include surrounding communities or previously rural areas, the Company has faced competition for new customers from town or rural water utilities.\nThe continuing regulation of the Commission covers, among other things, matters relating to rates, service, acquisition of properties, accounting practices, and the issuance of securities by IWC, Harbour or Zionsville. The Company does not pay a franchise tax and is not required to renew its franchise rights periodically.\nThe Company's unregulated utility-related services are currently provided in eight states. Data processing and billing and payment processing services are provided to the city of Indianapolis, the Company's water utilities, and to other unaffiliated utilities located in the state of Indiana. Underground facility locating services are provided in the states of Indiana, Ilinois, Missouri, Ohio, Texas, Wisconsin, Arkansas and Minnesota. Services provided by this segment are subject to competitive conditions and are generally contracted for a period of three to five years.\nRECENT AND PROPOSED CHANGES IN FACILITIES\nDuring the year ended December 31, 1993, the Company added $18,988,000 (including $5,021,000 from the acquisition of SM&P) to utility plant and other property, including 58 miles of new mains and 515 fire hydrants.\nDuring the past five years, additions to utility plant and other property have averaged $22,694,000 annually. The Company plans capital expenditures of approximately $125,000,000 during the five-year period 1994-1998 primarily for further extensions and improvements to the Company's utility distribution systems and further additions and improvements to its treatment, pumping and storage facilities. In 1993, the Company installed an additional filter at its Harding Station facility, on the south side of its service area, increasing the facility's treatment capacity to 5.5 MGD, at an approximate cost of $415,000. Construction of an additional well at Harbour was started in 1993 to increase the reliable supply to the existing filter plant, at an approximate cost of $40,000. For possible capital expenditures relating to environmental matters, which are not included above, see \"Environmental Matters.\"\nCAPACITY OF FACILITIES AND SOURCES OF WATER SUPPLY\nThe combined maximum daily capacity of the Company's treatment plants, together with the maximum daily capacity of its two primary well fields, is 219 million gallons per day (MGD). During 1993, the average consumption was 118 MGD and the maximum consumption was 154 MGD. See \"Operating Information by Industry Segment.\"\nThe principal sources of IWC's present water supply are (a) the White River, which flows through Indianapolis from north to south and is supplemented by Morse Reservoir on a tributary, Cicero Creek, (b) Fall Creek, which flows from the northeast and is supplemented by Geist Reservoir, and (c) the city of Indianapolis' Eagle Creek Reservoir, located on Eagle Creek in northwest Marion County, from which water is purchased under a long-term contract. See \"Properties-Source of Water Supply.\"\nThe three large surface reservoirs are essential to providing an adequate supply during dry periods. Two are used to supplement low stream flows in the White River and Fall Creek, respectively, and water is drawn directly from the third. The reservoirs are rated at a dependable capacity designed to maintain an adequate supply during a repetition of the worst two-year drought ever recorded in the Indianapolis area.\nThe theoretical dependable supply impounded by the three combined reservoirs represents about 65 percent of the total dependable supply available today with the balance coming from natural stream flow and wells. Wells constitute the source of supply for Harbour. The Zionsville system is connected to IWC's system.\nIn 1993, the Company completed its aquifer protection plan for the south well field in southwest Marion County. This plan will guide the Company's development of its newest major source of supply (40 to 50 MGD), and result in a land use plan to protect the aquifer system from potential contamination sources.\nSEASONAL NATURE OF BUSINESS\nTypically, the seasonal nature of the Company's business results in a higher proportion of operating revenues being realized in the second and third quarters of the year than the first and fourth quarters of the year.\nENVIRONMENTAL MATTERS\nThe Company's utility operations are subject to pollution control and water quality control regulations, including those issued by the Environmental Protection Agency (EPA), the Indiana Department of Environmental Management (IDEM), the Indiana Water Pollution Control Board and the Indiana Department of Natural Resources. Under the Federal Clean Water Act and Indiana's regulations, the Company must obtain National Pollutant Discharge Elimination System (NPDES) permits for discharges from its White River, White River North, Fall Creek, and Thomas W. Moses treatment stations.\nThe Company's current NPDES permits were to expire June 30, 1989, for White River and Fall Creek stations and December 31, 1990, for Thomas W. Moses treatment station. Applications for renewal of the permits have been filed with, but have not been acted upon by, IDEM (these permits continue in effect pending review of the applications). The Company received an NPDES permit for its White River North Station on April 1, 1991, and it has complied with the reporting requirements for the initial 12-month period of the permit. IDEM has authority to reopen this permit and it could propose in some or all of these permits additional limitations that could be difficult and expensive. Accordingly, the full impact of such restrictions cannot be assessed with certainty at this time. The Company anticipates, however, that the capital costs and expense of compliance with any such permits are likely to be significant.\nUnder the federal Safe Drinking Water Act (SDWA), the Company is subject to regulation by EPA of the quality of water it sells and treatment techniques it uses to make the water potable. EPA promulgates nationally applicable maximum contaminants levels (MCLs) for \"contaminants\" found in drinking water. Management believes that the Company is currently in compliance with all MCLs promulgated to date. EPA has continuing authority, however, to issue additional regulations under the SDWA, and Congress amended the SDWA in July 1986 to require EPA, within a three-year period, to promulgate MCLs for over 80 chemicals not then regulated. EPA has been unable to meet the three-year deadline, but has promulgated MCLs for many of these chemicals and has proposed additional MCLs.\nManagement of the Company believes that it will be able to comply with the promulgated MCLs and those now proposed without any change in treatment technique, but anticipates that in the future, because of EPA regulations, the Company may have to change its method of treating drinking water to include ozonation and\/or granular activated carbon (GAC). In either case, the capital costs could be significant (currently estimated at $37,000,000 for ozonation and $90,000,000 for GAC), as would be the Company's increase in annual operating costs (currently estimated at $1,600,000 for ozonation and $4,300,000 for GAC). Actual costs could exceed these estimates. The Company would expect to recover such costs through its water rates; however, such recovery may not necessarily be timely.\nUnder a 1991 law enacted by the Indiana Legislature, a water utility, including the utility subsidiaries of the Company, may petition the Indiana Utility Regulatory Commission (Commission) for prior approval of its plans and estimated expenditures required to comply with provisions of, and regulations under, the Federal Clean Water Act and SDWA. Upon obtaining such approval, the utility may include, to the extent of its estimated costs as approved by the Commission, such costs in its rate base for ratemaking purposes and recover its costs of developing and implementing the approved plans if statutory standards are met. The capital costs for such new systems, equipment or facilities or modifications of existing facilities may be included in the utility's rate base upon completion of construction of the project or any part thereof. While use of this statute is voluntary on the part of a utility, if utilized, it should allow utilities a greater degree of confidence in recovering major costs incurred to comply with environmental related laws on a timely basis.\nEMPLOYEES\nAt December 31, 1993, the Company had 904 employees including the addition of 499 employees as a result of the acquisition of SM&P. Approximately one-half of the Company's water utility employees are members of the International Brotherhood of Firemen and Oilers Local 131, AFL-CIO (Union).\nThe three-year contract between IWC and the Union is due to expire December 31, 1994.\nOPERATING INFORMATION BY INDUSTRY SEGMENT\nOperating information by industry segment for each of the past five years follows:\nOperating Revenues-Industry Segment (in thousands)\n1993 1992 1991 1990 1989 Water Utilities:\nResidential $41,513 40,633 38,901 34,231 31,924 Commercial and Industrial 18,032 16,696 15,393 14,225 13,589 Public Fire Protection 945 2,157 1,953 1,743 1,718 Other 3,849 3,966 3,683 3,43l 2,984\nTotal Water Utilities 64,339 63,452 59,930 53,630 50,215\nUtility-Related Services(1) 17,982 - - - -\nTotal Operating Revenues $82,321 63,452 59,930 53,630 50,215 ====== ====== ====== ====== ======\n(1) Reporting by segment was adopted in 1993 as a result of the acquisition of SM&P. Utility-related services for prior periods are not material and, accordingly, have not been reclassified to conform with the 1993 presentation.\nOperating Statistics-Water Utilities\n1993 1992 1991 1990 1989 Water Sold (million gallons)\nResidential 20,232 20,664 22,493 20,168 19,645 Commercial and Industrial 15,337 14,660 15,312 14,835 14,856 Public Fire Protection 39 29 32 46 50 Other 717 808 912 820 715 Total Water Sold 36,325 36,161 38,749 35,869 35,266 ====== ====== ====== ====== ====== Daily Pumpage (million gallons) Maximum 154 161 202 177 181 Minimum 93 90 91 95 92 Average 118 115 124 117 116\nUtility Customers (end of year, in thousands) 224 219 214 210 204\nFire Hydrants (end of year) 24,730 24,215 23,465 23,124 22,229\nMiles of Mains (end of year) 2,817 2,759 2,673 2,624 2,533\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nGENERAL DESCRIPTION\nThe Company's water utilities' properties consist of land, easements, rights (including water rights), buildings, reservoirs, canal, wells, supply lines, purification pla3ts, pumping stations, transmission and distribution pipes, mains and conduits, meters and other facilities used for the collection, purification, and storage of water, and the distribution of water to its customers. The water systems extend from well fields and raw water reservoirs on Cicero Creek and Fall Creek, north and northeast of Indianapolis, and from the intake structure in Indianapolis' Eagle Creek Reservoir, northwest of Indianapolis, to the service connections of the ultimate consumers. The principal properties are all located in or near Indianapolis and, except for Eagle Creek Reservoir, which is owned by the city of Indianapolis, are all owned by the Company, in fee, with the exception of its easements. Substantially all its utility property rights and interests, both tangible and intangible, are subject to the lien securing first mortgage bonds.\nThe Company's utility-related properties consist of data processing equipment used to provide data processing and billing and payment processing to both unaffiliated utilities and to the Company's water utilities, and land, building, vehicles and locating equipment used to provide line locating services to unaffiliated utilities. The Company also owns parcels of land which it holds for possible sale or development. A general description of the principal properties is set forth in the following paragraphs.\nSOURCE OF WATER SUPPLY\nWHITE RIVER: White River, supplemented by Morse Reservoir, furnished 70% of IWC's water supply during 1993, of which 64% was provided by IWC's White River plant and 6% was provided by IWC's new White River North plant (placed in service in 1991). The drainage area of the White River above the intake of IWC's canal is approximately 1,200 square miles. In 1956, IWC completed Morse Reservoir on Cicero Creek, a tributary of the White River. It is located on approximately 1,692 acres of land owned by IWC of which about 1,500 acres are inundated. The storage capacity of this reservoir is approximately 6.9 billion gallons. With the reservoir supplementing the natural flow, it is estimated by IWC that the combined dependable flow in the White River can be maintained at a volume sufficient to produce 88 MGD. IWC owns and maintains a\ndam across White River at Broad Ripple which serves to divert the flow into the canal. Water diverted at the Broad Ripple dam flows by gravity in an open canal to the White River treatment and pumping station. IWC's White River North plant has its intake directly on the White River.\nFALL CREEK: Fall Creek, supplemented by Geist Reservoir, provided 20% of IWC's water supply in 1993. The area of the watershed drained by Fall Creek upstream from the Fall Creek Station intake is approximately 300 square miles. In 1943, IWC completed the Geist Reservoir on Fall Creek. The reservoir is situated on about 1,983 acres of land owned by IWC, of which 1,890 acres are inundated, and has a storage capacity of approximately 6.1 billion gallons. With the reservoir supplementing the natural flow in Fall Creek, it is estimated by IWC that the combined dependable flow in Fall Creek can be maintained at a volume sufficient to provide 25 MGD. At the Fall Creek Station, IWC owns and maintains a concrete dam which diverts the flow of the creek into the station intake.\nEAGLE CREEK RESERVOIR: Raw water purchased from Eagle Creek Reservoir, a multipurpose reservoir owned and operated by the city of Indianapolis, provided 8% of IWC's water supply in 1993. On October 18, 1971, IWC and the City signed a 50-year contract, with an option for an additional 25 years, providing for the withdrawal, subject to certain restrictions, of up to 12.4 MGD on an annual average basis. IWC owns and maintains a raw water intake structure, pumping station, and pipeline within the reservoir property, which delivers the allotted supply to its Thomas W. Moses Treatment Plant.\nWELLS: IWC owns 37 wells, of which 31 are supplementary or auxiliary supply and six are primary sources of supply. The Company owns a total of 823 acres of well station land, of which 777 acres are located in Marion County and 46 acres are located in Johnson County. It is estimated that the aggregate dependable annual average yield under a repetition of the most severe two-year drought on record is approximately 14 MGD from the wells. In 1993, wells provided approximately 2% of IWC's water supply utilized.\nThe source of supply for Harbour consists of five wells having a total rated capacity and actual pumping capacity of 3.8 MGD. Zionsville purchases its entire treated water supply from IWC.\nPURIFICATION\nTreatment of surface water in IWC's system involves coagulation and flocculation, after which the water flows through the sedimentation basins and then to gravity-type rapid filters. IWC has four primary surface water filtration and purification plants--two for the White River supply sources, one for the Fall Creek supply source, and one for the Eagle Creek supply source--equipped with rapid filters having a maximum operating capacity aggregating 180 MGD and two ground water treatment plants totaling 9 MGD.\nThe water treatment plant for Harbour Water Corporation consists of four packaged filter iron removal units with a combined rated capacity of 3.5 MGD, including the new east plant which increased rated capacity by 1.5 MGD.\nPUMPING\nIWC owns seven principal pumping stations and eleven booster stations. The principal pumping stations have a total of 37 primary distribution pumps and have a maximum capacity of 311 MGD. The booster stations have 39 pumps, all of which are electrically driven with a maximum capacity of 99 MGD. IWC has not to date experienced, nor does it anticipate, any shortage of electrical energy to run its pumps.\nThe high service pumping facilities for Harbour consist of six electric motor-driven pumps housed in the same buildings as the treatment plants and have a maximum capacity of approximately 3.5 MGD.\nFILTERED WATER STORAGE\nThe Company's aggregate storage capacity for finished water is approximately 55 million gallons. IWC owns six filtered-water underground reservoirs at its five principal pumping stations which have an aggregate storage capacity of 39 million gallons. The filtered water in storage has been treated and is available to be pumped into the distribution system. Also, there are three elevated storage tanks with an aggregate storage capacity of over four million gallons and two ground storage tanks with an aggregate storage capacity of 12 million gallons.\nThe filtered water in the two ground storage tanks has been pumped by the principal pumping stations and is available to the respective booster stations to be pumped into the distribution system served by these stations. The three outlying elevated storage tanks \"ride on\" the distribution system and provide water by gravity flow.\nThere is one ground storage tank for Harbour located adjacent to the treatment plant with a storage capacity of 50,000 gallons. There is also an elevated storage tank in the distribution system which \"rides on\" the system and has a capacity of 250,000 gallons.\nZionsville has one elevated storage tank located in the town of Zionsville with a storage capacity of 400,000 gallons.\nTRANSMISSION AND DISTRIBUTION\nThe Company's utility transmission and distribution systems are composed of 2,817 miles of mains, most of which are cast iron and ductile iron. During the past ten years, an aggregate of 654 miles of mains, or approximately 23% of the total, were added to the systems. In general, the mains are located in city streets, other public ways and occasionally in easements. The supply mains are located partly in city streets and partly in rights-of-way and land owned by the Company. The Company furnishes public fire protection service through hydrants owned by the Company and located generally within the limits of street rights-of-way.\nUTILITY-RELATED PROPERTIES\nThe Company's data processing equipment is located at IWC's general office in Indianapolis, Indiana. The Company also owns land and a building in Noblesville, Indiana which is the headquarters for its line locating services, and leases (operating leases) fourteen buildings located in eight states which are used as district offices. Vehicles and locating equipment used in these operations are located at the various operating offices.\nREAL ESTATE INTERESTS\nAt December 31, 1993, the Company owned approximately 360 acres of undeveloped non-utility land. Most of the holdings consist of land located generally north and west of Geist Reservoir in Hamilton County, and several additional parcels in Marion County. The Company continues to explore the possible sale or development of this land.\nOFFICE BUILDING\nThe Company's main office building and service center was constructed in 1957 on 20 acres of land located approximately two miles from the center of the main business district of Indianapolis. The building houses the general and local commercial offices of the Company and provides a garage and building for storage of materials and vehicles, as well as shop space for repairs to automotive and other equipment. To provide for additional space and enhancement of customer service, the Company, in 1993, began construction of an office building adjacent to its existing building which will house certain general office employees. The new building is scheduled for completion in May 1994 at an approximate cost of $2,000,000.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company's business, to which the Company is a party or of which any of their property is the subject, except for the rate case described on page 3 under SECURITIES AND RATE REGULATION - Rate Case.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted during the fourth quarter of 1993 to a vote of security holders of the Registrant, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation regarding the trading market for the Company's Common Shares, the range of selling prices for each quarterly period during the past two years with respect to the Common Shares, the approximate number of holders of shares of Common Shares as of December 31, 1993, the frequency and amount of dividends paid during the past two years with respect to the Common Shares and other matters is included under the captions \"Stock Statistics\" and \"Distribution of Shareholders\" on page 39 of the 1993 Annual Report, which information is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe data included on page 34 of the 1993 Annual Report under \"Selected Financial Data\" is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe discussion entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included in the 1993 Annual Report on pages 35 through 38 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements included in the 1993 Annual Report and listed in Item 14.1. of this Report are incorporated herein by reference from the 1993 Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item regarding nominees for Director of the Company is incorporated herein by reference to the Company's definitive proxy statement for its 1994 annual meeting of common stockholders filed with the Commission pursuant to Regulation 14A (the \"1994 Proxy Statement\").\nThe following table sets forth the current officers of IWC Resources Corporation and its principal subsidiary, Indianapolis Water Company, their ages, and (as presented below in parentheses) their positions during the past five years. There is no family relationship between any of the officers of the Company. All officers are elected for a term of one year.\nIWC RESOURCES CORPORATION\nName Age Position\nJames T. Morris 50 Chairman of the Board, Chief Executive Officer and President (President and Chief Operating Officer)\nJ. A. Rosenfeld 62 Executive Vice President (Senior Vice President and Treasurer; Financial Consultant)\nKenneth N. Giffin 50 Senior Vice President- Governmental Relations and Real Estate\nJohn M. Davis 42 Vice President, General Counsel and Secretary\nAlan R. Kimbell 62 Vice President-Marketing\nJames P. Lathrop 48 Controller\nJane G. Ryan 53 Assistant Secretary\nINDIANAPOLIS WATER COMPANY\nJames T. Morris 50 Chairman of the Board and Chief Executive Officer (President and Chief Operating Officer)\nJoseph R. Broyles 51 President and Chief Operating Officer (Executive Vice President; Senior Vice President-Operations)\nPaul J. Doane 71 Executive Vice President (Senior Vice President-Operations; Vice President-Operations)\nJ. A. Rosenfeld 62 Executive Vice President (Senior Vice President and Treasurer)\nKenneth N. Giffin 50 Senior Vice President-Governmental Relations (Senior Vice President- Human Resources and Corporate Relations; Vice President-Human Resources and Corporate Relations)\nJohn M. Davis 42 Vice President, General Counsel and Secretary\nRobert F. Miller 49 Vice President-Engineering (Principal Projects Engineer)\nDavid S. Probst 55 Vice President-Business Development (Vice President-Engineering Services; Vice President-Customer Service)\nTim K. Bumgardner 45 Vice President-Operations (Vice President-Production; Director of Purification)\nRonald H. Carrell 57 Vice President - Customer Service (Director of Customer Services; Director of Corporate Communications)\nMartha L. Wharton 64 Vice President-Customer Relations (Assistant Secretary)\nL. M. Williams 50 Vice President - Human Resources (Director of Human Resources and Industrial Relations)\nJames P. Lathrop 48 Assistant Treasurer\nJane G. Ryan 53 Assistant Secretary (Executive Secretary)\nAll of the above have been employed by the Company for more than five years except for J. A. Rosenfeld and John M. Davis. Mr. Rosenfeld has been employed since January, 1992 and was previously employed by Melvin Simon & Associates. Mr. Davis has been employed since June, 1993 and was previously employed by KPMG Peat Marwick.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information required by this Item regarding compensation of the Company's officers and directors is incorporated herein by reference to the Company's 1994 Proxy Statement. The Compensation Committee Report to Shareholders and Comparative Stock Performance sections of the Company's 1994 Proxy Statement shall not be deemed \"filed\" herewith.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) The Company knows of no person who is the beneficial owner of more than 5% of the Company's Common Stock. Information required by this item applicable to the Company's Redeemable Preferred Stock follows:\nTitle Name and Address Amount and Nature Percent of of of Beneficial of Class Beneficial Owner Ownership Class Redeemable Patrick J. Baker 17,204 shares 33-1\/3% Preferred 1913 W. 116th St. Stock Carmel, IN 46032\nDaniel S. Baker (1) 17,204 shares 33-1\/3% 7285 Waterview Pt. Noblesville, IN 46060\nDiana L. Sosbey 17,204 shares 33-1\/3% 8596 Twin Pt. Cir. Indianapolis, IN 46236\n(1) Mr. Daniel S. Baker is President of SM&P Conduit Co., Inc., a wholly owned subsidiary of the Company.\n(b) The information required by this Item regarding the number of shares of the Company's Common Stock, beneficially owned by the nominees for Director and the officers of the Company is incorporated herein by reference to the Company's 1994 Proxy Statement.\n(c) The Company knows of no arrangements the operation of which may at a subsequent date result in a change of control of the Company.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item regarding certain relationships and related transactions is incorporated herein by reference to the Company's 1994 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe documents listed below are filed as a part of this report except as otherwise indicated:\n1. Financial Statements. The following described consolidated financial statements found on the pages of the 1993 Annual Report indicated below are incorporated into Item 8 of this Report by reference.\nDescription of Financial Location in 1993 Statement Item Annual Report Independent Auditors' Report Page 33 Consolidated Balance Sheets, December 31, 1993 and 1992 Pages 18 and 19 Consolidated Statements of Shareholders' Equity, Years ended December 31, 1993, 1992 and 1991 Page 20 Consolidated Statements of Earnings, Years ended December 31, 1993, 1992 and 1991 Page 21 Consolidated Statements of Cash Flows, Years ended December 31, 1993, 1992 and 1991 Page 22 Notes to Consolidated Financial Statements, Years ended Pages 23 December 31, 1993, 1992 and 1991 through 33\n2. Financial Statement Schedules.\n(a) Independent Auditors' Report on Financial Statement Schedules\n(b) Supplemental Schedules for the Years ended December 31, 1993, 1992 and 1991\nThe supplementary schedules of short-term borrowings and supplementary income statement information required by Rule 12-10 and Rule 12-11, respectively, of Regulation S-X for 1993, 1992 and 1991 are as follows:\n1. Schedule IX Short-term Borrowings\n2. Schedule X Supplementary Income Statement Information\n(c) Other Financial Statement Schedules\nThe schedules of property, plant and equipment and accumulated depreciation as required by Rule 12-06 are omitted for 1993, 1992 and 1991 because neither total additions nor total retirements during these years exceeded 10% of the ending balances and the other information required by this rule is set forth in the consolidated financial statements or notes thereto. All other schedules for which provision is made in Regulation S-X have been omitted for the reason that they are not required, are not applicable, or the required information is set forth in the consolidated financial statements or notes thereto.\nIndependent Auditors' Report\nThe Board of Directors and Shareholders IWC Resources Corporation:\nUnder date of January 26, 1994, we reported on the consolidated balance sheets of IWC Resources Corporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules as listed in Item 14 of the Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in the notes to the consolidated financial statements, the Company changed its method of revenue recognition in 1991 and, effective January 1, 1993, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions.\nKPMG PEAT MARWICK Indianapolis, Indiana\nJanuary 26, 1994\nSchedule IX\nIWC Resources Corporation Short-term Borrowings Years Ended December 31, 1993, 1992 and 1991 (in thousands)\nDescription 1993 1992 1991\nShort-term Bank Borrowings:\nBalance at end of year $21,779 5,071 16,618 ====== ====== ======\nWeighted average interest rate 3.70% 3.12% 6.5% ====== ====== ======\nMaximum amount outstanding during year (1) $23,673 18,873 16,618 ====== ====== ======\nAverage amount outstanding during year (1) $15,257 15,735 10,787 ====== ====== ======\nWeighted average interest rate during the year (1) 3.21% 5.02% 7.42% ====== ====== ======\n(1) Calculated as determined using end of month amounts or rates during the year.\nSchedule X\nIWC Resources Corporation Supplementary Income Statement Information Years Ended December 31, 1993, 1992 and 1991 (in thousands)\nAccount Charges to Expense Description 1993 1992 1991\nMaintenance and repairs $3,768 $2,994 $3,176 ===== ===== =====\nThe other items required to be disclosed in this schedule, depreciation and property taxes, are omitted because they are included in the consolidated financial statements or notes thereto.\nOTHER MATTERS\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statement on Form S-8 No. 33-33021 (filed August 17, 1989):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned thereunto duly authorized.\nIWC RESOURCES CORPORATION Registrant\nDate March 25, 1994 J. A. Rosenfeld, Executive Vice President\nPursuant 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 and on the dates indicated.\nDate March 25, 1994 James T. Morris, Chairman of the Board, Chief Executive Officer and President and Director\nDate March 25, 1994 Robert B. McConnell, Chairman of the Executive Committee\nDate March 25, 1994 J. A. Rosenfeld, Executive Vice President (Principal Financial Officer)\nDate March 25, 1994 James P. Lathrop, Controller (Principal Accounting Officer)\nDate March 25, 1994 Joseph R. Broyles, President and Chief Operating Officer, Indianapolis Water Company and Director\nDate March 25, 1994 Joseph D. Barnette, Jr., Director\nDate March 25, 1994 Thomas W. Binford, Director\nDate March 25, 1994 Murvin S. Enders, Director\nDate March 25, 1994 Otto N. Frenzel III, Director\nDate March 25, 1994 Elizabeth Grube, Director\nDate March 25, 1994 J. B. King, Director\nDate March 25, 1994 J. George Mikelsons, Director\nDate March 25, 1994 Thomas M. Miller, Director\nDate March 25, 1994 Jack E. Reich, Director\nDate March 25, 1994 Fred E. Schlegel, Director\n3. Exhibits. The following exhibits are filed as part of this Report:\n3-A-1 Restated Articles of Incorporation of Registrant, as amended to date. The copy of this exhibit filed as Exhibit 3-A to Registrant's Registration Statement on Form S-8 effective August 17, 1989 \"Registration No. 33-30221,\" is incorporated by reference.\n3-B Bylaws of Registrant, as amended to date. The copy of this exhibit filed as Exhibit 3-B to Registrant's Registration Statement on Form S-8 effective August 17, 1989 \"Registration No. 33-30221,\" is incorporated by reference.\n4.1 Sixteenth Supplemental Indenture dated as of November 1, 1985, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A1 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, is incorporated herein by reference.\n4.2 Ninth Supplemental Indenture dated as of August 1, 1967. The copy of this exhibit filed as Exhibit 4-B5 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.3 Eleventh Supplemental Indenture dated as of December 1, 1971. The copy of this exhibit filed as Exhibit 4-B6 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.4 Seventeenth Supplemental Indenture dated as of March 1, 1989, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A9 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.5 Eighteenth Supplemental Indenture dated as of March 1, 1989, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A10 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.6 Nineteenth Supplemental Indenture dated as of June 1, 1989, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A9 to Registrant's Registration Statement on Form S-2 effective December 12, 1991 (Registration No. 33-43939), is incorporated herein by reference.\n4.7 Fourteenth Supplemental Indenture dated as of January 15, 1978, between the Fidelity Bank (formerly Fidelity-Philadelphia Trust Company) and IWC, including as Appendix A the \"Restatement of Principal Indenture of Indianapolis Water Company,\" which, except as otherwise specified, restates the granting clauses and all other sections contained in the First Mortgage dated July 1, 1936, between Fidelity-Philadelphia Trust Company and Registrant as amended by the Fourth, Fifth, Sixth, Eighth, Twelfth and Fourteenth Supplemental Indentures. A copy of this exhibit filed as Exhibit 4-B1 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.8 Twentieth Supplemental Indenture dated as of December 1, 1992, between Fidelity Bank, National Association, and IWC. The copy of this Exhibit filed as Exhibit 4-A9 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.9 Twenty-First Supplemental Indenture dated as of December 1, 1992, between Fidelity Bank, National Association, and IWC. The copy of this Exhibit filed as Exhibit 4-A10 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.10 Rights Agreement, dated as of February 9, 1988, between IWC Resources Corporation and Bank One, Indianapolis, NA (as Rights Agent), which includes the Form of Certificate of Designations of Series A Junior Participating Preferred Stock as Exhibit A, the Form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C. The copy of this exhibit filed as Exhibit 4 to the Registrant's Current Report on Form 8-K dated February 9, 1988, is incorporated by reference.\n4.11 Indenture of Trust dated as of March 1, 1989, between IWC, City of Indianapolis, Indiana, and Merchants National Bank & Trust Company of Indianapolis, as Trustee. The copy of this exhibit filed as Exhibit 10-F to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.12 Indenture of Trust dated as of March 1, 1989, between IWC, Town of Fishers, Indiana, and Merchants National Bank & Trust Company of Indianapolis, as Trustee. The copy of this exhibit filed as Exhibit 10-G to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.13 Indenture of Trust dated as of December 1, 1992, between City of Indianapolis, Indiana, and IWC to National City Bank, Indiana, as Trustee. The copy of this Exhibit filed as Exhibit 10-J to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.14 Indenture of Trust, City of Indianapolis, Indiana, and Indianapolis Water Company to National City Bank, Indiana, as Trustee, dated as of April 1, 1993.\n4.15 Twenty-Second Supplemental Indenture dated as of April 1, 1993, between Indianapolis Water Company and Fidelity Bank, National Association.\n10.1 Agreement dated October 18, 1971, between IWC and the Department of Public Works of the City of Indianapolis, Indiana, relating to the purchase of water at Eagle Creek Reservoir. The copy of this exhibit filed as Exhibit 5 to IWC's Statement (No. 2-55201), effective January 14, 1976, is incorporated herein by reference.\n*10.2 The description of \"split dollar\" life insurance policies owned by IWC with respect to certain officers of Registrant is incorporated hereby by reference to the Company's 1988 Proxy Statement.\n*10.3 Form of Executive Supplemental Benefits Plan of IWC. The copy of this exhibit filed on\nExhibit 10-D to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, is incorporated herein by reference.\n10.4 Loan Agreement dated as of March 1, 1989, between IWC and the City of Indianapolis, Indiana. The copy of this exhibit filed as Exhibit 10-D to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.5 Loan Agreement dated as of March 1, 1989, between IWC and Town of Fishers, Indiana. The copy of this exhibit filed as Exhibit 10-E to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.6 Guaranty Agreement dated as of March 1, 1989, between Registrant and Merchants National Bank & Trust Company of Indianapolis re: City of Indianapolis, Indiana Industrial Development Bonds. The copy of this exhibit filed as Exhibit 10-H to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.7 Guaranty Agreement dated as of March 1, 1989, between Registrant and Merchants National Bank & Trust Company of Indianapolis re: Town of Fishers, Indiana Industrial Development Bonds. The copy of this exhibit filed as Exhibit 10-I to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.8 Loan Agreement dated as of December 1, 1992, between IWC and City of Indianapolis, Indiana. The copy of this exhibit filed as Exhibit 10-K to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n10.9 Guaranty Agreement dated as of December 1, 1992, between Resources and National City Bank, Indiana, as Trustee. The copy of this exhibit filed as Exhibit 10-L to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n10.10 Note Agreement dated as of March 1, 1994, between Registrant and American United Life Insurance Company.\n10.11 Loan Agreement dated as of April 1, 1993, between Indianapolis Water Company and City of Indianapolis.\n10.12 Guaranty Agreement between Registrant and National City Bank, Indiana, as Trustee, dated as of April 1, 1993.\n10.13 Agreement for the Operation and Maintenance of the City of Indianapolis, Indiana, Advanced Wastewater Treatment Facilities dated as of December 20, 1993, among the City of Indianapolis, White River Environmental Partnership, the Registrant and certain other parties.\n10.14 White River Environmental Partnership Agreement between IWC Services, Inc., JMM White River Corporation and LAH White River Corporation, dated as of August 20, 1993.\n10.15 Plan and Agreement of Merger among Registrant, Resources Acquisition Corp., S. M. & P. Conduit Co., Inc., and its shareholders dated as of June 14, 1993.\n10.16 Executive Employment Agreement between Registrant and James T. Morris, dated as of December 31, 1993 (substantially similar agreements in favor of J.A. Rosenfeld, Joseph R. Broyles and Kenneth N. Giffin have been omitted pursuant to Instruction 2 to Item 601 of Regulation S-K).\n13 Registrant's Annual Report to Stockholders for the year ended December 31, 1993. This exhibit, except for the portions thereof that have expressly been incorporated by reference into this Report, is furnished for the information of the Commission and shall not be deemed \"filed\" as part hereof.\n21 Subsidiaries.\n23 Consent of Independent Certified Public Accounts.\n4. Reports on Form 8-K. No reports on Form 8-K were filed during the three months ended December 31, 1992.\n_______ * This exhibit relates to executive compensation or benefit plans.\nEXHIBIT INDEX\nThe following Exhibits are filed as part of this Report and not incorporated by reference from another document:\n3A-1 Restated Articles of Incorporation of Registrant, as amended to date.\n4.14 Indenture of Trust, City of Indianapolis, Indiana, and Indianapolis Water Company to National City Bank, Indiana, as Trustee, dated as of April 1, 1993.\n4.15 Twenty-Second Supplemental Indenture dated as of April 1, 1993, between Indianapolis Water Company and Fidelity Bank, National Association.\n10.10 Note Agreement dated as of March 1, 1994, between Registrant and American United Life Insurance Company.\n10.11 Loan Agreement dated as of April 1, 1993, between Indianapolis Water Company and City of Indianapolis.\n10.12 Guaranty Agreement between Registrant and National City Bank, Indiana, as Trustee, dated as of April 1, 1993.\n10.13 Agreement for the Operation and Maintenance of the City of Indianapolis, Indiana, Advanced Wastewater Treatment Facilities dated as of December 20, 1993, among the City of Indianapolis, White River Environmental Partnership, the Registrant and certain other parties.\n10.14 White River Environmental Partnership Agreement between IWC Services, Inc., JMM White River Corporation and LAH White River Corporation, dated as of August 20, 1993.\n10.15 Plan and Agreement of Merger among Registrant, Resources Acquisition Corp., S. M. & P. Conduit Co., Inc., and its shareholders dated as of June 14, 1993.\n10.16 Executive Employment Agreement between Registrant and James T. Morris, dated as of December 31, 1993 (substantially similar agreements in favor of J.A. Rosenfeld, Joseph R. Broyles and Kenneth N. Giffin have been omitted pursuant to Instruction 2 to Item 601 of Regulation S-K).\n13 Registrant's Annual Report to Stockholders for the year ended December 31, 1993. This exhibit, except for the portions thereof that have expressly been incorporated by reference into this Report, is furnished for the information of the Commission and shall not be deemed \"filed\" as part hereof.\n21 Subsidiaries.\n23 Consent of Independent Certified Public Accounts.\nSee Item 14 of this Report for a list of other Exhibits that have been filed as part of this Report through incorporation by reference from other documents.","section_15":""}
{"filename":"101265_1993.txt","cik":"101265","year":"1993","section_1":"Item 1. Business - \"Competition\" and \"Arrangements with Other Utilities\".\nShown below is a summary of the Company's sources and uses of electricity for 1993.\nTRANSMISSION AND DISTRIBUTION PLANT\nThe transmission lines of the Company consist of approximately 95 circuit miles of overhead lines and approximately 17 circuit miles of underground lines, all operated at 345 KV or 115 KV and located within or immediately adjacent to the territory served by the Company. These transmission lines interconnect the Company's English, Bridgeport Harbor and New Haven Harbor generating stations and are part of the New England transmission grid through connections with the transmission lines of The Connecticut Light and Power Company. A major portion of the Company's transmission lines is constructed on a railroad right-of-way pursuant to a Transmission Line Agreement that expires in May 2000.\nThe Company owns and operates 23 bulk electric supply substations with a capacity of 2,547,000 KVA and 50 distribution substations with a capacity of 288,750 KVA. The Company has 3,113 pole-line miles of overhead distribution lines and 130 conduit-bank miles of underground distribution lines.\n- 19 -\nSee \"Capital Expenditure Program\" concerning the estimated cost of additions to the Company's transmission and distribution facilities.\nSEABROOK\nThe Company has a 17.5% share in Seabrook Unit 1, a 1,150 megawatt nuclear generating unit located in Seabrook, New Hampshire. Eleven other New England electric utilities have ownership shares in Unit 1.\nAfter experiencing increasing financial stress beginning in May 1987, Public Service Company of New Hampshire (PSNH), which held the largest ownership share (35.6%) in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code in January of 1988. Under this statute, PSNH continued its operations while seeking a financial reorganization. A reorganization plan proposed by Northeast Utilities (NU) was confirmed by the bankruptcy court in April of 1990 and, on May 16, 1991, PSNH completed the financing required for payment of its pre-bankruptcy secured and unsecured debt under the first stage of the reorganization plan and emerged from bankruptcy. On May 19, 1992, the NRC issued the final regulatory approval necessary for the second stage of the NU reorganization plan, under which PSNH would be acquired by NU; and on June 5, 1992, this acquisition was completed. As part of the transaction, PSNH's ownership share of Seabrook Unit 1 was transferred to a wholly-owned subsidiary of NU. Two previous regulatory approvals of the NU reorganization plan for PSNH, by the Federal Energy Regulatory Commission (FERC) and the Securities and Exchange Commission (SEC), continue to be challenged in court proceedings, and the Company is unable to predict the outcome of these proceedings.\nOn February 28, 1991, EUA Power Corporation (EUA Power), the holder of a 12.1% ownership share in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code. EUA Power, a wholly-owned subsidiary of Eastern Utilities Associates (EUA), was organized solely for the purpose of acquiring an ownership share in Seabrook and selling in the wholesale market its share of the electric power produced by Seabrook. EUA Power commenced this bankruptcy proceeding because the cash generated by its sales of power at current market prices was insufficient to pay its obligations on its outstanding debt. Subsequently, EUA Power's name was changed to Great Bay Power Corporation (Great Bay). The official committee of Great Bay's bondholders (Bondholders Committee) has proposed, and the bankruptcy court has confirmed, a reorganization plan for Great Bay, under which substantially all of the equity ownership of Great Bay would pass to its bondholders. On February 2, 1994, the Bondholders Committee accepted a financing proposal that would inject $35 million of new ownership equity into Great Bay. The bankruptcy court must approve this structure before the Great Bay reorganization plan becomes effective. Further approvals are also required from the NRC, FERC and the New Hampshire Public Utilities Commission. The bankruptcy court has approved an agreement among Great Bay, the Bondholders Committee, UI and The Connecticut Light and Power Company (CL&P), under which up to $20 million in advance payments against their respective future monthly Seabrook payment obligations will be made available between UI and CL&P as needed until the reorganization plan becomes effective. UI's share of funding obligations under this agreement totals $8 million. As of December 31, 1993, $5.5 million had been advanced by UI under this agreement. At January 31, 1994, $602,000 of the Company's advances remained outstanding. This agreement can be terminated by UI and CL&P upon thirty days notice or upon failure of the reorganization process to achieve certain milestones by specified dates. UI is unable to predict what impact, if any, failure of the reorganization plan to become effective will have on the operating license for Seabrook Unit 1, or what other actions UI and the other joint owners of the unit may be required to take in response to developments in this bankruptcy proceeding as it may affect Seabrook.\nNuclear generating units are subject to the licensing requirements of the Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954, as amended, and a variety of other state and federal requirements. Although Seabrook Unit 1 has been issued a 40-year operating license, NRC proceedings and investigations prompted by inquiries from Congressmen and by NRC licensing board consideration of technical contentions may arise and continue for an indefinite period of time in the future. See \"Nuclear Generation\".\n- 20 -\nCAPITAL EXPENDITURE PROGRAM\nThe Company's 1994-1998 capital expenditure program, excluding allowance for funds used during construction (AFUDC) and its effect on certain capital related items, is presently budgeted as follows:\n- 21 -\nNUCLEAR GENERATION\nGeneral\nUI holds ownership and leasehold interests in Seabrook Unit 1 (17.5%) and Millstone Unit 3 (3.685%). UI also owns 9.5% of the common stock of Connecticut Yankee and is entitled to 9.5% of the generating capability of its nuclear generating unit. Each of these nuclear generating units is subject to the licensing requirements and jurisdiction of the NRC under the Atomic Energy Act of 1954, as amended, and to a variety of other state and federal requirements.\nThe NRC regularly conducts generic reviews of numerous technical issues, ranging from seismic design to education and fitness for duty requirements for licensed plant operators. The outcome of reviews that are currently pending, and the ways in which the nuclear generating units in which UI has interests may be affected by these reviews, cannot be determined; and the cost of complying with any new requirements that might result from the reviews cannot be estimated. However, such costs could be substantial.\nAdditional capital expenditures and increased operating costs for the nuclear generating units in which UI has interests may result from modifications of these facilities or their operating procedures required by the NRC, or from actions taken by other joint owners or companies having entitlements in the units. Some equipment modifications have required and may in the future require shutdowns or deratings of the generating units that would not otherwise be necessary and that result in additional costs for replacement power. The amounts of additional capital expenditures, increased operating costs and replacement power costs cannot now be predicted, but they have been and may in the future be substantial.\nPublic controversy concerning nuclear power could also adversely affect the nuclear generating units in which UI has interests. Proposals to force the premature shutdown of nuclear plants in other New England states have received serious attention, and the licensing of Seabrook Unit 1 was a regional issue. The continuing controversy can be expected to increase the costs of operating the nuclear generating units in which UI has interests; and it is possible that one or more of the units could be shut down prematurely.\nInsurance Requirements\nThe Price-Anderson Act, currently extended through August 1, 2002, limits public liability resulting from a single incident at a nuclear power plant. The first $200 million of liability coverage is provided by purchasing the maximum amount of commercially available insurance. Additional liability coverage will be provided by an assessment of up to $75.5 million per incident, levied on each of the nuclear units licensed to operate in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. In addition, if the sum of all public liability claims and legal costs resulting from any nuclear incident exceeds the maximum amount of financial protection, each reactor operator can be assessed an additional 5% of $75.5 million, or $3.775 million. The maximum assessment is adjusted at least every five years to reflect the impact of inflation. Based on its interests in nuclear generating units, the Company estimates its maximum liability would be $20.3 million per incident. However, assessment would be limited to $3.1 million per incident, per year. With respect to each of the operating nuclear generating units in which the Company has an interest, the Company will be obligated to pay its ownership and\/or leasehold share of any statutory assessment resulting from a nuclear incident at any nuclear generating unit.\nThe NRC requires nuclear generating units to obtain property insurance coverage in a minimum amount of $1.06 billion and to establish a system of prioritized use of the insurance proceeds in the event of a nuclear incident. The system requires that the first $1.06 billion of insurance proceeds be used to stabilize the nuclear reactor to prevent any significant risk to public health and safety and then for decontamination and cleanup operations. Only following completion of these tasks would the balance, if any, of the segregated insurance proceeds become available to the unit's owners. For each of the nuclear generating units in which the Company has an interest, the Company is required to pay its ownership and\/or leasehold share of the cost of purchasing such insurance.\n- 22-\nWaste Disposal and Decommissioning\nCosts associated with nuclear plant operations include amounts for disposal of nuclear wastes, including spent fuel, and for the ultimate decommissioning of the plants. Under the Nuclear Waste Policy Act of 1982, the federal Department of Energy (DOE) is required to design, license, construct and operate a permanent repository for high level radioactive wastes and spent nuclear fuel. The Act requires the DOE to provide, beginning in 1998, for the disposal of spent nuclear fuel and high level radioactive waste from commercial nuclear plants through contracts with the owners and generators of such waste; and the DOE has established disposal fees that are being paid to the federal government by electric utilities owning or operating nuclear generating units. In return for payment of the prescribed fees, the federal government is to take title to and dispose of the utilities' high level wastes and spent nuclear fuel beginning no later than 1998. However, the DOE has announced that its first high level waste repository will not be in operation earlier than 2010, notwithstanding the DOE's statutory and contractual responsibility to begin disposal of high-level radioactive waste and spent fuel beginning not later than January 31, 1998.\nUntil the federal government begins receiving such materials in accordance with the Nuclear Waste Policy Act, operating nuclear generating units will need to retain high level wastes and spent fuel on-site or make other provisions for their storage. Storage facilities for Millstone Unit 3 are expected to be adequate for the projected life of the unit. Storage facilities for the Connecticut Yankee unit are expected to be adequate through the mid-1990s. Storage facilities for Seabrook Unit 1 are expected to be adequate until at least 2010. Fuel consolidation and compaction technologies are being developed and are expected to provide adequate storage capability for the projected lives of the latter two units. In addition, other licensed technologies, such as dry storage casks, can accommodate spent fuel storage requirements.\nDisposal costs for low-level radioactive wastes (LLW) that result from normal operation of nuclear generating units have increased significantly in recent years and are expected to continue to rise. The cost increases are functions of increased packaging and transportation costs and higher fees and surcharges charged by the disposal facilities. Pursuant to the Low-Level Radioactive Waste Policy Act of 1980, each state was responsible for providing disposal facilities for LLW generated within the state and was authorized to join with other states into regional compacts to jointly fulfill their responsibilities. Pursuant to the Low-Level Radioactive Waste Policy Amendments Act of 1985, each state in which a currently operating disposal facility is located (South Carolina, Nevada and Washington) is allowed to impose volume limits and a surcharge on shipments of LLW from states that are not members of the compact in the region in which the facility is located. On June 19, 1992, the United States Supreme Court issued a decision upholding certain parts of the Low-Level Radioactive Waste Policy Amendments Act of 1985, but invalidating a key provision of that law requiring each state to take title to LLW generated within that state if the state fails to meet federally- mandated deadlines for siting LLW disposal facilities. The decision has resulted in uncertainty about states' continuing roles in siting LLW disposal facilities and may result in increased LLW disposal costs and the need for longer interim LLW storage before a permanent solution is developed.\nThe Connecticut Hazardous Waste Management Service (the Service), a state quasi-public corporation, was charged with coordinating the establishment of a facility for disposal of LLW originating in Connecticut. In June 1991, the Service announced that it had selected three potential sites in north-central Connecticut for further study. The Service's announcement provoked intense controversy in the affected municipalities and resulted in legislative action to stop the selection process. On February 1, 1993, the Service presented the legislature with a new site selection plan under which communities are urged to volunteer a site for a facility in return for financial and other incentives. The volunteer process is being continued in 1994. The Service's activities in this regard are funded by assessments on Connecticut's LLW generators. Due to a change in the volunteer process, there was no assessment for the 1993-1994 fiscal year and the state projects no assessment for the 1994-1995 and 1995-1996 fiscal years.\nAdditional LLW storage capacity has been or can be constructed or acquired at the Millstone and Connecticut Yankee sites to provide for temporary storage of LLW should that become necessary. Connecticut\n- 23 -\nLLW can be managed by volume reduction, storage or shipment at least through 1999. The Company cannot predict whether and when a disposal site will be designated in Connecticut.\nThe State of New Hampshire has not met deadlines for compliance with the Low-Level Radioactive Waste Policy Act, and Seabrook Unit 1 has been denied access to existing disposal facilities. Therefore, LLW generated by Seabrook Unit 1 is being stored on- site. The Seabrook storage facility currently has capacity to store approximately five years' accumulation of waste generated by Seabrook, and the plant operator plans to expand its storage capacity as necessary.\nNRC licensing requirements and restrictions are also applicable to the decommissioning of nuclear generating units at the end of their service lives, and the NRC has adopted comprehensive regulations concerning decommissioning planning, timing, funding and environmental reviews. UI and the other owners of the nuclear generating units in which UI has interests estimate decommissioning costs for the units and attempt to recover sufficient amounts through their allowed electric rates to cover expected decommissioning costs. Changes in NRC requirements or technology can increase estimated decommissioning costs, and UI's customers in future years may experience higher electric rates to offset the effects of any insufficient rate recovery in prior years.\nNew Hampshire has enacted a law requiring the creation of a government-managed fund to finance the decommissioning of nuclear generating units in that state. The New Hampshire Nuclear Decommissioning Financing Committee (NDFC) established $345 million (in 1993 dollars) as the decommissioning cost estimate for Seabrook Unit 1. This estimate premises the prompt removal and dismantling of the Unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments are being made to the state-managed decommissioning trust fund. UI's share of the decommissioning payments made during 1993 was $1.3 million. UI's share of the fund at December 31, 1993 was approximately $3.7 million.\nConnecticut has enacted a law requiring the operators of nuclear generating units to file periodically with the DPUC their plans for financing the decommissioning of the units in that state. Current decommissioning cost estimates for Millstone Unit 3 and Connecticut Yankee are $421 million (in 1994 dollars) and $324 million (in 1994 dollars), respectively. These estimates premise the prompt removal and dismantling of each unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments, based on these cost estimates, are being made to decommissioning trust funds managed by Northeast Utilities. UI's share of the Millstone Unit 3 decommissioning payments made during 1993 was $328,000. UI's share of the fund at December 31, 1993 was approximately $1.9 million. For the Company's 9.5% equity ownership in Connecticut Yankee, decommissioning costs of $1.3 million were funded by UI during 1993, and UI's share of the fund at December 31, 1993 was $9.5 million.\nItem 3. Legal Proceedings.\nSee Item 2.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 1993.\n- 25 -\nEXECUTIVE OFFICERS OF THE COMPANY\nThe names and ages of all executive officers of the Company and all such persons chosen to become executive officers, all positions and offices with the Company held by each such person, and the period during which he or she has served as an officer in the office indicated, are as follows:\n- 26 -\nThere is no family relationship between any director, executive officer, or person nominated or chosen to become a director or executive officer of the Company. All executive officers of the Company hold office during the pleasure of the Company's Board of Directors and Messrs. Grossi, Fiscus and Crowe have each entered into an employment agreement with the Company. There is no arrangement or understanding between any executive officer of the Company and any other person pursuant to which such officer was selected as an officer.\nA brief account of the business experience during the past five years of each executive officer of the Company is as follows:\nRichard J. Grossi. Mr. Grossi served as President and Chief Operating Officer during the period January 1, 1989 to May 1, 1991. He has served as Chairman of the Board of Directors and Chief Executive Officer since May 1, 1991.\nRobert L. Fiscus. Mr. Fiscus served as Executive Vice President and Chief Financial Officer of the Company during the period January 1, 1989 to May 1, 1991. He has served as President and Chief Financial Officer since May 1, 1991.\nJames F. Crowe. Mr. Crowe served as Senior Vice President-Marketing of the Company during the period January 1, 1989 to May 1, 1992, and as Executive Vice President from May 1, 1992 to January 1, 1994. He has served as Executive Vice President and Chief Customer Officer since January 1, 1994.\nWalter E. Barker. Mr. Barker served as Superintendent of Transmission and Distribution of the Company during the period January 1, 1989 to July 23, 1990, and as Vice President-Transmission and Distribution Engineering and Operations from July 23, 1990 to January 1, 1994. He has served as Vice President-Transmission and Distribution since January 1, 1994.\nRita L. Bowlby. Ms. Bowlby has served as Vice President- Corporate Affairs since February 1, 1993. Prior to joining the Company, during the period from January 1, 1989 to February 1, 1993, she served as President of Bowlby & Associates, a business- to-business communications agency in Farmington, Connecticut.\nStephen F. Goldschmidt. Mr. Goldschmidt served as Vice President-Planning from January 1, 1989 to January 1, 1994. He has served as Vice President-Information Resources since January 1, 1994.\nAlbert N. Henricksen. Mr. Henricksen served as Vice President-Engineering of the Company during the period January 1, 1989 to July 23, 1990, and as Vice President-Human and Environmental Resources from July 23, 1990 to January 1, 1994. He has served as Vice President-Administration since January 1, 1994.\nDavid W. Hoskinson. Mr. Hoskinson served as Senior Vice President-Operations of the Company during the period January 1, 1989 to July 23, 1990, and as Senior Vice President-Generation Engineering and Operations from July 23, 1990 to January 1, 1994. He has served as Vice President-Generation since January 1, 1994.\nRobert H. Hyde. Mr. Hyde has served as Vice President-Customer Services of the Company since January 1, 1989.\nE. Jon Majkowski. Mr. Majkowski served as Vice President-Public Affairs of the Company during the period January 1, 1989 to May 1, 1992. He has served as Vice President since May 1, 1992.\nAnthony J. Vallillo. Mr. Vallillo served as Director of Sales and Market Development of the Company during the period January 1, 1989 to December 1, 1990, and as Director of Marketing from December 1, 1990 to June 1, 1992. He has served as Vice President-Marketing since June 1, 1992.\nJames L. Benjamin. Mr. Benjamin has served as Controller of the Company since January 1, 1989.\n- 27 -\nKurt D. Mohlman. Mr. Mohlman served as Director of Financial Planning during the period January 1, 1989 to September 1, 1990 and as Director of Financial Planning and Investor Relations from September 1, 1990 to January 1, 1994. He has served as Treasurer and Secretary of the Company since January 1, 1994.\nCharles J. Pepe. Mr. Pepe served as Director of Financing during the period January 1, 1989 to January 1, 1994. He has served as Assistant Treasurer and Assistant Secretary of the Company since January 1, 1994.\n- 28 -\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Equity and Related Stockholder Matters.\nUI's Common Stock is traded on the New York Stock Exchange, where the high and low sale prices during 1993 and 1992 were as follows:\nUI has paid quarterly dividends on its Common Stock since 1900. The quarterly dividends declared in 1992 and 1993 were at a rate of 64 cents per share and 66 1\/2 cents per share, respectively.\nThe indenture under which the Company's Medium-Term Notes and Notes are issued places limitations on the payment of cash dividends on common stock and on the purchase or redemption of common stock. Retained earnings in the amount of $82.6 million were free from such limitations at December 31, 1993.\nAs of January 31, 1994, there were 21,919 Common Stock shareowners of record.\n- 29 -\n- 30 -\n- 31 -\n- 32 -\n- 33 -\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nMAJOR INFLUENCES ON FINANCIAL CONDITION\nThe Company's financial condition should continue to improve as a result of the December 16, 1992 rate decision by the DPUC. The DPUC decision granted levelized rate increases of 2.66% ($15.8 million) in 1993 and 2.66% (an additional $17.3 million) in 1994.\nHowever, the Company's financial condition will continue to be dependent on the level of retail and wholesale sales. The two primary factors that affect sales volume are economic conditions and weather. The regional recession has restricted retail sales growth and been largely responsible for a weak wholesale sales market during the past two years. Sales increases due to economic recovery would help to increase the Company's earnings.\nAnother major factor affecting the Company's financial condition will be the Company's ability to control expenses. A significant reduction in interest expense has been achieved since 1989, and additional savings of $10 million are expected in 1994 due to debt refinancing. Since 1990, annual growth in total operation and maintenance expense, excluding one-time items and cogeneration capacity purchases, has averaged approximately 2.7%, and the Company hopes to restrict future increases to less than the rate of inflation.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's capital requirements are presently projected as follows:\nThe Company presently estimates that its cash on hand and temporary cash investments at the beginning of 1994, totaling $48.2 million, and its projected net cash provided by operations, less dividends, of $102 million, less capital expenditures of $73.4 million, will be insufficient to fund the Company's 1994 requirements for long-term debt maturities and mandatory redemptions and repayments, amounting to $113.3 million, by $36 million. The Company currently anticipates that its projected net cash provided by operations, less dividends and capital expenditures, for 1995 will be insufficient to fund the Company's 1995 requirements for long-term debt maturities and mandatory redemptions and repayments, by approximately $138 million. The Company currently anticipates that its projected net cash provided by operations, less dividends and capital expenditures, for 1996 through 1998 will be insufficient to fund the Company's requirements for long-term debt maturities and mandatory redemptions and repayments in the years 1996 through 1998, in amounts that cannot now be predicted accurately, but which may be substantial in the aggregate, depending on the levels of the Company's sales, wholesale and retail rates, operation and maintenance costs and taxes. All of the Company's capital requirements that exceed available net cash will have to be provided by external financing; and the Company has no commitment to provide such financing from any source of funds. The Company expects to be able to satisfy its external financing needs by issuing common stock and additional short-term and long-term debt, although the continued availability of these methods of financing will be dependent on many factors, including conditions in the securities markets, economic conditions, and the level of the Company's income and cash flow.\n- 34 -\nAt December 31, 1993, the Company had $48.2 million of cash and temporary cash investments, an increase of $37.1 million from the balance at December 31, 1992. The components of this increase, which are detailed in the Consolidated Statement of Cash Flows, are summarized as follows:\nThe Company has a revolving credit agreement with a group of banks, which currently extends to January 19, 1995. The borrowing limit of this facility is $75 million. The facility permits the Company to borrow funds at a fluctuating interest rate determined by the prime lending market in New York, and also permits the Company to borrow money for fixed periods of time specified by the Company at fixed interest rates determined by the Eurodollar interbank market in London, by the certificate of deposit market in New York, or by bidding, at the Company's option. If a material adverse change in the business, operations, affairs, assets or condition, financial or otherwise, or prospects of the Company and its subsidiaries, on a consolidated basis, should occur, the banks may decline to lend additional money to the Company under this revolving credit agreement, although borrowings outstanding at the time of such an occurrence would not then become due and payable. As of December 31, 1993, the Company had no short-term borrowings outstanding under this facility.\nThe Company's long-term debt instruments do not limit the amount of short-term debt that the Company may issue. The Company's revolving credit agreement described in the previous paragraph requires it to maintain an available earnings\/interest charges ratio of not less than 1.5:1.0 for each 12-month period ending on the last day of each calendar quarter.\nThe Company had a $50 million term loan facility with a group of banks during 1993. Under this agreement, the Company chose an interest rate from among three alternatives: (i) a fluctuating interest rate determined by the prime lending market in New York; (ii) a fixed interest rate determined by the Eurodollar interbank market in London; and (iii) a fixed interest rate determined by the certificate of deposit market in New York. On February 1, 1993, the Company borrowed $50 million from this group of banks, using the proceeds to repay short-term borrowings and other current obligations. On December 3, 1993, the Company repaid the $50 million borrowing and terminated the agreement.\nThe Company had a term loan agreement with PruLease, Inc. (PruLease) that expired on December 1, 1993. This agreement was executed on December 31, 1992, when the Company borrowed $49.1 million from PruLease and purchased all the nuclear fuel that was owned by PruLease and leased to the Company on that date. This\n- 35 -\nloan, which was collateralized by a first lien on the Company's ownership interest in the nuclear fuel for Seabrook Unit 1, was repaid in full at maturity.\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\nUI has four wholly-owned subsidiaries. Bridgeport Electric Company, a single-purpose corporation, owns and leases to UI a generating unit at Bridgeport Harbor Station. Research Center, Inc. (RCI) has been formed to participate in the development of one or more regulated power production ventures, including possible participation in arrangements for the future development of independent power production and cogeneration facilities. United Energy International, Inc. (UEI) has been formed to facilitate participation in a proposed joint venture relating to power production plants abroad. United Resources, Inc. (URI) serves as the parent corporation for several unregulated businesses, each of which is incorporated separately to participate in business ventures that will complement and enhance UI's electric utility business and serve the interests of the Company and its shareholders and customers.\nFour wholly-owned subsidiaries of URI have been incorporated. Souwestcon Properties, Inc. is participating as a 25% partner in the ownership of a medical hotel building in New Haven. A second wholly-owned subsidiary of URI is Thermal Energies, Inc., which is participating in the development of district heating and cooling water facilities in the downtown New Haven area, including the energy center for an office tower and participation as a 37% partner in the energy center for a new city hall and office tower complex. A third URI subsidiary, Precision Power, Inc., provides power-related equipment and services to the owners of commercial buildings and industrial facilities. A fourth URI subsidiary, American Payment Systems, Inc., manages agents and equipment for electronic data processing of bill payments made by customers of utilities, including UI, at neighborhood businesses. In addition to these subsidiaries, URI also has an 82% ownership interest in Ventana Corporation (Ventana), which offers energy conservation engineering and project management services to governmental and private institutions. In September 1993, URI recorded a $1.2 million after-tax write off of outstanding debt owed to URI by Ventana, which represented the difference between the amount owed to URI by Ventana and the value of an additional equity interest in Ventana received by URI in November 1993. This additional equity interest in Ventana was received in exchange for the forgiveness of debt owed to URI by Ventana.\nThe Board of Directors of the Company has authorized the investment of a maximum of $13.5 million, in the aggregate, of the Company's assets in all of URI's ventures, UEI and RCI, and, at December 31, 1993, approximately $10.6 million had been so invested.\nRESULTS OF OPERATIONS\n1993 vs. 1992 - -------------\nEarnings for the year 1993 were $36.2 million, or $2.57 per share, down $16.3 million, or $1.19 per share, from 1992. This decrease reflects a one-time reorganizational charge of approximately $7.8 million after-tax, or $.56 per share, and the non-recurrence of one-time gains of $.59 per share in 1992. Earnings per share for 1993, excluding one-time items and accounting changes, decreased by $.04 per share, to $3.13 per share from $3.17 per share for 1992.\n- 36 -\nSales margin increased by $10.3 million for the year. Retail revenues increased $36.6 million; $20.7 million from a recent rate decision ($12.1 million from rate changes and $13.2 million for the fold-in to base rates of the 1992 sales adjustment revenues, partly offset by the pass through to customers of expense credits of $4.6 million), and $15.9 million from increased retail sales. Retail sales increased by 2.7%, mostly due to a return to more normal summer weather.\nThe retail revenue increases were offset by anticipated reductions of $21 million from the sales adjustment provision and $13.7 million in wholesale capacity revenues. Other operating revenues decreased by $0.3 million. Reductions in wholesale energy revenues of $15.8 million were directly offset by reductions in energy expense.\nOther factors affecting sales margin were lower retail fuel expense, increasing margin by $9.4 million, and higher revenue related taxes, decreasing margin by $0.6 million.\nOther operation and maintenance expenses, including purchased capacity charges, increased by $10.2 million, or 4.5%, in 1993 relative to 1992. Major generating station overhauls and unscheduled repairs accounted for $5.2 million of this increase. Employment costs increased by $4.0 million, most of which resulted from the adoption of a liability for postretirement benefits other than pensions that the implementation of Statement of Financial Accounting Standards (SFAS) No. 106 requires to be accrued over employees' careers. Purchased capacity charges (cogeneration and Connecticut Yankee power purchases) for 1993 increased by $4.0 million, transmission costs increased by $2.4 million; but other nuclear operation and maintenance expenses decreased by $4.0 million.\nOther operating expenses, including income taxes but excluding a 1993 fourth quarter one-time reorganization charge, decreased by $20.3 million in 1993 from 1992, as the effect of accounting treatments ordered in recent rate decisions for recovery of canceled plant, the flow-through to income of certain income tax benefits and lower property taxes more than offset increases in depreciation expense.\nOther income declined by $23 million in 1993 from 1992, $9.4 million of which was attributable to the absence of net one-time gains realized in 1992. The remainder was due primarily due to an expected decline in deferred revenue and income tax benefits associated with the DPUC's 1992 rate decision, offset, in part, by lower interest charges of $9.3 million. \"Net\" interest margin (interest income less interest expense) improved by $6.6 million in 1993 over 1992.\n1992 vs. 1991 - -------------\nEarnings for 1992 were $52.4 million, or $3.76 per share, up $1.4 million, or $.09 per share, over 1991. Earnings per share for 1992, excluding one-time items and accounting changes, increased by $.27, to $3.17 from $2.90 per share for 1991. Non-recurring earnings declined to a level of $.59 per share in 1992 from $.77 per share in 1991.\nOperating revenues in 1992, exclusive of retail and wholesale fuel recovery revenue, were up $4.3 million over 1991 levels, adding $.18 per share after taxes. Increased rates provided only $11 million of an expected annual $15 million revenue increase, because commercial and industrial customers shifted into lower priced time-of-use rates. An additional $6 million of revenue was accrued under the terms of the sales adjustment provisions of the Company's 1990 rate decision by the Department of Public Utility Control (DPUC). Retail sales volume declined 1.6% from the prior year, reducing retail revenues by $10.6 million and sales margin (revenue minus fuel expense and revenue-based taxes) by $7.4 million. Most of this decline reflected the cool, wet weather for the summer of 1992. On a weather-adjusted basis, retail sales were about even with 1991. Wholesale capacity sales declined by $2.1 million for the year, reflecting the end of a major contract in October 1992.\nOther sales margin improvements were derived from increased nuclear generation, which added $10.5 million to margin in 1992 over 1991. An overall capacity factor of 76% for the nuclear units was achieved in 1992, compared to 65% for 1991. Offsetting this gain, the Company experienced unusually low and intermittent demand by the New England Power Pool for the operation of the Company's fossil generating units, thus\n- 37 -\ndegrading their efficiency, increasing fuel expense and decreasing sales margin by $2.5 million from 1991. These amounts are not recoverable through the fuel adjustment clause.\nOperation, maintenance and capacity expense for 1992 nuclear generation declined only $1.7 million from 1991 levels, compared to a savings of $4-5 million the Company originally expected to realize (principally from reduced Seabrook expenses). Other operation and maintenance expenses, excluding fuel and energy expenses, increased by $2.6 million for the year (excluding net non-recurring charges for 1992).\nOther taxes increased by $3.7 million (excluding a one-time charge in 1991), reflecting primarily the increased property tax placed on Seabrook by the State of New Hampshire. Depreciation increased by $2.5 million in 1992 over 1991. Net changes in interest income and expense added $2.9 million to pre-tax income in 1992, excluding one-time credits in 1991 and 1992. Reductions in plant balances not in rate base (Seabrook and other) led to reductions in deferred revenue of about $4 million after-tax.\nNon-recurring items decreased by $.18 per share compared to 1991 levels, to a net earnings figure of $.59 per share. In 1992, a net $2.7 million in income, or $.19 per share, was booked for Seabrook Unit 1 adjustments; $3.6 million, or $.26 per share, in non-operating income tax credits were realized; a net $3.0 million in income, or $.21 per share, from a gain on the sale of property was realized; and there were one-time charges to operating expenses of a net $1.0 million, for a loss of $.07 per share.\nOUTLOOK\nThe Company's financial condition should continue to improve as a result of the December 16, 1992 retail rate decision by the DPUC. The DPUC decision granted levelized rate increases of 2.66% ($15.8 million) in 1993 and 2.66% (an additional $17.3 million) in 1994. However, the Company did not realize the full anticipated benefit of the 1993 rate increase, realizing about $4 million less than awarded due to differences between the sales realized in individual rate classes and the sales projections used for rate case purposes. The differences arose principally from rate class shifting by customers and differential growth in sales among rate classes. A similar shortfall may develop in 1994.\nThe Company's financial condition will continue to be dependent on the level of retail and wholesale sales. The two primary factors that affect sales volume are economic conditions and weather. The regional recession has restricted retail sales growth and been largely responsible for a weak wholesale sales market during the past two years. Sales increases due to economic recovery would help to increase the Company's earnings. A 1% increase in sales would add about $6 million in revenue and about $5 million in sales margin (revenue minus fuel expense and revenue- based taxes). Wholesale capacity sales are expected to be approximately $6 million in 1994.\nAnother major factor affecting the Company's financial condition will be the Company's ability to control expenses. Fuel expense, excluding wholesale fuel expense, is expected to decline by approximately $2.3 million in 1994 from the 1993 level, reflecting significantly lower nuclear fuel prices. Also, significant reductions in interest expense have been achieved since 1989, and additional savings of $10 million are expected in 1994 due to debt refinancing. For 1994, operation and maintenance expenses are expected to increase from normal inflationary pressures, but these increases should be substantially offset by savings from the phase-in of the Company's corporate structure reorganization. Since 1990, annual growth in total operation and maintenance expense, excluding one-time items and cogeneration capacity purchases, has averaged approximately 2.7%, and the Company hopes to restrict future increases to less than the rate of inflation.\nThe final portion of the cost of Seabrook Unit 1 has been added to rate base (and retail revenues) for 1994. This will eliminate deferred revenues and reduce net income by $7.4 million after-tax in 1994 from 1993 levels.\nAlthough the Company believes that its financing outlook and plans are unlikely to be adversely affected by further developments with respect to the licensing and operation of Seabrook Unit 1, the Company's financial status and financing capability will continue to be sensitive to any such developments and to many other factors, including conditions in the securities markets, economic conditions, the level of the Company's income and cash\n- 38 -\nflow, and legislative and regulatory developments, including the cost of compliance with increasingly stringent environmental legislation and regulations and competition within the electric utility industry.\nINFLATION\nAs a result of inflation and increased environmental and regulatory requirements, the estimated cost of replacing the Company's productive capacity today would substantially exceed the historical cost of such facilities reported in the financial statements. Since the Company's rates for service to its customers have been based in the past on the cost of providing such service and have been revised from time to time to reflect increased costs of service, the Company believes that any higher replacement costs it may experience in the future will be recovered through the normal regulatory process.\n- 39 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 40 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 41 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 42 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 43 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 44 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(A) STATEMENT OF ACCOUNTING POLICIES\nAccounting Records\nThe accounting records are maintained in accordance with the uniform systems of accounts prescribed by the Federal Energy Regulatory Commission (FERC) and the Connecticut Department of Public Utility Control (DPUC).\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Bridgeport Electric Company (BEC), United Resources Inc., United Energy International, Inc. and Research Center, Inc. Intercompany accounts and transactions have been eliminated in consolidation.\nReclassification of Previously Reported Amounts\nCertain amounts previously reported have been reclassified to conform with current year presentations.\nUtility Plant\nThe cost of additions to utility plant and the cost of renewals and betterments are capitalized. Cost consists of labor, materials, services and certain indirect construction costs, including an allowance for funds used during construction (AFUDC). The cost of current repairs and minor replacements is charged to appropriate operating expense accounts. The original cost of utility plant retired or otherwise disposed of and the cost of removal, less salvage, are charged to the accumulated provision for depreciation.\nAllowance for Funds Used During Construction\nIn accordance with the applicable regulatory systems of accounts, the Company capitalizes AFUDC, which represents the approximate cost of debt and equity capital devoted to plant under construction. In accordance with FERC prescribed accounting, the portion of the allowance applicable to borrowed funds is presented in the Consolidated Statement of Income as a reduction of interest charges, while the portion of the allowance applicable to equity funds is presented as other income. Although the allowance does not represent current cash income, it has historically been recoverable under the ratemaking process over the service lives of the related properties. The Company compounds semi-annually the allowance applicable to major construction projects. AFUDC rates in effect for 1993, 1992 and 1991 were 8.75%, 10.25% and 10.88%, respectively.\nDepreciation\nProvisions for depreciation on utility plant for book purposes, excluding costs associated with the 1984 reconversion of BEC's plant to a dual-fired capability, are computed on a straight-line basis, using estimated service lives determined by independent engineers. One-half year's depreciation is taken in the year of addition and disposition of utility plant, except in the case of major operating units on which depreciation commences in the month they are placed in service and ceases in the month they are removed from service. During the years 1985-1989, depreciation associated with BEC's reconversion costs was computed on an annuity basis over the original ten-year period that this plant was being leased to the Company by BEC. Commencing January 1, 1990, the reconversion costs are being depreciated on a straight-line basis over a period ending July 2000. The aggregate annual provisions for depreciation for the years 1993, 1992 and 1991 were equivalent to approximately 3.22%, 3.15% and 3.10%, respectively, of the original cost of depreciable property.\n- 45 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIncome Taxes\nEffective January 1, 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes\". In accordance with SFAS 109, the Company has provided deferred taxes for all temporary book-tax differences using the liability method. The liability method requires that deferred tax balances be adjusted to reflect enacted future tax rates that are anticipated to be in effect when the temporary differences reverse. In accordance with generally accepted accounting principles for regulated industries, the Company has established a net regulatory asset that reflects anticipated future recovery in rates of these deferred tax provisions.\nFor ratemaking purposes, the Company practices full normalization for all investment tax credits (ITC) related to recoverable plant investments except for the ITC related to Seabrook Unit 1, which was taken into income in accordance with provisions of the 1989 Settlement Agreement.\nAccrued Utility Revenues\nThe estimated amount of utility revenues (less related expenses and applicable taxes) for service rendered but not billed is accrued at the end of each accounting period.\nCash and Cash Equivalents\nFor cash flow purposes, the Company considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash equivalents.\nThe Company is required to maintain an operating deposit with the project disbursing agent related to its 17.5% ownership interest in Seabrook Unit 1. This operating deposit, which is the equivalent to one and one half months of the funding requirement for operating expenses, is restricted for use and amounted to $3.4 million, $2.9 million, and $1.8 million at December 31, 1993, 1992 and 1991, respectively.\nInvestments\nThe Company's investment in the Connecticut Yankee Atomic Power Company joint venture, a nuclear generating company in which the Company has a 9 1\/2% stock interest, is accounted for on an equity basis.\nFossil Fuel Costs\nThe amount of fossil fuel costs that cannot be reflected currently in customers' bills pursuant to the FCA in the Company's rates is deferred at the end of each accounting period. Since adoption of the deferred accounting procedure in 1974, rate decisions by the DPUC and its predecessors have consistently made specific provision for amortization and rate-making treatment of the Company's existing deferred fossil fuel cost balances.\nResearch and Development Costs\nResearch and development costs, including environmental studies, are capitalized if related to specific construction projects and depreciated over the lives of the related assets. Other research and development costs are charged to expense as incurred.\nPension and Other Post-Employment Benefits\nThe Company accounts for normal pension plan costs in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 87, \"Employers' Accounting for Pensions\", and for supplemental\n- 46 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nretirement plan costs and supplemental early retirement plan costs in accordance with the provisions of SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits\".\nPrior to January 1, 1993, the Company accounted for other post- employment benefits, consisting principally of health and life insurance, on a pay-as-you-go basis. Effective January 1, 1993, the Company commenced accounting for these costs under the provisions of SFAS No. 106, \"Employers' Accounting for Post- Retirement Benefits Other than Pensions\", which requires, among other things, that the liability for such benefits be accrued over the employment period that encompasses eligibility to receive such benefits. The annual incremental cost of this accounting change has been allowed in retail rates in accordance with a 1992 rate decision.\nUranium Enrichment Obligation\nUnder the Energy Policy Act of 1992 (Energy Act), the Company will be assessed for its proportionate share of the costs of the decontamination and decommissioning of uranium enrichment facilities operated by the Department of Energy. The Energy Act imposes an overall cap of $2.25 billion on the obligation assessed to the nuclear utility industry and limits the annual assessment to $150 million each year over a 15-year period. At December 31, 1993, the Company's unfunded share of the obligation, based on its ownership interest in Seabrook Unit 1 and Millstone Unit 3, was approximately $1.5 million. Effective January 1, 1993, the Company was allowed to recover these assessments in rates as a component of fuel expense. Accordingly, the Company has recognized these costs as a regulatory asset on its Consolidated Balance Sheet.\nNuclear Decommissioning Trusts\nExternal trust funds are maintained to fund the estimated future decommissioning costs of the nuclear generating units in which the Company has an ownership interest. These costs are accrued as a charge to depreciation expense over the estimated service lives of the units and are recovered in rates on a current basis. The Company paid $1,616,000, $1,334,000 and $1,011,000 during 1993, 1992 and 1991 into the decommissioning trust funds for Seabrook Unit 1 and Millstone Unit 3. At December 31, 1993, the Company's share of the trust fund balances, which include accumulated earnings on the funds, were $3.7 million and $1.9 million for Seabrook Unit 1 and Millstone Unit 3, respectively. These fund balances are included in \"Other Property and Investments\" and the accrued decommissioning obligation is included in \"Noncurrent Liabilities\" on the Company's Consolidated Balance Sheet.\n- 47 -\n- 48 -\n- 49 -\n- 50 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(a) Common Stock\nThe Company issued 46,000 shares of common stock in 1993, 100,800 shares of common stock in 1992 and 44,600 shares of common stock in 1991 pursuant to a stock option plan. During 1993, the Company also issued 4,143 shares of common stock pursuant to a long-term incentive program.\nCommon stock, no par value, authorized at December 31, 1993, included 400,000 shares reserved for the Company's Employee Stock Ownership Plan (ESOP). There were no additions to ESOP in 1991, 1992 or 1993.\nThe Company purchased on the open market, on behalf of shareholders participating in the common stock Dividend Reinvestment Plan, 148,362 shares of stock in 1991, 136,679 shares of stock in 1992 and 138,145 shares of stock in 1993.\nIn 1990, the Company's Board of Directors and the shareowners approved a stock option plan for officers and key employees of the Company. The plan provides for the awarding of options to purchase up to 750,000 shares of the Company's common stock over periods of from one to ten years following the dates when the options are granted. On June 5, 1991, the DPUC approved the issuance of 500,000 shares of stock pursuant to this plan. The exercise price of each option cannot be less than the market value of the stock on the date of the grant. Options to purchase 214,000 shares of stock at an exercise price of $30.75 per share, 2,800 shares of stock at an exercise price of $28.3125 per share, 1,800 shares of stock at an exercise price of $31.1875 per share, 4,000 shares of stock at an exercise price of $35.625 per share, 36,200 shares of stock at an exercise price of $39.5625 per share and 5,000 shares of stock at an exercise price of $42.375 per share have been granted by the Board of Directors and remain outstanding at December 31, 1993. Options to purchase 44,600 shares of stock at an exercise price of $30.75 were exercised during 1991. Options to purchase 98,000 shares of stock at an exercise price of $30.75 and 2,800 shares of stock at an exercise price of $28.3125 were exercised during 1992. Options to purchase 42,400 shares of stock at an exercise price of $30.75 per share, 1,400 shares of stock at an exercise price of $28.3125 per share, 1,200 shares of stock at an exercise price of $31.1875 per share and 1,000 shares of stock at an exercise price of $35.625 per share were exercised during 1993.\nIn addition, certain executive officers were eligible to earn shares of the Company's common stock, based upon the dividend and market performance of the stock compared to a peer group of electric utilities over a four-year period ending December 31, 1992, under the Company's long-term incentive program. The issuance of shares of stock pursuant to this program received DPUC approval on June 5, 1991. The total number of shares of common stock that could have been earned under the long-term incentive program was limited to 7,091. For the four-year period ending December 31, 1992, 6,027 shares of the Company's common stock were earned. Of this amount, a total of 4,143 shares were issued to the participants in 1993, and the remainder was distributed in an equivalent amount of cash based on the closing price of the Company's Common Stock on March 1, 1993, pursuant to the terms of the long-term incentive program. This program ended as of December 31, 1992.\n(b) Retained Earnings Restriction\nThe indenture under which the Company's Medium-Term Notes and Notes are issued places limitations on the payment of cash dividends on common stock and on the purchase or redemption of common stock. Retained earnings in the amount of $82.6 million were free from such limitations at December 31, 1993.\n(c) Preferred and Preference Stock\nThe par value of each of these issues was credited to the appropriate stock account and expenses related to these issues were charged to capital stock expense.\n- 51 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn 1991, the Company purchased and cancelled shares of its $100 par value Preferred Stock, at a discount, resulting in a non-taxable addition to common equity of approximately $3,304,000. The 1991 purchases consisted of:\n9,575 shares of 4.35% Preferred Stock, Series A 7,320 shares of 4.72% Preferred Stock, Series B 39,900 shares of 4.64% Preferred Stock, Series C 13,800 shares of 5 5\/8% Preferred Stock, Series D\nIn 1992, the Company purchased and cancelled 16,950 shares of its $100 par value 4.72% Preferred Stock, Series B, at a discount, resulting in a non-taxable addition to common equity of approximately $796,650.\nThere was no redemption of preferred stock in 1993.\nShares of preferred stock have preferential dividend and liquidation rights over shares of common stock. Preferred shareholders are not entitled to general voting rights. However, if any preferred dividends are in arrears for six or more quarters, or if some other event of default occurs, preferred shareholders are entitled to elect a majority of the Board of Directors until all preferred dividend arrears are paid and any event of default is terminated.\nPreference stock is a form of stock that is junior to preferred stock but senior to common stock. It is not subject to the earnings coverage requirements or minimum capital and surplus requirements governing the issuance of preferred stock. There were no shares of preference stock outstanding at December 31, 1993.\n(d) Long-Term Debt\nIn January 1993, the net proceeds from the liquidation of an investment in tax-exempt municipal debt instruments were used to pay $60 million principal amount of maturing 10.32% First Mortgage Bonds of the Company's wholly-owned subsidiary, Bridgeport Electric Company; to repay a $7.5 million 13.1% term loan; to repay short- term borrowings incurred for the August 1, 1992 redemption of the Company's 12% Debentures, due August 1, 2017, and for repayment of a $7.5 million 12.9% term loan on September 30, 1992; and to repay short-term borrowings incurred for a $19.1 million rent payment on December 31, 1992 under the Company's facility sale and leaseback arrangement for a portion of its ownership interest in Seabrook Unit 1.\nOn September 30, 1993, the Company repaid a $5 million 12.9% term loan with funds obtained through short-term borrowings.\nOn September 17, 1993, the Company invited the owners of $68,400,000 aggregate principal amount of 14 1\/2% Pollution Control Revenue Bonds, due October 1 and December 1, 2009, (\"Bonds\") to sell to the Company, for cash, any and all of the Bonds. The Bonds were issued in 1984 by The Industrial Development Authority of the State of New Hampshire (\"NHIDA\"), which loaned the issue proceeds to the Company to pay for the cost of installing pollution control facilities at the Seabrook nuclear generating plant in New Hampshire; and the Business Finance Authority of the State of New Hampshire (\"NHBFA\"), successor to the NHIDA, agreed to issue Pollution Control Refunding Revenue Bonds (\"Refunding Bonds\") in a principal amount equal to the aggregate principal amount of Bonds purchased by the Company and surrendered to the Bond trustee for cancellation, and to loan the issue proceeds of the Refunding Bonds to the Company to pay for part of the purchase price of the Bonds being purchased and cancelled. On October 15, 1993, the Company accepted offers from holders of $64,460,000 aggregate principal amount of the Bonds to sell them for an aggregate purchase price of $75,710,000. On October 26, 1993, the NHBFA issued and sold $64,460,000 principal amount of 5 7\/8% Refunding Bonds, due October 1, 2033, and loaned the issue proceeds to the Company, which used them to pay\n- 52 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\na portion of the purchase price of the Bonds. The remainder of the purchase price was funded with the proceeds of short-term borrowings.\nOn December 7, 1993, the Company issued and sold $100 million principal amount of five-year and one month Notes at a coupon rate of 6.20%. The net proceeds were used to repay $60 million principal amount of maturing 10.32% First Mortgage Bonds of the Company's wholly-owned subsidiary, Bridgeport Electric Company in January 1994; to repay a $5 million 13.1% term loan in January 1994 and for general corporate purposes, including repayment of short-term borrowings.\nMaturities and mandatory redemptions\/repayments and annual interest expense on existing long-term debt are set forth below:\n(C) RATE-RELATED REGULATORY PROCEEDINGS\nOn December 16, 1992, the DPUC approved levelized rate increases of 2.66% ($15.8 million) for 1993 and 2.66% (an additional $17.3 million) for 1994, including allowed conservation and load management revenue increases. The rate increases totaled $33.1 million, or 5.4%, over two years.\nIn order to achieve levelized 2.66% rate increases for each of these two years, the DPUC determined that the recovery of $13.1 million of sales adjustment clause revenues would be deferred from 1993 to 1994.\nUtilities are entitled by Connecticut law to revenues sufficient to allow them to cover their operating and capital costs, to attract needed capital and maintain their financial integrity, while also protecting the public interest. Accordingly, the DPUC's 1992 rate decision authorized a return on equity of 12.4% for ratemaking purposes. However, the Company may earn up to 1% above this level before a mandatory review is required by the DPUC.\n- 53 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nSince January 1971, UI has had a fossil fuel adjustment clause (FCA) in virtually all of its retail rates. The DPUC is required by law to convene an administrative proceeding prior to approving FCA charges or credits for each month. The law permits automatic implementation of the charges or credits if the DPUC fails to act within five days of the administrative proceeding, although all such charges and credits are also subject to further review and appropriate adjustment by the DPUC at public hearings required to be held at least every three months. The DPUC has made no material changes in UI's FCA charges and credits as the result of any of these proceedings or hearings.\n(D) ACCOUNTING FOR PHASE-IN PLAN\nThe Company has been phasing into rate base its allowable investment in Seabrook Unit 1, amounting to $640 million, since January 1, 1990. In conjunction with this phase-in plan, the Company has been allowed to record a deferred return on the portion of allowable investment excluded from rate base during the phase-in period. The accumulated deferred return has been added to rate base each year since January 1, 1991 in the same proportion as the phase-in installment for that year has borne to the portion of the $640 million remaining to be phased-in. On January 1, 1994, the Company phased into rate base the remaining $74.5 million of allowable investment, plus the remaining $28.2 million of accumulated deferred return. The Company will be allowed to recover the accumulated deferred return, amounting to $62.9 million, over a five-year period commencing January 1, 1995.\n- 54 -\n- 55 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nTotal income taxes differ from the amounts computed by applying the federal statutory tax rate to income before taxes. The reasons for the differences are as follows:\nAt December 31, 1993, the Company had deferred tax liabilities for taxable temporary differences of $574 million and deferred tax assets for deductible temporary differences of $149 million, resulting in a net deferred tax liability of $425 million. Significant components of deferred tax liabilities and assets were as follows: tax liabilities on book\/tax plant basis differences, $229 million; tax liabilities on the cumulative amount of income taxes on temporary differences previously flowed through to ratepayers, $163 million; tax liabilities on normalization of book\/tax depreciation timing differences, $89 million and tax assets on the disallowance of plant costs, $77 million.\nThe Tax Reform Act of 1986 provides for a more comprehensive corporate alternative minimum tax (AMT) for years beginning after 1986. To the extent that the AMT exceeds the federal income tax computed at statutory rates, the excess must be paid in addition to the regular tax liability. For tax purposes, the excess paid in any year can be carried forward indefinitely and offset against any future year's regular tax liability in excess of that year's tentative AMT. The AMT carryforward at December 31, 1993, 1992 and 1991 was $11.4 million, $11.3 million and $9.9 million, respectively.\n(F) SHORT-TERM CREDIT ARRANGEMENTS\nThe Company has a revolving credit agreement with a group of banks, which currently extends to January 19, 1995. The borrowing limit of this facility is $75 million. The facility permits the Company to borrow funds at a fluctuating interest rate determined by the prime lending market in New York, and also permits the Company to borrow money for fixed periods of time specified by the Company at fixed interest rates determined by the Eurodollar interbank market in London, by the certificate of deposit market in New York, or by bidding, at the\n- 56 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nCompany's option. If a material adverse change in the business, operations, affairs, assets or condition, financial or otherwise, or prospects of the Company and its subsidiaries, on a consolidated basis, should occur, the banks may decline to lend additional money to the Company under this revolving credit agreement, although borrowings outstanding at the time of such an occurrence would not then become due and payable. As of December 31, 1993, the Company had no short-term borrowings outstanding under this facility.\nThe Company's long-term debt instruments do not limit the amount of short-term debt that the Company may issue. The Company's revolving credit agreement described in the previous paragraph requires it to maintain an available earnings\/interest charges ratio of not less than 1.5:1.0 for each 12-month period ending on the last day of each calendar quarter.\nThe Company had a $50 million term loan facility with a group of banks during 1993. Under this agreement, the Company chose an interest rate from among three alternatives: (i) a fluctuating interest rate determined by the prime lending market in New York; (ii) a fixed interest rate determined by the Eurodollar interbank market in London; and (iii) a fixed interest rate determined by the certificate of deposit market in New York. On February 1, 1993, the Company borrowed $50 million from this group of banks, using the proceeds to repay short-term borrowings and other current obligations. On December 3, 1993, the Company repaid the $50 million borrowing and terminated the agreement.\nThe Company had a term loan agreement with PruLease, Inc. (PruLease) that expired on December 1, 1993. This agreement was executed on December 31, 1992, when the Company borrowed $49.1 million from PruLease and purchased all the nuclear fuel that was owned by PruLease and leased to the Company on that date. This loan, which was collateralized by a first lien on the Company's ownership interest in the nuclear fuel for Seabrook Unit 1, was repaid in full at maturity.\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\n- 57 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nInformation with respect to short-term borrowings is as follows:\n- 58 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\n(G) SUPPLEMENTARY INFORMATION\n- 59 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(H) PENSION AND OTHER POST-EMPLOYMENT BENEFITS\nThe Company's qualified pension plan, which is based on the highest three years of pay, covers substantially all of its employees, and its entire cost is borne by the Company. The Company also has a non-qualified supplemental plan for certain executives and a non-qualified retiree only plan for certain early retirement benefits. The net pension costs for these plans for 1993, 1992 and 1991 were $14,966,000, $5,749,000 and $2,054,000, respectively.\nThe Company's funding policy for the qualified plan is to make annual contributions that satisfy the minimum funding requirements of ERISA but which do not exceed the maximum deductible limits of the Internal Revenue Code. These amounts are determined each year as a result of an actuarial valuation of the Plan. In accordance with this policy, the Company will be contributing $3.3 million in 1994 for 1993 funding requirements. Previously, due to the application of the full funding limitation under ERISA, the Company had not been required to make a contribution since 1985. The supplemental plan is unfunded.\nThe qualified plan's irrevocable trust fund consists principally of equity and fixed-income securities and real estate investments in approximately the following percentages:\n- 60 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n- 61 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn addition to providing pension benefits, the Company also provides other postretirement benefits (OPEB), consisting principally of health care and life insurance benefits, for retired employees and their dependents. Employees with 25 years of service are eligible for full benefits, while employees with less than 25 years of service but greater than 15 years of service are entitled to partial benefits. Years of service prior to age 35 are not included in determining the number of years of service.\nPrior to January 1, 1993, the Company recognized the cost of providing OPEB on a pay-as-you-go basis by expensing the annual insurance premiums. These costs amounted to $1.3 million and $1.1 million for 1992 and 1991, respectively. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\", which requires, among other things, that OPEB costs be recognized over the employment period that encompasses eligibility to receive such benefits. In its December 16, 1992 decision on the Company's application for retail rate relief, the DPUC recognized the Company's obligation to adopt SFAS No. 106, effective January 1, 1993, and approved the Company's request for revenues to recover OPEB expenses on a SFAS No. 106 basis. A portion of these expenses represents the transition obligation, which will accrue over a 20-year period, representing the future liability for medical and life insurance benefits based on past service for retirees and active employees.\nFor funding purposes, the Company has established two Voluntary Employees' Benefit Association Trusts (VEBA) to fund OPEB for employees who retire on or after January 1, 1994; one VEBA for union employees and one for non-union employees. Approximately 52% of the Company's employees are represented by Local 470-1, Utility Workers Union of America, AFL-CIO, for collective bargaining purposes. The funding policy assumes contributions to these trust funds to be the total OPEB expense under SFAS No. 106, excluding the amount that resulted from the reorganization minus pay-as-you- go benefit payments for pre-January 1, 1994 retirees, allocated in a manner that minimizes current income tax liability, without exceeding maximum tax deductible limits. In accordance with this policy, the Company contributed approximately $3 million to the union VEBA on December 30, 1993. The Company currently plans to fund the portion of the OPEB expense that is related to the reorganization during the years 1994-1996.\nThe 1993 cost for OPEB includes the following components:\nA one percentage point increase in the assumed health care cost trend rate would have increased the service cost and interest cost components of the 1993 net cost of periodic postretirement benefit by approximately $445,000 and would increase the accumulated postretirement benefit obligation for health care benefits by approximately $2,421,000.\n- 62 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe following table reconciles the funded status of the plan with the amount recognized in the Consolidated Balance Sheet as of December 31, 1993:\nThe weighted average discount rate used to measure the accumulated postretirement benefit obligation was 7.5%.\nDuring 1993, in conjunction with a in-depth organizational review, the Company offered a voluntary early retirement program to non-union employees who were eligible to receive pension benefits. This offer was accepted by 103 employees. The 1993 OPEB cost for this program was $1.267 million. These costs are recognized as a component of the reorganizational charge shown on the Company's Consolidated Statement of Income.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Post-Employment Benefits\". This statement, which will be adopted during the first quarter of 1994, establishes accounting standards for employers who provide benefits, such as unemployment compensation, severance benefits and disability benefits, to former or inactive employees after employment but before retirement and requires recognition of the obligation for these benefits. The adoption of this new standard will result in a pre-tax charge against earnings amounting to approximately $2 million during the first quarter of 1994. Subsequent period costs are not expected to be material.\n- 63 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(I) JOINTLY OWNED PLANT\nAt December 31, 1993, the Company had the following interests in jointly owned plants:\nThe Company's share of the operating costs of jointly owned plants is included in the appropriate expense captions in the Consolidated Statement of Income.\n(J) UNAMORTIZED CANCELLED NUCLEAR PROJECT\nFrom December 1984 through December 1992, the Company had been recovering its investment in Seabrook Unit 2 over a regulatory approved ten-year period without a return on its unamortized investment. In the Company's 1992 rate decision, the DPUC adopted a proposal by the Company to write off its remaining investment in Seabrook Unit 2, beginning January 1, 1993, over a 24-year period, corresponding with the flowback of certain Connecticut Corporation Business Tax (CCBT) credits. Such decision will allow the Company to retain the Seabrook Unit 2\/CCBT amounts for ratemaking purposes, with the accumulated CCBT credits not deducted from rate base during the 24-year period of amortization in recognition of a longer period of time for amortization of the Seabrook Unit 2 balance.\n(K) FUEL FINANCING OBLIGATIONS AND OTHER LEASE OBLIGATIONS\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\nThe Company has leases (some of which are capital leases), including arrangements for data processing and office equipment, vehicles, office space and oil tanks. The gross amount of assets recorded under capital leases and the related obligations of those leases as of December 31, 1993 are recorded on the balance sheet.\nFuture minimum lease payments under capital leases, excluding the Seabrook sale\/leaseback transaction, which is being treated as a long-term financing, are estimated to be as follows:\n- 64 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nCapitalization of leases has no impact on income, since the sum of the amortization of a leased asset and the interest on the lease obligation equals the rental expense allowed for ratemaking purposes.\nRental payments charged to operating expenses in 1993, 1992 and 1991 amounted to $14.1 million, $14.8 million and $14.9 million, respectively.\nOperating leases, which are charged to operating expense, consist of a large number of small, relatively short-term, renewable agreements for a wide variety of equipment.\n(L) COMMITMENTS AND CONTINGENCIES\nCapital Expenditure Program\nThe Company has entered into commitments in connection with its continuing capital expenditure program, which is presently estimated at approximately $366.5 million, excluding AFUDC, for 1994 through 1998.\nSeabrook\nAfter experiencing increasing financial stress beginning in May 1987, Public Service Company of New Hampshire (PSNH), which held the largest ownership share (35.6%) in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code in January of 1988. Under this statute, PSNH continued its operations while seeking a financial reorganization. A reorganization plan proposed by Northeast Utilities (NU) was confirmed by the bankruptcy court in April of 1990 and, on May 16, 1991, PSNH completed the financing required for payment of its pre-bankruptcy secured and unsecured debt under the first stage of the reorganization plan and emerged from bankruptcy. On May 19, 1992, the NRC issued the final regulatory approval necessary for the second stage of the NU reorganization plan, under which PSNH would be acquired by NU; and on June 5, 1992, this acquisition was completed. As part of the transaction, PSNH's ownership share of Seabrook Unit 1 was transferred to a wholly-owned subsidiary of NU. Two previous regulatory approvals of the NU reorganization plan for PSNH, by the Federal Energy Regulatory Commission (FERC) and the Securities and Exchange Commission (SEC), continue to be challenged in court proceedings, and the Company is unable to predict the outcome of these proceedings.\nOn February 28, 1991, EUA Power Corporation (EUA Power), the holder of a 12.1% ownership share in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code. EUA Power, a wholly-owned subsidiary of Eastern Utilities Associates (EUA), was organized solely for the purpose of acquiring an ownership share in Seabrook and selling in the wholesale market its share of the electric power produced by Seabrook. EUA Power commenced this bankruptcy proceeding because the cash generated by its sales of power at current market prices was insufficient to pay its obligations on its outstanding debt. Subsequently, EUA Power's name\n- 65 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nwas changed to Great Bay Power Corporation (Great Bay). The official committee of Great Bay's bondholders (Bondholders Committee) has proposed, and the bankruptcy court has confirmed, a reorganization plan for Great Bay, under which substantially all of the equity ownership of Great Bay would pass to its bondholders. On February 2, 1994, the Bondholders Committee accepted a financing proposal that would inject $35 million of new ownership equity into Great Bay. The bankruptcy court must approve this structure before the Great Bay reorganization plan becomes effective. Further approvals are also required from the NRC, FERC and the New Hampshire Public Utilities Commission. The bankruptcy court has approved an agreement among Great Bay, the Bondholders Committee, UI and The Connecticut Light and Power Company (CL&P), under which up to $20 million in advance payments against their respective future monthly Seabrook payment obligations will be made available between UI and CL&P as needed until the reorganization plan becomes effective. UI's share of funding obligations under this agreement totals $8 million. As of December 31, 1993, $5.5 million had been advanced by UI under this agreement. At January 31, 1994, $602,000 of the Company's advances remained outstanding. This agreement can be terminated by UI and CL&P upon thirty days notice or upon failure of the reorganization process to achieve certain milestones by specified dates. UI is unable to predict what impact, if any, failure of the reorganization plan to become effective will have on the operating license for Seabrook Unit 1, or what other actions UI and the other joint owners of the unit may be required to take in response to developments in this bankruptcy proceeding as it may affect Seabrook.\nNuclear generating units are subject to the licensing requirements of the Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954, as amended, and a variety of other state and federal requirements. Although Seabrook Unit 1 has been issued a 40-year operating license, NRC proceedings and investigations prompted by inquiries from Congressmen and by NRC licensing board consideration of technical contentions may arise and continue for an indefinite period of time in the future.\nNuclear Insurance Contingencies\nThe Price-Anderson Act, currently extended through August 1, 2002, limits public liability resulting from a single incident at a nuclear power plant. The first $200 million of liability coverage is provided by purchasing the maximum amount of commercially available insurance. Additional liability coverage will be provided by an assessment of up to $75.5 million per incident, levied on each of the nuclear units licensed to operate in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. In addition, if the sum of all public liability claims and legal costs resulting from any nuclear incident exceeds the maximum amount of financial protection, each reactor operator can be assessed an additional 5% of $75.5 million, or $3.775 million. The maximum assessment is adjusted at least every five years to reflect the impact of inflation. Based on its interests in nuclear generating units, the Company estimates its maximum liability would be $20.3 million per incident. However, assessment would be limited to $3.1 million per incident, per year. With respect to each of the operating nuclear generating units in which the Company has an interest, the Company will be obligated to pay its ownership and\/or leasehold share of any statutory assessment resulting from a nuclear incident at any nuclear generating unit.\nThe NRC requires nuclear generating units to obtain property insurance coverage in a minimum amount of $1.06 billion and to establish a system of prioritized use of the insurance proceeds in the event of a nuclear incident. The system requires that the first $1.06 billion of insurance proceeds be used to stabilize the nuclear reactor to prevent any significant risk to public health and safety and then for decontamination and cleanup operations. Only following completion of these tasks would the balance, if any, of the segregated insurance proceeds become available to the unit's owners. For each of the nuclear generating units in which the Company has an interest, the Company is required to pay its ownership and\/or leasehold share of the cost of purchasing such insurance.\n- 66 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nOther Commitments and Contingencies\nHydro-Quebec\nThe Company is a participant in the Hydro-Quebec transmission intertie facility linking New England and Quebec, Canada. Phase II of this facility, in which UI has a 5.45% participating share, has increased the capacity value of the intertie from 690 megawatts to a maximum of 2000 megawatts. A ten-year Firm Energy Contract, which provides for the sale of 7 million megawatt-hours per year by Hydro-Quebec to the New England participants in the Phase II facility, became effective on July 1, 1991. The Company is obligated to furnish a guarantee for its participating share of the debt financing for the Phase II facility. Currently, the Company's guarantee liability for this debt amounts to approximately $9.8 million.\nReorganization Charge\nDuring 1993, the Company undertook an in-depth organizational review with the primary objective of improving customer service. As a result of this review, the Company eliminated approximately 75 positions.\nIn conjunction with this review, the Company offered a voluntary early retirement program to non-union employees who were eligible to receive pension benefits. The early retirement offer was accepted by 103 employees and the Company incurred a one-time charge to 1993 earnings of approximately $13.6 million ($7.8 million, after-tax). No decision has been made as to whether to offer a severance program to employees who may be affected by the organizational review when it is completed, but who were not eligible for, or did not accept, the early retirement offer.\nSite Remediation Costs\nThe Company has estimated that the cost of environmental remediation of its decommissioned Steel Point Station property in Bridgeport will be approximately $10.3 million and has recorded a liability for this cost. Following remediation, the Company intends to sell the property for development for a value it estimates will not exceed $6 million. In the Company's last rate decision, the DPUC provided additional revenues to recover the $4.3 million difference during the period 1993-1996, subject to true-up in the Company's next retail rate proceeding, based on actual remediation costs and the actual gain on the sale of the property.\nProperty Taxes\nIn November 1993, the Company received \"updated\" personal property tax bills from the City of New Haven (the City) for the tax year 1991-1992, aggregating $6.6 million, based on an audit by the City's tax assessor. The Company anticipates receiving additional bills of this sort for the tax years 1992-1993 and 1993-1994, the amounts of which cannot be predicted at this time. The Company is contesting these tax bills vigorously and has commenced an action in the Superior Court to enjoin the City from any effort to collect these tax bills. Due to a lack of data, it is not possible, at this time, to assess accurately the Company's liability, if any.\n(M) NUCLEAR FUEL DISPOSAL AND NUCLEAR PLANT DECOMMISSIONING\nCosts associated with nuclear plant operations include amounts for disposal of nuclear wastes, including spent fuel, and for the ultimate decommissioning of the plants. Under the Nuclear Waste Policy Act of 1982, the federal Department of Energy (DOE) is required to design, license, construct and operate a permanent repository for high level radioactive wastes and spent nuclear fuel. The Act requires the DOE to provide, beginning in 1998, for the disposal of spent nuclear fuel and high level radioactive waste from commercial nuclear plants through contracts with the owners and generators of such waste; and the DOE has established disposal\n- 67 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nfees that are being paid to the federal government by electric utilities owning or operating nuclear generating units. In return for payment of the prescribed fees, the federal government is to take title to and dispose of the utilities' high level wastes and spent nuclear fuel beginning no later than 1998. However, the DOE has announced that its first high level waste repository will not be in operation earlier than 2010, notwithstanding the DOE's statutory and contractual responsibility to begin disposal of high-level radioactive waste and spent fuel beginning not later than January 31, 1998.\nUntil the federal government begins receiving such materials in accordance with the Nuclear Waste Policy Act, operating nuclear generating units will need to retain high level wastes and spent fuel on-site or make other provisions for their storage. Storage facilities for Millstone Unit 3 are expected to be adequate for the projected life of the unit. Storage facilities for the Connecticut Yankee unit are expected to be adequate through the mid-1990s. Storage facilities for Seabrook Unit 1 are expected to be adequate until at least 2010. Fuel consolidation and compaction technologies are being developed and are expected to provide adequate storage capability for the projected lives of the latter two units. In addition, other licensed technologies, such as dry storage casks, can accommodate spent fuel storage requirements.\nDisposal costs for low-level radioactive wastes (LLW) that result from normal operation of nuclear generating units have increased significantly in recent years and are expected to continue to increase. The cost increases are functions of increased packaging and transportation costs and higher fees and surcharges charged by the disposal facilities. Pursuant to the Low-Level Radioactive Waste Policy Act of 1980, each state was responsible for providing disposal facilities for LLW generated within the state and was authorized to join with other states into regional compacts to jointly fulfill their responsibilities. Pursuant to the Low-Level Radioactive Waste Policy Amendments Act of 1985, each state in which a currently operating disposal facility is located (South Carolina, Nevada and Washington) is allowed to impose volume limits and a surcharge on shipments of LLW from states that are not members of the compact in the region in which the facility is located. On June 19, 1992, the United States Supreme Court issued a decision upholding certain parts of the Low-Level Radioactive Waste Policy Amendments Act of 1985, but invalidating a key provision of that law requiring each state to take title to LLW generated within that state if the state fails to meet federally-mandated deadlines for siting LLW disposal facilities. The decision has resulted in uncertainty about states' continuing roles in siting LLW disposal facilities and may result in increased LLW disposal costs and the need for longer interim LLW storage before a permanent solution is developed.\nThe Connecticut Hazardous Waste Management Service (the Service), a state quasi-public corporation, was charged with coordinating the establishment of a facility for disposal of LLW originating in Connecticut. In June 1991, the Service announced that it had selected three potential sites in north-central Connecticut for further study. The Service's announcement provoked intense controversy in the affected municipalities and resulted in legislative action to stop the selection process. On February 1, 1993, the Service presented the legislature with a new site selection plan under which communities are urged to volunteer a site for a facility in return for financial and other incentives. The volunteer process is being continued in 1994. The Service's activities in this regard are funded by assessments on Connecticut's LLW generators. Due to a change in the volunteer process, there was no assessment for the 1993-1994 fiscal year and the state projects no assessment for the 1994-1995 and 1995-1996 fiscal years.\nAdditional LLW storage capacity has been or can be constructed or acquired at the Millstone and Connecticut Yankee sites to provide for temporary storage of LLW should that become necessary. Connecticut LLW can be managed by volume reduction, storage or shipment at least through 1999. The Company cannot predict whether and when a disposal site will be designated in Connecticut.\nThe State of New Hampshire has not met deadlines for compliance with the Low-Level Radioactive Waste Policy Act, and Seabrook Unit 1 has been denied access to existing disposal facilities. Therefore, LLW generated\n- 68 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nby Seabrook Unit 1 is being stored on-site. The Seabrook storage facility currently has capacity to store approximately five years' accumulation of waste generated by Seabrook, and the plant operator plans to expand its storage capacity as necessary.\nNRC licensing requirements and restrictions are also applicable to the decommissioning of nuclear generating units at the end of their service lives, and the NRC has adopted comprehensive regulations concerning decommissioning planning, timing, funding and environmental reviews. UI and the other owners of the nuclear generating units in which UI has interests estimate decommissioning costs for the units and attempt to recover sufficient amounts through their allowed electric rates to cover expected decommissioning costs. Changes in NRC requirements or technology can increase estimated decommissioning costs, and UI's customers in future years may experience higher electric rates to offset the effects of any insufficient rate recovery in prior years.\nNew Hampshire has enacted a law requiring the creation of a government-managed fund to finance the decommissioning of nuclear generating units in that state. The New Hampshire Nuclear Decommissioning Financing Committee (NDFC) established $345 million (in 1993 dollars) as the decommissioning cost estimate for Seabrook Unit 1. This estimate premises the prompt removal and dismantling of the Unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments are being made to the state-managed decommissioning trust fund. UI's share of the decommissioning payments made during 1993 was $1.3 million. UI's share of the fund at December 31, 1993 was approximately $3.7 million.\nConnecticut has enacted a law requiring the operators of nuclear generating units to file periodically with the DPUC their plans for financing the decommissioning of the units in that state. Current decommissioning cost estimates for Millstone Unit 3 and Connecticut Yankee are $421 million (in 1994 dollars) and $324 million (in 1994 dollars), respectively. These estimates premise the prompt removal and dismantling of each unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments, based on these cost estimates, are being made to decommissioning trust funds managed by Northeast Utilities. UI's share of the Millstone Unit 3 decommissioning payments made during 1993 was $328,000. UI's share of the fund at December 31, 1993 was approximately $1.9 million. For the Company's 9.5% equity ownership in Connecticut Yankee, decommissioning costs of $1.3 million were funded by UI during 1993, and UI's share of the fund at December 31, 1993 was $9.5 million.\nEnvironmental Concerns\nIn complying with existing environmental statutes and regulations and further developments in these and other areas of environmental concern, including legislation and studies in the fields of water and air quality (particularly \"air toxics\", \"ozone non-attainment\" and \"global warming\"), hazardous waste handling and disposal, toxic substances, and electric and magnetic fields, the Company may incur substantial capital expenditures for equipment modifications and additions, monitoring equipment and recording devices, and it may incur additional operating expenses. Litigation expenditures may also increase as a result of scientific investigations, and speculation and debate, concerning the possibility of harmful health effects of electric and magnetic fields. The Company believes that any additional costs incurred for these purposes will be recoverable through the ratemaking process. The total amount of these expenditures is not now determinable.\n(N) CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES\nEffective January 1, 1991, the Company changed its method of accounting for property taxes from accrual over the twelve-month period following assessment date to accrual over the fiscal period of the applicable taxing authority. The effect of the change in accounting was to increase 1991 earnings for common stock by $7.9 million, of which $7.3 million represented the cumulative effect of the change at January 1, 1991, and $.6 million represented an increase in earnings for 1991.\n- 69 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(O) FAIR VALUE OF FINANCIAL INSTRUMENTS (1)\nThe estimated fair values of the Company's financial instruments are as follows:\n- 70 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(P) QUARTERLY FINANCIAL DATA (UNAUDITED)\nSelected quarterly financial data for 1993 and 1992 are set forth below:\n- 71 -\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Shareowners and Directors of The United Illuminating Company:\nWe have audited the accompanying consolidated balances sheets of The United Illuminating Company as of December 31, 1993, 1992 and 1991, and related consolidated statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The United Illuminating Company as of December 31, 1993, 1992, and 1991, and the consolidated results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ COOPERS & LYBRAND\nHartford, Connecticut January 24, 1994\n- 72 -\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNot Applicable\nPART III\nItem 10. Directors and Executive Officers of the Company.\nThe information appearing under the captions \"NOMINEES FOR ELECTION AS DIRECTORS\" AND \"COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in partial answer to this item. See also \"EXECUTIVE OFFICERS OF THE COMPANY\", following Part I, Item 4 herein.\nItem 11. Executive Compensation.\nThe information appearing under the captions \"EXECUTIVE COMPENSATION,\" \"STOCK OPTION PLAN,\" \"RETIREMENT PLANS,\" \"STOCK OPTION EXERCISES IN 1993 AND YEAR-END OPTION VALUES,\" \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" AND \"DIRECTOR COMPENSATION\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information appearing under the captions \"PRINCIPAL SHAREHOLDERS\" and \"STOCK OWNERSHIP OF DIRECTORS AND OFFICERS\" in the Company's definitive Proxy Statement, dated April 8, 1994 for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 13. Certain Relationships and Related Transactions.\nThe information appearing under the caption \"NOMINEES FOR ELECTION AS DIRECTORS\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\n- 73 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) The following documents are filed as a part of this report:\nFinancial Statements (see Item 8):\nConsolidated statement of income for the years ended December 31, 1993, 1992 and 1991\nConsolidated statement of cash flows for the years ended December 31, 1993, 1992 and 1991\nConsolidated balance sheet, December 31, 1993, 1992 and 1991\nConsolidated statement of retained earnings for the years ended December 31, 1993, 1992 and 1991\nStatement of accounting policies\nNotes to consolidated financial statements\nReport of independent accountants\nFinancial Statement Schedules (see S-1 through S-5)\nSchedule V - Property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VI - Accumulated depreciation, depletion and amortization of property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VIII - Valuation and qualifying accounts for the years ended December 31, 1993, 1992 and 1991.\n- 74 -\nExhibits:\nPursuant to Rule 12b-32 under the Securities Exchange Act of 1934, certain of the following listed exhibits which are annexed as exhibits to previous statements and reports filed by the Company are hereby incorporated by reference as exhibits to this report. Such statements and reports are identified by reference numbers as follows:\n(1) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1991.\n(2) Filed with Registration Statement No. 2-45434, effective September 25, 1972, and Registration Statement No. 2-45435, effective September 26, 1972.\n(3) Filed with Registration Statement No. 2-60849, effective July 24, 1978.\n(4) Filed with Registration Statement No. 2-66518, effective February 25, 1980.\n(5) Filed with Registration Statement No. 2-57275, effective October 19, 1976.\n(6) Filed with Registration Statement No. 2-67998, effective June 19, 1980.\n(7) Filed with Registration Statement No. 2-72907, effective July 16, 1981.\n(8) Filed with Post-Effective Amendment No. 1 to Registration Statement No. 2-78643, effective August 19, 1982.\n(9) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1990.\n(10) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1991.\n(11) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended March 31, 1991.\n(12) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1992.\n(13 Filed with Registration Statement No. 33-40169, effective August 12, 1991.\n(14) Filed with Registration Statement No. 33-35465, effective August 1, 1990.\n(15) Filed with Registration Statement No. 2-49669, effective December 11, 1973.\n(16) Filed with Registration Statement No. 2-54876, effective November 19, 1975.\n(17) Filed with Registration Statement No. 2-52657, effective February 6, 1975.\n(18) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 1992.\n(19) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1990.\n- 75 -\nThe exhibit number in the statement or report referenced is set forth in the parenthesis following the description of the exhibit. Those of the following exhibits not so identified are filed herewith.\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.1 (1) Copy of Charter of The United Illuminating Company, dated December 15, 1965. (Exhibit 3.1) (3) 3.2 (2) Copy of a certificate concerning the creation of a class of Preferred Stock of The United Illuminating Company and the authority of the Board of Directors to issue said Preferred Stock, dated July 13, 1956, and filed with the Secretary of State of Connecticut July 13, 1956. (Exhibit 3.12) (3) 3.3 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated November 19, 1962, andfiled with the Secretary of State of Connecticut November 29, 1962. (Exhibit 3.3) (3) 3.4 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 25, 1965, and filed with the Secretary of State of Connecticut November 22, 1965. (Exhibit 3.4) (3) 3.5 (2) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 6, 1967, and filed with the Secretary of State of Connecticut June 6, 1967. (Exhibit 3.13) (3) 3.6 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated December 1, 1967, and filed with the Secretary of State of Connecticut December 7, 1967. (Exhibit 3.6) (3) 3.7 (3) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 27, 1971, and filed with the Secretary of State of Connecticut April 29, 1971. (Exhibit 2.2-14) (3) 3.8 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated March 29, 1972, and filed with the Secretary of State of Connecticut March 30, 1972. (Exhibit 3.8) (3) 3.9 (4) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 4 1973, and filed with the Secretary of State of Connecticut May 7, 1973. (Exhibit 2.2-17) (3) 3.10 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 2, 1973, and filed with the Secretary of State of Connecticut July 2, 1973. (Exhibit 3.10) (3) 3.11 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-18) (3) 3.12 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-19) (3) 3.13 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 20, 1976, and filed with the Secretary of State of Connecticut October 21, 1976. (Exhibit 3.13) (3) 3.14 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 4, 1979, and filed with the Secretary of State of Connecticut April 5, 1979. (Exhibit 3.14) (3) 3.15 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 29, 1980, and filed with the Secretary of State of Connecticut April 30, 1980. (Exhibit 3.15)\n- 76 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.16 (6) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 20, 1980, and filed with the Secretary of State of Connecticut May 23, 1980. (Exhibit 2.2-20) (3) 3.17 (7) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 12, 1981, and filed with the Secretary of State of Connecticut June 16, 1981. (Exhibit 1.20) (3) 3.18 (12) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 13, 1981, and filed with the Secretary of State of Connecticut July 14, 1981. (3) 3.19 (8) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 1, 1983, and filed with the Secretary of State of Connecticut June 3, 1983. (Exhibit 4.31) (3) 3.20 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 24, 1984, and filed with the Secretary of State of Connecticut July 24, 1984. (Exhibit 1) (3) 3.21 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated August 8, 1984, and filed with the Secretary of State of Connecticut August 9, 1984. (Exhibit 2) (3) 3.22 (9) Copy of Certificate Amending or Restating Certificate of Incorporation, filed with the Secretary of State of Connecticut August 1, 1990. (Exhibit 3.22) (3) 3.23 (10) Copy of Certificate Amending or Restating Certificate of Incorporation, dated May 9, 1991, and filed with the Secretary of State of Connecticut August 27, 1991. (Exhibit 3.22a) (3) 3.24a (3) Copy of Bylaws of The United Illuminating Company. (Exhibit 2.3) (3) 3.24b (10) Copy of Article II, Section 2, of Bylaws of The United Illuminating Company, as amended March 26, 1990, amending Exhibit 3.24a. (Exhibit 3.23b) (3) 3.24c (11) Copy of Article V, Section 1, of Bylaws of The United Illuminating Company, as amended April 22, 1991, amending Exhibit 3.24a. (Exhibit 3.23c) (4) 4.1 (9) Copy of First Mortgage Indenture and Deed of Trust, dated as of December 1, 1984, between Bridgeport Electric Company and The First National Bank of Boston, Trustee. (Exhibit 4.12) (4) 4.2 (12) Copy of First Supplemental Mortgage Indenture, dated as of February 15, 1987, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1. (Exhibit 4.2) (4) 4.3 (12) Copy of Second Supplemental Mortgage Indenture, dated as of January 14, 1988, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1 and amending Exhibit 4.2. (Exhibit 4.3) (4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1. (4) 4.5 (13) Copy of Indenture, dated as of August 1, 1991, from The United Illuminating Company to The Bank of New York, Trustee. (Exhibit 4) (4) 4.6 (14) Copy of Participation Agreement, dated as of (10) August 1, 1990, among Financial Leasing Corporation, Meridian Trust Company, The Bank of New York and The United Illuminating Company. (Exhibits 4(a) through 4(h), inclusive, Amendment Nos. 1 and 2).\n- 77 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.1 (5) Copy of Stockholder Agreement, dated as of July 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-1) (10) 10.2a (5) Copy of Power Contract, dated as of July 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-2) (10) 10.2b (3) Copy of Supplementary Power Contract, dated as of March 1, 1978, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 5.1-6) (10) 10.2c (1) Copy of Agreement Amending Supplementary Power Contract, dated August 22, 1980, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2b) (10) 10.2d (12) Copy of Second Amendment of the Supplementary Power Contract, dated as of October 15, 1982, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2d) (10) 10.2e (9) Copy of Second Supplementary Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 10.2e) (10) 10.2f (9) Copy of Additional Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 10.2f) (10) 10.3 (5) Copy of Capital Funds Agreement, dated as of September 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-3) (10) 10.4a (5) Copy of Connecticut Yankee Transmission Agreement, dated as of October 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-4) (10) 10.4b (4) Copy of Agreement Amending and Revising Connecticut Yankee Transmission Agreement, dated as of July 1, 1979, amending Exhibit 10.4a. (Exhibit 5.1-7) (10) 10.5 (3) Copy of Capital Contributions Agreement, dated October 16, 1967, between The United Illuminating Company and Connecticut Yankee Atomic Power Company. (Exhibit 5.1-5) (10) 10.6a (1) Copy of NEPOOL Power Pool Agreement, dated as of September 1, 1971, as amended to November 1, 1988. (Exhibit 10.6a) (10) 10.6b (15) Copy of Agreement Setting Out Supplemental NEPOOL Understandings, dated as of April 2, 1973. (Exhibit 5.7-10) (10) 10.6c (1) Copy of Amendment to NEPOOL Power Pool Agreement, dated as of March 15, 1989, amending Exhibit 10.6a. (Exhibit 10.6c) (10) 10.6d (1) Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of October 1, 1990, amending Exhibit 10.6a. (Exhibit 10.6d) (10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a. (10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a. (10) 10.7a (1) Copy of Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated May 1, 1973, as amended to February 1, 1990. (Exhibit 10.7a) (10) 10.7b (16) Copy of Transmission Support Agreement, dated as of May 1, 1973, among the Seabrook Companies. (Exhibit 5.9-2)\n- 78 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.7c (10) Copy of Twenty-third Amendment to Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated as of November 1, 1990, amending Exhibit 10.7a. (Exhibit 10.8ab) (10) 10.8a (4) Copy of Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of September 1, 1973, among The Connecticut Light and Power Company, The Hartford Electric Light Company, Western Massachusetts Electric Company, New England Power Company, The United Illuminating Company, Public Service Company of New Hampshire, Central Vermont Public Service Company, Montaup Electric Company and Fitchburg Gas and Electric Light Company, relating to a nuclear fueled generating unit in Connecticut. (Exhibit 5.8-1) (10) 10.8b (17) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of August 1, 1974, amending Exhibit 10.8a. (Exhibit 5.9-2) (10) 10.8c (5) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of December 15, 1975, amending Exhibit 10.8a. (Exhibit 5.8-4, Post-effective Amendment No. 2) (10) 10.9a (3) Copy of Transmission Line Agreement, dated January 13, 1966, between the Trustees of the Property of The New York, New Haven and Hartford Railroad Company and The United Illuminating Company. (Exhibit 5.4) (10) 10.9b (1) Notice, dated April 24, 1978, of The United Illuminating Company's intention to extend term of Transmission Line Agreement dated January 13, 1966, Exhibit 10.9a. (Exhibit 10.9b) (10) 10.9c (1) Copy of Letter Agreement, dated March 28, 1985, between The United Illuminating Company and National Railroad Passenger Corporation, supplementing and modifying Exhibit 10.9a. (Exhibit 10.9c) (10) 10.10 (12) Copy of Agreement, effective May 16, 1992, between The United Illuminating Company and Local 470-1, Utility Workers Union of America, AFL-CIO. (Exhibit 10.10) (10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested) (10) 10.12 (12) Copy of Coal Sales Agreement, dated as of August 1, 1992, between Pittston Coal Sales Corp. and The United Illuminating Company. (Confidential treatment requested) (Exhibit 10.13) (10) 10.13 (10) Copy of Fossil Fuel Supply Agreement between BLC Corporation and The United Illuminating Company, dated as of July 1, 1991. (Exhibit 10.31) (10) 10.14a (9) Copy of Lease, dated as of December 1, 1984, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee. (Exhibit 10.22a) (10) 10.14b (12) Copy of Amendment, dated as of February 15, 1987, to Lease between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16b) (10) 10.14c (12) Copy of Second Amendment to Lease, dated as of December 9, 1987, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16c) (10) 10.14d (12) Copy of Third Amendment to Lease, dated as of January 14, 1988, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16d)\n- 79 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.15a (12) Copy of Revolving Credit Agreement, dated as of January 25, 1993, among The United Illuminating Company, the Banks named therein, and Citibank, N.A., as Agent for the Banks. (Exhibit 10.19) (10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995. (10) 10.16a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Richard J. Grossi. (Exhibit 10.22a) (10) 10.16b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Richard J. Grossi, amending Exhibit 10.22a. (Exhibit 10.26a) (10) 10.17a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Robert L. Fiscus. (Exhibit 10.23a) (10) 10.17b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Robert L. Fiscus, amending Exhibit 10.23a. (Exhibit 10.27a) (10) 10.18a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and James F. Crowe. (Exhibit 10.24a) (10) 10.18b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and James F. Crowe, amending Exhibit 10.24a. (Exhibit 10.28a) (10) 10.19* (1) Copy of Executive Incentive Compensation Program of The United Illuminating Company. (Exhibit 10.24) (10) 10.21a* (19) Copy of The United Illuminating Company 1990 Stock Option Plan. (Exhibit 10.33) (10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22, 1993 and January 24, 1994. (21) 21 List of subsidiaries of The United Illuminating Company. (28) 28.1 (12) Copies of significant rate schedules of The United Illuminating Company. (Exhibit 28.1)\n- ----------------------- *Management contract or compensatory plan or arrangement.\nThe foregoing list of exhibits does not include instruments defining the rights of the holders of certain long-term debt of the Company and its subsidiaries where the total amount of securities authorized to be issued under the instrument does not exceed ten (10%) of the total assets of the Company and its subsidiaries on a consolidated basis; and the Company hereby agrees to furnish a copy of each such instrument to the Securities and Exchange Commission on request.\n(b) Reports on Form 8-K.\nItems Financial Statements Date of Reported Filed Report - -------- -------------------- -------\n5 None December 22, 1993\n- 80 -\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe consent to the incorporation by reference in the Registration Statement of The United Illuminating Company on Form S-3 (File No. 33-50221) and the Registration Statement on Form S-3 (File No. 33-50445) of our report, dated January 24, 1994, on our audits of the consolidated financial statements and financial statement schedules of The United Illuminating Company as of December 31, 1993, 1992 and 1991 and for the years then ended, which report is included in this Annual Report on Form 10-K.\n\/s\/ COOPERS & LYBRAND\nHartford, Connecticut February 15, 1994\n- 81 -\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE UNITED ILLUMINATING COMPANY\nBy \/s\/ Richard J. Grossi ------------------------------ Richard J. Grossi Chairman of the Board of Directors and Chief Executive Officer\nDate: February 18, 1994 -----------------\nPursuant 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 and on the dates indicated.\nSignature Title Date --------- ----- ---- Director, Chairman of the Board of Directors and \/s\/ Richard J. Grossi Chief Executive Officer February 18, 1994 - --------------------- (Richard J. Grossi) (Principal Executive Officer)\nDirector, President and \/s\/ Robert L. Fiscus Chief Financial Officer February 18, 1994 - --------------------- (Robert L. Fiscus) (Principal Financial and Accounting Officer)\n\/s\/ John D. Fassett Director February 18, 1994 - -------------------- (John D. Fassett)\n\/s\/ Leland W. Miles Director February 18, 1994 - -------------------- (Leland W. Miles)\n\/s\/ William S. Warner Director February 18, 1994 - ---------------------- (William S. Warner)\n\/s\/ John F. Croweak Director February 18, 1994 - -------------------- (John F. Croweak)\n\/s\/ F. Patrick McFadden, Jr. Director February 18, 1994 - ----------------------------- (F. Patrick McFadden, Jr.)\n\/s\/ J. Hugh Devlin Director February 18, 1994 - ------------------- (J. Hugh Devlin)\n\/s\/ Betsy Henley-Cohn Director February 18, 1994 - ---------------------- (Betsy Henley-Cohn)\nDirector February , 1994 - ------------------------ (Frank R. O'Keefe, Jr.)\n\/s\/ James A. Thomas Director February 18, 1994 - ---------------------- (James A. Thomas)\n\/s\/ David E.A. Carson Director February 18, 1994 - ---------------------- (David E.A. Carson)\n- 82 -\nS-1\nS-2\nS-3\nS-4\nS-5\nEXHIBIT INDEX\n(a) Exhibits\nExhibit Table Item Exhibit Number Number Description Page No. ---------- ------- ----------- --------\n(4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1.\n(10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a.\n(10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a.\n(10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested)\n(10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995.\n(10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22,1993 and January 24, 1994.\n(21) 21 List of subsidiaries of The United Illuminating Company.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nMAJOR INFLUENCES ON FINANCIAL CONDITION\nThe Company's financial condition should continue to improve as a result of the December 16, 1992 rate decision by the DPUC. The DPUC decision granted levelized rate increases of 2.66% ($15.8 million) in 1993 and 2.66% (an additional $17.3 million) in 1994.\nHowever, the Company's financial condition will continue to be dependent on the level of retail and wholesale sales. The two primary factors that affect sales volume are economic conditions and weather. The regional recession has restricted retail sales growth and been largely responsible for a weak wholesale sales market during the past two years. Sales increases due to economic recovery would help to increase the Company's earnings.\nAnother major factor affecting the Company's financial condition will be the Company's ability to control expenses. A significant reduction in interest expense has been achieved since 1989, and additional savings of $10 million are expected in 1994 due to debt refinancing. Since 1990, annual growth in total operation and maintenance expense, excluding one-time items and cogeneration capacity purchases, has averaged approximately 2.7%, and the Company hopes to restrict future increases to less than the rate of inflation.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's capital requirements are presently projected as follows:\nThe Company presently estimates that its cash on hand and temporary cash investments at the beginning of 1994, totaling $48.2 million, and its projected net cash provided by operations, less dividends, of $102 million, less capital expenditures of $73.4 million, will be insufficient to fund the Company's 1994 requirements for long-term debt maturities and mandatory redemptions and repayments, amounting to $113.3 million, by $36 million. The Company currently anticipates that its projected net cash provided by operations, less dividends and capital expenditures, for 1995 will be insufficient to fund the Company's 1995 requirements for long-term debt maturities and mandatory redemptions and repayments, by approximately $138 million. The Company currently anticipates that its projected net cash provided by operations, less dividends and capital expenditures, for 1996 through 1998 will be insufficient to fund the Company's requirements for long-term debt maturities and mandatory redemptions and repayments in the years 1996 through 1998, in amounts that cannot now be predicted accurately, but which may be substantial in the aggregate, depending on the levels of the Company's sales, wholesale and retail rates, operation and maintenance costs and taxes. All of the Company's capital requirements that exceed available net cash will have to be provided by external financing; and the Company has no commitment to provide such financing from any source of funds. The Company expects to be able to satisfy its external financing needs by issuing common stock and additional short-term and long-term debt, although the continued availability of these methods of financing will be dependent on many factors, including conditions in the securities markets, economic conditions, and the level of the Company's income and cash flow.\n- 34 -\nAt December 31, 1993, the Company had $48.2 million of cash and temporary cash investments, an increase of $37.1 million from the balance at December 31, 1992. The components of this increase, which are detailed in the Consolidated Statement of Cash Flows, are summarized as follows:\nThe Company has a revolving credit agreement with a group of banks, which currently extends to January 19, 1995. The borrowing limit of this facility is $75 million. The facility permits the Company to borrow funds at a fluctuating interest rate determined by the prime lending market in New York, and also permits the Company to borrow money for fixed periods of time specified by the Company at fixed interest rates determined by the Eurodollar interbank market in London, by the certificate of deposit market in New York, or by bidding, at the Company's option. If a material adverse change in the business, operations, affairs, assets or condition, financial or otherwise, or prospects of the Company and its subsidiaries, on a consolidated basis, should occur, the banks may decline to lend additional money to the Company under this revolving credit agreement, although borrowings outstanding at the time of such an occurrence would not then become due and payable. As of December 31, 1993, the Company had no short-term borrowings outstanding under this facility.\nThe Company's long-term debt instruments do not limit the amount of short-term debt that the Company may issue. The Company's revolving credit agreement described in the previous paragraph requires it to maintain an available earnings\/interest charges ratio of not less than 1.5:1.0 for each 12-month period ending on the last day of each calendar quarter.\nThe Company had a $50 million term loan facility with a group of banks during 1993. Under this agreement, the Company chose an interest rate from among three alternatives: (i) a fluctuating interest rate determined by the prime lending market in New York; (ii) a fixed interest rate determined by the Eurodollar interbank market in London; and (iii) a fixed interest rate determined by the certificate of deposit market in New York. On February 1, 1993, the Company borrowed $50 million from this group of banks, using the proceeds to repay short-term borrowings and other current obligations. On December 3, 1993, the Company repaid the $50 million borrowing and terminated the agreement.\nThe Company had a term loan agreement with PruLease, Inc. (PruLease) that expired on December 1, 1993. This agreement was executed on December 31, 1992, when the Company borrowed $49.1 million from PruLease and purchased all the nuclear fuel that was owned by PruLease and leased to the Company on that date. This\n- 35 -\nloan, which was collateralized by a first lien on the Company's ownership interest in the nuclear fuel for Seabrook Unit 1, was repaid in full at maturity.\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\nUI has four wholly-owned subsidiaries. Bridgeport Electric Company, a single-purpose corporation, owns and leases to UI a generating unit at Bridgeport Harbor Station. Research Center, Inc. (RCI) has been formed to participate in the development of one or more regulated power production ventures, including possible participation in arrangements for the future development of independent power production and cogeneration facilities. United Energy International, Inc. (UEI) has been formed to facilitate participation in a proposed joint venture relating to power production plants abroad. United Resources, Inc. (URI) serves as the parent corporation for several unregulated businesses, each of which is incorporated separately to participate in business ventures that will complement and enhance UI's electric utility business and serve the interests of the Company and its shareholders and customers.\nFour wholly-owned subsidiaries of URI have been incorporated. Souwestcon Properties, Inc. is participating as a 25% partner in the ownership of a medical hotel building in New Haven. A second wholly-owned subsidiary of URI is Thermal Energies, Inc., which is participating in the development of district heating and cooling water facilities in the downtown New Haven area, including the energy center for an office tower and participation as a 37% partner in the energy center for a new city hall and office tower complex. A third URI subsidiary, Precision Power, Inc., provides power-related equipment and services to the owners of commercial buildings and industrial facilities. A fourth URI subsidiary, American Payment Systems, Inc., manages agents and equipment for electronic data processing of bill payments made by customers of utilities, including UI, at neighborhood businesses. In addition to these subsidiaries, URI also has an 82% ownership interest in Ventana Corporation (Ventana), which offers energy conservation engineering and project management services to governmental and private institutions. In September 1993, URI recorded a $1.2 million after-tax write off of outstanding debt owed to URI by Ventana, which represented the difference between the amount owed to URI by Ventana and the value of an additional equity interest in Ventana received by URI in November 1993. This additional equity interest in Ventana was received in exchange for the forgiveness of debt owed to URI by Ventana.\nThe Board of Directors of the Company has authorized the investment of a maximum of $13.5 million, in the aggregate, of the Company's assets in all of URI's ventures, UEI and RCI, and, at December 31, 1993, approximately $10.6 million had been so invested.\nRESULTS OF OPERATIONS\n1993 vs. 1992 - -------------\nEarnings for the year 1993 were $36.2 million, or $2.57 per share, down $16.3 million, or $1.19 per share, from 1992. This decrease reflects a one-time reorganizational charge of approximately $7.8 million after-tax, or $.56 per share, and the non-recurrence of one-time gains of $.59 per share in 1992. Earnings per share for 1993, excluding one-time items and accounting changes, decreased by $.04 per share, to $3.13 per share from $3.17 per share for 1992.\n- 36 -\nSales margin increased by $10.3 million for the year. Retail revenues increased $36.6 million; $20.7 million from a recent rate decision ($12.1 million from rate changes and $13.2 million for the fold-in to base rates of the 1992 sales adjustment revenues, partly offset by the pass through to customers of expense credits of $4.6 million), and $15.9 million from increased retail sales. Retail sales increased by 2.7%, mostly due to a return to more normal summer weather.\nThe retail revenue increases were offset by anticipated reductions of $21 million from the sales adjustment provision and $13.7 million in wholesale capacity revenues. Other operating revenues decreased by $0.3 million. Reductions in wholesale energy revenues of $15.8 million were directly offset by reductions in energy expense.\nOther factors affecting sales margin were lower retail fuel expense, increasing margin by $9.4 million, and higher revenue related taxes, decreasing margin by $0.6 million.\nOther operation and maintenance expenses, including purchased capacity charges, increased by $10.2 million, or 4.5%, in 1993 relative to 1992. Major generating station overhauls and unscheduled repairs accounted for $5.2 million of this increase. Employment costs increased by $4.0 million, most of which resulted from the adoption of a liability for postretirement benefits other than pensions that the implementation of Statement of Financial Accounting Standards (SFAS) No. 106 requires to be accrued over employees' careers. Purchased capacity charges (cogeneration and Connecticut Yankee power purchases) for 1993 increased by $4.0 million, transmission costs increased by $2.4 million; but other nuclear operation and maintenance expenses decreased by $4.0 million.\nOther operating expenses, including income taxes but excluding a 1993 fourth quarter one-time reorganization charge, decreased by $20.3 million in 1993 from 1992, as the effect of accounting treatments ordered in recent rate decisions for recovery of canceled plant, the flow-through to income of certain income tax benefits and lower property taxes more than offset increases in depreciation expense.\nOther income declined by $23 million in 1993 from 1992, $9.4 million of which was attributable to the absence of net one-time gains realized in 1992. The remainder was due primarily due to an expected decline in deferred revenue and income tax benefits associated with the DPUC's 1992 rate decision, offset, in part, by lower interest charges of $9.3 million. \"Net\" interest margin (interest income less interest expense) improved by $6.6 million in 1993 over 1992.\n1992 vs. 1991 - -------------\nEarnings for 1992 were $52.4 million, or $3.76 per share, up $1.4 million, or $.09 per share, over 1991. Earnings per share for 1992, excluding one-time items and accounting changes, increased by $.27, to $3.17 from $2.90 per share for 1991. Non-recurring earnings declined to a level of $.59 per share in 1992 from $.77 per share in 1991.\nOperating revenues in 1992, exclusive of retail and wholesale fuel recovery revenue, were up $4.3 million over 1991 levels, adding $.18 per share after taxes. Increased rates provided only $11 million of an expected annual $15 million revenue increase, because commercial and industrial customers shifted into lower priced time-of-use rates. An additional $6 million of revenue was accrued under the terms of the sales adjustment provisions of the Company's 1990 rate decision by the Department of Public Utility Control (DPUC). Retail sales volume declined 1.6% from the prior year, reducing retail revenues by $10.6 million and sales margin (revenue minus fuel expense and revenue-based taxes) by $7.4 million. Most of this decline reflected the cool, wet weather for the summer of 1992. On a weather-adjusted basis, retail sales were about even with 1991. Wholesale capacity sales declined by $2.1 million for the year, reflecting the end of a major contract in October 1992.\nOther sales margin improvements were derived from increased nuclear generation, which added $10.5 million to margin in 1992 over 1991. An overall capacity factor of 76% for the nuclear units was achieved in 1992, compared to 65% for 1991. Offsetting this gain, the Company experienced unusually low and intermittent demand by the New England Power Pool for the operation of the Company's fossil generating units, thus\n- 37 -\ndegrading their efficiency, increasing fuel expense and decreasing sales margin by $2.5 million from 1991. These amounts are not recoverable through the fuel adjustment clause.\nOperation, maintenance and capacity expense for 1992 nuclear generation declined only $1.7 million from 1991 levels, compared to a savings of $4-5 million the Company originally expected to realize (principally from reduced Seabrook expenses). Other operation and maintenance expenses, excluding fuel and energy expenses, increased by $2.6 million for the year (excluding net non-recurring charges for 1992).\nOther taxes increased by $3.7 million (excluding a one-time charge in 1991), reflecting primarily the increased property tax placed on Seabrook by the State of New Hampshire. Depreciation increased by $2.5 million in 1992 over 1991. Net changes in interest income and expense added $2.9 million to pre-tax income in 1992, excluding one-time credits in 1991 and 1992. Reductions in plant balances not in rate base (Seabrook and other) led to reductions in deferred revenue of about $4 million after-tax.\nNon-recurring items decreased by $.18 per share compared to 1991 levels, to a net earnings figure of $.59 per share. In 1992, a net $2.7 million in income, or $.19 per share, was booked for Seabrook Unit 1 adjustments; $3.6 million, or $.26 per share, in non-operating income tax credits were realized; a net $3.0 million in income, or $.21 per share, from a gain on the sale of property was realized; and there were one-time charges to operating expenses of a net $1.0 million, for a loss of $.07 per share.\nOUTLOOK\nThe Company's financial condition should continue to improve as a result of the December 16, 1992 retail rate decision by the DPUC. The DPUC decision granted levelized rate increases of 2.66% ($15.8 million) in 1993 and 2.66% (an additional $17.3 million) in 1994. However, the Company did not realize the full anticipated benefit of the 1993 rate increase, realizing about $4 million less than awarded due to differences between the sales realized in individual rate classes and the sales projections used for rate case purposes. The differences arose principally from rate class shifting by customers and differential growth in sales among rate classes. A similar shortfall may develop in 1994.\nThe Company's financial condition will continue to be dependent on the level of retail and wholesale sales. The two primary factors that affect sales volume are economic conditions and weather. The regional recession has restricted retail sales growth and been largely responsible for a weak wholesale sales market during the past two years. Sales increases due to economic recovery would help to increase the Company's earnings. A 1% increase in sales would add about $6 million in revenue and about $5 million in sales margin (revenue minus fuel expense and revenue- based taxes). Wholesale capacity sales are expected to be approximately $6 million in 1994.\nAnother major factor affecting the Company's financial condition will be the Company's ability to control expenses. Fuel expense, excluding wholesale fuel expense, is expected to decline by approximately $2.3 million in 1994 from the 1993 level, reflecting significantly lower nuclear fuel prices. Also, significant reductions in interest expense have been achieved since 1989, and additional savings of $10 million are expected in 1994 due to debt refinancing. For 1994, operation and maintenance expenses are expected to increase from normal inflationary pressures, but these increases should be substantially offset by savings from the phase-in of the Company's corporate structure reorganization. Since 1990, annual growth in total operation and maintenance expense, excluding one-time items and cogeneration capacity purchases, has averaged approximately 2.7%, and the Company hopes to restrict future increases to less than the rate of inflation.\nThe final portion of the cost of Seabrook Unit 1 has been added to rate base (and retail revenues) for 1994. This will eliminate deferred revenues and reduce net income by $7.4 million after-tax in 1994 from 1993 levels.\nAlthough the Company believes that its financing outlook and plans are unlikely to be adversely affected by further developments with respect to the licensing and operation of Seabrook Unit 1, the Company's financial status and financing capability will continue to be sensitive to any such developments and to many other factors, including conditions in the securities markets, economic conditions, the level of the Company's income and cash\n- 38 -\nflow, and legislative and regulatory developments, including the cost of compliance with increasingly stringent environmental legislation and regulations and competition within the electric utility industry.\nINFLATION\nAs a result of inflation and increased environmental and regulatory requirements, the estimated cost of replacing the Company's productive capacity today would substantially exceed the historical cost of such facilities reported in the financial statements. Since the Company's rates for service to its customers have been based in the past on the cost of providing such service and have been revised from time to time to reflect increased costs of service, the Company believes that any higher replacement costs it may experience in the future will be recovered through the normal regulatory process.\n- 39 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 40 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 41 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 42 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 43 -\nThe accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.\n- 44 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(A) STATEMENT OF ACCOUNTING POLICIES\nAccounting Records\nThe accounting records are maintained in accordance with the uniform systems of accounts prescribed by the Federal Energy Regulatory Commission (FERC) and the Connecticut Department of Public Utility Control (DPUC).\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Bridgeport Electric Company (BEC), United Resources Inc., United Energy International, Inc. and Research Center, Inc. Intercompany accounts and transactions have been eliminated in consolidation.\nReclassification of Previously Reported Amounts\nCertain amounts previously reported have been reclassified to conform with current year presentations.\nUtility Plant\nThe cost of additions to utility plant and the cost of renewals and betterments are capitalized. Cost consists of labor, materials, services and certain indirect construction costs, including an allowance for funds used during construction (AFUDC). The cost of current repairs and minor replacements is charged to appropriate operating expense accounts. The original cost of utility plant retired or otherwise disposed of and the cost of removal, less salvage, are charged to the accumulated provision for depreciation.\nAllowance for Funds Used During Construction\nIn accordance with the applicable regulatory systems of accounts, the Company capitalizes AFUDC, which represents the approximate cost of debt and equity capital devoted to plant under construction. In accordance with FERC prescribed accounting, the portion of the allowance applicable to borrowed funds is presented in the Consolidated Statement of Income as a reduction of interest charges, while the portion of the allowance applicable to equity funds is presented as other income. Although the allowance does not represent current cash income, it has historically been recoverable under the ratemaking process over the service lives of the related properties. The Company compounds semi-annually the allowance applicable to major construction projects. AFUDC rates in effect for 1993, 1992 and 1991 were 8.75%, 10.25% and 10.88%, respectively.\nDepreciation\nProvisions for depreciation on utility plant for book purposes, excluding costs associated with the 1984 reconversion of BEC's plant to a dual-fired capability, are computed on a straight-line basis, using estimated service lives determined by independent engineers. One-half year's depreciation is taken in the year of addition and disposition of utility plant, except in the case of major operating units on which depreciation commences in the month they are placed in service and ceases in the month they are removed from service. During the years 1985-1989, depreciation associated with BEC's reconversion costs was computed on an annuity basis over the original ten-year period that this plant was being leased to the Company by BEC. Commencing January 1, 1990, the reconversion costs are being depreciated on a straight-line basis over a period ending July 2000. The aggregate annual provisions for depreciation for the years 1993, 1992 and 1991 were equivalent to approximately 3.22%, 3.15% and 3.10%, respectively, of the original cost of depreciable property.\n- 45 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIncome Taxes\nEffective January 1, 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes\". In accordance with SFAS 109, the Company has provided deferred taxes for all temporary book-tax differences using the liability method. The liability method requires that deferred tax balances be adjusted to reflect enacted future tax rates that are anticipated to be in effect when the temporary differences reverse. In accordance with generally accepted accounting principles for regulated industries, the Company has established a net regulatory asset that reflects anticipated future recovery in rates of these deferred tax provisions.\nFor ratemaking purposes, the Company practices full normalization for all investment tax credits (ITC) related to recoverable plant investments except for the ITC related to Seabrook Unit 1, which was taken into income in accordance with provisions of the 1989 Settlement Agreement.\nAccrued Utility Revenues\nThe estimated amount of utility revenues (less related expenses and applicable taxes) for service rendered but not billed is accrued at the end of each accounting period.\nCash and Cash Equivalents\nFor cash flow purposes, the Company considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash equivalents.\nThe Company is required to maintain an operating deposit with the project disbursing agent related to its 17.5% ownership interest in Seabrook Unit 1. This operating deposit, which is the equivalent to one and one half months of the funding requirement for operating expenses, is restricted for use and amounted to $3.4 million, $2.9 million, and $1.8 million at December 31, 1993, 1992 and 1991, respectively.\nInvestments\nThe Company's investment in the Connecticut Yankee Atomic Power Company joint venture, a nuclear generating company in which the Company has a 9 1\/2% stock interest, is accounted for on an equity basis.\nFossil Fuel Costs\nThe amount of fossil fuel costs that cannot be reflected currently in customers' bills pursuant to the FCA in the Company's rates is deferred at the end of each accounting period. Since adoption of the deferred accounting procedure in 1974, rate decisions by the DPUC and its predecessors have consistently made specific provision for amortization and rate-making treatment of the Company's existing deferred fossil fuel cost balances.\nResearch and Development Costs\nResearch and development costs, including environmental studies, are capitalized if related to specific construction projects and depreciated over the lives of the related assets. Other research and development costs are charged to expense as incurred.\nPension and Other Post-Employment Benefits\nThe Company accounts for normal pension plan costs in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 87, \"Employers' Accounting for Pensions\", and for supplemental\n- 46 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nretirement plan costs and supplemental early retirement plan costs in accordance with the provisions of SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits\".\nPrior to January 1, 1993, the Company accounted for other post- employment benefits, consisting principally of health and life insurance, on a pay-as-you-go basis. Effective January 1, 1993, the Company commenced accounting for these costs under the provisions of SFAS No. 106, \"Employers' Accounting for Post- Retirement Benefits Other than Pensions\", which requires, among other things, that the liability for such benefits be accrued over the employment period that encompasses eligibility to receive such benefits. The annual incremental cost of this accounting change has been allowed in retail rates in accordance with a 1992 rate decision.\nUranium Enrichment Obligation\nUnder the Energy Policy Act of 1992 (Energy Act), the Company will be assessed for its proportionate share of the costs of the decontamination and decommissioning of uranium enrichment facilities operated by the Department of Energy. The Energy Act imposes an overall cap of $2.25 billion on the obligation assessed to the nuclear utility industry and limits the annual assessment to $150 million each year over a 15-year period. At December 31, 1993, the Company's unfunded share of the obligation, based on its ownership interest in Seabrook Unit 1 and Millstone Unit 3, was approximately $1.5 million. Effective January 1, 1993, the Company was allowed to recover these assessments in rates as a component of fuel expense. Accordingly, the Company has recognized these costs as a regulatory asset on its Consolidated Balance Sheet.\nNuclear Decommissioning Trusts\nExternal trust funds are maintained to fund the estimated future decommissioning costs of the nuclear generating units in which the Company has an ownership interest. These costs are accrued as a charge to depreciation expense over the estimated service lives of the units and are recovered in rates on a current basis. The Company paid $1,616,000, $1,334,000 and $1,011,000 during 1993, 1992 and 1991 into the decommissioning trust funds for Seabrook Unit 1 and Millstone Unit 3. At December 31, 1993, the Company's share of the trust fund balances, which include accumulated earnings on the funds, were $3.7 million and $1.9 million for Seabrook Unit 1 and Millstone Unit 3, respectively. These fund balances are included in \"Other Property and Investments\" and the accrued decommissioning obligation is included in \"Noncurrent Liabilities\" on the Company's Consolidated Balance Sheet.\n- 47 -\n- 48 -\n- 49 -\n- 50 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(a) Common Stock\nThe Company issued 46,000 shares of common stock in 1993, 100,800 shares of common stock in 1992 and 44,600 shares of common stock in 1991 pursuant to a stock option plan. During 1993, the Company also issued 4,143 shares of common stock pursuant to a long-term incentive program.\nCommon stock, no par value, authorized at December 31, 1993, included 400,000 shares reserved for the Company's Employee Stock Ownership Plan (ESOP). There were no additions to ESOP in 1991, 1992 or 1993.\nThe Company purchased on the open market, on behalf of shareholders participating in the common stock Dividend Reinvestment Plan, 148,362 shares of stock in 1991, 136,679 shares of stock in 1992 and 138,145 shares of stock in 1993.\nIn 1990, the Company's Board of Directors and the shareowners approved a stock option plan for officers and key employees of the Company. The plan provides for the awarding of options to purchase up to 750,000 shares of the Company's common stock over periods of from one to ten years following the dates when the options are granted. On June 5, 1991, the DPUC approved the issuance of 500,000 shares of stock pursuant to this plan. The exercise price of each option cannot be less than the market value of the stock on the date of the grant. Options to purchase 214,000 shares of stock at an exercise price of $30.75 per share, 2,800 shares of stock at an exercise price of $28.3125 per share, 1,800 shares of stock at an exercise price of $31.1875 per share, 4,000 shares of stock at an exercise price of $35.625 per share, 36,200 shares of stock at an exercise price of $39.5625 per share and 5,000 shares of stock at an exercise price of $42.375 per share have been granted by the Board of Directors and remain outstanding at December 31, 1993. Options to purchase 44,600 shares of stock at an exercise price of $30.75 were exercised during 1991. Options to purchase 98,000 shares of stock at an exercise price of $30.75 and 2,800 shares of stock at an exercise price of $28.3125 were exercised during 1992. Options to purchase 42,400 shares of stock at an exercise price of $30.75 per share, 1,400 shares of stock at an exercise price of $28.3125 per share, 1,200 shares of stock at an exercise price of $31.1875 per share and 1,000 shares of stock at an exercise price of $35.625 per share were exercised during 1993.\nIn addition, certain executive officers were eligible to earn shares of the Company's common stock, based upon the dividend and market performance of the stock compared to a peer group of electric utilities over a four-year period ending December 31, 1992, under the Company's long-term incentive program. The issuance of shares of stock pursuant to this program received DPUC approval on June 5, 1991. The total number of shares of common stock that could have been earned under the long-term incentive program was limited to 7,091. For the four-year period ending December 31, 1992, 6,027 shares of the Company's common stock were earned. Of this amount, a total of 4,143 shares were issued to the participants in 1993, and the remainder was distributed in an equivalent amount of cash based on the closing price of the Company's Common Stock on March 1, 1993, pursuant to the terms of the long-term incentive program. This program ended as of December 31, 1992.\n(b) Retained Earnings Restriction\nThe indenture under which the Company's Medium-Term Notes and Notes are issued places limitations on the payment of cash dividends on common stock and on the purchase or redemption of common stock. Retained earnings in the amount of $82.6 million were free from such limitations at December 31, 1993.\n(c) Preferred and Preference Stock\nThe par value of each of these issues was credited to the appropriate stock account and expenses related to these issues were charged to capital stock expense.\n- 51 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn 1991, the Company purchased and cancelled shares of its $100 par value Preferred Stock, at a discount, resulting in a non-taxable addition to common equity of approximately $3,304,000. The 1991 purchases consisted of:\n9,575 shares of 4.35% Preferred Stock, Series A 7,320 shares of 4.72% Preferred Stock, Series B 39,900 shares of 4.64% Preferred Stock, Series C 13,800 shares of 5 5\/8% Preferred Stock, Series D\nIn 1992, the Company purchased and cancelled 16,950 shares of its $100 par value 4.72% Preferred Stock, Series B, at a discount, resulting in a non-taxable addition to common equity of approximately $796,650.\nThere was no redemption of preferred stock in 1993.\nShares of preferred stock have preferential dividend and liquidation rights over shares of common stock. Preferred shareholders are not entitled to general voting rights. However, if any preferred dividends are in arrears for six or more quarters, or if some other event of default occurs, preferred shareholders are entitled to elect a majority of the Board of Directors until all preferred dividend arrears are paid and any event of default is terminated.\nPreference stock is a form of stock that is junior to preferred stock but senior to common stock. It is not subject to the earnings coverage requirements or minimum capital and surplus requirements governing the issuance of preferred stock. There were no shares of preference stock outstanding at December 31, 1993.\n(d) Long-Term Debt\nIn January 1993, the net proceeds from the liquidation of an investment in tax-exempt municipal debt instruments were used to pay $60 million principal amount of maturing 10.32% First Mortgage Bonds of the Company's wholly-owned subsidiary, Bridgeport Electric Company; to repay a $7.5 million 13.1% term loan; to repay short- term borrowings incurred for the August 1, 1992 redemption of the Company's 12% Debentures, due August 1, 2017, and for repayment of a $7.5 million 12.9% term loan on September 30, 1992; and to repay short-term borrowings incurred for a $19.1 million rent payment on December 31, 1992 under the Company's facility sale and leaseback arrangement for a portion of its ownership interest in Seabrook Unit 1.\nOn September 30, 1993, the Company repaid a $5 million 12.9% term loan with funds obtained through short-term borrowings.\nOn September 17, 1993, the Company invited the owners of $68,400,000 aggregate principal amount of 14 1\/2% Pollution Control Revenue Bonds, due October 1 and December 1, 2009, (\"Bonds\") to sell to the Company, for cash, any and all of the Bonds. The Bonds were issued in 1984 by The Industrial Development Authority of the State of New Hampshire (\"NHIDA\"), which loaned the issue proceeds to the Company to pay for the cost of installing pollution control facilities at the Seabrook nuclear generating plant in New Hampshire; and the Business Finance Authority of the State of New Hampshire (\"NHBFA\"), successor to the NHIDA, agreed to issue Pollution Control Refunding Revenue Bonds (\"Refunding Bonds\") in a principal amount equal to the aggregate principal amount of Bonds purchased by the Company and surrendered to the Bond trustee for cancellation, and to loan the issue proceeds of the Refunding Bonds to the Company to pay for part of the purchase price of the Bonds being purchased and cancelled. On October 15, 1993, the Company accepted offers from holders of $64,460,000 aggregate principal amount of the Bonds to sell them for an aggregate purchase price of $75,710,000. On October 26, 1993, the NHBFA issued and sold $64,460,000 principal amount of 5 7\/8% Refunding Bonds, due October 1, 2033, and loaned the issue proceeds to the Company, which used them to pay\n- 52 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\na portion of the purchase price of the Bonds. The remainder of the purchase price was funded with the proceeds of short-term borrowings.\nOn December 7, 1993, the Company issued and sold $100 million principal amount of five-year and one month Notes at a coupon rate of 6.20%. The net proceeds were used to repay $60 million principal amount of maturing 10.32% First Mortgage Bonds of the Company's wholly-owned subsidiary, Bridgeport Electric Company in January 1994; to repay a $5 million 13.1% term loan in January 1994 and for general corporate purposes, including repayment of short-term borrowings.\nMaturities and mandatory redemptions\/repayments and annual interest expense on existing long-term debt are set forth below:\n(C) RATE-RELATED REGULATORY PROCEEDINGS\nOn December 16, 1992, the DPUC approved levelized rate increases of 2.66% ($15.8 million) for 1993 and 2.66% (an additional $17.3 million) for 1994, including allowed conservation and load management revenue increases. The rate increases totaled $33.1 million, or 5.4%, over two years.\nIn order to achieve levelized 2.66% rate increases for each of these two years, the DPUC determined that the recovery of $13.1 million of sales adjustment clause revenues would be deferred from 1993 to 1994.\nUtilities are entitled by Connecticut law to revenues sufficient to allow them to cover their operating and capital costs, to attract needed capital and maintain their financial integrity, while also protecting the public interest. Accordingly, the DPUC's 1992 rate decision authorized a return on equity of 12.4% for ratemaking purposes. However, the Company may earn up to 1% above this level before a mandatory review is required by the DPUC.\n- 53 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nSince January 1971, UI has had a fossil fuel adjustment clause (FCA) in virtually all of its retail rates. The DPUC is required by law to convene an administrative proceeding prior to approving FCA charges or credits for each month. The law permits automatic implementation of the charges or credits if the DPUC fails to act within five days of the administrative proceeding, although all such charges and credits are also subject to further review and appropriate adjustment by the DPUC at public hearings required to be held at least every three months. The DPUC has made no material changes in UI's FCA charges and credits as the result of any of these proceedings or hearings.\n(D) ACCOUNTING FOR PHASE-IN PLAN\nThe Company has been phasing into rate base its allowable investment in Seabrook Unit 1, amounting to $640 million, since January 1, 1990. In conjunction with this phase-in plan, the Company has been allowed to record a deferred return on the portion of allowable investment excluded from rate base during the phase-in period. The accumulated deferred return has been added to rate base each year since January 1, 1991 in the same proportion as the phase-in installment for that year has borne to the portion of the $640 million remaining to be phased-in. On January 1, 1994, the Company phased into rate base the remaining $74.5 million of allowable investment, plus the remaining $28.2 million of accumulated deferred return. The Company will be allowed to recover the accumulated deferred return, amounting to $62.9 million, over a five-year period commencing January 1, 1995.\n- 54 -\n- 55 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nTotal income taxes differ from the amounts computed by applying the federal statutory tax rate to income before taxes. The reasons for the differences are as follows:\nAt December 31, 1993, the Company had deferred tax liabilities for taxable temporary differences of $574 million and deferred tax assets for deductible temporary differences of $149 million, resulting in a net deferred tax liability of $425 million. Significant components of deferred tax liabilities and assets were as follows: tax liabilities on book\/tax plant basis differences, $229 million; tax liabilities on the cumulative amount of income taxes on temporary differences previously flowed through to ratepayers, $163 million; tax liabilities on normalization of book\/tax depreciation timing differences, $89 million and tax assets on the disallowance of plant costs, $77 million.\nThe Tax Reform Act of 1986 provides for a more comprehensive corporate alternative minimum tax (AMT) for years beginning after 1986. To the extent that the AMT exceeds the federal income tax computed at statutory rates, the excess must be paid in addition to the regular tax liability. For tax purposes, the excess paid in any year can be carried forward indefinitely and offset against any future year's regular tax liability in excess of that year's tentative AMT. The AMT carryforward at December 31, 1993, 1992 and 1991 was $11.4 million, $11.3 million and $9.9 million, respectively.\n(F) SHORT-TERM CREDIT ARRANGEMENTS\nThe Company has a revolving credit agreement with a group of banks, which currently extends to January 19, 1995. The borrowing limit of this facility is $75 million. The facility permits the Company to borrow funds at a fluctuating interest rate determined by the prime lending market in New York, and also permits the Company to borrow money for fixed periods of time specified by the Company at fixed interest rates determined by the Eurodollar interbank market in London, by the certificate of deposit market in New York, or by bidding, at the\n- 56 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nCompany's option. If a material adverse change in the business, operations, affairs, assets or condition, financial or otherwise, or prospects of the Company and its subsidiaries, on a consolidated basis, should occur, the banks may decline to lend additional money to the Company under this revolving credit agreement, although borrowings outstanding at the time of such an occurrence would not then become due and payable. As of December 31, 1993, the Company had no short-term borrowings outstanding under this facility.\nThe Company's long-term debt instruments do not limit the amount of short-term debt that the Company may issue. The Company's revolving credit agreement described in the previous paragraph requires it to maintain an available earnings\/interest charges ratio of not less than 1.5:1.0 for each 12-month period ending on the last day of each calendar quarter.\nThe Company had a $50 million term loan facility with a group of banks during 1993. Under this agreement, the Company chose an interest rate from among three alternatives: (i) a fluctuating interest rate determined by the prime lending market in New York; (ii) a fixed interest rate determined by the Eurodollar interbank market in London; and (iii) a fixed interest rate determined by the certificate of deposit market in New York. On February 1, 1993, the Company borrowed $50 million from this group of banks, using the proceeds to repay short-term borrowings and other current obligations. On December 3, 1993, the Company repaid the $50 million borrowing and terminated the agreement.\nThe Company had a term loan agreement with PruLease, Inc. (PruLease) that expired on December 1, 1993. This agreement was executed on December 31, 1992, when the Company borrowed $49.1 million from PruLease and purchased all the nuclear fuel that was owned by PruLease and leased to the Company on that date. This loan, which was collateralized by a first lien on the Company's ownership interest in the nuclear fuel for Seabrook Unit 1, was repaid in full at maturity.\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\n- 57 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nInformation with respect to short-term borrowings is as follows:\n- 58 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\n(G) SUPPLEMENTARY INFORMATION\n- 59 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(H) PENSION AND OTHER POST-EMPLOYMENT BENEFITS\nThe Company's qualified pension plan, which is based on the highest three years of pay, covers substantially all of its employees, and its entire cost is borne by the Company. The Company also has a non-qualified supplemental plan for certain executives and a non-qualified retiree only plan for certain early retirement benefits. The net pension costs for these plans for 1993, 1992 and 1991 were $14,966,000, $5,749,000 and $2,054,000, respectively.\nThe Company's funding policy for the qualified plan is to make annual contributions that satisfy the minimum funding requirements of ERISA but which do not exceed the maximum deductible limits of the Internal Revenue Code. These amounts are determined each year as a result of an actuarial valuation of the Plan. In accordance with this policy, the Company will be contributing $3.3 million in 1994 for 1993 funding requirements. Previously, due to the application of the full funding limitation under ERISA, the Company had not been required to make a contribution since 1985. The supplemental plan is unfunded.\nThe qualified plan's irrevocable trust fund consists principally of equity and fixed-income securities and real estate investments in approximately the following percentages:\n- 60 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n- 61 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn addition to providing pension benefits, the Company also provides other postretirement benefits (OPEB), consisting principally of health care and life insurance benefits, for retired employees and their dependents. Employees with 25 years of service are eligible for full benefits, while employees with less than 25 years of service but greater than 15 years of service are entitled to partial benefits. Years of service prior to age 35 are not included in determining the number of years of service.\nPrior to January 1, 1993, the Company recognized the cost of providing OPEB on a pay-as-you-go basis by expensing the annual insurance premiums. These costs amounted to $1.3 million and $1.1 million for 1992 and 1991, respectively. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\", which requires, among other things, that OPEB costs be recognized over the employment period that encompasses eligibility to receive such benefits. In its December 16, 1992 decision on the Company's application for retail rate relief, the DPUC recognized the Company's obligation to adopt SFAS No. 106, effective January 1, 1993, and approved the Company's request for revenues to recover OPEB expenses on a SFAS No. 106 basis. A portion of these expenses represents the transition obligation, which will accrue over a 20-year period, representing the future liability for medical and life insurance benefits based on past service for retirees and active employees.\nFor funding purposes, the Company has established two Voluntary Employees' Benefit Association Trusts (VEBA) to fund OPEB for employees who retire on or after January 1, 1994; one VEBA for union employees and one for non-union employees. Approximately 52% of the Company's employees are represented by Local 470-1, Utility Workers Union of America, AFL-CIO, for collective bargaining purposes. The funding policy assumes contributions to these trust funds to be the total OPEB expense under SFAS No. 106, excluding the amount that resulted from the reorganization minus pay-as-you- go benefit payments for pre-January 1, 1994 retirees, allocated in a manner that minimizes current income tax liability, without exceeding maximum tax deductible limits. In accordance with this policy, the Company contributed approximately $3 million to the union VEBA on December 30, 1993. The Company currently plans to fund the portion of the OPEB expense that is related to the reorganization during the years 1994-1996.\nThe 1993 cost for OPEB includes the following components:\nA one percentage point increase in the assumed health care cost trend rate would have increased the service cost and interest cost components of the 1993 net cost of periodic postretirement benefit by approximately $445,000 and would increase the accumulated postretirement benefit obligation for health care benefits by approximately $2,421,000.\n- 62 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe following table reconciles the funded status of the plan with the amount recognized in the Consolidated Balance Sheet as of December 31, 1993:\nThe weighted average discount rate used to measure the accumulated postretirement benefit obligation was 7.5%.\nDuring 1993, in conjunction with a in-depth organizational review, the Company offered a voluntary early retirement program to non-union employees who were eligible to receive pension benefits. This offer was accepted by 103 employees. The 1993 OPEB cost for this program was $1.267 million. These costs are recognized as a component of the reorganizational charge shown on the Company's Consolidated Statement of Income.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Post-Employment Benefits\". This statement, which will be adopted during the first quarter of 1994, establishes accounting standards for employers who provide benefits, such as unemployment compensation, severance benefits and disability benefits, to former or inactive employees after employment but before retirement and requires recognition of the obligation for these benefits. The adoption of this new standard will result in a pre-tax charge against earnings amounting to approximately $2 million during the first quarter of 1994. Subsequent period costs are not expected to be material.\n- 63 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(I) JOINTLY OWNED PLANT\nAt December 31, 1993, the Company had the following interests in jointly owned plants:\nThe Company's share of the operating costs of jointly owned plants is included in the appropriate expense captions in the Consolidated Statement of Income.\n(J) UNAMORTIZED CANCELLED NUCLEAR PROJECT\nFrom December 1984 through December 1992, the Company had been recovering its investment in Seabrook Unit 2 over a regulatory approved ten-year period without a return on its unamortized investment. In the Company's 1992 rate decision, the DPUC adopted a proposal by the Company to write off its remaining investment in Seabrook Unit 2, beginning January 1, 1993, over a 24-year period, corresponding with the flowback of certain Connecticut Corporation Business Tax (CCBT) credits. Such decision will allow the Company to retain the Seabrook Unit 2\/CCBT amounts for ratemaking purposes, with the accumulated CCBT credits not deducted from rate base during the 24-year period of amortization in recognition of a longer period of time for amortization of the Seabrook Unit 2 balance.\n(K) FUEL FINANCING OBLIGATIONS AND OTHER LEASE OBLIGATIONS\nThe Company has a Fossil Fuel Supply Agreement with a financial institution providing for financing up to $37.5 million in fossil fuel purchases. Under this agreement, the financing entity acquires and stores natural gas, coal and fuel oil for sale to the Company, and the Company purchases these fossil fuels from the financing entity at a price for each type of fuel that reimburses the financing entity for the direct costs it has incurred in purchasing and storing the fuel, plus a charge for maintaining an inventory of the fuel determined by reference to the fluctuating interest rate on thirty-day, dealer-placed commercial paper in New York. The Company is obligated to insure the fuel inventories and to indemnify the financing entity against all liabilities, taxes and other expenses incurred as a result of its ownership, storage and sale of fossil fuel to the Company. This agreement currently extends to February 1995. At December 31, 1993, approximately $10.1 million of fossil fuel purchases were being financed under this agreement.\nThe Company has leases (some of which are capital leases), including arrangements for data processing and office equipment, vehicles, office space and oil tanks. The gross amount of assets recorded under capital leases and the related obligations of those leases as of December 31, 1993 are recorded on the balance sheet.\nFuture minimum lease payments under capital leases, excluding the Seabrook sale\/leaseback transaction, which is being treated as a long-term financing, are estimated to be as follows:\n- 64 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nCapitalization of leases has no impact on income, since the sum of the amortization of a leased asset and the interest on the lease obligation equals the rental expense allowed for ratemaking purposes.\nRental payments charged to operating expenses in 1993, 1992 and 1991 amounted to $14.1 million, $14.8 million and $14.9 million, respectively.\nOperating leases, which are charged to operating expense, consist of a large number of small, relatively short-term, renewable agreements for a wide variety of equipment.\n(L) COMMITMENTS AND CONTINGENCIES\nCapital Expenditure Program\nThe Company has entered into commitments in connection with its continuing capital expenditure program, which is presently estimated at approximately $366.5 million, excluding AFUDC, for 1994 through 1998.\nSeabrook\nAfter experiencing increasing financial stress beginning in May 1987, Public Service Company of New Hampshire (PSNH), which held the largest ownership share (35.6%) in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code in January of 1988. Under this statute, PSNH continued its operations while seeking a financial reorganization. A reorganization plan proposed by Northeast Utilities (NU) was confirmed by the bankruptcy court in April of 1990 and, on May 16, 1991, PSNH completed the financing required for payment of its pre-bankruptcy secured and unsecured debt under the first stage of the reorganization plan and emerged from bankruptcy. On May 19, 1992, the NRC issued the final regulatory approval necessary for the second stage of the NU reorganization plan, under which PSNH would be acquired by NU; and on June 5, 1992, this acquisition was completed. As part of the transaction, PSNH's ownership share of Seabrook Unit 1 was transferred to a wholly-owned subsidiary of NU. Two previous regulatory approvals of the NU reorganization plan for PSNH, by the Federal Energy Regulatory Commission (FERC) and the Securities and Exchange Commission (SEC), continue to be challenged in court proceedings, and the Company is unable to predict the outcome of these proceedings.\nOn February 28, 1991, EUA Power Corporation (EUA Power), the holder of a 12.1% ownership share in Seabrook, commenced a proceeding under Chapter 11 of the Bankruptcy Code. EUA Power, a wholly-owned subsidiary of Eastern Utilities Associates (EUA), was organized solely for the purpose of acquiring an ownership share in Seabrook and selling in the wholesale market its share of the electric power produced by Seabrook. EUA Power commenced this bankruptcy proceeding because the cash generated by its sales of power at current market prices was insufficient to pay its obligations on its outstanding debt. Subsequently, EUA Power's name\n- 65 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nwas changed to Great Bay Power Corporation (Great Bay). The official committee of Great Bay's bondholders (Bondholders Committee) has proposed, and the bankruptcy court has confirmed, a reorganization plan for Great Bay, under which substantially all of the equity ownership of Great Bay would pass to its bondholders. On February 2, 1994, the Bondholders Committee accepted a financing proposal that would inject $35 million of new ownership equity into Great Bay. The bankruptcy court must approve this structure before the Great Bay reorganization plan becomes effective. Further approvals are also required from the NRC, FERC and the New Hampshire Public Utilities Commission. The bankruptcy court has approved an agreement among Great Bay, the Bondholders Committee, UI and The Connecticut Light and Power Company (CL&P), under which up to $20 million in advance payments against their respective future monthly Seabrook payment obligations will be made available between UI and CL&P as needed until the reorganization plan becomes effective. UI's share of funding obligations under this agreement totals $8 million. As of December 31, 1993, $5.5 million had been advanced by UI under this agreement. At January 31, 1994, $602,000 of the Company's advances remained outstanding. This agreement can be terminated by UI and CL&P upon thirty days notice or upon failure of the reorganization process to achieve certain milestones by specified dates. UI is unable to predict what impact, if any, failure of the reorganization plan to become effective will have on the operating license for Seabrook Unit 1, or what other actions UI and the other joint owners of the unit may be required to take in response to developments in this bankruptcy proceeding as it may affect Seabrook.\nNuclear generating units are subject to the licensing requirements of the Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954, as amended, and a variety of other state and federal requirements. Although Seabrook Unit 1 has been issued a 40-year operating license, NRC proceedings and investigations prompted by inquiries from Congressmen and by NRC licensing board consideration of technical contentions may arise and continue for an indefinite period of time in the future.\nNuclear Insurance Contingencies\nThe Price-Anderson Act, currently extended through August 1, 2002, limits public liability resulting from a single incident at a nuclear power plant. The first $200 million of liability coverage is provided by purchasing the maximum amount of commercially available insurance. Additional liability coverage will be provided by an assessment of up to $75.5 million per incident, levied on each of the nuclear units licensed to operate in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. In addition, if the sum of all public liability claims and legal costs resulting from any nuclear incident exceeds the maximum amount of financial protection, each reactor operator can be assessed an additional 5% of $75.5 million, or $3.775 million. The maximum assessment is adjusted at least every five years to reflect the impact of inflation. Based on its interests in nuclear generating units, the Company estimates its maximum liability would be $20.3 million per incident. However, assessment would be limited to $3.1 million per incident, per year. With respect to each of the operating nuclear generating units in which the Company has an interest, the Company will be obligated to pay its ownership and\/or leasehold share of any statutory assessment resulting from a nuclear incident at any nuclear generating unit.\nThe NRC requires nuclear generating units to obtain property insurance coverage in a minimum amount of $1.06 billion and to establish a system of prioritized use of the insurance proceeds in the event of a nuclear incident. The system requires that the first $1.06 billion of insurance proceeds be used to stabilize the nuclear reactor to prevent any significant risk to public health and safety and then for decontamination and cleanup operations. Only following completion of these tasks would the balance, if any, of the segregated insurance proceeds become available to the unit's owners. For each of the nuclear generating units in which the Company has an interest, the Company is required to pay its ownership and\/or leasehold share of the cost of purchasing such insurance.\n- 66 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nOther Commitments and Contingencies\nHydro-Quebec\nThe Company is a participant in the Hydro-Quebec transmission intertie facility linking New England and Quebec, Canada. Phase II of this facility, in which UI has a 5.45% participating share, has increased the capacity value of the intertie from 690 megawatts to a maximum of 2000 megawatts. A ten-year Firm Energy Contract, which provides for the sale of 7 million megawatt-hours per year by Hydro-Quebec to the New England participants in the Phase II facility, became effective on July 1, 1991. The Company is obligated to furnish a guarantee for its participating share of the debt financing for the Phase II facility. Currently, the Company's guarantee liability for this debt amounts to approximately $9.8 million.\nReorganization Charge\nDuring 1993, the Company undertook an in-depth organizational review with the primary objective of improving customer service. As a result of this review, the Company eliminated approximately 75 positions.\nIn conjunction with this review, the Company offered a voluntary early retirement program to non-union employees who were eligible to receive pension benefits. The early retirement offer was accepted by 103 employees and the Company incurred a one-time charge to 1993 earnings of approximately $13.6 million ($7.8 million, after-tax). No decision has been made as to whether to offer a severance program to employees who may be affected by the organizational review when it is completed, but who were not eligible for, or did not accept, the early retirement offer.\nSite Remediation Costs\nThe Company has estimated that the cost of environmental remediation of its decommissioned Steel Point Station property in Bridgeport will be approximately $10.3 million and has recorded a liability for this cost. Following remediation, the Company intends to sell the property for development for a value it estimates will not exceed $6 million. In the Company's last rate decision, the DPUC provided additional revenues to recover the $4.3 million difference during the period 1993-1996, subject to true-up in the Company's next retail rate proceeding, based on actual remediation costs and the actual gain on the sale of the property.\nProperty Taxes\nIn November 1993, the Company received \"updated\" personal property tax bills from the City of New Haven (the City) for the tax year 1991-1992, aggregating $6.6 million, based on an audit by the City's tax assessor. The Company anticipates receiving additional bills of this sort for the tax years 1992-1993 and 1993-1994, the amounts of which cannot be predicted at this time. The Company is contesting these tax bills vigorously and has commenced an action in the Superior Court to enjoin the City from any effort to collect these tax bills. Due to a lack of data, it is not possible, at this time, to assess accurately the Company's liability, if any.\n(M) NUCLEAR FUEL DISPOSAL AND NUCLEAR PLANT DECOMMISSIONING\nCosts associated with nuclear plant operations include amounts for disposal of nuclear wastes, including spent fuel, and for the ultimate decommissioning of the plants. Under the Nuclear Waste Policy Act of 1982, the federal Department of Energy (DOE) is required to design, license, construct and operate a permanent repository for high level radioactive wastes and spent nuclear fuel. The Act requires the DOE to provide, beginning in 1998, for the disposal of spent nuclear fuel and high level radioactive waste from commercial nuclear plants through contracts with the owners and generators of such waste; and the DOE has established disposal\n- 67 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nfees that are being paid to the federal government by electric utilities owning or operating nuclear generating units. In return for payment of the prescribed fees, the federal government is to take title to and dispose of the utilities' high level wastes and spent nuclear fuel beginning no later than 1998. However, the DOE has announced that its first high level waste repository will not be in operation earlier than 2010, notwithstanding the DOE's statutory and contractual responsibility to begin disposal of high-level radioactive waste and spent fuel beginning not later than January 31, 1998.\nUntil the federal government begins receiving such materials in accordance with the Nuclear Waste Policy Act, operating nuclear generating units will need to retain high level wastes and spent fuel on-site or make other provisions for their storage. Storage facilities for Millstone Unit 3 are expected to be adequate for the projected life of the unit. Storage facilities for the Connecticut Yankee unit are expected to be adequate through the mid-1990s. Storage facilities for Seabrook Unit 1 are expected to be adequate until at least 2010. Fuel consolidation and compaction technologies are being developed and are expected to provide adequate storage capability for the projected lives of the latter two units. In addition, other licensed technologies, such as dry storage casks, can accommodate spent fuel storage requirements.\nDisposal costs for low-level radioactive wastes (LLW) that result from normal operation of nuclear generating units have increased significantly in recent years and are expected to continue to increase. The cost increases are functions of increased packaging and transportation costs and higher fees and surcharges charged by the disposal facilities. Pursuant to the Low-Level Radioactive Waste Policy Act of 1980, each state was responsible for providing disposal facilities for LLW generated within the state and was authorized to join with other states into regional compacts to jointly fulfill their responsibilities. Pursuant to the Low-Level Radioactive Waste Policy Amendments Act of 1985, each state in which a currently operating disposal facility is located (South Carolina, Nevada and Washington) is allowed to impose volume limits and a surcharge on shipments of LLW from states that are not members of the compact in the region in which the facility is located. On June 19, 1992, the United States Supreme Court issued a decision upholding certain parts of the Low-Level Radioactive Waste Policy Amendments Act of 1985, but invalidating a key provision of that law requiring each state to take title to LLW generated within that state if the state fails to meet federally-mandated deadlines for siting LLW disposal facilities. The decision has resulted in uncertainty about states' continuing roles in siting LLW disposal facilities and may result in increased LLW disposal costs and the need for longer interim LLW storage before a permanent solution is developed.\nThe Connecticut Hazardous Waste Management Service (the Service), a state quasi-public corporation, was charged with coordinating the establishment of a facility for disposal of LLW originating in Connecticut. In June 1991, the Service announced that it had selected three potential sites in north-central Connecticut for further study. The Service's announcement provoked intense controversy in the affected municipalities and resulted in legislative action to stop the selection process. On February 1, 1993, the Service presented the legislature with a new site selection plan under which communities are urged to volunteer a site for a facility in return for financial and other incentives. The volunteer process is being continued in 1994. The Service's activities in this regard are funded by assessments on Connecticut's LLW generators. Due to a change in the volunteer process, there was no assessment for the 1993-1994 fiscal year and the state projects no assessment for the 1994-1995 and 1995-1996 fiscal years.\nAdditional LLW storage capacity has been or can be constructed or acquired at the Millstone and Connecticut Yankee sites to provide for temporary storage of LLW should that become necessary. Connecticut LLW can be managed by volume reduction, storage or shipment at least through 1999. The Company cannot predict whether and when a disposal site will be designated in Connecticut.\nThe State of New Hampshire has not met deadlines for compliance with the Low-Level Radioactive Waste Policy Act, and Seabrook Unit 1 has been denied access to existing disposal facilities. Therefore, LLW generated\n- 68 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nby Seabrook Unit 1 is being stored on-site. The Seabrook storage facility currently has capacity to store approximately five years' accumulation of waste generated by Seabrook, and the plant operator plans to expand its storage capacity as necessary.\nNRC licensing requirements and restrictions are also applicable to the decommissioning of nuclear generating units at the end of their service lives, and the NRC has adopted comprehensive regulations concerning decommissioning planning, timing, funding and environmental reviews. UI and the other owners of the nuclear generating units in which UI has interests estimate decommissioning costs for the units and attempt to recover sufficient amounts through their allowed electric rates to cover expected decommissioning costs. Changes in NRC requirements or technology can increase estimated decommissioning costs, and UI's customers in future years may experience higher electric rates to offset the effects of any insufficient rate recovery in prior years.\nNew Hampshire has enacted a law requiring the creation of a government-managed fund to finance the decommissioning of nuclear generating units in that state. The New Hampshire Nuclear Decommissioning Financing Committee (NDFC) established $345 million (in 1993 dollars) as the decommissioning cost estimate for Seabrook Unit 1. This estimate premises the prompt removal and dismantling of the Unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments are being made to the state-managed decommissioning trust fund. UI's share of the decommissioning payments made during 1993 was $1.3 million. UI's share of the fund at December 31, 1993 was approximately $3.7 million.\nConnecticut has enacted a law requiring the operators of nuclear generating units to file periodically with the DPUC their plans for financing the decommissioning of the units in that state. Current decommissioning cost estimates for Millstone Unit 3 and Connecticut Yankee are $421 million (in 1994 dollars) and $324 million (in 1994 dollars), respectively. These estimates premise the prompt removal and dismantling of each unit at the end of its estimated 40-year energy producing life. Monthly decommissioning payments, based on these cost estimates, are being made to decommissioning trust funds managed by Northeast Utilities. UI's share of the Millstone Unit 3 decommissioning payments made during 1993 was $328,000. UI's share of the fund at December 31, 1993 was approximately $1.9 million. For the Company's 9.5% equity ownership in Connecticut Yankee, decommissioning costs of $1.3 million were funded by UI during 1993, and UI's share of the fund at December 31, 1993 was $9.5 million.\nEnvironmental Concerns\nIn complying with existing environmental statutes and regulations and further developments in these and other areas of environmental concern, including legislation and studies in the fields of water and air quality (particularly \"air toxics\", \"ozone non-attainment\" and \"global warming\"), hazardous waste handling and disposal, toxic substances, and electric and magnetic fields, the Company may incur substantial capital expenditures for equipment modifications and additions, monitoring equipment and recording devices, and it may incur additional operating expenses. Litigation expenditures may also increase as a result of scientific investigations, and speculation and debate, concerning the possibility of harmful health effects of electric and magnetic fields. The Company believes that any additional costs incurred for these purposes will be recoverable through the ratemaking process. The total amount of these expenditures is not now determinable.\n(N) CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES\nEffective January 1, 1991, the Company changed its method of accounting for property taxes from accrual over the twelve-month period following assessment date to accrual over the fiscal period of the applicable taxing authority. The effect of the change in accounting was to increase 1991 earnings for common stock by $7.9 million, of which $7.3 million represented the cumulative effect of the change at January 1, 1991, and $.6 million represented an increase in earnings for 1991.\n- 69 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(O) FAIR VALUE OF FINANCIAL INSTRUMENTS (1)\nThe estimated fair values of the Company's financial instruments are as follows:\n- 70 -\nTHE UNITED ILLUMINATING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(P) QUARTERLY FINANCIAL DATA (UNAUDITED)\nSelected quarterly financial data for 1993 and 1992 are set forth below:\n- 71 -\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Shareowners and Directors of The United Illuminating Company:\nWe have audited the accompanying consolidated balances sheets of The United Illuminating Company as of December 31, 1993, 1992 and 1991, and related consolidated statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The United Illuminating Company as of December 31, 1993, 1992, and 1991, and the consolidated results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ COOPERS & LYBRAND\nHartford, Connecticut January 24, 1994\n- 72 -\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNot Applicable\nPART III\nItem 10. Directors and Executive Officers of the Company.\nThe information appearing under the captions \"NOMINEES FOR ELECTION AS DIRECTORS\" AND \"COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in partial answer to this item. See also \"EXECUTIVE OFFICERS OF THE COMPANY\", following Part I, Item 4 herein.\nItem 11. Executive Compensation.\nThe information appearing under the captions \"EXECUTIVE COMPENSATION,\" \"STOCK OPTION PLAN,\" \"RETIREMENT PLANS,\" \"STOCK OPTION EXERCISES IN 1993 AND YEAR-END OPTION VALUES,\" \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" AND \"DIRECTOR COMPENSATION\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information appearing under the captions \"PRINCIPAL SHAREHOLDERS\" and \"STOCK OWNERSHIP OF DIRECTORS AND OFFICERS\" in the Company's definitive Proxy Statement, dated April 8, 1994 for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 13. Certain Relationships and Related Transactions.\nThe information appearing under the caption \"NOMINEES FOR ELECTION AS DIRECTORS\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\n- 73 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) The following documents are filed as a part of this report:\nFinancial Statements (see Item 8):\nConsolidated statement of income for the years ended December 31, 1993, 1992 and 1991\nConsolidated statement of cash flows for the years ended December 31, 1993, 1992 and 1991\nConsolidated balance sheet, December 31, 1993, 1992 and 1991\nConsolidated statement of retained earnings for the years ended December 31, 1993, 1992 and 1991\nStatement of accounting policies\nNotes to consolidated financial statements\nReport of independent accountants\nFinancial Statement Schedules (see S-1 through S-5)\nSchedule V - Property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VI - Accumulated depreciation, depletion and amortization of property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VIII - Valuation and qualifying accounts for the years ended December 31, 1993, 1992 and 1991.\n- 74 -\nExhibits:\nPursuant to Rule 12b-32 under the Securities Exchange Act of 1934, certain of the following listed exhibits which are annexed as exhibits to previous statements and reports filed by the Company are hereby incorporated by reference as exhibits to this report. Such statements and reports are identified by reference numbers as follows:\n(1) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1991.\n(2) Filed with Registration Statement No. 2-45434, effective September 25, 1972, and Registration Statement No. 2-45435, effective September 26, 1972.\n(3) Filed with Registration Statement No. 2-60849, effective July 24, 1978.\n(4) Filed with Registration Statement No. 2-66518, effective February 25, 1980.\n(5) Filed with Registration Statement No. 2-57275, effective October 19, 1976.\n(6) Filed with Registration Statement No. 2-67998, effective June 19, 1980.\n(7) Filed with Registration Statement No. 2-72907, effective July 16, 1981.\n(8) Filed with Post-Effective Amendment No. 1 to Registration Statement No. 2-78643, effective August 19, 1982.\n(9) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1990.\n(10) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1991.\n(11) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended March 31, 1991.\n(12) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1992.\n(13 Filed with Registration Statement No. 33-40169, effective August 12, 1991.\n(14) Filed with Registration Statement No. 33-35465, effective August 1, 1990.\n(15) Filed with Registration Statement No. 2-49669, effective December 11, 1973.\n(16) Filed with Registration Statement No. 2-54876, effective November 19, 1975.\n(17) Filed with Registration Statement No. 2-52657, effective February 6, 1975.\n(18) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 1992.\n(19) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1990.\n- 75 -\nThe exhibit number in the statement or report referenced is set forth in the parenthesis following the description of the exhibit. Those of the following exhibits not so identified are filed herewith.\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.1 (1) Copy of Charter of The United Illuminating Company, dated December 15, 1965. (Exhibit 3.1) (3) 3.2 (2) Copy of a certificate concerning the creation of a class of Preferred Stock of The United Illuminating Company and the authority of the Board of Directors to issue said Preferred Stock, dated July 13, 1956, and filed with the Secretary of State of Connecticut July 13, 1956. (Exhibit 3.12) (3) 3.3 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated November 19, 1962, andfiled with the Secretary of State of Connecticut November 29, 1962. (Exhibit 3.3) (3) 3.4 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 25, 1965, and filed with the Secretary of State of Connecticut November 22, 1965. (Exhibit 3.4) (3) 3.5 (2) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 6, 1967, and filed with the Secretary of State of Connecticut June 6, 1967. (Exhibit 3.13) (3) 3.6 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated December 1, 1967, and filed with the Secretary of State of Connecticut December 7, 1967. (Exhibit 3.6) (3) 3.7 (3) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 27, 1971, and filed with the Secretary of State of Connecticut April 29, 1971. (Exhibit 2.2-14) (3) 3.8 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated March 29, 1972, and filed with the Secretary of State of Connecticut March 30, 1972. (Exhibit 3.8) (3) 3.9 (4) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 4 1973, and filed with the Secretary of State of Connecticut May 7, 1973. (Exhibit 2.2-17) (3) 3.10 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 2, 1973, and filed with the Secretary of State of Connecticut July 2, 1973. (Exhibit 3.10) (3) 3.11 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-18) (3) 3.12 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-19) (3) 3.13 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 20, 1976, and filed with the Secretary of State of Connecticut October 21, 1976. (Exhibit 3.13) (3) 3.14 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 4, 1979, and filed with the Secretary of State of Connecticut April 5, 1979. (Exhibit 3.14) (3) 3.15 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 29, 1980, and filed with the Secretary of State of Connecticut April 30, 1980. (Exhibit 3.15)\n- 76 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.16 (6) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 20, 1980, and filed with the Secretary of State of Connecticut May 23, 1980. (Exhibit 2.2-20) (3) 3.17 (7) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 12, 1981, and filed with the Secretary of State of Connecticut June 16, 1981. (Exhibit 1.20) (3) 3.18 (12) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 13, 1981, and filed with the Secretary of State of Connecticut July 14, 1981. (3) 3.19 (8) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 1, 1983, and filed with the Secretary of State of Connecticut June 3, 1983. (Exhibit 4.31) (3) 3.20 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 24, 1984, and filed with the Secretary of State of Connecticut July 24, 1984. (Exhibit 1) (3) 3.21 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated August 8, 1984, and filed with the Secretary of State of Connecticut August 9, 1984. (Exhibit 2) (3) 3.22 (9) Copy of Certificate Amending or Restating Certificate of Incorporation, filed with the Secretary of State of Connecticut August 1, 1990. (Exhibit 3.22) (3) 3.23 (10) Copy of Certificate Amending or Restating Certificate of Incorporation, dated May 9, 1991, and filed with the Secretary of State of Connecticut August 27, 1991. (Exhibit 3.22a) (3) 3.24a (3) Copy of Bylaws of The United Illuminating Company. (Exhibit 2.3) (3) 3.24b (10) Copy of Article II, Section 2, of Bylaws of The United Illuminating Company, as amended March 26, 1990, amending Exhibit 3.24a. (Exhibit 3.23b) (3) 3.24c (11) Copy of Article V, Section 1, of Bylaws of The United Illuminating Company, as amended April 22, 1991, amending Exhibit 3.24a. (Exhibit 3.23c) (4) 4.1 (9) Copy of First Mortgage Indenture and Deed of Trust, dated as of December 1, 1984, between Bridgeport Electric Company and The First National Bank of Boston, Trustee. (Exhibit 4.12) (4) 4.2 (12) Copy of First Supplemental Mortgage Indenture, dated as of February 15, 1987, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1. (Exhibit 4.2) (4) 4.3 (12) Copy of Second Supplemental Mortgage Indenture, dated as of January 14, 1988, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1 and amending Exhibit 4.2. (Exhibit 4.3) (4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1. (4) 4.5 (13) Copy of Indenture, dated as of August 1, 1991, from The United Illuminating Company to The Bank of New York, Trustee. (Exhibit 4) (4) 4.6 (14) Copy of Participation Agreement, dated as of (10) August 1, 1990, among Financial Leasing Corporation, Meridian Trust Company, The Bank of New York and The United Illuminating Company. (Exhibits 4(a) through 4(h), inclusive, Amendment Nos. 1 and 2).\n- 77 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.1 (5) Copy of Stockholder Agreement, dated as of July 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-1) (10) 10.2a (5) Copy of Power Contract, dated as of July 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-2) (10) 10.2b (3) Copy of Supplementary Power Contract, dated as of March 1, 1978, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 5.1-6) (10) 10.2c (1) Copy of Agreement Amending Supplementary Power Contract, dated August 22, 1980, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2b) (10) 10.2d (12) Copy of Second Amendment of the Supplementary Power Contract, dated as of October 15, 1982, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2d) (10) 10.2e (9) Copy of Second Supplementary Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 10.2e) (10) 10.2f (9) Copy of Additional Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 10.2f) (10) 10.3 (5) Copy of Capital Funds Agreement, dated as of September 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-3) (10) 10.4a (5) Copy of Connecticut Yankee Transmission Agreement, dated as of October 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-4) (10) 10.4b (4) Copy of Agreement Amending and Revising Connecticut Yankee Transmission Agreement, dated as of July 1, 1979, amending Exhibit 10.4a. (Exhibit 5.1-7) (10) 10.5 (3) Copy of Capital Contributions Agreement, dated October 16, 1967, between The United Illuminating Company and Connecticut Yankee Atomic Power Company. (Exhibit 5.1-5) (10) 10.6a (1) Copy of NEPOOL Power Pool Agreement, dated as of September 1, 1971, as amended to November 1, 1988. (Exhibit 10.6a) (10) 10.6b (15) Copy of Agreement Setting Out Supplemental NEPOOL Understandings, dated as of April 2, 1973. (Exhibit 5.7-10) (10) 10.6c (1) Copy of Amendment to NEPOOL Power Pool Agreement, dated as of March 15, 1989, amending Exhibit 10.6a. (Exhibit 10.6c) (10) 10.6d (1) Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of October 1, 1990, amending Exhibit 10.6a. (Exhibit 10.6d) (10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a. (10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a. (10) 10.7a (1) Copy of Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated May 1, 1973, as amended to February 1, 1990. (Exhibit 10.7a) (10) 10.7b (16) Copy of Transmission Support Agreement, dated as of May 1, 1973, among the Seabrook Companies. (Exhibit 5.9-2)\n- 78 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.7c (10) Copy of Twenty-third Amendment to Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated as of November 1, 1990, amending Exhibit 10.7a. (Exhibit 10.8ab) (10) 10.8a (4) Copy of Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of September 1, 1973, among The Connecticut Light and Power Company, The Hartford Electric Light Company, Western Massachusetts Electric Company, New England Power Company, The United Illuminating Company, Public Service Company of New Hampshire, Central Vermont Public Service Company, Montaup Electric Company and Fitchburg Gas and Electric Light Company, relating to a nuclear fueled generating unit in Connecticut. (Exhibit 5.8-1) (10) 10.8b (17) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of August 1, 1974, amending Exhibit 10.8a. (Exhibit 5.9-2) (10) 10.8c (5) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of December 15, 1975, amending Exhibit 10.8a. (Exhibit 5.8-4, Post-effective Amendment No. 2) (10) 10.9a (3) Copy of Transmission Line Agreement, dated January 13, 1966, between the Trustees of the Property of The New York, New Haven and Hartford Railroad Company and The United Illuminating Company. (Exhibit 5.4) (10) 10.9b (1) Notice, dated April 24, 1978, of The United Illuminating Company's intention to extend term of Transmission Line Agreement dated January 13, 1966, Exhibit 10.9a. (Exhibit 10.9b) (10) 10.9c (1) Copy of Letter Agreement, dated March 28, 1985, between The United Illuminating Company and National Railroad Passenger Corporation, supplementing and modifying Exhibit 10.9a. (Exhibit 10.9c) (10) 10.10 (12) Copy of Agreement, effective May 16, 1992, between The United Illuminating Company and Local 470-1, Utility Workers Union of America, AFL-CIO. (Exhibit 10.10) (10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested) (10) 10.12 (12) Copy of Coal Sales Agreement, dated as of August 1, 1992, between Pittston Coal Sales Corp. and The United Illuminating Company. (Confidential treatment requested) (Exhibit 10.13) (10) 10.13 (10) Copy of Fossil Fuel Supply Agreement between BLC Corporation and The United Illuminating Company, dated as of July 1, 1991. (Exhibit 10.31) (10) 10.14a (9) Copy of Lease, dated as of December 1, 1984, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee. (Exhibit 10.22a) (10) 10.14b (12) Copy of Amendment, dated as of February 15, 1987, to Lease between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16b) (10) 10.14c (12) Copy of Second Amendment to Lease, dated as of December 9, 1987, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16c) (10) 10.14d (12) Copy of Third Amendment to Lease, dated as of January 14, 1988, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16d)\n- 79 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.15a (12) Copy of Revolving Credit Agreement, dated as of January 25, 1993, among The United Illuminating Company, the Banks named therein, and Citibank, N.A., as Agent for the Banks. (Exhibit 10.19) (10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995. (10) 10.16a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Richard J. Grossi. (Exhibit 10.22a) (10) 10.16b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Richard J. Grossi, amending Exhibit 10.22a. (Exhibit 10.26a) (10) 10.17a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Robert L. Fiscus. (Exhibit 10.23a) (10) 10.17b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Robert L. Fiscus, amending Exhibit 10.23a. (Exhibit 10.27a) (10) 10.18a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and James F. Crowe. (Exhibit 10.24a) (10) 10.18b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and James F. Crowe, amending Exhibit 10.24a. (Exhibit 10.28a) (10) 10.19* (1) Copy of Executive Incentive Compensation Program of The United Illuminating Company. (Exhibit 10.24) (10) 10.21a* (19) Copy of The United Illuminating Company 1990 Stock Option Plan. (Exhibit 10.33) (10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22, 1993 and January 24, 1994. (21) 21 List of subsidiaries of The United Illuminating Company. (28) 28.1 (12) Copies of significant rate schedules of The United Illuminating Company. (Exhibit 28.1)\n- ----------------------- *Management contract or compensatory plan or arrangement.\nThe foregoing list of exhibits does not include instruments defining the rights of the holders of certain long-term debt of the Company and its subsidiaries where the total amount of securities authorized to be issued under the instrument does not exceed ten (10%) of the total assets of the Company and its subsidiaries on a consolidated basis; and the Company hereby agrees to furnish a copy of each such instrument to the Securities and Exchange Commission on request.\n(b) Reports on Form 8-K.\nItems Financial Statements Date of Reported Filed Report - -------- -------------------- -------\n5 None December 22, 1993\n- 80 -\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe consent to the incorporation by reference in the Registration Statement of The United Illuminating Company on Form S-3 (File No. 33-50221) and the Registration Statement on Form S-3 (File No. 33-50445) of our report, dated January 24, 1994, on our audits of the consolidated financial statements and financial statement schedules of The United Illuminating Company as of December 31, 1993, 1992 and 1991 and for the years then ended, which report is included in this Annual Report on Form 10-K.\n\/s\/ COOPERS & LYBRAND\nHartford, Connecticut February 15, 1994\n- 81 -\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE UNITED ILLUMINATING COMPANY\nBy \/s\/ Richard J. Grossi ------------------------------ Richard J. Grossi Chairman of the Board of Directors and Chief Executive Officer\nDate: February 18, 1994 -----------------\nPursuant 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 and on the dates indicated.\nSignature Title Date --------- ----- ---- Director, Chairman of the Board of Directors and \/s\/ Richard J. Grossi Chief Executive Officer February 18, 1994 - --------------------- (Richard J. Grossi) (Principal Executive Officer)\nDirector, President and \/s\/ Robert L. Fiscus Chief Financial Officer February 18, 1994 - --------------------- (Robert L. Fiscus) (Principal Financial and Accounting Officer)\n\/s\/ John D. Fassett Director February 18, 1994 - -------------------- (John D. Fassett)\n\/s\/ Leland W. Miles Director February 18, 1994 - -------------------- (Leland W. Miles)\n\/s\/ William S. Warner Director February 18, 1994 - ---------------------- (William S. Warner)\n\/s\/ John F. Croweak Director February 18, 1994 - -------------------- (John F. Croweak)\n\/s\/ F. Patrick McFadden, Jr. Director February 18, 1994 - ----------------------------- (F. Patrick McFadden, Jr.)\n\/s\/ J. Hugh Devlin Director February 18, 1994 - ------------------- (J. Hugh Devlin)\n\/s\/ Betsy Henley-Cohn Director February 18, 1994 - ---------------------- (Betsy Henley-Cohn)\nDirector February , 1994 - ------------------------ (Frank R. O'Keefe, Jr.)\n\/s\/ James A. Thomas Director February 18, 1994 - ---------------------- (James A. Thomas)\n\/s\/ David E.A. Carson Director February 18, 1994 - ---------------------- (David E.A. Carson)\n- 82 -\nS-1\nS-2\nS-3\nS-4\nS-5\nEXHIBIT INDEX\n(a) Exhibits\nExhibit Table Item Exhibit Number Number Description Page No. ---------- ------- ----------- --------\n(4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1.\n(10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a.\n(10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a.\n(10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested)\n(10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995.\n(10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22,1993 and January 24, 1994.\n(21) 21 List of subsidiaries of The United Illuminating Company.","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNot Applicable\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company.\nThe information appearing under the captions \"NOMINEES FOR ELECTION AS DIRECTORS\" AND \"COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in partial answer to this item. See also \"EXECUTIVE OFFICERS OF THE COMPANY\", following Part I, Item 4 herein.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information appearing under the captions \"EXECUTIVE COMPENSATION,\" \"STOCK OPTION PLAN,\" \"RETIREMENT PLANS,\" \"STOCK OPTION EXERCISES IN 1993 AND YEAR-END OPTION VALUES,\" \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" AND \"DIRECTOR COMPENSATION\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information appearing under the captions \"PRINCIPAL SHAREHOLDERS\" and \"STOCK OWNERSHIP OF DIRECTORS AND OFFICERS\" in the Company's definitive Proxy Statement, dated April 8, 1994 for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information appearing under the caption \"NOMINEES FOR ELECTION AS DIRECTORS\" in the Company's definitive Proxy Statement, dated April 8, 1994, for the Annual Meeting of the Shareholders to be held on May 18, 1994, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 8, 1994, is incorporated by reference in answer to this item.\n- 73 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) The following documents are filed as a part of this report:\nFinancial Statements (see Item 8):\nConsolidated statement of income for the years ended December 31, 1993, 1992 and 1991\nConsolidated statement of cash flows for the years ended December 31, 1993, 1992 and 1991\nConsolidated balance sheet, December 31, 1993, 1992 and 1991\nConsolidated statement of retained earnings for the years ended December 31, 1993, 1992 and 1991\nStatement of accounting policies\nNotes to consolidated financial statements\nReport of independent accountants\nFinancial Statement Schedules (see S-1 through S-5)\nSchedule V - Property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VI - Accumulated depreciation, depletion and amortization of property, plant and equipment for the years ended December 31, 1993, 1992 and 1991.\nSchedule VIII - Valuation and qualifying accounts for the years ended December 31, 1993, 1992 and 1991.\n- 74 -\nExhibits:\nPursuant to Rule 12b-32 under the Securities Exchange Act of 1934, certain of the following listed exhibits which are annexed as exhibits to previous statements and reports filed by the Company are hereby incorporated by reference as exhibits to this report. Such statements and reports are identified by reference numbers as follows:\n(1) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1991.\n(2) Filed with Registration Statement No. 2-45434, effective September 25, 1972, and Registration Statement No. 2-45435, effective September 26, 1972.\n(3) Filed with Registration Statement No. 2-60849, effective July 24, 1978.\n(4) Filed with Registration Statement No. 2-66518, effective February 25, 1980.\n(5) Filed with Registration Statement No. 2-57275, effective October 19, 1976.\n(6) Filed with Registration Statement No. 2-67998, effective June 19, 1980.\n(7) Filed with Registration Statement No. 2-72907, effective July 16, 1981.\n(8) Filed with Post-Effective Amendment No. 1 to Registration Statement No. 2-78643, effective August 19, 1982.\n(9) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1990.\n(10) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1991.\n(11) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended March 31, 1991.\n(12) Filed with Annual Report (Form 10-K) for fiscal year ended December 31, 1992.\n(13 Filed with Registration Statement No. 33-40169, effective August 12, 1991.\n(14) Filed with Registration Statement No. 33-35465, effective August 1, 1990.\n(15) Filed with Registration Statement No. 2-49669, effective December 11, 1973.\n(16) Filed with Registration Statement No. 2-54876, effective November 19, 1975.\n(17) Filed with Registration Statement No. 2-52657, effective February 6, 1975.\n(18) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 1992.\n(19) Filed with Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1990.\n- 75 -\nThe exhibit number in the statement or report referenced is set forth in the parenthesis following the description of the exhibit. Those of the following exhibits not so identified are filed herewith.\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.1 (1) Copy of Charter of The United Illuminating Company, dated December 15, 1965. (Exhibit 3.1) (3) 3.2 (2) Copy of a certificate concerning the creation of a class of Preferred Stock of The United Illuminating Company and the authority of the Board of Directors to issue said Preferred Stock, dated July 13, 1956, and filed with the Secretary of State of Connecticut July 13, 1956. (Exhibit 3.12) (3) 3.3 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated November 19, 1962, andfiled with the Secretary of State of Connecticut November 29, 1962. (Exhibit 3.3) (3) 3.4 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 25, 1965, and filed with the Secretary of State of Connecticut November 22, 1965. (Exhibit 3.4) (3) 3.5 (2) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 6, 1967, and filed with the Secretary of State of Connecticut June 6, 1967. (Exhibit 3.13) (3) 3.6 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated December 1, 1967, and filed with the Secretary of State of Connecticut December 7, 1967. (Exhibit 3.6) (3) 3.7 (3) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 27, 1971, and filed with the Secretary of State of Connecticut April 29, 1971. (Exhibit 2.2-14) (3) 3.8 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated March 29, 1972, and filed with the Secretary of State of Connecticut March 30, 1972. (Exhibit 3.8) (3) 3.9 (4) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 4 1973, and filed with the Secretary of State of Connecticut May 7, 1973. (Exhibit 2.2-17) (3) 3.10 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 2, 1973, and filed with the Secretary of State of Connecticut July 2, 1973. (Exhibit 3.10) (3) 3.11 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-18) (3) 3.12 (5) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated April 26, 1976, and filed with the Secretary of State of Connecticut April 27, 1976. (Exhibit 2.2-19) (3) 3.13 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated October 20, 1976, and filed with the Secretary of State of Connecticut October 21, 1976. (Exhibit 3.13) (3) 3.14 (1) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 4, 1979, and filed with the Secretary of State of Connecticut April 5, 1979. (Exhibit 3.14) (3) 3.15 Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated April 29, 1980, and filed with the Secretary of State of Connecticut April 30, 1980. (Exhibit 3.15)\n- 76 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(3) 3.16 (6) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated May 20, 1980, and filed with the Secretary of State of Connecticut May 23, 1980. (Exhibit 2.2-20) (3) 3.17 (7) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 12, 1981, and filed with the Secretary of State of Connecticut June 16, 1981. (Exhibit 1.20) (3) 3.18 (12) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 13, 1981, and filed with the Secretary of State of Connecticut July 14, 1981. (3) 3.19 (8) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors and Shareholders, dated June 1, 1983, and filed with the Secretary of State of Connecticut June 3, 1983. (Exhibit 4.31) (3) 3.20 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated July 24, 1984, and filed with the Secretary of State of Connecticut July 24, 1984. (Exhibit 1) (3) 3.21 (9) Copy of Certificate Amending Certificate of Incorporation by Action of Board of Directors, dated August 8, 1984, and filed with the Secretary of State of Connecticut August 9, 1984. (Exhibit 2) (3) 3.22 (9) Copy of Certificate Amending or Restating Certificate of Incorporation, filed with the Secretary of State of Connecticut August 1, 1990. (Exhibit 3.22) (3) 3.23 (10) Copy of Certificate Amending or Restating Certificate of Incorporation, dated May 9, 1991, and filed with the Secretary of State of Connecticut August 27, 1991. (Exhibit 3.22a) (3) 3.24a (3) Copy of Bylaws of The United Illuminating Company. (Exhibit 2.3) (3) 3.24b (10) Copy of Article II, Section 2, of Bylaws of The United Illuminating Company, as amended March 26, 1990, amending Exhibit 3.24a. (Exhibit 3.23b) (3) 3.24c (11) Copy of Article V, Section 1, of Bylaws of The United Illuminating Company, as amended April 22, 1991, amending Exhibit 3.24a. (Exhibit 3.23c) (4) 4.1 (9) Copy of First Mortgage Indenture and Deed of Trust, dated as of December 1, 1984, between Bridgeport Electric Company and The First National Bank of Boston, Trustee. (Exhibit 4.12) (4) 4.2 (12) Copy of First Supplemental Mortgage Indenture, dated as of February 15, 1987, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1. (Exhibit 4.2) (4) 4.3 (12) Copy of Second Supplemental Mortgage Indenture, dated as of January 14, 1988, between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending and supplementing Exhibit 4.1 and amending Exhibit 4.2. (Exhibit 4.3) (4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1. (4) 4.5 (13) Copy of Indenture, dated as of August 1, 1991, from The United Illuminating Company to The Bank of New York, Trustee. (Exhibit 4) (4) 4.6 (14) Copy of Participation Agreement, dated as of (10) August 1, 1990, among Financial Leasing Corporation, Meridian Trust Company, The Bank of New York and The United Illuminating Company. (Exhibits 4(a) through 4(h), inclusive, Amendment Nos. 1 and 2).\n- 77 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.1 (5) Copy of Stockholder Agreement, dated as of July 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-1) (10) 10.2a (5) Copy of Power Contract, dated as of July 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-2) (10) 10.2b (3) Copy of Supplementary Power Contract, dated as of March 1, 1978, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 5.1-6) (10) 10.2c (1) Copy of Agreement Amending Supplementary Power Contract, dated August 22, 1980, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2b) (10) 10.2d (12) Copy of Second Amendment of the Supplementary Power Contract, dated as of October 15, 1982, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, amending Exhibit 10.2b. (Exhibit 10.2d) (10) 10.2e (9) Copy of Second Supplementary Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company, supplementing Exhibit 10.2a. (Exhibit 10.2e) (10) 10.2f (9) Copy of Additional Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 10.2f) (10) 10.3 (5) Copy of Capital Funds Agreement, dated as of September 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-3) (10) 10.4a (5) Copy of Connecticut Yankee Transmission Agreement, dated as of October 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-4) (10) 10.4b (4) Copy of Agreement Amending and Revising Connecticut Yankee Transmission Agreement, dated as of July 1, 1979, amending Exhibit 10.4a. (Exhibit 5.1-7) (10) 10.5 (3) Copy of Capital Contributions Agreement, dated October 16, 1967, between The United Illuminating Company and Connecticut Yankee Atomic Power Company. (Exhibit 5.1-5) (10) 10.6a (1) Copy of NEPOOL Power Pool Agreement, dated as of September 1, 1971, as amended to November 1, 1988. (Exhibit 10.6a) (10) 10.6b (15) Copy of Agreement Setting Out Supplemental NEPOOL Understandings, dated as of April 2, 1973. (Exhibit 5.7-10) (10) 10.6c (1) Copy of Amendment to NEPOOL Power Pool Agreement, dated as of March 15, 1989, amending Exhibit 10.6a. (Exhibit 10.6c) (10) 10.6d (1) Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of October 1, 1990, amending Exhibit 10.6a. (Exhibit 10.6d) (10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a. (10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a. (10) 10.7a (1) Copy of Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated May 1, 1973, as amended to February 1, 1990. (Exhibit 10.7a) (10) 10.7b (16) Copy of Transmission Support Agreement, dated as of May 1, 1973, among the Seabrook Companies. (Exhibit 5.9-2)\n- 78 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.7c (10) Copy of Twenty-third Amendment to Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units, dated as of November 1, 1990, amending Exhibit 10.7a. (Exhibit 10.8ab) (10) 10.8a (4) Copy of Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of September 1, 1973, among The Connecticut Light and Power Company, The Hartford Electric Light Company, Western Massachusetts Electric Company, New England Power Company, The United Illuminating Company, Public Service Company of New Hampshire, Central Vermont Public Service Company, Montaup Electric Company and Fitchburg Gas and Electric Light Company, relating to a nuclear fueled generating unit in Connecticut. (Exhibit 5.8-1) (10) 10.8b (17) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of August 1, 1974, amending Exhibit 10.8a. (Exhibit 5.9-2) (10) 10.8c (5) Copy of Amendment to Sharing Agreement - 1979 Connecticut Nuclear Unit, dated as of December 15, 1975, amending Exhibit 10.8a. (Exhibit 5.8-4, Post-effective Amendment No. 2) (10) 10.9a (3) Copy of Transmission Line Agreement, dated January 13, 1966, between the Trustees of the Property of The New York, New Haven and Hartford Railroad Company and The United Illuminating Company. (Exhibit 5.4) (10) 10.9b (1) Notice, dated April 24, 1978, of The United Illuminating Company's intention to extend term of Transmission Line Agreement dated January 13, 1966, Exhibit 10.9a. (Exhibit 10.9b) (10) 10.9c (1) Copy of Letter Agreement, dated March 28, 1985, between The United Illuminating Company and National Railroad Passenger Corporation, supplementing and modifying Exhibit 10.9a. (Exhibit 10.9c) (10) 10.10 (12) Copy of Agreement, effective May 16, 1992, between The United Illuminating Company and Local 470-1, Utility Workers Union of America, AFL-CIO. (Exhibit 10.10) (10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested) (10) 10.12 (12) Copy of Coal Sales Agreement, dated as of August 1, 1992, between Pittston Coal Sales Corp. and The United Illuminating Company. (Confidential treatment requested) (Exhibit 10.13) (10) 10.13 (10) Copy of Fossil Fuel Supply Agreement between BLC Corporation and The United Illuminating Company, dated as of July 1, 1991. (Exhibit 10.31) (10) 10.14a (9) Copy of Lease, dated as of December 1, 1984, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee. (Exhibit 10.22a) (10) 10.14b (12) Copy of Amendment, dated as of February 15, 1987, to Lease between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16b) (10) 10.14c (12) Copy of Second Amendment to Lease, dated as of December 9, 1987, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16c) (10) 10.14d (12) Copy of Third Amendment to Lease, dated as of January 14, 1988, between Bridgeport Electric Company as Lessor and The United Illuminating Company as Lessee, amending Exhibit 10.16a. (Exhibit 10.16d)\n- 79 -\nExhibit Table Exhibit Reference Item No. No. No. Description - -------- ------- --------- -----------\n(10) 10.15a (12) Copy of Revolving Credit Agreement, dated as of January 25, 1993, among The United Illuminating Company, the Banks named therein, and Citibank, N.A., as Agent for the Banks. (Exhibit 10.19) (10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995. (10) 10.16a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Richard J. Grossi. (Exhibit 10.22a) (10) 10.16b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Richard J. Grossi, amending Exhibit 10.22a. (Exhibit 10.26a) (10) 10.17a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and Robert L. Fiscus. (Exhibit 10.23a) (10) 10.17b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and Robert L. Fiscus, amending Exhibit 10.23a. (Exhibit 10.27a) (10) 10.18a* (12) Copy of Employment Agreement, dated as of January 1, 1988, between The United Illuminating Company and James F. Crowe. (Exhibit 10.24a) (10) 10.18b* (19) Copy of Amendment to Employment Agreement, dated as of July 23, 1990, between The United Illuminating Company and James F. Crowe, amending Exhibit 10.24a. (Exhibit 10.28a) (10) 10.19* (1) Copy of Executive Incentive Compensation Program of The United Illuminating Company. (Exhibit 10.24) (10) 10.21a* (19) Copy of The United Illuminating Company 1990 Stock Option Plan. (Exhibit 10.33) (10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22, 1993 and January 24, 1994. (21) 21 List of subsidiaries of The United Illuminating Company. (28) 28.1 (12) Copies of significant rate schedules of The United Illuminating Company. (Exhibit 28.1)\n- ----------------------- *Management contract or compensatory plan or arrangement.\nThe foregoing list of exhibits does not include instruments defining the rights of the holders of certain long-term debt of the Company and its subsidiaries where the total amount of securities authorized to be issued under the instrument does not exceed ten (10%) of the total assets of the Company and its subsidiaries on a consolidated basis; and the Company hereby agrees to furnish a copy of each such instrument to the Securities and Exchange Commission on request.\n(b) Reports on Form 8-K.\nItems Financial Statements Date of Reported Filed Report - -------- -------------------- -------\n5 None December 22, 1993\n- 80 -\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe consent to the incorporation by reference in the Registration Statement of The United Illuminating Company on Form S-3 (File No. 33-50221) and the Registration Statement on Form S-3 (File No. 33-50445) of our report, dated January 24, 1994, on our audits of the consolidated financial statements and financial statement schedules of The United Illuminating Company as of December 31, 1993, 1992 and 1991 and for the years then ended, which report is included in this Annual Report on Form 10-K.\n\/s\/ COOPERS & LYBRAND\nHartford, Connecticut February 15, 1994\n- 81 -\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE UNITED ILLUMINATING COMPANY\nBy \/s\/ Richard J. Grossi ------------------------------ Richard J. Grossi Chairman of the Board of Directors and Chief Executive Officer\nDate: February 18, 1994 -----------------\nPursuant 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 and on the dates indicated.\nSignature Title Date --------- ----- ---- Director, Chairman of the Board of Directors and \/s\/ Richard J. Grossi Chief Executive Officer February 18, 1994 - --------------------- (Richard J. Grossi) (Principal Executive Officer)\nDirector, President and \/s\/ Robert L. Fiscus Chief Financial Officer February 18, 1994 - --------------------- (Robert L. Fiscus) (Principal Financial and Accounting Officer)\n\/s\/ John D. Fassett Director February 18, 1994 - -------------------- (John D. Fassett)\n\/s\/ Leland W. Miles Director February 18, 1994 - -------------------- (Leland W. Miles)\n\/s\/ William S. Warner Director February 18, 1994 - ---------------------- (William S. Warner)\n\/s\/ John F. Croweak Director February 18, 1994 - -------------------- (John F. Croweak)\n\/s\/ F. Patrick McFadden, Jr. Director February 18, 1994 - ----------------------------- (F. Patrick McFadden, Jr.)\n\/s\/ J. Hugh Devlin Director February 18, 1994 - ------------------- (J. Hugh Devlin)\n\/s\/ Betsy Henley-Cohn Director February 18, 1994 - ---------------------- (Betsy Henley-Cohn)\nDirector February , 1994 - ------------------------ (Frank R. O'Keefe, Jr.)\n\/s\/ James A. Thomas Director February 18, 1994 - ---------------------- (James A. Thomas)\n\/s\/ David E.A. Carson Director February 18, 1994 - ---------------------- (David E.A. Carson)\n- 82 -\nS-1\nS-2\nS-3\nS-4\nS-5\nEXHIBIT INDEX\n(a) Exhibits\nExhibit Table Item Exhibit Number Number Description Page No. ---------- ------- ----------- --------\n(4) 4.4 Copy of Third Supplemental Mortgage Indenture, dated as of March 31, 1988 between Bridgeport Electric Company and The First National Bank of Boston, Trustee, amending Exhibit 4.1.\n(10) 10.6e Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of September 15, 1992, amending Exhibit 10.6a.\n(10) 10.6f Copy of Agreement Amending NEPOOL Power Pool Agreement, dated as of June 1, 1993, amending Exhibit 10.6a.\n(10) 10.11 Copy of Fuel Oil Purchase and Sale Agreement, dated as of October 1, 1993, among Tosco Corporation, The United Illuminating Company and The Connecticut Light and Power Company. (Confidential treatment requested)\n(10) 10.15b Copy of letter, dated January 27, 1994, from Citibank, N.A., extending the expiration date of Exhibit 10.15a to January 19, 1995.\n(10) 10.21b Amendments to The United Illuminating Company 1990 Stock Option Plan, adopted November 22,1993 and January 24, 1994.\n(21) 21 List of subsidiaries of The United Illuminating Company.","section_15":""}
{"filename":"30875_1993.txt","cik":"30875","year":"1993","section_1":"ITEM 1. BUSINESS\nThe Company was incorporated in Delaware in 1964. The Company designs, develops and produces advanced electronic systems and products, primarily for sale in defense related markets, and provides various related technical services. The Company's largest business segments are the design, development and production of reconnaissance and surveillance systems and command, control and communications systems which represented approximately 80% of the Company's sales in 1993. The Company also designs, develops and manufactures intelligence collection and processing systems, which through reconnaissance and surveillance activities collect radio frequency signals and images, process that data, correlate it with other information (\"fusion\"), and communicate the information to users including various decision makers, such as battlefield tactical commanders and the National Command Authority. In addition, the Company produces navigation and control systems, and performs aircraft maintenance and modification and other services.\nApproximately 89% of the Company's sales in 1993 were made under contracts with the U.S. Government or to prime contractors with the U.S. Government and approximately 9% were to international customers (principally governments). A substantial portion of the Company's business is conducted under contracts which carry governmental security classifications, many of which prohibit the disclosure of any of the information concerning the nature of the work being done.\nThe sales and operating profits of the Company's business segments for the three years ending December 31, 1993, are set forth in tables at page 39 of this Annual Report on Form 10-K.\nThe backlog believed to be firm at December 31, 1993 was $2,133 million compared to $2,320 million at December 31, 1992. Approximately 87% of the backlog is represented by contracts with the U.S. Government and prime contractors, excluding foreign military sales contracted directly with the U.S. Government. The backlog figures consist of the sales value of U.S. Government contracts and subcontracts which have been contractually documented and for which funds have been authorized by the procuring agency and contracting authority, and the aggregate sales price of firm orders for undelivered nongovernment business. Approximately 70% of the backlog at December 31, 1993 is expected to result in sales during 1994, and the remainder is expected to result in sales in subsequent years. No single contract accounts for more than 10% of the Company's backlog.\nRECONNAISSANCE AND SURVEILLANCE\nThe Company believes that it is a leader in design, development and integration of sophisticated reconnaissance and surveillance systems. These systems include signal intelligence systems (i.e., communications and electronic intelligence systems), intrusion detection systems, electronic support measures and automated, remotely controlled reconnaissance systems. A wholly owned subsidiary of the Company, Engineering Research Associates, Inc., headquartered in Vienna, Virginia (\"ERA\"), designs and develops high frequency surveillance systems. Another wholly owned subsidiary, HRB Systems, Inc., (\"HRB\") headquartered in State College, Pennsylvania, designs and develops signal collection, processing and analysis systems, which complement the Company's activities in the intelligence and reconnaissance systems market.\nStrategic reconnaissance and surveillance systems produced by the Company utilize technically advanced sensors, receivers, electro-optical devices, processing equipment, computers and display and communications devices which detect, locate and analyze hostile electromagnetic signals and other data. These systems provide information as to the location and sources of such signals and the functions, operating characteristics and intentions of such sources. The systems consist of various electronic components and other materials manufactured by the Company and others, which are integrated to perform functions specified by customers. Many systems are integrated using complex interconnection and processing equipment such as mini-computers and micro-processors together with related software.\nThese versatile systems are adaptable to meet evolving needs such as arms-control verification, drug interdiction and improved submarine detection. As an example, one program calls for the design, development and production of a transportable ground station integrating multi-sensor processing and dissemination of strategic and tactical imagery. It will provide, for the first time, near real-time imagery intelligence to tactical commanders. Each system will be specifically tailored to the particular branch of the service to which it is assigned and to the commander's unique needs.\nThe Company has developed reconnaissance and surveillance systems which operate in all environments. The Company's activities in the field of airborne reconnaissance and surveillance systems also involve the modification of aircraft, the installation of the systems, flight testing and technical support and maintenance service for the systems.\nAn advanced version of the EGRETT aircraft, developed as a reconnaissance and surveillance platform for the German Air Force, can carry a variety of payloads including signal intelligence, imagery and environment sensors and communications devices. In January 1993, the Company was notified by the German government that it does not plan to proceed with the GAFECS program, which was the principal user of the EGRETT aircraft. The loss of this program adversely impacted the Company's short-term international business goals, however, the Company believes that there are other government and commercial applications for the aircraft, such as special operations and anti-terrorist support, drug interdiction, search and rescue, communications relay, environmental sensing and monitoring, geophysical surveys and scientific experiments.\nThe Company generally engages in the design, development and production of reconnaissance and surveillance systems under a number of separate contracts, each of which involves relatively few units of production.\nCOMMAND, CONTROL AND COMMUNICATIONS\nThe Company develops and produces a broad range of systems and products for instantaneous communication via line-of-sight, satellites or integrated networks. These systems receive information that is gathered by advanced electronic means and conventional measures such as radar, photo reconnaissance and radio. The information is then transmitted to data processing systems and is displayed in a command center in a form which can readily be used to command and control forces and to monitor rapidly changing strategic and tactical events. These systems include communications (both analog and digital), large scale data processing, software, data link terminals, antennas and display equipment.\nThe Commanders Tactical Terminal is a joint service, interoperable system using airborne relays to disseminate and receive intelligence information to widely dispersed field units on a near real-time basis. The Company is developing a high-priority survivable communications integration system for the U.S. Space Command. It uses microwave, satellite, land lines, fiber optics, sensors and processors to provide secure and accurate communications between U.S. early warning stations and The North American Air Defense Command (\"NORAD\") in Colorado Springs.\nThe Company produces a transportable, interoperable and self-contained signal intelligence system called Celtic, which provides a readily reconfigurable system to support signal acquisition or a combination of signal acquisition and direction finding. Celtic is one of the fundamental building blocks E-Systems is using to expand in the international marketplace.\nThe Company produces a Multi-mission UHF Satcom Transceiver (\"MUST\"), a full duplex radio, which combines state-of-the-art modem and transceiver functions into a single unit. As the smallest airborne demand assured multiple access and interoperable radio available today, the MUST transceiver supplies upgrades while simplifying existing communication systems. E-Systems has also developed key components of the Government Emergency Telecommunications Service (\"GETS\"). This service allows priority status for officials and emergency support personnel to establish communication over public telephone networks in times of crisis.\nE-Systems also designed and furnishes the Data Distribution System, a key element of the United States Navy's Cooperative Engagement Capability, which provides a highly reliable secure data communication link to distribute real time sensor information for ship defense. Threat tracking information is shared interactively between all ships and aircraft in the same battle group.\nAn outgrowth of the Company's command, control and communications business segment has been the development of complex, computer-based digital data storage systems for easy information retrieval and rapid transmission to the users. The Company's EMASS-R- Data Storage and Retrieval System is being marketed to energy exploration companies, which have extremely large geological databases to maintain and access, and to other non-defense Government customers with huge databases.\nThe Company also produces mobile command and control facilities which can be airlifted anywhere in a worldwide command mission area. These shelters are self-contained command centers for the control of airlift operations from tactical airfields which have no other communications facilities in place. They provide secure line-of-sight or satellite data and voice communications. These systems were used during the Iraq-Kuwait war in the Middle East.\nNAVIGATION AND CONTROLS\nThe Company develops and manufactures automatic control products for aircraft, missile steering and tracking systems, and aircraft navigation aids.\nSubstantially all Boeing commercial jet aircraft, including the 757 and 767 aircraft, flown by domestic and international airlines are equipped with flight controls designed and manufactured by the Company. Flight controls are sold to manufacturers as original equipment and to airlines as replacements. The Company also produces an automatic pilot module for the Boeing 737 and 757. The Company's flight control systems provide the pilot with computer measured responses to stress on aircraft control surfaces or perform other precision control functions.\nThe Company manufactures portable tactical air navigation systems for military use to assist pilots in landing at remote or unimproved locations.\nAIRCRAFT MAINTENANCE AND MODIFICATION AND OTHER SERVICES\nThe Company provides maintenance, repair and modification services for commercial, executive and military aircraft of all types. Other similar work by the Company involves U.S. Air Force aircraft which are regularly returned to the Company for maintenance and systems updating. In addition, the Company maintains field teams for servicing and operational support throughout the world. The Company also has designed and installed a number of executive or head-of-state custom interiors in various types of aircraft. The Company and a wholly owned subsidiary, Serv-Air, Inc., performs special services such as facilities operations, logistics and support, electronics repair, computer based training and simulation systems and base management and support services at various military installations in both the continental United States and worldwide.\nThe Company provides worldwide technical and logistics support for the United States Air Force fleet of KC-10 aircraft used for in-flight refueling and cargo transport. Logistics support includes an on-line computerized inventory management system, which supports material procurement, inventory control and specialized repair and overhaul activity for more than 10,000 line items. Serv-Air also provides base support to four major U.S. Army Commands, maintaining infrastructure, utilities and services equivalent to those required in a large city. Primary functions include facility engineering, utility systems operation and repair, equipment and vehicle maintenance, audio visual services, supply and inventory control, housing management, transportation and various administrative efforts. At a Government facility in Lexington, Kentucky, Serv-Air converts crash damaged Apache helicopters into training devices. The Company also provides contract field teams on call to modify, maintain or repair aircraft, watercraft, vehicles and heavy support equipment for the U.S. military forces anywhere in the world.\nOperating from 17 fixed sites and additional remote sites, E-Systems maintains a fleet of 150 aircraft for the U.S. Customs Service. These aircraft are equipped with sophisticated airborne avionics sensor systems, including downward and forward looking infrared sensors. The Company also performs work for the Federal Aviation Administration on its flight inspection fleet of aircraft used to verify the accuracy and integrity of the country's en route flight guidance system and approach and takeoff airport guidance and control. The Company has a contract to modify four Lear Jet Model 60 aircraft and a Challenger 601-3R aircraft for the Federal Aviation Administration in connection with this program.\nNON-TRADITIONAL BUSINESS\nAs the defense budget declines, the Company is devoting many of its resources and competencies into systems suited for non-defense Government and commercial customers using leading edge technologies developed for the Department of Defense. Although none of the current programs contribute a significant amount of sales or profits to the Company, the management believes that some of these projects will lead to business areas of which may offer growth potential and make contributions to earnings within the not too distant future. Examples of the initiatives throughout the Company include the harnessing of surveillance technology developed for the Department of Defense into products which can provide nondisruptive means to detect traffic incidents and to estimate traffic volume and flow rates. This system, developed in part with a Government grant, is designed to reduce congestion on the public highways and is expected to be part of a national intelligent vehicle highway plan. Another product aimed at the transportation industry is Accutrans, which uses existing technology to develop a real time system for fleet management, location and status of mass transit vehicles. Another system, Vista Flight Net, enhances weather and flight information for the Federal Aviation Administration's Flight Service Stations, making current and accurate information more readily available to the general aviation pilot.\nSeveral of the Company's divisions are working on initiatives in the medical and health care industry. The Company's PACS systems (Picture Archiving and Communications System) is the core element of a comprehensive image management and communications system within a major medical center.\nThe Company is performing contracts involving large data handling capabilities to apply this knowledge to the Federal Student Loan program. Designed to detect and locate those who default on student loans, the system provides support for the United States Health, Education and Welfare Department.\nThe emergence of the so-called \"Information Highway\", and its opportunities for massive data exchange, is leading to demands for increased levels of integrity and privacy in data systems. E-Systems has a family of products called TeleSecurity-TM- which build on defense security communications systems and have been developed as inexpensive and superior wide area network security systems which control remote access to protected resources. The Company's INFOSEC systems offers a completely secure information storage and retrieval system to protect both Government and civilian sensitive data. INFOSEC automates information processing through consolidation of data systems using media encryptors and encrypted compact discs.\nGOVERNMENT CONTRACTS\nCompanies engaged primarily in supplying defense related equipment to the Government are subject to certain business risks unique to that industry. Among these are dependence on Government appropriations, changing policies and regulations, complexity of design and rapidly changing technologies and possible cost overruns. Since the Government usually awards or funds contracts for only one year at a time, the Company's business depends primarily upon such relatively short-term contracts, the periodic exercise by the Government of contract options and annual funding of continuing contracts.\nApproximately 47% of the Company's current Government contracts are firm, fixed price contracts accounting for approximately $1.0 billion. Under this type of contract, the price paid to the Company is not subject to adjustment by reason of the costs incurred by the Company in the\nperformance of the contract, except for costs incurred due to contract changes ordered by the Government. Multi-year fixed price contracts normally allow for price revision based on U.S. Government price indices.\nThe Company incurs significant work-in-process costs in the performance of United States Government contracts. However, the Company is usually entitled to invoice the U.S. Government for monthly progress payments on fixed price contracts and twice-monthly on some cost reimbursable contracts. The Government recently reduced the progress payment rate on fixed price contracts from 85% to 75%, increasing the Company's working capital requirements. The Company does not normally acquire inventory in advance of contract award, and the Company does not maintain significant stocks of finished products for sale. Government progress payments affect the amount of working capital necessary for the Company to finance work-in-process costs in the performance of these contracts. The Government does not recognize interest or other costs associated with the use of capital and, therefore, progress payment reductions may have adverse effects on the Company's profitability.\nThe Company also performs work for the Government under cost reimbursable and incentive type contracts. Cost reimbursable contracts provide for reimbursement of costs incurred, to the extent such costs are allowable under Government regulations, plus a fee. Under incentive type contracts, the amount of profit or fee realized varies with the attainment of incentive goals such as costs incurred, delivery schedule, quality and other criteria. Fixed price contracts normally carry a higher profit rate than cost reimbursable and incentive type contracts to compensate for higher business risk. In addition, government law and regulation provides that certain types of costs may not be included in either the directly-billed cost or the indirect overheads for which the government is responsible. Many of these so-called \"unallowable\" costs include ordinary costs of doing business in a commercial context. These costs must be borne out of the pretax profit of the corporation and, thus, tend to reduce margins on government work.\nThe so called \"unallowable costs\", which are not recoverable as a cost of business on Government contracts, although they are ordinary and necessary costs of doing business in the commercial context, are spelled out in Government acquisition regulations which do not permit contractors to bill the Government directly or indirectly for specified kinds of costs on Government cost reimbursement contracts, and do not allow these costs to be included in the bidding and pricing structure of negotiated fixed price contracts. The allowability or unallowability of such costs and other similar costs are covered in detail in the Federal Acquisition Regulations. Examples of such unallowable costs, including costs which are generally regarded as ordinary and necessary business expenses are: Public relations and advertising costs; contributions to local civil defense funds and projects; donations; business entertainment; independent research and development costs and bid and proposal costs over a negotiated ceiling; insurance costs to protect from the cost of correcting defects in material and workmanship; interest on borrowings and other financial costs, including costs associated with raising capital; lobbying; organizational costs including pursuit of mergers and acquisitions; patent and intellectual property costs not specifically required by contract; reconversion costs; employee relocation costs (with exceptions); travel and per diem costs in excess of those reimbursed to government employees and certain legal fees.\nAny Government contract may be terminated for the convenience of the Government at any time the Government believes that such termination would be in its best interests. Under contracts terminated for the convenience of the Government, the Company is entitled to receive payments for its allowable costs and, in general, a proportionate share of its fee or profit for the work actually performed.\nRecognition of profits is based upon estimates of final performance, which may change as contracts progress. Work may be performed prior to formal authorization or adjustment of contract price for increased work scope, change orders and other funding adjustments. Because of the complexity of Government contracts and applicable regulations, contract disputes with the Government occur in the ordinary course of the Company's business. The resolution of such disputes may affect the\nprofitability of the Company in performing these contracts. The Company believes that adequate provision has been made in its financial statements for these and other normal uncertainties incident to its Government business.\nChanges to procurement regulations in recent years, as well as the Government's drive against \"fraud, waste and abuse\" in defense procurement systems have increased the complexity and cost of doing business with the Government. Some of these changes have redefined the ability to recover various standard business costs which the Government will not allow, in whole or in part, as the cost of doing business on Government contracts. Other legal and regulatory practices have increased the number of auditors, inspectors general and investigators to the point that the Company, like every other major Government contractor, is the constant subject of audits, investigations and inquiries concerning various aspects of its business practices. One pending investigation resulted in subpoenas by the Government for a large number of documents, and Government interviews of a large number of current and former employees. The Company believes that this investigation, which has been ongoing for over three years, is currently dormant. The Company is unaware that the investigation produced credible evidence of material wrongdoing by it or its employees and, therefore, believes that charges or claims will not be brought against it or its employees arising from this investigation.\nThe Company regards charges of violation of government procurement regulations as extremely serious and recognizes that such charges could have a material adverse effect on the Company. If the Company is determined to be in noncompliance with any of the applicable laws and regulations, the possibility exists of penalties and debarment or suspension from receiving additional Government contracts.\nINTERNATIONAL SALES\nThe distribution of the Company's international sales is shown on the table set forth on Page 38 of the Company's 1993 Consolidated Financial Statements included herein. These sales are primarily export sales.\nReconnaissance and surveillance systems, high altitude platforms and ground-based transportable aircraft navigation systems are the principal source of international sales revenues of the Company. Since most of the Company's export sales involve technologically advanced products, services and expertise, U.S. export control regulations limit the type of products and services that may be offered and the countries and governments to which sales may be made. Consequently, the Company's international sales may be adversely affected by changes in U.S. Government export policy. In addition, the Company's international sales are subject to risks inherent in foreign commerce, including currency fluctuations and devaluations, changes in foreign governments and their policies, differences in foreign laws and difficulties in negotiating and litigating with foreign sovereigns. The Company believes that it has mitigated certain of these risks by obtaining letters of credit and advance payments and by denominating contracts in U.S. dollars where possible.\nCOMPETITION\nWith the recent end of the \"Cold War\" and prospects of substantial reductions in defense budgets for the procurement of military systems and equipment, the Company expects that its niche business in the reconnaissance, surveillance and intelligence market will probably be funded at a level which is less drastically cut than other elements of the defense budget. Therefore, the Company expects that its business will become even more attractive to competitors.\nThe Company faces intense competition with respect to all of its products and services. Competition is heightened by \"competitive advocates\" required of each Department of Defense procurement office, whose jobs are to see that new and renewal contracts are subjected to increased competition. Many of the Company's significant competitors are, or are controlled by, companies which are larger and have substantially greater financial resources than the Company. The Company also competes with small companies operating within a particular business segment. Sales are made principally\nthrough competitive proposals in response to requests for bids from U.S. Government agencies and prime contractors. The principal competitive factors are price, technology, service and ability to perform.\nThe Company's business consists largely of projects which involve the production of a relatively small number of units. Due to the diversity and specialized nature of the products produced and the governmental security restrictions applicable to many of the Company's activities, the Company cannot determine its market position in significant areas of its business. However, the Company believes that it is one of the leading manufacturers of reconnaissance and surveillance systems.\nRESEARCH AND DEVELOPMENT\nResearch and development and the Company's technological expertise have been important factors in the Company's growth. A substantial portion of the Company's business consists of research and development oriented products conducted under cost reimbursable contracts, many of which also result in the production of prototype hardware and systems. It is not possible to estimate separately the value of the research and development portion of these contracts as compared to the preproduction and prototype portion.\nIn 1993, the Company spent approximately $53.2 million on product research, design and development related to U.S. Government contracts (in addition to the activities described in the above paragraph). This compares to approximately $53.9 million in 1992 and $51.4 million in 1991 and includes research, development and engineering and costs incurred to submit bids and proposals for the Company's highly technical products and services to its customers. Most of the expenditures during these periods were recovered by the Company pursuant to independent research and development agreements negotiated with the U.S. Government. These agreements generally provide that the research and development costs up to specified ceiling limits and for specified efforts may be included in the overhead expense charged to certain Government contracts and recovered as part of the contract price.\nRAW MATERIALS\nThe Company's products require a wide variety of components and materials. The Company has multiple external sources for most of the components and materials it uses in production and produces certain components and materials internally. Although the Company has experienced shortages and long lead times for certain components and materials, such shortages and long lead times have not had a material effect on the Company's business, and the Company believes that the sources and availability of its raw materials are adequate.\nENVIRONMENTAL PROTECTION\nFederal environmental regulation of the electronics manufacturing industry is effected primarily through the Environmental Protection Agency (\"EPA\"). Regulations promulgated and proposed by the EPA, as well as state and local authorities, contain detailed provisions governing the types and amounts of waste generated from the electronic manufacturing process and the manner of disposal of such waste. Federal \"Superfund\" legislation mandates the clean-up of toxic waste sites, which may include sites used by the Company and others in the electronics manufacturing industry. See \"Item 3. Legal Proceedings, ENVIRONMENTAL MATTERS\".\nEMPLOYEES\nAt December 31, 1993, the Company employed approximately 16,700 persons, approximately 42% of whom are engineers, scientists and highly skilled technicians. Approximately 1,900 of the Company's employees are covered by collective bargaining agreements with various unions. The Company considers its employee relations to be good.\nPATENTS, TRADEMARKS AND LICENSES\nThe Company is a high technology company and, as such, is a holder of numerous patents. In addition, the Company is a party to various license agreements and has registered trademarks for a number of its products. None of the business segments of the Company are materially dependent upon patents, licenses, or trademarks.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company occupies buildings which contain approximately 7,053,000 square feet of floor space. Approximately 1,860,000 square feet are owned by the Company and the remaining 5,195,000 square feet are leased. Approximately 37,000 square feet of space are leased (or subleased) to non-affiliated persons. The principal plants and offices are located as follows:\nThe plant located at Greenville, Texas, is held under a lease, which expires as of October 1, 2017. A portion of the Garland, Texas, facilities of the Company is held under a lease which expires June 1, 2001, with options to renew for seven successive five-year periods. The Falls Church, Virginia, facility is held under a lease which expires in December 2005, with an option to renew for an additional five-year period. The plant located at Salt Lake City, Utah, is held under a lease which expires in October 1994, with options to renew the lease for three successive five-year periods.\nThe facilities located at State College, Pennsylvania are held under various leases expiring from June 1992 to December 2005 with options to renew, ranging from ten years to multiple five-year periods.\nAll real property and buildings are suitable for the Company's business and are generally fully utilized. The plants, machinery and equipment owned and leased by the Company are well maintained and suitable for its operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nENVIRONMENTAL MATTERS\nORANGE COUNTY, FLORIDA. An administrative proceeding was instituted in 1984 by the EPA and the Florida Department of Environmental Regulation against approximately 150 entities, including the Company, for disposal of hazardous waste at the City Chemical Company, Inc. hazardous waste recycling plant in Orange County, Florida. The extent of the Company's contribution of hazardous waste to that plant is estimated at 6.55% of the total waste deposited at the site.\nIn conjunction with other Potentially Responsible Parties (\"PRP's\"), the Company had conducted a Remedial Investigation\/Feasibility Study to define the parameters of needed remedial action. Based upon that study, a Record of Decision was issued by the EPA on March 29, 1990. That decision estimates the capital cost of the selected remedial measure at $1,516,725. Estimated operations and maintenance expenditures over a ten year period at the site are approximately $3,000,000. The EPA entered into a settlement agreement with the Company and approximately 130 other PRP's to finance the remedial program. A Consent Decree to effect that program was entered at the U.S. District Court for the Middle District of Florida on December 9, 1991. The design of the remedial program was completed in 1992. A contract for implementation of that design was awarded on January 20, 1993 with construction completion expected in mid-1994. Since the date of the initial Consent Decree, a substantial number of PRP's have exercised their right to buy-out of their liability at this site by paying a substantial premium above their volumetric contribution. As a result of those payments, no payment by the Company has been required to implement the construction of the remedial program; however, at the 80% construction completion point, the EPA will demand, pursuant to the Consent Decree, that the PRP's replenish the trust account by funding it to 120% of the initial program cost estimate. This will require the Company to make a payment of approximately $165,000 in 1994. The trust account will be used for annual operations and maintenance expenditures. Overruns will be funded at approximately 11% by the Company. The Company estimates total liability to the EPA at this site at approximately $400,000.\nThe Company will also be responsible for a portion of the state's environmental response costs based upon its volumetric share of waste sent to the site. Liability for repayment of the state expenditures is estimated at approximately $100,000.\nSIMPSONVILLE, SOUTH CAROLINA. An Administrative Proceeding was instituted in 1987 by the EPA against the Company, along with other entities, for environmental response costs at the Golden Strip Septic Tank National Priority List (NPL) Site in Simpsonville, South Carolina. The EPA alleges that the Company and its predecessor corporation, LTV, disposed of hazardous waste at this site at various times prior to 1975. Documents relating to these allegations have been destroyed due to the significant lapse of time between the cessation of operations of the Golden Strip Site in 1975 and the notification to the Company from the EPA in 1987. The Company and other potentially Responsible Parties formed a group to conduct a Remedial Investigation\/Feasibility Study. That study developed and analyzed several alternative remedial programs. A Record of Decision was executed by the EPA on September 12, 1991 selecting a remedial program estimated to cost approximately $4,000,000 with recurring annual operations and maintenance costs of approximately $75,000. A Consent Decree negotiated between the EPA and the PRP's was lodged in October, 1992. That Decree approves and authorizes implementation of the remedial program selected by the EPA. The environmental consulting firm of RMT, Inc. has completed a detailed design for the selected remedy. The design is currently\nawaiting EPA approval prior to implementation. The four major PRP's have executed an agreement allocating liability for the remedial costs. Under the terms of the agreement, the Company is responsible for 19.25% of remedial program costs. Two additional companies will participate to the extent of their very limited resources. The 1994 aggregate expenditures for the site are estimated at $1,500,000 with the Company's share being approximately $290,000. The Company's total liability for construction of the remedial program is estimated at approximately $886,000.\nSALT LAKE CITY, UTAH. The Company entered into a Stipulated Consent Agreement with the State of Utah, Division of Solid and Hazardous Waste on May 16, 1991 based upon preliminary data which indicated that soil and groundwater contamination existed immediately adjacent to a former underground storage tank located at the Montek Division. The Company has identified the lateral extent of the contamination and has proposed a remedial program consisting of limited soil removal and a groundwater pump and treat system. The remedial program is awaiting approval from the State of Utah. Remedial costs for this program are not expected to exceed $950,000 over a three year period.\nNeither the anticipated costs to be incurred by the Company to clean-up the sites where the Company has been named a \"Potentially Responsible Party\", the aggregate of those costs, nor the aggregate of all costs to be incurred to clean-up soil and groundwater contamination are expected to have a material adverse effect on the Company's financial condition.\nThe Company is engaged in an industry which uses relatively insignificant quantities and varieties of hazardous chemicals. However, the current state of the law provides for liability without fault for companies dealing with hazardous waste materials. The federal courts have held that a single company may be held liable for the entire clean-up costs at a given site. Therefore, the Company may be sued for the total cost of cleaning up any of the sites where the Company's waste has been deposited. Should the Government institute such an action, the Company will vigorously oppose any attempt to impose liability beyond its volumetric share of waste sent to the site.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, offices held and other information with respect to each of the executive officers of the Company as of February 25, 1994 are as follows:\nEach of the executive officers has been employed as indicated in the table above for more than five years except as may be indicated below:\nE. GENE KEIFFER -- Mr. Keiffer is Chairman of the Board having been elected to that position on April 25, 1989. He had served as Chief Executive Officer from April 25, 1989 to January 26, 1994. Previously he served as Senior Vice President and Group Executive Officer since November 1, 1983.\nA. LOWELL LAWSON -- Mr. Lawson was elected Chief Executive Officer on January 26, 1994. He has held the position of President since April 25, 1989. Previously he served as Executive Vice President from April 21, 1987 to April 25, 1989 and Senior Vice President and Group Executive since November 1, 1983.\nTERRY W. HEIL -- Dr. Heil was elected Senior Vice President effective October 12, 1988. Prior to joining the Company at that time, Dr. Heil had been executive vice president of the Defense Electronics Group of the Singer Corporation since 1986 and had held other senior executive positions with Singer for more than five years previous.\nPETER A. MARINO -- From July 1991 until October 1991, Mr. Marino was executive vice president and chief operating officer of Fairchild Corporation. From September 1989 to July 1991, Mr. Marino was president and chief operating officer of Fairchild Industries, Inc. a high-technology company engaged in spacecraft and space subsystems, military avionics, defense communications, telecommunications, aerospace fasteners and capital equipment for the plastics molding industry. Between October 1988 and September 1989, he was senior vice president of Fairchild Industries, Inc. From October 1986 to September 1988, Mr. Marino was, first, executive vice president and then, president and chief operating officer of Lockheed Electronics Company, Inc. and a vice president of the parent, Lockheed Corporation. Prior to that time, Mr. Marino had been with the United States Central Intelligence Agency from 1970 to 1986, serving in various technical and managerial positions.\nBRIAN D. CULLEN -- Mr. Cullen served as Vice President of the Company from April 27, 1987 to January 26, 1994.\nJ. ROBERT COLLINS -- Dr. Collins was vice president of business development of the Garland Division, Garland, Texas, from March 16, 1992 to September 22, 1993 when he was elected to his current position. Prior to that, he was division vice president of the Garland Division from May 20, 1985 to March 16, 1992.\nART HOBBS -- Prior to his current position, Mr. Hobbs was the vice president of human resources of the Greenville Division, Greenville, Texas, the largest operating division of the Company. He had served in such capacity since 1982, having previously been director of employee relations for three years.\nJAMES J. REILLY -- Mr. Reilly was director of Financial Controls from April 14, 1989 to August 10, 1989. Before joining the Company, he was Group Controller for the Pullman Company, which is engaged in the production of aerospace and electronic and material components, since 1987. From 1978 to 1987 he was Vice President-Finance for Loral Electronics Systems Division.\nMARSHALL D. WILLIAMSON -- From February 1, 1993 until being elected to his current position, Mr. Williamson was vice president and assistant general manager of the Garland Division, Garland, Texas. He served as vice president of the Garland Division from May 20, 1985 until February 1, 1993 previously having held various managerial positions since joining the Company in 1975.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is listed on the New York and London Stock Exchanges and principally traded in those markets. The table below shows the high and low closing prices of the Company's common stock on the New York Stock Exchange, as reported in the WALL STREET JOURNAL, and the cash dividends declared per share for each quarter during the past two years.\nHOLDERS OF RECORD:\nAt March 4, 1994, there were 10,386 holders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR SUMMARY OF OPERATIONS AND FINANCIAL CONDITION YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS EXCEPT PER SHARE DATA)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSOURCES OF LIQUIDITY AND CAPITAL RESOURCES -- Net working capital increased $83 million from the prior year-end to $581 million. Net cash provided by operating activities was $96 million for 1993 compared to $123 million for 1992. This change was primarily due to collections of accounts receivable. Cash and cash equivalents at the beginning of the year and funds provided by operations were used to finance capital expenditures of $52 million, pay dividends of $36 million and pay-off $52 million in long-term debt and installment lease obligations.\nThe ratio of total debt to equity was .04 at December 31, 1993 which is down from the total debt to equity ratio of .16 at December 31, 1992. This decrease is due to the $50 million pay-off of the five year, fixed rate Senior Notes in August 1993.\nThe ratio of current assets to current liabilities was 4.4 at December 31, 1993 compared to 3.0 at December 31, 1992. Excluding the effect of adoption of Statement of Financial Accounting Standards (SFAS) No. 106 in 1992, return on equity increased from 15 percent in 1992 to 17 percent in 1993.\nThe Government recently reduced the progress payment rate on fixed-price contracts from 85 percent to 75 percent. This change will increase requirements for working capital. Current financing agreements provide lines of credit up to $350 million of which $24 million was borrowed at December 31, 1993. Management believes these lines of credit and internally generated funds will be more than adequate to meet increased working capital requirements, capital expansion projects, dividend payments to shareholders and satisfy payment of the Company's maturing debt obligations.\nIn the first quarter of 1993, the Company made the decision to fund a portion of the recurring costs associated with retiree health care benefits. To do so, the Company established a 401(h) account, which is a part of the E-Systems Salaried Retirement Plan, and a 501(c)(9) trust known as a voluntary employees' beneficiary association (VEBA). Funding the retiree health care costs will make them allowable under government contracts and deductible under Internal Revenue Service regulations, thereby, minimizing future profit impact.\nBUSINESS ENVIRONMENT -- The ongoing and dramatic geopolitical changes occurring in the United States and throughout the world continue to result in changes in the requirements and priorities established by Congress and the administration. Defense spending continues to decline with FY 1994 authorization at $262 billion and an administration target of $200 billion by the end of the decade. The total intelligence budget is expected to remain approximately flat over the next several years. Our customer environment is also changing with a continuing re-evaluation of roles and missions, pressure to reduce spending and a push to combine common functions within the various departments and agencies.\nThere continues to be a large number of political and military pressure points throughout the world. The two currently dominating are the Bosnian conflict in Eastern Europe and the uncertainty that exists in the former Soviet Union. The number and diversity of conflicts or potential conflicts, coupled with decreasing forces, makes the intelligence function more important than ever. The company believes there will be a continuing need for precision weapon systems, expert command and control capabilities, and the collection and distribution of precise and timely intelligence information. As a leader in the design, development, deployment and operation of sophisticated information- oriented collection, analysis, monitoring and dissemination systems, the company is well-positioned to respond to these needs.\nWe are also applying our technical and business strengths to markets which are outside our traditional business. This is evidenced by contract awards from the Department of Education for the development and operation of the national data base for student loans and grants and the FAA for the flight inspection aircraft program. The total value of this FAA contract including options exercisable through FY 1996 is approximately $400 million. These programs combined with increasing market\nacceptance of our EMASS-R- information storage and retrieval products and our continuing push into medical image processing and information are expected to provide a larger non-traditional business base for the company within the next several years.\nIn January 1993, the company was notified by the German government that it does not plan on proceeding with the GAFECS reconnaissance and surveillance program at this time. Though the loss of this program will have an impact on the company's short-term international business goals, we believe there are opportunities in the international arena which will sustain the growth of our international business.\nWith the above mentioned geopolitical changes, the international market for our products and systems is taking on a new look. Governments who previously depended on the United States and\/or NATO to provide Command, Control and Communications, surveillance and analysis functions are now faced with providing these capabilities. As a result we are presently seeing opportunities in several countries and have booked projects in some. We believe that this trend, along with our increasing EMASS-R- penetration, will continue to yield a growing international component of our business base.\nThe company is a developer and producer of high technology electronic systems and services, consisting principally of systems design, integration, hardware modification and development for the United States government or other prime government contractors. The company's business base consists of both cost-type and fixed price contracts with 60 percent being cost-type. The profitability of cost-type contracts is contingent upon several factors: customer's evaluation of performance on contracts, costs actually incurred, delivery schedule, quality and incentive or award fee arrangements. Given this determination of profitability, contract costs and related margins are not readily explainable in typical manufacturing terms. Also, due to the nature of the products or services provided by the company, many contracts are highly sensitive and classified under relevant U.S. Government regulations.\n1993 COMPARED TO 1992\nNET SALES. Net sales for 1993 totaled $2,097 million compared to $2,095 million in 1992. Net sales in the Reconnaissance and Surveillance product segment decreased 9 percent to $1,260 million. The decline is attributable to the absence of the German reconnaissance and surveillance program which was canceled in January of 1993.\nCOSTS AND EXPENSES. Operating profits increased 6 percent in 1993. This increase was primarily due to increased sales in the Aircraft Maintenance & Modification and Other Services product segment and improved margins in the Command, Control & Communications product segment. Operating profits for the Reconnaissance and Surveillance product segment were $111 million, down $3 million when compared to the same period in 1992. Operating profits in the Command, Control and Communications product segment increased $4 million, or 20 percent, to $27 million in 1993. Operating profits in the Aircraft Maintenance & Modification and Other Services product segment were $23 million, up 28 percent, or $5 million in 1993.\nOther income totaled $10.8 million for 1993 compared to $3.8 million for the same period in 1992. This increase was primarily due to interest associated with a one-time gain from a favorable tax settlement coupled with an increase in capital gains earned on the Company's Supplemental Executive Retirement Plan investments.\nINCOME. Excluding the cumulative effect of adopting SFAS 106 in 1992, net income increased 12 percent in 1993 to $121 million compared to $109 million in 1992. This increase was due to improved margins discussed above.\n1992 COMPARED TO 1991\nNET SALES. Net sales from operations increased 5 percent, or $104 million, in 1992. This increase was primarily due to increased deliveries in the Reconnaissance and Surveillance and Aircraft Maintenance & Modification and Other Services product segments. Net sales in the Reconnaissance and Surveillance segment totaled $1,379 million for the year ended December 31, 1992, up 7 percent, or $89 million, from $1,290 million in the comparable period in 1991. Net sales in the Aircraft Maintenance & Modification and Other Services product segment increased $28 million or 10 percent in 1992.\nCOSTS AND EXPENSES. Excluding the effect of adopting SFAS 106, operating profits increased 12 percent in 1992. This increase was primarily the result of increased sales in the Reconnaissance and Surveillance segment and improved margins due to production efficiencies in the Command, Control & Communications product segment. Operating profits for the Reconnaissance and Surveillance product segment were $114 million, up $6 million when compared to the same period in 1991. Operating profits in the Command, Control and Communication product segment increased $3 million, or 14 percent, to $22 million in 1992. Higher than anticipated costs resulted in a decrease in operating profits in the Aircraft Maintenance & Modification and Other Services product segment. Operating profits in this product segment decreased from $23 million in 1991 to $18 million for the year ended December 31, 1992.\nLOSS. Excluding the effect of adopting SFAS 106, net income increased 10 percent for the year ended December 31, 1992. Adoption of the new accounting standard required recognition of a non-recurring charge of $179 million which resulted in a loss of $69 million for the year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe index to Consolidated Financial Statements and Financial Statement Schedule is found on page 21. The Company's Financial Statements, Notes to Consolidated Financial Statements and Financial Statement Schedule follow the index.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nInapplicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item is set forth in the Company's proxy statement dated March 25, 1994 at pages 4 through 7 in the section entitled \"Election of Directors,\" and is incorporated herein by reference. Reference is made to the section entitled \"Executive Officers of the Registrant\" under Part I.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is set forth in the Company's proxy statement, dated March 25, 1994, at pages 8 through 17, under the sections entitled \"Executive Compensation, Salaried Retirement Plan, Supplemental Executive Retirement Plan and Employment Agreements,\" and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is set forth under \"Principal Stockholders\" on pages 2 and 3 of the Company's proxy statement dated March 25, 1994, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInapplicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report.\n1. Financial Statements\n2. Financial Statement Schedule\nThe financial statements and the financial statement schedule filed as a part of this report are listed in the \"Index to Consolidated Financial Statements and Financial Statement Schedule\" on page 21. The index, statements and schedule are incorporated herein by reference.\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n3. Exhibits required by Item 601 of Regulation S-K.\nA list of the exhibits required by Item 601 of Regulation S-K and filed as part of this report is set forth in the Index to Exhibits on pages 41 and 42, which immediately precedes such exhibits.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed for the three months ended December 31, 1993.\nSIGNATURES\nPursuant 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.\nE-SYSTEMS, INC.\n\/s\/ A. LOWELL LAWSON\n-------------------------------------- A. Lowell Lawson DIRECTOR, CHIEF EXECUTIVE OFFICER AND PRESIDENT March 28, 1994\nPursuant 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 and on the date indicated.\nE-SYSTEMS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors of E-Systems, Inc.\nWe have audited the consolidated balance sheets of E-Systems, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of E-Systems, Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note J to the consolidated financial statements, in 1992 the company changed its method of accounting for retiree health care and life insurance benefits in accordance with FASB Statement No. 106.\nERNST & YOUNG\nDallas, Texas January 27, 1994\nE-SYSTEMS, INC. AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED OPERATIONS\nTHREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee \"Notes to Consolidated Financial Statements.\"\nE-SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1993 AND 1992 (IN THOUSANDS) ASSETS\nSee \"Notes to Consolidated Financial Statements.\"\nE-SYSTEMS, INC. AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nTHREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nSee \"Notes to Consolidated Financial Statements.\"\nE-SYSTEMS, INC. AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY\nTHREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nSee \"Notes to Consolidated Financial Statements.\"\nE-SYSTEMS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nNOTE A -- SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION -- The accounts of all subsidiaries have been included in the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated.\nREVENUE AND PROFIT DETERMINATION -- Sales and costs of sales (including general and administrative expenses) on fixed-price contracts are generally recorded when units are delivered, based on the profit rates anticipated on the contracts at completion. Sales and costs of sales on long-term, small quantity, high unit value fixed-price contracts, and sales (costs and fees) on cost reimbursable contracts are recorded under the percentage-of-completion method of accounting as costs (including general and administrative expenses) are incurred. Profits expected to be realized on contracts are based on estimates of total sales value and costs at completion. These estimates are reviewed and revised periodically throughout the lives of the contracts and adjustments to profits resulting from such revisions are made cumulative to the date of change. Amounts in excess of agreed upon contract price for customer-caused delays, errors in specification and design, unapproved change orders or other causes of unanticipated additional costs are recognized in contract value if it is probable that the claim will result in additional revenue and the amount can be reasonably estimated (SEE NOTE C). Losses on contracts are recorded in full as they are identified.\nFIXED-PRICE CONTRACTS AND RAW MATERIALS -- Costs incurred in advance of contractual coverage receive an allocated portion of general and administrative expenses and are valued at the lower of cost incurred or market. Raw materials and purchased parts are valued at average cost not in excess of market.\nPROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment are stated at cost. Capitalized leases are recorded at the present value of the net fixed minimum lease commitments (SEE NOTE H). Provisions for depreciation are computed on both accelerated and straight-line methods using rates calculated to amortize the cost of the assets over their estimated useful lives and include amortization of capitalized leases. Leasehold improvements are amortized over the life of the lease and renewal options which are expected to be exercised. The company's policy is to remove the amounts related to fully-depreciated assets from the financial records.\nEARNINGS PER SHARE -- Earnings per share are computed based on the sum of the average outstanding common shares and common equivalent shares (1993 -- 34,041,000; 1992 -- 32,941,000; 1991 -- 32,723,000). Common equivalent shares assume the exercise of all dilutive stock options. Primary and fully diluted earnings per share are essentially the same.\nSTATEMENT OF CASH FLOWS -- The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nCOSTS IN EXCESS OF NET ASSETS ACQUIRED -- The costs in excess of net assets acquired (goodwill) are being amortized using the straight-line method over a period of 20 to 40 years. Accumulated amortization was $6,557,000 and $4,580,000 at December 31, 1993 and 1992, respectively.\nFINANCIAL INSTRUMENTS AND RISK CONCENTRATION -- Financial instruments which potentially subject the company to concentrations of credit risk consist of cash equivalents, billed accounts receivable and unreimbursed costs and fees under cost-plus-fee contracts. The company's cash equivalents consist principally of U.S. Government securities and Eurodollar accounts with high credit quality financial institutions. Generally, the investments mature within 90 days and therefore are subject to minimal risk. Billed accounts receivable and unreimbursed costs and fees under cost-plus-fee contracts result primarily from contracts with the U.S. Government or prime contractors with the U.S.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE A -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Government and some international customers (principally governments). Contracts involving the U.S. Government do not require collateral or other security. The company conducts ongoing credit evaluations of domestic non-U.S. Government customers and generally does not require collateral or other security from these customers. The company generally requires international customers to furnish letters of credit or make advance payments in amounts sufficient to limit the company's credit risk to a minimal level. Historically, the company has not incurred any significant credit-related losses.\nRECLASSIFICATIONS -- Certain prior year amounts have been reclassified to conform to the current year presentation.\nNOTE B -- RECEIVABLES Accounts Receivable and Unreimbursed Costs and Fees Under Cost-Plus-Fee Contracts by major classification are as follows:\nAccrued recoverable costs and profits and accrued costs and fees under customer contracts represent revenue earned under the percentage-of-completion method but not yet billable under the terms of the contracts. These amounts are billable based on the terms of the contract which include shipments of the product, achievement of milestones or completion of the contract. Substantially all of the accrued recoverable costs and profits and accrued costs and fees at December 31, 1993 are to be billed during 1994.\nOffset against accrued recoverable costs and profits are unliquidated progress payments of $470,604,000 for 1993 and $549,950,000 for 1992.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE C -- FIXED-PRICE CONTRACTS Cost elements included in Fixed-Price Contracts in Progress are as follows:\nSubstantially all of the costs incurred in advance of negotiated contracts at December 31, 1993 are expected to receive firm contractual coverage in 1994.\nNOTE D -- DEBT The company's long-term debt at December 31 is summarized as follows:\nAs of December 31, 1993, the maturities of long-term debt were as follows:\nThe company has two lines of credit dated October 21, 1992, with total credit available of $250 million. One credit agreement in the amount of $150 million terminates October 19, 1995, and the other agreement in the amount of $100 million terminates October 14, 1994 and contains a provision for a one-year extension. These agreements, with a group of eight banks, provide for a floating interest rate based upon competitive bids from the member banks and repayment terms negotiated at the time of each borrowing. The credit agreement in the amount of $150 million provides for a facility fee of .15 percent of the committed amount, and the credit agreement in the amount of $100 million provides for a facility of .125 percent of the committed amount. The company had no borrowings under either line in 1993.\nThe company has total lines of credit available under short-term borrowing agreements of $100 million of which none and $19,533,000 were borrowed at December 31, 1993 and 1992, respectively. The lines of credit provide for interest at each bank's offered rate at the date of the advance.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE D -- DEBT (CONTINUED) Borrowings under the ESOP line of credit were used to purchase the company's common stock for contribution to the company's Employee Stock Ownership Plan.\nThe company's various debt agreements require, among other things, that the Company maintain a specified current ratio, debt to equity ratio, and tangible net worth. Under the most restrictive of these covenants, the company has unrestricted retained earnings of $169,996,000 at December 31, 1993.\nThe company made interest payments in 1993, 1992, and 1991, respectively, of $7,027,000, $6,817,000, and $7,880,000.\nNOTE E -- INCOME TAXES During 1992, the company adopted FASB Statement No. 109 \"Accounting for Income Taxes.\" The adoption had no material impact on the company's financial statements. A reconciliation of the provision for taxes on income to the U.S. statutory rate follows:\nDeferred income taxes result primarily from the use of accelerated methods of depreciation for tax purposes, pension income not currently taxable and safe harbor leasing transactions offset by accrued employee and retiree benefits which are not deductible until paid.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE E -- INCOME TAXES (CONTINUED) The tax effects of the significant temporary differences which comprise the deferred tax assets and liabilities at December 31, 1993 and 1992 are as follows:\nA valuation allowance has not been recorded for the deferred federal income tax benefits as the company believes it will generate sufficient taxable income in the future to realize all of the recorded benefits.\nIncluded in operating costs and expenses are state income taxes of $6,688,000, $6,575,000, and $2,700,000 in 1993, 1992 and 1991, respectively.\nThe company made federal income tax payments in 1993, 1992, and 1991, respectively, of $55,450,000, $62,027,000, and $43,250,000.\nNOTE F -- ACCRUED LIABILITIES\nNOTE G -- STOCKHOLDERS EQUITY At December 31, 1993, there were 50,000,000 authorized shares of common stock and 185,000 shares of authorized but undesignated preferred stock, par value $20.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE G -- STOCKHOLDERS EQUITY (CONTINUED) Stock option plans, which include both \"nonqualified\" and incentive stock options, provide for options to be granted to key employees at prices equal to, greater than or less than market value at the date of grant and for terms not to exceed ten years. The options outstanding under the plan expire at various dates through 2003.\nInformation on stock options is summarized as follows:\nNOTE H -- LEASE COMMITMENTS Certain plant facilities are leased under agreements expiring at various dates through 2017. Substantially all of the leases for plant facilities may be renewed for up to seven years after the initial term of the lease. The capitalized value of leases amounted to $17,461,000 and $25,568,000 at December 31, 1993 and 1992, respectively, and net book value amounted to approximately $9,765,000 and $11,352,000 at December 31, 1993 and 1992, respectively.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE H -- LEASE COMMITMENTS (CONTINUED) Future minimum payments as of December 31, 1993 under the capital leases and noncancelable operating leases with initial or remaining terms of one year or more follow:\nLease expense on plant facilities, machinery and equipment amounted to $18,890,000, $22,616,000 and $24,015,000 in 1993, 1992, and 1991, respectively.\nNOTE I -- EMPLOYEE BENEFITS The company has several noncontributory defined benefit pension plans covering substantially all employees. Plans covering salaried and non-union employees provide pension benefits that are based on the highest consecutive 60 months of an employee's compensation. Plans covering employees governed by collective bargaining agreements generally provide pension benefits of stated amounts for each year of service and provide for supplemental benefits for employees who retire with 20 years of service before age 62. The company's funding policy for all plans is to make annual contributions generally equal to the amounts accrued for pension expense, up to the maximum amount that can be deducted for federal income tax purposes.\nA summary of the components of net periodic expense for the company's defined benefit plans and SERP follows:\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE I -- EMPLOYEE BENEFITS (CONTINUED) The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets for the company's defined benefit pension plans, excluding the SERP:\nApproximately 52 percent of the defined benefit plans' assets at December 31, 1993 are invested in mutual funds, commercial paper, common stocks and other assets, and 48 percent of the plans' assets are invested in real estate. The market value of the common stock of the company held by the plans was $63,960,000 at December 31, 1993.\nThe company also sponsors a Supplemental Executive Retirement Program (SERP), which is a nonqualified plan that provides certain officers with defined pension benefits in excess of limits imposed by federal tax laws. The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets for the company's SERP:\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE I -- EMPLOYEE BENEFITS (CONTINUED) The company has established a trust to fund the payment of pension benefits under the SERP. Trust assets totaled $42,134,000 and $38,497,000 at December 31, 1993 and 1992, respectively, and are included in Deferred Charges and Other in the Consolidated Balance Sheets. The assets of the Trust are invested at the discretion of the outside trustee, and at December 31, 1993, consisted primarily of listed common stock, convertible securities and fixed-income investments. Marketable equity securities held by the Trust are carried at the lower of aggregate cost or market. Income and expenses of the Trust are included in the company's consolidated income and expenses. At December 31, 1993, the outside trustee estimates the market value of the trust assets to be $46,119,000. The Trust became irrevocable in 1988 subject only to the claims of creditors in the event of insolvency of the company.\nIn May 1993 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective for fiscal years beginning after December 15, 1993. The company plans to adopt the Statement in 1994, and it is not expected to have a material impact on the company's financial position or results of operations.\nThe company has an Employee Stock Ownership Plan (ESOP) which includes substantially all employees. The ESOP provides for voluntary annual contributions by the company in amounts determined by the Board of Directors. The contributions may be in cash, common stock, securities or other property. The annual contributions are to be at least sufficient to discharge any current obligations of the Employee Stock Ownership Trust. The Employee Stock Ownership Trust borrows funds at various times to purchase common stock of the company for subsequent distribution to the employees over a defined period in accordance with the Employee Stock Ownership Plan. The repayment of the loans is guaranteed by the company; however, at December 31, 1993 and 1992, there were no such obligations outstanding. Contributions to the Trust for 1993, 1992, and 1991 were $11,709,000, $13,045,000 and $12,072,000, respectively.\nThree of the company's subsidiaries sponsor separate 401K savings plans. The plans provide for voluntary annual contributions by the company at the discretion of management. The company contributed $4,202,000, $2,480,000, and $2,217,000 to the plans in 1993, 1992 and 1991, respectively.\nDuring 1987, the Board of Directors approved a retirement policy for its outside directors which provides for post retirement remuneration and death benefits. The expense of the plan is being amortized over the anticipated remaining terms of the directors.\nNOTE J -- RETIREE HEALTH CARE AND LIFE INSURANCE BENEFITS The company also provides certain health care and life insurance benefits for its retired employees. Employees retiring from the company between the ages of 55 and 65 with at least 10 years of service or who age vest under the E-Systems, Inc. Salaried Retirement Plan are eligible for these benefits. Election to participate must be made as of the date of retirement, and the retiree may elect to cover qualifying dependents. If the retiree elects no medical coverage, it may not be added at a later date.\nPrior to 1992, the costs for providing retiree health care and life insurance benefits were recognized as an expense as claims were paid. In 1992, the company began to recognize the projected future cost of providing postretirement benefits, such as health care and life insurance, as an expense during the employee's vesting service. Upon implementation of this change, the company immediately recognized the January 1, 1992 accumulated postretirement benefit obligation (APBO) of $270.5 million.\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE J -- RETIREE HEALTH CARE AND LIFE INSURANCE BENEFITS (CONTINUED) A summary of the components of net periodic retiree health care and life insurance benefits cost follows:\nThe cost shown in 1992 for retiree health care and life insurance benefits is $16,856,000 higher than it would have been had the change in accounting not been made in 1992. Annual costs for 1991 are not restated.\nThe company has begun contributing to a Voluntary Employees' Beneficiary Association trust and a 401(h) trust that will be used to partially fund health care benefits for retirees. The company is funding benefits to the extent contributions are tax-deductible, which under current legislation is limited. In general, retiree health care benefits are paid as covered expenses are incurred. Plan assets consist of listed mutual funds, and the expected long-term rate of return on plan assets is 9 percent. The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets for the company's retiree health care and life insurance plans:\nThe health care cost trend rates, used to calculate both net periodic cost and the APBO, are as follows:\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE J -- RETIREE HEALTH CARE AND LIFE INSURANCE BENEFITS (CONTINUED) Increasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO as of December 31, 1993 by $22,428,000 and net periodic benefit cost for the year ended December 31, 1993 by $2,516,000.\nIn November 1992, the Financial Accounting Standards Board issued Statement No. 112, \"Employers Accounting for Postemployment Benefits.\" This statement is effective for fiscal years beginning after December 15, 1993. The company plans to adopt the Statement in 1994, and it is not expected to have a material impact on the company's financial position or results of operations.\nNOTE K -- COMMITMENTS AND CONTINGENCIES Changes to procurement regulations in recent years, as well as the Government's drive against \"fraud, waste and abuse\" in defense procurement systems have increased the complexity and cost of doing business with the Government. Some of these changes have redefined the ability to recover various standard business costs which the Government will not allow, in whole or in part, as the cost of doing business on Government contracts. Other legal and regulatory practices have increased the number of auditors, inspectors general and investigators to the point that the company, like every other major Government contractor, is the constant subject of audits, investigations and inquiries concerning various aspects of its business practices. One pending investigation resulted in subpoenas by the Government for a large number of documents and government interviews of a large number of current and former employees. The company believes that this investigation, which has been ongoing for over three years, is currently dormant. The company is unaware that the investigation produced credible evidence of material wrongdoing by it or its employees and, therefore, believes that charges or claims will not be brought against it or its employees arising from this investigation.\nThe company regards charges of violation of government procurement regulations as extremely serious and recognizes that such charges could have a material adverse effect on the company. If the company is determined to be in noncompliance with any of the applicable laws and regulations, the possibility exists of penalties and debarment or suspension from receiving additional Government contracts.\nThe company is involved in other disagreements which are in the ordinary course of the company's business activities that are not expected to have a material adverse effect on the company's financial position. In addition, the company is involved in certain environmental matters with governmental agencies, and pending or threatened lawsuits and claims of current and former employees alleging various age, race, sex and disability discrimination or retaliatory discharge.\nManagement believes that the impact of the above matters, if any, on the company's financial condition will not be material.\nNOTE L -- OPERATIONS BY PRODUCT CATEGORY The company has four significant product segments. The Reconnaissance and Surveillance category includes strategic systems for intelligence, reconnaissance and surveillance applications and tactical systems relating to electronic countermeasures and jamming and deception devices. The Command, Control and Communications category includes communications equipment and command and control systems which process data for ready analysis and decision making. In the Navigation and Controls category, automatic control products for aircraft, missile steering and tracking systems, and aircraft navigation aids are developed and manufactured. The company provides maintenance, repair and modification services for aircraft of all types and other maintenance services\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE L -- OPERATIONS BY PRODUCT CATEGORY (CONTINUED) through its Aircraft Maintenance and Modification and Other Services category. Product category information is reported herein by product type since each category involves several divisions. There are no sales between product categories.\nIdentifiable assets by product category include both assets specifically identified with those operations and an allocable share of jointly used assets. Corporate assets consist primarily of cash, deferred federal income taxes, miscellaneous receivables, investments and fixed assets.\nSales to the United States Government from all categories amounted to $1,865,069,000, $1,867,043,000, and $1,774,288,000, in 1993, 1992 and 1991, respectively.\nInternational sales which are primarily export sales to foreign governments and from all categories are summarized by geographic area as follows:\nE-SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nNOTE L -- OPERATIONS BY PRODUCT CATEGORY (CONTINUED) Financial information by product category (in thousands) is summarized as follows:\nSCHEDULE IX\nE-SYSTEMS, INC. AND SUBSIDIARIES SHORT-TERM BORROWINGS\nINDEX OF EXHIBITS SECURITIES EXCHANGE ACT OF 1934","section_15":""}
{"filename":"70040_1993.txt","cik":"70040","year":"1993","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nNBD Bancorp, Inc. (the Corporation) is a bank holding company incorporated under the laws of the State of Delaware on July 14, 1972. Through bank subsidiaries in Michigan, Illinois, Indiana, Ohio and Florida, the Corporation provides domestic retail banking, worldwide commercial banking, cash management, trust and investment management services. The Corporation also engages in mortgage lending and servicing, insurance, trust, leasing, discount brokerage and data processing activities through its bank-related subsidiaries to the extent permitted by the Bank Holding Company Act of 1956, as amended. The Corporation and its subsidiaries employ approximately 18,700 persons on a full-time equivalent basis. At December 31, 1993, the Corporation and its subsidiaries had total assets of $40.8 billion, total deposits of $29.8 billion and shareholders' equity of $3.2 billion. Based on rankings by total assets as of December 31, 1993, the Corporation was the 17th largest bank holding company in the United States.\nDetailed financial information about the Corporation is presented under Part II later in this Form 10-K and is incorporated by reference herein.\nSUBSIDIARIES\nNBD BANK, N.A. (MICHIGAN)\nThe principal subsidiary of the Corporation is NBD Bank, N.A. (Michigan), formerly named National Bank of Detroit, which remains the largest single contributor to the Corporation's earnings. NBD Bank, N.A. accounted for approximately 62 percent of the consolidated assets and 64 percent of the consolidated net income of the Corporation in 1993.\nNBD Bank, N.A. was organized under the National Bank Act in 1933. It was the largest bank in the State of Michigan and among the 20 largest commercial banks in the United States based on total deposits as of year-end 1993. At December 31, 1993, it operated 330 banking offices located throughout the lower peninsula of Michigan. The Bank maintains correspondent relationships with banks and savings associations throughout the country, including many of the largest commercial banking organizations in the United States.\nInternational banking activities of NBD Bank, N.A. include operations in the Euro-Currency markets, the extension of lines of credit, export and import financing, making credit facilities available to foreign firms and subsidiaries of United States corporations, foreign exchange transactions and issuance of letters of credit. This international business is conducted (a) through the International Division in the main office in Detroit, (b) through full-service branch offices located in London, Frankfurt, Tokyo and Hong Kong, (c) through an off-shore banking facility in Nassau, Bahamas, (d) through a wholly-owned Edge Act subsidiary, the International Bank of Detroit (IBD), and its overseas affiliate, (e) through a wholly-owned Canadian banking subsidiary, NBD Bank, Canada, and (f) through an International Banking Facility. IBD is authorized, subject to government regulations, to make both equity investments and loans overseas and presently owns 50% of the equity, 100% of the voting rights and fully guarantees all obligations of Michell NBD Limited, a merchant banking company located in Australia. These overseas facilities are supplemented by a network of correspondent banks in more than 100 foreign countries.\nNBD Bank, N.A.'s activities in foreign exchange markets are conducted primarily to service the needs of its customers. Foreign exchange risks are controlled through detailed counterparty limits for purchases, sales and one-day risk at liquidation, preapproved position limits, and closely supervised and controlled maturity gaps.\nOTHER SIGNIFICANT SUBSIDIARIES\nIn addition to steady internal growth, the Corporation has expanded significantly in recent years through selective acquisitions, primarily in its Midwest market. In 1990, it acquired from the Resolution Trust Corporation (RTC) approximately $1.1 billion in deposits and selected assets in Michigan, Ohio and Florida. The Corporation acquired a suburban Chicago bank holding company with assets of approximately $1.5 billion in 1991. During 1992, the Corporation acquired three bank holding companies in the State of Indiana with aggregate assets of approximately $10.3 billion. The Corporation will continue to regularly explore opportunities for additional acquisitions of financial institutions and related businesses.\nThe foregoing acquisitions have enhanced the Corporation's geographic diversity outside of the State of Michigan, particularly in the States of Indiana and Illinois where operations are conducted through second-tier bank holding companies. At December 31, 1993, NBD Indiana, Inc. had consolidated total assets of $10.3 billion and total deposits of $8.4 billion, while NBD Illinois, Inc. had consolidated total assets of $5.0 billion and total deposits of $4.0 billion.\nAdditional details of the operations of the Corporation's subsidiaries are set forth under \"Item 7. Management's Discussion and Analysis of Earnings and Financial Position -- Organizational Performance\" later in this Form 10-K and are incorporated by reference herein.\nLINES OF BUSINESS\nThe three primary lines of business from which the Corporation derives most of its income are corporate banking, retail banking and trust services. A commitment to the development and use of advanced technology has been a key to growth and cost control in all three of these areas.\nCORPORATE BANKING\nServices to industry, commerce and government include the maintenance of demand and time deposit accounts and the granting of various types of loans, including loans under lines of credit and revolving credit, term loans, real estate mortgage loans and other specialized loans. In addition, the Corporation's subsidiaries provide financial advisory services and numerous other banking services to its customers. These subsidiaries serve the requirements of large and small industrial and commercial enterprises throughout the Midwest. The Corporation and its subsidiaries also have important banking relationships with many major corporations throughout the country.\nRETAIL BANKING\nThe retail banking business consists of traditional consumer deposit and loan services, mortgage banking, electronic banking services and safe deposit facilities. Services to individuals include demand, savings and time accounts, charge cards and other open-end credit products, and a variety of installment and mortgage loans. The Corporation has achieved significant growth in this line of business in recent years and has expanded product offerings to include auto leasing, student loans, manufactured housing loans, marine loans, home equity loans and private label credit cards. The Corporation has also begun to make a variety of non-deposit investments, including mutual funds and annuities, available in its branch offices through an unaffiliated third party marketer under the name Charterpoint Investment Centers.\nTRUST SERVICES\nThe Corporation's subsidiaries furnish a wide range of trust services to individuals, corporations, municipalities and charitable organizations. In terms of total trust assets administered, the trust operation of NBD Bank, N.A. is one of the largest among commercial banks in the United States. NBD Bank, N.A. and the Corporation's other bank and trust company subsidiaries act as trustee of personal, corporate, pension, profit-sharing and other employee-benefit trusts, provide investment advisory and custody services, act as executor, administrator, personal representative and trustee of estates, and act as registrar, fiscal and paying agent for corporations. NBD Bank, N.A. also serves as investment advisor to The Woodward Funds, a mutual fund family of fourteen funds covering a wide variety of investment objectives. As of December 31, 1993, The Woodward Funds ranked as the seventh largest bank-managed fund family in the country, with more than $5.3 billion in assets.\nTECHNOLOGY\nThe Corporation has made a strong commitment to the development and use of advanced technology across its various lines of business in order to produce low-cost, high-quality products and generate fees. This technological sophistication enables the Corporation and its subsidiaries to realize economies of scale, especially in its newly acquired operations, and to enhance staff productivity. Prominent technological involvements include the operation, under contract with MasterCard, of the computerized transaction routing switch for CIRRUS, a national shared network of automated teller machines (ATMs); and the operation of a similar routing switch for Magic Line, Inc., a regional shared network of ATMs in which the Corporation has an ownership interest. Magic Line, Inc. recently announced a preliminary agreement to merge with Cash Station, Inc., which operates the largest ATM network in Illinois, to form one of the largest ATM networks in the Midwest. It is expected that the Corporation will continue to serve as transaction processor for the combined network. In addition, the Corporation and its subsidiaries are actively involved in technology-based cash\nmanagement services for the wholesale and middle market, merchant and issuer credit card processing, telephone bill payment services and a telephone banking center.\nCOMPETITION\nActive competition exists in all principal areas where the Corporation, its bank subsidiaries, and its bank-related subsidiaries are presently engaged, not only with other commercial banks, but also with savings associations, securities brokers, mutual funds, credit unions, finance companies, mortgage bankers, leasing companies, insurance companies and other domestic and foreign financial institutions and various non-financial intermediaries.\nGOVERNMENT AND MONETARY POLICIES\nThe operations of financial institutions may be affected by legislative changes and by the policies of various regulatory authorities. In particular, bank holding companies and their subsidiaries are affected by the credit policies of the Board of Governors of the Federal Reserve System (the Federal Reserve Board) through its regulation of the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve Board to implement its objectives are open market operations in U.S. Government securities, changes in the discount rate on bank borrowings and changes in reserve requirements on bank deposits.\nREGULATION AND SUPERVISION\nBank holding companies, banks and financial institutions generally are highly regulated, with numerous federal and state laws and regulations governing their activities. As a bank holding company, the Corporation is subject to regulation under the Bank Holding Company Act of 1956, as amended (the Act) and is subject to examination and supervision by the Federal Reserve Board. Under the Act the Corporation is prohibited, with certain exceptions, from acquiring or retaining direct or indirect ownership or control of voting shares of any company that is not a bank or bank holding company, and from engaging in activities other than those of banking or of managing or controlling banks, other than subsidiary companies and activities that the Federal Reserve Board determines to be so closely related to the business of banking as to be a proper incident thereto. The acquisition of direct or indirect ownership or control of a bank or bank holding company by the Corporation is also subject to certain restrictions under the Act and applicable state laws.\nVarious federal and state laws govern the operations of the Corporation's bank subsidiaries. National banks, including NBD Bank, N.A., are supervised and regulated by the Office of the Comptroller of the Currency under the National Bank Act. Since national banks are also members of the Federal Reserve System and their deposits are insured by the Federal Deposit Insurance Corporation (FDIC), they are also subject to the applicable provisions of the Federal Reserve Act and the Federal Deposit Insurance Act and, in certain respects, to state laws applicable to financial institutions. The state-chartered bank subsidiaries of the Corporation are, in general, subject to the same or similar restrictions and regulations, but with more extensive regulation and examination by state banking departments, the Federal Reserve Board for Federal Reserve member banks, and the FDIC. NBD Bank, Federal Savings Bank (Florida) is under the regulatory authority of the Office of Thrift Supervision, Department of Treasury.\nThe Corporation is a legal entity separate and distinct from its affiliate banks and its non-banking subsidiaries. Accordingly, the right of the Corporation, and thus the right of the Corporation's creditors and shareholders, to participate in any distribution of the assets or earnings of any affiliate bank or other subsidiary is necessarily subject to the prior claims of creditors of such affiliate bank or subsidiary. The principal source of the Corporation's revenues is dividends and fees from its affiliates. There are legal limitations on the extent to which the Corporation's subsidiary banks can lend or otherwise supply funds to the Corporation or certain of its affiliates. Federal law prevents the Corporation from borrowing from its subsidiary banks unless the loans are secured by specified obligations and, with respect to the Corporation or any single non-bank affiliate, such secured loans by any subsidiary bank are generally limited to 10 percent of the subsidiary bank's capital and surplus and, with respect to the Corporation and all of its non-bank affiliates, to an aggregate of 20 percent of the subsidiary bank's capital and surplus. In addition, payment of dividends to the Corporation by subsidiary banks is subject to various state and federal regulatory limitations. Net assets of the Corporation's subsidiary banks not available for dividends or loans amounted to approximately $2,567.9 million at December 31, 1993. In 1994, the Corporation's bank subsidiaries may distribute to the Corporation (in addition to their 1994 net income) approximately $503.0 million in dividends without the prior approval of bank regulatory agencies. In addition, federal bank regulatory agencies have the authority to prohibit the banking organizations they supervise from engaging in what, in the bank\nregulator's opinion, constitutes an unsafe or unsound practice in conducting its business. Depending upon the financial condition of a bank, the payment of dividends could be deemed to constitute such an unsafe or unsound practice.\nRecent banking legislation, including particularly the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), has broadened the regulatory powers of the federal bank regulatory agencies. Among other things, FIRREA contains a \"cross-guarantee\" provision which could result in insured depository institutions owned by the Corporation being assessed for losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other insured depository institution owned by the Corporation. In addition, under Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support such subsidiary bank. As a result of such policies, the Corporation could be required to commit resources to its subsidiary banks in circumstances where it might not do so absent such policies.\nFDICIA revises sections of the Federal Deposit Insurance Act affecting bank regulation, deposit insurance and provisions for funding of the Bank Insurance Fund (BIF) administered by the FDIC. FDICIA also revises bank regulatory structures embodied in several other federal banking statutes, strengthens the bank regulators' authority to intervene in cases of deterioration of a bank's capital level, places limits on real estate lending and imposes detailed audit requirements. Among the significant revisions that could have an impact on each of the Corporation and its banking subsidiaries is the authority granted the FDIC to impose special assessments on insured depository institutions to repay FDIC borrowings from the United States Treasury or other sources and to establish semiannual assessment rates on BIF-member banks so as to maintain the BIF at the designated reserve ratio defined in FDICIA. FDICIA also provides for implementation of a system of risk-based premiums for deposit insurance, which became effective beginning in 1993, pursuant to which the premiums paid by a depository institution are based on the capital strength of each institution within certain defined categories. The new premium assessment rules have not had a material effect on the Corporation's bank subsidiaries and are not expected to have such effect in the future.\nProposals to change the laws and regulations governing banks, companies that control banks, and other financial institutions are frequently raised in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood of any changes and the impact such changes might have are impossible to determine.\nThe bank-related subsidiaries of the Corporation are also supervised and examined by the Federal Reserve Board as well as other applicable regulatory agencies. For example, the Corporation's discount brokerage subsidiaries are subject to supervision and regulation by the Securities and Exchange Commission (SEC), the National Association of Securities Dealers, Inc. and state securities regulators. Other bank-related subsidiaries are subject to other extensive laws and regulations of both the federal government and the various states in which they are authorized to do business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of the Corporation are located in the main office of NBD Bank, N.A., a 14-story building in the central financial and business district of Detroit. This building, which has two additional floors below the street level, is owned by NBD Bank, N.A. and occupied exclusively by NBD Bank, N.A., the Corporation and other direct and indirect subsidiaries of the Corporation. The Corporation also owns a 14-story, 300,000 square foot office building in Troy, Michigan, and a 380,000 square foot Technology Center in Van Buren Township, Wayne County, Michigan, near Detroit Metropolitan Airport. During 1993, NBD Bank, N.A. acquired approximately 143 acres of land in Farmington Hills, Michigan for possible future facility needs.\nAs of December 31, 1993, the Corporation's subsidiaries operated 699 offices within the United States of which 384 are owned by such subsidiaries and 315 are leased. Foreign offices in London, Frankfurt, Tokyo, Hong Kong, Canada and Australia are located in leased premises. Historic rental expense and anticipated rental payments are set forth under \"Item 8. Financial Statements and Supplementary Data -- Note 5. Premises and Equipment\" and are incorporated by reference herein.\nAll of these properties are considered by management to be suitable and adequate for the purpose intended.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings pending against the Corporation or any of its subsidiaries. On December 17, 1993, without admitting or denying the allegations, NBD Bank, N.A., agreed to the entry of a Consent Judgment in the U.S. District Court for the Southern District of New York in an SEC action brought against NBD Bank, N.A. and other institutions for alleged violations of Regulation U promulgated under Section 7(d) of the Securities Exchange Act of 1934. The SEC alleged that NBD Bank, N.A. and the other defendant banks violated the margin rules by unlawfully extending credit in custodial accounts that the bank maintained for four customers. The Consent Judgment imposed a civil money penalty on NBD Bank, N.A., required it to disgorge custody fees that it had received from the custodial accounts, enjoined NBD Bank, N.A. from future violations of Regulation U and required it to adopt revised policies and procedures with respect to these matters.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Corporation as of March 1, 1994, are as follows:\nOfficers of the Corporation are elected in the spring of each year at the annual organizational meeting of the Board of Directors to serve for the ensuing year and until their successors are elected and qualified.\nAll of the executive officers of the Corporation named above have held various positions with NBD Bank, N.A. or its affiliates or their predecessors for more than five years.\nThere is no family relationship between any of the executive officers, nor is there any arrangement or understanding between any such officer and any other person pursuant to which the officer was elected.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE CORPORATION'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe 160,715,173 shares of common stock of the Corporation outstanding at December 31, 1993, had a market value of $4.8 billion and were held by approximately 28,000 individuals and institutions located throughout the United States and several foreign countries.\nAt December 31, 1993, the Corporation had $199,985,000 of 7 1\/4% Convertible Subordinated Debentures outstanding. The debentures have been called by the Corporation for redemption on March 15, 1994, at a redemption price of $1,050.75 per $1,000 of principal outstanding. Holders may elect to convert their holdings into the Corporation's common stock before the redemption date at the conversion price of $30.40 per share.\nSince April 1986, NBD Bancorp, Inc. common stock has been included in the Standard & Poor's 500 index. The index is composed of 400 industrials, 40 utilities, 40 financial firms and 20 transportation companies.\nThe following table lists the high and low prices of the Corporation's common stock, which trades on the New York Stock Exchange (ticker symbol -- NBD), as well as the quarterly dividends declared per share, in each of the last three years.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the Corporation's consolidated financial statements and the accompanying notes presented elsewhere herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis are intended to cover the significant factors affecting the Corporation's consolidated balance sheet and income statement from 1991 to 1993. It provides shareholders with a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. To establish a framework for this discussion, the major components of the Corporation's operating results for 1993, 1992 and 1991 are summarized in the following table and then discussed in greater detail on subsequent pages.\nNET INTEREST INCOME\nIn the summary of operating results shown above, the excess of interest earned on assets, including loan fees and lease financing income, over the interest paid for funds is designated \"Net Interest Income.\" An adjustment to this figure has been made that increases fully or partially tax-exempt interest income to an amount comparable to interest subject to normal income taxes. An offsetting adjustment of the same amount is made in the income tax section of the earnings summary. Therefore, the final earnings figure remains the same before and after this taxable equivalent adjustment.\nNet interest income on a fully taxable equivalent (FTE) basis accounted for 73.6 percent of total income before any provision for possible credit losses in 1993, 75.0 percent in 1992 and 75.1 percent in 1991. It is influenced primarily by changes in: (1) the volume and mix of earning assets and sources of funding; (2) market rates of interest, and (3) income tax rates. The impact of some of these factors can be controlled by management policies and actions. External factors also can have a significant impact on changes in net interest income from one period to another. Some examples of such factors are: (1) the strength of credit demand by customers; (2) liquidity and maturity preferences of savings and time deposit customers; (3) Federal Reserve Board monetary policy, and (4) fiscal and debt management policies of the federal government, including changes in tax laws.\nThe following table presents average daily balances, interest income on an FTE basis and interest expense, as well as average rates earned and paid on the Corporation's major asset and liability items for the years 1993, 1992 and 1991.\n- ------------------------- * Primarily $100,000 and over. Notes: Nonaccrual loans are included in average balances. The FTE adjustments are computed using a combined federal and state income tax rate of 36.4 percent in 1993 and 35.4 percent in 1992 and 1991.\nNet interest income on an FTE basis increased by $39.6 million, or 2.5 percent, in 1993 following a gain of $160.8 million, or 11.2 percent, in 1992.\nA better understanding of the factors accounting for the year-to-year increases in net interest income can be obtained by examining the changes in: (1) the volume of earning assets and (2) the net interest income produced after the related cost of funding these earning assets.\nThe following table allocates total interest income between the amounts earned at the \"interest spread\" on assets funded with: (1) interest-bearing liabilities and (2) non-interest-bearing liabilities (primarily demand deposits) and equity capital. The interest spread on earning assets funded by interest-bearing liabilities is defined as the difference between the average rate earned on total earning assets and the average rate paid on the interest-bearing liabilities. The interest spread on assets funded with non-interest-bearing sources of funds is simply the rate earned on total earning assets.\nApproximately three-quarters of the $39.6 million increase in total net interest income between 1992 and 1993 can be attributed to an increased interest spread (3.85 percent in 1993 versus 3.69 percent in 1992) on earning assets funded with interest-bearing liabilities, which more than offset the lower volume of earning assets funded by the interest-bearing liabilities. The balance of the increase in net interest income can be accounted for by the significantly higher level of earning assets supported by non-interest-bearing funds during 1993, notwithstanding the lower yield on earning assets (7.41 percent in 1993 versus 8.07 percent in 1992).\nThe $160.8 million increase in total net interest income between 1991 and 1992 can be attributed entirely to a higher level of earning assets funded with interest-bearing liabilities at an increased interest spread (3.69 percent in 1992 versus 3.29 percent in 1991). The combination of these two factors more than offset the impact of a substantially lower interest spread (8.07 percent in 1992 versus 9.53 percent in 1991) on a higher level of earning assets funded with non-interest-bearing funds.\nANALYSIS OF NET INTEREST INCOME (FTE)\nA more detailed analysis of the effect of volume and rate changes on net interest income between 1991, 1992 and 1993 is set forth in the following table.\nFor purposes of this table, changes in interest due to volume and rates were determined as follows: (1) volume variance -- change in volume multiplied by previous rate, (2) rate variance -- change in rate multiplied by previous volume, and (3) rate\/volume variance -- change in volume multiplied by change in rate. The rate\/volume variance was\nallocated entirely to volume. Net interest income has been computed on a fully taxable equivalent basis and includes loan fees. Average balances for non-accrual loans have been included in this table.\n- ------------------------- * Primarily over $100,000.\nPROVISION AND ALLOWANCE FOR POSSIBLE CREDIT LOSSES\nThe Provision for Possible Credit Losses was increased from $166.2 million in 1991 to $228.5 million in 1992 and then reduced to $119.7 million in 1993. Of the $62.3 million increase between 1991 and 1992, approximately $51 million represented provisions to conform acquired banks' loan evaluation policies with those of NBD Bancorp. The reduced provision in 1993 was made in view of the decline in nonperforming loans and a significantly lower level of net loan charge-offs during the year.\nNet charge-offs as a percentage of average loans and leases outstanding rose from 0.65 of 1 percent in 1991 to 0.81 of 1 percent in 1992 and then dropped to 0.46 of 1 percent in 1993. During the past five years, gross charge-offs totaled $996 million, while recoveries amounted to $295 million for a \"recovery ratio\" of approximately 30 percent. The net charge-off ratio during the same period averaged 0.60 of 1 percent.\nIn the commercial loan and lease portfolio, the largest single net charge-off in 1993 was $10.0 million on a loan to a retail chain. During 1992, the largest net charge-off was a $19.2 million balance of a loan to an air transportation company.\nReal estate construction loan net charge-offs totaled $19.4 in 1993 and $22.9 million in 1992 and were spread over several credits in each year. None of the individual charge-offs exceeded $4 million in either year.\nCharge-offs in the residential mortgage loan portfolio were nominal in 1993, as in prior years.\nCharge-off experience in the consumer loan area during 1993 was considerably lower than in either 1992 or 1991 and was below the industry average in each year. The net charge-off ratio was 0.43 of 1 percent in 1993, 0.64 of 1 percent in 1992 and 0.86 of 1 percent in 1991.\nForeign loan net charge-offs amounted to $12.4 million in 1993, down from $14.1 million in the prior year. The 1993 charge-off figure included the write-off of the remaining $8.7 million balance of credits to individual political entities formerly known as Yugoslavia. Results for 1992 included net charge-offs of $10.5 million in Canada where the economy was experiencing a recession.\nAt December 31, 1993, the Allowance for Possible Credit Losses amounted to $423.0 million, or 1.66 percent of total loans and leases outstanding and approximately 157 percent of nonperforming loans, as well as 3.7 times net charge-offs during the year.\nThe following tables present an analysis of the Corporation's Allowance for Possible Credit Losses, together with summary loan and lease data, including charge-offs and recoveries, as well as related ratios for the five years ended December 31, 1993\nRECONCILIATION OF ALLOWANCE FOR POSSIBLE CREDIT LOSSES\nIn order to comply with certain regulatory reporting requirements, management has prepared the following table that provides the components of the Allowance for Possible Credit Losses by loan category. This breakdown of the Allowance reflects management's best estimate of possible credit losses based on the loss potential associated with specific loans, subjective assessment of risk characteristics in the portfolio and historical loss experience. This breakdown should not be regarded as an indication of future losses or that losses will occur in these proportions.\nThe Corporation and its subsidiaries do not maintain specific reserves against any loan or particular group of loans as it is management's policy to charge off all losses as they become known. The Allowance should be considered in its entirety and is available for credit losses across the entire portfolio. It is management's opinion that the Allowance for Possible Credit Losses at December 31, 1993, is adequate to cover future losses.\nANALYSIS OF ALLOWANCE FOR POSSIBLE CREDIT LOSSES BY CATEGORY\nAS OF DECEMBER 31, 1993:\nANALYSIS OF LOAN AND LEASE LOSSES\nDAILY AVERAGE LOANS AND LEASES OUTSTANDING\nANALYSIS OF NET CHARGE-OFF RATIOS\nSELECTED CREDIT RATIOS\n- ------------------------- * Excludes $88.9 million of renegotiated Mexican government debt at December 31, 1992, 1991 and 1990. Concurrent with the implementation of SFAS No. 115, effective December 31, 1993, this debt was reclassified from loans to \"Investment Securities Available-for-Sale.\"\nNON-INTEREST INCOME\nNon-interest income increased by $56.2 million, or 10.6 percent, in 1993 following an increase of $56.2 million, or 11.9 percent, in 1992. Approximately one-quarter of the gain between 1991 and 1992 can be attributed to the inclusion of Gainer Bank's revenues in those of the Corporation since January 23, 1992.\nThe two largest components of non-interest income, accounting for nearly 54 percent of the total for 1993, were deposit service charges and trust fees. Service charges on deposit account business rose $7.0 million, or 4.4 percent, in 1993 after an increase of $21.0 million, or 15.3 percent, in the prior year. The higher service charge revenues can be attributed to greater account activity, selective increases in charges for certain services and lower earnings credits for business account balances due to a general decline in market rates of interest. Service charge fees in 1992 were boosted by approximately $5 million from the inclusion of Gainer's results.\nTrust fees rose $9.7 million, or 6.9 percent, in 1993 following an increase of $9.6 million, or 7.4 percent in 1992. Approximately $2.2 million of the increase in 1992 is attributable to the inclusion of Gainer's trust revenues. Increased volumes of business, selective fee increases and higher market values contributed to the growth of trust revenues in 1993 and 1992.\nA particularly strong gain in non-interest income was generated from the profits on the sale of mortgages during the past two years. This was the result of the decline in interest rates, which increased the value of mortgages held for sale, as well as from an increased volume of mortgage sales. Other areas exhibiting strong growth during the past two years were data processing fees, mutual fund and annuity product fees, rental income and fees for the issuance of commercial and standby letters of credit. The growth of standby letter of credit business has been fostered by the \"double A\" credit ratings from Moody's and Standard & Poor's for NBD Bank, N.A. (Michigan).\nThe large variability in securities gains over the past three years can be attributed mainly to: (1) a $7.6 million gain taken in 1993 on the sale of an equity holding in a nonbank financial services company and (2) a $5.0 million gain realized from the sale of common stock of the Student Loan Marketing Association in 1991.\nThe \"Other\" classification contains income items that are generally small in amount or infrequent in occurrence. The major factors contributing to the large increase in 1993 were: (1) a gain of $9.6 million on the sale of certain charge card receivables and (2) gains of $13.9 million from the disposal of certain real estate previously acquired in settlement of loans. Included in the \"Other\" category in 1992 and 1991 were gains of $1.8 million and $4.1 million, respectively, from the sale of common stock warrants.\nANALYSIS OF NON-INTEREST INCOME\nCOMPENSATION EXPENSE\nTotal compensation expense rose $27.5 million, or 4.1 percent, in 1993. This was primarily the result of a 3.7 percent increase in average compensation per employee, as average employment on a full-time equivalent basis increased by 65 people, or 0.3 percent, between 1992 and 1993.\nCompensation expense increased by $53.0 million, or 8.5 percent, in 1992. Excluding the effect of the Gainer acquisition, the increase was $29.2 million, or 4.7 percent. While total employment increased by 4.4 percent in 1992, this was more than accounted for by the inclusion of approximately 885 employees from Gainer since early in the year. Excluding the Gainer acquisition, there were 100 fewer employees in 1992 compared to 1991.\nThe rate of increase for employee benefit costs has been reduced from 15.1 percent in 1991 to 11.9 percent in 1992 and then to 6.2 percent in 1993. A continuing emphasis on controlling health care costs was responsible for the sharp drop in the rate of increase in total benefit costs in 1993. We continue to monitor our various health care plans to achieve a better control of these costs while still providing a comprehensive plan for employees. Increased employee deductibles were instituted in 1992, and certain other cost-sharing arrangements have been implemented on an annual basis in recent years. While substantial changes in the nation's health care system have been proposed by the Clinton Administration, we cannot determine at this time what the impact might be on the Corporation.\nANALYSIS OF COMPENSATION EXPENSE\nThe Corporation's pension plans remain well funded. At December 31, 1993, the total projected benefit obligation was $585 million, while the market value of pension fund assets amounted to approximately $583 million. The decline in long-term interest rates and a relative stability in the inflation rate at a lower level in recent years has affected the assumptions used in determining the actuarial present value of the projected benefit obligations. For a more detailed description of the pension and other employee benefit plans, see Note 8 to the Financial Statements.\nDuring 1992, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This Statement requires accrual of employee postretirement benefits during the years earned while employed. The initial obligation for prior service amounted to $58.9 million ($37.9 million -- or $0.24 per share -- after tax effect). This future obligation was recognized as a one-time charge at the beginning of 1992. The adoption of SFAS No. 106 increased the annual provision for this benefit expense, which is almost entirely related to future health care costs, by approximately $3 million ($0.01 per share after tax effect).\nOTHER NON-INTEREST EXPENSES\nAll other non-interest expenses declined by $43.8 million between 1992 and 1993. However, the 1992 figure included $76.1 million of one-time merger-related expenses in connection with the INB Financial Corporation (INB) and Summcorp acquisitions. Excluding these special charges, other non-interest expenses rose $32.3 million, or 5.5 percent in 1993, following a $47.9 million, or 8.9 percent increase in 1992. Nearly two-thirds of the increase between 1991 and 1992 can be attributed to the inclusion of Gainer's expenses in 1992 but not in 1991.\nThe largest factor accounting for the increase in amortization of intangibles during the past two years is the acceleration of the write-off of certain purchased mortgage servicing rights. This reflects the significant increase in mortgage principal repayments due to an increase in refinancing activities. The $6.1 million decline in purchased services expense between 1992 and 1993 is largely attributable to the corporation's assumption of certain processing activities formerly outsourced by the Indiana banks. A significant portion of the $4.2 million increase in travel and entertainment expense in 1993 can be attributed to the additional travel-related expenses resulting from the large-scale conversion of the Indiana banks' operating systems to those of NBD Bancorp. Expenses involved in other real estate owned rose by $3.1 million in 1993 following an increase of $2.8 million in the prior year. These increases resulted primarily from higher write-downs recorded on properties taken in settlement of loans. The subsequent gain or loss when the property is sold is recognized as \"Other\" non-interest income. (Net gains on the disposition of such properties amounted to $13.9 million in 1993 but were inconsequential in 1992 and 1991.) The increase of approximately 33 percent in the expense for public relations in 1993 is essentially due to a higher level of charitable contributions.\nThe increase in \"Other\" expense of approximately $12 million between 1991 and 1992 primarily resulted from: (1) a $2.4 million non-recurring loss on sub-leased premises; (2) a $1.5 million prepayment penalty on the retirement of high-rate, long-term debt, and (3) the inclusion of Gainer's expenses since its January 1992 acquisition.\nANALYSIS OF NON-INTEREST EXPENSES\nINCOME TAXES\nThe Corporation's income tax expense was $220.1 million in 1993, up from $134.4 million in 1992 and $122.3 million in 1991. The increase of $85.7 million in income tax expense for 1993 can be accounted for principally by: (1) a $229.6 million rise in pre-tax income between 1992 (which was impacted by $76.1 million of merger-related expenses) and 1993; (2) an increase in the statutory tax rate, and (3) an increase in the proportion of pre-tax income that was subject to income taxes.\nThe statutory tax rate on NBD Bancorp taxable earnings was increased to 35 percent in 1993 from 34 percent in 1992 and 1991. The higher tax rate increased the corporation's income tax expense by $7.0 million; however, this was partially offset by a $4.8 million income tax benefit relating to a revaluation of the net deferred tax receivable to the new tax rate.\nThe adoption early in 1993 of SFAS No. 109, \"Accounting for Income Taxes,\" increased reported earnings by nearly $4.0 million, or $0.03 per share. For a more detailed discussion and analysis of income taxes, including the adoption of SFAS No. 109, see Note 9 to the Financial Statements.\nThe tax reform act of 1986 raised from 20 percent to 100 percent the disallowance of the interest cost on funds employed to carry most tax-exempt loans and securities acquired after August 7, 1986. As a result of continued maturities in the tax-exempt portfolio, a greater proportion of pre-tax earnings has been subject to federal income taxes in each of the past three years. The effective rate increased from 25.3 percent in 1991 to 28.4 percent in 1992 and then to 31.4 percent in 1993.\nThe Corporation's banks are required to maintain sizeable cash reserves at the Federal Reserve Bank. These non-earning reserves are not required of nonbank companies (e.g., money market mutual funds) that offer competitive deposit-type instruments and services. When the average yield on our earning assets (7.41 percent) is applied to the average reserve maintained ($308 million) during 1993, the result is a reduction in after-tax income equal to $0.10 per share. Inasmuch as nearly all of the earnings of the Federal Reserve System (estimated to have been $22 billion in 1993) are remitted to the United States Treasury, this foregone income essentially represents an additional tax on shareholders.\nWhen all direct taxes and regulatory assessments are added to the interest foregone on cash balances at the Federal Reserve Bank, the Corporation's total \"taxes\" for 1993 amounted to a very substantial $335 million.\nCAPITAL ACCOUNTS\nShareholders' equity increased by $307.7 million, or 10.5 percent, in 1993, to approximately $3 1\/4 billion at year-end. Shareholders' equity, as a percent of total assets, increased from 7.18 percent at the end of 1992 to 7.97 percent at December 31, 1993. This was the highest end-of-year equity capital ratio in nearly 30 years.\nANALYSIS OF SHAREHOLDERS' EQUITY\n- ------------------------- (1) Based on daily average balances.\n(2) Excludes impact of conversions of capital notes, purchases and issuance of common stock and other adjustments to capital accounts.\nNew regulatory risk-adjusted capital adequacy standards became fully effective on January 1, 1993. The principal features of the new standards are as follows: (1) required capital levels are based on the perceived risk in the various asset categories; (2) certain \"off-balance sheet\" items, such as standby letters of credit and interest rate swaps, require capital allocations, and (3) the definition of what constitutes capital has been refined. Equity capital, net of certain adjustments for intangible assets and investments in nonconsolidated subsidiaries, and certain classes of preferred stock are considered\nTier 1 capital. Total capital consists basically of Tier 1 capital plus subordinated debt, some types of preferred stock and a limited amount of the Allowance for Possible Credit Losses.\nRegulatory authorities have also established a minimum level of Tier 1 capital to total assets, a so-called \"leverage\" ratio. The new standards call for minimum Tier 1, Total and Tier 1 Leverage capital ratios of 4 percent, 8 percent and 3 percent, respectively. As can be noted in the following table, the Corporation's ratios have comfortably exceeded these regulatory standards.\nANALYSIS OF REGULATORY CAPITAL\nDuring the past three years, the Corporation has bolstered its regulatory total capital base through the issuance of subordinated debt (totaling $750 million) of the parent company (NBD Bancorp, Inc.). An additional $200 million was raised in 1993 through the issuance of 6 1\/4% Subordinated Notes of NBD Bank, N.A. (Michigan).\nThe debt that is included in regulatory total capital at December 31, 1993, had no significant scheduled maturities until the year 2002. However, on January 27, 1994, the Corporation called for redemption the $199,985,000 outstanding 7 1\/4% Convertible Subordinated Debentures Due 2006 at a price of 105.075 percent of its principal amount, plus accrued interest to the March 15, 1994, redemption date. Holders of the debentures may opt to convert their debentures into NBD Bancorp common stock at a conversion price of $30.40 per share, or 32.895 shares per $1,000 principal amount of debentures. If all debentures were redeemed for cash, the Corporation's pro forma Tier 1 and Total Capital Ratios at year-end 1993 would be 9.10 percent and 12.96 percent, respectively, and the Tier 1 Leverage Ratio would be 7.34 percent.\nSOURCE OF FUNDS\nWhile total funds to support earning assets increased only $146 million, on a daily average basis, or less than 1 percent in 1993, the mix of funds changed significantly. Demand deposits, net of items in process of collection (\"float\") and due from other banks, increased by $467 million, or nearly 12 percent, on a year-over-year basis. An accommodative Federal Reserve Board monetary policy fostered a strong growth of demand deposits, as did the relatively low level of market rates of interest that encouraged many customers to maintain higher balances to avoid paying certain service charges on their deposit activity. We also believe that the increased level of residential mortgage refinancing activity resulted in higher than normal customer deposits from those who increased their indebtedness as a result of such transactions. For many of these same reasons, as well as customer preference for more liquid asset holdings, total savings account balances averaged nearly $1 billion, or 15.5 percent, higher in 1993 than in the prior year.\nConsumer time deposits declined by more than $1.8 billion, or approximately 20 percent, from the 1992 level, as investors searched for higher market returns when their high-rate time deposits issued in prior years matured. While the proceeds from many of these maturing time deposits were re-deposited in demand and savings accounts, considerable money flowed out of the banking system into direct market investments, including bond and stock mutual funds and\nannuity products. Indeed, our Charterpoint Investment Centers attracted a substantial amount of this type of investor money, much of which was invested in our proprietary family of Woodward Funds, from which we earn investment management fees.\nReliance on large (i.e., $100,000 and over) certificates of deposit as a source of funds continued to decline in 1993, as less costly alternatives were utilized to a greater extent.\nManagement categorizes time deposits of $100,000 or more as either \"Other Time Deposit\" or \"Large Certificates of Deposit\" depending on whether they are considered to be \"retail\" (i.e., primarily from individuals) or \"wholesale\" (i.e., primarily from large corporations, institutions or public authorities). However, there is a regulatory requirement to disclose the total amount and maturity distribution of such large time deposits regardless of the source of such funds. At December 31, 1993, domestic time deposits of $100,000 or more in size amounted to approximately $1.5 billion and were scheduled to mature as shown below.\nANALYSIS OF MATURITY DISTRIBUTION OF DOMESTIC TIME DEPOSITS OF $100,000 OR MORE\nBy closely managing the alternative sources of funds, the Corporation has been able to improve its overall net interest margin on earning assets from 4.13 percent in 1990 to 4.22 percent in 1991, and then to 4.39 percent and 4.48 percent in 1992 and 1993, respectively. Other things equal, each basis point (0.01 percent) increase in the net interest margin equates to an increase in earnings of $0.01 1\/2 per share.\nANALYSIS OF SOURCES OF FUNDS FOR EARNING ASSETS\nThe increase in \"Long-Term Debt\" in recent years is related to management's desire to strengthen the Corporation's and subsidiary banks' risk-based capital ratios, as well as to serve as a funding source for long-term investments, including acquisitions.\nThe \"All Other\" category basically represents that portion of equity capital that funds earning assets.\nA detailed analysis of the composition of our principal short-term borrowings over the past three years is summarized in the following table. The use of \"Bank Notes\" as a source of funds was initiated late in 1991 and provides an additional source of relatively low-cost funds for asset funding and liquidity purposes. Our ability to issue large amounts of these notes, which are not deposit liabilities and hence do not carry the cost of deposit insurance premiums, is enhanced by the high credit rating that NBD Bank, N.A. (Michigan) has earned in the money markets.\nANALYSIS OF PRINCIPAL SHORT-TERM BORROWINGS\n- ------------------------- * With original maturity of less than one year.\nINVESTMENT SECURITIES\nTotal holdings of investment securities, on a daily average and on a year-end to year-end basis, declined by 1 percent and about 4 1\/2 percent, respectively.\nFor a number of years, the Corporation has been increasing its holdings of U. S. Government Agency securities, primarily mortgage pass-through securities issued or guaranteed by the Government National Mortgage Association, Federal National Mortgage Association or Federal Home Loan Mortgage Corporation. These are high-quality, marketable investments that provide yields above those available on U. S. Treasury securities of comparable duration. The \"Other\" securities category primarily consists of collateralized mortgage obligations backed by federal agency pass-throughs. The substantial volume of refinancings and prepayments of mortgages during 1993 required a concomitant increase in purchases of mortgage-backed securities to maintain portfolio positions.\nHoldings of tax-exempt securities have steadily declined in recent years. The tax reform act of 1986 increased the disallowance of the interest cost of funding all but certain small issues of tax-exempt securities from 20 percent to 100 percent.\nHOLDINGS OF INVESTMENT SECURITIES\nEffective December 31, 1993, the Corporation implemented SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This requires the following: (1) debt securities that the Corporation has the positive intent and ability to hold to maturity are to be classified as \"Investment Securities Held-to-Maturity\" and reported at amortized cost; (2) debt and equity securities that are bought and held principally for the purpose of selling in the near term are to be classified as \"Trading Account Securities\" and reported at fair value, with unrealized gains and losses included in earnings, and (3) debt and equity securities not classified as \"Held-to-Maturity\" or \"Trading Account\" are to be classified as \"Investment Securities Available-for-Sale\" and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity, net of tax.\nThe \"Unrealized Loss on Available-for-Sale Securities\" component of shareholders' equity shows a negative balance of approximately $7 million, as of December 31, 1993. This essentially represents the unrealized loss (after tax effect) on that date of $88.9 million of United Mexican States obligations that were reclassified for balance sheet purposes from loans to securities on that date. (A further discussion of this indebtedness can be found in the \"International Banking\" section beginning on page 30.)\nAt December 31, 1993, Investment Securities held by the Corporation's banks were classified as follows: (1) Held-to-Maturity -- U. S. Government Securities with remaining maturities of more than two years, essentially all tax-exempt securities and fixed-rate mortgage pass-through securities and (2) Available-for-Sale -- all other investment securities. At that date, the aggregate fair value of the Investment Securities Held-to-Maturity was $410 million, or 6.2 percent, above the carrying value shown on the Consolidated Balance Sheet.\nThe maturity distribution and yields, on a fully taxable equivalent basis, of the four major components of the investment securities portfolio at December 31, 1993, are shown below. Investment Securities \"Available-for-Sale\" and \"Held-to-Maturity\" are shown separately.\nINVESTMENT SECURITIES -- YIELDS AND MATURITIES\nAS OF DECEMBER 31, 1993:\n- ------------------------- * Fully taxable equivalent yield is based on a combined federal and state tax rate of 36.4% in 1993. ** Consists primarily of mortgage-backed securities. The maturity distribution of such securities is based on average expected maturities. Note: Yields are based on amortized cost of securities.\nFor several years, a portion of the tax-exempt portfolio -- $371 million with an average maturity of approximately 5 years at year-end 1993 -- has had its funding spread protected by a series of interest rate \"swaps\" of comparable amount but shorter maturity. At December 31, 1993, the fair value of this block of tax-exempt securities was approximately $39 million above carrying cost. However, the recognition of the unrealized gains would leave the Corporation with an unfavorable interest rate swap position. The cost of eliminating the rate swap position under the market conditions that prevailed at year-end 1993 would have offset the gain that could have been realized by the sale of these securities. It should be noted that $190 million of rate swaps for these and similar transactions are scheduled to mature in 1994 and another $135 million in 1995.\nIncluded in the $1,507 million of tax-exempt securities at December 31, 1993, were $462 million of obligations of the State of Michigan and its political subdivisions. Except for the securities issued or guaranteed by the State of Michigan and its political subdivisions, no investment in securities of a single issuer of non-U. S. Government-guaranteed securities exceeded 10 percent of shareholders' equity at December 31, 1993 or 1992.\nLOANS AND LEASE FINANCING\nTotal loans and leases outstanding, on a daily average basis, increased by $418 million, or 1.7 percent, in 1993, following an increase of $1,405 million, or 6.0 percent, in 1992. Consumer loans and commercial loans were up approximately 6 percent and 3 percent, respectively, in 1993, while real estate construction and residential mortgage loans were about 18 percent and 4 1\/2 percent lower, respectively. The significant decline in real estate construction loans in 1993, as well as in 1992, reflects the strenuous efforts made to improve the credit quality of the portfolio, as well as a reduced level of new lending activity.\nThe following two tables summarize year-end totals for the major sectors of the Corporation's total loan portfolio over the last five years. The principal change in the mix of the loan portfolio since 1989 is reflected in the growing importance of consumer loans and the decline in the real estate construction loan portfolio.\nANALYSIS OF LOAN AND LEASE PORTFOLIO\n- ------------------------- * \"Mortgages Held for Sale\" are included in the \"Residential Mortgage\" category for 1989.\nA more detailed discussion of the major elements of the loan portfolio, as well as an analysis of loans involving highly leveraged transactions (HLTs) and exposures in the commercial real estate sector, including construction loans, can be found on subsequent pages.\nAs can be seen in the following tables, the Corporation's domestic business loans at December 31, 1993, were well diversified geographically, as well as by type of borrower.\nOn June 30, 1992, the banking regulators phased out their definition of HLTs and the related reporting requirements. The following information is based on the regulatory definition in effect prior to June 30, 1992.\nAs of December 31, 1993, the Corporation's HLT commitments totaled $337.7 million, and the outstandings under the commitments amounted to $153.5 million. The average commitment size in the HLT portfolio was $10.9 million, and the average outstanding loan was $5.0 million. The largest single commitment was for $30.0 million, of which nothing was outstanding at December 31, 1993. At the same date, a total of $1.0 million involving one company, or 0.7 percent of HLT outstandings, was classified as nonperforming. During 1993, there were net recoveries of $1.6 million on loans previously charged off. During 1992, there were net charge-offs of HLTs amounting to $23.7 million.\nThe geographic distribution and industry concentration of the HLT outstandings at year-end 1993 are shown in the following tables.\nIn the commercial real estate sector, construction loans totaled $789 million, while investment property term loans amounted to $1,573 million at December 31, 1993. Approximately 92 percent of the construction loans were located in the Midwest, with 39 percent in the state of Michigan, 30 percent in Indiana and 13 percent in Illinois. The largest loan outstanding was $24.0 million. At year-end 1993, $45.7 million was classified as nonperforming, the largest of which was $6.4 million. One year earlier, the comparable figures were $68.4 million and $6.1 million, respectively. Net charge-offs of construction loans totaled $19.4 million in 1993, compared with $22.9 million in 1992.\nEssentially all of the investment property loans were sited in the Midwest, with 38 percent in Michigan, 32 percent in Indiana and 22 percent in Illinois. The largest loan outstanding at year-end 1993 was for $20.1 million. At December 31, 1993, $49.6 million was classified as nonperforming, the largest of which amounted to $5.6 million. One year earlier, $41.4 million was classified as nonperforming. Net charge-offs of investment property loans amounted to $18.8 million in 1993 and $10.4 million in 1992.\nA more detailed analysis of the outstanding construction and investment property loans at year-end 1993 is shown in the following table. The geographic distribution of commitments to lend and loans outstanding is comparable.\nIn addition to the construction and investment property loans, at year-end 1993, the Corporation's banks held $1,946 million of loans on owner-occupied commercial real estate, of which the largest single category (42 percent) was classified as industrial. Nearly 48 percent of the dollar total was located in Michigan and almost 24 percent and 20 percent in Indiana and Illinois, respectively.\nResidential mortgage loans outstanding, on a daily average basis, declined from $2,915 million in 1992 to $2,784 million in 1993. While the volume of loan originations rose between 1992 and 1993, prepayments, refinancings and loan sales were also higher.\nThe consumer loan portfolio increased by $367 million, or 6.0 percent, from $6,126 million on a daily average basis in 1992 to $6,493 million in 1993. It ended the year at $6,758 million.\nThe 1992 acquisitions of INB, Summcorp and Gainer significantly expanded the size and changed the composition of the consumer loan portfolio. In particular, the large credit card and student loan balances of INB have noticeably increased the relative size of these types of loans within the corporation's total consumer loan portfolio.\nThe expansion of the consumer loan portfolio in recent years has been considerably greater than the growth in both the Corporation's total loan portfolio and total earning assets. With more than 600 banking offices in five states, the network is in place to support continued good growth in the consumer loan portfolio.\nConsumer loan loss experience continues to compare favorably with industry averages. This is the result of the high underwriting standards employed in extending credit, as well as the close monitoring of delinquency trends within the loan portfolio. It also reflects the particular mix of the portfolio, which includes a relatively large proportion of home equity loans and government-guaranteed student loans. Net charge-offs, as a percentage of average outstandings, amounted to\n0.86 and 0.87 of 1 percent in the recession years of 1990 and 1991, respectively. As the subsequent business recovery gathered strength, the net charge-off ratio declined to 0.64 of 1 percent in 1992 and then to 0.43 of 1 percent in 1993.\nForeign loans, on a daily average basis, declined by $46 million, or 4.1 percent, in 1993, following a decline of $60 million, or 5.1 percent, in 1992. In part, this trend reflects generally weak economic conditions in most major overseas markets where we are represented.\nNONPERFORMING LOANS\nNonperforming loans are defined to include loans on which interest is not being accrued and restructured loans where interest rates have been renegotiated at below market rates. The trend of such loans over the past five year ends is shown below. Also shown are: (1) loans 90 days or more past due but still accruing interest -- largely consumer loans, which are charged off when they become 120 days to 150 days past due, and (2) Other Real Estate Owned, which primarily represents the value of collateral taken in settlement of loans.\nANALYSIS OF NONPERFORMING LOANS\n- ------------------------- * Excludes $88.9 million of United Mexican States (UMS) obligations (secured by zero-coupon U.S. Treasury securities of comparable maturity) that were renegotiated early in 1990 at a then below market rate. These obligations were reclassified to \"Investment Securities Available-for-Sale\" at year-end 1993, concurrent with the implementation of SFAS No. 115.\nTotal nonperforming loans declined by $83 million, or 23.6 percent, in 1993 following a decrease of $38 million, or 9.7 percent, during 1992. Approximately 62 percent of the net reduction in nonperforming loans during 1993 can be accounted for by a combination of repayments, charge-offs and a return to performing status on three credits -- two\nretailing firms and a manufacturing concern -- and an $8.7 million charge-off of the remaining balance of loans to individual political entities formerly known as Yugoslavia. The largest nonperforming loan at December 31, 1993, was the $21.6 million balance of a loan to another retail firm. No other nonperforming loan exceeded $7 million at year-end 1993.\nThe largest reductions within the nonperforming category between year-ends 1991 and 1992 were: (1) the $19.7 million balance of a loan to an air transportation company that was charged off during 1992 and (2) the return to performing status of a $12.4 million balance of a loan to a cable television operation. The four largest nonperforming loans at December 31, 1992, totaled $51.5 million. They were essentially eliminated during 1993 as described in the preceding paragraph.\nThe interest foregone for the past two years based on nonperforming loans at each year end was as follows:\nIn addition to the loans classified as nonperforming, there were other loans totaling $56.2 million at December 31, 1993 (and $73.1 million at December 31, 1992), where management was closely monitoring the borrowers' ability to comply with payment terms, but where existing conditions did not warrant either a partial charge-off or classification as nonaccrual. The largest of such loans was $13.2 million at year-end 1993.\nMATURITY AND RATE SENSITIVITY OF LOANS\nThe following tables summarize the maturity distribution and interest rate sensitivity of the loan portfolio, excluding real estate mortgage and consumer loans. There was a modest increase in the proportion of these loans that were scheduled to mature within one year between year-ends 1992 and 1993. This increase was more than accounted for by changes in the scheduled maturities within the Commercial and Foreign categories, inasmuch as the reduced level of Real Estate Construction outstandings included a lesser proportion of maturities of one year or less at year-end 1993.\nMATURITY DISTRIBUTION OF LOANS\nThe total amount of loans with maturities beyond one year declined by $246 million, or 5.1 percent, between December 31, 1992, and the end of 1993. At the same time, the proportion of these loans that carried fixed rates of interest rose from 52.7 percent at year-end 1992 to 53.6 percent at December 31, 1993. The significantly lower level of foreign loans carrying a fixed rate of interest is in large part due to the reclassification of approximately $89 million of renegotiated Mexican debt from the loan category to \"Investment Securities Available-for-Sale.\" This indebtedness is discussed in greater detail in the following section on International Banking.\nLOANS WITH MATURITIES BEYOND ONE YEAR\nThe following table details the residential mortgage and consumer loan portfolios, as of December 31, 1993 and 1992, according to management's estimate of their sensitivity to interest rate changes. For purposes of this analysis, Mortgages Held for Sale have been included in the Residential Mortgage totals.\nThe proportion of the residential mortgage portfolio that was of a variable rate nature or scheduled to mature within one year declined from 61.2 percent ($1,798 million out of $2,938 million) at the end of 1992 to 46.8 percent ($1,317 million out of $2,817 million) at year-end 1993. This decrease reflects customers' actions taken to lock in relatively low rates at the time of original borrowing or when existing loans were refinanced.\nAt both year-ends 1992 and 1993, approximately 57 1\/2 percent of total consumer loans were considered to be sensitive to interest rate changes within a one-year time horizon.\nRATE SENSITIVITY OF RESIDENTIAL MORTGAGE AND CONSUMER LOANS\nINTERNATIONAL BANKING\nThe Corporation's foreign cross-border outstandings consist primarily of loans, interest-bearing deposits, bankers' acceptances and federal funds sold. An item is classified as either foreign or domestic based on the domicile of the party ultimately responsible for payment. The balances are reported net of any legally enforceable written guarantees by domestic or other non-local partners. Assets of our foreign offices denominated in the local currency are included to the extent that they are not hedged or are not funded by local currency borrowings. At December 31, 1993 and 1992, total foreign cross-border outstandings amounted to $900 million, compared to $1.0 billion at the end of 1991.\nDuring the first quarter of 1990, $88.9 million of Mexican debt was exchanged for new United Mexican States (UMS) 30-year bonds. The debt that was exchanged had interest rates at 13\/16 of 1 percent above the London interbank rate for three-or six-month Eurodollar deposits and had maturities not extending beyond December 31, 2006. The bonds bear interest at 6.25 percent and had a market value of approximately $74 million at December 31, 1993, up from $58 million and $55 million at year-ends 1992 and 1991, respectively. These bonds are collateralized by zero-coupon U. S. Treasury bonds, which have an identical final maturity. The collateral is held at the Federal Reserve Bank of New York. Payment of semi-annual interest on the bonds is collateralized by cash or permitted short-term investments in an amount equal to but not less than 18 months' interest on a rolling basis. Interest collateral also is held at the collateral agent for the benefit of the bondholders. These bonds are fully performing in compliance with terms of the exchange agreements.\nIncluded in foreign outstandings at year-end 1992 were $10.4 million in aggregate (all of which was nonperforming) for countries that management considered to be experiencing severe economic and liquidity problems. There were no such credits outstanding at year-end 1993.\nSTANDBY LETTERS OF CREDIT\nAt December 31, 1993, aggregate standby letters of credit (SLC) of various subsidiaries amounted to $1,720 million. The comparable amounts at year-ends 1992 and 1991 were $1,558 million and $1,203 million, respectively. While these dollar amounts represent contingent liabilities of the Corporation's issuing banks, they are not reflected on the Consolidated Balance Sheet since funds had not been advanced against the commitments.\nFees for the \"standby\" backing are generally recognized over the life of the commitment. Such fees recognized in 1993 and 1992 were $9.6 million and $7.9 million, respectively. At year-end 1993, total SLC fees received but not yet recognized as income amounted to $4.6 million. The comparable figure one year earlier was $4.4 million.\nThe following table summarizes the Corporation's SLC position as of year-ends 1993 and 1992 according to maturity and type of obligation guaranteed.\nSTANDBY LETTERS OF CREDIT\nThe credit risk associated with SLC commitments is evaluated and monitored using the same policies and practices applicable to commercial loans.\nRATE SENSITIVITY ANALYSIS\nThe difference between the amount of earning assets and interest-bearing liabilities that would reprice, within comparable time periods, in response to changes in the level of interest rates is typically referred to as the asset or liability funding gap or the rate sensitivity position. To mitigate the potential impact on earnings of changes in interest rates, it is the Corporation's policy that the cumulative asset or liability gap out to one year may not exceed 10 percent of total earning assets, although individual bank subsidiaries, other than NBD Bank, N.A. (Michigan), may exceed this level from time to time with the approval of NBD Bancorp management. Positions are monitored daily by management and reviewed monthly by the Board of Directors for compliance with corporate policy.\nSimulations of the effect on net interest income of changes in interest rate levels, of various magnitudes and over various time periods, are periodically reviewed by management to determine, given the probability of interest rate changes, whether changes in the composition of the balance sheet are prudent.\nAs highlighted in the accompanying table, at December 31, 1993, the Corporation's interest rate sensitivity showed a net asset sensitive position of $606 million (1.6 percent of earning assets) within a one-year maturity range, a net liability sensitivity of $1,636 million (4.4 percent of earning assets) out to six months, and a net liability sensitive position of $1,784 million (4.8 percent of earning assets) in the shorter maturity range of 1-90 days.\nRATE SENSITIVITY OF EARNING ASSETS AND INTEREST-BEARING LIABILITIES\nAt year-end 1993, total earning assets exceeded aggregate interest-bearing liabilities by $7,113 million. These assets were funded by demand deposits and equity capital of the Corporation. These interest-free sources funded 19.2 percent of total earning assets at that date.\nBeginning in the second quarter of 1984, the Corporation entered into a series of interest rate swaps. The primary purposes of these rate management swaps has been to provide a greater assurance of fixing the net interest spread on certain earning assets in the investment, loan and lease financing portfolios and, to a lesser extent, to hedge certain long-term debt costs. At the end of 1993, there were $1,381 million of interest rate swap contracts outstanding for these purposes, as shown in the following table.\nANALYSIS OF INTEREST RATE MANAGEMENT SWAP POSITION\nAS OF DECEMBER 31, 1993:\nBy itself, the effect of carrying the interest rate management swap position was to reduce the Corporation's aggregate net interest margin by 16 basis points and 15 basis points during 1993 and 1992, respectively. However, the purpose of entering into these rate swaps is to provide greater flexibility in overall asset and liability management policies.\nAn additional $1.4 billion of customer accommodation contracts, unrelated to the funding of specific earning assets of the Corporation, were outstanding at December 31, 1993.\nThe creditworthiness of each counterparty to a rate swap is analyzed under the same procedures that would apply to a commercial loan request. The transaction is also subject to the approval of the Credit Policy Committee.\nLIQUIDITY CONSIDERATIONS\nThe parent holding company has four primary sources to meet its liquidity requirements -- the commercial paper market, established credit facilities from unaffiliated banks, capital markets and dividends from its subsidiaries.\nFunds raised in the commercial paper market are primarily employed to support the activities of the mortgage banking subsidiaries. The Corporation's ability to attract funds from this market on a regular basis and at a competitive cost is fostered by the highest credit ratings given by the major credit rating agencies for commercial paper -- P1 from Moody's and A1+ from Standard & Poor's. Commercial paper borrowings averaged $143 million in 1993, $191 million in 1992 and $128 million in 1991.\nDuring 1990, NBD Bancorp established a $200 million revolving credit with a group of unaffiliated banks. This credit facility was renewed at $180 million in 1991 for a two-year period with the right to convert to a three-year term loan. No drawings have been made under this facility, and its conversion feature was extended to August of 1995 during the past year.\nThe parent company has gone to the capital markets on four occasions in the past three years to issue a total of $750 million of long-term debt and preferred purchase units, of which $150 million was raised in 1993. An additional $200 million of ten-year, 6 1\/4% subordinated debt was issued by NBD Bank, N.A. (Michigan) in 1993. At December 31, 1993, a total of $846 million of parent company debt was outstanding, with the earliest scheduled maturity falling in the\nyear 2002. (As noted earlier, on January 27, 1994, the corporation called for redemption, on March 15, 1994, the $200 million outstanding 7 1\/4% Convertible Subordinated Debentures Due 2006.) The parent company's subordinated debt ratings were reaffirmed in 1993 at A1 (Moody's) and A+ (Standard & Poor's).\nThe cash requirements of the parent company can also be met to a limited extent by dividends from its subsidiaries, which are the primary source of funds for dividend payments to shareholders. During the past three years, NBD Bank, N.A. (Michigan) declared dividends totaling $379.9 million, while upstream dividends from other subsidiaries amounted to $252.6 million. NBD Bancorp itself declared dividends to shareholders amounting to $479.9 million over this same three-year period, a 41.8 percent payout of Net Income.\n* * *\nNBD Bank, N.A. (Michigan) supports the funding requirements of its wholly-owned subsidiary bank in Canada and merchant bank in Australia by guaranteeing their deposit and other liabilities.\nManagement considers the liquidity of NBD Bank, N.A. (Michigan) to be excellent. In addition to a high degree of liquidity embodied in the loan and securities portfolios, the bank has demonstrated an ability to raise substantial amounts of funds on a consistent basis during all phases of the credit cycle by: (1) borrowing federal funds (i.e., the excess reserves of other financial institutions) through a long-established and extensive network of correspondent banks; (2) issuing large CDs, deposit notes and bank notes to regular customers, as well as in the national money markets; (3) entering into repurchase agreements whereby U. S. Government and U. S. Government Agency securities are pledged as collateral for short-term borrowings, and (4) pledging acceptable assets as collateral for certain tax collection monies held temporarily in the U. S. Treasury Tax and Loan accounts in the commercial banking system. Borrowings from the Federal Reserve Bank can be relied upon for short periods of time to meet unexpected liquidity needs of a temporary nature. No such borrowings occurred during the last three years at NBD Bank, N.A. (Michigan).\nThe ability to attract funds from the money and capital markets on a regular basis is enhanced by the strong credit ratings of NBD Bank, N.A. (Michigan). Among these ratings, as of December 31, 1993, were: (1) Aa2 and P1 from Moody's on the bank's long-and short-term deposits, respectively; (2) AA from Standard & Poor's on the bank's long-term deposits and letter of credit-backed issues, and (3) Aa3 and AA- from Moody's and Standard & Poor's, respectively, on the bank's long-term subordinated debt issues.\n* * *\nThe Corporation's other subsidiary banks typically meet their need for funds from core deposit growth and through asset management policies designed to maintain adequate liquidity. Individual banks also raise money from time to time in the federal funds market, through repurchase agreements, Treasury Tax and Loan account borrowings and borrowings from the Federal Reserve Bank. They can also draw upon the resources of NBD Bank, N.A. (Michigan) and the parent holding company for temporary liquidity needs, as well as to meet longer term capital needs and requirements.\nORGANIZATIONAL PERFORMANCE\nNet Income contributed by the major organizational units of the Corporation is presented in the table below. NBD Bank, N.A., with 330 banking offices in Michigan and 10 foreign offices, accounted for approximately 62 percent of the Corporation's assets at year-end 1993 and 64 percent of consolidated net income for the year.\nThe Indiana banks operated 233 offices and accounted for 25 percent of the Corporation's total assets at year-end 1993 and 23 percent of earnings. Results in Indiana for 1993 reflect an after-tax gain of $5.7 million from the sale of certain charge card receivables to an outside party early in the year, as well as a $4.9 million after-tax profit on the sale of an equity investment in a nonbank financial services firm. Their earnings for 1992 were substantially reduced by special merger-related charges and provisions amounting to $85.3 million (after tax effect).\nThe earnings of the Illinois banks comprised 12 percent of the Corporation's Net Income in 1993. With 39 banking offices, they also accounted for 12 percent of consolidated corporate assets at year-end 1993.\nIn its third full year of operation, the Ohio bank operated 24 offices and accounted for less than 2 percent of the Corporation's year-end assets and less than 1 percent of consolidated earnings.\nThe substantial increase in the operating earnings of the mortgage companies during the 1991-93 period can be attributed to increased gains on the sale of mortgages and wider funding spreads on the mortgages held for sale. An increased flow of mortgage servicing fees from a larger loan servicing portfolio also favorably affected earnings in 1992.\nParent company losses primarily reflect the fact that the majority of the Corporation's consolidated long-term debt is an obligation of the parent company. This includes $200 million of convertible debentures issued in 1991, $400 million of subordinated notes and debentures issued in 1992, and $150 million of debt securities issued in 1993.\nANALYSIS OF ORGANIZATIONAL PERFORMANCE\n- ------------------------- * Restated for mergers.\n** 1993 results are net of the cumulative effect of SFAS No. 109 -- $4.5 million for NBD Bank, N.A., $(0.2) million for the Indiana banks, $(1.8) million for the Illinois banks and $1.5 million for all other subsidiaries, the total of which is $4.0 million for consolidated NBD Bancorp.\n*** 1992 results are net of the after-tax effect of merger-related charges and the cumulative effect of SFAS No. 106 -- $25.7 million for NBD Bank, N.A., $91.5 million for the Indiana banks, $4.1 million for the Illinois banks and $1.9 million for all other subsidiaries, the total of which is $123.2 million for consolidated NBD Bancorp.\nCONSOLIDATED SIX-YEAR SUMMARY AVERAGE BALANCES AND AVERAGE RATES\n- ------------------------- Note: Average rates are on a fully taxable equivalent basis.\nCONSOLIDATED SIX-YEAR SUMMARY (CONTINUED) AVERAGE BALANCES AND AVERAGE RATES\n- ------------------------- Note: Average rates are on a fully taxable equivalent basis.\nCONSOLIDATED SIX-YEAR SUMMARY (CONTINUED) SUPPLEMENTARY FINANCIAL DATA\n- ------------------------- Note: Rates of return and per share data are after SFAS No. 109 and No. 106 Cumulative Adjustments.\nCONSOLIDATED SIX-YEAR SUMMARY (CONTINUED) SUPPLEMENTARY FINANCIAL DATA\n- ------------------------- Note: Rates of return and per share data are after SFAS No. 109 and No. 106 Cumulative Adjustments.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n(a) The following audited consolidated financial statements and independent auditors' report are set forth in this Form 10-K on the following pages:\n(b) The following additional data is set forth in this Form 10-K on the following pages:\nMANAGEMENT'S LETTER OF FINANCIAL RESPONSIBILITY\nTO THE SHAREHOLDERS:\nManagement of NBD Bancorp, Inc. has prepared and is responsible for the financial statements and for the integrity and consistency of other related information contained in the Annual Report and Form 10-K. In the opinion of management, the financial statements, which necessarily include amounts based on management estimates and judgments, have been prepared in conformity with generally accepted accounting principles appropriate to the circumstances.\nThe Corporation maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with the Corporation's authorizations and policies, and that transactions are properly recorded so as to permit preparation of financial statements that fairly present financial position and results of operations in conformity with generally accepted accounting principles. Internal accounting controls are augmented by written policies covering standards of personal and business conduct and an organizational structure providing for division of responsibility and authority.\nThe effectiveness of and compliance with established control systems is monitored through a continuous program of internal audit and credit examinations. In recognition of cost-benefit relationships and inherent control limitations, some features of the control systems are designed to detect rather than prevent errors, irregularities and departures from approved policies and practices. Management believes the system of controls has prevented or detected on a timely basis any occurrences that could be material to the financial statements and that timely corrective actions have been initiated when appropriate.\nWith the ratification of the shareholders, the Corporation engaged the firm of Deloitte & Touche, independent auditors, to render an opinion on the financial statements. The independent auditors have advised management that they were provided with access to all information and records necessary to render their opinion.\nThe Board of Directors exercises its responsibility for the financial statements and related information through the Audit Committee, which is composed entirely of outside directors. The Audit Committee meets regularly with management, the General Auditor of the Corporation and the independent auditors to assess the scope of the annual audit plan, to review status and results of audits, to review the Annual Report and Form 10-K including major changes in accounting policies and reporting practices and to approve non-audit services rendered by the independent auditors.\nThe independent auditors also meet with the Audit Committee, without management being present, to afford them the opportunity to express their opinion on the adequacy of compliance with established corporate policies and procedures and the quality of financial reporting.\nJanuary 19, 1994\nNBD BANCORP, INC.\nCONSOLIDATED BALANCE SHEET (in thousands except share data)\nASSETS\nThe accompanying notes are an integral part of the financial statements.\nLIABILITIES AND SHAREHOLDERS' EQUITY\nNBD BANCORP, INC.\nCONSOLIDATED STATEMENT OF INCOME (in thousands except share data)\nThe accompanying notes are an integral part of the financial statements.\nNBD BANCORP, INC.\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (in thousands except share data)\nThe accompanying notes are an integral part of the financial statements.\nNBD BANCORP, INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)\nThe accompanying notes are an integral part of the financial statements.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accounting and reporting policies of NBD Bancorp, Inc. and its subsidiaries (the Corporation) conform to generally accepted accounting principles.\n(A) CONSOLIDATION:\nThe consolidated financial statements of the Corporation include the accounts of NBD Bancorp, Inc. (the Parent) and its majority-owned subsidiary companies. All material inter-company accounts and transactions have been eliminated.\n(B) STATEMENT OF CASH FLOWS:\nCash and Due From Banks is considered Cash and Cash Equivalents in the Consolidated Statement of Cash Flows.\n(C) SECURITIES:\nThe Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective December 31, 1993.\nSFAS No. 115 requires the following: (a) Debt securities that the Corporation has the positive intent and ability to hold to maturity are to be classified as Held-to-Maturity and reported at amortized cost; (b) Debt and equity securities that are bought and held principally for the purpose of selling in the near term are to be classified as Trading and reported at fair value, with unrealized gains and losses included in earnings; and (c) Debt and equity securities not classified as Held-to-Maturity or Trading are to be classified as Available-for-Sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity, net of tax.\nPrior to December 31, 1993, the Corporation classified securities purchased with the intent and the ability to hold to maturity as Investment Securities and reported them at amortized cost. If it was subsequently determined that certain investment securities were to be sold, their reported value was adjusted as necessary to the lower of cost or fair value with the adjustments included in Securities Gains(Losses). Securities purchased that the Corporation intended to sell prior to maturity were classified as Other Money Market Investments and recorded at the lower of amortized cost or fair value. Fair value adjustments were included in Securities Gains(Losses). The Corporation's accounting for Trading Account Securities was not changed by the adoption of SFAS No. 115; these securities are carried at fair value with unrealized gains and losses included in Other Non-Interest Income.\nGains and losses realized on the sale of Investment Securities are determined by the specific identification method and included in Securities Gains(Losses).\n(D) LOANS:\nLoans are generally reported at the principal amount outstanding, net of unearned income. Non-refundable loan origination and commitment fees and certain costs of origination are deferred and either included in interest income over the term of the related loan or commitment or, if the loan is held for sale, included in Other Non-Interest Income when the loan is sold.\nMortgages Held For Sale are valued at the lower of aggregate cost or fair value. Unrealized losses, as well as realized gains or losses, are included in Other Non-Interest Income.\nInterest income on loans is accrued as earned. Except for consumer loans, loans are placed on non-accrual status and previously accrued but unpaid interest is reversed against current period interest income when collectibility of principal or interest is considered doubtful, payment of principal or interest is 90 days or more past due, or the loan is completely or partially charged off. Interest income on loans considered doubtful or 90 days or more past due is recorded as collected. Collections of principal and interest on charged-off loans are applied in the following sequence: (1) as a reduction of remaining principal balance; (2) as recovery of principal charged off; and (3) as interest income.\nConsumer loans are not placed on a non-accrual status because they are charged off when 120 days to 150 days past due. Accrued but unpaid interest is generally reversed against current period interest income when the loan is charged off.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n(E) ALLOWANCE FOR POSSIBLE CREDIT LOSSES:\nThe Allowance is maintained at a level considered by management to be adequate to provide for probable loan and lease losses inherent in the portfolio. Management's evaluation is based on a continuing review of the loan and lease portfolio and includes consideration of the actual loan and lease loss experience, the present and prospective financial condition of borrowers, balance of the loan and lease portfolio, industry and country concentrations within the portfolio and general economic conditions.\n(F) BANK PREMISES AND EQUIPMENT:\nBank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is charged to operations over the estimated useful lives of the assets and is computed on either the straight-line or accelerated depreciation method. The estimated useful lives are generally 10 to 35 years for buildings and building improvements, and three to 10 years for furniture and equipment.\nLeasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter.\nMaintenance, repairs and minor alterations are expensed as incurred.\n(G) INTANGIBLE ASSETS:\nThe unamortized amount of intangible assets is included in Other Assets. Goodwill, representing the excess of the cost of investments in consolidated subsidiaries over the fair value of net assets acquired, is amortized on a straight-line basis over periods ranging from 15 to 25 years.\nOther intangible assets such as purchased mortgage servicing rights, core deposits, and credit card relationships are amortized using various methods over the periods benefited.\n(H) INCOME TAXES:\nThe Corporation adopted SFAS No. 109, \"Accounting For Income Taxes,\" effective January 1, 1993. SFAS No. 109 requires an asset and liability approach to accounting and reporting for income taxes. Under this approach, current and deferred income taxes payable and refundable are remeasured annually using provisions of then enacted tax laws and rates. SFAS No. 109 also changed the criteria for recognition and measurement of deferred income tax benefits.\nPrior to January 1, 1993, the Corporation accounted and reported for income taxes in accordance with Accounting Principles Board Opinion (APB) No. 11, \"Accounting For Income Taxes.\" Under APB No. 11, income tax expense was based on income as reported in the financial statements. Deferred income tax liabilities and benefits were measured using tax rates in effect when the deferred item was first created, and were not adjusted for subsequent changes in the statutory tax rate.\n(I) INTEREST RATE CONTRACTS:\nThe Corporation enters into interest rate contracts to manage the market risk of its assets and liabilities (hedge contracts), as a source of fee income (customer contracts), and to generate profits (trading contracts).\nHedge contracts reduce the Corporation's exposure to interest rate changes that cause financial instruments to decrease in value or to be more costly to settle. Income or loss on a hedge contract is accrued over its life and is included in Net Interest Income. Any gain or loss from early termination of a hedge contract is deferred and amortized to the earlier of the maturity date of the hedged asset or liability, or the original expiration date of the contract. If the hedged asset or liability is disposed of, any unrealized or deferred gain or loss on the related hedge contract is included in determining the gain or loss on the disposition.\nAny fee, including the initial bid\/offer spread, on a customer contract is recognized as Other Non-Interest Income over the life of the contract.\nCustomer contracts and trading contracts are recorded at fair value, with changes in their value recorded as Other Non-Interest Income.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n(J) FOREIGN CURRENCY EXCHANGE AND TRANSLATION:\nThe Corporation distinguishes between (1) adjustments arising principally from translation of foreign entity financial statements into U.S. dollar equivalents, which are recorded in a separate component of shareholders' equity, and (2) translation gains or losses arising from transactions conducted in foreign currencies, which are recorded in Other Non-Interest Income.\nForeign exchange positions on forward contracts are valued monthly at market rates and the unrealized gain or loss is included in Other Non-Interest Income.\n(K) LETTERS OF CREDIT AND GUARANTEES:\nIn the normal course of business, the Corporation issues and participates in letters of credit and financial guarantees. Fees are accrued over the life of the agreements and included in Other Non-Interest Income.\n(L) POSTRETIREMENT BENEFITS OTHER THAN PENSION:\nThe Corporation adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective January 1, 1992. This Statement requires that the expected cost of providing postretirement benefits be recognized in the financial statements during an employee's active service period. Prior to 1992, the Corporation's practice was to expense these benefits when paid.\n(M) INCOME PER SHARE:\nPrimary per share amounts are based on the weighted average number of shares outstanding throughout the year and the assumed exercise of stock options. Fully diluted per share amounts assume conversion of all outstanding convertible debt of the Corporation and the elimination of related after-tax interest expense.\n(N) RECLASSIFICATION:\nPrior years' financial statements have been reclassified to conform with the current financial statement presentations.\n2. CASH AND DUE FROM BANKS\nThe subsidiary banks of the Corporation are required to maintain non-interest-bearing reserve balances with the Federal Reserve Bank based on a percentage of the subsidiary banks' deposits. During 1993 and 1992, the average reserve balances were approximately $308,100,000 and $297,900,000, respectively.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n3. INVESTMENT SECURITIES\nThe Corporation adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective December 31, 1993. Following are the carrying value (i.e., fair value) and amortized cost of Investment Securities Available-for-Sale, and the carrying value (i.e., amortized cost) and fair value of Investment Securities Held-to-Maturity at DECEMBER 31, 1993:\nFollowing are the carrying value (i.e., amortized cost) and fair value of Investment Securities at DECEMBER 31, 1992:\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe maturity distribution of investment securities at December 31, 1993, is shown below. The distribution of mortgage-backed securities is based on average expected maturities. Actual maturities may differ because issuers may have the right to call or prepay obligations.\nProceeds from the sale of Investment Securities during 1993 were $66,037,000 resulting in gross realized gains of $9,047,000 and gross realized losses of $129,000. Securities Gains in 1993 also included $410,000 of gains realized on the sale of Other Money Market Investments. Proceeds from the sale of Investment Securities during 1992 were $703,193,000 resulting in gross realized gains of $9,516,000 and gross realized losses of $7,902,000. Proceeds from the sale of Investment Securities during 1991 were $1,102,863,000 resulting in gross realized gains of $12,827,000 and gross realized losses of $4,082,000.\nAssets, principally Investment Securities, carried at approximately $5,868,081,000 were pledged at December 31, 1993, to secure public deposits (including deposits of $27,870,000 of the Treasurer, State of Michigan), repurchase agreements and for other purposes required by law.\nExcluded from the Consolidated Statement of Cash Flows is the reclassification to Investment Securities Available-for-Sale of $88.9 million of United Mexican States obligations previously classified as Loans, and $30.9 million of obligations previously classified as Other Money Market Investments. These reclassifications were made concurrent with the implementation of SFAS No. 115 as of December 31, 1993.\n4. ALLOWANCE FOR POSSIBLE CREDIT LOSSES\nThe changes in the Allowance for Possible Credit Losses for 1993, 1992 and 1991 are summarized below:\nIn May 1993, the Financial Accounting Standards Board issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan.\" This statement requires that an impaired loan be measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate. The statement is effective for fiscal years beginning after December 15, 1994. The Corporation has not determined the impact that adoption of the standard will have on the financial statements.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n5. PREMISES AND EQUIPMENT\nThe components of premises and equipment are as follows:\nDepreciation and amortization expense was $65,914,000 in 1993, $59,976,000 in 1992 and $54,409,000 in 1991.\nRental expense for leased properties and equipment totaled $42,453,000 in 1993, $41,814,000 in 1992 and $40,679,000 in 1991. Aggregate future minimum rental payments on operating leases having non-cancelable lease terms in excess of one year amounted to $211,515,000 as of December 31, 1993; minimum annual rental payments for such leases are $25,443,000 in 1994 and do not exceed $21,909,000 for any year thereafter.\n6. SHORT-TERM BORROWINGS\nShort-term borrowings consist of the following:\nAt December 31, 1993, the Parent had an unused revolving credit of $180 million, convertible to a term loan at the option of the Corporation, to support general corporate financing needs. An annual commitment fee of 17 1\/2 basis points is paid on the credit facility.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. LONG-TERM DEBT\nThe following is a summary of long-term debt:\nThe 7 1\/4% Convertible Subordinated Debentures Due 2006 are convertible, in whole or in part, into shares of common stock of the Parent at any time prior to maturity at a conversion price of $30.40 per share, subject to adjustment in certain events. Interest on the notes is payable semiannually on March 15 and September 15. During 1993, $15,000 of the Debentures were converted. Subsequent to December 31, 1993, the debentures were called by the Parent for redemption on March 15, 1994, at a redemption price of $1,050.75 per $1,000 of the principal amount. Holders who elect to convert between the March 1, 1994, interest payment record date and the March 15, 1994, redemption date will be entitled to accrued interest to the date of conversion. Holders may not convert after March 15, 1994, and interest will cease to accrue after redemption.\nThe 7 1\/4% Fixed Rate Subordinated Debentures Due 2004 will mature on August 15, 2004. The Debentures are unsecured, subordinated to all present and future Senior Indebtedness of the Parent, and are not redeemable prior to maturity. Interest is payable semiannually on February 15 and August 15.\nThe 8.10% Subordinated Notes Due 2002 will mature on March 1, 2002. The Notes are unsecured, subordinated to all present and future Senior Indebtedness of the Parent, and are not redeemable prior to maturity. Interest is payable semiannually on March 1 and September 1. In connection with these Notes, the Corporation has entered into interest rate swap contracts to exchange the fixed rate on $120,000,000 of the Notes for a floating rate. The contracts mature on the same date as the Notes. The Notes, coupled with the interest rate swap contracts, provide the Corporation with $120,000,000 of funding at an approximate effective interest rate of the six-month LIBOR plus 0.25 percent.\nEach 7 1\/2% Preferred Purchase Unit consists of a 7.40% subordinated debenture due May 10, 2023, in a principal amount of $25 and a related purchase contract paying fees of 0.10% per year. The contract requires the purchase on May 10, 2023, of one depositary share representing a one-fourth interest in a share of 7 1\/2% cumulative preferred stock of NBD Bancorp at a purchase price of $25 per depositary share.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe Floating Rate Subordinated Notes Due 2005 will mature on the interest payment date in December 2005 at par. Interest on the Notes is payable quarterly in arrears at a rate of 1\/4 of 1 percent per annum above the LIBOR for three- month Eurodollar deposits. In no event will the rate be less than 5.25 percent per annum.\nThe 6 1\/4% Fixed Rate Subordinated Notes Due 2003 will mature on August 15, 2003. The Notes are unsecured, subordinated to the claims of depositors and other creditors of NBD Bank, N.A. (Michigan), and are not redeemable prior to maturity. Interest is payable semiannually on February 15 and August 15.\nThe Bank Notes are unsecured and unsubordinated debt obligations of NBD Bank, N.A. (Michigan). The Bank Notes are offered with maturities from twelve months to ten years and are issued in denominations of $250,000 or any amount in excess thereof that is a multiple of $1,000. Each Note bears interest at a fixed rate that is established by the bank at the time of issuance. The interest payment dates on the Bank Notes are January 15 and July 15 of each year.\nThe Senior Notes are 8.75% fixed rate notes originally issued by NBD Indiana, Inc. on May 1, 1987. The debt provisions call for no principal payments during the first ten years, then equal principal payments at the end of the 10th, 11th and 12th years. In addition, NBD Indiana, Inc. prepaid $1,000,000 of 11.00% Senior Notes during 1993.\nAggregate long-term debt of $154,784,000, $68,921,000, $53,379,000, $91,447,000 and $6,710,000 will mature in 1994, 1995, 1996, 1997 and 1998, respectively.\n8. PENSION AND OTHER EMPLOYEE BENEFITS\nThe Corporation maintains pension plans (the Pension Plans) covering substantially all full-time salaried employees. The Pension Plans are non-contributory, defined benefit plans which provide benefits based on years of service and compensation level. The Corporation's policy is to fund the Pension Plans according to the requirements of the Employee Retirement Income Security Act of 1974 (ERISA).\nPlan assets are stated at market value and are composed primarily of equity securities and debt securities issued by the U.S. Government and its agencies and corporations.\nIn addition, the Corporation maintains separate unfunded nonqualified pension restoration plans (the Restoration Plans) for certain officers when the defined benefits provided under the terms of the Pension Plans exceed limits imposed by federal tax law on benefits payable from qualified plans.\nThe pension expense is comprised of:\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe following table sets forth the Plans' funded status and amounts recognized in the consolidated balance sheet at December 31:\nThe funded status of the Pension Plans as of December 31, 1993, includes plan assets of $75,880,000, accumulated benefit obligation of $85,607,000, and projected benefit obligation of $112,809,000 relating to a pension plan maintained by NBD Indiana, Inc. (formerly INB Financial Corporation, or INB), a wholly-owned subsidiary of NBD Bancorp, Inc. The INB plan will be merged with the NBD Bancorp, Inc. plan on January 1, 1994.\nThe assumptions used in determining the actuarial present value of the projected benefit obligations are set forth below:\nService cost in 1992 includes $4,014,000 and $245,000 for the Pension Plans and the Restoration Plans, respectively, of additional expense for individuals who elected to accept an early retirement option offered to employees of INB.\nPostretirement Benefits Other Than Pensions\nThe Corporation adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective January 1, 1992. The Statement requires that the expected cost of providing postretirement benefits be recognized in the financial statements during employees' active service periods. The Corporation's previous practice was to expense these benefits when paid.\nThe Corporation provides medical and life insurance for employees who retire after age 55 with a minimum of 15 years of service. The postretirement health care benefit, which can also cover eligible dependents, is contributory with retiree contributions adjusted annually to reflect increases in the Corporation's health care costs. The postretirement life insurance benefit is noncontributory.\nThe Corporation elected to immediately recognize the January 1, 1992, accumulated benefit obligation which resulted in a charge of $58,924,000 ($37,885,000 after tax) to 1992 earnings. In addition, such postretirement benefit\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nexpense for 1992 was $2,981,000 higher ($1,897,000 after tax) than what would have been recorded on the previous accounting basis.\nNet periodic postretirement benefit cost included the following components for the years ended December 31:\nThe Corporation funds postretirement benefit cost as claims are incurred. The following table sets forth the plan's funded status and amounts recognized in the consolidated balance sheet at December 31:\nFor measurement purposes, an 11 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994; the rate was assumed to trend downward to 5.5 percent by the year 2001 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point in each year would have increased the accumulated postretirement benefit obligation as of December 31, 1993, by $8,560,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1993 by approximately $1,000,000.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0 percent at December 31, 1993, and 8.0 percent at year-end 1992.\nIn November 1992, the Financial Accounting Standards Board issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Postemployment benefits are benefits provided to former or inactive employees after employment, but before retirement. This statement, which becomes effective for fiscal years beginning after December 15, 1993, requires accrual of the obligation to provide postemployment benefits. The Corporation does not expect adoption of the statement to have a material impact on the financial statements.\nEmployee Savings Plans\nThe Corporation contributes to various 401(k) savings plans and profit sharing plans for the benefit of employees meeting certain eligibility requirements. The Corporation's participation in the 401(k) savings plans is in the form of \"matching funds\" wherein it contributes an amount equal to the participant's contributions up to 2 percent of the participant's compensation, plus an amount equal to one-half of the participant's contribution between 2 percent and 6 percent of the participant's compensation subject to certain limitations imposed by the IRS.\nIn addition, INB sponsored a leveraged Employee Stock Ownership Plan (ESOP), wherein the ESOP used the proceeds of a $33.0 million loan from INB to acquire 1,236,500 shares of its common stock. Subsequently, shares of\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\ncommon stock held by the ESOP were allocated to participating employees. The ESOP was terminated in the fourth quarter of 1992.\nTotal expense for all plans was $15,467,000 in 1993, $12,659,000 in 1992, and $13,958,000 in 1991.\nStock Award and Stock Option Plans\nThe executive officers of the Corporation and certain other employees are eligible for awards pursuant to the Performance Incentive Plan (the PIP Plan) administered by the Compensation Committee of the Board of Directors. The Committee is empowered to make two types of awards and to establish two groups of awardees.\nThe first group is selected from among the more senior officers. The Committee is authorized to award to this group Performance Shares. A Performance Share is one share of the Corporation's common stock. Distribution of the awards is tied to the achievement of certain financial performance goals for the Corporation as set by the Committee, over performance periods of at least one year and up to five years in duration. The second group of employees (which excludes the more senior officers) may be awarded shares of the Corporation's common stock, the ultimate distribution of which is not tied to corporate performance goals. The award periods for this group have ranged from one to five years in duration.\nThe cost of stock awards to the more senior officers is the market value of the stock on the date the award is finally distributed. For the second group of employees, the cost of stock awards is the market value of the stock on the date of grant. The cost, either estimated or actual, of stock awards for both groups is amortized on a straight-line basis over the award duration periods. The unamortized cost of these awards is included in Shareholders' Equity.\nThe PIP Plan also permits the granting of stock options. The term of each option is determined by the Committee, except that the term of an incentive option may not exceed ten years from the date of grant. No option can be exercised prior to the expiration of the first year of its term. The option price may not be less than the fair market value of the common stock on the date the option is granted.\nThe Committee may grant stock options that include the right to receive \"restoration options.\" A restoration option allows a participant who exercises the original option prior to retirement, and who pays all or part of the purchase price of the option with shares of the Corporation's common stock, the right to receive an option to purchase the number of shares of the common stock of the Corporation equal to the number of shares used by the participant in payment of the original option price. The exercise price of the restoration option is equal to the fair market value of the common stock on the date the restoration option is granted.\nThe following table summarizes activity under the option and award plans for 1992 and 1993:\nAs of December 31, 1993, 966,000 options were exercisable.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n9. INCOME TAXES\nThe Corporation adopted SFAS No. 109, \"Accounting For Income Taxes,\" effective January 1, 1993. In prior years, the Corporation accounted and reported for income taxes in accordance with APB No. 11, \"Accounting for Income Taxes.\" The cumulative effect of adopting SFAS No. 109 increased 1993 Net Income by $3,950,000. Under the new standard, the change in the statutory tax rate during 1993 from 34% to 35% required a revaluation of deferred tax assets and liabilities, which reduced tax expense in 1993 by $4,805,000 as compared to what tax expense would have been under APB No. 11.\nThe consolidated income tax expense (benefit) is comprised of the following elements:\nThe tax effects of certain valuation adjustments to securities, foreign currency translation adjustments, and certain tax benefits related to stock options are recorded directly in Shareholders' Equity. Net tax credits recorded directly in Shareholders' Equity amounted to $9,450,000, $5,330,000 and $1,428,000 for 1993, 1992 and 1991, respectively. In addition, a deferred tax benefit of $21,039,000 was recorded in 1992 as part of the cumulative effect of adopting SFAS No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions.\"\nThe Corporation has substantial investments in tax-exempt debt securities and loans on which borrowers pay a lower rate of interest than would be required if the income were subject to federal income taxes. Because of these and other differences, Income Tax Expense is less than that computed by applying the federal statutory income tax rate of 35 percent in 1993 and 34 percent in 1992 and 1991. A summary reconciliation of reported income tax expense to income tax based on the statutory rate is as follows:\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe significant components of the Corporation's deferred tax assets and liabilities as of December 31, 1993, are as follows:\nDuring 1992 and 1991, in accordance with APB No. 11, deferred income tax provisions were recorded resulting from the differences in the timing of recognizing certain revenues and expenses for financial statement and income tax purposes. The sources of the differences and their income tax effect are as follows:\nThe cumulative deferred tax benefit amounted to $188,534,000 (which included $21,039,000 attributable to the cumulative effect of adopting SFAS No. 106) and $124,959,000 at December 31, 1992 and 1991, respectively.\n10. INTEREST RATE AND FOREIGN EXCHANGE CONTRACTS\nThe Corporation, in the normal course of business, utilizes various types of off-balance sheet financial instruments to accommodate customer needs, to manage the Corporation's exposure to market risk in both on and off-balance sheet instruments and, on a limited scale, to generate trading profits.\nFinancial instruments may contain elements of both market risk and credit risk. Market risk is the possibility of changes in interest or currency rates that would cause a financial instrument to decrease in value or to be more costly to settle. Credit risk is the possibility of loss arising from failure by a party to the transaction to perform according to terms of the contract. Credit risk is controlled through credit policies, approval processes, collateral requirements, limits, and monitoring procedures similar to the Corporation's practices employed to monitor and control the credit risk of loans and loan commitments.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe contract or notional amount of interest rate and foreign exchange contracts at December 31 are shown below.\nThe credit risk inherent in interest rate and foreign exchange contracts is measured as the cost of replacing, in the current market, contracts having a positive value with contracts having identical terms. This amount for contracts used to manage market risk is not recorded on the balance sheet and totaled $16,121,000 at December 31, 1993, and $7,232,000 at December 31, 1992. This amount for customer and trading contracts is recorded on the balance sheet.\nInterest rate swaps are contracts where the parties agree to exchange fixed rate for floating rate interest payments for a specified time period on a specified (notional) amount.\nOptions are contracts that allow the holder to purchase or sell a financial instrument, at a specified price, prior to the expiration date of the contract. Caps and floors are contracts under which the holder will receive the interest rate differential when a specified benchmark rate exceeds the cap rate, or falls below the floor rate. The writer of these contracts charges a fee at the outset in exchange for assuming the risk of an unfavorable change in the price of the financial instrument or interest rate underlying the contract.\nFutures contracts require the seller of a contract to deliver a specified instrument to the purchaser at a specified price or yield, on a specified future date.\nCommitments to purchase securities are made for the future delivery of investment securities at a specified price or yield. The commitments to sell loans are made to protect against a decline in the value of mortgage loans held for sale and of commitments to make mortgage loans at specified rates.\nForeign exchange contracts are agreements to exchange different currencies at specified future dates and rates. Foreign exchange options allow the holder to purchase or sell foreign currency at a specified date and price. The Corporation manages its exposure to changes in exchange rates by establishing limits for individual currencies. Income from revaluing forward and spot foreign exchange positions to market amounted to $12,567,000 in 1993, $11,619,000 in 1992 and $9,885,000 in 1991.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n11. COMMITMENTS AND CONTINGENCIES\nA commitment to extend credit obligates the Corporation to advance funds to a customer providing there is compliance with terms of the commitment. Commitments generally have fixed expiration dates or other termination clauses, permit the customer to borrow at a market rate of interest and require payment of a fee. Unused commitments totaled $14,917,545,000 and $13,712,602,000 at December 31, 1993 and 1992, respectively. Since many commitments typically expire without being utilized, the total does not necessarily represent future cash requirements.\nA standby letter of credit is a conditional commitment issued to guarantee contractual performance by a customer to a third party. Typical uses are to back commercial paper, bond financing and similar transactions of public and private borrowers. Total standby letters of credit outstanding at December 31, 1993 and 1992, were $1,720,489,000 and $1,558,240,000, respectively. The Corporation does not expect, in the normal course of business, to be required to fund these commitments.\nA commercial letter of credit is a commitment issued to facilitate the shipment of goods from seller to buyer by guaranteeing payment to the seller. Absent inability of the buyer to perform, fund disbursement to the seller occurs simultaneously with receipt of funds from the buyer. Commercial letters of credit outstanding were $196,654,000 and $225,835,000 at December 31, 1993 and 1992, respectively.\nCollateral requirements for the above commitments are based on credit evaluation of the customer.\nThe Corporation is a defendant in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Corporation's financial statements.\n12. CONCENTRATIONS OF CREDIT RISK\nIn the normal course of business, the Corporation enters into transactions exposing it to credit risk. At December 31, 1993, the maximum credit exposure for funded transactions of $39.5 billion and unfunded commitments of $17.5 billion was well diversified geographically and by industry, as shown in the following tables.\n- ------------------------- *Includes 18 percent of U.S. Government and Agencies\nOver 90 percent of the Corporation's assets, revenue and net income are in the banking industry; no individual customer provides 10 percent or more of the Corporation's revenue, and total foreign assets, revenue, income before income taxes and net income comprise less than 10 percent of the Corporation's consolidated amounts.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nFor purposes of this disclosure, the estimated fair value of financial instruments with immediate and shorter-term maturities (generally 90 days or less) is assumed to be the same as the recorded book value. These instruments include the balance sheet lines captioned Cash and Due From Banks, Interest-Bearing Deposits, Federal Funds Sold and Resale Agreements, Other Money Market Investments, Customers' Liability on Acceptances, Short-Term Borrowings, and Liability on Acceptances.\nTrading Account Securities are recorded on the balance sheet at fair value, which is based on quoted market prices.\nThe recorded book and estimated fair values of other financial instruments were as follows:\nBased on the valuation techniques discussed below, the excess of estimated fair values over recorded book values was $541 million at December 31, 1993. These values do not recognize the potential earning power of the corporate franchise, including customer relationships, which are inseparable from related financial instruments. In Management's opinion, the fair value of the Corporation is more accurately reflected in the market value of its common stock, which at December 31, 1993, was $4.8 billion, or $1.5 billion in excess of book value.\nEstimated fair values were determined as follows:\nInvestment Securities\nFair values are based on quoted market prices or dealer quotes.\nLoans and Leases\nThe estimated fair value is determined by discounting contractual cash flows from the loans and leases using current lending rates for new loans with similar remaining maturities. The resulting value is reduced by an estimate of losses inherent in the portfolio.\nInterest Rate and Foreign Exchange Contracts\nContracts used to hedge assets and liabilities are not recorded on the balance sheet. All other contracts are recorded on the balance sheet at their fair value. Estimated fair values are based on quoted market prices and rates, when available, or the amount the Corporation would receive or pay at current rates to terminate the contracts.\nDeposit Liabilities\nThe fair value of Demand, Savings, and Money Market Deposits with no defined maturity is, by definition, the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the future cash flows to be paid, using the current rates at which similar deposits with similar remaining maturities would be issued.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nLong-Term Debt\nThe fair value of the Corporation's long-term debt is based on quoted market prices, where available. The fair values of other issues are estimated by discounting the future cash flows using the current rates at which similar debt could be issued.\nCommitments\nCommitments to make or sell loans, standby letters of credit and financial guarantees are not recorded on the balance sheet. Their fair values are estimated as the fees that would be charged customers to enter into a similar agreement with comparable pricing and maturity. For fixed rate commitments, the estimated fair value also considers the difference between current levels of interest rates and the committed rates.\n14. RESTRICTIONS ON CASH FLOWS TO THE PARENT COMPANY\nNational and state banking laws and regulations place certain restrictions on loans or advances made by the banking subsidiaries to members of the affiliated group, including the Parent, and also place restrictions on dividends paid by the subsidiary banks. In addition, the subsidiary banks are subject to the risk-based capital standards of the banking regulatory agencies. At December 31, 1993, net assets of the subsidiary banks not available for dividends or loans amounted to approximately $2,567,886,000.\nIn 1994, bank subsidiaries may distribute to the Parent (in addition to their 1994 net income) approximately $503,004,000 in dividends without prior approval from bank regulatory agencies.\n15. RELATED PARTY TRANSACTIONS\nCertain directors and officers of the Parent, their families and certain entities in which they have an ownership interest were customers of the Corporation in 1993 and 1992. Management believes all transactions with such parties, including loans and commitments, were in the ordinary course of business and at normal terms prevailing at the time, including interest rates and collateralization and did not represent more than normal risks. The amount of such loans attributable to persons who were related parties at December 31, 1993, was $71,446,000 at the beginning and $41,942,000 at the end of 1993. During 1993, new loans to related parties totaled $1,180,219,000 and repayments aggregated $1,209,723,000.\n16. ACQUISITIONS\nOn October 1, 1991, the Corporation issued approximately 7,942,000 shares of its common stock in exchange for all of the common stock of FNW Bancorp, Inc., a bank holding company located in Mt. Prospect, Illinois. This combination was accounted for as a pooling of interests.\nOn January 23, 1992, the Corporation acquired all of the common stock of Gainer Corporation, a bank holding company located in Merrillville, Indiana. The acquisition was accounted for as a purchase and, accordingly, operations of Gainer Corporation are included in the consolidated financial statements since the date of acquisition. Essentially all of the purchase price of $168,379,000 was provided by issuing 5,729,000 shares of the Corporation's stock. The transaction generated $41,260,000 of goodwill, which is being amortized over 15 years using the straight-line method.\nOn July 1, 1992, the Corporation issued approximately 11,911,000 shares of its common stock in exchange for all the common stock of Summcorp, a bank holding company located in Fort Wayne, Indiana. The combination was accounted for as a pooling of interests.\nIn June 1992, Summcorp recorded $6.0 million ($4.4 million after tax) of merger-related expenses. These expenses were composed of charges taken to eliminate duplicate facilities and equipment, and intangibles revaluation. Summcorp also recorded a $9.8 million ($5.9 million after tax) provision for possible credit losses, to conform its credit evaluation policies to those of the Corporation, and other merger-related charges totaling $2.9 million ($1.9 million after tax).\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nOn October 15, 1992, the Corporation issued approximately 29,892,000 shares of its common stock for all of the common stock of INB Financial Corporation, Inc. (INB), of Indianapolis, Indiana. This merger was also accounted for as a pooling of interests.\nIn the third quarter of 1992, the Corporation recorded $70.1 million ($48.0 million after tax) of merger-related expenses for severance and early retirement, facilities, and equipment and intangibles revaluation. In addition, INB recorded a $41.6 million ($25.1 million after tax) provision for credit losses to conform their credit evaluation policies to those of the Corporation.\n17. SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION\nThe following quarterly financial information, in the opinion of management, fairly presents the results of operations for such periods.\n- ------------------------- * Net income per share before the cumulative effect of the change in accounting principle was $.71 per share (primary) and $.70 per share (fully diluted) in the first quarter 1993, and $.62 per share (primary) and $.60 per share (fully diluted) in the first quarter 1992.\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS\nA Condensed Balance Sheet as of December 31, 1993 and 1992, and Condensed Statement of Income and Condensed Statement of Cash Flows for each of the three years ended December 31, 1993, for NBD Bancorp, Inc. (Parent Only) are as follows:\nNBD BANCORP, INC. (PARENT ONLY)\nCONDENSED BALANCE SHEET\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNBD BANCORP, INC. (PARENT ONLY)\nCONDENSED STATEMENT OF INCOME\nNBD BANCORP, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNBD BANCORP, INC. (PARENT ONLY)\nCONDENSED STATEMENT OF CASH FLOWS\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors NBD Bancorp, Inc. Detroit, Michigan\nWe have audited the accompanying consolidated balance sheet of NBD Bancorp, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the mergers of NBD Bancorp, Inc. and Summcorp, and of NBD Bancorp, Inc. and INB Financial Corporation (\"INB\"), each of which has been accounted for as a pooling of interests as described in Note 16 to the consolidated financial statements. We did not audit the statements of income, stockholders' equity, and cash flows of Summcorp and INB for the year ended December 31, 1991, whose combined statements reflect total revenues of $888,101,000 for the year ended December 31, 1991. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Summcorp and INB for 1991, is based solely on the reports of such other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NBD Bancorp, Inc. and subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Corporation changed its method of accounting for investment securities and income taxes in 1993, and its method of accounting for postretirement benefits other than pensions in 1992, to conform to pronouncements of the Financial Accounting Standards Board.\n\/s\/ Deloitte & Touche DELOITTE & TOUCHE\nJanuary 18, 1994 Detroit, Michigan\nNBD BANCORP, INC.\nSUPPLEMENTARY DATA EARNINGS PER SHARE COMPUTATION\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information set forth under the captions \"Election of Directors\" and \"Security Ownership Reporting\" in the definitive Proxy Statement of the Corporation dated April 8, 1994, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nReference is made to PART I of this Form 10-K for information as to the executive officers of the Corporation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Director Compensation\" and \"Executive Officer Compensation\" in the definitive Proxy Statement of the Corporation dated April 8, 1994, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the definitive Proxy Statement of the Corporation dated April 8, 1994, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the caption \"Compensation Committee Interlocks and Insider Participation\" in the definitive Proxy Statement of the Corporation dated April 8, 1994, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this Report:\n1. FINANCIAL STATEMENTS:\n- ------------------------- * Refers to page number of this Form 10-K. ** Refers to number of Exhibit to this Form 10-K.\n2. SCHEDULES:\nAll schedules are omitted because they are inapplicable, not required, or the information is included in the financial statements or notes thereto.\n3. EXHIBITS:\nThe Exhibits marked with one asterisk below were filed as Exhibits to the Corporation's Form 10-K for the fiscal year ended December 31, 1989 [file number 1-7127]; the Exhibit marked with two asterisks below was filed as an Exhibit to the Corporation's Form 10-K for the fiscal year ended December 31, 1990; the Exhibit marked with three asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on February 14, 1992; the Exhibit marked with four asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on July 15, 1992; the Exhibit marked with five asterisks was filed as Exhibits to the Corporation's Form 8-K Report filed on May 11, 1993; the Exhibit marked with six asterisks below was filed as an Exhibit to the Corporation's Form 10-K for the fiscal year ended December 31, 1991; the Exhibits marked with seven asterisks below were filed as Exhibits to the Corporation's Form 10-K for the fiscal year ended December 31, 1992; the Exhibit marked with eight asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on April 9, 1993; and all such Exhibits are incorporated herein by reference, the Exhibit numbers in brackets being those in such Forms S-3, 10-K and 8-K.\n- ------------------------- Exhibits 10(a) through 10(k) constitute the management contracts and executive compensatory plans or arrangements of the Corporation and its subsidiaries.\n(b) Reports on Form 8-K\nThe Corporation has not filed any reports on Form 8-K during the last quarter of the year covered by this Form 10-K.\nSIGNATURES\nPursuant 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 in the City of Detroit, State of Michigan on March 1, 1994.\nNBD BANCORP, INC.\n\/S\/ VERNE G. ISTOCK -------------------------- Verne G. Istock, Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 1, 1994.\n[NBD LOGO]\nEXHIBIT INDEX\nThe Exhibits marked with one asterisk below were filed as Exhibits to the Corporation's Form 10-K for the fiscal year ended December 31, 1989 [file number 1-7127]; the Exhibit marked with two asterisks below was filed as an Exhibit to the Corporation's Form 10-K for the fiscal year ended December 31, 1990; the Exhibit marked with three asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on February 14, 1992; the Exhibit marked with four asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on July 15, 1992; the Exhibit marked with five asterisks was filed as Exhibits to the Corporation's Form 8-K filed on May 11, 1993; the Exhibit marked with six asterisks below was filed as an Exhibit to the Corporation's Form 10-K for the fiscal year ended December 31, 1991; the Exhibits marked with seven asterisks below were filed as Exhibits to the Corporation's Form 10-K for the fiscal year ended December 31, 1992; the Exhibit marked with eight asterisks below was filed as an Exhibit to the Corporation's Form S-3 Registration Statement filed on April 9, 1993; and all such Exhibits are incorporated herein by reference, the Exhibit numbers in brackets being those in such Forms S-3, 10-K and 8-K.","section_15":""}
{"filename":"41719_1993.txt","cik":"41719","year":"1993","section_1":"Item 1. Business. - ------ --------\nThe Registrant, a paper manufacturing company, began operations in Spring Grove, Pennsylvania in 1864 and was incorporated as a Pennsylvania corporation in 1905. On January 30, 1979 the Registrant acquired by merger Bergstrom Paper Company (\"Bergstrom\") with paper mills located in Wisconsin and Ohio. The Ohio mill was sold on September 10, 1984. On May 7, 1987 the Registrant acquired all of the outstanding capital stock of Ecusta Corporation (\"Ecusta\") with a paper mill located in North Carolina and other operations in North Dakota, Canada and Australia. Ecusta was merged into and became a division of the Registrant on June 30, 1987.\nThe Registrant's present papermaking operations are located in Spring Grove, Pennsylvania, Pisgah Forest, North Carolina and Neenah, Wisconsin. It manufactures printing papers and tobacco and other specialty papers. The Registrant's products are used principally for case bound and quality paperback books, commercial and financial printing, converting and cigarette manufacturing.\nThe Registrant sells its products throughout the United States and in a number of foreign countries. Net export sales in 1993, 1992 and 1991 were $38,577,000, $48,830,000 and $60,311,000, respectively. In 1993, sales of paper for book publishing and commercial printing generally were made through wholesale paper merchants, whereas sales of paper to cigarette manufacturers, financial printers and converters generally were made directly. No single user of the Registrant's products accounted for more than 10% of the Registrant's 1993 net dollar sales. In 1993, the Registrant did not supply tobacco paper products to the domestic tobacco operations of Philip Morris Companies, Inc., in accordance with a decision communicated by Philip Morris to the Registrant on October 29, 1992. Philip Morris had been one of Registrant's six domestic customers for tobacco paper products. Sales to Philip Morris amounted to 7.5% of the Registrant's total sales in 1992. During 1993, the Registrant succeeded in redirecting the lost Philip Morris product volume to printing paper customers. However, these sales were not as profitable as sales to Philip Morris in 1992. In addition, due to increased competitive pressure and cost- cutting measures within the tobacco industry, sales to remaining tobacco paper customers in 1993 were less profitable than in 1992. As a result, the 1993 profit performance of the Registrant's Pisgah Forest mill was sharply below that of 1992. The Registrant\ncontinues its efforts to maximize utilization of its Pisgah Forest mill assets by attempting to direct sales volume to its most profitable grades and by controlling costs. Even with these efforts, the 1994 profit performance of the Pisgah Forest mill is not expected to improve over that of 1993.\nSet forth below is the amount (in thousands) and percentage of net sales contributed by each of the Registrant's two classes of similar products during each of the years ended December 31, 1993, 1992 and 1991.\nPrinting and specialty papers are manufactured in each of the Registrant's mills. Tobacco papers are manufactured in the Registrant's Pisgah Forest mill.\nThe competitiveness of the markets in which the Registrant sells its products varies. There are numerous concerns in the United States manufacturing printing papers, and no one company holds a dominant position. Capacity in the uncoated free-sheet industry, which includes uncoated printing papers, is expected to increase in the first quarter of 1994. Industry operating rates should improve, particularly in the latter half of the year, once the new capacity is absorbed by the market. In the interim, competition with respect to printing papers is likely to be intense with continuing pressure on prices. In the tobacco papers business, while there is only one significant domestic competitor, there are numerous international competitors. Despite recent events described above, the Registrant remains a major tobacco papers supplier to the domestic tobacco products industry. Declining consumption of cigarettes in the United States, the shift to lower-priced and lower-cost cigarettes and lower- priced tobacco paper products from foreign manufacturers caused tobacco companies to pressure the Registrant to reduce prices, but have not, and are not expected to, affect the Registrant's relative competitive\nposition. Increasing foreign production of tobacco products by U.S. companies may have an adverse effect on the Registrant's overall competitive position. Service, product performance and technological advances are important competitive factors in the Registrant's business. The Registrant believes its reputation in these areas continues to be excellent.\nBacklogs are not significant in the Registrant's business.\nThe principal raw material used at the Spring Grove mill is pulpwood. In 1993, the Registrant acquired approximately 83% of its pulpwood from saw mills and independent logging contractors and 17% from Company-owned timberlands. Hardwood purchases constituted slightly more than half of the pulpwood acquired and softwood the balance. Hardwoods are growing in abundance within a relatively short distance of the Registrant's Spring Grove mill. Softwood is obtained primarily from Maryland, Delaware and Virginia. In order to protect its sources of pulpwood, the Registrant has actively promoted conservation and forest management among suppliers and woodland owners. In addition, its subsidiary, The Glatfelter Pulp Wood Company, has acquired, and is acquiring, woodlands, particularly softwood growing land, with the objective of having sufficient softwood growing on its lands to provide a significant portion of the Spring Grove mill's future softwood requirements. Wood chips produced from sawmill waste also accounted for a substantial amount of the Registrant's pulpwood purchases for the Spring Grove mill.\nThe Neenah mill uses high-grade recycled wastepaper as its principal raw material. There is currently an adequate supply of wastepaper.\nThe major raw materials used at the Pisgah Forest mill are purchased wood pulp and processed flax straw, which is derived from linseed flax plants. Flax has become a less important raw material as a result of the loss of business of Philip Morris (referred to above), since it was the Registrant's major customer for flax-based products. In addition, declining consumption of cigarettes in the United States and the shift to lower-priced and lower-cost cigarettes, which are manufactured using predominately wood pulp-based tobacco papers, has caused further deterioration in demand for flax-based papers. This has necessitated the purchase of additional wood pulp to manufacture products to replace the lost flax-based business. The current supply of flax and wood pulp is sufficient for the present and anticipated future operations at the Pisgah Forest mill.\nDue to sufficient levels of processed flax straw inventory, the Registrant elected not to contract for the purchase of flax straw for 1994. The Registrant's future operations in North Dakota and Canada are contingent upon the Registrant's ongoing review of the demand for and profitability of its flax- based tobacco papers.\nWood pulp purchased from others comprised approximately 109,000 short tons or 25% of the total 1993 fiber requirements of the Registrant. Wood pulp is currently in more than adequate supply.\nThe Registrant is subject to numerous Federal, state and foreign laws and rules and regulations thereunder with respect to solid waste disposal and the abatement of air and water pollution and noise. It has been the Registrant's experience over many years that directives with respect to the abatement of pollution have periodically been made increasingly stringent. During the past twenty years or more, the Registrant has taken a number of measures and spent substantial sums of money both for the installation of facilities and operating expenses in order to abate air, water and noise pollution and to alleviate the problem of disposal of solid waste. In spite of the measures it has already taken, the Registrant expects that compliance with the laws and the rules and regulations thereunder relating to solid waste disposal and the abatement of air and water pollution could become increasingly difficult and that such compliance, when and if technologically feasible, will require additional capital expenditures and operating expenses. For further information with respect to such compliance, reference is made to Item 3 of this report.\nCompliance with government environmental regulations is a matter of high priority to the Registrant. In order to meet environmental requirements, the Registrant has undertaken certain projects, the most significant of which is the Spring Grove pulpmill modernization. The related construction cost for all of these projects, based on presently available information, is estimated to be $34 million in 1994 and $7 million in 1995, including approximately $31 million in 1994 for the Spring Grove pulpmill modernization project. The pulpmill modernization project began in 1990 and is expected to be completed in 1994. The total cost of the pulpmill modernization project is expected to be $170 million (exclusive of capitalized interest) of which $20 million was expended in 1991 or prior thereto, $48 million in 1992 and $71 million in 1993. Since capital expenditures for pollution abatement generally do not increase the productivity or efficiency of the Registrant's mills, the Registrant's earnings will be adversely affected to the extent that selling prices cannot be increased to offset incremental operating costs, including depreciation, resulting from such capital expenditures,\nadditional interest expense or the loss of any income which otherwise could have been earned on the amounts expended for environmental purposes. The Registrant does not expect, however, that its capital expenditures for, or operating costs of, pollution abatement facilities for its present mills will have a significant adverse effect on its competitive position.\nThe Registrant's Spring Grove mill generates all of its steam requirements and is 100% self-sufficient in electrical energy generation. It also produces excess electricity which is sold to the local power company under a long-term co-generation contract, which resulted in 1993 net energy sales of $5,602,000. Principal fuel sources used by the Registrant's Spring Grove mill are coal, spent chemicals, bark and wood waste, and oil which in 1993 were used to produce approximately 66%, 27%, 6% and 1%, respectively, of the total energy internally generated at the Spring Grove mill.\nThe Pisgah Forest mill generates all of its steam requirements and a majority of its electrical requirements (63% in 1993) and purchases electric power for the remainder. The principal fuel source used at the Pisgah Forest mill is coal (98.5% in 1993).\nThe Neenah mill generates all of its steam requirements and a portion of its electric power requirements (13% in 1993) and purchases the remainder of its electric power requirements. Gas and oil were used to produce 81% and 19%, respectively, of the mill's internally generated energy during 1993.\nAt December 31, 1993, the Registrant had 3,019 active full-time employees.\nHourly employees at the Registrant's mills are represented by different locals of the United Paperworkers International Union, AFL-CIO. A labor agreement covering approximately 1,025 employees at the Pisgah Forest mill expires in October 1996. Under this agreement, wages increased 2.75% in 1993 and are to increase 3% in both 1994 and 1995. A five-year labor agreement covering approximately 770 hourly employees in Spring Grove was ratified in 1993 and expires in January 1998. Under this agreement, wages increased by 2.5% in 1993 and are to increase by 3% in each of the four years, 1994 through 1997. In January 1994, a new five-year labor agreement covering Neenah employees (approximately 320) was ratified. Under this agreement, which expires in August 1997, wages increased 2.75% in 1993 and are to increase 3% in each of 1994, 1995 and 1996.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - ------ ----------\nThe Registrant's executive offices are located in Spring Grove, Pennsylvania, 11 miles southwest of York. The Registrant's paper mills are located in Spring Grove, Pennsylvania, Pisgah Forest, North Carolina and Neenah, Wisconsin.\nThe Spring Grove facilities include seven uncoated paper machines with a daily capacity ranging from 11 to 273 tons and an aggregate annual capacity of about 279,000 tons of finished paper. The machines have been rebuilt and modernized from time to time. A high speed off-machine coater gives the Registrant a potential annual production capacity for coated paper of approximately 48,000 tons. Since uncoated paper is used in producing coated paper, this does not represent an increase in the Spring Grove plant capacity. The pulpmill has a production capacity of approximately 550 tons of bleached pulp per day.\nThe Pisgah Forest facilities include twelve paper machines, stock preparation equipment and a modified kraft bleached flax pulpmill with thirteen rotary digesters. The annual light weight paper capacity is approximately 98,000 tons. This represents a recent 7,000 ton increase due to a shift from tobacco paper to printing paper. Nine paper machines are essentially identical while the newer three machines have design variations specific for the products produced. Converting equipment includes winders, calendars, slitters, perforators and printing presses.\nThe Neenah facilities, consisting of a paper manufacturing mill, converting plant and offices, are located at two sites. The Neenah mill includes three paper machines, with an aggregate annual capacity of approximately 156,000 tons, a wastepaper processing and warehousing building, a wastepaper de-inking and bleaching plant, stock preparation equipment, power plant, water treatment and waste treatment plants, and warehousing space. The converting plant contains a paper processing area and warehouse space.\nThe Glatfelter Pulp Wood Company, a subsidiary of the Registrant, owns and manages approximately 109,000 acres of land, most of which is timberland.\nThe Registrant owns substantially all of the properties used in its papermaking operations except for certain land leased from the City of Neenah under leases expiring in 2050, on which wastewater treatment and storage facilities and a parking lot are located. All of the Registrant's properties, other than those which are leased, are free from any major liens or encumbrances. The Registrant considers that all of its buildings are in good\nstructural condition and well maintained and its properties are suitable and adequate for present operations.\nItem 3.","section_3":"Item 3. Pending Legal Proceedings. - ------ -------------------------\nThe Registrant does not believe that the environmental matters discussed below will have a material effect on its business or consolidated financial position.\nOn May 16, 1989, the Pennsylvania Environmental Hearing Board approved and entered an Amended Consent Adjudication between the Registrant and the Pennsylvania Department of Environmental Resources (\"DER\") in connection with the Registrant's permit to discharge effluent into the West Branch of the Codorus Creek. The Amended Consent Adjudication establishes limitations on in- stream color, and requires the Registrant to conduct certain studies and to submit certain reports regarding internal and external measures to control the discharge of color and certain other adverse byproducts of chlorine bleaching to the West Branch of the Codorus Creek.\nDuring 1990 and again in 1991, the Pennsylvania DER proposed to reissue the Registrant's waste water discharge permit on terms with which the Registrant does not agree. The Registrant is contesting these terms. Among those terms is an unacceptable term concerning a suspected discharge of 2,3,7,8 tetrachlorodibenzo-p-dioxin (\"dioxin\"). At the behest of the United States Environmental Protection Agency (\"EPA\"), DER has included the Registrant's Spring Grove mill on the list of dischargers submitted to and approved by EPA pursuant to Section 304(l) of the Clean Water Act. EPA has approved that list because EPA suspects that the Spring Grove mill may discharge dioxin in concentrations of concern. The Registrant believes that the Spring Grove mill should not be included on the discharger list.\nThe Registrant has been identified by EPA and the Ohio Environmental Protection Agency as one of 34 potentially responsible parties (\"PRP\") for the clean-up of the Cardington Road Landfill in Montgomery County, Ohio. EPA has selected a remedy estimated to cost approximately $8.2 million and, by letter dated February 9, 1994, demanded that the PRPs perform a remedial design. Appleton Paper, Inc., which purchased the Registrant's West Carrolton, Ohio mill, was previously identified as a PRP and has demanded that the Company indemnify it for costs incurred in connection with this landfill, but did not receive the February 9 letter. On March 25, 1994 the Registrant received notice that the court in Cardington Road Site Coalition v. Snyder Properties, ------------------------------ ------------------ Inc. (Case No. C-3-88-632 S.D. Ohio), a superfund cost recovery action brought - ---- by the PRPs who implemented the remedial investigation, had authorized the filing of a complaint naming the Registrant as a third-party defendant in such action.\nThe Wisconsin DNR has reissued the Registrant's wastewater discharge permit for the Neenah mill on terms unacceptable to the Registrant. The Registrant has requested an adjudicatory hearing on the terms of that permit. The Wisconsin Paper Council is presently engaged in joint negotiation of some issues common to a number of permits issued at the same time to similar mills.\nThe Registrant has been named as a fourth-party defendant in an action captioned United States v. Modern Trash Removal of York, Inc., Civil No. --------------------------------------------------- 92-0819, pending in the United States District Court for the Middle District of Pennsylvania. The action, brought pursuant to the Comprehensive Environmental Response, Compensation and Liability Act and the Pennsylvania Hazardous Sites Cleanup Act, seeks contribution from the Registrant for its alleged share of past and future costs incurred during the cleanup of the Modern Sanitation Landfill (the \"Landfill\") located in Windsor and Lower Windsor Townships, York County, Pennsylvania. Modern Trash Removal York, Inc., a subsidiary of Waste Management, Inc., has agreed in principle to defend and to indemnify the Registrant against any liability the Registrant may have with respect to the cleanup of the Landfill. The terms of a definitive agreement are currently being negotiated.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. - ------ ---------------------------------------------------\nNot Applicable.\nExecutive Officers of the Registrant. - ------------------------------------\nOfficers are elected to serve at the pleasure of the Board of Directors. Except in the case of officers elected to fill a new position or a vacancy occurring at some other date, officers are elected at the annual meeting of the Board held immediately after the annual meeting of shareholders.\n____________________\n(a) Unless otherwise indicated, the offices listed have been held for five or more years.\n(b) Mr. Newcomer became Vice President and Treasurer on May 1, 1993. From June 1, 1989 to April 30, 1993 he was Assistant Comptroller. From January 1, 1988 to May 31, 1989 he was Corporate Manager, Budgets and Financial Analysis.\n(c) Mr. Lawrence became Vice President - General Manager, Ecusta Division on May 1, 1993. From February 1, 1989 to April 30, 1993 he was Director of Planning, Acquisitions and Governmental Affairs.\n(d) Dr. Myers became Vice President - Manufacturing Technology on April 26, 1989. From April 27, 1988 to April 26, 1989, he was Vice President - Manufacturing, Glatfelter Paper Division.\n(e) Mr. Glatfelter became Vice President - General Manager, Glatfelter Paper Division on May 1, 1993. From April 1989 until May 1993, he was General Manager, Glatfelter Paper Division. From April 1988 to April 1989, he was Assistant to the Chief Executive Officer.\n(f) Mr. Smith became Comptroller on May 1, 1993. From December 1990 to May 1993, he was a Financial Analyst. From January 1988 to December 1990, he was Comptroller for Flagship Cleaning Services, Inc.\n(g) Mr. Wood became Secretary and Assistant Treasurer on September 23, 1992. From December 22, 1987 to September 22, 1992 he was Assistant Secretary and Assistant Treasurer.\nPART II -------\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder - ------ ---------------------------------------------------- ----------- Matters. -------\nCommon Stock Prices and Dividends Paid Information\nThe table below shows the high and low prices of the Company's common stock on the American Stock Exchange (Ticker Symbol \"GLT\") and the dividends paid per share for each quarter during the past two years. Stock prices and dividends paid per share have been adjusted to reflect the two-for-one common stock split effected April 22, 1992.\nAs of December 31, 1993, the Company had 5,030 shareholders of record. A number of the shareholders of record are nominees.\nItem 6.","section_6":"Item 6. Selected Financial Data. - ------ -----------------------\nFive-Year Summary of Selected Consolidated Financial Data\n(a) After impact of an after tax charge for unusual items of $8,430,000 or $.19 per share and the effect of an increased federal corporate income tax rate of $3,587,000 or $.08 per share. (b) Includes an increase of $61,062,000 for the adoption of Statement of Financial Accounting Standard No. 109.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ------ ------------------------------------------------- ------------- Results of Operations. ---------------------\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFinancial Condition\nLiquidity:\nDuring 1993, the primary source of cash and marketable securities was the Company's issuance of $150,000,000 principal amount of its 5 7\/8% Notes. The Notes will mature on March 1, 1998, and may not be redeemed prior to maturity. In addition to the proceeds of such issuance, the Company generated $45,380,000 of cash from operations. These funds were used for, among other things, capital spending of $112,820,000, the payment of $30,847,000 in dividends and the retirement of $41,100,000 of short-term debt, $10,100,000 of which was outstanding as of December 31, 1992. During 1993, the Company's cash and cash equivalents increased by $16,089,000. In addition, the Company's marketable securities increased by $27,184,000.\nThe Company expects to meet all its near and long-term cash needs from internally generated funds, cash, cash equivalents, marketable securities and bank lines of credit, as discussed in Note 12 of the Notes to Consolidated Financial Statements, or a combination of these sources.\nCapital Resources:\nCapital spending in 1993 of $112,820,000 was $22,504,000 higher than in 1992, due primarily to the Company's pulpmill modernization project at its Spring Grove mill. Capital spending in 1994 is expected to decrease significantly from 1993 due to the completion of the pulpmill modernization project, offset somewhat by an estimated $15,000,000 of cash expenditures related to the purchase and installation of a new turbine generator. The new turbine generator is expected to be operational in the first quarter of 1995 at a total cost in excess of $20,000,000.\nResults of Operations\nThe Company classifies its sales into two product groups: 1) printing papers; and 2) tobacco and other specialty papers. Significant production capacity increases have occurred in the printing paper industry in 1991, 1992 and 1993. As a result, printing paper prices were down slightly in 1993 compared to 1992. The Company's printing paper volume was up slightly in 1993, as printing paper volume gains at the Pisgah Forest mill offset volume decreases at the Neenah mill.\nThe trend of declining domestic tobacco consumption continued in 1993, with no change in the trend expected. On October 29, 1992, Philip Morris Companies, Inc. informed the Company that, effective January 1, 1993, it would cease to make purchases from the Company for its domestic tobacco operations. Sales to this customer in 1992 were 7.5% of total sales for the year. The Company's dollar amount of sales of tobacco paper products direct to foreign tobacco product manufacturers declined in 1993 as a result of sharply lower unit prices due to increased foreign competition.\nMost of the Company's printing paper sales are directed at the uncoated free-sheet segment of the industry. Industry uncoated free-sheet capacity is expected to increase in the first quarter of 1994. Industry operating rates should improve, particularly in the latter half of the year once the new capacity is absorbed by the market. Product pricing is expected to be relatively flat compared to 1993, with any significant improvements not anticipated until the third or fourth quarter. Profit from operations for the Spring Grove and Neenah mills is expected to decline modestly in 1994 as a result of unchanged selling prices and increases in wood costs, pulp costs, depreciation, salaries, wages and other manufacturing costs.\nDuring 1993, the Company succeeded in redirecting the lost Philip Morris product volume to printing paper customers. These sales were not as profitable as sales to Philip Morris were in 1992. In addition, due to increased competitive pressure and cost-cutting measures within the tobacco industry, sales to remaining tobacco customers in 1993 were less profitable than in 1992. As a result, the 1993 profit performance of the Company's Pisgah Forest mill was sharply below that of 1992. The Company continues its efforts to maximize utilization of its Pisgah Forest mill assets by attempting to direct sales volume to its most profitable grades and by controlling costs. Even with these efforts, the 1994 profit performance of the Pisgah Forest mill is not expected to improve over that of 1993.\nEffective January 1, 1993, the Company adopted the provisions of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pension\" (\"SFAS No. 106\"), No. 109 \"Accounting for Income Taxes\" (\"SFAS No. 109\"), and No. 112 \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"). The combined 1993 net of tax charge due to the adoption of these standards was approximately $4.2 million, or $.09 per common share. Note 1(h) of the Notes to Consolidated Financial Statements further describes the expected effects of implementing these Standards.\nDuring 1993, the Company incurred net unusual charges of $13,229,000, or $.19 per common share, due to rightsizing and restructuring costs of $16,363,000, partially offset by a gain of $1,492,000 on the disposal of its Ecusta Division's airplane and a credit of $1,642,000 resulting from the updating of estimates relating to SFAS No. 106, subsequent to its adoption on January 1, 1993. The rightsizing and restructuring costs include provisions for the costs of early retirements and other terminations in 1993 and other one-time net costs relating to the rightsizing and restructuring of the Company's operations.\nDuring 1993, the Company's inventory level increased approximately $10,500,000. This increase was primarily due to an increase in the Company's finished goods inventory. This increase was the result of increased stocking levels to meet customer demand, primarily in the financial printing market. The Company also purchased a large quantity of pulp near the end of 1993 at an attractively low price. This purchase also resulted in an increase in the Company's accounts payable balance at December 31, 1993.\n1993 Compared to 1992\nNet sales in 1993 decreased $66,548,000 from 1992 with lower tobacco paper sales accounting for 94% of this decrease. Tobacco paper sales were adversely impacted by the loss of the Philip Morris domestic tobacco paper business. Increased competitive pressure and cost-cutting measures taken by the remaining domestic and foreign customers resulted in lower unit prices and lower revenues.\nProfit from operations, before restructuring charges, accounting changes, interest income and expense and taxes, was $48,563,000 compared to $90,302,000 in 1992, a decrease of 46.2%.\nThe Company's Pisgah Forest mill showed a decline in profits from operations of $29,018,000 in 1993 compared to 1992. Net sales decreased $47,707,000 for the reasons noted above.\nProfit from operations at the Neenah mill showed a decline of $6,997,000 in 1993 compared to 1992. Net sales declined $8,651,000 in 1993 due primarily to lower sales volume.\nThe Spring Grove mill had a decrease in its profits from operations of $5,724,000 in 1993 compared to 1992. Net sales were $10,190,000 lower in 1993. The Spring Grove mill had a 4% decrease in average net selling price, primarily as a result of less favorable product mix.\nSelling, administrative and general expenses decreased $3,728,000 in 1993, $3,640,000 of which was the result of lower management incentive bonuses and profit sharing expenses.\nNet interest income increased by $2,414,000 in 1993 due to increased cash available for investment as a result of the $150,000,000 debt issuance. Interest on debt increased by $2,824,000, net of an increase in capitalized interest of $4,050,000.\n1992 Compared to 1991\nNet sales in 1992 decreased $27,707,000 from 1991. Lower printing paper sales accounted for 60% of this decrease with lower sales of tobacco and other specialty papers accounting for the balance. Higher unit sales were more than offset by lower unit prices and unfavorable mix changes within both product categories.\nIn 1992, profit from operations, before net interest income and income taxes, was $90,302,000 compared to $120,912,000 in 1991, a decrease of 25.3%.\nThe Company's Pisgah Forest mill showed a decline in profit from operations of $12,278,000 in 1992 compared to 1991. Net sales declined $12,814,000 as a result of a less favorable mix of product sales and lower international and domestic tobacco paper sales.\nProfit from operations at the Neenah mill showed a decline of $9,999,000 in 1992. Net sales declined $9,187,000 in 1992 due mainly to lower unit prices as volume was virtually the same.\nThe Spring Grove mill had a decrease in its profits from operations of $8,333,000 in 1992. Net sales were $5,706,000 lower in 1992. Volume increased by 2.1% in 1992, but lower unit prices and a less favorable product mix more than offset the increased volume. Increases in salaries, wages, depreciation and other manufacturing costs were also contributing factors.\nSelling, administrative and general expenses decreased by $6,999,000 in 1992; $4,406,000 of which was the result of lower management incentive\nbonus and profit sharing expenses. The balance was as a result of the Company's ongoing cost control measures.\nNet interest income declined by $1,814,000 in 1992 due to reduced investment in interest-bearing securities and lower interest rates.\nEffects of Changing Prices\nThe moderate levels of inflation during recent years have not had a material effect on the Company's net sales, revenues or income from operations. Although the replacement cost of assets increases during inflationary periods, earnings and cash flow can be maintained through an increase in selling prices.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - ------ -------------------------------------------\nConsolidated Statements of Income and Retained Earnings P. H. Glatfelter Company and subsidiaries For the Years Ended December 31, 1993, 1992 and 1991\nSee notes to consolidated financial statements.\nConsolidated Balance Sheets P. H. Glatfelter Company and subsidiaries December 31, 1993 and 1992\nSee notes to consolidated financial statements.\nConsolidated Statements of Cash Flows P. H. Glatfelter Company and subsidiaries For the Years Ended December 31, 1993, 1992 and 1991\nSee notes to consolidated financial statements.\n1. Summary of Significant Accounting Policies\n(a) Principles of Consolidation\nThe accounts of the Company, and its wholly-owned, significant subsidiaries, are included in the consolidated financial statements. All intercompany transactions have been eliminated. Certain reclassifications have been made of previously reported amounts in order to conform with classifications used in the current year.\n(b) Earnings per Share\nNet income per share of common stock is computed on the basis of the weighted average number of shares of common stock and common stock equivalents (Note 5) outstanding during each year.\nThe 1993 net income per share of common stock of $.37, as presented in the Consolidated Statements of Income and Retained Earnings, appropriately reflects the negative impact of rightsizing and restructuring charges (Note 2), adopting certain Statements of Financial Accounting Standards (Note 1(h)) and the increase in the federal corporate income tax rate from 34% to 35% (Note 8). The 1993 net income per share of common stock, exclusive of these items, would have been $.73. A reconciliation of these amounts follows:\n(c) Cash Equivalents and Investments\nThe Company considers all highly liquid financial instruments with effective maturities at date of purchase of three months or less to be cash equivalents. Highly liquid financial instruments with maturities in excess of three months but which the Company considers available for sale are classified as marketable securities on the Company's Consolidated Balance Sheets.\nEffective January 1, 1994, the Company changed its accounting for investments in debt and equity securities to conform to Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). All of the Company's securities are either \"available for sale\" or \"held to maturity\" as defined by SFAS No. 115. As noted in Note 1(i), the Company's marketable securities approximate fair value. The adoption of this standard is not expected to have a material impact on the Company's Consolidated Balance Sheets or Consolidated Statements of Income and Retained Earnings.\n(d) Inventories\nInventories are stated at the lower of cost or market. Raw materials and in-process and finished inventories are valued using the last-in, first-out (LIFO) method, and the supplies inventory is valued principally using the average cost method. Inventories at December 31 are as follows:\nIf the Company had valued all inventories using the average cost method, inventories would have been $2,141,000 lower than reported at December 31, 1993, and $1,105,000 and $3,168,000 greater than reported at December 31, 1992 and 1991, respectively. Net income would not have been significantly different than that reported.\nAt December 31, 1993, the value of the above inventories exceeded inventories for income tax purposes by approximately $27,000,000.\n(e) Plant, Equipment and Timberlands\nDepreciation is computed for financial reporting on the straight-line method over the estimated useful lives of the respective assets and for income taxes principally on accelerated methods over lives established by statute or Treasury Department procedures. Provision is made for deferred income taxes applicable to this difference.\nMaintenance and repairs are charged to income and major renewals and betterments are capitalized. At the time property is retired or sold, the cost and related reserve are eliminated and any resultant gain or loss is included in income.\nDepletion of the cost of timber is computed on a unit rate of usage by growing area based on estimated quantities of recoverable material.\n(f) Income Tax Accounting\nEffective January 1, 1993, the Company changed its policy of accounting for income taxes to conform to Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\") (Note 8). The Company previously followed Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes\". Deferred taxes are provided for differences between amounts shown for financial reporting purposes and those included with tax return filings that will reverse in future periods.\n(g) Interest Expense Capitalized\nThe Company capitalizes interest expense incurred in connection with qualified additions to property. The Company capitalized $4,138,000 and $88,000 of interest in 1993 and 1992, respectively. No interest was capitalized in 1991.\n(h) Accounting Changes for Statements of Financial Accounting Standards\nEffective January 1, 1993, the Company adopted the provisions of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\"), No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"), and No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). The cumulative effect of the accounting changes, net of tax charges (credits) due to the adoption of these Standards, is as follows:\nSFAS No. 106 requires recognition of the cost of retiree health and insurance benefits during an employee's active service. The cumulative effect, as of January 1, 1993, of the adoption of SFAS No. 106 was a one-time charge for postretirement health care costs of $20,900,000 which, after deferred income tax benefits of $8,050,000, resulted in a 1993 first quarter net charge of $12,850,000.\nThe Company had previously recognized the cost of postretirement benefits in the period benefits were paid. The effect of this change in accounting for the year ended December 31, 1993 was an additional pre-tax expense of approximately $770,000. The postretirement expense for the years ended December 31, 1992 and 1991 were approximately $1,320,000 and $1,358,000, respectively.\nThe pro forma effect on operations of this change for the years ended December 31, 1992 and 1991 would have been an additional pre-tax expense of approximately $855,000 and $647,000, respectively.\nSFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits under certain conditions. Such benefits, relating primarily to disability-related benefits, were not previously recognized by the Company until paid. The cumulative effect as of January 1, 1993 of the adoption of SFAS No. 112 was a provision for accrued postemployment benefits of $3,201,000 which, after deferred income tax benefits of $1,234,000, resulted in a 1993 first quarter net charge of $1,967,000. The pro forma effect on operations of this change for the years ended December 31, 1992 and 1991 would not have been significant.\nSFAS No. 109 requires a remeasurement of the Company's Ecusta Division acquisition which results in an increase in the fair value of the acquired assets and the establishment of a deferred income tax liability for the difference between the book and tax values of such assets. The adoption of SFAS No. 109 also resulted in a reversal of deferred income taxes provided during years when the effective income tax rates were higher than those currently in effect. The cumulative effect of these changes was an increase in plant and equipment of approximately $61,062,000; an increase in deferred income taxes of approximately $50,438,000; and a credit to operations as a cumulative effect of the change in method of accounting for income taxes of approximately $10,624,000. The pro forma effect on\noperations of this change for the years ended December 31, 1992 and 1991, would not have been significant.\n(i) Fair Market Value of Financial Instruments\nIn 1993, the Company adopted SFAS 107, \"Disclosures About Fair Value of Financial Instruments\". This Statement requires that fair values be disclosed for most of the Company's financial instruments. The amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, marketable securities, trade receivables, certain other current assets and long-term debt approximate fair value.\n2. Rightsizing and Restructuring (Unusual Items)\nDuring 1993, the Company incurred net pre-tax unusual charges of $13,229,000, including rightsizing and restructuring costs of $16,363,000, partially offset by a gain of $1,492,000 on the disposal of its Ecusta Division's airplane and a credit of $1,642,000 resulting from the updating of estimates relating to SFAS No. 106, subsequent to its adoption on January 1, 1993. The rightsizing and restructuring costs include provisions for the costs of early retirements and other terminations in 1993 and other one-time net costs relating to the rightsizing and restructuring of the Company's operations. The after tax impact of these charges was $8,430,000, or $.19 per common share.\n3. Capital Stock\nA summary of the number of shares of common stock outstanding follows:\nUnder the employee stock purchase plans, eligible employees may acquire shares of the Company's common stock at its fair market value. Employees may contribute up to 10% of their compensation, as defined, and the Company will contribute, as specified in the plans, amounts up to 50% of the employee's contribution but not more than 3% of the employee's compensation, as defined.\nOn September 22, 1993, the Company's Board of Directors called for the redemption of all 3,147 outstanding shares of 4 5\/8 % preferred stock. The preferred shares were redeemed on October 27, 1993 for $50.75 per share. The redeemed shares of preferred stock and all shares of preferred stock held in treasury were cancelled on October 27, 1993. At December 31, 1993, the Company had 40,000 shares of preferred stock which are authorized but not issued. A summary of preferred stock follows:\n4. Capital in Excess of Par Value\nA summary of changes in capital in excess of par value follows:\n5. Key Employee Long-Term Incentive Plan and Restricted Common Stock Award Plan\nOn April 22, 1992, the common shareholders approved the 1992 Key Employee Long-Term Incentive Plan which authorizes the issuance of up to 3,000,000 shares of the Company's common stock to eligible participants. The Plan provides for incentive stock options, non-qualified stock options, restricted stock awards, performance shares and performance units. The Company's 1988 Restricted Common Stock Award Plan (1988 Plan) was simultaneously amended to provide that no further awards of common shares may be made thereunder.\nOn May 1, 1993, the Company granted to certain key employees non-qualified stock options to purchase an aggregate of up to 940,000 shares of common stock. Subject to certain conditions, beginning on January 1, 1994, the stock options are exercisable for 25% of such common stock and for an additional 25% of such common stock beginning on January 1 of each of the next three years. The stock options, which expire on April 30, 2003, were granted at an exercise price of approximately $18 per share, representing the average of the fair market values of the Company's common stock on April 30, 1993 and May 3, 1993.\nDuring 1988 and 1991, 755,000 and 76,000 shares, respectively, were awarded under the 1988 Plan. Awarded shares will be subject to forfeiture, in whole\nor in part, if the recipient ceases to be an employee within a specified period of time. Compensation expense equal to the market value of awarded shares on the award date is recognized over the period from the award date to the date the forfeiture provisions lapse. The Company may reduce the number of shares otherwise required to be delivered by an amount which would have a market value equal to the taxes withheld by the Company on delivery. The Company may also, at its sole discretion, elect to pay to the recipients in cash an amount equal to the market value of the shares that would otherwise be required to be delivered. In conjunction with the Company's rightsizing and restructuring, the vesting dates were accelerated to 1993 for 120,000 shares and to 1994 for 28,000 shares.\nIn 1993, under the 1988 Plan, in lieu of delivering 271,000 shares, the Company elected to pay in cash an amount equal to market value of such shares. On May 1, 1992, 62,256 shares were delivered from treasury (after reduction of 33,744 shares for taxes). On December 1, 1992, the Company paid cash in lieu of delivering 26,000 shares. In 1991, the Company paid cash in lieu of delivering 36,000 shares. Shares awarded under the 1988 Plan cease to be subject to forfeiture as follows: 52,000 in 1994, 182,000 in 1996, and 20,000 in each of 1997, 1998, and 1999.\n6. Pension Plans\nThe Company and its subsidiaries have trusteed, noncontributory pension plans covering substantially all of their employees. The benefits are based, in the case of certain plans, on average salary and years of service and, in the case of other plans, on a fixed amount for each year of service. Plan provisions and funding met the requirements of the Employee Retirement Income Security Act of 1974. Pension income of $4,205,000, $2,760,000, and $1,868,000 was recognized in 1993, 1992 and 1991, respectively.\nAs discussed in Note 2, during 1993, the Company incurred rightsizing and restructuring costs, including provisions for the costs of termination benefits. In accordance with Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits\", the Company recognized a charge of $7,978,000 related to early retirement termination benefits. The following table sets forth the status of the Company's plans at December 31, 1993 and 1992:\nNet pension income, excluding unusual charges, includes the following components (in thousands):\nThe assumed rates of discount, increase in long-term compensation levels and expected long-term return on assets were 7.0%, 3.5% and 8.5%, respectively, in 1993 and 7.5%, 3.5% and 8.0%, respectively, in 1992 and 1991.\n7. Other Postretirement Benefits\nThe Company provides certain health care benefits to eligible retired employees. These benefits include a comprehensive medical plan for retirees prior to age 65 and supplemental premium payments to retirees over age 65 to help defray the costs of Medicare. As discussed in Note 1(h), the Company adopted SFAS No. 106, effective January 1, 1993. The plan is not funded; claims are paid as incurred.\nThe following table sets forth the plan's status as of December 31, 1993:\nNet periodic postretirement benefit cost for 1993 included the following components:\nThe Company assumes an increase in the annual rate of per capita cost of covered health benefits of 11.0% for 1994 decreasing by approximately 1% per year to 5.5% in 2000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation is 7.0%. An increase in the assumed health care cost trend rate of 1% for each year would increase the December 31, 1993 accumulated postretirement benefit obligation by approximately $1,820,000 and the net periodic postretirement benefit cost by approximately $215,000.\n8. Income Taxes\nAs discussed in Note 1(f), effective January 1, 1993, the Company adopted SFAS No. 109. Under SFAS No. 109, income taxes are recognized for (a) the amount of taxes payable or refundable for the current year, and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The effects of income taxes are measured based on effective tax law and rates.\nDuring 1993, federal tax legislation was enacted that significantly changed the Company's 1993 income tax provisions. The principal provision of the new law affecting the Company is an increase in the federal corporate income tax rate from 34% to 35%. Taxes currently payable and deferred tax liabilities increased by $226,000 and $3,361,000, respectively, as a result of the new law. As a result, income tax expense from continuing operations for the year was increased by $3,587,000, causing a reduction in net income by the same amount and a reduction in earnings per share of $.08.\nSet forth below are the domestic and foreign components of income before income taxes and accounting changes:\nThe income tax provision consists of the following:\nThe net deferred tax amounts reported on the Company's Consolidated Balance Sheet at December 31, 1993 are as follows:\nFollowing are components of the net deferred tax balance at December 31, 1993:\nThe tax effects of temporary differences at December 31, 1993 are as follows:\nA reconciliation between the provision for income taxes, computed by applying the statutory federal income tax rate of 35% for 1993, and 34% for 1992 and 1991, to income before income taxes, and the actual provision for\nincome taxes follows:\n9. Commitments and Contingencies\nIn order to meet environmental requirements, the Company has undertaken certain projects, the most significant of which relates to the modernization of the Spring Grove pulpmill. The related construction cost for all of these projects, based on presently available information, is estimated to be $34 million in 1994 and $7 million in 1995, including approximately $31 million in 1994 for the pulpmill modernization project. The pulpmill modernization project began in 1990 and is expected to be completed in 1994. The total cost of the project is expected to be $170 million (exclusive of capitalized interest) of which $20 million was expended through 1991, $48 million in 1992 and $71 million in 1993. On October 29, 1992, Philip Morris Companies, Inc. informed the Company that, effective January 1, 1993, it would cease to make purchases from the Company for its domestic tobacco operations. Sales to this customer in 1992 were 7.5% of total sales for the year. During 1993, the Company succeeded in redirecting the lost Philip Morris product volume to printing paper customers. These sales were not as profitable as sales to Philip Morris in 1992. In addition, due to increased competitive pressure and cost-cutting measures within the tobacco industry, sales to remaining tobacco paper customers in 1993 were less profitable than in 1992. As a result, the 1993 profit performance of the Company's Pisgah Forest mill was sharply below that of 1992. The Company continues its efforts to maximize utilization of its Pisgah Forest mill assets by attempting to direct sales volume to its most profitable grades and by controlling costs. Even with these efforts, the 1994 profit performance of the Pisgah Forest mill is not expected to improve over that of 1993.\n10. Legal Proceedings\nThe Company is involved in lawsuits and administrative proceedings under the environmental protection laws and various lawsuits pertaining to other matters. Although the ultimate outcome of these matters cannot be predicted with certainty, the Company's management, after consultation with legal counsel, does not expect that they will have a material adverse effect on the Company's financial position or results of operations.\n11. Foreign Sales\nNet sales in dollars to foreign customers were 8.1%, 9.0% and 10.6% of total net sales in 1993, 1992, and 1991, respectively.\n12. Borrowings\nThe Company has available lines of credit from two different banks aggregating $70,000,000 at interest rates approximating money market rates. In March 1993, the Company issued $150,000,000 principal amount of its 5 7\/8% Notes. These Notes will mature on March 1, 1998 and may not be redeemed prior to maturity. Interest on the Notes is payable semiannually on March 1 and September 1. The Notes are unsecured obligations of the Company.\nIn March 1993, the Company entered into an interest rate swap agreement having a total notational principal amount of $50,000,000. Under the agreement, the Company receives a fixed rate of 5 7\/8 % and pays a floating rate, as determined at six-month intervals. The floating rate is 4.0375% for the six-month period ending March 1, 1994. The agreement converts a portion of the Company's debt obligation from a fixed rate to a floating rate basis. During 1993, the Company recognized $2,448,000 of interest income and $1,677,000 of interest expense, resulting in a net credit of $771,000. This net amount is included in \"Interest on debt\" on the Company's Consolidated Statements of Income and Retained Earnings. The Company has pledged $2,500,000 of its marketable securities as security under the swap agreement.\nThe Company has approximately $9,500,000 of letters of credit outstanding as of December 31, 1993. The Company bears the credit risk on this amount to the extent that the Company does not comply with the provisions of certain agreements. The letters of credit do not reduce the amount available under the Company's lines of credit.\nIndependent Auditors' Report\nP. H. Glatfelter Company, Its Shareholders and Directors:\nWe have audited the accompanying consolidated balance sheets of P. H. Glatfelter Company and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income and retained earnings, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of P. H. Glatfelter Company and subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1(h) to the consolidated financial statements, the Company changed its method of accounting for income taxes, postretirement benefits other than pensions and postemployment benefits as of January 1, 1993.\nDeloitte & Touche Philadelphia, Pennsylvania\nFebruary 11, 1994\nQUARTERLY FINANCIAL DATA\n(a) Adjusted for two-for-one common stock split effected April 22, 1992. (b) After impact of an after tax charge for unusual items of $8,430,000 or $.19 per share. (c) After impact of the effect of an increased federal corporate income tax rate of $3,472,000 or $.08 per share. (d) After impact of an after tax charge for unusual items of $8,430,000 or $.19 per share and the effect of an increased federal corporate income tax rate of $3,587,000 or $.08 per share.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and - ------ --------------------------------------------------------------- Financial Disclosure. --------------------\nNot Applicable.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. - ------- --------------------------------------------------\n(a) Directors. The information with respect to directors required --------- under this item is incorporated herein by reference to pages 1 through 3 of the Registrant's Proxy Statement dated March 17, 1994.\n(b) Executive Officers of the Registrant. The information with ------------------------------------ respect to the executive officers required under this item is set forth in Part I of this Report.\nItem 11.","section_11":"Item 11. Executive Compensation. - ------- ----------------------\nThe information required under this item is incorporated herein by reference to pages 5 through 12 of the Registrant's Proxy Statement dated March 17, 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. - ------- --------------------------------------------------------------\nThe information required under this item is incorporated herein by reference to pages 13 through 15 of the Registrant's Proxy Statement dated March 17, 1994.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - ------- ----------------------------------------------\nThe information required under this item is incorporated herein by reference to page 12 of the Registrant's Proxy Statement dated March 17, 1994.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - ------- ----------------------------------------------------------------\n(a) 1. A. Financial Statements filed as part of this report:\nConsolidated Statements of Income and Retained Earnings for the Years Ended December 31, 1993, 1992 and 1991 Consolidated Balance Sheets, December 31, 1993 and 1992 Consolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements for the Years Ended December 31, 1993, 1992 and\nB. Supplementary Data for each of the three years in the period ended December 31, 1993.\n2. Financial Statement Schedules (Consolidated):\nFor Each of the Three Years in the Period Ended December 31, 1993:\nV - Plant, Equipment, and Timberlands VI - Reserves for Depreciation of Plant and Equipment IX - Short-term Borrowings\nSchedules other than those listed above are omitted because of the absence of conditions under which they\nare required or because the required information is included in the Notes to the Consolidated Financial Statements.\nIndividual financial statements of the Registrant are not presented inasmuch as the Registrant is primarily an operating company and its consolidated subsidiaries are wholly-owned.\n3. Executive Compensation Plans and Arrangements: see Exhibits 10(a) through 10(h), described below.\nExhibits:\nNumber Description of Documents - ------ ------------------------\n(3)(a) Articles of Amendment dated April 27, 1977, including restated Articles of Incorporation, as amended by Articles of Merger dated January 30, 1979, by Articles of Amendment dated April 25, 1984 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1984) and by Articles of Amendment dated April 23, 1986 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986; a Statement of Reduction of Authorized Shares dated May 12, 1980; a Statement of Reduction of Authorized Shares dated September 23, 1981; a Statement of Reduction of Authorized Shares dated August 2, 1982; a Statement of Reduction of Authorized Shares dated July 29, 1983; a Statement of Reduction of Authorized Shares dated October 15, 1984 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1984); a Statement of Reduction of Authorized Shares dated December 24, 1985 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1985); a Statement of Reduction of Authorized Shares dated July 11, 1986 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1986); a Statement of Reduction of Authorized Shares dated March 25, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1987); a Statement of Reduction of Authorized Shares dated November 9, 1988 (incorporated by reference to Exhibit (3)(b) of\nRegistrant's Form 10-K for the year ended December 31, 1988); a Statement of Reduction of Authorized Shares dated April 24, 1989 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1989); Articles of Amendment dated November 29, 1990 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1990); Articles of Amendment dated June 26, 1991 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1991); and Articles of Amendment dated August 7, 1992 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(3)(b) Articles of Amendment dated July 30, 1993 and dated January 26, 1994.\n(3)(c) Articles of Incorporation, as amended through January 26, 1994 (restated for the purpose of filing on EDGAR).\n(3)(d) By-Laws as amended through March 16, 1994.\n(4)(a) Indenture between P. H. Glatfelter Company and Wachovia Bank of Georgia, N.A. as Trustee dated as of January 15, 1993.\n(4)(b) Form of Note issued to Purchasers of 5 7\/8% Notes due March 1, 1998 (incorporated by reference to Exhibit 4(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(9) P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993 (incorporated by reference to Exhibit 1 of the Schedule 13D filed by P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993).\n(10)(a) P. H. Glatfelter Company Management Incentive Plans, effective January 1, 1982, as amended and restated effective January 1, 1994.\n(10)(b) P. H. Glatfelter Company Management Incentive Plans, Operating Rules, as revised through February 18, 1994.\n(10)(c) P. H. Glatfelter Company 1988 Restricted Common Stock Award Plan, as amended and restated June 24, 1992 (incorporated by reference to Exhibit (10)(c) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(d) P. H. Glatfelter Company Supplemental Executive Retirement Plan, effective January 1, 1988, as amended and restated March 17, 1993 (incorporated by reference to Exhibit (10)(d) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(e) Deferral Benefit Pension Plan of Ecusta Division, effective May 22, 1986 (incorporated by reference to Exhibit (10)(ee) of Registrant's Form 10-K for the year ended December 31, 1987).\n(10)(f) Description of Executive Salary Continuation Plan (incorporated by reference to Exhibit (10)(g) of Registrant's Form 10-K for the year ended December 31, 1990).\n(10)(g) P. H. Glatfelter Company Plan of Supplemental Retirement Benefits for the Management Committee, as amended and restated effective June 28, 1989 (incorporated by reference to Exhibit (10)(h) of Registrant's Form 10-K for the year ended December 31, 1989).\n(10)(h) P.H. Glatfelter Company 1992 Key Employee Long-Term Incentive Plan, effective April 22, 1992 (incorporated by reference to Exhibit (10)(i) of Registrant's Form 10-K for the year ended December 31, 1992).\n(11) Computation of Earnings Per Share\n(21) Subsidiaries of the Registrant\n(23) Consent of Independent Certified Public Auditors\n(b) The Registrant filed the following report on Form 8-K during the quarter ended December 31, 1993:\nN O N E\nSIGNATURES ----------\nPursuant 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.\nP. H. GLATFELTER COMPANY (Registrant) March 25, 1994 By \/s\/ T. C. Norris ------------------------ T. C. Norris Chairman of the Board\nPursuant 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 in the capacities and on the dates indicated:\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\nSupplementary Data and Financial Statement Schedules For Each of the Three Years in the Period Ended December 31, 1993\nPrepared for Filing As Part of Annual Report (Form 10-K) to the Securities and Exchange Commission\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\nSUPPLEMENTARY DATA FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1993 - --------------------------------------------------------------------------------\nA. PLANT, EQUIPMENT AND TIMBERLANDS\nPlant and equipment are depreciated for financial reporting purposes over the following estimated service lives:\nAdditions to buildings and machinery and equipment in 1993 include $3.8 million relating to the precision sheeter and $1.0 million relating to the sludge water treatment project at the Spring Grove Mill; $6.5 million for the #5 paper machine rebuild at the Neenah Mill; and $4.7 million for the refining stock blend system and $2.0 million related to the #10 paper machine dryer rebuild at the Pisgah Forest Mill. Additions to construction in progress in 1993 include $71.1 million relating to the ongoing Pulp Mill Modernization project at the Spring Grove Mill. Retirements in 1993 include $1.5 million related to the disposal of the Pisgah Forest Mill's airplane and $0.4 million related to the #10 paper machine dryer at the Pisgah Forest Mill.\nAdditions to buildings and machinery and equipment in 1992 include $4.2 million for the Mill Information Processing System, $3.3 million relating to upgrades of one of the largest paper machines, and $2.2 million relating to the woodwaste\/sludge\/bark project, all at the Spring Grove Mill. Additions to construction in progress in 1992 include $47.7 million relating to the ongoing Pulp Mill Modernization project at the Spring Grove Mill. Retirements in 1992 include $3.6 million for retirement of equipment being removed as part of the Pulp Mill Modernization project and $2.4 million for trade-in of an airplane.\nAdditions to buildings and machinery and equipment in 1991 include $5.2 million relating to the sludge combustor at the Neenah Mill and $1.8 million for the rebuild of one of the largest paper machines at the Pisgah Forest Mill. Net additions to construction in progress in 1991 included approximately $17.4 million primarily relating to the new wood yard currently under construction at the Spring Grove Mill.\nB. ALLOWANCES FOR DOUBTFUL ACCOUNTS AND SALES DISCOUNTS\nThe provision for doubtful accounts is included in administrative expense and the provision for sales discounts is deducted from sales. The related allowances are deducted from accounts receivable.\nC. SUPPLEMENTARY INCOME STATEMENT INFORMATION\nMaintenance and repairs charged to costs and expenses for each of the three years in the period ended December 31, 1993 were: 1993 - $48,156,000; 1992 - $49,111,000; and 1991 - $47,045,000.\nDepreciation and amortization of intangible assets, taxes (other than payroll and income taxes), royalties and advertising costs have not been shown since each does not exceed 1% of total net sales as reported in the consolidated statements of income and retained earnings.\nFINANCIAL STATEMENT SCHEDULE V\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\n(a) Depletion credited directly to asset account and charged to costs and expenses. (b) Net change during year. (c) See supplementary data (Note A) for description of significant additions and retirements. (d) Reclassification and other. (e) Adjustment for the implementation of FASB Statement No. 109 Accounting for Income Taxes.\nFINANCIAL STATEMENT SCHEDULE VI\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\n(a) Reclassification and other.\n(b) Accumulated depreciation with respect to retirements. See supplementary data (Note A).\nFINANCIAL STATEMENT SCHEDULE IX\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\n(a) Maximum amount outstanding at any month end during period.\n(b) Average computed by summing amount outstanding at month end during the year and dividing by 12.\n(c) Weighted average computed using balance outstanding at end of each month and interest rate in place at that time.\n(d) No short-term borrowings during the year ended December 31, 1991.\nNote - In March of 1993 the Company issued $150,000,000 principal amount of notes and used a portion of the proceeds to repay the outstanding balance of short-term borrowings of $41,100,000.\nN\/A - Not applicable.\nIndex to Exhibits -----------------\nNumber - ------\n(3)(a) Articles of Amendment dated April 27, 1977, including restated Articles of Incorporation, as amended by Articles of Merger dated January 30, 1979, by Articles of Amendment dated April 25, 1984 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1984) and by Articles of Amendment dated April 23, 1986 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986; a Statement of Reduction of Authorized Shares dated May 12, 1980; a Statement of Reduction of Authorized Shares dated September 23, 1981; a Statement of Reduction of Authorized Shares dated August 2, 1982; a Statement of Reduction of Authorized Shares dated July 29, 1983; a Statement of Reduction of Authorized Shares dated October 15, 1984 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1984); a Statement of Reduction of Authorized Shares dated December 24, 1985 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1985); a Statement of Reduction of Authorized Shares dated July 11, 1986 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1986); a Statement of Reduction of Authorized Shares dated March 25, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1987); a Statement of Reduction of Authorized Shares dated November 9, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1988); a Statement of Reduction of Authorized Shares dated April 24, 1989 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1989); Articles of Amendment dated November 29, 1990 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1990); Articles of Amendment dated June 26, 1991 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1991); and Articles of Amendment dated August 7, 1992 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(3)(b) Articles of Amendment dated July 30, 1993 and dated January 26, 1994.\n(3)(c) Articles of Incorporation, as amended through January 26, 1994 (restated for the purpose of filing on EDGAR).\n(3)(d) By-Laws as amended through March 16, 1994.\n(4)(a) Indenture between P. H. Glatfelter Company and Wachovia Bank of Georgia, N.A. as Trustee dated as of January 15, 1993.\n(4)(b) Form of Note issued to Purchasers of 5 7\/8% Notes due March 1, 1998 (incorporated by reference to Exhibit 4(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(9) P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993 (incorporated by reference to Exhibit 1 of the Schedule 13D filed by P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993).\n(10)(a) P. H. Glatfelter Company Management Incentive Plans, effective January 1, 1982, as amended and restated effective January 1, 1994.\n(10)(b) P. H. Glatfelter Company Management Incentive Plans, Operating Rules, as revised through February 18, 1994.\n(10)(c) P. H. Glatfelter Company 1988 Restricted Common Stock Award Plan, as amended and restated June 24, 1992 (incorporated by reference to Exhibit (10)(c) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(d) P. H. Glatfelter Company Supplemental Executive Retirement Plan, effective January 1, 1988, as amended and restated March 17, 1993 (incorporated by reference to Exhibit (10)(d) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(e) Deferral Benefit Pension Plan of Ecusta Division, effective May 22, 1986 (incorporated by reference to Exhibit (10)(ee) of Registrant's Form 10-K for the year ended December 31, 1987).\n(10)(f) Description of Executive Salary Continuation Plan (incorporated by reference to Exhibit (10)(g) of Registrant's Form 10-K for the year ended December 31, 1990).\n(10)(g) P. H. Glatfelter Company Plan of Supplemental Retirement Benefits for the Management Committee, as amended and restated effective June 28, 1989 (incorporated by reference to Exhibit (10)(h) of Registrant's Form 10-K for the year ended December 31, 1989).\n(10)(h) P.H. Glatfelter Company 1992 Key Employee Long-Term Incentive Plan, effective April 22, 1992 (incorporated by reference to Exhibit (10)(i) of Registrant's Form 10-K for the year ended December 31, 1992).\n(11) Computation of Earnings Per Share\n(21) Subsidiaries of the Registrant\n(23) Consent of Independent Certified Public Auditors","section_15":""}
{"filename":"808450_1993.txt","cik":"808450","year":"1993","section_1":"Item 1. BUSINESS\nNavistar International Corporation is a holding company and its principal operating subsidiary is Navistar International Transportation Corp. referred to as \"Transportation\". As used hereafter, \"Navistar\" or \"Company\" refers to Navistar International Corporation and its subsidiaries and \"Parent Company\" refers to Navistar International Corporation alone.\nNavistar, through its wholly-owned subsidiary Transportation, operates in one principal business segment, the manufacture and marketing of medium and heavy diesel trucks, including school bus chassis, mid-range diesel engines and service parts in North America and in selected export markets. Transportation is the industry market share leader in the North American combined medium and heavy truck market, offering a full line of diesel- powered products in the common carrier, private carrier, government\/service, leasing, construction, energy\/petroleum and student transportation markets. Transportation also produces mid-range diesel engines for use in its medium trucks and for sale to original equipment manufacturers. Transportation markets its products through an extensive distribution network which includes 950 North American dealer and distribution outlets. Service and customer support are also supplied at these outlets. As a further extension of its business, Transportation provides financing and insurance for its dealers, distributors and retail customers through its wholly-owned subsidiary, Navistar Financial Corporation, referred to as \"Navistar Financial\". See \"Important Supporting Operations\".\nTHE MEDIUM AND HEAVY TRUCK INDUSTRY\nNavistar competes in the North American market for medium and heavy trucks, including school bus chassis, which spans weight classes 5 and above (16,000 lbs. and over). This market is subject to considerable volatility as it moves in response to cycles in the overall business environment and is particularly sensitive to the industrial sector which generates a significant portion of the freight tonnage hauled. Government regulation has impacted and will continue to impact trucking operations and efficiency and the specifications of equipment.\nThe following table shows retail deliveries in the combined United States and Canadian markets for the five years ended October 31, 1993, in thousands of units. YEARS ENDED OCTOBER 31, -----------------------\n1993 1992 1991 1990 1989 ----- ----- ----- ----- ----- Medium trucks and school bus chassis .. 122.5 118.3 120.1 149.8 162.8 Heavy trucks .............. 166.4 125.2 109.0 139.0 172.2 ----- ----- ----- ----- ----- Total ..................... 288.9 243.5 229.1 288.8 335.0 ===== ===== ===== ===== =====\nSource: Based upon monthly data by the American Automobile Manufacturers Associations (AAMA) in the United States and Canada and other sources.\nThe North American truck market is highly competitive. Major domestic competitors include PACCAR, Ford and General Motors, as well as foreign- controlled manufacturers, such as Freightliner, Mack and Volvo GM. In addition, manufacturers from Japan (Hino, Isuzu, Nissan, Mitsubishi) are attempting to increase their North American sales levels. The intensity of this competitiveness, which is expected to continue, results in price discounting and margin pressures throughout the industry. In addition to the influence of price, market position is driven by product quality, engineering, styling and utility and a comprehensive distribution system.\nTRANSPORTATION MARKET SHARE\nTransportation delivered 79,800 medium and heavy trucks in North America in fiscal 1993, compared to a total of 69,300 for fiscal 1992, an increase of 15.1% in overall units. Navistar's combined share of the medium and heavy truck market in 1993 was 27.6%. Transportation has been the leader in combined market share for medium and heavy trucks, including school bus chassis, in North America in each of its last 13 fiscal years.\nPRODUCTS AND SERVICES\nThe following table illustrates the percentage of Transportation's sales by class of product by dollar amount:\nYEARS ENDED OCTOBER 31, -------------------------- PRODUCT CLASS 1993 1992 1991 - ------------- ---- ---- ----\nMedium trucks and school bus chassis ........ 35% 40% 44% Heavy trucks .................... 40 34 31 Service parts ................... 14 16 16 Engines ......................... 11 10 9 --- --- --- Total ......................... 100% 100% 100% === === ===\nTransportation offers a full line of medium and heavy trucks, with the objective of serving the customer better and more effectively by addressing requirements for increased performance and value. Transportation has made continuing improvements in its heavy truck image and performance and has responded to drivers' desires for increased amenities with the introduction of new sleeper compartments, interiors and aerodynamic chassis skirts for premium conventional models. New interiors were also introduced for cabover and severe service trucks. In addition, new mid-range DT 408 and DT 466 diesel engines were introduced into the medium model trucks which meet 1994 emission control standards without the need for catalytic converters. These engines will further enhance medium truck operating performance and life.\nIn 1993, Transportation introduced new products including the 9200 model premium conventional tractor as well as other enhancements to its products to improve operating performance and durability. In addition, Transportation has launched special \"NavTrucks\" programs to meet the needs of customers in targeted regional vocations. Each NavTruck program tailors existing medium, heavy and severe service truck models to an individual regional vocation by packaging appropriate vehicle specifications and marketing programs.\nAccording to a recent survey conducted by J. D. Power and Associates on 1993 Medium-Duty Truck Customer Satisfaction, Navistar ranked number one in customer satisfaction in product and service for medium conventional trucks.\nFor over two decades, Transportation has been the leading supplier of school bus chassis in the United States. Chassis have traditionally been sold to body companies, which complete the buses and deliver them to the ultimate customer. Transportation manufactures chassis for conventional and transit-style school buses, as well as chassis for use in small capacity buses designed to meet the needs of disabled students. In addition to its traditional chassis business, Transportation has invested in American Transportation Corporation (AmTran), a manufacturer of school bus bodies. Through its relationship with AmTran, Transportation participates in the trend toward the integrated design and manufacture of school buses, which offers the potential for improved production and marketing efficiencies and a reduction in the school bus order cycle.\nTransportation offers only diesel-powered trucks and buses because of their improved fuel economy, ease of serviceability and greater durability over gasoline-powered vehicles. Transportation's heavy trucks use diesel engines purchased from outside suppliers, while its medium trucks are powered by diesel engines manufactured by Transportation. In 1993, Transportation launched its all new world class series of in-line six cylinder diesel engines for bus, medium and heavy models. Transportation is the leading supplier of mid-range diesel engines in the 150-300 horsepower range according to data supplied by a private research firm, Power Systems Research of Minneapolis, Minnesota. Based upon information published by R.L. Polk & Company, diesel-powered medium truck shipments represented 81% of all medium truck shipments for fiscal year 1993 in North America.\nTransportation's North American truck manufacturing operations consist principally of the assembly of components manufactured by its suppliers, although Transportation produces its own medium range truck engines, sheet metal components (including cabs) and miscellaneous other parts.\nThe following is a summary of Transportation's truck manufacturing capacity utilization for the five years ended October 31, 1993.\nYEARS ENDED OCTOBER 31, ------------------------------------------- 1993 1992 1991 1990 1989 ------- ------- ------- ------- -------\nProduction units .......... 88,274 73,901 70,502 80,737 90,897 Total production capacity ................ 106,032 106,088 106,762 114,402 119,325 Capacity utilization ...... 83.3% 69.7% 66.0% 70.6% 76.2%\nTotal production capacity varies as a result of changes in the number of days of production during a year as well as changes in production constraints.\nENGINE & FOUNDRY\nTransportation builds diesel engines for use in its medium trucks and for sale to original equipment manufacturers. Production in 1993 totalled 175,500 units, an increase of 18% from the 149,000 units produced in 1992. In 1993, Transportation produced the DTA 466 (195-270 horsepower), DTA 360 (170-190 horsepower) and 7.3 liter (155-190 horsepower) mid-range diesel engines. In September 1993, the DT 408 (175-230 horsepower) was introduced which replaced the DTA 360 while the DT 466 (195-275 horsepower) replaced the DTA 466. Transportation believes that its family of mid-range diesel engines, each designed to provide superior performance in customer applications, offers both the lowest cost of ownership and excellent durability to users.\nBased on U.S. registrations published by R.L. Polk & Company, the 7.3 liter diesel engine is the leading engine of its class. In addition to its strong contribution to the market position of Transportation's medium trucks, the 7.3 liter engine and the predecessor 6.9 liter engine have had significant external sales.\nEngine sales to original equipment manufacturers are primarily made to a major automotive company, which currently accounts for approximately 91% of sales, and to DINA Camiones, S.A. (DINA), a major truck manufacturer in Mexico. The automotive company uses the engine in all of its diesel- powered light trucks and vans having a gross vehicle weight between 8,500 pounds and 14,000 pounds. Shipments to original equipment manufacturers totalled a record 118,200 units in 1993, an increase of 21% from the 97,400 units shipped in 1992.\nIn addition to the use of foundry castings in its products, Transportation sells castings to other original equipment manufacturers. Sales of rough grey iron engine blocks and cylinder heads to Consolidated Diesel Corporation (CDC) for its B and C engines were 24,700 tons in 1993 and represented 26% of total foundry capacity. 1993 was the fifth year of a five year agreement with CDC.\nThe following is a summary of Transportation's engine capacity utilization for the five years ended October 31, 1993.\nYEARS ENDED OCTOBER 31, ------------------------------------------- 1993 1992 1991 1990 1989 ------- ------- ------- ------- -------\nEngine production units ... 175,464 148,991 126,103 160,434 169,797 Total production capacity . 166,260 166,260 166,720 166,720 167,242 Capacity utilization ...... 105.5% 89.6% 75.6% 96.2% 101.5%\nTotal production capacity varies as a result of changes in product mix.\nTransportation recently completed a major capital improvement program in its engine facilities to manufacture a new generation of mid-range diesel engines in both the in-line six cylinder and V-8 configurations to be used in trucks and school bus chassis manufactured by the Company and also sold to other original equipment manufacturers. This new generation of engines is designed to respond to customer demands for engines that have more power, improved fuel economy, longer life, and meet current emission requirements through 1997. The engines also will be offered in a wider horsepower range, which will give Transportation an opportunity to expand the number of applications for its engines and broaden its customer base.\nIn September 1993, Transportation introduced three new in-line six cylinder engines that replaced its current DT family of engines in International medium trucks. These new engines, which offer displacements of 408, 466 and 530 cubic inches and encompass a horsepower range from 175 to 300, feature 20 percent longer life as a result of larger main and rod bearings, stronger crankshafts, gear driven accessories and, in 1994, electronically controlled fuel systems will be introduced. With their expanded horsepower range and larger displacement, Transportation will also be able to offer the new engines as a lighter-weight, more cost-effective product, which meet emission standards, to customers who currently buy heavier engines from other suppliers.\nThe 7.3 Liter V-8 diesel engine product will also be replaced in February 1994, when Transportation begins production of an entirely new product, with electronically controlled fuel injection. This new diesel engine will offer significant customer advantages, with a 10 to 15 percent improvement in fuel economy, 30 to 40 percent enhancement in durability, and improved power and torque, when compared to Transportation's existing V-8 product. The new V-8 also will meet the 1994 emissions requirements cost-effectively and will allow such options as cruise control, electronically controlled power take-off and diagnostics capabilities. Transportation has entered into an agreement to supply the new 7.3 Liter engine to a major automotive company through the year 2000 for use in all of its diesel-powered light trucks and vans.\nTransportation is exploring the development of alternative fuel engines, including engines powered by compressed natural gas. Transportation has entered into an agreement with Detroit Diesel Corporation to develop a natural gas engine based upon one of Transportation's existing engines and Detroit Diesel's electronic alternative fuel technology.\nSERVICE PARTS\nThe service parts business is a significant contributor to Transportation's sales and gross margin and to the maintenance of its medium and heavy truck customer base. In North America, Transportation operates seven regional parts distribution centers, which allows it to offer 24-hour availability and same day shipment of the parts most frequently requested by customers. Transportation is undertaking initiatives to increase parts sales outside of North America. As customers have explored ways to reduce their costs and improve efficiency, Transportation and its dealers have established programs to help them manage the parts and maintenance aspects of their businesses more efficiently. Transportation also offers a \"Fleet Charge\" program, which allows participating customers to purchase parts on credit at all of its dealer locations at consistent and competitive prices. In 1993, service parts sales increased as a result of higher net selling prices, export business expansion and growth in dealer and national accounts.\nMARKETING AND DISTRIBUTION\nNorth American Operations. Transportation's truck products are distributed in virtually all key markets in North America through the largest retail organization specializing in medium and heavy trucks. As part of its continuing program to adapt to changing market conditions, Transportation has been assisting dealers to expand their operations to better serve their customer base. Transportation's truck distribution and service network in North America was composed of 950, 952 and 919 dealers and retail outlets at October 31, 1993, 1992 and 1991, respectively. Included in these totals were 467, 460 and 415 secondary and associate locations at October 31, 1993, 1992 and 1991, respectively.\nRetail dealer activity is supported by 5 regional operations in the United States and a Canadian general office. Transportation has a national account sales group responsible for its 175 major national account customers.\nTransportation's 10 retail and 6 wholesale North American used truck centers provide sales and trade-in benefits to its dealers and retail customers.\nInternational Operations. International Operations exports trucks, components and service parts, both wholesale and retail, to more than 70 countries around the world and is active in procurement of United States Government business worldwide. Transportation exported 5,300 trucks in 1993 and 4,900 trucks in 1992 and cumulatively, from 1986 through 1992, was the leading North American exporter of Class 6-8 trucks from the United States and Canada, according to data provided by the AAMA.\nIn Mexico, Transportation has an agreement with DINA to supply product technology, components and technical services for assembly of DINA trucks and buses. In 1993, Transportation exported almost 7,000 engines to DINA, bringing the total engines shipped to approximately 20,000 over the past three years. Transportation also has initiated sales of the in-line six cylinder family of mid-range diesel engines to Perkins Group, Ltd., of Peterborough, England, for worldwide distribution and to Detroit Diesel Corporation, the North American distributor of Perkins.\nNAVISTAR FINANCIAL CORPORATION\nNavistar Financial is engaged in the wholesale, retail and to a lesser extent lease financing of new and used trucks sold by Transportation and its dealers in the United States. Navistar Financial also finances wholesale accounts and selected retail accounts receivable of Transportation. To a minor extent, sales of new products (including trailers) of other manufacturers are also financed regardless of whether designed or customarily sold for use with Transportation's truck products. During fiscal 1993 and 1992, Navistar Financial provided wholesale financing for 90% and 89%, respectively, of the new truck units sold by Transportation to its dealers and distributors, and retail financing for approximately 15% and 14%, respectively, of the new truck units sold by Transportation and its dealers and distributors in the United States.\nNavistar Financial's wholly-owned insurance subsidiary, Harco National Insurance Company, provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers and to the general public through an independent insurance agency system.\nIMPORTANT SUPPORTING OPERATIONS\nThird Party Sales Financing Agreements. In the United States, Transportation has an agreement with Associates Commercial Corporation (Associates) to provide wholesale financing to certain of its truck dealers and retail financing to their customers. During fiscal 1993 and 1992, Associates provided 10% and 11%, respectively, of the wholesale financing utilized by Transportation's dealers and distributors.\nNavistar International Corporation Canada has an agreement with a subsidiary of General Electric Canadian Holdings Limited to provide financing for Canadian dealers and customers.\nForeign Insurance Subsidiaries. Harbour Assurance Company of Bermuda Limited offers a variety of programs to the Company, including general liability insurance, ocean cargo coverage for shipments to and from foreign distributors and reinsurance coverage for various Transportation policies. The company also writes minimal third party coverage and provides a variety of insurance programs to Transportation, its dealers, distributors and customers.\nCAPITAL EXPENDITURES AND RESEARCH AND DEVELOPMENT\nTransportation designs and manufactures its trucks and diesel engines to meet or exceed specific industry requirements. New models are introduced and improvements of current models are made, from time to time, in accordance with operating plans and market requirements and not on a predetermined cycle.\nDuring 1993, capital expenditures totalled $110 million. Major product program expenditures included continued investment in machinery and equipment at the Melrose Park, Illinois and Indianapolis, Indiana engine facilities to manufacture a new generation of mid-range diesel engines to be used in trucks and school bus chassis manufactured by the Company and also sold to other original equipment manufacturers. The Company began introducing these engines in the fall of 1993. Other expenditures were made for truck product improvements, modernization of facilities and compliance with environmental regulations.\nCapital expenditures totalled $55 million in 1992. Major product program expenditures included machinery and equipment to manufacture the new series of mid-range diesel engines at the Melrose Park, Illinois and Indianapolis, Indiana engine facilities. Other expenditures were made for truck product improvements, modernization of facilities and compliance with environmental regulations. In 1991, capital expenditures were $77 million.\nProduct development is an ongoing process at Transportation. Research and development activities are directed toward the introduction of new products and improvement of existing products and processes used in their manufacture. Spending for company-sponsored activities totalled $95 million, $90 million and $87 million for 1993, 1992 and 1991, respectively.\nBACKLOG\nThe backlog of unfilled truck orders (subject to cancellation or return in certain events) was as follows:\nAT OCTOBER 31 MILLIONS OF DOLLARS UNITS ------------- ------------------- -------\n1993 ........ $ 1,353 23,939 1992 ........ $ 1,124 20,456 1991 ........ $ 613 13,534\nAlthough the backlog of unfilled orders is one of many indicators of market demand, many factors may affect point-in-time comparisons such as changes in production rates, available capacity, new product introductions and competitive pricing actions.\nEMPLOYEES\nThe following table summarizes employment levels as of the end of fiscal years 1991 through 1993:\nTOTAL AT OCTOBER 31 EMPLOYMENT ------------- ----------\n1993 ........................... 13,612 1992 ........................... 13,945 1991 ........................... 13,472\nLABOR RELATIONS\nAt October 31, 1993, the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW) represented approximately 7,144 of the Company's active employees in the U.S., and the Canadian Auto Workers (CAW) represented approximately 1,393 of the Company's active employees in Canada. Other unions represented approximately 1,342 of the Company's active employees in North America. The Company entered into collective bargaining agreements with the UAW and CAW in 1993 which expire on October 1, 1995 and October 24, 1996, respectively. These agreements permit greater productivity and efficiency, manufacturing flexibility and customer responsiveness, which will contribute to a reduction in costs and the Company's goal of improving profitability.\nPATENTS AND TRADEMARKS\nTransportation continuously obtains patents on its inventions and thus owns a significant patent portfolio. Additionally, many of the components which Transportation purchases for its products are protected by patents that are owned or controlled by the component manufacturer. Transportation has licenses under third party patents relating to its products and their manufacture, and Transportation grants licenses under its patents. The royalties paid or received under these licenses are not significant. No\nparticular patent or group of patents is considered by Transportation to be essential to its business as a whole.\nLike all businesses which offer well-known products or services, Transportation's primary trademarks symbolize the Company's goodwill and provide instant identification of its products and services in the marketplace and thus, are an important part of its worldwide sales and marketing efforts. To support these efforts, Transportation maintains, or has pending, registrations of its primary trademarks in those countries in which it does business or expects to do business.\nRAW MATERIALS AND ENERGY SUPPLIES\nTransportation purchases raw materials, parts and components from numerous outside suppliers but relies upon some suppliers for a substantial number of components for its truck products. Transportation's purchasing strategies have been designed to improve access to the lowest cost, highest quality sources of raw materials, parts and components, and to reduce inventory carrying requirements. A portion of Transportation's requirements for raw materials and supplies is filled by single source suppliers.\nThe impact of an interruption in supply will vary by commodity. Some parts are generic to the industry while others are of a proprietary design requiring unique tooling which would require time to recreate. However, the Company's exposure to a disruption in production as a result of an interruption of raw materials and supplies is no greater than the industry as a whole. In order to remedy any losses resulting from an interruption in supply, the Company maintains contingent business interruption insurance. Transportation does not currently foresee critical shortages of raw materials and supplies.\nIMPACT OF GOVERNMENT REGULATION\nTruck and engine manufacturers have faced continually increasing governmental regulation of their products especially in the environmental and safety areas. In particular, diesel engine manufacturers will be required to achieve lower emission levels in terms of unburned hydrocarbons, particulates and oxides of nitrogen. These regulations have and will impose significant research, design and tooling costs on diesel engine manufacturers. They may also result in the use of after-treatment equipment, such as particulate traps and catalytic converters, which will add to the cost of the vehicle emission control system.\nThe Company's engines are subject to extensive regulatory requirements. Specific emissions standards for diesel engines are imposed by the U.S. Environmental Protection Agency (the U.S. EPA) and by other regulatory agencies such as the California Air Resources Board (CARB). The Company believes that its diesel engine products comply with all applicable emissions requirements currently in effect. The Company's ability to comply with emissions requirements which may be imposed in the future is an important element in maintaining and improving the Company's position in the diesel engine marketplace. Capital and operating expenditures will continue to be required to comply with these emissions requirements.\nThe 1990 Clean Air Act amendments established the U.S. emissions standards for on-highway diesel engines produced through 2001. Insofar as light and medium heavy duty diesel engines are concerned, the CARB standards are similar to those adopted by the U.S. EPA. The Company's products meet the U.S. EPA and CARB standards for on-highway diesel engines produced through 1993. The Company expects that its engines will satisfy all U.S. EPA and CARB on-highway emissions control requirements applicable through 1997.\nIn North America, both Canada and Mexico are expected to adopt U.S. emissions standards. Various diesel engine manufacturers, including the Company, have voluntarily signed a memorandum of understanding with the Canadian government, pursuant to which these manufacturers have agreed to sell only U.S. certified engines in Canada beginning in 1995. In June 1993, Mexico proposed a regulatory program that incorporates U.S. standards and test procedures. This program is expected to be in place in 1994.\nTruck manufacturers are subject to various noise standards imposed by federal, state and local regulations. The engine is one of a truck's primary noise sources, and the Company therefore works closely with original equipment manufacturers to develop strategies to reduce engine noise. The Company is also subject to the National Traffic and Motor Vehicle Safety Act (Safety Act) and Federal Motor Vehicle Safety Standards (Safety Standards) promulgated by the National Highway Traffic Safety Administration. The Company believes it is in compliance with the Safety Act and the Safety Standards.\nExpenditures to comply with various environmental regulations relating to the control of air, water and land pollution at production facilities and to control noise levels and emissions from Transportation's products have not been material. Investigations into the nature and extent of cleanup activities under the Superfund law are being conducted at two sites formerly owned by the Company. The eventual scope, timing and cost of such activities as well as the availability of defenses to any such claims, and possible claims against third parties and insurance companies are not known and cannot be reasonably estimated; however, substantial claims could be asserted against the Company. See \"Management's Discussion and Analysis in the 1993 Annual Report to Shareowners-Environmental Matters.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nTransportation has 7 manufacturing and assembly plants in the United States and 1 in Canada. All plants are owned by Transportation. The aggregate floor space of these 8 plants is approximately 8 million square feet.\nTransportation also owns or leases other significant properties in the United States and Canada, including a paint facility, a small component fabrication plant, vehicle and parts distribution centers, sales offices, engineering centers and its headquarters in Chicago.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nENVIRONMENTAL MATTERS\nBeginning in March 1984, Transportation received several enforcement notices from the U.S. EPA, all of which relate to Transportation's painting activities at its Springfield, Ohio assembly and body plants. The notices alleged that these painting activities violated the Federal Clean Air Act because the paint contained volatile organic compounds (VOC) in greater quantities than permitted under applicable Ohio regulations (the VOC Regulations).\nIn an administrative action instituted under Section 120 of the Clean Air Act, begun in September 1984, U.S. EPA seeks to recover a noncompliance penalty, measured as the costs allegedly saved by Transportation by not complying with the VOC Regulations at the assembly plant. Transportation has calculated that it did not save any costs. The case went to a hearing before an administrative law judge who ruled in early 1987 that Transportation was liable for a noncompliance penalty in an amount to be determined in a subsequent hearing. All Transportation appeals of this ruling were denied. No hearing to determine the amount of the noncompliance penalty has yet been scheduled.\nIn a court action instituted under Section 113(b) of the Clean Air Act, the United States filed civil complaints pertaining to the assembly plant (filed on April 30, 1985) and the body plant (filed on November 3, 1986) in the U.S. District Court in the Southern District of Ohio. These complaints ask the judge to impose fines of up to $25,000 per violation of the VOC Regulations per day since December 31, 1982, and also ask the judge to issue an injunction prohibiting Transportation from continuing the alleged violations. In March 1993, the judge granted the United States' motion for partial summary judgment, ruling that Transportation violated the VOC Regulations at the assembly plant during the period from December 31, 1982 to April 30, 1985. The judge has not yet made any determination as to fines for the violation.\nTransportation built a new paint facility adjacent to the assembly plant which replaced some of the painting activities formerly performed at the assembly plant and the body plant. New technology at the paint facility reduces or destroys VOCs emitted in the painting operations. These reductions enabled Transportation to apply for a bubble variance, an administrative exemption which permits Transportation to comply with the VOC Regulations by averaging VOC emissions from the assembly and body plants with VOC emissions from the paint facility. Ohio EPA issued the bubble variance to Transportation in February 1989. U.S. EPA approved the bubble variance in December 1990, effective January 1991.\nIn November 1993, Transportation received a settlement offer from U.S. EPA to settle all allegations contained in both the administrative action and the court action in exchange for a payment of $2.7 million. Transportation is pursuing settlement discussions to resolve these cases.\nOTHER MATTERS\nIn July 1992, the Company announced its decision to change its retiree health care benefit plans and concurrently filed a declaratory judgment class action lawsuit in the U.S. District Court for the Northern District of Illinois (Illinois Court) to confirm its right to change these benefits. A countersuit was filed against the Company by its unions in the U.S. District Court for the Southern District of Ohio (Ohio Court). On October 16, 1992, the Company withdrew its declaratory judgment action in the Illinois Court and began negotiations with the UAW to resolve issues affecting both retirees and employees. On December 17, 1992, the Company announced that a tentative agreement had been reached with the UAW on restructuring retiree health care and life insurance benefits (the Settlement Agreement). During the third quarter of 1993, all court, regulatory agency and shareowner approvals required to implement the Settlement Agreement concerning retiree health care benefit plans were obtained. The Settlement Agreement became effective and the restructured retiree health care and life insurance plan was implemented on July 1, 1993.\nIn May 1993, a jury issued a verdict in favor of Vernon Klein Truck & Equipment, Inc. and against Transportation in the amount of $10.8 million in compensatory damages and $15 million in punitive damages. In order to appeal the verdict in the case, the Company was required to post a bond collateralized with $30 million in cash. This amount has been recorded as restricted cash on the Statement of Financial Condition. The amount of any potential liability is uncertain and Transportation believes that there are meritorious arguments for overturning or diminishing the verdict.\nThe Company and its subsidiaries are subject to various other claims arising in the ordinary course of business, and are parties to various legal proceedings which constitute ordinary routine litigation incidental to the business of the Company and its subsidiaries. In the opinion of the Company's management, none of these proceedings or claims are material to the business or the financial condition of the Company.\nEXECUTIVE OFFICERS\nThe following selected information for each of the Company's current executive officers was prepared as of November 5, 1993.\nOFFICERS AND POSITIONS WITH NAME AGE NAVISTAR AND OTHER INFORMATION ---- --- ------------------------------\nJames C. Cotting ... 60 Chairman and Chief Executive Officer since 1987 and a Director since 1983. Mr. Cotting also is Chairman and Chief Executive Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Cotting served as Vice Chairman and Chief Financial Officer, 1983-1987.\nJohn R. Horne ...... 55 President and Chief Operating Officer and a Director since 1990. Mr. Horne also is President and Chief Operating Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Horne served as Group Vice President and General Manager, Engine and Foundry, 1990 and Vice President and General Manager, Engine and Foundry, 1983-1990.\nRobert C. Lannert .. 53 Executive Vice President and Chief Financial Officer and a Director since 1990. Mr. Lannert also is Executive Vice President and Chief Financial Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Lannert served as Vice President and Treasurer, 1987-1990 and Vice President and Treasurer of Transportation, 1979-1990.\nRobert A. Boardman . 46 Senior Vice President and General Counsel since 1990. Mr. Boardman also is Senior Vice President and General Counsel of Transportation since 1990. Prior to this, Mr. Boardman served as Vice President of Manville Corporation, 1988-1990 and Corporate Secretary, 1983-1990.\nThomas M. Hough ... 48 Vice President and Treasurer since 1992. Mr. Hough also is Vice President and Treasurer of Transportation since 1992. Prior to this, Mr. Hough served as Assistant Treasurer 1987-1992, and Assistant Treasurer of Transportation, 1987-1992. Mr. Hough also served as Assistant Controller, Accounting and Financial Systems, 1987 and Controller of Navistar Financial Corporation, 1982-1987.\nRobert I. Morrison . 55 Vice President and Controller since 1987. Mr. Morrison also is a Vice President and Controller of Transportation since 1985. Prior to this, Mr. Morrison served as Assistant Treasurer and Vice President, Finance and Planning, International Group, 1983-1985.\nSteven K. Covey ... 42 Corporate Secretary since 1990. Mr. Covey is Associate General Counsel of Transportation since November 1992. Prior to this, Mr. Covey served as General Attorney, Finance and Securities of Transportation, 1989-1992, Senior Counsel, Finance and Securities, 1986-1989 and Senior Attorney, Corporate Operations 1984-1986.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable\nPART II\nThe information required by Items 5-8 is incorporated herein by reference from the 1993 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows:\nAnnual Report Page -------- ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS .............. 62\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ...................... 60\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION .......................... 3\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .. 17\nWith the exception of the aforementioned information (Part II; Items 5- 8) and the information specified under Items 1 and 14 of this report, the 1993 Annual Report to Shareowners is not to be deemed filed as part of this report.\n----------------------------------------------------------\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEMS 10, 11, 12 AND 13\nInformation required by Part III (Items 10, 11, 12 and 13) of this Form is incorporated herein by reference from Navistar's definitive Proxy Statement for the March 16, 1994 Annual Meeting of Shareowners.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nInformation required by Part IV (Item 14) of this form is incorporated herein by reference from Navistar International Corporation's 1993 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows:\nAnnual Report Page ------ Financial Statements - --------------------\nStatement of Income (Loss) for the years ended October 31, 1993, 1992 and 1991 ...................... 17 Statement of Financial Condition as of October 31, 1993 and 1992 ............................ 19 Statement of Cash Flow for the years ended October 31, 1993, 1992 and 1991 ...................... 21 Statement of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for the years ended October 31, 1993, 1992 and 1991 ................ 23 Notes to Financial Statements .......................... 25\nForm 10-K Schedules Page - --------- ----\nVII - Guarantees of Securities of Other Issuers ..... VIII - Valuation and Qualifying Accounts and Reserves. IX - Short-Term Borrowings ......................... X - Supplementary Income Statement Information ....\nAll schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto in the 1993 Annual Report to Shareowners.\nFinance and Insurance Subsidiaries:\nThe financial statements of Navistar Financial Corporation for the years ended October 31, 1993, 1992 and 1991 appearing on pages 5 through 7 in Annual Report on Form 10-K for Navistar Financial Corporation for the fiscal year ended October 31, 1993, Commission No. 1-4146-1, are incorporated herein by reference and filed as Exhibit 28 to this Form 10-K.\nFinancial information regarding all Navistar subsidiaries engaged in finance and insurance operations, including Navistar Financial Corporation, appears as supplemental information to the Financial Statements in the Navistar 1993 Annual Report to Shareowners and is incorporated herein by reference.\nExhibits, Including those Incorporated by Reference Form 10-K Page - --------------------------------------------------- --------------\n(3) Articles of Incorporation and By-Laws ......... E-1 (4) Instruments Defining the Rights of Security Holders, including Indentures ... E-2 (10) Material Contracts ............................ E-4 (11) Computation of Net Income (Loss) Per Common Share ............................ E-5 (13) Navistar International Corporation 1993 Annual Report to Shareowners ........... N\/A (22) Subsidiaries of the Registrant ................ E-6 (24) Independent Auditors' Consent ................. 20 (25) Power of Attorney ............................. 18 (28) Navistar Financial Corporation Annual Report on Form 10-K for the fiscal year ended October 31, 1993 ............................ N\/A\nAll exhibits other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information called for is shown in the financial statements and notes thereto in the 1993 Annual Report to Shareowners.\nReports on Form 8-K - -------------------\nA report on Form 8-K dated December 9, 1992, was filed by the Company to describe developments in negotiations with the United Automobile, Aerospace and Agricultural Implement Workers of America.\nA report on Form 8-K dated December 9, 1992, was filed by the Company to disclose a change in credit rating.\nA report on Form 8-K dated December 14, 1992, was filed by the Company to disclose a change in credit rating.\nA report on Form 8-K dated December 18, 1992, was filed by the Company to announce a tentative agreement on restructuring retiree health care and life insurance benefits.\nA report on Form 8-K, dated May 14, 1993, was filed by the Company indicating Navistar Financial Corporation granted security interests in substantially all of its assets pursuant to an Amended and Restated Credit Agreement and amended and restated an existing revolving credit facility and a retail notes receivable purchase facility.\nA report on Form 8-K, dated May 28, 1993, was filed by the Company announcing court approval of a retiree health care and life insurance benefit settlement.\nA report on Form 8-K, dated July 1, 1993, was filed by the Company describing shareowner approval of the postretirement health care and life insurance benefit settlement as well as a one-for-ten reverse split of the Common stock and Class B Common stock.\nA report on Form 8-K, dated July 9, 1993, was filed by the Company announcing the merger of Navistar International Corporation with and into its wholly-owned subsidiary, Navistar Holding, Inc. SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURE\nPursuant to the requirements of Section 13 and 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.\nNAVISTAR INTERNATIONAL CORPORATION - ---------------------------------- (Registrant)\n\/s\/ Robert I. Morrison - ------------------------------------- Robert I. Morrison January 27, 1994 Vice President and Controller (Principal Accounting Officer)\nPAGE 20 EXHIBIT 25 SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n---------------------------------\nPOWER OF ATTORNEY\nEach person whose signature appears below does hereby make, constitute and appoint James C. Cotting and Robert I. Morrison and each of them acting individually, true and lawful attorneys-in-fact and agents with power to act without the other and with full power of substitution, to execute, deliver and file, for and on such person's behalf, and in such person's name and capacity or capacities as stated below, any amendment, exhibit or supplement to the Form 10-K Report making such changes in the report as such attorney-in-fact deems appropriate.\nSIGNATURES\nPursuant 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 and on the dates indicated:\nSignature Title Date - ------------------------ -------------------------- ----------------\n\/s\/ James C. Cotting - ------------------------ James C. Cotting Chairman of the Board, January 27, 1994 and Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Robert I. Morrison - ------------------------- Robert I. Morrison Vice President and Controller January 27, 1994 (Principal Accounting Officer)\n\/s\/ Jack R. Anderson - ------------------------- Jack R. Anderson Director January 27, 1994\n\/s\/ William F. Andrews - ------------------------- William F. Andrews Director January 27, 1994\n\/s\/ Wallace W. Booth - ------------------------- Wallace W. Booth Director January 27, 1994\n\/s\/ Andrew F. Brimmer - ------------------------- Andrew F. Brimmer Director January 27, 1994\n\/s\/ Bill Casstevens - ------------------------- Bill Casstevens Director January 27, 1994\nPAGE 21 EXHIBIT 25 (CONTINUED) SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n---------------------------------\nSIGNATURES (Continued)\n\/s\/ Richard F. Celeste - ------------------------- Richard F. Celeste Director January 27, 1994\n\/s\/ William Craig - ------------------------- William Craig Director January 27, 1994\n\/s\/ Jerry E. Dempsey - ------------------------- Jerry E. Dempsey Director January 27, 1994\n\/s\/ Mary Garst - ------------------------- Mary Garst Director January 27, 1994\n\/s\/ Arthur G. Hansen - ------------------------- Arthur G. Hansen Director January 27, 1994\n\/s\/ John R. Horne - ------------------------- John R. Horne Director January 27, 1994\n\/s\/ Robert C. Lannert - ------------------------- Robert C. Lannert Director January 27, 1994\n\/s\/ Donald D. Lennox - ------------------------- Donald D. Lennox Director January 27, 1994\n\/s\/ Elmo R. Zumwalt, Jr. - ------------------------- Elmo R. Zumwalt, Jr. Director January 27, 1994\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES ----------------------------------\nINDEPENDENT AUDITORS' REPORT\nNavistar International Corporation:\nWe have audited the Statement of Financial Condition of Navistar International Corporation and Consolidated Subsidiaries as of October 31, 1993 and 1992, and the related Statement of Income (Loss), of Cash Flow, and of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for each of the three years in the period ended October 31, 1993, and have issued our report thereon dated December 15, 1993 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and No. 109); such consolidated financial statements and report are included in your 1993 Annual Report to Shareowners and are incorporated herein by reference. Our audits also included the financial statement schedules of Navistar International Corporation and Consolidated Subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDeloitte & Touche December 15, 1993 Chicago, Illinois\n----------------------------------\nEXHIBIT 24 INDEPENDENT AUDITORS' CONSENT\nNavistar International Corporation:\nWe consent to the incorporation by reference in this Post-Effective Amendment No. 1 to Registration No. 2-70979 on Form S-8 and in Post- Effective Amendment No. 6 to Registration No. 2-55544 on Form S-8 and in Post-Effective Amendment No. 1 to Registration No. 2-9604 on Form S-8 of our report dated December 15, 1993 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and 109); appearing in the Annual Report on Form 10-K of Navistar International Corporation for the year ended October 31, 1993.\nDeloitte & Touche January 27, 1994 Chicago, Illinois","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nInformation required by Part IV (Item 14) of this form is incorporated herein by reference from Navistar International Corporation's 1993 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows:\nAnnual Report Page ------ Financial Statements - --------------------\nStatement of Income (Loss) for the years ended October 31, 1993, 1992 and 1991 ...................... 17 Statement of Financial Condition as of October 31, 1993 and 1992 ............................ 19 Statement of Cash Flow for the years ended October 31, 1993, 1992 and 1991 ...................... 21 Statement of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for the years ended October 31, 1993, 1992 and 1991 ................ 23 Notes to Financial Statements .......................... 25\nForm 10-K Schedules Page - --------- ----\nVII - Guarantees of Securities of Other Issuers ..... VIII - Valuation and Qualifying Accounts and Reserves. IX - Short-Term Borrowings ......................... X - Supplementary Income Statement Information ....\nAll schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto in the 1993 Annual Report to Shareowners.\nFinance and Insurance Subsidiaries:\nThe financial statements of Navistar Financial Corporation for the years ended October 31, 1993, 1992 and 1991 appearing on pages 5 through 7 in Annual Report on Form 10-K for Navistar Financial Corporation for the fiscal year ended October 31, 1993, Commission No. 1-4146-1, are incorporated herein by reference and filed as Exhibit 28 to this Form 10-K.\nFinancial information regarding all Navistar subsidiaries engaged in finance and insurance operations, including Navistar Financial Corporation, appears as supplemental information to the Financial Statements in the Navistar 1993 Annual Report to Shareowners and is incorporated herein by reference.\nExhibits, Including those Incorporated by Reference Form 10-K Page - --------------------------------------------------- --------------\n(3) Articles of Incorporation and By-Laws ......... E-1 (4) Instruments Defining the Rights of Security Holders, including Indentures ... E-2 (10) Material Contracts ............................ E-4 (11) Computation of Net Income (Loss) Per Common Share ............................ E-5 (13) Navistar International Corporation 1993 Annual Report to Shareowners ........... N\/A (22) Subsidiaries of the Registrant ................ E-6 (24) Independent Auditors' Consent ................. 20 (25) Power of Attorney ............................. 18 (28) Navistar Financial Corporation Annual Report on Form 10-K for the fiscal year ended October 31, 1993 ............................ N\/A\nAll exhibits other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information called for is shown in the financial statements and notes thereto in the 1993 Annual Report to Shareowners.\nReports on Form 8-K - -------------------\nA report on Form 8-K dated December 9, 1992, was filed by the Company to describe developments in negotiations with the United Automobile, Aerospace and Agricultural Implement Workers of America.\nA report on Form 8-K dated December 9, 1992, was filed by the Company to disclose a change in credit rating.\nA report on Form 8-K dated December 14, 1992, was filed by the Company to disclose a change in credit rating.\nA report on Form 8-K dated December 18, 1992, was filed by the Company to announce a tentative agreement on restructuring retiree health care and life insurance benefits.\nA report on Form 8-K, dated May 14, 1993, was filed by the Company indicating Navistar Financial Corporation granted security interests in substantially all of its assets pursuant to an Amended and Restated Credit Agreement and amended and restated an existing revolving credit facility and a retail notes receivable purchase facility.\nA report on Form 8-K, dated May 28, 1993, was filed by the Company announcing court approval of a retiree health care and life insurance benefit settlement.\nA report on Form 8-K, dated July 1, 1993, was filed by the Company describing shareowner approval of the postretirement health care and life insurance benefit settlement as well as a one-for-ten reverse split of the Common stock and Class B Common stock.\nA report on Form 8-K, dated July 9, 1993, was filed by the Company announcing the merger of Navistar International Corporation with and into its wholly-owned subsidiary, Navistar Holding, Inc. SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURE\nPursuant to the requirements of Section 13 and 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.\nNAVISTAR INTERNATIONAL CORPORATION - ---------------------------------- (Registrant)\n\/s\/ Robert I. Morrison - ------------------------------------- Robert I. Morrison January 27, 1994 Vice President and Controller (Principal Accounting Officer)\nPAGE 20 EXHIBIT 25 SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n---------------------------------\nPOWER OF ATTORNEY\nEach person whose signature appears below does hereby make, constitute and appoint James C. Cotting and Robert I. Morrison and each of them acting individually, true and lawful attorneys-in-fact and agents with power to act without the other and with full power of substitution, to execute, deliver and file, for and on such person's behalf, and in such person's name and capacity or capacities as stated below, any amendment, exhibit or supplement to the Form 10-K Report making such changes in the report as such attorney-in-fact deems appropriate.\nSIGNATURES\nPursuant 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 and on the dates indicated:\nSignature Title Date - ------------------------ -------------------------- ----------------\n\/s\/ James C. Cotting - ------------------------ James C. Cotting Chairman of the Board, January 27, 1994 and Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Robert I. Morrison - ------------------------- Robert I. Morrison Vice President and Controller January 27, 1994 (Principal Accounting Officer)\n\/s\/ Jack R. Anderson - ------------------------- Jack R. Anderson Director January 27, 1994\n\/s\/ William F. Andrews - ------------------------- William F. Andrews Director January 27, 1994\n\/s\/ Wallace W. Booth - ------------------------- Wallace W. Booth Director January 27, 1994\n\/s\/ Andrew F. Brimmer - ------------------------- Andrew F. Brimmer Director January 27, 1994\n\/s\/ Bill Casstevens - ------------------------- Bill Casstevens Director January 27, 1994\nPAGE 21 EXHIBIT 25 (CONTINUED) SIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n---------------------------------\nSIGNATURES (Continued)\n\/s\/ Richard F. Celeste - ------------------------- Richard F. Celeste Director January 27, 1994\n\/s\/ William Craig - ------------------------- William Craig Director January 27, 1994\n\/s\/ Jerry E. Dempsey - ------------------------- Jerry E. Dempsey Director January 27, 1994\n\/s\/ Mary Garst - ------------------------- Mary Garst Director January 27, 1994\n\/s\/ Arthur G. Hansen - ------------------------- Arthur G. Hansen Director January 27, 1994\n\/s\/ John R. Horne - ------------------------- John R. Horne Director January 27, 1994\n\/s\/ Robert C. Lannert - ------------------------- Robert C. Lannert Director January 27, 1994\n\/s\/ Donald D. Lennox - ------------------------- Donald D. Lennox Director January 27, 1994\n\/s\/ Elmo R. Zumwalt, Jr. - ------------------------- Elmo R. Zumwalt, Jr. Director January 27, 1994\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES ----------------------------------\nINDEPENDENT AUDITORS' REPORT\nNavistar International Corporation:\nWe have audited the Statement of Financial Condition of Navistar International Corporation and Consolidated Subsidiaries as of October 31, 1993 and 1992, and the related Statement of Income (Loss), of Cash Flow, and of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for each of the three years in the period ended October 31, 1993, and have issued our report thereon dated December 15, 1993 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and No. 109); such consolidated financial statements and report are included in your 1993 Annual Report to Shareowners and are incorporated herein by reference. Our audits also included the financial statement schedules of Navistar International Corporation and Consolidated Subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDeloitte & Touche December 15, 1993 Chicago, Illinois\n----------------------------------\nEXHIBIT 24 INDEPENDENT AUDITORS' CONSENT\nNavistar International Corporation:\nWe consent to the incorporation by reference in this Post-Effective Amendment No. 1 to Registration No. 2-70979 on Form S-8 and in Post- Effective Amendment No. 6 to Registration No. 2-55544 on Form S-8 and in Post-Effective Amendment No. 1 to Registration No. 2-9604 on Form S-8 of our report dated December 15, 1993 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and 109); appearing in the Annual Report on Form 10-K of Navistar International Corporation for the year ended October 31, 1993.\nDeloitte & Touche January 27, 1994 Chicago, Illinois","section_15":""}
{"filename":"37032_1993.txt","cik":"37032","year":"1993","section_1":"ITEM 1. BUSINESS --------\nFirst Virginia Banks, Inc. (the \"Corporation\") is a registered bank holding company which was incorporated under the laws of the Commonwealth of Virginia in October, 1949. Since its formation in 1949, the Corporation has acquired control of 55 operating commercial banks, with three acquisitions in the State of Maryland and three in the State of Tennessee, and has organized seven new banks located in the State of Virginia. Forty-one of the banks have been merged or consolidated with other banks controlled by the Corporation and located in the same geographic area, so that, as of December 31, 1993, the Corporation owned all of the outstanding stock of 21 commercial banks (the \"Member Banks\") with combined assets of $6.916 billion. On that date, the Member Banks operated 268 offices throughout the State of Virginia, 37 offices in Maryland and 20 offices in Tennessee. In addition to the 21 banks, the Corporation owns, directly or through subsidiaries, several bank related member companies with offices in Virginia and six other states, making the Corporation the fourth largest Bank Holding Company with headquarters in the state and the sixth largest banking organization in Virginia, based on total assets of $7.037 billion as of December 31, 1993.\nCompetitive Factors - -------------------\nOther banking organizations have been active in opening new banking offices through acquisition and control of existing banks, mergers, branching and formation of new banks and in acquiring or forming bank-related subsidiaries in areas where the Corporation's Member Banks compete. Accordingly, each Member Bank faces strong competition. Savings and loan associations and credit unions actively compete for deposits. Such institutions, as well as consumer finance companies, mortgage companies, loan production offices of out-of-state banks, factors, insurance companies and pension trusts are important competitors for various types of loans. The bank-related member companies also operate in highly competitive fields.\nAt midyear 1993, the banking offices and deposits controlled by the Corporation's Member Banks represented approximately 12.7% and 9.4% of the banking offices and domestic bank deposits, respectively, in Virginia.\nRegulation - ----------\nThe Corporation and its subsidiaries are subject to the supervision and examination of the Federal Reserve Board, the Federal Deposit Insurance Corporation and the state regulators of Virginia, Maryland and Tennessee which have jurisdiction over financial institutions and have obtained regulatory approval for their various activities to the extent required.\nEmployees - ---------\nAs of December 31, 1993, the Corporation and its subsidiaries employed 5,255 individuals.\nLines of Business - -----------------\nAll of the Corporation's income is derived from banking or bank-related activities. While each of the member companies is engaged in bank-related activities, several of them conduct lines of business not expressly permitted for banks under applicable regulations. During the last three years, the results of their operations have not been material in relation to the consolidated operating results of the Corporation.\nStatistical Disclosure by Bank Holding Companies - ------------------------------------------------\nThe following statistical information appears in this Form 10-K on the page indicated: Page ---- Average balance sheets and interest rates on earning assets and interest-bearing liabilities 12\/17\nAverage book value of investment securities 12\/17\nAverage demand, savings and time deposits 12\/17\nEffect of rate-volume changes on net interest income 18\/19\nType of loans 26\nPage ---- Maturity ranges of time certificates of deposit of $100,000 or more 28\nRisk elements - loan portfolio 31\nSummary of loan loss experience 33\nMaturity ranges and average yields - investment securities 35\nLoan maturities and sensitivity to changes in interest rates 36\nReturn on equity and assets, dividend payout ratio and equity to assets ratio 9\/10\nExecutive Officers of the Registrant - ------------------------------------\nThere are no arrangements or understandings between the named executive officers and any other person pursuant to which they were selected as an officer.\nThere are no family relationships among the executive officers.\nMessrs. Campbell, Cash, Geithner, Hicks, Lanzillotta, O'Donnell and Zalokar and Ms. Tomlin have held their present positions with the Corporation for more than five years.\nROBERT H. ZALOKAR Chairman of the Board and Chief Executive Officer since 1985 and President from 1978 through 1984; 38 years of service; BS, University of Kansas. Has held numerous executive officer positions with the First Virginia organization including President of First Virginia Bank, Falls Church, from 1973 to 1978, CEO from 1979 to 1985, and Chairman since 1979. Mr. Zalokar is 66.\nPAUL H. GEITHNER, JR. President and Chief Administrative Officer since 1985; 25 years of service; BA, Amherst College; MBA, Wharton Graduate Division, University of Pennsylvania. Elected Vice President 1969, responsible for member banks from 1973 to 1975; Senior Vice President 1974; Assistant to the Chairman and President 1978. Mr. Geithner is 63.\nSHIRLEY C. BEAVERS, JR. Executive Vice President since April 1992; President and Chief Executive Officer of First Virginia Services, Inc. since May 1986; 24 years of service; BS and MBA, American University. Has held various officer positions with First Virginia organizations including that of Executive Vice President and Chief Operating Officer, First Virginia Bank, Falls Church. Mr. Beavers is 48.\nBARRY J. FITZPATRICK Executive Vice President since April 1992; 24 years of service; BBA, University of Notre Dame; MBA, American University, and graduate of the Stonier Graduate School of Banking. Has held several officer positions with First Virginia organizations including Senior Vice President and Regional Executive Officer, Eastern Region, from March 1982 to April 1992 and President and CEO of member banks in the Roanoke Valley from 1972 to 1982. Mr. Fitzpatrick is 54.\nRAYMOND E. BRANN, JR. Senior Vice President and Regional Executive Officer, Eastern Region, since April 1992; 29 years of service, BS, University of Virginia; MBA, Old Dominion University. Has held various officer positions with First Virginia organizations including that of Senior Vice President and Regional Executive Officer, Tennessee-Western Virginia Region from December 1986 to April 1992, and President and CEO of several member banks, including First Virginia Bank- Colonial and Tri-City Bank and Trust Company. Mr. Brann is 53.\nHUGH L.CAMPBELL Senior Vice President since 1978; 30 years of service; AB, Washington & Lee University; MBA, Colgate Darden Graduate School of Business Administration, University of Virginia; Advanced Management Program, Harvard University, 1979. Responsible for commercial lending, loan administration and financial planning. Mr. Campbell is 56.\nCHARLES R. CASH Senior Vice President and Regional Executive Officer, Shenandoah Valley Region, since 1982; Chairman, President and CEO of First Virginia Bank- Shenandoah Valley since 1970; 30 years of service; graduate certificate, American Institute of Banking. Has held several executive officer positions with banks in the Shenandoah Valley area which have, through merger, become First Virginia Bank-Shenandoah Valley. Mr. Cash is 64.\nDOUGLAS M. CHURCH, JR. Senior Vice President since October 1990; 20 years of service; BS, University of Virginia, and graduate of The Stonier Graduate School of Banking. Has held various officer positions with First Virginia organizations including Executive Vice President of First Virginia Services, Inc. and Executive Vice President, Retail Services, of First Virginia Bank from May 1988 until October 1990. Mr. Church is 43.\nHENRY HOWARD HICKS, JR. Senior Vice President and Regional Executive Officer, Southwest Region, since 1982; 40 years of service; graduate certificate, American Institute of Banking. Has held various executive officer positions with First Virginia organizations including President and CEO of First Virginia Bank-Southwest from 1971 to 1982. Mr. Hicks is 58.\nA. PAUL LANZILLOTTA Senior Vice President, Trust Services, since 1979; Executive Vice President, First Virginia Bank, Falls Church, since 1978; 31 years of service; BS, Boston College; JD and LLM, Georgetown University. Joined First Virginia Bank as Trust Officer; appointed Vice President and Trust Officer of the Corporation in 1967 and Senior Vice President and Trust Officer in 1976. Mr. Lanzillotta is 62.\nJUSTIN C. O'DONNELL Senior Vice President and Regional Executive Officer, Northern Region, since 1988; President and CEO, First Virginia Bank, Falls Church, since 1985; 11 years of service; BS, Duquesne University, and graduate of The Stonier Graduate School of Banking. Joined First Virginia Bank as Senior Vice President and Manager of the Commercial Division in 1982. Mr. O'Donnell is 58.\nCHARLES L. ROBBINS, III Senior Vice President and Regional Executive Officer, Tennessee-Western Virginia Region, since April 1992; President and CEO, Tri-City Bank and Trust Company, Tennessee, since 1992; 20 years of service; BS, George Mason University, and graduate of The Stonier Graduate School of Banking. Has held various officer positions with First Virginia Bank, Falls Church, including Senior Vice President and Branch Administrator from August 1987 until April 1992. Mr. Robbins is 41.\nRICHARD F. BOWMAN Vice President and Treasurer since February 1992; 18 years of service; AB, College of William & Mary; Certified Public Accountant and Chartered Bank Auditor. Employed as Staff Auditor; appointed Assistant General Auditor in 1978 and served as Vice President and Controller from November 1979 thru January 1992. Mr. Bowman is 42.\nTHOMAS P. JENNINGS Vice President, General Counsel and Secretary since January 1993; 15 years of service; BA, Wake Forest University; JD, University of Virginia. Employed as Assistant Counsel; appointed Associate Counsel in 1979, General Counsel in 1980, and Vice President and General Counsel in March 1986. Mr. Jennings is 46.\nMELODYE MAYES TOMLIN Vice President and General Auditor since 1986; 15 years of service; BS, Radford University, and graduate of The Stonier Graduate School of Banking; Certified Public Accountant. Employed as Staff Auditor; appointed Regional Audit Manager in 1980 and Assistant General Auditor in 1983. Mrs. Tomlin is 37.\nAges are as of February 25, 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe banking subsidiaries operated a total of 325 banking offices on December 31, 1993. Of these offices, 195 were owned by the banks, two are owned by the Corporation and leased to the banks, one was owned by an affiliated company and leased to a bank, and 127 were leased from others. The Corporation owns other properties, including the two Corporate headquarters buildings which house personnel of the Corporation and its subsidiaries. On December 31, 1993, the book value of all real estate and the unamortized cost of improvements to leased premises totaled $113,312,000. There are no mortgages secured by properties.\nAs of December 31, 1993, a total annual base rental of approximately $11,210,000 was being paid on leased premises, of which approximately $5,465,000 was being paid to affiliated companies. As of December 31, 1993,\ntotal lease commitments having a remaining term in excess of one year to persons other than affiliates were approximately $29,593,000.\nThe majority of the properties are modern and well furnished and provide adequate parking.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nThere are no legal proceedings, other than ordinary routine litigation incidental to the business, to which the Corporation or any of its subsidiaries is a party or of which any of their property is subject. Management believes that the liability, if any, resulting from current litigation will not be material to the financial statements of the Corporation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nThere was no submission of matters to a vote of security holders during the fourth quarter of 1993.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED ----------------------------------------------------- STOCKHOLDER MATTERS -------------------\nThe common stock of the Corporation is listed for trading on the New York Stock Exchange (Trading Symbol: FVB) and the Philadelphia Stock Exchange. The dividends paid per share and the high and low sales price (adjusted for the three-for-two stock split in July 1992) for common shares traded on the New York Stock Exchange were: Sales Price ------------------------------ Dividends 1993 1992 Per Share -------------- -------------- ------------ High Low High Low 1993 1992 ------ ------ ------ ------ ----- ----- 1st Quarter...... $40.00 $36.37 $26.83 $23.33 $.260 $.233 2nd Quarter...... 39.00 32.50 30.75 25.58 .260 .233 3rd Quarter ..... 41.00 34.00 33.63 29.87 .280 .247 4th Quarter...... 40.50 31.75 37.87 30.25 .280 .250\nThe Corporation's preferred stock is not actively traded. The 5% cumulative convertible preferred stock, Series A, pays a dividend of 12 1\/2 cents per share in each quarter. The 7% cumulative convertible preferred stock, Series B and C, pays a dividend of 17 1\/2 cents per share each quarter. The 8% cumulative convertible preferred stock, Series D, pays a dividend of 20 cents per share each quarter. As of December 31, 1993, there were 17,868 holders of record of the Corporation's voting securities, of which 16,965 were holders of common stock. ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n6. SELECTED FINANCIAL DATA -----------------------\nA five-year summary of selected financial data follows:\n1993 1992 1991 1990 1989 ---------- ---------- ---------- ---------- ---------- (Dollar amounts in thousands, except per-share data)\nBalance Sheet Data Cash.................. $ 326,136 $ 381,384 $ 361,027 $ 291,275 $ 314,125 Overnight investments. 235,000 235,000 205,000 160,000 215,000 Investment securities: Taxable ............. 1,940,671 1,911,301 1,554,940 1,015,684 830,479 Tax-exempt........... 235,363 253,926 257,889 271,097 238,603 Loans, net............ 4,036,391 3,793,033 3,470,561 3,390,486 3,294,770 Other assets.......... 263,322 265,903 269,843 255,605 230,987 ---------- ---------- ---------- ---------- ---------- Total Assets......... $7,036,883 $6,840,547 $6,119,260 $5,384,147 $5,123,964 ========== ========== ========== ========== ==========\nDeposits ............. $6,136,389 $6,013,746 $5,349,971 $4,715,882 $4,426,663 Short-term borrowings. 151,859 150,681 144,816 85,667 132,197 Mortgage and other indebtedness ........ 1,008 5,227 11,467 11,836 37,480 Other liabilities .... 56,126 63,494 72,888 73,075 73,025 Stockholders' Equity.. 691,501 607,399 540,118 497,687 454,599 ---------- ---------- ---------- ---------- ---------- Total Liabilities and Stockholders' Equity $7,036,883 $6,840,547 $6,119,260 $5,384,147 $5,123,964 ========== ========== ========== ========== ==========\nOperating Results Interest income ...... $ 504,782 $ 525,270 $ 515,837 $ 501,412 $ 471,560 Interest expense ..... 164,959 204,826 260,286 264,856 243,105 ---------- ---------- ---------- ---------- ---------- Net interest income..... 339,823 320,444 255,551 236,556 228,455 Provision for loan loss. 6,450 17,355 14,024 13,404 11,039 Noninterest income...... 82,540 77,087 72,283 68,376 63,060 Noninterest expenses.... 245,767 238,891 218,243 202,037 188,129 ---------- ---------- ---------- ---------- ---------- Income before income tax 170,146 141,285 95,567 89,491 92,347 Provision for income tax 54,122 43,812 25,959 24,380 24,973 ---------- ---------- ---------- ---------- ---------- Net income ............$ 116,024 $ 97,473 $ 69,608 $ 65,111 $ 67,374 ========== ========== ========== ========== ==========\nDividends declared: Preferred ............$ 54 $ 61 $ 71 $ 76 $ 78 Common................ 36,519 31,830 28,995 27,247 25,242\nPer Share of Common Stock Net income ............ 3.57 3.02 2.17 2.03 2.13 Dividends declared..... 1.13 .99 .91 .85 .80 Stockholders' equity... 21.29 18.85 16.80 15.51 14.37 Market price at year-end 32.75 36.63 23.67 15.17 20.00\n1993 1992 1991 1990 1989 ---------- ---------- ---------- ---------- ---------- Ratios - ------ Earnings: Return on average assets 1.68% 1.50% 1.22% 1.25% 1.39% Return on average equity 17.81 17.03 13.44 13.59 15.55 Net interest margin..... 5.46 5.46 5.03 5.15 5.36 Risk-based capital: Tier 1 or core capital.. 16.84 15.52 14.74 14.05 - Tier 2 or total capital. 18.09 16.77 16.00 15.28 - Capital strength: Ratio of average equity to average assets...... 9.45 8.80 9.08 9.22 8.94 Dividends declared as a percentage of net income (per share, not restated for poolings of interests).......... 31.65 32.78 41.94 41.87 37.56\nData for prior years have been restated for material acquisitions accounted for as poolings of interests.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nNet income for First Virginia Banks, Inc. increased to a record level in 1993. The record earnings continued from the excellent levels achieved in the previous two years, and allowed First Virginia to outperform almost all of the other 100 largest banks in the country. Many banks had difficulty in maintaining deposit levels with interest rates declining to the lowest level in many years, and, as a result, nonbanking organizations competed aggressively for the consumer dollar. First Virginia, however, was able to increase its average deposits by 6%, with particularly strong growth in consumer transaction accounts. Similarly, despite a lackluster economy, First Virginia capitalized on its strong position in the consumer automobile financing market and increased its average loans by 8%. The value of First Virginia's extensive retail-oriented branch network was a key factor in increasing market share during 1993, with minimal increases in expense. Net income in 1993 increased 19% to $116,024,000, as compared to the $97,473,000 earned in the previous year. Net income per share increased $.55 to $3.57, as compared to the $3.02 earned in 1992. This remarkable performance allowed the Corporation to achieve a return on assets of 1.68%, which exceeded First Virginia's peer group figures by 25% and was one of the highest of all banks in the country. While many banking institutions had excellent results in 1993, First Virginia has performed at consistently high levels. Over the past ten years, First Virginia has averaged a return on assets of 1.35% where 1.00% generally has been considered the benchmark of a high performance bank. The Corporation achieved a return on stockholders' equity of 17.81%, as compared to 17.03% in the previous year. This level also exceeded the Corporation's industry peer group average of 16.00% in 1993, which is particularly noteworthy as the Corporation has an equity level that is 17% greater than banks of comparable size. First Virginia has consistently achieved a higher return on stockholders' equity than its peer group. For the past ten years, First Virginia's return on equity has averaged 15.87%, as compared to the 13.73% average for its peer group of banks in the $5-$10 billion asset size range. During 1993, the Corporation increased its dividend rate twice and has increased its dividend 25 times over the past twelve years. By year-end, the annual dividend rate was $1.24 per share, up 19% over the $1.04 rate at the end of 1992. Average assets increased 6% during 1993 and at year-end exceeded $7 billion for the first time. This increase was slower than the 14% average growth in 1992 and the 10% average growth in 1991, as the concern by depositors over the safety and soundness of their financial institution dissipated due to the considerable improvement in the asset quality, capital and income of banks in 1993. In addition, during 1992, the Corporation had acquired $270 million in deposits from the former CorEast Federal Savings Bank, and acquisition activity in 1993 was not as great. The Corporation added seven branches during 1993. Three branches with approximately $44 million in assets were added when the Corporation acquired United Southern Bank of Morristown in Tennessee, and one branch with approximately $22 million in deposits was acquired from Home Federal Savings Bank in Greeneville, Tennessee. Loans grew 8% on average during 1993 to $3.958 billion which was more than the 6% growth in 1992. Indirect automobile loan production activity increased 25% during 1993; however, commercial lending was weak and real estate loans did not increase at as great a rate as in 1992. The decline in interest expense was the primary contributor to the increase in income for both 1993 and 1992. Most of the decline in rates occurred throughout 1992, and interest levels were fairly stable in 1993. However, interest costs declined 19%, because the rates in early 1992 were higher than those in 1993. A decline in the Corporation's provision for loan losses due to improved credit quality was also a major factor in increasing net income and contributed $.22 per share. An increase in the federal corporate income tax rate reduced income by $.05 per share in 1993.\nYear Ended December 31 1993 1992 1991 vs. vs. vs. 1992 1991 1990 ----- ----- ----- Earnings per share - prior period............. $3.02 $2.17 $2.03 ----- ----- ----- Net change during the year: Taxable interest income..................... (.37) .24 .30 Tax-exempt interest income.................. (.04) (.05) - Interest expense ........................... .80 1.13 .09 Provision for loan losses................... .22 (.07) (.01) Gain on sale of mortgage servicing rights... .02 (.04) - Other noninterest income.................... .08 .14 .07 FDIC insurance premium expense.............. (.02) (.05) (.10) Other noninterest expense................... (.12) (.37) (.23) Income taxes................................ (.01) (.07) .02 Increased common shares outstanding......... (.01) (.01) - ----- ----- ----- Net increase during the period............ .55 .85 .14 ----- ----- ----- Earnings per share - current period........... $3.57 $3.02 $2.17 ===== ===== =====\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-earning assets: Investment securities: U.S. Government & its agencies $1,863,228 $117,634 6.31% State and municipal obligations(1) 240,503 19,222 7.99 Other(1) 36,906 2,571 6.97 ---------- -------- Total investment securities 2,140,637 139,427 6.51 ---------- -------- Loans, net of unearned income:(2) Installment 2,669,463 254,157 9.52 Real estate 691,048 63,413 9.18 Other(1) 597,811 47,549 7.95 ---------- -------- Total loans 3,958,322 365,119 9.22 ---------- -------- Federal funds sold and securities purchased under agreements to resell 270,392 8,359 3.09 ---------- -------- Total earning assets and interest income 6,369,351 512,905 8.05 ---------- -------- Noninterest-earning assets: Cash and due from banks 305,900 Premises and equipment, net 137,124 Other assets 129,245 Less allowance for loan losses (50,882) ---------- Total Assets $6,890,738 ==========\n(1) Income from tax-exempt securities and loans is included in interest income on a taxable-equivalent basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 35% in 1993, 34% in 1992 and 1991, increased by 5.0% in recognition of the partial disallowance of interest costs incurred to carry the tax-exempt investments.\n(2) Nonaccruing loans are included in their respective categories.\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-bearing liabilities: Transaction accounts $1,218,697 $ 31,840 2.61% Money-market accounts 746,703 20,090 2.69 Savings deposits 1,276,937 37,432 2.93 Certificates of deposit: Large denomination 167,697 6,353 3.79 Other 1,627,982 65,460 4.02 ---------- -------- Total interest-bearing deposits 5,038,016 161,175 3.20 Short-term borrowings 150,951 3,563 2.36 Notes and mortgages 1,374 221 16.06 ---------- -------- Total interest-bearing liabilities and interest expense 5,190,341 164,959 3.18 ---------- -------- Noninterest-bearing liabilities: Demand deposits 990,007 Other 58,929 Stockholders' equity 651,461 ---------- Total liabilities and stockholders' equity $6,890,738 ========== Net interest income and net interest margin $347,946 5.46% ========\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-earning assets: Investment securities: U.S. Government & its agencies $1,815,126 $125,528 6.92% State and municipal obligations(1) 252,240 21,615 8.57 Other(1) 43,047 3,297 7.66 ---------- -------- Total investment securities 2,110,413 150,440 7.13 ---------- -------- Loans, net of unearned income:(2) Installment 2,431,099 261,774 10.77 Real estate 610,223 61,814 10.13 Other(1) 618,784 50,447 8.15 ---------- -------- Total loans 3,660,106 374,035 10.22 ---------- -------- Federal funds sold and securities purchased under agreements to resell 260,606 9,516 3.65 ---------- -------- Total earning assets and interest income 6,031,125 533,991 8.85 ---------- -------- Noninterest-earning assets: Cash and due from banks 246,218 Premises and equipment, net 140,016 Other assets 133,129 Less allowance for loan losses (47,060) ---------- Total Assets $6,503,428 ==========\n(1) Income from tax-exempt securities and loans is included in interest income on a taxable-equivalent basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 35% in 1993, 34% in 1992 and 1991, increased by 5.0% in recognition of the partial disallowance of interest costs incurred to carry the tax-exempt investments.\n(2) Nonaccruing loans are included in their respective categories.\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-bearing liabilities: Transaction accounts $1,059,112 $ 34,540 3.26% Money-market accounts 788,729 26,067 3.30 Savings deposits 954,503 35,883 3.76 Certificates of deposit: Large denomination 187,662 8,767 4.67 Other 1,856,277 94,207 5.08 ---------- -------- Total interest-bearing deposits 4,846,283 199,464 4.12 Short-term borrowings 145,227 4,149 2.86 Notes and mortgages 10,833 1,213 11.20 ---------- -------- Total interest-bearing liabilities and interest expense 5,002,343 204,826 4.09 ---------- -------- Noninterest-bearing liabilities: Demand deposits 864,000 Other 64,812 Stockholders' equity 572,273 ---------- Total liabilities and stockholders' equity $6,503,428 ========== Net interest income and net interest margin $329,165 5.46% ========\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-earning assets: Investment securities: U.S. Government & its agencies $1,236,261 $ 97,334 7.87% State and municipal obligations(1) 265,679 23,136 8.71 Other(1) 52,846 4,462 8.44 ---------- -------- Total investment securities 1,554,786 124,932 8.04 ---------- -------- Loans, net of unearned income:(2) Installment 2,314,535 269,373 11.64 Real estate 502,038 54,832 10.92 Other(1) 629,980 60,694 9.63 ---------- -------- Total loans 3,446,553 384,899 11.17 ---------- -------- Federal funds sold and securities purchased under agreements to resell 256,574 14,880 5.80 ---------- -------- Total earning assets and interest income 5,257,913 524,711 9.98 ---------- -------- Noninterest-earning assets: Cash and due from banks 232,017 Premises and equipment, net 141,302 Other assets 114,018 Less allowance for loan losses (43,865) ---------- Total Assets $5,701,385 ==========\n(1) Income from tax-exempt securities and loans is included in interest income on a taxable-equivalent basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 35% in 1993, 34% in 1992, increased by 5.0% in recognition of the partial disallowance of interest costs incurred to carry the tax-exempt investments.\n(2) Nonaccruing loans are included in their respective categories.\nAVERAGE BALANCE SHEETS AND INTEREST RATES ON EARNING ASSETS AND INTEREST-BEARING LIABILITIES\n------------------------------ Interest Average Income\/ Balance Expense Rate ---------- --------- ------- (Dollars in thousands) Interest-bearing liabilities: Transaction accounts $ 845,836 $ 40,382 4.77% Money-market accounts 632,143 32,573 5.15 Savings deposits 588,709 28,243 4.80 Certificates of deposit: Large denomination 250,484 16,381 6.54 Other 1,908,463 135,009 7.07 ---------- -------- Total interest-bearing deposits 4,225,635 252,588 5.98 Short-term borrowings 125,422 6,479 5.17 Notes and mortgages 11,466 1,219 10.63 ---------- -------- Total interest-bearing liabilities and interest expense 4,362,523 260,286 5.97 ---------- -------- Noninterest-bearing liabilities: Demand deposits 755,998 Other 65,010 Stockholders' equity 517,854 ---------- Total liabilities and stockholders' equity $5,701,385 ========== Net interest income and net interest margin $264,425 5.03% ========\nEFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME 1993 Compared to 1992 Increase (Decrease) Due to Change in ------------------------------ Total Average Average Increase Volume Rate (Decrease) -------- -------- -------- Interest income (In thousands) - --------------- Investment securities: U.S. Government and its agencies $ 3,327 $(11,221) $ (7,894) State and municipal obligations* (1,006) (1,387) (2,393) Other* (470) (256) (726) -------- -------- -------- Total investment securities 1,851 (12,864) (11,013) -------- -------- -------- Loans: Installment 25,666 (33,283) (7,617) Real estate 8,187 (6,588) 1,599 Other* (1,709) (1,189) (2,898) -------- -------- -------- Total loans 32,144 (41,060) (8,916) -------- -------- -------- Federal funds sold and securities purchased under agreements to resell 357 (1,514) (1,157) -------- -------- -------- Total interest income 34,352 (55,438) (21,086) -------- -------- -------- Interest expense - ---------------- Transaction accounts 5,204 (7,904) (2,700) Money-market accounts (1,389) (4,588) (5,977) Savings deposits 12,122 (10,573) 1,549 Certificates of deposit: Large denomination (933) (1,481) (2,414) Other (11,586) (17,161) (28,747) -------- -------- -------- Total interest-bearing deposits 3,418 (41,707) (38,289) Short-term borrowings 164 (750) (586) Notes and mortgages (1,059) 67 (992) -------- -------- -------- Total interest expense 2,523 (42,390) (39,867) -------- -------- -------- Net interest income $ 31,829 $(13,048) $ 18,781 ======== ======== ========\n*Fully taxable-equivalent basis\nThe increase or decrease due to a change in average volume has been determined by multiplying the change in average volume by the average rate during the preceding period, and the increase or decrease due to a change in average rate has been determined by multiplying the current average volume by the change in average rate.\nEFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME 1992 Compared to 1991 Increase (Decrease) Due to Change in ------------------------------ Total Average Average Increase Volume Rate (Decrease) -------- -------- -------- Interest income (In thousands) - --------------- Investment securities: U.S. Government and its agencies $ 45,576 $(17,382) $ 28,194 State and municipal obligations* (1,170) (351) (1,521) Other* (827) (338) (1,165) -------- -------- -------- Total investment securities 43,579 (18,071) 25,508 -------- -------- -------- Loans: Installment 13,566 (21,165) (7,599) Real estate 11,816 (4,834) 6,982 Other* (1,079) (9,168) (10,247) -------- -------- -------- Total loans 24,303 (35,167) (10,864) -------- -------- -------- Federal funds sold and securities purchased under agreements to resell 234 (5,598) (5,364) -------- -------- -------- Total interest income 68,116 (58,836) 9,280 -------- -------- -------- Interest expense - ---------------- Transaction accounts 10,182 (16,024) (5,842) Money-market accounts 8,069 (14,575) (6,506) Savings deposits 17,549 (9,909) 7,640 Certificates of deposit: Large denomination (4,108) (3,506) (7,614) Other (3,692) (37,110) (40,802) -------- -------- -------- Total interest-bearing deposits 28,000 (81,124) (53,124) Short-term borrowings 1,023 (3,353) (2,330) Notes and mortgages (67) 61 (6) -------- -------- -------- Total interest expense 28,956 (84,416) (55,460) -------- -------- -------- Net interest income $ 39,160 $ 25,580 $ 64,740 ======== ======== ========\n*Fully taxable-equivalent basis\nThe increase or decrease due to a change in average volume has been determined by multiplying the change in average volume by the average rate during the preceding period, and the increase or decrease due to a change in average rate has been determined by multiplying the current average volume by the change in average rate. STATEMENT OF INCOME\nSTATEMENT OF INCOME - -------------------\nNET INTEREST INCOME\nThe table on the previous pages details the changes in earning assets, interest-bearing liabilities and demand deposits for the last three years, along with the related levels of fully taxable-equivalent interest income and expense. The variance in interest income and expense caused by differences in average balances and rates is shown in the table on the previous pages. Interest rates during 1993 declined slightly but were fairly stable for most of the year and bounced around in a narrow band. Lower inflation rates and a sluggish economy in 1993 resulted in little action by the Federal Reserve, following vigorous actions in 1991 and 1992 in lowering the general level of interest rates. Long-term rates fell by a greater degree than short-term rates in 1993; however, because the Corporation maintains a short-term maturity distribution of its loans and investments, this decline did not have a great effect on First Virginia. Net interest income increased 6% in 1993, mirroring the 6% increase in average earning assets while the net interest margin remained unchanged at a relatively high level of 5.46%, as compared to 1992. Although interest rates were fairly stable during 1993, the decline in rates during 1992 resulted in a faster rate of decline in interest income than in interest expense. The Corporation is slightly liability sensitive in the short term and consequently, as rates declined in 1992, the Corporation was able to decrease the cost of funds on deposits at a faster pace than its decline on loans and investments. In 1993, however, maturing loans and investments were being repriced at a faster rate than deposits, and the net interest margin fell steadily throughout the year after peaking in the fourth quarter of 1992. It is anticipated that this trend will continue in the first half of 1994, before stabilizing later in the year. The decline in net interest income in 1993 due to rates was offset by an increase in income due to volume and also by the mix of earning assets. Almost all of the increase in deposits during 1993 was invested in loans which produce a higher yield than investment securities. Loans comprised 62.1% of earning assets in 1993, up from the 60.7% recorded in 1992 but significantly lower than the 70% level achieved in the late 1980s and early 1990s. Deposits grew 6% on average during 1993, with the majority of that growth concentrated in relatively low-cost demand deposits and NOW accounts, both of which grew 15% on average. In addition, consumer savings were up 34% on average, as consumers showed a preference to stay liquid due to the low level of interest rates so that they could take advantage of any increases in rates as the economy improved. The Corporation continued its policy of maintaining a slightly higher rate on these types of core consumer deposits than did its major competitors. The Corporation's primary source of deposits is from its retail base of consumer accounts. Despite paying slightly higher rates for these types of accounts, the Corporation still was able to lower its cost of funds 91 basis points to 3.18% during 1993.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses declined 63%, or $10.9 million during 1993 to $6.5 million after increasing 24% in 1992. The decline in the provision during 1993 was due primarily to a lower level of net charge-offs which dropped to a record low of .13% of loans, as compared to .35% of loans in 1992. The allowance for loan losses, as a percentage of year-end loans, declined three basis points to 1.25% of loans due to the improvement in the Corporation's charge-off experience and the improvement in asset quality. If loan quality and net charge-off experience remain favorable, the Corporation intends to reduce its allowance for loan losses further in 1994 which will lower the provision for loan loss expense. The decline in net charge-offs during 1993 was reflected in all categories of loans, particularly in indirect automobile loans. The Corporation has increased the quality of automobile loans that it has purchased from dealers over the past several years and as a result, the charge-off rate has declined from .50% in 1991 to .29% in 1992 and to a low of .06% in 1993. As the economy improved during 1993 and consumers reduced their debt levels and refinanced their mortgage loans at substantially lower interest rates, they improved their liquidity and debt payment ability which resulted in lower loan charge-offs. This trend was also reflected in record low levels of charge-offs in direct installment loans and by a reduction of 31 basis points in the charge-off rate of credit cards, to 2.80%. The Corporation substantially avoided the problems with commercial real estate and development loans which plagued its competitors in the early 1990s. During 1993, only $22,000 in net real estate loan losses were charged off, and the Corporation had a net recovery in commercial loans for the year. In the previous year, the Corporation had net charge-offs of $3.1 million in commercial loans, primarily for residential real estate development loans. The Corporation makes approximately 81% of its loans to consumers for small amounts with regular, monthly repayment schedules, which therefore makes its risk exposure to loan charge-offs less than that of many other banks.\nOTHER INCOME\nNoninterest income increased 7% in both 1993 and 1992, reflecting the Corporation's efforts to increase the percentage of income received from noninterest income sources. During 1993, the Corporation introduced a mutual fund product and continued its promotion of brokerage services, insurance products and other noninterest products. While noninterest income, as a percentage of total income, is smaller than the percentage at most other banking organizations, it meets the Corporation's objective of growing at a faster pace than noninterest expense, which increased 3% in 1993. Historically, the Corporation has not had the commercial or specialized services enjoyed by comparably sized banks which provide a major source of noninterest income generating customers.\nEfficiency Ratio Chart (The lower, the better) National First Southern Peer Virginia Regionals Group -------- --------- -------- 1993 57.0% 61.4% 60.6% 1992 58.4% 61.8% 60.0% 1991 65.1% 64.7% 63.6% 1990 64.7% 64.0% 63.8% 1989 62.8% 64.3% 64.0%\nSouthern Regionals: Banking companies with assets over $2 billion (30 in 1993)\nNational Peer Group: Banking companies with assets of between $5 and $10 billion (19 in 1993)\nSource: Keefe, Bruyette & Woods\nService charges on deposit accounts increased 4% during 1993 after increasing 2% in the previous year, and they comprise the largest segment of noninterest income. Despite the 15% growth in transaction accounts in 1993 and the 20% growth in 1992, competitive pressures did not permit the Corporation to increase prices during 1993, and, as a result, service charge income did not grow as rapidly as outstanding balances. Service charges from commercial deposit accounts increased at an 8% pace, as the Corporation increased the processing fees on major corporate accounts. Income from other customer services increased 9% in 1993, following two years of double-digit growth. Interchange income from automated teller machines continued to increase rapidly due to the Corporation's extensive branch network and the location of its teller machines. Income from this area increased 13% in 1993, following a 19% increase in 1992. Commissions from the sale of customer checks increased 7% in 1993, after increasing 28% in the prior year due to higher volumes and a change in the Corporation's contract with its primary check provider. Income from insurance premiums and commissions declined slightly in 1993, resulting from lower sales of annuity products which became less attractive due to the decline in interest rates, and from lower sales of homeowners insurance following record mortgage origination activity in the previous year. Sales had increased 8% in 1992, as the Corporation had acquired two insurance agencies in the middle of 1991. Fee income from credit card activities declined 2% in 1993, after declining 4% in 1992, which reflects the increased competition in the credit card area from nonbank issuers and large, nationwide issuers. The Corporation issues its credit cards primarily in its geographic market areas at very competitive rates. Income from trust services increased 12% in 1993, following a 9% increase in 1992 and 11% growth in 1991. Assets under management exceeded one billion dollars for the first time in 1993, as the Corporation increased its emphasis on growth from this area. The Corporation had a $711,000 gain from the sale of securities in 1993, as compared to a small loss in 1992. The gain in 1993 was due primarily to a gain on the sale of an equity security acquired a number of years ago. The Corporation's policy is to retain its investment securities to maturity. Dispositions prior to maturity normally are the result of the sale of an acquired bank's securities which do not conform to First Virginia's investment policies, or the sale of securities for which the underlying credit has deteriorated. Other noninterest income includes $1.2 million in 1993 and $1.9 million in 1991 from the sale of mortgage servicing rights. The Corporation normally sells a package of servicing rights each year but elected not to make a sale in 1992 in order to build the servicing portfolio for future fee income. Excluding the sale of mortgage servicing rights in 1993, other income increased 5% due to a 16% increase in mortgage servicing fees. In 1992, other income increased 29% due to increases in mortgage-related fees, as higher loan origination volume generated increased fees.\nOTHER EXPENSES\nNoninterest expenses increased 3% in 1993, following a 9% increase in 1992. The 1992 increase was largely attributable to a 24% increase in Federal Deposit Insurance Corporation (FDIC) insurance assessments, as rates increased significantly due to the failures of savings banks and the depletion of the insurance fund. In 1993, the FDIC adopted a new fee schedule reflecting the risk and capital levels of each institution. Due to the Corporation's high level of capital and conservative asset structure, its member banks qualified for the lowest assessment level possible. As a result, the insurance rate for First Virginia did not increase in 1993, and expense in this area increased 8%, consistent with deposit growth. Salaries and employee benefits increased 4% in 1993, following an 11% increase in 1992. Salaries and wages increased 4% in 1993, consistent both with inflation and with the minimal growth in employment levels resulting from new branches and service growth only. Profit-sharing expense increased 19% in 1993 and 38% in 1992, due to the increase in the overall profitability of the Corporation. Incentive plans linked to the price of the Corporation's stock declined $4.2 million in 1993, due to the decline in the Corporation's stock price during the year. Health-care costs continued to grow at a faster pace than inflation and employment levels, and it increased 14% in both 1993 and 1992. In 1993, the Corporation adopted the Financial Accounting Standards Board Statement (SFAS) No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The adoption of this statement requires that postretirement benefits, such as retirees' medical expenses paid by the employer, be accounted for during the years of the retirees' active employment. As a result of adopting this statement, the Corporation increased its annual expense for retiree medical benefits by $1.9 million. See note 13 to the consolidated financial statements for additional information. Occupancy expense increased 4% in both 1993 and 1992, due to an increase in the number of branches. In addition, in 1993, a major tenant in the Corporation's headquarters building left upon termination of its lease, and replacement tenants have not yet occupied all of the vacated space. Equipment expense increased 4% in 1993, as compared to a 7% increase in 1992, because the Corporation increased its branch automation project slightly in 1993. In December, the existing mainframe computer was replaced, almost doubling the capacity of the old computer while reducing the operating cost substantially. Other operating expenses declined 2% in 1993, after increasing 11% in 1992. Due to the improvement in loan quality, collection expenses declined 25% in 1993. Foreclosed property expenses were not material and totaled $.9 million each year. Charge-offs due to teller differences and miscellaneous customer claims declined 28%. Both years had higher advertising expenses and an increase in amortization of mortgage servicing rights due to the decline in interest rates and the subsequent refinancing and prepayment of many mortgages.\nPROVISION FOR INCOME TAXES\nIncome tax expense increased 24% in 1993, to $54.1 million, due primarily to a 20% increase in pretax income. During 1993, the federal corporate income tax rate increased 1%, to 35%, and this change resulted in an increase of the Corporation's effective income tax rate to 31.8%, up from the 31.0% rate in 1992. Income tax expense increased 69% in 1992, due primarily to the increase in income in that year but also due to a 3.8% increase in the effective tax rate from 1991 to 1992. The primary reason for the increase in the effective tax rate in 1992, and to a lesser extent in 1993, was a decline in the benefit received from tax-exempt municipal securities. Since 1982, various changes in tax laws have reduced the availability and attractiveness of tax- exempt securities for banks, and the Corporation has not been able to replace maturing tax-exempt securities with new, comparable, tax-exempt securities. In the fourth quarter of 1992, the Corporation adopted SFAS No. 109 \"Accounting for Income Taxes.\" This statement changed the manner in which deferred income taxes are recorded, from an income-statement approach to a balance-sheet approach. In 1992, the Corporation charged an additional $886,000 to expense upon adopting this statement. Due to the change in the federal corporate tax rate in 1993, the Corporation credited expense of $432,000 to adjust for certain deferred-tax benefits, as required by SFAS No. 109.\nBalance Sheet - -------------\nThe Corporation's objective is to invest 70%-80% of its deposits in loans, which is the primary source of income. At the end of 1993, the ratio of loans to deposits was 65.8%, as compared to 63.1% at the end of 1992. The Corporation last met its loan objective in 1990 when the loan-to-deposit ratio stood at 72.8%. Despite the relatively low level of loans to deposits, the Corporation has been able to maintain its net interest margin at a high level without extending the life of its investment portfolio or compromising the quality of earning assets. Strong loan growth in 1993 enabled the Corporation to increase the percentage of its average earning assets invested in loans, as average loans increased 8%. The Corporation experienced relatively strong loan growth in 1992, but the increase in deposits outpaced the growth of loans. In 1992, the Corporation purchased $278 million in deposits from failed thrifts. And from 1990 to 1992, the Corporation's reputation for safety and soundness and the well-publicized problems of its competitors resulted in annual, double-digit increases in deposits that could not be invested immediately in loans. This deposit influx slowed in 1993, as the savings and loan crisis abated and as the capital and asset quality levels of the Corporation's competitors improved. The table below shows the average balances of the various categories of earning assets as a percentage of total earning assets for the years indicated.\n1993 1992 1991 1990 1989 ------ ------ ------ ------ ------ Loans .................. 62.14% 60.69% 65.55% 71.26% 73.90% Taxable securities...... 29.83 30.81 24.52 19.74 17.10 Tax-exempt securities... 3.78 4.18 5.05 5.18 5.18 Overnight investments... 4.25 4.32 4.88 3.82 3.82 ------ ------ ------ ------ ------ 100.00% 100.00% 100.00% 100.00% 100.00% ====== ====== ====== ====== ======\nLOANS\nThe economy strengthened in 1993 and consumer confidence increased throughout the year as concerns over employment prospects decreased somewhat. The decline in interest rates over the last several years has induced many consumers to refinance their homes at substantially lower rates, thus improving their liquidity and disposable income. Automobile sales nationally were very strong, and First Virginia's traditional strength in the indirect automobile financing market resulted in a 25% increase in the production of these loans. At the end of 1993, automobile loans outstanding were up 15% from the end of 1992, and prospects for further increases in 1994 are promising. The age of the average automobile on the road is still very high, and with the increased monthly income freed up from mortgage refinancings, consumers are in a good position to purchase new cars. During 1993, the Corporation opened its first automobile loan production office outside of its natural market areas. This office has been very successful, and the Corporation is currently exploring additional locations. The Corporation has combined local attention and service to its automobile dealers with central oversight and administration of the program. Each loan application is examined individually by a seasoned loan administrator rather than using a depersonalized credit-scoring system. This procedure permits the Corporation to limit its delinquencies and losses while simultaneously examining each application for compensating credit attributes. Home equity loans are the second largest source of loans for the Corporation and comprise 28% of all loans. At year-end, home equity loans were up 5% over 1992, after advancing 6% in the previous year. Activity was down slightly, as compared to 1992, due to the high level of activity in first mortgage loans as consumers refinanced and consolidated existing home equity loans. Consumers utilized the cash received from these transactions rather than borrowing additional funds. At the end of the year, however, strong advertising promotions and a slowdown in first mortgage refinance activity brought about much stronger activity in this area, and the \"pipeline\" of loans in process was at a record level. The Corporation typically requires a maximum loan-to-equity ratio of 70%-75% and does not take a second mortgage behind a jumbo first mortgage, in order to reduce its risk in foreclosure. Residential real estate loans declined 7% during 1993, after increasing 30% in 1992. Activity was very strong in this area all year, and the Corporation's mortgage banking subsidiary had its second most successful year in loan originations. Due to the low level of interest rates, however, the Corporation did not deem it appropriate to invest in long-term, fixed-rate loans in 1993 and sold most of the loans it originated to unaffiliated investors. The Corporation primarily retains 15-year, fixed-rate mortgage loans for its own portfolio or longer-term loans with rates that adjust every three to five years. Due to the intense competition with \"teaser\" financing rates and their higher probability for early refinancing, the Corporation does not normally invest in one-year, adjustable-rate mortgages. Revolving credit loans, including credit cards, declined for the fourth consecutive year and were down 1% at year-end, after falling 2% in 1992. The Corporation limits its solicitation efforts primarily to its natural market areas and despite attractive interest rates and fee schedules, as compared to its competitors, it has experienced slight attrition. Commercial loans increased 3% at the end of 1993, as compared to a 7% drop at the end of 1992. The majority of the advance was due to an increase in floor plan loans to automobile dealers to finance their inventory. Approximately 33% of commercial loans are floor plan loans to automobile dealers which are secured by individual automobiles, subject to periodic inventory audits. Other commercial loan activity has been weak with little demand following the end of the recession and expansion plans being curtailed at many businesses. The Corporation has experienced increased competition for attractive commercial loans, with some of its competitors offering extended terms and low, fixed rates at levels the Corporation is not willing to accept. Real estate development and construction loans declined 17% to $90.8 million at the end of 1993, comprised only 2% of the total loan portfolio, and were primarily for residential properties with strong sales. Commercial mortgage loans increased 6% in 1993, after advancing 10% in 1992, and consisted primarily of owner-occupied facilities. The majority of the growth in this area came from loans to well-established country clubs and churches.\nLOANS\nDecember 31 1993 1992 1991 1990 1989 ---------- ---------- ---------- ---------- ---------- (In thousands) Consumer: Automobile...........$1,571,418 $1,362,138 $1,243,927 $1,271,395 $1,249,131 Home equity, fixed and variable rate 1,242,982 1,178,378 1,109,067 1,033,336 911,219 Revolving credit loans, including credit cards 161,995 163,711 166,961 173,780 174,809 Other......... 167,942 184,879 193,175 200,767 203,247 Real estate: Construction and land development 90,823 109,378 109,809 133,475 107,731 Commercial mortgage. 301,315 284,579 257,944 207,195 182,483 Residential mortgage.. 493,968 529,315 405,924 382,474 384,012 Other, including Industrial Development Authority loans 63,082 69,898 70,204 75,959 76,002 Commercial 321,428 311,932 336,264 365,021 435,050 ---------- ---------- ---------- ---------- ---------- 4,087,318 3,842,373 3,919,378 3,434,403 4,723,684 Deduct unearned income, principally on consumer loans (327,635) (351,835) (377,897) (408,999) (388,009) ---------- ---------- ---------- ---------- ---------- Loans, net of unearned income $4,087,318 $3,842,373 $3,515,378 $3,434,403 $3,335,675 ========== ========== ========== ========== ==========\nLoans and other assets which were not performing in accordance with their original terms are discussed on several of the following pages under the caption NONPERFORMING ASSETS.\nINVESTMENT SECURITIES\nThe investment portfolio increased on average by 1% in 1993, after increasing at 30% plus rates in the preceding two years. The rapid deposit growth in 1991 and 1992, which exceeded loan growth, resulted in large increases in the investment portfolio. With the slowdown in deposit growth in 1993 and the increase in lending, the residual amount of excess funds invested in the securities portfolio declined. The Corporation places primary importance on safety and liquidity in the investment portfolio. Accordingly, the majority of the portfolio is invested in U.S. Government securities with a maximum life of five years and an average life of approximately two years. At the end of 1993, U.S. Government securities comprised 88% of the securities portfolio, as compared to 86% at the end of 1992. The Corporation generally does not invest in mortgage-backed securities or collateralized mortgage obligations due to the unpredictability of cash flows and maturities, and to the Corporation's emphasis on liquidity. The percentage of securities invested in U.S. Government securities has been increasing gradually since 1982 when changes in federal income tax laws reduced the tax benefits derived by banks on investments in municipal securities. The limited availability of bank-qualified municipal securities and the reduction in yield due to the loss of tax benefits have generally made municipal securities less attractive to the Corporation. First Virginia has limited its investments in municipal securities primarily to publicly issued securities of municipalities with a rating of A1 or better, or to unrated, general-obligation securities of municipalities in its market areas with which it is familiar. In May 1993, the Financial Accounting Standards Board issued Statement No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement requires investments to be classified into one of three categories. Securities for which an enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and are accounted for at amortized cost. Securities which are bought and held primarily for the purpose of sale in the near term are classified as trading securities and are accounted for at market value, with unrealized gains and losses included in earnings. All other securities are classified as available-for-sale securities, are accounted for at market value with unrealized gains and losses excluded from earnings, but are reported as a separate component of shareholders' equity. The impact of this statement may cause some banks to report widely fluctuating earnings and capital. The Corporation will adopt this statement in the first quarter of 1994. Because the Corporation's stated policy is to hold most securities until their stated maturity and it has the ability to do so, it is expected that almost all securities will be classified as held to maturity, and therefore, the statement will not have a material effect. Less than $.5 million in equity securities will be classified as available for sale and subject to market valuation.\nOVERNIGHT INVESTMENTS\nOvernight investments, consisting primarily of federal funds sold and securities repurchase agreements, generally are governed by the size of normally anticipated deposit swings and loan demand. In addition, the amount of customer repurchase agreements are covered by investments in overnight securities. In 1993, average overnight investments increased 4% to $270.4 million, after increasing 2% in 1992.\nDEPOSITS\nDeposit growth slowed substantially in 1993, after increasing rapidly in the preceding two years. Average outstanding deposits increased 6%, following a 15% increase in 1992. Many banks experienced deposit stagnation or declines in 1993, as the low level of interest rates induced many depositors to seek higher-yielding instruments in areas outside the banking system. Competition from the stock market and mutual funds, insurance products, and bonds placed pressure on banks to maintain their deposits. In addition, in the Corporation's market area, the concern for safety and soundness arising from the thrift crisis and the problems of other banks evaporated due to the demise of most thrifts and the improvement in asset quality and capital of its banking competitors. The Corporation's large and extensive branch system placed the Corporation in good position to continue garnering low-cost consumer core deposits. In addition, the Corporation's largest market -- the Washington-Baltimore area - - - continues to be very attractive and generated the majority of the growth in 1993. First Virginia continued to increase market share to 9.4% of the Virginia market in the middle of 1993. The Corporation was able to capitalize on the changes in ownership of the former First American, Dominion and Maryland National banks in attracting depositors. Demand deposits increased 15% in 1993, following a 14% increase in 1992, while NOW accounts increased 15%, following 25% growth in 1992. Demand deposits comprise 16.4% of average deposits, while NOW accounts comprise 20.2%. Total transaction accounts constitute 36.6% of total deposits. The decline in interest rates which occurred in 1992 has influenced consumers to remain liquid while they wait for interest rates to increase again. Traditional consumer savings accounts, which can be withdrawn at any time without penalty, increased 34% in 1993 following a 62% increase in 1992 and now comprise 21.2% of deposits. At some point, consumers may transfer these funds to higher-cost certificates of deposit when interest rates go up; however, the Corporation is benefiting from the lower cost of these funds at this time. Money-market accounts declined 5% in 1993 after growing 25% in 1992, as some of these customers transferred balances to higher-yielding accounts in 1993. Other certificates of deposit, which are primarily consumer deposits, declined 12.3% on average after declining 2.7% in 1992. The low level of interest rates induced consumers to lengthen their maturities in this category, with the most popular new and reinvestment categories being two or five-year certificates. Large-denomination certificates declined 11% in 1993, as compared to a 25% decline in 1992. The Corporation does not actively bid on these types of deposits or rely on them for its funding sources, and they constitute less than 3% of total deposits. They are primarily composed of high-savings-level consumers and bear rates identical to other certificates of deposit. The Corporation does not purchase any brokered deposits or solicit deposits outside of its primary market areas.\nMaturity ranges for certificates of deposit with balances of $100,000 or more on December 31, 1993 were (in thousands):\nOne month or less.............................................. $ 21,980 After one month through three months........................... 38,332 After three through six months ................................ 38,023 After six through twelve months ............................... 37,635 Over twelve months............................................. 29,390 -------- $165,360 ========\nAverage Deposits Pie Chart (Millions of Dollars)\n1993 1992 1991 -------- -------- -------- Noninterest Bearing $ 990.0 $ 864.0 $ 756.0 Transaction 1,218.7 1,059.1 845.8 Savings 1,276.9 954.5 588.7 Money Market 746.7 788.7 632.1 Other Consumer CDs 1,628.0 1,856.3 1,908.5 Large-Denomination CDs 167.7 187.7 250.5 -------- -------- -------- $6,028.0 $5,710.3 $4,981.6 ======== ======== ========\nOTHER INTEREST-BEARING LIABILITIES\nShort-term borrowings consist primarily of commercial paper issued by the parent company and securities sold by the member banks with an agreement to repurchase them on the following business day. These short-term obligations are issued principally as a convenience to customers in connection with cash management activities utilized by these customers. Average short-term borrowings from these sources increased 4% in 1993 after advancing 16% during 1992. During 1993, the Corporation paid off its remaining long-term indebtedness composed of a mortgage loan on its headquarters building in Falls Church. The only remaining long-term debt are capitalized lease obligations on branch office facilities which are not subject to prepayment. A shelf registration for the issuance of $50 million of senior notes was filed with the Securities and Exchange Commission in 1989. Moody's has indicated that the notes, when and if issued, will have a rating of A-1. The Corporation's commercial paper is rated P-1 by Moody's and A-1 by Standard & Poor's, and the lead bank's certificates of deposit are rated A+\/A-1 by Standard & Poor's. In 1993, Moody's initiated a rating on the lead bank's long and short-term deposits and obligations of Aa3 and Prime-1, respectively, the highest rating of any bank's deposits in the Corporation's market area.\nSTOCKHOLDERS' EQUITY\nFirst Virginia maintains its capital at some of the highest levels relative to other banks in the country. The ratio of stockholders' equity to assets was 9.83% at the end of 1993, as compared to an average of 8.38% for similar banks in its peer group with assets between $5 - $10 billion, according to Keefe, Bruyette & Woods. The Corporation's Tier 1 leverage ratio was 9.68% at the end of 1993, as compared to 8.91% at the end of 1992. This level exceeds the regulatory minimum of 3.0% by over three times and gives the Corporation considerable available capital for growth and safety. Each of the Corporation's individual banks maintains a capital ratio well in excess of regulatory minimums, and all qualify as \"well capitalized\" banks, allowing them the lowest FDIC premium rate and the freedom to operate without restrictions from regulatory bodies. Over the past five years, stockholders' equity has increased at an annual, compounded growth rate of 10.9% and totaled $692 million at the end of 1993. The dividend rate on the common stock was increased twice in 1993, and at the end of 1993, the annual rate had increased 19.2% over the rate at the end of 1992. Dividends have grown at an 8.5% compound growth rate over the past five years. In 1992, a three-for-two stock split was declared and was accounted for in the form of a dividend. As a result, $10.7 million was transferred from surplus to common stock; however, the total capital of the Corporation was not affected. First Virginia and its subsidiary banks are required to comply with capital adequacy standards established by the Federal Reserve and the FDIC. The Corporation exceeded the additional, regulatory risk-based capital requirements by wide margins due in part to the high level of capital and in part to the conservative nature of the Corporation's assets. The Tier 1 risk- based capital ratio totaled 16.84% at the end of 1993, and the Tier 2 or total risk-based capital ratio equaled 18.09%. The regulatory minimums are 4.0% and 8.0%, respectively.\nAsset Quality - -------------\nThe Corporation has a number of policies to ensure that lending and investment activities expose the Corporation to a minimum of risk while producing a profit consistent with the exposure to risk. These policies are reviewed constantly by the Corporation's senior management, and each member bank's internal loan monitoring system provides a detailed, monthly report of production, delinquencies, and nonperforming and potential problem loans. This careful monitoring has resulted in a consistent record of low delinquencies and charge-offs as well as few nonperforming loans in relation to the entire loan portfolio. The Corporation has no foreign or highly leveraged transaction loans, and loans are made only within the trade areas of the member banks. Loans are generally not participated with or purchased from banks not affiliated with the First Virginia system. In addition, participations between banks within the First Virginia system must be participated first with the Corporation's lead bank where another comprehensive loan review process is performed. Approximately 82% of the Corporation's loans is made to consumers and normally is secured by personal or real property. First Virginia has no significant concentration of credit to any single industry or borrower, and its loans are spread throughout its market areas. The Corporation's legal lending limit to any one borrower is approximately $97 million; however, it generally limits its loans to any one borrower and related interests to $15 million. Occasionally, the Corporation may exceed its internal limit. One of the Corporation's specialty loan areas is the automobile finance area, and loans are made to consumers both directly in the branches of the member banks and indirectly through automobile dealerships. Roughly 34% of the total loan portfolio is comprised of consumer automobile loans, but because the loan amounts are relatively small and are spread across many individual borrowers, the risk of any major charge-offs is minimized. The Corporation also makes loans directly to automobile dealers in order to finance their inventories. Over the past several years, real estate development and construction loans have been a problem for many banks in the Corporation's market areas, particularly in the Washington, D.C., market. The Corporation has a small exposure in these types of loans, and at the end of 1993, total construction and development loans amounted to only $90.8 million, or approximately 2% of the total loan portfolio. While the Corporation has not been unaffected by the problems affecting the real estate industry, its conservative lending policies and orientation, primarily toward owner-occupied or residential properties, has minimized the extent of exposure in this area.\nNONPERFORMING ASSETS\nNonperforming assets declined 15% in 1993 and totaled $27.6 million at year-end. Nonperforming assets were .68% as a percentage of total loans and nonperforming assets, down from the .85% at the end of 1992. After peaking in 1990 at 1.07%, nonperforming assets have steadily declined to their historical levels and are significantly below the levels of similarly sized institutions both in the Corporation's market areas and nationwide. Foreclosed properties declined 36% in 1993, following a 31% decline in 1992. At the end of 1993, the Corporation had $7.1 million in foreclosed real estate, with slightly less than one half of that total comprised of one property in the Norfolk area and the rest composed of small, individual properties spread throughout the Corporation's market areas. The Corporation had no in-substance foreclosures at the end of 1993 and no foreclosed commercial real estate in the Washington, D.C., area market. The table on the following page shows the total of nonperforming assets at the end of the past five years. Experience has shown that actual losses on nonperforming assets are only a small percentage of such assets. The Corporation expects to recover virtually all of its nonperforming assets, many with full interest. During 1993, the Corporation collected approximately $1.5 million in previously unaccrued interest on loans in a nonaccrual status that were collected in full.\nNonperforming Assets\nDecember 31 1993 1992 1991 1990 1989 ------- ------- ------- ------- ------- (In thousands) Nonaccruing loans ..... $18,387 $20,453 $17,425 $24,812 $12,576 Restructured loans..... 2,175 1,139 1,337 1,745 2,539 Properties acquired by foreclosure........ 7,086 11,099 16,160 10,278 1,507 ------- ------- ------- ------- ------- Total................ $27,648 $32,691 $34,922 $36,835 $16,622 ======= ======= ======= ======= ======= Percentage of total loans and foreclosed real estate .68% .85% .99% 1.07% .50%\nLoans 90 days past due.. $ 2,752 $ 4,595 $ 8,935 $ 6,293 $ 6,958 ======= ======= ======= ======= =======\nLoans past due 90 days or more totaled $2.8 million at the end of 1993, a decline of 40% as compared to 1992 which in turn had a 49% decline as compared to 1991. This decrease represented a record low of .07% of outstanding loans. Loans past due 30 days or more declined 21% to $17.0 million and also represented a record low of .42% of the total loan portfolio. These ratios are considerably below industry averages and reflect the high, overall quality of the Corporation's loan portfolio. A loan generally is classified as nonaccrual when full collectibility of principal or interest is in doubt; when repossession, foreclosure or bankruptcy proceedings are initiated; or when other legal actions are taken. In the case of installment loans, a loan is placed in nonaccrual if payments are delinquent 120 days. The same is true for credit card loans if they are 180 days past due, and for other loans after payments are delinquent for 90 days. If collateral on a loan is sufficient to insure full collection of principal and interest, an exception to the general policy might be made. Loans may also be placed in a nonaccruing status at any time prior to that indicated above if the Corporation anticipates that interest or principal will not be collected.\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is maintained at a level which management believes is adequate to absorb potential losses in the loan portfolio. Management's methodology in determining the adequacy of the allowance considers specific credit reviews, past loan-loss experience, current economic conditions and trends, and the growth and composition of the loan portfolio. Every commercial loan is reviewed and rated at least annually according to the Corporation's credit standards, and trends in the total portfolio are examined for potential deterioration in overall quality. At the end of 1993, the allowance represented 1.25% of total loans - down three basis points from the level at the end of 1992 and within the long- range band the Corporation believes to be adequate. The allowance covered net charge-offs approximately 10 times, up considerably from the end of 1992 when it covered net charge-offs 3.85 times. Only a small percentage of the allowance has been allocated to specific credits, with the majority being available for currently unidentified losses. Management believes that the allowance is adequate to absorb any potential, unidentified losses. Net charge-off experience improved significantly during 1993, and nonperforming loans and delinquencies all improved to historical lows. The Corporation constantly monitors the level of the allowance, considering its long-term experience and short-term individual requirements. If asset quality and loan charge-offs remain at the current historically low levels, the Corporation intends to lower its long-term band during 1994 to the 1.15% - 1.20% range. The allowance is charged when management determines that the prospect of recovering the principal of a loan has diminished significantly. Subsequent recoveries, if any, are credited to the allowance. Net charge-offs declined 60% in 1993 to $5.1 million, after maintaining itself in a band between $10 and $13 million from 1989 to 1992. All categories of loans showed significant declines in net charge-offs, as asset quality improved. Net loan charge-offs on credit card loans still remained at the relatively high level of 2.80%, reflecting a trend since 1989 of higher bankruptcies and fraud in this area. The Corporation's loss experience with credit card loans is still significantly below the national averages. Despite the Corporation's exposure to automobile lending, its actual loss experience has been very favorable, and its net charge-offs declined 77% in 1993 to .06% of the portfolio. Part of this favorable experience reflects the effort beginning in early 1991 to increase the credit standards for indirect automobile loans and the Corporation's policy of purchasing primarily \"A\" paper on new cars. Commercial loans had a net recovery during 1993, as the Corporation experienced no significant problems during the year. An analysis of the activity in the allowance for loan losses for each of the last five years is presented in the table on the following page.\nAllowance for Loan Losses\nDecember 31 1993 1992 1991 1990 1989 ------- ------- ------- ------- ------- (In thousands) Balance at beginning of year $49,340 $44,817 $43,917 $40,905 $40,165 Balances of acquired banks 259 - - 291 - Provision charged to operating expense........ 6,450 17,355 14,024 13,404 11,039 ------- ------- ------- ------- ------- Total ................ 56,049 62,172 57,941 54,600 51,204 ------- ------- ------- ------- ------- Charge-offs: Consumer: Credit card............. 4,516 4,852 4,756 3,189 2,474 Indirect automobile..... 2,827 5,139 7,062 5,826 6,187 Other................... 1,464 2,758 3,291 2,555 2,662 Real estate.............. 39 473 201 224 454 Commercial............... 365 3,298 1,176 2,235 1,597 ------- ------- ------- ------- ------- Total ................ 9,211 16,520 16,486 14,029 13,374 ------- ------- ------- ------- ------- Recoveries: Consumer: Credit card............. 758 632 516 438 410 Indirect automobile..... 2,102 2,024 1,807 1,698 1,417 Other................... 765 813 681 812 815 Real estate.............. 17 18 53 34 22 Commercial............... 447 201 305 364 411 ------- ------- ------- ------- ------- Total ................ 4,089 3,688 3,362 3,346 3,075 ------- ------- ------- ------- ------- Net charge-offs deducted.. 5,122 12,832 13,124 10,683 10,299 ------- ------- ------- ------- ------- Balance at end of year ... $50,927 $49,340 $44,817 $43,917 $40,905 ======= ======= ======= ======= =======\nNet Loan Losses (Recoveries) to Average Loans by Category: Credit card.............. 2.80% 3.11% 2.96% 1.87% 1.48% Indirect automobile...... .06 .29 .50 .40 .47 Other consumer........... .05 .16 .23 .16 .18 Real estate.............. - .07 .03 .04 .10 Commercial............... (.01) .50 .14 .28 .17 ------- ------- ------- ------- ------- Total Loans............... .13% .35% .38% .31% .31% ======= ======= ======= ======= =======\nPercentage of allowance for loan losses to year-end loans. 1.25% 1.28% 1.27% 1.28% 1.23%\nNonperforming Asset Ratios Ribbon Chart (the lower, the better) National First Southern Peer Virginia Regionals Group -------- --------- -------- 1993 0.68% 1.24% 0.98% 1992 0.85% 2.62% 1.58% 1991 0.99% 2.49% 2.22% 1990 1.07% 2.56% 2.28% 1989 0.50% 1.31% 1.30%\nSouthern Regionals: Banking companies with assets over $2 billion (30 in 1993)\nNational Peer Group: Banking companies with assets of between $5 and $10 billion (19 in 1993) Source: Keefe, Bruyette & Woods\nReserve Coverage Ratios Ribbon Chart (the higher, the better) National First Southern Peer Virginia Regionals Group -------- --------- -------- 1993 248 252 265 1992 229 161 204 1991 239 139 134 1990 165 104 117 1989 271 142 146\nSouthern Regionals: Banking companies with assets over $2 billion (30 in 1993)\nNational Peer Group: Banking companies with assets of between $5 and $10 billion (19 in 1993) Source: Keefe, Bruyette & Woods\nNet Charge-Offs Ratios Ribbon Chart (the lower, the better) National First Southern Peer Virginia Regionals Group -------- --------- -------- 1993 0.13 0.33 0.29 1992 0.35 0.78 0.66 1991 0.38 0.96 0.89 1990 0.31 0.87 0.75 1989 0.31 0.49 0.47\nSouthern Regionals: Banking companies with assets over $2 billion (30 in 1993)\nNational Peer Group: Banking companies with assets of between $5 and $10 billion (19 in 1993) Source: Keefe, Bruyette & Woods\nLIQUIDITY AND SENSITIVITY TO INTEREST RATES - -------------------------------------------\nThe primary functions of asset\/liability management are to assure adequate liquidity and maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. Liquidity management involves the ability to meet the cash flow requirements of the Corporation's loan and deposit customers. Interest-rate-sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The Corporation does not hedge its position with swaps, options or futures but instead maintains a highly liquid and short-term position in all of its earning assets and interest-bearing liabilities. In order to meet its liquidity needs, the Corporation schedules the maturity of its investment securities so that approximately an equal amount will mature each month. The weighted-average life of the securities portfolio at the end of 1993 was just over 24 months - basically unchanged from the end of 1992 and 1991. Because the Corporation views its securities portfolio primarily as a source of liquidity and safety, it does not necessarily react to changes in the yield curve in an attempt to enhance its yield. Accordingly, the average life of the portfolio does not change much as the Corporation maintains a constant approach to its portfolio and invests primarily in U.S. Government securities with a life no greater than five years. Municipal securities are also generally limited to lives of no more than five years but due to availability and other factors are occasionally purchased in serial issues with longer lives. The maturity ranges of the securities and the average taxable-equivalent yields as of December 31, 1993, are as follows:\nU.S. Government State and and its Agencies Municipal Other --------------- ------------- ------------ Amount Yield Amount Yield Amount Yield ---------- ---- -------- ---- ------- ---- (Dollars in thousands) One year or less.............. $ 553,240 6.3% $ 79,720 7.9% $10,484 7.6% After one year through five years 1,351,086 5.7 146,797 7.5 18,256 5.6 After five through ten years.. 391 8.3 3,491 9.1 99 6.8 After ten years............... - - 5,355 9.2 50 10.0 No stated maturity............ - - - - 7,065 6.7 ---------- -------- ------- Total ........................ $1,904,717 5.9% $235,363 7.7% $35,954 6.5% ========== ======== =======\nWeighted-average maturity..... 25 months 25 months\nA cash reserve consisting primarily of overnight investments is also maintained by the parent company to meet any contingencies and to provide additional capital, if needed, to the member banks. The majority of the Corporation's loans are fixed-rate installment loans to consumers, and mortgage loans whose maturities are longer than the deposits by which they are funded. A degree of interest-rate risk is incurred if the interest rate on deposits should rise before the loans mature. However, the substantial liquidity provided by the monthly repayments on these loans can be reinvested at higher rates which largely reduces the interest-rate risk. Home equity lines of credit have adjustable rates that are tied to the Prime Rate. Many of the loans not in the installment or mortgage categories have maturities of less than one year or have floating rates which may be adjusted periodically to reflect current market rates. These loans are summarized in the following table.\nBetween 1 year 1 and 5 After or less years 5 years Total -------- -------- ------- -------- (In thousands)\nMaturity ranges: Commercial........................ $295,953 $ 92,220 $44,036 $432,209 Construction and land development. 81,424 7,303 2,096 90,823 -------- -------- ------- -------- Total ............................. $377,377 $ 99,523 $46,132 $523,032 ======== ======== ======= ========\nFloating-rate loans: Commercial........................ $ 16,285 $ 7,075 $ 23,360 Construction and land development. 6,343 515 6,858 -------- ------- -------- Total ............................. $ 22,628 $ 7,590 $ 30,218 ======== ======= ========\nFirst Virginia's Asset\/Liability Committee is responsible for reviewing the Corporation's liquidity requirements and for maximizing net interest income, consistent with capital requirements, liquidity, interest rates and economic outlooks, competitive factors and customer needs. Liquidity requirements are reviewed in detail for each of the Corporation's individual banks; however, overall asset\/liability management is performed on a consolidated basis in order to achieve a consistent and coordinated approach. One of the tools the Corporation uses to determine its interest-rate risk is gap analysis. Gap analysis attempts to examine the volume of interest- rate-sensitive assets minus interest-rate-sensitive liabilities. The difference between the two is the interest sensitivity gap which indicates how future changes in interest rates may affect net interest income. Regardless of whether interest rates are expected to increase or fall, the objective is to maintain a gap position that will minimize any changes in net interest income. A negative gap exists when the Corporation has more interest-sensitive liabilities maturing within a certain time period than interest-sensitive assets. Under this scenario, if interest rates were to increase, it would tend to reduce net interest income. At December 31, 1993, the Corporation had a slightly negative interest-rate gap in the short term (under three months) but was slightly asset sensitive in the longer term. The table on the next page shows the Corporation's interest-sensitivity position at December 31, 1993.\nINTEREST-SENSITIVITY ANALYSIS\n1 to 30-Day 1 to 90-Day 1 to 180-Day Sensitivity Sensitivity Sensitivity ----------- ----------- ----------- (Dollars in thousands) Earning assets: Loans, net of unearned income.... $ 792,200 $1,044,228 $1,391,412 Investment securities............ 52,499 116,805 303,745 Federal funds purchased and securities purchased under agreements to resell........... 235,000 235,000 235,000 ----------- ----------- ----------- Total earning assets......... 1,079,699 1,396,033 1,930,157 ----------- ----------- -----------\nFunding sources: Non-interest bearing demand deposits................ - - - NOW accounts..................... - - - Money-market accounts............ 724,462 724,462 724,462 Savings deposits................. - - - Certificates of deposit.......... 235,634 493,640 859,741 Large-denomination certificates of deposit..................... 21,980 60,312 98,335 Short-term borrowings............ 151,859 151,859 151,859 Long-term borrowings............. - - - ----------- ----------- ----------- Total funding sources........ 1,133,935 1,430,273 1,834,397 ----------- ----------- ----------- Interest-sensitivity gap........... $ (54,236) $ (34,240) $ 95,760 =========== =========== =========== Interest-sensitivity gap as a percentage of earning assets..... (.83)% (.53)% 1.47%\nRatio of interest-sensitive assets to interest-sensitive liabilities .95x .98x 1.05x\nINTEREST-SENSITIVITY ANALYSIS (Continued)\nBeyond One 1 to 365-Day Year or Sensitivity Nonsensitive Total ----------- ----------- ----------- (Dollars in thousands) Earning assets: Loans, net of unearned income.... $2,087,491 $1,999,827 $4,087,318 Investment securities............ 560,678 1,615,356 2,176,034 Federal funds purchased and securities purchased under agreements to resell........... 235,000 - 235,000 ----------- ----------- ----------- Total earning assets......... 2,883,169 3,615,183 6,498,352 ----------- ----------- -----------\nFunding sources: Noninterest-bearing demand deposits................ 1,039,933 1,039,933 NOW accounts..................... 1,294,867 1,294,867 Money-market accounts............ 724,462 - 724,462 Savings deposits................. 1,325,943 1,325,943 Certificates of deposit.......... 1,226,052 359,772 1,585,824 Large-denomination certificates of deposit..................... 135,970 29,390 165,360 Short-term borrowings............ 151,859 - 151,859 Long-term borrowings............. 1,008 1,008 ----------- ----------- ----------- Total funding sources........ 2,238,343 4,050,913 6,289,256 ----------- ----------- ----------- Interest-sensitivity gap........... $ 644,826 $ (435,730) $ 209,096 =========== =========== =========== Interest-sensitivity gap as a percentage of earning assets..... 9.92% (6.71)% 3.22%\nRatio of interest-sensitive assets to interest-sensitive liabilities 1.29x .89x 1.03x\nFirst Virginia does not manage its interest-rate risk simply with static maturity and repricing reports. It also uses a dynamic modeling process which projects the impact of different interest rate, loan and deposit growth scenarios over a twelve-month period. A large part of First Virginia's loans and deposits comes from its retail base and does not automatically reprice on a contractual basis in reaction to changes in interest-rate levels. Accordingly, First Virginia has not experienced earnings volatility as may be indicated by its interest-sensitive gap position. The Corporation has consistently maintained a net interest margin in excess of 5.00%, whether rates are high or low, and has been able to maintain adequate liquidity to provide for changes in interest rates and in loan and deposit demands.\nQuarterly Results - -----------------\nThe results of operations for the first three quarters of 1993 have been analyzed in quarterly reports to shareholders. The results of operations for each of the quarters during the two years ended December 31, 1993, are summarized in the table on the next two pages (in thousands, except per-share data or as otherwise indicated). The figures for the first two quarters of 1993 have been restated to include the results of the acquisition of United Southern Bank of Morristown during the third quarter. Prior-year results have not been restated, because they would not have a material effect upon the Corporation's financial statements. Net income for the fourth quarter of 1993 increased 9% over the same quarter in 1992. The primary reason for the increase was a 66% decline in the provision for loan losses due to a lower rate of actual net charge-offs on loans. In addition, the fourth quarter of 1993 included a gain of $679,000 on the sale of some equity securities that the Corporation acquired a number of years ago. The net interest margin declined 37 basis points to 5.28% in the fourth quarter of 1993, as compared to the same quarter in 1992, because the Corporation's investments and loans continued to reprice at a faster rate than deposits. In the fourth quarter of 1992, the net interest margin peaked, after increasing throughout the year, due to declining interest rates which affected deposits to a greater degree than earning assets. During the fourth quarter of 1993, the Corporation sold a package of mortgage servicing rights and recorded a gain of $1.2 million. Over the past several years, the Corporation has sold a package of servicing rights each year but did not do so in 1992 due to its desire to increase future service fee income through the retention of mortgages it originated. The fourth quarter of 1993 also included an additional write-down of $1.0 million on previously purchased mortgage servicing rights due to an increase in the prepayment rate of the underlying mortgages. The comparable quarter of 1992 reflected an additional expense of $.8 million for the write-down of mortgage servicing rights. Nonperforming assets declined 15%, as compared to the fourth quarter of 1992, and were down 5%, as compared to the third quarter. At the end of the fourth quarter, nonperforming assets amounted to .68% of loans as compared to .85% at the end of 1992. Noninterest income increased 10%, as compared to the 1992 fourth quarter, due to the gain on the sale of servicing rights and the gain on the sale of securities. Noninterest expenses declined slightly, as compared to the fourth quarter of 1992, due to a decrease in employment expense primarily related to a decline in stock-related compensation resulting from the decline in the Corporation's stock price.\nQUARTERLY RESULTS\n-------------------------------------- Quarter Ended -------------------------------------- Dec. 31 Sept. 30 June 30 Mar. 31 Condensed Statements of Income -------- -------- -------- -------- (Dollar amounts in thousands, except per-share data)\nInterest and fees on loans $ 89,372 $ 91,778 $ 91,424 $ 90,545 Income from securities 32,589 32,752 33,460 34,503 Other interest income 2,059 2,212 2,260 1,828 -------- -------- -------- -------- Total interest income 124,020 126,742 127,144 126,876 -------- -------- -------- -------- Interest on deposits 38,990 40,729 40,826 40,630 Interest on borrowed funds 1,062 981 850 891 -------- -------- -------- --------\nTotal interest expense 40,052 41,710 41,676 41,521 -------- -------- -------- -------- Net interest income 83,968 85,032 85,468 85,355 Provision for loan losses 1,416 820 2,026 2,188 Other income 22,088 20,802 20,084 19,566 Other expense 62,392 62,452 60,820 60,103 Provision for income taxes 13,259 14,039 13,414 13,410 -------- -------- -------- -------- Net income $ 28,989 $ 28,523 $ 29,292 $ 29,220 ======== ======== ======== ======== Net income per share $ .89 $ .88 $ .90 $ .90\nAverage Quarterly Balances\nAverage balances (in millions): Securities $ 2,182 $ 2,128 $ 2,111 $ 2,140 Loans 4,047 3,992 3,936 3,857 Total earning assets 6,495 6,403 6,344 6,233 Total assets 7,021 6,919 6,869 6,750\nDemand deposits 1,037 1,005 988 929 Interest-bearing deposits 5,073 5,044 5,043 4,991 Total deposits 6,110 6,049 6,031 5,920 Interest-bearing liabilities 5,245 5,199 5,181 5,135 Total stockholders' equity 681 662 642 621\nKey Ratios\nRates earned on assets 7.72% 8.02% 8.16% 8.33% Rates paid on liabilities 3.03 3.18 3.23 3.28 Net interest margin 5.28 5.43 5.53 5.63\nReturn on average assets 1.65 1.65 1.71 1.73 Return on average equity 17.03 17.23 18.25 18.81\nQUARTERLY RESULTS\n-------------------------------------- Quarter Ended -------------------------------------- Dec. 31 Sept. 30 June 30 Mar. 31 Condensed Statements of Income -------- -------- -------- -------- (Dollar amounts in thousands, except per-share data)\nInterest and fees on loans $ 92,287 $ 92,570 $ 93,977 $ 92,927 Income from securities 36,373 36,844 37,088 33,688 Other interest income 1,891 1,991 2,501 3,133 -------- -------- -------- -------- Total interest income 130,551 131,405 133,566 129,748 -------- -------- -------- -------- Interest on deposits 43,724 48,451 52,446 54,843 Interest on borrowed funds 1,279 1,264 1,373 1,446 -------- -------- -------- --------\nTotal interest expense 45,003 49,715 53,819 56,289 -------- -------- -------- -------- Net interest income 85,548 81,690 79,747 73,459 Provision for loan losses 4,192 3,505 5,704 3,954 Other income 20,096 19,301 19,328 18,362 Other expense 62,644 60,102 58,972 57,173 Provision for income taxes 12,266 11,778 10,595 9,173 -------- -------- -------- -------- Net income $ 26,542 $ 25,606 $ 23,804 $ 21,521 ======== ======== ======== ======== Net income per share $ .82 $ .79 $ .74 $ .67\nQuarterly Average Balances\nAverage balances (in millions): Securities $ 2,188 $ 2,184 $ 2,176 $ 1,891 Loans 3,786 3,704 3,635 3,514 Total earning assets 6,213 6,126 6,072 5,710 Total assets 6,693 6,586 6,544 6,182\nDemand deposits 909 880 875 791 Interest-bearing deposits 4,958 4,905 4,889 4,631 Total deposits 5,867 5,785 5,764 5,422 Interest-bearing liabilities 5,123 5,064 5,042 4,778 Total stockholders' equity 599 580 563 547\nKey Ratios\nRates earned on assets 8.53% 8.70% 8.96% 9.26% Rates paid on liabilities 3.49 3.91 4.29 4.74 Net interest margin 5.65 5.48 5.40 5.30\nReturn on average assets 1.59 1.56 1.46 1.39 Return on average equity 17.74 17.74 16.91 15.73\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nCONSOLIDATED BALANCE SHEETS\nDecember 31 1993 1992 ---------- ---------- (In thousands)\nASSETS Cash and noninterest-bearing deposits in banks $ 326,136 $ 381,384 Federal funds sold and securities purchased under agreements to resell................. 235,000 235,000 ---------- ---------- Total cash and cash equivalents....... 561,136 616,384 ---------- ---------- Investment securities: U.S. Government & its agencies............. 1,904,717 1,871,284 State and municipal obligations............ 235,363 253,926 Other...................................... 35,954 40,017 ---------- ---------- Total investment securities (market value $2,228,818-1993 and $2,225,780-1992)................... 2,176,034 2,165,227 ---------- ---------- Loans......................................... 4,414,953 4,194,208 Deduct: Unearned income................... (327,635) (351,835) ---------- ---------- Loans, net of unearned income.......... 4,087,318 3,842,373 Allowance for loan losses......... (50,927) (49,340) ---------- ---------- Net loans............................. 4,036,391 3,793,033 ---------- ---------- Premises and equipment........................ 137,007 136,654 Other assets.................................. 126,315 129,249 ---------- ---------- Total Assets............................... $7,036,883 $6,840,547 ========== ==========\nCONSOLIDATED BALANCE SHEETS (Continued)\nDecember 31 1993 1992 ---------- ---------- (In thousands)\nLIABILITIES Deposits: Noninterest-bearing........................ $1,039,933 $1,012,268 Interest-bearing: Transaction accounts.................. 1,294,867 1,204,929 Money-market accounts................. 724,462 766,156 Savings deposits...................... 1,325,943 1,195,665 Certificates of deposit: Large denomination................. 165,360 157,810 Other.............................. 1,585,824 1,676,918 ---------- ---------- Total deposits..................... 6,136,389 6,013,746 Interest, taxes and other liabilities......... 56,126 63,494 Short-term borrowings......................... 151,859 150,681 Mortgage indebtedness......................... 1,008 5,227 ---------- ---------- Total Liabilities.......................... 6,345,382 6,233,148 ---------- ---------- STOCKHOLDERS' EQUITY Preferred stock, $10 par value................ 805 825 Common stock, $1 par value.................... 32,444 32,185 Capital Surplus............................... 68,406 64,930 Retained Earnings............................. 589,846 509,459 ---------- ---------- Total Stockholders' Equity................. 691,501 607,399 ---------- ---------- Total Liabilities and Stockholders' Equity. $7,036,883 $6,840,547 ========== ==========\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF INCOME\nYear Ended December 31\n1993 1992 1991 -------- -------- -------- (In thousands, except per share data) Interest income: Interest and fees on loans.......... $363,119 $371,761 $382,456 Interest and dividends on investment securities: U.S. Government & its agencies... 117,634 125,528 97,334 State and municipal obligations..................... 13,165 15,209 16,759 Other............................ 2,505 3,256 4,408 Income from federal funds sold and securities purchased under agreements to resell......... 8,359 9,516 14,880 -------- -------- -------- Total interest income............ 504,782 525,270 515,837 -------- -------- --------\nInterest expense: Deposits: Transaction accounts............. 31,840 34,540 40,382 Money market accounts............ 20,090 26,067 32,573 Savings deposits................. 37,432 35,883 28,243 Certificates of deposit: Large denomination............ 6,353 8,767 16,381 Other......................... 65,460 94,207 135,009 Short-term borrowings............... 3,563 4,149 6,479 Long-term indebtedness.............. 221 1,213 1,219 -------- -------- -------- Total interest expense........... 164,959 204,826 260,286 -------- -------- -------- Net interest income...................... 339,823 320,444 255,551 Provision for loan losses................ 6,450 17,355 14,024 -------- -------- -------- Net interest income after provision for loan losses......................... 333,373 303,089 241,527 -------- -------- --------\nCONSOLIDATED STATEMENTS OF INCOME (Continued)\nYear Ended December 31\n1993 1992 1991 -------- -------- -------- (In thousands, except per share data)\nNet interest income after provision for loan losses......................... 333,373 303,089 241,527 -------- -------- -------- Other income: Service charges on deposit accounts.. 34,448 33,080 32,475 Insurance premiums and commissions... 6,555 6,591 6,107 Credit card service charges and fees. 11,070 11,278 11,696 Trust services....................... 5,001 4,467 4,113 Income from other customer services.. 16,533 15,173 12,742 Securities gains (losses) before income tax provisions (credits) of $246-1993, $(100)-1992, and $(12)-1991..................... 711 (159) 8 Other................................ 8,222 6,657 5,142 -------- -------- -------- Total other income............... 82,540 77,087 72,283 -------- -------- -------- Other expenses: Salaries and employee benefits...... 134,296 129,137 116,490 Occupancy........................... 18,207 17,499 16,841 Equipment........................... 19,634 18,864 17,554 Telephone........................... 5,508 5,511 5,305 Printing and supplies............... 5,485 5,219 5,337 Credit card processing fees......... 6,431 6,467 7,100 FDIC assessment..................... 13,412 12,453 10,046 Other............................... 42,794 43,741 39,570 -------- -------- -------- Total other expenses............. 245,767 238,891 218,243 -------- -------- -------- Income before income taxes............... 170,146 141,285 95,567 Provision for income taxes............... 54,122 43,812 25,959 -------- -------- -------- NET INCOME............................... $116,024 $ 97,473 $ 69,608 ======== ======== ======== Net income per share of common stock..... $ 3.57 $ 3.02 $ 2.17\nAverage primary shares of common stock outstanding......... 32,512 32,252 32,092\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\n1993 1992 1991 -------- -------- -------- Preferred stock (Dollars in thousands) - --------------- Balance at beginning of year.............. $ 825 $ 1,027 $ 1,114 Redemption of 2,021 shares-1993, 20,241 shares-1992 and 8,635 shares-1991 upon conversion to common stock.............. (20) (202) (87) -------- -------- -------- Balance at end of year.................... $ 805 $ 825 $ 1,027 ======== ======== ======== Common stock - ------------ Balance at beginning of year.............. $ 32,185 $ 32,093 $ 32,009 Issuance of 196,679 shares for an acquired bank........................ 197 - - Issuance of 3,026 shares-1993, 29,770 shares-1992 and 12,746 shares-1991 upon conversion of preferred stock...... 3 30 13 Issuance of 48,500 shares-1993, 25,467 shares-1992 and 52,875 shares-1991 for stock options....................... 48 26 53 Issuance of 11,084 shares-1993, 36,239 shares-1992 and 18,624 shares-1991 for stock appreciation rights........... 11 36 18 -------- -------- -------- Balance at end of year.................... $ 32,444 $ 32,185 $ 32,093 ======== ======== ======== Capital surplus - --------------- Balance at beginning of year.............. $ 64,930 $ 63,121 $ 61,229 Increase arising from: Acquisition of a bank................... 2,117 - - Conversion of preferred stock........... 17 172 74 Issuance of common stock for the dividend reinvestment plan............ - 222 719 Exercise of stock options............... 937 321 696 Exercise of stock appreciation rights... 405 1,094 403 -------- -------- -------- Balance at end of year.................... $ 68,406 $ 64,930 $ 63,121 ======== ======== ======== Retained earnings - ----------------- Balance at beginning of year.............. $509,459 $443,877 $403,335 Increase attributable to an acquired bank. 1,139 Net income................................ 116,024 97,473 69,608 Dividends declared: Preferred stock......................... (54) (61) (71) Common stock $1.13 per share-1993, $.99 per share-1992 and $.91 per share-1991 (36,519) (31,830) (28,995) Dividends paid by a bank prior to its acquisition......................... (203) - - -------- -------- -------- Balance at end of year.................... $589,846 $509,459 $443,877 ======== ======== ======== See notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYear Ended December 31\n1993 1992 1991 -------- -------- -------- (In thousands) Operating activities - -------------------- Net income.................................... $116,024 $ 97,473 $ 69,608 Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and amortization 12,487 12,280 11,567 Gain on sale of fixed assets............... (208) (54) (105) Provision for loan losses.................. 6,450 17,355 14,024 Amortization of securities premiums........ 20,936 20,099 10,178 Accretion of securities discounts.......... (775) (1,232) (1,957) Net increase in mortgage loans held for sale (9,068) (34,263) (13,476) Loss (gain) on sale of securities.......... (711) 159 (8) Amortization of intangible assets.......... 3,963 3,666 2,262 Deferred income tax credits................ (1,943) (1,445) (3,394) Decrease (increase) in prepaid expenses.... (2,708) (5,566) 3,999 Decrease (increase) in interest receivable. 6,489 (2,733) (8,579) Decrease in interest payable............... (1,940) (14,531) (1,302) Increase in other accrued expenses......... 2,720 9,423 437 -------- -------- -------- Net cash provided by operating activities 151,716 100,631 83,254 -------- -------- -------- Investing activities - -------------------- Maturity of investment securities............. 626,353 475,329 448,358 Sale of investment securities................. 5,122 2,941 716 Purchase of investment securities............. (662,409) (849,695) (983,334) Net increase in loans......................... (240,530) (305,355) (80,413) Purchase of premises and equipment............ (12,996) (8,393) (11,275) Sales of premises and equipment............... 362 786 594 Goodwill acquired............................. - - (1,170) Mortgage servicing rights acquired............ (747) (748) (1,066) Other intangible assets acquired.............. (625) (2,987) (1,322) Other......................................... (7,409) 3,759 (5,759) -------- -------- -------- Net cash used for investing activities... (292,879) (684,363) (634,671) -------- -------- --------\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nYear Ended December 31\n1993 1992 1991 -------- -------- -------- (In thousands) Financing activities - -------------------- Net increase in deposits...................... 122,643 663,775 634,089 Net increase in short-term borrowings......... 1,178 5,865 59,149 Principal payments on long-term borrowings.... (4,219) (6,240) (712) Proceeds from long-term borrowings............ - - 344 Cash dividends paid: Common $1.08 per share-1993, $.96 per share-1992 and $.89 per share-1991......... (34,830) (30,945) (28,517) Preferred................................... (54) (65) (73) Cash dividends paid by a bank prior to its acquisition............................. (204) - - Proceeds from issuance of common stock........ 1,401 1,699 1,889 -------- -------- -------- Net cash provided by financing activities 85,915 634,089 666,169 -------- -------- -------- Net increase (decrease) in cash and cash equivalents..................... (55,248) 50,357 114,752\nCash and cash equivalents at beginning of year...................... 616,384 566,027 451,275 -------- -------- -------- Cash and cash equivalents at end of year. $561,136 $616,384 $566,027 ======== ======== ========\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Corporation and all of its subsidiaries. The Corporation's subsidiaries are predominantly engaged in banking. Foreign banking activities and operations other than banking are not significant. All material intercompany transactions and accounts have been eliminated. Certain amounts for years prior to 1993 have been reclassified for comparative purposes. All prior years have been restated to reflect a three-for-two common stock split in 1992.\nINVESTMENT SECURITIES\nAll securities are held for investment purposes. Debt securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. Equity securities are carried at the lower of aggregate cost or market value. Changes in market values of equity securities regarded as temporary are charged (credited) directly to stockholders' equity. Reductions in market values of equity securities regarded as other than temporary are charged to income, and the carrying value of the securities is permanently reduced by such amounts. The adjusted carrying value of the specific security sold is used to compute gains or losses on the sale of investment securities.\nLOANS\nInterest on installment loans is recorded as income in amounts that will provide an approximate level yield over the terms of the loans. Accrual of interest on other loans is based generally on the daily amount of principal outstanding. Interest is not accrued on loans if the collection of such interest is doubtful.\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is maintained at a level that is considered adequate to provide for potential losses in the loan portfolio. Management's evaluation of the adequacy of the allowance is based on a review of individual loans, past loss experience, current and anticipated economic conditions, the value of underlying collateral and other factors.\nPREMISES AND EQUIPMENT\nPremises and equipment are carried at cost, less accumulated depreciation and amortization computed principally on the straight-line method over lives not exceeding 50 and 20 years for buildings and equipment, respectively. Gains and losses on disposition are reflected in current operations. Maintenance and repairs are charged to operating expenses, and major alterations and renovations are capitalized. Capital leases are carried at the lower of the present value of their net minimum lease payments or the fair value of the leased properties at the inception of the lease, less accumulated amortization computed on the straight-line method over the noncancelable terms of the leases which do not exceed 20 years.\nINCOME TAXES\nIn 1992, the Corporation changed its method of accounting for income taxes from the deferred method to the liability method required by Financial Accounting Standards Board Statement No. 109 (SFAS No. 109), \"Accounting for Income Taxes\" (see Note 14 \"Income Taxes\"). Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. As permitted under SFAS No. 109, prior years' financial statements have not been restated.\nOTHER REAL ESTATE OWNED\nOther real estate owned primarily represents properties acquired by the Corporation's affiliates through customer loan defaults. The real estate is stated at an amount equal to the lesser of the loan balance prior to foreclosure, plus the costs incurred for improvements to the property, or fair value, less the estimated selling costs of the property. At the time of foreclosure, any excess of cost over the estimated fair value is charged to the allowance for loan losses. After foreclosure, the estimated fair value is reviewed periodically by management. Any further declines in fair value are charged against current earnings or any applicable foreclosed property valuation allowance.\n2. ACQUISITIONS\nOn August 27, 1993, the Corporation acquired United Southern Bank of Morristown, Tennessee, in exchange for 196,679 shares of common stock. As of December 31, 1992, United Southern Bank had total assets of $43.2 million and stockholders' equity of $3.4 million. Because the restatement would not have had a material effect upon the Corporation's financial statements, the accounts of United Southern Bank have not been retroactively reflected in periods prior to 1993. On June 19, 1991, Harwood-Andrews, Inc., was acquired for cash and was merged into First Virginia Insurance Services, Inc. On August 1, 1991 assets of Ferraro & Pinholster, Inc. were acquired by First Virginia Insurance Services, Inc. Both acquisitions were accounted for using the purchase method of accounting and were not material to the consolidated assets. As of December 31, 1993, unamortized goodwill of $10,136,000 arose from purchase acquisitions and is being amortized on a straight-line basis. Acquisitions purchased prior to 1976 are being amortized over 40 years, and those acquired after 1975 are being amortized over periods of 10 to 20 years. Unamortized core deposit intangibles were $3,141,000 on December 31, 1993, and are being amortized over periods of 5 to 10 years.\n3. RESTRICTIONS ON CASH BALANCES\nThe Corporation's banking affiliates are required by the Federal Reserve Board or by state banking laws to maintain certain minimum cash balances consisting of vault cash and deposits in the Federal Reserve Bank or in other commercial banks. Such restricted balances totaled $162,948,000 and $149,970,000 as of December 31, 1993 and 1992, respectively.\n4. INVESTMENT SECURITIES\nThe carrying amounts of investment securities and the related approximate market values were (in thousands): Carrying Unrealized Unrealized Fair Amount Gains Losses Value ---------- ------- ------ ---------- December 31,1993: U.S. Government and its agencies...$1,904,717 $46,992 $1,788 $1,949,921 State and municipal obligations.... 235,363 6,712 313 241,762 Other ............................. 35,954 1,201 20 37,135 ---------- ------- ------ ---------- Total............................$2,176,034 $54,905 $2,121 $2,228,818 ========== ======= ====== ========== December 31,1992: U.S. Government and its agencies...$1,871,284 $53,122 $1,797 $1,922,609 State and municipal obligations.... 253,926 7,486 151 261,261 Other ............................. 40,017 1,961 68 41,910 ---------- ------- ------ ---------- Total............................$2,165,227 $62,569 $2,016 $2,225,780 ========== ======= ====== ==========\nProceeds from the sale of investment securities during 1993 were $5,122,000, resulting in gains of $712,000 and losses of $1,000. Proceeds from the maturity of investment securities were $626,353,000, resulting in no gains or losses. Securities having a carrying value of $444,986,000 and $364,349,000 at December 31, 1993 and 1992, respectively, were pledged to secure public deposits and for other purposes required by law.\n5. LOANS\nLoans consisted of (in thousands): December 31 1993 1992 ---------- ---------- Consumer: Automobile installment ............................$1,571,418 $1,362,138 Home equity, fixed and variable rate............... 1,242,982 1,178,378 Revolving credit loans, including credit cards..... 161,995 163,711 Other.............................................. 167,942 184,879 Real estate: Construction and land development.................. 90,823 109,378 Commercial mortgage................................ 301,315 284,579 Residential mortgage............................... 493,968 529,315 Other, including Industrial Development Authority.. 63,082 69,898 Commercial........................................... 321,428 311,932 ---------- ---------- 4,414,953 4,194,208 Less unearned income, principally on consumer loans . 327,635 351,835 ---------- ---------- Loans, net of unearned income ..................... 4,087,318 3,842,373 Less allowance for loan losses....................... 50,927 49,340 ---------- ---------- Net loans .........................................$4,036,391 $3,793,033 ========== ==========\nLoans on which interest is not being accrued or whose terms have been modified to provide for a reduced rate of interest because of financial difficulties of borrowers and interest income earned with respect to such loans were (in thousands): December 31 1993 1992 ------- ------- Nonaccruing loans.....................................$18,387 $20,453 Restructured loans ................................... 2,175 1,139 ------- ------- $20,562 $21,592 ======= ======= Income recorded.......................................$ 107 $ 85\nIncome anticipated under original loan agreements ....$ 1,639 $ 1,507\nThere were no formal commitments of a material amount to lend additional funds under these agreements, but additional advances may be made in the future if it is in the interest of the Corporation to do so. Loans modified for reasons other than a reduction in the interest rate were not material in amount. The Corporation's loans are widely dispersed among individuals and industries. On December 31, 1993, there was no concentration of loans in any single industry that exceeded 5% of total loans.\nThe Corporation, in the normal course of business, has made commitments to extend loans and has written standby letters of credit which are not recognized in the financial statements. On December 31, 1993 and 1992, standby letters of credit totaled $19,984,000 and $20,495,000, respectively, and the unfunded amounts of loan commitments were (in thousands):\n1993 1992 ---------- ----------\nFixed rate revolving credit lines ...................$ 497,728 $ 478,754 Adjustable rate loans: Home equity lines ................................. 333,530 315,648 Commercial loans................................... 276,570 295,070 Construction and land development loans............ 49,783 42,446 Other ............................................. 132,543 79,956 ---------- ---------- Total ...........................................$1,290,154 $1,211,874 ========== ==========\nA majority of the commercial, construction and land development commitments, and letters of credit will expire within one year, and all loan commitments can be terminated by the Corporation if the borrower violates any condition of the commitment agreement. The credit risk associated with loan commitments and letters of credit is essentially the same as that involved with loans that are funded and outstanding. The Corporation uses the same credit standards on a case-by-case basis in evaluating loan commitments and letters of credit as it does when funding loans, including the determination of the type and amount of collateral, if required.\n6. ALLOWANCE FOR LOAN LOSSES\nActivity in the allowance for loan losses was (in thousands): Year ended December 31 1993 1992 1991 ------- ------- ------- Balance January 1...............................$49,340 $44,817 $43,917 Increase attributable to an acquired bank ...... 259 - - Provision charged to operating expense ......... 6,450 17,355 14,024 ------- ------- ------- 56,049 62,172 57,941 ------- ------- ------- Deduct: Loans charged off............................. 9,211 16,520 16,486 Less recoveries............................... 4,089 3,688 3,362 ------- ------- ------- Net charge-offs............................... 5,122 12,832 13,124 ------- ------- ------- Balance December 31.............................$50,927 $49,340 $44,817 ======= ======= =======\n7. PREMISES AND EQUIPMENT\nPremises and equipment consisted of (in thousands): December 31 1993 1992 -------- --------\nLand .................................................$ 28,035 $ 24,666 Premises and improvements............................. 134,939 131,010 Furniture and equipment............................... 88,207 83,175 -------- -------- 251,181 238,851 Accumulated depreciation and amortization............. 114,174 102,197 -------- -------- Carrying value .....................................$137,007 $136,654 ======== ========\n8. INDEBTEDNESS\nShort-term borrowings consisted of (in thousands): December 31 1993 1992 -------- -------- Securities sold under agreements to repurchase .......$134,637 $129,345 Commercial paper (parent company only) ............... 17,222 21,336 -------- -------- $151,859 $150,681 ======== ========\nSecurities sold under agreements to repurchase generally mature within three days from the transaction date. Commercial paper maturities range from 1 to 270 days. Bank lines of credit available to the Corporation amounted to $25,000,000 at December 31, 1993 and 1992. Such lines were not being used on either of those dates.\nMortgage indebtedness, including capital lease obligations, of the Corporation and its subsidiaries was (in thousands): December 31 1993 1992 ------ ------ 9 3\/4%, payable through February 2012 (parent company only)...................$ - $4,095 Capital leases ........................................ 1,008 1,132 ------ ------ $1,008 $5,227 ====== ====== The capital leases are on properties which had a carrying value of $609,000 on December 31, 1993.\nThe principal maturities of debt, other than short-term borrowings, in each of the five years after December 31, 1993, will be $123,000, $133,000, $140,000, $29,000, and $16,000, respectively. Interest paid on deposits and indebtedness during the years 1993, 1992 and 1991 totaled $166,892,000, $219,356,000 and $261,580,000, respectively.\n9. PREFERRED STOCK\nThere are 3,000,000 shares of preferred stock, par value of $ 10.00 per share, authorized. The following four series of cumulative convertible pre- ferred stock were outstanding as of December 31: Number of Shares Series Dividends 1993 1992 ------ ------ A 5% 24,673 25,831 B 7% 10,110 10,670 C 7% 13,964 13,968 D 8% 31,712 32,011 ------ ------ 80,459 82,480 ====== ======\nThe Series A and Series B shares are convertible into one and one-half shares of common stock, and the Series C shares are convertible into one and two-tenths shares of common stock. They may be redeemed at the option of the Corporation for $10.00 per share. The Series D shares are convertible into one and one-half shares of common stock. They are redeemable at the option of the Corporation for $10.16 until March 15, 1994, and for $.08 less per year each succeeding year to a minimum of par value.\n10. COMMON STOCK\nThere are 60,000,000 shares of common stock, par value $1.00 per share, authorized, and 32,444,000 shares and 32,185,000 shares were outstanding on December 31, 1993 and 1992, respectively. On December 31, 1993, options to purchase 345,263 shares of common stock and 11,625 stock appreciation rights were outstanding under employee stock option and stock appreciation rights plans. An additional 281,500 shares are authorized for further granting of options and rights. Options for 207,512 shares were exercisable on December 31, 1993, at a weighted-average price of $18.96. Additional options becoming exercisable in subsequent years total 60,001 in 1994 at an average price of $28.15, 20,250 in 1995 at an average price of $32.43, 19,250 in 1996 at an average price of $32.45, 19,250 in 1997 at an average price of $32.45, and 19,000 in 1998 at an average price of $32.45.\nTransactions involving employee stock options were as follows:\nYear ended December 31 1993 1992 1991 ------- ------- -------\nBalance at beginning of year (41,250 for $12.25, 62,250 for $19.75, 71,241 for $14.833 and 120,000 for $19.167 and 63,000 for $15.25 in 1991)....................304,613 389,004 357,741 Options granted: For $23.083 per share ........................ - - 113,250 For $32.75 per share ......................... 60,000 - - For $32.125 per share ........................ 50,000 - - Options exercised: For $12.25 per share ......................... (3,000) (14,250) (16,500) For $19.75 per share .........................(10,850) (21,000) (3,750) For $14.833 per share ........................ (9,750) (9,966) (34,875) For $19.167 per share ........................(15,750) (16,675) (25,362) For $15.25 per share ......................... - (22,500) - For $23.083 per share ........................(30,000) - - Options canceled or forfeited: For $14.833 per share ........................ - - (1,500) ------- ------- ------- Balance at end of year ........................345,263 304,613 389,004 ======= ======= =======\nA stock appreciation right entitles the holder to the difference between the value of a share of common stock on the exercise date and the value on the date the right was granted. Payment will be made with common stock based on its value on the exercise date. In 1984, 78,000 rights were granted for $12.25, and in 1989, 48,750 were granted for $19.167. In 1991, 18,624 shares were issued for 81,612 rights. In 1992, 36,239 shares were issued for 78,350 rights, and in 1993, 11,084 shares were issued for 22,800 rights. On December 31, 1993, 11,625 rights were exercisable for an average price of $18.05 per share. Holders of 172,113 options outstanding on December 31, 1993, with an average price of $21.15, may elect on the exercise date to receive the benefits of a stock appreciation right rather than an option. Compensation expense is recognized in connection with stock appreciation rights based on the current market value of the common stock. No compensation expense is recognized in connection with stock options, unless an election can be made by the holder to treat the option as a stock appreciation right. A stock option is accounted for at the difference between the market price of the option on the measurement date or date granted and the amount the employee is required to pay. All options are granted at full market price on the date of the grant and, therefore, no compensation expense is recognized. In certain cases, a holder may exercise an option as a stock appreciation right. Stock appreciation rights are measured in the same way as an option, except that in subsequent periods if a change in the market value of the shares occurs, then adjustments between the current market price and previously accrued amounts are recorded as compensation expense. At December 31, 1993, 1,142,863 shares of common stock were reserved: 116,498 for the conversion of preferred stock and 638,388 for stock options and stock appreciation rights and 387,977 for a bank acquisition. The Corporation has adopted a shareholder rights plan, which under certain circumstances will give the holders of the Corporation's common stock the right to purchase shares of its preferred stock or other securities. The rights will become exercisable if a person or entity should acquire 20% or more of the Corporation's voting stock, unless it is acquired pursuant to an offer for all outstanding shares of common stock at a price and on terms determined by the Board of Directors to be adequate and in the best interests of the Corporation and its stockholders. If the rights become exercisable, the holder of each share of common stock, except the person or entity acquiring 20% or more of the voting stock, will have the right to purchase for $90 the number of one one-hundredths of a share of preferred stock or equivalent security equal to $180, divided by the then market value of one share of common stock. In the event of a merger involving an exchange of common stock, the holder of each right, except the acquiring person or entity, will also have the right to purchase for $90 the number of shares of common stock of the acquiring company having a then market value of $180. The Corporation may redeem the rights for $.01 per right, at its option, at any time prior to the date they become exercisable. The rights expire on August 8, 1998.\n11. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, (SFAS No. 107) \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flow analysis or other valuation techniques. Those techniques involve subjective judgment and are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. As a result, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, cannot be realized in immediate settlement of the instrument. The following methods and assumptions were used by the Corporation in estimating the fair value of its financial instruments:\nCash and Cash Equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.\nInvestment Securities: Fair values for investment securities are based on quoted market prices.\nLoans: For variable-rate loans that reprice frequently, with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans (e.g., one-to-four family residential) and credit cards are based on quoted market prices of similar loans sold in con- junction with securitization transactions and are adjusted for differences in loan characteristics. The fair values for other loans are estimated with discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.\nDeposits: For deposits with no defined maturity, SFAS No. 107 defines the fair value as the amount payable on demand and prohibits adjusting fair value for any value derived from retaining those deposits for an expected future period of time. That component, commonly referred to as a deposit base intangible, is neither considered in the fair value amounts nor is it recorded as an intangible asset in the balance sheet. Fair values for fixed- rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated, expected monthly maturities.\nShort-Term Borrowings: The carrying amount of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings approximate their fair values.\nLong-Term Debt: The Corporation's long-term debt consists entirely of capitalized lease obligations which are exempt from the disclosure requirements of SFAS No. 107.\nOff-Balance Sheet Instruments: The estimated fair value of off-balance sheet items was not material at December 31, 1993.\nThe estimated fair values of the Corporation's financial instruments as of December 31, 1993 are as follows: Carrying Fair Amount Value ---------- ---------- Financial assets: Cash and cash equivalents..........................$ 561,136 $ 561,136 Investment securities.............................. 2,176,034 2,228,813 Loans, net......................................... 4,087,318 4,171,083\nFinancial liabilities: Deposits........................................... 6,136,389 6,144,630 Short-term borrowings.............................. 151,859 151,859\nSFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. The disclosures also do not include certain intangible assets such as deposit base intangibles, mortgage servicing rights and goodwill. Accordingly, the aggregate fair value amount presented should not be interpreted as representing the underlying value of the Corporation.\n12. RETIREMENT BENEFITS\nThe Corporation and its subsidiaries have a noncontributory, defined- benefit pension plan covering substantially all of their qualified employees. The benefits are based on years of service and the employee's compensation during the last five years of employment. The Corporation's funding policy is to make annual contributions in amounts necessary to satisfy the Internal Revenue Service's funding standards to the extent they are deductible against taxable income. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Contributions to the plan totaled $3,385,000, $2,587,000 and $732,000 in 1993, 1992 and 1991, respectively. Contributions include normal costs of the plan and amortization for periods of up to 40 years of unfunded past service cost.\nPension expense included the following components (in thousands): Year ended December 31 1993 1992 1991 ------ ------ ------ Service cost - benefits earned during the period..$2,541 $2,239 $2,059 Interest cost on projected benefit obligation..... 4,615 4,185 3,951 Actual return on plan assets......................(3,267) (2,609) (9,014) Net amortization and deferral ....................(2,336) (2,510) 4,652 ------ ------ ------ Net periodic pension cost.......................$1,553 $1,305 $1,648 ====== ====== ======\nThe following table sets forth the plan's funded status and amounts recognized in the consolidated balance sheets (in thousands): December 31 1993 1992 1991 ------- ------- ------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $46,693, $38,372 and $32,877......... $51,485 $42,535 $36,653 ======= ======= ======= Plan assets at fair value ........................ $67,126 $62,489 $59,136 Projected benefit obligation for service rendered to date............................. 66,242 58,553 54,195 ------- ------- ------- Plan assets in excess of projected benefit obligation 884 3,936 4,941 Unrecognized net (gain) loss from past experience different from that assumed and effects of change in assumptions............................. 7,988 3,343 (2,077) Unamortized prior service cost....................... (2,611) (2,864) 255 Unrecognized net obligation at January 1, 1990 being recognized over 15 years ................... 86 100 114 ------- ------- ------- Prepaid pension cost included in other assets........$ 6,347 $ 4,515 $ 3,233 ======= ======= =======\nThe assets of the plan consist of U.S. Treasury securities-33%, other debt obligations- 33%, stocks- 28%, and cash and equivalents- 6%. The weighted- average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.25% and 4.75%, respectively. The expected long-term rate of return on plan assets was 9%. The Corporation and its subsidiaries have a thrift plan to which employees with one year of service may elect to contribute up to 6% of their salary. The Corporation contributes to the plan to the extent of 50% of the employees' contributions, and an additional 25% contribution is made if a specified profit objective is met. A 75% employer match was made in each of the years 1993, 1992 and 1991 when the Corporation's contributions to the plan totaled $3,055,000, $2,784,000 and $2,681,000, respectively. The plan is administered under the provisions of Section 401(k) of the Internal Revenue Code. Certain retired individuals who were participating in any of the Corporation's medical plans at retirement may elect to receive medical benefits similar to those provided for active employees if they make their elections within 30 days of retirement. Terminated employees may elect to receive such benefits for a limited period.\n13. OTHER POSTRETIREMENT BENEFIT PLANS\nIn addition to the Corporation's defined benefit pension plan, the Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits to full-time employees who have worked at least 10 years and have attained age 55 while in service with the Corporation. The benefits are based on years of service and are contributory, with retiree contributions adjusted annually, and contain other cost-sharing features such as deductibles and coinsurance. Employees hired after December 31, 1993, may participate in the plan but must pay 100% of the cost. The accounting for the plan anticipates future cost-sharing changes to the written plan that are consistent with the Corporation's expressed intent to increase the retiree contribution rate annually for the expected increase in medical costs for that year. The Corporation has set a maximum amount that it will contribute per year of approximately three times the 1993 contribution level. The plan is not funded. In 1993, the Corporation adopted Financial Accounting Standards Board Statement No. 106 (SFAS No. 106), \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" The effect of adopting the new rules increased 1993 net periodic postretirement benefit cost by $1,977,000 and decreased 1993 net income by $1,285,000. Postretirement benefit cost for 1992, which was recorded on a cash basis, has not been restated.\nThe following table presents the plan's funded status, reconciled with amounts recognized in the Corporation's statement of financial position (in thousands). December 31 ------- Accumulated postretirement benefit obligation: Retirees ................................................ $ 6,083 Fully eligible, active plan participants ................ 2,587 Other active plan participants .......................... 8,206 ------- 16,876\nPlan assets at fair value .................................. - ------- Accumulated postretirement benefit obligation in excess of plan assets ................................ 16,876 Unrecognized net gain or (loss) ............................ 3,299 Unrecognized transition obligation ......................... 11,600 ------- Accrued postretirement benefit cost ........................ $ 1,977 =======\nNet periodic postretirement benefit cost includes the following components:\n1993 1992 ------ ------ Service cost ........................................ $ 691 $ 270 Interest cost ....................................... 977 - Amortization of transition obligation over 20 years . 610 - ------ ------ Net periodic postretirement benefit cost............. $2,278 $ 270 ====== ======\nThe weighted-average, annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is 11.3% for 1994 and is assumed to decrease gradually to 5.0% for 2003 and to remain at that level thereafter. The health care, cost-trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care, cost-trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993, by $967,000, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1993 by $81,000. The Corporation has limited its exposure to increases in health care, cost-trend rates by setting a cap on the maximum amount it will ever pay on any one retiree and by passing through 100% of the cost of retiree\nhealth care to new employees hired after December 31, 1993. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% at December 31, 1993.\n14. INCOME TAXES\nIn 1992, the Corporation adopted Financial Accounting Standards Board Statement No. 109 (SFAS No. 109), \"Accounting for Income Taxes,\" which increased the 1992 provision for income taxes by $886,000. Significant components of the Corporation's deferred-tax liabilities and assets are as follows (in thousands):\nDecember 31 1993 1992 ------- ------- Deferred-tax liabilities: Life insurance reserves................................$ 2,812 $ 2,487 Depreciation........................................... 6,635 6,726 Other.................................................. 4,252 4,017 ------- ------- Total deferred-tax liabilities ........................ 13,699 13,230 ------- ------- Deferred-tax assets: Installment loan interest and fees..................... 2,628 2,537 Deferred compensation.................................. 4,504 4,040 Allowance for loan losses.............................. 17,769 16,691 Other.................................................. 5,262 4,483 ------- ------- Total deferred tax assets.............................. 30,163 27,751 ------- ------- Net deferred-tax assets .................................$16,464 $14,521 ======= =======\nThe provision for income taxes includes amounts currently payable and amounts deferred to or from other years as a result of differences in timing of income or expenses for reporting and tax purposes. The income tax provision includes the following amounts (in thousands): Liability Deferred Method Method ---------------- ------- 1993 1992 1991 ------- ------- ------- Current: Federal income taxes ..............................$54,590 $44,120 $28,515 State income taxes................................. 1,475 1,137 838 ------- ------- ------- Total current...................................... 56,065 45,257 29,353 ------- ------- ------- Deferred (benefit): Federal income taxes .............................. (1,858) (1,272) (3,349) State income taxes................................. (85) (173) (45) ------- ------- ------- Total deferred .................................... (1,943) (1,445) (3,394) ------- ------- ------- $54,122 $43,812 $25,959 ======= ======= ======= Income taxes paid during the year..................$60,207 $46,010 $28,744 ======= ======= =======\nThe components of the provision for deferred income taxes for the year ended December 31, 1991 are as follows (in thousands):\n------- Deferred (benefit): Provision for loan loss..............................................$ (317) Depreciation ........................................................ (333) Installment loan interest and fees .................................. (978) Other, net........................................................... (1,766) ------- Provision for deferred income taxes....................................$(3,394) =======\nThe exclusion of certain categories of income and expense from taxable net income results in an effective tax rate which is lower than the statutory federal rate. The differences in the rates are as follows (dollars in thousands):\nLiability Method Deferred Method ------------------------------- --------------- 1993 1992 1991 --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent ------- ------- ------- ------- ------- ------- Statutory rate................$59,551 35.0% $48,037 34.0% $32,493 34.0% Nontaxable interest on municipal obligations....... (5,847) (3.4) (6,210) (4.4) (6,704) (7.0) Adoption of SFAS No. 109...... 886 .6 Other items .................. 418 .2 1,099 .8 170 .2 ------- ------- ------- ------- ------- ------- Effective rate................$54,122 31.8% $43,812 31.0% $25,959 27.2% ======= ======= ======= ======= ======= =======\n15. EARNINGS PER SHARE\nEarnings per share of common stock, after giving effect to dividends on preferred stock of $54,000 in 1993, $61,000 in 1992 and $71,000 in 1991, are based on 32,512,000, 32,252,000 and 32,092,000 average shares outstanding, respectively. The dilutive effect upon earnings per share of the conversion of the outstanding, convertible preferred stock and other items was not material for any of the three years.\n16. LEASES\nThe Corporation's subsidiaries have entered into lease agreements with unaffiliated persons for premises, principally banking offices. Many of the leases have one or more renewal options, generally for five or ten years, and some contain a provision for increased rent during the renewal period. Leases containing a provision for contingent payments are immaterial in number or amount. Portions of a few premises are subleased, and the amount of rent received is not material. There are no significant restrictions imposed on the Corporation or its subsidiaries by the lease agreements. The subsidiaries also lease a portion of their computer systems and other equipment. Leases on 10 banking offices have been recorded as capital leases. The effect of capitalizing such leases on net income has not been material.\nMinimum rental payments over the noncancelable term of operating and capital leases having a remaining term in excess of one year are (in thousands):\n1994..............................................$ 4,890 1995.............................................. 4,509 1996.............................................. 3,935 1997.............................................. 3,173 1998.............................................. 2,449 Thereafter........................................ 10,637 ------- Total minimum lease payments......................$29,593 =======\nDuring 1993, 1992 and 1991, occupancy and equipment expense included the rent paid on operating leases of $13,668,000, $13,242,000 and $12,387,000, respectively, and was reduced by rental income of $2,024,000, $2,571,000 and $2,555,000, respectively, applicable to leases to unaffiliated persons, generally for a five-to-ten-year duration.\n17. COMMITMENTS AND CONTINGENCIES\nThe Corporation, in the normal course of its business, is the subject of legal proceedings instituted by customers and others. In the opinion of the Corporation's management, there were no legal matters pending as of December 31, 1993, which would have a material effect on its financial statements.\n18. RESTRICTIONS ON LOANS AND DIVIDENDS FROM SUBSIDIARIES\nThe Corporation's banking affiliates and its life insurance subsidiary are subject to federal and\/or state statutes which prohibit or restrict certain of their activities, including the transfer of funds to the Corporation. There are restrictions on loans from banks to their parent company, and banks and life insurance companies are limited as to the amount of cash dividends which they can pay. As of December 31, 1993, the Corporation's equity in the net assets of its subsidiaries, after elimination of intercompany deposits and loans, totaled $606,939,000. Of that amount, $511,005,000 was restricted as to the payment of dividends. Consolidated retained earnings in the amount of $250,005,000 were free of limitations on the payment of dividends to the Corporation's stockholders as of December 31, 1993.\n19. RELATED-PARTY TRANSACTIONS\nDirectors and officers of the Corporation and their affiliates were customers of, and had other transactions with, the Corporation in the ordinary course of business. The Corporation has made residential mortgage loans at favorable rates to officers of the Corporation and its subsidiaries who have been relocated for the convenience of the Corporation. Other loan transactions with directors and officers were made on substantially the same terms as those prevailing for comparable loans to other persons and did not involve more than normal risk of collectibility or present other unfavorable features. As of December 31, 1993, and 1992, loans to directors and executive officers of the Corporation and its largest subsidiary bank, where the aggregate of such loans exceeded $60,000, totaled $35,056,000 and $39,342,000, respectively. During 1993, $1,850,000 of new loans were made and repayments totaled $6,136,000. These totals include loans to certain business interests and family members of the directors and executive officers, and no losses are anticipated in connection with any of the loans.\n20. FIRST VIRGINIA BANKS, INC. (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION (IN THOUSANDS)\nBALANCE SHEETS December 31 1993 1992 -------- -------- Assets Cash and noninterest-bearing deposits principally in affiliated banks.......................$ 1,474 $ 1,158 Securities purchased under agreements to resell......... 28,390 30,080 Investment in affiliates based on the Corporation's equity in their net assets: Member banks......................................... 541,769 491,781 Bank-related companies............................... 10,381 9,748 Investment securities, (market value $28,107-1993 and $7,215-1992)................................... 27,101 5,732 Loans (including $52,758-1993 and $47,896-1992 to affiliated companies) .......................... 53,429 49,391 Premises and equipment.................................. 40,128 40,524 Goodwill................................................ 7,884 8,540 Other assets ........................................... 30,360 26,478 -------- -------- Total Assets .........................................$740,916 $663,432 ======== ========\nLiabilities Interest, taxes and other liabilities ..................$ 32,193 $ 30,602 Commercial paper ....................................... 17,222 21,336 Mortgage indebtedness .................................. - 4,095 -------- -------- Total Liabilities .................................... 49,415 56,033 -------- -------- Stockholders' Equity Preferred stock......................................... 805 825 Common stock............................................ 32,444 32,185 Capital surplus......................................... 68,406 64,930 Retained earnings....................................... 589,846 509,459 -------- --------\nTotal Stockholders' Equity............................ 691,501 607,399 -------- -------- Total Liabilities and Stockholders' Equity............$740,916 $663,432 ======== ========\nSTATEMENTS OF INCOME\nYear Ended December 31 1993 1992 1991 -------- ------- ------- Income Dividends from affiliates: Member banks .....................................$ 68,674 $63,171 $37,784 Bank-related companies ........................... 25 335 170 Service fees from affiliates........................ 10,529 10,884 9,810 Rental income: Affiliates ...................................... 5,185 5,891 5,921 Other ........................................... 1,782 2,252 2,307 Interest and dividends on investment securities .... 1,901 1,433 2,744 Other income: Affiliates ....................................... 2,390 2,096 1,774 Other ............................................ 751 494 49 -------- ------- ------- Total income.................................... 91,237 86,556 60,559 -------- ------- -------\nExpenses Salaries and employee benefits...................... 12,685 16,680 12,673 Interest ........................................... 517 1,594 1,999 Other expenses: Paid to affiliates................................ 806 1,517 1,493 Other ............................................ 9,673 9,834 10,119 -------- ------- ------- Total expenses.................................. 23,681 29,625 26,284 -------- ------- ------- Income before income taxes and equity in undistributed income of affiliates ............ 67,556 56,931 34,275 Income tax benefits................................. 1,054 2,368 1,701 -------- ------- ------- Income before equity in undistributed income of affiliates............. 68,610 59,299 35,976 Equity in undistributed income of affiliates ....... 47,414 38,174 33,632 -------- ------- ------- Net income..........................................$116,024 $97,473 $69,608 ======== ======= =======\nSTATEMENTS OF CASH FLOWS\nYear Ended December 31 1993 1992 1991 ------- ------- ------- Net cash provided by operating activities............$69,025 $68,301 $40,638 ------- ------- ------- Investing activities: Proceeds from maturity of investment securities.... 27,343 5,920 7,969 Proceeds from the sale of investment securities.... 824 Purchase of investment securities .................(48,931) (5,198) (11,908) Net (increase) decrease in loans................... (4,862) (37,152) 308 Purchases of premises and equipment ............... (1,891) (1,096) (1,388) Sales of premises and equipment ................... 3 (28) 23 Investment in affiliates........................... (3,453) (6,000) (271) Other.............................................. 2,260 (4,654) (2,441) ------- ------- ------- Net cash used for investing activities..........(28,707) (48,208) (7,708) Financing activities: Net increase (decrease) in short-term borrowings .. (4,114) 2,054 2,914 Principal payments on long-term borrowings......... (4,095) (5,890) (422) Cash dividends - common............................(34,830) (30,945) (28,517) Cash dividends - preferred ........................ (54) (65) (73) Proceeds from issuance of common stock............. 1,401 1,698 1,890 ------- ------- ------- Net cash used for financing activities .........(41,692) (33,148) (24,208) ------- ------- ------- Net increase (decrease) in cash and cash equivalents..................... (1,374) (13,055) 8,722 Cash and cash equivalents at beginning of year . 31,238 44,293 35,571 ------- ------- ------- Cash and cash equivalents at end of year........$29,864 $31,238 $44,293 ======= ======= =======\nNet cash provided by operating activities has been reduced (increased) by the following cash payments (receipts): Interest on indebtedness...........................$ 518 $ 1,598 $ 1,998 Income taxes....................................... (954) (1,727) (420)\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING - ---------------------------------------------------\nThe management of First Virginia Banks, Inc. has prepared and is responsible for the accompanying financial statements, together with the financial data and other information presented in this annual report. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances. The financial statements include amounts that are based on management's best estimates and judgments. Management maintains and depends upon an internal accounting control system designed to provide reasonable assurance that transactions are executed in accordance with management's authorization, that financial records are reliable as the basis for the preparation of all financial statements, and that the Corporation's assets are safeguarded. The design and implementation of all systems of internal control are based on judgments required to evaluate the costs of control in relation to the expected benefits and to determine the appropriate balance between these costs and benefits. The Corporation maintains a professional internal audit staff to monitor compliance with the system of internal accounting control. Operational and special audits are conducted, and internal audit reports are submitted to appropriate management. The Audit Committee of the Board of Directors, comprised solely of outside directors, meets periodically with the independent public accountants, management and internal auditors to review accounting, auditing and financial reporting matters. The independent public accountants and internal auditors have free access to the Committee, without management present, to discuss the results of their audit work and their evaluations of the adequacy of internal controls and the quality of financial reporting. The financial statements in this annual report have been audited by the Corporation's independent auditors, Ernst & Young, for the purpose of determining that the financial statements are presented fairly. Their independent professional opinion on the Corporation's financial statements is presented on the following page.\n\/S\/ Robert H. Zalokar _______________________ Robert H. Zalokar Chairman and Chief Executive Officer\n\/S\/ Richard F. Bowman _______________________ Richard F. Bowman Vice President, Treasurer and Chief Financial Officer\nREPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS - ---------------------------------------------\nTo the Stockholders and Board of Directors First Virginia Banks, Inc.\nWe have audited the accompanying consolidated balance sheets of First Virginia Banks, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Virginia Banks, Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nWashington, D.C. January 13, 1994\n\/S\/ Ernst & Young ___________________\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nNot applicable.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nThe Board of Directors is divided into three classes (A, B and C). The term of office for Class A directors will expire at the Annual Meeting to be held on April 22, 1994. Five persons, all of whom are presently on the Board, have been nominated to serve as Class A directors. If elected, the five nominees will serve for a term of three years.\nIt is the intention of the persons named in the proxy, unless stockholders specify otherwise by their proxies, to vote for the election of the five nominees named below as Class A Directors. Although the Board of Directors does not expect that any of the persons named will be unable to serve as a director, should any of them be unable to accept nomination or election, it is intended that shares represented by the proxy will be voted by the proxy holders for such other person or persons as may be designated by the present Board of Directors.\nCertain information concerning the nominees for election and the Class B and Class C directors who will continue in office after the meeting is set forth below and on the following pages, as furnished by them.\nNominees For Class A Directors\nE. Cabell Brand, 70, is President of Recovery and Development Systems, Inc., a company in Salem, Virginia that engages in business and environmental consulting and international development projects. He is a director of First Virginia Bank-Southwest, Roanoke, Virginia and has been a director of First Virginia since 1976. He serves on the Management Compensation and Benefits Committee and the Director Nominating Committee and beneficially owns 5,538 shares of Common Stock. (1)\nElsie C. Gruver, 67, is a community and civic leader in Arlington, Virginia and has been a director of First Virginia since 1973. She is Chairman of the Public Policy Committee and a member of the Audit Committee and beneficially owns 7,837 shares of Common Stock. (2)\nW. Lee Phillips, Jr., 58, is a professional engineer and land surveyor based in Falls Church, Virginia and has been a director of First Virginia since 1985. He is a director of First Virginia Bank, Falls Church, Virginia. He serves on the Audit Committee as well as the Management Compensation and Benefits Committee and beneficially owns 8,209 shares of Common Stock. (3)\nJosiah P. Rowe, III, 66, is Co-Publisher and General Manager of The Free Lance Star Publishing Co. of Fredericksburg, Virginia and has been a director of First Virginia since 1991. He is a director of First Virginia Bank, Falls Church, Virginia. He serves on the Public Policy Committee and the Director Nominating Committee and beneficially owns 1,500 shares of Common Stock and 100 shares of Preferred Stock.\nAlbert F. Zettlemoyer, 59, is President of the Government Systems Group of UNISYS Corporation in McLean, Virginia and is Executive Vice President of UNISYS and has been a director of First Virginia since 1978. He serves on the Audit Committee and chairs the Management Compensation and Benefits Committee. He beneficially owns 3,000 shares of Common Stock. (4)\nClass B Directors\nEdward L. Breeden, III, 59, is a partner in the law firm of Breeden, MacMillan & Green in Norfolk, Virginia, and has been a director of First Virginia since 1982. He is a director of First Virginia Bank of Tidewater, Norfolk, Virginia and of First Virginia Life Insurance Company. He serves on both the Executive Committee and the Public Policy Committee and chairs the Audit Committee. He beneficially owns 65,747 shares of Common Stock. (5)\nGilbert R. Giordano, 65, is a partner in the law firm of Giordano, Bush, Villareale & Vaughan, P.A. in Upper Marlboro, Maryland and has been a director of First Virginia since 1989. He is Chairman of the Board of First Virginia Bank-Maryland, Upper Marlboro, Maryland. He serves on the Audit Committee and the Director Nominating Committee and beneficially owns 203,755 shares of Common Stock. (6)\nEric C. Kendrick, 47, is President of Mereck Associates, Inc., a real estate management and development firm in Arlington, Virginia and has been a director of First Virginia since 1986. He serves on the Management Compensation and Benefits Committee and the Public Policy Committee. He beneficially owns 63,127 shares of Common Stock. (7)\nRichard T. Selden, 71, is the Carter Glass Professor of Economics at the University of Virginia in Charlottesville, Virginia and has been a director of First Virginia since 1978. He is a director of First Virginia Bank, Falls Church, Virginia. Dr. Selden serves on the Audit Committee and beneficially owns 3,200 shares of Common Stock. (8)\nRobert H. Zalokar, 66, is Chairman of the Board and Chief Executive Officer of First Virginia and Chairman of the Board, First Virginia Bank, Falls Church, Virginia. He has been a director of First Virginia since 1959. Mr. Zalokar is also Chairman of First Virginia Life Insurance Company, First Virginia Mortgage Company and First Virginia Services, Inc. as well as Chairman or director of other nonbank affiliates. He serves on the Executive Committee and is an ex officio member of the Public Policy Committee and the Director Nominating Committee. He owns 124,055 shares of Common Stock. (9)\nClass C Directors\nPaul H. Geithner, Jr., 63, is President and Chief Administrative Officer of First Virginia and has been a director of First Virginia since 1984. He is also a director of First Virginia Bank in Falls Church, First Virginia Life Insurance Company, First Virginia Insurance Services, Inc., First Virginia Mortgage Company and other affiliated companies. He is a member of the Public Policy Committee and the Executive Committee and beneficially owns 45,849 shares of Common Stock. (10)\nL. H. Ginn, III, 60, is President of Lighting Affiliates, Inc., a distributor of electrical fixtures located in Richmond, Virginia and has been a director of First Virginia since 1978. Mr. Ginn is a retired U. S. Army Reserve Major General. He is Chairman of the Board of First Virginia Bank-Colonial, Richmond, Virginia. He is a member of the Executive Committee and the Director Nominating Committee and beneficially owns 10,856 shares of Common Stock. (11)\nT. Keister Greer, 72, is counsel for Greer & Melesco, attorneys in Rocky Mount, Virginia and has been a director of First Virginia since 1976. He is Chairman of the Board of First Virginia Bank-Franklin County, Rocky Mount, Virginia. Mr. Greer is a member of the Public Policy Committee and the Director Nominating Committee and beneficially owns 17,400 shares of Common Stock. (12)\nEdward M. Holland, 54, is an attorney in Arlington, Virginia and a member of the Virginia General Assembly (Senate) and has been a director of First Virginia since 1974. He is also a director of First Virginia Bank, Falls Church, Virginia. He serves on the Executive Committee and the Management Compensation and Benefits Committee and beneficially owns 60,979 shares of Common Stock. (13)\nThomas K. Malone, Jr., 74, is retired Chairman and Chief Executive Officer of First Virginia and has been a director of First Virginia since 1957. He is a director of First Virginia Bank in Falls Church, First Virginia Life Insurance Company and First Virginia Mortgage Company. He is also Chairman Emeritus of Marymount University in Arlington, Virginia. Mr. Malone is Chairman of both the Executive Committee and the Director Nominating Committee. He also serves on the Public Policy Committee and beneficially owns 44,632 shares of Common Stock. (14)\n(1)Includes 264 shares of Common Stock held indirectly through his spouse.\n(2)Includes 1,782 shares of Common Stock held in a Keogh Plan, 900 shares held in an Individual Retirement Account, 1,900 shares held in her spouse's Keogh Plan, and 900 shares held in her spouse's Individual Retirement Account.\n(3)Includes 3,000 shares held by a trust in which Mr. Phillips is a trustee.\n(4)All of the shares are held jointly with his spouse.\n(5)Includes 7,500 shares held by a corporation of which Mr. Breeden is President, 16,325 shares held by two foundations of which Mr. Breeden is Chairman, 16,275 shares held by two trusts in which Mr. Breeden is trustee, and 21,900 shares held by an estate in which Mr. Breeden is the executor.\n(6)Includes 4,669 shares held by his spouse, 5,355 shares held by his spouse as trustee for his son, 108 shares held by his spouse and daughter, 484 shares held by his spouse and son, 6,000 shares held by the Giordano Family Foundation and 387 shares held by his daughter.\n(7)Includes 16,998 shares held by two trusts in which Mr. Kendrick is trustee, 1,729 shares held by a corporation in which Mr. Kendrick is a director and 750 shares held by his spouse.\n(8)Includes 652 shares held in a trust in which Dr. Selden is trustee.\n(9)Includes options to purchase 5,213 shares of Common Stock which are currently exercisable.\n(10)Includes 2,359 shares held indirectly through his spouse and includes options to purchase 14,750 shares of Common Stock which are currently exercisable. It does not include options to purchase 13,750 shares which are not currently exercisable and 9,750 stock appreciation rights (\"SARs\").\n(11)Includes 229 shares held indirectly through his spouse and 837 shares held by a trust in which Mr. Ginn is trustee.\n(12)Includes 5,400 shares of Common Stock held by a trust in which Mr. Greer has a beneficial interest.\n(13)Includes 34,479 shares held by a corporation in which Mr. Holland is an officer, director, and owner.\n(14)Includes 10,125 shares of Common Stock held jointly with his spouse (shared voting and investment power).\nAs of February 25, 1994, executive officers and directors as a group beneficially owned 922,049 shares of Common Stock representing approximately 2.8% of those shares outstanding, of which 170,238 shares represent shares covered by currently exercisable options (or options exercisable within 60 days) and 200 shares of Preferred Stock representing approximately .25% of those shares outstanding. No officer or director owned as much as 1.0% of First Virginia Common Stock. Messrs. Breeden, Greer and Giordano are members of or are associated with law firms which have been in the last two years, and are proposed in the future to be, retained by First Virginia and its subsidiaries. During the past two years, Dr. Selden has been and is proposed in the future to be, retained by First Virginia as a consultant. Messrs. Brand, Breeden, Geithner, Ginn, Giordano, Greer, Holland, Malone, Phillips, Rowe, Selden and Zalokar have been directors of various subsidiaries of First Virginia during the past five years. Ages of the directors are stated as of February 25, 1994.\nBENEFICIAL OWNERSHIP OF NAMED EXECUTIVE OFFICERS\nThe following table sets forth certain information regarding the named executives' beneficial ownership of First Virginia Common Stock as of February 25, 1994.\nShares of Common Stock of First Virginia Beneficially Owned Name of Officer Number * Percent of Class\nRobert H. Zalokar 124,055 .3824\nPaul H. Geithner, Jr. 45,849 .1413\nBarry J. Fitzpatrick 40,722 .1255\nShirley C. Beavers, Jr. 31,134 .0960\nJustin C. O'Donnell 25,042 .0772\n* The amounts shown represent the total shares owned outright by such individuals together with shares which are issuable upon the exercise of all stock options which are currently exercisable. Specifically, the following individuals have the right to acquire the shares indicated after their names, upon the exercise of stock options: Mr. Zalokar, 5,213; Mr. Geithner, 14,750; Mr. Fitzpatrick, 25,500; Mr. Beavers, 22,500; and Mr. O'Donnell, 15,750.\nCOMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS\nFirst Virginia's Board of Directors has a standing Audit Committee, Director Nominating Committee, Management Compensation and Benefits Committee, Public Policy Committee, and Executive Committee.\nThe Audit Committee, comprised of Directors Breeden, Giordano, Gruver, Phillips, Selden, and Zettlemoyer, held five meetings during 1993. Functions of the Committee include (1) reviewing with the independent public accountants and management such matters as: the financial statements and the scope of First Virginia's audit, compliance with laws and regulations, and the adequacy of First Virginia's system of internal procedures and controls and resolution of material weaknesses; (2) reviewing with First Virginia's internal auditors the activities and performance of the internal auditors; (3) reviewing with management the selection and termination of the independent public accountants and any significant disagreements between the independent public accountants and management; and (4) reviewing the nonaudit services of the independent public accountant. Under Section 36 of the Federal Deposit Insurance Act, the Audit Committee also performs similar functions for the two largest First Virginia member banks.\nThe Director Nominating Committee, comprised of Directors Malone, Brand, Ginn, Giordano, Greer, Rowe, and Zalokar, held one meeting in 1993. The functions of the Committee include annually recommending to the Board the names of persons to be considered for nomination and election by First Virginia's stockholders and, as necessary, recommending to the Board the names of persons to be elected to the Board between annual meetings. The Committee also considers candidates recommended by stockholders upon receipt of a letter and resume for the proposed candidate. Such information should be sent to First Virginia's Secretary.\nThe Management Compensation and Benefits Committee, comprised of Directors Zettlemoyer, Brand, Holland, Kendrick, and Phillips, held one meeting in 1993. The Committee has the authority to establish the level of compensation (including bonuses) and benefits of management of First Virginia. In addition, the Committee has authority to award long-term incentive compensation, e.g., stock options and stock appreciation rights, to First Virginia's management based on such factors as individual and corporate performance.\nThe Public Policy Committee, comprised of Directors Gruver, Breeden, Geithner, Kendrick, Malone, Rowe, and Zalokar, met four times during 1993. This Committee recommends to the full Board the amount of funds to be allocated each year for charitable contributions, approves contributions upon request, and supervises First Virginia's matching gifts program. The Committee also monitors the programs developed for compliance with the Community Reinvestment Act and Title VII of the Civil Rights Act of 1964.\nThe Executive Committee, comprised of Directors Malone, Breeden, Geithner, Ginn, Holland, and Zalokar, held 12 meetings in 1993. The Committee exercises all of the powers of the Board of Directors when the Board is not in session, except for those powers reserved for the Board under state law and by First Virginia's Articles of Incorporation and Bylaws and those powers delegated to other committees.\nDuring 1993, there were 12 meetings of the Board of Directors. All directors attended more than 75% of the aggregate total number of meetings of the Board and committees of the Board on which they served.\nSECTION 16 TRANSACTIONS\nSection 16(a) of the Securities Exchange Act of 1934 requires First Virginia's executive officers and directors to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the New York Stock Exchange. Executive officers and directors are required by SEC regulation to furnish First Virginia with copies of all Section 16(a) forms they file.\nBased on a review of the forms that were filed and written representations from the executive officers and directors, First Virginia believes that during the year 1993 all filing requirements applicable to its officers and directors were met.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following Summary Compensation Table shows the annual compensation for First Virginia's Chief Executive Officer and for the four most highly compensated executive officers other than First Virginia's Chief Executive Officer for the last three fiscal years.\nSUMMARY COMPENSATION TABLE Long-Term Annual Compensation Compensation\n(a) (b) (c) (d) (e) (f) (g) Other All Annual Options\/ Other Name And Compen- SARs Compen- Principal Salary Bonus sation Awarded sation Position Year ($) (1) ($) (2) ($) (3) (#) (4) ($) (5) - -------- ---- ------- ------- ------- ------- -------\nRobert H. Zalokar 1993 500,000 306,388 8,509 0 108,901 Chairman and Chief Executive 1992 490,000 270,714 10,608 0 93,979 Officer of First Virginia 1991 478,923 210,660 30,000\nPaul H. Geithner, Jr. 1993 315,000 131,679 5,583 10,000 60,347 President of First Virginia 1992 300,000 113,050 3,987 0 52,513 1991 293,885 86,526 11,250\nBarry J. Fitzpatrick 1993 189,000 90,406 69,099 10,000 25,203 Executive Vice President 1992 169,310 72,830 29,236 0 18,723 of First Virginia 1991 152,576 28,366 11,250\nShirley C. Beavers, Jr. 1993 189,000 90,406 6,045 10,000 31,385 Executive Vice President of 1992 175,769 72,830 5,160 0 26,112 First Virginia and President, 1991 171,250 33,698 11,250 First Virginia Services, Inc.\nJustin C. O'Donnell 1993 202,600 45,386 5,437 2,000 33,604 Senior Vice President of 1992 192,950 43,394 4,089 0 30,549 First Virginia and President 1991 190,481 34,197 4,500 and Chief Executive Officer of First Virginia Bank\n(1)The Salary Column (Column (c)) includes the base salary earned by the executive officer, which includes amounts that are deferred under the First Virginia Banks, Inc. Employees Thrift Plan and the First Virginia Pre-Tax Health Benefit Plan.\n(2)The Bonus Column (Column (d)) includes the amount earned as a bonus for that year even if paid in the following year. It also includes amounts earned for that year under the First Virginia Banks, Inc. Profit Sharing Plan.\n(3)The Other Annual Compensation Column (Column (e)) includes the amount of taxes paid by First Virginia for certain benefits. In the case of Barry J. Fitzpatrick, it includes perquisites which amounted to $46,503 for 1993. Of this amount, $23,432 was for a country club initiation fee and dues and $15,247 was for moving expenses. None of the other named executive officers had perquisites and other personal benefits that exceeded the lesser of $50,000 or 10% of the total of annual salary and bonus reported for the named executive officer in the Summary Compensation Table.\n(4)Column (f) includes the number of stock options and SARs that were granted, after adjusting for the three-for-two stock split in July, 1992. Some of the options granted in 1991 had tandem SARs attached to them.\n(5)The All Other Compensation Column (Column (g)) includes the amount paid by the employer under the First Virginia Banks, Inc. Employees Thrift Plan which, for each of the named officers, was $6,745. It also includes the amounts paid by the employer under the First Virginia Supplemental Benefits Plan. This plan provides supplemental retirement benefits for those key officers who are restricted from receiving further benefits under the Thrift Plan as a result of the $8,994 limitation on pretax contributions imposed by the Internal Revenue Code for 1993. For 1993, these amounts were: for Mr. Zalokar, $40,548; Mr. Geithner, $17,703; Mr. Fitzpatrick, $8,637; Mr. Beavers, $8,648; and Mr. O'Donnell, $5,910. It also includes the premium amounts paid by the employer under the First Virginia Split Dollar Life Insurance Plan. For 1993, these amounts were: for Mr. Zalokar, $41,750; Mr. Geithner, $28,247; Mr. Fitzpatrick, $8,642; Mr. Beavers, $14,800; and Mr. O'Donnell, $15,296. It also includes the \"above-market\" earnings on deferred compensation earned during 1993. These amounts were: for Mr. Zalokar, $19,858; Mr. Geithner, $7,652; Mr. Fitzpatrick, $1,179; Mr. Beavers, $1,192; and Mr. O'Donnell, $5,653. Pursuant to SEC transition rules regarding executive compensation disclosure, Columns (e) and (g) do not include information for fiscal year 1991.\nFirst Virginia has supplemental compensation agreements with Messrs. Zalokar and Geithner which provide that in the event of their resignation or retirement, they are entitled to annual compensation equal to 60% of their average annual compensation earned by them during the five consecutive years of their highest compensation less any benefits they receive under the First Virginia Pension Trust Plan. \"Compensation\" under the Agreements includes not only their \"Salary\" and \"Bonus\" shown in the Summary Compensation Table but any other compensation that would be included on their IRS Form W-2. Mr. Geithner's Agreement also provide for a 50% survivor benefit to his surviving spouse should she survive him. Under their supplemental compensation agreements, Messrs. Zalokar and Geithner are to provide consulting services to First Virginia following retirement and must not engage in any activities which compete with First Virginia.\nSTOCK OPTIONS AND STOCK APPRECIATION RIGHTS\nThe following table shows for each of the named executive officers (1) the number of options that were granted during 1993, (2) out of the total number of options granted to all employees, the percent granted to the named executive officer, (3) the exercise price, (4) the expiration date and (5) the potential realizable value of the options, assuming that the market price of the underlying securities appreciates in value from the date of grant to the end of the option term, at a 5% and 10% annualized rate.\nStock Option Grants In 1993\nPotential Percent Realizable of Total Value at Options Assumed Annual Options Granted to Exercise Rates of Stock Granted Employees or Base Expir- Price Appreciation (# Shs.) in Fiscal Price ation for Option Term (1) Year (2) ($\/Sh.) Date 5%($) 10%($) Robert H. Zalokar ---- ---- ---- ---- ---- ----\nPaul H. Geithner,Jr. 10,000 9.09% 32.75 12\/14\/03 205,960 621,950\nBarry J. Fitzpatrick 10,000 9.09% 32.75 12\/14\/03 205,960 621,950\nShirley C. Beavers, Jr. 10,000 9.09% 32.75 12\/14\/03 205,960 621,950\nJustin C. O'Donnell 2,000 1.82% 32.125 12\/15\/03 40,406 102,398\n(1)Except in the case of Mr. Geithner (all of whose options are exercisable in one year), options granted to the named executive officers in 1993 are exercisable over a five year period provided certain performance goals are achieved by First Virginia.\n(2)Options to purchase 110,000 shares of First Virginia Common Stock were granted to employees during 1993. No freestanding SARs were granted in 1993 to employees and none of the options that were granted had any tandem SARs.\nThe following table shows for each of the named executive officers the number of shares of First Virginia Common Stock acquired upon the exercise of stock options and stock appreciation rights during 1993, the value realized upon their exercise, the number of unexercised stock options and SARs at the end of 1993 and the value of unexercised in-the-money stock options and SAR rights at the end of 1993. Stock options or freestanding SARs are considered \"in-the- money\" if the fair market value of the underlying securities exceeds the exercise price of the option or SAR. Some of the stock options which were granted to First Virginia's executive officers include a provision that would accelerate the vesting of the options upon a change-in-control of First Virginia.\nAggregated Options\/SAR Exercises in 1993 and Yearend Options\/SAR Values\nValue Number of Unexercised Unexercised In-the-Money Options\/SARs Options\/ Shares at Yearend SARs at Acquired (#) Yearend ($) Name on Value Exercisable\/ Exercisable\/ Exercise Realized Unexercisable Unexercisable (#) ($) -------- -------- ------------- -------------\nRobert H. 30,000 297,501 5,213\/0 70,810\/0 Zalokar\nPaul H. 4,939 137,000 26,500\/13,750 328,250\/36,250 Geithner, Jr.\nBarry J. 1,500 20,750 25,500\/13,750 343,750\/36,250 Fitzpatrick\nShirley C. 5,154 133,438 22,500\/13,750 305,625\/36,250 Beavers, Jr.\nJustin C. O'Donnell 2,944 110,750 15,750\/3,500 231,562\/15,750\nPENSION PLAN\nThe table on the following page shows the estimated annual benefit payable upon retirement under the First Virginia Pension Trust Plan based on specified remuneration and years of credited service classifications, assuming a participant retired on December 31, 1993 at age 65. The table ends at an average annual pay of $250,000, although because of IRS regulations, compensation in excess of $235,840 was not taken into account in determining benefits under the Plan in 1993. In 1994, compensation in excess of $150,000 will not be taken into account in determining benefits under the Plan. Credited service in excess of thirty years is also not taken into account in determining benefits under the Plan.\nAnnual Benefits Under First Virginia's Pension Trust Plan\nAverage Annual 10 Years 15 Years 20 Years 25 Years 30 Years Pay of of of of of for Past Service Service Service Service Service 60 Months - --------- ------- ------- ------- ------- ------- $150,000 22,860 34,290 45,720 57,150 68,580 175,000 26,860 40,290 53,720 67,150 80,580 200,000 30,860 46,290 61,720 77,150 92,580 225,000 34,860 52,290 69,720 87,150 104,580 250,000 38,860 58,290 77,720 97,150 115,641\nUnder the First Virginia Pension Trust Plan, a participant retiring at age 65 with 30 years of credited service under the Plan will receive a maximum annual pension benefit equal to 1.1% of his average annual pay multiplied by 30 years of credited service plus 0.5% of his average annual pay in excess of his covered compensation multiplied by 30 years of credited service. The calculation of \"average annual pay\" is based on annual compensation for the highest five consecutive years out of the participant's final 10 years of service. \"Covered compensation\" is calculated by multiplying the annual average of Social Security taxable wage bases in effect for the 35 years ending with the last day of the year in which the participant attains Social Security retirement age.\nThis table and the Summary Compensation Table may be used to estimate pension benefits for each of the individuals listed in the Summary Compensation Table. Remuneration on earnings determining pension benefits under the Plan includes salaries and bonuses (which are listed in the Summary Compensation Table) but it also includes any other taxable compensation including compensation resulting from the exercise of nonqualified options and SARs. Credited service as of December 31, 1993 for each of the named executives was as follows: Mr. Zalokar, 31 years; Mr. Geithner, 25.3 years; Mr. Fitzpatrick, 24.4 years; Mr. Beavers, 24.3 years and Mr. O'Donnell, 11.3 years.\nDIRECTORS' COMPENSATION, CONSULTING ARRANGEMENTS AND PLANS WHICH INCLUDE CHANGE IN CONTROL ARRANGEMENTS\nFor 1994, directors of First Virginia who are not salaried officers will be paid an annual retainer of $13,000 per year, a fee of $850 for each meeting of the Board of Directors attended, and a fee of $700 for each meeting of a Committee of the Board of Directors attended. Committee chairmen will receive $850 for each committee meeting they chair, except that the Chairman of the Executive Committee shall receive $1,750 for each meeting. Directors are reimbursed for out-of-town expenses incurred in connection with Board and Committee meetings. Directors can participate in First Virginia's deferred compensation plans which allow them to defer their retainers and fees.\nDuring 1993, Mr. Edwin T. Holland, the founder and former Chairman and Chief Executive Officer of First Virginia, and Mr. Thomas K. Malone, Jr., former Chairman and Chief Executive Officer of First Virginia, were paid $139,608 and $84,337 respectively under their supplemental compensation agreements, in addition to the amounts they received from the First Virginia Pension Trust Plan. Both Messrs. Holland and Malone provide consulting services under their supplemental compensation agreements.\nDuring 1993, Virginia H. Brown, formerly Virginia H. Beeton, received $71,000 pursuant to her former husband's Supplemental Retirement Agreement with First Virginia in addition to what she received from the First Virginia Pension Trust Plan. Her former husband, Ralph A. Beeton, was Chairman and Chief Executive Officer of First Virginia.\nFirst Virginia also has two key employee salary reduction deferred compensation plans, one of which began in 1983 and the other in 1986, and two directors' deferred compensation plans, one of which also began in 1983 and the other in 1986, (\"Deferred Compensation Plans\") for key employees of First Virginia and its subsidiaries and directors of First Virginia. Under the Deferred Compensation Plans, participants elect to defer some or all of their compensation from First Virginia, and First Virginia agrees to pay at retirement (or to participant's beneficiary or estate on participant's death) a sum substantially in excess of what each participant has deferred. To fund the benefits under the Deferred Compensation Plans, First Virginia has purchased life insurance contracts on the lives of the participants with First Virginia as the beneficiary. For the period ending December 31, 1993, none of the executive officers of First Virginia deferred any compensation under the Deferred Compensation Plans.\nThe 1983 deferred compensation plans include a provision regarding \"change in control,\" which is defined to include, among other things, an acquisition by one person or group of 25% of the voting power of First Virginia's outstanding securities. Generally, the 1983 Key Employee Salary Reduction Deferred Com- pensation Plan requires that an employee continue his\/her position with First Virginia and\/or its subsidiaries until retirement in order to receive his\/her benefits. If there is a \"change in control\" of First Virginia, and a director is terminated under the directors' plan, or in the case of the employee plan, an employee is terminated \"without cause\" or the employee terminates his\/her employment for \"good reason,\" as those terms are defined under the employee plan, then the director or employee, as the case may be, becomes entitled to his\/her benefits under the 1983 Deferred Compensation Plans at retirement, notwithstanding the fact that his\/her affiliation with First Virginia has terminated.\nIn 1988, First Virginia established a Split Dollar Life Insurance Plan (\"Split Dollar Plan\") under which individual life insurance is available to 17 executive employees (two of whom have retired) including those named in the Cash Compensation Table. Under the Split Dollar Plan, an executive can purchase ordinary life insurance policies with coverage of at least two times the executive's base annual salary, up to a limit of $1,000,000. A portion of the premiums will be loaned to the executives by First Virginia up to the later of ten years or the executive's retirement date. At the end of this period, if assumptions about mortality, dividends and other factors are realized, First Virginia will recover all of its loans for premiums from the cash value of the policy. The policy will then be transferred to the executive, who will pay all further premiums, if any, under the policy. Executives who participate in the Split Dollar Plan forego any insurance coverage over $50,000 under the First Virginia Group Life Insurance Plan. During 1989, the Split Dollar Plan was amended so that in the event of a \"change in control,\" which term is defined in the same manner as the 1983 deferred compensation plans, only the executive would have the right to terminate the policy.\nFirst Virginia's Board of Directors approved in 1992 the establishment of a trust with Chemical Bank as the trustee to partially secure the benefits of some of First Virginia's nonqualified compensation plans, including the Deferred Compensation Plans and the First Virginia Supplemental Benefits Plan, in case of a change in control. Under the trust agreement establishing the trust, if a \"change in control\" takes place, the trustee would pay the benefits under the covered compensation plans out of the trust assets that have been contributed to the trust by First Virginia if First Virginia refused to pay the benefits. The trust is considered a \"grantor trust\" subject to the claims of First Virginia's general creditors. For accounting purposes, the trust assets are considered corporate assets and, therefore, there will be no balance sheet impact to First Virginia from the establishment of the trust. The trust agreement does not include a provision which would accelerate the vesting or payment of any of the benefits under the covered compensation plans in case of a change in control. During 1993, First Virginia contributed approximately $1,464,000 to the Trust.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe current members of First Virginia's Management Compensation and Benefits Committee are E. Cabell Brand, Edward M. Holland, Eric C. Kendrick, W. Lee Phillips, Jr. and Albert F. Zettlemoyer. Edward M. Holland is the son of Edwin T. Holland, the founder and former Chairman and Chief Executive Officer of First Virginia. As noted above, Edwin T. Holland receives a fee from First Virginia pursuant to a Supplemental Compensation Agreement. Also, as noted above, Edward M. Holland's sister, Virginia H. Brown, receives a benefit pursuant to her former husband's Supplemental Retirement Agreement with First Virginia. Albert F. Zettlemoyer's daughter is an officer of First Virginia Bank. None of the members of the Management Compensation and Benefits Committee served as members of the compensation committees of another entity. No executive officer of First Virginia served as a director of another entity that had an executive officer serving on First Virginia's compensation committee. No executive officer of First Virginia served as a member of the compensation committee of another entity which had an executive officer who served as a director of First Virginia.\nMANAGEMENT COMPENSATION AND BENEFITS COMMITTEE REPORT CONCERNING FIRST VIRGINIA'S EXECUTIVE COMPENSATION POLICY\nThe Management Compensation and Benefits Committee (the \"Committee\") of the Board of Directors establishes the policy for the compensation of the executive officers of First Virginia. It is also responsible for administering some of First Virginia's executive compensation programs. The Committee is composed entirely of outside directors who are not eligible, with the exception of the Directors' Deferred Compensation Plans, to participate in the plans over which it has authority.\nThe overall goal of First Virginia's compensation policy is to motivate, reward and retain its key executive officers. The Committee believes this should be accomplished through an appropriate combination of competitive base salaries and both short-term and long-term incentives.\nThe primary components of First Virginia's executive compensation program are base salaries, bonuses, (e.g. short-term compensation), and equity compensation (e.g. long-term compensation). Executive officers also participate in other broad based employee compensation and benefit programs.\nBase Salary\nThe Committee's policy for determining base salaries is that two primary factors should be considered:\n(1)the degree of responsibility the executive officer has, and\n(2)the compensation levels of corresponding positions at other banking companies of comparable size that compete with and serve the same markets as First Virginia. This \"Local Peer Group\" of companies consists of Central Fidelity Banks, Inc., Crestar Financial Corporation and Signet Banking Corporation based in Virginia, First Maryland Bancorp and Mercantile Bankshares Corporation based in Maryland, and First Tennessee National Corporation and First American Corporation of Tennessee. Base salaries are targeted to be competitive with those in the \"Local Peer Group.\" For 1993 Mr. Zalokar's base salary was $500,000 which was approximately the mid-point of the salaries for CEOs paid to his counterparts in the \"Local Peer Group.\"\nShort Term Incentives\/Bonuses\nThe Committee grants bonuses to the executive officers and CEO based on the extent to which the Corporation achieves or exceeds annual performance objectives. The Committee may award bonuses to the CEO and to the executive officers if First Virginia achieves a return on total average assets (ROA) of at least 1% (the same basis for determining payments of profit sharing to all employees). ROA is generally considered the most important single factor in measuring the performance of a banking company and achievement of a 1% ROA is generally considered the mark of a good performing banking company.\nBonus awards are based on the following:\n(a)Up to 50% of the executive's salary may be awarded if First Virginia achieves a return on average assets (\"ROA\") equivalent to 80% or more of its target amount for the year. For the chief executive officer, First Virginia would also have to achieve 80% of targeted amounts for return on total stockholders' equity (\"ROE\"), asset quality (as determined by the ratios of nonperforming assets to total loans [\"NPA ratio\"] and net loan charge-offs [\"CO ratio\"]) and capital strength (based on the average equity to asset ratio [\"Equity\/asset ratio\"] and the Tier I risk based capital ratio); and\n(b)Up to 30% depending upon the degree to which First Virginia's earnings, asset quality and capital ratios exceed the average for the other major banking companies based in the Southeast, (the \"Southeastern Regional Peer Group,\") as compiled by Keefe, Bruyette and Woods, the New York securities firm which specializes exclusively in the banking and thrift industry; and\n(c)Up to 20% may be awarded at the discretion of the Committee based on an individual executive's performance.\nListed below are the annualized ratios for First Virginia and the Southeastern Regional Peer Group based on results for the first nine months of 1993, the latest data available to the Committee at the time the incentive awards were considered.\nFirst Virginia KBW Southeastern Profit Plan Actual Regional Peer Group\nEarnings\nROA 1.44% 1.70% 1.22% ROE 15.89 18.09 15.68\nAsset Quality\nNPA Ratio 1.00 .72 1.72 CO Ratio .38 .13 .28\nCapital Strength\nEquity\/Asset Ratio 8.5 9.57 7.94 Tier I Risk Based Capital Ratio 12.5 16.18 11.18\nBased on these results the Committee awarded Mr. Zalokar a bonus of $280,000.\nLong Term Compensation\/Stock Options\nThe Committee believes that the granting of stock options is the most appropriate form of long-term compensation for executives and that such awards of equity encourage the executive to achieve a significant ownership stake in First Virginia's success.\nEquity compensation awards are only made if First Virginia exceeds the weighted average of the returns reported by the major competitors in its banking markets (Central Fidelity, Signet, Crestar, Mercantile Bancshares, First Tennessee and First American of Tennessee). The performance ratios are weighted as follows: ROA 35%, ROE 25%, five year cumulative total return to shareholder (\"Five Year Return\") 15%, Nonperforming Asset Ratio 15% and Charge- off Ratio 10%. The following table shows the performance ratios of First Virginia and average for its major market area competitors of comparable size for the first nine months of 1993, the latest data available to the Committee at the time incentive awards were considered.\nMarket Area First Virginia Major Competitors\nROA 1.70% 1.33% ROE 18.09 16.56 Five Year Return 296.80 230.19 NPA Ratio .72 2.20 CO Ratio .13 .81\nAs of September 30, 1993 (the latest date information is available for the peer group), the weighted average of these performance factors for First Virginia was 199.5% of the peer group.\nExcept in the case of executive officers who are close to retirement, awards vest and are exercisable over a five-year period in equal annual installments beginning one year from the date of grant. However, each installment can only be exercised if the performance goals for that year are met; otherwise, that portion of the option lapses.\nFor 1993, the Committee awarded stock options to various executive officers because First Virginia did meet the performance criteria mentioned above. Mr. Zalokar did not receive any of the stock option awards.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT ----------\nNo person is known by management of the Corporation to own beneficially, directly or indirectly, more than five percent of any class of the Corporation's voting securities. The number of shares of the Corporation's voting securities beneficially owned by each of the Corporation's directors and by all of its directors and officers as a group is shown in Part III, item 10, on pages 69 through 72 of this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nDuring the past year, certain of the directors and officers of First Virginia and their associates had loans outstanding from First Virginia's banking subsidiaries. Each of these loans was made in the ordinary course of the lending bank's business. In some cases, where officers of First Virginia or its subsidiaries had to be relocated, residential mortgage loans were made by First Virginia at favorable interest rates. All other loans have been made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than the normal risk of collectibility, or present other unfavorable features. As of December 31, 1993, the aggregate amount of loans outstanding to all directors and executive officers of First Virginia and associates and members of their immediate families was approximately $10,908,000.\nFirst Virginia Bank and First Virginia Card Services, Inc. extend VISA and MasterCard privileges to directors, officers and employees of First Virginia and its subsidiaries. Except as noted below, interest is charged on VISA and MasterCard credit balances of employees and officers at a rate of 1% per month on sales transactions. Directors and executive officers of First Virginia and its subsidiaries are subject to generally prevailing rates.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ---------------------------------------------------------------\nFINANCIAL STATEMENTS:\nThe following consolidated financial statements and report of independent auditors of the Corporation and its subsidiaries are in Part I, item 8 on the following pages: Page Consolidated Balance Sheets - December 31, 1993 and 1992 42\/43\nConsolidated Statements of Income - Three Years Ended December 31, 1993 44\/45\nConsolidated Statements of Stockholders' Equity - Three Years Ended December 31, 1993 46\nConsolidated Statements of Cash Flows - Three Years Ended December 31, 1993 47\/48\nNotes to Consolidated Financial Statements 49\/66\nReport of Independent Auditors 68\nEXHIBITS:\nThe following exhibits are filed as a part of this report:\n(3) Restated Articles of Incorporation and Bylaws.\n(4) Instruments defining the rights of holders of the Corporation's long-term debt are not filed herein because the total amount of securities authorized thereunder does not exceed 10% of consolidated total assets. The Corporation hereby agrees to furnish a copy of such instruments to the Commission upon its request.\n(10) Management contracts for Messrs. Ralph A. Beeton, Paul H. Geithner, Jr., Edwin T. Holland, Thomas K. Malone, Jr., and Robert H. Zalokar are incorporated by reference to Exhibit 10 of the 1992 Annual Report on Form 10-K. Also incorporated from that exhibit are: (1) Key employee salary reduction deferred compensation plans and Directors' deferred compensation plans for 1983 and 1986 and (2) A compensatory plan known as the Split-Dollar Life Insurance Plan. (3) There are also four plans relating to options and rights. The 1982 Stock Appreciation Rights Plan is incorporated by reference to Registration Statement Number 33-6759 on Form S-8 dated Juns 25, 1986. The 1982 Incentive Stock Option Plan is incorporated by reference to Post- effective Amendment Number 2 to Registration Statement Number 2-77151 on Form S-8 dated October 30, 1987. The 1986 Incentive Stock Option Plan, Nongualified Stock Option Plan and Stock Appreciation Rights Plan is incorporated by reference to Registration Statement Number 33-17358 on Form S-8 dated September 28, 1987. The 1991 Incentive Stock Option Plan, Nonqualified Stock Option Plan and Stock Appreciation Rights Plan is incorporated by reference to Registration Statement Number 33-54802 on Form S-8 dated November 20, 1992.\n(11) Statement RE: Computation of Per Share Earnings.\n(13) First Virginia Banks, Inc. 1993 Annual Report to its Stockholders. (Not included in the electronic filing)\n(22) Subsidiaries of the Registrant.\n(24) Consent of Independent Auditors.\nFINANCIAL STATEMENT SCHEDULES:\nSchedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.\nREPORTS ON FORM 8-K:\nNo reports on form 8-K were required to be filed during the last quarter of 1993.\nSIGNATURES - ----------\nPursuant 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 as of March 23, 1993 on its behalf by the undersigned, thereunto duly authorized.\nFIRST VIRGINIA BANKS, INC.\n\/s\/ Robert H. Zalokar ___________________________________ Robert H. Zalokar, Chairman and Chief Executive Officer\n\/s\/ Richard F. Bowman ___________________________________ Richard F. Bowman, Vice President and Treasurer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons as of March 23, 1994 on behalf of the registrant and in the capacities indicated.\nSIGNATURE TITLE --------- -----\n\/s\/ Robert H. Zalokar ____________________________ Chairman, Chief Robert H. Zalokar Executive Officer and Director\n\/s\/ Richard F. Bowman ____________________________ Principal Financial Richard F. Bowman and Accounting Officer\n\/s\/ E. Cabell Brand ____________________________ Director E. Cabell Brand\n\/s\/ Edward L. Breeden ____________________________ Director Edward L. Breeden, III\n____________________________ Director Paul H. Geithner, Jr.\n\/s\/ L. H. Ginn ____________________________ Director L. H. Ginn, III\nSIGNATURE TITLE --------- -----\n\/s\/ Gilbert R. Giordano ____________________________ Director Gilbert R. Giordano\n\/s\/ T. Keister Greer ____________________________ Director T. Keister Greer\n\/s\/ Elsie C. Gruver ____________________________ Director Elsie C. Gruver\n\/s\/ Edward M. Holland ____________________________ Director Edward M. Holland\n\/s\/ Eric C. Kendrick ____________________________ Director Eric C. Kendrick\n\/s\/ Thomas K. Malone, Jr. ____________________________ Director Thomas K. Malone, Jr.\n\/s\/ W. Lee Phillips, Jr. ____________________________ Director W. Lee Phillips, Jr.\n\/s\/ Josiah P. Rowe ____________________________ Director Josiah P. Rowe, III\n\/s\/ Richard T. Selden ____________________________ Director Richard T. Selden\n\/s\/ Albert F. Zettlemoyer ____________________________ Director Albert F. Zettlemoyer\nANNUAL REPORT ON FORM 10-K\nFor the Year Ended December 31, 1993\nITEM 14\nEXHIBITS\nThe Exhibits filed with this annual report are\nincluded herein.\nFIRST VIRGINIA BANKS, INC. 6400 Arlington Boulevard Falls Church, Virginia 22042-2336\nExhibit 3\nFIRST VIRGINIA BANKS, INC.\nARTICLES OF INCORPORATION\nARTICLE I.\nThe name of the Corporation is First Virginia Banks, Inc.\nARTICLE II.\nThe purpose of the Corporation is to acquire, own, manage and dispose of the capital stock and other securities of banks and other corporations and to render to such banks and corporations, and to others, such advice and services as may be permitted by law. In addition, the Corporation shall have the power to transact any business not prohibited by law or required to be stated in these Articles of Incorporation.\nARTICLE III.\nThe Corporation shall have the authority to issue 60,000,000 shares of Common Stock, $1.00 par value, and 3,000,000 shares of Preferred Stock, $10.00 par value.\nA. Voting of Shares. Except as otherwise made mandatory by law, there shall be no class voting, and each outstanding share regardless of class (whether Common or Preferred), shall entitle the holder thereof to one vote on each matter submitted to a vote at any meeting of stockholders.\nB. Preemptive Rights. No holders of any class of stock of this Corporation shall have any preemptive or other preferential right to purchase or subscribe to (i) any shares of any class of stock of the Corporation, whether now or hereafter authorized, (ii) any warrants, rights or options to purchase any such stock, or (iii) any obligations convertible into any such stock or into warrants, rights or options to purchase any such stock.\nC. Preferred Shares Issuable in Series. Authority is expressly vested in the Board of Directors to divide the Preferred Stock into series and, within the following limitations, to fix and determine the relative rights and preferences of the shares of any series so established, and to provide for the issuance thereof. Each series shall be so designated as to distinguish the shares thereof from the shares of all other series and classes. All shares of the Preferred Stock shall be identical except as to the following relative rights and preferences, as to which there may be variations between different series:\n1. The rate of dividend, the time of payment, and the dates from which they shall be cumulative, and the extent of participation rights, if any;\n2. The price at and the terms and conditions on which shares may be redeemed;\n3. The amount payable upon shares in event of involuntary liquidation;\n4. The amount payable upon shares in event of voluntary liquidation;\n5. Sinking fund provisions for the redemption or purchase of shares; and\n6. The terms and conditions on which shares may be converted, if the shares of any series are issued with the privilege of conversion.\nPrior to the issuance of any shares of a series of Preferred Stock, the Board of Directors shall establish such series by adopting a resolution setting forth the designation and number of shares of the series and the relative rights and preferences thereof, to the extent permitted by the provisions hereof, and the Corporation shall file in the office of the State Corporation Commission of Virginia articles of serial designation as required by law, and the Commission shall have issued a certificate of serial designation.\nD. Common Characteristics of All Series of Preferred Stock. Each and every series of Preferred Stock, now existing or hereafter issued, shall have the following common characteristics:\n1. It shall rank on a parity and be of equal dignity as to dividends and assets with all other series according to the respective dividend rates and amounts distributable upon any voluntary or involuntary liquidation of the Corporation fixed for each such series and without preference or priority of any series over any other series.\n2. It shall have no other dividend rights than those set forth in the provisions pertaining to dividends for such series contained herein or in any articles of serial designation.\n3. If at any time less than all of a series then outstanding shall be called for redemption, the shares to be redeemed shall be selected by lot in such manner as may be determined by the Board of Directors.\n4. All shares of a series redeemed or repurchased by the Corporation shall be canceled in the manner provided by law and shall become authorized and unissued shares undesignated as to series.\n5. On or at any time before the date fixed for redemption of any Preferred Stock which has been issued, the Corporation shall deposit in trust, for the account of the holders of the shares to be redeemed, funds necessary for such redemption with a bank or trust company in good standing doing business in the State of Virginia, and having capital, surplus and undivided profits aggregating at least $5,000,000, designated or to be designated in such notice of redemption. Upon the making of such deposit, then all shares with respect to the redemption shall, whether or not the certificates therefor shall have been surrendered for cancellation, be deemed no longer to be outstanding for any purpose, and all rights with respect to such shares shall thereupon cease and terminate, except the right of the holders of the certificates for such shares to receive, out of the funds so deposited in trust, from and after the date of such deposit, the amount payable upon the redemption thereof, and except for such right, if any, to convert such shares in the manner prescribed for the series of which it is a part. At the expiration of three years after the redemption date, any such moneys then remaining on deposit with such bank or trust company shall be paid over to the Corporation, free of trust, and thereafter the holders of the certificates for such shares shall have no claims against such bank or trust company, but only claims as unsecured creditors against the Corporation, or against the Commonwealth of Virginia in the event of escheat by law, for amounts equal to their pro rata shares of the money so paid over.\nARTICLE IV.\nThe Corporation may, with the approval of a majority of the entire Board of Directors, establish, adopt, alter, amend or repeal pension plans, pension trust, profit-sharing plans, stock-option plans, stock- purchase plans and other incentive, bonus or deferred compensation plans, for the officers or employees of the Corporation or its subsidiaries, including employees who are directors of the Corporation or any subsidiary.\nARTICLE V.\nA. The number of directors of the Corporation, not less than 3 and not more than 30, shall be fixed by the Bylaws and in the absence of a Bylaw fixing the number, shall be sixteen. Upon the adoption of this Paragraph A, of Article V, the directors shall be divided into three classes (A, B and C), as nearly equal in number as possible. The initial term of office for members of Class A shall expire at the annual meeting of stockholders in 1985; the initial term of office for members of Class B shall expire at the annual meeting of stockholders in 1986; and the initial term of office for members of Class C shall expire at the annual meeting of stockholders in 1987. At each annual meeting of stockholders following such initial classification and election, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election, and shall continue to hold office until their respective successors are elected and qualified. In the event of any increase in the number of directors fixed in the Bylaws, the additional directors shall be so classified that all classes of directors have as nearly equal numbers of directors as may be possible. In the event of any decrease in the number of directors of the Corporation, all classes of directors shall be decreased equally as nearly as may be possible.\nB. Subject to the rights of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from an increase by not more than two in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause shall be filled by the affirmative vote of a majority of the directors then in office, whether or not a quorum. Each director so chosen shall hold office until the expiration of the term of the director, if any, whom he has been chosen to succeed, or if none, until the expiration of the term of the class assigned to the additional directorship to which he has been elected, or until his earlier death, resignation or removal. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director. Subject to the rights of the holders of any series of Preferred Stock then outstanding, any director or the entire Board of Directors may be removed from office at any time, but only the affirmative vote of the holders of at least four-fifths (80%) of the stock entitled to vote generally in the election of directors at a meeting called for that purpose.\nC. The affirmative vote of the holders of not less than four-fifths (80%) of the stock entitled to vote generally in the election of directors shall be required to amend, or repeal this Article V or adopt any provision inconsistent with this Article V, or to adopt a Bylaw to fix the number of directors.\nARTICLE VI.\nINDEMNIFICATION AND ELIMINATION OF LIABILITY OF DIRECTORS, ADVISORY DIRECTORS AND OFFICERS\nA. The Corporation shall indemnify a person who is or was made a party to any proceeding, or is threatened to be made a party to any proceeding, including a proceeding by or in the right of the Corporation, because the person is or was a director, advisory director, or officer of the Corporation or because, while a director, advisory director, or officer of the Corporation, the person is or was serving any other legal entity in any capacity at the request of the Corporation against all liabilities, fines, penalties, and claims imposed upon or asserted against the person(including amounts paid in settlement) and reasonable expenses incurred in the proceeding (including counsel fees), except such liabilities and expenses as are incurred because of the person's willful misconduct or knowing violation of the criminal law. The right to indemnify under this paragraph shall inure to the benefit of heirs, executors and administrators of such a person. The Corporation may, upon majority vote of a quorum of disinterested directors, contract in advance to indemnify and advance the expenses of any director, advisory director, or officer.\nB. Unless a determination has been made that indemnification is not permissible, the Corporation shall make advances and reimbursements for expenses incurred by a director, advisory director, or officer in a proceeding upon receipt of an undertaking from the director, advisory director, or officer to repay the same if it is ultimately determined that the director, advisory director, or officer is not entitled to indemnification. Such undertaking shall be an unlimited unsecured general obligation of the director, advisory director, or officer and shall be accepted without reference to his ability to make repayment.\nC. The Corporation may, to a lesser extent or to the same extent that the Corporation is required to provide indemnification and make advances and reimbursements for expenses to its present or former directors, advisory directors, and officers, provide indemnification and make advances and reimbursements for expenses to its present or former employees and agents, the directors, advisory directors, officers, employees and agents of its affiliates, subsidiaries and predecessor entities, and any person serving in any other legal entity in any capacity at the request of the Corporation, and may contract in advance to do so. The determination that indemnification under this paragraph is permissible, the authorization of such indemnification and the evaluation as to the reasonableness of expenses in a specific case shall be made as authorized from time to time by general or specific action of the Board of Directors, which action may be taken before or after a claim for indemnification is made, or as otherwise provided by law.\nD. In any proceeding brought by a shareholder in the right of the Corporation or brought by or on behalf of shareholders of the Corporation, no damages may be assessed against a director, advisory director or officer of the Corporation arising out of a single transaction, occurrence or course of conduct, provided that this elimination of liability shall not be applicable\nif the director, advisory director or officer engaged in willful misconduct or knowing violation of the criminal law or of any federal or state securities law.\nE. The provisions of this Article shall be applicable from and after its adoption, even though some or all of the underlying conduct or events relating to the proceeding with respect to which indemnity is claimed may have occurred before such adoption. No amendment, modification or repeal of this Article shall diminish the rights provided hereunder to any person arising from conduct or events occurring before the adoption of such amendment, modification or repeal.\nF. The Corporation may purchase and maintain insurance to indemnify it against the whole or any portion of the liability assumed by it in accordance with this Article and may also procure insurance on behalf of any person who is or was a director, advisory director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against any liability or expenses incurred by such person in any such capacity or arising from the person's status as such, whether or not the Corporation would have the power to indemnify the person against such liability under the provisions of this Article.\nARTICLE VII.\nSERIAL DESIGNATIONS\nThe first series of Preferred Stock, consisting of 522,500 shares, is designated as \"Series A Preferred Stock.\" Said series, in addition to the common characteristics described in section D of ARTICLE III, is issued subject to the following terms and conditions:\nDIVIDENDS:\nThe holders of the Series A Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors, yearly dividends at the rate of 5% per annum, payable quarterly on such dates as the Board of Directors shall determine, together with proper adjustment for any dividend period which is less than a full quarter. Such dividends shall be paid before any dividends are paid upon, or set apart for, the Common Stock of the Corporation and shall be cumulative from the date of issuance so that if for any quarterly dividend period dividends at the rate of 5% per annum shall not have been paid upon or set apart for the Series A Preferred Stock, the deficiency, with interest thereon at the rate of six percent (6%) per annum on such dividends as are in arrears, shall be fully paid or set apart for payment before any dividends shall be paid upon, or set apart for, the Common Stock.\nREDEMPTION:\nThe Corporation shall have no right to redeem the Series A Preferred Stock until five years after the date on which it is issued. Thereafter, all or any part thereof may be redeemed at any time at the option of the Board of Directors upon not less than forty-five nor more than ninety days written notice of the date fixed for redemption given to the holders thereof in the manner in which notices of stockholders' meetings are required to be given by law. The redemption price at any time during the sixth year after such stock is issued shall be $10.50 per share. Thereafter during the seventh and each subsequent full year after such stock is issued the redemption price shall be reduced by 5 cents per share per year until the beginning of the sixteenth full year after it is issued, after which time it may be redeemed for $10 per share. In addition the redemption price shall include all unpaid accrued dividends, with interest thereon at the rate of six percent (6%) per annum on such dividends as are in arrears, to the date fixed for redemption.\nLIQUIDATION:\n1. In the event of the voluntary dissolution of the Corporation and the distribution of its assets to its stockholders, if there is no other series of Preferred Stock issued or outstanding, then the holders of the Series A Preferred Stock shall be entitled to receive the then redemption price for their shares plus all unpaid accrued dividends, with interest thereon at the rate of six percent (6%) per annum on such dividends as are in arrears, to the date of payment before any amount shall be paid to the holders of the Common Stock.\n2. In the event of the voluntary dissolution of the Corporation and the distribution of its assets to its stockholders, if there are other series of Preferred Stock issued and outstanding, then the holders of the Preferred Stock of all series shall be preferred as to both dividends and assets over the holders of the Common Stock. In such event the holders of the Series A Preferred Stock shall be entitled to receive the then redemption price for their shares plus all unpaid accrued dividends, with interest thereon at the rate of six percent (6%) per annum on such dividends as are in arrears, to the date of payment before any amount shall be paid to the holders of the Common Stock. If, for any reason, there are insufficient assets to pay these amounts to the holders of the Series A Preferred Stock and to pay the holders of other series of preferred stock the amounts to which they are also entitled, then the holders of the Series A Preferred Stock and of such other preferred stock, as stated aforesaid, shall be paid ratably in proportion to the amounts to which they are respectively entitled.\n3. The provisions hereinabove set forth with regard to a voluntary dissolution of the Corporation shall also be applicable to an involuntary dissolution except that the holders of Preferred Stock shall only be entitled to receive, in addition to dividends and interest, if any, the par value of their shares in lieu of the then redemption price.\nCONVERSION:\n1. At the election of the holder, shares of Series A Preferred Stock may be converted into shares of the Common Stock ($1 par value) of the Corporation at any time at the following listed Basic Conversion Rates, or at such Adjusted Conversion Rates as may hereafter be determined by application of the formulae set forth in paragraph 8, subject to the following listed terms and conditions:\na. Until and including March 31, 1977 (herein called the first conversion period) the Basic Conversion Rate shall be 1.40 shares of Common Stock for one share of Series A Preferred Stock;\nb. Thereafter, until and including March 31, 1982 (herein called the second conversion period) the Basic Conversion Rate shall be 1.20 shares of Common Stock for one share of Series A Preferred Stock;\nc. Thereafter for as long as any Series A Preferred Stock shall remain outstanding (herein called the third conversion period) the Basic Conversion Rate shall be one share of Common Stock for one share of Series A Preferred Stock.\n2. Any holder of shares of Series A Preferred Stock desiring to convert the same shall, during regular business hours, deliver the certificate(s) therefor, properly endorsed, to any transfer agent therefor or to any transfer agent for the Common Stock of the Corporation, or to the Corporation, if there be no such transfer agent, together with a notice in writing of his election to convert the same, and shall receive, in exchange therefor a certificate or certificates for shares of Common Stock in accordance with the conversion rate prevailing with respect to shares of Series A Preferred Stock upon the day of delivery of such notice accompanied by such certificate(s) for the shares of Series A Preferred Stock to be converted. All shares of Series A Preferred Stock surrendered for conversion during any day shall be deemed to have been surrendered together as of the close of business on such day in order that a single conversion rate as to all of such shares shall be determined after giving effect to any transactions affecting the conversion rate during or prior to such day.\n3. The right of conversion shall expire as to any shares of Series A Preferred Stock which shall be called for redemption unless, on or before the day and hour for the expiration of the right of conversion specified in the notice of redemption, the certificate(s) representing such shares together with the notice hereinabove provided for shall have been delivered as provided in the foregoing paragraph 2. In case of voluntary or involuntary dissolution of the Corporation all conversion rights applicable to shares of Series A Preferred Stock shall terminate at 2 P.M. Eastern Standard Time, on the sixtieth day next following the date on which such dissolution shall have been authorized by the stockholders of the Corporation, or otherwise ordered, and in case of such dissolution, the Corporation shall notify the holders of the Series A Preferred Stock in the same manner that it is required to give notice of a redemption of such stock that the conversion rights of the shares of Series A Preferred Stock will terminate, which notice shall specify the date of such termination and the conversion rate then in effect applicable to the shares of Series A Preferred Stock.\n4. As to any shares of Series A Preferred Stock converted or any shares of Common Stock issuable on conversion no dividends shall be deemed to have accrued at the time of conversion and the holders thereof shall only receive such dividends as they are entitled to receive as holders of record on the dates dividends are declared.\n5. The Corporation shall not be required to issue any fraction of a share upon conversion of any share or shares of Series A Preferred Stock. If more than one share of Series A Preferred Stock shall be surrendered for conversion at one time by the same holder, the number of full shares of Common Stock issuable upon conversion thereof shall be computed on the basis of the total number of shares of Series A Preferred Stock so surrendered. If any fractional interest in a share of Common Stock would be deliverable upon conversion, the Corporation shall make an adjustment therefor in cash unless its Board of Directors shall have determined to adjust fractional interests by issuance of scrip certificates or in some other manner. Adjustment in cash shall be made on the basis of the Current Market Value of one share of Common Stock as that term is defined in paragraph 8C below.\n6. If the holder of any shares of Series A Preferred Stock so surrendered for conversion shall request that the stock certificate(s) representing the Common Stock issuable upon such conversion be issued in the name of a person or names of persons other than the holder of record thereof, such holder shall pay all stock transfer taxes that may be payable in respect thereof. The Corporation shall pay all original issue taxes imposed, if any, in respect of the issuance of Common Stock upon conversion of shares of Series A Preferred Stock in order that such shares may be issued in the name or names of the respective holder or holders of record of the shares of Series A Preferred Stock so surrendered for conversion.\n7. No adjustment shall be made in the Basic Conversion Rates, hereinabove specified, or in any Adjusted Conversion rate which may be in effect at any time if the Corporation shall (i) issue or sell any shares of its Common Stock or securities convertible into Common Stock to the public for cash or to the public or others in consideration for the acquisition by the Corporation or any of its subsidiaries of all or a portion of the stock or assets of any corporation, partnership, or proprietorship, for the business purposes of the Corporation, or (ii) issue or sell any rights to purchase shares of its Common Stock to the then holders of its Common Stock if, at the same time, similar rights are offered to the then holders of the Series A Preferred Stock in such a manner that each of them receives the same rights to purchase shares of Common Stock that he would have received if he had converted his shares of Series A Preferred Stock into Common Stock immediately prior to the time such rights were issued, or (iii) issue or sell any shares of its Common Stock to the holders of the warrants outstanding on March 24, 1967, which warrants provided for the sale and purchase of 350,000 shares of Common Stock, or (iv) issue any shares of its Common Stock to the holders of the options outstanding on March 24, 1967, which options provided for the sale and purchase of 46,500 shares of Common Stock, or (v) issue any shares of its Common Stock pursuant to its Incentive Bonus Plan initially approved by the stockholders on April 28, 1966, or (vi) issue any shares of its Common Stock upon the exercise of rights, warrants or options, the execution of stock purchase contracts, or the conversion of convertible securities if, at the time such rights, warrants or options were issued, such stock purchase contracts entered into, or such convertible securities were issued the conversion rates then in effect were adjusted, in the manner hereinafter described in paragraph 8 or if, at that time, no adjustments in conversion rates were required by the provisions of paragraph 8.\n8. Except as is provided in paragraph 7 above the conversion rates in effect from time to time shall be subject to adjustments, made to the nearest one-hundredth share of Common Stock, as follows:\nA. If the Corporation shall pay any dividend or make any other distribution in shares of Common Stock or in securities convertible into Common Stock the conversion rate for each conversion period in effect immediately prior to such action shall be proportionately increased so that the holders of the Series A Preferred Stock shall be able to convert their shares of Series A Preferred Stock into a number of shares of Common Stock equal to the same percentage of the shares of Common Stock outstanding immediately after the payment of such dividend or the making of such distribution into which they could have converted their shares of Series A Preferred Stock immediately prior to the payment of such dividend or the making of such distribution. For purpose of determining the number of shares of Common Stock outstanding both before and after the payment of such dividend or the making of such distribution all rights (which term as hereinafter used in the description of the Series A Preferred Stock shall be deemed to mean rights, warrants or options) and contracts (which term as hereinafter used in the description of the Series A Preferred Stock shall be deemed to mean contracts or agreements of any kind) then outstanding for the purchase of shares of Common Stock and all of the then outstanding securities issued by the Corporation which are convertible into shares of Common Stock shall be deemed to have been exercised or converted in the manner which they could have been exercised or converted immediately prior to the paying of such dividend or the making of such distribution or, if any of them could not have been exercised or converted on that date in accordance with their terms, then such rights, contracts and convertible securities shall be deemed to have been exercised or converted in the manner which they could be exercised or converted on the date upon which they first become exercisable or convertible.\nB. If the Corporation shall split the outstanding shares of its Common Stock into a greater number of shares or combine its outstanding shares of Common Stock into a smaller number of shares the conversion rates for each conversion period in effect immediately prior to such action shall be proportionately increased, in the case of a split, or decreased, in case of a combination, so that the holders of the Series A Preferred Stock shall be able to convert their shares of Series A Preferred Stock into a number of shares of Common Stock equal to the same percentage of the shares of Common Stock outstanding immediately after the completion of such action into which they could have converted their shares of Series A Preferred Stock immediately prior to the taking of such action. For the purpose of determining the number of the shares of Common Stock outstanding both before and after the taking of such action all rights, contracts, and convertible securities then outstanding for the purchase of shares of Common Stock shall be deemed to have been exercised or converted in the manner which they could have been exercised or converted immediately prior to such split or combination or, if any of them could not have been exercised or converted on that date in accordance with their terms, then such rights, contracts and convertible securities shall be deemed to have been exercised or converted in the manner which they could be exercised or converted on the date upon which they first become exercisable or convertible.\nC. If the Corporation shall issue any rights or enter into any contracts for the purchase of shares of its Common Stock, whether or not said rights or contracts can be exercised or executed immediately, at a price (including the consideration received for such rights or contracts) which is less than ninety-five percent of the Current Market Value (as defined below in this paragraph) of the Common Stock of the Corporation on the date such rights are issued or such contracts are entered into, the conversion rates for each conversion period in effect immediately prior to such date shall be increased to an amount determined by multiplying such conversion rates by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to the date such rights are issued or such contracts entered into plus the number of additional shares of Common Stock offered for sale pursuant to such rights or contracts and the denominator of which shall be the number of shares of Common Stock of the Corporation outstanding immediately prior to such date plus the number of shares of Common Stock of the Corporation which the aggregate subscription or purchase price (including the consideration received for such rights or contracts) of the total number of shares offered pursuant to said rights or contracts would purchase at the Current Market Value of the Common Stock of the Corporation at such date. For the purpose of determining the number of shares of Common Stock of the Corporation outstanding immediately prior to the issue of such rights or the making of such contracts all outstanding rights and contracts for the purchase of shares of Common Stock and all securities issued by the Corporation which are convertible into shares of Common Stock shall be deemed to have been exercised or converted in the manner which they could have been exercised or converted immediately prior to the issuing of such rights or the making of such contracts or, if any then outstanding rights or contracts or any then outstanding convertible securities could not have been exercised or converted on that date in accordance with their terms, then such outstanding rights, contracts and convertible securities shall be deemed to have been exercised or converted in the manner which they could be exercised or converted on the date upon which they first become exercisable or convertible. As used in this paragraph the term Current Market Value at the date of issue of such rights or making of such contracts shall mean the last reported sales price per share of the Common Stock of the Corporation on the American Stock Exchange or the New York Stock Exchange on such date, if the shares are listed on either of said exchanges, or the mean of the low bid and high asked price in the over-the-counter market on such day if such shares are not listed on either of said exchanges.\nD. If the Corporation shall issue any rights or enter into any contracts for the purchase of any security convertible into shares of its Common Stock, whether or not said rights or contracts can be exercised or executed immediately, and, on the date such rights are issued or such contracts are made the price per share of each share of Common Stock of the Corporation into which such security is initially convertible (including the consideration received for such rights or contracts) is less than ninety- five per cent of the Current Market Value of the Common Stock of the Corporation, as defined in paragraph C above, then the conversion rates for each conversion period in effect immediately prior to the issue of such rights or the making of such contracts shall be increased in the manner hereinabove described in paragraph C in the same manner as if such rights or contracts were rights or contracts to purchase the number of shares of Common Stock represented by such convertible securities on the date they are issued, if they are convertible on the date on which they are issued and, if not, the number of shares of Common Stock represented by such convertible securities on the date when they first become convertible.\nE. If any rights or contracts to purchase any shares of Common Stock or convertible securities of the Corporation shall be issued in connection with the issue or sale of other securities of the Corporation, such rights or contracts shall be deemed to have been issued or sold without consideration.\nF. If the Corporation shall consolidate or merge with another corporation, or reclassify its Common Stock (other than by way of subdivision or contraction of outstanding shares of Common Stock) each share of Series A Preferred Stock shall thereafter be convertible into the number of shares of stock or other securities or property of the Corporation or of the corporation resulting from such consolidation, merger, or reclassification, to which the Common Stock of the Corporation, deliverable upon conversion of shares of Series A Preferred Stock, would have been entitled, upon such consolidation, merger or reclassification had the holder of such share of Series A Preferred Stock exercised his right of conversion in the manner in which it could have been exercised on the date of such consolidation, merger or reclassification or, if it could not have been converted on that date, then in the manner in which it could have first been exercised thereafter, and such shares of Common Stock been issued and outstanding, and had such\nholder been the holder of record of such Common Stock at the time thereof, and lawful provision therefor shall be made as part of any such consolidation, merger or reclassification.\nG. If (i) The Corporation shall declare any dividend payable otherwise than in cash upon its Common Stock to the holders of its Common Stock, or (ii) The Corporation shall offer only to the holders of its Common Stock any additional shares of stock of any class of the Corporation or any right to subscribe thereto, or (iii) Any capital reorganization, or reclassification of the capital stock of the Corporation, or consolidation or merger of the Corporation with another corporation, or sale of all or substantially all of the assets of the Corporation shall be proposed, then, in any one or more of said events, the Corporation shall notify the holders of the Series A Preferred Stock in the same manner that it is required to give notice of the redemption of said stock prior to the date on which (a) the books of the Corporation shall close, or a record be taken for such stock dividend or subscription rights, or (b) such reclassification, reorganization, consolidation, merger or sale, shall take place, as the case may be. Such notice shall also state the conversion rate at the time in effect applicable to the shares of Series A Preferred Stock.\nH. The Corporation shall at all times reserve and keep available out of its authorized and unissued Common Stock, solely for the purpose of effecting the conversion of shares of Series A Preferred Stock, such number of shares of Common Stock as, from time to time, shall be sufficient to effect the conversion of all shares of Series A Preferred Stock from time to time outstanding. The Corporation, from time to time, shall in accordance with the laws of the Commonwealth of Virginia, increase the authorized amount of its Common Stock if at any time the number of shares of Common Stock remaining unissued shall not be sufficient to permit the conversion of all shares of Series A Preferred Stock then outstanding.\nI. The exercise of the conversion privilege shall be subject to such regulations not inconsistent with the provisions of this paragraph 8 as may at any time or from time to time be adopted by resolution of the Board of Directors, and any resolution so adopted may, at any time or from time to time, be amended or repealed.\nMISCELLANEOUS:\n1. There shall be no sinking fund provided for the redemption of shares of Series A Preferred Stock.\n2. The Corporation may not redeem any shares of its Common Stock so long as any dividends on its Series A Preferred Stock are in arrears.\nARTICLE VIII.\nThe second series of Preferred Stock, consisting of 84,000 shares, is designated as \"Second Series A Preferred Stock.\" Said series, in addition to the common characteristics described in Section D of ARTICLE III, is issued subject to the following terms and conditions (whenever the words \"Identical to ARTICLE VII\" appear next to a subject heading or paragraph(s) thereof, they shall be taken to mean (i) that the entire contents of the particular heading or paragraph(s) thereof, as the case may be, are identical to the corresponding provisions pertaining to \"Series A Preferred Stock\" set forth in ARTICLE VII hereof, except that each reference therein to \"Series A Preferred Stock\" is changed to \"Second Series A Preferred Stock,\" and (ii) that such corresponding provisions of ARTICLE VII, with each reference therein to \"Series A Preferred Stock\" changed to \"Second Series A Preferred Stock,\" are incorporated herein verbatim by reference):\nDIVIDENDS: All provisions are Identical to ARTICLE VII. REDEMPTION: All provisions are Identical to ARTICLE VII. LIQUIDATION: All provisions are Identical to ARTICLE VII. CONVERSION: Paragraphs 1, 2, 3, 4, 5 and 6 pertaining to CONVERSION are Identical to ARTICLE VII.\n7. No adjustment shall be made in the Basic Conversion Rates, hereinabove specified, or in any Adjusted Conversion Rate which may be in effect at any time if the Corporation shall (i) issue or sell any shares of its Common Stock or securities convertible into Common Stock to the public for cash or to the public or others in consideration for the acquisition by the Corporation or any of its subsidiaries of all or a portion of the stock or assets of any corporation, partnership, or proprietorship, for the business purposes of the Corporation, or (ii) issue or sell any rights to purchase shares of its Common Stock to the then holders of its Common Stock if, at the same time, similar rights are offered to the then holders of the Second Series A Preferred Stock in such a manner that each of them receives the same rights to purchase shares of Common Stock that he would have received if he had converted his shares of Second Series A Preferred Stock into Common Stock immediately prior to the time such rights were issued, or (iii) issue or sell any shares of its Common Stock to the holders of the warrants outstanding on February 16, 1968, which warrants provided for the sale and purchase of 350,000 shares of Common Stock, or (iv) issue any shares of its Common Stock to the holders of the options outstanding on February 16, 1968, which options provided for the sale and purchase of 42,500 shares of Common Stock, or (v) issue any shares of its Common Stock pursuant to its Incentive Bonus Plan initially approved by the stockholders on April 28, 1966, or (vi) issue any shares of its Common Stock upon the exercise of rights, warrants or options, the execution of stock purchase contracts, or the conversion of convertible securities if, at the time such rights, warrants or options were issued, such stock purchase contracts entered into, or such convertible securities were issued the conversion rates then in effect were adjusted, in the manner hereinafter described in paragraph 8 or if, at that time, no adjustments in conversion rates were required by the provisions of paragraph 8.\nParagraph 8 and subparagraphs A through I thereunder, inclusive, pertaining to CONVERSION are Identical to ARTICLE VII.\nMISCELLANEOUS: All provisions are Identical to ARTICLE VII.\nARTICLE IX.\nThe third series of Preferred Stock, consisting of 80,000 shares, is designated as \"Third Series A Preferred Stock.\" Said series, in addition to the common characteristics described in section D of ARTICLE III, is issued subject to the following terms and conditions (whenever the words \"Identical to ARTICLE VII\" appear next to a subject heading or paragraph(s) thereof, they shall be taken to mean (i) that the entire contents of the particular heading or paragraph(s) thereof, as the case may be, are identical to the corresponding provisions pertaining to \"Series A Preferred Stock\" set forth in ARTICLE VII hereof, except that each reference therein to \"Series A Preferred Stock\" is changed to \"Third Series A Preferred Stock,\" and (ii) that such corresponding provisions of ARTICLE VII, with each reference therein to \"Series A Preferred Stock\" changed to \"Third Series A Preferred Stock,\" are incorporated herein verbatim by reference):\nDIVIDENDS: All provisions are Identical to ARTICLE VII. REDEMPTION: All provisions are Identical to ARTICLE VII. LIQUIDATION: All provisions are Identical to ARTICLE VII. CONVERSION: Paragraphs 1, 2, 3, 4, 5 and 6 pertaining to CONVERSION are identical to ARTICLE VII.\n7. No adjustment shall be made in the Basic Conversion Rates, hereinabove specified, or in any Adjusted Conversion Rate which may be in effect at any time if the Corporation shall (i) issue or sell any shares of its Common Stock or securities convertible into Common Stock to the public for cash or to the public or others in consideration for the acquisition by the Corporation or any of its subsidiaries of all or a portion of the stock or assets of any corporation, partnership, or proprietorship, for the business purposes of the Corporation, or (ii) issue or sell any rights to purchase shares of its Common Stock to the then holders of its Common Stock if, at the same time, similar rights are offered to the then holders of the Third Series A Preferred Stock in such a manner that each of them receives the same rights to purchase shares of Common Stock that he would have received if he had converted his shares of Third Series A Preferred Stock into Common Stock immediately prior to the time such rights were issued, or (iii) issue or sell any shares of its Common Stock to the holders of the warrants outstanding on October 2, 1968, which warrants provided for the sale and purchase of 350,000 shares of Common Stock, or (iv) issue any shares of its Common Stock to the holders of the options outstanding on October 2, 1968, which options provided for the sale and purchase of 38,875 shares of Common Stock, or (v) issue any shares of its Common Stock pursuant to its Incentive Bonus Plan initially approved by; the stockholders on April 28, 1966, or (vi) issue any shares of its Common Stock upon the exercise of rights, warrants or options, the execution of stock purchase contracts, or the conversion of convertible securities if, at the time such rights, warrants or options were issued, such stock purchase contracts entered into, or such convertible securities were issued the conversion rates then in effect were adjusted, in the manner hereinafter described in paragraph 8 or if, at that time, no adjustments in conversion rates were required by the provisions of paragraph 8.\nParagraph 8 and subparagraphs A through I thereunder, inclusive, pertaining to CONVERSION are identical to ARTICLE VII.\nMISCELLANEOUS: All provisions are Identical to ARTICLE VII.\nARTICLE X.\nA. Higher Vote for Certain Business Combinations. In addition to any affirmative vote of holders of a class or series of capital stock of the Corporation required by law or these Articles, and except as otherwise expressly provided in Section B of this Article X, a Business Combination (as hereinafter defined) with or upon a proposal by a Related Person (as hereinafter defined) shall require the affirmative vote of the holders of at least eighty percent (80%) of the voting power of the voting stock of the Corporation, voting together as a single class.\nB. When Higher Vote Is Not Required. The provisions of Section A of this Article X shall not be applicable to a particular Business Combination and such Business Combination shall require only such affirmative vote as is required by law and other provisions of the Articles or the Bylaws of the Corporation, if all of the conditions specified in any one of the following Paragraphs (1), (2) or (3) are met:\n1. Approval by Directors. The Business Combination has been approved by a vote of a majority of directors, which includes a majority of all the Continuing Directors (as hereinafter defined); or\n2. Combination with Subsidiary. The Business Combination is solely between the Corporation and a subsidiary of the Corporation; or\n3. Price Conditions and Procedures. All of the following conditions have been met:\na. Such holders shall receive the aggregate amount of (i) cash and (ii) fair market value (as of the date of the consummation of the Business Combination) of consideration other than cash, per share of Common or Preferred in such Business Combination by holders thereof at least equal to the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Related Person for any shares of such class or series of stock acquired by it; provided, that if the highest preferential amount per share of a series of Preferred Stock to which the holders thereof would be entitled in the event of any voluntary or involuntary liquidation, dissolution or winding-up of the affairs of the Corporation (regardless of whether the Business Combination to be consummated constitutes such an event) is greater than such aggregate amount, holders of such series of Preferred Stock shall receive an amount for each such share at least equal to the highest preferential amount applicable to such series of Preferred Stock.\nb. The consideration to be received by holders of a particular class or series of outstanding Common or Preferred Stock shall be in cash or in the same form as the Related Person has previously paid for shares of such class or series of stock. If the Related Person has paid for shares of any class or series of stock with varying forms of consideration, the form of consideration given for such class or series of stock in the Business Combination shall be either cash or the form used to acquire the largest number of shares of such class or series of stock previously acquired by it.\nc. No Extraordinary Event (as hereinafter defined) occurs after the Related Person has become a Related Person and prior to the consummation of the Business Combination.\nd. A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) is mailed to public stockholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required pursuant to such Act or subsequent provisions).\nC. Certain Definitions. For purposes of this Article X:\n1. A \"person\" shall mean any individual, firm, corporation or other entity, or a group of \"persons\" acting or agreeing to act in the manner set forth in Rule 13d-5 under the Securities Exchange Act of 1934, as in effect on January 1, 1984.\n2. The term \"Business Combination\" shall mean any of the following transactions, when entered into by the Corporation, or a subsidiary of the Corporation, with, or upon a proposal by, a Related Person:\na. the merger or consolidation of the Corporation, or any subsidiary of the Corporation; or\nb. the sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one or a series of transactions) of any assets of the Corporation or any subsidiary of the Corporation having an aggregate fair market value of $5,000,000 or more; or\nc. the issuance or transfer by the Corporation or any subsidiary of the Corporation (in one or a series of transactions) of securities of the Corporation or that subsidiary having an aggregate fair market value of $5,000,000 or more; or\nd. the adoption of a plan or proposal for the liquidation or dissolution of the Corporation; or\ne. the reclassification of securities (including a reverse stock split), recapitalization, consolidation or any other transaction (whether or not involving a Related Person) which has the direct or indirect effect of increasing the voting power, whether or not then exercisable, of a Related Person in any class or series of capital stock of the Corporation or any subsidiary of the Corporation; or\nf. any agreement, contract or other arrangement providing directly or indirectly for any of the foregoing.\n3. The term \"Related Person\" shall mean any person (other than the Corporation, a subsidiary of the Corporation or any profit sharing, employee stock ownership or other employee benefit plan of the Corporation or a subsidiary of the Corporation or any trustee of or fiduciary with respect to any such plan acting in such capacity) that is the direct or indirect beneficial owner (as defined in Rule 13d-3 and Rule 13d- 5 under the Securities Exchange Act of 1934, as in effect on January 1, 1984) of five percent (5%) or more than five percent (5%) of the outstanding capital stock of the Corporation entitled to vote for the election of directors, and any Affiliate or Associate of any such person.\n4. The term \"Continuing Director\" shall mean any member of the Board of Directors who is not affiliated with a Related Person and who was a member of the Board of Directors immediately prior to the time that the Related Person became a Related Person, and any person who is not affiliated with the Related Person and is recommended to be a Continuing Director by a majority of Continuing Directors who are then members of the Board of Directors.\n5. \"Affiliate\" and \"Associate\" shall have the respective meanings ascribed to such terms in Rule 12b-2 under the Securities Exchange Act of 1934, as in effect on January 1, 1984.\n6. The term \"Extraordinary Event\" shall mean, as to any Business Combination and Related Person, any of the following events that is not approved by a majority of all Continuing Directors:\na. any failure to declare and pay at the regular date therefor any full quarterly dividend (whether or not cumulative) on outstanding Preferred Stock; or\nb. any reduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock); or\nc. any failure to increase the annual rate of dividends paid on the Common Stock as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction that has the effect of reducing the number of outstanding shares of the Common Stock; or\nd. the receipt by the Related Person, after such Related Person has become a Related Person, of a direct or indirect benefit (except proportionately as a shareholder) from any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation or any subsidiary of the Corporation, whether in anticipation of or in connection with the Business Combination or otherwise.\n7. A majority of the Continuing Directors shall have the power to make all determinations with respect to this Article X, including, without limitation, determining the transactions that are Business Combinations, the persons who are Related Persons, the time at which a Related Person became a Related Person, and the fair market value of any assets, securities or other property, and any such determinations of such Continuing Directors shall be conclusive and binding.\nD. No Effect on Fiduciary Obligations of Related Persons. Nothing contained in this Article X shall be construed to relieve any Related Person from any fiduciary obligation imposed by law.\nE. Amendment or Repeal. The affirmative vote of the holders of not less than eighty percent (80%) of the total voting power of the voting stock of the Corporation, voting together as a single class, shall be required in order to amend or repeal this Article X or adopt any provision inconsistent with this Article X.\nARTICLE XI.\nA. The power to adopt, alter, amend or repeal Bylaws shall be vested in the Board of Directors, which may take such action by the vote of a majority of the directors present and voting at a meeting where a quorum is present, provided that if, as of the date such action shall occur, there is a Related Person as defined in this Article XI of the Articles of Incorporation, such majority shall include a majority of the Continuing Directors as defined in this Article XI of the Articles of Incorporation; the stockholders, by the affirmative vote of the holders of not less than four-fifths (80%) of the voting power of all of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors, may adopt new Bylaws, or alter, amend or repeal Bylaws adopted by either the stockholders or the Board of Directors. In addition, the stockholders may prescribe by the affirmative vote of the holders of not less than four-fifths (80%) of the voting power of all of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors that any Bylaw made by them shall not be altered, amended or repealed by the Board of Directors.\nB. This Article shall not be amended, modified or repealed except by the affirmative vote of the holders of not less than four-fifths (80%) of the voting power of all of the then outstanding shares of capital stock of the Corporation then entitled to vote generally in the election of directors.\nC. Certain Definitions. For purposes of this Article XI:\n1. A \"person\" shall mean any individual, firm, corporation or other entity, or a group of \"persons\" acting or agreeing to get together in the manner set forth in Rule 13d-5 under the Securities Exchange Act of 1934, as in effect on January 1, 1984.\n2. The term \"Related Person\" shall mean any person (other than the Corporation, a subsidiary of the Corporation or any profit sharing, employee stock ownership or other employee benefit plan of the Corporation or a subsidiary of the Corporation or any trustee of or fiduciary with respect to any such plan acting in such capacity) that is the direct or indirect beneficial owner (as defined in Rule 13d-3 and Rule 13d-5 under the Securities Exchange Act of 1934, as in effect on January 1, 1984) of five percent (5%) or more than five percent (5%) of the outstanding capital stock of the Corporation entitled to vote for the election of directors, and any Affiliate or Associate of any such person.\n3. The term \"Continuing Director\" shall mean any member of the Board of Directors who is not affiliated with a Related Person and who was a member of the Board of Directors immediately prior to the time that the Related Person became a Related Person, and any successor to a Continuing Director who is not affiliated with the Related Persons and is recommended to succeed a Continuing Director by a majority of Continuing Directors who are then members of the Board of Directors.\n4. \"Affiliate\" and \"Associate\" shall have the respective meanings ascribed to such terms in Rule 12b-2 under the Securities Exchange Act of 1934, as in effect on January 1, 1984.\nARTICLE XII.\nA. A seventh series of Preferred Stock, par value $10.00 per share, is created as follows:\nSection 1. Designation and Amount. The shares of such series shall be designated as \"Series E Participating Preferred Stock,\" and the number of shares constituting such series shall be 300,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series E Participating Preferred Stock to a number less than that of the shares then outstanding plus the number of shares issuable upon exercise of outstanding rights, options or warrants or upon conversion of outstanding securities issued by the Corporation.\nSection 2. Dividends and Distributions.\n(A) The holders of shares of Series E Participating Preferred Stock in preference to the holders of shares of Common Stock, par value $1.00 per share (the \"Common Stock\"), of the Corporation and any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of January, April, July and October in each year (each such date being referred to herein as a \"Quarterly Dividend Payment Date\"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series E Participating Preferred Stock in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1.00, or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock, since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series E Participating Preferred Stock. In the event the Corporation shall at any time after August 8, 1988 (the \"Rights Declaration Date\") (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the amount to which holders of shares of Series E Participating Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event.\n(B) The Corporation shall declare a dividend or distribution on the Series E Participating Preferred Stock as provided in paragraph (A) above immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1.00 per share on the Series E Participating Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date.\n(C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series E Participating Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares of Series E Participating Preferred Stock unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series E Participating Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series E Participating Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by- share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series E Participating Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be no more than 30 days prior to the date fixed for the payment thereof.\nSection 3. Certain Restrictions.\n(A) Whenever quarterly dividends or other dividends or distributions payable on the Series E Participating Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series E Participating Preferred Stock outstanding shall have been paid in full, the Corporation shall not\n(i) declare or pay dividends on, make any other distributions on, or redeem or purchase or otherwise acquire for consideration any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series E Participating Preferred Stock;\n(ii) declare or pay dividends on or make any other distributions on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series E Participating Preferred Stock except dividends paid ratably on the Series E Participating Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled;\n(iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series E Participating Preferred Stock provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such parity stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series E Participating Preferred Stock; or\n(iv) purchase or otherwise acquire for consideration any shares of Series E Participating Preferred Stock or any shares of stock ranking on a parity with the Series E Participating Preferred Stock except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes.\n(B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 3, purchase or otherwise acquire such shares at such time and in such manner.\nSection 4. Liquidation, Dissolution or Winding Up.\n(A) Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series E Participating Preferred Stock unless, prior thereto, the holders of shares of Series E Participating Preferred Stock shall have received per 1\/100 share thereof, the greater of the issuance price thereof or the payment made per share of Common Stock, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment (the \"Series E Liquidation Preference\"). Following the payment of the full amount of the Series E Liquidation Preference, no additional distributions shall be made to the holders of shares of Series E Participating Preferred Stock unless, prior thereto, the holders of shares of Common Stock shall have received an amount per share (the \"Common Adjustment\") equal to the quotient obtained by dividing (i) the Series E Liquidation Preference by (ii) 100 (as appropriately adjusted as set forth in subparagraph C below to reflect such events as stock splits, stock dividends and recapitalizations with respect to the Common Stock) (such number in clause (ii), the \"Adjustment Number\"). Following the payment of the full amount of the Series E Liquidation Preference and the Common Adjustment in respect to all outstanding shares of Series E Participating Preferred Stock and Common Stock, respectively, holders of Series E Participating Preferred Stock and holders of shares of Common Stock shall receive their ratable and proportionate share of the remaining assets to be distributed in the ratio of the Adjustment Number to 1 with respect to such Preferred Stock and Common Stock, on a per share basis, respectively.\n(B) In the event there are not sufficient assets available to permit payment in full of the Series E Liquidation Preference and the liquidation preferences of all other series of Preferred Stock, if any, which rank on a parity with the Series E Participating Preferred Stock then such remaining assets shall be distributed ratably to the holders of such parity shares in proportion to their respective liquidation preferences. In the event there are not sufficient assets available to permit payment in full of the Common Adjustment, then such remaining assets shall be distributed ratably to the holders of Common Stock.\n(C) In the event the Corporation shall at any time after the Rights Declaration Date (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Adjustment Number in effect immediately prior to such event shall be adjusted by multiplying such Adjustment Number by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event.\nSection 5. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and\/or any other property, then in any such case the shares of Series E Participating Preferred Stock shall at the same time be similarly exchanged or changed in an amount per share (subject to the provision for adjustment hereinafter set forth) equal to 100 times the aggregate amount of stock, securities, cash and\/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time after the Rights Declaration Date (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series E Participating Preferred Stock shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that are outstanding immediately prior to such event.\nSection 6. Redemption. The shares of Series E Participating Preferred Stock shall not be redeemable.\nSection 7. Ranking. The Series E Participating Preferred Stock shall rank on a parity with all other series of the Corporation's Preferred Stock as to the payment of dividends and the distribution of assets.\nSection 8. Amendment. The Articles of Incorporation of the Corporation shall not be further amended in any manner which would materially alter or change the powers, preferences or special rights of the Series E Participating Preferred Stock so as to affect them adversely without the affirmative vote of the holders of a majority or more of the outstanding shares of Series E Participating Preferred Stock voting separately as a class.\nSection 9. Fractional Shares. Series E Participating Preferred Stock may be issued in fractions of a share which shall entitle the holder in proportion to such holders' fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series E Participating Preferred Stock.\nARTICLE XIII.\nExcept as otherwise provided under Article V, Article X and Article XI, these Articles of Incorporation may be amended by the affirmative vote of a majority of all votes entitled to be cast by each voting group of the Corporation entitled to vote on the amendment at a meeting at which a quorum of each voting group exists.\nExhibit 3\nBYLAWS\nOF\nFIRST VIRGINIA BANKS, INC.\nARTICLE I\nMEETING OF STOCKHOLDERS\nSection 1. Annual Meetings. The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held on such date each year that shall be established by the board of directors; however, if no such date is established, then the annual meeting shall be on the fourth Wednesday in April each year, if not a legal holiday, and if so, then on the next succeeding business day.\nSection 2. Special Meetings. Except as provided in Article II, Section 4 of these bylaws, special meetings of the stockholders shall be called by the president or secretary only at the written request of a majority of the directors, provided that, if as of the date of the request for such special meeting there is a Related Person as defined in Article X of the Articles of Incorporation, such majority shall include a majority of the Continuing Directors, as defined in Article X of the Articles of Incorporation or by the holders of four-fifths (80%) of the voting power of all of the then outstanding shares of capital stock of the corporation entitled to vote generally in the election of directors. The request shall state the purpose or purposes for which the meeting is to be called. The notice of every special meeting of stockholders shall state the purpose for which it is called.\nSection 3. Hour and Place of Meeting. All meetings of the stockholders may be held at such hour and place within or without the State of Virginia as may be provided in the notice of meeting.\nSection 4. Notice of Meetings. Written notice of the annual and of any special meeting of the stockholders shall be given not less than ten days nor more than sixty days before the meeting (except as a different time is specified by law), by or at the direction of the board of directors or the person calling the meeting, to each holder of record of shares of the corporation entitled to vote at the meeting, in person or by mail sent to the address recorded on the stock transfer books of the corporation on the date mailed, unless otherwise required by law. If any stockholder shall fail or decline to furnish mailing address, then such notice need not be sent to him unless required by law. All such notices should state the day, hour, place and purpose(s) of the meeting, and the matters to be considered.\nSection 5. Voting List. A complete list of the stockholders entitled to vote at any meeting or any adjournment thereof, with the address of and number of shares held by each on the record date, shall, for a period of ten days prior to such meeting, be kept on file at the registered office or principal place of business of the corporation or at the office of the transfer agent or registrar and shall be subject to inspection by any stockholder at any time during usual business hours except as such right of inspection may be subject to limitations prescribed by law. Such list shall also be produced and kept open at the time and place of the meeting and shall be open to inspection by any stockholder during the whole time of the meeting. Whenever the production or exhibition of any voting list, or of the stock transfer books of the corporation, shall be required by law, the production of a copy thereof certified correct by the transfer agent shall be deemed to be substantial compliance with such requirement.\nSection 6. Quorum. A majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of stockholders. Once a quorum has been duly convened, the quorum shall not be deemed broken by the departure of any stockholder or holder of a proxy. In the absence of a quorum, the stockholders present in person or by proxy, by majority vote and without notice other than by announcement at the meeting, may adjourn the meeting from time to time until a quorum shall be present. At any such adjourned meeting at which a quorum shall be present, any business may be transacted which could have been transacted at the meeting as originally called.\nSection 7. Organization. At all meetings of the stockholders, the chairman of the board, or in his absence the vice chairmen, in the order of their appointment, or in their absence the president, or in the absence of all of them a person chosen by a majority of the stockholders represented in person or by proxy and entitled to vote at the meeting shall preside as chairman of the meeting. The secretary of the corporation, or in his absence or if he be appointed chairman of the meeting, an assistant secretary shall act as secretary at all meetings of the stockholders; but if neither the secretary nor any assistant secretary be present and able to act as such, the chairman may appoint any person to act as secretary of the meeting.\nSection 8. Conduct of Meetings. Parliamentary rules as formulated by Cushman, Robert's or Sturgis' Manual shall govern the conduct of all meetings of the stockholders upon verbal announcement thereof by the chairman, except that where such rules conflict with the provisions of these bylaws, the statutes of Virginia, or the Articles of Incorporation, the provisions of the said bylaws, statutes or Articles shall prevail. The chairman of all meetings of the stockholders may announce from time to time such rules and guidelines for the conduct of business as he may determine in his discretion.\nSection 9. Voting. Except as otherwise provided by law or by Articles of Serial Designation with respect to any class or classes of preferred stock outstanding, each stockholder shall be entitled to one vote for each share of stock held by him and registered in his name on the books of the corporation on the date fixed by the resolution of the board of directors as the record date for the determination of the stockholders entitled to notice of and to vote at such meeting as more fully set forth elsewhere in these bylaws. Such vote may be given in person or by proxy appointed by an instrument in writing executed by a stockholder or his duly authorized attorney, and delivered to the secretary of the meeting. No proxy shall be valid after eleven months from its date, unless otherwise provided therein. If a quorum is present, the affirmative vote of a majority of the shares represented at the meeting and entitled to vote on the subject matter shall be the act of the stock- holders, except when a larger vote or a vote by class is required by the Articles of Incorporation, any other provision of these bylaws or the laws of the state of Virginia and except that in elections of directors those receiving the greatest number of votes shall be deemed elected even though not receiving a majority.\nSection 10. Counting of Votes. The chairman shall appoint three tellers to count the vote respecting the election of directors and any other questions put to vote, whether such vote is by written ballot or by a show of hands or by viva voce', and at least two out of three tellers shall certify in writing the results of any such voting. Written ballots shall not be required unless first decided upon by the chairman on matters to be brought before the stockholders and a teller may but need not be, a stockholder of the corporation.\nARTICLE II\nBOARD OF DIRECTORS\nSection 1. General Powers. The business and affairs of the corporation shall be managed by the board of directors subject to any requirement of stockholder action.\nSection 2. Number. The number of directors shall be fifteen (15).\nSection 3. Terms of Directors. A person up for election shall be elected to serve a term of three years and shall not be eligible to stand for election or re-election if on the date of the stockholders' meeting at which he is to be elected or re-elected, he has then reached the age of 72 years, except that if any such person shall have been duly appointed as chairman of the corporation or of a member bank at any time prior to the date that he reaches the age of 72 years, he shall be eligible to continue to stand for election as a director thereafter; provided, however, that he shall not in any case be eligible to stand for such election beyond the date that he reaches the age of 75. Further, except as provided above, when a director shall reach the age of 72 during such term, he shall resign from the board of directors effective on the day preceding the next succeeding annual meeting of the stockholders at which such director's term expires. If any such director shall become ill and unable to perform his duties as a director, he shall resign from the board of directors effective on the day of the next succeeding meeting of the board of directors or the date set forth in the notice of resignation, whichever is earlier.\nSection 4. Vacancies. Any vacancy on the board of directors for any cause, except a vacancy created by an increase by more than two in the number of directors, may be filled for the unexpired portion of the term by a majority vote of all of the remaining directors, though less than a quorum, given at a regular meeting or at a special meeting called for that purpose. In case the entire board shall die or resign, any stockholder may call a spe- cial meeting of the stockholders upon notice as hereinbefore provided for meetings of the stockholders, at which special meeting the directors for the unexpired portion of the term may be elected.\nSection 5. Fees. Directors, as such, shall not receive any stated salary for their services, but, by resolution of the board of directors, a fixed sum and expenses of attendance, if any, may be allowed for attendance at each regular or special meeting of the board or any meeting of any committee. Nothing herein contained shall be construed to preclude any director from serving the corporation in any other capacity and receiving compensation therefor.\nSection 6. Senior Advisory Board. There shall be a senior advisory board which shall consist of such directors of the corporation as shall resign from the board of directors hereafter at or after reaching the age of 72 or as shall resign because of poor health and who request to transfer to it. The members of such board shall serve at the pleasure of the corporation's board of directors and shall be subject to reappointment from year to year by said board of directors, but not more than three years from the date first elected to such senior advisory board. Members of the senior advisory board shall receive notice of and be entitled to attend all meetings of the corporation's regular board of directors and shall receive the same fees and expenses as are paid to members of the board of directors, but will not be entitled to vote at such meetings.\nSection 7. Stock Ownership of Directors. Every director shall be the owner in his sole name and have in his personal possession or control stock of the corporation having a par value of not less than One Thousand Dollars ($1,000). Such stock must be unpledged and unencumbered at the time such director becomes a director and during the whole of his term as such. Any director violating the provisions of this section shall immediately vacate his office.\nARTICLE III\nDIRECTORS' MEETINGS\nSection 1. Regular Meetings. Regular meetings of the board of directors shall be held without other notice than this bylaw immediately after, and at the same place as, the annual meeting of stockholders. Additional regular meetings shall be held at least monthly. The board of directors may provide by resolution the time and place, either within or without this state, for the holding of additional regular meetings without other notice than such resolution.\nSection 2. Special Meetings. Special meetings of the board of directors shall be held whenever called by the chairman of the board, by the president, or by any two of the directors. Notice of each such meeting shall be mailed to each director, addressed to his residence or usual place of business, at least three days before the day on which the meeting is to be held, or shall be sent to such place by telegraph or mailgram, or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held. Neither the business to be transacted\nat, nor the purpose of, any special meeting need be specified in the notice or waiver of notice of such meeting.\nSection 3. Organization. At all meetings of the board of directors, the chairman, or in his absence the vice chairmen in the order of their appointment, or in their absence, the president (or in his absence the executive vice president if a member of the board), or, in the absence of all of them, any director selected by the board of directors shall act as chair- man; and the secretary of the corporation, or, in his absence or if he be elected chairman of the meeting, an assistant secretary, shall act as secretary; but if neither the secretary nor any assistant secretary be present and able to act as such, the chairman may appoint any person present to act as secretary of the meeting.\nSection 4. Quorum and Manner of Acting. Unless otherwise provided by law or the Articles of Incorporation, a majority of the number of directors fixed by the bylaws at the time of any regular or special meeting shall constitute a quorum for the transaction of business at such meeting, and the act of a majority of the directors present at any such meeting at which a quorum is present shall be the act of the board of directors. In the absence of a quorum, a majority of those present may adjourn the meeting from time to time until a quorum be had. Notice of any such adjourned meeting need not be given.\nSection 5. Order of Business. At all meetings of the board of directors business may be transacted in such order as from time to time the board may determine.\nSection 6. Action Without a Meeting. Any action which is required to be taken at a meeting of the directors or of a director's committee may be taken without a meeting if a consent in writing, setting forth the action so to be taken, shall be signed either before or after such action by all of the directors or by all of the members of the committee, as the case may be, and such consent is filed in the minute book of the proceedings of the board or committee. Such consent shall have the same force and effect as a unanimous vote.\nSection 7. Telephone Meetings. Members of the board of directors or any committee designated thereby may participate in a meeting of such board or committee by means of conference telephone or similar communications equipment whereby all persons participating in the meeting can hear each other, and a written record can be made of the action taken at the meeting.\nARTICLE IV\nCOMMITTEES OF THE BOARD\nSection 1. Executive Committee. The board of directors, by a resolution adopted by a majority of the number of directors, may designate three or more directors, to include the chairman, the vice chairmen, if one or more be appointed, and the president, to constitute an executive committee. Members of the executive committee shall serve until removed, until their successors are designated or until the executive committee is dissolved by the board of directors. All vacancies which may occur in the executive committee shall be filled by the board of directors. The executive committee, when the board of directors is not in session, may exercise all of the powers of the board of directors except to approve an amendment to the Articles of Incorporation, these bylaws, a plan of merger or consolidation, a plan of exchange under which the corporation would be acquired, the sale, lease or exchange, or the mortgage or pledge for a consideration other than money, of all, or substantially all, the property and assets of the corporation otherwise than in the usual and regular course of its business, the voluntary dissolution of the corporation, or revocation of voluntary dissolution proceedings, and may authorize the seal of the corporation to be affixed as required. The executive committee may make its own rules for the holding and conduct of its meetings (except that at least two members of the committee shall be necessary to constitute a quorum), the notice thereof required and the keeping of its records, and shall report all of its actions to the board of directors.\nSection 2. Management Compensation and Benefits Committee. The board of directors shall, by resolution, appoint a Management Compensation and Benefits Committee that shall be comprised entirely of \"outside directors\" as that term is defined under proposed Item 402(j)(2) of Regulation S-K of the Securities and Exchange Commission; that is, \"directors who do not have employment or consulting arrangements with the corporation or its affiliates and who are not employed by an entity that has an employee of the corporation serving as a member of a committee which establishes that entity's compensation policy.\" (If, in the final SEC rules, Item 402(j)(2) of the SEC's Regulation S-K includes a different definition of \"outside directors\" than that described above, then these Bylaws will follow the definition as stated in the final rules, as amended from time to time.) Such committee shall fix its own rules and procedures and shall meet at least once each year. The committee shall have the authority to establish the level of compensation (including bonuses) and benefits of management of the corporation. Such committee shall also have all of the authority vested under any stock option or other equity-based compensation plan of the corporation including but not limited to the authority to grant stock options, stock appreciation rights, restricted or phantom stock, etc. to the corporation's management.\nSection 3. Public Policy Committee. The board of directors shall, by resolution, appoint not less than three nor more than six of its members to constitute a public policy committee. The board shall likewise designate the chairman of the committee. In addition, the chairman of the board shall be an ex-officio member of the public policy committee and shall be entitled to vote on all matters coming before the committee. The committee shall recommend to the board of directors the total amount of funds to be allocated each calendar year for charitable contributions to be made by the corporation. The committee shall have authority to approve contributions by the corporation within the dollar limits set by the approved annual budget and may delegate some or all of its authority for final approval to the chief executive officer provided that all contributions approved by the chief executive officer are subsequently reported to the committee for review. The committee shall exercise general supervision over the corporation's matching gifts program and shall have authority to add and\/or delete those colleges and universities eligible for inclusion in the program. The committee shall monitor on an ongoing basis the programs developed for compliance with the Community Reinvestment Act as well as Title VII of the Civil Rights Act of 1964 (Equal Employment Opportunity) and as a result may make recommendations to the chief executive officer in respect thereto. The committee shall perform such other duties and functions as shall be assigned to said committee from time to time by the board of directors. The chairman of the committee shall report regularly to the board of directors on the results of its meetings. The committee shall meet quarterly except that it may additionally meet on call of its chairman as may be necessary.\nSection 4. Audit Committee. The Board of Directors shall appoint an Audit Committee that shall be comprised entirely of directors who meet the standard of independence set forth by the New York Stock Exchange for audit committees of listed companies. Such committee shall be comprised of a minimum of three members and shall fix its own rules and procedures. The committee shall meet at least quarterly. The committee shall review the following: (1) with the independent public accountant and management, the financial statements and the scope of the corporation's audit; (2) with the independent public accountant and management, the adequacy of the corporation's system of internal procedures and controls, including the resolution of material weaknesses; (3) with the corporation's internal auditors, the activities and performance of the internal auditors; (4) with management and the independent accountant, compliance with laws and regulations; (5) with management, the selection and termination of the independent public accountant and any significant disagreements between the independent public accountant and management; and (6) the nonaudit services of the corporation's independent public accountant. The committee, when so delegated by a member bank, shall perform such audit committee functions for such bank as are requested by the bank to fulfill its requirements under Section 36 of the Federal Deposit Insurance Act and under the regulations and guidelines adopted by the FDIC to implement Section 36. The committee shall also review any other matters concerning auditing and accounting as it deems necessary and appropriate. The committee, at its discretion, may retain counsel without prior permission of the Board or management.\nSection 5. Other Committees. Other committees with limited authority may be designated by a resolution adopted by a majority of the directors present at a meeting at which a quorum is present.\nARTICLE V\nOFFICERS\nSection 1. Number. The officers of the corporation may be a chairman of the board, a president, one or more vice chairmen (who also may serve as a consultant and advisor to the board but not as a full-time employee of the corporation or any of its affiliates), one or more executive vice presidents, one or more vice presidents (any one or more of whom may be designated as senior vice presidents), a secretary, and a treasurer. At the discretion of the board of directors, there may be one or more assistant vice presidents, assistant secretaries, and assistant treasurers; a general counsel and one or more assistant general counsel and assistant counsel; a general auditor, one or more assistant general auditors and audit managers, an electronic data processing auditor, and a trust auditor; a communications officer; one or more marketing officers, and such other officer titles designated by the board from time to time. The chairman of the board, the vice chairmen, and the president shall be chosen from members of the board of directors. The same person may hold any two of such offices, except the office of secretary may not be held by any person holding the office of president.\nSection 2. Election, Term of Office and Qualifications. Officers of the corporation shall be chosen annually by the board of directors at its regular meeting immediately following the annual meeting of stockholders, and each officer shall hold office until the next annual meeting of stockholders and until his successor shall have been chosen and qualified or until he shall resign or shall have been removed in the manner hereinafter provided.\nSection 3. Other Officers, Agents and Employees. The board of directors may from time to time appoint such other officers as it may deem necessary, to hold office for such time as may be designated by it or during its pleasure, and may also appoint, from time to time, such agents and employees of the corporation as may be deemed proper, or may authorize any officer to appoint and remove such agents and employees, and may from time to time prescribe the powers and duties of such officers, agents and employees of the corporation in the management of its property and affairs, and may authorize any officer to prescribe the powers and duties of agents and employees.\nSection 4. Vacancies. If any vacancy shall occur among the officers of the corporation, such vacancy shall be filled by the board of directors.\nSection 5. Removal of Officers. Any officer or agent of the corporation may be removed with or without cause at any time by the board of directors or such officer as may be provided in the bylaws. Any person or agent appointed or employed by the corporation otherwise than by the board of directors may be removed with or without cause at any time by any officer having authority to appoint whenever such officer in his absolute discretion shall consider that the best interests of the corporation will be served thereby.\nSection 6. Chairman of the Board. The chairman of the board shall be the chief executive officer of the corporation and subject to the control of the board of directors, shall have general direction of the business affairs and property of the corporation and shall do and perform such other duties as may be prescribed in these bylaws or which may be assigned to him from time to time by the board of directors. The chairman of the board shall preside at all meetings of the board of directors and at all meetings of the stock- holders. He shall prescribe the duties and have general supervision over all other officers, employees and agents of the corporation enumerated in these bylaws or established by resolution of the board of directors or otherwise, and shall have the power to appoint, employ, suspend or remove with or without the advice of the board of directors any such officer, employee or agent unless otherwise specifically provided in these bylaws, and shall fix the salaries of all such officers, employees and agents of the corporation and its subsidiaries within the limits established from time to time by the board of directors. He shall have power to sign all stock certificates, deeds, contracts and other instruments authorized by the board of directors or its executive committee unless other direction is given therefor, and he shall be a member of all standing committees of the board except the account- ing and auditing committee and the management compensation and benefits committee.\nHonorary Chairman of the Board. The board of directors may appoint a former full-time officer who has held the office of chairman of the board of the corporation to the position of honorary chairman of the board and provide such person with a reasonable amount of office space as long as desired by him. If appointed, such person shall act as chairman of the senior advisory board as such body exists from time to time.\nSection 7. Vice Chairmen of the Board. The board of directors may appoint one or more vice chairmen of the board and, if any such officers are appointed, may assign such specific duties to any one of them as it deems necessary and advisable. Such officers may, but need not, be full-time salaried employees of the corporation. Any such full-time vice chairmen shall report to the corporation's chief executive officer and shall perform such duties as such officers may prescribe and assign from time to time.\nSection 8. Succession of Duties. The bylaw duties of the chairman of the board may be exercised and carried out by any vice chairmen when such have been appointed by the board of directors in the absence or disability of the chairman of the board in order of their appointment; if no vice chairmen are so appointed, then the president shall carry out such duties in the absence of the chairman of the board; and in the absence of the president, the executive vice president or any vice president in the order of their election shall carry out all such duties in the absence or disability of the chairman of the board.\nSection 9. President. The president shall be the chief administrative officer of the corporation and as such shall perform such duties as the chairman of the board or the board of directors may prescribe from time to time by resolution or as may be prescribed by these bylaws. He shall exercise all the powers and discharge all the duties of the chairman of the board during the latter's absence or inability to act. He shall have concurrent power with the chairman of the board to sign all deeds, contracts and instruments authorized by the board of directors or its executive committee unless the board otherwise directs, and he may be a member of the standing committees of the board except the accounting and auditing committee when appointed by the board. He shall report to the chairman of the board in carrying out his assignments and in conducting the affairs of his office.\nSection 10. Executive Vice President. The board of directors may elect one or more executive vice presidents and any such person so elected to such office shall perform such duties as the board of directors or the chairman of the board may assign and prescribe from time to time.\nSection 11. Vice Presidents. Each vice president shall have such powers and perform such duties as the board of directors or the chairman may from time to time prescribe, and shall perform such other duties as may be prescribed in these bylaws. Each vice president shall have power to sign all deeds, contracts and instruments authorized by the board of directors or its executive committee unless they otherwise direct. In case of the absence or inability to act of the president, and the executive vice presidents in the order of their appointments, then such vice president as the board of directors may designate for the purpose (but in the absence of such designation then the vice presidents in order of appointment) shall have the powers and discharge the duties of the president.\nSection 12. Secretary. The secretary shall keep the minutes of all meetings of the stockholders, the board of directors and meetings of committees of the board as they are held, in a book or books kept for that purpose. He shall keep in safe custody the seal of the corporation and he may affix such seal to any instrument duly executed on behalf of the corporation. The secretary shall have charge of the certificate books and such other books and papers as the board of directors may direct. He shall attend to the giving and serving of all notices of the corporation, and shall also have such other powers and perform such other duties as pertain to his office, or as from time to time may be assigned to him by the board of directors or the corporation's chief executive officer.\nSection 13. Treasurer. The treasurer shall be the principal financial and accounting officer of the corporation. He shall have charge of the funds, securities, receipts and disbursements of the corporation, and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such banks or other depositaries as the board of directors may from time to time designate. He shall render to the chairman of the board, or to the board of directors, or to the president, whenever any of them shall require him so to do, an account of the financial condition of the corporation and its affiliates and all of his transactions as treasurer. He shall keep correct books of account of all its business and transactions. If required by the board of directors, he shall give a bond in such sum and on such conditions and with such surety as the board of directors may designate, for the faithful performance of the duties of his office and the restoration to the corporation, at the expiration of his term of office, or, in case of his death, resignation or removal from office, of all books, papers, vouchers, money or other property of whatever kind in his possession belonging to the corporation. He shall also have such other powers and perform such other duties as pertain to his office or as from time to time may be assigned to him by the board of directors or the president.\nSection 14. General Counsel. The general counsel, if one be appointed, shall have charge of all litigation of the corporation, and shall keep himself advised of the character and progress of all legal proceedings and claims by and against the corporation or in which it is interested by reason of its ownership and control of other corporations. He shall give to the board of directors reports from time to time on all legal matters affecting the corporation and, when requested, his opinion upon any question affecting the interests of the corporation. He may, with the consent of the chief executive officer, employ on behalf of the corporation special counsel for the handling of any legal matter pertaining to the business of the corporation which he deems necessary and advisable. The general counsel may, but need not be, a full-time salaried officer of the corporation. He shall from time to time consult with the corporation's legal advisory committee on legal matters affecting the corporation and its affiliates.\nSection 15. General Auditor. The general auditor, if one be appointed, shall perform such internal auditing and accounting functions with regard to the member banks and companies as the board of directors or any appropriate committee thereof may from time to time determine, and shall have such additional powers and duties as may be prescribed by these bylaws and as the board of directors or any appropriate committee thereof may from time to time determine, and shall have additional responsibilities and duties in con- nection therewith as may be prescribed by these bylaws, applicable laws and regulations or the board of directors or any appropriate committee thereof. Except as stated, the general auditor and other auditing staff shall be subject to day-to-day administrative direction of the chief executive officer of the corporation and any such officer or employee may be dismissed by the chief executive officer for reasons as may be applied in dismissing any other personnel of the corporation, provided that a report of any such dismissal of internal auditing personnel with the reasons therefor shall be made to the board of directors or its executive committee at the next succeeding meeting thereof. All other officers and personnel appointed or assigned to assist in the internal audit function of the corporation, its member banks and companies, may be assigned such day-to-day duties and responsibilities as may be necessary by the general auditor to carry out the responsibilities of the internal audit function. The office of general auditor may not be held by any person holding other offices in the corporation or its affiliates except with the specific approval of the board of directors.\nSection 16. Assistant Secretary. In the absence or disability of the secretary, the assistant secretary (or if more than one, then the assistant secretary designated by the board of directors or the president for such purpose) shall perform all the duties of the secretary and, when so acting, shall have all the powers of, and be subject to all the restrictions upon, the secretary. Each assistant secretary shall also perform such other duties as from time to time may be assigned to him by the board of directors, the chief executive officer or the secretary.\nSection 17. Assistant Treasurer. In the absence or disability of the treasurer, the assistant treasurer (or if more than one, then the assistant treasurer designated by the board of directors or the chief executive officer for such purpose) shall perform all the duties of the treasurer and, when so acting, shall have all the powers of, and be subject to all restrictions upon, the treasurer. Each assistant treasurer shall also perform such other duties as from time to time may be assigned to him by the board of directors, the chief executive officer or the treasurer.\nARTICLE VI\nCAPITAL STOCK\nSection 1. Certificates. Certificates representing shares of the capital stock of the corporation shall be in such form as is permitted by law and prescribed by the board of directors or the chief executive officer and shall be signed by the persons authorized to sign the same by the bylaws or specific resolution of the board of directors. Certificates may, but need not be, sealed with the seal of the corporation or a facsimile thereof. The signature of the officers upon such certificates may be facsimiles if the certificate is countersigned by a transfer agent or registered by registrar other than the corporation itself or an employee of the corporation. In case any officer who has signed or whose facsimile signature has been placed upon a stock certificate shall have ceased to be such officer before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer at the date of its issue.\nSection 2. Issue and Registration of Certificates: Transfer Agents and Registrars. Transfer agents and\/or registrars for the stock of the corporation may be appointed by the board of directors and may be required to countersign stock certificates. Certificates of stock shall be issued in consecutive order and the certificate books shall be kept at an office of the corporation or at the office of the transfer agent. Certificates shall be numbered and registered in the order in which they are issued. New certificates and, in the case of cancellation, old certificates, shall, before they are delivered, be passed to a registrar if one is appointed by the board of directors, and such registrar shall register the issue or transfer of such certificates. Upon the return of the certificates by the registrar, the new certificates shall be delivered to the person entitled thereto.\nSection 3. Transfer of Stock. The stock of the corporation shall be transferable or assignable on the books of the corporation by the holders in person or by attorney on surrender of the certificates for such shares duly endorsed and, if sought to be transferred by attorney, accompanied by a written power of attorney to have the same transferred on the books of the corporation.\nSection 4. Lost, Destroyed and Mutilated Certificates. Holders of the stock of the corporation shall immediately notify the corporation of any loss, destruction or mutilation of the certificate therefor, and the board of directors may in its discretion, or any officer of the corporation appointed by the board of directors for that purpose may in his discretion, cause one or more new certificates for the same number of shares in the aggregate to be issued to such stockholder upon the surrender of the mutilated certificate or upon satisfactory proof of such loss or destruction and the deposit of a bond in such form and amount and with such surety as the board of directors may require.\nSection 5. Record Date. For the purposes of determining stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend, or in order to make a determination of stockholders for any other proper purpose, the board of directors may fix in advance a date as the record date for any such determination of stockholders, such date in any case to be not more than fifty days prior to the date on which the particular action requiring such determination of stockholders is to be taken. If no record date is fixed for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders, or stockholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the board of directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of stockholders. When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof.\nARTICLE VII\nCONTRACTS, LOANS, BANK ACCOUNTS, CHECKS, SECURITIES, ETC.: AUTHORITY OF OFFICERS\nSection 1. Contracts. The board of directors may authorize any officer or officers, agent or agents to enter any contract or to execute and deliver\nany instrument on behalf of the Corporation, and such order may be general or confined to specific instances.\nSection 2. Loans. The board of directors may authorize any officer or officers, agent or agents to effect loans and advances at any time for the corporation from any bank, trust company, insurance company, or other institution, or from any person, firm, association, or corporation, and in connection with such loans and advances to make, execute and deliver promissory notes or other evidences of indebtedness of the corporation, and, as security for the payment of any and all loans, advances, indebtedness and liabilities of the corporation, to pledge, hypothecate or transfer any and all stocks, securities and other personal property at any time held by the corporation, and to that end to transfer, endorse, assign and deliver the same in the name of the corporation. Such authority may be general or confined to specific instances, except that any pledge, hypothecation or transfer of the capital stock or assets of any subsidiary corporation shall be authorized only by a specific resolution of the board of directors.\nSection 3. Bank Accounts. All funds of the corporation, not otherwise employed, shall be deposited from time to time to the credit of the corporation in such banks or trust companies or other depositaries as the board of directors may select.\nSection 4. Checks, Securities, Etc. All checks, drafts or orders for the payment of money, notes or other evidences of indebtedness issued in the name of the corporation, all stock powers, endorsements, assignments, or other instruments for the transfer of securities held by the corporation shall be executed and delivered by, and all such securities shall be voted and proxies for the voting thereof shall be executed and delivered by such officer or officers, agent or agents to whom the board of directors shall delegate the power, and under such conditions and restrictions as they may impose.\nARTICLE VIII\nMISCELLANEOUS\nSection 1. Fiscal Year. The fiscal year of the corporation shall begin on the first day of January and end on the thirty-first day of December in each year.\nSection 2. Dividends. The board of directors may from time to time declare, and the corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and its Articles of Incorporation.\nSection 3. Corporate Seal. The board of directors shall provide a corporate seal which shall be circular in form and shall have inscribed thereon the name of the corporation, the state of Virginia, and year of incorporation and the words, \"Corporate Seal\".\nARTICLE IX\nEMERGENCIES\nSection 1. Emergency Bylaws. During any emergency resulting from an attack on the United States or any nuclear or atomic disaster, which is declared to be such by an appropriate agency of the state or federal government, these bylaws shall be modified (but only to the extent required by such emergency) as follows: a. A meeting of the board of directors may be called by any officer or director by giving at least one hour's notice to such of the directors as it may be feasible to reach at the time and by such means as may be feasible at the time, including publication or radio. b. The directors in attendance at the meeting, if not less than three, shall constitute a quorum. To the extent required to constitute a quorum at any meeting of the board of directors, the officers of the corporation who are present shall be deemed, in order of rank and within the same rank in order of seniority, directors for such meeting. For purposes of this bylaw, officers shall rank as follows: chairman of the board, vice chairmen, president, executive vice president, senior vice president, vice president, secretary, treasurer, assistant vice president, assistant secretary, and assistant treasurer. Officers holding similar titles shall rank in the order of their appointment.\nSection 2. Termination of Emergency. Except as provided in this article, the regular bylaws of the corporation shall remain in full force and effect during any emergency, and upon its termination, these emergency bylaws shall cease to be operative.\nARTICLE X\nAMENDMENTS\nThe board of directors shall have the power to alter, amend or repeal any bylaws of the corporation and to adopt new bylaws; but any bylaws made by the board of directors may be repealed or changed, and new bylaws made, by the stockholders, who may prescribe that any bylaw made by them shall not be altered, amended or repealed by the board of directors.\nEXHIBIT 11\nFIRST VIRGINIA BANKS, INC. STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS\nYear Ended December 31 1993 1992 1991 -------- ------- ------- (In thousands, except per share data) PRIMARY:\nAverage common shares outstanding 32,408 32,144 32,036 Dilutive effect of stock options 104 108 56 -------- ------- ------- Total average common shares 32,512 32,252 32,092 ======== ======= =======\nNet income $116,024 $97,473 $69,608 Provision for preferred dividends (53) (61) (71) -------- ------- ------- Net income applicable to common stock $115,971 $97,412 $69,537 ======== ======= =======\nNet income per share of common stock $3.57 $3.02 $2.17 ======== ======= =======\nFULLY DILUTED:\nAverage common shares outstanding 32,408 32,144 32,036 Dilutive effect of stock options 107 113 64 Conversion of preferred stock 117 133 154 -------- ------- ------- Total average common shares 32,632 32,390 32,254 ======== ======= =======\nNet income $116,024 $97,473 $69,608 ======== ======= =======\nNet income per share of common stock $3.56 $3.01 $2.16 ======== ======= =======\nYears prior to 1992 have been restated to reflect the three-for-two common stock split in July of 1992.\nEXHIBIT 22 SUBSIDIARIES OF THE REGISTRANT December 31, 1993 State of Incorporation ------------- First Virginia Banks, Inc. Virginia Banking Subsidiaries: Northern Region: First Virginia Bank Virginia First General Mortgage Company Virginia First Virginia Mortgage Company Virginia First Virginia Commercial Corporation Virginia First Virginia Card Services, Inc. Virginia First Virginia Credit Services, Inc. Virginia First Virginia Bank-Central Maryland Maryland C.B. Properties, Inc. Maryland C.B. Properties II, Inc. Maryland First Virginia Bank-Maryland Maryland Eastern Region: First Virginia Bank of Tidewater Virginia First Virginia Bank-Colonial Virginia First Virginia Bank-Commonwealth Virginia First Virginia Bank-Central Virginia First Virginia Bank-South Hill Virginia Southwest Region: First Virginia Bank-Southwest Virginia First Virginia Bank-Franklin County Virginia First Virginia Bank-Southside Virginia First Virginia Bank-Highlands Virginia First Virginia Bank-Piedmont Virginia First Virginia Bank-Clinch Valley Virginia Shenandoah Valley Region: First Virginia Bank-Shenandoah Valley Virginia First Virginia Bank of Augusta Virginia First Virginia Bank-Planters Virginia Tennessee-Western Virginia Region: First Virginia Bank-Mountain Empire Virginia Tri-City Bank and Trust Company Tennessee Bank of Madisonville Tennessee United Southern Bank Tennessee Nonbanking Subsidiaries First Virginia Insurance Services, Inc. Virginia First Virginia Services, Inc. Virginia First Virginia Life Insurance Company Virginia Springdale Advertising Agency, Inc. Virginia Northern Operations Center, Inc. Virginia Southwest Operations Center, Inc. Virginia Eastern Operations Center, Inc. Virginia First Virginia Software, Inc. Virginia United Land Corporation Maryland Springdale Temporary Services, Inc. Virginia All of the organizations listed above are 100% owned by First Virginia Banks, Inc. or one of its subsidiary banks.\nEXHIBIT 24\nConsent of Independent Auditors\nBoard of Directors First Virginia Banks, Inc.\nWe consent to the incorporation by reference into Registration Statement Number 33-52507 on Form S-4 dated March 4, 1994, Post-effective Amendment No. 1 to Registration Statement Number 33-38024 on Form S-8 dated January 10, 1994, Registration Statement Number 33-51587 on Form S-3 dated December 20, 1993, Registration Statement Number 33-54802 on Form S-8 dated November 20, 1992, Registration Statement Number 33-31890 on form S-3 dated November 1, 1989, Post-effective Amendment Number 3 to Registration Statement Number 2-67507 on Form S-3 dated January 7, 1988, Post-effective Amendment Number 2 to Registration Statement Number 2-77151 on Form S-8 dated October 30, 1987, Registration Statement Number 33-17358 on Form S-8 dated September 28, 1987, Registration Statement Number 33-15360 on Form S-3 dated June 26, 1987, of our report dated January 13, 1994, with respect to the consolidated financial statements of First Virginia Banks, Inc. included in this Annual Report on Form 10-K for the year ended December 31, 1993.\nWashington, D.C. March 23, 1994","section_15":""}
{"filename":"753308_1993.txt","cik":"753308","year":"1993","section_1":"Item 1. Business\nFPL GROUP, INC.\nFPL Group, incorporated under the laws of Florida in 1984, is a public utility holding company (as defined in the Holding Company Act) that is engaged, through its subsidiaries, in utility and non-utility operations.\nFPL Group is exempt from substantially all of the provisions of the Holding Company Act on the basis that FPL Group's and FPL's businesses are predominantly intrastate in character and carried on substantially in a single state, in which both are incorporated. FPL Group, together with its subsidiaries, employs approximately 12,400 persons.\nUtility operations are conducted through FPL, which is engaged in the generation, transmission, distribution and sale of electric energy. Non- utility operations are conducted through FPL Group Capital and its subsidiaries and consist mainly of investments in non-utility energy projects and agricultural operations.\nUTILITY OPERATIONS\nGeneral. FPL, a wholly-owned subsidiary of FPL Group, supplies electric service throughout most of the east and lower west coasts of Florida. This service territory contains 27,650 square miles with a population of approximately 6.5 million. During 1993, FPL served approximately 3.4 million customer accounts. Operating revenues amounted to approximately $5.2 billion, of which about 56% was derived from residential customers, 37% from commercial customers, 4% from industrial customers and 3% from other sources. FPL provided approximately 98% of FPL Group's operating revenues in each of the years 1991 through 1993.\nRegulation. The retail operations of FPL represent approximately 98% of operating revenues and are regulated by the FPSC, which has jurisdiction over retail rates, service territory, issuances of securities, planning, siting and construction of facilities and other matters. FPL is also subject to regulation by the FERC in various respects, including the acquisition and disposition of certain facilities, interchange and transmission services and wholesale purchases and sales of electric energy.\nFPL is subject to the jurisdiction of the NRC with respect to its nuclear power plants. NRC regulations govern the granting of licenses for the construction and operation of nuclear power plants and subject such power plants to continuing review and regulation.\nFederal, state and local environmental laws and regulations cover air and water quality, land use, power plant and transmission line siting, electric and magnetic fields from power lines and substations, noise and aesthetics, solid waste and other environmental matters. Compliance with these laws and regulations increases the cost of electric service by requiring, among other things, changes in the design and operation of existing facilities and changes or delays in the location, design, construction and operation of new facilities. FPL estimates that capital expenditures for improvements needed to comply with environmental laws and regulations will be approximately $10 million to $30 million annually for the years 1994 through 1998. These amounts are included in FPL's projected capital expenditures set forth in Item 1. Capital Expenditures.\nFPL holds franchises with varying expiration dates to provide electric service in various municipalities and seven counties in Florida. FPL considers its franchises to be adequate for the conduct of its business.\nRetail Ratemaking. The underlying concept of utility ratemaking is to set rates at a level that allows the utility to collect total revenues (revenue requirements) equal to its cost of providing service, including a reasonable return on invested capital. To accomplish this, the FPSC uses various ratemaking mechanisms.\nThe basic costs of providing electric service, other than fuel and certain other costs, are recovered through base rates, which are designed to recover the costs of constructing, operating and maintaining the utility system. These costs include operations and maintenance expenses, depreciation and taxes, as well as a rate of return on FPL's investment in assets used and useful in providing electric service (rate base). The rate of return on rate base approximates FPL's weighted cost of capital, which includes its costs for debt and preferred stock and an allowed ROE. Base rates are determined in rate proceedings which occur at irregular intervals at the initiative of FPL, the FPSC or a substantially affected party.\nFuel costs are recovered through levelized monthly charges established pursuant to the fuel clause. These charges, which are calculated semi- annually, are based on estimated costs of fuel and estimated customer usage for the ensuing six-month period, plus or minus a true-up adjustment to reflect the variance of actual costs and usage from the estimates used in setting the fuel adjustment charges for prior periods.\nCapacity payments to other utilities and generators for purchased power are recovered primarily through the capacity clause. Costs associated with implementing energy conservation programs are recovered through rates established pursuant to the conservation clause. Certain other non-fuel costs and the accelerated recovery of the costs of certain projects that displace oil-fired generation are recovered through the oil-backout clause.\nBeginning in April 1994, costs of complying with new federal, state and local environmental regulations will be recovered through the environmental compliance cost recovery clause. In the past such costs would have been recoverable through base rates.\nThe FPSC has the power to disallow recovery of costs which it considers excessive or imprudently incurred. Such costs may include operations and maintenance expenses, the cost of replacing power lost when fossil and nuclear units are unavailable and costs associated with the construction or acquisition of new facilities. Also, the FPSC does not provide any assurance that the allowed ROE will be achieved.\nSystem Capability and Load. FPL's resources for serving load as of January 1, 1994 consist of 16,708 mw of firm electric power generated by FPL-owned facilities (see Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nFPL Group and its subsidiaries maintain properties which are adequate for their operations. The operating properties of FPL constitute approximately 98% of FPL Group's gross investment in property at December 31, 1993.\nGenerating Facilities. As of December 31, 1993, FPL had the following generating facilities:\nTransmission and Distribution. FPL owns and operates 451 substations with a total capacity of 100,054,470 kva. Electric transmission and distribution lines owned and in service as of December 31, 1993 are as follows:\n(1) Includes approximately 80 miles owned jointly with the JEA.\nCharacter of Ownership. Substantially all of FPL's properties are subject to the lien of its mortgage, which secures debt securities issued by FPL. The principal properties of FPL are held by it in fee and are free from other encumbrances, subject to minor exceptions, none of which is of such a nature as to substantially impair the usefulness to FPL of such properties. Some of the electric lines are located on land not owned in fee but are covered by necessary consents of governmental authorities or rights obtained from owners of private property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn October 1988, Union Carbide Corporation, the corporate predecessor of Praxair, Inc. (Praxair), filed suit against FPL and Florida Power Corporation (Florida Power) in the United States District Court for the Middle District of Florida. Praxair requested that Florida Power sell power to its facility located within FPL's service territory, and that FPL transport the power to the facility. Florida Power and FPL denied the request as being inconsistent with Florida law and public policy. The FPSC has issued a declaratory statement that FPL's denial of Praxair's request was proper and ordered FPL not to wheel power under such circumstances. The suit alleges that through a territorial agreement, FPL and Florida Power have conspired to eliminate competition for the sale of electric power to retail customers, thereby unreasonably restraining trade and commerce in violation of federal antitrust laws as contained in Section 1 of the Sherman Antitrust Act (Sherman Act). The suit seeks an award of three times Praxair's alleged damages in an unspecified amount based on alleged higher prices paid for electricity and product sales lost by Praxair. Cross motions for summary judgment were denied. Both parties are appealing the denials.\nIn November 1988, TEC Cogeneration, Inc., its affiliate Thermo Electron Corporation, RRD Corp. and its affiliate Rolls Royce Inc. filed suit in the United States District Court for the Southern District of Florida against FPL Group and its subsidiaries, FPL and ESI, on behalf of South Florida Cogeneration Associates (SFCA), a joint venture which since 1986 has operated a cogeneration facility for Metropolitan Dade County within FPL's service territory in Miami, Florida. The suit alleges that the defendants have engaged in anti-competitive conduct intended to prevent and defeat competition from cogenerators within FPL's service territory and from SFCA's Metropolitan Dade County facility in particular. It alleges that the defendants' actions constitute monopolization and attempts to monopolize in violation of Section 2 of the Sherman Act; conspiracy in restraint of trade in violation of Section 1 of the Sherman Act; unlawful discrimination in prices, services or facilities in violation of Section 2 of the Clayton Act; and intentional interference with SFCA's contractual relationship with Metropolitan Dade County in violation of Florida law. The suit seeks damages in excess of $100 million, to be trebled under the Sherman and Clayton Acts, as well as compensatory and punitive damages under Florida law, and injunctive relief. A motion for summary judgment by FPL Group, FPL and ESI has been denied.\nIn November 1989, Johnson Enterprises of Jacksonville, Inc. (Johnson Enterprises) filed suit in the United States District Court for the Middle District of Florida against FPL Group, FPL Group Capital and Telesat, a subsidiary of FPL Group Capital. The suit, which arises out of a cable television facilities installation agreement between Johnson Enterprises and Telesat, alleges breach of contract, fraud and violations of racketeering statutes. The suit seeks compensatory damages in excess of $24 million, treble damages under racketeering activity statutes, punitive damages and attorneys' fees, as well as the revocation of Telesat's corporate charter and cable television franchises.\nFPL Group believes that it and its subsidiaries have meritorious defenses to all of the litigation described above and is vigorously defending these suits. Accordingly, the liabilities, if any, arising from this litigation are not anticipated to have a material adverse effect on FPL Group's financial statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nCommon Stock Data. FPL Group's common stock is traded on the New York Stock Exchange.\nThe high and low sales prices for the common stock of FPL Group as reported in the consolidated transaction reporting system of the New York Stock Exchange for each quarter during the past two years are as follows:\nApproximate Number of Stockholders. As of the close of business on February 28, 1994, there were 85,688 holders of record of FPL Group's common stock.\nDividends. Quarterly dividends have been paid on common stock of FPL Group during the past two years in the following amounts:\nThe amount and timing of dividends payable on common stock are within the sole discretion of FPL Group's Board of Directors. The increases in the annual dividend rates shown in the table above should not be viewed as indicating a trend for the future. As a practical matter, the ability of FPL Group to pay dividends on its common stock is dependent upon dividends paid to it by its subsidiaries, primarily FPL. Given FPL's current financial condition, there are no restrictions in effect that currently limit FPL's ability to pay dividends to FPL Group. See Management's Discussion - Financial Covenants.\nItem 6.","section_6":"Item 6. Selected Financial Data\nCertain amounts included in prior years' selected financial data were reclassified to conform to current year's presentation.\n(1) Reduced by after-tax effect of cost reduction program or restructuring charge. See Note 4. (2) Reduced by charges related to the write-down of businesses to be discontinued. See Note 5. (3) Reduced by charges related to the disposition of Colonial Penn. See Note 6. (4) Includes unbilled sales. (5) The winter season generally represents November and December of the prior year and January through March of the current year. (6) Includes unbilled and deferred cost recovery clause revenues.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nFor the three periods presented, net income benefitted from increased energy sales, primarily from customer growth, and the effects of cost control measures. Charges associated with a cost reduction program in 1993 and a corporate restructuring in 1991 reduced net income in those years. In addition, 1992 net income was adversely affected by Hurricane Andrew. In the following discussion, all comparisons are with the corresponding items in the prior year.\nOperating Income - Approximately 98% of FPL Group's operating revenue is derived from the electric utility operations of FPL. FPL's retail operations are regulated by the FPSC. Energy sales to retail customers, which represent over 96% of total energy sales, increased 4.0%, 0.1% and 3.3% in 1993, 1992 and 1991, respectively. Retail customer growth for those years was 2.1%, 1.7% and 2.1%, respectively. Revenues from base rates, which represented 61%, 57% and 56% of total operating revenues for 1993, 1992 and 1991, respectively, increased for the three years presented due to higher energy sales. Revenues derived from cost recovery clauses (including fuel) and franchise fees comprise substantially all of the remaining portion of operating revenues. These revenues represent a pass-through of costs and do not significantly affect net income.\nWith increasing competition in the utility industry, FPL is continuing its efforts to reduce its operating and capital costs and avoid filing for rate increases, the traditional response to increased rate base and cost pressures. In connection with these efforts, a major cost reduction program was implemented during 1993, resulting in a $138 million pretax charge. The charge consisted primarily of severance pay and employee retirement benefits related to a workforce reduction of approximately 1,700 positions. Approximately 45% of the charge relates to retirement benefits. Substantially all of the balance represents severance costs, of which about $60 million remains to be paid in 1994. In addition, substantial reductions were reflected in FPL's 1994-98 capital expenditure forecast, including a $210 million reduction from the previous capital expenditure forecast for 1994. The majority of the reductions in the 1994-97 period reflect a decrease in transmission and distribution expenditures through more efficient use of existing plant and more cost effective designs for new facilities. In 1991, FPL implemented a corporate restructuring that eliminated approximately 1,400 FPL positions and about 900 contractor positions. See Note 4.\nOther operations and maintenance expenses reflect cost savings from the 1991 restructuring, partially offset by the effects of an increasing customer base, changes in prices and operating activities, as well as the implementation of two new accounting standards relating to postretirement and postemployment benefits. See Note 3. As a result of FPL's recent cost reduction measures, other operations and maintenance expense is expected to decline in 1994, despite projected sales growth, additional generating units in service and two additional nuclear refueling outages. Higher utility plant balances, reflecting facilities added to meet customer growth, resulted in increased depreciation expense in each of the last three years. FPL filed new depreciation studies with the FPSC in December 1993. Changes in depreciation rates, when adopted, will be retroactive to January 1994 and, together with increases in utility plant, will increase depreciation expense in 1994. In addition, FPL is scheduled to file updated nuclear decommissioning studies with the FPSC in December 1994. Changes, if any, in the accrual for nuclear decommissioning costs will be effective January 1995. See Note 1.\nNon-Operating Income and Deductions - Allowance for funds used during construction (AFUDC) increased in 1993 and 1992 due to higher construction activity in the generation area. In future periods AFUDC is expected to decrease because the repowered Lauderdale units were placed in service in the second quarter of 1993, the Martin units are scheduled to be in service by June 1994 and no new generating capacity is under construction.\nDespite the obligation to fund growth in electric plant, interest and preferred dividends were relatively flat over the three-year period due to refunding approximately $3.3 billion of debt and preferred stock with lower rate instruments.\nThe income contribution from other-net increased in 1993 mainly due to improved equity in earnings of partnerships and joint ventures associated with ESI Energy, Inc. (ESI) and its non-utility energy projects. This increase was largely offset by premiums paid to redeem high cost debt of FPL Group Capital Inc (FPL Group Capital). Premiums paid on the redemption of FPL debt are amortized over the remaining life of the respective debt securities, consistent with the ratemaking treatment. See Note 1.\nEffective January 1, 1993, the corporate federal income tax rate increased from 34% to 35%. The rate change increased income tax expense by approximately $11 million, including $4 million resulting from the adjustment of the deferred income tax balances of the non-utility subsidiaries.\nPending Accounting Changes - In November 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (SOP) 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\" If adopted, SOP 93-6 would significantly change the manner in which FPL Group recognizes compensation expense associated with the matching contributions to its thrift plans. Based on preliminary estimates, adoption of the statement would reduce net income by approximately $20 million but would increase earnings per share by $0.04 in 1994, since shares held by the trust for the thrift plans that have not been allocated to employees would not be considered outstanding for purposes of computing earnings per share. FPL Group is not required to adopt the accounting guidance in this pronouncement and is evaluating whether to adopt it.\nLiquidity and Capital Resources\nCapital Requirements and Resources - FPL Group's primary capital requirements consist of expenditures under FPL's construction program. FPL's capital expenditures for the period 1994-98, including AFUDC, are expected to be $3.7 billion, including $879 million in 1994. Internally generated funds are expected to fund an increasing percentage of capital expenditures. The balance will be provided primarily through the issuance of FPL long-term debt, preferred stock and commercial paper.\nFPL Group Capital and ESI have committed to invest approximately $3.2 million in, and lend approximately $4.2 million to, partnerships and joint ventures entered into through ESI, all of which are expected to be funded in 1994. Additionally, FPL Group Capital and its subsidiaries, primarily ESI, have guaranteed up to approximately $89.2 million of lease obligations, debt service payments and other payments subject to certain contingencies.\nDebt maturities and minimum sinking fund requirements will require cash outflows of approximately $809 million through 1998, including $280 million in 1994. See Note 10. Bank lines of credit currently available to FPL Group and its subsidiaries aggregate $950 million.\nFinancial Covenants - FPL Group's charter does not limit the dividends that may be paid on its common stock; however, FPL's charter and mortgage contain provisions which, under certain conditions, restrict the payment of dividends and other distributions to FPL Group. Given FPL's current financial condition and level of earnings, these restrictions do not currently limit FPL's ability to pay dividends to FPL Group. FPL's charter limits the amount of unsecured debt and FPL's mortgage limits the amount of secured debt FPL can issue. At December 31, 1993, the charter and mortgage provisions would allow issuance of approximately $1.3 billion of additional unsecured debt and $5.5 billion of additional first mortgage bonds, respectively. The amount of additional first mortgage bonds that are permitted to be issued will increase as the amount of unfunded property additions increases. FPL's charter also prohibits the issuance of preferred stock unless the preferred stock coverage ratio, as prescribed, is at least 1.5; for the 12 months ended December 31, 1993 it was 2.24.\nFPL Group Capital, under a financial covenant in connection with a bank loan, is required to maintain a minimum level of consolidated net worth. At December 31, 1993, the required level was $100 million and actual consolidated net worth of FPL Group Capital was $333 million.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEPENDENT AUDITORS' REPORT\nFPL GROUP, INC.:\nWe have audited the consolidated financial statements of FPL Group, Inc. and its subsidiaries, listed in the accompanying index as Item 14(a)1 of this Annual Report (Form 10-K) to the Securities and Exchange Commission for the year ended December 31, 1993. Our audits also comprehended the financial statement schedules of FPL Group, Inc. and its subsidiaries, listed in the accompanying index as Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of FPL Group, Inc. and its subsidiaries at December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information shown therein.\nAs discussed in Notes 2 and 3 to the consolidated financial statements, FPL Group, Inc. and its subsidiaries changed their method of accounting for income taxes and postretirement benefits other than pensions effective January 1, 1993.\nDELOITTE & TOUCHE Certified Public Accountants\nMiami, Florida February 11, 1994\nFPL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nFPL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS (Thousands of dollars)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nFPL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS CAPITALIZATION AND LIABILITIES (Thousands of dollars)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nFPL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars)\n(1) Represents the effect on cash flows from operating activities of the net amounts deferred or recovered under the fuel and purchased power, oil-backout, energy conservation, capacity and environmental cost recovery clauses. (2) Excludes allowance for other funds used during construction.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nFPL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1993, 1992 and 1991\n1. Summary of Significant Accounting and Reporting Policies\nBasis of Presentation - The consolidated financial statements include the accounts of FPL Group, Inc. (FPL Group) and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts included in prior years' consolidated financial statements have been reclassified to conform to the current year's presentation.\nRegulation - The principal operating company of FPL Group is Florida Power & Light Company (FPL), a utility subject to regulation by the Florida Public Service Commission (FPSC) and the Federal Energy Regulatory Commission (FERC). As a result of such regulation, FPL follows the accounting practices set forth in Statement of Financial Accounting Standard (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation.\"\nRevenues and Rates - FPL's retail and wholesale utility rate schedules are approved by the FPSC and the FERC, respectively. FPL records the estimated amount of base revenues for energy delivered to customers but not billed. Such unbilled revenues are included in receivables - customers and amounted to approximately $112 million and $120 million at December 31, 1993 and 1992, respectively.\nRevenues include amounts resulting from cost recovery clauses, which are designed to permit full recovery of certain costs and provide a return on certain assets utilized by these programs, and franchise fees. Such revenues represent a pass-through of costs and include substantially all fuel, purchased power and interchange expenses, conservation-related expenses, revenue taxes and franchise fees. Revenues from cost recovery clauses are recorded when billed; FPL achieves matching of costs and related revenues by deferring the net under or over recovery.\nElectric Utility Plant, Depreciation and Amortization - The cost of additions to units of utility property is added to electric utility plant. The cost of units of property retired, less net salvage, is charged to accumulated depreciation. Maintenance and repairs of property as well as replacements and renewals of items determined to be less than units of property are charged to operating expenses - other operations and maintenance of utility plant.\nDepreciation of utility property is provided primarily on a straight-line average remaining life basis. Depreciation studies are performed at least every four years for substantially all utility property. The weighted annual composite depreciation rate was approximately 3.9%, 3.5% and 3.8% for the years 1993, 1992 and 1991, respectively. These rates exclude decommissioning expense and certain accelerated depreciation under cost recovery clauses. All depreciation methods and rates are approved by the FPSC.\nNuclear fuel costs, including a charge for spent nuclear fuel disposal, is accrued in fuel expense on a unit of production method.\nSubstantially all electric utility plant is subject to the lien of the Mortgage and Deed of Trust, as supplemented, securing FPL's first mortgage bonds.\nAllowance for Funds Used During Construction (AFUDC) - FPL recognizes AFUDC as a noncash item which represents the allowed cost of capital used to finance a portion of FPL's construction work in progress. AFUDC is capitalized as an additional cost of utility plant and is recorded as an addition to income. The capitalization rate used in computing AFUDC was 8.67% from January 1993 through June 1993, 8.26% from July 1993 through December 1993, 8.61% in 1992 and 8.46% in 1991. FPL allocates total AFUDC between borrowed funds and other funds. The portion of AFUDC attributable to short and long-term borrowed funds amounted to $31 million, $27 million and $17 million for the years ended December 31, 1993, 1992 and 1991, respectively.\nNuclear Decommissioning - FPL accrues nuclear decommissioning costs over the expected service life of each plant. Nuclear decommissioning studies are performed at least every five years for FPL's four nuclear units. A provision for nuclear decommissioning of $38 million for each of the years 1993, 1992 and 1991 is included in depreciation expense. The accumulated provision for nuclear decommissioning totaled $445 million and $390 million at December 31, 1993 and 1992, respectively, and is included in accumulated depreciation.\nAmounts equal to decommissioning expense are deposited in either qualified funds on a pretax basis or in a non-qualified fund on a net of tax basis. Fund earnings, net of taxes, are reinvested in the funds. Both fund earnings and the charge resulting from reinvestment of the earnings are included in other income - net. The related income tax effects are included in deferred taxes. The decommissioning reserve funds, the predominant component of the utility special use funds, may be used only for the payment of the cost of decommissioning FPL's nuclear units. Securities held in the funds consist primarily of tax-exempt obligations and are carried at cost. See Note 11.\nThe most recent decommissioning studies assume prompt dismantlement for the Turkey Point nuclear units commencing in the year 2005 and for St. Lucie Unit No. 2 commencing in 2021. St. Lucie Unit No. 1 will be mothballed in 2016 until St. Lucie Unit No. 2 is ready for dismantlement. FPL's portion of the cost of decommissioning these units, including dismantlement and reclamation, expressed in 1993 dollars, is currently estimated to aggregate $935 million.\nStorm and Property Insurance Reserve Fund - The storm and property insurance reserve fund provides coverage toward storm damage costs and possible retrospective premium assessments stemming from a nuclear incident under the various insurance programs covering FPL's nuclear generating plants. The storm and property insurance reserve represents amounts accumulated to date net of expenditures for storm damages. The related income tax effects are included in accumulated deferred income taxes. Securities held in the fund consist primarily of tax-exempt obligations and are carried at cost. In 1992, $21 million of the storm fund was used for storm damage costs associated with Hurricane Andrew. See Note 11.\nInvestments in Partnerships and Joint Ventures - The majority of investments in partnerships and joint ventures are accounted for under the equity method. The cost method is used when FPL Group has virtually no ability to influence the operating or financial decisions of the investee.\nSecurities Transactions - Marketable securities are held by a consolidated limited partnership and are accounted for at market value. Partnership assets are managed by an independent investment advisor. Earnings on the investments are included in other - net in the consolidated statements of income.\nIncluded in other current liabilities at December 31, 1993 are approximately $94 million of securities sold, but not yet purchased. These obligations are carried at their market value and create off-balance sheet market risk to the extent that the market value of the underlying securities (U.S. Treasury Notes) subsequently increases.\nCash Equivalents - Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less. The carrying amount of these investments approximates their market value.\nRetirement of Long-Term Debt - The excess of FPL's reacquisition cost over the book value of long-term debt is deferred and amortized to expense ratably over the remaining life of the original issue, which is consistent with its treatment in the ratemaking process. FPL Group Capital Inc (FPL Group Capital) expenses this cost in the period incurred.\nRate Matters - Deferred litigation items of FPL at December 31, 1993 and 1992, represent costs approved by the FPSC for recovery over five years commencing with the effective date of new base rates to be established in the next general rate proceeding.\nIncome Taxes - Deferred income taxes are provided on all significant temporary differences between the financial statement and tax bases of assets and liabilities. Investment tax credits are used to reduce current federal income taxes and, in the case of FPL, are deferred and amortized to income over the approximate lives of the related property.\n2. Income Taxes\nIn 1993, FPL Group adopted SFAS No. 109, \"Accounting for Income Taxes,\" which requires the use of the liability method in accounting for income taxes. Under the liability method, the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities are reported as deferred taxes measured at current tax rates. At FPL, the principal effect of adopting SFAS No. 109 was the reclassification of the revenue equivalent of deferred taxes in excess of the amount required to be reported as a liability under SFAS No. 109 from accumulated deferred income taxes to a newly-established deferred regulatory credit - income taxes. This amount will be amortized over the estimated lives of the assets or liabilities which resulted in the initial recognition of the deferred tax amount. Adoption of this standard had no effect on results of operations. The net result of amortizing the deferred regulatory credit and the related deferred taxes established under SFAS No. 109 is to yield comparable amounts to those included in the tax provision under accounting rules applicable to prior periods.\nThe components of income taxes are as follows:\nA reconciliation between income tax expense and the expected income tax expense at the applicable statutory rates is as follows:\nThe income tax effects of discontinued operations in 1991 differ from the effects computed at statutory rates primarily due to FPL Group's assessment of loss disallowance rules and limitations on the ability to utilize capital loss benefits. FPL Group plans to challenge the loss disallowance rules. Based on the uncertainties associated with the ultimate outcome of this challenge and recognition of offsetting capital gains, a valuation allowance was recorded to fully offset the effect of establishing a deferred tax asset of approximately $170 million under SFAS No. 109 for the tax benefits of the capital loss carryforward.\nThe income tax effects of temporary differences giving rise to FPL Group's consolidated deferred income tax assets and liabilities after adoption of SFAS No. 109 are as follows:\n3. Employee Retirement Benefits\nPension Benefits - Substantially all employees of FPL Group and its subsidiaries are covered by a noncontributory defined benefit pension plan. Plan benefits are generally based on employees' years of service and compensation during the last years\nof employment. Participants are vested after five years of service. Plan assets consist primarily of bonds, common stocks and short-term investments.\nFor 1993, 1992 and 1991 the components of pension cost, a portion of which has been capitalized, are as follows:\nPrior to 1993, an adjustment was made to reflect in the results of operations FPL's pension cost calculated under the actuarial cost method used for utility ratemaking purposes. In 1993, FPL adopted consistent pension measurements for ratemaking and financial reporting. The accumulated regulatory adjustment is being amortized to income over five years. At December 31, 1993 and 1992, the cumulative amount of this regulatory adjustment included in other liabilities was approximately $16 million and $20 million, respectively.\nDuring 1992, the method used for valuing plan assets in the calculation of pension cost was changed from fair value to a calculated market-related value. The new method was adopted to reduce the volatility in annual pension expense that results from short-term fluctuations in the securities markets. The cumulative effect of the change was to reduce prepaid pension costs and the related accumulated regulatory adjustment by approximately $37 million, with no effect on earnings.\nDuring 1993, the effect of a prior plan amendment that changed the manner in which benefits accrue was recognized and included as part of prior service cost to be amortized over the remaining service life of the employees.\nFPL Group funds the pension cost calculated under the entry age normal level percentage of pay actuarial cost method, provided that this amount satisfies the Employee Retirement Income Security Act minimum funding standards and is not greater than the maximum tax deductible amount for the year. No contributions to the plan were required for 1993, 1992 or 1991.\nA reconciliation of the funded status of the plan to the amounts recognized in the Consolidated Balance Sheets is presented below:\n(1) Includes $37 million effect of changing to calculated market-related method of valuing plan assets.\nAs of December 31, 1993 and 1992, the weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.0% and 6.0%, respectively. The assumed rate of increase in future compensation levels at those respective dates was 5.5% and 6.0%. The expected long-term rate of return on plan assets used in determining pension cost was 7.75% for 1993 and 7.0% for 1992 and 1991.\nOther Postretirement Benefits - FPL Group and its subsidiaries have defined benefit postretirement plans for health care and life insurance benefits that cover substantially all employees. Eligibility for health care benefits is based upon age plus years of service at retirement. The plans are contributory, and contain cost-sharing features such as deductibles and coinsurance. FPL Group has capped company contributions for postretirement health care at a defined level which, depending on actual claims experience, may be reached by the year 2000. Generally, life insurance benefits for retirees are capped at $50,000. FPL Group's policy is to fund postretirement benefits in amounts determined at the discretion of management. Benefit payments in 1993 and 1992 totaled $13 million and $12 million, respectively, and were paid out of existing plan assets.\nIn 1993, FPL Group adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" For the year ended December 31, 1993, the components of net periodic postretirement benefit cost, a portion of which has been capitalized, are as follows:\nA reconciliation of the funded status of the plan to the amounts recognized in the Consolidated Balance Sheets is presented below:\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) for 1993 is 10.5% for retirees under age 65 and 6.5% for retirees over age 65. These rates are assumed to decrease gradually to 6.0% by the year 2000, which is when it is anticipated that benefit costs will reach the defined level at which company contributions will be capped. The cap on FPL Group's contributions mitigates the potential significant increase in costs resulting from an increase in the health care cost trend rate. Increasing the assumed health care cost trend rate by one percentage point would increase the plan's accumulated postretirement benefit obligation as of December 31, 1993 by $8 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost of the plan for 1993 by approximately $1 million.\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% at December 31, 1993. The expected long-term rate of return on plan assets was 7.75% at December 31, 1993.\nPostemployment Benefits - In 1993, FPL Group adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires a change from recognizing expenses when paid to recording the benefits as the liability is incurred. Implementation of this pronouncement did not have a material effect on FPL Group's results of operations.\n4. Cost Reduction Program and Restructuring Charge\nIn 1993, FPL implemented a major cost reduction program, which resulted in a $138 million charge and reduced net income by approximately $85 million. The program consisted primarily of a Voluntary Retirement Plan (VRP) and a Special Severance Plan (SSP). The VRP was offered to all employees who were at least 54 years of age and had at least 10 years of service. The plan, among other things, added five years to age and service for the determination of plan benefits to be received by eligible employees. Approximately 700 employees, or 75% of those eligible, elected to retire under this program. The impact on pension cost resulting from the two programs as determined under the provisions of SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" was approximately $34 million. The impact on postretirement benefits as determined under SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" was approximately $29 million. These amounts are included as part of the total charge of $138 million. See Note 3.\nIn 1991, FPL recorded a $90 million restructuring charge in connection with a company-wide restructuring which reduced net income by $56 million. The charge included severance pay for departing employees, as well as relocation and facility modification expenditures.\n5. Businesses to be Discontinued\nIn 1990, FPL Group decided to sell or otherwise dispose of the real estate, cable television, environmental remediation and utility-related services businesses. In 1991, the environmental remediation and utility-related services businesses were sold with no significant impact on net income. During 1993, FPL Group sold or otherwise liquidated certain cable television and real estate assets, including cable television operating systems, interests in three cable television joint ventures and real estate rental properties. FPL Group's remaining developed real estate properties are under contract for sale. This pending sale, if closed, and the currently estimated result of disposing of the balance of FPL Group's cable television and real estate assets are not expected to have a significant adverse effect on net income.\n6. Discontinued Operations\nIn 1991, Colonial Penn Group, Inc. (Colonial Penn) was sold, resulting in a $135 million after-tax loss. The sale did not include Bay Loan and Investment Bank (Bay Loan), a former Colonial Penn subsidiary, which is winding down its operations and will be dissolved. The principal business of Bay Loan was investing in loans secured by real estate using funds provided from the issuance of insured certificates of deposit. Bay Loan ceased investing in new loans in 1990 and is in the process of effecting an orderly liquidation. The date when such liquidation will be completed cannot be predicted with certainty because it is dependent on the timing of loan prepayments and asset sales. FPL Group has no legal obligation and has no intention to contribute additional equity to Bay Loan. The investment in Bay Loan was written off in 1990; the orderly liquidation of its operations is not expected to have an adverse effect on FPL Group's future operating results.\nColonial Penn and Bay Loan have been accounted for as discontinued operations. Operating revenues of Bay Loan were $16.3 million and $21.4 million for 1993 and 1992, respectively. Combined operating revenues of Colonial Penn (through date of closing) and Bay Loan were $714.1 million for 1991. Bay Loan reported operating income of $5.1 million in 1993 and operating losses of $5.9 million and $8.5 million in 1992 and 1991, respectively. The losses incurred subsequent to the measurement date (date on which Bay Loan was initially classified as discontinued operations) had no effect on FPL Group's results of operations as such losses had been provided for in the loss on disposal of discontinued operations in 1991.\nThe remaining assets of Bay Loan consist primarily of loans secured by real estate and real estate owned as a result of foreclosures. Most of Bay Loan's loan customers and the real estate securing their loans are located in the northeast United States. The remaining liabilities of Bay Loan consist primarily of FDIC-insured certificates of deposit, which will be settled with funds generated from loan repayments and the sale of Bay Loan assets. Total assets and liabilities of Bay Loan at December 31, 1993 were $149.3 million and $129.7 million, respectively. Total assets and liabilities of Bay Loan at December 31, 1992 were $194.9 million and $180.4 million, respectively. The carrying amounts of assets and liabilities at December 31, 1993 and 1992, approximate the estimated fair values of the financial instruments of Bay Loan.\n7. Leases\nIn 1991, FPL expanded its nuclear fuel lease program to include all four of its nuclear units. In connection with this expansion, FPL sold to a non-affiliated lessor and leased back approximately $220 million of nuclear fuel held in reactors of these units, as well as nuclear fuel in various stages of enrichment. The fuel was sold at book value. Nuclear fuel payments, which are based on energy production and are charged to fuel expense, were $122 million, $120 million and $81 million for the years ended December 31, 1993, 1992 and 1991, respectively. Included in these payments was an interest component of $11 million, $13 million and $9 million in 1993, 1992 and 1991, respectively. Under certain circumstances of lease termination, FPL is required to purchase all nuclear fuel in whatever form at a purchase price designed to allow the lessor to recover its net investment cost in the fuel, which totaled $226 million at December 31, 1993. For ratemaking purposes, the leases encompassed within this lease arrangement are classified as operating leases. For financial reporting purposes, the capital lease obligation is recorded at the amount due in the event of lease termination.\nIn 1992, FPL entered into a noncancelable capital lease arrangement for an office building whose net book value at December 31, 1993 and 1992 was approximately $46 million and $48 million, respectively. The present value of future minimum lease payments at December 31, 1993 totaled $49 million. Future minimum annual lease payments under this lease arrangement, which expires in 2016, are estimated to be $4 million.\nExcluding these leases, the amount of assets and capitalized lease obligations for other capital leases is not material.\nFPL Group, through its subsidiaries, leases automotive, computer, office and other equipment through rental agreements with various terms and expiration dates. Rental expense totaled $33 million, $55 million and $51 million for 1993, 1992 and 1991, respectively. Minimum annual rental commitments for noncancelable operating leases are $22 million for 1994, $19 million for 1995, $13 million for 1996, $7 million for 1997, $6 million for 1998 and $15 million thereafter.\n8. Jointly-Owned Electric Utility Plant\nFPL owns approximately 85% of the St. Lucie Nuclear Unit No. 2, 20% of the St. Johns River Power Park (SJRPP) units and coal terminal and a 49% undivided interest in Scherer Unit No. 4. FPL expects to purchase an additional 27% undivided ownership interest in Scherer Unit No. 4 in two stages through 1995. At December 31, 1993, FPL's investment in St. Lucie Unit No. 2 was $768 million, net of accumulated depreciation of $397 million; the investment in the SJRPP units and coal terminal was $221 million, net of accumulated depreciation of $110 million; the investment in Scherer Unit No. 4 was $296 million, net of accumulated depreciation of $54 million.\nFPL is responsible for its share of the operating costs, as well as providing its own financing. At December 31, 1993, there was no significant balance of construction work in progress on these facilities.\n9. Common Shareholders' Equity\nThe changes in common shareholders' equity accounts are as follows:\nCommon Stock Dividend Restrictions - FPL Group's Charter does not limit the dividends that may be paid on its common stock. As a practical matter, the ability of FPL Group to pay dividends on its common stock is dependent upon dividends paid to it by its subsidiaries, primarily FPL. FPL's charter and mortgage contain provisions that, under certain conditions, restrict the payment of dividends and other distributions to FPL Group. Given FPL's current financial condition and level of earnings, these restrictions do not currently limit FPL's ability to pay dividends to FPL Group.\nEmployee Stock Ownership Plan - The employee thrift plans of FPL Group and FPL include a leveraged Employee Stock Ownership Plan feature. Shares of common stock held by the Trust for the Thrift Plans (Trust) are used to provide all or a portion of the employers' matching contributions. In 1990, the Trust borrowed the funds from FPL Group Capital, at an interest rate of 9.69% to purchase the shares and is repaying the loan with dividends received on the shares along with cash contributions from the employers. Reducing stockholders' equity at December 31, 1993 is approximately $317 million of unearned compensation related to unallocated shares of common stock held by the Trust. The unallocated shares are considered outstanding for purposes of computing earnings per share. Dividends paid aggregated approximately $30 million in all years.\nIn November 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\" If adopted, SOP 93-6 would significantly change the manner in which FPL Group recognizes compensation expense associated with the matching contributions to its thrift plans. Based on preliminary estimates, adoption of the standard would reduce net income by approximately $20 million but would increase earnings per share by $0.04 in 1994, since shares held by the Trust which have not yet been allocated to employees would not be considered outstanding for purposes of computing earnings per share. FPL Group is not required to adopt the accounting guidance in this pronouncement and is evaluating whether or not to adopt it.\nLong-Term Incentive Plan - FPL Group has a long-term incentive plan under which an aggregate of 4 million shares may be awarded to officers and key employees of FPL Group and its subsidiaries. At December 31, 1993, 3,304,739 shares were available for future awards. Total compensation charged against earnings under the incentive plan, and the effect on earnings per share, were not material in any year. The changes in share awards under the incentive plan are as follows:\n(1) Payment of performance shares is based on the market price of FPL Group's common stock when the related performance goal is achieved. (2) Shares of restricted stock were issued at market value at the date of the grant. (3) All outstanding options are exercisable at $30 7\/8.\nStock appreciation rights in an equivalent amount have been granted in conjunction with the options referred to above. No awards of incentive stock options have been granted as of December 31, 1993.\nOther - FPL Group has reserved 17 million shares of common stock for issuance under the Dividend Reinvestment and Common Share Purchase Plan and Employee Benefit Plans. At December 31, 1993, 9 million of the shares reserved for these plans had been issued. Each share of common stock has been granted a Preferred Share Purchase Right, which is exercisable in the event of certain attempted business combinations. The Rights will cause substantial dilution to a person or group attempting to acquire FPL Group on terms not approved by the FPL Group Board of Directors.\n10. Preferred Stock and Long-Term Debt\nPreferred Stock (1)(2)\n(1) FPL Group's charter authorizes the issuance of 100 million shares of serial preferred stock, $.01 par value. None of these shares are outstanding. (2) FPL's charter authorizes the issuance of 5 million shares of subordinated preferred stock, no par value. No shares of subordinated preferred stock are outstanding. In 1993, FPL issued 1,900,000 shares of $100 par value preferred stock. In 1992, FPL issued 5,000,000 shares of $2.00 No Par Value, Series A, preferred stock. There were no issuances of preferred stock in 1991. (3) Not redeemable prior to 2003. (4) Minimum annual sinking fund requirements on preferred stock are approximately $2 million for each of the years 1994 and 1995 and $4 million for each of the years 1996, 1997 and 1998. In the event that FPL should be in arrears on its sinking fund obligations, FPL may not pay dividends on common stock. (5) Entitled to a sinking fund to retire a minimum of 15,000 shares and a maximum of 30,000 shares annually from 1994 through 2026 at $100 per share plus accrued dividends. FPL redeemed and retired 15,000 shares in 1992, satisfying the 1993 minimum annual sinking fund requirement. (6) Entitled to a sinking fund to retire a minimum of 25,000 shares and a maximum of 50,000 shares annually from 1996 through 2015 at $100 per share plus accrued dividends.\nLong-Term Debt (1)(2)\n(1) Minimum annual maturities and sinking fund requirements of long-term debt are approximately $278 million for 1994, $82 million for 1995, $101 million for 1996, $151 million for 1997 and $181 million for 1998. (2) Available lines of credit aggregated approximately $950 million at December 31, 1993, all of which were based on firm commitments. (3) Excludes approximately $46 million principal amount of bonds removed from the balance sheet in December 1993 as a result of an in-substance defeasance. Such bonds were redeemed in January 1994 with funds previously placed in an irrevocable trust.\n11. Fair Value of Financial Instruments\nThe following estimates of the fair value of financial instruments have been made using available market information and other valuation methodologies. However, the use of different market assumptions or methods of valuation could result in different estimated fair values.\n(1) Based on quoted market prices for these or similar issues. (2) Includes current maturities.\n12. Commitments and Contingencies\nCapital Commitments - FPL has made certain commitments in connection with its projected capital expenditures. These expenditures, for the construction or acquisition of additional facilities and equipment to meet customer demand, are estimated to be $3.7 billion, including AFUDC, for the years 1994 through 1998.\nFPL Group Capital and ESI Energy, Inc. (ESI), have committed to invest $3 million in, and lend approximately $4 million to, partnerships and joint ventures entered into through ESI, all of which are expected to be funded in 1994. Additionally, FPL Group Capital and its subsidiaries, primarily ESI, have guaranteed up to approximately $89 million of lease obligations, debt service payments and other payments subject to certain contingencies.\nFPL Group, through a consolidated limited partnership, has entered into forward commitments at December 31, 1993 to purchase $100 million of mortgage-backed securities on various dates through February 1994 at specified prices. The market value of these securities totaled $100 million at December 31, 1993. Additionally, the partnership had entered into forward commitments to sell short $87 million of U.S. Treasury Notes on various dates in January 1994 at specified prices. At December 31, 1993, the market value of those securities totaled $89 million.\nInsurance - Liability for accidents at nuclear power plants is governed by the Price-Anderson Act, which limits the liability of nuclear reactor owners to the amount of the insurance available from private sources and under an industry retrospective payment plan. In accordance with this Act, FPL maintains $200 million of private liability insurance, which is the maximum obtainable, and participates in a secondary financial protection system under which it is subject to retrospective assessments of up to $317 million per incident at any nuclear utility reactor in the United States, payable at a rate not to exceed $40 million per incident per year.\nFPL participates in insurance pools and other arrangements that provide $2.75 billion of limited insurance coverage for property damage, decontamination and premature decommissioning risks at its nuclear plants. The proceeds from such insurance, however, must first be used for reactor stabilization and site decontamination before they can be used for plant repair. FPL also participates in an insurance program that provides limited coverage for replacement power costs if a plant is out of service because of an accident. In the event of an accident at one of FPL's or another participating insured's nuclear plant, FPL could be assessed up to $58 million in retrospective premiums, and in the event of a subsequent accident at such\nnuclear plants during the policy period, the maximum assessment is $72 million under the programs in effect at December 31, 1993. This contingent liability would be partially offset by a portion of FPL's storm and property insurance reserve (storm fund), which totaled $82 million at that date.\nIn the event of a catastrophic loss at one of FPL's nuclear plants, the amount of insurance available may not be adequate to cover property damage and other expenses incurred. Uninsured losses, to the extent not recovered through rates, would be borne by FPL and could have a material adverse effect on FPL Group's and FPL's financial condition.\nIn 1993, FPL replaced its transmission and distribution (T&D) property insurance coverage with a self-insurance program due to the high cost and limited coverage available from third-party insurers. Costs incurred under the self-insurance program will be charged against FPL's storm fund. Recovery of any losses in excess of the storm fund from ratepayers will require the approval of the FPSC. FPL's available lines of credit include $300 million to provide additional liquidity in the event of a T&D property loss.\nContracts - FPL has take-or-pay contracts with the Jacksonville Electric Authority (JEA) for 374 megawatts (mw) through 2023 and with the subsidiaries of the Southern Company to purchase 1,406 mw of power through May 1994, and declining amounts thereafter through mid-2010. FPL also has various firm pay-for-performance contracts to purchase 1,031 mw from certain cogenerators and small power producers (qualifying facilities) with expiration dates ranging from 2002 through 2026. These contracts provide for capacity and energy payments. Capacity payments for the pay-for-performance contracts are subject to the qualifying facilities meeting certain contract obligations. Energy payments are based on the actual power taken under these contracts.\nThe required capacity payments through 1998 under these contracts are estimated to be as follows:\nFPL's capacity and energy charges under these contracts for 1993, 1992 and 1991 were as follows:\n(1) Recovered through base rates and the capacity cost recovery clause (capacity clause). (2) Recovered through the capacity clause. (3) Recovered through the fuel and purchased power cost recovery clause. (4) Recoverable through base rates.\nFPL has take-or-pay contracts for the supply and transportation of natural gas under which it is required to make payments estimated to be $280 million for 1994, $380 million for 1995 and $390 million for each of the years 1996, 1997 and 1998. Total payments made under these contracts were $270 million, $269 million and $221 million for 1993, 1992 and 1991, respectively.\nLitigation - Union Carbide Corporation sued FPL and Florida Power Corporation alleging that, through a territorial agreement approved by the FPSC, they conspired to eliminate competition in violation of federal antitrust laws. Praxair, Inc., an entity that was formerly a unit of Union Carbide, has been substituted as the plaintiff. The suit seeks treble damages of an unspecified amount based on alleged higher prices paid for electricity and product sales lost. Cross motions for summary judgement were denied. Both parties are appealing the denials.\nA suit brought by the partners in a cogeneration project located in Dade County, Florida, alleges that FPL Group, FPL and ESI have engaged in anti-competitive conduct intended to eliminate competition from cogenerators generally, and from their facility in particular, in violation of federal antitrust laws and have wrongfully interfered with the cogeneration project's contractual relationship with Metropolitan Dade County. The suit seeks damages in excess of $100 million, before trebling under antitrust law, plus other unspecified compensatory and punitive damages. A motion for summary judgment by FPL Group, FPL and ESI has been denied.\nA former cable installation contractor for Telesat Cablevision, Inc. (an indirect subsidiary of FPL Group) has sued FPL Group, FPL Group Capital and Telesat for breach of contract, fraud and violation of racketeering statutes. The suit seeks compensatory damages in excess of $24 million, treble damages under racketeering activity statutes, punitive damages and attorneys' fees, as well as the revocation of Telesat's corporate charter and cable television franchises.\nFPL Group believes that it and its subsidiaries have meritorious defenses to all of the litigation described above and is vigorously defending these suits. Accordingly, the liabilities, if any, arising from this litigation are not anticipated to have a material adverse effect on FPL Group's financial statements.\n13. Quarterly Data (Unaudited)\nCondensed consolidated quarterly financial information for 1993 and 1992 is as follows:\n(1) In the opinion of FPL Group, all adjustments, which consist of normal recurring accruals necessary to present a fair statement of such amounts for such periods, have been made. Results of operations for an interim period may not give a true indication of results for the calendar year. (2) Charge resulting from cost reduction program reduced operating income by $138 million, net income by $85 million and earnings per share by $0.45. See Note 4.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information required by this Item will be included in FPL Group's Definitive Proxy Statement which will be filed with the SEC in connection with the 1994 Annual Meeting of Shareholders (FPL Group's Proxy Statement) and is incorporated herein by reference, or is included in Part I under Executive Officers of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item will be included in FPL Group's Proxy Statement and is incorporated herein by reference, provided that the Compensation Committee Report and Performance Graphs which are contained in FPL Group's Proxy Statement shall not be deemed to be incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item will be included in FPL Group's Proxy Statement and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this Item will be included in FPL Group's Proxy Statement and is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements Page(s)\nIndependent Auditors' Report 15 Consolidated Statements of Income for the Years Ended December 31, 1993, 1992 and 1991 16 Consolidated Balance Sheets at December 31, 1993 and 1992 17-18 Consolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1992 and 1991 19 Notes to Consolidated Financial Statements for the Years Ended December 31, 1993, 1992 and 1991 20-35\n2. Financial Statement Schedules(1)\nSchedule V Property, Plant and Equipment 39-40 Schedule VI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 41-42 Schedule IX Short-Term Borrowings 43 Schedule X Supplementary Income Statement Information 44\n(1) All other schedules are omitted as not applicable or not required.\n3. Exhibits including those Incorporated by Reference\nExhibit Number Description\n*3(i) Restated Articles of Incorporation of FPL Group dated December 31, 1984, as amended through December 17, 1990 (filed as Exhibit 4(a) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n3(ii) Bylaws of FPL Group dated November 15, 1993\n*4(a) Rights Agreement, dated as of June 16, 1986, between FPL Group, Inc. and the First National Bank of Boston (filed as Exhibit 4(e) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*4(b) Mortgage and Deed of Trust dated as of January 1, 1944, and Ninety-four Supplements thereto between FPL and Bankers Trust Company and The Florida National Bank of Jacksonville (now First Union National Bank of Florida), Trustees (as of September 2, 1992, the sole trustee is Bankers Trust Company) (filed as Exhibit B-3, File No. 2-4845; Exhibit 7(a), File No. 2-7126; Exhibit 7(a), File No. 2-7523; Exhibit 7(a), File No. 2-7990; Exhibit 7(a), File No. 2-9217; Exhibit 4(a)-5, File No. 2-10093; Exhibit 4(c), File No. 2-11491; Exhibit 4(b)-1, File No. 2-12900; Exhibit 4(b)-1, File No. 2-13255; Exhibit 4(b)-1, File No. 2-13705; Exhibit 4(b)-1, File No. 2-13925; Exhibit 4(b)-1, File No. 2-15088; Exhibit 4(b)-1, File No. 2-15677; Exhibit 4(b)-1, File No. 2-20501; Exhibit 4(b)-1, File No. 2-22104; Exhibit 2(c), File No. 2-23142; Exhibit 2(c), File No. 2-24195; Exhibit 4(b)-1, File No. 2-25677; Exhibit 2(c), File No. 2-27612; Exhibit 2(c), File No. 2-29001; Exhibit 2(c), File No. 2-30542; Exhibit 2(c), File No. 2-33038; Exhibit 2(c), File No. 2-37679; Exhibit 2(c), File No. 2-39006; Exhibit 2(c), File No. 2-41312; Exhibit 2(c), File No. 2-44234; Exhibit 2(c), File No. 2-46502; Exhibit 2(c), File No. 2-48679; Exhibit 2(c), File No. 2-49726; Exhibit 2(c), File No. 2-50712; Exhibit 2(c), File No. 2-52826; Exhibit 2(c), File No. 2-53272; Exhibit 2(c), File No. 2-54242; Exhibit 2(c), File No. 2-56228; Exhibits 2(c) and 2(d), File No. 2-60413; Exhibits 2(c) and 2(d), File No. 2-65701; Exhibit 2(c), File No. 2-66524; Exhibit 2(c), File No. 2-67239; Exhibit 4(c), File No. 2-69716; Exhibit 4(c), File No. 2-70767; Exhibit 4(b), File No. 2-71542; Exhibit 4(b), File No. 2-73799; Exhibits 4(c), 4(d) and 4(e), File No. 2-75762; Exhibit 4(c), File No. 2-77629; Exhibit 4(c), File No. 2-79557; Exhibit 99(a) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669; Exhibit 99(a) to Post-Effective Amendment No. 1 to Form S-3, File No. 33-46076); and Exhibit 4(b) to Form 10-K dated March 21, 1994, File No. 1-3545).\n*10(a) Supplemental Executive Retirement Plan, as amended and restated (filed as Exhibit 99(b) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(b) Benefit Restoration Plan of FPL Group and affiliates, as amended and restated (filed as Exhibit 99(c) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(c) FPL Group Amended and Restated Supplemental Executive Retirement Plan for J. L. Broadhead (filed as Exhibit 99(d) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(d) Employment Agreement between FPL Group and D. P. Coyle dated June 12, 1989 (filed as Exhibit 99(e) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(e) Employment Agreement between FPL and Stephen E. Frank dated July 31, 1990 (filed as Exhibit 99(f) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(f) Employment Agreement between FPL and Jerome H. Goldberg dated August 9, 1989 (filed as Exhibit 99(g) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(g) FPL Group Long-Term Incentive Plan of 1985, as amended (filed as Exhibit 99(h) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(h) Director and Executive Compensation Deferral Plan of FPL, as amended (filed as Exhibit 99(i) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n*10(i) Employment Agreement between FPL Group and James L. Broadhead dated February 13, 1989 (filed as Exhibit 99(j) to Post-Effective Amendment No. 5 to Form S-8, File No. 33-18669)\n10(j) Employment Agreement between FPL Group and James L. Broadhead dated as of December 13,\n21 Subsidiaries of the Registrant\n23 Independent Auditors' Consent\n* Incorporated herein by reference\n(b) Reports on Form 8-K\n(1) A Current Report on Form 8-K dated October 22, 1993 was filed October 22, 1993 reporting one event under Item 5. Other Events.\nSCHEDULE V\nFPL GROUP, INC. AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT\nSCHEDULE V\nFPL GROUP, INC. AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT (Concluded)\nSCHEDULE VI\nFPL GROUP, INC. AND SUBSIDIARIES ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nSCHEDULE VI\nFPL GROUP, INC. AND SUBSIDIARIES ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (Concluded)\n(1) Depreciation of transportation equipment is charged to various accounts based on the use of such equipment. Amortization of nuclear fuel assemblies is charged to fuel, purchased power and interchange expense. (2) This reserve is maintained for all depreciable property. The amount in the retirements column is net of removal costs and salvage. (3) Includes fossil decommissioning reserves of $102 million, $92 million and $83 million at December 31, 1993, 1992 and 1991, respectively.\nSCHEDULE IX\nFPL GROUP, INC. AND SUBSIDIARIES SHORT-TERM BORROWINGS\n(1) Represents the maximum amount outstanding at any month end. (2) Computed by dividing the sum of the daily ending balances by the number of days in the year. (3) Computation is based upon the principal amounts weighted by the number of days outstanding.\nSCHEDULE X\nFPL GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INCOME STATEMENT INFORMATION (1)\n(1) Other information required by Article 5, Schedule X - Supplementary Income Statement Information is shown in the Consolidated Financial Statements or notes thereto, or is not presented as such amounts are less than 1% of total revenues.\nSIGNATURES\nPursuant 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.\nDate: March 21, 1994 FPL Group, Inc.\nBy JAMES L. BROADHEAD James L. Broadhead (Chairman of the Board, President and Chief Executive Officer, Principal Executive Officer and Director)\nPursuant 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 and on the date indicated.\nSignature Title Date\nPAUL J. EVANSON Principal Financial Officer Paul J. Evanson (Vice President, Finance and Chief Financial Officer)\nK. MICHAEL DAVIS Principal Accounting Officer K. Michael Davis (Controller and Chief Accounting Officer)\nMarch 21, 1994\nH. JESSE ARNELLE H. Jesse Arnelle\nROBERT M. BEALL, II Directors Robert M. Beall, II\nDAVID BLUMBERG David Blumberg\nSignature Title Date\nJ. HYATT BROWN J. Hyatt Brown\nMARSHALL M. CRISER Marshall M. Criser\nJEAN MCARTHUR DAVIS Jean McArthur Davis\nBEVERLY F. DOLAN Beverly F. Dolan Directors March 21, 1994\nWILLARD D. DOVER Willard D. Dover\nALFONSO FANJUL Alfonso Fanjul\nSTEPHEN E. FRANK Stephen E. Frank\nDREW LEWIS Drew Lewis\nFREDERIC V. MALEK Frederic V. Malek\nPAUL R. TREGURTHA Paul R. Tregurtha","section_15":""}
{"filename":"732718_1993.txt","cik":"732718","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nU S WEST, Inc. (\"U S WEST\") was incorporated under the laws of the State of Colorado and has its principal executive offices at 7800 East Orchard Road, Englewood, Colorado 80111, telephone number (303) 793-6500. U S WEST is a diversified global communications company engaged in the telecommunications, directory publishing, marketing and, most recently, entertainment services businesses. Telecommunications services are provided by U S WEST's principal subsidiary, U S WEST Communications, Inc., to more than 25 million residential and business customers in the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (collectively, the \"U S WEST Region\"). Directory publishing, marketing and entertainment services as well as cellular mobile communications services are provided by other U S WEST subsidiaries to customers both inside and outside the U S WEST Region. (Financial information concerning U S WEST's operations is set forth in the Consolidated Financial Statements and Notes thereto in the U S WEST 1993 Annual Report to Shareowners (the \"1993 Annual Report\") and is incorporated herein by reference.) U S WEST and its subsidiaries had 60,778 employees at December 31, 1993.\nRECENT DEVELOPMENTS\nU S WEST COMMUNICATIONS\nDEVELOPMENT OF BROADBAND NETWORK. In February, 1993, U S WEST announced its intention to build a broadband telecommunications network (the \"Broadband Network\") capable of providing voice, data and video services to customers within the U S WEST Region. When completed, the Broadband Network will carry multimedia signals over a mix of optical fiber, coaxial cable and copper wire. U S WEST expects that it will ultimately deliver a variety of integrated communications, entertainment and information services and other high speed digital services, including data applications, through the Broadband Network in selected areas of the U S WEST Region. These integrated services, including video-on-demand, targeted advertising, home shopping, interactive games, high- definition broadcast television and two-way, video telephony are expected to become available over time as the Broadband Network develops. The Broadband Network architecture is currently being installed and technical trials are beginning in Omaha, Nebraska. U S WEST is seeking approval from the Federal Communications Commission (the \"FCC\") to install Broadband Network architecture in Denver, Minneapolis-St. Paul, Portland, and Boise. U S WEST expects to put the Broadband Network into commercial use in selected areas by 1995, subject to a number of competitive and other factors, some of which are beyond its control, including the receipt of necessary regulatory approvals and the availability of suitable technology.\nRESTRUCTURING. On September 17, 1993, U S WEST announced that U S WEST Communications would implement a plan (the \"Restructuring Plan\") designed to provide faster, more responsive customer services while reducing the costs of providing these services. Pursuant to the Restructuring Plan, U S WEST Communications will develop new systems that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, provide automated inventory systems and centralize its service centers so that customers can have their telecommunications needs resolved with one phone call. U S WEST Communications will also gradually reduce its work force by approximately 8,000 employees by the end of 1996 (in addition to a remaining reduction of 1,000 employees pursuant to a restructuring plan announced in 1991) and consolidate the operations of its existing 560 customer centers into 26 customer centers in ten cities. U S WEST expects cost reductions will be realized as these components of the Restructuring Plan are implemented. In connection with the Restructuring Plan, U S WEST recognized a pretax restructuring charge of\n$1 billion, the components of which are described under \"Costs and Expenses\" in Management's Discussion and Analysis of Financial Condition and Results of Operations on page 17 of the 1993 Annual Report, which is incorporated by reference herein.\nDISCONTINUANCE OF SFAS 71 ACCOUNTING. In the third quarter of 1993, U S WEST incurred a $3.1 billion non-cash, extraordinary charge, net of an income tax benefit of $2.3 billion, against its earnings in conjunction with its decision to discontinue accounting for the operations of U S WEST Communications in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"SFAS 71\"). SFAS 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, notwithstanding competition, by charging its customers at prices established by its regulators. U S WEST's decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS 71 was based on the belief that the development of competition, market conditions, and broadband technology, more than prices established by regulators, will determine the future revenues of U S WEST Communications. As a result of this change, the remaining asset lives of U S WEST Communications' telephone plant have been shortened to more closely reflect the useful (economic) lives of such plant. U S WEST Communications' accounting and reporting for regulatory purposes will not be affected by the change. U S WEST Communications expects that it will continue to work with regulators to set appropriate prices that reflect changing market conditions, including shorter depreciation lives.\nTWE INVESTMENT\nOn September 15, 1993, U S WEST acquired a 25.51% pro rata priority capital and residual equity interests in Time Warner Entertainment Company, L.P. (\"TWE\") for an aggregate purchase price of $2.553 billion, consisting of $1.532 billion in cash and $1.021 billion in the form of a four-year promissory note bearing interest at a rate of 4.391% per annum (the \"TWE Investment\"). TWE owns and operates substantially all of the filmed entertainment (including Warner Bros.), programming (including HBO and Cinemax) and cable operations previously owned and operated by Time Warner Inc. TWE is the second-largest domestic multiple system cable operator, owning or operating 22 of the top 100 cable systems in the United States.\nU S WEST and TWE intend to upgrade a substantial portion of TWE's cable systems to \"Full Service Network-TM-\" capacity over the next five years. U S WEST and TWE will jointly designate the systems to be upgraded, and after any required approvals are obtained, U S WEST will share management control with TWE over those systems. U S WEST believes that each Full Service Network-TM-, when completed, will utilize fiber optics, digital compression, digital switching and storage services to provide consumers with video-on-demand, interactive games, distance learning, full motion video, interactive shopping and alternative access and local telephone service. In January, 1993, TWE announced that its first Full Service Network-TM- was being built in Orlando, Florida. This Full Service Network-TM- is expected to be available to 10,000 residential customers in that area in 1994. Full implementation of the Full Service Network-TM- will require the receipt of certain regulatory approvals.\nU S WEST has an option to increase its pro rata priority capital and residual equity interests in TWE from 25.51% to 31.84%. The option is exercisable, in whole or in part, between January 1, 1999 and May 31, 2005 upon the attainment of certain earnings thresholds for an aggregate cash exercise price of $1.25 billion to $1.8 billion (depending on the year of exercise). At the election of U S WEST or TWE, the exercise price will be payable by surrendering a portion of the limited partnership interest receivable upon exercise of such option. In connection with the TWE Investment, U S WEST acquired 12.75% of the common stock of Time Warner Entertainment Japan Inc., a joint venture company established to expand and develop the market for entertainment services in Japan.\nPERSONAL COMMUNICATIONS SERVICES\nIn September, 1993, Mercury One-2-One, a 50-50 joint venture between U S WEST and Cable & Wireless PLC, launched the world's first commercial Personal Communications Services (\"PCS\") in\nthe United Kingdom. Mercury One-2-One's PCS is a form of digital cellular communications designed to offer consumer users both a higher quality of service and more features at lower prices than existing cellular communications systems.\nDISCONTINUANCE OF CAPITAL ASSETS SEGMENT\nIn June, 1993, in connection with its decision to concentrate its resources and efforts on developing its telecommunications business, U S WEST determined to treat its capital assets business segment (the \"Capital Assets Segment\") as a discontinued operation and announced its intention to dispose of the businesses comprising that segment. U S WEST's remaining business segment, \"Communications and Related Services,\" comprises the continuing operations of U S WEST.\nThe Capital Assets Segment includes U S WEST Financial Services, Inc. (\"U S WEST Financial Services\"), which provided a variety of financial services to clients, an approximately 92% interest in Financial Security Assurance Holdings Ltd. (\"FSA\"), which provides financial guarantee insurance policies for corporate and municipal clients and U S WEST Real Estate, Inc., which holds a portfolio of real estate assets. On December 7, 1993, U S WEST Financial Services closed a transaction pursuant to which it sold to NationsBank Corporation assets representing approximately $2.0 billion of U S WEST Financial Services' business and finance receivables, on a consolidated basis.\nOn October 12, 1993, FSA filed a registration statement with respect to a proposed underwritten initial public offering of 12 million shares of its common stock. In December, 1993, the proposed public offering was postponed indefinitely. U S WEST is continuing to explore its strategic alternatives with respect to FSA, which include a public offering or other disposition of the business.\nU S WEST'S CONTINUING OPERATIONS\nU S WEST COMMUNICATIONS. U S WEST Communications was formed January 1, 1991, when Northwestern Bell Telephone Company (\"Northwestern Bell\") and Pacific Northwest Bell Telephone Company (\"Pacific Northwest Bell\") were merged into The Mountain States Telephone and Telegraph Company (\"Mountain States\"), which simultaneously changed its name to U S WEST Communications, Inc. U S WEST acquired ownership of Mountain Bell, Northwestern Bell and Pacific Northwest Bell on January 1, 1984, when American Telephone and Telegraph Company (\"AT&T\") transferred its ownership interests in these three wholly-owned operating telephone companies to U S WEST. This divestiture was made pursuant to a court-approved consent decree entitled the \"Modification of Final Judgment\" (\"MFJ\") which arose out of an antitrust action brought by the United States Department of Justice against AT&T.\nOPERATIONS OF U S WEST COMMUNICATIONS. U S WEST Communications serves approximately 80% of the population in the U S WEST Region and approximately 40% of the land area. At December 31, 1993, U S WEST Communications had approximately 13,843,000 telephone network access lines in service, a 3.7% increase over year end 1992.\nUnder the terms of the MFJ, the U S WEST Region was divided into 29 geographical areas called \"Local Access and Transport Areas\" (\"LATAs\") with each LATA generally centered on a metropolitan area or other identifiable community of interest. The principal types of telecommunications services offered by U S WEST Communications are (i) local service, (ii) intraLATA long distance network service and (iii) exchange access service (which connects customers to the facilities of interLATA service providers). For the year ended December 31, 1993, local service, exchange access service and intraLATA long distance network service accounted for 37%, 27% and 14%, respectively, of the sales and other revenues of U S WEST's continuing operations. In 1993, revenues from a single customer, AT&T, accounted for approximately 11% of the sales and other revenues of U S WEST's continuing operations.\nU S WEST Communications incurred capital expenditures of approximately $2.2 billion in 1993 and expects to incur approximately $2.3 billion in 1994. The 1993 capital expenditures of U S WEST\nCommunications were substantially devoted to the continued modernization of telephone plant, including investments in fiber optic cable and the conversion of central offices to digital technology, in order to improve customer services and network productivity.\nCentral to U S WEST Communications' operations in 1993 were its initial efforts respecting the Broadband Network and the Restructuring Plan. See \"Recent Developments -- U S WEST Communications.\"\nREGULATION OF U S WEST COMMUNICATIONS. U S WEST Communications is subject to varying degrees of regulation by state commissions with respect to intrastate rates and service, and access charge tariffs. Under traditional rate of return regulation, intrastate rates are generally set on the basis of the amount of revenues needed to produce an authorized rate of return.\nU S WEST Communications has sought alternative forms of regulation (\"AFOR\") plans which provide for competitive parity, enhanced pricing flexibility and improved capability in bringing to market new products and services. In a number of states where AFOR plans have been adopted, such actions have been accompanied by requirements to refund revenues, reduce existing rates or upgrade service, any of which could have adverse short-term effects on earnings. Similar agreements may have resulted under traditional rate of return regulation. (See \"State Regulatory Issues\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. 21 of the 1993 Annual Report, which is incorporated by reference herein.)\nU S WEST Communications is also subject to the jurisdiction of the FCC with respect to interstate access tariffs (that specify the charges for the origination and termination of interstate communications) and other matters. U S WEST's interstate services have been subject to price cap regulation since January 1991. Price caps are a form of incentive regulation and, ostensibly, limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels with interexchange carriers. The Company believes that competition will ultimately be the determining factor in pricing telecommunications services. In January, 1994, the FCC announced that it will begin reviewing its current form of regulation.\nIn September, 1993, the FCC adopted licensing rules for Personal Communications Services (\"PCS\") and announced that it would auction the spectrum frequencies available for PCS in late 1994. PCS offers users mobile voice and data communications capabilities similar to existing analog cellular service. U S WEST intends to pursue PCS opportunities as they become available.\nCOMPETITION. Historically, communications, entertainment and information services were provided by different companies in different industries. The convergence of these technologies is changing both the competitive environment and the way U S WEST does business. This convergence, which is being fueled by technological advances, will lead to more intense competition from companies with which U S WEST has not historically competed. U S WEST became the first of the regional holding companies to potentially compete beyond its region through its investment in TWE. (See \"TWE Investment\" under \"Recent Developments.\")\nU S WEST Communications' principal current competitors are competitive access providers (\"CAPs\"). Competition from CAPs is currently limited to providing large business customers (with high-volume traffic) private line access to the facilities of interexchange carriers. In coming years, CAPs could also become significant competitors for other local exchange services. MCI announced plans in early 1994 to build fiber-optic rings and local switching infrastructures in major metropolitan markets, hence providing the ability to compete directly with the local telephone company. Additionally, AT&T's entrance into the cellular communications market through its proposed acquisition of McCaw Cellular Communications Inc. has the potential to create increased competition in local exchange as well as cellular services. The loss of local exchange customers to competitors would affect multiple revenue streams, including those related to local and access services, and long-distance network services, and could have a material, adverse effect on the Company's operations.\nCompetition from long-distance companies continues to erode U S WEST Communications' market share of intraLATA long-distance services such as WATS and \"800.\" These revenues have declined over the last several years as customers have migrated to interexchange carriers that have the ability to offer these services on both an intraLATA and interLATA basis. U S WEST and its affiliates are prohibited from providing interLATA long-distance services.\nThe actions of state and federal public policymakers will play an important role in determining how increased competition affects U S WEST. The Company is working with regulators and legislators to help ensure that public policies keep pace with our rapidly changing industry -- and allow the Company to bring new services to the marketplace.\nU S WEST supports regulatory reform. It is increasingly apparent that the legal and regulatory framework under which the Company operates, which includes restrictions on equipment manufacturing, prohibitions on cross-ownership of cable TV by telephone companies and the provision of cable TV programming content, and restrictions on the transport of voice, video and data across LATA boundaries, limits both competition and consumer choice. U S WEST believes that it is in the public interest to lift these restrictions and to place all competitors under the same rules to ensure the industry's technological development and long-term financial health.\nFor an additional discussion respecting competition, see \"Other Items\" in Management's Discussion and Analysis of Financial Condition and Results of Operations on page 18 of the 1993 Annual Report, which is incorporated by reference herein.\nOTHER U S WEST SUBSIDIARIES AND INVESTMENTS. Other continuing operations include subsidiaries engaged in (i) publishing services, primarily \"Yellow Pages\" and other directories, (ii) designing, engineering and operating mobile telecommunications systems, (iii) cellular and land-line telecommunications, network infrastructure and cable television businesses in certain foreign countries, and (iv) entertainment services.\nU S WEST Marketing Resources Group, Inc. (\"Marketing Resources\"), which accounted for about 9% of U S WEST's 1993 revenues from continuing operations, publishes nearly 300 white and yellow page directories in 14 states. Marketing Resources competes with local and national publishers of directories, as well as other advertising media such as newspapers, magazines, broadcast media and direct mail. Marketing Resources intends to focus on enhancing core products, developing and packaging new information products through new and existing databases.\nU S WEST NewVector Group, Inc. (\"NewVector\"), which accounted for approximately 5% of U S WEST's 1993 revenues from continuing operations, provides communications and information products and services, including cellular and radio communications services, over wireless networks in 31 Metropolitan Service Areas and 34 Rural Service Areas, primarily located in the U S WEST Region. Competition for full service cellular customers is currently limited to holders of the two cellular licenses granted in a given cellular market. Despite its rapid growth, the cellular industry is faced with many challenges including the introduction of new technologies, increased competition and an uncertain regulatory environment.\nU S WEST Multimedia Communications, Inc. (\"Multimedia Communications\") was formed to manage the TWE Investment, and has primary responsibility for aiding U S WEST in achieving its strategic goal of becoming a leading provider of interactive, integrated communications, entertainment and information services in the U S WEST Region and other selected domestic and international markets.\nMultimedia Communications is also responsible for identifying and pursuing alliances, acquisitions and\/or investments that complement U S WEST's strategy. U S WEST is seeking to strengthen its national out-of-region presence by acquiring or forming alliances with other communications, entertainment and information services companies throughout the United States. The first major step toward that goal was the TWE Investment made in September, 1993. See \"Recent Developments --\nTWE Investment.\" U S WEST intends to pursue additional out-of-region opportunities that complement its out-of-region strategy and believes that through the TWE Investment and those other opportunities it will be able to provide a variety of integrated communications, entertainment and information products and services to users through multimedia broadband networks across the United States. However, U S WEST's ability to pursue certain of those opportunities with third parties may be limited by the TWE Agreement.\nDuring 1993, U S WEST continued expanding its international ventures, which include investments in cable television and telecommunications, wireless communications including PCS, and international networks. See \"Recent Developments -- Personal Communications Services.\" U S WEST's net investment in international ventures approximated $477 million at December 31, 1993, approximately 70% of which is in the United Kingdom.\nBecause U S WEST's international investments are in new, developing businesses, they typically are in a high growth, investment phase for several years and do not show net income or positive cash flow until they become more mature. Consequently, start-up losses, which are part of the expected investment in these businesses, will continue in the near term. The Company's future commitment to international ventures is currently planned at about $450 million over the next five years. The Company will continue to pursue opportunities in attractive local markets around the world that fit its strategic objectives.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties of U S WEST do not lend themselves to description by character and location of principal units. At December 31, 1993, the majority of U S WEST property was utilized in providing telecommunications services by U S WEST Communications. Substantially all of U S WEST Communications' central office equipment is located in owned buildings situated on land owned in fee, while many garages and administrative and business offices are in leased quarters. For information regarding the distribution of property, plant and equipment at December 31, 1993, reference is made to Schedule V on page S-1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn May 12, 1992, an alleged shareholder of U S WEST filed an amended class action complaint (the \"Amended Complaint\") in the United States District Court for the District of Colorado against U S WEST and various individuals, including certain present and former officers of U S WEST (the \"Defendants\"). ROSENBAUM V. U S WEST, INC. ET AL, Civ. Action No. 91-B-2164 (D. Colo. filed May 12, 1992). The Amended Complaint challenged the Defendants' actions in connection with U S WEST's real estate activities and planned work force reductions, including its December, 1991 decision to write down certain assets of U S WEST Real Estate, and related disclosures, and alleged violations of the Securities Exchange Act of 1934, the Securities Act of 1933 and the rules of the Securities and Exchange Commission. This litigation was settled by the parties and the terms of the settlement were approved by the court in November, 1993. In connection with the settlement, U S WEST issued to certified class members non-transferable rights (the \"Rights\") to purchase shares of common stock directly from U S WEST on a commission-free basis at a 3% discount from the average of the high and low trading prices of such stock on the New York Stock Exchange on February 23, 1994, the pricing date designated in accordance with the settlement. Class members exercised approximately 5.6 million of these Rights and, in March, 1994, approximately 5.6 million shares of U S WEST common stock were issued pursuant to the settlement.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF U S WEST\nPursuant to General Instructions G(3), the following information is included as an additional item in Part I:\nExecutive Officers are not elected for a fixed term of office, but serve at the discretion of the Board of Directors.\nEach of the above executive officers has held a managerial position with U S WEST or an affiliate of U S WEST since 1989, except for Messrs. Osterhoff, Rubis and Russ. Mr. Osterhoff was Vice President -- Finance and Chief Financial Officer of Digital Equipment Corporation from 1985 to 1991. Mr. Rubis was Vice President -- Quality for U S WEST International and Business Development Group, a division of U S WEST, from 1991 to 1992; Director -- Quality and Service Improvement for U S WEST NewVector Group, Inc., a subsidiary of U S WEST, from 1990 to 1991. Prior to joining the U S WEST family, Mr. Rubis worked as an independent labor relations consultant and as co-founder and principal of Workplace One, Ltd., a Canadian-based consulting firm, from 1979 to 1988. In 1988, he merged his firm with Deltapoint Corp., a Seattle-based Quality Improvement consulting firm. Mr. Russ was Vice President, Secretary and General Counsel of NCR Corporation from February, 1984 to June, 1992.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required by this item is included on page 47 of the 1993 Annual Report under the heading \"Note 14: Quarterly Financial Data (Unaudited)\" and is incorporated herein by reference. The U.S. markets for trading in U S WEST common stock are the New York Stock Exchange and the Pacific Stock Exchange. As of December 31, 1993, U S WEST common stock was held by approximately 836,328 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item is included on page 3 of the 1993 Annual Report under the heading \"Financial Highlights\" and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by this item is included on pages 12 through 26 of the 1993 Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item is included on pages 28 through 47 of the 1993 Annual Report and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required by this item with respect to executive officers is set forth in Part I, page 10, under the caption \"Executive Officers of U S WEST.\"\nThe information required by this item with respect to Directors is included in the U S WEST definitive Proxy Statement dated March 17, 1994 (\"Proxy Statement\") under \"Election of Directors\" on pages 4 and 5 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item is included in the Proxy Statement under \"Executive Compensation\" on pages 14 through 21 and \"Compensation of Directors\" on page 10 and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this item is included in the Proxy Statement under \"Securities Owned by Management\" on page 3 and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following independent accountants' report and consolidated financial statements are incorporated by reference in Part II of this report on Form 10-K:\nFinancial statement schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n(b) Reports on Form 8-K:\nU S WEST filed the following reports on Form 8-K during the fourth quarter of 1993:\n(i) report dated October 13, 1993 relating to a press release announcing the filing by Financial Security Assurance Holdings of an initial public offering of 12,000,000 shares of common stock;\n(ii) report dated October 19, 1993 relating to a release of earnings for the period ended September 30, 1993;\n(iii) report dated November 10, 1993 filing the U.S. version of a form of Underwriting Agreement among U S WEST, Inc., Goldman, Sachs & Co., Lehman Brothers Inc., Merrill Lynch & Co., Morgan Stanley & Co. Incorporated, and Salomon Brothers, Inc. and the international version of a form of Underwriting Agreement among U S WEST, Inc., Goldman Sachs International Limited, Lehman Brothers International (Europe), Merrill Lynch International Limited, Morgan Stanley International, and Salomon Brothers International Limited; and\n(iv) report dated December 8, 1993 restating the condensed consolidated financial statements of Financial Security Assurance Inc. for nine months ended September 30, 1993 and 1992, as amended by Forms 8-K\/A dated December 13 and 28, 1993.\n(c) Exhibits:\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (\"SEC\"), are incorporated herein by reference as exhibits hereto.\nSIGNATURES\nPursuant 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, in the City of Englewood, State of Colorado, on March 17, 1994.\nU S WEST, Inc.\nBy \/s\/ JAMES M. OSTERHOFF -------------------------------------- James M. Osterhoff EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nPursuant 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 and on the date indicated.\nDirectors: \/s\/ Richard B. Cheney* \/s\/ Remedios Diaz-Oliver* \/s\/ Grant A. Dove* \/s\/ Mary M. Gates* \/s\/ Allan D. Gilmour* \/s\/ Pierson M. Grieve* \/s\/ Shirley M. Hufstedler* \/s\/ Allen F. Jacobson* \/s\/ Richard D. McCormick* \/s\/ Frank P. Popoff* \/s\/ Glen L. Ryland* \/s\/ Jerry O. Williams* \/s\/ Daniel Yankelovich* *By \/s\/ JAMES M. OSTERHOFF ---------------------------------------- James M. Osterhoff (for himself and as Attorney-in-Fact) Dated March 17, 1994\nINDEPENDENT ACCOUNTANTS' REPORT\nOur report on the consolidated financial statements of U S WEST, Inc., which includes an explanatory paragraph regarding the discontinuance of accounting for the operations of U S WEST Communications, Inc. in accordance with Statement of Financial Accounting Standard No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1993, and a change in the method of accounting for postretirement benefits other than pensions and other postemployment benefits in 1992, has been incorporated by reference in this Form 10-K from page 27 of the 1993 Annual Report to Shareowners of U S WEST, Inc. In connection with our audits of such consolidated financial statements, we have also audited the related consolidated financial statement schedules listed in the index on page 13 of this Form 10-K for the years ended December 31, 1993, 1992 and 1991.\nIn our opinion, the consolidated financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ COOPERS & LYBRAND\nCOOPERS & LYBRAND Denver, Colorado January 20, 1994\nU S WEST, INC. SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT (DOLLARS IN MILLIONS)\nS-1\nU S WEST, INC. SCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION (DOLLARS IN MILLIONS)\nS-2\nU S WEST, INC. SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN MILLIONS)\nS-3\nU S WEST, INC. SCHEDULE IX -- SHORT-TERM BORROWINGS (DOLLARS IN MILLIONS)\nS-4\nU S WEST, INC. SCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION (DOLLARS IN MILLIONS)\nS-5\n[LOGO] RECYCLED PAPER","section_15":""}
{"filename":"202356_1993.txt","cik":"202356","year":"1993","section_1":"Item 1. DESCRIPTION OF BUSINESS\n(a) General Development of Business.\nKysor Industrial Corporation (\"Kysor\", the \"Company\" or the \"Registrant\") is a Michigan corporation. It is the successor to a Delaware corporation of the same name organized in 1970 and also previously a Michigan corporation of the same name originally organized in 1925.\nIn April 1988, Kysor purchased an 80 percent interest in Kysor\/Warren Refrigeration GmbH of Limburg, West Germany. In January 1989 the remaining 20 percent interest was acquired. Kysor\/Warren Refrigeration GmbH designs, manufactures and markets refrigerated display cases for the European market.\nIn July 1990, Kysor acquired a portion of the truck and off-highway heater and air-conditioning business from Valeo Climate Control Ltd., located in South Wales, United Kingdom.\nIn February 1994, Kysor acquired Kalt Manufacturing Co., Inc., located in Portland, Oregon and Goodyear, Arizona. Kalt manufactures walk-in coolers and panels for the supermarket convenience store and food service industry.\nThe Aluminum Fabricated Products operations, located in Perry, Florida and Greeneville, Tennessee, were divested during 1990 in three separate transactions.\n(b) Segment Information.\nKysor Industrial Corporation's operations include two segments: commercial products and transportation products. Operations in the commercial products segment design, manufacture and market refrigerated display cases, energy control systems, refrigerated building systems, and heating and air-conditioning systems. Operations in the transportation products segment design, manufacture and market engine performance systems, engine protection systems, and components and accessories for heavy-duty trucks, other commercial vehicles and marine equipment. The information in the following schedule excludes intercompany transactions which are deemed to be immaterial.\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Financial Information by Segment\nYears Ended December 31, (amounts in thousands) ________________________________\nNET SALES 1993 1992 1991 ________ ________ ________\nCommercial products United States $166,347 $171,437 $135,433 Europe 19,398 16,234 18,287 _________ _________ _________\nTotal commercial products 185,745 187,671 153,720 _________ _________ _________\nTransportation products United States 80,518 65,075 57,578 Europe 6,344 9,428 12,345 _________ _________ _________\nTotal transportation products 86,862 74,503 69,923 _________ _________ _________\nNET SALES $272,607 $262,174 $223,643 _________ _________ _________ _________ _________ _________\nOPERATING PROFIT (LOSS)* Commercial products United States $ 21,784 $ 22,651 $ 12,866 Europe (1,871) (1,599) (1,478) _________ _________ _________\nTotal commercial products 19,913 21,052 11,388 _________ _________ _________\nTransportation products United States 11,859 8,210 5,017 Europe (412) (346) (1,991) _________ _________ _________\nTotal transportation products 11,447 7,864 3,026 _________ _________ _________\nTOTAL OPERATING PROFIT 31,360 28,916 14,414\nCorporate administrative expense (net) (11,190) (8,794) (6,732) Provision for litigation - (1,500) (4,000) Interest expense (2,162) (2,595) (3,748) _________ _________ _________\nINCOME (LOSS) BEFORE INCOME TAXES AND BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 18,008 $ 16,027 $ (66) _________ _________ _________ _________ _________ _________\n* Operating profit includes net sales less operating expenses. Excluded from the computation of operating profit are interest and other non- operating revenues, general corporate expenses and interest expense.\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Financial Information by Segment\nYears Ended December 31, (amounts in thousands) ________________________________\n1993 1992 1991 ________ ________ ________\nASSETS Commercial products United States $ 63,667 $ 65,718 $ 63,789 Europe 9,847 9,937 10,950 _________ _________ _________\nTotal commercial products 73,514 75,655 74,739 _________ _________ _________\nTransportation products United States 29,542 26,921 29,383 Europe 2,938 4,356 5,880 _________ _________ _________\nTotal transportation products 32,480 31,277 35,263 ________ ________ ________\nSubtotal 105,994 106,932 110,002\nCash and other corporate assets 50,461 28,918 23,008 ________ ________ ________\nTOTAL ASSETS $156,455 $135,850 $133,010 ________ ________ ________ ________ ________ ________\nDEPRECIATION AND AMORTIZATION\nCommercial products $ 3,734 $ 3,784 $ 3,718 Transportation products 3,677 3,617 3,699 Corporate 243 249 296 ________ ________ ________\nTOTAL DEPRECIATION AND AMORTIZATION $ 7,654 $ 7,650 $ 7,713 ________ ________ ________ ________ ________ ________\nCAPITAL EXPENDITURES\nCommercial products $ 3,829 $ 2,398 $ 2,864 Transportation products 4,758 1,379 2,005 Corporate 66 142 87 ________ ________ ________\nTOTAL CAPITAL EXPENDITURES $ 8,653 $ 3,919 $ 4,956 ________ ________ ________ ________ ________ ________\n(c) Narrative Description of Business.\nAt December 31, 1993, Kysor had approximately 1,904 employees. Information as of December 31, 1993 concerning Kysor's two industry segments is presented below. Certain financial information related to the individual industry segments is incorporated in response to Item 1.(b) above.\nThere were no material expenditures for compliance with federal, state or local provisions regulating the discharge of materials into the environment except with respect to ongoing proceedings relating to soil and groundwater contamination at the Cadillac Industrial Park in Cadillac, Michigan which is explained further under Note 11, Contingent Liabilities, to the Consolidated Financial Statements included under Part II, Item 8.\nCommercial Products\nThe principal products of the commercial products group include supermarket refrigerated display cases, condensing units, insulated panels for refrigerated building systems and walk-in coolers, commercial vehicle heating, ventilating and air-conditioning (HVAC) units and truck trailer supports. The principal markets for Kysor's commercial products group include supermarkets, convenience stores and original equipment manufacturers for such vehicles as heavy-duty trucks, buses, vans, agriculture and military off-highway equipment and truck trailers. Refrigerated display equipment, refrigerated building systems, and sundry food store equipment are sold directly to supermarkets and convenience stores, as well as through independent commercial refrigeration distributors. Vehicle HVAC units and truck trailer support product sales are made directly to original equipment manufacturers and through a nationwide network of distributors.\nThe basic raw materials used by Kysor in this group are galvanized sheet and other types of steel, aluminum, glass, copper tubing, foam insulation, refrigerants, brass, copper, plastics and a variety of purchased electronic components. All raw materials used in this segment are readily available in adequate quantities from a number of sources.\nKysor holds or is licensed under a number of patents and trademarks relating to its commercial products. While none of these patents or trademarks are considered individually to be material, collectively these patents and trademarks are important to the business of the commercial products group.\nThere are no significant seasonal factors. Backlogs at year-end 1993 and 1992 were approximately $48.0 million and no material portion of this business is subject to renegotiation or termination by the government. There are no working capital requirements peculiar to this industry segment.\nThe commercial products industry is highly competitive. Kysor competes with numerous companies in this group, some of which are larger and have greater financial resources than Kysor. Kysor believes that it competes primarily on the basis of quality, service, product performance, and price for most of its products, and warrants the majority of its products in accordance with general industry practices.\nThe commercial products group generated $29.0 million, $48.4 million and $34.7 million of sales and revenues from Food Lion Stores in the years ended December 31, 1993, 1992 and 1991 respectively.\nTransportation Products\nThe principal products of this group include engine performance systems consisting of radiator shutters, fan clutches and plastic fans; engine protection systems consisting of various engine monitoring devices, truck fuel tanks, and marine instruments. The principal markets for Kysor's transportation products group are original equipment manufacturers of such vehicles as medium- and heavy-duty trucks, buses, off-highway equipment and the marine industry. The majority of the group's sales are made directly to manufacturers. Additionally, Kysor utilizes a network of independent distributors to provide aftermarket and replacement parts service to end users.\nThe basic raw materials used by Kysor in this group are steel, brass, copper, aluminum, plastics and a variety of purchased electronic components which are widely available in adequate quantities from a number of sources.\nKysor holds or is licensed under a number of patents and trademarks relating to its transportation products. While none of these patents or trademarks are considered individually to be of material value, collectively these patents and trademarks are important to the business of the transportation products group.\nThere are no significant seasonal factors. Backlogs at year-end 1993 were approximately $16.0 million compared to $13.0 million in 1992 and no material portion of this business is subject to renegotiation or termination by the government. There are no working capital requirements peculiar to this industry segment. The Transportation Products Group generated $26.5 million of sales and revenue from Ford Motor Company in the year ended December 31, 1993.\nThe transportation products industry is highly competitive. Kysor competes with numerous companies in this group, some of which are larger and have greater financial resources than Kysor. Kysor believes that it competes primarily on the basis of quality, service, product performance, and price for most of its products, and warrants the majority of its products in accordance with general industry practices.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nThis information is included in Item 1(b) above under the heading \"Financial Information by Segment\". The \"Financial Information by Segment\" does not include separately reported export sales as they are not significant.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nKysor and its subsidiaries owned or leased the following offices and manufacturing facilities as of December 31, 1993:\nCOMMERCIAL PRODUCTS GROUP\nLOCATION DESCRIPTION INTEREST\nGEORGIA:\nConyers Plant & office; 480,000 Owned in fee simple sq. ft. on 50-acre site\nColumbus Plant & office; 295,826 Owned in fee simple sq. ft. on 22.7-acre site\nTEXAS:\nFort Worth Plant & office; 100,162 Owned in fee simple sq. ft. on 11-acre site\nILLINOIS:\nByron Plant, warehouse & office; 176,716 sq. ft. on Owned in fee simple \t\t 31-acre site\nW.GERMANY:\nLimburg Plant & office; 52,096 Owned in fee simple sq. ft. on 6.9-acre site\nTRANSPORTATION PRODUCTS GROUP\nINDIANA:\nScottsburg Plant & office; 42,048 Owned in fee simple sq. ft. on 10.7-acre site\nMICHIGAN:\nCadillac Plant, warehouse & office; Owned in fee simple 131,426 sq. ft. on \t\t 12.4-acre site \t\t Spring Lake Plant & office; 80,000 Owned in fee simple sq. ft. on 8.l-acre site\nRothbury Plant, warehouse & office; Owned in fee simple 18,543 sq. ft. on \t\t 3.4-acre site\nWalker Plant & office; 49,188 Owned in fee simple sq. ft. on 3-acre site\nWhite Pigeon Plant & office; 42,000 Owned in fee simple sq. ft. on 5-acre site\nN.CAROLINA:\nCharlotte Plant & office; 91,150 Owned in fee simple sq. ft. on 3.5-acre site\nSOUTH WALES:\nHengoed Plant & office; Leased 50,000 sq. ft.\nCORPORATE\nMICHIGAN:\nCadillac Executive office; Owned in fee simple 23,000 sq. ft. on \t\t 102-acre site\nOKLAHOMA:\nDuncan Vacant plant, wrhse. Owned in fee simple & office; 93,000 sq. ft. \t\t on 22.1-acre site\nIt is believed that Kysor's facilities are generally adequate for its operations and such properties are maintained in a good state of repair.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nAs previously reported, the Company is involved in the following legal proceedings:\nThe Company is involved in an environmental proceeding with respect to a site in Cadillac, Michigan. The description of such proceeding is set forth in Part II, Item 8 of this report, Note 11 to the Consolidated Financial Statements.\nOn July 3, 1991, the Michigan Attorney General and the Department of Natural Resources filed a lawsuit against the Company and various other parties in the United States Federal District Court for the Western District of Michigan. The description of such proceeding is set forth under Part II, Item 8 of this report, Note 11 to the Consolidated Financial Statements.\nOn December 31, 1991, General Electric (\"GE\") filed a third-party claim against the Company in the United States District Court for the Western District of Michigan. The dispute arose out of claims made by Midwest Aluminum Manufacturing Company (\"Midwest\") against GE. The description of such proceeding is set forth in Part I, Item 3 of the Company's 1991 Annual Report on Form 10-K filed with the Commission on March 25, 1992. In February 1993, an agreement-in- principle was reached settling the underlying dispute between Midwest and GE, which settlement was finanlized in early 1994. As part of the settlement, the Company has been released by Midwest from all past and future environmental claims with respect to the Midwest site, and by GE with respect to all claims for indemnity or contribution arising out of Midwest's underlying claims against GE. The settlement is without prejudice to GE's remaining claims against the Company, pursuant to which GE seeks to recover response costs associated with certain environmental cleanup at GE's property, formerly owned by Kysor, and its defense costs incurred in connection with the Midwest suit.\nOn December 4, 1992, Kysor was named as a defendant, together with over 30 other parties, in an action commenced by the Township of Oshtemo, City of Kalamazoo, Kalamazoo County and The Upjohn Company with respect to alleged contamination at the West KL Avenue Landfill site located in Kalamazoo, Michigan. On November 16, 1993 Kysor Industrial Corporation entered into a settlement agreement requiring the payment of $20,000 which dismisses Kysor from all claims.\nOn March 30, 1993, the Company received a notification from the Michigan Department of Natural Resources that it has been named as a potentially responsible party (\"PRP\") with respect to a site commonly referred to as the SCA Independent Landfill Superfund Site, located in Muskegon County, Michigan. The notice alleges that the Company, together with numerous other parties, was an owner, generator or transporter of waste materials deposited at the site. The PRP notice request the Company and the other named PRPs to conduct a Remedial Investigation\/Feasibility Study to determine the extent of contamination at the site, and seeks recovery of investigative costs expended by the MDNR to date. No significant discovery has taken place with respect to this matter.\nOther contingent liabilities include various legal actions, proceedings and claims which are pending or which may be instituted or asserted in the future against the Company. Litigation is subject to many uncertainties, the outcome of individual matters is not predictable with assurance and it is reasonably possible that some of these other legal actions, proceedings and claims could be decided unfavorable to the Company. Although the liability with regard to these matters at December 31, 1993 cannot be ascertained, it is the opinion of management, after conferring with counsel, that any liability resulting from these other matters should not materially affect the consolidated financial position of the Company and its subsidiaries at December 31, 1993.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAs of December 31, 1993, Kysor Industrial Corporation had a total of 5,467,840 shares of Common Stock issued and outstanding and 1,396 shareholders of record. A large number of shares are held by brokerage firms and banks for the benefit of other shareholders in all 50 states of the United States and several foreign countries. In addition, the Corporation had 810,163 shares of Series A. Convertible Voting Preferred Stock outstanding, all of which are owned by the Kysor Industrial Corporation Employee Stock Ownership Plan.\nThe annual dividends declared amounted to $.44 and $.40 during 1993 and 1992, respectively. The quarterly rate was $.10 per share for all of 1992 and the first quarter 1993, $.11 for the second and third quarter, 1993, and $.12 for the fourth quarter.\nA quarterly summary of Kysor Industrial Corporation's Common Stock trading range is as follows:\n1993\t \t 1992 High Low High Low First Quarter \t\t 21.75 16.125 8.875 6.875 Second Quarter\t\t 20.875 15.875 11.25 8.625 Third Quarter \t\t 18.00 14.50 13.00 10.125 Fourth Quarter\t\t 17.875 15.625 19.125 12.00\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nComparison of 1993 and 1992 Kysor Industrial Corporation's 1993 total sales and revenues were $273.9 million, up 3.8 percent from 1992. Net income, before the accounting change for postretirement benefits, was $10.1 million compared to $9.1 million reported in 1992. Primary earnings per share before the accounting change was $1.62 in 1993, compared to $1.52 per share in 1992. Primary earnings per share after the accounting change was $.27 per share in 1993. Included in 1993 results is a provision for environmental matters amounting to $.14 per share, which are described in greater detail under Note 11, while 1992 results include a provision for litigation equaling $.18 per share. The increase in 1993 profitability resulted primarily from the increases in the Transportation Products Group where they benefited from the best Class-8 heavy-duty truck market since 1979 and the increased market penetration of Kysor's injection molded polymer engine fans.\nOn December 21, 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard #106 (\"SFAS #106\"), effective for 1993. SFAS #106 requires employers to accrue the cost of postretirement benefits other than pensions during the working careers of active employees instead of expensing the benefits when paid as allowed under prior rules. Actuarial valuation of the Company's transition obligation is $7.5 million (net of tax). In addition to the transition obligation, the Company is now required to accrue recurring annual postretirement benefits higher than the \"pay as you go\" expense. This additional accrual was $564,000 for 1993. The Company elected to record the transition obligation as a charge against income during the first quarter, 1993.\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard #112 (\"SFAS #112\") which requires employers, effective for fiscal years beginning after December 15, 1993, to recognize the liability for postemployment benefits provided to former or inactive employees. The Company has reviewed the requirements of SFAS #112 and determined that the impact on the Company was not material. The Financial Accounting Standards Board also has adopted SFAS #109, Accounting for Income Taxes effective for years beginning after December 15, 1992 which replaces SFAS #96. There was no material impact on the Company when this standard was adopted in 1993.\nSales backlogs at the end of 1993 were up 4.6 percent from record levels at year-end 1992.\nThe continued improvement in 1993 results allowed Kysor to reduce its long-term debt and improve its debt ratio from 40.8 percent to 38.1 percent at the end of the year, after giving consideration to the decrease in equity resulting from the accrual for postretirement benefits.\nThe Company is presently involved in certain environmental proceedings with respect to soil and groundwater contamination in Cadillac, Michigan, as described below under the heading \"Liquidity and Capital Resources\" and in Note 11, Contingent Liabilities. In addition, the Company is involved in various other legal proceedings including certain proceedings involving allegedly contaminated sites with respect to which the Company has been named a potentially responsible party under the Federal Superfund law or comparable state laws. Although discovery in certain of these proceedings has not been completed, subject to the contingencies discussed in Note 11, the information presently available to management does not cause management to believe that the ultimate aggregate cost to the Company of such proceedings will result in a material adverse effect on its future financial condition or results of operation.\nComparative summaries and review of operations for the two business groups follows:\nTRANSPORTATION PRODUCTS\nAMOUNTS IN THOUSANDS 1993 1992 1991\nNet Sales $ 86,862 $ 74,503 $69,923 Operating Profit 11,447 7,864 3,026\nSales in the Transportation Products Group increased 16.6 percent and operating profit increased 45.6 percent compared to 1992. The increase in sales and the significant increase in operating profit are the result of improved market conditions in the heavy-duty truck market and the positive impact of cost containment measures initiated over the past years. Backlogs at year-end 1993 were 22.9 percent above year-end 1992 levels and set the stage for another outstanding year in 1994.\nDuring 1993, the Company's Kysair injection molded fan continued to gain market share, both domestically and internationally. As a result of that success, Kysor approved capital expenditures for 1994 which will establish manufacturing capabilities in the United Kingdom and management is currently studying a similar expansion into Korea.\nCOMMERCIAL PRODUCTS\nAMOUNTS IN THOUSANDS 1993 1992 1991\nNet Sales $185,745 $187,671 $153,710 Operating Profit 19,913 21,052 11,388\nCommercial Products Group sales and operating profits decreased slightly as a result of the trimming of expansion plans by a major customer in the Kysor\/Warren division during 1993. Kysor\/Needham, the group's walk-in cooler manufacturer, increased sales 13.8 percent and made significant inroads in Mexico where sales increased substantially year-over-year. Additionally, in February 1994, Kysor purchased another cooler and panel manufacturer, Kalt Manufacturing Co., Inc., with manufacturing facilities in Portland, Oregon and Phoenix, Arizona.\nBacklogs at year-end 1993 and 1992 for the Commercial Products Group were approximately $48.0 million.\nComparison of 1992 and 1991 Kysor Industrial Corporation's 1992 total sales and revenues were $264 million, up 17.3 percent from 1991. Net income was $9 million compared to a loss of $726,000 in 1991. Primary earnings per share were $1.52 in 1992 compared to a loss of $.35 per share in 1991. 1991's loss was the result of establishing a $4.0 million provision for a judgment in a commercial lawsuit equaling $.49 per share. Although the Company was in the process of appealing the verdict in the lawsuit, the parties, on December 15, 1992, reached an acceptable settlement agreement. The settlement was adequately reserved in 1991 and had no adverse effect on income in 1992. The increase in 1992 sales and revenue and its positive impact on profits resulted from improvement in all six domestic divisions, particularly the commercial refrigeration division where Kysor's major customers continued to expand aggressively throughout the year. Included in 1992 results is a $1.5 million provision for litigation which relates primarily to certain environmental proceedings against the Company which is described in greater detail under Note 11, Contingent Liabilities of the 1993 Annual Report to Shareholders.\nInternational Operations Kysor Industrial Corporation has two foreign manufacturing subsidiaries - Kysor\/Warren Refrigeration GmbH, which is part of the Commercial Products Group, and Kysor\/Europe, part of the Transportation Products Group.\nKysor\/Warren Refrigeration GmbH, with manufacturing operations in Limburg, Germany, experienced a 19.5 percent increase in sales compared to 1992. The increase in sales was primarily the result of low margin sales to Eastern Europe which contributed to additional losses during 1993. A new German general manager has been hired during 1994 and stringent cost-containment programs have been implemented to stem losses in the future.\nKysor\/Europe, serving the European commercial vehicle truck market, with manufacturing operations located in Hengoed, South Wales, experienced a 29 percent decrease in sales in 1993 compared to 1992. The decrease is primarily attributable to the significant recession in the European markets. Notwithstanding the significant decrease in sales, improved internal controls and cost-containment programs allowed Kysor\/Europe to minimize its operating losses at $412,000 in 1993 compared to $346,000 in 1992.\nLiquidity and Capital Resources The Company's debt to invested capital ratio decreased from 40.8 percent at December 31, 1992, to 38.1 percent at December 31, 1993. Working capital at December 31, 1993 was $45.1 million, an increase of $3.5 million from the same period last year. Cash flow generated from operating activities in 1993 was $27.6 million, an increase of $8.7 million over the cash flow generated during 1992. At December 31, 1993, the Company has current maturities of long-term debt amounting to $5.7 million. All temporary borrowings are executed under a $20 million, long-term, revolving credit facility of which none was utilized at December 31, 1993.\nCorporate philosophy is that long-term debt, properly utilized, can contribute to the sustained long-term growth of the Company. In furtherance of this philosophy, the Company will use long-term debt to the point financial flexibility is preserved and undue financial risk is not incurred. The Company's long-term objective is to maintain debt at less than 40 percent of total capitalization.\nCapital expenditures during 1993 were financed through internally generated funds. The Company's capital expenditures for the year were $8.7 million relating primarily to the replacement and improvement of manufacturing equipment. Depreciation and amortization were $7.7 million for 1993. Capital expenditures are expected to increase during 1994, while depreciation and amortization should remain at approximately the same levels.\nThe ultimate amount of the environmental cleanup costs associated with the Cadillac, Michigan site described in Note 11 to the financial statements, the amount of costs allocated to the Company and the other contingencies discussed in such note, could impact earnings and liquidity in a material way, could result in the violation of one or more loan covenants and could result in the limitation or discontinuance of the payment of future dividends. However, the Company believes, subject to the referenced contingencies, that anticipated cash flow from operations, available borrowings on the resolving line of credit, and other potential sources of borrowing will be adequate to meet its short- and long-term liquidity and capital resource needs.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nKysor Industrial Corporation Cadillac, Michigan\nWe have audited the accompanying consolidated balance sheet of Kysor Industrial Corporation and Subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kysor Industrial Corporation and Subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 8 to the consolidated financial statements, effective January 1, 1993, the Corporation changed its method of accounting for postretirement benefits other than pensions.\nDetroit, Michigan February 14, 1994\nKYSOR INDUSTRIAL CORPORATION Consolidated Balance Sheet (Dollars in thousands, except per share data)\nDecember 31, December 31, ASSETS 1993 1992 ____________ ____________\nCURRENT ASSETS Cash and equivalents $ 21,339 $ 6,913 Accounts receivable less $1,546 and $1,496 allowance for doubtful accounts 35,968 32,070 Inventories 28,409 34,435 Prepaid expenses 1,228 1,402 Deferred income taxes 6,266 5,695 __________ __________\nTOTAL CURRENT ASSETS 93,210 80,515 __________ __________\nPROPERTY, PLANT AND EQUIPMENT Land 2,616 2,628 Buildings 30,155 29,336 Machinery and equipment 61,970 55,180 __________ __________\n94,741 87,144 Less accumulated depreciation 51,918 45,246 __________ __________\nTOTAL PROPERTY, PLANT AND EQUIPMENT 42,823 41,898 __________ __________\nOTHER ASSETS Goodwill, patents and other intangibles 2,806 3,046 Cash value of officers' life insurance 9,547 8,589 Deferred income taxes 4,031 - Miscellaneous receivables and other assets 4,038 1,802 __________ __________\nTOTAL OTHER ASSETS 20,422 13,437 __________ __________\nTOTAL ASSETS $ 156,455 $ 135,850 __________ __________ __________ __________\nThe accompanying notes are an integral part of the financial statements.\nKYSOR INDUSTRIAL CORPORATION Consolidated Balance Sheet (Dollars in thousands, except per share data) (continued)\nDecember 31, December 31, LIABILITIES 1993 1992 ____________ ____________\nCURRENT LIABILITIES Current maturities of long-term debt $ 5,670 $ 1,595 Accounts payable 14,353 14,388 Accrued income taxes payable 2,426 1,719 Accrued expenses and contingent liabilities 25,699 21,204 __________ __________\nTOTAL CURRENT LIABILITIES 48,148 38,906\nLong-term debt, less current maturities, plus guarantee of ESOP indebtedness 33,673 36,521 Deferred income taxes - 1,108 Accumulated postretirement benefit obligation 12,628 - Other long-term liabilities 7,313 6,410 __________ __________\nTOTAL LIABILITIES AND DEFERRED CREDITS 101,762 82,945 __________ __________\nPREFERRED SHAREHOLDERS' EQUITY Employee Stock Ownership Plan Preferred Stock, shares authorized 5,000,000; outstanding 810,163 and 814,612 stated value of $24.375 19,748 19,856 Unearned deferred compensation under employee stock ownership plan (16,175) (17,039) __________ __________\nTOTAL PREFERRED SHAREHOLDERS' EQUITY 3,573 2,817 __________ __________\nCOMMON SHAREHOLDERS' EQUITY Common stock, $1 par value, shares authorized 30,000,000, outstanding 5,467,840 and 5,332,201 5,468 5,332 Additional paid-in capital 3,386 1,631 Retained earnings 43,997 44,908 Translation adjustment 286 627 Notes receivable-common stock 99,116 and 104,188 shares (1,319) (1,364) Unearned deferred compensation under employee stock ownership plan (698) (1,046) __________ __________\nTOTAL COMMON SHAREHOLDERS' EQUITY 51,120 50,088 __________ __________\nTOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 156,455 $ 135,850 __________ __________ __________ __________\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Shareholders' Equity (Dollars in thousands, except per share data) Unearned Total Deferred Preferred Preferred Compensation Shareholders' Stock ESOP Equity BALANCE, DECEMBER 31, 1990 $19,982 ($18,780) $1,202 Employee Stock Ownership Plan, deferred compensation earned 0 877 877 Purchase of common stock, returned to an unissued status (85,180 shares) 0 0 0 Preferred stock distributions (1,933 shares for 5,345 shares of common) (47) 0 (47) Exercise of employee stock options, 8,005 shares issued 0 0 0 Collections of notes receivable 0 0 0 Forfeitures of notes receivable 0 0 0 Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income (loss) 0 0 0 Preferred stock dividends (net of income tax benefit of $542) 0 0 0 share 0 0 0 BALANCE, DECEMBER 31, 1991 19,935 (17,903) 2,032 Employee Stock Ownership Plan, deferred compensation earned 0 864 864 Preferred stock distributions (3,223 shares for 8,040 shares of common) (79) 0 (79) Exercise of employee stock options, 172,975 shares issued 0 0 0 Collections of notes receivable 0 0 0 Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income 0 0 0 Preferred stock dividends (net of income tax benefit of $541) 0 0 0 Common dividends declared, $ .40 per share 0 0 0 BALANCE, DECEMBER 31, 1992 19,856 (17,039) 2,817 Employee Stock Ownership Plan, deferred compensation earned 0 864 864 Preferred stock distributions (4,449 shares for 6,528 shares of common) (108) 0 (108) Exercise of employee stock options, 129,111 shares issued 0 0 0 Collections of notes receivable 0 0 0 Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income 0 0 0 Preferred stock dividends (net of income tax benefit of $601) 0 0 0 share 0 0 0 BALANCE, DECEMBER 31, 1993 $19,748 ($16,175) $3,573\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Shareholders' Equity (Dollars in thousands, except per share data) Paid-In Retained Common Stock Capital Earnings BALANCE, DECEMBER 31, 1990 $5,264 $0 $44,948 0 0 0 Employee Stock Ownership Plan, deferred compensation earned 0 0 0 Purchase of common stock, returned to an unissued status (85,180 shares) (85) 0 (915) Preferred stock distributions (1,933 shares for 5,345 shares of common) 5 0 41 Exercise of employee stock options, 8,005 shares issued 8 0 36 Collections of notes receivable 0 0 0 Forfeitures of notes receivable (41) 0 (548) Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income (loss) 0 0 (726) Preferred stock dividends (net of income tax benefit of $542) 0 0 (1,053) share 0 0 (2,869) BALANCE, DECEMBER 31, 1991 5,151 0 38,914 Employee Stock Ownership Plan, deferred compensation earned 0 0 0 Preferred stock distributions (3,223 shares for 8,040 shares of common) 8 70 0 Exercise of employee stock options, 172,975 shares issued 173 1,561 0 Collections of notes receivable 0 0 0 Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income 0 0 9,127 Preferred stock dividends (net of income tax benefit of $541) 0 0 (1,050) Common dividends declared, $ .40 per share 0 0 (2,083) BALANCE, DECEMBER 31, 1992 5,332 1,631 44,908 Employee Stock Ownership Plan, deferred compensation earned 0 0 0 Preferred stock distributions (4,449 shares for 6,528 shares of common) 7 101 0 Exercise of employee stock options, 129,111 shares issued 129 1,654 0 Collections of notes receivable 0 0 0 Translation adjustment on investments in foreign subsidiaries 0 0 0 Net income 0 0 2,470 Preferred stock dividends (net of income tax benefit of $601) 0 0 (983) share 0 0 (2,398) BALANCE, DECEMBER 31, 1993 $5,468 $3,386 $43,997\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Shareholders' Equity (Dollars in thousands, except per share data) Unearned Notes Deferred Translation Receivable- Compensation Adjustment Common Stock ESOP BALANCE, DECEMBER 31, 1990 $1,632 ($2,042) ($1,744) Employee Stock Ownership Plan, deferred compensation earned 0 0 349 Purchase of common stock, returned to an unissued status (85,180 shares) 0 0 0 Preferred stock distributions (1,933 shares for 5,345 shares of common) 0 0 0 Exercise of employee stock options, 8,005 shares issued 0 0 0 Collections of notes receivable 0 38 0 Forfeitures of notes receivable 0 589 0 Translation adjustment on investments in foreign subsidiaries (347) 0 0 Net income (loss) 0 0 0 Preferred stock dividends (net of income tax benefit of $542) 0 0 0 share 0 0 0 BALANCE, DECEMBER 31, 1991 1,285 (1,415) (1,395) Employee Stock Ownership Plan, deferred compensation earned 0 0 349 Preferred stock distributions (3,223 shares for 8,040 shares of common) 0 0 0 Exercise of employee stock options, 172,975 shares issued 0 0 0 Collections of notes receivable 0 51 0 Translation adjustment on investments in foreign subsidiaries (658) 0 0 Net income 0 0 0 Preferred stock dividends (net of income tax benefit of $541) 0 0 0 Common dividends declared, $ .40 per share 0 0 0 BALANCE, DECEMBER 31, 1992 627 (1,364) (1,046) Employee Stock Ownership Plan, deferred compensation earned 0 0 348 Preferred stock distributions (4,449 shares for 6,528 shares of common) 0 0 0 Exercise of employee stock options, 129,111 shares issued 0 0 0 Collections of notes receivable 0 45 0 Translation adjustment on investments in foreign subsidiaries (341) 0 0 Net income 0 0 0 Preferred stock dividends (net of income tax benefit of $601) 0 0 0 share 0 0 0 BALANCE, DECEMBER 31, 1993 $286 ($1,319) ($698)\nKYSOR INDUSTRIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Shareholders' Equity Dollars in thousands, except per share data) Total Common Total Stockholders' Shareholders' Equity Equity BALANCE, DECEMBER 31, 1990 $48,058 $49,260 Employee Stock Ownership Plan, deferred compensation earned 349 1,226 Purchase of common stock, returned to an unissued status (85,180 shares) (1,000) (1,000) Preferred stock distributions (1,933 shares for 5,345 shares of common) 46 (1) Exercise of employee stock options, 8,005 shares issued 44 44 Collections of notes receivable 38 38 Forfeitures of notes receivable 0 0 Translation adjustment on investments in foreign subsidiaries (347) (347) Net income (loss) (726) (726) Preferred stock dividends (net of income tax benefit of $542) (1,053) (1,053) share (2,869) (2,869) BALANCE, DECEMBER 31, 1991 42,540 44,572 Employee Stock Ownership Plan, deferred compensation earned 349 1,213 Preferred stock distributions (3,223 shares for 8,040 shares of common) 78 (1) Exercise of employee stock options, 172,975 shares issued 1,734 1,734 Collections of notes receivable 51 51\nTranslation adjustment on investments in foreign subsidiaries (658) (658) Net income 9,127 9,127 Preferred stock dividends (net of income tax benefit of $541) (1,050) (1,050) Common dividends declared, $ .40 per share (2,083) (2,083) BALANCE, DECEMBER 31, 1992 50,088 52,905 Employee Stock Ownership Plan, deferred compensation earned 348 1,212 Preferred stock distributions (4,449 shares for 6,528 shares of common) 108 0 Exercise of employee stock options, 129,111 shares issued 1,783 1,783 Collections of notes receivable 45 45 Translation adjustment on investments in foreign subsidiaries (341) (341) Net income 2,470 2,470 Preferred stock dividends (net of income tax benefit of $601) (983) (983) share (2,398) (2,398) BALANCE, DECEMBER 31, 1993 $51,120 $54,693\nThe accompanying notes are an integral part of the financial statements.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation The consolidated financial statements include the accounts of Kysor Industrial Corporation and all of its subsidiaries (\"Kysor\" or \"Company\").\nForeign Currency Translation Translation adjustments have been accumulated as a separate component of Shareholders' Equity.\nCash and Equivalents Kysor considers all highly-liquid debt instruments purchased with a maturity of less than one year to be cash equivalents.\nInventories Inventories are generally stated at the lower of FIFO (first in, first out) cost or market. Kysor has one subsidiary on LIFO (last in, first out), the inventory value of which was $828,000 and $735,000 lower than it would have been under FIFO at December 31, 1993 and 1992, respectively.\nProperty, Plant and Equipment and Depreciation Property, plant and equipment are stated at cost. Depreciation is computed by the straight-line method based on the estimated useful lives of the assets.\nBuildings are depreciated over lives ranging from 10 to 40 years. Machinery, equipment, and office furniture are depreciated over lives ranging from 3 to 25 years.\nWhen properties are retired, the cost of such properties, net of accumulated depreciation and any salvage proceeds, is reflected in income.\nGoodwill Goodwill, resulting from the excess of cost over the net assets of purchased companies, is amortized on a straight-line basis over periods not exceeding 20 years.\nIncome Taxes In 1993, the Company adopted Statement of Financial Accounting Standards # 109, \"Accounting for Income Taxes,\" which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse (see Note 10).\nPrior to 1993, the provision for income taxes was based on income and expenses included in the accompanying consolidated statements of operations. Differences between taxes so computed and taxes payable under applicable statutes and regulations were classified as deferred taxes arising from timing differences.\nFinancial Instruments The Company has cash, cash equivalents, and long-term debt which are considered financial instruments. The market values of these financial instruments, as determined through information obtained from banking sources and management estimates, approximate their carrying values.\nPension and Retirement Plans Annual provisions for pension and retirement plan costs recognize amortization of prior service costs over the expected service period of active employees. Accrued pension costs are funded annually to the extent deductible for federal income tax purposes.\nIn 1993, the Company adopted Financial Accounting Standards # 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" which requires the accrual of postretirement benefits such as health care and life insurance during the working careers of active employees instead of expensing the benefits when paid as allowed under prior rules (see Note 8).\nProduct Warranty Costs Anticipated costs related to product warranty are expensed in the period of sale.\nEnvironmental Costs Environmental expenditures that relate to current or future revenues are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and do not contribute to current or future revenues, are expensed. Liabilities are recorded when environmental assessments and\/or cleanups are probable and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with Kysor's commitment to a formal plan of action.\nNOTE 2. BALANCE SHEET INFORMATION\n(amounts in thousands)\nThe following information is provided as of December 31:\nInventories 1993 1992\nFinished products $ 5,338 $ 7,442 Work-in-process 8,973 9,689 Raw materials 14,098 17,304 $28,409 $34,435\nNonoperating Properties Nonoperating properties included in property, plant and equipment are as follows:\n1993 1992\nLand $ 118 $ 134 Buildings 654 654 772 788 Less accumulated depreciation 100 100 $ 672 $ 688\nNonoperating properties held for resale are stated at cost less accumulated depreciation, which amounts are not in excess of net realizable value.\nGoodwill, Patents and Other Intangible Assets 1993 1992\nGoodwill 4,868 4,968 Less accumulated amortization 2,062 1,922 $ 2,806 $ 3,046\nAccrued Expenses and Contingent Liabilities 1993 1992\nCompensation $ 5,744 $ 3,689 Workers' compensation insurance 5,078 4,483 Warranty 4,120 4,010 Litigation 2,900 2,900 Other 7,857 6,122 $25,699 $21,204\nNOTE 3. FINANCING (amounts in thousands)\nLong-term debt consists of the following: Years Ended December 31, 1993 1992 Long-Term Debt Term note, $750 quarterly principal payments, beginning 1994, plus interest at 9.9% $ 15,000 $15,000 Loan agreement for Kysor Industrial Corporation Employee Stock Ownership Plan, $1,250 semiannual principal payments beginning 1996, plus interest at 8.36% 20,000 20,000 Other, $2,321 principal payments due in, 1994, plus interest at rates ranging from 5.0% to 8.0% 3,646 2,070\nLoan Guarantee Loan guarantee for Kysor Industrial Corporation Employee Stock Ownership Plan, $174 semiannual principal payments, plus interest at 7.0% 697 1,046 39,343 38,116 Less current maturities 5,670 1,595 $33,673 $36,521\nAt December 31, 1993, the Company maintained revolving credit agreements with two banks which provide for borrowings up to $20 million. At December 31, 1993, there were no outstanding borrowings under this facility. Interest rates are fixed at the date of borrowing based on current LIBOR or CD rates plus a spread of .75 - 1.0 percent. An annual commitment fee of .375 percent is paid on the unused balance. In January 1994, the Company entered into a modification of the revolving credit terms which reduced the spread on LIBOR borrowing to .50 percent and reduced the annual commitment fee to .25 percent. The Company has an interest rate swap under which the variable rate of interest on the $15 million term note is converted to a fixed rate.\nDuring the years ended December 31, 1993 and 1992, there was no short-term debt.\nAggregate maturities of obligations under long-term debt, during the next five years ended December 31, are as follows:\n(amounts in thousands) 1994 1995 1996 1997 1998\nMaturities of Long-Term Debt $5,670 $3,349 $4,250 $5,500 $5,500\nUnder various loan arrangements, Kysor is subject to certain restrictions relating, among other things, to the creation of indebtedness, the maintenance of minimum consolidated working capital, the payment of dividends, and the purchase of common stock.\nInterest paid was $2,073,000, $3,039,000, and $3,348,000 for the years ended December 31, 1993, 1992, and 1991, respectively.\nNOTE 4. STOCK OPTION PLANS As of December 31, 1993, Kysor administered its 1980 Nonqualified Stock Option Plan; 1983 Incentive Stock Option Plan; 1984 Stock Option Plan; 1987 Stock Option and Restricted Stock Plan, and 1993 Long-Term Incentive Plan which was approved by Shareholders on April 30, 1993. Options may be granted to officers, directors, and key employees to purchase common shares of the Company's stock at a price equal to the mean market value of such stock at the date of the grant. All options granted prior to January 1, 1990 are exercisable at the date of grant, except for a nonqualified stock option for 100,000 shares granted to the Chairman of the Board on January 30, 1987 which vested at the rate of 20 percent per year through January 30, 1991. All options granted after January 1, 1990 vest at the rate of 20 percent at time of grant and 20 percent each year thereafter, except for the final 20 percent which vests only upon exercise and retention for one year of the entire vested 80 percent.\nChanges in options outstanding for the years ended December 31, 1992 and 1993 are as follows:\nNumber of Number of Shares Optioned Reserved Shares Option Price Range Total Balance December 31, 1991 574,391 1,587,256 $ 3.875 - $19.125 19,913,818 Granted [377,000] 377,000 7.8125- 16.1875 3,164,500 Terminated 114,950 [114,950] 7.25 - 18.6875 [1,337,576] Exercised - [207,156] 3.875 - 14.375 [1,753,905] Balance December 31, 1992 312,341 1,642,150 7.25 - 19.125 19,986,837 Granted [288,500] 288,500 16.3125- 18.9375 5,384,719 Terminated 59,700 [59,700] 7.25 - 19.125 [668,300] Exercised - [138,650] 7.25 - 18.6875 [1,488,494] 1993 Long-Term Incentive Plan 1,000,000 - - - - Balance December 31, 19931,083,541 1,732,300 $ 7.25 -$19.125 $23,214,762 At December 31, 1993, 1,179,470 of the shares granted were exercisable. The fair market value of options exercised in 1993 ranged from $15.50 to $20.4375 per share for a total market value of $2,591,225. The fair market value of options exercised in 1992 ranged from $9.0625 to $18.8125 for a total market value of $3,411,376.\nIn 1989, optionees executed 4.5 percent nonrecourse installment purchase agreements of $2,090,793 with respect to 157,128 shares previously granted under the nonqualified plans. During 1991, three optionee participants relinquished their stock option loans in the amount of $589,383 and forfeited the attendant 41,150 common shares. Under the terms of the installment purchase agreements, the shares are pledged as collateral and the extension of credit is subject to Federal Reserve Bank Regulation G. Required annual payments are calculated using a 15-year amortization with a balloon payment due within the original life of the option being exercised. The participants have limited rights of principal deferral in cases of hardship. The Board of Directors, in January 1992, passed a resolution to permit participants to defer the 1992 principal payments to the end of the loan. Dividends paid, in respect to the shares, are received by the Company and first applied to accrued interest and then to principal.\nNOTE 5. COMMON STOCK REPURCHASED In October 1991, Kysor purchased 85,108 shares of its Common Stock for $11.75 per share in accordance with an agreement, granted in conjunction with restricted stock issued for the 1986 acquisition of Medallion Instruments, Inc.\nNOTE 6. PREFERRED STOCK On February 24, 1989, Kysor sold 820,513 shares of newly issued 8 percent cumulative Series A Convertible Voting Preferred Stock, $24.375 stated value per share (the \"Convertible Stock\"), to the Kysor Industrial Corporation Employee Stock Ownership Plan (the \"ESOP\"). The Convertible Stock may be voluntarily converted at the option of the holder, unless previously redeemed, into shares of Kysor Industrial Corporation Common Stock (the \"Common Stock\") on a one-for-one basis, subject to certain antidilution adjustments, and will convert automatically into Common Stock (in certain instances subject to a conversion floor equal to liquidation value of $24.375 per share plus accrued and unpaid dividends) if transferred to a holder other than the ESOP or another Kysor Industrial Corporation employee benefit plan. The Convertible Stock is subject to redemption by the Company. Each share of Convertible\nStock entitles its holder to one vote on all matters submitted for a vote of shareholders, again subject to possible antidilution adjustments. The Convertible Stock ranks senior to the Common Stock and is at least on a parity with any other series of Preferred Stock that may be subsequently issued.\nPreferred Stock issued and outstanding was 810,163 and 814,612 shares at December 31, 1993 and 1992, respectively. Preferred shares allocated to ESOP participants were 35,463 for each of the years ended December 31, 1993 and 1992.\nNOTE 7. EARNINGS PER COMMON SHARE Primary earnings per common share have been computed using the weighted average shares of Common Stock and dilutive Common Stock equivalents outstanding during the year. The Convertible Stock has been determined not to be a Common Stock equivalent.\nFully diluted earnings per common share are calculated assuming the conversion of the Convertible Stock to Common Stock as well as other dilutive assumptions.\nNOTE 8. PENSION AND RETIREMENT PLANS Kysor has several noncontributory defined benefit pension plans and defined contribution plans covering substantially all of its domestic employees. The defined benefit plans provide benefits based on the participants' years of service and compensation or stated amounts for each year's service. The Company's funding policy is to make annual contributions as required by contract or applicable regulations.\nThe pension cost components were:\n(amounts in thousands) Years Ended December 31,\n1993 1992 1991 Defined Benefit Plans: Service cost benefits earned during period $1,905 $1,497 $1,595 Interest cost on projected benefit obligation 3,388 3,024 2,858 Actual investment return on plan assets [6,001] [3,434] [6,937] Net amortization and deferral 2,967 670 4,347 Net periodic pension cost $2,259 $1,757 $1,863\nAssumptions used in the accounting were: Years Ended December 31,\n1993 1992 1991\nDiscount rates 8.0% 8.0% 8.0% Rates of increase in compensation levels 5.4% 5.3% 6.0% Expected long-term rate of return on assets 8.0% 8.0% 8.0%\nThe following table sets forth the funded status and amounts recognized in the Company's statement of financial position for defined benefit plans:\n(amounts in thousands) Years Ended December 31,\n1993 1992 Plans in Which Plans in Which Assets Accum. Assets Accum. Exceed Benefits Exceed Benefits Accum. Exceed Accum. Exceed Benefits Assets Benefits Assets\nActuarial present value of benefit obligations: Vested benefit obligation $[30,503] $[3,239] $[28,375] $[3,336]\nAccumulated benefit obligation $[32,955] $[5,804] $[30,475] $[4,919]\nProjected benefit obligation $[38,434] $[7,432] $[35,490] $[5,551]\nPlan assets at fair market value 49,267 - 42,376 - Projected benefit obligation (in excess of) or less than plan assets 10,833 [7,432] 6,886 [5,551] Unrecognized net (gain) or loss [6,782] 1,678 [4,703] 677 Prior service cost not yet recognized in net periodic pension cost 778 82 966 98 Unrecognized net (asset) obligation at January 1, [1,980] 779 [2,229] 890 Pension asset (liability) recognized in the statement of financial position $ 2,849 $[4,893] $ 920 $[3,886]\nAt both December 31, 1993 and 1992, 100 percent of plan assets was invested in publicly traded stocks, bonds, and money market investments.\nIn 1985, Kysor adopted a nonqualified, unfunded supplemental executive retirement plan for senior management. Kysor has purchased life insurance policies on the lives of participants and is the sole owner and beneficiary of such policies. The amount of coverage is designed to provide sufficient revenues to cover all costs of the plan if the assumptions made as to mortality experience, policy earnings, and other factors are realized. The Company is charging earnings with the present value of the future cost of the plan over the remaining working life of the participants. In addition, life insurance premiums, in excess of the increase in cash value of the policies, are expensed as a period cost.\nIn September 1985, Kysor established an Employee Stock Ownership Plan (\"ESOP\") and trust for its domestic salaried employees. The ESOP authorized the trust to borrow $3,487,000 from a bank in September 1985. The proceeds were used to purchase 357,668 shares of common stock at $9.75 per share, that being the mean market price on the New York Stock Exchange on August 22, 1985, the day preceding the date the transaction was agreed upon. The Company has guaranteed the loan and is obligated to contribute sufficient cash to the ESOP to enable it to repay the loan principal ($349,000 annually) plus interest.\nIn February 1989, Kysor expanded the ESOP with the sale to the ESOP of $20 million of newly issued Series A Convertible Voting Preferred Stock from the Company (see Note 6). The ESOP purchase of Preferred Stock was financed by a loan from the Company which issued a $20 million, 15-year ESOP note to raise the necessary funds. In 1993, 1992, and 1991, dividends on Preferred Stock of $1,584,000, $1,591,000, and $1,595,000 plus interest expense of $88,000, $81,000, and $77,000, respectively, were used to service the debt obligation related to the ESOP. The Company amortized $864,000 in 1993 and 1992, and $877,000 in 1991, of unearned deferred compensation relating to the shares allocated for the year as a percentage of the total shares to be allocated.\nPostretirement Health and Life Insurance Benefits Kysor provides certain defined health care and life insurance benefits for retired employees. All salaried and certain hourly employees may become eligible for these benefits if they reach retirement age while working for the Company. Effective January 1, 1993, the Company adopted Statement of Accounting Standards #106, \"Employers accounting for Postretirement Benefits other than Pensions\" (\"'SFAS #106\"). SFAS #106 requires the accrual method of accounting for postretirement health care and life insurance benefits based on actuarially determined cost to be recognized over the period from the date of hire to the full eligibility date of employees who are expected to qualify for such benefits. At January 1, 1993, the Company recognized the full amount of its estimated accumulated postretirement benefit obligation which represents the present value of the estimated future benefits payable to current retirees and a pro rata portion of estimated benefits payable to active employees after retirement. The pretax charge to 1993 earnings for this transition obligation was $12,063,000 ($7,628,000 net of income tax benefit) or $1.35 per share. This amount has been reflected in the consolidated statement of income as the cumulative effect of an accounting change.\nThe incremental cost in 1993 of accounting for postretirement health care and life insurance benefits under the new accounting method amounted to $564,000, less a deferred tax benefit of $212,000, or $.06 per share. In prior years, the Company expensed claims for postretirement benefits on a pay as you go method. The total pretax amount recognized for retiree health and life insurance benefits in 1993 was $1,352,000. The amounts included in expense for 1992 was $862,000. For the year ended December 31, 1993, the components of periodic expense for these postretirement benefits were as follows:\n(amounts in thousands)\nService cost - benefits earned during the year $ 413 Interest cost on accumulated postretirement benefit obligation 939 Net periodic benefit costs $1,352\nAt December 31, 1993, the actuarial and recorded liabilities for these postretirement benefits, none of which have been funded, were as follows:\n(amounts in thousands)\nAccumulated postretirement benefit obligation (APBO): Retirees $10,191 Fully eligible active plan participants 1,146 Other active participants 1,429 Total APBO 12,766 Fair market value of plan assets - Accumulated postretirement benefit obligation in excess of plan assets 12,766 Unrecognized net (loss) [138] Accrued postretirement benefit liability at December 31, 1993 $12,628\nThe accumulated postretirement benefit obligation was determined using the unit credit method and an assumed discount rate of 8 percent. The assumed gross claim health care trend rate used for under age 65 claims was 10 percent in 1993, graded uniformly down to 5.5 percent in 2005 and level thereafter. For ages 65 and over claims, the assumed trend rate was 8 percent in 1993, graded uniformly down to 5.5 percent in 2005 and level thereafter. A 1 percent increase each year in the health care cost trend rate used would have resulted in a $129,000 increase in the aggregate service and interest components of expense for the year ended December 31, 1993, and a $1,279,000 increase in the accumulated postretirement benefit obligation at December 31, 1993.\nThe Company has a continuing deferred compensation arrangement with Raymond A. Weigel former chairman which provides for annual payments of $350,000.\nNOTE 9. LEASE COMMITMENTS Kysor leases some real estate and equipment. In most cases, management expects that in the normal course of business these leases will be renewed and replaced by other leases. Kysor has future minimum rental payments required through 1998 under operating leases that have initial or remaining noncancelable lease terms in excess of one year in the following amounts:\n(amounts in thousands) Years Ended December 31,\n1994 1995 1996 1997 1998\nFuture minimum rental payments $966 $513 $368 $342 $475\nIn addition to fixed rentals, certain of these leases requires Kysor to pay maintenance, property taxes, and insurance.\nRental expense charged to operations is as follows:\n(amounts in thousands) Years Ended December 31,\n1993 1992 1991\nMinimum rentals $1,829 $1,909 $1,811 Contingent rentals 53 30 31 $1,882 $1,939 $1,842\nNOTE 10. INCOME TAXES The Company adopted Statement of Financial Accounting Standards #109, \"Accounting for Income Taxes\" (\"SFAS #109\"), as of January 1, 1993. The cumulative effect of this change in accounting principle was immaterial. Prior years' financial statements have not been restated to apply the provisions of SFAS #109. The adoption of SFAS #109 changes the Company's method of accounting for income taxes from the deferred method using Accounting Principles Board Opinion #11 (\"APB #11\") to an asset and liability approach.\nThe provision (credit) for income tax consists of the following:\n(amounts in thousands) Year Ended December 31,\n1993 1992 1991 \t Currently payable Federal $7,733 $7,318 $2,025 State and local 1,022 800 283 Foreign 55 28 - Total currently payable 8,810 8,146 2,308 Deferred Federal [790] [1,076] [1,268] State and local [110] [170] [154] Foreign - - [226] Total deferred [900] [1,246] [1,648] Total Provision $7,910 $6,900 $ 660\nDeferred income taxes, on a SFAS #109 basis, reflect the estimated future tax effect of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations.\nThe components of deferred income tax assets and liabilities as of December 31, 1993 are as follows:\n(amounts in thousands) Deferred tax Deferred tax assets liabilities Post-retirement health care $4,644 $ - Employee benefit plans 3,147 1,053 Workers' compensation\/product liability 2,377 - Warranty 1,100 - Litigation expense 1,072 - Service contract 896 - Slow-moving inventory 704 - Bad debts 482 - Environmental costs 481 - Vacation pay 453 - Depreciation - 3,693 LIFO reserve at acquisition - 535 Other 297 75 $15,653 $ 5,356\nDeferred income taxes for 1992 and 1991 were derived using guidelines in APB #11. Under APB #11 deferred income taxes result from timing differences in the recognition of revenues and expenses between financial statements and tax returns. The sources of these differences and the related effect of each on the Company's provision for income taxes were as follows:\n(amounts in thousands) Year Ended December 31,\n1992 1991\nSlow-moving inventory $ [496] $148 Workers' compensation\/product liability [433] 336 Depreciation [395] [58] Warranty [360] [61] Bad debts [156] 22 Service contract [99] [129] Reserves for self-insurance [72] 521 Foreign earnings - [226] Environmental costs 90 183 Employee benefit plans 127 [622] Interest 145 [145] Alternative minimum tax 150 [150] Litigation 407 [1,477] Other [154] 10 $[1,246] $[1,648]\nMajor differences between the income taxes computed using the United States statutory tax rate and the actual income tax expense were as follows:\n(amounts in thousands) Years Ended December 31,\n1993 1992 1991\nFederal income taxes at statutory rate $ 6,303 $ 5,449 $[22]\nNondeductible losses related to foreign subsidiaries and other foreign expenses 1,071 981 728 Goodwill 84 82 82 State and local income taxes (net of Federal benefit) 593 472 85 Life insurance [165] [169] [161] Other 24 85 [52] Provision for income taxes $ 7,910 $ 6,900 $660\nIncome taxes paid were $7,427,000, $6,245,000, and $1,788,000 for the years ended December 31, 1993, 1992, and 1991, respectively. Income tax refunds were $71,000 in 1993, $283,000 in 1992, and $657,000 in 1991. Domestic operations contributed a profit of $15,305,000, $18,261,000, and $3,513,000 to income before income taxes and before cumulative effect of accounting change for 1993, 1992, and 1991, respectively. Foreign operations sustained a loss of $2,704,000, $2,234,000, and $3,579,000 for the same periods. Income tax benefits of $473,000 and $560,000 have been credited to shareholders' equity for the years ended December 31, 1993 and 1992, respectively, for deemed compensation deductions attributable to stock options. Income tax benefits of $601,000, $541,000, and $542,000 for preferred stock dividends related to the Company's ESOP have been credited to shareholders' equity in 1993, 1992, and 1991, respectively.\nNOTE 11. CONTINGENT LIABILITIES As previously reported, the Company has been involved in ongoing proceedings relating to soil and groundwater contamination at the Cadillac Industrial Park in Cadillac, Michigan.\nSince the Company's initial involvement in the referenced proceedings, extensive testing has been performed to determine the extent of contamination at the site. Based upon certain of those tests, in 1989 the United States Environmental Protection Agency (\"U.S. EPA\") issued a Record of Decision which selected certain cleanup methods for the site and estimated the present value of the costs for selected cleanups. In particular, the EPA estimated the cost for the Company's soil cleanup at $925,000, and estimated the costs for the areawide groundwater cleanup at $15,124,000.\nPursuant to a unilateral administrative order that was issued by the U.S. EPA in 1990 to the Company and other potentially responsible parties (\"PRPs\"), the Company is continuing to perform design work for remedial action for the area groundwater contamination and for the soil contamination at the Company site. The Company is the only PRP that is complying with the order. The order was issued pursuant to Section 106 of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, which authorizes the U.S. EPA to seek treble damages and civil penalties of up to $25,000 per day for violation of an administrative order. The scope of the present order is limited to design work, and does not at this time require the Company or the other PRPs to undertake the construction or implementation of any remedial action.\nThe Company's design work plan has been approved by the U.S. EPA and, as required by the design work plan, the Company has submitted an Additional Studies Report to the U.S. EPA, which was also approved. As further required by the design work plan, the Company submitted to the U.S. EPA preliminary design documents, which EPA has reviewed up through 95% of the design. The current schedule calls for completion of design work in 1994. The costs presently estimated for completion of the remaining design work, including the incremental work described in the following paragraph, is $90,000. The costs to date for design work have been approximately $1,300,000. Approximately $255,000 of the total estimated design costs relate to the soil cleanup at the Company site, and the Company has previously accrued these estimated cleanup costs.\nU.S. EPA recently requested that the Company include two additional areas of groundwater contamination within the area to be addressed by the remediation system which is the subject of the ongoing design work. These additional areas are immediately adjacent to the original area of groundwater contamination covered by the remedial design. Without admitting liability for the contamination, the Company has agreed to include these additional areas in the remedial design. The incremental design and remediation costs are estimated at $40,000 and $310,000, respectively. As a potential solution to the referenced groundwater contamination, the Company has become a limited partner in Beaver Michigan Associates, a Michigan limited partnership formed to construct a $58 million wood-fired cogeneration plant in Cadillac, Michigan. It is intended that the project would facilitate treatment of the groundwater contamination at the Cadillac Industrial Park. In that regard, the City of Cadillac, also a limited partner in the venture, has established a Local Development Finance Authority (\"LDFA\") which intends to use tax- generated revenues from the project to service bonds to be issued to pay the capital cost to build the groundwater cleanup facility. It is anticipated that assessments for operating and maintenance costs of the cleanup facility would be shared primarily by the PRPs, including Kysor, as well as other beneficiaries within the Cadillac Industrial Park. In January 1992, Beaver Michigan Associates obtained financing to construct the facility from General Electric Capital Corporation. In 1993, the cogeneration facility construction was completed and the plant began commercial operation. The LDFA is currently pursuing the permanent placement of bonds totally $7.4 million to fund the capital costs to build the cleanup facility.\nWith respect to the groundwater cleanup discussed above, there are a number of evolving factors that will affect the extent of the Company's liability for these costs. First, the U.S. EPA's cost estimate may be overstated. While detailed estimates cannot be made until completion of the ongoing design work, the initial modeling work performed by the Company's consultants indicates that the U.S. EPA's cost estimate is too high. In addition, the Company is continuing to pursue mixed funding (i.e., partial government funding) from the U.S. EPA and participation of others PRPs, and the extent of funding from these sources is not yet known. The regional office of the U.S. EPA has agreed that mixed funding should be provided for a portion of the remedial design and remedial action, although the actual amount of such funding, if any, is subject to further negotiation with the regional office of the U.S. EPA and final approval by the U.S. EPA headquarters. As described above, the LDFA is presently pursuing the permanent placement of bonds, the proceeds of which would pay the initial capital costs for the cleanup facility and certain future capital costs for continued operation of the facility. The bond debt would be serviced by tax increment revenues collected by the LDFA from the cogeneration facility. Possible insurance coverage for this matter remains unresolved.\nOn July 3, 1991, the Michigan Attorney General and Department of Natural Resources commenced a lawsuit in Federal District Court, Western District Michigan against the Company and various other parties seeking to recover expenses allegedly incurred by the State in investigating the nature and extent of contamination at the Cadillac site, incidental expenses associated therewith, fines, penalties, interest, attorneys' fees and damages for injury to the natural resources of the State. Discovery has commenced in this action although it is not yet complete. The suit also seeks a declaratay judgement holding Kysor and others jointly and severally liable for clean-up at the site. The Attorney General asserts that the Department of Natural Resources has expended approximately $3.0 million to date on tests and related studies at the site and provide city water to contaminated areas, for which the Attorney General claims Kysor and others are jointly responsible. The Attorney General also asserts that the State is entitled to statutory interest, which it claims is approximately $1.6 million as of Fall 1992, and noted that under the Michigan Water Resource Commission Act the court in its discretion may impose penalties of up to $10,000 a day ($25,000 a day from May 1990) dating back to the early 1980's. The Attorney General finally asserts that the Company may be responsible for injury to the State's natural resources as well as attorneys fees.\nThe Company continues to dispute the State's allegations and intends to vigorously defend against the damages sought. Though discovery is not yet complete, the Company believes that many of the costs claimed by the State were duplicative or related to areas of contamination for which the Company is not responsible. The Company also disputes the claimed interest calculation and believes that it is unlikely that material penalties would be imposed due to the continuing efforts of the Company to investigate and remediate the contamination at the site which date back to as early as 1980. If ongoing settlement negotiations are unsuccessful, the Company intends to vigorously defend against the claims to the extent they relate to the testing of contamination not caused by the Company or costs which were duplicative and unnecessary. The Company is investigating the possibility of insurance coverage of the matter and has made cross-claims and third-party claims for contribution against other parties located at this site, including parties involved in the referenced proceeding as a co-defendant.\nWhile it is clear that the Company is responsible for the soil contamination at its site and the Company shares a portion of the responsibility for the groundwater contamination described above, it is presently impossible to provide a precise estimate of the Company's actual liability. Kysor has accrued its best estimate of the liability for soil cleanup costs. As noted above, the U.S. EPA cost figures on the groundwater cleanup are estimates that may be overstated, and the Company continues to aggressively promote the referenced cogeneration project as a means of facilitating a cleanup at the site. The Company is also pursuing insurance coverage as well as mixed funding from the EPA for this matter, but there has been no determination as to the availability or extent of such coverage or funding. Specifically, with respect to the referenced costs for design and the capital costs of the cleanup work, the Company is not only pursuing insurance coverage and mixed funding, but also intends to seek reimbursement and funding from a bond offering planned by the Cadillac LDFA in connection with the cogeneration project, as described above. The availability of this latter source of reimbursement would depend, among other things, upon the sale of the referenced bonds.\nOther contingent liabilities include various legal actions, proceedings and claims which are pending or which may be instituted or asserted in the future against the Company. Litigation is subject to many uncertainties, the outcome of individual matters is not predictable with assurance and it is reasonably possible that some of these other legal actions, proceedings and claims could be decided unfavorable to the Company. Although the liability with regard to these matters at December 31, 1993 cannot be ascertained, it is the opinion of management, after conferring with counsel, that any liability resulting from these other matters should not materially affect the consolidated financial position of the Company and its subsidiaries at December 31, 1993.\nNOTE 12. SEGMENT INFORMATION Kysor Industrial Corporation's operations include two segments: commercial products and transportation products. Operations in the commercial products segment design, manufacture and market refrigerated display cases, energy control systems, refrigerated building systems, and heating and air-conditioning systems. Operations in the transportation products segment design, manufacture and market engine performance systems, engine protection systems, and components and accessories for heavy-duty trucks, other commercial vehicles and marine equipment.\nThe commercial products segment generated $29.0 million, $48.4 million and $34.7 million of sales and revenues from one customer in the years ended December 31, 1993, 1992 and 1991, respectively. The transportation products segment generated $27.3 million of sales and revenues from one customer in the year ended December 31, 1993.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information under the caption \"Directors and Executive Officers\" in the Company's definitive Proxy Statement for its April 29, 1994 Annual Meeting of Shareholders is here incorporated by reference.\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than 10 percent of the Company's Common Stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the New York Stock Exchange. Officers, directors and greater than 10 percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that all filing requirements applicable to its officers, directors, and greater than 10 percent beneficial owners, with respect to fiscal year 1992, were satisfied.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nThe information under the caption \"Executive Compensation\" in the Company's definitive Proxy Statement for its April 29, 1994 Annual Meeting of Shareholders is here incorporated by reference.\nIn lieu of filing Annual Reports on Form 11-K on behalf of the Kysor Industrial Corporation Employee Stock Ownership Plan, pursuant to Rule 15d-21 promulgated under the Securities Exchange Act of 1934, as amended, the report of Coopers & Lybrand, Certified Public Accountants, and Examination of Financial Statements and Supplemental Schedule of Reportable Transactions with respect to the Plan is included in the exhibits to this Form 10-K Annual Report.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information under the caption \"Voting Securities\" in the Company's definitive Proxy Statement for its April 29, 1994 Annual Meeting of Shareholders is here incorporated by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information under the caption \"Management Transactions\", \"Indebtedness of Management\", and \"Compensation Committee Interlocks and Insider Participation\", in the Company's definitive Proxy Statement for its April 29, 1994 Annual Meeting of Shareholders is here incorporated by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. The following financial statement schedules are filed as a part of this report:\nII. Amounts Receivable From Related Parties, Underwriters, Promoters and Employees Other Than Related Parties - pages 45, 46 & 47.\nV. Property, Plant and Equipment - pages 48, 49 & 50.\nVI. Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment - pages 51, 52 & 53.\nVIII. Valuation and Qualifying Accounts and Reserves - page 54.\nX. Supplementary Income Statement Information from Continuing Operations - page 55.\nSchedules other than those listed above are omitted because they are not required, not applicable, or the information is disclosed elsewhere in the financial statements.\nIndividual financial statements of the Company are omitted because the Company is primarily an operating Company and the subsidiaries included in the consolidated financial statements are wholly owned subsidiaries and are not indebted to any person other than the Parent or the consolidated subsidiaries in amounts exceeding five percent (5%) of the total assets as shown by the Consolidated Balance Sheet at December 31, 1993.\n2. The following exhibits are filed as part of this report:\nNUMBER EXHIBIT LOCATION\n3(a) Restated Articles of Incorporation (8)\n(b) Restated Bylaws (1)\n(c) Certificate of Designations, Rights and Preferences - \t Series A Convertible Voting \t Preferred Stock (11)\n4(a) Rights Agreement dated as of April 28, 1986 between Kysor Industrial Corporation and NBD, N.A. (5)\n(b) Amendment dated as of May, 1988 to Rights Agreement dated as of April 28, 1986 between Kysor \t Industrial Corporation and NBD Bank, N.A. (8)\n(c) Revolving Credit Agreements between Kysor Industrial Corporation and NBD \t Bank, N.A., and Old Kent Bank \t and Trust Company (12)\n(d) Amendment dated January 1994 to the Revolving Credit Agreements between \t NBD Bank, N.A., and Old Kent Bank \t and Trust Company (1)\n(e) Term Note Agreement with NBD Bank, N.A. dated as of October4, 1988 (8)\n(f) Note Agreement between Kysor Industrial Corporation and Massachusetts Mutual Life Insurance \t Company dated February 24, 1989 (8)\n(g) Loan Agreement between Kysor Industrial Corporation Employee Stock Ownership Plan and NBD Bank, \t N.A. and Related Guaranty and Note Purchase Agreement (3)\n(h) The Company has outstanding several classes of long-term debt instruments. \t None of these classes of debt is \t registered under the Securities Act of 1933. None of these classes of \t debt outstanding at the date of \t this report exceeds 10% of the Company's \t total consolidated assets except for \t the previously disclosed item included as \t exhibit 4(d) and 4(f). The Company \t agrees to furnish copies of the agreements \t defining the rights of holders of such long-term indebtedness to the Securities \t and Exchange Commission upon request\nThe following management contracts of compensatory plans or arrangements are included in the exhibits filed as part of this report:\n10(a) Stock Option and Stock Appreciation Rights Plan of 1980 (2) \t (b) Kysor Industrial Corporation amended 1983 Incentive Stock Option Plan (6) \t (c) Kysor Industrial Corporation amended 1984 Stock Option Plan (6) \t (d) Kysor Industrial Corporation 1987 Stock Option Plan (4) \t (e) Kysor Industrial Corporation 1993 Long-Term Incentive Plan (14)\n(f) Form of Termination Agreements with corporate officers David W. Crooks, \t Thomas P. Forrestal, Jr., Timothy J. \t Campbell, Timothy D. Peterson, \t Peter W. Gravelle, Richard G. De Boer, \t Ellen E. Hovey, Mary C. Janik, \t Robert L. Joseph, Terry M. Murphy (3) \t (g) Employment Contract with corporate officer George R. Kempton (4) \t\t (h) Service Contract with Raymond A. Weigel (3)\n(i) Form of Supplemental Executive Retirement Plan with George R. Kempton, \t Peter W. Gravelle, Timothy J. Campbell, \t Thomas P. Forrestal, Jr., David W. Crooks, \t Timothy D. Peterson, Logan F. Wernz, Wilbert J. Venema, John B. Stevenson, \t William G. Cobb (3)\n(j) Amendment dated as of August 15, 1989 to Supplemental Executive Retirement \t Plan dated July 10, 1985 (9)\n(k) Amendment dated as of January 31, 1990 to Supplemental Executive Retirement Plan \t dated July 10, 1985 (9)\n(l) Kysor Industrial Corporation S.E.R.P. Irrevocable Trust (9)\n(m) Form of Indemnity Agreement with directors and corporate officers; \t William E. Callahan, Timothy J. Campbell, \t Thomas P. Forrestal, Jr., Paul K. Gaston, \t Grant C. Gentry, Peter W. Gravelle, George R. Kempton, Philip LeBoutillier, \t Jr., Robert W. Navarre, Frederick W. \t Schwier, John D. Selby, Raymond A. Weigel, \t David W. Crooks, Terry M. Murphy, \t Timothy D. Peterson, Richard G. De Boer, \t Ellen E. Hovey, Mary C. Janik, \t Robert L. Joseph (6) \t (n) Kysor Industrial Corporation Pension Plan for Directors dated January 1, 1985, amended \t January, 1989 (9)\n(o) Amendment dated as of July 28, 1989 to Kysor Industrial Corporation Pension \t Plan for Directors dated January 1, 1985 (8)\n(p) Directors Pension Plan Trust (9)\n(q) Kysor Industrial Corporation Corporate Management Variable Compensation Program (12) \t (r) Form of Nonrecourse Promissory Note and Pledge Agreement - Stock Option \t Loan Program; George R. Kempton, \t Philip LeBoutillier,Jr., \t Paul K. Gaston (12) \t\nThe Following are Other Material Contracts Included in the Exhibits Filed as Part of this Report:\n(s) AFP Divestiture Agreements (10)\n(t) Beaver Michigan Associates Limited Partnership Agreement (12) \t (u) Development Agreement between Beaver Michigan Associates Limited Partnership, The City of \t Cadillac and the Local Development Finance Authority of the \t City of Cadillac (12) \t (v) Kysor Industrial Corporation Employee Stock Ownership Plan Amended and \t Restated effective January 1, 1989 (1)\n(w) Employee Stock Ownership Trust between Kysor Industrial Corporation \t and Old Kent Bank and Trust Co. \t dated January 1, 1989 (1)\n(x) Note Agreement between Employee Stock Ownership Plan and Kysor Industrial Corporation (7)\n11 Computation of Consolidated Earnings Per Share (1)\n22 Significant Subsidiaries (1)\n24 Consent of Independent Accountants (1)\n25 Power of Attorney (1)\n28 Report of Coopers & Lybrand, Certified Public Accountants, on Examination of Financial Statements \t and Supplemental Schedule of Reportable Transactions for the \t Kysor Industrial Corporation Employee Stock Ownership Plan (1)\nNotes\n(1) Filed as a new exhibit to this report.\n(2) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1981, and is here incorporated by reference.\n(3) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1985, and is here incorporated by reference.\n(4) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1986, and is here incorporated by reference.\n(5) This exhibit was previously filed as an exhibit to the Registrant's Form 8-K Current Report dated May 1, 1986, and is here incorporated by reference.\n(6) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1987, and is here incorporated by reference.\n(7) This exhibit was filed as an exhibit to the Registrant's Form 8-K Current Report dated March 1, 1989, and is here incorporated by reference.\n(8) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1988, and is here incorporated by reference.\n(9) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1989, and is here incorporated by reference.\n(10) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1990, and is here incorporated by reference.\n(11) This exhibit was filed as an exhibit to the Registrant's Form 8-K Current Report dated February 28, 1989, and is here incorporated by reference.\n(12) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1991, and is here incorporated by reference.\n(13) This exhibit was previously filed as an exhibit to the Registrant's Form 10-K Annual Report for its fiscal year ended December 31, 1992, and is here incorporated by reference.\n(14) This exhibit was previously filed as an exhibit to the Registrant's Proxy Statement for its fiscal year ended December 31, 1992 and is here incorporated by reference.\nThe Company will furnish a copy of any exhibit listed above to any shareholder of the Company without charge upon written request to Investor Relations, Kysor Industrial Corporation, One Madison Avenue, Cadillac, Michigan 49601-9785.\nSIGNATURES\nPursuant 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.\nKYSOR INDUSTRIAL CORPORATION\nBy \/s\/ Terry M. Murphy Terry M. Murphy Vice President, Chief Financial Officer\nDate: March 9, 1994\nPursuant 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 and on the dates indicated.\n\/s\/ Raymond A. Weigel * \/s\/ George R. Kempton * Raymond A. Weigel, Chairman George R. Kempton,Chairman of Emeritus, Director the Board, Chief Executive Officer, Director (Principal Executive Officer)\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ Peter W. Gravelle * \/s\/ Robert L. Joseph * Peter W. Gravelle, Executive Robert L. Joseph, Comptroller Vice President and Chief (Principal Accounting Officer) Operating Officer\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ William E. Callahan * \/s\/ Thomas P. Forrestal, Jr. * William E. Callahan, Director Thomas P. Forrestal, Jr., Group Vice President, Director\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ Paul K. Gaston * \/s\/ Grant C. Gentry * Paul K. Gaston, Director Grant C. Gentry, Director\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ Philip LeBoutillier, Jr. * \/s\/ Timothy J. Campbell * Philip LeBoutillier, Jr., Timothy J.Campbell, Group Director Vice President, Director\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ Frederick W. Schwier * \/s\/ John D. Selby * Frederick W. Schwier, Director John D. Selby, Director\nDate: March 9, 1994 Date: March 9, 1994\n\/s\/ Robert W. Navarre* Robert W. Navarre, Director\nDate: March 9, 1994\n*By \/s\/ Terry M. Murphy Terry M. Murphy Attorney-in-fact\nREPORT OF INDEPENDENT ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nKysor Industrial Corporation Cadillac, Michigan\nOur report on the consolidated financial statements of Kysor Industrial Corporation and Subsidiaries is included in Item 8 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14(a)1 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nDetroit, Michigan February 14, 1994","section_15":""}
{"filename":"800575_1993.txt","cik":"800575","year":"1993","section_1":"Item 1. Business\n(a) General Development of Business\nPremark International, Inc. (the \"Registrant\") is a multinational consumer and commercial products company. The Registrant is a Delaware corporation which was organized on August 29, 1986 in connection with the corporate reorganization of Kraft, Inc. (\"Kraft\"). In the reorganization, the businesses of the Registrant and certain other assets and liabilities of Kraft and its subsidiaries were transferred to the Registrant. On October 31, 1986 the Registrant became a publicly held company through the pro-rata distribution by Kraft to its shareholders of all of the outstanding shares of common stock of the Registrant.\nThe Registrant's principal operating subsidiaries are Dart Industries Inc. (\"Dart\"), which owns the operating subsidiaries comprising the Registrant's Tupperware business; Premark FEG Corporation, which owns the operating subsidiaries comprising the Registrant's Food Equipment Group; Ralph Wilson Plastics Company (\"Ralph Wilson Plastics\"); The West Bend Company (\"West Bend\"); Florida Tile Industries, Inc. (\"Florida Tile\"); Tibbals Flooring Co. (\"Tibbals Flooring\"); and Precor Incorporated (\"Precor\"). Dart was organized in Delaware in 1928 as a successor to a business originally established in 1902. Tupperware U.S., Inc. is a Delaware corporation formed in 1989 which operates the U.S. Tupperware business. In 1988, Ralph Wilson Plastics and West Bend were organized in Delaware as separate corporations owned directly by the Registrant, having previously been operating divisions of Dart. Premark FEG Corporation was organized in Delaware in 1984, a successor to a business originally incorporated in 1897. Florida Tile, a Florida corporation organized in 1954, was acquired in 1990. Tibbals Flooring, acquired in 1988, was organized in Tennessee in 1946. Precor, a Delaware corporation, was acquired in 1984.\n(b) Financial Information About Industry Segments\nFor certain financial information concerning the Registrant's business segments, see Note 10 (\"Segments of the Business\") of the Notes to the Consolidated Financial Statements of Premark International, Inc., appearing on pages 38 and 39 of the Annual Report to Shareholders for the year ended December 25, 1993, which is incorporated by reference into this Report by Item 8 hereof.\n(c) Narrative Description of Business\nThe Registrant conducts its business through its three business segments: Tupperware, Food Equipment Group, and Consumer and Decorative Products. A discussion of the three business segments follows. Words appearing in italics constitute trademarks and tradenames utilized by the Registrant's businesses.\nTUPPERWARE\nPrincipal Products, Markets and Distribution\nTupperware manufactures and markets a broad line of highest- quality plastic consumer products for the kitchen, gifts and children's products. Important products include Bell tumblers, Modular Mates stackable storage containers, Wonderlier and Servalier bowls, Tuppertoys educational toys, One Touch canisters, and Tupperwave microwave cookware. The containers and canisters both feature highly successful Tupperware seals.\nDuring 1993, Tupperware continued to introduce new designs and colors in its products lines, and to extend existing products into new markets around the world. Tupperware also continued a major design upgrade program in its U.S. product line, which was launched in 1991.\nBeginning in 1989, a number of U.S. franchisees converted to the Tupperware Express product delivery system, under which Tupperware products are shipped directly from the plant to the ultimate consumer. Prior to Tupperware Express, all franchisees warehoused an inventory of Tupperware products for resale to their consultants, who in turn were responsible for coordinating delivery to the ultimate consumers. Under Tupperware Express, there are presently 95 franchisees who process the orders of their sales consultants for direct shipment and no longer are required to maintain an inventory of Tupperware products. High shipping and administrative costs have adversely affected Tupperware Express. Tupperware is continuing to test alternatives in the distribution network.\nIn fiscal years 1993, 1992, and 1991, Tupperware contributed approximately 40%, 38% and 38%, respectively, of the sales of the Registrant's businesses. Tupperware products are sold in the United States and in 55 foreign countries. In 1993, sales in foreign countries represented approximately 81% of total Tupperware revenues. Although Tupperware's international distribution system is similar to that of its domestic operations, international product lines vary. Market penetration varies significantly throughout the world, with the highest levels occurring in Germany and Australia.\nTupperware products are sold directly to the consumer through over 500,000 dealers (called \"consultants\" in the U.S.) worldwide, over 25% of which are considered active. Consultants are supported by over 32,000 unit managers and approximately 1,400 distributors or franchisees. All of such distributors and franchisees, and the vast majority of consultants, dealers and managers, are independent contractors. The dealer force continued to increase overall in 1993.\nTupperware primarily relies on the \"party plan\" method of sales, which is designed to enable the purchaser to appreciate through demonstration the features and benefits of Tupperware products. Approximately 1.9 million parties and product demonstrations were held in 1993 in the United States, with millions more held in foreign countries. Parties are held in homes, offices, social clubs and other locations. Tupperware products are also being marketed through preview catalogs mailed to persons invited to attend parties and various other types of demonstrations. Sales of Tupperware products are supported through a program of sales promotions, sales and training aids and motivational conferences. Tupperware U.S. also utilizes catalogs and toll-free telephone ordering, which increases its success with hard-to-reach customers, in support of its sales force.\nRaw Materials and Facilities\nThe manufacture of Tupperware products requires plastic resins meeting Tupperware's specifications. These resins are purchased from a number of large chemical companies, and Tupperware has experienced no difficulties in obtaining adequate supplies. Tupperware's headquarters are in Florida. Tupperware's domestic manufacturing plant (which is owned) is located in South Carolina. In 1993, Tupperware ceased manufacturing operations at its Halls, Tennessee facility, eliminating excess capacity in the United States. Fourteen additional manufacturing plants (one of which is leased) are located in 14 foreign countries. Tupperware conducts a continuing program of new product design and development at its research and development facilities in Florida, Hong Kong and Belgium. Research and development of resins used in Tupperware products are performed by its suppliers.\nCompetition\nThe Registrant believes that Tupperware holds approximately 65% of the U.S. market for plastic storage and serving containers. Tupperware products compete with a broad range of food preparation, cooking, storage and serving items made of various materials, which are sold primarily through retail outlets. Tupperware's competitive strategy is to provide high-quality products at premium prices through a direct-selling distribution system. Direct selling, featuring demonstration of its products prior to purchase, price, and new product development are significant factors affecting competition. Tupperware competes with other direct selling organizations for sales personnel and party dates.\nFOOD EQUIPMENT GROUP\nPrincipal Products, Markets and Distribution\nThe Food Equipment Group, composed primarily of Premark FEG Corporation and its operating subsidiaries (the \"Group\"), is a leading manufacturer of commercial equipment relating to food preparation, cooking, storage and cleaning. Its core products include warewashing equipment; food preparation machines, such as mixers, slicers, cutters, meat saws and grinders; weighing and wrapping equipment and related systems; baking and cooking equipment, such as ovens, ranges, fryers, griddles and broilers; and refrigeration equipment. Products are marketed under the trademarks Hobart, Stero, Vulcan, Wolf, Tasselli, Adamatic, Still and Foster.\nFood equipment products are sold to the retail food industry, including supermarket chains, independent grocers, delicatessens, bakeries and convenience and other food stores, and to the foodservice industry, including independent restaurants, fast-food chains, hospitals, schools, hotels, resorts and airlines. Although historically the retail food market has grown at a faster pace than the larger foodservice industry, in 1993 this growth trend was reversed.\nFood equipment products are distributed in more than 100 countries, either through wholly-owned subsidiaries or through distributors, dealers or licensing arrangements covering virtually all areas of the world where a market for such products currently exists. The Group is the only major food equipment manufacturer in the U.S. with its own nationwide service network for the markets in which it sells, providing not only an important source of income but also an important source for developing new sales. The Group directly services its food machines, warewashers, weigh\/wrap equipment and cooking equipment, while authorized independent agents service refrigeration units and some cooking equipment.\nFor the fiscal years 1993, 1992, and 1991, sales by the Group contributed approximately 32%, 36%, and 36%, respectively, of the sales of the Registrant's businesses. Revenues from foreign operations constituted approximately 40% of the Group's 1993 sales. Major new products introduced by the Group in 1993 included a new undercounter warewasher, a new line of fryers and the Ultima 2000 weighing system in the U. S., as well as a new concept mixer, a new line of warewashers, a new refrigeration line and a new line of combi steam ovens in Europe.\nRaw Materials and Facilities\nThe Group uses stainless and carbon steel, aluminum and plastics in the manufacture of its products. These materials are readily available from several sources, and no difficulties have been experienced with respect to their availability. In addition to manufacturing certain component parts, the Group also purchases many component parts, including electrical and electronic components, castings, hardware, fasteners and bearings, certain manufacturers of which utilize tooling provided by the Group.\nThe Group owns its headquarters building and a major manufacturing complex consisting of four plants in Ohio. In addition, the Group operates 13 manufacturing plants in California, Georgia, Kansas, Maryland, New Jersey, Ohio, and Virginia, and nine manufacturing plants in Canada, France, Italy, the United Kingdom and Germany. Most of these plants are owned.\nCompetition\nThe Group competes in a slowly growing worldwide market which is highly fragmented. No single manufacturer competes with respect to all of the Group's products, and the degree of competition varies among different customer segments and products. The extensiveness of the Group's brand acceptance across a broad range of products is deemed by the Registrant to be a significant competitive advantage. Competition is also based on numerous other factors, including product quality, performance and reliability, labor savings and energy conservation.\nMiscellaneous\nThe Group grants extended payment terms to end-user customers who meet its creditworthiness requirements. Currently, payment periods range from three to 36 months, with installments including finance charges. The Group also grants extended payment terms to dealers who meet specified creditworthiness and facility requirements, which allow its products to be on display at the dealerships or to be available for immediate delivery by the dealer to end-users. Payments to the Group by such dealers are generally without interest and are made at the earlier of the date of final sale or up to six months after delivery to the dealer.\nThe Group had approximately $99 million and $102 million of backlog orders at the end of 1993 and 1992, respectively, after restatement for exchange rate effects. The Group considers such orders to be firm, though changes or cancellations of insignificant amounts may occur, and expects that the 1993 backlog orders will be filled in 1994.\nCONSUMER AND DECORATIVE PRODUCTS\nConsumer and Decorative Products is comprised of the Decorative Products Group and the Consumer Products Group, which contributed 28%, 26% and 26% of the sales of the Registrant's businesses for the fiscal years 1993, 1992 and 1991, respectively. Ralph Wilson Plastics, Florida Tile and Tibbals Flooring make up the Decorative Products Group, while the Consumer Products Group contains West Bend and Precor.\nDECORATIVE PRODUCTS GROUP\nPrincipal Products, Markets and Distribution\nRalph Wilson Plastics manufactures decorative laminates through a production process utilizing heated high pressure presses. These laminates, sold principally under the Wilsonart trademark in more than 550 colors, designs and finishes, are used for numerous interior surfacing applications, including cabinetry, countertops, vanities, store fixtures and furniture. Approximately 50% of the Wilsonart brand decorative laminate sold is used in residential applications, primarily for surfacing kitchen and bathroom countertops and cabinetry. Decorative laminate applications in the commercial market include office furniture, retail store fixtures, restaurant and hotel furniture, and doors. Ralph Wilson Plastics also manufactures specialty- grade laminates, including chemical-resistant, wear-resistant, and fire-retardant types. Among the specialized applications for Wilsonart brand laminates are those in laboratory work surfaces, jetways and naval vessels. In addition to laminate products, Ralph Wilson Plastics manufactures a solid surface product which is marketed under the Gibraltar brand. In 1993, Ralph Wilson Plastics added approximately 17 new designs to its laminate product line and 16 new designs to its line of Gibraltar solid surfacing products.\nThe company also produces and\/or sells contact adhesives under the Lokweld trademark, metallic surfacings, and decorative edge molding for countertops and furniture.\nWilsonart brand decorative products are sold throughout the United States through wholesale building material distributors and directly to original equipment manufacturers. Export sales are now made to Japan, Ireland, Canada, Mexico, Central and South America, the Caribbean, Australia, New Zealand, Hong Kong, Taiwan, Korea and Singapore.\nFlorida Tile manufactures glazed ceramic wall and floor tile products in a wide variety of sizes, shapes, colors and finishes, which are suitable for residential and commercial uses. Tile products are marketed under the Florida Tile trademark through company-owned and independent distributors. Major product groups of Florida Tile are marketed under the trademarks Natura and Artura. Products are exported to Canada, the Caribbean Basin, Iceland, Ireland, the United Kingdom, Mexico, Saudi Arabia and Pacific Rim nations. Florida Tile also imports foreign-produced tile products to meet the growing demand for low to mid-priced products.\nTibbals Flooring manufactures and distributes high-quality, prefinished oak flooring for residential and commercial applications. Its flooring products are pre-cut parquet panels and laminated two and three-ply oak plank lineal flooring products, each of which is sold in a variety of colors and finishes. Tibbals Flooring also manufactures wood moldings, installation adhesives and a full line of proprietary floor care products to complement its line of oak flooring products. These products are marketed under the Hartco trademark to a nationwide network of wholesale floor covering distributors.\nRaw Materials and Facilities\nThe manufacture of decorative laminates requires various raw materials, including kraft and decorative paper, overlays, and melamine and phenolic resins. Each of these items is available from a limited number of manufacturers, but Ralph Wilson Plastics has not experienced difficulties in obtaining sufficient quantities. The principal raw materials used in Florida Tile products are talc, stains, frit (ground glass) and clay, all of which are available to Florida Tile in sufficient quantities. The principal raw materials used in Tibbals Flooring's hardwood flooring products are Appalachian red and white oak, steel wire, and various chemicals. All such raw materials are readily available from many sources in sufficient quantities, but lumber supplies are at a premium price compared to prior years.\nRalph Wilson Plastics owns and operates three manufacturing facilities in Texas and North Carolina, giving it the largest decorative laminate production capacity in North America. Adhesives are produced at two plants located in Louisiana and Texas. Solid surfacing products are manufactured in one facility in Texas. Ralph Wilson Plastics has 14 regional distribution centers which are geographically dispersed throughout the United States. Stock items can be delivered in 24 hours, and non-stock items can be produced and delivered within 10 working days. Florida Tile manufactures products in three owned manufacturing plants located in Florida, Georgia, and Kentucky, and distributes its products through a network of company-owned and independent distribution outlets. Tibbals Flooring manufactures its products in an owned manufacturing facility in Tennessee and a leased facility in Kentucky.\nCompetition\nWilsonart brand products are sold in highly competitive markets in the United States. Ralph Wilson Plastics has approximately 47% of the U.S. market for decorative laminates. Ralph Wilson Plastics successfully competes with other companies by providing fast product delivery, offering a broad choice of colors, designs, and finishes, and emphasizing quality and service. Florida Tile competes with a number of other domestic and foreign tile manufacturers, and the Registrant believes Florida Tile is the third largest U.S. tile manufacturer. Foreign-manufactured products account for approximately 54% of the U.S. tile market. Important competitive factors in the tile market include price, style, quality, and service. Tibbals Flooring competes with a number of other domestic and foreign suppliers of prefinished wood flooring product, and estimates that it has a major share of this market. Important competitive factors include the fit, appearance and durability of the flooring products, the variety of finishes and colors, and the complementary molding, adhesive and floor care products.\nMiscellaneous\nThe Decorative Products Group maintains a continuing program of product development. Its efforts emphasize product design, performance and durability, product enhancement, and new product applications, as well as manufacturing processes. Materials development for laminate products is generally performed by the companies providing those materials.\nCONSUMER PRODUCTS GROUP\nPrincipal Products, Markets and Distribution\nWest Bend manufactures and sells small electric appliances (such as electric skillets, slow cookers, woks, corn poppers, beverage makers and electronic timers) primarily under the West Bend trademark, and high-quality, direct-to-the-home stainless steel cookware. Precor manufactures physical fitness equipment, such as treadmills, stationary bicycles, low-impact climbers and ski machines marketed under the Precor trademark. During 1993, West Bend introduced an automatic breadmaker, a line of hand mixers and a food steamer. In 1993 Precor extended to its treadmill lines its Ergo Logic fitness software, which records and recalls personal exercise information for up to four people, and introduced a line of commercial treadmills featuring a low- impact bed to minimize stress to ankles and knees.\nWest Bend small appliances are sold primarily in the United States and Canada, directly to mass merchandisers, department stores, hardware stores, warehouse stores and catalog showrooms. West Bend's stainless steel cookware is sold to consumers through food preparation dinner parties and by other direct sales methods. Cookware is sold in 19 countries under 14 separate product lines. Precor equipment is sold primarily through specialty fitness equipment retail stores and high-end sporting goods and bicycle stores in the U.S. and Canada. In Asia, Europe, Latin America, and the Middle East, Precor products are sold through select distributors.\nRaw Materials and Facilities\nWest Bend uses aluminum, stainless steel, plastic resins and other materials in the manufacture of its products. Precor uses steel, stainless steel, aluminum and other materials in the manufacture of its products. Generally, neither West Bend nor Precor has experienced any significant difficulties in obtaining any of these raw materials or products. West Bend owns and operates two manufacturing plants in Wisconsin and Mexico. Precor maintains three leased plants in Washington state.\nCompetition\nProducts sold by West Bend and Precor compete with products sold by numerous other companies of varying sizes in highly competitive markets. Important competitive factors include price, development of new products, product performance, warranties, and service.\nMiscellaneous\nWest Bend's sales in the fourth quarter are significantly higher due to the gift-giving season. Precor's business is significantly higher in the first and fourth quarters, when winter weather forces more people to exercise indoors. The West Bend small appliance business is dependent upon two customers for approximately 33% of its revenues.\nOTHER INFORMATION RELATING TO THE BUSINESS\nTrademarks and Patents. The Registrant considers trademarks and patents to be of importance to its businesses. The Registrant's trademarks represent the leading brand names for most of its product lines. Its businesses have followed the practice of applying for patents with respect to most of the significant patentable developments and now own a number of patents relating to their products, including design patents covering Tupperware products. In certain cases the Registrant has elected common law trade secret protection in lieu of obtaining patent protection. In addition, exclusive and nonexclusive licenses under patents owned by others are utilized. No business is, however, dependent to any material extent upon any single patent or trade secret or group of patents or trade secrets.\nResearch and Development. For fiscal years ended 1993, 1992 and 1991, the Registrant spent approximately $41 million, $41 million and $31 million, respectively, on research and development activities.\nEnvironmental Laws. Compliance by the Registrant's businesses with federal, state and local environmental protection laws has not in the past had, and is not expected to have in the future, a material effect upon its capital expenditures, liquidity, earnings or competitive position. The Registrant expects to expend approximately $1.1 million through 1995 on capital expenditures related to environmental facilities. In 1993, the Registrant had approximately $4 million of capital expenditures for environmental facilities, and approximately $3.7 million of remedial expenditures for environmental sites. See Item 3 for a further discussion of environmental matters.\nEmployees. The Registrant and its subsidiaries employ approximately 24,000 people. Approximately 18% of such employees are affiliated with one of the several unions with which the Registrant's subsidiaries have collective bargaining agreements. In recent years there has been no major effort to organize additional persons working for the Registrant's businesses, and there have been no significant work stoppages. The Registrant considers its relations with its employees to be good. The independent consultants, dealers, managers, distributors and franchisees engaged in the direct sale of Tupperware products are not employees of the Registrant.\nProperties. The principal executive offices of the Registrant are located in Illinois and are leased. Most of the principal properties of the Registrant and its subsidiaries are owned, and none of the owned principal properties is subject to any encumbrance material to the consolidated operations of the Registrant. The Registrant considers the condition and extent of utilization of the plants, warehouses and other properties in its respective businesses to be generally good, and the capacity of its plants generally to be adequate for the needs of its businesses.\nMiscellaneous. Except as disclosed above in the narrative descriptions of the Registrant's business segments, none of the Registrant's businesses are seasonal, have working capital practices or backlog conditions which are material to an understanding of their businesses, are dependent on a small number of customers, or are subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Federal Government.\nExecutive Officers of the Registrant. Following is a list of the names and ages of all the Executive Officers of the Registrant, indicating all positions and offices with the Registrant held by each such person, and each such person's principal occupations or employment during the past five years. Each such person has been elected to serve until the next annual election of officers of the Registrant (expected to occur on May 4, 1994).\nName and Age Positions and Offices Held and Principal Occupations or Employment During Past Five Years\nWarren L. Batts (61) Chairman of the Board and Chief Executive Officer.\nJames M. Ringler (48) President and Chief Operating Officer since June 1992, after having served as Executive Vice President, Consumer and Commercial Products since January, 1990, and President, Food Equipment Group since August, 1990. Prior to January, 1990, Mr. Ringler served as President of White Consolidated Industries.\nE. V. Goings (48) Executive Vice President of Premark and President of Tupperware Worldwide since November 1992, after serving as a Senior Vice President of Sara Lee Corporation Prior thereto, Mr. Goings served in various executive positions with Avon Products, Inc.\nJoseph W. Deering(53) Group Vice President of Premark and President of Premark's Food Equipment Group since June 1992, after serving as President of Leucadia National's Manufacturing Group. Prior thereto, Mr. Deering served in various executive positions with Philips Industries, Inc.\nBobby D. Dillon (64) Group Vice President and President of the Decorative Products Group since August 1989, after serving in various executive positions with Ralph Wilson Plastics.\nThomas W. Kieckhafer(55) Corporate Vice President and President of West Bend since December 1989, after serving in various executive positions with West Bend.\nJames C. Coleman(54) Senior Vice President, Human Resources since July 1991. Prior thereto, Mr. Coleman served as Staff Vice President, Personnel Relations for General Dynamics Corporation.\nJohn M. Costigan (51) Senior Vice President, General Counsel, and since December 1990, Secretary.\nLawrence B. Skatoff (54) Senior Vice President and Chief Financial Officer since September\n1991. Mr. Skatoff served as Vice President-Finance of Monsanto Company from October 1987 until joining the Registrant.\nL. John Fletcher(50) Vice President and Assistant General Counsel.\nRobert W. Hoaglund(55) Vice President, Control & Information Systems since December 1990, after serving as Vice President, Control & Administrative Services, Vice President, Internal Audit and Corporate Services, and Vice President, Auditing.\nWendy R. Katz (36) Vice President, Internal Audit since May 1992. Prior thereto, Ms. Katz served in various financial positions at Tupperware.\nThomas P. O'Neill,Jr.(40) Vice President and Treasurer since February 1992, after serving as Vice President, Auditing since April, 1989. Prior thereto, Mr. O'Neill served as Director, External Reporting and Accounting Standards.\nLisa Kearns Richardson (41) Vice President, Planning and Analysis since February 1991. Prior thereto, Ms. Kearns Richardson served as Assistant Controller, a position assumed in October 1986.\nJames E. Rose, Jr. (51) Vice President, Taxes.\nFor information concerning foreign and domestic operations and export sales, see Note 7 (\"Income Taxes\") appearing on pages 33 and 34, and \"Segments of Business by Geographical Areas\" in Note 10 (\"Segments of the Business\") appearing on page 39 of the Annual Report to Shareholders for the year ended December 25, 1993, which are incorporated by reference into this Report by Item 8 hereof.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nFor information concerning material properties of the Registrant and its subsidiaries, see the information under the sub-captions \"Narrative Description of Business\" in Section (c) of Item 1 above and \"Properties\" under the caption \"Other Information Relating To The Business\" in Section (c) of Item 1 above.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Registrant and its subsidiaries are parties against which are pending a number of legal and administrative proceedings. Among such proceedings are those involving the discharge of materials into or otherwise relating to the protection of the environment. Certain of such proceedings involve Federal environmental laws such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as well as state and local laws. The Registrant establishes reserves with respect to certain of such sites. Because of the involvement of other parties and the uncertainty of potential environmental impacts, the eventual outcomes of such actions and the cost and timing of expenditures cannot be estimated with certainty. It is not expected that the outcome of such proceedings, either individually or in the aggregate, will have a materially adverse effect upon the Registrant's consolidated financial position or operations.\nKraft has assumed any liabilities arising out of any legal proceedings in connection with certain divested or discontinued former Dart businesses, including matters alleging product liability, environmental liability and infringement of patents.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe stock price information set forth in Note 12 (\"Quarterly Summary (unaudited)\") appearing on page 40 of the Annual Report to Shareholders for the year ended December 25, 1993 is incorporated by reference into this Report. The information set forth in Note 13 (\"Shareholders' Rights Plan\") on page 40 of the Annual Report to Shareholders for the year ended December 25, 1993 is incorporated by reference into this Report. As of March 8, 1994, the Registrant had 26,442 shareholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth under the caption \"Selected Financial Data\" on pages 24 and 25 of the Annual Report to Shareholders for the year ended December 25, 1993 is incorporated by reference into this Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information entitled \"Financial Review\" set forth on pages 19 through 23 of the Annual Report to Shareholders for the year ended December 25, 1993 constitutes \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and is incorporated by reference into this Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n(a) The following Consolidated Financial Statements of Premark International, Inc. and Report of Independent Accountants set forth on pages 26 through 40, and on page 41, respectively, of the Annual Report to Shareholders for the year ended December 25, 1993 are incorporated by reference into this Report:\nConsolidated Statements of Operations, Cash Flows and Shareholders' Equity--Years ended December 25, 1993, December 26, 1992 and December 28, 1991\nConsolidated Balance Sheet--December 25, 1993 and December 26, 1992\nNotes to the Consolidated Financial Statements\nReport of Independent Accountants dated February 11, 1994\n(b) The supplementary data regarding quarterly results of operations contained in Note 12 (\"Quarterly Summary (unaudited)\") of the Notes to the Consolidated Financial Statements of Premark International, Inc. on page 40 of the Annual Report to Shareholders for the year ended December 25, 1993 is incorporated by reference into this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information as to the Directors of the Registrant set forth under the sub-caption \"Board of Directors\" appearing under the caption \"Election of Directors\" on pages 1 through 3 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 4, 1994 is incorporated by reference into this Report. The information as to the Executive Officers of the Registrant is included in Part I hereof under the caption \"Executive Officers of the Registrant\" in reliance upon General Instruction G to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the caption \"Compensation of Directors\" and beginning on page 14 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 4, 1994, and the information on pages 6 through 8, and beginning on page 10 of such Proxy Statement relating to executive officers' compensation, is incorporated by reference into this Report.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information set forth under the captions \"Security Ownership of Certain Beneficial Owners\" on page 5 and \"Security Ownership of Management\" on page 4 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 4, 1994 is incorporated by reference into this Report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports On Form 8-K\n(a) (1) List of Financial Statements\nThe following Consolidated Financial Statements of Premark International, Inc. and Report of Independent Accountants set forth on pages 26 through 40, and on page 41, respectively, of the Annual Report to Shareholders for the year ended December 25, 1993 are incorporated by reference into this Report by Item 8 hereof:\nConsolidated Statements of Operations, Cash Flows and Shareholders' Equity--Years ended December 25, 1993, December 26, 1992 and December 28, 1991\nConsolidated Balance Sheet--December 25, 1993 and December 26, 1992\nNotes to the Consolidated Financial Statements\nReport of Independent Accountants dated February 11, 1994\n(a) (2) List of Financial Statement Schedules\nThe following consolidated financial statement schedules (numbered in accordance with Regulation S-X) of Premark International, Inc. are included in this Report:\nReport of Independent Accountants on Financial Statement Schedules, page 21 of this Report\nSchedule V--Property, Plant and Equipment for the three years ended December 25, 1993, page 22 of this Report\nSchedule VI--Accumulated Depreciation of Property, Plant and Equipment for the three years ended December 25, 1993, page 24 of this Report\nSchedule VII--Guarantees of Securities of Other Issuers as of December 25, 1993, page 26 of this Report\nSchedule VIII--Valuation and Qualifying Accounts for the three years ended December 25, 1993, page 28 of this Report\nSchedule X--Supplementary Income Statement Information for the three years ended December 25, 1993, page 30 of this Report\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable, or the information called for therein is included elsewhere in the financial statements or related notes thereto contained or incorporated by reference herein.\n(a) (3) List of Exhibits: (numbered in accordance with Item 601 of Regulation S-K)\nExhibit Number Description\n* 3A Restated Certificate of Incorporation (Exhibit 3A to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n* 3B Amended By-Laws (Exhibit 3B to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n* 4A Form of Common Stock Certificate (Exhibit 3 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4B Rights Agreement dated March 7, 1989 (Exhibit 1 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4C Form of Right Certificate of Common Stock Purchase Right (Exhibit 1 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4D Form of Indenture (Revised) in connection with the Registrant's Form S-3 Registration Statement No. 33-35137 (Exhibit (c)(3) to the Registrant's Current Report on Form 8-K dated September 17, 1990)\n*10A Reorganization and Distribution Agreement dated as of September 4, 1986 (Exhibit 2 to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10B Tax Sharing Agreement dated as of September 4, 1986 (Exhibit 10C to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10C Facilities and Guarantee Agreement, as amended, and Termination Agreement dated as of September 4, 1986 (Exhibit 10D to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10D $250,000,000 Credit Agreement dated as of May 12, 1992 (Exhibit (19)(10) to the Registrant's Quarterly Report on Form 10-Q for the 26 weeks ended June 27, 1992)\nCOMPENSATORY PLANS OR ARRANGEMENTS\n*10E Premark International, Inc. Annual Incentive Plan (Exhibit 10H to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n*10F Premark International, Inc. Restricted Stock Plan (Exhibit 10I to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n*10G Premark International, Inc. Performance Unit Plan (Exhibit 10J to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n10H Premark International, Inc. Stock Option Plan, as amended\n*10I Premark International, Inc. Supplemental Benefits Plan (Exhibit 10L to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n*10J Premark International, Inc. Change of Control Policy, as amended 1989 (Exhibit 4 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n*10K Employment Agreement entered into on July 11, 1991 between the Registrant and Lawrence B. Skatoff (Exhibit 10K to the Registrant's Annual Report on Form 10-K for the year ended December 26, 1992)\n*10L Form of Employment Agreement entered into on March 7, 1989 between the Registrant and certain executive officers (Exhibit 5 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n*10M Employment Agreement entered into on June 2, 1992 between the Registrant and Joseph W. Deering (Exhibit 10M to the Registrant's Annual Report on Form 10-K for the year ended December 26, 1992)\n10N Employment Agreement dated November 9, 1992 between the Registrant and E. V. Goings\n10O Premark International, Inc. Director Stock Plan, as amended 1993\n11 A statement of computation of 1993 per share earnings\n13 Pages 19 through 41 of the Annual Report to Shareholders of the Registrant for the year ended December 25, 1993\n22 Subsidiaries of the Registrant as of March 8, 1994\n24 Manually signed Consent of Independent Accountants to the incorporation of their report by reference into the prospectuses contained in specified registration statements on Form S-8 and Form S-3\n25 Powers of Attorney\n*Document has heretofore been filed with the Commission and is incorporated by reference and made a part hereof.\nThe Registrant agrees to furnish, upon request of the Commission, a copy of all constituent instruments defining the rights of holders of long-term debt of the Registrant and its consolidated subsidiaries.\n(b) Reports on Form 8-K\nNo Current Reports on Form 8-K were filed by the Registrant for the quarter ended December 25, 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Premark International, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 11, 1994, appearing on page 41 of the 1993 Annual Report to Shareholders of Premark International, Inc., (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ Price Waterhouse Chicago, Illinois February 11, 1994\nSIGNATURES\nPursuant 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.\nPremark International, Inc. (Registrant)\nBy \/s\/ WARREN L. BATTS Warren L. Batts Chairman of the Board and Chief Executive Officer\nMarch 14, 1994\nPursuant 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 and on the date indicated.\nSignature Title\n\/s\/ Warren L. Batts Chairman of the Board of Directors, Warren L. Batts Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Lawrence B. Skatoff Senior Vice President and Chief Lawrence B. Skatoff Financial Officer (Principal Financial Officer)\n\/s\/ Robert W. Hoaglund Vice President, Control and Robert W. Hoaglund Information Systems (Principal Accounting Officer)\n* Director William O. Bourke\n* Director Dr. Ruth M. Davis\n* Director Lloyd C. Elam, M.D.\n* Director Clifford J. Grum\n* Director Joseph E. Luecke\n* Director Bob Marbut\n* Director John B. McKinnon\n* Director David R. Parker\n* Director Robert M. Price\n\/s\/ James M. Ringler President, Chief Operating Officer and James M. Ringler Director\n* Director Janice D. Stoney\n*By \/s\/ John M. Costigan John M. Costigan Attorney-in-fact\nMarch 14, 1994\nEXHIBIT INDEX\nExhibit No. Description Page\n10H Premark International, Inc. 34-44 Stock Option Plan, as amended\n10N Employment Agreement dated 45-50 November 9, 1992 between Registrant and E. V. Goings\n10O Premark International, Inc. 51-59 Director Stock Plan, as amended 1993\n11 A statement of computation of 60-61 1993 per share earnings\n13 Pages 19 through 41 of the Annual Report to Shareholders of the Registrant for the year ended December 25, 1993 62-96\n22 Subsidiaries of the Registrant as of March 8, 1994 97-99\n24 Manually signed Consent of Independent Accountants to the incorporation of their report by reference into the prospec- tuses contained in specified registration statements on Form S-8 and Form S-3 100\n25 Powers of Attorney 101-102","section_15":""}
{"filename":"69659_1993.txt","cik":"69659","year":"1993","section_1":"Item 1. BUSINESS THE SYSTEM\nSYSTEM ORGANIZATION\nNew England Electric System (NEES) is a voluntary association created under Massachusetts law on January 2, 1926, and is a registered holding company under the Public Utility Holding Company Act of 1935 (the 1935 Act). NEES owns voting stock in the amounts indicated of the following companies, which together constitute the System.\n% Voting Securities State of Type of Owned by Name of Company Organization Business NEES --------------- ------------ --------- ----------\nSubsidiaries:\nGranite State Electric Company N.H. Retail 100 (Granite State) Electric\nMassachusetts Electric Company Mass. Retail 100 (Mass. Electric) Electric\nThe Narragansett Electric Company R.I. Retail 100 (Narragansett) Electric\nNarragansett Energy Resources R.I. Wholesale 100 Company (Resources) Electric Generation\nNew England Electric Resources, Inc. Mass. Consulting 100 (NEERI) Services\nNew England Electric Transmission N.H. Electric 100 Corporation (NEET) Transmission\nNew England Energy Incorporated Mass. Oil and Gas 100 (NEEI) Exploration & Development\nNew England Hydro-Transmission N.H. Electric 53.97(a) Corporation (N.H. Hydro) Transmission\nNew England Hydro-Transmission Mass. Electric 53.97(a) Electric Company, Inc. Transmission (Mass. Hydro)\nNew England Power Company (NEP) Mass. Wholesale 98.80(b) Electric Generation & Transmission\nNew England Power Service Company Mass. Service 100 (Service Company) Company\n(a) The common stock of these subsidiaries is owned by NEES and certain participants (or their parent companies) in Phase II of the Hydro-Quebec project. See Interconnection with Quebec, page 21.\n(b) Holders of common stock and 6% Cumulative Preferred Stock of NEP have general voting rights. The 6% Cumulative Preferred Stock represents 1.20% of the total voting power.\nIn 1993, the System was realigned into two strategic business units, a wholesale business unit and a retail business unit.\nThe facilities of NEES' three retail electric subsidiaries, Mass. Electric, Narragansett, and Granite State (collectively referred to as the Retail Companies), and of its principal wholesale electric subsidiary, NEP, constitute a single integrated electric utility system that is directly interconnected with other utilities in New England and New York State, and indirectly interconnected with utilities in Canada. See ELECTRIC UTILITY OPERATIONS, page 3.\nNEET owns and operates a portion of an international transmission interconnection between the electric systems of Hydro-Quebec and New England. Mass. Hydro and N.H. Hydro own and operate facilities in connection with an expanded second phase of this interconnection. See Interconnection with Quebec, page 21.\nNEEI is engaged in various activities relating to fuel supply for the System. These activities presently include participation (principally through a partnership with a non-affiliated oil company) in domestic oil and gas exploration, development, and production (see OIL AND GAS OPERATIONS, page 43) and the sale to NEP of fuel purchased in the open market.\nResources is a general partner, with a 20% interest, in each of two partnerships formed in connection with the Ocean State Power project. See Ocean State Power, page 21.\nThe Service Company has contracted with NEES and its subsidiaries to provide, at cost, such administrative, engineering, construction, legal, and financial services as the companies request. The Service Company also provides maintenance and construction services under contract to certain non-affiliated utility customers. Profits from these contracts are used to reduce the cost of services to affiliated companies.\nNEERI is a wholly-owned, non-utility subsidiary of NEES which provides consulting services domestically and internationally to non-affiliates.\nEMPLOYEES\nAs of December 31, 1993, NEES subsidiaries had approximately 5,000 employees. As of that date, the total number of employees was approximately 840 at NEP, 1,800 at Mass. Electric, 760 at Narragansett, 80 at Granite State, and 1,500 at the Service Company. Of the 5,000 employees, approximately 3,300 are members of labor organizations. Collective bargaining agreements with the Brotherhood of Utility Workers of New England, Inc., the International Brotherhood of Electrical Workers, and the Utility Workers Union of America, AFL-CIO expire in May 1995.\nFINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS\nThe business of the System is conducted in two primary business segments, electric utility operations and oil and gas operations. The financial information with respect to Electric Utility Operations is as follows:\nYear Ended December 31 (thousands of dollars) 1993 1992 1991 - ---------------------- ---- ---- ----\nOperating revenues $2,187,040 $2,138,302 $2,056,798 Operating income 332,843 341,650 317,487 Total assets 4,460,652 4,177,781 3,964,569 Capital expenditures 304,659 241,872 209,674\nThe financial information with respect to Oil and Gas Operations is as follows:\nYear Ended December 31 (thousands of dollars) 1993 1992 1991 - ---------------------- ---- ---- ----\nOperating revenues $ 46,938 $ 43,374 $ 37,580 Pre-tax loss passed (46,355) (54,607) (39,303) on to customers Total assets 335,226 407,015 485,508 Capital expenditures 18,965 21,262 32,969\nELECTRIC UTILITY OPERATIONS\nGENERAL\nNEP's business is principally generating, purchasing, transmitting, and selling electric energy in wholesale quantities. In 1993, 95% of NEP's revenue from the sale of electricity was derived from sales for resale to affiliated companies and 5% from sales for resale to municipal and other utilities. NEP is the wholesale supplier of the electric energy requirements of the Retail Companies. Narragansett, however, receives credits against its purchases of power from NEP for the cost of generation from its Providence units, which are integrated with NEP's facilities to\nachieve maximum economy and reliability. Discussions of NEP's generating properties, load growth, energy mix, and fuel supplies include the related properties of Narragansett. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 28 of the New England Power Company 1993 Annual Report to Stockholders (the NEP 1993 Annual Report).\nThe combined service area of the Retail Companies constitutes the retail service area of the System and covers more than 4,400 square miles with a population of about 3,000,000 (1990 census). See Map, page 17. The largest cities served are Worcester, Mass. (population 170,000) and Providence, R.I. (population 161,000).\nMass. Electric and Narragansett are engaged principally in the distribution and sale of electricity at retail. Mass. Electric provides approximately 930,000 customers with electric service at retail in a service area comprising approximately 43% of the area of The Commonwealth of Massachusetts. The population of the service area is about 2,160,000 or 36% of the total population of the Commonwealth (1990 Census). Mass. Electric's territory consists of 149 cities and towns including rural, suburban, and urban communities with Worcester, Lawrence, Lowell, and Quincy being the largest cities served. The economy of the area is diversified. Principal industries served by Mass. Electric include electrical and industrial machinery, computer manufacturing and related products, plastic goods, fabricated metals and paper, and chemical products. In addition, a broad range of professional, banking, high-technology, medical, and educational concerns is served. During 1993, 41% of Mass. Electric's revenue from the sale of electricity was derived from residential customers, 36% from commercial customers, 22% from industrial customers, and 1% from others. In 1993, the 20 largest customers of Mass. Electric accounted for less than 8% of its electric revenue. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 26 of Mass. Electric's 1993 Annual Report to Stockholders (the Mass. Electric 1993 Annual Report).\nNarragansett provides approximately 323,000 customers with electric service at retail. Its service territory, which includes urban, suburban, and rural areas, covers about 839 square miles or 80% of the area of Rhode Island, and encompasses 27 cities and towns including the cities of Providence, East Providence, Cranston, and Warwick. The population of the area is about 725,000 (1990 Census) which represents about 72% of the total population of the state. The economy of the territory is diversified. Principal industries served by Narragansett produce fabricated metal products, jewelry, silverware, electrical and industrial machinery, transportation equipment, textiles, and chemical and allied products. In addition, a broad range of professional, banking, medical, and educational institutions is served. During 1993, 42% of Narragansett's revenue from the sale of electricity was derived from residential customers, 40% from commercial customers, 16% from industrial customers, and 2% from others. In 1993, the 20 largest customers of Narragansett accounted for approximately 11% of its electric revenue. For details of sales of energy and operating\nrevenue for the last five years see OPERATING STATISTICS on page 23 of Narragansett's 1993 Annual Report to Stockholders (the Narragansett 1993 Annual Report).\nGranite State provides approximately 35,000 customers with electric service at retail in the State of New Hampshire in an area having a population of about 73,000 (1990 Census), including the city of Lebanon and the towns of Hanover, Pelham, Salem and surrounding communities. During 1993, 48% of Granite State's revenue from the sale of electricity was derived from commercial customers, 39% from residential customers, 12% from industrial customers, and 1% from others. In 1993, the 10 largest customers of Granite State accounted for about 20% of its electric revenue. Granite State is not subject to the reporting requirements of the Securities Exchange Act of 1934, and its financial impact on the System is relatively small. Information on Granite State is provided herein solely for the purpose of furnishing a more complete description of System operations.\nThe electric utility business of NEP and the Retail Companies is not highly seasonal. For NEP and the Retail Companies, industrial customers are broadly distributed among standardized industrial classifications. No single industrial classification exceeds 4% of operating revenue, and no single customer of the System contributes more than 1% of operating revenue.\nKilowatthour (KWH) sales billed to ultimate customers in 1993 increased by 1.4% over 1992. A return to more normal weather conditions in 1993 was largely offset by the fact that 1992 included an extra day for leap year. KWH sales billed to ultimate customers increased 0.4% in 1992.\nCOMPETITIVE CONDITIONS\nThe electric utility business is being subjected to increasing competitive pressures, stemming from a combination of increasing electric rates, improved technologies and new regulations, and legislation intended to foster competition. Recently, this competition has been most prominent in the bulk power market in which non-utility generating sources have noticeably increased their market share. For example, in 1984, less than 1% of NEP's capacity was supplied by non-utility generation sources. By the end of 1993, non-utility power purchases accounted for 380 MW or 7% of NEP's total capacity. In addition to competition from non- utility generators, the presence of excess generating capacity in New England has resulted in the sale of bulk power by utilities at prices less than the total costs of owning and operating such generating capacity.\nElectric utilities are also facing increased competition in the retail market. Currently, retail competition comes from alternative fuel suppliers (principally natural gas companies) for heating and cooling, customer-owned generation to displace purchases from electric utilities, and direct competition among electric utilities to attract major new manufacturing facilities to their service territories. In the future, the potential exists for electric utilities and non-utility generators to sell electricity to retail customers of other electric utilities.\nThe NEES companies are responding to current and anticipated competitive pressures in a variety of ways including cost control and a corporate reorganization into separate retail and wholesale business units. The wholesale business unit is positioning itself for increased competition through such means as terminating certain purchased power contracts, past and future shutdowns of uneconomic generating stations, and rapid amortization of certain plant assets. NEP's rates currently include approximately $100 million per year associated with the recovery of certain Seabrook Nuclear Generating Station Unit 1 (Seabrook 1) costs under a 1988 rate settlement and coal conversion expenditures at NEP's Salem Harbor station. The recovery of these costs will be completed prior to the end of 1995. The retail business unit's response to competition includes the development of value-added services for customers and the offering of economic development rates to encourage businesses to locate in our service territory. In its recent rate settlement, Mass. Electric was able to change the standard terms under which it offers service to commercial and industrial customers to extend the notice period a customer must give from one to two years before purchasing electricity from others or generating any additional electricity for the customer's own use. In addition, Mass. Electric began offering a discount from base rates in return for a contract requiring the customer to provide five years written notice before purchasing electricity from others or generating any additional electricity for the customer's own use. The discount is available to customers with average monthly peak demands over 500 kilowatts.\nElectric utility rates are generally based on a utility's costs. Therefore, electric utilities are subject to certain accounting standards that are not applicable to other business enterprises in general. These accounting rules allow regulated entities, in appropriate circumstances, to establish regulatory assets and to defer the income statement impact of certain costs that are expected to be recovered in future rates. The effects of competition could ultimately cause the operations of the NEES companies, or a portion thereof, to cease meeting the criteria for application of these accounting rules. While the NEES companies do not expect to cease meeting these criteria in the near future, if this were to occur, accounting standards of enterprises in general would apply and immediate recognition of any previously deferred costs would be necessary in the year in which these criteria were no longer applicable.\nRATES\nGeneral\nIn 1993, 74% of the System's electric utility revenues was attributable to NEP, whose rates are subject to regulation by the Federal Energy Regulatory Commission (FERC). The rates of Mass. Electric, Narragansett, and Granite State are subject to the respective jurisdictions of the state regulatory commissions in Massachusetts, Rhode Island, and New Hampshire.\nThe rates of each of the Retail Companies contain a purchased power cost adjustment clause (PPCA). The PPCA is designed to allow the Retail Companies to pass on to their customers increases in purchased power expense resulting from increases allowed by the FERC in NEP's rates. The Retail Companies are also required to reflect rate decreases or refunds. PPCA changes become effective on the dates specified in the filing of the adjustments with the state regulatory commission (not earlier than 30 days after such filing) unless the state regulatory commission orders otherwise. There have been, on occasion, regulatory delays in permitting PPCA increases. Effective March 1, 1993, Narragansett and Granite State received approval for PPCA clauses that fully reconcile on an annual basis purchased power expenses incurred by the companies against purchased power related revenues.\nUnder the doctrine of Narragansett v. Burke, a case decided by the Rhode Island Supreme Court in 1977, NEP's wholesale rates must be accepted as allowable expenses for rate-making purposes by state commissions in retail rate proceedings. In 1986 and 1988 the U.S. Supreme Court reaffirmed this doctrine in two cases that did not involve NEP. However, the Narragansett v. Burke doctrine has been indirectly challenged by a number of state regulatory commissions which have held that federal preemption of the regulation of wholesale electric rates does not preclude the state commission from reviewing the prudence of a utility's decision to purchase power under a FERC-approved rate, and from disallowing costs if it finds that the purchase was an imprudent choice among alternative sources. In a 1985 opinion, the New Hampshire Supreme Court took\nthis position on the issue of state regulation of wholesale power purchases. Also, legislation has been filed from time to time in Congress that would have eroded or repealed the doctrine. If state commissions were to refuse to allow the Retail Companies to include the full cost of power purchased from NEP in their rates, System earnings could be adversely affected.\nThe rates of NEP and the Retail Companies contain fuel adjustment clauses that allow the rates to be adjusted to reflect changes in the cost of fuel. NEP's fuel clause is on a current basis. Mass. Electric has a fuel clause billing procedure that provides for monthly billing of estimated quarterly fuel costs, while Narragansett's and Granite State's fuel costs are estimated on a semi-annual basis. Billings are adjusted in the subsequent period for any excess or deficiency in fuel cost recovery.\nThe FERC rules allow up to 50% of construction work in progress (CWIP) to be included in rate base in addition to CWIP already allowed in rate base for fuel conversion projects or pollution control facilities. This rule allows NEP the option of recovering currently through rates a portion of the costs of financing its construction program, rather than recording allowance for funds used during construction (AFDC) on that portion.\nThe FERC rules with regard to canceled plants provide that utilities may recover in rates only 50% of prudently incurred canceled plant costs. However, the FERC allows utilities to include the recoverable amount in rate base and earn a return on the unamortized balance.\nNEP is recovering the cost of the conversion to coal of three units at Salem Harbor Station by means of an oil conservation adjustment (OCA), a FERC-approved rate. The OCA is designed to amortize the conversion costs by the mid-1990s. Through 1993, NEP has recovered approximately 84% of the conversion costs. The Retail Companies have OCA provisions designed to pass on to their customers amounts billed through NEP's OCA, which totaled $24.6 million for 1993.\nNEP Rates\nNo NEP rate cases were filed with the FERC during 1993.\nSeabrook 1 Nuclear Unit\nNEP owns approximately 10% of Seabrook 1, a 1,150 MW nuclear generating unit, that entered commercial service on June 30, 1990. NEP's rate recovery of its investment in Seabrook 1 was resolved through two separate rate settlement agreements. The pre-1988 portion of NEP's investment is being recovered over a period of seven years and five months ending in July 1995. NEP's investment in Seabrook 1 since January 1, 1988, which amounts to approximately $50 million at December 31, 1993, is being recovered over its useful life.\nW-92 Rate Case\nIn May 1992, the FERC approved a settlement of NEP's W-92 rate case under which base rates were increased by $39.7 million, effective March 1992. The entire increase was attributable to costs associated with the commercial operation of Unit 2 of the Ocean State Power (OSP) generating facility. These costs had been collected through NEP's fuel clause since the unit entered service in late 1991. The settlement also incorporated new depreciation rates proposed in NEP's filing, which reduced NEP's overall revenue requirement by $18 million.\nMass. Electric Rates\nRate schedules applicable to electric services rendered by Mass. Electric are on file with the Massachusetts Department of Public Utilities (MDPU).\nIn November 1993, the MDPU approved a rate agreement filed by Mass. Electric, the Massachusetts Attorney General, and two groups of large commercial and industrial customers.\nUnder the agreement, Mass. Electric began implementing an 11- month general rate decrease effective December 1, 1993 of $26 million (on an annual basis) from the level of rates then in effect. This rate reduction will continue in effect until October 31, 1994, after which rates will increase to the previously approved levels. The agreement also provided for rate discounts of up to $4 million available for the period ending October 31, 1994 for large commercial and industrial customers who agree to give a five-year notice to Mass. Electric before they purchase power from another supplier or generate any additional power themselves. These discounts will increase after October 31, 1994 to a level of $11 million per year if all eligible customers participate. Mass. Electric also agreed not to increase its base rates above currently approved levels before October 1, 1995. The decrease in revenues will be offset by the recognition for accounting purposes of revenues for electricity delivered but not yet billed.\nThe agreement also resolved all issues associated with providing funds and securing rate recovery for environmental cleanup costs of Massachusetts manufactured gas waste sites formerly owned by Mass. Electric and its affiliates, as well as certain other Mass. Electric environmental cleanup costs (see Hazardous Substances, page 30). The rate agreement allows for these costs to be met by establishing a special interest bearing fund on Mass. Electric's books. On a consolidated basis, the fund's initial balance of $30 million comes from previously recorded environmental reserves and is not recoverable from customers. The establishment of the fund's initial balance at Mass. Electric resulted in a one-time charge to fourth quarter earnings of $9 million, before tax. Annual contributions of $3 million, adjusted for inflation, will be added to the fund by Mass. Electric and will be recoverable in rates. In addition, any shortfalls in the fund will be paid by Mass. Electric and be\nrecovered through rates over seven years, without interest. Lastly, the agreement provided for the rate recovery of $8 million of certain storm restoration and other costs previously charged to expense.\nEffective October 1992, the MDPU authorized a $45.6 million annual increase in rates for Mass. Electric. This general rate increase included $2.5 million representing the first step of a four-year phase-in of Mass. Electric's tax deductible costs associated with post-retirement benefits other than pensions (PBOPs). A second $2.5 million increase took effect October 1, 1993.\nNarragansett Rates\nRate schedules applicable to electric services rendered by Narragansett are on file with the Rhode Island Public Utilities Commission (RIPUC) and the Rhode Island Division of Public Utilities and Carriers.\nEffective March 1993, Narragansett implemented a new rate design which reallocated costs among its various rate classes, but which are not expected to affect total revenues over a twelve month period. Among other things, the new rates reduced the seasonality of the rates applicable to Narragansett's larger commercial and industrial customers. This change will result in lower revenues in summer months and higher revenues in other months when compared to Narragansett's prior rate design.\nEffective May 1992, the RIPUC authorized a $3.5 million annual increase in rates for Narragansett. In addition, effective January 1993, the RIPUC approved a $1.5 million increase in rates for Narragansett representing the first step of a three-year phase-in of Narragansett's recovery of costs associated with PBOPs. A second $1.5 million increase took effect in January 1994.\nEffective April 1991, the RIPUC approved Narragansett's settlement of a $13 million rate increase.\nGranite State Rates\nEffective March 1993, the New Hampshire Public Utilities Commission (NHPUC) authorized a $2.0 million rate increase for Granite State, with a retroactive adjustment to September 15, 1992 to reflect the difference between the authorized amount and the $1.4 million Granite State had been collecting on an interim basis since September 15, 1992.\nEffective July 1, 1993, the NHPUC approved a $0.7 million increase in rates for Granite State to recover costs associated with PBOPs.\nRecovery of Demand-Side Management Expenditures\nThe three Retail Companies offer conservation and load management programs, usually referred to in the industry as Demand- Side Management (DSM) programs, which are designed to help customers use electricity efficiently, as a part of meeting the System's future resource needs and customers' needs for energy services. See RESOURCE PLANNING, page 36.\nThe Retail Companies file their DSM programs regularly with their respective regulatory agencies and have received approval to recover in rates estimated DSM expenditures on a current basis. The rates provide for reconciling estimated expenditures to actual DSM expenditures, with interest. Mass. Electric's expenditures subject to the reconciliation mechanism were $47 million, $44 million, and $55 million in 1993, 1992, and 1991, respectively. Narragansett's expenditures subject to the reconciliation mechanism were $12 million, $12 million, and $19 million in 1993, 1992, and 1991, respectively.\nSince 1990, the Retail Companies have been allowed to earn incentives based on the results of their DSM programs. The Retail Companies must be able to demonstrate the electricity savings produced by their DSM programs to their respective state regulatory agencies before incentives are recorded. Mass. Electric recorded $6.7 million, $8.6 million, and $6.0 million of before-tax incentives in 1993, 1992, and 1991, respectively. Narragansett recorded $0.5 million, $1.3 million, and $1.6 million of before-tax incentives in 1993, 1992, and 1991, respectively. The Retail Companies have received regulatory approvals that will give them the opportunity to continue to earn incentives based on 1994 DSM program results.\nGENERATION\nEnergy Mix\nThe following table displays the contributions of various fuel sources and other generation to total net generation of electricity by NEP during the past three years, as well as an estimate for 1994:\n% of Net Generation -------------------------- Estimated Actual --------- ---------------- 1994 1993 1992 1991 ---- ---- ---- ----\nCoal 37 38 41 44 Nuclear 18 18 18 18 Gas (1) 16 16 15 11 Oil 11 11 10 11 Hydroelectric 6 6 6 7 Hydro-Quebec 6 5 4 3 Renewable Non-Utility Generation (2) 6 6 6 6 --- --- --- --- 100 100 100 100\n(1) Gas includes both utility and non-utility generation. (2) Waste to energy and hydro.\nElectric Utility Properties\nThe electric utility properties of the System companies consist of NEP's and Narragansett's fossil-fuel base load and intermediate load steam generating units, conventional and pumped storage hydroelectric stations, internal combustion peaking units, portions of fossil fuel and nuclear generating units, the ownership interests of NEET, Mass. Hydro, and N.H. Hydro in the Hydro-Quebec Interconnection, and an integrated system of transmission lines, substations, and distribution facilities. See MAP - ELECTRIC UTILITY PROPERTIES, page 17.\nNEP's integrated system consists of 2,290 circuit miles of transmission lines, 116 substations with an aggregate capacity of 13,265,588 kVA, and 7 pole or conduit miles of distribution lines. The properties of Mass. Electric and Narragansett include substations and distribution and transmission lines, which are interconnected with transmission and other facilities of NEP. At December 31, 1993, Mass. Electric owned 282 substations, which had an aggregate capacity of 2,859,309 kVA, 147,090 line transformers with the capacity of 7,489,447 kVA, and 15,948 pole or conduit miles of distribution lines. Mass. Electric also owns 81 circuit miles of transmission lines. At December 31, 1993, Narragansett\nowned 248 substations, which had an aggregate capacity of 2,838,927 kVA, 53,100 line transformers with the capacity of 2,239,554 kVA, and 4,492 pole or conduit miles of distribution lines. Narragansett, in addition, owns 325 circuit miles of transmission lines.\nSubstantially all of the properties and franchises of Mass. Electric, Narragansett, and NEP are subject to the liens of indentures under which mortgage bonds have been issued. For details of the mortgage liens on these properties see the long-term debt note in Notes to Financial Statements in each of these companies' respective 1993 Annual Report. The properties of NEET are subject to a mortgage under its financing arrangements.\n(a) These units currently burn coal, but are also capable of burning oil.\n(b) For a discussion of the Manchester Street Station repowering project, see Manchester Street Station Repowering on page 37.\n(c) Includes (i) an interest in a jointly owned oil-fired unit in Yarmouth, Maine, and (ii) diesel units at various locations.\n(d) See Hydroelectric Project Licensing, page 28.\n(e) See Nuclear Units, page 21.\n(f) Capability includes contracted purchases (1,312 MW) less contract sales (164 MW). Net generation includes the effects of the above contracted purchases and economy interchanges through the New England Power Exchange (including Hydro-Quebec purchases and purchases from non-utility generation). For further information see Non-Utility Generation Sources, page 20.\nNEP and Narragansett are members of the New England Power Pool (NEPOOL), a group of over 90 New England utilities that comprises virtually all of New England's electric generation. Mass. Electric and Granite State participate in NEPOOL through NEP. The NEPOOL Agreement provides for coordination of the planning and operation of the generation and transmission facilities of its members. The NEPOOL Agreement incorporates generating capacity reserve obligations, provisions regarding the use of major transmission lines, and provisions for payment for facilities usage. The NEPOOL Agreement further provides for New England-wide central dispatch of generation through the New England Power Exchange. Through NEPOOL, operating and capital economies are achieved and reserves are established on a region-wide rather than an individual company basis. The electric energy available to NEES subsidiaries and other members is determined by the aggregate available to NEPOOL.\nThe 1993 NEPOOL peak demand of 19,570 MW occurred on July 8, 1993. The maximum demand to date of 19,742 MW occurred on July 19, 1991.\nThe 1993 summer peak for the System of 4,081 MW occurred on July 8, 1993. This was below the previous all time peak load of 4,250 MW which occurred on July 19, 1991. The 1993-1994 winter peak of 4,121 MW occurred on January 19, 1994. For a discussion of resource planning, see RESOURCE PLANNING, page 36.\nMAP\n(Displays electric utility properties of NEES subsidiaries)\nFuel for Generation\nNEP burned the following amounts of coal, residual oil, and gas during the past three years:\n1993 1992 1991 ---- ---- ---- Coal (in millions of tons) 3.2 3.3 3.6\nOil (in millions of barrels) 5.0 4.9 6.4\nNatural Gas (in billions of cubic feet) 0.7 3.2 1.7\nCoal Procurement Program\nDepending on coal-fired generating unit availability and the degree to which the units are dispatched, NEP's 1994 coal requirements should range between 3.0 and 3.2 million tons. NEP obtains its domestic coal under contracts of varying lengths and on a spot basis from domestic coal producers in Kentucky, West Virginia, and Pennsylvania, and from mines in Colombia and Venezuela. Three different rail systems (CSX, Norfolk Southern, and Conrail) transport coal from domestic sources to loading ports on the east coast. NEP's coal is transported from east coast ports by ocean-going collier to Brayton Point and Salem Harbor. NEP has a term charter with the Energy Independence, a self-unloading collier, which carries all of NEP's U.S. coal and a portion of foreign coal. NEP also charters other coal-carrying vessels for the balance of foreign coal. As protection against interruptions in coal deliveries, NEP maintained coal inventories at its generating stations during 1993 in the range of 40 to 60 days. A United Mine Workers strike lasting the second half of 1993 interrupted one long-term contract which was replaced prior to its 1994 expiration.\nTo meet environmental requirements, NEP uses coal with a relatively low sulphur and ash content. NEP's average price for coal burned, including transportation costs, calculated on a 26 million Btu per ton basis, was $44.72 per ton in 1991, $44.15 in 1992, and $43.53 per ton in 1993. Based on a 42 gallon barrel of oil producing 6.3 million Btu's, these coal prices were equivalent to approximately $10.83 per barrel of oil in 1991, $10.70 in 1992 and $10.57 per barrel of oil in 1993.\nOil Procurement Program\nThe System's 1994 oil requirements are expected to be approximately 5.0 million barrels. The System obtains its oil requirements through contracts with oil suppliers and purchases on the spot market. Current contracts provide for minimum annual purchases of 2.6 million barrels at market related prices. The System currently has a total storage capacity for approximately 2.3 million barrels of residual and diesel fuel oil. The System's\naverage cost of oil burned, calculated on a 6.3 million Btu per barrel basis, was $11.82 in 1991, $12.68 in 1992, and $13.30 in 1993.\nNatural Gas\nNEP uses natural gas at both Brayton 4 and Manchester Street Stations when gas is priced less than residual fuel oil. At Brayton 4, natural gas currently displaces 2.2% sulphur residual fuel oil. At Manchester Street Station, gas currently displaces 1.0% sulphur residual fuel oil. In 1993, approximately 0.7 billion cubic feet of gas were consumed at an average cost of $2.58 per thousand cubic feet excluding pipeline demand charges. This gas price was equivalent to approximately $16.25 per barrel of oil.\nFirm year-round gas deliveries to Manchester Street Station are planned as part of its repowering project. The repowered facility would use up to 95 million cubic feet of natural gas per day. See Manchester Street Station Repowering, page 37.\nNEP has contracted with six pipeline companies for transportation of natural gas from supply regions to these two generating stations: (1) 60 million cubic feet per day from Western Canada via TransCanada PipeLines, Ltd. (TransCanada), Iroquois Gas Transmission System, Tennessee Gas Pipeline Company and Algonquin Gas Transmission Company, and (2) 60 million cubic feet per day from the U.S. Mid-Continent region via ANR Pipeline Company, Columbia Gas Transmission Company and Algonquin.\n(a) NEP has entered into a firm service agreement with TransCanada. Service commenced on November 1, 1992.\n(b) NEP has entered into a firm service agreement with Iroquois. Service commenced on November 1, 1993.\n(c) NEP has entered into a firm service agreement with Tennessee. Service commenced on November 1, 1993.\n(d) NEP has entered into a firm service agreement with Algonquin for delivery of Canadian gas. Service commenced on November 1, 1993. Additional service for a portion of the domestic gas is expected to commence in December 1994. NEP has also entered into a firm service agreement for deliveries of gas to its Brayton Point Station. All facilities for this service have been constructed and in service since December of 1991.\n(e) ANR has constructed substantially all facilities necessary to serve NEP. NEP has entered into a firm service agreement with ANR. Service is expected to commence in December 1994.\n(f) Columbia has received and accepted a FERC certificate to construct facilities for service to NEP. NEP has entered into a firm service agreement with Columbia. Service is expected to commence in December 1994.\nNEP has also signed contracts with four Canadian gas suppliers for a total of 60 million cubic feet per day. NEP has not yet signed supply arrangements with Mid-Continent producers.\nThe pipeline agreements require minimum fixed payments. NEP's minimum net payments are currently estimated to be approximately $45 million in 1994, $65 million in 1995, and $70 million each in 1996, 1997, and 1998. The amount of the fixed payments are subject to FERC regulation and will depend on FERC actions affecting the rates on each of the pipelines.\nAs part of its W-12 rate settlement, NEP is recovering 50% of the fixed pipeline capacity payments through its current fuel clause and deferring the recovery of the remaining 50% until the Manchester Street repowering project is completed. NEP has deferred payments of approximately $13 million as of December 31, 1993.\nNuclear Fuel Supply\nAs noted above, NEP participates with other New England utilities in the ownership of several nuclear units. See Nuclear Units, page 21. The utilities responsible for supply for these units are not experiencing any difficulty in obtaining commitments for the supply of each element of the nuclear fuel cycle.\nNon-Utility Generation Sources\nThe System companies purchase a portion of the electricity generated by, or provide back-up or standard service to, 139 small power producers or cogenerators (a total of 3,185,101 MWh of purchases in 1993). As of December 31, 1993, these non-utility generation sources include 32 low-head hydroelectric plants, 51 wind or solar generators, seven waste to energy facilities, and 49 cogenerators. The total capacity of these sources is as follows:\nIn Service Future Projects (12\/31\/93) Under Contract Source (MW) (MW) ------ ---------- --------------- Hydro 43 - Wind - 20 Waste to Energy 169 33 Cogeneration 303 40 Independent Power Producers - 83* ---- --- Total 515 176\n* Milford Power was accepted for dispatch by NEPOOL on January 20, 1994.\nThe in-service amount includes 377 MW of capacity and 138 MW treated as load reductions and excludes the Ocean State Power contracts discussed below.\nOcean State Power\nOcean State Power (OSP) and Ocean State Power II (OSP II) are general partnerships that own and operate a two unit gas-fired combined cycle electric power plant in Burrillville, R.I. Resources is a general partner with a 20% interest in both OSP and OSP II and had an equity investment of approximately $40 million at December 31, 1993. The first unit began commercial operation on December 31, 1990 and the second unit went into service on October 1, 1991. The two units have a combined winter net electrical capability of approximately 562 MW. Each unit's capacity and energy output is sold under 20-year unit power agreements to a group of New England utilities, including NEP, which has contracts for 48.5% of the output of each unit. NEP is required to make certain minimum fixed payments to cover capital and fixed operating costs of these units in amounts estimated to be $70 million per year.\nInterconnection with Quebec\nNEET, Mass. Hydro, and New Hampshire Hydro own and operate, on behalf of NEPOOL participants in the project, a 450 kV direct current (DC) transmission line and related terminals to interconnect the New England and Quebec transmission systems (the Interconnection). The transfer capability of the Interconnection is 2,000 MW. NEPOOL members purchase from and sell energy to Hydro-Quebec pursuant to several agreements. The principal agreement calls for NEPOOL members to purchase 7 billion KWH of energy each year for ten years (the Firm Energy Contract). Purchases under the Firm Energy Contract totaled over 6.4 billion KWH in 1993.\nNEP is a participant in both the Phase I and Phase II projects of the Interconnection. NEP's participation percentage in both projects is approximately 18%. NEP and the other participants have entered into support agreements that end in 2020, to pay monthly their proportionate share of the total cost of constructing, owning, and operating the transmission facilities. NEP accounts for these support agreements as capital leases and accordingly recorded approximately $78 million in utility plant at December 31, 1993. Under the support agreements, NEP has agreed, in conjunction with any Phase II project debt financing, to guarantee its share of project debt. At December 31, 1993, NEP had guaranteed approximately $34 million. In the event any Interconnection facilities are abandoned for any reason, each participant is contractually committed to pay its pro-rata share of the net investment in the abandoned facilities.\nNuclear Units\nGeneral\nNEP is a stockholder of Yankee Atomic Electric Company (Yankee Atomic), Vermont Yankee Nuclear Power Corporation (Vermont Yankee), Maine Yankee Atomic Power Company (Maine Yankee), and Connecticut\nYankee Atomic Power Company (Connecticut Yankee). Each of these companies (collectively referred to as the Yankee Companies) owns a single nuclear generating unit. In addition, NEP is a joint owner of the Millstone 3 nuclear generating unit in Connecticut and the Seabrook 1 nuclear generating unit in New Hampshire. Millstone 3 and Seabrook 1 are operated by subsidiaries of Northeast Utilities (NU). NEP pays its proportionate share of costs and receives its proportionate share of each unit's output. NEP's interest and investment in each of the Yankee Companies, Millstone 3, and Seabrook 1 and the net capability of each plant are as follows:\nEquity Net Investment Capability (12\/31\/93) Interest (MW) (in millions) -------- ---------- -------------\nYankee Atomic 30.0% * $ 7 Vermont Yankee 20.0% 93 10 Maine Yankee 20.0% 158 14 Connecticut Yankee 15.0% 87 15 ---- ---- Subtotal 338 $ 46\nNet Investment in Plant** (12\/31\/93) (in millions) -------------\nMillstone 3 12.2% 140 $405 Seabrook 1 9.9% 115 149 ---- Subtotal 255 ---- Total 593 ====\n*Operations ceased **Excludes nuclear fuel\nNEP has a 30% ownership interest in Yankee Atomic which owns a 185 megawatt nuclear generating station in Rowe, Massachusetts. The station began commercial service in 1960. In February 1992, the Yankee Atomic board of directors decided to permanently cease power operation of, and in time, decommission the facility.\nIn March 1993, the FERC approved a settlement agreement that allows Yankee Atomic to recover all but $3 million of its approximately $50 million remaining investment in the plant over the period extending to July 2000, when the plant's Nuclear Regulatory Commission (NRC) operating license would have expired. Yankee Atomic recorded the $3 million before-tax write-down in 1992. The settlement agreement also allows Yankee Atomic to earn\na return on the unrecovered balance during the recovery period and to recover other costs, including an increased level of decommissioning costs, over this same period. Decommissioning cost recovery increased from $6 million per year to $27 million per year for the period 1993 to 1995. This level of recovery is subject to review in 1996.\nNEP has recorded an estimate of its entire future payment obligations to Yankee Atomic as a liability on its balance sheet and an offsetting regulatory asset reflecting its expected future rate recovery of such costs. This liability and related regulatory asset amounted to approximately $104 million each at December 31, 1993.\nNEP purchases the output of the other Yankee nuclear electric generating plants in the same percentages as its stock ownership of the Yankee Companies, less small entitlements taken by municipal utilities for Maine Yankee and Vermont Yankee. NEP has power contracts with each Yankee Company that require NEP to pay an amount equal to its share of total fixed and operating costs (including decommissioning costs) of the plant plus a return on equity.\nThe stockholders of three Yankee Companies (Vermont Yankee, Maine Yankee and Connecticut Yankee) have agreed, subject to regulatory approval, to provide capital requirements in the same proportion as their ownership percentages of the particular Yankee Company. Pursuant to the terms of a lending agreement, Yankee Atomic will not pay dividends to its shareholders, including NEP, until such lender is paid in full.\nThere is widespread concern about the safety of nuclear generating plants. The NRC regularly reviews the adequacy of its comprehensive requirements for nuclear plants. Many local, state, and national public officials have expressed their opposition to nuclear power in general and to the continued operation of nuclear power plants. It is possible that this controversy will result in cost increases and modifications to, or premature shutdown of, the operating nuclear units in which NEP has an interest.\nOn three occasions (most recently in 1987), referenda appeared on the ballot in Maine that, if passed, would have required the prompt shutdown of Maine Yankee. All the referenda were defeated. There is no assurance that similar measures will not appear on future ballots.\nPending before FERC is an initial decision of an administrative law judge disallowing full rate recovery for the unamortized portion of a nuclear plant to be retired before the end of its operating license. The decision, if affirmed, would result in rate recovery of less than the full investment in a nuclear plant retired from service prior to the end of its operating license. The amount of the disallowance would depend upon the plant's historic capacity factor and the number of years remaining on its operating license.\nDecommissioning\nEach of the Yankee Companies includes charges for all or a portion of decommissioning costs in its cost of energy. These charges vary depending upon rate treatment, the method of decommissioning assumed, economic assumptions, site and unit specific variables, and other factors. Any increase in these charges is subject to FERC approval.\nEach of the operating nuclear units has established decommissioning trust funds or escrow funds into which payments are being made to meet the projected cost of decommissioning its plant. If any of the units were shut down prior to the end of its operating license, the funds collected for decommissioning to that point would be insufficient. Estimates of NEP's pro-rata share (based on ownership) of decommissioning costs, NEP's share of the actual book values of decommissioning fund balances set aside for each unit at December 31, 1993 (in millions of dollars), and the expiration date of the operating license of each plant are as follows:\nNEP's share of ----------------------------- Estimated Decommissioning Fund License Costs Balances (1) Expiration Unit (in 1993 $) (12\/31\/93) Date ---- --------------- ------------ ----------\nYankee Atomic (2) $78 $26 -- Connecticut Yankee $49 $18 2007 Maine Yankee $63 $19 2008 Vermont Yankee $57 $20 2012 Millstone 3 $50 $10 2025 Seabrook 1 $36 $ 3 2026\n(1) Certain additional amounts are anticipated to be available through tax deductions.\n(2) The estimated cost of decommissioning for Yankee Atomic does not reflect the benefit of the component removal project (CRP) for which decommissioning funds were spent in 1993. Additional expenditures for CRP will be made in 1994.\nNEP is currently collecting through rates amounts for decommissioning based upon cost estimates and funding methodologies authorized by FERC. Such estimates are determined periodically for each plant and may not reflect the current projected cost of decommissioning.\nThere is no assurance that decommissioning costs actually incurred by the Yankee Companies, Millstone 3 or Seabrook 1 will not substantially exceed these amounts. For example, current\ndecommissioning cost estimates assume the availability of permanent repositories for both low-level and high-level nuclear waste which do not currently exist. NRC rules require that reasonable assurance be provided that adequate funds will be available for the decommissioning of commercial nuclear power plants. The rule establishes minimum funding levels that licensees must satisfy. Each of the units in which NEP has an interest has filed a report with the NRC providing assurance that funds will be available to decommission the facility.\nA Maine statute provides that if both Maine Yankee and its decommissioning trust fund have insufficient assets to pay for the plant decommissioning, the owners of Maine Yankee are jointly and severally liable for the shortfall. The definition of owner under the statute covers NEP and may cover companies affiliated with it. NEP and the Retail Companies cannot determine, at this time, the constitutionality, applicability, or effect of this statute. If NEP or the Retail Companies were required to make payments under this statute, they would assess their legal remedies at that time. In any event, NEP and the Retail Companies would attempt to recover through rates any payments required. If any claim in excess of NEP's ownership share were enforced against a NEES company, that company would seek reimbursement from any other Maine Yankee stockholder which failed to pay its share of such costs.\nThe Energy Policy Act of 1992 assesses the domestic nuclear power industry for a portion of costs associated with the decontamination and decommissioning of the Department of Energy's (DOE) uranium enrichment facilities. An annual assessment of $150 million (escalated for inflation) on the domestic nuclear power industry will be allocated to each plant based upon the amount of DOE uranium enrichment services utilized in the past. The total DOE assessment, which began in October 1992, will remain in place for up to 15 years and will amount to $2.25 billion (escalated). The Yankees, Millstone 3 and Seabrook have been assessed and initial billings indicate NEP's obligation for such costs over the next 14 years will be approximately $29 million. In accordance with the provisions of the Energy Policy Act, these costs are being recovered through NEP's fuel clause.\nHigh-Level Waste Disposal\nThe Nuclear Waste Policy Act of 1982 provides a framework and timetable for selection of sites for repositories of high-level radioactive waste (spent nuclear fuel) from United States nuclear plants. The DOE has entered into contracts with the Yankee Companies, the Millstone 3 joint owners, and the Seabrook 1 joint owners for acceptance of title to, and transportation and storage of, this waste. Under these contracts, each operating unit will pay fees to the DOE to cover the development and creation of waste repositories. Fees for fuel burned since April 1983 have been collected by the DOE on an ongoing basis at the rate of one tenth of a cent per KWH of net generation. Fees for generation up through April 1983 were determined by the DOE as follows: $13.2 million for Yankee Atomic, $48.7 million for Connecticut\nYankee, $50.4 million for Maine Yankee, and $39.3 million for Vermont Yankee. Neither Millstone 3 nor Seabrook 1 has been assessed any fees for fuel burned through April 1983, because they did not enter commercial operation until 1986 and 1990, respectively.\nThe Yankee Companies had several options to pay these fees. Yankee Atomic paid its fee to the DOE for the period through April 1983. The other three Yankee Companies elected to defer payment until a future date, thereby incurring interest expense. However, payment to the DOE must occur prior to the first delivery of spent fuel. Connecticut, Maine, and Vermont Yankee have segregated a portion of their respective DOE obligations in external accounts. The remainder of the funds have been used to support general capital requirements. All expect to separately fund in full in external accounts their DOE obligation (including accrued interest) prior to payment to the DOE. To the extent that any of the three Yankee Companies is unable to fully meet its DOE obligation at the prescribed time, NEP might be required to provide additional funds.\nPrior to such time that the DOE takes delivery of a plant's spent nuclear fuel, it is stored on site in spent fuel pools. Connecticut Yankee and Maine Yankee have adequate existing storage through the late 1990's. Millstone 3 will be able to maintain a full core discharge capability through the end of its current license. Seabrook 1's current licensed storage capacity is adequate until at least 2010. Vermont Yankee is able to maintain a full core discharge capability until 2001. Yankee Atomic has adequate on-site storage capacity for all its spent fuel.\nFederal legislation enacted in December 1987 directed the DOE to proceed with the studies necessary to develop and operate a permanent high-level waste disposal site at Yucca Mountain, Nevada. There is local opposition to development of this site. Although originally scheduled to open in 1998, the DOE announced in November 1989 that the permanent disposal site is not expected to open before 2010, a date the DOE has defined as optimistic. The legislation also provides for the development of a Monitored Retrievable Storage (MRS) facility and abandons plans to identify and select a second, permanent disposal site. An MRS facility would provide temporary storage for high-level waste prior to eventual permanent disposal. It is not known when an MRS facility would begin accepting deliveries. Additional delays due to political and technical problems are likely. It is extremely unlikely deliveries would be accepted prior to 1999.\nFederal authorities have deferred indefinitely the commercial reprocessing of spent nuclear fuel.\nLow-Level Waste Disposal\nIn 1986, the Low-Level Radioactive Waste Policy Amendments Act was enacted by Congress. This statute sets a time limit of December 31, 1992, beyond which disposal of low-level waste at any of the three existing sites is impermissible. Under the statute,\nindividual states are responsible for finding local sites for disposal or forming regional disposal compacts by defined milestone dates.\nAs of December 1991, all of the states in which NEP holds an interest in a nuclear facility had met the 1990 milestone which required the filing of a facility operating license application or Governor's certification that the state will provide for storage, disposal, and management of waste generated after 1992. Although New Hampshire met the 1990 milestone, the arrangements made by the state did not encompass low-level waste generated by Seabrook 1 and it is currently prohibited from shipping its low-level waste out of the state. Connecticut Yankee, Millstone 3, Vermont Yankee, Maine Yankee and Yankee Atomic are currently allowed to ship low-level radioactive waste to the existing disposal site in South Carolina.\nThe 1992 milestone required each state to file a facility operating license application. None of the states in which NEP holds an interest in a nuclear facility has met this milestone. Failure to meet this milestone means that those states may be subject to surcharges on waste shipped out of state. Disposal costs could increase significantly. Since January 1, 1993, the South Carolina low-level waste disposal site has been the only site open to accept low-level waste from NEP's units. The South Carolina site will remain open until June 30, 1994 to generators whose states are making progress toward developing their own disposal facilities. Effective June 30, 1994, the South Carolina low-level waste disposal site will be closed permanently to non- regional wastes. However, all of the nuclear facilities in which NEP has an interest have temporary storage facilities on site to meet short-term low-level radioactive waste storage requirements.\nPrice-Anderson Act\nThe Price-Anderson Act limits the amount of liability claims that would have to be paid in the event of a single incident at a nuclear plant to $9.2 billion (based upon 114 licensed reactors). The maximum amount of commercially available insurance coverage to pay such claims is only $200 million. The remaining $9.0 billion would be provided by an assessment of up to $79.3 million per incident levied on each of the nuclear units in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. The maximum assessment, which was most recently calculated in 1993, is to be adjusted at least every five years to reflect inflationary changes. NEP's current interest in the Yankees, Millstone 3, and Seabrook 1 would subject NEP to an $81.8 million maximum assessment per incident. NEP's payment of any such assessment would be limited to a maximum of $10.3 million per incident per year. As a result of the permanent cessation of power operation of the Yankee Atomic plant, Yankee Atomic has petitioned the NRC for an exemption from obligations under the Price-Anderson Act.\nOther Items\nFederal legislation requires emergency response plans, approved by federal authorities, for nuclear generating units. The Yankee Companies, Seabrook 1, and Millstone 3 are not currently experiencing difficulty in maintaining approval of their emergency response plans.\nREGULATORY AND ENVIRONMENTAL MATTERS\nRegulation\nNumerous activities of NEES and its subsidiaries are subject to regulation by various federal agencies. Under the 1935 Act, many transactions of NEES and its subsidiaries are subject to the jurisdiction of the Securities and Exchange Commission (SEC). Under the Federal Power Act, certain electric subsidiaries of NEES are subject to the jurisdiction of the FERC with respect to rates, accounting, and hydroelectric facilities. In addition, the NRC has broad jurisdiction over nuclear units and federal environmental agencies have broad jurisdiction over environmental matters. The electric utility subsidiaries of NEES are also subject to the jurisdiction of regulatory bodies of the states and municipalities in which they operate.\nFor more information, see: RATES, page 8, Nuclear Units, page 21, RESOURCE PLANNING, page 36, Fuel for Generation, page 18, Environmental Requirements, page 29, and OIL AND GAS OPERATIONS, page 43.\nHydroelectric Project Licensing\nNEP is the largest operator of conventional hydroelectric facilities in New England. NEP's hydroelectric projects are licensed by the FERC. These licenses expire periodically and the projects must be relicensed at that time. NEP's present licenses expire over a period from 2001 to 2020 excluding the Deerfield River Project discussed below. Upon expiration of a FERC license for a hydro project, the project may be taken over by the United States or licensed to the existing, or a new licensee. If the project were taken over, the existing licensee would receive an amount equal to the lesser of (i) fair value of the project or (ii) original cost less depreciation and amounts held in amortization reserves, plus in either case severance damages. The net book value of NEP's hydroelectric projects was $245 million as of December 31, 1993.\nIn the event that a new license is not issued when the existing license expires, FERC must issue annual licenses to the existing licensee which will allow the project to continue operation until a new license is issued. A new license for a project may incorporate operational restrictions and requirements for additional non-power facilities (e.g., recreational facilities) that could affect operation of the project, and may also require\nadditional capital investment. For example, NEP has previously received new licenses for projects on the Connecticut River that involved construction of an extensive system of fish ladders.\nThe license for the 84 MW Deerfield River Project expired at the end of 1993. NEP filed an application for a new license in 1991, which is still under review. Several advocacy groups have intervened proposing operational modifications which would reduce the energy output of the project substantially. FERC has issued NEP an annual license to continue operation of the project under the terms and conditions of the expired license until a new license issues or other disposition of the project takes place.\nThe next NEP project to require a new license will be the 368 MW Fifteen Mile Falls Project on the Connecticut River in New Hampshire and Vermont. This license expires in 2001. The formal process of preparing an application for a new license will begin in 1996.\nFERC has recently issued a Notice of Inquiry regarding the decommissioning of licensed hydroelectric projects. Responses to this notice are still under review at FERC. Some parties have advocated positions in this docket that would draw into question recovery of investment and severance damages in the event of project decommissioning. Depending upon the scope of any project decommissioning regulations, the associated costs could be substantial.\nEnvironmental Requirements\nExisting Operations\nThe NEES subsidiaries are subject to federal, state, and local environmental regulation of, among other things: wetlands and flood plains; air and water quality; storage, transportation, and disposal of hazardous wastes and substances; underground storage tanks; and land-use. It is likely that the stringency of environmental regulation affecting the System and its operations will increase in the future.\nSiting and Construction Activities for New Facilities\nAll New England states require, in certain circumstances, regulatory approval for site selection or construction of electric generating and major transmission facilities. Connecticut, Maine, Massachusetts, New Hampshire, and Rhode Island also have programs of coastal zone management that might restrict construction of power plants and other electrical facilities in, or potentially affecting, coastal areas. All agencies of the federal government must prepare a detailed statement of the environmental impact of all major federal actions significantly affecting the quality of the environment. The New England states have environmental laws which require project proponents to prepare reports of the environmental impact of certain proposed actions for review by\nvarious agencies. Except for the planned Manchester Street Repowering Project, the System is not currently constructing generating plants or major transmission facilities.\nEnvironmental Expenditures\nTotal System capital expenditures for environmental protection facilities have been substantial. System capital expenditures for such facilities amounted to approximately $29 million in 1991, $31 million in 1992, and $23 million in 1993, including expenditures by NEP of $25 million, $28 million, and $14 million, respectively, for those years. The System estimates that total capital expenditures for environmental protection facilities will be approximately $65 million in 1994 ($50 million by NEP) and $25 million in 1995 ($15 million by NEP).\nHazardous Substances\nThe United States Environmental Protection Agency (EPA) has established a comprehensive program for the management of hazardous waste. The program allows individual states to establish their own programs in coordination with the EPA; Massachusetts, New Hampshire, Vermont, and Rhode Island have established such programs. Both the EPA and Massachusetts regulations cover certain operations at Brayton Point and Salem Harbor. Other System activities, including hydroelectric and transmission and distribution operations, also involve some wastes that are subject to EPA and state hazardous waste regulation. In addition, numerous System facilities are subject to federal and state underground storage tank regulations.\nThe EPA regulates the manufacture, distribution, use, and disposal of polychlorinated biphenyls (PCB), which are found in dielectric fluid used in some electrical equipment. The System has completed the removal from service of all PCB transformers and capacitors. Some electrical equipment contaminated with PCBs remains in service. At sites where PCB equipment has been operated, removal, disposal, and replacement of contaminated soils may be required.\nThe Federal Comprehensive Environmental Response, Compensation and Liability Act, more commonly known as the \"Superfund\" law, imposes strict, joint and several liability, regardless of fault, for remediation of property contaminated with hazardous substances. Parties liable include past and present site owners and operators, transporters that brought wastes to the site, and entities that generated or arranged for disposal or treatment of wastes ultimately disposed of at the site. A number of states, including Massachusetts, have enacted similar laws.\nThe electric utility industry typically utilizes and\/or generates in its operations a range of potentially hazardous products and by-products. These products or by-products may not have previously been considered hazardous, and may not currently be considered hazardous, but may be identified as such by federal,\nstate, or local authorities in the future. NEES subsidiaries currently have in place an environmental audit program intended to enhance compliance with existing federal, state, and local requirements regarding the handling of potentially hazardous products and by-products.\nFederal and state environmental agencies, as well as private parties, have contacted or initiated legal proceedings against NEES and certain subsidiaries regarding liability for cleanup of sites alleged to contain hazardous waste or substances. NEES and\/or its subsidiaries have been named as a potentially responsible party (PRP) by either the EPA or the Massachusetts Department of Environmental Protection (DEP) for 18 sites (6 for NEP, 13 for Mass. Electric, and 2 for Narragansett) at which hazardous waste is alleged to have been disposed. NEES and its subsidiaries are also aware of other sites which they may be held responsible for remediating and it is likely that, in the future, NEES and its subsidiaries will become involved in additional proceedings demanding contribution for the cost of remediating additional hazardous waste sites.\nThe most prevalent types of hazardous waste sites that NEES and its subsidiaries have been connected with are former manufactured gas locations. Until the early 1970s, NEES was a combined electric and gas holding company system. Gas was manufactured from coal and oil until the early 1970s to supply areas in which natural gas was not yet available or for peaking purposes. Among the waste byproducts of that process were coal and oil tars. The NEES companies are currently aware of approximately 40 locations at which gas may have been manufactured and\/or stored. Of the manufactured gas locations, 17 have been listed for investigation by the DEP. Two manufactured gas plant locations that have been the subject of extensive litigation are discussed in more detail below: the Pine Street Canal Superfund site in Burlington, Vermont and a site located in Lynn, Massachusetts.\nApproximately 18 parties, including NEES, have been notified by the EPA that they are PRPs for cleanup of the Pine Street Canal site, at which coal tar and other materials were deposited. Between 1931 and 1951, NEES and its predecessor owned all of the common stock of Green Mountain Power Corporation. Prior to, during, and after that time, gas was manufactured at the Pine Street Canal site. The EPA had brought a lawsuit against NEES and other parties to recover all of the EPA's past and future response costs at this site. In 1990, the litigation ended with the filing of a final consent decree with the court. Under the terms of the settlement, to which 14 entities were party, the EPA recovered its past response costs. NEES recorded its share of these costs in 1989. NEES remains a PRP for ongoing and future response costs. In November 1992, the EPA proposed a cleanup plan estimated by the EPA to cost $50 million. In June 1993, the EPA withdrew this cleanup plan in response to public concern about the plan and the cost. It is not known at this time what the ultimate cleanup plan will be, how much it will cost, or what portion NEES will have to pay.\nOn May 26, 1993, the United States Court of Appeals for the First Circuit affirmed on appeal an earlier adverse decision against NEES and two of its subsidiaries, Mass. Electric and New England Power Service Company, with respect to the Lynn, Massachusetts site which was once owned by an electric and gas utility formerly owned by NEES. The electric operations of this subsidiary were merged into Mass. Electric. The decision held NEES and these subsidiaries liable for cleanup of the properties involved in the case. Although the circumstances differ from location to location, the Court of Appeals opinion has adverse implications for the potential liability of NEES and its subsidiaries with respect to other gas manufacturing locations operated by gas utilities once owned by NEES.\nIn November 1993, the MDPU approved a rate agreement filed by Mass. Electric (see RATES, page 8) that resolved all rate recovery issues related to Massachusetts manufactured gas sites formerly owned by NEES or its subsidiaries as well as certain other Massachusetts hazardous waste sites. The agreement allows for these costs to be met by establishing a special fund on Mass. Electric's books. On a consolidated basis, the fund's initial balance of $30 million comes from previously recorded environmental reserves and is not recoverable from customers. NEES had previously established approximately $40 million of reserves related to Massachusetts manufactured gas locations earlier in 1993 and in prior years. The establishment of the fund's initial balance at Mass. Electric resulted in a one-time charge to fourth quarter earnings of $9 million, before tax. The agreement also provides that contributions of $3 million, adjusted for inflation, be added to the fund each year by Mass. Electric and be recoverable in rates. Under the agreement, any shortfalls in the fund will be paid by Mass. Electric and be recovered through rates over seven years, without interest.\nPredicting the potential costs to investigate and remediate hazardous waste sites continues to be difficult. Factors such as the evolving nature of remediation technology and regulatory requirements and the particular characteristics of each site, including, for example the size of the site, the nature and amount of waste disposed at the site, and the surrounding geography and land use, make precise estimates difficult. There are also significant uncertainties as to the portion, if any, of the investigation and remediation costs of any particular hazardous waste site that may ultimately be borne by NEES or its subsidiaries. At year end 1993, NEES had total reserves for environmental response costs of $56 million and a related regulatory asset of $19 million.\nNEES and each of its subsidiaries believe that hazardous waste liabilities for all sites of which each is aware, and which are not covered by a rate agreement, will not be material (10% of common equity) to their respective financial positions. Where appropriate, the NEES companies intend to seek recovery from their insurers and from other PRPs, but it is uncertain whether, and to what extent, such efforts would be successful.\nNEP, in burning coal and oil to produce electricity, produces approximately 308,000 tons per year of coal ash and other coal combustion by-products and 18,500 tons per year of oil ash. In August 1993, the EPA determined that coal combustion byproducts would not be regulated as a hazardous waste. The EPA is expected to issue regulations regarding oil ash treatment in 1997.\nThe EPA and the New England states in which System companies operate regulate the removal and disposal of material containing asbestos. Asbestos insulation is found extensively on power plant equipment and, to a lesser extent, in buildings and underground electric cable. System companies routinely remove and dispose of asbestos insulation during equipment maintenance.\nElectric and Magnetic Fields (EMF)\nIn recent years, concerns have been raised about whether EMF, which occur near transmission and distribution lines as well as near household wiring and appliances, cause or contribute to adverse health effects. Numerous studies on the effects of these fields, some of them sponsored by electric utilities (including NEES companies), have been conducted and are continuing. Some of the studies have suggested associations between certain EMF and various types of cancer, while other studies have not substantiated such associations. In February 1993, the EPA called for significant additional research on EMF. It is impossible to predict the ultimate impact on NEES subsidiaries and the electric utility industry if further investigations were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems.\nSeveral state courts have recognized a cause of action for damage to property values in transmission line condemnation cases based on the fear that power lines cause cancer. It is difficult to predict what impact there would be on the NEES companies if this cause of action is recognized in the states in which NEES companies operate and in contexts other than condemnation cases.\nBills have been introduced in the Rhode Island Legislature to require transmission lines to be placed underground. In July 1993, two bills passed by the legislature restricting the construction of overhead transmission lines were vetoed by the governor. EMF- related legislation has also been introduced in Massachusetts.\nAir\nUnder federal regulations, each New England state has issued a state implementation plan that limits air pollutants emitted from facilities such as generating stations. These implementation plans are intended to ensure continued maintenance of national and state ambient air quality standards, where such standards are currently met. The plans are also intended to bring areas not currently meeting standards into compliance.\nIn 1985, the Massachusetts legislature enacted an acid rain law that requires that sulphur dioxide (SO2) emissions from fossil fuel generating stations be reduced. Regulations implementing the statute were adopted in 1989. Emission reductions required by the regulations must be fully implemented by January 1, 1995, and will require NEP to use more costly lower sulphur oil and coal and make capital expenditures. Use of natural gas at Brayton 4 is one of NEP's methods for helping to meet the requirements of the acid rain law. See Fuel for Generation - Natural Gas, page 19. NEP may also use emission credits for conservation from non-combustion energy sources and cogeneration technology toward meeting the law's requirements.\nNEP produces approximately 50% of its electricity at eight older thermal generating units located in Massachusetts. The 1990 amendments to the federal Clean Air Act require a significant reduction in the nation's SO2 and nitrogen oxide (NOx) emissions by the year 2000. Under the amendments, NEP is not subject to Phase 1 of the acid rain provisions of the federal law that will become effective in 1995. However, NEP is subject to the Massachusetts SO2 acid rain law that will become effective in 1995. Phase 2 of the federal acid rain requirements, effective in 2000, will apply to NEP and its units.\nUnder the federal Clean Air Act, state environmental agencies in ozone non-attainment areas were required to develop regulations (also known as Reasonably Available Control Technology requirements, or RACT) that will become effective in 1995 to address the first phase of ozone air quality attainment. These regulations were adopted in Massachusetts in September 1993. The RACT regulations require control technologies (such as low NOx burners) to reduce NOx emissions, an ozone precursor. Additional control measures may be necessary to ensure attainment of the ozone standard. These measures would have to be developed by the states in 1994 and fully implemented no later than 1999. The extent of these additional control measures is unknown at this time, but could range from minor additions to the RACT requirements to extensive emission reduction requirements, such as costly add-on controls or fuel switching.\nTo date, NEP has expended approximately $7 million of one-time operation and maintenance costs and $50 million of capital costs in connection with Massachusetts and federal Clean Air Act compliance requirements. NEP expects to incur additional one-time operation and maintenance costs of approximately $18 million and capital costs of approximately $70 million in 1994 and 1995 to comply with the federal and state clean air requirements that will become effective in 1995. In addition, as a result of federal and state clean air requirements, NEP will begin incurring increased fuel costs which are estimated to reach an annual level of $13 million by 1995.\nThe generation of electricity from fossil fuels may emit trace amounts of hazardous air pollutants as defined in the Clean Air Act Amendments of 1990. The Act mandates a study of the potential\ndangers of hazardous air pollutant emissions from electric utility plants. Such research is currently under way and is expected to be complete in 1995. The study conclusions could result in new emission standards and the need for additional costly controls on NEP plants. At this time, NEES and its subsidiaries cannot estimate the impact that findings of this research might have on operations.\nThe federal Clean Air Act Amendments of 1990 and the Rio Convention on global climate change have increased the public focus on industrial emissions to the air. Electric utilities' use of fossil fuels is a significant source of emissions which evoke concerns about such issues as acid rain, ozone levels, global warming, small particulates, and hazardous air pollutants.\nShould the 1999 ozone attainment requirements be extensive or additional Clean Air Act Amendments or other environmental requirements be imposed, continued operation of certain existing generating units of NEP beyond 1999 could be uneconomical. NEP believes that premature retirement of substantially all of its older thermal generating units would cause substantial rate increases.\nWater\nThe federal Clean Water Act prohibits the discharge of any pollutant (including heat), except in compliance with a discharge permit issued by the states or the EPA for a term of no more than five years. NEP and Narragansett have received required permits for all their steam-generating plants. NEET has received its required surface water discharge permits for all of its current operations. Occasional violations of the terms of these permits have occurred.\nNEES facilities store substantial amounts of oil and are required to have spill prevention control and counter-measure (SPCC) plans. Currently, major System facilities such as Brayton Point and Salem Harbor have up-to-date SPCC plans. A comprehensive study of smaller facilities has been completed to determine the appropriate plans for these facilities and a five-year implementation plan has been developed.\nNuclear\nThe NRC, along with other federal and state agencies, has extensive regulations pertaining to environmental aspects of nuclear reactors. Safety aspects of nuclear reactors, including design controls and inspection programs to mitigate any possibility of nuclear accidents and to reduce any damages therefrom, are also subject to NRC regulation. See Nuclear Units, page 21.\nRESOURCE PLANNING\nLoad Forecasts and History\nThe Retail Companies currently forecast an increase in KWH sales of 1.4% in 1994. The System has been projecting that, in the absence of significant energy conservation by its customers, annual weather-normalized peak load growth over the next 15 years will average approximately 2.3%. Peak load growth would be limited to about 1.1% annually over this period if planned DSM programs described below are successfully implemented. These projections are being updated.\nDuring the late 1980s unusually high load growth caused a tight capacity situation to develop for both the System and the New England region. More recently, the sluggish regional economy plus the addition of new generating facilities in the region alleviated concerns about inadequate resources for the next several years. Future resource additions from the Manchester Street repowering project described below and contracts with non-utility generators along with the continued demand-side management programs are expected to meet NEP's resource needs until approximately 2000. Additional new capacity may be required in that time frame. A return to the high load growth of the late 1980s, the cancellation of future planned capacity, or the shutdown of existing capacity could necessitate additional generation or power purchase contracts on the supply-side, or demand-side conservation and load management programs, in order to meet customer demands.\nCorporate Plans\nNEES has a history of planning for change to meet resource requirements and other goals. NEES' current plan, called NEESPLAN 4, was completed in 1993. NEESPLAN 4 attempts to reconcile the increasing importance and cost of environmental impact mitigation and utilities' traditional obligation to serve, with growing competition at all levels in the industry. NEESPLAN 4 also addresses planning methodology and implements a resource strategy that restricts commitments to those necessary to meet highly certain loads, and develops options on future resources to meet less certain loads and meet future fuel diversity needs.\nThe new plan also strengthens the emission reduction goals previously established by the System and calls for CO2, SOx, and NOx reductions by 2000 to 20%, 60%, and 60%, respectively, below 1990 levels. Most of this reduction will come from current plans and commitments, including demand-side management, the Manchester Street repowering, increased use of natural gas and lower sulphur fuels, the installation of emission control equipment, low NOx burners, combustion controls, and other new power sources entering the energy mix through the year 2000. Many of these actions are being taken to comply with state and federal environmental laws. See Environmental Requirements, page 29. The remaining improvement will come from actions beyond current commitments. They may include further fuel conversions or efficiency improvements in\npower plants and the transmission and distribution system, as well as competitively acquired renewable resources and greenhouse gas offsets. NEP is currently participating in an experimental project investigating greenhouse gas offsets which involves funding the use of improved forestry techniques in Malaysia to limit unnecessary destruction of forests.\nPast NEES plans have concerned similar challenging issues the System faced and continues to address. In 1979, NEES instituted NEESPLAN, the key objectives of which were to keep customer costs to a minimum and to reduce the System's reliance on foreign oil. In 1985, NEES announced an updated plan, NEESPLAN II, the objectives of which were to provide an adequate supply of electricity to customers at the lowest possible cost and to encourage customers to use electricity efficiently. NEESPLAN 3, announced in 1990, continued these objectives and directly addressed the environmental impacts of providing electricity service.\nDemand-Side Management\nAs mentioned above, the System believes that DSM programs are an important part of meeting its resource goals. Since 1987, the System has put in place a series of customer programs for encouraging electric conservation and load management. Through these DSM programs, the System has achieved over 825,000 MWh of annual energy savings. During 1993, the System spent a total of $76 million on DSM programs and related expenses. The System has budgeted to spend up to $103 million in 1994. Recovery of these expenditures through rates on a current, as incurred, basis has been approved by the various regulatory commissions. See RATES, page 8.\nManchester Street Station Repowering\nThe NEES subsidiaries' major construction project is the repowering of the Manchester Street Station, a 140 MW electric generating station in Providence, R.I. During 1993, construction continued on the joint Narragansett\/NEP project. The project began in 1992 and remains on schedule and within budget, with an expected in-service date of late 1995.\nNarragansett and NEP operate three steam electric generating units of approximately 50 MW each which went into service at Manchester Street Station in the 1940s. During 1992, NEP acquired a 90% interest in the site and the Station in anticipation of the repowering project. As part of the repowering project, three new combustion turbines and heat recovery steam generators will be added to the Station, replacing the existing boilers. The existing steam turbines will be replaced with new and more efficient turbines of slightly larger capacity. The fuel for generation, which is now primarily residual oil, will be replaced with natural gas, using distillate oil as an emergency backup. See Fuel for Generation, page 18.\nRepowering will more than triple the power generation capacity of Manchester Street Station, and substantially increase the plant's thermal efficiency. It is expected that the plant's capacity factor will also increase. Certain air emissions are projected to decrease relative to historical levels because of the change in fuels and the increase in efficiency.\nSubstantial additions to Narragansett's high voltage transmission network will be necessary in order to accommodate the output of the plant. Two 7-mile 115 kV underground transmission cables (located primarily in public ways) are under construction to connect the repowered station to existing 115 kV lines at a new substation. Total cost for the generating station, scheduled for completion in late 1995, is estimated to be approximately $525 million, including AFDC. In addition, related transmission work, which is principally the responsibility of Narragansett, is estimated to cost approximately $75 million and is scheduled for completion in late 1994. At December 31, 1993, $161 million, including AFDC, has been spent on the project which includes the related transmission work. Substantial commitments have been made relative to future planned expenditures for this project.\nRegulation\nThe activities and specific projects in the System's resource plans are subject to regulation by state and federal authorities. Approval by these agencies is necessary to site and license new facilities and to recover the costs for new DSM programs and non- utility resources. See Regulation, page 28.\nResearch and Development\nExpenditures for the System's research and development activities totaled $9.5 million, $8.9 million, and $8.8 million in 1993, 1992, and 1991, respectively. Total expenditures are expected to be about $12 million in 1994.\nAbout 50% of these expenditures support the Electric Power Research Institute, which conducts research and development activities on behalf of its sponsors and provides NEES companies with access to a wide range of relevant research results at minimum cost.\nThe System also directly funds research projects of a more site-specific concern to the System and its customers. These projects include:\n- creating options to allow the use of economically-priced fossil fuels without adversely affecting plant performance, and to insure safe, reliable and environmentally sound production of electric energy at the lowest cost;\n- developing and assessing new information and methods to understand and reduce the environmental impacts\nof System operations including investigation of offset methods for counterbalancing greenhouse gas emissions away from the source;\n- developing, assessing and demonstrating new generation technologies and fuels that will ensure economic, efficient and environmentally sound production of electric energy in the future;\n- creating options to maintain electric service quality and reliability for customers at the lowest cost; and\n- developing conservation, load control, and rate design measures that will help customers use electric energy more efficiently.\nConstruction and Financing\nEstimated construction expenditures (including nuclear fuel) for the System's electric utility companies are shown below for 1994 through 1996.\nThe System conducts a continuing review of its construction and financing programs. These programs and the estimates shown below are subject to revision based upon changes in assumptions as to System load growth, rates of inflation, receipt of adequate and timely rate relief, the availability and timing of regulatory approvals, new environmental and legal or regulatory requirements, total costs of major projects, and the availability and costs of external sources of capital.\nThe anticipated capital requirements for oil and gas operations are not included in the table below. See OIL AND GAS OPERATIONS page 43.\nEstimated Construction Expenditures ----------------------------------- 1994 1995 1996 Total ---- ---- ---- ----- (In Millions - excluding AFDC)\nNEP - ---\nManchester St. Station Generation $145 $ 95 $ 40 $ 280 Manchester St. Station Substation 10 0 0 10 Other Generation (1) 70 50 60 180 Other Transmission 15 15 20 50 ---- ---- ---- ------ Total NEP $240 $160 $120 $ 520 ---- ---- ---- ------\nMass. Electric - --------------\nDistribution $ 90 $ 90 $ 95 $ 275\nNarragansett - ------------\nManchester St. Station Generation $ 15 $ 15 $ 5 $ 35 Manchester St. Station Transmission\/ 30 0 0 30 Substation Other Transmission 15 15 15 45 Distribution 20 25 25 70 ---- ---- ---- ------ Total Narragansett $ 80 $ 55 $ 45 $ 180 ---- ---- ---- ------\nGranite State - -------------\nDistribution $ 5 $ 5 $ 5 $ 15 ---- ---- ---- ------\nOther $ 10 $ 0 $ 0 $ 10 - ----- ---- ---- ---- ------\nCombined Total - --------------\nManchester St. Station Generation $160 $110 $ 45 $ 315 Manchester St. Station Transmission\/ 40 0 0 40 Substation Other Generation (1) 70 50 60 180 Other Transmission 40 30 35 105 Distribution 115 120 125 360 ---- ---- ---- ------ Grand Total $425 $310 $265 $1,000 ---- ---- ---- ------\n(1) Includes Nuclear Fuel\nFinancing\nThe proportion of construction expenditures estimated to be financed by internally generated funds during the period from 1994 to 1996 is:\nNEP 80% Mass. Electric 80% Narragansett 70% Granite State 80%\nThe general practice of the operating subsidiaries of NEES has been to finance construction expenditures in excess of internally generated funds initially by issuing unsecured short-term debt. This short-term debt is subsequently reduced through sales by such subsidiaries of long-term debt securities and preferred stock, and through capital contributions from NEES to the subsidiaries. NEES, in turn, generally has financed capital contributions to the operating subsidiaries through retained earnings and the sale of additional NEES shares. Since April 1991, NEES has been meeting all of the requirements of its dividend reinvestment and common share purchase plan and employee share plans through open market purchases. Under these plans, NEES may revert to the issuance of new common shares at any time.\nThe ability of NEP and the Retail Companies to issue short-term debt is limited by regulatory restrictions, by provisions contained in their charters, and by certain debt and other instruments. Under the charters or by-laws of NEP, Mass. Electric, and Narragansett, short-term debt is limited to 10% of capitalization. The preferred stockholders authorized these limitations to be increased to 20% of capitalization until the late 1990's, at which time the limits will revert to 10% of capitalization. The following table summarizes the short-term debt limits at December 31, 1993, and the amount of outstanding short-term debt at such date.\n($ millions) Limit Outstanding ----- -----------\nNEP 315 51 Mass. Electric 139 38 Narragansett 75 20 Granite State 10 -\nIn order to issue additional long-term debt and preferred stock, NEP and the Retail Companies must comply with earnings coverage requirements contained in their respective mortgages, note agreements, and preference provisions. The most restrictive of these provisions in each instance generally requires (1) for the issuance of additional mortgage bonds by NEP, Mass. Electric, and Narragansett, for purposes other than the refunding of certain outstanding mortgage bonds, a minimum earnings coverage (before income tax) of twice the pro forma annual interest charges on\nmortgage bonds, and (2) for the issuance of additional preferred stock by NEP, Mass. Electric, and Narragansett, minimum gross income coverage (after income tax) of one and one-half times pro forma annual interest charges and preferred stock dividends, in each case for a period of twelve consecutive calendar months within the fifteen calendar months immediately preceding the proposed new issue.\nThe respective long-term debt and preferred stock coverages of NEP and the Retail Companies under their respective mortgage indentures, note agreements, and preference provisions, are stated in the following table for the past three years:\nCoverage ----------------------- 1993 1992 1991 ---- ---- ----\nNEP - ---\nGeneral and Refunding Mortgage Bonds 4.66 4.15 4.02 Preferred Stock 2.76 2.80 2.71\nMass. Electric - --------------\nFirst Mortgage Bonds 3.15 3.60 3.07 Preferred Stock 2.02 2.14 2.12\nNarragansett - ------------\nFirst Mortgage Bonds 2.47 3.79 2.98 Preferred Stock 1.78 2.52 2.06\nGranite State - -------------\nNotes (1) 2.41 2.53 1.98\n(1) As defined under the most restrictive note agreement.\nOIL AND GAS OPERATIONS\nGENERAL\nSince 1974, NEEI has engaged in oil and gas exploration and development, primarily through a partnership with Samedan Oil Corporation (Samedan), a subsidiary of Noble Affiliates, Inc. NEEI's oil and gas activities are regulated by the SEC under the 1935 Act.\nUnder the terms of the Samedan-NEEI partnership agreement, Samedan is the managing partner and oversees all partnership operations including the sale of production. Effective January 1, 1987, NEEI decided not to acquire new oil and gas prospects due to prevailing and expected oil and natural gas market conditions. This decision did not affect NEEI's interests and commitments in oil and gas properties owned as of December 31, 1986 by the Samedan-NEEI partnership. Samedan continues to explore, develop, and manage these properties on behalf of the partnership. Thus, the results of NEEI's operations are substantially affected by the performance of Samedan. Samedan may elect to terminate the partnership at the end of any calendar year upon one year's prior notice.\nNEEI is required to obtain SEC approval for further investment in these oil and gas properties. On December 21, 1993, the SEC issued an order authorizing NEEI to invest up to $10 million in its partnership with Samedan during 1994. The SEC has reserved jurisdiction over an additional $5 million of spending authority. NEEI is winding down its oil and gas program. The level of expenditures for exploration and development of existing properties has declined as a result of the decision not to acquire new oil and gas prospects after December 31, 1986.\nNEEI's activities are primarily rate-regulated and consist of all prospects entered into prior to 1984. Savings and losses from this rate-regulated program are being passed on to NEP and ultimately to retail customers, under an intercompany pricing policy (Pricing Policy) approved by the SEC. Due to precipitate declines in oil and gas prices, NEEI has incurred operating losses since 1986 and expects to generate substantial additional losses in the future. NEP's ability to pass such losses on to its customers was favorably resolved in NEP's 1988 FERC rate settlement. This settlement covered all costs incurred by or resulting from commitments made by NEEI through March 1, 1988. Other subsequent costs incurred by NEEI are subject to normal regulatory review. NEEI follows the full cost method of accounting for its oil and gas operations, under which capitalized costs (including interest paid to banks) relating to wells and leases determined to be either commercial or non-commercial are amortized using the unit of production method.\nDue to the Pricing Policy, NEEI's rate-regulated program has not been subject to certain SEC accounting rules, applicable to non-rate-regulated companies, which limit the costs of oil and gas\nproperty that can be capitalized. The Pricing Policy has allowed NEEI to capitalize all costs incurred in connection with fuel exploration activities of its rate regulated program, including interest paid to banks of which $9 million, $14 million, and $22 million was capitalized in 1993, 1992, and 1991, respectively. In the absence of the Pricing Policy, the SEC's full cost \"ceiling test\" rule requires non-rate regulated companies to write-down capitalized costs to a level which approximates the present value of their proved oil and gas reserves. Based on NEEI's 1993 average oil and gas selling prices and NEEI's proved reserves at December 31, 1993, if this test were applied, it would have resulted in a write-down of approximately $138 million after-tax.\nRESULTS OF OPERATIONS\nRevenues from natural gas sales were approximately 13% higher in 1993 than 1992 even though NEEI's natural gas production declined by about 9%. NEEI expects 1994 natural gas revenues to be slightly higher than 1993 revenues on slightly lower total production. NEEI's 1993 oil and gas exploration and development expenditures were $9 million.\nNEEI's estimated proved reserves decreased from 17.3 million barrels of oil and gas equivalent at December 31, 1992, to 15.1 million barrels of oil and gas equivalent at December 31, 1993. Production, primarily from offshore Gulf properties, decreased reserves by 3.8 million equivalent barrels. Additions and revisions primarily on offshore Gulf properties increased reserves by 1.6 million equivalent barrels.\nPrices received by NEEI for its natural gas varied considerably during 1993, from approximately $1.31\/MCF to $2.90\/MCF, due principally to seasonal fluctuations and regional variations in gas prices. NEEI's overall average gas price in 1993 was $1.96\/MCF.\nThe results of NEEI's oil and gas program will continue to be affected by developments in the world oil market and the domestic market for natural gas, including actions by the federal government and by foreign governments, which may affect the price of oil and gas, the terms of contracts under which gas is sold, and changes in regulation of the domestic interstate gas pipelines.\nThe following table summarizes NEEI's crude oil and condensate production in barrels, natural gas production in MCF, and the average sales price per barrel of oil and per MCF of natural gas produced by NEEI during the years ended December 1993, 1992, and 1991, and the average production (lifting) cost per dollar of gross revenues.\nYears Ended December 31, ---------------------------------- 1993 1992 1991 ---- ---- ---- Crude oil and condensate production (barrels) 477,545 506,428 435,890\nNatural gas production 19,696,944 21,514,986 17,904,015 (MCF)\nAverage sales price per barrel of oil and $17.05 $19.34 $22.80 condensate\nAverage sales price per MCF of natural gas $1.96 $1.59 $1.61\nAverage production cost (including severance taxes) per dollar of gross revenue $0.14 $0.17 $0.18\nOIL AND GAS PROPERTIES\nDuring 1993, principal producing properties, representing 58% of NEEI's 1993 revenues, were (i) a 50% working interest in Brazos Blocks A-52, A-53, A-65, and A-37 located in federal waters offshore Texas, (ii) a 12% working interest in Main Pass Blocks 107 and 108, located in federal waters offshore Louisiana, (iii) a 25% working interest in Main Pass Blocks 93, 102, and 90, located in federal waters offshore Louisiana, (iv) a 20% working interest in Matagorda Island 587, located in federal waters offshore Texas, and (v) a 15% working interest in Eugene Island Block 28, located in federal waters offshore Louisiana. Other major producing properties during 1993 included a 20% working interest in Vermilion Block 114, located in federal waters offshore Louisiana, a 15% working interest in High Island Blocks 21, 22, and 34, located in federal waters offshore Texas, and a 15% working interest in West Delta 18\/33, located in federal waters offshore Louisiana.\nAs used in the tables below, (i) a productive well is an exploratory or a development well that is not a dry well, (ii) a dry well is an exploratory or development well found to be incapable of producing either oil or gas in commercial quantities, (iii) \"gross\" refers to the total acres or wells in which NEEI has a working interest, and (iv) \"net,\" as applied to acres or wells, refers to gross acres or wells multiplied by the percentage working interest owned by NEEI.\nThe following table shows the approximate undeveloped acreage held by NEEI as of December 31, 1993. Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether such acreage contains proved reserves.\nLocation Gross Acres Net Acres -------- ----------- ---------\nOffshore-Gulf of Mexico 124,209 21,676 Other 278,203 49,756 ------- ------ Total 402,412 71,432\nDuring the years ended December 31, 1993, 1992, and 1991 NEEI participated in the completion of the following net exploratory and development wells:\nNet Exploratory Wells Net Development Wells --------------------- ---------------------\nYear Ended Productive* Dry Productive* Dry ---------- ---------- --- ---------- ---\nDecember 31, 1993 0 2 0 0\nDecember 31, 1992 2 0 0 0\nDecember 31, 1991 1 4 3 5\n* Includes depleted wells\nThe following table summarizes the total gross and net productive wells and the approximate total gross and net developed acres, both as of December 31, 1993:\nOil Gas Developed Acres --- --- --------------- Gross Net Gross Net Gross Net ----- --- ----- --- ----- ---\n139 16 557 64 312,492 57,400\nAt December 31, 1993, NEEI was in the process of drilling or completing 4 gross and 0 net wells.\nCAPITAL REQUIREMENTS AND FINANCING\nEstimated expenditures in 1994 for NEEI's exploration and development program are approximately $10 million which is the amount authorized by the SEC. In addition, NEEI's estimated 1994 interest costs are approximately $10 million.\nInternal funds are expected to provide 100% of NEEI's capital requirements for 1994. In 1989, NEEI refinanced its outstanding borrowings through a credit agreement which currently provides for borrowings of up to $275 million. Borrowings under this credit agreement are principally secured by a pledge of NEEI's rights with respect to NEP under the Pricing Policy covering the rate-regulated program. The amount available for borrowing under the revolving credit agreement decreases by varying amounts annually, beginning December 31, 1995 and expiring December 31, 1998.\nNEEI MAP\nMajor Oil and Gas Properties\nEXECUTIVE OFFICERS\nNEES - ----\nAll executive officers are elected to continue in office subject to Article 19 of the Agreement and Declaration of Trust until the first meeting of the Board of Directors following the next annual meeting of shareholders, or the special meeting of shareholders held in lieu of such annual meeting, and until their successors are chosen and qualified. The executive officers also serve as officers and\/or directors of various subsidiary companies.\nJohn W. Rowe - Age: 48 - President and Chief Executive Officer since 1989 - Elected Chairman of NEP in 1993 - President of NEP from 1991 to 1993 - Chairman of NEP from 1989 to 1991 - President and Chief Executive Officer of Central Maine Power Company from 1984 to 1989.\nFrederic E. Greenman - Age: 57 - Senior Vice President since 1987 - General Counsel since 1985 - Secretary since 1984 - Vice President of NEP since 1979.\nAlfred D. Houston - Age: 53 - Elected Executive Vice President in 1994 - Senior Vice President-Finance from 1987 to 1994 - Vice President-Finance from 1985 to 1987 - Vice President of NEP since 1987 - Vice President of Narragansett since 1976 - Treasurer of Narragansett since 1977.\nJohn W. Newsham - Age 61 - Vice President since 1991 - Executive Vice President of NEP since 1993 - Vice President of NEP and Director of Thermal Production from 1987 to 1993.\nRichard P. Sergel - Age: 44 - Vice President since 1992 - Treasurer from 1990 to 1991 - Chairman of Mass. Electric and Narragansett since 1993 - Treasurer of NEP and Mass. Electric from 1990 to 1991 - Vice President of the Service Company since 1988 - Director of Rates from 1982 to 1990.\nJeffrey D. Tranen - Age: 47 - Vice President since 1991 - President of NEP since 1993 - Vice President of NEP from 1984 to 1993 - Vice President of Mass. Hydro, N.H. Hydro, and NEET from 1987 to 1991 - President of Mass. Hydro, N.H. Hydro, and NEET since 1991.\nMichael E. Jesanis - Age: 37 - Treasurer since 1992 - Director of Corporate Finance from 1990 to 1991 - Manager, Financial Planning from 1986 to 1990.\nNEP - ---\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive\nofficers are elected by the Board of Directors to hold office subject to the pleasure of the directors and until the first meeting of directors after the next annual meeting of stockholders and until their successors are duly chosen and qualified. Certain officers of NEP are, or at various times in the past have been, officers and\/or directors of the System companies with which NEP has entered into contracts and had other business relations.\nJeffrey D. Tranen* - President since 1993 - Vice President from 1984 to 1993.\nJohn W. Rowe* - Chairman since 1993 - President from 1991 to 1993 - Chairman from 1989 to 1991.\nJohn W. Newsham* - Executive Vice President since 1993 - Vice President from 1987 to 1993.\nLawrence E. Bailey - Age: 50 - Vice President since 1989 - Plant Manager of Brayton Point Station from 1987 to 1991.\nJeffrey A. Donahue - Age: 35 - Vice President since 1993 - various engineering positions with the Service Company since 1983 - Director of Construction since 1992 - Chief Electrical Engineer since 1991.\nFrederic E. Greenman* - Vice President since 1979.\nAlfred D. Houston* - Vice President since 1987 - Treasurer from 1983 to 1987.\nJohn F. Malley - Age: 45 - Vice President since 1992 - Manager of Generation Planning for the Service Company from 1986 to 1991.\nArnold H. Turner - Age: 53 - Vice President since 1989 - Director of Planning and Power Supply since 1985.\nJeffrey W. VanSant - Age: 40 - Vice President since 1993 - Manager of Oil and Gas Exploration and Development for the Service Company from 1985 to 1993 - Manager of Oil and Gas Procurement from 1992 to 1993 - Manager of Natural Gas Supply from 1989 to 1992.\nMichael E. Jesanis* - Treasurer since 1992.\nHoward W. McDowell - Age: 50 - Controller since 1987 - Controller of Mass. Electric and Narragansett since 1987 - Treasurer of Granite State since 1984.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding this officer.\nMass. Electric - --------------\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive officers are elected by the board of directors to hold office subject to the pleasure of the directors and until the first meeting of the directors after the next annual meeting of stockholders. Certain officers of Mass. Electric are, or at various times in the past have been, officers and directors of System companies with which Mass. Electric has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nJohn H. Dickson - Age: 51 - President since 1990 - Treasurer from 1985 to 1990 - Treasurer of NEES from 1985 to 1990 - Treasurer of NEP from 1987 to 1990 - Vice President of NEEI from 1982 to 1990 - Treasurer of NEEI from 1983 to 1990.\nDavid L. Holt - Age: 45 - Executive Vice President since 1993 - Vice President of NEP from 1992 to 1993 - Chief Engineer and Director of Engineering for the Service Company since 1991 - Chief Electrical Engineer for the Service Company from 1986 to 1991.\nJohn C. Amoroso - Age: 55 - Vice President since 1993 - District Manager, Southeast District from 1992 to 1993 - Manager, Southeast District from 1985 to 1992.\nGregory A. Hale - Age: 43 - Vice President since 1993 - Senior Counsel for the Service Company from 1988 to 1993.\nCheryl A. LaFleur - Age: 39 - Vice President since 1993 - Vice President of the Service Company from 1992 to 1993 - Assistant to the NEES Chairman and President from 1990 to 1991 - Senior Counsel for the Service Company from 1989 to 1991.\nCharles H. Moser - Age: 53 - Vice President since 1993 - Chief Protection and Planning Engineer for the Service Company from 1984 to 1993.\nLydia M. Pastuszek - Age: 40 - Vice President since 1993 - Vice President of NEP from 1990 to 1993 - President of Granite State since 1990 - Assistant to the President of Granite State from 1989 to 1990 - Director of Demand Planning for the Service Company from 1985 to 1989.\nAnthony C. Pini - Age: 41 - Vice President since 1993 - Assistant Controller for the Service Company from 1985 to 1993.\nNancy H. Sala - Age: 42 - Vice President since 1992 - Central District Manager since 1992 - Assistant to the President of Mass. Electric from 1990 to 1992 - Manager of the Central District for Mass. Electric from 1989 to 1990 - Manager of Petroleum Supply and NEEI Shipping for the Service Company from 1986 - 1989.\nDennis E. Snay - Age: 52 - Vice President and Merrimack Valley District Manager since 1990 - Assistant to President of Mass. Electric from 1984 to 1990.\nMichael E. Jesanis - Treasurer since 1992 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Jesanis.\nHoward W. McDowell - Controller since 1987 and Assistant Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nNarragansett - ------------\nOfficers are elected by the board of directors or appointed, as appropriate, to serve until the meeting of directors following the annual meeting of stockholders, and until their successors are chosen and qualified. Officers other than the President, Treasurer, and Secretary, serve also at the pleasure of the directors. Certain officers of Narragansett are, or at various times in the past have been, officers and directors of System companies with which Narragansett has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nRobert L. McCabe - Age: 53 - President since 1986.\nWilliam Watkins, Jr. - Age 61 - Executive Vice President since 1992 - Vice President of the Service Company from 1981 to 1992.\nFrancis X. Beirne - Age: 50 - Vice President since 1993 - Manager, Southern District from 1988 to 1993 - District Manager, Customer Service from 1983 - 1988.\nRichard W. Frost - Age: 54 - Vice President since 1993 - Division Superintendent of Transmission and Distribution from 1986 to 1990 - District Manager - Southern District from 1990 to 1993.\nAlfred D. Houston - Vice President since 1976 - Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Houston.\nJames V. Mahoney - Age: 48 - Vice President and Director of Business Services since 1993 - President of NEEI from 1992 to 1993 - Vice President of the Service Company from 1989 to 1993 - Director of Fuel Supply for the Service Company from 1985 to 1993.\nHoward W. McDowell - Controller since 1987 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nSee Item 1. Business - ELECTRIC UTILITY PROPERTIES, page 13 and OIL AND GAS PROPERTIES, page 45.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn February 1993, a jury in Salem Massachusetts Superior Court assessed damages of $7.5 million, including interest, against Mass. Electric in a case arising from the installation by Mass. Electric of an allegedly undersized transformer for the plaintiff's manufacturing facility. Mass. Electric settled this case with its general liability insurance carrier and the plaintiff in 1993.\nSee Item 1. RATES, page 8; Nuclear Units, page 21; Hydro Electric Project Licensing, page 28; Environmental Requirements, page 29; OIL AND GAS OPERATIONS, page 43.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the last quarter of 1993.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nNEES information in response to the disclosure requirements specified by this Item 5. appears under the captions in the NEES Annual Report indicated below:\nRequired Information Annual Report Caption -------------------- ---------------------\n(a) Market Information Shareholder Information\n(b) Holders Shareholder Information\n(c) Dividends Financial Highlights\nThe information referred to above is incorporated by reference in this Item 5.\nNEP, Mass. Electric, and Narragansett - The information required by this item is not applicable as the common stock of all these companies is held solely by NEES. Information pertaining to payment of dividends and restrictions on payment of dividends is incorporated herein by reference to each company's 1993 Annual Report.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to page 21 of the NEES 1993 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to page 29 of the NEP 1993 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to page 27 of the Mass. Electric 1993 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to page 24 of the Narragansett 1993 Annual Report.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 12 through 20 of the NEES 1993 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 4 through 9 of the NEP 1993 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 4 through 10 of the Mass. Electric 1993 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 4 through 9 of the Narragansett 1993 Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 21 through 40 of the NEES 1993 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 3, 10 through 27, and 29 of the NEP 1993 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 3, 11 through 25, and 27 of the Mass. Electric 1993 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 3, 10 through 22, and 24 of the Narragansett 1993 Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNEES, NEP, Mass. Electric, and Narragansett - None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption ELECTION OF DIRECTORS in the definitive proxy statement of NEES, dated March 10, 1994, for the 1994 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate\nPerformance\" are not so incorporated. Reference is also made to the information under the caption EXECUTIVE OFFICERS - NEES in Part I of this report.\nNEP ---\nThe names of the directors of NEP, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - NEP in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok - Director since 1979 - Age: 64 - Chairman of the Board of NEES - Vice Chairman of the Company from 1993 to 1994 - Chairman or Vice Chairman of the Company from 1988 to 1994 - Vice Chairman of the Company from 1989 to 1991 - Chairman of NEES from 1984 to 1994 (Chairman, President, and Chief Executive Officer from July 26, 1988 until February 13, 1989). Directorships of NEES System companies: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company. Other directorships: Avery Dennison Corporation, John Hancock Mutual Life Insurance Company, Monsanto Company, and the Federal Reserve Bank of Boston.\nFrederic E. Greenman* - Director since 1986. Directorships of NEES System companies and affiliates: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., New England Power Service Company, Yankee Atomic Electric Company, Connecticut Yankee Atomic Power Company, Maine Yankee Atomic Power Company, and Vermont Yankee Nuclear Power Corporation.\nAlfred D. Houston* - Director since 1984. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\nJohn W. Newsham* - Director since 1991. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Resources, Inc., and New England Power Service Company.\nJohn W. Rowe* - Director since 1989. Directorships of NEES System companies and affiliates: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., New England Power Service Company, and Maine Yankee Atomic Power Company. Other directorships: Bank of Boston Corporation and UNUM Corporation.\nJeffrey D. Tranen* - Director since 1991. Directorships of NEES System affiliates: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES and EXECUTIVE OFFICERS - NEP in Part I of this report for other information regarding this director.\nMass. Electric --------------\nThe names of the directors of Mass. Electric, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Mass. Electric in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nUrville J. Beaumont - Director since 1984 - Age: 61 - Treasurer and Director, law firm of Beaumont & Campbell, P.A.\nJoan T. Bok* - Director since 1979.\nSally L. Collins - Director since 1976 - Age: 58 - Health Services Administrator at Kollmorgen Corporation EOD since January 1989 - Former Director of Medical Services at Oxbow Health Associates, Inc., Hadley, Mass. - Former member of Mass. Electric Customer Advisory Council.\nJohn H. Dickson - Director since 1990 - Reference is made to material supplied under the caption EXECUTIVE OFFICERS - Mass. Electric for other information regarding Mr. Dickson. Other directorship: Worcester Business Development Corporation.\nCharles B. Housen - Director since 1979 - Age: 61 - Chairman, President, and Director of Erving Industries, Inc., Erving, Mass.\nDr. Kathryn A. McCarthy - Director since 1973 - Age: 69 - Research Professor of Physics at Tufts University, Medford, Mass. - Senior Vice President and Provost at Tufts from 1973 to 1979 - Other directorships: State Mutual Life Assurance Company of America.\nPatricia McGovern - Elected Director in 1994 - Age: 52 - Of Counsel to law firm of Goulston & Storrs, P.C. since 1993 - Massachusetts State Senator and Chair of the Senate Ways and Means Committee from 1984 to 1992.\nJohn F. Reilly - Director since 1988 - Age: 61 - President and CEO of Fred C. Church, Inc., Lowell, Mass. - Other as directorships: Colonial Gas Company and NE Insurance Co., Ltd.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Director since 1993.\nRichard M. Shribman - Director since 1979 - Age: 68 - Treasurer of Norick Realty Corporation, Salem, Mass. - President of Norick Realty Corporation until 1992 - Other directorships: Eastern Bank.\nRoslyn M. Watson - Director since 1992 - Age: 44 - President of Watson Ventures (commercial real estate development and management) Boston, Mass. - Vice President of the Gunwyn Company (commercial real estate development) Cambridge, Mass. from 1990 - 1993 and Project Manager from 1986 - 1990 - Other directorships: The Boston Company Funds.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES in Part I of this report and\/or the material supplied under the caption DIRECTORS AND OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nNarragansett ------------\nThe names of the directors of Narragansett, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Narragansett in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok* - Director since 1979.\nStephen A. Cardi - Director since 1979 - Age: 52 - Treasurer and Director of Cardi Corporation (construction), Warwick, R.I.\nFrances H. Gammell - Director since 1992 - Age: 44 - Director, Vice President of Finance, and Secretary of Original Bradford Soap Works, Inc.\nJoseph J. Kirby - Director since 1988 - Age: 62 - President of Washington Trust Bancorp, Inc., Westerly, R.I. and President and Director of the Washington Trust Company.\nRobert L. McCabe - President and Director of Narragansett since 1986 - Other directorship: Citizens Savings Bank - Please refer to the material supplied under the caption EXECUTIVE OFFICERS - Narragansett in Part I of this report for other information regarding Mr. McCabe.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Chairman and Director since 1993.\nWilliam E. Trueheart - Director since 1989 - Age: 50 - President of Bryant College, Smithfield, Rhode Island - Executive Vice President of Bryant College from 1986 to 1989 - Other directorships: Fleet National Bank.\nJohn A. Wilson, Jr. - Director since 1971 - Age: 62 - Former Consultant to and President of Wanskuck Co., Providence, R.I., - Former Consultant to Hinckley, Allen, Snyder & Comen (attorneys), Providence, R.I.\n*Please refer to the material supplied under the caption DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nSection 16(a) of the Securities Exchange Act of 1934 requires the System's officers and directors, and persons who own more than 10% of a registered class of the System's equity securities, to file reports on Forms 3, 4, and 5 of share ownership and changes in share ownership with the SEC and the New York Stock Exchange and to furnish the System with copies of all Section 16(a) forms they file.\nBased solely on Mass. Electric's and Narragansett's review of the copies of such forms received by them, or written representations from certain reporting persons that such forms were not required for those persons, Mass. Electric and Narragansett believe that, during 1993, all filing requirements applicable to\nits officers, directors, and 10% beneficial owners were complied with, except that one report on Form 3 was filed late for each of Mr. Beirne, Mr. Frost, and Mr. Mahoney.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the captions BOARD STRUCTURE AND COMPENSATION, EXECUTIVE COMPENSATION, PAYMENTS UPON A CHANGE IN CONTROL, PLAN SUMMARIES, and RETIREMENT PLANS in the definitive proxy statement of NEES, dated March 10, 1994, for the 1994 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT -------------------------------------\nEXECUTIVE COMPENSATION\nThe following tables give information with respect to all compensation (whether paid directly by NEP, Mass. Electric, or Narragansett or billed to it as hourly charges) for services in all capacities for NEP, Mass. Electric, or Narragansett for the years 1991 through 1993 to or for the benefit of the Chief Executive Officer and the four other most highly compensated executive officers for each company.\nNEP\nSUMMARY COMPENSATION TABLE\nLong-Term Compensa- Annual Compensation (b) tion -------------------------- --------- Other Name and Annual Restricted All Other Principal Compensa- Share Compensa- Position Year Salary Bonus tion Awards tion (a) ($) ($)(c) ($)(d) ($)(e) ($)(f) - ---------- ---- ------- ------ --------- ---------- ---------\nJohn W. 1993 181,269 112,095 2,318 54,256 2,386(g) Rowe 1992 184,532 69,205 2,318 56,479 2,340 Chairman 1991 160,202 67,618 2,188 58,394 2,153\nJoan T. 1993 154,428 92,949 3,323 46,245 3,444(h) Bok 1992 157,705 59,310 2,899 48,274 3,326 Vice 1991 155,392 66,005 3,135 56,641 3,615 Chairman\nJeffrey D. 1993 159,936 112,105 2,974 32,753 3,563(i) Tranen 1992 120,843 52,286 2,307 23,732 2,670 President 1991 129,725 45,832 2,240 20,970 2,595\nFrederic E. 1993 123,648 75,058 2,131 22,811 3,110(j) Greenman 1992 133,223 50,258 2,361 26,960 3,298 Vice 1991 125,237 43,804 2,516 24,028 3,145 President\nLawrence E. 1993 135,123 61,283 101 21,286 3,790(k) Bailey 1992 129,711 47,737 101 20,985 2,594 Vice 1991 122,928 32,588 102 14,474 2,459 President\n(a) Certain officers of NEP are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by NEP. See description under Plan Summaries.\n(d) Includes amounts reimbursed by NEP for the payment of taxes.\n(e) These shares receive the same dividends as the other common shares of NEES. The shares become unrestricted after five years. See also Payments Upon a Change in Control, below. As of December 31, 1993, the following executive officers held the amount of restricted shares with the value indicated: Mr. Rowe 11,807 shares, $461,949 value; Mrs. Bok 10,241 shares, $400,679 value; Mr. Greenman 3,220 shares, $125,983 value; Mr. Tranen 2,193 shares, $85,019 value; and Mr. Bailey 1,369 shares, $53,562 value. These amounts do not include the restricted share awards for 1993 which were not determined until February 1994. The value was calculated by multiplying the closing market price on December 31, 1993 by the number of shares.\n(f) Includes NEP contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by NEP.\n(g) For Mr. Rowe, the amount and type of compensation in 1993 is as follows: $1,879 for contributions to the thrift plan and $507 for life insurance.\n(h) For Mrs. Bok, the amount and type of compensation in 1993 is as follows: $1,937 for contributions to the thrift plan and $1,507 for life insurance.\n(i) For Mr. Tranen, the amount and type of compensation in 1993 is as follows: $3,198 for contributions to the thrift plan and $365 for life insurance.\n(j) For Mr. Greenman, the amount and type of compensation in 1993 is as follows: $2,478 for contributions to the thrift plan and $637 for life insurance.\n(k) For Mr. Bailey, the amount and type of compensation in 1993 is as follows: $2,702 for contributions to the thrift plan and $1,088 for life insurance.\nMASS. ELECTRIC\nSUMMARY COMPENSATION TABLE\nLong-Term Compensa- Annual Compensation (b) tion -------------------------- --------- Other Name and Annual Restricted All Other Principal Compensa- Share Compensa- Position Year Salary Bonus tion Awards tion (a) ($) ($)(c) ($)(d) ($)(e) ($)(f) - ---------- ---- ------- ------ --------- ---------- ---------\nRichard P. 1993 93,628 71,187 1,657 20,713 2,036(h) Sergel (g) Chairman\nJohn H. 1993 156,900 116,399 3,005 28,103 3,623(i) Dickson 1992 150,469 61,561 3,087 27,801 3,442 President 1991 141,720 51,451 2,389 23,606 3,255 and CEO\nNancy H. 1993 102,860 43,386 103 13,370 2,378(j) Sala (g) 1992 96,785 20,508 103 8,326 1,936 Vice President\nDennis E. 1993 105,768 29,175 101 11,173 3,025(k) Snay 1992 101,208 28,448 103 12,207 2,024 Vice 1991 94,862 23,320 103 10,001 1,897 President\nCheryl A. 1993 71,488 43,373 68 13,206 1,575(l) LaFleur (g) Vice President\n(a) Certain officers of Mass. Electric are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Mass. Electric. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Mass. Electric for the payment of taxes.\n(e) These shares receive the same dividends as the other common shares of NEES. The shares become unrestricted after five years. See also Payments Upon a Change in Control, below. As of December 31, 1993, the following executive officers held the amount of restricted shares with the value indicated: Mr. Sergel 2,022 shares, $79,110 value; Mr. Dickson 2,190 shares, $85,683 value; Ms. Sala 360 shares, $14,085 value; Mr. Snay 859 shares, $33,608 value; and Ms. LaFleur 824 shares, $32,239 value. These amounts do not include the restricted share awards for 1993 which were not determined until February 1994. The value was calculated by multiplying the closing market price on December 31, 1993 by the number of shares.\n(f) Includes Mass. Electric contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Mass. Electric.\n(g) Mr. Sergel and Ms. LaFleur were elected as officers of Mass. Electric in 1993, and Ms. Sala was elected in 1992. Compensation data is provided for the years in which they have served as officers.\n(h) For Mr. Sergel, the type and amount of compensation in 1993 is as follows: $1,873 for contributions to the thrift plan and $163 for life insurance.\n(i) For Mr. Dickson, the type and amount of compensation in 1993 is as follows: $3,138 for contributions to the thrift plan and $485 for life insurance.\n(j) For Ms. Sala, the type and amount of compensation in 1993 is as follows: $2,057 for contributions to the thrift plan and $321 for life insurance.\n(k) For Mr. Snay, the type and amount of compensation in 1993 is as follows: $2,115 for contributions to the thrift plan and $910 for life insurance.\n(l) For Ms. LaFleur, the type and amount of compensation in 1993 is as follows: $1,430 for contributions to the thrift plan and $145 for life insurance.\nNARRAGANSETT\nSUMMARY COMPENSATION TABLE\nLong-Term Compensa- Annual Compensation (b) tion -------------------------- --------- Other Name and Annual Restricted All Other Principal Compensa- Share Compensa- Position Year Salary Bonus tion Awards tion (a) ($) ($)(c) ($)(d) ($)(e) ($)(f) - ---------- ---- ------- ------ --------- ---------- ---------\nRichard P. 1993 48,207 36,653 854 10,665 1,048(h) Sergel (g) Chairman\nRobert L. 1993 139,632 98,654 2,408 22,617 3,771(i) McCabe 1992 134,536 54,109 2,041 25,076 2,603 President 1991 128,863 40,428 1,306 18,024 2,388 and CEO\nWilliam 1993 118,501 39,403 101 13,370 5,847(j) Watkins, 1992 65,586 17,315 66 7,350 1,312 Jr. (g) Executive Vice President\nRichard W. 1993 96,408 28,667 103 11,211 2,628(k) Frost (g) Vice President\nFrancis X. 1993 87,300 10,580 113 2,462 1,859(l) Beirne (g) Vice President\n(a) Certain officers of Narragansett are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Narragansett. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Narragansett for the payment of taxes.\n(e) These shares receive the same dividends as the other common shares of NEES. The shares become unrestricted after five years. See also Payments Upon a Change in Control, below. As of December 31, 1993, the following executive officers held the amount of restricted shares with the value indicated: Mr. Sergel 2,022 shares, $79,110 value; Mr. McCabe 2,082 shares, $81,458 value; Mr. Watkins 954 shares, $37,325 value; Mr. Frost 942 shares, $36,855 value; and Mr. Beirne 206 shares, $8,059 value. These amounts do not include the restricted share awards for 1993 which were not determined until February 1994. The value was calculated by multiplying the closing market price on December 31, 1993 by the number of shares.\n(f) Includes Narragansett contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Narragansett.\n(g) Messrs. Sergel, Frost, and Beirne were elected as officers of Narragansett in 1993, and Mr. Watkins was elected in 1992. Compensation data is provided for the years in which they have served as officers.\n(h) For Mr. Sergel, the type and amount of compensation in 1993 is as follows: $964 for contributions to the thrift plan and $84 for life insurance.\n(i) For Mr. McCabe, the type and amount of compensation in 1993 is as follows: $2,682 for contributions to the thrift plan and $1,089 for life insurance.\n(j) For Mr. Watkins, the type and amount of compensation in 1993 is as follows: $2,370 for contributions to the thrift plan and $3,477 for life insurance.\n(k) For Mr. Frost, the type and amount of compensation in 1993 is as follows: $1,928 for contributions to the thrift plan and $700 for life insurance.\n(l) For Mr. Beirne, the type and amount of compensation in 1993 is as follows: $1,746 for contributions to the thrift plan and $113 for life insurance.\nDirectors' Compensation\nMembers of the Mass. Electric and Narragansett Boards of Directors, except Dickson, McCabe, Rowe, and Sergel receive a quarterly retainer of $1,250, a meeting fee of $600 plus expenses, and 50 NEES common shares each year. Since all members of the NEP Board are employees of NEES System companies, no fees are paid for service on the Board except as noted below for Mrs. Bok.\nMrs. Bok retired as an employee of the NEES companies on January 1, 1994 (remaining as Chairman of NEES and a director for NEES subsidiaries). Mrs. Bok has agreed to waive the normal fees and annual retainers otherwise payable for services by non- employees on NEES subsidiary boards and will receive in lieu thereof a single annual stipend of $60,000. Mrs. Bok also became a consultant to NEES as of January 1, 1994. Under the terms of her contract, she will receive an annual retainer of $100,000. No payments were made in 1993 pursuant to these arrangements.\nMass. Electric and Narragansett permit directors to defer all or a portion of their retainers and meeting fees. Special accounts are maintained on Mass. Electric's and Narragansett's books showing the amounts deferred and the interest accrued thereon.\nOther\nNEP, Mass. Electric, and Narragansett do not have any share option plans.\nThe NEES Compensation Committee administers certain of the incentive compensation plans, and the Management Committee administers the others (including the incentive share plan).\nRetirement Plans\nThe following table shows estimated annual benefits payable to executive officers under the qualified pension plan and the supplemental retirement plan, assuming retirement at age 65 in 1994.\nPENSION TABLE\nFive-Year Average 15 Years 20 Years 25 Years 30 Years 35 Years 40 Years Compensa- of of of of of of tion Service Service Service Service Service Service - --------- -------- -------- -------- -------- -------- --------\n$100,000 28,000 36,600 45,000 53,400 58,900 61,600 $150,000 43,000 56,300 69,300 82,200 90,300 94,800 $200,000 58,000 76,000 93,500 111,000 122,100 128,100 $250,000 73,000 95,700 117,800 139,800 153,800 161,300 $300,000 88,100 115,400 142,000 168,600 185,500 194,500 $350,000 103,100 135,100 166,300 197,400 217,200 227,700 $400,000 118,100 154,800 190,500 226,200 249,000 261,000 $450,000 133,100 174,500 214,800 255,000 280,700 294,200\nFor purposes of the retirement plans, Messrs. Rowe, Tranen, Greenman, and Bailey currently have 16, 24, 30, and 25 credited years of service, respectively. Mr. Sergel, Mr. Dickson, Ms. Sala, Mr. Snay, and Ms. LaFleur currently have 15, 20, 24, 30, and 7 credited years of service, respectively. Messrs. McCabe, Watkins, Frost, and Beirne currently have 25, 21, 31, and 22 credited years of service, respectively. At the time she retired from NEP, Mrs. Bok had 38 credited years of service, and she commenced receiving the described benefits under the pension plans and the life insurance program. As a non-employee, she no longer accrues service credit or additional benefits under these plans.\nBenefits under the pension plans are computed using formulae based on percentages of highest average compensation computed over five consecutive years. The compensation covered by the pension plan includes salary, bonus, and restricted share awards. The benefits listed in the pension table are not subject to deduction for Social Security and are shown without any joint and survivor benefits.\nThe Pension Table above does not include annuity payments to be received in lieu of life insurance. The policies are described above under Plan Summaries.\nIn February 1993, NEP announced a voluntary early retirement program available to all non-union employees over age 55 with 10 or more years of service as of June 30, 1993. Mrs. Bok accepted the offer. The program offered either an annuity or a lump sum equal to the greater value of either one week's base pay times the number of years of service plus two weeks base pay or an additional five years of service and five years of age. In accordance with the terms of the offer, Mrs. Bok received an additional annuity of $12,611 from a supplemental pension plan and a lump sum of $110,896 from the qualified plan.\nMrs. Bok had not been eligible for a bonus under the prior incentive compensation plan. In lieu thereof she will receive a limited cost of living (consumer price index) adjustment to her benefits from the qualified pension plan and the supplemental\nretirement plan. Since this plan serves to adjust the pension benefit only after retirement, there will be no supplement paid under the plan until at least 1995.\nSenior executives receive the same post-retirement health benefits as those offered non-union employees who retire with a combination of age and years of service equal to 85.\nPAYMENTS UPON A CHANGE OF CONTROL\nThe incentive compensation plans would provide a payment of 40% of base compensation in the event of a \"change in control\" as defined in the plans. This payout would be made in lieu of any cash bonuses under the plans for the year in which the \"change in control\" occurs. A similar payment is provided for the previous plan year if awards for that year had not yet been distributed. A \"change in control\" is defined, generally, as an occurrence of certain events that either evidence a merger or acquisition of NEES or cause a significant change in the makeup of the NEES board of directors over a short period of time.\nUpon the occurrence of a \"change in control,\" restrictions on all shares issued to participants under the incentive share plan would cease and the participants would receive an award of shares for that year, determined in the usual manner, based upon the cash awards described in the preceding paragraph.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT PLAN SUMMARIES\nA brief description of the various plans through which compensation and benefits are provided to the named executive officers is presented below to better enable shareholders to understand the information presented in the tables shown earlier. The amounts of compensation and benefits provided to the named executive officers under the plans described below (and charged to NEP, Mass. Electric, or Narragansett) are presented in the Summary Compensation Tables.\nGoals Program\nThe goals program covers all employees who have completed one year of service with any NEES subsidiary. Goals are established annually. For 1993, these goals related to earnings per share, customer costs, safety, absenteeism, conservation, generating station availability, transmission reliability, environmental and OSHA compliance, and customer favorability attitudes. Some goals apply to all employees, while others apply to particular functional groups. Depending upon the number of goals met, and provided the minimum goal for earnings per share is met, employees may earn a cash bonus of 1% to 4-1\/2% of their compensation.\nIncentive Thrift Plan\nThe incentive thrift plan (a 401(k) program) provides for a match of one-half of up to the first 4% of base compensation contributed to the System's incentive thrift plan (shown under All Other Compensation in the Summary Compensation Tables) and, based on an incentive formula tied to earnings per share, may fully match the first 4% of base compensation contributed (the additional amount, if any, is shown under Bonus in the Summary Compensation Tables). Under Federal law, contributions to these plans are restricted. In 1993, the salary reduction amount was limited to $8,994.\nLife Insurance\nNEES has established for certain senior executives life insurance plans funded by individual policies. The combined death benefit under these insurance plans is three times the participant's annual salary.\nAfter termination of employment, participants may elect, commencing at age 55 or later, to receive an annuity income equal to 40% of annual salary. In that event, the life insurance is reduced over fifteen years to an amount equal to the participant's final annual salary. Due to changes in the tax law, this plan was closed to new participants, and an alternative was established with only a life insurance benefit. The individuals listed in the NEP summary compensation table are in one or the other of these plans. Mass. Electric and Narragansett each have two executive officers eligible to participate in one or the other of these plans.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption TOTAL COMMON EQUITY BASED HOLDINGS in the definitive proxy statement of NEES, dated March 10, 1994, for the 1994 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, Mass. Electric, and Narragansett -------------------------------------\nNEES owns 100% of the voting securities of Mass. Electric and Narragansett. NEES owns 98.80% of the voting securities of NEP.\nSECURITY OWNERSHIP\nThe following tables list the holdings of NEES common shares as of March 10, 1994 by NEP, Mass. Electric, and Narragansett directors, the executive officers named in the Summary Compensation Tables, and all directors and executive officers, as a group.\nNEP ---\nName Shares Beneficially Owned (a) ---- -----------------------------\nLawrence E. Bailey 1,953 Joan T. Bok 25,162 Frederic E. Greenman 10,632 Alfred D. Houston 10,953 John W. Newsham 10,270 John W. Rowe 20,419 Richard P. Sergel 6,702 Jeffrey D. Tranen 6,604\nAll directors and executive officers, as a group (13 persons) 115,340 (b)\n(a) Includes restricted shares and allocated shares in employee benefit plans.\n(b) This is less than 1% of the total number of shares of NEES outstanding.\nMass. Electric --------------\nName Shares Beneficially Owned ---- -------------------------\nUrville J. Beaumont 104 (a) Joan T. Bok 25,162 (b) Sally L. Collins 105 John H. Dickson 7,883 (b) Charles B. Housen 52 Cheryl A. LaFleur 1,796 (b) Kathryn A. McCarthy 100 Patricia McGovern 0 John F. Reilly 105 John W. Rowe 20,419 (b) Nancy H. Sala 5,459 (b),(c) Richard P. Sergel 6,702 (b) Richard M. Shribman 105 Dennis E. Snay 3,720 (b) Roslyn M. Watson 205\nAll directors and executive officers, as a group (23 persons) 105,713 (d)\n(a) Mr. Beaumont disclaims a beneficial ownership interest in these shares held under an irrevocable trust.\n(b) Includes restricted shares and allocated shares in employee benefit plans.\n(c) Ms. Sala disclaims a beneficial ownership interest in 205 shares held under the Uniform Gift to Minors Act.\n(d) This is less than 1% of the total number of shares of NEES outstanding.\nNarragansett ------------\nName Shares Beneficially Owned ---- -------------------------\nFrancis X. Beirne 2,956 (a) Joan T. Bok 25,162 (a) Stephen A. Cardi 104 Richard W. Frost 4,521 (a) Frances H. Gammell 105 Joseph J. Kirby 105 Robert L. McCabe 7,671 (a) John W. Rowe 20,419 (a) Richard P. Sergel 6,702 (a) William E. Trueheart 105 William Watkins, Jr. 7,143 (a) John A. Wilson, Jr. 508\nAll directors and executive officers, as a group (15 persons) 95,477 (b)\n(a) Includes restricted shares and allocated shares in employee benefit plans.\n(b) This is less than 1% of the total number of shares of NEES outstanding.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe construction company of Mr. Stephen A. Cardi, a director of Narragansett, was awarded two contracts by New England Power Company for construction work at its Brayton Point Station. The contract amounts totalled $600,000 and $1,000,000, respectively.\nReference is made to Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT and Item 11. EXECUTIVE COMPENSATION.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nList of Exhibits\nUnless otherwise indicated, the exhibits listed below are incorporated by reference to the appropriate exhibit numbers and the Commission file numbers indicated in parentheses.\nNEES ----\n(3) Agreement and Declaration of Trust dated January 2, 1926, as amended through April 28, 1987 (Exhibit 3 to 1987 Form 10-K, File No. 1-3446).\n(4) Instruments Defining the Rights of Security Holders\n(a) Massachusetts Electric Company First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 Form 10-K, File No. 1-3446; Twentieth Supplemental Indenture dated as of September 1, 1993 (filed herewith).\n(b) The Narragansett Electric Company First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-one supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4 to 1991 Form 10-K, File No. 0-898); Exhibit 4(b) to 1992 Form 10-K, File No. 1-3446; Twenty-First Supplemental Indenture dated as of October 1, 1993 (filed herewith).\n(c) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (filed herewith).\n(d) New England Power Company Indentures\nGeneral and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and nineteen supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 Form 10-K, File No. 1-3446; Nineteenth Supplemental Indenture dated as of August 1, 1993 (filed herewith).\n(10) Material Contracts\n(a) Boston Edison Company et al. and New England Power Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and New England Power Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986; (Exhibit 10(b), to 1990 Form 10-K, File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to NEP with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and New England Power Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-23006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 1-3446); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006); Transmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to 1979 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and New England Power Company: Capital Funds Agreement dated May 20, 1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to 1983 Form 10-K, File No. 1-3446), October 1, 1984, and August 1, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20, File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446).\n(e) New England Energy Incorporated Contracts\n(i) Capital Funds Agreement with NEES dated November 1, 1974 (Exhibit 10-29(b), File No. 2-52969); Amendment dated July 1, 1976, and Amendment dated July 26, 1979 (Exhibit 10(g)(i) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(i) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10 (e)(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1990 (Exhibit 10(e)(i) to 1990 Form 10-K, File No. 1-3446).\n(ii) Loan Agreement with NEES dated July 19, 1978 and effective November 1, 1974, and Amendment dated July 26, 1979 (Exhibit 10(g)(iii) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(ii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(ii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(ii) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1990 (Exhibit 10(e)(ii) to 1990 Form 10-K, File No. 1-3446).\n(iii) Fuel Purchase Contract with New England Power Company dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 Form 10-K, File No. 1-3446).\n(iv) Partnership Agreement with Samedan Oil Corporation as Amended and Restated on February 5, 1985 (Exhibit 10(e)(iv) to 1984 Form 10-K, File No. 1-3446); Amendment dated as of January 14, 1992 (Exhibit 10(e)(iv) to 1991 Form 10-K, File No. 1-3446).\n(v) Credit Agreement dated as of April 28, 1989 (Exhibit 10(e)(v) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1990 (Exhibit 10(e)(v) to 1990 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1992 (Exhibit 10(e)(v) to 1992 Form 10-K, File No. 1-3446).\n(vi) Capital Maintenance Agreement dated November 15, 1985, and Assignment and Security Agreement dated November 15, 1985 (Exhibit 10(e)(vi) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(vi) to 1989 Form 10-K, File No. 1-3446).\n(f) New England Power Company and New England Electric Transmission Corporation et al.: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit (10)(f) 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of New England Power Company's Transmission System dated as of April 1, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Upper Development - Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446).\n(g) New England Electric Transmission Corporation and PruCapital Management, Inc. et al: Note Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Mortgage, Deed of Trust and Security Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Equity Funding Agreement with New England Electric System dated as of December 1, 1985 (Exhibit 10(g) to 1991 Form 10-K, File No. 1-3446).\n(h) Vermont Electric Transmission Company, Inc. et al. and New England Power Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(g) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to 1986 Form 10-K, File No. 1-3446).\n(i) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 Form 10-K, File No. 1-3446).\n(j) Public Service Company of New Hampshire et al. and New England Power Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, December 31, 1980 (Exhibit 10(i) to 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984,\nJune 15, 1984 (Exhibit 10(j) to 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986 and September 19, 1986 (Exhibit 10(j) to 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of November 1, 1990 (Exhibit 10(j) to 1991 Form 10-K, File No. 1- 3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to NEP with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 10-16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent (Exhibit 10(j) to 1991 Form 10-K, File No. 1-3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10-K, File No. 1-3446); Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, and amendment to Seabrook Project Managing Agent Agreement dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10-K, File No. 1-3446).\n(k) Vermont Yankee Nuclear Power Corporation et al. and New England Power Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968, and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972 and April 15, 1983 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446) and April 24, 1985 (Exhibit 10(k) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(k) to 1987 Form 10-K, File No. 1-3446); Amendments dated as of May 6, 1988 (Exhibit 10(k) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to 1981 Form 10-K, File No. 1-3446).\n(l) Yankee Atomic Electric Company et al. and New England Power Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10 (l) to 1989 Form 10-K,\nFile No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 Form 10-K, File No. 1- 3446).\n*(m) New England Electric Companies' Deferred Compensation Plan as amended dated December 8, 1986 (Exhibit 10(m) to 1986 Form 10-K, File No. 1-3446).\n*(n) New England Electric System Companies Retirement Supplement Plan as amended dated April 1, 1991 (Exhibit 10(n) to 1991 Form 10-K, File No. 1-3446).\n*(o) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated April 1, 1991 (Exhibit 10(o) to 1991 Form 10-K, File No. 1-3446).\n*(p) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1992 (Exhibit 10(q) to 1992 Form 10-K, File No. 1-3446).\n*(q) New England Electric Companies' Senior Incentive Compensation Plan as amended dated November 26, 1991 (Exhibit 10(q) to 1991 Form 10-K, File No. 1- 3446).\n*(r) New England Electric Companies' Incentive Compensation Plan II as amended dated September 3, 1992 (Exhibit 10(r) to 1992 Form 10-K, File No. 1-3446).\n*(s) New England Electric System Directors Deferred Compensation Plan as amended dated November 24, 1992 (Exhibit 10(s) to 1992 Form 10-K, File No. 1-3446).\n*(t) Forms of Life Insurance Program (Exhibit 10(s) to 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to 1991 Form 10-K, File No. 1-3446).\n(u) New England Power Company and New England Hydro-Transmission Electric Company, Inc. et al: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10(u) to 1990 Form 10-K, File No. 1-3446).\n(v) New England Power Company and New England Hydro-Transmission Corporation et al: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1,1988 (Exhibit 10(v) to 1988 Form 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10(v) to 1990 Form 10-K, File No. 1-3446).\n(w) New England Power Company et al: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to 1988 Form 10-K, File No. 1-3446).\n(x) New England Hydro-Transmission Electric Company, Inc. and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of September 1, 1987 (Exhibit 10(x) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(x) to 1988 Form 10-K, File No. 1-3446).\n(y) New England Hydro-Transmission Corporation and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of September 1, 1987 (Exhibit 10(y) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(y) to 1988 Form 10-K, File No. 1-3446).\n(aa) Ocean State Power, et al., and Narragansett Energy Resources Company: Equity Contribution Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10 (aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power, et al., and New England Electric System: Equity\nContribution Support Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10 (aa) to 1989 Form 10-K, File No. 1-3446); Ocean State Power II, et al., and Narragansett Energy Resources Company:Equity Contribution Agreement dated as of September 29, 1989 (Exhibit 10 (aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power II, et al., and New England Electric System: Equity Contribution Support Agreement dated as of September 29, 1989 (Exhibit 10 (aa) to 1989 Form 10-K File No. 1-3446).\n*(bb) New England Power Service Company and Joan T. Bok: Service Credit Letter dated October 21, 1982 (Exhibit 10(cc) to 1992 Form 10-K, File No. 1-3446).\n*(cc) New England Electric System and John W. Rowe: Service Credit Letter dated December 5, 1988 (Exhibit 10(dd) to 1992 Form 10-K, File No. 1-3446).\n*(dd) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(13) 1993 Annual Report to Shareholders (filed herewith).\n(18) Coopers & Lybrand Preferability Letter dated February 25, 1994 (filed herewith).\n(22) Subsidiary list appears in Part I of this document.\n(25) Power of Attorney (filed herewith).\nNEP ---\n(3) (a) Articles of Organization as amended through June 27, 1987 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-1229).\n(b) By-laws of the Company as amended June 25, 1987 (Exhibit 3 to 1987 Form 10-K, File No. 0-1229).\n(4) General and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and nineteen supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to\n1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1988 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and the Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986 (Exhibit 10(b) to NEES' 1990 Form 10-K File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to the Company with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and the Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-2006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 0-1229); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006);\nTransmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to NEES' 1979 Form 10-K, File No. 1-3446); Five Year Capital Contribution Agreement dated November 1, 1980 (Exhibit 10(e) to NEES' 1980 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to NEES' 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to NEES' 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and the Company: Capital Funds Agreement dated May 20,\n1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to NEES' 1983 Form 10-K, File No. 1-3446); October 1, 1984, and August 1, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20; File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446).\n(e) Mass. Electric and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated June 22, 1983 (Exhibit 10(b) to Mass. Electric's 1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (filed herewith).\n(f) The Narragansett Electric Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service Agreement dated July 26, 1990 (Exhibit 4(f) to New England Power Company's 1990 Form 10-K, File No. 0-1229). Amendment of Service Agreement dated July 24, 1991 (Exhibit 10(f) to 1991 Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (filed herewith).\n(g) Time Charter between Intercoastal Bulk Carriers, Inc., and New England Power Company dated as of December 27, 1989 (Exhibit 10(g) to 1989 Form 10-K, File No. 1-3446).\n(h) New England Electric Transmission Corporation et al. and the Company: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(f) to NEES' 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of the Company's Transmission System dated as of April 1, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446);\nUpper Development-Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446).\n(i) Vermont Electric Transmission Company, Inc. et al. and the Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(g) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to NEES' 1986 Form 10-K, File No. 1-3446).\n(j) New England Energy Incorporated and the Company: Fuel Purchase Contract dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 NEES Form 10-K, File No. 1-3446).\n(k) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, March 1, 1973 (Exhibit 10-15, File No. 2-48543);Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10 (i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 Exhibit 10(i) to\n1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446).\n(l) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(l) to 1988 Form 10-K, File No. 0-1229).\n(m) Public Service Company of New Hampshire et al. and the Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, and December 31, 1980 (Exhibit 10(i) to NEES' 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984, and June 15, 1984 (Exhibit 10(j) to NEES' 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986, and September 19, 1986 (Exhibit 10(j) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to NEES' 1990 Form 10-K, File No. 1-3446); Seventh Amendment as of November 1, 1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to the Company with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1, 1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446). Settlement Agreement dated as of July 19, 1990 between Northeast Utilities Service Company and the Company (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, Amendment to Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446).\n(n) Vermont Yankee Nuclear Power Corporation et al. and the Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968 and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972, April 15, 1983 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 0-1229) and April 24, 1985 (Exhibit 10(n) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendments dated May 6, 1988 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 NEES Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to NEES' 1981 Form 10-K, File No. 1-3446).\n(o) Yankee Atomic Electric Company et al. and the Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to NEES' 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10(l) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 NEES Form 10-K, File No. 1-3446).\n*(p) New England Electric Companies' Deferred Compensation Plan as amended dated December 8, 1986 (Exhibit 10(m) to NEES' 1986 Form 10-K, File No. 1-3446).\n*(q) New England Electric System Companies Retirement Supplement Plan as amended dated April 1, 1991 (Exhibit 10(n) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(r) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated April 1, 1991 (Exhibit 10(o) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(s) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1992 (Exhibit 10(p) to NEES' 1992 Form 10-K, File No. 1-3446); New England Electric Companies' Senior Incentive Compensation Plan as amended dated November 26, 1991 (Exhibit 10(q) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(t) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(u) New England Electric Companies' Incentive Compensation Plan II as amended dated September 1, 1992 (Exhibit 10 (r) to NEES' 1992 Form 10-K, File No. 1-3446).\n(v) New England Hydro-Transmission Electric Company, Inc. et al. and the Company: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10 (u) to NEES' 1990 Form 10-K, File No. 1-3446).\n(w) New England Hydro-Transmission Corporation et al. and the Company: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to NEES' 1987 Form 10-K, File No. 1-3446). Amendment dated as of August 1, 1988 (Exhibit 10(v) to NEES' 1988 Form 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10 (v) to NEES' 1990 Form 10-K, File No. 1-3446).\n(x) Vermont Electric Power Company et al. and the Company: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446). Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to NEES' 1988 Form 10-K, File No. 1-3446).\n(y) TransCanada Pipelines Limited and the Company: Firm Service Contract for Firm Transportation Service for natural gas dated as of January 6, 1992;\nAmendments dated as of March 2, 1992 and October 30, 1992 (Exhibit 10(y) to 1992 Form 10-K, File No. 0-1229).\n(z) TransCanada Pipelines Limited and the Company: Firm Service Contract for Firm Transportation Service for natural gas dated as of October 30, 1992 (Exhibit 10(z) to 1992 Form 10-K, File No. 0-1229).\n(aa) Algonquin Gas Transmission Company and the Company: X-38 Service Agreement for Firm Transportation of natural gas dated July 3, 1992; Amendment dated July 31, 1992 (Exhibit 10(aa) to 1992 Form 10-K, File No. 0-1229).\n(bb) ANR Pipeline Company and the Company: Gas Transportation Agreement dated July 18, 1990 (Exhibit 10(bb) to 1992 Form 10-K, File No. 0-1229).\n(cc) Columbia Gas Transmission Corporation and the Company: Service Agreement for Service under FTS Rate Schedule dated June 13, 1991 (filed herewith).\n(dd) Iroquois Gas Transmission System, L.P. and the Company: Gas Transportation Contract for Firm Reserved Service dated as of June 5, 1991 (Exhibit 10(dd) to 1992 Form 10-K, File No. 0-1229).\n(ee) Tennessee Gas Pipeline Company and the Company: Firm Natural Gas Transportation Agreement dated July 9, 1992 (Exhibit 10(ee) to 1992 Form 10-K, File No. 0-1229).\n*(ff) New England Power Service Company and Joan T. Bok: Service Credit Letter dated October 21, 1982 (Exhibit 10(cc) to 1992 NEES Form 10-K, File No. 1-3446).\n*(gg) New England Electric System and John W. Rowe: Service Credit Letter dated December 5, 1988 (Exhibit 10(dd) to 1992 NEES Form 10-K, File No. 1-3446).\n*(hh) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into NEP registration statements on Form S-3, Commission File Nos. 33-48257, 33-48897, and 33-49193 (filed herewith).\n(13) 1993 Annual Report to Stockholders (filed herewith).\n(22) Subsidiary list (filed herewith).\n(25) Power of Attorney (filed herewith).\nMass. Electric --------------\n(3) (a) Articles of Organization of the Company as amended March 5, 1993, August 11, 1993, September 20, 1993, and November 15, 1993 (filed herewith).\n(b) By-Laws of the Company as amended February 4, 1993, July 30, 1993, and September 15, 1993 (filed herewith).\n(4) First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464); Exhibit 4 to 1988 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1993 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated July 22, 1983 (Exhibit 10(b) to 1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(e) to 1993 NEP Form 10-K, File No. 0- 1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated\nSeptember 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446).\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(d) to 1988 Form 10-K, File No. 0-5464).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 4(e), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan as amended dated December 8, 1986 (Exhibit 10(m) to NEES' 1986 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan as amended dated April 1, 1991 (Exhibit 10(n) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated April 1, 1991 (Exhibit 10(o) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(i) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1992 (Exhibit 10(p) to NEES' 1992 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated November 26, 1991 (Exhibit 10(q) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated September 1, 1992 (Exhibit 10(r) to NEES' 1992 Form 10-K, File No. 1-3446).\n*(n) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Mass. Electric registration statement on Form S-3, Commission File No. 33-49251 (filed herewith).\n(13) 1993 Annual Report to Stockholders (filed herewith).\n(18) Coopers & Lybrand Preferability Letter dated February 25, 1994 (Exhibit 18 to 1993 NEES Form 10-K, File No. 1-3446).\n(25) Power of Attorney (filed herewith).\nNarragansett ------------\n(3) (a) Articles of Incorporation as amended June 9, 1988 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-898).\n(b) By-Laws of the Company (Exhibit 3 to 1980 Form 10-K, File No. 0-898).\n(4) (a) First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-one supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4(b) to 1991 NEES Form 10-K, File No.\n1-3446; Exhibit 4(b) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1993 NEES Form 10-K, File No. 1-3446).\n(b) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1- 3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service Agreement dated July 26, 1990 (Exhibit 10(f) to 1990 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement dated July 24, 1991 (Exhibit 4(f) to 1991 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(f) to 1993 NEP Form 10-K, File No. 0-1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10 (i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form\n10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES' Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to NEES' 1992 Form 10-K, File No. 1-3446.\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(d) to 1989 Form 10-K, File No. 0-898).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 3(d), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan for Officers, as amended December 8, 1986 (Exhibit 10(m) to NEES' 1986 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan, as amended April 1, 1991 (Exhibit 10(n) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan, as amended dated April 1, 1991 (Exhibit 10(o) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(i) New England Companies' Incentive Compensation Plan, as amended dated January 1, 1992 (Exhibit 10(p) to NEES' 1992 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated November 26, 1991 (Exhibit 10(q) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated September 1, 1992 (Exhibit 10(r) to NEES' 1992 Form 10-K, File No. 1-3446).\n*(n) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit\nAgreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Narragansett registration statement on Form S-3, Commission File No. 33-45052 (filed herewith).\n(13) 1993 Annual Report to Stockholders (filed herewith).\n(25) Power of Attorney (filed herewith).\nFinancial Statement Schedules\nSee Index to Financial Statements and Financial Statement Schedules for NEES, NEP, Mass. Electric, and Narragansett on pages 100, 109, 115, and 121, respectively.\nReports on Form 8-K\nNEES ----\nNEES filed reports on Form 8-K dated October 14, 1993 and November 30, 1993, both of which contained Item 5.\nNEP ---\nNone.\nMass. Electric --------------\nMass. Electric filed reports on Form 8-K dated October 14, 1993 and November 30, 1993, both of which contained Item 5.\nNarragansett ------------\nNone.\nNEW ENGLAND ELECTRIC SYSTEM\nSIGNATURES\nPursuant 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.\nNEW ENGLAND ELECTRIC SYSTEM*\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer March 28, 1994\nPursuant 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 and on the date indicated.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Executive Vice President and Chief Financial Officer\nPrincipal Accounting Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nDirectors (a majority)\nJoan T. Bok Paul L. Joskow John M. Kucharski Edward H. Ladd Joshua A. McClure s\/John G. Cochrane Malcolm McLane All by: Felix A. Mirando, Jr. John G. Cochrane John W. Rowe Attorney-in-fact George M. Sage Charles E. Soule Anne Wexler James Q. Wilson James R. Winoker\nDate (as to all signatures on this page)\nMarch 28, 1994\n*The name \"New England Electric System\" means the trustee or trustees for the time being (as trustee or trustees but not personally) under an agreement and declaration of trust dated January 2, 1926, as amended, which is hereby referred to, and a copy of which as amended has been filed with the Secretary of the Commonwealth of Massachusetts. Any agreement, obligation or liability made, entered into or incurred by or on behalf of New England Electric System binds only its trust estate, and no shareholder, director, trustee, officer or agent thereof assumes or shall be held to any liability therefor.\nNEW ENGLAND POWER COMPANY\nSIGNATURES\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nNEW ENGLAND POWER COMPANY\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPursuant 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 and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority) Joan T. Bok Frederic E. Greenman Alfred D. Houston s\/John G. Cochrane John W. Newsham All by: John W. Rowe John G. Cochrane Jeffrey D. Tranen Attorney-in-fact\nDate (as to all signatures on this page)\nMarch 28, 1994\nMASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nMASSACHUSETTS ELECTRIC COMPANY\ns\/John H. Dickson\nJohn H. Dickson President\nPursuant 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 and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John H. Dickson\nJohn H. Dickson President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nUrville J. Beaumont Joan T. Bok Sally L. Collins John H. Dickson s\/John G. Cochrane Charles B. Housen All by: Kathryn A. McCarthy John G. Cochrane Patricia McGovern Attorney-in-fact John F. Reilly John W. Rowe Richard P. Sergel Richard M. Shribman Roslyn M. Watson\nDate (as to all signatures on this page)\nMarch 28, 1994\nTHE NARRAGANSETT ELECTRIC COMPANY\nSIGNATURES\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nTHE NARRAGANSETT ELECTRIC COMPANY\ns\/Robert L. McCabe\nRobert L. McCabe President\nPursuant 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 and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Robert L. McCabe\nRobert L. McCabe President\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Vice President and Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority) Joan T. Bok Stephen A. Cardi Frances H. Gammell s\/John G. Cochrane Joseph J. Kirby All by: Robert L. McCabe John G. Cochrane John W. Rowe Attorney-in-fact Richard P. Sergel William E. Trueheart John A. Wilson, Jr.\nDate (as to all signatures on this page)\nMarch 28, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of New England Electric System on Form S-3 of the Dividend Reinvestment and Common Share Purchase Plan (File No. 33-12313) and on Forms S-8 of the New England Electric System Companies Employees' Share Ownership Plan (File No. 2-89648), the New England Electric System Companies Incentive Thrift Plan (File No. 33-26066), the New England Electric System Companies Incentive Thrift Plan II (File No. 33-35470), the NEES Goals Program (File No. 2-94447) and the Yankee Atomic Electric Company Thrift Plan (File No. 2-67531) of our reports dated February 25, 1994 on our audits of the consolidated financial statements and financial statement schedules of New England Electric System and subsidiaries as of December 31, 1993 and 1992 and for each of the three years in the period ended December 31, 1993, which reports are incorporated by reference or included in this Annual Report on Form 10-K.\nWe also consent to the incorporation by reference in the registration statements of New England Power Company on Forms S-3 (File Nos. 33-48257, 33-48897, and 33-49193), Massachusetts Electric Company on Form S-3 (File No. 33-49251) and The Narragansett Electric Company on Form S-3 (File No. 33-45052) of our reports dated February 25, 1994 on our audits of the financial statements and financial statement schedules of New England Power Company, Massachusetts Electric Company and The Narragansett Electric Company, respectively, as of December 31, 1993 and 1992 and for each of the three years in the period ended December 31, 1993, which reports are incorporated by reference or included in this Annual Report on Form 10-K.\ns\/ Coopers & Lybrand\nBoston, Massachusetts COOPERS & LYBRAND March 25, 1994\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur reports on the consolidated financial statements of New England Electric System and subsidiaries and on the financial statements of certain of its subsidiaries, listed in item 14 herein, which financial statements and reports are included in the respective 1993 Annual Reports to Shareholders, have been incorporated by reference in this Form 10K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14 herein.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the corresponding basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\ns\/ Coopers & Lybrand\nBoston, Massachusetts COOPERS & LYBRAND February 25, 1994\nNEW ENGLAND ELECTRIC SYSTEM AND SUBSIDIARIES CONSOLIDATED ---------------------------------------------------------\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nYear Ended December 31, 1993, 1992, and 1991","section_15":""}
{"filename":"8462_1993.txt","cik":"8462","year":"1993","section_1":"ITEM 1 - BUSINESS - -----------------\nGeneral - -------\nAugat Inc. (\"Augat\") is a Massachusetts corporation organized in 1946. As used herein the term the \"Company\" means Augat and, unless the context indicates otherwise, its consolidated subsidiaries.\nAugat designs and manufactures a broad range of electromechanical components for the electronics industry. The Company's principal products are interconnection components, including integrated circuit sockets and accessories, coaxial cable network and fiber optic interconnection products, packaging panels and interconnection test probes and systems. The Company also makes terminals, custom connector assemblies, wiring harnesses and specialty wiring systems for the automotive, communications, information processing and business equipment markets.\nIndustry Segments - -----------------\nThe Company operates within a single segment of the electronics industry defined as the electromechanical component and subsystem sector. Although the Company operates internally with several profit centers, the products of these centers all have similar purposes or end uses, i.e., interconnecting or controlling the flow of electricity among components or boards and other assemblies within electronic equipment or systems. These products are used by manufacturers of electronic equipment or systems. These products are used by manufacturers of electronic equipment in their products to obtain specified interconnections of components, subassemblies or subsystems.\nEach profit center is responsible for the manufacture of its own products within its own facilities. The manufacturing equipment and technology used by each profit center, while similar, are not interchangeable because they are customized for the particular product. However, Augat's manufacturing labor force, for the most part, is similar and interchangeable, as are the basic materials that make up the Company's products. Each profit center has comparable capital-to-labor ratios, as well as labor costs as a percentage of sales, with the exception of the Company's wire harness business, which consumes twice as much labor cost as a percentage of sales as the other profit centers.\nProducts of the various profit centers, while sold to different market segments, principally the automotive, computer, dataprocessing, telecommunications and CATV markets, are sold across the same geographic areas and marketed via similar methods. Augat's customers are primarily companies that manufacture or install electronic equipment.\nNarrative Description of the Business - -------------------------------------\nThe Company designs, manufactures and markets electromechanical products used for the interconnection of circuits in electronic applications. Passive components used in electronic equipment, such as resistors and capacitors, and more complex active components, such as transistors, integrated circuits, hybrid circuits and microprocessors, must be attached and electrically interconnected to perform their specified functions. The Company's products principally relate to mounting and interconnecting components, testing or controlling the flow of electricity among components, boards and\/or other assemblies within electronic equipment or systems.\nIn general terms, the Company's products can be applied wherever computer logic is used, either in business or scientific systems or in the numerous products which incorporate computer functions. More specifically, the Company's products are used in computers, computer-aided engineering and manufacturing systems, industrial electronics, test equipment, medical electronics, business equipment, and additional applications in automotive, aerospace, telecommunications and broadband communications - including CATV - markets.\nPrincipal Products - ------------------\nThe Company's products include a broad range of integrated circuit sockets, miniature and subminiature switches, custom connector assemblies for the automotive and telecommunications industries, packaging panels, coaxial cable network and fiberoptic products and related hardware accessories and wire harness assemblies for the automotive industry.\nIntegrated circuit sockets are mechanical devices into which integrated circuits are plugged to provide easy component replacement. The sockets are usually soldered to printed circuit boards by customers in order to connect integrated circuits, including microprocessors, large and very large scale integrated circuits and other dual-in-line packages, onto boards. Several thousand varieties of miniature and subminiature control switches of the toggle, slide, pushbutton and lighted types for use on printed circuit boards or elsewhere in electronic equipment are sold by the Company.\nPackaging panels are used to interconnect integrated circuits and other components. Each panel consists of a board with one or more copper etched and plated power and ground planes and incorporates sockets in particular patterns for placement of integrated circuits or other components on one side and wire-wrappable interconnections on the other. The Company also provides design and wiring services for purchasers of packaging panels and for the wiring of back planes and interconnection panels manufactured by others and provides spring loaded test probes and test fixtures for use in conjunction with functional board and device testers.\nThe Company is a manufacturer of high density discrete connectors for both conventional board mounting and surface mounting.\nThe Company also manufactures a wide range of interconnection hardware accessories generally used on or in connection with printed circuit boards, such as test jacks and jumpers, relay and crystal sockets, breadboards, racks and enclosures, adaptor plugs and cable assemblies as well as marketing flat cable and related components manufactured by others.\nThe Company is also a major supplier of connectors and electronic packaging modules and wire harnesses to two major U.S. automotive manufacturers and is actively participating in the development of interconnection components for future automotive model years. Such automotive programs include a \"mass air flow module\", an \"actuating assembly\" that triggers automatic seatbelts and an \"electronic search module\" for a luxury car audio system.\nProducts manufactured for the telecommunication industry include central office distribution, remote-switching and cross-connect applications. The Company also is a leading supplier of coaxial connector, fiber optic and broadband products for the cable television and local area network (LAN) markets. Specifically in the CATV market, the Company provides single-part assemblies and connectors as well as line amplifiers to cable system operators who, in turn, construct cable television systems that distribute signals from the head-end to a home. The Company is pursuing market opportunities for its coaxial, broadband and fiber optic products in the rapidly evolving communications technology marketplace.\nSources and Availability of Raw Materials - -----------------------------------------\nThe Company's manufacturing operations utilize a wide variety of mechanical components, raw materials and other supplies. It has multiple commercial sources of supply for all materials which are important to its business.\nPatents and Licenses - --------------------\nThe Company owns a number of domestic and foreign patents and has filed a number of additional patent applications. The Company's general policy has been to seek patent protection for those inventions and improvements likely to be incorporated in its products. While the Company believes that its patents and patent applications have value, it considers that its competitive position in the marketplace is not materially dependent upon patent protection and no individual patent or patent application is considered material to future operations.\nSeasonality - -----------\nThe only seasonal effect experienced by the Company is in the third quarter of the calendar year and is principally due to vacation shutdowns at selected Company locations and by many of its customers, particularly in Europe.\nWorking Capital - ---------------\nThe Company manufactures and markets a full line of standard catalog items and also an extensive line of special products to meet specific customer needs. In order to maximize its market opportunities, the Company maintains a high level of inventory of both raw materials and finished products. Sales by the Company are generally made on credit and customers typically take 30 to 70 days to make payment; thus, the Company also has significant amounts of money invested in accounts receivable. Despite the high level of accounts receivable and inventory required, the Company has generally been able to finance these assets from current operations. When additional working capital in excess of that generated by the business has been required, the use of short-term\nborrowings, long-term debt and equity financing have been utilized. The Company's payment terms and the rights of return offered by it to customers and to it by manufacturers vary among such customers and manufacturers, but do not differ substantially from industry practice. The Company has generally allowed credits for returns by customers under appropriate circumstances.\nMarketing - ---------\nThe Company sells to a broadly diversified group of customers located primarily in the United States, Western Europe, Far East and Canada. Sales are made to industrial and commercial customers within the computer, computer-aided engineering and manufacturing, industrial electronics, test equipment, telecommunications, aerospace, automotive and broadband communication markets. The Company's products are also widely used in both industrial and institutional research laboratories. During 1993 the Company's products and services were sold directly to approximately 5,600 customers and a substantial number of additional customers were served through a network of industrial electronic component distributors. Of total sales 20% was derived from sales through a number of distributors located throughout the world and no distributor accounted for as much as 2% of the Company's sales. One customer, Ford Motor Company, accounted for approximately 28% and another customer for 7% of the Company's sales in 1993; no other customer accounted for more than 4% of sales.\nThe Company markets its products and services through independent sales representatives and direct Company sales personnel working throughout the United States and abroad, including wholly owned marketing subsidiaries in the United Kingdom, France, Germany, Switzerland, Sweden, Italy, Japan, Canada and Australia and sales offices in other areas.\nIn 1993 the Company's international sales amounted to approximately 21% of total sales. Approximately 51% of these sales were derived from Western Europe. The overall net margins on international sales are somewhat less than those obtained on sales made in the United States. The Company's international business is subject to risks customarily encountered in foreign operations, including fluctuations in monetary exchange rates.\nBacklog - -------\nThe Company estimates that its backlog of unfilled orders at December 31, 1993 was $104 million compared with $90 million at December 31, 1992. Orders tend to fluctuate during the year according to customer requirements and business conditions, and the backlog level from quarter to quarter does not follow a consistent pattern. Although unfilled orders can be cancelled, the Company's experience has been that the dollar amount of cancelled orders is not material.\nSubstantially all of the backlog is reasonably expected to be shipped within twelve months.\nGovernment Contracts - --------------------\nThe amount of the Company's business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government is insignificant.\nCompetition - -----------\nThe Company encounters competition in all areas of its business activity from a number of competitors but does not compete with any one company in all areas. Competitors range from some of the country's largest diversified companies to small and highly specialized firms. The Company competes primarily on the basis of technology, innovation, performance and reliability. Price and company reputation are also important competitive factors. Although there are no precise statistics available, the Company believes it is a principal factor in the markets in which it competes.\nResearch, Development and Engineering - -------------------------------------\nThe Company maintains a continuous program of design, development and engineering of new products and improvement of existing products to meet the changing needs of its customers. The Company provides engineering assistance to its customers, designing products to fill their individual requirements. The majority of new product development, manufacturing research, quality control development, new equipment development and related research and development expenditures take place in product management groups involving engineering, marketing, manufacturing, quality control and general management personnel. These expenses are included in the categories of marketing, manufacturing and general administrative expenses. In calendar year 1993, 1992 and 1991 expenditures for such research, development and engineering were approximately $19 million, $19 million, and $16 million, respectively.\nEnvironmental Affairs - ---------------------\nThe Company's manufacturing facilities are subject to numerous laws and regulations designed to protect the environment. The Company has spent substantial amounts to purchase, install, and operate pollution control equipment and conduct appropriate environmental audits. The Company believes that its efforts in this regard places it in substantial compliance with existing environmental laws and regulations.\nIn connection with the acquisition of National Industries, Inc. in 1991, the Company determined that possible contamination at certain National facilities in Alabama warranted additional study. The Company informed the State of Alabama about the possible contamination and its desire to voluntarily proceed with further study and, if necessary, remediation of the possible contamination. The Company has completed its investigation and provided this information to the State. The State has informed the Company that it believes further investigation is necessary. The Company, however, has considered and disagreed with the State's comments and is voluntarily proceeding to design and implement an appropriate remedy. The Company has included in its financial statements an allowance of $4.7 million for estimated environmental cleanup costs as of December 31, 1993.\nEmployees - ---------\nThe Company had approximately 4,300 employees as of December 31, 1993. None of the employees are covered by collective bargaining agreements and operations have never been interrupted by a work stoppage. The Company believes that relations with its employees are good. The Company also contracts for manufacturing labor and as of December 31, 1993 had approximately 2,000 contract laborers.\nFinancial Information about Foreign and Domestic Operations and Export Sales - ----------------------------------------------------------------------------\nCertain financial information concerning domestic and international operations and export sales can be found in Footnote number 10 to the accompanying financial statements of the Registrant which are included under Item 8 hereof.\nBalance of this page intentionally left blank.\nThe Company believes that its existing facilities are adequate and suitable for the manufacture and sale of its products and have sufficient capacity to meet its current requirements. Machine capacity is adequate although additional machine capacity is currently being added in the business to meet increasing demands for the Company's new products and for ongoing cost reduction programs.\nThe Company anticipates no difficulty in retaining occupancy of any of its manufacturing, office or sales facilities through lease renewals prior to expiration or through month-to-month occupancy, or in replacing them with equivalent facilities.\nIn addition to the above listed properties, the Company leases a small amount of other office\/warehouse space in the United States and foreign countries. The amount of such space is not significant.\nSee Note 7 - \"Commitments and Contingencies\" to the accompanying financial statements of the Registrant which are included under Item 8 hereof for information concerning the Company's obligations under all leases.\nITEM 3","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 - LEGAL PROCEEDINGS - --------------------------\nOn April 26, 1985, the Company and its subsidiary, Isotronics, Inc. (\"Isotronics\"), commenced an action in the Bristol County Superior Court of Massachusetts against Aegis, Inc. (\"Aegis\"), and a former employee of Isotronics (the \"Employee\"), seeking damages to be trebled under the Massachusetts statute relating to unfair trade practices (M.G.L. c. 93A) and injunctive relief. The complaint alleged wrongdoing by the defendants in connection with the organization and operation of Aegis, which competed with Isotronics in the manufacture and sale of microcircuit packages.\nOn May 21, 1985, the defendants filed a counterclaim, and added the Chairman of the Board of the Company as an additional defendant. The counterclaim alleged improper interference with a contract of Aegis; the making of disparaging remarks about the Employee and another officer of Aegis; that the action is groundless; and that it was commenced because of personal animosity toward the Employee. The counterclaim seeks damages of $7,500,000 for abuse of process, damages of $50,000 for interference with the contract, and damages of $7,500,000, to be trebled, for violation of the Massachusetts statute relating to unfair trade practices (M.G.L. c 93A). A reply was filed which denied the material allegations of the counterclaim.\nOn May 13, 1985, Aegis commenced an action in the U.S. District Court for the District of Massachusetts. The allegations of the amended complaint in the federal case generally are similar to those of the counterclaim in the Superior Court case, but include an additional claim that the Company and Isotronics had attempted to monopolize interstate commerce in violation of the Sherman Act. The allegations with respect to damages are similar to those of the Superior Court counterclaim.\nAssets of Isotronics were sold by the Company in May 1989, but all claims relating to the litigation were retained by the Company.\nOn August 31, 1989 the Bristol County Superior Court ruled that Aegis and the Employee violated the Massachusetts statute relating to unfair trade practices. The court ruled further that Aegis and the Employee had failed to prove the counterclaims they had asserted against the Company, Isotronics and an officer of the Company.\nAegis and the Employee appealed the decision and on October 1, 1990, the case was argued to the Massachusetts Supreme Judicial Court. The court rendered a decision on January 16, 1991, affirming the trial court's finding of a knowing and willful violation of the Massachusetts Unfair Trade Practices statute. A further trial to determine the amount of damages to be awarded against Aegis and the Employee took place in the Bristol County Superior Court from January 6, 1992 until February 20, 1992.\nOn November 2, 1992, the Court issued a 173 page Memorandum of Decision and Order (\"Order\"). The Order concluded that the illegal conduct of defendants Aegis and Employee proximately caused the Company to suffer $14,140,000 in lost profits during the period January 1, 1985 until March 31, 1987.\nIn 1987, a joint venture owned by Olin Corporation (\"Olin\") and Asahi Glass Co, Ltd. purchased the stock of Aegis. Because of alleged indemnity obligations which may run from Olin to the defendant Employee, the Company moved to amend its Complaint and add Olin as a defendant. On November 25, 1992 the court allowed the Company's motion. Olin moved to dismiss that complaint. The Court denied Olin's motion on December 14, 1992. At the same time the Court granted the Company a preliminary injunction restraining Olin from modifying any obligation it may have to defendant Employee. Olin has renewed its objections to the Company's complaint.\nOn December 14, 1992, final judgment was entered entitling the Company to recover from the defendants jointly and severally, the sum of $14,140,000 in compensatory damages, plus costs of $376,632.98, interest of $10,744,460.47, and attorneys' fees of $1,216,188.06, for a total of $26,477,281.51. The judgment also awarded the Company noncompensatory damages of $14,140,000. The judgment also found in favor of the former Chairman of the Board on all counts of the defendants' counterclaims against him.\nThe defendants have appealed the judgment, generally challenging the entire damages decision. The Company has filed a cross appeal limited to the question of whether a portion of the damages award should be assessed against each of the defendants jointly instead of jointly and severally. The appeal of the damages decision was argued before the Supreme Judicial Court in early October 1993, and the Court has not issued its decision.\nOn September 4, 1992, the Company filed suit in the United States District Court for the District of Massachusetts against June M. Collier (\"Collier\"). This suit arises out of an Agreement of Merger which the Company entered into in August 1991, and through which an Alabama manufacturing company, National Industries, Inc. was merged into Augat National Inc., a wholly owned subsidiary of the Company. The Company alleges that the defendant, who was the sole stockholder of National Industries, breached certain warranties she made in connection with the merger and misrepresented the financial and operating conditions of National Industries. The suit also alleges a violation of Mass. Gen. Laws c. 93A. Collier has answered the company's complaint and asserted counterclaims for breach of contract, breach of the implied covenant of good faith and fair dealing, violation of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, duress, misrepresentation and violations of Mass. Gen. Laws c. 93A. The Company has responded to Collier's counterclaims and has denied all of the substantive allegations. Management believes that Collier's counterclaims are without merit and will defend them vigorously. Discovery is scheduled to end on June 15, 1994. Trial has been set for August 1, 1994.\nThere are no other material legal proceedings to which the Registrant is a party. Routine litigation incidental to its business is immaterial.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNot Applicable.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------\nThe Company's Common Stock is currently traded on the New York Stock Exchange under the symbol \"AUG\".\nThe Company, in December 1991, suspended its quarterly common stock dividend in order to maintain a strong balance sheet and to ensure Augat's financial long-term objectives. As discussed in Note 3 of the Notes to Consolidated Financial Statements which are included under Item 8","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------------------------ Not Applicable.\nThe balance of this page intentionally left blank.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item concerning directors is incorporated herein by reference pursuant to Rule 12b-23 to the Company's Proxy Statement dated March 24, 1994 with respect to the Annual Meeting of Shareholders to be held April 26, 1994.\nThe executive officers of the Company are elected annually. * Effective, February, 1994\nITEMS 11 AND 12 - EXECUTIVE COMPENSATION AND SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------\nThe information required by these items is incorporated herein by reference pursuant to Rule 12b-23 to the Company's Proxy Statement dated March 24, 1994 for the Annual Meeting of Shareholders to be held April 26, 1994.\nITEM 13","section_11":"","section_12":"","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nNot applicable.\nThe balance of this page intentionally left blank.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ----------------------------------------------------------------\n(a) 1. Financial Statements\nThe Financial Statements listed below appear in Part II, Item 8 hereof.\nFinancial Statements: --------------------- Independent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\n(a) 2. Financial Statement Schedules -----------------------------\nThe Financial Statement Schedules listed below appear in Part II, Item 8 hereof.\nSchedule V - Property, Plant and Equipment Schedule VI - Accumulated Depreciation, and Amortization of Property, Plant and Equipment Schedule VIII- Valuation and Qualifying Accounts Schedule IX - Short-Term Borrowings Schedule X - Supplementary Income Statement Information\nSchedules not included with this additional financial data have been omitted because of the absence of conditions under which they are required or because the required financial information is included in the financial statements submitted.\n(a) 3. Exhibits --------\n(3) Articles of Incorporation and By-Laws\n(a) Restated Articles of Organization, as amended. Incorporated by reference to Exhibit 3(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(b) By-Laws, as amended. Incorporated by reference to Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n(4) Instruments Defining the Rights of Security Holders, Including Indentures\n(a) Specimen certificate representing shares of the Registrant's $.10 par value common stock. Incorporated by reference to Exhibit 4(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(b) Trust Indenture dated as of August 2, 1988 between Augat Inc. and The Chase Manhattan Bank, N.A. as Trustee. Incorporated by reference to Exhibit 2 of the Registrant's Registration Statement on Form 8-A dated August 2, 1988.\n(10) Material Contracts\n(a) 1994 Stock Plan (Exhibit 10(a)).\n(b) 1984 Stock Option and Appreciation Right Plan. Incorporated by reference to Exhibit A to the Proxy Statement dated March 12, 1984 for the Annual Meeting of the Registrant's Shareholders on April 24, 1984.\n(c) 1987 Stock Option and Appreciation Right Plan. Incorp- orated by reference to Exhibit A to the Registrant's Proxy Statement dated March 25, 1987 for the Annual Meeting of the Registrant's Shareholders held on April 28, 1987.\n(d) 1989 Stock Plan. Incorporated by reference to Exhibit 10(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(e) Supplementary Employee Retirement Plan. Incorporated by reference to Exhibit 10(c) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(f) Letter of Credit and Reimbursement Agreement among Chemical Bank as Letter of Credit Issuer, Altair International, Inc. as Borrower and Augat Inc. as Guarantor dated as of December 1, 1986. Incorporated by reference to Exhibit 10(f) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(g) Employment Agreement dated January 3, 1991 between the Registrant and Marcel P. Joseph. Incorporated by reference to Exhibit 10(g) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(h) Augat Inc. Savings and Retirement Plan. Incorporated by reference to Exhibit 10(h) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(i) Rights Agreement dated as of August 2, 1988 between Augat Inc. and The Chase Manhattan Bank, N.A., Rights Agent. Incorporated by reference to Exhibit 1 of the Registrant's Registration Statement on Form 8-A dated August 2, 1988.\n(j) Severance Agreements. Incorporated by reference to Exhibit 10(k) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(k) Deferred Compensation Plan. Incorporated by reference to Exhibit 10(1) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(l) Supplemental Disability Income Plan. Incorporated by reference to Exhibit 10(m) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(m) Supplemental Survivor Benefit Plan. Incorporated by reference to Exhibit 10(n) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(n) Agreement of Merger among Augat Inc., National Industries, Inc. and June M. Collier dated August 30, 1991. Incorporated by reference to Exhibit 2 to the Registrants' Form 8-K filed September 16, 1991.\n(p) Note Agreement between Augat Inc., as Borrower and Principal Mutual Life Insurance Company and Allstate Life Insurance Company, as Lenders, dated as of February 1, 1992. Incorporated by reference to Exhibit 10(p) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n(q) Revolving Credit Agreement among Augat Inc., Augat Wiring Systems Inc., Augat Automotive Inc., Augat Communications Group Inc., LRC Electronics Inc., Reed Devices Inc., The First National Bank of Boston, Shawmut Bank, N.A., Chemical Bank and The First National Bank of Boston, as agent, dated as of September 14, 1992. Incorporated by reference to the Exhibit (10.1) to the prospectus included in Registration Statement No. 33- 53600 dated December 2, 1992.\n(r) 1993 Employee Stock Purchase Plan. Incorporated by reference to Exhibit 10(r) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n(s) Amendment No. 3 to the Revolving Credit Agreement among Augat Inc., Augat Wiring Systems Inc., Augat Automotive Inc., Augat Communication Products Inc., LRC Electronics Inc., Reed Devices Inc., The First National Bank of Boston, Shawmut Bank, N.A., Chemical Bank and The First National Bank of Boston, as agent, dated as of July 9, 1993.\n(21) Subsidiaries of the Registrant. Exhibit 21.\n(23) Independent Auditors' Consent. Exhibit 23.\n(b) Reports on Form 8-K. --------------------\nNo reports on Form 8-K were filed with the Commission during the last quarter of calendar year 1993.\nSIGNATURES\nPursuant to the requirement 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 of the undersigned thereunto duly authorized.\n(Registrant) AUGAT INC. ---------------------------------------------------------\nBy \/s\/ MARCEL P. JOSEPH By \/s\/ ELLEN B. RICHSTONE --------------------------- --------------------------- Marcel P. Joseph Ellen B. Richstone Chairman of the Board, Vice President & Title Chief Executive Officer Title Chief Financial Officer ----------------------- ----------------------- & President -----------\nDate March 24, 1994 --------------------\nPursuant 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 and on the date indicated.","section_15":""}
{"filename":"829966_1993.txt","cik":"829966","year":"1993","section_1":"ITEM 1. BUSINESS\nOrganization\nPSI Resources, Inc. (Resources) is a holding company incorporated under the laws of the State of Indiana.\n. Merger Agreement with The Cincinnati Gas & Electric Company (CG&E) - Refer to the information appearing in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 and Notes 20, 21, and 22 of the \"Notes to Consolidated Financial Statements\" beginning on page 63.\n. IPALCO Enterprises Inc.'s Withdrawn Acquisition Offer - Refer to the information appearing in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 20.\nPSI Energy, Inc.\nPSI Energy, Inc. (Energy), Resources' principal subsidiary, is an Indiana corporation engaged in the production, transmission, distribution, and sale of electric energy in north central, central, and southern Indiana. It serves an estimated population of 1.9 million people located in 69 of the state's 92 counties including the cities of Terre Haute, Kokomo, Columbus, Lafayette, Bloomington, and New Albany. In 1992, PSI Energy Argentina, Inc., (PSI Energy Argentina), a wholly-owned subsidiary of Energy, was formed for the purpose of acquiring, purchasing, owning, and holding the stock of other energy, environmental, or functionally-related corporations and as a holding company for Energy's other energy ventures. PSI Energy Argentina is a member of a multinational consortium which has controlling ownership of Edesur, S.A. (Edesur). Edesur is an electricity-distribution network serving the southern half of Buenos Aires, Argentina. Edesur provides distribution services to 1.8 million customers. PSI Energy Argentina owns a small equity interest in this project and provides operating and consulting services.\nPSI Investments, Inc.\nPSI Investments, Inc. (Investments) is a wholly-owned subsidiary of Resources formed to operate non-regulated and non-utility businesses. In 1990, Power Equipment Supply Co. (PESCO), a wholly-owned subsidiary of Investments, was formed to buy equipment for resale, broker equipment, and sell equipment on consignment for others. Wholesale Power Services, Inc., also a wholly-owned subsidiary of Investments, was formed in 1992 to engage in the business of brokering power, emission allowances, electricity futures, and related products and services and provide consulting services in the wholesale power- related markets.\nPSI Recycling, Inc.\nPSI Recycling, Inc. (Recycling) was formed in 1990 as a wholly-owned subsidiary of Resources to recycle paper, metal, and other materials from Energy and other sources. Goodwill Industries of Central Indiana provides labor to Recycling and receives a portion of the profits.\nPSI Argentina, Inc.\nPSI Argentina, Inc. (PSI Argentina) was formed in 1992 as a wholly-owned subsidiary of Resources to acquire, purchase, own, and hold the stock of other energy, environmental, or functionally-related corporations and to act as a holding company for other energy ventures. In 1992, PSI Argentina formed two wholly-owned subsidiaries: Costanera Power Corp. (Costanera Power) was formed to engage in the construction, operation, development, or ownership of power production facilities; and Energy Services, Inc. of Buenos Aires was formed to engage in the construction, operation, development, or ownership of power production and distribution facilities. Costanera Power is a member of a multinational consortium which has controlling ownership of the 1,260-megawatt (mw) Costanera power plant serving Buenos Aires, Argentina. Costanera Power owns a small equity interest in this project, and PSI Argentina provides consulting services to the project.\nRegulation\nEnergy, being a public utility under the laws of Indiana, is regulated by the Indiana Utility Regulatory Commission (IURC) as to its retail rates, services, accounts, depreciation, issuance of securities, acquisitions and sales of utility properties, and in other respects as provided by Indiana law. Energy is also subject to regulation by the Federal Energy Regulatory Commission (FERC) with respect to borrowings and the issuance of securities not regulated by the IURC, the classification of accounts, rates to wholesale customers, interconnection agreements, and acquisitions and sales of certain utility properties as provided by Federal law.\nFuel Supplies\nEnergy has both long- and short-term coal supply agreements for a major portion of the coal requirements for its generating stations from mines located principally in Indiana and Illinois. Several of these agreements include extension options, and some are subject to price revision. Energy monitors alternative sources to assure a continuing availability of economical fuel supplies. At the present time, Energy is evaluating the use of western and midwestern coal blends in connection with its plans to comply with the acid rain provisions of the Clean Air Act Amendments of 1990.\nRefer to the information appearing in Note 16(c) of the \"Notes to Consolidated Financial Statements\" on page 61.\nCustomer, Kilowatt-hour Sales, and Revenue Data\nApproximately 97% of Resources' operating revenues are derived from Energy's sales of electricity. The area served by Energy is a residential, agricultural, and widely diversified industrial territory. As of December 31, 1993, Energy supplied electric service to over 624,000 customers in approximately 700 cities, towns, unincorporated communities, and adjacent rural areas, including municipal utilities and rural electric cooperatives. No one customer accounts for more than 5% of electric operating revenues. Sales of electricity by Energy are affected by the various seasonal patterns throughout the year and, therefore, its operating revenues and associated operating expenses are not generated evenly during the year.\nPower Supply\nEnergy and 28 other electric utilities in an eight-state area are participating in the East Central Area Reliability Coordination Agreement for the purpose of coordinating the planning and operation of generating and transmission facilities to provide for maximum reliability of regional bulk power supply.\nEnergy's electric system is interconnected with the electric systems of CG&E, Kentucky Utilities Company, Louisville Gas and Electric Company, Indianapolis Power & Light Company, Indiana Michigan Power Company, Northern Indiana Public Service Company, Central Illinois Public Service Company, Southern Indiana Gas and Electric Company, and Hoosier Energy R.E.C., Inc. In addition, Energy has a power supply relationship with Wabash Valley Power Association, Inc. (WVPA) and Indiana Municipal Power Agency (IMPA) through power coordination agreements. These two entities are also parties with Energy to a Joint Transmission and Local Facilities Agreement.\nCompetition\nRefer to the information appearing under the caption \"Competitive Pressures\" in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 13.\nEnvironmental Matters\nRefer to the information appearing in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 13.\nEmployees\nThe number of employees of Resources and its subsidiaries at December 31, 1993, was 4,248.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRefer to the information appearing in Note 18 of the \"Notes to Consolidated Financial Statements\" on page 62.\nSubstantially all electric utility plant is subject to the lien of Energy's first mortgage bond indenture.\nEnergy operates six steam electric generating stations, one hydroelectric generating station, and 16 rapid-start internal combustion generating units, all within the State of Indiana. Energy owns all of the above, except for 49.95% of Gibson Unit 5 which is jointly owned by WVPA (25%) and IMPA (24.95%). Company-owned system generating capability as of December 31, 1993, was 5,807 mw. Additionally, in May 1993, the IURC issued \"certificates of need\" for Energy and Destec Energy, Inc.'s 262-mw clean coal power generating facility to be located at Energy's Wabash River Generating Station. The clean coal facility consists of a coal gasification plant and a gas turbine generator. Exhaust heat from the gas turbine (192 mw) will produce steam to repower an existing steam turbine (70 mw). Refer to the information appearing under the caption \"New Generation\" in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 26.\nEnergy's 1993 summer peak load, which occurred on August 26, was 4,812 mw, and its 1993 winter peak load, which occurred on February 18, was 4,155 mw, exclusive of off-system transactions. For the period 1994 to 2003, summer and winter peak load and kilowatt-hour (kwh) sales are each forecasted to have annual growth rates of 2%. These forecasts reflect Energy's assessment of load growth, alternative fuel choices, population growth, and housing starts. These forecasts exclude non-firm power transactions and any potential long- term firm power sales at market-based prices.\nAs of December 31, 1993, Energy's transmission system consisted of 719 circuit miles of 345,000 volt line, 656 circuit miles of 230,000 volt line, 1,601 circuit miles of 138,000 volt line, and 2,418 circuit miles of 69,000 volt line, all within the State of Indiana. As of the same date, Energy's transmission substations had a combined capacity of 20,520,154 kilovolt- amperes and the distribution substations had a combined capacity of 5,952,175 kilovolt-amperes.\nFor the year ended December 31, 1993, 99% and 1% of Energy's kwh production was obtained from coal-fired generation and hydroelectric generation, respectively.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMerger Agreement Litigation Resources' original merger agreement with CG&E was amended in response to a June 25, 1993, ruling by the IURC which dismissed a petition by Energy for approval of the transfer of its license or property to CINergy Corp., an Ohio corporation, pursuant to the original merger agreement. The IURC held that such transfer could not be made to a corporation incorporated outside of Indiana. Under the terms of the amended merger agreement, CINergy Corp. (CINergy), a Delaware corporation, will be the parent holding company of Energy and CG&E and will be required to register under the Public Utility Holding Company Act of 1935 (PUHCA). Pursuant to the amended merger agreement, Energy agreed to appeal the IURC's decision or take other action to obtain the permission of the IURC for a non-Indiana corporation to own Energy's assets. Energy has appealed the IURC's decision. In the event the appeal or other action is successful, the parties to the amended merger agreement could take actions to achieve the original merger structure. The original structure provided that Resources, Energy, and CG&E would be merged into CINergy Corp., an Ohio corporation. Under this structure, Energy and CG&E would become operating divisions of CINergy Corp., ceasing to exist as separate corporations, and CINergy Corp. would not be a registered holding company under the PUHCA. Any action taken with respect to this litigation is not expected to delay the merger of Resources and CG&E under a registered holding company structure.\nThe Katz Action On March 16, 1993, after the announcement of IPALCO Enterprises, Inc.'s acquisition offer, a purported class action was filed by Moise Katz (Katz Action) in the Superior Court for Hendricks County in the State of Indiana (Superior Court) in which Resources and the directors of Resources and Energy were named as defendants. The Katz Action alleges, among other things, that the directors breached their fiduciary duties in connection with the original merger agreement, Resources Stock Option Agreement (see Note 20 of the \"Notes to Consolidated Financial Statements\" beginning on page 63), and Resources Shareholder Rights Plan and seeks, among other things, to enjoin the CINergy merger transaction and to require that an auction for Resources be held. On April 7, 1993, Resources and the other defendants filed a motion to dismiss the Katz Action, and on July 1, 1993, the Superior Court granted that motion. On July 19, 1993, the Superior Court issued an order which vacated its July 1, 1993, order but granted Resources' motion to dismiss Count I of the Katz Action for failure to bring the breach of fiduciary duty claims in a derivative proceeding.\nOn August 18, 1993, a purported third amended class action and derivative complaint was filed in the Katz Action, seeking injunctive relief and damages for alleged breach of fiduciary duty by the directors of Resources. Among other things, this complaint alleges that the defendants failed to disclose (i) the factors that Resources' Board of Directors considered in reaffirming its recommendation that Resources' shareholders approve the merger with CG&E and whether those factors included a consideration of the divestiture of the CG&E gas operations; (ii) whether and to what extent Lehman Brothers took into consideration the divestiture of the CG&E gas operations, and the ramifications thereof, in rendering its July 2, 1993, fairness opinion regarding the merger with CG&E; (iii) the pro forma effect on the merged company taking into consideration the divestiture of the CG&E gas operations; (iv) whether the \"comparable\" company analysis performed by Lehman Brothers consisted of companies operating electrical systems or gas and electrical systems and whether such analysis included or excluded the CG&E gas operations; and (v) whether Resources' Board of Directors was informed of the ramifications of the divestiture of the CG&E gas operations and to what extent, if any, Resources' Board of Directors took into consideration such ramifications before it endorsed the amended merger agreement to Resources' shareholders. Resources denies these allegations. Resources anticipates that the dismissal of the PSI Merger Shareholder Action and the resolution of related attorney fees, as discussed below, will result in the dismissal of the Katz Action.\nThe foregoing descriptions of the July 1993 orders and the August 18, 1993, third amended complaint in the Katz Action are qualified in their entirety by reference to copies of such orders incorporated by reference as exhibits hereto.\nThe PSI Merger Shareholder Action On March 17, 1993, a purported class action was filed by Lydia Grady (Grady Action) in the Superior Court in which Resources and 13 directors of Resources and Energy were named as defendants. On April 13, 1993, the Indiana District Court issued an order which, among other things, consolidated the Grady Action with the following cases: J.E. and Z.B. Butler Foundation v. PSI Resources, Inc., et al.; Lamont Carpenter, et al. v. PSI Resources, Inc., et al.; Ronald Gaudiano, et al. v. PSI Resources, Inc., et al.; and Sonny Merrit v. PSI Resources, Inc., et al. (together, the \"PSI Merger Shareholder Action\").\nOn July 19, 1993, a hearing was held in the Indiana District Court in the PSI Merger Shareholder Action on the plaintiffs' motion for a preliminary injunction. On August 5, 1993, the Indiana District Court issued an order granting the preliminary injunction sought by the plaintiffs and ordered Resources, within 20 days, to provide shareholders with certain additional information relating to the pro forma effect on CINergy Corp.'s financial condition of the possible divestiture of CG&E's gas operations. The Indiana District Court also ordered additional disclosure concerning, among other things, Lehman Brothers' consideration of that possibility in connection with its July 2, 1993, fairness opinion to Resources' Board of Directors. Resources complied with this order in its Proxy Statement Supplement dated August 12, 1993.\nIn January 1994, the parties in the PSI Merger Shareholder Action as well as the parties to the Katz Action signed a Stipulation and Agreement of Dismissal (the \"Stipulation\"). The Stipulation contemplates, among other things, that the parties will jointly move the Indiana District Court for entry of a final order dismissing the PSI Merger Shareholder Action with prejudice and ruling on the plaintiffs' application for fees and expenses. The parties to the Stipulation have agreed to provide notice to Resources' shareholders of a hearing during which the proposed final order will be considered by the Indiana District Court. If the plaintiffs are entitled to recover these fees, Resources does not anticipate this cost to have a material adverse effect on its financial condition.\nThe foregoing descriptions of the April 13, 1993, class actions consolidation order, and the August 5, 1993, Indiana District Court order are qualified in their entirety by reference to copies of such documents incorporated by reference as exhibits hereto.\nIn addition to the above litigation, see Notes 2, 3(a), and 16(b) and (c) beginning on pages 45, 47, and 60, respectively, of the \"Notes to Consolidated Financial Statements\".\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nResources' merger agreement with CG&E to form CINergy was approved at Resources' Special Meeting of Shareholders held on November 9, 1993. Resources had 56,948,282 outstanding shares of common stock as of September 24, 1993, constituting all of the outstanding voting securities of Resources. Each share of common stock was entitled to one vote. The holders of 48,020,085 shares were represented with 47,325,271 shares voting FOR and 332,431 shares voting AGAINST the approval of the merger agreement; 362,383 shares ABSTAINED from voting on the merger agreement.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAge at Dec. 31, Name 1993 Office & Date Elected or in Job\nJames E. Rogers 46 Chairman and Chief Executive Officer of Resources - 1993 Chairman, President and Chief Executive Officer of Energy - 1990 Chairman, President and Chief Executive Officer of Resources - 1988 Chairman and Chief Executive Officer of Energy - 1988\nJohn M. Mutz 1\/ 58 President of Resources - 1993 President - Lilly Endowment, Inc. 2\/ - 1989\nJon D. Noland 55 Executive Vice President of Resources - 1992 Executive Vice President and Chief Administration Officer of Energy - 1992 Executive Vice President of Energy - 1990 Vice President and General Counsel of Resources - 1989 Executive Vice President - Law and Regulation of Energy - 1989 Vice President of Resources - 1988 Executive Vice President - Law and Financial Services of Energy - 1986\nJ. Wayne Leonard 43 Senior Vice President and Chief Financial Officer of Resources and Energy - 1992 Vice President and Chief Financial Officer of Resources and Energy - 1989 Vice President - Corporate Planning of Energy - 1987\nCheryl M. Foley 3\/ 46 Vice President, General Counsel and Secretary of Resources and Energy - 1991 Vice President and General Counsel of Resources - 1990 Vice President and General Counsel of Energy - 1989 Vice President and General Counsel - Interstate Pipelines - Enron Corporation 2\/ - 1987\nM. Stephen Harkness 45 Treasurer of Resources and Energy - 1991 Treasurer and Assistant Secretary of Resources - 1988 Treasurer and Assistant Secretary of Energy - 1986\nCharles J. Winger 48 Comptroller of Resources - 1988 Comptroller of Energy - 1984\nEXECUTIVE OFFICERS OF THE REGISTRANT (continued)\nNone of the officers are related in any manner. Executive officers of Resources are elected to the offices set opposite their respective names until the next annual meeting of the Board of Directors and until their successors shall have been duly elected and shall have been qualified.\n1\/ Prior to becoming president of Resources, Mr. Mutz was president of Lilly Endowment, Inc., a private philanthropic foundation located in Indianapolis, Indiana and also served two terms as lieutenant governor of Indiana.\n2\/ Non-affiliates of Resources and Energy.\n3\/ Prior to joining Energy, Mrs. Foley was vice president and general counsel for various divisions\/subsidiaries of Enron Corporation, a diversified energy company headquartered in Houston, Texas.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nResources' common stock is listed on the New York Stock Exchange and has unlisted trading privileges on the Boston, Chicago, Cincinnati, Pacific, and Philadelphia exchanges. As of February 28, 1994, there were 22,075 common shareholders of record. Refer to the information in Notes 4 through 7 of the \"Notes to Consolidated Financial Statements\" beginning on page 48.\nThe following table shows the high and low sale prices of Resources' common stock and the dividends declared per share for the past two years:\nSee \"Significant Achievements\" in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on page 17 for a discussion of Resources' quarterly common dividend payments.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nThe financial condition of PSI Resources, Inc. (Resources) and its principal subsidiary, PSI Energy, Inc. (Energy), is currently, and will continue to be, significantly affected by:\n. The changing competitive environment for electric utilities, including more intense competition in wholesale power markets and emerging competition for the provision of energy services to retail customers, particularly industrial;\n. The regulatory response to the changing competitive environment, including the application of incentive ratemaking, the need for more flexible pricing, and the treatment of business alliances entered into in response to such changes (e.g., the merger with The Cincinnati Gas & Electric Company [CG&E] discussed further herein); and\n. The substantial costs associated with Energy's construction program, including environmental compliance and the regulatory response to the potentially significant earnings attrition resulting from such program.\nEnergy's goal is to achieve the financial measures necessary to assure access, at a reasonable cost, to the capital required to finance its construction program, which is necessary to provide adequate and reliable service to its customers. Specific financial objectives include achieving and maintaining common equity at a minimum of 45% of capitalization, achieving at least an \"A\" credit rating on senior securities, and increasing the common dividend in an orderly manner. Energy's achievement of its goal is increasingly dependent upon maintaining its favorable competitive position.\nCompetitive Pressures\nThe increasing competitive pressures in the electric utility industry are primarily driven by the need of U.S. industries for low cost power in order to remain competitive in the global marketplace. The restrictions on access to low cost power are exacerbated by cost-of-service regulation which has produced average industrial rates to customers that vary substantially across the U.S. (from 3 cents per kilowatt-hour [kwh] to over 10 cents per kwh). Although the electric utility industry has already experienced substantial competition in the wholesale power market, the effect of competition has arguably had only a marginal effect on the overall profitability of the industry. The effect of the Energy Policy Act of 1992 (Energy Act), the most comprehensive energy legislation enacted since the late 1970s, is to essentially provide open competition, at the wholesale level, for new generation resources. The Energy Act increases the level of competition by creating a new class of wholesale power providers that are not subject to the restrictive requirements of the Public Utility Holding Company Act of 1935 (PUHCA) nor the ownership restrictions of the Public Utility Regulatory Policies Act of 1978. This, combined with the provision of the Energy Act granting the Federal Energy Regulatory Commission (FERC) the authority to order wholesale transmission access, makes the competition real in the wholesale power market. However, by prohibiting the FERC from ordering utilities to provide transmission access to retail customers (retail wheeling), Congress clearly intended to allow states to decide whether a competitive generation market will extend to retail customers. In the face of ongoing international competition, Energy believes major industrial customers of electric utilities will continue to pressure state legislatures and utility regulatory commissions to permit retail wheeling. Although specific proposals for retail wheeling have not been advanced in Indiana, at least eight states are at various stages in considering proposals for retail wheeling.\nIn the fourth quarter of 1993, major credit rating agencies issued reports sounding a warning as to the long-term effect of competition on the electric utility industry. Standard & Poor's (S&P), in particular, announced fundamental changes in the way it evaluates credit quality of electric utilities, essentially declaring its view that business risk is increasing, in part, because electric utility prices will be capped at some level established by competition, regardless of the particular company's costs. Not only will it be difficult for high cost producers to secure further rate increases, they also will likely experience substantial price decreases as competition intensifies. Consequently, it appears inevitable that high cost producers will require better financial fundamentals than low cost producers to secure the same credit rating. Specifically, S&P has categorized each electric utility's business position, ranking it as being above average, average, or below average. As a result, S&P revised the rating outlooks of approximately one-third of the electric utility industry from stable to negative and placed several electric utilities on CreditWatch with negative implications.\nEnergy believes the concerns raised by S&P and other major credit rating agencies, in part, explain recent activity in the electric utility segment of the stock market. The electric utility group dropped substantially more in the fourth quarter of 1993 than the bond market (usually a barometer for electric utility stocks). As a result, the yield spread between long-term U.S. Treasuries and electric utility stocks dropped from the 3 to 5 year average of 110 to 120 basis points to 20 to 30 basis points.\nDuring this same period, several \"sell-side\" equity analysts have expressed their concerns in written reports that investors, particularly small retail investors, do not currently understand the increased business risk facing electric utilities due to competitive pressures, the threat of lower prices to customers, and the threat of \"regulated competition\". As a result, some equity analysts believe that electric utility stock prices were driven upwards to near record market to book levels by investors seeking higher yields during a period of lower interest rates without full recognition of the changed risks in the industry. Similar to S&P's analysis of fixed income securities, Energy believes that many equity analysts are now basing their buy-sell equity recommendations for electric utility stocks, in large part, on (i) the price position of the utility relative to neighboring competition, (ii) the elasticity of the current customer make-up, particularly industrial, (iii) the response of state regulators to competitive issues, and (iv) the aggressiveness of management in \"inventing its own future\".\nEnergy believes it is well positioned to succeed in the increasingly competitive environment. Energy's favorable competitive position is a result of and\/or will be enhanced by:\n. The consummation of the merger with CG&E which will combine two low cost providers of electric energy and provide substantial competitive benefits and opportunities;\n. Energy's demonstrated ability to be a low cost producer of electric energy. Energy has consistently held operating cost increases below inflation and has current average retail rates below 1983 levels. This low cost position is further illustrated in a December 1993 report (using 1992 data) by Bear, Stearns & Co., Inc. which listed Energy as the third lowest cost (fixed plus variable production costs) provider of generation among 28 utilities in the North Central Region of the U.S. Additionally, in a May 1993 study (using 1992 data) by Regulatory Research Associates, Inc. (RRA) of 135 major investor-owned operating utilities and holding companies, Energy's average industrial rate of 3.5 cents per kwh was approximately 30% lower than the national average industrial rate of 5.1 cents per kwh. This same study also indicated that the average rate for Energy's retail customers of 4.6 cents per kwh was at least 35% below the national average of 7.1 cents per kwh, and lower than at least 85% of the companies included in the study. Further, Energy's average industrial and retail rates were both at least 15% below the North Central Region of the U.S. average rates derived from the data relating to these utilities included in the May 1993 RRA report;\n. Management's focus on flexible strategies which are directed toward reducing its cost structure and reducing operating leverage, in part, by shifting the cost mix from fixed to variable. For example, Energy is actively enforcing its rights under its existing coal contracts, litigating where necessary, in order to significantly lower fuel costs. Energy has also recently received approval of its emission allowance banking strategy, which is expected not only to substantially reduce Energy's future cost structure and capital outlays, but also to greatly enhance its flexibility to meet future energy needs and environmental requirements. Additionally, Energy intends to purchase power to defer the construction of new generation which will likely be further deferred if the merger with CG&E is consummated; and\n. Energy's success at creating customer value, as demonstrated by customer satisfaction levels at the top of a peer group of 16 electric and combination electric and gas utilities. This success was further demonstrated during 1993 as several mayors and leaders of communities within Energy's service territory, including over 30 economic development organizations across Energy's service territory and eight Indiana environmental groups, actively supported Energy in its response to IPALCO Enterprises, Inc.'s (IPALCO) hostile takeover attempt, as the electric utility of choice to serve their communities.\nEnergy further believes its low cost position and strategic initiatives will allow it to maintain, and perhaps expand, its wholesale market share and its current base of industrial customers. Sales to industrial customers represented approximately 28% of Resources' 1993 total operating revenues.\nDuring the fourth quarter of 1993, S&P, using its revised benchmarks for rating electric utility senior securities, placed Energy in an above average business position. At the same time, certain sell-side equity analysts placed Energy near the top of their lists of those best equipped to handle increasing competitive pressures. Energy believes that the reaction of these equity analysts and the stock market in 1993 supports its position that its competitive strategy will be successful. According to a January 1994 edition of Electric Utility Week, the 32.5% increase in Resources' stock price was the third highest of the 105 utilities studied, while the group as a whole averaged only a 5.5% gain over 1992.\nIncreasing competitive pressures, and the regulatory response thereto, may ultimately result in some electric utilities being unable to continue their current basis of accounting. The basis of accounting currently followed by most regulated electric utilities is based on the premise that customer rates authorized by regulators are cost based and that a utility will be able to charge and collect rates based on its costs. To the extent regulators no longer provide assurances for recovery of a utility's costs or the marketplace does not allow the pricing necessary to fully recover costs, a regulated utility could be required to prepare its financial statements on the same basis as enterprises in general for all or some portion of its business. Energy believes its low cost position and competitive strategy, combined with its current regulatory environment, would mitigate the potentially adverse effects of such changes.\nSecurities Ratings\nThe current ratings of Energy's senior securities reflect the risk associated with the costs of achieving compliance with environmental laws and regulations. However, Duff & Phelps, Fitch Investors Service, and S&P continue to place Energy's debt ratings on review for possible upgrade primarily as a result of the announced merger with CG&E. The ratings are currently as follows: First Mortgage Bonds and Secured Preferred Medium-term Notes Stock Duff & Phelps BBB+ BBB Fitch Investors Service BBB+ BBB Moody's Baa1 baa2 Standard & Poor's BBB+ BBB These securities ratings may be revised or withdrawn at any time, and each rating should be evaluated independently of any other rating.\nSignificant Achievements\nThe following events during 1993 indicate Energy's progress towards achieving its financial objectives:\n. The announced merger with CG&E, which was initiated in response to the changing competitive environment in the electric utility industry, was approved by shareholders of Resources and CG&E in November 1993 (see Merger Agreement with CG&E discussion beginning on page 18);\n. In October 1993, Resources' Board of Directors increased its quarterly common dividend 3 cents (10.7%), to 31 cents per share. This marks the fourth consecutive year in which the dividend has increased at a double-digit rate and is an integral part of the ongoing effort to strengthen and broaden the market for Resources' common stock. Future increases in Resources' common dividend will continue to be influenced by Energy's financial condition (see Dividend Restrictions discussion on page 34). Resources currently has an effective shelf registration statement for the sale of up to eight million shares of common stock;\n. The Indiana Utility Regulatory Commission (IURC) issued an order approving Energy's plan for complying with Phase I of the acid rain provisions of the Clean Air Act Amendments of 1990 (CAAA) and Energy's emission allowance banking strategy (see Regulatory Matters and Capital Needs discussions beginning on pages 21 and 24, respectively);\n. Energy filed testimony with the IURC in support of a $103 million, 11.6% retail rate increase. This testimony also includes proposals for certain innovative ratemaking mechanisms designed to reduce business and regulatory risks over the next three years (see Regulatory Matters discussion beginning on page 21);\n. In accordance with a January 1993 IURC order, Energy implemented accounting changes on certain major capital projects to offset the effects of regulatory lag, i.e., earnings attrition. These accounting changes favorably affected 1993 earnings by approximately $7 million. Energy's current retail rate proceeding includes a proposal to continue this accounting treatment for certain major capital projects (see Regulatory Matters discussion beginning on page 21);\n. Energy refinanced $223 million of long-term debt and preferred stock to take advantage of lower interest and dividend rates. Energy expects to save approximately $4 million in annualized interest and preferred stock dividends as a result of these refinancings; and\n. The IURC approved a settlement agreement which resolved outstanding issues related to the IURC's April 1990 rate order (April 1990 Order) and June 1987 tax order (June 1987 Order) (see Regulatory Matters discussion beginning on page 21). Although this settlement resulted in a significant customer refund, it resolved major uncertainties with respect to Energy's financial condition.\nRecent Developments\nMerger Agreement with CG&E\nGeneral Resources, Energy, and CG&E entered into an Agreement and Plan of Reorganization dated as of December 11, 1992, which was subsequently amended and restated on July 2, 1993, and as of September 10, 1993 (as amended and restated, the \"Merger Agreement\"). Under the Merger Agreement, Resources will be merged with and into a newly formed corporation named CINergy Corp. (CINergy) and a subsidiary of CINergy will be merged with and into CG&E (\"CG&E Merger\", collectively referred to as the \"Mergers\"). Following the Mergers, CINergy will be the parent holding company of Energy and CG&E and will be required to register under the PUHCA. The combined entity will be the 13th largest investor-owned electric utility in the nation, based on generating capacity, and will serve approximately 1.3 million electric customers and 420,000 gas customers in a 25,000-square-mile area of Indiana, Ohio, and Kentucky. See the discussion under \"Shareholder and Regulatory Approvals\" for information concerning the possible divestiture of CG&E's gas operations as a consequence of the Mergers. Customer revenue requirement savings as a result of the Mergers are estimated to be approximately $1.5 billion over the first 10 years. These savings are expected to include the elimination or deferral of certain capital expenditures and a reduction in production, administrative, and financing costs.\nThe Merger Agreement can be terminated by any party, without financial penalty, if the Mergers are not consummated by June 30, 1994. Under certain circumstances, the termination of the Merger Agreement would result in the payment of termination fees, which may not exceed $70 million, if Resources is required to pay, or $130 million, if CG&E is required to pay.\nExchange Ratio The Merger Agreement provides that, upon consummation of the Mergers, each outstanding share of common stock of Resources will be converted into the right to receive not less than .909 nor more than 1.023 shares of common stock of CINergy depending on certain closing sales prices of the common stock of CG&E during a period prior to the consummation of the Mergers. The Merger Agreement also provides that, upon consummation of the Mergers, each outstanding share of common stock of CG&E will be converted into the right to receive one share of common stock of CINergy. The outstanding preferred stock and debt securities of Energy and CG&E will not be affected.\nShareholder and Regulatory Approvals In November 1993, the Mergers were approved by the shareholders of Resources and CG&E. In August 1993, the FERC conditionally approved the Mergers. This conditional approval was made by the FERC without a formal hearing and, according to public statements by the FERC Commissioners, was done in reliance, in part, on the FERC's belief that the regulatory commissions of the affected states would have authority to approve or disapprove the Mergers. The companies accepted the FERC's conditions and indicated their belief that none of the conditions would have a material adverse effect on the operations, financial condition, or business prospects of CINergy. Certain parties petitioned for rehearing of the FERC's conditional approval. On September 15, 1993, Energy and CG&E filed a statement with the FERC clarifying their conclusions at that time that the Mergers would not require any prior approval of a state commission under state law. Given the issues raised on the requests for rehearing and the lack of certainty in the record regarding state regulatory powers, on January 12, 1994, the FERC issued an order withdrawing its prior conditional approval of the Mergers and initiating a 60-day, FERC-sponsored settlement procedure. The settlement procedure is expected to be concluded prior to the end of March 1994. The FERC has indicated that, if the settlement procedure is not successful, it intends to issue a further order setting appropriate issues for hearing.\nThe companies are currently participating in a collaborative process with representatives from the IURC, the Public Utilities Commission of Ohio, various consumer groups, and other parties to settle all merger-related issues. Discussions have also taken place with representatives of the Kentucky Public Service Commission (KPSC) regarding merger-related issues at the FERC. In conjunction with the FERC-sponsored settlement procedure, on February 11, 1994, Energy filed a petition with the IURC requesting approval of various proposals regarding state regulation after consummation of the Mergers. These proposals do not address the allocation between shareholders and customers of projected revenue requirement savings as a result of the Mergers. This allocation will be the subject of a subsequent IURC proceeding.\nIn connection with the 60-day, FERC-sponsored settlement procedure and the collaborative process, Resources, Energy, CINergy, the Indiana Utility Consumer Counselor, the Citizens Action Coalition of Indiana, Inc., and industrial customer representatives reached a global settlement agreement on merger-related issues. This agreement was filed with the IURC on March 2, 1994, and is expressly conditioned upon approval by the IURC in its entirety and without any change or condition that is unacceptable to any party. On March 4, 1994, CG&E, the Public Utilities Commission of Ohio, and the Ohio Office of Consumers Counsel reached an agreement substantially similar to the Indiana agreement. Both settlement agreements were filed with the FERC on March 4, 1994. Energy expects the FERC settlement judge to forward the settlements to FERC Commissioners on or about March 21, 1994, beginning what is normally a 30-day comment period. The Indiana settlement addresses, among other things, the coordination of state and Federal regulation, the operation of the combined Energy and CG&E electric utility system, the allocation of costs and their effect on customer rates, and a retail \"hold harmless\" provision that provides that Energy's retail rates will not reflect merger- related costs to the extent that they are not offset entirely by merger- related benefits.\nIURC hearings on the Indiana settlement were held on March 17, 1994. Energy has asked the IURC for an order approving the settlement agreement by early April 1994, which should fall within the expected comment period at the FERC.\nCG&E also filed with the FERC a unilateral offer of settlement addressing all issues raised in the KPSC's application for rehearing with the FERC. On March 15, 1994, CG&E filed an application with the KPSC seeking approval of the indirect acquisition of control of CG&E's Kentucky subsidiary, The Union Light, Heat and Power Company.\nAlso included in the filings with the FERC were settlement agreements with WVPA and the city of Hamilton, Ohio. These agreements resolve issues related to the transmission of power and operation of Energy's jointly owned transmission system. Negotiations with other parties at the FERC are continuing.\nEnergy and CG&E also filed with the FERC the operating agreement among Energy, CG&E, and CINergy Services, Inc., a subsidiary of CINergy. The parties to the Indiana and Ohio FERC settlements have agreed to support or not oppose the operating agreement, and the settlements are conditioned upon the FERC approving the filed operating agreement without material change.\nThe Mergers are also subject to the approval of the Securities and Exchange Commission (SEC) under the PUHCA. An application requesting such SEC approval is expected to be filed during the first quarter or early second quarter of 1994. The PUHCA imposes restrictions on the operations of registered holding company systems. Among these are requirements that securities issuances, sales and acquisitions of utility assets or of securities of utility companies, and acquisitions of interests in any other business be approved by the SEC. The PUHCA also limits the ability of registered holding companies to engage in non-utility ventures and regulates holding company system service companies and the rendering of services by holding company affiliates to the system's utilities. Also, under the PUHCA, the divestiture of CG&E's gas operations may be required. The companies believe they have a justifiable basis for retention of CG&E's gas operations and will request SEC approval to retain this portion of the business. Divestiture, if ordered, would occur after the consummation of the Mergers. Historically, the SEC has allowed companies sufficient time to accomplish divestitures in a manner that protects shareholder value, which, in some cases, has been 10 to 20 years.\nThe companies' goal is to consummate the Mergers during the third quarter of 1994. However, if the settlement procedure is not successful and a hearing is convened by the FERC, the consummation of the Mergers would likely be further extended. There can be no assurance that the Mergers will be consummated.\nSee Notes 20, 21, and 22 beginning on page 63.\nIPALCO's Withdrawn Acquisition Offer\nOn March 15, 1993, IPALCO announced its intention to make an offer to exchange IPALCO common stock and cash for all of the outstanding shares of Resources' common stock (Exchange Offer). IPALCO also announced its intention to solicit proxies to vote (i) in favor of its slate of five nominees for the Board of Directors of Resources at Resources' 1993 Annual Meeting of Shareholders and (ii) against the merger with CG&E. On April 21, 1993, IPALCO commenced its Exchange Offer and also commenced solicitation of proxies. On August 23, 1993, at Resources' 1993 Annual Meeting of Shareholders, IPALCO announced that it had received insufficient proxies to elect its nominees to Resources' Board of Directors, and on that same date, terminated its Exchange Offer.\nOn October 27, 1993, Resources, Energy, CG&E, IPALCO, and other parties entered into a settlement agreement pursuant to which the parties agreed to settle all pending issues related to IPALCO's Exchange Offer. Among other things, the parties agreed, for a period of five years, to grant one another transmission access rights to other utilities, in certain circumstances, if those rights are required for one of the parties to obtain approval for a business combination with another utility. The parties would be fully compensated for any facilities made available. Energy currently has an open access tariff that allows other utilities to use its transmission facilities to deliver power, which it believes should be sufficient to satisfy this provision of the settlement agreement. The settlement agreement also provides that Indianapolis Power & Light (IP&L), IPALCO's principal subsidiary, will have the right to purchase power from Energy at current market prices. Energy has offered to sell IP&L up to 100 megawatts of power for each month in 1996 and up to 250 megawatts for each month in the years 1997 through 2000. The offer will remain open for one year, and if IP&L does not accept the offer, it will have a right of first refusal on the power for an additional six months.\nRegulatory Matters\nEnvironmental Order In 1992, Energy filed its plan for complying with Phase I of the acid rain provisions of the CAAA with the IURC. This filing was made pursuant to a state law enacted in 1991 which allows utilities to seek pre- approval of their compliance plans. In October 1993, the IURC issued an order approving Energy's Phase I compliance plan. The IURC's order also approved Energy's emission allowance banking strategy, which will afford Energy greater flexibility in developing its plan for complying with Phase II of the acid rain provisions of the CAAA. The IURC accepted Energy's proposal to annually review the implementation of its Phase I compliance plan and ordered a semi- annual review of Energy's emission allowance banking plan.\nEnergy had proposed innovative performance incentive mechanisms as part of its Phase I compliance plan and emission allowance banking strategy. In its post- hearing filing, Energy requested that the IURC defer consideration of such incentives to Energy's pending retail rate proceeding in which Energy has proposed modified environmental compliance incentives with respect to its emission allowance banking strategy.\nRate Case Energy filed testimony with the IURC in support of a $103 million, 11.6% retail rate increase. This rate proceeding addresses the financial and operating requirements of Energy on a \"stand-alone\" basis without consideration of the anticipated effects of the Mergers. Approximately 3.7% of the rate increase is needed to meet new environmental requirements, 6.6% is primarily needed to meet Energy's growing electric needs, including construction and operation of one combustion turbine generating unit and implementation of demand-side management (DSM) programs, and 1.3% of the increase is necessary for the recognition of postretirement benefits other than pensions on an accrual basis. Energy's petition for an increase in retail rates includes a \"performance efficiency plan\" which would allow Energy to retain all earnings up to a 12.5% common equity return and provide for sharing of common equity returns from 12.5% to 14.5% between shareholders and ratepayers depending upon Energy's performance on measures of customer prices, customer satisfaction, customer service reliability, equivalent availability of its generating units, and employee safety. All earnings above a 14.5% return on common equity would be returned to ratepayers. In addition, Energy is requesting approval of various ratemaking mechanisms to address regulatory lag on specific environmental and new generation projects to ensure that the interests of ratepayers and shareholders are properly aligned. One such mechanism includes capital costs associated with major environmental compliance projects and the applicable portion of its Wabash River clean coal project (Clean Coal Project) in rate base while the projects are under construction, as permitted by state law, thus allowing Energy to earn a cash return on these costs prior to the projects' in-service dates. Hearings are expected to begin in April 1994, and a final rate order is anticipated in late 1994 or early 1995. Energy cannot predict what action the IURC may take with respect to this proposed rate increase.\nSettlement Agreement In December 1993, the IURC issued an order (December 1993 Order) approving a settlement agreement entered into by Energy, the appellants, and certain other intervenors which resolved the outstanding issues related to the appeals of the IURC's April 1990 Order and June 1987 Order. At issue with respect to the April 1990 Order was whether the level of return on common equity allowed Energy was adequately supported by factual findings. The April 1990 Order had been remanded to the IURC by the Indiana Court of Appeals for further proceedings, including redetermination of the cost of equity and its components. The June 1987 Order, which related to the effect on Energy of the 1987 reduction in the Federal income tax rate, had been remanded to the IURC by the Indiana Supreme Court and was awaiting a final order from the IURC. The December 1993 Order provides for Energy to refund $150 million to its retail customers ($119 million applicable to the June 1987 Order and $31 million applicable to the April 1990 Order). The December 1993 Order further provides for Energy to reduce its retail rates by 1.5% (approximately $13.5 million on an annual basis) to reflect a return on common equity of 14.25%. The refunds and rate reduction commenced in December 1993 (see Note 3 beginning on page 47).\nEnergy had previously recognized a loss of $139 million for the June 1987 Order. The difference between the $139 million and the $119 million portion of the refund applicable to the June 1987 Order is reflected in the Consolidated Statement of Income for the year ended December 31, 1993, as a reduction of the loss. The $31 million portion of the refund applicable to the April 1990 Order is reflected in the Consolidated Statement of Income for the same period as a reduction in operating revenues.\nEnergy has an agreement through January 1996 to sell, with limited recourse, an undivided percentage interest in certain of its accounts receivable from customers up to a maximum of $90 million. The refund provided for by the December 1993 Order reduced Energy's accounts receivable available for sale and caused a termination event under the agreement governing the sale of accounts receivable. Due to the temporary nature of the event, Energy obtained a waiver of the termination event provision of the agreement as it relates to the refund (see Note 10 on page 52).\nManufactured Gas Plants\nCoal tar residues and other substances associated with manufactured gas plant (MGP) sites have been found at former MGP sites in Indiana, including, but not limited to, two sites previously owned by Energy. Energy has identified at least 21 MGP sites which it previously owned, including 19 it sold in 1945 to Indiana Gas and Water Company, Inc. (now Indiana Gas Company [IGC]).\nIn April 1993, IGC filed testimony with the IURC seeking recovery of costs incurred in complying with Federal, state, and local environmental regulations related to MGP sites in which it has an interest, including sites acquired from Energy. In its testimony, IGC stated that it would also seek to recover a portion of these costs from other potentially responsible parties, including previous owners. The IURC has not ruled on IGC's petition.\nWith the exception of one site (Shelbyville), it is premature for Energy to predict the nature, extent, and costs of, or Energy's responsibility for, any environmental investigations and remediations which may be required at MGP sites owned, or previously owned, by Energy. With respect to the Shelbyville site, for which Energy and IGC are sharing the costs, based upon environmental investigations completed to date, Energy believes that any required investigation and remediation will not have a material adverse effect on its financial condition (see Note 16 beginning on page 60).\nOther Industry Issues\nGlobal Climate Change Concern has been expressed by environmentalists, scientists, and policymakers as to the potential climate change from increasing amounts of \"greenhouse\" gases released as by-products of burning fossil fuel and other industrial processes. In response to this concern, in October 1993, the Clinton Administration announced its plan to reduce greenhouse gases to 1990 levels by the year 2000. The plan calls for the reduction of 109 million metric tons of carbon equivalents of all greenhouse gases. Initially, the plan would rely largely on voluntary participation of many industries, with a substantial contribution expected from the utility industry. Numerous utilities, including Energy, have agreed to study voluntary, cost-effective emission reduction programs. Energy's voluntary participation would likely include its residential, commercial, and industrial DSM programs, increased use of natural gas in generation, and other energy efficiency improvements, and possibly other pollution prevention measures. The Clinton Administration has stated it will monitor the progress of industry to determine whether targeted reductions are being achieved. If the Clinton Administration or Congress should conclude that further reductions are needed, legislation requiring utilities to achieve additional reductions is possible.\nAir Toxics The air toxics provisions of the CAAA exempt fossil-fueled steam utility plants from mandatory reduction of 189 listed air toxics until the Environmental Protection Agency (EPA) completes a study on the risk of these emissions on public health. The EPA is not expected to complete its study until November 1995. If additional air toxics regulations are established, the cost of compliance could be significant. Energy cannot predict the outcome of this EPA study.\nFuture Outlook\nNotwithstanding the anticipated benefits from the timely consummation of the Mergers, further improvement in Energy's financial condition is largely dependent on:\n. Effectively responding to the increasing competitive pressures in the electric utility industry;\n. Effectively managing its substantial construction program and achieving favorable results from related regulatory proceedings, including the current retail rate proceeding;\n. Maintaining a regulatory climate that is responsive to and supportive of changes in the utility industry, including increased competition, business alliances, and the need to more closely align the economic interests of customers and shareholders through the application of incentive ratemaking, and more flexible pricing strategies; and\n. Successfully accessing financial markets for capital needs, including issuance by Resources of significant amounts of common stock (see Capital Resources discussion beginning on page 27).\nCAPITAL NEEDS\nConstruction\nEnergy's total construction expenditures over the 1994 to 1998 period are forecasted to be $1.1 billion, of which approximately $.8 billion is for capital improvements to, and expansion of, Energy's operating facilities, $.2 billion is for new generation, and $.1 billion is for environmental compliance. Total construction expenditures for 1993 and forecasted construction expenditures for the 1994 to 1997 period are approximately $.2 billion less than forecasted amounts for the same period reflected in Resources' 1992 Annual Report to Shareholders. This reduction reflects continued aggressive management by Energy of its substantial construction program consistent with maintaining its competitive position and providing adequate and reliable service to its customers. (All forecasted amounts are in nominal dollars and reflect assumptions as to the economy, capital markets, construction program, legislative and regulatory actions, frequency and timing of rate increase requests, and other related factors which may be subject to significant change. In addition, forecasted construction expenditures do not reflect any consideration for the effects of the Mergers.)\nForecasted construction expenditures by year for new business, system reliability, new generation, environmental, and other projects are presented in the following table:\nEnvironmental\nThe acid rain provisions of the CAAA require reductions in both sulfur dioxide (SO2) and nitrogen oxide (NOx) emissions from utility sources. Reductions of both SO2 and NOx emissions will be accomplished in two phases. Compliance under Phase I affects Energy's four largest coal-fired generating stations and is required by January 1, 1995. Phase II includes all of Energy's existing power plants, and compliance is required by January 1, 2000.\nTo achieve the SO2 reduction objectives of the CAAA, SO2 emission allowances will be allocated by the EPA to affected sources. Each allowance permits one ton of SO2 emissions. Energy will receive approximately 277,000 of these emission allowances per year during Phase I. As one of the most affected utilities, Energy will also be entitled to approximately 35,000 \"midwestern\" bonus allowances per year from 1995 through 1999. In addition, as a member of the Utility Extension Allowance Pooling Group, a group composed of a majority of the affected utilities currently planning to use qualifying Phase I technologies, e.g., flue-gas desulfurization (scrubbers), Energy expects to receive approximately 150,000 allowances during the Phase I period. The CAAA allows compliance to be achieved on a national level, which provides companies the option to achieve compliance by reducing emissions or purchasing emission allowances.\nThe Chicago Board of Trade (CBOT) was authorized to establish a futures- options market, and the CBOT also plans to administer a cash market in emission allowances. In addition, the CBOT will administer the EPA's annual auction and direct sales of emission allowances. In March 1993, the first annual auction of emission allowances was held. The EPA provided 150,000 allowances for this auction with the intent of stimulating the allowance trading market. The allowances provided by the EPA for auction become useable in either the year 1995 or 2000. The average price paid at the auction for an allowance first useable in 1995 was $156, with prices ranging from $131 to $450. Energy purchased 10,000 of these allowances for $150 each. The prices paid at the auction for an allowance first useable in the year 2000 ranged from $122 to $310 with an average of $136. The availability and economic value of allowances in the long-term is still uncertain.\nAs previously discussed, in October 1993, the IURC issued an order approving Energy's Phase I compliance plan and emission allowance banking strategy. To comply with Phase I of the CAAA SO2 requirements, Energy will have to reduce SO2 emissions by approximately 34% (based on an approximate 334,000 ton annual target) from 1991 levels or acquire offsetting emission allowances. Energy's compliance plan for the Phase I SO2 reduction requirements includes the addition of one scrubber at Gibson Unit 4 by late 1994, installation of flue- gas conditioning equipment on certain units, upgrading certain precipitators, implementation of its DSM programs, burning lower-sulfur coal at its four major coal-fired generating stations, and inclusion of the value of emission allowances in the economic dispatch process. To meet NOx reductions required by Phase I, Energy is installing low-NOx burners on affected units at these same stations. Energy's capital expenditures for Phase I compliance projects totaled approximately $290 million through December 31, 1993. In addition, the successful operation of Energy's Clean Coal Project will further reduce SO2 and NOx emissions (see New Generation discussion below).\nTo comply with Phase II SO2 requirements, Energy must reduce SO2 emissions an additional 38% from 1991 levels (based on an approximate 143,000 ton annual cap) or acquire offsetting emission allowances. Own-system compliance alternatives could include additional scrubbers, use of western and midwestern coal blends, installation of precipitators, and installation of flue-gas conditioning equipment. Energy is evaluating these alternatives in order to provide the most cost-effective strategy for meeting Phase II SO2 requirements while maintaining optimal flexibility to meet potentially significant new environmental demands. To meet NOx reductions required by Phase II, Energy plans to install low-NOx burners on affected units. Energy anticipates filing its Phase II plan with the IURC as early as the fourth quarter of 1994.\nEnergy's implementation of its emission allowance banking strategy is a critical component of maintaining optimal flexibility in its Phase II compliance plan. In order to delay or eliminate own-system compliance alternatives, which could be significantly more costly, Energy intends to utilize its emission allowance banking strategy to the extent a viable emission allowance market is available. Energy is forecasting environmental compliance expenditures to meet the acid rain provisions of the CAAA ranging from $.6 billion to $1.2 billion during the 1994 to 2005 period. Energy's Phase I plan is expected to result in banked emission allowances by the year 2000 sufficient to meet its Phase II SO2 requirements for approximately three years. The low-end of the capital costs range assumes that Energy achieves Phase II compliance primarily by purchasing additional emission allowances and continuing to delay, or eliminate, capital intensive alternatives. However, as previously stated, the availability and economic value of emission allowances in the long-term is still uncertain. As such, the high-end of the range assumes that Energy is forced to achieve compliance through the own- system compliance alternatives previously discussed.\nNew Generation\nIn 1992, the United States Department of Energy (DOE) approved for partial funding a joint proposal by Energy and Destec Energy, Inc. (Destec) for a 262- megawatt clean coal power generating facility to be located at Energy's Wabash River Generating Station. In May 1993, the IURC issued \"certificates of need\" for the project. The total project cost, including construction, Destec's operating costs for a three-year demonstration period, and Energy's operating costs for a one-year demonstration period, is estimated to be $550 million. The DOE awarded the project up to $198 million. Of this amount, Energy will receive approximately $53 million to be used to offset project costs. The remainder of the project costs will be funded by Energy and Destec, with Energy's portion being approximately $108 million. The project is currently under construction and the three-year demonstration period of the project is expected to commence in the third quarter of 1995.\nIn 1992, the IURC issued certificates of need to Energy for the construction of two 100-megawatt combustion turbine generating units adjacent to its Cayuga Generating Station. The first unit went into service in June 1993. Energy intends to defer the second unit until 1996 and will purchase power during the interim period.\nOther\nMandatory redemptions of long-term debt total $97 million during the 1994 to 1998 period (see Note 9 on page 52). Additionally, funds are required to make a payment of $80 million in accordance with the settlement of the Wabash Valley Power Association, Inc. (WVPA) litigation. This payment is not currently expected to occur before 1995 (see Note 2 beginning on page 45).\nSince 1990, Energy has focused its marketing efforts on the aggressive implementation of various DSM programs. DSM generally refers to actions taken by a utility to affect customers' energy usage patterns. DSM programs are evaluated on an \"equal footing\" with supply-side options, with the goal of deferring the need for new generating capacity. The expenditures for these programs over the next five years are forecasted to be approximately $185 million. It is anticipated that these expenditures will result in a summer peak demand reduction of 236 megawatts by 1998, of which approximately 77 megawatts have already been achieved. The IURC has authorized Energy to defer DSM expenditures, with carrying costs, for subsequent recovery through rates. In its current retail rate proceeding, Energy has proposed to amortize and recover amounts deferred through July 1993 ($35 million), together with carrying costs, over a four-year period commencing with the effective date of the IURC's order in the current retail rate proceeding. Deferred DSM costs as of the effective date of an order in Energy's current retail rate proceeding, which are not included for recovery in the current proceeding, will continue to be deferred, with carrying costs, for recovery in subsequent rate proceedings. In addition, Energy has proposed the recovery of approximately $23 million of DSM expenditures in base rates on an annual basis. Energy has also requested that the IURC approve the deferral of reasonably incurred DSM expenditures which exceed the base level of $23 million.\nCAPITAL RESOURCES\nCash flows from operations are forecasted to provide approximately 70% of the capital needs during the 1994 to 1998 period. External funds required during this period are estimated to be $.6 billion. (All forecasted amounts are in nominal dollars and reflect assumptions as to the economy, capital markets, construction program, legislative and regulatory actions, frequency and timing of rate increase requests, and other related factors which may be subject to significant change. In addition, forecasted cash flows from operations do not reflect any consideration for the effects of the Mergers.)\nInternal Cash Flows\nOver the next several years, Energy's internal cash flows are heavily dependent upon timely retail rate relief and obtaining the related requested modifications to traditional regulation. Integral to this effort is Energy's success in controlling its costs, obtaining performance based regulatory incentives, and securing alternative measures where necessary that allow for ultimate, although deferred, recovery of its costs, including a return to investors. This is especially important during the next three years when Energy's substantial construction program creates potentially significant regulatory lag (i.e., scheduling of capital investment projects cannot be fully synchronized with rate case timing). As previously discussed, Energy has filed testimony with the IURC in support of a $103 million, 11.6% retail rate increase. Approximately 10.3% of the pending rate increase request is needed to meet new environmental requirements and Energy's growing electric needs. Energy is also requesting approval of ratemaking mechanisms to provide more timely recovery of the costs associated with environmental and new generation projects. One such mechanism includes capital costs associated with major environmental compliance projects and the applicable portion of its Clean Coal Project in rate base, while the projects are under construction, as permitted by state law, thus allowing Energy to earn a cash return on these costs prior to the projects' in-service dates. The IURC's ruling in this proceeding is anticipated in late 1994 or early 1995.\nWhere the adverse effects on earnings and cash flows cannot be mitigated by rate relief, Energy is further addressing the issue of regulatory lag through accounting and ratemaking mechanisms that align the interests of customers and shareholders. In January 1993, Energy received authority from the IURC to continue accrual of the debt component of the allowance for funds used during construction (AFUDC) and to defer depreciation expense on its planned combustion turbine generating units and major environmental compliance projects from the respective in-service dates until the effective date of an order in its current retail rate proceeding. Energy has requested similar accounting treatment to mitigate regulatory lag in its current retail rate proceeding.\nEnergy's construction program will require rate relief during the next three years in addition to the current petition. Specifically, Energy expects to file for additional rate relief, primarily to reflect the costs of the Gibson Unit 4 scrubber, the Clean Coal Project, and potentially two additional combustion turbine generating units in rates. All of the major projects (Phase I environmental compliance, the Clean Coal Project, and one of the two combustion turbines) creating the need for retail rate relief have received pre-approval from the IURC for construction. Pre-approval of the second combustion turbine generating unit would be required before commencement of the project. Given its current low cost position, Energy believes that these rate increases, while significant, will not prevent it from maintaining competitive rates over the long-term.\nCash flows will be adversely affected by the $150 million refund resulting from the December 1993 Order, which will be partially offset by tax refunds in 1994 of approximately $29 million to realize the remaining tax consequences of the refund.\nExternal Financing\nEnergy currently has IURC authority to issue up to an additional $428 million of long-term debt and $40 million of preferred stock. Energy will request regulatory approval to issue additional amounts of debt securities and preferred stock on an as needed basis. As of December 31, 1993, Energy has effective shelf registration statements for the sale of up to $315 million of debt securities and $40 million of preferred stock. In addition, as of December 31, 1993, Resources has an effective shelf registration statement for the sale of up to eight million shares of Resources' common stock. A public offering of Resources' common stock is expected to occur by mid-1994. The net proceeds from the issuance and sale of this common stock will be used by Resources to reduce its short-term indebtedness, with the balance contributed to the equity capital of Energy. Energy will use this contributed capital for general purposes, including construction expenditures.\nEnergy has regulatory authority to borrow up to $200 million under short-term credit arrangements. In connection with this authority, Energy has unsecured, but committed, lines of credit (Committed Lines) which currently permit borrowings of up to $155 million. In addition, Energy has temporary Committed Lines of $15 million. As of December 31, 1993, Energy had $111 million outstanding under these short-term borrowing arrangements. Energy also has Board of Directors approval to arrange for additional short-term borrowings of up to $100 million with various banks (Uncommitted Lines). The Uncommitted Lines are on an \"as offered\" basis with such banks. Under these arrangements, $16 million was outstanding as of December 31, 1993 (see Note 13 beginning on page 56).\nResources has a $30 million credit facility which expires on the earlier of (i) February 12, 1996, or (ii) the consummation of the Mergers. As of December 31, 1993, $20 million was outstanding under this credit facility.\nResources believes its current borrowing capacity and planned common stock issuance will be sufficient to meet short-term cash needs.\nRESULTS OF OPERATIONS\nKilowatt-hour Sales\nNew customers and a return to more normal weather contributed to the 4% increase in total kwh sales in 1993, as compared to 1992. In addition, growth in the primary metals, transportation equipment, and precision instruments, photographic and optical goods sectors resulted in increased industrial sales. Partially offsetting these increases was a reduction in non-firm power sales for resale, which reflected a significant decrease in sales associated with third party short-term power to other utilities through Energy's system.\nThe reduction of sales for resale in 1992 was largely responsible for a 5% decrease in total kwh sales, as compared to 1991. Reflected in this decrease was the reduction of firm power sales to WVPA and the Indiana Municipal Power Agency (IMPA) as they served more of their customers' requirements from their portion of the jointly owned Gibson Unit 5. This resulted from the final (January 1, 1992) scheduled reduction and elimination of Energy's purchase obligations from WVPA and IMPA under the Gibson Unit 5 joint ownership arrangement. In addition, beginning August 1, 1992, WVPA substantially reduced its purchases associated with an interim scheduled power agreement between Energy and WVPA. Non-firm power sales also decreased, partially reflecting a reduction in sales associated with third party short-term power sales to other utilities through Energy's system. The decrease in domestic and commercial sales due to the milder weather experienced in 1992 was offset, in part, by continued growth in industrial sales.\nSales increases in 1991 were primarily related to higher sales to retail customers. Specifically, unusually hot temperatures experienced during the second and third quarters of 1991 contributed to increased sales to domestic and commercial customers, whereas industrial sales increased, in part, due to continued growth in production at Nucor Steel. Partially offsetting these increases were decreased sales for resale due to reduced sales to WVPA and IMPA. They served more of their customers' requirements from their portion of the jointly owned Gibson Unit 5 as a consequence of a scheduled (January 1, 1991) reduction (from 156 megawatts to 78 megawatts) in Energy's purchase obligations from WVPA and IMPA under the Gibson Unit 5 joint ownership arrangement.\nYear-to-year changes in kwh sales for each class of customer are shown below:\nEnergy currently forecasts a 2% annual compound growth rate in kwh sales over the 1994 to 2003 period. This forecast excludes non-firm power transactions and any potential long-term firm power sales at market-based prices.\nRevenues\nRevenues in 1993 remained relatively unchanged, reflecting increased kwh sales which were substantially offset by the $31 million refund resulting from the settlement of the April 1990 Order (see Note 3 beginning on page 47) and the effects of lower fuel costs.\nTotal operating revenues decreased $41 million (4%) in 1992, as compared to 1991, primarily as a result of the lower kwh sales previously discussed. This decrease, however, was partially offset by increased revenues of $6 million from activities in Resources' subsidiaries other than Energy.\nIn 1991, revenues increased $14 million (1%). The increases realized from kwh sales were partially offset by the effects of the April 1990 (4.25%) retail rate reduction.\nAn analysis of operating revenues for the past three years is shown below:\nOperating Expenses\nFuel\nFuel costs, Energy's largest operating expense, decreased $6 million (2%) in 1993. This decrease reflects Energy's continuing efforts to reduce the unit cost of fuel, which include increased purchases in the spot market and realized benefits from price reopener provisions of existing contracts. An analysis of fuel costs for the past three years is shown below:\nPurchased and Exchanged Power\nIn 1993, Energy increased its purchases of non-firm power primarily to serve its own load, which resulted in an increase in purchased and exchanged power of $11 million (77%), as compared to 1992.\nPurchased and exchanged power decreased $40 million (74%) in 1992, as compared to 1991, reflecting the reduction in third party short-term power sales to other utilities through Energy's system and the scheduled reduction in Energy's purchase obligations from WVPA and IMPA under the Gibson Unit 5 joint ownership arrangement, as previously discussed.\nOther Operation and Maintenance\nIncreased other operation and maintenance expenses in 1993 were attributable to approximately $22 million of costs incurred by Resources associated with IPALCO's hostile takeover attempt.\nWhile total 1992 other operation and maintenance expenses remained relatively unchanged, Energy's expenses decreased $8 million (3%) primarily attributable to charges in 1991 for the incremental non-capital portion ($5 million) of the costs associated with a severe ice and wind storm. Energy's decrease was offset by the operating costs related to increased activities in Resources' other subsidiaries.\nThe incremental non-capital portion ($5 million) of storm damage repair costs described above and general inflationary effects on operating costs contributed to other operation and maintenance expenses increasing $16 million (6%) in 1991.\nDepreciation\nAdditions to electric utility plant led to increases in depreciation expense of $10 million (8%) in 1993 and $6 million (5%) in 1992, when compared to each of the prior years.\nIn 1991, depreciation expense increased $9 million (8%) primarily reflecting additional plant ($7 million) and a full year's effect of the May 1990 revision in depreciation rates ($2 million), following approval by the IURC in its April 1990 Order.\nOther Income and Expense - Net\nOther income and expense, excluding the effects of the loss related to the IURC's June 1987 Order, increased $7 million in 1993, as compared to 1992. This increase was due, in part, to the implementation of the January 1993 IURC order authorizing the accrual of post-in-service carrying costs (see Note 1 beginning on page 44). In addition, the equity component of AFUDC increased primarily as a result of increased construction.\nInterest and Other Charges\nIncreased borrowings and accrued interest of $4 million in connection with the loss related to the IURC's June 1987 Order resulted in increased interest and other charges of $8 million (12%) in 1992, as compared to 1991.\nACCOUNTING CHANGES\nIn 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (Statement 112). Statement 112 establishes accounting standards for the costs of benefits provided to former or inactive employees, including their beneficiaries and dependents, after employment but before retirement. Under the provisions of Statement 112, the costs of these benefits will be recognized for accounting purposes when the employees or their beneficiaries become eligible for such benefits (accrual basis) rather than when such benefits are paid, which is Energy's current practice. Energy's unrecognized and unfunded obligation for these benefits (the transition obligation) as of September 30, 1993, measured in accordance with the new accounting standard, is $8.5 million. The new standard requires immediate recognition of the transition obligation at the date the new standard is adopted. Energy is required to adopt Statement 112 effective January 1, 1994. In connection with its current retail rate proceeding, Energy has requested deferral of the transition obligation for recovery over a reasonable period of time beginning with an order in its next retail rate proceeding.\nINFLATION\nIn a capital-intensive business such as the utility industry, inflation causes the internal generation of funds to be inadequate to replace and add to productive facilities. Depreciation, based on the original cost of property, does not adequately reflect the current cost of plant and equipment consumed during the year. Accounting based on historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-rate obligations such as long-term debt and preferred stock. Under the ratemaking prescribed by regulatory bodies, depreciation expense recoverable through Energy's rates is based on historical cost. Consequently, cash flows are inadequate to replace property in future years or preserve the purchasing power of common equity capital previously invested. As a result, the common shareholder may experience a significant net purchasing power loss under inflationary conditions.\nDIVIDEND RESTRICTIONS\nSee Note 7 on page 51 for a discussion of the restrictions on common dividends.\nIndex to Financial Statements and Financial Statement Schedules\nPage Number Financial Statements\nReport of Independent Public Accountants. . . . . . . . . 36-37 Consolidated Statements of Income for the three years ended December 31, 1993 . . . . . . . . . . 38 Consolidated Balance Sheets at December 31, 1993 and 1992. . . . . . . . . . . . . . . 39-40 Consolidated Statements of Changes in Common Stock Equity for the three years ended December 31, 1993 . . . . . . . . . . . . . . . . 41 Consolidated Statements of Cash Flows for the three years ended December 31, 1993 . . . . . . 42 Cumulative Preferred Stock. . . . . . . . . . . . . . . . 43 Long-term Debt. . . . . . . . . . . . . . . . . . . . . . 43 Notes to Consolidated Financial Statements. . . . . . . . 44-68\nPage Number Financial Statement Schedules\nSchedule V - Electric Utility Plant . . . . . . . . . . . 80-82 Schedule VI - Accumulated Depreciation. . . . . . . . . . 83-85 Schedule VIII - Valuation and Qualifying Accounts . . . . 86-88\nThe information required to be submitted in schedules other than those indicated above has been included in the consolidated balance sheets, the consolidated statements of income, related schedules, the notes thereto or omitted as not required by the Rules of Regulation S-X.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of PSI Resources, Inc.:\nWe have audited the consolidated balance sheets of PSI Resources, Inc. (Resources) (an Indiana corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in common stock equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the management of Resources. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly in all material respects, the financial position of Resources and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs more fully discussed in Note 2, Wabash Valley Power Association, Inc. (WVPA) filed suit against PSI Energy, Inc. (Energy), the principal subsidiary of Resources, for $478 million plus interest and other damages to recover its share of Marble Hill Nuclear Project (Marble Hill) costs. The suit was amended to include as defendants several officers of Energy and certain other parties, and to allege claims under the Racketeer Influenced and Corrupt Organizations Act, which would permit trebling of damages and assessment of attorneys' fees. The suit was further amended to add claims of common law fraud, constructive fraud and deceit and negligent misrepresentation against Energy and the other defendants. Energy and its officers have reached a settlement with WVPA that is subject to the approval of judicial and regulatory authorities and has recorded an estimated loss related to the litigation. The eventual outcome of this litigation cannot presently be determined.\nAs more fully discussed in Notes 12 and 15, effective January 1, 1993, Resources implemented the provisions of Statements of Financial Accounting Standards Nos. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and 109, \"Accounting for Income Taxes.\"\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index on page 35 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO. Indianapolis, Indiana, February 22, 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\n(a) Consolidation Policy The accompanying Consolidated Financial Statements include the accounts of PSI Resources, Inc. (Resources) and its subsidiaries, PSI Energy, Inc. (Energy), PSI Investments, Inc., PSI Recycling, Inc., and PSI Argentina, Inc., after elimination of intercompany transactions and balances. The assets, liabilities, revenues, and expenses of subsidiaries other than Energy are immaterial in relation to the consolidated amounts.\n(b) Regulation Energy is subject to regulation by the Indiana Utility Regulatory Commission (IURC) and the Federal Energy Regulatory Commission (FERC). Energy's accounting policies conform to generally accepted accounting principles, as applied to regulated public utilities, and to the accounting requirements and ratemaking practices of these regulatory authorities.\n(c) Electric Utility Plant, Depreciation, and Maintenance Substantially all electric utility plant is subject to the lien of Energy's first mortgage bond indenture (Indenture).\nConstruction work in progress is charged with a proportionate share of overhead costs. Construction overhead costs include salaries, payroll taxes, fringe benefits, and other expenses. Energy capitalizes an allowance for funds used during construction (AFUDC), an item not representing cash income, which is defined in the regulatory system of accounts prescribed by the FERC as the cost of capital used for construction purposes. The AFUDC rate was 9.5% in 1993, 8.5% in 1992, and 12.0% in 1991, and is compounded semi- annually.\nEnergy's provision for depreciation is determined by using the straight-line method applied to the cost of depreciable plant in service. The composite depreciation rate was 3.8% per year during 1991 to 1993.\nIn January 1993, Energy received authority from the IURC to continue accrual of the debt component of AFUDC (post-in-service carrying costs) and to defer depreciation expense (post-in-service deferred depreciation) on its planned combustion turbine generating units and major environmental compliance projects from the date the projects are placed in service until the effective date of an order in Energy's current retail rate proceeding. This proceeding includes a request for authorization to recover a portion of these deferrals and to continue similar accounting treatment on these projects until an order in Energy's next retail rate proceeding.\nMaintenance and repairs of property units and replacements of minor items of property are charged to maintenance expense. The costs of replacements of property units are capitalized. The original cost of the property retired and the related cost of removal, less salvage recovered, are charged to accumulated depreciation.\n(d) Federal and State Income Taxes Deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between the financial reporting and tax reporting bases of assets and liabilities. Investment tax credits utilized to reduce Federal income taxes payable have been deferred for financial reporting purposes and are being amortized over the useful lives of the property which gave rise to such credits.\n(e) Operating Revenues and Fuel Costs Energy records revenues each period for energy delivered during the period.\nRevenues reflect fuel cost charges based on the actual costs of fuel. Fuel cost charges applicable to all of Energy's metered kilowatt-hour sales are included in customer billings based on the estimated costs of fuel. Customer bills are adjusted in subsequent months to reflect the difference between actual and estimated costs of fuel. Indiana law subjects the recovery of fuel costs to a determination that such recovery will not result in earning a return in excess of that allowed by the IURC in its last general rate order.\n(f) Debt Discount, Premium, and Issuance Expense and Costs of Reacquiring Debt Debt discount, premium, and issuance expense on Energy's outstanding long-term debt are amortized over the lives of the respective issues.\nEnergy defers costs (principally call premiums) arising from the reacquisition of long-term debt and amortizes such amounts over the remaining life of the debt reacquired.\n(g) Consolidated Statements of Cash Flows All temporary cash investments with maturities of three months or less, when acquired, are reported as cash equivalents. Resources and its subsidiaries had no material non-cash investing or financing transactions during the years 1991 to 1993.\n(h) Reclassification Certain amounts in the 1991 and 1992 Consolidated Financial Statements have been reclassified to conform to the 1993 presentation.\n2. WVPA Litigation\nIn February 1984, Wabash Valley Power Association, Inc. (WVPA) discontinued payments to Energy for its 17% share of Marble Hill, a nuclear project jointly owned by Energy and WVPA which was cancelled by Energy in 1984, and filed suit against Energy in the United States District Court for the Southern District of Indiana (Indiana District Court), seeking $478 million plus interest and other damages to recover its Marble Hill costs. The suit was amended to include as defendants several officers of Energy along with certain contractors and their officers involved in the Marble Hill project, and to allege claims against all defendants under the Racketeer Influenced and Corrupt Organizations Act (RICO). Claims proven and damages allowed under RICO may be trebled and attorneys' fees assessed against the defendants. The suit was further amended to add claims of common law fraud, constructive fraud and deceit, and negligent misrepresentation against Energy and the other defendants.\nIn May 1985, WVPA filed for protection under Chapter 11 of the Federal Bank- ruptcy Code. Due to the Chapter 11 filing, Energy and WVPA entered into an agreement under which Energy agreed to place in escrow 17% of all salvage proceeds received from the sales of Marble Hill equipment, materials, and nuclear fuel after May 23, 1985.\nIn February 1989, Energy and its officers reached a settlement with WVPA which, if approved by judicial and regulatory authorities, will settle the suit filed by WVPA. The settlement is also contingent on the resolution of the WVPA bankruptcy proceeding.\nThe principal terms of the settlement are:\n. Energy, on behalf of itself and its officers, will pay $80 million on behalf of WVPA to the Rural Electrification Administration (REA) and the National Rural Utilities Cooperative Finance Corporation (CFC). The $80 million obligation, net of insurance proceeds, other credits, and applicable income tax effects, was charged to income in 1988 and 1989.\n. Energy will consent to the disbursement to REA and CFC of the balance in the Marble Hill salvage escrow account.\n. Energy will pay to REA and CFC 17% of future Marble Hill salvage pro- ceeds, net of related salvage program expenses.\n. WVPA will transfer its 17% interest in the Marble Hill site to Energy (exclusive of WVPA's interest in future salvage). Energy will assume responsibility for all future costs associated with the site, other than WVPA's 17% share of future salvage program expenses.\n. Energy will enter into a 35-year take-or-pay power supply agreement for the sale of 70 megawatts of firm power to WVPA. Such power will be supplied from Gibson Unit 1 and will be priced at Energy's firm power rates for service to WVPA. The difference between the revenues received from WVPA and the costs of operating Gibson Unit 1 (the Margin) will be remitted annually by Energy, on behalf of itself and its officers, to REA and CFC to discharge a $90 million obligation, plus accrued interest. If, at the end of the term of the power supply agreement, the $90 million obligation plus accrued interest has not been fully discharged, Energy must do so within 60 days. The settlement provides that in the event Energy is party to a merger or acquisition, Energy and WVPA will use their best efforts to obtain regulatory approval to price the power sale exclusive of the effects of the merger or acquisition.\nCertain aspects of the settlement are subject to approval by the FERC and potentially by the IURC and the Michigan Public Service Commission. At such time as the necessary approvals from these regulatory authorities are received, Energy will record a $90 million regulatory asset. Concurrently, a $90 million obligation to REA and CFC will be recorded as a long-term commitment. Recognition of the asset is based, in part, on projections which indicate that the Margin will be sufficient to discharge the $90 million obligation to REA and CFC, plus accrued interest, within the 35-year term of the power supply agreement. If, in some future period, projections indicate the Margin would not be sufficient to discharge the obligation plus accrued interest within the 35-year term, the deficiency would be recognized as a loss.\nThe alternative plans of reorganization sponsored by WVPA and REA incorporate the settlement agreement. However, REA's proposed plan provides for full recovery of principal and interest on WVPA's debt to REA, which is substantially in excess of the amount to be recovered under WVPA's proposed plan. In August 1991, the U.S. Bankruptcy Court for the Southern District of Indiana (Bankruptcy Court) confirmed WVPA's plan of reorganization and denied confirmation of REA's opposing plan. The Bankruptcy Court's approval of WVPA's reorganization plan is contingent upon WVPA's receipt of regulatory approval to increase its rates. REA appealed the Bankruptcy Court's decision to the Indiana District Court. Energy cannot predict the outcome of this appeal, nor is it known whether WVPA can obtain regulatory approval to increase its rates. If reasonable progress is not made in satisfying conditions to the settlement by February 1, 1995, either party may terminate the settlement agreement.\n3. Rates\n(a) Settlement Agreement In April 1993, the Indiana Court of Appeals (Court of Appeals) issued a decision in the appeal of the IURC's April 1990 retail rate order (April 1990 Order). In its decision, the Court of Appeals ruled that the level of return on common equity allowed Energy in the April 1990 Order, including the range of common equity return, was not adequately supported by factual findings. The April 1990 Order was remanded to the IURC by the Court of Appeals for further proceedings including a redetermination of the cost of equity and its components.\nIn December 1993, the IURC issued an order (December 1993 Order) approving a settlement agreement entered into by Energy, the appellants, and certain other intervenors which resolved the outstanding issues related to the appeals of the April 1990 Order and the IURC's June 1987 tax order (June 1987 Order), which related to the effect on Energy of the 1987 reduction in the Federal income tax rate. The June 1987 Order had been remanded to the IURC by the Indiana Supreme Court and was awaiting a final order from the IURC. The December 1993 Order provides for Energy to refund $150 million to its retail customers ($119 million applicable to the June 1987 Order and $31 million applicable to the April 1990 Order). The December 1993 Order further provides for Energy to reduce its retail rates by 1.5% (approximately $13.5 million on an annual basis) to reflect a return on common equity of 14.25%. The refunds and rate reduction commenced in December 1993. As of December 31, 1993, approximately $68 million of the $150 million refund has been reflected as a reduction in accounts receivable, with the remaining amount reflected in the accompanying Consolidated Balance Sheet at December 31, 1993, as \"Refund due to customers\".\nEnergy had previously recognized a loss of $139 million for the June 1987 Order. The difference between the $139 million and the $119 million portion of the refund applicable to the June 1987 Order is reflected in the Consolidated Statement of Income for the year ended December 31, 1993, as a reduction of the loss. The $31 million portion of the refund applicable to the April 1990 Order is reflected in the Consolidated Statement of Income for the same period as a reduction in operating revenues.\n(b) Current Retail Rate Proceeding Energy filed testimony with the IURC in support of a $103 million, 11.6% retail rate increase. The rate increase is needed to meet new environmental requirements, Energy's growing electric needs, including construction and operation of one combustion turbine generating unit and implementation of demand-side management (DSM) programs, and to recognize postretirement benefits other than pensions on an accrual basis. In addition, Energy is requesting approval of various ratemaking mechanisms to address regulatory lag on specific environmental and new generation projects. Hearings are expected to begin in April 1994, and a final rate order is anticipated in late 1994 or early 1995.\n4. Common Stock\nThe common stock shares reserved for issuance at December 31, 1993, and the shares issued in 1993, 1992, and 1991 were as follows:\nResources is a party to two Master Trust Agreements whereby all accrued benefit payments or awards under certain benefit plans are to be funded in the event of a \"potential change in control\" (as defined in the Master Trust Agreements). The Master Trust Agreements provide for the payment of amounts which may become due under such plans, subject only to claims of general creditors of Resources in the event Resources were to become bankrupt or insolvent. In addition to the issuances of common stock on the previous page, as of December 31, 1993, Resources had issued to the trustee of its Master Trust Agreements 1,093,520 shares of common stock for all employees and directors participating in the 1989 Stock Option Plan, and the Employee Stock Purchase and Savings Plan. These issuances were required as a result of the announcement of the merger with The Cincinnati Gas & Electric Company (CG&E) (see Note 20 beginning on page 63).\nIn April 1990, the shareholders of Resources approved an Employee Stock Purchase and Savings Plan designed to conform with Section 423 of the Internal Revenue Code. The initial offering under the plan allowed eligible employees, through payroll deductions, the option to purchase Resources' common stock at $16.51 per share on August 31, 1992, and the second offering under this plan allows for the purchase of Resources' common stock at $18.05 per share on October 31, 1994. With respect to the second offering, eligible employees purchased 71,188 shares of Resources' common stock at $18.05 per share on February 2, 1994. This accelerated opportunity was a result of the approval of the merger with CG&E by Resources' shareholders in November 1993.\nIn January 1994, Resources' Board of Directors approved the issuance of up to 94,364 shares, distributable over two years, under the Performance Shares Plan, a long-term incentive compensation plan for certain officers.\nResources currently has an effective shelf registration statement for the sale of up to eight million shares of common stock.\n5. Stock Option Plan\nIn April 1989, the shareholders of Resources approved a stock option plan (1989 Stock Option Plan) under which incentive and non-qualified stock options and stock appreciation rights may be granted to key employees, officers, and outside directors. Common stock granted under the 1989 Stock Option Plan may not exceed 2.5 million shares. Options are granted at the fair market value of the shares on the date of grant, except that non-qualified stock options were granted to two executive officers when the plan was adopted at an option price equal to 91% of the fair market value of the shares at the date of grant. Options have a purchase term of up to 10 years, and all options, not previously vested, became vested upon approval of the merger with CG&E by Resources' shareholders. No incentive stock options may be granted under the plan after January 31, 1999.\nThe 1989 Stock Option Plan activity for 1991, 1992, and 1993 is summarized as follows:\nNo stock appreciation rights have been granted under this plan. The total options exercisable at December 31, 1993, 1992, and 1991, were 1,024,000, 714,900, and 542,400, respectively.\n6. Shareholder Rights Plan\nPursuant to a Shareholder Rights Plan adopted by Resources' Board of Directors in 1992, one right is presently attached to, and trading with, each share of Resources' outstanding common stock. The rights are not currently exercisable, but would become exercisable (i) 10 days following a public announcement that a person or group (Acquiring Person) became the beneficial owner of 20% or more of Resources' common stock (Stock Acquisition Date); (ii) 10 business days (or such later date as Resources' Board of Directors shall determine) following the commencement of a tender or exchange offer which, when consummated, would result in a person or group owning 20% or more of Resources' common stock; or (iii) in the event a person or group owns, or expresses an intention to acquire, 10% or more of Resources' common stock and is declared an \"Adverse Person\" by Resources' Board of Directors. Once exercisable, and the under specified circumstances, the rights entitle the holder thereof to purchase shares of Resources' common stock at reduced prices.\nIn general, Resources may redeem the rights at any time until a determination that a person is an Adverse Person or until 10 days following the Stock Acquisition Date at a price of $.01 per right. Additionally, Resources must redeem all outstanding rights on the thirtieth day following its 1997 Annual Meeting of Shareholders, unless the shareholders approve continuation of the plan.\nThe merger agreement entered into among Resources, Energy, and CG&E contains a provision excluding the consummation of such merger from triggering any right or entitlement of Resources' shareholders under the plan.\n7. Common Stock of Subsidiary\nAll of Energy's common stock is held by Resources. No common dividends can be paid by Energy if there are dividends in arrears on its preferred stock.\nEnergy's Indenture provides that, so long as any bonds are outstanding under the Indenture, Energy shall not declare or pay cash dividends on shares of its capital stock (other than on preferred stock) except out of its earned surplus or net profits. In addition, Energy's Amended Articles of Consolidation limit dividends on common stock to 75% of net income available for common stock if the ratio of common stock equity to total capitalization is less than 25%, or to 50% of such net income available if such ratio is less than 20%. Compliance with this provision is determined based on income available for common stock during the preceding 12-month period and the common stock equity balance after payment of the applicable dividend. At December 31, 1993, Energy's common stock equity was 42% of total capitalization, excluding debt due within one year. The above restrictions would limit Energy's common dividends to $347 million as of December 31, 1993.\n8. Preferred Stock of Subsidiary\nIn 1993, Energy issued $100 million of 7.44% Series Cumulative Preferred Stock, $25 par value. This preferred stock is not redeemable prior to March 1, 1998, and is redeemable thereafter at the option of Energy. In addition, Energy issued $60 million of 6 7\/8% Series Cumulative Preferred Stock, $100 par value. This preferred stock is not redeemable prior to October 1, 2003, and is redeemable thereafter at the option of Energy. Energy applied the net proceeds of the $60 million issuance to the refinancing of 162,520 shares of 8.38% Series and 211,190 shares of 8.52% Series, $100 par value, Cumulative Preferred Stock at $101 per share and 216,900 shares of 8.96% Series, $100 par value, Cumulative Preferred Stock at $103 per share in December 1993. As of December 31, 1993, Energy can sell up to an additional $40 million of preferred stock under an effective shelf registration statement and IURC authority.\nEnergy retired 237 shares, 10 shares, and 50 shares in 1993, 1992, and 1991, respectively, of its $100 par value, 3 1\/2% Series Cumulative Preferred Stock. In addition, Energy redeemed all 255,000 outstanding shares of its $100 par value, 13.25% Series Cumulative Preferred Stock in 1992 and redeemed 30,000 shares of this series in 1991.\n9. Long-term Debt\nThe sinking fund requirements with respect to Energy's long-term debt outstanding at December 31, 1993, are $.2 million in 1994, $.4 million per year during 1995 to 1997, and $.5 million in 1998.\nLong-term debt maturities for the next five years are $50 million in 1996, $10 million in 1997, and $35 million in 1998.\nEnergy currently has IURC authority to issue up to $428 million of first mortgage bonds or other long-term debt. As of December 31, 1993, Energy can sell up to $315 million of these debt securities under an effective shelf registration statement.\n10. Sale of Accounts Receivable\nEnergy has an agreement through January 1996 to sell, with limited recourse, an undivided percentage interest in certain of its accounts receivable from customers up to a maximum of $90 million. As of December 31, 1993, Energy's obligation under the limited recourse provision is $22 million. The refund provided for by the December 1993 Order, as previously discussed (see Note 3 beginning on page 47), reduced accounts receivable available for sale at December 31, 1993, to $40 million. Accounts receivable on the Consolidated Balance Sheets are net of the $40 million and $90 million interest sold at December 31, 1993, and December 31, 1992, respectively. The excess of $90 million over the accounts receivable available for sale at December 31, 1993, is reflected in the Consolidated Balance Sheet as \"Advance under accounts receivable purchase agreement\".\nThe refund provided for by the December 1993 Order caused a termination event under the agreement governing the sale of accounts receivable. Due to the temporary nature of this event, Energy obtained a waiver of the termination event provision of the agreement as it relates to the refund.\nEffective February 1, 1991, Energy entered into an interest rate swap agreement which effectively changed Energy's variable interest rate exposure on its sale of accounts receivable to a fixed rate of 8.19%. The interest rate swap agreement matures January 31, 1996. In the event of nonperformance by the other parties to the interest rate swap agreement, Energy would be exposed to floating rate conditions.\n11. Pension Plan\nEnergy's defined benefit pension plan (Plan) covers all employees meeting certain minimum age and service requirements. Plan benefits are determined under a final average pay formula with consideration of years of participation, age at retirement, and the applicable average Social Security wage base.\nEnergy's funding policy is to maintain the Plan on an actuarially sound basis. Energy's contribution for the 1993 plan year is $8.2 million. Contributions applicable to the 1992 and 1991 plan years were $7.4 million and $7.9 million, respectively. The Plan's assets consist of investments in equity and fixed income securities.\nPension costs for 1993, 1992, and 1991 include the following components:\nThe following table reconciles the Plan's funded status at September 30, 1993, 1992, and 1991 with amounts recorded in the Consolidated Financial Statements. Under the provisions of Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions (Statement 87), certain assets and obligations of the Plan are deferred and recognized in the Consolidated Financial Statements in subsequent periods.\n12. Other Postretirement and Postemployment Benefits\n(a) Postretirement Benefits Energy provides certain health care and life insurance benefits to retired employees and their eligible dependents. Energy's employees are eligible for postretirement health care benefits if they retire at age 55 or older with at least 10 years of service and are eligible for life insurance if they retire with unreduced pension benefits. The health care benefits provided include medical, prescription drugs, and dental. Prior to 1993, the cost of retiree health care was charged to expense as claims were paid and the cost of life insurance benefits was charged to expense at retirement. Energy does not currently pre-fund its obligation for these postretirement benefits.\nEffective with the first quarter of 1993, Energy implemented the provisions of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (Statement 106). Under the provisions of Statement 106, the costs of health care and life insurance benefits provided to retirees are recognized for accounting purposes during periods of employee service (accrual basis). The unrecognized and unfunded Accumulated Postretirement Benefit Obligation (APBO) existing at the date of initial application of Statement 106 (i.e., the transition obligation) of $107.6 million is being amortized over a 20-year period.\nPostretirement benefit costs for 1993 include the following components:\nAmount (in millions)\nBenefits earned during the period. . . . . . . . . . $ 3.4 Interest accrued on APBO . . . . . . . . . . . . . . 9.3 Amortization of transition obligation. . . . . . . . 5.4\nTotal postretirement benefit costs . . . . . . . . . $18.1\nIn December 1993, the IURC issued a generic order regarding regulatory treatment of postretirement benefit costs other than pensions determined in accordance with the provisions of Statement 106. In accordance with the provisions of this order, Energy has included a request for recovery of these costs on an accrual basis in its current retail rate proceeding. Prior to the recovery of these costs in customers' rates on an accrual basis, the difference between postretirement benefit costs determined in accordance with the provisions of Statement 106 and the costs determined in accordance with Energy's previous accounting practice is being deferred for future recovery in accordance with the provisions of the generic order.\nPostretirement benefit costs for 1993, 1992, and 1991, determined in accordance with Energy's previous accounting practice, were $5.3 million, $5.0 million, and $4.6 million, respectively.\nThe following table reconciles the APBO of the health care and life insurance plans at September 30, 1993, with amounts recorded in the Consolidated Financial Statements:\nAmount (in millions) Actuarial present value of benefits Fully eligible active plan participants. . . . . . $ (20.8) Other active plan participants . . . . . . . . . . (54.7) Retirees and beneficiaries . . . . . . . . . . . . (61.5) Projected APBO . . . . . . . . . . . . . . . . . . . (137.0) Unamortized transition obligation. . . . . . . . . . 102.2 Benefit payments subsequent to September 30, 1993 . . . . . . . . . . . . . . . . 1.1 Unrecognized net loss resulting from experience different from that assumed and effect of changes in assumptions . . . . . . . 16.0 Accrued postretirement benefit obligation at December 31, 1993. . . . . . . . . . . . . . . . . $ (17.7)\nThe weighted-average discount rate used in determining the APBO at September 30, 1993, was 7.5%. The assumed initial health care cost trend rate used in measuring the APBO was 8% for dental and post-65 medical and 12% for pre-65 medical and prescription drugs. These rates are assumed to decrease gradually to an ultimate level of 5% by the year 2007. Increasing the health care cost trend rate by one percentage point in each year would increase the APBO as of September 30, 1993, by approximately $19 million (14%) and the aggregate of the service and interest cost components of the postretirement benefit costs for 1993 by approximately $2 million (17%).\n(b) Postemployment Benefits In 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (Statement 112). Statement 112 establishes accounting standards for the costs of benefits provided to former or inactive employees, including their beneficiaries and dependents, after employment but before retirement. Under the provisions of Statement 112, the costs of these benefits will be recognized for accounting purposes when the employees or their beneficiaries become eligible for such benefits (accrual basis) rather than when such benefits are paid, which is Energy's current practice. Energy's unrecognized and unfunded obligation for these benefits (the transition obligation) as of September 30, 1993, measured in accordance with the new accounting standard, is $8.5 million. The new standard requires immediate recognition of the transition obligation at the date the new standard is adopted. Energy is required to adopt Statement 112 effective January 1, 1994. In connection with its current retail rate proceeding, Energy has requested deferral of the transition obligation for recovery over a reasonable period of time beginning with an order in its next retail rate proceeding.\n13. Notes Payable\nEnergy currently has IURC authority to borrow up to $200 million under short- term credit arrangements. In connection with this authority, Energy has established agreements with 11 banks for unsecured, but committed, lines of credit (Committed Lines) which currently permit borrowings of up to $155 million. These Committed Lines provide for maturities of one year and one day with interest rate options at or below prime rate. In addition, Energy has a temporary Committed Line with one bank of $15 million which provides for maturities of less than one year. Energy also issues commercial paper from time to time. All outstanding commercial paper is supported by Energy's Committed Lines.\nResources has a $30 million credit facility which expires on the earlier of (i) February 12, 1996, or (ii) the completion of the merger with CG&E. As of December 31, 1993, $20 million was outstanding under this credit facility.\nAmounts outstanding under the above credit arrangements would become immediately due upon an event of default which includes non-payment, default under other agreements governing company indebtedness, bankruptcy, or insolvency. Commitment fees, which are assessed on the daily unused portion of the Committed Lines, were immaterial during 1991 to 1993.\nEnergy also has Board of Directors' approval to arrange for additional short- term borrowings of up to $100 million with various banks on an \"as offered\" basis (Uncommitted Lines). All Uncommitted Lines provide for maturities of 364 days with various interest rate options.\nResources established a $70 million irrevocable standby letter of credit in favor of CG&E in conjunction with the merger (see Note 20 beginning on page 63).\nFor the years 1993, 1992, and 1991, short-term borrowings outstanding at various times were as follows:\n14. Fair Value of Financial Instruments\nThe estimated fair values of Resources' and its subsidiaries' financial instruments were as follows:\nThe following methods and assumptions were used to estimate the fair values of these financial instruments:\nCash and temporary cash investments, restricted deposits, and notes payable The carrying amounts approximate fair values.\nLong-term debt The fair value of Energy's long-term debt issues, excluding tax-exempt bonds, was estimated based on the latest quoted market prices or, if not publicly traded, on the current rates offered to Energy for debt of the same remaining maturities. The fair value of tax-exempt bonds was estimated by obtaining broker quotes.\nUnder current regulatory treatment, gains and losses on reacquisition of long- term debt are amortized in customers' rates over the remaining life of the debt reacquired. Accordingly, any reacquisition would not have a material effect on Resources' financial position or results of operations.\n15. Income Taxes\nEffective with the first quarter of 1993, Resources implemented the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement 109). Statement 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of existing differences between the financial reporting and tax reporting bases of assets and liabilities. Resources adopted this new accounting standard as the cumulative effect of a change in accounting principle with no restatement of prior periods. The adoption of Statement 109 had no material effect on Resources' consolidated earnings or the Consolidated Balance Sheet.\nIn August 1993, Congress enacted the Omnibus Budget Reconciliation Act of 1993 (Act), which included a provision to increase the Federal corporate income tax rate from 34% to 35%, retroactive to January 1, 1993. Statement 109 requires adjustment of deferred income taxes upon enacted changes in income tax rates. The change in the income tax rate resulted in an increase in the net deferred income tax liability of approximately $12 million and recognition of a regulatory asset of approximately $12 million to reflect expected future recovery of the increased liability in customers' rates.\nThe significant components of Resources' net deferred income tax liability at December 31, 1993, and January 1, 1993, after adoption of the provisions of Statement 109, are as follows:\nA summary of Federal and state income taxes charged (credited) to income and the allocation of such amounts is as follows:\nDuring 1993, Resources incurred a Federal income tax net operating loss of approximately $22 million primarily due to the $150 million refund resulting from the December 1993 Order. The loss can be carried forward or back to offset taxable income in other years. As a result of the net operating loss, Resources incurred an alternative minimum tax (AMT) liability of approximately $2.3 million for 1993. AMT paid can be used as a tax credit to offset income taxes (other than AMT) payable in future years. Resources expects to be able to utilize both the net operating loss and AMT credit in 1994. The tax benefits of the net operating loss and income taxes paid during 1993 in excess of the AMT liability are reported as \"Income tax refunds\" on the December 31, 1993, Consolidated Balance Sheet.\nFederal income taxes computed by applying the statutory Federal income tax rate to book income before Federal income tax are reconciled to Federal income tax expense reported in the Consolidated Statements of Income as follows:\nResources' consolidated Federal income tax returns for the years 1989 and 1990 are currently under examination by the Internal Revenue Service. Resources believes it has adequate reserves to cover issues which may be raised in conjunction with this examination and does not believe the outcome of the examination will have a material effect on its financial condition or results of operations.\n16. Commitments and Contingencies\n(a) Construction Energy will have substantial commitments in connection with its construction program for capital improvements to, and expansion of, its operating facilities, new generation, and environmental compliance. Aggregate expenditures for Energy's construction program for the years 1994 to 1998 are estimated to be $1.1 billion.\n(b) Manufactured Gas Plants Coal tar residues and other substances associated with manufactured gas plant (MGP) sites have been found at former MGP sites in Indiana, including, but not limited to, sites in Shelbyville and Lafayette, two sites previously owned by Energy. Energy has identified at least 21 MGP sites which it previously owned, including 19 it sold in 1945 to Indiana Gas and Water Company, Inc. (now Indiana Gas Company [IGC]), including the Shelbyville and Lafayette sites.\nThe Shelbyville site has been the subject of an investigation and cleanup enforcement action by the Indiana Department of Environmental Management (IDEM) against IGC and Energy. Without admitting liability, Energy and IGC have jointly negotiated with the IDEM for a consent order to conduct a remedial investigation and feasibility study of the Shelbyville site. Energy and IGC are sharing equally in the costs of investigation and cleanup of this site.\nIn 1992, the IDEM issued an order to IGC, naming IGC as a responsible party as defined by the Comprehensive Environmental Response, Compensation and Liability Act, which requires investigation and remediation of the Lafayette MGP site. IGC entered into an agreed order with the IDEM for the removal of MGP contamination at the site.\nIn April 1993, IGC filed testimony with the IURC seeking recovery of costs incurred in complying with Federal, state, and local environmental regulations related to MGP sites in which it has an interest, including sites acquired from Energy. In its testimony, IGC stated that it would also seek to recover a portion of these costs from other potentially responsible parties, including previous owners. At this time, the IURC has not ruled on IGC's petition.\nExcept for the Shelbyville site, Energy has not assumed any responsibility to reimburse IGC for its costs for investigating and cleaning up MGP sites. With respect to the Shelbyville site, based upon environmental investigations completed to date, Energy believes that any required investigation and remediation will not have a material adverse effect on its financial condition. At this time, it is premature for Energy to predict the nature, extent, and costs of, or Energy's responsibility for, any environmental investigations and remediations which may be required at other MGP sites owned, or previously owned, by Energy.\n(c) Fuel Litigation Energy is currently involved in litigation with Exxon Coal USA, Inc. and Exxon Corporation (Exxon) regarding, among other things, coal quality and pricing disputes, including whether the price for coal delivered under a coal supply contract should be $23.266 or $30 per ton. On February 22, 1994, the United States Court of Appeals for the Seventh Circuit established the contract price at $30 per ton, reversing the trial court's decision determining the price at $23.266 per ton. During 1993, Energy paid $23.266 per ton. Energy believes the additional cost to be incurred as a result of this decision should be recoverable through rates. Additionally, Exxon is seeking $17 million to $63 million in damages for Energy's failure to take coal after Energy terminated the contract pursuant to a December 1992 court decision, which was subsequently reversed. Energy believes the damages, if any, will be less than $17 million. Exxon has also alleged anticipatory breach of the contract; however, after reversal of the December 1992 court decision and reinstatement of the contract, Energy resumed acceptance of deliveries and has moved for summary judgment on this issue. At this time, Energy cannot predict the outcome of the remaining litigation, but no material adverse effect on Energy's financial condition is expected.\nEnergy initiated several arbitration proceedings to resolve disputes, including disputes related to price and coal quality, which have arisen under agreements between Amax Coal Company (Amax) and Energy. Energy cannot predict the ultimate resolution of the remaining issues subject to arbitration, but in the event the arbitrators decide that Amax is due additional amounts, Energy believes that Indiana's fuel adjustment clause process provides for recovery of such amounts from its customers.\n17. Regulatory Assets\nThe IURC has authorized Energy to defer DSM expenditures, with carrying costs, for subsequent recovery through rates. In its current retail rate proceeding, Energy has proposed to amortize and recover amounts deferred through July 1993 ($35 million), together with carrying costs, over a four-year period commencing with the effective date of the IURC's order in the current retail rate proceeding. Deferred DSM costs as of the effective date of an order in Energy's current retail rate proceeding, which are not included for recovery in the current proceeding, will continue to be deferred, with carrying costs, for recovery in subsequent rate proceedings. In addition, Energy has proposed the recovery of approximately $23 million of DSM expenditures in base rates on an annual basis. Energy has also requested that the IURC approve the deferral of reasonably incurred DSM expenditures which exceed the base level of $23 million. Deferred DSM expenditures totaled $53 million and $23 million at December 31, 1993, and 1992, respectively.\nAdditionally, consistent with authorized ratemaking treatment, Energy is deferring certain costs associated with income taxes, postretirement benefits other than pensions, and its planned combustion turbine generating units and major environmental compliance projects. These deferrals totaled $45 million and $3 million at December 31, 1993, and 1992, respectively. Finally, in Energy's current retail rate proceeding, it is requesting ratemaking treatment for deferred costs associated with the merger with CG&E and certain fuel litigation. These deferrals totaled $21 million and $4 million at December 31, 1993, and 1992, respectively (see Notes 1, 3, 12, and 21 beginning on pages 44, 47, 54, and 65, respectively).\n18. Jointly Owned Plant\nEnergy is a joint owner of Gibson Unit 5 with WVPA and the Indiana Municipal Power Agency (IMPA). Energy is also a joint owner with WVPA and IMPA of transmission property and local facilities. These facilities constitute part of the integrated transmission and distribution systems which are operated and maintained by Energy. Proportionate operating expenses are billed to WVPA and IMPA and are reflected as a reduction of operating expenses in the Consolidated Statements of Income.\nEnergy's investment in jointly owned plant is as follows:\n19. 1993 and 1992 Quarterly Financial Data (unaudited)\n20. Pending Merger\nGeneral Resources, Energy, and CG&E entered into an Agreement and Plan of Reorganization dated as of December 11, 1992, which was subsequently amended and restated on July 2, 1993, and as of September 10, 1993 (as amended and restated, the \"Merger Agreement\"). Under the Merger Agreement, Resources will be merged with and into a newly formed corporation named CINergy Corp. (CINergy) and a subsidiary of CINergy will be merged with and into CG&E (\"CG&E Merger\", collectively referred to as the \"Mergers\"). Following the Mergers, CINergy will be the parent holding company of Energy and CG&E and will be required to register under the Public Utility Holding Company Act of 1935 (PUHCA).\nThe Merger Agreement can be terminated by any party, without financial penalty, if the Mergers are not consummated by June 30, 1994. Under certain circumstances, the termination of the Merger Agreement would result in the payment of termination fees which may not exceed $70 million, if Resources is required to pay, or $130 million, if CG&E is required to pay.\nIn August 1993, Resources established a $70 million irrevocable standby letter of credit in favor of CG&E to fund the aggregate amounts (not to exceed $70 million) payable in certain circumstances pursuant to the provisions of the Merger Agreement and the related Resources Stock Option Agreement as termination fees, option repurchase payments, and related expenses.\nExchange Ratio The Merger Agreement provides that, upon consummation of the Mergers, each outstanding share of common stock of Resources will be converted into the right to receive that number of shares of the common stock, par value of $.01 each, of CINergy obtained by dividing $30.69 by the average closing sales price of common stock, par value of $8.50 each, of CG&E as reported on the Transaction Reporting System operated by the Consolidated Tape Association for the 15 consecutive trading days preceding the fifth trading day prior to the Mergers; provided that, if the actual quotient obtained thereby is less than .909, the quotient shall be .909, and if the actual quotient obtained thereby is more than 1.023, the quotient shall be 1.023. The Merger Agreement also provides that, upon consummation of the Mergers, each outstanding share of common stock of CG&E will be converted into the right to receive one share of common stock of CINergy. The outstanding preferred stock and debt securities of Energy and CG&E will not be affected.\nShareholder and Regulatory Approvals In November 1993, the Mergers were approved by the shareholders of Resources and CG&E. In August 1993, the FERC conditionally approved the Mergers. This conditional approval was made by the FERC without a formal hearing and, according to public statements by the FERC Commissioners, was done in reliance, in part, on the FERC's belief that the regulatory commissions of the affected states would have authority to approve or disapprove the Mergers. The companies accepted the FERC's conditions and indicated their belief that none of the conditions would have a material adverse effect on the operations, financial condition, or business prospects of CINergy. Certain parties petitioned for rehearing of the FERC's conditional approval. On September 15, 1993, Energy and CG&E filed a statement with the FERC clarifying their conclusions at that time that the Mergers would not require any prior approval of a state commission under state law. Given the issues raised on the requests for rehearing and the lack of certainty in the record regarding state regulatory powers, on January 12, 1994, the FERC issued an order withdrawing its prior conditional approval of the Mergers and initiating a 60-day, FERC-sponsored settlement procedure. The settlement procedure is expected to be concluded prior to the end of March 1994. The FERC has indicated that, if the settlement procedure is not successful, it intends to issue a further order setting appropriate issues for hearing.\nThe companies are currently participating in a collaborative process with representatives from the IURC, the Public Utilities Commission of Ohio, the Kentucky Public Service Commission (KPSC), various consumer groups, and other parties to settle all merger-related issues. In conjunction with the FERC- sponsored settlement procedure, on February 11, 1994, Energy filed a petition with the IURC requesting approval of various proposals regarding state regulation after consummation of the Mergers. These proposals do not address the allocation between shareholders and customers of projected revenue requirement savings as a result of the Mergers. This allocation will be the subject of a subsequent IURC proceeding. Hearings on the current petition are expected to conclude prior to the end of the 60-day settlement period established by the FERC. In addition, CG&E had originally intended to file, in January 1994, an application with the KPSC for approval of the CG&E Merger. However, given the initiation of the FERC settlement procedure, CG&E notified the KPSC, and the KPSC agreed, that CG&E would temporarily defer such filing (see Note 22 on page 68 for a discussion of subsequent events).\nThe Mergers are also subject to the approval of the Securities and Exchange Commission (SEC) under the PUHCA. An application requesting such SEC approval is expected to be filed during the first quarter or early second quarter of 1994. Under the PUHCA, the divestiture of CG&E's gas operations may be required. The companies believe they have a justifiable basis for retention of CG&E's gas operations and will request SEC approval to retain this portion of the business. Divestiture, if ordered, would occur after the consummation of the Mergers. Historically, the SEC has allowed companies sufficient time to accomplish divestitures in a manner that protects shareholder value, which, in some cases, has been 10 to 20 years.\nThe companies' goal is to consummate the Mergers during the third quarter of 1994. However, if the settlement procedure is not successful and a hearing is convened by the FERC, the consummation of the Mergers would likely be further extended. There can be no assurance that the Mergers will be consummated.\nStock Option Agreements Concurrently with the Merger Agreement, Resources and CG&E have entered into reciprocal stock option agreements granting each other the right to purchase certain shares of their common stock under certain circumstances if the Merger Agreement becomes terminable, or is terminated, because of a breach or a third party proposal for a business combination. Specifically, under these certain circumstances, CG&E has the option to purchase 10 million shares of common stock of Resources at a price of $18.65 per share, and Resources has the option to purchase approximately 7.7 million shares of common stock of CG&E at a price of $24.325 per share. These options will terminate upon the earlier of the consummation of the Mergers, termination of the Merger Agreement pursuant to its terms (other than a breach or a third party proposal for a business combination), 180 days, or longer under certain circumstances, following the termination of the Merger Agreement due to a breach or a third party proposal for a business combination, or June 30, 1994.\n21. Pro Forma Condensed Consolidated Financial Information (unaudited)\nThe following pro forma condensed consolidated financial information combines the historical Consolidated Statements of Income and Consolidated Balance Sheets of Resources and CG&E after giving effect to the Mergers. The unaudited Pro Forma Condensed Consolidated Statements of Income for each of the three years ended December 31, 1993, give effect to the Mergers as if the Mergers had occurred at January 1, 1991. The unaudited Pro Forma Condensed Consolidated Balance Sheet at December 31, 1993, gives effect to the Mergers as if the Mergers had occurred at December 31, 1993. These statements are prepared on the basis of accounting for the Mergers as a pooling of interests and are based on the assumptions set forth in the notes thereto. In addition, the following pro forma condensed consolidated financial information should be read in conjunction with the historical consolidated financial statements and related notes thereto of Resources and CG&E. The following information is not necessarily indicative of the operating results or financial position that would have occurred had the Mergers been consummated at the beginning of the periods, or on the date, for which the Mergers are being given effect, nor is it necessarily indicative of future operating results or financial position.\n22. Events Subsequent to Date of Report of Independent Public Accountants - Pending Merger (unaudited)\nIn connection with the 60-day, FERC-sponsored settlement procedure and the collaborative process, Resources, Energy, CINergy, the Indiana Utility Consumer Counselor, the Citizens Action Coalition of Indiana, Inc., and industrial customer representatives reached a global settlement agreement on merger-related issues. This agreement was filed with the IURC on March 2, 1994, and is expressly conditioned upon approval by the IURC in its entirety and without any change or condition that is unacceptable to any party. On March 4, 1994, CG&E, the Public Utilities Commission of Ohio, and the Ohio Office of Consumers Counsel reached an agreement substantially similar to the Indiana agreement. Both settlement agreements were filed with the FERC on March 4, 1994. Energy expects the FERC settlement judge to forward the settlements to FERC Commissioners on or about March 21, 1994, beginning what is normally a 30-day comment period. The Indiana settlement addresses, among other things, the coordination of state and Federal regulation, the operation of the combined Energy and CG&E electric utility system, the allocation of costs and their effect on customer rates, and a retail \"hold harmless\" provision that provides that Energy's retail rates will not reflect merger- related costs to the extent that they are not offset entirely by merger- related benefits.\nIURC hearings on the Indiana settlement were held on March 17, 1994. Energy has asked the IURC for an order approving the settlement agreement by early April 1994, which should fall within the expected comment period at the FERC.\nCG&E also filed with the FERC a unilateral offer of settlement addressing all issues raised in the KPSC's application for rehearing with the FERC. On March 15, 1994, CG&E filed an application with the KPSC seeking approval of the indirect acquisition of control of CG&E's Kentucky subsidiary, The Union Light, Heat and Power Company.\nAlso included in the filings with the FERC were settlement agreements with WVPA and the city of Hamilton, Ohio. These agreements resolve issues related to the transmission of power and operation of Energy's jointly owned transmission system. Negotiations with other parties at the FERC are continuing.\nEnergy and CG&E also filed with the FERC the operating agreement among Energy, CG&E, and CINergy Services, Inc., a subsidiary of CINergy. The parties to the Indiana and Ohio FERC settlements have agreed to support or not oppose the operating agreement, and the settlements are conditioned upon the FERC approving the filed operating agreement without material change.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nBoard of Directors\nReference is made to pages 5 through 9 of the 1994 Proxy Statement, \"Directors and Nominees\", with respect to identification of directors and their current principal occupations. In addition, reference is made to page 22 of the 1994 Proxy Statement, \"Directors' Compensation\", regarding compliance with Section 16 of the Securities Exchange Act of 1934.\nExecutive Officers\nThe information included in Part I of this report on pages 10 and 11 under the caption \"Executive Officers of the Registrant\" is referenced in reliance upon General Instruction G to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the discussion \"Executive Compensation and Other Transactions\" on pages 17 through 27 of the 1994 Proxy Statement with respect to executive compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to the discussions \"Record Date; Votes Required; Voting Securities; Principal Shareholders\" and \"Security Ownership of Management\" on pages 2 through 4 of the 1994 Proxy Statement with respect to security ownership of certain beneficial owners, security ownership of management, and changes in control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the discussion \"Directors and Nominees\" on pages 5 through 9 of the 1994 Proxy Statement concerning certain relationships and related transactions. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Schedules.\nRefer to the page captioned \"Index to Financial Statements and Financial Statement Schedules\", page 35 of this report, for an index of the financial statements and financial statement schedules included in this report.\n(b) Reports on Form 8-K.\nThe following reports on Form 8-K or Form 8-K\/A were filed during the last quarter of 1993 and through March 18, 1994:\nDate of Report Items Filed\nForm 8-K:\nOctober 27, 1993 Item 5 - Other Events. (On October 27, 1993, PSI Resources, Inc., PSI Energy, Inc., IPALCO Enterprises, Inc., Indianapolis Power & Light Company, The Cincinnati Gas & Electric Company, CINergy Corp., James E. Rogers, John R. Hodowal, and Ramon L. Humke entered into an agreement pursuant to which, among other things, the parties agreed to settle certain pending lawsuits and other issues in connection with IPALCO Enterprises, Inc.'s attempted acquisition of PSI Resources, Inc. and IPALCO Enterprises, Inc.'s opposition to the merger of PSI Resources, Inc. and The Cincinnati Gas & Electric Company to create CINergy Corp.) Item 7 - Financial Statements and Exhibits. (Text of Agreement dated October 27, 1993, by and among PSI Resources, Inc., PSI Energy, Inc., The Cincinnati Gas & Electric Company, CINergy Corp., IPALCO Enterprises, Inc., Indianapolis Power & Light Company, James E. Rogers, John R. Hodowal, and Ramon L. Humke (together with the exhibits and schedules thereto) and text of joint press release issued by PSI Resources, Inc. and The Cincinnati Gas & Electric Company on October 27, 1993.)\nDate of Report Items Filed\nForm 8-K (continued):\nNovember 2, 1993 Item 5 - Other Events. (On November 2, 1993, PSI Resources, Inc. entered into Amendment No. 1 to the Rights Agreement dated December 11, 1992, between PSI Resources, Inc. and First Chicago Trust Company of New York which provides for the redemption of all Rights outstanding on the thirtieth day following PSI Resources, Inc.'s 1997 Annual Meeting of Shareholders, unless the shareholders approve continuation of the Rights Agreement.) Item 7 - Financial Statements and Exhibits. (Amendment No. 1 dated as of November 2, 1993, to the Rights Agreement dated as of December 11, 1992, between PSI Resources, Inc. and First Chicago Trust Company of New York, as Rights Agent.)\nNovember 19, 1993 Item 7 - Financial Statements and Exhibits. (The Cincinnati Gas & Electric Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\nJanuary 12, 1994 Item 5 - Other Events. (On January 12, 1994, the Federal Energy Regulatory Commission issued an order withdrawing its prior conditional approval of PSI Resources, Inc.'s merger with The Cincinnati Gas & Electric Company and initiating a 60-day, FERC-sponsored settlement procedure.)\nForm 8-K\/A:\nNovember 26, 1993 Item 7 - Financial Statements and Exhibits. (Amendment No. 1 filed by The Cincinnati Gas & Electric Company on Form 10-K\/A dated November 26, 1993, to The Cincinnati Gas & Electric Company's Annual Report on Form 10-K for the year ended December 31, 1992, and Consent of Independent Public Accountants.)\n(c) Exhibits.\nRefer to the page captioned \"Exhibits\", page 72 of this report, for a listing of all exhibits included in this report.\nExhibits\nCopies of the documents listed below which are identified with an asterisk (*) have heretofore been filed with the Securities and Exchange Commission and are incorporated herein by reference and made a part hereof; and the exhibit number and file number of the document so filed, and incorporated herein by reference, are stated in parentheses in the description of such exhibit. Exhibits not so identified are filed herewith.\nExhibit Designation Nature of Exhibit\n2-a *Amended and Restated Agreement and Plan of Reorganization by and among The Cincinnati Gas & Electric Company, PSI Resources, Inc., PSI Energy, Inc., CINergy Corp., an Ohio corporation, CINergy Corp., a Delaware corporation, and CINergy Sub, Inc. dated as of December 11, 1992, as amended and restated on July 2, 1993 (Exhibit to Amendment No. 21 to the Schedule 14D-9 filed by PSI Resources, Inc. on July 2, 1993), as further amended and restated on September 10, 1993. (Exhibit to PSI Resources, Inc.'s Form 8-K dated September 27, 1993.)\n2-b *Press release issued by The Cincinnati Gas & Electric Company and PSI Resources, Inc. dated July 2, 1993, announcing the restructured merger transaction. (Exhibit to Amendment No. 21 to Schedule 14D-9 filed by PSI Resources, Inc. on July 2, 1993.)\n2-c *Letter Agreement dated as of August 13, 1993, between PSI Resources, Inc. and The Cincinnati Gas & Electric Company (with attachments thereto). (Exhibit to Amendment No. 32 to the Schedule 14D-9 filed by PSI Resources, Inc. on August 16, 1993 (PSI Resources, Inc.'s Schedule 14D-9, Amendment No. 32).)\nExhibit Designation Nature of Exhibit\n2-d *Press release issued by PSI Resources, Inc. and The Cincinnati Gas & Electric Company dated August 16, 1993, announcing that The Cincinnati Gas & Electric Company, under a letter agreement, will increase the exchange ratio of CINergy Corp. common stock for PSI Resources, Inc. common stock in the proposed merger to form CINergy Corp., contingent on PSI Resources, Inc.'s nominees for directors being elected at PSI Resources, Inc.'s Annual Shareholders Meeting. (Exhibit to PSI Resources, Inc.'s Schedule 14D-9, Amendment No. 32.)\n3-a *Amended Articles of Incorporation dated April 20, 1990, of PSI Resources, Inc. (Exhibit to PSI Resources, Inc.'s Form 8 dated April 26, 1991.)\n3-b *By-laws, as amended January 28, 1993, of PSI Resources, Inc. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n4-a *Rights Agreement dated as of December 11, 1992, by and between PSI Resources, Inc. and The First Chicago Trust Company of New York, as Rights Agent (Exhibit to PSI Resources, Inc.'s Form 8-K dated December 11, 1992.)\n4-b *Amendment No. 1 dated as of November 2, 1993, to the Rights Agreement dated as of December 11, 1992, between PSI Resources, Inc. and The First Chicago Trust Company of New York, as Rights Agent. (Exhibit to PSI Resources, Inc.'s Form 8-K dated November 2, 1993.)\n10-a *Post-effective Amendment No. 1-A on Form S- 8 to Form S-4 dated June 15, 1988. (Exhibit to PSI Resources, Inc.'s, formerly PSI Holdings, Inc., 1988 Form 10-K.)\n10-b *Post-effective Amendment No. 1-B on Form S- 8 to Form S-4 dated June 15, 1988. (Exhibit to PSI Resources, Inc.'s 1988 Form 10-K.)\nExhibit Designation Nature of Exhibit\n10-c *+PSI Resources, Inc. 1989 Stock Option Plan, amended and restated July 30, 1991, retroactively effective July 1, 1991. (Exhibit to PSI Resources, Inc.'s 1991 Form 10-K.)\n10-d *PSI Resources, Inc. Employee Stock Purchase and Savings Plan, amended and restated July 30, 1991, retroactively effective July 1, 1991. (Exhibit to PSI Resources, Inc.'s 1991 Form 10-K.)\n10-e *+PSI Resources, Inc. Directors' Deferred Compensation Plan, amended and restated January 30, 1992, effective September 1, 1992. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-f +Amendment to PSI Resources, Inc. Directors' Deferred Compensation Plan dated September 1, 1992.\n10-g *+PSI Resources, Inc. Annual Incentive Plan adopted January 30, 1992, retroactively dated January 1, 1991. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-h *+PSI Resources, Inc. Performance Shares Plan adopted January 30, 1992, retroactively dated January 1, 1991. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-i *+Amendment to PSI Resources, Inc. Annual Incentive Plan dated December 1, 1992. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-j *+PSI Resources, Inc. Retirement Plan for Directors, amended and restated July 31, 1991, retroactively effective July 1, 1991. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-k *+Amendment to PSI Resources, Inc. Retirement Plan for Directors dated December 1, 1992. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\nExhibit Designation Nature of Exhibit\n10-l *PSI Energy, Inc. Union Employees' 401(k) Savings Plan, amended and restated December 11, 1991, effective January 1, 1992. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-m *PSI Energy, Inc. Employees' 401(k) Savings Plan, amended and restated December 11, 1991, effective January 1, 1992. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n10-n *+Employment Agreement dated May 17, 1990, among PSI Resources, Inc., PSI Energy, Inc. and James E. Rogers, Jr. (Exhibit to the Schedule 14D-9 filed by PSI Resources, Inc. on April 7, 1993 (the \"Resources Schedule 14D-9\").)\n10-o *+Employment Agreement dated December 11, 1992, among PSI Resources, Inc., PSI Energy, Inc., The Cincinnati Gas & Electric Company, CINergy Corp. and James E. Rogers, Jr. (Exhibit to Form S-4 filed by CINergy Corp. (Commission File No. 33-59964) on March 23, 1993.)\n10-p *+Severance Agreement dated December 11, 1992, among PSI Resources, Inc., PSI Energy, Inc. and James E. Rogers, Jr. (Exhibit to PSI Resources, Inc.'s Form 10-K\/A, Amendment No. 1, filed April 29, 1993.)\n10-q *+Form of Severance Agreement dated December 11, 1992, among PSI Resources, Inc., PSI Energy, Inc. and each of Cheryl M. Foley, Joseph W. Messick, Jr., Jon D. Noland, J. Wayne Leonard, and Larry E. Thomas. (Exhibit to PSI Resources, Inc.'s Form 10-K\/A, Amendment No. 1, filed April 29, 1993.)\n10-r *+Master Trust Agreement for Employees' Plans (the \"Employees' Trust Agreement\") between PSI Resources, Inc. and National City Bank, Indiana. (Exhibit to the Resources Schedule 14D-9.)\nExhibit Designation Nature of Exhibit\n10-s *+Master Trust Agreement for Directors' Plans (the \"Directors' Trust Agreement\") between PSI Resources, Inc. and National City Bank, Indiana. (Exhibit to the Resources Schedule 14D-9.)\n10-t *+Amendment No. 1 to each of the Employees' Trust Agreement and the Directors' Trust Agreement. (Exhibit to the Resources Schedule 14D-9.)\n10-u *+Form of Amendment No. 2 to the Employees' Trust Agreement. (Exhibit to Amendment No. 1 to the Resources Schedule 14D-9 filed April 23, 1993.)\n10-v *Employment Agreement dated October 4, 1993, among PSI Resources, Inc., PSI Energy, Inc., and John M. Mutz. (Exhibit to PSI Resources, Inc.'s September 30, 1993, Form 10-Q.)\n10-w *Text of Settlement Agreement dated October 27, 1993, by and among PSI Resources, Inc., PSI Energy, Inc., The Cincinnati Gas & Electric Company, CINergy Corp., IPALCO Enterprises, Inc., Indianapolis Power & Light Company, James E. Rogers, John R. Hodowal, and Ramon L. Humke (together with the exhibits and schedules thereto). (Exhibit to PSI Resources, Inc.'s Form 8-K dated October 27, 1993.)\n10-x +Amendment to PSI Resources, Inc. Annual Incentive Plan dated July 2, 1993.\n10-y +Amendment to PSI Resources, Inc. Retirement Plan for Directors dated July 2, 1993.\n10-z +Amendment No. 2 to the Directors' Trust Agreement.\n10-aa +Amendment No. 3 to the Employees' Trust Agreement.\nExhibit Designation Nature of Exhibit\n10-bb +Amendment to PSI Resources, Inc. Retirement Plan for Directors adopted December 15, 1993, retroactively dated February 1, 1990.\n10-cc +Amendment No. 3 to the Directors' Trust Agreement.\n10-dd +Amendment No. 4 to the Employees' Trust Agreement.\n21 Subsidiaries of PSI Resources, Inc.\n23 Consent of Independent Public Accountants.\n24 Power of Attorney.\n99-a *Complaint of Lydia Grady, as Plaintiff, and PSI Resources, Inc. et al., as Defendants dated March 17, 1993. Superior Court No. 1 of Hendricks County in the State of Indiana. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n99-b *Complaint of Moise Katz, as Plaintiff, and PSI Resources, Inc. et al., as Defendants dated March 16, 1993. Superior Court No. 2 of Hendricks County in the State of Indiana. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n99-c *Complaint of J. E. and Z. B. Butler Foundation, as Plaintiff, and PSI Resources, Inc., et al., as Defendants dated March 17, 1993. U.S. District Court for the Southern District of Indiana, Indianapolis Division. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\n99-d *Amended Complaint of J. E. and Z. B. Butler Foundation, as Plaintiff, and PSI Resources, Inc., et al., as Defendants dated March 23, 1993. U.S. District Court for the Southern District of Indiana, Indianapolis Division. (Exhibit to PSI Resources, Inc.'s 1992 Form 10-K.)\nExhibit Designation Nature of Exhibit\n99-e *Class Action Complaint of Lamont Carpenter, individually, and on behalf of all others situated, as Plaintiffs, and PSI Resources, Inc., et al., as Defendants dated March 26, 1993. U.S. District Court for the Southern District of Indiana, Indianapolis Division. (Exhibit to the Resources Schedule 14D-9.)\n99-f *Complaint of Ronald Gaudiano and Gladys Post, as Plaintiffs, and PSI Resources, Inc., et al., as Defendants dated March 26, 1993. U.S. District Court for the Southern District of Indiana, Indianapolis Division. (Exhibit to the Resources Schedule 14D-9.)\n99-g *Stipulated Order of Consolidation and Appointment of Co-Lead Counsel and Liaison Counsel, dated April 13, 1993, in the case entitled Lydia Grady v. PSI Resources, Inc. et al., (Case No. IP-93-345-C), U.S. District Court for the Southern District of Indiana. (Exhibit to Amendment No. 1 to Schedule 14D-9 filed by PSI Resources, Inc. on April 23, 1993.)\n99-h *Order of Dismissal dated July 1, 1993, issued in Katz v. PSI Resources, Inc., et al., (Case No. 32D02-9303-CP-27) Superior Court for Hendricks County in the State of Indiana. (Exhibit to Amendment No. 22 to the Schedule 14D-9 filed by PSI Resources, Inc. on July 6, 1993.)\n99-i *Order entered on July 19, 1993, in Katz v. PSI Resources, Inc., et al., (Case No. 32D02-9303-CP-27), Superior Court for Hendricks County in the State of Indiana. (Exhibit to Amendment No. 26 to the Schedule 14D-9 filed by PSI Resources, Inc. on July 23, 1993.)\nExhibit Designation Nature of Exhibit\n99-j *Text of an Order Granting Preliminary Injunction dated August 5, 1993, in In re: PSI Merger Shareholder Litigation, (Consolidated Master File No. IP 93-345-C), U.S. District Court for the Southern District of Indiana, Indianapolis Division; Entry Regarding Motion for Preliminary Injunction in the foregoing case. (Exhibit to Amendment No. 29 to the Schedule 14D-9 filed by PSI Resources, Inc. on August 6, 1993.)\n99-k *Third amended complaint of Moise Katz, as Plaintiff, and PSI Resources, Inc., et al., as Defendants dated August 18, 1993. Superior Court No. 2 of Hendricks County in the State of Indiana. (Exhibit to PSI Resources, Inc.'s September 30, 1993, Form 10-Q.)\n99-l *Press release issued by PSI Resources, Inc. and The Cincinnati Gas & Electric Company announcing that PSI Resources, Inc., The Cincinnati Gas & Electric Company, and IPALCO Enterprises, Inc. had reached a settlement agreement. (Exhibit to PSI Resources, Inc.'s Form 8-K dated October 27, 1993.)\n_________________________\n+ Management contract, compensation plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nSIGNATURES\nPursuant 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.\nPSI RESOURCES, INC. Registrant\nDated: March 18, 1994\nBy \/s\/ James E. Rogers (James E. Rogers) Chairman\nPursuant 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 and on the dates indicated.\nSignature Title Date James K. Baker Director Hugh A. Barker Director Michael G. Browning Director Kenneth M. Duberstein Director John A. Hillenbrand, II Director John M. Mutz President & Director Melvin Perelman, Ph.D. Director Van P. Smith Director Robert L. Thompson, Ph.D Director\n\/s\/ J. Wayne Leonard Senior Vice President March 18, 1994 (J. Wayne Leonard) and Director Attorney-in-fact for all (Principal Financial Officer) the foregoing persons\n\/s\/ James E. Rogers Chairman and Director March 18, 1994 (James E. Rogers) (Principal Executive Officer)\n\/s\/ Charles J. Winger Comptroller March 18, 1994 (Charles J. Winger) (Principal Accounting Officer)","section_15":""}
{"filename":"38195_1993.txt","cik":"38195","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nFort Howard Corporation (the \"Company\"), founded in 1919, is a major manufacturer, converter and marketer of a diversified line of single-use sanitary tissue paper products for the home and away-from-home markets. The Company's principal products include paper towels, bath tissue, table napkins, wipers and boxed facial tissue. The Company produces and ships its products from manufacturing facilities located in Wisconsin, Oklahoma, Georgia and the United Kingdom. For an analysis of net sales, operating income (loss) and identifiable operating assets by geographic area, refer to Note 16 of the Company's audited consolidated financial statements.\nThe Company believes that it is the largest producer of tissue products sold into the domestic commercial (away-from-home) market. The Company sells a majority of its tissue products through paper and institutional food wholesalers into commercial markets. The Company continues to expand its domestic consumer tissue business for the home market. Tissue products for household use are sold principally through brokers to accounts that include major food store chains, mass merchandisers and wholesale grocers. The Company's domestic tissue products for home use are sold under the brand names Soft 'N Gentle, Mardi Gras, Green Forest, Page and So-Dri.\nTHE ACQUISITION\nIn 1988, FH Acquisition Corp. (\"FH Acquisition\") was organized on behalf of The Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\") to effect the acquisition of the Company. Pursuant to an Agreement and Plan of Merger dated as of June 25, 1988, FH Acquisition commenced a tender offer (the \"Offer\") on July 1, 1988 for all outstanding shares at $53 per share in cash, and subsequently purchased approximately 53.5 million shares in the Offer. Thereafter, FH Acquisition was merged with and into the Company (the \"Merger\"). The Offer and the Merger are referred to herein collectively as the \"Acquisition.\" Unless the context otherwise requires, all references in this report to \"Common Stock\" refer to the common stock of the Company subsequent to the Merger.\nMSLEF II, an affiliate of Morgan Stanley & Co. Incorporated (\"MS&Co.\"), is a limited partnership formed to finance investments in industrial and other companies. Its principal investors include major U.S. and foreign banks, insurance companies, pension funds and corporations. As a result of the Acquisition, the Company became privately held by MSLEF II and other investors.\nDOMESTIC TISSUE OPERATIONS\nThe Company's principal markets are in the United States where the Company believes, based on an analysis of publicly available information, that its operating income margins are higher than those of its publicly reporting competition. A key factor contributing to these high operating income margins has been the Company's proprietary de-inking technology, which enables it to use a broad range of wastepaper grades and process wastepaper efficiently to recover the fibers which are the principal raw material in papermaking. However, the Company's operating income margins have been adversely affected by the adverse tissue industry operating conditions experienced since 1991,\n- 2 - and continue to be affected by low pricing resulting in part from relatively low industry operating rates. Announced industry capacity additions through 1995 and the weak economic recovery indicate that these industry conditions may continue to affect the Company's selling prices and operating income margins in the near term.\nCommercial Tissue\nThe Company believes it is the leading manufacturer of tissue products for the commercial segment of the U.S. tissue market. The Company believes, based upon industry data, including data collected by the American Forest and Paper Association, that the commercial market represents approximately 40% of the total United States tissue market. The Company's primary thrust in the tissue business has been in the commercial segment which, though smaller in total size than the consumer segment, grew significantly faster than the consumer segment from 1987 to 1990. From 1991 through 1993, the commercial segment grew at a slower rate than the consumer segment due in part to the effects of the recession and weak recovery. The commercial segment of the Company's tissue business includes folded and roll towels, bath and facial tissue, bulk and dispenser napkins, disposable wipers and specialty printed merchandise. The Company also offers a line of tissue products under the Envision brand name which meets U.S. Environmental Protection Agency (\"U.S. EPA\") guidelines for tissue products containing postconsumer recovered wastepaper. Based primarily on the Company's analysis of publicly available information, the Company estimates that in 1993 its market share in the United States for sales of commercial tissue products was approximately 28%.\nConsumer Tissue\nThe Company's consumer tissue business has experienced significant growth over the past fifteen years. Based primarily on the Company's analysis of publicly available information, the Company estimates that its market share in the United States for sales of consumer tissue products has grown from 1% in the late 1970's to approximately 9% in the most recent years. The Company's retail line includes bath and facial tissue, household roll towels and table napkins. The Company's brands include Soft 'N Gentle, Mardi Gras, Green Forest, Page and So-Dri. Green Forest bath tissue, napkins and towels, which are made with 100% recycled fibers, are marketed to the environmentally conscious consumer. In addition, the Company has become a major supplier of private label tissue products to the retail grocery trade.\nThe market share information presented herein reflects the Company's best estimates based on publicly available information, and no assurance can be given regarding the accuracy of such estimates.\nINTERNATIONAL TISSUE OPERATIONS\nThe Company's international operations consist of tissue facilities in the United Kingdom which manufacture and sell a broad line of tissue products. The Company's principal brand in the United Kingdom is Nouvelle.\nCAPITAL EXPENDITURES\nThe Company has invested heavily in its manufacturing operations. Capital expenditures in the Company's tissue business were approximately $741 million for the five-year period ended December 31, 1993. Given the Company's high leverage and adverse tissue industry operating conditions, the\n- 3 - Company intends to continue to maintain and modernize existing tissue mills but does not currently intend to make capital expenditures to add material new capacity. Total capital expenditures after 1993 are projected to approximate $55-$80 million annually over the next ten years, plus $32 million in 1994 to complete the Muskogee mill expansion and an additional $32 million over 1994 and 1995 for a new coal-fired boiler under construction at the Company's Savannah River mill.\nA significant portion of the Company's capital budget in recent years has been invested in the Savannah River mill located in Effingham County, near Savannah, Georgia, which was completed in 1991. Total expenditures for the Savannah River mill were $570 million.\nIn 1993, the Company completed an expansion of its Green Bay, Wisconsin tissue mill. The expansion includes a new paper machine and related environmental protection, pulp processing, converting, and steam generation equipment. The new paper machine commenced production on August 31, 1992. Total expenditures for the expansion were $180 million.\nIn 1992, the Company began the installation of a fifth paper machine, environmental protection equipment and associated facilities at its Muskogee, Oklahoma tissue mill. The expansion is planned for completion in 1994 at an estimated cost of $140 million. Total expenditures for the expansion through December 31, 1993 were $109 million.\nIn 1993, the Company completed an expansion of its United Kingdom tissue mill. The expansion included a new paper machine and related environmental protection, pulp processing and converting equipment. The new paper machine commenced production on February 7, 1993. Total expenditures for the expansion were $96 million. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's Green Bay, Wisconsin tissue mill includes a coal-fired cogenerating power plant; a de-inking and pulp processing plant; a chemical plant; papermaking machines and related drying equipment; nonwoven and dry form manufacturing machines; and converting equipment for cutting, folding, printing and packaging paper and nonwovens into the Company's finished products. The Company's Green Bay mill is well maintained and considered suitable for its intended purpose.\nA second domestic tissue mill is located in Muskogee, Oklahoma. This mill includes a coal-fired cogenerating power plant; a de-inking and pulp processing plant; a chemical plant; papermaking machines and related drying equipment; and converting equipment for cutting, folding, printing and packaging paper into the Company's finished products. The Muskogee mill was specifically designed for its purpose.\nA third domestic tissue mill, the Savannah River mill, is located in Effingham County, near Savannah, Georgia. This mill includes a de-inking and pulp processing plant; a chemical plant; papermaking machines and related drying equipment; and converting equipment for the cutting, folding, printing and packaging of paper into the Company's finished products. The Savannah River mill also contains coal-fired cogenerating power equipment and combustion turbines for the production of electrical power and steam. The Savannah River mill was specifically designed for its purpose.\nThe Company's tissue manufacturing facilities in the United Kingdom include a de-inking and pulp processing plant; papermaking machines and related drying equipment; and converting equipment for the cutting, folding, printing and packaging of paper into the Company's finished products. The Company's United Kingdom operations are well maintained and considered suitable for their intended purpose.\nExcept for certain facilities and equipment constructed or acquired in connection with sale and leaseback transactions pursuant to which the Company continues to possess and operate such facilities and equipment, substantially all the Company's manufacturing facilities and equipment are owned in fee. The Company's domestic and United Kingdom tissue manufacturing facilities are pledged as collateral under the terms of the Company's debt agreements. See Note 8 to the audited consolidated financial statements.\nThe Green Bay, Muskogee, Savannah River and United Kingdom facilities generally operate paper machines at full capacity seven days per week. Converting facilities are generally operated on a 3-shift, 5-day per week basis or a 7-day per week schedule. Converting capacity could be expanded by working additional hours and\/or adding converting equipment.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are parties to lawsuits and state and federal administrative proceedings in connection with their businesses. Although the final results in such suits and proceedings cannot be predicted with certainty, the Company believes that they will not have a material adverse effect on the Company's financial condition.\nThe Internal Revenue Service (\"IRS\") issued a statutory notice of deficiency (\"Notice\") to the Company in March 1992 for additional income tax for the 1988 tax year. The Notice resulted from an audit of the Company's\n- 8 - 1988 tax year wherein the IRS adjusted income and disallowed deductions, including deductions for fees and expenses related to the Acquisition. The IRS also disallowed deductions for fees and expenses related to 1988 debt financing and refinancing transactions. In March 1992, the Company filed a petition in the U.S. Tax Court opposing substantially all of the claimed deficiency and the case was tried in September 1993. After the trial, the Company and the IRS executed an agreed Supplemental Stipulation of Facts by which the IRS and the Company partially settled the case by agreeing that certain fees and expenses (previously disallowed by the IRS and potentially representing approximately $26 million of tax liability) were properly deductible by the Company over the term of the 1988 debt financing and refinancing. In addition, the Company agreed to capitalize certain amounts identified by the IRS and paid additional federal income tax of approximately $5 million representing its liability with respect to the agreed adjustments. The U.S. Tax Court has not yet decided the points that remain in dispute in the case after the partial settlement. The Company estimates that if the IRS were to prevail in disallowing deductions for the fees and expenses remaining in dispute before the trial judge, the potential amount of additional taxes due the IRS on account of such disallowance for the period 1988 through 1993 would be approximately $31 million and for the periods after 1993 (assuming current statutory tax rates) would be approximately $11 million, in each case exclusive of IRS interest charges. Since the Company's 1988 tax case involves disputed issues of law and fact, the Company is unable to predict its final result with certainty. The Company believes, however, that its ultimate resolution will not have a material adverse effect on the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThere is no public market for the stock of the Company. The number of holders of record of the Company's Common Stock as of December 31, 1993 was 61.\n- 9 -\nITEM 6.","section_6":"ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA\n- 10 -\n(a) Effective January 1, 1992, the Company prospectively changed its estimates of the depreciable lives of certain machinery and equipment. The change had the effect of reducing depreciation expense by approximately $38 million and net loss by $24 million in 1992.\n(b) During the third quarter of 1993, the Company wrote off the unamortized balance of its goodwill of $1.98 billion. See Note 4 of the Company's audited consolidated financial statements.\n(c) In 1989, the Company transferred all the capital stock of Fort Howard Cup Corporation to Sweetheart Holdings Inc. (\"Sweetheart\") for a 49.9% equity interest in Sweetheart and other assets for a total consideration of $620 million (the \"Cup Transfer\"). The Company also undertook a plan to divest all its remaining international cup operations. As a result, the Company recorded a $120 million charge in 1989. As of December 31, 1991, the Company had sold all its international cup operations and had discontinued recording equity in net losses of Sweetheart because the carrying value of the the Company's investment in Sweetheart was reduced to zero. During the third quarter of 1993, the Company sold its remaining equity interest in Sweetheart for $5.1 million recognizing a gain of the same amount.\n(d) Reflects the cumulative effect on years prior to 1992 of adopting SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This change in accounting principle, excluding the cumulative effect, decreased operating income for 1992 by $1.2 million.\n(e) Represents operating income plus depreciation of property, plant and equipment, amortization of goodwill, the goodwill write-off and the effects of employee stock compensation (credits). EBDIAT is presented here, not as a measure of operating results, but rather as a measure of the Company's debt service ability. Certain financial and other restrictive covenants in the Company's Bank Credit Agreement, the 1993 Term Loan Agreement, the Senior Secured Note Agreement and other instruments governing the Company's indebtedness are based on the Company's EBDIAT, subject to certain adjustments.\n(f) For purposes of these computations, earnings consist of consolidated income (loss) before taxes plus fixed charges (excluding capitalized interest) of both consolidated and unconsolidated subsidiaries. Amounts applicable to unconsolidated subsidiaries are excluded from such computations commencing on November 14, 1989, due to the Cup Transfer. Fixed charges consist of interest on indebtedness (including capitalized interest and amortization of deferred loan costs) plus that portion (deemed to be one-fourth) of operating lease rental expense representative of the interest factor.\n- 11 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Acquisition was accounted for using the purchase method of accounting. The aggregate purchase price of approximately $3.7 billion, including related acquisition costs, was allocated first to the assets and liabilities of the Company based upon their respective fair values, with the remainder of approximately $2.3 billion allocated to goodwill. In the third quarter of 1993, the Company wrote-off its remaining goodwill balance of $1.98 billion.\nRESULTS OF OPERATIONS Year Ended December 31, ----------------------------- 1993 1992 1991 ---- ---- ---- (In millions, except percentages) Net sales: Domestic tissue................ $ 1,004 $ 978 $ 994 International operations....... 143 143 110 Eliminations and other......... 40 30 34 ------- ------ ------ Consolidated................... $ 1,187 $1,151 $1,138 ======= ====== ======\nOperating income (loss): Domestic tissue(a)(b).......... $(1,715) $ 252 $ 251 International operations(a).... (1) 17 16 Eliminations and other(a)...... (1) 2 3 ------- ------ ------ Consolidated(b)................ (1,717) 271 270 Amortization of purchase accounting..................... 57 75 85 Goodwill write-off(a)............ 1,980 -- -- Employee stock compensation...... (8) 1 1 ------- ------ ------ Adjusted operating income...... 312 347 356 Other depreciation............... 75 63 88 ------- ------ ------ EBDIAT......................... $ 387 $ 410 $ 444 ======= ====== ====== Consolidated net loss............ $(2,052) $ (80) $ (111) ======= ====== ====== EBDIAT as a percent of net sales...................... 32.6% 35.6% 39.0%\n(a) See Note 4 to the audited consolidated financial statements.\n(b) Effective January 1, 1992, the Company prospectively changed its estimates of the depreciable lives of certain machinery and equipment. The change had the effect of reducing depreciation expense and increasing operating income by approximately $38 million in 1992.\n- 12 - A progressive decline in domestic commercial and consumer market selling prices occurred during 1991. Low industry operating rates and aggressive competitive pricing among tissue producers resulting from the recession, additions to capacity in the industry and other factors adversely affected tissue industry operating conditions in 1991. These conditions persisted through 1992 and 1993 causing further price declines. Although the Company introduced domestic net selling price increases in each of the first three quarters of 1993, industry operating rates were relatively low during this period and are expected to be relatively low in the first quarter of 1994, a period of seasonally lower volume. Accordingly, in the first quarter of 1994, the Company's results may be adversely affected as a result of weak industry demand. In addition, announced industry capacity additions through 1995 and the weak economic recovery indicate that these industry conditions may continue to affect the Company's net selling prices and operating income margins in the near term.\nFiscal Year 1993 Compared to Fiscal Year 1992\nNet Sales. Consolidated net sales for 1993 increased 3.1% compared to 1992. Domestic tissue net sales for 1993 increased 2.7% compared to 1992 due to volume increases that were largely offset by lower net selling prices. In mid-1992, average net selling prices rose principally as a result of an attempted price increase in the commercial market but then fell to pre-price increase levels in the fourth quarter of 1992 and fell again in the first quarter of 1993, periods of seasonally lower volume shipments. Average net selling prices held flat from the first quarter of 1993 to the second quarter of 1993 and increased in each of the third and fourth quarters of 1993 from the previous quarter levels. However, in spite of introductions of net selling price increases in each of the first three quarters of 1993, average net selling prices for 1993 were below average net selling prices for 1992. Net sales of the Company's international operations were flat in 1993 compared to 1992 primarily due to significantly lower net selling prices and lower exchange rates offset by volume increases resulting from the acquisition of Stuart Edgar and the start-up of a new paper machine. United Kingdom retailers engaged in increasingly competitive pricing activity in 1993 across a broad range of consumer products including disposable paper products. Such competitive pricing activity is expected to continue into 1994.\nGross Income. Consolidated gross margins decreased to 34.0% in 1993 compared to 36.9% in 1992. Domestic tissue gross margins decreased to 37.4% in 1993 from 40.0% in 1992 primarily due to lower net selling prices and an increase in wastepaper costs. Gross margins of international operations also declined in 1993 principally due to the lower net selling prices. Unit manufacturing costs of international operations declined in 1993 compared to 1992 as a result of the start-up of a new paper machine and related facilities in the first quarter of 1993 at the Company's United Kingdom tissue operations.\nSelling, General and Administrative Expenses. Due to the effects of adverse tissue industry operating conditions on its long-term earnings forecast, the Company decreased the estimated fair market valuation of its Common Stock. Accordingly, in 1993 the Company reversed all previously accrued employee stock compensation expense of $8 million, resulting in a decrease in selling, general and administrative expenses, as a percent of net sales, to 8.2% in 1993 from 8.5% in 1992. Excluding the effects of employee stock compensation from both years, selling, general and administrative expenses, as a percent of net sales, would have increased slightly in 1993 to 8.8% from 8.4% for 1992.\n- 13 - Goodwill Write-Off. As previously reported by the Company (and as further described below), low industry operating rates and aggressive competitive pricing among tissue producers resulting from the recession, additions to industry capacity and other factors have been adversely affecting tissue industry operating conditions and the Company's operating results since 1991.\nDeclining Selling Prices. Although sales volumes have increased, industry pricing has been very competitive due to the factors discussed below. The Company's average domestic net selling prices have declined by approximately 5% in each of 1991 and 1992. Commercial market price increases attempted in mid-1992 were not achieved as commercial market pricing fell to pre-price increase levels in the fourth quarter of 1992 and fell again in the first quarter of 1993, periods of seasonally lower volume shipments. Average net selling prices held flat from the first quarter of 1993 to the second quarter of 1993 and increased from the second to the third quarter of 1993. However, in spite of introductions of net selling price increases in each of the first three quarters of 1993, average net selling prices for the first nine months of 1993 were below average net selling prices for the same period in 1992. Pricing in the Company's international markets declined significantly over this time period as well.\nIndustry Operating Rates. Based on publicly available information, including data collected by the American Forest and Paper Association (\"AFPA\"), industry capacity additions in 1990 through 1992 significantly exceeded historic capacity addition rates. Such additions and weak demand caused industry operating rates to fall to very low levels in 1991 and 1992 in comparison to historic rates. Tissue industry operating rates increased only slightly during the first nine months of 1993 from the low levels experienced in 1991 and 1992. Announced tissue industry capacity additions through 1995, as reported by the AFPA through the first three quarters of 1993, approximated average industry shipment growth rates after 1990. For the first nine months of 1993, the industry shipment growth rate fell sharply from the already low rates in 1991 and 1992. Consequently, without an improved economic recovery and improved industry demand, tissue industry operating rates may remain at relatively low levels for the near term, adversely affecting industry pricing.\nEconomic Conditions. The recession and weak recovery have continued to adversely affect tissue market growth. Job formation is an important stimulus for growth in the commercial tissue market where approximately two-thirds of the Company's domestic tissue sales are targeted. Since 1990, job formation has been weak and was projected to improve only slightly in 1994. Accordingly, demand growth was weak in 1991, 1992 and in the first nine months of 1993, and does not appear to offer any substantial relief to the outlook for industry operating rates and pricing for the near term.\nGross Margins. The Company's gross margins steadily declined in 1991, 1992 and 1993 as a result of the factors noted above. In 1993, the Company's gross margins were also affected by increased wastepaper costs.\nAs a result of these conditions, the Company expected that the significant pricing deterioration experienced in 1991 through mid-1993 would be followed by average annual price increases that approximated the Company's annual historical price increase trend for the years 1984 through 1993 of approximately 1% per year. Accordingly, during the second quarter of 1993, the Company commenced an evaluation of the carrying value of its goodwill for possible impairment. The Company revised its projections and concluded its evaluation in the third quarter of 1993 determining that its forecasted\n- 14 - cumulative net income before goodwill amortization was inadequate to recover the future amortization of the Company's goodwill balance over the remaining amortization period of the goodwill.\nFor a more detailed discussion of the methodology and assumptions employed to assess the recoverability of the Company's goodwill, refer to Note 4 of the Company's audited consolidated financial statements.\nOperating Income (Loss). As a result of the goodwill write-off, the Company's operating loss was $1,717 million for 1993 compared to operating income of $271 million for 1992. The depreciation of asset write-ups to fair market value in purchase accounting is charged against the Company's cost of sales and selling, general and administrative expenses. Excluding this purchase accounting depreciation, amortization of goodwill, the goodwill write-off and the reversal of employee stock compensation, adjusted operating income (as reported in the preceding table) declined to $312 million for 1993 from $347 million for 1992. Adjusted operating income declined in 1993 compared to 1992 principally due to the effects of lower domestic and foreign net selling prices, higher wastepaper costs in the U.S. and lower exchange rates.\nEBDIAT. Earnings before depreciation, interest, amortization and taxes (\"EBDIAT\") declined to $387 million for 1993 from $410 million for 1992. EBDIAT is reported by the Company, not as a measure of operating results, but rather as a measure of the Company's debt service ability. Certain financial and other restrictive covenants in the Company's Bank Credit Agreement, the Senior Secured Note Agreement, the 1993 Term Loan Agreement and other instruments governing the Company's indebtedness are based on the Company's EBDIAT, subject to certain adjustments.\nOther Income, Net. In 1993, the Company sold its remaining equity interest in Sweetheart for $5.1 million recognizing a gain of the same amount. The Company had previously reduced the carrying value of its investment in Sweetheart to zero in 1991.\nIncome Taxes. The income tax credit for 1993 principally reflects the reversal of previously provided deferred income taxes. The income tax credit for 1992 reflects the reversal of previously provided deferred income taxes related to domestic tissue operations offset almost entirely by foreign income taxes.\nExtraordinary Loss and Accounting Change. The Company's net loss in 1993 was increased by an extraordinary loss of $12 million (net of income taxes of $7 million) representing the write-off of unamortized deferred loan costs associated with the repayment of $250 million of term loan indebtedness under the Company's Bank Credit Agreement (the \"Term Loan\"), the repurchase of all the Company's 14 5\/8% Junior Subordinated Debentures due 2004 (the \"14 5\/8% Debentures\") and the repurchase of $50 million of the Company's 12 3\/8% Senior Subordinated Notes due 2000 (the \"12 3\/8% Notes\"). The net loss for 1992 was increased by the Company's adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106. The cumulative effect on years prior to 1992 of adopting SFAS No. 106 is stated separately in the Company's unaudited condensed consolidated statement of income for 1992 as a one-time, after-tax charge of $11 million.\nNet Loss. For 1993, the Company's net loss increased, principally due to the goodwill write-off, to $2,052 million compared to $80 million for 1992.\n- 15 - Fiscal Year 1992 Compared to Fiscal Year 1991\nNet Sales. Domestic tissue sales decreased 1.6% in 1992 compared to 1991. The decrease was attributable to lower net selling prices which were partially offset by volume increases.\nNet sales of the Company's United Kingdom tissue operations increased 30.0% in 1992 compared to 1991. The increase primarily was due to volume increases in both the consumer and commercial markets, and to a lesser extent, due to the acquisition of Stuart Edgar in September 1992, partially offset by lower net selling prices and lower exchange rates.\nGross Income. Effective January 1, 1992, the Company prospectively changed its estimates of the depreciable lives of certain machinery and equipment. These changes were made to better reflect the estimated periods during which such assets will remain in service. As a result, the Company believes, based primarily on an analysis of publicly available information, that the lives over which the Company depreciates the cost of its operating equipment and other capital assets more closely approximates industry norms. For 1992, the change had the effect of reducing depreciation expense by $38 million and reducing net loss by $24 million.\nDomestic tissue gross margins increased slightly in 1992 to 40.0% compared to 39.4% in 1991 due to lower depreciation expense and lower raw material costs, which were largely offset by the decline in net selling prices. Excluding the effects of the changes in depreciable lives, domestic tissue gross margins would have declined to 36.1% in 1992. Gross margins for international operations declined in 1992 due to purchases of parent rolls to support volume increases in anticipation of the start-up of a new paper machine in 1993 and the effects of the acquisition of Stuart Edgar.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses, as a percent of net sales, decreased to 8.5% in 1992 compared to 8.6% in 1991. These results occurred principally due to an overall cost containment effort on the part of the Company, partially offset by the effects of the lower net selling prices and higher volume.\nOperating Income. Operating income of $271 million in 1992 was flat with operating income in 1991. The depreciation of asset write-ups to fair market value in purchase accounting is charged against the Company's cost of sales and selling, general and administrative expenses. Excluding this purchase accounting depreciation, amortization of goodwill and employee stock compensation, adjusted operating income would have been $347 million and $356 million or 30.1% and 31.3% as a percent of net sales in 1992 and 1991, respectively. Adjusted operating income as a percent of net sales declined in 1992 from 1991 due to the effects in 1992 of lower net selling prices, the higher volume growth rate of the lower margin international operations compared to domestic operations and the acquisition of Stuart Edgar, partially offset by the effects of the changes in depreciable lives.\nEBDIAT. EBDIAT declined $34 million in 1992 to $410 million from $444 million in 1991 and declined as a percent of net sales to 35.6% in 1992 from 39.0% in 1991.\nInterest Expense. Interest expense declined approximately $33 million in 1992 as compared to 1991. Debt repurchased with the proceeds of a private placement of Common Stock in 1991 reduced the Company's average outstanding indebtedness in 1992 compared to 1991. Lower average interest rates, in part\n- 16 - due to borrowings under the Company's Revolving Credit Facility to repurchase high yield subordinated debt, also contributed to lower interest expense in 1992 as compared to 1991.\nEquity Earnings. The Company's results for 1992 exclude any equity in the net loss of Sweetheart for the year compared to equity in net losses totaling $32 million in 1991. The Company discontinued the recording of equity in the net losses of Sweetheart, an unconsolidated subsidiary, when the carrying value of its investment in Sweetheart was reduced to zero in the fourth quarter of 1991.\nIncome Taxes. The lower income tax credit for 1992 reflects the Company's lower domestic net loss for the year, offset by foreign income taxes. The income tax credit for 1991 principally reflects the reversal of previously provided deferred income taxes.\nExtraordinary Loss and Accounting Change. Results for 1991 were impacted by an extraordinary loss of $5 million (net of income taxes) related to debt repurchases. As of January 1, 1992, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The standard requires that the expected cost of postretirement health care benefits be charged to expense during the years that employees render service. The cumulative effect on years prior to 1992 of adopting SFAS No. 106 is stated separately in the Company's consolidated statement of income for 1992 as a one-time after-tax charge of $11 million. This change in accounting principle, excluding the cumulative effect, decreased operating income for 1992 by $1 million.\nNet Loss. For 1992, the Company's net loss decreased 27.7% to $80 million from $111 million in 1991. Excluding the effects of the changes in depreciable lives and the change in accounting principle for postretirement benefits in 1992, and excluding the extraordinary item attributable to debt repurchases and equity in net losses incurred by unconsolidated subsidiaries in 1991, the net loss for 1992 would have increased 7.3% compared to 1991.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1993, cash increased $39,000. Capital additions of $166 million and debt repayments of $841 million, including the repayment of $250 million of the Term Loan, the repurchase of all the 14 5\/8% Debentures, and the repurchase of $50 million of the 12 3\/8% Notes, were funded principally by cash provided from operations of $151 million, net proceeds from the sale of 9 1\/4% Senior Unsecured Notes due 2001 (the \"9 1\/4% Notes\") and 10% Subordinated Notes due 2003 (the \"10% Notes\") of $729 million, net proceeds of a new bank term loan in 1993 (the \"1993 Term Loan\") of $95 million, borrowings of $28 million under the revolving credit facility under the Bank Credit Agreement (the \"Revolving Credit Facility\") and Fort Sterling borrowings of $9 million.\nDuring 1992, cash decreased $9 million. Capital additions of $233 million, the acquisition of Stuart Edgar for $8 million (net of debt assumed of $17 million) and debt repayments of $168 million, principally for the retirement of the Company's 7% Notes due 1992 (the \"7% Notes\"), were funded principally by cash provided from operations of $210 million, borrowings under the Revolving Credit Facility of $141 million and borrowings of $49 million by Fort Sterling.\n- 17 - Although the obligations under the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement bear interest at floating rates, the Company is required to enter into interest rate agreements which effectively fix or limit the interest cost to the Company. Pursuant to the Bank Credit Agreement, the Company is a party to interest rate cap agreements which limit the interest cost to the Company to 8.25% (including the Company's borrowing margin on Eurodollar rate loans) until June 1, 1996, with respect to $500 million. Pursuant to the 1993 Term Loan Agreement, the Company is party to an interest rate swap agreement which limits the interest cost to the Company to 6.53% (including the Company's borrowing margin on Eurodollar rate loans) until April 21, 1994 with respect to $100 million. The Company is also a party to an interest rate cap agreement which limits the interest cost to the Company to rates between 11.25% and 12.00% until September 11, 1994, with respect to $300 million received through the issuance of the Senior Secured Notes. See Note 8 to the Company's audited consolidated financial statements for additional information concerning the agreements.\nOn March 22, 1993, the Company sold $450 million principal amount of 9 1\/4% Notes due 2001 and $300 million principal amount of 10% Notes due 2003 in a registered public offering (collectively, the \"1993 Notes\"). On April 21, 1993, the Company borrowed $100 million pursuant to the 1993 Term Loan. Proceeds from the sale of the 1993 Notes and from the 1993 Term Loan were applied to the prepayment of $250 million of the Term Loan, to the repayment of a portion of the Company's indebtedness under the Revolving Credit Facility, to the repurchase of all the Company's outstanding 14 5\/8% Debentures and to the payment of fees and expenses.\nThe 9 1\/4% Notes are senior unsecured obligations of the Company, rank equally in right of payment with the other senior indebtedness of the Company and are senior to all existing and future subordinated indebtedness of the Company. The 10% Notes are subordinated in right of payment to all existing and future senior indebtedness of the Company, including the 12 3\/8% Notes (to be repurchased in 1994 as described below), rank equally with the 12 5\/8% Subordinated Debentures due 2000 (the \"12 5\/8% Debentures\") and constitute senior indebtedness with respect to the 14 1\/8% Junior Subordinated Discount Debentures due 2004 (the \"14 1\/8% Debentures\"). The 1993 Term Loan bears interest, at the Company's option, at Bankers Trust's prime rate, plus 1.75% or, subject to certain limitations, at a reserve adjusted Eurodollar rate, plus 3.00%, and matures May 1, 1997. The 1993 Term Loan constitutes senior secured indebtedness of the Company.\nIn connection with the sale of the 1993 Notes and the borrowing under the 1993 Term Loan, the Company amended the Bank Credit Agreement and the Senior Secured Note Agreement. Among other changes, the amendments reduced domestic capital spending limits for 1993 and future years. In addition, the Company's required ratios of earnings before non-cash charges, interest and taxes to cash interest for 1993 and subsequent years were lowered to give effect to the greater amount of the Company's cash interest payments as a result of the issuance of the 9 1\/4% Notes and the 10% Notes and subsequent repurchases of 14 5\/8% Debentures.\nThe Company redeemed $50 million of its 12 3\/8% Notes at the redemption price of 105% of the principal amount thereof on November 1, 1993, the first date that such notes were redeemable. The redemption was funded principally from excess funds from the sale of the 1993 Notes. In connection with the redemption, the Company incurred an extraordinary loss in the fourth quarter of 1993 of $2 million (net of income taxes), representing the redemption premium and unamortized deferred loan costs.\n- 18 - On February 9, 1994, the Company sold $100 million principal amount of 8 1\/4% Senior Unsecured Notes due 2002 (the \"8 1\/4% Notes\") and $650 million principal amount of 9% Senior Subordinated Notes due 2006 (the \"9% Notes\") in a registered public offering (collectively, the \"1994 Notes\"). Proceeds from the sale of the 1994 Notes have been or will be applied to the repurchase of all the remaining 12 3\/8% Notes at the redemption price of 105% of the principal thereof, to the repurchase of $238 million of 12 5\/8% Debentures at the redemption price of 105% of the principal thereof, to the prepayment of $100 million of the Term Loan, to the repayment of a portion of the Company's indebtedness under the Revolving Credit Facility and to the payment of fees and expenses.\nThe 8 1\/4% Notes are senior unsecured obligations of the Company, rank equally in right of payment with the other senior indebtedness of the Company and are senior to all existing and future subordinated indebtedness of the Company. The 9% Notes are subordinated in right of payment to all existing and future senior indebtedness of the Company, and constitute senior indebtedness with respect to the 10% Notes, the 12 5\/8% Debentures and the 14 1\/8% Debentures.\nIn connection with the sale of the 1994 Notes, the Company amended the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement. Among other changes, the amendments reduced the required ratio of earnings before non-cash charges, interest and taxes to cash interest for the four fiscal quarters ending March 31, 1994, from 1.50 to 1.00 to 1.40 to 1.00.\nThe Company will incur an extraordinary loss of $27 million (net of income taxes of $16 million) in the first quarter of 1994 representing the redemption premiums on the repurchases of the 12 3\/8% Notes and the 12 5\/8% Debentures, and the write-off of deferred loan costs associated with the repayment of the $100 million of the Term Loan and the repurchases of the 12 3\/8% Notes and the 12 5\/8% Debentures.\nIn 1991, Fort Sterling entered into a credit agreement to provide financing for the addition of a third paper machine and related equipment at its tissue mill. The facility consists of a 20 million pound sterling (approximately $30 million) term loan due March 2001, and a 5 million pound sterling (approximately $7 million) revolving credit facility due March 1996. In 1992, Fort Sterling entered into a second credit agreement to finance the acquisition of Stuart Edgar. This facility consists of a term loan due December 1997 with 3.4 million pounds sterling (approximately $5 million) outstanding at December 31, 1993, and a second term loan due December 1997 with 6.8 million pounds sterling (approximately $10 million) outstanding at December 31, 1993. Both credit agreements bear interest at floating rates and are secured by certain assets of Fort Sterling and Stuart Edgar but are nonrecourse to the Company. At December 31, 1993, $47 million was outstanding under these credit agreements.\nThe Company's principal use of funds for the next several years will be for the repayment of indebtedness under the Bank Credit Agreement, the repurchase of the 12 5\/8% Debentures and the 14 1\/8% Debentures, capital expenditures, including capital expenditures to comply with environmental regulations, the repurchase of its subordinated debt securities generally as described below, and support of the Company's working capital requirements. The Term Loan matures and the Revolving Credit Facility expires in 1996. In connection with the sale of the 1994 Notes, the Company prepaid $100 million of the $107 million mandatory payment due under the Term Loan in 1994, will\n- 19 - repurchase all the 12 3\/8% Notes that were due in 1997 and will repurchase $238 million principal amount of the 12 5\/8% Debentures due in 2000. The Company is required to make repayments of the Term Loan of $107 million in 1995 and $118 million in 1996. The 1993 Term Loan matures in 1997. The Company intends to use funds generated from operations and borrowings under the Bank Credit Agreement or from other sources to meet its principal needs for funds.\nGiven the Company's high leverage and adverse tissue industry operating conditions, the Company intends to continue to maintain and modernize existing tissue mills but does not currently intend to make capital expenditures to add material new capacity. Capital expenditures were $166 million, $233 million and $144 million in 1993, 1992 and 1991, respectively. Capital expenditures are projected to approximate $55-$80 million annually over the next ten years, plus $32 million in 1994 to complete the Muskogee mill expansion and another $32 million over 1994 and 1995 for a new coal-fired boiler under construction at the Company's Savannah River mill. The Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement impose limits for domestic capital expenditures, subject to certain exceptions, of $175 million for 1994, $100 million for 1995 and $100 million for 1996 (with lower sublimits for foreign subsidiaries). In addition, the Company may carryover to one or more years (thereby increasing the scheduled permitted limit for capital expenditures in respect of such year) the sum of all previously unutilized amounts in 1993 and subsequent years (up to $400 million per year) by which the scheduled permitted limit for each prior year exceeded the capital expenditures actually made in respect of such prior year. The Company does not believe such limitations impair its plans for capital expenditures. For a discussion of the Company's capital expenditures in connection with environmental control matters, see \"Item 1 - Business - Environmental Matters.\"\nMarket conditions with respect to high yield debt securities may from time to time be such that it is to the Company's advantage to repurchase some or all of its subordinated debt securities in privately negotiated transactions or in the open market. However, the repurchase of subordinated debt securities is limited by certain provisions contained in the Company's senior debt agreements and the indentures under which such subordinated debt securities were issued. As of December 31, 1993, the Company may borrow up to $39 million to repurchase 14 1\/8% Debentures. Subsequent to the issuance of the 1994 Notes, the Company may borrow up to $75 million to repurchase 12 5\/8% Debentures, until June 30, 1995. Subject to and in compliance with the limitations contained in the Company's debt agreements, and depending upon market conditions, prevailing prices and cash available, the Company may from time to time repurchase subordinated debt.\nThe Company has a $350 million Revolving Credit Facility (including letters of credit) under the Bank Credit Agreement with a final maturity of December 31, 1996, which may be used for general corporate purposes. At December 31, 1993, the Company had $106 million in available capacity under the Revolving Credit Facility.\nThe Company believes that, notwithstanding the adverse tissue industry operating conditions and the non-cash charge to write-off the remaining balance of the Company's goodwill discussed above, cash provided by operations and access to debt financing in the public and private markets will be sufficient to enable it to fund maintenance and modernization capital expenditures and meet its debt service requirements for the foreseeable future. However, in the absence of improved financial results, it is likely\n- 20 - that in 1995 the Company would be required to seek a waiver of the cash interest coverage covenant under the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement because the Company's 14 1\/8% Debentures will accrue interest in cash commencing on November 1, 1994 and will require payments of interest in cash on May 1, 1995. Although the Company believes that it will be able to obtain appropriate waivers from its lenders, there can be no assurance that this will be the case.\nDuring 1993, 1992, and 1991, a slightly higher amount of the Company's revenues and operating income have been recognized during the second and third quarters. The Company expects to fund seasonal working capital needs from the Revolving Credit Facility.\nThe Bank Credit Agreement, the 1993 Term Loan Agreement, the Senior Secured Note Agreement, and the Fort Sterling credit agreements impose certain limitations on the liquidity of the Company that include restrictions on the Company's ability to incur additional indebtedness and mandatory principal repayment requirements, including scheduled principal repayments and repayments out of excess cash flow and from proceeds of asset sales. Refer to Note 8 to the audited consolidated financial statements for a description of other covenants under the terms of the Company's debt agreements.\nThe limitations contained in the Bank Credit Agreement, the 1993 Term Loan Agreement, the Senior Secured Note Agreement, and in the Company's indentures on the ability of the Company and its subsidiaries to incur indebtedness, together with the highly leveraged position of the Company, could limit the Company's ability to effect future financings and may otherwise restrict corporate activities, including the Company's ability to take advantage of business opportunities which may arise or to take actions that require funds in excess of those available to the Company. In addition, as a result of the Company's highly leveraged position and related debt service obligations, the Company will be less able to meet its obligations during a further downturn in its business.\nRefer to Note 7 to the audited consolidated financial statements for a description of certain matters related to income taxes.\n- 21 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of FORT HOWARD CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Fort Howard Corporation (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income and cash flows for the years ended December 31, 1993, 1992 and 1991. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Fort Howard Corporation and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for the years ended December 31, 1993, 1992 and 1991, in conformity with generally accepted accounting principles.\nAs discussed in Notes 1, 7 and 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its methods of accounting for postretirement benefits other than pensions and income taxes.\nARTHUR ANDERSEN & CO.\nMilwaukee, Wisconsin, February 1, 1994\n- 22 -\nFORT HOWARD CORPORATION CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) Year Ended December 31, ------------------------------ 1993 1992 1991 ---- ---- ----\nNet sales............................... $ 1,187,387 $1,151,351 $1,138,210 Cost of sales........................... 784,054 726,356 713,135 ----------- ---------- ---------- Gross income............................ 403,333 424,995 425,075 Selling, general and administrative..... 96,966 97,620 97,885 Amortization of goodwill................ 42,576 56,700 56,658 Goodwill write-off...................... 1,980,427 -- -- ----------- ---------- ---------- Operating income (loss)................. (1,716,636) 270,675 270,532 Interest expense........................ 342,792 338,374 371,186 Other (income) expense, net............. (2,996) 2,101 (2,655) ----------- ---------- ---------- Loss before taxes....................... (2,056,432) (69,800) (97,999) Income taxes (credit)................... (16,314) (398) (23,963) ----------- ---------- ---------- Loss before equity earnings, extraordinary items and adjustment for accounting change................. (2,040,118) (69,402) (74,036) Equity in net loss of unconsolidated subsidiaries.......................... -- -- (31,504) ----------- ---------- ---------- Net loss before extraordinary items and adjustment for accounting change..................... (2,040,118) (69,402) (105,540) Extraordinary items - losses on debt repurchases (net of income taxes of $7,333 in 1993 and $3,090 in 1991)....................... (11,964) -- (5,044) Adjustment for adoption of SFAS No. 106.......................... -- (10,587) -- ----------- ---------- ---------- Net loss................................ $(2,052,082) $ (79,989) $ (110,584) =========== ========== ==========\nLoss per share: Net loss before extraordinary items and adjustment for accounting change .................. $ (347.99) $ (11.83) $ (19.67) Extraordinary items................... (2.04) -- (0.94) Adjustment for adoption of SFAS No. 106 ....................... -- (1.81) -- ----------- ---------- ---------- Net loss ............................... $ (350.03) $ (13.64) $ (20.61) =========== ========== ==========\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 23 -\nFORT HOWARD CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands)\nDecember 31, ------------------ 1993 1992 ---- ---- Assets Current assets: Cash and cash equivalents................... $ 227 $ 188 Receivables, less allowances of $2,366 and $1,376......................... 105,834 103,491 Inventories................................. 118,269 100,975 Deferred income taxes....................... 14,000 10,000 Income taxes receivable..................... 9,500 2,500 ----------- ---------- Total current assets...................... 247,830 217,154 Property, plant and equipment................. 1,845,052 1,694,946 Less: Accumulated depreciation............. 516,938 437,518 ----------- ---------- Net property, plant and equipment......... 1,328,114 1,257,428 Goodwill, net of accumulated amortization of $247,495 in 1992......................... -- 2,023,416 Other assets.................................. 73,843 76,569 ----------- ---------- Total assets............................ $1,649,787 $3,574,567 ========== ==========\nLiabilities and Shareholders' Equity (Deficit) Current liabilities: Accounts payable............................ $ 101,665 $ 104,405 Interest payable............................ 54,854 33,057 Income taxes payable........................ 122 1,792 Other current liabilities................... 70,138 64,282 Current portion of long-term debt........... 112,750 137,747 ----------- ---------- Total current liabilities................. 339,529 341,283 Long-term debt................................ 3,109,838 2,953,027 Deferred and other long-term income taxes. ... 243,437 259,625 Other liabilities............................. 26,088 36,473 Voting Common Stock with put right............ 11,820 13,219 Shareholders' equity (deficit): Voting Common Stock......................... 600,459 600,465 Cumulative translation adjustment........... (5,091) (3,915) Retained earnings (deficit)................. (2,676,293) (625,610) ----------- ---------- Total shareholders' equity (deficit)...... (2,080,925) (29,060) ----------- ---------- Total liabilities and shareholders' equity (deficit)...................... $1,649,787 $3,574,567 ========== ==========\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 24 -\nFORT HOWARD CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, ---------------------------- 1993 1992 1991 ---- ---- ---- Cash provided from (used for) operations: Net loss................................ $(2,052,082) $(79,989) $(110,584) Depreciation and amortization........... 130,671 137,977 172,671 Goodwill write-off...................... 1,980,427 -- -- Non-cash interest expense............... 100,844 139,700 141,362 Deferred income tax (credit)............ (17,874) (17,799) (34,881) Employee stock compensation............. (7,832) 1,120 1,256 Equity in net loss of unconsolidated subsidiaries........... -- -- 31,504 Pre-tax loss on debt repurchases........ 19,297 -- 8,134 Pre-tax adjustment for adoption of SFAS No. 106....................... -- 17,076 -- (Increase) decrease in receivables .... (2,343) (5,284) 4,087 Increase in inventories................. (17,294) (1,215) (6,001) (Increase) decrease in income taxes receivable............................ (7,000) (2,500) 26,300 Increase (decrease) in accounts payable .............................. (2,740) 13,572 3,429 Increase (decrease) in interest payable. 21,797 (298) (1,468) Decrease in income taxes payable........ (1,670) (5,094) (394) All other, net.......................... 6,854 12,684 5,466 ----------- -------- --------- Net cash provided from operations..... 151,055 209,950 240,881\nCash provided from (used for) investment activities: Additions to property, plant and equipment............................. (165,539) (232,844) (144,055) Acquisition of Stuart Edgar Limited, net of acquired cash of $749.......... -- (8,302) -- Net proceeds from dispositions of investments in and advances to unconsolidated subsidiaries........... -- -- 38,568 ----------- -------- --------- Net cash used for investment activities.......................... (165,539) (241,146) (105,487)\nCash provided from (used for) financing activities: Proceeds from long-term borrowings...... 887,088 189,518 462,995 Repayment of long-term borrowings....... (841,399) (167,731) (759,487) Debt issuance costs..................... (31,160) -- (11,058) Issuance (purchase) of Common Stock..... (6) -- 163,357 ----------- -------- --------- Net cash provided from (used for) financing activities................ 14,523 21,787 (144,193) ----------- -------- --------- Increase (decrease) in cash................ 39 (9,409) (8,799) Cash, beginning of year.................... 188 9,597 18,396 ----------- -------- --------- Cash, end of year....................... $ 227 $ 188 $ 9,597 =========== ======== =========\nSupplemental Cash Flow Disclosures: Interest paid........................... $ 228,360 $208,051 $ 236,140 Income taxes paid (refunded), net....... 4,432 9,997 (11,090)\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 25 -\nFORT HOWARD CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1993\n1. SIGNIFICANT ACCOUNTING POLICIES\n(A) PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of Fort Howard Corporation and all domestic and foreign subsidiaries other than the Company's former cup subsidiaries. Assets and liabilities of foreign subsidiaries are translated at the rates of exchange in effect at the balance sheet date. Income amounts are translated at the average of the monthly exchange rates. The cumulative effect of translation adjustments is deferred and classified as a cumulative translation adjustment in the consolidated balance sheet. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to conform prior years' data to the current format.\nOn September 4, 1992, Fort Sterling Limited (\"Fort Sterling\"), the Company's United Kingdom tissue operations, acquired for $25 million, including debt assumed of $17 million, Stuart Edgar Limited (\"Stuart Edgar\"), a converter of consumer tissue products with annual net sales approximating $43 million. The operating results of Stuart Edgar are included in the consolidated financial statements since September 4, 1992.\nThe Company's investments in unconsolidated subsidiaries were reduced to zero at December 31, 1991 as a result of sales of all foreign cup subsidiaries and recognition of equity in the net losses of its remaining cup subsidiary, Sweetheart Holdings Inc. (\"Sweetheart\"). During 1993, the Company sold its remaining equity interest in Sweetheart for $5.1 million recognizing a gain of the same amount.\n(B) CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value due to the short maturity of the investments.\n(C) INVENTORIES -- Inventories are carried at the lower of cost or market, with cost principally determined on a first-in, first-out basis (see Note 2).\n(D) PROPERTY, PLANT AND EQUIPMENT -- Prior to August 9, 1988, property, plant and equipment were stated at original cost and depreciated using the straight-line method. Effective with the Acquisition (as defined below), properties were adjusted to their estimated fair values and are being depreciated on a straight-line basis.\nEffective January 1, 1992, the Company prospectively changed its estimates of the depreciable lives of certain machinery and equipment. These changes were made to better reflect the estimated periods during which such assets will remain in service. For the year ended December 31, 1992, the change had the effect of reducing depreciation expense by $38 million and net loss by $24 million. Subsequent to the change, depreciation is provided over useful lives of 30 to 50 years for buildings and 2 to 25 years for equipment.\nAssets under capital leases principally arose in connection with sale and leaseback transactions as described in Note 9 and are stated at the present value of future minimum lease payments. These assets are amortized over the respective periods of the leases which range from 15 to 25 years.\n- 26 - Amortization of assets under capital leases is included in depreciation expense.\nThe Company follows the policy of capitalizing interest incurred in conjunction with major capital expenditure projects. The amounts capitalized in 1993, 1992 and 1991 were $8,369,000, $11,047,000 and $5,331,000, respectively.\n(E) REVENUE RECOGNITION -- Sales of the Company's paper products are recorded upon shipment of products.\n(F) ENVIRONMENTAL EXPENDITURES -- Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when material environmental assessments and\/or remedial efforts are probable, and the cost can be reasonably estimated.\n(G) GOODWILL -- In 1988, FH Acquisition Corp., a company organized on behalf of The Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\"), acquired the Company in a leveraged buyout and was subsequently merged with and into the Company (the \"Acquisition\"). Goodwill (the acquisition costs in excess of the fair value of net assets of acquired businesses) acquired in connection with the Acquisition and the purchases of other businesses was amortized on a straight-line basis over 40 years through the third quarter of 1993 when the Company wrote off its remaining goodwill balance (see Note 4). The Company evaluates the carrying value of goodwill for possible impairment using a methodology which assesses whether forecasted cumulative net income before goodwill amortization is adequate to recover the future amortization of the Company's goodwill balance over the remaining amortization period of the goodwill.\n(H) EMPLOYEE BENEFIT PLANS -- A substantial majority of the Company's employees are covered under defined contribution plans. The Company's annual contributions to defined contribution plans are based on pre-tax income, subject to percentage limitations on participants' earnings and a minimum return on shareholders' equity. In recent years, the Company made discretionary contributions as permitted under the plans. Participants may also contribute a certain percent of their wages to the plans. Costs charged to operations for defined contribution plans were approximately $12,725,000, $11,716,000 and $12,231,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nEmployees retiring prior to February 1, 1990 from the Company's U.S. tissue operations who have met certain eligibility requirements are entitled to postretirement health care benefit coverage. These benefits are subject to deductibles, copayment provisions, a lifetime maximum benefit and other limitations. In addition, employees who retire after January 31, 1990 at age 55 or older with ten years of service may purchase health care benefit coverage from the Company up to age 65. The Company has reserved the right to change or terminate this benefit at any time. As of January 1, 1992, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" The standard requires that the expected cost of postretirement health care benefits be charged to expense during the years that employees render service (see Note 10). Prior to 1992, the annual cost of these benefits had been expensed as claims and premiums were paid. Employees of the Company's U.K.\n- 27 - tissue operations are not entitled to Company-provided postretirement benefit coverage.\nIn November 1992, the Financial Accounting Standards Board issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This new standard requires that the expected cost of benefits to be provided to former or inactive employees after employment but before retirement be charged to expense during the years that the employees render service. In the fourth quarter of 1992, the Company retroactively adopted the new standard effective January 1, 1992. Adoption of the new accounting standard had no effect on the Company's 1992 consolidated statement of income.\n(I) INTEREST RATE CAP AND SWAP AGREEMENTS -- The cost of interest rate cap agreements is amortized over the respective lives of the agreements. The differential to be paid or received in connection with interest rate swap agreements is accrued as interest rates change and is recognized over the lives of the agreements.\n(J) INCOME TAXES -- Effective January 1, 1992, the Company has adopted SFAS No. 109, \"Accounting for Income Taxes.\" The Company had previously adopted SFAS No. 96, \"Accounting for Income Taxes\" in 1988. As a result of the accounting change, the Company reclassified certain deferred tax benefits from long-term deferred income taxes payable to current assets in the accompanying 1992 consolidated balance sheet. The adoption of SFAS No. 109 had no effect on the Company's provision for income taxes for the year ended December 31, 1992.\nDeferred income taxes are provided to recognize temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The principal difference relates to depreciation expense. Deferred income tax expense represents the change in the deferred income tax asset and liability balances, excluding the deferred tax benefit related to extraordinary losses.\n(K) EARNINGS (LOSS) PER SHARE -- Earnings (loss) per share has been computed on the basis of the average number of common shares outstanding during the years. The average number of shares used in the computation was 5,862,639, 5,862,685 and 5,364,357 for the years ended December 31, 1993, 1992 and 1991, respectively.\n(L) SEGMENT INFORMATION -- The Company operates in one industry segment as a manufacturer, converter and marketer of a diversified line of single-use paper products for the home and away-from-home markets.\n- 28 - 2. INVENTORIES\nInventories are summarized as follows:\nDecember 31, -------------------- 1993 1992 ---- ---- (In thousands)\nComponents Raw materials and supplies.................. $ 61,285 $ 53,872 Finished and partly-finished products.................................. 56,984 47,103 -------- -------- $118,269 $100,975 ======== ========\nValued at lower of cost or market: First-in, first-out (FIFO).................. $ 94,436 $ 82,805 Average cost by specific lot................ 23,833 18,170 -------- -------- $118,269 $100,975 ======== ========\n3. PROPERTY, PLANT AND EQUIPMENT\nThe Company's major classes of property, plant and equipment are:\nDecember 31, -------------------- 1993 1992 ---- ---- (In thousands)\nLand.......................................... $ 44,429 $ 44,631 Buildings..................................... 318,955 294,768 Machinery and equipment....................... 1,367,839 1,212,136 Construction in progress...................... 113,829 143,411 ---------- ---------- $1,845,052 $1,694,946 ========== ==========\nIncluded in the property, plant and equipment totals above are assets under capital leases, as follows:\nDecember 31, -------------------- 1993 1992 ---- ---- (In thousands)\nBuildings..................................... $ 3,989 $ 3,998 Machinery and equipment....................... 185,624 179,487 ---------- ---------- Total assets under capital leases........... $ 189,613 $ 183,485 ========== ==========\n- 29 - 4. GOODWILL\nChanges in the Company's goodwill are summarized as follows:\nYear Ended December 31, ------------------------------ 1993 1992 1991 ---- ---- ---- Balance, beginning of year......... $2,023,416 $2,075,525 $2,132,183 Acquisition of Stuart Edgar........ -- 6,043 -- Amortization of goodwill........... (42,576) (56,700) (56,658) Effects of foreign currency translation............. (413) (1,452) -- Goodwill write-off................. (1,980,427) -- -- ---------- ---------- ---------- Balance, end of year............... $ -- $2,023,416 $2,075,525 ========== ========== ==========\nLow industry operating rates and aggressive competitive activity among tissue producers resulting from the recession, additions to capacity and other factors have been adversely affecting tissue industry operating conditions and the Company's operating results since 1991. Accordingly, the Company revised its projections and determined that its projected results would not support the future amortization of the Company's remaining goodwill balance of approximately $1.98 billion at September 30, 1993.\nThe methodology employed to assess the recoverability of the Company's goodwill first involved the projection of operating results forward 35 years, which approximated the remaining amortization period of the goodwill as of October 1, 1993. The Company then evaluated the recoverability of goodwill on the basis of this forecast of future operations. Based on such forecast, the cumulative net income before goodwill amortization of approximately $100 million over the remaining 35-year amortization period was insufficient to recover the goodwill balance. Accordingly, the Company wrote off its remaining goodwill balance of $1.98 billion in the third quarter of 1993.\nThe Company's forecast assumed that sales volume increases would be limited to production from a new paper machine under construction at the Company's Muskogee mill which is scheduled to start-up in 1994 and that further capacity expansion was not justifiable given the Company's high leverage and adverse tissue industry operating conditions. Net selling price and cost increases were assumed to approximate 1% per year, based on the Company's annual historical price increase trend for the years 1984 through 1993 and managements estimates of future performance. Through the year 2001, the Company's projections indicated that interest expense would exceed operating income, which is determined after deducting annual depreciation expense. However, projected operating income before depreciation was adequate to cover projected interest expense. Inflation and interest rates were assumed to remain low at 1993 levels during the projected period. Each of the Company's highest yielding debt securities, the 12 3\/8% Senior Subordinated Notes due 1997 (the \"12 3\/8% Notes\"), the 12 5\/8% Subordinated Debentures due 2000 (the \"12 5\/8% Debentures\") and the 14 1\/8% Junior Subordinated Discount Debentures due 2004 (the \"14 1\/8% Debentures\"), were further assumed to be refinanced at lower interest rates. Total capital expenditures were projected to approximate $55-$80 million annually over the next ten years, plus $32 million in 1994 to complete the Muskogee mill expansion and another $32 million over 1994 and 1995 for a new coal-fired boiler under construction at the Company's Savannah River mill. Management believed that the projected\n- 30 - future results based on these assumptions were the most likely scenario given the Company's high leverage and adverse tissue industry operating conditions.\n5. OTHER ASSETS\nThe components of other assets are as follows:\nDecember 31, -------------- 1993 1992 ---- ---- (In thousands)\nDeferred loan costs, net of accumulated amortization................... $71,459 $70,983 Prepayments and other........................ 2,384 5,586 ------- ------- $73,843 $76,569 ======= =======\nAmortization of deferred loan costs for the years ended December 31, 1993, 1992 and 1991, totaled $ 13,488,000, $14,910,000 and $14,883,000, respectively. During 1993, $19,297,000 of deferred loan costs were written off in conjunction with the retirement of long-term debt and $31,160,000 of deferred loan costs were incurred for the issuance of a new bank term loan (the \"1993 Term Loan), the 9 1\/4% Senior Unsecured Notes due 2001 (the \"9 1\/4% Notes\") and the 10% Subordinated Notes due 2003 (the \"10% Notes\") and for the purchase of interest rate caps. During 1991, $11,250,000 of deferred loan costs were written off in conjunction with the retirement of long-term debt and $11,058,000 of deferred loan costs were incurred for the issuance of Senior Secured Notes (see Note 8).\n6. OTHER CURRENT LIABILITIES\nThe components of other current liabilities are as follows:\nDecember 31, -------------- 1993 1992 ---- ---- (In thousands)\nSalaries and wages ........................... $38,152 $35,939 Contributions to employee benefit plans ...... 12,805 11,858 Taxes other than income taxes ................ 5,492 2,536 Other accrued expenses ....................... 13,689 13,949 ------- ------- $70,138 $64,282 ======= =======\n- 31 -\n7. INCOME TAXES\nThe income tax provision (credit) includes the following components:\nYear Ending December 31, ---------------------------------- 1993 1992 1991 ---- ---- ---- (In thousands) Current Federal.......................... $ (6,012) $ 10,501 $ 2,040 State............................ 465 411 551 Foreign.......................... (225) -- 5,237 -------- -------- -------- Total current.................. (5,772) 10,912 7,828 Deferred Federal.......................... (7,731) (13,678) (27,120) State............................ (2,956) (2,380) (4,231) Foreign.......................... 145 4,748 (440) -------- -------- -------- Total deferred................. (10,542) (11,310) (31,791) -------- -------- -------- $(16,314) $ (398) $(23,963) ======== ======== ========\nThe effective tax rate varied from the U.S. federal tax rate as a result of the following:\nYear Ended December 31, --------------------------------- 1993 1992 1991 ---- ---- ----\nU.S. federal tax rate.............. (34.0)% (34.0)% (34.0)% Amortization of intangibles........ 33.4 27.6 19.6 Interest on long-term income taxes..................... -- 5.7 4.1 State income taxes net of U.S. tax benefit.............. (0.1) (3.0) (3.9) Equity in net loss of Sweetheart.................... -- -- (10.9) Other, net......................... (0.1) 3.1 0.6 ----- ----- ----- Effective tax rate................. (0.8)% (0.6)% (24.5)% ===== ===== =====\nThe net deferred income tax liability at December 31, 1993, includes $229 million related to property, plant and equipment. All other components of the gross deferred income tax assets and gross deferred income tax liabilities are individually not significant. The Company has not recorded a valuation allowance with respect to any deferred income tax asset.\n- 32 -\nThe Internal Revenue Service (\"IRS\") issued a statutory notice of deficiency (\"Notice\") to the Company in March 1992 for additional income tax for the 1988 tax year. The Notice resulted from an audit of the Company's 1988 tax year wherein the IRS adjusted income and disallowed deductions, including deductions for fees and expenses related to the Acquisition. The IRS also disallowed deductions for fees and expenses related to 1988 debt financing and refinancing transactions. In March 1992, the Company filed a petition in the U.S. Tax Court opposing substantially all of the claimed deficiency and the case was tried in September 1993. After the trial, the Company and the IRS executed an agreed Supplemental Stipulation of Facts by which the IRS and the Company partially settled the case by agreeing that certain fees and expenses (previously disallowed by the IRS and potentially representing approximately $26 million of tax liability) were properly deductible by the Company over the term of the 1988 debt financing and refinancing. In addition, the Company agreed to capitalize certain amounts identified by the IRS and paid additional federal income tax of approximately $5 million representing its liability with respect to the agreed adjustments. The U.S. Tax Court has not yet decided the points that remain in dispute in the case following the partial settlement. The Company estimates that if the IRS were to prevail in disallowing deductions for the fees and expenses remaining in dispute before the trial judge, the potential amount of additional taxes due the IRS on account of such disallowance for the period 1988 through 1993 would be approximately $31 million and for the periods after 1993 (assuming current statutory tax rates) would be approximately $11 million, in each case exclusive of IRS interest charges. Since the Company's 1988 tax case involves disputed issues of law and fact, the Company is unable to predict its final result with certainty. The Company believes, however, that its ultimate resolution will not have a material adverse effect on the Company's financial condition.\n- 33 -\n8. LONG-TERM DEBT\nLong-term debt and capital lease obligations, including amounts payable within one year, are summarized as follows (in thousands):\n- 34 -\nThe aggregate fair values of the Company's long-term debt and capital lease obligations approximated $3,276 million and $3,116 million compared to aggregate carrying values of $3,223 million and $3,091 million at December 31, 1993 and 1992, respectively. The fair values of the Term Loan, Revolving Credit Facility and 1993 Term Loan are estimated based on secondary market transactions in such securities. Fair values for the Senior Secured Notes, the 9 1\/4% Notes, the 12 3\/8% Notes, the 12 5\/8% Debentures, the 10% Notes, the 14 1\/8% Debentures and the Pollution Control Revenue Refunding Bonds were estimated based on trading activity in such securities. Of the capital lease obligations, the fair values of the 1991 Series Pass Through Certificates were estimated based on trading activity in such securities. The fair values of other capital lease obligations were estimated based on interest rates implicit in the valuation of the 1991 Series Pass Through Certificates. The fair value of debt of foreign subsidiaries is deemed to approximate its carrying amount.\nThe 14 1\/8% Debentures do not accrue interest in cash until November 1, 1994, and were issued at a discount to yield a 14 1\/8% effective annual rate. The 14 1\/8% Debentures will require payments of interest in cash commencing on May 1, 1995. For the years ended December 31, 1993, 1992, and 1991, interest related to these debentures was added to the balance due.\nOn March 22, 1993, the Company sold $450 million principal amount of 9 1\/4% Notes and $300 million principal amount of 10% Notes in a registered public offering. On April 21, 1993, the Company borrowed $100 million pursuant to the 1993 Term Loan. Proceeds from the sale of the 9 1\/4% Notes and the 10% Notes and from the 1993 Term Loan were applied to the prepayment of $250 million of the Term Loan, to the repayment of a portion of the Company's indebtedness under the Revolving Credit Facility, to the repurchase of all the Company's outstanding Junior Subordinated Debentures due 2004 (the \"14 5\/8% Debentures\") and to the payment of fees and expenses. As a result of the repayment of $250 million of the Term Loan and the repurchases of the 14 5\/8% Debentures, the Company incurred an extraordinary loss of $10 million (net of income taxes of $6 million) representing the write-off of unamortized deferred loan costs.\nThe 9 1\/4% Notes are senior unsecured obligations of the Company, rank equally in right of payment with the other senior indebtedness of the Company and are senior to all existing and future subordinated indebtedness of the Company. The 10% Notes are subordinated in right of payment to all existing and future senior indebtedness of the Company, including the 12 3\/8% Notes, rank equally with the 12 5\/8% Debentures and constitute senior indebtedness with respect to the 14 1\/8% Debentures. The 1993 Term Loan bears interest, at the Company's option, at Bankers Trust's prime rate, plus 1.75% or, subject to certain limitations, at a reserve adjusted Eurodollar rate, plus 3.00%, and matures May 1, 1997. The 1993 Term Loan constitutes senior secured indebtedness of the Company.\nIn connection with the sale of the 9 1\/4% Notes and the 10% Notes and the borrowing under the 1993 Term Loan, the Company amended its Bank Credit Agreement and the Senior Secured Note Agreement. Among other changes, the amendments reduced domestic capital spending limits. In addition, the Company's required ratios of earnings before non-cash charges, interest and taxes to cash interest were lowered to give effect to the greater amount of the Company's cash interest payments as a result of the issuance of the 9 1\/4% Notes and 10% Notes and subsequent repurchases of 14 5\/8% Debentures.\n- 35 - The Company redeemed $50 million of its 12 3\/8% Notes at the redemption price of 105% of the principal amount thereof on November 1, 1993, the first date that such notes were redeemable. The redemption was funded principally from excess funds from the sale of the 9 1\/4% Notes and the 10% Notes. In connection with the redemption, the Company incurred an extraordinary loss of $2 million (net of income taxes of $1 million), representing the redemption premium and unamortized deferred loan costs.\nIn 1991, Fort Sterling entered into a credit agreement to provide financing for the addition of a third paper machine and related equipment at its tissue mill. The facility consists of a 20 million pound sterling (approximately $30 million) term loan due March 2001 and a 5 million pound sterling (approximately $7 million) revolving credit facility due March 1996. In 1992, Fort Sterling entered into a second credit agreement to finance the acquisition of Stuart Edgar. This facility consists of a term loan due December 1997 with 3.4 million pounds sterling (approximately $5 million) outstanding at December 31, 1993, and a second term loan due December 1997 with 6.8 million pounds sterling (approximately $10 million) outstanding at December 31, 1993. These credit agreements bear interest at floating rates and are secured by certain assets of Fort Sterling and Stuart Edgar but are nonrecourse to the Company.\nAlthough the obligations under the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement bear interest at floating rates, the Company is required to enter into interest rate agreements which effectively fix or limit the interest cost to the Company. Pursuant to the Bank Credit Agreement, the Company is a party to interest rate cap agreements which limit the interest cost to the Company to 8.25% (including the Company's borrowing margin on Eurodollar rate loans) until June 1, 1996 with respect to $500 million. Pursuant to the 1993 Term Loan Agreement, the Company is party to an interest rate swap agreement which limits the interest cost to the Company to 6.53% (including the Company's borrowing margin on Eurodollar rate loans) until April 21, 1994 with respect to $100 million. The Company is also a party to an interest rate cap agreement which limits the interest cost to the Company to rates between 11.25% and 12.00% until September 11, 1994 with respect to $300 million received through the issuance of the Senior Secured Notes. At current market rates at December 31, 1993, the fair value of the Company's interest rate cap agreements is $1.6 million. The fair value of the interest rate swap agreement at December 31, 1993 is zero. The Company monitors the risk of default by the counterparties to the interest rate cap and swap agreements and does not anticipate nonperformance.\nIn addition to the scheduled mandatory annual repayments, the Bank Credit Agreement provides for mandatory repayments from proceeds of any significant asset sales (except for proceeds from certain foreign asset sales which are redeployed outside the U.S.), from proceeds of sale and leaseback transactions, and annually an amount equal to 50% of excess cash flow for the prior calendar year, as defined.\nAmong other restrictions, the Bank Credit Agreement, the 1993 Term Loan Agreement, the Senior Secured Note Agreement, the foreign credit agreements and the Company's indentures: (1) restrict payments of dividends, repayments of subordinated debt, purchases of the Company's stock, additional borrowings and acquisition of property, plant and equipment; (2) require that the ratios of current assets to current liabilities, senior debt to adjusted net worth plus subordinated debt and earnings before non-cash charges, interest and taxes to cash interest be maintained at prescribed levels; (3) restrict the ability of the Company to make fundamental changes and to enter into new lines\n- 36 - of business, the pledging of the Company's assets and guarantees of indebtedness of others; and (4) limit dispositions of assets, the ability of the Company to enter lease and sale and leaseback transactions, and investments which might be made by the Company. The Company believes that such limitations should not impair its plans for continued maintenance and modernization of facilities or other operating activities.\nPursuant to amendments to the Bank Credit Agreement and the Senior Secured Note Agreement and the completion of various transactions, at December 31, 1993, the Company may borrow up to $39 million to repurchase 14 1\/8% Debentures.\nThe Company believes that, notwithstanding the adverse tissue industry operating conditions and the non-cash charge to write-off the remaining balance of the Company's goodwill (see Note 4), cash provided by operations and access to debt financing in the public and private markets will be sufficient to enable it to fund maintenance and modernization capital expenditures and meet its debt service requirements for the foreseeable future. However, in the absence of improved financial results, it is likely that in 1995 the Company would be required to seek a waiver of the cash interest coverage covenant under the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement because the Company's 14 1\/8% Debentures will accrue interest in cash commencing on November 1, 1994 and will require payments of interest in cash on May 1, 1995. Although the Company believes that it will be able to obtain appropriate waivers from its lenders, there can be no assurance that this will be the case.\nPursuant to 1993 amendments to the Bank Credit Agreement, the 1993 Term Loan Agreement and the Senior Secured Note Agreement, the required ratio of earnings before non-cash charges, interest and taxes to cash interest for the four fiscal quarters ending March 31, 1994 was reduced from 1.50 to 1.00 to 1.40 to 1.00.\nAt December 31, 1993, receivables totaling $100 million, inventories totaling $118 million and property, plant and equipment with a net book value of $1,177 million were pledged as collateral under the terms of the Bank Credit Agreement, the 1993 Term Loan Agreement, the Senior Secured Note Agreement, the foreign credit agreements and under the indentures for sale and leaseback transactions.\nThe Company is charged a 0.5% fee with respect to any unused balance available under its $350 million Revolving Credit Facility, and a 2% fee with respect to any letters of credit issued under the Revolving Credit Facility. At December 31, 1993, $244 million of borrowings reduced available capacity under the Revolving Credit Facility to $106 million.\nThe aggregate annual maturities of long-term debt and capital lease obligations at December 31, 1993, are as follows (in thousands):\n1994........................... $ 112,750 1995........................... 115,906 1996........................... 376,192 1997........................... 541,214 1998........................... 87,498 1999 and thereafter............ 1,989,028 ---------- $3,222,588 ==========\n- 37 -\n9. SALE AND LEASEBACK TRANSACTIONS\nBuildings and machinery and equipment related to various capital additions at the Company's tissue mills were sold and leased back from various financial institutions (the \"sale and leaseback transactions\") for periods from 15 to 25 years. The terms of the sale and leaseback transactions contain restrictions which are less restrictive than the covenants of the Bank Credit Agreement described in Note 8.\nThese leases are treated as capital leases in the accompanying consolidated financial statements. Future minimum lease payments at December 31, 1993, are as follows (in thousands):\nYear Ending December 31, Amount ------ 1994........................... $ 21,205 1995........................... 23,397 1996........................... 24,492 1997........................... 24,492 1998........................... 24,280 1999 and thereafter............ 386,412 -------- Total payments................. 504,278 Less imputed interest at rates approximating 10.9%.... 320,255 -------- Present value of capital lease obligations............ $184,023 ========\n10. EMPLOYEE POSTRETIREMENT BENEFIT PLANS\nAs of January 1, 1992, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" The cumulative effect on years prior to 1992 of adopting SFAS No. 106 is stated separately in the Company's consolidated statement of income for 1992 as a one-time after- tax charge of $10.6 million. This change in accounting principle, excluding the cumulative effect, decreased operating income by $2.1 million and $1.2 million in 1993 and 1992, respectively.\nNet periodic postretirement benefit cost included the following components (in thousands):\nYear Ended December 31, ------------------- 1993 1992 ---- ---- Service cost........................ $1,140 $ 902 Interest cost....................... 1,800 1,366 Other............................... 99 -- ------ ------ Net periodic postretirement benefit cost.................... $3,039 $2,268 ====== ======\n- 38 - The following table sets forth the components of the plan's unfunded accumulated postretirement benefit obligation (in thousands):\nDecember 31, ------------------- 1993 1992 ---- ---- Accumulated postretirement benefit obligation: Retirees.................................. $ 7,504 $ 6,632 Fully eligible active plan participants....................... 4,401 2,890 Other active plan participants............ 12,037 13,558 ------- ------- 23,942 23,080 Unrecognized actuarial losses................. (3,517) (4,800) ------- ------- Accrued postretirement benefit cost................................ $20,425 $18,280 ======= =======\nThe medical trend rate assumed in the determination of the accumulated postretirement benefit obligation at December 31, 1993 begins at 12% in 1994, decreases 1% per year to 6% for 2000 and remains at that level thereafter. Increasing the assumed medical trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $2.9 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $0.5 million. The medical trend rate assumed in the determination of the accumulated postretirement benefit obligation at December 31, 1992 began at 14% in 1993, decreasing 1% per year to 7% for 2000 and remained at that level thereafter.\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7% and 8% compounded annually with respect to the 1993 and 1992 valuations, respectively.\n11. SHAREHOLDERS' EQUITY (DEFICIT)\nThe Company is authorized to issue up to 8,400,000 shares of $.01 par value Voting Common Stock. At December 31, 1993, 5,862,735 shares were issued and 5,862,635 shares were outstanding. At December 31, 1992, 5,862,735 shares were issued and 5,862,685 shares were outstanding. In addition, 600,000 shares of $.01 par value Non-Voting Common Stock have been authorized, of which none were issued and outstanding at both December 31, 1993 and 1992.\nDuring 1991, the Company sold 1,361,469 shares of Voting Common Stock and 6,200 shares of Voting Common Stock with put right pursuant to a private placement of Common Stock. The net proceeds of the sales totaled $163.4 million. Also during 1991, 26,918 shares of Non-Voting Common Stock were exchanged on a one-for-one basis for Voting Common Stock.\n- 39 - Changes in the Company's shareholders' equity (deficit) accounts for the years ended December 31, 1993, 1992 and 1991, are as follows:\nThe aggregate par value of the Voting Common Stock reported in the amounts above at December 31, 1993 was $58,626.\n12. VOTING COMMON STOCK WITH PUT RIGHT\nPursuant to an Amended and Restated Management Equity Participation Agreement, as amended (the \"Management Equity Participation Agreement\"), members of the Company's senior management have acquired shares of the Company's $.01 par value Voting Common Stock. In addition, the Fort Howard Corporation Management Equity Plan (the \"Management Equity Plan\") provides for the offer of Voting Common Stock and the grant of options to purchase Voting Common Stock to officers and certain other key employees of the Company.\n- 40 - Officers or other key employees of the Company who purchase shares of Voting Common Stock or are granted options pursuant to the Management Equity Plan are required to enter into a Management Equity Plan Agreement with the Company and to become bound by the terms of the Company's stockholders agreement. All Voting Common Stock acquired by management investors, including shares acquired by the Company's former chairman and chief executive officer, are collectively referred to as the \"Putable Shares.\"\nBeginning with the fifth anniversary of the respective dates of purchase of certain of the Putable Shares to the date on which 15% or more of the Company's Voting Common Stock has been sold in one or more public offerings, specified percentages of the shares may be put to the Company at the option of the holders thereof, with certain limitations, at their fair market value. Subject to certain exceptions, the Management Equity Participation Agreement and Management Equity Plan also provide that management investors who terminate their employment with the Company shall sell their shares of Voting Common Stock and vested options to the Company or its designee. Subject to certain exceptions, options which have not vested at the time a management investor's employment is terminated are forfeited to the Company. At the time of his resignation, all the Putable Shares then owned by the Company's former chairman and chief executive officer became putable to the Company.\nDuring 1993, the Company decreased the estimated fair market valuation of its Common Stock as a result of the effects of adverse tissue industry operating conditions on its long-term earnings forecast and, as a result, reduced the carrying amount of its Voting Common Stock with put right to its original cost. The effect of the adjustment was to reduce both the Voting Common Stock with put right and the deficit in retained earnings by approximately $1.4 million.\nChanges in the Company's Voting Common Stock with put right, are as follows (in thousands, except number of shares):\nYear Ended December 31, ---------------------------- 1993 1992 1991 ---- ---- ---- Balance, beginning of year.......... $13,219 $12,963 $ 9,574 Issuance of 6,200 shares including 4,934 shares from treasury........ -- -- 744 Amortization of the increase (decrease) in fair market value and increased vested portion of Putable Shares......... (1,399) 256 2,645 ------- ------- ------- Balance, end of year................. $11,820 $13,219 $12,963 ======= ======= =======\n13. STOCK OPTIONS\nPursuant to the Management Equity Participation Agreement and the Management Equity Plan, 808,225 shares of Voting Common Stock are reserved for sale to officers and key employees as stock options. The exercisability of such options is subject to certain conditions. Options must be exercised within ten years of the date of grant. All options and shares to be issued under the terms of these plans are restricted as to transferability. Under certain conditions, the Company has the right or obligation to redeem shares issued under terms of the options at a price equal to their fair market value.\n- 41 - All options outstanding at December 31, 1993, except for fully vested options held by the Company's former chairman and chief executive officer, have a vesting schedule of twenty percent per year, measured from the date of initial grant. Any such options will be subject to partial acceleration of vesting in the event of death or disability and must be exercised within 10 years of the date of grant.\nChanges in stock options outstanding are summarized as follows:\nNumber of Exercise Price Options Per Option --------- -------------- Balance, December 31, 1990............... 482,662 $100 to 135 Options Granted........................ 136,960 120 Options Cancelled...................... (55,960) 100 to 135 ------- ----------- Balance, December 31, 1991............... 563,662 100 to 120 Options Granted........................ 12,400 120 Options Cancelled...................... (1,060) 100 to 120 ------- ----------- Balance, December 31, 1992............... 575,002 $100 to 120 Options Granted........................ 15,200 120 Options Cancelled...................... (1,640) 100 to 120 ------- ----------- Balance 31, 1993......................... 588,562 $100 to 120 ======= =========== Exercisable at December 31, 1993......... 497,498 $100 to 120 ======= =========== Shares available for future grant at December 31, 1993................... 219,663 =======\nThe Company amortizes the excess of the fair market value of its Common Stock over the strike price of options granted to employees over the periods the options vest. Due to the effects of adverse tissue industry operating conditions on its long-term earnings forecast, the Company decreased the estimated fair market valuation of its Common Stock and, as a result, reversed all previously accrued employee stock compensation expense in 1993. The reversal of the accrued employee stock compensation resulted in a credit to operations of $7,832,000 for 1993. Employee stock compensation expense was $1,120,000 and $1,256,000 for 1992 and 1991, respectively.\n14. RELATED PARTY TRANSACTIONS\nMorgan Stanley Group Inc. (\"Morgan Stanley Group\") and an affiliate acquired a substantial majority equity interest in the Company to effect the Acquisition. At December 31, 1993, Morgan Stanley Group and its affiliates controlled 57% (on a fully diluted basis) of the Company's Voting Common Stock.\nThe Company has entered into an agreement with Morgan Stanley & Co. Incorporated (\"MS&Co.\") for financial advisory services in consideration for which the Company will pay MS&Co. an annual fee of $1 million. MS&Co. will also be entitled to reimbursement for all reasonable expenses incurred in the performance of the foregoing services. The Company paid MS&Co. $1,046,000, $1,096,000 and $1,064,000 for these and other miscellaneous services in 1993, 1992 and 1991, respectively. In 1993, MS&Co. received approximately $19.5 million related to the underwriting of the issuance of the 1993 Notes. In\n- 42 - 1992, MS&Co. received approximately $0.7 million related to the underwriting of the reissuance of the Company's Development Authority of Effingham County Pollution Control Revenue Refunding Bonds, Series 1988. In connection with a 1991 sale and leaseback transaction, MS&Co. received approximately $2.9 million of advisory and underwriting fees. Also in 1991, in connection with the offering of Senior Secured Notes, MS&Co. received approximately $6.8 million of advisory fees.\nMS&Co. served as lead underwriter for the initial offering of the Company's subordinated debt securities and since the Acquisition has been a market maker with respect to those securities. In connection with the 1991 repurchases of the Company's subordinated debt securities, $52.8 million aggregate principal amount at maturity of the 14 5\/8% Debentures and $132.7 million aggregate principal amount at maturity of the 14 1\/8% Debentures were purchased through MS&Co. In addition, $46.5 million and $77.5 million aggregate principal amount at maturity of the 14 1\/8% Debentures were purchased from Leeway & Co. and First Plaza Group Trust, respectively, shareholders of the Company. The purchases were made in negotiated transactions at market prices.\n15. COMMITMENTS AND CONTINGENCIES\nIn 1992, the Company commenced the installation of a fifth paper machine, environmental protection equipment and associated facilities at its Muskogee, Oklahoma tissue mill. The expansion is planned for completion in 1994 at an estimated cost of $140 million. Total expenditures for the expansion through December 31, 1993 were $109 million.\nThe Company's domestic manufacturing operations are subject to regulation by various federal, state and local authorities concerned with the limitation and control of emissions and discharges to the air and waters and the handling, use and disposal of specified chemicals and solid waste. The Company's United Kingdom operations are subject to similar regulation.\nThe Company has made significant capital expenditures in the past to comply with environmental regulations. Future environmental legislation and developing regulations are expected to further limit emission and discharge levels and to expand the scope of regulation, all of which will require continuing capital expenditures. There can be no assurance that such costs would not be material to the Company.\nThe Company operates a licensed solid waste landfill at each of its tissue mills in the United States to dispose residue from recycling wastepaper and ash from coal-fired boilers. In March 1990, the Company began a remedial investigation of its Green Bay, Wisconsin landfill. The investigation is being overseen by the United States Environmental Protection Agency under authority granted to the agency by the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as the \"Superfund Act.\" A Preliminary Health Assessment released by the United States Department of Health and Human Services in January 1992 reported that the Company's Green Bay landfill does not pose any apparent public health hazard. Based upon the results of the remedial investigation through December 31, 1993, the Company believes that costs or expenditures associated with any future remedial action, were it to be required, would not have a material adverse effect on the Company's financial condition.\nExcept for the Green Bay landfill site, the Company is not presently named as a potentially responsible party at any other Superfund related sites;\n- 43 - however, there can be no certainty that the Company will not be named as a potentially responsible party at any other sites in the future or that the costs associated with those sites would not be material.\nThe Company and its subsidiaries are parties to lawsuits and state and federal administrative proceedings in connection with their businesses. Although the final results in such suits and proceedings cannot be predicted with certainty, the Company believes that they will not have a material adverse effect on the Company's financial condition.\n16. GEOGRAPHIC INFORMATION\nA summary of the Company's operations by geographic area as of December 31, 1993, 1992 and 1991, and for the years then ended is presented below (in thousands):\nUnited United States Kingdom Consolidated ------ ------- ------------ Net sales.......................... $1,044,174 $143,213 $1,187,387 Operating income (loss)............ (1,715,777) (859) (1,716,636) Identifiable operating assets...... 1,482,166 163,621 1,645,787\nNet sales.......................... $1,008,129 $143,222 $1,151,351 Operating income................... 253,437 17,238 270,675 Identifiable operating assets...... 3,411,833 162,734 3,574,567\nNet sales.......................... $1,027,969 $110,241 $1,138,210 Operating income................... 254,603 15,929 270,532 Identifiable operating assets...... 3,373,199 96,603 3,469,802\nIntercompany sales and charges between geographic areas and export sales are not material.\nIn 1993, the Company determined that its projected results would not support the future amortization of the Company's remaining goodwill balance. Accordingly, the Company wrote off its remaining goodwill balance of $1,980 million in the third quarter of 1993, resulting in charges of $1,968 million and $12 million to the operating income of the United States and United Kingdom operations, respectively.\nIn 1992, the Company changed its estimates of the depreciable lives of certain machinery and equipment resulting in a reduction of depreciation expense and an increase in operating income of $38 million in the United States.\n- 44 -\n17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nA summary of the quarterly results of operations for 1993 and 1992 follows (in millions, except per share data):\n- 45 - ITEM 9.","section_9":"ITEM 9. DISAGREEMENT ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nDIRECTORS\nThe following table provides certain information about each of the current directors of the Company. All directors hold office until the next annual meeting of shareholders of the Company and until their successors are duly elected and qualified.\nPresent Principal Occupation or Employment; Name and Position Five-Year Employment History with the Company Age and other Directorships ----------------- --- -------------------------------------------\nDonald H. DeMeuse 58 Chairman of the Board of Directors and Chairman of the Board Chief Executive Officer since March 1992; President and Chief Executive Officer from July 1990 to March 1992. Prior to March 1992, President for more than five years. Director of Associated Bank Green Bay.\nKathleen J. Hempel 43 Vice Chairman and Chief Financial Officer Vice Chairman since March 1992; Senior Executive Vice President and Chief Financial Officer prior to that time.\nMichael T. Riordan 43 President and Chief Operating Officer since Director March 1992; Vice President prior to that time.\nDonald P. Brennan 53 Managing Director of MS&Co. since prior to Director 1988 and head of MS&Co.'s Merchant Banking Division. Chairman and President of Morgan Stanley Leveraged Equity Fund II, Inc. (\"MSLEF II, Inc.\") and Chairman of Morgan Stanley Capital Partners III, Inc. (\"MSCP III\"). Director of Agricultural Minerals and Chemicals Inc., Agricultural Minerals Corporation, A\/S Bulkhandling, Beaumont Methanol Corporation, BMC Holdings Inc., Coltec Industries Inc., Container Corporation of America, Hamilton Services Limited, Jefferson Smurfit Corporation, PSF Finance Holdings, Inc., Shuttleway, SIBV\/MS Holdings, Inc., Stanklav Holdings, Inc., Waterford Wedgwood plc (Deputy Chairman) and Waterford Wedgwood U.K. plc.\n- 46 - Present Principal Occupation or Employment; Name and Position Five-Year Employment History with the Company Age and other Directorships ----------------- --- -------------------------------------------\nFrank V. Sica 42 Managing Director of MS&Co. since 1988. Vice Director President and Director of MSLEF II, Inc. since 1989 and Vice Chairman of MSCP III. Director of ARM Financial Group, Inc., Consolidated Hydro, Inc., Emmis Broadcasting Corporation, Integrity Life Insurance Company, Interstate Natural Gas Company, Kohl's Corporation, Kohl's Department Stores, Inc., National Integrity Life Insurance Company, PageMart, Inc., Southern Pacific Rail Corporation, Sullivan Communications, Inc., Sullivan Graphics, Inc. and Sullivan Plastics, Inc.\nRobert H. Niehaus 38 Managing Director of MS&Co. since 1990 Director Principal of MS&Co. prior to that time. Vice President and Director of MSLEF II, Inc. and Vice Chairman of MSCP III. Director of American Italian Pasta Company, MS Distribution Inc., MS\/WW Holdings Inc., NCC L.P., Randall's Food Markets, Inc., Randall's Management Corp., Randall's Management of Nevada, Randall's Properties, Inc., Randall's Warehouse, Inc., Shuttleway, Silgan Containers Corporation, Silgan Corporation, Silgan Holdings Inc., Silgan Plastics Inc., Tennessee Valley Steel Corp., Waterford Wedgwood U.K. plc and Waterford Crystal Ltd.\nJames S. Hoch 33 Principal of MS&Co. since February 1993; Director Vice President of MS&Co. from January 1991 to February 1993; Associate of MS&Co. prior to that time. Director of Silgan Containers Corporation, Silgan Corporation, Silgan Holdings Inc., Silgan Plastics Inc., Sullivan Communications, Inc. and Sullivan Marketing Inc.\nEXECUTIVE OFFICERS\nThe following table provides certain information about each of the current executive officers of the Company. All executive officers are elected by, and serve at the discretion of, the Board of Directors. None of the executive officers of the Company is related by blood, marriage or adoption to any other executive officer or director of the Company.\n- 47 -\nPresent Principal Occupation or Employment; Name and Position Five-Year Employment History with the Company Age and other Directorships ----------------- --- -------------------------------------------\nDonald H. DeMeuse 58 See description under \"Directors and Chairman of the Board and Executive Officers of Registrant -- Chief Executive Officer Directors.\"\nKathleen J. Hempel 43 See description under \"Directors and Vice Chairman and Chief Executive Officers of Registrant -- Financial Officer Directors.\"\nMichael T. Riordan 43 See description under \"Directors and President and Chief Executive Officers of Registrant -- Operating Officer Directors.\"\nAndrew W. Donnelly 51 Executive Vice President for more than Executive Vice President five years.\nJohn F. Rowley 53 Executive Vice President for more than Executive Vice President five years.\nJeffrey P. Eves 47 Vice President for more than five years. Vice President\nGeorge F. Hartmann, Jr. 51 Vice President for more than five years. Vice President\nJames W. Nellen II 46 Vice President and Secretary for more Vice President and than five years. Secretary\nDaniel J. Platkowski 43 Vice President for more than five years. Vice President\nTimothy G. Reilly 43 Vice President for more than five years. Vice President\nDonald J. Schneider 57 Vice President since July 1989. Director Vice President of Research and Development prior to that time.\nDavid K. Wong 44 Vice President since June 1993; Director of Vice President Personnel from September 1990 until June 1993. Director of Recruiting and Training prior to that time.\nR. Michael Lempke 41 Treasurer since November 1989; Assistant Treasurer Treasurer prior to that time.\nCharles L. Szews 37 Controller since November 1989; Director Controller of Financial Reporting prior to that time.\nDavid A. Stevens 45 Assistant Vice President for more than Assistant Vice President five years.\n- 48 -\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table presents information concerning compensation paid for services to the Company during the last three fiscal years to the Chief Executive Officer and the four other most highly compensated executive officers (the \"Named Executive Officers\") of the Company.\nSUMMARY COMPENSATION TABLE\n(a) Includes amounts reimbursed for the payment of taxes. (b) Company contributions to the Company's profit sharing plan and supplemental retirement plan, including Company contributions to the Company's supplemental retirement plan which were paid to the participant.\n- 49 -\nThe following table presents information concerning individual grants of stock options made during the last completed fiscal year to each of the Named Executive Officers.\n(a) The stock options granted in 1993 to Equity Investors (as defined below under \"Item 13. Certain Relationships and Related Transactions--Management Equity Plan\"), including the options granted to Mr. Riordan, were granted pursuant to the Management Equity Plan as defined below under \"Item 13. Certain Relationships and Related Transactions--Management Equity Plan.\" The options vest and become exercisable at a rate of 20% per year, subject to partial acceleration of vesting in the event of death or disability. Subject to certain exceptions, Equity Investors who terminate their employment with the Company before the later of (i) the fifth anniversary of the date on which the options were granted, and (ii) the date on which 15% or more of the Common Stock has been sold in one or more public offerings, must sell their vested options to the Company or its designee. In addition, Equity Investors may put specified percentages of their vested options to the Company annually during the period from the fifth anniversary of the date the options were granted to the date on which 15% or more of the Common Stock has been sold in one or more public offerings. See \"Item 13. Certain Relationships and Related Transactions -- Management Equity Plan.\"\nThe following table presents information concerning unexercised stock options for the Named Executive Officers. No stock options were exercised by the Named Executive Officers during 1993.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION\/SAR VALUES\nValue of Unexercised Number of Unexercised Options In-the-money Options Held Held at December 31, 1993 at December 31, 1993 (a) ----------------------------- -------------------------- Exercisable Unexercisable Exercisable Unexercisable ----------- -------------- ----------- ------------- Donald H. DeMeuse 74,375 9,200 -- -- Kathleen J. Hempel 85,515 3,000 -- -- Michael T. Riordan 15,409 11,300 -- -- Andrew W. Donnelly 20,235 4,200 -- -- John F. Rowley 14,342 3,800 -- --\n- 50 -\na) The Common Stock of the Company is not registered or publicly traded and, therefore, a public market price for the stock is not available. The Company believes that none of the exercisable or unexercisable stock options held at December 31, 1993 were in-the-money as of such date. See Notes 12 and 13 of the Company's audited consolidated financial statements.\nDIRECTOR'S COMPENSATION\nDirectors of the Company do not receive any compensation for services on the Board of Directors.\nEMPLOYMENT AGREEMENTS\nThe Named Executive Officers have three-year employment agreements with the Company (the \"Employment Agreements\") which took effect in 1993. The Employment Agreements contain customary employment terms, have an initial duration of three years beginning October 15, 1993 for Mr. DeMeuse, Ms. Hempel and Mr. Riordan and December 10, 1993 for Mr. Donnelly and Mr. Rowley, provide for automatic one-year extensions (unless notice not to extend is given by either party at least six months prior to the end of the effective term), and provide for base annual salaries and annual incentive bonuses. In addition, the Employment Agreements for Mr. DeMeuse, Ms. Hempel and Mr. Riordan provide for participation in additional bonus arrangements which may be agreed upon in good faith from time to time with the Company. The Employment Agreements provide that certain payments in lieu of salary and bonus are to be made and certain benefits are to be continued for a stated period following termination of employment. The time periods for such payments vary depending on the cause of termination. The amount of the payments to be made to each individual would vary depending upon such individual's level of compensation and benefits at the time of termination and whether such employment is terminated prior to the end of the term by the Company for \"cause\" or by the employee for \"good reason\" (as such terms are defined in the Employment Agreements) or otherwise during the term of the agreements. In addition, the Employment Agreements for Mr. DeMeuse, Ms. Hempel and Mr. Riordan include noncompetition and confidentiality provisions.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Executive Committee of the Board of Directors of the Company (the \"Executive Committee\") acts as a compensation committee for determining certain aspects of the compensation of the executive officers of the Company. The members of the Executive Committee are Donald H. DeMeuse, the Company's Chairman and Chief Executive Officer, and Donald P. Brennan.\nThe Executive Committee administers the Management Equity Plan which provides for the offer of Common Stock and the grant of options to purchase Common Stock to executive officers and certain other key employees of the Company. See \"Item 13. Certain Relationships and Related Transactions -- Management Equity Plan.\" The Executive Committee selects the officers and key employees to whom Common Stock will be offered or options will be granted.\nThe Executive Committee also administers the Company's Management Incentive Plan under which annual cash awards are paid to employees serving in key executive, administrative, professional and technical capacities. Awards are based upon the extent to which the Company's financial performance during the year has met or exceeded certain performance goals specified by the Executive Committee.\n- 51 - Salaries and employment contract terms are determined by the entire Board of Directors for the Chief Executive Officer, by the Executive Committee for other executive officers who also serve as directors of the Company and by the Company's Chief Executive Officer for other executive officers of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of March 1, 1994 by holders having beneficial ownership of more than 5% of the Company's Common Stock, by certain other principal holders, by each of the Company's directors, by the Named Executive Officers, and by all directors and all executive officers of the Company as a group.\nShares Beneficially Owned ----------------------------- Number of Percentage Name Shares of Class ---- --------- ----------\nTHE MORGAN STANLEY LEVERAGED 2,850,000 (a) 48.6 EQUITY FUND II, L.P. 1251 Avenue of the Americas New York, New York 10020\nFIRST PLAZA GROUP TRUST 1,033,155 17.6 c\/o Mellon Bank, N.A., as Trustee 1 Mellon Bank Center Pittsburgh, Pennsylvania 15258\nLEEWAY & CO. 516,577 8.8 1 Monarch Drive North Quincy, Massachusetts 02177\nMORGAN STANLEY GROUP INC. 427,213 (b) 7.3 1251 Avenue of the Americas New York, New York 10020\nFORT HOWARD EQUITY INVESTORS II, L.P. 261,737 (c) 4.5 1251 Avenue of the Americas New York, New York 10020\nFORT HOWARD EQUITY INVESTORS, L.P. 102,000 (d) 1.7 1251 Avenue of the Americas New York, New York 10020\nDonald H. DeMeuse 100,100 (e) 1.7\nKathleen J. Hempel 90,491 (f) 1.5\nMichael T. Riordan 17,934 (g) less than 1\nDonald P. Brennan 0 --\nFrank V. Sica 0 --\n- 52 -\nShares Beneficially Owned ----------------------------- Number of Percentage Name Shares of Class ---- --------- ----------\nRobert H. Niehaus 0 --\nJames S. Hoch 0 --\nAndrew W. Donnelly 22,735 (h) less than 1\nJohn F. Rowley 16,042 (i) less than 1\nDirectors and Executive Officers 347,414 (j) 5.7 as a Group\n(a) MSLEF II, Inc. is the sole general partner of MSLEF II and is a wholly owned subsidiary of Morgan Stanley Group Inc. (\"Morgan Stanley Group\"). (b) Excludes 40,000 shares for which Morgan Stanley Group exercises exclusive voting rights on shares not beneficially owned. (c) Morgan Stanley Equity Investors Inc. is the sole general partner of Fort Howard Equity Investors II, L.P. and is a wholly owned subsidiary of Morgan Stanley Group. (d) Morgan Stanley Equity Investors Inc. is the sole general partner of Fort Howard Equity Investors, L.P. and is a wholly owned subsidiary of Morgan Stanley Group. (e) Includes 74,375 shares subject to acquisition within 60 days by exercise of employee stock options. (f) Includes 85,515 shares subject to acquisition within 60 days by exercise of employee stock options. (g) Includes 15,409 shares subject to acquisition within 60 days by exercise of employee stock options. (h) Includes 20,235 shares subject to acquisition within 60 days by exercise of employee stock options. (i) Includes 14,342 shares subject to acquisition within 60 days by exercise of employee stock options. (j) Includes 284,453 shares subject to acquisition within 60 days by exercise of employee stock options.\nCertain affiliates of Morgan Stanley Group are entitled, subject to the satisfaction of certain conditions, to receive up to 20% of certain gains realized by MSLEF II on its investment in Common Stock, up to 10% of certain gains realized by Fort Howard Equity Investors, L.P. and up to 10% of certain gains realized by Fort Howard Equity Investors II, L.P.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nMANAGEMENT EQUITY PLAN\nEffective as of April 29, 1991, the Board of Directors adopted the Fort Howard Corporation Management Equity Plan (the \"Management Equity Plan\"). The Management Equity Plan provides for the offer of Common Stock and the grant of options to purchase Common Stock to executive officers and certain other key employees of the Company.\nExecutive officers or other key employees of the Company who purchase shares of Common Stock or are granted options pursuant to the Management\n- 53 - Equity Plan (\"Equity Investors\") are required to enter into a Management Equity Plan Agreement with the Company, and to become bound by the terms of the Company's stockholders agreement. See \"Stockholders Agreement.\"\nOptions granted pursuant to the Management Equity Plan vest in accordance with a schedule determined at the time of grant and set forth in the applicable Management Equity Plan Agreement. Any such options will be subject to partial acceleration of vesting in the event of death or disability.\nShares of Common Stock purchased pursuant to the Management Equity Plan, as well as options that have become vested, may not be transferred for an extended period of time, except in certain limited circumstances. Options which have not vested are not transferable.\nSubject to certain exceptions, under the Management Equity Plan, Equity Investors who terminate their employment with the Company before the later of (i) the fifth anniversary of the date on which shares of Common Stock were purchased or options were granted, as the case may be, and (ii) the date on which 15% or more of the Common Stock has been sold in one or more public offerings, must sell their shares of Common Stock and vested options to the Company or its designee. The terms and conditions of such repurchases by the Company (including the determination of the applicable repurchase price) are substantially similar to those prescribed for the repurchase by the Company of shares of Common Stock and vested options acquired by certain executive officers and other key employees of the Company pursuant to the Management Equity Participation Agreement (as defined below). See \"Management Equity Participation.\" Subject to certain exceptions, options which have not vested at the time an Equity Investor's employment is terminated are forfeited to the Company.\nThe Management Equity Plan also provides that Equity Investors may put specified percentages of their shares of Common Stock and vested options to the Company annually during the period from the fifth anniversary of the date on which such shares were purchased or options were granted, as the case may be, to the date on which 15% or more of the Common Stock has been sold in one or more public offerings. The terms and conditions governing such put option are substantially similar to those prescribed for the exercise of the put option set forth in the Management Equity Participation Agreement.\nIn April 1991, certain executive officers and other key employees of the Company purchased an aggregate of 6,200 shares of Common Stock at $120 per share pursuant to the Management Equity Plan. In addition, options to purchase a total of 111,100 shares of Common Stock at an exercise price of $120 per share were granted in 1991, 1992 and 1993 pursuant to the Management Equity Plan to certain executive officers and other key employees of the Company. Such options vest at the rate of 20% per year. Further, the terms and conditions of options to purchase 15,500 shares of Common Stock granted in December 1988 at an exercise price of $100 per share pursuant to a predecessor plan are now governed by the Management Equity Plan.\nMANAGEMENT EQUITY PARTICIPATION\nMr. DeMeuse, Ms. Hempel, Mr. Riordan and other current executive officers and members of the Company's senior management (the \"Management Investors\") are parties to an Amended and Restated Management Equity Participation Agreement, as amended, with the Company, Morgan Stanley Group and MSLEF II (the \"Management Equity Participation Agreement\"), pursuant to which the Management Investors purchased 63,107 shares of Common Stock in 1988 and 4,896\n- 54 - shares of Common Stock in 1990 at $100 and $135 per share, respectively. Management Investors who purchased shares of Common Stock pursuant to the Management Equity Participation Agreement were also granted stock options to acquire 278,052 and 42,460 shares of Common Stock pursuant to the Management Equity Participation Agreement at exercises prices of $100 and $120 per share, respectively. Such options vest at the rate of 20% per year and are subject to partial acceleration of vesting in the event of death or disability. Certain of the Management Investors have also purchased shares of Common Stock and have been granted options to acquire additional shares of Common Stock pursuant to the terms of the Management Equity Plan. See \"Management Equity Plan.\"\nThe Management Equity Participation Agreement prohibits for an extended period of time, except in certain limited circumstances, the transfer of Common Stock and rights to acquire Common Stock, including options that have become vested (\"Vested Options\"), held by the Management Investors. Options which have not vested are not transferable. Subject to certain exceptions relating to death and disability, the Management Equity Participation Agreement also provides that Management Investors who terminate their employment with the Company within five years of the date (the \"Effective Date\") on which shares of Common Stock were purchased and options were granted shall sell their shares of Common Stock and Vested Options to the Company or its designee. In the case of termination by the Company without \"cause\" (as defined), termination as a result of death or disability or retirement at an age of at least 55 years, or, only in the case of Mr. DeMeuse or Ms. Hempel, the voluntary termination of employment by a Management Investor for \"good reason\" (as defined), the purchase price to be paid by the Company for shares of Common Stock is equal to the greater of the consideration paid for each share or the fair market value of such shares (except that the purchase price is equal to fair market value with respect to shares acquired in 1990 by Management Investors other than Mr. DeMeuse). (Under the Management Equity Plan, the purchase price upon such a termination of employment is in all cases equal to fair market value.) In all other cases, the purchase price to be paid by the Company for shares of Common Stock is equal to the lesser of the consideration paid for each share or the fair market value of such shares. Without regard to the reason for termination, the purchase price to be paid by the Company for Vested Options is equal to the fair market value of the shares subject to the options, minus the aggregate exercise price. The Management Equity Participation Agreement also provides that Management Investors shall sell to the Company or its designee the shares of Common Stock and Vested Options held by them if they terminate their employment with the Company after the date which is five years from the Effective Date unless as of such date 15% or more of the Common Stock has been sold in one or more public offerings. In such event, the purchase price to be paid by the Company for shares of Common Stock and Vested Options is equal to their fair market value. Subject to certain exceptions, any options which have not vested at the time a Management Investor's employment is terminated are forfeited to the Company.\nThe Management Equity Participation Agreement also provides that the Management Investors may put to the Company annually during the period from the fifth anniversary of the Effective Date to the date on which 15% or more of the Common Stock has been sold in one or more public offerings, specified percentages of their shares of Common Stock and Vested Options at a price equal to their fair market value. In certain circumstances and subject to certain limitations, Mr. DeMeuse and Ms. Hempel may require MSLEF II or Morgan Stanley Group to fulfill the Company's purchase obligations upon any termination of employment or exercise of the put option.\n- 55 - The Management Equity Participation Agreement also provides that the Company will indemnify Management Investors for taxes on income which may be recognized upon the vesting of shares of Common Stock under certain circumstances. The indemnity is limited to the tax benefit to the Company, and if the tax benefit has not yet been received by the Company in cash at the time when the taxes must be paid by a Management Investor, the Company will make a nonrecourse loan to the Management Investor (secured by Common Stock and Vested Options) until the time the tax benefit is actually received.\nThe Management Equity Participation Agreement contains noncompetition provisions applicable to each Management Investor except Mr. DeMeuse, Ms. Hempel and Mr. Riordan, whose noncompetition agreements are contained in their respective Employment Agreements. (Similar noncompetition provisions are applicable to the Equity Investors under the Management Equity Plan.) The Company's obligation to make nonrecourse loans under the Management Equity Participation Agreement or purchase shares of Common Stock for cash pursuant to the Management Equity Participation Agreement or the Management Equity Plan is subject to restrictions contained in any debt or lease agreements to which it is a party.\nIn 1988 and 1990, the Company's former chairman of the board and chief executive officer acquired shares of Common Stock and was granted options to acquire additional shares of Common Stock pursuant to the Management Equity Participation Agreement. Under the terms of an agreement entered into with the Company at the time of his resignation in July 1990, he retained his entire interest in the Company's Common Stock and all options to acquire additional shares thereof granted to him pursuant to the Management Equity Participation Agreement were vested. In addition, all the shares of the Company's Common Stock then owned by him became putable to the Company, and he retained certain other put rights previously granted to him with respect to such options and the shares issuable upon the exercise thereof. Except as set forth above, the former chairman and chief executive officer's interest in the Company's Common Stock remains subject to terms substantially equivalent to the relevant terms of the Management Equity Participation Agreement.\nSTOCKHOLDERS AGREEMENT\nThe Company, Morgan Stanley Group, MSLEF II, certain other investors and the Management Investors have entered into a stockholders agreement (the \"Stockholders Agreement\"), which contains certain restrictions with respect to the transferability of Common Stock by the parties thereunder, certain registration rights granted by the Company with respect to such shares and certain voting arrangements. The Stockholders Agreement will terminate as of such time as more than 50% of the shares of Common Stock then outstanding have been sold pursuant to one or more public offerings.\nPursuant to the terms of the Stockholders Agreement, no holder of Common Stock who is a party or becomes a party to the Stockholders Agreement (a \"Holder\") may sell or otherwise encumber Common Stock beneficially owned by such Holder unless such transfer is to (i) certain permitted transferees (related persons or affiliated entities) of such Holder, (ii) the Company, or in certain cases its designees, (iii) subject to certain rights of first refusal by the other Holders and the Company, any person if immediately after such sale the transferee and its affiliates do not in the aggregate beneficially own more than 15% of the Common Stock then outstanding, subject to receipt of a legal opinion that such sale does not require the Common Stock to be registered under the Securities Act of 1933, and such transferee is not determined by the Board of Directors of the Company to be an \"Adverse Person\"\n- 56 - (as defined in the Stockholders Agreement), (iv) any person pursuant to a public offering, or (v) any person pursuant to Rule 144 under the Securities Act of 1933 after 15% or more of the Common Stock has been sold pursuant to one or more underwritten public offerings. Notwithstanding the above, however, Morgan Stanley Group and MSLEF II, have the right to transfer all or any portion of the Common Stock beneficially owned by them (i) at any time in connection with the refinancing of the Company's outstanding indebtedness, or (ii) at any time in connection with one transaction or a series of transactions in which Morgan Stanley Group and\/or MSLEF II intends to sell such number of shares of Common Stock then constituting a majority of the outstanding shares of Common Stock subject to the Stockholders Agreement.\nIn the event that one or more Holders (each a \"Controlling Stockholder\") sell a majority of the shares of Common Stock subject to the Stockholders Agreement to a third party, each other Holder has the right to elect to sell on the same terms the same percentage of such other Holder's shares to the third party as the Controlling Stockholder is selling of its shares of Common Stock. In addition, if a Controlling Stockholder sells all of its shares of Common Stock to a third party, the Controlling Stockholder has the right to require that the remaining Holders sell all of their shares to the third party on the same terms.\nPursuant to the terms of the Stockholders Agreement, Holders of specified percentages of Common Stock will be entitled to certain demand registration rights (\"Demand Rights\") with respect to shares of Common Stock held by them; provided, however, that the Company (or purchasers designated by the Company) shall have the right to purchase at fair market value the shares which are the subject of Demand Rights in lieu of registering such shares of Common Stock. In addition to the Demand Rights, Holders are, subject to certain limitations, entitled to register shares of Common Stock in connection with a registration statement prepared by the Company to register its equity securities. The Stockholders Agreement contains customary terms and provisions with respect to, among other things, registration procedures and certain rights to indemnification granted by parties thereunder in connection with the registration of Common Stock subject to such agreement.\nThe Stockholders Agreement also requires the Holders to vote for director designees of Morgan Stanley Group and its affiliates (including one director designated by MSLEF II) ensuring Morgan Stanley Group and its affiliates majority board representation for so long as they own a majority of the outstanding Common Stock.\nPursuant to the Stockholders Agreement, Holders have certain preemptive rights, subject to certain exceptions, with respect to future issuances of shares or share equivalents of Common Stock so that such Holders may maintain their proportional equity ownership interest in the Company.\nOTHER TRANSACTIONS\nThe Company has entered into an agreement with MS&Co. for financial advisory services in consideration for which the Company pays MS&Co. an annual fee of $1 million. MS&Co. is also entitled to reimbursement for all reasonable expenses incurred in performance of the foregoing services. The Company paid MS&Co. $1,046,000 for these and other miscellaneous services in 1993. In 1993, MS&Co. also received approximately $19,500,000 related to the underwriting of the issuance of the 1993 Notes. Based on transactions of similar size and nature, the Company believes the foregoing fees received by\n- 57 - MS&Co. are no less favorable to the Company than would be available from unaffiliated third parties.\nIn 1993, the Company sold its remaining equity interest in Sweetheart for $5.1 million. Terms of the sale were negotiated by Morgan Stanley Group pursuant to a 1992 agreement among the Company and the other holders of Sweetheart common stock granting Morgan Stanley Group the authority, among other things, to contract to sell all or some of the shares of Sweetheart common stock owned by the Company on the Company's behalf, or to restructure Sweetheart's debt and equity capitalization.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. 1. Financial Statements of Fort Howard Corporation\nIncluded in Part II, Item 8:\nReport of Independent Public Accountants.\nConsolidated Statements of Income for the years ended December 31, 1993, 1992 and 1991.\nConsolidated Balance Sheets as of December 31, 1993 and 1992.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991.\nNotes to Consolidated Financial Statements.\nSeparate financial statements and supplemental schedules of the Company and its consolidated subsidiaries are omitted since the Company is primarily an operating corporation and its consolidated subsidiaries included in the consolidated financial statements being filed do not have a minority equity interest or indebtedness to any other person or to the Company in an amount which exceeds five percent of the total assets as shown by the consolidated financial statements as filed herein.\na. 2. Financial Statement Schedules\nReport of Independent Public Accountants\nSchedule V -- Property, Plant and Equipment\nSchedule VI -- Accumulated Depreciation and Amortization of Property, Plant and Equipment\nSchedule VIII -- Valuation and Qualifying Accounts\nSchedule X -- Supplementary Income Statement Information\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the audited consolidated financial statements or notes thereto.\n- 58 - a. 3. Exhibits\nExhibit No. Description ----------- -----------\n3.1 Restated Certificate of Incorporation of the Company dated December 7, 1990. (Incorporated by reference to Exhibit 3.A as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n3.2 Amended and Restated By-Laws of the Company dated April 2, 1992. (Incorporated by reference to Exhibit 3.B as filed with the Company's Form 10-K for the year ended December 31, 1992.)\n4.1 Form of 12 3\/8% Senior Subordinated Note Indenture dated as of November 1, 1988 between the Company and State Street Bank and Trust Company, Trustee. (Incorporated by reference to Exhibit 4.1 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n4.2 Form of 12 5\/8% Subordinated Debenture Indenture dated as of November 1, 1988 between the Company and United States Trust Company, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.3 Form of 14 1\/8% Junior Discount Debenture Indenture dated as of November 1, 1988 between the Company and Ameritrust Company National Association, Trustee. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.4 Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.5 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.4(A) Amendment No. 1 dated as of February 21, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 1 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n4.4(B) Amendment No. 2 dated as of October 20, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 2 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n4.4(C) Amendment No. 3 dated as of November 14, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 3 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n- 59 -\n4.4(D) Instrument of Designation, Appointment and Acceptance dated as of June 22, 1988 among the Company, Bankers Trust Company and Security Pacific National Bank. (Incorporated by reference to Exhibit 4.7 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n4.4(E) Amendment No. 4 dated as of November 9, 1990 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.J as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990.)\n4.4(F) Amendment No. 5 dated as of December 19, 1990 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.K as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n4.4(G) Amendment No. 6 dated as of September 11, 1991 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.A as filed with the Company's report on Form 8-K on September 13, 1991.)\n4.4(H) Amendment No. 7 dated as of December 2, 1991 to Amended and Restated Credit Agreement dated as of October 14, 1988, and Amendment No. 1 dated as of December 2, 1991, to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.N as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n4.4(I) Amendment No. 8 dated as of October 7, 1992 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amendment No. 2 dated as of October 7, 1992 to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.O as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.)\n4.4(J) Amended and Restated Amendment No. 8 dated as of November 12, 1992 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amended and Restated Amendment No. 2 dated as of November 12, 1992 to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.P as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.)\n4.4(K) Form of Second Amended and Restated Amendment No. 8 dated as of March 4, 1993 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Second Amended and Restated Amendment No. 2 dated as of March 4, 1993 to Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.3(J) as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.4(L) Amendment No. 9 dated as of December 31, 1993 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amendment No. 3 dated as of December 31, 1993 to Note Purchase Agreement dated as of September 22, 1991.\n- 60 -\n4.5 Form of Senior Secured Floating Rate Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.B as filed with the Company's report on Form 8-K on September 13, 1991.)\n4.6 Form of 9 1\/4% Senior Note Indenture dated as of March 15, 1993 between the Company and Norwest Bank Wisconsin, N.A., Trustee. (Incorporated by reference to Exhibit 4.1 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.7 Form of 10% Subordinated Note Indenture dated as of March 15, 1993 between the Company and the United States Trust Company of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.8 Form of 9% Senior Subordinated Note Indenture dated as of February 1, 1994 between the Company and The Bank of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Form S-2 on December 17, 1993.)\nRegistrant agrees to provide copies of instruments defining the rights of security holders, including indentures, upon request of the Commission.\n10.1 Employment Agreements dated October 15, 1993 with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n10.2 Employment Agreements dated December 10, 1993 with certain executive officers of the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Form S-2 on December 17, 1993.)\n10.3 Stockholders Agreement dated as of December 7, 1990. (Incorporated by reference to Exhibit 10.C as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.4 Management Incentive Plan as amended and restated December 10, 1992. (Incorporated by reference to Exhibit 10.C as filed with the Company's Form 10-K for the year ended December 31, 1992.)\n10.5 Supplemental Retirement Plan. (Incorporated by reference to Exhibit No. 10.7 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n10.5(1) Amendment No. 1 to the Supplemental Retirement Plan. (Incorporated by reference to Exhibit 10.P as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n10.6 Form of Supplemental Retirement Agreement for the Company's Chief Executive Officer as Amended. (Incorporated by reference to Exhibit 10.M as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n- 61 -\n10.7 Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.T as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n10.7(A) Form of Amendment No. 1 to Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.U as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8 Amended and Restated Management Equity Participation Agreement dated as of August 1, 1988. (Incorporated by reference to Exhibit No. 10.9 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n10.8(A) Letter Agreement dated June 27, 1990, which modifies Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.V as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(B) Letter Agreement dated July 31, 1990, among the Company and the Principal Management Investors which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(C) Letter Agreement dated July 31, 1990, between the Company and the Management Investor Committee which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.X as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(D) Letter Agreement dated February 7, 1991, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(E) Form of Letter Agreement dated February 7, 1991, among the Company, the Management Investors Committee and Management Investors which cancels certain stock options, grants new stock options and amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.9 Management Equity Plan. (Incorporated by reference to Exhibit 10.H as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.9(A) Amendment dated December 28, 1993 to Management Equity Plan.\n10.10 Form of Management Equity Plan Agreement. (Incorporated by reference to Exhibit 10.I as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n- 62 -\n10.11 Agreement dated as of July 31, 1990, between the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.Y as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.11(A) Modification to Agreement dated as of July 31, 1990, between the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.Z as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.11(B) Letter Agreement dated February 7, 1991, between the Company and its former Chief Executive Officer which cancels stock options, grants new stock options and amends the Agreement dated as of July 31, 1990 among the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.12 Financial Advisory Agreement dated as of October 25, 1988, between MS&Co. and the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Post-Effective Amendment No. 1 to Form S-1 on April 6, 1989.)\n10.13 Participation Agreement dated as of October 26, 1989, among the Company, Philip Morris Credit Corporation, the Loan Participants listed therein, the Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.15 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.14 Facility Lease Agreement dated as of October 26, 1989, between the Connecticut National Bank in its capacity as Owner Trustee, the Lessor and the Company as Lessee. (Incorporated by reference to Exhibit 10.16 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.15 Power Installation Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.16 Equipment Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.17 Participation Agreement dated as of December 23, 1990, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.BB as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n- 63 -\n10.18 Amended and Restated Equipment Lease Agreement [1990] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee under the Trust Agreement, as Lessor, and the Company, as Lessee. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.19 Facility Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.EE as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.20 Equipment Lease Agreement [1991] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.FF as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.21 Power Plant Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.22 Amended and Restated Participation Agreement dated as of October 21, 1991, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee and the Form of the First Amendment thereto dated as of December 13, 1991. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 3 to Form S-3 on December 13, 1991).\n12 Statement of Deficiency of Earnings Available to Cover Fixed Charges.\n21 Subsidiaries of Fort Howard Corporation.\n25 Powers of Attorney (included as part of signature page).\nb. Reports on Form 8-K\nNo reports on Form 8-K were filed for the Company during the last quarter of 1993.\n- 64 -\nSIGNATURES\nPursuant 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.\nFORT HOWARD CORPORATION Green Bay, Wisconsin March 7, 1994 By \/s\/ Donald H. DeMeuse ---------------------------------- Donald H. DeMeuse, Chairman of the Board and Chief Executive Officer\nPOWER OF ATTORNEY\nThe undersigned directors and officer of Fort Howard Corporation hereby constitute and appoint Donald H. DeMeuse, Kathleen J. Hempel and James W. Nellen II and each of them, with full power to act without the other and with full power of substitution and resubstitution, our true and lawful attorneys- in-fact with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and hereby ratify and confirm all that such attorneys-in-fact, or any of them, or their substitutes shall lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on behalf of the registrant and in the capacities on the dates indicated:\n\/s\/ Donald H. DeMeuse Chairman of the Board, March 7, 1994 Donald H. DeMeuse Chief Executive Officer and Director\n\/s\/ Kathleen J. Hempel Vice Chairman, Chief March 7, 1994 Kathleen J. Hempel Financial Officer and Director\n\/s\/ Michael T. Riordan President, Chief March 7, 1994 Michael T. Riordan Operating Officer and Director\n\/s\/ Donald P. Brennan Director March 7, 1994 Donald P. Brennan\n\/s\/ Frank V. Sica Director March 7, 1994 Frank V. Sica\n\/s\/ Robert H. Niehaus Director March 7, 1994 Robert H. Niehaus\n\/s\/ James S. Hoch Director March 7, 1994 James S. Hoch\n\/s\/ Charles L. Szews Controller and Principal March 7, 1994 Charles L. Szews Accounting Officer\n- 65 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Fort Howard Corporation included in this Form 10-K and have issued our report thereon dated February 1, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nMilwaukee, Wisconsin February 1, 1994\n- 66 -\nSchedule V\nFORT HOWARD CORPORATION\nPROPERTY, PLANT AND EQUIPMENT (In thousands)\nNOTE: *Other includes the effects of foreign currency translation, transfers from construction in progress, the effects of the acquisition of Stuart Edgar in 1992, and the effects of the sale and leaseback transactions in 1991.\n- 67 - Schedule VI\nFORT HOWARD CORPORATION\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (In thousands)\nNOTES: *The provision is based on the straight-line depreciation method with rates varying from 2% to 50% per year.\n**Other includes the effects of foreign currency translation and reclassifications.\n- 68 -\nSchedule VIII\nFORT HOWARD CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS (In thousands)\nFor the Years Ended December 31, --------------------------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: 1993 1992 1991 ---- ---- ----\nBalance at beginning of year.......... $1,376 $1,379 $1,502 Additions charged to earnings......... 1,633 792 698 Charges for purpose for which reserve was created............... (643) (795) (821) ------ ------ ------ Balance at end of year................ $2,366 $1,376 $1,379 ====== ====== ======\n- 69 - Schedule X\nFORT HOWARD CORPORATION\nSUPPLEMENTARY INCOME STATEMENT INFORMATION (In thousands)\nCharged to Costs and Expenses ----------------------------- For the Years Ended December 31, ----------------------------- 1993 1992 1991 ---- ---- ----\nMaintenance and repairs.............. $49,626 $46,671 $45,324 ======= ======= =======\n- 70 - INDEX TO EXHIBITS\nExhibit No. - -----------\n3.1 Restated Certificate of Incorporation of the Company dated December 7, 1990. (Incorporated by reference to Exhibit 3.A as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n3.2 Amended and Restated By-Laws of the Company dated April 2, 1992. (Incorporated by reference to Exhibit 3.B as filed with the Company's Form 10-K for the year ended December 31, 1992.)\n4.1 Form of 12 3\/8% Senior Subordinated Note Indenture dated as of November 1, 1988 between the Company and State Street Bank and Trust Company, Trustee. (Incorporated by reference to Exhibit 4.1 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n4.2 Form of 12 5\/8% Subordinated Debenture Indenture dated as of November 1, 1988 between the Company and United States Trust Company, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.3 Form of 14 1\/8% Junior Discount Debenture Indenture dated as of November 1, 1988 between the Company and Ameritrust Company National Association, Trustee. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.4 Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.5 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n4.4(A) Amendment No. 1 dated as of February 21, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 1 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n4.4(B) Amendment No. 2 dated as of October 20, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 2 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n4.4(C) Amendment No. 3 dated as of November 14, 1989 to the Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.E 3 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.)\n- 71 -\n4.4(D) Instrument of Designation, Appointment and Acceptance dated as of June 22, 1988 among the Company, Bankers Trust Company and Security Pacific National Bank. (Incorporated by reference to Exhibit 4.7 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n4.4(E) Amendment No. 4 dated as of November 9, 1990 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.J as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990.)\n4.4(F) Amendment No. 5 dated as of December 19, 1990 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.K as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n4.4(G) Amendment No. 6 dated as of September 11, 1991 to Amended and Restated Credit Agreement dated as of October 24, 1988. (Incorporated by reference to Exhibit 4.A as filed with the Company's report on Form 8-K on September 13, 1991.)\n4.4(H) Amendment No. 7 dated as of December 2, 1991 to Amended and Restated Credit Agreement dated as of October 14, 1988, and Amendment No. 1 dated as of December 2, 1991, to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.N as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n4.4(I) Amendment No. 8 dated as of October 7, 1992 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amendment No. 2 dated as of October 7, 1992 to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.O as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.)\n4.4(J) Amended and Restated Amendment No. 8 dated as of November 12, 1992 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amended and Restated Amendment No. 2 dated as of November 12, 1992 to the Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.P as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.)\n4.4(K) Form of Second Amended and Restated Amendment No. 8 dated as of March 4, 1993 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Second Amended and Restated Amendment No. 2 dated as of March 4, 1993 to Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.3(J) as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n*4.4(L) Amendment No. 9 dated as of December 31, 1993 to Amended and Restated Credit Agreement dated as of October 24, 1988, and Amendment No. 3 dated as of December 31, 1993 to Note Purchase Agreement dated as of September 22, 1991.\n- 72 -\n4.5 Form of Senior Secured Floating Rate Note Purchase Agreement dated as of September 11, 1991. (Incorporated by reference to Exhibit 4.B as filed with the Company's report on Form 8-K on September 13, 1991.)\n4.6 Form of 9 1\/4% Senior Note Indenture dated as of March 15, 1993 between the Company and Norwest Bank Wisconsin, N.A., Trustee. (Incorporated by reference to Exhibit 4.1 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.7 Form of 10% Subordinated Note Indenture dated as of March 15, 1993 between the Company and the United States Trust Company of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.8 Form of 9% Senior Subordinated Note Indenture dated as of February 1, 1994 between the Company and The Bank of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Form S-2 on December 17, 1993.)\nRegistrant agrees to provide copies of instruments defining the rights of security holders, including indentures, upon request of the Commission.\n10.1 Employment Agreements dated October 15, 1993 with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n10.2 Employment Agreements dated December 10, 1993 with certain executive officers of the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Form S-2 on December 17, 1993.)\n10.3 Stockholders Agreement dated as of December 7, 1990. (Incorporated by reference to Exhibit 10.C as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.4 Management Incentive Plan as amended and restated December 10, 1992. (Incorporated by reference to Exhibit 10.C as filed with the Company's Form 10-K for the year ended December 31, 1992.)\n10.5 Supplemental Retirement Plan. (Incorporated by reference to Exhibit No. 10.7 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n10.5(1) Amendment No. 1 to the Supplemental Retirement Plan. (Incorporated by reference to Exhibit 10.P as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n10.6 Form of Supplemental Retirement Agreement for the Company's Chief Executive Officer as Amended. (Incorporated by reference to Exhibit 10.M as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n- 73 -\n10.7 Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.T as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n10.7(A) Form of Amendment No. 1 to Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.U as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8 Amended and Restated Management Equity Participation Agreement dated as of August 1, 1988. (Incorporated by reference to Exhibit No. 10.9 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n10.8(A) Letter Agreement dated June 27, 1990, which modifies Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.V as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(B) Letter Agreement dated July 31, 1990, among the Company and the Principal Management Investors which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(C) Letter Agreement dated July 31, 1990, between the Company and the Management Investor Committee which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.X as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(D) Letter Agreement dated February 7, 1991, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.8(E) Form of Letter Agreement dated February 7, 1991, among the Company, the Management Investors Committee and Management Investors which cancels certain stock options, grants new stock options and amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.9 Management Equity Plan. (Incorporated by reference to Exhibit 10.H as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n*10.9(A) Amendment dated December 28, 1993 to Management Equity Plan.\n10.10 Form of Management Equity Plan Agreement. (Incorporated by reference to Exhibit 10.I as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n- 74 -\n10.11 Agreement dated as of July 31, 1990, between the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.Y as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.11(A) Modification to Agreement dated as of July 31, 1990, between the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.Z as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.11(B) Letter Agreement dated February 7, 1991, between the Company and its former Chief Executive Officer which cancels stock options, grants new stock options and amends the Agreement dated as of July 31, 1990 among the Company and its former Chief Executive Officer. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.12 Financial Advisory Agreement dated as of October 25, 1988, between MS&Co. and the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Post-Effective Amendment No. 1 to Form S-1 on April 6, 1989.)\n10.13 Participation Agreement dated as of October 26, 1989, among the Company, Philip Morris Credit Corporation, the Loan Participants listed therein, the Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.15 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.14 Facility Lease Agreement dated as of October 26, 1989, between the Connecticut National Bank in its capacity as Owner Trustee, the Lessor and the Company as Lessee. (Incorporated by reference to Exhibit 10.16 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.15 Power Installation Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.16 Equipment Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.17 Participation Agreement dated as of December 23, 1990, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.BB as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n- 75 -\n10.18 Amended and Restated Equipment Lease Agreement [1990] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee under the Trust Agreement, as Lessor, and the Company, as Lessee. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.19 Facility Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.EE as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.20 Equipment Lease Agreement [1991] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.FF as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.21 Power Plant Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.22 Amended and Restated Participation Agreement dated as of October 21, 1991, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee and the Form of the First Amendment thereto dated as of December 13, 1991. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 3 to Form S-3 on December 13, 1991).\n*12 Statement of Deficiency of Earnings Available to Cover Fixed Charges.\n*21 Subsidiaries of Fort Howard Corporation.\n*25 Powers of Attorney (included as part of signature page).\n*Filed herewith.\n- 76 -","section_15":""}
{"filename":"20067_1993.txt","cik":"20067","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nMontrose Chemical Corporation of California (\"Montrose\"), whose stock is 50% owned by Chris-Craft and 50% by a subsidiary of ICI Americas, Inc. (\"ICI\"), discontinued its manufacturing operations in 1983 and has since been defending claims for costs and damages relating to environmental matters. Chris-Craft has been named as a defendant in certain of these actions by plaintiffs seeking to hold Chris-Craft liable for Montrose activities.\nIn April 1983, the United States of America and the State of California instituted an action in the Federal District Court for the Central District of California, United States of America et al. v. J.B. Stringfellow, et al., Case No. 83-2501 (JMI) (Mcx), against Montrose and approximately 30 other defendants relating to alleged environmental impairment at the Stringfellow Hazardous Waste Disposal Site in California. The complaint alleges that Montrose generated toxic wastes containing DDT which were deposited at the Stringfellow Site between 1969 and 1972, allegedly constituting approximately 19% by volume of all toxic wastes deposited at the site. During this period, the Stringfellow Site was licensed as a hazardous waste disposal facility by the State of California. The action seeks an injunction against numerous generators of waste materials which were deposited at the Stringfellow Site, including Montrose, the owners of the Stringfellow Site and others to abate the release of substances from the site and to remedy allegedly hazardous conditions. The action seeks to impose joint and several liability against all defendants for all costs of removal and remedial action incurred by the federal and state governments at the site. On September 30, 1990, the United States Environmental Protection Agency (\"EPA\") issued a Record of Decision for the site which selected some of the interim remedial measures preferred by the EPA and the State, the estimated present value of the capital costs of which was estimated by them to be $169,000,000, although the estimate purports to be subject to potential variations of up to 50%. Plaintiffs also seek recovery for remedial expenditures. The action also seeks unspecified damages for alleged harm to natural resources. Private parties have intervened in the action. On June 22, 1992, Montrose and other defendants signed a consent decree with the United States regarding certain remedial work at and near the Stringfellow Site, which decree was entered by the District Court in October 1992. On November 30, 1993 Special Master Harry V. Peetris entered a recommended ruling allocating liability at the site under both the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\") and state law. The CERCLA allocation was 65% to the State of California, 10% to the owners of the site and 25% to the generator defendants (including Montrose). The state law allocation was 100% to the State and 0% to the Stringfellow entities. The Special Master's recommended ruling will be reviewed by the District Court before it enters a final allocation decision. The State is expected to appeal when the final order is entered by the District Court. In addition, the United States Department of Justice has sought and received information regarding the relationship between Montrose and its two 50% shareholders. The Department's inquiry is directed to the issue whether Chris-Craft, as a shareholder of Montrose, shall be added as a party to the action.\nIn February 1993 Montrose and Chris-Craft were among a group of defendants which settled a case entitled Newman, et al. v. J.B. Stringfellow, et al., Case No. 165944 MF, in Riverside County (California) Superior Court. In Newman more than 4,000 plaintiffs sought unspecified monetary damages from more than 20 defendants for personal injury and property damage purportedly caused by substances allegedly released from the Stringfellow site. Montrose contributed approximately $7.5 million to the Newman settlement, over 80% of which was covered by insurance. Chris-Craft made no contribution to the settlement. The State of California is appealing the August 1993 order of the Newman court finding the settlement was in good faith.\nIn 1992 Chris-Craft was named a defendant in a personal injury action entitled Teresa Howell v. J.B. Stringfellow, Jr., et al., Case No. 216798 in Riverside County (California)\nSuperior Court, involving claims brought by an individual plaintiff seeking to recover unspecified damages from approximately 15 defendants (including Montrose) for alleged injuries purportedly resulting from exposure to substances disposed of at the Stringfellow Hazardous Waste Disposal Site in California. On January 25, 1994, the court in the Howell case ordered the suit to be dismissed as time-barred by applicable statutes of limitations.\nIn June 1990, the United States of America and the State of California commenced an action in the United States District Court for the Central District of California, entitled United States of America, et al. v. Montrose Chemical Corporation of California, et al., Civil Action No. 90-3122 AAH (JRX), against, among others, Montrose and Chris-Craft. Certain United States subsidiaries of ICI (the \"ICI Subsidiaries\"), as well as Westinghouse Electric Corporation, Potlatch Corporation and Simpson Paper Company, which have no connection with Chris-Craft, were also named as defendants. Brought under CERCLA, the complaint alleges that Montrose released hazardous substances, including DDT, into the environment in and around Los Angeles, California, including the waters surrounding the Palos Verdes Peninsula, the Los Angeles-Long Beach Harbor, and the Channel Islands. The complaint alleges that other defendants released PCBs into the same waters. The complaint seeks a declaration that defendants are jointly and severally liable for damages (in amounts not specified), including loss of use and cost of restoration, resulting from injury to natural resources caused by the alleged releases, plaintiffs' response costs incurred in connection with such damage, and plaintiffs' costs in assessing such damages. On April 26, 1993, the court approved a settlement between the plaintiffs, the Los Angeles County Sanitation District (\"LACSD\") and numerous municipalities and local government entities which had been sued by Montrose, Chris-Craft and other defendants as third-party defendants. The settlement would resolve all liability between the plaintiffs and the LACSD and the third-party entities for approximately $42 million in cash and in-kind services, and purports to immunize the settling defendants from the cross- claims and third party claims of Montrose and Chris-Craft. Montrose, Chris-Craft and other defendants have appealed the District court's approval of the settlement to the Ninth Circuit Court of Appeals. Plaintiffs also seek to hold Montrose, Chris-Craft, and the ICI Subsidiaries jointly and severally liable for all costs incurred in connection with the alleged hazardous substance contamination at the Montrose plant site in Torrance, California. Montrose terminated most of its operations, including all DDT manufacturing, prior to 1983.\nSince 1984 Montrose has been complying with a Consent Order entered into with the Nevada Department of Conservation and Natural Resources Division of Environmental Protection (\"DEP\") requiring operation of a ground water intercept treatment system near a production facility used by Montrose until 1985 in Henderson, Nevada. The EPA and DEP are currently reconsidering whether the complex that includes the Henderson facility should be included on the National Priority List. In April 1991, Montrose entered into a second consent order with DEP and other parties requiring investigation of environmental conditions at the Henderson facility.\nMontrose is a defendant in an action styled Levin Metals Corporation, et al. v. Parr-Richmond Terminal Company, et al., Case Numbers C-84-6273 BAC, C-84-6234 BAC and C-85-4776 BAC in the United States District Court for the Northern District of California, in which it is alleged that Montrose contributed to the contamination of certain real property in Richmond, California, and in which damages sought exceed $15 million. In December 1992 two parties to the Parr-Richmond action filed pleadings naming Chris-Craft as a defendant alleging, among other things, that Chris-Craft is secondarily liable under corporate liability theories for Montrose's liabilities, if any. Chris-Craft filed an answer denying liability on June 11, 1993, asserting numerous affirmative defenses and filing\ncounterclaims. The court in the Levin case has ordered discovery efforts to proceed in advance of a mediation conference scheduled for early June 1994.\nIn January 1990, Montrose and Chris-Craft were each notified by the United States National Oceanic and Atmospheric Administration that the United States intends to name each of them as a defendant in an action seeking recovery for alleged damage to natural resources emanating from the Richmond site. In March 1990, the EPA added the site to the National Priority List. In August 1991 and March 1992, the EPA invited potentially responsible parties, including Chris-Craft, to undertake investigation and remedial actions at the site. Chris-Craft has not taken any such actions.\nIn August 1992, Montrose was named one of approximately 18 defendants in Alderman, et al. v. Cadillac Fairview\/California, Inc., et al., Case No. BC062039 in Los Angeles County (California) Superior Court, where approximately 100 individual plaintiffs seek to recover unspecified amounts for alleged personal injuries and property damage purportedly caused by contamination at two neighboring properties in California, one of which formerly was used by Montrose for manufacturing operations. Chris-Craft was added as a defendant in December 1992. After the complaint against Chris-Craft was served, the United States of America, a third- party defendant, removed the Alderman action to the United States District Court for the Central District of California, where it is currently pending (Case No. 92-7535 ER). Plaintiffs have moved to remand the Alderman action to state court; their motion to remand is pending. In January 1993, Chris-Craft filed an answer denying the allegations against it and denying any and all liability. No substantial discovery has yet occurred in the Alderman action, although much is scheduled for 1994. A statement of damages filed by the plaintiffs alleges general damages of $7 million.\nIn October 1992, Montrose was named one of approximately 20 defendants in T H Agriculture and Nutrition Company, Inc. v. Aceto Chemical Co., Inc., Case No. C92-4152-MHP in the Federal District Court for the Northern District of California, where it is alleged Montrose contributed to contamination at a former pesticide formulation site in Fresno, California and where damages sought exceed $21 million. During 1993 Montrose rejected a settlement demand by the plaintiffs of $12.69 million. Chris-Craft was added as a defendant in January 1994.\nIn October 1992, Montrose was named one of approximately 28 third party defendants by a County Sanitation District of Los Angeles County in Acosta, et al. v. County Sanitation Districts of Los Angeles County, et al., Case No. BC057637 in Los Angeles County (California) Superior Court, where it is alleged Montrose is partially liable for an unspecified decrease in the values of properties owned by approximately 530 individual plaintiffs living near a Sanitation District sewage treatment facility.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\n\t EXECUTIVE OFFICERS OF THE REGISTRANT\n\tThe executive officers of Chris-Craft, as of February 28, 1994, are as follows:\n\t\t\t\t\t\t\t\tSchedule II\n\t\t CHRIS-CRAFT INDUSTRIES, INC. AND SUBSIDIARIES \t\t\tAMOUNTS RECEIVABLE FROM RELATED PARTIES, \t UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES \t\t\tFOR THE THREE YEARS ENDED DECEMBER 31, 1993 \t\t\t\t (In Thousands)\nThe loan was made for the purpose of assisting Mr. Lindsey in relocating his home in connection with the relocation of UTV's executive offices from Minneapolis to Los Angeles. The loan was represented by a non-interest bearing five-year note, with no payment due before maturity. In December 1988, the note was revised and extended. Under the Revision and Extension Agreement, 10% of the original balance is due and payable December 31 of each year through December 31, 1997. Such installments will be forgiven on each such December 31 if the borrower is still employed by UTV on each such forgiveness date. The note is secured by a deed of trust on the borrower's home and provides that at the option of the holder the loan will become due and payable upon sale or further encumbrance of the borrower's home without the consent of the holder or upon the borrower's voluntary termination of employment with UTV.\n\t\t\t\t\t\t\t Schedule X\n\t\t CHRIS-CRAFT INDUSTRIES, INC. AND SUBSIDIARIES \t\t SUPPLEMENTARY INCOME STATEMENT INFORMATION\n\t\t\t\t (In Thousands)\n\t\t\t\tEXHIBIT INDEX","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"52795_1993.txt","cik":"52795","year":"1993","section_1":"ITEM 1. BUSINESS OF THE COMPANY.\nGENERAL\nItel Corporation (the \"Company\" or \"Itel\"), which was incorporated in Delaware in 1967, is engaged in (i) the distribution of wiring systems products for voice, data and video networks and electrical power applications by Anixter Inc. and its subsidiaries (collectively \"Anixter\"), (ii) the development and distribution of products used in the cable television industry by ANTEC Corporation and its subsidiaries (collectively \"ANTEC\"), and (iii) rail car leasing by Itel Rail Corporation and its subsidiaries (collectively \"Rail\") (see discussion below of the 1992 rail car transaction for the limited nature of the Company's continuing interest in this business). In 1993, ANTEC was changed from a division of Anixter to a subsidiary of the Company and the Company's interest in ANTEC was later reduced to 53% following a public offering of ANTEC common stock. In 1993 and 1992, the Company sold substantially all of its other transportation services assets, except for one short-line railroad which is currently being held for sale. In 1991, the Company sold the distribution services business previously conducted by Itel Distribution Systems, Inc. (\"Itel Distribution\") and all the stock of Great Lakes International, Inc. which together with its subsidiaries (collectively \"Great Lakes\") was engaged in heavy marine construction, primarily dredging. At the end of 1990, the Company sold substantially all of its intermodal container leasing assets. For information about these sales see Item 7 -- Financial Liquidity and Capital Resources -- Asset Sales and Other Dispositions and Note 3 of the Notes to the Consolidated Financial Statements.\nAt December 31, 1993, the Company also had investments in securities of other companies, including approximately 9% of the common stock of Santa Fe Energy Resources, Inc. (\"Energy\") and approximately 9% of the common stock of Catellus Development Corporation (\"Real Estate\"). In 1991, the Company sold its 15% investment in the common stock of Santa Fe Pacific Corporation (\"Santa Fe\") and its 21% investment in the common stock of American President Companies, Ltd. (\"APC\"). The financing operations of Signal Capital Corporation and its subsidiaries (collectively \"Signal Capital\") and certain remaining other transportation services assets are being held for sale. See Note 3 of the Notes to the Consolidated Financial Statements.\nAs of December 31, 1993, the Company had cumulative net operating loss (\"NOL\") carryforwards for Federal income tax purposes of approximately $345 million expiring primarily in 1995 through 2007, and investment tax credit (\"ITC\") carryforwards of approximately $16 million that expire between 1994 and 2001. Certain of these carryforwards have not been examined by the Internal Revenue Service (\"IRS\") and, therefore, may be subject to adjustment. The availability of tax benefits of NOL and ITC carryforwards to reduce the Company's future Federal income tax liability is subject to various limitations under the Internal Revenue Code of 1986, as amended. These carryforwards are not applicable to ANTEC's results after September 1993. In addition, at December 31, 1993, various foreign subsidiaries of Itel had aggregate cumulative NOL carryforwards for foreign income tax purposes of approximately $50 million which are subject to various tax provisions of each respective country and expire primarily between 1995 and 2003.\nAt December 31, 1993, the Company and its subsidiaries employed approximately 4,600 persons. For information on segment and geographic data see Note 14 of the Notes to the Consolidated Financial Statements.\nANIXTER\nAnixter is a leading supplier of wiring systems, networking and internetworking products for voice, data and video networks and electrical power applications in the United States, Canada, Europe and parts of Asia. Anixter stocks and sells a full line of these products from a network of 87 locations in the United States, 21 in Canada, 20 in the United Kingdom, 23 in Continental Europe, 2 in Mexico, 2 in Australia and single locations in Singapore, Hong Kong and Ireland. Anixter sells approximately 80,000 products to over 60,000 active customers and works with over 2,000 suppliers. Its customers include international, national, regional and local companies that are end users of these products and engage in manufacturing, communications, finance,\neducation, health care, transportation, utilities and government. Also, Anixter sells products to resellers such as contractors, installers, system integrators, value added resellers, architects, engineers and wholesale distributors. The average order size is about $1,000.\nThe products sold by Anixter fall into two broad categories. The first category is communication (voice, data and video) products used to connect personal computers, peripheral equipment, mainframe equipment and various networks to each other. The products include an assortment of transmission media (copper and fiber optic cable) and components, such as adapters, outlets, cable assemblies, crossconnect systems, connectors, terminals, tools, test equipment and power protection devices. Active data components for networking applications include concentrators, intelligent hubs, multiplexers, transceivers, routers and servers. Anixter sells products that are incorporated in local area networks (\"LANs\"), the internetworking of LANs to form wide area networks (\"WANs\") and the increased use of fiber optic products in private networks, including factory environments. It is expected that these markets will continue to grow at double digit rates, with international growth somewhat outpacing U.S. growth. Anixter has followed a strategy of regularly expanding its product lines and the services that it provides to its customers. During 1993, Anixter began selling and providing technological support for internetworking products, including routers, as well as video-conferencing and network access products.\nThe second major product category is electrical wiring systems products used for the transmission of electrical energy and control\/monitoring of industrial processes. These products include power cables, high temperature or other critical environment cables, armored and control cable, instrumentation and thermalcouple cable, portable power cable, shielded electronic process cables and accessory products. Anixter is not a significant distributor to the residential or commercial construction industries.\nPrior to 1989, Anixter's operations were limited to the United States, Canada, the United Kingdom and Belgium. In 1989, Anixter made a major commitment to expand its operations into the international voice, data and video communications markets. Since then, Anixter has opened businesses in France, Germany, Italy, Norway, Spain, Sweden, Switzerland, Australia, Mexico, Portugal, Singapore, The Netherlands, Austria and Hong Kong. Anixter also has resident salespersons in Greece and Malaysia along with technical representatives in the Czech Republic, Hungary and Poland. While several of these expansion businesses achieved an operating profit in 1993 and 1992, the international expansion program is still considered to be in the startup mode. Since 1988, Anixter has experienced operating losses relating to the expansion program totalling approximately $33 million.\nAn important element of Anixter's business strategy is to develop and maintain close relationships with its key suppliers, which include the world's leading manufacturers of networking and electrical wiring systems products. Such relationships stress joint product planning, inventory management, technical support, advertising and marketing. In support of this strategy, Anixter does not compete with its suppliers in product design or manufacturing activities.\nAnixter has developed a competitive advantage through its proprietary computer system which connects all of its warehouses and sales offices throughout the world. The system is designed for sales support, order entry, inventory status, order tracking, credit review and material management. This fully integrated system connects Anixter's 158 worldwide service centers through more than 2,600 terminals. The computer system enables the sales staff to locate products at any location and ship them within 24 hours. Anixter provides a high level of customer service while maintaining a reasonable level of investment in inventory and facilities.\nAnixter competes with distributors and manufacturers who sell products directly or through existing distribution channels to end users or other resellers. In addition, Anixter's future performance could be subject to economic downturns and possibly rapid changes in applicable technologies. To guard against inventory obsolescence, Anixter has negotiated various return and price protection agreements with its key suppliers. Although Anixter's relationships with its suppliers are good, the loss of a major supplier could have a temporary adverse effect on Anixter's business but would not have a lasting impact since such products are available from alternate sources.\nANTEC\nANTEC is a leading developer and supplier of optical transmission, construction, rebuild and maintenance equipment for the broadband communications industry. The ANTEC business was originally formed as a division of Anixter in 1969 and, in 1993, ANTEC became a separate subsidiary of Itel.\nANTEC's role in the development of new products is to identify new product needs in the broadband communications industry and to work with strategic allies that generally contribute extensive engineering and design services in conjunction with ANTEC's engineers and then manufacture the product for sale by ANTEC. These alliances allow ANTEC to develop innovative products while minimizing its investment in engineering, facilities and equipment.\nANTEC is one of the leading suppliers to the cable market for fiber optic products. ANTEC also supplies cable system operators with almost all of the products required in a cable television system, including headend, distribution, drop and in-home subscriber products. ANTEC serves its customers through an efficient delivery network consisting of 23 sales and stocking locations in North America. ANTEC maintains complete inventories and is able to provide overnight as well as staged delivery of product on an \"as needed\" basis.\nMore than 95% of ANTEC's consolidated sales for the year ended December 31, 1993 came from sales to the cable industry. Demand for these products depends primarily on capital spending by cable operators for constructing, rebuilding, maintaining or upgrading their systems. The amount of capital spending and, therefore, ANTEC's sales and profitability, are affected by a variety of factors, including general economic conditions, access by cable operators to financing, government regulation of cable operators, demand for cable services and technological developments in the broadband communications industry. Technological developments are occurring rapidly in the communications industry and, while the effects of such developments are uncertain, they may have a material adverse effect on the demand for ANTEC products and on the cable industry as a whole. For example, technologies are being implemented that bypass existing cable systems and permit the transmission of signals directly into households.\nCable operators are subject to extensive regulation. For example, pursuant to the Cable Act of 1992, the Federal Communications Commission (the \"FCC\") has adopted regulations that govern cable operators. The regulations generally provide, among other things, for rate rollbacks for basic tier cable service, further rate reductions under certain circumstances and limitations on future rate increases. In addition, the Cable Act of 1992 provides that commercial broadcasting stations may elect (i) to require cable operators to carry their stations, or (ii) to bar cable operators from carrying their stations unless the cable operator agrees to pay to the station a \"re-transmission consent fee.\" Also in 1992, the FCC issued its \"video dialtone\" ruling which, among other things, allows local telephone companies to transmit all types of enhanced services, including interactive voice, video and data delivery in competition with cable operators. Additionally, in February 1994, the FCC announced that it intends to impose another rate cut of 7% for basic services. These regulations, among others, could limit capital expenditures by cable operators and, thus, could limit or reduce ANTEC's profitability. Moreover, changes in current regulation are possible and could have a similar effect.\nOn August 24, 1993, a Federal district court judge in Alexandria, Virginia declared unconstitutional, on First Amendment grounds, restrictions, as applied to Bell Atlantic Corporation and six other regional phone companies, under the 1984 Cable Act that prevent local exchange telephone companies from providing video programming to subscribers in their own telephone service area. It is uncertain whether this ruling will be upheld on appeal, and it is unclear what long-term effect, if any, this decision and related developments may have on the cable industry in general or ANTEC's business prospects. Similar uncertainty is created by proposed federal legislation to permit competition among cable operators, telephone companies and other companies.\nAlmost all of the products supplied by ANTEC are manufactured for it by domestic and foreign manufacturers. Approximately 23% of ANTEC's aggregate purchases in 1993 were of products manufactured by AT&T, and many ANTEC customers have demonstrated loyalty to AT&T products. In addition, approximately 57% of ANTEC's purchases in 1993 were from its ten largest suppliers. The loss of a significant manufacturing source, such as AT&T, could adversely affect ANTEC's business, although management\nbelieves that any such loss is unlikely to have a lasting impact on its business, since such products are generally available from alternate sources.\nThere can be no assurance that the technology applications under development by ANTEC and its strategic partners will be successfully developed or, if they are successfully developed, that they will be widely used by cable operators or that ANTEC will otherwise be able to successfully exploit these technology applications. Furthermore, ANTEC's competitors may develop similar or alternative new technology applications which, if successful, could have a material adverse effect on ANTEC. ANTEC relies on strategic alliances with various manufacturers for the development and production of new technology applications. These strategic alliances are based on business relationships and generally are not subject of written agreements expressly providing for the alliance to continue for a significant period of time. The loss of a strategic partner could have a material adverse effect on the development of the new products under development with that partner.\nThe cable industry is highly concentrated with over 75% of U.S. domestic subscribers being served by approximately twenty-five major multi-system operators (\"MSO's\"). In 1993, approximately 58% of ANTEC's revenues were obtained from sales to the twenty-five largest MSO's. A significant portion of ANTEC's revenue is derived from sales to Tele-Communications, Inc. (together with its affiliates, \"TCI\") aggregating $146.1 million, $86.7 million and $58.0 million for the years ended December 31, 1993, 1992 and 1991. In October, 1993, TCI and Bell Atlantic Corporation jointly announced their agreement for the acquisition of TCI and Bell Atlantic. In February, 1994, TCI and Bell Atlantic jointly announced the termination of their acquisition agreement. A variety of factors were identified, including the FCC rate cut, as the reasons for such termination. In the termination announcement, TCI also indicated that it plans to suspend its capital expenditure budget for 1994 by one-half pending clarification of the FCC action. It is not known what effect, if any, the recent FCC and TCI announcements will have on capital spending increases in general, or on ANTEC's performance in particular. However, ANTEC believes that while capital expenditures for some products by some operators may be adversely effected, capital spending for infrastructure improvements and upgrades will continue and, therefore, ANTEC does not anticipate a material adverse impact on its performance as a result of these recent announcements.\nAll aspects of ANTEC's business are highly competitive. ANTEC competes with national, regional and local manufacturers, distributors and wholesalers, including companies larger than ANTEC, such as General Instrument Corporation and Scientific-Atlanta, Inc. Various manufacturers who are suppliers to ANTEC sell directly as well as through distributors into the cable marketplace. In addition, because of the convergence of the cable, telecommunications and computer industries and rapid technological development, new competitors may seek to enter the cable market. Many of ANTEC's competitors or potential competitors are substantially larger and have greater resources than ANTEC. The principal methods of competition are product differentiation, performance and quality; price and terms; and service, technical and administrative support.\nThe future success of ANTEC depends in part on its ability to attract and retain key executive, marketing and sales personnel. Competition for qualified personnel in the cable industry is intense, and the loss of certain key personnel could have a material adverse effect on ANTEC. ANTEC has entered into employment contracts with its executive officers. ANTEC also has a stock option program designed to provide substantial incentives for its employees to remain with ANTEC.\nRAIL CAR LEASING\nIn June 1992, Itel and Rail completed a transaction with General Electric Capital Corporation and certain of its affiliates (\"GECC\") pursuant to which Rail contributed substantially all of its owned rail cars, subject to approximately $170 million of debt, to a trust (the \"Trust\") of which Rail is a 99% beneficiary and the Trust contributed these rail cars, subject to the debt, along with other rail cars the Trust received as a contribution from its 1% beneficiary, to a partnership (the \"Partnership\") of which the Trust is a 99% partner. The Partnership assumed the Rail debt and leased all of these contributed rail cars, along with other rail cars it received as a contribution from its other partners, to a subsidiary of GECC (the \"Lessee\"). These leases (the \"Leases\") expire in 2004, with fixed rentals of approximately $153 million annually. The Leases include the grant to the Lessee of an assignable fixed price purchase option at the end of the term of the leases for all, but\nnot less than all, of the rail cars for approximately $500 million. The Leases are net leases under which the Lessee is responsible for maintenance and other expenses of the rail cars and all obligations of the Lessee are unconditionally guaranteed by GECC. Rail also assigned to GECC, for certain consideration, substantially all of its contracts to lease rail cars from others.\nPrior to the rail car transaction, most of Rail's cars, other than boxcars, were leased to major railroads and shippers under fixed-rate leases which were typically one to five years in length. The majority of these leases required Rail to maintain the cars and provide other administrative services. The utilization of grain hoppers was affected by, among other things, export demand, domestic trade policies and weather. Prior to the rail car transaction, most of Rail's boxcars were leased to small railroads and used primarily for transportation by the paper and forest product industries. A majority of these leases were long-term \"per diem\" leases. Per diem leases did not require fixed rental payments. Instead, the rental paid by the lessee was a percentage of the use charges (\"car hire\") earned by the lessee railroad for the use of the leased equipment on the tracks of other railroads.\nSTOCK INVESTMENTS\nAt December 31, 1993, as the result of September 1988 acquisitions, other purchases and Santa Fe's 1990 restructuring and related spin-offs of Energy and Real Estate common stock, the Company owned 8,064,005 shares or approximately 9% of Energy's common stock and 6,687,575 shares or approximately 9% of Real Estate's common stock, both of which are listed on the New York Stock Exchange (the \"NYSE\"). Energy and Real Estate are subject to the informational filing requirements of the Securities Exchange Act of 1934 and, in accordance therewith, are required to file reports and other information with the Securities and Exchange Commission.\nIn 1993, 1992 and 1991, the Company wrote down the value of its investments in marketable equity securities by $25 million, $25 million and $50 million, respectively.\nASSETS HELD FOR SALE\nThe principal assets held for sale at December 31, 1993 are those of Signal Capital. The Company acquired Signal Capital in connection with the purchase of a major rail car fleet in 1988. The finance business of Signal Capital has been classified as assets held for sale in the Company's consolidated financial statements since its acquisition. The finance business is being liquidated and no material amounts of new loans or investments are being made by Signal Capital. Since the date of acquisition the portfolio has been reduced from $1.44 billion to $175 million at December 31, 1993, including reductions of $82 million, $82 million and $157 million in 1993, 1992 and 1991, respectively. All cash proceeds were used to reduce indebtedness.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nSee Item 1 - -Business of the Company--Rail Car Leasing and the Consolidated Financial Statements. The Company's rail cars have been leased to GECC under the Leases. Most of Anixter and ANTEC's facilities are leased. Certain of the debt agreements of the Company's subsidiaries are secured by their assets (see Note 9 of the Notes to the Consolidated Financial Statements).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn the ordinary course of business, the Company and its subsidiaries became involved as plaintiffs or defendants in various legal proceedings. The claims and counterclaims in such litigation, including those for punitive damages, individually in certain cases and in the aggregate, involve amounts which may be material. However, it is the opinion of the Company's management, based upon the advice of its counsel, that the ultimate disposition of pending litigation will not be material.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nDuring the fourth quarter of 1993, no matters were submitted to a vote of the security holders.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table lists the name, age as of March 25, 1994, position, offices and certain other information with respect to the executive officers of the Company. The term of office of each executive officer will expire upon the appointment of his successor by the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nA. MARKET INFORMATION\nItel Corporation's Common Stock is traded on the NYSE.\nB. STOCK PRICES\nThe following table sets forth the high and low sales prices for the Common Stock on the NYSE.\nC. DIVIDENDS ON COMMON STOCK\nThe Company has not paid dividends on its Common Stock since 1979 and does not anticipate declaring any such cash dividends in the foreseeable future. Certain loan agreements and indentures require that the Company maintain a minimum net worth or otherwise limit the Company's ability to declare dividends or make any distribution to holders of any shares of capital stock, or redeem or otherwise acquire such shares of the Company. Approximately $30 million is available for such distributions under the most restrictive of these covenants.\nD. NUMBER OF HOLDERS OF COMMON STOCK\nThere were approximately 6,000 holders of record of the Common Stock as of March 25, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n- --------------- Notes: (a) Operating income in 1992 includes $21.8 million of non-recurring operating costs relating to severance and transition costs due to the rail car transaction (see Note 7 of the Notes to the Consolidated Financial Statements). (b) Non-recurring items include an $84.5 million pre-tax gain on ANTEC Offering in 1993 relating to the September 1993 initial public offering of shares of common stock of ANTEC (see Note 4 of the Notes to the Consolidated Financial Statements). (c) The non-recurring pre-tax loss of $20.5 million in 1993 principally relates to the write-down of miscellaneous investments and certain non-operating assets to net realizable value. (d) In 1993, 1992 and 1991, the Company wrote down the value of its investments in marketable equity securities by $25.0 million, $25.0 million and $50.0 million, respectively. The remaining $29.4 million pre-tax charge in 1991 relates to the loss on sale of the Company's investment in Santa Fe. The $31.7 million pre-tax charge in 1990 primarily relates to the recognized loss in market value on other marketable equity securities. (e) Extraordinary items in 1993, 1992 and 1991 represent the gain\/(loss) net of related income taxes on early extinguishment of senior and subordinated debt at Itel and its subsidiaries. (f) Weighted average common and common equivalent shares outstanding decreased substantially from 1989 to 1992 primarily as a result of Itel's large treasury stock purchases in 1992, 1991 and 1990. Consequently, the loss per share in 1992 and 1991 was adversely impacted. In 1993, weighted average common and common equivalent shares increased slightly due primarily to the conversion of Series C convertible preferred stock into approximately 3.8 million shares of Common Stock in August 1993. (g) Stockholders' equity reflects treasury stock purchases of $.3 million, $114.3 million, $147.4 million, $187.6 million and $6.5 million in 1993, 1992, 1991, 1990 and 1989, respectively. No dividends on common stock were declared or paid during any of the periods shown. (h) Stockholders' equity includes unrealized losses on marketable equity securities available-for-sale, net of deferred income tax benefit of $23.7 million, $49.1 million, $47.8 million, $112.9 million and $24.9 million at December 31, 1993, 1992, 1991, 1990 and 1989, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nFINANCIAL LIQUIDITY AND CAPITAL RESOURCES\nAsset Sales and Other Dispositions\nRecapitalization Program: In 1990, the Company began a program of modifying its capital structure by reducing certain senior and subordinated debt at Itel and its subsidiaries and purchasing Common Stock. Over the last several years, the Company also implemented a program of selling or otherwise monetizing certain assets to fund the recapitalization program. Since the program began, the Company has used proceeds to substantially reduce debt at the holding company and subsidiary level and to repurchase approximately $450 million of outstanding Common Stock. The financial liquidity and capital resources in 1993 and 1992 reflect the impact of Itel's recapitalization program.\nANTEC Separation: In July 1993, ANTEC, formerly a business division of Anixter, was established as a separate and independent corporation through Anixter's contribution of assets and liabilities of its ANTEC business division to ANTEC and Anixter's distribution of 100% of the outstanding common stock of ANTEC to Itel. In September 1993, Itel and ANTEC completed a public offering (the \"Offering\") of shares of common stock of ANTEC. Net proceeds from the Offering were approximately $157 million of which Itel, after considering the redemption by ANTEC of preferred shares owned by Itel, received approximately $97 million. Proceeds were used to reduce indebtedness. As a result of the Offering, Itel's ownership of ANTEC common stock was reduced to 53%.\nLiquidation of Signal Capital: Signal Capital has been classified as assets held for sale since acquisition in connection with the purchase of a major rail car fleet in 1988. The finance business is being liquidated and no material amounts of new loans or investments are being made by Signal Capital. Since the date of acquisition the portfolio has been reduced from $1.44 billion to $175 million at December 31, 1993, including reductions of $82 million, $82 million and $157 million in 1993, 1992 and 1991, respectively.\nRail Car Transaction: In June 1992, Itel and Rail completed a transaction with GECC pursuant to which Rail contributed substantially all of its owned rail cars, subject to approximately $170 million of debt, to a Trust of which Rail is a 99% beneficiary and the Trust contributed these rail cars, subject to the debt, along with other rail cars the Trust received as a contribution from its 1% beneficiary, to a partnership (the \"Partnership\") of which the Trust is a 99% partner. The Partnership assumed the Rail debt and leased all of these contributed rail cars, along with other rail cars it received as a contribution from its other partners, to a subsidiary of GECC (the \"Lessee\"). The Leases expire in 2004, with fixed rentals of approximately $153 million annually. The Leases include the grant to the Lessee of an assignable fixed price purchase option at the end of the term of the Leases for all, but not less than all, of the rail cars for approximately $500 million. The Leases are net leases under which the Lessee is responsible for maintenance and other expenses of the rail cars and all obligations of the Lessee are unconditionally guaranteed by GECC. Rail also assigned to GECC, for certain consideration, substantially all of its contracts to lease rail cars from others.\nIn June 1992, the Trust issued $998 million of 7 3\/4% Notes (the \"Trust Notes\") secured by the Trust's ownership interest in the Partnership. The net proceeds were used to repay certain debt of Rail and Itel. The Trust Notes are non-recourse to Itel.\nOther Dispositions: In 1993 and 1992, the Company sold substantially all of its other transportation services assets, except for one short-line railroad which is currently being held for sale. In 1991, the Company sold its investments in American President Companies, Ltd. (\"APC\"), its third party distribution business, Great Lakes International, Inc. (\"Great Lakes\") and Santa Fe for aggregate cash proceeds in excess of $500 million. Proceeds from the sales were used to reduce debt or to purchase Common Stock.\nCash Flow\nConsolidated net cash provided (used) by continuing operating activities was $21.3 million for the year ended December 31, 1993 compared to ($5.5) million in 1992. Cash provided (used) by continuing operating activities increased due to higher operating income and lower interest costs caused by debt reductions somewhat offset by higher investment in net working capital attributable to Anixter and ANTEC sales volume\nincreases. Consolidated cash provided (used) by net investing activities was $11.7 million in 1993 versus ($18.7) million in 1992. Consolidated investing activities in 1993 primarily reflect net receipts from Itel's investment in Q-TEL (formerly Quadrum) of $23.7 million and proceeds from the sale of miscellaneous marketable securities and other investments somewhat offset by two ANTEC acquisitions aggregating $9.9 million and capital expenditures required at Anixter and ANTEC. Consolidated cash used for net financing activities was ($141.4) million for the year ended 1993 in comparison to ($50.4) million for the year ended 1992. The 1993 period includes approximately $156.6 million of proceeds from the Offering and the paydown of a substantial amount of subordinated debt. Consolidated net financing activities in 1992 reflect the issuance of $998 million of Trust Notes and subsequent paydown of substantial amounts of other debt. Cash from discontinued operations, net was $117.4 million in 1993 versus $68.0 million in 1992. Discontinued operations in 1993 and 1992 include net proceeds from the sale of most of the Company's other transportation services assets of $46 million and $8 million, respectively, and cash received from the reduction of assets at Signal Capital of $82 million in both years.\nConsolidated net cash provided (used) by continuing operating activities was ($5.5) million for the year ended December 31, 1992 compared to $34.4 million in 1991. This decrease was due primarily to higher investment in net working capital attributable to Anixter and ANTEC sales volume increases and severance and transition payments due to the rail car transaction. Consolidated cash provided (used) by net investing activities was ($18.7) million in 1992 versus $209.4 million in 1991. Consolidated cash provided from net investing activities in 1991 reflects significant proceeds from marketable securities sales, primarily Santa Fe. Consolidated investing activities in 1992 reflect significantly lower purchases of rail equipment due to the rail car transaction. Consolidated cash used for net financing activities was ($50.4) million for the year ended 1992 in comparison to ($442.0) million for the year ended 1991. Consolidated net financing activities in 1992 reflect the issuance of $998 million of Trust Notes and subsequent paydown of substantial amounts of other debt. Cash used for net financing activities in 1991 reflects the use of proceeds from significant asset sales to repay debt. The consolidated cash used for net financing activities in both years reflects large purchases of treasury stock, principally from Henley. Cash from discontinued operations, net was $68.0 million in 1992 versus $170.7 million in 1991. Discontinued operations in 1992 includes net proceeds from the sale of certain of the Company's other transportation services assets and cash received from the reduction of assets at Signal Capital. Discontinued operations in 1991 include net proceeds from the sales of the Company's investments in Great Lakes, APC and the third party distribution business aggregating $183 million and cash received from the reduction of assets at Signal Capital of $157 million.\nBased upon discussions with financial analysts and similar disclosures provided by competitors of Itel's businesses, the Company considers operating income before amortization of goodwill and operating income plus depreciation and amortization of goodwill (\"cash flow\") to be meaningful and readily comparable measures of Itel's relative performance. However, with the completion of the rail car transaction in June 1992, the ongoing fixed cash flow of Rail car leasing is available only to service interest and principal on the debt of the Trust and the Partnership. Cash flow by the Company's major business segments is presented in the following table. The decline in 1992 is due to the rail car transaction.\nConsolidated net interest expense was $151.1 million, $181.7 million and $179.7 million for the years ended December 31, 1993, 1992 and 1991, respectively. The Company has entered into interest rate agreements which effectively fix or cap, for a period of time, the interest rate on a portion of its floating rate\nobligations. As a result, the interest rate on substantially all debt obligations at December 31, 1993 is fixed or capped.\nFinancings\nOn December 13, 1993, the Company obtained a $250 million senior bank term loan (\"Term Loan\") from a group of banks. The Term Loan is secured by the Company's investments in the capital stock of Anixter, ANTEC and Signal Capital and its common shares of Energy and Real Estate aggregating $730 million at net book value at December 31, 1993. The Term Loan matures in 1996. The net proceeds from the Term Loan were used exclusively to repay other debt of Itel.\nIn August 1993, Itel's Series C convertible preferred stock was converted into approximately 3.8 million shares of Common Stock.\nIn July 1993, ANTEC executed an agreement with a group of banks for a new $100 million revolving credit facility. The revolving line of credit, which matures in 1997 and is extendible at the banks' option for one additional year, was reduced to $50 million upon completion of the Offering. Part of the proceeds from the new ANTEC revolving credit facility were used to repay a portion of a secured revolving line of credit of Anixter. The ANTEC revolving credit facility is non-recourse to Itel.\nIn May 1993, the Anixter secured revolving line of credit was extended to 1996 and was increased to $300 million. The revolving line of credit may be extended for two additional one-year periods at the option of the lenders. Upon completion of the new ANTEC revolving credit facility in July, Anixter's secured revolving line of credit was reduced to $210 million. In November, the Company increased the revolving line of credit to $220 million.\nAt December 31, 1993, $88.6 million was available under the bank revolving lines of credit at Anixter, most of which was available to Itel for general corporate purposes.\nDebt Maturities and Repayments\nCurrent maturities of non-recourse debt of $67.8 million at December 31, 1993 represent senior debt related to the Rail car leasing business to be serviced from Rail car leasing cash flow. In 1993 and 1992, Rail car leasing retired at maturity approximately $62.2 million and $17.9 million of non-recourse debt, respectively.\nIn 1993, the Company retired or called for redemption approximately $558 million of the face value of subordinated debt at Itel (including $180 million of 13% Senior Subordinated Notes (\"13% Notes\") called on December 17, 1993 for January 18, 1994 redemption and $41 million of 13% Notes called on January 27, 1994 for February 28, 1994 redemption). In 1992 and 1991, respectively, the Company retired $688 million and $79 million of the face value of senior and subordinated debt at Itel and its subsidiaries.\nNOL Carryforwards\nTo the extent of certain taxable income realized by the Company, liquidity is enhanced by potential tax benefits. As of December 31, 1993, the Company had cumulative NOL carryforwards for Federal income tax purposes of approximately $345 million expiring principally in 1995 through 2007, and ITC carryforwards of approximately $16 million expiring in 1994 through 2001. Certain of these carryforwards have not been examined by the IRS and, therefore, may be subject to adjustment. The availability of tax benefits of NOL and ITC carryforwards to reduce the Company's future Federal income tax liability is subject to various limitations under the Internal Revenue Code of 1986, as amended (the \"Code\"), which may limit their use in the event of substantial ownership changes of Itel's stock as defined in the Code. Such ownership changes may not be within the control of the Company. In addition, at December 31, 1993, various foreign subsidiaries of Itel had aggregate cumulative NOL carryforwards for foreign income tax purposes of approximately $50 million which are subject to various provisions of each respective country and expire between 1995 and 2003.\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"). Among other things, SFAS No. 109 requires recognition of deferred tax liability on the temporary differences between financial statement and income tax bases of assets and liabilities, measured at enacted tax rates, and the reduction of the liability for deferred taxes for NOL and ITC carryforwards, to the extent that realization of such carryforwards are more likely than not. Accordingly, the Company has reduced its deferred tax liability for its Federal and state NOL and ITC carryforwards in its consolidated financial statements. The Company's partial recognition of Federal and state future tax benefits is due to the expected utilization of those benefits based upon future receipt of substantial taxable income, specifically resulting from (a) over $546 million of existing temporary differences at December 31, 1993, primarily rail car depreciation, which will reverse prior to 2005 and (b) projected consolidated taxable income including the guaranteed minimum future rentals from the Leases of $153 million annually through 2004 and the discontinuance of the substantial capital expenditure program that gave rise to a significant portion of the NOL. Management anticipates that increases in taxable income during the carryforward period will arise primarily as a result of the factors mentioned above.\nThe following table presents the Company's, exclusive of ANTEC, scheduled reversal of existing temporary differences and the expiration dates and amounts of the Company's, exclusive of ANTEC, domestic NOL and ITC carryforwards at December 31, 1993.\nAt December 31, 1993, 1992 and 1991, consolidated valuation allowances for its tax carryforwards are $55.4 million, $58.4 million and $62.1 million, respectively, including valuation allowances on its foreign NOLs at December 31, 1993, 1992, 1991. The effect of the Revenue Reconciliation Act of 1993 enacted in August 1993 was not significant to the Company's consolidated results of operations.\nLiquidity Considerations and Other\nCertain debt agreements entered into by Itel's subsidiaries contain various restrictions including restrictions on payments to Itel. Such restrictions have not had nor are expected to have an adverse impact on Itel's ability to meet its cash obligations.\nAt December 31, 1993, the market value of the Company's investment in marketable equity securities was below cost by $36.5 million. In accordance with generally accepted accounting principles, the Company's investment in marketable equity securities has been reflected at market value in the consolidated balance sheet. The Company continuously evaluates the market value of its marketable securities held for investment in relation to its historical cost to determine whether a decline in market value is \"other than temporary\". When such decline in market value is deemed to be other than temporary, the Company records such decline as a charge against income. In 1993, 1992 and 1991, the Company wrote down the value of its investments in marketable equity securities by $25.0 million, $25.0 million and $50.0 million, respectively.\nCAPITAL EXPENDITURES\nConsolidated capital expenditures were $13.4 million, $17.0 million and $75.1 million for 1993, 1992 and 1991, respectively. Anixter capital expenditures were $11.4 million, $6.3 million and $8.4 million for 1993, 1992 and 1991, respectively. ANTEC capital expenditures were $2.0 million, $1.7 million and $2.0 million for 1993, 1992 and 1991, respectively. Rail car leasing capital expenditures were zero, $9.0 million and $64.7 million for 1993, 1992 and 1991, respectively. Due to the rail car transaction, future rail car leasing capital\nexpenditures, if any, will be funded from the proceeds of any dispositions of the rail cars involved in that transaction.\nRESULTS OF OPERATIONS\nAs a result of the rail car transaction with GECC in June 1992, the revenues and operating income of Rail car leasing, though essentially fixed, are lower than such results prior to the rail car transaction. Further, the ongoing fixed cash flow of Rail car leasing is available only to service interest and principal on the Trust Notes and the debt of the Partnership.\nEarnings Per Share: Weighted average common and common equivalent shares outstanding decreased substantially from 1989 to 1992 primarily as a result of Itel's large treasury stock purchases in 1992, 1991 and 1990. Consequently, the loss per share in 1992 and 1991 was adversely impacted. In 1993, weighted average common and common equivalent shares increased slightly due primarily to the conversion of Series C convertible preferred stock into approximately 3.8 million shares of Common Stock in August 1993.\nQuarter ended December 31, 1993: Loss from continuing operations for the fourth quarter of 1993 was ($17.5) million compared with ($29.2) million in the fourth quarter of 1992. The fourth quarter of 1993 and 1992 each include pre-tax charges associated with the write-down of marketable equity securities of $25.0 million. Net loss was ($22.6) million and ($53.6) million in the fourth quarter of 1993 and 1992, respectively. The Company retired or called for redemption approximately $206.0 million and $65.3 million of its subordinated and senior debt resulting in an extraordinary net loss of ($5.1) million and ($2.4) million in the fourth quarters of 1993 and 1992, respectively. The loss from discontinued operations in the fourth quarter of 1992 includes a ($16.1) million net loss from the discontinuance of the other transportation services segment.\nConsolidated revenues during the period, which includes revenues of Rail car leasing, increased 24% to $508.5 million, primarily reflecting increased volume at Anixter and ANTEC. Anixter revenues increased 21% to $359.7 million from $296.7 million reflecting increased volume in its U.S. wiring systems business and significantly higher volume in its European operations. ANTEC revenues increased 48% to $110.6 million in the fourth quarter of 1993 compared to $74.7 million in 1992 due to the upswing in spending by cable system operators and the acceptance of products developed by ANTEC.\nConsolidated operating income, including Rail car leasing, increased 27% to $39.4 million from $31.1 million in the fourth quarter of 1992 and consolidated operating income before amortization of goodwill increased 23% to $45.0 million from $36.5 million in the fourth quarter of 1992. Anixter's operating income before amortization of goodwill increased 78% to $16.4 million from $9.2 million in the fourth quarter of 1992 due to stronger European and U.S. Distribution earnings. The 1992 period also contained special charges related to a terminated equity participation plan. ANTEC's operating income before amortization of goodwill more than doubled to $7.1 million from $3.3 million in 1992 reflecting significantly increased volume.\nConsolidated net interest expense and other for the fourth quarter declined to $36.5 million from $48.8 million in 1992 due to the use of proceeds from the continued monetization of Itel's non-core assets to significantly reduce high-cost debt.\nYear ended December 31, 1993: Income (loss) from continuing operations was $16.1 million in 1993 compared with ($59.8) million in 1992. Results of continuing operations in 1993 include an $84.5 million pre-tax gain on the Offering and a ($20.5) million non-recurring pre-tax loss principally relating to the write-down of miscellaneous investments and certain non-operating assets to net realizable value. Operating income in 1992 includes a $21.8 million non-recurring operating charge related to the rail car transaction. Results of continuing operations in both 1993 and 1992 include pre-tax charges associated with the write-down of marketable equity securities of $25.0 million. Net loss was ($1.2) million and ($104.3) million for the years ended December 31, 1993 and 1992, respectively. The loss from discontinued operations in 1992 includes a ($16.1) million net loss on the discontinuance of the other transportation services segment. The Company retired or called for redemption a significant amount of its subordinated and senior debt resulting in an extraordinary net loss of ($16.0) million and ($20.4) million in 1993 and 1992, respectively.\nConsolidated revenues for the year ended December 31, 1993, which includes Rail car leasing, increased 14% to approximately $1.9 billion from $1.7 billion in 1992 primarily reflecting increased volume at Anixter and ANTEC. Anixter revenues rose 14% to $1.3 billion resulting from the continued growth of the U.S. wiring systems business and the continuing worldwide expansion. ANTEC revenues increased 42% to $427.6 million in 1993 compared to 1992 due to the upswing in spending by cable system operators and the acceptance of products developed by ANTEC. More than 95% of ANTEC's consolidated sales for the year ended December 31, 1993 came from sales to the cable industry. Demand for these products depends primarily on capital spending by cable operators for constructing, rebuilding, maintaining or upgrading their systems. In February 1994, the FCC announced its intention to impose a 7% rate reduction for basic cable services and ANTEC's largest customers announced it may reduce its capital expenditure budget for 1994. However, the Company believes that while capital expenditures for some products by some operators may be adversely affected, capital spending for infrastructure improvements and upgrades will continue and, therefore, the Company does not anticipate a material adverse impact on its performance as a result of these recent announcements. Rail car leasing revenue in 1993 decreased to $153.0 million from $217.5 million due to the effect of the rail car transaction in June 1992.\nConsolidated operating income, including Rail car leasing, was $157.9 million compared with $148.7 million (before the $21.8 million non-recurring operating charge) in 1992. Consolidated operating income before amortization of goodwill and the non-recurring operating charge increased to $179.4 million from $166.3 million in 1992. Anixter operating income before amortization of goodwill for 1993 increased 36% to $61.1 million due to improved margins and volume at U.S. distribution offset slightly by increased spending in international markets. Net start-up losses from recently established foreign operations were ($4.4) million in 1993 compared to ($2.5) million in 1992. The 1992 period also contained special charges related to a terminated equity participation plan. ANTEC's operating income before amortization of goodwill increased 70% to $25.2 million in 1993 from $14.8 million in 1992 reflecting significantly increased volume. Rail car leasing operating income before amortization of goodwill increased to $102.4 million from $93.5 million in 1992. Rail car leasing results in 1992 include a $21.8 million non-recurring operating charge relating to the rail car transaction.\nConsolidated net interest expense and other for 1993 declined to $151.1 million from $181.7 million in 1992 due to the use of proceeds from the 1992 rail car transaction and the continued monetization of Itel's non-core assets to significantly reduce high-cost debt.\nYear ended December 31, 1992: Loss from continuing operations was ($59.8) million in 1992 compared with ($57.7) million in 1991. Operating income in 1992 includes a $21.8 million non-recurring operating charge related to the rail car transaction. Results of continuing operations in 1992 and 1991 include pre-tax charges associated with the sale and write-down of marketable equity securities of $25.0 million and $79.4 million, respectively. Net loss was ($104.3) million and ($55.7) million for the years ended December 31, 1992 and 1991, respectively. The loss from discontinued operations in 1992 includes a ($16.1) million net loss on the disposition of certain other transportation services assets. The loss from discontinued operations in 1991 includes a ($14.6) million net loss on the sale of APC and Great Lakes. The Company retired a significant amount of its subordinated and senior debt resulting in an extraordinary net gain (loss) of ($20.4) million and $8.8 million in 1992 and 1991, respectively.\nConsolidated revenues for the year ended December 31, 1992, which includes revenues of Rail car leasing, increased 6% to approximately $1.7 billion from $1.6 billion in 1991 primarily reflecting increased volume at Anixter and ANTEC. Anixter revenues increased 13% to $1.2 billion reflecting strong U.S. data markets and significantly higher European volume. ANTEC revenues increased 17% to $301.0 million due to stronger fiber optics sales. Rail car leasing revenues decreased to $217.5 million from $307.0 million primarily due to the effect of the June 1992 rail car transaction.\nConsolidated operating income before the $21.8 million non-recurring operating charge was $148.7 million compared with $165.3 million in 1991. Consolidated operating income before the non-recurring operating charge and amortization of goodwill decreased to $166.3 million from $177.8 million in 1991. Anixter operating income before amortization of goodwill for 1992 increased 7% to $44.8 million due to lower European losses and stronger U.K. results partially offset by lower Canadian earnings. Net start-up losses from\nrecently established foreign operations decreased to ($2.5) million in 1992 from ($9.6) million in 1991. ANTEC's operating income before amortization of goodwill increased 48% to $14.8 million in 1992 from $10.0 million in 1991 reflecting significantly increased volume. Rail car leasing operating income before amortization of goodwill decreased to $93.5 million in 1992 from $136.4 million in 1991 reflecting the rail car transaction.\nConsolidated net interest expense and other for 1992 was $181.7 million compared to $179.7 million in 1991. Results in 1992 reflect the effects of debt reduction and lower interest costs following the 1991 sales of the Company's investments in APC, Santa Fe and Great Lakes, and the 1992 rail car transaction offset by the effect of the Company's treasury stock purchases and lower investment income. Net interest expense includes the carrying costs on the remaining marketable equity securities of approximately $25 million for the year ended December 31, 1992.\nYear ended December 31, 1991: Loss from continuing operations was ($57.7) million compared with ($32.4) million in 1990. Results in both years include pre-tax charges associated with the sale and write-down of marketable equity securities of $79.4 million and $31.7 million in 1991 and 1990, respectively. Net income (loss) was ($55.7) million and $128.7 million for the years ended December 31, 1991 and 1990, respectively. The loss from discontinued operations in 1991 includes a ($14.6) million net loss on the sales of APC and Great Lakes. Income from discontinued operations in 1990 primarily reflects a $154.9 million net gain on the sale of the Company's container leasing assets. In 1991, the Company retired approximately $78.9 million of the face value of its subordinated debt resulting in an extraordinary net gain of $8.8 million.\nConsolidated revenues for the year ended December 31, 1991 decreased slightly to approximately $1.6 billion. Anixter revenues, which included the start-up operations in Europe, increased 5% over 1990. ANTEC revenues declined 21% from 1990 due to significantly lower cable industry spending. Rail car leasing revenue was $307.0 million, slightly lower than 1990 primarily due to continued softness in the grain car leasing market.\nConsolidated operating income was $165.3 million compared with $168.2 million in 1990. Consolidated operating income before amortization of goodwill was $177.8 million compared with $180.8 million in 1990. Anixter operating income before amortization of goodwill for 1991 increased 14% to $42.0 million. Net start-up losses from recently established foreign operations were ($9.6) million and ($10.1) million in 1991 and 1990, respectively. ANTEC's operating income before amortization of goodwill decreased to $10.0 million in 1991 from $22.0 million in 1990 due to the poor cable television market. Rail car leasing operating income before amortization of goodwill was $136.4 million, up slightly from 1990 due to lower maintenance costs, partially offset by lower rental revenues.\nNet interest expense and other for the year was $179.7 million compared to $174.7 million in 1990 as the effect of the Company's treasury stock purchases was partially offset by the effects of debt reduction following the 1991 sales of the Company's investments in APC, Santa Fe and Great Lakes and excess proceeds from the sale of the Company's container leasing assets at the end of 1990. Net interest expense includes the carrying costs on marketable equity securities of approximately $60 million and $70 million for the years ended December 31, 1991 and 1990, respectively.\nImpact of Inflation: Inflation has slowed in recent years and is currently not an important determinant of Anixter and ANTEC's results of operations due, in part, to rapid inventory turnover. Due to the rail car transaction, inflation is currently not a determinant of the Company's rail car leasing business results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\n[This page left intentionally blank]\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Itel Corporation\nWe have audited the accompanying consolidated balance sheets of Itel Corporation as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Itel Corporation at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nOur audits were conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The accompanying supplemental balance sheets at December 31, 1993 (page 22) and supplemental statements of operations for the years ended December 31, 1993 and 1992 (page 24) and supplemental statements of cash flows for the year ended December 31, 1993 (page 26) are presented for purposes of additional analysis and are not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in our audits of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.\nERNST & YOUNG\nChicago, Illinois February 8, 1994\nITEL CORPORATION\nCONSOLIDATED BALANCE SHEETS\n(IN THOUSANDS, EXCEPT SHARE AMOUNTS)\nSee accompanying notes to the consolidated financial statements.\nITEL CORPORATION\nSUPPLEMENTAL BALANCE SHEETS\n(IN THOUSANDS)\nSupplemental consolidating data are shown for Anixter, ANTEC, Rail car leasing and All other. Transactions between Anixter, ANTEC, Rail car leasing and All other have been eliminated from the consolidated column.\nITEL CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to the consolidated financial statements.\nITEL CORPORATION\nSUPPLEMENTAL STATEMENTS OF OPERATIONS\n(IN THOUSANDS)\nSupplemental consolidating data are shown for Anixter, ANTEC, Rail car leasing and All other. Transactions between Anixter, ANTEC, Rail car leasing and All other have been eliminated from the consolidated columns.\nITEL CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nSee accompanying notes to the consolidated financial statements.\nITEL CORPORATION\nSUPPLEMENTAL STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nSupplemental consolidating data are shown for Anixter, ANTEC, Rail car leasing and All other. Transactions between Anixter, ANTEC, Rail car leasing and All other have been eliminated from the consolidated column.\nITEL CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)\nSee accompanying notes to the consolidated financial statements.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation: The consolidated financial statements include the accounts of Itel Corporation (\"Itel\") and its majority-owned subsidiaries (collectively \"the Company\") after elimination of intercompany transactions. Minority interests of $98.2 million at December 31, 1993 primarily relate to the 47% public ownership in ANTEC (see Note 4) and the 1% external ownership interests in the Trust and Partnership, respectively (see Note 7).\nReclassifications: The 1992 and 1991 consolidated financial statements and related notes have been reclassified to reflect the 1993 presentation. The Company adopted the Statements of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" and No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" at December 31, 1993. The effect on the consolidated financial statements was immaterial.\nCash and equivalents and restricted cash: The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amount of cash and equivalents approximates fair value because of the short maturity of those instruments. Restricted cash consists primarily of cash to be used for interest and principal on the debt related to Rail car leasing (see Note 9).\nInventories: Inventories are valued principally at the lower of average, approximating first-in, first-out, cost or market.\nDepreciation: The Company provides for depreciation of property principally on the straight-line basis over various useful lives including the term of the Leases (see Note 7) for rental equipment--rail cars, 25 to 40 years for buildings and improvements, 3 to 10 years for machinery and equipment and the term of the lease for leasehold improvements.\nGoodwill: Goodwill relates to the excess of cost over net tangible assets of businesses acquired. The Company at each balance sheet date evaluates, for recognition of potential impairment, its recorded goodwill against the current and undiscounted expected future operating income before goodwill amortization expense of the entities to which goodwill relates. In the opinion of management, goodwill at Anixter Inc. and its subsidiaries (collectively \"Anixter\") and ANTEC Corporation and its subsidiaries (collectively \"ANTEC\") has not diminished in value since their date of acquisition, and, having an indefinite life, is not subject to amortization. However, in accordance with Opinion 17 of the Accounting Principles Board of the American Institute of Certified Public Accountants, goodwill is being amortized over a period of 40 years using the straight-line method. The remaining goodwill relates to the purchase of Pullman Leasing Company in 1988 and is being amortized over the term of the Leases (see Note 7).\nMarketable equity securities available-for-sale: Marketable equity securities available-for-sale are reflected in the balance sheet at the quoted market price as of the balance sheet date. The difference between cost and market is reflected in stockholders' equity net of deferred tax benefit. Realized gains on dispositions of securities are determined using the average cost method. Realized pre-tax gains, before related interest carrying costs, were $.3 million, zero and $5.5 million in 1993, 1992 and 1991, respectively. Aggregate unrealized pre-tax loss on marketable equity securities available-for-sale amounted to $36.6 million at December 31, 1993 (see Note 5).\nInvestment in and advances to Q-TEL S.A. de C.V. of Mexico (\"Q-TEL\"): Investment in and advances to Q-TEL, formerly Quadrum, include a 19% equity interest in Q-TEL and at December 31, 1993 a $6.6 million loan.\nInterest rate agreements: The Company has entered into interest rate agreements which effectively fix or cap, for a period of time, the interest rate on a portion of its floating rate obligations. As a result, the interest rate on substantially all debt obligations at December 31, 1993 is fixed or capped. The net effects of such\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nagreements are included in interest expense.\nRevenue recognition: Sales and related cost of sales are recognized primarily upon shipment of products.\nAdvertising and sales promotion: Advertising and sales promotion costs are expensed as incurred.\nIncome taxes: Provisions for income taxes include deferred taxes resulting from temporary differences in determining income for financial and tax purposes using the liability method. Such temporary differences result primarily from differences in the carrying value of assets and liabilities.\nIncome (loss) per common share: Income (loss) per share amounts are based upon results from operations after deducting preferred dividends earned and the amortization of preferred stock discounts. Weighted average common and common equivalent shares were 30,132,000, 29,085,000 and 34,440,000 for 1993, 1992 and 1991, respectively.\nNOTE 2. SUPPLEMENTAL CASH FLOW INFORMATION\nContinuing operations of the Company paid interest, including interest allocated to discontinued operations, of approximately $187.9 million, $232.5 million and $248.6 million for the years ended December 31, 1993, 1992 and 1991, respectively. Approximately $7.0 million, $1.5 million and $3.3 million was paid principally for foreign and certain state income taxes for the years ended December 31, 1993, 1992 and 1991, respectively.\nIn a non-cash transaction Itel's Series C convertible preferred stock (\"Preferred Stock\") was converted into approximately 3.8 million shares of common stock in August 1993.\nNOTE 3. DISCONTINUED AND ASSETS HELD FOR SALE\nThe finance business of Signal Capital Corporation (\"Signal Capital\") has been included as assets held for sale since acquisition in connection with the purchase of a major railcar fleet in 1988. The finance business is being liquidated and no material amounts of new loans or investments are being made by Signal Capital. Since the date of acquisition the portfolio has been reduced from $1.44 billion to $175 million at December 31, 1993, including reductions of $82 million, $82 million and $157 million in 1993, 1992 and 1991 respectively. Proceeds were used to repay indebtedness.\nIn 1993 and 1992, the Company sold substantially all of its other transportation services assets, except for one short-line railroad which is currently being held for sale, for aggregate net cash proceeds of $54 million. The Company recorded a $26 million pre-tax loss in 1992 in discontinued operations to reflect the disposal of this segment.\nIn 1991, the Company sold its investments in various other businesses for aggregate cash proceeds in excess of $250 million. These 1991 sales resulted in pre-tax losses totaling $65 million which was reflected in discontinued operations.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe results of operations of the other transportation services segment, other previously sold businesses and Signal Capital have been included in discontinued operations net of allocated corporate interest expense. Allocated corporate interest expense amounted to $19.0 million, $38.1 million and $53.6 million for the years ended December 31, 1993, 1992 and 1991, respectively. Summarized financial results of discontinued operations were as follows:\nThe composition of remaining discontinued and assets held for sale, net consisted of the following:\nNOTE 4. GAIN ON ANTEC OFFERING AND NON-RECURRING ITEMS\nThe pre-tax gain on ANTEC Offering relates to the September 1993 initial public offering of shares of common stock of ANTEC (the \"Offering\"). Itel provided deferred taxes relating to the recognized pre-tax book gain. Itel and ANTEC sold approximately 4.0 million and 5.4 million shares of ANTEC common stock, respectively, at $18 per share. Net proceeds from the Offering were approximately $157 million of which Itel, after considering the redemption by ANTEC of preferred shares owned by Itel, received approximately $97 million. As a result of the Offering, Itel's ownership of ANTEC common stock was reduced to 53%.\nThe non-recurring pre-tax loss in 1993 principally relates to the write-down of miscellaneous investments and certain non-operating assets to net realizable value.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5. MARKETABLE EQUITY SECURITIES AVAILABLE-FOR-SALE\nIn 1993, 1992 and 1991, the Company wrote down the value of its investments in marketable equity securities by $25.0 million, $25.0 million and $50.0 million, respectively. Also in 1991, the Company recorded a pre-tax loss of $29.4 million on the sale of its investment in Santa Fe Pacific Corporation (\"Santa Fe\"). The Company has reduced the pre-tax unrealized losses on marketable equity securities available-for-sale included in stockholders' equity by $12.9 million at December 31, 1993 to reflect a deferred tax benefit due to the Company's current ability to either (a) carryback all December 31, 1993 unrealized capital losses to previously generated capital gains or (b) generate capital gains by the future sale of capital assets to offset December 31, 1993 unrealized capital losses.\nNOTE 6. EXTRAORDINARY ITEMS\nIn 1993, 1992 and 1991, the Company retired or called for redemption senior and subordinated debt resulting in a pre-tax extraordinary gain (loss) of ($26.2) million, ($32.9) million and $13.3 million, respectively.\nNOTE 7. RAIL CAR TRANSACTION\nIn 1992, a 98% owned affiliate of Itel leased all of the rail cars owned by the Company to an affiliate of General Electric Capital Corporation (\"GECC\") for twelve years with fixed annual rentals of approximately $153 million. The leases (the \"Leases\") include an option for GECC to purchase all, but not less than all, of the rail cars for approximately $500 million at the end of the term of the Leases. GECC is responsible for the maintenance and other expenses of the rail cars and has unconditionally guaranteed all obligations of its affiliate. Operating income in 1992 includes $21.8 million of non-recurring operating expense relating to severance and transition costs due to the rail car transaction.\nNOTE 8. ACCRUED EXPENSES\nAccrued expenses consists of the following:\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 9. DEBT\nDebt is summarized below. Subsequent to December 31, 1993, the Company retired $221.0 million of the 13% Senior Subordinated Notes (\"13% Notes\") primarily using a $250 million senior bank term loan (\"Term Loan\") at Itel (see discussion below). The pro forma column reflects such redemption of 13% Notes as if it occurred on December 31, 1993.\nItel--\n13% Notes: On December 17, 1993, Itel called $180 million of the 13% Notes for redemption on January 18, 1994. Itel called the remaining $41 million of 13% Notes on January 27, 1994 for redemption on February 28, 1994.\n10.2% Senior Subordinated Extendible Notes (\"Extendible Notes\"): The Extendible Notes are callable in January 1995 and may be extended for periods of one to five years after January 1995 at an interest rate and period established by Itel. Unless repurchased by Itel at the option of the holder at the end of any interest period, the Extendible Notes mature in 2001.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nTerm Loan: On December 13, 1993, the Company obtained a $250 million Term Loan from a group of banks. The Term Loan is secured by the Company's investments in the capital stock of Anixter, ANTEC and Signal Capital and its common shares of Santa Fe Energy Resources, Inc. (\"Energy\") and Catellus Development Corporation (\"Real Estate\") aggregating $730 million at net book value at December 31, 1993. The Term Loan matures in 1996. Various interest rate options are available. The interest rate at December 31, 1993 was 4 3\/4%. The net proceeds from the Term Loan were used exclusively to repay other debt of Itel.\nAnixter--\nBank revolving lines of credit: Anixter has various secured revolving bank lines of credit worldwide which provide for up to $281 million of borrowings contingent on the level of certain assets. At December 31, 1993, $184.7 million was borrowed and $88.6 million was available under the bank revolving lines of credit at Anixter, most of which was available for general corporate purposes. These lines of credit reduce or mature at various dates from 1994 through 1996. The $220.0 million domestic revolving line of credit, which matures in 1996, may be extended for two additional one-year periods at the option of the lender. Various interest rate options are available under these facilities and the average interest rate at December 31, 1993 was 6.0%. Commitment fees of 1\/2% are payable on the unused portion of these revolving lines of credit. The 1993 commitment fees paid were insignificant.\nANTEC--\nBank revolving line of credit: ANTEC has a revolving line of credit which provides for up to $50.0 million in borrowings. The line of credit is non-recourse to Itel, matures in 1997 and is extendible at the banks' option for one additional year. Various interest rate options are available. The interest rate at December 31, 1993 was 4.5%. Commitment fees of 1\/2% are payable on the unused portion of the revolving line of credit. The 1993 commitment fees paid were insignificant.\nRail car leasing--\nIn connection with the completion of the rail car transaction (see Note 7), a trust (the \"Trust\") issued $998 million of 7 3\/4% Notes (the \"Trust Notes\"). The Trust Notes are non-recourse to Itel, mature through 2004 and are secured by the Trust's ownership interest in a partnership, which holds substantially all of the rail cars formerly operated by Itel Rail Corporation and its subsidiaries (collectively \"Rail\"). The net proceeds from the Trust Notes were used to repay certain senior indebtedness of Rail and other debt of Itel. Equipment Trust Certificates (\"ETCs\") and other secured indebtedness of the Partnership are non-recourse to Itel, have interest rates ranging from 9.5% to 11.1% and mature through 2003. The ETCs have annual sinking fund requirements. With the completion of the rail car transaction in June 1992, the ongoing fixed cash flow of the Company's Rail car leasing business is available only to service interest and principal on the debt of the Rail car leasing business.\nOther--\nCertain debt agreements entered into by Itel's subsidiaries contain various restrictions including restrictions on payments to Itel. These debt agreements are secured by certain assets of the subsidiaries aggregating approximately $1.6 billion at December 31, 1993. Itel has guaranteed certain debt and other obligations of Anixter. Restricted net assets of subsidiaries were approximately $600 million at December 31, 1993.\nCertain of Itel's loan agreements or indentures require that Itel maintain a minimum net worth and interest coverage, use the proceeds of certain asset sales to repay debt, and limit Itel's ability to make capital investments, incur debt, declare dividends or make distributions to holders of any shares of capital stock, or\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nredeem or otherwise acquire such shares of the Company. Approximately $30 million is available for such distributions under the most restrictive of these covenants.\nAt December 31, 1993, the Company had four outstanding interest swap agreements having a total notional principal amount of $193.0 million and an average fixed rate of approximately 8.4%. The swap agreements expire in 1994. The Company also had five future interest swap agreements having a total notional principal amount of $150.0 million and an average fixed rate of 6.8%. These swap agreements begin in the latter half of 1994 and expire in 1995 and 1996.\nAggregate annual maturities of debt, after consideration of early 1994 retirements of the 13% Notes, are as follows:\nThe fair value of the Company's debt and interest rate swaps is presented below. The fair value of the Company's debt is estimated based on the quoted market prices. The fair value of interest rate swaps is the estimated amount that the Company would be required to pay to terminate the swap agreements at the reporting date, taking into account current interest rates.\nNOTE 10. INCOME TAXES\nItel and its U.S. subsidiaries (other than ANTEC for periods after September 1993) file their Federal income tax return on a consolidated basis. As of December 31, 1993, the Company had cumulative net operating loss (\"NOL\") carryforwards for Federal income tax purposes of approximately $345 million expiring principally in 1995 through 2007, and investment tax credit (\"ITC\") carryforwards of approximately $16 million expiring in 1994 through 2001. Certain of these carryforwards have not been examined by the Internal Revenue Service and, therefore, may be subject to adjustment. The availability of NOL and ITC carryforwards to reduce the Company's future Federal income tax liability is subject to various limitations under the Internal Revenue Code of 1986, as amended (the \"Code\"), which may limit their use in the event of substantial ownership changes of Itel's stock as defined in the Code. Such ownership changes may not be within the control of the Company. In addition, at December 31, 1993, various foreign subsidiaries of Itel had aggregate cumulative NOL carryforwards for foreign income tax purposes of approximately $50 million which are subject to various provisions of each respective country and expire primarily between 1995 and 2003.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn accordance with generally accepted accounting principles, the Company has reduced its deferred tax liability to reflect its Federal and state NOL and ITC carryforwards. The Company's partial recognition of Federal and state future tax benefits is based on the expected utilization of those benefits based upon future receipt of substantial taxable income, specifically resulting from (a) over $546 million of existing temporary differences at December 31, 1993, primarily rail car depreciation, which will reverse prior to 2005 and (b) projected consolidated taxable income including the receipt of guaranteed minimum future rentals from the Leases of $153 million annually through 2004 and the discontinuance of the substantial capital expenditure programs that gave rise to a significant portion of the NOL. Management anticipates that increases in taxable income during the carryforward period will arise primarily as a result of the factors mentioned above.\nDomestic income (loss) from continuing operations before income taxes was $58.6 million, ($68.5) million and ($79.9) million for the years ended December 31, 1993, 1992 and 1991, respectively. Foreign loss from continuing operations before income taxes was ($12.8) million, ($11.3) million and ($13.9) million for the years ended December 31, 1993, 1992 and 1991, respectively.\nDeferred income taxes reflect the impact of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. Deferred income taxes also result from differences between the fair value of assets acquired in business combinations accounted for as purchases and their tax bases.\nSignificant components of the Company's deferred tax liabilities and assets were as follows:\nAt December 31, 1993, 1992 and 1991, consolidated valuation allowances for its tax carryforwards were $55.4 million, $58.4 million and $62.1 million, respectively, including valuation allowances on its foreign NOLs at December 31, 1993, 1992 and 1991.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIncome tax (expense) benefit relating to operations was comprised of:\nReconciliations of income tax (expense) benefit in continuing operations to the statutory corporate Federal tax rate, 35% in 1993 and 34% in 1992 and 1991, were as follows:\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe income tax effects of items comprising the deferred income tax (expense) benefit were as follows:\nNOTE 11. CONTINGENCIES AND LITIGATION\nIn the ordinary course of business, Itel and its subsidiaries become involved as plaintiffs or defendants in various legal proceedings. The claims and counterclaims in such litigation, including those for punitive damages, individually in certain cases and in the aggregate, involve amounts which may be material. However, it is the opinion of the Company's management, based upon the advice of its counsel, that the ultimate disposition of pending litigation will not be material.\nNOTE 12. PENSION PLANS, POST-RETIREMENT BENEFITS AND OTHER BENEFITS\nThe Company's various pension plans are non-contributory and cover substantially all full-time domestic employees. Retirement benefits are provided based on compensation as defined in the plans. The Company's policy is to fund these plans as required by ERISA and the Code.\nAssets of the Company's plans at fair value were $44.0 million and $40.1 million at December 31, 1993 and 1992, respectively. Projected benefit obligations of the Company's plans were $57.2 million and $48.3 million at December 31, 1993 and 1992, respectively. The accumulated benefit obligations of the Company's plans were $44.5 million and $33.5 million at December 31, 1993 and 1992, respectively. The weighted-average assumed discount rate used to measure the projected benefit obligation was 6.8% and 7.3% at December 31, 1993 and 1992, respectively. Pension expense, including the cost of 401(k) plans, for 1993, 1992 and 1991 was insignificant. The Company's liability for post-retirement benefits other than pensions is insignificant.\nNOTE 13. PREFERRED STOCK AND COMMON STOCK\nItel has authorized 15 million shares of Preferred Stock, par value $1.00 per share. In August 1993, the Preferred Stock was converted into approximately 3.8 million shares of Common Stock. At December 31, 1993, 1992 and 1991, 33,010,000, 28,080,000 and 32,140,000 shares of Common Stock, respectively, were issued and outstanding. In connection with all Itel employee stock plans described below, 2,998,485 shares were reserved for issuance at December 31, 1993.\nStock options and stock grants--\nItel has Employee Stock Incentive Plans (\"ESIP\") authorizing an aggregate of 5.7 million stock options or restricted grants. In addition, Itel has a Director Stock Option Plan (\"DSOP\") authorizing an aggregate of .2 million stock options. Substantially all options and grants under these plans have been at fair market value or higher. The exercise price of certain options increase at a specified fixed rate. One-third of the options granted become exercisable each year after the year of grant (except in the case of director options which vest fully in six months) and the options expire seven to ten years after the date of grant.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAdditionally, Itel has an Employee Stock Purchase Plan (\"ESPP\") covering most employees, excluding ANTEC after September 1993. Participants can request that up to 10% of their base compensation be applied toward the purchase of Common Stock under Itel's ESPP. The exercise price is the lower of 85% of the fair market value of the Common Stock at the date of grant or at the later exercise date (currently one year).\nUnder the ESIP, DSOP and ESPP, total options currently exercisable at December 31, 1993 and 1992 were 763,336 and 1,374,030, respectively.\nThe following table summarizes the 1993 activity under the ESIP, DSOP and ESPP.\nTotal stock options exercised for the years ended December 31, 1992 and 1991 were 1,438,316 and 353,103, respectively. The purchase price per share for all stock options exercised ranged from $4.44 to $21.88 in 1992 and $3.38 to $16.50 in 1991.\nStock option plans of subsidiaries--\nIn 1993, Anixter adopted the Anixter Employee Stock Incentive Plan and options to purchase approximately 2.1 million shares of Anixter common stock were granted with an exercise price of $9.00 per share to key employees of Anixter. Substantially, all options and grants under these plans have been at fair market value. These options vest immediately to three years and terminate one to seven years from the date of grant. At December 31, 1993, Itel owned all of the 29.0 million shares of outstanding Anixter common stock.\nIn 1993, ANTEC adopted the ANTEC Employee Stock Incentive Plan and options to purchase approximately 1.5 million shares of ANTEC common stock were granted with exercise prices of $10.00 to $18.00 per share to key employees of ANTEC. All options and grants under these plans have been at fair market value or higher. These options vest over four years beginning in January 1995 and terminate seven years from the date of grant. At December 31, 1993, Itel owned 53% of the 20.1 million shares of outstanding ANTEC common stock.\nIn 1993, ANTEC also adopted the ANTEC Employee Stock Purchase Plan, with terms identical to Itel's ESPP described above, and the ANTEC Director Stock Option Plan. Options to purchase 56,000 shares of ANTEC common stock were granted under the ANTEC Employee Stock Purchase Plan at $15.30 per share. At December 31, 1993, no options were outstanding under the ANTEC Director Stock Option Plan. In connection with all ANTEC option plans, 2.3 million ANTEC shares were reserved for issuance at December 31, 1993.\nWarrants--\nThe Company has issued warrants to directors, which are currently exercisable, to purchase 130,000 shares of Common Stock at prices ranging from $10.13 to $24.25 per share expiring between 1995 and the year 2000.\nIn 1992, Itel acquired warrants to purchase 4.675 million shares of Common Stock held by an affiliate of Samuel Zell, the chairman of the board of directors of Itel. In connection with the warrant purchase, a $15.0 million note receivable was cancelled.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nCommon Stock--\nIn a series of transactions in 1992, 1991 and 1990, the Company purchased from the Henley Group, Inc. (\"Henley\") 18.7 million shares of the Company's Common Stock for an aggregate price of $377 million. In addition to the Common Stock purchased from Henley, in 1992 and 1991, Itel purchased 2,046,000 and 1,605,300 shares of Common Stock, respectively. All treasury stock was retired.\nThere are restrictions in several of Itel's debt agreements which limit the payment of dividends and the repurchases or redemption of Common Stock (see Note 9).\nNOTE 14. BUSINESS SEGMENTS\nThe Company is engaged in three principal areas of business: distribution of wiring systems products for voice, data and video networks and electrical power applications (Anixter), the development and distribution of products used in the cable television industry (ANTEC) and rail car leasing operations through the Leases. Itel Corporate obtains and coordinates financing, legal and other related services, certain of which are rebilled to these segments.\nInformation for the years ended December 31, 1993, 1992 and 1991 regarding the Company's major business segments is presented in the following table. The business segments of Itel have been reclassified to reflect ANTEC as a separate segment.\n- --------------- (a) Identifiable assets are principally comprised of marketable equity securities (including Energy and Real Estate) and discontinued and assets held for sale.\n(b) Reflects $9.0 million of expenses relating to a terminated equity participation plan.\n(c) Includes $21.8 million of non-recurring operating costs relating to severance and transition costs due to the rail car transaction.\nITEL CORPORATION\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe classification of the Company's 1993, 1992 and 1991 foreign operations in the following table includes all revenues and related items of the Company's non-U.S. operations. Export sales are insignificant.\nSUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following tables summarize the Company's quarterly financial information.\n- --------------- (a) The third quarter of 1993 has been restated from amounts previously reported to reflect a $4.6 million reclassification from non-recurring items to extraordinary items relating to the write-off of deferred financing fees on early extinguishment of debt.\n(b) The second quarter of 1992 includes a $21.8 million non-recurring operating charge relating to severance and transition costs due to the rail car transaction.\n(c) Continuing operations in the third quarter of 1993 include an $84.5 million pre-tax gain on the Offering and a ($20.5) million non-recurring pre-tax loss principally relating to the write-down of miscellaneous investments and certain non-operating assets to net realizable value. Continuing operations in the fourth quarter of 1993 and 1992 include pre-tax charges of $25.0 million associated with the write-down of the Company's marketable equity securities.\n(d) Discontinued operations in the fourth quarter of 1992 include a $26.0 million pre-tax loss on the discontinuance of the other transportation services segment.\n(e) The extraordinary items in 1993 and 1992 reflect a pre-tax loss of ($26.2) million and ($32.9) million, respectively, on the early extinguishment of the Company's subordinated and senior debt.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.\nSee Registrant's Proxy Statement for the 1994 Annual Meeting of Stockholders -- \"Election of Directors\" and \"Timeliness of Certain Filings.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSee Registrant's Proxy Statement for the 1994 Annual Meeting of Stockholders -- \"Summary Compensation Table,\" \"Option Grants in Last Fiscal Year,\" \"Aggregated Option Exercised in Last Fiscal Year and FY-End Option Value,\" \"Pension Plan Table,\" \"Compensation of Directors,\" \"Employment Contracts and Termination of Employment and Changes in Control Arrangements,\" and \"Compensation Committee Interlocks and Insider Participation.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSee Registrant's Proxy Statement for the 1994 Annual Meeting of Stockholders -- \"Security Ownership of Management\" and \"Security Ownership of Principal Stockholders.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nSee Registrant's Proxy Statement for the 1994 Annual Meeting of Stockholders -- \"Certain Relationships and Related Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Exhibits. The exhibits listed below in Item 14(a)1, 2 and 3 are filed as part of this annual report. Each management contract or compensatory plan required to be filed as an exhibit is identified by an asterisk(*).\n(b) Reports on Form 8-K. None.\nITEM 14(A)1 AND 2. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nFinancial Statements.\nThe following Consolidated Financial Statements of Itel Corporation and Report of Independent Auditors are filed as part of this report.\nFinancial Statement Schedules.\nThe following financial statement schedules of Itel Corporation are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Itel Corporation.\nConsolidated Schedules for the years ended December 31, 1993, 1992 and 1991, except as noted:\nAll other schedules are omitted because they are not required or are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.\nITEM 14(A)3. EXHIBIT LIST. Each management contract or compensation plan required to be filed as an exhibit is identified by an asterisk(*).\n(28) Additional exhibits.\nThis Annual Report on Form 10-K includes the following Financial Statement Schedules:\nITEL CORPORATION AND SUBSIDIARIES-- FINANCIAL SCHEDULES\nAll other schedules are omitted because they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes thereto. - ---------------\n+ Copies of other instruments defining the rights of holders of long-term debt of Itel Corporation and its subsidiaries not filed pursuant to Item 601(b)(4)(iii) of Regulation S-K and omitted copies of attachments to plans and material contracts will be furnished to the Securities and Exchange Commission upon request.\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, as amended, the Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into the Registrant's Registration Statement on Form S-8 Nos. 2-93173 (filed September 30, 1987), 33-13486 (filed April 15, 1987), 33-21656 (filed May 3, 1988) and 33-60676 (filed April 5, 1993):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provision, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nITEL CORPORATION\nSCHEDULE I--MARKETABLE SECURITIES--OTHER INVESTMENTS\nDECEMBER 31, 1993 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n- ---------------\n(a) At December 31, 1993, the Company wrote down its investment in marketable equity securities by $25 million.\nITEL CORPORATION\nSCHEDULE II--AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)\n- ---------------\n(a) In 1992, Itel acquired warrants to purchase 4.675 million shares of Common Stock held by an affiliate of Samuel Zell, a director of Itel. In connection with the warrant purchase, a $15.0 million note receivable was cancelled.\nITEL CORPORATION\nSCHEDULE III--CONDENSED FINANCIAL INFORMATION OF REGISTRANT ITEL CORPORATION (PARENT COMPANY)\nBALANCE SHEETS (IN THOUSANDS)\nITEL CORPORATION\nSCHEDULE III--CONDENSED FINANCIAL INFORMATION OF REGISTRANT ITEL CORPORATION (PARENT COMPANY)\nSTATEMENTS OF OPERATIONS (IN THOUSANDS)\nITEL CORPORATION\nSCHEDULE III--CONDENSED FINANCIAL INFORMATION OF REGISTRANT ITEL CORPORATION (PARENT COMPANY)\nSTATEMENTS OF CASH FLOWS (IN THOUSANDS)\nITEL CORPORATION\nSCHEDULE V--PROPERTY AND EQUIPMENT\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n(IN THOUSANDS)\nITEL CORPORATION\nSCHEDULE VI--ACCUMULATED DEPRECIATION\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n(IN THOUSANDS)\nITEL CORPORATION\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)\n- ---------------\n(a) At December 31, 1993, 1992 and 1991, the Company wrote down its investment in marketable equity securities by $25.0 million, $25.0 million and $50.0 million, respectively. The remaining deduction of $29.4 million in 1991 relates to the loss on sale of the Company's investment in Santa Fe.\nSIGNATURES\nPURSUANT 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, IN THE CITY OF CHICAGO, STATE OF ILLINOIS, ON THE 25TH DAY OF MARCH, 1994.\nITEL CORPORATION\nJAMES E. KNOX ---------------------------------------- James E. Knox Senior Vice President, General Counsel and Secretary\nPURSUANT 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 AND ON THE DATES INDICATED.\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 2-93173) pertaining to the Itel Corporation 1983 Stock Incentive Plan, the Registration Statement (Form S-8 No. 33-13486) pertaining to the Itel Corporation Key Executive Equity Plan, the Registration Statement (Form S-8 No. 33-21656) pertaining to the Itel Corporation 1988 Employee Stock Purchase Plan, the Registration Statement (Form S-8 No. 33-38364) pertaining to the Itel Corporation 1989 Employee Stock Incentive Plan and the Registration Statement (Form S-8 No. 33-60676) pertaining to the Itel Corporation 1993 Director Stock Option Plan and in the related Prospectuses of our report dated February 8, 1994 with respect to the consolidated financial statements and schedules of Itel Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 1993.\nERNST & YOUNG\nChicago, Illinois March 25, 1994","section_15":""}
{"filename":"205520_1993.txt","cik":"205520","year":"1993","section_1":"Item 1. Business 6-32 Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties 6-32 Item 3.","section_3":"ITEM 3. Legal Proceedings\nIn 1990, a verdict was rendered against the company's subsidiary, Philadelphia Newspapers, Inc., (PNI), publisher of The Philadelphia Inquirer and Philadelphia Daily News, in a libel action entitled Sprague v. Philadelphia Newspapers, Inc., for $2.5 million in compensatory damages and $31.5 million in punitive damages. Following entry of the judgment on Sept. 15, 1992, PNI, as required by statute, posted a bond equal to 120% of the amount of the verdict and appealed the judgment to the Pennsylvania Superior Court. PNI believes that substantial grounds exist for a decision by an appellate court to reverse the trial court and remand the case for a new trial. The Comprehensive Environmental Response, Compensation and Liability Act (Superfund) establishes a fund to clean up deposits and spills of hazardous substances. The Company has been identified by certain regulatory agencies as one of several potentially responsible parties in connection with the generation of allegedly hazardous substances which may have been disposed of or reclaimed by third-party contractors at sites in New Jersey, Maryland, South Carolina, North Carolina, Pennsylvania, and Kansas. The Company, certain other potentially responsible parties and the United States Environmental Protection Agency (EPA) have entered into consent orders relating to the sites in New Jersey, South Carolina and North Carolina providing for remedial investigations and feasibility studies or remediation to be performed.\nThe Company does not anticipate that any liability arising from ultimate relief secured by regulatory agencies or other persons will have a material effect on the Company's business or financial condition. The Company is cooperating with the appropriate regulatory agencies with respect to compliance with environmental laws.\nITEM 4.","section_4":"ITEM 4. Submission of matters to a vote of security holders\nNone. PART II ITEM 5.","section_5":"ITEM 5. Market for registrant's common stock and related stockholder matters -------------------------------------------------------------------- KRI STOCK Knight-Ridder common stock is listed on the New York Stock Exchange and the Frankfurt Stock Exchange under the symbol KRI and on the Tokyo Stock Exchange with the designation 9491. The stock also is traded on exchanges in Philadel- phia, Chicago, Boston, San Francisco, Los Angeles and Cincinnati, as well as through the Intermarket Trading System. Options are traded in the Philadel- phia Exchange.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data -----------------------\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations -------------------------\nKnight-Ridder is an international information and communications company engaged in newspaper publishing, business news and information services, electronic retrieval services and news, graphics and photo services. In 1993, the gross revenue from these businesses was almost $2.5 billion. The company also is involved in other newspaper businesses, cable television and newsprint manufacturing through business arrangements, including joint ventures and partnerships. The charts at the end of this section illustrate the approximate relative percentages of the components of operating revenue and of operating costs as a percentage of revenue.\nGlossary of Newspaper Advertising Terms The following definitions may be helpful when reading the Discussion and Analysis of Operations. RETAIL - display advertising from local merchants, such as department and grocery stores, selling goods and services to the public. GENERAL - display advertising by national advertisers who promote products or brand names on a nationwide basis. CLASSIFIED - small, locally placed ads listed together and organized by category, such as real estate sales, employment opportunities and automobile sales and display-type advertisements in these categories. FULL-RUN - advertising appearing in all editions of a newspaper. PART-RUN - advertising appearing in select editions or zones of a newspaper's market. Part-run advertising is translated into full-run equivalent linage (referred to as factored) based on the ratio of the circulation in a particular zone to the total circulation of a newspaper. RUN-OF-PRESS (ROP) - all advertising printed on Knight-Ridder presses and appearing within a newspaper. PREPRINT - advertising supplements prepared by advertisers and inserted into a newspaper.\nNEWSPAPER revenue is derived principally from advertising and newspaper copy sales. Newspaper advertising currently accounts for 60% of consolidated revenue. This revenue comes from the three basic categories of advertising - retail, general and classified - discussed above. Newspaper advertising volume is categorized as either run-of-press (ROP) or preprint. Volume for ROP advertising is measured in terms of either full-run or part-run advertising linage and reported in six-column inches. A six-column inch consists of one inch of advertising in one column of a newspaper page when that page is divided into six columns of equal size. By using part-run advertising, advertisers can direct their messages to selected market segments. Circulation revenue results from the sale of newspapers. Circulation of daily and Sunday newspapers currently accounts for 19% of consolidated revenue. It is reported at the net wholesale price for newspapers delivered or sold by independent contractors and at the retail price for newspapers delivered or sold by employees. Other newspaper revenue comes from alternate delivery systems, commercial job printing, newsprint scrap sales, newspaper trucking services, book publishing, niche publications and other miscellaneous sources. BUSINESS INFORMATION SERVICES (BIS) revenue includes operations of Dialog, Knight-Ridder Financial and the Journal of Commerce. Dialog includes Dialog Information Services and Data-Star, a 1993 acquisition with Europe-based online operations. Dialog and Data-Star have more than 155,000 customers in over 100 countries and offer more than 450 databases. Subscribers are charged according to the amount of time they spend online and which databases they access. Knight-Ridder Financial products include real-time and archival information services focusing on global sovereign debt, foreign exchange, money markets and futures instruments. Information displayed on these products consists of news, quotations, charts and a variety of other analytical services. The group generates revenue from subscribers in more than 30 countries. The Journal of Commerce publishes The Journal of Commerce, a business daily newspaper that focuses on global trade and transportation issues, and several more-targeted periodicals. It also provides access to electronic databases on imports, exports and steamship tariffs. SUMMARY OF OPERATIONS: A summary of the company's operations, certain share data and other financial data for the past 11 years is provided in Item 6. Compound growth rates for the past five- and 10-year periods are also included, if applicable. A review of this summary and of the\nSupplemental Information section (Items 1 & 2) will provide a better understanding of the following discussion and analysis of operating results and of the financial statements as a whole. The Supplemental Information section contains financial data for the company's operations by line of business and includes discussions of the company's largest newspapers and information regarding the company's properties, technology and the raw materials used in operations. RESULTS OF OPERATIONS: 1993 vs. 1992 - Knight-Ridder, Inc., earnings per share was $2.68, up $.03, or 1.1%, from $2.65 per share before the cumulative effect of changes in accounting principles in 1992. Operating income increased 2.3% on a 5.2% increase in revenue in 1993. Operating income as a percentage of revenue was 11.6% compared with 12.0% in 1992. A 20.7% increase in net interest expense resulted from a reduction in capitalization of interest related to the Philadelphia plant. This was partially offset by higher earnings from our cable investment. NEWSPAPERS: The Newspaper Division's operating income increased $8.2 million, or 2.8%, to $298.8 million. The increase resulted from improved revenues that more than offset a 3.4% increase in the average price of newsprint, and increased costs due to the transition to the new plant in Philadelphia. Overall, newspaper advertising revenue increased by $37.5 million, or 2.6%, in 1993 on a full-run ROP linage increase of 1.3%. The following table summarizes the percentage change in revenue and full-run ROP linage from 1992. Percent Percent Gain Gain (Decline) (Decline) in Full-Run Advertising Category in Revenue ROP Linage - -------------------- ---------- ---------- Retail 1.0 (1.0) General (3.4) (7.8) Classified 7.0 5.3 Total 2.6 1.3\nRetail advertising revenue improved $7.6 million, or 1.0%. A 1.9% increase in full-run average rates and an increase in part-run ROP revenue was partially offset by a 1.0% decrease in full-run ROP linage.\nGeneral advertising revenue declined by $6.0 million, or 3.4%, from 1992 on a 7.8% decline in full-run ROP general linage, partially offset by an increase in preprint revenue. General advertising revenue did show year-over-year improvement in the fourth quarter of 1993. Classified revenue improved by $35.9 million, or 7.0%, on a 5.3% increase in full-run ROP volume. Circulation revenue increased $14.4 million, or 3.1%, despite a decline in average number of copies. Morning circulation declined 11,300 copies, or 0.4%, and afternoon circulation declined 11,800 copies, or 2.5%. Sunday circulation declined 14,300 copies, or 0.3%. Other newspaper revenue increased $16.8 million, or 42.2%, during 1993, primarily due to efforts to augment the revenue of our core newspaper business. BUSINESS INFORMATION SERVICES: In 1993, BIS contributed 17.9% of consolidated revenue, compared with 16.5% in 1992. Operating income was $23.4 million, up $1.3 million, or 6.1%, from 1992 on a 13.8% increase in revenue. About half of the revenue growth was due to the first-quarter acquisition of Data-Star. Excluding Data-Star revenue, BIS revenue was up 6.5% from the prior year. The graph at the end of this section illustrates the 22.4% compound growth rate for BIS revenue from 1983. EXPENSES: Labor and employee benefit costs were up $33.9 million, or 3.4%, with 141, or 0.7%, more employees resulting from expansion and acquisitions in the BIS division. The average wage per employee increased 3.9%. Included in 1992 results were $10.5 million in severance and buyout costs related to a Detroit joint operating agreement (JOA) labor settlement. Newsprint, ink and supplements cost increased by $18.2 million, or 5.8%, due to a 3.4% increase in both consumption and average newsprint prices from the prior year. Depreciation and amortization expense increased 10.6%, or $13.5 million, due to the completion of the new Philadelphia printing plant and BIS expansion. Other operating costs increased 8.1% from 1992 due partially to a $21.7 million increase in volume-related BIS royalty and exchange fee expenses. NON-OPERATING ITEMS: Net interest expense increased $6.7 million, or 20.7%, from 1992 as a result of the $14.6 million reduction in capitalized interest. This was partially offset by a reduction of interest expense reserves related to prior year tax audits and the call of $100.0 million of 8.0% notes, replaced by lower-rate commercial paper. Average interest rates on commercial paper decreased from 4.3% in 1992 to 3.2% in 1993.\nOther non-operating items improved to a $2.2 million loss, a $4.1 million improvement from 1992. Most of the improvement came from our cable investment, which this year contributed an additional $3.5 million to our pretax income. INCOME TAXES: The effective income tax rate for 1993 was 39.2%, up 0.1% from 39.1% in 1992. Income tax expense included the $5.1 million unfavorable effect of the retroactive and current impact of the tax rate change in the Omnibus Budget Reconciliation Act of 1993. It was mostly offset by favorable adjustments of tax reserves and deferred tax assets resulting from settlement of IRS audits of prior years and resolution of other state tax issues. RESULTS OF OPERATIONS: 1992 vs. 1991 - Knight-Ridder, Inc., earnings per share before the cumulative effect of changes in accounting principles was $2.65, up $.10, or 3.9%, from $2.55 per share in 1991. The company recorded a non-recurring net charge of $105.2 million ($1.91 per share) related to the adoption of Financial Accounting Standards (FAS) 106 (Postretirement Benefits Other Than Pensions) and FAS 109 (Accounting For Income Taxes). The cumulative effect of adoption of FAS 106, relating to postretirement benefits other than pensions, was an after-tax reduction in earnings of $131.0 million, or $2.37 per share. This represents the unrecognized net obligation based on plans in place at the beginning of 1992. The company chose to recognize this \"transition\" amount immediately, rather than prospectively. In the second quarter, the company announced medical plan changes effective Jan. 1, 1993, that placed a maximum annual dollar cap for medical premiums that the company would pay for most future non-union retirees. Additionally, coverage after the age of 65 was eliminated for most future non-union retirees. The result of this announced plan change was a reduction in the prior service cost, which will be amortized over future years. The full-year operating profit reduction resulting from the recurring additional costs related to FAS 106 was $6.6 million, or an after-tax $.07 reduction in earnings per share. The adoption of FAS 109, which relates to accounting for deferred income taxes, resulted in an increase to 1992 net income of $25.8 million, or almost $.47 per share. Operating income increased 14.5% on a 3.2% increase in revenue in 1992. Operating income as a percentage of revenue improved to 12.0% from 10.8% in 1991. Revenue gains and a decline in the cost of newsprint contributed positively to operating income. A decline in net interest expense and higher earnings from our cable investment helped to offset the decline in earnings from our newsprint manufacturing investments.\nNEWSPAPERS: The Newspaper Division's operating income increased $30.9 million, or 11.9%, to $290.5 million. The increase resulted from improved revenue and a decline in the cost of newsprint. Newspaper Division operating costs increased $9.3 million. Overall, newspaper advertising revenue increased by $14.5 million, or 1.0%, in 1992 on a full-run ROP linage decline of 1.5%. The following table summarizes the percentage change in revenue and full-run ROP linage from 1991.\nPercent Percent Gain Gain (Decline) (Decline) in Full-Run Advertising Category in Revenue ROP Linage - -------------------- ---------- ----------- Retail (0.1) (2.8) General 1.0 (7.9) Classified 2.7 1.1 Total 1.0 (1.5)\nRetail advertising revenue was down $520,000, or 0.1%. A 2.8% decline in volume was partially offset by a 1.5% increase in full-run average rates and an increase in preprint and part-run revenue. General advertising revenue increased by $1.8 million, or 1.0%, from 1991 on the strength of an 8.2% increase in rates and an increase in preprint and part-run revenue. General full-run ROP linage declined 7.9% from 1991. Classified revenue improved by $13.2 million, or 2.7%, on a 1.1% increase in full-run ROP volume and a 1.7% increase in full-run average rates. Circulation revenue increased $21.0 million, or 4.8%, due to a 6.4% increase in average rates. Morning circulation declined 26,400 copies, or 0.8%, and afternoon circulation declined 40,900 copies, or 7.9%. Sunday circulation declined 7,200 copies, or 0.2%. BUSINESS INFORMATION SERVICES: In 1992, BIS contributed 16.5% of consolidated revenue, compared with 15.7% in 1991. Operating income was $22.1 million, up $1.9 million, or 9.3%, from 1991 on an 8.8% increase in revenue. EXPENSES: Labor and employee benefit costs were up $47.9 million, or 5.1%, with 83, or 0.4%, fewer employees. The average wage per employee increased 5.2%. Included in 1992 results were $10.5 million in severance and buyout costs related to a Detroit JOA labor settlement in the first half of the year.\nNewsprint, ink and supplements cost declined by $63.0 million, or 16.6%, due to a 17.8% decrease in average newsprint prices from the prior year. Newsprint consumption was 0.1% less than 1991 as a result of shifting the printing of the Journal of Commerce to an outside company. Supplements cost decreased by $4.8 million, or 10.6%. Depreciation and amortization expense increased 3.4%, or $4.2 million, due to the start-up of the new Philadelphia printing plant and BIS expansion. Other operating costs increased 8.3% from 1991 due partially to an $11.8 million increase in volume-related BIS royalty and exchange fee expenses, and increased circulation promotion costs. Additionally, Knight-Ridder increased its level of contributions to help with the aftermath of Hurricane Andrew. NON-OPERATING ITEMS: Net interest expense declined $7.7 million, or 19.2%, from 1991 as a result of lower average debt balances and lower interest rates. Average interest rates on commercial paper decreased from 6.4% in 1991 to 4.3% in 1992. Other non-operating items decreased to a $6.2 million loss, a $13.6 million decline from 1991. The major reason for the decline was unfavorable results from our investments in newsprint manufacturing, which suffered from soft newsprint prices in 1992. Our cable investments performed well, but this was not enough to offset other non-operating losses. INCOME TAXES: The effective income tax rate for 1992 was 39.1%, up 1.9% from 1991's 37.2% as a result of the resolution of prior year tax issues. RESULTS OF OPERATIONS: 1991 vs. 1990 - Knight-Ridder, Inc., earnings per share from continuing operations for 1991 of $2.55 was down $.39, or 13.3%, from $2.94 per share in 1990. The serious impact of the recession and the effects of the war in the Middle East early in the year resulted in our first down year after 15 consecutive years of earnings per share growth, excluding the impact of gains from major asset sales. Operating income from continuing operations decreased 19.1% on a 2.9% decrease in revenue in 1991. Operating income as a percentage of revenue was 10.8%, compared with 12.9% in 1990. Gains in the Business Information Services Division and a decline in total newsprint expense contributed positively to operating income, but were not enough to offset the softness in advertising revenue. A decline in net interest expense and higher earnings from investments in cable and newsprint manufacturing also helped offset the decline in operating income. NEWSPAPERS: The Newspaper Division's operating income decreased $64.2 million, or 19.8%, to $259.6 million. The decrease resulted from the\ncyclical weakness in advertising revenue being experienced throughout the newspaper industry and other advertising media. Newspaper Division operating costs decreased 1.4%. Overall, newspaper advertising revenue declined by $127.3 million, or 8.2%, in 1991 on a full-run ROP linage decline of 9.4%. The following table summarizes the percentage changes in revenue and full-run ROP linage from 1990. Percent Percent Decline Decline in Full-Run Advertising Category in Revenue ROP Linage - -------------------- ---------- ----------- Retail (4.1) (8.6) General (6.8) (12.5) Classified (14.1) (10.0) Total (8.2) (9.4)\nRetail advertising revenue was down $32.8 million, or 4.1%. An 8.6% decline in volume was partially offset by a 2.7% increase in full-run average rates and an increase in preprint revenue. The retail linage decline reflected the weakened condition of the retail industry and the economy in general. General advertising revenue declined $12.6 million, or 6.8%, from 1990. The volume decrease of 12.5% was slightly offset by a 3.9% increase in full-run average rates and greater volume in preprints. The continued decline in full-run ROP volume reflected softness in airline, food and factory automotive advertising. Classified revenue declined $81.9 million, or 14.1%, on a 10.0% drop in full-run ROP volume and a 4.8% decrease in full-run average rates. Almost every market was affected, with the biggest losses coming in the employment category. Employment revenue was down 24.4% on a 30.7% volume decrease, with the biggest losses in San Jose and Philadelphia. Real estate revenue dropped 13.8% on a 12.9% decline in linage. Automotive revenue was down 6.3% on a 0.3% decrease in volume. Circulation revenue increased $35.8 million, or 8.9%, due to a 12.0% increase in average rates. Morning circulation declined 12,000 copies, or 0.4%. Afternoon circulation declined 115,000 copies, or 18.2%. Sunday circulation declined 26,000 copies, about the same percentage reduction experienced in weekday morning circulation.\nBUSINESS INFORMATION SERVICES: In 1991, BIS contributed 15.7% of consolidated revenue, compared with 14.3% in 1990. While the company reinvested significant profits in the development of this division, operating income was $20.2 million, up $3.0 million, or 17.3%, from 1990 on a 6.5% increase in revenue. Dialog and MoneyCenter accounted for most of the revenue increases as a result of increases in the number of customers served. EXPENSES: Labor and employee benefit costs were up $12.5 million, or 1.3%, with 3.5% fewer employees. The average wage per employee increased 3.5%. Additionally, 1991 includes $14.3 million of severance and early retirement costs incurred in the second half of the year by several newspapers, designed to streamline operations and further reduce costs in future years. Excluding these buyout costs from 1990 and 1991, total labor costs were almost flat and employee benefits increased $6.7 million, or 3.8%. Newsprint, ink and supplements cost decreased $22.4 million, or 5.6%, due to a 7.3% decrease in consumption partially offset by a 1.5% increase in average newsprint prices. The reduced consumption reflected the lower volume in advertising linage and circulation. Supplements cost decreased by $2.8 million, or 5.9%. Other operating costs decreased 0.2% from 1990 due to strong efforts to control costs. NON-OPERATING ITEMS: Net interest expense was $40.3 million in 1991, down $13.8 million, or 25.6%, from 1990. The decline was primarily a result of higher capitalized interest, which increased by $12.0 million as a result of the construction of the Philadelphia production plant. Lower average debt balances and lower interest rates also helped. In the last half of 1991, the proceeds from the sale of 3 million shares of new common stock were used to reduce debt. Average interest rates on commercial paper decreased from 8.3% in 1990 to 6.4% in 1991. Other non-operating income increased to $7.4 million from a $579,000 loss in 1990. This resulted from significant improvement in the earnings of our cable investments and reduced royalties paid to joint operating agreement participants in Miami and Fort Wayne. INCOME TAXES: The effective income tax rate for 1991 was 37.2%, down 2.2% from 1990's 39.4%, mostly as a result of the favorable resolution of several outstanding tax issues.\nEarlier Years 1990 was the first full year of operations after entering the joint operating agreement between the Detroit Free Press and The Detroit News (owned by Gannett Co., Inc.) creating the Detroit Newspaper Agency (DNA), now\ndoing business as Detroit Newspapers. DNA performs the newspaper's production, sales and distribution functions, while the two papers maintain separate and independent newsrooms. This resulted in significantly improved bottom-line results from our Detroit operation. In October 1989, Knight-Ridder completed the sale of its eight television stations for an after-tax gain of $66.9 million, or $1.07 per share. In November 1989, the DNA was formed. Knight-Ridder purchased Dialog Information Services in mid-year 1988 for approximately $353.0 million, and an effective 7-1\/2% interest in SCI Holdings, Inc. (parent of Storer Communication) in November 1988. Despite the $.13 per share dilutive impact of these acquisitions, the company's earnings per share from continuing operations increased 2.0% over 1987. In 1987, the company's newspaper operations received a boost from strong classified advertising and a full year of operations from the State-Record Company acquisition. The acquisition, however, cost the company approximately $.15 in earnings per share dilution. Excluding the State-Record newspapers, newspaper advertising revenue increased 4.9% on a 0.4% decline in full-run ROP linage. In 1986, Knight-Ridder acquired six daily newspapers in South Carolina and Mississippi. The company closed its Viewdata operation and sold the assets of TelAir Network, Inc. Newspaper advertising revenue increased 9.2% on a 0.5% gain in full-run ROP linage. Excluding the impact of a 46-day strike in Philadelphia in 1985, linage declined 1.2%. The volume decline was due to softness in Miami and various airline mergers. Consistent with the company's experience, newspaper advertising, particularly retail and classified, mirrored the general state of the economy from 1983 through 1985. In 1985, newspaper advertising revenue increased 2.9% on a 2.4% decline in full-run ROP linage. The linage decline resulted from the strike in Philadelphia and softness in Miami. Fueled by a strengthening economy in 1984, full-run advertising revenue was up 14.7% on a 4.6% increase in full-run linage.\nA Look Ahead The outlook for 1994 is more positive than it has been going into the last few years. Signs indicate a slow but steady improvement in the economy, and the company is well positioned to benefit from the economic upturn.\nThe Newspaper Division is expected to have moderate revenue growth, with fairly stable newsprint pricing. We will benefit from a reduction in operating costs related to the transition to the new Philadelphia printing facility. The BIS Division, strengthened by recent acquisitions, is expected to continue its strong double-digit revenue growth and will continue its global expansion efforts. We expect to continue to benefit from lower interest rates, as higher-rate notes are called and mature, and are replaced by lower-rate commercial paper. At this time, we don't expect significant changes in our 1994 share of investee earnings from our equity investments. In early 1994, the company made several strategic moves that should strengthen our position in the future. The company acquired the assets of Technimetrics, which publishes information documenting the equity holdings of major global investment professionals. The company formed a joint venture with the Canadian electronic publishing operations of Southam, Inc., to produce a more efficient and focused operation for the Canadian marketplace. The company announced an agreement with Bell Atlantic Video Services to explore ways to deliver news, information and advertising for Bell Atlantic's Stargazer service.\nRecent Acquisitions\/Investments 1993 - In March, the company purchased all of the outstanding stock of Data-Star, Europe's leading online information service. In December, the company purchased all of the outstanding shares of Equinet Pty. Ltd. and EFECOM. Equinet is an Australia-based provider of online business real-time and archival equity, option price and analytical information services. EFECOM is a Spanish financial news service now known as KRF\/Iberia. The company also made strategic minority investments in Individual, Inc., and Personal Library Software, Inc. In December, the company acquired a 6.0% interest in US Order, which provides a network of interactive electronic services to consumers utilizing screen-based telephones and other front-end devices. Capital Spending Program The company's capital spending program includes normal replacements, productivity improvements, capacity increases, building construction, expansion and printing press equipment. Over the past three years, expenditures have totaled $337.4 million for these items. Construction of the 693,000-square-foot production facility in Philadelphia began in 1989. The $299.5 million plant became fully operational in 1993.\nAlso included in capital expenditures is the San Jose press project completed during 1992 for $38.6 million and the Dialog mainframe computer equipment enhancements for $20.3 million. Financial Position and Liquidity 1993 vs. 1992 - During 1993 net cash provided by operating activities decreased 2.5% from 1992 to $330.0 million. Cash and short-term cash investments were $23.0 million at year end, down $74.1 million from the prior year. The decrease in cash and short-term cash investments was primarily due to the acquisition of Data-Star and Equinet, the repurchase of treasury shares and the prepayment of debt. During 1993, the company acquired 750,000 shares of its common stock in the open market for an aggregate price of $40.7 million. Approximately $100.0 million in notes payable, bearing 8.0% interest and maturing in 1996, were early retired in April 1993. Total debt at year-end 1993 was $109.2 million less than at year-end 1992. This resulted in an improved long-term-debt-to-equity ratio of 33.0% from 42.0% at the end of 1992 and an improved total-debt-to-total-capital ratio of 26.6% from 32.2%. Standard & Poor's and Moody's rate the company's commercial paper A1+ and P1 and long-term bonds AA- and A1, respectively. Average outstanding commercial paper during the year was $97.4 million with an average effective interest rate of 3.2%. At the end of 1993, commercial paper outstanding was $54.0 million and aggregate unused credit lines were approximately $446.0 million. Various libel actions, environmental and other legal proceedings that have arisen in the ordinary course of business are pending against the company and its subsidiaries. In the opinion of management, the ultimate liability to the company and its subsidiaries as a result of these actions and proceedings will not be material. 1992 vs. 1991 - During 1992, net cash provided by continuing operations was $338.5 million, an increase of $32.5 million from 1991 due to investee distributions being less than investee earnings and net changes in working capital. Cash and short-term cash investments of $97.1 million were $70.9 million more than the prior year. Net cash required for investing activities decreased $9.9 million, or 5.1%, from 1991 levels, due to completion of the Philadelphia plant. Total debt declined $46.6 million from 1991 levels. This resulted in an improved long-term-debt-to-equity ratio from 48.5% to 42.0% and total-debt-to-total-capital ratio from 34.6% to 32.2%. These ratios improved despite the FAS 106 and FAS 109 net cumulative charge of $105.2 million. Average outstanding commercial paper during the year was $54.6 million with an average effective interest rate of 4.3%. At the end of 1992, commercial paper outstanding was $62.3 million.\n1991 vs. 1990 - During 1991, net cash provided by continuing operations was $305.9 million, a decline of $19.0 million from 1990. The 5.9% decrease was primarily due to a lower level of operating income. Cash and short-term cash investments of $26.2 million were flat with 1990. Net cash required for investing activities of $192.9 million was $85.3 million, or 30.7% less, due to reduced capital requirements for the new Philadelphia plant as it approached completion. Total debt declined $217.1 million from 1990 levels, due largely to the use of proceeds of approximately $147.0 million from the company's sale of 3 million shares of common stock in August. No treasury stock was purchased in 1991. This resulted in an improved long-term-debt-to-equity ratio from 89.8% to 48.5% and total-debt-to-total-capital ratio from 47.9% to 34.6%. During 1991 the company redeemed $160.0 million of 7-1\/4% notes due in 1992 and $100.0 million of 7-7\/8% notes due in 1993, and issued $160.0 million of new 8-1\/2% notes, maturing in 25% increments from 1998 through 2001. Average outstanding commercial paper during the year was $250.0 million with an average effective interest rate of 6.4%. Commercial paper outstanding at the end of 1991 was $111.3 million.\nEffect of Changing Prices The Consumer Price Index, a widely used measure of the impact of changing prices, has increased only moderately in recent years, up between 3% and 6% each year since 1983. Historically, when inflation was at higher levels, the impact on the company's operating costs was not significant. Historical cost depreciation charges may not accurately reflect the economic cost of replacing capital assets, but depreciation expense represents less than 5% of total operating costs. Newsprint expense represents a significant percentage of total costs, but it is a relatively current cost as inventory levels normally fluctuate between a 30- and 45-day supply. Labor and other operating costs are, by their very nature, current costs. The principal effect of inflation on the company's operating results is to increase reported costs. Historically, the company has demonstrated the ability to raise sales prices to offset these cost increases.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial statements and supplementary data ------------------------------------------- See Quarterly Operations in Item 5.\nNotes to Consolidated Financial Statements\nSummary of Significant Accounting Policies Note A\nA description of the company's business and the nature and scope of its operations are set forth on Items 1 & 2. Reading this information is recommended for a more complete understanding of the financial statements. The company reports on a fiscal year, ending the last Sunday in the calendar year. Results for 1993, 1992 and 1991 are for the 52 weeks ended Dec. 26, Dec. 27 and Dec. 29, respectively. The basis of consolidation is to include in the consolidated financial statements all the accounts of Knight-Ridder, Inc., and its more-than-50%-owned subsidiaries. All significant intercompany transactions and account balances have been eliminated in consolidation. The joint operating agency of Fort Wayne Newspapers, Inc., is the only subsidiary with a minority interest. The minority shareholder's interest in the net income of this subsidiary has been provided for as an expense ($5.2 million in 1993, $5.1 million in 1992 and $5.2 million in 1991) in the Consolidated Statement of Income in the caption \"Other, net.\" The company is a 50% partner in the Detroit Newspaper Agency (DNA), a joint operating agency between Detroit Free Press, Inc., a wholly owned\nsubsidiary of Knight-Ridder, Inc., and The Detroit News, Inc., a wholly owned subsidiary of Gannett Co., Inc. The Consolidated Statement of Income includes on a line-by-line basis the company's pro rata share of the revenue and expense generated by the operation of the agency. Investments in companies in which Knight-Ridder, Inc., has an equity interest of at least 20% but not more than 50% are accounted for under the equity method. Under this method, the company records its share of earnings as income and increases the investment by the equivalent amount. Dividends are recorded as a reduction in the investment. All other investments are recorded at the lower of cost or net realizable value, and the company recognizes income from such investments upon receipt of a dividend. The investment caption \"Equity in unconsolidated companies and joint ventures\" in the Consolidated Balance Sheet represents the company's equity in the net assets of the Detroit Newspaper Agency, the Seattle Times Company and subsidiaries, a company responsible for the sales and services of general, retail and classified advertising accounts for a group of newspapers, two newsprint mill partnerships, a cable television joint venture and a joint venture that offers full-service copies of original journal articles. The company owns 49-1\/2% of the voting common stock and 65% of the non-voting common stock of the Seattle Times Company, owns 33-1\/3% of the voting stock of Newspapers First, is a one-third partner in the Southeast Paper Manufacturing Co., owns a 13-1\/2% equity share of Ponderay Newsprint Company, and jointly owns TKR Cable Company and TKR Cable Partners. Effective December 1992, after a restructuring, the company has a 15% interest in TCI\/TKR Limited Partnership through TKR Cable Partners. Prior to December 1992, the company held a 7-1\/2% interest in SCI Holdings, Inc., the holding company for Storer Communications, Inc. Dialog, a Knight-Ridder subsidiary, owns 33.78% of the voting stock and 100% of the non-voting stock of Article Express International, Inc. The investment amount at Dec. 26, 1993, includes $64.1 million representing the company's share of undistributed earnings (excluding the DNA) accumulated since the investment dates. The company's share of the earnings of the unconsolidated companies (except for the DNA) of $7.3 million in 1993, $3.9 million in 1992 and $14.5 million in 1991 is included in the caption \"Other, net\" in the Consolidated Statement of Income. The company also recorded its share of Ponderay Newsprint Company's operating losses ($7.4 million in 1993 and $6.5 million in 1992) in this caption. Dividends and cash distributions received from the unconsolidated companies and joint ventures (excluding the DNA) were $3.0 million in 1993, $2.8 million in 1992 and $8.1 million in 1991 and offset against the investment account.\n\"Cash and short-term cash investments\" includes currency and checks on hand, demand deposits at commercial banks, overnight repurchase agreements of government securities and investment-grade commercial paper with maturities of fewer than 90 days. Cash and short-term investments are recorded at cost. Due to the short-term nature of marketable securities, cost approximates market value. In 1994, the company will adopt Statement of Financial Accounting Standards (FAS) 115, Accounting for Certain Investments in Debt and Equity Securities, the impact of which is immaterial. \"Inventories\" are priced at the lower of cost ( first-in, first-out FIFO method), or market. Most of the inventory is newsprint, ink and other supplies used in printing newspapers. \"Property, plant and equipment\" is recorded at cost and the provision for depreciation for financial statement purposes is computed principally by the straight-line method over the estimated useful lives of the assets. The company capitalizes interest expense as part of the cost of major construction projects. \"Excess of cost over net assets acquired\" arises from the purchase of at least a 50% interest in a company for a price higher the fair market value of the net tangible assets. Intangible assets of this type arising from acquisitions accounted for as purchases and occurring subsequent to Oct. 31, 1970, totaled approximately $773.0 million at Dec. 26,1993. They are generally being amortized over a 40-year period on a straight-line basis, unless management has concluded a shorter term is more appropriate. If, in the opinion of management, an impairment in value occurs, based on the undiscounted cash flow method, any necessary additional write-downs will be charged to expense. \"Deferred revenue\" arises as a normal part of business from advance subscription payments for newspapers and business information services. Revenue is recognized in the period in which it is earned. \"Short-term borrowings\" represents the carrying amounts of commercial paper and other short-term borrowings that approximate fair value. \"Long-term debt\" represents the carrying amounts of debentures and notes payable. Fair values, disclosed in Note C, are estimated using discounted cash flow analyses based on the company's current incremental borrowing rates for similar types of borrowing arrangements. In 1992, the company adopted the FAS 106, Accounting For Postretirement Benefits Other Than Pensions, and FAS 109, Accounting For Income Taxes. The effects of adoption are described in Notes H and B, respectively. In 1994, the company will adopt FAS 112, Employers' Accounting for Postemployment Benefits. The impact on the consolidated financial statements will not be material.\nEarnings per share is computed by dividing net income by the weighted average number of common and common equivalent shares outstanding. Quarterly earnings per share may not add to the total for the year, since each quarter and the year are calculated separately based on average outstanding shares during the period. Certain amounts in 1992 and 1991 have been reclassified to conform to the 1993 presentation.\nIncome Taxes Note B The company's income tax expense is determined under the provisions of Statement of Financial Accounting Standards 109, Accounting for Income Taxes, which was adopted in 1992. This accounting standard requires the use of the liability method in adjusting previously deferred taxes for changes in tax rates. The company chose to reflect the cumulative effect of adopting this standard as a change in accounting principle as of the beginning of 1992. The adoption resulted in a credit to earnings of $25.8 million. Prior years' financial statements were not restated. Substantially all of the company's earnings are subject to domestic taxation. With the exception of immaterial amounts of taxes withheld on trans-border receipts, no foreign income taxes have been imposed on reported earnings.\nIn 1991, deferred tax expense resulted principally from the excess of tax depreciation over financial statement depreciation (including depreciation on assets of partnerships in which the company participates), the tax effect of which amounted to $8.8 million. Cash payments of income taxes for the years 1993, 1992 and 1991 were $82.7 million $60.2 million and $61.4 million, respectively. Payments in 1993 include the payment and settlement of prior year state and federal income tax examinations.\nAt the end of fiscal years 1993 and 1992, the company's deferred tax assets totaled $135.8 million and $120.7 million, respectively, of which the most significant component was postretirement benefit plans, $87.2 million and $83.0 million, respectively (including amounts relating to partnerships in which the company participates). Other material components were: compens- ation and benefits accruals of $11.2 million in 1993 and $19.2 million in 1992,\nand state net operating loss carryovers, net of allowance, of $7.0 million in 1993. Management is satisfied that a substantial portion of the state net operating loss carryovers will be realized within the applicable carryover periods. Accordingly, the related valuation allowance was reduced to $4.0 million in 1993. At the end of fiscal years 1993 and 1992, deferred tax liabilities totaled $249.3 million and $204.1 million, respectively, of which the most significant component was depreciation and amortization (including depreciation and amortization deductions claimed by partnerships in which the company has an interest). \t The components of deferred taxes included in the Consolidated Balance Sheet are as follows (in thousands):\nDebt Note C\nDebt consisted of the following (in thousands):\nThe following table presents (in thousands) the approximate annual maturities of long-term debt for the five years after 1993:\nThe carrying amounts and fair values of debt as of Dec. 26, 1993, are as follows (in thousands):\nUnconsolidated Companies and Joint Ventures Note D\nBeginning in 1992, the company's investment in Ponderay Newsprint Company is reported in \"Equity in unconsolidated companies and joint ventures\" in the Consolidated Balance Sheet, and related amounts are included in the above table. In 1989, the Detroit Free Press and The Detroit News began operating under a joint operating agreement as the Detroit Newspaper Agency (DNA). Balance sheet amounts for the DNA at Dec. 26, 1993, Dec. 27, 1992, and Dec. 29, 1991, are included above and the net assets contributed to the DNA are included in \"Equity in unconsolidated companies and joint ventures\" in the Consolidated Balance Sheet.\nCapital Stock Note E\nIn 1991, shareholders authorized 20.0 million shares of preferred stock for future issuance. Common stock authorized for issuance is 250.0 million shares at par value $.02-1\/12 per share. The Employees Stock Purchase Plan provides for the sale of common stock to employees of the company and its subsidiaries at a price equal to 85% of the market value at the end of each purchase period. Participants under the plan received 278,251 shares in 1993, 240,022 shares in 1992 and 266,330 shares in 1991. The purchase price of shares issued in 1993 under this plan ranged between $46.59 and $50.89, and the market value on the purchase dates of such shares ranged from $54.81 to $59.88. The Employee Stock Option Plan provides for the issuance of non-qualified stock options and incentive stock options. Options are issued at prices not less than market value at date of grant and are exercisable when issued. There is no expiration date for the granting of options, but options must expire no later than 10 years from the date of grant. The option plan provides for the discretionary grant of stock appreciation rights (SARs) in tandem with previously granted options, which allow a holder to receive in cash, stock or combinations thereof the difference between the exercise price and the fair market value of the stock at date of exercise. The value of stock appreciation rights is charged to compensation expense. When options and stock appreciation rights are granted in tandem, the exercise of one cancels the exercise right of the other. Proceeds from the issuance of shares under these plans are included in shareholders' equity and do not affect income.\nThe exercise price of the shares issued upon exercise of stock options in 1993 ranged between $24.63 and $58.63. In 1993, shareholders voted in favor of a proposal amending the Employee Stock Option Plan to make an additional 3.5 million shares of the company's common stock available for options. In addition, shareholders voted in favor of an amendment to make 1.5 million shares of common stock available for purchase under the Employees Stock Purchase Plan.\nAt Dec. 26, 1993, shares of the company's authorized but unissued common stock were reserved for issuance as follows:\nShares --------- Employee stock option plans 3,569,818 Employees stock purchase plan 1,741,089 --------- Total 5,310,907 ========= Since 1985, the company has purchased 21.2 million shares of its own stock for approximately $872.0 million. See Treasury Stock Purchases in Item 5. Each holder of a common share has been granted a right, under certain conditions, to purchase from the company one common share at a price of $200, subject to adjustment. The rights provide that in the event the company is a surviving corporation in a merger, each holder of a right will be entitled to receive common shares having a value equal to two times the exercise price of the right. In the event the company engages in a merger or other business combination transaction in which the company is not the surviving corporation, the rights agreement provides that proper provision shall be made so that each holder of a right will be entitled to receive common stock of the acquiring company having a value equal to two times the exercise price of the right. The rights agreement also provides that in the event any person acquires 20% or more of the company's outstanding common stock (other than pursuant to an offer for all outstanding stock that the board determines is fair and in the best interests of the company and stockholders), each right (other than rights held by the person who has acquired such 20% or larger block) will entitle its holder to purchase common stock of the company having a value equal to twice the exercise price of the right. No rights certificates will be distributed until 10 days following a public announcement that a person or group has acquired beneficial ownership of 20% or more of the company's outstanding common stock, or 10 days following the commencement of a tender offer or exchange offer for 20% or more of the company's outstanding stock. Until such time, the rights are evidenced by the common share certificates of the company. The rights are not exercisable until distributed and will expire on July 10, 1996, unless earlier redeemed. The company has the option to redeem the rights in whole, but not in part, at a price of $.05 per right.\nRetirement Plans Note F\nThe company and its subsidiaries have several company-administered non-contributory defined benefit plans covering most non-union employees. These plans provide benefits that are based on the employees' compensation during various times before retirement. The funding policy for these plans is to contribute annually an amount that is intended to provide the projected benefit earned during the year for the covered employees. The company also contributes to certain union-administered, company-administered and jointly administered negotiated plans covering union employees. The funding policy for these plans is to make annual contributions in accordance with applicable agreements. The company also sponsors certain defined contribution plans established pursuant to Section 401(k) of the Internal Revenue Code. Subject to certain dollar limits, employees may contribute a percentage of their salaries to these plans, and the company will match a portion of the employees' contributions. A summary of the components of net periodic pension cost for the defined benefit plans (both company-administered non-negotiated and single-employer negotiated plans) is presented here, along with the total amounts charged to pension expense for multi-employer union plans, defined contribution plans and other agreements (in thousands):\nThe following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheet for the defined benefit plans (in thousands):\nSegment Information Note G\nThe company is a diversified information and communications company with two principal business segments: Newspapers and Business Information Services. Financial data regarding the company's business segments are presented in Items 1 & 2 in the supplemental information. Operating revenue by industry segment includes sales to un- affiliated customers, as reported in the company's consolidated income statement. Operating income is operating revenue less operating expenses, including depreciation expense and amortization of intangibles. General corporate expenses are not allocated to the Newspaper or Business Information Services divisions. Equity in net income of unconsolidated companies and joint ventures, interest income, net interest expense, other non-operating income and expense items, as well as income taxes, have not been included in the amounts reflected as operating income by segment. Identifiable assets by segment are all assets employed in the individual operations of each business segment and excess of cost over net assets acquired associated with acquisitions in each segment. General corporate assets include cash and equivalents, other investments, net assets of unconsolidated companies and joint ventures (other than the Detroit Newspaper Agency, which is included in Newspaper Division assets), and property, plant and equipment used primarily for corporate purposes. Investments in unconsolidated companies and joint ventures are discussed in Notes A and D.\nPostretirement Benefits Other Than Pensions Note H The company and its subsidiaries have defined postretirement benefit plans that provide medical and life insurance for retirees and eligible dependents. Effective with the beginning of fiscal year 1992, the company implemented, on the immediate recognition basis, Statement of Financial Accounting Standards (FAS) 106, Accounting for Postretirement Benefits Other Than Pensions. This statement requires that the cost of these benefits, which are primarily for health care and life insurance, be recognized in the financial statements throughout the employees' active working careers. The company's previous practice was to expense these costs on a cash basis, principally after retirement. The cumulative effect of adopting FAS 106 on the immediate recognition basis, as of the beginning of 1992, was to reduce net income by $131.0\nmillion (net of income taxes of $80.3 million), or $2.37 per share. The 1992 after-tax impact of FAS 106 (excluding the cumulative effect of adoption) was to reduce earnings by $4.0 million, or $.07 per share. This charge includes a previously unrecognized accumulated postretirement benefit obligation of $211.3 million, including $47.2 million related to the company's share of the Detroit Newspaper Agency (DNA). This obligation was based on plans in place at the beginning of 1992. The company valued the accumulated postretirement benefit obligation as of Dec. 26, 1993, and Dec. 27, 1992, using the following actuarial assumptions: Discount rate: 7.5% in 1993 and 8.5% in 1992 Return on plan assets: 8.5% in 1993 and 1992 Annual rate of increase in salaries: 4.5% in 1993 and 5.0% in 1992 Medical trend rate: 12.0% for 1994, reducing to 5.5% in 2001 and thereafter and 14.0% for 1993, reducing to 6.5% in 2001 and thereafter. In 1992, the company announced several changes to its retiree non-union benefit plans that established a maximum annual dollar cap for medical premiums the company would pay and eliminated coverage for future retirees after the age of 65. During 1993, many of the company's unions adopted similar changes to their retiree benefit plans. Most current retirees will keep their current plans. Proforma amounts for 1991 show that net income would have been reduced by approximately $8.4 million (approximately $.16 per share). The impact on 1992 and 1993 is substantially less due to the effect of the plan amendments described above. These plan amendments resulted in an unrecognized reduction in prior service cost, which is being amortized over future years. 1993 reflects a full year of amortization for the reduction in prior service cost.\nAcquisitions Note I On March 1, 1993, the company (through its wholly owned subsidiaries Knight-Ridder Business Information Services, Inc., and Dialog Information Services, Inc.) acquired all of the outstanding shares of Data-Star (composed of Radio Suisse and Data-Star Marketing) from Motor-Columbus and Peter Martin, respectively. Data-Star is Europe's leading online information service. On Dec. 2, 1993, the company acquired all of the outstanding shares of Equinet Pty. Ltd. Equinet is an Australia-based provider of online business real-time and archival equity, option price and analytical information services. The acquisitions were accounted for as purchases and, accordingly, the accompanying financial statements include their operations from the acquisition dates. The cost of acquisitions is included in the caption \"Other items, net\" in the \"Cash Required For Investing Activities\" section of the Consolidated Statement of Cash Flows. The effect on operations and proforma results of operations was not material.\nCommitments and Contingencies Note J At Dec. 26, 1993, the company had lease commitments currently estimated to aggregate approximately $84.1 million that expire from 1994 through 2051 as follows (in thousands):\nPayments under the lease contracts were $25.4 million in 1993, $25.2 million in 1992 and $24.1 million in 1991. Various libel actions, environmental and other legal proceedings that have arisen in the ordinary course of business are pending against the company and its subsidiaries. In 1990, a verdict was rendered against the company's subsidiary, Philadelphia Newspapers, Inc., (PNI), publisher of The Philadelphia Inquirer and Philadelphia Daily News, in a libel action entitled Sprague v. Philadelphia Newspapers, Inc., for $2.5 million in compensatory damages and $31.5 million in punitive damages. Following entry of the judgment on Sept. 15, 1992, PNI, as required by statute, posted a bond equal to 120% of the amount of the verdict and appealed the judgment to the Pennsylvania Superior Court. PNI believes that substantial grounds exist for a decision by an appellate court to reverse the trial court and remand the case for a new trial. In the opinion of management, the ultimate liability to the company and its subsidiaries as a result of this and other legal proceedings will not be material.\nManagement's Responsibility for Financial Statements Shareholders: The consolidated financial statements and other financial information were prepared by management in conformity with generally accepted accounting principles applied on a consistent basis throughout the periods. The manner of presentation, the selection of accounting policies and the integrity of the financial information are the responsibility of management. Some of the amounts included in the financial statements are estimates based on management's best judgment of current conditions and circumstances. To fulfill its responsibilities, management has developed and continues to maintain a system of internal accounting controls. We believe the controls in use are adequate to provide reasonable assurance that assets are safeguarded\nfrom loss or unauthorized use, and that the financial records are reliable for preparing the financial statements and maintaining accountability for assets. These systems are augmented by written policies, organizational structures providing for division of responsibilities, qualified financial officers at each operating unit, careful selection and training of financial personnel and a program of internal audits. There are, however, inherent limitations in any control system, in that the cost of maintaining a control system should not exceed the benefits to be derived. The Audit Committee of the Board of Directors is composed of outside directors and meets periodically with management, internal auditors and independent auditors, both separately and together, to review and discuss the auditors' findings and other financial and accounting matters. Both the independent and internal auditors have free access to the committee. The consolidated financial statements have been audited by the company's independent auditors and their report is presented below. The independent auditors are elected each year at the annual shareholders meeting based on a recommendation by the Audit Committee and the Board of Directors.\nJames K. Batten - -------------------- James K. Batten Chairman and Chief Executive Officer\nRoss Jones - -------------------- Ross Jones Senior Vice President\/Finance and Chief Financial Officer\nReport of Independent Certified Public Accountants Shareholders Knight-Ridder, Inc.\nWe have audited the consolidated balance sheet of Knight-Ridder, Inc., and subsidiaries as of Dec. 26, 1993, Dec. 27, 1992, and Dec. 29, 1991, and the related consolidated statements of income, cash flows and shareholders' equity for each of the three years then ended. Our audits also included the financial statement schedules listed in the Index at Item 14 (a). These financial statements and schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Knight-Ridder, Inc., and subsidiaries at Dec. 26, 1993, Dec. 27, 1992, and Dec. 29, 1991, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Notes B and H the consolidtaed financial statements, in 1992 the Company changed its method of accounting for income taxes and postretirement benefits other than pensions.\nERNST & YOUNG\nMiami, Fla. Feb. 1, 1994\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure. ---------------------\nNot Applicable\nPART III\nITEM\n10.","section_9A":"","section_9B":"","section_10":"ITEM\n10. Directors and Executive Officers of the Registrant -------------------------------------------------- 1994 Proxy Statement page 2, \"Election of Directors\"; page 3, \"Nominees for Election as Directors for Terms Ending 1997\"; page 4, \"Nominees for Election as Directors for Terms Ending 1995\"; \"Nominees for Election as Directors for Terms Ending 1996\"; page 15, \"Certain Transactions, Relationships and Reports of Certain Stock Transactions.\"\nKnight-Ridder's Executive Committee:\nJames K. Batten, 58, chairman since 1989 and chief executive officer since 1988. Served as president 1982 to 1989; senior vice president 1980 to 1982; vice president\/news 1975 to 1980; Charlotte Observer executive editor 1972 to 1975. Advanced Management Program, Harvard Business School, 1981; M.P.A., public affairs, Princeton University, 1962; B.S., chemistry\/ biology, Davidson College, 1957.\nAlvah H. Chapman Jr., 72, chairman of the Executive Committee since 1984. Served as chairman of the board 1982 to 1989; chief executive officer 1976 to 1988; president 1973 to 1982; executive vice president 1967 to 1973; vice president 1966 to 1967; Miami Herald general manager 1962 to 1969. B.S., business administration, The Citadel, 1942.\nMary Jean Connors, 41, vice president\/human resources since 1989. Served as Philadelphia Newspapers, Inc., vice president\/human resources 1988 to 1989; assistant to the senior vice president\/ news for Knight-Ridder 1988; The Miami Herald assistant managing editor\/ personnel 1985 to 1988; held various editing positions at The Miami Herald 1980 to 1985. B.A., English, Miami University in Oxford, Ohio, 1973.\nJohn C. Fontaine, 62, executive vice president since January 1994; senior vice president 1987 to 1993; general counsel 1980 to 1993. Formerly a partner with Hughes Hubbard & Reed. LL.B., Harvard Law School, 1956; B.A., political science, University of Michigan, 1953.\nRoss Jones, 51, senior vice president and chief financial officer since October 1993; vice president\/finance since March 1993. Served as vice president and treasurer of Reader's Digest Association, Inc., 1985 to 1993 and in other positions there 1977 to 1985. Served as manager at Brown Brothers Harriman & Co. 1970 to 1977. M.B.A., finance, Columbia University Business School, 1970; B.A. in classics, Brown University, 1965.\nBernard H. Ridder Jr., 77, former chairman of the board 1979 to 1982; former chairman of the Executive Committee 1976 to 1984; former vice chairman of the board 1974 to 1979. Served as president and chief executive officer of Ridder Publications, Inc., 1969 to 1974. B.A., history, Princeton University, 1938.\nP. Anthony Ridder, 53, president since 1989; president of Newspaper Division since 1986; chairman of the Operating Committee since 1985; board member since 1987. Served as publisher of the San Jose Mercury News 1977 to 1986; general manager 1975 to 1977; business manager 1969 to 1975. B.A., economics, University of Michigan, 1962.\nOther Officers:\nMarty Claus, 45, vice president\/ news since 1993. Served as Detroit Free Press managing editor\/business and features from 1987 to 1992; held various editing positions at the Free Press 1977 to 1987. Held various writing and editing positions at the San Bernardino (Calif.) Sun-Telegram 1970 to 1977. B.A., journalism, Michigan State University Honors College, 1970.\nStephen D. Dempsey, 41, assistant vice president\/information systems since February 1994. Served as director of information systems from 1990 to 1994; San Jose Mercury News information systems director from 1984 to 1990; various technical positions 1979 to 1984; Boulder Daily Camera, various programming and circulation positions, 1969 to 1979. B.A., history, University of Colorado, 1975.\nGary R. Effren, 37, assistant vice president\/assistant treasurer since December 1993. Served as assistant to the vice president\/ finance and treasurer 1989 to 1993; director of corporate accounting 1986 to 1989; business manager of Viewdata Corp. of America 1984 to 1986; manager of financial reporting 1983 to 1984. M.B.A., University of Miami, 1989; B.S., accounting, Rider College, 1978.\nVirginia Dodge Fielder, 45, vice president\/research since 1989. Served as vice president\/news and circulation research 1986 to 1989. Served as director\/news and circulation research 1981 to 1985; editorial research manager, Chicago Sun-Times 1979 to 1981; held various positions at Lexington Herald-Leader 1976 to 1979. Ph.D., mass communications, Indiana University, 1976; M.A., journalism, Indiana University, 1974; B.A., psychology, Transylvania University, 1970.\nDouglas C. Harris, 54, vice president and secretary since 1986. Served as vice president\/personnel 1977 to 1985; director\/personnel 1972 to 1977. Formerly with Peat, Marwick, Mitchell and Co. as director of college and special recruiting. Advanced Management Program, Harvard Business School, 1987; Ed.D., counseling and guidance, Indiana University, 1968; M.S., student personnel, Indiana University, 1964; B.S., business administration, Murray State University, 1961.\nW. H. (Gus) Harwell Jr., 64, senior vice president\/operations since 1989. Served as group vice president\/operations 1981 to 1989. Served as Tallahassee Democrat president and publisher 1978 to 1981; general manager 1973 to 1978; Boca Raton News publisher 1968 to 1973. B.J., community journalism, University of Missouri, 1951.\nClark Hoyt, 51, vice president\/news since August 1993. Served as chief of the Knight-Ridder Washington Bureau 1987 to 1993; news editor 1985 to 1987; managing editor, The Wichita Eagle, 1981 to 1985; various editing positions, Detroit Free Press, 1977 to 1981; various reporting positions, the Detroit Free Press and Washington Bureau. B.A., English literature, Columbia College, 1964.\nIvan A. Jones, 51, assistant vice president\/personnel research and development since 1986. Served as director\/ personnel research and development 1977 to 1986; personnel consultant 1975 to 1977. Formerly with the consulting firm of Byron Harless, Reid & Associates 1973 to 1975. Ph.D., industrial psychology, Baylor University, 1969; M.A., psychology, Baylor University, 1967; B.A., psychology, University of Arizona, 1964.\nPolk Laffoon IV, 48, vice president\/ corporate relations since March 1994. Served as assistant to the president 1992 to 1994; assistant circulation director\/distribution, The Miami Herald, 1991 to 1992; executive assistant to the vice president\/marketing 1989 to 1991; Living Today editor, 1987 to 1989. Served as director and vice president\/ investor relations, Taft\nBroadcasting Co., 1982 to 1987. Held various writing and editing positions at the Detroit Free Press 1978 to 1982. M.B.A., marketing, Wharton School, 1970; B.A., English, Yale, 1967.\nTally C. Liu, 43, vice president\/finance and controller since October 1993; vice president and controller 1990 to 1993. Served as San Jose Mercury News vice president and chief financial officer 1987 to 1990; chief financial officer 1986 to 1987; controller 1983 to 1986; Boca Raton News controller 1980 to 1983; assistant controller 1978 to 1980. M.B.A., Florida Atlantic University, 1977; B.S., business administration, National Chen-Chi University, 1973; CPA.\nMario R. Lopez, 54, assistant vice president\/internal audit since July 1993. Served as partner at Deloitte & Touche 1978 to 1993 and in other positions there from 1964 to 1978. B.S., business administration, Saint Joseph's University, 1962, CPA.\nLarry D. Marbert, 40, vice president\/ technology since February 1994. Served as Philadelphia Newspapers, Inc., senior vice president\/operations 1991 to 1994; vice president\/operations research and planning 1988 to 1991; vice president\/production 1986 to 1988; Knight-Ridder director of production\/Newspaper Division 1981 to 1986; various production positions, The Miami Herald, 1977 to 1981. M.S., management science, Auburn University, 1977; B.S., University of North Carolina, business administration, 1976.\nJerry M. Marshall, 55, assistant vice president\/financial services since 1986. Served as director of accounting administration 1984 to 1985; director of corporate accounting 1977 to 1984; manager of corporate accounting 1972 to 1977; internal auditor 1969 to 1972. B.S., accounting, Kent State University, 1963.\nCristina Lagueruela Mendoza, 47, vice president\/general counsel since 1993; vice president\/associate general counsel 1992 to 1993; associate general counsel since 1990. Served as a partner in the Miami law firm of Murai, Wald, Biondo, Moreno & Mendoza, P.A., 1988 to 1990; associate 1984 to 1988. J.D., University of Miami Law School, 1982; M.A., political science, University of Miami, 1967; B.A., political science, Chatham College, 1966.\nLaurence D. Olmstead, 36, assistant vice president\/ human resources\/ diversity since December 1993. Served as special projects editor\/metro staff of The New York Times 1993; city editor of the Detroit Free Press 1991 to 1993; held various editing and reporting positions 1980 to 1991. Attended George Washington University.\nPeter E. Pitz, 52, vice president\/operations since February 1994. Served as vice president\/technology 1989 to 1994; San Jose Mercury News vice president\/operations 1987 to 1989; Detroit Free Press director of operations 1983 to 1987; Denver Post operations manager 1974 to 1983. M.B.A., Denver University, 1979; B.S., business administration, Northern Illinois University, 1963.\nDavid K. Ray, 52, president of Business Information Services Division since 1983; Knight-Ridder vice president since 1980. Formerly a vice president, LIN Broadcasting Co. M.B.A., University of Chicago, 1965; B.A., liberal arts, Colgate University, 1963.\nStephen H. Sheriff, 47, assistant vice president\/taxation since 1989. Served as director of taxation 1987 to 1989. Formerly with Federal Express as director of taxation. J.D., University of Miami School of Law, 1992; B.B.A., accounting, University of Georgia, 1971; CPA.\nHomer E. Taylor, 51, vice president\/supply since 1987. Formerly vice president\/manufacturing and supply with Scripps Howard. B.S., business, West Virginia Institute of Technology, 1973; A.S., electrical engineering, West Virginia Institute of Technology, 1970.\nJerome S. Tilis, 51, vice president\/marketing since 1987. Served as president of the Detroit Free Press 1985 to 1989; senior vice president of Philadelphia Newspapers, Inc., 1980 to 1985; vice president of advertising sales and marketing 1979 to 1980; advertising director 1977 to 1979. Advanced Management Program, Harvard Business School, 1984; B.S., chemistry, Hunter College, 1964.\nKnight-Ridder Board: The Knight-Ridder Board of Directors is composed of members who represent a wide cross-section of American business and journalism. The group includes highly experienced investment and commercial bankers, leaders of top American corporations, senior executives and retired executives of the company and members of the Knight and Ridder families. The group is the central governing body of the company.\nEric Ridder, 75, publisher emeritus of The Journal of Commerce, a director since 1983; attended Harvard University.\nJesse Hill Jr., 67, chairman and chief executive officer of Atlanta Life Insurance Co., a director since 1980; M.B.A., actuarial science, University of Michigan, 1949; B.S., mathematics and physics, Lincoln University, 1947.\nBarbara Knight Toomey, 56, experienced in management consulting, data retrieval and storage, resort management and library science, a director since 1989; B.A., geography and zoology, Boston University, 1959.\nJames K. Batten, 58, chairman and chief executive officer, a director since 1981; Advanced Management Program, Harvard Business School, 1981; M.P.A., public affairs, Princeton University, 1962; B.S., chemistry\/biology, Davidson College, 1957.\nBen R. Morris, 71, former president of The State-Record Company, a director since 1986; B.S., textile engineering, North Carolina State University, 1948.\nPeter C. Goldmark Jr., 53, president of The Rockefeller Foundation, a director since 1990; B.A., government, Harvard College, 1962.\nBernard H. Ridder Jr., 77, former chairman of the board and of the Executive Committee, a director since 1946; B.A., history, Princeton University, 1938.\nP. Anthony Ridder, 53, president of Knight-Ridder and of the Newspaper Division, a director since 1987; B.A., economics, University of Michigan, 1962.\nC. Peter McColough, 71, former chairman and CEO of Xerox Corp., a director since 1982; LL.B., law, Dalhousie University (Nova Scotia), 1947; M.B.A., Harvard University, 1949.\nJoan Ridder Challinor, 66, research associate at the National Museum of American History, Smithsonian Institution, a director since 1989; Ph.D., U.S. history, The American University in Washington, D.C., 1982; M.A., U.S. history\/ancient history, The American University, 1974; B.A., history, The American University, 1971.\nThomas L. Phillips, 69, retired chairman and chief executive officer of Raytheon Co., a director since 1983; M.S., electrical engineering, Virginia Polytechnic Institute, 1948; B.S., electrical engineering, Virginia Polytechnic, 1947.\nBarbara Barnes Hauptfuhrer, 65, director of several public companies, a Knight-Ridder director since 1979; B.A., sociology and economics, Wellesley College, 1949.\nWilliam S. Lee, 64, chairman and president of Duke Power, a director since 1990; B.S., civil engineering, Princeton University, 1951.\nJohn L. Weinberg, 69, senior chairman of Goldman, Sachs & Co., a director since 1969; M.B.A., business administration, Harvard University, 1950; B.A., economics, Princeton University, 1948.\nGonzalo F. Valdes-Fauli, 47, regional chief executive: Latin America of Barclays Bank PLC, a director since 1992; master's in international finance, Thunderbird Graduate School for International Management, 1970; B.S., economics, Spring Hill College, 1968.\nAlvah H. Chapman Jr., 72, chairman of the Executive Committee and former chairman of the board and chief executive officer, a director since 1962; B.S., business administration, The Citadel, 1942.\n11. Executive Compensation ---------------------- 1994 Proxy Statement, pages 7 and 8, \"Compensation Committee Interlocks and Insider Participation\"; pages 8 through 10, \"Executive Compensation;\" page 11, \"Senior Executive Compensation;\" page 12, \"Stock Options Granted;\" pages 12 and 13, \"Stock Options Exercised;\" page 13, \"Pension Benefits;\" and page 15, \"Compensation of Directors\"\n12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- 1994 Proxy Statement page 1, \"Common Stock Outstanding and Principal Holders\" and page 6, \"Security Ownership of Management\"\nSee Note E in Item 8.\n13. Certain Relationships and Related Transactions ---------------------------------------------- 1994 Proxy Statement page 15, \"Certain Transactions, Relationships and Reports of Certain Stock Transactions\"\nPART IV\n14. Exhibits, Financial Statement Schedules, and Reports on Form ------------------------------------------------------------ 8-K. ---- (a)\n1. The following consolidated financial statements of Knight-Ridder, Inc. and subsidiaries, included in the annual report of the registrant to its shareholders for the year ended December 26, 1993, are included in Item 8:\nConsolidated Balance Sheet - December 26, 1993, December 27, 1992 and December 29, 1991\nConsolidated Statement of Income - Years ended December 26, 1993, December 27, 1992 and December 29, 1991\nConsolidated Statement of Cash Flows - Years ended December 26, 1993, December 27, 1992 and December 29, 1991\nConsolidated Statement of Shareholders' Equity - Years ended December 26, 1993, December 27, 1992 and December 29, 1991\nNotes to consolidated financial statements - December 26, 1993\n2. The following consolidated financial statement schedules of Knight-Ridder, Inc. and subsidiaries are submitted as a separate section of this report.\nSchedule V - Property, plant and equipment\nSchedule VI - Accumulated depreciation, depletion and amortization of property, plant and equipment\nSchedule VIII - Valuation and qualifying accounts\nSchedule IX - Short-term borrowings\nSchedule X - Supplementary income statement information\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, or are inapplicable, or have been shown in the consolidated financial statements or notes thereto, and therefore have been omitted from this section.\n3. Exhibits Filed\nNo. 3 - Articles of Incorporation and Bylaws are incorporated by reference to the Company's Form 10K, filed in March, 1981.\nNo. 4 - Indenture, dated as of April 6, 1989, is incorporated by reference to the Company's Registration Statement on Form S-3, effective April 7, 1989. (No. 33-28010)\nNo. 10 - 1993 Executive MBO Plan description is incorporated herein on pages 116 to 121.\n- Amendment to the Employee Stock Option Plan originally filed on May 6, 1980 is incorporated herein on pages 121-129\n- Director's Pension Plan dated January 1, 1994 is filed herein on pages 129-131\n- Executive Officer's Retirement Agreement dated July 19, 1993 is incorporated herein on pages 131-133\nNo. 11 - Statement re Computation of Per Share Earnings is filed herein on pages 133-135.\nNo. 12 - Statement re Computation of Earnings to Fixed Charges Ratio From Continuing Operations is filed herein on page 135-136.\nNo. 19 - Executive Officer's Consulting\/Retirement Agreement dated September 20, 1989 is incorporated herein on pages 136-138\n- Executive Officer's Retirement Agreement dated December 19, 1991 is incorporated herein on pages 139-142.\nNo. 22 - Subsidiaries of the registrant is filed herein on pages 142-144.\nNo. 24 - \"Consent of Independent Certified Public Accountants\" is filed herewith on page 145.\nNo. 25 - \"Powers of Attorney\" for all members of the Board of Directors, are filed herein on pages 146-161.\n(b) Reports on Form 8-K None were filed during the fourth quarter of 1993.\n(c) Exhibits The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules The response to this portion of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPursuant 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.\nKNIGHT-RIDDER, INC.\nDated March 22, 1994 By James K. Batten - -------------------- ------------------------------- James K. Batten Chairman of the Board and Chief Executive Officer\nPursuant 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 and on the dates indicated.\nDated March 22, 1994 James K. Batten - ---------------------- ------------------------------- James K. Batten Chairman of the Board and Chief Executive Officer\nDated March 22, 1994 Ross Jones - ---------------------- ------------------------------- Ross Jones Chief Financial Officer and Senior Vice President\/Finance\nDated March 22, 1994 Tally C. Liu - ---------------------- -------------------------------\nTally C. Liu Vice President\/Finance and Controller (Chief Accounting Officer)\n\/s\/ James K. Batten* -------------------------------- James K. Batten Director\n\/s\/ Alvah H. Chapman, Jr.* -------------------------------- Alvah H. Chapman, Jr. Director\n\/s\/ Joan Ridder Challinor * ------------------------------- Joan Ridder Challinor Director\n\/s\/ Peter C. Goldmark, Jr.* ------------------------------- Peter C. Goldmark, Jr. Director\n\/s\/ Barbara Barnes Hauptfuhrer* ------------------------------- Barbara Barnes Hauptfuhrer Director\n\/s\/ Jesse Hill, Jr.* ------------------------------- Jesse Hill, Jr. Director\n\/s\/ William S. Lee* ------------------------------- William S. Lee Director\n\/s\/ C. Peter McColough* ------------------------------- C. Peter McColough Director\n\/s\/ Ben R. Morris* ------------------------------- Ben R. Morris Director\n\/s\/ Thomas L. Phillips* ------------------------------- Thomas L. Phillips Director\n\/s\/ P. Anthony Ridder* ------------------------------- P. Anthony Ridder Director\n\/s\/ Bernard H. Ridder, Jr.* ------------------------------- Bernard H. Ridder, Jr. Director\n\/s\/ Eric Ridder* ------------------------------- Eric Ridder Director\n\/s\/ Barbara Knight Toomey * ------------------------------- Barbara Knight Toomey Director\n\/s\/ John L. Weinberg* ------------------------------- John L. Weinberg Director\n\/s\/Gonzalo F. Valdes-Fauli* ------------------------------- Gonzalo F. Valdes-Fauli Director\nDated March 22, 1994 *By Ross Jones - ---------------------- ---------------------------- Ross Jones Attorney-in-fact\nANNUAL REPORT ON FORM 10-K\nITEM 14 (a) (2), (c) and (d)\nSUPPLEMENTARY DATA\nCERTAIN EXHIBITS\nYEAR ENDED DECEMBER 26, 1993\nKNIGHT-RIDDER, INC. AND SUBSIDIARIES\nMIAMI, FLORIDA\nSCHEDULE V\nSCHEDULE VIII\nSCHEDULE IX\nEXHIBIT 10 ---------- GENERAL DESCRIPTION 1993 EXECUTIVE MBO PLAN (DESCRIPTION)\nI. Program Overview\nFollowing is an outline of the KRI Executive MBO Program. A. Basic Performance Criteria\nThis incentive MBO program is related directly to:\n1. The growth of operating profit for the corporation or for individual operating units.\n2. The meeting of budgeted profit levels.\n3. The attainment of individual performance goals that will contribute to the long-range strength of KRI.\nB. Factors Affecting Design of the Program.\n1. Survey Data - Annual compensation studies by Towers Perrin and by others provide up-to-date data on compensation levels. From these studies, reliable competitive averages (as well as maximums and minimums) on most of our major positions are established.\n2. KRI Position Within Our Industry - We wish to achieve a position such that an average KRI executive's total compensation will be competitive with compensation of executives at comparable companies. This positioning is necessary to continue to attract and retain the type of executive we want.\n3.Rewards Increase With Responsibility - In general, the practice in American industry is for higher award opportunities at the top of the organization, since these executives have greater influence on profitability and should have more at risk.\nC. Program Regulations\n1. Effective Starting Date - January 1, 1993, for this revised program.\n2. Maximum Limit - It is usual practice to establish a limit to the amount that can be paid out in an executive award program in a given year. An appropriate limiting formula for the Category I and II participants will be one half of one percent of beginning shareholder equity.\n3. Eligibility - Participants in the KRI Executive MBO Program are in three basic categories as follows: (The Chairman\/CEO, President and Executive Vice President are excluded from the program. Awards, if any, for incumbents in these three offices are at the sole discretion of the KRI Compensation Committee.)\n*Category I - Included as participants are all corporate officers, and certain director - level corporate employees.\n*Category II - Included are newspaper publishers and other unit operating heads who report directly to corporate officers. The President of Ft. Wayne News-Sentinel, the Chief of the Washington Bureau and the Editor of KRTN are included in this category.\n*Category III - Includes top editors, general managers and all division directors. (Any employee in this category not currently in the program joined the program on January 1, 1989. Exceptions may be negotiated with the Division Presidents in cases of inequity).\n*Category IV - Employees not included in Categories I,II or III of the MBO program who hold positions of sufficient scope and organizational impact to be deemed by senior management as appropriately included in the KRI Executive MBO program.\nD. Goals\nIndividual performance goals are an integral part of the KRI Executive Compensation Program.\n1. Each participant in this program is or will be committed to written, defined goals in a number of fields such as: editorial product improvement, customer service, increased readership and\/or product usage, circulation improvement, advertising share, personnel development and training, pluralism, leadership, etc.\n2. The individual performance goals are the manager's program of how the operating unit will be improved. They are then reviewed, adjusted and finally accepted as meaningful and attainable by the senior officer to ensure that the goals have a valid corporate purpose. In this way, these goals are established from the \"bottom up\" rather than imposed by top management.\n3. Goals should not number more than 6 to 8 objectives. Each goal will be given a weight, based on its relative importance, on a scale of 1 to 100. The combined weight of all the goals must equal 100. At the end of each year an individual is evaluated on the percentage of each goal accomplished, with the total yielding an individual's performance factor.\nII Award Calculations\nThe award will be determined by these factors:\nA. The salary of the individual participant. See Appendix A.\nB. Operating profit - This factor measures operating profit for the current year against the previous year on a scale running from 90% to 115 %. This represents 25% of the award potential.\nC. Budgeted performance - This factor measures operating profit performance against budgeted performance on a scale running from 90% to 105%. This represents the other 75% of award potential.\nD. Individual performance - This factor measures the individual performance against pre-established goals.\nEXHIBIT 10 KNIGHT-RIDDER, INC. ----------\nEMPLOYEE STOCK OPTION PLAN (As amended through May 13, 1993) 1. PURPOSE The purpose of this Stock Option Plan (hereinafter referred to as the \"Plan\") is to attract and retain key employees of Knight-Ridder, Inc. (hereinafter referred to as the \"Company\") and its subsidiaries, by the grant of options and stock appreciation rights. \"Subsidiaries\" as used herein shall mean corporations (other than Knight- Ridder, Inc.) or partnerships in an unbroken chain of corporations and\/or partnerships beginning with Knight-Ridder, Inc. if, at the time the granting of the option or stock appreciation right, each of the corporations and\npartnerships other than the last corporation or partnership in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in a corporation in such chain or at least a 50% partnership in such chain. Except as provided in Paragraph 7, a \"stock appreciation right\" shall mean the right of a holder thereof to receive from the Company, upon surrender of the related option, an amount equal to (A) the excess of the fair market value of a share of common stock on the date the stock appreciation right is exercised over the option price provided for in the related option, multiplied by (B) the number of shares with respect to which such stock appreciation right shall have been exercised. The term \"fair market value\" of a share of common stock as of any date shall be the mean between the highest and lowest sales price of a share of common stock on the date in question as reported on the composite tape for issues listed on the New York Stock Exchange. If no transaction was reported on the composite tape in the common stock on such date, the prices used shall be the prices reported on the nearest day preceding the date in question. If the common stock is not then listed or admitted to trading on such Exchange, \"fair market value\" shall be the mean between the closing bid and asked prices on the date in question as furnished by any member firm of the New York Stock Exchange selected from time to time for that purpose by the Compensation Committee. 2. ADMINISTRATION OF THE PLAN The Plan shall be administered by a committee as appointed from time to time by the Board of Directors of the Company, which committee shall consist of not less than three (3) members of such Board of Directors, all of whom shall be disinterested persons. Said committee shall be called the \"Compensation Committee.\" In administering the Plan, the Compensation Committee may adopt rules and regulations for carrying out the Plan. The interpretation and decision with regard to any question arising under the Plan made by the Committee shall, unless overruled or modified by the Board of Directors of the Company, be final and conclusive on all employees of the Company and its subsidiaries participating or eligible to participate in the Plan. A Committee member shall be a \"disinterested person\" only if such person is not, at the time such person exercises discretion in administering the Plan, eligible and has not at any time within one year prior thereto been eligible for selection as a person to whom stock may be allocated or to whom stock options or stock appreciation rights may be granted pursuant to the Plan or any other plan of the Company or any of its affiliates entitling the\nparticipants therein to acquire stock, stock options or stock appreciation rights of the Company or any of its affiliates. 3. STOCK The stock which may be issued and sold pursuant to the exercise of options or stock appreciation rights granted under the Plan may be authorized and unissued common stock or shares of common stock reacquired by the Company and held in treasury of a total number not exceeding 16,100,000 shares. The shares deliverable under the Plan shall be fully paid and non- assessable shares. Any shares, in respect of which an option is granted under the Plan which shall have for any reason expired or terminated, may be again allotted under the Plan. Any shares covered by options which have been canceled by reason of the exercise of related stock appreciation rights as provided in the immediately following paragraph or which are used to exercise other options or to satisfy tax withholding obligations shall not be available for other options under the Plan. The exercise of options with respect to which stock appreciation rights shall have been granted shall cause a corresponding cancellation of such stock appreciation rights, and the exercise of stock appreciation rights issued in respect of options shall cause a corresponding cancellation of such options. Each option and stock appreciation right granted under the Plan shall be subject to the requirement and condition that if the Board of Directors shall determine that the listing, registration or qualification upon any Securities Exchange under any state or federal law, or the approval or consent of any governmental body is necessary or desirable as a condition of granting such option or stock appreciation right, or the issue or purchase of any shares thereunder, then no such option or stock appreciation right may be exercised in whole or in part unless or until such listing, registration, qualification or approval has been obtained, free of any conditions which are not acceptable to the Board of Directors of the Company. 4. ELIGIBILITY Options and stock appreciation rights will be granted only to persons who are employees of the Company and its subsidiaries (including officers and directors except for persons acting as directors only). The Compensation Committee of the Board of Directors of the Company shall determine in its sole discretion the employees to be granted options, the number of shares subject to each option, the employees to be granted stock appreciation rights and the options with respect to which such stock appreciation rights shall be granted.\n5. PRICE The purchase price under each option shall be determined by the Compensation Committee subject to approval by the Board of Directors of the Company, but such price shall not be less than one hundred percent (100%) of the fair market value of the stock at the time such option is granted. 6. THE PERIOD OF THE OPTION AND THE EXERCISE OF THE SAME Each option granted under the Plan shall expire no later than ten (10) years from the date such option is granted, but the Compensation Committee may prescribe a shorter period for any individual option or options. The shares subject to the option may be purchased from time to time during the option period, subject to any waiting period or vesting schedule the Compensation Committee may specify for any individual option or options. In order to exercise the option or any part thereof, the employee shall give notice in writing to the Company of his intention to purchase all or part of the shares subject to the option, and in said notice he shall set forth the number of shares as to which he desires to exercise such option, and shall pay for such shares at the time of exercise of such option. Such payment may be made in cash, through the delivery to the Company of shares of common stock of the Company with a value equal to the total option price, or through a combination of cash and shares, and any shares so delivered shall be valued at their fair market value on the date on which the option is exercised. Such payment may also be made through the delivery to the Company of all or part of the shares of common stock of the Company that are the subject of the option; provided that such option is not an incentive stock option, and such employee instructs Manufacturers Hanover Trust Company (\"MHTC\") to effect on the date of such exercise or as early as practicable thereafter the sale of such number of such shares \"at the market\" in a broker's transaction (within the meaning of Section 4(4) of the Securities Act of 1933, as amended), the proceeds of which shall be at least equal to the purchase price of such option, plus the amount of income tax required to be withheld by the Company plus transaction costs. In accordance with these instructions MHTC shall sell such shares, deliver to the Company the portion of the proceeds of such sale which equals the purchase price of such option plus the amount of income tax required to be withheld by the Company and remit the remaining sale proceeds (net of transaction costs) to such employee. Said employee shall set forth in said notice, if in the opinion of Counsel for the Company it is necessary or desirable, that it is his present intention to acquire said shares being purchased for investment and not with a view to, or for sale in connection with, any distribution thereof. Except\nas specified in Paragraph 10 below, no option may be exercised except by the Optionee personally while he is in the employ of the Company or its subsidiaries and shall have been so employed continuously since the granting of his option. No Optionee or his legal representative, legatees or distributees, as the case may be, shall be or have any of the rights and privileges of a shareholder of the Company by reason of such option unless and until certificates for shares are issued to him under the terms of the Plan.\n7. THE PERIOD OF THE STOCK APPRECIATION RIGHT AND THE EXERCISE OF THE SAME\nA stock appreciation right granted under the Plan shall be exercisable during the period commencing on a date specified by the Compensation Committee and ending on the date on which the related option expires unless such option is earlier canceled or terminated, provided that such right may be exercised by an officer (as that term is defined in the Securities Exchange Act of 1934), a director or a beneficial owner of more than 10% of any class of the Company's equity securities only during any period beginning on the third business day following the release of a quarterly or annual summary statement of the Company's sales and earnings and ending on the twelfth business day following such date (a \"ten-day window period\"). Notwithstanding the preceding sentence, the Compensation Committee may provide for the grant of a stock appreciation right the exercise of which may occur outside of a ten-day window period but shall be limited to a sixty-day period following certain events specified by the Compensation Committee in the grant of such stock appreciation right. Moreover, notwithstanding the third subparagraph of Paragraph 1 above, the Compensation Committee may provide that such stock appreciation right shall be payable only in cash and that, in addition to payment of the amount otherwise due upon exercise of such stock appreciation right, the holder thereof shall receive (unless such stock appreciation right is in tandem with an incentive stock option, as defined in Section 422A(b) of the Internal Revenue Code of 1986, as amended), an amount equal to the excess of the highest price paid for a share of common stock in the open market or otherwise over the sixty-day period prior to exercise over the fair market value of a share of common stock on the date the stock appreciation right is exercised. In order to exercise the stock appreciation right or any part thereof, the employee shall give notice in writing to the Company of the intention to exercise such right, and in said notice the employee shall set forth the number of shares as to which such employee desires to exercise the stock\nappreciation right, provided that such right may not be exercised with respect to a number of shares in excess of the number for which such option could then be exercised. Except as specified in Paragraph 10 below, no stock appreciation right may be exercised except by the holder thereof personally while such holder is in the employ of the Company or its subsidiaries and shall have been so employed continuously since the granting of the stock appreciation right. No holder of a stock appreciation right or such holder's legal representatives, legatees or distributees, as the case may be, shall be or have any of the rights and privileges of a shareholder of the Company by reason of such stock appreciation right unless and until certificates for such shares are issued to such holder under the terms of the Plan. 8. NON-TRANSFERABILITY OF OPTION AND STOCK APPRECIATION RIGHT No option or stock appreciation right granted under the Plan to an employee shall be transferred by him otherwise than by Will or by the laws of Descent and Distribution, and such option or stock appreciation right shall be exercisable during his lifetime only by him. 9. TERMINATION OF EMPLOYMENT If an Optionee shall cease to be employed by the Company or one of its subsidiaries, as the case may be, for any reason other than death, disability or retirement pursuant to a retirement plan of the Company or one of its sub- sidiaries, any option and any stock appreciation right theretofore granted to him which has not been exercised shall forthwith cease and terminate. However, the Compensation Committee of the Board of Directors may provide in the grant of any option or stock appreciation right or in an amendment of such grant that in the event of any such termination of employment (except termination for cause by the Company or one of its subsidiaries), any option and any stock appreciation right theretofore granted to him which has not been exercised shall be exercisable only within three months after his termination, but in no event after the expiration of the stated term of said option or any such stock appreciation right. The Company or any of its subsidiaries shall have \"cause\" to terminate the Optionee's employment only on the basis of the Optionee's having been guilty of fraud, misappropriation, embezzlement or any other act or acts of dishonesty constituting a felony and resulting or intended to result directly or indirectly in a substantial gain or personal enrichment to the Optionee at the expense of the Company or any of its subsidiaries. Notwithstanding the foregoing, the Optionee shall not be deemed to have been terminated for cause unless and until there shall have been delivered to the Optionee a copy of a resolution (i) duly adopted by three-quarters (3\/4) of the entire membership of the Compensation Committee\nof the Board of Directors, or of the Board of directors of the Company, at a meeting called and held for such purpose after reasonable notice to the Optionee and an opportunity for the Optionee, together with the Optionee's counsel, to be heard before such Committee or the Board of Directors of the Company, as the case may be, and (ii) finding that in the good faith opinion of such Committee or the Board of Directors of the Company, as the case may be, the Optionee was guilty of conduct described in the preceding sentence of this paragraph and specifying the particulars of such conduct in detail. 10. RETIREMENT OR DEATH OF OPTIONEE OR HOLDER OF STOCK APPRECIATION RIGHT In the event of the retirement of an Optionee pursuant to a retirement plan of the Company or one of its subsidiaries, as the case may be, the option and any stock appreciation right heretofore granted to him shall be exercisable during such period of time, not to exceed one (1) year after the date of such retirement with respect to incentive stock options, as defined in Section 422A(b) of the Internal Revenue Code of 1986, as amended, and not to exceed three (3) years after the date of such retirement with respect to all other stock options and stock appreciation rights, as the Compensation Committee shall specify in the option grant either at the time of grant or by amendment, but in no event after the expiration of the term of said option or any such stock appreciation right. In the event of the disability or death of an Optionee while in the employ of the Company or one of its subsidiaries, or during the post employment period referred to in the immediately preceding paragraph, the option hereto- fore granted to him shall be exercisable any time prior to the expiration of six (6) months after the date of such disability or death but in no event after the expiration of the term of said option. In the event of the disability or death of the holder of a stock appreciation right while in the employ of the Company or one of its subsidiaries, or during the post employment period referred to in the first paragraph of this Section 10, the stock appreciation right heretofore granted to him shall be exercisable any time prior to six (6) months after the date of such disability or death, but in no event after the expiration of the term of such stock appreciation right. Such option or stock appreciation right may only be exercised by the personal representative of such decedent or by the person or persons to whom such employee's rights under the option or stock appreciation right shall pass by such employee's Will or by the laws of Descent and Distribution of the state of such employee's domicile at the time of death, and then only as and to the extent that such employee was entitled to exercise the option or stock appreciation right on the date of death.\n11. WRITTEN AGREEMENT Within a reasonable time after the date of grant of an option, an option and stock appreciation right or a stock appreciation right related to a previously granted option, a written agreement in a form approved by the Compensation Committee shall be duly executed and delivered to the Optionee. 12. ADJUSTMENT BY REASON OF RECAPITALIZATION, STOCK SPLITS STOCK DIVIDENDS, ETC. If, after the effective date of this Plan, there shall be any changes in the common stock structure of the Company by reason of the declaration of stock dividends, recapitalization resulting in stock split-ups, or combina- tions or exchanges of shares by reason of merger, consolidation, or by any other means, then the number of shares available for options and stock appreciation rights, the shares subject to any options and the number of shares available for and subject to stock appreciation rights shall be equitably and appropriately adjusted by the Board of Directors of the Company as in its sole and uncontrolled discretion shall seem just and reasonable in the light of all the circumstances pertaining thereto. 13. RIGHT TO TERMINATE EMPLOYMENT The plan shall not confer upon any employee any right with respect to being continued in the employ of the Company and its subsidiaries or interfere in any way with the right of the Company and its subsidiaries to terminate his employment at any time, nor shall it interfere in any way with the employee's right to terminate his employment. 14. WITHHOLDING AND OTHER TAXES The Company or one of its subsidiaries shall have the right to withhold from salary or otherwise or to cause an Optionee (or the executor or administrator of his estate or his distributee) to make payment of any Federal, State, local or foreign taxes required to be withheld with respect to any exercise of a stock option or a stock appreciation right. An Optionee may irrevocably elect to have the withholding tax obligation or, if the Compensation Committee so determines, any additional tax obligation with respect to any exercise of a stock option satisfied by (a) having the Company or one of its subsidiaries withhold shares otherwise deliverable to the Optionee with respect to the exercise of the stock option, or (b) delivering back to the Company shares received upon the exercise of the stock option or delivering other shares of common stock; that any such election shall be made either (i) during a \"ten-day window period\", or (ii) at least six months prior to the date income is recognized with respect to the exercise of a stock option.\n15. AMENDMENT TO THE PLAN The Board of Directors shall have the right to amend, suspend or terminate the Plan at any time; provided, however, that no such action shall affect or in any way impair the rights of the holder of any option or stock appreciation right theretofore granted under the Plan; and provided further, that unless first duly approved by the common shareholders of the Company entitled to vote thereon at a meeting (which may be the annual meeting) duly called and held for such purpose, no amendment or change shall be made in the Plan (a) increasing the total number of shares which may be purchased or transferred upon exercise of options or stock appreciation rights under the Plan by all employees; (b) changing the minimum purchase price hereinbefore specified for the optioned shares; (c) changing the maximum option period; (d) increasing the amount that may be received upon exercise of a stock appreciation right; or (e) allowing a stock appreciation right to be exercised after the expiration date of the related option. 16. EFFECTIVE DATE OF THE PLAN The Plan shall be effective as of February 24, 1971. 17. SAVINGS CLAUSE Nothing included in this Plan by amendment shall revoke or alter the terms and provisions of the Plan as in effect prior to such amendment with respect to options granted under the Plan prior thereto.\nEXHIBIT 10 ----------\nDIRECTOR'S PENSION PLAN Plan Provisions\nEffective Date\nJanuary 1, 1994\nNormal Retirement Date\nThe first of the month following attainment of Age 65\nNormal Annual Pension 100% of annual retainer fee (currently $26,000 per year)\nTermination Benefits\nAfter vesting an annuity payable for life starting at the later of age 65 or termination from the Board.\nDeath Benefits\nNone\nPreretirement Spouse's Death Benefits\nNone\nPostretirement Spouse's Death Benefit\nNone\nDisability Pension\n50% of the Normal Annual Pension payable after 2 years of Credited Service. Increases by 10% per year for years of Credited Service over 5 years until it is 100% of the Normal Annual Pension. Credited Service does not accrue while on Disability.\nEarly Retirement Benefit\nAn unreduced accrued benefit is available upon attainment of age 65 and 5 years of Credited Service.\nEligibility\nAll Outside Members of the Board of Directors. An Outside Member is a board member who has never been employed by the Company or an affiliate of the Company.\nCredited Service\nOne year of Credited Service is granted for each calender year in which a Board member is on the Board for at least four months and attends at least one Board Meeting.\nBenefit Accrual\n10% of the Normal Retirement Benefit for each year of Credited Service. A maximum of 100% after 10 years.\nVesting\nVesting Service equals Credited Service. Benefits vest after 5 years of Vesting Service.\nContributions\nNone\nForms of Payment\nLife Annuity only\nEXHIBIT 10 ----------\nEXECUTIVE OFFICER'S RETIREMENT AGREEMENT\nJuly 19, 1993\nRobert F. Singleton 8496 Old Cutler Road Coral Gables, FL. 33143\nDear Bob:\nThis letter describes the conditions of your retirement agreement with Knight-Ridder, Inc.\n1. Your current job, compensation and benefit arrangements will continue through September 30, 1993.\n2. On September 30, 1993 you will retire as an officer and as a member of the Board Of Directors of Knight-Ridder, Inc.\n3. Upon retirement, you will be paid for any accrued, but unused vacation time. You will also be paid a prorated bonus for 1993, based on the potential bonus, if any, you would have received had you not retired until the end of 1993. This bonus will be calculated on the basis of projected 1993 KRI performance computed on the basis of nine months actual, plus three months budget.\n4. For a one-year period beginning October 1, 1993, you will serve as a consultant to the company, reporting to me, at an annual fee of $50,000. You will be available to Ross Jones the new CFO, and other officers of the company. You will continue to represent Knight-Ridder on the TKR Cable, TCI\/TKR LP and Southeast Paper Manufacturing Company Management Committees during the period you serve Knight-Ridder as a consultant.\n5. Effective October 1, 1993, you will receive an annual pension of $200,000 in the form of a 66 2\/3% joint and survivor annuity (66 2\/3% CA Option), comprising the following elements:\nSENN Plan $ 88,082 BRP Plan 41,105 Special Retirement Agreement 70,813 -------- Total Annual Benefit $200,000 ========\n6 Upon your retirement, you and your dependents will be covered under the Knight-Ridder medical and dental plans for retirees. Because you originally intended to retire under the medical plan for retirees that was effective prior to January 1, 1993, upon your retirement, you will be paid a one-time bonus of $86,806 representing the difference in present value costs to you of continuing coverage for you and your dependents under the new plan versus the old plan.\n7. All normal travel and out-of pocket expenses incurred in carrying out your assignments for the company during the period October 1, 1993 through September 30, 1994, will be paid for by the company upon submission of expenses.\n8. Outside directorships not in conflict with Knight-Ridder, Inc. will be cleared with me.\n9. You may retain your personal computer and have free access to Dialog, Moneycenter and other agreed-upon KRI electronic services until March 20, 1995.\nAccepted by: Knight-Ridder, Inc.\nRobert F. Singleton James K. Batten - ----------------------- --------------------- Robert F. Singleton James K. Batten\nDate: July 19, 1993 Date: July 19, 1993\nEXECUTIVE OFFICER'S CONSULTING\/RETIREMENT AGREEMENT EXHIBIT 19 ----------\nSeptember 20, 1989\nMr. Alvah H. Chapman, Jr. 4255 Lake Road Miami, Florida 33137\nDear Alvah: This letter sets forth our agreement with respect to your services to Knight-Ridder following your retirement as an officer and employee of the Company on October 1st.\nYou have agreed to continue to serve as a Director of the Company and as Chairman of its Executive Committee. I am also pleased that you have agreed to serve as a consultant to the company for the 12 months beginning October 1, 1989 and, thereafter, for such period as you, the Compensation Committee and I may agree.\nIn consideration of your services as Chairman of the Executive Committee and as a consultant, the Company will pay you $150,000 annually. This agree- ment extends from October 1, 1989 through September 30, 1994*. And as customary, you will be compensated as an outside director, including meeting fees for the Board and Board Committees (including the Executive Committee of the Company).\nWe have calculated that you will be entitled to an aggregate annual pension benefit under the Knight-Ridder Retirement and Benefit Restoration Plans of $328,670. In addition, in recognition of your contribution to the Company and your future services to it, the Company has agreed to pay you an additional retirement benefit of $100,000 per year for your life, in equal monthly installments.\nAlthough I hope to be able to take full advantage of your broad range of experience and knowledge of the Company, it is understood between us that we will make only reasonable demands upon your time and will seek to schedule our requests for your counsel so as to accommodate your schedule of other activities in retirement.\nThe specific matters on which we will need your help necessarily will change from time to time. I anticipate that you and I will talk at least quarterly about your then current list of consultative duties. At the outset we look forward to your continued participation in (a) our Detroit JOA undertaking and I hope you will be willing to serve on the DNA Management Committee for at least a year following implementation; (b) our ongoing shareholder relations projects (with particular attention to the founding families); and (c) the Miami property development project. I know that there will be a number of other key issues where your counsel will be invaluable.\nOur consulting relationship will preclude you from accepting consulting assignments and from other companies and from other profit-making activities, provided your other assignments and activities do not constitute a conflict of interest with Knight- Ridder.\nThe Company will reimburse you, in accordance with its usual policies and procedures, for your travel and other out of pocket expenses incurred in connection with your Knight-Ridder consulting activities, your attending ANPA and other industry meetings as long as you are a Knight- Ridder director, and your activities as Chairman of the FIU Foundation, Vice Chairman of The Miami Coalition, and other civic activities which are of benefit to KRI over the next several years.\nIn accordance with our historical practice, we will provide you as a former CEO of the Company with an office and a secretary as long as you want them.\nI am happy we will continue to work together. If I have accurately summarized our understanding, I'd appreciate your signing and returning the enclosed copy of this letter to me for the Company's files.\nSincerely yours, Knight- Ridder, Inc.\nBy: James K. Batten ----------------- J.K. Batten President & CEO\nAgreed:\nAlvah H. Chapman Jr. - -------------------- Alvah H. Chapman, Jr. (*The initial agreement was for one year and has been renewed annually through September 30, 1994).\nEXECUTIVE OFFICER'S RETIREMENT AGREEMENT EXHIBIT 19 (John C. Fontaine) ----------\nAGREEMENT\nTHIS AGREEMENT made and entered into as of the 1st day of January, 1992, by and between John C. Fontaine (hereinafter referred to as \"Mr. Fontaine\") and Knight-Ridder, Inc. (hereinafter referred to as \"KRI\") WITNESSETH THAT:\nWHEREAS Mr. Fontaine will work approximately nine-tenths (90%) of his time for KRI, commencing January 1, 1992; and,\nWHEREAS KRI desires to provide Mr. Fontaine with an adequate pension benefit for his services;\n1. KRI will pay to Mr. Fontaine an amount, payable in monthly installments, under this Agreement which, together with benefits earned under the Retirement Plan for Employees of Knight-Ridder, Inc. Corporate Division (the \"Plan\") will equal $135,000 annually if Mr. Fontaine retires at age 62 or $200,000 annually if Mr. Fontaine retires at age 65. These amounts are given on a life-only basis; they may be converted to any of the optional forms of benefit available under the Plan using the same conversion factors which would apply under the Plan.\n2. In the event that the employment relationship ends prior to attainment of age 62 by Mr. Fontaine other than (a) by reason of Mr. Fontaine's death or disability or (b) following a change in the control of the company, a pension benefit commencing at age 65 will be payable. The amount of the benefit will be calculated by multiplying $200,000 by the ratio of years and completed months of service since August 1, 1987 to 9 years 3 months. In the event of retirement at or after age 62, a pension determined in the same manner will be payable commencing immediately (except that the benefit payable at age 62 will be $135,000). See Exhibits I and II. Amounts payable under optional payment forms are shown in Exhibit III.\n3. In the event Mr. Fontaine's employment terminates by reason of his disability or following a change in the control of the company, he will be 100% vested immediately in the benefits provided under paragraph 2 above for retirement at age 65. In the event of Mr. Fontaine's death while\nemployed by KRI, there shall be paid to his surviving spouse for her life 50% of the amount which would otherwise be payable to him under this paragraph in the event of his disability; no beneficiary other than his surviving spouse shall be entitled to any death benefit under this Agreement. Benefit payments under this paragraph will commence on the first of the month following the occurrence of any of the above-mentioned circumstances. For purposes of this Agreement: (a) a \"change in the control of the company\" will be deemed to have occurred if the company is a party to a merger in which it is not the surviving entity or pursuant to which the company's common stock is converted into other property or securities; or upon the approval of the liquidation or dissolution of the company; or upon the sale of all or substantially all the company's assets; or upon the acquisition by any person or group of 35% of the company's outstanding stock; or upon a change within any 13- month period in the composition of a majority of the company's Board of Directors; and\n(b) \"disability\" shall mean a physical or mental condition which prevents Mr. Fontaine from fully performing the duties of Senior Vice President and General Counsel as agreed to by him and the company for a period of 90 consecutive days.\n4. This Agreement does not give Mr. Fontaine the right to be retained in the employ of KRI. Effective January 1, 1992, this Agreement supersedes the agreement between Mr. Fontaine and KRI concerning pension benefits dated October 16, 1989.\n5. This Agreement does not give Mr. Fontaine other rights or benefits provided under the Plan except as set forth in paragraphs 1, 2 and 3 above.\n6. Neither this Agreement nor any benefits that may be payable under this Agreement are assignable by Mr. Fontaine. None of Mr. Fontaine's rights under this Agreement shall be subject to any encumbrance or to the claims of his creditors.\n7. This Agreement shall be governed and construed in accordance with the laws of the State of Florida.\n8. Nothing contained in this Agreement shall be deemed to require KRI to make any payment to Mr. Fontaine or to any other person contrary to applicable law.\n9. IN WITNESS WHEREOF, the parties hereto have hereunto set their hands to duplicates this 19th day of December, 1991. JOHN C. FONTAINE\nJohn C. Fontaine ---------------- KNIGHT-RIDDER, INC.\nBy James K. Batten ------------------ James K. Batten Chairman & CEO\nExhibit 22 SUBSIDIARIES OF THE REGISTRANT ----------\nState\/Country of Incorporation --------------- KNIGHT-RIDDER, INC. Aberdeen News Company Delaware The Beacon Journal Publishing Company Ohio\nBoca Raton News, Inc. Florida Boulder Publishing, Inc. Colorado The Bradenton Herald, Inc. Florida Circom Corporation Pennsylvania Detroit Free Press, Incorporated Michigan Detroit Newspaper Agency Michigan(partnership) Drinnon, Inc. Georgia Grand Forks Herald, Incorporated Delaware Journal of Commerce, Inc. Delaware Keynoter Publishing Company, Inc. Florida KR Newsprint Company Florida Southeast Paper Manufacturing Co. Georgia (partnership) Knight News Services, Inc. Michigan Knight-Ridder Tribune News Services District of Columbia (partnership) The Knight Publishing Co. Delaware Knight-Ridder Business Information Services, Inc. Delaware Knight-Ridder Financial, Inc. Delaware Commodity News Services (International), Inc. Delaware Knight-Ridder Financial Holding AEA Company, Inc. Delaware Knight-Ridder Financial AEA, Inc. Delaware Knight-Ridder Financial JM, Inc. Delaware Knight-Ridder Financial Japan, Inc. Delaware Knight-Ridder Financial Iberica, S.A. Spain Equinet Pty Ltd. Australia Equinet Information (NZ), Ltd. New Zealand Dialog Information Services, Inc. California Dialog Information Europe, Inc. California D-S Marketing UK, Ltd. United Kingdom D-S Marketing, Inc. Pennsylvania D-S Marketing, SARL France D-S Marketing, GMBH Germany Radio-Suisse Marketing AB Sweden Knight-Ridder Nova AG Switzerland Radio-Suisse Ltd. Switzerland Knight-Ridder Cablevision, Inc. Florida KRC Sub, Inc. Delaware SCI Cable Partners Colorado (partnership) TKR Cable Company Colorado (partnership)\nKnight-Ridder Investment Company Delaware Seattle Times Company Delaware KR Video, Inc. Delaware Lexington Herald-Leader Co. Kentucky The Macon Telegraph Publishing Company Georgia The Miami Herald Publishing Company - News Publishing Company Indiana Fort Wayne Newspapers, Inc. Indiana Fort Wayne Newspaper Agency Indiana (partnership) Newspapers First Delaware Nittany Printing and Publishing Company Pennsylvania Northwest Publications, Inc. Delaware Duluth News-Tribune - Saint Paul Pioneer Press - The Observer Transportation Company North Carolina Philadelphia Newspapers, Inc. Pennsylvania Portage Graphics Co. Ohio Post-Tribune Publishing, Inc. Indiana PressLink Corporation Delaware The R.W. Page Corporation Georgia Ridder Publications, Inc. Delaware KR Land Holding Corporation Delaware San Jose Mercury News, Inc. California Silicon Valley D.A.T.A., Inc. California The State-Record Holding Company Delaware The State-Record Company, Inc. South Carolina Gulf Publishing Company, Inc. Mississippi Newberry Publishing Company, Inc. South Carolina Sun Publishing Company, Inc. South Carolina Tallahassee Democrat, Inc. Florida Tribune Newsprint Company Utah Ponderay Newsprint Company Washington (partnership) Twin Cities Newspaper Service, Inc. Minnesota Twin Coast Newspapers, Inc. New York Long Beach Press-Telegram - P.T. Sales and Marketing, Inc. California VU\/TEXT Information Services, Inc. Florida Wichita Eagle and Beacon Publishing Company, Inc. Kansas\nExhibit 24 ----------\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWe consent to the incorporation by reference in Registration Statement No. 33-11021 on Form S-3 dated December 22, 1986, in Registration Statement No. 33-28010 on Form S-3 dated April 7, 1989, in Registration Statement No. 33-31747 on Form S-8 dated October 30, 1989 and in Registration Statement No. 33-69206 on Form S-8 dated May 18, 1993, and in the related Prospectuses of our report dated February 1, 1994, with respect to the consolidated financial statements and schedules of Knight-Ridder, Inc. included in this Annual Report (Form 10-K) for the year ended December 26, 1993.\nERNST & YOUNG\nMarch 22, 1994\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nGonzalo F. Valdes- Fauli Date: March 22, 1994 - ---------------------------- -------------------- Gonzalo F. Valdes-Fauli\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBernard H. Ridder, Jr. Date: March 22, 1994 - --------------------------- -------------------- Bernard H. Ridder, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBarbara Barnes Hauptfuhrer Date: March 22, 1994 - ------------------------------- -------------------- Barbara Barnes Hauptfuhrer\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nAlvah H. Chapman, Jr. Date: March 22, 1994 - ------------------------ -------------------- Alvah H. Chapman, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nPeter C. Goldmark, Jr. Date: March 22, 1994 - ------------------------- -------------------- Peter C. Goldmark, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nWilliam S. Lee Date: March 22, 1994 - ------------------ -------------------- William S. Lee\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJohn L. Weinberg Date: March 22, 1994 - -------------------- -------------------- John L. Weinberg\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBen R. Morris Date: March 22, 1994 - ----------------- -------------------- Ben R. Morris\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nEric Ridder Date: March 22, 1994 - --------------- -------------------- Eric Ridder\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJames K. Batten Date: March 22, 1994 - ------------------- -------------------- James K. Batten\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJoan Ridder Challinor Date: March 22, 1994 - ------------------------- -------------------- Joan Ridder Challinor\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJesse Hill, Jr. Date: March 22, 1993 - ------------------- -------------------- Jesse Hill, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nC. Peter McColough Date: March 22, 1994 - ---------------------- -------------------- C. Peter McColough\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThomas L. Phillips Date: March 22, 1994 - ----------------------- -------------------- Thomas L. Phillips\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nP. Anthony Ridder Date: March 22, 1994 - --------------------- -------------------- P. Anthony Ridder\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBarbara Knight Toomey Date: March 22, 1994 - ------------------------- --------------------- Barbara Knight Toomey","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14 (a) (2), (c) and (d)\nSUPPLEMENTARY DATA\nCERTAIN EXHIBITS\nYEAR ENDED DECEMBER 26, 1993\nKNIGHT-RIDDER, INC. AND SUBSIDIARIES\nMIAMI, FLORIDA\nSCHEDULE V\nSCHEDULE VIII\nSCHEDULE IX\nEXHIBIT 10 ---------- GENERAL DESCRIPTION 1993 EXECUTIVE MBO PLAN (DESCRIPTION)\nI. Program Overview\nFollowing is an outline of the KRI Executive MBO Program. A. Basic Performance Criteria\nThis incentive MBO program is related directly to:\n1. The growth of operating profit for the corporation or for individual operating units.\n2. The meeting of budgeted profit levels.\n3. The attainment of individual performance goals that will contribute to the long-range strength of KRI.\nB. Factors Affecting Design of the Program.\n1. Survey Data - Annual compensation studies by Towers Perrin and by others provide up-to-date data on compensation levels. From these studies, reliable competitive averages (as well as maximums and minimums) on most of our major positions are established.\n2. KRI Position Within Our Industry - We wish to achieve a position such that an average KRI executive's total compensation will be competitive with compensation of executives at comparable companies. This positioning is necessary to continue to attract and retain the type of executive we want.\n3.Rewards Increase With Responsibility - In general, the practice in American industry is for higher award opportunities at the top of the organization, since these executives have greater influence on profitability and should have more at risk.\nC. Program Regulations\n1. Effective Starting Date - January 1, 1993, for this revised program.\n2. Maximum Limit - It is usual practice to establish a limit to the amount that can be paid out in an executive award program in a given year. An appropriate limiting formula for the Category I and II participants will be one half of one percent of beginning shareholder equity.\n3. Eligibility - Participants in the KRI Executive MBO Program are in three basic categories as follows: (The Chairman\/CEO, President and Executive Vice President are excluded from the program. Awards, if any, for incumbents in these three offices are at the sole discretion of the KRI Compensation Committee.)\n*Category I - Included as participants are all corporate officers, and certain director - level corporate employees.\n*Category II - Included are newspaper publishers and other unit operating heads who report directly to corporate officers. The President of Ft. Wayne News-Sentinel, the Chief of the Washington Bureau and the Editor of KRTN are included in this category.\n*Category III - Includes top editors, general managers and all division directors. (Any employee in this category not currently in the program joined the program on January 1, 1989. Exceptions may be negotiated with the Division Presidents in cases of inequity).\n*Category IV - Employees not included in Categories I,II or III of the MBO program who hold positions of sufficient scope and organizational impact to be deemed by senior management as appropriately included in the KRI Executive MBO program.\nD. Goals\nIndividual performance goals are an integral part of the KRI Executive Compensation Program.\n1. Each participant in this program is or will be committed to written, defined goals in a number of fields such as: editorial product improvement, customer service, increased readership and\/or product usage, circulation improvement, advertising share, personnel development and training, pluralism, leadership, etc.\n2. The individual performance goals are the manager's program of how the operating unit will be improved. They are then reviewed, adjusted and finally accepted as meaningful and attainable by the senior officer to ensure that the goals have a valid corporate purpose. In this way, these goals are established from the \"bottom up\" rather than imposed by top management.\n3. Goals should not number more than 6 to 8 objectives. Each goal will be given a weight, based on its relative importance, on a scale of 1 to 100. The combined weight of all the goals must equal 100. At the end of each year an individual is evaluated on the percentage of each goal accomplished, with the total yielding an individual's performance factor.\nII Award Calculations\nThe award will be determined by these factors:\nA. The salary of the individual participant. See Appendix A.\nB. Operating profit - This factor measures operating profit for the current year against the previous year on a scale running from 90% to 115 %. This represents 25% of the award potential.\nC. Budgeted performance - This factor measures operating profit performance against budgeted performance on a scale running from 90% to 105%. This represents the other 75% of award potential.\nD. Individual performance - This factor measures the individual performance against pre-established goals.\nEXHIBIT 10 KNIGHT-RIDDER, INC. ----------\nEMPLOYEE STOCK OPTION PLAN (As amended through May 13, 1993) 1. PURPOSE The purpose of this Stock Option Plan (hereinafter referred to as the \"Plan\") is to attract and retain key employees of Knight-Ridder, Inc. (hereinafter referred to as the \"Company\") and its subsidiaries, by the grant of options and stock appreciation rights. \"Subsidiaries\" as used herein shall mean corporations (other than Knight- Ridder, Inc.) or partnerships in an unbroken chain of corporations and\/or partnerships beginning with Knight-Ridder, Inc. if, at the time the granting of the option or stock appreciation right, each of the corporations and\npartnerships other than the last corporation or partnership in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in a corporation in such chain or at least a 50% partnership in such chain. Except as provided in Paragraph 7, a \"stock appreciation right\" shall mean the right of a holder thereof to receive from the Company, upon surrender of the related option, an amount equal to (A) the excess of the fair market value of a share of common stock on the date the stock appreciation right is exercised over the option price provided for in the related option, multiplied by (B) the number of shares with respect to which such stock appreciation right shall have been exercised. The term \"fair market value\" of a share of common stock as of any date shall be the mean between the highest and lowest sales price of a share of common stock on the date in question as reported on the composite tape for issues listed on the New York Stock Exchange. If no transaction was reported on the composite tape in the common stock on such date, the prices used shall be the prices reported on the nearest day preceding the date in question. If the common stock is not then listed or admitted to trading on such Exchange, \"fair market value\" shall be the mean between the closing bid and asked prices on the date in question as furnished by any member firm of the New York Stock Exchange selected from time to time for that purpose by the Compensation Committee. 2. ADMINISTRATION OF THE PLAN The Plan shall be administered by a committee as appointed from time to time by the Board of Directors of the Company, which committee shall consist of not less than three (3) members of such Board of Directors, all of whom shall be disinterested persons. Said committee shall be called the \"Compensation Committee.\" In administering the Plan, the Compensation Committee may adopt rules and regulations for carrying out the Plan. The interpretation and decision with regard to any question arising under the Plan made by the Committee shall, unless overruled or modified by the Board of Directors of the Company, be final and conclusive on all employees of the Company and its subsidiaries participating or eligible to participate in the Plan. A Committee member shall be a \"disinterested person\" only if such person is not, at the time such person exercises discretion in administering the Plan, eligible and has not at any time within one year prior thereto been eligible for selection as a person to whom stock may be allocated or to whom stock options or stock appreciation rights may be granted pursuant to the Plan or any other plan of the Company or any of its affiliates entitling the\nparticipants therein to acquire stock, stock options or stock appreciation rights of the Company or any of its affiliates. 3. STOCK The stock which may be issued and sold pursuant to the exercise of options or stock appreciation rights granted under the Plan may be authorized and unissued common stock or shares of common stock reacquired by the Company and held in treasury of a total number not exceeding 16,100,000 shares. The shares deliverable under the Plan shall be fully paid and non- assessable shares. Any shares, in respect of which an option is granted under the Plan which shall have for any reason expired or terminated, may be again allotted under the Plan. Any shares covered by options which have been canceled by reason of the exercise of related stock appreciation rights as provided in the immediately following paragraph or which are used to exercise other options or to satisfy tax withholding obligations shall not be available for other options under the Plan. The exercise of options with respect to which stock appreciation rights shall have been granted shall cause a corresponding cancellation of such stock appreciation rights, and the exercise of stock appreciation rights issued in respect of options shall cause a corresponding cancellation of such options. Each option and stock appreciation right granted under the Plan shall be subject to the requirement and condition that if the Board of Directors shall determine that the listing, registration or qualification upon any Securities Exchange under any state or federal law, or the approval or consent of any governmental body is necessary or desirable as a condition of granting such option or stock appreciation right, or the issue or purchase of any shares thereunder, then no such option or stock appreciation right may be exercised in whole or in part unless or until such listing, registration, qualification or approval has been obtained, free of any conditions which are not acceptable to the Board of Directors of the Company. 4. ELIGIBILITY Options and stock appreciation rights will be granted only to persons who are employees of the Company and its subsidiaries (including officers and directors except for persons acting as directors only). The Compensation Committee of the Board of Directors of the Company shall determine in its sole discretion the employees to be granted options, the number of shares subject to each option, the employees to be granted stock appreciation rights and the options with respect to which such stock appreciation rights shall be granted.\n5. PRICE The purchase price under each option shall be determined by the Compensation Committee subject to approval by the Board of Directors of the Company, but such price shall not be less than one hundred percent (100%) of the fair market value of the stock at the time such option is granted. 6. THE PERIOD OF THE OPTION AND THE EXERCISE OF THE SAME Each option granted under the Plan shall expire no later than ten (10) years from the date such option is granted, but the Compensation Committee may prescribe a shorter period for any individual option or options. The shares subject to the option may be purchased from time to time during the option period, subject to any waiting period or vesting schedule the Compensation Committee may specify for any individual option or options. In order to exercise the option or any part thereof, the employee shall give notice in writing to the Company of his intention to purchase all or part of the shares subject to the option, and in said notice he shall set forth the number of shares as to which he desires to exercise such option, and shall pay for such shares at the time of exercise of such option. Such payment may be made in cash, through the delivery to the Company of shares of common stock of the Company with a value equal to the total option price, or through a combination of cash and shares, and any shares so delivered shall be valued at their fair market value on the date on which the option is exercised. Such payment may also be made through the delivery to the Company of all or part of the shares of common stock of the Company that are the subject of the option; provided that such option is not an incentive stock option, and such employee instructs Manufacturers Hanover Trust Company (\"MHTC\") to effect on the date of such exercise or as early as practicable thereafter the sale of such number of such shares \"at the market\" in a broker's transaction (within the meaning of Section 4(4) of the Securities Act of 1933, as amended), the proceeds of which shall be at least equal to the purchase price of such option, plus the amount of income tax required to be withheld by the Company plus transaction costs. In accordance with these instructions MHTC shall sell such shares, deliver to the Company the portion of the proceeds of such sale which equals the purchase price of such option plus the amount of income tax required to be withheld by the Company and remit the remaining sale proceeds (net of transaction costs) to such employee. Said employee shall set forth in said notice, if in the opinion of Counsel for the Company it is necessary or desirable, that it is his present intention to acquire said shares being purchased for investment and not with a view to, or for sale in connection with, any distribution thereof. Except\nas specified in Paragraph 10 below, no option may be exercised except by the Optionee personally while he is in the employ of the Company or its subsidiaries and shall have been so employed continuously since the granting of his option. No Optionee or his legal representative, legatees or distributees, as the case may be, shall be or have any of the rights and privileges of a shareholder of the Company by reason of such option unless and until certificates for shares are issued to him under the terms of the Plan.\n7. THE PERIOD OF THE STOCK APPRECIATION RIGHT AND THE EXERCISE OF THE SAME\nA stock appreciation right granted under the Plan shall be exercisable during the period commencing on a date specified by the Compensation Committee and ending on the date on which the related option expires unless such option is earlier canceled or terminated, provided that such right may be exercised by an officer (as that term is defined in the Securities Exchange Act of 1934), a director or a beneficial owner of more than 10% of any class of the Company's equity securities only during any period beginning on the third business day following the release of a quarterly or annual summary statement of the Company's sales and earnings and ending on the twelfth business day following such date (a \"ten-day window period\"). Notwithstanding the preceding sentence, the Compensation Committee may provide for the grant of a stock appreciation right the exercise of which may occur outside of a ten-day window period but shall be limited to a sixty-day period following certain events specified by the Compensation Committee in the grant of such stock appreciation right. Moreover, notwithstanding the third subparagraph of Paragraph 1 above, the Compensation Committee may provide that such stock appreciation right shall be payable only in cash and that, in addition to payment of the amount otherwise due upon exercise of such stock appreciation right, the holder thereof shall receive (unless such stock appreciation right is in tandem with an incentive stock option, as defined in Section 422A(b) of the Internal Revenue Code of 1986, as amended), an amount equal to the excess of the highest price paid for a share of common stock in the open market or otherwise over the sixty-day period prior to exercise over the fair market value of a share of common stock on the date the stock appreciation right is exercised. In order to exercise the stock appreciation right or any part thereof, the employee shall give notice in writing to the Company of the intention to exercise such right, and in said notice the employee shall set forth the number of shares as to which such employee desires to exercise the stock\nappreciation right, provided that such right may not be exercised with respect to a number of shares in excess of the number for which such option could then be exercised. Except as specified in Paragraph 10 below, no stock appreciation right may be exercised except by the holder thereof personally while such holder is in the employ of the Company or its subsidiaries and shall have been so employed continuously since the granting of the stock appreciation right. No holder of a stock appreciation right or such holder's legal representatives, legatees or distributees, as the case may be, shall be or have any of the rights and privileges of a shareholder of the Company by reason of such stock appreciation right unless and until certificates for such shares are issued to such holder under the terms of the Plan. 8. NON-TRANSFERABILITY OF OPTION AND STOCK APPRECIATION RIGHT No option or stock appreciation right granted under the Plan to an employee shall be transferred by him otherwise than by Will or by the laws of Descent and Distribution, and such option or stock appreciation right shall be exercisable during his lifetime only by him. 9. TERMINATION OF EMPLOYMENT If an Optionee shall cease to be employed by the Company or one of its subsidiaries, as the case may be, for any reason other than death, disability or retirement pursuant to a retirement plan of the Company or one of its sub- sidiaries, any option and any stock appreciation right theretofore granted to him which has not been exercised shall forthwith cease and terminate. However, the Compensation Committee of the Board of Directors may provide in the grant of any option or stock appreciation right or in an amendment of such grant that in the event of any such termination of employment (except termination for cause by the Company or one of its subsidiaries), any option and any stock appreciation right theretofore granted to him which has not been exercised shall be exercisable only within three months after his termination, but in no event after the expiration of the stated term of said option or any such stock appreciation right. The Company or any of its subsidiaries shall have \"cause\" to terminate the Optionee's employment only on the basis of the Optionee's having been guilty of fraud, misappropriation, embezzlement or any other act or acts of dishonesty constituting a felony and resulting or intended to result directly or indirectly in a substantial gain or personal enrichment to the Optionee at the expense of the Company or any of its subsidiaries. Notwithstanding the foregoing, the Optionee shall not be deemed to have been terminated for cause unless and until there shall have been delivered to the Optionee a copy of a resolution (i) duly adopted by three-quarters (3\/4) of the entire membership of the Compensation Committee\nof the Board of Directors, or of the Board of directors of the Company, at a meeting called and held for such purpose after reasonable notice to the Optionee and an opportunity for the Optionee, together with the Optionee's counsel, to be heard before such Committee or the Board of Directors of the Company, as the case may be, and (ii) finding that in the good faith opinion of such Committee or the Board of Directors of the Company, as the case may be, the Optionee was guilty of conduct described in the preceding sentence of this paragraph and specifying the particulars of such conduct in detail. 10. RETIREMENT OR DEATH OF OPTIONEE OR HOLDER OF STOCK APPRECIATION RIGHT In the event of the retirement of an Optionee pursuant to a retirement plan of the Company or one of its subsidiaries, as the case may be, the option and any stock appreciation right heretofore granted to him shall be exercisable during such period of time, not to exceed one (1) year after the date of such retirement with respect to incentive stock options, as defined in Section 422A(b) of the Internal Revenue Code of 1986, as amended, and not to exceed three (3) years after the date of such retirement with respect to all other stock options and stock appreciation rights, as the Compensation Committee shall specify in the option grant either at the time of grant or by amendment, but in no event after the expiration of the term of said option or any such stock appreciation right. In the event of the disability or death of an Optionee while in the employ of the Company or one of its subsidiaries, or during the post employment period referred to in the immediately preceding paragraph, the option hereto- fore granted to him shall be exercisable any time prior to the expiration of six (6) months after the date of such disability or death but in no event after the expiration of the term of said option. In the event of the disability or death of the holder of a stock appreciation right while in the employ of the Company or one of its subsidiaries, or during the post employment period referred to in the first paragraph of this Section 10, the stock appreciation right heretofore granted to him shall be exercisable any time prior to six (6) months after the date of such disability or death, but in no event after the expiration of the term of such stock appreciation right. Such option or stock appreciation right may only be exercised by the personal representative of such decedent or by the person or persons to whom such employee's rights under the option or stock appreciation right shall pass by such employee's Will or by the laws of Descent and Distribution of the state of such employee's domicile at the time of death, and then only as and to the extent that such employee was entitled to exercise the option or stock appreciation right on the date of death.\n11. WRITTEN AGREEMENT Within a reasonable time after the date of grant of an option, an option and stock appreciation right or a stock appreciation right related to a previously granted option, a written agreement in a form approved by the Compensation Committee shall be duly executed and delivered to the Optionee. 12. ADJUSTMENT BY REASON OF RECAPITALIZATION, STOCK SPLITS STOCK DIVIDENDS, ETC. If, after the effective date of this Plan, there shall be any changes in the common stock structure of the Company by reason of the declaration of stock dividends, recapitalization resulting in stock split-ups, or combina- tions or exchanges of shares by reason of merger, consolidation, or by any other means, then the number of shares available for options and stock appreciation rights, the shares subject to any options and the number of shares available for and subject to stock appreciation rights shall be equitably and appropriately adjusted by the Board of Directors of the Company as in its sole and uncontrolled discretion shall seem just and reasonable in the light of all the circumstances pertaining thereto. 13. RIGHT TO TERMINATE EMPLOYMENT The plan shall not confer upon any employee any right with respect to being continued in the employ of the Company and its subsidiaries or interfere in any way with the right of the Company and its subsidiaries to terminate his employment at any time, nor shall it interfere in any way with the employee's right to terminate his employment. 14. WITHHOLDING AND OTHER TAXES The Company or one of its subsidiaries shall have the right to withhold from salary or otherwise or to cause an Optionee (or the executor or administrator of his estate or his distributee) to make payment of any Federal, State, local or foreign taxes required to be withheld with respect to any exercise of a stock option or a stock appreciation right. An Optionee may irrevocably elect to have the withholding tax obligation or, if the Compensation Committee so determines, any additional tax obligation with respect to any exercise of a stock option satisfied by (a) having the Company or one of its subsidiaries withhold shares otherwise deliverable to the Optionee with respect to the exercise of the stock option, or (b) delivering back to the Company shares received upon the exercise of the stock option or delivering other shares of common stock; that any such election shall be made either (i) during a \"ten-day window period\", or (ii) at least six months prior to the date income is recognized with respect to the exercise of a stock option.\n15. AMENDMENT TO THE PLAN The Board of Directors shall have the right to amend, suspend or terminate the Plan at any time; provided, however, that no such action shall affect or in any way impair the rights of the holder of any option or stock appreciation right theretofore granted under the Plan; and provided further, that unless first duly approved by the common shareholders of the Company entitled to vote thereon at a meeting (which may be the annual meeting) duly called and held for such purpose, no amendment or change shall be made in the Plan (a) increasing the total number of shares which may be purchased or transferred upon exercise of options or stock appreciation rights under the Plan by all employees; (b) changing the minimum purchase price hereinbefore specified for the optioned shares; (c) changing the maximum option period; (d) increasing the amount that may be received upon exercise of a stock appreciation right; or (e) allowing a stock appreciation right to be exercised after the expiration date of the related option. 16. EFFECTIVE DATE OF THE PLAN The Plan shall be effective as of February 24, 1971. 17. SAVINGS CLAUSE Nothing included in this Plan by amendment shall revoke or alter the terms and provisions of the Plan as in effect prior to such amendment with respect to options granted under the Plan prior thereto.\nEXHIBIT 10 ----------\nDIRECTOR'S PENSION PLAN Plan Provisions\nEffective Date\nJanuary 1, 1994\nNormal Retirement Date\nThe first of the month following attainment of Age 65\nNormal Annual Pension 100% of annual retainer fee (currently $26,000 per year)\nTermination Benefits\nAfter vesting an annuity payable for life starting at the later of age 65 or termination from the Board.\nDeath Benefits\nNone\nPreretirement Spouse's Death Benefits\nNone\nPostretirement Spouse's Death Benefit\nNone\nDisability Pension\n50% of the Normal Annual Pension payable after 2 years of Credited Service. Increases by 10% per year for years of Credited Service over 5 years until it is 100% of the Normal Annual Pension. Credited Service does not accrue while on Disability.\nEarly Retirement Benefit\nAn unreduced accrued benefit is available upon attainment of age 65 and 5 years of Credited Service.\nEligibility\nAll Outside Members of the Board of Directors. An Outside Member is a board member who has never been employed by the Company or an affiliate of the Company.\nCredited Service\nOne year of Credited Service is granted for each calender year in which a Board member is on the Board for at least four months and attends at least one Board Meeting.\nBenefit Accrual\n10% of the Normal Retirement Benefit for each year of Credited Service. A maximum of 100% after 10 years.\nVesting\nVesting Service equals Credited Service. Benefits vest after 5 years of Vesting Service.\nContributions\nNone\nForms of Payment\nLife Annuity only\nEXHIBIT 10 ----------\nEXECUTIVE OFFICER'S RETIREMENT AGREEMENT\nJuly 19, 1993\nRobert F. Singleton 8496 Old Cutler Road Coral Gables, FL. 33143\nDear Bob:\nThis letter describes the conditions of your retirement agreement with Knight-Ridder, Inc.\n1. Your current job, compensation and benefit arrangements will continue through September 30, 1993.\n2. On September 30, 1993 you will retire as an officer and as a member of the Board Of Directors of Knight-Ridder, Inc.\n3. Upon retirement, you will be paid for any accrued, but unused vacation time. You will also be paid a prorated bonus for 1993, based on the potential bonus, if any, you would have received had you not retired until the end of 1993. This bonus will be calculated on the basis of projected 1993 KRI performance computed on the basis of nine months actual, plus three months budget.\n4. For a one-year period beginning October 1, 1993, you will serve as a consultant to the company, reporting to me, at an annual fee of $50,000. You will be available to Ross Jones the new CFO, and other officers of the company. You will continue to represent Knight-Ridder on the TKR Cable, TCI\/TKR LP and Southeast Paper Manufacturing Company Management Committees during the period you serve Knight-Ridder as a consultant.\n5. Effective October 1, 1993, you will receive an annual pension of $200,000 in the form of a 66 2\/3% joint and survivor annuity (66 2\/3% CA Option), comprising the following elements:\nSENN Plan $ 88,082 BRP Plan 41,105 Special Retirement Agreement 70,813 -------- Total Annual Benefit $200,000 ========\n6 Upon your retirement, you and your dependents will be covered under the Knight-Ridder medical and dental plans for retirees. Because you originally intended to retire under the medical plan for retirees that was effective prior to January 1, 1993, upon your retirement, you will be paid a one-time bonus of $86,806 representing the difference in present value costs to you of continuing coverage for you and your dependents under the new plan versus the old plan.\n7. All normal travel and out-of pocket expenses incurred in carrying out your assignments for the company during the period October 1, 1993 through September 30, 1994, will be paid for by the company upon submission of expenses.\n8. Outside directorships not in conflict with Knight-Ridder, Inc. will be cleared with me.\n9. You may retain your personal computer and have free access to Dialog, Moneycenter and other agreed-upon KRI electronic services until March 20, 1995.\nAccepted by: Knight-Ridder, Inc.\nRobert F. Singleton James K. Batten - ----------------------- --------------------- Robert F. Singleton James K. Batten\nDate: July 19, 1993 Date: July 19, 1993\nEXECUTIVE OFFICER'S CONSULTING\/RETIREMENT AGREEMENT EXHIBIT 19 ----------\nSeptember 20, 1989\nMr. Alvah H. Chapman, Jr. 4255 Lake Road Miami, Florida 33137\nDear Alvah: This letter sets forth our agreement with respect to your services to Knight-Ridder following your retirement as an officer and employee of the Company on October 1st.\nYou have agreed to continue to serve as a Director of the Company and as Chairman of its Executive Committee. I am also pleased that you have agreed to serve as a consultant to the company for the 12 months beginning October 1, 1989 and, thereafter, for such period as you, the Compensation Committee and I may agree.\nIn consideration of your services as Chairman of the Executive Committee and as a consultant, the Company will pay you $150,000 annually. This agree- ment extends from October 1, 1989 through September 30, 1994*. And as customary, you will be compensated as an outside director, including meeting fees for the Board and Board Committees (including the Executive Committee of the Company).\nWe have calculated that you will be entitled to an aggregate annual pension benefit under the Knight-Ridder Retirement and Benefit Restoration Plans of $328,670. In addition, in recognition of your contribution to the Company and your future services to it, the Company has agreed to pay you an additional retirement benefit of $100,000 per year for your life, in equal monthly installments.\nAlthough I hope to be able to take full advantage of your broad range of experience and knowledge of the Company, it is understood between us that we will make only reasonable demands upon your time and will seek to schedule our requests for your counsel so as to accommodate your schedule of other activities in retirement.\nThe specific matters on which we will need your help necessarily will change from time to time. I anticipate that you and I will talk at least quarterly about your then current list of consultative duties. At the outset we look forward to your continued participation in (a) our Detroit JOA undertaking and I hope you will be willing to serve on the DNA Management Committee for at least a year following implementation; (b) our ongoing shareholder relations projects (with particular attention to the founding families); and (c) the Miami property development project. I know that there will be a number of other key issues where your counsel will be invaluable.\nOur consulting relationship will preclude you from accepting consulting assignments and from other companies and from other profit-making activities, provided your other assignments and activities do not constitute a conflict of interest with Knight- Ridder.\nThe Company will reimburse you, in accordance with its usual policies and procedures, for your travel and other out of pocket expenses incurred in connection with your Knight-Ridder consulting activities, your attending ANPA and other industry meetings as long as you are a Knight- Ridder director, and your activities as Chairman of the FIU Foundation, Vice Chairman of The Miami Coalition, and other civic activities which are of benefit to KRI over the next several years.\nIn accordance with our historical practice, we will provide you as a former CEO of the Company with an office and a secretary as long as you want them.\nI am happy we will continue to work together. If I have accurately summarized our understanding, I'd appreciate your signing and returning the enclosed copy of this letter to me for the Company's files.\nSincerely yours, Knight- Ridder, Inc.\nBy: James K. Batten ----------------- J.K. Batten President & CEO\nAgreed:\nAlvah H. Chapman Jr. - -------------------- Alvah H. Chapman, Jr. (*The initial agreement was for one year and has been renewed annually through September 30, 1994).\nEXECUTIVE OFFICER'S RETIREMENT AGREEMENT EXHIBIT 19 (John C. Fontaine) ----------\nAGREEMENT\nTHIS AGREEMENT made and entered into as of the 1st day of January, 1992, by and between John C. Fontaine (hereinafter referred to as \"Mr. Fontaine\") and Knight-Ridder, Inc. (hereinafter referred to as \"KRI\") WITNESSETH THAT:\nWHEREAS Mr. Fontaine will work approximately nine-tenths (90%) of his time for KRI, commencing January 1, 1992; and,\nWHEREAS KRI desires to provide Mr. Fontaine with an adequate pension benefit for his services;\n1. KRI will pay to Mr. Fontaine an amount, payable in monthly installments, under this Agreement which, together with benefits earned under the Retirement Plan for Employees of Knight-Ridder, Inc. Corporate Division (the \"Plan\") will equal $135,000 annually if Mr. Fontaine retires at age 62 or $200,000 annually if Mr. Fontaine retires at age 65. These amounts are given on a life-only basis; they may be converted to any of the optional forms of benefit available under the Plan using the same conversion factors which would apply under the Plan.\n2. In the event that the employment relationship ends prior to attainment of age 62 by Mr. Fontaine other than (a) by reason of Mr. Fontaine's death or disability or (b) following a change in the control of the company, a pension benefit commencing at age 65 will be payable. The amount of the benefit will be calculated by multiplying $200,000 by the ratio of years and completed months of service since August 1, 1987 to 9 years 3 months. In the event of retirement at or after age 62, a pension determined in the same manner will be payable commencing immediately (except that the benefit payable at age 62 will be $135,000). See Exhibits I and II. Amounts payable under optional payment forms are shown in Exhibit III.\n3. In the event Mr. Fontaine's employment terminates by reason of his disability or following a change in the control of the company, he will be 100% vested immediately in the benefits provided under paragraph 2 above for retirement at age 65. In the event of Mr. Fontaine's death while\nemployed by KRI, there shall be paid to his surviving spouse for her life 50% of the amount which would otherwise be payable to him under this paragraph in the event of his disability; no beneficiary other than his surviving spouse shall be entitled to any death benefit under this Agreement. Benefit payments under this paragraph will commence on the first of the month following the occurrence of any of the above-mentioned circumstances. For purposes of this Agreement: (a) a \"change in the control of the company\" will be deemed to have occurred if the company is a party to a merger in which it is not the surviving entity or pursuant to which the company's common stock is converted into other property or securities; or upon the approval of the liquidation or dissolution of the company; or upon the sale of all or substantially all the company's assets; or upon the acquisition by any person or group of 35% of the company's outstanding stock; or upon a change within any 13- month period in the composition of a majority of the company's Board of Directors; and\n(b) \"disability\" shall mean a physical or mental condition which prevents Mr. Fontaine from fully performing the duties of Senior Vice President and General Counsel as agreed to by him and the company for a period of 90 consecutive days.\n4. This Agreement does not give Mr. Fontaine the right to be retained in the employ of KRI. Effective January 1, 1992, this Agreement supersedes the agreement between Mr. Fontaine and KRI concerning pension benefits dated October 16, 1989.\n5. This Agreement does not give Mr. Fontaine other rights or benefits provided under the Plan except as set forth in paragraphs 1, 2 and 3 above.\n6. Neither this Agreement nor any benefits that may be payable under this Agreement are assignable by Mr. Fontaine. None of Mr. Fontaine's rights under this Agreement shall be subject to any encumbrance or to the claims of his creditors.\n7. This Agreement shall be governed and construed in accordance with the laws of the State of Florida.\n8. Nothing contained in this Agreement shall be deemed to require KRI to make any payment to Mr. Fontaine or to any other person contrary to applicable law.\n9. IN WITNESS WHEREOF, the parties hereto have hereunto set their hands to duplicates this 19th day of December, 1991. JOHN C. FONTAINE\nJohn C. Fontaine ---------------- KNIGHT-RIDDER, INC.\nBy James K. Batten ------------------ James K. Batten Chairman & CEO\nExhibit 22 SUBSIDIARIES OF THE REGISTRANT ----------\nState\/Country of Incorporation --------------- KNIGHT-RIDDER, INC. Aberdeen News Company Delaware The Beacon Journal Publishing Company Ohio\nBoca Raton News, Inc. Florida Boulder Publishing, Inc. Colorado The Bradenton Herald, Inc. Florida Circom Corporation Pennsylvania Detroit Free Press, Incorporated Michigan Detroit Newspaper Agency Michigan(partnership) Drinnon, Inc. Georgia Grand Forks Herald, Incorporated Delaware Journal of Commerce, Inc. Delaware Keynoter Publishing Company, Inc. Florida KR Newsprint Company Florida Southeast Paper Manufacturing Co. Georgia (partnership) Knight News Services, Inc. Michigan Knight-Ridder Tribune News Services District of Columbia (partnership) The Knight Publishing Co. Delaware Knight-Ridder Business Information Services, Inc. Delaware Knight-Ridder Financial, Inc. Delaware Commodity News Services (International), Inc. Delaware Knight-Ridder Financial Holding AEA Company, Inc. Delaware Knight-Ridder Financial AEA, Inc. Delaware Knight-Ridder Financial JM, Inc. Delaware Knight-Ridder Financial Japan, Inc. Delaware Knight-Ridder Financial Iberica, S.A. Spain Equinet Pty Ltd. Australia Equinet Information (NZ), Ltd. New Zealand Dialog Information Services, Inc. California Dialog Information Europe, Inc. California D-S Marketing UK, Ltd. United Kingdom D-S Marketing, Inc. Pennsylvania D-S Marketing, SARL France D-S Marketing, GMBH Germany Radio-Suisse Marketing AB Sweden Knight-Ridder Nova AG Switzerland Radio-Suisse Ltd. Switzerland Knight-Ridder Cablevision, Inc. Florida KRC Sub, Inc. Delaware SCI Cable Partners Colorado (partnership) TKR Cable Company Colorado (partnership)\nKnight-Ridder Investment Company Delaware Seattle Times Company Delaware KR Video, Inc. Delaware Lexington Herald-Leader Co. Kentucky The Macon Telegraph Publishing Company Georgia The Miami Herald Publishing Company - News Publishing Company Indiana Fort Wayne Newspapers, Inc. Indiana Fort Wayne Newspaper Agency Indiana (partnership) Newspapers First Delaware Nittany Printing and Publishing Company Pennsylvania Northwest Publications, Inc. Delaware Duluth News-Tribune - Saint Paul Pioneer Press - The Observer Transportation Company North Carolina Philadelphia Newspapers, Inc. Pennsylvania Portage Graphics Co. Ohio Post-Tribune Publishing, Inc. Indiana PressLink Corporation Delaware The R.W. Page Corporation Georgia Ridder Publications, Inc. Delaware KR Land Holding Corporation Delaware San Jose Mercury News, Inc. California Silicon Valley D.A.T.A., Inc. California The State-Record Holding Company Delaware The State-Record Company, Inc. South Carolina Gulf Publishing Company, Inc. Mississippi Newberry Publishing Company, Inc. South Carolina Sun Publishing Company, Inc. South Carolina Tallahassee Democrat, Inc. Florida Tribune Newsprint Company Utah Ponderay Newsprint Company Washington (partnership) Twin Cities Newspaper Service, Inc. Minnesota Twin Coast Newspapers, Inc. New York Long Beach Press-Telegram - P.T. Sales and Marketing, Inc. California VU\/TEXT Information Services, Inc. Florida Wichita Eagle and Beacon Publishing Company, Inc. Kansas\nExhibit 24 ----------\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWe consent to the incorporation by reference in Registration Statement No. 33-11021 on Form S-3 dated December 22, 1986, in Registration Statement No. 33-28010 on Form S-3 dated April 7, 1989, in Registration Statement No. 33-31747 on Form S-8 dated October 30, 1989 and in Registration Statement No. 33-69206 on Form S-8 dated May 18, 1993, and in the related Prospectuses of our report dated February 1, 1994, with respect to the consolidated financial statements and schedules of Knight-Ridder, Inc. included in this Annual Report (Form 10-K) for the year ended December 26, 1993.\nERNST & YOUNG\nMarch 22, 1994\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nGonzalo F. Valdes- Fauli Date: March 22, 1994 - ---------------------------- -------------------- Gonzalo F. Valdes-Fauli\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBernard H. Ridder, Jr. Date: March 22, 1994 - --------------------------- -------------------- Bernard H. Ridder, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBarbara Barnes Hauptfuhrer Date: March 22, 1994 - ------------------------------- -------------------- Barbara Barnes Hauptfuhrer\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nAlvah H. Chapman, Jr. Date: March 22, 1994 - ------------------------ -------------------- Alvah H. Chapman, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nPeter C. Goldmark, Jr. Date: March 22, 1994 - ------------------------- -------------------- Peter C. Goldmark, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nWilliam S. Lee Date: March 22, 1994 - ------------------ -------------------- William S. Lee\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJohn L. Weinberg Date: March 22, 1994 - -------------------- -------------------- John L. Weinberg\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBen R. Morris Date: March 22, 1994 - ----------------- -------------------- Ben R. Morris\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nEric Ridder Date: March 22, 1994 - --------------- -------------------- Eric Ridder\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJames K. Batten Date: March 22, 1994 - ------------------- -------------------- James K. Batten\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJoan Ridder Challinor Date: March 22, 1994 - ------------------------- -------------------- Joan Ridder Challinor\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nJesse Hill, Jr. Date: March 22, 1993 - ------------------- -------------------- Jesse Hill, Jr.\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nC. Peter McColough Date: March 22, 1994 - ---------------------- -------------------- C. Peter McColough\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThomas L. Phillips Date: March 22, 1994 - ----------------------- -------------------- Thomas L. Phillips\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nP. Anthony Ridder Date: March 22, 1994 - --------------------- -------------------- P. Anthony Ridder\nExhibit 25 ----------\nPOWER OF ATTORNEY\nThe undersigned member of the Board of Directors of Knight-Ridder, Inc. hereby constitutes and appoints John C. Fontaine, Ross Jones, and Tally C. Liu and each of them severally, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all Reports on Form 10-K (Annual Report pursuant to the Securities Exchange Act of 1934) and any amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nBarbara Knight Toomey Date: March 22, 1994 - ------------------------- --------------------- Barbara Knight Toomey","section_15":""}
{"filename":"19731_1993.txt","cik":"19731","year":"1993","section_1":"Item 1. Business\nGENERAL\nChesapeake Corporation, a Virginia corporation organized in 1918, is a paper and packaging company, whose primary businesses are kraft products, tissue and packaging. Our operating businesses include: Chesapeake Paper Products Company and Chesapeake Forest Products Company (kraft products, building products and woodlands operations); Wisconsin Tissue Mills Inc. (commercial and industrial tissue products); Chesapeake Consumer Products Company (consumer tabletop tissue products); Chesapeake Packaging Co. (point-of-sale displays and specialty packaging, consumer graphic packaging and corrugated shipping containers); and Delmarva Properties, Inc. and Stonehouse Inc. (land development).\nChesapeake competes in a large, capital-intensive industry. Until several years ago, Chesapeake's products were primarily kraft commodity products manufactured at Chesapeake Paper Products. In commodity markets, selling prices are controlled by total market supply and demand. To be successful in these markets, it is important to maximize production and minimize operating costs. Selling prices and profits for commodity products are usually cyclical and follow general economic conditions.\nDuring the past several years, Chesapeake has pursued a strategy of focusing on specialty products in markets that management believes have growth potential or in which the Company has or may be able to achieve competitive advantages. The Company's strategy for success with its specialty products is to utilize its recycling expertise creatively, to differentiate itself from its competition by producing products which are distinctive and to utilize its superior ability to respond to customers' requirements. Management believes this strategy allows the Company to achieve less cyclical and greater profits than with commodity products and to better utilize Chesapeake's strengths. During 1993, sales of specialty products were approximately 60% of Chesapeake's total sales. During the last three years, low selling prices for commodity products, such as bleached market pulp and corrugating medium, have offset much of the benefit derived from specialty product sales.\nBecause we understand the service needs of our customers, we believe we are able to provide quality products quickly and efficiently. Our decentralized management style allows quick decision making. Our operations are designed to be flexible to changing customer demands and business conditions.\nOur manufacturing and converting processes are capital intensive; property, plant and equipment, including timber and timberlands, comprise approximately 70% of our total assets. Our tissue and kraft operations require major investments in paper machines, fiber preparation equipment and converting equipment. In 1992, the Company completed an eight-year $600 million capital spending program for machinery, equipment and new technology to increase production of specialty products while reducing the company's emphasis on pure commodity products such as brown paperboard and bleached hardwood pulp. About one-half of these expenditures have been for paper machine projects for our kraft and tissue businesses. This program also included a $100 million project for a recovery boiler, evaporators and related equipment for our kraft business. At our other businesses, we have continued to invest in specialized converting and processing equipment needed to meet our strategic goals and customer requirements. During the past nine years, acquisitions have amounted to approximately $200 million. The major acquisition was Wisconsin Tissue, which provided the Company with a significant, immediate presence in the industrial and commercial tissue market. Other acquisitions, primarily in packaging, have benefited the Company with immediate expertise or marketing strength for our future needs and requirements.\nOur businesses are grouped into three major segments: kraft products, tissue and packaging. The information presented in \"Notes to Consolidated Financial Statements, Note 14 - Business Segment Information\" of the 1993 Annual Report to Stockholders (the \"1993 Annual Report\") is incorporated herein by reference. Industry segment groupings were changed in 1993 to better reflect the way Chesapeake manages its businesses. Information with respect to the registrant's working capital is set forth under the caption \"Financial Review 1991-1993, Liquidity and Capital Structure\" of the 1993 Annual Report and is incorporated herein by reference. Information regarding the registrant's anticipated capital spending is set forth under the caption \"Financial Review 1991-1993, Capital Expenditures\" of the 1993 Annual Report and is incorporated herein by reference.\nKRAFT PRODUCTS\nChesapeake's kraft products segment includes Chesapeake Paper Products Company, our kraft products operations, and Chesapeake Forest Products Company, our woodlands and building products operations, both based in West Point, Virginia. Chesapeake Building Products Company, a wholly owned subsidiary of Chesapeake Forest Products Company, was formed in 1993 with the merger of the company's lumber division and Chesapeake Wood Treating Co.\nChesapeake Paper Products Company\nChesapeake Paper Products manufactures white top paperboard, which accounts for 80% of the total paperboard product mix, kraft paperboard, kraft paper, corrugating medium and bleached hardwood pulp at its mill located in West Point, Virginia. Paperboard and corrugating medium, the outer and inner materials of a corrugated container, are sold to external and company-owned container and packaging plants. Kraft paper is sold to external converters to make bags and wrappings. Our bleached hardwood pulp is sold primarily to non-pulp producing paper manufacturers which manufacture predominantly printing and writing paper. Most of our customers are located in the eastern half of the United States, primarily in the mid-Atlantic and northeastern states, where we have the advantage of lower freight rates compared to many of our competitors. We also sell to international customers, primarily in Canada and Europe. Our salesforce markets these products to integrated and independent converters and manufacturers. Total shipments from the West Point mill were 798,000 tons in 1993, 721,000 tons in 1992 and 708,000 tons in 1991.\nIn 1993, approximately 65% of the raw materials for products from our kraft products mill was virgin wood fiber, with the remainder being recycled fiber recovered through our recycling system. Five company-owned recycling centers collect recycled fiber for the mill. About 76% of the virgin wood fiber used in 1993 was purchased from wood producers or independent timberland owners and the rest was from company-owned timberlands. In addition to our three paper machines and a market pulp machine, the West Point facility includes wood storage, wood pulping, paper recycling and steam and power generation equipment.\nChesapeake Forest Products Company, Woodlands Division\nChesapeake Forest Products, Woodlands Division owns and actively manages approximately 330,000 acres of timberland located in Virginia, Maryland, Delaware and North Carolina. The primary objective of our woodlands operation is to provide an adequate supply of wood at a competitive cost to our kraft products mill located at West Point. Wood comes from our company-owned lands and from independent landowners. Our foresters use environmentally sound, modern forestry methods intended to ensure a long-term, low-cost fiber supply. Our genetically superior pine seedlings, which are used in our reforestation program on company-owned land and by private landowners, grow quicker and provide higher quality, more uniform fibers at time of harvest than traditional seedlings. We are actively utilizing natural reforestation techniques to generate new hardwood timber stands on company-owned and privately held land.\nFor more than 25 years, Chesapeake has participated in research programs that have improved the quality, disease resistance and growth rate of our planted trees.\nChesapeake Building Products Company\nChesapeake Building Products Company operates four sawmills in Virginia and Maryland, manufacturing pine and hardwood lumber. The raw materials are provided from both company-owned timberlands and from other independent landowners. Our sawmill products are sold by our own salesforce to independent users.\nSubstantially all of the assets of the former Chesapeake Wood Treating Co. were conveyed to Universal Forest Products, Inc. under lease and purchase agreements in October 1993. Chesapeake Wood Treating Co. produced chemically treated pine lumber for the home improvement and residential construction markets. Net sales of this business were $85.8 million in 1993, $97.7 million in 1992 and $81.7 million in 1991.\nTISSUE\nChesapeake's tissue segment includes Wisconsin Tissue Mills Inc., which produces tissue for industrial and commercial markets, and Chespeake Consumer Products Company, a converter of tissue products for the consumer market.\nWisconsin Tissue Mills Inc.\nWisconsin Tissue, acquired in 1985, manufactures napkins, tablecovers, toweling, placemats, wipers and facial and bathroom tissue for commercial and industrial markets at its paper mill and converting facilities located in Menasha, Wisconsin. Our strategy is to provide a full line of disposable products for the commercial and industrial tissue markets. Our 2,200 products are found in full-menu and fast-food restaurants, hotels, motels, clubs, health care facilities, schools and office locations and on airlines.\nThe raw material for the paper we manufacture is 100% recycled fiber. Four paper machines manufacture base tissue stock that is converted on over 100 specialized machines. The Company believes that its computerized warehouse inventory and distribution systems give it an advantage over many of its competitors in product shipping efficiency and inventory control. Our tissue products are sold throughout the United States and in Canada by our national salesforce. Shipments by Wisconsin Tissue were 220,000 tons in 1993, 211,000 tons in 1992 and 190,000 tons in 1991.\nChesapeake Consumer Products Company\nThe strategic objective of Chesapeake Consumer Products, formed in 1989 from acquired companies and an internally developed product line, is to expand the marketing and distribution of tabletop tissue products. In 1990 the product line was narrowed to focus on napkins, plates, cups, tablecovers and accessories, and in 1992 and 1993 the company reorganized the former Finess portion of the business. With our narrow product focus we believe we can be successful in the highly competitive consumer products marketplace. Our consumer products are sold throughout the United States by our own salesforce and by independent representatives, and can be found in supermarkets, retail chain stores and other mass merchandisers. We have improved our manufacturing process by installing state-of-the-art napkin converting and napkin wrapping machines and adding a new warehouse and shipping area. During 1993, Chesapeake Consumer Products began producing napkins that used flexographic edge-to-edge printing technology.\nPACKAGING\nChesapeake Packaging Co.\nChesapeake Packaging has three marketing thrusts: point-of-sale displays and specialty packaging, consumer graphic packaging and corrugated shipping containers.\nWe believe that our packaging group is a leader in serving the point- of-sale display and specialty packaging needs of major national consumer products companies. Through a network of regional sales and design offices, the point-of-sale group, Chesapeake Display and Packaging Company, provides creative design services to our customers. Our manufacturing facilities utilize modern production, assembly and packaging processes to meet our customers' stringent quality and shipment demands. With the recent consolidation of the company's West Des Moines, Iowa packaging plant into its Sandusky, Ohio facility, at year-end 1993 we had two strategically located point-of-sale display and specialty packaging manufacturing plants and four assembly plants which provide service to customers throughout the United States.\nOur Color-Box facility supplies consumer graphic packaging to customers nationwide that require full litho-laminated point-of-sale packaging. The final phase of a $13 million expansion project to double the capacity of this facility was completed 1993.\nAt year-end 1993 we owned seven corrugated container plants that manufactured corrugated boxes and specialty packaging for customers within each plant's geographic area. The raw materials\nfor the packaging plants include paperboard and corrugating medium (purchased both from independent suppliers and from Chesapeake Paper Products) that are converted to make the walls of the packaging unit. Various converting equipment is used to print, cut, slot and glue the container to customer specifications.\nAdditional growth is anticipated in graphic packaging and corrugated shipping containers with the January 24, 1994 acquistion of Lawless Holding Corporation by Chesapeake Packaging. This acquisition included the Lawless Container Corporation corrugated container plant in North Tonawanda, New York; corrugated sheet plants in Scotia, New York, LeRoy, New York and Madison, Ohio; and Lawless Packaging and Display, a consumer graphic packaging plant in Buffalo, New York.\nOTHER BUSINESSES\nDelmarva Properties, Inc. and Stonehouse Inc.\nDelmarva Properties develops and markets land that has potential for value greater than as timberland. Nearly all of Delmarva Properties' present land inventory of approximately 15,000 acres was formerly timberland owned by Chesapeake Forest Products. Delmarva Properties develops land in Virginia, Maryland and Delaware primarily for residential housing. Sales also include large lots and acreage for others to develop.\nStonehouse Inc. is managing the planning for development of a new 7,600-acre planned community near Williamsburg, Virginia. The company is in the process of applying for required permits and approvals for this large project. Sales are not anticipated until at least the latter part of the 1990s. Most of Stonehouse's land was formerly timberland owned by Chesapeake Forest Products.\nRAW MATERIALS\nThe Company's raw materials are readily available at competitive prices.\nENVIRONMENTAL\nThe information presented under the caption \"Financial Review 1991- 1993, Environmental\" of the 1993 Annual Report is incorporated herein by reference.\nEMPLOYEES\nAs of December 31, 1993, the Company had 4,833 employees. The Company believes that its relations with its employees are good. In 1992, the Company reached agreement on five-year collective bargaining agreements with the unions representing employees at the Wisconsin Tissue and Chesapeake Paper Products mills.\nCOMPETITION AND SEASONALITY\nWith its diversity of products, Chesapeake has many customers buying different products and is not dependent on any single customer, or group of customers, in any market segment. Longstanding relationships exist with many of our customers who place orders on a continuing basis. Because of the nature of our business, order backlog is not large. The third and fourth quarters of each year are usually the highest in sales and earnings. Our major businesses generally experience peak activity during the months of August through October.\nCompetition is intense in all business segments from much larger companies and from local and regional producers and converters. The Company believes that competitive factors in our industry preclude a meaningful estimate of the number of competitors and, except as noted, the Company's relative competitive position. The Company does not have any appreciable market share in pure commodity products, such as bleached hardwood pulp and brown paperboard. For this reason, the Company has de- emphasized these products to pursue specialty products that we believe will provide less pricing volatility and increased profitability. We believe that, with our strengths of customer service and competitive products, we are well positioned to compete in these specialized markets.\nRESEARCH AND DEVELOPMENT\nIn addition to forestry research programs, the Company conducts limited continuing technical research and development projects relating to new products and improvements of existing products and processes. Expenditures for research and development activities are not material.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAt year-end 1993, Chesapeake manufactured or converted paper and wood products at 36 facilities in 11 states. The information presented under \"Operating Managers and Locations\" in the 1993 Annual Report is incorporated herein by reference. The Company owns substantially all of its production facilities, which are\nwell maintained and in good operating condition, and are utilized at practical capacities that vary in accordance with product mixes, market conditions and machine configurations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information presented in \"Notes to Consolidated Financial Statements, Note 10 - Litigation\" of the 1993 Annual Report is incorporated herein by reference. Item 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers of the Registrant\nThe names and ages of each executive officer of Chesapeake, together with a brief description of the principal occupation or employment of each such person during the last five years, is set forth below. Executive officers serve at the pleasure of the board of directors and are elected at each annual organizational meeting of the board of directors.\nJ. Carter Fox (54) President & Chief Executive Officer since 1980 Paul A. Dresser, Jr. (51) Chief Operating Officer since 1991 Executive Vice President since 1990 Chief Financial Officer 1981-1991 Group Vice President-Finance & Administration 1984-1990 Thomas Blackburn (42) Group Vice President-Kraft Products since 1991 President, Chesapeake Paper Products Company and Chesapeake Forest Products Company since 1991 Kraft Products-Executive Vice President 1990-1991 General Manager, Crossett, Arkansas, Georgia-Pacific Corporation 1988-1990 Charles S. Cianciola (60) Group Vice President-Tissue Products since 1988 President, Wisconsin Tissue Mills Inc. since 1988 Samuel J. Taylor (54) Group Vice President-Packaging since 1988 President, Chesapeake Packaging Co. since 1988 J. P. Causey Jr. (50) Vice President, Secretary & General Counsel since 1986 John W. Kirk (47) Vice President-Strategic Development since 1992 Controller & Chief Acccounting Officer 1990-1992 Controller 1981-1992\nAndrew J. Kohut (35) Vice President-Finance & Chief Financial Officer since 1991 President and General Manager, Color-Box, Inc. 1989-1991 Senior Director-Strategic Development 1987-1989 Thomas A. Smith (47) Vice President-Human Resources & Assistant Secretary since 1987\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe dividend and stock price information presented under the caption \"Recent Quarterly Results\" and the information concerning retained earnings available for dividends presented in \"Notes to Consolidated Financial Statements, Note 3 - Long-Term Debt\" of the 1993 Annual Report are incorporated herein by reference. The Company is listed on the New York Stock Exchange under the symbol - CSK. As of March 2, 1994, there were 7,466 stockholders of record of the Company's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information for the years 1989-1993 presented under the caption \"Eleven-Year Comparative Record\" of the 1993 Annual Report is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nThe information presented under the caption \"Financial Review 1991- 1993\" of the 1993 Annual Report is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements of the Company and subsidiaries, including the notes thereto, and the information presented under the caption \"Recent Quarterly Results\" of the 1993 Annual Report are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information presented under the captions \"Information Concerning Nominees\" and \"Directors Continuing in Office\" of the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 27, 1994 (the \"1994 Proxy Statement\") is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information presented under the captions \"Compensation of Directors\" and \"Executive Compensation\" of the 1994 Proxy Statement (excluding, however, the information presented under the subheadings \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\") is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information presented under the caption \"Security Ownership of Certain Beneficial Owners and Management\" of the 1994 Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information presented under the caption \"Certain Transactions\" of the 1994 Proxy Statement is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\na. Documents\n(i) Financial Statements\nThe financial statements incorporated by reference into this report are listed in the Index to Financial Statements and Schedules on page 13 hereof.\n(ii) Financial Statement Schedules\nThe financial statement schedules filed as a part of this report are listed in the Index to Financial Statements and Schedules on page 13 hereof.\n(iii) Exhibits filed or incorporated by reference\nThe exhibits that are required to be filed or incorporated by reference herein are listed in the Exhibit Index found on pages 18-19 hereof. Exhibits 10.1 - 10.11 hereto constitute management contracts or compensatory plans or arrangements required to be filed as exhibits hereto.\nb. Reports on Form 8-K\nNone\nSIGNATURES\nPursuant 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. CHESAPEAKE CORPORATION (Registrant)\nFebruary 8, 1994 By \/s\/ CHRISTOPHER R. BURGESS Christopher R. Burgess Controller\nPursuant 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.\nBy By \/s\/ WALLACE STETTINIUS Paul A. Dresser, Jr. Wallace Stettinius Director\nBy \/s\/ J. CARTER FOX By \/s\/ JOHN HOYT STOOKEY J. Carter Fox John Hoyt Stookey Director; President & Director Chief Executive Officer\nBy \/s\/ ROBERT L. HINTZ By \/s\/ RICHARD G. TILGHMAN Robert L. Hintz Richard G. Tilghman Director Director By \/s\/ WILLIAM D. McCOY By William D. McCoy Joseph P. Viviano Director\nBy \/s\/ STURE G. OLSSON By \/s\/ H. H. WARNER Sture G. Olsson Harry H. Warner Chairman of the Board Director of Directors\nBy \/s\/ JOHN W. ROSENBLUM By \/s\/ ANDREW J. KOHUT John W. Rosenblum Andrew J. Kohut Director Vice President & Chief Financial Officer\nBy \/s\/ FRANK S. ROYAL By \/s\/ CHRISTOPHER R. BURGESS Frank S. Royal Christopher R. Burgess Director Controller\nEach of the above signatures is affixed as of February 8, 1994.\nCHESAPEAKE CORPORATION\nIndex to Financial Statements and Schedules\nThe consolidated balance sheet of Chesapeake Corporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income and retained earnings and cash flows for each of the three years in the period ended December 31, 1993, including the notes thereto, are presented in the Company's 1993 Annual Report and are incorporated herein by reference. With the exception of the aforementioned information, and the information incorporated by reference in numbered Items 1, 2, 3, 5, 6, 7 and 8, no other data appearing in the 1993 Annual Report is deemed to be \"filed\" as part of this Form 10-K. The following additional financial data should be read in conjunction with the consolidated financial statements.\nPage\nReport of Independent Accountants .......................... 14\nFinancial Statement Schedules* Schedules for each of the three years in the period ended December 31, 1993 II. Amounts Receivable from Related Parties and Underwriters, Promoters and Employees Other Than Related Parties......... ............................ 15 V. Property, Plant and Equipment........................ 16 VI. Accumulated Depreciation of Property, Plant and Equipment............................................. 17\n*Schedules other than those listed above are omitted because they are not applicable or are not required.\nREPORT OF INDEPENDENT ACC0UNTANTS\nTo the Stockholders and Board of Directors Chesapeake Corporation:\nWe have audited the consolidated financial statements of Chesapeake Corporation and subsidiaries as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, which financial statements are included in the 1993 Annual Report to Stockholders of Chesapeake Corporation and incorporated herein by reference. We have also audited the financial statement schedules listed in the index on page 13 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chesapeake Corporation and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in notes 4, 6 and 13 to the consolidated financial statements, the company changed its methods of accounting for postretirement benefits other than pensions and accounting for income taxes in 1992. \/s\/ COOPERS & LYBRAND\nCOOPERS & LYBRAND Richmond, Virginia January 25, 1994\nCHESAPEAKE CORPORATION AND SUBSIDIARIES SCHEDULE II - AMOUNTS RECEIVABLE (IN EXCESS OF $100,000) FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\nBalance at Deductions\nend of year Number of Balance at Amounts collateral beginning Amounts written\nNot shares at Name of debtor(a) of year Additions collected off Current Current end of year\n(Dollar amounts in thousands) Year ended December 31, 1991: J. Carter Fox $103 $ - $41 $ - $ 32 $ 30 13,850\nYear ended December 31, 1992: J. Carter Fox $ 62 $ - $ 62 $ - $ - - -\nYear ended December 31, 1993: $ - $ - $ - $ - $ - $ - -\nNote: (a) Under the provisions of the Company's stock option plans, five-year loans may be made to individuals in connection with their exercise of options for shares of common stock. Outstanding loans bear interest at 9% per annum, mature within five years in installments that\ncomply with applicable rules of the Federal Reserve Board and are collateralized by shares of common stock.\nCHESAPEAKE CORPORATION AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nCost of timber Balance at Additions harvested Balance\nbeginning at Sales and credited to Other at end of year Cost retirements asset cost Changes of year\n(In millions) Year ended December 31, 1991 Land - plant sites $ 11.6 $ .2 $ .6 $ -\n$ - $ 11.2 Buildings and structures 111.1 5.5 1.6 -\n- 115.0 Machinery and equipment 828.8 36.9 (a) 16.1\n- - 849.6 Construction in progress 19.4 47.5 (a) - -\n- 66.9 Subtotals 970.9 90.1\n18.3 - - - 1,042.7 Timber and timberlands 39.7 2.1 - 1.1\n- 40.7\nTotals $1,010.6 $92.2 $18.3\n$ 1.1 $ - $1,083.4\nYear ended December 31, 1992 Land - plant sites $ 11.2 $ .1 $ - $ -\n$ - $ 11.3 Buildings and structures 115.0 5.4\n.6 - - 3.2 (b) 123.0 Machinery and equipment 849.6 129.6 (a) 10.7\n- 16.4 (b) 984.9 Construction in progress 66.9 (52.1) (a) - -\n- 14.8 Subtotals 1,042.7 83.0 11.3\n- 19.6 1,134.0 Timber and timberlands 40.7 2.0 .2\n1.1 - - 41.4\nTotals $1,083.4 $ 85.0 $11.5 $ 1.1 $19.6 $1,175.4\nYear ended December 31, 1993 Land - plant sites $ 11.3 $ .4 $ .8 $ - $ - $ 10.9 Buildings and structures 123.0 12.6 5.5 - (.2) 129.9 Machinery and equipment 984.9 44.4 30.1 - .2 999.4 Construction in progress 14.8 4.9 .4 - - 19.3 Subtotals 1,134.0 62.3 36.8 - - 1,159.5 Timber and timberlands 41.4 1.6 2.5 .7 - 39.8\nTotals $1,175.4 $63.9 $39.3 $ .7 $ - $1,199.3\nNotes: (a) Major additions 1991 and 1992 - Number 5 recovery boiler (Chesapeake Paper Products) (b) Adoption of SFAS 109\nCHESAPEAKE CORPORATION AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT\nAdditions Balance at charged to Balance at beginning costs and Other end of of year expenses Retirements changes year\n(Inmillions)\nYear ended December 31, 1991: Buildings and structures $ 28.8 $ 4.3 $ 1.2 $ .3 $ 32.2 Machinery and equipment 365.6 56.7 13.0 .3 409.6\nTotals $394.4 $61.0 $14.2 $ .6 $441.8\nYear ended December 31, 1992: Buildings and structures $ 32.2 $ 5.2 $ .5 $ 1.6 (a) $ 38.5 Machinery and equipment 409.6 60.2 9.9 8.7 (a) 468.6\nTotals $441.8 $65.4 $10.4 $10.3 $507.1\nYear ended December 31, 1993: Buildings and structures $ 38.5 $ 5.1 $ 4.2 $ (.2) $ 39.2 Machinery and equipment 468.6 64.4 26.9 .2 506.3\nTotals $507.1 $69.5 $31.1 $ - $545.5\nNotes: (a) Adoption of SFAS 109\nEXHIBIT INDEX\n2.1 Asset Purchase Agreement, dated as of September 24, 1993, By and Between Chesapeake Building Products Company and Universal ForestProducts, Inc.\n2.2 Agreement of Merger, dated as of December 31, 1993, By andAmong Chesapeake Packaging Co., Lawless Acquistion Co., Lawless Holding Corporation and the Common Shareholders of Lawless Holding Corporation The registrant agrees to furnish supplementally to the Securities and Exchange Commission, upon request, copies of the schedules and exhibits to Exhibits 2.1 and 2.2 hereto that are not filed herewith prusuant to Item 601(b)(2) of Regulation S-K.\n3.1 Articles of Incorporation (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n3.2 Bylaws (filed as Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference)\n4.1 Indenture, dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to Form S-3 Registration Statement No. 33-30900 and incorporated herein by reference)\n4.2 First Supplemental Indenture, dated as of September 1, 1989, to the Indenture dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed October 9, 1990, and incorporated herein by reference)\nThe registrant agrees to furnish to the Securities and Exchange Commission, upon request, copies of those agreements defining the rights of holders of long-term debt of the registrant and its subsidiaries that are not filed herewith pursuant to Item 601(b)(4)(iii) of Regulation S-K.\n10.1 1981 Stock Incentive Plan (included as Exhibit A to the Prospectus contained in Post-Effective Amendment No. 1 to Form S-8 Registration Statement No. 2-71595 and incorporated herein by reference)\n10.2 1987 Stock Option Plan (filed as Exhibit A to the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders held April 22, 1987 and incorporated herein by reference)\n10.3 Directors' Deferred Compensation Plan (filed as Exhibit VII to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.4 Non-Employee Director Stock Option Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-53478 and incorporated herein by reference)\n10.5 Executive Supplemental Retirement Plan (filed as Exhibit VI to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.6 Retirement Plan for Outside Directors (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n10.7 Officers' Incentive Program (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n10.8 Chesapeake Corporation Salaried Employees' Benefits Continuation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.9 Chesapeake Corporation Long-Term Incentive Plan (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.10 Chesapeake Corporation 1993 Incentive Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-67384 and incorporated herrein by reference)\n10.11 Agreement between Thomas Blackburn and Chesapeake Paper Products Company dated as of November 24, 1993\n11.1 Computation of Net Income Per Share of Common Stock\n12.1 Computation of Ratio of Earnings to Fixed Charges\n13.1 Portions of the Chesapeake Corporation Annual Report to Stockholders for the year ended December 31, 1993\n21.1 Subsidiaries\n23.1 Consent of Coopers & Lybrand\n28.1 Form 11-K Annual Report, Hourly Employees' Stock Purchase Plan for the plan fiscal year ended November 30, 1993","section_15":""}
{"filename":"764625_1993.txt","cik":"764625","year":"1993","section_1":"ITEM 1. Business\nEnserch Exploration Partners, Ltd. (\"EP\"), a Texas limited partnership, was formed in 1985 to succeed to substantially all of the domestic gas and oil exploration and production business of ENSERCH Corporation (\"ENSERCH\"). ENSERCH and an affiliate own more than 99% of the outstanding limited partnership units and the remaining units of slightly more than 800,000, are publicly held.\nEP operates through EP Operating Limited Partnership (\"EPO\"), a Texas limited partnership, in which EP holds a 99% limited partner's interest and the general partners own a 1% interest. Enserch Exploration, Inc. (\"EEI\") is the managing general partner and ENSERCH is the special general partner of EP and EPO.\nEP is engaged in the exploration for and the development, production and marketing of natural gas and crude oil throughout Texas, offshore in the Gulf of Mexico, onshore in the Gulf Coast and Rocky Mountain areas and in various other areas in the United States. Activities include geological and geophysical studies; acquisition of gas and oil leases; drilling of exploratory wells; development and operation of producing properties; acquisition of interests in developed or partially developed properties; and the marketing of natural gas, crude oil and condensate. Production offices are maintained in Dallas, Houston, Athens, Bridgeport, Longview and Midland, Texas.\nEP has no officers, directors or employees. Instead, officers, directors and employees of EEI perform all management and operating functions for EP. At December 31, 1993, EEI employed 382 persons, including 36 geologists, 21 geophysicists and 19 land representatives who investigate prospective areas, generate drilling prospects, review submitted prospects and acquire leasehold acreage in prospective areas. In addition, EEI maintains a staff of 56 engineers and 46 technologists who plan and supervise the drilling and completion of wells, evaluate prospective gas and oil reservoirs, plan the development and management of fields, and manage the daily production of gas and oil.\nSpot-market sales, which include monthly and short-term industrial sales, covered about 70% of 1993 gas sales, compared with 80% in 1992 and 75% in 1991. During 1994, the percentage of gas sold in the spot market is expected to be in the range of 75% to 85%. Approximately 70% of EP's natural-gas sales volumes (75% of gas revenues) for the year ended December 31, 1993 was sold to affiliated customers. In 1993, affiliated revenues include gas sales under new contracts effective March 1, 1993 with Enserch Gas Company covering essentially all gas production not committed under existing contracts. Affiliated purchasers do not have a preferential right to purchase natural gas produced by EP other than under existing contracts.\nSales data are set forth under \"Selected Financial and Operating Data\" in Appendix A to this report.\nFollowing is a summary of EP's exploration and development activity during 1993:\nGulf of Mexico. Offshore exploration provides EP the opportunity to improve its ratio of production to reserve base by the addition of gas wells with relatively higher production rates. This is coupled with ongoing deep- water development projects, which are expected to provide long-term reserves. State-of-the-art technology, including three-dimensional (\"3-D\") seismic, specialized seismic processing, and innovative well completion and production techniques, are being used to help accomplish these objectives.\nMississippi Canyon Block 441, the first development project in the Gulf of Mexico that EP has operated, is indicative of this approach. A 3-D seismic program, prior to field development, confirmed that the majority of the reservoir lies beneath a shipping fairway. A production program was developed that involved drilling highly deviated wells under the shipping fairway, subsea completing the deep-water wells, and tying the wells back to a conventional shallow-water production platform using bundled flowlines. The high-angle wells required special gravel-pack completion techniques. After a year of production, the field has been essentially maintenance free, producing some 70 million cubic feet (\"MMcf\") of natural gas and more than 500 barrels (\"Bbls\") of condensate per day from six wells.\nThe 3-D seismic on Mississippi Canyon Block 441 is being reprocessed, using depth migration and other state-of-the-art techniques to aid in the identification of deeper exploratory targets, which, if successfully drilled, could add to the field reserves. EP has a 37.5% working interest in this project.\nThe Garden Banks Block 388 oil development project remains on schedule, with initial production anticipated by mid-1995. Installation of the offshore facilities, which consist of a subsea template, gathering and sales pipelines, and shallow-water production facilities, will begin by mid-1994. After the rig and all facilities are in place, the three existing wells will be connected, with initial production from the first well expected to be approximately 5 thousand barrels (\"MBbls\") of oil and 5 MMcf of gas per day. Peak daily production from the project is anticipated to be 40 MBbls of oil and 60 MMcf of gas. EP is 100% owner and operator of the Garden Banks Block 388 project.\nAnother prospect delineated by seismic amplitude anomalies lies approximately four miles to the west of Garden Banks Block 388 on Garden Banks Blocks 386\/387. If successfully drilled, this prospect could add production to the Block 388 development by incorporating some of the production technology that was utilized on Mississippi Canyon Block 441.\nIn 1994, an offset well to EP's discovery on Green Canyon Block 254 is scheduled to be drilled. The exploratory well, which was drilled in 1991, encountered 11 sands with a combined thickness of more than 360 feet of oil pay. EP has a 25% working interest in this block and a similar working interest in three adjacent blocks believed to be part of the same project.\nOnshore. EP participated in 78 development wells (62 net) in 1993, with the majority completed as gas producers in East Texas. Thirty-six wells were in progress at yearend. In East Texas, EP is positioned in a prolific gas- prone area which, despite its maturity, provides growth opportunities. EP is one of the oldest and most active operators in this basin in East Texas, which includes Opelika, Tri-Cities, Whelan, Willow Springs, North Lansing and Freestone fields.\nIn early 1993, EP initiated a 26-well program in East Texas to accelerate the development of natural-gas reserves from the Travis Peak formation in the Opelika field. The program was targeted to test new techniques for shortening the average life of its reserve base. The project was completed in seven months yielding initial daily per well production rates of up to 1.8 MMcf of gas and 48 Bbls of oil. EP has a 100% working interest in these wells.\nEP performed additional development drilling in the Freestone field, where seven well completions flowed at daily rates ranging from 1.0 MMcf to 2.3 MMcf of gas per well. EP has 50% to 100% working interests in these wells.\nIn the Bralley field in West Texas, the combined daily oil production rate from six wells increased to 800 Bbls from 500 Bbls following production optimization work. EP owns a 50% working interest in each of these wells.\nIn South Texas, seven wells drilled and completed in the Fashing field flowed at daily rates of 1.2 MMcf to 2.6 MMcf of gas and 14 Bbls to 30 Bbls of oil per well. Twelve wells drilled and completed in the Boonsville field in north central Texas resulted in daily production of .4 MMcf to 1.5 MMcf of gas per well.\nOnshore development activity planned for 1994 includes drilling approximately 35 wells outside East Texas. Some of the larger projects include wells in the Fashing, Rancho Viejo and Boonsville fields.\nIn the Fashing field, results of three wells and a field study indicate development potential for new wells, as well as recompletions that could result in reserve additions.\nCompetition\nCompetition in the natural gas and oil exploration and production business is intense and is present from a large number of firms of varying sizes and financial resources, some of which are much larger than EP. Competition involves all aspects of marketing products (including terms, prices, volumes and length of contracts), terms relating to lease bonus and royalty arrangements, and the schedule of future development activity.\nRegulation\nEnvironmental Protection Agency (\"EPA\") rules, regulations and orders affect the operations of EP. EPA regulations promulgated under the Superfund Amendments and Reauthorization Act of 1986 require EP to report on locations and estimates of quantities of hazardous chemicals used in EP's operations. The EPA has determined that most gas and oil exploration and production wastes are exempt from the hazardous waste management requirements of the Resource Conservation Recovery Act. However, the EPA determined that certain exploration and production wastes resulting from the maintenance of production equipment and transportation are not exempt, and these wastes must be managed and disposed of as hazardous waste. Also, regulations issued by the EPA under the Clean Water Act require a permit for \"contaminated\" stormwater discharges from exploration and production facilities.\nMany states have issued new regulations under authority of the Clean Air Act Amendments of 1990, and such regulations are in the process of being implemented. These regulations may require certain gas and oil related installations to obtain federally enforceable operating permits and may require the monitoring of emissions; however, the impact of these regulations on EP is expected to be minor.\nSeveral states have adopted regulations on the handling, transportation, storage, and disposal of naturally occurring radioactive materials that are found in gas and oil operations. Although applicable to certain EP facilities, it is not believed that such regulations will materially impact current or future operations.\nIn the aggregate, compliance with federal and state environmental rules and regulations is not expected to have a material effect on EP's operations.\nThe Railroad Commission of Texas (\"RRC\") regulates the production of natural gas and oil by EP in Texas. Similar regulations are in effect in all states in which EP explores for and produces natural gas and oil. These regulations generally require permits for the drilling of gas and oil wells and regulate the spacing of the wells, the prevention of waste, the rate of production, and the prevention and cleanup of pollution and other materials.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe following table sets forth a summary of certain information relating to EP's gas and oil properties:\nThe 1994 capital spending budget has been set at $114 million, about the same as 1993 actual capital expenditures. More than half of the 1994 capital expenditures is earmarked for domestic onshore drilling. The exploration program includes a balanced mix of projects with regard to reserve potential\nand risk, focusing on as many core area opportunities as possible. See \"Financial Review - Capital Resources and Liquidity\" included in Appendix A to this report.\nDuring 1993, Enserch Exploration filed Form EIA-23 with the Department of Energy reflecting reserve estimates for the year 1992. Such reserve estimates were not materially different from the 1992 reserve estimates reported in Note 7 of the Notes to Consolidated Financial Statements included in Appendix A to this report.\nA summary of EP's average sales prices, average production costs and amortization are set forth under \"Selected Financial and Operating Data\" included in Appendix A to this report.\nEP owned leasehold interests or licenses in 17 states and offshore Texas and Louisiana, as of December 31, 1993, as follows:\nThe number of wells drilled is not a significant measure or indicator of the relative success or value of a drilling program because the significance of the reserves and economic potential may vary widely for each project. It is also important to recognize that reported completions may not necessarily track capital expenditures, since Securities and Exchange Commission guidelines do not allow a well to be reported as complete until it is ready for production. In the case of offshore wells, this may be several years following initial drilling because of construction of platforms, pipelines and other necessary facilities.\nAdditional information relating to the gas and oil activities of EP is set forth in Note 7 of the Notes to Financial Statements appearing in Appendix A to this report.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe information required hereunder is set forth in Note 5 of the Notes to Financial Statements in Appendix A to this report.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe information required hereunder is set forth under \"Depositary Unit Market Prices and Distribution Information\" set forth in Appendix A to this report.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe information required hereunder is set forth under \"Selected Financial and Operating Data\" set forth in Appendix A to this report.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required hereunder is set forth under \"Financial Review\" included in Appendix A to this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe information required hereunder is set forth under \"Independent Auditors' Report,\" \"Management Report on Responsibility for Financial Reporting,\" \"Statements of Operations,\" \"Statements of Cash Flows,\" \"Balance Sheets,\" \"Statements of Changes in Partners' Capital\" and \"Notes to Financial Statements\" included in Appendix A to this report.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nSet forth below is information concerning the directors and executive officers of EEI and directors of ENSERCH who are involved with the conduct of operations of EP. Presently, all directors of EEI and ENSERCH are elected annually.\nDirectors of ENSERCH\nD. W. Beigler, age 47, is Chairman and President, Chief Executive Officer of ENSERCH. Prior to his election to his present position in 1993, he served Lone Star Gas Company, the utility division of the Corporation, as President from 1985 and as Chairman from 1989 and was elected President and Chief Operating Officer of the Corporation in 1991. Mr. Biegler is a Director of ENSERCH, Texas Commerce Bancshares, Inc. and Trinity Industries, Inc. He has been a Director of ENSERCH since 1991.\nW. C. McCord, age 65, is retired Chairman and Chief Executive Officer of ENSERCH. Mr. McCord is a Director of Lone Star Technologies, Inc., and Pool Energy Services Co. He has been a Director of ENSERCH since 1970.\nPreston M. Geren, Jr., age 70, is an investor active in real estate, oil and gas, and banking. He was formerly the owner of Geren Associates, Architects, Engineers & Planners. Mr. Geren has been a Director of ENSERCH\nsince 1973 and serves as Chairman of the Audit Committee and is a member of the Policy and Conflicts of Interest Committee. He is a Director of Overton Bancshares, Inc., Overton Bank & Trust Co., Pool Energy Services Co., and Cassco Development Corporation.\nW. Ray Wallace, age 71, is Chairman, President and Chief Executive Officer, and Director, Trinity Industries, Inc., a fabricated steel products company. Mr. Wallace has been a Director of ENSERCH since 1978 and serves as Chairman of the Compensation Committee and is a member of the Audit Committee. He is a Director of Lomas Financial Corporation.\nWilliam B. Boyd, age 70, is retired Chairman of the Board, President and Chief Executive Officer, American Standard Inc., a manufacturer of air conditioning, building, and transportation products. Mr. Boyd has been a Director of ENSERCH since 1984 and serves as Chairman of the Nominating Committee and is a member of the Compensation Committee. Mr. Boyd is a Director of Armco Inc. and FMC Corporation.\nB. A. Bridgewater, Jr., age 60, is Chairman, President and Chief Executive Officer, and Director, Brown Group, Inc., a consumer products company with operations in footwear and specialty retailing. Mr. Bridgewater has been a Director of ENSERCH since 1987 and serves as Chairman of the Policy and Conflicts of Interest Committee and is a member of the Audit Committee. He is a Director of Boatmen's Bancshares, Inc., FMC Corporation, and McDonnell Douglas Corporation.\nJ. M. Haggar, Jr., age 69, is retired Chairman of the Board, and Director, Haggar Apparel Company, a manufacturer of apparel for men. Mr. Haggar has been a Director of ENSERCH since 1988 and is a member of the Directors' Nominating Committee and the Policy and Conflicts of Interest Committee. He is a Director of Brinker International, Inc.\nDr. L. E. Fouraker, age 70, is retired from the position of Dean of the Harvard Business School. Dr. Fouraker has been a Director of ENSERCH since 1990 and is member of the Compensation Committee and the Directors' Nominating Committee. He is a Director of Alcan Aluminum Limited, Citicorp, General Electric Company, Gillette Company, Ionics, Inc., and The New England.\nM. J. Girouard, age 54, is President and Chief Operating Officer, and Director, Pier 1 Imports, Inc. Mr. Girouard has been a Director of ENSERCH since 1992 and is a member of the Compensation Committee and the Directors' Nominating Committee.\nDr. Diana S. Natalicio, age 54, is President, University of Texas at El Paso. Dr. Natalicio has been in her present position since 1988. She is a Director of Lomas Financial Corporation and Sandia Corporation.\nThe Policy and Conflicts of Interest Committee of ENSERCH reviews areas of potential conflict between EP and ENSERCH, its subsidiaries and affiliates (\"ENSERCH\" companies) and takes such action as it deems appropriate in order to provide reasonable assurances of fair dealings between such entities. The Committee meets at least annually, and more frequently if necessary.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe total amount of compensation paid by EEI to all its executive officers for the year ended December 31, 1993, which was charged to EP, was $500,129 (2 persons). The amounts paid include base salary, bonus and other miscellaneous earnings categories. The directors of EEI are not compensated in their capacities as directors.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 9, 1994:\nName and Address of Beneficial Owner Amount and Nature Percent of Depositary Units of Beneficial Ownership of Class - -------------------- ----------------------- ----------\nENSERCH Corporation 101,694,162 Indirect 99.2(1) 300 South St. Paul Street Dallas, Texas 75201 - ------------ (1) Includes 98,581,800 units representing limited partnership interests held by an affiliate, Enserch Processing Partners, Ltd., which may be exchanged at any time for Depositary Units of EP. No Directors or Officers of ENSERCH or EEI own any units.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nEP commenced operations in 1985 following the transfer to it of substantially all of the domestic gas and oil exploration and production business of ENSERCH. For a description of the transactions and properties involved in the transfer, see \"Business\", \"Properties\" and Notes to Financial Statements in Appendix A to this report.\nFor information concerning related party transactions between EP and ENSERCH (including its affiliates), see \"Directors and Executive Officers of Registrant-Directors of ENSERCH\" and the Notes to Financial Statements in Appendix A to this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)-1 Financial Statements\nThe following items appear in the Financial Information section included as Appendix A to this report:\nItem Page ----- ----\nSelected Financial and Operating Data. . . . . . . . . . . . . . . A-2 Financial Review . . . . . . . . . . . . . . . . . . . . . . . . . A-3 Independent Auditors' Report . . . . . . . . . . . . . . . . . . . A-7 Management Report on Responsibility for Financial Reporting. . . . A-8 Financial Statements: Statements of Operations . . . . . . . . . . . . . . . . . . . A-10 Statements of Cash Flows . . . . . . . . . . . . . . . . . . . A-11 Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . A-12 Statements of Changes in Partners' Capital . . . . . . . . . . A-13 Notes to Financial Statements. . . . . . . . . . . . . . . . . . . A-14 Depositary Unit Market Prices and Distribution Information . . . . A-25\n(a)-2 Financial Statement Schedules\nThe following items are included in Appendix B to this report:\nItem Page ---- ----\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . . . B-2 Financial Statement Schedules for the Three Years Ended December 31, 1993: IV -Indebtedness to Related Parties . . . . . . . . . . B-3 V -Property, Plant and Equipment . . . . . . . . . . . B-4 VI -Accumulated Depreciation and Amortization of Property, Plant and Equipment . . . . . . . . . . . B-5 X -Supplementary Statements of Operations Information . . . . . . . . . . . . . . . . . . . . B-6\nThe financial statement schedules, other than those listed above, are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto.\n(a)-3 Exhibits\n4.1* - Agreement of Limited Partnership of EP and amendment No. 1 thereto as currently in effect, filed as Exhibit 4.1 to Registrant's Form 10-K for the fiscal year ended December 31, 1992.\n4.2* - Form of Certificate for Limited Partner's Units of EP filed as Exhibit 3.2 and included as Annex I to Exhibit B to the Prospectus included in Registration Statement No. 2-96373.\n4.3* - Agreement of Limited Partnership of EPO and amendments No. 1 and No. 2 thereto currently in effect, filed as Exhibit 4.3 to Registrant's Form 10-K for the fiscal year ended December 31, 1992.\n4.4* - Depositary Agreement among EP, Harris Trust Company of New York as the Depositary and the Unitholders, relating to EP Depositary Units, filed as Exhibit 4.1 to Registration Statement No. 2- 96373.\n4.5* - Form of Specimen Depositary Receipt filed as Exhibit 4.2 to Registration Statement No. 2-96373.\n10.1*- Assignment and Conveyance from EP Operating Limited Partnership \"Grantor\" to Encogen One Partners, Ltd. \"Grantee\" dated February 29, 1988, filed as Exhibit 10.1 to Registrant's Form 10-K for the fiscal year ended December 31, 1987.\n23** - Consent of DeGolyer and MacNaughton.\n24** - Powers of Attorney - ------------ * Incorporated and herein by reference made a part hereof. ** Filed herewith\n(b) No reports on Form 8-K were filed during the three months ended December 31, 1993.\nSIGNATURES\nPursuant 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:\nENSERCH EXPLORATION PARTNERS, LTD. (A Texas Limited Partnership):\nBy: ENSERCH EXPLORATION, INC. Managing General Partner\nMarch , 1994 By \/s\/ D. W. Biegler ---------------------- D. W. Biegler, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the date indicated.\nSignature and Title Date ------------------ ------\nD. W. Biegler, Chairman, Chief Executive Officer and Director; Gary J. Junco, President, Chief Operating Officer and Director; R. L. Kincheloe, Senior Vice President, Offshore and International, March , 1994 and Director; W. T. Satterwhite, Director; S. R. Singer, Director; and J. W. Pinkerton, Vice President and Controller\nBy: \/s\/ D. W. Biegler D. W. Biegler As Attorney-in-Fact\nAPPENDIX A\nENSERCH EXPLORATION PARTNERS, LTD. INDEX TO FINANCIAL INFORMATION December 31, 1993\nPage\nSelected Financial and Operating Data. . . . . . . . . . . . . . . . . . A-2\nFinancial Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-3\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . A-7\nManagement Report on Responsibility for Financial Reporting. . . . . . . A-8\nFinancial Statements:\nStatements of Operations. . . . . . . . . . . . . . . . . . . . A-10\nStatements of Cash Flows. . . . . . . . . . . . . . . . . . . . A-11\nBalance Sheets. . . . . . . . . . . . . . . . . . . . . . . . . A-12\nStatements of Changes in Partners' Capital. . . . . . . . . . . A-13\nNotes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . A-14\nDepositary Unit Market Prices and Distribution Information . . . . . . . A-25\nA-1\nA-2\nENSERCH EXPLORATION PARTNERS, LTD. FINANCIAL REVIEW\nRESULTS OF OPERATIONS\nEP had a net loss of $4 million in 1993, compared with a loss of $20 million in 1992 and a loss of $50 million in 1991. The 1992 loss included a $16 million write-off of an idle pipeline and shallow-water production facility from an abandoned offshore project, and 1991 results included a $51 million noncash charge for a write-down under the \"ceiling test\" for the \"full cost\" method of accounting. Excluding the write-downs, EP's 1993 net loss was about the same as in 1992 and compares with income of $1.8 million in 1991.\nExcluding the write-downs, operating income for 1993 was $26 million versus $16 million in 1992 and $21 million in 1991. The improvement resulted from significantly increased natural-gas prices and higher sales volumes. Revenues for 1993 of $185 million were 12% higher than 1992 and 6% above 1991.\nNatural-gas revenues were $145 million, compared with $117 million for 1992 and $122 million for 1991. The average natural-gas price per thousand cubic feet (Mcf) in 1993 was $2.09, up 15% from $1.82 in 1992 and 19% from $1.76 in 1991. Natural-gas sales volumes in 1993 of 69 billion cubic feet increased 7% from the 1992 level and were virtually the same as in 1991. The increase in volumes for 1993 was principally due to accelerated natural-gas development drilling in East Texas and offshore production from Mississippi Canyon Block 441 in the Gulf of Mexico, which went on stream in the second quarter of 1993.\nSpot-market sales, which include monthly and short-term industrial sales, covered about 70% of 1993 gas sales, compared with 80% in 1992 and 75% in 1991. During 1994, the percentage of gas sold in the spot market is expected to be in the range of 75% to 85%.\nOil revenues were $34 million in 1993, compared with $41 million in 1992 and $49 million in 1991. The average sales price per barrel for 1993 of $17.20 was 10% below 1992 and 16% under 1991. Oil sales volumes for 1993 were 2.0 million barrels (MMBbls), an 8% decline from the 1992 level which was down 11% from the 1991 level. The lower volumes in 1993 were primarily the result of declining production from several North Texas reservoirs.\nExcluding the previously noted write-downs, costs and expenses for 1993 were $159 million, compared with $150 million in 1992 and $153 million in 1991. The increase in expenses for 1993 reflects provisions totaling $7.1 million for pending litigation. Also, depreciation and amortization expense for 1993 of $77 million was $1.6 million higher than 1992, primarily due to increased production. The overall rate of amortization was $.91 per million British thermal units (MMBtu) produced for both 1993 and 1992, compared with $.83 in 1991. Costs of additional offshore projects and increased development costs associated with older East Texas fields largely account for the increase from 1991. Average production cost per MMBtu in 1993 was $.54, compared with $.53 in 1992 and $.56 in 1991.\nA-3\nInterest expense in 1993 of $30 million was approximately $10 million higher than both 1992 and 1991. The increase reflects a $6 million provision for interest due royalty owners. A higher level of debt and less interest capitalized also contributed to the 1993 increase.\nEP's natural-gas reserves at January 1, 1994, were 1.09 trillion cubic feet (Tcf), compared with 1.10 Tcf the year earlier, as estimated by DeGolyer and MacNaughton, independent petroleum consultants. Oil and condensate reserves, including natural gas liquids attributable to leasehold interest, were 38 MMBbls, virtually the same as the year-ago level.\nAt January 1, 1994, estimated future net cash flows from EP's owned proved gas and oil reserves, based on average prices and contracts in effect in December 1993, were $2.0 billion, about the same as the year earlier. The net present value of such cash flows, discounted at the Securities and Exchange Commission (SEC)-prescribed 10%, was $1.1 billion, virtually the same as the prior year. These discounted cash flow amounts are the basis for the SEC-prescribed cost- center ceiling under the full-cost accounting method. The margin between the cost-center ceiling and the unamortized capitalized costs of U.S. gas and oil properties was approximately $150 million at December 31, 1993. Product prices are subject to seasonal and other fluctuations. A significant decline in prices from yearend 1993 or other factors, without mitigating circumstances, could cause a future write-down of capitalized costs and a noncash charge against earnings.\nCAPITAL RESOURCES AND LIQUIDITY\nNet cash flows from operating activities in 1993 were $76 million, $12 million lower than 1992 primarily due to less cash provided by changes in net current operating assets and liabilities, and were virtually the same as in 1991. Investing activities required net cash flows of $124 million, compared with $69 million in 1992 and $105 million in 1991. The increase in 1993 is primarily due to a higher level of capital spending for natural-gas and oil exploration and development programs.\nIn 1993, $48 million was required for investing activities after cash provided by operations, and cash of $31 million was required for the payment of distributions to unitholders. The total requirement of $79 million was provided by an increase in borrowings from affiliated companies and advances under leasing arrangements that temporarily exceeded disbursements for the facilities under construction.\nEP has budgeted $114 million for additions to property, plant and equipment in 1994, compared with expenditures of $113 million in 1993. In 1992, EP's capital spending was sharply curtailed to $63 million in response to poor prices for both natural gas and oil. If the early 1994 weakness in oil prices persists throughout 1994, appropriate cutbacks in spending may be undertaken. More than half of EP's 1994 capital expenditures is earmarked for domestic onshore drilling.\nIn 1992, EP entered into operating lease arrangements to provide financing for its portion of the offshore platforms and related facilities for the Mississippi Canyon Block 441 (37.5% owned) and Garden Banks Block 388 (100% owned) projects. A total of $34 million was required for the Mississippi Canyon Block 441 project, which was completed in early 1993. The lease arrangement to\nA-4\nfund the construction costs for the Garden Banks facility is estimated to total $235 million when completed in 1995. (See Note 5)\nOn January 3, 1994, EP paid a quarterly distribution of $.075 per unit. In February 1994, EP announced that the quarterly distributions to unitholders had been indefinitely suspended.\nEven though inflation has abated considerably from the levels of the early 1980s, and was only about 2.5% in 1993, it continues to have some influence on EP's operations. Most notable is that allowances for depreciation and amortization based on the historical cost of fixed assets may be insufficient to cover the replacement of some long-lived fixed assets.\nThe impact of the Clean Air Act Amendments of 1990 (Act) on EP cannot be fully ascertained until the regulations that implement that Act have been approved and adopted. Management currently believes that operating costs that will be incurred under the new permit fee structure, any capital expenditures associated with equipment modifications, and any other miscellaneous permitting costs required under the Act will not have a material adverse effect on EP's results of operations. Management expects the provisions of the Act will increase the attractiveness of natural gas as compared with certain alternative fuels; however, it is impossible to quantify any increase in demand for natural gas, if any, that may be created by the Act.\nFOURTH-QUARTER RESULTS\nEP had a net loss of $6.5 million for the fourth quarter of 1993, compared with a loss of $16 million for the 1992 fourth quarter, which included the $16 million write-off of the abandoned offshore facilities. Excluding the write- off, operating income for the fourth quarter was $4.8 million versus $6.2 million for the same period of 1992. Revenues in 1993 of $50 million were 14% greater than 1992 primarily due higher natural-gas revenues resulting from a 24% increase in sales volumes. The average natural-gas sales price for the fourth quarter of $2.22 per Mcf was about the same as the prior year. Operating expenses and interest expense were both higher than in the prior year due to the previously noted provisions for pending litigation and interest due royalty owners.\nDRILLING PROGRAM\nDrilling activity during the first half of 1993 increased to levels last experienced in 1987, primarily because of development work in East Texas. EP participated in 109 wells (79 net) in 1993, with the majority completed as gas producers in East Texas. Thirty-six wells were in progress at yearend. Recompletions and production optimization measures had a major role in the 1993 production enhancement program.\nResults for 1994 will include a full year of production from the Mississippi Canyon Block 441 deep-water project in the Gulf of Mexico, which began production in early 1993. The field is producing some 70 million cubic feet (MMcf) of natural gas and more than 500 barrels of condensate per day from six wells. EP is the operator, with a 37.5% working interest in the project.\nA-5\nThe Garden Banks Block 388 oil development project, also in the Gulf, remains on schedule and on budget, with initial production anticipated by mid- 1995. The final major contract for the conversion of a semi-submersible drilling rig to a floating production facility was finalized in early 1994. Installation of the offshore facilities, consisting of the subsea template, gathering and sales pipelines and shallow-water operations, will begin by mid-year. Three previously drilled oil wells will be connected to the subsea template in 1995. Initial daily production from three predrilled wells is expected to total 15 thousand barrels (MBbls) of oil and 12 to 15 MMcf of gas by late 1995, with peak daily production from the Garden Banks project anticipated in late 1996 at 40 MBbls of oil and 60 MMcf of gas. Gross proven reserves are presently estimated to be equivalent to 28 MMBbls of oil by DeGolyer and MacNaughton. EP is 100% interest owner and operator of the Garden Banks project.\nNEW ACCOUNTING STANDARDS\nSFAS No. 106, \"Employer's Accounting for Postretirement Benefits Other than Pensions,\" which mandates the accounting for medical and life insurance and other nonpension benefits provided to retired employees, was adopted by EP effective January 1, 1993. (See Note 2)\nSFAS No. 112, \"Employer's Accounting for Postemployment Benefits,\" will become effective for EP in 1994. This standard covers the accounting for estimated costs of benefits provided to former or inactive employees before their retirement. EP receives an allocation of these benefits from ENSERCH which currently accrues costs of benefits to former or inactive employees by varying methods. The new standard is not expected to have a significant effect on results of operations or financial condition.\nA-6\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Enserch Exploration Partners, Ltd.:\nWe have audited the accompanying balance sheets of Enserch Exploration Partners, Ltd. as of December 31, 1993 and 1992, and the related statements of operations, cash flows and changes in partners' capital for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of the Partnership at December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE\nDallas, Texas February 7, 1994\nA-7\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Enserch Exploration, Inc. (a wholly owned subsidiary of ENSERCH), as Managing General Partner of Enserch Exploration Partners, Ltd., is responsible for the preparation, presentation and integrity of the financial statements. These statements have been prepared in conformity with accounting principles generally accepted in the United States and include amounts that represent management's best estimates and judgments. Management has established practices and procedures designed to support the reliability of the estimates and minimize the possibility of a material misstatement. Management also is responsible for the accuracy of the other information presented in the annual report on Form 10-K and for its consistency with the financial statements.\nManagement has established and maintains internal accounting controls that provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management continually monitors compliance with the system of internal accounting controls. ENSERCH maintains a strong internal audit function that evaluates the adequacy of the system of internal accounting controls. As part of the annual audit of the financial statements, Deloitte & Touche also performs a study and evaluation of the system of internal accounting controls as necessary to determine the nature, timing and extent of their auditing procedures. The Board of Directors of ENSERCH maintains an Audit Committee composed of Directors who are not employees. The Audit Committee meets periodically with management, the independent auditors and the internal auditors to discuss significant accounting, auditing, internal accounting control and financial reporting matters. A procedure exists whereby either the independent auditors or the internal auditors through the independent auditors may request, directly to the Audit Committee, a meeting with the Committee.\nManagement has given proper consideration to the independent and internal auditors' recommendations concerning the system of internal accounting controls and has taken corrective action believed appropriate in the circumstances. Management further believes that, as of December 31, 1993, the overall system of internal accounting controls is sufficient to accomplish the objectives discussed herein.\nA-8\nManagement recognizes its responsibility for establishing and maintaining a strong ethical climate so that the Partnership's affairs are conducted according to the highest standards as defined in ENSERCH's Statement of Policies. The Statement of Policies is publicized throughout ENSERCH and addresses, among other issues, open communication within ENSERCH; the disclosure of potential conflicts of interest; compliance with the laws, including those relating to financial disclosures; and the confidentiality of proprietary information.\nEnserch Exploration, Inc. Managing General Partner of Enserch Exploration Partners, Ltd.\n\/s\/ Gary J. Junco - ------------------ Gary J. Junco President, Chief Operating Officer\n\/s\/J. W. Pinkerton - ------------------ J. W. Pinkerton Vice President and Controller\nA-9\nA-10\nA-11\nA-12\nA-13\nENSERCH EXPLORATION PARTNERS, LTD. NOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND CONTROL\nEnserch Exploration Partners, Ltd. (\"EP\"), a Texas limited partnership, was formed in 1985 to succeed to substantially all of the domestic gas and oil exploration and production business of ENSERCH Corporation (\"ENSERCH\"). At December 31, 1993, ENSERCH and Enserch Processing Partners, Ltd. (\"Processing\") owned 3,112,362 (3.0%) and 98,581,800 (96.2%), respectively, of EP's limited partnership units outstanding. The balance of 805,914 (.8%) of EP's units outstanding is held by the public. For administrative convenience, EP operates through EP Operating Limited Partnership (\"EPO\"), formerly EP Operating Company, a Texas limited partnership, in which EP holds a 99% limited partner's interest and the general partners own a 1% interest. Enserch Exploration, Inc. (\"EEI\") is the managing general partner and ENSERCH is the special general partner of EP and EPO.\nEP has no officers, directors or employees. Instead, officers, directors and employees of EEI perform all management and operating functions for EP. Neither ENSERCH nor EEI, as general partners of EP, receives any carried interests, promotions, back-ins or other compensation.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation - The financial statements of EP have been prepared in conformity with generally accepted accounting principles but will not be the basis for reporting taxable income to unitholders. The proportional consolidation method is used whereby the financial statements reflect EP's 99% interest in EPO's assets, liabilities and operations. All dollar amounts except per unit amounts in the notes to financial statements are stated in thousands unless otherwise indicated.\nNatural Gas and Oil Hedging Contracts - Gains and losses from transactions to hedge against volatile product prices are included in revenues in the statements of operations.\nGas and Oil Properties - The full-cost method, as prescribed by the Securities and Exchange Commission (SEC), is used whereby the costs of proved and unproved gas and oil properties, together with successful and unsuccessful exploration and development costs, are capitalized. The carrying value is limited to the present value of estimated future net revenues of proved reserves, the cost of excluded properties and the lower of cost or market value of unproved properties being amortized (\"full-cost ceiling\"). The full-cost ceiling is calculated quarterly under current SEC rules. In March 1991, EP recorded a $51 million noncash write-down of the carrying value of its gas and oil properties due to the full-cost center ceiling limitation test.\nDry-hole costs resulting from exploration activities are classified as evaluated costs and are included in the amortization base. Costs directly associated with the acquisition and evaluation of unproved properties are excluded from the amortization base until the related properties are evaluated. Such unproved properties are assessed periodically and a provision for impairment is made to the full-cost amortization base when appropriate. Sales of gas and oil properties are credited to capitalized costs unless the sale would have a significant impact on the amortization rate.\nA-14\nIn December 1992, EP recorded a $16 million noncash write-off of an idle pipeline and shallow-water production facility from an abandoned offshore project.\nDepreciation and Amortization - Amortization of evaluated gas and oil properties is computed on the unit-of-production method using estimated proved gas and oil reserves quantified on the basis of their equivalent energy content. Depreciation of other property, plant and equipment is provided principally by the straight-line method over the estimated service lives of the related assets.\nIncome Taxes - EP is a partnership and, as a result, the income or loss of the partnership, which reflects differences in the timing of the deduction of certain gas and oil drilling and development costs for federal income tax purposes, is includable in the tax returns of the individual partners. Accordingly, no recognition has been given to income taxes in the financial statements of EP. The assets and liabilities reported in the financial statements of EP exceeded the federal income-tax bases by approximately $704 million and $720 million at December 31, 1993 and 1992, respectively.\nRetirement Plan - Substantially all personnel who are associated with EP are covered by an ENSERCH retirement plan and are eligible for certain health care and life insurance benefits upon retirement. Total pension costs allocated to EP were $867, $1,054, and $929 in 1993, 1992 and 1991, respectively. Post-retirement health care and life insurance benefit costs allocated to EP were $821, $550, and $577 in 1993, 1992 and 1991, respectively. Postretirement benefits in 1993 reflect the impact of SFAS No. 106 \"Employer's Accounting for Postretirement Benefits Other Than Pensions\", effective in January 1993. This new standard requires the accrual of these benefits over the working life of the employee rather than charging to expense on a cash basis.\nFair Value of Financial Instruments - The fair value of financial instruments has been estimated using valuation methodologies in accordance with SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments\". Determinations of fair value are based on subjective data and significant judgment relating to timing of payments and collections and the amounts to be realized. Accordingly, the estimates presented are not necessarily indicative of the amounts that EP could realize in a current market exchange.\nManagement believes that the fair value of financial instruments, other than long-term debt, is not materially different than the related carrying value. The estimated fair value for long-term debt is presented in Note 3.\nA-15\n3. LINE OF CREDIT AND BORROWINGS\nShort-term Borrowing Arrangements - Both EP and EPO maintain separate short-term borrowing arrangements with ENSERCH to meet operating needs. Under these arrangements, ENSERCH may advance funds to EP or EPO, and EP or EPO may advance funds to ENSERCH. EPO further maintains a short-term borrowing arrangement with EEI by which EEI may advance funds to EPO and EPO may advance funds to EEI. Under all these arrangements, the aggregate amount of short-term loans available between the parties is at the respective lender's sole discretion, and any amounts advanced under the arrangements mature within 12 months from the date the advance is made. The interest rate is the 30-day commercial paper rate available for similar amounts on commercial paper borrowings by ENSERCH. Interest is payable monthly. These arrangements are renewed annually. At December 31, 1993, there were $27,216 of net short-term borrowings outstanding under these arrangements at an interest rate of 3.28%.\nLong-term Notes Payable - Long-term notes payable to Processing are summarized below:\nInterest on the above notes is payable semiannually on June 30 and December 31. The estimated fair value of these notes was $352 million at December 31, 1993 and $300 million at December 31, 1992. The calculation was made using a discounted cash flow approach based on the interest rates currently available to ENSERCH for debt with similar terms and remaining maturities.\n4. RELATED PARTY TRANSACTIONS\nIn the ordinary course of business, EP engages in various transactions with ENSERCH and its affiliates. All such transactions are subject to review by the Policy and Conflicts of Interest Committee of ENSERCH, a committee composed solely of outside directors. The Committee has found no unfair dealings between and among such parties. EP is charged for direct costs incurred by ENSERCH and EEI that are associated with managing EP's business and operations. Additionally, indirect costs (principally general and\nA-16\nadministrative costs) applicable to EP are allocated to EP by ENSERCH. Such charges amounted to $2,026, $1,927 and $1,798 in 1993, 1992 and 1991, respectively.\nEP had sales to affiliated companies (Enserch Gas Company, Lone Star Gas Company and Processing) of $108,916, $32,508 and $32,710 in 1993, 1992 and 1991, respectively. In 1993, affiliated revenues include gas sales of $91,000 under new contracts effective March 1, 1993 with Enserch Gas Company covering essentially all gas production not committed under existing contracts.\nNet interest costs incurred on affiliated borrowings were $27,120, $25,336, and $22,872 in 1993, 1992 and 1991, respectively.\n5. COMMITMENTS AND CONTINGENT LIABILITIES\nAdvances Under Leasing Arrangements - In May 1992, EP entered into an operating leasing arrangement to provide financing for its portion of the offshore platform and related facilities for the 37 1\/2% owned Mississippi Canyon Block 441 project. A total of $34 million was required for the project, which was completed in early 1993. EP leased the facilities for an initial period through May 20, 1994, with an option to renew the lease, with the consent of the lessor, for up to 10 successive six-month periods. The lease has been renewed through November 20, 1994 and EP expects to renew the lease for all renewal periods. EP has the option to purchase the facilities throughout the lease periods and as of December 31, 1993, has guaranteed an estimated residual value for the facilities of approximately $27 million should the lease not be renewed. Expenses incurred under the lease in 1993 was $2.1 million. The estimated future minimum net rentals for the Mississippi Canyon operating lease is $6.3 million for 1994.\nIn September 1992, EP entered into an operating lease arrangement to provide financing for the offshore platform and related facilities of its 100% owned Garden Banks Block 388 project. The lessor will fund the construction cost of the facilities quarterly, up to a maximum of $235 million. As of December 31, 1993, a total of $60 million had been advanced to EP under the lease as agent for the lessor, $31 million of which was unexpended and reflected as a current liability. EP will lease the facilities for an initial period through March 31, 1997, with the option to renew the lease, with the consent of the lessor, for up to three successive two-year periods. EP, as agent for the lessors, will acquire, construct and operate the units of leased property and has guaranteed completion of construction of the facilities. EP has the option to purchase the facilities throughout the lease periods and has guaranteed an estimated residual value for the facilities of approximately $188 million, assuming the full lease amounts are advanced and expended, should the lease not be renewed. The estimated future minimum net rentals for the Garden Banks operating lease are as follows: $4.8 million for 1994; $9.1 million for 1995; $9.1 million for 1996; and $2.3 million for 1997. Lease payments are being deferred during the construction period and will be amortized when production begins.\nA-17\nAt December 31, 1993, EEI had several noncancelable operating leases, principally for buildings and office space, that expire at various dates through 1998. EP bears an allocated share of rental expenses incurred by EEI under noncancelable operating leases. EP's allocated share of rental expenses (99% of EEI's rental expenses) totaled $4,985, $3,547 and $2,938 in 1993, 1992 and 1991, respectively. Future minimum rentals under such leases, of which EP would bear its proportionate share, are as follows: $1.3 million for 1994; $1.3 million for 1995; $1.4 million for 1996; $1.5 million for 1997; and $1.4 million for 1998.\nLegal Proceedings - A lawsuit was filed against EEI, ENSERCH, its utility division and EPO in the 348th Judicial District Court of Tarrant County in May 1989. Plaintiffs seek unspecified actual damages and punitive damages in the amount of $5 million. Plaintiffs allege royalties were not fully paid, certain expenses were improperly charged against the amount of royalties due, negligence in the venting of gas and liquid hydrocarbons into the air, and breach of duty of good faith and fair dealing by wrongfully concealing certain material facts concerning sales of gas from the subject leases to the utility division.\nA lawsuit was filed on February 24, 1987, in the 112th Judicial District of Sutton County, Texas, against subsidiaries and affiliates of ENSERCH, as well as its utility division. The plaintiffs have claimed that defendants failed to make certain production and minimum purchase payments under a gas- purchase contract. In this connection, the plaintiffs have alleged a conspiracy to violate purchase obligations, improper accounting of amounts due, fraud, misrepresentation, duress, failure to properly market gas and failure to act in good faith. In this case, plaintiffs seek actual damages in excess of $5 million and punitive damages in an amount equal to 0.5% of the consolidated gross revenues of ENSERCH for the years 1982 through 1986 (approximately $85 million), interest, costs and attorneys' fees.\nOn December 26, 1989, a lawsuit was filed against EEI and EPO in the 130th Judicial District Court of Matagorda County, Texas. The plaintiff claims that the defendants breached an alledged contract to sell a working interest and net revenue interest in two leases located in Matagorda County. Trial of the case resulted in a jury verdict in favor of the plaintiff. Judgment was entered by the trial court on October 8, 1992, ordering EEI and EPO to convey the leases to the plaintiff and to pay damages of $3.1 million, which includes principal, prejudgment interest, attorneys' fees and costs. This judgment was appealed to the Corpus Christi Court of Appeals on September 2, 1992. Counsel has advised that there is a reasonable basis to believe that the decision of the trial court will be reversed.\nOn October 25, 1991, a lawsuit was filed against EEI, EPO and ENSERCH in the 111th District Court of Webb County Texas. Other parties have intervened. The plaintiffs and intervenors claim that the defendants' failure to reassign\nA-18\npart of an gas and oil lease covering approximately 33,000 net mineral acres in breach of defendants' contractual reassignment obligations entitles them to recover the fair market value of the lost leasehold estate and lost overriding royalty interests. Plaintiffs and intervenors claim actual damages of approximately $3.1 million for the lost leasehold estate, and approximately $2.2 million for the lost overriding royalty interests. They also seek pre- judgment interest, attorney's fees and costs.\nManagement believes that the named defendants have meritorious defenses to the claims made in these and other actions. In the opinion of management, EP will incur no liability from these and all other pending claims and suits that would be considered material for financial reporting purposes.\n6. SUPPLEMENTAL FINANCIAL INFORMATION\nQuarterly Results (Unaudited) - The results of operations by quarters are summarized below. In the opinion of EP's management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been made.\nDecrease (Increase) in Current Operating Assets and Liabilities by Components - is summarized below:\nA-19\nInterest Costs - are summarized below:\n7. SUPPLEMENTAL GAS AND OIL INFORMATION\nGas and Oil Producing Activities - The following tables set forth information relating to gas and oil producing activities. Reserve data for natural gas liquids attributable to leasehold interests owned by EP are included in oil and condensate.\nA-20\nExcluded Costs - The following table sets forth the composition of capitalized costs excluded from the amortizable base as of December 31, 1993:\nAt December 31, 1993, approximately 43% of excluded costs relates to offshore activities in the Gulf of Mexico and the remainder relates to domestic onshore exploration activities. The anticipated timing of the inclusion of these costs in the amortization computation will be determined by the rate at which exploratory and development activities continue, which is expected to be accomplished within ten years.\nGas and Oil Reserves (Unaudited) - The following table of estimated proved and proved developed reserves of gas and oil has been prepared utilizing estimates of yearend reserve quantities provided by DeGolyer and MacNaughton, independent petroleum consultants. Reserve estimates are inherently imprecise and estimates of new discoveries are more imprecise than those of producing gas and oil properties. Accordingly, the reserve estimates are expected to change as additional performance data becomes available. Oil reserves (which include condensate and natural gas liquids attributable to leasehold interests) are stated in thousands of barrels (MBbl). Gas reserves are stated in million cubic feet (MMcf). All reserves are located in the United States.\nA-21\nIncluded in oil reserve estimates are natural gas liquids for leaseold interest of 931 MBbl for 1993; 789 MBbl for 1992; and 743 MBbl for 1991.\nA-22\nResults of Operations for Producing Activities (excluding corporate overhead and interest costs) - are as follows:\nStandardized Measure of Discounted Future Net Cash Flows Relating to Proved Gas and Oil Reserve Quantities (Unaudited) - has been prepared by EP using estimated future production rates and associated production and development costs. Continuation of economic conditions existing at the balance sheet date was assumed. Accordingly, estimated future net cash flows were computed by: applying prices in contracts in effect in December to estimated future production of proved gas and oil reserves; estimating future expend- itures to develop proved reserves; and estimating costs to produce the proved reserves based on average costs for the year. Average prices used in the computations were:\nBecause of the imprecise nature of reserve estimates and the unpredictable nature of other variables used, the standardized measure should be interpreted as indicative of the order of magnitude only and not as precise amounts.\nA-23\nThe following table sets forth an analysis of changes in the standardized measure of discounted future net cash flows from proved gas and oil reserves:\nA-24\nENSERCH EXPLORATION PARTNERS, LTD. DEPOSITARY UNIT MARKET PRICES AND DISTRIBUTION INFORMATION\nMarket Prices\nEP's Depositary Units evidenced by Depositary Receipts are traded on the New York Stock Exchange. The following table shows the high and low sales prices per unit reported in the New York Stock Exchange - Composite Transactions report for the periods shown, as quoted in The Wall Street Journal.\nDepositary Unit Data\nDistributions Per Unit\nIn February 1994, the Board of Directors of EEI, managing general partner of EP, announced that the quarterly cash distributions to unitholders had been indefinitely suspended. Reinstatement of a cash distribution will depend on a number of considerations, including future cash flows and capital spending requirements. The following table shows the distributions per limited partnership unit paid by EP during 1993, 1992 and 1991.\nA-25\nAPPENDIX B\nENSERCH EXPLORATION PARTNERS, LTD. INDEX TO FINANCIAL STATEMENT SCHEDULES December 31, 1993\nPage\nIndependent Auditors' Report . . . . . . . . . . B-2\nFinancial Statement Schedules for Each of the Three Years in the Period Ended December 31, 1993:\nIV - Indebtedness to Related Parties. . . . B-3\nV - Property, Plant and Equipment. . . . . B-4\nVI - Accumulated Depreciation and Amortization of Property, Plant and Equipment. . . . . . . . . . B-5\nX - Supplementary Statements of Operations Information. . . . . . . . . . . . . . B-6\nB-1\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Enserch Exploration Partners, Ltd.:\nWe have audited the financial statements of Enserch Exploration Partners, Ltd. as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated February 7, 1994; such report is included elsewhere in this Form 10-K. Our audits also included the financial statement schedules of Enserch Exploration Partners, Ltd. listed in Item 14. These financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE\nDallas, Texas February 7, 1994\nB-2","section_15":""}
{"filename":"88128_1993.txt","cik":"88128","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings.\nIn December 1993, a Consent Decree was entered in the U. S. District Court in Jacksonville, Florida to settle claims of Federal Clean Water Act violations alleged against CSXT. The Consent Decree resolves a civil enforcement action initiated in June, 1992, by the U.S. Environmental Protection Agency with respect to alleged violations by CSXT of permit discharge limitations at five rail yard waste water treatment facilities in Florida and North Carolina. The settlement called for a civil penalty of $3 million, which has been paid by CSXT, as well as the establishment of an escrow account in the amount of $4 million to fund certain environmentally beneficial projects.\nSee Note 12 to the Consolidated Financial Statements, Contingent Liabilities and Long-Term Operating Agreements, on pages 32 and 33.\n- 6 -\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nInformation omitted in accordance with General Instruction J(2)(c).\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.\nThere is no market for CSXT's common stock as CSXT is a wholly- owned subsidiary of CSX. During the years 1993, 1992 and 1991, CSXT paid dividends on its common stock aggregating $28 million, $74 million and $120 million, respectively.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nInformation omitted in accordance with General Instruction J(2)(a).\nHowever, included as part of \"Management's Narrative Analysis and Results of Operations\" on page 35 is various selected financial and statistical information.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nInformation omitted in accordance with General Instruction J(2)(a).\nHowever, in compliance with said Instruction, see \"Management's Narrative Analysis and Results of Operations\" on pages 35 through 41.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements of CSXT and notes thereto required in response to this item are included herein (refer to Index to Financial Statements on page 10).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\n- 7 -\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors, Executive Officers, Promoters and Control Persons of the Registrant.\nInformation omitted in accordance with General Instruction J(2)(c).\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation omitted in accordance with General Instruction J(2)(c).\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation omitted in accordance with General Instruction J(2)(c).\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation omitted in accordance with General Instruction J(2)(c).\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1. Financial Statements.\nSee Index to Financial Statements on page 10.\n2. Financial Statement Schedules.\nNone.\n3. Exhibits.\n(3.1) Articles of Incorporation, as amended, incorporated herein by reference to Registrant's report on Form 10-K for the year ended December 31, 1987.\n(3.2) By-laws of the Registrant, incorporated herein by reference to Registrant's report on Form 10-K for the year ended December 31, 1992.\n(b) Reports on Form 8-K.\nNone.\n- 8 -\nPursuant 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, on the 11th day of March, 1994.\nCSX TRANSPORTATION, INC.\n\/s\/ GREGORY R. WEBER ------------------------------ Gregory R. Weber (Principal Accounting Officer)\nPursuant 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 and on the dates indicated.\nSignatures Title - ----------------------- -------------------------------------\n\/s\/ John W. Snow Chairman of the Board and Director - ----------------- John W. Snow*\n\/s\/ Alvin R. Carpenter President and Chief Executive Officer - ----------------------- (Principal Executive Officer) and Alvin R. Carpenter* Director\n\/s\/ Jerry R. Davis Executive Vice-President and Chief - ------------------- Operating Officer and Director Jerry R. Davis*\n\/s\/ Mark G. Aron Director - ----------------- Mark G. Aron*\n\/s\/ James Ermer Director - ---------------- James Ermer*\n\/s\/ Paul R. Goodwin Senior Vice President - Finance - -------------------- (Principal Finance Officer) Paul R. Goodwin*\n\/s\/ PATRICIA J. AFTOORA - ----------------------- *Patricia J. Aftoora (Attorney-in-Fact) March 11, 1994\n- 9 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES Index to Consolidated Financial Statements\nPage ---- Report of Independent Auditors 11\nCSX Transportation, Inc. and Subsidiaries:\nConsolidated Financial Statements and Notes to Consolidated Financial Statements Submitted Herewith:\nConsolidated Statement of Earnings - Years Ended December 31, 1993, 1992 and 1991 12\nConsolidated Statement of Cash Flows - Years Ended December 31, 1993, 1992 and 1991 13\nConsolidated Statement of Financial Position - December 31, 1993 and 1992 15\nConsolidated Statement of Retained Earnings - Years Ended December 31, 1993, 1992 and 1991 16\nNotes to Consolidated Financial Statements 17\nAll schedules are omitted because of the absence of the conditions under which they are required or because the required information is set forth in the financial statements or related notes thereto.\n- 10 -\nREPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS ---------------------------------------------\nTo the Shareholder and Board of Directors of CSX Transportation, Inc.\nWe have audited the accompanying consolidated statement of financial position of CSX Transportation, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above (appearing on pages 12-34) present fairly, in all material respects, the consolidated financial position of CSX Transportation, Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Notes 1 and 11 to the consolidated financial statements, CSXT changed its method of accounting for post-retirement benefits other than pensions in 1991.\n\/s\/ ERNST & YOUNG ----------------- Ernst & Young\nRichmond, Virginia January 28, 1994\n- 11 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (Millions of Dollars)\nYear Ended December 31, -------------------------------- 1993 1992 1991 ------- ------- ------- OPERATING REVENUE Merchandise $ 2,909 $ 2,770 $ 2,634 Coal 1,363 1,565 1,573 Other 108 99 129 ------- ------- ------- Transportation 4,380 4,434 4,336 Non-Transportation 64 74 88 ------- ------- ------- Total 4,444 4,508 4,424 ------- ------- ------- OPERATING EXPENSE Labor and Fringe Benefits 1,809 1,830 1,849 Materials, Supplies and Other 1,011 973 1,026 Equipment Rent 387 383 376 Depreciation 371 354 344 Fuel 253 262 271 Productivity Charge --- 664 647 ------- ------- ------- Transportation 3,831 4,466 4,513 Non-Transportation 22 20 20 ------- ------- ------- Total 3,853 4,486 4,533 ------- ------- -------\nOPERATING INCOME (LOSS) 591 22 (109) Other Income 11 1 20 Interest Expense 60 73 87 ------- ------- -------\nEARNINGS (LOSS) BEFORE INCOME TAXES 542 (50) (176)\nIncome Tax Expense (Benefit) 234 (33) (71) ------- ------- ------- EARNINGS (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING 308 (17) (105) Cumulative Effect on Years Prior to 1991 of Change in Accounting for Post- retirement Benefits Other than Pensions --- --- (159) ------- ------- ------- NET EARNINGS (LOSS) $ 308 $ (17) $ (264) ======= ======= =======\nSee accompanying Notes to Consolidated Financial Statements.\n- 12 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Millions of Dollars)\nYear Ended December 31, -------------------------- 1993 1992 1991 ------- ------- -------\nOPERATING ACTIVITIES Net Earnings (Loss) $ 308 $ (17) $ (264) Adjustments to Reconcile Earnings (Loss) to Cash Provided Depreciation 371 354 344 Deferred Income Taxes (Benefits) 183 (52) (152) Productivity Charge - Provision --- 664 647 - Payments (245) (353) (72) Cumulative Effect of Change in Accounting --- --- 159 Proceeds from Real Estate Sales 28 41 41 Gain on Sale of Investments (26) --- (39) Gain on Sale of South Florida Track (20) (7) (7) Gain from Disposition of Properties (25) (38) (32) Other Operating Activities 12 (31) (38) Changes in Operating Assets and Liabilities Accounts Receivable 27 30 60 Sale of Accounts Receivable-Net 6 200 --- Materials and Supplies (4) 10 43 Other Current Assets 22 20 (9) Accounts Payable and Other Current Liabilities (7) (96) (156) ------- ------- ------- Cash Provided by Operating Activities 630 725 525 ------- ------- ------- INVESTING ACTIVITIES Property Additions (569) (539) (563) Proceeds from Sale-Leaseback Transactions --- --- 117 Acquisition and Reconstruction Costs for Sale-Leaseback Transactions --- --- (80) Proceeds from Property Dispositions 36 41 53 Proceeds from Sale of Investments 26 --- 106 Proceeds from Sale of South Florida Track 26 10 9 Other Investing Activities 3 (18) (37) ------- ------- ------- Cash Used by Investing Activities (478) (506) (395) ------- ------- -------\n- 13 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS, CONTINUED (Millions of Dollars)\nYear Ended December 31, -------------------------- 1993 1992 1991 ------- ------- ------- FINANCING ACTIVITIES Long-Term Debt Issued 80 148 79 Long-Term Debt Repaid (160) (213) (135) Cash Dividends Paid (28) (74) (120) Affiliated Company Activity (18) (123) 82 Other Financing Activities (2) 4 8 ------- ------- ------- Cash Used by Financing Activities (128) (258) (86) ------- ------- -------\nCASH AND CASH EQUIVALENTS Increase (Decrease) in Cash and Cash Equivalents 24 (39) 44\nCash and Cash Equivalents at Beginning of Year 248 287 243 ------- ------- ------- Cash and Cash Equivalents at End of Year $ 272 $ 248 $ 287 ======= ======= =======\nSee accompanying Notes to Consolidated Financial Statements.\n- 14 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL POSITION (Millions of Dollars)\nDecember 31, --------------------- 1993 1992 ------ ------ ASSETS Current Assets Cash and Cash Equivalents $ 272 $ 248 Accounts and Notes Receivable 98 83 Materials and Supplies 116 112 Deferred Income Taxes 103 --- Other Current Assets 43 63 ------ ------ Total Current Assets 632 506 ------ ------ Properties and Other Assets Properties-Net 8,631 8,463 Affiliates and Other Companies 155 169 Other Assets 235 337 ------ ------ Total Properties and Other Assets 9,021 8,969 ------ ------ Total Assets $9,653 $9,475 ====== ====== LIABILITIES Current Liabilities Accounts Payable and Other Current Liabilities $1,111 $1,280 Current Maturities of Long-Term Debt 87 114 Due to Parent Company 40 43 ------ ------ Total Current Liabilities 1,238 1,437 ------ ------ Long-Term Debt 593 646 ------ ------ Due to Parent Company 69 86 ------ ------ Deferred Income Taxes 1,937 1,649 ------ ------ Long-Term Liabilities and Deferred Gains 1,631 1,754 ------ ------ SHAREHOLDER'S EQUITY Common Stock, $20 Par Value; Authorized 10,000,000 Shares; 9,061,038 Shares Issued and Outstanding 181 181 Other Capital 1,047 1,047 Retained Earnings 2,957 2,675 ------ ------ Total Shareholder's Equity 4,185 3,903 ------ ------ Total Liabilities and Shareholder's Equity $9,653 $9,475 ====== ====== See accompanying Notes to Consolidated Financial Statements. - 15 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF RETAINED EARNINGS (Millions of Dollars)\n1993 1992 1991 ------ ------ ------ BALANCE - JANUARY 1 $2,675 $2,764 $3,152\nNet Earnings (Loss) 308 (17) (264)\nDividends - Common (28) (74) (120)\nMinimum Pension Liability Adjustments and Other 2 2 (4) ------ ------ ------\nBALANCE - DECEMBER 31 $2,957 $2,675 $2,764 ====== ====== ======\nSee accompanying Notes to Consolidated Financial Statements.\n- 16 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All Tables in Millions of Dollars)\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES.\nPrinciples of Consolidation\nThe Consolidated Financial Statements reflect the results of operations, cash flows and financial position of CSXT and its majority-owned subsidiaries as a single entity. All significant intercompany accounts and transactions have been eliminated. CSXT is a wholly-owned subsidiary of CSX Corporation (CSX).\nInvestments in companies that are not majority-owned are carried at either cost or equity, depending on the extent of control.\nCash and Cash Equivalents\nCash and cash equivalents primarily represent amounts due from CSX for CSXT's participation in the CSX cash management plan and are net of outstanding checks which are funded daily as presented for payment.\nAccounts Receivable\nCSXT has an ongoing agreement to sell without recourse, on a revolving basis each month, an undivided percentage ownership interest in all freight accounts receivable to CSX Trade Receivable Corporation (CTRC), a wholly-owned subsidiary of CSX. At December 31, 1993 and 1992, accounts receivable sold under this agreement totaled $556 million and $600 million, respectively. In addition, CSXT has an agreement to sell with recourse on a monthly basis, an undivided ownership interest in all miscellaneous accounts receivable to a financial institution. At December 31, 1993, accounts receivable sold under this agreement totaled $50 million.\nMaterials and Supplies\nMaterials and supplies are carried at average cost.\n- 17 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES, Continued\nProperties\nProperties are carried principally at cost. Provisions for depreciation are based on estimated useful service lives of seven to 42 years, computed primarily on the straight-line composite method. Under this method, gains and losses on ordinary dispositions are recorded to accumulated depreciation.\nPost-retirement Benefits Other Than Pensions\nCSXT has adopted SFAS No. 106, \"Employers' Accounting for Post-retirement Benefits Other than Pensions.\" Under the accrual method specified by SFAS No. 106, the total future cost of providing other post-retirement employment benefits (OPEBs) is estimated and recognized as expense over the employees' requisite service period.\nFair Values of Financial Instruments\nThe following methods and assumptions were used by CSXT in estimating fair values for financial instruments as required by SFAS No. 107, \"Disclosures about Fair Value of Financial Instruments\":\nCurrent Assets and Current Liabilities The carrying amounts reported in the statement of financial position for current assets and current liabilities qualifying as financial instruments approximate their fair values.\nLong-Term Debt The fair values of CSXT's long-term debt have been based upon market quotations for similar debt instruments or have been estimated using discounted cash flow analyses based upon CSXT's current incremental borrowing rates for similar types of borrowing arrangements. Currently, CSXT has no short-term debt arrangements.\nCSXT's remaining financial instruments at December 31, 1993, are not significant.\nEnvironmental Costs\nEnvironmental costs that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to remediating an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when CSXT's responsibility for environmental remedial efforts is deemed probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or CSXT's commitment to a formal plan of action. The recorded liabilities for estimated future environmental costs at December 31, 1993, 1992 and 1991, were $131 million, $77 million and $81 million, respectively.\n- 18 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES, Continued\nCommon Stock and Other Capital\nThere have been no changes in common stock during the last three years.\nPrior Year Data\nCertain prior-year data have been reclassified to conform to the 1993 presentation.\nNOTE 2. PRODUCTIVITY CHARGES.\nIn the fourth quarter of 1991, CSXT recorded a pretax charge to provide for the estimated costs of implementing work force reductions, improvements in productivity and other cost reductions. The charge amounted to $647 million on a pretax basis and reduced 1991 net earnings by $409 million. In the second quarter of 1992, CSXT recorded a charge principally to recognize the estimated additional costs of buying out certain trip-based compensation elements paid to train crew employees. The additional pretax charge amounted to $664 million and reduced net earnings for 1992 by $427 million.\nThe $1.3 billion in combined charges includes $1.2 billion for reductions from three to two member train crews and for buying out productivity funds and short-crew allowances. CSXT has reached labor agreements across virtually all of its rail system allowing it to operate trains with two-member crews. The estimated cost based on the ratified labor agreements with the United Transportation Union members is approximately 93% of the amount initially provided.\nAs of December 31, 1993, payments totaling $518 million have been recorded as a reduction of the aggregate liabilities for the productivity charges. The remaining liability consists of $604 million for employee separations and associated costs and $189 million for claims, litigation and other negotiated settlements.\n- 19 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 3. SUPPLEMENTAL STATEMENT OF EARNINGS FINANCIAL DATA.\n1993 1992 1991 ------ ------ ------\nMaintenance and Repair Expense $987 $994 $1,015 ==== ==== ======\nSelling, General and Administrative Expense (a) $802 $673 $ 687 ==== ==== ======\nTaxes Other Than Income and Payroll Taxes $ 79 $ 75 $ 68 ==== ==== ======\n(a) Selling, general and administrative expense during 1993 increased $129 million over 1992 primarily due to an increase in the management service fee charged by CSX and increases in certain employee related incentive costs.\nNOTE 4. OTHER INCOME (EXPENSE). 1993 1992 1991 ---- ---- ----\nInterest Income - Other $ 16 $ 18 $ 21 - CSX 12 9 9 Gain on Sale of RF&P Corporation Stock (a) --- --- 39 Gain on Sale of Investment 26 --- --- Gain on Sale of South Florida Track (b) 20 7 7 Fees on Sale of Accounts Receivable (44) (17) (32) Miscellaneous (19) (16) (24) ---- ---- ---- Total $ 11 $ 1 $ 20 ==== ==== ====\n(a) In a series of transactions consummated in October 1991, CSXT exchanged its 6.8 million shares of RF&P Corporation (RF&P) stock for the rail assets of RF&P and $106 million in cash. These transactions resulted in a pretax gain of $39 million, before associated minority interest expense of $5 million.\n(b) In May 1988, CSXT sold approximately 80 miles of track and right of way in Broward, Dade and Palm Beach counties to the state of Florida for $264 million. The sale, which is being recognized on the installment basis, resulted in cash proceeds of $75 million, a pretax gain of $59 million and an after-tax gain of $37 million. The remaining proceeds of $189 million, which were received in the form of an installment mortgage note, are subject to annual legislative appropriations. The deferred installment gain of $148 million will be recognized each year through 1997 as scheduled payments are received. At December 31, 1993 and 1992, the long-term portion of the mortgage note receivable totaled $102 and $130 million, respectively, and was included in other assets in the consolidated statement of financial position.\n- 20 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 5. INCOME TAXES.\nEffective January 1, 1993, CSXT adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 superseded SFAS No. 96, \"Accounting for Income Taxes,\" which CSXT adopted effective January 1, 1987. SFAS No. 109 requires that deferred income tax assets and liabilities be classified as current or non-current based upon the classification of the related asset or liability for financial reporting. Net earnings for 1993 were not impacted by the adoption of SFAS No. 109. As permitted under the new rules, prior-year financial statements have not been restated.\nIncome tax expense (benefit) information is as follows:\n1993 1992 1991 ------- ------- ------- Current Federal $ 47 $ 17 $ 66 State and Foreign 4 2 15 ---- ---- ---- Total Current 51 19 81 ---- ---- ---- Deferred Federal 166 (48) (122) State 17 (4) (30) ---- ---- ---- Total Deferred 183 (52) (152) ---- ---- ---- Total Expense (Benefit) $234 $(33) $(71) ==== ==== ====\nIncome tax expense (benefit) reconciled to the tax computed at statutory rate is as follows:\n1993 1992 1991 ----------- ----------- -----------\nTax at Statutory Rates $190 35 % $(17) (34)% $(60) (34)% State Income Taxes 13 2 (2) (4) (10) (6) Prior Years' Income Taxes (15) (3) (10) (20) (10) (6) Increase in Statutory Rate (a) 46 9 --- -- --- -- Other --- -- (4) (9) 9 6 ---- -- ---- -- ---- -- Total Expense (Benefit) $234 43 % $(33) (67)% $(71) (40)% ==== == ==== == ==== ==\n(a) CSXT revised its annual effective tax rate in 1993 to reflect the change in the federal statutory rate from 34 to 35 percent. The effect of this change was to increase deferred income tax expense by $46 million related to applying the newly enacted statutory income tax rate to deferred tax balances as of January 1, 1993.\n- 21 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 5. INCOME TAXES, Continued\nThe significant components of deferred tax assets and liabilities after considering the adoption of SFAS No. 109 include:\nDecember 31, January 1, 1993 1993 ------ ------ Deferred Tax Assets Productivity Charge $ 289 $ 356 Employee Benefit Plans 167 143 Investment Tax Credits 100 126 Alternative Minimum Tax Credits 168 148 Other 215 206 ------ ------ Total 939 979 ------ ------ Deferred Tax Liabilities Accelerated Depreciation 2,556 2,455 Other 217 173 ------ ------ Total 2,773 2,628 ------ ------ Net Deferred Tax Liabilities $1,834 $1,649 ====== ======\nCSXT and its subsidiaries are included in the consolidated federal income tax return filed by CSX. The consolidated federal income tax expense or benefit is allocated to CSXT and its subsidiaries as though CSXT had filed a separate consolidated return.\nFederal income tax payments to CSX and payments to state taxing authorities during 1993, 1992 and 1991 totaled $80 million, $56 million and $58 million, respectively.\nAt December 31, 1993 and 1992, investment tax credits of approximately $100 million and $126 million and alternative minimum tax credits of $168 million and $148 million, respectively, are being carried forward for separate tax return purposes and have been recognized for financial reporting purposes as a reduction of the deferred tax liability. Investment tax credits are accounted for under the flow-through method. The earliest carryforwards of investment tax credits begin to expire in 1997.\nExaminations of the federal income tax returns of CSX and its principal subsidiaries have been completed through 1987. Returns for 1988-1990 are currently under examination. Management believes adequate provision has been made for any adjustments that might be assessed.\n- 22 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 6. RELATED PARTIES.\nCash and cash equivalents at December 31, 1993 and 1992, includes $336 million and $310 million, respectively, representing amounts due from CSX for CSXT's participation in the CSX cash management plan. Under this plan, excess cash is advanced to CSX for investment and CSX makes cash funds available to its subsidiaries as needed for use in their operations. CSX is committed to repay all amounts due on demand should circumstances require. The companies are charged for borrowings or compensated for investments based on returns earned by the plan portfolio.\nEffective December 18, 1992, CSXT entered into an agreement with CTRC to sell, on a revolving basis, without recourse, all existing accounts receivable to CTRC. In October, 1993, this agreement was amended to sell only freight accounts receivable to CTRC. As of December 31, 1993 and 1992, CSXT had sold $556 million and $600 million, respectively, of accounts receivable to CTRC.\nCSXT has formal long-term borrowings from CSX which mature from 1994 to 2012 and total $86 million at December 31, 1993, and $106 million at December 31, 1992. Maturities during the next five years aggregate $17 million in 1994, $17 million in 1995, $7 million in 1996, $7 million in 1997 and $7 million in 1998. Fixed interest rates range from 9% to 10% per annum and are based on the market rates in effect when the respective borrowings were placed. Interest expense on borrowings from CSX was $9 million, $11 million and $15 million in 1993, 1992 and 1991, respectively.\nIn 1989, CSXT's pension plan for salaried employees was merged with the CSX Corporation Plan, and all assets of CSXT's plan were transferred to the CSX merged plan. Since the plans were merged, CSX has allocated to CSXT a portion of the net pension expense for the CSX Corporation Plan based on CSXT's relative level of participation in the merged plan which considers the assets and personnel previously in the CSXT plan. The allocated expense from the CSX Corporation Plan amounted to $32 million in 1993, $23 million in 1992 and $32 million in 1991.\nIncluded in Materials, Supplies and Other expense are amounts related to a management service fee charged by CSX, data processing related charges from CSX Technology, Inc., and the reimbursement, under an operating agreement, from CSX Intermodal, Inc. (CSXI), for costs incurred by CSXT related to intermodal operations. CSX Technology and CSXI are wholly-owned subsidiaries of CSX. Materials, Supplies and Other expense includes net expense of $214 million, $128 million and $183 million in 1993, 1992 and 1991, respectively, relating to the above arrangements. The $86 million increase from 1993 to 1992 was predominately the result of an increase in the management fee charged by CSX and a one-time intercompany transfer to CSXI in 1992.\nIn 1991, CSXT entered into an operating lease agreement with CSXI for 3,400 rebuilt coal gondola cars. The cars, which were previously owned and rebuilt by CSXT, were sold to CSXI for $117 million which resulted in no gain. These cars are presently being leased by CSXT through March 2006. In addition, CSXT is leasing 65 locomotives from CSXI pursuant to a pre-existing operating\n- 23 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 6. RELATED PARTIES, Continued\nlease agreement acquired by CSXI from a third party at year-end 1992. These locomotives are being leased by CSXT through May 2008. The minimum lease payments for the locomotives and coal gondola cars discussed above are approximately $18 million annually. These lease payments are included in the minimum lease payments as discussed in Note 12.\nIn 1988, CSXT participated with Sea-Land Service, Inc. (Sea-Land), a wholly-owned subsidiary of CSX, in four sale-leaseback arrangements. Under these arrangements, Sea-Land sold equipment to a third party and CSXT leased the equipment and assigned the lease to Sea-Land. Sea-Land is obligated for all lease payments and other associated equipment expenses. If Sea-Land defaults on its obligations, CSXT would assume the asset lease rights and obligations of $174 million at December 31, 1993, under the arrangements.\nCSX purchases futures and options contracts as a partial hedge against fluctuations in fuel oil prices on behalf of CSXT and other CSX subsidiaries. Gains and losses on contracts to hedge fuel oil commitments are deferred and accounted for as a part of the commitment transaction. When recognized, these gains and losses are recorded by the subsidiary. During 1993 and 1991, CSXT recognized $2 million and $3 million, respectively, in net losses with 1992 yielding a slight gain associated with these fuel hedges. The counterparties to certain futures and options contracts consist of a large number of major financial institutions. Through CSX, the positions and the credit ratings of these counterparties are continually monitored, and the amount of agreements or contracts entered into with any one party are limited. While the company may be exposed to credit losses in the event of non-performance by counterparties, it does not currently anticipate losses.\nNOTE 7. ACCOUNTS PAYABLE AND OTHER CURRENT LIABILITIES.\nDecember 31, ---------------------- 1993 1992 ------ ------ Trade Accounts Payable $ 457 $ 457 Labor and Fringe Benefits(a) 337 543 Interest, Taxes and Other 180 144 Casualty Reserves 137 136 ------ ------ Total $1,111 $1,280 ====== ======\n(a) Labor and Fringe Benefits includes separation liabilities of $26 million for 1993 and $225 million for 1992.\n- 24 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 8. PROPERTIES.\nBalance Balance at Beginning Retirements Other at End of Year Additions and Sales Changes of Year ------------ --------- ----------- ------- ------- - ---- Property: Transportation Road $ 9,074 $ 323 $380 $ 9 $ 9,026 Equipment 3,567 243 199 4 3,615 ------- ------ ---- ---- ------- 12,641 566 579 13 12,641 Non-transportation 61 3 2 1 63 ------- ------ ---- ---- ------- Total $12,702 $ 569 $581 $ 14 $12,704 ======= ====== ==== ==== =======\nAccumulated Depreciation: Transportation Road $ 2,781 $ 209 $373 $--- $ 2,617 Equipment 1,453 162 163 --- 1,452 ------- ------ ---- ---- ------- 4,234 371 536 --- 4,069 Non-transportation 5 --- 1 --- 4 ------- ------ ---- ---- ------- Total $ 4,239 $ 371 $537 $--- $ 4,073 ======= ====== ==== ==== =======\nProperties - December 31, 1993 $ 8,631 =======\n- 25 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 8. PROPERTIES, Continued\nBalance Balance at Beginning Retirements Other at End of Year Additions and Sales Changes of Year ------------ --------- ----------- ------- ------- - ---- Property: Transportation Road $ 9,003 $ 313 $ 211 $(31) $9,074 Equipment 3,618 226 268 (9) 3,567 ------- ------ ----- ---- ------- 12,621 539 479 (40) 12,641 Non-transportation 63 --- 1 (1) 61 ------- ------ ----- ---- ------- Total $12,684 $ 539 $ 480 $(41) $12,702 ======= ====== ===== ==== =======\nAccumulated Depreciation: Transportation Road $ 2,787 $ 205 $ 208 $ (3) $ 2,781 Equipment 1,527 149 223 --- 1,453 ------- ------ ----- ---- ------- 4,314 354 431 (3) 4,234 Non-transportation 5 1 --- (1) 5 ------- ------ ----- ---- ------- Total $ 4,319 $ 355 $ 431 $ (4) $ 4,239 ======= ====== ===== ==== =======\nProperties - December 31, 1992 $ 8,463 =======\n- 26 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 9. CASUALTY AND OTHER RESERVES, SEPARATION LIABILITIES AND DEFERRED GAINS.\nLong-term liabilities and deferred gains totaled $1.6 billion and $1.8 billion in 1993 and 1992, respectively, and include casualty reserves; deferred gains; pension and other post-retirement obligations; productivity\/restructuring charge liabilities; and other liabilities.\nActivity relating to casualty reserves, separation liabilities and deferred gains is as follows:\nDeferred Gains ---------------------------\nCasualty Separation Sale-Leaseback Installment Reserves(a) Liabilities(a) Transactions(c) Sale(d) ----------- ------------ --------------- -----------\nBalance 12\/31\/91 $ 354 $ 655 $ 84 $ 129\nCharged to Expense and Other Additions 237 644 (1) --- Payments and Other Reductions (222) (382)(b) (6) (7) ----- ----- ----- ----- Balance 12\/31\/92 369 917 77 122\nCharged to Expense and Other Additions 189 --- --- --- Payments and Other Reductions (179) (295)(b) (6) (20) ----- ----- ----- ----- Balance 12\/31\/93 $ 379 $ 622 $ 71 $ 102 ===== ===== ===== =====\n(a) Balances include current portion of casualty reserves and separation liabilities, respectively, of $136 million and $225 million at December 31, 1992 and $137 million and $26 million at December 31, 1993.\n(b) Includes reallocation of $95 million in 1993 and $62 million in 1992 to litigation claims and other negotiated settlements.\n(c) Deferred gains on sale-leaseback transactions are being amortized over periods not exceeding 21 years.\n(d) A portion of the deferred gain on South Florida Track installment sale will be recognized each year through 1997 as scheduled payments are received.\n- 27 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 10. LONG-TERM DEBT.\nDecember 31, Type Average ---------------------- (Maturity Dates) Interest Rates 1993 1992 - ----------------- -------------- ------ ------\nEquipment Obligations (1994-2008) 9% $ 417 $ 437 Mortgage Bonds (1995-2003) 4% 84 137 Other Obligations (1994-2021) 6% 179 186 ------ ------ Total 8% 680 760\nLess Debt Due Within One Year 87 114 ------ ------ Total Long-Term Debt $ 593 $ 646 ====== ======\nThe estimated fair value of long-term debt at December 31, 1993 and 1992, is as follows: Fair Value of Total Debt 1993 1992 ------------------------ Equipment Obligations $453 $476 Mortgage Bonds 69 115 Other Obligations 192 194 ---- ---- Total $714 $785 ==== ====\nIn March 1993, CSXT issued $74 million of Series A Equipment Trust Certificates. The certificates will mature in 15 annual installments from 1994 through 2008.\nCSXT has long-term debt maturities during the next five years aggregating $87 million in 1994, $85 million in 1995, $64 million in 1996, $45 million in 1997 and $41 million in 1998.\nSubstantially all of the properties and certain other assets of CSXT and its subsidiaries are pledged as security for various long-term debt issues.\nInterest payments, including the amounts on CSX borrowings totaled $74 million, $85 million and $93 million, respectively, for 1993, 1992 and 1991. These payments are net of capitalized interest, which was approximately $7 million for each of the three years.\n- 28 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 11. EMPLOYEE BENEFIT PLANS.\nPension Plans\nCSX and its subsidiaries, including CSXT, have defined benefit pension plans principally for salaried employees. The plans provide for eligible employees to receive benefits primarily based on years of service and compensation rates near retirement. Contributions to the plans are made on the basis of not less than the minimum funding standards set forth in the Employee Retirement Income Security Act of 1974, as amended. See Note 6 for the allocated pension expense from the CSX Corporation Plan.\nSavings Plans\nCSXT has established savings plans for virtually all full-time salaried employees and certain employees covered by collective bargaining units of CSXT and subsidiary companies. CSXT matches 50% of each salaried employee's contribution, which is limited to 6% of the employee's earnings. CSXT contributes fixed amounts for each participating employee covered by a collective bargaining agreement. Expense for these plans was $22 million for each of the years 1993, 1992 and 1991.\nOther Post-Retirement Benefit Plans\nIn addition to the CSX defined benefit pension plans, CSXT participates in two defined benefit post-retirement plans along with CSX and other affiliates which cover most full-time salaried employees. One plan provides medical benefits and another provides life insurance benefits. The post-retirement health care plan is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. The accounting for the health care plan anticipates future cost-sharing changes to the written plan that are consistent with the company's expressed intent to increase the retiree contribution rate annually for the expected medical inflation rate for that year. The life insurance plan is non- contributory.\nEffective January 1, 1991, CSXT adopted SFAS No. 106. The effect of adopting the new guidelines had a minimal impact on 1991 results, as the net periodic post-retirement benefit expense of $28 million approximated the expense under the prior method of accounting for the above defined benefit plans, which was on a pay-as-you-go basis. Net earnings for 1991 were decreased by $159 million (net of related income tax benefit of $96 million), by the cumulative effect of the change in accounting related to years prior to 1991, which were not restated.\nThe SFAS No. 106 calculations shown below were prepared for CSXT as if it was participating in such plans on a stand-alone basis. Therefore, although CSXT participates along with CSX and other affiliates in these two plans, a separate measurement of the funding status and benefit expense attributable to its participation in the plans was determined and recognized by CSXT on this basis.\n- 29 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 11. EMPLOYEE BENEFIT PLANS, Continued\nOther Post-Retirement Benefit Plans, Continued\nThe company's current policy is to fund the cost of the post- retirement health care and life insurance benefits on a pay-as-you-go basis, as in prior years. The following table shows the two plans' combined status reconciled with the amounts recognized in CSXT's statement of financial position:\nLife Medical Insurance Plan Plan 1993 1992 1993 1992 ---- ---- ---- ---- Accumulated Post-Retirement Benefit Obligation: Retirees $154 $125 $67 $62 Fully Eligible Active Participants 13 13 2 2 Other Active Participants 20 16 2 1 ---- ---- --- --- Accumulated Post-Retirement Benefit Obligation 187 154 71 65 Unrecognized Prior Service Cost 17 21 4 4 Unrecognized Net Loss (40) (10) (10) (3) ---- ---- --- --- Net Post-Retirement Benefit Obligation $164 $165 $65 $66 ==== ==== === ===\nNet periodic post-retirement benefit expense for 1993, 1992 and 1991 is as follows:\nLife Medical Insurance Plan Plan 1993 1992 1991 1993 1992 1991 ---- ---- ---- ---- ---- ---- Service Cost $ 4 $ 4 $ 5 $1 $1 $1 Interest Cost 12 13 16 5 6 6 Amortization of Prior Service Cost (Benefit) (4) (2) -- - - - Unrecognized Net Gain (2) -- -- - - - --- --- --- -- -- -- Net Periodic Post-Retirement Benefit Expense $10 $15 $21 $6 $7 $7 === === === == == ==\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) for the medical plan is 11.5% for 1993-1994 and is assumed to decrease gradually to 5.5% in 2005 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the\n- 30 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 11. EMPLOYEE BENEFIT PLANS, Continued\nOther Post-Retirement Benefit Plans, Continued\nassumed health care cost trend rates by one percentage point in each year would increase the accumulated post-retirement benefit obligation for the medical plan as of December 31, 1993 by 9%, and the aggregate of the service and interest cost components of net periodic post-retirement benefit expense for 1993 by $2 million.\nThe weighted-average discount rate used in determining the accumulated post-retirement benefit obligation was 7.25% and 8.25% at December 31, 1993 and 1992, respectively.\nPost-employment Benefits\nEffective January 1, 1994, the company will adopt SFAS No. 112 \"Employers' Accounting for Post-employment Benefits.\" This statement requires that certain benefits provided to former or inactive employees, after employment but before retirement, such as workers' compensation and disability benefits, be accrued if attributable to employees' service already rendered. The financial impact of adopting SFAS No. 112 is not expected to be significant.\nOther Plans\nUnder collective bargaining agreements, the company participates in a number of union-sponsored, multi-employer benefit plans. Payments to these plans are made as part of aggregate assessments generally based on hours worked, tonnage moved or a combination thereof. The administrators of the multi- employer plans generally allocate funds received from participating companies to various health and welfare benefit plans and pension plans. Current information regarding such allocations has not been provided by the administrators. Total contributions of $139 million, $125 million and $150 million were made to these plans in 1993, 1992 and 1991, respectively.\nCertain officers and key employees of CSXT participate in stock purchase performance and award plans of CSX. CSXT is allocated its share of any cost to participate in these plans.\nNOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES.\nLease Commitments\nCSXT leases equipment under agreements with terms up to 21 years. Non-cancelable, long-term leases generally include provisions for maintenance, options to purchase at fair value and to extend the terms. At December 31, 1993, minimum equipment rentals under non-cancelable operating leases totaled approximately $180 million for 1994, $165 million for 1995, $161 million for 1996, $165 million for 1997, $167 million for 1998 and $1.6 billion thereafter.\n- 31 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES, Continued\nLease Commitments, Continued\nRent expense on equipment operating leases, including net daily rental charges on railroad operating equipment of $214 million, $204 million and $182 million in 1993, 1992 and 1991, respectively, amounted to $387 million in 1993, $383 million in 1992 and $376 million in 1991. Deferred gains arising from sale-leaseback transactions are being amortized over periods not exceeding 21 years and have reduced rent expense by $6 million in 1993, $6 million in 1992 and $5 million in 1991.\nPurchase Commitment\nCSXT entered into an agreement to purchase 300 locomotives from GE Transportation Systems, a unit of General Electric Co. This large single order will cover CSXT's normal locomotive replacement needs over the next four years. This purchase agreement will introduce alternating current traction technology to CSXT's locomotive fleet. CSXT will take delivery of 50 direct current and 30 alternating current locomotives in 1994, and the remaining 220 alternating current units will be delivered during 1995-1997.\nContingent Liabilities and Long-Term Operating Agreements\nCSXT and its subsidiaries are contingently liable individually and jointly with others principally as guarantors of long-term debt and obligations, primarily related to leased properties, joint ventures and joint facilities. These contingent obligations amounted to approximately $199 million at December 31, 1993.\nCSXT has various long-term railroad operating agreements that allow for exclusive operating rights over various railroad lines. Under these agreements, CSXT is obligated to pay usage fees of approximately $10 million annually. The terms of these agreements range from 30 to 40 years.\nCSXT is a party to various proceedings brought both by private parties and regulatory agencies related to environmental issues. CSXT has been identified as a potentially responsible party in a number of governmental investigations and actions relating to environmentally impaired sites that are or may be subject to remedial action under the Federal Superfund Statute (\"Superfund\") or corresponding state statutes. The majority of these proceedings are based on allegations that CSXT, or its railroad predecessors, sent hazardous substances to the facilities in question for disposal. Such proceedings arising under Superfund typically involve numerous other waste generators and disposal companies and seek to allocate or recover costs associated with site investigation and cleanup, which could be substantial.\nThe assessment of the required response and remedial costs associated with these sites is extremely complex. Among the variables that management must assess are imprecise and changing remedial cost estimates and continually evolving governmental standards.\n- 32 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES, Continued\nContingent Liabilities and Long-Term Operating Agreements, Continued\nCSXT frequently reviews its role, if any, with respect to each such location, giving consideration to the nature of CSXT's alleged connection to the location (e.g., generator, owner or operator), the extent of CSXT's alleged connection (e.g., volume of waste sent to the location and other relevant factors), the accuracy and strength of evidence connecting CSXT to the location, and the number, connection and financial position of other named and unnamed potentially responsible parties at the location. Further, CSXT periodically reviews its exposure in all non-Superfund environmental proceedings with which it is involved.\nBased upon such reviews and updates of the sites with which it is involved, CSXT has recorded, and periodically reviews for adequacy, reserves to cover estimated contingent future environmental costs with respect to such sites. Liabilities are recorded for environmental matters in accordance with CSXT's accounting policy described in Note 1. CSXT does not currently possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies. Such additional liabilities could be significant to future consolidated results of operations and cash flows. Based upon information currently available, however, CSXT believes that its environmental reserves are adequate to accomplish remedial actions to comply with present laws and regulations.\nLegal Proceedings\nA number of legal actions, other than environmental, are pending against CSXT in which claims are made in substantial amounts. While the ultimate results of environmental investigations, lawsuits and claims involving CSXT cannot be predicted with certainty, management does not currently expect that these matters will have a material adverse effect on the consolidated financial position, results of operations and cash flows of the company.\nIn December 1993, a Consent Decree was entered in the U. S. District Court in Jacksonville, Florida to settle claims of Federal Clean Water Act violations alleged against CSXT. The Consent Decree resolves a civil enforcement action initiated in June, 1992, by the U.S. Environmental Protection Agency with respect to alleged violations by CSXT of permit discharge limitations at five rail yard waste water treatment facilities in Florida and North Carolina. The settlement called for a civil penalty of $3 million, which has been paid by CSXT, as well as the establishment of an escrow account in the amount of $4 million to fund certain environmentally beneficial projects.\n- 33 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nNOTE 13. QUARTERLY DATA (Unaudited). ----------------------------------------- 1st 2nd 3rd(a) 4th(b) ------ ------ ------ ------ Operating Revenue $1,094 $1,134 $1,081 $1,135 Operating Income 105 172 123 191 Net Earnings 56 131 19 102 ----------------------------------------- 1st 2nd(c) 3rd 4th ------ ------ ------ ------ Operating Revenue $1,123 $1,123 $1,104 $1,158 Operating Income (Loss) 125 (498) 149 246 Net Earnings (Loss) 65 (322) 80 160 ----------------------------------------- 1st(d) 2nd 3rd 4th(e)(f) ------ ------ ------ ------ Operating Revenue $1,059 $1,079 $1,130 $1,156 Operating Income (Loss) 111 137 150 (507) Earnings (Loss) before Cumulative Effect of Change in Accounting 57 74 78 (314)\n(a) CSXT revised its estimated annual effective tax rate in the third quarter of 1993 to reflect the change in the federal statutory rate from 34 to 35 percent. The effect of this change was to increase income tax expense for the third quarter of 1993 by $50 million. Of this amount, $46 million, related to applying the newly enacted statutory income tax rate to deferred tax balances as of January 1, 1993.\n(b) The quarterly results were affected by certain adjustments, including credits of $12 million for favorable experience on health and welfare benefits. Other adjustments were not significant to the operating results for the quarter.\n(c) Includes impact of $664 million pretax productivity charge, $427 million after tax.\n(d) The first quarter 1991 results exclude the cumulative effect of the accounting change for years prior to 1991 that decreased net earnings $159 million. The effect of adopting SFAS No. 106 on 1991 operating income was not significant and was included in the results of the fourth quarter. The first-, second- and third-quarter 1991 results were not restated.\n(e) Includes impact of $647 million pretax productivity charge, $409 million after tax.\n(f) Includes pretax gain of $39 million, before associated minority interest expense of $5 million, on the sale of the stock of RF&P Corporation. - 34 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS (Millions of Dollars)\nThe following information should be read in conjunction with all other items in this report including \"Business\", \"Properties\" and \"Financial Statements and Supplementary Data.\"\nSelected Financial & Statistical Information -------------------------------------------- 1993 1992(a) 1991(b)(c)1990 1989 ------- ------ ----- ------ ------ Selected Earnings Data: Operating Revenue $4,444 $4,508 $4,424 $4,551 $4,470 Operating Expense 3,853 3,822 3,886 3,929 3,876 Productivity\/Restructuring Charge --- 664 647 --- --- ------ ------ ------ ------ ------ Operating Income (Loss) 591 22 (109) 622 594 Other Income 11 1 20 --- 29 Interest Expense 60 73 87 111 146 Income Tax Expense (Benefit) Productivity\/Restructuring Charge --- (237) (238) --- --- Other 234 204 167 164 173 Cumulative Effect of Change in Accounting --- --- (159) --- --- ------ ------ ------ ------ ------ Net Earnings (Loss) $ 308 $ (17) $ (264) $ 347 $ 304 ====== ====== ====== ====== ====== Selected Cash Flow Data: Cash Provided by Operating Activities $ 630 $ 725 $ 525 $ 814 $ 881 Cash Used by Investing Activities $ (478) $ (506) $ (395) $ (394) $ (296) Cash Used by Financing Activities $ (128) $ (258) $ (86) $ (364) $ (461) Selected Financial Position Data: Cash and Cash Equivalents $ 272 $ 248 $ 287 $ 243 $ 187 Working Capital (Deficit) $ (606) $ (931) $ (773) $ (707) $ (590) Total Assets $9,653 $9,475 $9,629 $9,510 $9,357 Long-Term Debt $ 593 $ 646 $ 639 $ 742 $ 874 Due to Parent Company: Long-Term Advances $ 69 $ 86 $ 178 $ 157 $ 198 Shareholder's Equity $4,185 $3,903 $3,992 $4,368 $4,103\n(a) Includes impact of $664 million pretax productivity charge, $427 million after tax.\n(b) Includes impact of $647 million pretax productivity charge, $409 million after tax.\n(c) Net earnings for 1991 were decreased by $159 million by the cumulative effect of the change in accounting related to the adoption of SFAS No. 106.\n- 35 -\nCSX TRANSPORTATION, INC. AND SUBSIDIARIES MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS\nResults of Operations ---------------------\nCSXT met the challenges of a prolonged U.S. coal strike and sharp decline in its export coal markets in 1993 by continuing to lower the cost of its operations while increasing its focus on merchandise markets. Despite a $202 million decline in coal revenue, this dual emphasis allowed CSXT to earn operating income of $591 million, $95 million below 1992's comparable $686 million. Operating income rose 10% compared with 1991 earnings of $538 million on a like basis. These comparisons exclude productivity charges of $664 million and $647 million in 1992 and 1991, respectively, associated with labor reductions. Including these charges, the rail unit recorded operating income of $22 million in 1992 and an operating loss of $109 million in 1991.\nTransportation operating revenue was $4.38 billion, a 1% decline from $4.43 billion a year earlier, but a slight increase from 1991's revenue of $4.34 billion. The decrease in 1993 was caused by a 13% decline in coal revenue, the largest source of CSXT revenue. Coal revenue also was 13% lower than 1991's level. Total coal originated by CSXT was 144.1 million tons in 1993, 11% and 13% below levels originated in 1992 and 1991, respectively.\nCSXT COMMODITIES BY CARLOADS AND REVENUE\nMarket Share (a) Carloads Revenue (Percent) (Thousands) (Millions of Dollars) --------- -------------------- ---------------------- 1993 1993 1992 1991 1993 1992 1991 ---- ----- ----- ----- ----- ------ ------ Automotive 27 326 288 265 $ 461 $ 413 $ 367 Chemicals 40 371 356 347 652 619 587 Minerals 36 374 345 327 332 310 290 Food and Consumer 34 166 161 164 196 196 201 Agricultural Products 30 284 264 262 327 297 295 Metals 22 258 225 199 243 219 200 Forest Products 30 435 441 439 442 448 425 Phosphates and Fertilizer 70 423 457 475 256 268 269 Coal 40 1,566 1,760 1,816 1,363 1,565 1,573 ----- ----- ----- ----- ------ ------ Total Freight Revenue 4,203 4,297 4,294 4,272 4,335 4,207 ===== ===== ===== Other Revenue 108 99 129 ------ ------ ------ Total Transportation Operating Revenue $4,380 $4,434 $4,336 ====== ====== ======\n(a) Market share is defined as CSXT carloads vs. carloads handled by all major Eastern railroads.\nWeakened demand for U.S. coal from the European Community nations and Japan, due to lower levels of economic growth, continued foreign government\n- 36 -\nsubsidies and intensified foreign competition, caused CSXT's export coal shipments to decline significantly from the prior two years. In addition, both domestic and export shipments were negatively affected by selective coal strikes against eastern coal operators, which diminished shipments during nine months of 1993. While CSXT anticipates only a slight recovery in the export coal market, the company does expect notably higher carloadings of coal to utilities since the strikes ended in December 1993.\nCSXT merchandise volume and revenue jumped 4% and 5% from 1992's levels and 6% and 10% from 1991's results, respectively, to 2.6 million carloads and $2.9 billion in revenue. The gains reflected expansion in the domestic economy and improved conditions in key industries served by CSXT.\nWith U.S. auto producers enjoying large gains in market share and increased demand from consumers, CSXT's automotive traffic led the growth in merchandise carloadings and revenue. CSXT also recorded large gains in metals, due to surging scrap demand from U.S. mini-mill steel producers. Minerals traffic advanced due to renewed activity in construction and highway projects. CSXT's agriculture volumes and revenues moved well beyond prior-year levels, benefiting from export of 1992's bumper grain crop through late summer 1993 and continued expansion in the southeastern poultry and feed grain businesses throughout the year. The strengthening economy and higher level of auto production contributed to a sizeable increase in chemical traffic.\nWith foreign demand for U.S.-mined phosphates remaining depressed, phosphate and fertilizer carloadings declined further. The forest products market also was off slightly from 1992 and 1991 levels as a result of excess paper production during 1992.\nCSXT anticipates modest improvement in merchandise traffic volume and revenue for 1994, reflecting continued expansion of the U.S. economy. Also, while no marked improvement is forecast in export phosphate demand, increased shipments of fertilizer products to the U.S. Midwest is expected as farmers replenish fields following last year's flooding.\nCSXT transportation operating expense was $3.8 billion, an increase of 1% from comparable 1992 expense and a decline of 1% from 1991 expense, excluding the previously mentioned productivity charges.\nLabor expense continued to decline, to $1.81 billion, from a level of $1.83 billion and $1.85 billion in 1992 and 1991, respectively, despite the negative impact of a greater number of crew starts associated with moving a larger proportion of merchandise traffic. The 1993 expense includes a 3% wage increase awarded to most contract employees mid-year and also reflects a decrease in employment levels due to implementation of two-member crews and continued personnel reductions. A 4% wage increase is scheduled for mid-1994. CSXT expects to continue to decrease the size of its work force over the next few years.\nCSXT estimated the average size of its train crews for through, local and yard trains to be 2.7 members at year-end. CSXT plans to lower its average crew size for all trains to 2.3 over the next few years through implementation of smaller yard and local crews as contemplated by the 1992 and 1991 productivity charges.\n- 37 -\nMaterials, supplies and other expense, which includes the cost of maintenance, information services, management fees from CSX and personal injuries, increased 4% over 1992 and decreased 1% from 1991 levels. The 1993 increase over 1992 was primarily the result of increased management fees from CSX, partially offset by CSXT's intensive Performance Improvement Team (PIT) program and the company's ongoing commitment to safety.\nCSXT's PIT process has been responsible for marked reductions in the expense base of CSXT operations over the past two years and is expected to contribute additional savings in 1994 and 1995. While shrinking expenses, this program also has led to significant improvements in reliability, performance and efficiency. Major strides have been made in locomotive and freight car maintenance and repair, information technology, contract labor scheduling and purchasing among other areas of rail activity. Specifically, through PIT initiatives, CSXT reduced expenses by $147 million and $116 million in 1993 and 1992, respectively. Further savings of over $100 million each year are targeted for 1994 and 1995.\nFuel expense fell to $253 million from $262 million and $271 million in 1992 and 1991, respectively. Fuel consumption decreased from levels in earlier years, reflecting the level of operation and increased fuel efficiency. In 1993, CSXT locomotives consumed 1.33 gallons of diesel fuel per thousand gross ton miles, compared with 1.37 gallons in the prior year and 1.4 gallons in 1991. CSXT diesel fuel averaged 64 cents per gallon vs. 65 cents in 1992 and 68 cents in 1991, net of the CSX hedging program.\nBuilding and equipment rent expense increased slightly from earlier years. Depreciation expense increased slightly from earlier years as new equipment was purchased and deployed in the business.\nWith continued effort throughout CSXT to lower its expense base, the company anticipates only a slight increase in total operating expense for 1994, assuming modest improvements in traffic levels and no unusual operating conditions.\nProperty additions for 1993 totaled $569 million, compared with $539 million and $563 million for the years 1992 and 1991, respectively. Included in the 1993 total was $323 million for roadway improvements, including 400 miles of rail that were installed or replaced.\nCSXT added a total of 75 new, fuel-efficient locomotives to its fleet during the year at a cost of $101 million, bringing the total fleet to 2,810 locomotives compared with 2,965 and 3,123 for year-end 1992 and 1991, respectively. At year-end 1993, the average age of the locomotive fleet was 14.3 years, reflecting the retirement of 230 older units from service.\nCSXT's car fleet benefited from $73 million in new capital. Additional capital was spent on terminals, technology and other equipment.\nFor 1994, CSXT projects an increase of approximately 10% in its capital additions program. As in past years, the largest share of the total will be directed to track and roadway improvements.\n- 38 -\nProperty Additions --------------------- (Millions of Dollars)\nProperty Additions 1993 1992 1991 - ------------------ ---- ---- ---- Merchandise Cars $ 68 $ 45 $ 43 Coal Cars 5 4 10 ---- ---- ---- Total Freight Cars 73 49 53 ---- ---- ---- Locomotives 120 134 168 Roadway 323 306 327 Other Equipment and Properties 53 50 15 ---- ---- ---- Total Property Additions $569 $539 $563 ==== ==== ====\nCSXT has embarked on a four-year program to acquire 300 locomotives, with 80 of these to be delivered in 1994. Included will be 50 Dash-9-44CW direct current (DC) powered and 250 alternating current (AC) locomotives, 197 of these at 4,400 horsepower and 53 at 6,000 horsepower. The first of the AC units will be delivered in mid-1994. This new technological breakthrough for the railroad industry will allow CSXT to replace an average of two units in its existing fleet with each new unit.\nRemaining capital in the 1994 budget has been earmarked for car acquisitions, technology and a rail-barge venture to transfer freight between CSXT's rail territory in the southeastern United States and ports along Mexico's eastern coast.\n- 39 -\nFinancial Condition Liquidity and Capital Resources -------------------------------\nCash provided by operating activities totaled $630 million, a decrease of $95 million from 1992 and an increase of $105 million from 1991. Cash provided by operating activities included an increase of $6 million for 1993, an increase of $200 million for 1992 and a decrease of $75 million for 1991, relating to the amount of accounts receivable sold. In addition, cash provided by operating activities included payments for productivity and restructuring charges of $245 million, $353 million and $72 million for 1993, 1992 and 1991, respectively. Excluding the effect of the sale of receivables and the productivity charge payments, cash provided by operating activities would have been $869 million in 1993, $878 million in 1992 and $672 million in 1991.\nCash used by investing activities was $478 million which was $28 million lower than the $506 million used in 1992 and $83 million higher than the $395 million used in 1991. Proceeds from the sale of RF&P Corporation stock of $106 million in 1991 resulted in lower overall uses of cash in 1991 as compared to 1993 and 1992.\nProperty additions of $569 million in 1993 increased $30 million from $539 million in 1992, and $6 million from $563 million in 1991. In the late 1980's, the company launched a major roadway, equipment and locomotive improvement program. Completion of this program has allowed a return to a normalized capital budget that assures the required level of routine maintenance, customer service and safe operation.\nSale-leaseback transactions provided net cash of $37 million in 1991. These transactions were focused primarily on improving the rail car fleet. There were no sale-leaseback transactions in 1993 and 1992.\nCash used by financing activities decreased to $128 million in 1993 from $258 million in 1992 and increased from $86 million in 1991. The 1993 decrease in cash used was primarily the result of lower repayments of public and affiliated company debt.\nCash and cash equivalents increased $24 million during 1993 to a level of $272 million versus $248 million at the end of 1992 and decreased $15 million over the 1991 level of $287 million.\nWorking capital increased by $325 million to a year-end deficit of $606 million in 1993, compared to $931 million in 1992 and $773 million in 1991. A working capital deficit is not unusual for CSXT and does not indicate a lack of liquidity. CSXT maintains adequate current assets to satisfy current liabilities when they are due and has sufficient financial resource capacity, primarily from access to advances from CSX, to manage its day-to-day cash requirements.\nEnvironmental concerns have drawn considerable attention. CSXT, like many American companies today, faces the challenge of dealing with this issue and is addressing its environmental responsibilities and managing the related expenditures. Environmental management is an important part of CSXT's strategic planning, which includes promotion of policies and procedures that emphasize environmental awareness throughout the company. - 40 -\nThe following financial ratios, exclusive of the cumulative effect of the change in accounting in 1991, are measures of the condition of CSXT and its subsidiaries as of year end:\n1993 1992 1991 ---- ---- ---- Current Ratio .5 .4 .5 Debt-to-Total Capitalization Ratio 13.7% 15.8% 16.4% Return on Assets 3.2% (0.2)% (1.1)% Return on Equity 7.4% (0.4)% (2.5)% Ratio of Earnings to Fixed Charges 4.8X 0.6X N\/A\nExcluding the impacts of the 1992 and 1991 productivity charges, the measures would have been as follows:\n1993 1992 1991 ---- ---- ---- Current Ratio .5 .4 .5 Debt-to-Total Capitalization Ratio 13.7% 14.5% 15.2% Return on Assets 3.2% 4.3% 3.2% Return on Equity 7.4% 9.5% 6.7% Ratio of Earnings to Fixed Charges 4.8X 4.6X 3.6X\n- 41 -","section_15":""}
{"filename":"61425_1993.txt","cik":"61425","year":"1993","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nMagma Copper Company (\"Magma\" or the \"Company\") is a fully-integrated producer of electrolytic copper and ranks among the largest U.S. copper producers. Magma's principal products are high quality copper cathode and high quality copper rod, the latter of which is the basic feedstock of the copper wire and cable industry. Magma's copper operations also produce gold and silver-bearing residues, molybdenum disulfide and sulfuric acid as by-products. Excluding custom processing, in 1993 Magma produced 563 million pounds of saleable copper in concentrates and electrowon, 4.8 million pounds of molybdenum contained in molybdenum disulfide, and residues containing 2,947,911 ounces of silver and 90,751 ounces of gold including gold and silver in raw materials purchased from others. An additional 12,635 ounces of gold was produced in 1993 at the Company's Robinson Mining District.\nThe Company produces copper cathode both by traditional mining\/ concentrating\/smelting\/refining methods and by leaching\/solvent extraction-electrowinning (\"SX-EW\") methods. The Company owns and operates underground copper mines at its San Manuel and Superior Mining Divisions, open-pit copper mines at its San Manuel and Pinto Valley Mining Divisions and in situ leaching operations at its San Manuel and Pinto Valley Mining Divisions, all in southeastern Arizona.\nThrough its wholly-owned subsidiary Magma Metals Company, Magma operates the largest and most modern copper smelting and refining complex in the United States. The smelter has a rated treatment capacity of 1.25 million tons of copper concentrate per year, which represents approximately 25% of U.S. smelting and refining capacity. In addition to smelting and refining copper concentrate production from its own mines, the Company smelts and refines a substantial amount of copper concentrates on a toll or purchase basis. The profits from processing third party concentrates are deducted from the Company's overall cost of producing copper from its own mines.\nThe Company was originally incorporated in the State of Maine in 1910, and was reincorporated in the State of Delaware in 1969. From 1968 until March 1987, the Company was a wholly-owned subsidiary of Newmont Mining Corporation (\"Newmont\"), a publicly traded natural resource company. In March 1987, Newmont distributed 80% of Magma's outstanding common stock to Newmont's shareholders, deposited 5% of such stock in a trust for issuance from time to time to Magma employees and retained common and preferred stock interests in the Company. The Company remained under the influence of Newmont until November 1988, when Magma undertook a recapitalization (the \"Recapitalization\") in which it purchased all of the equity interests held by Newmont.\nThe Company's principal office is in Tucson, Arizona. Its mailing address is 7400 North Oracle Road, Suite 200, Tucson, Arizona 85704 and its telephone number is (602) 575-5600.\nRECENT DEVELOPMENTS\nImproved Operating Performance. Since the Recapitalization, Magma has substantially improved its operating performance. Magma has increased copper production from its own sources by approximately 40% from 402 million pounds in 1988 to 563 million pounds in 1993. Production from the leaching, solvent extraction and electrowinning operations increased by 87% from 86 million pounds in 1988 to 161 million pounds in 1993. Total smelting and refining production has increased by approximately 48% from 414 million pounds of copper in 1988 to 615 million pounds in 1993. Net cash operating costs of copper sold have decreased from $.78 per pound ($.93 per pound adjusted for inflation) in 1988 to $.66 per pound in 1992. In 1993, despite the effects of extraordinary rains and flooding early in the year, the Company was able to maintain the $.66 per pound cost level that had been achieved in 1992. Further, as a result of intensified cost reduction efforts, cash operating costs decreased to $.63 per pound in the third quarter and $.61 per pound in the fourth quarter of 1993. Net cash operating costs per pound represent (a) production costs of Magma source copper sold (excluding depreciation, depletion and amortization) reduced by credits for by-products and profits from custom processing divided by (b) total pounds sold from Magma sources. The Company attributes the increase in production and productivity and reduction in operating costs primarily to improved labor relations and the use of innovative operating technology.\nDebt Refinancing. Prompted by favorable interest rate conditions and an upgrade to its long-term debt ratings, the Company refinanced a substantial portion of its long-term debt in 1991 and 1992. The refinancing of Magma's debt structure provided the Company with less restrictive covenants on its long-term debt and reduced its weighted average interest rate on outstanding debt from 14.1% to 10.7%. In total, the refinancings resulted in a $9.7 million decrease in net interest expense (1992 vs. 1991), partially offset by a $3 million extraordinary loss related to premiums paid on early debt repayment.\nIn May 1993, the Company entered into a five-year $200 million revolving credit agreement (the \"Revolver\"). The Revolver is provided by a consortium of ten banks and is available for general corporate purposes. Currently, borrowings would bear interest at the rate of London InterBank Offered Rate (LIBOR) plus 1%. There was no amount outstanding under the Revolver at December 31, 1993.\nChanges in Capital Structure. In the fourth quarter of 1992, the Company undertook measures to simplify and improve its common equity base. On October 30, 1992, Magma stockholders approved an amendment to the Company's Certificate of Incorporation to reclassify and convert all shares of its Class A and Class B Common Stock into a new single class of common stock. In December 1992, Magma made an offer to its preferred stockholders to exchange their Series B Cumulative Convertible Exchangeable Preferred Stock (\"Series B Preferred Stock\") for Common Stock. All shares of Series B Preferred Stock were exchanged by December 31, 1992.\nDuring 1993, the Company issued two new series of preferred stock to enhance its capital base and liquidity. In July 1993, the Company issued $100 million, or 2.0 million shares, of 5 5\/8 percent Cumulative Convertible Preferred Stock, Series D, with a liquidation preference of $50.00 per share and a conversion rate of 3.448 (equivalent to a conversion price of $14.50 per share). Additionally, in November 1993, the Company issued $100 million, or 2.0 million shares, of 6 percent Cumulative Convertible Preferred Stock, Series E, with a liquidation preference of $50.00 per share and a conversion rate of 3.5945 (equivalent to a conversion price of $13.91 per share). Dividends are paid quarterly on each series of preferred stock. The Company intends to use the net proceeds from the sale of these securities for general corporate purposes, which may include the development of projects.\nImproved Financial Position and Increased Liquidity. The debt refinancing and preferred stock issuances have improved the Company's financial position and increased its liquidity. The Company's debt, net of cash and marketable securities, has decreased by $325 million from $390 million at December 31, 1988 to $65 million at December 31, 1993. Magma's debt to capitalization ratios have decreased from 57% in 1988 to 37% in 1993. The Company's operating cash flow (earnings before net interest, taxes, depreciation, depletion and amortization or \"EBITDA\") improved from $91 million in 1988 to $125 million in 1993, despite the fact that Magma's average realized price per pound of copper sold, declined from $1.07 in 1988 to $.94 in 1993. Magma's average price realized was higher than the average London Metals Exchange (LME) price for 1993 of $.86 per pound because of a copper price protection program which included the purchase of put options that protected cash flow and earnings at prices below $.95 per pound. Although Magma is optimistic about copper prices, Magma has extended this program to provide a copper price floor of $.75 per pound for 1994 production and $.74 per pound for the first three quarters of 1995. This program, together with a cost reduction program, were implemented to help assure cashflow to fund Magma's strategic growth opportunities.\nStrategic Growth Opportunities. The Company is currently pursuing or evaluating several mine development opportunities and the upgrade and expansion of its smelter. In March 1993, the Company approved the development of its Lower Kalamazoo orebody. Based upon the current mine plan, this orebody is scheduled to produce 2.13 billion pounds of copper during the period from 1996 to 2009. The Company has completed a feasibility analysis for mining at its Robinson property near Ely, Nevada, and is pursuing various approvals and permits necessary to develop and operate a copper\/gold mine at this property. The Company has also commissioned a pre-feasibility study of its Florence property to assess its development potential.\nIn February 1993, the Company approved a capital project to expand the San Manuel smelting and refining facility and further improve its environmental performance.\nCOPPER PRICE INFORMATION\nCopper is an internationally traded commodity. The copper prices established on the two major metals exchanges - The Commodity Exchange, Inc. (\"Comex\") in New York and the London Metal Exchange (\"LME\") - - broadly reflect the worldwide balance of copper supply and demand. The profitability of the Company's operations is largely dependent upon the worldwide market price for copper. A $0.01 per pound change in the average price realized for the Company's 1993 output would have affected pre-tax income by an estimated $5.6 million. Copper prices have historically been subject to wide fluctuations and are affected by numerous factors beyond the control of the Company, including international economic and political conditions, levels of supply and demand, the availability and cost of copper substitutes, inventory levels maintained by copper producers and others and, to a lesser degree, inventory carrying costs (primarily interest charges) and international exchange rates.\nThe following table of pertinent copper industry data contains Comex high, low and average copper prices per pound and illustrates the historic volatility of copper prices. Price data are given for the Comex standard-grade copper contract for the years 1984-1989. Thereafter, prices are given for contracts for delivery of high-grade copper cathode, which replaced the standard-grade contract effective January 1, 1990.\nThe Company's average realized price per pound of copper was $.94 in 1993, $1.00 in 1992 and $1.01 in 1991.\nFrom time to time the Company enters into options and futures contracts or fixed price forward sales agreements as part of its copper price protection program. During the second, third and fourth quarters of 1993, the Company benefited from put option contracts that provided price protection at LME prices below $0.95 per pound. During these quarters, option contracts totalling 384 million pounds were exercised, resulting in a realized price above the market prices reflected in the table above. In addition, the Company's 1993 realized price was impacted by fixed price forward sales of 42 million pounds at an average price of $0.91 per pound. During 1992 and 1991 the Company had fixed price sales of 179 million pounds at $0.93 per pound and 183 million pounds at $0.98 per pound, respectively.\nThe Company's realized price per pound includes a premium of several cents over the market price for copper cathode to reflect net delivery and financing costs. The Company's price for copper rod commands a premium over its price for copper cathode to reflect the value added by additional processing.\nCOMPETITION\nThe Company does not believe that it or any other copper producer can individually exercise a material influence on the markets in which the Company operates. The price of copper depends almost entirely upon industrial consumption and other market conditions beyond the Company's control. Many foreign and domestic copper producers benefit from higher-grade orebodies than those owned by the Company. Further, most foreign producers benefit from lower labor rates and less stringent environmental regulation than those of United States producers. Because of their need for foreign exchange and the political impact layoffs might have, some foreign producers maintain maximum production without regard to the condition of the world copper market or the profitability of their mining operations.\nThe Company's custom smelting and refining operations compete with other smelting and refining operations, primarily Japanese based companies, for the treatment of copper concentrates. At present, the Japanese government imposes a tariff on refined copper that protects smelting margins by increasing the price of finished cathode to domestic consumers. Additionally, the economic benefit accruing to Japanese operators from the tariff allows them a protected base from which they can aggressively export to nearby Asian countries.\nThe Company and other copper producers also compete with manufacturers of other materials, including aluminum, stainless steel, plastics and fiber optic cables. Should copper prices increase sharply, substitution of these alternative materials for copper may occur.\nPRODUCTS AND SALES\nProducts. Magma's principal products are high quality copper cathode and high quality copper rod, the latter of which is the basic feedstock of the copper wire and cable industry. Approximately 58% of the copper sold by the Company in 1993 (447.1 million pounds) was sold as copper cathode, 36% (276.3 million pounds) was sold in the form of continuous cast rod, and the remaining 6% (41.0 million pounds) was sold in other forms. Copper revenue in 1993 decreased by 3% to $710.5 million, compared to $736.2 million for 1992, due to a $.06 decrease in Magma's average realized price per pound, which was partially offset by higher sales volume.\nIn addition to smelting and refining copper concentrate production from its own mines, the Company processes a substantial amount of copper concentrates on a toll or purchase basis. The profits from processing third party concentrates are deducted from the Company's overall cost of producing copper from its own mines. The total quantities of copper produced by the Company, copper smelted and refined on a custom basis and copper sold by the Company from its own mines during each year in the five-year period ended December 31, 1993 were as follows (in millions of pounds):\nMagma's copper operations also produce gold and silver-bearing residues and molybdenum disulfide as by-products. Revenue from gold sales in 1993, including gold contained in raw materials purchased from others, was $32.4 million on sales of 90,751 ounces. Revenue from silver sales in 1993, including silver in raw materials purchased from others, was $12.7 million on sales of 2,947,911 ounces. An additional $4.5 million of revenue represented sales of 12,635 ounces of gold in dore produced in 1993 at the Company's Robinson Mining District. Revenue from sales of molybdenum disulfide in 1993 was $9.2 million on sales of 4.8 million pounds molybdenum contained. The Company uses sulfuric acid produced in the smelting process in its copper leaching operations and sells any excess acid to third parties.\nSales. The Company's sales strategy includes (i) expanding sales to North American consumers, while preserving a core of long-term customer relationships in Asia, (ii) custom smelting and refining of third party concentrate to supplement feedstock to its smelter from Magma's own mines, and (iii) an optimal mix of copper rod and copper cathode sales.\nThe Company's export sales have declined in recent years primarily due to increasing U.S. consumption and the recession in Japan. The Company is maintaining its presence in the Asian markets by supplying cathode to major fabricators on an annual basis. The Company's export sales as a percent of total revenues were 25%, 29% and 50% for the years ended December 31, 1993, 1992 and 1991, respectively.\nCustomers. During 1993, the Company's copper was sold to approximately sixty customers. Sales of copper to the Company's largest customer during the year accounted for 19% of total revenues. Because copper is an internationally traded commodity, the Company does not believe that the loss of any one customer would have a material adverse effect on the results of its operations.\nOPERATIONS\nOverview. Currently, all of the Company's copper mining, smelting and refining operations are in southeastern Arizona. Its mining operations are conducted through its San Manuel, Pinto Valley, and Superior Mining Divisions. Magma Metals Company, a wholly-owned subsidiary, operates the smelting and refining complex and rod plant and conducts the Company's sales and marketing activities. The Company has two subsidiaries which conduct railroad operations in support of its copper mining operations. The Company also operates a gold mine at its Robinson Mining District near Ely, Nevada and operated a small gold mine near Humboldt, Arizona. A detailed description of the Company's mining properties is included in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOverview. The Company owns or has interests in approximately 32,500 acres of land in southeastern Arizona, where it currently conducts all of its copper operations. It also owns 12,500 acres of land at its Robinson Mining District near Ely, Nevada, where it conducts a gold leaching operation and is developing a major copper project. The Company's mineral interests are held in fee or are derived from patented and unpatented mining claims and mineral leases. The Company also owns water rights, rights-of-way and interest in other leases.\nThe Company's ore reserves are determined by its engineering staff utilizing standard techniques and standard modeling software, typically with the assistance of independent mining consultants.\nThe Company's ore reserves may not conform to geological, geomechanical, metallurgical or other expectations with the result that the volume and grade of reserves recovered and rates of production may be more or less than anticipated. Further, market price fluctuations in copper, changes in operating and capital costs, further orebody definition, drilling and testing, and other factors affect ore reserves. In addition, the Company is subject to the normal risks encountered in the mining industry, such as unusual or unexpected geological formations, cave-ins, flooding, fires and environmental issues.\nThe Company's mining operations are conducted by several divisions described below and in Item 1 - Business.\nSAN MANUEL MINING DIVISION\nThe San Manuel Mining Division, near San Manuel, Arizona, 45 miles northeast of Tucson, Arizona, is accessed by State Hwy. 79 to State Hwy. 77 to Redington Road which terminates at the minesite to the north and reaches the concentrator and plantsite to the south. Sulfide ore is mined from the San Manuel orebody through underground block caving while oxide ore is mined through open-pit mining\/heap leaching and in situ leaching. Cathode copper is produced from leach solutions at the SX-EW plant using a solvent extraction-electrowinning process. The Division utilizes a concentrator to produce concentrate from sulfide ore which is further processed at the Company's smelting and refining complex.\nInvestment in the Division's property, including plant and equipment totaled $187 million as of December 31, 1993. Electricity is provided by the Arizona Public Service Company.\nThe San Manuel Mining Division ore reserves are contained on land held by the Company under patented mining claims and mineral leases from the State of Arizona. Approximately 2% of the sulfide ore deposit lies on land leased from the State and subject to production royalties. Mineral leases will expire in the years 2003 through 2007, but the Company has a preferential right to renew these leases for a term of twenty (20) years. Currently there is no active production from state-leased land. Mining on leased land is scheduled to resume in 1997. The Company owns or controls through lease agreements, easements, and rights-of-way, surface use of surrounding land in support of the mining operations.\nExtraction of sulfide ore from the San Manuel underground mine began in 1956, and the mine now ranks as one of the world's largest underground copper mines in terms of production. The San Manuel mine and concentrator, and the Company, were wholly-owned by Newmont Mining Corporation from 1968 until March 1987.\nThe San Manuel and Kalamazoo orebodies are two faulted segments of what was once a single, cylindrical-shaped shell of disseminated copper mineralization about 7,700 feet long and 2,500 to 5,000 feet in diameter. The shell itself varies in thickness from 100 to 1,000 feet and wraps around a central unmineralized core.\nOre reserves in the San Manuel orebody consist of both copper sulfide and oxide ores with oxide ores confined to the upper reaches of the orebody. The sulfide ore consists essentially of disseminated chalcopyrite in quartz monzonite and monzonite porphyry. Some chalcocite enrichment is present in minor amounts. Much of the upper part of the orebody has been oxidized in varying degrees, mainly to chrysocolla. Ore reserves are estimated using standard techniques and standard modeling software by division geology and engineering staff. The Lower Kalamazoo deposit is discussed in Item 7 under Development Opportunities.\nPINTO VALLEY MINING DIVISION\nThe Pinto Valley Mining Division had its beginning in the early 1900's. The division started as Miami Copper Company in 1909. In 1960, the Tennessee Corporation took over Miami Copper Company and, in 1963, Cities Service Company acquired the Tennessee Corporation. In late 1982, Occidental acquired Cities Service Company. By early 1983, Occidental concluded a sale of the Miami operations to Newmont Mining Corporation which contributed those assets to its new, wholly-owned subsidiary, Pinto Valley Copper Corporation. In late 1986, Newmont merged Pinto Valley Copper Corporation into Magma Copper Company and Pinto Valley Copper Corporation became the Pinto Valley Mining Division of Magma Copper Company.\nInvestment in the Division's property, including plant and equipment, totaled $77 million as of December 31, 1993. Electricity is provided by Salt River Project.\nMining is conducted through two units: the Pinto Valley Unit and the Miami Unit. The Pinto Valley Unit mines copper sulfide ore from its open-pit mine for both concentrating\/smelting\/refining and leaching\/SX-EW production methods, while the Miami Unit conducts in situ leaching of the area of rubble above the closed underground mine and leaching of concentrator tailings.\nPinto Valley Unit\nThe Pinto Valley mine is about six miles west of the town of Miami in Gila County, Arizona. Substantially all the operations take place on land owned by Magma. The land consists of patented mining claims, unpatented mining claims and fee lands.\nThe Pinto Valley deposit is an orebody containing chalcopyrite, pyrite and minor molybdenite as the only significant primary sulfide minerals. These minerals occur in vein sand microfractures, and less abundantly as disseminated grains. As presently defined, the deposit is bounded by post mineralization faults. On the south is the South Hill fault, on the east is the Jewel Hill fault, and on the west is the Gold Gulch fault. Ore reserves are estimated using standard techniques and standard modeling software.\nMining and Concentrating of Copper Sulfide Ore. Sulfide ore from the open-pit mine is processed at the Pinto Valley Unit's concentrator, which produces copper concentrate containing approximately 28% copper and a molybdenum disulfide by-product. The concentration process used is similar to that used in the San Manuel Mining Division's concentrator. The copper concentrate produced in the concentrator is trucked to San Manuel for smelting and refining.\nDump Leaching of Copper Sulfide Ore. Low-grade copper-bearing waste material which has been stripped from the open-pit mine and is classified as leachable is transported to large sulfide ore dumps. The dumps are sprayed with water and sulfuric acid which dissolve contained copper and produce a pregnant leach solution. The pregnant leach solution is fed into the SX-EW plant located near the dumps. The SX-EW plant has the capacity to produce approximately 18 million pounds of copper cathode per year. The copper cathode is cast into rod at the Company's rod casting facility in San Manuel. Essentially all of the sulfuric acid used in the Pinto Valley Unit's dump leaching operation is produced by the Company.\nMiami Unit\nThe Miami Unit is immediately north of the town of Miami. All operations take place on Magma-owned land. It produces copper by leaching material remaining from historic underground mining of a large, disseminated copper orebody in which original copper minerals have naturally been dissolved and reprecipitated in readily soluble form by a long history of weathering.\nIn Situ Leaching. The Miami Unit's underground mine ceased operation in 1959 upon the depletion of all the copper ore that could be economically mined using block caving methods. However, the area of rubble created by the block caving has been used for in situ leaching of mixed oxide\/sulfide ore since 1963. The geographic area of the leaching operations was expanded in 1986 and the sulfuric acid content of the leach solution was increased. The copper bearing leach solution is processed in the SX-EW plant near the underground mine. The plant has the capacity to produce 28 million pounds of copper cathode per year.\nMiami No. 2 Tailings Project. Mill tailings associated with the old Miami underground mine are reclaimed using hydraulic mining methods to produce a slurry of tailings and water. Sulfuric acid is added to the slurry to dissolve the copper contained therein and the resulting pregnant leach solution is processed through the Miami Unit's SX-EW plant. The remaining tailings are transported for disposal through an overland pipeline to an abandoned pit. Production from the project is expected to continue through 2001.\nSUPERIOR MINING DIVISION\nThe Superior Mining Division is an underground operation near Superior, Arizona, approximately 65 miles east of Phoenix. Access to the mine is through the No. 9 Shaft located four miles east of Superior via U.S. Highway 60 and the No. 9 Shaft Mine Road. Milling operations are conducted at the concentrator, north of Superior. Ore is hoisted from mine working levels to the 500 foot level and then carried by underground railroad to the concentrator at Superior.\nThe Superior Mining Division owns patented mining claims, unpatented mining claims, and fee lands in the Superior area. Mine production is currently from orebodies on patented mining claims. Exploration activities are being conducted on patented and unpatented mining claims and under state prospecting permits held by the Division.\nThe Magma Mine at Superior was in continuous operation by Magma or its former parent from 1912 to 1982, when it was closed due to low productivity and depressed copper prices. The current operation was reopened in late 1990.\nThe mine currently produces copper sulfide ore from underground using the undercut and fill mining method at a rate of 1,650 tons per day. The No. 9 shaft facilities, originally commissioned in 1972, were dewatered and rehabilitated when the mine was reactivated in 1990. Since reactivation a ramp system has been installed and utilizes mechanized mining equipment.\nThe flotation concentrator was erected in 1928. Additions and modifications were made during the expansions of 1940 and 1970. When reactivated in 1990, all pumping and piping was downsized in accordance with the new mine plan. The crusher, ball mills, filter plant, and certain ancillary equipment have been rehabilitated since startup.\nInvestment in the underground development, surface facilities, and concentrator complex totaled $33 million as of December 31, 1993. Commercial electric power is supplied to the operation by Salt River Project.\nThe Superior Division is currently conducting diamond drilling exploration in areas in the vicinity of the No. 9 shaft. Exploration activities are directed toward host formations similar to ore bearing areas of the current and past operations.\nOre in the Magma Mine is composed of high grade sulfide minerals, chalcopyrite and bornite, associated with the gangue minerals hematite, quartz and calcite. Copper is the primary metal in the ore with silver and gold occurring as by-products. Orebodies occur as massive replacement of limestone by hematite, chalcopyrite and bornite and as vein type orebodies, which have been significant producers in the district in the past. One vein orebody is under development for production in 1994 and additional vein targets are included in the exploration program.\nCurrent ore reserves occur in orebodies in several favorable horizons within the limestone sequence and in vein structures. Ore reserves are estimated using standard techniques and standard modeling software.\nROBINSON MINING DISTRICT\nThe Robinson Mining District, formerly the Kennecott Nevada Mines Division, was acquired by Magma from the Kennecott Corporation and Alta Gold through a series of transactions in 1990 and 1991. Investment in this project totaled $74 million at December 31, 1993. The Robinson Mining District consists of 12,500 acres and is 8 miles west of Ely, Nevada along State Highway 50. The patented mining claims and other real property comprising this project are owned by the Robinson Mining Limited Partnership, of which Magma's wholly-owned subsidiaries, Magma Nevada Mining Company, is the general partner and Magma Limited Partner Company is the limited partner.\nIn August of 1992, Magma discontinued gold mining operations other than gold leaching operations at existing dumps. Electricity is presently provided by Mt. Wheeler Power Company and a new 10 year contract has been negotiated for future operations. In December 1993, Magma completed the detailed engineering phase for the development of a copper\/gold mine at this property and is continuing to review construction scheduling, while awaiting environmental permits. In this regard, in June 1993, the Bureau of Land Management reversed an earlier decision approving an Environmental Assessment prepared by Magma, and has required the preparation of an Environmental Impact Statement (an \"EIS\") as a precursor to final permitting of the Robinson project. The Company anticipates that the EIS will be completed and that permitting could be achieved as early as September 1994. If these events occur as targeted, of which there can be no assurance, copper and gold production could be achieved by the first quarter of 1996. Based on present estimates, development of the Robinson property could require capital expenditures of approximately $300 million for a traditional sulfide processing facility. The property is expected to produce an average of 247,000 tons of concentrate per year containing 135 million pounds of copper, 97,300 ounces of gold and 390,000 ounces of silver from sulfide copper ore over a sixteen year mine life. In addition to the copper sulfide operations, it is projected that an average of 17,500 ounces of gold will be produced annually over the life of mine as dore. Additional Robinson Mining District test work is discussed in Item 7 under Development Opportunities.\nOre reserves are estimated using standard techniques and standard modeling software by division geology and engineering staff. These reserves are in a cretaceous porphyry copper system emplaced into paleozoic limestone and sandstone formations. Post-mineralization faulting shaped the porphyry deposit. The various ore bodies, Liberty, Veteran-Tripp, Ruth, Kimbley, and Wedge, represent the fault slices of the porphyry system.\nFLORENCE PROJECT\nThe Florence project consists of 10,000 private and state-leased acres west of State Highway 79, north of Florence, Arizona. The Company acquired this project in July 1992. The state mineral lease expired at the end of 1993, and the Company has exercised its right to renew for an additional twenty (20) year term. The deposit was subject to extensive exploratory and metallurgical work by the previous owner in the mid-1970's. The acquisition of this property is part of Magma's long-term strategy to increase copper production through the application of its SX-EW leaching technology. Magma has begun a pre-feasibility study to assess possibilities for further development. Investment in the property was $9 million at December 31, 1993.\nMINERALIZED ROCK\nMagma also owns various other properties containing mineralized rock that it believes could be brought into production should market conditions warrant. Capital commitments, a favorable copper price, and in some instances planning or technical innovations would be required before operations could commence at these properties. These deposits are estimated to contain the following mineralizations as of January 1, 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in legal proceedings of a character normally incidental to its business, including claims and pending actions against the Company seeking damages in large amounts or clarifications of legal rights. Although there can be no assurance in this regard, the Company does not believe that adverse decisions in any pending or threatened proceedings, or any amounts which it may be required to pay by reason thereof, would have a material adverse effect on the financial condition or results of operations of the Company.\nThe Company is involved in legal proceedings pending in the Superior Court of Maricopa County, Arizona to adjudicate water rights of the Gila River system and source (the \"Adjudication\"). The Company's right to use groundwater at its facilities is potentially at issue in this case. These proceedings commenced in the 1970's and to date, over 62,000 claims have been filed. Among the claimants to the largest amounts of surface water are the United States, on behalf of itself and various Indian tribes, the State of Arizona, various municipal water providers, agricultural irrigation districts, and the Company. The Gila River Indian Community has asserted claims against the Company for damages attributable to groundwater withdrawals at San Manuel, but these claims have been stayed pending the outcome of the adjudication. The Company has filed a claim challenging the Court's jurisdiction to adjudicate the Company's groundwater rights or alternatively seeking to confirm its groundwater rights. Previous rulings by the Maricopa County Superior Court that included some categories of groundwater within the scope of this proceeding were the subject of an interlocutory appeal to the Arizona Supreme Court. In its opinion dated July 27, 1993, the Arizona Supreme Court partially reversed the Superior Court's rulings. As a consequence, the Superior Court ordered that a hearing be held to re-evaluate whether groundwater should be included in this proceeding, and if so, what criteria should apply to this inclusion. The hearing will be concluded after a field trip to the River, scheduled for March 3, 1994. The judge's decision is expected within ninety days thereafter.\nAs part of the conditions of the purchase of the Florence property from Conoco Oil Company, the Company was required to intervene in litigation instituted in October 1925 by the Gila River Indian Community, and captioned United States v. Gila Valley Irrigation District, et al., filed in the Tucson Division of the United States District Court for the District of Arizona, (a\/k\/a \"Globe Equity No. 59\"). In that action, the Gila River Indian Community seeks to alter the administration of water rights above the Ashurst-Hayden Diversion Dam, near Florence, on the Gila River. Several phases of this action involving water rights near Safford, Arizona have been tried and are currently on appeal to the Unites States Court of Appeals for the Ninth Circuit. Other issues, which may affect Magma's use of water on the Florence property, have yet to be scheduled for trial.\nThe Company is currently involved in investigations by the Arizona State Mine Inspector's office and the Federal Mine Safety and Health Administration involving an accident occurring August 10, 1993, at the Company's Superior Mining Division, in which four miners were fatally injured (\"the Accident\"). The Accident occurred when several tons of ore spilled into the manway compartment of the transfer raise in which the four victims were working. The Company does not believe, at this time, that the findings of these investigations will result in any material adverse effects on the financial condition or results of operations of the Company, but does believe that citations and monetary fines will probably be issued.\nSee Item 1: Business - Environmental Regulations for information relating to certain other proceedings pertaining to the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo issues were submitted for a vote of stockholders during the fourth quarter of 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock (trading symbol MCU) commenced trading on the New York Stock Exchange (\"NYSE\") on February 10, 1992. Prior to that time, the Company's Common Stock had traded on the American Stock Exchange (\"AMEX\"). The following table sets forth the high and low last sale prices of the Common Stock, as reported by the NYSE and the AMEX.\nOn March 1, 1994, the closing sale price for the Company's Common Stock, as reported by the NYSE, was $14 5\/8 per share. On March 1, 1994, there were approximately 5,209 stockholders of record of the Common Stock. This figure does not reflect beneficial ownership of shares held in nominee names.\nAt a Special Meeting of Stockholders on October 30, 1992, the stockholders of the Company approved an amendment to the Restated Certificate of Incorporation of the Company that reclassified and converted each outstanding share of Class A Common Stock and Class B Common Stock into one share of a single, new class of Common Stock. The new class of common stock created by the amendment possesses one vote on all matters properly coming before the stockholders, including elections of the Board of Directors, is not subject to any transfer restrictions, and possesses no veto power over the issuance of any other class of stock.\nIn December 1992, the Company offered to exchange 15.446825 shares of its Common Stock for each share of its Series B Preferred Stock. On December 29, 1992, each share of Series B Preferred Stock was exchanged, resulting in an issuance of 14,133,047 shares of Common Stock. Prior to the Exchange, each share of Series B Preferred Stock was convertible into 14.285714 shares of Common Stock.\nThe Company has not declared or paid cash dividends on its Common Stock since the 1988 Recapitalization. The Company's dividend policy is reviewed from time to time by its Board of Directors. Future dividend decisions will take into account then current business results, cash requirements and the financial condition of the Company. The indentures which govern the Company's 12% and 11 1\/2% Notes limit the amount the Company can pay as dividends, or use to make distributions on or repurchase its capital stock. Further, covenants in the Company's revolving credit facility require that the Company and its subsidiaries maintain a minimum consolidated net worth and establish a maximum ratio of debt to capitalization that may indirectly limit the Company's ability to pay dividends.\nSeven-year warrants (the \"Common Stock Warrants\") covering 4,112,765 shares of Common Stock were distributed by the Company on December 29, 1988 as dividends to Common Stockholders of record on December 12, 1988. Each Common Stock Warrant entitles the holder thereof to purchase one share of Common Stock at an exercise price of $8.50 per share. The Common Stock Warrants have traded on the NYSE since February 10, 1992. Prior to that time, they were traded on the AMEX. During 1993 and 1992, the sales price for the Common Stock Warrants ranged from $1 5\/8 to $11 5\/8. On March 1, 1994, the closing sale price of the Common Stock Warrants was $7 1\/4. Additionally, seven year warrants to purchase 1,000,000 shares of Common Stock, exercisable at $8.50 per share, were issued with the Series B Preferred Stock on November 30, 1988. These warrants are not listed or traded on an exchange. All warrants are exercisable through November 30, 1995.\nIn July 1993, the Company issued $100 million, or 2.0 million shares, of 5 5\/8 percent Cumulative Convertible Preferred Stock, Series D, with a liquidation preference of $50.00 per share and a conversion rate of 3.448 (equivalent to a conversion price of $14.50 per share). Additionally, in November 1993, the Company issued $100 million, or 2.0 million shares, of 6 percent Cumulative Convertible Preferred Stock, Series E, with a liquidation preference of $50.00 per share and a conversion rate of 3.5945 (equivalent to a conversion price of $13.91 per share). Dividends are paid quarterly on both series of preferred stock issued in 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (Dollar amounts in millions, except per share amounts)\nThe following selected financial data for each of the five years in the period ended December 31, 1993 are derived from the Consolidated Financial Statements audited by Arthur Andersen & Co., independent public accountants. The report of Arthur Andersen & Co. with respect to the financial position of the Company and its subsidiaries as of December 31, 1993 and 1992, and the results of the Company's operations and cash flows for each of the years ended December 31, 1993, 1992 and 1991, appear elsewhere in this document. The selected financial data should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations at Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOver the past six years, Magma has substantially improved its operating performance. Magma has increased copper production from its own sources by approximately 40% from 402 million pounds in 1988 to 563 million pounds in 1993. Production from the leaching, solvent extraction and electrowinning operations increased by 87% from 86 million pounds in 1988 to 161 million pounds in 1993. Total smelting and refining production has increased by approximately 48% from 414 million pounds of copper in 1988 to 615 million pounds in 1993. Net cash operating costs of copper sold have decreased from $.78 per pound ($.93 per pound adjusted for inflation) in 1988 to $.66 per pound in 1992. In 1993, despite the effects of extraordinary rains and flooding early in the year, the Company was able to maintain the $.66 per pound cost level that had been achieved in 1992. Further, as a result of intensified cost reduction efforts, cash operating costs decreased to $.63 per pound in the third quarter and $.61 per pound in the fourth quarter of 1993. Net cash operating costs per pound represent (a) production costs of Magma source copper sold (excluding depreciation, depletion and amortization) reduced by credits for by-products and profits from custom processing divided by (b) total pounds sold from Magma sources. The Company attributes the increase in production and productivity and reduction in operating costs primarily to improved labor relations and the use of innovative operating technology.\nDuring 1993, the Company's operations were adversely affected by extraordinary rainfall conditions, lower copper prices (which were partially offset by hedging activities) and other factors. As a result, total sales and net income were $792.4 million and $21.9 million, respectively, for the year ended December 31, 1993, compared to $819.5 million and $55.3 million, respectively, for the year ended December 31, 1992. In addition, production of Magma source copper was down slightly from 1992 to 1993. The Company estimates that the extraordinary rainfalls reduced net income by approximately $15.5 million during the first six months of 1993. Although the Company is still in the process of repairing, upgrading and expanding certain of its facilities that were damaged by the rainfalls, operations that were affected by the rainfalls returned to normal in the second half of 1993. See \"Environmental Matters\" below.\nThe Company issued two series of preferred stock in 1993, which yielded net proceeds of $193 million. The proceeds will be used for general corporate purposes, which may include the development of projects. In this regard, the Company is pursuing or reviewing a number of capital projects in a continuing effort to lower unit production costs and increase ore reserves. Improvements to its smelting and refining complex are well underway, as is the development of its Lower Kalamazoo orebody and permitting of the Robinson property near Ely, Nevada. These and other projects are described more fully below in \"Capital Resources and Liquidity\".\nThe Company continues to place great emphasis on the program to reduce cash cost of production. In the last year, Magma has reduced its workforce by approximately 4% through attrition, voluntary retirements and other appropriate measures.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nTotal Sales and Earnings. Total 1993 sales were $792.4 million, a 3% decrease from 1992 sales of $819.5 million. The decrease in sales was a result of lower copper prices which were partly offset by increased volume. Total sales for 1992 were 13% above 1991 sales of $724.8 million due to increased volume.\nNet income, before restructuring expenses, an accounting change and the effects of first quarter rains and flooding, was $39.8 million, or $.76 per share, for 1993, compared to $58.3 million, or $1.25 per share, for 1992. Earnings for 1993 were lower due primarily to a decline in the average copper price realized by Magma from $1.00 per pound in 1992 to $.94 per pound in 1993. The rains reduced after-tax earnings for the first six months of 1993 by $15.5 million, or $.30 per share. After restructuring expenses, an accounting change and the effects of first quarter rains and flooding, Magma reported net income for 1993 of $21.9 million, or $.40 per share. Magma's first quarter 1993 results were restated to recognize a $0.9 million after-tax charge for the adoption of Statement of Financial Accounting Standards No. 112, \"Accounting for Postemployment Benefits\" (SFAS 112).\nComparing 1992 to 1991, increased sales volume and lower unit costs contributed to the increase in earnings. 1991 net income, before giving effect to the Non-Cash Accounting Adjustments described below was $34.4 million ($.80 per share). After giving effect to these adjustments, the 1991 loss was $120.5 million ($4.22 per share).\nAfter deducting dividends on the 5 5\/8% Series D Preferred Stock and 6% Series E Preferred Stock issued in July and November 1993, respectively, 1993 primary earnings available to stockholders were $19.4 million ($.40 per share), compared to $42.7 million ($1.28 per share) in 1992 and a loss of $128.3 million ($4.22 per share) in 1991.\n1991 Non-Cash Accounting Adjustments. In 1991, the Company recorded a series of accounting adjustments (the \"Non-Cash Accounting Adjustments\") which had no effect on its cash flow. The Non-Cash Accounting Adjustments resulted from studies, completed during 1991, of various balance sheet items that were undertaken in connection with a reorganization of the Company into distinct profit centers. In addition, execution of a new collective bargaining agreement and achievement of productivity increases at the upper Kalamazoo orebody enabled the Company to further study the feasibility of developing and mining the lower portion of this orebody. Based upon these studies, and in conjunction with its internal reorganization, the Company implemented, as of December 31, 1991, the following Non-Cash Accounting Adjustments:\n(1) Adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" and Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\n(2) An after tax restructuring charge of approximately $141 million, which included a $92 million after tax write-down of the Company's investment in its Kalamazoo orebody, as well as other amounts related to detailed reviews of the Company's balance sheet.\n(3) Implementation of a \"quasi-reorganization,\" in which certain assets and liabilities were restated and the accumulated deficit resulting from the adjustments described above was reclassified to capital in excess of par value.\nAfter giving effect to the Non-Cash Accounting Adjustments in 1991, the Company's stockholders' equity at December 31, 1990 was restated to $447.2 million, compared to $534.2 million, as was originally reported.\nCopper Prices and Sales. Copper prices have historically been subject to wide fluctuations and are dependent to a significant extent on factors outside the control of the Company. The Company's average realized price per pound of copper was $.94 in 1993, $1.00 in 1992 and $1.01 in 1991.\nDuring the second, third and fourth quarters of 1993, the Company benefited from put option contracts that provided price protection at LME prices below $.95 cents per pound. During these quarters, option contracts totalling 384 million pounds were exercised, resulting in a realized price above the market price. In addition, the Company's 1993 realized price was impacted by fixed price forward sales of 42 million pounds at an average of $.91 per pound. During 1992 and 1991, the Company had fixed price sales of 179 million pounds at $.93 per pound and 183 million pounds at $.98 per pound, respectively.\nThe Company's realized price per pound also includes a premium of several cents over the market price for copper cathode to reflect net delivery and financing costs. The Company's price for copper rod commands a premium over its price for copper cathode to reflect the value added by additional processing.\nCopper revenue in 1993 decreased by 3% to $710.5 million, compared to $736.2 million for 1992 and $652.3 million for 1991. During 1993, lower revenue resulted from a $.06 decrease in Magma's average realized price partially offset by higher sales volume. In 1992, higher sales volume was primarily responsible for the sharp increase in revenue from 1991.\nThe Company sold 764.4 million pounds of copper in 1993, a 5% increase from 725.4 million pounds sold in 1992, which was a 14% increase from the 638.1 million pounds sold in 1991. Sales of copper from Magma sources was negatively impacted in 1993 as the result of Arizona's abnormally high rainfall earlier in the year. The following table sets forth the volume of copper sold in relation to its sources:\nPounds of Copper Sold By Source (in millions)\nThe Company's wholly-owned subsidiary, Magma Metals Company sells the Company's products, operates its smelting, refining and rod plant complex, and purchases raw materials.\nThe Company's export sales have declined in recent years primarily due to increasing U.S. consumption and the recession in Japan. The Company is maintaining its presence in the Asian markets by supplying cathode to major fabricators on an annual basis. The Company's export sales as a percent of total revenues were 25%, 29% and 50% for the years ended December 31, 1993, 1992 and 1991, respectively.\nOther Metal Sales and Treatment Tolls Earned. Sales of other metals and metal by-products, sulfuric acid and treatment tolls earned in 1993 were $81.9 million, as compared to $83.3 million in 1992 and $72.5 million in 1991. The decrease for 1993 was primarily attributable to lower gold sales from the Company's Robinson Mining District and the closure of its McCabe mining division, together with a weak market for acid sales. These decreases were largely offset by higher purchased by-products that were contained in custom concentrates processed by Magma and an increase in volume of toll material processed. The increase for 1992 was primarily attributable to higher gold sales from the Robinson Mining District and from purchased by-products that were contained in custom concentrates processed by Magma.\nCost of Sales. Cost of products sold during 1993 of $639.4 million was up 1% from $630.4 million in 1992. Lower unit cost of Magma source copper contributed to lower cost of products sold by $21 million in addition to lower volume sold of $6 million. Higher sales volume of copper purchased or tolled from third parties increased cost of sales by $28 million. Storm damage production costs resulting from Arizona's abnormally high rainfall earlier in 1993 caused a $14 million increase (cost of sales impact only). Additionally, cost of sales of other metals decreased by $6 million.\nCost of products sold during 1992 of $630.4 million was up 8% from $585.7 million in 1991. This increase was due primarily to an increase in sales volume of Magma source copper of 43 million pounds ($35 million) and copper purchased from third parties of 44 million pounds ($49 million). These volume increases were offset by a $.05 per pound decrease in unit costs that reduced costs of sales by $26 million. Lower cost associated with purchased copper reduced cost of sales by $13 million.\nOther. Depreciation, depletion and amortization expense totaled $65.4 million in 1993 compared to $54.6 million in 1992. The increase was largely due to the initiation of depreciation related to new capital improvements. The $11.0 million increase in 1992 from 1991 was attributable to higher depreciation expense related to increased sales volume, the initiation of depreciation related to new capital improvements and the Non-Cash Accounting Adjustments made in connection with the Company's reorganization at the end of 1991.\nThe increase in selling, general and administrative expense for 1993 is largely due to higher insurance costs along with consulting and professional services. The increase for 1992 was a result of higher legal and consulting fees primarily relating to business development activities and special projects.\nInterest expense in 1993 was $35.0 million, as compared to $45.3 million in 1992 and $53.2 million in 1991. The decrease in 1993 reflected the capitalization of interest in connection with the Company's major capital projects. The decrease in 1992 reflected lower interest rates resulting from a refinancing of the Company's long-term debt.\nInterest income was $8.7 million in 1993 as compared to $9.5 million in 1992 and $7.7 million in 1991. The decrease in 1993 was largely the result of lower interest rates. The increase in 1992 from 1991 was the result of increased cash balances which were partly offset by declining interest rates. In 1993, other income decreased to $3.7 million from $4.3 million primarily due to lower townsite sales while in 1992 higher townsite sales contributed to the increase in other income from 1991 of $2.4 million.\nIn May 1992, the Company redeemed all $100 million of its Subordinated Reset Debentures which paid interest at a rate of 14.5%. The premium paid on this early extinguishment of debt is treated as an extraordinary item and is reflected as an after tax cost of $3.0 million for 1992.\nIn the fourth quarter of 1993, the Company recorded a $2.0 million charge for restructuring expenses related to workforce reductions as a part of its major cost reduction program.\nPreferred stock dividends were $2.5 million in 1993 compared to $12.6 million in 1992. The decrease was the result of the conversion in 1992 of the Company's Series B Preferred Stock. In July 1993 the Company issued $100.0 million Series D Preferred Stock and in November 1993 it issued $100.0 million of Series E Preferred Stock. These issues pay quarterly dividends at the annual rate of 5 5\/8% and 6%, respectively.\nEffects of Inflation. Generally, the Company's operating costs, other than labor and energy costs, are not materially affected by inflation. Recent low levels of inflation have not had a material effect on the Company's operating costs.\nCAPITAL RESOURCES & LIQUIDITY\nGeneral. The Company's 1993 operating cash flow (earnings before interest, taxes, depreciation and amortization or \"EBITDA\") was $125.3 million, as compared to $171.3 million in 1992. The decrease is attributable to lower copper prices and storm damage costs from Arizona's abnormally high rainfall which occurred early in 1993. Cash flow from operations, along with new issuances of preferred stock yielding net proceeds of $193 million and existing cash balances funded capital expenditures.\nDuring 1993, the Company spent $137 million for capital expenditures. In addition, capital expenditures of $11 million were financed by capital leases. These capital expenditures include $64 million for upgrading its smelting and refining complex, $24 million on the development of its Lower Kalamazoo orebody and $17 million on the engineering and development of its Robinson Mining District. The Company anticipates spending $150 million on capital expenditures in 1994. This includes $21 million to complete the smelting and refining complex upgrade, $20 million on continued development of the Lower Kalamazoo orebody and pending timely completion of permitting and other factors, $39 million on the development of the Robinson Mining District.\nThe Company's cash and marketable securities increased to $339 million at December 31, 1993. Working capital, including cash and marketable securities, was $360.4 million on December 31, 1993 compared to $226.8 million at December 31, 1992.\nAlthough the Company's operations are highly dependent on copper prices, the Company believes it will have sufficient liquidity to fund its operating expense and debt service obligations for the foreseeable future. In this regard, from time to time the Company enters into options and futures contracts or fixed price forward sales agreements as a hedge against lower copper prices. For the first and second quarters of 1994, the Company has purchased put option contracts covering 287 million pounds of production, providing a minimum realized price of $.72 per pound on a London Metals Exchange (\"LME\") basis. For the third and fourth quarters, the Company has entered into LME futures contracts covering 121 million pounds of production at an average price of $.82 per pound and purchased put option contracts covering 176 million pounds of production that provide a minimum realized price of $.74 per pound on a LME basis. The Company has also purchased put option contracts covering 374 million pounds of its production during the first three quarters of 1995 providing a minimum realized price of $.74 per pound on a LME basis.\nDevelopment Opportunities. The Company is currently pursuing or evaluating several major mine development opportunities, and has made significant capital improvements to its smelting and refining complex.\nRobinson Mining District. In 1991, Magma completed a series of transactions in which it acquired a 100% interest in the Robinson Mining District (\"Robinson\") near Ely, Nevada, for an aggregate acquisition cost of approximately $58 million. Based upon drill and assay results, the Company believes that Robinson has 252 million tons of proven\/probable sulfide ore reserves with an average grade of .553% copper and with .0102 ounces of gold per ton and 57 million tons of gold oxide reserves with an average grade of .0086 ounces of gold per ton. Robinson could produce approximately 135 million pounds of copper annually for 16 years through traditional mining\/concentrating\/smelting\/refining methods and could produce 97,300 ounces of gold and 390,000 ounces of silver annually from sulfide copper ore and 17,500 ounces of gold annually from leaching operations during this time period. A metallurgical test program is currently under way to evaluate the feasibility of processing Keystone dump material which contains in excess of 92 million tons at a grade of .34% copper.\nDevelopment of Robinson requires, among other factors, capital commitment of approximately $300 million and appropriate environmental and operating permits. In early 1993, the Bureau of Land Management determined that an Environmental Impact Statement (\"EIS\") must be prepared to analyze the Company's proposed re-development of the property. The Company believes the EIS process will be completed during 1994 and project start-up will begin in the first quarter of 1996, although there can be no assurance in this regard.\nKalamazoo. The Company's Kalamazoo orebody, which is near its San Manuel underground mine, is comprised of two levels, an upper level which contains approximately 33 million tons of proven\/probable ore reserves and a lower level which contains approximately 186 million tons of proven\/probable ore reserves. Development of the Lower Kalamazoo orebody was approved and capital of approximately $140 million was committed to the project in 1993. Based on the current mine plan, this project is scheduled to produce 2.13 billion pounds of copper during the period from 1996 to 2009.\nFlorence. In July 1992, Magma completed the acquisition of a large copper deposit near Florence, Arizona. Magma's project team has begun a pre-feasibility study. The deposit, completely on private and state-leased lands, was the subject of extensive exploratory and metallurgical work by the previous owner. The acquisition of this property is part of Magma's long-term strategy to increase copper production through the application of its advanced SX-EW leaching technology. Because evaluation of the Florence property is still in the early stages, the Company has not yet made any determination of the cost to develop the property.\nSmelting and Refining Complex. The Company is in the process of further upgrading its smelting and refining complex. The capital cost of the project is estimated at $85 million. The project includes the addition of a new large acid plant which will increase offgas handling capacity. The project will further improve environmental performance.\nDuring 1993, the smelter produced 681 million pounds of copper in anode form, significantly in excess of its design capacity of 600 million pounds. When the expansion is completed the Company anticipates that it will have the ability to produce at levels in excess of the 720 million pounds originally anticipated when the expansion was undertaken. This increase in capacity should enable the Company to maintain its custom smelting business even with the expected increase in smelting of Magma source copper when the Robinson Mining District begins production.\nTo the extent undertaken, the Company intends to finance these projects with internal cash flow, current cash balances and new borrowings if required. The Company does not currently anticipate difficulty in attracting any additional borrowing which may be required. The decision to undertake or complete these projects is subject to a variety of factors, which may include (depending on the project) the completion of favorable feasibility studies and permitting. There can be no assurance that the Company will undertake all of these opportunities or that, if undertaken, they will prove successful. If the Company is unable to replace its reserves from the mine development projects being evaluated, or with other reserves identified or acquired in the future, the Company's dependency upon third party sources to supply copper concentrate to its smelting and refining operations would increase.\nEnvironmental Matters. The Company maintains and funds an ongoing environmental compliance program. The program includes mine reclamation and remediation, as well as technological improvements and upgrades to its operating facilities.\nThe Company is currently in the process of completing improvements to its smelting and refining complex. The upgrades will improve the environmental performance of the smelter in anticipation of changing regulatory standards.\nDuring the first half of 1993 the Company's Pinto Valley and Superior Mining Divisions were adversely affected by significant rainfalls which caused flooding, water containment structural failures and operating difficulties, as well as technical violations of various permitting conditions and state surface water quality standards. The Company has tentatively agreed to enter into a consent decree with appropriate regulatory authorities to settle all claims relating to this matter. The consent decree is expected to be executed by the Company and its governmental counterparts during the first quarter of 1994. Under the proposed settlement, the Company would pay fines totaling $625,000 and would contribute monies towards or perform supplementary environmental projects of approximately $200,000. In addition, the Company would agree to perform remedial investigation studies and corrective activities and to upgrade its tailings containment and water containment facilities at these divisions. The Company expended $6 million to correct and upgrade affected facilities in 1993. The Company expects to spend an additional $8 million to upgrade and expand these facilities in 1994. These costs are being capitalized and will be amortized over the remaining mine life.\nThe Company is participating in a remediation and assessment of ground water quality at Pinal Creek near Miami, Arizona as part of the Arizona Department of Environmental Quality's Process Water Quality Assurance Revolving Fund Program. The Company and other companies sharing voluntary responsibility for ground water clean up and a remedial investigation have sued certain other mining companies with existing or prior operations in the area to obtain reimbursement for all or part of the costs that have been and will be incurred at the site. Some of these defendants have counterclaimed against the Company asserting indemnification for the costs and any liabilities relating to this project. To date, the Company's costs of remediation have not been material and, although there can be no assurance in this regard, the Company does not believe it will incur any material liability or costs in relation to this matter.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nMAGMA COPPER COMPANY AND CONSOLIDATED SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage\nReport of Independent Public Accountants . . . . . . . . . . . . . . 43 Consolidated Financial Statements: Consolidated Balance Sheets-December 31, 1993 and 1992 . . . . . 44 Consolidated Statements of Operations-for each of the years ended December 31, 1993, 1992 and 1991. . . . . . . 46 Consolidated Statements of Changes in Stockholders' Equity-for each of the years ended December 31, 1993, 1992 and 1991. . . . . . . . . . . . . . . . . . . . . . . . . . 47 Consolidated Statements of Cash Flows-for each of the years ended December 31, 1993, 1992 and 1991 . . . . . . . . 50 Notes to Consolidated Financial Statements. . . . . . . . . . . 52 Consolidated Financial Statement Schedules at and for the years ended December 31, 1993, 1992 and 1991: Report of Independent Public Accountants. . . . . . . . . . 72 Schedule I-Marketable Securities-Other Investments. . . . . . . . . . . . . . . . . . . . . . . 73 Schedule IV-Indebtedness of and to Related Parties-Not Current. . . . . . . . . . . . . . . . . . . 74 Schedule V-Property, Plant and Mine Development . . . . . . 75 Schedule VI-Accumulated Depreciation, Depletion and Amortization of Property, Plant and Mine Development. . . . . . . . . . . . . . . . . . . . . . . 76 Schedule VIII-Valuation and Qualifying Accounts . . . . . . 78 Schedule IX-Short-term Borrowings . . . . . . . . . . . . . 79 Schedule X-Supplementary Income Statement Information. . . . . . . . . . . . . . . . . . . . . . . 81\nAll other schedules are omitted as the information required is immaterial or inapplicable or because the required information is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Magma Copper Company:\nWe have audited the accompanying consolidated balance sheets of Magma Copper Company (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 1993 and 1992 (post quasi-reorganization - Note B), and for the year ended December 31, 1991 (pre quasi-reorganization - Note B). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Magma Copper Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for the years ended December 31, 1993 and 1992 (post quasi-reorganization), and the results of their operations and cash flows for the year ended December 31, 1991 (pre quasi- reorganization), in conformity with generally accepted accounting principles.\nAs explained in Note B and Note M to the financial statements, effective January 1, 1991, and January 1, 1993, the Company changed its method of accounting for postretirement benefits other than pensions and for postemployment benefits, respectively.\nARTHUR ANDERSEN & CO.\nTucson, Arizona, January 27, 1994.\nMAGMA COPPER COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - NATURE OF OPERATIONS\nMagma Copper Company and its subsidiaries (\"Magma\" or the \"Company\") are in the business of mining and concentrating nonferrous copper ore, smelting and refining its production, as well as that of third parties, and producing copper cathode and continuous-cast copper rod at its facilities in San Manuel, Miami (Pinto Valley Mining Division) and Superior, Arizona. The Company's primary product is electrolytic copper, most of which is sold as either cathode or continuous-cast copper rod. By-products derived from the treatment processes are sold to third parties.\nThe Company produces copper by both the traditional method (mining\/concentrating\/smelting\/refining) and by the leaching\/solvent extraction-electrowinning (\"SX-EW\") method. The Company owns and operates underground sulfide and open-pit oxide and sulfide mines at San Manuel, Miami (Pinto Valley Mining Division) and Superior, Arizona and Ely, Nevada. In addition to processing the Company's mined material, the San Manuel smelter, refinery and rod casting facilities process third party material on a custom basis, including tolled and purchased concentrates.\nNOTE B - RESTRUCTURING AND QUASI-REORGANIZATION\n1991 Non-Cash Accounting Adjustments. The Non-Cash Accounting Adjustments resulted from studies, completed during 1991, of various balance sheet items that were undertaken in connection with a reorganization of the Company into distinct profit centers. In addition, execution of the new collective bargaining agreement and achievement of productivity increases at the upper Kalamazoo orebody enabled the Company to further study the feasibility of developing and mining the lower portion of this orebody. Based upon these studies, and in conjunction with its internal reorganization, the Company implemented, as of December 31, 1991, the following Non-Cash Accounting Adjustments:\n(1) Adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" and Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\n(2) An after tax restructuring charge of approximately $141 million, which included a $92 million after tax write-down of the Company's investment in its Kalamazoo orebody, as well as other amounts related to detailed reviews of the Company's balance sheet.\n(3) Implementation of a \"quasi-reorganization\", in which certain assets and liabilities were restated and the accumulated deficit resulting from the adjustments described above was reclassified to capital in excess of par value.\nAfter giving effect to the Non-Cash Accounting Adjustments in 1991, the Company's stockholders' equity at December 31, 1990 was restated to $447.2 million, compared to $534.2 million, as was originally reported.\nNOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n1. Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Magma Gold Ltd., Magma Nevada Mining Company, Magma Arizona Railroad Company, San Manuel Arizona Railroad Company, Magma Metals Company and Magma Limited Partner Co. All significant intercompany accounts and transactions have been eliminated in consolidation.\n2. Property, Plant and Mine Development\nProperty, plant and mine development is stated at original historical cost less accumulated depreciation, depletion and amortization, except for certain assets which were restated in connection with the quasi- reorganization. Expenditures for property, plant and equipment are capitalized. Maintenance and repairs are expensed as incurred. Mine development expenditures incurred substantially in advance of production or to develop new mines are capitalized. Expenditures for mineral exploration or evaluations directed towards the discovery of mineral resources are expensed as incurred, as are expenditures for mine development costs which maintain current production levels. The amount expensed for exploration, research and development was $9.4 million, $2.6 million and $.9 million in 1993, 1992 and 1991, respectively.\nInvestments in property, plant and equipment are depleted or depreciated over the estimated productive lives of the assets, using the straight-line method, and deferred mine development costs are charged to operations on the units-of-production method based on the estimated pounds of copper ore to be recovered.\nIncluded in \"equipment and buildings\" in the accompanying consolidated balance sheets is $109,646,000 and $36,893,000 of construction-in-progress at December 31, 1993 and 1992, respectively. Included in \"deferred mine development costs\" is $21,353,000 and $10,775,000 of mine development-in- progress at December 31, 1993 and 1992, respectively. The accumulated amortization of deferred mine development costs was $9,263,000 and $2,863,000 at December 31, 1993 and 1992, respectively. The accumulated depletion of mining claims and land was $1,137,000 and $860,000 at December 31, 1993 and 1992, respectively.\n3. Inventories\nInventories of metals and materials and supplies are stated at the lower of moving-average cost or estimated market value.\nInventories included in current assets were (in thousands):\n4. Income Taxes\nSFAS 109, Accounting for Income Taxes, requires the adoption of the \"liability\" method for providing deferred taxes. The Company elected to adopt SFAS 109 by reflecting its provisions in the 1991 financial statements and retroactively restating the prior year financial statements from January 1, 1987 through December 31, 1990.\nDeferred income taxes result from temporary differences in the recognition of accounting transactions for tax and financial reporting purposes. The principal temporary differences relate to depreciation and amortization of mine development costs and certain financial reserves not deductible for tax purposes until paid.\n5. Method of Recording Sales and Treatment Toll Revenue\nRevenue from sales of copper and acid is recorded when ownership of the products is legally transferred to the customer. Certain copper sales are provisionally priced and later adjusted in the month the sales prices are contractually finalized. Revenue from by-products is recognized on a production basis. Treatment toll revenue earned for the smelting of concentrates is recorded in the month that the copper concentrates are smelted. Treatment toll revenue earned for refining copper and rod conversion is recorded in the period that the copper becomes returnable to the customer.\n6. Capitalized Interest\nThe Company capitalizes interest allocable to the construction of major new facilities and deferred mine development until operations commence. The Company capitalized $7,786,000 of interest in 1993. No interest was capitalized in 1992 or 1991.\n7. Earnings Per Share\nPrimary earnings per share is computed by dividing net income, less dividends on preferred stock, by the weighted average number of common shares outstanding and common shares payable as preferred stock dividends. Under the treasury stock method, common stock warrants outstanding at December 31, 1991 were antidilutive and therefore were not included in the computation of earnings per share. The weighted average number of primary common stock and common stock equivalents outstanding during 1993, 1992 and 1991 were 48,174,000, 33,444,000 and 30,382,000, respectively.\nEarnings per share assuming full dilution is computed by dividing net income by the weighted average number of common shares outstanding, including the potential dilutive effect of the Series D and Series E Preferred Stock. For purposes of the computation, all the preferred stock is included based on the weighted average converted shares outstanding. The weighted average number of common stock and common stock equivalents outstanding for 1992, assuming full dilution, was 46,605,000. For 1993 and 1991 the preferred stock was antidilutive.\n8. Stock Option and Stock Award Plans\nThe 1987 Stock Option and Stock Award Plan (\"the 1987 Plan\") was established by contributing 5% of Magma's then outstanding stock (1,903,630 shares of Class B Common Stock) to a trust. The trust holds the shares until used for direct grants or grants of stock options to key members of Magma's management as directed by a committee (\"the Committee\") of directors appointed by the Board of Directors. During 1989, the Committee authorized the purchase by the trust of 54,300 shares of Class B Common Stock from the open market for $390,000.\nThe Company's shareholders approved the adoption of the Magma Copper Company 1989 Stock Option and Stock Award Plan (\"the 1989 Plan\") on June 1, 1989. The 1989 Plan is administered by the Committee. Under the 1989 Plan, the Committee has authority to determine the key employees to whom, and the time or times at which, incentive awards in the form of stock options, stock appreciation rights, restricted stock awards and performance units may be granted.\nSubject to certain exceptions set forth in the 1989 Plan, the aggregate numbers of shares of the Company's Common Stock that may be the subject of awards under the Plan is 2,000,000.\nThe Company's shareholders approved adoption of the Magma Copper Company 1993 Stock Option and Stock Award Plan (\"the 1993 Plan\") on May 13, 1993. The 1993 Plan is administered by the Committee. Under the 1993 Plan, the Committee has authority to determine the key employees to whom, and the time or time at which, incentive awards in the form of stock options, stock appreciation rights, restricted stock awards, phantom stock rights, performance units and performance shares may be granted.\nSubject to certain exceptions set forth in the 1993 Plan, the aggregate number of shares of the Company's common stock that may be the subject of awards under the Plan is 2,250,000.\nOptions under the 1987 Plan primarily become exercisable over a three- year vesting period, subject to certain restrictions, at the rate of one- third per year. The options under the 1989 Plan become exercisable over a three or four-year vesting period. Options granted under the 1993 Plan become exercisable over a three year vesting period.\nThe following table summarizes the activity related to stock options under the plans:\nStock grants represent compensation to management for future periods and are treated as a capital contribution to Magma as they vest.\nGrants under the 1987 Plan vest over various terms. Most grants awarded in 1991 vest at the yearly rate of 20%, 20%, 30% and 30% over a four-year period. Most grants awarded in 1992 and 1993 vest over a three or four- year period.\nCompensation expense under the 1987 Plan in the form of stock grants earned for 1993, 1992 and 1991 was approximately $500,000, $500,000 and $1,400,000, respectively.\nGrants under the 1989 Plan primarily vest over a four-year period at 20% in each of the first two years and at 30% in the last two years or 25% per year over a four-year period. Compensation expense related to the 1989 Plan was approximately $100,000, $100,000 and $200,000 in 1993, 1992 and 1991, respectively.\nThe following table summarizes the activity under the stock grant plans:\nUnder the Company's 1989 Stock Option Plan for Non-Employee Directors, options awarded for 1993, 1992 and 1991 were 6,359, 6,164 and 13,521, respectively. Under this plan, the directors forego cash compensation in exchange for discounted options. The average exercise price was $5.97, $6.17 and $3.00 per share for 1993, 1992 and 1991, respectively.\nAt a meeting held on May 14, 1992, the Company's shareholders approved the adoption of the 1992 Restricted Stock Plan for Non-Employee Directors; 8,000 grants of stock were awarded in 1992 and 8,000 grants of stock were awarded in 1993.\n9. Stock Warrants\nThe Company has warrants outstanding covering the purchase of 5,077,756 shares exercisable at $8.50 per share. The warrants are exercisable through November 30, 1995.\n10. Cash, Cash Equivalents and Marketable Securities\nFor purposes of the consolidated balance sheets and the consolidated statements of cash flows, the Company considers all highly liquid investments, purchased with a maturity of three months or less, to be cash equivalents. Marketable securities are highly liquid investments, primarily in United States treasury notes, purchased with maturities greater than three months. These securities are carried at the lower of cost or market.\n11. Restatements and Reclassifications\nCertain amounts for 1992 have been reclassified to conform with 1993 reporting classifications.\nNOTE D - MAJOR CUSTOMERS, EXPORT SALES AND SALES COMMITMENTS\nDuring 1993, the Company's copper was sold to approximately sixty (60) customers. Sales of copper to the Company's largest customer during the year accounted for 19% of total revenue. Because copper is an internationally traded commodity, the Company does not believe that the loss of any one customer would have a material adverse effect on the results of its operations.\nThe Company's export sales have declined in recent years primarily due to increasing U.S. consumption and the recession in Japan. The Company is maintaining its presence in the Asian markets by supplying cathode to major fabricators on an annual basis. Export sales as a percent of total revenues were 25%, 29% and 50% for the years ended December 31, 1993, 1992 and 1991, respectively.\nFrom time to time the Company enters into options and futures contracts or fixed price forward sales agreements as a hedge against lower copper prices. For the first and second quarters of 1994, the Company has purchased put option contracts covering 287 million pounds of production, providing a minimum realized price of $.72 per pound on a London Metals Exchange (\"LME\") basis. For the third and fourth quarters, the Company has entered into LME futures contracts covering 121 million pounds of production at an average price of $.82 per pound and purchased put option contracts covering 176 million pounds of production that provide a minimum realized price of $.74 per pound on a LME basis. For 1995, the Company purchased put option contracts covering 374 million pounds of its first, second and third quarter production, providing a minimum realized price of $.74 per pound on a LME basis.\nNOTE E - INCOME TAXES\nDuring the fourth quarter of 1991, Magma adopted SFAS 109 and retroactively restated its financial statements from January 1, 1987. SFAS 109 requires an asset and liability approach for financial accounting and reporting for income tax purposes. This statement recognizes (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns.\nIn August 1993 the Revenue Reconciliation Act of 1993 (the \"Act\") was enacted by Congress. Under the Act, and effective as of January 1, 1993, the top marginal corporate tax rate was increased from 34% to 35%. Under Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS 109) the cumulative impact of a change in tax rate is recognized as an element of tax expense for the period of enactment. During the three month period ended September 30, 1993, the Company recorded a one time charge to tax expense of $2.8 million to reflect the impact of the change in statutory rate.\nIn calculating income taxes, the Company has benefitted from deductions for percentage depletion. In general, the Company's cumulative percentage depletion deductions exceed cost basis of depletable properties, resulting in current percentage depletion being treated as a permanent difference. The effect of this permanent difference causes the effective tax rate to be generally lower than the statutory tax rate. Of the total $6.3 million benefit for percentage depletion, approximately $3.1 million relates to a change in estimate formalized in July of 1993.\nThe components of the income tax (provision) benefit consist of the following (in thousands):\nThe (provision) benefit for income taxes differs from the amounts computed by applying the federal statutory rate as follows (in thousands):\nThe components of the net deferred tax liability are as follows (in thousands):\nAt December 31, 1993, Magma has for federal income tax purposes approximately $50 million of regular tax net operating loss carryforwards which expire, if unused, in the years 2003 through 2006. Under the federal alternative minimum tax system, Magma has no net operating loss carryforwards. As a result of shorter carryforward periods and other statutory differences, Magma has no net operating loss carryforwards for state income tax purposes.\nMagma also has alternative minimum tax credits aggregating approximately $52 million which carryforward indefinitely for federal income tax purposes. These credits can be used in the future to the extent that Magma's regular tax liability exceeds its liability calculated under the alternative minimum tax system.\nNOTE F - PENSION AND RETIREMENT PLANS\nThe Company and its subsidiaries have defined benefit pension and retirement plans covering substantially all employees (the \"Plans\"). Plans covering salaried employees provide pension benefits based on the employee's compensation during the ten years before retirement. Plans covering hourly employees provide pension benefits based on stated amounts, for each year of service, and provide for supplemental benefits for employees who retire with 30 years of service before age 65.\nThe Company's funding policy is to contribute annually the minimum amount that can be deducted for federal income tax purposes. Total pension and retirement plan costs were $2,257,000, $1,422,000 and $1,240,000 in 1993, 1992 and 1991, respectively.\nThe net periodic pension cost for 1993, 1992 and 1991 included the following components (in thousands):\nOn December 31, 1993 and 1992, the Plans' assets were invested in fixed income instruments and equity securities.\nThe following tables set forth the Plans' funded status and amounts recognized in the Company's consolidated balance sheets at December 31, 1993 and 1992 (in thousands):\nDuring 1990, an amendment changed the benefit formula and the definition of compensation used to compute the salaried employees' benefit. These changes resulted in an increase in the projected obligation of $3,100,000 which is accounted for as prior service cost and amortized over 13.9 years.\nThe Company provides executives with excess benefit and supplemental benefit pension plans. Plan costs for 1993 including interest and amortization of the transition obligation was $710,000. The projected benefit obligation of these plans at December 31, 1993 was $3,192,000. Funding is on a current basis and there are no plan assets.\nThe Company also sponsors postretirement medical and life insurance benefit plans. Effective January 1, 1991, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The Company elected to adopt this statement early and to record the entire cumulative adjustment in the year of adoption. The accompanying statement of operations for 1991 reflects a pre-tax charge of $23,000,000 less a $9,000,000 tax benefit as a cumulative effect in a change in accounting principle in accordance with SFAS 106.\nThe postretirement medical and life insurance plans cover salaried and hourly employees with at least ten years of service prior to retirement. The medical plan provides benefits for hospital coverage and surgical fees up to a lifetime limit of $80,000. The life insurance plan provides benefits to hourly employees of $4,000 and to salaried employees based on their preretirement compensation.\nThe Company funds the postretirement benefit costs on a current basis and there are no plan assets.\nThe net periodic postretirement benefit costs for 1993, 1992 and 1991 included the following components (in thousands):\nThe following table sets forth postretirement amounts recognized in the Company's consolidated balance sheets at December 31, 1993 and 1992 (in thousands):\nThe 1993 plan accounting assumes a health care cost trend rate for pre-age 65 benefits of 13% and post-age 65 benefits of 10%. These rates were assumed to decrease one percentage point each year to 5.5% and remain at that level thereafter. The assumed discount rate and rate of increase in compensation levels was 7.5% and 4.25%, respectively. The effect of a one percentage point increase in the assumed health care cost trend rates for each future year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $3,873,000. The effect of this change on the aggregate of the service and interest cost components of the net periodic postretirement benefit costs would have been an increase of $238,000 for 1993.\nNOTE G - LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nAt December 31, 1993, aggregate debt maturities are as follows for the years ending December 31 (in thousands):\n1. 12% Senior Subordinated Notes\nIn December 1991, the Company sold $200,000,000 of 12% Senior Subordinated Notes (\"12% Notes\") due December 15, 2001. Interest on the 12% Notes is payable on June 15 and December 15 of each year.\nThe 12% Notes are redeemable at the option of the Company, at any time or from time to time, on and after December 15, 1996 in whole or in part. Redemption of the 12% Notes is at 106% of the principal amount thereof for the twelve month period beginning on December 15, 1996, at 103% of the principal amount thereof for the twelve month period beginning on December 15, 1997, and thereafter at 100% of the principal amount thereof. The indenture pursuant to which the 12% Notes were issued contains, among other restrictions, limitations on the incurrence of additional debt, payment of cash dividends, distributions on and repurchases of the Company's capital stock and loans or contributions to the capital of or investment in Designated Subsidiaries, as defined by the Indenture.\n2. 11 1\/2% Senior Subordinated Notes\nIn January 1992, the Company issued $125,000,000 of 11 1\/2% Senior Subordinated Notes (\"11 1\/2% Notes\") due January 15, 2002. Interest on the 11 1\/2% Notes is payable January 15 and July 15 of each year.\nThe 11 1\/2% Notes are redeemable at the option of the Company, at any time or from time to time, on and after January 15, 1995 in whole or in part. Redemption of the 11 1\/2% Notes is at 108% of the principal amount thereof for the twelve month period beginning on January 15, 1995, at 106% of the principal amount thereof for the twelve month period beginning January 15, 1996, at 104% of the principal amount thereof for the twelve month period beginning January 15, 1997, at 102% of the principal amount thereof for the twelve month period beginning January 15, 1998, and thereafter at 100% of the principal amount thereof. The indenture pursuant to which the 11 1\/2% Notes were issued contains restrictions which are similar in nature to the 12% Senior Subordinated Notes.\n3. Industrial Development Authority Bonds\nAt December 31, 1993, Industrial Development Authority (\"IDA\") bonds outstanding totaled $49,700,000. These bonds have been issued through the Pinal County IDA, the locale of the Company's smelting and refining facility. The interest rates on these bonds is based on the minimum rate determined by the remarketing agent necessary to sell the bonds. The effective interest rate on the bonds was approximately 2.3% for 1993 and 4% for 1992 and 1991.\nPrincipal at December 31, 1993 is repayable as follows (in thousands):\nIn December 1992, the Company refinanced maturing bonds totaling $14,081,639 with a new $14,000,000 IDA bond issuance due December 1, 2011. The proceeds of the original bond issues were used to provide funds to finance certain pollution control facilities and retrofit the Company's smelter.\n4. Promissory Note\nIn July 1992, the Company purchased a major Arizona copper deposit. In conjunction with this purchase, the Company signed an $8,000,000, 9.75% Promissory Note (\"Promissory Note\") due in eight annual installments of $1,000,000 commencing January 1993. The Promissory Note may be prepaid at any time without penalty. The Promissory Note contains no significant covenants; however, it is secured by a deed of trust on the property purchased.\n5. Non-Interest Bearing Junior Subordinated Notes\nFrom March 1989 through March 1992, the Company issued non-interest- bearing junior subordinated notes (the \"Zero-Interest-Notes\") in lieu of quarterly cash dividends to holders of the Series B Preferred Stock (see Note H-Preferred Stock). The Zero-Interest-Notes are due and payable on May 4, 1994.\n6. Capitalized Lease Obligations\nThe Company has capitalized lease obligations for heavy mining equipment and a computer system. These leases have maturities from 1994 through 2008 and implicit rates ranging from 7.0% to 9.2%.\n7. Revolving Credit Facility\nIn May 1993, the Company entered into a five-year $200 million revolving credit agreement (the \"Revolver\"). The Revolver is provided by a consortium of ten banks and is available for general corporate purposes. Amounts outstanding under the Revolver may bear interest at the London InterBank Offered Rate (LIBOR), the Certificate of Deposit or the prime rate, as defined, plus a margin which may vary depending on the credit rating of the Company. Currently, borrowings would bear interest at the rate of LIBOR plus 1%. An annual agency fee of $30,000 plus a commitment fee (which also varies depending on the credit rating of the Company) of 3\/8% per annum on the unused portion of the Revolver is payable by the Company.\nUnder the terms of the Revolver, the Company must: (i) maintain a consolidated net worth of not less than the sum of $350 million plus 50% of consolidated net income for each fiscal year beginning with fiscal 1993; (ii) not permit the ratio of its consolidated debt to total capitalization (debt and equity) to exceed 60% and (iii) maintain a consolidated coverage ratio of at least 2.0 to 1.\nNOTE H - PREFERRED STOCK\nThe Company has 50,000,000 shares of authorized Preferred Stock. At December 31, 1993, 5,112,765 shares (none issued or outstanding) had been designated as Series C Convertible Preferred Stock (\"Series C Preferred Stock\"); 2,005,000 shares (2,000,000 issued and outstanding) had been designated as Series D Cumulative Convertible Preferred Stock (\"Series D Preferred Stock\"); 2,000,000 shares (issued and outstanding) had been designated as Series E Cumulative Convertible Preferred Stock, and 40,882,235 shares (none issued or outstanding) were undesignated. In 1988, 930,000 shares of the Series B Preferred Stock were issued in conjunction with a recapitalization of the Company. The Series C Preferred Stock was created for issuance upon conversion of the Series B Preferred Stock or exercise of outstanding warrants, if, for any reason, the Company were unable to issue Common Stock to satisfy applicable conversion or exercise requirements. No Series C Preferred Stock is outstanding and the Company is not presently aware of any reason that would require it to issue such stock or preclude it from issuing Common Stock.\nIn December 1992, the Company offered to exchange 15.446825 shares of its Common Stock for each share of its Series B Preferred Stock outstanding. On December 29, 1992, each share of Series B Preferred Stock was exchanged, resulting in an issuance of 14,133,047 shares of Common Stock.\nEach share of Series B Preferred Stock was entitled to cumulative dividends in each of the first five years after issuance, paid quarterly, at the rate of one share of Class B Common Stock per annum and, if the market price of a share of Class B Common Stock at the time was less than $10 plus an additional amount (payable, at the Company s option, in cash or non-interest-bearing junior subordinated notes due five years from the issuance date of the first of such notes issued), not to exceed $.625 per quarter, equal to one quarter of the excess of $10 over the market value of a share of Class B Common Stock. After November 1993, each share of Series B Preferred Stock would have been entitled to receive dividends of $10 per annum in cash.\nIn July 1993, the Company issued $100 million, or 2.0 million shares of 5 5\/8 % Cumulative Convertible Preferred Stock, Series D (\"Series D Preferred Stock\") and in December 1993, the Company issued $100 million, or 2.0 million shares of 6% Cumulative Convertible Preferred Stock, Series E (\"Series E Preferred Stock\"). Both the Series D Preferred Stock and Series E Preferred Stock have a liquidation preference of $50.00 per share and dividends are payable quarterly at the annual rate of 5 5\/8% and 6%, respectively.\nEach share of the Series D Preferred Stock and Series E Preferred Stock is convertible at any time at the option of the holder into shares of Common Stock of Magma Copper Company at a conversion rate of 3.448 and 3.5945 shares, (equivalent to a conversion price of $14.50 and $13.91 per share of Common Stock) respectively, subject to adjustment under certain conditions.\nThe Series D Preferred Stock and Series E Preferred Stock are not redeemable prior to July 20, 1996 and December 1, 1996, respectively. On and after the above dates, the Series D Preferred Stock and Series E Preferred Stock are redeemable at the option of the Company, in whole or in part, initially for $51.969 and $52.10 per share, respectively, and thereafter at prices declining ratably annually to $50 per share in 2003, plus, in each case, an amount equal to accrued and unpaid dividends to the redemption date.\nDuring 1993, the Company paid cash dividends on its Series D Preferred Stock and Series E Preferred Stock totaling $2,296,850 and $225,067, respectively.\nNOTE I - COMMON STOCK\nAt a Special Meeting of Stockholders on October 30, 1992, Magma's stockholders voted to amend the Company's Certificate of Incorporation to reclassify and convert all shares of Class A Common Stock and Class B Common Stock into a new, single class of Common Stock.\nEach share of Common Stock created by the amendment possesses one vote on all matters properly coming before stockholders, including elections of the Board of Directors, and is not subject to any transfer restrictions, and possesses no veto power over the issuance of any other class of stock.\nNOTE J - COMMITMENTS AND CONTINGENCIES\n1. Legal Matters\nThe Company is involved in legal proceedings of a character normally incidental to its business, including substantial claims and pending actions against the Company seeking recovery of alleged damages or clarifications of legal rights. The Company does not believe that adverse decisions in any pending or threatened proceedings, or any amounts which it may be required to pay by reason thereof, would have a material adverse effect on the financial condition or results of operations of the Company.\nThe Company is involved in legal proceedings (the \"Adjudication\") regarding the allocation of water rights of the Gila River system and source pending in the Superior Court of Maricopa County, Arizona. The Company's right to use surface and groundwater at its San Manuel, Pinto Valley and Superior operations, as well as the rights of all other claimants to use water from the Gila River system and source, is to be decided in this matter. Claims for damages for the Company's withdrawal of ground water have been asserted by Indian tribes, but have been stayed pending outcome of the Adjudication. A final resolution of this litigation may not be made for several years. Management believes that, despite this litigation, it will be able to obtain water necessary for its mining operations.\n2. Labor Contracts\nOn October 21, 1991 the Company and its labor unions executed a 15 year collective bargaining agreement. The agreement prohibits strikes and lockouts for at least seven years. Hourly-rated employees have received and will receive annual wage increases of $.25 to $.35 per hour in each of the next five years following 1991, some of which are dependent upon Magma's quarterly earnings performance during such periods. After the initial five-year period, the agreement will continue in effect for an additional 10 years on the same terms and conditions, unless either party proposes a modification of the economic terms. If the parties are unable to agree on the proposed modifications, they will be submitted to an arbitration panel which will establish major economic terms for a one-year period in accordance with certain specified criteria. If during any five- year period after the initial term there are two such arbitration proceedings, the agreement will terminate upon the anniversary date of the second arbitration award. Under the agreement, teams of management, union represented employees and their representatives are committed to work together to, among other things, increase productivity and reduce costs.\nNOTE K - LEASE COMMITMENTS\nThe Company leases railcars, haul trucks, other heavy mining equipment and a computer system. Rent expense for the years ended December 31, 1993, 1992 and 1991 was $4,464,000, $4,833,000 and $3,300,000, respectively.\nThe following is a schedule of the future minimum lease payments for the years ending December 31, (in thousands):\nNOTE L - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash. The carrying amount approximates fair value because of the short maturity of those instruments.\nMarketable Securities. The fair values of marketable securities are estimated based on quoted market prices for those or similar investments.\nLong-Term Debt. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.\nPrice Protection Contracts. As discussed further in Note D, at December 31, 1993 the Company has purchased put options for the first half of 1994 and entered into LME futures contracts for the second half of 1994. The carrying amount of these contracts reflects the cost of the option premium which will be amortized ratably as the options expire. The fair value of these contracts is estimated based on quotes from brokers and market prices at December 31, 1993. During January 1994, the Company purchased additional put options with a carrying amount which approximates fair value, but which are not included in the table below\nGold and Silver Swap Contracts. The Company has sold forward and repurchased a portion of its gold and silver production. Through the execution of swap contracts, the Company will effectively receive the difference between the fixed sales prices and fixed purchase prices added to the market average at the time of the physical gold and silver sales. The fair value of these contracts is based on the difference between the fixed sales and fixed purchase prices as of the valuation date.\nThe estimated fair values of the Company's financial instruments as of December 31, 1993 are as follows (in thousands):\nThe fair value estimates are made at discrete points in time based on relevant market information and information about the financial instruments. These estimates may be subjective in nature and involve uncertainties and significant judgment and therefore cannot be determined with precision.\nNOTE M - ADOPTION OF FASB 112 - EMPLOYERS' ACCOUNTING FOR POSTEMPLOYMENT BENEFITS\nAt December 31, 1993, the Company adopted SFAS 112 - \"Employers' Accounting for Postemployment Benefits\". The Company elected to adopt this statement early and to record the entire cumulative adjustment in the year of adoption. Under SFAS 112, $.9 million (after tax) was charged to first quarter 1993 earnings.\nNOTE N - STORM DAMAGE\nThe Company estimates that pre-tax earnings for 1993 were reduced by $21 million ($15.5 million after tax) as a result of storm damage. The largest cost was a writedown of inventory to net realizable value of $10 million caused by higher than normal production costs. Additionally, there was a $4 million loss of production and $4 million of one-time rain related repair costs. The Company's operating margin was reduced by $3 million as the Company was unable to mine from the higher-grade area of its open-pit mine at its Pinto Valley Mining Division. The Company is seeking to recover a portion of the amounts expended as a result of the storm damage from its property and casualty insurers.\nNOTE O - SELECTED QUARTERLY FINANCIAL DATA (Information for all periods shown below is unaudited).\nAmounts for the three months ended March 31, 1993 have been restated to reflect the adoption of SFAS 112 (see Note M). (In thousands, except per share data)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Magma Copper Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Magma Copper Company and subsidiaries included in this Form 10-K, and have issued our report thereon dated January 27, 1994. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index to consolidated financial statements of this Form 10-K are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nTucson, Arizona, January 27, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nAdditional information required by Part III (Items 10, 11, 12 and 13) is incorporated by reference from the registrant's definitive proxy statement which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K, provided, however, that the \"Compensation Committee Report on Executive Compensation\" and the \"Stock Performance Graph\" contained in the Proxy Statement are not incorporated by reference herein.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Consolidated Financial Statements: Index on page 42 of this Report.\n2. Consolidated Financial Statement Schedules: Index on page 42 of this Report.\n3. Exhibits. The exhibits as indexed on pages 83 through 91 of this Report are included as a part of this Form 10-K.\n(b) Reports on Form 8-K:\nThe following reports on Form 8-K were filed by the registrant during the three months ended December 31, 1993:\nThe Company filed a report on Form 8-K, dated November 17, 1993, to announce a proposed public offering of up to $100 million principal amount of Cumulative Convertible Preferred Stock, Series E, par value $.01 per share. The Company also announced that it had established a hedging program covering a portion of its 1994 production.\nThe Company filed a report on Form 8-K, dated November 24, 1993, to announce the conclusion of the sale of $100 million of Series E Preferred Stock.\nExhibit Number Description\n3.1 Restated Certificate of Incorporation (Incorporated by reference; of Magma Copper Company, dated previously filed as Exhibit February 21, 1991 3.4 to the Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1990.)\n3.2 Certificate of Correction to Restated (Incorporated by reference; Certificate of Incorporation of previously filed as Exhibit Magma Copper Company dated 3.2 to the Registrant's February 27, 1992 annual report on Form 10-K for the fiscal year ended December 31, 1991.)\n3.3 Certificate of Amendment to (Incorporated by reference; Restated Certification of previously filed as Exhibit Incorporation of Magma Copper 3.3 to the Registrant's Company dated October 30, 1992 1992 Form 10-K.)\n3.4 By-laws of Magma Copper Company (Incorporated by reference; as amended to and including previously filed as Exhibit July 22, 1992 3.4 to the Registrant's 1992 Form 10-K.)\n4.0 Specimen Common Stock Certificate (Incorporated by reference; previously filed as Exhibit 4.0 to the Registrant's 1992 Form 10-K.)\n4.1 Specimen Warrant Certificate (Incorporated by reference; previously filed as Exhibit 4.1 to the Registrant's 1988 Warrants Registration Statement.)\n4.2 Form of Warrant Agreement, dated (Incorporated by reference; as of December 15, 1988, between previously filed as Exhibit the Company and Manufacturers 4.2 to the Registrant's Hanover Trust Company, as warrant 1988 Warrants Registration agent Statement.)\n4.3 Form of Note Indenture for 12% (Incorporated by reference; Senior Subordinated Notes due previously filed as Exhibit 2001, dated December 15, 1991 4 to the Registrant's Current Report on Form 8-K dated January 9, 1992.)\nExhibit Number Description\n4.4 Specimen of 12% Note (Incorporated by reference; previously filed as Article Two of Exhibit 4 to the Registrant's Current Report on Form 8-K dated January 9, 1992.)\n4.5 Form of 11.5% Note Indenture for (Incorporated by reference; 11.5% Senior Subordinated Notes previously filed as Exhibit due 2002, dated January 15, 1992 28B to the Registrant's Current Report on Form 8-K dated January 17, 1992.)\n4.6 Specimen of 11.5% Note (Incorporated by reference; previously filed as Article Two of Exhibit 28B to the Registrant's Current Report on Form 8-K dated January 17, 1992.)\n4.7 Certificate of Designation of (Incorporated by reference; Series B Preferred Stock previously filed as Exhibit 3.6 to the Registrant's Registration Statement on Form S-1, File No. 33-24960 (the \"Copper Notes Registration Statement\").)\n4.8 Amendment to Certificate of (Incorporated by reference; Designation of Series B previously filed as Exhibit Preferred Stock 3.6 to the Registrant's Statement on Form S-1, File No. 33-26294 (the \"1988 Warrants Registration Statement\").)\n4.9 Certificate of Decrease in (Incorporated by reference; the Number of Authorized Shares previously filed as Exhibit of Series B Preferred Stock 3.7 to the Registrant's 1992 Form 10-K.)\n4.10 Certificate of Designations of (Incorporated by reference; Series D Preferred Stock previously filed as Exhibit 4.0 to the Registrant's Current Report on Form 8-K dated July 12, 1993.)\nExhibit Number Description\n4.11 Specimen Series D Preferred (Incorporated by reference; Stock Certificate previously filed as Exhibit 4.0 to the Registrant's Form 8-A dated July 8, 1993.)\n4.12 Certificate of Designations of (Incorporated by reference; Series E Preferred Stock previously filed as Exhibit 4.1 to the Registrant's Form 8-A dated November 17, 1993.)\n4.13 Specimen Series E Preferred Stock (Incorporated by reference; Certificate previously filed as Exhibit 4.0 to the Registrant's Form 8-A dated November 17, 1993.)\n10.0 Performance Rights Agreement, (Incorporated by reference; dated August 10, 1988, Between previously filed as Exhibit Donald J. Donahue and Magma 10.34 to the Registrant's Copper Company Copper Notes Registration Statement.)\n10.1 Tax-Matters Agreement, dated (Incorporated by reference; as of March 6, 1987 between previously filed as 10I to Newmont Mining Corporation and the Registrant's Magma Copper Company Form 10.)\n10.2 Tax Sharing Agreement between (Incorporated by reference; Newmont Mining Corporation and previously filed as Exhibit Magma Copper Company 10.15 to the Registrant's 1987 Form 10-K.)\n10.3 Memorandum Agreement, dated (Incorporated by reference, July 1, 1989, between Magma previously filed as Exhibit Copper Company and the unions 40.0 to the Registrant's comprising the Magma Unity Council 1989 Form 10-K.)\n10.4 Memorandum Agreement, dated (Incorporated by reference, November 1, 1991, between Magma previously filed as Exhibit Copper Company and the union 10.41 to the Registrant's comprising the Magma Unity 1991 Form 10-K.) Counsel\n10.5 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1984 between previously filed as Exhibit Magma Copper Company and National 10O to the Registrant's Westminister Bank PLC, New York Form 10.) Branch (Series 1984A Bonds)\nExhibit Number Description\n10.6 Loan Agreement, dated as of (Incorporated by reference; December 1, 1984, between The previously filed as Exhibit Industrial Development Authority 10K to the Registrant's of the County of Pinal and Magma Form 10.) Copper Company Series 1984A Bonds)\n10.7 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1984, between previously filed as Exhibit Magma Copper Company and National 10L to the Registrant's Westminster Bank PLC, New York Form 10.) Branch (Series 1984 Bonds)\n10.8 Loan Agreement, dated as of (Incorporated by reference; December 1, 1984, between The previously filed as Exhibit Industrial Development Authority 10M to the Registrant's of the County of Pinal and Magma Form 10.) Copper Company (Series 1984 Bonds)\n10.9 Letter Agreement amending the (Incorporated by reference; Reimbursement Agreement and previously filed as Exhibit Guaranty, among the Company, 10.12 to the Registrant's Newmont and National Westminster 1988 Warrants Registration Bank PLC, dated November 30, 1988 Statement.)\n10.10 Loan Agreement dated as of (Incorporated by reference; December 1, 1992, between the previously filed as Exhibit Industrial Development Authority 10.11 to the Registrant's of the County of Pinal and Magma 1992 Form 10-K.) Copper Company (Series 1992 Bonds)\n10.11 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1992, between previously filed as Exhibit Magma Copper Company and Banque 10.12 to the Registrant's Nationale de Paris 1992 Form 10-K.)\n10.12 Trust Agreement, dated as of (Incorporated by reference; March 10, 1987, among Newmont previously filed as Exhibit Mining Corporation, First 10.23 to the Registrant's Interstate Bank of Arizona and 1987 Form 10-K.) Magma Copper Company\n10.13 Amendment to Trust Agreement, (Incorporated by reference; dated December 27, 1988, between previously filed as Exhibit Newmont Mining Corporation, 27.0 to the Registrant's Magma Copper Company and First 1988 Form 10-K.) Interstate Bank of Arizona, N.A.\n10.14 User License, dated as of (Incorporated by reference; August 28, 1984, between previously filed as Exhibit Southwire Company and Magma 10.26 to the Registrant's Copper Company 1987 Form 10-K.)\nExhibit Number Description\n10.15 License Agreement, dated as of (Incorporated by reference; October 28, 1986, between previously filed as Exhibit Outokumpu Oy and Magma Copper 10.27 to the Registrant's Company 1987 Form 10-K.)\n10.16 License Agreement, dated as of (Incorporated by reference; February 1, 1986, between Phelps previously filed as Exhibit Dodge Refining Corporation and 10.28 to the Registrant's Magma Copper Company 1987 Form 10-K.)\n10.17 License Agreement, dated as of (Incorporated by reference; April 10, 1985, between MIM previously filed as Exhibit Technology Marketing Limited 10.30 to the Registrant's and Magma Copper Company 1987 Form 10-K.)\n10.18 Purchase Agreement, dated (Incorporated by reference; November 20, 1988, between previously filed as Exhibit Magma Copper Company and 10.50 to the Registrant's Warburg, Pincus Capital Company, Copper Notes Registration L.P. Statement.)\n10.19 Amendment to Purchase Agreement, (Incorporated by reference; dated November 30, 1988, between previously filed as Exhibit Magma Copper Company and Warburg, 10.27 to the Registrant's Pincus Capital Company, L.P. 1988 Warrants Registration Statement.)\n10.20 Registration Rights Agreement, (Incorporated by reference; dated November 30, 1988, between previously filed as Exhibit Magma Copper Company and Warburg, 10.29 to the Registrant's Pincus Capital Company, L.P. 1988 Warrants Registration Statement.)\n10.21 Revolving Credit Facility (Incorporated by reference; Agreement dated May 5, 1993 previously filed as Exhibit among Magma Copper Company 10.1 to the Registrant's and Chemical Bank, National Registration Statement on Westminster Bank PLC, and Form S-3 File No. other lenders 33-64030.)\n10.22 1987 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 10B to the Registrant's Form 10.)\n10.23 Amendments to 1987 Stock (Incorporated by reference; Option and Stock Award Plan previously filed as Exhibit 28.1 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\nExhibit Number Description\n10.24 1989 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 35.0 to the Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1989 (the \"1989 Form 10-K.\")\n10.25 Amendments to 1989 Stock (Incorporated by reference; Option and Stock Award previously filed as Exhibit Plan 28.2 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\n10.26 1989 Stock Option Plan for (Incorporated by reference; Non-employee Directors previously filed as Exhibit 10.27 to the Registrant's 1991 Form 10-K.)\n10.27 Amendment to 1989 Stock Option (Incorporated by reference; Plan for Non-Employee Directors previously filed as Exhibit 28 to the Registrant's Quarterly Report on Form 10-Q dated September 30, 1991.)\n10.28 Excess Benefit Plan (Incorporated by reference; previously filed as Exhibit 10.28 to the Registrant's 1991 Form 10-K.)\n10.29 Executive Supplemental Benefit (Incorporated by reference; Plan previously filed as Exhibit 10.29 to the Registrant's 1991 Form 10-K.)\n10.30 Special Executive Supplemental (Incorporated by reference; Benefit Plan previously filed as Exhibit 10.30 to the Registrant's 1991 Form 10-K.)\n10.31 Special Executive Deferred (Incorporated by reference; Compensation Plan previously filed as Exhibit 10.31 to the Registrant's 1991 Form 10-K.)\n10.32 First Amendment to Special (Incorporated by reference; Executive Deferred Compensation previously filed as Exhibit Plan 10.33 to the Registrant's 1992 Form 10-K.)\n10.33 Second Amendment to Special (Incorporated by reference; Executive Deferred Compensation previously filed as Exhibit Plan 10.34 to the Registrant's 1992 Form 10-K.)\n10.34 1992 Restricted Stock Plan for (Incorporated by reference; Non-Employee Directors previously filed as Exhibit 28.3 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\nExhibit Number Description\n10.35 Amendment to 1987 Stock Plan (Incorporated by reference; for Non-Employee Directors previously filed as Exhibit 10.36 to the Registrant's 1992 Form 10-K.)\n10.36 1993 Revised Incentive Compensation Filed herewith. Plan Guidelines\n10.37 Chief Executive Officer (Incorporated by reference; Supplemental Retirement Plan previously filed as Exhibit 10.38 to the Registrant's 1992 Form 10-K.)\n10.38 Employment Agreement - (Generic Filed herewith. Copy)\n10.39 Third Amendment to Employment Filed herewith. Agreement between J. B. Winter and Magma Copper Company\n10.40 Retention and Severance Benefit Filed herewith. Agreement between Magma Copper Company and J. B. Winter\n10.41 Revised 1993 Long-Term Incentive Filed herewith. Plan guidelines\n10.42 1993 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 4 to the Registrant's Form S-8 Registration Statement, File No. 33-64766.)\n10.43 First amendment to the Magma Filed herewith. Copper Company Executive Supplemental Benefit Plan\n10.44 Second amendment to the Magma Filed herewith. Copper Company Executive Supplemental Benefit Plan\n10.45 First Amendment to the Magma Filed herewith. Copper Company Special Executive Supplemental Benefit Plan\n10.46 Second Amendment to the Magma Filed herewith. Copper Company Special Executive Supplemental Benefit Plan\n11.0 Statement re: computation of Filed herewith. per share earnings\n21.0 Subsidiaries of Magma Copper Filed herewith. Company\n23.0 Consent of independent public Filed herewith. accountant\n99.0 Statement re: indemnification (Incorporated by reference; of directors, officers and previously filed as Exhibit controlling persons 28.0 to the Registrant's 1990 Form 10-K.)\nSIGNATURES\nPursuant 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.\nMAGMA COPPER COMPANY\nBy:\/s\/ Donald J. Donahue (Donald J. Donahue) Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated.\nSignature Title Date\nChairman of the Board \/s\/ Donald J. Donahue and Director March 10, 1994 (Donald J. Donahue)\nPresident, Chief Executive Officer, Director \/s\/ J. Burgess Winter (Principal Executive Officer) March 10, 1994 (J. Burgess Winter)\nVice President and \/s\/ Douglas J. Purdom Chief Financial Officer March 10, 1994 (Douglas J. Purdom) (Principal Financial and Accounting Officer)\n\/s\/ Christopher W. Brody Director March 10, 1994 (Christopher W. Brody)\n\/s\/ Judd R. Cool Director March 10, 1994 (Judd R. Cool)\n\/s\/ John W. Goth Director March 10, 1994 (John W. Goth)\n\/s\/ John R. Kennedy Director March 10, 1994 (John R. Kennedy)\n\/s\/ Thomas W. Rollins Director March 10, 1994 (Thomas W. Rollins)\n\/s\/ Henry B. Sargent Director March 10, 1994 (Henry B. Sargent)\n\/s\/ Simon D. Strauss Director March 10, 1994 (Simon D. Strauss)\n\/s\/ H. Wilson Sundt Director March 10, 1994 (H. Wilson Sundt)\n\/s\/ John L. Vogelstein Director March 10, 1994 (John L. Vogelstein)","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Consolidated Financial Statements: Index on page 42 of this Report.\n2. Consolidated Financial Statement Schedules: Index on page 42 of this Report.\n3. Exhibits. The exhibits as indexed on pages 83 through 91 of this Report are included as a part of this Form 10-K.\n(b) Reports on Form 8-K:\nThe following reports on Form 8-K were filed by the registrant during the three months ended December 31, 1993:\nThe Company filed a report on Form 8-K, dated November 17, 1993, to announce a proposed public offering of up to $100 million principal amount of Cumulative Convertible Preferred Stock, Series E, par value $.01 per share. The Company also announced that it had established a hedging program covering a portion of its 1994 production.\nThe Company filed a report on Form 8-K, dated November 24, 1993, to announce the conclusion of the sale of $100 million of Series E Preferred Stock.\nExhibit Number Description\n3.1 Restated Certificate of Incorporation (Incorporated by reference; of Magma Copper Company, dated previously filed as Exhibit February 21, 1991 3.4 to the Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1990.)\n3.2 Certificate of Correction to Restated (Incorporated by reference; Certificate of Incorporation of previously filed as Exhibit Magma Copper Company dated 3.2 to the Registrant's February 27, 1992 annual report on Form 10-K for the fiscal year ended December 31, 1991.)\n3.3 Certificate of Amendment to (Incorporated by reference; Restated Certification of previously filed as Exhibit Incorporation of Magma Copper 3.3 to the Registrant's Company dated October 30, 1992 1992 Form 10-K.)\n3.4 By-laws of Magma Copper Company (Incorporated by reference; as amended to and including previously filed as Exhibit July 22, 1992 3.4 to the Registrant's 1992 Form 10-K.)\n4.0 Specimen Common Stock Certificate (Incorporated by reference; previously filed as Exhibit 4.0 to the Registrant's 1992 Form 10-K.)\n4.1 Specimen Warrant Certificate (Incorporated by reference; previously filed as Exhibit 4.1 to the Registrant's 1988 Warrants Registration Statement.)\n4.2 Form of Warrant Agreement, dated (Incorporated by reference; as of December 15, 1988, between previously filed as Exhibit the Company and Manufacturers 4.2 to the Registrant's Hanover Trust Company, as warrant 1988 Warrants Registration agent Statement.)\n4.3 Form of Note Indenture for 12% (Incorporated by reference; Senior Subordinated Notes due previously filed as Exhibit 2001, dated December 15, 1991 4 to the Registrant's Current Report on Form 8-K dated January 9, 1992.)\nExhibit Number Description\n4.4 Specimen of 12% Note (Incorporated by reference; previously filed as Article Two of Exhibit 4 to the Registrant's Current Report on Form 8-K dated January 9, 1992.)\n4.5 Form of 11.5% Note Indenture for (Incorporated by reference; 11.5% Senior Subordinated Notes previously filed as Exhibit due 2002, dated January 15, 1992 28B to the Registrant's Current Report on Form 8-K dated January 17, 1992.)\n4.6 Specimen of 11.5% Note (Incorporated by reference; previously filed as Article Two of Exhibit 28B to the Registrant's Current Report on Form 8-K dated January 17, 1992.)\n4.7 Certificate of Designation of (Incorporated by reference; Series B Preferred Stock previously filed as Exhibit 3.6 to the Registrant's Registration Statement on Form S-1, File No. 33-24960 (the \"Copper Notes Registration Statement\").)\n4.8 Amendment to Certificate of (Incorporated by reference; Designation of Series B previously filed as Exhibit Preferred Stock 3.6 to the Registrant's Statement on Form S-1, File No. 33-26294 (the \"1988 Warrants Registration Statement\").)\n4.9 Certificate of Decrease in (Incorporated by reference; the Number of Authorized Shares previously filed as Exhibit of Series B Preferred Stock 3.7 to the Registrant's 1992 Form 10-K.)\n4.10 Certificate of Designations of (Incorporated by reference; Series D Preferred Stock previously filed as Exhibit 4.0 to the Registrant's Current Report on Form 8-K dated July 12, 1993.)\nExhibit Number Description\n4.11 Specimen Series D Preferred (Incorporated by reference; Stock Certificate previously filed as Exhibit 4.0 to the Registrant's Form 8-A dated July 8, 1993.)\n4.12 Certificate of Designations of (Incorporated by reference; Series E Preferred Stock previously filed as Exhibit 4.1 to the Registrant's Form 8-A dated November 17, 1993.)\n4.13 Specimen Series E Preferred Stock (Incorporated by reference; Certificate previously filed as Exhibit 4.0 to the Registrant's Form 8-A dated November 17, 1993.)\n10.0 Performance Rights Agreement, (Incorporated by reference; dated August 10, 1988, Between previously filed as Exhibit Donald J. Donahue and Magma 10.34 to the Registrant's Copper Company Copper Notes Registration Statement.)\n10.1 Tax-Matters Agreement, dated (Incorporated by reference; as of March 6, 1987 between previously filed as 10I to Newmont Mining Corporation and the Registrant's Magma Copper Company Form 10.)\n10.2 Tax Sharing Agreement between (Incorporated by reference; Newmont Mining Corporation and previously filed as Exhibit Magma Copper Company 10.15 to the Registrant's 1987 Form 10-K.)\n10.3 Memorandum Agreement, dated (Incorporated by reference, July 1, 1989, between Magma previously filed as Exhibit Copper Company and the unions 40.0 to the Registrant's comprising the Magma Unity Council 1989 Form 10-K.)\n10.4 Memorandum Agreement, dated (Incorporated by reference, November 1, 1991, between Magma previously filed as Exhibit Copper Company and the union 10.41 to the Registrant's comprising the Magma Unity 1991 Form 10-K.) Counsel\n10.5 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1984 between previously filed as Exhibit Magma Copper Company and National 10O to the Registrant's Westminister Bank PLC, New York Form 10.) Branch (Series 1984A Bonds)\nExhibit Number Description\n10.6 Loan Agreement, dated as of (Incorporated by reference; December 1, 1984, between The previously filed as Exhibit Industrial Development Authority 10K to the Registrant's of the County of Pinal and Magma Form 10.) Copper Company Series 1984A Bonds)\n10.7 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1984, between previously filed as Exhibit Magma Copper Company and National 10L to the Registrant's Westminster Bank PLC, New York Form 10.) Branch (Series 1984 Bonds)\n10.8 Loan Agreement, dated as of (Incorporated by reference; December 1, 1984, between The previously filed as Exhibit Industrial Development Authority 10M to the Registrant's of the County of Pinal and Magma Form 10.) Copper Company (Series 1984 Bonds)\n10.9 Letter Agreement amending the (Incorporated by reference; Reimbursement Agreement and previously filed as Exhibit Guaranty, among the Company, 10.12 to the Registrant's Newmont and National Westminster 1988 Warrants Registration Bank PLC, dated November 30, 1988 Statement.)\n10.10 Loan Agreement dated as of (Incorporated by reference; December 1, 1992, between the previously filed as Exhibit Industrial Development Authority 10.11 to the Registrant's of the County of Pinal and Magma 1992 Form 10-K.) Copper Company (Series 1992 Bonds)\n10.11 Reimbursement Agreement, dated (Incorporated by reference; as of December 1, 1992, between previously filed as Exhibit Magma Copper Company and Banque 10.12 to the Registrant's Nationale de Paris 1992 Form 10-K.)\n10.12 Trust Agreement, dated as of (Incorporated by reference; March 10, 1987, among Newmont previously filed as Exhibit Mining Corporation, First 10.23 to the Registrant's Interstate Bank of Arizona and 1987 Form 10-K.) Magma Copper Company\n10.13 Amendment to Trust Agreement, (Incorporated by reference; dated December 27, 1988, between previously filed as Exhibit Newmont Mining Corporation, 27.0 to the Registrant's Magma Copper Company and First 1988 Form 10-K.) Interstate Bank of Arizona, N.A.\n10.14 User License, dated as of (Incorporated by reference; August 28, 1984, between previously filed as Exhibit Southwire Company and Magma 10.26 to the Registrant's Copper Company 1987 Form 10-K.)\nExhibit Number Description\n10.15 License Agreement, dated as of (Incorporated by reference; October 28, 1986, between previously filed as Exhibit Outokumpu Oy and Magma Copper 10.27 to the Registrant's Company 1987 Form 10-K.)\n10.16 License Agreement, dated as of (Incorporated by reference; February 1, 1986, between Phelps previously filed as Exhibit Dodge Refining Corporation and 10.28 to the Registrant's Magma Copper Company 1987 Form 10-K.)\n10.17 License Agreement, dated as of (Incorporated by reference; April 10, 1985, between MIM previously filed as Exhibit Technology Marketing Limited 10.30 to the Registrant's and Magma Copper Company 1987 Form 10-K.)\n10.18 Purchase Agreement, dated (Incorporated by reference; November 20, 1988, between previously filed as Exhibit Magma Copper Company and 10.50 to the Registrant's Warburg, Pincus Capital Company, Copper Notes Registration L.P. Statement.)\n10.19 Amendment to Purchase Agreement, (Incorporated by reference; dated November 30, 1988, between previously filed as Exhibit Magma Copper Company and Warburg, 10.27 to the Registrant's Pincus Capital Company, L.P. 1988 Warrants Registration Statement.)\n10.20 Registration Rights Agreement, (Incorporated by reference; dated November 30, 1988, between previously filed as Exhibit Magma Copper Company and Warburg, 10.29 to the Registrant's Pincus Capital Company, L.P. 1988 Warrants Registration Statement.)\n10.21 Revolving Credit Facility (Incorporated by reference; Agreement dated May 5, 1993 previously filed as Exhibit among Magma Copper Company 10.1 to the Registrant's and Chemical Bank, National Registration Statement on Westminster Bank PLC, and Form S-3 File No. other lenders 33-64030.)\n10.22 1987 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 10B to the Registrant's Form 10.)\n10.23 Amendments to 1987 Stock (Incorporated by reference; Option and Stock Award Plan previously filed as Exhibit 28.1 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\nExhibit Number Description\n10.24 1989 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 35.0 to the Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1989 (the \"1989 Form 10-K.\")\n10.25 Amendments to 1989 Stock (Incorporated by reference; Option and Stock Award previously filed as Exhibit Plan 28.2 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\n10.26 1989 Stock Option Plan for (Incorporated by reference; Non-employee Directors previously filed as Exhibit 10.27 to the Registrant's 1991 Form 10-K.)\n10.27 Amendment to 1989 Stock Option (Incorporated by reference; Plan for Non-Employee Directors previously filed as Exhibit 28 to the Registrant's Quarterly Report on Form 10-Q dated September 30, 1991.)\n10.28 Excess Benefit Plan (Incorporated by reference; previously filed as Exhibit 10.28 to the Registrant's 1991 Form 10-K.)\n10.29 Executive Supplemental Benefit (Incorporated by reference; Plan previously filed as Exhibit 10.29 to the Registrant's 1991 Form 10-K.)\n10.30 Special Executive Supplemental (Incorporated by reference; Benefit Plan previously filed as Exhibit 10.30 to the Registrant's 1991 Form 10-K.)\n10.31 Special Executive Deferred (Incorporated by reference; Compensation Plan previously filed as Exhibit 10.31 to the Registrant's 1991 Form 10-K.)\n10.32 First Amendment to Special (Incorporated by reference; Executive Deferred Compensation previously filed as Exhibit Plan 10.33 to the Registrant's 1992 Form 10-K.)\n10.33 Second Amendment to Special (Incorporated by reference; Executive Deferred Compensation previously filed as Exhibit Plan 10.34 to the Registrant's 1992 Form 10-K.)\n10.34 1992 Restricted Stock Plan for (Incorporated by reference; Non-Employee Directors previously filed as Exhibit 28.3 to the Registrant's Quarterly Report on Form 10-Q dated June 30, 1992.)\nExhibit Number Description\n10.35 Amendment to 1987 Stock Plan (Incorporated by reference; for Non-Employee Directors previously filed as Exhibit 10.36 to the Registrant's 1992 Form 10-K.)\n10.36 1993 Revised Incentive Compensation Filed herewith. Plan Guidelines\n10.37 Chief Executive Officer (Incorporated by reference; Supplemental Retirement Plan previously filed as Exhibit 10.38 to the Registrant's 1992 Form 10-K.)\n10.38 Employment Agreement - (Generic Filed herewith. Copy)\n10.39 Third Amendment to Employment Filed herewith. Agreement between J. B. Winter and Magma Copper Company\n10.40 Retention and Severance Benefit Filed herewith. Agreement between Magma Copper Company and J. B. Winter\n10.41 Revised 1993 Long-Term Incentive Filed herewith. Plan guidelines\n10.42 1993 Stock Option and Stock (Incorporated by reference; Award Plan previously filed as Exhibit 4 to the Registrant's Form S-8 Registration Statement, File No. 33-64766.)\n10.43 First amendment to the Magma Filed herewith. Copper Company Executive Supplemental Benefit Plan\n10.44 Second amendment to the Magma Filed herewith. Copper Company Executive Supplemental Benefit Plan\n10.45 First Amendment to the Magma Filed herewith. Copper Company Special Executive Supplemental Benefit Plan\n10.46 Second Amendment to the Magma Filed herewith. Copper Company Special Executive Supplemental Benefit Plan\n11.0 Statement re: computation of Filed herewith. per share earnings\n21.0 Subsidiaries of Magma Copper Filed herewith. Company\n23.0 Consent of independent public Filed herewith. accountant\n99.0 Statement re: indemnification (Incorporated by reference; of directors, officers and previously filed as Exhibit controlling persons 28.0 to the Registrant's 1990 Form 10-K.)\nSIGNATURES\nPursuant 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.\nMAGMA COPPER COMPANY\nBy:\/s\/ Donald J. Donahue (Donald J. Donahue) Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated.\nSignature Title Date\nChairman of the Board \/s\/ Donald J. Donahue and Director March 10, 1994 (Donald J. Donahue)\nPresident, Chief Executive Officer, Director \/s\/ J. Burgess Winter (Principal Executive Officer) March 10, 1994 (J. Burgess Winter)\nVice President and \/s\/ Douglas J. Purdom Chief Financial Officer March 10, 1994 (Douglas J. Purdom) (Principal Financial and Accounting Officer)\n\/s\/ Christopher W. Brody Director March 10, 1994 (Christopher W. Brody)\n\/s\/ Judd R. Cool Director March 10, 1994 (Judd R. Cool)\n\/s\/ John W. Goth Director March 10, 1994 (John W. Goth)\n\/s\/ John R. Kennedy Director March 10, 1994 (John R. Kennedy)\n\/s\/ Thomas W. Rollins Director March 10, 1994 (Thomas W. Rollins)\n\/s\/ Henry B. Sargent Director March 10, 1994 (Henry B. Sargent)\n\/s\/ Simon D. Strauss Director March 10, 1994 (Simon D. Strauss)\n\/s\/ H. Wilson Sundt Director March 10, 1994 (H. Wilson Sundt)\n\/s\/ John L. Vogelstein Director March 10, 1994 (John L. Vogelstein)","section_15":""}
{"filename":"86940_1993.txt","cik":"86940","year":"1993","section_1":"ITEM 1. BUSINESS\nSOUTHERN was incorporated under the laws of Delaware on November 9, 1945. SOUTHERN is domesticated under the laws of Georgia and is qualified to do business as a foreign corporation under the laws of Alabama. SOUTHERN owns all the outstanding common stock of ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH, each of which is an operating public utility company. ALABAMA and GEORGIA each own 50% of the outstanding common stock of SEGCO. The operating affiliates supply electric service in the states of Alabama, Georgia, Florida, Mississippi and Georgia, respectively, and SEGCO owns generating units at a large electric generating station which supplies power to ALABAMA and GEORGIA. More particular information relating to each of the operating affiliates is as follows:\nALABAMA is a corporation organized under the laws of the State of Alabama on November 10, 1927, by the consolidation of a predecessor Alabama Power Company, Gulf Electric Company and Houston Power Company. The predecessor Alabama Power Company had had a continuous existence since its incorporation in 1906.\nGEORGIA was incorporated under the laws of the State of Georgia on June 26, 1930, and admitted to do business in Alabama on September 15, 1948.\nGULF is a corporation which was organized under the laws of the State of Maine on November 2, 1925, and admitted to do business in Florida on January 15, 1926, in Mississippi on October 25, 1976 and in Georgia on November 20, 1984.\nMISSISSIPPI was incorporated under the laws of the State of Mississippi on July 12, 1972, was admitted to do business in Alabama on November 28, 1972, and effective December 21, 1972, by the merger into it of the predecessor Mississippi Power Company, succeeded to the business and properties of the latter company. The predecessor Mississippi Power Company was incorporated under the laws of the State of Maine on November 24, 1924, and was admitted to do business in Mississippi on December 23, 1924, and in Alabama on December 7, 1962.\nSAVANNAH is a corporation existing under the laws of Georgia; its charter was granted by the Secretary of State on August 5, 1921.\nSOUTHERN also owns all the outstanding common stock of SEI, Southern Nuclear, SCS (the system service company), and various other subsidiaries related to foreign operations and domestic non-utility operations (see Exhibit 21 herein). At this time, the operations of the other subsidiaries are not material. SEI designs, builds, owns and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. A further description of SEI's business and organization follows later in this section. Southern Nuclear provides services to the Southern electric system's nuclear plants.\nSEGCO owns electric generating units with an aggregate capacity of 1,019,680 kilowatts at Plant Gaston on the Coosa River near Wilsonville, Alabama, and ALABAMA and GEORGIA are each entitled to one-half of SEGCO's capacity and energy. ALABAMA acts as SEGCO's agent in the operation of SEGCO's units and furnishes coal to SEGCO as fuel for its units. SEGCO also owns three 230,000 volt transmission lines extending from Plant Gaston to the Georgia state line at which point connection is made with the GEORGIA transmission line system.\nTHE SOUTHERN SYSTEM\nThe transmission facilities of each of the operating affiliates and SEGCO are connected to the respective company's own generating plants and other sources of power and are interconnected with the transmission facilities of the other operating affiliates and SEGCO by means of heavy-duty high voltage lines. (In the case of GEORGIA's integrated transmission system, see Item 1 - BUSINESS - \"Territory Served\" herein.)\nOperating contracts covering arrangements in effect with principal neighboring utility systems provide for capacity exchanges, capacity purchases and sales, transfers of economy energy and other similar transactions. Additionally, the operating affiliates have entered into voluntary reliability agreements with the subsidiaries of Entergy Corporation, Florida Electric Power Coordinating Group and TVA and with Carolina Power & Light Company, Duke Power Company, South Carolina Electric & Gas Company and Virginia Electric\nI-1\nand Power Company, each of which provides for the establishment and periodic review of principles and procedures for planning and operation of generation and transmission facilities, maintenance schedules, load retention programs, emergency operations, and other matters affecting the reliability of bulk power supply. The operating affiliates have joined with other utilities in the Southeast (including those referred to above) to form the SERC to augment further the reliability and adequacy of bulk power supply. Through the SERC, the operating affiliates are represented on the National Electric Reliability Council.\nAn intra-system interchange agreement provides for coordinating operations of the power producing facilities of the operating affiliates and SEGCO and the capacities available to such companies from non-affiliated sources and for the pooling of surplus energy available for interchange. Coordinated operation of the entire interconnected system is conducted through a central power supply coordination office maintained by SCS. The available sources of energy are allocated to the operating affiliates to provide the most economical sources of power consistent with good operation. The resulting benefits and savings are apportioned among the operating affiliates.\nSCS has contracted with each operating affiliate, SEI, various of the other subsidiaries, Southern Nuclear and SEGCO to furnish, at cost and upon request, the following services: general executive and advisory services, power pool operations, general engineering, design engineering, purchasing, accounting and statistical, finance and treasury, taxes, insurance and pensions, corporate, rates, budgeting, public relations, employee relations, systems and procedures and other services with respect to business and operations. SOUTHERN also has a contract with SCS for certain of these specialized services.\nSouthern Nuclear has contracted with ALABAMA to operate its Farley Nuclear Plant, as authorized by amendments to the plant operating licenses. Southern Nuclear also has a contract to provide GEORGIA with technical and other services to support GEORGIA's operation of plants Hatch and Vogtle. Applications are now pending before the NRC for amendments to the Hatch and Vogtle operating licenses which would authorize Southern Nuclear to become the operator. See Item 1 - BUSINESS - \"Regulation - Atomic Energy Act of 1954\" herein.\nNEW BUSINESS DEVELOPMENT\nSOUTHERN continues to consider new business opportunities, particularly those which allow use of the expertise and resources developed through its regulated utility experience. These endeavors began in 1981 and are conducted through SEI and other existing subsidiaries.\nSEI's primary business focus is international and domestic cogeneration, the independent power market, and the privatization of generation facilities in the international market. SEI currently operates two domestic independent power production projects totaling 225 megawatts and is one-third owner of one of these (which produces 180 megawatts). It has a contract to sell electric energy to Virginia Electric and Power Company from a facility SEI is developing (through subsidiaries) in King George, Virginia. Upon completion, currently planned for 1996, SEI will operate the 220 megawatt coal-fired plant and own 50% of the project.\nIn April 1993, SOUTHERN completed the purchase of a 50% interest in Freeport, an electric utility on the Island of Grand Bahama, for a purchase price of $35.5 million. Freeport has generating capacity of about 112 megawatts. In August 1993, SOUTHERN completed the purchase of a 55% interest in Alicura, an entity that owns the right to use the generation from a 1,000 megawatt hydroelectric generating facility in Argentina, for a net purchase price of approximately $188 million. In December 1993, SOUTHERN completed the purchase of a 35% interest in Edelnor for the purchase price of $73 million. Edelnor is a utility located in Northern Chile that owns and operates a transmission grid and a 96 megawatt generating facility and is building an additional 150 megawatt facility.\nSEI has continued to render consulting services and market SOUTHERN system expertise in the United States and throughout the world. It contracts with other public utilities, commercial concerns and government agencies for the rendition of services and the licensing of intellectual property. In addition, SEI engages in energy management-related services and activities.\nThese continuing efforts to invest in and develop new business opportunities offer the potential of earning returns which may exceed those of rate-regulated operations. However, because of the absence of any assured return or rate of return, they also involve a higher\nI-2\ndegree of risk. SOUTHERN expects to make substantial investments over the period 1994-1996 in these and other new businesses.\nCERTAIN FACTORS AFFECTING THE INDUSTRY\nThe electric utility industry is expected to become increasingly competitive in the future as a result of the enactment of the Energy Act (see each registrant's \"Management's Discussion and Analysis - Future Earnings Potential\" in Item 7 herein), deregulation, competing technologies and other factors. In recent years the electric utility industry in general has experienced problems in a number of areas including the uncertain cost of capital needed for construction programs, difficulty in obtaining sufficient return on invested capital and in securing adequate rate increases when required, high costs and other issues associated with compliance with environmental and nuclear regulations, changes in regulatory climate, prudence audits and the effects of inflation and other factors on the costs of operations and construction expenditures. The SOUTHERN system has been experiencing certain of these problems in varying degrees and management is unable to predict the future effect of these or other factors upon its operations and financial condition.\nCONSTRUCTION PROGRAMS\nThe subsidiary companies of SOUTHERN are engaged in continuous construction programs to accommodate existing and estimated future loads on their respective systems. Construction additions or acquisitions of property during 1994 through 1996 by the operating affiliates, SEGCO, SCS and Southern Nuclear are estimated as follows: (in millions)\n*Does not add due to changes made in subsidiaries' construction budget subsequent to approval of SOUTHERN system construction budget.\nReference is made to Note 4 to the financial statements of each registrant in Item 8 herein for the amounts of AFUDC included in the above estimates. The construction estimates for the period 1994 through 1996 do not include amounts which may be spent by SEI (or the subsidiary(s) created to effect such project(s)) on future power production projects or the projects discussed earlier under \"New Business Development.\" (See also Item 1 - BUSINESS - \"Financing Programs\" herein.)\nI-3\nEstimated construction costs in 1994 are expected to be apportioned approximately as follows: (in millions)\n*SCS and Southern Nuclear plan capital additions to general plant in 1994 of $26 million and $1 million, respectively, while SEGCO plans capital additions of $14 million to generating facilities. Does not add due to changes made in subsidiaries' construction budget subsequent to approval of SOUTHERN system construction budget.\nThe construction programs are subject to periodic review and revision, and actual construction costs may vary from the above estimates because of numerous factors. These factors include changes in business conditions; revised load growth estimates; changes in environmental regulations; changes in existing nuclear plants to meet new regulatory requirements; increasing cost of labor, equipment and materials; cost of capital and SEI securing a contract(s) to buy or build additional generating facilities.\nThe operating affiliates do not have any baseload generating plants under construction and current energy demand forecasts do not require any additional baseload generating facilities before 2011. However, within the service area, the construction of combustion turbine peaking units with an aggregate capacity of approximately 1,700 megawatts is planned to be completed by 1996. In addition, significant construction of transmission and distribution facilities and upgrading of generating plants will be continuing.\nDuring 1991, the Georgia legislature passed legislation which requires GEORGIA and SAVANNAH each to file an Integrated Resource Plan for approval by the Georgia PSC. Under the plan rules, the Georgia PSC must pre-certify the construction of new power plants. (See Item 1 - BUSINESS - \"Rate Matters - Integrated Resource Planning\" herein.)\nSee Item 1 - BUSINESS - \"Regulation - Environmental Regulation\" herein for information with respect to certain existing and proposed environmental requirements and Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nELECTRIC PROPERTIES\nThe operating affiliates and SEGCO, at December 31, 1993, operated 33 hydroelectric generating stations, 31 fossil fuel generating stations and three nuclear generating stations. The amounts of capacity owned by each company are shown in the table below.\nI-18\nNotes: (1) Owned by ALABAMA and MISSISSIPPI as tenants in common in the proportions of 60% and 40%, respectively. (2) Excludes the capacity owned by AEC. (See Item 2 - PROPERTIES - \"Jointly-Owned Facilities\" herein.) (3) Capacity shown is GEORGIA's or GULF's (Unit 3 only) current portion: 8.4% of Units 1 and 2, 75% (25% for GULF) for Unit 3 and 33.1% for Unit 4 of total plant capacity. See Item 2 - PROPERTIES - \"Proposed Sales of Property\" and \"Jointly-Owned Facilities\" herein. (4) Capacity shown is GEORGIA's portion (53.5%) of total plant capacity. (5) Represents 50% of the plant which is owned as tenants in common by GULF and MISSISSIPPI. (6) SEGCO is jointly-owned by ALABAMA and GEORGIA. (See Item 1 - BUSINESS herein.) (7) Capacity shown is GEORGIA's portion (50.1%) of total plant capacity. (8) Capacity shown is GEORGIA's portion (45.7%) of total plant capacity. (9) Generation is dedicated to a single industrial customer.\nExcept as discussed below under \"Titles to Property\", the principal plants and other important units of the SOUTHERN system are owned in fee by the operating affiliates and SEGCO. It is the opinion of management of each such company that its operating properties are adequately maintained and are substantially in good operating condition.\nMISSISSIPPI owns a 79-mile length of 500-kilovolt transmission line which is leased to Gulf States. The line, completed in 1984, extends from Plant Daniel to the Louisiana state line. Gulf States is paying a use fee over a forty-year period covering all expenses and the amortization of the original $57 million cost of the line.\nThe all-time maximum demand on the SOUTHERN system was 25,936,900 kilowatts and occurred in July 1993. This amount excludes demand served by generation retained by OPC, MEAG and Dalton and excludes demand associated with power purchased from SEPA by its preference customers. At that time, 27,342,700 kilowatts were supplied by SOUTHERN system generation and 1,405,800 kilowatts (net) were sold to other parties through net purchased and interchanged power. The reserve margin for the Southern electric system at that time was 13.2%. For information on the other registrants' peak demands reference is made to Item 6 - SELECTED FINANCIAL DATA herein.\nALABAMA and GEORGIA will incur significant costs in decommissioning their nuclear units at the end of their useful lives. (See Item 1 - BUSINESS -\nI-19\n\"Regulation - Atomic Energy Act of 1954\" and Note 1 to SOUTHERN's, ALABAMA's and GEORGIA's financial statements in Item 8 herein.)\nOTHER ELECTRIC GENERATION FACILITIES\nThrough special purpose subsidiaries, SOUTHERN owns a 50% interest in Freeport, a 35% interest in Edelnor, a 55.3% interest Alicura and a 33.3% interest in a co-generation facility in Hawaii. For further discussion of other SEI projects, see Item 1 - BUSINESS - \"New Business Development\" herein. The generating capacity of these utilities (or facilities) at December 31, 1993, was as follows:\n* Represents a concession contract that provides SEI with the rights to use the generation.\nI-20\nJOINTLY-OWNED FACILITIES\nALABAMA has sold an undivided interest in two units of Plant Miller to AEC. GEORGIA has sold undivided interests in certain generating plants and other related facilities to OPC, MEAG, Dalton, FP&L and JEA. The percentages of ownership resulting from these sales are as follows:\nALABAMA and GEORGIA have contracted to operate and maintain the respective units in which each has an interest (other than Rocky Mountain, as described below) as agent for the joint owners. See \"Proposed Sales of Property\" below for a description of the proposed sale of GEORGIA's remaining unsold ownership interest in Plant Scherer Unit 4.\nIn connection with the joint ownership arrangements for Plant Vogtle, GEORGIA has remaining commitments to purchase declining fractions of OPC's and MEAG's capacity and energy until 1994 for Unit 1 and 1996 for Unit 2 and, with regard to a portion of a 5% interest in Plant Vogtle owned by MEAG, until the latter of the retirement of the plant or the latest stated maturity date of MEAG's bonds issued to finance such ownership interest. The payments for capacity are required whether any capacity is available. The energy cost is a function of each unit's variable operating costs. Except for the portion of the capacity payments related to the 1987 and 1990 write-offs of Plant Vogtle costs, the cost of such capacity and energy is included in purchased power in the Statements of Income in Item 8 herein.\nIn December 1988, GEORGIA and OPC completed a joint ownership agreement for the Rocky Mountain project under which GEORGIA will retain its present investment in the project and OPC will finance, complete and operate the facility. Upon completion (scheduled for 1995), GEORGIA will own an undivided interest in the project equal to the proportion its investment bears to the total investment in the project (excluding each party's cost of funds and ad valorem taxes). For purposes of the ownership formula, GEORGIA's investment will be expressed in nominal dollars and OPC's investment will be expressed in constant 1987 dollars. Based on current cost estimates, GEORGIA's final ownership is estimated at approximately 25% of the project at completion. GEORGIA has held preliminary discussions regarding the potential disposition of its remaining interest in the project.\nPROPOSED SALES OF PROPERTY\nIn 1991 and 1993, GEORGIA completed the first two in a series of four separate transactions to sell Unit 4 of Plant Scherer to FP&L and JEA for a total price of approximately $806 million, including any gains on these transactions. FP&L would eventually own approximately 76.4% of this unit, with JEA owning the remainder. The capacity from this unit was previously dedicated to off-system sales contracts with Gulf States that were suspended in 1988. GEORGIA will continue to operate the unit.\nI-21\nThe 1991 and 1993 sales and the remaining transactions are scheduled as follows:\nPlant Scherer, a jointly owned coal-fired generating plant, has four units with a total capacity of 3,272 megawatts. Unit 4 was completed in 1989.\nTITLES TO PROPERTY\nThe operating affiliates' and SEGCO's interests in the principal plants (other than certain pollution control facilities, one small hydroelectric generating station leased by GEORGIA and the land on which four combustion turbine generators of MISSISSIPPI are located, which is held by easement) and other important units of the respective companies are owned in fee by such companies, subject only to the liens of applicable mortgage indentures (except for SEGCO) and to excepted encumbrances as defined therein. The operating affiliates own the fee interests in certain of their principal plants as tenants in common. (See Item 2 - PROPERTIES - \"Jointly-Owned Facilities\" herein.) Properties such as electric transmission and distribution lines and steam heating mains are constructed principally on rights-of-way which are maintained under franchise or are held by easement only. A substantial portion of lands submerged by reservoirs is held under flood right easements. In substantially all of its coal reserve lands, SEGCO owns or will own the coal only, with adequate rights for the mining and removal thereof.\nPROPERTY ADDITIONS AND RETIREMENTS\nDuring the period from January 1, 1989, to December 31, 1993, the operating affiliates, SEGCO, and other (i.e. SCS, Southern Nuclear and, beginning in 1993, various of the special purpose subsidiaries) gross property additions and retirements were as follows:\n(1) Includes approximately $62 million attributable to property sold to AEC in 1992. (2) Includes approximately $480 million attributable to property sold to OPC, FP&L and JEA, but excludes $231 million from the write-off of certain Plant Vogtle costs in 1990. (3) Net of intercompany eliminations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(1) STEPAK V. CERTAIN SOUTHERN OFFICIALS (U.S. District Court for the Southern District of Georgia)\nIn April 1991, two SOUTHERN stockholders filed a derivative action suit against certain current and former directors and officers of SOUTHERN. The suit alleges violations of RICO by officers and breaches of fiduciary duty and gross negligence by all defendants resulting from alleged fraudulent accounting for spare parts, illegal political campaign contributions, violations of federal securities laws involving misrepresentations and omissions in SEC filings, and concealment of the foregoing acts. The complaint seeks damages, including treble damages pursuant to RICO, in an unspecified amount, which if awarded, would be payable to SOUTHERN. The plaintiffs' amended complaint was dismissed by the court in March 1992. The court ruled the plaintiffs had failed to present adequately their allegation that the\nI-22\nSOUTHERN board of directors' refusal of an earlier demand by the plaintiffs was wrongful. The plaintiffs appealed the dismissal to the U.S. Court of Appeals for the Eleventh Circuit.\n(2) JOHNSON V. ALABAMA (Circuit Court of Shelby County, Alabama)\nIn September 1990, two customers of ALABAMA filed a civil complaint in the Circuit Court of Shelby County, Alabama, against ALABAMA seeking to represent all persons who, prior to June 23, 1989, entered into agreements with ALABAMA for the financing of heat pumps and other merchandise purchased from vendors other than ALABAMA. The plaintiffs contended that ALABAMA was required to obtain a license under the Alabama Consumer Finance Act to engage in the business of making consumer loans. The plaintiffs were seeking an order declaring these agreements null and void and requiring ALABAMA to refund all payments, principal and interest, made under these agreements. The aggregate amount under these agreements, together with interest paid, currently is estimated to be $40 million.\nIn June 1993, the court ordered ALABAMA to refund or forfeit interest of approximately $10 million because of ALABAMA's failure to obtain such license. However, the court's order did not require any refund or forfeiture with respect to any principal payments under the agreements at issue. ALABAMA has appealed the court's order to the Supreme Court of Alabama.\nThe final outcome of this matter cannot be determined; however, in management's opinion, the final outcome will not have a material adverse effect on SOUTHERN's or ALABAMA's financial statements.\n(3) OHIO RIVER COMPANY, ET AL.VS. GULF, ET AL. (U.S. District Court for Southern District of Ohio, Western Division)\nIn 1993, a complaint against GULF and SCS was filed in federal district court in Ohio by two companies with which GULF had contracted for the transportation by barge for certain GULF coal supplies. The complaint alleges breach of the contract by GULF and seeks damages estimated by the plaintiffs to be in excess of $85 million.\nThe final outcome of this matter cannot now be determined; however, in management's opinion the final outcome will not have a material adverse effect on SOUTHERN's or GULF's financial statements.\nSee Item 1 - BUSINESS - \"Construction Programs,\" \"Fuel Supply,\" \"Regulation - - Federal Power Act\" and \"Rate Matters\", for a description of certain other administrative and legal proceedings discussed therein.\nAdditionally, each of the operating affiliates and SEI are, in the normal course of business, engaged in litigation or administrative proceedings that include, but are not limited to, acquisition of property, injuries and damages claims, and complaints by present and former employees. In management's opinion these various actions will not have a material adverse effect on any of the registrants' financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nI-23\nEXECUTIVE OFFICERS OF SOUTHERN\n(Inserted in Part I in accordance with Regulation S-K, Item 401(b), Instruction 3)\nEDWARD L. ADDISON Chairman and CEO Age 63 Elected in 1983; responsible primarily for the formation of overall corporate policy. He was elected Chairman of SOUTHERN effective January 1994.\nA. W. DAHLBERG President and Director Age 53 Elected in 1985; President and Chief Executive Officer of GEORGIA from 1988 through 1993. He was elected Executive Vice President of SOUTHERN in 1991. He was elected President of SOUTHERN effective January 1994.\nPAUL J. DENICOLA Executive Vice President and Director Age 45 Elected in 1989; Executive Vice President of SOUTHERN since 1991. Elected President and Chief Executive Officer of SCS effective January 1994. He previously served as Executive Vice President of SCS from 1991 to 1993 and President and Chief Executive Officer of MISSISSIPPI from 1989 to 1991.\nH. ALLEN FRANKLIN Executive Vice President and Director Age 49 Elected in 1988; President and Chief Executive Officer of SCS from 1988 through 1993 and, beginning 1991, Executive Vice President of SOUTHERN. He was elected President and CEO of GEORGIA effective January 1994.\nELMER B. HARRIS Executive Vice President and Director Age 54 Elected in 1989; President and Chief Executive Officer of ALABAMA since 1989 and, beginning 1991, Executive Vice President of SOUTHERN. He previously served as Senior Executive Vice President of GEORGIA from 1986 to 1989.\nW. L. WESTBROOK Financial Vice President Age 54 Elected in 1986; responsible primarily for all aspects of financing for SOUTHERN. He has served as Executive Vice President of SCS since 1986.\nBILL M. GUTHRIE Vice President Age 60 Elected in 1991; serves as Chief Production Officer for the SOUTHERN system. Senior Executive Vice President of SCS effective January 1994. He has also served as Executive Vice President of ALABAMA since 1988.\nEach of the above is currently an officer of SOUTHERN, serving a term running from the last annual meeting of the directors (May 26, 1993) for one year until the next annual meeting or until his successor is elected and qualified.\nI-24 PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) The common stock of SOUTHERN is listed and traded on the New York Stock Exchange. The stock is also traded on regional exchanges across the United States. High and low stock prices, per the New York Stock Exchange Composite Tape and as adjusted to reflect a two-for-one stock split in the form of a stock distribution for each share held as of February 7, 1994, during each quarter for the past two years were as follows:\nThere is no market for the other registrants' common stock, all of which is owned by SOUTHERN. On February 28, 1994, the closing price of SOUTHERN's common stock was $20-5\/8.\n(b) Number of SOUTHERN's common stockholders at December 31, 1993: 237,105\nEach of the other registrants have one common stockholder, SOUTHERN.\n(c) Common dividends are payable at the discretion of each registrant's board of directors. The common dividends paid by SOUTHERN and the operating affiliates to their stockholder(s) for the past two years were as follows: (in thousands)\nIn January 1994, SOUTHERN's board of directors authorized a two-for-one common stock split in the form of a stock distribution for each share held as of February 7, 1994. For all reported common stock data, the number of common shares outstanding and per share amounts for earnings, dividends, and market price have been adjusted to reflect the stock distribution.\nII-1\nThe dividend paid per share by SOUTHERN was 27.5c. for each quarter of 1992 and 28.5c. for each quarter of 1993. SOUTHERN's common dividend for the first quarter of 1994 was raised to 29.5c. per share.\nThe amount of common dividends that may be paid by the subsidiary registrants is restricted in accordance with their respective first mortgage bond indenture and charter. The amounts of earnings retained in the business and the amounts restricted against the payment of cash dividends on common stock at December 31, 1993, were as follows:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSOUTHERN. Reference is made to information under the heading \"Selected Consolidated Financial and Operating Data,\" contained herein at pages II-38 through II-49.\nALABAMA. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-78 through II-91.\nGEORGIA. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-123 through II-137.\nGULF. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II- 166 through II-179.\nMISSISSIPPI. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-207 through II-220.\nSAVANNAH. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-245 through II-258.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nSOUTHERN. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-8 through II-15.\nALABAMA. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-53 through II-58.\nGEORGIA. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-95 through II-101.\nGULF. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-141 through II-147.\nMISSISSIPPI. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-183 through II-189.\nSAVANNAH. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-224 through II-230.\nII-2\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO 1993 FINANCIAL STATEMENTS\nII-3\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nII-4\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nFINANCIAL SECTION\nII-5\nMANAGEMENT'S REPORT The Southern Company and Subsidiary Companies 1993 Annual Report\nThe management of The Southern Company has prepared -- and is responsible for - -- the consolidated financial statements and related information included in this report. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on the best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that books and records reflect only authorized transactions of the company. Limitations exist in any system of internal controls, however, based on a recognition that the cost of the system should not exceed its benefits. The company believes its system of internal accounting controls maintains an appropriate cost\/benefit relationship.\nThe company's system of internal accounting controls is evaluated on an ongoing basis by the company's internal audit staff. The company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, composed of three directors who are not employees, provides a broad overview of management's financial reporting and control functions. Periodically, this committee meets with management, the internal auditors, and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal controls, and financial reporting matters. The internal auditors and independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the company's operations are conducted according to a high standard of business ethics.\nIn management's opinion, the consolidated financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of The Southern Company and its subsidiaries in conformity with generally accepted accounting principles. As discussed in Note 4 to the financial statements, an uncertainty exists with respect to the actions of regulators regarding recoverability of the investment in the Rocky Mountain pumped storage hydroelectric project. The outcome of this uncertainty cannot be determined until regulatory proceedings are concluded. Accordingly, no provision for any write-down of the costs associated with the Rocky Mountain project resulting from the potential actions of the Georgia Public Service Commission has been made in the accompanying financial statements.\n\/s\/ E. L. Addison \/s\/ W. L. Westbrook - ------------------------------------ ---------------------------- Edward L. Addison W. L. Westbrook Chairman and Chief Executive Officer Financial Vice President\nII-6 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND TO THE STOCKHOLDERS OF THE SOUTHERN COMPANY:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of The Southern Company (a Delaware corporation) and its subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, retained earnings, paid-in capital, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-16 through II-37) referred to above present fairly, in all material respects, the financial position of The Southern Company and its subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 9 to the financial statements, effective January 1, 1993, The Southern Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\nAs more fully discussed in Note 4 to the financial statements, an uncertainty exists with respect to the actions of the regulators regarding recoverability of the investment in the Rocky Mountain pumped storage hydroelectric project. The outcome of this uncertainty cannot be determined until regulatory proceedings are concluded. Accordingly, no provision for any write-down of the costs associated with the Rocky Mountain project resulting from the potential actions of the Georgia Public Service Commission has been made in the accompanying financial statements.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nII-7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The Southern Company and Subsidiary Companies 1993 Annual Report\nRESULTS OF OPERATIONS\nEARNINGS AND DIVIDENDS\nThe Southern Company's 1993 financial performance exceeded the strong results recorded for 1992, and set several new records. The company's financial strength continued to gain momentum for the third consecutive year. In January 1994, The Southern Company board of directors increased the quarterly dividend rate by 3.5 percent, and approved a two-for-one common stock split in the form of a stock distribution. For all reported common stock data, the number of common shares outstanding and per share amounts for earnings, dividends, and market price have been adjusted to reflect the stock distribution. For 1993, The Southern Company's net income of $1.0 billion established a new record high and the company's common stock reached an all-time high closing price during the year of 23 3\/8 -- surpassing the record of 19 1\/2 set in 1992. Also, return on average common equity reached the highest level since 1986.\nEarnings reported for 1993 totaled $1,002 million or $1.57 per share, an increase of $49 million or 6 cents per share from the previous year. Both 1993 and 1992 earnings were affected by special non-operating or non-recurring items. After excluding these special items in both years, earnings from operations of the ongoing business of selling electricity were $1,016 million or $1.59 per share, an increase of $77 million or 10 cents per share compared with 1992. The special items that affected 1993 and 1992 earnings were as follows:\nIn 1993, several items -- both positive and negative -- had an impact on earnings, which resulted in a net reduction of $14 million. These items were: (1) The conclusion of a settlement agreement -- discussed later -- with Gulf States Utilities (Gulf States) increased earnings. (2) The second in a series of four separate transactions to sell Plant Scherer Unit 4 to two Florida utilities increased earnings. (3) Environmental clean-up costs incurred at sites located in Alabama and Georgia decreased earnings. (4) Costs associated with a transportation fleet reduction program decreased earnings. The improvements in 1993 earnings resulted primarily from increased retail energy sales and continued emphasis on effective cost controls.\nThe special items that increased 1992 earnings were primarily related to additional settlement provisions from Gulf States, and to gains on the sale of Gulf States common stock received in 1991.\nReturns on average common equity were 13.43 percent in 1993, 13.42 percent in 1992, and 12.74 percent in 1991. Dividends paid on common stock during 1993 were $1.14 per share or 28 1\/2 cents per quarter. During 1992 and 1991, dividends paid per share were $1.10 and $1.07, respectively. In January 1994, The Southern Company board of directors raised the quarterly dividend to 29 1\/2 cents per share or an annual rate of $1.18 per share.\nREVENUES\nOperating revenues increased in 1993 and 1992 and decreased in 1991 as a result of the following factors:\nII-8 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nRetail revenues of $7.3 billion in 1993 increased 7.4 percent from last year, compared with an increase of 1.6 percent in 1992. Under fuel cost recovery provisions, fuel revenues generally equal fuel expense -- including the fuel component of purchased energy -- and do not affect net income.\nSales for resale revenues within the service area were $447 million in 1993, up 9.2 percent from the prior year. This increase resulted primarily from the prolonged hot summer weather, which increased the demand for electricity. Revenues from sales for resale within the service area were $409 million in 1992, down 1.9 percent from the prior year. The decrease resulted from certain municipalities and cooperatives in the service area retaining more of their own generation at facilities jointly owned with Georgia Power.\nRevenues from sales to utilities outside the service area under long-term contracts consist of capacity and energy components. Capacity revenues reflect the recovery of fixed costs and a return on investment under the contracts. Energy is generally sold at variable cost. The capacity and energy components were as follows:\nCapacity revenues decreased in 1993 and 1992 because the amount of capacity under contract declined by some 500 megawatts and 300 megawatts, respectively. In 1994, the contracted capacity will decline another 400 megawatts.\nChanges in revenues are influenced heavily by the amount of energy sold each year. Kilowatt-hour sales for 1993 and the percent change by year were as follows:\nThe rate of growth in 1993 retail energy sales was the highest since 1986. Residential energy sales registered the highest annual increase in two decades as a result of hotter-than-normal summer weather and the addition of 46,000 new customers. Commercial sales were also affected by the warm summer. Industrial energy sales in 1993 and 1992 showed moderate growth, reflecting a recovery in the business and economic conditions in The Southern Company's service area. Energy sales to retail customers are projected to grow at an average annual rate of 1.7 percent during the period 1994 through 2004.\nEnergy sales for resale outside the service area are predominantly unit power sales under long-term contracts to Florida utilities. Economy sales and amounts sold under short-term contracts are also sold for resale outside the service area. Sales to customers outside the service area have decreased for the third consecutive year primarily as a result of the scheduled decline in megawatts of capacity under contract. In addition, the decline in 1992 and 1991 sales was also influenced by fluctuations in prices for oil and natural gas, the primary fuel sources for utilities with which the company has long-term contracts. When oil and gas prices fall below a certain level, these customers can generate electricity to meet their requirements more economically. However, the fluctuation in these energy sales, excluding the impact of contractual declines, had minimal effect on earnings because The Southern Company is paid for dedicating specific amounts of its generating capacity to these utilities.\nEXPENSES\nTotal operating expenses of $6.7 billion for 1993 were up 6.5 percent compared with the prior year. The increase was attributable to higher production expenses of $75 million to meet increased energy demands and an additional $50 million in depreciation expenses and property taxes resulting from additional utility plant being placed into service. The transportation fleet reduction program and environmental clean-up costs discussed earlier increased expenses by some $62 million. Also, a $67 million change in deferred Plant Vogtle expenses compared with the amount in 1992 contributed to the rise in total operating expenses.\nIn 1992, total operating expenses of $6.3 billion were at the same level reported for 1991. The costs to produce and deliver electricity in 1992 declined by $165 million primarily as a result of less energy being sold and continued effective cost controls. However, expenses in 1991 were reduced by proceeds from a settlement\nII-9 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nagreement with Gulf States that more than offset the decline in 1992 expenses when compared with 1991. Deferred expenses related to Plant Vogtle in 1992 increased by $47 million when compared with the prior year.\nFuel costs constitute the single largest expense for The Southern Company. The mix of fuel sources for generation of electricity is determined primarily by system load, the unit cost of fuel consumed, and the availability of hydro and nuclear generating units. The amount and sources of generation and the average cost of fuel per net kilowatt-hour generated were as follows:\nFuel and purchased power expenses of $2.6 billion in 1993 increased 1.3 percent compared with the prior year because of increased energy demands and slightly higher average cost of fuel per net kilowatt-hour generated. Fuel and purchased power costs in 1992 decreased $137 million or 5.0 percent compared with 1991 primarily because 1.1 billion fewer kilowatt-hours were needed to meet customer requirements. Also, the decrease in these costs was attributable to a lower average cost of fuel per net kilowatt-hour generated.\nIncome taxes for 1993 increased $69 million compared with the prior year. The increase is attributable to a number of factors, including a 1 percent increase in the corporate federal income tax rate effective January 1993, the second sale of additional ownership interest in Plant Scherer Unit 4, and the increase in taxable income from operations. For 1992, income taxes rose $11 million or 1.7 percent above the amount reported for 1991.\nFor the fifth consecutive year, total gross interest charges and preferred stock dividends declined from amounts reported in the previous year. The declines are attributable to lower interest rates and significant refinancing activities during the past two years. In 1993, these costs were $831 million - -- down $21 million or 2.3 percent. These costs for 1992 decreased $71 million. As a result of favorable market conditions during 1993, some $3.0 billion of senior securities was issued for the primary purpose of retiring higher-cost debt and preferred stock.\nEFFECTS OF INFLATION\nThe Southern Company is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the company is recovering its costs of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on The Southern Company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors ranging from growth in energy sales to regulatory matters.\nGeorgia Power has completed two of four separate transactions to sell Unit 4 of Plant Scherer to two Florida utilities. The remaining transactions are scheduled to take place in 1994 and 1995. If the sales take place as planned, Georgia Power could realize an after-tax gain currently estimated to total approximately $20 million. See Note 7 to the financial statements for additional information.\nIn early 1994, Georgia Power and the system service company announced work force reduction programs that are estimated to reduce 1994 earnings by some $55 million. These actions will assist in efforts to control the growth in operating expenses.\nII-10 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nSee Note 4 to the financial statements for information on an uncertainty regarding full recovery of an investment in the Rocky Mountain pumped storage hydroelectric project.\nFuture earnings in the near term will depend upon growth in energy sales, which are subject to a number of factors. Traditionally, these factors have included changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, weather, competition, and the rate of economic growth in the company's service area. However, the Energy Policy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric utilities. The law also includes provisions to streamline the licensing process for new nuclear plants. The Southern Company is preparing to meet the challenge of this major change in the traditional business practices of selling electricity. The Energy Act allows independent power producers (IPPs) to access a utility's transmission network in order to sell electricity to other utilities, and this may enhance the incentive for IPPs to build cogeneration plants for a utility's large industrial and commercial customers and sell excess energy generation to other utilities. Although the Energy Act does not require transmission access to retail customers, pressure for legislation to allow retail wheeling will continue. If The Southern Company does not remain a low-cost producer and provide quality service, the company's retail energy sales growth, as well as new long-term contracts for energy sales outside the service area, could be limited, and this could significantly erode earnings.\nAn important part of the Energy Act was to amend the Public Utility Holding Company Act of 1935 (PUHCA) and allow holding companies to form exempt wholesale generators and foreign utility companies to sell power largely free of regulation under PUHCA. These new entities are able to sell power to affiliates -- under certain restrictions -- and to own and operate power generating facilities in other domestic and international markets. To take advantage of these opportunities, Southern Electric International (Southern Electric) -- founded in 1981 -- is focusing on international and domestic cogeneration, the independent power market, and the privatization of generating facilities in the international market. During 1993, investments of some $315 million were made in entities that own and operate generating facilities in various international markets. In the near term, Southern Electric is expected to have minimal effect on earnings, but the possibility exists that it could be a prime contributor to future earnings growth.\nDemand-side options -- programs that enable customers to lower or alter their peak energy requirements -- have been implemented by some of the system operating companies and are a significant part of integrated resource planning. See Note 3 to the financial statements under \"Georgia Power's Demand-Side Conservation Programs\" for information concerning the recovery of certain costs. Customers can receive cash incentives for participating in these programs as well as reduce their energy requirements. Expansion and increased utilization of these programs will be contingent upon sharing of cost savings between the customers and the utility. Besides promoting energy efficiency, another benefit of these programs could be the ability to defer the need to construct baseload generating facilities further into the future. The ability to defer major construction projects in conjunction with precertification approval processes of such projects by the respective state public service commissions in Alabama, Georgia, and Mississippi will diminish the possible exposure to prudency disallowances and the resulting impact on earnings. In addition, Georgia Power has conducted a competitive bidding process for additional peaking capacity needed in 1996 and 1997. To meet expected requirements for 1996, Georgia Power has filed a plan with the state public service commission for certification of a four-year purchase power contract and for an ownership interest in a combustion turbine peaking unit.\nRates to retail customers served by the system operating companies are regulated by the respective state public service commissions in Alabama, Florida, Georgia, and Mississippi. Rates for Alabama Power and Mississippi Power are adjusted periodically within certain limitations based on earned retail rate of return compared with an allowed return. See Note 3 to the financial statements for information about other regulatory matters.\nThe Federal Energy Regulatory Commission (FERC) regulates wholesale rate schedules and power sales contracts that The Southern Company has with its sales for resale customers. The FERC currently is reviewing the rate of return on common equity included in some of these schedules and contracts and may require such returns to be lowered, possibly retroactively. See Note 3 to the financial statements under \"FERC Reviews Equity Returns\" for additional information.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could reduce earnings if such costs are not fully recovered. The Clean Air Act is discussed later under \"Environmental Matters.\"\nII-11 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be effective by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental unemployment benefits, disability-related benefits, job training, and health and life insurance coverage. In 1993, The Southern Company adopted Statement No. 112, with no material effect on the financial statements.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which is effective in 1994. Statement No. 115 supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. The Southern Company adopted the new rules January 1, 1994, with no material effect on the financial statements.\nFINANCIAL CONDITION\nOVERVIEW\nThe Southern Company's financial condition is now the strongest since the mid-1980s. Record levels of performance were set in 1993 related to earnings, market price of common stock, and energy sold to retail customers. In January 1994, The Southern Company board of directors increased the common stock dividend for the third consecutive year, and approved a two-for-one common stock split in the form of a stock distribution.\nAnother major change in The Southern Company's financial condition was gross property additions of $1.4 billion to utility plant. The majority of funds needed for gross property additions since 1990 have been provided from operating activities, principally from earnings and non-cash charges to income such as depreciation and deferred income taxes. The Consolidated Statements of Cash Flows provide additional details.\nOn January 1, 1993, The Southern Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes. See notes 2 and 9 to the financial statements, regarding the impact of these changes.\nCAPITAL STRUCTURE\nThe company achieved a ratio of common equity to total capitalization -- including short-term debt -- of 43.5 percent in 1993, compared with 42.8 percent in 1992 and 41.5 percent in 1991. The company's goal is to maintain the common equity ratio generally within a range of 40 percent to 45 percent.\nDuring 1993, the operating companies sold $2.2 billion of first mortgage bonds and, through public authorities, $385 million of pollution control revenue bonds, at a combined weighted interest rate of 6.5 percent. Preferred stock of $426 million was issued at a weighted dividend rate of 5.7 percent. The operating companies continued to reduce financing costs by retiring higher-cost bonds and preferred stock. Retirements, including maturities, of bonds totaled $2.5 billion during 1993, $2.8 billion during 1992, and $1.0 billion during 1991. Retirements of preferred stock totaled $516 million during 1993, $326 million during 1992, and $125 million during 1991. As a result, the composite interest rate on long-term debt decreased from 9.2 percent at December 31, 1990, to 7.6 percent at December 31, 1993. During this same period, the composite dividend rate on preferred stock declined from 8.5 percent to 6.4 percent.\nIn 1993, The Southern Company raised $205 million from the issuance of new common stock under the Dividend Reinvestment and Stock Purchase Plan (DRIP) and the Employee Savings Plan. At the close of 1993, the company's common stock had a market value of $22.00 per share, compared with a book value of $11.96 per share. The market-to-book value ratio was 184 percent at the end of 1993, compared with 168 percent at year-end 1992 and 156 percent at year-end 1991.\nCAPITAL REQUIREMENTS FOR CONSTRUCTION\nThe construction program of the operating companies is budgeted at $1.5 billion for 1994, $1.3 billion for 1995, and $1.5 billion for 1996. The total is $4.3 billion for the three years. Actual construction costs may vary from this estimate because of factors such as changes in environmental regulations; changes in existing nuclear plants to meet new regulations; revised load projections; the cost and efficiency of construction labor, equipment, and materials; and the cost of capital.\nThe operating companies do not have any baseload generating plants under construction, and current energy demand forecasts do not require any additional baseload facilities until well into the future. However, within the\nII-12 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nservice area, the construction of combustion turbine peaking units of approximately 1,700 megawatts of capacity is planned to be completed by 1996 to meet increased peak-hour demands. In addition, significant construction of transmission and distribution facilities and upgrading of generating plants will be continuing.\nOTHER CAPITAL REQUIREMENTS\nIn addition to the funds needed for the construction program, approximately $789 million will be required by the end of 1996 for present sinking fund requirements, redemptions announced, and maturities of long-term debt. Also, the operating subsidiaries plan to continue a program to retire higher-cost debt and preferred stock and replace these obligations with lower-cost capital.\nENVIRONMENTAL MATTERS\nIn November 1990, the Clean Air Act was signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- will have a significant impact on The Southern Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995 and affects eight generating plants -- some 10,000 megawatts of capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing slower than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $275 million through 1995.\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I, increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 to 2000, compliance could require total construction expenditures ranging from approximately $450 million to $800 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nAn average increase of up to 3 percent in revenue requirements from customers could be necessary to fully recover the cost of compliance for both Phase I and Phase II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nThere can be no assurance that all Clean Air Act costs will be recovered.\nMetropolitan Atlanta is classified as a non-attainment area with regard to the ozone ambient air quality standards. Title I of the Clean Air Act requires the state of Georgia to conduct specific studies and establish new control rules by November 1994 -- affecting sources of nitrogen oxides and volatile organic compounds -- to achieve attainment by 1999. As the required first step, the state has issued rules for the application of reasonably available control technology to reduce nitrogen oxide emissions by May 31, 1995. The results of these new rules require nitrogen oxide controls, above Title IV\nII-13 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nrequirements, on some Georgia Power plants. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions as early as 1997. Compliance with any new rules could result in significant additional costs. The impact of new rules will depend on the development and implementation of such rules.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standards could result in significant additional costs. The impact of new standards -- if any -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a new standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provision of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matter, nitrogen oxides, and ozone. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the non-hazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes -- coal ash and other utility wastes -- as either non-hazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nThe Southern Company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the company could incur costs to clean up properties currently or previously owned. The company conducts studies to determine the extent of any required clean-up costs and has recognized in the financial statements costs to clean up known sites.\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; and the Resource Conservation and Recovery Act. Changes to these laws could affect many areas of The Southern Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields, and other environmental and health concerns could significantly affect The Southern Company. The impact of new legislation -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the potential for lawsuits alleging damages caused by electromagnetic fields exists.\nSOURCES OF CAPITAL\nIn early 1994, The Southern Company sold -- through a public offering -- common stock with proceeds totaling $120 million. The company may require additional equity capital during the remainder of 1994. The amount and timing of additional equity capital to be raised in 1994 -- as well as in subsequent years -- will be contingent on The Southern Company's investment opportunities. Equity capital can be provided from any combination of public offerings, private placements, or the company's stock plans. Any portion of the common stock required during 1994 for the DRIP and the employee stock plans that is not provided from the issuance of new stock will be acquired on the open market in accordance with the terms of such plans.\nThe operating subsidiaries plan to obtain the funds required for construction and other purposes from sources similar to those used in the past. However, the type and timing of any financings -- if needed -- will depend on market conditions and regulatory approval.\nII-14 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nCompleting the sale of Unit 4 of Plant Scherer will provide some $260 million of cash during the years 1994 and 1995.\nAs required by the Nuclear Regulatory Commission, Alabama Power and Georgia Power established external sinking funds for nuclear decommissioning costs. For 1994 through 2000, the combined amount to be funded for both Alabama Power and Georgia Power totals $36 million annually. The cumulative effect of funding over this period will diminish internally funded capital and may require capital from other sources. For additional information concerning nuclear decommissioning costs, see Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning.\"\nTo meet short-term cash needs and contingencies, the system companies had approximately $178 million of cash and cash equivalents and $1.1 billion of unused credit arrangements with banks at the beginning of 1994.\nTo issue additional first mortgage bonds and preferred stock, the operating companies must comply with certain earnings coverage requirements designated in their mortgage indentures and corporate charters. The ability to issue securities in the future will depend on coverages at that time. The coverage ratios were, at the end of the respective years, as follows:\n*Savannah Electric's requirement is 2.50.\nII-15 CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 The Southern Company and Subsidiary Companies 1993 Annual Report\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991\nThe accompanying notes are an integral part of these statements.\nII-16 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1993, 1992, and 1991 The Southern Company and Subsidiary Companies 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-17 CONSOLIDATED STATEMENTS OF BALANCE SHEETS At December 31, 1993, and 1992 The Southern Company and Subsidiary Companies 1993 Annual Report\nThe accompanying notes are an integral part of these balance sheets.\nII-18 CONSOLIDATED BALANCE SHEETS (continued) At December 31, 1993 and 1992 The Southern Company and Subsidiary Companies 1993 Annual Report\nThe accompanying notes are an integral part of these balance sheets.\nII-19 CONSOLIDATED STATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 The Southern Company and Subsidiary Companies 1993 Annual Report\nII-20 CONSOLIDATED STATEMENTS OF CAPITALIZATION (continued) At December 31, 1993 and 1992 The Southern Company and Subsidiary Companies 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-21 NOTES TO FINANCIAL STATEMENTS The Southern Company and Subsidiary Companies 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nThe Southern Company is the parent company of five operating companies, a system service company, Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and various other subsidiaries related to foreign utility operations and domestic non-utility operations. At this time, the operations of the other subsidiaries are not material. The operating companies provide electric service in four Southeastern states. Contracts among the companies -- dealing with jointly owned generating facilities, interconnecting transmission lines, and the exchange of electric power -- are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission (SEC). The system service company provides, at cost, specialized services to The Southern Company and to the subsidiary companies. Southern Electric designs, builds, owns, and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides services to The Southern Company's nuclear power plants.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA). Both the company and its subsidiaries are subject to the regulatory provisions of the PUHCA. The operating companies also are subject to regulation by the FERC and their respective state regulatory commissions. The companies follow generally accepted accounting principles and comply with the accounting policies and practices prescribed by their respective commissions.\nAll material intercompany items have been eliminated in consolidation. Consolidated retained earnings at December 31, 1993, include $2.6 billion of undistributed retained earnings of subsidiaries.\nCertain prior years' data presented in the consolidated financial statements have been reclassified to conform with current year presentation.\nREVENUES AND FUEL COSTS\nThe operating companies accrue revenues for service rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as the fuel is used. The operating companies' electric rates include provisions to adjust billings for fluctuations in fuel and the energy component of purchased power costs. Revenues are adjusted for differences between recoverable fuel costs and amounts actually recovered in current rates.\nFuel expense includes the amortization of the cost of nuclear fuel and a charge, based on nuclear generation, for the permanent disposal of spent nuclear fuel. Total charges for nuclear fuel included in fuel expense amounted to $137 million in 1993, $132 million in 1992, and $162 million in 1991. Alabama Power and Georgia Power have contracts with the U.S. Department of Energy (DOE) that provide for the permanent disposal of spent nuclear fuel, which was scheduled to begin in 1998. However, the actual year this service will begin is uncertain. Sufficient storage capacity currently is available to permit operation into 2003 at Plant Hatch, into 2009 at Plant Vogtle, and into 2012 and 2014 at Plant Farley units 1 and 2, respectively.\nAlso, the Energy Policy Act of 1992 required the establishment in 1993 of a Uranium Enrichment Decontamination and Decommissioning Fund, which is to be funded in part by a special assessment on utilities with nuclear plants. This assessment will be paid over a 15-year period, which began in 1993. This fund will be used by the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The law provides that utilities will recover these payments in the same manner as any other fuel expense. Georgia Power -- based on its ownership interests -- and Alabama Power currently estimate their liability under this law to be approximately $39 million and $46 million, respectively. These obligations are recorded in the Consolidated Balance Sheets.\nDEPRECIATION AND NUCLEAR DECOMMISSIONING\nDepreciation of the original cost of depreciable utility plant in service is provided primarily by using composite straight-line rates, which approximated 3.3 percent in 1993, 1992, and 1991. When property subject to depreciation is retired or otherwise disposed of in the normal course of business, its cost -- together with the cost of removal, less salvage -- is charged to the accumulated provision for depreciation. Minor items of property included in the original cost of the plant are retired when the related property unit is retired. Depreciation expense includes an amount for the expected costs of decommissioning nuclear facilities.\nII-22 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nIn 1988, the Nuclear Regulatory Commission (NRC) adopted regulations requiring all licensees operating commercial power reactors to establish a plan for providing, with reasonable assurance, funds for decommissioning. Reasonable assurance may be in the form of an external sinking fund, a surety method, or prepayment. Alabama Power and Georgia Power have established external sinking funds to comply with the NRC's regulations. Prior to the enactment of these regulations, Alabama Power and Georgia Power had reserved nuclear decommissioning costs. The NRC's minimum external funding requirements are based on a generic estimate of the cost to decommission the radioactive portions of a nuclear unit based on the size and type of reactor. Alabama Power and Georgia Power have filed plans with the NRC to ensure that -- over time -- the deposits and earnings of the external trust funds will provide the minimum funding amounts prescribed by the NRC.\nThe estimated cost of decommissioning and the amounts being recovered through rates at December 31, 1993, for Alabama Power's Plant Farley and Georgia Power's plants Hatch and Vogtle -- based on its ownership interests -- were as follows:\nThe amounts in the internal reserve are being transferred into the external trust fund over a set period of time as approved by the respective state public service commissions.\nThe decommissioning cost estimates are based on prompt dismantlement and removal of the plant from service. The actual decommissioning costs may vary from the above estimates because of regulatory requirements, changes in technology, and changes in costs of labor, materials, and equipment.\nPLANT VOGTLE PHASE-IN PLANS\nIn 1987 and 1989, the Georgia Public Service Commission (GPSC) ordered that the allowed costs of Plant Vogtle, a two-unit nuclear facility of which Georgia Power owns 45.7 percent, be phased into rates under plans that meet the requirements of Financial Accounting Standards Board (FASB) Statement No. 92, Accounting for Phase-In Plans. Under these plans, Georgia Power deferred financing costs and depreciation expense until the allowed investment was fully reflected in rates as of October 1991. In 1991, the GPSC modified the Plant Vogtle phase-in plan to begin earlier amortization of the costs deferred under the plan. Also, the GPSC levelized capacity buyback expense from co-owners of Plant Vogtle. See Note 3 for additional information regarding Georgia Power's 1991 rate order. Previously, pursuant to two separate interim accounting orders by the GPSC, Georgia Power deferred substantially all operating expenses and financing costs related to Plant Vogtle. Units 1 and 2 began commercial operation in May 1987 and May 1989, respectively. The accounting orders were for the periods from the date of each unit's commercial operation until October 1987 and 1989, respectively. Under phase-in plans and accounting orders from the GPSC, Georgia Power deferred and began amortizing the costs -- recovered through rates -- related to Plant Vogtle as follows:\nThe unrecovered balance above includes approximately $160 million related to the adoption in 1993 of FASB Statement No. 109, Accounting for Income Taxes. See Note 9 for information about Statement No. 109.\nII-23\nNOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nEach GPSC order calls for recovery of deferred costs within 10 years. Also, the orders authorized Georgia Power to impute a return similar to allowance for funds used during construction (AFUDC) on its investment in Plant Vogtle units 1 and 2 after the units began commercial operation. These deferred returns are included in the above amounts, except for the equity component in the case of the Unit 2 accounting order.\nINCOME TAXES\nThe companies provide deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, The Southern Company adopted FASB Statement No. 109, Accounting for Income Taxes. Statement No. 109 required, among other things, conversion to the liability method of accounting for accumulated deferred income taxes. See Note 9 for additional information about Statement No. 109.\nAFUDC AND DEFERRED RETURN\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. The composite rates used by the companies to calculate AFUDC during the years 1991 through 1993 ranged from a before-income-tax rate of 4.9 percent to 11.4 percent. Deferred income taxes related to capitalized debt cost were $5 million, $4 million, and $7 million in 1993, 1992, and 1991, respectively. After Plant Vogtle units 1 and 2 began commercial operation in 1987 and 1989, respectively, Georgia Power imputed a deferred return similar to AFUDC on its investment in the units under the short-term cost deferrals and phase-in plans, as discussed earlier. AFUDC and the deferred return, net of income tax, as a percent of consolidated net income were 1.7 percent in 1993, 1.8 percent in 1992, and 6.0 percent in 1991. The deferred return was discontinued in October 1991 after the allowed investment in Plant Vogtle was fully reflected in rates.\nUTILITY PLANT\nUtility plant is stated at original cost less regulatory disallowances. Original cost includes: materials; labor; minor items of property; appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; and the estimated cost of funds used during construction. The cost of maintenance, repairs, and replacement of minor items of property is charged to maintenance expense. The cost of replacements of property (exclusive of minor items of property) is charged to utility plant.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Consolidated Statements of Cash Flows, temporary cash investments are considered cash equivalents. Temporary cash investments are securities with original maturities of 90 days or less.\nFINANCIAL INSTRUMENTS\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, all financial instruments of The Southern Company -- for which the carrying amount does not approximate fair value -- are shown in the table below at December 31:\nThe fair values of nuclear decommissioning trusts and investment securities were based on listed closing market prices. The fair values for long-term debt and preferred\nII-24 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nstock subject to mandatory redemption were based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution, and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed. In 1992, Georgia Power converted to the inventory method of accounting for certain emergency spare parts. This conversion resulted in a regulatory liability that will be amortized as a credit to income over approximately four years. This conversion will not have a material effect on net income.\nVACATION PAY\nThe operating companies' employees earn their vacation in one year and take it in the subsequent year. However, for ratemaking purposes, vacation pay is recognized as an allowable expense only when paid. Consistent with this ratemaking treatment, the companies accrue a current liability for earned vacation pay and record a current asset representing the future recoverability of this cost. The amount was $73 million and $70 million at December 31, 1993 and 1992, respectively. In 1994, an estimated 71 percent of the 1993 deferred vacation cost will be expensed, and the balance will be charged to construction and other accounts.\n2. RETIREMENT BENEFITS\nPENSION PLAN\nThe system companies have defined benefit, trusteed, non-contributory pension plans that cover substantially all regular employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and final average pay or years of service and a flat-dollar benefit. Primarily, the companies use the \"entry age normal method with a frozen initial liability\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension fund are primarily invested in equity and fixed-income securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the \"projected unit credit\" actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nThe system companies also provide certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. A qualified trust for medical benefits has been established for funding amounts to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded.\nEffective January 1, 1993, the system companies adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\" In October 1993, the GPSC ordered Georgia Power to phase in the adoption of Statement No. 106 to cost of service over a five-year period, whereby one-fifth of the additional costs would be expensed in 1993 and the remaining costs would be deferred. An additional one-fifth of the costs would be expensed each succeeding year until the costs are fully reflected in cost of service in 1997. The costs deferred during the five-year period will be amortized to expense over a 15-year period beginning in 1998. As a result of regulatory treatment allowed by the operating companies' respective public service commissions, the adoption of Statement No. 106 did not have a material impact on consolidated net income.\nPrior to 1993, the system companies, except for Georgia Power and Savannah Electric, recognized these benefit costs on an accrual basis using the \"aggregate cost\" actuarial method, which spreads the expected cost of such benefits over the remaining periods of employees' service as a level percentage of payroll costs. Consistent with regulatory treatment in these years, Georgia Power and Savannah Electric recognized these costs on a cash basis as payments were made. The total costs of such benefits recognized by system companies in 1992 and 1991 were $42 million and $36 million, respectively.\nSTATUS AND COST OF BENEFITS\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of FASB Statement Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown only for 1993 because Statement\nII-25 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nNo. 106 was adopted as of January 1, 1993, on a prospective basis. The funded status of the plans at December 31 was as follows:\nThe weighted average rates assumed in the above actuarial calculations were:\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1 percent would increase the accumulated medical benefit obligation at December 31, 1993, by $129 million and the aggregate of the service and interest cost components of the net retiree medical cost by $14 million.\nComponents of the plans' net cost are shown below:\nOf the above net pension amounts, pension income of $9 million in 1993 and pension expense of $2 million in 1992 and $11 million in 1991 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nOf the above net postretirement medical and life insurance costs recorded in 1993, $64 million was charged to operating expenses, $21 million was deferred, and the remainder was charged to construction and other accounts.\nII-26 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nWORK FORCE REDUCTION PROGRAMS\nThe system companies have incurred additional costs for work force reduction programs. The costs related to these programs were $35 million, $37 million, and $72 million for the years 1993, 1992, and 1991, respectively. A portion of the cost of these programs was deferred and is being amortized in accordance with regulatory treatment. The unamortized balance of these costs was $19 million at December 31, 1993.\n3. LITIGATION AND REGULATORY MATTERS\nRETAIL RATEPAYERS' SUIT CONCLUDED\nIn March 1993, several retail ratepayers of Georgia Power filed a civil complaint in the Superior Court of Fulton County, Georgia, against Georgia Power, The Southern Company, the system service company, and Arthur Andersen & Co. The complaint alleged that Georgia Power obtained excessive rate increases by improper accounting for spare parts and sought actual damages estimated by the plaintiffs to be in excess of $60 million -- plus treble and punitive damages -- for alleged violations of the Georgia Racketeer Influenced and Corrupt Organizations Act and other state statutes, statutory and common law fraud, and negligence. These state law allegations were substantially the same as those included in a 1989 suit brought in federal district court in Georgia. That suit and similar ones filed in Alabama, Florida, and Mississippi federal courts were subsequently dismissed.\nThe defendants' motions to dismiss the current complaint were granted by the Superior Court of Fulton County, Georgia, in July 1993. In January 1994, the plaintiffs' appeal of the dismissal to the Supreme Court of Georgia was rejected, and this matter is concluded.\nSTOCKHOLDER SUIT\nIn April 1991, two Southern Company stockholders filed a derivative action suit in the U.S. District Court for the Southern District of Georgia against certain current and former directors and officers of The Southern Company. The suit alleges violations of the Federal Racketeer Influenced and Corrupt Organizations Act (RICO) by officers and breaches of fiduciary duty and gross negligence by all defendants resulting from alleged fraudulent accounting for spare parts, illegal political campaign contributions, violations of federal securities laws involving misrepresentations and omissions in SEC filings, and concealment of the foregoing acts. The complaint seeks damages -- including treble damages pursuant to RICO -- in an unspecified amount, which if awarded, would be payable to The Southern Company. The plaintiffs' amended complaint was dismissed by the court in March 1992. The court ruled the plaintiffs had failed to present adequately their allegation that The Southern Company board of directors' refusal of an earlier demand by the plaintiffs was wrongful. The plaintiffs have appealed the dismissal to the U.S. Court of Appeals for the 11th Circuit.\nALABAMA POWER HEAT PUMP FINANCING SUIT\nIn September 1990, two customers of Alabama Power filed a civil complaint in the Circuit Court of Shelby County, Alabama, against Alabama Power seeking to represent all persons who, prior to June 23, 1989, entered into agreements with Alabama Power for the financing of heat pumps and other merchandise purchased from vendors other than Alabama Power. The plaintiffs contended that Alabama Power was required to obtain a license under the Alabama Consumer Finance Act to engage in the business of making consumer loans. The plaintiffs were seeking an order declaring these agreements null and void and requiring Alabama Power to refund all payments -- principal and interest -- made under these agreements. The aggregate amount under these agreements, together with interest paid, currently is estimated to be $40 million.\nIn June 1993, the court ordered Alabama Power to refund or forfeit interest of approximately $10 million because of Alabama Power's failure to obtain such license. However, the court's order did not require any refund or forfeiture with respect to any principal payments under the agreements at issue. Alabama Power has appealed the court's order to the Supreme Court of Alabama.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the company's financial statements.\nGULF POWER COAL BARGE TRANSPORTATION SUIT\nIn 1993, a complaint against Gulf Power and the system service company was filed in federal district court in Ohio by two companies with which Gulf Power had contracted for the transportation by barge for certain Gulf Power coal supplies. The complaint alleges breach of the contract by Gulf Power and seeks damages estimated by the plaintiffs to be in excess of $85 million.\nII-27 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the company's financial statements.\nALABAMA POWER RATE ADJUSTMENT PROCEDURES\nIn November 1982, the Alabama Public Service Commission (APSC) adopted rates that provide for periodic adjustments based upon Alabama Power's earned return on end-of-period retail common equity. The rates also provide for adjustments to recognize the placing of new generating facilities in retail service. Both increases and decreases have been placed into effect since the adoption of these rates. The rate adjustment procedures allow a return on common equity range of 13.0 percent to 14.5 percent and limit increases or decreases in rates to 4 percent in any calendar year.\nThe APSC issued an order in December 1991 that reduced a scheduled 2.03 percent annual increase in rates to 1.03 percent, effective January 1992. The 1 percent reduction will remain in effect through 1994. The rate reduction was designed to refund to retail ratepayers a portion of the benefits from a settled contract dispute with Gulf States Utilities Company (Gulf States). The present value of this portion of the settlement -- amounting to some $60 million -- is being amortized to income to offset the rate reduction in accordance with the APSC's rate order. See Note 8 for additional information concerning the Gulf States settlement.\nAlso in the December 1991 rate order, the APSC reaffirmed its satisfaction with the ratemaking mechanism and stated that it did not foresee any further review or changes in the procedures until after 1994. The ratemaking procedures will remain in effect after 1994 unless the APSC votes to modify or discontinue them.\nGEORGIA POWER'S DEMAND-SIDE CONSERVATION PROGRAMS\nIn October 1993, a Superior Court of Fulton County, Georgia, judge ruled that rate riders previously approved by the GPSC for recovery of Georgia Power's costs incurred in connection with demand-side conservation programs were unlawful. The judge held that the GPSC lacked statutory authority to approve such rate riders except through general rate case proceedings and that those procedures had not been followed. Georgia Power suspended collection of the demand-side conservation costs and appealed the court's decision to the Georgia Court of Appeals. In December 1993, the GPSC approved Georgia Power's request for an accounting order allowing Georgia Power to defer all current unrecovered and future costs related to these programs until the superior court's decision is reversed or until the next general rate case proceedings. An association of industrial customers has filed a petition for review of the accounting order in superior court. Georgia Power's costs related to these conservation programs through 1993 were $60 million, of which $15 million has been collected and the remainder deferred. The estimated costs, assuming no change in the programs certified by the GPSC, are $38 million in 1994 and $40 million in 1995.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the company's financial statements.\nGEORGIA POWER 1991 RATE ORDER; PHASE-IN PLAN MODIFICATIONS\nGeorgia Power received a rate order in 1991 from the GPSC that modified the Plant Vogtle phase-in plans to begin earlier amortization of the costs deferred under the plans. The amortization period began October 1991 -- rather than October 1994 as originally scheduled -- and extends through September 1999. In addition, the GPSC ordered the levelization of capacity buyback expense from the co-owners of Plant Vogtle over a six-year period beginning October 1991. This results in net cost deferrals during the first three years and subsequent amortization of the deferred amounts in the last three years.\nMISSISSIPPI POWER RETAIL RATE ADJUSTMENT PLAN\nMississippi Power's retail base rates have been set under a Performance Evaluation Plan (PEP) since 1986 with various modifications in 1991 and the latest in 1994. In 1993, the Mississippi Public Service Commission (MPSC) ordered Mississippi Power to review and propose changes that would enhance the plan. Mississippi Power filed a revised plan, and the MPSC approved PEP-2 on January 4, 1994. Under PEP-2, Mississippi Power's rate of return will be measured on retail net investment rather than on common equity, as previously calculated. Also, the number of indicators used to evaluate Mississippi Power's performance was reduced to three with emphasis on price and service to the customer. In addition, PEP-2 provides for the sharing of rate adjustments based on low rates and on the performance rating. The evaluation periods for PEP-2 are semiannual. Any change in rates is limited to 2 percent of retail revenues per period before a public hearing is required. PEP-2 will remain in effect until the MPSC modifies or terminates the plan.\nII-28 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nFERC REVIEWS EQUITY RETURNS\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the Southern electric system's wholesale rate schedules and contracts that have a return on common equity of 13.75 percent or greater. The contracts that could be affected by the hearings include substantially all of the transmission, unit power, long-term power, and other similar contracts. Any changes in the rate of return on common equity that may occur as a result of this proceeding would be effective 60 days after a proper notice of the proceeding is published. A notice was published on May 10, 1991.\nIn August 1992, a FERC administrative law judge issued an opinion that changes in rate schedules and contracts were not necessary and that the FERC staff failed to show how any changes were in the public interest. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the company's financial statements.\n4. CONSTRUCTION PROGRAM\nGENERAL\nThe operating companies are engaged in continuous construction programs, currently estimated to total some $1.5 billion in 1994, $1.3 billion in 1995, and $1.5 billion in 1996. These estimates include AFUDC of $34 million in 1994, $41 million in 1995, and $35 million in 1996. The construction programs are subject to periodic review and revision, and actual construction costs may vary from the above estimates because of numerous factors. These factors include changes in business conditions; revised load growth estimates; changes in environmental regulations; changes in existing nuclear plants to meet new regulatory requirements; increasing costs of labor, equipment, and materials; and cost of capital. At December 31, 1993, significant purchase commitments were outstanding in connection with the construction program. The operating companies do not have any new baseload generating plants under construction. However, within the service area, the construction of combustion turbine peaking units of approximately 1,700 megawatts is planned to be completed by 1996. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\nSee Management's Discussion and Analysis under \"Environmental Matters\" for information on the impact of the Clean Air Act Amendments of 1990 and other environmental matters.\nROCKY MOUNTAIN PROJECT STATUS\nIn its 1985 financing order, the GPSC concluded that completion of the Rocky Mountain pumped storage hydroelectric project in 1991 was not economically justifiable and reasonable and withheld authorization for Georgia Power to spend funds from approved securities issuances on that project. In 1988, Georgia Power and Oglethorpe Power Corporation (OPC) entered into a joint ownership agreement for OPC to assume responsibility for the construction and operation of the project, as discussed in Note 6. However, full recovery of Georgia Power's costs depends on the GPSC's treatment of the project's cost and disposition of the project's capacity output. In the event Georgia Power cannot demonstrate to the GPSC the project's economic viability based on current ownership, construction schedule, and costs, then part or all of such costs may have to be written off. At December 31, 1993, Georgia Power's investment in the project amounted to approximately $197 million. AFUDC accrued on the Rocky Mountain project has not been credited to income or included in the project cost since December 1985. If accrual of AFUDC is not resumed, Georgia Power's portion of the estimated total plant additions at completion would be approximately $199 million. The plant is currently scheduled to begin commercial operation in 1995. Georgia Power has held preliminary discussions with other parties regarding the potential disposition of its remaining interest in the project.\nThe ultimate outcome of this matter cannot now be determined.\n5. FINANCING, INVESTMENT, AND COMMITMENTS\nGENERAL\nIn early 1994, The Southern Company sold -- through a public offering -- 5.6 million shares of common stock with proceeds totaling $120 million. The company may require additional equity capital during the remainder of 1994. The amount and timing of additional equity capital to be raised in 1994 -- as well as in subsequent years -- will be contingent on The Southern Company's investment opportunities. Equity capital can be provided from any combination of public offerings, private placements, or the company's stock plans.\nII-29 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nTo the extent possible, the operating companies' construction programs are expected to be financed primarily from internal sources. Short-term debt will be utilized when necessary; the amounts available are discussed below. The subsidiary companies may issue additional long-term debt and preferred stock primarily for the purposes of debt maturities and for redeeming higher-cost securities.\nFOREIGN UTILITY OPERATIONS\nDuring 1993, The Southern Company made investments of approximately $315 million in utilities that own and operate generating facilities in various foreign markets. The consolidated financial statements reflect these investments in majority-owned subsidiaries on a consolidated basis and other investments on an equity basis.\nBANK CREDIT ARRANGEMENTS\nAt the beginning of 1994, unused credit arrangements with banks totaled $1.1 billion, of which approximately $500 million expires at various times during 1994 and 1995; $130 million expires at May 1, 1996; $400 million expires at June 30, 1996; and $70 million expires at December 1, 1996.\nGeorgia Power's revolving credit agreements of $150 million, of which $130 million remained unused as of December 31, 1993, expire May 1, 1996. During the term of these agreements, Georgia Power may convert short-term borrowings into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at Georgia Power's option. In connection with these credit arrangements, Georgia Power agrees to pay commitment fees based on the unused portions of the commitments or to maintain compensating balances with the banks.\nThe $400 million expiring June 30, 1996, is under revolving credit arrangements with several banks providing The Southern Company, Alabama Power, and Georgia Power up to the total credit amount of $400 million. To provide liquidity support to commercial paper programs, $135 million and $165 million of the $400 million available credit are currently dedicated to the exclusive use of Alabama Power and Georgia Power, respectively. During the term of these agreements, short-term borrowings may be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the companies' option. In addition, these agreements require payment of commitment fees based on the unused portions of the commitments or the maintenance of compensating balances with the banks.\nMississippi Power has $70 million of revolving credit agreements expiring December 1, 1996. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at Mississippi Power's option. In connection with these credit arrangements, Mississippi Power agrees to pay commitment fees based on the unused portions of the commitments or to maintain compensating balances with the banks.\nSavannah Electric has $20 million of revolving credit arrangements expiring December 31, 1995. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at Savannah Electric's option. In connection with these credit arrangements, Savannah Electric agrees to pay commitment fees based on the unused portions of the commitments.\nIn connection with all other lines of credit, the companies have the option of paying fees or maintaining compensating balances, which are substantially all the cash of the companies except for daily working funds and similar items. These balances are not legally restricted from withdrawal.\nIn addition, the companies from time to time borrow under uncommitted lines of credit with banks, and in the case of Alabama Power and Georgia Power, through commercial paper programs that have the liquidity support of committed bank credit arrangements.\nASSETS SUBJECT TO LIEN\nThe operating companies' mortgages, which secure the first mortgage bonds issued by the companies, constitute a direct first lien on substantially all of the companies' respective fixed property and franchises.\nFUEL COMMITMENTS\nTo supply a portion of the fuel requirements of the system's generating plants, the subsidiary companies have\nII-30 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nentered into various long-term commitments for the procurement of fossil and nuclear fuel. In most cases, these contracts contain provisions for price escalations, minimum purchase levels, and other financial commitments. Total estimated long-term obligations were approximately $15 billion at December 31, 1993. Additional commitments for coal and nuclear fuel will be required in the future to supply the operating companies' fuel needs.\nTo take advantage of lower-cost coal supplies, agreements were reached in 1986 for the payment of $121 million to terminate two contracts for the supply of coal to Plant Daniel, which is jointly owned by Gulf Power and Mississippi Power. Also, in March 1988, Gulf Power made an advance payment of $60 million to a coal supplier under an agreement to lower the cost of future coal purchased under an existing contract. These amounts are being amortized to expense. The remaining unamortized amount included in deferred charges at December 31, 1993, was $70 million.\nOPERATING LEASES\nThe operating companies have entered into coal rail car rental agreements with various terms and expiration dates. Rental expense totaled $11 million, $9 million, and $7 million for 1993, 1992, and 1991, respectively. At December 31, 1993, estimated minimum rental commitments for noncancelable operating leases were as follows:\n6. FACILITY SALES AND JOINT OWNERSHIP AGREEMENTS\nIn 1992, Alabama Power sold an undivided interest in units 1 and 2 of Plant Miller and related facilities to Alabama Electric Cooperative, Inc.\nSince 1975, Georgia Power has sold undivided interests in plants Vogtle, Hatch, Scherer, and Wansley in varying amounts, together with transmission facilities, to OPC, the Municipal Electric Authority of Georgia (MEAG), and the city of Dalton, Georgia. Georgia Power has completed two of four separate transactions to sell Unit 4 of Plant Scherer to two Florida utilities. See Note 7 for additional information concerning these sales. In addition, Georgia Power has entered into a joint ownership agreement with OPC with respect to the Rocky Mountain project, as discussed later.\nAt December 31, 1993, Alabama Power's and Georgia Power's ownership and investment (exclusive of nuclear fuel) in jointly owned facilities with the above entities were as follows:\n*Estimated ownership at date of completion.\nGeorgia Power and OPC have entered into a joint ownership agreement regarding the 848-megawatt Rocky Mountain pumped storage hydroelectric project. Under the agreement, Georgia Power will retain its present investment in the project and OPC will finance, complete, and operate the facility. Upon completion, Georgia Power will own an undivided interest in the project equal to the proportion its investment bears to the total investment in the project (excluding each party's cost of funds and ad valorem taxes). Based on current cost estimates, Georgia Power's final ownership is estimated at approximately 25 percent of the project at completion. Georgia Power has held preliminary discussions with other parties regarding the potential disposition of its remaining interest in the project.\nII-31 NOTES (continued) THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES 1993 ANNUAL REPORT\nAlabama Power and Georgia Power have contracted to operate and maintain the jointly owned facilities -- except for the Rocky Mountain project -- as agents for their respective co-owners. The companies' proportionate share of their plant operating expenses is included in the corresponding operating expenses in the Consolidated Statements of Income.\nIn connection with a joint ownership arrangement at Plant Vogtle, Georgia Power has remaining commitments to purchase declining fractions of OPC's and MEAG's capacity and energy from this plant for periods of up to 10 years following commercial operation (and, with regard to a portion of the 5 percent additional interest in Plant Vogtle owned by MEAG, until the latter of the retirement of the plant or the latest stated maturity date of MEAG's bonds issued to finance such ownership interest). The payments for such capacity are required whether any capacity is available. The energy cost of these purchases is a function of each unit's variable operating costs. Except as noted below, the cost of such capacity and energy is included in purchased power in the Consolidated Statements of Income. Capacity payments totaled $183 million, $289 million, and $320 million, for 1993, 1992, and 1991, respectively. Projected capacity payments for the next five years are as follows: $132 million in 1994; $77 million in 1995; $70 million in 1996; $59 million in 1997; and $59 million in 1998. Also, a portion of the above capacity payments relates to Plant Vogtle costs that were written off after being disallowed for retail ratemaking purposes.\nIn 1991, the GPSC ordered that the Plant Vogtle capacity buyback expense be levelized over a six-year period. The amounts deferred and not expensed in the year paid totaled $38 million in 1993, $100 million in 1992, and $30 million in 1991. The projected net amount to be deferred in 1994 is $1 million. The projected net amortization of the deferred expense is $49 million in 1995, $62 million in 1996, and $57 million in 1997.\n7. PLANNED SALES OF INTEREST IN PLANT SCHERER\nGeorgia Power has completed two of four separate transactions to sell Unit 4 of Plant Scherer to Florida Power & Light Company (FP&L) and Jacksonville Electric Authority (JEA) for a total price of approximately $806 million, including any gains on these transactions. FP&L would eventually own approximately 76.4 percent of the unit, with JEA owning the remainder. The capacity from this unit was previously dedicated to long-term power sales contracts with Gulf States that were suspended in 1988. Georgia Power will continue to operate the unit.\nThe completed and scheduled remaining transactions are as follows:\nPlant Scherer -- a jointly owned coal-fired generating plant -- has four units with a total capacity of 3,272 megawatts. Unit 4 was completed in 1989. See Note 6 for information regarding current plant ownership.\n8. LONG-TERM POWER SALES AGREEMENTS\nGENERAL\nThe operating subsidiaries of The Southern Company have entered into long-term contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside the system's service area. Certain of these agreements are non-firm and are based on capacity of the system in general. Other agreements are firm and pertain to capacity related to specific generating units. Because the energy is generally sold at cost under these agreements, revenues from capacity sales primarily affect profitability. The capacity revenues have been as follows:\nLong-term non-firm power of 400 megawatts was sold in 1993 to Florida Power Corporation (FPC). In January 1994, this amount decreased to 200 megawatts, and the contract will expire at year-end.\nUnit power from specific generating plants is currently being sold to FP&L, FPC, JEA, and the city of Tallahassee, Florida. Under these agreements, an average\nII-32 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nof 1,700 megawatts of capacity is scheduled to be sold during 1994 and 1995. Thereafter, these sales will decline to some 1,600 megawatts and remain at that approximate level -- unless reduced by FP&L, FPC, and JEA for the periods after 1999 -- until the expiration of the contracts in 2010.\nGULF STATES SETTLEMENT COMPLETED\nOn November 7, 1991, subsidiaries of The Southern Company entered into a settlement agreement with Gulf States that resolved litigation between the companies that had been pending since 1986 and arose out of a dispute over certain unit power and other long-term power sales contracts. In 1993, all remaining terms and obligations of the settlement agreement were satisfied.\nBased on the value of the settlement proceeds received -- less the amounts to be refunded to customers and the amounts previously included in income -- The Southern Company recorded an increase in consolidated net income of $114 million, or 18 cents per share, in November 1991. With respect to Alabama Power's portion of proceeds received in 1991, see Note 3 concerning the regulatory treatment of amounts being refunded to retail customers over a three-year period.\n9. INCOME TAXES\nEffective January 1, 1993, The Southern Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no material effect on consolidated net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $1.5 billion are revenues to be received from customers. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The related liabilities of $1.1 billion are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nDetails of the federal and state income tax provisions are as follows:\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities, are as follows:\nII-33 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Consolidated Statements of Income. Credits amortized in this manner amounted to $29 million in 1993, $41 million in 1992, and $48 million in 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:\nThe Southern Company and its subsidiaries file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\n10. COMMON STOCK\nSTOCK DISTRIBUTION\nIn January 1994, The Southern Company board of directors authorized a two-for-one common stock split in the form of a stock distribution for each share held as of February 7, 1994. For all reported common stock data, the number of common shares outstanding and per share amounts for earnings, dividends, and market price have been adjusted to reflect the stock distribution.\nSHARES RESERVED\nAt December 31, 1993, a total of 24 million shares was reserved for issuance pursuant to the Dividend Reinvestment and Stock Purchase Plan, the Employee Savings Plan, and the Executive Stock Option Plan.\nEXECUTIVE STOCK OPTION PLAN\nThe Southern Company's Executive Stock Option Plan authorizes the granting of non-qualified stock options to key employees of The Southern Company, including officers. Currently, 34 employees are eligible to participate in the plan. As of December 31, 1993, 38 current and former employees participated in the plan. The maximum number of shares of common stock that may be issued under the Executive Stock Option Plan may not exceed 6 million. The price of options granted to date has been at the fair market value of the shares on the date of grant. Options granted to date become exercisable pro rata over a maximum period of four years from date of grant, such that all options generally are exercisable by 1997. Options outstanding will expire upon termination of the plan, which will occur on December 7, 1997, unless terminated earlier by the board of directors. Stock option activity in 1992 and 1993 is summarized below:\nII-34 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\n11. OTHER LONG-TERM DEBT\nDetails of other long-term debt are as follows:\nWith respect to the collateralized pollution control revenue bonds, the operating companies have authenticated and delivered to trustees a like principal amount of first mortgage bonds as security for obligations under installment sale or loan agreements. The principal and interest on the first mortgage bonds will be payable only in the event of default under the agreements.\nAssets acquired under capital leases are recorded as utility plant in service, and the related obligation is classified as other long-term debt. The net book value of capitalized leases was $217 million and $236 million at December 31, 1993 and 1992, respectively. At December 31, 1993, the composite interest rates for nuclear fuel, buildings, and other were 3.6 percent, 9.7 percent, and 12.0 percent, respectively. Sinking fund requirements and\/or serial maturities through 1998 applicable to other long-term debt are as follows: $89 million in 1994; $154 million in 1995; $58 million in 1996; $26 million in 1997; and $7 million in 1998.\n12. LONG-TERM DEBT DUE WITHIN ONE YEAR\nA summary of the improvement fund requirements and scheduled maturities and redemptions of long-term debt due within one year is as follows:\nThe first mortgage bond improvement (sinking) fund requirements amount to 1 percent of each outstanding series of bonds authenticated under the indentures prior to January 1 of each year, other than those issued to collateralize pollution control and other obligations. The requirements may be satisfied by depositing cash or reacquiring bonds, or by pledging additional property equal to 166 2\/3 percent of such requirements.\nII-35 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\n13. NUCLEAR INSURANCE\nUnder the Price-Anderson Amendments Act of 1988, Alabama Power and Georgia Power maintain agreements of indemnity with the NRC that, together with private insurance, cover third-party liability arising from any nuclear incident occurring at the companies' nuclear power plants. The act limits to $9.4 billion public liability claims that could arise from a single nuclear incident. Each nuclear plant is insured against this liability to a maximum of $200 million by private insurance, with the remaining coverage provided by a mandatory program of deferred premiums that could be assessed, after a nuclear incident, against all owners of nuclear reactors. A company could be assessed up to $79 million per incident for each licensed reactor it operates but not more than an aggregate of $10 million per incident to be paid in a calendar year for each reactor. Such maximum assessment, excluding any applicable state premium taxes, for Alabama Power and Georgia Power -- based on its ownership and buyback interests -- is $159 million and $171 million, respectively, per incident but not more than an aggregate of $20 million and $22 million, respectively, to be paid for each incident in any one year.\nAlabama Power and Georgia Power are members of Nuclear Mutual Limited (NML), a mutual insurer established to provide property damage insurance in an amount up to $500 million for members' nuclear generating facilities. The members are subject to a retrospective premium adjustment in the event that losses exceed accumulated reserve funds. Alabama Power's and Georgia Power's maximum annual assessments are limited to $14 million and $18 million, respectively, under current policies.\nAdditionally, both companies have policies that currently provide decontamination, excess property insurance, and premature decommissioning coverage up to $2.25 billion for losses in excess of the $500 million NML coverage. This excess insurance is provided by Nuclear Electric Insurance Limited (NEIL), a mutual insurance company, and American Nuclear Insurers\/Mutual Atomic Energy Liability Underwriters.\nNEIL also covers the additional costs that would be incurred in obtaining replacement power during a prolonged accidental outage at a member's nuclear plant. Members can be insured against increased costs of replacement power in an amount up to $3.5 million per week -- starting 21 weeks after the outage -- for one year and up to $2.3 million per week for the second and third years.\nUnder each of the NEIL policies, members are subject to assessments if losses each year exceed the accumulated funds available to the insurer under that policy. The maximum annual assessments under current policies for Alabama Power and Georgia Power for excess property damage would be $16 million and $15 million, respectively. The replacement power assessments are $9 million for Alabama Power and $13 million for Georgia Power.\nFor all on-site property damage insurance policies for commercial nuclear power plants, the NRC requires that the proceeds of such policies issued or renewed on or after April 2, 1991, shall be dedicated first for the sole purpose of placing the reactor in a safe and stable condition after an accident. Any remaining proceeds are to be applied next toward the costs of decontamination and debris removal operations ordered by the NRC, and any further remaining proceeds are to be paid either to the company or to its bond trustees as may be appropriate under the policies and applicable trust indentures.\nAlabama Power and Georgia Power participate in an insurance program for nuclear workers that provides coverage for worker tort claims filed for bodily injury caused at commercial nuclear power plants. In the event that claims for this insurance exceed the accumulated reserve funds, Alabama Power and Georgia Power could be subject to a maximum total assessment of $6 million and $7 million, respectively.\nII-36 NOTES (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\n14. COMMON STOCK DIVIDEND RESTRICTIONS\nThe income of The Southern Company is derived primarily from equity in earnings of its operating subsidiaries. At December 31, 1993, $1.6 billion of consolidated retained earnings was restricted against the payment by the operating companies of cash dividends on common stock under terms of bond indentures or charters.\n15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly financial data for 1993 and 1992 are as follows:\n*Common stock data have been adjusted to reflect a two-for-one stock split in the form of a stock distribution for each share held as of February 7, 1994.\nThe company's business is influenced by seasonal weather conditions and the timing of rate changes.\nII-37 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1993 Annual Report (See Note Below)\nNote: Common stock data have been adjusted to reflect a two-for-one stock split in the form of a stock distribution for each share held as of February 7, 1994.\nII-38 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1993 Annual Report (See Note Below)\nII-39 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nII-40 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1993 Annual Report\nII-41 CONSOLIDATED STATEMENTS OF INCOME The Southern Company and Subsidiary Companies\nII-42\nCONSOLIDATED STATEMENTS OF INCOME The Southern Company and Subsidiary Companies\nII-43\nCONSOLIDATED STATEMENTS OF CASH FLOWS The Southern Company and Subsidiary Companies\nII-44\nCONSOLIDATED STATEMENTS OF CASH FLOWS The Southern Company and Subsidiary Companies\nII-45\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-46\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-47\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-48\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-49\nALABAMA POWER COMPANY\nFINANCIAL SECTION\nII-50\nMANAGEMENT'S REPORT Alabama Power Company 1993 Annual Report\nThe management of Alabama Power Company has prepared -- and is responsible for - -- the financial statements and related information included in this report. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on the best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that the books and records reflect only authorized transactions of the company. Limitations exist in any system of internal controls based on a recognition that the cost of the system should not exceed its benefits. The company believes its system of internal accounting controls maintains an appropriate cost\/benefit relationship.\nThe company's system of internal accounting controls is evaluated on an ongoing basis by the company's internal audit staff. The company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, composed of directors who are not employees, provides a broad overview of management's financial reporting and control functions. Periodically, this committee meets with management, the internal auditors and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal controls, and financial reporting matters. The internal auditors and independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the company's operations are conducted according to a high standard of business ethics. In management's opinion, the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows of Alabama Power Company in conformity with generally accepted accounting principles.\n\/s\/ Elmer B. Harris \/s\/ William B. Hutchins, III - -------------------------- ------------------------------ Elmer B. Harris William B. Hutchins III President Senior Vice President and Chief Executive Officer and Chief Financial Officer\nII-51\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF ALABAMA POWER COMPANY:\nWe have audited the accompanying balance sheets and statements of capitalization of Alabama Power Company (an Alabama corporation and wholly owned subsidiary of The Southern Company) as of December 31, 1993 and 1992, and the related statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-59 through II-77) referred to above present fairly, in all material respects, the financial position of Alabama Power Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 8 to the financial statements, effective\nJanuary 1, 1993, the company changed its methods of accounting for postretirement benefits other than pensions, and for income taxes.\n\/s\/ Arthur Andersen & Co.\nBirmingham, Alabama February 16, 1994\nII-52 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Alabama Power Company 1993 Annual Report\nRESULTS OF OPERATIONS\nEARNINGS\nThe company's 1993 net income after dividends on preferred stock was $346 million, representing a 2.3 percent increase over the prior year. This improvement can be attributed to higher retail energy sales and lower financing costs. Retail energy sales increased 5.1 percent from 1992 levels. This was primarily due to the extreme weather during 1993, especially when compared to the unusually mild weather of 1992. Long-term debt interest expense and preferred stock dividends decreased in 1993 reflecting the continued redemption and refinancing of higher cost debt and preferred stock. These positive factors were partially offset by higher operating costs and a scheduled reduction in capacity sales to non-affiliated utilities.\nWhen comparing 1992 earnings with the prior year, it should be noted that 1991 earnings included an unusual item -- the settlement of litigation with Gulf States Utilities Company (Gulf States) that resulted in an after-tax gain of $9 million. A comparison of 1992 to 1991, excluding this unusual item, would reflect a 1992 increase in earnings of $8 million.\nThe return on average common equity for 1993 was 13.9 percent compared to 14.0 percent in 1992, and 14.6 percent in 1991.\nREVENUES\nThe following table summarizes the principal factors that affected operating revenues for the past three years:\nRetail revenues of $2.4 billion in 1993 increased $180 million (8.0 percent) over the prior year, compared with no increase in 1992. The extreme weather during 1993 and sales growth contributed to the increase in retail revenues over 1992. Fuel revenues increased substantially during 1993. However, changes in fuel revenues are offset with corresponding changes in recoverable fuel expenses and have no effect on net income. Gains in 1992 retail revenues, due to higher rates and sales growth, were partially offset by lower fuel cost recovery revenues.\nRevenues from sales to non-affiliated utilities under long-term contracts consist of capacity and energy components. Capacity revenues reflect the recovery of fixed costs and a return on investment under the contracts. Energy is generally sold at variable cost. The capacity and energy components were:\nII-53 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1993 Annual Report\nCapacity revenues decreased in 1993 due to a scheduled reduction in capacity dedicated to unit power sales customers for the first five months of the year. The major factor contributing to the increase in capacity revenues in 1992 and 1991 was a new generating unit, Plant Miller Unit 4, that was placed in commercial service in March 1991 and dedicated to unit power sales. This unit's fixed costs are higher than those of the unit it replaced, which previously provided energy to unit power sales customers.\nSales to affiliated companies within the Southern electric system will vary from year to year depending on demand and the availability and cost of generating resources at each company. These sales have no material impact on earnings.\nKilowatt-hour (KWH) sales for 1993 and the percent change by year were as follows:\nEXPENSES\nTotal operating expenses of $2.4 billion for 1993 were up 7.0 percent compared with the prior year. The increase was mainly attributable to higher production expenses of $95 million to meet increased energy demands.\nTotal operating expenses for 1992 increased moderately over those recorded in 1991. However, absent the Gulf States settlement, which reduced 1991 operating expenses, total operating expenses would have decreased $6 million.\nFuel costs are the single largest expense for the company. The mix of fuel sources for generation of electricity is determined primarily by system load, the unit cost of fuel consumed, and the availability of hydro and nuclear generating units. Fuel expense increases in 1993 represent $83 million of the production expense increase mentioned above. Fuel expense decreased in 1992 as a result of the reduction in the cost of both coal and nuclear fuel, offset somewhat by a small increase in generation. Fuel cost per kilowatt-hour generated was 1.73 cents in 1993, 1.64 cents in 1992 and 1.69 cents in 1991. Purchased power expenses decreased in 1992 primarily due to less purchased energy and a decrease in the price of such energy.\nOther operation expenses increased 6.0 percent in 1993 following a minimal increase in 1992. The increase in 1993 is primarily the result of environmental cleanup costs, net expenses of a March snowstorm, and the one-time cost of a transportation fleet reduction program, which together totaled $16.1 million.\nDepreciation and amortization expense increased 3.4 percent in 1993 and 3.5 percent in 1992. This is principally due to continued growth in depreciable plant in service. Taxes other than income taxes increased 4.0 percent in 1993 and 1.4 percent in 1992. These increases were the result of the addition of new facilities and higher revenue-related taxes.\nThe increase in income tax expense of 2.6 percent for 1993 is primarily attributable to a one percent increase in the corporate federal income tax rate effective January 1, 1993.\nInterest expense and dividends on preferred stock decreased $7.5 million (2.8 percent) and $7.2 million (2.6 percent) in 1993 and 1992, respectively. These reductions are due to significant refinancing of long-term debt and preferred stock.\nII - 54\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1993 Annual Report\nEFFECTS OF INFLATION\nThe company is subject to rate regulation that is based on the recovery of historical costs and, therefore is subject to economic losses caused by inflation. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations, such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors ranging from growth in energy sales to regulatory matters.\nFuture earnings in the near term will also depend upon growth in electric sales, which are subject to a number of factors. Traditionally, these factors have included changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, weather, competition, and the rate of economic growth in the company's service area. In addition, the Energy Policy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric utilities. The law also includes provisions to streamline the licensing process for new nuclear plants. The company is preparing to meet the challenge of this major change in the traditional business practices of selling electricity. The Energy Act allows independent power producers (IPPs) to access a utility's transmission network in order to sell electricity to other utilities, and this may enhance the incentive for IPPs to build cogeneration plants for a utility's large industrial and commercial customers and sell excess energy generation to other utilities. Although the Energy Act does not require transmission access to retail customers, pressure for legislation to allow retail wheeling will continue. If the company does not remain a low-cost producer and provide quality service, the company's retail energy sales growth, as well as any new long-term contracts for energy sales outside the service area, could be limited, and this could significantly erode earnings.\nRates to retail customers served by the company are regulated by the Alabama Public Service Commission (APSC). Rates for the company can be adjusted periodically within certain limitations based on earned retail rate of return compared with an allowed return. See Note 3 to the financial statements for information about other regulatory matters.\nThe Federal Energy Regulatory Commission (FERC) regulates wholesale rate schedules and power sales contracts that the company has with its sales for resale customers. The FERC currently is reviewing the rate of return on common equity included in these schedules and contracts and may require such returns to be lowered, possibly retroactively. See Note 3 to the financial statements under \"FERC Reviews Equity Returns\" for additional information.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could reduce earnings if such costs are not fully recovered. The Clean Air Act is discussed later under \"Environmental Matters.\"\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be effective by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental unemployment benefits, disability-related benefits, job training, and health and life insurance coverage. In 1993, the company adopted Statement No. 112, with no material effect on the financial statements.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which is effective in 1994. Statement No. 115 supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. The company adopted the new rules January 1, 1994, with no material effect on the financial statements.\nII-55 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1993 Annual Report\nFINANCIAL CONDITION\nOVERVIEW\nThe company's financial condition remained stable in 1993. Growth in energy sales combined with a significant lowering of the cost of capital, achieved through the refinancing and\/or redemption of higher-cost long-term debt and preferred stock contributed to this stability.\nThe company had gross property additions of $436 million in 1993. The majority of funds needed for gross property additions since 1990 have been provided from operating activities, principally from earnings and non-cash charges to income such as depreciation and deferred income taxes. The Statements of Cash Flows provide additional details.\nOn January 1, 1993, the company changed its methods of accounting for postretirement benefits other than pensions, and for income taxes. See Notes 2 and 8 to the financial statements, regarding the impact of these changes.\nCAPITAL STRUCTURE\nThe company's ratio of common equity to total capitalization was 47.4 percent in 1993, compared with 47.6 percent in 1992, and 45.4 percent in 1991.\nIn 1993, the company issued $860 million of first mortgage bonds, $158 million of preferred stock and, through public authorities, $144 million of pollution control revenue bonds. The company continued to reduce financing costs by retiring higher-cost bonds and preferred stock. Retirements, including maturities, of bonds totaled $835 million, and preferred stock retirements totaled $207 million. Composite financing rates as of year-end for 1991 through 1993 were as follows:\nThe company's current securities ratings are as follows:\nCAPITAL REQUIREMENTS\nCapital expenditures are estimated to be $588 million for 1994, $572 million for 1995, and $531 million for 1996. The total is $1.7 billion for the three years. Actual capital costs may vary from this estimate because of factors such as changes in environmental regulations; changes in the existing nuclear plant to meet new regulations; revised load projections; increasing costs of labor, equipment, and materials; and the cost of capital.\nThe company does not have any baseload generating plants under construction, and current energy demand forecasts do not require any additional baseload generating units until well into the future. However, the construction of combustion turbine peaking units of approximately 720 megawatts of capacity is planned by 1996 to meet increased peak-hour demands. In addition, significant construction of transmission and distribution facilities and upgrading of generating plants will continue.\nIn addition to the funds needed for the capital budget, approximately $80 million will be required by the end of 1996 for present sinking fund requirements, redemptions announced, and maturities of first mortgage bonds. Also, the company plans to continue a program to retire higher-cost debt and preferred stock and replace these obligations with lower-cost capital.\nENVIRONMENTAL MATTERS\nIn November 1990, the Clean Air Act was signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- will have a significant impact on the Southern electric system. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995 and affects eight generating plants -- some 10,000\nII-56 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1993 Annual Report\nmegawatts of capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing slower than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $275 million through 1995 for The Southern Company, of which the company's portion is approximately $30 million.\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I, increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 to 2000, compliance could require total construction expenditures ranging from approximately $450 million to $800 million for The Southern Company, of which the company's portion is approximately $225 million to $350 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nAn increase of up to 2 percent in annual revenue requirements from customers could be necessary to fully recover the company's cost of compliance for both Phase I and Phase II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nThere can be no assurance that all Clean Air Act costs will be recovered.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standards could result in significant additional costs. The impact of new standards -- if any -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a new standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provision of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matter, nitrogen oxides, and ozone. The impact of any new standard will depend on the level chosen for the standard\nII-57 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1993 Annual Report\nand cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the non-hazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes -- coal ash and other utility wastes -- as either non-hazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nThe company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the company could incur costs to clean up properties currently or previously owned. The company conducts studies to determine the extent of any required clean-up costs and has recognized in the financial statements costs to clean up known sites.\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; and the Resource Conservation and Recovery Act. Changes to these laws could affect many areas of The Southern Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields, and other environmental and health concerns could significantly affect the Southern electric system. The impact of new legislation -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the potential for lawsuits alleging damages caused by electromagnetic fields exists.\nSOURCES OF CAPITAL\nIt is anticipated that the funds required will be derived from sources in form and quantity similar to those used in the past. To issue additional first mortgage bonds and preferred stock, the company must comply with certain earnings coverage requirements designated in its mortgage indenture and corporate charter. The company's coverages are at a level that would permit any necessary amount of security sales at current interest and dividend rates.\nAs required by the Nuclear Regulatory Commission and as ordered by the APSC, the company has established external trust funds for nuclear decommissioning costs. Also, during 1993, the APSC issued a policy statement which will require external funding of postretirement benefits. The cumulative effect of funding these items over a long period will diminish internally funded capital and may require capital from other sources. For additional information concerning nuclear decommissioning costs, see Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning.\"\nII-58 STATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 Alabama Power Company\nThe accompanying notes are an integral part of these statements.\nII-59\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1993, 1992, and 1991 Alabama Power Company\n( ) Denotes use of cash. The accompanying notes are an integral part of these statements.\nII-60\nBALANCE SHEETS At December 31, 1993 and 1992 Alabama Power Company\nThe accompanying notes are an integral part of these statements.\nII-61 BALANCE SHEETS At December 31, 1993 and 1992 Alabama Power Company\nThe accompanying notes are an integral part of these statements.\nII-62 STATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 Alabama Power Company\nThe accompanying notes are an integral part of these statements.\nII-63 STATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991 Alabama Power Company\nThe accompanying notes are an integral part of these statements.\nII-64\nNOTES TO FINANCIAL STATEMENTS Alabama Power Company 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nThe company is a wholly owned subsidiary of The Southern Company which is the parent company of five operating companies, a system service company, Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and various other subsidiaries related to foreign utility operations and domestic non-utility operations. At this time, the operations of the other subsidiaries are not material. The operating companies (Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, and Savannah Electric and Power Company) provide electric service in four Southeastern states. Contracts among the companies -- dealing with jointly-owned generating facilities, interconnecting transmission lines, and the exchange of electric power -- are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission (SEC). The system service company provides, at cost, specialized services upon request to The Southern Company and to the subsidiary companies. Southern Electric designs, builds, owns and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides services to The Southern Company's nuclear power plants.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA). Both The Southern Company and its subsidiaries are subject to the regulatory provisions of the PUHCA. The company is also regulated by the FERC and the Alabama Public Service Commission (APSC). The company follows generally accepted accounting principles and complies with the accounting policies and practices prescribed by the respective commissions.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nREVENUES AND FUEL COSTS\nThe company accrues revenues for services rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as the fuel is used. The company's electric rates include provisions to adjust billings for fluctuations in fuel and the energy component of purchased power costs. Revenues are adjusted for differences between recoverable fuel costs and amounts actually recovered in current rates.\nFuel expense includes the amortization of the cost of nuclear fuel and a charge, based on nuclear generation, for the permanent disposal of spent nuclear fuel. Total charges for nuclear fuel included in fuel expense amounted to $62 million in 1993, $48 million in 1992, and $69 million in 1991. The company has a contract with the U.S. Department of Energy (DOE) that provides for the permanent disposal of spent nuclear fuel, which was scheduled to begin in 1998. However, the actual year this service will begin is uncertain. Sufficient storage capacity currently is available to permit operation into 2012 and 2014 at Plant Farley units 1 and 2, respectively.\nAlso, the Energy Policy Act of 1992 required the establishment in 1993 of a Uranium Enrichment Decontamination and Decommissioning Fund, which is to be funded in part by a special assessment on utilities with nuclear plants. This assessment will be paid over a 15-year period, which began in 1993. This fund will be used by the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The law provides that utilities will recover these payments in the same manner as any other fuel expense. The company currently estimates its liability under this law to be approximately $46 million. This obligation is recognized in the accompanying Balance Sheets.\nDEPRECIATION AND NUCLEAR DECOMMISSIONING\nDepreciation of the original cost of depreciable utility plant in service is provided primarily by using composite straight-line rates which approximated 3.3 percent in 1993, 1992, and 1991. When property subject to depreciation is retired or otherwise disposed of in the normal course of business, its cost -- together with the cost of removal, less salvage -- is charged to the accumulated provision for depreciation. Minor items of property included in the original cost of the plant are retired when the related property unit is retired. Depreciation expense includes an amount for the expected cost of decommissioning nuclear facilities.\nII-65 NOTES (continued) Alabama Power Company 1993 Annual Report\nIn 1988, the Nuclear Regulatory Commission (NRC) adopted regulations requiring all licensees operating commercial power reactors to establish a plan for providing, with reasonable assurance, funds for decommissioning. Reasonable assurance may be in the form of an external trust fund, a surety method, or prepayment. The company has established external trust funds to comply with the NRC's regulations. Prior to the enactment of these regulations, the company had reserved nuclear decommissioning costs. The NRC's minimum external funding requirements are based on a generic estimate of the cost to decommission the radioactive portions of a nuclear unit based on the size and type of reactor. The company has filed plans with the NRC to ensure that -- over time -- the deposits and earnings of the external trust funds will provide the minimum funding amount prescribed by the NRC.\nThe estimated cost of decommissioning and the amounts being recovered through rates at December 31, 1993, for Plant Farley were as follows:\nThe amount in the internal reserve is being transferred into the external trust funds over the remaining life of the license for Plant Farley as approved by the APSC.\nThe decommissioning cost estimates are based on prompt dismantlement and removal of the plant from service. The actual decommissioning costs may vary from the above estimates because of regulatory requirements, changes in technology, and changes in costs of labor, materials, and equipment.\nINCOME TAXES\nThe company provides deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, the company adopted Financial Accounting Standards Board (FASB) Statement No. 109, Accounting for Income Taxes. Statement No. 109 required, among other things, conversion to the liability method of accounting for accumulated deferred income taxes. See Note 8 for additional information about Statement No. 109.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. The composite rate used to determine the amount of allowance, net of deferred income tax, was 6.2 percent in 1991. Such method of computing AFUDC ceased upon the commercial operation of Plant Miller Unit 4 in March 1991. For construction projects begun after 1986, deferral of taxes related to capitalized interest is no longer permitted. For those projects, the composite rate used to determine the amount of allowance was 7.8 percent in 1993, 7.9 percent in 1992, and 8.3 percent in 1991. AFUDC, net of income tax, as a percent of net income after dividends on preferred stock was 1.5 percent in 1993, 1.1 percent in 1992, and 2.0 percent in 1991.\nUTILITY PLANT\nUtility plant is stated at original cost. Original cost includes: materials; labor; minor items of property; appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; and the estimated cost of funds used during construction. The cost of maintenance, repairs and replacements of minor items of property is charged to maintenance expense. The cost of replacements of property (exclusive\nII-66 NOTES (continued) Alabama Power Company 1993 Annual Report\nof minor items of property) is charged to utility plant.\nFINANCIAL INSTRUMENTS\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, all financial instruments of the company -- for which the carrying amount does not approximate fair value -- are shown in the table below as of December 31:\nThe fair values of nuclear decommissioning trusts and investment securities were based on listed closing market prices. The fair values for long-term debt were based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution, and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed.\nVACATION PAY\nThe company's employees earn their vacation in one year and take it in the subsequent year. However, for ratemaking purposes, vacation pay is recognized as an allowable expense only when paid. Consistent with this ratemaking treatment, the company accrues a current liability for earned vacation pay and records a current asset representing future recoverability of this cost. The amount was $23 million and $22 million at December 31, 1993 and 1992, respectively. In 1994, an estimated 65 percent of the 1993 deferred vacation cost will be expensed and the balance will be charged to construction and other accounts.\n2. RETIREMENT BENEFITS\nPENSION PLAN\nThe company has a defined benefit, trusteed, non-contributory pension plan that covers substantially all regular employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and final average pay or years of service and a flat-dollar benefit. The company uses the \"entry age normal method with a frozen initial liability\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension fund are primarily invested in equity and fixed-income securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the \"projected unit credit\" actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nThe company also provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. A qualified trust for medical benefits has been established for funding amounts to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded. However, in December 1993, the APSC issued an accounting policy statement which requires the company to externally fund all postretirement benefits. It is expected that an external funding program will begin in 1994.\nEffective January 1, 1993, the company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\"\nII-67 NOTES (continued) Alabama Power Company 1993 Annual Report\nBecause the adoption of Statement No. 106 was reflected in rates, it did not have a material impact on net income.\nPrior to 1993, the company recognized these benefit costs on an accrual basis using the \"aggregate cost\" actuarial method, which spreads the expected cost of such benefits over the remaining periods of employees' service as a level percentage of payroll costs. The total costs of such benefits recognized by the company in 1992 and 1991 were $15.2 million and $15.4 million, respectively.\nStatus and Cost of Benefits\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of Statement Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown only for 1993 because Statement No. 106 was adopted as of January 1, 1993, on a prospective basis. The funded status of the plans at December 31 was as follows:\nThe weighted average rates assumed in the actuarial calculations were:\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1993, by $32.8 million and the aggregate of the service and interest cost components of the net retiree medical cost by $3.4 million.\nII-68\nNOTES(continued) Alabama Power Company 1993 Annual Report\nComponents of the plans' net cost are shown below:\nOf the above net pension amounts, $(8.9) million in 1993, $(5.1) million in 1992, and $0.7 million in 1991 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nOf the above net postretirement medical and life insurance costs recorded in 1993, $22 million was charged to operating expenses and the remainder was charged to construction and other accounts.\nWORK FORCE REDUCTION PROGRAM\nThe company has incurred additional costs for work force reduction programs. The costs related to these programs were $16.1 million, $13.4 million and $6.7 million for the years 1993, 1992 and 1991, respectively. A portion of the cost of these programs was deferred and is being amortized in accordance with regulatory treatment. The unamortized balance of these costs was $15.3 million at December 31, 1993.\n3. LITIGATION AND REGULATORY MATTERS\nRETAIL RATE ADJUSTMENT PROCEDURES\nIn November 1982, the APSC adopted rates that provide for periodic adjustments based upon the company's earned return on end-of-period retail common equity. The rates also provide for adjustments to recognize the placing of new generating facilities in retail service. Both increases and decreases have been placed into effect since the adoption of these rates. The rate adjustment procedures allow a return on common equity range of 13.0 percent to 14.5 percent and limit increases or decreases in rates to 4 percent in any calendar year.\nThe APSC issued an order in December 1991 that reduced a scheduled 2.03 percent annual increase in rates to 1.03 percent, effective January 1992. The 1 percent reduction will remain in effect through 1994. The rate reduction was designed to refund to retail ratepayers a portion of the benefits from a settled contract dispute with Gulf States Utilities Company (Gulf States). The present value of this portion of the settlement amounting to approximately $60 million is being amortized to revenues to offset the rate reduction in accordance with the APSC's rate order. See Note 7 for additional information concerning the Gulf States settlement.\nAlso in the December 1991 rate order, the APSC reaffirmed its satisfaction with the ratemaking mechanism and stated that it did not foresee any further review or changes in the procedures until after 1994. The ratemaking procedures will remain in effect after 1994 unless the APSC votes to modify or discontinue them.\nIn February 1993, the APSC ordered - at the company's request - a moratorium on rate increases for the first two quarters of 1993, which facilitated the transition of an accounting change. This accounting change permitted the accrual of estimated operation and maintenance expenses related to nuclear refueling outages during the period between outages rather than at the time the expenses are incurred.\nHEAT PUMP FINANCING SUIT\nIn September 1990, two customers of the company filed a civil complaint in the Circuit Court of Shelby County, Alabama, against the company seeking to represent all\nII-69 NOTES(continued) Alabama Power Company 1993 Annual Report\npersons who, prior to June 23, 1989, entered into agreements with the company for the financing of heat pumps and other merchandise purchased from vendors other than the company. The plaintiffs contended that the company was required to obtain a license under the Alabama Consumer Finance Act to engage in the business of making consumer loans. The plaintiffs were seeking an order declaring these agreements null and void and requiring the company to refund all payments -- principal and interest -- made under these agreements. The aggregate amount under these agreements, together with interest paid, currently is estimated to be $40 million.\nIn June, 1993, the court ordered the company to refund or forfeit interest of approximately $10 million because of the company's failure to obtain such license. However, the court's order did not require any refund or forfeiture with respect to any principal payments under the agreements at issue. The company has appealed the court's order to the Supreme Court of Alabama.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material effect on the company's financial statements.\nFERC REVIEWS EQUITY RETURNS\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the Southern electric system's wholesale rate schedules and contracts that have a return on common equity of 13.75 percent or greater. The contracts that could be affected by the hearings include substantially all of the transmission, unit power, long-term power and other similar contracts. Any changes in the rate of return on common equity that may occur as a result of this proceeding would be effective 60 days after a proper notice of the proceeding is published. A notice was published on May 10, 1991.\nIn August 1992, a FERC administrative law judge issued an opinion that changes in rate schedules and contracts were not necessary and that the FERC staff failed to show how any changes were in the public interest. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material effect on the company's financial statements.\n4. CAPITAL BUDGET\nThe company's capital expenditures are currently estimated to total $588 million in 1994, $572 million in 1995 and $531 million in 1996. The estimates include AFUDC of $10 million in 1994, $11 million in 1995 and $12 million in 1996. The estimates for property additions for the three-year period includes $36.5 million committed to meeting the requirements of the Clean Air Act. The capital budget is subject to periodic review and revision, and actual capital cost incurred may vary from the above estimates because of numerous factors. These factors include changes in business conditions; revised load growth projections; changes in environmental regulations; changes in the existing nuclear plant to meet new regulatory requirements; increasing costs of labor, equipment, and materials; and cost of capital. At December 31, 1993, significant purchase commitments were outstanding in connection with the construction program. The company does not have any new baseload generating plants under construction. However, the construction of combustion turbine peaking units of approximately 720 megawatts is planned to be completed by 1996. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\n5. FINANCING, INVESTMENT, AND COMMITMENTS\nGENERAL\nTo the extent possible, the company's construction program is expected to be financed primarily from internal sources. Short-term debt will be utilized when necessary; the amounts available are discussed below. The company may issue additional long-term debt and preferred stock primarily for the purposes of debt maturities and for redeeming higher-cost securities.\nFINANCING\nThe ability of the company to finance its capital budget depends on the amount of funds generated internally and the funds it can raise by external financing. The\nII-70 NOTES(continued) Alabama Power Company 1993 Annual Report\ncompany's primary sources of external financing are sales of first mortgage bonds and preferred stock to the public, receipt of additional paid-in capital from The Southern Company, and leasing of nuclear material. In order to issue additional first mortgage bonds and preferred stock, the company must comply with certain earnings coverage requirements contained in its mortgage indenture and corporate charter. The most restrictive of these provisions requires, for the issuance of additional first mortgage bonds, that before-income-tax earnings, as defined, cover pro forma annual interest charges on outstanding first mortgage bonds at least twice; and for the issuance of additional preferred stock, that gross income available for interest cover pro forma annual interest charges and preferred stock dividends at least one and one-half times. These coverages, for first mortgage bonds and for preferred stock for the year ended December 31, 1993, were 5.70 and 2.71, respectively.\nBANK CREDIT ARRANGEMENTS\nThe company, along with The Southern Company and Georgia Power Company, has entered into agreements with several banks outside the service area to provide $400 million of revolving credit to the companies through June 30, 1996. To provide liquidity support for commercial paper programs, the company and Georgia Power Company have exclusive right to $135 million and $165 million, respectively, of the available credit. The companies have the option of converting the short-term borrowings into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the companies' option. In addition, these agreements provide for payment of commitment fees based on the unused portions of the commitments or the maintenance of compensating balances with the banks.\nAdditionally, the company maintains committed lines of credit in the amount of $350 million which expire at various times during 1994 and, in certain cases, provide for average annual compensating balances. Because the arrangements are based on an average balance, the company does not consider any of its cash balances to be restricted as of any specific date. Moreover, the company borrows from time to time pursuant to arrangements with banks for uncommitted lines of credit.\nIn connection with all other lines of credit, the company has the option of paying fees or maintaining compensating balances, which are substantially all the cash of the company except for daily working funds and similar items. These balances are not legally restricted from withdrawal.\nAt December 31, 1993, the company had regulatory approval to have outstanding up to $450 million of short-term borrowings.\nASSETS SUBJECT TO LIEN\nThe company's mortgage, as amended and supplemented, securing the first mortgage bonds issued by the company, constitutes a direct lien on substantially all of the company's fixed property and franchises.\nFUEL COMMITMENTS\nTo supply a portion of the fuel requirements of its generating plants, the company has entered into various long-term commitments for the procurement of fossil and nuclear fuel. In most cases, these contracts contain provisions for price escalations, minimum purchase levels and other financial commitments. Total estimated long-term obligations through the year 2013 were approximately $8 billion at December 31, 1993.\nIn addition, a contract with a certain coal contractor requires reimbursement or purchase, at net book value, of the investment in the mine or equipment upon termination of the contract. At December 31, 1993, such net book value was approximately $13 million. Additional commitments for coal and for nuclear fuel will be required in the future to supply the company's fuel needs.\n6. FACILITY SALES AND JOINT OWNERSHIP AGREEMENTS\nThe company and Georgia Power Company own equally all of the outstanding capital stock of Southern Electric Generating Company (SEGCO), which owns electric generating units with a total rated capacity of 1,019,680 kilowatts, together with associated transmission facilities. The capacity of these units is sold equally to the company and Georgia Power Company under a contract expiring in 1994 which, in substance, requires payments sufficient to provide for the operating expenses, taxes, interest expense\nII-71 NOTES(continued) Alabama Power Company 1993 Annual Report\nand a return on equity, whether or not SEGCO has any capacity and energy available. The company's share of expenses totaled $86 million in 1993, $73 million in 1992 and $82 million in 1991, and is included in \"Purchased power from affiliates\" in the Statements of Income. An amended contract has been filed with the FERC with substantially the same provisions, but the term thereof would be extended automatically for two year periods, subject to any party's right to cancel upon two years' notice.\nIn addition, the company has guaranteed unconditionally the obligation of SEGCO under an installment sale agreement for the purchase of certain pollution control facilities at SEGCO's generating units, pursuant to which $24.5 million principal amount of pollution control revenue bonds are outstanding. Georgia Power Company has agreed to reimburse the company for the pro rata portion of such obligation corresponding to its then proportionate ownership of stock of SEGCO if the company is called upon to make such payment under its guaranty.\nAt December 31, 1993, the capitalization of SEGCO consisted of $58 million of equity and $84 million of long-term debt on which the annual interest requirement is $3.8 million. SEGCO paid dividends totaling $11.3 million in 1993, $12.0 million in 1992, and $4.5 million in 1991, of which one-half of each was paid to the company. SEGCO's net income was $8.3 million, $9.3 million and $9.2 million for 1993, 1992 and 1991, respectively.\nIn June 1992 the company completed the sale of a portion of Plant Miller Units 1 and 2 to Alabama Electric Cooperative, Inc. (AEC). The company's percentage ownership and investment in jointly-owned generating plants at December 31, 1993, follows:\n(1) Jointly owned with an affiliate, Mississippi Power Company. (2) Jointly owned with AEC.\n7. LONG-TERM POWER SALES AGREEMENTS\nGENERAL\nThe operating subsidiaries of The Southern Company, including the company, have entered into long-term and short-term contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside the system's service area. Certain of these agreements are non-firm and are based on capacity of the system in general. Other agreements are firm and pertain to capacity related to specific generating units. Because the energy is generally sold at cost under these agreements, revenues from capacity sales primarily affect profitability. The company's portion of off-system capacity revenues has been as follows:\nLong-term non-firm power of 400 megawatts was sold by the Southern electric system in 1993 to Florida Power Corporation (FPC). In January 1994, this amount decreased to 200 megawatts, and the contract will expire at year-end.\nUnit power from Plant Miller is being sold to FPC, Florida Power & Light Company (FP&L), Jacksonville Electric Authority (JEA) and the City of Tallahassee, Florida (Tallahassee). Under these agreements, an average of 1,100 megawatts of capacity is scheduled to be\nII-72 NOTES(continued) Alabama Power Company 1993 Annual Report\nsold during 1994. Thereafter, these sales will increase to some 1,200 megawatts and remain at that approximate level -- unless reduced by FP&L, FPC, and JEA for the periods after 1999 -- until the expiration of the contracts in 2010.\nGULF STATES SETTLEMENT COMPLETED\nOn November 7, 1991, subsidiaries of The Southern Company entered into a settlement agreement with Gulf States that resolved litigation between the companies that had been pending since 1986 and arose out of a dispute over certain unit power and other long-term power sales contracts. In 1993, all remaining terms and obligations of the settlement agreement were satisfied.\nWith respect to the company's portion of proceeds received in 1991, see Note 3 concerning the regulatory treatment of amounts being refunded to retail customers over a three-year period.\nALABAMA MUNICIPAL ELECTRIC AUTHORITY (AMEA) CAPACITY CONTRACTS\nIn August 1986, the company entered into a firm power purchase contract with AMEA entitling AMEA to scheduled amounts of capacity (to a maximum 100 megawatts) for a period of 15 years commencing September 1, 1986 (1986 Contract). In October 1991, the company entered into a second firm power purchase contract with AMEA entitling AMEA to scheduled amounts of additional capacity (to a maximum 80 megawatts) for a period of 15 years commencing October 1, 1991 (1991 Contract). In both contracts the power will be sold to AMEA for its member municipalities that previously were served directly by the company as wholesale customers. Under the terms of the contracts, the company received payments from AMEA representing the net present value of the revenues associated with the respective capacity entitlements, discounted at effective annual rates of 9.96 percent and 11.19 percent for the 1986 and 1991 Contracts, respectively. These payments are being recognized as operating revenues and the discounts are being amortized to other interest expense as scheduled capacity is made available over the terms of the contracts.\nIn order to secure AMEA's advance payments and the company's performance obligation under the contracts, the company issued and delivered to an escrow agent first mortgage bonds representing the maximum amount of liquidated damages payable by the company in the event of a default under the contracts. No principal or interest is payable on such bonds unless and until a default by the company occurs. As the liquidated damages decline under the contracts, a portion of the bonds equal to the decreases are returned to the company. At December 31, 1993, $153 million of such bonds were held by the escrow agent under the contracts.\n8. INCOME TAXES\nEffective January 1, 1993, the company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no material effect on net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $469 million are revenues to be received from customers. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The related liabilities of $441 million are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nII-73 NOTES (continued) Alabama Power Company 1993 Annual Report\nDetails of the federal and state income tax provisions are as follows:\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities are as follows:\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Statements of Income. Credits amortized in this manner amounted to $13 million in 1993, $18 million in 1992, and $16 million in 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:\nThe Southern Company and its subsidiaries file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\nII-74 NOTES (continued) Alabama Power Company 1993 Annual Report\n9. OTHER LONG-TERM DEBT\nDetails of other long-term debt are as follows:\nPollution control obligations represent installment purchases of pollution control facilities financed by funds derived from sales by public authorities of revenue bonds. The company is required to make payments sufficient for the authorities to meet principal and interest requirements of such bonds. With respect to $154.5 million of such pollution control obligations, the company has authenticated and delivered to the trustees a like principal amount of first mortgage bonds as security for its obligations under the installment purchase agreements. No principal or interest on these first mortgage bonds is payable unless and until a default occurs on the installment purchase agreements.\nThe company has capitalized leased nuclear material and recorded the related lease obligations. The arrangement provides for the payment of interest at varying rates and times dependent on options selected by the company from types of loans available under the arrangement. At the end of 1993 the effective rate of this lease arrangement, including applicable fees, was 3.58 percent. Principal payments are required under the arrangement based on the cost of fuel burned.\nThe company has also capitalized certain office building leases and a street light lease. Monthly principal payments plus interest are required, and at December 31, 1993, the interest rate was 9.5 percent for office buildings and 13.0 percent for street lights.\nThe net book value of capitalized leases included in utility plant in service was $94.7 million and $103.0 million at December 31, 1993 and 1992, respectively. The estimated aggregate annual maturities of other long-term debt through 1998 are as follows: $38.9 million in 1994, $33.3 million in 1995, $18.7 million in 1996, $6.4 million in 1997 and $3.0 million in 1998.\n10. LONG-TERM DEBT DUE WITHIN ONE YEAR\nA summary of the improvement fund requirements and scheduled maturities and redemptions of long-term debt due within one year is as follows:\nThe annual first mortgage bond improvement fund requirement is one percent of the aggregate principal amount of bonds of each series authenticated, so long as a portion of that series is outstanding, and may be satisfied by the deposit of cash and\/or reacquired bonds, the certification of unfunded property additions or a combination thereof. The 1994 requirement of $20.1 million was satisfied by the deposit of cash in 1994, which was used for the partial redemption of various series of outstanding bonds. In addition, maturing in 1994 are other long-term debt of $38.9 million consisting primarily of capitalized nuclear fuel obligations.\nII-75 NOTES (continued) Alabama Power Company 1993 Annual Report\n11. NUCLEAR INSURANCE\nUnder the Price-Anderson Amendments Act of 1988 (Act), the company maintains agreements of indemnity with the NRC that, together with private insurance, cover third-party liability arising from any nuclear incident occurring at Plant Farley. The Act limits to $9.4 billion, public liability claims that could arise from a single nuclear incident. Plant Farley is insured against this liability to a maximum of $200 million by private insurance, with the remaining coverage provided by a mandatory program of deferred premiums which could be assessed, after a nuclear incident, against all owners of nuclear reactors. A company could be assessed up to $79 million per incident for each licensed reactor it operates but not more than an aggregate of $10 million per incident to be paid in a calendar year for each reactor. Such maximum assessment, excluding any applicable state premium taxes, for the company is $159 million per incident but not more than an aggregate of $20 million to be paid for each incident in any one year.\nThe company is a member of Nuclear Mutual Limited (NML), a mutual insurer established to provide property damage insurance in an amount up to $500 million for members' nuclear generating facilities. The members are subject to a retrospective premium adjustment in the event that losses exceed accumulated reserve funds. The company's maximum annual assessment per incident is limited to $14 million under the current policy.\nAdditionally, the company has policies that currently provide decontamination, excess property insurance, and premature decommissioning coverage up to $2.25 billion for losses in excess of the $500 million NML coverage. This excess insurance is provided by Nuclear Electric Insurance Limited (NEIL), a mutual insurance company, and American Nuclear Insurers\/Mutual Atomic Energy Liability Underwriters.\nNEIL also covers the additional cost that would be incurred in obtaining replacement power during a prolonged accidental outage at a member's nuclear plant. Members can be insured against increased cost of replacement power in an amount up to $3.5 million per week (starting 21 weeks after the outage) for one year and up to $2.3 million per week for the second and third years.\nUnder each of the NEIL policies, members are subject to assessments if losses each year exceed the accumulated funds available to the insurer under that policy. The maximum annual assessments per incident under current policies for the company would be $16 million for excess property damage and $9 million for replacement power.\nFor all on-site property damage insurance policies for commercial nuclear power plants, the NRC requires that the proceeds of such policies issued or renewed on or after April 2, 1991, shall be dedicated first for the sole purpose of placing the reactor in a safe and stable condition after an accident. Any remaining proceeds are to be applied next toward the costs of decontamination and debris removal operations ordered by the NRC, and then, any further remaining proceeds are to be paid either to the company or to its bond trustees as may be appropriate under applicable trust indentures.\nThe company participates in an insurance program for nuclear workers that provides coverage for worker tort claims filed for bodily injury caused at commercial nuclear power plants. In the event that claims for this insurance exceed the accumulated reserve funds, the company could be subject to a maximum total assessment of $6.4 million.\nII-76 NOTES (continued) Alabama Power Company 1993 Annual Report\n12. COMMON STOCK DIVIDEND RESTRICTIONS\nThe company's first mortgage bond indenture contains various common stock dividend restrictions that remain in effect as long as the bonds are outstanding. At December 31, 1993, $653 million of retained earnings was restricted against the payment of cash dividends on common stock under terms of the mortgage indenture. Supplemental indentures in connection with future first mortgage bond issues may contain more stringent common stock dividend restrictions than those currently in effect.\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly financial data for 1993 and 1992 are as follows:\nThe company's business is influenced by seasonal weather conditions and the timing of rate adjustments.\nII-77 SELECTED FINANCIAL AND OPERATING DATA Alabama Power Company\nII-78 SELECTED FINANCIAL AND OPERATING DATA Alabama Power Company\nII-79 SELECTED FINANCIAL AND OPERATING DATA (continued) Alabama Power Company\nNotes: (1) Generating capacity and fuel data includes Alabama Power Company's 50% portion of SEGCO. (2) Includes Southeastern Power Administration allotment. * Less than one-tenth of one percent.\nII-80 SELECTED FINANCIAL AND OPERATING DATA (continued) Alabama Power Company\nII-81\nSTATEMENTS OF INCOME Alabama Power Company\n* Includes the effect of recognizing, beginning in 1987, retail service rendered but not yet billed to customers.\nII-82\nSTATEMENTS OF INCOME Alabama Power Company\nII-83 STATEMENTS OF CASH FLOWS Alabama Power Company\n( ) Denotes use of cash.\nII-84\nSTATEMENTS OF CASH FLOWS Alabama Power Company\nII-85\nBALANCE SHEETS Alabama Power Company\n*Includes the effect of recognizing, beginning in 1987, retail service rendered but not yet billed to customers.\nII-86\nBALANCE SHEETS Alabama Power Company\nII-87\nBALANCE SHEETS Alabama Power Company\n*Includes the effect of recognizing, beginning in 1987, retail service rendered but not yet billed to customers.\nII-88\nBALANCE SHEETS Alabama Power Company\nII-89\nALABAMA POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1993 FIRST MORTGAGE BONDS\nII-90\nALABAMA POWER COMPANY\nSECURITIES RETIRED DURING 1993\nFIRST MORTGAGE BONDS\nII-91 GEORGIA POWER COMPANY\nFINANCIAL SECTION\nII-92\nMANAGEMENT'S REPORT Georgia Power Company 1993 Annual Report\nThe management of Georgia Power Company has prepared this annual report and is responsible for the financial statements and related information. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances, and necessarily include amounts that are based on the best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that the books and records reflect only authorized transactions of the Company. Limitations exist in any system of internal controls based upon the recognition that the cost of the system should not exceed its benefits. The Company believes that its system of internal accounting controls maintains an appropriate cost\/benefit relationship.\nThe Company's system of internal accounting controls is evaluated on an ongoing basis by the Company's internal audit staff. The Company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, which is composed of five directors who are not employees, provides a broad overview of management's financial reporting and control functions. At least three times a year this committee meets with management, the internal auditors, and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal control and financial reporting matters. The internal auditors and the independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the Company's operations are conducted with a high standard of business ethics.\nIn management's opinion, the financial statements present fairly the financial position, results of operations and cash flows of Georgia Power Company in conformity with generally accepted accounting principles. As discussed in Note 4 to the financial statements, an uncertainty exists with respect to the actions of regulators regarding recoverability of the Company's investment in the Rocky Mountain pumped storage hydroelectric project. The outcome of this uncertainty cannot be determined until regulatory proceedings are concluded. Accordingly, no provision for any write-down of the costs associated with the Rocky Mountain project resulting from the potential actions of the Georgia Public Service Commission has been made in the accompanying financial statements.\n\/s\/ H. Allen Franklin \/s\/ Warren Y. Jobe - --------------------- -------------------------- H. Allen Franklin Warren Y. Jobe President and Chief Executive Vice President, Executive Officer Treasurer and Chief Financial Officer\nII-93 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF GEORGIA POWER COMPANY:\nWe have audited the accompanying balance sheets and statements of capitalization of Georgia Power Company (a Georgia corporation) as of December 31, 1993 and 1992, and the related statements of income, retained earnings, paid-in capital, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-102 through II-122) referred to above present fairly, in all material respects, the financial position of Georgia Power Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 7 to the financial statements, effective January 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\nAs more fully discussed in Note 4 to the financial statements, an uncertainty exists with respect to the actions of the regulators regarding the recoverability of the Company's investment in the Rocky Mountain pumped storage hydroelectric project. The outcome of this uncertainty cannot be determined until regulatory proceedings are concluded. Accordingly, no provision for any write-down of the costs associated with the Rocky Mountain project resulting from the potential actions of the Georgia Public Service Commission has been made in the accompanying financial statements.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nII-94 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Georgia Power Company 1993 Annual Report\nRESULTS OF OPERATIONS\nEARNINGS\nGeorgia Power Company's 1993 earnings totaled $570 million, representing a $49 million (9.5 percent) increase over the prior year. This improvement is primarily a result of higher retail revenues and lower financing costs. Also, during the period, the Company had an $18 million after-tax gain on the sale of a portion of Plant Scherer Unit 4. Higher retail revenues reflect growth in energy sales of 6.1 percent from 1992 levels primarily due to exceptionally hot summer weather during 1993. Interest expense and preferred stock dividends decreased in 1993 due to the redemption and refinancing of higher-cost debt and preferred stock. These positive events were partially offset by higher operating expenses.\nIn comparing 1992 earnings to the prior year, it should be noted that 1991 earnings included two unusual items that significantly affect this comparison. Earnings in 1991 were $89 million higher due to the completion of a settlement agreement with Gulf States Utilities Company (Gulf States) related to power sales contracts. This increase was partially offset by an after-tax charge of $33 million in 1991 for a work force reduction program. A comparison of 1992 to 1991 -- excluding these unusual items -- would reflect a 1992 increase in earnings of $102 million.\nREVENUES\nThe following table summarizes the factors impacting operating revenues for the 1991-1993 period:\nRetail revenues of $3.8 billion in 1993 increased $262 million (7.4 percent) over the prior year, compared with an increase of $87 million (2.5 percent) in 1992. The exceptionally hot weather during the summer of 1993 was the primary factor affecting the increase in retail revenues over 1992. The increase in retail revenues for 1992 was a result of higher retail rates and sales growth, partially offset by mild weather and lower fuel revenues. Fuel revenues generally represent the direct recovery of fuel expense, including the fuel component of purchased energy, and do not affect net income. Revenues from demand-side options programs generally represent the direct recovery of program costs. See Note 3 to the financial statements for further information on these programs.\nRevenues from sales to non-affiliated utilities decreased in both 1993 and 1992. Contractual unit power sales to Florida utilities for 1993 and 1992 are down compared with prior years, primarily due to scheduled reductions that corresponded with the sales to these utilities of portions of Plant Scherer Unit 4 in July 1991 and June\nII-95 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\n1993. Sales to municipalities and cooperatives increased slightly in 1993 due to the hot summer weather. Generally, these sales have been decreasing as these customers retain more of their own generation at facilities jointly owned with the Company.\nRevenues from sales to non-affiliated utilities outside the service area under long-term contracts consist of capacity and energy components. Capacity revenues reflect the recovery of fixed costs and a return on investment under the contracts. Energy is generally sold at variable cost. The capacity and energy components were as follows:\nRevenues from sales to affiliated companies within the Southern electric system will vary from year to year depending on demand and the availability and cost of generating resources at each company. Sales to affiliated companies do not have a significant impact on earnings.\nChanges in revenues are a function of the amount of energy sold each year. Kilowatt-hour (KWH) sales for 1993 and the percent change by year were as follows:\nThe hot summer weather during 1993 contributed primarily to the sales growth in the residential and commercial classes. Continued improvement in economic conditions positively impacted sales growth in the commercial and industrial classes. Residential energy sales growth in 1992 reflected mild weather. Commercial and industrial sales growth in 1992 is attributable to improved economic conditions.\nThe decrease in energy sales to non-affiliated utilities reflects scheduled reductions in contractual power sales.\nEXPENSES\nFuel expense increased 2.3 percent in 1993 due to higher generation, which was partially offset by lower nuclear fuel costs. In 1992, fuel expense decreased 6.9 percent due to lower generation and lower fuel costs. Purchased power expense has decreased significantly since 1991, reflecting declining contractual capacity purchases from the co-owners of plants Vogtle and Scherer. Purchased power expense decreased $88 million in 1993 and $43 million in 1992. The declines in Plant Vogtle contractual capacity purchases did not have a significant impact on earnings in 1993 or 1992 as these costs are being levelized over six years under the terms of the 1991 Georgia Public Service Commission (GPSC) retail rate order. The levelization is reflected in the amortization of deferred Plant Vogtle expenses in the income statements. See Note 3 to the financial statements for additional information.\nOther Operation and Maintenance (O & M) expenses increased 9.0 percent in 1993 after remaining relatively flat in 1992. The increase in 1993 is primarily the result of environmental remediation costs at various current and former operating sites, the one- time costs of an automotive fleet reduction program and the recognition of higher employee benefit costs under new accounting rules adopted in 1993. See Note 2 to the financial statements for additional information concerning these new rules. Also, during 1993, O & M expenses reflect costs associated with new demand-side option programs. These costs were offset by increases in retail revenues. See Note 3 to the financial statements for additional information on the recovery of demand-side option program costs.\nDepreciation and amortization expense increased slightly due to additional plant investment. The 1992 decrease is due to the effects of lower depreciation rates effective in October 1991. Taxes other than income taxes increased 7.4 percent in 1993 and 3.8 percent in 1992.\nII-96\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\nThese increases reflect higher ad valorem taxes. The 1993 increase also includes higher taxes paid to municipalities as a result of increased sales.\nIncome tax expense increased $62 million in 1993 due primarily to higher earnings and the effect of a one percent increase in the federal tax rate effective January, 1993. Also, the Company incurred $27 million of tax expense in connection with the second in a series of four separate transactions to sell Plant Scherer Unit 4. The sale resulted in an after-tax gain of $18 million.\nInterest expense and dividends on preferred stock decreased $19 million (4.0 percent) and $49 million (9.3 percent) in 1993 and 1992, respectively. These reductions are due to significant refinancing of long-term debt and preferred stock. The Company refinanced $1.7 billion of securities in both 1993 and 1992. In addition, the Company has retired $544 million of long-term debt with the proceeds from the 1991 and 1993 Plant Scherer Unit 4 sales. Other interest charges in 1993 include interest related to the settlement of an Internal Revenue Service audit. The settlement, in total, did not have an effect on 1993 net income.\nThe Company has deferred certain expenses and recorded a deferred return related to Plant Vogtle under phase-in plans. See Note 3 to the financial statements under \"Plant Vogtle Phase-In-Plans\" for information regarding the deferral and subsequent amortization of costs related to Plant Vogtle.\nEFFECTS OF INFLATION\nThe Company is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its costs of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize either this economic loss or the partially offsetting gain that arises through financing facilities with fixed-money obligations such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings. The level of future earnings depends on numerous factors ranging from growth in energy sales to regulatory matters.\nGrowth in energy sales is subject to a number of factors which traditionally have included changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, weather, competition, and the rate of economic growth in the Company's service area. Assuming normal weather, retail sales growth is projected to be approximately 2 percent annually on average during 1994 through 1996.\nThe scheduled addition of four combustion turbine generating units in 1994, four units in 1995 and one unit in 1996, as well as the Rocky Mountain pumped storage hydroelectric project in 1995, will increase related O & M and depreciation expenses. See Note 4 to the financial statements for information on regulatory uncertainties related to the Rocky Mountain project. The GPSC has certified the construction of the 1994 and 1995 combustion turbine generating units for meeting peak generating needs. In addition, the Company has completed a demonstration competitive bidding process for its supply-side requirements expected for 1996. The Company has filed with the GPSC for certification of a four-year purchase power agreement beginning in 1996, and for construction of a jointly owned combustion turbine to be completed in 1996 to meet these needs.\nAs part of efforts to curtail growth in operating expenses, the Company is reducing its work force through an early-retirement program announced in January 1994. The program resulted in a first quarter 1994 after-tax charge to earnings of $39 million. The program has an expected payback period of approximately two years.\nPursuant to an Integrated Resource Plan approved by the GPSC in 1992, the Company has implemented various demand-side option programs and has been authorized by the GPSC to recover associated program costs through rate riders. On October 15, 1993, a superior court judge ruled that recovery of these costs through rate riders is unlawful. The Company has ceased collection of the rate riders and is deferring program costs as ordered by the\nII-97 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\nGPSC pending the final outcome of this matter. See Note 3 to the financial statements for additional information.\nThe Company has completed two in a series of four separate transactions to sell Unit 4 of Plant Scherer to two Florida utilities. The remaining transactions are scheduled to take place in 1994 and 1995. If the sales take place as planned, the Company would realize an additional after-tax gain estimated to total approximately $20 million. See Note 5 to the financial statements for additional information.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could reduce earnings if such costs cannot be billed to customers. The Clean Air Act is discussed later under \"Environmental Issues.\"\nThe Energy Policy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition among electric utilities. The law also includes provisions to streamline the licensing process for new nuclear generating plants. The Energy Act marks the beginning of a major change in the traditional business practices of selling electricity. The Energy Act allows Independent Power Producers (IPPs) and other electric suppliers access to a utility's transmission lines to sell their electricity to other utilities. This may enhance the incentives for IPPs to build cogeneration plants for the Company's large industrial and commercial customers. If the Company does not remain a low cost producer and provide quality service, the Company's sales growth could be limited and this could significantly erode earnings.\nThe Company continues to compete with other electric suppliers within the state. In Georgia, most new retail customers with more than 900 kilowatts of connected load may choose their electricity supplier. In addition, the bulk power market has become very competitive as utilities, IPPs and cogenerators seek to supply future capacity needs. Competition can create new business opportunities, but it increases risk and has the potential to adversely affect earnings.\nThe Federal Energy Regulatory Commission (FERC) regulates wholesale rate schedules and power sales contracts that the Company has with its sales for resale customers. The FERC currently is reviewing the rate of return on common equity included in these schedules and contracts and may require such returns to be lowered, possibly retroactively. See Note 3 to the financial statements under \"FERC Review of Equity Returns\" for additional information.\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be adopted by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental unemployment benefits, disability-related benefits, job training, and health and life insurance coverage. In 1993, the Company adopted Statement No. 112, with no material effect on the financial statements.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which will be effective in 1994. Statement No. 115 supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. The Company adopted the new rules in January, 1994, with no material effect on the financial statements.\nFINANCIAL CONDITION\nOVERVIEW\nThe principal changes in the Company's financial condition in 1993 were gross utility plant additions of $674 million and the lowering of the cost of capital achieved through the refinancing or retirement of $1.7 billion of long-term debt and preferred stock.\nOn January 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes. See Notes 2 and 7 to the financial statements regarding the impact of these changes.\nThe funds needed for gross property additions are currently provided from operations. The Statements of Cash Flows provide additional details.\nII-98 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\nFINANCING ACTIVITIES\nIn 1993, the Company continued to lower its financing costs by issuing new securities and other debt, and retiring or repaying high-cost issues. New issues during 1991 through 1993 totaled $3.0 billion and retirement or repayment of securities totaled $4.2 billion. The retirements included the redemption of $253 million and $291 million in 1993 and 1991, respectively, of first mortgage bonds with the proceeds from the Plant Scherer Unit 4 sales. Composite financing rates for the years 1991 through 1993, as of year-end, were as follows:\nThe Company's current securities ratings are as follows:\n* Not rated by Duff & Phelps\nLIQUIDITY AND CAPITAL REQUIREMENTS\nCash provided from operations increased by $236 million in 1993, primarily due to higher retail sales, lower interest costs, decreasing capacity purchases from the co-owners of plants Vogtle and Scherer and the receipt of cash payments from Gulf States that completed the settlement of litigation.\nThe Company estimates that construction expenditures for the years 1994 through 1996 will total $688 million, $555 million and $629 million, respectively. The Company will continue to invest in transmission and distribution facilities and enhance existing generating plants. These expenditures also include amounts for nine combustion turbine generating units and equipment that will be required to comply with the provisions of the Clean Air Act. The Company's contractual capacity purchases will decline by $113 million over the next three years. Cash requirements for sinking fund requirements, redemptions announced, and maturities of long-term debt are expected to total $377 million during 1994 through 1996.\nAs a result of requirements by the Nuclear Regulatory Commission, the Company has established external sinking funds for the purpose of funding nuclear decommissioning costs. For 1994 through 1996, the amount to be funded for the Company totals $16 million annually. For additional information concerning nuclear decommissioning costs, see Note 1 to the financial statements under \"Nuclear Decommissioning.\"\nSOURCES OF CAPITAL\nThe Company expects to meet future capital requirements primarily using funds generated from operations and, if needed, by the issuance of new debt and equity securities, term loans, and short-term borrowings. To meet short-term cash needs and contingencies, the Company had approximately $540 million of unused credit arrangements with banks at the beginning of 1994. See Note 8 to the financial statements for additional information.\nCompleting the remaining two transactions for the sale of Plant Scherer Unit 4 will generate approximately $130 million in both 1994 and in 1995.\nThe Company is required to meet certain coverage requirements specified in its mortgage indenture and corporate charter to issue new first mortgage bonds and preferred stock. The Company's ability to satisfy all coverage requirements is such that it could issue new first mortgage bonds and preferred stock to provide sufficient funds for all anticipated requirements.\nENVIRONMENTAL ISSUES\nIn November 1990, the Clean Air Act was signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- will have a significant impact on The Southern Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995 and affects eight generating plants -- some 10,000 megawatts\nII-99 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\nof capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing slower than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, Georgia Power's construction expenditures are estimated to total approximately $150 million through 1995.\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I, increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 to 2000, compliance could require total Georgia Power construction expenditures ranging from approximately $150 million to $325 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nAn increase of up to 2 percent in Georgia Power's annual revenue requirements from customers could be necessary to fully recover the cost of compliance for both Phase I and Phase II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances. There can be no assurance that all Clean Air Act costs will be recovered.\nMetropolitan Atlanta is classified as a non-attainment area with regard to the ozone ambient air quality standards. Title I of the Clean Air Act requires the state of Georgia to conduct specific studies and establish new control rules by November 1994 -- affecting sources of nitrogen oxides and volatile organic compounds -- to achieve attainment by 1999. As the required first step, the state has issued rules for the application of reasonably available control technology to reduce nitrogen oxide emissions by May 31, 1995. The results of these new rules require nitrogen oxide controls, above Title IV requirements, on some Company plants. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions as early as 1997. Compliance with any new rules could result in significant additional costs. The impact of new rules will depend on the development and implementation of such rules.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standards could result in significant additional costs. The impact of new standards -- if any -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a\nII-100 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1993 Annual Report\nnew standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provision of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. In addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matter, nitrogen oxides, and ozone. The impact of any new standards will depend on the level chosen for the standards and cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the nonhazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes -- coal ash and other utility wastes -- as either nonhazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nThe Company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. These laws include the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA or Superfund). Under these various laws and regulations, the Company could incur costs to clean up properties currently or previously owned. The Company conducts studies to determine the extent of any required clean-up costs and has recognized costs to clean-up known sites in the financial statements.\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; and the Resource Conservation and Recovery Act. Changes to these laws could affect many areas of the Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields and other environmental and health concerns could significantly affect the Company. The impact of new legislation -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the potential for lawsuits alleging damages caused by electromagnetic fields exists.\nII-101\nSTATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-102\nBALANCE SHEETS At December 31, 1993 and 1992 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-103\nBALANCE SHEETS At December 31, 1993 and 1992 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-104\nSTATEMENTS OF CAPITALIZATION AT December 31, 1993 and 1992 Georgia Power Company 1993 Annual Report\nII-105\nSTATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-106\nSTATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-107\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1993, 1992, and 1991 Georgia Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-108\nNOTES TO FINANCIAL STATEMENTS Georgia Power Company 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nThe Company is a wholly owned subsidiary of The Southern Company, which is the parent company of five operating companies, Southern Company Services (SCS), Southern Electric International (Southern Electric), and Southern Nuclear Operating Company (Southern Nuclear), and various other subsidiaries related to foreign utility operations and domestic non-utility operations. The operating companies (Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, and Savannah Electric and Power Company) provide electric service in four southeastern states. Intracompany contracts dealing with jointly owned generating facilities, transmission lines and exchange of electric power are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission. SCS provides, at cost, specialized services to The Southern Company and each of the subsidiary companies. Southern Electric designs, builds, owns, and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides support services for nuclear power plants in the Southern electric system.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935. Both The Southern Company and its subsidiaries are subject to the regulatory provisions of this act. The Company is also subject to regulation by the FERC and the Georgia Public Service Commission (GPSC). The Company follows generally accepted accounting principles and complies with the accounting policies and practices prescribed by the respective regulatory commissions.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nREVENUES AND FUEL COSTS\nThe Company accrues revenues for services rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as fuel is used. The Company is authorized by state law and FERC regulations to recover fuel costs and the fuel component of purchased energy costs through fuel cost recovery provisions, which are periodically adjusted to reflect increases or decreases in such costs. Revenues are adjusted for differences between recoverable fuel costs and amounts actually recovered in current rates. Fuel costs were under recovered by $79 million and $4 million at December 31, 1993, and 1992, respectively. These amounts are included in customer accounts receivable on the balance sheets. The fuel cost recovery rate was increased effective December 6, 1993.\nThe cost of nuclear fuel is amortized to fuel expense based on estimated thermal units used to generate electric energy and includes a provision for the disposal of spent fuel. Total charges for nuclear fuel amortized to expense were $75 million in 1993, $84 million in 1992, and $93 million in 1991. The Company has contracted with the U.S. Department of Energy (DOE) for permanent disposal of spent fuel beginning in 1998; however, the actual year this service will begin is uncertain. Pending permanent disposition of the spent fuel, sufficient storage capacity is available at Plant Hatch into 2003 and at Plant Vogtle into 2009. Also, the Energy Policy Act of 1992 required the establishment in 1993 of a Uranium Enrichment Decontamination and Decommissioning Fund which is to be funded, in part, by a special assessment on utilities with nuclear plants. This fund will be used by the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The law provides that utilities will recover these payments in the same manner as any other fuel expense. The Company -- based on its ownership interest -- estimates its total assessment under this law to be approximately $42 million to be paid over a 15-year period beginning in 1993. This obligation is recognized in the accompanying Balance Sheets and is being recovered through the fuel cost recovery provisions. The remaining liability at December 31, 1993, is $39 million.\nII-109 NOTES (continued) Georgia Power Company 1993 Annual Report\nNUCLEAR REFUELING OUTAGE COSTS\nPrior to 1992, the Company expensed nuclear refueling outage costs as incurred during the outage period. Pursuant to the 1991 GPSC retail rate order, the Company began accounting for these costs on a normalized basis in 1992. Under this method of accounting, refueling outage costs are deferred and subsequently amortized to expense over the operating cycle of each unit, which is normally 18 months. Deferred nuclear outage costs were $17 million and $6 million at December 31, 1993 and 1992, respectively.\nDEPRECIATION\nDepreciation is provided on the cost of depreciable utility plant in service and is calculated primarily on the straight-line basis over the estimated composite service life of the property. The composite rate of depreciation was 3.1 percent in 1993 and 1992, and 3.2 percent in 1991. Effective October 1991, the Company adopted lower depreciation rates consistent with the 1991 GPSC retail rate order. When a property unit is retired or otherwise disposed of in the normal course of business, its costs and the costs of removal, less salvage, are charged to the accumulated provision for depreciation. Minor items of property included in the cost of the plant are retired when the related property unit is retired.\nNUCLEAR DECOMMISSIONING\nIn 1988, the Nuclear Regulatory Commission (NRC) adopted regulations requiring all licensees operating commercial nuclear power reactors to establish a plan for providing, with reasonable assurance, funds for decommissioning. Reasonable assurance may be in the form of an external sinking fund, a surety method, or prepayment. The Company has established external trust funds to comply with the NRC's regulations. Prior to the enactment of these regulations, the Company had internally reserved nuclear decommissioning costs. The NRC's minimum external funding requirements are based on a generic estimate of the cost to decommission the radioactive portions of a nuclear unit based on the size and type of reactor.\nThe estimated cost of decommissioning and the amounts being recovered through rates at December 31, 1993, for the Company's ownership interest in plants\nHatch and Vogtle were as follows:\nThe amounts in the internal reserve are being transferred into the external trust fund over a period of approximately nine years as approved by the GPSC in its 1991 retail rate order.\nThe estimates approved by the GPSC for ratemaking exclude costs of non-radiated structures and site contingency costs. The actual decommissioning cost may vary from the above estimates because of regulatory requirements, changes in technology, and increased costs of labor, materials, and equipment. The decommissioning cost estimates are based on prompt dismantlement and removal of the plant from service. The Company expects the GPSC to periodically review and adjust, if necessary, the amounts collected in rates for the anticipated cost of decommissioning.\nPLANT VOGTLE PHASE-IN PLANS\nIn 1987 and 1989, the GPSC ordered that the costs of Plant Vogtle Units 1 and 2 be phased into rates under plans that meet the requirements of Financial Accounting Standards Board (FASB) Statement No. 92, Accounting for Phase-In Plans. In 1991, the GPSC modified the phase-in plans. In addition, the Company deferred certain Plant Vogtle operating expenses and financing costs under accounting orders issued by the GPSC. See Note 3 for further information. II-110 NOTES (continued) Georgia Power Company 1993 Annual Report\nINCOME TAXES\nThe Company provides deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. See Note 7 to the financial statements for further information.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC) AND DEFERRED RETURN\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. For the years 1993, 1992 and 1991, the average AFUDC rates were 4.87 percent, 7.16 percent and 9.90 percent, respectively. The reduction in the average AFUDC rate since 1991 reflects the Company's greater use of lower cost short-term debt.\nThe Company also imputed a return on its investment in Plant Vogtle Units 1 and 2 after they began commercial operation, under short-term cost deferrals and phase-in plans as described in Note 3. AFUDC and the Vogtle deferred returns, net of taxes, as a percentage of net income after dividends on preferred stock, amounted to 1.4 percent, 2.1 percent and 9.2 percent for 1993, 1992 and 1991, respectively.\nUTILITY PLANT\nUtility plant is stated at original cost with the exception of Plant Vogtle, which is stated at cost less regulatory disallowances. Original cost includes materials; labor; appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; and the estimated cost of funds used during construction.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Statements of Cash Flows, temporary cash investments are considered cash equivalents. Temporary cash investments are securities with original maturities of 90 days or less.\nFINANCIAL INSTRUMENTS\nAll financial instruments of the Company -- for which the carrying amount does not approximate fair value -- are shown in the table below at December 31:\nThe fair values of nuclear decommissioning trusts and investment securities were based on listed closing market prices. The fair values for long-term debt and preferred stock subject to mandatory redemption were based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed. In December 1992, the Company converted to the inventory method of accounting for certain emergency spare parts. This conversion resulted in a regulatory liability that is being amortized as credits to income over\nII-111 NOTES (continued) Georgia Power Company 1993 Annual Report\napproximately four years. This conversion will not have a material effect on income in any year.\nVACATION PAY\nCompany employees earn vacation in one year and take it in the subsequent year. However, for ratemaking purposes, vacation pay is recognized as an allowable expense only when paid. Consistent with this ratemaking treatment, the Company accrues a current liability for earned vacation pay and records a current asset representing the future recoverability of this cost. This amount was $42 million at December 31, 1993, and $40 million at December 31, 1992. In 1994, approximately 72 percent of the 1993 deferred vacation costs will be expensed, and the balance will be charged to construction and other accounts.\n2. RETIREMENT BENEFITS\nPENSION PLAN\nThe Company has a defined benefit, trusteed, non-contributory pension plan covering substantially all regular employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and final average pay or years of service and a flat dollar benefit. The Company uses the \"entry age normal method with a frozen initial liability\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension fund are primarily invested in equity and fixed-income securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the projected unit credit actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nThe Company also provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. For medical care benefits, a qualified trust has been established for funding amounts to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded.\nEffective January 1, 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\"\nIn October 1993, the GPSC ordered the Company to phase in the adoption of Statement No. 106 to cost of service over a five-year period, whereby one-fifth of the additional expense was recognized -- approximately $6 million -- in 1993 and the remaining additional expense was deferred. An additional one-fifth of the costs will be expensed each succeeding year until the costs are fully reflected in cost of service in 1997. The cost deferred during the five-year period will be amortized to expense over a 15-year period beginning in 1998. As a result of the regulatory treatment allowed by the GPSC, the adoption of Statement No. 106 did not have a material impact on net income.\nPrior to 1993, the Company recognized these cost on a cash basis as payments were made. The total costs of such benefits recognized by the Company in 1993, 1992, and 1991 were $56 million, $13 million, and $9 million, respectively.\nSTATUS AND COST OF BENEFITS\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of Statement Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown only for 1993 because Statement No. 106 was adopted as\nII-112\nNOTES (continued) Georgia Power Company 1993 Annual Report\nof January 1, 1993, on a prospective basis. The funded status of the plans at December 31 was as follows:\nWeighted average rates used in actuarial calculations:\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1993, by $68 million and the aggregate of the service and interest cost components of the net retiree medical cost by $7 million.\nThe components of the plans' net costs are shown below:\nOf net pension costs (income) recorded, $(6) million in 1993 and $5 million in 1991, were recorded to operating expense, with the balance being recorded to construction and other accounts.\nII-113 NOTES (continued) Georgia Power Company 1993 Annual Report\nOf the above net postretirement medical and life insurance costs recorded in 1993, $21 million was charged to operating expenses, $21 million was deferred, and the remainder was charged to construction and other accounts.\n3. LITIGATION AND REGULATORY MATTERS\nDEMAND-SIDE CONSERVATION PROGRAMS\nIn October 1993, a Superior Court of Fulton County, Georgia, judge ruled that rate riders previously approved by the GPSC for recovery of the Company's costs incurred in connection with demand-side conservation programs were unlawful. The judge held that the GPSC lacked statutory authority to approve such rate riders except through general rate case proceedings and that those procedures had not been followed. The Company has suspended collection of the demand-side conservation costs and appealed the court's decision to the Georgia Court of Appeals. In December 1993, the GPSC approved the Company's request for an accounting order allowing the Company to defer all current unrecovered and future costs related to these programs until the court's decision is reversed or until the next general rate case proceeding. An association of industrial customers has filed a petition for review of such accounting order in the Superior Court of Fulton County, Georgia. The Company's costs related to these conservation programs through 1993 were $60 million of which $15 million has been collected and the remainder deferred. The estimated costs, assuming no change in the programs certified by the GPSC, are $38 million in 1994 and $40 million in 1995.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on these financial statements.\nRETAIL RATEPAYERS' SUIT CONCLUDED\nIn March 1993, several retail ratepayers of Georgia Power filed a civil complaint in the Superior Court of Fulton County, Georgia, against Georgia Power, The Southern Company, the system service company, and Arthur Andersen & Co. The complaint alleged that Georgia Power obtained excessive rate increases by improper accounting for spare parts and sought actual damages estimated by the plaintiffs to be in excess of $60 million -- plus treble and punitive damages -- for alleged violations of the Georgia Racketeer Influenced and Corrupt Organizations Act and other state statutes, statutory and common law fraud, and negligence. These state law allegations were substantially the same as those included in a 1989 suit brought in federal district court in Georgia. That suit and similar ones filed in Alabama, Florida, and Mississippi federal courts were subsequently dismissed.\nThe defendants' motions to dismiss the current complaint were granted by the Superior Court of Fulton County, Georgia, in July 1993. In January 1994, the plaintiffs' appeal of the dismissal to the Supreme Court of Georgia was rejected. This matter is now concluded.\nGULF STATES SETTLEMENT\nOn November 7, 1991, subsidiaries of The Southern Company entered into a settlement agreement with Gulf States that resolved litigation between the companies that had been pending since 1986 and arose out of a dispute over certain unit power and long-term power sales contracts. In 1993, all remaining terms and obligations of the settlement agreement were satisfied.\nBased on the value of the settlement proceeds received, the Company recorded increases of $3 million in 1992 and $89 million in 1991 net income.\nFERC REVIEW OF EQUITY RETURNS\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the Southern electric system's wholesale rate schedules and contracts that have a return on common equity of 13.75 percent or greater. The contracts that could be affected by the hearings include substantially all of the transmission, unit power, long-term power, and other similar contracts. Any changes in the rate of return on common equity that may occur as a result of this proceeding would be effective 60 days after a proper notice of the proceeding is published. A notice was published on May 10, 1991.\nIn August 1992, a FERC administrative law judge issued an opinion that changes in rate schedules and contracts were not necessary and that the FERC staff failed to show how any changes were in the public interest. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\nII-114\nNOTES (continued) Georgia Power Company 1993 Annual Report\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the Company's financial statements.\nPLANT VOGTLE PHASE-IN PLANS\nPursuant to orders from the GPSC, the Company recorded a deferred return under phase-in plans for Plant Vogtle Units 1 and 2 until October 1991 when the allowed investment was fully reflected in rates. In addition, the GPSC issued two separate accounting orders that required the Company to defer substantially all operating and financing costs related to both units until rate orders addressed these costs. These GPSC orders provide for the recovery of deferred costs within 10 years. The GPSC modified the phase-in plans in 1991 to accelerate the recognition of costs previously deferred under the Plant Vogtle Unit 2 phase-in plan and to levelize the remaining Plant Vogtle declining capacity buyback expenses.\nUnder these orders, the Company has deferred and begun amortizing these costs (as recovered through rates) as follows:\nNUCLEAR PERFORMANCE STANDARDS\nIn October 1989, the GPSC adopted a nuclear performance standard for the Company's nuclear generating units under which the performance of plants Hatch and Vogtle will be evaluated every three years. The performance standard is based on each unit's capacity factor as compared to the average of all U.S. nuclear units operating at a capacity factor of 50% or higher during the three-year period of evaluation. Depending on the performance of the units, the Company could receive a monetary reward or penalty under the performance standards criteria. The first evaluation was conducted in 1993 for performance during the 1990-92 period. During this three-year period, the Company's units performed at an average capacity factor of 81 percent compared to an industry average of approximately 73 percent. Based on these results, the GPSC approved a performance reward of approximately $8.5 million for the Company. This reward is being collected through the retail fuel cost recovery provision and recognized in income over a 36- month period beginning November, 1993.\n4. COMMITMENTS AND CONTINGENCIES\nCONSTRUCTION PROGRAM\nThe Company is engaged in a continuous construction program and currently estimates property additions to be approximately $688 million in 1994, $555 million in 1995 and $629 million in 1996. These estimated additions include AFUDC of $19 million in 1994, $27 million in 1995, and $18 million in 1996. The estimates for property additions for the three-year period include $88 million committed to meeting the requirements of the Clean Air Act.\nWhile the Company has no new baseload generating plants under construction, the construction of nine combustion turbine peaking units is planned to be completed by 1996. In addition, significant construction of transmission and distribution facilities, and upgrading and extending the useful life of generating plants will continue. The construction program is subject to periodic review and revision, and actual construction costs may vary from estimates because of numerous factors, including, but not limited to, changes in business conditions, load growth estimates, environmental regulations, and regulatory requirements.\nII-115 NOTES (continued) Georgia Power Company 1993 Annual Report\nFUEL COMMITMENTS\nTo supply a portion of the fuel requirements of its generating plants, the Company has entered into various long-term commitments for the procurement of fossil and nuclear fuel. In most cases, these contracts contain provisions for price escalations, minimum purchase levels and other financial commitments. Total estimated long-term obligations were approximately $4.8 billion at December 31, 1993. Additional commitments for coal and for nuclear fuel will be required in the future to supply the Company's fuel needs.\nOPERATING LEASES\nThe Company has entered into coal rail car rental agreements with various terms and expiration dates. Rental expense totaled $8 million, $7 million, and $5 million for 1993, 1992, and 1991, respectively. Minimum annual rental commitments for noncancellable rail car leases are $9 million annually for years 1994 through 1998, and total approximately $191 million thereafter.\nROCKY MOUNTAIN PROJECT STATUS\nIn its 1985 financing order, the GPSC concluded that completion of the Rocky Mountain pumped storage hydroelectric project in 1991 as then planned was not economically justifiable and reasonable and withheld authorization for the Company to spend funds from approved securities issuances on that project. In 1988, the Company and Oglethorpe Power Corporation (OPC) entered into a joint ownership agreement for OPC to assume responsibility for the construction and operation of the project, as discussed in Note 5. The joint ownership agreement significantly reduces the risk of the project being canceled. However, full recovery of the Company's costs depends on the GPSC's treatment of the project's cost and disposition of the project's capacity output. In the event the Company cannot demonstrate to the GPSC the project's economic viability based on current ownership, construction schedule, and costs, then part or all of such costs may have to be written off in accordance with FASB Statement No. 90, Accounting for Abandonments and Disallowed Plant Costs. At December 31, 1993, the Company's investment in the project amounted to approximately $197 million. AFUDC accrued on the Rocky Mountain project has not been credited to income or included in the project cost since December 1985. If accrual of AFUDC is not resumed, the Company's portion of the estimated total plant additions at completion would be approximately $199 million. The plant is currently scheduled to begin commercial operation in 1995.\nThe Company has held preliminary discussions with other parties regarding the potential disposition of its remaining interest in the project.\nThe ultimate outcome of this matter cannot now be determined.\nNUCLEAR INSURANCE\nUnder the Price-Anderson Amendments Act of 1988, the Company maintains agreements of indemnity with the NRC that, together with private insurance, cover third-party liability arising from any nuclear incident occurring at the Company's nuclear power plants. The act limits to $9.4 billion public liability claims that could arise from a single nuclear incident. Each nuclear plant is insured against this liability to a maximum of $200 million by private insurance, with the remaining coverage provided by a mandatory program of deferred premiums that could be assessed, after a nuclear incident, against all owners of nuclear reactors. A company could be assessed up to $79 million per incident for each licensed reactor it operates but not more than an aggregate of $10 million per incident to be paid in a calendar year for each reactor. Such maximum assessment for the Company -- based on its ownership and buyback interests -- is $171 million per incident but not more than an aggregate of $22 million to be paid for each incident in any one year.\nThe Company is a member of Nuclear Mutual Limited (NML), a mutual insurer established to provide property damage insurance in an amount up to $500 million for members' nuclear generating facilities. The members are subject to a retrospective premium adjustment in the event that losses exceed accumulated reserve funds. The Company's maximum assessment per incident is limited to $18 million under current policies.\nAdditionally, the Company has policies that currently provide decontamination, excess property insurance, and premature decommissioning coverage up to $2.25 billion for losses in excess of the $500 million NML coverage. This excess insurance is provided by Nuclear Electric\nII-116 NOTES (continued) Georgia Power Company 1993 Annual Report\nInsurance Limited (NEIL), a mutual insurance company, and American Nuclear Insurers\/Mutual Atomic Energy Liability Underwriters.\nNEIL also covers the additional costs that would be incurred in obtaining replacement power during a prolonged accidental outage at a member's nuclear plant. Members can be insured against increased costs of replacement power in an amount up to $3.5 million per week -- starting 21 weeks after the outage -- for one year and up to $2.3 million per week for the second and third years.\nUnder each of the NEIL policies, members are subject to assessments if losses each year exceed the accumulated funds available to the insurer under that policy. The maximum assessments per incident under the current policies for the Company would be $15 million for excess property damage and $13 million for replacement power.\nFor all on-site property damage insurance policies for commercial nuclear power plants, the NRC requires that the proceeds of such policies issued or renewed on or after April 2, 1991, shall be dedicated first for the sole purpose of placing the reactor in a safe and stable condition after an accident. Any remaining proceeds are to be applied next toward the costs of decontamination and debris removal operations ordered by the NRC, and any further remaining proceeds are to be paid either to the Company or to its bond trustees as may be appropriate under the policies and applicable trust indentures.\nThe Company participates in an insurance program for nuclear workers that provides coverage for worker tort claims filed for bodily injury caused at commercial nuclear power plants. In the event that claims for this insurance exceed the accumulated reserve funds, the Company could be subject to a maximum total assessment of $7 million.\n5. FACILITY SALES AND JOINT OWNERSHIP AGREEMENTS\nSince 1975, the Company has sold undivided interests in plants Hatch, Wansley, Vogtle, and Scherer Units 1 and 2, together with transmission facilities, to OPC, an electric membership generation and transmission corporation; the Municipal Electric Authority of Georgia (MEAG), a public corporation and an instrumentality of the state of Georgia; and the City of Dalton, Georgia. The Company has sold an interest in Plant Scherer Unit 3 to Gulf Power, an affiliate.\nAdditionally, the Company has completed two of four separate transactions to sell Unit 4 of Plant Scherer to Florida Power & Light Company (FPL) and Jacksonville Electric Authority (JEA) for a total price of approximately $806 million, including any gains on these transactions. FPL will eventually own approximately 76.4 percent of the unit, with JEA owning the remainder. Georgia Power will continue to operate the unit.\nThe completed and scheduled remaining transactions are as follows:\nExcept as otherwise noted, the Company has contracted to operate and maintain all jointly owned facilities. The Company includes its proportionate share of plant operating expenses in the corresponding operating expenses in the Statements of Income.\nAs discussed in Note 4, the Company and OPC have a joint ownership arrangement for the Rocky Mountain pumped storage hydroelectric project under which the Company will retain its present investment in the project and OPC will finance and complete the remainder of the project and operate the completed facility. Based on current cost estimates the Company's ownership will be approximately 25% of the project (194 megawatts of capacity) at completion.\nThe Company will own six of eight 80 megawatt combustion turbine generating units and 75% of the related common facilities being jointly constructed with Savannah Electric, an affiliate. The Company's investment in the project at December 31, 1993, was $100 million and is expected to total approximately $182 million when the project is completed. All units are\nII-117 NOTES (continued) Georgia Power Company 1993 Annual Report\nexpected to be completed by June, 1995. Savannah Electric will operate these units.\nIn connection with the joint ownership arrangements for plants Vogtle and Scherer, the Company has made commitments to purchase declining fractions of OPC's and MEAG's capacity and energy from these units. These commitments are in effect during periods of up to 10 years following commercial operation (and with regard to a portion of a 5 percent interest in Plant Vogtle owned by MEAG, until the latter of the retirement of the plant or the latest stated maturity date of MEAG's bonds issued to finance such ownership interest). The payments for capacity are required whether or not any capacity is available. The energy cost is a function of each unit's variable operating costs. Except as noted below, the cost of such capacity and energy is included in purchased power from non-affiliates in the Company's Statements of Income. Capacity payments totaled $183 million, $289 million and $320 million in 1993, 1992 and 1991, respectively. The Plant Scherer buyback agreements ended in 1993. The current projected Plant Vogtle capacity payments for the next five years are as follows: $132 million in 1994, $77 million in 1995, $70 million in 1996, $59 million in 1997 and $59 million in 1998. Portions of the payments noted above relate to costs in excess of Plant Vogtle's allowed investment for ratemaking purposes. The present value of these portions was written off in 1987 and 1990. Additionally, the Plant Vogtle declining capacity buyback expense is being levelized over a six-year period. See Note 3 for further information.\nAt December 31, 1993, the Company's percentage ownership and investment (exclusive of nuclear fuel) in jointly owned facilities in commercial operation, were as follows:\n(1) Investment net of write-offs.\nThe Company and an affiliate, Alabama Power, own equally all of the outstanding capital stock of Southern Electric Generating Company (SEGCO), which owns electric generating units with a total rated capacity of 1,020 megawatts, as well as associated transmission facilities. The capacity of the units has been sold equally to the Company and Alabama Power under a contract expiring in 1994, which, in substance, requires payments sufficient to provide for the operating expenses, taxes, debt service and return on investment, whether or not SEGCO has any capacity and energy available. An amended contract has been filed with the FERC with substantially the same provisions, but the term thereof would be extended automatically for two year periods, subject to any party's right to cancel upon two year's notice. The Company's share of expenses included in purchased power from affiliates in the Statements of\nII-118 NOTES (continued) Georgia Power Company 1993 Annual Report\nIncome, is as follows:\nAt December 31, 1993, the capitalization of SEGCO consisted of $58 million of equity and $84 million of long-term debt on which the annual interest requirement is $3.8 million.\n6. LONG-TERM POWER SALES AGREEMENTS\nThe Company and the operating affiliates of The Southern Company have entered into long-term contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside the system's service territory. Certain of these agreements are non-firm and are based on the capacity of the Southern system. Other agreements are firm and pertain to capacity related to specific generating units. Because energy is generally sold at cost under these agreements, it is primarily the capacity revenues that affect the Company's profitability. The capacity revenues have been as follows:\nLong-term non-firm power of 400 megawatts was sold by the Southern electric system in 1993 to Florida Power Corporation (FPC). This amount decreases to 200 megawatts in 1994 and the contract expires at year-end. Sales under these long-term non-firm power sales agreements are made from available power pool energy, and the revenues from the sales are shared by the operating affiliates.\nUnit power from specific generating plants is being sold to FPL, JEA, and the City of Tallahassee, Florida and beginning in 1994 to FPC. Under these agreements, the Company sold approximately 830 megawatts of capacity in 1993 and is scheduled to sell approximately 403 megawatts of capacity in 1994. Thereafter, these sales will decline to an estimated 157 megawatts by the end of 1996 and will remain at that approximate level through 1999. After 2000, capacity sales will decline to approximately 101 megawatts -- unless reduced by FPL and JEA -- until the expiration of the contracts in 2010.\n7. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no material effect on net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $993 million are revenues to be received from customers. These assets are attributable to tax benefits flowed-through to customers in prior years, and taxes applicable to capitalized AFUDC. The related liabilities of $453 million are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nDetails of the federal and state income tax provisions are as follows:\nII-119 NOTES (continued) Georgia Power Company 1993 Annual Report\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax basis, which give rise to deferred tax assets and liabilities are as follows:\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Statements of Income. Credits amortized in this manner amounted to $19 million in 1993, $19 million in 1992, and $27 million in 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the federal statutory tax rate to effective income tax rate is as follows:\nThe Southern Company and its subsidiaries file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\n8. CAPITALIZATION\nCOMMON STOCK DIVIDEND RESTRICTIONS\nThe Company's first mortgage bond indenture contains various common stock dividend restrictions that remain in effect as long as the bonds are outstanding. At December 31, 1993, $742 million of retained earnings were restricted against the payment of cash dividends on common stock under terms of the mortgage indenture. Supplemental indentures in connection with future first mortgage bond issues may contain more stringent common stock dividend restrictions than those currently in effect.\nThe Company's charter limits cash dividends on common stock to the lesser of the retained earnings balance or 75 percent of net income available for such stock during a prior period of 12 months if the ratio of common stock equity to total capitalization, including retained earnings, adjusted to reflect the payment of the proposed dividend, is below 25 percent, and to 50 percent of such net income if such ratio is less than 20 percent. At December 31, 1993, the ratio as defined was 46.1 percent.\nII-120 NOTES (continued) Georgia Power Company 1993 Annual Report\nREMARKETED BONDS\nIn 1992, the Company issued two series of variable rate first mortgage bonds each with principal amounts of $100 million due 2032. The current composite interest rate on the bonds is 6.20 percent and is fixed for the first three years of the issues.\nPOLLUTION CONTROL BONDS\nThe Company has incurred obligations in connection with the sale by public authorities of tax-exempt pollution control and industrial development revenue bonds. The Company has authenticated and delivered to trustees an aggregate of $407.7 million of its first mortgage bonds, which are pledged as security for its obligations under pollution control and industrial development contracts. No interest on these first mortgage bonds is payable unless and until a default occurs on the installment purchase or loan agreements. An aggregate of approximately $1.3 billion of the pollution control and industrial development bonds is secured by a subordinated interest in specific property of the Company.\nDetails of pollution control bonds are as follows:\nBANK CREDIT ARRANGEMENTS\nAt the beginning of 1994, the Company had unused credit arrangements with banks totaling $540 million, of which $10 million expires June 30, 1994, $130 million expires at May 1, 1996, and $400 million expires at June 30, 1996.\nThe $400 million expiring June 30, 1996, is under revolving credit arrangements with several banks providing the Company, Alabama Power, and The Southern Company up to a total credit amount of $400 million. To provide liquidity support for commercial paper programs and for other short-term cash needs, $165 million and $135 million of the $400 million available credit are currently dedicated for the Company and Alabama Power, respectively. However, the allocations can be changed among the borrowers by notifying the respective banks.\nDuring the term of the agreements expiring in 1996, short-term borrowings may be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the companies' option. In addition, these agreements require payment of commitment fees based on the unused portions of the commitments or the maintenance of compensating balances with the banks.\nThe $10 million credit arrangement expiring in 1994 allows borrowings for up to 90 days. Commitment fees are based on the unused portion of the commitment.\nIn addition, the Company borrows under uncommitted lines of credit with banks and through a $150 million commercial paper program that has the liquidity support of committed bank credit arrangements. Average compensating balances held under these committed facilities were not material in 1993.\nOTHER LONG-TERM DEBT\nAssets acquired under capital leases are recorded in the Balance Sheets as utility plant in service, and the related obligations are classified as long-term debt. At December 31, 1993, the Company had a capitalized lease obligation for its corporate headquarters building of $88 million with an interest rate of 8.1 percent. Other capitalized lease obligations were $137 thousand with a composite interest rate of 6.8 percent.\nThe maturities of capital lease obligations through 1998 are approximately as follows: $423 thousand in 1994, $309 thousand in 1995, $335 thousand in 1996, $362 thousand in 1997, and $392 thousand in 1998.\nThe lease agreement for the corporate headquarters building provides for payments that are minimal in early years and escalate through the first 21 years of the lease. For ratemaking purposes, the GPSC has treated the lease as an operating lease and has allowed only the lease\nII-121 NOTES (continued) Georgia Power Company 1993 Annual Report\npayments in cost of service. The difference between the accrued expense and the lease payments allowed for ratemaking purposes is being deferred as a cost to be recovered in the future as ordered by the GPSC. At December 31, 1993, and 1992, the interest and lease amortization deferred on the Balance Sheets are $47 million and $48 million, respectively.\nIn December 1993, the Company borrowed $37 million through a long-term note due in 1995.\nASSETS SUBJECT TO LIEN\nThe Company's mortgage dated as of March 1, 1941, as amended and supplemented, securing the first mortgage bonds issued by the Company, constitutes a direct lien on substantially all of the Company's fixed property and franchises.\nLONG-TERM DEBT DUE WITHIN ONE YEAR\nThe current portion of the Company's long-term debt is as follows:\n*Less than .1 million\nThe indenture's first mortgage bond improvement fund requirement amounts to 1 percent of each outstanding series of bonds authenticated under the indenture prior to January 1 of each year, other than those issued to collateralize pollution control obligations. The requirement may be satisfied by depositing cash or reacquired bonds, or by pledging additional property equal to 1 2\/3 times the requirement. The 1993 and 1992 requirements were met in the first quarter of each year by depositing cash subsequently used to redeem bonds. The 1994 requirement was funded in December 1993.\nREDEMPTION OF HIGH-COST SECURITIES\nThe Company plans to continue a program of redeeming or replacing high-cost debt and preferred stock in cases where opportunities exist to reduce financing costs. High-cost issues may be repurchased in the open market or called at premiums as specified under terms of the issue. They may also be redeemed at face value to meet improvement fund and sinking fund requirements, to meet replacement provisions of the mortgage, or by use of proceeds from the sale of property pledged under the mortgage. In general, for the first five years a series is outstanding the Company is prohibited from redeeming for improvement fund purposes more than 1 percent annually of the original issue amount.\n9. QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial information for 1993 and 1992 is as follows:\nThe Company's business is influenced by seasonal weather conditions and the timing of rate increases.\nII-122\nSELECTED FINANCIAL AND OPERATING DATA Georgia Power Company 1993 Annual Report\nII-123\nSELECTED FINANCIAL AND OPERATING DATA Georgia Power Company 1993 Annual Report\nII-124\nSELECTED FINANCIAL AND OPERATING DATA (continued) Georgia Power Company 1993 Annual Report\nNote: As of 9\/1\/91, Georgia Power Company's sales to Oglethorpe Power Company are not included in Peak-Hour Demand * Less than one-tenth of one percent.\nII-125\nSELECTED FINANCIAL AND OPERATING DATA (continued) Georgia Power Company 1993 Annual Report\nII-126\nSTATEMENTS OF INCOME Georgia Power Company\nNote: Reflects major sales of facilities to Jacksonville Electric Authority, Florida Power & Light Company, OPC, MEAG, and Dalton. Increases in net income, after total taxes, from these sales were $18,391,000 in 1993, $14,542,000 in 1991, $6,336,000 in 1990, $3,851,000 in 1987, and $21,250,000 in 1984.\nII-127\nSTATEMENTS OF INCOME Georgia Power Company\nII-128\nSTATEMENTS OF CASH FLOWS Georgia Power Company\n( ) Denotes use of cash.\nII-129 STATEMENTS OF CASH FLOWS Georgia Power Company\nII-130\nBALANCE SHEETS Georgia Power Company\nII-131\nBALANCE SHEETS Georgia Power Company\nII-132\nBALANCE SHEETS Georgia Power Company\nII-133 BALANCE SHEETS Georgia Power Company\nII-134\nGEORGIA POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1993\nFIRST MORTGAGE BONDS\nII-135\nGEORGIA POWER COMPANY\nOUTSTANDING SECURITIES (Continued) AT DECEMBER 31, 1993\n(1) Issued in exchange for $5.00 preferred outstanding at the time of company formation.\nII-136\nGEORGIA POWER COMPANY\nSECURITIES RETIRED DURING 1993\nFIRST MORTGAGE BONDS\n(1) Issued in exchange for $5.00 preferred outstanding at the time of company formation. * Less than $500.\nII-137\nGULF POWER COMPANY\nFINANCIAL SECTION\nII-138\nMANAGEMENT'S REPORT Gulf Power Company 1993 Annual Report\nThe management of Gulf Power Company has prepared and is responsible for the financial statements and related information included in this report. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on the best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that books and records reflect only authorized transactions of the Company. Limitations exist in any system of internal controls, however, based on a recognition that the cost of the system should not exceed its benefits. The Company believes its system of internal accounting controls maintains an appropriate cost\/benefit relationship.\nThe Company's system of internal accounting controls is evaluated on an ongoing basis by the Company's internal audit staff. The Company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, composed of the directors who are not employees, provides a broad overview of management's financial reporting and control functions. Periodically, this committee meets with management, the internal auditors, and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal controls, and financial reporting matters. The internal auditors and independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the Company's operations are conducted according to a high standard of business ethics.\nIn management's opinion, the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of Gulf Power Company in conformity with generally accepted accounting principles.\n\/s\/ D. L. McCrary \/s\/ A. E. Scarbrough - -------------------------- ------------------------ Douglas L. McCrary Arlan E. Scarbrough Chairman of the Board Vice President - Finance and Chief Executive Officer\nII-139 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF GULF POWER COMPANY:\nWe have audited the accompanying balance sheets and statements of capitalization of Gulf Power Company (a Maine corporation and a wholly owned subsidiary of The Southern Company) as of December 31, 1993 and 1992, and the related statements of income, retained earnings, paid-in capital, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-148 through II-165) referred to above present fairly, in all material respects, the financial position of Gulf Power Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 8 to the financial statements, effective January 1, 1993, Gulf Power Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nII-140 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Gulf Power Company 1993 Annual Report\nRESULTS OF OPERATIONS\nEARNINGS\nGulf Power Company's net income after preferred stock dividends was $54.3 million for 1993, a $0.2 million increase over 1992 net income. Earnings reflect a $2.3 million gain on the sale of Gulf States Utilities Company (Gulf States) stock and the reversal of a $1.7 million wholesale rate refund as the result of a court order which is further discussed in Note 3 to the financial statements under \"Recovery of Contract Buyout Costs\". The company also experienced growth in residential and commercial sales and a decrease in interest expense on long-term debt as a result of security refinancings, offset by higher operation and maintenance expense, and decreased industrial sales reflecting the loss of the Company's largest industrial customer, Monsanto, which began cogeneration in August of 1993.\nThe Company's 1992 net income after dividends on preferred stock decreased $3.7 million compared to the prior year. The 1991 earnings included an after-tax gain of $12.7 million representing the settlement of litigation with Gulf States. See Note 7 to the financial statements under \"Gulf States Settlement Completed\" for further details. Excluding this settlement from 1991, earnings for 1992 increased $8.4 million -- or approximately -- 18.7 percent over 1991. This improvement was due to increased energy sales; lower interest expense and preferred dividends as a result of security refinancings; and continued emphasis on cost controls.\nThe Company's return on average common equity was 13.29 percent for 1993, a slight decrease from the 13.62 percent return earned in 1992, which was up from the 12.03 percent earned in 1991 (excluding the Gulf States settlement).\nREVENUES\nChanges in operating revenues over the last three years are the result of the following factors:\n* Includes the non-interest portion of the wholesale rate refund reversal discussed in \"Earnings.\"\nRetail revenues of $471.7 million in 1993 increased $10.2 million or 2.2 percent from last year, compared with an increase of 1.2 percent in 1992 and 4.9 percent in 1991. Revenues increased in the residential and commercial classes primarily due to customer growth, and favorable weather and economic conditions. Revenues in the industrial class declined due to the loss of the Company's largest industrial customer, Monsanto, which began operating its cogeneration facility in August 1993. See \"Future Earnings Potential\" for further details. The change in base rates for 1993 and 1992 reflects the expiration of a retail rate penalty in September 1992.\nSales for resale were $95.4 million in 1993, increasing $1.2 million or 1.3 percent over 1992. Sales to affiliated companies vary from year to year depending on demand and the availability and cost of generating resources at each company. The majority of non-affiliated energy sales arise from long-term contractual agreements. Non-affiliated long-term contracts include capacity and energy components. Capacity revenues reflect the recovery of\nII-141 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nfixed costs and return on investment. Energy is sold at its variable cost.\nThe capacity and energy components under these long-term contracts were as follows:\nBeginning in June 1992, all the capacity from the Company's ownership portion of Plant Scherer Unit No. 3 was sold through unit power sales, resulting in increased capacity revenues.\nIn 1993, changes in other operating revenues are primarily due to the recognition of $2.6 million under the Environmental Cost Recovery (ECR) clause which is fully discussed in Note 3 to the financial statements under \"Environmental Cost Recovery\", which is offset by true-ups of other regulatory cost recovery clauses. The increase in other operating revenues in 1992 was primarily due to true-ups of regulatory cost recovery clauses and the changes in franchise fee collections and Florida gross receipts taxes (discussed under \"Expenses\") which had no effect on earnings.\nEnergy sales for 1993 and percent changes in sales since 1991 are reported below.\nOverall retail sales remained relatively flat in 1993. Increases in residential and commercial sales -- reflecting customer growth, favorable weather and an improving economy -- were offset by the decreased sales in the industrial class reflecting the loss of Monsanto. Retail sales increased 3.8 percent in 1992 primarily due to an increase in the number of customers served and a moderately improving economy.\nEnergy sales for resale to non-affiliates increased 2.0 percent and are predominantly unit power sales under long-term contracts to Florida utilities which are discussed above. Energy sales to affiliated companies vary from year to year as mentioned above.\nEXPENSES\nTotal operating expenses for 1993 increased $16.6 million or 3.5 percent over 1992 primarily due to increased operation and maintenance expenses and higher taxes. Other operation expenses increased $10.9 million or 11.1 percent from the 1992 level. The increase is attributable to additional costs of $7.4 million related to increases in the buyout of coal supply contracts and $1.4 million of environmental clean-up costs. Also, higher employee benefit costs and the costs of an automotive fleet reduction program increased expenses by $2.1 million. Operating expenses for 1992 increased by approximately $16 million over 1991. Excluding the Gulf States settlement, an after-tax reduction of $0.6 million in 1992 and $12.7 million in 1991, 1992 total operating expenses increased $4.3 million or 0.9 percent over 1991.\nFuel and purchased power expenses decreased $3.8 million or 1.8 percent from 1992 reflecting the lower cost of fuel. Total 1992 fuel and purchased power increased $1.4 million or 0.7 percent from 1991.\nMaintenance expense increased $4.1 million or 9.7 percent over 1992 due to scheduled maintenance of production facilities. The 1992 maintenance expense was down $3.5 million or 7.7 percent from 1991 due to a decrease in scheduled maintenance.\nFederal income taxes increased $0.7 million primarily due to a corporate federal income tax rate increase from 34 percent to 35 percent effective January 1993. Taxes other than income taxes increased $2.3 million in 1993, an increase of 6.1 percent over the 1992 expense\nII-142 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nprimarily due to increases in property taxes and gross receipt taxes. Taxes other than income taxes decreased $4.5 million, or 10.5 percent in 1992 compared to 1991 due primarily to the Company discontinuing the collection of franchise fees for two Florida counties which was partially offset by an increase in gross receipt taxes. Changes in franchise fee collections and gross receipt taxes had no impact on earnings.\nInterest expense decreased $3.2 million or 8.1 percent from the 1992 level and 1992 interest expense decreased $5.6 million or 12.5 percent from 1991. The decrease in both years is primarily attributable to refinancing some of the Company's higher cost securities.\nEFFECTS OF INFLATION\nThe Company is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its cost of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations, such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on a number of factors. It is expected that higher operating costs and carrying charges on increased investment in plant, if not offset by proportionate increases in operating revenues (either by periodic rate increases or increases in sales), will adversely affect future earnings. Growth in energy sales will be subject to a number of factors, including the volume of sales to neighboring utilities, energy conservation practiced by customers, the elasticity of demand, customer growth, weather, competition, and the rate of economic growth in the service area.\nIn addition to the traditional factors discussed above, the Energy Policy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric utilities. The Company is preparing to meet the challenges of a major change in the traditional business practices of selling electricity. The Energy Act allows independent power producers (IPPs) to access the Company's transmission network in order to sell electricity to other utilities, and this may enhance the incentive for IPPs to build cogeneration plants for the Company's large industrial and commercial customers and sell excess energy generation to the Company or other utilities. Although the Energy Act does not require transmission access to retail customers, pressure for legislation to allow retail wheeling will continue. If the Company does not remain a low-cost producer and provide quality service, the Company's retail energy sales growth, its ability to retain large industrial and commercial customers, and obtain new long-term contracts for energy sales outside the Company's service area, could be limited, and this could significantly erode earnings.\nThe future effect of cogeneration and small-power production facilities cannot be fully determined at this time, but may be adverse. One effect of cogeneration which the Company has experienced is the loss of its largest industrial customer, Monsanto, in August of 1993. The loss of the Monsanto load reduced revenues, and will result in a reduction in net income of approximately $3 million in the first twelve months.\nThe Federal Energy Regulatory Commission (FERC) regulates wholesale rate schedules and power sales contracts that the Company has with its sales for resale customers. The FERC is currently reviewing the rate of return on common equity included in these schedules and contracts that have a return on common equity of 13.75 percent or greater, and may require such returns to be lowered, possibly retroactively. See Note 3 to the financial statements under \"FERC Reviews Equity Returns\" for additional information.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could reduce earnings if such costs are not fully recovered. The Clean Air Act is discussed later under \"Environmental Matters\".\nII-143 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nAlso, recently enacted legislation that provides for recovery of prudent environmental compliance costs is discussed in Note 3 to the financial statements under \"Environmental Cost Recovery.\"\nThe Company filed a notice with the Florida Public Service Commission (FPSC) of its intent to obtain rate relief in February 1993. On May 4, 1993, the FPSC approved a stipulation between the Company, the Office of Public Counsel, and the Florida Industrial Power Users Group to cancel the filing of the rate case. The stipulation also allowed the Company to retain, for the next four years, its existing method for calculating accruals for future power plant dismantlement costs. The existing method provides a more even allocation of expenses over the life of the plants and results in an avoided increase in expenses of about $6 million annually over the next four years when compared to the FPSC method. The stipulation also provided for the reduction of the Company's allowed return on equity midpoint from 12.55 percent to 12.0 percent. After the February 1993 filing date, interest rates continued to remain low, resulting in lower cost of capital. Also, the Florida legislature adopted legislation which allows utilities to petition the FPSC for recovery of environmental costs through an adjustment clause if these costs are not being recovered in base rates. See Note 3 to the financial statements under \"Environmental Cost Recovery\" for further details. The combination of the circumstances discussed above, placed the Company in a better position to manage its finances without an increase in base rates while still providing a fair return for the Company's investors. Consequently, the Company agreed, as a part of this stipulation, to cancel the filing of the rate case.\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be effective by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental benefits, disability-related benefits, job training, and health and life insurance coverage. In 1993, the Company adopted Statement No. 112, which resulted in a decrease in earnings of $0.3 million.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which is effective in 1994. Statement No. 115 supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. The Company does not have any investments that qualify for FASB Statement No. 115 treatment.\nFINANCIAL CONDITION\nOVERVIEW\nThe principal changes in the Company's financial condition during 1993 were gross property additions of $79 million. Funds for these additions were provided by internal sources. The Company continued to refinance higher cost securities to lower the Company's cost of capital. See \"Financing Activities\" below and the Statements of Cash Flows for further details.\nOn January 1, 1993, the Company changed its method of calculating the accruals for postretirement benefits other than pensions and its method of accounting for income taxes. See Notes 2 and 8 to the financial statements, regarding the impact of these changes.\nFINANCING ACTIVITIES\nAs mentioned above, the Company continued to lower its financing costs by issuing new securities and other debt, and retiring higher-cost issues in 1993. The Company sold $75 million of first mortgage bonds and, through public authorities, $53.4 million of pollution control revenue bonds, issued $35 million of preferred stock, and obtained $25 million with a long-term bank note. Retirements, including maturities during 1993, totaled $88.8 million of first mortgage bonds, $40.7 million of pollution control revenue bonds, and $21.1 million of preferred stock. (See the Statements of Cash Flows for further details.)\nII-144 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nComposite financing rates for the years 1991 through 1993 as of year end were as follows:\nCAPITAL REQUIREMENTS FOR CONSTRUCTION\nThe Company's gross property additions, including those amounts related to environmental compliance, are budgeted at $200 million for the three years beginning 1994 ($77 million in 1994, $55 million in 1995, and $68 million in 1996). The estimates of property additions for the three-year period include $25 million committed to meeting the requirements of the Clean Air Act, the cost of which is expected to be recovered through the ECR clause which is discussed in Note 3 to the financial statements under \"Environmental Cost Recovery\". Actual construction costs may vary from this estimate because of factors such as the granting of timely and adequate rate increases; changes in environmental regulations; revised load projections; the cost and efficiency of construction labor, equipment, and materials; and the cost of capital.\nThe Company does not have any baseload generating plants under construction. However, the Company plans to construct two 80 megawatt combustion turbine peaking units. The first is scheduled to be completed in 1998, and the second in 1999. Significant construction of transmission and distribution facilities and upgrading of generating plants will be continuing.\nOTHER CAPITAL REQUIREMENTS\nIn addition to the funds needed for the construction program, approximately $86 million will be required by the end of 1996 in connection with maturities of long-term debt and preferred stock subject to mandatory redemption. Also, the Company plans to continue a program to retire higher-cost debt and preferred stock and replace these obligations with lower-cost capital.\nENVIRONMENTAL MATTERS\nIn November 1990, the Clean Air Act was signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- will have a significant impact on the Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995 and affects eight generating plants -- some 10,000 megawatts of capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing slower than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $275 million for The Southern Company including $34 million for Gulf Power Company through 1995.\nII-145 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I, increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 to 2000, compliance could require total construction expenditures ranging from approximately $450 million to $800 million for The Southern Company including approximately $30 million to $40 million for Gulf Power Company. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nFollowing adoption of legislation in April of 1992, allowing electric utilities in Florida to seek FPSC approval of their Clean Air Act Compliance Plans, the Company filed its petition for approval. The Commission approved the Company's plan for Phase I compliance, deferring until a later date approval of its Phase II Plan.\nAn average increase of up to 4 percent in annual revenue requirements from Gulf Power Company customers could be necessary to fully recover the cost of compliance for both Phase I and Phase II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nThe Florida Legislature recently adopted legislation that allows a utility to petition the FPSC for recovery of prudent environmental compliance costs through an ECR clause without lengthy regulatory full revenue requirements rate proceedings. The legislation is discussed in Note 3 to the financial statements under \"Environmental Cost Recovery\".\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standards could result in significant additional costs. The impact of new standards -- if any -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a new standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provision of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matter, nitrogen oxides, and ozone. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the non-hazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes -- coal ash and other utility wastes -- as either non-hazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nGulf Power Company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the Company could incur costs to clean up properties currently or previously owned. The Company conducts studies to determine the extent of any required clean-up costs and has recognized in the financial statements costs to clean up known sites.\nII-146 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1993 Annual Report\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; and the Resource Conservation and Recovery Act. Changes to these laws could affect many areas of Gulf Power Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields, and other environmental and health concerns could significantly affect Gulf Power Company. The impact of new legislation - -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the potential for lawsuits alleging damages caused by electromagnetic fields exists.\nCOAL STOCKPILE DECREASES\nTo reduce the working capital invested in the coal stockpile inventory, the Company implemented a coal stockpile reduction program in 1992. The Company's actual year end inventory at December 31, 1993 was $20.7 million which is considerably lower than the desired level of $31.4 million. This situation exists because a limited supply of coal was available at competitive prices primarily due to the United Mine Workers strike from July to December 1993. In addition, barge transportation was stranded due to floods in the Midwest. As a result of these circumstances, management chose to allow the existing coal inventory to decline until coal prices stabilized. Current market conditions indicate that substantial coal supplies at competitive prices are now available. Therefore, the Company plans to increase purchases and return the coal stockpile inventory to the desired level by the end of the third quarter, 1994.\nSOURCES OF CAPITAL\nAt December 31, 1993, the Company had $5.6 million of cash and cash equivalents to meet its short-term cash needs.\nIt is anticipated that the funds required for construction and other purposes, including compliance with environmental regulations, will be derived from operations; the sale of additional first mortgage bonds, pollution control bonds, and preferred stock; and capital contributions from The Southern Company. The Company is required to meet certain coverage requirements specified in its mortgage indenture and corporate charter to issue new first mortgage bonds and preferred stock. The Company's coverage ratios are sufficient to permit, at present interest and preferred dividend levels, any foreseeable security sales. The amount of securities which the Company will be permitted to issue in the future will depend upon market conditions and other factors prevailing at that time.\nII-147 STATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 Gulf Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-148 STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1993, 1992, and 1991 Gulf Power Company 1993 Annual Report\n( ) Denotes use of cash. The accompanying notes are an integral part of these statements.\nII-149 BALANCE SHEETS At December 31, 1993 and 1992 Gulf Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-150 BALANCE SHEETS (continued) At December 31, 1993 and 1992 Gulf Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-151 STATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 Gulf Power Company 1993 Annual Report\nII-152 STATEMENTS OF CAPITALIZATION (CONTINUED) At December 31, 1993 and 1992 Gulf Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-153 STATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991 Gulf Power Company 1993 Annual Report\nSTATEMENTS OF PAID-IN CAPITAL For the Years Ended December 31, 1993, 1992, and 1991 Gulf Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-154 NOTES TO FINANCIAL STATEMENTS At December 31, 1993, 1992 and 1991 Gulf Power Company 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nGENERAL\nGulf Power Company is a wholly owned subsidiary of The Southern Company, which is the parent company of five operating companies, Southern Company Services, Inc. (SCS), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear) and various other subsidiaries related to foreign utility operations and domestic non-utility operations. At this time, the operations of the other subsidiaries are not material. The operating companies (Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, and Savannah Electric and Power Company) provide electric service in four Southeastern states. Contracts among the companies -- dealing with jointly owned generating facilities, interconnecting transmission lines, and the exchange of electric power -- are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission. SCS provides, at cost, specialized services to The Southern Company and to the subsidiary companies. Southern Electric designs, builds, owns and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides services to The Southern Company's nuclear power plants.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA). Both The Southern Company and its subsidiaries are subject to the regulatory provisions of the PUHCA. The Company is also subject to regulation by the FERC and the Florida Public Service Commission (FPSC). The Company follows generally accepted accounting principles and complies with the accounting policies and practices prescribed by these commissions.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nREVENUES AND FUEL COSTS\nThe Company accrues revenues for service rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as fuel is used. The Company's electric rates include provisions to periodically adjust billings for fluctuations in fuel and the energy component of purchased power costs. Revenues are adjusted for differences between recoverable fuel costs and amounts actually recovered in current rates. The FPSC has also approved the recovery of purchased power capacity costs, energy conservation costs, and environmental compliance costs in cost recovery clauses that are similar to the method used to recover fuel costs.\nDEPRECIATION AND AMORTIZATION\nDepreciation of the original cost of depreciable utility plant in service is provided primarily using composite straight-line rates which approximated 3.8 percent in 1993, 1992, and 1991. When property subject to depreciation is retired or otherwise disposed of in the normal course of business, its cost -- together with the cost of removal, less salvage -- is charged to the accumulated provision for depreciation. Minor items of property included in the original cost of the plant are retired when the related property unit is retired.\nINCOME TAXES\nThe Company provides deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. Statement No. 109 required, among other things, conversion to the liability method of accounting for accumulated deferred income taxes. See Note 8 for additional information about Statement No. 109. The Company is included in the consolidated federal income tax return of The Southern Company.\nII-155 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of certain new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of plant through a higher rate base and higher depreciation expense. The FPSC-approved composite rate used to calculate AFUDC was 7.27 percent effective on July 1, 1993 and 8.03 percent for the first half of 1993, and for 1992, and 1991. AFUDC amounts for 1993, 1992, and 1991 were $966 thousand, $60 thousand, and $149 thousand, respectively. The increase in 1993 is due to an increase in construction projects at Plant Daniel.\nUTILITY PLANT\nUtility plant is stated at original cost. Original cost includes: materials; labor; minor items of property; appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; and the estimated cost of funds used during construction. The cost of maintenance, repairs, and replacement of minor items of property is charged to maintenance expense. The cost of replacements of property (exclusive of minor items of property) is charged to utility plant.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Statements of Cash Flows, temporary cash investments are considered cash equivalents. Temporary cash investments are securities with original maturities of 90 days or less.\nFINANCIAL INSTRUMENTS\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, all financial instruments of the Company -- for which the carrying amount does not approximate fair value -- are shown in the table below as of December 31:\nThe fair values of investment securities were based on listed closing market prices. The fair values for long-term debt and preferred stock subject to mandatory redemption were based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution, and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed.\nVACATION PAY\nThe Company's employees earn their vacation in one year and take it in the subsequent year. However, for ratemaking purposes, vacation pay is recognized as an allowable expense only when paid. Consistent with this ratemaking treatment, the Company accrues a current liability for earned vacation pay and records a current asset representing the future recoverability of this cost. The amount was $4.0 million and $3.8 million at December 31, 1993 and 1992, respectively. In 1994, an estimated 84 percent of the 1993 deferred vacation cost\nII-156 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nwill be expensed and the balance will be charged to construction.\nPROVISION FOR INJURIES AND DAMAGES\nThe Company is subject to claims and suits arising in the ordinary course of business. As permitted by regulatory authorities, the Company is providing for the uninsured costs of injuries and damages by charges to income amounting to $1.2 million annually. The expense of settling claims is charged to the provision to the extent available. The accumulated provision of $2.2 million and $2.5 million at December 31, 1993 and 1992, respectively, is included in miscellaneous current liabilities in the accompanying Balance Sheets.\nPROVISION FOR PROPERTY DAMAGE\nDue to a significant increase in the cost of traditional insurance, effective in 1993, the Company became self-insured for the full cost of storm and other damage to its transmission and distribution property. As permitted by regulatory authorities, the Company provides for the estimated cost of uninsured property damage by charges to income amounting to $1.2 million annually. At December 31, 1993 and 1992, the accumulated provision for property damage amounted to $10.5 million and $9.7 million, respectively. The expense of repairing such damage as occurs from time to time is charged to the provision to the extent it is available.\n2. RETIREMENT BENEFITS:\nPENSION PLAN\nThe Company has a defined benefit, trusteed, non-contributory pension plan that covers substantially all regular employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and final average pay or years of service and a flat-dollar benefit. The Company uses the \"entry age normal method with a frozen initial liability\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension trust fund are primarily invested in equity and fixed-income securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the \"projected unit credit\" actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nThe Company also provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. A qualified trust for medical benefits has been established for funding amounts to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded.\nEffective January 1, 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\" Prior to the adoption of Statement No. 106, Gulf Power Company recognized these benefit costs on an accrual basis using the \"aggregate cost\" actuarial method, which spreads the expected cost of such benefits over the remaining periods of employees' service as a level percentage of payroll costs. The costs of such benefits recognized by the Company in 1993, 1992, and 1991 were $3.9 million, $3.1 million, and $2.7 million, respectively.\nSTATUS AND COST OF BENEFITS\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of Statement Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown only for 1993 because Statement No. 106 was adopted as of January 1, 1993, on a prospective basis.\nII-157 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nThe funded status of the plans at December 31 was as follows:\nThe weighted average rates assumed in the actuarial calculations were:\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1993, by $4.8 million and the aggregate of the service and interest cost components of the net retiree medical cost by $543 thousand.\nComponents of the plans' net cost are shown below:\nOf the above net pension amounts, $(601) thousand in 1993, $3 thousand in 1992, and $518 thousand in 1991, were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nOf the above net postretirement medical and life insurance amounts recorded in 1993, $3.0 million was recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nII-158 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\n3. LITIGATION AND REGULATORY MATTERS:\nCOAL BARGE TRANSPORTATION SUIT\nOn August 19, 1993, a complaint against the Company and Southern Company Services, an affiliate, was filed in federal district court in Ohio by two companies with which the Company had contracted for the transportation by barge for certain of the Company's coal supplies. The complaint alleges breach of the contract by the Company and seeks damages estimated by the plaintiffs to be in excess of $85 million.\nThe final outcome of this matter cannot now be determined; however, in management's opinion the final outcome will not have a material adverse effect on the Company's financial statements.\nFPSC APPROVES STIPULATION\nIn February 1993, the Company filed a notice with the FPSC of its intent to obtain rate relief. On May 4, 1993, the FPSC approved a stipulation between the Company, the Office of Public Counsel, and the Florida Industrial Power Users Group to cancel the filing of the rate case and to allow the Company to retain for the next four years its existing method for calculating accruals for future power plant dismantlement costs. The stipulation also required the reduction of the Company's allowed return on equity midpoint from 12.55 percent to 12.0 percent. See Management's Discussion and Analysis under \"Future Earnings Potential\" for further details of circumstances that contributed to the company canceling the rate case.\nFERC REVIEWS EQUITY RETURNS\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the Southern electric system's wholesale rate schedules and contracts that have a return on common equity of 13.75 percent or greater. The contracts that could be affected by the hearings include substantially all of the transmission, unit power, long-term power and other similar contracts. Any changes in the rate of return on common equity that may occur as a result of this proceeding would be effective 60 days after a proper notice of the proceeding is published. A notice was published on May 10, 1991.\nIn August 1992, a FERC administrative law judge issued an opinion that changes in rate schedules and contracts were not necessary and that the FERC staff failed to show how any changes were in the public interest. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on the Company's financial statements.\nRECOVERY OF CONTRACT BUYOUT COSTS\nIn July 1990, the Company filed a request for waiver of FERC's fuel adjustment charge regulation to permit recovery of coal contract buyout costs from wholesale customers. On April 4, 1991, the FERC issued an order granting recovery of the buyout costs from wholesale customers from July 19, 1990, forward, but denying retroactive recovery of the buyout costs from January 1, 1987 through July 18, 1990. The Company's request for rehearing was denied by the FERC. The Company refunded $2.7 million (including interest) in June 1991 to its wholesale customers. On July 31, 1991, the Company filed a petition for review of the FERC's decision to the U.S. Court of Appeals for the District of Columbia Circuit. On January 22, 1993, the Court vacated the Commission's order, finding FERC's denial of the Company's request for a retroactive waiver to be arbitrary and capricious. The Court remanded the matter to FERC for consideration consistent with its opinion. Management expects that the commission will ultimately allow the Company to recover the amount refunded plus interest. Accordingly, the Company recorded the reversal of the $2.7 million refund to income in 1993.\nENVIRONMENTAL COST RECOVERY\nIn April 1993, the Florida Legislature adopted legislation for an Environmental Cost Recovery (ECR) clause, which allows a utility to petition the FPSC for recovery of all prudent environmental compliance costs that are not being recovered through base rates or any other rate-adjustment clause. Such environmental costs include operation and maintenance expense, depreciation, and a return on invested capital.\nII-159 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nOn January 12, 1994, the FPSC approved the Company's petition under the ECR clause for recovery of environmental costs that were projected to be incurred from July 1993 through September 1994. The order allows the recovery from customers of such costs amounting to $7.8 million during the period, February through September 1994. Thereafter, recovery under ECR will be determined semi-annually and will include a true-up of the prior period and a projection of the ensuing six-month period. In December 1993, the Company recorded $2.6 million as additional revenue for the portion of costs incurred during 1993.\n4. CONSTRUCTION PROGRAM:\nThe Company is engaged in a continuous construction program, the cost of which is currently estimated to total $77 million in 1994, $55 million in 1995, and $68 million in 1996. These estimates include AFUDC of approximately $0.7 million, $0.3 million, and $0.2 million, in 1994, 1995, and 1996, respectively. The construction program is subject to periodic review and revision, and actual construction costs may vary from the above estimates because of numerous factors. These factors include changes in business conditions; revised load growth estimates; changes in environmental regulations; increasing costs of labor, equipment and materials; and cost of capital. The Company does not have any new baseload generating plants under construction. However, the Company plans to construct two 80 megawatt combustion turbine peaking units. The first is scheduled to be completed in 1998, and the second in 1999. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\nSee Management's Discussion and Analysis under \"Environmental Matters\" for information on the impact of the Clean Air Act Amendments of 1990 and other environmental matters.\n5. FINANCING AND COMMITMENTS:\nGENERAL\nCurrent projections indicate that funds required for construction and other purposes, including compliance with environmental regulations will be derived primarily from internal sources. Requirements not met from internal sources will be financed from the sale of additional first mortgage bonds, preferred stock, and capital contributions from The Southern Company. In addition, the Company may issue additional long-term debt and preferred stock primarily for the purposes of debt maturities and redemptions of higher-cost securities. Because of the attractiveness of current short term interest rates, the Company may maintain a higher level of short term indebtedness than has historically been true.\nAt December 31, 1993, the Company had $49 million of lines of credit with banks of which $6.1 million was committed to cover checks presented for payment. These credit arrangements are subject to renewal June 1 of each year. In connection with these committed lines of credit, the Company has agreed to pay certain fees and\/or maintain compensating balances with the banks. The compensating balances, which represent substantially all the cash of the Company except for daily working funds and like items, are not legally restricted from withdrawal. In addition, the Company has bid-loan facilities with eight major money center banks that total $180 million, of which, none was committed at December 31, 1993.\nASSETS SUBJECT TO LIEN\nThe Company's mortgage, which secures the first mortgage bonds issued by the Company, constitutes a direct first lien on substantially all of the Company's fixed property and franchises.\nFUEL COMMITMENTS\nTo supply a portion of the fuel requirements of its generating plants, the Company has entered into long-term commitments for the procurement of fuel. In most cases, these contracts contain provisions for price escalations, minimum purchase levels and other financial commitments. Total estimated long-term obligations were approximately $1.4 billion at December 31, 1993. Additional commitments will be required in the future to supply the Company's fuel needs.\nTo take advantage of lower-cost coal supplies, agreements were reached in 1986 to terminate two long-term contracts for the supply of coal to Plant Daniel, which is jointly owned by the Company and Mississippi Power, an operating affiliate. The Company's portion of\nII-160 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nthis payment was some $60 million. This amount is being amortized to expense on a per ton basis over a nine-year period. The remaining unamortized amount included in deferred charges, including the current portion, was $18 million at December 31, 1993.\nIn 1988, the Company made an advance payment of $60 million to another coal supplier under an arrangement to lower the cost of future coal purchased under an existing contract. This amount is being amortized to expense on a per ton basis over a ten-year period. The remaining unamortized amount included in deferred charges, including the current portion, was $36 million at December 31, 1993.\nAlso, in 1993 the Company made a payment of $16.4 million to a coal supplier under an arrangement to suspend the purchase of coal under an existing contract for one year. This amount is being amortized to expense on a per ton basis over a one year period. The remaining unamortized amount, which is included in current assets, was $11 million at December 31, 1993.\nThe amortization of these payments is being recovered through the fuel cost recovery clause discussed under \"Revenues and Fuel Costs\" in Note 1.\nLEASE AGREEMENT\nIn 1989, the Company entered into a twenty-two year operating lease agreement for the use of 495 aluminum railcars to transport coal to Plant Daniel. Mississippi Power, as joint owner of Plant Daniel, is responsible for one half of the lease costs. The Company's share of the lease is charged to fuel inventory and allocated to fuel expense as the fuel is used. The lease costs charged to inventory were $1.2 million in 1993, $1.2 million in 1992 and $1.3 million in 1991. For the year 1994, the Company's annual lease payment will be $1.2 million. The Company's annual lease payment for 1995 will be $2.4 million and for 1996, 1997, and 1998 the payment will be $1.2 million. Lease payments after 1998 total approximately $17.4 million. The Company has the option, after three years from the date of the original contract, to purchase the railcars at the greater of termination value or fair market value. Additionally, at the end of the lease term, the Company has the option to renew the lease.\n6. JOINT OWNERSHIP AGREEMENTS:\nThe Company and Mississippi Power jointly own Plant Daniel, a steam-electric generating plant, located in Jackson County, Mississippi. In accordance with an operating agreement, Mississippi Power acts as the Company's agent with respect to the construction, operation, and maintenance of the plant.\nThe Company and Georgia Power jointly own Plant Scherer Unit No. 3, a steam-electric generating plant, located near Forsyth, Georgia. In accordance with an operating agreement, Georgia Power acts as the Company's agent with respect to the construction, operation, and maintenance of the unit.\nThe Company's pro rata share of expenses related to both plants is included in the corresponding operating expense accounts in the Statements of Income.\nAt December 31, 1993, the Company's percentage ownership and its amount of investment in these jointly owned facilities were as follows:\n(1) Includes net plant acquisition adjustment. (2) Total megawatt nameplate capacity: Plant Scherer Unit No. 3: 818 Plant Daniel: 1,000\nII-161 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\n7. LONG-TERM POWER SALES AGREEMENTS:\nGENERAL\nThe Company and the other operating affiliates of The Southern Company have contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside of the system's service area. Certain of these agreements are non-firm and are based on the capacity of the system in general. Other agreements are firm and pertain to capacity related to specific generating units. Because the energy is generally sold at cost under these agreements, the capacity revenues from these sales primarily affect profitability. The Company's capacity revenues have been as follows:\nLong-term non-firm power of 400 megawatts was sold in 1993 to Florida Power Corporation (FPC) by the Southern electric system. In 1994, this amount decreased to 200 megawatts, and the contract will expire at year-end 1994. Capacity and energy sales under these long-term non-firm power sales agreements are made from available power pool capacity, and the revenues from the sales are shared by the operating affiliates.\nUnit power from specific generating plants is currently being sold to FPC, Florida Power & Light Company (FP&L), Jacksonville Electric Authority (JEA), and the City of Tallahassee, Florida. Under these agreements, 209 megawatts of net dependable capacity were sold by the Company during 1993, and sales will remain at that approximate level until the expiration of the contracts in 2010, unless reduced by FPC, FP&L and JEA after 1999.\nCapacity and energy sales to FP&L, the Company's largest single customer, provided revenues of $39.5 million in 1993, $46.2 million in 1992, and $42.1 million in 1991, or 6.8 percent, 8.1 percent, and 7.5 percent of operating revenues, respectively.\nGULF STATES SETTLEMENT COMPLETED\nOn November 7, 1991, the subsidiaries of The Southern Company entered into a settlement agreement with Gulf States Utilities Company (Gulf States) that resolved litigation between the companies that had been pending since 1986 and arose out of a dispute over certain unit power and other long-term power sales contracts. In 1993, all remaining terms and obligations of the settlement agreement were satisfied.\nBased on the value of the settlement proceeds received - less the amounts previously included in income - the Company recorded increases in net income of approximately $0.6 million in 1992 and $12.7 million in 1991. In 1993, the Company sold all of its remaining Gulf States common stock received in the settlement, resulting in a gain of $2.3 million after tax.\n8. INCOME TAXES:\nEffective January 1, 1993, Gulf Power Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no effect on net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $31.3 million are revenues to be received from customers. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The related liabilities of $76.9 million are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nII-162 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\nDetails of the federal and state income tax provisions are as follows:\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities are as follows:\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Statements of Income. Credits amortized in this manner amounted to $2.3 million in 1993, 1992 and 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:\nGulf Power Company and the other subsidiaries of The Southern Company file a consolidated federal tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\nII-163 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\n9. LONG-TERM DEBT:\nPOLLUTION CONTROL OBLIGATIONS\nObligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds are as follows:\n* Sinking fund requirement applicable to the 6 percent pollution control bonds is $100 thousand for 1994 with increasing increments thereafter through 2005, with the remaining balance due in 2006.\nWith respect to the collateralized pollution control revenue bonds, the Company has authenticated and delivered to trustees a like principal amount of first mortgage bonds as security for obligations under collateralized installment agreements. The principal and interest on the first mortgage bonds will be payable only in the event of default under the agreements.\nOTHER LONG-TERM DEBT\nLong-term debt also includes $17.5 million for the Company's portion of notes payable issued in connection with the termination of Plant Daniel coal contracts (see Note 5 for information on fuel commitments). The notes bear interest at 8.25 percent with the principal being amortized through 1995. Also included in long-term debt is a 30-month note payable for $25 million which was obtained to refinance higher cost securities. The principal is due in June 1996 and bears interest at 4.69 percent which is payable quarterly beginning March 1994. The estimated annual maturities of the notes payable through 1996 are as follows: $8.4 million in 1994, $9.1 million in 1995, and $25 million in 1996.\n10. LONG-TERM DEBT DUE WITHIN ONE YEAR:\nA summary of the improvement fund requirement and scheduled maturities and redemptions of long-term debt due within one year is as follows:\nThe first mortgage bond improvement (sinking) fund requirement amounts to 1 percent of each outstanding series of bonds authenticated under the indenture prior to January 1 of each year, other than those issued to collateralize pollution control obligations. The requirement may be satisfied by depositing cash, reacquiring bonds, or by pledging additional property equal to 1 and 2\/3 times the requirement. In 1994, $12 million of 4 5\/8 percent First Mortgage Bonds due October 1, 1994 and $15 million of 6 percent First Mortgage Bonds due June 1, 1996 are scheduled to be redeemed.\nII-164 NOTES (CONTINUED) Gulf Power Company 1993 Annual Report\n11. COMMON STOCK DIVIDEND RESTRICTIONS:\nThe Company's first mortgage bond indenture contains various common stock dividend restrictions which remain in effect as long as the bonds are outstanding. At December 31, 1993, $101 million of retained earnings was restricted against the payment of cash dividends on common stock under the terms of the mortgage indenture.\nThe Company's charter limits cash dividends on common stock to 50 percent of net income available for such stock during a prior period if the capitalization ratio is below 20 percent and to 75 percent of such net income if such ratio is 20 percent or more but less than 25 percent. The capitalization ratio is defined as the ratio of common stock equity to total capitalization, including retained earnings, adjusted to reflect the payment of the proposed dividend. At December 31, 1993, the ratio was 44.4 percent.\n12. QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data for 1993 and 1992 are as follows:\nThe Company's business is influenced by seasonal weather conditions and the timing of rate changes, among other factors.\nII-165 SELECTED FINANCIAL AND OPERATING DATA Gulf Power Company 1993 Annual Report\nII-166 SELECTED FINANCIAL AND OPERATING DATA (CONTINUED) Gulf Power Company 1993 Annual Report\nII-167 SELECTED FINANCIAL AND OPERATING DATA (CONTINUED) Gulf Power Company 1993 Annual Report\nII-168 SELECTED FINANCIAL AND OPERATING DATA (CONTINUED) Gulf Power Company 1993 Annual Report\nII-169\nSTATEMENTS OF INCOME Gulf Power Company\nII-170\nSTATEMENTS OF INCOME Gulf Power Company\nII-171\nSTATEMENTS OF CASH FLOWS Gulf Power Company\nII-172\nSTATEMENTS OF CASH FLOWS Gulf Power Company\nII-173\nBALANCE SHEETS Gulf Power Company\nII-174\nBALANCE SHEETS Gulf Power Company\nII-175 BALANCE SHEETS Gulf Power Company\nII-176\nBALANCE SHEETS Gulf Power Company\nII-177\nGULF POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1993\nFIRST MORTGAGE BONDS\nPOLLUTION CONTROL BONDS\nPREFERRED STOCK\n(1) Subject to mandatory redemption of 5% annually on or before February 1.\nII-178\nGULF POWER COMPANY\nSECURITIES RETIRED DURING 1993\nFIRST MORTGAGE BONDS\nPOLLUTION CONTROL BONDS\nPREFERRED STOCK\nII-179\nMISSISSIPPI POWER COMPANY\nFINANCIAL SECTION\nII-180\nMANAGEMENT'S REPORT Mississippi Power Company 1993 Annual Report\nThe management of Mississippi Power Company has prepared--and is responsible for--the financial statements and related information included in this report. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that books and records reflect only authorized transactions of the Company. Limitations exist, however, in any system of internal control, based upon a recognition that the cost of the system should not exceed its benefits. The Company believes its system of internal accounting control maintains an appropriate cost\/benefit relationship.\nThe Company's system of internal accounting controls is evaluated on an ongoing basis by the internal audit staff. The Company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, composed of four directors who are not employees, provides a broad overview of management's financial reporting and control functions. Periodically, this committee meets with management, the internal auditors, and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal controls, and financial reporting matters. The internal auditors and independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the Company's operations are conducted according to a high standard of business ethics.\nIn management's opinion, the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of Mississippi Power Company in conformity with generally accepted accounting principles.\n\/s\/ David M. Ratcliffe -------------------------------------------------- David M. Ratcliffe President and Chief Executive Officer\n\/s\/ Thomas A. Fanning -------------------------------------------------- Thomas A. Fanning Vice President and Chief Financial Officer\nII-181\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF MISSISSIPPI POWER COMPANY:\nWe have audited the accompanying balance sheets and statements of capitalization of Mississippi Power Company (a Mississippi corporation and a wholly owned subsidiary of The Southern Company) as of December 31, 1993 and 1992, and the related statements of income, retained earnings, paid-in capital, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-190 through II-206) referred to above present fairly, in all material respects, the financial position of Mississippi Power Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 9 to the financial statements, effective January 1, 1993, Mississippi Power Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16 , 1994\nII-182\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Mississippi Power Company 1993 Annual Report\nRESULTS OF OPERATIONS\nEARNINGS\nMississippi Power Company's net income after dividends on preferred stock for 1993 totaled $42.4 million, an increase of $5.6 million over the prior year. This improvement is attributable primarily to increased energy sales and retail rate increases. A retail rate increase under the Company's Performance Evaluation Plan (PEP-1A) of $6.4 million annually became effective in July 1993. Under the Environmental Compliance Overview Plan (ECO Plan) retail rates increased by $2.6 million annually effective April 1993.\nA comparison of 1992 to 1991 - excluding the events occurring in 1991 discussed below - would reflect a 1992 increase in earnings of $4.9 million or 15.5 percent. The Company's financial performance in 1991 reflected the after-tax operating and disposal losses of $11.9 million recorded by the Company's former merchandise subsidiary. These losses were partially offset by a $2.6 million positive impact on earnings from the settlement of the contract dispute with Gulf States Utilities Company (Gulf States).\nREVENUES\nThe following table summarizes the factors impacting operating revenues for the past three years:\n*Includes the effect of the retail rate increase approved under the ECO Plan.\nRetail revenues of $368 million in 1993 increased 9.0 percent over the prior year, compared with an increase of 2.2 percent for 1992 and a decrease of 1.5 percent in 1991. The increase in retail revenues for 1993 was a result of growth in energy sales and customers, the favorable impact of weather, and retail rate increases. Changes in base rates reflect rate changes made under the PEP plans and the ECO Plan as approved by the Mississippi Public Service Commission (MPSC).\nThe increase in revenues for the recovery of fuel costs for 1993 reversed two years of decline. Under the fuel cost recovery provision, recorded fuel revenues are equal to recorded fuel expenses, including the fuel component and the operation and maintenance component of purchased energy. Therefore, changes in recoverable fuel expenses are offset with corresponding changes in fuel revenues and have no effect on net income.\nII-183\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\nIncluded in sales for resale to non-affiliates are revenues from rural electric cooperative associations and municipalities located in southeastern Mississippi. Energy sales to these customers in 1993 increased 9.0 percent over the prior year with the related revenues rising 14.1 percent. The customer demand experienced by these utilities is determined by factors very similar to Mississippi Power's.\nSales for resale to non-affiliated non-territorial utilities are primarily under long-term contracts consisting of capacity and energy components. Capacity revenues reflect the recovery of fixed costs and a return on investment under the contracts. Energy is generally sold at variable cost. The capacity and energy components were:\nCapacity revenues for Mississippi Power increased in 1993 and 1992 due to a change in the allocation of transmission capacity revenues throughout the Southern electric system. Most of the Company's capacity revenues are derived from transmission charges.\nSales to affiliated companies within the Southern electric system will vary from year to year depending on demand and the availability and cost of generating resources at each company. These sales have no material impact on earnings.\nThe increase in other operating revenues for 1993 was due to increased rents collected from microwave equipment use and the transmission of non-associated companies' electricity.\nBelow is a breakdown of kilowatt-hour sales for 1993 and the percent change for the last three years:\nTotal retail energy sales in 1993 increased compared to the previous year, due primarily to weather influences and the improvement in the economy. The increase in commercial energy sales also reflects the impact of recently established casinos within the Company's service area. Industrial sales increased in 1992 as a result of new contracts with two large industrial customers.\nThe decrease in energy sales for resale to non-affiliates is predominantly due to reductions in unit power sales under long-term contracts to Florida utilities. Economy sales and amounts sold under short-term contracts are also sold for resale to non-affiliates. Sales for resale to non-affiliates are influenced by those utilities' own customer demand, plant availability, and the cost of their predominant fuels -- oil and natural gas.\nEXPENSES\nTotal operating expenses for 1993 were higher than the previous year because of higher production expenses, which reflects increased demand, an increase in the federal income tax rate, and higher employee-related costs. (See Note 2 to the financial statements for information regarding employee and retiree benefits.) Additionally, included in other operation expenses are increased costs associated with environmental remediation of a Southern electric system research facility. Expenses in 1992 were lower than 1991, excluding the Gulf States settlement, primarily because of lower production expenses stemming from decreased demand.\nII-184 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\nFuel costs constitute the single largest expense for Mississippi Power. These costs increased in 1993 due to an 11.0 percent increase in generation, which reflects higher demand. Fuel expenses in 1992, compared to 1991, were lower because of less generation and the negotiation of new coal contracts. Generation decreased primarily because of the availability of lower cost generation elsewhere within the Southern electric system.\nPurchased power consists primarily of energy purchases from the affiliates of the Southern electric system. Purchased power transactions (both sales and purchases) among Mississippi Power and its affiliates will vary from period to period depending on demand and the availability and variable production cost at each generating unit in the Southern electric system.\nTaxes other than income taxes increased in 1993 because of higher ad valorem taxes, which are property based, and municipal franchise taxes, which are revenue based. The decline in 1992 was attributable to lower franchise taxes.\nIncome tax expense in 1993 increased because of the enactment of a higher corporate income tax rate retroactive to January 1, 1993, coupled with higher earnings. The change in income taxes for 1992 and 1991 reflected the change in operating income.\nEFFECTS OF INFLATION\nMississippi Power is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its costs of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical costs does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations, such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors ranging from regulatory matters to growth in energy sales. Expenses are subject to constant review and cost control programs. Among the efforts to control costs are utilizing employees more effectively through a functionalization program for the Southern electric system, redesigning compensation and benefit packages, and re- engineering work processes. Mississippi Power is also maximizing the utility of invested capital and minimizing the need for capital by refinancing, decreasing the average fuel stockpile, raising generating plant availability and efficiency, and curbing the construction budget. Operating revenues will be affected by any changes in rates under the PEP-2, the Company's revised performance based ratemaking plan. The PEP plans have proved to be a stabilizing force on electric rates, with only moderate changes in rates taking place.\nThe ECO Plan, approved by the MPSC in 1992, provides for recovery of costs associated with environmental projects approved by the MPSC, most of which are required to comply with Clean Air Act Amendments of 1990 regulations. The ECO Plan is operated independently of PEP-2.\nThe FERC regulates wholesale rate schedules and power sales contracts that Mississippi Power has with its sales for resale customers. The FERC is currently reviewing the rate of return on common equity included in these schedules and contracts and may require such returns to be lowered, possibly retroactively. Also, pending before the FERC is the Company's request for a $3.6 million wholesale rate increase.\nFurther discussion of the PEP plans, the ECO Plan, and proceedings before the FERC is made in Note 3 to the financial statements herein.\nFuture earnings in the near term will depend upon growth in energy sales, which are subject to a number of factors. Traditionally, these factors have included changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, weather, competition, and the rate of economic growth in Mississippi Power's service area. However, the Energy\nII-185\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\nPolicy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric utilities. The Energy Act allows Independent Power Producers (IPPs) to access a utility's transmission network in order to sell electricity to other utilities, and this may enhance the incentive of IPPs to build cogeneration plants for a utility's large industrial and commercial customers. Although the Energy Act does not require transmission access to retail customers, pressure for legislation to allow retail wheeling will continue. Mississippi Power is preparing to meet the challenge of this major change in the traditional business practices of selling electricity. If Mississippi Power does not remain a low-cost producer and provider of quality service, the Company's retail energy sales growth, as well as new long-term contracts for energy sales outside the service area, could be limited, which could significantly reduce earnings.\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be effective by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental unemployment benefits, disability-related benefits, job training, and health and life insurance coverage. In 1993, Mississippi Power adopted Statement No. 112, with no material effect on the financial statements.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which is effective in 1994. Statement No. 115 supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. In January 1994, Mississippi Power adopted the new rules, with no material effect on the financial statements.\nOn January 1, 1993, Mississippi Power changed its methods of accounting for postretirement benefits other than pensions and income taxes. See Notes 2 and 9 to the financial statements regarding the impact of these changes.\nFINANCIAL CONDITION\nOVERVIEW\nThe principal changes in Mississippi Power's financial condition during 1993 were gross property additions of $140 million to utility plant, a significant lowering of cost of capital through refinancings, and the resolution of PEP and ratepayer litigation. Funding for gross property additions came primarily from capital contributions from The Southern Company, earnings and other operating cash flows. The Statements of Cash Flows provide additional details.\nFINANCING ACTIVITY\nMississippi Power continued to lower its financing costs in 1993 by issuing new debt and equity securities and retiring high- cost issues. The Company sold $132 million of first mortgage bonds, preferred stock and, through public authorities, pollution control revenue bonds. Retirements, including maturities during 1993, totaled some $101 million of such securities. (See the Statements of Cash Flows for further details.) Composite financing rates for the years 1991 through 1993 as of year-end were as follows:\nII-186 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\nCAPITAL STRUCTURE\nAt year-end 1993, the Company's ratio of common equity to total capitalization was 49.8 percent, compared to 47.3 percent in 1992 and 44.4 percent in 1991. The increase in the ratio in 1993 can be attributed primarily to the receipt of $30 million of capital contributions from The Southern Company.\nCAPITAL REQUIREMENTS FOR CONSTRUCTION\nThe Company's projected construction expenditures for the next three years total $256 million ($96 million in 1994, $62 million in 1995, and $98 million in 1996). The major emphasis within the construction program will be on complying with Clean Air Act regulations, completion of a 78-megawatt combustion turbine, and upgrading existing facilities. The estimates for property additions for the three-year period include $39 million committed to meeting the requirements of Clean Air Act regulations. Revisions may be necessary because of factors such as revised load projections, the availability and cost of capital, and changes in environmental regulations.\nOTHER CAPITAL REQUIREMENTS\nIn addition to the funds required for the Company's construction program, approximately $51 million will be required by the end of 1996 for present sinking fund requirements and maturities of long-term debt. Mississippi Power plans to continue, when economically feasible, to retire high-cost debt and preferred stock and replace these obligations with lower-cost capital.\nENVIRONMENTAL MATTERS\nIn November 1990, the Clean Air Act Amendments of 1990 (Clean Air Act) were signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- will have a significant impact on Mississippi Power and the other operating companies of The Southern Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995, and affects eight generating plants -- some 10 thousand megawatts of capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing more slowly than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $275 million through 1995 for The Southern Company, of which Mississippi Power's portion is approximately $60 million.\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I, increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 to 2000, compliance for The Southern Company could require total construction expenditures ranging from approximately $450 million to $800 million,\nII-187 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\nof which Mississippi Power's portion is approximately $25 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nAn average increase of up to 3 percent in revenue requirements from customers could be necessary to fully recover The Southern Company's costs of compliance for both Phase I and II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nMississippi Power's ECO Plan is designed to allow recovery of costs of compliance with the Clean Air Act, as well as other environmental statutes and regulations. The MPSC reviews environmental projects and the Company's environmental policy through the ECO Plan. Under the ECO Plan, any increase in the annual revenue requirement is limited to 2 percent of retail revenues. However, the plan also provides for carryover of any amount over the 2 percent limit into the next year's revenue requirement. Mississippi Power's management believes that the ECO Plan will provide for recovery of the Clean Air Act costs.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standard could result in significant additional costs. The impact of new standards -- if any -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a new standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provisions of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matter, nitrogen oxides, and ozone. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the non-hazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes -- coal ash and other utility wastes -- as either non-hazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nThe Company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the Company could incur costs to clean up properties currently or previously owned. The Company conducts studies to determine the extent of any required clean-up costs and has recognized in the financial statements costs to clean up known sites.\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act; the Resource Conservation and Recovery Act; and the Comprehensive Environmental Response, Compensation, and Liability Act. Changes to these laws could affect many areas of the Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields, and other environmental and health concerns could significantly affect the Company. The impact of new legislation -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the\nII-188\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1993 Annual Report\npotential for lawsuits alleging damages caused by electromagnetic fields exists.\nSOURCES OF CAPITAL\nAt December 31, 1993, the Company had $70 million of committed credit in revolving credit agreements and also had $21 million of committed short-term credit lines. The $40 million of notes payable outstanding at year end 1993 were apart from the committed credit facilities.\nIt is anticipated that the funds required for construction and other purposes, including compliance with environmental regulations will be derived from operations, the sale of additional first mortgage bonds, pollution control obligations, and preferred stock, and the receipt of additional capital contributions from The Southern Company. Mississippi Power is required to meet certain coverage requirements specified in its mortgage indenture and corporate charter to issue new first mortgage bonds and preferred stock. The Company's coverage ratios are sufficiently high enough to permit, at present interest rate levels, any foreseeable security sales. The amount of securities which the Company will be permitted to issue in the future will depend upon market conditions and other factors prevailing at that time.\nII-189\nSTATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 Mississippi Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-190\nSTATEMENTS OF CASH FLOWS For the Years ended December 31, 1993, 1992, and 1991 Mississippi Power Company 1993 Annual Report\n( ) Denotes use of cash. The accompanying notes are an integral part of these statements.\nII-191\nBALANCE SHEETS At December 31, 1993 and 1992 Mississippi Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-192\nBALANCE SHEETS At December 31, 1993 and 1992 Mississippi Power Company 1993 Annual Report\nII-193\nSTATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 Mississippi Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-194\nSTATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991 Mississippi Power Company 1993 Annual Report\nSTATEMENTS OF PAID-IN CAPITAL For the Years Ended December 31, 1993, 1992, and 1991\nThe accompanying notes are an integral part of these statements.\nII-195\nNOTES TO FINANCIAL STATEMENTS Mississippi Power Company 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nMississippi Power Company is a wholly owned subsidiary of The Southern Company, which is the parent company of five operating companies, Southern Company Services (SCS), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and various other subsidiaries related to foreign utility operations and domestic non-utility operations. The operating companies (Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, and Savannah Electric and Power Company) provide electric service in four southeastern states. Contracts among the companies--dealing with jointly owned generating facilities, interconnecting transmission lines, and the exchange of electric power--are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission. SCS provides, at cost, specialized services to The Southern Company and to the subsidiary companies. Southern Electric designs, builds, owns, and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides services to The Southern Company's nuclear power plants.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA). Both The Southern Company and its subsidiaries are subject to the regulatory provisions of the PUHCA. Mississippi Power is also subject to regulation by the FERC and the Mississippi Public Service Commission (MPSC). The Company follows generally accepted accounting principles and complies with the accounting policies and practices prescribed by the respective commissions.\nThe 1991 financial statements of the Company included the accounts of Electric City Merchandise Company, Inc. (Electric City), which discontinued operations in 1991. All significant intercompany transactions were eliminated in consolidation.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nREVENUES\nMississippi Power accrues revenues for service rendered but unbilled at the end of each fiscal period. The Company's retail and wholesale rates include provisions to adjust billings for fluctuations in fuel and the energy component of purchased power. Retail rates also include provisions to adjust billings for fluctuations in costs for ad valorem taxes. Revenues are adjusted for differences between the recoverable fuel and ad valorem expenses and the amounts actually recovered in current rates.\nDEPRECIATION\nDepreciation of the original cost of depreciable utility plant in service is provided by using composite straight-line rates which approximated 3.1 percent in 1993 and 3.3 percent in 1992 and 1991. When property subject to depreciation is retired or otherwise disposed of in the normal course of business, its cost -- together with the cost of removal, less salvage -- is charged to the accumulated provision for depreciation. Minor items of property included in the original cost of the plant are retired when the related property unit is retired.\nINCOME TAXES\nMississippi Power provides deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, Mississippi Power adopted FASB Statement No. 109, Accounting for Income Taxes. Statement No. 109 required, among other things, conversion to the liability method of accounting for accumulated deferred income taxes. See Note 9 to the financial statements for additional information about Statement No. 109.\nII-196\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. The composite rates used to capitalize the cost of funds devoted to construction were 6.8 percent in 1993, 8.2 percent in 1992, and 9.8 percent in 1991. AFUDC (net of income taxes), as a percent of net income after dividends on preferred stock, was 3.5 percent in 1993, 2.7 percent in 1992, and 4.8 percent in 1991.\nUTILITY PLANT\nUtility plant is stated at original cost. This cost includes: materials; labor; minor items of property; appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; and the estimated cost of funds used during construction. The cost of maintenance, repair, and replacement of minor items of property is charged to maintenance expense except for the maintenance of coal cars and a portion of the railway track maintenance, which are charged to fuel stock. The cost of replacements of property (exclusive of minor items of property) is charged to utility plant.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Statements of Cash Flows, temporary cash investments are considered cash equivalents. Temporary cash investments are securities with original maturities of 90 days or less.\nFINANCIAL INSTRUMENTS\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, all financial instruments of the Company -- for which the carrying amount does not approximate fair value -- are shown in the table below as of December 31:\nThe fair value of investment securities was based on listed closing market prices. The fair value for long-term debt was based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when used or installed.\nVACATION PAY\nMississippi Power's employees earn their vacation in one year and take it in the subsequent year. However, for ratemaking purposes, vacation pay is recognized as an allowable expense only when paid. Consistent with this ratemaking treatment, the Company accrues a current liability for earned vacation pay and records a current asset representing the future recoverability of this cost. Such amounts were $4.8 million and $4.7 million at December 31, 1993 and 1992, respectively. In 1994, an estimated 80 percent of the 1993 deferred vacation cost will be expensed, and the balance will be charged to construction and other accounts.\nII-197\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nPROVISION FOR PROPERTY DAMAGE\nDue to the significant increase in the cost of traditional insurance, effective in 1993, Mississippi Power became self-insured for the full cost of storm and other damage to its transmission and distribution property. As permitted by regulatory authorities, the Company provided for the cost of storm, fire and other uninsured casualty damage by charges to income of $1.5 million in 1993, 1992, and 1991. The cost of repairing damage resulting from such events that individually exceed $50 thousand is charged to the accumulated provision to the extent it is available. As of December 31, 1993, the accumulated provision amounted to $10.5 million. Regulatory treatment by the MPSC allows a maximum accumulated provision of $10.9 million.\nDISCONTINUED OPERATIONS\nElectric City began operating as a subsidiary of Mississippi Power in October 1987 and was formally dissolved as of December 31, 1991. Under an agreement reached in October 1991, a portion of Electric City's assets, including inventory and fixed assets, was sold to a concern independent of Mississippi Power. The remaining assets and liabilities, which were not material, were transferred to the Company.\nThe impact of Electric City on Mississippi Power's consolidated earnings in 1991 consisted of (a) a pretax operating loss of $10.2 million ($6.4 million after income taxes) and (b) the pretax loss of $8.7 million ($5.5 million after income taxes) resulting from the disposal of Electric City.\n2. RETIREMENT BENEFITS:\nPENSION PLAN\nMississippi Power has a defined benefit, trusteed, non-contributory pension plan that covers substantially all regular employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and final average pay or years of service and a flat-dollar benefit. The Company uses the \"entry age normal method with a frozen initial liability\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension fund are primarily invested in equity and fixed-income securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the \"projected unit credit\" actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nMississippi Power also provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. A qualified trust for medical benefits has been established for funding amounts to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded.\nEffective January 1, 1993, Mississippi Power adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\" Because the adoption of Statement No. 106 was reflected in rates, it did not have a material impact on net income.\nPrior to 1993, Mississippi Power recognized these benefit costs on an accrual basis using the \"aggregate cost\" actuarial method, which spreads the expected cost of such benefits over the remaining periods of employees' service as a level percentage of payroll costs. The total costs of such benefits recognized by the Company in 1992 and 1991 were $3.6 million and $3.0 million, respectively.\nII-198\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nSTATUS AND COST OF BENEFITS\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of FASB Statement Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown only for 1993 because Statement No. 106 was adopted as of January 1, 1993, on a prospective basis. The funded status of the plans at December 31 was as follows:\nThe weighted average rates assumed in the above actuarial calculations were:\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1993, by $6.4 million and the aggregate of the service and interest cost components of the net retiree medical cost by $722 thousand.\nComponents of the plans' net cost are shown below:\nII-199\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nOf the above net pension amounts recorded, ($170 thousand) in 1993, $269 thousand in 1992, and $576 thousand in 1991 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nOf the above net postretirement medical and life insurance costs recorded in 1993, $3.9 million was charged to operating expense and the remainder was charged to construction and other accounts.\n3. LITIGATION AND REGULATORY MATTERS:\nRETAIL RATE ADJUSTMENT PLANS\nMississippi Power's retail base rates have been set under a Performance Evaluation Plan (PEP) since 1986. During 1993, all matters related to the original PEP case were finally resolved when the Supreme Court of Mississippi granted a joint motion to dismiss pending appeals. Also in 1993, the MPSC ordered Mississippi Power to review and propose changes to the plan that would reduce the impact of rate changes on the customer and provide incentives for Mississippi Power to keep customer prices low. In response, Mississippi Power filed a revised plan and, on January 4, 1994, the MPSC approved PEP-2. The revised plan includes a mechanism for sharing rate adjustments based on the Company's ability to maintain low rates for customers and on the Company's performance as measured by three performance indicators that emphasize those factors which most directly impact the customers. PEP-2 provides for semiannual evaluations of Mississippi's performance-based return on investment, rather than on common equity as previously calculated. As in previous plans, any change in rates is limited to 2 percent of retail revenues per evaluation period before a public hearing is required. PEP-2 will remain in effect until the MPSC modifies or terminates the plan.\nENVIRONMENTAL COMPLIANCE OVERVIEW PLAN\nThe MPSC approved Mississippi Power's ECO Plan in 1992. The plan establishes procedures to facilitate the MPSC's overview of the Company's environmental strategy and provides for recovery of costs associated with environmental projects approved by the MPSC. Under the ECO Plan any increase in the annual revenue requirement is limited to 2 percent of retail revenues. However, the plan also provides for carryover of any amount over the 2 percent limit into the next year's revenue requirement. The ECO Plan resulted in an annual retail rate increase of $2.6 million effective April 1993.\nFERC REVIEWS EQUITY RETURNS AND OTHER REGULATORY MATTERS\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the Southern electric system's wholesale rate schedules and contracts that have a return on equity of 13.75 percent or greater. The contracts that could be affected by the hearings include substantially all of the transmission, unit power, long-term power and other similar contracts, including the Company's Transmission Facilities Agreement (TFA) discussed in Note 8 under \"Lease Agreements.\" Any changes in rate of return on common equity that may occur as a result of this proceeding would be effective 60 days after a proper notice of the proceeding is published. A notice was published on May 10, 1991.\nIn August 1992, an administrative law judge issued an opinion that changes in rate schedules and contracts were not necessary and that the FERC staff failed to show how any changes were in the public interest. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, the final outcome will not have a material adverse effect on Mississippi Power's financial statements.\nIn 1988, the Company and its operating affiliates filed with the FERC a contract governing the pricing and other aspects of power transactions among the companies. In 1989, the FERC ordered hearings on the contract and made revenues collected under the contract subject to refund. In 1992, the\nII-200 NOTES (continued) Mississippi Power Company 1993 Annual Report\nFERC ruled that certain production costs under the contract had not been properly classified and ordered that the contract be revised and that refunds be made. Under reconsideration, the FERC determined that refunds were not necessary and ordered that its mandated changes in computing certain expenses under the system interchange contract become effective in August 1993. The changes mandated by the FERC will not materially affect the Company's net income.\nWHOLESALE RATE FILING\nOn September 1, 1993, Mississippi Power filed a $3.6 million wholesale rate increase request with the FERC. Prior to this filing, the Company conferred and negotiated a settlement with all of its wholesale all requirements customers, who have executed a Settlement Agreement and Certificates of Concurrence to be included in this filing with the FERC. The Company is awaiting a response from the FERC.\nRETAIL RATEPAYERS' SUITS CONCLUDED\nIn 1989, three retail ratepayers of the Company filed a civil complaint in the U.S. District Court for the Southern District of Mississippi against Mississippi Power and other parties. The complaint alleged that Mississippi Power obtained excessive rate increases by improper accounting for spare parts and sought actual damages estimated to be at least $10 million, plus treble and punitive damages, on behalf of all retail ratepayers of the Company for alleged violations of the federal Racketeer Influenced and Corrupt Organizations Act, federal and state antitrust laws, other federal and state statutes, and common law fraud. Mississippi Power also was named as a defendant, together with other parties in a similar civil action filed in the U.S. District Court for the Northern District of Florida. The defendants' motions for dismissal were granted by the courts, resolving these suits.\n4. CONSTRUCTION PROGRAM:\nMississippi Power is engaged in continuous construction programs, the costs of which are currently estimated to total some $96 million in 1994, $62 million in 1995, and $98 million in 1996. These estimates include AFUDC of $1.6 million in 1994, $1.6 million in 1995, and $2.7 million in 1996.\nThe construction program is subject to periodic review and revision, and actual construction costs may vary from the above estimates because of numerous factors. These factors include changes in business conditions; revised load growth estimates; changes in environmental regulations; increasing costs of labor, equipment and materials; and cost of capital. The Company does not have any new baseload generating plants under construction. However, the construction of a combustion turbine generation unit of 78 megawatts was completed in February 1994. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\nSee Management's Discussion and Analysis under \"Environmental Matters\" for information on the impact of the Clean Air Act and other environmental matters.\n5. FINANCING AND COMMITMENTS:\nFINANCING\nMississippi Power's construction program is expected to be financed from internal and other sources, such as the issuance of additional long-term debt and preferred stock and the receipt of capital contributions from The Southern Company.\nThe amounts of first mortgage bonds and preferred stock which can be issued in the future will be contingent upon market conditions, adequate earnings levels, regulatory authorizations and other factors. See Management's Discussion and Analysis under \"Sources of Capital\" for information regarding the Company's coverage requirements.\nAt December 31, 1993, Mississippi Power had committed credit agreements (360 day committed lines) with banks for $21 million. Additionally, Mississippi Power had $70 million of unused committed credit agreements in the form of revolving credit agreements expiring December 1, 1996. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the Company's option. In connection with these credit arrangements, the Company agrees to pay commitment fees based on the unused portions of the commitments or to maintain compensating balances with the banks.\nAs of December 31, 1993, Mississippi Power had $40 million in short-term bank borrowings all of which were made apart from committed credit arrangements. II-201 NOTES (continued) Mississippi Power Company 1993 Annual Report\nASSETS SUBJECT TO LIEN\nMississippi Power's mortgage indenture dated as of September 1, 1941, as amended and supplemented, which secures the first mortgage bonds issued by the Company, constitutes a direct first lien on substantially all the Company's fixed property and franchises.\nFUEL COMMITMENTS\nTo supply a portion of the fuel requirements of its generating plants, Mississippi Power has entered into various long-term commitments for the procurement of fuel. In most cases, these contracts contain provisions for price escalations, minimum production levels, and other financial commitments. Total estimated obligations were approximately $243 million at December 31, 1993. Additional commitments for fuel will be required in the future to supply the Company's fuel needs.\nIn order to take advantage of lower cost coal supplies, agreements were reached in December 1986 to terminate two contracts for the supply of coal to Plant Daniel, which is jointly owned by Mississippi Power and Gulf Power, an operating affiliate. The Company's portion of this payment was about $60 million. In accordance with the ratemaking treatment, the cost to terminate the contracts is being amortized through 1995 to match costs with savings achieved. The remaining unamortized amount of Mississippi Power's share of principal payments to the suppliers including the current portion totaled $18 million at December 31, 1993.\n6. JOINT OWNERSHIP AGREEMENTS:\nMississippi Power and Alabama Power own as tenants in common Greene County Electric Generating Plant (coal) located in Alabama; and Mississippi Power and Gulf Power own as tenants in common Daniel Electric Generating Plant (coal) located in Mississippi. At December 31, 1993, Mississippi Power's percentage ownership and investment in these jointly owned facilities were as follows:\nMississippi Power's share of plant operating expenses is included in the corresponding operating expenses in the Statements of Income.\n7. LONG-TERM POWER SALES AGREEMENTS:\nGENERAL\nMississippi Power and the other operating affiliates of The Southern Company have entered into long-term contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside of the system's service area. Some of these agreements (unit power sales) are firm commitments and pertain to capacity related to specific generating units. Mississippi Power's participation in firm production capacity unit power sales ended in January 1989. However, the Company continues to participate in transmission and energy sales under the unit power sales agreements. The other agreements (other long-term sales) are non-firm commitments and are based on capacity of the system in general. Because the energy is generally sold at variable costs under these agreements, only revenues from capacity sales affect profitability. Off-system capacity revenues for the Company have been as follows:\nLong-term non-firm power of 400 megawatts was sold in 1993 by the Southern electric system to Florida Power Corporation. In January 1994, this amount decreased to 200 megawatts, and the contract will expire at year-end. II-202\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nGULF STATES SETTLEMENT COMPLETED\nOn November 7, 1991, subsidiaries of The Southern Company entered into a settlement agreement with Gulf States that resolved litigation between the companies that had been pending since 1986 and arose out of a dispute over certain unit power and other long-term power sales contracts. In 1993, all remaining terms and obligations of the settlement agreement were satisfied.\nBased on the value of the settlement proceeds received -- less the amounts previously included in income -- Mississippi Power recorded an increase in net income of approximately $2.6 million in 1991.\n8. LEASE AGREEMENTS:\nIn 1984, Mississippi Power and Gulf States entered into a forty-year transmission facilities agreement whereby Gulf States began paying a use fee to the Company covering all expenses relative to ownership and operation and maintenance of a 500 kV line, including amortization of its original $57 million cost. In 1993, 1992, and 1991 the use fees collected under the agreement, net of related expenses, amounted to $3.9 million, $3.9 million and $4.0 million, respectively, and are included with other income, net, in the Statements of Income. For other information see Note 3 under \"FERC Reviews Equity Returns and Other Regulatory Matters.\"\nIn 1989, Mississippi Power entered into a twenty-two year operating lease agreement for the use of 495 aluminum railcars to transport coal to Plant Daniel. Gulf Power, as joint owner of Plant Daniel, is responsible for one half of the lease costs. The Company's share of the lease is charged to fuel inventory and allocated to fuel expense as the fuel is used. The lease costs charged to inventory were $1.2 million in 1993, $1.2 million for 1992 and $1.3 million for 1991. For the year 1994, the Company's annual lease payment will be $1.2 million. The Company's annual lease payment for 1995 will be $2.4 million and for 1996, 1997, and in 1998 the payment will be $1.2 million. Lease payments after 1998 total approximately $17.4 million. The Company has the option after three years to purchase the railcars at the greater of termination value or fair market value. Additionally, at the end of the lease term, Mississippi Power has the option to renew the lease.\n9. INCOME TAXES:\nEffective January 1, 1993, Mississippi Power adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no effect on net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $25 million are revenues to be received from customers. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The related liabilities of $48 million are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nII-203\nNOTES (continued) Mississippi Power Company 1993 Annual Report\nDetails of the federal and state income tax provisions are shown below:\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities are as follows:\nIn 1989, under order of the MPSC, Mississippi Power began amortizing deferred income taxes not covered by the Internal Revenue Service normalization requirements, that had been recorded at rates higher than those specified by the current statutory income tax rules. This amortization occurred over a 60-month period, the effect of which was a reduction of income tax expense of approximately $2.7 million per year. At December 31, 1993, this tax rate differential was fully amortized.\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Statements of Income. Credits amortized in this manner amounted to $1.5 million in 1993, $1.4 million in 1992 and $1.5 million in 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nII-204 NOTES (continued) Mississippi Power Company 1993 Annual Report\nThe total provision for income taxes as a percentage of pre-tax income and the differences between those effective rates and the statutory federal tax rates were as follows:\nMississippi Power and its affiliates file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\n10. OTHER LONG-TERM DEBT:\nDetails of other long-term debt are as follows:\nPollution control obligations represent installment or lease purchases of pollution control facilities financed by application of funds derived from sales by public authorities of tax-exempt revenue bonds. Mississippi Power has authenticated and delivered to the Trustee a like principal amount of first mortgage bonds as security for obligations under collateralized installment agreements. The principal and interest on the first mortgage bonds will be payable only in the event of default under these agreements. The 5.8% Series of pollution control obligations has a cash sinking fund requirement of $10 thousand annually through 1997 and $20 thousand in 1998.\nAt December 31, 1993, under \"Other Property and Investments\" approximately $6 million related to the 6.20% Series of Pollution Control Obligations remains available for completion of certain solid waste disposal facilities.\nThe 8.25 percent notes payable relate to the termination of two coal contracts. See Note 5 under \"Fuel Commitments\" for information on these coal contracts.\nThe annual estimated maturities of total notes payable are $8.8 million in 1994 and $10.8 million in 1995.\nII-205\nNOTES (continued) Mississippi Power Company 1993 Annual Report\n11. LONG-TERM DEBT DUE WITHIN ONE YEAR:\nA summary of the improvement fund requirements and scheduled maturities and redemptions of long-term debt due within one year is as follows:\nThe first mortgage bond improvement fund requirement is one percent of each outstanding series authenticated under the indenture of Mississippi Power prior to January 1 of each year, other than first mortgage bonds issued as collateral security for certain pollution control obligations. The requirement must be satisfied by June 1 of each year by depositing cash or reacquiring bonds, or by pledging additional property equal to 166-2\/3 percent of such requirement.\n12. COMMON STOCK DIVIDEND RESTRICTIONS:\nMississippi Power's first mortgage bond indenture and the Articles of Incorporation contain various common stock dividend restrictions. At December 31, 1993, $86 million of retained earnings was restricted against the payment of cash dividends on common stock under the most restrictive terms of the mortgage indenture or Articles of Incorporation.\n13. QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data for 1993 and 1992 are as follows:\nMississippi Power's business is influenced by seasonal weather conditions and the timing of rate changes.\nII-206\nSELECTED FINANCIAL AND OPERATING DATA Mississippi Power Company 1993 Annual Report\nII-207\nII-208\nII-209\nII-210\nSTATEMENTS OF INCOME Mississippi Power Company\nII-211\nSTATEMENTS OF INCOME Mississippi Power Company\nII-212\nSTATEMENTS OF CASH FLOWS Mississippi Power Company\nII-213\nSTATEMENTS OF CASH FLOWS Mississippi Power Company\nII-214\nBALANCE SHEETS Mississippi Power Company\nII-215\nBALANCE SHEETS Mississippi Power Company\nII-216\nBALANCE SHEETS Mississippi Power Company\nII-217\nBALANCE SHEETS Mississippi Power Company\nII-218\nMISSISSIPPI POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1993\nFIRST MORTGAGE BONDS\nPOLLUTION CONTROL BONDS\nPREFERRED STOCK\nII-219\nMISSISSIPPI POWER COMPANY\nSECURITIES RETIRED DURING 1993\nFIRST MORTGAGE BONDS\nPOLLUTION CONTROL BONDS\nPREFERRED STOCK\nII-220\nSAVANNAH ELECTRIC AND POWER COMPANY\nFINANCIAL SECTION\nII-221\nMANAGEMENT'S REPORT Savannah Electric and Power Company 1993 Annual Report\nThe management of Savannah Electric and Power Company has prepared -- and is responsible for -- the financial statements and related information included in this report. These statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on the best estimates and judgments of management. Financial information throughout this annual report is consistent with the financial statements.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that books and records reflect only authorized transactions of the Company. Limitations exist in any system of internal controls, however, based on a recognition that the cost of the system should not exceed its benefits. The Company believes its system of internal accounting controls maintains an appropriate cost\/benefit relationship.\nThe Company's system of internal accounting controls is evaluated on an ongoing basis by the Company's internal audit staff. The Company's independent public accountants also consider certain elements of the internal control system in order to determine their auditing procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors, composed of four directors who are not employees, provides a broad overview of management's financial reporting and control functions. Periodically, this committee meets with management, the internal auditors and the independent public accountants to ensure that these groups are fulfilling their obligations and to discuss auditing, internal controls and financial reporting matters. The internal auditors and the independent public accountants have access to the members of the audit committee at any time.\nManagement believes that its policies and procedures provide reasonable assurance that the Company's operations are conducted according to a high standard of business ethics. In management's opinion, the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows of Savannah Electric and Power Company in conformity with generally accepted accounting principles.\n\/s\/ Arthur M. Gignilliat, Jr. \/s\/ K. R. Willis - -------------------------------- ------------------------------------- Arthur M. Gignilliat, Jr. K. R. Willis President Vice-President and Chief Executive Officer Treasurer and Chief Financial Officer\nII-222 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF SAVANNAH ELECTRIC AND POWER COMPANY:\nWe have audited the accompanying balance sheets and statements of capitalization of Savannah Electric and Power Company (a Georgia corporation) as of December 31, 1993 and 1992, and the related statements of income, retained earnings, paid-in capital, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-231 through II-244) referred to above present fairly, in all material respects, the financial position of Savannah Electric and Power Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\nAs explained in Notes 2 and 7 to the financial statements, effective January 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia, February 16, 1994\nII-223 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Savannah Electric and Power Company 1993 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nSavannah Electric and Power Company's net income after dividends on preferred stock for 1993 totaled $21.5 million, representing a $1.0 million (4.6 percent) increase from the prior year. The revenue impact of an increase in retail energy sales due to exceptionally hot summer weather was partially offset by the implementation of a work force reduction program which resulted in a one-time charge to operating expenses of approximately $4.5 million.\nIn 1992, earnings were $20.5 million, representing a $3.5 million (14.6 percent) decrease from the prior year. This decrease resulted primarily from increases in maintenance and administrative and general expenses, partially offset by a 4.6 percent increase in retail operating revenues. Operating revenues increased despite the negative impact of a $2.8 million annual reduction in retail base rates effective in June 1992, and mild weather.\nREVENUES\nTotal revenues for 1993 were $218.4 million, reflecting a 10.5 percent increase over 1992, primarily due to an increase in retail energy sales.\nThe following table summarizes the factors impacting operating revenues compared to the prior year for the 1991-1993 period:\nTotal retail revenues increased 11.5 percent in 1993, compared to a 4.6 percent increase in 1992. The increase in 1993 retail revenues attributable to growth in both retail customers and average use per customer was enhanced by exceptionally hot weather during the summer. The substantial increase in fuel cost recovery and other revenues reflects increases in net generation and the unit cost of purchased power. The increase in 1992 retail revenues resulted from growth in both retail customers and average use per customer, but was substantially offset by mild weather and the June 1992 base rate reduction.\nII-224 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\nUnder the Company's fuel cost recovery provisions, fuel revenues equal fuel expense, including the fuel and capacity components of purchased energy, and have no effect on earnings. Revenues from sales to non-affiliated utilities under long-term contracts consist of capacity and energy components. Capacity revenues reflect the recovery of fixed costs and a return on investment under the contracts. Energy is generally sold at variable cost. The capacity and energy components were:\nSales to affiliated companies within the Southern electric system vary from year to year depending on demand and the availability and cost of generating resources at each company. These sales have little impact on earnings.\nKilowatt-hour sales for 1993 and the percent change by year were as follows:\nThe increases in energy sales in 1993 and 1992 continue to reflect a growing customer base, an increase in average energy sales per customer, and improved economic conditions in the Company's service area. Sales were enhanced in 1993 by temperature extremes in the summer months and in December.\nEXPENSES\nTotal operating expenses for 1993 increased $20.3 million (12.4 percent) over the prior year. This increase includes a $10.8 million increase in fuel expense, and an $8.7 million increase in other operation expenses. Fuel expenses increased primarily because of higher generation due to extremely hot weather and higher cost fuel sources. In 1992 an increase in purchased power reflected a 15.4 percent decrease in generation compared to 1991. Despite the decrease in generation, total 1992 fuel expenses were substantially unchanged from the prior year reflecting generation from higher cost fuel sources.\nThe increase in other operation expenses reflects a $4.5 million cost associated with a one-time charge related to a work force reduction program. The Company also recognized higher employee benefits costs under new accounting rules adopted in 1993. See Note 2 to the financial statements for additional information on these new rules. In 1992, the increase in other operation expenses was primarily a result of increases in outside services and administrative and general expenses, which reflected higher employee training and benefits expenses. Total interest expense on long-term debt was reduced by 5.4 percent in 1992, as the Company refinanced higher-cost debt.\nII-225 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\nThe mix of energy supply is determined primarily by system load, the unit cost of fuel consumed and the availability of units.\nThe amount and sources of energy supply and the average cost of fuel per net kilowatt-hour generated and purchased power were as follows:\nEFFECTS OF INFLATION\nThe Company is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its costs of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFUTURE EARNINGS POTENTIAL\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors ranging from growth in energy sales to regulatory matters.\nFuture earnings in the near term will depend upon growth in energy sales, which is subject to a number of factors. Traditionally, these factors included changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, weather, competition, and the rate of economic growth in the Company's service area. However, the Energy Policy Act of 1992 (Energy Act) will have a profound effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric utilities. The Energy Act allows Independent Power Producers (IPPs) to access a utility's transmission network to sell electricity to other utilities. This may enhance the incentives for IPPs to build cogeneration plants for the Company's large industrial and commercial customers. Although the Energy Act does not require transmission access to retail customers, pressure for legislation to allow retail wheeling will continue. The Company is preparing now to meet the challenge of these major changes in the traditional business practices of selling electricity. If the Company does not remain a low-cost producer and provide quality service, the Company's retail energy sales growth, as well as new long-term contracts for energy sales outside the service area, could be limited, and this could significantly erode earnings.\nDemand-side options -- programs that enable customers to lower or alter their peak energy requirements -- have been initiated by the Company and are a significant part of integrated resource planning. Customers can receive cash incentives for participating in these programs in addition to reducing their energy requirements. Expansion and increased utilization of these programs will be contingent upon sharing of cost savings between the customers and the Company. Besides promoting energy efficiency, another benefit of these programs could be the ability to defer the need to construct baseload generating facilities further into the future. The ability to defer major construction projects, in conjunction with the precertification approval process for such projects by the Georgia Public Service Commission (GPSC), will\nII-226 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\ndiminish the possible exposure to prudency disallowances and the resulting impact on earnings.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could reduce earnings if such costs are not fully recovered. The Clean Air Act is discussed later under \"Environmental Matters.\"\nRates to retail customers served by the Company are regulated by the GPSC. In May 1992, the Company requested, and subsequently received, approval by the GPSC to reduce annual base revenues by $2.8 million, effective June 1992. The reduction includes a base rate reduction of approximately $2.5 million spread among all classes of retail customers. An additional $0.3 million reduction resulted from the implementation of an experimental, time-of-use rate for certain commercial customers. As part of this rate settlement, it was informally agreed that the Company's earned rate of return on common equity should be 12.95 percent.\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 112, Employers' Accounting for Postemployment Benefits, which must be implemented by 1994. The new standard requires that all types of benefits provided to former or inactive employees and their families prior to retirement be accounted for on an accrual basis. These benefits include salary continuation, severance pay, supplemental unemployment benefits, disability-related benefits, job training, and health and life insurance coverage.\nThe FASB has issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which is effective in 1994. Statement No. 115, supersedes FASB Statement No. 12, Accounting for Certain Marketable Securities. The Company adopted the new rules January 1, 1994, with no material effect on the financial statements.\nOn January 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes. See notes 2 and 7 to the financial statements regarding the impact of these changes.\nFINANCIAL CONDITION\nOVERVIEW\nThe principal change in the Company's financial condition in 1993 was additions of $73 million to utility plant. The majority of funds needed for gross property additions since 1990 have been provided from operating activities, principally from earnings and non-cash charges to income such as depreciation and deferred income taxes. See Statements of Cash Flows for additional information.\nCAPITAL STRUCTURE\nAs of December 31, 1993, the Company's capital structure consisted of 45.3 percent common equity, 10.3 percent preferred stock and 44.4 percent long-term debt, excluding amounts due within one year. The Company's long-term financial objective for capitalization ratios is to maintain a capital structure of common equity at 45 percent, preferred stock at 10 percent and debt at 45 percent.\nMaturities and retirements of long-term debt were $4 million in 1993, $53 million in 1992 and $23 million in 1991.\nIn November 1993, the Company issued 1,400,000 shares of 6.64 percent series preferred stock. In December 1993, the Company redeemed all 800,000 shares outstanding of its 9.5 percent series preferred stock at the prescribed redemption price of $26.57 plus accrued dividends.\nThe composite interest rates for the years 1991 through 1993 as of year-end were as follows:\nII-227 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\nThe Company's current securities ratings are as follows:\nCAPITAL REQUIREMENTS FOR CONSTRUCTION\nThe Company's projected construction expenditures for the next three years total $98 million ($33 million in 1994, $32 million in 1995, and $33 million in 1996). Actual construction costs may vary from this estimate because of such factors as changes in environmental regulations; revised load projections; the cost and efficiency of construction labor, equipment and materials; and the cost of capital. The largest project during this period is the addition of two 80 megawatt combustion turbine units, to be placed into service in 1994. The estimated cost of this project is $61 million. The Company is also constructing six combustion turbine units for Georgia Power Company.\nOTHER CAPITAL REQUIREMENTS\nIn addition to the funds needed for the construction program, approximately $5.9 million will be needed by the end of 1996 for present sinking fund requirements and maturities.\nENVIRONMENTAL MATTERS\nIn November 1990, the Clean Air Act was signed into law. Title IV of the Clean Air Act -- the acid rain compliance provision of the new law -- will have a significant impact on the Company and other subsidiaries of the Southern electric system. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants will be required in two phases. Phase I compliance must be implemented in 1995, and affects eight generating plants -- some 10,000 megawatts of capacity or 35 percent of total capacity -- in the Southern electric system. Phase II compliance is required in 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nBeginning in 1995, the Environmental Protection Agency (EPA) will allocate annual sulfur dioxide emission allowances through the newly established allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for allocating allowances is based on the fossil fuel consumed from 1985 through 1987 for each affected generating unit. Emission allowances are transferable and can be bought, sold, or banked and used in the future.\nThe sulfur dioxide emission allowance program is expected to minimize the cost of compliance. The market for emission allowances is developing slower than expected. However, The Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as the market develops.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, and this would require some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment would be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $275 million through 1995 for The Southern Company, of which the Company's portion is approximately $2 million.\nPhase II compliance costs are expected to be higher because requirements are stricter and all fossil-fired generating plants are affected. For sulfur dioxide compliance, The Southern Company could use emission allowances banked during Phase I and increase fuel switching, install flue gas desulfurization equipment at selected plants, and\/or purchase more allowances depending on the price and availability of allowances. Also, in Phase II, equipment to control nitrogen oxide emissions will be installed on additional system fossil-fired plants as required to meet anticipated Phase II limits. Therefore, during the period 1996 through 2000, compliance could require total construction expenditures ranging from approximately $450 million to $800 million of which the Company's portion is expected to be approximately $25 million. However, the full impact of\nII-228 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\nPhase II compliance cannot now be determined with certainty, pending the development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nAn increase of up to 5 percent in annual revenue requirements from customers could be necessary to fully recover the Company's costs of compliance for both Phase I and II of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nThere can be no assurance that all Clean Air Act costs will be recovered.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The study will serve as the basis for a decision on whether additional regulatory control of these substances is warranted. Compliance with any new control standards could result in significant additional costs. The impact of new standards -- if any - -- will depend on the development and implementation of applicable regulations.\nThe EPA continues to evaluate the need for a new short-term ambient air quality standard for sulfur dioxide. Preliminary results from an EPA study on the impact of a new standard indicate that a number of plants could be required to install sulfur dioxide controls. These controls would be in addition to the controls already required to meet the acid rain provision of the Clean Air Act. The EPA is expected to take some action on this issue in 1994. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn addition, the EPA is evaluating the need to revise the ambient air quality standards for particulate matters, nitrogen oxides, and ozone. The impact of any new standard will depend on the level chosen for the standard and cannot be determined at this time.\nIn 1994 or 1995, the EPA is expected to issue revised rules on air quality control regulations related to stack height requirements of the Clean Air Act. The full impact of the final rules cannot be determined at this time, pending their development and implementation.\nIn 1993, the EPA issued a ruling confirming the non-hazardous status of coal ash. However, the EPA has until 1998 to classify co-managed utility wastes--coal ash and other utility wastes--as either non-hazardous or hazardous. If the EPA classifies the co-managed wastes as hazardous, then substantial additional costs for the management of such wastes may be required. The full impact of any change in the regulatory status will depend on the subsequent development of co-managed waste requirements.\nSavannah Electric and Power Company must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the Company could incur costs to clean up properties currently or previously owned. The Company conducts studies to determine the extent of any required clean-up costs and will recognize in the financial statements any costs to clean up known sites.\nSeveral major pieces of environmental legislation are in the process of being reauthorized or amended by Congress. These include: the Clean Water Act, the Comprehensive Environmental Response, Compensation, and Liability Act, and the Resource Conservation and Recovery Act. Changes to these laws could affect many areas of the Company's operations. The full impact of these requirements cannot be determined at this time, pending the development and implementation of applicable regulations.\nCompliance with possible new legislation related to global climate change, electromagnetic fields, and other environmental and health concerns could significantly affect The Southern Company. The impact of new legislation - -- if any -- will depend on the subsequent development and implementation of applicable regulations. In addition, the potential for lawsuits alleging damages caused by electromagnetic fields exists.\nSOURCES OF CAPITAL\nAt December 31, 1993, the Company had $3.9 million of cash and $14.5 million of unused credit arrangements with banks to meet its short-term cash needs. The Company had $3 million of short-term bank borrowings at December 31, 1993. In January 1994, the Company renegotiated a two-year revolving credit arrangement with four of its\nII-229 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1993 Annual Report\nexisting banks for a total credit line of $20 million. The primary purpose of this additional credit is to provide interim funding for the Company's combustion turbine construction program.\nIt is anticipated that the funds required for construction and other purposes, including compliance with environmental regulations, will be derived from operations and the sale of additional first mortgage bonds and preferred stock and capital contributions from The Southern Company. The Company is required to meet certain coverage requirements specified in its mortgage indenture and corporate charter to issue new first mortgage bonds and preferred stock. The Company's coverage ratios are sufficiently high enough to permit, at present interest levels, any foreseeable security sales. The amount of securities which the Company will be permitted to issue in the future will depend upon market conditions and other factors prevailing at that time.\nII-230 STATEMENTS OF INCOME For the Years Ended December 31, 1993, 1992, and 1991 Savannah Electric and Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-231\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1993, 1992, and 1991 Savannah Electric and Power Company 1993 Annual Report\n( ) Denotes use of cash. The accompanying notes are an integral part of these statements.\nII-232\nBALANCE SHEETS At December 31, 1993 and 1992 Savannah Electric and Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-233\nBALANCE SHEETS At December 31, 1993 and 1992 Savannah Electric and Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-234\nSTATEMENTS OF CAPITALIZATION At December 31, 1993 and 1992 Savannah Electric and Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-235\nSTATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1993, 1992, and 1991 Savannah Electric and Power Company 1993 Annual Report\nThe accompanying notes are an integral part of these statements.\nII-236\nNOTES TO FINANCIAL STATEMENTS Savannah Electric and Power Company 1993 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nSavannah Electric and Power Company is a wholly owned subsidiary of The Southern Company, which is the parent company of five operating companies, a system service company, Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and various other subsidiaries related to foreign utility operations and domestic non-utility operations. At this time, the operations of the other subsidiaries are not material. The operating companies (Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, and Savannah Electric and Power Company) provide electric service in four Southeastern states. Contracts among the companies -- dealing with jointly owned generating facilities, interconnecting transmission lines and the exchange of electric power -- are regulated by the Federal Energy Regulatory Commission (FERC) or the Securities and Exchange Commission (SEC). The system service company provides, at cost, specialized services to The Southern Company and to the subsidiary companies. Southern Electric designs, builds, owns and operates power production facilities and provides a broad range of technical services to industrial companies and utilities in the United States and a number of international markets. Southern Nuclear provides services to The Southern Company's nuclear power plants.\nThe Southern Company is registered as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA). Both The Southern Company and its subsidiaries are subject to the regulatory provisions of the PUHCA. The Company also is subject to regulation by the FERC and the Georgia Public Service Commission (GPSC). The Company follows generally accepted accounting principles and complies with the accounting policies and practices prescribed by the GPSC.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nREVENUES AND FUEL COSTS\nThe Company accrues revenues for services rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as the fuel is used. The Company's electric rates include provisions to adjust billings for fluctuations in capacity and the energy components of purchased power costs. Revenues include the actual cost of fuel and purchased power incurred.\nDEPRECIATION AND AMORTIZATION\nDepreciation of the original cost of depreciable utility plant in service is provided primarily by using composite straight-line rates, which approximated 2.9 percent in 1993 and 3.2 percent in 1992, and 1991. The decrease in 1993 reflects the Company's implementation of new depreciation rates approved by the GPSC. These new rates provide for a timely recovery of the investments in the Company's depreciable properties.\nWhen property subject to depreciation is retired or otherwise disposed of in the normal course of business, its cost -- together with the cost of removal, less salvage -- is charged to the accumulated provision for depreciation. Minor items of property included in the original cost of the plant are retired when the related property unit is retired.\nINCOME TAXES\nThe Company, which is included in the consolidated federal income tax return filed by The Southern Company, provides deferred income taxes for all significant income tax temporary differences. Investment tax credits utilized are deferred and amortized to income over the average lives of the related property.\nIn years prior to 1993, income taxes were accounted for and reported under Accounting Principles Board Opinion No. 11. Effective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. Statement No. 109 required, among other things, conversion to the liability method of accounting for accumulated deferred income taxes. See Note 7 for additional information about Statement No. 109.\nII-237 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. The composite rates used by the Company to calculate AFUDC were 8.77 percent in 1993, 11.27 percent in 1992, and 11.38 percent in 1991.\nUTILITY PLANT\nUtility plant is stated at original cost, which includes materials, labor, minor items of property, appropriate administrative and general costs, payroll-related costs such as taxes, pensions and other benefits and the estimated cost of funds used during construction. The cost of maintenance, repairs, and replacement of minor items of property is charged to maintenance expense. The cost of replacements of property (exclusive of minor items of property) is charged to utility plant.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Statements of Cash Flows, temporary cash investments are considered cash equivalents. Temporary cash investments are securities with original maturities of 90 days or less.\nFINANCIAL INSTRUMENTS\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, items for which the carrying amount does not approximate fair value must be disclosed. At December 31, 1993, the fair value of long-term debt was $164 million and the carrying amount was $154 million. The fair value of long-term debt was $117 million and the carrying amount was $109 million at December 31, 1992. The fair value for long-term debt was based on either closing market prices or closing prices of comparable instruments.\nMATERIALS AND SUPPLIES\nGenerally, materials and supplies include the cost of transmission, distribution, and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed.\n2. RETIREMENT BENEFITS\nPENSION PLANS\nThe Company has a defined benefit, trusteed, non-contributory pension plan that covers substantially all regular employees. Benefits under this plan reflect the employee's years of service, age at retirement and average compensation for the three years immediately preceding retirement. The Company uses the projected unit credit actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension fund are primarily invested in equity and debt securities. FASB Statement No. 87, Employers' Accounting for Pensions, requires use of the \"projected unit credit\" actuarial method for financial reporting purposes.\nPOSTRETIREMENT BENEFITS\nThe Company also provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. A qualified trust for medical benefits has been established for funding amounts to the extent deductible under federal income tax regulations. Accrued costs of life insurance benefits, other than current cash payments for retirees, currently are not being funded.\nEffective January 1, 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, on a prospective basis. Statement No. 106 requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\"\nII-238 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\nConsistent with regulatory treatment, the Company recognized these costs on a cash basis as payments were made in 1992 and 1991. The total costs of such benefits recognized by the Company amounted to $375 thousand in 1992 and $487 thousand in 1991.\nSTATUS AND COST OF BENEFITS\nShown in the following tables are actuarial results and assumptions for pension and postretirement medical and life insurance benefits as computed under the requirements of FASB Statements Nos. 87 and 106, respectively. Retiree medical and life insurance information is shown for 1993 only because Statement No. 106 was adopted as of January 1, 1993, on a prospective basis. The funded status of the plans at December 31 was as follows:\nThe weighted average rates assumed in the actuarial calculations were:\nIn accordance with Statement No. 87, an additional liability related to under-funded accumulated benefit obligations was recognized at December 31, 1993. A corresponding net-of-tax charge of $2.1 million was recognized as a separate component of Common Stock Equity in the Statements of Capitalization.\nThe assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 11.3 percent for 1993, decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate by 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1993, by $1.7 million and the aggregate of the service and interest cost components of the net retiree medical cost by $0.2 million.\nII-239 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\nComponents of the plans' net costs are shown below:\nOf the above net pension amounts, $2.0 million in 1993, $1.7 million in 1992 and $1.5 million in 1991 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nNet postretirement medical and life insurance costs of $1.8 million in 1993 were charged to operating expenses.\nThe Company has a supplemental retirement plan for certain executive employees. The plan is unfunded and payable from the general funds of the Company. The Company has purchased life insurance on participating executives, and plans to use these policies to satisfy this obligation. Benefit costs associated with this plan for 1993, 1992 and 1991 were $980 thousand, $316 thousand and $338 thousand, respectively. The 1993 benefit costs reflect a one-time expense related to employees who were part of the work force reduction program.\nWORK FORCE REDUCTION PROGRAM\nThe Company has incurred additional costs for a one-time charge related to the implementation of a work force reduction program. In 1993, $4.5 million was charged to operating expenses and $0.6 million was charged to other income (expense).\n3. REGULATORY MATTERS\nRATE MATTERS\nIn May 1992, the Company filed for, and subsequently received, GPSC approval to implement new base rates designed to decrease base operating revenues by $2.8 million annually. The reduction included a base rate reduction of approximately $2.5 million spread among all classes of customers, effective June 1992. An additional $0.3 million reduction resulted from the implementation of an experimental, time-of-use rate for certain commercial customers in August 1992.\n4. CONSTRUCTION PROGRAM\nThe Company is engaged in a continuous construction program, currently estimated to total $33 million in 1994, $32 million in 1995 and $33 million in 1996. The estimates include AFUDC of $1.6 million in 1994, $0.6 million in 1995 and $0.7 million in 1996. The construction program is subject to periodic review and revision, and actual construction costs may vary from the above estimates because of numerous factors. These factors include: changes in business conditions; revised load growth estimates; changes in environmental regulations; increasing cost of labor, equipment and materials; and cost of capital. The construction of two combustion turbine peaking units totaling 160 megawatts is planned to be completed in mid 1994. The Company is also constructing six combustion turbine peaking units owned by Georgia Power Company. The construction is to be completed in 1996.\nSee Management's Discussion and Analysis under \"Environmental Matters\" for information on the impact of the Clean Air Act Amendments of 1990 and other environmental matters.\nII-240 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\n5. FINANCING AND COMMITMENTS\nGENERAL\nTo the extent possible, the Company's construction program is expected to be financed from internal sources and from the issuance of additional long-term debt and preferred stock and capital contributions from The Southern Company. Should the Company be unable to obtain funds from these sources, the Company would have to use short-term indebtedness or other alternative, and possibly costlier, means of financing.\nThe amounts of long-term debt and preferred stock that can be issued in the future will be contingent on market conditions, the maintenance of adequate earnings levels, regulatory authorizations and other factors. See Management's Discussion and Analysis for information regarding the Company's earnings coverage requirements.\nBANK CREDIT ARRANGEMENTS\nAt the beginning of 1994, unused credit arrangements with four banks totaled $14.5 million, and expire at various times during 1994.\nThe Company has $20 million of revolving credit arrangements expiring December 31, 1995. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the Company's option. In connection with these credit arrangements, the Company agrees to pay commitments fees based on the unused portions of the commitments.\nIn connection with all other lines of credit, the Company has the option of paying fees or maintaining compensating balances, which are substantially all the cash of the Company except for daily working funds and similar items. These balances are not legally restricted from withdrawal.\nASSETS SUBJECT TO LIEN\nAs amended and supplemented, the Company's Indenture of Mortgage, which secures the first mortgage bonds issued by the Company, constitutes a direct first lien on substantially all of the Company's fixed property and franchises.\nOPERATING LEASES\nThe Company has rental agreements with various terms and expiration dates. Rental expenses totaled $1.5 million, $1.5 million, and $1.4 million for 1993, 1992, and 1991, respectively. At December 31, 1993, estimated future minimum lease payments for non-cancelable operating leases were as follows:\n6. LONG-TERM POWER SALES AGREEMENTS\nThe operating subsidiaries of The Southern Company, including the Company, have entered into long-term contractual agreements for the sale of capacity and energy to certain non-affiliated utilities located outside the system's service area. Certain of these agreements are non-firm and are based on capacity of the system in general. Other agreements are firm and pertain to the capacity related to specific generating units. Because the energy is generally sold at cost under these agreements, revenues from capacity sales primarily affect profitability. The Company's portion of capacity revenues has been as follows:\nLong-term non-firm power of 400 megawatts was sold by the Southern electric system in 1993 to Florida Power Corporation (FPC). In January 1994, this amount decreased to 200 megawatts, and the contract will expire at year-end.\nII-241 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\n7. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 resulted in cumulative adjustments that had no material effect on net income. The adoption also resulted in the recording of additional deferred income taxes and related assets and liabilities. The related assets of $25 million are revenues to be received from customers. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The related liabilities of $26 million are revenues to be refunded to customers. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and unamortized investment tax credits. Additionally, deferred income taxes related to accelerated tax depreciation previously shown as a reduction to utility plant were reclassified.\nDetails of the federal and state income tax provisions are as follows:\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities are as follows:\nDeferred investment tax credits are amortized over the life of the related property with such amortization normally applied as a credit to reduce depreciation in the Statements of Income. Credits amortized in this manner amounted to $0.7 million in 1993, 1992 and 1991. At December 31, 1993, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the effective income tax rate to the statutory tax rate is as follows:\nThe Southern Company and its subsidiaries file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each company's current and deferred tax expense is computed on a stand-alone basis, and consolidated tax savings are allocated to each company based on its ratio of taxable income to total consolidated taxable income.\nII-242 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\n8. CUMULATIVE PREFERRED STOCK\nIn November 1993, the Company issued 1,400,000 shares of 6.64 percent Series Preferred stock which has redemption provisions of $26.66 per share plus accrued dividends if on or prior to November 1, 1998, and at $25 per share plus accrued dividends thereafter.\nIn December 1993, the Company redeemed all 800,000 shares outstanding of its 9.5 percent Series Preferred stock at the prescribed redemption price of $26.57 plus accrued dividends. Cumulative preferred stock dividends are preferential to the payment of dividends on common stock.\n9. LONG-TERM DEBT\nThe Company's Indenture related to its First Mortgage Bonds is unlimited as to the authorized amount of bonds which may be issued, provided that required property additions, earnings and other provisions of such Indenture are met.\nOn February 19, 1993, the Company refunded its $4.1 million, 6.25 percent Series Pollution Control Bonds, due 1998 with $4.1 million of variable rate Series Pollution Control Bonds due 2016.\nIn 1994, there is a first mortgage bond maturity of $3.7 million. The sinking fund requirements of first mortgage bonds are being satisfied by certification of property additions. See Note 10 \"Long-Term Debt Due Within One Year\" for details.\nDetails of other long-term debt are as follows:\nSinking fund requirements and \/or maturities through 1998 applicable to long-term debt are as follows: $4.5 million in 1994; $0.7 million in 1995; $0.7 million in 1996; $0.1 million in 1997 and no requirement is needed for 1998.\nAssets acquired under capital leases are recorded as utility plant in service and the related obligation is classified as other long-term debt. Leases are capitalized at the net present value of the future lease payments. However, for ratemaking purposes, these obligations are treated as operating leases, and as such, lease payments are charged to expense as incurred.\nThe Company leases combustion turbine generating equipment under a non-cancelable lease expiring in 1995, with renewal options extending until 2010. The Company also leases a portion of its transportation fleet. Under the terms of these leases, the Company is responsible for taxes, insurance and other expenses.\nII-243 NOTES (continued) Savannah Electric and Power Company 1993 Annual Report\n10. LONG-TERM DEBT DUE WITHIN ONE YEAR\nA summary of the improvement fund\/sinking fund requirements and scheduled maturities and redemptions of long-term debt due within one year is as follows:\nThe first mortgage bond improvement (sinking) fund requirements amount to 1 percent of each outstanding series of bonds authenticated under the indentures prior to January 1 of each year, other than those issued to collateralize pollution control and other obligations. The requirements may be satisfied by depositing cash or reacquiring bonds, or by pledging additional property equal to 1 2\/3 times the requirements.\n11. COMMON STOCK DIVIDEND RESTRICTIONS\nThe Company's Charter and Indentures contain certain limitations on the payment of cash dividends on the preferred and common stocks. At December 31, 1993, approximately $55 million of retained earnings was restricted against the payment of cash dividends on common stock under the terms of the Mortgage Indenture.\n12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly financial data for 1993 and 1992 are as follows (in thousands):\nThe Company's business is influenced by seasonal weather conditions, a seasonal rate structure and the timing of rate changes, among other factors.\nII-244\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1993 Annual Report\nNote: NR = Not Rated\nII-245\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1993 Annual Report\nII-246 SELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1993 Annual Report\nII-247\nSELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1993 Annual Report\nII-248\nSTATEMENTS OF INCOME Savannah Electric and Power Company\n* Tax-free common stock\/bond exchange\nII-249\nSTATEMENTS OF INCOME Savannah Electric and Power Company\nII-250\nSTATEMENTS OF CASH FLOWS Savannah Electric and Power Company\nII-251\nSTATEMENTS OF CASH FLOWS Savannah Electric and Power Company\nII-252\nBALANCE SHEETS Savannah Electric and Power Company\nII-253\nBALANCE SHEETS Savannah Electric and Power Company\nII-254\nBALANCE SHEETS Savannah Electric and Power Company\nII-255\nBALANCE SHEETS Savannah Electric and Power Company\nII-256\nSAVANNAH ELECTRIC AND POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1993\nFIRST MORTGAGE BONDS\nII-257\nSAVANNAH ELECTRIC AND POWER COMPANY\nSECURITIES RETIRED DURING 1993\nPOLLUTION CONTROL BONDS\nII-258 PART III\nItems 10, 11, 12 and 13 for SOUTHERN are incorporated by reference to ELECTION OF DIRECTORS in SOUTHERN's definitive Proxy Statement relating to the 1994 annual meeting of stockholders.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nALABAMA\n(a) (1) Identification of directors of ALABAMA.\nELMER B. HARRIS (1) President and Chief Executive Officer of ALABAMA Age 54 Served as Director since 3-1-89.\nBILL M. GUTHRIE Executive Vice President of ALABAMA Age 60 Served as Director since 12-16-88\nEDWARD L. ADDISON (2) Age 63 Served as Director since 11-1-83\nWHIT ARMSTRONG (2) Age 46 Served as Director since 9-24-82\nPHILIP E. AUSTIN (2) Age 52 Served as Director since 1-25-91\nMARGARET A. CARPENTER (2) Age 69 Served as Director since 2-26-93\nPETER V. GREGERSON, SR. (2) Age 65 Served as Director since 10-22-93\nCRAWFORD T. JOHNSON, III (2) Age 68 Served as Director since 4-18-69\nCARL E. JONES, JR. (2) Age 53 Served as Director since 4-22-88\nWALLACE D. MALONE, JR. (2) Age 57 Served as Director since 6-22-90\nWILLIAM V. MUSE (2) Age 54 Served as Director since 2-26-93\nJOHN T. PORTER (2) Age 62 Served as Director since 10-22-93\nGERALD H. POWELL (2) Age 67 Served as Director since 2-28-86\nROBERT D. POWERS (2) Age 43 Served as Director since 1-24-92\nJOHN W. ROUSE (2) Age 56 Served as Director since 4-22-88\nWILLIAM J. RUSHTON, III (2) Age 64 Served as Director Since 9-18-70\nJAMES H. SANFORD (2) Age 49 Served as Director since 8-1-83\nJOHN C. WEBB, IV (2) Age 51 Served as Director since 4-22-77\nLOUIS J. WILLIE (2) Age 70 Served as Director since 3-23-84\nJOHN W. WOODS (2) Age 62 Served as Director since 4-20-73\n(1) Previously served as Director of ALABAMA from 1980 to 1985. (2) No position other than Director.\nEach of the above is currently a director of ALABAMA, serving a term running from the last annual meeting of ALABAMA's stockholder (April 23, 1993) for\nIII-1 meeting of ALABAMA's stockholder (April 23, 1993) for one year until the next annual meeting or until a successor is elected and qualified, except for the individuals elected in October 1993. There are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as a director or nominee, other than any arrangements or understandings with directors or officers of ALABAMA acting solely in their capacities as such.\n(b)(1) Identification of executive officers of ALABAMA.\nELMER B. HARRIS (1) President, Chief Executive Officer and Director Age 54 Served as Executive Officer since 3-1-89\nBANKS H. FARRIS Senior Vice President Age 59 Served as Executive Officer since 12-3-91\nWILLIAM B. HUTCHINS, III Senior Vice President and Chief Financial Officer Age 50 Served as Executive Officer since 12-3-91\nT. HAROLD JONES Senior Vice President Age 63 Served as Executive Officer since 12-1-91\nCHARLES D. MCCRARY Senior Vice President Age 42 Served as Executive Officer since 1-1-91\n(1) Previously served as executive officer of ALABAMA from 1979 to 1985.\nEach of the above is currently an executive officer of ALABAMA, serving a term running from the last annual meeting of the directors (April 23, 1993) for one year until the next annual meeting or until his successor is elected and qualified.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as an officer, other than any arrangements or understandings with officers of ALABAMA acting solely in their capacities as such.\n(c)(1) Identification of certain significant employees. None.\n(d)(1) Family relationships. None.\n(e)(1) Business experience.\nELMER B. HARRIS - Elected in 1989; Chief Executive Officer. He previously served as Senior Executive Vice President of GEORGIA from 1986 to 1989. Director of SOUTHERN and AmSouth Bancorporation.\nBILL M. GUTHRIE - Elected in 1988; also served since 1991 as Chief Production Officer of SOUTHERN system and Executive Vice President and Chief Production Officer of SCS; Vice President of SOUTHERN, GULF, MISSISSIPPI and SAVANNAH and Executive Vice President of GEORGIA. Responsible primarily for providing overall management of materials management, fuel services, operating and planning services, fossil, hydro and bulk power operations of the Southern electric system.\nEDWARD L. ADDISON - Elected in 1983; President of SOUTHERN from 1983 until elected Chairman of the Board in 1994. Director of SOUTHERN, GEORGIA, Phelps Dodge Corporation, Protective Life Corporation, Wachovia Bank of Georgia, N.A., Wachovia Corporation of Georgia and CSX Corporation.\nWHIT ARMSTRONG - President, Chairman and Chief Executive Officer of The Citizens Bank, Enterprise, Alabama. Also, President and Chairman of the Board of Enterprise Capital Corporation, Inc.\nPHILIP E. AUSTIN - Chancellor, The University of Alabama System. Previously President and Chancellor of Colorado State University.\nMARGARET A. CARPENTER - President, Compos-it, Inc. (typographics), Montgomery, Alabama.\nPETER V. GREGERSON, SR. - Chairman Emeritus of Gregerson's Foods, Inc. (retail groceries), Gadsden, Alabama. Director of AmSouth Bank of Gadsden, Alabama.\nIII-2\nCRAWFORD T. JOHNSON, III - Chairman of Coca-Cola Bottling Company United, Inc., Birmingham, Alabama. Director of Protective Life Corporation, AmSouth Bancorporation and Russell Corporation.\nCARL E. JONES, JR. - Chairman and Chief Executive Officer of First Alabama Bank, Mobile, Alabama.\nWALLACE D. MALONE, JR. - Chairman and Chief Executive Officer of SouthTrust Corporation, bank holding company, Birmingham, Alabama.\nWILLIAM V. MUSE - President and Chief Executive Officer of Auburn University. He previously served as President of the University of Akron from 1984 to 1992.\nJOHN T. PORTER - Pastor of Sixth Avenue Baptist Church, Birmingham, Alabama. Director of Citizen Federal Bank.\nGERALD H. POWELL - President, Dixie Clay Company of Alabama, Inc. (refractory clay producer), Jacksonville, Alabama.\nROBERT D. POWERS - President, The Eufaula Agency, Inc. (real estate and insurance), Eufaula, Alabama.\nJOHN W. ROUSE - President and Chief Executive Officer of Southern Research Institute (non-profit research institute), Birmingham, Alabama. Director of Protective Life Corporation.\nWILLIAM J. RUSHTON, III - Chairman of the Board, Protective Life Corporation (insurance holding company), Birmingham, Alabama. Director of SOUTHERN and AmSouth Bancorporation.\nJAMES H. SANFORD - President, HOME Place Farms Inc. (diversified farmers and ginners), Prattville, Alabama.\nJOHN C. WEBB, IV - President, Webb Lumber Company, Inc. (wholesale lumber), Demopolis, Alabama.\nLOUIS J. WILLIE - Chairman of the Board and President of Booker T. Washington Insurance Co. Director of SOUTHERN.\nJOHN W. WOODS - Chairman and Chief Executive Officer, AmSouth Bancorporation (multi-bank holding company), Birmingham, Alabama. Director of Protective Life Corporation.\nBANKS H. FARRIS - Elected in 1991; responsible primarily for providing the overall management of the Human Resources, Information Resources, Power Delivery and Marketing Departments and the six geographic divisions. He previously served as Vice President - Human Resources from 1989 to 1991 and Division Vice President from 1985 to 1989.\nWILLIAM B. HUTCHINS, III - Elected in 1991; Chief Financial Officer, responsible primarily for providing the overall management of accounting and financial planning activities. He previously served as Vice President and Treasurer from 1983 to 1991.\nT. HAROLD JONES - Elected in 1991; responsible primarily for providing the overall management of the Fossil Generation, Hydro Generation, Power Generation Services and Fuels Departments. He previously served as Vice President - Fossil Generation from 1986 to 1991.\nCHARLES D. MCCRARY - Elected in 1991; responsible for the External Relations Department, Operating Services and Corporate Services. Also, assumes responsibility for financial matters while Mr. Hutchins is on medical leave. He previously served as Vice President of Administrative Services - Nuclear of SCS from 1988 to 1991.\n(f)(1) Involvement in certain legal proceedings. None.\nIII-3 GEORGIA\n(a)(2) Identification of directors of GEORGIA.\nH. ALLEN FRANKLIN President and Chief Executive Officer. Age 49 Served as Director since 1-1-94.\nWARREN Y. JOBE Executive Vice President, Treasurer and Chief Financial Officer. Age 53 Served as Director since 8-1-82\nEDWARD L. ADDISON (1) Age 63 Served as Director since 11-1-83\nBENNETT A. BROWN (1) Age 64 Served as Director since 5-15-80\nWILLIAM P. COPENHAVER (1) Age 69 Served as Director since 6-18-86\nA. W. DAHLBERG (1) Age 53 Served as Director since 6-1-88\nWILLIAM A. FICKLING, JR. (1) Age 61 Served as Director since 4-18-73\nL. G. HARDMAN, III (1) Age 54 Served as Director since 6-25-79\nJAMES R. LIENTZ, JR. (1) Age 50 Served as Director since 7-1-93\nWILLIAM A. PARKER, JR. (1) Age 66 Served as Director since 5-19-65\nG. JOSEPH PRENDERGAST (1) Age 48 Served as Director since 1-20-93\nHERMAN J. RUSSELL (1) AGE 63 Served as Director since 5-18-88\nGLORIA M. SHATTO (1) Age 62 Served as Director since 2-20-80\nROBERT STRICKLAND (1) Age 66 Served as Director since 11-21-79\nWILLIAM JERRY VEREEN (1) Age 53 Served as Director since 5-18-88\nTHOMAS R. WILLIAMS (1) Age 65 Served as Director since 3-17-82\n(1) No position other than Director.\nEach of the above is currently a director of GEORGIA, serving a term running from the last annual meeting of GEORGIA's stockholder (May 19, 1993) for one year until the next annual meeting or until a successor is elected and qualified, except Messrs. Franklin and Lientz.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he\/she was or is to be selected as a director or nominee, other than any arrangements or understandings with directors or officers of GEORGIA acting solely in their capacities as such.\n(b)(2) Identification of executive officers of GEORGIA.\nH. ALLEN FRANKLIN President, Chief Executive Officer and Director Age 49 Served as Executive Officer since 1-1-94\nWARREN Y. JOBE Executive Vice President, Treasurer, Chief Financial Officer and Director Age 53 Served as Executive Officer since 5-19-82\nIII-4\nDWIGHT H. EVANS Executive Vice President - External Affairs Age 45 Served as Executive Officer since 4-19-89\nGENE R. HODGES Executive Vice President - Customer Operations Age 55 Served as Executive Officer since 11-19-86\nKERRY E. ADAMS Senior Vice President - Fossil and Hydro Power Age 49 Served as Executive Officer since 5-1-89\nWAYNE T. DAHLKE Senior Vice President - Power Delivery Age 53 Served as Executive Officer since 4-19-89\nJAMES K. DAVIS Senior Vice President - Corporate Relations Age 53 Served as Executive Officer since 10-1-93\nROBERT H. HAUBEIN Senior Vice President - Administrative Services Age 54 Served as Executive Officer since 2-19-92\nGALE E. KLAPPA Senior Vice President - Marketing Age 43 Served as Executive Officer since 2-19-92\nFRED D. WILLIAMS Senior Vice President - Bulk Power Markets Age 49 Served as Executive Officer since 11-18-92\nEach of the above is currently an executive officer of GEORGIA, serving a term running from the last annual meeting of the directors (May 19,1993) for one year until the next annual meeting or until his successor is elected and qualified, except Messrs. Franklin and Davis.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as an officer, other than any arrangements or understandings with officers of GEORGIA acting solely in their capacities as such.\n(c)(2) Identification of certain significant employees. None.\n(d)(2) Family relationships. None.\n(e)(2) Business experience.\nH. ALLEN FRANKLIN - President and Chief Executive Officer since January 1994. He previously served as President and Chief Executive Officer of SCS from 1988 through 1993. Director of SOUTHERN and SouthTrust Bank.\nWARREN Y. JOBE - Executive Vice President and Chief Financial Officer since 1982 and Treasurer since 1992. Responsible for financial and accounting operations and planning, internal auditing, procurement, corporate secretary and treasury operations.\nEDWARD L. ADDISON - President of SOUTHERN from 1983 until his election as Chairman of Board in 1994. Director of SOUTHERN, ALABAMA, Wachovia Bank of Georgia, N.A., Wachovia Corporation of Georgia, Phelps Dodge Corporation, Protective Life Corporation and CSX Corporation.\nBENNETT A. BROWN - Retired from serving as Chairman of the Board of NationsBank on December 31, 1992. Previously Chairman of the Board and Chief Executive Officer of C&S\/Sovran Corporation. Director of Confederation Life Insurance Company.\nWILLIAM P. COPENHAVER - Director, Arcadian Fertilizer, L.P. (agricultural and industrial chemicals). Director of SOUTHERN and Georgia Bank & Trust Company.\nA. W. DAHLBERG - President of SOUTHERN effective in 1994. He previously served as President and Chief Executive Officer of GEORGIA from 1988 through 1993. Director of SOUTHERN, Trust Company Bank, Trust Company of Georgia, Protective Life Corporation and Equifax, Inc.\nWILLIAM A. FICKLING, JR. - Chairman of the Board, Mulberry Street Investment Company, Macon, Georgia, and Co-chairman of Beech Street Corporation (insurance).\nIII-5\nL. G. HARDMAN, III - Chairman of the Board of First National Bank of Commerce, Georgia and Chairman of the Board and Chief Executive Officer of First Commerce Bancorp. Chairman of the Board, President and Treasurer of Harmony Grove Mills, Inc. (real estate investments). Director of SOUTHERN.\nJAMES R. LIENTZ, JR. - President of NationsBank of Georgia since 1993. He previously served as President and Chief Executive Officer of former Citizens & Southern Bank of South Carolina (now NationsBank) from 1990 to 1993, and from 1987 to 1990, he was head of Corporate Bank Group of NationsBank of Georgia, N.A.\nWILLIAM A. PARKER, JR. - Chairman of the Board, Cherokee Investment Company, Inc. (private investments), Atlanta, Georgia. Director of SOUTHERN, Genuine Parts Company, Life Insurance Company of Georgia, First Union Real Estate Investment Trust, Atlantic Realty Company, ING North America Insurance Company, Post Properties, Inc. and Haverty Furniture Companies, Inc.\nG. JOSEPH PRENDERGAST - President and Chief Executive Officer, Wachovia Corporation of Georgia and Wachovia Bank of Georgia, N.A. since 1993. From 1988 to 1993, he served as Executive Vice President of Wachovia Corporation and President of Wachovia Corporate Services, Inc.\nHERMAN J. RUSSELL - Chairman of the Board and Chief Executive Officer, H. J. Russell & Company (construction), Atlanta, Georgia. Chairman of the Board, Citizens Trust Bank, and Citizens Bancshares Corporation Atlanta, Georgia. Director of Wachovia Corporation.\nGLORIA M. SHATTO - President, Berry College, Mount Berry, Georgia. Director of SOUTHERN, Becton Dickinson & Company, Kmart Corporation and Texas Instruments, Inc.\nROBERT STRICKLAND - Retired Chairman of the Board and Chief Executive Officer of SunTrust Banks, Inc. Director of Georgia US Corporation, Equifax, Inc., Life Insurance Company of Georgia, Oxford Industries, Inc. and The Investment Centre.\nWILLIAM JERRY VEREEN - President and Chief Executive Officer of Riverside Manufacturing Company (manufacture and sale of uniforms), Moultrie, Georgia. Director of Gerber Garment Technology, Inc. and Textile Clothing Technology Corp.\nTHOMAS R. WILLIAMS - President of The Wales Group, Inc. (investments) Atlanta, Georgia. Director of ConAgra, Inc., BellSouth Corporation, National Life Insurance Company of Vermont, AppleSouth, Inc., and American Software, Inc.\nDWIGHT H. EVANS - Executive Vice President - External Affairs since 1989. Senior Vice President - Public Affairs from 1988 to 1989.\nGENE R. HODGES - Executive Vice President - Customer Operations since 1992. Senior Vice President - Region\/Land Operations from 1990 to 1992. Senior Vice President - Division Operations from 1986 to 1990.\nKERRY E. ADAMS - Senior Vice President - Fossil and Hydro Power since 1989.\nWAYNE T. DAHLKE - Senior Vice President - Power Delivery since February 1992. Senior Vice President - Marketing from 1989 to 1992.\nJAMES K. DAVIS - Senior Vice President - Corporate Relations since October 1993. Vice President of Corporate Relations from 1988 to 1993.\nROBERT H. HAUBEIN - Senior Vice President - Administrative Services since 1992. Vice President - Northern Region from 1990 to 1992. Division Vice President of ALABAMA from 1985 to 1990.\nGALE E. KLAPPA - Senior Vice President - Marketing since 1992. Vice President - - Public Relations of SCS from 1981 to 1992.\nFRED D. WILLIAMS - Senior Vice President - Bulk Markets since 1992. Vice President - Bulk Power Markets from 1984 to 1992.\n(f)(2) Involvement in certain legal proceedings. None.\nIII-6\nGULF\n(a)(3) Identification of directors of GULF.\nD. L. MCCRARY (1) Chairman of the Board and Chief Executive Officer Age 64 Served as Director since 4-28-83\nTRAVIS J. BOWDEN President Age 55 Served as Director since 2-1-94\nPAUL J. DENICOLA (2) Age 45 Served as Director since 4-19-91\nREED BELL, SR., M.D. (2) Age 67 Served as Director since 1-17-86\nFRED C. DONOVAN, SR. (2) Age 53 Served as Director since 1-18-91\nW. D. HULL, JR. (2) Age 61 Served as Director since 10-14-83\nC. W. RUCKEL (2) Age 66 Served as Director since 4-20-62\nJ. K. TANNEHILL (2) Age 60 Served as Director since 7-19-85\n(1) Retires May 1, 1994. (2) No position other than Director.\nEach of the above is currently a director of GULF, serving a term running from the last annual meeting of GULF's stockholder (June 29, 1993) for one year until the next annual meeting or until a successor is elected and qualified, except for Mr. Bowden.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as a director or nominee, other than any arrangements or understandings with directors or officers of GULF acting solely in their capacities as such.\n(b)(3) Identification of executive officers of GULF.\nD. L. MCCRARY Chairman of the Board and Chief Executive Officer Age 64 Served as Executive Officer since 5-1-83\nTRAVIS J. BOWDEN President Age 55 Served as Executive Officer since 2-1-94\nF. M. FISHER, JR. Vice President - Employee and External Relations Age 45 Served as Executive Officer since 5-19-89\nJOHN E. HODGES, JR. Vice President - Customer Operations Age 50 Served as Executive Officer since 5-19-89\nG. EDISON HOLLAND, JR. Vice President and Corporate Counsel Age 41 Served as Executive Officer since 4-25-92\nEARL B. PARSONS, JR. Vice President - Power Generation and Transmission Age 55 Served as Executive Officer since 4-14-78\nA. E. SCARBROUGH Vice President - Finance Age 57 Served as Executive Officer since 9-21-77\nEach of the above is currently an executive officer of GULF, serving a term running from the last annual meeting of the directors (July 23, 1993) for one year until the next annual meeting or until his successor is elected and qualified, except for Mr. Bowden.\nIII-7\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as an officer, other than any arrangements or understandings with officers of GULF acting solely in their capacities as such.\n(c)(3) Identification of certain significant employees. None.\n(d)(3) Family relationships. None.\n(e)(3) Business experience.\nD. L. MCCRARY - Elected Chairman of the Board effective February 1994. He previously served as President and Chief Executive Officer from 1983 to 1994; responsible primarily for formation of overall corporate policy.\nTRAVIS J. BOWDEN - Elected President effective February 1994 and, upon Mr. McCrary's retirement May 1994, Chief Executive Officer. He previously served as Executive Vice President of ALABAMA from 1985 to 1994.\nPAUL J. DENICOLA - President and Chief Executive Officer of SCS effective January 1994. He previously served as Executive Vice President of SCS from 1991 through 1993 and President and Chief Executive Officer of MISSISSIPPI from 1989 to 1991. Director of SOUTHERN, MISSISSIPPI and SAVANNAH.\nREED BELL, SR., M.D. - Medical Doctor and since 1989, employee of the State of Florida. He serves as Medical Director of Children's Medical Services, District 1. He previously served as Medical Director of the Escambia County Public Health Unit until July 1992. He also previously maintained a private medical practice and served as Medical Director of Children's Medical Services from 1988 to 1989.\nFRED C. DONOVAN, SR. - President of Baskerville - Donovan, Inc., Pensacola, Florida, an architectural and engineering firm. Director of Baptist Health Care, Inc.\nW. D. HULL, JR. - Vice Chairman of the Sun Bank\/West Florida, Panama City, Florida. He previously served as President and Chief Executive Officer and Director of the Sun Commercial Bank, Panama City, Florida from 1987 to 1992.\nC. W. RUCKEL - Chairman of the Board of The Vanguard Bank and Trust Company, Valparaiso, Florida. President and owner of Ruckel Properties, Inc., Valparaiso, Florida.\nJ. K. TANNEHILL - President and Chief Executive Officer of Tannehill International Industries, Lynn Haven, Florida. He previously served as President and Chief Executive Officer of Stock Equipment Company, Chagrin Falls, Ohio, until 1991. Director of Sun Bank\/West Florida, Panama City, Florida.\nF. M. FISHER, JR. - Elected Vice President - Employee and External Relations in 1989. He previously served as General Manager of Central Division from 1988 to 1989.\nJOHN E. HODGES, JR. - Elected Vice President - Customer Operations in 1989. He previously served as General Manager of Western Division from 1986 to 1989.\nG. EDISON HOLLAND, JR. - Elected Vice President and Corporate Counsel in 1992; responsible for all legal matters associated with GULF and serves as compliance officer. Also served, since 1982, as a partner in the law firm, Beggs & Lane.\nEARL B. PARSONS, JR. - Elected Vice President - Power Generation and Transmission in 1989; responsible for generation and transmission of electrical energy. He previously served as Vice President - Electric Operations from 1978 to 1989.\nA. E. SCARBROUGH - Elected Vice President - Finance in 1980; responsible for all accounting and financial services of GULF.\n(f)(3) Involvement in certain legal proceedings. None.\nIII-8\nMISSISSIPPI\n(a)(4) Identification of directors of MISSISSIPPI.\nDAVID M. RATCLIFFE President and Chief Executive Officer Age 45 Served as Director since 4-24-91\nPAUL J. DENICOLA (1) Age 45 Served as Director since 5-1-89\nEDWIN E. DOWNER (1) Age 62 Served as Director since 4-24-84\nROBERT S. GADDIS (1) Age 62 Served as Director since 1-21-86\nWALTER H. HURT, III (1) Age 58 Served as Director since 4-6-82\nAUBREY K. LUCAS (1) Age 59 Served as Director since 4-24-84\nEARL D. MCLEAN, JR. (1) Age 68 Served as Director since 10-21-78\nGERALD J. ST. Pe (1) Age 54 Served as Director since 1-21-86\nLEO W. SEAL, JR. (1) Age 69 Served as Director since 4-4-67\nN. EUGENE WARR (1) Age 58 Served as Director since 1-21-86\n(1) No position other than Director.\nEach of the above is currently a director of MISSISSIPPI, serving a term running from the last annual meeting of MISSISSIPPI's stockholder (April 6, 1993) for one year until the next annual meeting or until a successor is elected and qualified. There are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he or she was or is to be selected as a director or nominee, other than any arrangements or understandings with directors or officers of MISSISSIPPI acting solely in their capacities as such.\n(b)(4) Identification of executive officers of MISSISSIPPI.\nDAVID M. RATCLIFFE President, Chief Executive Officer and Director Age 45 Served as Executive Officer since 4-24-91\nH. E. BLAKESLEE Vice President - Customer Services and Marketing Age 53 Served as Executive Officer since 1-25-84\nTHOMAS A. FANNING Vice President and Chief Financial Officer Age 37 Served as Executive Officer since 4-1-92\nDON E. MASON Vice President - External Affairs and Corporate Services Age 52 Served as Executive Officer since 7-27-83\nEach of the above is currently an executive officer of MISSISSIPPI, serving a term running from the last annual meeting of the directors (April 28, 1993) for one year until the next annual meeting or until his successor is elected and qualified.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as an officer, other than any arrangements or understandings with officers of MISSISSIPPI acting solely in their capacities as such.\n(c)(4) Identification of certain significant employees. None.\n(d)(4) Family relationships. None.\n(e)(4) Business experience.\nIII-9\nDAVID M. RATCLIFFE - President and Chief Executive Officer since 1991. He previously served as Executive Vice President of SCS from 1989 to 1991 and Vice President of SCS from 1985 to 1989.\nPAUL J. DENICOLA - President and Chief Executive Officer of SCS effective 1994. Executive Vice President of SCS from 1991 through 1993. He previously served as President and Chief Executive Officer of MISSISSIPPI from 1989 to 1991. Director of SOUTHERN, SAVANNAH and GULF.\nEDWIN E. DOWNER - Business consultant specializing in economic analysis, management controls and procedural studies since 1990. President and Chief Executive Officer, Unifirst Bank for Savings, F.A., Midland Division, Meridian, Mississippi from 1985 to 1990.\nROBERT S. GADDIS - President of the Trustmark National Bank - Laurel, Mississippi.\nWALTER H. HURT, III - President and Director of NPC Inc. (Investments). Vicar, All Saints Church, Inverness, Mississippi, and St. Thomas Church, Belzoni, Mississippi. Retired newspaper editor and publisher.\nAUBREY K. LUCAS - President of the University of Southern Mississippi, Hattiesburg, Mississippi.\nEARL D. MCLEAN, JR. - Co-owner of the T. C. Griffith Insurance Agency, Inc. (insurance and real estate), Columbia, Mississippi. Director of SOUTHERN.\nGERALD J. ST. Pe - President of Ingalls Shipbuilding and Corporate Vice President of Litton Industries, Inc. since 1985. Director of Merchants and Marine Bank, Pascagoula, Mississippi.\nLEO W. SEAL, JR. - Chairman of the Board and Chief Executive Officer of Hancock Bank, Gulfport, Mississippi, and Chairman of the Board of Harrison Life Insurance Company. Director of Hancock Bank and Bank of Wiggins.\nN. EUGENE WARR - Retailer (Biloxi and Gulfport, Mississippi.) Chairman of the Board of First Jefferson Corporation and the Jefferson Bank of Biloxi, Mississippi.\nH. E. BLAKESLEE - Elected Vice President in 1984. Primarily responsible for rate design, economic analysis and revenue forecasting, economic development, marketing and district operations.\nTHOMAS A. FANNING - Elected Vice President in 1992; responsible primarily for accounting, treasury, finance, information resources and risk management. He previously served as Treasurer of SEI from 1986 to 1992 and Director of Corporate Finance of SCS from 1988 to 1992.\nDON E. MASON - Elected Vice President in 1983. Primarily responsible for the external affairs functions, including governmental and regulatory affairs, corporate communications, security, materials and general services, as well as the human resources function.\n(f)(4) Involvement in certain legal proceedings. None.\nSAVANNAH\n(a)(5) Identification of directors of SAVANNAH.\nARTHUR M. GIGNILLIAT, JR. President and Chief Executive Officer Age 61 Served as Director since 8-31-82\nHELEN QUATTLEBAUM ARTLEY (1) Age 66 Served as Director since 5-17-77\nPAUL J. DENICOLA (1) Age 45 Served as Director since 3-14-91\nBRIAN R. FOSTER (1) Age 44 Served as Director since 5-16-89\nWALTER D. GNANN (1) Age 58 Served as Director since 5-17-83\nJOHN M. MCINTOSH (1) Age 69 Served as Director since 2-27-68\nIII-10\nROBERT B. MILLER, III (1) Age 48 Served as Director since 5-17-83\nJAMES M. PIETTE (1) Age 69 Served as Director since 6-12-73\nARNOLD M. TENEBAUM (1) Age 57 Served as Director since 5-17-77\nFREDERICK F. WILLIAMS, JR. (1) Age 66 Served as Director since 7-2-75\n(1) No Position other than Director.\nEach of the above is currently a director of SAVANNAH, serving a term running from the last annual meeting of SAVANNAH's stockholder (May 18, 1993) for one year until the next annual meeting or until a successor is elected and qualified.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he\/she was or is to be selected as a director or nominee, other than any arrangements or understandings with directors or officers of SAVANNAH acting solely in their capacities as such.\n(b)(5) Identification of executive officers of SAVANNAH.\nARTHUR M. GIGNILLIAT, JR. President, Chief Executive Officer and Director Age 61 Served as Executive Officer since 2-15-72\nW. MILES GREER Vice President - Marketing and Customer Services Age 50 Served as Executive Officer since 11-20-85\nLARRY M. PORTER Vice President - Operations Age 49 Served as Executive Officer since 7-1-91\nKIRBY R. WILLIS Vice President, Treasurer and Chief Financial Officer Age 42 Served as Executive Officer since 1-1-94\nEach of the above is currently an executive officer of SAVANNAH, serving a term running from the last annual meeting of the directors (May 18, 1993) for one year until the next annual meeting or until his successor is elected and qualified, except Mr. Willis.\nThere are no arrangements or understandings between any of the individuals listed above and any other person pursuant to which he was or is to be selected as an officer, other than any arrangements or understandings with officers of SAVANNAH acting solely in their capacities as such.\n(c)(5) Identification of certain significant employees. None.\n(d)(5) Family relationships. None.\n(e)(5) Business experience.\nARTHUR M. GIGNILLIAT, JR. - Elected President and Chief Executive Officer in 1985. Director of Savannah Foods and Industries, Inc.\nHELEN QUATTLEBAUM ARTLEY - Homemaker and Civic Worker.\nPAUL J. DENICOLA - President and Chief Executive Officer of SCS effective January 1994. Executive Vice President of SCS from 1991 through 1993. He previously served as President and Chief Executive Officer of MISSISSIPPI from 1989 to 1991. Director of SOUTHERN, GULF and MISSISSIPPI.\nBRIAN R. FOSTER - President of NationsBank of Georgia, N.A., in Savannah since 1988.\nWALTER D. GNANN - President of Walt's TV, Appliance and Furniture Co., Inc., Springfield, Georgia. Past Chairman of the Development Authority of Effingham County, Georgia.\nIII-11\nJOHN M. MCINTOSH - Chairman of the Executive Committee, SAVANNAH; retired Chairman of the Board of Directors and Chief Executive Officer, SAVANNAH from 1974 to 1984. Director of SOUTHERN.\nROBERT B. MILLER, III - President of American Builders of Savannah.\nJAMES M. PIETTE - Vice President - Special Projects, Union Camp Corporation, since 1989. Retired Vice Chairman, Board of Directors, Union Camp Corporation from 1987 to 1989.\nARNOLD M. TENENBAUM - President of Chatham Steel Corporation. Director of First Union National Bank of Georgia and Savannah Foods and Industries, Inc.\nFREDERICK F. WILLIAMS, JR. - Retired Partner and Consultant, Hilb, Rogal and Hamilton Employee Benefits, Incorporated (Insurance Brokers), formerly Jones, Hill & Mercer.\nW. MILES GREER - Vice President - Marketing and Customer Services effective January 1994. Formerly served as Vice President - Economic Development and Corporate Services from 1989 through 1993 and Vice President - Economic Development and Governmental Affairs from 1985 to 1989.\nLARRY M. PORTER - Vice President - Operations since 1991. Responsible for managing the areas of fuel procurement, power production, transmission and distribution, engineering and system operation. Previously he served as Assistant Plant Manager of GEORGIA's Plant Scherer from 1984 to 1991.\nKIRBY R. WILLIS - Vice President, Treasurer and Chief Financial Officer effective January 1994. Responsible for all financial activities, Information Resources, Human Resources, Corporate Services, and Environmental Affairs and Safety. He previously served as Treasurer, Controller and Assistant Secretary from 1991 to 1993 and Treasurer and Secretary from 1987 to 1991.\n(f)(5) Involvement in certain legal proceedings. None.\nIII-12\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n(A) SUMMARY COMPENSATION TABLES. The following tables set forth information concerning the Chief Executive Officer and the four most highly compensated executive officers for each of the operating affiliates (ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH), serving as of December 31, 1993 whose total annual salary and bonus exceeded $100,000. No information is provided for any person for any year in which such person did not serve as an executive officer of the operating affiliate. The number of SOUTHERN common shares do not reflect the stock distribution resulting from the two-for-one common stock split approved by SOUTHERN's board of directors in January, 1994.\nKEY TERMS used in this Item will have the following meanings:-\nAME........... ABOVE-MARKET EARNINGS ON DEFERRED COMPENSATION ESP........... EMPLOYEE SAVINGS PLAN ESOP.......... EMPLOYEE STOCK OWNERSHIP PLAN SBP........... SUPPLEMENTAL BENEFIT PLAN VBP........... VEHICLE BUYOUT PROGRAM\nALABAMA\nSUMMARY COMPENSATION TABLE\nIII-13 ALABAMA SUMMARY COMPENSATION TABLE (CONTINUED)\n(1) Tax reimbursement by ALABAMA and certain personal benefits, including membership fee of $28,402 for Mr. Jones in 1992. In accordance with the transition rules of the SEC, information for 1991 is omitted. (2) Payouts made in 1992, 1993 and 1994 for the four-year performance periods ending December 31, 1991, 1992 and 1993, respectively. (3) ALABAMA contributions to the ESP, ESOP, non-pension related accruals under the SBP (ERISA excess plan under which accruals are made to offset Internal Revenue Code imposed limitations under the Employee Savings and Stock Ownership Plans), and payments under a VBP for the following:- Name ESP ESOP SBP VBP - ---- --- ---- --- --- E. B. Harris $6,746 $1,709 $12,933 $18,000 T. J. Bowden 8,369 1,709 3,193 18,000 B. H. Farris 7,193 1,499 726 18,000 T. H. Jones 6,908 1,331 754 5,100 W. B. Hutchins, III 6,746 1,400 671 18,000 In accordance with the transition rules of the SEC, information for 1991 is omitted. (4) Effective January 31, 1994, Mr. Bowden resigned to become president of GULF.\nIII-14\nGEORGIA SUMMARY COMPENSATION TABLE\n(1) Due to the pay schedules at GEORGIA, 1992 salary reflects one additional pay period compared with 1991. (2) Tax reimbursement by GEORGIA on certain personal benefits. In accordance with the transition rules of the SEC, information for 1991 is omitted. (3) Payouts made in 1992, 1993 and 1994 for the four-year performance periods ending December 31, 1991, 1992 and 1993, respectively. (4) GEORGIA contributions to the ESP, ESOP, non-pension related accruals under the SBP (ERISA excess plan under which accruals are made to offset Internal Revenue Code imposed limitations under the Employee Savings and Stock Ownership Plans) and payments under a VBP for the following:- Name ESP ESOP SBP VBP - ---- --- ---- --- --- A. W. Dahlberg $6,746 $1,709 $18,092 $18,000 D. H. Evans 8,592 1,709 1,218 18,000 W. Y. Jobe 7,667 1,709 1,882 18,000 G. R. Hodges 7,349 1,620 3,660 18,000 K. E. Adams 7,204 1,634 1,462 18,000 In accordance with the transition rules of the SEC, information for 1991 is omitted. (5) Effective December 31, 1993, Mr. Dahlberg resigned to become president of SOUTHERN.\nIII-15 GULF SUMMARY COMPENSATION TABLE\n(1) Tax reimbursement by GULF on certain personal benefits. In accordance with the transition rules of the SEC, information for 1991 is omitted. (2) Payouts made in 1992, 1993 and 1994 for the four-year performance periods ending December 31, 1991, 1992 and 1993, respectively. (3) GULF contributions to the ESP, ESOP, non-pension related accruals under the SBP (ERISA excess plan under which accruals are made to offset Internal Revenue Code imposed limitations under the Employee Savings and Stock Ownership Plans) and payments under a VBP for the following:- Name ESP ESOP SBP VBP - ---- --- ---- --- --- D. L. McCrary $9,300 $1,709 $6,057 $ 2,788 G. E. Holland, Jr. 4,652 - - 16,363 E. B. Parsons, Jr 6,948 1,709 410 16,363 A. E. Scarbrough 6,746 1,338 282 16,363 J. E. Hodges, Jr. 6,651 1,313 - 16,363 In accordance with the transition rules of the SEC, information for 1991 is omitted. (4) Employee and executive officer of GULF since April 25, 1992. Not eligible to participate in the Long-Term Incentive Plan until January 1, 1993. (5) \"All Other Compensation\" previously reported as $4,149 for Mr. Holland in the Form 10-K for the year ended December 31, 1992, should have been $0 since Mr. Holland was not yet eligible to participate in ESP and ESOP.\nIII-16\nMISSISSIPPI SUMMARY COMPENSATION TABLE\n(1) Tax reimbursement by MISSISSIPPI on certain personal benefits. In accordance with the transition rules of the SEC, information for 1991 is omitted. (2) Payouts made in 1992, 1993 and 1994 for the four-year performance periods ending December 31, 1991, 1992 and 1993, respectively. (3) MISSISSIPPI contributions to the ESP, ESOP, non-pension related accruals under the SBP (ERISA excess plan under which accruals are made to offset Internal Revenue Code imposed limitations under the Employee Savings and Stock Ownership Plans) and payments under a VBP for the following:- Name ESP ESOP SBP VBP - ---- --- ---- --- --- David M. Ratcliffe $7,895 $1,709 $2,774 $5,509 R. G. Dawson 6,746 1,252 - 7,045 H. E. Blakeslee 6,843 1,355 - 7,452 D. E. Mason 6,671 1,286 - 7,452 T. A. Fanning 5,520 1,019 - 8,116 In accordance with the transition rules of the SEC, information for 1991 is omitted. (4) Effective March 1, 1994, Mr. Dawson resigned to become a vice president of SEI. (5) Benefits under MISSISSIPPI's VBP for 1992 in the amounts of $13,169 and $12,425 to Messrs. Dawson and Fanning, respectively, previously reported in the Form 10-K for the year ended December 31, 1992, under the \"Other Annual Compensation\" column have been moved to the \"All Other Compensation\" column.\nIII-17\nSAVANNAH SUMMARY COMPENSATION TABLE\n(1) Tax reimbursement by SAVANNAH on certain personal benefits. In accordance with the transition rules of the SEC, information for 1991 is omitted. (2) Payouts made in 1992, 1993 and 1994 for the four-year performance periods ending December 31, 1991, 1992 and 1993, respectively. (3) SAVANNAH contributions to the ESP, under Section 401(k) of the Internal Revenue Code, ESOP, AME and payments under a VBP for the following:- Name ESP ESOP AME VBP - ---- --- ---- --- --- A. M. Gignilliat $6,746 $3,092 $7,479 $14,195 E. O. Veale 6,163 2,359 5,702 - L. M. Porter 4,943 1,774 658 14,195 W. M. Greer 5,045 1,764 877 14,195 J. L. Rayburn 2,284 1,650 1,911 14,195 In accordance with the transition rules of the SEC, information for 1991 is omitted. (4) Retired effective December 31, 1993. (5) Not eligible for Long-term Incentive Payout until January 1, 1994. (6) Resigned effective December 31, 1993.\nIII-18\nSTOCK OPTION GRANTS IN 1993\n(B) STOCK OPTION GRANTS. The following table sets forth all stock option grants to the named executive officers of each operating subsidiary during the year ending December 31, 1993. The number of SOUTHERN common shares shown and the per share exercise price and market price do not reflect the stock distribution resulting from the two-for-one common stock split approved by SOUTHERN's board of directors in January, 1994.\nSee next page for footnotes.\nIII-19\nSTOCK OPTION GRANTS IN 1993\n(1) Grants were made on July 19, 1993, and vest 25% per year on the anniversary date of the grant. Grants fully vest upon termination incident to death, disability, or retirement. The exercise price is the average of the high and low fair market value of SOUTHERN's common stock on the date granted. In accordance with the terms of the Executive Stock Plan, Mr. Jones' unexercised options expire on April 1, 1998, three years after his normal retirement date; Mr. McCrary's unexercised options expire on May 1, 1997, three years after his normal retirement date; and Mr. Gignilliat's unexercised options expire on September 3, 2000, three years after his normal retirement date. (2) A total of 179,746 stock options were granted in 1993 to key executives participating in SOUTHERN's Executive Stock Plan. (3) Based on the Black-Scholes option valuation model. The actual value, if any, an executive officer may realize ultimately depends on the market value of SOUTHERN's common stock at a future date. This valuation is provided pursuant to SEC disclosure rules and there is no assurance that the value realized will be at or near the value estimated by the Black-Scholes model. Assumptions used to calculate this value: price volatility - 12.45%; risk-free rate of return - 5.81%; dividend yield - 5.37%; and time to exercise - ten years.\nIII-20\nAGGREGATED STOCK OPTION EXERCISES IN 1993 AND YEAR-END OPTION VALUES\n(C) AGGREGATED STOCK OPTION EXERCISES. The following table sets forth information concerning options exercised during the year ending December 31, 1993, by the named executive officers and the value of unexercised options held by them as of December 31, 1993. The number of SOUTHERN common shares shown and the per share exercise price and market price do not reflect the stock distribution resulting from the two-for-one common stock split approved by SOUTHERN's board of directors in January, 1994.\nSee next page for footnotes.\nIII-21\nAGGREGATED STOCK OPTION EXERCISES IN 1993 AND YEAR-END OPTION VALUES\n(1) This represents the excess of the fair market value of SOUTHERN's common stock of $44.125 per share, as of December 31, 1993, above the exercise price of the options. One column reports the \"value\" of options that are vested and therefore could be exercised; the other \"value\" of options that are not vested and therefore could not be exercised as of December 31, 1993. (2) The \"Value Realized\" is ordinary income, before taxes, and represents the amount equal to the excess of the fair market value of the shares at the time of exercise over the exercise price.\nIII-22\nLONG-TERM INCENTIVE PLANS - AWARDS IN 1993\n(D) LONG-TERM INCENTIVE PLANS. The following table sets forth the long-term incentive plan awards made to the named executive officers for the performance period January 1, 1993 through December 31, 1996.\nSee next page for footnotes.\nIII-23\nLONG-TERM INCENTIVE PLANS - AWARDS IN 1993\nIII-24\nPENSION PLAN TABLE\n(e)(1) The following table sets forth the estimated combined annual pension benefits under the pension and supplemental defined benefit plans in effect during 1993 for ALABAMA, GEORGIA, GULF and MISSISSIPPI. Employee compensation covered by the pension and supplemental benefit plans for pension purposes is limited to the average of the highest three of the final 10 years' base salary and wages (reported under column titled \"Salary\" in the Summary Compensation Tables on pages III-13 through III-18).\nThe amounts shown in the table were calculated according to the final average pay formula and are based on a single life annuity without reduction for joint and survivor annuities (although married employees are required to have their pension benefits paid in one of various joint and survivor annuity forms, unless the employee elects otherwise with the spouse's consent) or computation of the Social Security offset which would apply in most cases. This offset amounts to one-half of the estimated Social Security benefit (primary insurance amount) in excess of $3,000 per year times the number of years of accredited service, divided by the total possible years of accredited service to normal retirement age.\nAs of December 31, 1993, the applicable compensation levels and years of accredited service are presented in the following tables:\nIII-25\nSAVANNAH has in effect a qualified, trusteed, noncontributory, defined benefit pension plan which provides pension benefits to employees upon retirement at the normal retirement age after designated periods of accredited service and at a specified compensation level. The plan provides pension benefits under a formula which includes each participant's years of service with the Southern system and average annual earnings of the highest three of the final ten years of service with the Southern system preceding retirement. Plan benefits are reduced by a portion of the benefits participants are entitled to receive under Social Security. The plan provides for reduced early retirement benefits at age 55 and a pension for the surviving spouse equal to one-half of the deceased retiree's pension.\nThe following table sets forth the estimated annual pension benefits under the pension plan in effect during 1993 which are payable by SAVANNAH to employees upon retirement at the normal retirement age after designated periods of accredited service and at a specified compensation level.\n(1)The number of accredited years of service includes ten years credited to Mr. Holland pursuant to a supplemental pension agreement.\nIII-26\nAs of December 31, 1993, the applicable compensation levels and years of accredited service is presented in the following table:\n(e)(2) DEFERRED COMPENSATION PLAN; SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN.\nSAVANNAH has in effect a voluntary deferred compensation plan for certain executive employees pursuant to which such employees may defer a portion of their respective annual salaries. In addition, SAVANNAH has a supplemental executive retirement plan for certain of its executive employees which became effective January 1, 1984. The deferred compensation plan is designed to provide supplemental retirement or survivor benefit payments. The supplemental executive retirement plan is also designed to provide retiring executives of SAVANNAH with a supplemental retirement benefit, which, in conjunction with social security and benefits under SAVANNAH's qualified pension plan, will equal 70 percent of the highest three of the final ten years average annual compensation (including deferrals under the deferred compensation plan). Both of these plans are unfunded and the liability is payable from general funds of SAVANNAH. The deferred compensation plan became effective December 1, 1983, and all of SAVANNAH's executive officers are participating in the plan. In addition, all executives are participating in the supplemental executive retirement plan.\nIn order to provide for its liabilities under the deferred compensation plan and the supplemental executive retirement plan, SAVANNAH has purchased life insurance on participating executive employees in actuarially determined amounts which, based upon assumptions as to mortality experience, policy dividends, tax effects, and other factors which, if realized, along with compensation deferred by employees and the death benefits payable to\n(1) The plan benefits are subject to the maximum benefit limitations set forth in Section 415 of the Internal Revenue Code.\nIII-27\nSAVANNAH, are expected to cover all such insurance premium payments, and all benefit payments to participants, plus a factor for the cost of funds of SAVANNAH.\n(f) COMPENSATION OF DIRECTORS.\n(1) Standard Arrangements. The following table presents compensation paid to the directors, during 1993 for service as a member of the board of directors and any board committee(s), except that employee directors received no fees or compensation for service as a member of the board of directors or any board committee. All or a portion of these fees may be deferred until membership on the board is terminated.\nALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH also provide retirement benefits to non-employee directors who are credited with a minimum of 60 months of service on the board of directors of one or more system companies, under the Outside Directors Pension Plan. Eligible directors are entitled to benefits under the Plan upon retirement from the board on the retirement date designated in the respective companies by-laws. The annual benefit payable ranges from 75 to 100 percent of the annual retainer fee in effect on the date of retirement, based upon length of service. Payments continue for the greater of the lifetime of the participant or 10 years.\n(2) Other Arrangements. No director received other compensation for services as a director during the year ending December 31, 1993 in addition to or in lieu of that specified by the standard arrangements specified above.\n(1) Committee Chairmen receive an additional $500 per year fee. (2) Established for period September 15, 1993 through May 31, 1994. (3) Chairman of Executive Committee receives an additional $3,000 per month fee.\nIII-28\n(g) EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS.\nNone.\n(h) REPORT ON REPRICING OF OPTIONS.\nNone.\n(i) ADDITIONAL INFORMATION WITH RESPECT TO COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISION.\nALABAMA\nElmer B. Harris serves on the Compensation Committee of AmSouth Bancorporation. John W. Woods, a director of ALABAMA is an executive officer of AmSouth Bancorporation.\nGULF\nMessrs. Paul J. DeNicola and Douglas L. McCrary are ex officio members of its Compensation Committee.\nIII-29\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS.\nSOUTHERN is the beneficial owner of 100% of the outstanding common stock of registrants ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH.\n(B) SECURITY OWNERSHIP OF MANAGEMENT. The following table shows the number of shares of SOUTHERN common stock and operating subsidiary preferred stock owned by the directors, nominees and executive officers as of December 31, 1993. It is based on information furnished by the directors, nominees and executive officers. The shares owned by all directors, nominees and executive officers as a group constitute less than one percent of the total number of shares of the respective classes outstanding on December 31, 1993. The number of SOUTHERN common shares shown do not reflect the stock distribution resulting from the two-for-one common stock split approved by SOUTHERN'S board of directors in January, 1994.\nIII-30\nIII-31\nIII-32\nIII-33\n(1) As used in this table, \"beneficial ownership\" means the sole or shared power to vote, or to direct the voting of, a security and\/or investment power with respect to a security (i.e., the power to dispose of, or to direct the disposition of, a security). (2) The shares shown include shares of common stock of which certain directors and executive officers have the right to acquire beneficial ownership within 60 days pursuant to the Executive Stock Plan, as follows: Mr. Addison, 86,357 shares; Mr. Blakeslee, 660 shares; Mr. Bowden, 5,763 shares; Mr. Dahlberg, 4,278 shares; Mr. Farris, 863 shares; Mr. Gignilliat, 8,556 shares; Mr. Guthrie 15,720 shares; Mr. Harris, 14,215 shares; Mr. Haubein, 835 shares; Mr. Hodges, 5,429 shares; Mr. Holland, 698 shares; Mr. Hutchins, 706 shares; Mr. Jones, 848 shares; Mr. Klappa, 671 shares, Mr. C. D. McCrary, 691 shares; Mr. D. L. McCrary, 9,668 shares; and Mr. Ratcliffe, 5,643 shares. Also included are shares of SOUTHERN common stock held by the spouses of the following directors: Mr. Addison, 670 shares; Mr. Copenhaver, 350 shares; Mr. Harris, 155 shares; Mr. Parker, 22 shares; and Dr. Shatto, 5,067 shares.\nIII-34\n(C) CHANGES IN CONTROL. The operating affiliates know of no arrangements which may at a subsequent date result in any change in control.\nGEORGIA'S Mr. Russell failed to file on a timely basis a single report disclosing one transaction on Form 4 as required by Section 16 of the Securities Exchange Act of 1934.\nMISSISSIPPI'S Messrs. McLean, Jr., Hurt and Seal, Jr. each failed to file on a timely basis a single report disclosing one transaction on Form 4 as required by Section 16 of the Securities Exchange Act of 1934.\nSAVANNAH'S Mr. Gnann failed to file on a timely basis a single report disclosing one transaction on Form 4 as required by Section 16 of the Securities Exchange Act of 1934.\nMR. DENICOLA, a director of GULF, MISSISSIPPI and SAVANNAH, failed to file on a timely basis a single report, disclosing one transaction on Form 4 as required by Section 16 of the Securities Exchange Act of 1934.\nIII-35\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nALABAMA\n(a) Transactions with management and others.\nDuring 1993, ALABAMA, in the ordinary course of business, paid premiums amounting to approximately $400,000 for various types of insurance policies purchased from Protective Life Insurance Company, a subsidiary of Protective Life Corporation, a company in which Mr. William J. Rushton, III, a director of ALABAMA, owns an interest and of which he serves as Chairman.\nThe firm of Inzer, Stivender, Haney & Johnson, P.A., performed certain legal services for ALABAMA during 1993. Mr. James C. Inzer, Jr., partner in this firm, is also a director of ALABAMA.\nALABAMA purchased automobiles and parts in the amount of approximately $200,000 from companies in which Mr. Blount, a director of ALABAMA, owns 85% interests.\nALABAMA purchased electrical supplies in the amount of approximately $200,000 from L & K Electric Supply Company, Ltd. during 1993. Mr. Willie, director of ALABAMA and SOUTHERN, owns an interest in and serves as president of this firm.\nALABAMA believes that these transactions have been on terms representing competitive market prices that are no less favorable than those available from others.\n(b) Certain business relationships. None.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nGEORGIA\n(a) Transactions with management and others.\nIn 1993, GEORGIA was indebted in a maximum amount of $105 million to Wachovia Bank and its affiliates, of which G. Joseph Prendergast serves as President and Chief Executive Officer of Wachovia Corporation of Georgia and Wachovia Bank of Georgia, N.A.\nIn 1993, GEORGIA was indebted in a maximum amount of $285 million to NationsBank and its affiliates of which Mr. James R. Lientz, Jr. serves as President of NationsBank of Georgia.\n(b) Certain business relationships. None.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nGULF\n(a) Transactions with management and others.\nThe firm of Beggs & Lane, P.A. serves as local counsel for GULF and received from GULF approximately $800,000 for services rendered. Mr. G. Edison Holland, Jr. is a partner in the firm and also serves as Vice President and Corporate Counsel of GULF.\n(b) Certain business relationships. None.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nMISSISSIPPI\n(a) Certain business relationships.\nDuring 1993, MISSISSIPPI was indebted in a maximum amount of $12.4 million to Hancock Bank, of which Leo W. Seal, Jr. serves as Chairman of the Board and Chief Executive Officer.\n(b) Certain business relationships. None.\n(c) Indebtedness of management. None.\nIII-36\n(d) Transactions with promoters. None.\nSAVANNAH\n(a) Transactions with management and others.\nMr. Tenenbaum is a Director of First Union national Bank of Georgia, and Mr. Foster is President of NationsBank of Georgia, N.A., in Savannah. During 1993, these banks furnished a number of regular banking services in the ordinary course of business to SAVANNAH. SAVANNAH intends to maintain normal banking relations with all of the aforesaid banks in the future.\n(b) Certain business relationships.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nIII-37 PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this report on this Form 10-K:\n(1) Financial Statements:\nReports of Independent Public Accountants on the financial statements for SOUTHERN and Subsidiary Companies, ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH are listed under Item 8 herein.\nThe financial statements filed as a part of this report for SOUTHERN and Subsidiary Companies, ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH are listed under Item 8 herein.\n(2) Financial Statement Schedules:\nReports of Independent Public Accountants as to Schedules for SOUTHERN and Subsidiary Companies, ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH are included herein on pages IV-12 through IV-17.\nFinancial Statement Schedules for SOUTHERN and Subsidiary Companies, ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH are listed in the Index to the Financial Statement Schedules at page S-1.\n(3) Exhibits:\nExhibits for SOUTHERN, ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH are listed in the Exhibit Index at page E-1.\n(b) Reports on Form 8-K: During the fourth quarter of 1993 the registrants filed Current Reports on Form 8-K as follows:\nALABAMA filed Forms 8-K dated October 27, 1993, and November 16, 1993, to facilitate security sales.\nGEORGIA filed a Form 8-K dated October 20, 1993, to facilitate a security sale.\nGULF filed a Form 8-K dated November 3, 1993, to facilitate a security sale.\nSAVANNAH filed a Form 8-K dated November 9, 1993, to facilitate a security sale.\nIV-1 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nTHE SOUTHERN COMPANY\nBy Edward L. Addison, Chairman\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nEdward L. Addison Chairman of the Board (Principal Executive Officer)\nW. L. Westbrook Financial Vice President (Principal Financial and Accounting Officer)\nDirectors:\nW. P. Copenhaver John M. McIntosh. A. W. Dahlberg Earl D. McLean, Jr. Paul J. DeNicola William A. Parker Jack Edwards William J. Rushton, III H. Allen Franklin Gloria M. Shatto L. G. Hardman, III Herbert Stockham Elmer B. Harris Louis J. Willie\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nALABAMA POWER COMPANY\nBy Elmer B. Harris, President\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nElmer B. Harris President, Chief Executive Officer and Director (Principal Executive Officer)\nCharles D. McCrary Senior Vice President (Principal Financial Officer)\nDavid L. Whitson Vice President and Comptroller (Principal Accounting Officer)\nDirectors:\nEdward L. Addison William V. Muse Whit Armstrong John T. Porter Philip E. Austin Gerald H. Powell Margaret A. Carpenter Robert D. Powers Peter V. Gregerson, Sr. John W. Rouse Bill M. Guthrie James H. Sanford Crawford T. Johnson, III John Cox Webb, IV Carl E. Jones, Jr. Louis J. Willie Wallace D. Malone, Jr. John W. Woods\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nIV-2\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nGEORGIA POWER COMPANY\nBy H. Allen Franklin, President\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nH. Allen Franklin President, Chief Executive Officer and Director (Principal Executive Officer)\nWarren Y. Jobe Executive Vice President, Treasurer, Chief Financial Officer and Director (Principal Financial Officer)\nC. B. Harreld Vice President and Comptroller (Principal Accounting Officer)\nDirectors: Edward L. Addison G. Joseph Prendergast Bennett A. Brown Herman J. Russell William P. Copenhaver Gloria M. Shatto A. W. Dahlberg Robert Strickland William A. Fickling, Jr. William Jerry Vereen L. G. Hardman, III Thomas R. Williams James R. Lientz, Jr.\nBy Wayne Boston (Wayne Boston, Attorney-in-fact) Date: March 25, 1994\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nGULF POWER COMPANY\nBy D. L. McCrary, Chairman of the Board\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nD. L. McCrary Chairman of the Board and Chief Executive Officer (Principal Executive Officer)\nA. E. Scarbrough Vice President - Finance (Principal Financial and Accounting Officer)\nDirectors: Reed Bell Travis J. Bowden Paul J. DeNicola Fred C. Donovan W. D. Hull, Jr. C. W. Ruckel J. K. Tannehill\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25,1994\nIV-3\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nMISSISSIPPI POWER COMPANY\nBy David M. Ratcliffe, President\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nDavid M. Ratcliffe President, Chief Executive Officer and Director (Principal Executive Officer)\nThomas A. Fanning Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors: Paul J. DeNicola Edwin E. Downer Robert S. Gaddis Walter H. Hurt, III Aubrey K. Lucas Earl D. McLean, Jr. Gerald J. St. Pe' Leo W. Seal, Jr. N. Eugene Warr\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nSAVANNAH ELECTRIC AND POWER COMPANY\nBy Arthur M. Gignilliat, Jr., President\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nPursuant 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 and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nArthur M. Gignilliat, Jr. President, Chief Executive Officer and Director (Principal Executive Officer)\nKirby R. Willis Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors: Helen Q. Artley Paul J. DeNicola Brian R. Foster Walter D. Gnann John M. McIntosh Robert B. Miller, III James M. Piette Arnold M. Tenenbaum Frederick F. Williams, Jr.\nBy Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 25, 1994\nIV-4\nEXHIBIT 21. SUBSIDIARIES OF THE REGISTRANTS.\n(1) Owned by Alabama Power Company. (2) Owned by Georgia Power Company. (3) Owned by SEI Holdings, Inc. (4) 94% owned jointly by Asociados de Electricidad, S. A. (14%) and SEI Holdings, Inc. (80%) (5) 59% owned by SEI y Asociados de Argentina, S. A. (6) Owned by SEI Holdings III, Inc. (7) 36% owned by SEI Chile, S. A. (8) Owned by SEI Holdings IV, Inc. (9) Owned jointly by Inversores de Electricidad, S. A. (15%) and SEI Bahamas Argentina I, Inc. (85%) (10) Owned by Southern Electric Bahamas Holdings, Ltd. (11) 50% owned by Southern Electric Bahamas, Ltd. (12) Owned equally by Alabama Power Company and Georgia Power Company. (13) Owned by Southern Electric International, Inc. (14) Owned by Southern Electric Wholesale Generators, Inc.\nIV-5 ARTHUR ANDERSEN & CO.\nExhibit 23(a)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of The Southern Company and its subsidiaries and the related financial statement schedules, included in this Form 10-K, into The Southern Company's previously filed Registration Statement File Nos. 2-78617, 33-3546, 33-23152, 33-30171, 33-23153 and 33-51433.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia March 25, 1994\nIV-6 ARTHUR ANDERSEN & CO.\nExhibit 23(b)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of Alabama Power Company and the related financial statement schedules, included in this Form 10-K, into Alabama Power Company's previously filed Registration Statement File No. 33-49653.\n\/s\/ Arthur Andersen & Co.\nBirmingham, Alabama March 25, 1994\nIV-7 ARTHUR ANDERSEN & CO.\nExhibit 23(c)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of Georgia Power Company and the related financial statement schedules, included in this Form 10-K, into Georgia Power Company's previously filed Registration Statement File No. 33-49661.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia March 25, 1994\nIV-8 ARTHUR ANDERSEN & CO.\nExhibit 23(d)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of Gulf Power Company and the related financial statement schedules, included in this Form 10-K, into Gulf Power Company's previously filed Registration Statement File No. 33-50165.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia March 25, 1994\nIV-9 ARTHUR ANDERSEN & CO.\nExhibit 23(e)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of Mississippi Power Company and the related financial statement schedules, included in this Form 10-K, into Mississippi Power Company's previously filed Registration Statement File Nos. 33-49320 and 33-49649.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia March 25, 1994\nIV-10 ARTHUR ANDERSEN & CO.\nExhibit 23(f)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 16, 1994 on the financial statements of Savannah Electric and Power Company and the related financial statement schedules, included in this Form 10-K, into Savannah Electric and Power Company's previously filed Registration Statement File Nos. 33-45757 and 33-52509.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia March 25, 1994\nIV-11 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo The Southern Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of The Southern Company and its subsidiaries included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our report on the consolidated financial statements includes an explanatory paragraph which states that an uncertainty exists with respect to the actions of the regulators regarding recoverability of the investment in the Rocky Mountain pumped storage hydroelectric project, as discussed in Note 4 to The Southern Company's consolidated financial statements. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to The Southern Company and its subsidiaries (pages S-2 and S-3, S-11 through S-14, S-35 through S-37, S-53, and S-59) are the responsibility of The Southern Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nIV-12 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo Alabama Power Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Alabama Power Company included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to Alabama Power Company (pages S-4, S-15 through S-18, S-38 through S-40, S-54, and S-60) are the responsibility of Alabama Power Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nBirmingham, Alabama February 16, 1994\nIV-13 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo Georgia Power Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Georgia Power Company included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our report on the financial statements includes an explanatory paragraph which states that an uncertainty exists with respect to the actions of the regulators regarding the recoverability of Georgia Power Company's investment in the Rocky Mountain pumped storage hydroelectric project, as discussed in Note 4 to Georgia Power Company's financial statements. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to Georgia Power Company (pages S-5, S-19 through S-22, S-41 through S-43, S-55, and S-61) are the responsibility of Georgia Power Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nIV-14 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo Gulf Power Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Gulf Power Company included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to Gulf Power Company (pages S-6, S-23 through S-26, S-44 through S-46, S-56, and S-62) are the responsibility of Gulf Power Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nIV-15 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo Mississippi Power Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Mississippi Power Company included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to Mississippi Power Company (pages S-7 and S-8, S-27 through S-30, S-47 through S-49, S-57, and S-63) are the responsibility of Mississippi Power Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nIV-16 ARTHUR ANDERSEN & CO.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES\nTo Savannah Electric and Power Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Savannah Electric and Power Company included in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14(a)(2) herein as it relates to Savannah Electric and Power Company (pages S-9 and S-10, S-31 through S-34, S-50 through S-52, S-58, and S-64) are the responsibility of Savannah Electric and Power Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen & Co.\nAtlanta, Georgia February 16, 1994\nIV-17\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedules I through XIV not listed above are omitted as not applicable or not required. Columns omitted from schedules filed have been omitted because the information is not applicable or not required.\nS-1\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nSee Summary of Transactions and Notes on Page S-3\nS-2\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991, 1992 and 1993, as summarized below, were each less than 10% of the total balances as of the respective year-ends. Retirements include non-depreciable plant retirements and unamortized portions of retirements to acquisition adjustments. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress.\n(NOTE 1) OTHER CHANGES INCLUDE THE FOLLOWING (STATED IN THOUSANDS OF DOLLARS)\nS-3\nALABAMA POWER COMPANY SCHEDULE V -- UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991, 1992 and 1993, as summarized below, were each less than 10% of the total balances as of the respective year-ends. Retirements below include non-depreciable plant retirements. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress. Other changes include a reduction to utility plant of $61,960,000 for the partial sale of Miller Steam Plant in 1992.\nS-4\nGEORGIA POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991, 1992 and 1993, as summarized below, were each less than 10% of the total balances as of the respective year-ends. Retirements include non-depreciable plant retirements and unamortized portions of Plant Scherer acquisition adjustment retired for sales in 1991 and 1993. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress. Other changes for 1993, include an increase to plant of $46,473,000 for the taxes applicable to capitalized AFUDC debt.\nS-5\nGULF POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991, 1992 and 1993, as summarized below, were each less than 10% of the total balances as of the respective year-ends. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress.\nS-6\nMISSISSIPPI POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991 and 1992, as summarized below, were each less than 10% of the total balances as of the respective year-ends. Additions for 1993 were greater than 10% of the year-end balance and, consequently, 1993 is reported in full detail on page S-8. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress.\nS-7\nMISSISSIPPI POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES FOR THE YEAR ENDED DECEMBER 31,1993 (STATED IN THOUSANDS OF DOLLARS)\nS-8\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES (STATED IN THOUSANDS OF DOLLARS)\nTotal additions and total retirements for 1991 and 1992, as summarized below, were each less than 10% of the total balances as of the respective year-ends. Additions for 1993 were greater than 10% of the year-end balance and, consequently, 1993 is reported in full detail on page S-10. There were no additions to individual accounts in excess of two percent of total assets other than transfers from Construction Work in Progress.\nS-9\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE V - UTILITY PLANT, INCLUDING INTANGIBLES FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nS-10\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-14\nS-11\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-14\nS-12\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-14\nS-13\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES NOTES TO SCHEDULE VI -ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-14\nALABAMA POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-18\nS-15\nALABAMA POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-18\nS-16\nALABAMA POWER COMPANY SCHEDULE VI --ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-18\nS-17\nALABAMA POWER COMPANY NOTES TO SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-18\nGEORGIA POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-22\nS-19\nGEORGIA POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-22\nS-20\nGEORGIA POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-22 S-21\nGEORGIA POWER COMPANY NOTES TO SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-22\nGULF POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-26\nS-23\nGULF POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-26 S-24\nGULF POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-26\nS-25\nGULF POWER COMPANY NOTES TO SCHEDULE VI -ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-26\nMISSISSIPPI POWER COMPANY SCHEDULE VI --ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-30\nS-27\nMISSISSIPPI POWER COMPANY SCHEDULE VI --ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-30\nS-28\nMISSISSIPPI POWER COMPANY SCHEDULE VI --ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-30\nS-29\nMISSISSIPPI POWER COMPANY NOTES TO SCHEDULE VI -ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PL FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-30\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE VI --ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1993 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-34\nS-31\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1992 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-34\nS-32\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEAR ENDED DECEMBER 31, 1991 (STATED IN THOUSANDS OF DOLLARS)\nSee Notes on Page S-34\nS-33\nSAVANNAH ELECTRIC AND POWER COMPANY NOTES TO SCHEDULE VI -- ACCUMULATED PROVISION FOR DEPRECIATION OF UTILITY PLANT FOR THE YEARS ENDING DECEMBER 31, 1993, 1992 AND 1991 (STATED IN THOUSANDS OF DOLLARS)\nS-34\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- ------------------------- Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) Insurance recoveries net of charges to reserve for purposes for which reserve was created. (3) See Note 1 to SOUTHERN's financial statements under \"Nuclear Decommissioning\" in Item 8 herein for further information. (4) Represents additional funding to reserve. (5) See Note 1 to SOUTHERN's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further information.\nS-35\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- ----------------------------- Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) See Note 1 to SOUTHERN's financial statements under \"Depreciation and Nuclear Decommissioning\" in Item 8 herein for further information. (3) See Note 1 to SOUTHERN's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further information. (4) Capitalized.\nS-36 THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in Thousands of Dollars)\n- ------------------ Notes: (1) See Note 8 to SOUTHERN's financial statements in Item 8 herein for a description of the Gulf States settlement. (2) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (3) Insurance recoveries net of charges to reserve for purposes for which reserve was created. (4) See Note 1 to SOUTHERN's financial statements under \"Depreciation and Nuclear Decommissioning\" in Item 8 herein for further information.\nS-37 ALABAMA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- ------------------ Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) See Note 1 to ALABAMA's financial statements under \"Depreciation and Nuclear Decommissioning\" in Item 8 herein for further information. (3) Represents additional funding to reserve. (4) See Note 1 to ALABAMA's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further information.\nS-38 ALABAMA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- ----------------------------- Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) See Note 1 to ALABAMA's financial statements under \"Depreciation and Nuclear Decommissioning\" in Item 8 herein for further information. (3) See Note 1 to ALABAMA's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further Information.\nS-39 ALABAMA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in Thousands of Dollars)\n- ----------------------- Notes: (1) See Note 7 to the financial statements in Item 8 herein for a description of the Gulf States settlement. The provision for uncollectible was reversed. (2) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (3) See Note 1 to ALABAMA's financial statements under \"Depreciation and Nuclear Decommissioning\" in Item 8 herein for further information.\nS-40 GEORGIA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- -------------------- Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) See Note 1 to GEORGIA's financial statements under \"Nuclear Decommissioning\" in Item 8 herein for further information. (3) Represents additional funding to reserve. (4) See Note 1 to GEORGIA's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further information.\nS-41 GEORGIA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- ----------------------- Notes: (1) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (2) See Note 1 to GEORGIA's financial statements under \"Nuclear Decommissioning\" in Item 8 herein for further information. (3) See Note 1 to GEORGIA's financial statements under \"Revenues and Fuel Costs\" in Item 8 herein for further information.\nS-42 GEORGIA POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in Thousands of Dollars)\n- ------------------ Note: (1) See Note 3 to GEORGIA's financial statements in Item 8 herein for a description of the Gulf States settlement. The provision for uncollectible accounts was reversed. (2) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off. (3) See Note 1 to GEORGIA's financial statements under \"Nuclear Decommissioning\" in Item 8 herein for further information.\nS-43 GULF POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- --------------- Note: Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-44 GULF POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- -------------------- Note: Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-45 GULF POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in Thousands of Dollars)\n- ------------------ Notes: (1) See Note 7 to GULF's financial statements in Item 8 herein for a description of the Gulf States settlement. The provision for uncollectible was reversed. (2) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-46 MISSISSIPPI POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- --------------- Note: Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-47 MISSISSIPPI POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- ------------------ Note: Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-48 MISSISSIPPI POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in thousands of Dollars)\n- ----------------- Notes: (1) See Note 7 to MISSISSIPPI's financial statements in Item 8 herein for a description of the Gulf States settlement. The provision for uncollectible was reversed. (2) Represents write-off of accounts considered to be uncollectible, less recoveries of amounts previously written off.\nS-49 SAVANNAH ELECTRIC AND POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(Stated in Thousands of Dollars)\n- -------------------------- Note: Represents write-off of accounts receivable considered to be uncollectible, less recoveries of amounts previously written off.\nS-50 SAVANNAH ELECTRIC AND POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1992\n(Stated in Thousands of Dollars)\n- ---------------------- Note: Represents write-off of accounts receivable considered to be uncollectible, less recoveries of amounts previously written off.\nS-51 SAVANNAH ELECTRIC AND POWER COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEAR ENDED DECEMBER 31, 1991\n(Stated in Thousands of Dollars)\nNote: Represents write-off of accounts receivable considered to be uncollectible, less recoveries of amounts previously written off.\nS-52 THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\nDECEMBER 31, 1993, 1992 AND 1991\n(Stated in Thousands of Dollars)\n- ---------------------- Notes: (1) At month-end. (2) Average based on daily borrowings during period (averages and rates quoted on an actual day year basis). (3) This note payable is an obligation of SEI and does not include borrowings from SOUTHERN. (4) See Note 5 to SOUTHERN's financial statements in Item 8 herein for details regarding SOUTHERN's and its subsidiaries lines of credit and general terms of commitment agreements.\nS-53 ALABAMA POWER COMPANY\nSCHEDULE IX - SHORT -TERM BORROWINGS\nDECEMBER 31, 1993, 1992, 1991\n(Stated in Thousands of Dollars)\n- ----------------- Notes: (1) At month-end. (2) Average based on daily borrowings during the period (averages and rates quoted on an actual day year basis). (3) ALABAMA also issued commercial paper during 1993, although none was outstanding at year-end. The data shown reflects the issuance of commercial paper. (4) See Note 5 to ALABAMA's financial statements in Item 8 herein for details regarding ALABAMA's lines of credit.\nS-54 GEORGIA POWER COMPANY\nSCHEDULE IX - SHORT -TERM BORROWINGS\nDECEMBER 31, 1993, 1992 AND 1991\n(Stated in Thousands of Dollars)\n- -------------------- Notes: (1) At month-end (2) Average based on daily borrowings during period (averages and rates quoted on an actual day year basis). (3) See Note 8 to GEORGIA's financial statements in Item 8 herein for details regarding GEORGIA's lines of credit and general terms of its commitment agreements.\nS-55 GULF POWER COMPANY\nSCHEDULE IX - SHORT -TERM BORROWINGS\nDECEMBER 31, 1993, 1992 AND 1991\n(Stated in Thousands of Dollars)\n- ---------------------- Notes: (1) At month-end (2) Average based on daily borrowings during period (averages and rates quoted on an actual day year basis). (3) See Note 5 to GULF's financial statements in Item 8 herein for a description of this short-term indebtedness. (4) See Note 5 to GULF's financial statements in Item 8 herein for details regarding GULF's lines of credit and general terms of its commitment agreements.\nS-56 MISSISSIPPI POWER COMPANY\nSCHEDULE IX - SHORT -TERM BORROWINGS\nDECEMBER 31, 1993, 1992 AND 1991\n(Stated in Thousands of Dollars)\n- ---------------------- Notes: (1) At month-end (2) Average based on daily borrowings during period (averages and rates quoted on an actual day year basis). (3) See Note 5 to MISSISSIPPI's financial statements in Item 8 herein for details regarding MISSISSIPPI's lines of credit and general terms of its commitment agreements.\nS-57 SAVANNAH ELECTRIC AND POWER COMPANY\nSCHEDULE IX - SHORT -TERM BORROWINGS\nDECEMBER 31, 1993, 1992 AND 1991\n(Stated in Thousands of Dollars)\nNotes: (1) At month-end (2) Average based on daily borrowings during period (averages and rates quoted on an actual day year basis). (3) See Note 5 to SAVANNAH's financial statements in Item 8 herein for details regarding SAVANNAH's lines of credit and general terms of its commitment agreements.\nS-58 THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-59 ALABAMA POWER COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-60 GEORGIA POWER COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-61 GULF POWER COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-62 MISSISSIPPI POWER COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-63 SAVANNAH ELECTRIC AND POWER COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993, 1992 AND 1991\n(Thousands of Dollars)\nS-64 EXHIBIT INDEX\nThe following exhibits indicated by an asterisk preceding the exhibit number are filed herewith. The balance of the exhibits have heretofore been filed with the SEC, respectively, as the exhibits and in the file numbers indicated and are incorporated herein by reference. Reference is made to a duplicate list of exhibits being filed as a part of this Form 10-K, which list, prepared in accordance with Item 601 of Regulation S-K of the SEC, immediately precedes the exhibits being physically filed with this Form 10-K.\n(3) ARTICLES OF INCORPORATION AND BY-LAWS\nSOUTHERN\n(a) 1 - Composite Certificate of Incorporation of SOUTHERN, reflecting all amendments to date. (Designated in Registration No. 33-3546 as Exhibit 4(a), in Certificate of Notification, File No. 70-7341, as Exhibit A and in Certificate of Notification, File No. 70-8181, as Exhibit A.)\n(a) 2 - By-laws of SOUTHERN as amended effective October 21, 1991, and as presently in effect. (Designated in Form U-1, File No. 70-8181 as Exhibit A-2.)\nALABAMA\n(b) 1 - Charter of ALABAMA and amendments thereto through November 19, 1993. (Designated in Registration Nos. 2-59634 as Exhibit 2(b), 2-60209 as Exhibit 2(c), 2-60484 as Exhibit 2(b), 2-70838 as Exhibit 4(a)-2, 2-85987 as Exhibit 4(a)-2, 33-25539 as Exhibit 4(a)-2, 33-43917 as Exhibit 4(a)-2, in Form 8-K dated February 5, 1992, File No. 1-3164, as Exhibit 4(b)-3, in Form 8-K dated July 8, 1992, File No. 1-3164, as Exhibit 4(b)-3, in Form 8-K dated October 27, 1993, File No. 1-3164, as Exhibits 4(a) and 4(b) and in Form 8-K dated November 16, 1993, File No. 1-3164, as Exhibit 4(a).)\n(b) 2 - By-laws of ALABAMA as amended effective April 24, 1992, and as presently in effect. (Designated in Registration No. 33-48885 as Exhibit 4(c).)\nGEORGIA\n(c) 1 - Charter of GEORGIA and amendments thereto through October 25, 1993. (Designated in Registration Nos. 2-63392 as Exhibit 2(a)-2, 2-78913 as Exhibits 4(a)-(2) and 4(a)-(3), 2-93039 as Exhibit 4(a)-(2), 2-96810 as Exhibit 4(a)-2, 33-141 as Exhibit 4(a)-(2), 33-1359 as Exhibit 4(a)(2), 33-5405 as Exhibit 4(b)(2), 33-14367 as Exhibits 4(b)-(2) and 4(b)-(3), 33-22504 as Exhibits 4(b)-(2), 4(b)-(3) and 4(b)-(4), in GEORGIA's Form 10-K for the year ended December 31, 1991, File No. 1-6468, as Exhibits 4(a)(2) and 4(a)(3), in Registration No. 33-48895 as Exhibits 4(b)-(2) and 4(b)-(3), in Form 8-K dated December 10, 1992, File No. 1-6468 as Exhibit 4(b), in Form 8-K dated June 17, 1993, File No. 1-6468, as Exhibit 4(b) and in Form 8-K dated October 20, 1993, File No. 1-6468, as Exhibit 4(b).)\nE-1 (c) 2 - By-laws of GEORGIA as amended effective July 18, 1990, and as presently in effect. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No.1-6468, as Exhibit 3.) GULF\n(d) 1 - Restated Articles of Incorporation of GULF and amendments thereto through November 8, 1993. (Designated in Registration No. 33-43739 as Exhibit 4(b)-1, in Form 8-K dated January 15, 1992, File No. 0-2429, as Exhibit 1(b), in Form 8-K dated August 18, 1992, File No. 0-2429, as Exhibit 4(b)-2, in Form 8-K dated September 22, 1993, File No. 0-2429, as Exhibit 4 and in Form 8-K dated November 3, 1993, File No. 0-2429, as Exhibit 4.)\n*(d) 2 - By-laws of GULF as amended effective February 25, 1994, and as presently in effect.\nMISSISSIPPI\n(e) 1 - Articles of incorporation of MISSISSIPPI, articles of merger of Mississippi Power Company (a Maine corporation) into MISSISSIPPI and articles of amendment to the articles of incorporation of MISSISSIPPI through August 19, 1993. (Designated in Registration No. 2-71540 as Exhibit 4(a)-1, in Form U5S for 1987, File No. 30-222-2, as Exhibit B-10, in Registration No. 33-49320 as Exhibit 4(b)-(1), in Form 8-K dated August 5, 1992, File No. 0-6849, as Exhibits 4(b)-2 and 4(b)-3, in Form 8-K dated August 4, 1993, File No. 0-6849, as Exhibit 4(b)-3 and in Form 8-K dated August 18, 1993, File No. 0-6849, as Exhibit 4(b)-3.)\n(e) 2 - By-laws of MISSISSIPPI as amended effective August 22, 1989, and as presently in effect. (Designated in MISSISSIPPI's Form 10-K for the year ended December 31, 1989, as Exhibit 3(b).)\nSAVANNAH\n(f) 1 - Charter of SAVANNAH and amendments thereto through November 10, 1993. (Designated in Registration Nos. 33-25183 as Exhibit 4(b)-(1), 33-45757 as Exhibit 4(b)-(2) and in Form 8-K dated November 9, 1993, File No. 1-5072, as Exhibit 4(b).)\n*(f) 2 - By-laws of SAVANNAH as amended effective February 16, 1994, and as presently in effect.\n(4) INSTRUMENTS DESCRIBING RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES\nALABAMA\n(b) - Indenture dated as of January 1, 1942, between ALABAMA and Chemical Bank, as Trustee, and indentures supplemental thereto through that dated as of January 1, 1994. (Designated in Registration Nos. 2-59843 as Exhibit 2(a)-2, 2-60484 as Exhibits 2(a)-3 and 2(a)-4, 2-60716 as Exhibit 2(c), 2-67574 as\nE-2 Exhibit 2(c), 2-68687 as Exhibit 2(c), 2-69599 as Exhibit 4(a)-2, 2-71364 as Exhibit 4(a)-2, 2- 73727 as Exhibit 4(a)-2, 33-5079 as Exhibit 4(a)-2, 33-17083 as Exhibit 4(a)-2, 33-22090 as Exhibit 4(a)-2, in ALABAMA's Form 10-K for the year ended December 31, 1990, File No. 1-3164, as Exhibit 4(c), in Registration Nos. 33-43917 as Exhibit 4(a)-2, 33-45492 as Exhibit 4(a)-2, 33- 48885 as Exhibit 4(a)-2, 33-48917 as Exhibit 4(a)-2, in Form 8-K dated January 20, 1993, File No. 1-3436, as Exhibit 4(a)-3, in Form 8-K dated February 17, 1993, File No.1-3436, as Exhibit 4(a)-3, in Form 8-K dated March 10, 1993, File No. 1-3436, as Exhibit 4(a)-3, in Certificate of Notification, File No. 70-8069, as Exhibits A and B, in Form 8-K dated June 24, 1993, File No. 1- 3436, as Exhibit 4, in Certificate of Notification, File No. 70-8069, as Exhibit A, in Form 8-K dated November 16, 1993, File No. 1-3436, as Exhibit 4(b) and in Certificate of Notification, File No. 70-8069, as Exhibits A and B.)\nGEORGIA\n(d) - Indenture dated as of March 1, 1941, between GEORGIA and Chemical Bank, as Trustee, and indentures supplemental thereto dated as of March 1, 1941, March 3, 1941 (3 indentures), March 6, 1941 (139 indentures), March 1, 1946 (88 indentures) and December 1, 1947, through January 1, 1994. (Designated in Registration Nos. 2-4663 as Exhibits B-3 and B-3(a), 2-7299 as Exhibit 7(a)-2, 2- 61116 as Exhibit 2(a)-3 and 2(a)-4, 2-62488 as Exhibit 2(a)-3, 2-63393 as Exhibit 2(a)-4, 2-63705 as Exhibit 2(a)-3, 2-68973 as Exhibit 2(a)-3, 2-70679 as Exhibit 4(a)-(2), 2-72324 as Exhibit 4(a)-2, 2-73987 as Exhibit 4(a)-(2), 2-77941 as Exhibits 4(a)-(2) and 4(a)-(3), 2-79336 as Exhibit 4(a)-(2), 2-81303 as Exhibit 4(a)-(2), 2-90105 as Exhibit 4(a)-(2), 33-5405 as Exhibit 4(a)-(2), 33-14367 as Exhibits 4(a)-(2) and 4(a)-(3), 33-22504 as Exhibits 4(a)-(2), 4(a)-(3) and 4(a)-(4), 33-32420 as Exhibit 4(a)-(2), 33-35683 as Exhibit 4(a)-(2), in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 4(a)(3), in Form 10-K for the year ended December 31, 1991, File No. 1-6468, as Exhibit 4(a)(5), in Registration No. 33-48895 as Exhibit 4(a)-(2), in Form 8-K dated August 26, 1992, File No. 1-6468, as Exhibit 4(a)-(3), in Form 8-K dated September 9, 1992, File No. 1-6468, as Exhibits 4(a)-(3) and 4(a)-(4), in Form 8-K dated September 23, 1992, File No. 1-6468, as Exhibit 4(a)-(3), in Form 8-A dated October 12, 1992, as Exhibit 2(b), in Form 8-K dated January 27, 1993, File No. 1-6468, as Exhibit 4(a)-(3), in Registration No. 33-49661 as Exhibit 4(a)-(2), in Form 8-K dated July 26, 1993, File No. 1-6468, as Exhibit 4, in Certificate of Notification, File No. 70-7832, as Exhibit M and in Certificate of Notification, File No. 70-7832, as Exhibit C.)\nGULF\n(e) - Indenture dated as of September 1, 1941, between GULF and The Chase Manhattan Bank (National Association) and The Citizens & Peoples National Bank of Pensacola, as Trustees, and indentures supplemental thereto through\nE-3 November 1, 1993. (Designated in Registration Nos. 2-4833 as Exhibit B-3, 2-62319 as Exhibit 2(a)-3, 2-63765 as Exhibit 2(a)-3, 2-66260 as Exhibit 2(a)-3, 33-2809 as Exhibit 4(a)-2, 33-43739 as Exhibit 4(a)-2, in GULF's Form 10-K for the year ended December 31, 1991, File No. 0-2429, as Exhibit 4(b), in Form 8-K dated August 18, 1992, File No. 0-2429, as Exhibit 4(a)-3, in Registration No. 33-50165 as Exhibit 4(a)-2, in Form 8-K dated July 12, 1993, File No. 0-2429, as Exhibit 4 and in Certificate of Notification, File No. 70-8229, as Exhibit A.)\nMISSISSIPPI\n(f) - Indenture dated as of September 1, 1941, between MISSISSIPPI and Morgan Guaranty Trust Company of New York, as Trustee, and indentures supplemental thereto through November 1, 1993. (Designated in Registration Nos. 2-4834 as Exhibit B-3, 2-62965 as Exhibit 2(b)-2, 2-66845 as Exhibit 2(b)-2, 2-71537 as Exhibit 4(a)-(2), 33-5414 as Exhibit 4(a)-(2), 33-39833 as Exhibit 4(a)-2, in MISSISSIPPI's Form 10-K for the year ended December 31, 1991, File No. 0-6849, as Exhibit 4(b), in Form 8-K dated August 5, 1992, File No. 0-6849, as Exhibit 4(a)-2, in Second Certificate of Notification, File No. 70-7941, as Exhibit I, in MISSISSIPPI's Form 8-K dated February 26, 1993, File No. 0-6849, as Exhibit 4(a)-2, in Certificate of Notification, File No. 70-8127, as Exhibit A, in Form 8-K dated June 22, 1993, File No. 0-6849, as Exhibit 1 and in Certificate of Notification, File No. 70-8127, as Exhibit A.)\nSAVANNAH\n(g) - Indenture dated as of March 1, 1945, between SAVANNAH and NationsBank of Georgia, National Association, as Trustee, and indentures supplemental thereto through July 1, 1993. (Designated in Registration Nos. 33-25183 as Exhibit 4(a)-(1), 33-41496 as Exhibit 4(a)-(2), 33-45757 as Exhibit 4(a)-(2), in SAVANNAH's Form 10-K for the year ended December 31, 1991, File No. 1-5072, as Exhibit 4(b), in Form 8-K dated July 8, 1992, File No. 1-5072, as Exhibit 4(a)-3, in Registration No. 33-50587 as Exhibit 4(a)-(2) and in Form 8-K dated July 22, 1993, File No. 1-5072, as Exhibit 4.)\n(10) MATERIAL CONTRACTS\nSOUTHERN\n(a) 1 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated as of September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SEGCO and SOUTHERN. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1984, File No. 1-3526, as Exhibit 10(a) and in SOUTHERN's Form 10-K for the year ended December 31, 1985, File No. 1-3526, as Exhibit 10(a)(3).)\n(a) 2 - Service contract dated as of July 17, 1981, between SCS and SEI. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1985, File No. 1-3526, as Exhibit 10(a)(2).)\nE-4 (a) 3 - Service contract dated as of March 3, 1988, between SCS and SAVANNAH. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1987, File No. 1-5072, as Exhibit 10-p.)\n(a) 4 - Service contract dated as of January 15, 1991, between SCS and Southern Nuclear. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1991, File No. 1-3526, as Exhibit 10(a)(4).)\n(a) 5 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1988, File No. 1-5072, as Exhibit 10(b).)\n(a) 6 - Agreement dated as of January 27, 1959 and Amendment No. 1 dated as of October 27, 1982, among SEGCO, ALABAMA and GEORGIA. (Designated in Registration No. 2-59634 as Exhibit 5(c) and in GEORGIA's Form 10-K for the year ended December 31, 1982, File No. 1-6468, as Exhibit 10(d)(2).)\n(a) 7 - Joint Committee Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. (Designated in Registration No. 2-61116 as Exhibit 5(d).)\n(a) 8 - Edwin I. Hatch Nuclear Plant Purchase and Ownership Participation Agreement dated as of January 6, 1975, between GEORGIA and OPC. (Designated in Form 8-K for January, 1975, File No. 1-6468, as Exhibit (b)(1).)\n(a) 9 - Edwin I. Hatch Nuclear Plant Operating Agreement dated as of January 6, 1975, between GEORGIA and OPC. (Designated in Form 8-K for January, 1975, File No. 1-6468, as Exhibit (b)(3).)\n(a) 10 - Revised and Restated Integrated Transmission System Agreement dated as of November 12, 1990, between GEORGIA and OPC. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(g).)\n(a) 11 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of March 26, 1976, between GEORGIA and OPC. (Designated in Certificate of Notification, File No. 70-5592, as Exhibit A.)\n(a) 12 - Plant Hal Wansley Operating Agreement dated as of March 26, 1976, between GEORGIA and OPC. (Designated in Certificate of Notification, File No. 70-5592, as Exhibit B.)\n(a) 13 - Edwin I. Hatch Nuclear Plant Purchase and Ownership Participation Agreement dated as of August 27, 1976, between GEORGIA, MEAG and Dalton. (Designated in Form 8-K dated as of June 13, 1977, File No. 1-6468, as Exhibit (b)(1).)\nE-5 (a) 14 - Edwin I. Hatch Nuclear Plant Operating Agreement dated as of August 27, 1976, between GEORGIA, MEAG and Dalton. (Designated in Form 8-K for February, 1977, File No. 1-6468, as Exhibit (b)(2).)\n(a) 15 - Alvin W. Vogtle Nuclear Units Number One and Two Purchase and Ownership Participation Agreement dated as of August 27, 1976 and Amendment No. 1 dated as of January 18, 1977, among GEORGIA, OPC, MEAG and Dalton. (Designated in Form U-1, File No. 70-5792, as Exhibit B-1 and in Form 8-K for January 1977, File No. 1-6468, as Exhibit (B)(3).)\n(a) 16 - Alvin W. Vogtle Nuclear Units Number One and Two Operating Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. (Designated in Form U-1, File No. 70-5792, as Exhibit B-2.)\n(a) 17 - Alvin W. Vogtle Nuclear Units Number One and Two Purchase, Amendment, Assignment and Assumption Agreement dated as of November 16, 1983, between GEORGIA and MEAG. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1983, File No. 1-6468, as Exhibit 10(k)(4).)\n(a) 18 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of August 27, 1976, between GEORGIA and MEAG. (Designated in Form 8-K dated as of July 5, 1977, File No. 1-6468, as Exhibit (b)(2).)\n(a) 19 - Plant Hal Wansley Operating Agreement dated as of August 27, 1976, between GEORGIA and MEAG. (Designated in Form 8-K dated as of July 5, 1977, File No. 1-6468, as Exhibit (b)(4).)\n(a) 20 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and Dalton. (Designated in Form 8-K dated as of July 5, 1977, File No. 1-6468, as Exhibit (b)(8).)\n(a) 21 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and MEAG. (Designated in Form 8-K for February, 1977, File No. 1-6468, as Exhibit (b)(4).)\n(a) 22 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of April 19, 1977, between GEORGIA and Dalton. (Designated in Form 8-K dated as of June 13, 1977, File No. 1-6468, as Exhibit (b)(3).)\n(a) 23 - Plant Hal Wansley Operating Agreement dated as of April 19, 1977, between GEORGIA and Dalton. (Designated in Form 8-K dated as of June 13, 1977, File No. 1-6468, as Exhibit (b)(7).)\n(a) 24 - Plant Robert W. Scherer Units Number One and Two Purchase and Ownership Participation Agreement dated as of May 15, 1980, Amendment No. 1 dated as of December 30, 1985, Amendment No. 2 dated as of July 1, 1986 and Amendment No. 3 dated as of August 1, 1988, among GEORGIA, OPC, MEAG and Dalton. (Designated in Form U-1, File No. 70-6481, as Exhibit B-3, in SOUTHERN's Form 10-K for the year ended December 31, 1987, File\nE-6 No. 1-3526, as Exhibit 10(o)(2) and in SOUTHERN's Form 10-K for the year ended December 31, 1989, File No. 1-3526, as Exhibit 10(n)(2).)\n(a) 25 - Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of May 15, 1980 and Amendment No. 1 dated as of December 3, 1985, among GEORGIA, OPC, MEAG and Dalton. (Designated in Form U-1, File No. 70-6481, as Exhibit B-4 and in SOUTHERN's Form 10-K for the year ended December 31, 1987, File No. 1-3526, as Exhibit 10(o)(4).)\n(a) 26 - Plant Robert W. Scherer Purchase, Sale and Option Agreement dated as of May 15, 1980, between GEORGIA and MEAG. (Designated in Form U-1, File No. 70-6481, as Exhibit B-1.)\n(a) 27 - Plant Robert W. Scherer Purchase and Sale Agreement dated as of May 16, 1980, between GEORGIA and Dalton. (Designated in Form U-1, File No. 70-6481, as Exhibit B-2.)\n(a) 28 - Plant Robert W. Scherer Unit Number Three Purchase and Ownership Participation Agreement dated as of March 1, 1984, Amendment No. 1 dated as of July 1, 1986 and Amendment No. 2 dated as of August 1, 1988, between GEORGIA and GULF. (Designated in Form U-1, File No. 70-6573, as Exhibit B-4, in SOUTHERN's Form 10-K for the year ended December 31, 1987, as Exhibit 10(o)(2) and in SOUTHERN's Form 10-K for the year ended December 31, 1989, as Exhibit 10(n)(2).)\n(a) 29 - Plant Robert W. Scherer Unit Number Three Operating Agreement dated as of March 1, 1984, between GEORGIA and GULF. (Designated in Form U-1, File No. 70-6573, as Exhibit B-5.)\n(a) 30 - Plant Robert W. Scherer Unit No. Four Amended and Restated Purchase and Ownership Participation Agreement by and among GEORGIA, FP&L and JEA, dated as of December 31, 1990. (Designated in Form U-1, File No. 70-7843, as Exhibit B-1.)\n(a) 31 - Plant Robert W. Scherer Unit No. Four Operating Agreement by and among GEORGIA, FP&L and JEA, dated as of December 31, 1990. (Designated in Form U-1, File No. 70-7843, as Exhibit B-2.)\n(a) 32 - Amended and Restated Unit Power Sales Agreement dated February 18, 1982 and Amendment No. 1 dated May 18, 1982, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. (Designated in MISSISSIPPI's Form 10-K for the year ended December 31, 1981, File No. 0-6849, as Exhibit 10(c)(2) and in GEORGIA's Form 10-K for the year ended December 31, 1982, File No. 1-6468, as Exhibit 10(r)(3).)\n(a) 33 - Amended and Restated Unit Power Sales Agreement dated May 19, 1982, Amendment No. 1 dated August 30, 1984 and Amendment No. 2 dated October 30, 1987, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. (Designated in GEORGIA's Form 10-K for the year\nE-7 ended December 31, 1982, File No. 1-6468, as Exhibit 10(s)(2), in SOUTHERN's Form 10-K for the year ended December 31, 1984, File No. 1-3526, as Exhibit 10(r)(2) and in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468 as Exhibit 10(s)(2).)\n(a) 34 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1988, File No. 1-5072, as Exhibit 10(d).)\n(a) 35 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1988, File No. 1-5072, as Exhibit 10(e).)\n(a) 36 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1988, File No. 1-5072, as Exhibit 10(f).)\n(a) 37 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(x).)\n(a) 38 - The Southern Company Executive Stock Plan For the Southern Electric System and the First Amendment thereto. (Designated in Registration No. 33-30171 as Exhibit 4(c).)\n(a) 39 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in GULF's Form 10-K for the year ended December 31, 1991, File No. 0-2429, as Exhibit 10(1).)\n(a) 40 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in GULF's Form 10-K for the year ended December 31, 1991, File No. 0-2429, as Exhibit 10(m).)\n(a) 41 - Rocky Mountain Pumped Storage Hydroelectric Project Ownership Participation Agreement dated November 18, 1988, between OPC and GEORGIA. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1988, File No. 1-6468, as Exhibit 10(x).)\n(a) 42 - Rocky Mountain Pumped Storage Hydroelectric Project Operating Agreement dated November 18, 1988, between OPC and GEORGIA. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1988, File No. 1-6468, as Exhibit 10(y).)\nE-8 (a) 43 - Purchase and Ownership Agreement for Joint Ownership Interest in the James H. Miller, Jr. Steam Electric Generating Plant Units One and Two dated November 18, 1988, between ALABAMA and AEC. (Designated in Form U-1, File No. 70-7609, as Exhibit B-1.)\n(a) 44 - Operating Agreement for Joint Ownership Interest in the James H. Miller, Jr. Steam Electric Generating Plant Units One and Two dated November 18, 1988, between ALABAMA and AEC. (Designated in Form U-1, File No. 70-7609, as Exhibit B-2.)\n(a) 45 - Transmission Facilities Agreement dated February 25, 1982, Amendment No. 1 dated May 12, 1982 and Amendment No. 2 dated December 6, 1983, between Gulf States and MISSISSIPPI. (Designated in MISSISSIPPI's Form 10-K for the year ended December 31, 1981, File No. 0-6849, as Exhibit 10(f), in MISSISSIPPI's Form 10-K for the year ended December 31, 1982, File No. 0-6849, as Exhibit 10(f)(2) and in MISSISSIPPI's Form 10-K for the year ended December 31, 1983, File No. 0-6849, as Exhibit 10(f)(3).)\n(a) 46 - Form of commitment agreement, Amendment No. 1 and Amendment No. 2 with respect to SOUTHERN, ALABAMA, GEORGIA and MISSISSIPPI revolving credits. (Designated in Form U-1, File No. 70-7738, as Exhibit A-5 and in Form U-1, File No. 70-7937, as A-5(b).)\n(a) 47 - Block Power Sale Agreement between GEORGIA and OPC dated as of November 12, 1990. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(cc).)\n(a) 48 - Coordination Services Agreement between GEORGIA and OPC dated as of November 12, 1990. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(dd).)\n*(a) 49 - Amended and Restated Nuclear Managing Board Agreement for Plant Hatch and Plant Vogtle among GEORGIA, OPC, MEAG and Dalton dated as of July 1, 1993.\n(a) 50 - Integrated Transmission System Agreement, Power Sale and Coordination Umbrella Agreement between GEORGIA and OPC dated as of November 12, 1990. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(ff).)\n(a) 51 - Revised and Restated Integrated Transmission System Agreement between GEORGIA and Dalton dated as of December 7, 1990. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(gg).)\n(a) 52 - Revised and Restated Integrated Transmission System Agreement between GEORGIA and MEAG dated as of December 7, 1990. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1990, File No. 1-6468, as Exhibit 10(hh).)\nE-9 (a) 53 - Long Term Transmission Service Agreement between Entergy Power, Inc. and ALABAMA, MISSISSIPPI and SCS. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1992, File No. 1-3526, as Exhibit 10(a)53.)\n*(a) 54 - Amendment No. 4 to the Plant Robert W. Scherer Units Number One and Two Purchase and Ownership Participation Agreement dated as of December 31, 1990.\n*(a) 55 - Amendment No. 2 to the Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of December 31, 1990.\n*(a) 56 - Plant Scherer Managing Board Agreement dated as of December 31, 1990 among GEORGIA, OPC, MEAG, Dalton, GULF, FP&L and JEA.\n*(a) 57 - Plant McIntosh Combustion Turbine Purchase and Ownership Participation Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992.\n*(a) 58 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992.\n*(a) 59 - Power Purchase Agreement dated as of December 3, 1993 between GEORGIA and FPC.\nALABAMA\n(b) 1 - Indenture dated as of June 1, 1959, between SEGCO and Citibank, N.A., as Trustee, and indentures supplemental thereto through December 1, 1962. (Designated in Registration No. 2-59843 as Exhibit 2(a)-8.)\n(b) 2 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated as of September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SEGCO and SOUTHERN. See Exhibit 10(a)1 herein.\n(b) 3 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)5 herein.\n(b) 4 - Agreement dated as of January 27, 1959 and Amendment No. 1 dated as of October 27, 1982, among SEGCO, ALABAMA and GEORGIA. See Exhibit 10(a)6 herein.\n(b) 5 - Amended and Restated Unit Power Sales Agreement dated February 18, 1982 and Amendment No. 1 dated May 18, 1982, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)32 herein.\nE-10 (b) 6 - Amended and Restated Unit Power Sales Agreement dated May 19, 1982, Amendment No. 1, dated August 30, 1984 and Amendment No. 2, dated October 30, 1987, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)33 herein.\n(b) 7 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)34 herein.\n(b) 8 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)35 herein.\n(b) 9 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)36 herein.\n(b) 10 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\n(b) 11 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)39 herein.\n(b) 12 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)40 herein.\n(b) 13 - Firm Power Purchase Contract between ALABAMA and AMEA. (Designated in Certificate of Notification, File No. 70-7212, as Exhibit B.)\n(b) 14 - 1991 Firm Power Purchase Contract between ALABAMA and AMEA. (Designated in Form U-1, File No. 70- 7873, as Exhibit B-1.)\n(b) 15 - Purchase and Ownership Agreement for Joint Ownership Interest in the James H. Miller, Jr. Steam Electric Generating Plant Units One and Two dated November 18, 1988, between ALABAMA and AEC. See Exhibit 10(a)43 herein.\n(b) 16 - Operating Agreement for Joint Ownership Interest in the James H. Miller, Jr. Steam Electric Generating Plant Units One and Two dated November 18, 1988, between ALABAMA and AEC. See Exhibit 10(a)44 herein.\n(b) 17 - Form of commitment agreement, Amendment No. 1 and Amendment No. 2 with respect to SOUTHERN, ALABAMA, GEORGIA and MISSISSIPPI revolving credits. See Exhibit 10(a)46 herein.\nE-11 (b) 18 - Long Term Transmission Service Agreement between Entergy Power, Inc. and ALABAMA, MISSISSIPPI and SCS. See Exhibit 10(a)53 herein.\nGEORGIA\n(c) 1 - Indenture dated as of June 1, 1959, between SEGCO and Citibank, N.A., as Trustee, and indentures supplemental thereto through December 1, 1962. See Exhibit 10(b)1 herein.\n(c) 2 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated as of September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIP PI, SEGCO and SOUTHERN. See Exhibit 10(a)1 herein.\n(c) 3 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)5 herein.\n(c) 4 - Agreement dated as of January 27, 1959 and Amendment No. 1 dated as of October 27, 1982, among SEGCO, ALABAMA and GEORGIA. See Exhibit 10(a)6 herein.\n(c) 5 - Joint Committee Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)7 herein.\n(c) 6 - Edwin I. Hatch Nuclear Plant Purchase and Ownership Participation Agreement dated as of January 6, 1975, between GEORGIA and OPC. See Exhibit 10(a)8 herein.\n(c) 7 - Edwin I. Hatch Nuclear Plant Operating Agreement dated as of January 6, 1975, between GEORGIA and OPC. See Exhibit 10(a)9 herein.\n(c) 8 - Revised and Restated Integrated Transmission System Agreement dated as of November 12, 1990, between GEORGIA and OPC. See Exhibit 10(a)10 herein.\n(c) 9 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of March 26, 1976, between GEORGIA and OPC. See Exhibit 10(a) 11 herein.\n(c) 10 - Plant Hal Wansley Operating Agreement dated as of March 26, 1976, between GEORGIA and OPC. See Exhibit 10(a)12 herein.\n(c) 11 - Edwin I. Hatch Nuclear Plant Purchase and Ownership Participation Agreement dated as of August 27, 1976, between GEORGIA, MEAG and Dalton. See Exhibit 10(a)13 herein.\n(c) 12 - Edwin I. Hatch Nuclear Plant Operating Agreement dated as of August 27, 1976, between GEORGIA, MEAG and Dalton. See Exhibit 10(a)14 herein.\nE-12 (c) 13 - Alvin W. Vogtle Nuclear Units Number One and Two Purchase and Ownership Participation Agreement dated as of August 27, 1976 and Amendment No. 1 dated as of January 18, 1977, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)15 herein.\n(c) 14 - Alvin W. Vogtle Nuclear Units Number One and Two Operating Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)16 herein.\n(c) 15 - Alvin W. Vogtle Nuclear Units Number One and Two Purchase, Amendment, Assignment and Assumption Agreement dated as of November 16, 1983, between GEORGIA and MEAG. See Exhibit 10(a)17 herein.\n(c) 16 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)18 herein.\n(c) 17 - Plant Hal Wansley Operating Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)19 herein.\n(c) 18 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and Dalton. See Exhibit 10(a)20 herein.\n(c) 19 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)21 herein.\n(c) 20 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of April 19, 1977, between GEORGIA and Dalton. See Exhibit 10(a)22 herein.\n(c) 21 - Plant Hal Wansley Operating Agreement dated as of April 19, 1977, between GEORGIA and Dalton. See Exhibit 10(a)23 herein.\n(c) 22 - Plant Robert W. Scherer Units Number One and Two Purchase and Ownership Participation Agreement dated as of May 15, 1980, Amendment No. 1 dated as of December 30, 1985, Amendment No. 2 dated as of July 1, 1986 and Amendment No. 3 dated as of August 1, 1988, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)24 herein.\n(c) 23 - Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of May 15, 1980 and Amendment No. 1 dated as of December 3, 1985, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)25 herein.\n(c) 24 - Plant Robert W. Scherer Purchase, Sale and Option Agreement dated as of May 15, 1980, between GEORGIA and MEAG. See Exhibit 10(a)26 herein.\n(c) 25 - Plant Robert W. Scherer Purchase and Sale Agreement dated as of May 16, 1980, between GEORGIA and Dalton. See Exhibit 10(a)27 herein.\nE-13 (c) 26 - Plant Robert W. Scherer Unit Number Three Purchase and Ownership Participation Agreement dated as of March 1, 1984, Amendment No. 1 dated as of July 1, 1986 and Amendment No. 2 dated as of August 1, 1988, between GEORGIA and GULF. See Exhibit 10(a)28 herein.\n(c) 27 - Plant Robert W. Scherer Unit Number Three Operating Agreement dated as of March 1, 1984, between GEORGIA and GULF. See Exhibit 10(a)29 herein.\n(c) 28 - Plant Robert W. Scherer Unit No. Four Amended and Restated Purchase and Ownership Participation Agreement by and among GEORGIA, FP&L and JEA dated as of December 31, 1990. See Exhibit 10(a) 30 herein.\n(c) 29 - Plant Robert W. Scherer Unit No. Four Operating Agreement by and among GEORGIA, FP&L and JEA dated as of December 31, 1990. See Exhibit 10(a)31 herein.\n(c) 30 - Amended and Restated Unit Power Sales Agreement dated February 18, 1982 and Amendment No. 1 dated May 18, 1982, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)32 herein.\n(c) 31 - Amended and Restated Unit Power Sales Agreement dated May 19, 1982, Amendment No. 1, dated August 30, 1984 and Amendment No. 2 dated October 30, 1987, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)33 herein.\n(c) 32 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 34 herein.\n(c) 33 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 35 herein.\n(c) 34 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 36 herein.\n(c) 35 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\n*(c) 36 - Power Purchase Agreement dated as of December 3, 1993 between GEORGIA and FPC. See Exhibit 10(a) 59 herein.\n(c) 37 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 39 herein.\nE-14 (c) 38 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 40 herein.\n(c) 39 - Rocky Mountain Pumped Storage Hydroelectric Project Ownership Participation Agreement dated November 18, 1988, between OPC and GEORGIA. See Exhibit 10(a)41 herein.\n(c) 40 - Rocky Mountain Pumped Storage Hydroelectric Project Operating Agreement dated November 18, 1988, between OPC and GEORGIA. See Exhibit 10(a)42 herein.\n(c) 41 - Form of commitment agreement, Amendment No. 1 and Amendment No. 2 with respect to SOUTHERN, ALABAMA, GEORGIA and MISSISSIPPI revolving credits. See Exhibit 10(a)46 herein.\n(c) 42 - Block Power Sale Agreement between GEORGIA and OPC dated as of November 12, 1990. See Exhibit 10(a)47 herein.\n(c) 43 - Coordination Services Agreement between GEORGIA and OPC dated as of November 12, 1990. See Exhibit 10(a)48 herein.\n*(c) 44 - Amended and Restated Nuclear Managing Board Agreement for Plant Hatch and Plant Vogtle among GEORGIA, OPC, MEAG and Dalton dated as of July 1, 1993. See Exhibit 10(a)49 herein.\n(c) 45 - Integrated Transmission System Agreement, Power Sale and Coordination Umbrella Agreement between GEORGIA and OPC dated as of November 12, 1990. See Exhibit 10(a)50 herein.\n(c) 46 - Revised and Restated Integrated Transmission System Agreement between GEORGIA and Dalton dated as of December 7, 1990. See Exhibit 10(a)51 herein.\n(c) 47 - Revised and Restated Integrated Transmission System Agreement between GEORGIA and MEAG dated as of December 7, 1990. See Exhibit 10(a)52 herein.\n*(c) 48 - Amendment No. 4 to the Plant Robert W. Scherer Units Number One and Two Purchase and Ownership Participation Agreement dated as of December 31, 1990. See Exhibit 10(a)54 herein.\n*(a) 49 - Amendment No. 2 to the Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of December 31, 1990. See Exhibit 10(a)55 herein.\n*(c) 50 - Plant Scherer Managing Board Agreement dated as of December 31, 1990 among GEORGIA, OPC, MEAG, Dalton, GULF, FP&L and JEA. See Exhibit 10(a)56 herein.\nE-15 *(c) 51 - Plant McIntosh Combustion Turbine Purchase and Ownership Participation Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. See Exhibit 10(a)57 herein.\n*(c) 52 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. See Exhibit 10(a)58 herein.\nGULF\n(d) 1 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated as of September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SEGCO and SOUTHERN. See Exhibit 10(a)1 herein.\n(d) 2 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)5 herein.\n(d) 3 - Plant Robert W. Scherer Unit Number Three Purchase and Ownership Participation Agreement dated as of March 1, 1984, Amendment No. 1 dated as of July 1, 1986 and Amendment No. 2 dated as of August 1, 1988, between GEORGIA and GULF. See Exhibit 10(a)28 herein.\n(d) 4 - Plant Robert W. Scherer Unit Number Three Operating Agreement dated as of March 1, 1984, between GEORGIA and GULF. See Exhibit 10(a)29 herein.\n(d) 5 - Amended and Restated Unit Power Sales Agreement dated February 18, 1982 and Amendment No. 1 dated May 18, 1982, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)32 herein.\n(d) 6 - Amended and Restated Unit Power Sales Agreement dated May 19, 1982, Amendment No. 1 dated August 30, 1984 and Amendment No. 2 dated October 30, 1987, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)33 herein.\n(d) 7 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 34 herein.\n(d) 8 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 35 herein.\n(d) 9 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 36 herein.\nE-16 (d) 10 - Agreement between GULF and AEC, effective August 1, 1985. (Designated in GULF's Form 10-K for the year ended December 31, 1985, File No. 0-2429, as Exhibit 10(g).)\n(d) 11 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\n(d) 12 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 39 herein.\n(d) 13 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 40 herein.\nMISSISSIPPI\n(e) 1 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SEGCO and SOUTHERN. See Exhibit 10(a)1 herein.\n(e) 2 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)5 herein.\n(e) 3 - Amended and Restated Unit Power Sales Agreement dated February 18, 1982 and Amendment No. 1 dated May 18, 1982, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)32 herein.\n(e) 4 - Amended and Restated Unit Power Sales Agreement dated May 19, 1982, Amendment No. 1 dated August 30, 1984, and Amendment No. 2 dated October 30, 1987, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI and SCS. See Exhibit 10(a)33 herein.\n(e) 5 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 34 herein.\n(e) 6 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 35 herein.\n(e) 7 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 36 herein.\nE-17 (e) 8 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\n(e) 9 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 39 herein.\n(e) 10 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 40 herein.\n(e) 11 - Transmission Facilities Agreement dated February 25, 1982, Amendment No. 1 dated May 12, 1982 and Amendment No. 2 dated December 6, 1983, between Gulf States and MISSISSIPPI. See Exhibit 10(a)45 herein.\n(e) 12 - Form of commitment agreement, Amendment No. 1 and Amendment No. 2 with respect to SOUTHERN, ALABAMA, GEORGIA and MISSISSIPPI revolving credits. See Exhibit 10(a)46 herein.\n(e) 13 - Long Term Transmission Service Agreement between Entergy Power, Inc. and ALABAMA MISSISSIPPI and SCS. See Exhibit 10(a)53 herein.\nSAVANNAH\n(f) 1 - Service contract dated as of March 3, 1988, between SCS and SAVANNAH. See Exhibit 10(a)3 herein.\n(f) 2 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)5 herein.\n(f) 3 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 34 herein.\n(f) 4 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 35 herein.\n(f) 5 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 36 herein.\n(f) 6 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\nE-18 (f) 7 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 39 herein.\n(f) 8 - Transition Energy Agreement dated December 31, 1990, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a) 40 herein.\n*(f) 9 - Plant McIntosh Combustion Turbine Purchase and Ownership Participation Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. See Exhibit 10(a) 57 herein.\n*(f) 10 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated December 15, 1992. See Exhibit 10(a)58 herein.\n(21) *SUBSIDIARIES OF REGISTRANTS - Contained herein at page IV-5.\n(23) CONSENTS OF EXPERTS AND COUNSEL\nSOUTHERN\n*(a) - The consent of Arthur Andersen & Co. is contained herein at page IV-6.\nALABAMA\n*(b) - The consent of Arthur Andersen & Co. is contained herein at page IV-7.\nGEORGIA\n*(c) - The consent of Arthur Andersen & Co. is contained herein at page IV-8.\nGULF\n*(d) - The consent of Arthur Andersen & Co. is contained herein at page IV-9.\nMISSISSIPPI\n*(e) - The consent of Arthur Andersen & Co. is contained herein at page IV-10.\nSAVANNAH\n*(f) - The consent of Arthur Andersen & Co. is contained herein at page IV-11.\nE-19 (24) POWERS OF ATTORNEY AND RESOLUTIONS\nSOUTHERN\n*(a) - Power of Attorney and resolution.\nALABAMA\n*(b) - Power of Attorney and resolution.\nGEORGIA\n*(c) - Power of Attorney and resolution.\nGULF\n*(d) - Power of Attorney and resolution.\nMISSISSIPPI\n*(e) - Power of Attorney and resolution.\nSAVANNAH\n*(f) - Power of Attorney and resolution.\nE-20","section_15":""}
{"filename":"21175_1993.txt","cik":"21175","year":"1993","section_1":"ITEM 1. BUSINESS\nCNA Financial Corporation and its consolidated subsidiaries (CNA) constitute the ninth largest insurance company in the United States as measured by 1992 statutory premium volume. CNA was incorporated in 1967 as the parent company of Continental Casualty Company (\"CCC\"), incorporated in 1897, and Continental Assurance Company (\"CAC\") incorporated in 1911. In 1975, CAC became a wholly-owned subsidiary of CCC. CNA's property and casualty insurance operations are conducted by CCC and its property and casualty insurance affiliates, and its life insurance operations are conducted by CAC and its life insurance affiliates. CNA's principal business conducted through its insurance subsidiaries is insurance. As multiple-line insurers, the insurance companies underwrite property, casualty, life, and accident and health coverages. Their principal market for insurance is the United States. Foreign operations are not significant.\nCOMPETITION\nAll aspects of the insurance business are highly competitive. CNA's insurance operations compete with a large number of stock and mutual insurance companies and other entities for both producers and customers and must continuously allocate resources to refine and improve insurance products and services.\nThere are approximately 3,900 property\/casualty insurance companies in the United States, about 900 of which operate in all or most states. CCC consolidated is ranked as the sixth largest property\/casualty insurance organization based on statutory net premiums written in 1992.\nThere are approximately 2,000 companies selling life insurance (including health insurance and pension products) in the United States. CAC is ranked as the seventeenth largest consolidated life insurance organization based on statutory premium revenue in 1992.\nDIVIDENDS BY INSURANCE SUBSIDIARIES\nThe payment of dividends to CNA by its insurance affiliates without prior approval of the Illinois Insurance Department (\"IID\") is limited to formula amounts determined in accordance with the accounting practices prescribed or permitted by the IID. The current formula limits dividends, without approval of the insurance commissioner, to the greater of 10% of prior year statutory surplus or prior year statutory net income (excluding realized gains in excess of 20% of the cumulative unrealized gains position). For 1994, approximately $360 million in dividends could be paid to CNA by its insurance affiliates without prior approval. The National Association of Insurance Commissioners (\"NAIC\") Financial Regulation Standards and Accreditation Committee approved the Illinois dividend formula as complying with the NAIC Model Dividend Law. All dividends must be reported to the insurance department within five business days of declaration and ten days prior to payment.\nREGULATION\nThe insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative power relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, maintaining guarantee funds, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports and regulating solvency and the type and amount of investments permitted. Regulatory powers also extend to premium rate regulation which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries discussed above, intercompany transfers of assets may be subject to prior notice or approval, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer.\nThe trend for legislation and voter initiatives continues, particularly for personal lines products, directly impacting insurance rate development, rate application and the ability of insurers to cancel or renew insurance policies. Restrictions on the consideration of certain expenses, limits on services provided by advisory organizations and politically suppressed workers' compensation rates in certain states continue to be of concern.\nInsurers are also required by the states to provide coverage to risks which would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage which must be provided to such involuntary risks. CNA's insurance subsidiaries share of these involuntary risks is generally a function of its share of the voluntary market by line of insurance in each state.\nIn recent years, insolvencies of a few large insurers previously believed to be on solid financial ground by many rating agencies and state regulators have led to increased scrutiny of state regulated insurer solvency requirements by the members of the U.S. Congress. Certain members of Congress have formally introduced legislative initiatives that, if passed, would subject insurers to federal solvency regulation. In response to this challenge the NAIC has developed new industry minimum Risk-Based Capital (RBC) requirements, established a formal state accreditation process designed to minimize the diversity of approved statutory accounting and actuarial practices, and has increased the annual statutory statement disclosure requirements.\nRBC requirements are effective for life insurers in 1993 and for property and casualty insurers in 1994. The RBC formulas were designed to identify an insurer's minimum capital requirements based upon the inherent risks (e.g., asset default, credit and insurance) of its operations. In addition to the minimum capital requirements, the RBC formula and related regulations identify various levels of capital adequacy and corresponding action that the state insurance departments should initiate. The highest such level of capital adequacy above which insurance departments would take no action is defined as the Company Action Level. As of December 31, 1993, CNA's life insurance affiliates, Continental Assurance Company and Valley Forge Life Insurance Company, had adjusted capital amounts in excess of NAIC Company Action Levels. The new property\/casualty RBC formula was adopted in December, 1993. Absent significant changes in the industry experience components of the formula, CNA's property\/casualty domestic insurers have adjusted capital amounts in excess of NAIC Company Action Levels.\nIn addition to the newly established minimum capital requirements, the NAIC also maintains the Insurance Regulatory Information System (\"IRIS\"), which assists the state insurance departments in overseeing the financial condition of both life and property\/casualty insurers. These tests are in the form of ratios and have a range of results characterized as \"usual\" by the NAIC. The NAIC IRIS user guide regarding these ratios specifically states that \"Falling outside the usual range is not considered a failing result...\" and \"...in some years it may not be unusual for financially sound companies to have several ratios with results outside the usual range.\" It is important, therefore, that IRIS ratio test results be reviewed carefully in conjunction with all other financial information.\nCCC had three IRIS ratios with unusual values in 1993, four in 1992 and none in 1991. The three ratios with unusual values in 1993 were the two year overall operating, investment yield, and the two year reserve development ratios. The four IRIS ratios with unusual values in 1992 were the two year overall operat- ing, the change in surplus, and both the one and two year reserve development ratios. Catastrophe losses and reserve increases associated with potential exposure to asbestos-related bodily injury cases recognized in 1992 triggered all the unusual values generated in 1992. These same events were primarily responsible for the unusual values for the two year overall operating and development ratios in 1993. Additionally, lower interest rates in the capital markets in 1993, coupled with the maintenance of a large short-term investment portfolio, triggered the unusual value for the investment yield ratio.\nCAC had two IRIS ratios with unusual values in 1993, net gain to total income and change in net written premium. CAC had one unusual value for IRIS ratios in 1992, net gain to total income, and none in 1991. CAC's reported statutory net income was adversely affected in both 1993 and 1992 by the transfer of significant realized capital gains to the Interest Maintenance Reserve and depressed investment earnings. The unusual value for the change in premium ratio primarily relates to decreases in the Separate Account annuity products fund deposits.\nFederal measures which may significantly affect the insurance business include proposals for directly regulating insurance company solvency as well as repeal of the McCarran-Ferguson Act, which exempts certain aspects of insurance from Federal regulation to the extent regulated by the states. The potential for Federal health care reform has been widely publicized and debated over the past year. Although legislative reforms could come as soon as 1994, the impact of such reforms are as yet unknown. Among the options discussed has been a single comprehensive health care program that would provide access for all Americans, while attempting to reduce cost via enactment of various cost containment measures and tort reforms. If implemented, such reforms may impact both individual and group accident and health, workers' compensation, automobile liability and medical malpractice lines of business currently underwritten by CNA.\nAlthough the courts and legislatures are often asked to expand liability, there is a growing trend among business and professional organizations to wage campaigns, which in several instances have been successful, aimed at limiting their liability risks. Several states have adopted and some are considering \"tort reform\" measures which, among other things, limit non-economic and punitive damages and otherwise limit damage awards in product liability and malpractice cases.\nREINSURANCE\nCNA's insurance subsidiaries assume and cede insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk.\nThe ceding of insurance does not discharge the primary liability of the original insurer. It had been the practice of insurers to account for the portion of the risks which have been reinsured with other companies as though they were risks for which the original insurer is not liable. In December 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") 113,\"Accounting and Reporting for Reinsurance of Short-duration and Long-duration Contracts.\" SFAS 113 sets forth new requirements for accounting and reporting of reinsurance contracts. The provisions of this Statement are effective in 1993 and did not impact CNA's income or stockholders' equity as all material reinsurance arrangements are prospective and provided for the transfer of risk.\nCNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in Illinois, CNA receives collateral primarily in the form of bank letters of credit, securing a large portion of the recoverables.\nReinsurance recoverables on paid and unpaid claims were $2.9, $3.2, and $3.7 billion at year end 1993, 1992 and 1991, respectively. Of the $2.9 billion recoverable at December 31, 1993, approximately $351 million was due from unauthorized reinsurers. These balances were partially collateralized by letters of credit; at December 31, 1993, such collateral totaled $155 million. Despite best efforts to ensure collection of reinsurance recoverables, the long-tail nature of many of these recoverables inevitably results in some credit risk. In estimating CNA's allowance for doubtful accounts, reinsurance recoverables are carefully analyzed.\nCNA's largest recoverable at December 31, 1993 was $484 million due from Lloyd's of London. The recoverable from Lloyd's of London is dispersed among thousands of individual members who have unlimited liability, many of which are Illinois authorized reinsurers. Although Lloyd's of London has recently reported large underwriting losses, it continues to carry substantial reserves, including $9 billion in premium trust funds, $6 billion in member trust funds and policyholder surplus of $381 million. Accordingly, the credit risk associated with these recoverable balances appears to be minimal. Premiums of $58 million were ceded to Lloyd's of London in 1993.\nEMPLOYEE RELATIONS\nCNA has approximately 16,800 employees and has experienced satisfactory labor relations. CNA has never had work stoppages due to labor disputes.\nCNA has comprehensive benefit plans for substantially all of its employees, including a retirement plan, a savings plan, a disability program, a group life program, and a group health care program.\nBUSINESS SEGMENTS\nInformation as to CNA's business segments is set forth in Note L to the consolidated financial statements, incorporated by reference in Item 8, herein.\nLIFE BUSINESS\nCNA's life insurance operations market individual and group insurance products through licensed agents, most of whom are independent contractors, who sell life insurance for CNA and for other companies on a commission basis. Individual insurance products include life, accident and health and annuity products, and are sold to individuals and small businesses.\nThe individual life products currently being marketed consist primarily of term, universal life and participating policies. Included in the universal life category is a salary allotment product marketed through employers as a supplement to employers' benefit plans. Premiums are collected from employees through payroll deduction. The individual accident and health product currently being marketed is long-term disability. Individual annuity products are primarily periodic payment plans.\nGroup insurance products include life, accident and health and pension products, and are sold to employers, employer associations and trusts ranging in size from small local employers to large multinational corporations. The group accident and health plans are primarily major medical and hospitalization. Most of the major medical and hospitalization plans are written under experience-rated contracts or contracts to provide claim administrative services only.\nCNA's products are designed and priced using assumptions management believes to be reasonably conservative for mortality, morbidity, persistency, expense levels and investment results. Underwriting practices that management believes are prudent are followed in selecting the risks that will be insured. Further, actual experience related to pricing assumptions is monitored closely so that adjustments to these assumptions may be implemented as necessary. CNA mitigates the risk related to persistency by including surrender charge provisions in its ordinary life and annuity policies in the first five to ten years, thus providing for the recovery of acquisition expenses. Investment portfolios supporting interest sensitive products, including universal life and individual annuities, are segregated from other investments and managed so as to minimize the liquidity and interest rate risks.\nProfitability in the life insurance business has decreased over the past two years as a result of declining investment income, reflecting lower interest rates and a large investment in short-term investments. Further, results continue to be impacted by intense competition and rising medical costs. CNA has aggressively pursued expense reduction through increases in automation and other productivity improvements. Further, increasing costs of health care have resulted in a continued market shift away from traditional forms of health coverage toward managed care products and experience-rated plans. CNA's ability to compete in this market will be increasingly dependent on its ability to control costs through managed care techniques, innovation, and quality customer- focused service in order to properly position CNA in the evolving health care environment.\nThe Federal Government's initiative to control health care costs and provide universal access to health care was presented in 1993. The impact of potential health care reform cannot be determined at this time. Such reform may affect both CNA's individual and group accident and health businesses. CNA has urged a meaningful role for the private sector in any proposed plan. The present health care system is clearly in need of reform, and CNA has emphasized that the competitive strengths of the insurance industry must be an integral part of a workable solution.\n(a) Group accident and health premiums include contracts involving U.S. Government employees and their dependents amounting to approximately $1.7, $1.6, $1.5, $1.3, and $1.3 billion in 1993, 1992, 1991, 1990 and 1989, respectively.\n(b) Other Data is determined on the basis of statutory accounting principles and reflects capital contributions from Continental Casualty Company of $100 million in 1990 and $130 million in 1989. Life insurance subsidiaries have received, or will receive, reimbursement from CNA for general management and administrative expenses and investment expenses in the amounts of $25.6, $24.5, $25.7, $25.0, and $27.1 million in 1993, 1992, 1991, 1990 and 1989, respectively. Statutory capital and surplus as a percent of total liabilities is determined after excluding Separate Account liabilities and reclassifying the Asset Valuation and Interest Maintenance Reserves as surplus.\n(c) Lapse ratios as measured by surrenders and withdrawals as a percentage of average ordinary life insurance in force were 9.7%, 8.6%, 10.4%, 11.4%, and 13.5%, in 1993, 1992, 1991, 1990, and 1989, respectively.\nAnnuities and Guaranteed Investment Contracts - ---------------------------------------------\nCAC writes the majority of its annuities and guaranteed investment contracts (\"GlC's\") in a fixed or non-variable Separate Account, which is permitted by Illinois insurance statutes. This treatment affords the contractholders additional security, in the form of CAC's general account surplus, which supports any principal and\/or guaranteed interest payment shortfalls of the Separate Account.\nCNA manages the liquidity and interest rate risks on the GIC portfolio by matching the GIC assets and liabilities on the basis of duration and maintaining market value surrender adjustments on the majority of the contracts.\nLIFE BUSINESS --(CONTINUED)\nThe table below illustrates the matching in the duration of assets and liabilities for the GIC portfolio, the investment yield, the weighted average interest crediting rates and withdrawal characteristics.\nAs shown above, the investment yields at December 31, 1993 and 1992 were less than the average crediting rates. However, this occurred because of security sales resulting in realized capital gains. Although the sales proceeds were invested at lower yields, the asset base was increased. At December 31, 1993 and 1992, the GIC estimated market value of assets exceeded the estimated market value of contract liabilities and expenses.\nPROPERTY\/CASUALTY BUSINESS\nCNA's property\/casualty operations market commercial and personal lines of property\/casualty insurance through independent agents and brokers.\nCCC and its property\/casualty insurance subsidiaries write primarily commercial lines coverages. Customers include large national corporations, small and medium-sized businesses, groups and associations, and professionals. Coverages are written primarily through traditional insurance contracts, under which risk is transferred to the insurer. Many commercial account policies are written under retrospectively-rated contracts, which are experience-rated. Premiums for such contracts may be adjusted, subject to limitations set by contract, based on loss experience of the insureds. Other experience-rated policies include provisions for adjustments to dividends based on loss experience. Experience-rated contracts reduce risk to the insurer. Approximately 40% of CNA's property\/casualty insurance is written on an experience-rated basis.\nCNA also provides loss control, policy administration and claim adminis- tration services under service contracts for fees. Such services are provided primarily in the workers' compensation market where retention of risk through self-insurance or high-deductible programs has become increasingly prevalent.\nCommercial business includes such lines as workers' compensation, general liability, professional and specialty, multiple peril, and accident and health coverages. Professional and specialty coverages include liability coverage for architects and engineers, lawyers, accountants, medical and dental profes- sionals; directors and officers liability; and other specialized coverages. CNA also assumes commercial risks from other insurers. CNA's primary lines are workers' compensation, general liability and professional and specialty cover- ages, which accounted for 29%, 18% and 13%, respectively, of 1993 premiums earned, including premiums for involuntary risks. Premiums for involuntary risks result from mandatory participation in residual markets. CNA is required by the various states in which it does business to provide coverage for risks that would not otherwise be considered under CNA's underwriting standards. CNA's share of involuntary risks is generally a function of its share of the voluntary market by line of insurance in each state.\nCNA also markets personal lines of insurance, primarily automobile and homeowners coverages sold to individuals under monoline and package policies.\nPROPERTY\/CASUALTY BUSINESS --(CONTINUED)\nThe following table sets forth supplemental data for the property\/casualty business:\n(*) In 1991, CNA changed its statutory method of accounting for property\/ casualty written premium on indeterminate premium products (policies subject to exposure audits). This new method defers the recognition of written premium and acquisition expenses generally until billed. The effect of this change in 1991 was a one-time reduction in written premium and related acquisition expenses of $864 million and $78 million, respectively. In order to provide comparability, the Other Data and Trade Ratios for 1991 shown above do not reflect the one-time impact of this statutory accounting change.\n(a) Property\/casualty involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other involuntary charges.\n(b) Trade ratios reflect the results of Continental Casualty Company and its property\/casualty insurance subsidiaries. Trade ratios are industry measures of property\/casualty underwriting results. The loss ratio is the percentage of incurred claim and claim adjustment expenses to premiums earned. Under generally accepted accounting principles, the expense ratio is the percentage of underwriting expenses, including the change in deferred acquisition costs, to premiums earned. Under statutory accounting principles, the expense ratio is the percentage of underwriting expenses (with no deferral of acquisition costs) to premiums written. The combined ratio is the sum of the loss ratio and the expense ratio. The policyholder dividend ratio is the ratio of dividends incurred to premiums earned.\n(c) Other Data is determined on the basis of statutory accounting principles and reflects capital contributions from CNA of $475 million in 1993, $120 million in 1990 and $200 million in 1989. In addition, dividends of $150 million, $100 million, $130 million and $100 million were paid to CNA by Continental Casualty Company in 1993, 1992, 1991 and 1989, respectively. Property\/casualty insurance subsidiaries have received, or will receive, reimbursement from CNA for general management and administrative expenses, unallocated loss adjustment expenses and investment expenses in the amounts of $167.5, $141.1, $133.8, $128.1, and $115.3 million in 1993, 1992, 1991, 1990 and 1989, respectively.\nThe following table displays the distribution of domestic written premium by state:\nThe growth and profitability of CNA's property\/casualty insurance business is dependent on many factors, including competitive and regulatory influences, the efficiency and costs of operations, underwriting quality, the level of natural disasters, and investment results.\nIn recent years, CNA's growth and earnings have been impacted by a prolonged cycle of inadequate commercial lines pricing, particularly in the workers' compensation market. CNA has intensified efforts in the political sphere on behalf of a more predictable and equitable insurance marketing climate. CNA has taken a leadership role in seeking workers' compensation reform in several states. Among CNA's marketing strategies during this difficult time are to emphasize responsible pricing over premium growth and to aggressively adapt to changes in certain markets such as those in which self-insurance has become important. CNA has also initiated wide-scale cost management measures. CNA has continued actions to reduce or stabilize the costs of doing business, including costs of health care, fraud and tort liability. Programs include managed health care programs and formation of a department devoted exclusively to fighting fraud.\nWorkers' compensation has been a difficult line of business during the past several years. Despite rapidly escalating loss costs, state regulators have been unwilling to allow premium rate increases sufficient for insurers to earn a profit. Unlike other insurance carriers, CNA has remained in this market in most states. It continues to believe that workers' compensation is a critical product to its customers, and with its proven expertise in this line, that there is a profit potential over the long term.\nDuring this current industry downcycle, CNA has restricted its exposure to workers' compensation and has taken other steps to mitigate the underwriting losses in workers' compensation. These steps include increasing conservatism of underwriting standards, continuing migration of guaranteed cost policies to experience-rated contracts, and as mentioned previously, aggressive cost con- tainment programs geared to reduce the frequency and severity of claims. During 1993, 65% of workers' compensation insurance was written on an experience-rated basis. As a result of these steps, the past two years' experience has been encouraging as accident year loss ratios have improved slightly. After factoring in the investment income related to projected cash flows, this line of business produced a positive economic return in the 1992 and 1993 accident years. CNA believes that further improvement in workers' compensation results will occur as its many efforts toward this objective continue.\nThe state of California is CNA's largest market, accounting for 12% of its premium volume in 1993. Workers' compensation is the largest line of business in California accounting for approximately 40% of premiums written in 1993. As noted in the discussion of countrywide strategies for workers' compensation, approximately 87% of California's workers' compensation business was written via loss sensitive contracts. Profitability trends are slightly more favorable in this state than countrywide primarily as a result of recently enacted major workers' compensation reform legislation which included improved benefit provisions and open premium rating. As a result, favorable profitability trends in workers' compensation are expected to continue. Other major lines of busi- ness in California, including commercial multiple peril, commercial automobile and general liability, are producing less favorable results than countrywide. CNA is aggressively seeking adequate premium rates for these lines within the confines of the current regulatory constraints.\nPROPERTY\/CASUALTY CLAIM AND CLAIM EXPENSES\nProperty\/casualty claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims are based on (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of assumed insurance, (d) estimates of future expenses to be incurred in settlement of claims and (e) estimates of claim recoveries. Loss reserve calculations are based on quantitative techniques which utilize historical trends to project future payments. Other factors, including mix of business, the anticipated effects of inflation, and other current conditions and trends, are implicit in the estimation process. The schedule on page 9 provides information on mix of business.\nStructured settlements have been negotiated for certain liability claims under commercial automobile, personal automobile, workers' compensation, professional liability and other liability coverages. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settle- ments are funded by annuities purchased from Continental Assurance Company, an affiliate. Related annuity obligations are carried in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at discounted values which approximate the alternative cost of annuity purchases. Such reserves, discounted at interest rates ranging from 6.25% to 7.5%, totaled $749 million, $663 million and $555 million at December 31, 1993, 1992 and 1991, respectively. Ultimate payouts under all existing con- tracts at December 31, 1993 and 1992 will approximate $2.2 billion and $2.0 billion, respectively.\nIn 1992, CNA changed its accounting for claim reserves related to workers' compensation lifetime claims and accident and health disability claims. Reserving practices under both statutory and generally accepted accounting principles allow discounting of reserves for fixed and determinable claim obligations. Reserve discounting for these types of claims is common industry practice. These claim reserves are discounted at interest rates ranging from 3.5% to 5.5% with mortality and morbidity assumptions reflecting current industry experience. At December 31, 1993 and 1992, such discounted reserves totaled $970 million and $911 million, respectively. Ultimate payouts for these claims are estimated to be $1.4 billion and $1.3 billion at December 31, 1993 and 1992, respectively.\nClaim and claim expense reserves are based on estimates and the ultimate liability may vary significantly from such estimates. Any adjustments that are made to the reserves are reflected in operating income in the year such adjustments are made.\nIn 1993, CNA adopted Statement of Financial Accounting Standards 113, which requires that balances pertaining to reinsurance transactions be reported \"gross\" on the balance sheet rather than as reductions of reserves for claims and claim expenses. As a result of this change in reporting, the reserve balances reported in the financial statements prepared in accordance with generally accepted accounting principles and those prepared under statutory accounting practices differ by the amount of ceded reserves of $2.9 billion and $2.5 billion at December 31, 1993 and 1992, respectively.\nThe retention limits of CNA's property\/casualty business vary by type of coverage and are based on individual risks underwritten. In general, retention limits have been increased with the growth in underwriting capacity. There have been no reinsurance transactions, such as portfolio reserve transfers or swaps of reserves, that have had a material impact on net income.\nAsbestos-related and Environmental Pollution Claims - ---------------------------------------------------\nReserves include estimated amounts for exposures to asbestos-related and environmental pollution claims. Reserving for such claims involves significant uncertainties for both CNA and the industry, characterized by complex and costly litigation and further compounded by the tendency of the courts to broadly reinterpret contracts beyond their original intent.\nA summary of asbestos-related and environmental pollution claims and claims expense activity follows:\nA major portion of CNA's asbestos-related claim exposure involves litigation with Fibreboard Corporation, as discussed in Note J of Notes to Consolidated Financial Statements. Adverse reserve developments for asbestos-related claims totaled $601 million, $1.689 billion, and $48 million in 1993, 1992 and 1991, respectively.\nPotential exposures also exist for claims involving environmental pollution, including toxic waste clean-up. Environmental pollution clean-up is the subject of both Federal and state regulation. By some estimates there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies.\nReserve development for environmental claims totaled $446, $48, and $47 million in 1993, 1992 and 1991, respectively, including litigation costs of $28, $25 and $21 million. Adverse development for 1993 primarily resulted from the allocation of approximately $340 million of reserves for unreported claims. The results of operations in future years may continue to be adversely affected by environmental pollution claims and claim expenses. Management will continue to monitor potential liabilities and make further adjustments as warranted. See Note J to the Consolidated Financial Statements.\nReserve Development - -------------------\nThe table below provides a reconciliation between beginning and ending claim and claim expense reserve balances for 1993, 1992 and 1991. In 1992, beginning and ending reserve balances were restated to retroactively reflect the accounting change for discounting discussed previously. Not included in the table below is premium development related to certain insurance policies subject to retroactive premium adjustments, based on various factors including loss experience. As a result, CNA also recorded premium and dividend related development to prior years (increasing (decreasing) premium) of $(127), $50 and $(43) million in 1993, 1992 and 1991, respectively.\nThe following table displays the development of financial statement claim and claim expense reserves for 1983 through 1993. In this table, development of reserves is included in each calendar year between the date of loss and the date of reestimation. Therefore, the deficiencies of the original estimates of required reserves that are reflected are cumulative and should not be summed. All reserve data has been restated to retroactively reflect the accounting change for discounting discussed previously.\nAs the above table illustrates, most of the unfavorable reserve development is due to asbestos claims. A discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims can be found in Note J of the Consolidated Financial Statements in the Annual Report to Shareholders.\nIn addition to the asbestos and environmental reserve developments noted on page 12, the unfavorable reserve developments relate primarily to accident years 1986 and prior and are comprised of the following lines of business: product liability, medical malpractice, other liability, professional liability, reinsurance, and workers' compensation. In the early to mid-1980's, frequency and severity trends exceeded expectations, resulting in reserve deficiencies in 1986 and prior accident years. For accident years 1987 and subsequent, frequency and severity trends have noticeably moderated. In calendar year 1993, positive severity experience in professional liability lines and improvement in involuntary workers' compensation experience resulted in favorable development in accident years 1987 through 1992.\nINVESTMENTS\nCNA's general account investment portfolio is managed to maximize after-tax investment return, while minimizing credit risks with investments concentrated in high quality securities to support its insurance underwriting operations. At December 31, 1993, approximately 20% of CNA's general account portfolio is invested in long-term state and municipal bonds in order to maximize after-tax yield and provide for a more stable yield on the portfolio with a higher quality of investment than may otherwise be available.\nCNA has the capacity to hold its fixed income portfolio to maturity. However, securities may be sold as part of CNA's asset\/liability strategies or to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed income securities are classified as available for sale. CNA's portfolio is managed based on the following investment strategies: i) diversification is used to limit exposures to any one issue or issuer, and ii) in general, the public market is used in order to provide liquidity.\nHistorically, CNA has maintained short-term assets at a level that provided for liquidity to meet its short-term obligations, principally anticipated claim payout patterns. Throughout 1992 and 1993, the level of short-term investments has increased beyond that needed for short-term liquidity. Though expected to result in a decline in investment income in the near term, management believes that the increased concentration in short-term investments will reduce the impact that a rise in interest rates would have on its fixed income portfolio. At December 31, 1993, the major components of the short-term investment portfolio were approximately $1.2 billion of U.S. Treasury bills and $4.5 billion of high-grade commercial paper.\nThe following summarizes CNA's distribution of general account investments:\nAs noted in Management's Discussion and Analysis of Financial Condition and Results of Operations, in 1993 CNA began a program of realigning its portfolio which resulted in realizing substantial gains. For the year ended December 31, 1993, CNA's property and casualty insurance subsidiaries sold approximately $35.4 billion of fixed income and equity securities realizing pretax net gains of $741.3 million. Of the securities sold, approximately $5.8 billion was from the tax-exempt municipal bond portfolio. Most of the proceeds from those sales have been invested in short-term securities, primarily U.S. Treasury bills and high-grade commercial paper. In addition to reducing the impact that a rise in interest rates would have on the fixed income portfolio, the increase in taxable short-term securities and the decrease in tax-exempt investments will allow the Company to minimize additional alternative minimum tax credit carryforwards.\nCNA's general account fixed income portfolio has consistently been of high quality as illustrated in the following table using the Standard & Poor's ratings convention (see Note).\nCNA's Separate Account investment portfolio is managed to specifically support the underlying insurance products (see the discussion of annuities and GIC's in \"Life Insurance\" above). Approximately 86% or $5.6 billion of Separate Account investments are used to fund GlC's; the remaining investments are funding variable products. Approximately 97% of the GlC investment portfolio is comprised of taxable fixed income securities. The quality of the GIC fixed income portfolio is as follows (see Note):\nNote: The bond ratings shown in the two tables above are primarily from Standard & Poor's (94% of the general account portfolio and 93% of the GIC portfolio in 1993). In the case of private placements and other unrated securities, comparable internal ratings are developed by CNA. These ratings are derived by management using available information on the issuer to assess the credit risk. Reference also may be made to similar instruments of the issuer that are rated by Standard & Poor's. In the case of unrated municipal bonds, a AAA rating may be assigned to issues with financial guarantee insurance.\nCNA actively manages its high yield bonds and maintains the level of such investments at prudent levels, as illustrated above. In 1993, the level of high yield investments within the GIC portfolio increased $261 million to $1.068 billion at year end. This increase is a result of the relative attractiveness of the high yield investment market in comparison to other investment opportunities during the year. Although the level of high yield investments has increased, the components of the high yield portfolio have shifted toward lower risk issues, with B and BB rated bonds comprising 91% of the high yield portfolio at December 31, 1993, compared to 82% at the end of 1992. High yield securities generally involve a greater degree of risk than that of investment grade securities. Expected returns should, however, compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. Further, CNA's investment in real estate and mortgage loans amounted to less than one-half of one percent of its total assets, substantially below industry averages.\nIncluded in CNA's 1993 AAA-rated fixed income securities (general and GIC portfolios) are $4.4 billion of asset-backed securities, consisting of approximately 47% in collateralized mortgage obligations (\"CMO's\"), 47% in U.S. Government agency issued pass-through certificates, and 6% in corporate asset-backed obligations. The majority of CMO's held are U.S. Government agency issues, are actively traded in liquid markets and are priced monthly by broker-dealers. At December 31, 1993, market value exceeded amortized cost by approximately $87 million. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in early planned amortization classes with wide bands and relatively short principal repayment windows.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nA. HOME OFFICE\nCNA Plaza, owned by Continental Assurance Company, is a 1,097,000 square foot office complex located at 333 S. Wabash, Chicago, Illinois. The forty-five story office building serves as the home office for CNA and its insurance subsidiaries. CNA Plaza and the adjacent building (a 454,000 square foot building located at 55 E. Jackson Blvd.) are partially situated on grounds under leases expiring in 2058 and 2067. Approximately 35% of the adjacent building is rented to non-affiliates.\nB. FIELD OFFICES\nCNA also maintains four regional offices and forty branch offices in major cities throughout the United States. This office space is leased except for offices located in four CNA owned buildings.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIncorporated herein by reference from Note J of the Notes to the Consolidated Financial Statements in the 1993 Annual Report to Shareholders.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nIncorporated herein by reference from page 55 of the 1993 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated herein by reference from page 2 of the 1993 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated herein by reference from pages 12 through 21 of the 1993 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated Balance Sheet - December 31, 1993 and 1992 Statement of Consolidated Operations - Year Ended December 31, 1993, 1992 and 1991 Statement of Consolidated Stockholders' Equity - Year Ended December 31, 1993, 1992 and 1991 Statement of Consolidated Cash Flows - Year Ended December 31, 1993, 1992 and 1991 Notes to the Consolidated Financial Statements Independent Auditors' Report\nThe above Consolidated Financial Statements, the related Notes to the Consolidated Financial Statements and the Independent Auditors' Report are incorporated herein by reference from pages 22 through 54 of the 1993 Annual Report to Shareholders.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation l4A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\nPage (a) 1. FINANCIAL STATEMENTS: Number ------ A separate index to the Consolidated Financial Statements is presented in Part II, Item 8........................... 17\n(a) 2. FINANCIAL STATEMENT SCHEDULES:\nSchedule I Summary of Investments..................... 21\nSchedule III Condensed Financial Information (Parent Company)................................... 22\nSchedule V Supplemental Insurance Information......... 25\nSchedule VI Reinsurance ............................... 26\nSchedule VIII Valuation and Qualifying Accounts and Reserves................................... 26\nSchedule IX Short-term Borrowings ..................... 27\nSchedule X Supplemental Information Concerning Property\/Casualty Insurance Operations..... 27\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED) Page (a) 2. FINANCIAL STATEMENT SCHEDULES (CONTINUED): Number ------ Other schedules are omitted because of the absence of con- ditions under which they are required or because the required information is provided in the Consolidated Financial Statements or notes thereto.\nIndependent Auditors' Report ............................. 28\n(a) 3. EXHIBITS: Exhibit Description of Exhibit Number ---------------------- -------\n(3) Articles of incorporation and by-laws:\nCertificate of Incorporation of CNA Financial Corporation, as amended May 6, 1987 (Exhibit 3.1 to 1987 Form 10-K incorporated herein by reference.). 3.1\nBy-Laws of CNA Financial Corporation, as amended November 3, 1993 .................................... 3.2*\n(4) Instruments defining the rights of security holders, including indentures:\nCNA Financial Corporation hereby agrees to furnish to the Commission upon request copies of instruments with respect to long-term debt, pursuant to Item 601(b) (4) (iii) of Regulation S-K.............. -\n(10) Material contracts:\nEmployment Agreement between CNA Financial Corporation and Dennis H. Chookaszian, dated February 22, 1993 (Exhibit 10.1 to 1992 Form 10-K incorporated herein by reference.)................... 10.1\nEmployment Agreement between CNA Financial Corporation and Philip L. Engel, dated February 22, 1993 (Exhibit 10.2 to 1992 Form 10-K incorporated herein by reference.)............................... 10.2\nContinuing Services Agreement between CNA Financial Corporation and Edward J. Noha, dated February 27, 1991 (Exhibit 6.0 to 1991 Form 8-K, filed March 18, 1991, incorporated herein by reference.)............. 10.3\nCNA Employees' Retirement Benefit Equalization Plan, as amended through January 1, 1993 (Exhibit 10.4 to 1992 Form 10-K incorporated herein by reference.).... 10.4\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED)\n(a) 3. EXHIBITS (CONTINUED): Exhibit Description of Exhibit Number ---------------------- -------\nCNA Employees' Long Term Award Program (Exhibit 10.5 to 1990 Form 10-K incorporated herein by reference.) The plan was terminated effective December 31, 1993................................... 10.5\nCNA Employees' Supplemental Savings Plan, as amended through January 1, 1993 (Exhibit 10.6 to 1992 Form 10-K incorporated herein by reference.)......... 10.6\nFederal Income Tax Allocation Agreement dated February 29, 1980 between CNA Financial Corporation and Loews Corporation (Exhibit 10.2 to 1987 Form 10-K incorporated herein by reference.)........ 10.7\nAgreement between Fibreboard Corporation and Continental Casualty Company, dated April 9, 1993 (Exhibit A to 1993 Form 8-K filed April 12, 1993 incorporated herein by reference.)................... 10.8\nSettlement Agreement entered into on October 12, 1993 by and among Fibreboard Corporation, Continental Casualty Company, CNA Casualty of California, Columbia Casualty Company and Pacific Indemnity Company together the \"Parties\" (Exhibit 10.1 to September 30, 1993 Form 10-Q incorporated herein by reference.).......................................... 10.9\nContinental-Pacific Agreement entered into October 12, 1993 between Continental Casualty Company and Pacific Indemnity Company (Exhibit 10.2 to September 30, 1993 Form 10-Q incorporated herein by reference.)....................................... 10.10\nGlobal Settlement Agreement among Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company, Pacific Indemnity Company and the Settlement Class dated December 23, 1993............. 10.11*\nGlossary of Terms in Global Settlement Agreement, Trust Agreement, Trust Distribution Process and Defendant Class Settlement Agreement as of December 23, 1993.................................... 10.12*\nFibreboard Asbestos Corporation Trust Agreement dated December 23, 1993.................................... 10.13*\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED)\n(a) 3. EXHIBITS (CONTINUED): Exhibit Description of Exhibit Number ---------------------- -------\nTrust Distribution Process - Annex A to the Trust Agreement as of December 23, 1993.................... 10.14*\nDefendant Class Settlement Agreement dated December 22, 1993.................................... 10.15*\nEscrow Agreement among Continental Casualty Company, Pacific Indemnity Company and The First National Bank of Chicago dated December 23, 1993.............. 10.16*\n(11) Computation of Net Income per Common Share........... 11.1*\n(12) Statements regarding computation of ratios:\nComputation of Ratio of Earnings to Fixed Charges.... 12.1*\nComputation of Ratio of Net Income, As Adjusted, to Fixed Charges..................................... 12.2*\n(13) 1993 Annual Report................................... 13.1*\n(21) Subsidiaries of CNA.................................. 21.1*\n(23) Consent of Deloitte & Touche......................... 23.1*\n(28) Information from reports furnished to state insurance regulatory authorities:\nProperty\/Casualty Reserve Reconciliation-Statutory Basis to Generally Accepted Accounting Principles.... 28.1*\nSchedule P from Continental Casualty Company's 1993 Consolidated Annual Statutory Statement provided to state insurance regulatory authorities............... 28.2* -------------------------------- *Filed herewith\n(b) REPORTS ON FORM 8-K:\nIn a report on Form 8-K dated November 3, 1993, CNA issued a press release that disclosed third quarter operating results and noted the addition of $500 million to Continental Casualty Company's loss reserves for asbestos-related bodily injury claims.\nSCHEDULE I\nCNA FINANCIAL CORPORATION SUMMARY OF INVESTMENTS\nSCHEDULE III\nCNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION\nSCHEDULE III (CONTINUED) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION\nSCHEDULE III (CONTINUED) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION\n23 SCHEDULE III (CONTINUED) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION\nNOTES TO CONDENSED FINANCIAL INFORMATION\nIn October 1993, a shelf registration statement was filed with the Securities and Exchange Commission which made $900 million of debt securities available for issuance from time to time. In addition, $100 million from a previous shelf registration remained available for issuance.\nIn November 1993, CNA sold $250 million principal amount of 6.25% notes due 2003 and $250 million principal amount of 7.25% debentures due 2023 at effective rates per annum of 6.4% and 7.3%, respectively. An additional $500 million of securities and\/or preferred stock will remain available for issuance under the shelf registration statement.\nb. Dividends of $150 million, $100 million, and $130 million were received by CNA from Continental Casualty Company in 1993, 1992 and 1991, respectively.\nc. CNA has reimbursed, or will reimburse, its subsidiaries for general management and administrative expenses, unallocated loss adjustment expenses and investment expense in the amounts of $193.1 million, $165.6 million and $159.5 million in 1993, 1992, and 1991, respectively.\nd. CNA contributed $475 million in capital to Continental Casualty Company in 1993. There were no capital contributions by CNA in 1992 and 1991. - -----------------------------------------------------------------------------\nSCHEDULE V CNA FINANCIAL CORPORATION SUPPLEMENTARY INSURANCE INFORMATION\nSCHEDULE V CNA FINANCIAL CORPORATION (CONTINUED) NOTES TO SUPPLEMENTARY INSURANCE INFORMATION\n============================================================================= *Excludes participating policyholders' interest related to realized investment losses of $13,142, $12,140, and $20,055 in 1993, 1992 and 1991, respectively. **1992 and 1991 have been restated to conform to the classifications followed in 1993 upon adoption of SFAS 113.\nSCHEDULE VI\nCNA FINANCIAL CORPORATION REINSURANCE\nThe effects of reinsurance on premium revenues are shown in the following schedule:\nThe impact of reinsurance on life insurance in force is shown in the following schedule:\nSCHEDULE IX\nCNA FINANCIAL CORPORATION SHORT-TERM BORROWINGS\nNotes: (a) Average amounts outstanding during the period are calculated by an average of end of month balances.\n(b) Weighted average interest rate for the period is calculated by dividing short-term interest expense by the average amount outstanding for the period.\n(c) Excludes CNA's 81\/2% Sinking Fund Debentures due December 15, 1995 in the outstanding principal amount of $23.4 million which were called for redemption on February 28, 1992.\nSCHEDULE X\nCNA FINANCIAL CORPORATION SUPPLEMENTAL INFORMATION CONCERNING PROPERTY\/CASUALTY INSURANCE OPERATIONS\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders CNA Financial Corporation\nWe have audited the consolidated financial statements of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries as of December 31, 1993 and 1992 and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated February 16, 1994, which report includes an explanatory paragraph as to certain accounting changes; such consolidated financial statements and report are included in the Company's 1993 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of CNA Financial Corporation and subsidiaries listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nDeloitte & Touche Chicago, Illinois February 16, 1994\nSIGNATURES\nPursuant 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.\nCNA Financial Corporation\nBy Laurence A. Tisch ----------------------------- Laurence A. Tisch Chief Executive Officer (Principal Executive Officer)\nBy Peter E. Jokiel ----------------------------- Peter E. Jokiel Senior Vice President and Chief Financial Officer\nDate: March 23, 1994\nSIGNATURES --(CONTINUED)\nPursuant 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 and on the date indicated.\nSIGNATURE TITLE\nAntoinette Cook Bush Director - ------------------------------ Antoinette Cook Bush\nDennis H. Chookaszian Director - ------------------------------ Dennis H. Chookaszian\nPhilip L. Engel Director - ------------------------------ Philip L. Engel\nRobert P. Gwinn Director - ------------------------------ Robert P. Gwinn\nEdward J. Noha Chairman of the Board - ------------------------------ and Director Edward J. Noha Dated: Lester Pollack Director March 23, 1994 - ------------------------------ Lester Pollack\n- ------------------------------ Director* John E. Stipp\nRichard L. Thomas Director - ------------------------------ Richard L. Thomas\nJames S. Tisch Director - ------------------------------ James S. Tisch\nLaurence A. Tisch Chief Executive Officer - ------------------------------ and Director Laurence A. Tisch\nPreston R. Tisch Director - ------------------------------ Preston R. Tisch\nMarvin Zonis Director - ------------------------------ Marvin Zonis *Passed away on March 8, 1994.","section_15":""}
{"filename":"882135_1993.txt","cik":"882135","year":"1993","section_1":"ITEM 1. Business\nThe Ford Credit Auto Loan Master Trust (the \"Trust\") was created on February 5, 1992 pursuant to the Pooling and Servicing Agreement (the \"Pooling and Servicing Agreement\") dated as of December 31, 1991 among Ford Motor Credit Company (\"Ford Credit\"), as servicer, Ford Credit Auto Receivables Corporation (the \"Company\"), as seller, and Chemical Bank (the \"Trustee\"), as trustee. Pursuant to the Pooling and Servicing Agreement, the Company transferred to the trust property primarily consisting of wholesale receivables generated from time to time in a portfolio of revolving financing arrangements with automobile dealers to finance their automobile and light truck inventory, collections as to the receivables, security interests in the vehicles financed thereby and certain other property. Such property was obtained by the Company pursuant to the Receivables Purchase Agreement dated as of December 31, 1991 between the Company, as purchaser, and Ford Credit, as servicer.\nIn 1992, the Company, registered with the Securities Exchange Commission under the Securities Act of 1933, as amended, and sold to the general public the Series 1992-1, 6 7\/8% Auto Loan Asset Backed Certificates (the \"Series 1992-1 Certificates\") in the initial principal amount of $1,000,000,000, the Series 1992-2, 7 3\/8% Auto Loan Asset Backed Certificates (the \"Series 1992-2 Certificates\") in the initial principal amount of $700,000,000, and the Series 1992-3, 5 5\/8% Auto Loan Asset Backed Certificates (the \"1992-3 Certificates\") in the initial principal amount of $1,000,000,000. The Series 1992-1 Certificates, Series 1992-2 Certificates and Series 1992-3 Certificates were created pursuant to the Series 1992-1 Supplement dated as of December 31, 1991 to the Pooling and Servicing Agreement (the \"1992-1 Supplement\"), the Series 1992-2 Supplement dated as of March 31, 1992 to the Pooling and Servicing Agreement (the \"1992-2 Supplement\") and the Series 1992-3 Supplement dated as of September 30, 1992 to the Pooling and Servicing Agreement (the \"1992-3 Supplement\"), respectively. Each Series of Certificates represents an undivided interest in certain assets of the Trust.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nFor information regarding the property of the Trust, see the Pooling and Servicing Agreement, the 1992-1 Supplement, the 1992-2 Supplement, the 1992-3 Supplement and the prospectuses (Exhibits 19.14, 19.15 and 19.16) relating to the Series 1992-1 Certificates, the Series 1992-2 Certificates and the Series 1992-3 Certificates and incorporated hereby by reference. For additional information regarding the Certificates contained in the Distribution Date Statements furnished to the Trustee on each Distribution Date during 1993, see the Current Reports on Form 8-K incorporated by reference herein (Exhibits 19.1 through 19.12). For additional information, regarding the Certificates, see Exhibit 99.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNothing to report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNothing to report.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThere were 72 Series 1992-1 Certificateholders, 54 Series 1992-2 Certificateholders and 79 Series 1992-3 Certificateholders at March 3, 1994. There is no established public trading market for any of the Certificates.\nITEM 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNothing to report.\nPART III.\nITEM 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(3)Amount and nature of (2) Name and Address beneficial (1)Title of of beneficial ownership (4)Percent Class owner* (in thousands) of Class --------- ---------------- -------------- -------- Series 1992-1, Bankers Trust Company $ 87,645 8.8% 6 7\/8% Auto Loan 16 Wall Street Asset Backed New York, NY 10007 Certificates\nSeries 1992-1, Chemical Bank\/MHT 115,155 11.5% 6 7\/8% Auto Loan 270 Park Avenue Asset Backed New York, NY 10017 Certificates\nSeries 1992-1, Marine Treasury $75,300 7.5% 6 7\/8% Auto Loan Investment Asset Backed 140 Broadway, Certificates Level A New York, NY 10015\nITEM 12. (CONTINUED)\n(3)Amount and nature of (2) Name and Address beneficial (1)Title of of beneficial ownership (4)Percent Class owner* (in thousands) of Class --------- ---------------- -------------- -------- Series 1992-1 Morgan Guaranty Trust $60,600 6.1% 6 7\/8% Auto Loan Co. of New York Asset Backed 37 Wall Street Certificates New York, NY 10260\nSeries 1992-1 Shawnut Bank $99,525 9.9% 6 7\/8% Auto Loan Connecticut, N. A.\/ Asset Backed Investment Dealer Certificates 777 Main Street Hartford, CT 06115\nSeries 1992-1, SSB-Custodian $154,897 15.5% 6 7\/8% Auto Loan c\/o ADP Proxy Services Asset Backed 51 Mercedes Way Certificates Edgewood, NY 11717\nSeries 1992-2, Bankers Trust Company $153,995 22.0% 7 3\/8% Auto Loan 16 Wall Street Asset Backed New York, NY 10005 Certificates\nSeries 1992-2, The Chase Manhattan $51,455 7.4% 7 3\/8% Auto Loan Bank N.A. Asset Backed 1 Chase Manhattan Plaza Certificates New York, NY 10081\nSeries 1992-2, Continental Bank, $76,440 10.9% 7 3\/8% Auto Loan National Association Asset Backed Trust Certificates c\/o ADP Proxy Services 51 Mercedes Way Edgewood, NY 11717\nSeries 1992-2, Northern Trust Co. $54,975 7.9% 7 3\/8% Auto Loan Trust Asset Backed c\/o ADP Proxy Services Certificates 51 Mercedes Way Edgewood, NY 11717\nSeries 1992-2 Mellon Bank, N.A. $96,200 13.8% 7 3\/8% Auto Loan c\/o ADP Proxy Services Asset Backed 51 Mercedes Way Certificates Edgewood, NY 17717\nITEM 12. (CONTINUED) (3)Amount and nature of (2) Name and Address beneficial (1)Title of of beneficial ownership (4)Percent Class owner* (in thousands) of Class --------- ---------------- -------------- -------- Series 1992-2 SSB-Custodian $54,590 7.8% 7 3\/8% Auto Loan c\/o ADP Proxy Services Asset Backed 51 Mercedes Way Certificates Edgewood, NY 17717\nSeries 1992-3, Bankers Trust Company $128,020 12.8% 5 5\/8% Auto Loan 16 Wall Street Asset Backed New York, NY 10005 Certificates\nSeries 1992-3, Continental Bank $170,464 17.0% 5 5\/8% Auto Loan National Association Asset Backed Trust Certificates c\/o ADP Proxy Services 51 Mercedes Way Edgewood, NY 17717\nSeries 1992-3, Chemical Bank\/MHT $80,865 8.1% 5 5\/8% Auto Loan 270 Park Ave. Asset Backed New York, NY 10017 Certificates\nSeries 1992-3, SSB-Custodian $76,185 7.6% 5 5\/8% Auto Loan c\/o ADP Proxy Services Asset Backed 51 Mercedes Way Certificates Edgewood, NY 17717\nSeries 1992-3, The Bank of New York $66,535 6.6% 5 5\/8% Auto Loan 925 Patterson Plank Rd. Asset Backed Secaucus, NJ 07094 Certificates\nSeries 1992-3, Northern Trust Co. $59,620 6.0% 5 5\/8% Auto Loan c\/o ADP Proxy Services Asset Backed 51 Mercedes Way Certificates Edgewood, NY 17717\nSeries 1992-3, Morgan Guaranty Trust $71,110 7.1% 5 5\/8% Auto Loan Company of New York Asset Backed 37 Wall Street Certificates New York, NY 10260\n* As of March 3, 1994\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNothing to report.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)3. Exhibits\nDesignation Description Method of Filing - ----------- ----------- ----------------\nExhibit 3.1 Restated Certificate of Filed as Exhibit 3.1 to Incorporation of Ford Ford Credit Auto Credit Auto Receivables Receivables Corporation's Corporation. Registration Statement on Form S-1 (No. 33-44432) and incorporated herein by reference.\nExhibit 3.2 By-Laws of Ford Credit Filed as Exhibit 3.2 to Auto Receivables Ford Credit Auto Corporation. Receivables Corporation's Registration Statement on Form S-1 (No. 33-44432) and incorporated herein by reference.\nExhibit 4.1 Conformed copy of Pooling Filed as Exhibit 4.1 to and Servicing Agreement Ford Credit Auto dated as of December 31, Receivables Corporation's 1991 among Ford Credit Registration Statement on Auto Receivables Form S-1 (No. 33-47582) Corporation, as seller, and incorporated herein Ford Motor Credit Company by reference. as servicer, and Chemical Bank, as trustee.\nExhibit 4.2 Conformed copy of Series Filed as Exhibit 4.2 to 1992-1 Supplement dated Ford Credit Auto Loan as of December 31, 1991 Master Trust Current to the Pooling and Report on Form 8-K dated Servicing Agreement February 7, 1992 and referenced in Exhibit and incorporated herein 4-A above among Ford by reference. Credit Auto Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nITEM 14. (Continued)\nDesignation Description Method of Filing - ----------- ----------- -----------------\nExhibit 4.3 Conformed copy of Series Filed as Exhibit 4.2 to 1992-2 Supplement dated Ford Credit Auto Loan as of March 31, 1993 to Master Trust Current Pooling and Servicing Report on Form 8-K dated Agreement referred to in May 15, 1992 and Exhibit 4-A above among incorporated herein by Ford Credit Auto reference. Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 4.4 Conformed copy of Series Filed as Exhibit 4.2 to 1992-3 Supplement dated Ford Credit Auto Loan as of September 30, 1992 Master Trust Current to Pooling and Servicing Report on Form 8-K dated Agreement referred to in November 12, 1992 and Exhibit 4-A above among incorporated herein by Ford Credit Auto Reference. Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 19.1 Distribution Date Statement Filed as Exhibit 28 to for Collection Period Ford Credit Auto Loan ended January 31, 1993. Master Trust Current Report on Form 8-K dated February 9, 1993 and incorporated herein by reference.\nExhibit 19.2 Distribution Date Statement Filed as Exhibit 28 to for Collection Period ended Ford Credit Auto Loan February 28, 1993. Master Trust Current Report on Form 8-K dated March 11, 1993 and incorporated herein by reference.\nExhibit 19.3 Distribution Date Statement Filed as Exhibit 28 to for Collection Period ended Ford Credit Auto Loan March 31, 1993. Master Trust Current Report on Form 8-K dated April 7, 1993 and incorporated herein by reference.\nITEM 14. (Continued)\nDesignation Description Method of Filing - ----------- ----------- -----------------\nExhibit 19.4 Distribution Date Statement Filed as Exhibit 28 to for Collection Period Ford Credit Auto Loan ended April 30, 1993. Master Trust Current Report on Form 8-K dated May 14, 1993 and incorporated herein by reference.\nExhibit 19.5 Distribution Date Statement Filed as Exhibit 28 to for Collection Period Ford Credit Auto Loan ended May 31, 1993. Master Trust Current Report on Form 8-K dated June 4, 1993 and incorporated herein by reference.\nExhibit 19.6 Distribution Date Statement Filed as Exhibit 28 to for Collection Period Ford Credit Auto Loan ended June 30, 1993. Master Trust Current Report on Form 8-K dated July 7, 1993 and incorporated herein by reference.\nExhibit 19.7 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan ended July 31, 1993. Master Trust Current Report on Form 8-K dated August 10, 1993 and incorporated herein by reference.\nExhibit 19.8 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan ended August 31, 1993. Master Trust Current Report on Form 8-K dated September 8, 1993 and incorporated herein by reference.\nExhibit 19.9 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan ended September 30, 1993. Master Trust Current Report on Form 8-K dated October 19, 1993 and incorporated herein by reference.\nITEM 14. (Continued)\nDesignation Description Method of Filing - ----------- ----------- -----------------\nExhibit 19.10 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan ended October 31, 1993. Master Trust Current Report on Form 8-K dated November 9, 1993 and incorporated herein by reference.\nExhibit 10.11 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan November 30, 1993. Master Trust Current Report on Form 8-K dated December 9, 1993 and incorporated herein by reference.\nExhibit 10.12 Distribution Date Statement Filed as Exhibit 19 to for Collection Period Ford Credit Auto Loan December 31, 1993. Master Trust Current Report on Form 8-K dated January 10, 1994 and incorporated herein by reference.\nExhibit 19.14 Prospectus dated January Filed as Exhibit 28.1 30, 1992 relating to to Ford Credit Auto Series 1992-1 Master Trust Current Certificates. Report on Form 8-K dated February 7, 1992 and incorporated herein by reference.\nExhibit 19.15 Prospectus dated May Filed as Exhibit 28.1 to 11, 1993 relating to Ford Credit Auto Loan Series 1992-2 Master Trust Current. Certificates. Report on Form 8-K dated May 15, 1992 and incorporated herein by reference.\nExhibit 19.16 Prospectus dated November Filed as Exhibit 28.1 to 6, 1992 relating to Ford Credit Auto Loan Series 1992-3 Master Trust Current Certificates. Report on Form 8-K dated November 12, 1992 and incorporated herein by reference.\nITEM 14. (Continued)\nDesignation Description Method of Filing - ----------- ----------- -----------------\nExhibit 99 Selected Information Filed with this report. relating to the Series 1992-1 Certificates, the the Series 1992-2 Certificates and the Series 1992-3 Certificates.\n(b) Reports on Form 8-K\nDate of Report Item\nOctober 19, 1993 Item 5 - Other Events November 9, 1993 Item 5 - Other Events December 9, 1993 Item 5 - Other Events January 10, 1994 Item 5 - Other Events\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nFord Credit Auto Loan Master Trust (Registrant)\nMarch 18, 1994 By: \/s\/ Richard P. Conrad ------------------------ Richard P. Conrad (Assistant Secretary of Ford Credit Auto Receivables Corporation, originator of Trust)\nEXHIBIT INDEX\nExhibit Number Description of Exhibit Page - -------- ---------------------- ----\nExhibit 3.1 Restated Certificate of * Incorporation of Ford Credit Auto Receivables Corporation.\nExhibit 3.2 By-Laws of Ford Credit Auto * Receivables Corporation.\nExhibit 4.1 Conformed copy of Pooling and * Servicing Agreement dated as of December 31, 1991 among Ford Credit Auto Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 4.2 Conformed copy of Series * 1992-1 Supplement dated as of December 31, 1991 to the Pooling and Servicing Agreement referenced in Exhibit 4-A above among Ford Credit Auto Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 4.3 Conformed copy of Series * 1992-2 Supplement dated as of March 31, 1993 to the Pooling and Servicing Agreement referred to in Exhibit 4-A above among Ford Credit Auto Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 4.4 Conformed copy of Series * 1992-3 Supplement dated as of September 30, 1992 to Pooling and Servicing Agreement referred to in Exhibit 4-A above among Ford Credit Auto Receivables Corporation, as seller, Ford Motor Credit Company, as servicer, and Chemical Bank, as trustee.\nExhibit 19.1 Distribution Date Statement * for Collection Period ended January 31, 1993.\nExhibit 19.2 Distribution Date Statement * for Collection Period ended February 28, 1993.\nExhibit 19.3 Distribution Date Statement * for Collection Period ended March 31, 1993.\nExhibit 19.4 Distribution Date Statement * for Collection Period ended April 30, 1993.\nExhibit 19.5 Distribution Date Statement * for Collection Period ended May 31, 1993.\nExhibit 19.6 Distribution Date Statement * for Collection Period ended June 30, 1993.\nExhibit 19.7 Distribution Date Statement * for Collection Period ended July 31, 1993\nExhibit 19.8 Distribution Date Statement * for Collection Period ended August 31, 1993\nExhibit 19.9 Distribution Date Statement * for Collection Period ended September 30, 1993\nExhibit 19.10 Distribution Date Statement * for Collection Period ended October 31, 1993\nExhibit 19.11 Distribution Date Statement * for Collection Period ended November 30, 1993\nExhibit 19.12 Distribution Date Statement * for Collection Period ended December 31, 1993\nExhibit 19.14 Prospectus dated January 30, * 1992 relating to Series 1992-1 Certificates.\nExhibit 19.15 Prospectus dated May 11, 1992 * relating to Series 1992-2 Certificates.\nExhibit 19.16 Prospectus dated November 6, * 1992 relating to Series 1992-3 Certificates.\nExhibit 99 Selected Information relating Filed with this Report. to the Series 1992-1 Certificates, the Series 1992-2 Certificates and the Series 1992-3 Certificates.\n__________________ * Previously Filed","section_15":""}
{"filename":"874783_1993.txt","cik":"874783","year":"1993","section_1":"Item 1. Business\nThe Sears Credit Account Trust 1991 B (the \"Trust\") was formed pursuant to the Pooling and Servicing Agreement dated as of May 15, 1991 (the \"Pooling and Servicing Agreement\") among Sears, Roebuck and Co. (\"Sears\") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. (\"SRFG\") as Seller, and Continental Bank, National Association as trustee (the \"Trustee\"). The Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe property of the Trust includes a portfolio of receivables (the \"Receivables\") arising in selected accounts under open-end credit plans of Sears (the \"Accounts\") and all monies received in payment of the Receivables. At the time of the Trust's formation, Sears sold and contributed to SRFG, which in turn conveyed to the Trust, all Receivables existing under the Accounts as of the end of certain of Sears regular billing cycles ending in April, 1991 and all Receivables arising under the Accounts from time to time thereafter until the termination of the Trust. Information related to the performance of the Receivables during 1993 is set forth in the ANNUAL STATEMENT filed as Exhibit 21 to this Annual Report on Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInvestor Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company (\"DTC\"), a \"clearing agency\" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended. All outstanding definitive Investor Certificates are held by CEDE and Co., the nominee of DTC.\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 15, 1994, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1994, owned 100% of the Seller Certificate, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Exhibits:\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\n(b) Reports on Form 8-K:\nCurrent reports on Form 8-K are filed on or before the Distribution Date each month (on, or the first business day after, the 15th of the month). The reports include as an exhibit, the MONTHLY INVESTOR CERTIFICATEHOLDERS' STATEMENT. Current Reports on Form 8-K were filed on October 15, 1993, November 15, 1993, and December 15, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nSears Credit Account Trust 1991 B (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: \/S\/ALICE M. PETERSON _____________________________________ Alice M. Peterson President and Chief Executive Officer\nDated: March 30, 1994\nEXHIBIT INDEX\nPage number in sequential Exhibit No. number system\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\nExhibit 21\nSEARS CREDIT ACCOUNT TRUST 1991 B\n8.60% CREDIT ACCOUNT PASS-THROUGH CERTIFICATES\n1993 ANNUAL STATEMENT\nPursuant to the terms of the letter issued by the Securities and Exchange Commission dated September 5, 1991 (granting relief to the Trust from certain reporting requirements of the Securities Exchange Act of 1934, as amended), aggregated information regarding the performance of Accounts and payments to Investor Certificateholders in respect of the Due Periods related to the twelve Distribution Dates which occurred in 1993 is set forth below.\n1) The total amount of the distribution to Investor Certificateholders during 1993, per $1,000 interest..$86.00\n2) The amount of the distribution set forth in paragraph 1 above in respect of interest on the Investor Certificates, per $1,000 interest....................$86.00\n3) The amount of the distribution set forth in paragraph 1 above in respect of principal on the Investor Certificates, per $1,000 interest.................... $0.00\n4) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods.................................$454,012,270.03\n5) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods.....................................$131,780,783.31\n6) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates................................$325,465,482.33\n7) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates.................................$94,561,320.27\n8) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate.................................$128,546,787.70\n9) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate..................................$37,219,463.04\n10) The excess of the Investor Charged-Off Amount over the sum of (i) payments in respect of the Available Subordinated Amount and (ii) Excess Servicing, if any (an \"Investor Loss\"), per $1,000 interest.............$0.00\n11) The aggregate amount of Investor Losses in the Trust as of the end of the day on December 15, 1993, per $1,000 interest.......................................$0.00\n12) The total reimbursed to the Trust from the sum of the Available subordinated Amount and Excess Servicing, if any, in respect of Investor Losses, per $1,000 interest..............................................$0.00\n13) The amount of the Investor Monthly Servicing Fee payable by the Trust to the Servicer..........$9,999,999.96\n14) The aggregate amount which was deposited in the Principal Funding Account in respect of Collections of Principal Receivables during the related Due Periods..$0.00\n15) The aggregate amount of Investment Income during the related Due Periods...................................$0.00\n16) The total amount on deposit in the Principal Funding Account in respect of Collections of Principal Receivables, as of the end of the reportable year.....$0.00\n17) The Deficit Accumulation Amount, as of the end of the reportable year.......................................$0.00\n18) The aggregate amount which was deposited in the Interest Funding Account in respect of Certificate Interest during the related Due Periods...............$42,999,999.96\n19) The total amount on deposit in the Interest Funding Account in respect of Certificate Interest, as of the end of the reportable year....................$3,583,333.33\nExhibit 28(a)\nFebruary 11, 1994\nMs. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank National Sears Tower Association as Trustee Chicago, Illinois 60684 231 South La Salle Street Chicago, Illinois 60697\nWe have applied the procedures listed below to the accounting records of Sears, Roebuck and Co. (\"Sears\") relating to the servicing procedures performed by Sears as Servicer under Section 3.06(b) of the Pooling and Servicing Agreement (the \"Agreement\") for the following Trusts:\nDate of Pooling and Trust Servicing Agreement\nSears Credit Account Trust 1991A March 1, 1991 Sears Credit Account Trust 1991B May 15, 1991 Sears Credit Account Trust 1991C July 1, 1991 Sears Credit Account Trust 1991D September 15, 1991 Sears Credit Account Master Trust I November 18, 1992\nIt is understood that this report is solely for your information and is not be referred to or distributed for any purpose to anyone other than Continental Bank, National Association as Trustee, Investor Certificateholders or the management of Sears. The procedures we performed are as follows:\nCompared the mathematical calculations of each amount set forth in each monthly certificate forwarded by the Servicer, pursuant to Section 3.04(b) of the Agreement, during the calendar year 1993 to the Servicer's computer-generated Portfolio Monitoring and Monthly Cash Flow Allocations report. We found such amounts to be in agreement.\nBecause the above procedures do not constitute an audit conducted in accordance with generally accepted auditing standards, we do not express an opinion on any of the items referred to above.\nFebruary 11, 1994\nMs. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank National Association as Trustee\nAs a result of the procedures performed, no matters came to our attention that caused us to believe that the amounts in the monthly certificates require adjustment. Had we performed additional procedures or had we conducted an audit of the monthly certificates in accordance with generally accepted auditing standards, matters might have come to our attention that would have been reported to you. This report relates only to the items specified above and does not extend to any financial statements of Sears taken as a whole.","section_15":""}
{"filename":"752290_1993.txt","cik":"752290","year":"1993","section_1":"Item 1. Business\nGeneral\nUnimar Company (the Company) was organized as a general partnership in 1984 under the Texas Uniform Partnership Act. The partners are LASMO (Ustar), Inc. (Ultrastar), a Delaware corporation and an indirect, wholly owned subsidiary of LASMO plc (LASMO), a public limited company organized under the laws of England, and Unistar, Inc. (Unistar), a Delaware corporation and a direct subsidiary of Union Texas Petroleum Holdings, Inc. (UTPH), a Delaware corporation. UTPH is approximately 38 percent owned by two partnerships controlled by an affiliate of Kohlberg Kravis Roberts & Co. (KKR) with the remaining outstanding common stock publicly held.\nThe Company's sole business is its ownership of ENSTAR Corporation (ENSTAR) which, through its wholly-owned subsidiaries, Virginia International Company (INTERNATIONAL) and Virginia Indonesia Company (VICO), has a 23.125 percent working interest in, and is the operator of, a joint venture (the Joint Venture) for the exploration, development and production of oil and natural gas (gas) in East Kalimantan, Indonesia, under a production sharing contract (Production Sharing Contract or PSC) with Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), the state petroleum enterprise of the Republic of Indonesia. The majority of the revenue derived from the Joint Venture results from the sale of liquefied natural gas (LNG). Currently, the LNG is sold principally to utility and industrial companies in Japan, Taiwan and Korea. See \"The Joint Venture\" below.\nThe principal executive offices of the Company are at 1221 McKinney, Suite 600, Houston, Texas 77010 and its telephone number is (713) 654-8550. A Management Board consisting of six members, three appointed by each partner, exercises management, budgeting and financial control of the Company. As of December 31, 1993, VICO, in its capacity as the Joint Venture operator, had approximately 2,130 employees in the United States and Indonesia. The Company presently does not have any other employees. All aspects of the Company's business that are not associated with the management of the Joint Venture, such as operations, legal, accounting, tax and other management functions, are supplied by employees of the partners in accordance with management agreements.\nThe Company can give no assurance as to the future trend of its business and earnings, or as to future events and developments that could affect the Company in particular or the oil industry in general. These include such matters as environmental quality control standards, new discoveries of hydrocarbons, and the demand for petroleum products. Furthermore, the Company's business could be profoundly affected by future events including price changes or controls, payment delays, increased expenditures, legislation and regulations affecting the Company's business, expropriation of assets, renegotiation of contracts with foreign governments, political instability, currency exchange and repatriation losses, taxes, litigation, the competitive environment, and international economic and political developments including actions of members of the Organization of Petroleum Exporting Countries (OPEC). See Item 7 - Management Discussion and Analysis of Financial Condition and Results of Operations.\nDescription of the Company's Indonesian Participating Units\n(a) Market information. The Company's Indonesian Participating Units (IPUs) are listed for trading on the American Stock Exchange under the symbol \"UMR.\" The following table shows the reported high and low sales prices of the IPUs on a quarterly basis:\nINDONESIAN PARTICIPATING UNITS' PRICE RANGE\nFirst Qtr. Second Qtr. Third Qtr. Fourth Qtr. High 9-1\/8 10-1\/4 9-3\/4 9-1\/2 Low 6-7\/8 8-1\/4 8-5\/8 8-1\/4\nHigh 8 6-1\/2 7 7-5\/8 Low 5 5-1\/4 5-3\/4 6-3\/8\nSource of prices: American Stock Exchange\n(b) Holders. As of March 1, 1994, 10,778,590 IPUs were outstanding and held by approximately 4,301 holders of record.\n(c) Payments per Indonesian Participating Unit.\nPeriod Payment Date Payment\nFirst Quarter - 1992 June 1, 1992 0.35 Second Quarter - 1992 August 31, 1992 0.37 Third Quarter - 1992 November 30, 1992 0.54 Fourth Quarter - 1992 March 1, 1993 0.44 First Quarter - 1993 June 1, 1993 0.46 Second Quarter - 1993 August 30, 1993 0.28 Third Quarter - 1993 November 29, 1993 0.45 Fourth Quarter - 1993 March 1, 1994 0.38\nEach IPU entitles the holder thereof to receive until September 25, 1999, a payment (Participation Payment) for any quarterly period equal to the product of (i) a fraction, the numerator of which is 1 and the denominator of which is equal to the number of IPUs outstanding on the last business day of such quarterly period, multiplied by (ii) the amount by which cumulative Net Cash Flow (as defined below) through the end of such quarterly period exceeds the aggregate amount of all preceding Participation Payments in respect of all IPUs. If Net Cash Flow is zero or negative for any quarterly period, no Participation Payment for that quarter will be made.\nThe amount of Net Cash Flow for any quarterly period is equal to the product of (i) a fraction, the numerator of which is equal to the number of IPUs outstanding on the last business day of such quarterly period, and the denominator of which is 14,077,747, multiplied by (ii) 32 percent of (a) all cash actually received in the United States by INTERNATIONAL and VICO (for purposes hereof, the Special Subsidiaries) during such quarterly period from their aggregate 23.125 percent interest in the Joint Venture (or actually received by them outside the United States if they voluntarily elect not to repatriate such cash) minus (b) an amount equal to the sum of (A) the aggregate amount of all accruals or expenditures made by the Special Subsidiaries during such quarterly period as a result of their interest in the Joint Venture, (B) foreign or domestic taxes paid by the Special Subsidiaries, (C) any award, judgment or settlement and related legal fees incurred by the Special Subsidiaries, (D) certain operating expenses incurred by the Special Subsidiaries, and (E) the amortization of capitalized advances made by the Special Subsidiaries for certain major capital expenditures, together with interest thereon.\nParticipation Payments for any quarterly period will be paid 60 days in arrears to holders of record on the date 45 days after the last day of the period. Participation Payments of less than $0.01 per IPU for any quarterly period will be accumulated and paid when Participation Payments in any succeeding quarter, together with previously unpaid amounts, exceed $0.01 per IPU.\nUnits of Measure Restatement\nIn order to better conform the Company's disclosures to those of its partners, the definition of a Net Equivalent Cargo and MCF have been revised. All relevant disclosures relating to prior years have been restated to conform to these two new definitions.\nNet Equivalent Cargo (NEC)\nIn prior years one NEC equaled the quantity of LNG delivered for the Joint Venture's 97.9 percent interest in a 1973 Sales Contract shipment or any average of 2,873 BBTUs of gas. The definition of a NEC has now been changed to the quantity of LNG delivered in a 1973 Sales Contract shipment or an average of 2,942 BBTUs.\nMMCF of Gas\nIn prior years an MMCF of gas was referred to as \"wet gas\" which contained residual amounts of condensate. This definition has been changed to \"dry gas\" after any residual condensate has been removed. As an example, approximately 3.1 billion cubic feet of wet gas are required to produce 2.9 trillion BTUs of LNG; whereas, approximately 3.0 billion cubic feet of dry gas are required to produce 2.9 trillion BTUs of LNG.\nBUSINESS The Joint Venture\nThe Joint Venture participants are INTERNATIONAL (15.625%), VICO (7.5%), LASMO Sanga Sanga Limited (an indirect subsidiary of LASMO formerly called Ultramar Indonesia Limited) (26.25%), Union Texas East Kalimantan Limited (an indirect subsidiary of UTPH) (26.25%), and Universe Gas & Oil Company, Inc. (a subsidiary of a consortium led by Japan Petroleum Exploration Co., Ltd.) (4.375 %). In addition, Opicoil Houston, Inc. (an affiliate of the Chinese Petroleum Corporation) holds a 16.67 percent equity interest and a 20 percent voting interest, with the remaining 3.33 percent non-voting equity interest held by assignees of Opicoil Houston, Inc. VICO in its capacity as the Joint Venture operator conducts exploration and development activities within the PSC area. The cost of such activities is funded by the Joint Venture participants. The vote of participants holding 66-2\/3 percent of the total ownership is generally required for approval of significant matters pertaining to the Joint Venture.\nTerms of Production Sharing Contract\nUnder a PSC with Pertamina that was amended and extended in 1990 until August 7, 2018, the Joint Venture is authorized to explore for, develop, and produce petroleum reserves in an approximate 1.4 million acre area in East Kalimantan. In accordance with the requirements of the PSC, during 1991, the Joint Venture selectively relinquished approximately 10 percent of the PSC area. The Joint Venture must relinquish 10 percent of the PSC area by April 23, 1994; 10 percent by August 7, 1998; 10 percent by December 31, 2000; 15 percent by December 31, 2002 and 15 percent by December 31, 2004. However, the Joint Venture is not required to relinquish any of the PSC area in which oil or gas is held for production. Additionally, pursuant to the terms of the PSC, the Joint Venture, having produced 185 million barrels of oil, paid Pertamina a $5 million non-cost recoverable bonus in March 1993.\nUnder the PSC, the Joint Venture participants are entitled to recover cumulative operating and certain capital costs out of the crude oil, condensate and gas produced each year, and to receive a share of the remaining crude oil and condensate production and a share of the remaining revenues from the sale of gas on an after-Indonesian tax basis. The method of recovery of capital costs is a system of depreciation and amortization that is similar to U.S. tax accounting methods. The share of revenues from the sale of gas after cost recovery through August 7, 1998 will remain at 35 percent to the Joint Venture after Indonesian income taxes and 65 percent to Pertamina. The split after August 7, 1998, will be 25 percent to the Joint Venture after Indonesian income taxes and 75 percent to Pertamina for gas sales under the 1973 and 1981 LNG Sales Contracts, Korean carryover quantities and the seven 1986 liquefied petroleum gas (LPG) Sales Contracts (and any extensions thereto) to the extent that the gas to fulfill these contracts is committed from the Badak or Nilam fields; after August 7, 1998, all other LNG sales contract revenues will be split 30 percent to the Joint Venture after Indonesian income taxes and 70 percent to Pertamina. Based on current and projected oil production, the revenue split from oil sales after cost recovery through August 7, 2018 will remain at 15 percent to the Joint Venture after Indonesian income taxes and 85 percent to Pertamina. These revenue splits are based on Indonesian income tax rates of 56 percent through August 7, 1998 and 48 percent thereafter.\nIn addition, the Joint Venture is required to sell out of its share of production 8.5 percent (7.2 percent after August 7, 1998) of the total oil and gas condensate production from the contract area for Indonesian domestic consumption. The sales price for the domestic market consumption is $0.20 per barrel with respect to fields commencing production prior to February 23, 1989. For fields commencing production after that date, domestic market consumption is priced at 10 percent of the weighted average price of crude oil sold from such fields. However, for the first sixty consecutive months of production from new fields, domestic market consumption is priced at the official Indonesian Crude Price (ICP). The participants' remaining oil and condensate production is generally sold in world markets.\nThe Joint Venture has no ownership interest in the oil and gas reserves. The Joint Venture has long-term supply agreements with Pertamina for the supply of gas and petroleum gas to be liquefied at a liquefaction plant owned by Pertamina at Bontang Bay (the LNG Plant) and sold to certain buyers pursuant to sales contracts. The Joint Venture, other participating production sharing contractors and Pertamina together market the LNG and the LPG produced at the LNG Plant and LPG facilities and, as to the amounts allocable to the PSC, the Joint Venture and Pertamina divide the net proceeds in accordance with the percentages set out above.\nPayment for LNG and LPG is made in U. S. dollars to a U. S. bank as trustee for Pertamina, the Joint Venture, other participating production sharing contractors and lenders that have provided funds to build the LNG Plant and the LPG facilities. The LNG Plant's processing costs, principal and interest payable on borrowings from such lenders, transportation costs, and certain other miscellaneous costs are deducted from the gross LNG and LPG sales proceeds. The remaining amount represents the net proceeds for gas delivered to the LNG Plant and is divided among Pertamina, the Joint Venture, and the other production sharing contractors in accordance with the terms of their respective agreements.\nExploration and Development\nFrom inception in 1972 up to and including December 31, 1993, the following wells were drilled in the East Kalimantan contract area:\nTotal Completed Field Wells Productive Dry Suspended Location Drilled Wells Holes Wells\nBadak 184 174 7 3 Nilam 154 154 - - Semberah 53 49 4 - Mutiara 44 37 6 1 Pamaguan 32 26 6 - Wailawi 6 6 - - Other 44 8 30 6\nTotals 517 454 53 10\nTwo significant fields, Badak and Nilam, have been discovered in the East Kalimantan area. The Badak field is in the northeast portion of the East Kalimantan contract area, and the Nilam field is located immediately south of the Badak field. Total Indonesie and Indonesia Petroleum, Ltd. (the Total Group), who are not parties to the Joint Venture but have interests in the Nilam and Badak fields, are parties to unitization agreements with the Joint Venture in both fields. All gas and condensate from the Badak and Nilam fields and all oil from the Nilam field, as well as all allowable costs incurred in connection therewith, are deemed attributable to the Joint Venture and the Total Group in the ratio of their respective participating interests under the Badak and Nilam unitization agreements. VICO acts as operator for the Joint Venture and the Total Group in both fields. See \"Business - The Joint Venture.\" The Joint Venture is also producing from four additional fields in the East Kalimantan area: Pamaguan, Mutiara, Semberah and Wailawi.\nThe tables below summarize completed exploratory and development drilling from 1991 through 1993 for the East Kalimantan contract area.\nEXPLORATORY DRILLING\nWells Dry Year Drilled Discoveries Holes\n1991 2 1 1 1992 2 0 2 1993 3 0 3\nTotals 7 1 6\nDEVELOPMENT OR FIELD EXTENSION DRILLING\nCompleted Wells For For For Dual Dry Year Drilled Gas Oil Oil & Gas Holes\n1991 37 30 3 4 - 1992 31 24 5 2 - 1993 31 25 1 3 2\nTotals 99 79 9 9 2\nOf 454 completed productive wells in the East Kalimantan contract area, approximately 250 contain more than one completion in the same bore hole.\nSix wells were in progress as of December 31, 1993. This includes wells that were drilled but not completed at the end of 1993. None of the suspended or \"in-progress\" wells are included in the tables above.\nThe Company's share of the costs of the above wells ranged from 18.53 percent to 23.125 percent.\nThe following table sets forth total gas liquefied and sold as LNG, the Company's net share of such production (calculated on a million cubic feet equivalency basis as described in Note b below), average sales prices (excluding transportation costs) and production (lifting) costs of such production for the years 1991 through 1993.\nYears ended December 31, (a) 1993 1992 1991 (Restated) Gas Production for LNG (MMCF) (b) 637,847 621,600 579,001\nCompany's Net Share (MMCF equivalency) (c) 80,873 77,264 78,598\nAverage Sales Price per MCF (d) $2.75 $2.92 $3.07\nAverage Production (Lifting) Cost per MCF $0.13 $0.14 $0.15\n(a) All amounts appearing in this table are for dry gas. The 1992 and 1991 amounts were previously reported on a wet gas basis and have been restated as dry gas.\n(b) Represents the volumes of LNG delivered and sold to purchasers which is measured by its British Thermal Unit (BTU) content and, for purposes of this table, has been converted to MMCF equivalents based on a ratio of approximately 3.0 billion cubic feet (BCF) of gas required at the plant to produce 2.9 trillion BTUs of LNG. The Gas Production for LNG includes production attributable to UNOCAL Indonesia Ltd., the Total Group and Pertamina. The term \"MMCF\" refers to 1,000,000 cubic feet of gas measured at 60 degrees Fahrenheit and 14.7 pounds per square inch of pressure.\n(c) The net share figures shown above have been calculated by dividing the Company's total LNG revenues for each year by the average price per MCF (in the form of LNG) received by Pertamina for the sale of LNG during such year. The result represents the MCF equivalent of the Company's LNG revenues.\n(d) The sales price is based on the average sales price (excluding transportation) per MMBTU of LNG received by Pertamina. The term \"MMBTU\" refers to 1,000,000 British Thermal Units. The sales price per MMBTU has been converted to a price per MCF based on the conversion ratio referred to in note (b) above. The term \"MCF\" refers to 1,000 cubic feet of gas measured at 60 degrees Fahrenheit and 14.7 pounds per square inch of pressure.\nThe Company's production costs are small in relation to its revenues because the Joint Venture's revenues under the LNG contracts are net of costs associated with transporting and converting the gas to LNG and shipping the LNG to the purchasers. The costs, which are considered to be production costs, are those costs incurred to operate and maintain wells and related equipment and facilities.\nDuring 1993, the Company's share of the Joint Venture's expenditures was approximately $59 million, including $5 million of exploration expenditures and $37 million of development expenditures. In 1994, the Company's share of the Joint Venture's expenditures is expected to total $56 million, including $3 million of exploration expenditures and $35 million of development expenditures. The 1994 budgeted expenditures primarily reflect continued development drilling required to maintain adequate gas deliverability.\nReserves\nThe Company files no reports which include estimates of oil or gas reserves with any federal agency other than the Securities and Exchange Commission.\nThe estimated proved reserves of gas and of oil and condensate as of December 31, 1990, 1991, 1992 and 1993 attributable to the Joint Venture's interest in the PSC in East Kalimantan were prepared by petroleum engineers employed by LASMO, an affiliate of Ultrastar. Gross proved field reserves are as follows:\nCrude Oil and Condensate Gas Total Proved Reserves (000's barrels) (Dry MMCFs)\nDec. 31, 1990 (Gas restated) 149,194 7,294,804 Dec. 31, 1991 (Gas restated) 135,712 7,615,739 Dec. 31, 1992 (Gas restated) 146,055 7,436,171 Dec. 31, 1993 203,068 7,187,995*\n* equivalent to approximately 6,966 trillion BTUs.\nThe Joint Venture, and thus the Company, has no ownership interest in oil and gas reserves but rather has the right to receive production and revenues from the sale of oil, condensate, gas, LNG and LPG in accordance with the PSC and other agreements.\nThe Company has revised its method of disclosing all proved and proved developed gas reserves from a wet gas basis to a dry gas basis. This change has been effected to conform to the reporting method used by the Company's partners. The Company's estimates of its net share of proved developed and undeveloped reserves, as of December 31 of each year since 1990, are included in the Supplemental Financial Information in Item 8.\nLNG Plant\nGas produced from the Joint Venture's interest in the PSC reserves is liquefied at the LNG Plant, which is owned by Pertamina and operated on a cost-reimbursement basis by a corporation in which the Joint Venture owns a 20 percent interest. The LNG Plant currently consists of six processing units (trains) having a combined input capacity at year-end 1993 of approximately 2.6 billion cubic feet of gas per operating day and a production capacity of approximately 626,000 barrels or 99,500 cubic meters of LNG and 28,000 barrels of condensate per day. The five storage tanks at the LNG Plant have a total capacity of 3.2 million barrels of LNG. Gas is supplied to the plant through three pipelines (two 36 inch and one 42 inch) which are connected to the central gas facilities at the Badak field, 35 miles south of the LNG Plant.\nThe LNG Plant has been developed in four phases. The original facility, which consisted of two trains (Trains A and B) and a dock, was constructed with financing arranged by Pertamina with the Central Bank of the Republic of Indonesia, a consortium of Japanese banks and a corporation owned substantially by the Japanese LNG purchasers, and became fully operational in August 1977. Final payment on the loans was made in the first quarter of 1990.\nExpansion of the LNG Plant from two to four trains (Trains C and D) was completed in 1983. Funding was arranged by Pertamina with Japan Indonesia LNG Co., Ltd. (JILCO). Final payment on this financing arrangement was made in the third quarter of 1993.\nA fifth processing train (Train E) was completed in 1989 and supplies LNG required for the Taiwan LNG Sales Contract with the Chinese Petroleum Corporation (CPC), the state petroleum enterprise of the Republic of China (Taiwan). Project financing was arranged through a trustee borrowing with a consortium of Japanese banks and is supported by revenues from such sales contract, as well as in certain limited circumstances by portions of other revenue streams. The financing contains two tranches, with tranche A totalling $176.4 million at a fixed interest rate of 11.5 percent, and tranche B totalling $117.6 million at a floating interest rate initially of LIBOR plus 1 percent. The financing is repayable in graduated quarterly payments over ten years that began in the fourth quarter of 1990.\nThe sixth processing train (Train F) was completed in November 1993 and will supply the LNG required for the LNG sales contract signed in October 1990 with Osaka Gas, Tokyo Gas and Toho Gas (the Buyers) for the sale of 2,020 trillion BTUs over a twenty-year period commencing in 1994. In August 1991, Pertamina and an international consortium of commercial banks completed project financing of $750 million to fund the construction of Train F and related support facilities at an interest rate of LIBOR plus 1.25 percent. Financial support for the financing is limited to revenues from such sales contract. The financing is repayable over ten years in graduated quarterly payments commencing in December 1994. Only $699 million of the $750 million project financing will be required to complete the construction of Train F and its related support facilities.\nAs a result of the production performance of Train E, Pertamina had undertaken modifications to Trains A through D known as \"debottlenecking.\" Trains C and D were modified in 1992 during regularly scheduled maintenance shutdowns. Likewise, Trains A and B were modified in 1993 during regularly scheduled maintenance shutdowns. Capacity tests on all four trains exceeded design rates such that Trains A through D are now capable of LNG production rates comparable to the most recently completed Train F, an increase of 14 percent, or 22 cargoes in total. The total cost of the Trains A through D debottlenecking project amounted to $79 million. These costs were funded through Package IV revenues (See description of Package IV beginning on page 15).\nWith the completion of Train F and the debottlenecking project, the expanded six train plant is expected to have the capacity to deliver 275 cargoes per year.\nLPG Facilities and Second Dock\nThe LPG processing facilities at the LNG Plant were constructed concurrently with the fifth processing train. The LPG facilities were completed in 1988, at a cost of approximately $158 million. Financing was made available to Pertamina through a consortium of Japanese banks. A significant portion of the LPG sales proceeds is dedicated to the financing, which is repayable through 1999.\nA second dock facility at the LNG Plant is used for both LNG and LPG deliveries. The portion of the second dock costs attributable to the LPG trade was financed through the same consortium of Japanese banks that financed the LPG processing facilities at the LNG Plant. Financing for the LNG portion of the second dock was provided by a trustee borrowing from Japanese banks.\nThe table below sets forth information regarding the status of the project financings incurred or arranged by Pertamina to construct the LNG Plant:\nOriginal Principal\/ Balance at Final Primary Payment December 31, Payment Source of Financing Amount 1993 Date Repayment (000's) (000's)\nTrains A&B and 1st Loading Dock $771,500 $ - - 1973 LNG Sales Contract\nTrains C & D 995,800 - - 1981 LNG Sales Contract\nTrain E 294,000 217,560 2000 Taiwan LNG Sales Contract Train F and Support Facilities (a) 750,000 633,000 2004 Train F LNG Sales Contract\nMisc. Capital Projects 42,700 - - 1973 LNG Sales Contract (b) 2nd Loading Dock & Train E Support Facilities 135,000 48,600 1995 1973 LNG Sales Contract (b)\nLPG Facilities 157,700 91,640 1999 LPG Sales Contract\n(a) Total financing required is not expected to exceed $699 million.\n(b) Debt service is allocated among all of the gas producers according to the quantity of gas delivered.\nMarketing and Distribution of LNG\nCertain information regarding deliveries of LNG from the LNG Plant is set forth below:\nBTUs Average Number of LNG in Trillions Price Per Tanker Liftings (Approximate) MMBTU\n1991 . . . . . 197 564 $3.16 1992 . . . . . 211 606 $3.00 1993 . . . . . 216 621 $2.82\nAs a result of variations in LNG tanker capacity among the various sales contracts, the measure of a net equivalent cargo has been established. One net equivalent cargo equates to the quantity of LNG delivered in a 1973 Sales Contract shipment or an average of 2,942 BBTUs.\nThe following table sets forth information regarding the LNG Plant share of the LNG Sales Contracts grouped together by the Joint Venture's participating percentages in the sales contracts (each such group being referred to as a \"package\"):\nCommencing in 1994, LNG is primarily sold under five long- term sales contracts between Pertamina and buyers in Japan, Taiwan and Korea. These contracts are the 1973 LNG Sales Contract (Package I), the 1981 LNG Sales Contract (Package II), the Taiwan LNG Sales Contract (included in Package IIIB), the Train F LNG Sales Contract and the Korea II LNG Sales Contract (both included in Package IV). The gas processed by the LNG Plant is supplied from the Joint Venture's contract area as well as other fields in which the Joint Venture has no interest.\nLNG sales contracts and amendments thereto are executed between Pertamina and the buyers for the sale and delivery of a fixed quantity of BTUs of LNG at a price that reflects an LNG element derived from a basket of Indonesian crude oil prices that is recalculated monthly. A transportation charge is added to the LNG element under all contracts except for Package II where the buyers bear the risk of loss and the transportation costs. In those instances when the seller bears the risk of loss during shipment, the cargoes are insured. The buyers also bear the risk of loss and transportation costs for cargoes under the Train F LNG Sales Contract (included in Package IV), which commenced deliveries in early 1994.\nThe LNG to be delivered under the sales contracts is supplied from the LNG Plant and from a separate facility at Arun in Sumatra (Arun Plant). The Joint Venture does not supply gas to the Arun Plant or have any interest in revenues from the sale of its product. The allocation of contract quantities between the LNG Plant and the Arun Plant is determined by Pertamina. Presently, all deliveries under the 1981 LNG Sales Contract (Package II), the Taiwan LNG Sales Contract (included in Package IIIB) and the Train F LNG Sales Contract (included in Package IV) are exclusively supplied by the LNG Plant.\nThe Joint Venture and other gas producers in this area have the opportunity to participate in each sales package. The Joint Venture's equity interest in a sales package is based on its share of gas reserves available for commitment to the package and represents the percentage of gross revenues attributable to the Joint Venture before deducting plant operating costs and debt service.\nIn January of 1990, certain of the buyers under the 1973 Sales Contract agreed to increase their purchased commitments during the years 1997 through 1999 by approximately 667 trillion BTUs. The LNG Plant will provide 67.1 percent of the additional quantities and the Arun Plant the remainder. The Joint Venture's participation percentage for these quantities was finalized at 27.2064 percent in early January of 1994 after agreement with Pertamina and the East Kalimantan producers.\nIn October of 1990, Pertamina signed an LNG sales contract with Osaka Gas, Tokyo Gas, and Toho Gas (Train F LNG Sales Contract) for the sale of at least 2,020 trillion BTUs over a twenty-year period commencing in January 1994.\nIn May of 1991, Pertamina signed an LNG sales contract with Korea Gas Corporation for the sale of at least 2,044 trillion BTUs over a twenty-year period commencing in July 1994, at a price similar to the LNG element of the 1973 LNG Sales Contract. The LNG Plant will provide 50 percent and the Arun Plant 50 percent of the LNG requirements for the contract. In August of 1991, Pertamina signed a contract with Tokyo Gas for delivery of six cargoes from the LNG Plant over two years commencing in 1992. Three of the six cargoes were delivered in 1992 and the remaining three were delivered in 1993. The contract price is similar to the 1973 LNG Sales Contract price. The Joint Venture's participation percentage for these contracts was finalized at 27.2064 percent in early January of 1994 after agreement with Pertamina and the East Kalimantan producers.\nIn October and November of 1991, Pertamina signed agreements with Osaka Gas and Toho Gas to increase deliveries in 1992 and 1993 by 69 cargoes, of which 51 cargoes would be shipped from the LNG Plant. Of the cargoes to be supplied by the LNG Plant, 25 were shipped in 1992 and the remaining 26 were shipped in 1993. These contracts were split between Package III and Package IV sharing percentages.\nIn December of 1991, Pertamina entered into an LNG sales contract with several Japanese buyers (the Medium City Gas Companies) for the sale of 358 trillion BTUs over a twenty-year period commencing in 1996. The LNG Plant will provide 50 percent of the LNG requirements for the contract. The Joint Venture's participation percentage for this contract was finalized at 27.2064 percent in early January of 1994 after agreement with Pertamina and the East Kalimantan producers.\nAs a result of the sales agreements entered into by Pertamina and expected spot sales, the Company anticipates that the Joint Venture will ship approximately 135 net equivalent cargoes in 1994.\nOther Gas Sales - The Joint Venture is also obligated to supply approximately 74 MMCF per day of gas to three local fertilizer plants at a price of $1.00 per MMBTU subject to a pipeline tariff. In addition, the Joint Venture is required to supply approximately 5 MMCF per day of gas to the Balikpapan refinery at a price of $1.49 per MMBTU.\nMarketing and Distribution of LPG\nPertamina has individual sales contracts with seven Japanese utility companies for the sale and delivery of 1,950,000 metric tons per year of LPG through the year 1998, of which 315,000 metric tons, subject to Pertamina's right to increase or decrease such amount, will be produced by the LPG facilities at the LNG Plant. In 1993, 23 cargoes, including spot sales, totaling 453,000 metric tons were shipped to Japan. The first 285,000 metric tons of LPG sold under the contract were sold at the weighted average price for all LPG imported into Japan, except Indonesia and Abu Dhabi, plus $3 per ton. The next 168,000 metric tons of LPG were sold at the aforementioned price plus a premium of $20 to $22 per metric ton. The LPG is extracted from the LNG stream and stored at facilities at the LNG Plant. Based on dedicated reserves, the Joint Venture is allocated 29.6 percent of the revenues from the first 385,000 metric tons sold and 27.2 percent for sales in excess of 385,000 metric tons per year, after deducting LPG-related operating costs and debt service.\nMarketing of Oil and Condensate\nEach party to the Joint Venture and Pertamina are entitled to take their respective shares of oil and condensate in kind and to market such shares separately. The Company, through affiliates of Ultrastar and Unistar, markets its share of oil and condensate f.o.b. Santan Terminal, in East Kalimantan, independently of Pertamina and the other Joint Venture participants. The Santan Terminal (operated by UNOCAL Indonesia Ltd.) is used for storing and loading oil produced by the Joint Venture.\nThe Company's percentage share of the Joint Venture's oil and condensate, except for that sold to Pertamina for Indonesian domestic consumption, is sold at ICP. Prior to July 1, 1993, the price for crude and condensate sales reflected world market conditions at the time of sale. The sales price for the domestic market consumption is $0.20 per barrel with respect to fields commencing production prior to February 23, 1989. For fields commencing production after that date, domestic market consumption is priced at 10 percent of the weighted average price of crude oil sold from such fields. However, for the first sixty consecutive months of production from new fields, domestic market consumption is priced at ICP.\nSubstantially all of the oil and condensate currently being produced by the Joint Venture from the PSC contract area is being produced from the Badak, Nilam, Mutiara and Semberah fields. The Company's average sales prices and production (lifting) costs for 1991 through 1993 are:\nYears ended December 31, 1993 1992 1991\nTotal Oil and Condensate Sales (barrels) (a) 20,905,232 18,633,441 15,089,945\nCompany's Net Share (barrel equivalency) (a) 1,928,005 1,804,511 1,337,349\nAverage Sale Price - f.o.b. Indonesia (per barrel) (b) $18.31 $20.65 $20.59\nAverage Production (Lifting) Cost (per barrel) $0.77 $ 0.80 $ 0.84\n(a) The total oil and condensate sales include production attributable to other contractors' shares of unitized operations in the Badak and Nilam fields. See \"Exploration and Development.\" The net share figures shown above have been calculated by dividing the Company's total oil revenues for each year by the average price per barrel received for sale of oil during such year. The result represents the barrel equivalent of the Company's oil revenues.\n(b) Excludes domestic consumption sales. Also excluded are gains or losses incurred on the sale of the Company's share of oil, which resulted in marketing gains\/(losses) of $(0.32), $(0.02) and $0.07 per barrel in 1993, 1992 and 1991, respectively. Effective July 1, 1993, the Company is no longer exposed to marketing gains\/(losses) incurred on the sale of its share of oil and condensate.\nThe Joint Venture's sales of oil and condensate averaged approximately 48,600 barrels per day (BOPD) during 1993, compared to approximately 42,700 BOPD during 1992.\nCompetition and Risks\nIndonesian oil competes in the world market with oil produced from other nations. Indonesia is a member of OPEC, and any OPEC-imposed restrictions on oil or LNG exports in which Indonesia participates could have a material adverse effect on the Company.\nIn addition to the LNG being sold from the Arun Plant, LNG plants in the Middle East, Australia, Malaysia, or elsewhere may provide competition for sales of any additional Joint Venture LNG to Japanese and other markets, beyond the amount under current contracts.\nThe Joint Venture's activities in Indonesia are subject to risks common to foreign operations in the oil and gas industry, including political and economic uncertainties, the risks of cancellation or unilateral modification of contract rights, operating restrictions, currency repatriation restrictions, expropriation, export restrictions, increased taxes and other risks arising out of foreign governmental sovereignty over areas in which the Joint Venture's operations are conducted. The Company's foreign operations and investment may also be subject to the laws and policies of the U. S. affecting foreign trade, investment and taxation that could affect the conduct and profitability of those operations.\nAll of the Company's oil and gas activities are subject to the risks normally incident to exploration for and production of oil and gas, including blowouts, cratering and fires, each of which could result in damage to life and property. Production from the LNG Plant, which is the source of most of the Company's revenues, is subject to the risks associated with maintaining and operating a complex, technologically intensive processing plant, including the risks of equipment failures, fire and explosion. To the extent that the seller of the LNG produced by the LNG Plant bears the risk of loss of cargoes, the seller is subject to the usual risks of maritime transportation, including adverse incidents arising from loading and unloading cargoes. In accordance with customary industry practices, the Company carries insurance against some, but not all, of these risks. Losses and liabilities arising from such events would reduce revenues and increase costs of the Company to the extent not covered by insurance.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSee Item 1. Business.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company has pending litigation arising in the ordinary course of its business. However, none of the litigation is expected to have a material adverse effect on the Company's financial position or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Shareholder Matters\nRefer to Item 12 for a description of the Registrant's Equity.\nRefer to Item 1 for a description of the Indonesian Participating Units.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following financial data was derived from the audited consolidated financial statements of the Company and should be read in conjunction with the consolidated financial statements and related notes included elsewhere herein.\n1993 1992 1991 1990 1989 (millions of dollars)\nOperating revenues $201 $206 $208 $203 $146\nEarnings (loss) from continuing operations 30 24 18 7 (15)\nNet earnings 30 24 18 11 11\nTotal assets 449 472 500 519 608\nDebt and security subject to mandatory redemption 33 32 31 50 111\nSee Note 2(e) to Notes to Consolidated Financial Statements.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nCash flow from operations amounted to $81.5 million in 1993, compared to 1992 cash flow of $93.4 million. Capital expenditures of $40.1 million were primarily spent on continued development drilling in the Badak, Nilam, Mutiara and Semberah fields as was the case in 1992. Net capital distributions in 1993 to the partners from the Company were $41.1 million (1992, $58.2 million).\nOn January 5, 1994, the Company redeemed its 8-1\/4 percent convertible subordinated guaranteed debentures, originally due in 1995, in the amount of $36.4 million at a loss of $3.1 million. The redemption was funded through contributions from the partners of the Company.\nThe Company's ability to generate cash is primarily dependent on the prices it receives for the sale of LNG, and to a lesser extent, the sale of crude oil and LPG. In the event cash generated from operations is not sufficient to meet capital investment and other requirements, any shortfall will be funded through additional cash contributions by the partners. The Company cannot predict with any degree of certainty the prices it will receive in 1994 and future years for its crude oil and LNG. The Company's financial condition, operating results and liquidity will be materially affected by any significant fluctuations in sales prices.\nLNG sales are made under five principal long-term contracts and several short- and medium-term contracts with Japanese, Korean and Taiwanese industrial and utility companies. Sales pursuant to the fourth long-term contract (Train F LNG Sales Contract) commenced in the first quarter of 1994; sales under the fifth long- term contract will commence in July 1994. The long- term contracts contain take-or-pay provisions that generally require that the purchasers either take the contracted quantities or pay for such quantities if not taken; such provisions tend to support the Company's ability to generate cash. During 1993, 127 net equivalent cargoes were shipped, of which 107 were under these long-term contracts. In 1994, the Company anticipates shipping approximately 135 net equivalent cargoes.\nThe sixth processing train (Train F) was completed in November 1993 and will supply the LNG required for the fourth long-term LNG sales contract signed in October 1990 with Osaka Gas, Tokyo Gas and Toho Gas for the sale of at least 2,020 trillion BTUs over a twenty-year period commencing in 1994.\nIn January of 1990, certain of the buyers under the 1973 Sales Contract agreed to increase their purchased commitments during the years 1997 through 1999 by approximately 667 trillion BTUs. The LNG Plant will provide 67.1 percent of the additional quantities and the Arun Plant the remainder.\nIn May of 1991, Pertamina signed an LNG sales contract with Korea Gas Corporation for the sale of at least 2,044 trillion BTUs over a twenty-year period commencing in July 1994, at a price similar to the LNG element of the 1973 LNG Sales Contract. The LNG Plant will provide 50 percent and the Arun Plant 50 percent of the LNG requirements for the contract.\nIn December of 1991, Pertamina entered into an LNG sales contract with several Japanese buyers (the Medium City Gas Companies) for the sale of 358 trillion BTUs over a twenty-year period commencing in 1996. The LNG Plant will provide 50 percent of the LNG requirements for the contract.\nThe debottlenecking of Trains A through D was completed in 1993. Capacity tests on all four trains exceeded design rates such that the four trains are now capable of LNG production rates comparable to the recently completed Train F, an increase of 14 percent or 22 cargoes in total.\nThe Company's operating and capital expenditures are directed toward the Joint Venture. Capital expenditures of the Joint Venture relate to the exploration and development of the oil and gas fields. In 1994, the Company's share of the Joint Venture expenditures is expected to total $56 million, including $3 million of exploration expenditures and $35 million of development expenditures. The 1994 budgeted expenditures primarily reflect continued development drilling required to maintain gas deliverability.\nThe Company can give no assurance as to the future trend of its business and earnings, or as to future events and developments that could affect the Company in particular or the oil industry in general. These include such matters as environmental quality control standards, new discoveries of hydrocarbons and the demand for petroleum products. Furthermore, the Company's business could be profoundly affected by future events including price changes or controls, payment delays, increased expenditures, legislation and regulations affecting the Company's business, expropriation of assets, renegotiation of contracts with foreign governments, political instability, currency exchange and repatriation losses, taxes, litigation, the competitive environment and international economic and political developments including actions of members of the Organization of Petroleum Exporting Countries (OPEC).\nThe Company's revenues are predominately based on the market price of crude oil, which is denominated in U. S. dollars. Certain operating costs, taxes and capital costs represent commitments settled in foreign currency. Currency exchange rate fluctuations on transactions in currencies other than U. S. dollars are recognized as adjustments to the U. S. dollar cost of the transaction.\nThe Company is unaware of any unrecorded environmental claims as at December 31, 1993 which would have a material impact upon the Company's financial condition or operations.\nResults of Operations\n1993 Compared to 1992\nNet earnings for the year 1993 were $30.5 million as compared to $23.7 million in 1992. Cash flow from operations for 1993 was $81.5 million (1992, $93.4 million).\nOil and gas production revenues for 1993 were $200.6 million, or lower by $5.3 million when compared to 1992 revenues of $205.9 million. The increase in the Joint Venture's share of delivered LNG sales volumes was not sufficient to offset a decline in the average LNG sales price. The quantity of LNG delivered from the LNG Plant was 621 trillion BTU's (216 cargoes) in 1993 as compared to 606 trillion BTU's (211 cargoes) in 1992. The Joint Venture's interest in the LNG delivered was 369 trillion BTU's (127 net equivalent cargoes) in 1993 as compared to 363 trillion BTU's (124 net equivalent cargoes) in 1992. The average LNG sales price, excluding transportation charges, declined to $2.82 per million BTU's in 1993 as compared to $3.00 per million BTU's in 1992. Crude oil sales volumes of 1.93 million barrels were higher by 7 percent in 1993 as compared to 1992's 1.8 million barrels, while the average crude oil realized sales price of $17.99 per barrel was lower than 1992 by $2.64 per barrel.\nProduction costs of $18.8 million were lower than 1992 costs by about $6.8 million. This improvement in production costs was caused by a provision included in 1992 related to the Company's prior years' windfall profits tax liability. After a re- evaluation of the ultimate exposure on this tax liability, the Company has reversed $3.5 million as being no longer required. At the same time, the Company has provided an offsetting amount for the potential exposure in a royalty dispute.\nDepletion , depreciation and amortization of $52.7 million was lower than 1992 by $4.6 million primarily as a result of a lower depletion rate associated with the increase in proved reserves that more than offset the higher level of LNG volumes delivered.\nExploration costs, including dry holes, of $4.9 million were lower than 1992 by $4.2 million due to a lower level of seismic and dry hole costs.\nGeneral and administrative expenses of $1.8 million were $1.0 million lower than last year's $2.8 million due to the absence of certain non-recurring charges. Both interest expense and interest income were in line with last year's results. Other income in 1992 included a non-recurring benefit due to the favorable disposition of a legal action.\nThe effective tax rates for 1993 and 1992 were 74 percent and 78 percent respectively. These rates were the aggregate of Indonesian source income taxed at a 56 percent rate, and certain expenses attributable to the Unimar activities which are not deductible in the partnership.\n1992 Compared to 1991\nNet earnings for 1992 were $23.7 million as compared to $18.3 million in 1991. Revenues of $205.9 million in 1992 were lower by $1.9 million when compared to last year as an increase in the Joint Venture's share of delivered LNG volumes was not sufficient to offset a decline in the average LNG price. The quantity of LNG delivered from the LNG Plant increased to 606 trillion BTUs (211 cargoes) in 1992 from 564 trillion BTUs (197 cargoes) in 1991. The Joint Venture's interest in the LNG delivered was 363 trillion BTUs (126 net equivalent cargoes) in 1992 as compared to 354 trillion BTUs (123 net equivalent cargoes) in 1991. The average unit LNG price, excluding delivery charges, declined to $3.00 per million BTUs in 1992 from $3.16 per million BTUs in 1991. The average realized crude oil price decreased slightly to $20.63 per barrel in 1992 from $20.64 per barrel in 1991, while crude oil sales volumes increased 36 percent to 1.8 million barrels.\nProduction costs of $25.6 million increased $5.0 million and included an amount related to a proposed adjustment by the U. S. federal tax authorities relating to the Company's prior years' windfall profit tax liability.\nDepletion, depreciation and amortization of $57.3 million declined $4.2 million principally as a result of a lower depletion rate associated with an increase in proved developed reserves that more than offset the impact of the higher level of volumes delivered.\nExploration costs of $9.1 million decreased $0.6 million over last year's costs.\nGeneral and administrative expenses of $2.8 million were $0.3 million lower than last year's level. Interest expense of $4.7 million declined $5.0 million primarily as a result of the payoff of an Indonesian Production Payment bank loan in 1991. Interest income of $0.6 million was $0.7 million lower than 1991 primarily as a result of declining interest rates on short-term deposits.\nOther income of $1.2 million in 1992 principally represented the reversal of a provision due to a favorable disposition of certain legal action. In 1991, other (expense) of $0.9 million was mainly a provision for residual domestic operations costs.\nThe effective tax rates relating to continuing operations for the 1992 and 1991 periods were 78 percent and 82 percent respectively. These rates were the aggregate of Indonesian source income taxed at a 56 percent rate and certain expenses attributable to Unimar activities not deductible in the partnership. The decrease in the effective rate is principally the result of decreased non-deductible interest expense.\nIn 1992, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 109, \"Accounting for Income Taxes\". The effect of adopting Statement 109 was to decrease net income by $0.3 million and $2.6 million for the years ended December 31, 1991 and 1990 respectively. Refer to Note 2(e) of the Notes to Consolidated Financial Statements for further discussion of the effects of this adoption.\nIn 1992, the Company adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The effect of adopting the new rules did not significantly impact the Company's profits. Postretirement benefit costs for 1991 and 1990, which were recorded on a cash basis, have not been restated.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT AUDITORS\nTo The Partners of Unimar Company\nWe have audited the accompanying consolidated balance sheets of Unimar Company and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings, cash flows and partners' capital for each of the three years in the period ending December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs more fully described in the notes to the consolidated financial statements, the Company has material transactions with its partners and affiliates.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Unimar Company and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nHouston, Texas February 28, 1994\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe management, budgeting and financial control of the Company's interest in the Indonesian Joint Venture operations are exercised by a Management Board consisting of six members, three appointed by each partner. The following persons currently serve as members of the Company's Management Board:\nGEORGE W. BERKO (age 47) was appointed to the Company's Management Board in May 1992. Since May 1992, he has served as the Partners' representative for Investor Relations, Treasurer and Chief Financial and Accounting Officer of ENSTAR, ENSTAR Indonesia, Inc., INTERNATIONAL, and certain of their subsidiaries, and has been LASMO America Ltd.'s Vice President - Unimar Accounting. From October 1990 until April 1992, he was Vice President, Controller of Ultramar Oil and Gas Limited, and prior to that time, he was a General Manager of American Ultramar Ltd. from December 1984.\nIAN D. BROWN (age 44) was appointed to the Company's Management Board in February 1993. He is also Director and Chairman of ENSTAR and certain of its affiliates. In January 1994 he was appointed President and General Manager of LASMO Companies in Indonesia. In January 1993, he was appointed Director, Indonesian Joint Venture for LASMO plc and a member of the VICO Board. Since May 1986, he served as Commercial Manager for LASMO plc, and from February 1987, Managing Director, LASMO Trading Limited, the marketing, trading and transportation affiliates of the parent company.\nLARRY D. KALMBACH (age 42) was appointed to the Company's Management Board in February 1993. Since February 1, 1993, he has been Vice President-Finance of UTPH after serving as Vice President and Controller of UTPH since September 1986. Prior to that time, he held various financial management positions with UTPH since 1974.\nWILLIAM M. KRIPS (age 54) was appointed to the Company's Management Board in January 1987. He is also a Director of ENSTAR and certain of its affiliates. Since December 1991, he has been Senior Vice President Exploration & Production of UTPH. Prior to that time, he served as Senior Vice President and General Manager - U. S. Exploration and Production, Senior Vice President and General Manager - Hydrocarbon Products Group and Vice President and General Manager - International Operations.\nARTHUR W. PEABODY (age 50) was appointed to the Company's Management Board in February 1992 and in April 1993 was appointed Chairman of the Management Board. He is also a Director of ENSTAR, ENSTAR Indonesia, Inc., INTERNATIONAL and VICO. Since February 1992, he has been Senior Vice President - Exploration and Production of UTPH, and prior to that time, he held various positions at UTPH including Senior Vice President and General Manager - Hydrocarbon Products Group, Vice President - Planning and Administration and Vice President - Acquisitions and Planning.\nJERRY L. PICKERILL (age 56) was appointed to the Company's Management Board in June 1992 and also serves as a Director of ENSTAR Corporation. Since February of 1989, he has served as President of LASMO Energy Corporation and is currently President and Director of LASMO America Limited, the holding company for the LASMO U. S. subsidiaries. He previously served as Vice President and General Counsel for CNG Producing Company, Tulsa Division, Vice President and General Counsel of Mapco Oil & Gas, Inc., and an attorney for Amerada Hess Corporation.\nAs set forth above, control of the Company's operations is exercised by the Management Board. The Company, a Texas general partnership, does not have any Executive Officers.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe Company has no executive officers, and no members of the Management Board are paid directly by the Company. All members of the Management Board are full-time employees of UTPH or LASMO, or their respective subsidiaries, and do not receive from the Company any remuneration for their services to the Company. Moreover, the Company has no employees who are compensated for their services to the Company. VICO, a subsidiary of the Company, has employees who are responsible for the daily operating activities of the Joint Venture and are compensated by the Joint Venture. See Item 13 below for information concerning the Company's reimbursement to LASMO for services rendered to the Company by one of LASMO's designees on the Management Board.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe Company is a Texas general partnership and as such has no voting securities apart from the general partnership interests owned by the partners. The table below reflects the beneficial ownership of 100 percent of the partnership interests in the Company as of March 15, 1994:\nName and Address of Amount Beneficially Title of Class Beneficial Owner Owned\nGeneral Partnership LASMO plc 50% Interest 100 Liverpool Street London EC2M 2BB England\nName and Address of Amount Beneficially Title of Class Beneficial Owner Owned\nGeneral Partnership Union Texas Petroleum 50% Interest Holdings, Inc. 1330 Post Oak Boulevard Houston, Texas 77252\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe partners of the Company provide management expertise, office space, and administrative, legal and professional services. For such services, a management fee of approximately $508 and $600 was charged in 1993 and 1992, respectively, including $138 ($96 in 1992) paid in respect of Mr. Berko's services.\nThe Company holds demand notes in the amount of $40 million from or generated by affiliates of each partner. These funds will be made available to the Company if additional working capital is required.\nAs operator of the Joint Venture, VICO conducts exploration and development activities within the PSC area. The cost of such activities is funded by the Joint Venture participants to VICO. In addition, VICO performs services for the operator of the LNG Plant, P.T. Badak Natural Gas Liquefaction Company (P.T. Badak). For the year ended December 31, 1993, VICO charged P.T. Badak approximately $32 million ($41 million in 1992) for engineering services and costs incurred on P.T. Badak's behalf. Also, during 1993 VICO billed P.T. Badak approximately $1.5 million ($1.8 million in 1992) principally for field pipeline maintenance services. Accounts receivable from P.T. Badak approximated $3.3 million at December 31, 1993 ($3.0 million at December 31, 1992).\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a)(1) Financial Statements listed below are included as Part II, Item 8 hereof on the pages indicated:\nReport of Independent Auditors 25\nConsolidated Balance Sheet, December 31, 1993 and 1992 26\nConsolidated Statement of Earnings, Years ended December 31, 1993, 1992 and 1991 27\nConsolidated Statement of Cash Flows, Years ended December 31, 1993, 1992 and 1991 28\nConsolidated Statement of Changes in Partners' Capital, Years ended December 31, 1993, 1992 and 1991 29\nNotes to Consolidated Financial Statements 30-44\nSupplemental Financial Information (unaudited) 45-51\n(2) Financial Statement Schedules listed below are filed as a part hereof on the pages indicated:\nV - Property, Plant and Equipment 52\nVI - Accumulated Depreciation and Depletion of Property, Plant and Equipment 53\nAll other schedules are omitted as they are not required or are not applicable.\n(a)(3) The following documents are included as Exhibits to this Report. Unless it has been indicated that a document listed below is incorporated by reference herein, copies of the document have been filed herewith.\n(2)-1- Merger Agreement, dated May 22, 1984, and Amendment Agreements thereto, dated June 8, 1984 and June 12, 1984 (incorporated by reference to Annex A to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-2- Agreement of Merger, dated as of August 28, 1984 (incorporated by reference to Annex B to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-3- Divestiture Agreement, dated June 20, 1984 (filed as Exhibit 2.3 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(3)-1- Amended and Restated Agreement of General Partnership of Unimar Company dated September 11, 1990 between Unistar, Inc. and Ultrastar, Inc. (filed as Exhibit (3)-4- to the Company's 1990 Form 10-K (No. 18791)).*\n(4)-1- Form of Indenture between Unimar and Irving Trust Company, as Trustee (filed as Exhibit 4 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(4)-2- First Supplemental Indenture, dated as of October 31, 1986, to the Indenture between Unimar and Irving Trust Co., as Trustee (Exhibit (4)-1 above) (Filed as Exhibit 10.114 to Union Texas Petroleum Holdings, Inc.'s Registration Statement on Form S-1 (No. 33-16267)).*\n(10)-1- Joint Venture Agreement, dated August 8, 1968, among Roy M. Huffington, Inc., Virginia International Company, Austral Petroleum Gas Corporation, Golden Eagle Indonesia, Limited, and Union Texas Far East Corporation, as amended (filed as Exhibit 6.6 to Registration Statement No. 2- 58834 of Alaska Interstate Company).*\n(10)-2- Agreement dated as of October 1, 1979, among the parties to the Joint Venture Agreement referred to in Exhibit (10)-1- above (filed as Exhibit 5.2 to Registration Statement No. 2-66661 of Alaska Interstate Company).*\n* Incorporated herein by reference.\n(10)-3- Amendment to the Operating Agreement dated April 1, 1990, between Roy M. Huffington, Inc., a Delaware corporation, Ultramar Indonesia Limited, a Bermuda corporation, Virginia Indonesia Company, a Delaware corporation, Virginia International Company, a Delaware corporation, Union Texas East Kalimantan Limited, a Bahamian corporation, and Universe Gas & Oil Company, Inc., a Liberian corporation.\n(10)-4- Amended and Restated Production Sharing Contract dated April 23, 1990 (effective August 8, 1968 - August 7, 1998) by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation.\n(10)-5- Production Sharing Contract dated April 23, 1990 (effective August 8, 1998 - August 7, 2018) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation.\n(10)-6- Nilam Unit Agreement, effective as of January 1, 1980, to establish the manner in which the Joint Venture and Total will cooperate to develop the unitized area of the Nilam Field (filed as Exhibit (10)-58- to the Company's 1991 Form 10-K (No. 1- 8791)).*\n(10)-7- Third Amended and Restated Implementation Procedures for Crude Oil Liftings, effective as of July 1, 1993, among Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n(10)-8- Amended and Restated 1973 LNG Sales Contract, dated as of the 1st day of January 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n* Incorporated herein by reference.\n(10)-9- Amendment to the 1973 LNG Sales Contract dated as of the 3rd day of December, 1973, amended by Amendment No. 1 dated as of the 31st day of August, 1976, and amended and restated as of the 1st day of January, 1990 (\"1973 LNG Sales Contract\"), is entered into as of the 1st day of June, 1992, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, a state enterprise of the Republic of Indonesia (Seller), on the one hand, and Kyushu Electric Power Co., Inc. (Kyushu Electric), Nippon Steel Corporation (Nippon Steel), and Toho Gas Co., Ltd. (Toho Gas), all corporations organized and existing under the laws of Japan, on the other hand.\n(10)-10- Amended and Restated Supply Agreement (In Support of the Amended and Restated 1973 LNG Sales Contract) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective December 3, 1973.\n(10)-11- Amended and Restated Badak LNG Sales Contract, dated as of the 1st day of January, 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n(10)-12- Supply Agreement, dated as of April 14, 1981 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement, including the Company.\n(10)-13- Seventh Supply Agreement for Excess Sales (Additional Fixed Quantities under Badak LNG Sales Contract as a Result of Contract Amendment and Restatement) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company, dated September 28, 1992, but effective as of January 1, 1990.\n* Incorporated herein by reference.\n(10)-14- Bontang II Trustee and Paying Agent Agreement Amended and Restated as of July 15, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Virginia International Company, Union Texas East Kalimantan Limited, Ultramar Indonesia Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International.\n(10)-15- Producers Agreement No. 2 dated as of June 9, 1987 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation in favor of The Industrial Bank of Japan Trust Company as Agent (filed as Exhibit (10)-30- to the Company's 1987 Form 10-K (No. 1-8791)).*\n(10)-16- Badak III LNG Sales Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Chinese Petroleum Corporation as Buyer signed on March 19, 1987 (filed as Exhibit (10)-59- to the Company's 1991 Form 10-K (No. 1- 8791)).*\n(10)-17- Badak III LNG Sales Contract Supply Agreement, dated October 19, 1987 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n(10)-18- LNG Sales and Purchase Contract (Korea II) effective May 7, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation.\n(10)-19- Schedule A to the LNG Sales and Purchase Contract (Korea II FOB) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation.\n(10)-20- Bontang III Producers Agreement, dated February 9, 1988, among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n* Incorporated herein by reference.\n(10)-21- Amendment No. 1 to Bontang III Producers Agreement dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Train-E Finance Co., Ltd., as Tranche A Lender, The Industrial Bank of Japan Trust Company, as Agent and The Industrial Bank of Japan Trust Company on behalf of the Tranche B Lenders.\n(10)-22- Amendment No. 2 to Producers Agreement No. 2 dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited and Universe Tankships, Inc. (filed as Exhibit (10)-44- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-23- $316,000,000 Bontang III Loan Agreement dated February 9, 1988 among Continental Bank International as Trustee, Train-E Finance Co., Ltd. as Tranche A Lender and The Industrial Bank of Japan Trust Company as Agent.\n(10)-24- Bontang III Trustee and Paying Agent Agreement, dated February 9, 1988, among Pertamina, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, VICO, Ultrastar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesia, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International (filed as Exhibit 10.42 to the Union Texas Petroleum Holdings, Inc.'s 1991 Form 10-K (Commission File No. 1-9019)).*\n(10)-25- Amendment No. 1 to Bontang III Trustee and Paying Agent Agreement, dated as of December 11, 1992, among Pertamina, VICO, Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesia, Unocal Indonesia Ltd., Indonesia Petroleum, Ltd. and Continental Bank International, as Bontang III Trustee (Filed as Exhibit 10.83 to the Union Texas Petroleum Holdings, Inc.'s 1992 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-26- Amended and Restated Debt Service Allocation Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation, Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd. (filed as Exhibit (10)- 40- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-27- Letter agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Chinese Petroleum Corporation, dated December 1, 1989.\n(10)-28- Memorandum of Agreement (Yokkaichi Extension), made as of December 21, 1989, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., as Buyer (filed as Exhibit (10)-60- to the Company's 1989 Form 10-K (No. 1-8791)).*\n(10)-29- Badak IV LNG Sales Contract dated October 23, 1990 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), as Seller and Osaka Gas Co., Ltd., Tokyo Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n(10)-30- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Hiroshima Gas Co., Ltd. and Nippon Gas Co., Ltd., as Buyers.\n(10)-31- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Osaka Gas Co., Ltd., as Buyer.\n(10)-32- Supply Agreement for Natural Gas to Badak IV LNG Sales Contract dated August 12, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n(10)-33- Second Supply Agreement for Package IV Excess Sales (Osaka Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1991.\n* Incorporated herein by reference.\n(10)-34- Third Supply Agreement for Package IV Excess Sales (Toho Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 28, effective January 1, 1991.\n(10)-35- Eleventh Supply Agreement for Package IV Excess Sales (1973 Contract Build-Down Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1990.\n(10)-36- Bontang IV Producers Agreement dated August 26, 1991 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd., in favor of The Chase Manhattan Bank, N.A. as Agent for the Lenders.\n(10)-37- $750,000,000 Bontang IV Loan Agreement dated August 26, 1991 among Continental Bank International as Trustee under the Bontang IV Trustee and Paying Agent Agreement as Borrower, Chase Manhattan Asia Limited and The Mitsubishi Bank, Limited as Coordinators, the other banks and financial institutions named herein as Arrangers, Co- Arrangers, Lead Managers, Managers, Co-Managers and Lenders, The Chase Manhattan Bank, N.A. and the Mitsubishi Bank, Limited as Co-Agents and The Chase Manhattan Bank, N.A. as Agent.\n(10)-38- Bontang IV Trustee and Paying Agent Agreement dated August 26, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International.\n* Incorporated herein by reference.\n(10)-39- Amended and Restated Bontang Processing Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and P.T. Badak Natural Gas Liquefaction Company (filed as Exhibit (10)-39- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-40- Bontang Capital Projects Loan Agreement No. 1 between Continental Bank International as Trustee under the Badak Trustee and Paying Agent Agreement, Borrower, and The Industrial Bank of Japan Trust Company, Agent, for the Lenders dated as of September 10, 1986 (filed as Exhibit (4)-13- to the Company's 1986 Form 10-K (No. 1-8791)).*\n(10)-41- Bontang Capital Projects Loan Agreement No. 2 dated June 9, 1987, among Continental Bank International, as Trustee under the Badak Trustee and Paying Agent Agreement (Borrower), the banks named therein as Lead Managers and Lenders and The Industrial Bank of Japan Trust Company (Agent) (filed as Exhibit (10)-31 to the Company's 1987 Form 10-K (No. 1- 8791)).*\n(10)-42- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and National Federation of Agricultural Co-Operative Associations (Zen-Noh), as Buyer, dated February 21, 1992.\n(10)-43- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Japan Indonesia Oil Co., Ltd., as Buyer, dated February 20, 1992.\n(10)-44- Arun and Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Kyodo Oil Co., Ltd., Idemitsu Kosan Co., Ltd. and Mitsui Liquefied Gas Co., Ltd. as Buyers dated July 15, 1986 (filed as Exhibit (10)-60- to the Company's 1991 Form 10-K (No. 1-8791)).*\n(10)-45- Bontang LPG Supply Agreement, dated November 17, 1987, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n* Incorporated herein by reference.\n(10)-46- Advance Payment Agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Arun Bontang Project Finance Co., Ltd., dated February 16, 1987 (filed as Exhibit (4)-15- to the Company's 1986 Form 10-K (No. 1-8791)).*\n(10)-47- Agreement and Plan of Reorganization of ENSTAR Corporation, dated December 22, 1989, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Newstar Inc., Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited.\n(10)-48- Amendment to Agreement and Plan of Reorganization of ENSTAR Corporation, dated May 1, 1990, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Ultramar Production Company, Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited.\n(21)-1- List of Subsidiaries of the Company.\n(23)-1- Consent of Ernst & Young.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the fiscal year ended December 31, 1993.\n* Incorporated herein by reference.\nSIGNATURES\nPursuant 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.\nUNIMAR COMPANY\nMarch 24, 1994 By \/S\/ ARTHUR W. PEABODY Arthur W. Peabody Chairman of the Management Board\nPursuant 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 as of March 24, 1994.\nBy \/S\/ GEORGE W. BERKO By \/S\/ LARRY D. KALMBACH George W. Berko Larry D. Kalmbach Management Board Management Board (LASMO Representative) (UTPH Representative)\nBy \/S\/ IAN D. BROWN By \/S\/ WILLIAM M. KRIPS Ian D. Brown William M. Krips Management Board Management Board (LASMO Representative) (UTPH Representative)\nBy \/S\/ JERRY L. PICKERILL By \/S\/ ARTHUR W. PEABODY Jerry L. Pickerill Arthur W. Peabody Management Board Chairman of the (LASMO Representative) Management Board (UTPH Representative)\nINDEX TO EXHIBITS\nSequential Numbered Exhibit Number Page\nThe following documents are included as Exhibits to this Report. Unless it has been indicated that a document listed below is incorporated by reference herein, copies of the document have been filed herewith.\n(2)-1- Merger Agreement, dated May 22, 1984, and Amendment Agreements thereto, dated June 8, 1984 and June 12, 1984 (incorporated by reference to Annex A to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S- 14 (No. 2-93037)).*\n(2)-2- Agreement of Merger, dated as of August 28, 1984 (incorporated by reference to Annex B to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-3- Divestiture Agreement, dated June 20, 1984 (filed as Exhibit 2.3 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(3)-1- Amended and Restated Agreement of General Partnership of Unimar Company dated September 11, 1990 between Unistar, Inc. and Ultrastar, Inc. (filed as Exhibit (3)-4- to the Company's 1990 Form 10-K (No. 18791)).*\n(4)-1- Form of Indenture between Unimar and Irving Trust Company, as Trustee (filed as Exhibit 4 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(4)-2- First Supplemental Indenture, dated as of October 31, 1986, to the Indenture between Unimar and Irving Trust Co., as Trustee (Exhibit (4)-1 above) (Filed as Exhibit 10.114 to Union Texas Petroleum Holdings, Inc.'s Registration Statement on Form S- 1 (No. 33-16267)).*\n(10)-1- Joint Venture Agreement, dated August 8, 1968, among Roy M. Huffington, Inc., Virginia International Company, Austral Petroleum Gas Corporation, Golden Eagle Indonesia, Limited, and Union Texas Far East Corporation, as amended (filed as Exhibit 6.6 to Registration Statement No. 2-58834 of Alaska Interstate Company).*\n* Incorporated herein by reference.\n(10)-2- Agreement dated as of October 1, 1979, among the parties to the Joint Venture Agreement referred to in Exhibit (10)-1- above (filed as Exhibit 5.2 to Registration Statement No. 2-66661 of Alaska Interstate Company).*\n(10)-3- Amendment to the Operating Agreement dated April 1, 1990, between Roy M. Huffington, Inc., a Delaware corporation, Ultramar Indonesia Limited, a Bermuda corporation, Virginia Indonesia Company, a Delaware corporation, Virginia International Company, a Delaware corporation, Union Texas East Kalimantan Limited, a Bahamian corporation, and Universe Gas & Oil Company, Inc., a Liberian corporation.\n(10)-4- Amended and Restated Production Sharing Contract dated April 23, 1990 (effective August 8, 1968 - August 7, 1998) by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation.\n(10)-5- Production Sharing Contract dated April 23, 1990 (effective August 8, 1998 - August 7, 2018) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation.\n(10)-6- Nilam Unit Agreement, effective as of January 1, 1980, to establish the manner in which the Joint Venture and Total will cooperate to develop the unitized area of the Nilam Field (filed as Exhibit (10)-58- to the Company's 1991 Form 10-K (No. 1- 8791)).*\n(10)-7- Third Amended and Restated Implementation Procedures for Crude Oil Liftings, effective as of July 1, 1993, among Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n* Incorporated herein by reference.\n(10)-8- Amended and Restated 1973 LNG Sales Contract, dated as of the 1st day of January 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n(10)-9- Amendment to the 1973 LNG Sales Contract dated as of the 3rd day of December, 1973, amended by Amendment No. 1 dated as of the 31st day of August, 1976, and amended and restated as of the 1st day of January, 1990 (\"1973 LNG Sales Contract\"), is entered into as of the 1st day of June, 1992, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, a state enterprise of the Republic of Indonesia (Seller), on the one hand, and Kyushu Electric Power Co., Inc. (Kyushu Electric), Nippon Steel Corporation (Nippon Steel), and Toho Gas Co., Ltd. (Toho Gas), all corporations organized and existing under the laws of Japan, on the other hand.\n(10)-10- Amended and Restated Supply Agreement (In Support of the Amended and Restated 1973 LNG Sales Contract) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective December 3, 1973.\n(10)-11- Amended and Restated Badak LNG Sales Contract, dated as of the 1st day of January, 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n(10)-12- Supply Agreement, dated as of April 14, 1981 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement, including the Company.\n(10)-13- Seventh Supply Agreement for Excess Sales (Additional Fixed Quantities under Badak LNG Sales Contract as a Result of Contract Amendment and Restatement) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company, dated September 28, 1992, but effective as of January 1, 1990.\n* Incorporated herein by reference.\n(10)-14- Bontang II Trustee and Paying Agent Agreement Amended and Restated as of July 15, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Virginia International Company, Union Texas East Kalimantan Limited, Ultramar Indonesia Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International.\n(10)-15- Producers Agreement No. 2 dated as of June 9, 1987 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation in favor of The Industrial Bank of Japan Trust Company as Agent (filed as Exhibit (10)-30- to the Company's 1987 Form 10-K (No. 1-8791)).*\n(10)-16- Badak III LNG Sales Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Chinese Petroleum Corporation as Buyer signed on March 19, 1987 (filed as Exhibit (10)-59- to the Company's 1991 Form 10-K (No. 1-8791)).*\n(10)-17- Badak III LNG Sales Contract Supply Agreement, dated October 19, 1987 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n(10)-18- LNG Sales and Purchase Contract (Korea II) effective May 7, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation.\n(10)-19- Schedule A to the LNG Sales and Purchase Contract (Korea II FOB) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation.\n(10)-20- Bontang III Producers Agreement, dated February 9, 1988, among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n* Incorporated herein by reference.\n(10)-21- Amendment No. 1 to Bontang III Producers Agreement dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Train-E Finance Co., Ltd., as Tranche A Lender, The Industrial Bank of Japan Trust Company, as Agent and The Industrial Bank of Japan Trust Company on behalf of the Tranche B Lenders.\n(10)-22- Amendment No. 2 to Producers Agreement No. 2 dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited and Universe Tankships, Inc. (filed as Exhibit (10)-44- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-23- $316,000,000 Bontang III Loan Agreement dated February 9, 1988 among Continental Bank International as Trustee, Train-E Finance Co., Ltd. as Tranche A Lender and The Industrial Bank of Japan Trust Company as Agent.\n(10)-24- Bontang III Trustee and Paying Agent Agreement, dated February 9, 1988, among Pertamina, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, VICO, Ultrastar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesia, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International (filed as Exhibit 10.42 to the Union Texas Petroleum Holdings, Inc.'s 1991 Form 10-K (Commission File No. 1- 9019)).*\n(10)-25- Amendment No. 1 to Bontang III Trustee and Paying Agent Agreement, dated as of December 11, 1992, among Pertamina, VICO, Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesia, Unocal Indonesia Ltd., Indonesia Petroleum, Ltd. and Continental Bank International, as Bontang III Trustee (Filed as Exhibit 10.83 to the Union Texas Petroleum Holdings, Inc.'s 1992 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-26- Amended and Restated Debt Service Allocation Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation, Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd. (filed as Exhibit (10)- 40- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-27- Letter agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Chinese Petroleum Corporation, dated December 1, 1989.\n(10)-28- Memorandum of Agreement (Yokkaichi Extension), made as of December 21, 1989, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., as Buyer (filed as Exhibit (10)-60- to the Company's 1989 Form 10-K (No. 1-8791)).*\n(10)-29- Badak IV LNG Sales Contract dated October 23, 1990 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), as Seller and Osaka Gas Co., Ltd., Tokyo Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers.\n(10)-30- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Hiroshima Gas Co., Ltd. and Nippon Gas Co., Ltd., as Buyers.\n(10)-31- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Osaka Gas Co., Ltd., as Buyer.\n(10)-32- Supply Agreement for Natural Gas to Badak IV LNG Sales Contract dated August 12, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n(10)-33- Second Supply Agreement for Package IV Excess Sales (Osaka Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1991.\n* Incorporated herein by reference.\n(10)-34- Third Supply Agreement for Package IV Excess Sales (Toho Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 28, effective January 1, 1991.\n(10)-35- Eleventh Supply Agreement for Package IV Excess Sales (1973 Contract Build-Down Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1990.\n(10)-36- Bontang IV Producers Agreement dated August 26, 1991 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd., in favor of The Chase Manhattan Bank, N.A. as Agent for the Lenders.\n(10)-37- $750,000,000 Bontang IV Loan Agreement dated August 26, 1991 among Continental Bank International as Trustee under the Bontang IV Trustee and Paying Agent Agreement as Borrower, Chase Manhattan Asia Limited and The Mitsubishi Bank, Limited as Coordinators, the other banks and financial institutions named herein as Arrangers, Co-Arrangers, Lead Managers, Managers, Co-Managers and Lenders, The Chase Manhattan Bank, N.A. and the Mitsubishi Bank, Limited as Co-Agents and The Chase Manhattan Bank, N.A. as Agent.\n(10)-38- Bontang IV Trustee and Paying Agent Agreement dated August 26, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International.\n* Incorporated herein by reference.\n(10)-39- Amended and Restated Bontang Processing Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and P.T. Badak Natural Gas Liquefaction Company (filed as Exhibit (10)-39- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-40- Bontang Capital Projects Loan Agreement No. 1 between Continental Bank International as Trustee under the Badak Trustee and Paying Agent Agreement, Borrower, and The Industrial Bank of Japan Trust Company, Agent, for the Lenders dated as of September 10, 1986 (filed as Exhibit (4)-13- to the Company's 1986 Form 10-K (No. 1-8791)).*\n(10)-41- Bontang Capital Projects Loan Agreement No. 2 dated June 9, 1987, among Continental Bank International, as Trustee under the Badak Trustee and Paying Agent Agreement (Borrower), the banks named therein as Lead Managers and Lenders and The Industrial Bank of Japan Trust Company (Agent) (filed as Exhibit (10)-31 to the Company's 1987 Form 10-K (No. 1-8791)).*\n(10)-42- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and National Federation of Agricultural Co-Operative Associations (Zen-Noh), as Buyer, dated February 21, 1992.\n(10)-43- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Japan Indonesia Oil Co., Ltd., as Buyer, dated February 20, 1992.\n(10)-44- Arun and Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Kyodo Oil Co., Ltd., Idemitsu Kosan Co., Ltd. and Mitsui Liquefied Gas Co., Ltd. as Buyers dated July 15, 1986 (filed as Exhibit (10)-60- to the Company's 1991 Form 10-K (No. 1-8791)).*\n(10)-45- Bontang LPG Supply Agreement, dated November 17, 1987, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement.\n* Incorporated herein by reference.\n(10)-46- Advance Payment Agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Arun Bontang Project Finance Co., Ltd., dated February 16, 1987 (filed as Exhibit (4)-15- to the Company's 1986 Form 10-K (No. 1- 8791)).*\n(10)-47- Agreement and Plan of Reorganization of ENSTAR Corporation, dated December 22, 1989, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Newstar Inc., Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited.\n(10)-48- Amendment to Agreement and Plan of Reorganization of ENSTAR Corporation, dated May 1, 1990, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Ultramar Production Company, Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited.\n(21)-1- List of Subsidiaries of the Company.\n(23)-1- Consent of Ernst & Young.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the fiscal year ended December 31, 1993.\n* Incorporated herein by reference.","section_15":""}
{"filename":"869844_1993.txt","cik":"869844","year":"1993","section_1":"Item 1. Business\nThe Sears Credit Account Trust 1990 E (the \"Trust\") was formed pursuant to the Pooling and Servicing Agreement dated as of December 1, 1990 (the \"Pooling and Servicing Agreement\") among Sears, Roebuck and Co. (\"Sears\") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. (\"SRFG\") as Seller, and Continental Bank, National Association as trustee (the \"Trustee\"). The Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe property of the Trust includes a portfolio of receivables (the \"Receivables\") arising in selected accounts under open-end credit plans of Sears (the \"Accounts\") and all monies received in payment of the Receivables. At the time of the Trust's formation, Sears sold and contributed to SRFG, which in turn conveyed to the Trust, all Receivables existing under the Accounts as of the end of certain of Sears regular billing cycles ending in November, 1990 and all Receivables arising under the Accounts from time to time thereafter until the termination of the Trust. Information related to the performance of the Receivables during 1993 is set forth in the ANNUAL STATEMENT filed as Exhibit 21 to this Annual Report on Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInvestor Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company (\"DTC\"), a \"clearing agency\" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended. All outstanding definitive Investor Certificates are held by CEDE and Co., the nominee of DTC.\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 15, 1994, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1994, owned 100% of the Seller Certificate, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Exhibits:\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\n(b) Reports on Form 8-K:\nCurrent reports on Form 8-K are filed on, or before the Distribution Date each month (on, or the first business day after, the 15th of the month). The reports include as an exhibit, the MONTHLY INVESTOR CERTIFICATEHOLDERS' STATEMENT. Current Reports on Form 8-K were filed on October 15, 1993, November 15, 1993 and December 15, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nSears Credit Account Trust 1990 E (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: \/S\/ALICE M. PETERSON _____________________________________ Alice M. Peterson President and Chief Executive Officer\nDated: March 30, 1994\nEXHIBIT INDEX\nPage number in sequential Exhibit No. number system\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\nExhibit 21\nSEARS CREDIT ACCOUNT TRUST 1990 E\n8.80% CREDIT ACCOUNT PASS-THROUGH CERTIFICATES\n1993 ANNUAL STATEMENT\nPursuant to the terms of the letter issued by the Securities and Exchange Commission dated February 19, 1991 (granting relief to the Trust from certain reporting requirements of the Securities Exchange Act of 1934, as amended), aggregated information regarding the performance of Accounts and payments to Investor Certificateholders in respect of the Due Periods related to the twelve Distribution Dates which occurred in 1993 is set forth below.\n1) The total amount of the distribution to Investor Certificateholders during 1993, per $1,000 interest..$88.00\n2) The amount of the distribution set forth in paragraph 1 above in respect of interest on the Investor Certificates, per $1,000 interest....................$88.00\n3) The amount of the distribution set forth in paragraph 1 above in respect of principal on the Investor Certificates, per $1,000 interest.................... $0.00\n4) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods.................................$443,741,135.81\n5) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods.................................$117,808,180.74\n6) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates................................$341,853,855.74\n7) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates.................................$91,797,197.02\n8) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate.................................$101,887,280.07\n9) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate..................................$26,010,983.72\n10) The excess of the Investor Charged-Off Amount over the sum of (i) payments in respect of the Available Subordinated Amount and (ii) Excess Servicing, if any (an \"Investor Loss\"), per $1,000 interest.............$0.00\n11) The aggregate amount of Investor Losses in the Trust as of the end of the day on December 15, 1993, per $1,000 interest.......................................$0.00\n12) The total reimbursed to the Trust from the sum of the Available subordinated Amount and Excess Servicing, if any, in respect of Investor Losses, per $1,000 interest..............................................$0.00\n13) The amount of the Investor Monthly Servicing Fee payable by the Trust to the Servicer..........$7,708,333.33\n14) The aggregate amount which was deposited in the Principal Funding Account in respect of Collections of Principal Receivables during the related Due Periods.................................$249,999,999.96\n15) The aggregate amount of Investment Income during the related Due Periods...........................$3,973,171.52\n16) The total amount on deposit in the Principal Funding Account in respect of Collections of Principal Receivables, as of the end of the reportable year........................................$249,999,999.96\n17) The Deficit Accumulation Amount, as of the end of the reportable year.......................................$0.00\n18) The aggregate amount which was deposited in the Interest Funding Account in respect of Certificate Interest during the related Due Periods...............$44,000,000.04\n19) The total amount on deposit in the Interest Funding Account in respect of Certificate Interest, as of the end of the reportable year...................$22,000,000.02\nExhibit 28(a)\nFebruary 11, 1994\nMs. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank, National Sears Tower Association as Trustee Chicago, Illinois 60684 231 South La Salle Street Chicago, Illinois 60697\nWe have applied the procedures listed below to the accounting records of Sears, Roebuck and Co. (\"Sears\") relating to the servicing procedures performed by Sears as Servicer under Section 3.06(b) of the Pooling and Servicing Agreement (the \"Agreement\") for the following Trusts:\nDate of Pooling and Trust Servicing Agreement\nSears Credit Account Trust 1989E November 13, 1989 Sears Credit Account Trust 1990A January 12, 1990 Sears Credit Account Trust 1990B February 22, 1990 Sears Credit Account Trust 1990C July 31, 1990 Sears Credit Account Trust 1990D October 15, 1990 Sears Credit Account Trust 1990E December 1, 1990\nIt is understood that this report is solely for your information and is not to be referred to or distributed for any purpose to anyone other than Continental Bank, National Association as Trustee, Investor Certificateholders or the management of Sears. The procedures we performed are as follows:\nCompared the mathematical calculations of each amount set forth in each monthly certificate forwarded by the Servicer, pursuant to Section 3.04(b) of the Agreement, during the calendar year 1993 to the Servicer's computer-generated Portfolio Monitoring and Monthly Cash Flow Allocations Report. We found such amounts to be in agreement.\nFebruary 11, 1994 Ms. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank, National Association as Trustee\nBecause the above procedures do not constitute an audit conducted in accordance with generally accepted auditing standards, we do not express an opinion on any of the items referred to above.\nAs a result of the procedures performed, no matters came to our attention that caused us to believe that the amounts in the monthly certificates require adjustment. Had we performed additional procedures or had we conducted an audit of the monthly certificates in accordance with generally accepted auditing standards, matters might have come to our attention that would have been reported to you. This report relates only to the items specified above and does not extend to any financial statements of Sears taken as a whole.","section_15":""}
{"filename":"43362_1993.txt","cik":"43362","year":"1993","section_1":"Item 1. BUSINESS\nGENERAL\nGreat Lakes Chemical Corporation is a Delaware corporation incorporated in 1933, having its principal executive offices in West Lafayette, Indiana. The Company's operations consist of one dominant industry segment - chemicals and allied products. Within this segment the Company is well diversified focusing on performance chemicals, water treatment chemicals, petroleum additives and specialized services and manufacturing. The Corporate profile on page 3 and the Review of Operations on pages 14 through 19 of the 1993 Annual Report to Stockholders is incorporated herein by reference.\nThe term \"Great Lakes\" as used herein means Great Lakes Chemical Corporation and Subsidiaries unless the context indicates otherwise.\nNet sales by product group are set forth in the following table (dollars in millions):\n1993 Developments\nIn June 1993, the Company augmented its polymer additives business with the acquisition of Chemische Werke LOWI GmbH & Co. (Lowi), a leading manufacturer of antioxidants, and hindered amine light stabilizers (HALS). This acquisition also expanded the polymer additives business into the rubber and adhesives markets.\nIn the Functional Intermediates and Fine Chemicals Group, the Company increased bromine capacity and other derivative production to meet incremental market demands for bromine-based specialty derivatives. Also, the Company expanded production facilities in El Dorado, AR, to meet increased demand for tetrabromobisphenol-A.\nOctel Chemicals Limited (OCL) doubled its sales, performing a wide range of custom synthesis activities, enhancing Great Lakes' presence in the European specialty and fine chemicals industry.\nA new industrial specialty chemicals plant was commissioned to produce high purity bromide salts used in photographic materials, catalysts, pharmaceutical intermediates and other fine chemicals. Also, FM-200(TM), a clean gaseous fire extinguishing agent that replaces halon-based products, received U.S. EPA approval and the Underwriters Laboratories (UL) listing mark, and passed testing for U.S. Military and Factory Mutual insured facilities applications.\nThe Water Treatment Chemicals Group completed two acquisitions during 1993 that strengthened its presence in the recreational market. In January 1993, Bayrol Chemische Fabrik GmbH was acquired which extended the Company's presence in the European market. In May 1993, Aqua Chem was acquired which provides an important foothold in mass merchandising, the fastest growing sector of the pool and spa products market.\nIn the Petroleum Additives Group, Octel supplied additional quantities of antiknock compound for the Mexican market through the extension of an earlier marketing and distribution agreement with DuPont. Also, a long-term agreement to supply Ethyl Corporation's requirements for alkyl lead antiknock compound will take effect in the middle of 1994.\nThe Specialized Services and Manufacturing Group expanded its environmental services business with the January 1993 acquisition of Four Seasons Industrial Services, Inc. and two associated companies.\nRaw Materials\nThe sources of essential raw materials for bromine are the brine from company-owned wells in Arkansas, sea water extraction plants in Europe and bromine purchased from an affiliated company. The Arkansas properties are located atop the Smackover lime deposits, which constitute a vast underground sea of bromine-rich brine. The area between ElDorado and Magnolia, Arkansas, (located about 35 miles west of ElDorado) provides the best geological location for bromine production and both major domestic bromine manufacturers are located there. Based on projected production rates, the Company's brine reserves are conservatively estimated to be adequate for the foreseeable future.\nFurfural is extracted from agricultural by-products and waste materials such as corncobs, sugar cane bagasse, rice hulls and oat hulls for which there are few alternative uses. These raw material sources for furfural production are expected to remain abundant and relatively inexpensive. Other materials used in the chemical processes are obtained from outside suppliers through purchase contracts. Supplies of these materials are believed to be adequate for the Company's future operations.\nInternational Operations\nGreat Lakes has a substantial presence in foreign markets. The Company's investment in foreign countries is principally in Western Europe and represents $793 million or 42 percent of total assets.\nSales to customers in foreign countries (primarily Europe and the Far East) amount to 62, 61 and 58 percent of total sales for the years ended December 31, 1993, 1992, and 1991, respectively. Approximately 15, 19, and 21 percent of these foreign sales, respectively for the three years shown, are products exported from the U.S., with the balance primarily being products manufactured and sold by the Company's European subsidiaries and branches. The profitability on foreign sales (including U.S. exports and foreign manufactured products, except Octel) approximates those for domestic operations. Because of value-added pricing, Octel's alkyl lead products have a higher profitability than do most of the Company's other products.\nThe geographic segment data contained in the note \"Industry Segments and Foreign Operations\" of Notes to Consolidated Financial Statements on page 36 of the 1993 Annual Report to Stockholders is incorporated herein by reference.\nCustomers and Distribution\nDuring the last three years, no single customer accounted for more than 10 percent of Great Lakes' total consolidated sales. The Company has no material contract or subcontract with the government. A major portion of the Company's sales are sold to industrial or commercial users for use in the production of other products. Some products such as recreational water treatment chemicals and supplies are sold to a large number of users or distributors. Some export sales are marketed through distributors and brokers.\nThe Company's business does not normally reflect any material backlog of orders at year-end.\nCompetition\nGreat Lakes is in competition with businesses producing the same or similar products as well as businesses producing products intended for similar use. There is one other major bromine and alkyl lead producer in the United States who competes with the Company in varying degrees, depending on the product involved. There is also one major overseas bromine competitor. In addition, there are several small producers in the U.S. and overseas who are competitors in several individual products. The Company is the only U.S. producer of furfural and furfuryl alcohol, and it enjoys a strong market share in every major geographic and product market in which it competes. The Company competes with several manufacturers and distributors of swimming pool and spa chemicals and equipment. Through its Bio-Lab subsidiary, the Company operates 33 branch distribution outlets for chemicals and pool and spa equipment in the U.S. Products are differentiated by brand names to the retail, wholesale and mass merchandising markets.\nPrincipal methods of competition are price, product quality and purity, technical services and ability to deliver promptly. The Company is able to move quickly in providing new products to meet identified market demands, and believes its production costs are among the lowest in the world. These factors, combined with high technical skills, allow the Company to compete effectively. One negative factor in its ability to compete with the major overseas producer of bromine is the fact that this producer receives significant subsidies from its government, and enjoys favorable duty advantages on its exports to certain markets.\nSeasonality and Working Capital\nThe products, which the Company sells to the agricultural and swimming pool markets, do exhibit some seasonality; however, the effect on overall Company sales and profits is not material. Seasonality results\nin the need to build inventories for rapid delivery at certain times of the year. The pool product season is strongest during the first six months, requiring a build-up of inventory at the beginning of the year. Except for certain arrangements with distributors and dealers of swimming pool and spa products, customers are not permitted to return unsold material at the end of a season. Extended credit terms are granted only in cases where the Company chooses to do so to meet competition.\nThe alkyl lead products have somewhat larger working capital requirements than do the Company's other major products, because of extended distribution lines and credit terms for large volume refinery customers.\nThe effect of the above items on working capital requirements is not material.\nResearch and Development and Patents\nResearch and development expenditures are included in the note \"Research and Development Expense\" of the Notes to Consolidated Financial Statements on page 36 of the 1993 Annual Report to Stockholders and is incorporated herein by reference. The Company holds no patents, licenses, franchises or concessions which are essential to its operations.\nEnvironmental and Toxic Substances Control\nDue to the hazardous nature of certain of its products, the Company is keenly aware of the potential damage that could be done to the environment if effective pollution controls were not maintained. Therefore, the Company has made a commitment as one of its business objectives to install, maintain and improve pollution control facilities wherever they are needed.\nThe Company meets or exceeds all presently known governmental requirements for protection of the environment. In addition, all new facilities include provisions for any necessary pollution controls as a normal part of their projected costs.\nEmployees\nThe Company has approximately 7,000 employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nGreat Lakes has plants at 32 locations in 14 states and 14 plants in 8 foreign countries. Most principal plants are owned. Listed under Item 1 above in a table captioned Products and Services are the principal locations at which products are manufactured, distributed or marketed.\nThe Company leases warehouses, distribution centers and space for offices throughout the world. All of the Company's facilities are in good repair, suitable for the Company's businesses, and have sufficient space to meet present marketing demands at an efficient operating level.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings involving the Company, its subsidiaries or any of its properties. Furthermore, no director, officer or affiliate of the Company, or any associate of any director or officer is involved, or has a material interest in, any proceeding which would have a material adverse effect on the Company.\nItem 103 of Regulation S-K requires disclosure of administrative or judicial proceedings arising under any federal, state or local provisions dealing with protection of the environment, if the monetary sanctions might\nexceed $100,000. The following proceedings may result in sanctions exceeding $100,000.\nIn 1993, the Company and the United States Environmental Protection Agency agreed in principle to settle an action brought by the EPA under Section 15(1)(c) of TOSCA for a payment of $125,000 and the performance of $2,000,000 of environmentally beneficial capital projects at the Company's ElDorado, Arkansas, site. The proposed consent decree states that the Company does not admit the allegations made by the EPA.\nThe United States Environmental Protection Agency and the Company have agreed in principle to a payment by the Company of a civil penalty in the amount of $190,000 in full satisfaction of claims by the EPA that the Company violated the Clean Water Act based on allegations of discharges from its ElDorado, Arkansas, facility. No complaint has been filed and no formal action has been commenced. The proposed consent decree states that the Company does not admit the allegations made by the EPA.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the quarter ended December 31, 1993.\nPART II -------\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs of March 7, 1994, there were approximately 4,850 registered holders of Great Lakes Common Stock. Additional information is contained in the 1993 Annual Report to Stockholders, under the captions \"Stock Price Data\" and \"Cash Dividends Paid\" on pages 1 and 26, respectively, all of which are incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThis information is contained in the 1993 Annual Report to Stockholders, under the caption \"Financial Review\" on pages 20 and 21, and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n\"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 14 through 19 and pages 22 through 26 of the 1993 Annual Report to Stockholders, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements together with the report thereon of Ernst & Young dated January 31, 1994, appearing on pages 27 through 38 and the \"Quarterly Results of Operations\" on page 39 of the 1993 Annual Report to Stockholders, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. DISAGREEMENT OF ACCOUNTING AND FINANCIAL DISCLOSURE\nNo change of auditors or disagreements on accounting methods have occurred which would require disclosure hereunder.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nExecutive Officers\nInformation with respect to directors of the Company is contained under the heading \"Proposal One: Election of Directors\" in the Great Lakes' Proxy Statement relating to the 1994 Annual Meeting of Shareholders dated March 29, 1994, which is incorporated herein by reference.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information under the heading \"Executive Compensation and Other Information\" in the 1994 Proxy Statement is incorporated by reference in this report.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under the heading \"Security Ownership of Certain Beneficial Owners and Management\" in the 1994 Proxy Statement is included by reference in this report.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under the heading \"Compensation Committee Interlocks and Insider Participation\" in the 1994 Proxy Statement is included by reference in this report.\nPART IV -------\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe following Consolidated financial statements of Great Lakes Chemical Corporation and Subsidiaries and related notes thereto, together with the report thereon of Ernst & Young dated January 31, 1994, appearing on pages 27 through 38 of the 1993 Annual Report to Stockholders, are incorporated by\nreference in Item 8:\nConsolidated Balance Sheets -- December 31, 1993 and 1992 Consolidated Statements of Income and Retained Earnings -- Years ended December 31, 1993, 1992 and 1991 Consolidated Statements of Cash Flows -- Years ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following additional information is filed as part of this report and should be read in conjunction with the 1993 financial statements.\nSchedule VIII -- Valuation and Qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n3. Exhibits\n11. Computation of Per Share Earnings 13. 1993 Annual Report to Stockholders 21. Subsidiaries -- Incorporated herein by reference is the list of subsidiaries appearing on page 40 of the 1993 Annual Report to Stockholders. 23. Consents of Independent Auditors\n(b) Reports on Form 8-K\nThere were no Form 8-K's filed during the quarter ended December 31, 1993.\n(c) Exhibits\nThe response to this section of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules\nThe response to this section of Item 14 is submitted as a separate section of this report.\n(A) Reserve balance of Bayrol and Lowi at date of acquisition. (B) Uncollectible accounts receivable written off, net of recoveries and foreign currency translation.\nSIGNATURES - ----------\nPursuant 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.\nPursuant 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 and on the dates indicated:\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders of Arkansas Chemicals, Inc.:\nWe have audited the balance sheets of Arkansas Chemicals, Inc. as of December 31, 1993 and 1992, and the related statements of income and retained earnings and of cash flows for each of the three years in the period ended December 31, 1993 (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nDeloitte & Touche\nPittsburgh, Pennsylvania January 31, 1994\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Huntsman Chemical Corporation:\nWe have audited the consolidated balance sheets of Huntsman Chemical Corporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for the years then ended (not presented separately herein). These financial statements are the responsibilities of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Huntsman Chemical Corporation and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nDeloitte & Touche\nSalt Lake City, Utah January 26, 1994 (March 18, 1994 as to note 5)","section_15":""}
{"filename":"40877_1993.txt","cik":"40877","year":"1993","section_1":"Item 1. Business\nGTE Northwest Incorporated (the Company) (formerly General Telephone Company of the Northwest, Inc., formerly West Coast Telephone Company) was incorporated in Washington on March 31, 1964. The Company is a wholly-owned subsidiary of GTE Corporation (GTE). Together with its wholly-owned subsidiary, GTE West Coast Incorporated, the Company provides communications services in the states of California, Idaho, Montana, Oregon and Washington.\nOn February 23, 1993, the Idaho properties of Contel of the West, Inc. were purchased by the Company. On February 26, 1993, Contel of the Northwest, Inc. merged into the Company. Both Contel of the West, Inc. and Contel of the Northwest, Inc. were wholly-owned subsidiaries of Contel Corporation (a wholly- owned subsidiary of GTE). The merger was accounted for in a manner consistent with a transfer of entities under common control which is similar to that of a \"pooling of interests.\"\nOn December 31, 1993, the Company sold its telephone plant in service, materials and supplies and customers (representing 17,000 access lines) in the state of Idaho to Citizens Utilities Company.\nThe Company provides local telephone service within its franchise area and intraLATA (Local Access Transport Area) long distance service between the Company's facilities and the facilities of other telephone companies within the Company's LATAs in Idaho and Montana. InterLATA service to other points in and out of the states in which the Company operates is provided through connection with interexchange (long distance) common carriers. These common carriers are charged fees (access charges) for interconnection to the Company's local facilities. End user business and residential customers are also charged for access to the facilities of the long distance carrier. The Company also earns other revenues by leasing interexchange plant facilities and providing such services as billing and collection and operator services to interexchange carriers, primarily the American Telephone and Telegraph Company (AT&T). The number of access lines served has grown steadily from 934,856 on January 1, 1989 to 1,271,916 on December 31, 1993.\nThe following table denotes the access lines in the states in which the Company operates as of December 31, 1993:\nAccess State Lines Served ----- ------------ Washington 753,005 Oregon 397,799 Idaho 101,474 California 12,010 Montana 7,628 --------- Total 1,271,916 =========\nThe Company's principal line of business is providing telecommunication services. These services fall into five major classes: local network, network access, long distance, equipment sales and services and other. Revenues from each of these classes over the last three years are as follows:\nYears Ended December 31 --------------------------------------------- 1993 1992 1991 ---- ---- ---- (Thousands of Dollars)\nLocal Network Services $ 331,369 $ 321,575 $ 303,880 % of Total Revenues 38% 36% 36%\nNetwork Access Services $ 370,980 $ 382,997 $ 379,382 % of Total Revenues 42% 43% 45%\nLong Distance Services $ 14,444 $ 17,789 $ 16,994 % of Total Revenues 2% 2% 2%\nEquipment Sales and Services $ 77,989 $ 78,279 $ 80,272 % of Total Revenues 9% 9% 9%\nOther $ 80,513 $ 86,147 $ 67,365 % of Total Revenues 9% 10% 8%\nAt December 31, 1993, the Company had 4,509 employees. The Company has written agreements with the Communications Workers of America (CWA) and the International Brotherhood of Electrical Workers (IBEW) covering substantially all non-management employees. In 1993, agreements were reached on two contracts with the IBEW. During 1994, there are no contracts which will expire.\nTelephone Competition\nThe Company holds franchises, licenses and permits adequate for the conduct of its business in the territories which it serves.\nThe Company is subject to regulation by the regulatory bodies of the states of California, Idaho, Montana, Oregon and Washington as to its intrastate business operations and the Federal Communications Commission (FCC) as to its interstate business operations. Information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies can be found in Note 12 of the Company's Annual Report to Shareholders for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.\nThe year was marked by important changes in the U.S. telecommunications industry. Rapid advances in technology, together with government and industry initiatives to eliminate certain legal and regulatory barriers are accelerating and expanding the level of competition and opportunities available to the Company. As a result, the Company faces increasing competition in virtually all aspects of its business. Specialized communications companies have constructed new systems in certain markets to bypass the local exchange network. Additional competition from interexchange carriers as well as wireless companies continues to evolve for both intrastate and interstate communications.\nDuring 1994, the Company will begin implementation of a re-engineering plan that will redesign and streamline processes. Implementation of its re- engineering plan will allow the Company to continue to respond aggressively to these competitive and regulatory developments through reduced costs, improved service quality, competitive prices and new product offerings. Moreover, implementation of this program will position the Company to accelerate delivery of a full array of voice, video and data services. The re-engineering program will be implemented over three years. During the year, the company continued to introduce new business and consumer services utilizing advanced technology, offering new features and pricing options while at the same time reducing costs and prices.\nDuring 1991, the FCC announced its decision to auction licenses during 1994 in 51 major markets and 492 basic trading areas across the united States to encourage the development of a new generation of wireless personal communications services (PCS). These services will both complement and compete with the Company's traditional wireline services. The Company will be permitted to fully participate in the license auctions in areas outside of GTE's existing cellular service areas. Limited participation will be permitted in areas in which GTE has an existing cellular presence.\nIn 1992, the FCC issued a \"video dialtone\" ruling that allows telephone companies to transmit video signals over their networks. The FCC also recommended that Congress amend the Cable Act of 1984 to permit telephone companies to supply video programming in their service areas.\nActivity directed toward changing the traditional cost-based rate of return regulatory framework for intrastate and interstate telephone services has continued. Various forms of alternative regulation have been adopted, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for the pricing flexibility necessary to address competitive entry into the markets the Company serves.\nIn September 1993, the FCC released an order allowing competing carriers to interconnect to the local-exchange network for the purpose of providing switched access transport services. This ruling complements similar interconnect arrangements for private line services ordered during 1992. The order encourages competition for the transport of telecommunications traffic between local exchange carriers' (LECs) switching offices and interexchange carrier locations. In addition, the order allows LECs flexibility in pricing competitive services.\nThe GTE Consent Decree, which was issued in connection with the 1983 acquisition of GTE Sprint (since divested) and GTE Spacenet, prohibits GTE's domestic telephone operating subsidiaries from providing long distance service beyond the boundaries of the LATA. This prohibition restricts their direct provision of long distance service to relatively short distances. The degree of competition allowed in the intraLATA market is subject to state regulation. However, regulatory constraints on intraLATA competition are gradually being relaxed. In fact, some form of intraLATA competition is authorized in many of the states in which the Company provides service.\nThese and other actions to eliminate the existing legal and regulatory barriers, together with rapid advances in technology, are facilitating a convergence of the computer, media and telecommunications industries. In addition to allowing new forms of competition, these developments are also creating new opportunities to develop interactive communications networks. The Company supports these initiatives to assure greater competition in telecommunications, provided that overall the changes allow an opportunity for all service providers to participate equally in a competitive marketplace under comparable conditions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's property consists of network facilities (82%), customer premises equipment (14%), company facilities (1%) and other (3%). From January 1, 1989 to December 31, 1993, the Company made gross property additions of $1.2 billion and property retirements of $0.5 billion. Substantially all of the Company's property is subject to liens securing long-term debt. In the opinion of management, the Company's telephone plant is substantially in good repair.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no pending legal proceedings, either for or against the Company, which would have a material impact on the Company's financial statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters\nMarket information is omitted since the Company's common stock is wholly-owned by GTE Corporation.\nItem 6.","section_6":"Item 6. Selected Financial Data\nReference is made to the Registrant's Annual Report to Shareholders, page 32, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nReference is made to the Registrant's Annual Report to Shareholders, pages 27 to 31, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReference is made to the Registrant's Annual Report to Shareholders, pages 5 to 25, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe names, ages and positions of all the directors and executive officers of the Company as of March 21, 1994 are listed below along with their business experience during the past five years.\na. Identification of Directors\nDirector Name Age Since Business Experience ---- --- -------- ----------------------------------------\nKent B. Foster 50 1993 Vice Chairman of the Board of Directors of GTE Corporation, October 1993. President, GTE Telephone Operations, 1989; Director, GTE Corporation, 1992; Director, all GTE domestic telephone subsidiaries, 1993; Director, BC Telecom, Inc.; Director, Compania Anonima Nacional Telefonos de Venezuela; Director, National Bank of Texas.\nRichard M. Cahill 55 1993 Vice President - General Counsel of GTE Telephone Operations, 1988; Director, all GTE domestic telephone subsidiaries, 1993; Director, GTE Vantage Incorporated, 1991; Director, GTE Intelligent Network Services Incorporated, 1993.\nGerald K. Dinsmore 44 1993 Senior Vice President - Finance and Planning for GTE Telephone Operations, 1994. Vice President - Finance, GTE Telephone Operations, 1993; Vice President - Intermediary Customer Markets, GTE Telephone Operations, 1991. President, South Area, GTE Telephone Operations, 1992; Director, all GTE domestic telephone subsidiaries, 1993.\nMichael B. Esstman 47 1993 Executive Vice President-Operations, GTE Telephone Operations, 1993; President, Central Area, GTE Telephone Operations, 1991. President, Contel Eastern Region, Telephone Operations Sector, 1983; Director, AG Communications System; Director, all GTE domestic telephone subsidiaries, 1993.\nLarry J. Sparrow 50 1992 Director and President, GTE California Incorporated and GTE Northwest Incorporated; Director and Chairman of the Board and Chief Executive Officer of GTE Hawaiian Telephone Company Incorporated, 1992; Vice President - Regulatory and Governmental Affairs, GTE Telephone Operations, 1989; Director, California Chamber of Commerce; Director, The Los Angeles Area Chamber of Commerce; Director, California Economic Development Corporation.\nThomas W. White 47 1993 Executive Vice President of GTE Telephone Operations, 1993; Senior Vice President - General Office Staff, GTE Telephone Operations, 1989; Director, all GTE domestic telephone subsidiaries, 1993; Director, Quebec- Telephone.\nDirectors are elected annually. The term of each director expires on the date of the next annual meeting of shareholders, which may be held on any day during March, as specified in the notice of the meeting.\nThere are no family relationships between any of the directors or executive officers of the Company.\nAll of the directors, with the exception of Mr. Sparrow, were elected December 10, 1993 following the resignations from the Board of Donald M. Anderson, J. Cleve Borth, Walter A. Dods, Jr., Elizabeth A. Edwards, Admiral Ronald J. Hays, William N. Lampson, Dr. John N. Lein, Donald A. Lockwood, Harry F. Magnuson, Charles T. Manatt, Esq. and James B. Thayer.\nb. Identification of Executive Officers\nYear Assumed Current Name Age Position Position with Company --------- --- -------- --------------------------------\nLarry J. Sparrow(1) 50 1992 Area President - West\nElizabeth A. Edwards 42 1991 Regional Vice President - General Manager-Northwest\nAnthony W. Armstrong 47 1984 Regional Vice President - External Affairs-Northwest\nClark Michael Crawford (1) 47 1992 Area Vice President - General Manager\nJorge Jackson (1)(2) 49 1993 Area Vice President - Public Affairs\nTimothy J. McCallion (1)(3) 40 1993 Area Vice President - Regulatory and Governmental Affairs\nRobert G. McCoy (1) 49 1992 Area Vice President - Sales\nRichard J. Nordman (1)(4) 44 1993 Area Vice President - Finance\nKenneth K. Okel (1) 47 1991 Area Vice President - General Counsel and Secretary\nRonald E. Pejsa (1)(5) 50 1993 Area Vice President - Human Resources\nYear Assumed Current Position with Name Age Position GTE Telephone Operations (6) ---- --- -------- ---------------------------------\nKent B. Foster 50 1989 President\nMichael B. Esstman (7) 47 1993 Executive Vice President - Operations\nThomas W. White 47 1989 Executive Vice President\nGuillermo Amore 55 1990 Senior Vice President - International\nGerald K. Dinsmore (8) 44 1993 Senior Vice President - Finance and Planning\nRobert C. Calafell (9) 52 1993 Vice President - Video Services\nA. T. Jones 54 1992 Vice President - International\nBrad M. Krall (10) 52 1993 Vice President - Centralized Services\nDonald A. Hayes 56 1992 Vice President - Information Technology\nRichard L. Schaulin 51 1989 Vice President - Human Resources\nClarence F. Bercher 50 1991 Vice President - Sales\nMark S. Feighner 45 1991 Vice President - Product Management\nGeoff C. Gould 41 1989 Vice President - Regulatory and Governmental Affairs\nG. Bruce Redditt 43 1991 Vice President - Public Affairs\nRichard M. Cahill 55 1989 Vice President and General Counsel\nLeland W. Schmidt 60 1989 Vice President - Industry Affairs\nPaul E. Miner 49 1990 Vice President - Regional Operations Support\nKatherine J. Harless 43 1992 Vice President- Intermediary Markets\nWilliam M. Edwards, III(11) 45 1993 Controller\nEach of these executive officers has been an employee of the Company or an affiliated company for the last five years.\nExcept for duly elected officers and directors, no other employees had a significant role in decision making.\nAll officers are appointed for a term of one year.\n- ---------- NOTES:\n(1) Individual is an executive officer for West Area which is comprised of GTE California Incorporated, GTE Hawaiian Telephone Company Incorporated and GTE Northwest Incorporated.\n(2) Jorge Jackson was appointed Area Vice President - Public Affairs effective November 12, 1993, replacing Jim J. Parrish who retired.\n(3) Timothy J. McCallion was appointed Area Vice President- Regulatory and Governmental Affairs effective November 21, 1993, replacing Keith M. Kramer who retired.\n(4) Richard J. Nordman was appointed Area Vice President - Finance effective November 7, 1993, replacing Paul R. Shuell.\n(5) Ronald E. Pejsa was appointed Area Vice President - Human Resources effective October 24, 1993, replacing James R. Poling who retired.\n(6) Position is with, and duties are performed at, the GTE Telephone Operations General Office Headquarters in Irving, Texas.\n(7) Michael B. Esstman was appointed Executive Vice President - Operations effective April 25, 1993 replacing Charles A. Crain who retired on April 1, 1993.\n(8) Gerald K. Dinsmore, previously South Area President, was appointed Senior Vice President - Finance and Planning effective November 21, 1993, replacing John L. Hume who retired.\n(9) Robert C. Calafell was appointed Vice President - Video Services effective March 28, 1993.\n(10) Brad M. Krall was appointed Vice President - Centralized Services effective November 7, 1993.\n(11) William M. Edwards, III was appointed Controller effective November 7, 1993 replacing John D. Utzinger.\nLong-Term Incentive Plan - Awards in Last Fiscal Year\nThe GTE Long-Term Incentive Plan (LTIP) provides for awards, currently in the form of stock options with tandem stock appreciation rights and cash bonuses, to participating employees. The stock options and stock appreciation rights awarded under the LTIP to the five most highly compensated individuals in 1993 are shown in the table on page 10.\nUnder the LTIP, performance bonuses are paid in cash based on the achievement of pre-established goals for GTE's return on equity (ROE) over a three-year award cycle. Performance bonuses are denominated in units of GTE Common Stock (\"Common Stock Units\") and are maintained in a Common Stock Unit Account.\nExecutive Agreements\nGTE has entered into agreements (the Agreements) with Messrs. Sparrow, Foster and White regarding benefits to be paid in the event of a change in control of GTE (a \"Change in Control\").\nA Change in Control is deemed to have occurred if a majority of the members of the Board do not consist of members of the incumbent Board (as defined in the Agreements) or if, in any 12-month period, three or more directors are elected without the approval of the incumbent Board. An individual whose initial assumption of office occurred pursuant to an agreement to avoid or settle a proxy or other election contest is not considered a member of the incumbent Board. In addition, a director who is elected pursuant to such a settlement agreement will not be deemed a director who is elected or nominated by the incumbent Board for purposes of determining whether a Change in Control has occurred. A Change in Control will not occur in the following situations: (1) certain merger transactions in which there is at least 50% GTE shareholder continuity in the surviving corporation, at least a majority of the members of the board of directors of the surviving corporation consists of members of the Board of GTE and no person owns more than 20% (or under certain circumstances, a lower percentage, not less than 10%) of the voting power of the surviving corporation following the transaction, and (2) transactions in which GTE's securities are acquired directly from GTE.\nThe Agreements provide for benefits to be paid in the event this individual separates from service and has a \"good reason\" for leaving or is terminated without \"cause\" within two years after a Change in Control of GTE.\nGood reason for leaving includes but is not limited to the following events: demotion, relocation or a reduction in total compensation or benefits, or the new entity's failure to expressly assume obligations under the Agreements. Termination for cause includes certain unlawful acts on the part of the executive or a material violation of his or her responsibilities to the Corporation resulting in material injury to the Corporation.\nAn executive who experiences a qualifying separation from service will be entitled to receive up to two times the sum of (i) base salary and (ii) the average of his or her other percentage awards under the EIP for the previous three years. The executive will also continue to receive medical and life insurance coverage for up to two years and will be provided with financial and outplacement counseling.\nIn addition, the Agreements with Messrs. Sparrow, Foster and White provide that in the event of a separation from service, they will receive service credit in the following amounts: two times years of service otherwise credited if the executive has five or fewer years of credited service; 10 years if credited service is more than five and not more than 10 years; and, if the executive's credited service exceeds 10 years, the actual number of credited years of service. These additional years of service will apply towards vesting, retirement eligibility, benefit accrual and all other purposes under the Supplemental Executive Retirement Plan and the Executive Retired Life Insurance Plan. In addition, each executive will be considered to have not less than 76 points and 15 years of accredited service for the purpose of determining his or her eligibility for early retirement benefits. However, there will be no duplication of benefits.\nThe Agreements remain in effect until the earlier of July 1 of each successive year or the date on which the executive reaches age 65, unless the Agreement is terminated earlier pursuant to its terms. The Agreements will be automatically renewed on each successive July 1 unless, not later than December 31 of the preceding year, one of the parties notifies the other that he does not wish to extend the Agreement. If a Change in Control occurs, the Agreements will remain in effect until the obligations of GTE (or its successor) under the Agreements have been satisfied.\nRetirement Programs\nPension Plans\nThe estimated annual benefits payable, calculated on a single life annuity basis, under GTE's defined benefit pension plans at normal retirement at age 65, based upon final average earnings and years of employment, are illustrated in the table below:\nPENSION PLAN TABLE\nYears of Service Final Average --------------------------------------------------------- Earnings 15 20 25 30 35 -------- --------- --------- --------- --------- ----------\n$ 150,000 $ 31,604 $ 42,138 $ 52,672 $ 63,207 $ 73,742 200,000 42,479 56,638 70,797 84,957 99,117 300,000 64,229 85,638 107,048 128,457 149,867 400,000 85,979 114,638 143,298 171,957 200,617 500,000 107,729 143,638 179,548 215,457 251,367 600,000 129,479 172,638 215,798 258,957 302,117 700,000 151,229 201,638 252,048 302,457 352,867 800,000 172,979 230,638 288,298 345,957 403,617 900,000 194,729 259,638 324,548 389,457 454,367 1,000,000 216,479 288,638 360,798 432,957 505,117 1,200,000 259,979 346,638 433,298 519,957 606,617\nGTE Service Corporation, a wholly-owned subsidiary of GTE, maintains a noncontributory pension plan for the benefit of GTE employees based on years of service. Pension benefits to be paid from this plan and contributions to this plan are related to basic salary exclusive of overtime, differentials, incentive compensation (except as otherwise described) and other similar types of payment. Under this plan, pensions are computed on a two-rate formula basis of 1.15% and 1.45% for each year of service, with the 1.15% service credit being applied to that portion of the average annual salary for the five highest consecutive years that does not exceed the Social Security Integration Level (the portion of salary subject to the Federal Security Act), and the 1.45% service credit being applied to that portion of the average annual salary that exceeds said level. As of March 1, 1994, the credited years of service under the plan for Mr. Sparrow, Ms. Edwards, Messrs. Armstrong, Foster and White are 26, 17, 20, 23 and 25, respectively.\nUnder Federal law, an employee's benefits under a qualified pension plan such as the GTE Service Corporation plan are limited to certain maximum amounts. GTE maintains a Supplemental Executive Retirement Plan (SERP), which supplements the benefits of any participant in the qualified pension plan by direct payment of a lump sum or by an annuity, on an unfunded basis, of the amount by which any participant's benefits under the GTE Service Corporation pension plan are limited by law. In addition, the SERP includes a provision permitting the payment of additional retirement benefits determined in a similar manner as under the qualified pension plan on remuneration accrued under management incentive plans as determined by the Executive Compensation and Organizational Structure Committee.\nExecutive Retired Life Insurance Plan\nThe Executive Retired Life Insurance Plan (ERLIP) provides Mr. Sparrow, Ms. Edwards, Messrs. Armstrong, Foster and White a maximum postretirement life insurance benefit of three times final base salary. Upon retirement, ERLIP benefits may be paid as life insurance or optionally, an equivalent amount may be paid as a lump sum payment equal to the present value of the life insurance amount (based on actuarial factors and the interest rate then in effect), as an annuity or as installment payments. If an optional payment method is selected, the ERLIP benefit will be based on the actuarial equivalent of the present value of the insurance amount.\nDirectors' Compensation:\nThe current directors, all of whom are employees of GTE, are not paid any fees or remuneration, as such, for service on the Board.\nItem 12.","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners as of February 28, 1994:\nName and Shares of Title Address of Beneficial Percent of Class Beneficial Owner Ownership of Class -------- ---------------- ---------- ----------- Common Stock of GTE Corporation 17,920,000 100% GTE Northwest One Stamford Forum shares of Incorporated Stamford, Connecticut record\n(b) Security Ownership of Management as of December 31, 1993:\nName of Director or Nominee --------------------------- Common Stock of Richard M. Cahill (1) 37,188 All less GTE Corporation Gerald K. Dinsmore (1) 18,503 than 1% Michael B. Esstman 54,051 Kent B. Foster 168,299 Larry J. Sparrow 33,749 Thomas W. White 83,071 ------- 394,861 =======\nExecutive Officers(1)(2) ------------------------ Larry J. Sparrow 33,749 Elizabeth A. Edwards 11,256 Anthony W. Armstrong 1,451 Kent B. Foster 168,299 Thomas W. White 33,749 ------- 248,504 ======= All directors and executive officers as a group(1)(2) 771,063 ======= - ---------- (1) Includes shares acquired through participation in GTE's Consolidated Employee Stock Ownership Plan and\/or the GTE Savings Plan.\n(2) Included in the number of shares beneficially owned by Mr. Sparrow, Ms. Edwards, Messrs. Armstrong, Foster and White and all directors and executive officers as a group are 27,537; 6,033; 0; 115,583; 69,466 and 522,451, shares, respectively, which such persons have the right to acquire within 60 days pursuant to stock options.\n(c) There were no changes in control of the Company during 1993.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Company's executive officers or directors were not materially indebted to the Company or involved in any material transaction in which they had a direct or indirect material interest. None of the Company's directors were involved in any business relationships with the Company.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)(1) Financial Statements - Reference is made to the Registrant's Annual Report to Shareholders, pages 5 - 25 , for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.\nReport of Independent Public Accountants.\nConsolidated Balance Sheets - December 31, 1993 and 1992.\nConsolidated Statements of Income for the years ended December 31, 1993-1991.\nConsolidated Statements of Reinvested Earnings for the years ended December 31, 1993-1991.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993-1991.\nNotes to Consolidated Financial Statements.\n(2) Financial Statement Schedules - Included in Part IV of this report for the years ended December 31, 1993-1991: Page(s) ------- Report of Independent Public Accountants 21\nSchedules:\nV - Property, Plant and Equipment 22-24\nVI - Accumulated Depreciation and Amortization of Property, Plant and Equipment 25\nVIII - Valuation and Qualifying Accounts 26\nX - Supplementary Income Statement Information 27\nNote: Schedules other than those listed above are omitted as not applicable, not required, or the information is included in the financial statements or notes thereto.\n(3) Exhibits - Included in this report or incorporated by reference.\n2.1 Plan of Merger of Contel of the Northwest, Inc. into GTE Northwest Incorporated dated November 18, 1992.\n13 Annual Report to Shareholders for the year ended December 31, 1993, filed herein as Exhibit 13.\n(b) Reports on Form 8-K - No reports on Form 8-K were filed during the fourth quarter of 1993. - ---------- * Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo GTE Northwest Incorporated:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in GTE Northwest Incorporated and subsidiary's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes in 1992 as discussed in Note 1 to the consolidated financial statements. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed under Item 14 are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nDallas, Texas January 28, 1994.\nGTE NORTHWEST INCORPORATED AND SUBSIDIARY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (Thousands of Dollars)\n- ------------------------------------------------------------------------------ Column A Column B --------------- ------------------------------------------- Item Charged to Operating Expenses - ------------------------------------------------------------------------------\n1993 1992 1991 ---------- ---------- ---------- Maintenance and repairs $ 144,364 $ 136,018 $ 140,579 ========== ========== ========== Taxes, other than payroll and income taxes, are as follows:\nReal and personal property $ 28,742 $ 21,207 $ 26,461 State gross receipts 10,015 7,578 8,467 Other 6,926 4,728 6,728 Portion of above taxes charged to plant and other accounts (4,333) (4,301) (4,450) ---------- ---------- ---------- Total $ 41,350 $ 29,212 $ 37,206 ========== ========== ==========\nSIGNATURES\nPursuant 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.\nGTE NORTHWEST INCORPORATED (Registrant)\nDate March 21, 1994 By LARRY J. SPARROW -------------- --------------------------- LARRY J. SPARROW Area President - West\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nLARRY J. SPARROW President and Director March 21, 1994 - ---------------- (Principal Executive Officer) LARRY J. SPARROW\nGERALD K. DINSMORE Senior Vice President--Finance March 21, 1994 - ------------------ and Planning and Director GERALD K. DINSMORE (Principal Financial Officer)\nWILLIAM M. EDWARDS, III Controller March 21, 1994 - ----------------------- (Principal Accounting Officer) WILLIAM M. EDWARDS, III\nRICHARD M. CAHILL Director March 21, 1994 - ----------------- RICHARD M. CAHILL\nMICHAEL B. ESSTMAN Director March 21, 1994 - ------------------ MICHAEL B. ESSTMAN\nKENT B. FOSTER Director March 21, 1994 - -------------- KENT B. FOSTER\nTHOMAS W. WHITE Director March 21, 1994 - --------------- THOMAS W. WHITE","section_15":""}
{"filename":"75488_1993.txt","cik":"75488","year":"1993","section_1":"ITEM 1. BUSINESS.\nGENERAL\nCORPORATE STRUCTURE AND BUSINESS\nPacific Gas and Electric Company (the Company) is an operating public utility engaged principally in the business of supplying electric and natural gas service throughout most of Northern and Central California, a territory with an estimated population of 12,800,000. As of December 31, 1993, the Company served approximately 4,400,000 electric customers and 3,600,000 gas customers. As of December 31, 1993, the Company (excluding subsidiaries) had approximately 23,000 employees.\nThe Company was incorporated in California in 1905. Its principal executive office is located at 77 Beale Street, P.O. Box 770000, San Francisco, California 94177, and its telephone number is (415) 973-7000.\nThe Company's service territory covers 94,000 square miles, and includes all or portions of 48 of California's 58 counties. The area's diverse economy includes aerospace, electronics, financial services, food processing, petroleum refining, agriculture and tourism.\nAs of December 31, 1993, the Company had approximately $27 billion in assets. The Company generated approximately $10.6 billion in operating revenues for 1993. The Company's revenues come from three sources: traditional gas and electric utility operations, Diablo Canyon Nuclear Power Plant (Diablo Canyon) operations, and activities conducted through the Company's nonregulated subsidiary, PG&E Enterprises (Enterprises). The Company's traditional utility operations are generally regulated under the cost-based approach to ratemaking. Diablo Canyon operations are conducted under a performance based approach to alternative ratemaking, as a result of the Diablo Canyon rate case settlement, effective in 1988. Under this approach, revenues for the plant are based primarily on the amount of electricity generated, rather than on the costs associated with the plant's operations. Enterprises, a wholly owned subsidiary of the Company, is the parent company for the nonregulated portion of the Company's business, which includes non-utility electric generation facilities and natural gas and oil exploration and development.\nThe Company serves its electric customers with power generated by eight primarily natural gas-fueled power plants, ten combustion turbines, one nuclear power plant, 70 hydroelectric powerhouses, one hydroelectric pumped storage plant and a geothermal energy complex of 14 units. The Company also purchases power produced by other generating entities that use a wide array of resources and technologies, including hydroelectric, wind, solar, biomass, geothermal and cogeneration. In addition, the Company is interconnected with electric power systems in 14 western states and British Columbia, Canada, for the purposes of buying, selling and transmitting power.\nTo ensure a diverse and competitive mix of natural gas supplies, the Company has supply contracts of varying lengths with both Canadian and United States suppliers. In 1993, about 55% of the Company's gas supply came from fields in Canada, about 40% came from fields in other states (substantially all from the U.S. Southwest) and about 5% came from fields in California.\nIn February 1993, the Company announced a corporate reorganization to consolidate certain business units, operating regions and operating divisions. As a result of the reorganization, the Company is organized into five business units: Customer Energy Services (formerly known as the Distribution business unit), Electric Supply, Gas Supply, Nuclear Power Generation and Enterprises. The former Engineering and Construction business unit has been disbanded, with its functions assumed by the remaining business units. The business units will continue to be supported by Corporate Services departments, which provide essential corporate services and management functions.\nCOMPETITION\nUnder traditional utility regulatory schemes, utilities have been accorded the exclusive right to serve customers within designated areas in return for their commitment to provide service to all who request it.\nRegulation was designed in part to take the place of competition to ensure that utility services were provided at fair prices.\nThe Company is currently experiencing increasing competition in both the gas and electric energy markets. Recent restructuring in both the gas and electric industries has resulted in the separation of the energy supply function from the energy services function in both the gas and electric businesses. These changes have allowed competition to flourish in the gas supply and electric production segments of the energy business.\nAs a result of regulatory changes in the gas industry, the Company no longer provides combined purchase and transportation services to many of its industrial and large commercial (noncore) gas customers. Instead, many noncore customers now purchase gas supplies directly from a gas shipper or producer, reserve interstate transportation capacity directly from an interstate pipeline, and then purchase intrastate transportation service from the Company once their gas arrives at the California border. In addition, an interstate pipeline company has proposed expanding its facilities into the Company's service territory. If approved, the expansion would allow that pipeline company to compete directly for intrastate transportation service to the Company's noncore customers. See \"Gas Utility Operations -- Other Competitive Interstate Pipeline Projects\" below.\nIf, in the restructured gas industry, the Company's gas customers elect to serve their own gas supply needs, reserve their own interstate transportation capacity, or leave the Company's system altogether by moving to an alternative intrastate delivery system, the Company may find that it needs to spread the fixed costs of its gas supply and delivery system over fewer units of sales. Unless costs are reduced or imposed as transition charges on exiting customers, or other measures are taken, the price per unit would go up and remaining customers would be asked to pay higher prices, further exacerbating the competitive pressures.\nThe restructuring of the natural gas industry has already had a significant impact on the Company's gas operations. In 1993, the Company terminated its long-term Canadian gas purchase contracts and entered into new, more flexible arrangements for the purchase of the Company's current lower gas supply requirements. In addition, the Company is continuing its efforts to permanently assign or broker its commitments for firm gas transportation capacity which it once held for its noncore customers.\nChanges in the electric utility industry are following the pattern of change in the natural gas industry. The Company continues to perform the functions of electricity production, transmission, distribution and customer service. However, the Company already obtains one-third of its electrical power supply from generation sources outside its service territory and from qualifying facilities, or QFs (small power producers or cogenerators who meet certain federal guidelines which qualify them to supply generating capacity and electric energy to utilities), owned and operated by independent power producers (IPPs). Future additions to satisfy electric supply needs in the Company's service territory will be determined largely through a competitive resource procurement process, a feature of the new competitive market for electric generation. It is expected that new power plant projects will be increasingly undertaken by IPPs rather than utilities, and indeed, the Company has indicated a willingness to forgo building new generation capacity in its service territory if the electric resource procurement process is appropriately reformed. In addition, federal regulators now have increased authority to order a utility to transport and deliver, or \"wheel,\" energy for any wholesale purchaser or seller of power, and it is possible that the trend of increasing wholesale transmission access could lead to increased pressure for state regulators to mandate wheeling to retail customers. Whether states have authority to order retail wheeling is as yet undetermined. If future restructuring were to include retail wheeling whereby customers purchase energy directly from an IPP or other supplier and separately pay the Company to wheel the purchased power, the Company's power generation plants and resources would be subject to even greater competition from other available supply options.\nUnder current regulation, customer prices are based on an allocation among customer classes of the Company's approved cost-of-service revenue requirements. Currently, large industrial and commercial customers are most likely to have lower cost competitive gas supply and electric generation alternatives. If a substantial number of these customers were to elect those alternatives and leave the Company's system, the Company's recovery of its investment in production sources and distribution facilities would be dependent on prices charged to remaining customers and the Company's ability to reduce costs. This could lead to lower\nshareholder returns. In addition, the continuing recession in California's economy has resulted in reduced growth in demand for the Company's products and services. California's current economic condition could also lead to increased regulatory resistance to, and reduced customer acceptance of, higher prices.\nCurrently, the Company's average gas prices for residential, commercial and industrial customers are among the lowest utility gas prices in California. The Company's current electric prices are less competitive than its gas prices. Although the Company's residential electric bills are at the low end of the scale nationally, the Company's prices per kilowatt-hour (kWh) are high when compared with national averages. The Company's prices for industrial customers average approximately 7.3 cents per kWh, which is comparable to prices charged by the other major California utilities, but above the industrial electric prices in many other states. The Company's system average electric price, at 10.6 cents per kWh, is the highest in California and has increased slightly faster than inflation over the past five years. The Company's electric prices include the costs for generation, transmission, distribution and customer service.\nIn an effort to improve its ability to succeed in the face of greater competition, the Company has taken steps to improve service to customers, reduce costs and lower the price of gas and electric service. To help reduce its costs and maintain competitive prices, the Company has:\n-- reduced its workforce by approximately 3,000 positions, which is expected to result in net revenue requirement savings of approximately $170 million during the three-year 1993 General Rate Case cycle and annual revenue requirement savings of at least $200 million beginning in 1996 (see \"Current Rate Proceedings -- Workforce Reduction Rate Mechanism\" below);\n-- reduced its cost of capital by taking advantage of significantly lower interest rates to refinance a significant portion of its long-term debt and a portion of its preferred stock; and\n-- obtained California Public Utilities Commission (CPUC) approval to freeze current electric rates through the end of 1994 and to reduce electric rates by $100 million for major businesses over an 18-month period beginning in July 1993 (see \"Current Rate Proceedings -- Electric Rate Initiative\" below).\nThe Company has also taken specific steps which will assist it in remaining competitive in the restructured gas industry.\n-- In November 1993, the Company terminated its long-term Canadian gas purchase contracts and entered into new, more flexible arrangements for the purchase of the Company's current lower gas supply requirements. See \"Gas Utility Operations -- Restructuring of Canadian Gas Supply Arrangements -- Decontracting Plan\" below.\n-- The Company has implemented gas rate design modifications intended to more accurately reflect the cost to serve each customer class. Although implementation of the new rates did not result in an overall increase in the Company's authorized revenues, upon implementation the overall gas transportation rates for large industrial noncore customers decreased by approximately 31% and the overall transportation rate for utilities using gas to generate electricity decreased by approximately 20%, while residential and smaller commercial (core) customer rates for bundled gas service (procurement and transportation) increased by approximately 5% compared to rates previously in effect.\n-- The Company has entered into long-term gas transportation contracts providing discounted rates for certain major industrial customers. The CPUC has approved on an expedited basis eleven long-term contracts with existing customers, ten of those under the Expedited Application Docket (EAD) procedure. The eleven long-term contracts together represent approximately 7% of the Company's noncore transportation revenues and approximately 12% of the Company's transportation revenues from industrial and cogeneration customers. The Company is currently precluded from recovering in rates 25% of the revenue shortfalls resulting from discounts given in these contracts until the CPUC adopts final rules regarding noncore transportation pricing or approves recovery by the Company of such amounts as part of the Company's next gas ratemaking proceeding. See \"California Ratemaking\nMechanisms -- Gas Revenue Mechanisms\" below. At that time, the CPUC is expected to make a further determination as to the rate recovery of revenue shortfalls attributable to EAD contracts.\n-- The Company has filed for approval new long-term gas transportation rates to be offered to its largest industrial and cogeneration customers. See \"Long-Term Gas Transportation Rates\" below. Approval of these rates will enable the Company to offer competitive long-term rates without the burden of the contract-by-contract approval required under the EAD procedure.\nIn addition, the Company is currently seeking fundamental changes in the overall regulatory regime under which it must operate in order to allow the Company greater flexibility to compete in today's markets and still achieve its pricing and earnings goals. In March 1994, the Company filed an application with the CPUC requesting it adopt the Company's Regulatory Reform Initiative (RRI). The RRI has three components. The first, performance based ratemaking for determining base revenues, would replace several traditional rate cases with a framework which includes a base revenue index and financial incentives tied to performance standards. The Company would manage its non-fuel costs in accordance with revenue determined by an external index, instead of having its actual or forecast costs subject to detailed CPUC review. The performance standards would provide the Company with significant incentives to maintain its quality of service, as well as to provide that service while lowering residential customers' bills as much as possible. The PBR proposal provides for the sharing between ratepayers and shareholders of earnings above or below a target utility return on equity that would be computed annually.\nThe second component of the RRI involves the creation of a Large Electric Manufacturing Class (LEMC) of customers. This proposal is intended to provide large manufacturing customers the price certainty and tariff options they need to be competitive, as well as the ability to negotiate customized contracts with the Company. The Company expects that the new tariff options will influence the LEMC customers' decisions to retain and\/or expand their operations in California, and encourage other manufacturers to establish operations in the state. Also, the flexibility afforded by the LEMC proposal would allow a more prompt response to the LEMC customers' existing competitive alternatives, and thus help to avert the uneconomic bypass of the Company's electric system.\nThe third component involves the use of market benchmarks to evaluate gas procurement costs. A specific proposal regarding the third component is not included in the Company's March 1994 filing but is expected to be filed at a later date. See \"Regulatory Reform Initiative\" for more details regarding the RRI.\nCALIFORNIA RATEMAKING MECHANISMS\nThe ratemaking mechanisms currently applied by the CPUC in setting the Company's rates are discussed below. As noted above (see \"Competition\"), the Company has filed an application with the CPUC requesting adoption of the RRI as an alternative to the current regulatory approach to setting rates. If adopted, the RRI would significantly alter the ratemaking mechanisms described below. In addition, the Company implemented its electric rate initiative in 1993, which impacted the application of certain of these ratemaking mechanisms in current rate proceedings (see \"Current Rate Proceedings\" below).\nGENERAL RATE CASE AND ATTRITION MECHANISMS\nGeneral Rate Case (GRC). Under the CPUC's Rate Case Plan, the CPUC sets the Company's base revenue requirements for both electric and gas operations in the GRC proceeding. Base revenue is revenue intended to recover the Company's fixed costs and non-fuel variable costs and to provide a return on invested capital. (Fuel revenue requirements, intended to offset the Company's fuel and fuel-related costs, are set as part of the Energy Cost Adjustment Clause proceeding for electric operations and the Biennial Cost Allocation Proceeding for gas operations, as discussed below.) The Company files a GRC application once every three years, with a decision issued approximately 13 months after the application is filed. In this proceeding, revenues and expenses are determined on a forecast or future test-year basis, rather than on a historic-year basis. A decision was issued in the Company's 1993 GRC in December 1992. In November 1993, the CPUC denied the petition filed in January 1993 by the CPUC's Division of Ratepayer Advocates\n(DRA) and various special interest groups to modify the decision in the Company's 1993 GRC so as to reduce the authorized revenue requirements. Under the current GRC mechanism, the Company's next GRC, based on a 1996 test year, would be filed in late 1994. Pending adoption of the RRI, the Company will proceed to make that filing in 1994.\nAttrition Rate Adjustment (ARA). The ARA adjusts base rates in the years between GRC decisions to partially offset attrition in earnings due to changes in operating expenses and capital costs. Labor expenses and nonlabor maintenance and operation expenses are indexed, and a prescribed amount is allowed for recovery of expenses related to changes in depreciation, income taxes, financing costs, rate base growth and other items. The cost of capital, including authorized return on equity, is determined separately by the CPUC in the annual Cost of Capital consolidated proceeding which reviews financing costs and adopts capital structures for all California energy utilities. Changes in fuel and fuel-related costs are addressed in the Energy Cost Adjustment Clause proceeding for electric operations and the Biennial Cost Allocation Proceeding for gas operations, both of which are discussed below. The ARA improves the Company's ability to earn its authorized rate of return for utility operations in the years between GRCs.\nIn May 1993, the DRA and various special interest groups filed a joint petition with the CPUC requesting suspension, for an indefinite period, of the ARA mechanism currently in place for the Company. The petition requests that any future attrition rate increases be considered only upon application by the Company for such relief and only if the then current rate of inflation exceeds 6% on an annual basis. Under such circumstances, the petition recommends that the level of any attrition rate adjustment ultimately authorized by the CPUC be limited only to inflation above the 6% threshold level. In June 1993, the Company filed its response to the petition stating that the current ARA mechanism is a necessary feature of the three-year GRC cycle even during periods of low inflation.\nELECTRIC REVENUE MECHANISMS\nEnergy Cost Adjustment Clause (ECAC). Starting in 1994 with the reinstatement of the Annual Energy Rate (AER) mechanism described below, the ECAC provides for recovery of 91% of the cost of fuel and purchased energy, fuel oil inventory carrying costs up to an authorized level, facility charges and certain gains or losses from the sale of fuel oil, and for collection of performance-based Diablo Canyon revenues. The remaining 9% of the energy costs are recoverable through the AER procedure described below. Differences between total ECAC revenues and the sum of actual electric energy costs recoverable through the ECAC and Diablo Canyon revenues accumulate in a balancing account, usually with interest, and are recovered from or returned to customers through subsequent ECAC rates. Also included in the ECAC proceeding are revenue adjustments resulting from the Low Income Rate Assistance program and the Electric Revenue Adjustment Mechanism described below. Recovery of costs included in the ECAC is subject to a determination that such costs were incurred reasonably. (Diablo Canyon costs are not subject to reasonableness review, but are recovered pursuant to the Diablo Canyon rate case settlement. See \"Diablo Canyon -- Diablo Canyon Settlement\" below.) ECAC rates are set once a year, based on a January 1 revision date, to recover electric energy-related costs based on a forward-looking calendar test year. ECAC rates also are subject to adjustment effective May 1 if the required adjustment would be more than 5% of total annual electric revenues. The Company's next ECAC application is expected to be filed on April 1, 1994.\nAnnual Energy Rate (AER). The AER mechanism, which had been suspended in August 1990, was reinstated by the CPUC in December 1993. The reinstatement of the AER mechanism places the Company at partial risk for variations between actual and forecasted energy expenses, since there is no specific balancing account associated with the AER. The AER provides for recovery of 9% of forecasted energy costs and the amounts collected under the AER will not be adjusted if actual costs differ from the amounts authorized. To minimize the revenue risk resulting from the potential for substantial swings in energy-related expenses, the allowable pre-tax earnings fluctuation (up or down) resulting from the AER procedure is limited by a 140 basis-point cap applied to earnings on the equity portion of total rate base. To the extent that AER-related energy expenses exceed the allowable range of fluctuation, such expenses outside the allowable range become subject to ECAC balancing account treatment. The AER mechanism is on the same time schedule as the ECAC mechanism.\nElectric Revenue Adjustment Mechanism (ERAM). The ERAM allows rate adjustments to offset the effect on base revenues of changes in electric sales from the level used to set rates in the last GRC or ARA proceeding. The ERAM eliminates the impact on earnings of sales fluctuations, including those resulting from conservation and weather conditions. Base revenue differences resulting from the disparity between actual and forecasted electric sales accumulate in a balancing account, with interest, and are recovered from or returned to customers through subsequent ERAM rate adjustments. ERAM rate adjustments are made as part of the ECAC process with a January 1 revision date.\nGAS REVENUE MECHANISMS\nBiennial Cost Allocation Proceeding (BCAP). The BCAP forecasts the cost of gas, allocates costs of providing gas service to various customer classes, including the base revenue amount approved in the GRC or ARA, and sets associated rates. Issues considered in the BCAP include: (i) the gas transportation forecast (throughput), purchased gas costs and transportation revenue requirement forecast for costs other than the base amount; (ii) the allocation of costs between core and noncore customer classes; and (iii) the rates for procurement services for core customers and for transportation and related services for each customer class. Core customers include all residential customers and commercial customers that do not exceed certain volume limitations. Noncore customers are industrial and larger commercial customers that exceed certain volume limitations. A filing is made on August 15 of every other year for rates to be effective on April 1 of the following year. The Company's next BCAP application is currently scheduled to be filed in August 1994. An interim filing, referred to as a trigger filing, is permitted to set new rates for the second year of the BCAP period if amortization of accumulated over-or under-collections in balancing accounts would change either bundled core rates or noncore transportation rates by more than 5%.\nIn December 1992, the CPUC announced proposed rules which would (i) extend the gas ratemaking cycle from two to three years and (ii) reduce the amount of balancing account protection provided for noncore transportation revenues. Other than accepting comments from interested parties, the CPUC has taken no further action on the proposed rules.\nPurchased Gas Account (PGA). The PGA is a balancing account which accumulates differences between actual cost of gas procured for the core portfolio and revenues intended to cover those costs. Those differences accumulate with interest, and are recovered from or returned to procurement customers through subsequent BCAP rate adjustments.\nGas Fixed Cost Accounts (GFCAs). The GFCAs include separate core and noncore accounts. The core GFCA is a balancing account that accumulates the differences between most of actual transportation revenues from core customers and the sum of the authorized core base revenue amount and core gas service costs. The difference accumulates with interest, and is recovered from or returned to customers through subsequent BCAP rate adjustments. The noncore GFCA tracks 75% of the difference between most of actual transportation revenues from noncore customers and the sum of the authorized noncore base revenues and noncore gas service costs. This amount accumulates with interest, and is recovered from or returned to customers through subsequent BCAP rate adjustments.\nInterstate Transition Cost Surcharge (ITCS) Account. The ITCS is a balancing account that accumulates unrecovered demand charges for interstate capacity acquired by a utility prior to the adoption of the CPUC's capacity brokering rules in November 1991. Demand charges that are not fully recovered because of the operation of the capacity brokering rules accumulate in the ITCS account and are recovered through subsequent BCAP rate adjustments as authorized by the CPUC. Unrecovered demand charges will be allocated to customers on an equal cents-per-therm-usage basis, subject to a limit on the amount that can be allocated to core customers.\nOTHER RATE ADJUSTMENT MECHANISMS\nLow Income Rate Assistance (LIRA). The LIRA program was established by the CPUC in 1989 to provide discount residential electric and gas rates for customers who qualify under low-income criteria. LIRA\nprogram administrative costs are recovered through base rate revenues and the direct cost of LIRA rate discounts are funded through LIRA rate adjustments made in the ECAC and BCAP proceedings.\nCustomer Energy Efficiency (CEE). Under the CEE ratemaking mechanism adopted in 1990, the Company is authorized to recover in rates some of the energy savings resulting from and costs of certain of its CEE programs. Beginning in 1994, CEE rate adjustments resulting from shareholder incentives earned on CEE programs will be determined as part of the Annual Earnings Assessment Proceeding (AEAP), a new consolidated proceeding established by the CPUC to authorize shareholder earnings for the Company and the other California energy utilities arising out of the previous year's CEE program accomplishments. See \"CEE\/DSM Programs\" below. Prior to 1994, these adjustments had been made in the ECAC proceeding.\nCATASTROPHIC EVENTS MEMORANDUM ACCOUNT (CEMA)\nThe CEMA permits utilities to record for eventual recovery through rates the reasonable costs they incur in restoring service, repairing or replacing facilities and complying with government orders following a catastrophic event which is declared a disaster by the appropriate federal or state authorities. The utility must seek recovery of costs accumulated in the CEMA through a GRC or other formal rate-setting application, with recovery subject to a reasonableness review by the CPUC.\nREGULATORY REFORM INITIATIVE\nThe Company has been engaged in discussions with the CPUC, customers and other interested parties concerning various reforms to the current regulatory approach to setting rates. On March 1, 1994, the Company filed an application with the CPUC requesting it adopt the Company's proposed RRI and approve 1995 electric and gas base revenue requirements.\nThe RRI is, in part, a response to the report issued in February 1993 by the CPUC's Division of Strategic Planning on electric industry restructuring. That report concluded that the current regulatory approach is incompatible with the emerging industry structure resulting from technological change, competitive pressure and new market forces. The report indicated that the existing cost-of-service ratemaking does not provide sufficient incentives for efficient utility operations and disproportionately favors additions to rate base as opposed to energy efficiency or purchased power alternatives, and that the number and complexity of proceedings result in significant administrative costs and burdens which threaten the quality of public participation in CPUC proceedings. Although the report indicated the necessity for reform of the regulatory framework, it did not ultimately recommend a specific strategy.\nThe Company's RRI has three components: (i) performance based ratemaking (PBR) for determining base revenues; (ii) establishment of the LEMC, consisting of large electric manufacturing customers; and (iii) use of market benchmarks to evaluate gas procurement costs. A specific proposal regarding the third component is not included in the Company's March 1, 1994 filing but is expected to be filed at a later date.\nIn its filing, the Company proposes a schedule calling for technical workshops in April, public hearings beginning in June and a final CPUC decision by the end of 1994. The Company has requested that the RRI become effective on January 1, 1995.\nPBR\nUnder the Company's PBR proposal, electric and natural gas base revenues would be determined annually by formula rather than through GRCs, ARAs and Cost of Capital proceedings. Base revenues are the revenues intended to recover the Company's operation and maintenance expenses (excluding costs for fuel or fuel-related items), depreciation expense, income and other taxes, and to provide a return on invested capital. Revenues to offset fuel and fuel-related costs would still be determined in the ECAC proceeding for electric operations and the BCAP for gas operations. The PBR mechanism will not apply to the base revenue associated with Diablo Canyon, including Diablo Canyon decommissioning costs, which will continue to be determined pursuant to the Diablo Canyon rate case settlement. See \"Diablo Canyon -- Diablo Canyon Settlement\" below.\nThe Company's proposed PBR mechanism would determine the base revenues for a given calendar year by multiplying the base revenues authorized for the prior calendar year by an index consisting of inflation plus customer growth less a prescribed productivity factor. Those revenues would also be adjusted up or down depending on the Company's achievement relative to four performance standards: CEE programs, Energy Bills (i.e., a comparison of the Company's overall residential electric and gas bills relative to national averages), Customer Satisfaction and Electric Service Reliability. The positive or negative adjustments related to the Company's performance in these four areas would be one-time modifications to that year's base revenues as calculated under the PBR index formula. The adjustments for CEE incentives would be determined as they currently are under existing ratemaking procedures. The maximum adjustments that the Company could earn related to Energy Bills and Customer Satisfaction is $25 million per year for each, and the maximum for Electric Service Reliability is $19 million per year. Under PBR, the Company could also apply for an adjustment to base revenues due to the occurrence of certain extraordinary events outside the Company's control, including events that would currently qualify for ratemaking treatment through the existing CEMA (see \"California Ratemaking Mechanisms -- Catastrophic Events Memorandum Account\" above).\nThe PBR proposal provides for the sharing between ratepayers and shareholders of earnings above or below a target utility return on equity (ROE) that would be computed annually. To the extent actual ROE exceeds more than 200 basis points above or below the target ROE, the difference would be shared equally with ratepayers through a reduction or increase in the next year's base revenue. If actual ROE was more than 500 basis points above or below the target ROE, then the Company and the CPUC would each have the option to initiate a proceeding to reexamine the PBR formula.\nThe Company is proposing that base revenue indexing begin in 1995. However, the Company proposes to forgo any increase in the electric base revenue for 1995 determined under the PBR mechanism. Instead, 1995 electric base revenue would be held at the 1994 level.\nIn its filing, the Company proposes that the RRI remain in place indefinitely. The Company recommends that after five years the CPUC review the PBR mechanism and make any necessary adjustments, but not return to the use of traditional rate cases to set rates.\nLEMC\nAs proposed by the Company, the LEMC would consist of the Company's largest electric accounts (having an average hourly electricity usage over a 12-month period of at least 2,000 kilowatts) engaged in manufacturing. Currently, approximately 120 accounts would qualify for inclusion in the LEMC.\nLEMC customers would be removed from cost-of-service ratemaking. Standard LEMC tariff rates would be determined every calendar year by an index formula, similar to that used in the PBR mechanism, which is intended to reflect inflation less a productivity factor. In addition, several long-term tariff options designed to respond to these customers' competitive alternatives would be offered to the LEMC. The Company also seeks authorization to negotiate and enter into customized contracts with LEMC customers. In some cases, the customized contracts would become effective without prior approval or subsequent review by the CPUC of the contract terms.\nGenerally, the Company proposes to separate the costs allocated to the LEMC and bear the risk of their recovery if sales to these customers decline over time. The Company's shareholders would bear the risk of LEMC costs that increase faster than the LEMC price index.\nACCOUNTING IMPLICATIONS\nBased on the regulatory framework in which it operates, the Company currently accounts for the economic effects of regulation in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" As a result, the Company defers recognition of costs which would otherwise be expensed when incurred because regulators have provided mechanisms that make it probable that the costs will be included in future rates. If the RRI is\nadopted, the mechanics of the rate setting process would change. However, the Company anticipates that rates derived from the RRI would remain based on cost-of-service, with the exception of rates for the LEMC customers and rates established under certain other regulatory mechanisms proposed to be discontinued upon adoption of the RRI.\nIf the RRI is adopted as proposed, the Company anticipates that it will write-off certain regulatory assets, including an estimated $65 million related to the LEMC customers and potentially additional amounts which may be affected by the adoption of the RRI, the aggregate amount of which could have a significant adverse impact on the Company's financial position or results of operations. The estimated amount related to the LEMC is based on the base revenue allocation currently used in establishing rates; the actual amount could vary depending on the allocation method adopted by the CPUC. The final determination of the accounting impact will be dependent upon the form of the regulatory reform ultimately adopted.\nIn the event that recovery of specific costs through rates becomes unlikely or uncertain for a portion or all of the Company's utility operations, whether resulting from the expanding effects of competition or specific regulatory actions which force the Company away from cost-of-service ratemaking, SFAS No. 71 would no longer apply. Discontinuation of SFAS No. 71 would cause the write-off of the applicable portion of regulatory assets, including regulatory balancing accounts receivable and those regulatory assets included in deferred charges, which could have a significant adverse impact on the Company's financial position or results of operations.\nLONG-TERM GAS TRANSPORTATION RATES\nOn March 18, 1994, the Company filed an advice letter with the CPUC, requesting authorization to implement an optional long-term noncore gas transportation tariff. This tariff would be offered to the Company's largest industrial and cogeneration gas transport customers (having an annual usage greater than three million therms) under a standard ten-year service agreement.\nThe proposed rates are intended to enable the Company to more effectively meet intensified competition by allowing it to offer a long-term competitive rate without having to obtain CPUC approval on a contract-by-contract basis as is currently required under the EAD procedure. The proposed rates are within the range of rates negotiated under existing EAD contracts and will exceed the marginal cost of serving the customers eligible for the new rates. The Company's shareholders will bear the risk of any revenue shortfalls attributable to any differences between the long-term rate option and the customer's otherwise applicable rate.\nThe Company has requested that the requested tariff changes become effective no later than June 1, 1994. If approved, the rates would be offered to existing qualifying customers in a two-month open season commencing on that date.\nIf its advice letter is approved, the Company anticipates that it will discontinue application of SFAS No. 71 for the customers accepting the long-term service agreement. This would cause a write-off of as much as approximately $25 million of regulatory assets related to those specific customers which elect to use the new tariff. This estimated amount is based on the base revenue allocation currently used in establishing rates; the actual amount could vary depending on the allocation method adopted by the CPUC.\nCURRENT RATE PROCEEDINGS\nELECTRIC RATE INITIATIVE\nIn April 1993, the Company proposed a comprehensive electric rate initiative to freeze current retail electric rates through the end of 1994 and to reduce electric rates by $100 million for major businesses as an economic stimulus for those customers. In June 1993, the CPUC approved the economic stimulus rate, effective for the period July 1993 through December 1994.\nIn December 1993, the CPUC approved the electric rate freeze and issued its decisions in the Company's ARA and ECAC proceedings. As part of the ECAC decision, the CPUC approved the Company's request to defer beyond 1994 recovery of a portion of the undercollections in the ECAC balancing account. The total undercollection at December 31, 1993 was $427 million.\nPursuant to the electric rate initiative, the effects of the CPUC decisions on the Company's various electric rate proceedings were consolidated resulting in a net change in electric rates of zero, effective January 1994 (see \"1994 Revenue Changes\" below).\n1994 REVENUE CHANGES\nThe following table summarizes the various rate case decisions that became effective on January 1, 1994.\nSUMMARY OF RATE CASE DECISIONS EFFECTIVE JANUARY 1, 1994 (IN MILLIONS)\nARA Proceeding. In December 1993, the CPUC issued a resolution authorizing the Company to implement an adjustment to base rates pursuant to the ARA mechanism, effective January 1, 1994, which results in a net attrition increase of $41 million for electric base rates and $54 million for gas base rates. These adjustments incorporate the final decision in the Company's 1994 Cost of Capital proceeding described below. As part of the Company's electric rate initiative, the $41 million increase excludes approximately $20 million of increased taxes attributable to the higher corporate tax rate recently adopted for which the Company would otherwise have sought recovery through the ARA mechanism but instead will forgo.\nThe CPUC's resolution also authorized the Company to reduce its 1994 electric and gas base revenues by approximately $143 million and $60 million, respectively, primarily as a result of the net savings from the Company's workforce reduction program and a plan change that will limit the amount the Company will contribute toward post-retirement medical benefits. These reductions in revenue requirements for electric operations were used to offset the $41 million attrition increase and to reduce undercollections in the ERAM balancing account by $102 million. Pursuant to the electric rate initiative, electric base revenues were held constant, resulting in a consolidated net change in electric rates of zero effective as of January 1, 1994.\n1994 Cost of Capital Proceeding. As part of its ruling in the annual generic Cost of Capital proceeding for California's major energy utilities, the CPUC authorized the Company to set rates in 1994 designed to provide a utility return on common equity of 11.00%. The decision authorizes a utility capital structure of 47.50% common equity, 5.50% preferred stock and 47.00% long-term debt, which represents an increase from 46.75% in the equity component of the Company's capital structure. The decision states that the increase will bring the Company in line with other comparable utilities and will better reflect the increasingly competitive environment facing electric utilities. When combined with the authorized costs of debt and preferred stock, the 11.00% return on equity results in a 9.21% overall authorized utility rate of return for 1994 compared with the 10.13% authorized for 1993. The decision would decrease revenue requirements by approximately $116 million for electric rates and $36 million for gas rates effective January 1, 1994. As proposed by the Company, the reduction in the cost of capital was consolidated with other electric revenue changes such that there was no net increase in electric revenue requirements effective January 1, 1994.\nECAC\/AER\/ERAM\/LIRA\/CEE. In December 1993, the CPUC issued a decision authorizing a net zero change in the Company's electric revenue requirement for the twelve-month forecast period beginning January 1, 1994. The decision also authorizes a gas revenue requirement increase of approximately $4 million relating to the Company's CEE programs for the same forecast period. The new rates are effective as of January 1, 1994.\nThe net zero change in the Company's overall annual electric revenue requirement for 1994 is composed of a $112 million increase under the ECAC balancing account, a $7 million increase under the AER mechanism, a $129 million decrease under the ERAM, a $1 million decrease under the LIRA account and a $11 million increase for recovery of incentives earned on CEE programs.\nConsistent with its electric rate initiative, the Company had requested deferral beyond 1994 of a portion of undercollections in the ECAC balancing accounts. The total undercollection at December 31, 1993 was $427 million. In its decision, the CPUC approved the Company's request, but cautioned that the CPUC does not view its action as simply a deferral with payment due in 1995. Rather, the CPUC indicated that it expects the Company to take the necessary measures over the year to reduce its rates. With the stated objective of providing additional incentives for cost containment, the CPUC refused to allow the Company to collect interest on the revenue requirement deferral and ordered the reinstatement of the AER mechanism, which places the Company at risk for nine percent of the variations between actual and forecasted energy expenses.\nWith respect to CEE, the decision authorizes the Company to recover in rates over three years an aggregate electric and gas revenue increase of approximately $41 million for shareholder incentives relating to CEE measures installed in 1992, a reduction from the $59 million initially requested by the Company. Those revenues will be recovered in equal annual amounts beginning in 1994. The electric and gas revenue increases of $11 million and $4 million, respectively, authorized in rates for 1994 relating to CEE include one third of the 1992 incentives as well as amounts earned in previous years. However, the decision also provides that the $41 million allowed as shareholder incentives shall be subject to refund pending completion of a CPUC audit of all the Company's 1990-1992 CEE expenses. The audit is required to be completed by the end of 1994.\nGAS COST ALLOCATION PROCEEDINGS\nIn October 1992, the CPUC issued a decision in the Company's 1992 BCAP which resulted in a $434 million decrease in the core gas revenue requirement and a $3 million decrease in the noncore gas revenue requirement over a two-year period from then current rates. The decision allocated approximately $250 million in annual revenues to be collected from the noncore transportation customers other than the Company's electric department, with 75% balancing account treatment for transportation revenues from all noncore customers.\nIn September 1993, the Company submitted an interim, or trigger, filing as permitted under the BCAP mechanism to set new rates. The Company's filing requests an increase of $136.7 million in the Company's core gas revenue requirement, which would result in a 7.7% increase in core rates over rates currently in effect. The Company requested that the proposed increase not be implemented until May 1, 1994. The CPUC has not acted yet on the Company's request.\nWORKFORCE REDUCTION RATE MECHANISM\nIn February 1993, the Company announced a corporate reorganization and workforce reduction program. In conjunction with implementing the workforce reduction program, the Company filed an application with the CPUC to establish a balancing account through which the labor savings, net of the related costs, would be flowed back to the Company's customers in the form of reduced gas and electric rates. In March 1993, the CPUC authorized the establishment of a memorandum account to record all costs and savings incurred in connection with the workforce reduction program, subject to a reasonableness review.\nIn October 1993, the Company filed a report with the CPUC to update the forecasted costs and savings associated with the workforce reduction program. In its filing with the CPUC, the Company proposed that the revenue requirement savings achieved during the balance of the 1993 GRC cycle through the workforce reduction program be passed on to ratepayers over a two-year period beginning January 1, 1994.\nAs of December 31, 1993, the Company had recorded net workforce reduction program costs of $264 million. In April 1993, the Company announced a freeze on electric rates through 1994. As a result, the\nCompany has expensed $190 million of such costs relating to electric operations. The remaining $74 million of such costs relating to gas operations has been deferred for future rate recovery. The amount deferred is currently being amortized as savings are realized. The Company is currently seeking rate recovery of all costs incurred in connection with the workforce reduction program relating to electric and gas operations. However, in its RRI filing (see \"Regulatory Reform Initiative\" above), the Company requests that if the CPUC's review of the costs and savings associated with the workforce reduction program is not completed and reflected in rates before PBR begins, such review not be conducted. Under the RRI, the memorandum account established for such costs and savings would be terminated as of January 1, 1995.\nDuring 1994 and 1995, the Company expects to benefit from the expense reduction attributable to the electric operations' workforce reduction. The Company currently estimates that the workforce reduction program will result in a net revenue requirement savings of approximately $170 million during the three-year 1993 GRC cycle, which ends December 31, 1995. Beginning in 1996, the workforce reduction program is expected to result in annual revenue requirement savings of at least $200 million.\nCEE\/DSM PROGRAMS\nThe Company has long been active in the implementation of CEE and other demand-side management (DSM) programs which provide incentives to customers to implement energy-efficient measures. These measures allow the Company to defer capital expenditures in connection with generating, transmission and distribution facilities, reduce operating costs, reduce the environmental impact of operations and provide service options to customers. In addition, these measures help to minimize the use of existing fossil fueled generation. Since the mid-1970s, the Company has expended over $1 billion on DSM programs, allowing the Company to avoid the need for approximately 1,600 megawatts (MW) of new generating capacity.\nIn 1990, the CPUC issued a decision which implemented expanded CEE programs developed through collaborative efforts by the Company, other California utilities, regulatory agencies and environmental and consumer groups. The decision approved an incentive mechanism intended to encourage and sustain the Company's commitment to CEE. The mechanism adopted in 1990 provided that the Company can recover in rates the authorized costs of DSM programs plus shareholders incentives equal to 15% of the estimated net present value of energy savings from specified resource, or shared savings, programs that produce substantial net avoided capacity, transmission, distribution and energy costs savings, and 5% of the cost of certain service programs, including the Company's direct weatherization and energy efficiency education programs. Incentives earned on the implementation of CEE measures were originally authorized to be recovered in rates over the three-year period following the year in which the recovery of those incentives was authorized in the Company's annual ECAC proceeding.\nThe CPUC subsequently initiated a rulemaking proceeding on CPUC policies related to DSM programs (DSM Proceeding), and in a February 1992 decision, concluded that, as an interim policy beginning in 1993, shareholders' return on DSM measures should be no greater than shareholders' return on equivalent investments in utility constructed plants. Accordingly, in the Company's 1993 GRC, the percentage of energy savings to be earned as shareholder incentives for 1993 resource program accomplishments was reduced to 5.1% from the 15% earned in 1990, 1991 and 1992. Pending determination of a permanent shareholder incentive mechanism in the DSM Proceeding, the percentage return applied in calculating the shared savings incentive will be recalculated each year based on the rate of return on utility constructed plants and the forecasted costs and benefits of DSM programs.\nIn another 1993 decision, the CPUC determined that shareholder incentives earned on shared savings programs will be based on actual measured energy savings rather than forecasted savings, beginning with the 1994 DSM programs. The decision also concluded that, starting with the 1994 programs, shareholder incentives will be recovered in rates in four equal installments over a ten-year period, and the amount recoverable will be subject to the outcome of periodic measurement and evaluation studies. In addition, the decision provided that, beginning in 1994, the amount of shareholder incentives authorized for the Company and other California energy utilities will be determined annually in the AEAP. See \"California Ratemaking Mechanisms -- Other Rate Adjustment Mechanisms\" above.\nThe CPUC held hearings in 1993 to determine whether shareholder incentives should be continued for DSM programs beyond 1994. In September 1993, the CPUC concluded that DSM shareholder incentives should be continued under the current regulatory framework. Hearings will be held in 1994 to determine the appropriate incentive mechanism and incentive level for DSM programs in 1995 and beyond.\nThe Company estimates that it will earn approximately $7 million (after-tax) in shareholder incentives from the 1993 CEE programs. The Company plans to spend approximately $260 million on CEE programs in 1994, an increase over the $186 million spent in 1993. If the Company meets its 1994 energy savings goals, it could earn over a ten-year period approximately $11 million (after-tax) under the shareholder incentive mechanism. The Company is permitted to recover, through a balancing account, up to a maximum of 130% of the amount authorized for shared savings programs. As in the past, the Company is subject to a penalty if actual accomplishments under a shared savings program fall below the minimum performance standard established for the program.\nCAPITAL REQUIREMENTS AND FINANCING PROGRAMS\nThe Company continues to require capital for additions to its facilities and to maintain and enhance the efficiency and reliability of existing generation, transmission and distribution facilities. Expenditures for these purposes, including the allowance for funds used during construction (AFUDC) were $1,883 million for 1993. New investments in nonregulated businesses totaled $234 million in 1993.\nThe following table sets forth the forecasted total capital requirements, consisting of capital expenditures for the utility functions, the expansion of the gas pipeline from Canada to California, Diablo Canyon and the nonregulated investments of Enterprises and amounts for maturing debt and sinking funds for the years 1994 through 1998. CAPITAL REQUIREMENTS (IN MILLIONS)\n- ------------ (1) Utility expenditures are shown net of reimbursed capital and include California electric and gas operations and existing operations of the gas pipeline from Canada to California. Utility expenditures also include any amounts relating to the expansion of Pacific Gas Transmission Company's (PGT) pipeline system in 1994 through 1996 to provide additional deliveries in the Pacific Northwest. Capital expenditures relating to such further expansion total approximately $84 million.\n(2) Utility expenditures include AFUDC. Diablo Canyon expenditures include capitalized interest.\n(3) Enterprises' actual capital expenditures may vary significantly depending on the availability of attractive investment opportunities.\n(4) In January 1994, the Company approved a final plan for the disposition of PG&E Resources Company (Resources) in 1994, if market conditions remain favorable. In light of the planned disposition, the forecasted capital expenditures for Resources in 1994 was recently increased to the level indicated in the table above. If Resources is not divested in 1994, the Company's capital expenditures would be approximately $100 million per year in each of the years 1994 through 1998.\n(5) U.S. Generating Company's expenditures include commitments by the Company and\/or Enterprises to make capital contributions for Enterprises' equity share of currently identified generating facility projects.\nThese contributions, payable upon commercial operation of the projects, are estimated to be $95 million, $151 million and $27 million in 1994, 1995 and 1996, respectively. There are no current commitments to make contributions in 1997, 1998 or thereafter.\nMost of the utility capital expenditures for 1994 through 1998 are associated with short lead time, modest capital expenditure projects aimed at providing the facilities required by new customers and at the replacement and enhancement of existing generation, transmission, distribution and common utility facilities to improve their efficiency and reliability and to comply with environmental laws and regulations. One exception is the seismic retrofit of part of the Company's general office complex in downtown San Francisco.\nThe Company estimates that, in addition to the capital expenditure objectives referred to above, its total capital requirements for the years 1994 through 1998 will include approximately $2,278 million for payment at maturity of outstanding long-term debt and for meeting sinking fund requirements for debt. In an effort to reduce financing costs, the Company redeemed or repurchased $3,536 million of high-cost first and refunding mortgage bonds and $267 million of redeemable preferred stock in 1993. In addition, in December 1993, the Board of Directors authorized the Company to redeem or repurchase up to $1.2 billion of first and refunding mortgage bonds, $125 million of medium-term notes and $175 million of redeemable preferred stock. Of those amounts, $80 million of bonds, $40 million of medium-term notes and $75 million of preferred stock were redeemed in February and March 1994. Redemptions and repurchases were financed in part by the issuance in 1993 of $2,950 million of first and refunding mortgage bonds (Series 93A through 93H), $750 million of medium-term notes and $200 million of redeemable preferred stock. In 1993, the Company also entered into loan agreements with the California Pollution Control Financing Authority to borrow proceeds of $260 million of tax-exempt pollution control bonds issued to finance sewage and solid waste disposal facilities.\nThe funds necessary for the Company's 1994-1998 capital requirements will be obtained from (i) internal sources, principally net income before noncash charges for depreciation and deferred income taxes, and (ii) external sources, including short-term financing, such as bank loans and the sale of short-term notes, and long-term financing, such as sales of equity and long-term debt securities, when and as required.\nThe Company conducts a continuing review of its capital expenditures and financing programs. These programs and the projections above are subject to revision based upon changes in assumptions as to system load growth, rates of inflation, receipt of adequate and timely rate relief, availability and timing of regulatory approvals, total cost of major projects, availability and cost of suitable nonregulated investments, and availability and cost of external sources of capital.\nELECTRIC UTILITY OPERATIONS ELECTRIC OPERATING STATISTICS The following table shows the Company's operating statistics (excluding subsidiaries except where indicated) for electric energy, including the classification of sales and revenues by type of service.\n- ---------- (1) Includes energy supplied through the Company's system by the City and County of San Francisco for San Francisco's own use and for sale by San Francisco to its customers, by the Department of Energy for government use and sale to its customers, and by the State of California for California Water Project pumping, as well as energy supplied by QFs and purchases from other utilities. (2) Includes energy output from Modesto and Turlock Irrigation Districts' own resources. (3) Represents energy required for pumping operations. (4) Includes use by business units other than Electric Supply.\n- ------------ (1) Area net capability at time of annual peak, based on 1977 water conditions which are the most adverse of record to date. (2) Net control area peak demand includes demand served by Modesto and Turlock Irrigation Districts' own resources.\nELECTRIC GENERATING AND TRANSMISSION CAPACITY\nAs of December 31, 1993, the Company owned and operated the following generating plants, all located in California, listed by energy source:\n- ----------\n(1) The following fossil fuel steam units (412 MW) were on long-term standby reserve during 1993. The units require a 12-18 month reactivation time, and are included as unavailable capacity in the Control Area Net Capacity table below. Contra Costa Unit 3 (116 MW) Kern Unit 1 (74 MW) Kern Unit 2 (106 MW) Moss Landing Unit 1 (116 MW)\n(2) Listed to show capability; subject to relocation within the system as required.\n(3) The Geysers net operating capacity is based on adequate geothermal steam supply conditions. Any decrease in capacity, at peak, is included as unavailable capacity in the Control Area Net Capacity table below. See \"Geothermal Generation\" below.\nTo transport energy to load centers, the Company as of December 31, 1993, owned and operated approximately 18,450 circuit miles of interconnected transmission lines of 60 kilovolts (kV) to 500 kV and transmission substations having a capacity of approximately 33,130,000 kilovolt-amperes (kVa). Energy is distributed to customers through approximately 104,133 circuit miles of distribution system and distribution substations having a capacity of approximately 24,805,000 kVa.\nThe following table sets forth the available capacity for the control area (the area served by the Company and various publicly-owned systems in Northern California) at the date of peak (including reduction for scheduled and forced outages and based on 1977 water conditions, which are the most adverse on record to date) by various sources of generation available to the control area and the total amount of generation provided by these sources during the year ended December 31, 1993.\n- ----------\n(1) The maximum control area peak demand to date was 19,607,000 kW which occurred in August 1993. (2) The reserve capacity margin at the time of the 1993 control area peak, taking into account short-term firm capacity purchases from utilities located outside the Company's service area: spinning reserve (capability already connected to the system and ready to meet instantaneous changes in demand) to the control area peak was 9.9% and total reserve (spinning reserve and capability available within a short period of time) was 18.5%. (3) Represents actual year net generation from sources shown.\nELECTRIC LOAD FORECAST AND RESOURCE PLANNING AND PROCUREMENT\nCalifornia's long-range electric resource planning is coordinated between the California Energy Commission (CEC) and the CPUC. Every two years, the CEC prepares an Electricity Report that includes load forecasts and resource assumptions for a 20-year period. The CPUC conducts a Biennial Resource Plan Update (BRPU) proceeding which is linked to a specific CEC Electricity Report. The purpose of the BRPU is to determine whether any cost-effective electric resources (either new generating resources or power purchases) should be added to the regulated utilities' electric systems based on a twelve-year planning horizon (as described below). In making this determination, the CPUC gives great weight to the load forecasts and resource assumptions included in the CEC's Electricity Report.\nThe Company forecasts area electric peak demand (on a CEC area basis) to increase from approximately 16,100 MW in 1994 to approximately 23,000 MW in 2013, reflecting a compound annual growth rate of 1.9%. The Company forecasts area electric energy load to increase from approximately 87,500 gigawatthours (GWh) in 1994 to 120,900 GWh in 2013, reflecting a compound annual growth rate of 1.7%. The Company's energy and peak demand forecasts closely approximate the CEC staff's forecasts through 2005, and are somewhat higher than the CEC staff's forecasts for periods thereafter, primarily due to the Company's more optimistic economic and demographic assumptions.\nFor the remainder of this decade, the Company anticipates adding between 600 and 750 MW of electric resources. These resources will be comprised of (i) up to 243.5 MW of new purchases or company-owned\nresources resulting from the BRPU solicitation, (ii) approximately 290 MW of new QF purchases to come on line by the end of 1996, (iii) between 49 and 200 MW of generation and DSM resources resulting from the integrated bid solicitation, (iv) improvements in its existing generating system, including 20 MW of upgrades of the hydroelectric system, and (v) further developments in regional operations efficiency from the Company's existing transmission lines from the Pacific Northwest. The Company also anticipates completing the 2,500 MW of CEE and load management improvements initiated in 1990. The Company currently plans no new major construction projects for electric supply before the year 2000, other than projects already under development.\nFuture additions to satisfy electric supply needs in the Company's service territory will be determined largely through a competitive resource procurement process open to all potential suppliers. The Company has indicated its willingness to forgo competing in this process to build new generation resources if the CPUC grants the Company significant flexibility in conducting the planning and procurement process.\nThe CPUC is exploring the use of an integrated bidding system in which both resource generation and DSM bidders would participate in the competitive procurement process. In October 1993, the CPUC issued a decision in the DSM Proceeding described above (see \"General -- CEE\/DSM Programs\" above) which selected the Company to conduct an integrated bidding pilot program. The CPUC ordered the Company to conduct a pilot bid program for between 49 and 200 MW to test the feasibility of integrated bidding. The Company is granted significant flexibility in designing and implementing the bid program, in exchange for its agreement not to submit a bid in the pilot program. The Company expects to issue requests for bids in late 1994.\nThe CEC committee conducting proceedings relating to the CEC's 1994 Electricity Report issued orders expanding the proceeding to include an extensive analysis of how changes in the structure of the electric industry may affect the achievement of California's energy policies. The orders direct comprehensive studies in a wide variety of areas, including wholesale wheeling and regional integration of transmission systems, performance based ratemaking and \"maximum feasible\" competitive choices for customers. Workshops and hearings related to these orders will take place during 1994, with the committee expected to report the results of its analysis to the CEC in early 1995.\nELECTRIC TRANSMISSION POLICIES\nIn September 1990, the CPUC issued an order instituting investigation into the development of transmission policies for (i) transmission access and allocation of transmission costs for a utility buying non-utility power; and (ii) transmission access, cost allocation and pricing issues for non-utility power producers who require transmission-only service from a utility. The CPUC explicitly stated that the investigation will not consider proposals for retail transmission service and should not be construed as a challenge to the franchise retail service territories of public utilities. The CPUC indicated that it believed the transmission investigation was necessary at this time in order to assure development of a competitive electricity generation sector in California.\nIn September 1992, the CPUC issued a decision in the first phase of the investigation. The decision adopted certain policies and procedures on an interim basis which permit the Company to consider the expected transmission impacts of non-utility power purchases as it selects new QF resources through a competitive bidding process. Among other things, the decision provided that ratepayers, as opposed to utility shareholders, will bear prudently incurred costs of the most cost-effective transmission upgrades necessary to accommodate purchases from winning bidders.\nThe second phase of the investigation could consider certain broader long-term transmission access and cost issues. In 1993, the assigned commissioner ruled that the scope of any future rulemaking in the second phase of the investigation would be limited to wholesale transmission issues which are not likely to be fully addressed by the Federal Energy Regulatory Commission (FERC). These issues include (i) coordinated regional transmission planning, (ii) unbundling of transmission service costs, (iii) determination of the best access form or vehicle, (iv) use of alternative dispute resolution mechanisms, (v) relative priority of transmission requests, and (vi) incentives for transmitting utilities. The assigned administrative law judge\n(ALJ) has been ordered to commence discussions regarding procedure and schedule in the second phase of the investigation.\nOn the federal level, in 1993 the FERC began implementation of the National Energy Policy Act of 1992 (Energy Act). The Energy Act expanded the FERC's authority to order an electric utility to provide wholesale transmission service. The FERC may order any owner of transmission lines to provide transmission service, subject to a public interest finding, on application of any wholesale purchaser or seller of power. The FERC must allow the transmitting utility to recover its costs and may not order transmission service which will unreasonably impair system reliability. The Energy Act prohibits the FERC from ordering retail transmission service, or wheeling, directly to an ultimate consumer.\nIn 1993, the FERC issued a final rule on the transmission access information utilities must file annually and policy statements concerning regional transmission groups and the necessary components of a good faith request and response for transmission access under the Energy Act. The FERC also opened an investigation on transmission pricing.\nQF GENERATION\nUnder the Public Utility Regulatory Policies Act of 1978 (PURPA), the Company is required to purchase electric energy and capacity produced by QFs. The CPUC established a series of power purchase agreements which set the applicable terms, conditions and price options. A QF must meet certain performance obligations, depending on the contract, prior to receiving capacity payments. The total cost of both energy and capacity payments to QFs is recoverable in rates.\nPayments to QFs are expected to vary in future years. The amount of energy received from QFs and the total energy and capacity payments made under these agreements were:\nAs of December 31, 1993, the Company had approximately 6,000 MW of QF capacity under CPUC-mandated power purchase agreements. Of the 6,000 MW, approximately 4,600 MW were operational. Development of the balance is uncertain but it is estimated that only 300 MW of the remaining contracts will become operational. The 6,000 MW of QF capacity consists of 3,400 MW from cogeneration projects, 1,500 MW from wind projects and 1,100 MW from other projects, including biomass, geothermal, solar and hydroelectric.\nELECTRIC REASONABLENESS PROCEEDING\nRecovery of costs through the ECAC are subject to a CPUC determination that such costs were incurred reasonably. Under the current regulatory framework, annual reasonableness proceedings are conducted on a historic calendar year basis.\nIn August 1993, the DRA filed a report on the Company's ECAC expenses for the 1991 record period, which questioned the Company's execution of amendments to three power purchase agreements with Texaco, Inc. for three QFs. In its report and in testimony filed in February 1994, the DRA asserted that the Company improperly agreed to extend the construction time under these agreements and recommended that the CPUC find these extensions unreasonable. Although no payments are at issue in the 1991 record period, the DRA argues that certain capacity payments under the contracts should be disallowed in subsequent year proceedings over the 15-year term of the contracts. The DRA indicated that it would recommend disallowances over the 15-year term of the contracts of approximately $80 million. In its report on ECAC expenses for the 1992 record period, the DRA recommended a disallowance of approximately $3.5 million for two of these agreements.\nThe Company contested the DRA's assertions in its rebuttal testimony which was filed in November 1993. A decision is not expected from the CPUC until mid-1994. The Company is unable to predict the outcome of this matter, but believes the ultimate outcome will not have a significant adverse impact on its financial position or results of operation.\nHELMS PUMPED STORAGE PLANT (HELMS)\nHelms, a three-unit hydroelectric combined generating and pumped storage facility, completion of which was delayed due to a water conduit rupture in September 1982 and various start-up problems related to the plant's generators, became commercially operable in June 1984. As a result of the damage caused by the rupture and the delay in the operational date, the Company incurred additional costs which are not yet included in rate base and lost revenues during the period while the plant was under repair. Excluding the costs of the conduit rupture already reserved by the Company and the amount received in settlement of litigation with the supplier of the plant's generators, the remaining unrecovered costs of Helms (after adjustment for depreciation) and revenues discussed above totaled approximately $106 million at December 31, 1993.\nIn August 1991, the Company filed an application with the CPUC to increase electric base rates to allow recovery of a portion of the remaining unrecovered costs associated with Helms. In addition to placing these costs in rate base, the Company seeks to recover the associated revenue requirement on such costs since 1984 and lost revenues during the time the generators were being repaired.\nIn June 1993, the DRA issued its report on the Company's 1991 Helms application and recommended a disallowance of all requested costs and revenues. As a matter of policy, the DRA recommends that ratepayers should not be held responsible for plant costs or losses incurred by a utility due to contractor error whether or not the utility was prudent, and cites past CPUC action for this policy. In addition, the DRA contends that the Company acted imprudently in the management of the project and failed to adequately oversee the engineering and design of the generators. The DRA argues that the Company should not recover any revenue requirements associated with the generator costs for the period since 1984 since those revenues were not authorized previously by the CPUC and would constitute retroactive ratemaking. With respect to the lost revenues and related recorded interest during the time that Helms was out of service for the modification and repair of the generators, the DRA asserts that the Company has failed to establish that the outage was not caused by a problem first identified during the precommercial testing program.\nThe Company filed its rebuttal testimony in January 1994 asserting it is unreasonable to hold a utility responsible for all costs arising out of contractor error in all instances without regard to the specific facts of the case. This testimony also asserts that the Company was prudent in managing and overseeing the project, and that various issues raised by the DRA were not based on facts or were irrelevant to the application.\nThe Company has commenced discussions with the DRA in an attempt to expeditiously resolve the treatment of Helms costs through a settlement. The Company is uncertain whether, and to what extent, any of the remaining $106 million of costs and revenues will be recovered through the ratemaking process.\nGEOTHERMAL GENERATION\nBecause of declining geothermal steam supplies, the Company's geothermal units at The Geysers Power Plant (The Geysers) are forecast to operate at reduced capacities. The consolidated Geysers capacity factor is forecast to be approximately 55.9% in 1994, which includes forced outages, scheduled overhauls, and projected steam shortage curtailments, as compared to the actual Geysers capacity factor of 61.8% in 1993. The Company expects steam supplies at The Geysers to continue to decline.\nThe Company has entered into new steam sale agreements with several of its steam suppliers which allow the Company to alter the operation of its units to more economically utilize the existing installed capacity and partially offset the impact of the declining steam supplies at The Geysers. The new agreements permit the steam suppliers to furnish lower pressure steam and require that they make payments to the Company to compensate for the declining steam supply to the Company's units.\nWESTERN SYSTEMS POWER POOL (WSPP)\nIn 1991, the FERC approved an agreement among 40 utilities operating in 22 states and British Columbia for a permanent WSPP. The entities participating in the WSPP may, on a voluntary basis, buy and sell surplus power and transmission capacity by posting quotes daily on a computer \"bulletin board.\" The prices are negotiable but cannot exceed ceilings approved by the FERC. The permanent WSPP agreement approved by the FERC, among other things, imposes cost-based ceilings calculated from pool-wide average costs and allows QFs to participate in the pool if they waive their rights under PURPA to be paid avoided cost prices for transactions performed within the pool. The FERC order approving the permanent WSPP agreement was challenged in the U.S. Court of Appeals for the District of Columbia Circuit on the basis that the cost-based ceilings were improperly calculated and that the FERC exceeded its authority in conditioning QF participation in the pool. The Court of Appeals affirmed the FERC's authority to set cost-based ceilings and, at the request of the FERC, remanded the QF participation issues to the FERC for further consideration. In February 1994, the FERC ordered WSPP to permit QFs to participate on the same basis as other members without being required to waive their rights under PURPA.\nGAS UTILITY OPERATIONS\nGAS OPERATIONS\nAs of December 31, 1993, the Company owned and operated approximately 5,700 miles of gas transmission lines and approximately 35,000 miles of gas distribution lines. The Company has three underground storage facilities. The Company's peak day send-out of gas during the year ended December 31, 1993, was 4,002 million cubic feet (MMcf). The total volume of gas throughput during that period was approximately 701,706 MMcf, of which 430,718 MMcf was sold to direct end-use or resale customers, 161,895 MMcf was used by the Company principally as fuel for fossil-fueled electric generating plants, and 109,093 MMcf was transported customer-owned gas.\nThe California Gas Report, which presents the outlook for natural gas requirements and supplies for the State of California through the year 2010, is prepared annually by the California electric and gas utilities as a result of a CPUC order. The 1993 report forecasts the Company's gas demand from 1993 through 2010.\nThe forecast growth rate for the Company's service territory of 1.8% per year from 1993 through 2010 is higher than the 1.3% annual forecasted growth rate shown in last year's report for the same period for two reasons. First, a more optimistic forecast of growth in the number of households leads to a higher forecasted growth rate of gas sales. Second, the expected success of the Company's natural gas vehicle program and the implementation of federal and state clean air regulations leads to a much higher forecast of natural gas vehicle use.\nThe gas requirements forecast is subject to many uncertainties and there are many factors that can influence the demand for natural gas, including weather conditions, level of utility electric generation, fuel switching and new technology. In addition, some large customers, mostly in the industrial and enhanced oil recovery sectors, have the ability to purchase gas directly from gas producers, using unregulated private pipelines or interstate pipelines, bypassing the Company's system entirely. The report forecasts a total bypass volume of 108 billion cubic feet for 1993. The forecast assumes that bypass which began in 1991 will change little from the 1993 level and does not include any potential bypass from the proposed Mojave Pipeline Company expansion project. See \"Other Competitive Interstate Pipeline Projects\" below.\nGAS OPERATING STATISTICS\nThe following table shows the Company's operating statistics (excluding subsidiaries except where indicated) for gas, including the classification of sales and revenues by type of service.\n- ---------------\n(1) Includes use by business units other than the Gas Supply business unit, principally as fuel for fossil-fueled generating plants.\n(2) In August 1991, the Company implemented its Customer Identified Gas (CIG) Program. Sales include approximately 105,000 MMcf, 130,000 MMcf and 50,000 MMcf in 1993, 1992 and 1991, respectively, of gas procured by the Company for CIG customers at prices negotiated directly between those customers and suppliers. The CIG Program was terminated on October 31, 1993 upon full implementation of the CPUC's capacity brokering program. (3) Over 100% indicates colder than normal.\nNATURAL GAS SUPPLIES\nThe objective of the Company's gas supply planning is to maintain a balanced supply portfolio which provides supply reliability and contract flexibility, minimizes costs and fosters competition among suppliers.\nUnder current CPUC regulations, the Company purchases natural gas from its various suppliers based on economic considerations, consistent with regulatory, contractual and operational constraints. During the year ended December 31, 1993, approximately 55% of the Company's total purchases of natural gas consisted of Canadian gas purchased from PGT, a wholly owned subsidiary of the Company, and, following implementation of the of the Decontracting Plan described below, from various Canadian producers and transported by PGT, approximately 5% was purchased from various California producers, and approximately 40% was purchased from other states (substantially all U.S. Southwest sources and transported by El Paso Natural Gas Company (El Paso) or Transwestern Pipeline Company (Transwestern)). The following table shows the volume and average price of gas in dollars per thousand cubic feet (Mcf) purchased by the Company from these sources during each of the last five years.\n- ----------\n(1) The average prices for Canadian and U.S. Southwest gas include the commodity gas prices, interstate pipeline demand or fixed charges and other pipeline assessments, including direct bills allocated over the quantities received at the California border. The average prices for California gas include only commodity gas prices delivered to the Company's gas system.\nGAS REGULATORY FRAMEWORK\nEffective in May 1988, a new regulatory framework for natural gas service was established in California. This framework (i) segmented customers into core (all residential customers and commercial customers that do not exceed certain volume limitations) and noncore (industrial and commercial customers that exceed certain volume limitations) classes; (ii) unbundled utilities' gas transportation and procurement services; (iii) allows noncore customers to purchase gas directly from producers, aggregators or marketers and separately negotiate gas transportation with their utilities; and (iv) places the utilities at risk for collecting a portion of the transportation revenues associated with their noncore markets.\nIn November 1991, the CPUC issued a decision adopting a statewide capacity brokering program, whereby noncore customers and other shippers can obtain rights to firm interstate pipeline transportation capacity held by the local gas distribution utilities. Under the capacity brokering program implemented August 1, 1993 for the Company's El Paso and Transwestern capacity, and November 1, 1993 for the Company's PGT capacity, the Company is required to make available for brokering all interstate pipeline capacity not reserved for its core customers and core subscription customers (noncore customers choosing bundled procurement and transportation service). Noncore customers, brokers and shippers, and the Company's electric department can bid for such capacity.\nIn addition, in April 1992, the FERC issued its Order 636, which required interstate pipelines to unbundle sales services from transportation services, established various programs providing for reallocation of pipeline capacity and adopted various mechanisms by which pipelines may recover transition costs arising from the restructuring of their services. Under the Order 636 capacity allocation rules, firm capacity holders are permitted to exercise a one-time opportunity to \"relinquish,\" i.e., permanently abandon, some or all of their transportation capacity, either by paying a negotiated exit fee or through a third party assuming the\nobligations of the existing transportation agreement. Thereafter, firm capacity holders may also \"release\" some or all of their capacity, i.e., give up capacity rights to third parties for a limited period of time. Releasing capacity holders remain liable on their existing contracts, but will receive a credit for the acquiring third parties' demand charge payments, the amounts of which will depend on the percentage of full rate paid by the acquiring third party.\nThe Company's compliance with these regulatory changes has allowed many of the Company's noncore customers to arrange for the purchase and transportation of their own gas supplies. These changes have resulted in a decrease in the amount of gas required to be purchased by the Company and a related decrease in the Company's need for firm transportation capacity, and contributed to the need to restructure the Company's gas supply arrangements.\nRESTRUCTURING OF CANADIAN GAS SUPPLY ARRANGEMENTS\nFORMER CANADIAN GAS SUPPLY AND TRANSPORTATION ARRANGEMENTS\nPrior to implementation of the Decontracting Plan described below, the Company purchased Canadian natural gas under various long-term contracts. The gas was shipped to the U.S. border by Alberta and Southern Gas Co., Ltd. (A&S), a wholly owned subsidiary of the Company, over the NOVA Corporation of Alberta (NOVA) and Alberta Natural Gas Company Ltd (ANG) pipelines under an export license from the National Energy Board of Canada (NEB), a removal permit from the Alberta Energy Resources Conservation Board and an energy removal certificate from the province of British Columbia. PGT purchased this Canadian natural gas from A&S and transported it from Canada to the California border, under authorization from the Department of Energy (DOE) to import the gas. The gas was purchased at the California-Oregon border by the Company. A&S had been authorized to export up to 1,126 MMcf per day (MMcf\/d) and 373,500 MMcf per year through October 31, 2005.\nDECONTRACTING PLAN\nThe CPUC's gas procurement and capacity brokering programs and the FERC's new regulatory structure resulted in a decrease in the amount of gas required to be purchased by the Company. As a result, A&S was required to terminate its gas supply arrangements with Canadian producers. A&S had commitments to purchase minimum quantities of gas from Canadian producers under various contracts, most of which extended through 2005. A number of Canadian gas producers had filed lawsuits against the Company during 1991 and 1992 claiming damages of at least Cdn. $466 million resulting from the alleged failure of A&S to meet its minimum contractual gas purchase obligations for the 1989-1992 contract years and for the anticipated failure of A&S to meet those obligations through 2005.\nAs a result of the regulatory changes discussed above, negotiations were conducted to terminate A&S's contracts with Canadian gas producers, restructure A&S's contracts with Canadian pipelines and gas processors and settle all litigation and claims arising from such contracts. Those negotiations resulted in the implementation of a Decontracting Plan, effective November 1, 1993. Gas producers representing more than 99.9% of the total volume of the gas supply of A&S participated in the Decontracting Plan. As a result, the Alberta provincial government and the NEB have ended restrictions imposed in 1992 on the shipment of gas to northern California and permitted the Decontracting Plan to be implemented. A&S also restructured its gas transportation and processing agreements.\nUnder the Decontracting Plan, the Canadian producers' contracts with A&S, the sales agreement between A&S and PGT, and the Company's service agreement with PGT each were terminated, effective on November 1, 1993. The termination of the agreements relieved the parties of their obligations under those agreements and permitted producers to decontract their reserves from the A&S supply pool. As a result, the Company may contract on an individual basis for its requirements directly with any producer, aggregator or marketer, whether or not they were formerly in the A&S supply pool.\nUnder the Decontracting Plan, participating producers released A&S, PGT and the Company from any claims they may have had that resulted from the termination of the former arrangements as well as any claims\nfor losses which arose from alleged historical shortfalls in gas taken by A&S. The total amount of settlement payments paid to the producers is approximately $210 million.\nAs part of the overall A&S decontracting process, A&S' operations have been significantly reduced, with Pan-Alberta Gas Ltd., a major aggregator of Canadian natural gas, acquiring A&S' restructured gas purchase contracts and its remaining Canadian sales contracts. A&S continues to hold gas transportation capacity on Canadian pipelines and is in the process of permanently assigning or brokering such capacity.\nAs part of the Decontracting Plan, A&S permanently assigned substantial portions of its commitments for transportation capacity with NOVA through October 2001 and ANG through October 2005 to third parties. A&S also assigned approximately 600 MMcf\/d of capacity on each of these pipelines to the Company for use in the servicing of the Company's core and core subscription customers. A&S currently holds remaining capacity of approximately 450 MMcf\/d with annual demand charges of approximately $25 million for which it is continuing its efforts to assign or broker. There is uncertainty about the ability of A&S to assign or broker this remaining capacity. To the extent others do not take this capacity, A&S will remain obligated to pay for the related demand charges.\nIn July 1993, FERC approved a transition cost recovery mechanism (TCRM) for PGT under which most costs which were incurred to restructure, reform or terminate the sales arrangements between A&S and PGT and underlying A&S gas supply contracts, or to resolve claims by gas suppliers related to past or future liabilities or obligations of PGT or A&S, are eligible for recovery in PGT's rates. The TCRM precludes most objections to the eligibility and prudence of such costs; prudence challenges may be made only on the grounds that the payment is unreasonably high in light of the damages claimed. Disposition of approved transition costs will be as follows: (1) 25% of such costs will be absorbed by PGT; (2) 25% will be recovered by PGT through direct bills (substantially all to the Company as PGT's principal customer); and (3) 50% will be recovered by PGT through volumetric surcharges over a three-year period. Costs associated with A&S's commitments for Canadian pipeline capacity do not qualify as transition costs recoverable under this mechanism.\nIn October 1993, PGT filed an application at the FERC for recovery of payments made under settlement agreements with 140 producers, representing approximately 97% of the volumes dedicated to A&S. The application seeks recovery of $154 million under the TCRM, which is 75% of the $206 million paid to such producers as of the time of the filing. PGT intends to submit further applications with the FERC for recovery of transition costs incurred under settlement agreements entered into after October 15. In November 1993, the FERC issued an order accepting the filing, with rates effective on November 15, but subject to refund to the extent not ultimately approved by the FERC. In December 1993, the CPUC filed a limited challenge to the costs. In its filing the CPUC decided not to challenge the prudence of the transition costs filed by PGT, but did challenge the eligibility for recovery under the TCRM of PGT's settlement payment to BC Gas Utility of $2.4 million. The CPUC also requested a technical conference or hearing to determine if other payments made by PGT are consistent with the TCRM.\nIn September 1993, the Company requested that the CPUC approve a memorandum account to track the direct bills charged to the Company by PGT for transition costs. In response, the DRA indicated that while it does not protest the Company's request to record the direct bills to a memorandum account, it does believe that these costs are unreasonable and that they should not be passed on to ratepayers. The DRA also urged that the CPUC investigate any gas supply restructuring costs that PGT attempts to pass on to the Company and to take into account these costs in its final decisions in the 1988-1990, 1991, 1992 and 1993 gas reasonableness proceedings. See \"Gas Reasonableness Proceedings\" below. In November 1993, the Company paid PGT approximately $51 million in payment of the direct bill charged by PGT for transition costs under the TCRM. The Company expects to seek recovery in its next BCAP application of this amount and volumetric surcharges to be billed to the Company.\nFINANCIAL IMPACT OF DECONTRACTING PLAN AND LITIGATION\nThe Company incurred transition costs of $228 million, consisting of settlement payments made to producers in connection with the implementation of the Decontracting Plan and amounts incurred by A&S in\nreducing certain administrative and general functions resulting from the restructuring. Of these costs, the Company deferred $143 million for future rate recovery. In addition, the Company recorded a reserve of $31 million due to the uncertainty of A&S's ability to assign or broker its remaining commitments for Canadian transportation capacity. Accordingly, the Company expensed $93 million in 1993 and a total of $23 million in prior years.\nPGT and the Company are seeking recovery of all transition costs eligible for recovery under the TCRM other than the 25% of such costs to be absorbed by PGT. While such transition costs are still subject to challenges at the FERC level and the recovery of such costs paid by the Company as a shipper of gas on PGT will depend on the recovery mechanism adopted by the CPUC, the Company believes that it will ultimately recover the deferred transition costs.\nRESTRUCTURING OF INTERSTATE GAS SUPPLY ARRANGEMENTS\nNEW INTERSTATE GAS TRANSPORTATION AND PROCUREMENT ARRANGEMENTS\nThe Company's contract for firm sales service from PGT had entitled the Company to purchase up to 1,066 MMcf\/d from PGT at Malin, Oregon. Effective November 1, 1993, the Company converted its firm sales service contract to firm transportation service of up to 1,066 MMcf\/d. The firm transportation agreement runs through October 31, 2005. The firm transportation demand charge associated with the Company's firm capacity on PGT is approximately $50 million per year. To procure Canadian gas, the Company may contract on an individual basis for gas supply directly with any Canadian producer, aggregator or marketer. The Company currently purchases substantially all of its Canadian gas under flexible, short-term arrangements.\nFollowing FERC approval of PGT's Order 636 compliance filing and pursuant to FERC rules on capacity relinquishment and release, the Company commenced capacity release on PGT's pipeline effective November 1, 1993. The Company retained approximately 610 MMcf\/d on the PGT pipeline to support its service to core and core subscription customers. The Company made amounts not needed for core or core subscription service available for capacity release. The Company's release of its PGT capacity is also subject to the CPUC's capacity brokering program.\nThe Company's contract for firm sales service from El Paso had entitled the Company to purchase up to 1,140 MMcf\/d from El Paso at Topock, Arizona. On September 1, 1991, the Company converted its firm sales service contract to firm transportation service of up to 1,140 MMcf\/d. The firm transportation agreement runs through 1997. The firm transportation reservation charge associated with the Company's firm capacity on El Paso is approximately $130 million per year. The Company may contract on an individual basis for gas supply directly with any producer, aggregator or marketer of Southwest gas and currently purchases substantially all of its Southwest gas under flexible, short-term arrangements.\nPursuant to FERC rules on capacity relinquishment and release, the Company began brokering its capacity on the El Paso system effective August 1, 1993. The Company retained approximately 610 MMcf\/d on the El Paso system to support its core and core subscription customers. The Company made amounts not needed for core or core subscription service available for capacity release. The Company's brokering of its El Paso capacity is also subject to the CPUC's capacity brokering program. During the period from August 1, 1993 to November 1, 1993, partial capacity brokering under the CPUC rules occurred. During this period, noncore customers who took assignment of the Company's brokered El Paso capacity received unbundled rates for intrastate service on the Company's system. The unbundled rates excluded the costs for the Company's El Paso and PGT capacity.\nIn April 1992, the Company executed firm transportation agreements with Transwestern to transport 200 MMcf\/d of San Juan basin gas supplies into the Company's southern gas system, of which 150 MMcf\/d is to be used to meet the Company's gas demands and 50 MMcf\/d is for use by the Company's electric department. The demand charges associated with the entire Transwestern capacity are currently approximately $30 million per year, effective November 1, 1993.\nRECOVERY OF INTERSTATE TRANSPORTATION DEMAND CHARGES\nBeginning November 1, 1993, when capacity release on both the PGT and El Paso systems was under way, full capacity brokering under the CPUC program went into effect. Under the full capacity brokering program, the Company's costs for interstate capacity on El Paso and PGT were unbundled from all the Company's rates for all noncore transportation service on its system. Noncore customers, or their gas suppliers, became responsible for the interstate transportation arrangements necessary to deliver gas at the Company's interconnections with the interstate pipelines. Under full capacity brokering, the Company continues to make its firm capacity on El Paso and PGT above the core and core subscription reservations, as well as capacity reserved for core and core subscription customers that is not being used to serve such customers' requirements at any given time, available for brokering to other potential shippers.\nInterstate transportation service which cannot be marketed at the full rates results in unrecovered demand charges. Under the CPUC brokering rules, the CPUC has authorized the use of the ITCS to account for unrecovered demand charges associated with interstate pipeline obligations in existence at the time the decision creating the ITCS was issued in November 1991. To the extent the Company is unable to broker its firm interstate capacity above core and core subscription reservations at the full as-billed rate, or to broker such capacity at all, the Company has been authorized to accumulate unrecovered demand charges for El Paso and PGT in the ITCS account for later review and allocation among customer classes. The Company has not succeeded in marketing its firm PGT or El Paso capacity above the core and core subscription reservations at the full cost of the capacity (the as-billed rate). The Company also has not been able to market all the El Paso and PGT capacity it has made available for brokering. Pursuant to the CPUC's ITCS mechanism, the Company has accumulated unrecovered demand charges for El Paso and PGT capacity in the ITCS.\nUltimate recovery of unrecovered interstate pipeline demand charges accumulated in the ITCS will be subject to CPUC ratemaking mechanisms. There may be instances where the CPUC may not allow full recovery with respect to discounted rates, such as rates given to a customer in a negotiated discount gas transportation contract entered into pursuant to the Company's EAD procedure. The CPUC has indicated that if an EAD rate discount results in a shortfall in recovery of ITCS costs contained in the otherwise applicable tariff rate, the Company will not recover those ITCS costs from other customers. Also, as described above (see \"General -- Long-Term Gas Transportation Rates\"), the Company has requested authorization to implement an optional long-term noncore gas transportation tariff. Under the Company's proposal, shareholders will bear the risk of any revenue shortfalls attributable to any differences between the long-term rate option and the customer's otherwise applicable rate. Accordingly, shareholders may bear the costs of any shortfall in recovery of ITCS costs contained in the otherwise applicable rate.\nIn July 1992, the CPUC issued a decision in its capacity brokering proceeding which denied the Company the authority to recover in gas rates at that time costs associated with 150 MMcf\/d of Transwestern capacity prior to a prudence determination by the CPUC. Instead, those costs may be entered into a balancing account, subject to reasonableness review proceedings. The July 1992 decision did not address the Company's use of 50 MMcf\/d on behalf of the electric department. The issue of the inclusion of the costs associated with the electric department's subscription to Transwestern capacity was raised in the Company's 1992 ECAC proceeding, but as a result of a settlement with the DRA, final resolution of the issue was deferred to a later reasonableness review proceeding. In the interim, the CPUC's decision in the ECAC case authorized the Company to record the demand charges incurred by the electric department in its ECAC balancing account, but such costs will not be recovered in electric rates until the CPUC makes a determination in a future reasonableness proceeding that the commitment to subscribe to the Transwestern capacity was prudent. Currently, the Company is not permitted to include any Transwestern firm capacity demand charges in the ITCS account.\nIn January 1994, the DRA issued its report on the reasonableness of the Company's gas procurement and operating activities for the 1992 record period. In its report, the DRA argued that the Company imprudently entered into firm transportation agreements with Transwestern in 1992 and recommended a disallowance of the associated demand charges of approximately $18 million paid by the Company during the record period, of which $4.5 million related to capacity for the electric department. The DRA asserted that the incremental\ninterstate capacity was unnecessary to meet the expected needs of the Company's core customers and that the Company should not have contracted for such capacity on account of noncore customers.\nThe Company is continuing its efforts to broker or assign its remaining interstate transportation capacity that is not used. Since the latter half of 1993 when implementation of capacity brokering began on interstate pipelines, including El Paso, PGT and Transwestern, the Company has been able to broker a significant portion of the unused capacity, including limited amounts of the capacity held for its core and core subscription customers when such capacity was not being used to serve those customers. Amounts brokered have been on a short-term basis, most of which were at a discounted price. The average monthly demand charges associated with the Company's unused interstate capacity have been approximately $10 million, of which the Company has been able to recover approximately 40% through capacity brokering during the past few months. Because the success of the Company's brokering efforts will depend on market demand, the Company cannot predict the volume or the price of the capacity that will be brokered in the future.\nGAS REASONABLENESS PROCEEDINGS\nRecovery of gas costs through the Company's regulatory balancing account mechanisms is subject to a CPUC determination that such costs were incurred reasonably. Under the current regulatory framework, annual reasonableness proceedings are conducted by the CPUC on a historic calendar year basis.\n1988-1990 RECORD PERIOD\nThe CPUC has consolidated its review of the reasonableness of gas system costs for 1988 through 1990.\nIn September 1991, the DRA issued its report on the Company's Canadian gas procurement activities during 1988 through 1990. The DRA recommended that the Company refund approximately $392 million for the approximately three-year period from February 1988 to December 1990, based on its contention that the Company should have purchased 50% of its Canadian supplies on the spot market instead of almost totally relying on long-term contracts.\nIn addition to the recommendation on Canadian gas procurement, the DRA proposed a $37 million disallowance related to gas operations. The DRA contended that the Company should have withdrawn gas from storage in the winter of 1989-1990 and December 1990 instead of burning fuel oil, which was more expensive.\nOn March 16, 1994, the CPUC issued a final decision on the Company's Canadian gas procurement activities during 1988 through 1990. The CPUC found that the Company could have saved its customers money if it had bargained more aggressively with its existing Canadian suppliers or bought cheaper gas from other Canadian sources. The CPUC concluded that it was appropriate for the Company to take about 70% of its daily customer demand for gas from its then-existing Canadian gas suppliers, but that the Company could have met the remainder of its daily demand with purchases from other available Canadian natural gas sources. The decision orders a disallowance of $90 million of gas costs, plus accrued interest estimated at approximately $25 million through December 31, 1993.\nThe CPUC also issued a final decision on the Company's non-Canadian gas operations during 1988 through 1990. The decision finds that the Company should have withdrawn more gas from storage during December 1990 for the electric department's generation and orders a disallowance of $8 million. The Company intends to file requests for rehearing of this decision and the decision on the Canadian gas procurement activities described above.\nThe decisions described above do not address an additional $18 million disallowance recommended by the DRA in connection with the Company's purchased power expenses for Pacific Northwest purchases during 1989 and 1990. In its September 1991 report on the Company's Canadian gas procurement activities during 1988 through 1990, the DRA noted that the Company purchased electric energy when it was cheaper than its incremental fossil fuel generation costs. However, the DRA argues that if cheaper Canadian gas supplies had been used then the Company's incremental fossil fuel generation costs would have been lower than the purchased power costs. The DRA has also sought permission to file additional testimony on the\neffects of any imprudently incurred Canadian gas costs on certain of the Company's electric operations costs during the 1988 through 1990 record periods. On March 7, 1994, the ALJ granted the DRA's motion requesting the right to file testimony concerning prices for energy purchased from QFs and geothermal steam prices. The ALJ's ruling combines these issues with the outstanding Pacific Northwest purchased power issues into a separate phase of the reasonableness proceeding. Hearings on these issues have not yet been scheduled.\n1991 RECORD PERIOD\nIn September 1992, the Company filed testimony to establish the reasonableness of its gas procurement and operating activities for 1991. In March 1993, the DRA issued its report on the reasonableness of those activities and recommended that the Company refund approximately $116 million in costs for that period.\nThe major recommended disallowance relates to the DRA's contention that the Company failed to pursue least-cost purchasing alternatives in acquiring Canadian gas supplies during the 1991 record period. The DRA calculated that the Company would have saved $105 million in gas costs if it had purchased 50% of its Canadian gas supply at spot market prices, and accordingly recommended that amount be disallowed. The DRA also asserted that the Company's electric department's procurement policies and decisions were strongly influenced by the Company's Canadian gas affiliate arrangements. The DRA indicated that although the electric department's excess costs are subsumed in the $105 million recommended disallowance for Canadian gas procurement activities, it recommended a disallowance of $15.8 million in electric department gas costs even if the Canadian gas costs are not deemed unreasonable, given the electric department's alleged failure to pursue least-cost procurement alternatives.\nThe DRA recommended an additional disallowance of approximately $2.4 million in connection with the Company's Southwest gas procurement activities during the 1991 record period. The DRA asserted that the Company imprudently incurred these additional costs by purchasing amounts in excess of minimum contract requirements at contract prices which were higher than spot market prices.\nIn addition, the DRA recommended an $8.5 million disallowance related to the Company's gas inventory operations. The DRA contended that the Company's operating assumptions regarding the quantity of gas to be reserved in storage for potential needs of residential customers under extreme weather conditions resulted in the electric department incurring excess costs as it had to burn higher priced fuel oil to generate electricity during the record period.\nHearings on the 1991 record period are scheduled for May 1994.\n1992 RECORD PERIOD\nIn January 1994, the DRA issued its report on the reasonableness of the Company's gas procurement and operating activities for 1992 and recommended a disallowance of approximately $92 million in costs for that period.\nThe major recommended disallowance relates to the DRA's contention that the Company failed to pursue least-cost purchasing alternatives in acquiring Canadian gas supplies during the 1992 record period. The DRA calculated that the Company would have saved $60.5 million in gas costs if it had purchased 50% of its Canadian gas supply at spot market prices, and accordingly recommended that amount be disallowed. In addition, the DRA recommended a disallowance of approximately $5.1 million in connection with the Company's Southwest gas procurement activities during a three-month period in 1992 and a disallowance of $8.2 million related to the Company's gas inventory operations.\nIn its report, the DRA also argued that the Company imprudently entered into firm transportation agreements with Transwestern in 1992 and recommended a disallowance of the associated demand charges of approximately $18 million paid by the Company during the record period, of which $4.5 million related to capacity for the electric department. The DRA asserted that the incremental interstate capacity was unnecessary to meet the expected needs of the Company's core customers and that the Company should not have contracted for such capacity on account of noncore customers.\nAFFILIATE AUDIT\nIn addition to challenging the prudence of the gas costs incurred by the Company under its Canadian gas supply arrangements, in 1992 the DRA also initiated an audit of the non-gas costs incurred by the Company's present and former Canadian affiliates.\nIn September 1993, the DRA distributed a report on its audit of A&S for the 1988 through 1991 period. The DRA report recommends that the CPUC impose a $50 million penalty on the Company and disallow approximately $6.2 million of primarily non-gas and administrative costs in 1991. The DRA has filed a motion asking that recommendations for the 1992 record period be made in a subsequent report. No action has been taken on this motion. In addition, the DRA has indicated that it will be filing in June 1994 a supplemental report addressing matters relating to the profitability of the Cochrane liquids extraction plant operated by the Company's former affiliate, ANG. The DRA has stated that the report will address the implications, if any, of ANG's status as an affiliate of the Company. In a previous report, the DRA had noted that a substantial portion of ANG's profits were derived from the operation of the Cochrane plant and that in part as a result of that profitability the Company had a pre-tax profit of $49 million from the sale of its ANG shares in 1992.\nThe DRA's proposed $50 million penalty relates primarily to its contention that the Company has committed serious lapses in the oversight of A&S. In particular, the DRA alleges that the Company failed to prevent A&S from passing through allegedly excessive and improper transportation and non-gas and administrative costs in A&S' cost of service. Based on its calculations, the DRA alleges that A&S contracted for excessive Canadian pipeline capacity on the pipeline systems of NOVA and ANG relative to the capacity necessary to service the Company's ratepayers. The DRA further argues that A&S misallocated its cost of service between the Company and its other customers resulting in cross-subsidies of Canadian customers by the Company's ratepayers. The Company filed its rebuttal testimony in March 1994. Hearings are scheduled in May 1994.\nIn December 1993, the ALJ denied a motion filed by the Company which had asked the CPUC to dismiss the penalty and disallowance because prior federal rulings approved such costs and thus preempt the issue.\nIn January 1994, the DRA filed with the CPUC a report on alleged conflicts of interest which discusses the stock holdings of certain officers and directors of A&S in companies from which A&S contracted for gas supplies that eventually flowed to California. In its report, the DRA indicates that it did not discover specific transactions resulting from the stock ownership which caused identifiable harm to California ratepayers. However, the DRA concluded that the stock ownership created the appearance of impropriety and that the interests may have created a disincentive for those officers to aggressively seek opportunities to drive down the price for gas paid to producers. The DRA's report also criticizes the Company for not taking sufficient action to ensure that A&S's conflicts threshold was as stringent as that which the Company employed in evaluating possible conflicts of interest of its employees.\nThe DRA's report does not request any specific disallowance associated with the conflicts of interest discussed in the report. Rather, the DRA argues that the Company's lack of oversight in this respect provides further evidence to support the $50 million penalty recommended in its September 1993 report on Canadian non-gas costs.\nFINANCIAL IMPACT OF GAS REASONABLENESS PROCEEDINGS\nThe Company recorded reserves of $61 million in 1993 and will accrue approximately an additional $90 million in the first quarter of 1994 as a result of the CPUC's disallowance in the 1988-1990 gas reasonableness proceedings and the Company's assessment of gas procurement activities in the periods 1991 through 1993.\nThe Company currently is unable to estimate the ultimate outcome of the gas reasonableness proceedings, including the affiliate audit, discussed above or predict whether such outcome will have a significant adverse impact on its financial position or results of operations.\nPGT\/PG&E PIPELINE EXPANSION PROJECT\nIn November 1993, PGT and the Company placed in service an expansion of their natural gas transmission systems from the Canadian border into California. The 840-mile combined pipeline will provide an additional 148 MMcf\/d of firm capacity to the Pacific Northwest and an additional 755 MMcf\/d of firm capacity to Northern and Southern California. At December 31, 1993, the Company's total investment in the project was approximately $1,587 million. The $1,587 million consisted of $767 million for the facilities within California (i.e., intrastate portion) and $820 million for the facilities outside California (i.e., interstate portion).\nThe construction of facilities within the state of California has been certificated by the CPUC. The conditions of the certificate place the Company at risk for its decision to construct based on its assessment of market demand and for any potential underutilization of the facility. The certificate requires the application of a \"cross-over\" ban under which volumes delivered from the incremental interstate (PGT) expansion must be transported at an incremental intrastate expansion rate. Incremental rate design is based on the concept that expansion shippers, not existing ratepayers, bear the incremental costs of the expansion facilities. Capacity on the interstate portion is fully subscribed under long-term firm transportation contracts. However, to date, shippers have only executed long-term firm transportation contracts for approximately 40% of the intrastate capacity, and the Company continues negotiations for the remaining capacity. The CPUC has authorized the Company to provide as-available service on the expansion project, which can provide additional revenues to recover the incremental costs of the expansion.\nThe CPUC certificate issued in December 1990 established a cost cap of $736 million for the California portion, which represented the maximum amount determined by the CPUC to be reasonable and prudent based on an estimate of the anticipated construction costs at that time. In October 1993, the CPUC issued a decision granting the Company's motion to put in place temporary interim rates based on the existing cost cap of $736 million. The decision authorized the temporary interim rates to become effective on the date of commercial operation, November 1, 1993, and remain in effect for five months or until interim rates are established by the CPUC.\nIn February 1994, the CPUC announced a decision on the Company's request for an increase in the California portion of the expansion project's cost cap and its interim rate filing. The CPUC granted the Company's request to increase the cost cap to $849 million, but set interim rates based on the original cost cap of $736 million, subject to adjustment within the newly approved cost cap after the outcome of a reasonableness review of capital costs. The CPUC's decision finds that given market conditions at the time, the Company was reasonable in constructing the expansion project. In its decision, the CPUC also approved a one percentage point increase in the return on equity over the authorized return on utility operations in order to reflect the risk associated with the additional leverage of a capital structure of 70% debt and 30% equity for the California portion of the expansion project. The decision rejects assignment of unused capacity costs on other pipelines (or the Company's intrastate facilities) to the expansion project as previously proposed by an ALJ's proposed decision.\nThe FERC issued an order in October 1991 approving the interstate portion of the expansion project. However, concluding that PGT had not sufficiently demonstrated that shippers would not be subject to discriminatory restraints on access into California or on the interstate portion of the project as a result of the \"cross-over\" ban imposed by the CPUC, the FERC reduced PGT's approved rate of return on equity to 10.13% (from the 12.5% return previously approved) until such time as PGT demonstrates that neither its rates or transportation policies nor those of the Company result in unduly discriminatory restraints. In March 1993, the FERC authorized an increase in the nominal return on equity to 12.75% from 12.5%, but reaffirmed the lower 10.13% return on equity it implemented as an incentive for PGT to seek removal of unduly discriminating restraints.\nBased upon the current status of the cost cap and interim rate case at the CPUC and market demand, the Company believes it will recover its investment in the expansion project.\nOTHER COMPETITIVE INTERSTATE PIPELINE PROJECTS\nIn 1992, several new gas pipeline projects were completed to serve the enhanced oil recovery market in Southern California and other customers. In March 1992, projects sponsored by Kern and the Mojave Pipeline Company (Mojave) commenced commercial operations. The projects involved construction of Kern's 700 MMcf\/d pipeline from Wyoming to California, Mojave's 400 MMcf\/d pipeline from Arizona border interconnection points with the El Paso and Transwestern systems to a point of interconnection with the Kern project in California, and a pipeline, jointly owned by Kern and Mojave, from the point of interconnection to the Bakersfield area. Also in 1992, both Transwestern and El Paso put into service expanded pipeline facilities from the San Juan Basin in New Mexico to the California border.\nThese projects provide additional capacity to some of the same markets served by the PGT\/PG&E expansion project. Some of the gas available from the U.S. Southwest over these projects is priced equal to or lower than the current price of Canadian gas available over the PGT\/PG&E expansion project, due in part to federal tax credits available for certain San Juan gas production.\nAltamont Gas Transmission Company (Altamont) has proposed to build a pipeline that would transport gas from Alberta, Canada, to Wyoming, where it would interconnect with the Kern project. However, in July 1992, Altamont announced a one-year delay (to late 1994) in the scheduled completion of its proposed pipeline project.\nIn March 1993, Mojave filed a request seeking FERC authorization for construction of a 475 MMcf\/d transportation-only pipeline expansion of its interstate natural gas pipeline. Mojave indicated that it intends to place the proposed expansion into service by January 1, 1996. The expansion would extend Mojave's system from its current terminus at Bakersfield, California, through California's Central Valley to Sacramento and the San Francisco Bay Area. Mojave's filing indicates that 433 MMcf\/d of the firm service capacity provided by the proposed expansion will be provided to customers located in the Company's service territory, with approximately 257 MMcf\/d of that amount to be used to provide gas service that currently is not provided by the Company. The remaining 176 MMcf\/d represents service to customers currently served by the Company.\nIn April 1993, the CPUC issued a resolution asserting jurisdiction over the rates and services of Mojave and the facilities used by Mojave to transport gas received by Mojave in California and ultimately consumed in California. The CPUC also filed with the FERC a protest and motion to dismiss Mojave's application. The Company also filed a protest and motion to dismiss Mojave's application, arguing that the FERC should dismiss Mojave's application because the CPUC, and not the FERC, has jurisdiction to review Mojave's proposed expansion. The Company indicated in its filing that Mojave's proposed expansion would bypass the Company's existing gas network, taking business from the Company and requiring the Company to spread costs over a smaller customer base. The Company contended that Mojave's project would cost over $330 million (net present value) more than if the Company served the targeted customers, while reducing the economic welfare of the Company's remaining customers by over $325 million in present value terms.\nIn December 1993, the FERC held hearings in response to the Company's and the CPUC's requests to dismiss Mojave's pending pipeline expansion application. In February 1994, the FERC issued a decision asserting jurisdiction over Mojave's pending application. In March 1994, both the Company and the CPUC filed requests for a rehearing in this matter, arguing that the FERC erred in asserting jurisdiction. In addition, the Company requested that, if the FERC denies rehearing on the jurisdictional issues, the FERC hold a hearing to review the merits of Mojave's proposal and to establish a mechanism to reimburse the Company for costs arising from bypass associated with Mojave's proposed expansion.\nSTORAGE SERVICE\nThe Company has generally provided natural gas storage service only in conjunction with its procurement and transportation services. In an open season ending in January 1993, noncore customers indicated an interest\nin obtaining unbundled storage service. In February 1993, the CPUC adopted policies and rules for permanent unbundled gas storage programs for noncore customers, and ordered the Company to submit a storage proposal in compliance with those policies. The Company's proposal regarding an unbundled storage program was submitted to the CPUC in July 1993 and hearings on the proposal were held in October and November 1993. CPUC authorization of an unbundled storage program for the Company is expected in the second quarter of 1994. Following authorization, the Company will hold an open season offering noncore customers short-term storage services from existing facilities and long-term storage services from expanded facilities.\nDIABLO CANYON\nDIABLO CANYON OPERATIONS\nDiablo Canyon Units 1 and 2 began commercial operation in May 1985 and March 1986, respectively. As of December 31, 1993, Diablo Canyon Units 1 and 2 had achieved lifetime capacity factors of 78% and 80%, respectively.\nThe table below outlines Diablo Canyon's refueling schedule for the next five years. This schedule assumes that a refueling outage for a unit will last approximately nine weeks, depending on the scope of the work required for a particular outage. The schedule is subject to change in the event of unscheduled plant outages or changes in the length of the fuel cycle.\nOn July 9, 1992, the Company filed a license amendment request with the Nuclear Regulatory Commission (NRC) to change the operating license expiration dates for both units at Diablo Canyon. Diablo Canyon Units 1 and 2 are currently licensed to operate for 40 years commencing on the date the construction permit for the respective unit was issued, which occurred in 1968 and 1970, respectively. In 1982, the NRC determined that the 40-year term of operation for nuclear power plants may instead begin upon issuance of the first operating license. The Company's request seeks to utilize that policy change, and if granted, would extend the operating license expiration date for Unit 1's license from April 2008 to September 2021 and the expiration date for Unit 2's license from December 2010 to April 2025.\nIn August 1992, a group intervened in opposition to the license amendment and requested hearings at the NRC. In October 1992, the intervenor group supplemented its petition with a request that eleven contentions be admitted for hearing. The Company and the NRC staff responded to the intervention petition and its supplement, asserting that the intervenors lack standing and none of the contentions are admissible. In January 1993, an NRC licensing board issued its order granting the intervenors standing and admitting for hearings two of the eleven contentions filed by the intervenors. The two admitted contentions relate to the Company's maintenance program for Diablo Canyon and the adequacy of the Company's implementation of certain compensatory measures approved by the NRC to address issues relating to a fire-barrier material known as Thermo-Lag pending NRC\/industry resolution of those issues. Hearings were completed in August 1993. In February 1994, the intervenor group filed a motion to reopen the record in the proceeding in order to take evidence on an NRC inspection issue which the intervenor group alleges represents significant new information regarding deficiencies in the Company's maintenance of the plant's auxiliary saltwater system. Both the Company and the NRC staff have replied to the motion, urging it be rejected. A decision by the NRC licensing board on the motion to reopen is expected in the next few months, and a decision on the Company's license amendment request is expected in 1994.\nThe Company is a member of Nuclear Mutual Limited (NML) and Nuclear Electric Insurance Limited (NEIL I and II). If the nuclear plant of a member utility is damaged or increased costs for business interruption are incurred due to a prolonged accidental outage, the Company may be subject to maximum\nassessments of $21 million (property damage) or $7 million (business interruption), in each case per policy period, if losses exceed premiums, reserves and other resources of NML, NEIL I or NEIL II.\nThe federal government has enacted laws that require all utilities with nuclear generating facilities with a capacity of 100 MW or more to share in payment of claims resulting from a nuclear incident. The Price-Anderson Act limits industry liability for third-party claims resulting from any nuclear incident to $9.4 billion per incident. Coverage of the first $200 million is provided by a pool of commercial insurers. If a nuclear incident results in public liability claims in excess of $200 million, the Company may be assessed up to $159 million per incident with payments in each year limited to a maximum of $20 million per incident; payments in excess are deferred to the next calendar year.\nDIABLO CANYON SETTLEMENT\nThe Diablo Canyon rate case settlement adopts alternative ratemaking for Diablo Canyon by basing revenues primarily on the amount of electricity generated by the plant, rather than on traditional cost-based ratemaking. Under this \"performance based\" approach, the Company assumes a significant portion of the operating risk of the plant because the extent and timing of the recovery of actual operating costs, depreciation and a return on the investment in the plant primarily depend on the amount of power produced and the level of costs incurred. The Company's earnings are affected directly by plant performance and costs incurred. Earnings relating to Diablo Canyon will fluctuate significantly as a result of refueling or other extended plant outages, plant expenses and the effects of a peak-period pricing mechanism. See \"Diablo Canyon Operations\" above for the plant refueling schedule.\nThe settlement decision explicitly affirmed that Diablo Canyon costs and operations no longer should be subject to CPUC reasonableness reviews. The decision states that, to the extent permitted by law, the CPUC intends that this decision be binding upon future Commissions, based upon a determination that taken as a whole the settlement produces a just and reasonable result, and that the settlement has been approved based on the reasonable reliance of the parties and the CPUC that all of the terms and conditions will remain in effect for the full term of the settlement, ending 2016. However, the decision states that the CPUC cannot bind future Commissions in fixing just and reasonable rates for Diablo Canyon.\nUnder the settlement, revenues are based on a pre-established price per kWh consisting of a fixed component (3.15 cents per kWh) and an escalating component for each kWh of electricity generated by the plant. Total prices for the years 1993 through 1994, effective January 1 of each year, are 11.16 cents and 11.89 cents per kWh, respectively. For 1995 through 2016, the escalating component will be adjusted by the change in the consumer price index plus 2.5%, divided by two. During the first 700 hours of full-power operation for each unit during the peak period (10 a.m. to 10 p.m. on weekdays in June through September), the price is 130% of the stated amount to encourage the Company to utilize the plant during the peak period. During the first 700 hours of full-power operation for each unit during the non-peak period of the year, the price is 70% of the stated amount. At all other times, the price is 100% of the stated amount.\nIf power generation drops below specified capacity levels, the Company may trigger an annual revenue floor provision, or under certain conditions, seek abandonment of the plant (discussed below). Floor payments ensure that the Company will receive some revenue, even if the plant stops producing power. Floor payments are based on the prices set in the agreement at a 36% capacity factor from 1988 through 1997 (reduced by 3% each time the floor provision is exercised and not repaid) with the capacity factor decreasing in the future. Floor payments must be refunded to customers under specified circumstances.\nIf actual operation falls below the floor capacity factor in three consecutive years, whether or not the floor payment provision has been triggered, the Company must file for abandonment or explain why continued application of the settlement is appropriate. In the event there is a prolonged plant outage and the Company files for abandonment, the Company may ask for recovery of the lesser of (a) floor payments allowed for ten years, less any years of floor payments already received and not repaid, or (b) $3 billion, reduced by $100 million per year of operation on January 1 of each year starting in 1989.\nThe settlement provides that certain Diablo Canyon costs, including decommissioning costs, be recovered over the term of the settlement, including a full return on such costs through base rates.\nIn March 1993, the CPUC denied a petition filed in September 1992 by a consumer advocacy group seeking to modify the CPUC's 1988 decision that adopted the Diablo Canyon rate case settlement. The petition contended that the Company has made unreasonably high profits because of the better-than-expected operating performance of Diablo Canyon. The petition did not propose any specific change to the Diablo Canyon rate provisions, but requested that the CPUC reopen the Diablo Canyon settlement to consider mechanisms for sharing with ratepayers additional benefits of Diablo Canyon's performance.\nThe CPUC found that there had been no failure in the underlying assumptions of the settlement and that reopening the settlement would be contrary to the public policy in favor of settlements. Although all four CPUC Commissioners voted to deny the petition, CPUC President Fessler indicated in his concurring opinion that he was concerned about the high electricity rates paid by all classes of ratepayers and would consider reopening the settlement if the Company does not reduce its rates within a year.\nNUCLEAR FUEL SUPPLY AND DISPOSAL\nThe Company has purchase contracts for, and an inventory of, uranium concentrates and contracts for conversion of uranium to uranium hexafluoride, uranium enrichment and fuel fabrication. Based on current operations forecasts, Diablo Canyon's requirements for uranium supply, enrichment services and conversion services will be satisfied through existing long-term contracts through 1994, 1996 and 1998, respectively. The Company is currently negotiating contracts for uranium supply and enrichment services through 2002. Fuel fabrication contracts for the two units will supply their requirements for the next five operating cycles for each unit. These contracts are intended to ensure long-term fuel supply, but permit the Company the flexibility to take advantage of short-term supply opportunities. In most cases, the Company's nuclear fuel contracts are requirements based, with the Company's obligations linked to the continued operation of Diablo Canyon.\nUnder the Nuclear Waste Policy Act of 1982 (the Act), the DOE is responsible for the transportation and ultimate long-term disposal of spent nuclear fuel and high-level waste. The Act sets a national policy for the disposal of nuclear waste from commercial reactors, and establishes a timetable for the DOE to choose one or more sites for the deep underground burial of wastes from nuclear power plants. Under the Act, utilities are required to provide interim storage facilities until permanent storage facilities are provided by the federal government. The Act mandates that one or more such permanent disposal sites be in operation by 1998, although DOE has indicated that such sites may not be in operation until 2010. DOE is also considering providing interim storage in a monitored retrievable storage facility earlier than 2010. However, under DOE's current estimated acceptance schedule for spent fuel, Diablo Canyon's spent fuel is not likely to be accepted by DOE for interim or permanent storage before 2011, at the earliest. At the projected level of operation for Diablo Canyon, the Company's facilities are sufficient to store on-site all spent fuel produced through approximately 2006 while maintaining the capability for a full-core off-load. In the event an interim or permanent DOE storage facility is not available for Diablo Canyon's spent fuel by 2006, the Company will examine options for providing additional temporary spent fuel storage at Diablo Canyon or other facilities, pending disposal or storage at a DOE facility. Such additional temporary spent fuel storage may be necessary in order for the Company to continue operating Diablo Canyon beyond approximately 2006, and may require approval by the NRC and other regulatory agencies.\nIn July 1988, the NRC gave final approval to the Company's plan to store radioactive waste from the Humboldt Bay Power Plant (Humboldt) at Humboldt for 20 to 30 years and, ultimately, to decommission the unit. The license amendment issued by the NRC allows storage of spent fuel rods at Humboldt until a federal repository is established. The Company has agreed to remove all nuclear waste as soon as possible after the federal disposal site is available.\nDECOMMISSIONING\nThe estimated cost of decommissioning the Company's nuclear power facilities is recovered in base rates through an annual allowance. For the year ended December 31, 1993, the amount recovered in rates for\ndecommissioning costs was $54 million. The estimated total obligation for decommissioning costs is approximately $1 billion in 1993 dollars; this obligation is being recognized ratably over the facilities' lives. This estimate considers the total costs of decommissioning and dismantling plant systems and structures and includes a contingency factor for possible changes in regulatory requirements and waste disposal cost increases.\nAs of December 31, 1993, the Company had accrued $537 million in accumulated depreciation and decommissioning and had accumulated that amount in external trust funds, to be used for the decommissioning of the Company's nuclear facilities. Funds may not be released from the external trust funds until authorized by the CPUC.\nThe CPUC reviews the funding levels for the Company's decommissioning trust in each GRC. Based upon the trust's then-current asset level, and revised earnings and decommissioning cost assumptions, the CPUC may revise the amount of decommissioning costs it has authorized in rates for contribution to the trust. To date the CPUC has not revised the funding levels initially established in 1987. However, to comply with tax law requirements, the Company anticipates that the CPUC will revise the funding levels no later than the 1997 tax year to reflect then-current earnings assumptions and decommissioning cost estimates.\nPG&E ENTERPRISES\nEnterprises is the parent company established to oversee the Company's principal non-utility unregulated business activities. Enterprises was established in 1988 and is a wholly owned subsidiary of the Company. Enterprises' activities are conducted through the entities described below.\nNON-UTILITY ELECTRIC GENERATION\nA wholly owned Enterprises subsidiary is a general partner in U.S. Generating Company (USGen), a California general partnership. A subsidiary of the Bechtel Group, Inc. is the other general partner of USGen. USGen develops and manages non-utility electric generation facilities which sell power to utilities other than the Company. Enterprises' ownership interest in projects developed by USGen varies by project. Profits and losses realized by USGen are distributed in proportion to the partners' relative interests in the project from which those profits or losses are derived. USGen is currently involved in seven operational plants and eight projects under construction or in advanced stages of development (with power sales agreements). Enterprises' share of capacity from those projects is approximately 1,515 MW. The projects are typically financed with a combination of equity commitments from the project sponsors and non-recourse debt. USGen also manages Enterprises' 39.9% limited partnership interest in Sycom Enterprises, which offers energy conservation services.\nGAS AND OIL EXPLORATION AND PRODUCTION\nResources, a wholly owned indirect subsidiary of Enterprises, is engaged in natural gas and oil exploration and production primarily in the Gulf Coast, east Texas, Anadarko and Rocky Mountain regions of the U.S.\nIn January 1994, the Company approved a final plan for the disposition of Resources in 1994 if market conditions remain favorable. The Company has retained Goldman, Sachs & Co. to advise it with respect to possible alternatives for the divestiture of Resources. In February 1994, Resources filed with the Securities and Exchange Commission a proposed S-1 registration statement with respect to one of these options. This option involves an initial public offering of all of the stock of Resources' parent holding company, PG&E Resources Holdings Company, which would be renamed Dalen Resources Corp. prior to the offering. Such an offering would be preceded by the transfer of Resources' non-strategic properties to a newly-formed subsidiary of Enterprises for disposition by sale. As of December 31, 1993, Resources had assets of approximately $680 million.\nPOWER PLANT OPERATING SERVICES\nU.S. Operating Services Company (USOSC), a California general partnership, provides operations and maintenance services for power facilities managed by USGen and to third parties in the independent power\nproduction business. An Enterprises subsidiary and a subsidiary of Bechtel Group, Inc. are the general partners of USOSC. Enterprises' economic interest in USOSC projects varies by project.\nREAL ESTATE DEVELOPMENT\nPG&E Properties, Inc. (Properties) develops real estate in the Company's service territory, focusing on residential lot creation. It also develops offices, industrial buildings, retail outlets and apartments. Properties is wholly owned by Enterprises.\nENVIRONMENTAL MATTERS AND OTHER REGULATION\nENVIRONMENTAL MATTERS\nThe Company is subject to a number of federal, state, and local laws and regulations designed to protect human health and the environment by imposing stringent controls with regard to planning and construction activities, land use, and air and water pollution, and, in recent years, by governing the use, treatment, storage and disposal of hazardous or toxic materials. These laws and regulations affect future planning and existing operations, including environmental protection and remediation activities. The Company has undertaken major compliance efforts with specific emphasis on its purchase, use and disposal of hazardous materials, the cleanup or mitigation of historic waste spill and disposal activities, and the upgrading or replacement of the Company's bulk waste handling and storage facilities.\nENVIRONMENTAL PROTECTION MEASURES\nThe Company's projected expenditures for environmental protection are subject to periodic review and revision to reflect changing technology and evolving regulatory requirements. Capital expenditures for environmental protection are currently estimated to be approximately $50 million, $50 million, $75 million, $95 million and $75 million for 1994, 1995, 1996, 1997 and 1998, respectively, and are included in the Company's five-year projection of capital requirements shown above in \"General -- Capital Requirements and Financing Programs.\" Expenditures during these years will be primarily for oxides of nitrogen (NOx) emission reduction projects.\nAir Quality\nThe Company's existing thermal electric generating plants are subject to numerous air pollution control laws, including the California Clean Air Act (CCAA) with respect to emissions. Pursuant to the CCAA and the Federal Clean Air Act, the three local air districts in which the Company operates fossil fuel fired generating plants have adopted final rules to reduce NOx emissions from these plants.\nThe three agencies that have adopted utility boiler NOx rules are the Monterey Bay Unified Air Pollution Control District (Rule 431 adopted September 15, 1993), the San Luis Obispo County Air Pollution Control District (Rule 429 adopted November 16, 1993) and the Bay Area Air Quality Management District (Regulation 9, Rule 11 adopted February 16, 1994). These rules prescribe emission limitations for the Company's Contra Costa, Hunters Point, Moss Landing, Morro Bay, Pittsburg and Potrero power plants. In each district, other NOx rules have been or will be adopted to regulate other NOx sources.\nBecause the Company's power plants operate as a system, the three agencies coordinated their NOx rulemakings. Together, the rules require a reduction in NOx emissions of approximately 90% from the power plants by 2004 (with numerous interim compliance deadlines). The first major retrofit is scheduled to begin in 1996. Certain retrofits will not be required if the smaller generating units are operated for emergency purposes only after 2000. Rule 431 also requires the Company to provide a total of $7 million to the Monterey Bay Unified Air Pollution Control District in 1994 and 1995 for emission reduction projects not related to Company sources. Rule 429 may require additional expenditures of up to $1.5 million in the San Luis Obispo County Air Pollution Control District, depending on air quality progress in that district.\nThe Company currently estimates that compliance with these NOx rules could require capital expenditures of approximately $300 million to $500 million over 10 years, depending on assumptions about fuel use and unit retirement. Ongoing business and engineering studies could change this estimate. In the Company's 1993 GRC, the CPUC authorized NOx related plant additions of approximately $70 million for 1993, and established an Air Quality Adjustment (AQA) mechanism under which the Company may seek cost recovery in rates for NOx reduction projects beyond January 1, 1994. However, in its RRI filing (see \"General -- Regulatory Reform Initiative\" above) the Company has proposed that the AQA mechanism be terminated as of January 1, 1995.\nIn the San Luis Obispo County Air Pollution Control District, the Company obtained permits to install the first phase of NOx emission reductions at the Morro Bay Power Plant, thereby commencing implementation of NOx reductions in that district. The Company spent $48 million for the first phase of this NOx reduction project, which has been completed.\nThe Company operates both reciprocating engine and gas turbine drivers at its natural gas compressor stations. They are located in local air districts whose attainment plans call for reductions in emissions of exhaust pollutants over the next few years. On December 20, 1993, the Mojave Desert Air Quality Management District adopted a rule that will require a reduction in NOx emissions of approximately 90% from the Hinkley Compressor Station by January 1, 1998. The Topock Compressor Station is currently exempt from this rule. The San Joaquin Valley Unified Air Pollution Control District expects to adopt a similar rule during 1994 that would require a reduction in NOx emissions of approximately 90% from the Kettleman Compressor Station by January 1, 1999. The Company currently estimates that compliance with these NOx rules could require capital expenditures of approximately $55 million over five years.\nIn 1990 Congress passed extensive amendments to the Federal Clean Air Act. The Environmental Protection Agency (EPA) has issued numerous regulations for the implementation of these amendments. The Company is currently assessing the impact of the regulations. Generally, existing or proposed state and local air quality requirements are more stringent than the new federal requirements, which should therefore have little impact on the Company. However, stringent federal air monitoring requirements, which must be met by January 1, 1995, are being incorporated in local air quality rules. The air monitoring rules will require the installation of monitoring equipment to measure emissions from the fossil fuel fired generating plants. The Company currently estimates that the cost of complying with the monitoring requirements will total approximately $29 million in 1994 and 1995.\nWater Quality\nThe Company's existing power plants, including Diablo Canyon, are subject to federal and state water quality standards with respect to discharge constituents and thermal effluents. The Company's fossil fueled power plants comply in all material respects with the discharge constituents standards and either comply in all material respects with or are exempt from the thermal standards. A thermal effects study at Diablo Canyon was completed in May 1988, and has been reviewed by the Central Coast Regional Water Quality Control Board (Regional Board). The Regional Board has not yet made a final decision on the report and has requested that the Company continue the marine monitoring program. In the event that Diablo Canyon does not comply with the thermal limitations and in the unlikely event that major modifications are required (e.g., cooling towers), significant additional construction expenditures could be required.\nA thermal effects study of the Company's Pittsburg and Contra Costa Power Plants was submitted to the San Francisco and Central Valley Regional Water Quality Control Boards in December 1992. In general, the study found no significant adverse effects associated with the thermal discharge at either plant. Additionally, several fish species listed or proposed for listing as endangered species may be found in the waters near these plants. There are severe restrictions on the \"taking\" (e.g. harassing, wounding or killing) of such species. Therefore, significant modifications could be required to plant operations (e.g., cooling towers) if a plant intake structure or thermal discharge is found to \"take\" an endangered species.\nPursuant to the federal Clean Water Act, the Company is required to demonstrate that the location, design, construction and capacity of power plant cooling water intake structures reflect the best technology\navailable (BTA) for minimizing adverse environmental impacts at all existing water-cooled thermal plants. The Company submitted detailed studies of each power plant's intake structure to various governmental agencies. Each plant's existing water intake structure was found to meet the BTA requirements. However, if in the future there are changes in available technology, these findings are subject to further review by various agencies. Thus, construction expenditures or operational changes may be necessary to meet a more stringent future standard.\nOil Spill Prevention\nThe Company operates two offshore moorings, three docks, approximately 103 large aboveground fuel tanks with a capacity of approximately 16,000,000 barrels and approximately 45 miles of fuel pipelines. These facilities are used for the transport, handling and storage of residual fuel oil and diesel, both of which are used at the Company's power plants and facilities.\nUnder the federal Clean Water Act Spill Prevention Control and Countermeasure (SPCC) regulations, many of the Company's power plants, substations and service centers must install and maintain facilities to prevent the release of oil and other hazardous materials to surface waters. Capitalized SPCC project costs for 1994 and 1995 are estimated to be approximately $4 million.\nIn addition, activities associated with the transport, storage and handling of petroleum products are regulated by the federal Oil Pollution Act of 1990 (OPA) and the California Oil Spill Prevention and Response Act of 1990 (OSPRA). Under these laws, the Company is required to demonstrate $500 million of financial responsibility, which it demonstrates through a combination of insurance and self insurance.\nRegulations under OPA and OSPRA require development of Emergency Response Plans utilizing worst case planning scenarios. Plans must include contracting for response resources to respond to the worst case scenarios. The Company is a member of the Clean Bay, Clean Seas and Humboldt Bay oil spill co-ops and the Marine Preservation Association through which it can obtain the services of the Marine Spill Response Corporation, a national oil spill response organization.\nCompany expenditures to comply with OPA and OSPRA requirements in 1994 and 1995 are estimated to total less than $2 million.\nHAZARDOUS MATERIALS AND HAZARDOUS WASTE COMPLIANCE AND REMEDIATION\nThe Company assesses, on an ongoing basis, measures that may need to be taken to comply with laws and regulations related to hazardous materials and hazardous waste compliance and remediation activities. Generally, these compliance costs are recovered through the GRC process. However, as discussed below, the CPUC has established a separate mechanism for recovery of certain hazardous waste remediation costs.\nThe EPA, the California Department of Toxic Substances Control (DTSC), and associated regional and local agencies have comprehensive rules which regulate the manufacture, distribution, use and disposal of polychlorinated biphenyls (PCBs). The Company has established programs and has committed resources to achieve compliance with these rules. In 1982, the EPA adopted new regulations greatly restricting the use of PCBs in electrical equipment. The regulations have resulted in the early retirement and replacement of certain equipment. Since Company operations generate PCB-contaminated waste which requires special handling, the Company has contracted with EPA-approved firms for the disposal or recycling of PCB waste. The Company estimates that PCB disposal will cost approximately $8 million in 1994 and 1995.\nThe Company has a comprehensive program to comply with the many hazardous waste storage, handling and disposal requirements promulgated by the EPA under the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), along with California's hazardous waste laws and other environmental requirements. As part of this general compliance effort, the Company has initiated programs to address three specific environmental issues: (i) wastewater holding ponds, (ii) underground storage tanks, and (iii) historic hazardous waste sites, including former manufactured gas plant sites.\nWastewater evaporation ponds contain materials such as compressor cooling water blowdown from gas compressor stations. The Company either is upgrading the existing ponds or closing the old ponds and building new evaporation ponds that meet new standards for leak monitoring, detection and containment. Capital expenditures for this work in the years 1994 and 1995 are estimated to be approximately $9.9 million. Closure and post-closure expenditures for these ponds, including remediation and cost contingencies, may approximate $20 million for a 30-year period.\nUnderground storage tanks are the subject of federal and California regulatory programs directed at identifying and eliminating the possibility of leaks. The Company has approximately 270 underground tanks, some of which must be upgraded to meet new standards. The tanks contain hazardous materials such as gasoline, waste automotive crankcase oil, transformer fluid or oily wastewater. The Company has an ongoing program to improve leak monitoring, test each tank for leakage and, if necessary, sample soil and water from the surrounding area and remediate any contamination detected. Costs for testing, remediation and tank replacement in 1994 and 1995 are estimated to be approximately $4.8 million.\nA third program is aimed at assessing whether and to what extent remedial action may be necessary to mitigate potential hazards posed by lampblack and tar residues, byproducts of a process that the Company and other utilities used as early as the 1850s to manufacture gas from coal and oil. As natural gas became widely available (beginning about 1930), the Company's manufactured gas plants were removed from service. The residues which may remain at some sites contain chemical compounds which now are classified as hazardous. The Company has identified and reported to federal and California environmental agencies 96 manufactured gas plant sites which the Company operated in its service territory. The Company owns all or a portion of 30 of these manufactured gas plant sites. The Company has begun a program, in cooperation with environmental agencies, to evaluate and take appropriate action to mitigate any potential health or environmental hazards at sites which the Company owns. The Company currently estimates that this program may result in expenditures of approximately $15.5 million over the period 1994 through 1995. The full long-term costs cannot be determined accurately until a closer study of each site or facility has been completed. It is expected that expenses will increase as remedial actions related to these sites are approved by regulatory agencies or if the Company is found to be responsible for clean up at sites it does not currently own.\nThe Company may be required to take remedial action at certain disposal sites and retired manufactured gas plant sites if they are determined to present a significant threat to human health or the environment because of an actual or potential release of hazardous substances. The Company has been designated as a potentially responsible party (PRP) under CERCLA, the federal Superfund law, with respect to the Purity Oil Sales site in Malaga, California; the Jibboom Junkyard site in Sacramento, California; the Industrial Waste Processing site near Fresno, California; and the Lorentz Barrel and Drum site in San Jose, California. The Company has been named as a PRP under the California Hazardous Substance Account Act (California Superfund law) with respect to the Martin Service Center former gas plant site and the Midway\/Bayshore sites in Daly City, California; the Berman Steel site in Salinas, California; the Emeryville Service Center site in Emeryville, California; the GBF Land Fill at Pittsburg, California; the former Sacramento gas plant site in Sacramento, California; the former San Rafael gas plant site in San Rafael, California; and the former Monterey gas plant site in Monterey, California. Although the Company has not been formally designated a PRP with respect to the Geothermal, Incorporated site in Lake County, California, the Central Valley Regional Water Quality Control Board and the California Attorney General's office have directed the Company and other parties to initiate measures with respect to the study and remediation of that site. In addition, the Company has been named as a defendant in several civil lawsuits in which plaintiffs allege that the Company is responsible for performing or paying for remedial action at sites the Company no longer owns or never owned.\nThe Company will perform a groundwater remedial action at its former Sacramento manufactured gas plant site during 1994, at a cost of up to $4 million. The DTSC must approve the groundwater remedial action design plan proposed for this site before it is implemented.\nThe overall costs of the hazardous materials and hazardous waste compliance and remediation activities described above are difficult to estimate due to uncertainty concerning the extent of environmental risks and\nthe Company's responsibility, the complexity of environmental laws and regulations and the selection of compliance alternatives. However, based on the information currently available, the Company has an accrued liability as of December 31, 1993, of $60 million for hazardous waste remediation costs. The ultimate amount of such costs may be significantly higher if, among other things, the Company is held responsible for cleanup at additional sites, other PRPs are not financially able to contribute to these costs, or further investigation indicates that the extent of contamination and affected natural resources is greater than anticipated at sites for which the Company is responsible.\nPotential Recovery of Hazardous Waste Compliance and Remediation Costs\nGenerally, the Company seeks recovery of hazardous waste compliance costs in the GRC. However, as part of the Company's 1987 GRC, the CPUC established a separate procedure through which the Company may receive ratepayer recovery of reasonable hazardous waste remediation costs incurred at certain historic hazardous waste sites. The CPUC indicated that it was establishing this procedure because the amount and timing of certain hazardous waste remediation expenditures was difficult to forecast in the context of the GRC. This procedure entails obtaining CPUC approval by advice letter prior to incurring any costs, as well as filing an application periodically with the CPUC for recovery of the amounts expended, subject to a review of the reasonableness of the expenditures.\nThe Company currently has received approval of advice letters totaling approximately $22.5 million, has filed two additional advice letters for approval, and expects to file additional requests for specific projects in 1994 and 1995. Amounts authorized by advice letters and subsequently spent by the Company may be collected from ratepayers only after a reasonableness review of the associated projects.\nIn November 1992, the CPUC issued a decision in Southern California Gas Company's (SoCal Gas) environmental reasonableness proceeding deferring a decision on rate recovery of remediation costs incurred by SoCal Gas and instead requesting comments on incentive and\/or cost sharing mechanisms for the ratemaking treatment of hazardous waste remediation costs as an alternative to the current reasonableness review of such expenses.\nIn response to the CPUC's request and as a result of a collaborative effort, in November 1993, the Company and various interested parties, including the DRA and other California utilities, filed a report with the CPUC in connection with the SoCal proceeding, which proposes a cost sharing mechanism for the ratemaking treatment of hazardous waste remediation costs. The proposed mechanism would assign 90% of the includable hazardous substance cleanup costs to utility ratepayers and 10% to utility shareholders, without a reasonableness review of such costs or of underlying activities. However, under the proposed mechanism, utilities would have the opportunity to recover the shareholder portion of the cleanup costs from insurance carriers. The parties supporting the proposed mechanism, including the Company, also filed a settlement, requesting that the mechanism be adopted only in its entirety. A special interest group opposes the proposed mechanism. The CPUC has authority to adopt the proposed mechanism, reject it, suggest certain changes to the proposed mechanism, schedule hearings on the issues it considers relevant, or send the parties back for further negotiations until they reach a consensus. On March 10, 1994, the assigned ALJ issued a proposed decision adopting the settlement and proposed mechanism. A final CPUC decision is expected in 1994.\nThe CPUC has put all parties on notice that the mechanism adopted for SoCal Gas may be applied to other utilities. Accordingly, a final decision in this proceeding is expected to establish the method by which the CPUC addresses similar issues in the Company's pending environmental reasonableness proceeding, which has been postponed indefinitely pending a decision in the SoCal Gas case. In the Company's environmental reasonableness proceeding, the Company seeks to recover approximately $10.2 million in costs for two environmental projects -- the Antioch Service Center site and the Sacramento Gas Plant site. However, in its RRI filing (see \"General -- Regulatory Reform Initiative\" above), the Company requests to withdraw its participation in the collaborative report and recommendation, the pending settlement and the Company's pending environmental reasonableness application if the CPUC approves the Company's RRI application.\nTo the extent that hazardous waste compliance and remediation costs are not recovered through insurance or by other means, the Company may apply for recovery through ratemaking procedures established by the CPUC and, assuming continuation of these procedures, expects that most prudently incurred hazardous waste compliance and remediation costs will be recovered through rates. However, under the Company's proposed RRI, the specific rate mechanism for recovery of these costs would be discontinued at the end of 1994. As of December 31, 1993, the Company has a deferred charge of $61 million for most hazardous waste remediation costs, which represents the minimum amount of such costs expected to be recovered under the current ratemaking mechanisms. The Company believes that the ultimate outcome of these matters will not have a significant adverse impact on its financial position or results of operations.\nIn December 1992, the Company filed a complaint in San Francisco County Superior Court against more than 100 of its domestic and foreign insurers, seeking damages and declaratory relief for remediation and other costs associated with hazardous waste mitigation. The Company had previously notified its insurance carriers that it seeks coverage under its Comprehensive General Liability Policies to recover costs incurred at certain specified sites. In the main, the Company's carriers neither admitted nor denied coverage, but requested additional information from the Company. The amount of recovery from insurance coverage, if any, cannot be quantified at this time.\nELECTRIC AND MAGNETIC FIELDS\nIn January 1991, the CPUC opened an investigation into potential interim policy actions to address increasing public concern, especially with respect to schools, regarding potential health risks which may be associated with electric and magnetic fields (EMF) from utility facilities. In its order instituting the investigation, the Commission acknowledged that the scientific community has not reached consensus on the nature of any health impacts from contact with EMF, but went on to state that a body of evidence has been compiled which raises the question of whether adverse health impacts might exist.\nThe CPUC proceeding was subsequently bifurcated into two phases -- one focusing on EMF related to electric power and the other on EMF generated by cellular telephone transmitters. In the electric power phase, the CPUC created a 17-member EMF Consensus Group, with representatives from government, utilities (including a representative from the Company), organized labor and the public. The Consensus Group submitted to the CPUC its recommendations for a CPUC interim policy on EMF, which were considered during evidentiary hearings held in December 1992. In November 1993, the CPUC adopted an interim EMF policy for California energy utilities which, among other things, requires California energy utilities to take no-cost and low-cost steps to reduce EMF from new and upgraded utility facilities. California energy utilities will be required to fund a $1.5 million EMF education program and a $5.6 million EMF research program managed by the California Department of Health Services over the next four years.\nAs part of its effort to educate the public about EMF, the Company provides interested customers with information regarding the EMF exposure issue. The Company also provides a free field measurement service to its customers which informs customers about EMF levels at different locations in and around their residences or commerical buildings.\nIn the event that the scientific community reaches a consensus that EMF presents a health hazard and further determines that the impact of utility-related EMF exposures can be isolated from other exposures, the Company may be required to take mitigation measures at its facilities. The costs of such mitigation measures cannot be estimated with any certainty at this time. However, such costs could be significant depending on the particular mitigation measures undertaken.\nLOW EMISSION VEHICLE (LEV) PROGRAMS\nIn October 1991, the CPUC issued an Order Instituting Investigation\/Order Instituting Rulemaking on LEVs to investigate policy issues surrounding electric and natural gas utility involvement in the market associated with LEVs, specifically natural gas vehicles (NGVs) and electric vehicles (EVs). Hearings in the LEV proceeding were conducted in August 1991, and examined long-term utility involvement in LEV\nprograms in relation to California's environmental, energy and transportation goals. The Company generally proposed that its long-term role in the LEV market be that of a fuel supplier, transporter and distributor.\nIn July 1993, the CPUC issued a decision in the LEV proceeding. The decision recognized a significant role for the Company in the LEV market and directed the Company to file a request for funding for a six-year program (1995-2000). In November 1993, the Company filed an application for approximately $200 million in funding for the Company's fleet and market development activities for NGVs and EVs over the six-year period. However, in its RRI filing (see \"General -- Regulatory Reform Initiative\" above), the Company requests permission to withdraw the funding request portion of its LEV application if the CPUC approves the Company's RRI proposal.\nIn July 1991, the CPUC approved the implementation of the Company's NGV market development program as proposed by the Company, and authorized initial funding for the program. The decision in the Company's 1993 GRC extended NGV funding of $8.5 million per year pending a final decision in the LEV proceeding described above, and authorized $1.8 million for EV programs. The Company is using the NGV funds to install additional natural gas refueling facilities, to purchase or convert additional NGVs for the Company's fleet, and to provide incentives and assistance in converting additional customer vehicles to NGVs. The Company and its customers currently operate nearly 2,000 NGVs.\nOTHER REGULATION\nCALIFORNIA PUBLIC UTILITIES COMMISSION\nIn addition to its jurisdiction over rate matters, the CPUC has the authority, among other things, to establish rules and conditions of service, to authorize disposition of utility property, to establish rules and policies governing utility facilities, to regulate securities issues, to prescribe rates of depreciation and uniform systems of accounts and to regulate transactions between the Company and its subsidiaries and affiliates.\nCALIFORNIA ENERGY COMMISSION\nThe Company also is subject to the jurisdiction of the CEC. The CEC has developed programs for forecasting peak demands and energy requirements, is encouraging and requiring certain types of energy conservation, has developed energy shortage and contingency plans, and is developing and coordinating a program of energy research and development. In addition, the CEC has statutory authority to certify future thermal-electric power plant sites and related facilities 50 MW and above within California.\nFEDERAL ENERGY REGULATORY COMMISSION\nThe Company is subject to regulation by the FERC under the Federal Power Act as a \"public utility\" as defined in the Act. The FERC has authority, among other things, to regulate the Company's rates and terms and conditions for sales of electricity for resale and transmission of electricity in interstate commerce, and to prescribe rates of depreciation and uniform systems of accounts. The FERC also regulates the terms and conditions of interstate pipeline transportation service utilized by the Company to transport gas it purchases outside California.\nFERC-HYDROELECTRIC LICENSING\nMost of the Company's hydroelectric facilities are subject to licenses issued under Part I of the Federal Power Act, with various expiration dates to the year 2026 and involving a total normal operating capability of 2,684 MW. Helms adds an additional capacity of 1,212 MW. As the initial licenses for these projects expire, they become susceptible to competition for a new license. In the years prior to 1986, several governmentally-run utilities, claiming a statutory \"preference\" in their favor superior to the Company, had filed competing applications for three of the Company's projects. Federal legislation enacted in 1986 has eliminated any preference for governmentally-run utilities in the relicensing of hydroelectric projects.\nThe 1986 law requires the Company to pay these challengers a \"reasonable\" settlement consisting of their costs incurred to pursue the licenses and a potential additional amount ranging from 0% to 100% of the Company's remaining net investment in the projects. In return, the challengers are required to withdraw their competing license applications. The FERC has approved the settlement agreement for one project. The\nchallengers for the other two projects have filed with the FERC to assert claims amounting to approximately $100 million, including 100% of the Company's net investment in the projects of approximately $89 million. In October 1991, the FERC approved a partial settlement agreement between the Company and one of the challengers which, among other things, required the Company to provide additional load following services under a power sale agreement and pay approximately $2 million to settle the challenger's claims related to both projects of approximately $40 million. In October 1992, the FERC issued an order requiring the Company to pay compensation of $1.9 million to the remaining challengers for the two projects, representing the costs incurred preparing their applications. The FERC declined to award the remaining challengers any additional compensation. In December 1992, the challengers filed with FERC a request for rehearing of the compensation order. In February 1993, the FERC reaffirmed the award and rejected the challengers' request for additional compensation. The challengers have appealed FERC's order to the U.S. Court of Appeals. The Company expects to recover the costs of FERC-awarded compensation and the partial settlement through rates.\nNUCLEAR REGULATORY COMMISSION\nThe Company also is subject to the jurisdiction of the NRC as to operation of its nuclear generating plants.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation concerning the Company's electric generation units, gas transmission facilities, and electric and gas distribution facilities is included in response to Item 1. All real properties and substantially all personal properties of the Company are subject to the lien of an indenture which provides security to the holders of the Company's First and Refunding Mortgage Bonds.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSee Item 1 - -Business, for other proceedings pending before governmental and administrative bodies. In addition to the following legal proceedings, the Company is subject to routine litigation incidental to its business.\nNATURAL GAS PURCHASE CONTRACTS LITIGATION\nIn connection with the implementation of the Decontracting Plan described above (see \"Gas Utility Operations -- Restructuring of Canadian Supply Arrangements -- Decontracting Plan\") in November 1993, the Canadian gas producers party to the Decontracting Plan released A&S, PGT and the Company from any claims they may have had that resulted from the termination of A&S' former Canadian gas purchase arrangements as well as any claims for losses which arose from alleged historical shortfalls in gas taken by A&S. Accordingly, the lawsuits filed by Amoco Canada Petroleum Company Ltd. and Amoco Canada Resources Ltd. (Amoco), Shell Canada Limited (Shell), Chevron Canada Resources (Chevron), Gulf Canada Resources Limited and Gulf Canada Frontier Exploration Limited (Gulf), and Scurry-Rainbow Oil Limited, Opinac Exploration Limited, Norco Resources Limited and Hershey Oil Corporation (North Coleman Producers) were each discontinued under Canadian Law.\nQF TRANSMISSION CONSTRAINED AREA LITIGATION\nThe Company was a defendant in three lawsuits concerning the existence, nature and extent of transmission constraints in the northern portion of the Company's service area, and whether the Company improperly used those transmission constraints and adopted policies and practices to defeat QF development. The plaintiffs all signed power purchase agreements with the Company for the sale of power from proposed projects that were to have been located in the northern portion of the Company's system. All of the power purchase agreements contained a provision stating that they would terminate if energy deliveries from the proposed projects did not begin within five years of the execution date of the agreement. None of the plaintiffs delivered power within those deadlines.\nThe first case was filed in Fresno County Superior Court by Griswold Creek Joint Power Authority, Tranquility Irrigation District, Thermalito Irrigation District, Table Mountain Irrigation District and Concow Power Authority (collectively, Griswold Creek). The second and third cases were filed in San Francisco County Superior Court by Pacific Oroville Power, Inc. (POPI) and Robert F. Tamaro, doing business as Power Project Ventures (Tamaro), respectively. The three cases had been coordinated in the San Francisco County Superior Court by order of the California Judicial Council, at the Company's request, with trial set for September 1993.\nThe September trial date was suspended while the parties pursued settlement discussion. The Griswold Creek and Tamaro cases were settled in October and November 1993, respectively. Trial of the POPI case, which commenced November 1, 1993, is expected to continue for at least six months.\nPlaintiff in the POPI case contends that: the Company misrepresented to the CPUC and to QFs its transmission capacity; the existence of transmission constraints extends the five-year deadline in the agreements; the Company was obligated to build transmission upgrades at utility (non-QF) expense which it failed to build; and the Company had a general goal of trying to stifle QF development. The POPI suit alleges breach of contract, negligent misrepresentation, misrepresentation, breach of the implied covenant of good faith and fair dealing, unfair business practices and negligent interference with prospective economic advantage, and seeks declaratory relief, damages, injunctive relief and relief from forfeiture. The POPI complaint seeks compensatory damages \"according to proof,\" together with interest, attorneys' fees and costs of suit. While the complaint makes no mention of any dollar amount of compensatory damages, the plaintiff's damage expert has given a preliminary estimate of damages sought of $67 million. POPI also seeks an unspecified amount of punitive damages.\nIf the trial of the POPI case results in an outcome adverse to the Company, there are other similarly-situated QFs which might choose to file similar complaints. How many such additional complaints might be filed will likely depend on the basis for any adverse decision in the POPI case. The Company believes that the matter has no merit and that the ultimate outcome of this matter will not have a significant adverse impact on its financial position or results of operations.\nAIR DISTRICT RULEMAKING PROCEEDINGS\nSee \"Environmental Matters and Other Regulations -- Environmental Matters -- Environmental Protection Measures\" above for a description of proceedings pending before local air districts in California relating to NOx emission reduction requirements.\nANTITRUST LITIGATION\nOn December 3, 1993, the County of Stanislaus and Mary Grogan, a residential customer of the Company, filed a complaint in the U.S. District Court, Eastern District of California, against the Company and PGT, on behalf of themselves and purportedly as a class action on behalf of all natural gas customers of the Company during the period of February 1988 through October 1993. The complaint alleges that the purchase of natural gas in Canada was accomplished in violation of various antitrust laws which resulted in increased prices of natural gas for the Company's customers.\nThe complaint alleges that the Company could have purchased as much as 50% of the Canadian gas on the spot market instead of relying on long-term contracts and that the damage to the class members is at least as much as the price differential multiplied by the replacement volume of gas, an amount estimated in the complaint as potentially exceeding $800 million. In addition, the complaint indicates that the damages to the class could include over $150 million paid by the Company to terminate the contracts with the Canadian gas producers in November 1993. The complaint seeks recovery of three times the amount of the actual damages pursuant to the antitrust laws.\nThe Company believes the case is without merit and has filed a motion to dismiss the complaint. The Company believes that the ultimate outcome of the antitrust litigation will not have a significant adverse impact on its financial position.\nHINKLEY COMPRESSOR STATION LITIGATION\nIn May 1993, a complaint was filed in San Bernardino County Superior Court on behalf of a number of individuals seeking recovery of an unspecified amount of damages for personal injuries and property damage allegedly suffered as a result of exposure to chromium near the Company's Hinkley Compressor Station, located along the Company's gas transmission system in San Bernardino County, as well as punitive damages. The original complaint has been amended, and additional complaints have been filed, to add additional individuals for a total of 178 plaintiffs. The complaints plead several causes of action, including negligence, negligent and intentional misrepresentation, fraudulent concealment, strict liability and violation of California's Safe Drinking Water and Toxic Enforcement Act of 1986 (Proposition 65).\nThe plaintiffs contend that between 1951 and 1966 the Company discharged Chromium VI-contaminated wastewater into unlined ponds, which led to chromium percolating into the groundwater of surrounding property. The plaintiffs further allege that the Company disposed of the chromium in those ponds to avoid costly alternatives. In 1987, the Company undertook an extensive project to remediate potential groundwater chromium contamination. The Company has incurred substantially all of the costs it currently deems necessary to clean up the affected groundwater contamination. In accordance with the remediation plan approved by the regional water quality board, the Company will continue to monitor the affected area and periodically perform environmental assessments.\nIn November 1993, the parties engaged in private mediation sessions. On December 20, 1993, the plaintiffs filed an offer to compromise and settle their claims against the Company for $250 million.\nThe Company is unable to estimate the ultimate outcome of this matter, but such outcome could have a significant adverse impact on the Company's results of operations. The Company believes that the ultimate outcome of this matter will not have a significant adverse impact on its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\n\"Executive officers,\" as defined by Rule 3b-7 of the General Rules and Regulations under the Securities and Exchange Act of 1934, of the Company are as follows:\nAll officers serve at the pleasure of the Board of Directors. All executive officers have been employees of the Company for the past five years. In addition to their current positions, the executive officers had the following business experience during that period:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation responding to Item 5 is set forth on page 47 under the heading \"Quarterly Consolidated Financial Data\" in the Company's 1993 Annual Report to Shareholders, which information is hereby incorporated by reference and filed as part of Exhibit 13 to this report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nA summary of selected financial information for the Company for each of the last five fiscal years is set forth on page 12 under the heading \"Selected Financial Data\" in the Company's 1993 Annual Report to Shareholders, which information is hereby incorporated by reference and filed as part of Exhibit 13 to this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nA discussion of the Company's results of operations and liquidity and capital resources is set forth on pages 13 through 24 under the heading \"Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition\" in the Company's 1993 Annual Report to Shareholders, which discussion is hereby incorporated by reference and filed as part of Exhibit 13 to this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nInformation responding to Item 8 is contained in the Company's 1993 Annual Report to Shareholders on page 48 and pages 25 through 47 under the headings \"Report of Independent Public Accountants,\" \"Statement of Consolidated Income,\" \"Consolidated Balance Sheet,\" \"Statement of Consolidated Cash Flows,\" \"Statement of Consolidated Common Stock Equity and Preferred Stock,\" \"Statement of Consolidated Capitalization,\" \"Schedule of Consolidated Segment Information,\" \"Notes to Consolidated Financial Statements,\" and \"Quarterly Consolidated Financial Data,\" which information is hereby incorporated by reference and filed as part of Exhibit 13 to this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation regarding executive officers of the Company is included in a separate item captioned \"Executive Officers of the Registrant\" contained on page 47 in Part I of this report. Other information responding to Item 10 is included on pages 3 through 5 under the heading \"Nominees for Director\" in the 1994 Proxy Statement relating to the 1994 Annual Meeting of Shareholders, which information is hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation responding to Item 11 is included on page 7 under the heading \"Compensation of Directors\" and on pages 11 through 17 under the heading \"Executive Compensation\" in the 1994 Proxy Statement relating to the 1994 Annual Meeting of Shareholders, which information is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation responding to Item 12 is included on pages 8 and 18 under the headings \"Security Ownership of Management\" and \"Principal Shareholders\" in the 1994 Proxy Statement relating to the 1994 Annual Meeting of Shareholders, which information is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation responding to Item 13 is included on page 7 under the heading \"Certain Relationships and Related Transactions\" in the 1994 Proxy Statement relating to the 1994 Annual Meeting of Shareholders, which information is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(A) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT:\n1. The following consolidated financial statements, schedules of consolidated segment information, supplemental information and report of independent public accountants contained in the 1993 Annual Report to Shareholders, are incorporated by reference in this report:\nStatement of Consolidated Income for the Years Ended December 31, 1993, 1992 and 1991.\nConsolidated Balance Sheet as of December 31, 1993 and 1992.\nStatement of Consolidated Cash Flows for the Years Ended December 31, 1993, 1992 and 1991.\nStatement of Consolidated Common Stock Equity and Preferred Stock for the Years Ended December 31, 1993, 1992 and 1991.\nStatement of Consolidated Capitalization as of December 31, 1993 and 1992.\nSchedule of Consolidated Segment Information for the Years Ended December 31, 1993, 1992 and 1991.\nNotes to Consolidated Financial Statements.\nQuarterly Consolidated Financial Data.\nReport of Independent Public Accountants.\n2. Report of Independent Public Accountants.\n3. Consolidated financial statement schedules:\nV -- Consolidated Property, Plant and Equipment for the Years Ended December 31, 1993, 1992 and 1991.\nVI -- Accumulated Depreciation of Consolidated Plant in Service for the Years Ended December 31, 1993, 1992 and 1991.\nVIII -- Consolidated Valuation and Qualifying Accounts for the Years Ended December 31, 1993, 1992 and 1991.\nIX -- Consolidated Short-term Borrowings for the Years Ended December 31, 1993, 1992 and 1991.\nX -- Consolidated Supplementary Income Statement Information for the Years Ended December 31, 1993, 1992 and 1991.\nSchedules not included are omitted because of the absence of conditions under which they are required or because the required information is provided in the consolidated financial statements including the notes thereto.\n4. Exhibits required to be filed by Item 601 of Regulation S-K:\n3.1 Restated Articles of Incorporation effective as of November 18, 1992 (Form 8-K dated March 25, 1994 (File No. 1-2348), Exhibit 4.1).\n3.2 Certificate of Determination of Preferences of 7.04% Redeemable First Preferred Stock (Form 8-K dated March 25, 1994 (File No. 1-2348), Exhibit 4.2).\n3.3 Certificate of Determination of Preferences of 6 7\/8% Redeemable First Preferred Stock (Form 8-K dated March 25, 1994 (File No. 1-2348), Exhibit 4.3).\n3.4 Certificate of Decrease in Number of Shares of Certain Series of First Preferred Stock (Form 8-K dated March 25, 1994 (File No. 1-2348), Exhibit 4.4).\n3.5 Certificate of Determination of Preferences of 6.30% Redeemable First Preferred Stock (Form 8-K dated March 25, 1994 (File No. 1-2348), Exhibit 4.5).\n3.6 By-Laws dated October 1, 1993.\n4. First and Refunding Mortgage dated December 1, 1920, and supplements thereto dated April 23, 1925, October 1, 1931, March 1, 1941, September 1, 1947, May 15, 1950, May 1, 1954, May 21, 1958, November 1, 1964, July 1, 1965, July 1, 1969, January 1, 1975, June 1, 1979, August 1, 1983, and December 1, 1988 (Registration No. 2-1324, Exhibits B-1, B-2, B-3; Registration No. 2-4676, Exhibit B-22; Registration No. 2-7203, Exhibit B-23; Registration No. 2-8475, Exhibit B-24; Registration No. 2-10874, Exhibit 4B; Registration No. 2-14144, Exhibit 4B; Registration No. 2-22910, Exhibit 2B; Registration No. 2-23759, Exhibit 2B; Registration No. 2-35106, Exhibit 2B; Registration No. 2-54302, Exhibit 2C; Registration No. 2-64313, Exhibit 2C; Registration No. 2-86849, Exhibit 4.3; Form 8-K dated January 18, 1989 (File No. 1-2348), Exhibit 4.2).\n10.1 Master Agreement for the Assignment of Service between the Company and NOVA Corporation of Alberta dated September 1, 1993 and schedule A.\n10.2 Service Agreement Rate Schedule FS between the Company and NOVA Corporation of Alberta dated October 1, 1993, rate schedule FS, and general terms and conditions.\n10.3 Service Agreement Applicable to Firm Transportation Service Under Rate Schedule FS-1 between the Company and Alberta Natural Gas Company LTD dated September 22, 1993, statement of effective rates and charges effective November 1, 1993, service schedule FS-1, and general terms and conditions.\n10.4 Firm Transportation Service Agreement between the Company and Pacific Gas Transmission Company dated October 26, 1993, rate schedule FTS-1, and general terms and conditions.\n10.5 Transportation Service Agreement as Amended and Restated Between the Company and El Paso Natural Gas Company dated November 1, 1993, rate schedule T-3, and general terms and conditions.\n10.6 Diablo Canyon Settlement Agreement dated June 24, 1988 (Form 8-K dated June 27, 1988) (File No. 1-2348), Exhibit 10.1), Implementing Agreement dated July 15, 1988 (Form 10-Q for the quarter ended June 30, 1988 (File No. 1-2348), Exhibit 10.1) and portions of the California Public Utilities Commission Decision No. 88-12-083, dated December 19, 1988, interpreting the Settlement Agreement (Form 10-K for fiscal year 1988 (File No. 1-2348), Exhibit 10.4).\n*10.7 Pacific Gas and Electric Company Deferred Compensation Plan for Directors (Form 10-K for fiscal year 1992 (File No. 1-2348), Exhibit 10.5).\n*10.8 Pacific Gas and Electric Company Deferred Compensation Plan for Officers (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.6).\n*10.9 Savings Fund Plan for Employees of Pacific Gas and Electric Company applicable to management employees, effective January 1, 1994.\n- --------------- * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.\n*10.10 Performance Incentive Plan of Pacific Gas and Electric Company.\n*10.11 The Pacific Gas and Electric Company Retirement Plan applicable to management employees, effective January 1, 1994.\n*10.12 Pacific Gas and Electric Company Supplemental Executive Retirement Plan, as amended through October 16, 1991 (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.11).\n*10.13 Pacific Gas and Electric Company Stock Option Plan, as amended effective as of September 16, 1992.\n*10.14 Pacific Gas and Electric Company Performance Unit Plan (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.13).\n*10.15 Pacific Gas and Electric Company Relocation Assistance Program for Officers (Form 10-K for fiscal year 1989 (File No. 1-2348), Exhibit 10.16).\n*10.16 Pacific Gas and Electric Company Executive Flexible Perquisites Program.\n*10.17 Management Contract with Jerry R. McLeod (Form 10-K for fiscal year 1989 (File No. 1-2348), Exhibit 10.18).\n*10.18 PG&E Postretirement Life Insurance Plan (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.16).\n*10.19 Pacific Gas and Electric Company Retirement Plan for Non-Employee Directors (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.18).\n*10.20 Executive Compensation Insurance Indemnity in respect of Deferred Compensation Plan for Directors, Deferred Compensation Plan for Officers, Supplemental Executive Retirement Plan and Retirement Plan for Non-Employee Directors (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.19).\n*10.21 Contract For Performance of Work Between George A. Maneatis and Pacific Gas and Electric Company (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.20).\n*10.22 Pacific Gas and Electric Company Long-Term Incentive Program (Form 10-K for fiscal year 1991 (File No. 1-2348), Exhibit 10.21).\n11. Computation of Earnings Per Common Share (Form 8-K dated March 2, 1994 (File No. 1-2348), Exhibit 11).\n12.1 Computation of Ratios of Earnings to Fixed Charges (Form 8-K dated March 2, 1994 (File No. 1-2348), Exhibit 12.1).\n12.2 Computation of Ratios of Earnings to Combined Fixed Charges and Preferred Stock Dividends (Form 8-K dated March 2, 1994 (File No. 1-2348), Exhibit 12.2).\n13. 1993 Annual Report to Shareholders (portions of the 1993 Annual Report to Shareholders under the headings \"Selected Financial Data,\" \"Management's Discussion and Analysis of Consolidated Results of Operations and Financial Information,\" \"Report of Independent Public Accountants,\" \"Statement of Consolidated Income,\" \"Consolidated Balance Sheet,\" \"Statement of Consolidated Cash Flows,\" \"Statement of Consolidated Common Stock Equity and Preferred Stock,\" \"Statement of Consolidated Capitalization,\" \"Schedule of Consolidated Segment Information,\" \"Notes to Consolidated Financial Statements,\" and \"Quarterly Consolidated Financial Data,\" included only) (except for those portions which are expressly incorporated herein by reference, such 1993 Annual Report to Shareholders is furnished for the information of the Commission and is not deemed to be \"filed\" herein).\n21. Subsidiaries of the Company (not included because the Company's subsidiaries, considered in the aggregate as a single subsidiary, would not constitute a \"significant subsidiary\" under Rule 1-02(v) of Regulation S-X as of the end of the year covered by this report).\n23. Consent of Arthur Andersen & Co.\n24.1 Resolution of the Board of Directors authorizing the execution of the Form 10-K.\n24.2 Powers of Attorney.\n99. Information required by Form 11-K with respect to the Savings Fund Plan for Employees of Pacific Gas and Electric Company, as permitted by Rule 15d-21. - --------------- * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.\nThe exhibits filed herewith are attached hereto (except as noted) and those indicated above which are not filed herewith were previously filed with the Commission as indicated and are hereby incorporated by reference. Exhibits will be furnished to security holders of the Company upon written request and payment of a fee of $.30 per page, which fee covers only the Company's reasonable expenses in furnishing such exhibits.\n(B) REPORTS ON FORM 8-K\nReports on Form 8-K during the quarter ended December 31, 1993 and through the date hereof:\n1. October 14, 1993\nItem 5. Other Events.\n-- Restructuring of Canadian Gas Purchase Obligations\n-- California Public Utilities Commission (CPUC) Proceedings\nCanadian Affiliates Audit\nWorkforce Reduction Memorandum Account\n1994 Attrition Rate Adjustment\nElectric Reasonableness Proceeding\n-- PGT\/PG&E Pipeline Expansion Project\n2. October 25, 1993\nItem 5. Other Events.\n-- Performance Incentive Plan -- Year-to-Date Financial Results\n-- Regulatory Reform Initiative\n-- Medium-Term Note Program\nItem 7. Financial Statements, Pro Forma Financial Information and Exhibits.\n3. November 4, 1993\nItem 5. Other Events.\n-- Restructuring of Canadian Gas Purchase Obligations\n-- California Public Utilities Commission Proceedings\n1994 Cost of Capital Proceeding\nCPUC Denial of Petition to Modify General Rate Case\n-- PGT\/PG&E Pipeline Expansion Project\n4. November 17, 1993\nItem 5. Other Events.\n-- Performance Incentive Plan -- Year-to-Date Financial Results\n-- California Public Utilities Commission Proceeding -- 1988-1990 Reasonableness Proceeding\n-- QF Constrained Area Litigation\n5. December 7, 1993\nItem 5. Other Events.\n-- Antitrust Litigation\n-- California Public Utilities Commission Proceeding\n1994 Cost of Capital Proceeding\nHazardous Materials and Hazardous Waste Compliance and Remediation\n6. December 23, 1993\nItem 5. Other Events.\n-- Performance Incentive Plan -- Year-to-Date Financial Results\n7. January 10, 1994\nItem 5. Other Events.\n-- Performance Incentive Plan -- 1994 Target\n-- California Public Utilities Commission Proceedings\nElectric Fuel and Sales Balancing Accounts\n1994 Attrition Rate Adjustment\n8. January 24, 1994\nItem 5. Other Events.\n-- Performance Incentive Plan -- 1993 Financial Results\n-- 1993 Consolidated Earnings (unaudited)\n-- Common Stock Dividend\n-- Potential Sale of PG&E Resources Company\n-- Hinkley Compressor Station Litigation\n9. March 2, 1994\nItem 5. Other Events.\n-- California Public Utilities Commission Proceedings\nPGT-PG&E Expansion Project\n1992 Reasonableness Proceeding-DRA Recommendation\n1988-1990 Reasonableness Proceeding -- Non-Canadian Gas Phase\nItem 7. Financial Statements, Pro Forma Information and Exhibits.\n-- 1993 Financial Statements\n-- Ratios of Earnings to Fixed Charges\n-- Ratios of Earnings to Combined Fixed Charges and Preferred Dividends\n-- Exhibits\n10. March 11, 1994\nItem 5. Other Events.\n-- Performance Incentive Plan -- Year-to-Date Financial Results\n-- California Public Utilities Commission Proceedings\nRegulatory Reform Initiative\n1988-1990 Reasonableness Proceeding -- Canadian Issues\n1988-1990 Reasonableness Proceeding -- Non-Canadian Issues\n11. March 25, 1994\nItem 5. Other Events.\n-- California Public Utilities Commission Proceedings -- Gas Reasonableness Proceedings\n-- Preferred Stock Offering\nItem 7. Financial Statements, Pro Forma Financial Information and Exhibits\nINDEMNIFICATION UNDERTAKING\nFor purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into the registrant's Registration Statement on Form S-8 No. 33-23692 (filed August 12, 1988):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in a successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPURSUANT 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, IN THE CITY AND COUNTY OF SAN FRANCISCO, ON THE 28TH DAY OF MARCH, 1994.\nPACIFIC GAS AND ELECTRIC COMPANY (Registrant)\nBy BRUCE R. WORTHINGTON (Bruce R. Worthington, Attorney-in-Fact)\nPURSUANT 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 AND ON THE DATES INDICATED.\n* By BRUCE R. WORTHINGTON (Bruce R. Worthington, Attorney-in-Fact)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and the Board of Directors of Pacific Gas and Electric Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements and the schedule of consolidated segment information included in the Pacific Gas and Electric Company Annual Report to Shareholders incorporated by reference in this Annual Report on Form 10-K and have issued our report thereon dated February 16, 1994. Our report on the 1993 consolidated financial statements includes explanatory paragraphs that describe the uncertainties regarding the ultimate outcome of the gas reasonableness proceedings, the recovery of certain Helms costs and revenues and the Hinkley litigation, as discussed in notes 2 and 11 to the consolidated financial statements. In addition, our report includes an explanatory paragraph indicating that, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits and income taxes as discussed in notes 1 and 7 to the consolidated financial statements.\nOur audits of the consolidated financial statements and the schedule of consolidated segment information were made for the purpose of forming an opinion on those statements taken as a whole. The supplemental schedules listed in Part IV, Item 14. (a)(3) of this Annual Report on Form 10-K are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the consolidated financial statements. These supplemental schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and the schedule of consolidated segment information and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements and schedule of consolidated segment information taken as a whole.\nARTHUR ANDERSEN & CO.\nARTHUR ANDERSEN & CO.\nSan Francisco, California February 16, 1994\nSCHEDULE V\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE V -- CONSOLIDATED PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1993\n- ------------\nSCHEDULE V\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE V -- CONSOLIDATED PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1992\n- ------------\nSCHEDULE V\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE V -- CONSOLIDATED PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1991\n- ---------------\n(1) Electric tangible cost at December 31, 1991 includes approximately $5.9 billion related to the Diablo Canyon Nuclear Power Plant, substantially all in electric production.\n(2) Additions are net of transfers of property to plant in service.\n(4) Other changes consist of:\nSCHEDULE VI\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION OF CONSOLIDATED PLANT IN SERVICE\nFOR THE YEAR ENDED DECEMBER 31, 1993\n- ------------\nSee Note 1 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders for the accounting policy with respect to plant in service and depreciation.\nSCHEDULE VI\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION OF CONSOLIDATED PLANT IN SERVICE\nFOR THE YEAR ENDED DECEMBER 31, 1992\n- ------------\nSee Note 1 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders for the accounting policy with respect to plant in service and depreciation.\nSCHEDULE VI\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION OF CONSOLIDATED PLANT IN SERVICE\nFOR THE YEAR ENDED DECEMBER 31, 1991\n- ------------\n(1) Electric accumulated depreciation at December 31, 1991 includes approximately $1.2 billion related to the Diablo Canyon Nuclear Power Plant, substantially all in electric production.\nSee Note 1 of the Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders for the accounting policy with respect to plant in service and depreciation.\nSCHEDULE VIII\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE VIII -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- --------------- (1) Company disposed of its investment in Alaska Natural Gas Transportation System in January 1993. (2) Construction on the gas transportation system was discontinued in 1983. The Company accrued and reserved AFUDC through January 1993, at which time the Company's subsidiary that was a partner in the partnership organized to build and operate the gas transportation system withdrew from that partnership. (3) Deductions consist principally of write-offs of expired leaseholds on reserved property. (4) Primarily due to development cost for power projects. (5) Deductions consist principally of write-offs, net of collections of receivables considered uncollectible.\nSCHEDULE IX\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE IX -- CONSOLIDATED SHORT-TERM BORROWINGS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- ------------\n(1) The general terms of aggregate short-term borrowings are described in Note 6 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders.\n(2) Calculated using a monthly average.\nSCHEDULE X\nPACIFIC GAS AND ELECTRIC COMPANY\nSCHEDULE X--CONSOLIDATED SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- ------------\nAmounts charged to expense for royalties, advertising costs, and miscellaneous taxes are not set forth inasmuch as such items do not exceed one percent of total revenues as shown in the related Statement of Consolidated Income.\nAmounts charged to expense for maintenance and repairs and depreciation and amortization of intangible assets, preoperating costs, and similar deferrals are not set forth inasmuch as the information is included in the Consolidated Financial Statements or Notes thereto.\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\nEXHIBITS\nTO\nFORM 10-K\nFOR THE YEAR ENDED DECEMBER 31, 1993\n------------------\nPACIFIC GAS AND ELECTRIC COMPANY\n------------------\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nINDEX TO EXHIBITS\n- ---------------\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.\nINDEX TO EXHIBITS--(CONTINUED)\n- ---------------\n*Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.","section_15":""}
{"filename":"104867_1993.txt","cik":"104867","year":"1993","section_1":"ITEM 1. BUSINESS\nGeneral Development of Business\nWashington National Corporation (WNC) was incorporated as a general business corporation under the Delaware General Corporation Law on February 26, 1968, for the initial purpose of becoming the parent company and sole stockholder of Washington National Insurance Company (WNIC), an Illinois insurance corporation dating back to 1911. WNC was organized in order to permit diversification into the broader field of financial services and is admitted to do business in Delaware, Indiana, and Illinois. Its executive offices are located at 300 Tower Parkway, Lincolnshire, Illinois 60069-3665.\nThe primary operating companies of WNC are WNIC and United Presidential Life Insurance Company (UPI). As of December 31, 1993, WNC and its affiliates had 971 employees.\nIn 1989, WNC and its affiliates completed a strategic plan and began restructuring their operations. The strategic plan called for the divestiture of the home service and direct response lines of business at WNIC and a subsidiary, Washington National Life Insurance Company of New York (WNNY). WNIC sold the direct response and home service product lines and WNNY in 1989, 1990, and 1991, respectively. The organization is now focused on four lines of business: individual health insurance, group employee benefits, disability insurance for educators (all underwritten by WNIC), and individual life insurance and annuities (underwritten by UPI).\nIn the third quarter of 1993, WNC issued 2.1 million new shares of common stock in a public offering that raised $47.3 million.\nGENERAL DESCRIPTION OF THE BUSINESS OF THE INDUSTRY SEGMENTS\nWNC is an insurance holding company which, through WNIC and UPI, provides life, annuity, health, disability, and specialty insurance products to individuals and groups in carefully targeted markets. The business segments related to WNC's business are a life insurance and annuities segment, an individual health insurance segment, a group products segment, and a corporate and other segment. The corporate and other segment includes realized investment gains and losses, as well as the operations of divested lines of business and the gain or loss on the sales thereof. In addition, this segment includes the operations of WNC that do not specifically support one of the other segments.\nFurther information about WNC's four business segments can be found in Item 8, under the caption \"Note K - Segment Information.\"\nWashington National Insurance Company\nWNIC is a legal reserve stock life insurance company organized under the laws of Illinois in 1926 and is the successor to other companies dating back to 1911. WNIC's home office is located at 300 Tower Parkway, Lincolnshire, Illinois 60069-3665. WNIC is licensed to do business in all states of the United States (except New York) and the District of Columbia.\nWNIC underwrites individual health insurance, group employee benefits, and disability insurance for educators. As part of the corporate strategy plan, the decision was made to write life insurance and annuity business solely at UPI. Therefore, as of November 1989, WNIC ceased writing individual life insurance policies and annuities, except for home service life products, which WNIC ceased writing in March 1990; however, WNIC continues to administer existing life insurance and annuity business.\nWNIC's individual health line of business includes major medical and hospital-surgical policies. Group employee benefits consists of term life, major medical, disability income, and dental insurance policies. Disability insurance for educators generally is sponsored by school districts or educational associations for voluntary purchase by employees of public school systems.\nIn 1993, 2% of WNIC's insurance premiums and other policy charges were derived from products in the life insurance and annuities segment. A total of 40% of WNIC's 1993 insurance premiums and other policy charges were derived from products in the individual health insurance segment. A total of 58% of WNIC's 1993 insurance premiums and other policy charges were derived from products in the group products segment, of which 16% and 84% were from life insurance and health insurance, respectively. Group health insurance premiums were 29%, 30%, and 35% of WNC's total revenues in 1993, 1992, and 1991, respectively.\nTexas, New Jersey, and Illinois account for approximately 33% of WNIC's annual premium revenue. Arizona, Louisiana, Florida, and Missouri also account for a significant portion of WNIC's premium revenue, with a combined 20% of the total premium revenue.\nWNIC's insurance products are primarily sold by salaried group insurance representatives and field marketing organizations. The sector of WNIC's field force that distributes group employee benefits and disability insurance for educators consists of 65 field representatives, including 12 managers, all of whom are salaried employees of WNIC. Their activities are supported by 110 other field employees. WNIC markets individual health products through brokers, who are employed by field marketing organizations under standard brokerage contracts. At December 31, 1993, WNIC had approximately 40,500 brokers employed by 66 field marketing organizations, who sell insurance for other companies as well as for WNIC.\nUnited Presidential Life Insurance Company\nUPI, an Indiana life insurance company, began business in 1965 and currently is licensed to do business in 45 states and the District of Columbia. UPI's parent company, United Presidential Corporation (UPC), was incorporated in 1961 as an Indiana corporation and, effective during the fourth quarter of 1993, is 71% owned by WNIC and 29% owned by WNC. Prior to fourth quarter 1993 UPC was owned 100% by WNIC. Both UPC and UPI have executive offices located at One Presidential Parkway, Kokomo, Indiana 46904-9006. UPI's primary business is the marketing and underwriting of individual life insurance and annuities. Its primary marketing focus is interest- sensitive products such as universal life insurance, excess-interest whole life insurance, and annuities. UPI's operating results are in the life insurance and annuities segment.\nCalifornia, Indiana, and Michigan account for approximately 29% of UPI's 1993 premiums and other charges. However, several other states make significant contributions to premiums and other charges, including Pennsylvania, Florida, Ohio, and Minnesota.\nSales are made through approximately 8,000 insurance agents and brokers having an independent contractor relationship with UPI. Such persons may also be independent insurance brokers. UPI has no internal or captive sales force and accordingly, has negligible training, maintenance, or financing expenses. This marketing system facilitates sales force expansion without significant cost, provided that product lines remain competitive with those being offered by other companies.\nNew Products of the Segments\nFor the life insurance and annuities segment, UPI introduced in 1993 two new universal life insurance products to meet the demands and needs of the marketplace. In 1994, UPI will introduce a low premium permanent life insurance product and an update to its annuity portfolio of products.\nThe individual health insurance segment introduced in 1993 new versions of its major-medical and in-hospital products. New products anticipated in 1994 are an individual disability product and a cancer insurance product.\nThe group products segment introduced in 1993 a cancer insurance product and several enhancements for disability insurance for employees of employer-sponsored groups. New products anticipated in 1994 are long-term care insurance and further enhancements to disability insurance.\nCompetitive Conditions of the Segments\nThe insurance subsidiaries, along with other insurance companies with whom they are in competition, are subject to regulation and supervision by the supervisory agency in each jurisdiction in which they are licensed to do business, greatly affecting the competitive environment in which they operate. These supervisory agencies have broad administrative powers, including those relating to the granting and revocation of licenses to transact business, licensing of agents, approval of policy forms, establishing reserve requirements as well as the form and content of required financial statements, and conducting of periodic examinations. The companies must meet the standards and tests established by the National Association of Insurance Commissioners and, in particular, the investment laws and regulations of their states of incorporation. This regulation and supervision is primarily for the protection of policyowners and not stockholders.\nWNIC's individual health insurance line of business faces competition from approximately 45 companies. There are approximately 90 group employee benefits insurers and less than 30 insurers of disability insurance for educators in competition with WNIC's group products segment. UPI competes for the sale of life insurance and annuity products with approximately 300 U.S. life insurance companies, including stock and mutual companies.\nFOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nNeither WNC nor any affiliated company is licensed to do business outside of the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWNC's home office building is in a five-story, 175,000 square-foot office building located at 300 Tower Parkway, Lincolnshire, Illinois. The building is leased from a joint venture partnership in which Washington National Development Company (WNDC), a subsidiary of WNIC, has a one-third interest. WNC first occupied the property in May, 1993 and WNIC signed a twenty-year lease to occupy the building.\nWNDC has a fifty percent interest in a joint venture partnership that owns a 22,000 square-foot data center in Vernon Hills, Illinois, that is leased and occupied solely by WNIC. WNIC first occupied the property in April, 1993 and signed a twenty-year lease.\nWNIC also owns a 335,000 square-foot office building in Evanston, Illinois. WNIC occupies approximately 7 percent of this building and leases the remainder to nonaffiliated commercial enterprises. At December 31, 1993, the outstanding balance on the mortgage loan secured by this property was $2,434,000. WNIC also occupies 28 field offices throughout the country, all of which are leased.\nUPI's home office is a 102,000 square-foot office building that UPI owns, and is located on a thirty-acre site in Kokomo, Indiana.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWNC and certain affiliated companies have been named in various pending legal proceedings considered to be ordinary routine litigation incidental to the business of such companies. A number of other legal actions have been filed against WNC's subsidiaries which demand compensatory and punitive damages aggregating material dollar amounts. WNC believes that such suits are substantially without merit and that valid defenses exist. WNC's management is of the opinion that such litigation will not have a material effect on WNC's consolidated financial position. No proceedings, or group of proceedings presenting in large degree the same issues, exceed the materiality standard for disclosure contained in Instruction 2 to Item 103 of Regulation S-K.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nExecutive officers of WNC and a description of their business experience are set forth below. The business experience of the officers who have been affiliated with WNC less than five years is described in detail; the business experience of officers who have been affiliated with WNC five years or more focuses on only such experience during the last five years.\nWade G. Brown\nMr. Brown, age 56, joined WNIC as Executive Vice President and Chief Information Officer in June, 1993. From 1990 to 1993, Mr. Brown was a senior management consultant with CompuPros, Inc. Prior to that, Mr. Brown spent over seven years with Computer Language Research, Inc. where his last position was as Director of Information Services. Mr. Brown is a Director of UPI and WNIC and serves on WNIC's Executive and Finance Committees.\nCurt L. Fuhrmann\nMr. Fuhrmann, age 47, President of WNIC's Health Division as of October, 1993, joined WNIC as President of the Individual Health Division in October, 1989. Between 1985 and 1989, Mr. Fuhrmann was President and Chief Executive Officer of Pyramid Life Insurance Company, a company with approximately $40 million in annual premiums. In these positions, Mr. Fuhrmann had total profit and loss responsibility for an individual health book of business. Mr. Fuhrmann is a Director of UPI and WNIC and serves on WNIC's Executive and Finance Committees.\nKenneth A. Grubb\nMr. Grubb, age 54, joined WNIC as President of the Education Division in June, 1992. From 1989 to 1992, Mr. Grubb was Director of the Louisville Service Center of Humana, Inc., a large publicly- held healthcare company, responsible for billing, claims, customer service, underwriting and staff support. Prior to joining Humana, Mr. Grubb spent nine years at Capital Holding Corporation where he served as head of the group insurance division among other responsibilities. Mr. Grubb is a Director of UPI and WNIC and serves on WNIC's Executive and Finance Committees.\nRobert W. Patin\nMr. Patin, age 51, was elected Chairman of the Board and Chief Executive Officer of WNC and Chairman of the Executive and Nominating Committees in July, 1988. At that time, he also assumed the position of Chairman of the Board of WNIC and Chairman of its Executive Committee. Mr. Patin also serves on WNIC's Finance Committee. Mr. Patin was elected President of WNC and WNIC in May, 1990 and February, 1991, respectively. He also is a Director of certain affiliated companies of WNC, including UPC and UPI.\nJames N. Plato\nMr. Plato, age 45, was elected Chairman of the Board, President and Chief Executive Officer of UPC and its principal subsidiary, UPI, effective February 1, 1994. From January 1, 1993 through January, 1994, Mr. Plato served as President and Chief Operating Officer of UPC and UPI. From March, 1992 through December, 1992, Mr. Plato held the position of Executive Vice President and Chief Marketing Officer. Mr. Plato joined UPI in 1990 as its Senior Vice President and Chief Marketing Officer. From 1986 to 1990, Mr. Plato was Senior Vice President of Marketing for Reserve Life Insurance, Dallas, Texas. Mr. Plato is a Director of WNIC.\nThomas Pontarelli\nMr. Pontarelli, age 44, has been Executive Vice President of WNC and WNIC and head of the Staff Division of WNIC since 1989. Mr. Pontarelli started at WNIC in 1974 and was elected Vice President, General Counsel and Corporate Secretary of WNC in 1984. In 1985, Mr. Pontarelli was elected Senior Vice President, General Counsel and Corporate Secretary of WNC and Senior Vice President of WNIC. He currently serves on the Board of Directors of WNIC, UPC, and UPI and is a member of the Finance and Executive Committees of WNIC's Board of Directors.\nThomas C. Scott\nMr. Scott, age 47, has been Executive Vice President and Chief Financial Officer of WNC and Executive Vice President, Chief Financial Officer and Chief Actuary of WNIC and head of its Financial Division since 1989. Mr. Scott joined WNIC in 1974, served as Vice President at WNIC from 1983 to 1987, and as Senior Vice President of WNIC from 1987 to 1989. He currently serves on the Board of Directors of WNIC, UPC, and UPI and is a member of the Executive Committee and Chairman of the Finance Committee of WNIC's Board of Directors.\nDon L. Wilhelm\nMr. Wilhelm, age 62, retired on December 31, 1993 as a Director of WNC, a position he has held since 1987, and as Chief Executive Officer of UPC and UPI, positions he has held since 1961 and 1965, respectively. On January 31, 1994, Mr. Wilhelm retired from the Board of UPC and UPI and from his position as Chairman of the Board.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nQUARTERLY INFORMATION (unaudited)\nWashington National Corporation and Subsidiaries\nThe following table summarizes selected unaudited quarterly information for 1993 and 1992. Stock quotes were obtained from the National Quotation Bureau, Inc. As of March 10, 1994, WNC had approximately 9,200 Common and Preferred stockholders, including individual participants in security depository position listings.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview Washington National Corporation (WNC or the Company) is an insurance holding company that, through its two principal operating subsidiaries, Washington National Insurance Company (WNIC) and United Presidential Life Insurance Company (UPI), provides life, annuity, health, disability, and specialty insurance products to individuals and groups in carefully targeted markets that the Company believes are underserved by other insurance carriers. In 1991, the Company completed a three-year corporate restructuring that narrowed its focus to three core businesses, improved its operating performance, and in management's view, positioned the Company for profitable expansion.\nThe Company's three core businesses are: (i) life insurance and annuities: universal life insurance and other interest-sensitive life insurance and annuity products marketed to individuals and small businesses; (ii) group products: employee-paid disability and other specialty insurance products for teachers and other employers with 100 to 1,000 employees; and (iii) individual health: individual health insurance products, primarily major medical and hospital coverage for persons under the age of 65 without employer-sponsored insurance.\nThe Company employs a decentralized operating structure and utilizes distinct distribution systems to access each of its targeted markets and to provide timely, individualized service to its customers. The Company emphasizes the sale of market-driven products, a profit-oriented rather than a volume-oriented approach to underwriting, tight expense controls, and a proactive approach to market and regulatory changes. The Company continually evaluates new products and markets in order to capitalize on potential opportunities and to anticipate and respond effectively to business and regulatory changes.\nCorporate Restructuring In 1988, the Company commenced a major restructuring effort to narrow its focus to three core businesses, reduced its work force by over two-thirds, and recruited new operating managers with many years of insurance industry experience. The Company decentralized decision-making and implemented performance-based management compensation in order to promote greater accountability at the operating business level. The Company also invested approximately $40 million in its operating businesses to improve computer systems, technical expertise, administrative facilities, and distribution systems. In addition, the Company implemented underwriting and pricing changes in its three core businesses to improve profitability, and upgraded the quality of its investment portfolio.\nStrategy The Company's current focus is on continuing the improvement in its operating performance, principally through a strategy of disciplined revenue growth in each of the three core businesses along with further reductions in expense ratios. The Company seeks to achieve revenue growth primarily by expanding its sale of existing and new products and services within targeted markets that are underserved by other insurance carriers. The Company anticipates that additional revenue growth may result from certain cross-marketing opportunities within its businesses and selected acquisitions of profitable blocks of business. Additionally, the Company believes that its life insurance and annuities business complements the Company's more cyclical health businesses, thereby providing greater stability to the Company's earnings base. The Company seeks to achieve reductions in its expense ratios through infrastructure improvements, ongoing work flow re-engineering, and revenue growth.\nThe Company is closely monitoring developments concerning health care reform and is preparing strategic responses to different possible outcomes. In anticipation of health care reform, the Company's health businesses have begun to diversify into product areas that the Company believes are consistent with its targeted market focus and may be less affected, or unaffected, by health care reform. The Company's strategy regarding health care reform is discussed in more detail under the caption \"Health Care Reform.\"\nYear Ended December 31, 1993 Compared to Year Ended December 31, 1992\nInsurance Premiums and Policy Charges. Insurance premiums and policy charges increased $57.8 million, or 15.2%, from $381.0 million in 1992 to $438.8 million in 1993. The increase was primarily due to an increase in individual health insurance premiums of $52.3 million and group products premiums of $4.1 million resulting from an increased amount of business in force and rate increases for both segments and $23.2 million of premium revenues from an individual health reinsurance transaction entered into in the second quarter of 1993. See \"Segment Information - Group Products\" and \"Segment Information - Individual Health,\" below.\nNet Investment Income. Net investment income decreased $3.4 million, or 1.8%, to $183.7 million in 1993 from $187.1 million in 1992. The decrease was due to a general decline in market interest rates which caused a decline in the Company's portfolio yield from 8.6% to 8.0%, offset in part by an increase in invested assets. Invested assets at December 31, 1993 increased $122.4 million from December 31, 1992, principally due to deposits on life insurance policies and annuity contracts exceeding withdrawals combined with proceeds from a secondary stock offering in the third quarter of 1993.\nRealized Investment Losses. Realized investment losses for 1993 were $0.4 million compared to $4.6 million in 1992. In 1993, realized gains of $7.8 million, $2.0 million, and $0.4 million on fixed maturity investments, mortgage loans on real estate, and equity securities, respectively, were offset by losses of $10.6 million on real estate investments. In 1992, realized gains of $5.6 million on fixed maturity investments were offset by losses of $4.9 million on mortgage loans on real estate, $3.6 million on real estate investments, and $1.7 million on equity securities.\nInsurance Benefits Paid or Provided. Insurance benefits paid or provided increased $10.6 million, or 2.6%, from $409.8 million in 1992 to $420.4 million in 1993. The increase was primarily due to increased individual health insurance benefits of $29.2 million resulting from an increase in the block of in force business and the reinsurance transaction referred to above. Partially offsetting this was a decline in life insurance and annuities benefits of $16.6 million resulting from a decrease in interest credited on interest-sensitive products, favorable mortality experience, and the annual review of benefits assumptions, discussed below in \"Amortization of Deferred Insurance Costs.\"\nInsurance and General Expenses. Insurance and general expenses increased $24.4 million from $107.1 million in 1992 to $131.5 million in 1993. Included in 1993 are expenses of $6.9 million related to an individual health reinsurance transaction. See \"Segment Information - Individual Health,\" below. Additionally, 1993 includes charges of $1.6 million related to re-engineering in the life insurance and annuities segment and $1.7 million for the combination of the individual health and employee benefits divisions. 1993 also includes move related costs, primarily due to the closing of the Company's previous headquarters.\nAmortization of Deferred Insurance Costs. Amortization of deferred insurance costs increased $10.8 million, or 39.9%, in 1993 to $37.9 million from $27.1 million in 1992. The change was primarily due to increased amortization of $3.5 million in the individual health insurance segment resulting from an increase in the block of in force business and $3.6 million due to the annual review of amortization assumptions in the life insurance and annuities segment, partially offset by the decrease in benefits, discussed above.\nIncome Before Income Taxes and Changes in Accounting Principles. Income before income taxes and changes in accounting principles increased $12.3 million, or 46.7%, to $38.7 million in 1993 compared to $26.4 million in 1992. The increase was due primarily to improved operations in the Company's individual health and life insurance and annuities segments, offset in part by lower pretax income from the group products segment.\nIncome Taxes. Income taxes increased $1.0 million to $10.5 million in 1993 compared to $9.5 million in 1992, primarily due to improved income from operations. Included in income taxes for 1993 is a tax credit of $3.2 million related to realized investment losses. Also in 1993, the Company's federal income tax rate increased from 34% to 35%, retroactive to January 1, 1993, due to legislation enacted in August, 1993.\nChanges in Accounting Principles (Net of Taxes). The Company recorded a one-time charge of $1.6 million after taxes effective the first quarter 1993 for the adoption of a new accounting standard on accounting for postemployment benefits. The adoption did not have a material impact on income before accounting changes. 1992 included a $22.8 million after-tax charge relating to the first quarter 1992 adoption of new accounting standards, related to postretirement benefits other than pensions and income taxes.\nNet Income (Loss). Net income for 1993 was $26.7 million compared to a net loss of $6.0 million in 1992. The improvement in net income resulted primarily from the charges in the first quarter of 1992 relating to the adoption of two new accounting standards described above and improved operations in the individual health and life insurance and annuities segments, partially offset by a decline in group products operating income and the charge relating to the new accounting standard in the first quarter of 1993.\nSegment Information Life Insurance and Annuities. Revenues for the life insurance and annuities segment, which is comprised of new business sold by UPI to individuals and small businesses and closed blocks of life insurance and annuities written by WNIC prior to 1990, were $229.0 million for 1993, down from $233.5 million in 1992. A decline in investment income of $5.8 million resulted from lower portfolio yield rates, offset in part by an increase in invested assets. A $1.5 million improvement in insurance revenues was primarily due to an increase in life insurance in force combined with higher policy charges at UPI, offset in part by a decline in insurance revenues on the closed blocks of business at WNIC.\nPretax income for the life insurance and annuities segment increased 28.7% to $28.1 million in 1993 from $21.9 million in 1992. The increase was primarily due to improved interest rate spreads, as the interest credited on account balances was reduced more than the reduction in the yield on invested assets, and favorable mortality experience. Also contributing to the improvement was a charge of $2.8 million for anticipated guaranty fund assessments recorded in 1992 compared to $0.5 million in 1993. Partially offsetting these increases were charges in 1993 of $1.6 million to combine the Company's data centers, implement work flow re-engineering at UPI, and transfer the administration of WNIC's closed block of life insurance to UPI.\nGroup Products. Revenues for the group products segment were $234.6 million in 1993 compared to $231.2 million in 1992, an increase of 1.5%. The increase was primarily due to an increase in the amount of business in force in the education product line resulting from sales in 1992 and 1993 and premium rate increases averaging 7% in the employee benefits product line. These increases were partially offset by a decline of approximately $6 million from the termination of a large group life insurance contract, with approximately $3 billion of life insurance in force, in the third quarter of 1993. The annual premiums and related benefits related to this contract were each approximately $11 million. The termination of this contract will not materially affect net income.\nPretax income for the group products segment was $6.1 million in 1993 compared to $10.2 million in 1992. The decline was primarily due to higher medical claims, less favorable mortality experience, and increased operating expenses, including the receipt in the first quarter of 1992 of an expense refund of $1.8 million in connection with a withdrawal from a partnership. Also included in operating expenses in 1993 were charges of $1.7 million related to the combination of the individual health and employee benefits divisions. These increases were partially offset by favorable disability claims experience in 1993.\nIndividual Health. Revenues for the individual health insurance segment increased 48.7% to $159.9 million in 1993 compared to $107.6 million in 1992. Revenues for this segment increased in part as a result of a reinsurance transaction that added a total of $23.2 million of premium revenue in 1993. In addition to the reinsurance transaction, the amount of business in force (based on the average number of policies in force) increased approximately 13% in 1993 compared to 1992 and premium rates increased an average of 7% in 1993.\nSales of individual health policies declined in 1993 compared to 1992 in part due to a decision to maintain pricing margins in spite of increased pricing competition. The Company expects such increased pricing competition to continue in 1994. However, as a result of an expanded sales force from the reinsurance agreements described below, the Company expects new sales will increase in 1994.\nPretax income for the individual health insurance segment was $5.4 million for 1993 compared to a loss of $3.2 million in 1992. The improvement was primarily due to a larger premium base over which to spread fixed operating expenses.\nEffective in the 1993 second quarter, the Company entered into a reinsurance agreement with The Harvest Life Insurance Company (Harvest Life) that provides that the Company will reinsure 100% of a block of major medical business issued by Harvest Life. Harvest Life will continue to administer this business for a period of at least three years. As part of the reinsurance agreement, Harvest Life has agreed to market the Company's major medical products in place of its own major medical products through Harvest Life's career agent sales force. Harvest Life agents sell to insureds in rural areas, primarily farming communities. In addition to $23.2 million of premium revenue and $0.2 million of other income recorded in 1993, insurance benefits of $15.5 million and insurance and general expenses of $6.9 million were attributable to the reinsurance agreement.\nIn 1994, the Company entered into a reinsurance agreement with National Casualty Company, a subsidiary of Nationwide Corporation, whereby the Company will reinsure 50% of a block of individual major medical health insurance, effective January 1, 1994. The block had approximately $60 million of premium revenue in 1993. Beginning in 1994, the Company will administer the entire block of business for a fee paid by National Casualty. In addition, WNIC will market its products through the existing National Casualty Company sales force.\nThe Company will carefully consider entering into additional, similar reinsurance transactions as they arise.\nCorporate and Other. The corporate and other segment includes realized investment gains and losses, the operations of non-insurance lines of business, and corporate expenses. For 1993, the pretax loss was $0.9 million compared to a loss of $2.5 million in 1992. The improvement was primarily due to the previously mentioned decrease in realized investment losses.\nRevenues for this segment are expected to increase slightly in 1994 due to investment income on a portion of the proceeds from the third quarter 1993 stock offering.\nYear Ended December 31, 1992 Compared to Year Ended December 31, 1991\nInsurance Premiums and Policy Charges. Insurance premiums and policy charges decreased $5.8 million, or 1.5%, from $386.8 million in 1991 to $381.0 million in 1992. The decrease was primarily attributable to a $36.5 million decline in the group products segment's premiums which was primarily due to the termination and restructuring of certain group health contracts resulting from rate increases in 1991 and a decrease of $3.4 million of premiums and policy charges resulting from the 1991 sale of discontinued lines. These declines were offset in part by increases in individual health premiums and policy charges of $24.2 million due to an increase in the block of in force business from higher sales of and premium rate increases on individual health policies and by increased policy charges on life and annuity contracts of $9.8 million.\nNet Investment Income. Net investment income decreased $12.3 million, or 6.1%, from $199.4 million in 1991 to $187.1 million in 1992. The decrease was due to a lower average yield on invested assets in 1992, which decreased from 9.1% in 1991 to 8.6% in 1992, resulting from a general decline in interest rates combined with the Company's reinvestment of assets in higher quality, lower yielding securities.\nRealized Investment Losses. Realized investment losses decreased $15.0 million, or 76.5%, from $19.6 million in 1991 to $4.6 million in 1992. Results in 1992 included gains of $5.6 million on the sale of fixed maturity investments and losses on mortgage loans on real estate and real estate investments of $4.9 million and $3.6 million, respectively, combined with losses on equity securities of $1.7 million. Results in 1991 included a $10.0 million loss related to bonds backed by guaranteed investment contracts issued by Executive Life Insurance Company as well as losses on mortgages loans on real estate of $6.6 million and real estate investments of $3.2 million.\nLoss on Divestitures. The 1991 pretax net loss consisted of a $1.8 million loss on the sale of a subsidiary, partially offset by a gain on blocks of business sold by WNIC. See Note J to the Consolidated Financial Statements for further information.\nInsurance Benefits Paid or Provided. Insurance benefits paid or provided decreased $20.5 million, or 4.8%, from $430.3 million in 1991 to $409.8 million in 1992. The decrease was due to a $26.0 million decline in the group products segment's benefits resulting from the termination and restructuring of certain group health policies and a $7.5 million decline in benefits related to the 1991 sale of discontinued lines, offset in part by an $11.8 million rise in individual health benefits directly associated with the increased business in force discussed above.\nInsurance and General Expenses. Insurance and general expenses, including a $4.0 million gain from the reduction of postretirement benefits, decreased $19.9 million, or 15.7%, from $127.0 million in 1991 to $107.1 million in 1992. The decline resulted primarily from the elimination of $3.7 million of expense from the sale of discontinued lines and a $7.7 million planned decrease in operating expenses in the group products segment.\nAmortization of Deferred Insurance Costs. Amortization of deferred insurance costs increased $6.0 million, or 28.4%, from $21.1 million in 1991 to $27.1 million in 1992, due primarily to additional amortization resulting from the early recognition of investment income caused by the prepayment of certain mortgage-backed securities combined with the increase in the individual health block of business.\nIncome (Loss) Before Income Taxes and Changes in Accounting Principles. Income (loss) before income taxes and changes in accounting principles increased $26.8 million from a pretax loss of $0.4 million in 1991 to pretax income of $26.4 million in 1992. The largest items contributing to the increase were the $10.6 million improvement in the individual health segment's pretax income and the $15.0 million decrease in realized investment losses.\nIncome Taxes. Income taxes increased $6.9 million from $2.6 million in 1991 to $9.5 million in 1992 due primarily to the higher level of pretax income of $26.4 million in 1992, versus a pretax loss of $0.4 million in 1991.\nChanges in Accounting Principles (Net of Taxes). Effective January 1, 1992, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS 109, \"Accounting for Income Taxes.\" The cumulative effect of adopting these new accounting standards was a charge of $20.1 million and $2.7 million, respectively.\nNet Loss. Net loss increased $3.0 million from $3.0 million in 1991 to $6.0 million in 1992. The change was primarily as a result of the $22.8 million cumulative effect of changes in accounting principles described above, partially offset by the increase in income before such changes of $19.8 million.\nSegment Information Life Insurance and Annuities. Revenues for the life insurance and annuities segment were $233.5 million in 1992 compared to $227.1 million in 1991. The increase was primarily due to increased policy revenues and investment income at UPI, offset in part by declines in revenues in the closed blocks of business at WNIC.\nPretax income for the life insurance and annuities segment decreased 8.9% to $21.9 million in 1992 compared to $24.0 million in 1991. The decline was primarily due to 1992 accruals for anticipated guaranty fund assessments of $2.8 million.\nGroup Products. Revenues for the group products segment were $231.2 million in 1992 compared to $268.0 million in 1991. The decline was attributable to terminated cases and the conversion of several cost plus cases to a minimum premium basis.\nPretax income for the group products segment declined 24.2% to $10.2 million in 1992 compared to $13.5 million in 1991. The decline was primarily due to a decline in premium revenues and an increase in the claims ratio for 1992.\nIndividual Health. Revenues for the individual health insurance segment increased 30.5% to $107.6 million in 1992 compared to $82.4 million in 1991. Revenues for this segment primarily increased due to an increase in the amount of business in force and an increase in premium rates.\nPretax loss for the individual health insurance segment declined $10.6 million to $3.2 million for 1992 compared to a loss of $13.8 million in 1991. The decline in the loss from 1991 was primarily due to a larger premium base over which to spread fixed operating expenses for this segment and an improved ratio of claims to premium revenues in 1992.\nCorporate and Other. The pretax loss for the corporate and other segment in 1992 was $2.5 million compared to a loss of $24.1 million in 1991. In 1992 realized investment losses were $4.6 million compared to losses of $19.6 million in 1991, which included losses of $10.0 million related to fixed maturity investments backed by guaranteed investment contracts. 1991 also included a loss of $1.2 million related to divestitures.\nInvestment Portfolio The Company's investment portfolio is managed by an experienced staff of in- house investment professionals, primarily at WNIC, and outside investment advisors, primarily the investment management group at Scudder, Stevens & Clark, Inc. Investments are made pursuant to strategies and guidelines approved by the Finance Committee of the Company's Board of Directors. The Company selects investments that match the needs of the businesses that the assets support in the areas of yield, liquidity, asset quality, and duration. The Company pursues a conservative investment philosophy by balancing a variety of objectives, including high credit quality, liquidity, high current income, preservation of capital, and protection against market and interest rate risk. The Company's investment portfolio consists primarily of investment grade, publicly-traded fixed maturity investments and mortgage loans on real estate. All investments made by WNIC and UPI are governed by Illinois and Indiana insurance laws and regulations, respectively.\nAt December 31, 1993, the Company had invested assets of $2.4 billion. The following table sets forth certain information about the Company's investment portfolio as of that date:\nFixed Maturity Investments The carrying value of fixed maturity investments at December 31, 1993 was $1.8 billion, or 74.7% of the Company's invested assets. This amount increased from $1.6 billion, or 69.5% of the Company's invested assets at December 31, 1992 primarily due to the Company making new investments principally in investment grade fixed maturity securities. At December 31, 1993 and December 31, 1992, the fair value of the Company's fixed maturity investments exceeded the carrying value by $82.3 million and $56.9 million, respectively.\nThe Company's policy for rating fixed maturity investments is to use the rating on such investments as determined by Standard & Poor's Company (S&P's) or Moody's Investor Service, Inc. (Moody's). If an investment has a split rating (i.e., different ratings from the two rating services) the Company categorizes the investment under the lower rating. For those investments that do not have a rating from either S&P's or Moody's, the Company categorizes those investments on ratings assigned by the National Association of Insurance Commissioners (NAIC), whose ratings are as follows: NAIC Class 1 is considered equivalent to a AAA\/Aaa, AA\/Aa, or A rating; NAIC Class 2, BBB\/Baa; and NAIC Classes 3-6, BB\/Ba and below. Fixed maturity investments that are not rated by S&P's or Moody's (unrated private placements), but instead rated with comparable NAIC ratings, comprise 0.4% of AAA-rated investments, 1.7% of AA-rated, 4.1% of A-rated, 23.2% of BBB-rated, and 50.2% of investments rated BB and lower at December 31, 1993.\nThe composition of the Company's fixed maturity portfolio, based on S&P's and Moody's ratings at December 31, 1993, was as follows:\nThe carrying value of the Company's high-yield investments (investments rated BB and lower) at December 31, 1993 was $94.0 million or 4.0% of the Company's invested assets compared to $108.3 million or 4.8% of invested assets at December 31, 1992. The fair value of this portfolio exceeded the carrying value by $6.2 million at December 31, 1993 and $6.1 million at December 31, 1992. The decline in the size of the high-yield portfolio in 1993 was primarily due to redemptions and sales, partially offset by downgrades.\nAt December 31, 1993, 29.5% of the Company's invested assets were in mortgage-backed fixed maturity investments, including collateralized mortgage obligations (CMOs) and mortgage-backed pass-through securities. Mortgage-backed securities generally are collateralized by mortgages backed by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), or the Federal Home Loan Mortgage Corporation (FHLMC), all of which are agencies of the U.S. Government. Only GNMA mortgage-backed securities are backed by the full faith and credit of the U.S. Government. Agency mortgage-backed securities are considered to have a AAA credit rating.\nIn some instances, the Company invests in non-agency mortgage-backed securities. At December 31, 1993, 89.1% of the Company's non-agency CMOs were rated AAA. The credit risk associated with non-agency mortgage-backed securities is generally greater than that of agency mortgage-backed securities.\nThe following details the carrying value and fair value of the Company's mortgage-backed securities portfolio at December 31, 1993:\nCertain mortgage-backed securities are subject to significant prepayment risk. This is due to the fact that in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as individuals refinance higher-rate mortgages to take advantage of lower rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments that cannot be reinvested at interest rates comparable to the rates on the prepaid mortgages.\nPlanned amortization class (PAC) and target amortization class (TAC) tranches, which together comprised 12.4% of the Company's invested assets at December 31, 1993, are designed to amortize in a manner that shifts the primary risk of prepayment of the underlying collateral to investors in other tranches of the CMO. The PAC and TAC instruments tend to be less sensitive to prepayment risk.\nSequential classes, which comprised 1.5% of the Company's invested assets at December 31, 1993, may have prepayment characteristics similar to mortgage-backed pass-through securities. Support classes, which comprised 1.0% of the Company's invested assets at December 31, 1993, are the most sensitive to prepayment risk.\nMortgage Loans and Real Estate The Company had investments in mortgage loans of $391.7 million at December 31, 1993 compared to $452.0 million at December 31, 1992. Investments in mortgage loans declined primarily due to prepayments and amortization of the mortgage loan portfolio. Of the outstanding loans at December 31, 1993, $3.7 million (net of allowances of $3.9 million), or 0.9%, were delinquent 60 days or more as to interest or principal.\nAt December 31, 1993, the Company's insurance subsidiaries had a delinquent mortgage loan ratio (mortgage loans overdue 60 days or in foreclosure, before allowances, as compared to the total mortgage portfolio before allowances) of 1.1% compared to 2.2% at December 31, 1992. The industry average delinquent mortgage loan ratio for residential and commercial mortgages, as measured by the American Council of Life Insurance, was 4.5% at December 31, 1993.\nThe following summarizes the additions and deductions to the Company's mortgage loan allowance:\nThe Company actively manages its non-current investments through restructuring of mortgages and sales and leasing of foreclosed real estate in order to achieve the highest current return as well as to preserve capital. Restructured loans, where modifications of the terms of the mortgage loan have generally occurred and which are considered current investments, were $16.9 million at December 31, 1993 compared to $18.2 million at December 31, 1992. At December 31, 1993, the Company's mortgage loan portfolio included $6.9 million of mortgage loans, before allowances, overdue at least three months and on which no interest income was being accrued. The Company does not expect the non-current investments to have a material adverse effect on its liquidity or ability to hold its other investments to maturity. This is primarily due to the relatively small amount of these non-current investments as compared to total invested assets and to the total amount of high quality, liquid investments.\nThe Company's mortgage loan portfolio at December 31, 1993 was diverse with respect to geographic distribution, principal repayment schedule dates, and property type as outlined below:\nThe Company's real estate investments totaled $39.1 million (net of allowances of $8.6 million) at December 31, 1993 compared to $60.0 million (net of allowances of $14.2 million) at December 31, 1992. The change was primarily due to sales of real estate investments. At December 31, 1993, $14.6 million of real estate investments were acquired through mortgage loan foreclosure, compared to $20.2 million at year-end 1992.\nCurrent and expected conditions in many real estate markets are depressed, with high vacancy rates and flat or declining rental rates. Moreover, the availability of financing is currently restricted as banks, insurance companies, and other lenders have reduced their exposure to real estate loans. In such an environment, the number of defaults on mortgage loans would be expected to remain at higher than historical average levels as borrowers' cash flows are insufficient to cover expenses. Additionally, the ability to rent investment real estate at favorable rates diminishes and properties may become vacant.\nEquity Securities At December 31, 1993, $7.0 million or 0.3% of the Company's invested assets consisted of common stocks and common stock mutual funds, $3.5 million or 0.2% of invested assets consisted of nonredeemable preferred stocks, and $5.4 million or 0.2% of invested assets consisted of fixed maturity and money-market mutual funds. Nonredeemable preferred stocks, common stocks, and common stock mutual funds are carried on the Company's balance sheet at fair value. The Company does not anticipate any significant change in the size of its equity securities portfolio.\nLiquidity and Capital Resources\nCash Flows During 1993, the Company's operating activities generated cash of $104.7 million compared to $93.3 million in 1992. The increase in cash provided by operations in 1993 primarily resulted from improved insurance operations in 1993 compared to 1992.\nInvesting activities (principally purchases and sales of investments) used cash of $130.8 million in 1993 compared to $140.0 million in 1992, primarily for the purchase of fixed maturity investments in both periods.\nFinancing activities provided cash of $27.1 million and $49.7 million, in 1993 and 1992, respectively. In 1993, $47.3 million of cash was provided by the sale of 2.1 million new shares of common stock and $18.1 million was provided by net receipts from universal life insurance and annuity policies. Partially offsetting these amounts in 1993 was the payment of $17.4 million of short-term notes payable, $9.5 million of mortgage and other notes payable, and $12.2 million of dividends to stockholders. In 1992, $46.0 million of cash was provided by net receipts from universal life insurance and annuity policies and net proceeds from debt, offset in part by $11.1 million of dividends to stockholders.\nThe fair value of the Company's investment portfolio, primarily fixed maturity investments, is affected by changing interest rates. When interest rates rise, the fair value of the Company's fixed maturity investments declines. In addition, the value of the Company's policy liabilities decreases. In periods of declining interest rates, the fair value of the Company's fixed maturity investments increases, accompanied by an increase in the value of its policy liabilities. The Company estimates that a one percentage point increase in market interest rates would result in a decrease in the fair value of its fixed maturity investments of approximately 5 percent, and a one percentage point decrease in market interest rates would result in an increase in the fair value of its fixed maturity investments of approximately 5 percent. In addition, rising interest rates could result in increased surrenders of life insurance policies and annuities causing the Company to sell fixed maturity investments below cost. In order to minimize the need to sell fixed maturity investments below cost, the Company seeks to maintain sufficient levels of cash and short-term investments.\nThe Company held cash and short-term investments of $85.7 million at December 31, 1993, compared to $60.2 million at December 31, 1992. The balance of cash and short-term investments plus cash inflow from premium revenues, investment income, and investment maturities is considered to be more than sufficient to meet the requirements of the Company and its subsidiaries.\nStock Offering During the third quarter of 1993, the Company issued 2,133,000 shares of Common Stock in a secondary stock offering. The sale of the additional shares resulted in an increase in stockholders' equity of $47.3 million and a decrease in 1993 primary earnings of 4.3% or $.11 per share. See Note E for additional information.\nDividends The Company's primary sources of funds to pay dividends to stockholders are investments held at the parent and dividends from WNIC. These dividends are subject to restrictions set forth by the Illinois Insurance Department. Illinois state regulations limit the amount of cash that can be withdrawn from WNIC to the greater of the previous year's statutory earnings or 10% of statutory capital and surplus. See Note E for further information.\nUPI is wholly owned by United Presidential Corporation, an insurance holding company which in turn is 71% owned by WNIC and 29% owned by WNC. UPI is not considered a source of funds for dividends to stockholders of the Company. Management expects UPI to pay no dividends in the foreseeable future in order to conserve capital at that subsidiary.\nHealth Care Reform On September 22, 1993, President Clinton provided the outline of the Administration's proposal for health care reform and delivered to Congress a more detailed package of the proposal in mid-October. The proposal relies heavily on a federally guaranteed package of health care benefits and medical services, primarily through an employer-based program for working Americans. In addition, the Administration's outline provides for health care coverage for non-working Americans. The Administration's proposal could have the following effects on insurers: (i) partially or fully replace products sold by insurers; (ii) limit the ability of insurers to charge higher rates to or decline to cover, insureds who present greater risks; (iii) limit the ability of insurers to exclude coverage for pre- existing conditions; (iv) mandate the types of insurance benefits to be provided in certain instances; (v) impose insurance rate regulation or additional taxes on insurance premiums or benefits; or (vi) increase competition by expanding employee choice of insurance plans and by requiring the employee to bear the full cost increment for higher priced plans.\nIn addition to the Administration's plan, a number of members of Congress have proposed alternative health care reform plans. These plans rely, in some instances, more on market-driven reform rather than on government mandated reform and several aspects of the Administration's proposal, such as universal coverage and employer mandates, are being challenged by these alternative plans.\nThe Company has monitored and will continue to monitor all aspects of the developments surrounding this issue and is preparing strategic responses to its possible outcomes. The Company's health businesses have begun to diversify into product areas, such as supplemental insurance products and disability products, that the Company believes are consistent with its targeted market focus and may be less affected or unaffected by health care reform. Such products may not be a component of a mandated benefits package and may be supplementally purchased by consumers. Health care reform at the federal and state levels may have a material adverse effect on the Company's operating results and financial position, but it is not possible at this time to predict the nature and effects of health care reform or how soon its measures will be adopted and implemented.\nDuring the 1993 fourth quarter, the Company announced that it had combined its individual health division and employee benefits division at WNIC. The combination is designed to accelerate the Company's positioning for strategic business opportunities under health care reform.\nA.M. Best Ratings The ability of an insurance company to compete successfully depends, in part, on its financial strength, operating performance, and claims-paying ability as rated by A.M. Best and other rating agencies. The Company's insurance subsidiaries are each currently rated \"A- (Excellent)\" by A.M. Best, based on their 1992 statutory financial results and operating performance.\nA.M. Best's 15 categories of ratings for insurance companies currently range from \"A++ (Superior)\" to \"F (In Liquidation).\" According to A.M. Best, an \"A\" or \"A-\" rating is assigned to companies which, in A.M. Best's opinion, have achieved excellent overall performance when compared to the standards of the life insurance industry and generally have demonstrated a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's statutory financial and operating performance, A.M. Best reviews the company's statutory profitability, leverage, and liquidity, as well as the company's spread of risk, quality and appropriateness of its reinsurance program, quality and diversification of assets, the adequacy of its policy reserves and surplus, capital structure, and the experience and competency of its management. A.M. Best ratings are based upon factors of concern to policyholders, agents, and intermediaries and are not directed toward the protection of investors.\nIn June 1993, the Company was advised by A.M. Best that, after review of the 1992 statutory financial results and operating performance, both WNIC and UPI were assigned ratings of \"A- (Excellent),\" an adjustment from their previous ratings of \"A (Excellent).\" Many of the Company's competitors have A.M. Best ratings of \"A-\" or lower, and the Company believes that its A.M. Best ratings are adequate to enable its insurance subsidiaries to compete successfully.\nIn communicating its most recent rating, A.M. Best advised WNIC that, if current trends persist, further rating adjustments may be required. The Company believes that the trends referred to by A.M. Best are (i) a decline in WNIC's statutory capital and surplus and (ii) increased net statutory operating losses on certain health insurance products of WNIC as calculated using statutory accounting practices. WNIC's statutory operating income in recent years has been adversely affected by the payment of first year commissions on new sales of certain health insurance products and investments in infrastructure improvements. The Company believes that as renewal business increases as a percentage of total revenues, statutory operating income for these products will improve. For 1993, statutory net operating income improved to $19.9 million from $5.8 million in 1992, and net income improved to $11.0 million from $36 thousand in 1992. Statutory capital and surplus increased $9.2 million, or 5.1%, to $188.3 million in 1993 versus a decrease of $9.1 million, or 4.8%, in 1992.\nNotwithstanding the foregoing, there can be no assurance that A.M. Best will maintain the ratings of the Company's insurance subsidiaries at their present levels. A rating downgrade at either WNIC or UPI could have a materially adverse effect on the ability of that subsidiary to write and retain business.\nInflation and Changing Prices Inflation and changing prices are anticipated by the Company in the pricing of its insurance products. Significant components of health insurance benefits are the medical care inflation rate, policyholder utilization of medical services, and cost-shifting, which is the transfer of medical care provider expenses that are not covered by governmental plans and HMOs to private insurers. As a result of relatively stable general and medical care inflation rates in 1993, WNIC's health insurance pricing assumptions regarding these factors were essentially unchanged from the prior year. For the first quarter of 1994, these assumptions have also not changed materially.\nThe effect of inflation on operating expenses has not been significant. However, if inflation increases significantly, operating expenses would be expected to increase.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote A Significant Accounting Policies and Practices\nPrinciples of Consolidation\nThe accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) and include the accounts and operations of Washington National Corporation and its subsidiaries (WNC or the Company). Significant intercompany transactions have been eliminated.\nReclassifications\nCertain amounts in the 1992 and 1991 financial statements have been reclassified to conform to the 1993 presentation.\nInvestments\nFixed Maturities.\nFixed maturity investments are securities that mature more than one year after issuance. They include bonds, notes, and redeemable preferred stocks. All fixed maturities are intended to be used by WNC as part of its asset\/liability matching strategy. Effective March 31, 1993, the Company reclassified its fixed maturity investments into investments that are \"held for sale\" and investments that are \"held to maturity.\" Fixed maturity investments held to maturity generally are carried at amortized cost, less write-downs for other-than-temporary impairments. Fixed maturity investments that are held for sale are those securities that may be sold in response to unanticipated policy surrenders, policy loan demand, or infrequent transactions. These fixed maturity investments are carried, on an aggregate basis, at the lower of amortized cost, less write-downs for other-than- temporary impairments and an allowance for below-investment grade securities, or fair value. Unrealized losses in aggregate on fixed maturity investments held for sale would be recorded in stockholders' equity, net of applicable deferred income taxes. At December 31, 1993 and 1992, the fair value of all fixed maturity investments exceeded carrying value by $82,332,000 and $56,894,000, respectively.\nEquity Securities.\nEquity securities represent investments in mutual funds, nonredeemable preferred stocks, and common stocks. These securities are carried at fair value which is determined primarily through published quotes of trading values. Changes in the valuation allowance necessary to adjust the carrying amount of the equity securities for temporary changes in fair value are reported directly in stockholders' equity. Other-than-temporary declines below cost are recorded as realized losses.\nMortgage Loans on Real Estate.\nMortgage loans on real estate are carried at unpaid principal, less unearned discount and allowance for possible losses. An allowance for mortgage loan losses is established based on an evaluation of the mortgage loan portfolio, past credit loss experience, and current economic conditions.\nReal Estate Investments.\nReal estate investments are principally carried at cost, less allowances for depreciation and possible losses. Foreclosed real estate is considered held for sale and is recorded at the lower of current carrying value or fair value, less estimated costs of disposal.\nOther Long-term Investments.\nOther long-term investments consist principally of venture capital investments which are carried at cost, less other- than-temporary impairments.\nShort-term Investments.\nShort-term investments include commercial paper, variable demand notes, and money market funds, and are carried at cost.\nInvestment Income.\nInterest on bonds, loans, and notes is recorded in income as earned. Income is adjusted for any amortization of premium or discount on these investments. Any excess cash flows arising from prepayments are booked as adjustments to the carrying value of the investment. Income on real estate and other long-term investments is recorded principally on a cash basis. Dividends are recorded as income on ex-dividend dates.\nRealized Gains or Losses.\nWhen an investment is sold, its selling price may be higher or lower than its carrying value. The difference between the selling price and the carrying value is recorded as a realized gain or loss, using the specific identification method. Investments that have declined in fair value below cost, and for which the decline is judged to be other-than-temporary, are written down to their estimated fair value. Write-downs and allowances for losses on mortgage loans and below-investment grade bonds are included in realized investment losses.\nFair Value of Financial Instruments\nGAAP requires the disclosure of fair value information about certain financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. The fair values are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instrument. As the fair value of all of WNC's assets and liabilities is not presented, the aggregate fair value of the amounts presented does not represent the underlying value of WNC.\nThe carrying amounts reported in the balance sheets for cash, short-term investments, short-term borrowings, and accrued investment income approximate their fair values.\nFair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments.\nFair values for mortgage loans and policy loans are estimated using discounted cash flow analyses, based on interest rates currently being offered for similar loans to borrowers with similar credit ratings.\nA pricing cap is put on mortgage loans that carry significant above-market interest rate yields to reflect the illiquid nature of the mortgage loans and the risk that such loans could be prepaid.\nFair values for liabilities under investment-type insurance contracts are estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with similar maturities.\nThe fair value of long-term debt is estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.\nFair values for real estate development guarantees, to the extent practicable, are based on estimates of fees to guarantee similar developments. Fair values for lending commitments are based on the commitment fee of the loans in question.\nDepreciation\nProvisions for depreciation of real estate investments and home office properties are computed using primarily the straight-line method over the estimated useful lives. Accumulated depreciation on real estate investments at December 31, was $24,184,000 in 1993 and $10,834,000 in 1992. Accumulated depreciation on home office properties at December 31, was $1,122,000 and $13,495,000 in 1993 and 1992, respectively. In 1993, the Company's previous home office real estate and related accumulated depreciation were transferred to investment real estate.\nInsurance Premiums and Policy Charges\nHealth insurance premiums are earned pro rata over the terms of the policies. For traditional life insurance products, premiums are recognized as revenues when due. Revenues for certain interest-sensitive products consist of charges earned and assessed against policy account balances during the period for the cost of insurance, policy initiation fees, policy administration expenses, and surrenders.\nPolicy Liabilities\nLiabilities for future policy benefits for traditional life insurance products are determined using the present value of future net premiums, benefits and expenses, and the net level valuation method, based on estimates of future investment yield, mortality, and withdrawal rates, adjusted to provide for possible adverse deviation. Interest rate assumptions are graded and range from 4.5% to 7.5%. Withdrawal assumptions are based principally on experience and vary by issue age, type of coverage, and duration.\nLiabilities for future policy benefits of certain interest-sensitive products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized as income over the term of the policies and a provision for the return of cost of insurance charges. Policy benefits and claims that are charged to expense include interest credited to policy account balances, benefit claims incurred in the period in excess of related policy account balances, and a provision for the return of cost of insurance charges. Credited interest rates for these products ranged from 3.0% to 7.5% at December 31, 1993.\nThe liabilities for policy and contract claims are determined using case- basis evaluations and statistical analyses. These liabilities represent estimates of the ultimate expected cost of incurred claims and the related claim adjustment expenses. Any required revisions in these estimates are included in operations in the period when such adjustments become determinable.\nThe carrying amounts, net of deferred insurance costs, for investment-type insurance contracts, principally included with future policy benefits of annuities were $1,226,238,000 and $1,197,340,000, at December 31, 1993 and 1992, respectively. The estimated fair values at December 31, 1993 and 1992 were $1,224,550,000 and $1,176,435,000, respectively.\nThe fair values of liabilities under all insurance contracts are taken into consideration in WNC's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.\nDeferred Insurance Costs\nCosts directly associated with the acquisition of new business are deferred and amortized. For traditional life insurance and health insurance products, costs are amortized over the premium-paying period of the products based on assumptions that are used in calculating policy benefit reserves. For certain interest-sensitive products, costs are generally amortized over the estimated lives of the products in relation to the present value of estimated gross profits from surrender charges and investment, mortality, and expense margins.\nThe unamortized cost of purchased insurance in force is included in deferred insurance costs. Amortization is in relation to the present value of estimated gross profits over the estimated remaining life of the related insurance in force of 23 years, with interest rates ranging from 7.5% to 8.5%.\nThe following summarizes the changes in the unamortized cost of purchased insurance in force for the years ended December 31:\nThe estimated percentage of the December 31, 1993 balance to be amortized over the next five years is as follows:\nGoodwill\nThe cost of purchased businesses in excess of net assets is reported as goodwill and amortized on a straight-line basis, generally over thirty-six years. Goodwill is evaluated based on the prospect for continued growth and the long-term nature of the insurance policies sold. The asset value is considered appropriate. Accumulated amortization of goodwill was $6,023,000 and $5,204,000 at December 31, 1993 and 1992, respectively.\nSeparate Account\nSeparate Account assets and liabilities are principally carried at fair value and represent funds that are separately administered for annuity contracts and for which the contract holders bear the investment risk. Investment income and realized gains and losses allocable to Separate Accounts generally accrue to the contract holders and are excluded from the Consolidated Statements of Operations.\nIncome Taxes\nIn 1992, WNC adopted the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) 109, \"Accounting for Income Taxes.\" The accounting policies of WNC result in deferred taxes being provided for significant temporary differences between financial statement and tax return bases, using the asset and liability method. These differences result primarily from policy reserves, insurance acquisition costs, and reserves for postretirement benefits. WNC and its subsidiaries file a consolidated life\/nonlife federal income tax return.\nReinsurance\nThe insurance subsidiaries of WNC reinsure a portion of their life, annuity, and health risks with other insurance companies to minimize their exposure to loss. In particular, for the life insurance and annuity business, the Company's policy is to retain a maximum of $300,000 of life insurance exposure on any one individual ($400,000 with accidental death). For the group products business, the Company limits its paid-claim exposure in any one calendar year to $750,000 per claim for major medical coverage and $250,000 per claim for individual stop-loss. The Company retains a maximum of 50% of each employee benefits long-term disability claim, and limits its group term life exposure to $200,000 per life ($400,000 with accidental death). The Company's reinsurance for individual health claims is designed to protect the Company from an excessive amount of claims in excess of $250,000 on an individual claim basis.\nSubstantially all of the reinsurance ceded by the Company is to entities rated \"A\" or better by A. M. Best, or to entities required to maintain assets in an independent trust fund whose fair value is sufficient to discharge the obligations of the reinsurer. To the extent that any reinsurance company is unable to meet its obligations under the agreements, WNC's insurance subsidiaries would remain liable.\nAmounts paid or deemed to have been paid for ceded reinsurance contracts are recorded as reinsurance recoverables. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.\nSubstantially all of the reinsurance assumed by the Company as of December 31, 1993 is on a 100% coinsurance basis and is accounted for in a manner similar to the direct business.\nNew Accounting Standards\nIn 1992, the FASB issued SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" which WNC adopted effective January 1, 1993. This standard requires employers to recognize the costs and obligations of all types of postemployment benefits provided to former or inactive employees, their beneficiaries, and covered dependents. Under the standard, vested benefits are to be accrued over the relevant service period rather than expensed as they are paid, as was the practice. For postemployment benefits that do not vest or accumulate, employers are to accrue a liability and recognize the expected cost when it is probable that a benefit obligation has been incurred and the amount is reasonably estimable. The adoption resulted in a one-time cumulative adjustment of $1,550,000, net of taxes of $834,000, relating to benefits previously recorded on a pay-as-you-go basis. The adoption of SFAS 112 did not have a material effect on 1993 pretax income and is not expected to have a material impact on future years' earnings.\nEffective January 1, 1993, WNC adopted SFAS 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" The statement requires that reinsurance recoverables, including amounts related to claims incurred but not reported and prepaid reinsurance premiums, be reported as assets instead of net of the related liabilities. The adoption resulted in an increase in total assets and liabilities of $58,173,000 and $60,266,000 at December 31, 1993 and 1992, respectively. The adoption had no impact on net income or stockholders' equity.\nIn June 1993, the FASB issued two new accounting standards. SFAS 114, \"Accounting by Creditors for Impairment of a Loan,\" must be adopted by the Company by January 1, 1995. The standard will require the Company to measure an impaired loan at (i) the present value of expected future cash flows, discounting those cash flows at the loan's effective interest rate, (ii) the fair value of the collateral of an impaired collateral dependent loan, or (iii) an observable market price. The impairment is recognized by a valuation allowance which may be subsequently increased or decreased based on changes in the measurement criteria. The Company is in the process of determining the effect the new standard will have on net income and stockholders' equity but does not expect the effect to be material.\nThe second standard, SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which the Company must adopt prospectively effective January 1, 1994, requires the Company to segregate its fixed maturity portfolio into three separate classifications on the balance sheet: investments held to maturity, trading securities, and investments available for sale. Investments held to maturity will include only those fixed maturities that the Company has a positive intent and ability to hold to maturity. These securities will be carried at amortized cost less write- downs for other-than-temporary impairments. Trading securities will consist of those fixed maturity and equity securities held for short periods of time and will be carried on the balance sheet at fair value, with any change in value reported as a component of income. Investments available for sale will consist of those securities that do not meet the criteria of investments held to maturity or trading securities and will be carried on the balance sheet at fair value, with any change in value recognized as an unrealized gain or loss in stockholders' equity. If a decrease in value of fixed maturity investments is other than temporary, the loss is recognized immediately as a realized loss. In addition, stockholders' equity will be reduced by the estimated amortization of deferred insurance costs that the realization of the unrealized gains would produce. The adoption of this standard at January 1, 1994 will result in an increase in stockholders' equity of approximately $43,000,000. This is the result of changing the carrying value of the current held for sale fixed maturities to fair value, a reduction in deferred insurance costs of $19,000,000, and a related increase in deferred taxes of $14,000,000. There will not be an income statement effect for adoption as the Company does not have a trading portfolio.\nThe Company foresees that this standard will result in added volatility to stockholders' equity as the standard does not permit a corresponding adjustment to the liabilities that these assets support.\nNote B\nInvestments\nGains and Losses and Income\nRealized investment gains (losses) for years ended December 31 are comprised of the following:\nMajor categories of net investment income for the years ended December 31 are as follows:\nAs of December 31, 1993, investments included real estate, mortgage loans, and fixed maturities with a carrying value of $22,158,000 which were non- income producing for the previous twelve months.\nFixed Maturities\nA comparison of amortized cost to fair value of fixed maturity investments by category at December 31, 1993 and 1992 is as follows:\nThe amortized cost and fair value of fixed maturities at December 31, 1993, by contractual maturity, are shown in the following table. Expected maturities differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nFixed maturities had an increase (decrease) in unrealized gains (the excess of fair value over amortized cost) of $25,438,000, $(4,245,000), and $88,953,000 in 1993, 1992, and 1991, respectively. At December 31, 1993, gross unrealized gains (losses) on investments in equity securities amounted to $386,000 and $(429,000), respectively.\nOther\nDuring 1993, 1992, and 1991, non-cash investing activities consisted of real estate acquired through foreclosure of mortgage loans which totaled $4,869,000, $14,302,000, and $3,829,000, respectively.\nThe fair value of investments in mortgage loans was estimated to be $411,250,000 and $471,082,000 at December 31, 1993 and 1992, respectively. The fair value of policy loans was estimated to be $50,340,000 and $48,246,000 at December 31, 1993 and 1992, respectively.\nNote C\nBorrowings and Other Credit Arrangements\nBorrowings\nBorrowings of $2,434,000 at December 31, 1993 consist of a mortgage on investment real estate with an interest rate of 6.5% that matures in March 1998. Payments of $526,000, $562,000, $599,000, $613,000 and $134,000 will be required in 1994, 1995, 1996, 1997, and 1998, respectively. The property is pledged as collateral.\nInterest paid on borrowings by WNC was $1,673,000, $1,313,000, and $2,130,000 in 1993, 1992, and 1991, respectively.\nThe fair value of WNC's mortgage and long-term notes payable at December 31, 1993 and 1992 was estimated to be $2,438,000 and $14,107,000, respectively.\nCredit Arrangements\nWNC has a line of credit arrangement for short-term borrowings with one bank amounting to $10,000,000, all of which was unused at December 31, 1993. The line of credit arrangement can be renewed annually, but credit can be withdrawn at the bank's option.\nIn addition, WNC has three letters of credit available from one bank totaling $1,892,000 with varying terms and conditions. As of December 31, 1993, the entire amount was unused.\nNote D\nIncome Taxes\nEffective January 1, 1992, WNC adopted SFAS 109, \"Accounting for Income Taxes.\" Amounts prior to 1992 are presented under the previous accounting rules.\nThe Omnibus Budget Reconciliation Act of 1993 changed WNC's prevailing federal income tax rate from 34% to 35% effective January 1, 1993. The application of the 35% tax rate to the December 31, 1992 deferred income tax liability balance resulted in a $38,000 increase in federal income tax expense for 1993.\nComponents of WNC's deferred tax liabilities and assets at December 31 are as follows:\nThe net deferred tax liabilities relate primarily to the future taxable temporary differences for deferred insurance costs. The net deferred tax assets relate primarily to the future deductible temporary differences for policy liabilities and liabilities for employee benefits items. The nature of WNC's deferred tax assets and liabilities is such that the general reversal pattern for these temporary differences should result in a full realization of WNC's deferred tax assets other than capital gain or loss items.\nThe components of the provision for deferred income taxes for the year ended December 31, 1991 are as follows:\nAt December 31, 1993, WNC had capital loss carryforwards for tax return purposes of $7,404,000 that expire in 1996. For financial reporting purposes, a valuation allowance of $14,903,000 has been recognized to offset the deferred tax assets related to those carryforwards, investment loss reserves, and other capital loss related deferred tax assets not expected to be realized. The valuation allowance was reduced by $3,272,000 and $500,000 in 1993 and 1992, respectively.\nThe components of income tax expense for the years ended December 31 are as follows:\nThe following reconciles the difference between the actual tax provision and the amounts obtained by applying the statutory federal income tax rate of 35% for 1993 and 34% for 1992 and 1991 to the income or loss before income taxes and cumulative effect of changes in accounting principles:\nAt December 31, 1993, up to $19,851,000 (at a 35% tax rate) would be required for possible federal income taxes that might become due in future years, in whole or in part, if any portion of $56,717,000 of the insurance companies' gains from operations which accumulated under pre-1984 income tax laws, presently included in earned untaxed surplus and identified as tax \"Policyholders' Surplus,\" becomes includable in taxable income. Also, distribution of amounts in excess of taxable \"Shareholders' Surplus\" ($221,591,000 at December 31, 1993) by the insurance companies under certain conditions may require payment of additional federal income taxes. However, WNC does not expect or intend that these taxable events will occur and, as such, the related deferred income taxes are not required to be provided.\nFederal income taxes paid by WNC were $4,100,000, $8,700,000, and $5,300,000 in 1993, 1992, and 1991, respectively. WNC has a nonlife net operating loss carryforward for tax purposes of $2,222,000 that will begin to expire in 2005.\nNote E\nStockholders' Equity\nConvertible Preferred Stock\nWNC has 10,000,000 shares of $5 par value Preferred Stock authorized that is designated as $2.50 Convertible Preferred Stock. Each share is entitled to a cumulative annual dividend of $2.50, and a preference of $50 in the event of involuntary liquidation and $55 in the event of voluntary liquidation of WNC. Further, each share is convertible at any time into 1.875 shares of Common Stock at the option of the holder and is redeemable at $55 at the option of WNC. Each holder is entitled to one vote for each share held and, except as otherwise provided by law, the $2.50 Convertible Preferred Stock and the Common Stock vote together as one class.\nStock Purchase Rights\nWNC has one outstanding Common Stock Purchase Right for each outstanding share of Common Stock. The Rights will become exercisable only if a person or group acquires 20% or more of WNC's Common Stock or announces a tender offer following which it would hold 30% or more of such Common Stock. If the Rights become exercisable, a holder will be entitled to buy from WNC one share of WNC Common Stock at a price of $100 per share. If, after the Rights become exercisable, WNC is acquired in a merger or other business combination or more than 50% of WNC's assets or earning power are sold, each Right will entitle its holder to buy that number of shares of Common Stock of the acquiring company having a market value of twice the exercise price of the Right. Alternatively, if a 20% WNC stockholder acquires WNC by means of a merger in which WNC and its Common Stock survive or that stockholder engages in self-dealing transactions with WNC, each Right not owned by the 20% holder would become exercisable for that number of shares of WNC Common Stock which have a market value of twice the exercise price of the Right. Until the Rights become exercisable, one additional Right will be distributed with each share of WNC Common Stock issued in the future. The Rights will expire in January 1997. The Rights may be redeemed by WNC at $.01 per Right prior to the time that 20% or more of WNC's Common Stock has been accumulated by a person or group or within ten days thereafter under certain circumstances.\nCommon Stock\nWNC has 60,000,000 authorized shares of $5 par value Common Stock including treasury shares. In the third quarter of 1993, the Company completed a public offering of 2,133,000 newly issued shares for $23.75 per share. Capital contributions of $14,000,000 were made to a subsidiary out of the net proceeds. In addition, short-term indebtedness was reduced $11,000,000. The remainder is being used for other general corporate purposes.\nAt December 31, 1993, 13,768,000 shares of WNC's Common Stock were reserved for future issuance. Of this amount 12,118,000 shares were reserved for future exercises of Purchase Rights, 271,000 shares were reserved for conversion of outstanding Convertible Preferred Stock, 1,344,000 shares were reserved for exercise of options to purchase Common Stock and for use in connection with the restricted stock grants, and 35,000 shares were reserved for issuance of Common Stock in connection with the dividend reinvestment plan. The annual dividend paid on WNC Common Stock in 1993, 1992, and 1991 was $1.08 per share.\nThe number of shares used in computing primary earnings per share for 1993, 1992, and 1991 was 10,755,000, 9,989,000, and 9,980,000, respectively. These consisted of average shares outstanding plus the effect of dilutive stock options totalling 112,000 shares in 1993 and 97,000 shares in 1992. No effect was given to stock options in 1991 because the effect would have decreased the loss per share.\nThe number of shares used in computing fully diluted earnings per share for 1993 was 11,026,000. This included average shares outstanding plus 383,000 shares of common stock equivalents consisting of dilutive stock options and the assumed conversion of preferred stock.\nPrimary and fully diluted earnings per share were the same for 1992 and 1991 because the computation of fully diluted earnings per share resulted in a smaller loss per share.\nStatutory\nThe statutory accounting practices prescribed for WNC's insurance subsidiaries by regulatory authorities differ from GAAP. The following reconciles statutory capital and surplus to GAAP stockholders' equity at December 31:\nThe following reconciles statutory net income (loss) to GAAP net income (loss) for the years ended December 31:\nThe net assets of WNC's insurance subsidiaries that are available for transfer to WNC generally are limited to the amounts by which such net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory capital requirements. In addition, transfers in excess of certain amounts require approval of regulatory authorities. Retained earnings at December 31, 1993 includes $125,000,000 in excess of the statutory unassigned surplus of the insurance subsidiaries.\nNote F\nStock Benefit Plan\nWNC has a stock benefit plan under which WNC's Compensation Committee may grant stock options, stock appreciation rights (SARs), and shares of restricted stock. The following summarizes the changes in the shares of Common Stock of WNC under the plan:\nStock options granted from 1991 to 1993 ranged from $10.21 per share to $26.57 per share. Stock options exercised from 1991 to 1993 ranged from $10.21 per share to $21.70 per share. Exercise prices on stock options outstanding range from $10.21 to $27.29 per share.\nShares of restricted stock may be granted either separately or in tandem with the grant of a stock option to key employees and others. These restricted shares are subject to certain terms and conditions defined in the plan. Options for 7,500 and 6,750 such shares were granted in 1992 and 1991, respectively.\nNote G\nDefined Benefit and Contribution Plans\nRetirement Plans\nWashington National Insurance Company (WNIC) and an indirect wholly-owned subsidiary, United Presidential Life Insurance Company (UPI), each have a defined benefit retirement plan covering substantially all employees who have met the prescribed requirements for participation. Both plans have been amended to terminate the accrual of future benefits. Benefits are based principally on years of service and compensation. Generally, the funding policies are to contribute annually amounts required by the Internal Revenue Code (IRC). Contributions are intended to provide benefits attributed to service to date.\nEffective January 1, 1991 for WNIC, and March 31, 1993 for UPI, the Company established two defined contribution retirement plans, a money-purchase retirement plan and a discretionary profit sharing plan. Neither plan allows employee contributions. These two plans, in addition to the contributory 401(k) plan, collectively represent the current retirement benefit program. The plans now cover substantially all WNIC and UPI employees who have met the prescribed requirements for participation. The contribution to the 401(k) plan matches employee contributions dollar for dollar up to a maximum of 3% of compensation. The contribution to the money- purchase retirement plan is 3% of each employee's compensation and an additional 3% of compensation in excess of the Social Security wage base. The contribution to the profit sharing plan is at the discretion of the insurance subsidiaries' Boards of Directors in consultation with the Board of Directors of WNC and is based on financial performance. WNC also has supplemental retirement plans under which benefits are paid equal to any amount by which benefits are reduced for any participant in the defined contribution or defined benefit retirement plans due to provisions of the IRC. The liabilities for the supplemental retirement plans at December 31, 1993 and 1992 were immaterial. The net pension expense for the defined contribution plans in 1993, 1992, and 1991 was $2,777,000, $2,110,000, and $1,866,000, respectively.\nA summary of the components of the net periodic pension expense for the defined benefit retirement plans follows:\nNet periodic pension expense for 1993 includes a $491,000 curtailment gain from the termination of the accumulation of benefits of UPI's defined benefit plan.\nThe defined benefit retirement plans' funded status and amounts reported in WNC's consolidated balance sheets as of December 31 are as follows:\nThe unrecognized transition gain in the preceeding schedule is the amount by which the plans' net assets exceeded the actuarial present value of projected benefit obligations as of January 1, 1985, net of amortization, the date on which current pension accounting standards were adopted. The transition gain is being amortized by credits to income over a fourteen- year period. In addition, the excess of actual investment and actuarial gains and losses realized over those expected are deferred and, when the cumulative deferred amounts exceed certain limits, will be amortized at a rate consistent with a fourteen-year amortization period. Costs created by plan amendments that are associated with prior employee service are also deferred and amortized over fourteen years.\nAccrued pension cost and the various net gains and losses not recognized in the consolidated financial statements are compared annually to the plans' funded status. The comparison is made using the plans' accumulated benefit obligations. When a deficiency exists, an adjustment is made for the amount of the deficiency to recognize a minimum liability. At December 31, 1993 and 1992, the pretax adjustment was $3,033,000 and $1,269,000, respectively. The liability and subsequent changes had no effect on net periodic pension expense and were reported directly in stockholders' equity.\nIn determining the actuarial present value of the projected benefit obligation as of December 31, 1993 and 1992, the discount rate used was 6.7% and 6.9%, respectively. The rate of increase in compensation levels used in 1992 was 5% for the UPI plan. The expected rate of return on plan assets was 7.5% for 1993, 1992, and 1991.\nAssets of the defined benefit plans are invested principally in mutual funds, bonds, and stocks. Assets of the WNIC retirement plan include Common and Preferred Stock of WNC of $10,863,000 and $10,332,000, at fair value, at December 31, 1993 and 1992, respectively. Dividends of $492,000 were received on the WNC Common and Preferred Stock in 1993 and 1992. No shares were purchased or sold during 1993.\nPostretirement Benefits\nIn addition to WNC's various retirement programs, WNIC provides certain health care and life insurance benefits to eligible retired employees. Employees generally have become eligible for these benefits after reaching age 55 with 20 years of service or after reaching age 65 with 10 years of service. Generally, the health plans pay a stated percentage of most medical expenses reduced for deductibles and any payments made by government programs or other group coverage. Retirees contribute to the plan according to a schedule which averages 16% of the benefits paid. Effective January 1, 1992, WNC adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Prior to December 1993, these benefits were unfunded. In December 1993, the Company contributed $1,100,000 to a Voluntary Employees' Beneficiary Association (VEBA) trust. The amount funded to the VEBA trust was based on the difference between the net periodic postretirement benefit expense and the retiree medical claims incurred during the period, subject to certain IRC limitations. Assets of the VEBA trust were invested in short-term variable demand notes at December 31, 1993.\nEffective December 31, 1992, the WNIC plan was changed to limit future eligibility. Active employees who were not at least age 50 as of December 31, 1992 and whose combination of age and years of service did not total at least 65 as of that date are not eligible for postretirement health insurance benefits and are only eligible for $10,000 of postretirement life insurance benefits. This curtailment resulted in a gain of $4,033,000 recorded as part of operations in the fourth quarter of 1992.\nThe net periodic postretirement benefit expense includes the following components at December 31:\nPostretirement benefit expenses were recorded on a pay-as-you-go basis in 1991 and totaled $3,100,000.\nThe following reconciles the plans' accumulated postretirement benefit obligation with amounts recognized in WNC's consolidated balance sheets at December 31:\nThe health care cost trend rate used in 1993 and 1992 was 15% grading to 6% evenly over thirty years. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the trend rate by 1% per year would increase the accumulated postretirement benefit obligation by $2,825,000 at December 31, 1993 and the aggregate of the service and interest cost components of the net periodic postretirement benefit expense for 1993 by $200,000.\nNote H\nReinsurance\nThe effect of reinsurance on premiums and policy charges for the years ended December 31 was as follows:\nReinsurance benefits ceded were $22,685,000, $22,516,000, and $17,372,000 in 1993, 1992, and 1991, respectively.\nAs a result of past divestitures, the Company reinsures 100% of certain blocks of supplemental health insurance, life insurance, and annuity business with unaffiliated companies. At December 31, 1993, approximately 50% of WNC's total reinsurance recoverables were ceded to Combined Life Insurance Company of America and approximately 19% was ceded each to American Founders Life Insurance Company and UNUM Life Insurance Company. Of these three, two are related to divestitures. Also at December 31, 1993, 89% of reinsurance premiums assumed were from Harvest Life Insurance Company. The reinsurance agreement provides that the Company will reinsure a block of individual major medical business issued by Harvest Life on a 100% coinsurance basis.\nThe Company also uses yearly renewable term reinsurance at UPI to maintain statutory profitability and other financial requirements at UPI while sustaining growth. At December 31, 1993, such reinsurance, net of related taxes had contributed $9,300,000 of statutory capital to UPI. These transactions do not materially impact the Company's GAAP financial statements.\nNote I\nCommitments and Contingencies\nLeases\nWNC has noncancelable operating leases primarily for office space and office equipment, the most significant of which relates to a twenty-year lease of WNIC's home office building with a related party as lessor. Future minimum lease payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 1993 are as follows:\nRental expenses were $6,900,000, $2,871,000, and $3,039,000 in 1993, 1992, and 1991, respectively.\nFinancial Commitments and Guarantees\nThe Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit, commitments to fund investments, standby purchase commitments, and financial guarantees related to various investments in real estate and joint ventures. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.\nThe exposure to credit loss in the event of nonperformance by the other party to the financial instrument for the aforementioned commitments and guarantees is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. If funded, the commitments and guarantees would be collateralized by the related real estate investments.\nCommitments to extend credit are agreements to lend to an entity as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. An entity's credit worthiness is evaluated on a case-by-case basis and the amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held would include the related real estate investment properties. At December 31, 1993 and 1992, commitments to extend credit were $6,425,000 and $11,049,000, respectively. These commitments principally expire by July 1994.\nCommitments to fund investments primarily for venture capital and fixed maturity investments amounted to $358,000 and $14,398,000 at December 31, 1993 and 1992, respectively. These commitments are on call and do not have a formal expiration date.\nStandby purchase commitments and financial guarantees are conditional commitments issued by the Company to guarantee the performance of an unrelated entity to a third party. These purchase commitments and guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and letters of credit, and expire in 1994, 1995, and 1996. The Company does not hold collateral for these conditional commitments; however, in the event of nonperformance by the entity, the Company would be entitled to the underlying collateral, principally commercial real estate properties. In addition, the Company is entitled to share in the appreciation of the collateral on the conditional commitments at the time of sale or refinancing. Management is not aware of any material losses on these conditional commitments. At December 31, 1993 and 1992, standby purchase commitments and guarantees were $24,323,000 and $34,126,000, respectively.\nThe Company issued financial guarantees on two real estate investments and received $676,000 of consideration, principally in 1986. The estimated fair value at December 31, 1993 of these guarantees is less than $500,000.\nThe Company also entered into financial guarantees that are integral and inseparable components of real estate and mortgage loan transactions. No consideration was received for these guarantees which relate primarily to the guarantee of debt repayment on three joint venture real estate investments. Accordingly, the fair value of these financial guarantees is zero.\nLitigation\nWNC and certain affiliated companies have been named in various pending legal proceedings considered to be ordinary routine litigation incidental to the business of such companies. A number of other legal actions have been filed against the Company that demand compensatory and punitive damages aggregating material dollar amounts. Management believes that such suits are substantially without merit and that valid defenses exist and are of the opinion that such litigation will not have a material effect on WNC's consolidated financial position.\nHealth Care Reform\nSee Item 7, \"Management's Discussion And Analysis Of Financial Condition And Results Of Operations - Health Care Reform\" for a discussion of health care reform and its possible effect on the Company's business.\nState Guaranty Funds\nUnder insolvency or guaranty laws in most states in which the Company's insurance subsidiaries operate, insurers can be assessed for policyholder losses incurred by insolvent insurance companies. At present, most insolvency or guaranty laws provide for assessments based on the amount of insurance underwritten in a given jurisdiction. The Company's insurance subsidiaries paid $2,500,000, $1,800,000, and $2,000,000 in state guaranty fund assessments in 1993, 1992, and 1991, respectively and had accrued liabilities of $2,800,000 for future assessments at December 31, 1993 and 1992. Mandatory assessments can be partially recovered through a reduction in future premium taxes in some states.\nThe Company's accounting policy with regard to payments to state guaranty funds is to treat as a deferred asset any such payments in those states where current law allows an offset against future premium taxes. At December 31, 1993 and 1992, other assets included $5,100,000 and $4,000,000 of deferred payments to state guaranty funds. Generally, this amount will be used to offset future premium tax payments over periods from five to ten years. In the event of a change in the law pertaining to prior tax offsets, such amounts might become unrecoverable.\nNote J\nDivestitures\nIn the third quarter of 1991, WNC completed the sale of its New York-based life insurance subsidiary. A pretax loss of $16,000,000 was recorded on this sale in 1990. An additional pretax loss of $1,826,000 was recognized in the second quarter of 1991. At June 30, 1991, this subsidiary had assets, principally investments, of $200,000,000 and liabilities, principally policy liabilities, of $176,000,000. In the consolidated statement of operations for 1991, total revenues of $12,200,000 are attributable to this subsidiary.\nIn the second and third quarters of 1991, WNIC sold blocks of universal life insurance and annuities for a pretax gain of $668,000. The gain is included in net loss on divestitures. The operations of these blocks of business are included in the life insurance and annuities segment. These blocks of business had policy-related assets, principally deferred insurance costs, of $13,000,000 and policy liabilities of $110,000,000.\nNote K\nSegment Information\nWNC has four business segments: life insurance and annuities; group products; individual health insurance; and corporate and other. The segments are based on WNC's insurance products. The corporate and other segment includes realized investment gains and losses, a curtailment gain in 1992 of $4,033,000 resulting from a change to WNIC's postretirement health benefits program, operations that do not specifically support one of the other segments, and the operations and the net loss on divestitures in 1991. See Note J for further information on divestitures. Assets not individually identifiable by segment are allocated based on the amount of segment liabilities. Depreciation expense and capital expenditures are not considered material. Revenues, income or loss before income taxes and cumulative effect of changes in accounting principles, and assets by segment for the years ended and as of December 31 are as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDescriptions of WNC's directors are contained in WNC's 1994 proxy under the caption \"Election of Directors.\" Information regarding compliance with Section 16(a) of the Exchange Act is contained in WNC's 1994 proxy statement under that caption. Additionally, biographical descriptions of Wade G. Brown, Executive Vice President and Chief Information Officer; Curt L. Fuhrmann, President - WNIC Health Division; Kenneth A. Grubb, President - WNIC Education Division; R. W. Patin, Chairman of the Board and Chief Executive Officer, WNC and WNIC; James N. Plato, President and Chief Executive Officer, United Presidential Life Insurance Company; Thomas Pontarelli, Executive Vice President, Thomas C. Scott, Executive Vice President and Chief Financial Officer; and Don L. Wilhelm, former Chairman of the Board and Chief Executive Officer, United Presidential Life Insurance Company, are contained in Part I of this Report, pursuant to General Instruction G.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nExecutive compensation and transactions are contained in WNC's 1994 proxy statement under the caption, \"Executive Compensation.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nA description of security ownership of certain beneficial owners and management is contained in WNC's 1994 proxy statement under the caption, \"Stock Ownership.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nA description of transactions with management is contained in WNC's 1994 proxy statement under the caption, \"Transactions with Management.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1)The following consolidated financial statements of WNC and subsidiaries included in the 1993 Annual Report to Stockholders are presented in Item 8:\nConsolidated Balance Sheets, December 31, 1993 and 1992\nConsolidated Statements of Operations, Year Ended December 31, 1993, 1992, and 1991\nConsolidated Statements of Cash Flows, Year Ended December 31, 1993, 1992, and 1991\nConsolidated Statements of Stockholders' Equity, Year Ended December 31, 1993, 1992 and 1991\nCapital Stock Activity, Year Ended December 31, 1993, 1992, and 1991\nNotes to Consolidated Financial Statements\nQuarterly Information\n(a)(2)The financial schedules required by Item 14(d) are presented in a separate section of this report and are preceded by the Index to Financial Schedules.\nAll other schedules pursuant to Regulation S-X are not submitted because they are not applicable, not required, or the required information is included in the consolidated financial statements, including the notes thereto.\n(a)(3)The exhibits filed with this Form 10-K are listed in the Exhibit Index located elsewhere herein. All management contracts and compensatory plans or arrangements set forth in such list are marked with a double asterisk (**).\n(b) WNC filed no reports on Form 8-K during the last quarter of the period covered by this report.\n(c) Included in 14(a)(3) above.\n(d) Included in 14(a)(2) above.\nSignatures\nPursuant 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.\nWASHINGTON NATIONAL CORPORATION REGISTRANT\nDate: March 11, 1994 \/c\/ Robert W. Patin Robert W. Patin Chairman of the Board, President and Chief Executive Officer and Director\nPursuant 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 and on the dates indicated.\nDate: March 11, 1994 \/c\/ Frederick R. Blume Frederick R. Blume Director\nDate: March 11, 1994 \/c\/ Elaine R. Bond Elaine R. Bond Director\nDate: March 11, 1994 \/c\/ Ronald L. Bornhuetter Ronald L. Bornhuetter Director\nDate: March 11, 1994 \/c\/ Joan K. Cohen Joan K. Cohen Vice President, Controller and Treasurer\nDate: March 11, 1994 \/c\/ Lee A. Ellis Lee A. Ellis Director\nDate: March 11, 1994 \/c\/ John R. Haire John R. Haire Director\nDate: March 11, 1994 \/c\/ Stanley P. Hutchison Stanley P. Hutchison Director\nDate: March 11, 1994 \/c\/ George P. Kendall, Jr. George P. Kendall, Jr. Director\nDate: March 11, 1994 \/c\/ Frank L. Klapperich, Jr. Frank L. Klapperich, Jr. Director\nDate: March 11, 1994 \/c\/ Lee M. Mitchell Lee M. Mitchell Director\nDate: March 11, 1994 \/c\/ Robert W. Patin Robert W. Patin Chairman of the Board, President and Chief Executive Officer and Director\nDate: March 11, 1994 \/c\/ Rex Reade Rex Reade Director\nDate: March 11, 1994 \/c\/ Thomas C. Scott Thomas C. Scott Executive Vice President and Chief Financial Officer\nDate: March 11, 1994 \/c\/ Patricia Y. Tsien Patricia Y. Tsien Director\nINDEX TO FINANCIAL SCHEDULES\nWASHINGTON NATIONAL CORPORATION AND SUBSIDIARIES\nSchedules filed pursuant to Rule 7-05 of Regulation S-X:\nI. Summary of Investments - Other than Investments in Related Parties\nII. Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other Than Related Parties\nIII. Condensed Financial Information of Registrant\nV. Supplementary Insurance Information\nVI. Reinsurance\nVII. Guarantees of Securities of Other Issuers\nIX. Short-Term Borrowings\nEXHIBIT INDEX\nWASHINGTON NATIONAL CORPORATION AND SUBSIDIARIES\nEXHIBITS FILED PURSUANT TO ITEM 14(a)(3)\nPage Number\n3.1 Certificate of Incorporation, as amended, on Form 10-K, for the year ended December 31, 1987 *\n3.2 By-laws, as amended, on Form 10-K, for the year ended December 31, 1986 *\n4 Rights agreement between WNC and The First National Bank of Chicago, on Form 8-K dated December 23, 1986 *\n10.1 Employment agreements with R. W. Patin, T. Pontarelli, T. C. Scott, and C. L. Fuhrmann, on Form 10-K, for the year ended December 31, 1991 ** *\n10.2 Employment agreements with K. A. Grubb and J. N. Plato, on Form 10-K, for the year ended December 31, 1992 ** *\n10.3 Employment agreement with W. G. Brown on Form 10-Q, for the period ended September 30, 1993 ** *\n10.4 Form of Indemnification Agreement between Registrant and each Director and Executive Officer of Registrant on Form 10-Q, for the period ended June 30, 1993 ** *\n11 Computation of Earnings per Share see below\n13 WNC's Annual Report to Stockholders for the year ended December 31, 1993, which is furnished for the information of the Commission and, except for those portions which are expressly incorporated by reference in this filing is not to be deemed \"filed\" as part of this filing *\n21 Subsidiaries of WNC see below\n23 Consent of Ernst & Young, Independent Auditors see below\n* Incorporated by reference. ** Management contract and compensatory plans or arrangements.","section_15":""}
{"filename":"101880_1993.txt","cik":"101880","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"837579_1993.txt","cik":"837579","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUTILITY SERVICES\nMichCon operates natural gas distribution, transmission and storage facilities in the state of Michigan. At December 31, 1993, MichCon's distribution system included 14,680 miles of distribution mains, 1,021,739 service lines and 1,145,687 active meters. MichCon owns 2,502 miles of transmission and production lines which deliver natural gas to the distribution districts and interconnect its storage fields with the sources of supply and the market areas. MichCon also owns properties relating to five underground storage fields with an aggregate storage capacity of approximately 130 Bcf. Additionally, MichCon owns district office buildings, service buildings and gas receiving and metering stations. MichCon occupies its principal office buildings, located in Detroit and Grand Rapids, Michigan under long-term leases. Portions of these buildings are subleased.\nMost of MichCon's properties are held in fee, by easement, or under lease agreements. The principal plants and properties of MichCon are held subject to the lien of MichCon's Indenture of Mortgage and Deed of Trust under which MichCon's First Mortgage Bonds are issued. Some existing properties are being fully utilized and new properties are being added to meet the requirements of expansion into new areas.\nCitizens owns all of the properties used in the conduct of its utility business. Included in these properties is a gas distribution system, a two-story office building in downtown Adrian and a one-story service center.\nNONUTILITY SERVICES\nThe Saginaw Bay partnerships own substantially all of the properties used in the conduct of their business, primarily a 126-mile transmission line and related lateral lines.\nThe Supply Development Group has interest in properties used for gas production, including compressor facilities and gathering lines.\nGenix owns certain properties including land, buildings and computer equipment located in Pittsburgh, Pennsylvania and the metropolitan Detroit area.\nMCN's facilities are suitable and adequate for their intended use.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn addition to utility services' regulatory proceedings and other matters described in Item 1, \"Business\", MCN is also involved in a number of law suits and administrative proceedings in the ordinary course of business with respect to taxes, environmental matters, personal injury, property damage claims and other matters.\nThe management of MCN believes that the resolution of these matters will not have a material adverse effect on the financial condition of MCN.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to all executive officers of MCN, as of February 28, 1994, is set forth below. Such officers are appointed by the Board of Directors for terms expiring at the next annual meeting of shareholders scheduled to be held on April 28, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMCN Common Stock is traded on the New York Stock Exchange. On March 1, 1994 there were 26,248 holders of record of MCN Common Stock. Information regarding the market price of MCN Common Stock and related security holder matters is incorporated by reference herein from the section entitled \"Supplementary Financial Information\" in MCN's 1993 Annual Report to Shareholders, pages 52 and 53.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation required pursuant to this item is incorporated by reference herein from the section entitled \"Supplementary Financial Information\" in MCN's 1993 Annual Report to Shareholders, pages 52 and 53.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation required pursuant to this item is incorporated by reference herein from the section entitled \"Management's Discussion and Analysis\" in MCN's 1993 Annual Report to Shareholders, pages 30 through 35.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation required pursuant to this item is incorporated by reference herein from the following sections of MCN's 1993 Annual Report to Shareholders. The consolidated statement of income, cash flows and capitalization are for each of the years ended December 31, 1993, 1992 and 1991 and the consolidated statement of financial position is as of December 31, 1993 and 1992.\nConsolidated Statement of Income, page 36;\nConsolidated Statement of Financial Position, page 37;\nConsolidated Statement of Capitalization, page 38;\nConsolidated Statement of Cash Flows, page 39;\nSummary of Accounting Policies, page 40;\nNotes to Consolidated Financial Statements, pages 41 through 49;\nIndependent Auditors' Report, page 50; and\nSupplementary Financial Information, pages 52 and 53.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information set forth in the section entitled \"Election of Directors\" in MCN's March 1994 definitive Proxy Statement is incorporated by reference herein.\nInformation concerning the executive officers of MCN is set forth in the section entitled \"Executive Officers of the Registrant\" on page 12 in Part I of this Report.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED\nThe information set forth in the section entitled \"Filings Under Section 16(a)\" in MCN's March 1994 definitive Proxy Statement is incorporated by reference herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the sections entitled \"Directors' Compensation,\" \"Executive Compensation,\" \"Change of Control Employment Agreements,\" \"Retirement Plans\" and \"Compensation Committee Interlocks and Insider Participation\" in MCN's March 1994 definitive Proxy Statement is incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth in the section entitled \"Election of Directors\" in MCN's March 1994 definitive Proxy Statement is incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth in the section entitled \"Executive Compensation\" in MCN's March 1994 definitive Proxy Statement is incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) LIST OF DOCUMENTS FILED AS PART OF THE REPORT:\n1. For a list of financial statements incorporated by reference, see the section entitled \"Financial Statements and Supplementary Data\", on page 13 in Part II, Item 8 of this Report.\n2. Financial Statement Schedules for each of the three years in the period ended December 31, 1993, unless otherwise noted, are included herein in response to Part II, Item 8:\nIndependent Auditors' Report\nSchedules other than those referred to above are omitted as not applicable or not required, or the required information is shown in the financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nMCN Corporation:\nWe have audited the consolidated financial statements of MCN Corporation and subsidiaries as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated February 8, 1994; such consolidated financial statements and report are included in your 1993 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of MCN Corporation and subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDeloitte & Touche Detroit, Michigan February 8, 1994\nSCHEDULE II\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (THOUSANDS OF DOLLARS)\n- ------------------------\nNOTES:\n(1) Represents unsecured promissory note payable, due August 2004, plus accrued interest thereon. Interest on the promissory note accrues at 9% per annum. The interest is payable upon maturity of the promissory note, but has been paid annually in recent years.\n(2) Represents notes payable, due various dates through May 2008, plus accrued interest thereon. Interest on the notes accrues at 16% per annum, compounded at the end of each calendar year. The interest is payable upon maturity of the notes.\n(3) Represents note payable, due June 1996, plus accrued interest thereon. Interest on the note accrues at 8 3\/4% per annum. The interest is payable upon maturity of the note.\n(4) Represents note payable, due June 1992, to temporarily support the construction of gas storage facilities. The note accrued interest at a variable interest rate based on the prime rate, payable quarterly and upon maturity.\nSCHEDULE V\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT (THOUSANDS OF DOLLARS)\nSCHEDULE V\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT -- (CONCLUDED) (THOUSANDS OF DOLLARS)\n- ------------------------\nNOTES:\nSCHEDULE VI\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (THOUSANDS OF DOLLARS)\nSCHEDULE VI\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT -- (CONCLUDED) (THOUSANDS OF DOLLARS)\n- ------------------------\nNOTES:\nSCHEDULE VII\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE VII -- GUARANTEES OF SECURITIES OF OTHER ISSUERS DECEMBER 31, 1993 (THOUSANDS OF DOLLARS)\n- ---------------------\nNOTES:\n(1) Reference is made to Note 5a to the Consolidated Financial Statements in the 1993 Annual Report to Shareholders of MCN Corporation, page 43.\nSCHEDULE VIII\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS)\nSCHEDULE VIII\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS -- (CONCLUDED)\n- ------------------------\nNOTES:\n(1) Reference is made to Note 5b to the Consolidated Financial Statements in the 1993 Annual Report to Shareholders of MCN Corporation, page 44. During the year ended December 31, 1993, $6,575,000 was transferred from Deferred Credits and Other Liabilities -- Other to Current Liabilities -- Other. Similarly, $2,000,000 was transferred during the year ended December 31, 1992. Actual expenditures deducted against the reserve in 1993 and 1992 were $2,073,000 and $781,000, respectively.\n(2) During 1991, MCN established a reserve relating to the restructuring of the gas technology business where MCN entered into a partnership with a third party to more effectively market its natural gas torch products.\nSCHEDULE IX\nMCN CORPORATION AND SUBSIDIARIES SCHEDULE IX -- SHORT-TERM BORROWINGS (THOUSANDS OF DOLLARS)\n- ------------------------\nNOTES:\n(1) Reference is made to Note 4 to the Consolidated Financial Statements in the 1993 Annual Report to Shareholders of MCN Corporation, page 43. Fees are paid to compensate banks for lines of credit.\n(2) Represents amounts payable, net of any discount.\n(3) Weighted average effective interest rates were calculated on the net proceeds basis and do not include the effect of line of credit fees.\nSCHEDULE X\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION (THOUSANDS OF DOLLARS)\n3. Exhibits, Including Those Incorporated By Reference\n(B) REPORTS ON FORM 8-K:\nNone. - ------------------------- * Indicates document filed herewith.\nReferences are to MCN (File No. 1-10070) for documents incorporated by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMCN CORPORATION (Registrant)\nBy: \/s\/ Patrick Zurlinden Patrick Zurlinden Controller and Chief Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.","section_15":""}
{"filename":"351616_1993.txt","cik":"351616","year":"1993","section_1":"Item 1. Business\nONE VALLEY BANCORP OF WEST VIRGINIA, INC.\nThe Board of Directors of One Valley Bank, National Association, formerly Kanawha Valley Bank, National Association (\"One Valley Bank\"), caused One Valley Bancorp of West Virginia, Inc. (\"One Valley\"), a West Virginia corporation, to be formed, through a corporate reorganization, as a single bank holding company holding all of the common stock of One Valley Bank. On September 4, 1981, the effective date of the reorganization, the shareholders of One Valley Bank exchanged their shares of Kanawha Valley Bank common stock for shares of One Valley common stock, $10 par value (\"One Valley Common Stock\"), and became shareholders of One Valley, and One Valley Bank became a wholly-owned subsidiary of One Valley.\nAs of December 31, 1993, One Valley owned eight operating banking subsidiaries (the \"Existing Banking Subsidiaries\") including: One Valley Bank, National Association; One Valley Bank of Huntington, Inc.; One Valley Bank of Mercer County, Inc.; One Valley Bank of Martinsburg, National Association; One Valley Bank of Oak Hill, Inc.; One Valley Bank of Ronceverte, National Association; One Valley Bank of Morgantown, Inc.; and One Valley Bank of Summersville, Inc. In addition, One Valley owns 100% of the outstanding stock of One Valley Services, Inc., which, until December, 1993, provided data processing services to the Banking Subsidiaries and other non affiliated banks, and 100% of the outstanding stock of One Valley Square, Inc., a Texas corporation, which owns the office building in which One Valley Bank and One Valley are located. (All of these subsidiaries, including the Existing Banking Subsidiaries, are collectively referred to as the \"Subsidiaries\".) One Valley's principal activities consist of owning and supervising its Subsidiaries. At December 31, 1993, One Valley had consolidated assets of $2,774,359,000, deposits of $2,328,644,000, and shareholders' equity of $242,590,000.\nOne Valley has, from time to time, engaged in merger or acquisition discussions with other banks and financial institutions both within and outside of West Virginia, and it is anticipated that such discussions will continue in the future.\nRECENT DEVELOPMENTS\nOn January 28, 1994, One Valley consummated its merger with Mountaineer Bankshares of W.Va., Inc., and as a result acquired ownership of 100% of the outstanding stock of the following seven banking subsidiaries: Old National Bank,\nMartinsburg; The Empire National Bank of Clarksburg; City National Bank of Fairmont; The Bank of Wadestown, Fairview; Mercantile Banking & Trust Company, Moundsville; The Bank of Cameron, Inc.; and The Sunshine Bank of Wheeling (the \"New Banking Subsidiaries\") (the Existing Banking Subsidiaries and the New Banking Subsidiaries are collectively referred to as the \"Banking Subsidiaries\"). The resulting company has total assets of more than $3,500,000,000 and total deposits of $2,900,000,000 making it the largest bank holding company in the State of West Virginia. Except as specifically noted, the information set forth in this Annual Report on Form 10-K includes all of the Banking Subsidiaries.\nIn September 1993, M & I Data Services, Inc., of Milwaukee, Wisconsin, began providing data processing services for the Existing Banking Subsidiaries. It is anticipated that the New Banking Subsidiaries will use data processing services from M & I Data Services, Inc., beginning in 1995.\nThe information set forth in the section captioned \"Acquisition Activity\" on page 7 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nHISTORY OF THE BANKING SUBSIDIARIES\nOne Valley Bank, the principal Banking Subsidiary of One Valley, was incorporated in 1867 as a state bank under the laws of West Virginia, with the name \"The Kanawha Valley Bank\". On February 10, 1975, Kanawha Valley Bank converted from a state bank to a national banking association, and on September 1, 1987, adopted its present corporate name. The other Banking Subsidiaries were incorporated or chartered as state or national banks in the years indicated in the chart below. In September 1987, all Existing Banking Subsidiaries adopted a common corporate identity utilizing \"One Valley Bank.\" Those name changes were undertaken primarily to promote a single corporate image for One Valley's diverse banking operations.\nYear in Currently Name Which Organized Chartered As\nOne Valley Bank of 1892 National Martinsburg\nOne Valley Bank of 1911 State Morgantown\nYear in Currently Name Which Organized Chartered As\nOne Valley Bank of 1906 State Mercer County\nOne Valley Bank of 1904 State Oak Hill\nOne Valley Bank of 1956 State Huntington\nOne Valley Bank of 1900 National Ronceverte\nOne Valley Bank of 1910 State Summersville\nOne Valley Bank-East, 1865 National (formerly Old National Bank)\nThe Empire National Bank of 1903 National Clarksburg\nOne Valley Bank of Marion 1939 National County, National Association (formerly City National Bank of Fairmont)\nThe Bank of Wadestown 1905 State\nMercantile Banking & Trust 1903 State Company\nThe Bank of Cameron, Inc. 1903 State\nThe Sunshine Bank of Wheeling 1965 State\nOPERATIONS OF THE BANKING SUBSIDIARIES\nFollowing consummation of the Mountaineer merger, and in conjunction with an orderly transition in each market, One Valley will undertake certain inter- company transactions among the Banking Subsidiaries to simplify its organizational structure. During the first half of 1994, the two banks in Martinsburg will be merged, and One Valley will operate one subsidiary bank (with branch offices) in each of the Fairmont, Martinsburg, Clarksburg and Moundsville areas. Applications seeking approval of these transactions have been filed with the appropriate regulatory agencies. All offices formerly operated by Mountaineer will be operated under the title \"One Valley Bank.\"\nThe Banking Subsidiaries offer all services traditionally offered by full-service commercial banks, including commercial and individual demand and time deposit accounts, commercial and individual loans, credit card (MasterCard and Visa) and drive-in banking services. In addition, One Valley Bank is active in correspondent banking services. Trust services are offered on a statewide basis. No material portion of any of the Banking Subsidiaries' deposits has been obtained from a single or small group of customers, and the loss of any one customer's deposits or a small group of customers' deposits would not have a material adverse effect on the business of any of the Banking Subsidiaries.\nAlthough the market areas of several of the Banking Subsidiaries encompass a portion of the coal fields located in southern West Virginia, an area of the State which has been economically depressed, the coal-related loans in the loan portfolios of the Existing Banking Subsidiaries constitute less than 5% of One Valley's total loans outstanding. Ten of the 22 counties within One Valley's market areas rank among the State's top ten counties in household income, and the Banking Subsidiaries generally serve the stronger economic areas of the State.\nThe Banking Subsidiaries also offer services to customers at various locations within their service areas by use of automated teller machines (\"ATMs\"). The ATMs allow customers to make deposits and withdrawals at convenient locations. Customers may also borrow against their revolving lines of credit at those locations. Customers of any Banking Subsidiary may conduct transactions at any One Valley ATM and, by means of the OWL\/MAC system, a regional ATM system, through the CIRRUS ATM network, can conduct ATM transactions nationwide. Customers of any of the Banking Subsidiaries may also make deposits or withdrawals at any of One Valley's 80 statewide main office and branch locations.\nAs of March 1, 1994, One Valley and its Subsidiaries had approximately 2013 full time equivalent employees.\nLEGISLATION\nThe 1980s was a period of significant legislative change in West Virginia for banks and bank holding companies. During the 1980s, West Virginia converted from a unit banking state to permit unlimited branch banking and the interstate acquisition of banks and bank holding companies on a reciprocal basis. State-wide unlimited branch banking commenced on and after January 1, 1987. Interstate banking activities became permissible on January 1, 1988. The entry by out-of-state bank holding companies is permitted only by the acquisition of an existing institution which has operated for two years prior to acquisition, but not by the chartering and acquisition of de novo banks in West Virginia by out- of-state bank holding companies or the establishment of branch banks across state lines (either de novo or by acquisition or merger).\nWest Virginia also allows reciprocal interstate acquisitions by thrift institutions such as savings and loan holding companies, savings and loan associations, savings banks, and building and loan associations.\nUnder the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\"), enacted in 1989, One Valley is subject to provisions which among other things create a so-called \"cross guarantee\" liability on the part of insured depository institutions which are \"commonly controlled.\" This liability permits the Federal Deposit Insurance Corporation (\"FDIC\"), as receiver of a failed insured depository institution, to assert claims against other commonly controlled insured depository institutions for losses suffered or reasonably anticipated to be suffered by the FDIC with respect to such failed depository institution.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nIn December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), which substantially revises the bank regulatory and funding provisions of the Federal Deposit Insurance Act and makes revisions to several other federal banking statutes.\nAmong other things, FDICIA requires federal bank regulatory authorities to take \"prompt corrective action\" with respect to depository institutions that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.\nThe Office of the Comptroller of the Currency (\"OCC\") and the Office of Thrift Supervision (\"OTS\") have adopted regulations to implement the prompt corrective\naction provisions of FDICIA. Among other things, the regulations define the relevant capital measures for the five capital categories. An institution is deemed to be \"well capitalized\" if it has a total risk-based capital ratio of 10% or greater, Tier 1 risk-based capital ratio of 6% or greater and a Tier 1 leverage ratio of 5% or greater and is not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. An institution is deemed to be \"adequately capitalized\" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and, generally, a Tier 1 leverage ratio of 4% or greater and the institution does not meet the definition of a \"well capitalized\" institution. An institution that does not meet one or more of the \"adequately capitalized\" tests is deemed to be \"undercapitalized\". If the institution has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a leverage ratio that is less than 3%, it is deemed to be \"significantly undercapitalized\". Finally, an institution is deemed to be \"critically undercapitalized\" if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%.\n\"Undercapitalized\" institutions are subject to growth limitations and are required to submit a capital restoration plan. If an \"undercapitalized\" institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. \"Significantly undercapitalized\" institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. \"Critically undercapitalized\" institutions may not, beginning 60 days after becoming \"critically undercapitalized\" make any payment of principal or interest on their subordinated debt. In addition, \"critically undercapitalized\" institutions are subject to appointment of a receiver or conservator.\nUnder FDICIA, a depository institution that is not \"well capitalized\" is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market.\nEach of One Valley's Banking Subsidiaries currently meet the FDIC's definition of a \"well capitalized\" institution for purposes of accepting brokered deposits. For the purposes of the brokered deposit rules, a bank is defined to be \"well capitalized\" if it maintains a ratio of Tier 1 capital to risk-adjusted assets of at least 6%, a ratio of total capital to risk-adjusted assets of at least 10% and a Tier 1 leverage ratio of at least 5% and is not otherwise in a \"troubled condition\" as specified by its appropriate federal regulatory agency.\nFDICIA directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to\ninternal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly- traded shares and such other standards as the agency deems appropriate. In December, 1993, the FDIC adopted final rules to implement these provisions of FDICIA. The rules set forth general standards to be observed, but in most instances do not specify operating or managerial procedures to be followed. The Board of Governors of the Federal Reserve System (\"Board of Govenors\") and the OCC are in the process of issuing rules implementing various aspects of FDICIA. At this time, One Valley believes that the rules will not have a material adverse effect on its operations.\nFDICIA also contains a variety of other provisions that may affect the operations of One Valley's Banking Subsidiaries, including new reporting requirements, revised regulatory standards for real estate lending, \"truth in savings\" provisions and the requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch.\nIn addition to FDICIA, there have been a number of legislative and regulatory proposals designed to strengthen the federal deposit insurance system and to improve the overall financial stability of the United States banking system. These include proposals to increase capital requirements above presently published guidelines, to place assessments on depository institutions to increase funds available to the FDIC and to allow national banks to branch on an interstate basis. It is impossible to predict whether or in what form these proposals may be adopted in the future and, if adopted, what their effect would be on One Valley. It is likewise impossible to predict what the competitive effect will be as a result of action by the OTS allowing certain thrift institutions to engage in interstate branching on a nationwide basis.\nCOMPETITION\nVigorous competition exists in all areas where One Valley and the Banking Subsidiaries are engaged in business. The primary market areas served by the Banking Subsidiaries are generally defined as West Virginia and certain adjoining areas in Kentucky, Maryland, Ohio, Pennsylvania and Virginia.\nFor most of the services which the Banking Subsidiaries perform, they compete with commercial banks as well as other financial institutions. For instance, savings banks, savings and loan associations, credit unions, stock brokers, and issuers of commercial paper and money market funds actively compete for funds and for various types of loans. In addition, insurance companies, investment counseling\nfirms and other business firms and individuals offer personal and corporate trust and investment counseling services. The opening of branch banks within One Valley's market areas has increased competition for the Banking Subsidiaries. Although the bank legislation has provided an opportunity for One Valley to acquire banking subsidiaries in other attractive banking areas of the State, it will likely result in increased competition for One Valley in its market areas, and, with reciprocal interstate banking, One Valley faces additional competition in efforts to acquire other subsidiaries throughout West Virginia and in neighboring states.\nUntil 1993, the various banks and bank-holding companies operating in West Virginia were predominantly owned by shareholders in West Virginia and were financed by operations arising principally in West Virginia. During 1993, Banc One Corp., the seventh largest bank holding company in the United States, consummated its acquisition of Key Centurion Bancshares Inc., and Huntington Bankshares Incorporated consummated its acquisitions of Commerce Banc Corporation and CB&T Financial Corp. It is anticipated that other large out-of-state banks will, over time, expand their operations into West Virginia. While One Valley believes that it can compete effectively with out-of-state banks, One Valley will face larger competitors which have access to increased capital resources and which have relatively sophisticated bank holding companies and marketing structures in place.\nAs of December 31, 1993, there were 18 multi-bank holding companies and 32 one-bank holding companies in the State of West Virginia registered with the Federal Reserve System and the West Virginia Board of Banking and Financial Institutions (\"Board of Banking\"). These holding companies are headquartered in various West Virginia cities and control banks throughout the State of West Virginia, including banks which compete with the Banking Subsidiaries in their market areas. One Valley has actively competed with some of these bank holding companies to acquire its Banking Subsidiaries.\nSUPERVISION AND REGULATION\nOne Valley is a bank holding company within the provisions of the Bank Holding Company Act of 1956, is registered as such, and is subject to supervision by the Board of Governors. The Bank Holding Company Act requires One Valley to secure the prior approval of the Board of Governors before One Valley acquires ownership or control of more than five percent (5%) of the voting shares or substantially all of the assets of any institution, including another bank.\nAs a bank holding company, One Valley is required to file with the Board of Governors an annual report and such additional information as the Board of\nGovernors may require pursuant to the Bank Holding Company Act. The Board of Governors may also make examinations of One Valley and of the Banking Subsidiaries. Furthermore, under Section 106 of the 1970 Amendments to the Bank Holding Company Act and the regulations of the Board of Governors, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or any provision of credit, sale or lease of property or furnishing of services. In addition, the Banking Subsidiaries are subject to certain restrictions under federal law that limit the transfer of funds by the Banking Subsidiaries to One Valley and its nonbanking subsidiaries, whether in the form of loans, other extensions of credit, investments or asset purchases. Such transfers by any Banking Subsidiaries to One Valley or any nonbanking subsidiary are limited in amount to 10% of such Banking Subsidiary's capital and surplus and, with respect to One Valley and all nonbanking subsidiaries, to an aggregate of 20% of such Banking Subsidiary's capital and surplus. Furthermore, such loans and extensions of credit are required to be secured in specified amounts and must be fully collateralized.\nOne Valley is required to register annually with the Commissioner of Banking of West Virginia (\"Commissioner\") and to pay a registration fee to the Commissioner based on the total amount of bank deposits in banks with respect to which One Valley is a bank holding company. Although legislation allows the Commissioner to prescribe the registration fee, it limits the fee to ten dollars per million dollars of deposits rounded off to the nearest million dollars. One Valley is also subject to regulation and supervision by the Commissioner.\nOne Valley is required to secure the approval of the West Virginia Board of Banking before acquiring ownership or control of more than five percent of the voting shares or substantially all of the assets of any institution, including another bank. West Virginia banking law prohibits any West Virginia or non- West Virginia bank or bank holding company from acquiring shares of a bank if the acquisition would cause the combined deposits of all banks in the State of West Virginia, with respect to which it is a bank holding company, to exceed 20% of the total deposits of all depository institutions in the State of West Virginia. The total deposits of the Banking Subsidiaries upon consummation of the Mountaineer merger, were approximately 15.5% of the total deposits in the State of West Virginia.\nBANKING SUBSIDIARIES\nThe Banking Subsidiaries are subject to FDIC deposit insurance assessments. The FDIC set an assessment rate for the Bank Insurance Fund (\"BIF\") of 0.23% which became effective on July 1, 1991. Because of decreases in the reserves of the BIF due to the increased number of bank failures in recent years, it is possible that\nBIF insurance assessments will be increased, and it is also possible that there may be a special additional assessment. A large special assessment could have an adverse impact on One Valley's results of operations. The information set forth in paragraph number seven in the subsection captioned \"Income Statement Analysis - Non-Interest Income and Expense\" on page 21 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nThe operations of the Banking Subsidiaries are subject to federal and state statutes, which apply to national and state banks. The operations of the Banking Subsidiaries may also be subject to regulations of the OCC, the Board of Governors, the Board of Banking and the FDIC.\nThe primary supervisory authority of One Valley's national Banking Subsidiaries is the OCC while the primary supervisory authority of its state chartered Banking Subsidiaries is the Commissioner. These two authorities regularly examine such areas as reserves, loans, investments, management practices and other aspects of the operations of the Banking Subsidiaries.\nOne Valley's nationally chartered Banking Subsidiaries are chartered under the laws of the United States and, as such, are member banks of the Federal Reserve System. Its state chartered Banking Subsidiaries are non-member banks of the Federal Reserve except for One Valley Bank of Summersville, which is a member bank.\nThe regulation and examination of One Valley and its Banking Subsidiaries are designed primarily for the protection of depositors and not One Valley or its shareholders.\nCAPITAL REQUIREMENTS\nThe Board of Governors has issued risk-based capital guidelines for bank holding companies, including One Valley. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. Under the guidelines and related policies, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and leverage ratio test on a consolidated basis. The risk- based ratio is determined by allocating assets and specified off- balance sheet commitments into four weighted categories, with higher levels of capital being required for categories perceived as representing greater risk. The leverage ratio is determined by relating core capital (as described below) to total assets adjusted as specified in the guidelines.\nAll of One Valley's Banking Subsidiaries are subject to substantially similar capital requirements adopted by applicable regulatory agencies.\nGenerally, under the applicable guidelines, the financial institution's capital is divided into two tiers. \"Tier 1\", or core capital, includes common equity, noncumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts or consolidated subsidiaries, less goodwill. Bank holding companies, however, may include cumulative perpetual preferred stock in their Tier 1 capital, up to a limit of 25% of such Tier 1 capital. \"Tier 2\", or supplementary capital, includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan losses, subject to certain limitations, less required deductions. \"Total capital\" is the sum of Tier 1 and Tier 2 capital.\nFinancial institutions are required to maintain a risk-based ratio of 8%, of which 4% must be Tier 1 capital. The appropriate regulatory authority may set higher capital requirements when an institution's particular circumstances warrant.\nFinancial institutions that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating, are required to maintain a minimum leverage ratio of 3%. Financial institutions not meeting these criteria are required to maintain a leverage ratio which exceeds 3% by a cushion of at least to 200 basis points.\nThe guidelines also provide that financial institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the Board of Governors' guidelines indicate that the Board of Governors will continue to consider a \"tangible Tier 1 leverage ratio\" in evaluating proposals for expansion or new activities. The tangible Tier 1 leverage ratio is the ratio of an institution's Tier 1 capital, less all intangibles, to total assets, less all intangibles.\nFailure to meet applicable capital guidelines could subject the financial institution to a variety of enforcement remedies available to the federal regulatory authorities, including limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital and the termination of deposit insurance by the FDIC, as well as to the measures described under FDICIA as applicable to undercapitalized institutions.\nAs of December 31, 1993, the Tier 1 risk-based ratio, total risk-based ratio and total assets leverage ratio for One Valley were as follows:\nRegulatory Requirement One Valley Tier 1 Risk-Based Ratio 4.00% 12.69% Total Risk-Based Ratio 8.00% 13.94% Total Assets Leverage Ratio 3.00% 8.57%\nAs of December 31, 1993 all of One Valley's Banking Subsidiaries had capital in excess of all applicable requirements.\nThe Board of Governors, as well as the FDIC, the OCC and the OTS, have adopted changes to their risk-based and leverage ratio requirements that require that all intangible assets, with certain exceptions, be deducted from Tier 1 capital. Under the Board of Governors' rules, the only types of intangible assets that may be included in (i.e., not deducted from) a bank holding company's capital are readily marketable purchased mortgage servicing rights (\"PMSRs\") and purchased credit card relationships (\"PCCRs\"), provided that, in the aggregate, that total amount of PMSRs and PCCRs included in capital does not exceed 50% of Tier 1 capital. PCCRs are subject to a separate sublimate of 25% of Tier 1 capital. The amount of PMSRs and PCCRs that a bank holding company may include in its capital is limited to the lesser of (i) 90% of such assets' fair market value (as determined under the guidelines), or (ii) 100% of such assets' book value, each determined quarterly. Identifiable intangible assets (i.e., intangible assets other than goodwill) other than PMSRs and PCCRs, including core deposit intangibles, acquired on or before February 19, 1992 (the date the Board of Governors issued its original proposal for public comment), generally will not be deducted from capital for supervisory purposes, although they will continue to be deducted for purposes of evaluating applications filed by bank holding companies.\nGOVERNMENTAL POLICIES\nIn addition to the effect of general economic conditions, the earnings and future business activities of the Banking Subsidiaries, both members and non- members of the Federal Reserve, are affected by the fiscal and monetary policies of the federal government and its agencies, particularly the Board of Governors. The Board of Governors regulates the national money supply in order to mitigate recessionary and inflationary pressures. The techniques used by the Board of Governors include setting the reserve requirements of member banks, establishing the discount rate on member bank borrowings and conducting open market operations in United States government securities to exercise control over the supply of money and credit.\nAlthough it is difficult to assess the impact on One Valley of the change from the Bush administration to the Clinton administration, during 1993 there was an increase in corporate taxes, and in the future there may be increased costs for medical and other employee benefits, and a possible change in the regulatory climate for financial institutions.\nThe policies of the Board of Governors have a direct and indirect effect on the amount of bank loans and deposits, and the interest rates charged and paid thereon. While the impact of current economic problems and the policies of the Board of Governors and other regulatory authorities designed to deal with these economic problems upon the future business and earnings of the Banking Subsidiaries cannot be accurately predicted, those policies can materially affect the revenues and income of the Banking Subsidiaries. The information set forth in paragraph number seven in the subsection captioned \"Income Statement Analysis - Non-Interest Income and Expense\" on page 21 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nSTATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES\nStatistical disclosures required by bank holding companies are included in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" set forth on pages 5 through 22 of One Valley's 1993 Annual Report to Shareholders for the fiscal year ended December 31, 1993. That information is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nONE VALLEY AND ONE VALLEY BANK\nOne Valley Bank owns the site of One Valley Bank's current banking quarters, One Valley Square in the City of Charleston, West Virginia. This property is leased by One Valley Bank to One Valley Square, Inc. One Valley Square, Inc., constructed a fifteen story (plus basement) office building on the site, and One Valley Bank leases a portion of the basement and seven floors of One Valley Square for its operations, consisting of approximately 130,000 square feet. In addition, One Valley Bank subleases a portion of the seventh floor to others. One Valley also conducts its operations from the space leased by One Valley Bank in One Valley Square. The remaining space is leased to various other tenants. Upon expiration of the land lease, all improvements will revert to the owner of the land. One Valley Bank also conducts operations at its operations center, also located in Charleston, and at 23 branch locations throughout Kanawha, Putnam, Jackson, and Wood Counties.\nOTHER AFFILIATE BANKS\nThe properties owned or leased by the other Banking Subsidiaries consist generally of fourteen main bank offices, related drive-in facilities, 42 branch offices and such other properties as are necessary to house related support activities of those banks. All of the properties of the Banking Subsidiaries are suitable and adequate for their current operations and are generally being fully utilized.\nItem 3.","section_3":"Item 3. Legal Proceedings\nVarious legal proceedings are presently pending to which the Banking Subsidiaries are parties; however, these proceedings are ordinary routine litigation incidental to the business of the Banking Subsidiaries. There are no material legal proceedings pending or threatened against One Valley or its Subsidiaries.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nAt a Special Meeting held on December 8, 1993, the shareholders of One Valley approved an Agreement and Plan of Merger whereby Mountaineer Bankshares of W.Va., Inc., was merged with and into One Valley. The terms and conditions of that Agreement and merger were fully described in One Valley's Registration Statement on Form S-4, Registration No. 33-50729, Filed October 22, 1993. At the Special Meeting that Agreement was approved as follows:\nFOR AGAINST ABSTAIN 10,332,995 (80.1%) 48,732 (.33%) 133,418 (1.03%)\nItem 4A. Executive Officers of the Registrant\nThe executive officers of One Valley are:\nName Age Banking Experience and Qualifications\nRobert F. Baronner 67 1991 to Present, Chairman of the Board, One Valley. 1971 to 1991, One Valley Bank. Previously, President and Chief Executive Officer, One Valley.\nJ. Holmes Morrison 53 1967 to present, One Valley Bank. Vice President and Trust Officer, 1970; Senior Vice President and Senior Trust Officer, 1978; Executive Vice President, 1982; President and Chief Operating Officer, 1985; President and Chief Executive Officer, 1988; Chairman of the Board, 1991. Vice President, One Valley, 1982; Senior Vice President, One Valley, 1984; Executive Vice President, One Valley, 1990; President and Chief Executive Officer, One Valley, 1991.\nPhyllis H. Arnold 45 1973-1979, One Valley Bank. Credit Officer, 1974-1977; Vice President, 1977- 1979. West Virginia State Banking Commissioner, 1979-1983. Executive Vice President, One Valley Bank, 1988; President and Chief Executive Officer, One Valley Bank, 1991; Executive Vice President, One Valley, 1994.\nFrederick H. Belden, Jr. 55 1968 to present, One Valley Bank. Senior Vice President and Senior Trust Officer, 1982; Executive Vice President, 1986. Executive Vice President, One Valley, 1994.\nJames L. Whytsell 54 1959 to present, One Valley Bank. Senior Vice President, 1977; Executive Vice President, 1986. Senior Vice President, One Valley, 1986. Data Processing.\nLaurance G. Jones 47 1969 to present, One Valley Bank. Controller, 1971; Vice President, Controller and Treasurer, 1979; Senior Vice President, 1980; Executive Vice President, 1992. Treasurer, One Valley, 1981; Treasurer and Chief Financial Officer, One Valley, 1984; Executive Vice President, One Valley, 1994. Finance and Accounting.\nBrent D. Robinson 46 1978 to 1994, Mountaineer Bankshares, Inc. and its predecessors. Executive Vice President, One Valley, 1994.\nJames A. Winter 41 1975 to present, One Valley Bank. Vice President, Controller and Assistant Treasurer, 1982. Senior Vice President, 1991; Vice President and Chief Accounting Officer, One Valley, 1989.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nDuring 1993, One Valley Common Stock was traded over the counter by Merrill Lynch, Pierce, Fenner & Smith, Inc.; Keefe, Bruyette & Woods, Inc.; Robinson-Humphrey Co. Inc.; Legg, Mason, Wood, Walker, Inc.; Wheat First Securities, Inc.; Rothschild, Inc.; Herzog, Heine, Geduld, Inc.; Mayer & Schweitzer, Inc.; McDonald & Company Sec., Inc.; and Sandler O'Neill & Partners. At March 8, 1994, the total number of holders of One Valley Common Stock was approximately 8,700, including shareholders of record and shares held in nominee name. The information set forth in paragraphs number two and three in the subsection captioned \"Balance Sheet Analysis-Capital Resources\" on page 17 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nNotes N and Q of Notes to the Consolidated Financial Statements appearing at pages 38 and 39 of One Valley's 1993 Annual Report to Shareholders are incorporated herein by reference. Table 1 \"Six-Year Selected Financial Summary\" on page five of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nTable 1 \"Six-Year Selected Financial Summary\" on page five of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information contained on pages 5 through 22 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information contained on pages 24 through 39 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference. See Item 14 for additional information regarding the financial statements.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information set forth in the sections captioned \"Election of Directors\", \"Management Nominees to the Board of One Valley\", \"Directors Continuing to Serve Unexpired Terms,\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on pages 2 through 6 and page 19 of One Valley's definitive Proxy Statement dated March 23, 1994, is incorporated herein by reference. Reference is also made to the information concerning One Valley's executive officers provided in Part I, Item 4A, of this report.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth in the sections captioned \"Executive Compensation\", \"Change of Control Agreements\", and \"Compensation of Directors\" on pages 12 through 15 and page 19 of One Valley's definitive Proxy Statement dated March 23, 1994, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information set forth in the sections captioned \"Principal Holders of Voting Securities\" and \"Ownership of Securities by Directors, Nominees and Officers\" on pages 8 through 11 of One Valley's definitive Proxy Statement dated March 23, 1994, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information set forth in the sections captioned \"Certain Transactions with Directors and Officers and Their Associates\" and \"Compensation Committee Interlocks and Insider Participation\" on page 19 of One Valley's definitive Proxy Statement dated March 23, 1994, and Note E of the Notes to the Consolidated Financial Statements appearing at page 31 of One Valley's 1993 Annual Report to Shareholders is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n1993 Annual Report to Shareholders Index Page(s)\n(a) 1. Financial Statements\nConsolidated Financial Statements of One Valley Bancorp of West Virginia, Inc. incorporated by reference in Part II, Item 8 of this report.\nConsolidated Balance Sheets at 24 December 31, 1993 and 1992\nConsolidated Statements of Income 25 for the years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Share- 26 holders' Equity for the years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Cash Flows 27 for the years ended December 31, 1993, 1992 and 1991\nNotes to Consolidated Financial 28-39 Statements\nReport of Independent Auditors 23\n(a) 2. Financial Statement Schedules\nAll schedules are omitted, as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or related notes thereto.\n(a) 3. Exhibits required to be Filed by Item 601 of Page(s) Regulation S-K and Item 14(c) of Form 10-K Form 10-K\nSee Index to Exhibits\n(b) Reports on Form 8-K:\nNone.\n(c) Exhibits\nSee Item 14(a)3 above.\n(d) Financial Statement Schedules\nSee Item 14(a)2 above.\nSIGNATURES\nPursuant 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.\nONE VALLEY BANCORP OF WEST VIRGINIA, INC.\nBy: \/s\/ J. Holmes Morrison J. Holmes Morrison, President and Chief Executive Officer\nMarch 16, 1994\nPursuant 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 and as of the date indicated.\nSignature Title Date\n\/s\/ Phyllis H. Arnold Director March 16, 1994 PHYLLIS H. ARNOLD\n\/s\/ Charles M. Avampato Director March 16, 1994 CHARLES M. AVAMPATO\n\/s\/ Robert F. Baronner Chairman of the Board March 15, 1994 ROBERT F. BARONNER\n\/s\/ James K. Brown Director March 16, 1994 JAMES K. BROWN\n\/s\/ John T. Chambers Director March 16, 1994 JOHN T. CHAMBERS\n\/s\/ Nelle Ratrie Chilton Director March 16, 1994 NELLE RATRIE CHILTON\n\/s\/ Ray M. Evans, Jr. Director March 16, 1994 RAY M. EVANS, JR.\n\/s\/ James Gabriel Director March 16, 1994 JAMES GABRIEL\n\/s\/ Phillip H. Goodwin Director March 16, 1994 PHILLIP H. GOODWIN\n\/s\/ Thomas E. Goodwin Director March 16, 1994 THOMAS E. GOODWIN\n\/s\/ Cecil B. Highland, Jr. Director March 16, 1994 CECIL B. HIGHLAND, JR.\n\/s\/ Laurance G. Jones Treasurer and Chief March 16, 1994 LAURANCE G. JONES Financial Officer (Principal Financial Officer)\n\/s\/ Robert E. Kamm, Jr. Director March 16, 1994 ROBERT E. KAMM, JR.\n\/s\/ David E. Lowe Director March 16, 1994 DAVID E. LOWE\n\/s\/ John D. Lynch Director March 16, 1994 JOHN D. LYNCH\n\/s\/ Edward H. Maier Director March 15, 1994 EDWARD H. MAIER\n\/s\/ J. Holmes Morrison Chief Executive Officer, March 16, 1994 J. HOLMES MORRISON Director and President\n\/s\/ Charles R. Neighborgall, III Director March 16, 1994 CHARLES R. NEIGHBORGALL, III\n\/s\/ Robert O. Orders, Sr. Director March 16, 1994 ROBERT O. ORDERS, SR.\n\/s\/ John L. D. Payne Director March 15, 1994 JOHN L. D. PAYNE\n\/s\/ Angus E. Peyton Director March 15, 1994 ANGUS E. PEYTON\n\/s\/ Lacy I. Rice, Jr. Director March 16, 1994 LACY I. RICE, JR.\n\/s\/ James W. Thompson Director March 16, 1994 JAMES W. THOMPSON\n\/s\/ J. Lee Van Metre, Jr. Director March 15, 1994 J. LEE VAN METRE, JR.\n\/s\/ Richard B. Walker Director March 16, 1994 RICHARD B. WALKER\n\/s\/ H. Bernard Wehrle, III Director March 15, 1994 H. BERNARD WEHRLE, III\nDirector March , 1994 JOHN H. WICK, III\n\/s\/ Thomas D. Wilkerson Director March 16, 1994 THOMAS D. WILKERSON\n\/s\/ James A. Winter Vice President and Chief March 16, 1994 JAMES A. WINTER Accounting Officer (Principal Accounting Officer)\nINDEX TO EXHIBITS\nExhibit No. Description:\n(3) Articles of Incorporation and Bylaws\nExhibit 3.1 Articles of Incorporation of One Valley, filed as part of One Valley's 1981 Annual Report on Form 10-K and incorporated herein by reference.\nExhibit 3.2 Articles of Amendment of One Valley dated July 17, 1981, filed as part of One Valley's 1981 Annual Report on Form 10- K and incorporated herein by reference.\nExhibit 3.3 Articles of Amendment of One Valley dated December 3, 1982, filed as part of One Valley's 1982 Annual Report on Form 10-K and incorporated herein by reference.\nExhibit 3.4 Articles of Amendment of One Valley dated May 6, 1986, filed as part of One Valley's Registration Statement on Form S-4, Registration No. 33-5737, May 15, 1986, and incorporated herein by reference.\nExhibit 3.5 Articles of Amendment of One Valley dated May 19, 1988, filed as part of One Valley's 1992 Annual Report on Form 10- K and incorporated herein by reference.\nExhibit 3.6 Articles of Amendment of One Valley dated May 26, 1993, filed as part of One Valley's Registration Statement on Form S-4, Registration No. 33-50729, October 22, 1993, and incorporated herein by reference.\nExhibit 3.7 Amendments to the Bylaws of One Valley dated June 20, 1990, and a complete copy of One Valley's Bylaws as amended, filed as part of One Valley's 1990 Annual Report on Form 10-K and incorporated herein by reference.\n(10) Material Contracts.\nExhibit 10.1 Indemnity Agreement between Resolution Trust Corporation and One Valley, filed as part of One Valley's Registration Statement on Form S-2, Registration No. 33- 43384, October 22, 1991, and incorporated herein by reference.\nExecutive Compensation Plans and Arrangements.\nExhibit 10.2 Agreement dated as of May 7, 1985, between One Valley and Thomas E. Goodwin, filed as part of One Valley's Registration Statement on Form S-4, Registration No. 2- 99417, August 5, 1985, and incorporated herein by reference.\nExhibit 10.3 Form of Change of Control Agreement between One Valley and 7 of its Executive Officers, dated as of January 1, 1987, filed as part of One Valley's 1986 Annual Report on Form 10-K and incorporated herein by reference.\nExhibit 10.4 One Valley Bancorp of West Virginia, Inc., 1983 Incentive Stock Option Plan, as amended, filed as Exhibit No. 4 to One Valley's Registration Statement on Form S-8, Registration No. 33-3570, July 2, 1990, and incorporated herein by reference.\nExhibit 10.5 One Valley Bancorp of West Virginia, Inc., 1993 Incentive Stock Option Plan, filed as part of One Valley's Definitive Proxy Statement, Registration No. 0-10042, and incorporated herein by reference.\nExhibit 10.6 One Valley Bancorp of West Virginia, Inc., Management Incentive Compensation Plan, as amended February, 1990, filed as part of One Valley's 1992 Annual Report on Form 10- K and incorporated herein by reference.\nExhibit 10.7 One Valley Bancorp of West Virginia, Inc., Supplemental Benefit Plan, as amended April, 1990, filed as part of One Valley's 1992 Annual Report on Form 10-K and incorporated herein by reference.\n(11) Computation of Earnings Per Share -- found at page 31 herein.\n(12) Statement Re Computation of Ratios -- found at page 32 herein.\n(13) 1993 Annual Report to Security Holders -- found at page 33 herein.\n(21) Consent of Ernst & Young -- found at page 82 herein.\n(23) Subsidiaries of Registrant -- found at page 81 herein.\n(99) Proxy Statement for the 1993 Annual Meeting of One Valley -- found at page 83 herein.\n**************************************************************************** APPENDIX\nOn Page 2 of Exhibit 13 a photo of J. Holmes Morrison appears in the upper right corner where indicated.\nOn Page 3 of Exhibit 13 a bar graph appears where indicated. The plot points are listed as follows:\nNet Income and Dividends Per Share 1988 1989 1990 1991 1992 1993 Net Income $1.33 $1.48 $1.75 $1.93 $2.29 $2.52 Dividends $0.50 $0.56 $0.59 $0.62 $0.70 $0.84\nOn Page 4 of Exhibit 13 two bar graphs appear where indicated. The plot points for both are listed as follows:\nReturn on Average Assets 1988 1989 1990 1991 1992 1993 0.91% 0.90% 1.00% 0.99% 1.10% 1.19%\nReturn on Average Equity 1988 1989 1990 1991 1992 1993 11.54% 12.02% 13.15% 13.14% 13.92% 13.98\nOn page 9 of Exhibit 13 the Average Earning Assets bar chart appears where indicated. It will be sent under cover of Form SE.\nOn Page 11 of Exhibit 13 the Total Loans bar chart appears where indicated. It will be sent under cover of Form SE.\nOn Page 12 of Exhibit 13 the Non-performing Assets and Loans 90 Days Past Due bar chart and the Provision for Loan Losses and Net Charge-Offs bar chart appears where indicated. It will be sent under cover of Form SE.\nOn Page 16 of Exhibit 13 the Average Deposits bar chart appears where indicated. It will be sent under cover of Form SE.\nOn Page 18 of Exhibit 13 the Net Interest Margin line graph appears where indicated. It will be sent under cover of Form SE.\nOn Page 19 of Exhibit 13 the Net Interest Income line graph appears where indicated. It will be sent under cover of Form SE.\nOn Page 21 of Exhibit 13 the Net Overhead Ratio line graph appears where indicated.It will be sent under cover of Form SE.\nOn Page 18 of Exhibit 99 the Performance Graph appears where noted. The plot points are listed in the table below that point.\nOn Page 43 of Exhibit 13 a photo appears on the left hand side of the page. The people pictured in the photo are listed in the text on that page.\nOn Page 44 of Exhibit 13 a photo appears in the center of the page. The people pictured in the photo are listed in the text on that page.\nOn the Back Cover of Exhibit 13 the One Valley Bancorp logo appears where indicated.","section_15":""}
{"filename":"83604_1993.txt","cik":"83604","year":"1993","section_1":"Item 1. BUSINESS\nReynolds Metals Company (the \"Registrant\") was incorporated in 1928 under the laws of the State of Delaware. As used herein, \"Reynolds\" and \"Company\" each means the Registrant and its consolidated subsidiaries unless otherwise indicated.\nGENERAL\nReynolds serves global markets as a supplier and recycler of aluminum and other products, with its core business being as an integrated producer of a wide variety of value-added aluminum products. Reynolds produces alumina, carbon products and primary and reclaimed aluminum, principally to supply the needs of its fabricating operations. These fabricating operations produce aluminum foil, sheet, plate, cans and extruded products (including heat exchanger tubing, driveshafts, bumpers and windows), flexible packaging and wheels, among other items. Reynolds also produces a broad range of plastic products, including film, bags, containers and lids, for consumer products, foodservice and packaging uses. The Company markets an extensive line of consumer products under the Reynolds brand name, including the well-known Reynolds Wrap aluminum foil. Reynolds' largest market for its products is the packaging and containers market, which includes consumer products. Reynolds is also a gold producer through operations in Western Australia.\nTo describe more fully the nature of its operations, Reynolds has separated its vertically integrated operations into two areas -- (1) Finished Products and Other Sales and (2) Production and Processing.\nFinished Products and Other Sales includes the manufacture and distribution of various finished aluminum products, such as cans, containers, flexible packaging products, foodservice and household foils (including Reynolds Wrap), laminated and printed foil and aluminum building products. Finished Products and Other Sales also includes the sale of plastic bags and food wraps (for example, Reynolds Plastic Wrap, Reynolds Crystal Color Plastic Wrap, Reynolds Oven Bags and Presto disposer bags), plastic lidding and container products, plastic film packaging, Reynolds Freezer Paper, Reynolds Baker's Choice baking cups, Reynolds Cut-Rite wax paper and wax paper sandwich bags, composite and nonaluminum building products, and printing cylinders and machinery.\nProduction and Processing includes the refining of bauxite into alumina, calcination of petroleum coke and production of prebaked carbon anodes, all of which are vertically integrated with aluminum production and processing plants. These plants produce and sell primary and reclaimed aluminum and a wide range of semifinished aluminum mill products, including flat rolled products, extruded and drawn products, cast products and other aluminum products. Examples of flat rolled products include aluminum can stock and machined plate. Examples of extruded and drawn products include heat exchanger tubing, driveshafts and bumpers. Examples of cast products include aluminum wheels. Production and Processing also includes the sale of gold and other nonaluminum products, technology, and various licensing, engineering and other services related to the production and processing of aluminum.\nIn the second quarter of 1993, Reynolds completed the sale of its Benton Harbor, Michigan aluminum reclamation plant to ALRECO Acquisition Corp., a subsidiary of FFS Inc.\nOn November 1, 1993, Reynolds acquired the aluminum beverage can and end manufacturing operations of Miller Brewing Company (\"Miller\"), increasing Reynolds' U.S. aluminum can capacity by almost 50 percent to 16 billion cans per year. Included in the purchase were five plants located in Wisconsin, New York, Texas, North Carolina and Georgia, having a combined annual capacity of 5 billion aluminum beverage cans and ends. Reynolds also entered into a long-term supply agreement with Miller to supply substantially all of Miller's aluminum beverage can requirements.\nIn the fourth quarter of 1993, Reynolds started production at a new facility in Arkansas which converts spent potliner from Reynolds' and other producers' North American aluminum smelting operations into an environmentally safe material with potential for recycling. Reynolds has entered into an agreement with a third party to market the treated residue from the facility for such uses as refractories and road construction. The facility, which is the only one of its kind, has the capacity to treat an estimated 115,000 metric tons of spent potliner each year.\nIn late 1993, Reynolds decided to take actions to restructure certain of its operations, principally in the fabricating area, to improve worldwide performance at a time of extremely difficult market conditions in the aluminum industry. The restructuring actions are in line with Reynolds' strategy of redirecting resources to those areas that meet its goal of profitable growth within its core businesses. The most significant operations affected are portions of Reynolds' business conducted at its McCook, Illinois sheet and plate plant, where a part of the plant's aluminum sheet production will be discontinued by mid-1994. As a result of its ongoing review of the economic viability of certain of its operations, Reynolds also decided to discontinue production of extruded irrigation tubing at its Torrance, California facility, idling the extrusion press at that facility effective December 31, 1993, and to eliminate extruded shapes operations at its Louisville, Kentucky extrusion plant, focusing instead on production of heat exchanger tubing products. See the discussion under \"Costs and Expenses - Restructuring Charges\" in Item 7, and under Note N to the consolidated financial statements in Item 8, of this report regarding the costs of these restructuring actions.\nInformation on shipments and net sales by classes of similar products is shown in Table 1.\nFinancial information relating to Reynolds' operations and identifiable assets by major operating and geographic areas is presented in Note J to the consolidated financial statements in Item 8 of this report.\nReynolds' products are generally sold to producers and distributors of industrial and consumer products in various markets. Information on sales of products by principal geographic and business markets is shown in Tables 2 and 3.\nTABLE 2\nPrincipal Geographic Markets\nApproximate Percentage of Sales _________________________\n1993 1992 1991 ____ ____ ____\nUnited States 75% 75% 75%\nCanada 6 5 5\nOther (Principally Europe) 19 20 20\nTotal 100% 100% 100%\nTABLE 3\nPrincipal Business Markets\nApproximate Percentage of Sales _________________________\n1993 1992 1991 ____ ____ ____\nPackaging and Containers 45% 45% 44%\nDistributors and Fabricators 13 15 15\nBuilding and Construction 12 12 12\nAutomotive and Transportation 11 11 9\nElectrical* 3 5 5\nOther 16 12 15\nTotal 100% 100% 100%\n_________________ *Reynolds sold its North American electrical cable operations in September, 1992.\nCOMPETITION\nPrincipal Competitors\nReynolds' principal competitors in the sale in North America of products derived from primary aluminum are ten other domestic companies, a Canadian company and other foreign companies. Reynolds and many other companies produce reclaimed aluminum.\nIn the sale of semifinished and finished products, Reynolds competes with (i) other producers of primary and reclaimed aluminum, which are also engaged in fabrication, (ii) other fabricators of aluminum and other products and (iii) other producers of plastic products. Reynolds' principal competitors in Europe are seven major multinational producers and a number of smaller European producers of aluminum semifabricated products. Aluminum and related products compete with various products, including those made of iron, steel, copper, zinc, tin, titanium, lead, glass, wood, plastic, magnesium and paper. Plastic products compete with products made of glass, aluminum, steel, paper, wood and ceramics, among others. Competition is based upon price, quality and service.\nReynolds' strategy is to continue improving its competitive position as an integrated producer of value-added aluminum products, with emphasis on growth opportunities in its core downstream fabricating operations, and to expand its packaging and containers and engineered automotive components businesses. Reynolds has undertaken continuing intensive cost reduction and performance improvement programs to improve its competitiveness that include work force reductions, permanent closures of higher cost facilities, disposal of uneconomic and non-core assets, and operational and organizational restructuring.\nIndustry Conditions\nA worldwide oversupply of aluminum, caused by high exports from the Commonwealth of Independent States (\"CIS\"), start-up of substantial new capacity in the industry and economic weakness, has severely depressed the price of aluminum on world commodity markets. This supply-demand imbalance, with its resultant effect on prices, has dramatically affected the aluminum industry and Reynolds. The timing and magnitude of any improvements in these conditions cannot be predicted with certainty.\nMultilateral government negotiations have been conducted to develop strategies to integrate the CIS aluminum industries into the world market. In late January, 1994, the governments of the six major aluminum-producing countries announced acceptance of a Memorandum of Understanding (the \"MOU\") addressing global supply-demand imbalance. The six governments finalized the text of the MOU during the week of February 28 and agreed to meet again on April 21, 1994 to review the global market situation. Among other things, the MOU contemplates reductions in Russian primary aluminum production of up to 500,000 metric tons per year for up to two years. Whether the MOU or other multilateral negotiations will be successful, and their ultimate effect on the supply-demand imbalance if successful, cannot be predicted with certainty. If multilateral negotiations are unsuccessful, unilateral trade sanctions (including, for example, import quotas or anti-dumping actions) may be pursued by governments or private parties. Such sanctions, if implemented, could result in improved prices in certain countries or regions but could also negatively impact Reynolds' globally integrated operations. The overall impact such sanctions might have on Reynolds' results of operations or competitive position therefore cannot be predicted with certainty.\nRAW MATERIALS AND PRECIOUS METALS\nBauxite, Alumina and Related Materials\nBauxite, the principal raw material used in the production of aluminum, is refined into alumina, which is then reduced by an electrolytic process into primary aluminum.\nReynolds' bauxite requirements and a portion of its alumina requirements are met from sources outside the United States.\nReynolds has long-term arrangements to obtain bauxite at negotiated prices from sources in Australia, Brazil, Guinea and Jamaica. Reynolds also has a long-term arrangement with the U.S. government under which Reynolds has agreed to purchase at a negotiated price an aggregate of approximately 1,450,000 long dry tons of Jamaican bauxite stored next to Reynolds' Sherwin alumina plant near Corpus Christi, Texas, for the period 1994 through 1998.\nReynolds refines bauxite into alumina at its Sherwin alumina plant. Reynolds also acquires alumina from two joint ventures in which it has interests, one located in Western Australia, known as the Worsley Joint Venture (\"Worsley\"), and the other located in Stade, Germany, known as Aluminium Oxid Stade (\"Stade\"). See Table 4 under this Item and the discussion of Worsley under \"Australia\".\nProduction and purchases of bauxite and production of alumina are adjusted from time to time in response to changes in demand for primary aluminum and other factors. Reynolds has reduced production at its Sherwin plant in connection with the curtailment of operations at its U.S. primary aluminum production plants. See \"Aluminum Production\". At December 31, 1993, the Sherwin plant was operating at 65% of capacity.\nAustralia\nReynolds has a 50% ownership interest in Worsley, which has a rated capacity of 1,600,000 metric tons of alumina per year (expandable to 2,400,000 metric tons per year). Worsley has proven bauxite reserves sufficient to operate the alumina plant at its rated capacity (taking into account future expansions to increase rated capacity to up to 2,400,000 metric tons per year) for at least the next 50 years. The joint venture has no specified termination date.\nReynolds has a long-term purchase arrangement under which it may purchase from a third party an aggregate of approximately 18,000,000 dry metric tons of Australian bauxite for the period 1994 through 2021. Of this amount, Reynolds has agreed to purchase 1,000,000 dry metric tons annually through 1996.\nReynolds has agreements under which it has agreed to purchase from two other third parties 300,000 dry, and 65,000 wet, metric tons, respectively, of Australian bauxite in 1994.\nBrazil\nReynolds and various other companies are participants in the Trombetas bauxite mining project in Brazil. Reynolds has a 5% equity interest in the project and has agreed to purchase an aggregate of approximately 2,400,000 dry metric tons of Brazilian bauxite from the project for the period 1994 through 1999.\nReynolds is also maintaining an interest in other, undeveloped bauxite deposits in Brazil.\nGuinea\nReynolds owns a 6% interest in Halco (Mining), Inc. (\"Halco\"). Halco owns 51% and the Guinean government owns 49% of Compagnie des Bauxites de Guinee (\"CBG\"), which has the exclusive right through 2038 to develop and mine bauxite in a 10,000 square-mile area in northwestern Guinea. Reynolds has a bauxite purchase contract with CBG which will provide Reynolds with an aggregate of approximately 1,200,000 dry metric tons of Guinean bauxite for the period 1994 through 1995.\nGuyana\nReynolds and the Guyanese government each own a 50% interest in a bauxite mining project in the Berbice region of Guyana. Reynolds has a bauxite purchase contract under which it has agreed to purchase 625,000 dry metric tons of Guyanese bauxite from the project in 1994.\nIndonesia\nReynolds has a purchase arrangement under which it has agreed to purchase from a third party 350,000 dry metric tons of Indonesian bauxite in 1994.\nJamaica\nReynolds has a long-term purchase arrangement under which it has agreed to purchase from a third party an aggregate of 3,000,000 dry metric tons of Jamaican bauxite for the period 1994 through 1995.\nReynolds' present sources of bauxite and alumina are more than adequate to meet the forecasted requirements of its primary aluminum production operations for the foreseeable future. To utilize excess alumina capacity, Reynolds enters into third-party sales arrangements. Reynolds also enters into arrangements to sell bauxite in excess of its needs to third parties.\nOther materials used in making aluminum are either purchased from others or supplied from Reynolds' carbon products plants in Baton Rouge and Lake Charles, Louisiana.\nPrecious Metals\nReynolds is currently a 40% participant in the Boddington gold project, and the owner of the Mt. Gibson gold project and the Marvel Loch gold property, all located in Western Australia. Mt. Gibson commenced production in late 1986; Boddington commenced production in mid-1987; and Reynolds acquired Marvel Loch in 1991.\nReynolds announced on February 9, 1994 that it has reached an agreement to sell Reynolds Australia Metals, Ltd., which holds its 40% interest in Boddington, to Poseidon Gold, Limited. The transaction, which is subject to certain conditions, was originally scheduled for completion in March, 1994. Another Boddington joint venturer has asserted that it has pre- emptive rights with respect to the transaction. Legal proceedings have been filed in the Supreme Court of Western Australia to resolve this issue. These proceedings will likely delay completion of the transaction until the second quarter of 1994 and, if adversely determined, could prevent completion of the transaction.\nIn the second quarter of 1993, Reynolds acquired the remaining 50% interest in the Mt. Gibson gold project that it did not previously own. In 1993, Mt. Gibson produced for Reynolds' account 64,300 ounces of gold. Mt. Gibson has a mining and processing capacity of up to 1.1 million metric tons of ore annually using standard carbon-in-leach technology. In 1993, Mt. Gibson commissioned a heap leach operation which has the capacity to process an additional 2.0 million metric tons of ore annually.\nIn 1993, Boddington produced for Reynolds' account 149,700 ounces of gold. Boddington has a mining and processing capacity of up to 7.2 million metric tons of ore per year. In 1993, Boddington commissioned a new underground mine which is supplying ore to its supergene\/basement plant which has the capacity to process up to 100,000 additional metric tons of ore annually.\nThe Marvel Loch gold property has a processing capacity of up to 1.0 million metric tons of ore annually. In 1993, Marvel Loch produced 145,200 ounces of gold.\nEach of the Australian sites is being prospected for possible additional reserves. Reynolds is also searching for gold at other sites in Australia and in North America.\nALUMINUM PRODUCTION\nReynolds owns and operates three primary aluminum production plants in the United States and one located at Baie Comeau, Quebec, Canada. Reynolds is also entitled to a share of the primary aluminum produced at three joint ventures in which it participates, one located in Quebec, Canada, known as the Becancour joint venture (\"Becancour\"), one located in Hamburg, Germany, known as Hamburger Aluminium-Werk GmbH (\"Hamburg\"), and the third in Ghana, Africa, known as Volta Aluminium Company Limited (\"Ghana\"). See Table 5 under this Item and note (h) thereto for information on these primary aluminum production plants. Reynolds also buys primary aluminum on the open market.\nReynolds has a 25% equity interest in Becancour and is entitled to a proportionate share of production. The plant currently consists of three fully operational potlines, each with a capacity of 120,000 metric tons of aluminum per year.\nProduction at the primary aluminum plants listed in Table 5 can vary due to a number of factors, including changes in worldwide supply and demand. Due to the continuing worldwide aluminum supply-demand imbalance, Reynolds has temporarily shut down 88,000 metric tons of primary aluminum production capacity at its Massena, New York (41,000 metric tons) and Longview, Washington (47,000 metric tons) plants, effective in the fourth quarter of 1993. Taking into account these latest curtailments, Reynolds has idled a total of 209,000 metric tons, or 21% of its 991,000 metric tons of primary aluminum capacity. Reynolds' Troutdale, Oregon plant, with a capacity of 121,000 metric tons, has been idle since 1991. At December 31, 1993, the U.S. plants listed in Table 5 were operating collectively at a rate of 53% of capacity; all other plants listed in Table 5 were operating at full capacity. See Table 6 under this Item. In order to balance its alumina supply system, Reynolds temporarily reduced production by 20% at its Sherwin alumina plant in Texas in connection with the latest curtailments. Production at the Sherwin alumina plant was previously reduced in connection with the Troutdale curtailment. See \"Raw Materials and Precious Metals - Bauxite, Alumina and Related Materials\". (See the discussion of threatened legal proceedings relating to the Massena, New York plant under \"Environmental Compliance\" and in Item 3 of this report.)\nReynolds has an 8% equity interest in C.V.G. Aluminio del Caroni, S.A., which produces primary aluminum in Venezuela.\nReynolds has agreed to acquire a 10% equity interest in the Aluminum Smelter Company of Nigeria (ALSCON), with the Nigerian government and private interests holding the remaining equity. As part of the arrangement, Reynolds will purchase at market-related prices 140,000 metric tons of primary aluminum annually from a 180,000 metric ton smelter being constructed by ALSCON in Nigeria.\nReynolds produces reclaimed aluminum from aluminum scrap at Bellwood, Virginia and Sheffield, Alabama. See Table 6 under this Item. Scrap for these facilities is obtained through Reynolds' nationwide recycling network and other scrap purchases and from Reynolds' manufacturing operations. In 1993, Reynolds obtained approximately 299,000 metric tons of recycled aluminum from its recycling network and other scrap purchases. Reynolds sold its Benton Harbor, Michigan aluminum reclamation plant in the second quarter of 1993. See \"General\".\nFABRICATING OPERATIONS\nReynolds' semifinished and finished aluminum products and nonaluminum products are produced at numerous domestic and foreign plants wholly or partly owned by Reynolds. These plants are included in Table 7 under Item 2","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nFor information on the location and general nature of Reynolds' principal domestic and foreign properties, see Item 1, BUSINESS. Table 7 lists as of February 7, 1994 Reynolds' wholly-owned domestic and foreign operations and shows the domestic and foreign locations of operations in which Reynolds has interests. The properties listed are held in fee except as otherwise indicated. Properties held other than in fee are not, individually or in the aggregate, material to Reynolds' operations and the arrangements under which such properties are held are not expected to limit their use. Reynolds believes that its facilities are suitable and adequate for its operations. With the exception of the Longview, Massena and Troutdale primary aluminum production plants and the Sherwin alumina plant, as explained above, there is no significant surplus or idle capacity at any of Reynolds' major manufacturing facilities. The restructured operations at Reynolds' McCook sheet and plate plant and Torrance and Louisville extrusion facilities are not considered as surplus or idle capacity. See Item 1 under the caption \"General\".\nTABLE 7\nWholly-Owned Domestic and Foreign Operations\nManufacturing, Mining and Distribution\nAlumina: Recycling: Corpus Christi, Texas Recycling Plants and Malakoff, Texas Centers (U.S.)(638)**\nCalcined Coke: Reclamation: Baton Rouge, Louisiana Sheffield, Alabama (2) Lake Charles, Louisiana Bellwood, Virginia\nCarbon Anodes: Mill Products: Lake Charles, Louisiana Sheffield, Alabama McCook, Illinois Primary Aluminum: Bellwood, Virginia Massena, New York Cap-de-la-Madeleine, Troutdale, Oregon Quebec, Canada Longview, Washington Hamburg, Germany*** Baie Comeau, Quebec, Canada Latina, Italy\nAluminum Cans: Spent Potliner Treatment: San Francisco, California Gum Springs, Arkansas Torrance, California Tampa, Florida Extruded Products: Moultrie, Georgia Auburn, Indiana Honolulu, Hawaii Louisville, Kentucky Kansas City, Missouri El Campo, Texas Fulton, New York Ashland, Virginia* Middletown, New York Bellwood, Virginia Reidsville, North Carolina (cans and Richmond Hill, Ontario, Canada ends) Ste. Therese, Quebec, Canada Salisbury, North Carolina Nachrodt, Germany* Fort Worth, Texas Harderwijk, Netherlands Houston, Texas Lelystad, Netherlands Seattle, Washington Maracay, Venezuela Milwaukee, Wisconsin Rocklin, California (ends) Bristol, Virginia (ends) Enzesfeld, Austria# Guayama, Puerto Rico\nPowder and Paste: Building and Construction Louisville, Kentucky Products: Eastman, Georgia* Electrical Rod: Bourbon, Indiana Becancour, Quebec, Canada Ashville, Ohio Lynchburg, Virginia Foil Feed Stock: Weston, Ontario, Canada Hot Springs, Arkansas Merxheim, France* Nachrodt, Germany Packaging and Consumer Dublin, Ireland* Products: Harderwijk, Netherlands Beacon Falls, Connecticut Lisburn, Northern Ireland* Louisville, Kentucky Service Centers (U.S.)(46)** Mt. Vernon, Kentucky Sparks, Nevada* Downingtown, Pennsylvania Lewiston, Utah Bellwood, Virginia Printing Cylinders: Grottoes, Virginia Longmont, Colorado* Richmond, Virginia Atlanta, Georgia* South Boston, Virginia Clarksville, Indiana* Appleton, Wisconsin (2) Louisville, Kentucky Little Chute, Wisconsin Newport, Kentucky* Weyauwega, Wisconsin Battle Creek, Michigan* Rexdale, Ontario, Canada St. Louis, Missouri Cap-de-la-Madeleine, Phoenix, New York* Quebec, Canada Wilmington, North Carolina* Latina, Italy Exton, Pennsylvania* Franklin, Tennessee* Richmond, Virginia\nWheels: Can Machinery and Systems: Ferrara, Italy Richmond, Virginia\nGold: Reynolds Aluminum Supply Marvel Loch and Mt. Gibson, Company: Western Australia, Australia Service Centers (U.S.)(22)** Processing Centers (U.S.)(2)\nResearch and Development\nRichmond, Virginia: Corpus Christi, Texas: Can Development Center Alumina Technology Corporate Research and Development Sheffield, Alabama: Central Laboratories Manufacturing Technology Packaging Technology Laboratory\nOther Operations In Which Reynolds Has Interests\nAustralia: Guinea: Bauxite and alumina, gold## Bauxite\nBelgium: Guyana: Building products and extrusions Bauxite*\nItaly: Brazil: Reclamation Bauxite, aluminum cans and ends, recycling Philippines: Mill products, extrusions, foil Canada: Primary aluminum, electric Russia: power generation, aluminum Foil feed stock wheels\nColombia: Spain: Mill products, extrusions, Mill products, extrusions, foil, foil wire and cable, packaging and consumer products, printing Egypt: cylinders Extrusions Venezuela: Germany: Primary aluminum, mill products, Alumina, primary aluminum* foil, aluminum cans and ends, recycling, aluminum wheels Ghana: Primary aluminum*\n____________________________ * Leased. ** Recycling Plants and Centers - 629 leased. Building and Construction Products Service Centers - 44 leased. Reynolds Aluminum Supply Company Service Centers - 14 leased. *** Held under an installment purchase arrangement. # Reynolds announced on February 15, 1994 an agreement to sell its Austria Dosen aluminum beverage can plant to PLM AB. The transaction, which is subject to certain conditions, is expected to be completed by the end of March, 1994. ## Reynolds has reached an agreement to sell Reynolds Australia Metals, Ltd., which holds its 40% interest in the Boddington gold project. See the discussion under Item 1 of this report under the caption \"Raw Materials and Precious Metals - Precious Metals\".\nThe titles to Reynolds' various properties were not examined specifically for this report.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nOn January 11, 1993, the Registrant received from the California Earth Corps (\"CEC\") a 60-day notice of intent to sue under the \"Proposition 65\" provision of the California Health and Safety Code. The notice alleges that the Registrant's Torrance Can Plant failed to provide a required warning of the public's exposure to certain chemicals listed pursuant to California law. Under California law, CEC may take action against the Registrant and receive a bounty if the action is successful. Penalties of up to $2,500 per day of violation could be sought in the potential action. The Registrant has responded to the notice, denying the alleged violations. CEC has taken no action to date.\nOn July 29, 1992, the U.S. Environmental Protection Agency (the \"EPA\") filed an administrative complaint against the Registrant alleging paperwork violations and failure to determine whether certain materials in storage constituted hazardous wastes under the federal Resource Conservation and Recovery Act and state hazardous waste regulations at the Registrant's Longview, Washington primary aluminum production plant. The EPA sought $296,000 in civil penalties. Based on the Registrant's response to the complaint, the EPA dropped certain claims and amended others. The parties have tentatively agreed to a settlement of the matter under which the Registrant would pay a penalty of $11,250 and agree to install certain parts washing stations that would result in a reduction in the generation of solvent wastes at the Longview plant. The parties are preparing documents to finalize the settlement.\nAs previously reported in the Registrant's Report on Form 10-Q for the Quarter ended March 31, 1993, on June 10, 1988, the Atlantic States Legal Foundation (\"Atlantic States\") filed suit against the Registrant in the U.S. District Court for the Western District of New York (the \"Court\") under the \"citizen suit\" provision of the federal Clean Water Act. The State of New York intervened in the case on December 1, 1989. The suit involved the discharge of substances from the Registrant's Massena, New York primary aluminum production plant. An agreement of the parties to settle the suit for payments by the Registrant aggregating $515,000, resolving claims for penalties and other costs, was approved by the Court on May 12, 1992; however, the Court retained jurisdiction of the matter. In a letter dated April 12, 1993, Atlantic States informed the Registrant that it has withdrawn its waiver of enforcement, citing violations at the Massena plant of interim effluent limits contained in the settlement agreement and other effluent limit violations. Atlantic States has stated that it would be providing the Registrant a settlement offer concerning such violations, which the Registrant to date has not received.\nOn November 9, 1993, counsel for the St. Regis Mohawk Tribe served the Registrant with a notice of intent to file a citizen suit for alleged violations of the federal Clean Air Act and certain New York state air emission standards at the Registrant's Massena, New York primary aluminum production plant. At a meeting with tribal and state representatives in December, 1993, the State of New York alleged that the Registrant's emissions were causing a violation of ambient air standards for benzo-a- pyrene. The state and Mohawk Tribe asked, among other things, that the Registrant agree to accelerate capital investments to achieve compliance with the Clean Air Act's Maximum Achievable Control Technology (\"MACT\") standards (although the EPA is not expected to establish such standards until 1996 or 1997). Discussions to resolve the matter are ongoing among the parties. Capital expenditures to achieve MACT standards at the Massena plant, together with related capital expenditures, could exceed $150 million. See the discussion of Clean Air Act compliance costs in Item 1 under the caption \"Environmental Compliance\".\nSee the discussion of legal proceedings related to the proposed sale of Reynolds Australia Metals, Ltd. under the caption \"Raw Materials and Precious Metals - Precious Metals\" in Item 1 of this report.\nVarious other suits and claims are pending against Reynolds. In the opinion of Reynolds' management, after consultation with counsel, disposition of these suits and claims and the actions referred to in the preceding paragraphs, either individually or in the aggregate, will not have a material adverse effect on Reynolds' competitive or financial position or its ongoing results of operations. No assurance can be given, however, that the disposition of one or more of such suits, claims or actions in a particular reporting period will not be material in relation to the reported results for such period.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Registrant's security holders during the fourth quarter of 1993.\nItem 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Registrant are as follows:\nName Age Positions Held During Past Five Years\nRichard G. Holder 62 Chairman of the Board and Chief Executive Officer since May 1992. President and Chief Operating Officer 1988-1992. Director since 1984.\nYale M. Brandt 63 Vice Chairman since May 1992. Executive Vice President, Fabricated Industrial Products 1990-1992. Executive Vice President, Fabricating Operations 1988-1990. Director since 1988.\nRandolph N. Reynolds 52 Vice Chairman since January 1994. Executive Vice President, International 1990-1994. Vice President 1985-1990. President, Reynolds International, Inc., a subsidiary of the Company, since November 1980, and Chief Executive Officer of that subsidiary since November 1981. Director since 1984.\nJeremiah J. Sheehan 55 President and Chief Operating Officer since January 1994. Executive Vice President, Fabricated Products 1993-1994. Executive Vice President, Consumer and Packaging Products 1990-1993. Vice President, Can Division 1988-1990. Director since January 1994.\nHenry S. Savedge, Jr. 60 Executive Vice President and Chief Financial Officer since May 1992. Vice President, Finance 1990-1992. Vice President, Planning and Analysis 1987-1990. Director since September 1992.\nDonald T. Cowles 46 Executive Vice President, Human Resources and External Affairs since February 1993. Vice President, General Counsel and Secretary 1989-1993. Secretary and Assistant General Counsel 1985-1989.\nJ. Wilt Wagner 52 Executive Vice President, Raw Materials, Metals and Industrial Products since March 1993. Executive Vice President, Fabricated Industrial Products 1992-1993. Vice President, Mill Products Division 1990-1992. Mill Products Division General Manager 1989-1990. Mill Products Division Operations Manager 1988-1989.\nThomas P. Christino 54 Vice President, Flexible Packaging Division since November 1993. Flexible Packaging Division General Manager 1992-1993. Flexible Packaging Products National Sales and Marketing Manager 1987-1992.\nE. Jack Gates 52 Vice President, Raw Materials and Precious Metals Division since April 1993. Raw Materials and Precious Metals Division General Manager 1993. Reduction Division General Manager 1990-1993. Reduction Division Operations Manager 1983-1990.\nRodney E. Hanneman 57 Vice President, Quality Assurance and Technology Operations since March 1985.\nDouglas M. Jerrold 43 Vice President, Tax Affairs since April 1990. Corporate Director of Tax Affairs 1987-1990.\nD. Michael Jones 40 Vice President, General Counsel and Secretary since February 1993. Associate General Counsel and Assistant Secretary 1990-1993. Senior Attorney and Assistant Secretary 1987-1990.\nJohn B. Kelzer 57 Vice President, Extrusion Division since April 1993. Extrusion Division General Manager 1990-1993. Manager of the Company's McCook, Illinois Sheet and Plate Plant 1985- 1990.\nWilliam E. Leahey, Jr. 44 Vice President, Can Division since April 1993. Can Division General Manager 1992- 1993. Can Division Sales and Marketing Director 1990-1992. Vice President, Asia Pacific Division, Continental Can International 1986-1990.\nJohn M. Lowrie 53 Vice President, Consumer Products Division since October 1988.\nJohn M. Noonan 60 Vice President, Construction Products and Properties Divisions since January 1984.\nWilliam G. Reynolds, Jr. 54 Vice President, Government Relations and Public Affairs since 1980.\nJulian H. Taylor 50 Vice President, Treasurer since April 1988.\nC. Stephen Thomas 54 Vice President, Mill Products Division since May 1992. Vice President, Can Division 1990-1992. Vice President, Operations, Can Division July-December 1990. Vice President, Extrusion Division 1987-1990.\nNicholas D. Triano 62 Vice President, Materials Management since April 1989. Corporate Director, Materials Management 1987-1989.\nAllen M. Earehart 51 Controller since March 1993. Director, Corporate Accounting 1982-1993.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Registrant's Common Stock is listed on the New York Stock Exchange and the Chicago Stock Exchange. At February 22, 1994, there were 10,876 holders of record of the Registrant's Common Stock.\nThe high and low sales prices for shares of the Registrant's Common Stock as reported on the New York Stock Exchange Composite Transactions Tape and the dividends declared per share during the periods indicated are set forth below:\nHigh Low Dividends\nFirst Quarter $58-7\/8 $48-5\/8 $.45 Second Quarter 49 42 .25 Third Quarter 52-3\/4 41-5\/8 .25 Fourth Quarter 48-7\/8 41-1\/8 .25\nFirst Quarter $59-3\/8 $48-7\/8 $.45 Second Quarter 64-3\/8 54 .45 Third Quarter 60-1\/2 48-5\/8 .45 Fourth Quarter 56-5\/8 47 .45\nOn February 18, 1994, the Board of Directors declared a dividend of $0.25 per share of Common Stock, payable April 1, 1994 to stockholders of record on March 4, 1994.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nItem 7 should be read in conjunction with the consolidated financial statements and notes thereto, and with the other sections of this report. All tonnage figures in Item 7 are expressed in metric tons.\nSTATE OF THE INDUSTRY\nThe past year marked a continuation of one of the most difficult periods in the history of the aluminum industry. One could best characterize our business climate as structurally changed and extremely competitive.\nOn the positive side, Western world demand for aluminum continues to grow, despite weakness in several major global economies, especially Europe and Japan. Global consumption of aluminum has set records every year since 1983, and 1994 is forecast to be yet another record year. While the rate of growth has slowed to an average of 1.5% over the last three years, compared to an average of 3% over the last seven years, we believe continued growth during this latest recession is an indicator of underlying long-term demand strength.\nThe industry's problem is on the supply side. Aluminum's previous down cycles were due primarily to excess capacity from overexpansion, a decline in demand, or some combination of the two. Today's supply problems are primarily the result of an extraordinary, unprecedented phenomenon in the industry-exports from the Commonwealth of Independent States (CIS), mostly from Russia.\nCIS exports have increased from 250,000 tons annually in 1989 to 1.7 million tons in 1993. Even in the best of times, with strong demand growth, there would be no way for the market to absorb this surge of aluminum, which approaches 10% of total world capacity. As a result, inventories on the London Metal Exchange ballooned during the same period from 100,000 tons to over 2.5 million tons, and primary aluminum ingot prices plummeted to an all-time low, on an inflation-adjusted basis. Low ingot prices in turn have had a negative impact on most fabricated aluminum prices.\nWhile the industry's boom years during the mid-to-late 1980s led many producers to increase primary aluminum capacity, this was largely offset by closing uneconomic capacity. Except for Russia's unexpected increased participation in the market, supply and demand essentially would be in balance today, even with the capacity increases.\nThe state of the industry is painfully evident in our results, which have deteriorated substantially since our third consecutive year of record earnings in 1989 - the last year before the flood of aluminum from Russia began.\nOUR BUSINESS\nReynolds is a vertically integrated producer of aluminum products. We also manufacture and sell a number of non-aluminum products which complement our aluminum business. In addition to reporting results for the Company as a whole, we provide a breakdown into two groups in order to more fully describe our operations: \"Finished Products and Other Sales\" and \"Production and Processing\".\nFor additional information on results and special items, see Notes H, I, M, N and the quarterly results of operations in Item 8","section_7A":"","section_8":"","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nFor information concerning the directors and nominees for directorship, see the information under the caption \"Election of Directors\" in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1994, which information is incorporated herein by reference.\nInformation concerning executive officers of the Registrant is shown in Part I - Item 4A of this report.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nFor information required by this item, see the information under the captions \"Election of Directors - Board Compensation and Benefits\", \"Election of Directors - Other Compensation\", \"Report of Compensation Committee on Executive Compensation\", \"Performance Graphs\" and \"Executive Compensation\" in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1994, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nFor information required by this item, see the information under the caption \"Beneficial Ownership of Securities\" in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1994, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information required by this item, see the information under the captions \"Election of Directors - Other Compensation\" and \"Executive Compensation - Pension Plan Table\" in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1994, which information is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The consolidated financial statements, financial statement schedules and exhibits listed below are filed as a part of this report.\n(1) Consolidated Financial Statements: Page\nConsolidated statement of income and retained earnings - Years ended December 31, 1993, 1992 and 1991. 32\nConsolidated balance sheet - December 31, 1993 and 1992. 33\nConsolidated statement of cash flows - Years ended December 31, 1993, 1992 and 1991. 34\nNotes to consolidated financial statements. 35\nReport of Ernst & Young, Independent Auditors. 51\n(2) Financial Statement Schedules S-1\nSchedule No.\nV. Property, plant and equipment\nVI. Accumulated depreciation, depletion and amortization of property, plant and equipment\nIX. Short-term borrowings 1993, 1992, 1991\nX. Supplementary income statement information 1993, 1992, 1991\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because they are not required, are inapplicable or the required information has otherwise been given.\nIndividual financial statements of Reynolds Metals Company have been omitted because the restricted net assets (as defined in Accounting Series Release 302) of all subsidiaries included in the consolidated financial statements filed, in the aggregate, do not exceed 25% of the consolidated net assets shown in the consolidated balance sheet as of December 31, 1993.\nFinancial statements of all associated companies (20% to 50% owned) have been omitted because no associated company is individually significant. Summarized financial information of all associated companies has been omitted because associated companies in the aggregate are not significant.\n(3) Exhibits\nEXHIBIT 2 - None\n* EXHIBIT 3.1 - Restated Certificate of Incorporation, as amended to the date hereof. (File No. 1-1430, Registration Statement on Form 8-A dated February 23, 1994, pertaining to Common Stock and Preferred Stock Purchase Rights, EXHIBIT 1)\n* EXHIBIT 3.2 - By-Laws, as amended to the date hereof. (File No. 1-1430, Registration Statement on Form 8-A dated February 23, 1994, pertaining to Common Stock and Preferred Stock Purchase Rights, EXHIBIT 2)\nEXHIBIT 4.1 - Restated Certificate of Incorporation. See EXHIBIT 3.1.\nEXHIBIT 4.2 - By-Laws. See EXHIBIT 3.2.\n* EXHIBIT 4.3 - Indenture dated as of April 1, 1989 (the \"Indenture\") between Reynolds Metals Company and The Bank of New York, as Trustee, relating to Debt Securities. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1989, EXHIBIT 4(c))\n* EXHIBIT 4.4 - Amendment No. 1 dated as of November 1, 1991 to the Indenture. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.4)\n* EXHIBIT 4.5 - $1,100,000,000 Credit Agreement (the \"Credit Agreement\") dated as of November 24, 1987 among Reynolds Metals Company, Canadian Reynolds Metals Company, Limited - Societe Canadienne de Metaux Reynolds, Limitee, the several banks parties thereto, Manufacturers Hanover Bank (Delaware), The Bank of Nova Scotia, Manufacturers Hanover Trust Company, and Manufacturers Hanover Agent Bank Services Corporation. (Registration Statement No. 33-20498 on Form S-8, dated March 7, 1988, EXHIBIT 4.4)\n* EXHIBIT 4.6 - Amendment No. 1 dated as of July 1, 1988 to the Credit Agreement. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1988, EXHIBIT 4(e))\n* EXHIBIT 4.7 - Amendment No. 2 dated as of February 8, 1989 to the Credit Agreement. (File No. 1-1430, 1988 Form 10-K Report, EXHIBIT 4.6)\n* EXHIBIT 4.8 - Amendment No. 3 dated as of August 4, 1989 to the Credit Agreement. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1989, EXHIBIT 4(g))\n* EXHIBIT 4.9 - Amendment No. 4 dated as of November 1, 1990 to the Credit Agreement. (Registration Statement No. 33-38020 on Form S-3, dated November 30, 1990, EXHIBIT 4.12)\n* EXHIBIT 4.10 - Rights Agreement dated as of November 23, 1987 (the \"Rights Agreement\") between Reynolds Metals Company and The Chase Manhattan Bank, N.A. (File No. 1-1430, Registration Statement on Form 8-A dated November 23, 1987, pertaining to Preferred Stock Purchase Rights, EXHIBIT 1)\n* EXHIBIT 4.11 - Amendment No. 1 dated as of December 19, 1991 to the Rights Agreement. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.11)\n* EXHIBIT 4.12 - Form of 9-3\/8% Debenture due June 15, 1999. (File No. 1-1430, Form 8-K Report dated June 6, 1989, EXHIBIT 4)\n* EXHIBIT 4.13 - Form of Fixed Rate Medium-Term Note. (Registration Statement No. 33-30882 on Form S-3, dated August 31, 1989, EXHIBIT 4.3)\n* EXHIBIT 4.14 - Form of Floating Rate Medium-Term Note. (Registration Statement No. 33-30882 on Form S-3, dated August 31, 1989, EXHIBIT 4.4)\n* EXHIBIT 4.15 - Form of Book-Entry Fixed Rate Medium-Term Note. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.15)\n* EXHIBIT 4.16 - Form of Book-Entry Floating Rate Medium- Term Note. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.16)\n* EXHIBIT 4.17 - Form of 9% Debenture due August 15, 2003. (File No. 1-1430, Form 8-K Report dated August 16, 1991, Exhibit 4(a))\n* EXHIBIT 4.18 - Articles of Continuance of Canadian Reynolds Metals Company, Limited -- Societe Canadienne de Metaux Reynolds, Limitee (\"CRM\"), as amended to the date hereof. (Registration Statement No. 33-59168 on Form S-3, dated March 5, 1993, EXHIBIT 4.1)\n* EXHIBIT 4.19 - By-Laws of CRM, as amended to the date hereof. (File No. 1-1430, Form 10-Q Report for the Quarter Ended September 30, 1993, EXHIBIT 4.19)\n* EXHIBIT 4.20 - Indenture dated as of April 1, 1993 among CRM, Reynolds Metals Company and The Bank of New York, as Trustee. (File No. 1-1430, Form 8-K Report dated July 14, 1993, EXHIBIT 4(a))\n* EXHIBIT 4.21 - Form of 6-5\/8% Guaranteed Amortizing Note due July 15, 2002. (File No. 1-1430, Form 8-K Report dated July 14, 1993, EXHIBIT 4(d))\nEXHIBIT 9 - None\n#* EXHIBIT 10.1 - Reynolds Metals Company 1982 Nonqualified Stock Option Plan, as amended through May 17, 1985. (File No. 1-1430, 1985 Form 10-K Report, EXHIBIT 10.2)\n#* EXHIBIT 10.2 - Reynolds Metals Company 1987 Nonqualified Stock Option Plan. (Registration Statement No. 33-13822 on Form S-8, dated April 28, 1987, EXHIBIT 28.1)\n#* EXHIBIT 10.3 - Reynolds Metals Company 1992 Nonqualified Stock Option Plan. (Registration Statement No. 33-44400 on Form S-8, dated December 9, 1991, EXHIBIT 28.1)\n#* EXHIBIT 10.4 - Reynolds Metals Company Performance Incentive Plan, as amended and restated effective January 1, 1985. (File No. 1-1430, 1985 Form 10-K Report, EXHIBIT 10.3)\n#* EXHIBIT 10.5 - Consulting Agreement dated April 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1986, EXHIBIT 19)\n#* EXHIBIT 10.6 - Form of Deferred Compensation Agreement dated February 17, 1984 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, 1983 Form 10-K Report, EXHIBIT 10.9)\n#* EXHIBIT 10.7 - Deferred Compensation Agreement dated May 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1986, EXHIBIT 19)\n#* EXHIBIT 10.8 - Agreement dated December 9, 1987 between Reynolds Metals Company and Jeremiah J. Sheehan. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.9)\n#* EXHIBIT 10.9 - Supplemental Death Benefit Plan for Officers. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.8)\n#* EXHIBIT 10.10 - Financial Counseling Assistance Plan for Officers. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.11)\n#* EXHIBIT 10.11 - Management Incentive Deferral Plan. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.12)\n# EXHIBIT 10.12 - Deferred Compensation Plan for Outside Directors as Amended and Restated Effective December 1, 1993\n#* EXHIBIT 10.13 - Retirement Plan for Outside Directors. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.10)\n#* EXHIBIT 10.14 - Death Benefit Plan for Outside Directors. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.11)\n#* EXHIBIT 10.15 - Form of Indemnification Agreement for Directors and Officers. (File No. 1-1430, Form 8-K Report dated April 29, 1987, EXHIBIT 28.3)\n#* EXHIBIT 10.16 - Form of Executive Severance Agreement between Reynolds Metals Company and key executive personnel, including each of the individuals listed in Item 4A hereof (other than Messrs. Christino, Jones, Leahey and Earehart). (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.18)\n#* EXHIBIT 10.17 - Renewal dated February 21, 1992 of Consulting Agreement dated April 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 10.19)\n#* EXHIBIT 10.18 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective May 20, 1988. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1988, EXHIBIT 19(a))\n#* EXHIBIT 10.19 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective October 21, 1988. (File No. 1-1430, Form 10-Q Report for the Quarter Ended September 30, 1988, EXHIBIT 19(a))\n#* EXHIBIT 10.20 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective January 1, 1987. (File No. 1-1430, 1988 Form 10-K Report, EXHIBIT 10.22)\n#* EXHIBIT 10.21 - Amendment to Reynolds Metals Company Performance Incentive Plan effective January 1, 1989. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1989, EXHIBIT 19)\n#* EXHIBIT 10.22 - Form of Stock Option and Stock Appreciation Right Agreement, as approved February 16, 1990 by the Compensation Committee of the Company's Board of Directors. (File No. 1-1430, 1989 Form 10-K Report, EXHIBIT 10.24)\n#* EXHIBIT 10.23 - Amendment to Reynolds Metals Company 1982 Nonqualified Stock Option Plan effective January 18, 1991. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.25)\n#* EXHIBIT 10.24 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective January 18, 1991. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.26)\n#* EXHIBIT 10.25 - Letter Agreement dated January 18, 1991 between Reynolds Metals Company and William O. Bourke. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.29)\n#* EXHIBIT 10.26 - Form of Stock Option Agreement, as approved April 22, 1992 by the Compensation Committee of the Company's Board of Directors. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1992, EXHIBIT 28(a))\n#* EXHIBIT 10.27 - Consulting Agreement dated May 1, 1992 between Reynolds Metals Company and William O. Bourke. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1992, EXHIBIT 28(b))\n# EXHIBIT 10.28 - Renewal dated February 18, 1994 of Consulting Agreement dated May 1, 1992 between Reynolds Metals Company and William O. Bourke\nEXHIBIT 11 - Omitted; see Item 8 for computation of earnings per share\nEXHIBIT 12 - Not applicable\nEXHIBIT 13 - Not applicable\nEXHIBIT 16 - Not applicable\nEXHIBIT 18 - None\nEXHIBIT 21 - List of Subsidiaries of Reynolds Metals Company\nEXHIBIT 22 - None\nEXHIBIT 23 - Consent of Independent Auditors\nEXHIBIT 24 - Powers of Attorney\nEXHIBIT 27 - Not applicable\nEXHIBIT 28 - Not applicable\n____________________________ * Incorporated by reference. # Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K.\nPursuant to Item 601 of Regulation S-K, certain instruments with respect to long-term debt of the Company are omitted because such debt does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of any such instrument to the Commission upon request.\n(b) Reports on Form 8-K\nDuring the fourth quarter of 1993, the Registrant filed with the Commission Current Reports on Form 8-K dated (i) November 23, 1993 reporting that it had filed with the Commission a Registration Statement on Form S-3 relating to the offer and resale from time to time by The Chase Manhattan Bank (National Association), as trustee of the Reynolds Metals Company Pension Plans Master Trust (the \"Master Trust\"), of up to 3,000,000 shares of Common Stock, without par value, of the Registrant proposed to be issued and contributed from time to time by the Registrant to one or more of the pension plans the assets of which are held by the Master Trust; (ii) December 10, 1993 reporting that the Registrant was considering actions to restructure certain of its operations, principally in the fabricating area; and (iii) December 30, 1993 reporting that the Registrant had filed with the Commission pre-effective Amendment No. 1 to Registration Statement No. 33-51631 on Form S-3 relating to the public offering of shares of convertible preferred stock of the Registrant.\nSIGNATURES\nPursuant 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.\nREYNOLDS METALS COMPANY\nBy *Richard G. Holder Richard G. Holder, Chairman of the Board and Chief Executive Officer\nDate March 15, 1994\nPursuant 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 and on the dates indicated.\nBy *Henry S. Savedge, Jr. By *Richard G. Holder Henry S. Savedge, Jr., Director, Richard G. Holder, Director, Executive Vice President and Chairman of the Board and Chief Chief Financial Officer Executive Officer\nDate March 15, 1994 Date March 15, 1994\nBy *William O. Bourke By Yale M. Brandt William O. Bourke, Director Yale M. Brandt, Director\nDate March 15, 1994 Date March 15, 1994\nBy *Thomas A. Graves, Jr. By *Gerald Greenwald Thomas A. Graves, Jr., Director Gerald Greenwald, Director\nDate March 15, 1994 Date March 15, 1994\nBy *John R. Hall By *Robert L. Hintz John R. Hall, Director Robert L. Hintz, Director\nDate March 15, 1994 Date March 15, 1994\nBy *David P. Reynolds By *Randolph N. Reynolds David P. Reynolds, Director Randolph N. Reynolds, Director\nDate March 15, 1994 Date March 15, 1994\nBy *Charles A. Sanders, M.D. By Jeremiah J. Sheehan Charles A. Sanders, M.D., Director Jeremiah J. Sheehan, Director\nDate March 15, 1994 Date March 15, 1994\nBy *Ralph S. Thomas By *Robert J. Vlasic Ralph S. Thomas, Director Robert J. Vlasic, Director\nDate March 15, 1994 Date March 15, 1994\nBy *Joe B. Wyatt By Allen M. Earehart Joe B. Wyatt, Director Allen M. Earehart, Controller\nDate March 15, 1994 Date March 15, 1994\n*By D. Michael Jones D. Michael Jones, Attorney-in-Fact\nDate March 15, 1994\nFINANCIAL STATEMENT SCHEDULES\nAND OTHER FINANCIAL INFORMATION\nYEAR ENDED DECEMBER 31, 1993\nREYNOLDS METALS COMPANY\nRICHMOND, VIRGINIA\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\nEXHIBITS\nTO\nFORM 10-K\nFor the fiscal year ended December 31, 1993\nCommission File No. 1-1430\nREYNOLDS METALS COMPANY\nAttached herewith are Exhibits 10.12, 10.28, 23 and 24\nINDEX\nSequential Page No. ___________\nEXHIBIT 2 - None\n*EXHIBIT 3.1 - Restated Certificate of Incorporation, as amended to the date hereof. (File No. 1-1430, Registration Statement on Form 8-A dated February 23, 1994, pertaining to Common Stock and Preferred Stock Purchase Rights, EXHIBIT 1)\n*EXHIBIT 3.2 - By-Laws, as amended to the date hereof. (File No. 1-1430, Registration Statement on Form 8-A dated February 23, 1994, pertaining to Common Stock and Preferred Stock Purchase Rights, EXHIBIT 2)\nEXHIBIT 4.1 - Restated Certificate of Incorporation. See EXHIBIT 3.1.\nEXHIBIT 4.2 - By-Laws. See EXHIBIT 3.2.\n*EXHIBIT 4.3 - Indenture dated as of April 1, 1989 (the \"Indenture\") between Reynolds Metals Company and The Bank of New York, as Trustee, relating to Debt Securities. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1989, EXHIBIT 4(c))\n*EXHIBIT 4.4 - Amendment No. 1 dated as of November 1, 1991 to the Indenture. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.4)\n*EXHIBIT 4.5 - $1,100,000,000 Credit Agreement (the \"Credit Agreement\") dated as of November 24, 1987 among Reynolds Metals Company, Canadian Reynolds Metals Company, Limited - Societe Canadienne de Metaux Reynolds, Limitee, the several banks parties thereto, Manufacturers Hanover Bank (Delaware), The Bank of Nova Scotia, Manufacturers Hanover Trust Company, and Manufacturers Hanover Agent Bank Services Corporation. (Registration Statement No. 33-20498 on Form S-8, dated March 7, 1988, EXHIBIT 4.4)\n*EXHIBIT 4.6 - Amendment No. 1 dated as of July 1, 1988 to the Credit Agreement. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1988, EXHIBIT 4(e))\n*EXHIBIT 4.7 - Amendment No. 2 dated as of February 8, 1989 to the Credit Agreement. (File No. 1-1430, 1988 Form 10-K Report, EXHIBIT 4.6)\n*EXHIBIT 4.8 - Amendment No. 3 dated as of August 4, 1989 to the Credit Agreement. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1989, EXHIBIT 4(g))\n*EXHIBIT 4.9 - Amendment No. 4 dated as of November 1, 1990 to the Credit Agreement. (Registration Statement No. 33-38020 on Form S-3, dated November 30, 1990, EXHIBIT 4.12)\n*EXHIBIT 4.10 - Rights Agreement dated as of November 23, 1987 (the \"Rights Agreement\") between Reynolds Metals Company and The Chase Manhattan Bank, N.A. (File No. 1-1430, Registration Statement on Form 8-A dated November 23, 1987, pertaining to Preferred Stock Purchase Rights, EXHIBIT 1)\n*EXHIBIT 4.11 - Amendment No. 1 dated as of December 19, 1991 to the Rights Agreement. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.11)\n*EXHIBIT 4.12 - Form of 9-3\/8% Debenture due June 15, 1999. (File No. 1-1430, Form 8-K Report dated June 6, 1989, EXHIBIT 4)\n*EXHIBIT 4.13 - Form of Fixed Rate Medium-Term Note. (Registration Statement No. 33-30882 on Form S-3, dated August 31, 1989, EXHIBIT 4.3)\n*EXHIBIT 4.14 - Form of Floating Rate Medium-Term Note. (Registration Statement No. 33-30882 on Form S-3, dated August 31, 1989, EXHIBIT 4.4)\n*EXHIBIT 4.15 - Form of Book-Entry Fixed Rate Medium-Term Note. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.15)\n*EXHIBIT 4.16 - Form of Book-Entry Floating Rate Medium- Term Note. (File No. 1-1430, 1991 Form 10-K Report, EXHIBIT 4.16)\n*EXHIBIT 4.17 - Form of 9% Debenture due August 15, 2003. (File No. 1-1430, Form 8-K Report dated August 16, 1991, Exhibit 4(a))\n*EXHIBIT 4.18 - Articles of Continuance of Canadian Reynolds Metals Company, Limited -- Societe Canadienne de Metaux Reynolds, Limitee (\"CRM\"), as amended to the date hereof. (Registration Statement No. 33-59168 on Form S-3, dated March 5, 1993, EXHIBIT 4.1)\n*EXHIBIT 4.19 - By-Laws of CRM, as amended to the date hereof. (File No. 1-1430, Form 10-Q Report for the Quarter Ended September 30, 1993, EXHIBIT 4.19)\n*EXHIBIT 4.20 - Indenture dated as of April 1, 1993 among CRM, Reynolds Metals Company and The Bank of New York, as Trustee. (File No. 1-1430, Form 8-K Report dated July 14, 1993, EXHIBIT 4(a))\n*EXHIBIT 4.21 - Form of 6-5\/8% Guaranteed Amortizing Note due July 15, 2002. (File No. 1-1430, Form 8-K Report dated July 14, 1993, EXHIBIT 4(d))\nEXHIBIT 9 - None\n*EXHIBIT 10.1 - Reynolds Metals Company 1982 Nonqualified Stock Option Plan, as amended through May 17, 1985. (File No. 1-1430, 1985 Form 10-K Report, EXHIBIT 10.2)\n*EXHIBIT 10.2 - Reynolds Metals Company 1987 Nonqualified Stock Option Plan. (Registration Statement No. 33-13822 on Form S-8, dated April 28, 1987, EXHIBIT 28.1)\n*EXHIBIT 10.3 - Reynolds Metals Company 1992 Nonqualified Stock Option Plan. (Registration Statement No. 33-44400 on Form S-8, dated December 9, 1991, EXHIBIT 28.1)\n*EXHIBIT 10.4 - Reynolds Metals Company Performance Incentive Plan, as amended and restated effective January 1, 1985. (File No. 1-1430, 1985 Form 10-K Report, EXHIBIT 10.3)\n*EXHIBIT 10.5 - Consulting Agreement dated April 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1986, EXHIBIT 19)\n*EXHIBIT 10.6 - Form of Deferred Compensation Agreement dated February 17, 1984 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, 1983 Form 10-K Report, EXHIBIT 10.9)\n*EXHIBIT 10.7 - Deferred Compensation Agreement dated May 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1986, EXHIBIT 19)\n*EXHIBIT 10.8 - Agreement dated December 9, 1987 between Reynolds Metals Company and Jeremiah J. Sheehan. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.9)\n*EXHIBIT 10.9 - Supplemental Death Benefit Plan for Officers. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.8)\n*EXHIBIT 10.10 - Financial Counseling Assistance Plan for Officers. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.11)\n*EXHIBIT 10.11 - Management Incentive Deferral Plan. (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.12)\nEXHIBIT 10.12 - Deferred Compensation Plan for Outside ------ Directors as Amended and Restated Effective December 1, 1993\n*EXHIBIT 10.13 - Retirement Plan for Outside Directors. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.10)\n*EXHIBIT 10.14 - Death Benefit Plan for Outside Directors. (File No. 1-1430, 1986 Form 10-K Report, EXHIBIT 10.11)\n*EXHIBIT 10.15 - Form of Indemnification Agreement for Directors and Officers. (File No. 1-1430, Form 8-K Report dated April 29, 1987, EXHIBIT 28.3)\n*EXHIBIT 10.16 - Form of Executive Severance Agreement between Reynolds Metals Company and key executive personnel, including each of the individuals listed in Item 4A hereof (other than Messrs. Christino, Jones, Leahey and Earehart). (File No. 1-1430, 1987 Form 10-K Report, EXHIBIT 10.18)\n*EXHIBIT 10.17 - Renewal dated February 21, 1992 of Consulting Agreement dated April 16, 1986 between Reynolds Metals Company and David P. Reynolds. (File No. 1- 1430, 1991 Form 10-K Report, EXHIBIT 10.19)\n*EXHIBIT 10.18 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective May 20, 1988. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1988, EXHIBIT 19(a))\n*EXHIBIT 10.19 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective October 21, 1988. (File No. 1-1430, Form 10-Q Report for the Quarter Ended September 30, 1988, EXHIBIT 19(a))\n*EXHIBIT 10.20 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective January 1, 1987. (File No. 1-1430, 1988 Form 10-K Report, EXHIBIT 10.22)\n*EXHIBIT 10.21 - Amendment to Reynolds Metals Company Performance Incentive Plan effective January 1, 1989. (File No. 1-1430, Form 10-Q Report for the Quarter Ended June 30, 1989, EXHIBIT 19)\n*EXHIBIT 10.22 - Form of Stock Option and Stock Appreciation Right Agreement, as approved February 16, 1990 by the Compensation Committee of the Company's Board of Directors. (File No. 1-1430, 1989 Form 10-K Report, EXHIBIT 10.24)\n*EXHIBIT 10.23 - Amendment to Reynolds Metals Company 1982 Nonqualified Stock Option Plan effective January 18, 1991. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.25)\n*EXHIBIT 10.24 - Amendment to Reynolds Metals Company 1987 Nonqualified Stock Option Plan effective January 18, 1991. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.26)\n*EXHIBIT 10.25 - Letter Agreement dated January 18, 1991 between Reynolds Metals Company and William O. Bourke. (File No. 1-1430, 1990 Form 10-K Report, EXHIBIT 10.29)\n*EXHIBIT 10.26 - Form of Stock Option Agreement, as approved April 22, 1992 by the Compensation Committee of the Company's Board of Directors. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1992, EXHIBIT 28(a))\n*EXHIBIT 10.27 - Consulting Agreement dated May 1, 1992 between Reynolds Metals Company and William O. Bourke. (File No. 1-1430, Form 10-Q Report for the Quarter Ended March 31, 1992, EXHIBIT 28(b))\nEXHIBIT 10.28 - Renewal dated February 18, 1994 of ______ Consulting Agreement dated May 1, 1992 between Reynolds Metals Company and William O. Bourke\nEXHIBIT 11 - Omitted; see Item 8 for computation of earnings per share\nEXHIBIT 12 - Not applicable\nEXHIBIT 13 - Not applicable\nEXHIBIT 16 - Not applicable\nEXHIBIT 18 - None\nEXHIBIT 21 - List of Subsidiaries of Reynolds Metals Company\nEXHIBIT 22 - None\nEXHIBIT 23 - Consent of Independent Auditors ______\nEXHIBIT 24 - Powers of Attorney ______\nEXHIBIT 27 - Not applicable\nEXHIBIT 28 - Not applicable\n____________________________ * Incorporated by reference.","section_15":""}
{"filename":"84567_1993.txt","cik":"84567","year":"1993","section_1":"ITEM 1. BUSINESS =================\nRochester Telephone Corporation (\"Rochester Tel\" or the \"Company\") is a major U.S. diversified telecommunications firm with headquarters in Rochester, New York. The Company was incorporated in 1920 under the laws of New York State to take over and unify the properties of a predecessor company and certain properties of the New York Telephone Company which were located in the same general territory. Currently, the Company's principal lines of business are Telecommunication Services and Telephone Operations. Telecommunication Services consists of a major regional long distance company, cellular and paging operations, and equipment sales. Telephone Operations consists of 37 local telephone companies which serve, as of December 31, 1993, approximately 931,650 access lines in 14 states.\nHistorically, Telephone Operations has provided the majority of the Company's revenues and income. However, an increasing percentage of Rochester Tel's revenues and income is being generated by the Company's long distance and wireless operations. In 1984, the Company made the strategic decision to enter the long distance business. It now provides long distance voice, video and data communication services throughout the United States with its major marketing and sales focus in New York State, New England, and the Mid-Atlantic and Midwest regions. The Company first began providing cellular communications services in the Rochester, New York metropolitan area in 1985. Today, it manages wireless communications operations which serve over 4.3 million potential subscribers in five states.\nPrior to 1988, the Company's Telephone Operations were heavily concentrated in New York State. Since 1988, the Company has acquired 29 local telephone companies and has significantly diversified its geographic base. The Company's largest telephone operation is in Rochester, New York and serves approximately 506,520 access lines. The Company refers to the other 36 telephone companies outside of Rochester, New York as \"Regional Telephone Operations\". This latter group now includes approximately 425,130 access lines and in 1993 reached an aggregate revenue level greater than the Rochester, New York Operating Company.\nA key strategy for the Company is to provide integrated communications services for its customers. These integrated services include long distance, wireless, and local telephone service as well as selected products and services that the Company will remarket to customers as a single source provider. Rochester Tel is committed to growing its business through expansion of its existing businesses, the development of value added products and services, and selected acquisitions.\nOn February 3, 1993, the Company filed a proposal with the New York State Public Service Commission (NYSPSC) to open its Rochester, New York local exchange market to competition. Adoption of the Company's plan would also result in the formation of a Holding Company that would own the various Rochester Tel companies. This filing is discussed in detail under the caption \"Open Market Plan\", at page 13, infra.\nRochester Tel and NYNEX have agreed to form a joint venture, Upstate Partners, to manage and operate certain of their cellular properties located within New York State. This joint venture will serve a territory that includes approximately 4,543,000 potential customers and includes the cities of Buffalo, Syracuse, Rochester, Binghamton, Utica, Elmira and Watertown, New York. One of Rochester Tel's subsidiaries will serve as managing partner of Upstate Partners. This is described in more detail under the caption \"Wireless Communications\", at page 7, infra.\nOn November 3, 1993, the Company announced a management reorganization to address the needs of specific market segments and to operate more cost effectively. The reorganization included the consolidation of redundant systems, a reduction in the number of customer service centers, and a continuing emphasis on streamlining and reducing management layers. Overall, the Company reduced its work force by 7 percent during 1993, and will continue to pursue further reductions in work force levels.\nOn December 20, 1993, the Company announced two transactions. In Alabama, the Company increased its ownership interest in the South Alabama Cellular Partnership from 50.6 percent to 69.6 percent. In addition, the Company has reached a definitive agreement to sell the Minot Telephone Company of North Dakota, representing approximately 26,000 access lines. Both of these transactions are subject to various regulatory approvals.\nOn February 1, 1994, the Company entered into a nonbinding letter of intent for the purchase of a partnership (\"Minnesota Cellular\") which owns the business and assets of a cellular company serving a Rural Service Area (\"RSA\") in Minnesota with a population of approximately 225,000 potential subscribers. The transaction is anticipated to involve the issuance of the Company's Common Stock. The transaction is contingent upon several factors, including the negotiation of a definitive agreement, approval of the Company's Board of Directors, and regulatory approvals.\nOn February 15, 1994, the Company completed a public offering of its common stock. A total of 2,605,500 new shares were issued in connection with this offering. The public offering also included the sale of 2,885,000 shares that were held by a subsidiary of Sprint Corporation.\nThe principal executive offices of the Company are located at 180 South Clinton Avenue, Rochester, New York 14646-0700. The telephone number is (716) 777-1000.\nTelecommunication Services ==========================\nGeneral - - - ------- The Telecommunication Services segment of Rochester Tel is comprised of Network Systems and Services, which provides long distance services, customer premises equipment, and wireless services. The Company's major deregulated business is long distance service. While regionally focused in the Northeast, Mid-Atlantic and Midwest states from a marketing and sales perspective, customers of the Company's long distance business enjoy nationwide and international connectivity. Telecommunication Services' revenues have increased significantly over the past few years and accounted for 34 percent of Rochester Tel's total revenues for the year ended December 31, 1993. The Company intends to expand Telecommunication Services by increasing its existing commercial and residential customer base, continuing to develop new products, and effecting selected acquisitions.\nLong Distance Services - - - ---------------------- The Company provides long distance services primarily through a subsidiary, RCI Long Distance, Inc. (\"RCI\"). RCI routes long distance traffic over its 100 percent digital state-of-the-art network and resells services obtained from other suppliers to route calls to areas where it does not have its own facilities. RCI currently owns and operates seven switching sites. These are located in Rochester, New York; New York City; Washington, D.C.; Philadelphia, Pennsylvania; Cleveland, Ohio; Burlington, Vermont; and Manchester, New Hampshire. RCI is installing a switch in Chicago, Illinois to handle its increased traffic volume in the Midwest. RCI's switched services include basic long distance or measured toll service which is accessible via \"1 + dialing\", 800 services, a variety of long distance products targeted at specific consumer and business segments, and value-added services such as travel cards, prepaid cards and information services. In addition, RCI provides flexible billing services such as multi-location billing, customized accounting codes and electronic billing features.\nRCI currently focuses its marketing efforts in New York State, New England and the Mid-Atlantic and Midwest regions. In these regions, RCI markets its products through a direct sales force, direct marketing campaigns, sales agents and affiliated local exchange carriers. The majority of RCI's revenues are derived from small to medium-sized business customers. RCI has introduced a number of programs designed to attract new long distance customers. For example, the \"Budget Call\" feature enables any telephone user to dial an access code and complete a call through RCI's long distance network. The cost of the call is invoiced by the customer's local telephone company. The rates for such calls are typically 10 percent lower than the rates charged by the major long distance carriers. Budget Call is currently available in five states. This program is anticipated to expand to as many as sixteen states by the end of 1994.\nAs part of the Company's overall service integration strategy, RCI has significantly increased residential usage through its \"Visions Long Distance\" program (as described in \"Telephone Operations-General\" at page 10) where RCI's long distance services are marketed through Company-owned as well as non-affiliated local exchange service providers. Through the Visions Long Distance program, the Company has achieved penetrations in excess of 50 percent in several markets as a result of customer preference for unified billing and service. Because residential long distance calling volumes peak in the evenings, on weekends and on holidays, when commercial traffic tends to be lowest, expanding the residential business increases revenues with virtually no need to increase existing switching and transmission facilities.\nRCI completed two acquisitions in 1993. In June 1993, the Company completed the purchase of Budget Call Long Distance Inc. (\"Budget Call\"), a long distance reseller in Pennsylvania. RCI then began to utilize the Budget Call program, described earlier in this section, throughout its long distance markets. On September 30, 1993, the Company completed the purchase of Mid Atlantic Telecom, Inc., (\"Mid Atlantic\"), an interexchange carrier headquartered in Washington D.C. with operations in New England and the Mid-Atlantic region. Mid Atlantic had more than tripled its revenue in the five years prior to the acquisition to approximately $21 million for the twelve months ended December 31, 1993. Both purchases served to implement RCI's strategy to expand its customer and market base. The Company intends to continue to pursue additional acquisitions to provide greater economies of size and scale to its operation and to extend its customer and market reach.\nThe long distance industry is dominated on a volume basis by the nation's three largest long distance providers, AT&T, MCI and Sprint, which generate an aggregate of approximately 86 percent of the nation's long distance revenue of approximately $59 billion. In each of its markets RCI competes with AT&T, MCI and Sprint, as well as with other national and regional long distance companies, for intercity communications transmission services such as 1 +, dedicated access, 800 service and private line service. The primary bases for competition in the long distance business are pricing, product offering, and service. One element of service includes billing and customer information. The Company intends to continue to compete aggressively in the long distance business.\nWireless Communications - - - ----------------------- Since 1985, the Company has provided cellular service in the Rochester Metropolitan Statistical Area (\"MSA\"), which has a population of approximately one million, in a partnership with ALLTEL Corporation. Rochester Tel has an 85 percent interest in this partnership which currently operates and maintains 25 cell sites in the Rochester, New York MSA. In addition, in April 1993, the Company acquired a 70 percent interest in a cellular system serving the Utica-Rome, New York MSA. The Company also has investments in wireless properties elsewhere in New York State and in Alabama, Georgia, Illinois and Iowa. The Company, through its subsidiaries, is a member of the MobiLink marketing alliance, a nationwide consortium of wireless operators. The Company intends to continue to pursue additional investments in cellular or wireless operations. The Company's preference is to invest in properties which are adjacent to existing Company-owned properties or where a controlling interest can be obtained.\nDespite intense price competition during the construction of its network in the Rochester, New York market, the Company's cellular business has remained profitable since its first full year of service. This business has consistently increased its subscriber base while maintaining an efficient cost structure.\nOn March 12, 1993, the Company and NYNEX signed a definitive agreement to form a joint venture, Upstate Partners, in upstate New York. This agreement was amended in December 1993 to add additional properties to the joint venture. A Rochester Tel subsidiary will operate the 50\/50 joint venture, and has already assumed certain operational responsibilities under an interim consulting contract. Under the joint venture agreement, Rochester Tel will contribute its cellular properties in Rochester, New York, its Utica-Rome Partnership interest, as well as its Rochester, New York area paging operations. NYNEX will contribute its cellular properties in Buffalo, Syracuse, its own minority interests in Utica-Rome and New York State Rural Service Area (\"RSA\") No. 1, as well as the Binghamton and Elmira MSAs. By combining marketing and service efforts and integrating networks, the Company and NYNEX will be able to provide seamless cellular service to a population of more than 4.5 million potential subscribers in upstate New York. This joint venture has been approved by the New York State Public Service Commission (\"NYSPSC\") and is subject to approval of the Federal Communications Commission (the \"FCC\") and the receipt of waivers by NYNEX from the U.S. District Court for the District of Columbia. The Company anticipates receipt of all required approvals by mid-1994.\nCellular systems compete principally on the basis of network quality, customer service, price and coverage area. Each market currently has two cellular providers, and the Company's chief competition in each market is from the other cellular licensee in that market. The Company believes that its technological expertise, emphasis on customer service and development of new products and services make it a strong competitor.\nSeveral recent FCC initiatives indicate that the Company is likely to face greater wireless competition in the future. The FCC has licensed specialized mobile radio (\"SMR\") system operators to construct digital mobile communications systems on existing SMR frequencies in many metropolitan areas throughout the United States. Also, in September 1993, the FCC announced its decision to allocate radio frequency spectrum for personal communications services (\"PCS\"), a form of wireless communication using lower power and more cell sites than current cellular service. The FCC's decision will permit the grant of seven new licenses: two 30 MHz blocks, one 20 MHz block and four 10 MHz blocks. (By comparison, the two cellular carriers in each market currently have 25 MHz of spectrum each.) The Company has committed resources to evaluating the expansion of wireless communications to include PCS offerings and, depending upon the Company's economic evaluations, may participate in the bidding for these new licenses, which is expected to occur in 1994.\nCellular Property Ownership Table ================================= The Company owned the following cellular properties as of December 31, 1993: 1993 Current Pending Estimated Ownership Adjusted Proposed Adjusted Market Population Interest Population Interest Population - - - ------ ---------- -------- ---------- -------- ---------- New York Rochester *1,012,000 85.0% 860,200 42.5% 430,100 Orange- Poughkeepsie 600,000 15.0% 90,000 15.0% 90,000 Binghamton** 305,000 24.0% 73,200 32.5% 99,125 Utica-Rome* 313,000 70.0% 219,100 50.0% 156,500 RSA #2** 231,000 12.5% 28,875 12.5% 28,875 RSA #3* 477,000 22.5% 107,325 22.5% 107,325 Buffalo** 1,180,000 0.0% 0 50.0% 590,000 Syracuse** 665,000 0.0% 0 27.5% 182,875 Elmira** 96,000 0.0% 0 50.0% 48,000 RSA #1 ** 264,000 0.0% 0 20.0% 52,800 Alabama RSA #4 134,000 69.6% 93,264 69.6% 93,264 RSA #6 118,000 69.6% 82,128 69.6% 82,128 Georgia RSA #3 202,000 25.0% 50,500 25.0% 50,500 Illinois RSA #2 250,000 6.7% 16,750 6.7% 16,750 RSA #3 199,000 6.4% 12,736 6.4% 12,736 Iowa Des Moines 411,000 4.0% 16,440 4.0% 16,440 --------- --------- --------- Total 6,457,000 1,650,518 2,057,418\nRTC Total 4,252,000 1,650,518 2,057,418\nTotal Managed Including Supersystem 4,543,000 1,288,700 1,695,600\n* Company managed systems. ** Additional Company managed systems pending completion of the Supersystem in 1994.\nCustomer Premises Equipment - - - ---------------------------\nRotelcom Network Systems (\"Rotelcom\"), which was established in 1978, markets and services a wide range of telecommunications and data equipment for mid- to large-size business customers, and competes directly with other interconnect vendors that market telephone systems to businesses and other enterprises. Rotelcom's product line includes: private branch exchanges (\"PBXs\") from Siemens\/ROLM and Northern Telecom; data communications equipment from leading manufacturers including Dowty and Newbridge; and videoconferencing equipment from PictureTel. The majority of Rotelcom's customers are in New York State. Rotelcom is also a partner in Anixter-Rotelcom, a joint venture telecommunication supply venture with Anixter Bros., Inc.\nTelephone Operations ====================\nGeneral - - - ------- Through its Telephone Operations, the Rochester, New York Operating Company and the 36 other local exchange companies serve, as of December 31, 1993, approximately 931,650 access lines in 14 states. The local exchange carriers provide local, toll access and resale services; sell, install and maintain customer premises equipment; and provide directory services. Since the beginning of 1988, the Company has invested over $560 million in upgrading its Telephone Operations business and over $480 million for the acquisition of independent telephone companies. Over this period, the Company installed advanced digital switching platforms throughout much of its switching network. The Company's network in Rochester, New York is over 99 percent digital, making Rochester one of the largest cities in the United States to be served by a virtually all-digital network. In aggregate, the 36 local exchange companies outside of Rochester, New York have over 91 percent digital capability. This is illustrated in the \"Access Line Table\" located on page 11. The Company has also achieved substantial cost reductions through the elimination of duplicative services and procedures and the consolidation of administrative functions. As of December 31, 1993, Telephone Operations had 37 employees per ten thousand access lines. The Company has reduced the number of telephone employees per ten thousand access lines by over 20 percent since 1988. Rochester Tel believes that additional reductions in employee levels will be necessary to further improve the competitive position of its Telephone Operations. The Company intends to vigorously pursue additional gains in productivity through reengineering while simultaneously improving customer service.\nAccess Line Table =================\nThe table below sets forth certain information with respect to access lines as of December 31, 1993:\nPercent of Total Company Access Telephone Properties at Access Lines at Percent December 31, 1993 Lines December 31, 1993 Digital ======================= ======= ================= ======= Rochester, NY 506,522 54.4% 99.9% Other NY Companies 82,942 8.9% 100% ------- ------ ---- Total New York 589,464 63.3% 100%\nAlabama (1) 26,809 2.9% 100% Georgia 20,693 2.2% 100% Illinois (1) 18,187 2.0% 96% Indiana 4,506 0.5% 100% Iowa 50,582 5.4% 54% Michigan (1) 25,635 2.8% 89% Minnesota 96,680 10.4% 89% Mississippi 5,064 0.5% 100% North Dakota 26,292 2.8% 100% Pennsylvania 33,197 3.6% 100% Wisconsin 34,541 3.6% 100% ------- ------ ---- Total Other States 342,186 36.7% 91% Consolidated Access Lines 931,650 100.0% 96% ======= ====== ====\n(1) These companies also have properties in one or more other states (Florida, Iowa and Ohio).\nThe Company operates 71 central office and remote switching centers in Rochester, New York, and a total of 275 central office and remote switching centers in its other telephone territories. Of the 931,650 access lines in service on December 31, 1993, 669,512 were residence lines and 262,138 were business lines. Long distance network service to and from points outside of the telephone companies' operating territories is provided by interconnection with the lines of interexchange carriers. As part of the Company's continuing strategy to provide a greater selection of value-added products, the Rochester, New York Operating Company introduced advanced services such as Caller ID, distinctive ringing, directory-assisted call completion, and an enhanced voice mail platform during 1992 and 1993. The Company is introducing similar advanced services, where appropriate, at its other telephone properties.\nThe Company is pursuing several alternatives to provide expanded broadband services to its customers. To date, the Company has installed over 10,000 miles of fiber optic cable in the Rochester, New York area to provide its customers with enhanced capacity and product capability. Throughout its telephone operations, Rochester Tel has over 24,000 miles of fiber optic cable in place. The Company is also conducting marketing trials and testing new technologies such as a video on demand service utilizing a hybrid fiber-optic\/coaxial cable network. The Company expects to market this technology to selected customers in its Rochester, New York service area during the second quarter of 1994. The Company is also providing expanded broadband services to select customers outside the Rochester, New York service area. These include video-distance learning arrangements at certain Midwest region telephone properties.\nIn connection with its integration strategy, the Company has developed a new program known as \"Visions Long Distance\", where its local exchange companies resell RCI's long distance services. The Company believes that many customers prefer the convenience of obtaining their long distance service through their local telephone company and receiving a single bill. The Company introduced Visions Long Distance at nine local telephone exchange companies in 1993 and intends to extend the program to additional subsidiaries in 1994. The results of Visions Long Distance operations are included as part of the Telecommunication Services segment.\nTechnological innovation and regulatory change are accelerating the level of competition in both local exchange and long distance services. New competitors now have the ability to provide basic local telephone service in some areas, including Rochester, New York. To benefit from these technological advances and broaden the scope and quality of its own product and service offerings, the Company has increased its fiber and digital switching capacity throughout its networks and is pursuing regulatory alternatives such as the Open Market Plan, which is described in more detail below. Currently, the Company may be considered the primary provider of basic local telephone service in its Rochester, New York property and may be considered the only provider of basic local exchange service in the various other geographic areas where it has telephone properties.\nOpen Market Plan - - - ---------------- On February 3, 1993, the Company filed its Open Market Plan with the New York State Public Service Commission (\"NYSPSC\"). The plan, if adopted, would open the Rochester, New York local exchange market to competition. Rochester Tel was the first communications company in the nation to propose such a plan for full open local competition. The Open Market Plan would enable customers to choose their local telephone service provider and have a broad selection of products, services and prices. It would also give Rochester Tel the flexibility to broaden the scope and quality of its own competitive service offerings.\nUnder the proposed Open Market Plan, the Company's local exchange operations would be divided into two companies--a wholesale provider of basic network services (\"R-Net\") and a retail provider of telecommunication services (\"R-Com\"). R-Net and R-Com would be subsidiaries of the Company, which would become an unregulated parent holding company. The parent holding company structure would provide financial flexibility for the Company to continue the acquisition and diversification efforts that are necessary for its long-term growth.\nR-Net would be a regulated company and would sell basic network services such as access to the network, transport between offices, and switching services to R-Com and all other local telecommunication companies. These local telecommunication companies, including R-Com, would then package services for resale to local customers.\nR-Com would be an unregulated full service provider of a broad array of integrated telecommunication services, including local, long distance, cellular and, potentially, video and other value-added offerings. R-Com would also be able to package the network elements purchased from R-Net and other network providers with services such as flat rate service, measured rate service, Centrex and ISDN. The Company intends that R-Com would eventually offer products and services outside of the Rochester, New York market.\nThe Open Market Plan must be approved by the NYSPSC. Negotiations among all interested parties began in 1993, and determinative action by the NYSPSC is expected during the second half of 1994. The Company will aggressively pursue approval of the Open Market Plan but cannot predict whether or when it will be approved by the NYSPSC, and, if so, in what form.\nRegulatory Matters ==================\nEach of Rochester Tel's local telephone service companies is regulated by the public utility regulatory agency of the state in which that company provides local telephone service. The respective states are listed on the Access Line Table on page 11. The telecommunication industry has become more competitive over time. This evolution has also resulted in a more fluid state regulatory framework. In general, state regulatory agencies exercise authority over the prices charged for the provision of local telephone service and intrastate long distance service, the quality of service provided, the issuance of securities, the construction of facilities and other matters. Each of the Company's long distance and wireless companies may be regulated to a limited extent by the public utility regulatory agency of the state in which each is providing service. The Company's long distance and wireless service providers are also subject to FCC jurisdiction.\n(a) Royalty Proceeding. In 1984, the NYSPSC initiated a proceeding to investigate the issue of whether the Company's competitive subsidiaries should pay a royalty to the Rochester, New York local telephone service provider primarily for the alleged intangible benefits received from the use of the Rochester Telephone name and reputation. This proceeding remains unresolved and is discussed in more detail in Item 3, Legal Proceedings.\n(b) Stipulated Agreement. In 1986, the Company and the NYSPSC entered into an agreement which allowed the Company to pursue certain acquisitions and investments without further Commission approval. This agreement was amended three times, most recently in conjunction with the 1991 acquisition of the Vista Telephone properties in Minnesota and Iowa from Centel Corporation. Certain portions of that amendment expired in June 1993, and the Company requested an extension of the expiration to December 1993. That extension was granted by the Commission in August 1993. In anticipation of a 1994 resolution on the Open Market Plan, the Company has elected to not pursue any further amendment to this agreement at this time. NYSPSC approval is required to effect additional acquisitions by the Company.\n(c) Wireline Transfer. In August 1989, the Company filed a petition with the NYSPSC seeking approval of the transfer of the Rochester, New York Operating Company's interest in the Rochester, New York wireline cellular business to its wholly-owned subsidiary, Rochester Tel Mobile Communications Inc. This application was consolidated with the May 18, 1993 application to form a joint venture with NYNEX to create a \"Supersystem\" in upstate New York. The joint venture is described in more detail on page 4. The NYSPSC approved the application and transfer on December 10, 1993.\n(d) Incentive Regulation. In January 1990, the NYSPSC approved an incentive regulation agreement for the Rochester, New York Operating Company. This agreement expired at the end of 1992, and the Company proposed a new incentive regulation agreement in January 1993. An interim settlement was approved by the NYSPSC in February 1994. The settlement reduces the Company's revenue requirement in 1993 by $5 million and by an additional $4.5 million in 1994. Each of these reductions is subject to adjustment for depreciation changes and the outcome in the Generic Financing Proceeding, which is discussed on page 17. The amount of allowable depreciation is the subject of a contested proceeding before the NYSPSC. Fifty percent of the Rochester, New York Operating Company's earnings in 1994 above the authorized return on equity of 10.9 percent (also subject to adjustment in the Generic Financing Proceeding which is described in more detail below) will be shared with ratepayers, with the specific form of the sharing to be determined by the NYSPSC as a part of the Open Market Plan deliberations. Customers of the Rochester, New York Operating Company will continue to receive service at a quality level no less than that enjoyed in 1992. In the event service deteriorates from this standard, the Rochester, New York Operating Company would be subject to a penalty of one-half of one percent of its local service revenues.\n(e) Ice Storm. In March 1991, Rochester, New York experienced a severe ice storm which caused the Rochester, New York Operating Company to spend approximately $9.7 million to repair and replace outside plant facilities and to provide customers billing credits for service disruptions. The Rochester, New York Operating Company filed a petition with the NYSPSC requesting that it be allowed to defer and amortize the portion of those costs which were intrastate expenses. In November 1991, the NYSPSC approved the deferral and amortization of $5.2 million of the intrastate local service expenses over a forty-eight month period beginning January 1, 1992 and the amortization of $1.6 million of the intrastate long distance service expenses through June 1993. The Rochester, New York Operating Company also filed a petition with the FCC requesting that it be allowed to defer and amortize the portion of the ice storm expenses that were allocated to or assigned the interstate jurisdiction. The FCC approved an order effective January 23, 1992, which permitted the Company to begin the amortization of $2.0 million of interstate expenses over an eighteen month period. In order to recover the expenses, the FCC permitted the Rochester, New York Operating Company to establish a temporary surcharge on interstate switched access charges to be billed to interexchange carriers and a monthly increase in the interstate customer access line charges applicable to Centrex and multiline business customers.\n(f) Canton Telephone Company. The Pennsylvania Public Utility Commission issued an Order to Show Cause on May 29, 1992 against the Canton Telephone Company. The Order required Canton to show cause why Canton's rates were not unreasonable and therefore subject to modification. Canton reached a settlement with the parties. The settlement allows Canton to eliminate prospectively a state tax adjustment surcharge, to flow through state deferred taxes, and to amortize a $451,000 reserve deficiency over three years. Canton agreed to refrain from filing a rate case for three years and the other parties agreed that they would not seek a rate reduction from Canton during this three year period. The Pennsylvania Commission approved the settlement effective December 17, 1992.\n(g) FAS 106. The Company adopted Financial Accounting Standards Board Statement 106 (FAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The estimated accumulated postretirement benefit obligation as of January 1, 1993 is $125 million. The Company elected to defer the recognition of the accrued Transition Benefit Obligation over a period of twenty years. Each state regulatory agency may treat these obligations differently in the rate-making process. On September 7, 1993, the NYSPSC issued its Statement of Policy and Order concerning postretirement benefit and pension accounting. Consistent with this NYSPSC policy the Rochester, New York Operating Company included the FAS 106 costs in its incentive regulation settlement agreement discussed on page 15.\nAlthough the FCC originally rejected the Company's petition to recover the FAS 106 transition costs through the rate-making process, the FCC later allowed the Company, subject to an investigation that remains pending, to recover the portion of the FAS 106 cost associated with the Transition Benefit Obligation (the unrecorded postretirement benefit liability) amortized over a twenty year period. The Company has also appealed the FCC's original order, but cannot, at this time, predict the outcome of that proceeding.\n(h) Tariff Disaggregation Filing. Effective January 1, 1993, the FCC approved the Company's request to disaggregate the switched access rates contained in Rochester Tel's interstate access tariff. Prior to this time, with a few exceptions, Rochester Tel and its telephone company subsidiaries concurred in a uniform set of switched access rates. Effective with this disaggregation, the Company established two sets of switched access rates: one for the Rochester, New York Operating Company; and one for most of the subsidiary operating telephone companies. (Certain of the subsidiary companies continue to concur in the National Exchange Carrier Association tariff. In addition, Rochester Tel's Illinois subsidiaries and its Thorntown Telephone Company subsidiary provide interstate switched access services under company-specific rates.) On a consolidated basis, the change is revenue neutral.\n(i) Open Market Plan. The Company filed a petition in February 1993 with the NYSPSC in which the Company requested approval to reorganize the corporation. This Open Market Plan is discussed in more detail on page 13. A series of meetings have been held with the Staff of the NYSPSC and all intervening parties. Negotiations are in process to reach a stipulated settlement. Although the Company cannot predict whether a settlement is likely to occur, a Commission decision is expected in the second half of 1994.\n(j) Vista Telephone Company of Minnesota. Vista Telephone Company of Minnesota filed a request to increase rates in March 1993 with the Minnesota Public Service Commission. A stipulated settlement was executed by all parties and was submitted for approval to the Minnesota Public Service Commission. The Administrative Law Judge recommended an annual regulated revenue increase of $4.5 million. The Company expects Commission approval during the first quarter of 1994.\n(k) Generic Financing Proceeding. In May 1993, the NYSPSC instituted a Generic Financing Proceeding to review its financial policy guidelines and to determine if there should be established a generic rate of return methodology for New York State local exchange companies. The Company favors a generic methodology because it would streamline the ratemaking process, provide all stakeholders a much greater sense of predictability, and create an environment more conducive to long term planning. The Company supports the implementation of a generic rate of return methodology, but it cannot, at this time, predict the outcome of this proceeding.\n(l) Vista Telephone Company of Iowa. Vista Telephone Company of Iowa filed in August 1993 for a rate increase in Iowa of approximately $4.5 million but with a temporary increase of $4.1 million. On February 11, 1994, the Iowa Utilities Board issued an order approving a proposed settlement of this case. Under the terms of the proposed order, the Board granted Vista Iowa an annual revenue increase of $2.9 million.\n(m) Undergrounding Proceeding. The NYSPSC, in an order dated September 21, 1993, stated that the Company's New York local exchange service providers should, for the next five years, accrue funds for the purposes of \"undergrounding\" construction of distribution plant in \"visually significant areas.\" Any unspent amounts are to be carried over to the next year until expensed. The amount of the accrual is determined in accordance with a NYSPSC approved formula. The Company estimates the total amount of the accrual to be approximately $408,000 for all of its New York local exchange companies. The Company has filed for reconsideration, but cannot predict the outcome at this time.\nCompetition ===========\nAlthough traditionally considered a monopoly, the telecommunications industry has experienced a significant increase in competition in recent years. Rochester Tel is intent on meeting and taking advantage of the various business opportunities which competition provides in the markets where it operates. The Company is addressing competition by focusing on improved customer satisfaction, by developing and offering products and services, and by reducing its cost base and becoming more efficient.\n(a) Local Exchange Networks. Prior to 1968, the telephone industry alone provided and maintained the telephones and lines of the public switched telecommunication network. In that year, an FCC order declared unlawful certain AT&T tariffs which prohibited customers from attaching their own equipment to the telephone network. However, the telephone equipment provided by telephone companies which remained in place on customers' premises, remained regulated. By a subsequent FCC order, effective January 1, 1983, telephone companies were required to deregulate all new telephone equipment. Although Rochester Tel experiences different levels of network regulation throughout the geographic territory of its telephone properties, in general the Company is subject to numerous competitors in the provision of equipment and facilities used in connection with the local exchange network.\nSince the deregulation of telephone equipment, sales of telephone equipment has become commonplace throughout all geographic areas of the United States. The Rochester, New York Operating Company has responded to this competition through operation of its retail Phone Centers for the direct sale of telephone sets, inside wire and telephone outlets. The Phone Centers also perform as maintenance centers where customers who lease equipment from the company can pick up or exchange telephones and receive a credit on their bills if they bring in a telephone that needs repair. In 1982, the Rochester, New York Operating Company formed its Consumer Equipment Services division to maintain all company provided leased equipment as well as maintain customer-owned equipment on a fee for service or contract basis. Many of the Company's other local exchange companies also sell, lease and maintain telephone sets and equipment.\nBusiness consumer equipment needs are another segment of the telecommunication network equipment market. The Company's local exchange companies market equipment and facilities directly to business consumers in much the same way as they market to residential customers. In addition, Rotelcom Network Systems, which was established in 1978, markets and services a wide range of telecommunications and data equipment for mid-to large-size business customers, and competes directly with other interconnect vendors that offer for sale telephone systems to\nbusinesses and other enterprises. Rotelcom's product line includes: private branch exchanges (PBX's) from ROLM, Siemens and Northern Telecom; data communications equipment from leading manufacturers including Dowty and Newbridge; and videoconferencing equipment from PictureTel. The majority of Rotelcom's customers are in New York State. Rotelcom is also a partner in Anixter-Rotelcom, a joint venture telecommunications supply venture with Anixter Bros., Inc.\nAlthough competitive providers of local exchange basic service are not expected to be active for the foreseeable future at the Company's smaller rural properties, local exchange basic service competition is occurring today in the Rochester, New York marketplace. For example, FiberNet, Inc. is an alternative local exchange service provider in Rochester. The Company is unaware of the exact revenues and market share of the local exchange market that FiberNet accounts for in the City of Rochester.\nOn February 3, 1993, Rochester Tel filed a plan with the NYSPSC, to open the local telephone market in the Rochester, New York service area to competition. This plan will enable customers to choose their local telephone service company and have a broader selection of products, services and prices. It will also give the Company greater flexibility to broaden the scope and quality of its own competitive offerings. See the discussion on the Open Market Plan on page 13 and Regulatory Matters on page 17.\nLong distance companies largely access their end users through interconnection with local telephone companies. Those long distance companies pay access fees to the local telephone companies for this service. This is one reason the Company derives at least ten percent of its consolidated gross revenues from AT&T. The Company provides a number of other services to AT&T, such as billing and collection.\nCompanies which provide alternative transmission media now exist and compete with local exchange companies to provide access services to long distance companies. Currently, FiberNet is the only Alternate Access Vendor active in the Rochester, New York area and no significant Alternate Access Vendors are active in any of the Company's other properties.\n(b) Interexchange Service. During the past two decades, rulings by the FCC and associated court decisions have restructured the market for the provision of interexchange telecommunication services and have opened up this market to competition. The Company recognized an opportunity to compete in this market. In 1984, RCI Long Distance was launched and a digital switching and transmission system was built throughout the Northeast. Today RCI operates in New York, New England and the Mid-Atlantic and Midwest regions, an area which accounts for nearly 25 percent of the nation's total interexchange revenues. Through arrangements with other interexchange carriers, RCI provides connectivity to the entire United States and to over 200 countries around the world.\nIn addition to growing its customer base in its original operating territory, RCI has expanded its network coverage and customer base through the acquisition of long distance companies in the Northeast: RCI Long Distance New England Inc., operating as Long Distance North (January 1991) and Taconic Long Distance Service Corp. (July 1991). In 1993, the Company purchased Mid Atlantic Telecom, Inc., a $20 million regional long distance company headquartered in Washington, D.C., and Budget Call Long Distance, Inc., a long distance reseller in Pennsylvania.\nA number of companies, including AT&T, MCI, Sprint and smaller regional long distance companies, compete with RCI and offer interexchange services such as Wide Area Telephone Service (\"WATS\"), private line and switched message toll. Given the competitive nature of the interexchange service industry, RCI is not aware of its exact market share in any specific market, however RCI does not believe that it holds a dominant market position in any market in which it operates.\n(c) Wireless. The Company is the managing partner of Rochester Telephone Mobile Communications (\"RTMC\"), which is a partnership with ALLTEL Corporation. The partnership constructed and now operates a cellular system in all or a part of the five New York counties which comprise the Rochester, New York Metropolitan Statistical Area (\"MSA\") which has a population of approximately 1.1 million potential subscribers. The Company has an 85% interest in the Rochester MSA and ALLTEL Corporation has a 15% interest. Cellular service in the Rochester MSA began on June 5, 1985, and RTMC currently operates and maintains 25 cell sites in the Rochester, New York MSA.\nRTMC is one of two competing cellular systems in the Rochester, New York MSA. The other cellular system is Genesee Telephone Company (\"GTC\") which does business as Cellular One. A proposed sale to Southwestern Bell of a controlling interest in GTC was recently announced. In the cellular industry, competitive characteristics include the geographic coverage area, transmission clarity and the price of the service offerings. Both RTMC and, it is believed, its competitor are believed to be digitally capable, however neither currently provides digital service. Because RTC does not have information on GTC's customer base, it is unable to calculate any specific assessment of its market share.\nIn addition to RTMC, the Company has partnership interests in various other MSAs and RSAs (Rural Service Areas.) Please see the \"Cellular Property Ownership Table\" on page 9 for a breakdown of the Company's cellular ownership interests and the estimated population in each of the indicated cellular markets. Although in the future the Company may divest itself of selected cellular properties, the Company will continue to place a heavy emphasis on cellular service growth and expansion. To this end, the Company recently entered into a nonbinding letter of intent for the purchase of a partnership which owns the business and assets of a cellular provider in Minnesota. Please also see the discussion of the Upstate Partnership's \"Supersystem\" on page 7.\nEnvironmental and Other Matters =============================== Underground duct systems are often used to house telephone cable. Some of the existing ducts are made of a material containing asbestos. This material poses a potential removal and disposal problem if a realignment of the duct system is necessary due to road construction or similar projects. The Company is in the process of identifying the portions of the duct system that contain this material so if need be, action may be taken in a timely fashion to minimize the cost of removal and disposal of such material. The asbestos presents no health risk as long as it remains buried and undisturbed. It cannot be determined how much of the affected underground duct system will undergo future reconstruction and, therefore, an estimate of the cost of asbestos removal and disposal cannot be made at this time.\nSee Item 3. Legal Proceedings, for discussion of environmental litigation.\nEmployees and Labor Relations ============================= As of December 31, 1993, the Company had 4,376 employees, of which 3,444 were employees of the various Telephone Operations businesses, and 932 were employees of the various Telecommunication Services businesses. At the Rochester, New York Operating Company, 578 clerical and service workers were represented by the Rochester Telephone Workers Association (RTWA) and 719 craft and clerical employees were represented by the Communications Workers of America (CWA), Local 1170.\nUnder the current three-year contract between the Rochester, New York Operating Company and the RTWA, effective August 15, 1993 bargaining unit employees received a 1.5 percent general increase plus a .678 percent \"Cost of Living Allowance\" increase. The RTWA contract will expire on August 11, 1994.\nThe current three-year contract between the Rochester, New York Operating Company and the CWA granted bargaining unit employees a wage increase of up to 4.75 percent, effective\nJanuary 1, 1993. Effective January 1, 1994 employees received a wage increase of up to 4.5 percent. On January 1, 1995, employees will receive a wage increase of up to 4.25 percent plus a \"Cost of Living Allowance\" increase based on 70 percent of the movement of the Consumer Price Index above 9.25 percent during the period from November 1992 to November 1994. The CWA contract will expire on January 31, 1996.\nThe International Brotherhood of Electrical Workers (IBEW) represents 155 employees at Highland, 16 employees at Sylvan Lake and 12 employees at AuSable Valley. Highland bargaining unit employees received a 3.85 percent increase in 1993. On May 25, 1993, Highland and the IBEW entered into a contract which expires February 13, 1997, and provides for an increase of 4% in September 1994, 4% in September 1995, and no increase thereafter until the contract is renegotiated. On September 29, 1992, Sylvan Lake and the IBEW entered into a three-year contract extension which provides for an increase of 3.0 percent in year one, 3.5 percent in year two, and 5.0 percent in year three of the contract. The current three-year contract between AuSable Valley and the IBEW granted bargaining unit employees an average wage increase of 3.6 percent effective May 1993, and also provides for an average 3.4 percent wage increase in the final year of the contract. That contract will expire May 10, 1995.\nThe IBEW also represents 20 employees of C, C & S Telco, Inc. Their current contract, which expires in October 1994, granted bargaining unit employees a 3.0 percent increase in October 1993. The IBEW additionally represents 6 employees at Midland, 7 employees at Inland, 1 employee at Lakeside, 1 employee at Prairie, 4 employees at Mt. Pulaski and 19 employees at Minot. On November 1, 1991, Midland, Inland, Lakeside, Mt. Pulaski and Prairie entered into a three-year contract with the IBEW that provided for a 4.0 percent wage increase on November 1, 1993. Effective January 1, 1993, Minot and the IBEW entered into a one-year contract with the IBEW which provided for a 1.5 percent wage increase plus a 1.0 percent lump sum payment based on 1992 wages. A new one year contract between Minot and the IBEW, ratified December 8, 1993, provides for a lump sum payment equal to 3 percent of salary.\nThe CWA, Local 7270, represents 179 employees at Vista Minnesota. On June 21, 1993, Vista Minnesota and the CWA entered into a three-year contract which provides for wage increases of 3.0 percent in June 1994, and a minimum of 2 percent in June 1995, with an opportunity to receive, also in June 1995, up to an additional 1.25 percent based upon the performance of the Vista Minnesota telephone operation. The CWA, Local 7171, represents 95 employees at Vista Iowa. On May 1, 1993, Vista Iowa and the CWA entered into a three-year contract which provides for wage increases of 2.7 percent in May 1994, and a minimum of 2 percent in May 1995, with an opportunity to receive, also in May 1995, up to an additional 1.25 percent based upon the performance of the Vista Iowa telephone operation.\nIn March, 1994, the Rochester, New York Operating Company announced a retirement incentive program which would add an additional five years of age and five years of service credit to covered employees. As of March 15, 1994, 112 management employees, and 69 members of the RTWA had announced their decision to take advantage of this retirement incentive.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ===================\nThe Company's local exchange service providers own, in their respective operating territories, telephone property which includes: connecting lines between customers' premises and the central offices; central office switching equipment; buildings, land and miscellaneous property; and customer premises equipment.\nThe connecting lines include aerial and underground cable, conduit, poles and wires, and microwave equipment. These facilities are located on public streets and highways or on privately owned land. The Company has permission to use these lands pursuant to governmental consent or lease, permit, easement, or other agreement.\nThe central office switching equipment includes electronic switches and peripheral equipment.\nThe Company owns or leases the land and buildings in which its central offices, warehouse space, office and traffic headquarters are located. The consolidated Company's general headquarters are located in a leased seven story building at 180 South Clinton Avenue, Rochester, New York. The lease expires in 2003 and is renewable for two successive ten year periods.\nThe Company's interexchange service providers own property in their respective operating territories which includes: fiber optic cable, switching equipment, microwave equipment, real estate and miscellaneous office and work equipment. The Company's wireless service providers own switching equipment, cell site towers and other site equipment, and miscellaneous office and work equipment.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS ==========================\nOn June 11, 1992, a group of corporate plaintiffs consisting of Cooper Industries, Inc., Keystone Consolidated Industries, Inc., The Monarch Machine Tool Company, Niagara Mohawk Corporation, and Overhead Door Corporation commenced an action in the United States District Court for the Northern District of New York seeking contribution from Rotelcom Inc., a wholly-owned subsidiary of the registrant held through intervening subsidiaries, and fourteen other corporate defendants seeking contribution for environmental \"response costs\" in the approximate amount of $1.5 million incurred by the plaintiffs pursuant to a decree entered into by plaintiffs with the United States Environmental Protection Agency.\nThe consent decree concerned the clean-up of an environmental Superfund site located in Cortland, New York. It is alleged that the corporate defendants disposed of hazardous substances at the site and are therefore liable under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The action is currently in discovery. Rotelcom Inc. has been vigorously defending this lawsuit. However, the Company is unable to predict the outcome at this time.\nIn its Opinion and Order in Case 87-C-8959, issued July 6, 1993, the New York State Public Service Commission (NYSPSC), by a three-to-two vote, imposed a royalty upon the Company in the amount of two percent of the total capitalization of the Company's unregulated operations. The NYSPSC justified the royalty on two grounds: first, that ratepayers are entitled to protection from the potential for cost misallocations and increased risk that accompany diversification of the Company's basic telephone business; and second, that the Company's unregulated operations benefit from their use of the Rochester name and reputation. The NYSPSC rejected the Company's statutory and constitutional defenses and concluded that it possessed the authority under the Public Service Law to impose a royalty and that its imposition is not unconstitutional. Based upon an initial interpretation of the Order, the Company estimates that its potential effect is in the range of two million dollars per year. The royalty, if implemented, would be an imputation against the Rochester, New York Operating Company's revenue requirement from regulated intrastate operations. The NYSPSC ordered the Rochester, New York Operating Company to file, by August 5, 1993, an accounting plan to account for the royalty amount, together with a plan for returning such amount to ratepayers. Although the Rochester, New York Operating Company requested the NYSPSC to waive this requirement, the NYSPSC denied this request. In compliance with the order of the NYSPSC, on August 5, 1993, the Rochester, New York Operating Company filed its plan.\nOn August 6, 1993, the Rochester, New York Operating Company filed with Supreme Court, Albany County, its petition pursuant to Article 78 of the New York Civil Practice Law and Rules seeking judicial review of the NYSPSC's Opinion and Order. By order dated October 7, 1993, this proceeding was transferred to the Appellate Division, Third Department. The Company filed its Brief on December 16, 1993. Respondents' briefs were filed on February 28, 1994, and reply briefs are currently due in mid-March. The Court has scheduled the case for oral argument at its April term. The Company is vigorously contesting this case and is of the opinion that it will ultimately prevail, but cannot predict the outcome with any certainty at this time.\nThe Regulatory Matters discussion in management's discussion of Business in Part I, Item 1, on pages 3 through 4 is incorporated herein by reference.\nCommon stock dividends 1st $ .395 $ .385 $ .375 declared per share: 2nd .395 .385 .375 3rd .395 .385 .375 4th .405 .395 .385 ------ ------ ------ Total dividends per year $1.590 $1.550 $1.510 ====== ====== ======\nNumber of Shareowners (at December 31) Individuals 20,338 19,731 18,641 Brokers, nominees and institutions 421 400 259 ------ ------ ------ Total Shareowners 20,759 20,131 18,900 ====== ====== ======\nITEM 7.","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is presented in pages 1 through 21 of Exhibit No. 13 of this Form 10-K and is incorporated herein by reference.\nExhibit 13 consists of material located at pages 26 through 47 of the Company's Annual Report to Shareowners for the fiscal year ended December 31, 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements, together with the report thereon of Price Waterhouse dated January 17, 1994, is presented in pages 23 through 31 of Exhibit No. 13 to this Form 10-K and are incorporated herein by reference.\nExhibit 13 consists of material located at pages 26 through 47 of the Company's Annual Report to Shareowners for the fiscal year ended December 31, 1993.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item for the Directors of Rochester Telephone Corporation is presented on pages 4 through 6 of the definitive Proxy Statement issued in connection with the Annual Meeting of Shareowners to be held April 27, 1994, which is Exhibit 99 to this Form 10-K and is incorporated herein by reference. That information is incorporated by reference into this Item 10. With respect to the Executive Officers, the following information is submitted.\nOther Positions Held Name Position and During the Past (Age) Offices Held Five Years ----- ------------ ---------------------\nRonald L. Bittner Chairman, President President and Chief (52) and Chief Executive Executive Officer; Officer since April Executive Vice 1993 President - Tele- communications Group\nJeremiah T. Carr Corporate Vice Corporate Vice (51) President and President and President President - Tele- Rochester Telephone phone Group since Operations; President November 1993 - Regional Telephone Operations; President of Rotelcom; Vice President - RCI Consumer Markets; President - RTMC\nDale M. Gregory Corporate Vice Corporate Vice (45) President and President and Presi- President - Tele- dent-Network Systems communication and Services; Group since Corporate Vice November 1993 President and President - Telecommunication Services; President - RCI Network and Systems; Consultant; President and Chief Operating Officer, Advanced Telecommunications Inc.\nLouis L. Massaro Corporate Vice Corporate Vice (47) President-Finance President and Presi- and Treasurer dent-Rochester since February 1993 Operations; Vice President - Tele- communications Group\nFrederick R. Pestorius Corporate Vice Corporate Vice (52) President and President and Presi- President-Rochester dent - Regional Business Markets Telephone Operations; since November 1993 Corporate Vice Presi- dent - Finance, Secretary and Treasurer\nJohn K. Purcell Corporate Vice Corporate Vice (50) President-Corporate President - Partnering and Planning and Presi- Alliances since dent - Wireless November 1993 Operations; Corporate Vice President - Development; Corporate Vice President and President - Telephone Subsidiaries\nJanet F. Sansone Corporate Vice Corporate Vice Presi- (48) President - Human dent - Human Resources Resources and and Excellence; Manager Corporate Services Management and Human since November 1993 Resources Education, General Electric Corporation; Manager Recruiting and University Development, General Electric Corporation\nJosephine S. Trubek Corporate Secretary General Counsel (51) since April 1993 and Secretary; Corporate Counsel and Assistant Secretary\nThe Position and Offices held as set forth above indicates the capacities in which each Executive Officer serves as of March 1, 1994. Each Officer serves for a period of one year or until a successor is elected.\nAdvanced Telecommunications, Inc. as of March 31, 1992, was the fourth largest interexchange service provider in the United States and its common stock was traded on the National Market System.\nGeneral Electric is one of the largest and most diversified industrial companies in the world. Its businesses include interests in a vast array of industrial products, as well as technology, service and communication entities.\nPART III\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is presented on pages 8 through 17 of the definitive Proxy Statement for the Annual Meeting of Shareowners to be held April 27, 1994, under the captions \"Report of Committee on Management,\" \"Performance Graph,\" \"Compensation of Company Management\" and \"Compensation Committee Interlocks and Insider Participation in Compensation Decisions\" and is incorporated in this report by reference. The Company's Proxy Statement is found at Exhibit 99 to this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is presented in the \"Management Security Ownership Table\" under the caption \"Security Ownership of Management\" on pages 6 through 7 of the definitive Proxy Statement for the Annual Meeting of Shareowners to be held April 27, 1994, and is incorporated in this report by reference. The Company's Proxy Statement is found at Exhibit 99 to this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is presented on page 17 of the definitive Proxy Statement for the Annual Meeting of Shareowners to be held April 27, 1994, under the caption \"Certain Relationships and Related Transactions\", together with the cross-reference to page 3 of that definitive Proxy Statement, and is incorporated in this report by reference. The Company's Proxy Statement is found at Exhibit 99 to this Form 10-K.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Index to Financial Statements\nThe financial statements and other information set forth below for the years 1991 through 1993 together with the report thereon of Price Waterhouse dated January 17, 1994, as presented on pages 23 through 31 of Exhibit No. 13 of this Form 10-K, are filed as part of this report:\nReport of Independent Accountants Business Segment Information Consolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Shareowners' Equity Notes to Consolidated Financial Statements\nExhibit 13 consists of material located at pages 26 through 47 of the Company's Annual Report to Shareowners for the fiscal year ended December 31, 1993.\n2. Index to Financial Statement Schedules for the years 1993, 1992 and 1991\nThe financial statement schedules listed below should be read in conjunction with the financial statements appearing on pages 24 through 31 of Exhibit No. 13 of this Form 10-K. Financial statement schedules not included in this Form 10-K Annual Report have been omitted because they are not applicable or the required information is shown on the financial statements or notes thereto.\nReport of Independent Accountants on Financial Statement Schedules\nProperty, Plant and Equipment Sch. V Accumulated Depreciation and Amortization Sch. VI of Property, Plant and Equipment Valuation and Qualifying Accounts and Reserves Sch. VIII Supplementary Income Statement Information Sch. X\nExhibit 13 consists of material located at pages 26 through 47 of the Company's Annual Report to Shareowners for the fiscal year ended December 31, 1993.\n3. See Exhibit Index for list of exhibits filed with this report.\n(b) Reports on Form 8-K.\nThe Company filed no Forms 8-K during the quarter ended December 31, 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Shareowners of Rochester Telephone Corporation\nOur audits of the consolidated financial statements referred to in our report dated January 17, 1994, appearing on page 23 of Exhibit No. 13 (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ PRICE WATERHOUSE PRICE WATERHOUSE\nRochester, New York January 17, 1994\nROCHESTER TELEPHONE CORPORATION SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 and 1991\nIn thousands of dollars 1993 1992 1991 ---- ---- ----\n1.) Taxes, other than payroll and income taxes:\nState and local property taxes $ 20,572 $ 20,645 $ 21,159 State and local taxes on gross revenues 25,813 23,508 22,900 -------- -------- --------\nTOTAL $46,385 $ 44,153 $ 44,059 ======== ======== ========\n2.) Total maintenance and repairs expense $ 92,147 $100,889 $ 89,436 ======== ======== ========\nPursuant 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.\nROCHESTER TELEPHONE CORPORATION (Registrant)\n\/s\/ Ronald L. Bittner Date: March 22, 1994 By ---------------------------- Ronald L. Bittner Chairman, President and Chief Executive Officer\nPursuant 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 and on the dates indicated.\n\/s\/ Ronald L. Bittner Date: March 22, 1994 By ---------------------------- Ronald L. Bittner Chairman, President and Chief Executive Officer and Director\n\/s\/ Louis L. Massaro Date: March 22, 1994 By ---------------------------- Louis L. Massaro Corporate Vice President- Finance and Treasurer (Principal Financial and Accounting Officer)\nDIRECTORS * By --------------------------- Patricia C. Barron Date: March 22, 1994\n* By --------------------------- John R. Block Date: March 22, 1994\n* By --------------------------- Harlan D. Calkins Date: March 22, 1994\n* By --------------------------- Brenda E. Edgerton Date: March 22, 1994\n* By --------------------------- Jairo A. Estrada Date: March 22, 1994\n* By --------------------------- Daniel E. Gill Date: March 22, 1994\n* By --------------------------- Alan C. Hasselwander Date: March 22, 1994\n* By --------------------------- Wolcott J. Humphrey, Jr. Date: March 22, 1994\n* \/s\/ Louis L. Massaro By --------------------------- March 22, 1994 By ---------------------- Douglas H. McCorkindale Louis L. Massaro Date: March 22, 1994 as attorney-in-fact. * Manually signed powers of attorney By --------------------------- for each Director are attached Richard P. Miller, Jr. hereto and filed herewith pursuant Date: March 22, 1994 to Regulation S-K Item 601(b)25 as Exhibit 24. * By --------------------------- G. Dennis O'Brien Date: March 22, 1994\n* * By --------------------------- By --------------------------- Dr. Leo J. Thomas Michael T. Tomaino Date: March 22, 1994 Date: March 22, 1994\nEXHIBIT INDEX\nExhibit Number Exhibit Reference - - - -------------- ------- ---------\n3.1 Company's Restated Certificate Incorporated by reference of Incorporation with all to Exhibit 3 to Form 10-Q Amendments. for the quarter ended September 30, 1980.\n3.2 Certificate of Amendment to Incorporated by reference Certificate of Incorporation. to Exhibit 3-2 to Form 10-K for the year ended December 31, 1984.\n3.3 Company's By-Laws. Filed herewith.\n3.4 Certificate of Change to Incorporated by reference to Certificate of Incorporation. Exhibit 3-4 to Form 10-K for the year ended December 31, 1988.\n3.5 Certificates of Amendment to Incorporated by reference to Restated Certificate of Exhibit 3-5 to Form 10-K for Incorporation. the year ended December 31, 1990.\n4.1 Copy of First Mortgage from the Incorporated by reference Company to Bankers Trust, as to Exhibits 5 and 5-A to Trustee, dated as of April 1, Registration Statement No. 1946 as supplemented by In- 2-6544. denture dated as of July 1, 1946.\n4.2 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 2(b)-6 Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated as of 2-9544. October 1, 1952.\n4.3 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 2(b)-5 to Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated as of 2-10547. November 1, 1954.\n4.4 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 4(b)-4 to Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated as of 2-13091. January 1, 1958.\n4.5 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 4(b)-5 to Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated as of 2-16822. September 1, 1960.\n4.6 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 4-6 to Form 10-K the Company to Bankers Trust for the year ended December Company, as Trustee, dated as of 31, 1980. May 1, 1964.\n4.7 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 2-B(7) to Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated 2-20488. March 1, 1971.\n4.8 Copy of Supplemental Indenture Incorporated by reference to said First Mortgage, made by to Exhibit 2-B(8) to Reg- the Company to Bankers Trust istration Statement No. Company, as Trustee, dated as 2-50804. of March 1, 1975.\n4.9 Copy of Indenture between the Incorporated by reference the Company and Morgan Guaranty to Exhibit 2(b) to Reg- Trust Company of New York, istration Statement No. Trustee, dated as of 2-20488. July 1, 1962.\n4.10 Copy of Indenture between the Incorporated by reference the Company and Morgan Guaranty to Exhibit 2(b) to Reg- Trust Company of New York, istration Statement No. Trustee, dated as of 2-31753. March 1, 1969.\n4.11 Agreement to furnish documents Filed herewith. of subsidiaries.\n4.12 Copy of Indenture between the Incorporated by reference to Company and Manufacturers Exhibit 4-12 to Form Hanover Trust Company, Trustee, 10-K for the year ended dated as of September 1, 1986. December 31, 1986.\n4.13 Copy of First Supplemental Incorporated by reference Indenture to said Indenture, to Exhibit 4(b) to made by the Company to Registration Statement Manufacturers Hanover Trust No. 33-32035. Company, as Trustee, dated as of December 1, 1989.\n4.14 Agreement to Furnish Copies of Incorporated by reference Debt Instruments. to Exhibit 4(c) to Reg- istration Statement No. 33-20698.\n4.15 Copy of 10.46% Non Negotiable Incorporated by reference Convertible Debenture due to Exhibit 4-14 to Form October 27, 2008 from the 10-K for the year ended Company to The Walters Trust. December 31, 1988.\n4.16 Copy of 9% Debenture due Incorporated by reference August 15, 2021. to Exhibit 4-16 to Form 10-K for the year ended December 31, 1991.\n10.1 Copy of the Company's Bonus Incorporated by reference Plan. to Exhibit 10-7 to Form 10-K for the year ended December 31, 1986.\n10.2 Copy of the Company's Restated Incorporated by reference Management Investment and Savings to Exhibit 10-11 to Form Plan\/Management Optional Salary 10-K for the year ended Treatment Plan and Amendment December 31, 1987. No. 1 thereto.\n10.3 Copy of the Company's Long Term Incorporated by reference Disability Plan together with to Exhibit 10-15 to Form Amendment No. 1 thereto. 10-K for the year ended December 31, 1987.\n10.4 Copy of the Company's Restated Incorporated by reference Management Pension Plan and to Exhibit 10-13 to Form Amendments Nos. 1-5 thereto. 10-K for the year ended December 31, 1988.\n10.5 Copy of Amendments Nos. 2 and 3 Incorporated by reference to the Company's Restated Manage- to Exhibit 10-15 to Form ment Investment and Savings Plan\/ 10-K for the year ended Management Optional Salary Treat- December 31, 1988. ment Plan.\n10.6 Copy of the Company's Executive Incorporated by reference Pre-Pension Leave Plan. to Exhibit 10-18 to Form 10-K for the year ended December 31, 1988.\n10.7 Form of management contracts with Filed herewith. each of Mr. Bittner, Mr. Gregory, Mr. Massaro and Mr. Purcell.\n10.8 Copy of Amendments Nos. 4 and 5 Incorporated by reference to to the Company's Restated Exhibit 10-23 to Form 10-K Management Investment and for the year ended Savings Plan\/Management December 31, 1989. Optional Salary Treatment Plan.\n10.9 Copy of Amendments Nos. 6, 7, 8 Incorporated by reference to and 9 to the Company's Restated Exhibit 10-13 to Form 10-K Management Pension Plan. for the year ended December 31, 1990.\n10.10 Copy of the Company's Restated Incorporated by reference to Supplemental Management Exhibit 10-14 to Form 10-K Pension Plan and Amendments Nos. 1 for the year ended and 2 thereto. December 31, 1990.\n10.11 Copy of the Company's Restated Incorporated by reference to Performance Unit Plan. Exhibit 10-15 to Form 10-K for the year ended December 31, 1990.\n10.12 Management contract with Filed herewith. Mr. Pestorius.\n10.13 Copy of Joint Venture Agreement, Incorporated by reference to dated as of March 9, 1993, by and Exhibit 10-13 to Form 10-K between Rochester Tel Cellular for the year ended Holding Corporation and New York December 31, 1992. Cellular Geographic Service Area, Inc. together with Exhibit A thereto.\n10.14 Copy of Cellular Consulting and Incorporated by reference to Other Services Agreement, dated as Exhibit 10-14 to Form 10-K of March 9, 1993, by and between for the year ended Rochester Tel Cellular Holding December 31, 1992. Corporation and New York Cellular Geographic Service Area, Inc.\n10.15 Copy of Amendments Nos. 10 and Incorporated by reference to 11 to the Company's Restated Exhibit 10-19 to Form 10-K Management Pension Plan. for the year ended December 31, 1991.\n10.16 Copy of Amendments Nos. 12 and 13 Incorporated by reference to to the Company's Restated Exhibit 10-16 to Form 10-K Management Pension Plan. for the year ended December 31, 1992.\n10.17 Copy of Amendments Nos. 6, 7 and Incorporated by reference to 8 to the Company's Restated Exhibit 10-20 to Form 10-K Management Investment and Savings for the year ended Plan\/Management Optional Salary December 31, 1991. Treatment Plan.\n10.18 Copy of Amendment No. 9 to the Incorporated by reference to Company's Restated Exhibit 10-18 to Form 10-K Management Investment and Savings for the year ended Plan\/Management Optional Salary December 31, 1992. Treatment Plan.\n10.19 Copy of Amendment No. 1 to the Incorporated by reference to Company's Restated Performance Exhibit 10-21 to Form 10-K Unit Plan. for the year ended December 31, 1991.\n10.20 Copy of Amendment No. 2 to the Incorporated by reference to Company's Restated Performance Exhibit 10-20 to Form 10-K Unit Plan. for the year ended December 31, 1992.\n10.21 Copy of Amendment No. 3 to the Incorporated by reference to Company's Restated Supplemental Exhibit 10-22 to Form 10-K Management Pension Plan. for the year ended December 31, 1991.\n10.22 Copy of Amendment No. 4 to the Incorporated by reference to Company's Supplemental Management Exhibit 10-22 to Form 10-K Pension Plan. for the year ended December 31, 1992.\n10.23 Copy of the Company's Restated Incorporated by reference to Supplemental Retirement Savings Exhibit 10-23 to Form 10-K Plan and Amendment No. 1 thereto. for the year ended December 31, 1991.\n10.24 Copy of Amendment No. 2 to the Incorporated by reference to Company's Supplemental Retirement Exhibit 10-24 to Form 10-K Savings Plan. for the year ended December 31, 1992.\n10.25 Copy of the Company's Employee Incorporated by reference to Assistance Program. Exhibit 10-25 to Form 10-K for the year ended December 31, 1992.\n10.26 Copy of the Company's Tel Flex Incorporated by reference to Plan. Exhibit 10-26 to Form 10-K for the year ended December 31, 1992.\n10.27 Copy of the Company's Directors Incorporated by reference to Stock Option Plan. Exhibit 10-27 to Form 10-K for the year ended December 31, 1992.\n10.28 Copy of the Company's Executive Incorporated by reference to Stock Option Plan and Amendment Exhibit 10-28 to Form 10-K No. 1 thereto. for the year ended December 31, 1992.\n10.29 Copy of Amendment No. 3 to the Incorporated by Performance Unit Plan. reference to Exhibit 10-30 to Form 10Q for the quarter ended March 31, 1993.\n10.30 Copy of amendments Nos. 14, 15 Incorporated by and 16 to the Company's Restated reference to Exhibits 10-31 Management Pension Plan. and 10-32 to Form 10Q for the quarter ended June 30, 1993.\n10.31 Copy of Amendments Nos. 17 and 18 Filed herewith. to the Company's Restated Management Pension Plan.\n10.32 Copy of Amendment No. 5 Incorporated by reference to the Supplemental Management to Exhibit 10-33 to Form 10Q Pension Plan. for the quarter ended June 30, 1993.\n10.33 Copy of Amendment No. 6 Filed herewith. to the Supplemental Management Pension Plan.\n10.34 Copy of Amendments Nos. 10 and 11 Incorporated by reference to the Management Investment and to Exhibit 10-34 to Form 10Q Savings Plan\/Management Optional for the quarter ended Salary Treatment Plan. June 30, 1993.\n10.35 Copy of the Employees' Retirement Filed herewith. Savings Plan.\n10.36 Copy of Amendment No. 3 Incorporated by reference to the Supplemental Retirement to Exhibit 10-35 to Form 10Q Savings Plan. for the quarter ended June 30, 1993.\n10.37 Copy of Amendment No. 2 Incorporated by reference to the Long Term Disability to Exhibit 10-36 to Form 10Q Benefit Plan. for the quarter ended June 30, 1993.\n10.38 Copy of Amendment No. 3 Incorporated by reference to the Long Term Disability to Exhibit 10-40 to Form 10Q Benefit Plan. for the quarter ended September 30, 1993.\n10.39 Copy of the Plan for the Deferral Filed herewith. of Directors Fees and Amendment No. 1 thereto.\n10.40 Copy of the Company's Directors' Filed herewith. Common Stock Deferred Growth Plan\n11 Computation of Fully Diluted Filed herewith. Earnings Per Share.\n13 Portions of the Annual Report Filed herewith. to Shareowners for Fiscal 1993.\n21 Subsidiaries of Rochester Filed herewith. Telephone Corporation.\n23 Consent of Independent Filed herewith. Accountant as Experts.\n24 Powers of Attorney for a Filed herewith. majority of Directors naming Louis L. Massaro attorney-in-fact.\n28.1 Form 11-K Information for Filed herewith. the Company's Management Investment and Savings Plan Including the Management Optional Salary Treatment Plan.\n28.2 Form 11-K Information for Filed herewith. the Company's Craft Savings Plan-I.\n28.3 Form 11-K Information for Filed herewith. the Company's Craft Savings Plan-II.\n28.4 Form 11-K Information for Filed herewith. the Company's Retirement Savings Program for Rochester Telephone Corporation Subsidiary Companies.\n28.5 Form 11-K Information for the Filed herewith. Company's Vista Telephone Company Retirement Savings Plan.\n28.6 Form 11-K Information for the Filed herewith. Company's Vista Telephone Company Retirement Savings Plan for Bargaining Unit Employees.\n28.7 Form 11-K Information for the Filed herewith. Company's Retirement Savings Plan for Affiliated Companies of Rochester Telephone Corporation.\n99 Proxy Statement for the Annual Filed herewith. Meeting of Shareowners to be held April 27, 1994.","section_15":""}
{"filename":"716801_1993.txt","cik":"716801","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL NATURE OF BUSINESS\nThe Company's business is principally divided into three segments: commercial leasing and financing, investments in commercial real property leasing and rental projects, and furniture and equipment sales.\nThe Company's assets primarily consist of: receivables from commercial borrowers; direct finance leases with commercial lessees; and interests in partnerships which own commercial real estate and rent it to others, generally under operating leases.\nAs of December 31, 1993, approximately 79% of such assets were receivables which arose from commercial leasing and financing, and 21% was real property owned by the Company and leased or rented to others under operating leases.\nCOMMERCIAL LEASING AND COMMERCIAL FINANCING\nThe Company conducts its commercial leasing and commercial lending operations, on a national basis, primarily from its corporate headquarters located in Reading, Pennsylvania. Additionally, the Company maintains offices in Crestview Hills, Kentucky (a suburb of Cincinnati, Ohio), and Deerfield, Illinois (a suburb of Chicago). Marketing personnel are also located in Pittsburgh, Pennsylvania; San Diego and Los Angeles, California; and Portland, Oregon.\nThe Company conducts its leasing and lending activities in several ways. A portion of its business is generated with customized sales aid leasing programs for vendors of equipment. Direct customer solicitation programs (telemarketing, mail solicitations, and direct customer visits and referrals) focusing primarily on present and former lessees and commercial borrowers also generate business for the Company. Also, three affinity marketing divisions generate volume for the Company -- American Legal Funding which offers funding programs specifically designed for the legal profession; the Information Systems Funding Group which offers leasing and lending services for the use or ownership of mid-size computers and computer software to businesses; and American Reli Financial which provides leasing and lending services to general equipment rental centers. Additionally, the Company through its General Services Division provides equipment leases and asset-based loans to a broader range of customers not serviced by the three affinity marketing divisions.\nSales aid leasing programs are programs wherein the Company provides full pay out or finance instruments (usually on a nonrecourse basis to the product seller) to assist sellers of commercial equipment in merchandising their products. The Company approves all contracts prior to authorizing purchase of the equipment under the sales aid leasing programs. No one program commitment is expected to exceed 15% of the Company's annual commercial leasing\/lending volume.\nAs of December 31, 1993, the Company held $99,000 in repossessed equipment and equipment returned to it at the conclusion of the lease terms (classified as other assets on the consolidated financial statements). Repossessed and returned equipment is initially recorded at no more than 70% of estimated fair value and is periodically written down until resold. (See \"Furniture and Equipment Sales\".)\nAcquisitions\nOn June 1, 1993, the Company purchased all of the capital stock of Canyon Capital, Inc. (\"Canyon\"), whose principal business consisted of financing and leasing equipment. (See Note R to the consolidated financial statements.) The Company does not intend to operate the acquired business under the trade name Canyon and intends to liquidate the portfolio of leases and loans while soliciting certain lessees for additional new business.\nOn January 31, 1992, the Company purchased substantially all the assets of Reli Financial Corp. (\"Reli\"), whose principal business consists of providing financing to the equipment rental\nindustry. The Company continues to operate this acquired business (as well as the existing rental and financing business) under the trade name \"American Reli Financial\". Reli's pre-acquisition policies, procedures and systems have been evaluated, and integrated with the Company's management practices. Direct solicitation remains the focus activity of this division, and has increased the Company's market penetration through expanded direct marketing efforts and trade show participation.\nDirect Finance Leasing\nFinance leases, often referred to as full pay out or capital leases, are non-cancellable contracts, generally for a longer term than operating leases, under which the original equipment cost to the Company is generally less than the stream of periodic payments to be received from the lessee during the initial lease term.\nThe Company's direct finance leases are those which meet one or more of the following four criteria: (a) the lease transfers ownership of the property to the lessee by the end of the lease term; (b) the lease gives the lessee an option to purchase the property at a price that is sufficiently lower than the expected fair value of the property at the time the option becomes exercisable such that its exercise appears, at the inception of the lease, to be reasonably assured; (c) the lease term is equal to 75% or more of the estimated economic life of the property; or (d) the present value of the minimum lease payments at the beginning of the lease term equals or exceeds 90% of the fair value of the property.\nIn the case of its direct finance leases, the Company retains title to the asset, yet the lessee generally bears the contractual risk of loss and the duty to maintain and insure the asset. The Company's principal exposure on a direct finance lease is the lessee's ability to make payments (i.e., the credit risk); therefore, only after the Company is satisfied of the lessee's credit worthiness and of its ability to make future lease payments, and upon receipt of an executed lease, does the Company issue a purchase order to a manufacturer or vendor for the equipment. Generally, the lessee pays the Company, over the non-cancellable term of the lease, an amount equal to the purchase price of the leased equipment, less its estimated unguaranteed residual value, if any, at the end of the lease term, plus a gross profit. The lessee generally has the option at the conclusion of the term of the lease to either (1) renew the lease; (2) purchase the equipment at its then market value or for a predetermined amount; or (3) return the equipment to the Company. The Company records a direct finance lease on its books as a receivable. The terms of direct finance leases vary in length with the size of the lease and the estimated useful life of the leased property and generally range from 12 to 60 months. The median original term of the Company's direct finance leases is approximately 33 months.\nDirect finance leases are originated through dealer sales organizations, or directly with the lessee. Approximately 35 marketing representatives and support staff present the Company's leasing programs to dealer\/vendors (thereby providing their customers the alternative of lease financing when acquiring various types of equipment), and\/or engage in direct solicitation programs focusing on present and former lessees and also potential new lessees, generally through telemarketing and direct mail solicitation. Because the Company generally purchases equipment from dealers on a nonrecourse basis, the leasing transaction provides a sale for the dealer\/vendor of the product. Frequently, former or existing lessees request to lease additional equipment from the Company. Upon re-examination and approval of the credit risk (including the lessee's credit, capacity to pay, and nature of the leased property) the Company makes a decision to purchase equipment for lease to the direct lessee.\nAs of year-end 1993, the Company owned and serviced 6,390 direct finance lease contracts. No individual lessee had direct finance leases accounting for more than 2.3% of the total finance lease contracts outstanding as of December 31, 1993. (See note C to the consolidated financial statements for concentration of credit risk related to finance receivables.) Direct finance lease\ncontracts (direct finance leasing receivables plus residual valuation less unearned income) totalled $92,532,000 as of December 31, 1993.\nCommercial Financing\nThe Company engages in commercial financing transactions with various commercial customers. Commercial loans are generally secured by inventory, receivables, equipment, or real estate. Installment loan agreements under which a seller of commercial equipment enters into an installment sale of equipment to a buyer are discounted by and assigned to the Company. Criteria to qualify for commercial loans include credit worthiness, ability to make future payments, and the quality of collateral used to secure the loans. As of December 31, 1993, the Company had 2,102 commercial loans totalling $35,050,000.\nAs of December 31, 1993, the Company held $732,000 in real estate from foreclosures on two commercial loans. The real estate is recorded at estimated fair value (net of disposal costs) and is included in other assets on the consolidated financial statements.\nREAL ESTATE\nThe Company, through American Real Estate Investment and Development Co., a wholly-owned subsidiary, is in the business of making and managing investments in commercial real property for itself and on behalf of third party investors. This activity principally involves the formation and management of investment partnerships, asset management, and related advisory and funding activities. The Company's portfolio was acquired through sale\/ leaseback transactions, where existing buildings are purchased and leased back to the seller; build-to-suit projects, where buildings are constructed for lease to a specific tenant; or through the acquisition of specific properties from third parties. In some instances, properties are acquired in joint venture with other investors or management companies. Presently the Company subcontracts all day-to-day asset management responsibilities to third parties with whom the Company works closely.\nThe emphasis the Company places on the activities of buying, managing and\/ or selling properties tends to vary from time to time in concert with the markets and the Company's objectives. Since 1991, the Company has primarily focused on managing and refinancing its properties. Purchases of real estate assets are likely to be considered in 1994 as certain market conditions have improved since the Company ceased acquisition activity at the end of 1991. The Company also is considering the sale of certain individual assets and groups of assets, as it does from time to time. It is likely that certain property sales will be consumated in 1994 based on present marketing activity.\nThe forty-one properties owned and managed as of December 31, 1993 are classified as follows: eighteen are office buildings, twelve are industrial buildings, three are limited service hotels, five are various retail centers, and three are various other commercial properties. Ten of the properties are multi-tenant, excluding the hotels. In these projects, assistance in leasing and other onsite management activities is provided either by co-managing partners local to the project or through third party management companies (or both). The Company is general partner in Hampton Inn hotels in Flint, Michigan, Reading, Pennsylvania, and Allentown, Pennsylvania, and provides hotel management services through American Hotel Management, Inc., a subsidiary of the Company.\nThe Company has in a select few instances made operating loans to individuals or corporate entities in connection with its real estate investment activities. These loans are included in the \"Commercial Financing\" section.\nWrite-down\nThe Company's commercial real estate continues to be affected by the general decline in real estate industry values and poor liquidity. Certain conditions improved in 1993, somewhat mitigating these value declines.\nGenerally accepted accounting principles which govern the Company's reporting of its carrying value of assets do not permit the Company to increase the reported book value (original cost less accumulated depreciation) of properties which increase in fair value. However, properties that are believed to have experienced material decreases below book value, of a permanent nature, must be written down by the Company in the current reporting period at the time of such determination. As of June 30, 1992, eleven properties were believed to have had an estimated current fair value materially below book value. The Company, in order to reflect this value degradation, incurred a charge to earnings, net of deferred taxes and net of losses allocable to minority interests, of $2,773,000 and reduced its share of reported book value in real estate assets by $4,302,000, to $33,836,000. As of December 31, 1993, the Company incurred an additional charge to earnings, net of deferred taxes, of $322,000, and reduced its share of reported book value in real estate assets by $488,000 to $31,419,000.\nManagement used the best information reasonably available to develop its estimates of market value and in the case of any substantial devaluations, the Company has secured appraisals performed by third party appraisers as a basis for establishing current value. The third party appraisals substantially corroborated management's estimates of value. Future changes to these estimates may be necessary if conditions differ substantially from the assumptions used in developing these valuations.\nInvestment in Real Estate Partnerships\nThe following table is a summary of the Company's total investment in and operating results from consolidated and unconsolidated real estate partnerships based on the Company's specific ownership percentages. (See \"Write-down.\")\nInvestment in real estate partnerships increased in 1993 primarily due to the conversion of debt owed by the partnerships to the Company into capital, capital contributions by the Company as part of the restructuring of one partnership, and the purchase of limited partnership interests previously held by third parties.\nInvestment in real estate partnerships decreased substantially in 1992 due to the write-down of property values (see \"Write-down,\"). Excluding the write- down, investment levels in 1992 increased $578,000 from 1991. Substantially all of the increase resulted from the purchase of limited partnership interests in investee partnerships previously held by third parties.\nContinuing the trend begun in 1991, the Company refrained from the making of investments in property acquisitions. From 1989 through 1990, investment in real estate partnerships expanded due to property acquisitions. The Company has not sold a material amount of properties since its inception. It is likely in the near future that property sales will represent a more significant part of the Company's real estate business.\nIncome before taxes from real estate partnerships is the aggregate of the Company's proportionate share of such income from all partnerships in which the Company has ownership interests.\nThis income measure includes both income or loss from operations (i.e., rental income less operating expenses, interest charges, and depreciation), and income or loss from the sale of properties owned by the partnerships. Income before taxes in 1993 and 1992 was negatively impacted by the write-downs described above. Excluding the write-down in 1993, income before taxes was $829,000. Excluding the write-down of $4,302,000 (including an adjustment for $198,000 of losses attributable to minority interests), income before taxes from real estate partnerships in 1992 was $666,000, an improvement from 1991. While a continuation of the positive trend since 1989, the improvement in 1993 and 1992 was substantially attributable to lower interest costs rather than an improvement in the operation of the Company's real estate. In general, this profitability from operations is expected to be negatively affected in future periods as leases expire and reset to prices reflecting the lower rents prevailing in many of the markets in which the Company owns real estate. Vacancy can also impact this income measure, although the Company did not experience significant fluctuations in income due to vacancy in 1993.\nAs is indicated in the above table, in 1993 and 1992 the Company generated only a nominal gain on sale of partnership interests as no meaningful sales activity was conducted. This inactivity was due primarily to poor market conditions resulting from general investor uncertainty over values and concerns over real estate's relative illiquidity. The Company's activities in earlier years had consisted of sales involving one to three partnerships. The Company considers sales based on (i) the Company's need for additional liquidity (ii) the extent to which the Company has access to the market for limited partnership capital, and (iii) the attractiveness of the Company's partnership interests as a vehicle for resale to limited partner investors.\nThe extent of gain on sale of partnership interests is dependent on a number of factors: the selling price (which is dependent on the yields necessary to attract investors as compared with the yields generated by the partnership), selling costs, and the book value of the interests being sold, against which gain is measured. The book value of a given interest is dependent in part on depreciation charges previously taken, which in turn is a function of the length of time the interest has been held prior to sale, and other factors. Because of the interaction of these various factors, the Company's gain on sale of partnership interests has not shown any consistent pattern over the last five years. Because of current economic conditions, the Company does not expect to recognize significant gains from the sale of partnership interests in the near term.\nReal Estate Financing and Contingencies\nThe Company has commercial loans outstanding to, and has guaranteed portions of the debt of, nine unconsolidated real estate partnerships (See notes E and O to the consolidated financial statements): The Company's ownership interest in these partnerships range from 10% to 58.2% in 1993 and 1992. As of December 31, 1993 and 1992, commercial loans outstanding to these partnerships totalled $2,412,000 and $1,408,000, respectively, and the guaranteed portions of the debt of these partnerships were $2,400,000 and $2,675,000, respectively.\nFURNITURE AND EQUIPMENT SALES\nThe Company, through The Business Outlet, Inc., a wholly-owned subsidiary located in a 36,000 square foot showroom\/warehouse in West Reading, Pennsylvania, is in the business of selling new, remanufactured and used office furniture and equipment to the retail and wholesale market place from the West Reading location and through several company sales representatives located throughout central and southeastern Pennsylvania. Also, The Business Outlet, Inc. services the computers, fax machines and copier equipment which it sells.\nThe Company expects to expand this segment of its business by (i) becoming a franchised distributor for certain lines of new office furniture; (ii) expanding the sale of used, remanufactured and reconditioned case goods (file cabinets, desks, shelves, etc.), seating, computer furniture, system furniture (cubicles and panels) and new and reconditioned computers, fax machines and copiers; and (iii) possibly opening additional showroom\/warehouse locations de novo or by acquisition.\nThe Company generated gross revenues from the furniture and equipment sales segment of its business of $1,858,000 in 1993, $1,130,000 in 1992, $281,000 in 1991, $317,000 in 1990 and $184,000 in 1989.\nAdditionally, The Business Outlet, Inc. continues to provide asset related services to the commercial leasing and commercial financing segments of the Company, including: purchase options and personal property tax collections, equipment appraisals, repossession services, and sales of off-lease and repossessed equipment. (See \"Business -- Commercial Leasing and Commercial Financing\".)\nCOMPETITION\nThe Company's business is highly competitive. A great number of financial institutions and others are engaged in the same lines of business as the Company, ranging from small enterprises to national corporations, many of which are substantially larger and have access to greater resources than the Company. The Company's competitors include foreign and domestic commercial and savings banks; investment banks; national and regional leasing companies; manufacturer-related, vendor-affiliated and bank-related leasing companies; diversified financial service companies, insurance companies, other credit grantors, other real estate investment companies and other sellers of new, used and remanufactured office furniture and equipment.\nBased upon information published in the American Banker, the Company ranked as the 62nd largest among all finance companies in the United States as of December 31, 1992, as measured by size of capital funds, which consist of capital, surplus, retained earnings and non-current subordinated debt. Finance companies in the American Banker survey include consumer and commercial finance and equipment leasing companies, but exclude banks and thrifts.\nAmong various types of commercial lenders and lessors, competition relates to such matters as the size and length of contracts, the interest or rental rate and other types of finance and service charges, and the nature of the asset residual risk which the lender or lessor is willing to assume.\nIn addition, equipment leasing companies and commercial finance companies compete with other leasing companies and commercial finance companies on the basis of name recognition, reputation for satisfactory customer service, and retention of customers through acquisition of repeat business.\nEMPLOYEES\nAs of December 31, 1993, the Company had 92 full-time and 6 part-time employees. The Company encourages its employees to participate in college and other professionally-sponsored programs to further their knowledge and professional expertise. Effective January 1, 1994, the Company has a 401(k) plan covering substantially all employees who qualify as to age and length of service. This plan will continue with a profit sharing component. Previously, the Company had two defined contribution profit sharing plans. The Company provides health, life, and disability insurance protection; educational assistance; supplemental health care expense reimbursement; and other standard employee benefits during, but not after, employment with the Company.\nFINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS\nSee note M to the consolidated financial statements for information relating to the Company's total revenues, operating profit, and identifiable assets by industry segments.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPROPERTY\nThe Company owns (through a consolidated real estate partnership) the Horrigan American, Inc. headquarters building in Flying Hills, Reading, Pennsylvania, which also houses the AEL\nLeasing Co., Inc. corporate staff and most of the commercial leasing and lending staff of this subsidiary, and other tenants. This office space is suitable and adequate for the Company's office staff and supporting computer operations, which principally utilize telephone, fax, and computer equipment. The Company also owns (through two consolidated real estate partnerships) the building in which The Business Outlet, Inc. showroom\/warehouse in West Reading, Pennsylvania is located and the building in which The Business Outlet, Inc. leases warehouse space in Fleetwood, Pennsylvania. The Company has space available in these facilities, which should adequately cover its growth requirements.\nThe Company leases its commercial leasing\/lending offices in Deerfield, Illinois (a suburb of Chicago), and Crestview Hills, Kentucky (a suburb of Cincinnati, Ohio). The American Real Estate Investment and Development Co. corporate staff is also located in the Deerfield, Illinois office. Rental expense for the year 1993 for the Company's leased offices was $77,000. These leases expire at various times through March, 1996. (See note N to the consolidated financial statements.) The Company believes that alternative office space is available in all areas.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLITIGATION\nThe Company is party (plaintiff or defendant) to certain legal actions. While any litigation has an element of uncertainty, management, after reviewing these actions with legal counsel, is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\nThere is no trading market for the registrant's common stock of the Registrant. See Item 13, \"Certain Relationships and Related Transactions\" for agreements restricting the right of individual parties to dispose of their stock in the Company.\nAt February 28, 1994, there were 60 holders of common stock of the Registrant.\nCommon stock dividends were paid in January and July of 1993 and 1992. In 1993, total dividends paid were $459,805 on 3,300,298 shares outstanding in January and 3,273,180 shares outstanding in July. In 1992, total dividends paid were $265,034 on 3,323,055 shares outstanding in January and 3,305,047 shares outstanding in July. (See Item 8, \"Consolidated Statements of Changes in Stockholders\" Equity.'')\nSee Item 8, Note J to the consolidated financial statements for covenants which restrict payment of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee accompanying notes to selected financial data.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES NOTES TO SELECTED FINANCIAL DATA\n1. Per Share Amounts Earnings from continuing operations per common share were computed using weighted average shares and dilutive stock options outstanding during each year after giving retroactive effect to the four- for-three stock split in 1989 and after deducting preferred dividend requirements from net earnings, and the purchase of treasury stock in 1993, 1992, 1991 and 1990. Earnings per common share assuming full dilution were not reported because dilution arising from the stock options is less than three percent.\n2. Ratio of Earnings to Fixed Charges The ratio of earnings to fixed charges has been computed by dividing earnings and fixed charges by the fixed charges. Earnings for this purpose includes earnings from continuing operations plus income taxes less equity in undistributed earnings of unconsolidated affiliates. Fixed charges are considered to consist of interest expense attributable to continuing operations and the portion of rentals deemed representative of the interest factor. The ratio of earnings to fixed charges is not expected to change by more than 10% as a\nresult of this offering. The Company guaranteed $2,400,000 of debt of unconsolidated real estate partnerships as of December 31, 1993. The amount of fixed charges associated with this guaranteed debt was $223,000 for 1993. The computation of the ratio of earnings to fixed charges does not include the fixed charges associated with the guaranteed debt because the Company has not been required to honor the guarantees nor is it probable that the Company will be required to honor the guarantees. In 1992, earnings from continuing operations were inadequate to cover fixed charges by $269,000. However, the ratio of earnings to fixed charges is not intended to disclose cash flow from operations. In addition to the normal noncash expenses, such as depreciation and provision for possible lease and loan losses, the provision for write-down of real estate negatively affects the ratio for 1992. The ratio of earnings to fixed charges would be 1.35 if the provision for write-down of real estate were excluded.\n3. Earnings (Loss) from Continuing Operations In 1993, the net earnings included an after-tax charge of $322,000 which resulted from the write-down of the Company's real estate assets by $488,000. Excluding the after-tax effect of this write-down, the Company's results of operations in 1993 were $3,369,000. In 1992, the net loss included an after-tax charge of $2,773,000 which resulted from the write-down of the Company's real estate assets by $4,302,000. Excluding the after-tax effect of this write-down, the Company's results of operations in 1992 were $2,360,000.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEARNINGS (LOSS)\nThe Company generated net earnings of $3,047,000 for 1993 compared to net a loss of $413,000 in 1992 and net earnings of $1,382,000 for 1991.\nAs a result of an overall revaluation of its real estate portfolio, the Company reduced the book value of its real estate assets by $4,302,000 as of June 30, 1992, and incurred a related after-tax, non-cash charge to earnings of $2,773,000. As of December 31, 1993, the Company reduced the book value of its real estate assets by an additional $488,000, and incurred a related after-tax, non-cash charge to earnings of $322,000. (See \"Business -- Real Estate -- Writedown\".) Excluding the after-tax effect of these write-downs, the Company's results of operations in 1993 were $3,369,000, a 42.8% increase from adjusted earnings of $2,360,000 in 1992, and the Company's results of operations in 1992 represented a 70.8% increase from net earnings of $1,382,000 for 1991.\nTOTAL FINANCE REVENUE\nCommercial leasing and financing revenue was $17,401,000 in 1993, $18,869,000 in 1992, and $20,785,000 in 1991.\nThe decrease in commercial leasing and financing revenue in each of the past two years is attributable primarily to lower effective yields on the lease and loan portfolio. Lower yields result from both relatively lower interest rates which tend to depress the Company's lease and loan rates, and to the mix of the Company's newly acquired leases and loans, which has moved to higher transaction sizes where credit quality and rate sensitivity are believed to be higher.\nThe Company's sales efforts have resulted in an increase in total volume of new leases and loans in 1993 compared to 1992. This increase in outstanding finance receivables will increase the average outstanding balance of finance receivables and will begin to offset the effect of lower yields. Net direct finance lease receivables and commercial finance receivables totalled $122,144,000 as of December 31, 1993 compared to $107,985,000 as of December 31, 1992.\nWhile such revenue levels have been lower than preferred by the Company, other factors have favorably impacted the Company, including reductions in interest expense, certain operating expenses, and credit losses.\nFINANCE REVENUE MARGIN\nFinance revenue margin represents the difference between total finance revenues and the amount the Company pays as interest on short-term borrowings and long-term debt allocated to finance receivables. The Company's finance revenue margin was $10,890,000 for 1993, $10,425,000 for 1992 and $10,869,000 for 1991.\nThe Company's finance revenue margin increased $465,000, or 4.5%, in 1993 from 1992. This increase in finance revenue margin was the result of a faster decrease (22.9%) in interest expense than the 7.8% decrease in total finance revenues. The average interest rate at which the Company prices its products decreased 111 basis points to 14.43% in 1993 from 15.54% in 1992. The average interest rate on the Company's borrowings decreased 149 basis points to 6.84% in 1993 from 8.33% in 1992.\nThe Company's finance revenue margin decreased $444,000, or 4.1%, in 1992 from 1991, primarily due to a decline in finance receivables. This decrease in finance revenue margin, however, was less than the 9.2% decrease in total finance revenues, because of a 14.8% decrease in interest expense. The average interest rate at which the Company priced its products decreased 161 basis points to 15.54% in 1992 from 17.15% in 1991. The average interest rate on the Company's borrowings decreased 138 basis points to 8.33% in 1992 from 9.71% in 1991.\nThe 1993 increase in finance revenue margin was due to the purchase of two portfolios of finance receivables, during 1993, at a higher interest rate spread. The Company continues to market higher average balance commercial leasing and financing contracts, with lower yields to achieve improved asset quality and economies of operations. As a consequence, the Company expects a future decrease of its finance revenue margin. The Company's Asset and Liability Committee reviews this risk regularly and manages the matching of debt with these finance receivables.\nPROVISION FOR POSSIBLE LEASE AND LOAN LOSSES\nThe provision for possible lease and loan losses decreased $617,000 (28.2%) to $1,573,000 in 1993 and decreased $2,390,000 (52.2%) to $2,190,000 in 1992. The following table details the components of the provision for possible lease and loan losses as of and for the years ended December 31, 1993, 1992 and 1991.\nThe Company maintains an allowance for possible lease and loan losses based on a periodic evaluation of the finance receivable portfolio. Management considers current economic conditions, diversification of the loan portfolio, historical loss experience, results of loan reviews, borrower's financial and managerial strengths, the adequacy of underlying collateral and other relevant factors in its evaluation. While management uses the best available information to make such evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluation. This allowance reflects an amount that in management's opinion is adequate to absorb known and inherent losses in the portfolio. Receivables which are determined to be uncollectible are charged off against the allowance for possible lease and loan losses, and recoveries on accounts previously charged off are credited to it.\nAs of December 31, 1993, the Company allocated $290,000 of the allowance for possible lease and loan losses in anticipation of future losses on certain individually significant accounts. This allocated allowance decreased $125,000 in 1993 over 1992. As of December 31, 1992, the Company allocated $415,000 of the allowance for possible lease and loan losses in anticipation of future losses on certain individually significant accounts. This allocated allowance increased $83,000 in 1992 over 1991.\nThe Company's net charge-offs of commercial leasing and financing receivables decreased by $427,000, or 21.1%, in 1993 over 1992. The Company's net charge-offs of commercial leasing and financing receivables increased by $1,911,000 or 48.5%, in 1992 over 1991. The decrease in net losses was the result of improved underwriting standards, improved adjusting procedures, aggressive use of legal remedies, strong remarketing efforts, and a somewhat healthier economy.\nThe Company continues to improve its asset quality and control the delinquency of receivables. The Company's tighter credit standards and more focused efforts within several market niches, has enhanced asset quality. In certain situations, larger down payments, additional security deposits, and\/or shorter terms are now required. An asset review committee monitors the quality of the Company's assets. The Company's improved collection and adjusting procedures have resulted in effective control of delinquent receivables. Management believes the allowance for possible lease and loan losses is adequate to cover estimated future credit losses.\nNET OPERATING LEASE REVENUES\nNet operating lease revenues represent rents on real estate and equipment operating leases offset by related interest and depreciation expenses. Net operating lease revenues increased $61,000 or 3.1% in 1993 over 1992, although total operating lease revenues decreased $254,000 or 4.3% to $5,681,000. The decrease in total operating lease revenues is due primarily to decreases in lease revenue resulting from the sale of two properties in 1993 and the write- off of uncollectible rents, offset by rents received on certain properties which were on a non-accrual basis in 1992, and the collection of lease arrearages on three properties. Interest expense attributable to net operating lease revenues decreased $289,000 due to lower interest rates on a portion of the outstanding mortgage debt and less mortgage debt outstanding during the period. Depreciation expense attributable to net operating leases decreased $26,000, primarily the result of the lower basis for certain real estate properties due to the write-down to fair value during 1992, and the sale of two properties, offset by an increase in depreciation due to equipment operating leases generated in 1993.\nNet operating lease revenues increased $666,000 or 51.6% in 1992 over 1991. Total operating lease revenues increased $596,000 or 11.2% to $5,935,000. The increase in total operating lease revenues is due primarily to revenue earned during 1992 on a real estate property acquired in May, 1991, collection of lease arrearages from tenants in three properties, and rental income from two partnerships, previously accounted for on the equity method, now included in the consolidated financial statements due to the Company's acquisition of a controlling interest in these partnerships. Interest expense attributable to net operating lease revenues decreased $157,000 in 1992\nover 1991 due to lower interest rates on a portion of the outstanding debt in 1992. Depreciation expense attributable to net operating leases increased $87,000.\nThe Company's principal objective with its real estate business for the foreseeable future is to (1) manage its properties aggressively, (2) maintain the integrity of the assets through appropriate capital expenditures, (3) accelerate paydown of the debt associated with those properties as available cash flow permits, (4) continue to refinance mortgage debt at more attractive rates, and (5) hold the assets until commercial real estate market conditions improve at which time(s) the Company may consider selling individual properties or groups of properties. Additionally, the Company may consider purchasing real estate assets in 1994 since certain market conditions have improved.\nThe Company's aggregate investment in real estate is not expected to significantly appreciate in value over the next several years. In addition, net operating lease revenues from some existing investments may decline in the short to intermediate term, as rents under many existing leases are expected to remain flat or decrease as leases expire over the next several years. While this will tend to depress the Company's profitability in its real estate operations for a period of time, it is expected that the Company's real estate investments (after third party mortgage debt service obligations and overhead expenses) will continue to provide positive cash flow to the Company.\nThe commercial real estate business is subject to several risks which management reviews on a regular basis. These risks are identified below with the status of each as of December 31, 1993:\n1. Credit risks.\nThere are various levels of credit risks inherent in the Company's lease receivables. A total of $21,200 of rents were thirty or more days past due of which $12,300 represents amounts due from one tenant.\n2. General market conditions nationally or within specific geographic areas.\nThe Company is maintaining an ownership interest, ranging from 10% to 100%, in 41 real estate properties with an original cost of $63,801,000 in the following states, with the percentage of concentration indicated in parenthesis: Pennsylvania (30%), Florida (27%), New Jersey (14%), Ohio (10%) and other (19%).\n3. Greater difficulty in releasing or selling special purpose buildings.\nThe Company's special purpose buildings include three day-care facilities and one nursing home. None are presently for sale and all are fully occupied. The Company also owns and manages three limited- service hotels.\n4. Vacancies.\nPresently there are partial vacancies in seven real estate projects which may require additional cash from the Company until the properties are substantially leased. Management is actively pursuing new tenants for these properties.\n5. Property repairs and improvements.\nPreservation of the quality and value of commercial real estate properties requires that repairs and improvements occur regularly. In a majority of the Company's properties, the obligation to incur such expenditures has been passed to the tenants. Provided the tenants have the financial resources to comply, the Company is able to avoid or defer this responsibility. In other cases, the responsibility is retained by the Company, and repairs and improvements are funded out of current operating lease cash flows or through cash reserves; and if necessary through increased investments or additional borrowings. It is estimated that, not including potential ADA requirements as discussed below, up to approximately $672,000 of improvements may be made within the next twelve months.\nThe timing and amount of repairs or improvements is determined by the operating history and present level of operating lease revenue levels of the property, by the Company's plans\nfor a property (such as a sale, lease, or renovation), and in some cases by regulatory directives. In 1992, the Americans with Disabilities Act (\"ADA\") was passed, requiring the improvement of many properties under certain conditions in order to accommodate the needs of the physically disabled. In certain of the Company's properties, meeting ADA requirements will necessitate improvements at various times. The Company has not finalized its review but estimates that the cost of improvements will not be material relative to the cost of the property.\n6. Inability to obtain the extension or replacement of existing mortgage loans as they mature.\nThe extensions or replacement of existing mortgage loans as they come due continue to involve a higher degree of risk in the current and reasonably foreseeable environment than was previously the case. Such loans, when available, are frequently at lower loan amounts. In 1994, approximately $855,000 of third party mortgage debt will come due and will require negotiation or replacement financing. It is expected that a substantial portion of this debt will be renegotiated for extended terms with existing lenders. To the extent any such debt is not extended in maturity, the Company expects to seek funding from other lenders or provide funding internally, if necessary.\n7. Valuation of real estate properties.\nA decline in the market value of the Company's investment in real estate can provide risk to the Company in several ways. To the extent the declines indicate a reduction in the rentals expected on a property, the Company will experience a decline in operating lease revenues. Also, lower values can reduce the amount of available loan borrowings or equity capital available from third parties to the Company to fund its continued ownership of the properties, and can reduce eventual sale proceeds if properties are sold and values have not recovered.\nIn general, conditions affecting the value of individual properties can change from period to period. Conditions include an extremely wide variety of factors outside the control of the Company. In the case of many of the Company's real estate operating leases, a change in conditions can also include the early termination of a favorable lease caused by a tenant's financial difficulties or the modification of such a lease arising out of the negotiation of a new lease with a tenant. The Company is presently in negotiations involving several of its properties, any of which may result in lower operating lease revenues in future periods.\nAs of December 31, 1993, three properties were believed to have an estimated current fair value materially below book value. Accordingly, these properties were written down as of the date of the determination.\nOTHER OPERATING REVENUES\nOther operating revenues increased $4,283,000 to $2,575,000 in 1993 from a loss of $1,708,000 in 1992. The loss in 1992 resulted from the write-down of the Company's real estate portfolio by $4,302,000 in June 1992. A $488,000 provision for write-down of real estate was recorded in 1993 (see \"Business -- Real Estate -- Write-down\"). Customer service fees decreased $260,000 primarily due to a reduction in insurance premiums earned as a result of the discontinuance of the lease insurance program in mid-1992 and fewer late charges earned. Management income decreased $88,000 primarily due to nonrecurring fees earned in 1992 from the negotiation of the sale of certain equipment. Furniture and equipment sales increased $296,000 due to the entry into the modular furniture business and the achievement of good volume. The Company's share of losses in unconsolidated real estate partnerships decreased $190,000. Gain on sale of debt and equity securities increased $405,000. Other income decreased $74,000.\nOther operating revenues decreased $4,919,000, in 1992 from 1991. $4,302,000 of the decrease is attributable to the provision for write-down of real estate (see \"Business -- Real Estate -- Write-down\"). Customer service fees decreased $179,000 due to fewer leases and loans in 1992, and\nmanagement and broker income decreased $12,000. Furniture and equipment sales increased $291,000 due to the expansion of the service department and improved volume of computer sales. The Company's share of losses in unconsolidated real estate partnerships increased $133,000. Other income decreased $588,000 in 1992 from 1991. Other income in 1992 includes gains of $149,000 from the sale of a building and $69,000 from the disposition of property under a capitalized lease. Other income in 1991 included gains totalling $547,000 recognized on the sale of interests held in three real estate partnerships, and a $44,000 gain from the sale of a building.\nOPERATING EXPENSES\nOperating expenses decreased $152,000 (1.7%) to $8,831,000 in 1993. Salaries, related taxes, and employee benefits decreased $80,000 (1.7%) due to a reduction in number of employees, offset by an increase in incentive compensation. Depreciation and amortization decreased $36,000 (6.0%) primarily due to a reduction in lease insurance expense due to the discontinuance of this program in July 1992, offset by the write-off of deferred costs associated with a mortgage which was subsequently refinanced. All remaining expenses decreased $36,000 (1.0%) due to an across the board reduction in expenses offset by fees paid to third party management companies to assist in managing the day-to-day operations of most of the real estate properties owned by the Company (this increase, however, is offset by a reduction in salary expense for the Company's real estate investment subsidiary) and consultant expenses incurred due to the acquisition of the capital stock of Canyon Capital, Inc. in June 1993 (see \"Business -- Commercial Leasing and Commercial Financing -- Acquisitions\"). Although the Company contained operating expenses based on the above analysis, further expense reductions are necessary due to an anticipated decrease in finance revenue margin.\nOperating expenses increased $533,000 (6.3%) to $8,983,000 in 1992. Salaries, related taxes, and employee benefits increased $160,000 (3.6%) due to the removal of a salary freeze, an increase in incentive compensation, and termination pay for several employees. Depreciation and amortization decreased $165,000 (21.7%) due to fewer asset acquisitions. All remaining expenses increased $538,000 (16.8%) due primarily to an increase in real estate expenses incurred by two real estate partnerships previously accounted for on the equity method, now included in the consolidated financial statements due to the Company's acquisition of a controlling interest in these partnerships.\nPROVISION FOR INCOME TAXES\nIncome taxes for 1993 were $1,900,000; for 1992 were $144,000 (including $241,000 of state income taxes for the Company's profitable subsidiaries); and for 1991 were $888,000. The effective income tax rates for 1993, 1992 and 1991 were 37.4%, 28.8% and 38.0%, respectively (see note L to the consolidated financial statements). The effective tax rate is higher than the statutory federal income tax rate due principally to the provision for state income taxes, net of federal tax benefit.\nIncome taxes for 1993 increased $1,756,000 due to higher pre-tax income. Income taxes for 1992 decreased $744,000 due to a pre-tax loss, principally the result of the net provision for real estate write-down which provided a $1,310,000 income tax benefit.\nEffective January 1, 1993, the Company adopted SFAS No. 109. The cumulative effect of this change in the method of accounting for income taxes is $0 to the 1993 consolidated statement of operations (see note A to the consolidated financial statements).\nNET INVESTMENT IN FINANCE RECEIVABLES AND PROPERTY UNDER OPERATING LEASES\nNet direct finance lease receivables and commercial finance receivables totaled $122,144,000 as of December 31, 1993 compared to $107,985,000 as of December 31, 1992, a net increase of $14,159,000 for the year. Property under operating leases, net of accumulated depreciation, decreased $3,108,000, resulting from normal depreciation, the sale of two properties, and the write- down of certain real estate properties (see \"Business -- Real Estate -- Write- down\".)\nThe increase in finance receivables was in accordance with the Company's growth plans. The Company's sales efforts have generated a larger volume of new leases and loans in 1993 due to increased penetration into focus markets, while maintaining the Company's policy of tight credit standards. In addition, the Company obtained the lease and loan portfolio of Canyon as part of the purchase of that company on June 1 (see \"Business -- Commercial Leasing and Commercial Financing -- Acquisitions\"), and the Company purchased a lease and loan portfolio for $3,914,000 in cash on September 30. Future originations will be dependent to a large extent upon economic conditions and the Company's ability to sell services in a competitive market environment. The Company continues to look for opportunities to acquire portfolios of leases and loans which will compliment the Company's existing finance receivables.\nThe change in property under operating leases is in accordance with management strategy. Due principally to the reduced availability of mortgage debt financing and the illiquidity in most commercial real estate markets (including those in which the Company owns properties), the Company, at the present time, is primarily holding its assets for investment purposes, except in limited circumstances, since the Company ceased acquiring properties in 1991. Purchases of real estate assets may be considered in 1994 since certain market conditions have improved. Sales are considered at various times depending on such factors as pricing, capital needs, and tenant interests.\nLIQUIDITY\nLiquidity represents the Company's ability to meet ongoing financial obligations. The Company's ongoing liquidity is dependent upon continued profitability and collection of its receivables and rentals, the ability to sell equipment or collect purchase option payments at the conclusion of maturing equipment leases, the sale of Subordinated Investment Certificates, the ability to secure new senior debt (loans from banks and other financial institutions), the ability to secure real estate mortgage financing, to sell real estate, and to sell equity interests in real estate partnerships, and other financing, and the ability to expand furniture and equipment sales activities.\nNet cash provided by continuing operating activities was $7,175,000 for 1993, $7,411,000 for 1992 and $7,044,000 for 1991.\nThe Company's direct finance lease receivables and equipment operating leases are funded primarily with unsecured senior debt. The Company generally attempts to match new leases with borrowings of like maturity and amount in which the interest rate is fixed at the time of the borrowing. Additionally, the Company borrows term debt with varying maturities and short-term floating interest rate debt, and uses Subordinated Investment Certificate debt. The Company's commercial finance receivables are similarly match funded by various forms of unsecured senior debt and Subordinated Investment Certificate debt. The Company has unused lines of credit totalling $51,871,000 as of December 31, 1993. (See \"Capital Resources\").\nThe Company's investment in real estate (property under operating leases) is leveraged substantially with borrowings by the Company. Much of the debt is comprised of mortgage loans securing individual properties. Of the mortgage debt, a substantial amount is nonrecourse to the Company, with the balance being recourse through guarantees by Horrigan American, Inc. or its real estate subsidiary. Of the investment in real estate not funded with mortgage debt, a substantial amount is funded indirectly by the Company with Subordinated Investment Certificate debt.\nIn the opinion of management, the Company's liquidity position is sufficient under present circumstances.\nCAPITAL RESOURCES\nFuture growth of the Company will depend in significant measure on its ability to obtain additional lines of credit and other financing, the continued sale of Subordinated Investment\nCertificates, the sale of equity interests in real estate partnerships and continued profitability. As of December 31, 1993, the Company had the following debt structure:\nTotal stockholders' equity increased by $2,647,000 from December 31, 1992 to December 31, 1993 due to the net earnings of $3,047,000 for 1993 and the net unrealized holding gains for available-for-sale securities ($1,374,000), offset by the payment of dividends ($475,000) and the purchase of treasury stock ($1,373,000).\nRefer to Notes H and I to the consolidated financial statements for disclosure of the outstanding short-term and long-term debt, including lines of credit information. In the opinion of management, the Company's capital resources are sufficient under present circumstances to satisfy its capital requirements based upon present asset growth projections, current leverage, continued profitability and historic ability to secure new sources of borrowings.\nINFLATION\nThe Company's financial statements, and the related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which generally require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operation of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of general levels of inflation.\nINTEREST RATES\nInterest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. Management believes that continuation of its efforts to manage the\nrates, liquidity and interest sensitivity of the Company's assets and liabilities is necessary to generate an acceptable return on assets and return on equity.\nInterest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest margins through periods of changing interest rates.\nInterest rate risks arise when interest-earning assets mature or when their rates of interest change in time frames that are different from those of interest-bearing liabilities. The matching of assets and liabilities may be analyzed by examining the extent to which they are \"interest rate sensitive\" and by monitoring an institution's interest rate sensitivity \"gap.\" An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest- earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.\nThe rate of growth in interest free sources of funds (e.g., stockholders' equity) will influence the level of interest sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest sensitivity gap is only one factor to be considered in estimating the net finance revenue margin. The Company monitors and adjusts the gap position, taking into consideration current interest rate projections, and maintaining flexibility if rates move contrary to expectations.\nAs of December 31, 1993, the Company had a three-month negative cumulative gap of 3.7%, a six-month negative cumulative gap of 3.8% and a twelve-month negative cumulative gap of 2.4% on total earning assets of $146,464,000. The cumulative gaps for years two through ten ranged from 18.5% positive to 3.1% positive. These percentages are reflective of scheduled principal payments only and have not been adjusted for anticipated early pay-offs. The relatively short duration of many of the Company's earning assets indicates that the interest rate sensitivity gap will probably remain within its present, rather narrow, margin under current market interest rate conditions. Management believes the Company's cumulative gap ranges are satisfactory for achieving acceptable net interest margins.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nAUDITED FINANCIAL STATEMENTS\nPrepared for filing as Item 8 of Annual Report (Form 10K) to the Securities and Exchange Commission for the Year Ended December 31, 1993.\nINDEPENDENT AUDITORS' REPORT\nTHE BOARD OF DIRECTORS HORRIGAN AMERICAN, INC.\nWe have audited the accompanying consolidated balance sheets of Horrigan American, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horrigan American, Inc. and subsidiaries as of December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note A to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, and Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, in 1993.\nKPMG PEAT MARWICK\nFebruary 2, 1994 Philadelphia, Pennsylvania\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- SUMMARY OF ACCOUNTING POLICIES A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.\nPrinciples of Consolidation The consolidated financial statements include the accounts of Horrigan American, Inc., eight wholly-owned subsidiaries (American Equipment Leasing Co., Inc., AEL Leasing Co., Inc., American Commercial Credit Corp., AEL Holdings, Inc., Horrigan American Securities, Inc., American Real Estate Investment and Development Co., American Hotel Management, Inc. and The Business Outlet, Inc.), and thirty real estate partnership investments, wherein the Company is maintaining a controlling interest, ranging from 10% to 100% (the Company).\nAll significant intercompany balances and transactions have been eliminated in consolidation.\nInvestments in ten real estate partnerships, wherein the Company is not maintaining a controlling interest, are stated at cost plus equity in undistributed net earnings since dates of acquisition.\nMinority interest, as reported in the consolidated balance sheets, includes the income or loss for the minority investors of real estate partnerships. This minority interest balance fluctuates due to current year income or loss, contributions to, and distributions from, the partnerships; changes in ownership percentages; or the addition or deletion of partnerships from the group of consolidated partnerships.\nInvestments in Debt and Equity Securities In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115). This statement requires investments in equity securities with a readily determinable fair value and investments in all debt securities to be classified at the date of acquisition in one of three categories. The three categories are (1) held to maturity -- carried at amortized cost; (2) available for sale -- carried at fair value (with unrealized gains and losses flowing through a separate component of stockholders' equity); and (3) trading account -- carried at fair value (with unrealized gains and losses flowing through the income statement).\nEffective December 31, 1993, the Company adopted SFAS No. 115. The fair value of securities is based on quoted market prices. The cumulative effect of this change in the method of accounting for the Company's investments in securities is $1,374,000 and has been included as a separate component of stockholders' equity as of December 31, 1993. Prior to 1993, the Company carried all debt securities at amortized cost (because it had the intent and ability to hold such securities until maturity) and all equity securities at the lower of aggregate cost or market.\nNet Investment in Finance Receivables Net investment in finance receivables consists of commercial leasing and financing receivables, and lease residual value receivables. Receivables are stated at gross balances net of unearned income and net of the allowance for possible lease and loan losses.\nReal Estate Investment Activity Included in Equity Investments in Real Estate Partnerships and Property Under Operating Leases are various investments in commercial real estate. This activity principally involves the formation and management of investment partnerships, property management, and related advisory and funding activities. The forty-one properties owned and managed as of December 31, 1993 are classified as follows: eighteen are office buildings, twelve are industrial buildings, three are limited service hotels, five are various retail centers and three are various other commercial\nNOTE A -- SUMMARY OF ACCOUNTING POLICIES -- CONTINUED properties. Ten of the properties are multi-tenant, excluding the hotels. Significant geographic concentrations (based on property cost) within the portfolio are: Pennsylvania (30%), Florida (27%), New Jersey (14%) and Ohio (10%).\nReal estate properties are recorded at the lower of cost or net realizable value. Properties that are believed to have experienced material decreases in net realizable value below book value, of a permanent nature, are written down in the current reporting period at the time of such determination. In making such determinations, consideration is given to such factors as cash flows, reserves, vacancy factors, capitalization rates and growth rates.\nOn a periodic basis, or upon the occurrence of a triggering event (e.g., default of a major tenant), management performs an internal valuation on such properties. These valuations reflect current expectations relating to cash flows, reserves, vacancy factors, capitalization rates and growth rates. If such valuation results in the devaluation of a property, which management believes is other than temporary, that valuation is recognized as a charge to earnings in the current period.\nRevenue Recognition The accounting for nonrefundable fees and costs associated with originating or acquiring loans and initial direct costs of leases is presented in accordance with Statement of Financial Accounting Standards No. 91.\nIncome on direct finance leases included in the minimum lease payments is deferred and earned on the interest method to reflect a constant periodic rate of return on the net investment in the lease. Residual values of leased equipment represent the estimated fair value of the equipment at the conclusion of the lease. Residual values for direct finance leases are earned on the interest method over the life of the related leases.\nIncome on commercial finance receivables is earned on the interest method to reflect a constant periodic rate of return.\nThe accrual of income on finance receivables is discontinued once a finance receivable becomes one day past due. Also, when in management's judgment it is determined that a reasonable doubt exists as to the collectibility of additional income, future payments are applied to the principal balance only, and the finance receivable is classified as non- performing.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS No. 114). This statement requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. SFAS No. 114 becomes effective for the Company in 1995, although earlier adoption is permitted. Management is currently analyzing the impact of SFAS No. 114 and does not expect this statement to have a material effect on the Company's consolidated financial position or results of operations.\nRentals from equipment operating leases are recognized as income when due. Depreciation is provided on the double declining-balance method over the useful life of the equipment as follows: transportation and machinery equipment -- five years; office, data processing and other equipment -- four to five years.\nRentals from real estate operating leases are recognized as income when due. Depreciation is provided on the straight-line method over the useful life of the property: nineteen to thirty-one and one-half years.\nAllowance for Possible Lease and Loan Losses The allowance for possible lease and loan losses is based on a periodic evaluation of the finance receivable portfolio and reflects an amount that in management's opinion is adequate to absorb known and inherent losses in the portfolio.\nNOTE A -- SUMMARY OF ACCOUNTING POLICIES -- CONTINUED\nManagement considers a variety of factors when evaluating the allowance recognizing that an inherent risk of loss always exists in the lending process. Consideration is given to the impact of current economic conditions, diversification of the loan portfolio, historical loss experience, results of loan reviews, borrower's financial and managerial strengths, the adequacy of underlying collateral and other relevant factors. While management uses the best available information to make such evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluation. The provision for possible lease and loan losses is charged to operating expense. Lease and loan losses are charged directly against the allowance and recoveries on previously charged- off leases and loans are added to the allowance.\nInterest Rate Swaps Interest rate swaps are entered into as hedges against fluctuations in the interest rates of specifically identified liabilities. There is no effect on the total liabilities of the Company, however, net amounts receivable or payable under agreements designated as hedges are recorded as adjustments to the interest expense related to the hedged liability.\nProperty and Equipment Depreciation on fixed assets (not including property leased to others) is provided primarily by the straight-line method over the estimated useful lives of the respective asset classes as follows: building and improvements -- five to forty years; office and data processing equipment -- two to eight years.\nIncome Taxes Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109) requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEffective January 1, 1993, the Company adopted SFAS No. 109. The cumulative effect of this change in the method of accounting for income taxes is $0 to the 1993 consolidated statement of operations.\nPursuant to the deferred method under APB Opinion 11, which was applied in 1992 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.\nRetirement and Postemployment Benefits Effective January 1, 1994, the Company has a 401(k) plan covering substantially all employees who qualify as to age and length of service. This plan will continue with a profit sharing component. During 1993, 1992 and 1991, the Company had two defined contribution profit sharing plans. The contribution percentage is determined each year by the Board of Directors of each subsidiary of the Company. Profit sharing expense, aggregating $315,000, $295,000 and $290,000 in 1993, 1992 and 1991, respectively, was reported as salaries and employee benefits. The Company currently has no postretirement benefits as contemplated under Statement of Financial Accounting Standards No. 106, nor postemployment benefits as contemplated under Statement of Financial Accounting Standards No. 112.\nNOTE A -- SUMMARY OF ACCOUNTING POLICIES -- CONTINUED\nEarnings Per Common Share Earnings per common share are computed using weighted average shares and dilutive stock options outstanding during each year after deducting preferred dividend requirements from net income. Earnings per common share assuming full dilution are not reported because dilution arising from the stock options is less than three percent.\nReclassifications Prior period amounts have been reclassified when necessary to conform to the current year's presentation.\nNOTE B -- INVESTMENTS IN DEBT AND EQUITY SECURITIES The following is a summary of information as of and for the years ended December 31:\nNOTE C -- NET INVESTMENT IN FINANCE RECEIVABLES Net investment in finance receivables and maximum terms remaining as of December 31, 1993 and 1992 are as follows:\nNOTE C -- NET INVESTMENT IN FINANCE RECEIVABLES -- CONTINUED\nInstallments due on total receivables for each of the five years subsequent to December 31, 1993 are as follows: 1994, $65,665,000; 1995, $40,410,000; 1996, $20,133,000 1997, $7,802,000; 1998, $2,669,000; and thereafter, $2,691,000.\nIncluded within the finance receivables are non-performing leases and loans on which the Company is applying payments to principal only. Such receivables approximated $101,000 and $700,000 as of December 31, 1993 and 1992, respectively. If these receivables had been current in accordance with their original terms, finance revenue in 1993, 1992 and 1991 would have increased $39,000, $100,000 and $63,000, respectively.\nThe Company's credit risk of finance receivables arises in the normal course of business, principally from commercial businesses, throughout the United States with some geographic concentration (based on equipment cost) in California (18%), Pennsylvania (9%), Texas (7%), New York (6%) and Ohio (6%). There is also some leased asset equipment concentration in computers and computer software (31%), construction (24%) and party rental equipment (10%). The Company has identified the following significant concentrations by industry type (including the total net investment) of credit risk as of December 31, 1993: Equipment Rental ($41,778,000), Attorneys ($16,936,000) and Printing Services ($8,447,000). The Company retains title to the equipment asset in the case of its direct finance leasing receivables, while the lessee bears the contractual risk of loss and the duty to maintain and insure the asset. The commercial financing receivables are generally secured by inventory, receivables, real estate or equipment.\nNOTE D -- ALLOWANCE FOR POSSIBLE LEASE AND LOAN LOSSES\nThe following is a summary of the Company's allowance for possible lease and loan losses as of and for the years ended December 31:\nNOTE E -- EQUITY INVESTMENTS IN REAL ESTATE PARTNERSHIPS Investments in ten unconsolidated real estate partnerships consist of total ownership interests ranging from 10% to 58.2%.\nSummary combined financial information for the investee partnerships as of and for the years ended December 31, 1993 and 1992 follows:\nNOTE E -- EQUITY INVESTMENTS IN REAL ESTATE PARTNERSHIPS -- CONTINUED\nThe unamortized portion of the excess of cost over the Company's share of net assets of investee partnerships was $56,000 and $43,000 as of December 31, 1993 and 1992, respectively.\nThe Company provides management services to the investee partnerships under terms of an agreement. The revenue for these services, aggregating $230,000, $223,000 and $246,000 in 1993, 1992 and 1991, respectively, was reported as management income.\nThe Company has commercial loans outstanding to investee partnerships of $2,412,000 and $1,408,000 as of December 31, 1993 and 1992, respectively. The Company has also guaranteed the debt (refer to note O) of certain unconsolidated real estate partnerships.\nThe Company has sold certain partnership interests. Total gain on sale of the partnership interests, aggregating $0, $1,000 and $547,000 in 1993, 1992 and 1991, respectively, was reported as other income.\nNOTE F -- PROPERTY UNDER OPERATING LEASES The following is a schedule of the Company's investment in property under operating leases as of December 31, 1993 and 1992:\nDepreciation for each of the three years ended December 31 follows:\nThe estimated minimum future rental revenues on operating leases for each of the five years subsequent to December 31, 1993 are as follows: 1994, $4,689,000; 1995, $4,051,000; 1996, $3,507,000; 1997, $3,046,000; 1998, $2,943,000; and thereafter, $21,504,000.\nNOTE G -- PROPERTY AND EQUIPMENT Property and equipment utilized by the Company is summarized by major classifications as follows as of December 31:\nLand and building value is based on the percentage of space occupied by the Company. For the years ended December 31, 1993, 1992 and 1991, depreciation of $308,000, $294,000 and $328,000, respectively, was provided on the Company's property and equipment.\nNOTE H -- SHORT-TERM BORROWINGS Short-term borrowings represent: (1) Amounts payable to banks, including unsecured demand notes with fixed interest rates and unsecured floating or fixed interest rate lines of credit of $28,503,000 as of December 31, 1993. The Company has the option to make $7,003,000 in long-term, fixed rate loans at negotiated rates which would reduce the available short-term lines of credit when elected. Short-term lines of credit in use as of December 31, 1993 are $13,500,000. (2) Amounts payable upon demand to holders of floating interest rate subordinated investment certificates.\nThe following is a summary of information pertaining to such borrowings as of and for the years ended December 31:\nNOTE I -- LONG-TERM DEBT\nLong-term debt as of December 31, 1993 and 1992 consists of the following:\nThe Company has $100,190,000 in unsecured lines of credit with banks. The total lines in use as of December 31, 1993 are $63,322,000.\nThe aggregate maturities of long-term debt for each of the five years subsequent to December 31, 1993 are as follows: 1994, $52,538,000; 1995, $26,185,000; 1996, $11,611,000; 1997, $4,772,000; 1998, $4,008,000; and thereafter, $14,201,000.\nNOTE J -- CERTAIN COVENANTS The terms of the subordinated investment certificate offerings, certain unsecured loan agreements and a bank letter of credit provide for various restrictive covenants. The most significant of these provide that: (1) American Equipment Leasing Co., Inc. and it's subsidiaries, AEL Leasing Co., Inc. and American Commercial Credit Corp., on a consolidated basis, shall maintain (a) a minimum cash flow ratio of receipts to disbursements, as specifically defined, of 1 to 1 (b) a ratio of debt to tangible net worth not in excess of 7 to 1 and (c) a minimum tangible net worth of $21,000,000. (2) AEL Leasing Co., Inc. and American Commercial Credit Corp., on a separate Company basis, shall maintain a ratio of debt to tangible net worth not in excess of 7 to 1.\nThe Company is in compliance with the above covenants as of December 31, 1993.\nNOTE K -- STOCKHOLDERS' EQUITY\nThe 8% noncumulative and nonvoting preferred stock has no earnings participation rights and, in case of involuntary liquidation, there is no preference to preferred stockholders other than the stated value of the stock. The preferred stock dividend was paid each quarter during 1993.\nThe common stock of the Company is covered by an agreement restricting its sale, redemption or transfer.\nDuring 1993, the Company retired all treasury stock then held by the Company.\nThe Company terminated on November 30, 1992 a non-qualified stock option plan for certain key employees. The options are exercisable at a price of 100% of the fair market value of the stock on the date that the option is granted. Options granted under the plan are exercisable at any time and expire five years from the date of issuance. An analysis of the activity in this plan for the last three years follows:\nUnder this stock option plan, the option price for the grant made in 1991 was $6.43 per share.\nThe total options outstanding, by each year's option price, as of December 31, 1993 are: 21,000 at $7.41, 23,900 at $7.79 and 30,070 at $6.43.\nNOTE L -- INCOME TAXES The total provision for income taxes consists of:\nNOTE L -- INCOME TAXES -- CONTINUED\nThe sources of deferred income taxes (benefits) and the tax effect of each are as follows:\nThe following is a reconciliation between the statutory federal income tax rate and the effective income tax rate on the total provision for income taxes:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1993, in accordance with SFAS No. 109, are presented below:\nIn order to fully realize the gross deferred tax asset, the Company will need to generate future taxable income of approximately $7,900,000. Based upon the Company's current and historical tax history and the anticipated level of future taxable income, management of the Company believes the existing deductible temporary differences will, more likely than not, reverse in future periods in which the Company generates net taxable income. There can be no assurance, however, that the Company will generate any earnings or any specific level of continuing earnings.\nNOTE L -- INCOME TAXES -- CONTINUED\nFor income tax reporting purposes: The Company has no credit carryover to offset regular tax liability during 1993.\nFor financial reporting purposes: (1) The Company records a provision for income taxes on the minority interest share of loss absorbed by the Company from any partnership investment. (2) The Company has no credit carryover to offset regular tax liability during 1993. (3) The Company records a deferred tax liability on the net unrealized holding gains for available-for-sale securities in accordance with SFAS No. 115.\nNOTE M -- BUSINESS SEGMENTS The Company operates principally in three business segments, reports a fourth segment pertaining to general corporate and other, and discloses any significant transaction which is not specifically related to the normal operations of a segment:\nCOMMERCIAL LEASING AND FINANCING -- leasing of various types of equipment under direct finance and operating leases, lease financing programs, and direct cash loans to commercial businesses.\nREAL ESTATE -- leasing of real estate property under operating leases, and investments in real estate. Three limited service hotel operations provide operating earnings on three equity investments. Real estate management, development and advisory services; and hotel management services are included.\nFURNITURE AND EQUIPMENT SALES -- selling various types of office furniture and equipment, and servicing equipment sold.\nGENERAL CORPORATE AND OTHER -- includes investment activities other than real estate; and consolidating elimination entries which are not material.\nUNALLOCATED GENERAL CORPORATE EXPENSE -- consists of interest expense allocated to the investments in marketable securities and long-term investments.\nRevenues by segment are comprised of revenues from unaffiliated customers; intersegment revenues are not significant.\nOperating profit is total revenue less directly incurred costs and expenses, and allocated corporate operating costs and expenses.\nIdentifiable assets by industry are those assets of the Company that are used exclusively in or are reasonably allocated to operations in each industry. Assets employed by the segment \"general corporate and other\" are principally cash, investments exclusive of the real estate industry segment, and property and equipment.\nThe following segment information is reconciled to the related consolidated financial statements' amounts.\nNOTE M -- BUSINESS SEGMENTS -- CONTINUED\nNOTE N -- LEASES Rental expense included in operating expenses for each of the years in the three-year period ended December 31, 1993 was $77,000, $64,000 and $10,000, respectively. The Company also incurred rent expense on an operating lease with an investee partnership. The rent expense, aggregated $53,000 in 1991, and was reported as operating expense.\nAs of December 31, 1993, the Company is committed to minimum rentals under various operating leases totaling $115,000. The minimum annual rentals for each of the five years subsequent to December 31, 1993 are as follows: 1994, $70,000; 1995, $38,000; 1996, $6,000; 1997, $1,000; and 1998, $0.\nNOTE O -- COMMITMENTS AND CONTINGENCIES In the normal course of business, there are outstanding commitments and contingent liabilities on which management does not anticipate any material losses. Such commitments and contingent liabilities expose the company to various degrees and types of risks, including credit risk, interest rate risk, and liquidity risk.\nA summary of significant commitments and contingent liabilities as of December 31 follows:\nUnused lines of credit represent conditional offers by the Company to lend additional funds to qualified customers. Commitments to fund leases and loans represent finance agreements secured by the Company wherein the equipment collateral has not yet been delivered. Financial guarantees are conditional commitments issued by the Company guaranteeing performance by an unconsolidated real estate partnership to a third party.\nInterest rate swap transactions are not reflected in the above table. The notional principal amounts of outstanding contracts were $2,000,000 and $3,000,000 as of December 31, 1993 and 1992. The weighted average maturity of these swap agreements was 2.2 and 0.7 years as of December 31, 1993 and 1992. The Company is exposed to loss should one of the counterparties to these agreements default when the variable rate exceeds the weighted average fixed rate. The weighted average rate paid by the Company was 4.25% and the weighted average rate received by the Company was 3.44% as of December 31, 1993.\nThe Company's Employee Stock Option Plan (ESOP) terminated in 1993 and paid off the outstanding ESOP debt which was guaranteed by the Company.\nAs of December 31, 1993, the Company was party (plaintiff or defendant) to certain legal actions. While any litigation has an element of uncertainty, management, after reviewing these actions with legal counsel, is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of the Company.\nIn connection with a state sales tax audit and the treatment of abandonment leases, the Company was assessed in 1992 an additional sales tax of $34,800 (net of income tax) and penalties and interest of $284,400 (net of income tax). During 1992, the Company paid and expensed $27,700 (net of income tax). During 1993, the Company expensed the balance due of $14,400 (net of income tax) after the penalties were waived and 94% of the interest reversed.\nNOTE P -- CASH FLOW INFORMATION The following is the reconciliation of net earnings (loss) to net cash provided by operating activities for the years ended December 31:\nThe following is a schedule of noncash investing and financing activities for the years ended December 31:\nNOTE Q -- FAIR VALUES OF FINANCIAL INSTRUMENTS The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (SFAS No. 107), which requires the estimation of fair values of financial instruments, as defined in SFAS No. 107. Limitations Estimates of fair value are made at a specific point in time, based upon, where available, relevant market prices and information about the financial instrument. Such estimates do not include any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. For a substantial portion of the Company's financial instruments, no quoted market exists. Therefore, estimates of fair value are necessarily based on a number of significant assumptions (many of which involve events outside the control of management). Such assumptions include assessments of current economic conditions, perceived risks associated with these financial instruments and their counterparties, future expected loss experience and other factors. Given the uncertainties surrounding these assumptions, the reported fair values represent estimates only and, therefore, cannot be compared to the historical accounting model. Use of different assumptions or methodologies are likely to result in significantly different fair value estimates. The estimated fair values presented neither include nor give effect to the values associated with the Company's existing customer relationships, property, equipment, goodwill or certain tax implications related to the realization of unrealized gains or losses. The following methods and assumptions were used by the Company to estimate the fair value as of December 31, 1993 of each class of financial instrument (refer to note B for the fair value of investments in debt and equity securities). Net Investment in Finance Receivables The fair value of net investment in finance receivables with variable rates and no significant change in credit risk approximates the carrying amount. The fair value of fixed-rate finance receivables is estimated by discounting future cash flows using current rates at which similar leases and loans would be made to borrowers with similar credit ratings and for similar remaining maturities. Included in direct finance leasing receivables is the fair value of lessee purchase options which approximates the net residual valuation carrying amount.\nShort-term Borrowings The fair value of short-term borrowings (refer to note H) is the amount payable. Customer deposits Customer deposits are interest bearing and non-interest bearing deposits received on finance lease receivables and real estate operating leases. The carrying amount of these deposits approximates fair value. Long-term debt The fair value of the Company's fixed rate long-term debt is estimated using discounted cash flow analyses based on the estimated current rates offered by banks to the Company for debt of similar remaining maturities, or current rates offered by the Company for subordinated investment certificate debt with similar remaining maturities. The fair value of floating rate long- term debt approximates the carrying amount. Unused lines of credit Proceeds from both short-term and long-term lines of credit are issued at current market rates at the time of each borrowing. The fair value of such unused lines is considered nominal. Commitments Unused lines of credit and commitments to fund leases and loans: the Company does not charge a fee to extend lines of credit and commitments to fund leases and loans to customers. Extension of credit is conditional upon Company approval (of the amount, rate, and maturity) at\nNOTE Q -- FAIR VALUES OF FINANCIAL INSTRUMENTS -- CONTINUED the time of request. The fair value of unused lines of credit and commitments to fund leases and loans is considered nominal. Financial guarantees for unconsolidated real estate partnerships: the Company receives nominal fees for two agreements, and the estimated cost to terminate such guarantees is considered nominal. Interest rate swap agreements: the fair value of interest rate swaps is based on the cost to terminate the agreement. The costs were obtained from the counterparties. The carrying amounts and estimated fair values of the Company's financial instruments as of December 31 were as follows:\nNOTE R -- ACQUISITION\nOn June 1, 1993, the Company purchased all of the capital stock of Canyon Capital, Inc. (\"Canyon\") whose principal business consisted of financing and leasing equipment, for $4,270,000 in cash. Until the purchase, Canyon was a wholly-owned subsidiary of KOA Holdings, Inc. The purchase price was based principally on the book value of the common stock multiplied by a factor of 126.8%. The acquisition has been accounted for as a purchase and, accordingly, the results of operations of Canyon have been included in the Company's consolidated financial statements since the acquisition date. The following unaudited pro forma financial information for the years ended December 31, 1993 and 1992 presents the combined results of operations of the Company and Canyon as if the acquisition had occurred as of the beginning of 1992, after giving effect to certain adjustments. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Canyon constituted a single entity during such periods.\nIn conjunction with the Company's acquisition of Canyon, Canyon recorded a total net loss of $139,000 for the five months ended May 31, 1993 (consisting of non-recurring after-tax charges of $269,000 and normal after-tax operating earnings of $130,000). The non-recurring after-tax charges were primarily due to additional charge-offs ($1,383,000) taken by Canyon and a replenishing of the allowance for possible lease and loan losses ($498,000) prior to the acquisition date. These additional adjustments were the result of applying the Company's more restrictive charge-off and reserving policies to Canyon's delinquent lease and loan accounts.\nINDEPENDENT AUDITORS' REPORT\nTHE BOARD OF DIRECTORS CANYON CAPITAL, INC.:\nWe have audited the accompanying balance sheets of Canyon Capital, Inc. as of December 31, 1992 and 1991, and the related statements of earnings, stockholders' equity, and cash flows for each of the years in the two year period ended December 31, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Canyon Capital, Inc. as of December 31, 1992 and 1991, and the results of its operations and its cash flows for each of the years in the two year period ended December 31, 1992, in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK\nOrange County, California February 9, 1993\nCANYON CAPITAL, INC.\nBALANCE SHEETS\nDECEMBER 31, 1992 AND 1991\nSee accompanying notes to financial statements.\nCANYON CAPITAL, INC.\nSTATEMENT OF EARNINGS\nYEARS ENDED DECEMBER 31, 1992 AND 1991\nSee accompanying notes to financial statements.\nCANYON CAPITAL, INC.\nSTATEMENTS OF STOCKHOLDER'S EQUITY\nYEARS ENDED DECEMBER 31, 1992 AND 1991\nSee accompanying notes to financial statements.\nCANYON CAPITAL, INC.\nSTATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1992 AND 1991\nSee accompanying notes to financial statements.\nCANYON CAPITAL, INC.\nNOTES TO FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness and Organization Canyon Capital, Inc. (the \"Company\") is a wholly-owned subsidiary of KOA Holdings Inc. (the \"Parent Company\") and is in the business of providing equipment financing to small businesses under direct financing leases. A portion of the Company's business (approximately 10% in 1992 and 8% in 1991) is leasing printing equipment to franchisees of Sir Speedy, Inc., also a wholly-owned subsidiary of the Parent Company.\nInvestment in Leases In accounting for direct financing leases, no income is recorded initially. The finance charges are deferred and subsequently amortized to income over the respective lease terms to produce a level rate of return on the unrecovered investments.\nResidual values are unguaranteed and represent amounts estimated to be recoverable on disposition of the equipment at the end of the lease terms. The Company periodically reviews the residual value estimates to ascertain if any impairment to the carrying value has occurred. Writedowns to the carrying values are recorded when identified. Gains are recorded only when realized. Terms of leases vary from two to five years; the majority are written for five years.\nDeferred Lease Origination Fees and Costs All fees and direct costs associated with the origination of leases are deferred and amortized to operations over the respective lease terms using the interest method. The amortization of fees is recorded as an adjustment to yield while the amortization of direct costs is recorded as an operating expense.\nAllowance for Possible Credit Losses The provision for possible credit losses is charged to operating expense based on management's evaluation of the lease portfolio, including residual values. It is management's policy to maintain the allowance for possible credit losses at an adequate level to absorb losses that may occur in the lease portfolio.\nEquipment Held for Lease Equipment held for lease consists of new and used equipment and is carried at the lower of cost or market on a specific identification basis.\nFurniture and Equipment Furniture and equipment are stated at cost less accumulated depreciation, which is charged to expense on a straight-line basis over the estimated useful lives of the related assets, principally five years.\nIncome Taxes The Company files a consolidated Federal tax return with the Parent Company. Tax expense is determined on a separate return basis.\nDeferred income taxes are provided for temporary differences arising from the classification of leases as operating leases for tax purposes and capital leases for financial reporting purposes in accordance with the provisions of Statement of Financial Accounting Standards No. 96, \"Accounting for Income Taxes\" (\"FASB 96\"). The Financial Accounting Standards Board has issued Statement 109, \"Accounting for Income Taxes\" (\"FASB 109\") which will supersede FASB 96. FASB 109 must be adopted in the first quarter of fiscal 1993 and may be adopted either prospectively or retroactively. The Company believes that the implementation of FASB 109 will not have a material impact on its financial statements.\n(2) INVESTMENT IN LEASES\nThe gross maturities of lease receivables at December 31, 1992 are as follows: Year Ended December 31, ------------------ 1993 $ 9,851,280 1994 7,420,065 1995 4,386,768 1996 1,927,787 1997 902,698 --------------- $24,488,598 --------------- ---------------\nLease receivables totaling $14,506,096 and the underlying leased equipment are pledged under equipment obligations (Note 5)\nThe credit risk associated with the Company's lease receivables arises in the normal course of business throughout the United States, with some geographic concentration. Geographic concentrations (based on gross lease receivables) exist in California (68%) and Arizona (6%). The Company has identified the following significant concentration by industry type (based on gross lease receivables) of 23% for the printing industry.\n(3) TRANSACTIONS WITH PARENT COMPANY AND AFFILIATES\nThe notes payable to Parent Company totaling $4,300,000 and $3,300,000 at December 31, 1992 and 1991, respectively, are subordinated to the Company's equipment obligations. Interest is payable monthly at the prime lending rate plus 1% and totaled $254,186 in 1992 and $104,142 in 1991. The prime lending rate as of December 31, 1992 was 6%.\nThe Company purchases equipment from Sir Speedy, Inc. for lease to Sir Speedy franchised printing centers; such purchases totaled approximately $225,000 in 1992 and $350,000 in 1991. Included in gross lease receivables at December 31, 1992 were three leases to affiliates totaling approximately $17,000.\n(4) FURNITURE AND EQUIPMENT\nFurniture and equipment are stated at cost less accumulated depreciation as follows: 1992 1991 -------- ------- Furniture and equipment $110,959 106,843 Accumulated depreciation (90,193) (78,393) -------- ------- $ 20,766 28,450 -------- ------- -------- -------\n(5) EQUIPMENT OBLIGATIONS\nEquipment obligations consist of debt incurred in acquiring equipment for lease and are secured by the related lease receivables and underlying equipment. Interest rates on these obligations range from 7.5% to 11.25%. Interest expense averaged 10.6% in 1992 and 11.9% in 1991. Maturities of equipment obligations as of December 31, 1992 are as follows: Year Ended December 31, ------------------ 1993 $3,543,212 1994 2,448,991 1995 1,532,768 1996 724,670 1997 223,773 -------------- $8,473,414 -------------- --------------\n(6) LEASE INCOME\nLease income is summarized as follows:\n(7) INCOME TAXES\nIncome tax expense (benefit) consists of:\nActual income tax expense differs from the amount computed by applying the statutory Federal income tax rate of 34% to earnings before income tax expense as follows:\nTemporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the $972,000 deferred tax liability at December 31, 1992 relate to differences arising from the classification of leases as operating leases for tax purposes and capital leases for financial reporting purposes.\n(8) COMMITMENTS\nThe Company has a two-year operating lease commitment for rental of its office space requiring rental payments totaling $42,000 per year in 1993 and 1994.\nRental expense totaled $44,148 and $37,423 in 1992 and 1991, respectively.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nUNAUDITED PRO FORMA CONSOLIDATED\nCONDENSED STATEMENT OF OPERATIONS\nThe attached pro forma financial information gives effect to the acquisition of Canyon Capital, Inc. (\"Canyon\") by the Company. The pro forma consolidated condensed statements of operations for the year ended December 31, 1992 reflects the operations of the combined entities as though the acquisition has been made at the beginning of 1992. It should be read in conjunction with the historical consolidated financial statements and notes thereto of the Company and Canyon as of and for the year ended December 31, 1992.\nThe pro forma financial information does not purport to be indicative of the actual results of operations that would have occurred if the acquisition had been consummated on the date indicated or that may be obtained in the future. Adjustments in anticipation of cost savings through consolidation of the Company and Canyon are not included.\nThe pro forma adjustments reflected in the pro forma statements of operations include adjustments to amortize the discount on the acquired net investment in finance receivables; to record the interest incurred on funds borrowed to fund the purchase and to refinance all outstanding debt of Canyon, and to remove Canyon's historical interest expenses; and to apply the Company's estimated incremental income tax rate. The pro forma statement of operations does not reflect a five-year covenant not to compete entered into as part of the acquisition, or the amortization thereof, because the amount is contingent upon future recoveries of previously charged off accounts. The amount, if any, will be amortized, beginning in the period in which the amount is determined, using the straight line method over the remainder of the five year term.\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nUNAUDITED PRO FORMA CONSOLIDATED CONDENSED\nSTATEMENT OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1992\n($ IN THOUSANDS, EXCEPT PER SHARE DATA)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nMANAGEMENT\nThe names and positions of the executive officers and directors of Horrigan American, Inc. (including certain executive officers of certain of its subsidiaries) are shown below. Also shown is the year in which each was first elected as an officer or director of Horrigan American, Inc. (or of its predecessor, Horrigan Companies, Inc.) or of the relevant subsidiary.\nAll of the officers except Richard W. Horrigan devote substantially all of their time to the activities of the Company.\nEach director serves until the next annual meeting of shareholders and until his successor is duly elected and qualified. All officers are elected to annual terms and serve at the pleasure of the Board of Directors.\nJOHN F. HORRIGAN, JR., is Chairman of the Board of Directors and Assistant Secretary of the Company, and a director and an executive officer of each of its operating subsidiaries. He has been employed by the Company since 1953. Mr. Horrigan is a member of the Banking-Securities Liaison and Governmental Affairs Committees of the Pennsylvania Financial Services Association, Harrisburg, Pennsylvania.\nRICHARD W. HORRIGAN is Vice Chairman of the Board of Directors and Treasurer of the Company and of its leasing and commercial financing subsidiaries. Mr. Horrigan is associated with the Company part time; his principal occupation is President of Dick Horrigan Volkswagen, Inc. and\nPresident of Dick Horrigan, Inc., both of Reading, Pennsylvania. Mr. Horrigan is a member of the Berks County Regional Advisory Committee of Meridian Bancorp, Inc., Reading, Pennsylvania; and Past Chairman of the Board and member of the Executive Committee of the American Imported Automobile Dealers Association, Washington, D.C.\nARTHUR A. HABERBERGER is President, Chief Executive Officer, Assistant Secretary, and a director of the Company and of its leasing and commercial financing subsidiaries; and a director and an executive officer of each of its other operating subsidiaries. He has been employed by the Company since 1963. Mr. Haberberger is a member of the Industry Future Council of the Equipment Leasing Association of America, Arlington, Virginia. Mr. Haberberger is also a director of Sovereign Bancorp, Inc. (and a director of its subsidiary, Sovereign Bank, F.S.B.), Wyomissing, Pennsylvania.\nW. MICHAEL HORRIGAN is Senior Vice President, Assistant Secretary, and a director of the Company, and a director and Executive Vice President of its leasing and commercial financing subsidiaries and a director of its furniture and equipment sales subsidiary. He has been employed by the Company since 1971.\nSIDNEY D. KLINE, JR., is a director of the Company and of its leasing and commercial financing subsidiaries. He is a principal in the law firm of Stevens & Lee, Reading, Pennsylvania. Mr. Kline is also a director of Meridian Bancorp, Inc., and two of its subsidiaries (Meridian Bank and Meridian Asset Management, Inc.), The Bachman Company, and Reading Eagle Company.\nJOHN A. MULLINEAUX, JR., is a director of the Company and of its leasing and commercial financing subsidiaries. Since February 1993, Mr. Mullineaux has been President of Fenner Manheim, Manheim, Pennsylvania, a division of Fenner, Inc. From September 1990 until February 1993, he was Vice President and General Manager of Fenner Manheim, and from October 1984 until September 1990, he was Vice President, Finance, of Fenner Manheim. He is also a director of Fenner, Inc. Mr. Mullineaux is a certified public accountant.\nELIZABETH HORRIGAN RATHZ is a director of the Company and of its leasing and commercial financing subsidiaries. Ms. Rathz has been employed as an investment banking consultant with CoreStates Financial Corp., Philadelphia, Pennsylvania, since 1993. From 1986 to 1993, she was employed with CoreStates in the Investment Banking Division, where she held the position of Assistant Vice President from 1987 to 1988 and Vice President from 1988 to 1993.\nALTHEA L. A. SKEELS is a director of the Company and of its leasing and commercial financing subsidiaries. Since March 1990, she has been Executive Vice President of Rittenhouse Financial Services, Inc., a registered investment advisory firm headquartered in Radnor, Pennsylvania. From 1975 to March 1990, Ms. Skeels was employed by Deloitte & Touche and its predecessor firm, Touche Ross & Co., and was a partner in the firm since 1987. Ms. Skeels is a certified public accountant.\nRICHARD W. HORRIGAN, JR., is a director of the Company and of its leasing and commercial financing subsidiaries. Since 1989, he has been Vice President of Customer Service and Finance with Wilkerson Corporation in Englewood, Colorado. From 1986 to 1989, Mr. Horrigan was employed with Whirlpool Kitchens, Denver, Colorado, serving last as Vice President of Finance. He currently serves as a director of the Continuing Professional Education Board for the Colorado Society of Certified Public Accountants, and as a director and treasurer of the Financial Executive Institute, Rocky Mountain Chapter. Mr. Horrigan is a certified public accountant.\nJOANNE HABERBERGER is Senior Vice President, Chief Human Resources Officer, and Secretary of the Company, Vice President and Secretary of its leasing and commercial financing subsidiaries, and Secretary of its furniture and equipment sales subsidiary. She has been employed by the Company since 1980. Ms. Haberberger is also a director of Inroads, a non-profit employee assistance program, and of the Reading Area Trainers Organization Chapter of the American Society for Training and Development.\nJOHN F. HORRIGAN, III, is Vice President, Funds Management, of the Company and of its leasing and commercial financing subsidiaries. He is also President of the Company's real estate investment and development subsidiary, and President of the Company's securities subsidiary. He has been employed by the Company since 1987. From 1985 to 1987, he was employed with the law firm of Schiff, Hardin, and Waite, Chicago, Illinois, as an associate. He is a member of the Illinois Bar Association.\nROBERT ORDWAY is Senior Vice President and Chief Financial Officer of the Company and of its leasing and commercial financing subsidiaries, and a director and officer of its investment subsidiary. He has been employed by the Company since 1977. Mr. Ordway is a certified public accountant.\nVINCENT A. FAINO is Senior Vice President of the Company's leasing and commercial financing subsidiaries, and President of the leasing subsidiary's legal market division. He has been employed by the Company since 1982. Mr. Faino is a member of the Equipment Leasing Association Lease Management Institute.\nMARK E. GUIDA is President, Chief Operating Officer, Treasurer, Assistant Secretary, and a director of the Company's furniture and equipment sales subsidiary. He has been employed by the Company since 1978. Mr. Guida is a member of the Berks County Chamber of Commerce Small Business Committee, Venture Capital Committee, and International Business Committee.\nJohn F. Horrigan, Jr., Richard W. Horrigan and W. Michael Horrigan are brothers. Elizabeth Horrigan Rathz and John F. Horrigan, III, are children of John F. Horrigan, Jr., and Richard W. Horrigan, Jr. is the son of Richard W. Horrigan. Mr. and Mrs. Haberberger are spouses.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table sets forth the cash compensation from the Company and its subsidiaries of the following executive officers of the Company.\nThe Company is party to employment agreements with each of the named officers. Under these agreements the Company is to pay for 1994 a minimum of $120,000 to John F. Horrigan, Jr., $125,000 to Mr. Haberberger, $87,200 to W. Michael Horrigan, $100,000 to Mr. Faino and $86,800 to John F. Horrigan, III. The agreements provide these officers with such benefits as life and health insurance, seniority bonuses, salary continuation to dependents in the event of death, and participation in the Company's 401(k) Plan. They also provide for the Company to pay an officer who is discharged without cause up to one year's compensation based on his pre-termination salary and incentive bonuses. At present, such payments would amount to approximately $169,726 to John F. Horrigan, Jr., $166,676 to Mr. Haberberger and $104,943 to W. Michael Horrigan.\nEach director receives a fee of $1,000 for each meeting attended. Successive meetings of directors of the Company and its subsidiaries held on the same day are treated as a single meeting for this purpose. Each member of the Audit Committee receives $150 for each meeting attended. Directors receive in addition an annual retainer of $1,500 for service on all Boards of Directors of which they are members.\nSTOCK OPTIONS\nThe following table sets forth certain information regarding options exercised during 1993 by the named executive officers of the Company and the unexercised options for these individuals as of December 31, 1993.\nLONG-TERM INCENTIVE PLANS\nThe following table sets forth certain information regarding the number of units awarded to each of the named executive officers of the Company in 1993 under the Company's Phantom Stock Plan.\nThe Phantom Stock Plan authorizes awards in the form of \"phantom stock units,\" each of which entitles the recipient to a future payment based on a hypothetical investment in a share of Common Stock. The Plan is administered by an administrative committee consisting of three directors of the Company, none of whom is eligible to participate in the Plan. Participation in the Plan is restricted to key officers of the Company and its principal subsidiaries, as determined by the administrative committee.\nA phantom stock unit does not represent or entitle the recipient to any equity securities of the Company, but instead involves the creation of an unfunded account for the recipient, the value of which is measured by reference to the value of the Company's common stock. Units vest in stages between the fifth and tenth anniversaries of an officer's becoming a participant in the Plan. Vesting is accelerated upon the participant's normal retirement, death or disability. All units are forfeited (even if previously vested) if a participant resigns or is dismissed for cause. The value of a participant's account is determined at the time of his or her retirement, death or disability, or at the time the participant is discharged by the Company without cause, to be equal to (1) the excess of the per-share fair market value of the Company's common stock at that time over the per-share fair market value at the respective dates of awards of units, times the number of units credited to the account at the time of determination, plus (2) the per-share amount by which common stock dividends paid in any year after an award of units exceeds 20% of the consolidated net earnings per share of the Company for the immediately preceding fiscal year, times the number of units credited to the account at the relevant dividend payment dates.\nPayment at the value of a participant's account is made beginning at the time of the participant's normal retirement, death or disability, or at the time a participant who is discharged without cause with vested units in his or her account reaches age 62. The Company may elect to pay the account value in a lump sum or in installments (with interest) over ten years.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's Board of Directors has no compensation committee or other committee performing similar functions. In their capacities as directors, John F. Horrigan, Jr., Richard W. Horrigan, Arthur A. Haberberger and W. Michael Horrigan participated in deliberations of the Company's Board of Directors concerning executive officer compensation in 1993.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table contains the indicated information as of February 15, 1994, concerning the ownership of the Company's common stock (the only class of voting securities), by the Company's directors and executive officers and by all persons who to the Company's knowledge own beneficially more than 5% of the Company's common stock. Except as otherwise indicated, such ownership consists of sole voting and investment power. Some or all of these persons may be deemed to be \"parents\" of the Company.\nAll of the Company's outstanding preferred stock (1,952 shares) is owned by the estate of John F. Horrigan, Sr., of which Messrs. J. F. Horrigan, Jr. and R. W. Horrigan are co-executors.\nSolely for the purpose of presenting information on the cover of this report concerning the market value of voting stock held by non-affiliates, the Company has excluded shares owned or controlled by its directors or executive officers.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company and all the individual common stockholders are parties to an agreement restricting the right of the individual stockholders to dispose of their stock in the Company and (with certain exceptions for transfers to family members and to other stockholders) giving the Company or the other individual parties to the agreement, in the event of a voluntary sale by one of the individuals, the right but not the obligation to purchase the shares of common stock offered for sale by the individual. The agreement currently provides that the purchase price in such event will be determined consistently with the method employed by the outside appraiser to determine the value per share under the Company's Employee Stock Ownership Plan (the \"ESOP\"). Because the ESOP was terminated in 1993, the Company intends to implement an alternative method of valuing the stock for purposes of the stockholders' agreement; in the interim, the Company will continue to use the value determined by an outside appraisal as of November, 1993, in connection with the termination of the ESOP. In the event the Company and the other individual stockholders decline to purchase all the common stock, the other individual common stockholders retain the right to purchase the common stock at a price offered by the third party.\nThe Company is party to an agreement with Mr. Arthur A. Haberberger under which the Company is obligated upon Mr. Haberberger's death, at the option of his estate, to purchase any or all shares of the Company owned by Mr. Haberberger at his death. The purchase price will be determined consistently with the method used under the stockholders' agreement described in the preceding paragraph. For purposes of funding its obligation under this agreement the Company maintains insurance in the amount of $3,000,000 on Mr. Haberberger's life. If the insurance proceeds are insufficient, the balance of the purchase price is payable, with interest, over a period of not more than ten years. If Mr. Haberberger's estate elects to require the Company to purchase no shares, or shares with a purchase price of less than $3,000,000, then his children and a trust established by him can require the Company to purchase shares held by them, so long as the total purchase price for their shares and any shares purchased from Mr. Haberberger's estate does not exceed $3,000,000.\nThe Company is party to agreements with John F. Horrigan, Jr., Richard W. Horrigan and W. Michael Horrigan under which the Company is obligated upon death, at the option of the decedant's estate, to purchase up to a specific amount of shares of the Company then owned by the decedant. The purchase price will be determined consistently with the method used under the stockholders' agreement described above. The maximum number of shares to be purchased is that number of shares for which the aggregate purchase price does not exceed the proceeds received by the Company from life insurance policies maintained by the Company in the amounts of $750,000 on Mr. J. F. Horrigan, Jr.; $500,000 on Mr. R. W. Horrigan, and $1,000,000 on Mr. W. M. Horrigan.\nJ. F. Horrigan, Jr. and ten investment partnerships consisting of various combinations of J. F. Horrigan, Jr., A. A. Haberberger, Elizabeth Horrigan Rathz, Sidney D. Kline, Jr., John A. Mullineaux, Jr., and various members of their families have invested as limited partners in eleven real estate partnerships sponsored by American Real Estate Investment and Development Co. (\"American Real Estate\"), a wholly-owned subsidiary of the Company (see \"Business -- Real Estate\"). American Real Estate is a general partner in each of the real estate partnerships and is also a limited partner in four of them. The Company is a general partner (in addition to American Real Estate) in one of the partnerships. Unaffiliated persons are limited partners in nine of the real estate partnerships. In each case, the investment partnership acquired its interest in the real estate partnership on terms not more favorable than those offered to American Real Estate and the Company and to unaffiliated persons. The Company leases its Corporate Office (which also contains various leasing departments) from one of the real estate partnerships for an annual rental of $343,000. The Company has loaned $1,753,000 to five of the real estate partnerships and has guaranteed $1,651,000 of indebtedness of two of the real estate partnerships. Mr. and Mrs. Haberberger are limited partners in a partnership to which the Company has finance receivables of $175,000 outstanding as of December 31, 1993.\nStevens & Lee, of which Sidney D. Kline, Jr. is a principal, has from time to time performed legal services for the Company and may perform services for the Company in 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed (or incorporated by reference, as indicated) as part of this report:\n1. Financial statements: Horrigan American, Inc. and subsidiaries:\n-- consolidated balance sheets as of December 31, 1993 and 1992;\n-- consolidated statements of earnings for the years ended December 31, 1993, 1992 and 1991;\n-- consolidated statements of changes in stockholders' equity for the years ended December 31, 1993, 1992, and 1991;\n-- consolidated statements of cash flows for the years ended December 31, 1993, 1992 and 1991;\n-- notes to consolidated financial statements.\n2. Financial statement schedules: None.\n3. Exhibits. The following exhibits are filed herewith or incorporated by reference, as indicated. Exhibits 10.1 through 10.8, 10.13, 10.14 and 10.16 are compensatory contracts, plans or arrangements in which certain members of registrant's management participate.\nCertain exhibits are incorporated by reference to registrant's registration statement on Form S-2, No. 33-59620, filed March 16, 1993 (the \"1993 Registration Statement\"); to registrant's current report on form 8-K, filed June 16, 1993 (the \"1993 8-K\"); to registrant's annual report on Form 10-K for the year ended December 31, 1992 (the \"1992 10-K); to registrant's registration statement on Form S-2, No. 33-46346, filed March 12, 1992 (the \"1992 Registration Statement\"); to registrant's current report on Form 8-K, filed February 18, 1992 (the \"1992 8-K\"); to registrant's annual report on Form 10-K for the year ended December 31, 1991 (the \"1991 10-K\"); to registrant's registration statement on Form S-2, No. 33-39469, filed March 15, 1991 (the \"1991 Registration Statement\"); to registrant's annual report on Form 10-K for the year ended December 31, 1990 (the \"1990 10-K\"); to registrant's registration statement on Form S-2, No. 33-33771, filed March 7, 1990 (the \"1990 Registration Statement\"), to registrant's annual report on Form 10-K for the year ended December 31, 1989 (the \"1989 10- K\"); to registrant's registration statement on Form S-2, No. 33-28009, filed April 7, 1989 (the \"1989 Registration Statement\"); to registrant's registration statement on Form S-2, No. 33-20953, filed March 30, 1988 (the \"1988 Registration Statement\"); to registrant's Annual Report on Form 10-K for the year ended December 31, 1987 (the \"1987 Form 10-K\"); to registrant's registration statement on Form S-2, No. 33-12869, filed March 24, 1987 (the \"1987 Registration Statement\"); to registrant's registration statement on Form S-2, No. 33-4051, filed March 17, 1986 (the \"1986 Registration Statement\"); to registrant's Annual Report on Form 10-K for the year ended December 31, 1985 (the \"1985 Form 10-K\"); to registrant's registration statement on Form S-1, No. 2-96525, filed March 19, 1985 (the \"1985 Registration Statement\"); to registrant's Registration Statement on Form S-1, No. 2-90161, filed March 26, 1984 (the \"1984 Registration Statement\"); to registrant's registration statement on Form S-1, No. 2-82551, filed March 21, 1983 (the \"1983 Registration Statement\") or Amendment No. 1 thereto, filed April 28, 1983 (the \"1983 Amendment\"); to Amendment No. 1 to the registration statement on Form S- 1, No. 2-76479, of registrant's predecessor, Horrigan Companies, Inc. (\"HCI\"), filed April 14, 1982 (the \"1982 Amendment\"); to Amendment No. 1, filed April 24, 1981, to HCI's registration statement on Form S-1, No. 2-71420, (the \"1981 Amendment\"); or to Amendment No. 1 to HCI's registration statement on Form S- 1, No. 2-58452, filed July 1, 1977 (the \"1977 Amendment\").\n(b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nHORRIGAN AMERICAN, INC. DATED: March 18, 1994 \/s\/ JOHN F. HORRIGAN, JR. By: ----------------------------------- JOHN F. HORRIGAN, JR. CHAIRMAN\nPURSUANT 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 AND ON THE DATES INDICATED.\nSIGNATURES TITLE DATE ------- --- ---\n\/s\/ JOHN F. HORRIGAN, JR. Chairman of the Board of March 18, 1994 - ----------------------------- Directors JOHN F. HORRIGAN, JR.\n\/s\/ RICHARD W. HORRIGAN Vice Chairman of the Board of March 18, 1994 - ----------------------------- Directors RICHARD W. HORRIGAN\n\/s\/ ARTHUR A. HABERBERGER President (principal executive March 18, 1994 - ----------------------------- officer) and Director ARTHUR A. HABERBERGER\n\/s\/ W. MICHAEL HORRIGAN Director March 18, 1994 - ----------------------------- W. MICHAEL HORRIGAN\n\/s\/ ELIZABETH HORRIGAN RATHZ Director March 18, 1994 - ----------------------------- ELIZABETH HORRIGAN RATHZ\n\/s\/ ROBERT ORDWAY Senior Vice President March 18, 1994 - ----------------------------- (principal and financial ROBERT ORDWAY and accounting officer)\nEXHIBIT 4.16\nAEL LEASING CO., INC. AMERICAN COMMERCIAL CREDIT CORP. UNSECURED FUNDING PROGRAM JANUARY 31, 1994\nEXHIBIT 4.16A\nUNSECURED FUNDING PROGRAM\nLOAN AGREEMENT\nAMONG\nAEL LEASING CO., INC.\nAND\nAMERICAN COMMERCIAL CREDIT CORP.\nAND\nMARYLAND NATIONAL BANK\nDATED: JUNE 28, 1993\nLOAN AGREEMENT AMONG AEL LEASING CO., INC. AND AMERICAN COMMERCIAL CREDIT CORP. AND MARYLAND NATIONAL BANK\nPAGE BACKGROUND............................................................... 1\nARTICLE 1 DEFINITIONS................................................. -- 1 1.1 General Provisions.......................................... 1 1.2 Defined Terms............................................... 2\nARTICLE 2 CREDIT FACILITY AND FACILITY PROCEDURES..................... -- 7 2.1 Prior Agreements\/Prior Notes................................ 7 2.2 Term........................................................ 7 2.3 Credit Facility............................................. 7 2.4 Determination of Available Borrowing Base................... 7 2.5 Nature of Draw.............................................. 8 2.6 Initial Draw................................................ 8 2.7 Empirical Study............................................. 8 2.8 Amount\/Timing of Draw....................................... 8 2.9 Accessing the Credit Facility............................... 8 2.10 Transfer of Funds........................................... 9 2.11 Conditions to Draw.......................................... 9 2.12 Note Validity............................................... 9 2.13 Rate of Interest............................................ 9 2.14 Computation of Interest..................................... 10 2.15 Place of Payment............................................ 10 2.16 Prepayment.................................................. 10 2.17 Proportionate Prepayment.................................... 10 2.18 Use of Proceeds............................................. 10 2.19 Additional Documentation.................................... 10\nARTICLE 3 --REPRESENTATIONS AND WARRANTIES.............................. 11 3.1 Organization................................................ 11 3.2 Corporate Power............................................. 11 3.3 Authority................................................... 11 3.4 Consent..................................................... 12 3.5 Proceedings................................................. 12 3.6 Financial Statements........................................ 12 3.7 Judgments................................................... 12 3.8 Contracts................................................... 12 3.9 Equipment................................................... 12 3.10 Environmental Matters....................................... 12 3.11 ERISA....................................................... 12 3.12 Group Health Plan........................................... 12 3.13 Investment Company Act...................................... 12 3.14 Burdensome Documents........................................ 12 3.15 Taxes....................................................... 13 3.16 Laws........................................................ 13 3.17 Regulation U................................................ 13 3.18 No Event of Default......................................... 13\ni\nPAGE ARTICLE 4 --FINANCIAL STATEMENTS........................................ 13 4.1 Books of Account............................................ 13 4.2 Quarterly Financial Statements.............................. 13 4.3 Annual Financial Statements................................. 13 4.4 Other Information........................................... 14 4.5 Compliance Certificate...................................... 14\nARTICLE 5 --AFFIRMATIVE COVENANTS....................................... 14 5.1 Corporate Existence......................................... 14 5.2 Subsidiary.................................................. 14 5.3 Trade Names................................................. 14 5.4 Insurance................................................... 14 5.5 Indebtedness................................................ 14 5.6 Taxes and Claims............................................ 14 5.7 Increased Cost.............................................. 14 5.8 Event of Default............................................ 15 5.9 Examination................................................. 15 5.10 Minimum Tangible Net Worth.................................. 15 5.11 Debt\/Tangible Net Worth Ratio............................... 15 5.12 Cash Flow Ratio............................................. 15 5.13 Compliance with Laws........................................ 15\nARTICLE 6 --NEGATIVE COVENANTS.......................................... 15 6.1 Subordinated Intercompany Debt.............................. 16 6.2 Limitation on Senior Debt\/Subordinated Intercompany Debt.... 16 6.3 Limitation on Draw.......................................... 16 6.4 Liens....................................................... 16 6.6 Transfer of Assets.......................................... 16 6.7 Loans\/Investments\/Guaranties................................ 16 6.8 Related Persons............................................. 16 6.9 Prohibited Uses............................................. 16\nARTICLE 7 --EVENTS OF DEFAULT AND REMEDIES.............................. 17 7.1 Events of Default........................................... 17 7.2 Remedies.................................................... 18 7.3 Remedies Cumulative......................................... 18 7.4 Waiver of Default........................................... 18\nARTICLE 8 --MISCELLANEOUS PROVISIONS.................................... 18 8.1 Notice...................................................... 18 8.2 Accounting Principles....................................... 19 8.3 Waiver of Jury Trial........................................ 19 8.4 Gender\/Number............................................... 19 8.5 Construction................................................ 19 8.6 Additional Documents\/Assurances............................. 19 8.7 Benefit..................................................... 19 8.8 Assignment.................................................. 20 8.9 Severability................................................ 20 8.10 Integration................................................. 20 8.11 Captions.................................................... 20 8.12 Counterparts................................................ 20 8.13 Jurisdiction................................................ 20 8.14 Law......................................................... 20\nii\nLIST OF EXHIBITS\nExhibit \"A\" -- Note Exhibit \"B\" -- Percentages Applicable to Initial Draws Exhibit \"C\" -- Modification Notice Exhibit \"D\" -- Loan Certificate Exhibit \"E\" -- Borrowing Base Certificate Exhibit \"F\" -- Suretyship Exhibit \"G\" -- Compliance Certificate\niii\nUNSECURED FUNDING PROGRAM LOAN AGREEMENT\nThis Unsecured Funding Program Loan Agreement is made as of this 28th day of June, 1993, by and among AEL LEASING CO., INC., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its principal offices at Flying Hills Corporate Center, Horrigan American Building, Flying Hills, Pennsylvania,\nA N D\nAMERICAN COMMERCIAL CREDIT CORP., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its principal offices at Flying Hills Corporate Center, Horrigan American Building, Flying Hills, Pennsylvania,\nA N D\nMARYLAND NATIONAL BANK, a national banking association having its principal offices at P.O. Box 987, Baltimore, MD, 21202.\nBACKGROUND\nEach of the Companies is engaged in various business activities, including the offering of various financial services. From time to time in the course of its business activities, each of the Companies acquires and makes Contracts.\nEach of the Companies presently maintains a separate Unsecured Funding Program pursuant to which from time to time it makes periodic borrowings, primarily in order to finance or refinance, directly or indirectly, the acquisition and making of Contracts.\nEach Participant Lender has agreed to modify the Unsecured Funding Program to permit, inter alia, a single Credit Facility which may be accessed by each of the Companies.\nIn order to re-document the Unsecured Funding Program, each Participant Lender, including the Lender, has been requested to enter into documentation substantially similar to this Agreement and the documents referred to herein, and each Participant Lender, including the Lender, has agreed thereto.\nNOW, THEREFORE, INTENDING TO BE LEGALLY BOUND HEREBY, each of the Companies and the Lender hereby agree as follows:\nARTICLE 1\nDEFINITIONS\n1.1 General Provisions. Unless the context clearly requires otherwise:\n(a) Words and phrases used in this Agreement or in any of the documents referred to herein which are not specifically defined in this Agreement or in any of the documents referred to herein but which are defined in the Uniform Commercial Code shall have the meanings assigned to them in the Uniform Commercial Code.\n(b) All accounting terms used in this Agreement or in the documents referred to herein which are not specifically defined in this Agreement or in any of the documents referred to herein shall have the meanings assigned to them in accordance with generally accepted accounting principles and practices.\n(c) The word \"including\" shall be a word of enlargement rather than a word of limitation and shall be deemed to mean \"including but not limited to\" rather than \"including only\".\n1.2 Defined Terms. Unless the context clearly requires otherwise, the following words and phrases whenever used in the singular or the plural form and capitalized shall have the following meanings for the purposes of this Agreement and all documents referred to herein:\n(a) \"ACCC\" shall mean American Commercial Credit Corp., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(b) \"AEL\" shall mean AEL Leasing Co., Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(c) \"AELH\" shall mean AEL Holdings, Inc., a corporation organized and existing under the laws of the State of Delaware.\n(d) \"Agreement\" shall mean this Agreement and all amendments or modifications hereto.\n(e) \"Available Borrowing Base\" with respect to each Company shall mean the dollar amount realized by subtracting the aggregate amount of outstanding Senior Debt of such Company and outstanding Subordinated Intercompany Debt of such Company from the amount of the Gross Borrowing Base of such Company.\n(f) \"Bankruptcy Code\" shall mean the federal Bankruptcy Code, as amended and supplemented from time to time.\n(g) \"Borrowing Base Certificate\" shall mean the document referred to in Section 2.9(d) of this Agreement.\n(h) \"Cash Flow Ratio\" shall mean the ratio of Ratio Cash Receipts to Ratio Cash Disbursements for any fiscal period.\n(i) \"COBRA\" shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended and supplemented from time to time.\n(j) \"Company\" shall mean, as applicable, either AEL or ACCC in its capacity as borrower under the Credit Facility.\n(k) \"Companies\" shall mean, collectively, AEL and ACCC.\n(l) \"Compliance Certificate\" shall mean the document referred to in Section 4.5 of this Agreement.\n(m) \"Contract\" shall mean any conditional sales contract, installment sales contract, commercial loan agreement, security agreement, lease, mortgage, other title retention instrument, promissory note or other evidence of indebtedness, whether secured or unsecured, arising out of:\n(i) the making of any commercial loan by either of the Companies or any of their respective Subsidiaries to any Person other than to any Related Person,\n(ii) the acquisition, by purchase, merger or otherwise, by either of the Companies or any of their respective Subsidiaries of the lender's rights with respect to any commercial loan to any Person other than to any Related Person,\n(iii) the sale or lease by either of the Companies or any of their respective Subsidiaries of any Equipment or other personal property to any Person other than to any Related Person, or\n(iv) the acquisition, by purchase, merger or otherwise, by either of the Companies or any of their respective Subsidiaries of the seller's or lessor's rights with respect to the sale or lease of any Equipment to any Person other than to any Related Person.\n(n) \"Controlling Interest\" shall mean, if applicable to a corporation, the right under ordinary circumstances to elect a majority of the members of the board of directors of such corporation, and if a partnership, general or limited, the ownership of fifty percent (50%) or more of the general partnership interests of such partnership.\n(o) \"Credit Facility\" shall mean the credit facility herein established by the Lender for the benefit of AEL and ACCC.\n(p) \"Draw\" shall mean the periodic borrowing by either Company of funds from the Lender by means of the making by the Lender to such Company of one (1) or more simultaneous Loans.\n(q) \"Empirical Study\" shall mean a retrospective analysis of the acquisition pattern by either of the Companies of Contracts over the prior six (6) month period and a prospective analysis of the anticipated acquisition pattern by such Company of Contracts.\n(r) \"Equipment\" shall mean all equipment and other personal property, including software and all other general intangibles, which either of the Companies leases or sells to any Person pursuant to any Contract.\n(s) \"ERISA\" shall mean the Employee Retirement Income Security Act of 1974, as amended and supplemented from time to time.\n(t) \"Event of Default\" shall mean any of the events specified in Section 7.1 of this Agreement provided that any requirement set forth in this Agreement or the documentation referred to herein for notice, lapse of time or both or any other condition has been satisfied.\n(u) \"Existing Indebtedness\" shall mean any indebtedness of either of the Companies to the Lender which is outstanding as of the date of this Agreement and which arises under any Prior Agreement and is evidenced by any Prior Note.\n(v) \"First Renewal Date\" shall mean June 30, 1994.\n(w) \"Gross Borrowing Base\" with respect to each Company shall mean the dollar amount realized by multiplying the Net Qualifying Assets of such Company by a factor of 0.9.\n(x) \"Gross Qualifying Assets\" with respect to each Company shall mean the aggregate dollar value of all Contracts which are not contractually delinquent for a period of more than ninety (90) days and which constitute valid and legally enforceable obligations of the parties thereto.\n(y) \"HAI\" shall mean Horrigan American, Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(z) \"Initial Term\" shall mean the period of time beginning as of the date of this Agreement and continuing until the First Renewal Date.\n(aa) \"Internal Revenue Code\" shall mean the Internal Revenue Code of 1986, as amended and supplemented from time to time.\n(ab) \"Investment Company Act\" shall mean the Investment Company Act of 1940, as amended and supplemented from time to time.\n(ac) \"Lender\" shall mean Maryland National Bank, a national banking association.\n(ad) \"Loan\" shall mean a borrowing by either Company from the Lender pursuant to the Credit Facility which, together with other such borrowings made on such date, shall constitute a Draw by such Company on the Credit Facility.\n(ae) \"Loan Certificate\" shall mean the document referred to in Section 2.9(a) of this Agreement.\n(af) \"Loan Term\" shall mean the period of time during which any Loan is to be repaid by the Company to the Lender in accordance with the provisions of the Note evidencing the same.\n(ag) \"Modification Notice\" shall mean the notice referred to in Section 2.7(b) of this Agreement.\n(ah) \"Net Qualifying Assets\" with respect to each Company shall mean the dollar amount realized by subtracting from Gross Qualifying Assets of such Company:\n(i) appropriate deferred income,\n(ii) accounts payable to suppliers and\n(iii) Security Deposits.\n(ai) \"Note\" shall mean the promissory note referred to in Section 2.5 of this Agreement.\n(aj) \"Officer\" shall mean the Chairman of the Board of Directors, the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer, the Vice President of Funds Management of either Company or such other executive employee of such Company whom such Company shall designate by resolution of the Board of Directors of such Company, certified as to authenticity by the Secretary or Assistant Secretary thereof, or by a consent in writing signed by all of the members of the Board of Directors of such Company, a copy of which has been delivered to the Lender.\n(ak) \"Participant Lender\" shall mean any bank, financial institution, insurance company, corporation or other entity which is participating or shall hereafter become a participant in the Unsecured Funding Program.\n(al) \"Permitted Lien\" shall mean any:\n(i) lien for taxes, assessments or other governmental charges, or lien imposed in connection with workers\" compensation, unemployment insurance and other forms of governmental insurance or benefits, or lien imposed to secure performance of statutory obligations or duties:\n(A) which is inchoate or relates to any obligation which is not yet due and payable, or\n(B) the validity of which, or the validity of the obligation to which such lien relates, is being contested in good faith by appropriate proceedings;\n(ii) lien of attachment or judgment respecting any claim, the validity of which, or the validity of the obligation to which such lien relates, is being contested in good faith by appropriate proceedings or the liability for which is fully covered by insurance, subject to deductibles reasonably acceptable to the Lender and with respect to which the insurer has not issued a written reservation of its rights or disclaimed its liabilities in writing;\n(iii) mechanic's, materialman's, warehouseman's or any other similar lien arising in the ordinary course of business of either Company which either:\n(A) is inchoate or relates to an obligation which is not yet due and payable, or\n(B) is being contested in good faith by appropriate proceedings;\n(iv) lien on any assets hereafter acquired which are existing at the time of such acquisition or created following any such acquisition solely to secure or provide for the payment of the purchase price or any part thereof or lien to secure indebtedness incurred to fund or refund any lien within the scope of this clause (iv); and\n(v) lien existing on the date either Company or their respective Subsidiaries acquires any Person, or any interest in such Person, which has as its principal activity any business\nactivity in which the Surety, either Company or any of their respective Subsidiaries was engaged as of the date of such acquisition.\n(am) \"Person\" shall mean any individual, corporation, partnership, association, trust or other entity or organization, including but not limited to a governmental or political subdivision or agency or instrumentality thereof.\n(an) \"Plan\" shall mean any employee benefit plan subject to the provisions of Title IV of ERISA which is maintained in whole or in part for employees of the Company.\n(ao) o\"Prior Agreement\" shall mean any unsecured Funding Program Agreement heretofore executed by either of the Companies and the Lender establishing or continuing an Unsecured Funding Program for the benefit of such Company, and all amendments and modifications thereto.\n(ap) \"Prior Note\" shall mean any promissory note heretofore issued by either of the Companies pursuant to any Prior Agreement.\n(aq) \"Public Offering\" shall mean the offering of any class of equity securities of the Surety or of either of the Companies pursuant to a registration statement under the Securities Act.\n(ar) \"Ratio Cash Disbursements\" for any fiscal period shall mean the sum of the following items, all as determined in accordance with generally accepted accounting principles as applied to the Surety's financial statements and as set forth in the Surety's Consolidated Balance Sheet and the Surety's Consolidated Statement of Cash Flows.\n(i) principal repayments of long-term Senior Debt;\n(ii) dividends paid;\n(iii) cost of acquired treasury stock;\n(iv) acquisition of investments;\n(v) acquisition of property and equipment (i.e. fixed assets);\n(vi) thirty-three and one-third percent (331\/3%) of the fiscal period ending net Subordinated Debt outstanding; and\n(vii) thirty-three and one-third percent (331\/3%) of the fiscal period ending short-term Senior Debt borrowings.\nAt its election, the Surety may exclude from (i) above any prepayments of principal which are not required to be made pursuant to the terms of the instruments and other documents governing such Senior Debt or any repayments which are concurrently refinanced in the ordinary course of business by a substantially equal amount of new Senior Debt.\n(as) \"Ratio Cash Receipts\" for any fiscal period shall mean the sum of the following items, all as determined in accordance with generally accepted accounting principles as applied to the Surety's financial statements and as set forth in the Surety's Consolidated Statement of Cash Flows:\n(i) net cash provided by operating activities;\n(ii) principal collections of finance receivables;\n(iii) proceeds from issuance of capital stock;\n(iv) proceeds from sale of investments;\n(v) proceeds from sale of property and equipment (i.e. fixed assets);\n(vi) proceeds from sale of finance receivables; and\n(vii) proceeds from sale of Equipment applicable to operating leases.\n(at) \"Related Person\" shall mean HAI, the Surety, either Company, any Subsidiary or any other Person in which HAI, the Surety, either Company or any Subsidiary has a Controlling Interest.\n(au) \"Renewal Term\" shall mean the period of time beginning as of the First Renewal Date or any subsequent Renewal Date, as applicable, and continuing for one (1) year therefrom.\n(av) \"Reportable Event\" shall mean a Reportable Event as defined in Section 4043(b) of ERISA, 29 U.S.C. Section 1343.\n(aw) \"Securities Act\" shall mean the Securities Act of 1933, as amended and supplemented from time to time.\n(ax) \"Security Deposits\" with respect to each Company shall mean all monies paid to such Company or any of its Subsidiaries in order to secure any obligation under any Contract.\n(ay) \"Senior Debt\" of each Company shall mean the sum total of all amounts owing with respect to funds borrowed by the Company or any of its Subsidiaries from banks, financial institutions, insurance companies, corporations and other entities other than Related Persons.\n(az) \"Subordinated Intercompany Debt\" of each Company shall mean the sum total of all amounts owing with respect to funds borrowed by the Company or any of its Subsidiaries from HAI, the Surety, the other Company or any Subsidiary of either the Surety or the other Company, the repayment of which by its terms is subordinated to the repayment of Senior Debt of such Company.\n(ba) \"Subsidiary\" shall mean any corporation in which HAI, the Surety, either Company or any subsidiary of any of the foregoing, as applicable, directly or indirectly, owns or hereafter acquires a sufficient amount of capital stock having general voting power so as to permit HAI, the Surety, either Company or any subsidiary of any of the foregoing, as applicable, under ordinary circumstances to elect a majority of the members of the board of directors of such corporation.\n(bb) \"Suppliers\" shall mean any manufacturer, vendor or dealer of Equipment which either Company or any of their respective Subsidiaries sells or leases to any Person.\n(bc) \"Surety\" shall mean American Equipment Leasing Co., Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its registered office at Flying Hills Corporate Center, Flying Hills, Reading, Pennsylvania, 19607.\n(bd) \"Suretyship\" shall mean the document referred to in Section 2.19(a) of this Agreement, and all amendments and modifications thereto.\n(be) \"Tangible Net Worth\" of a Company shall mean the aggregate amount of equity of the stockholders of the Company as determined in accordance with generally accepted accounting principles, less the aggregate amount of intangible assets of the Company, which shall include goodwill, organization costs, franchises and trademarks.\n(bf) \"Term\" shall mean the period of time beginning as of the date of this Agreement and continuing so long as the Credit Facility established pursuant to this Agreement is available for the purposes of making Draws by the Companies.\n(bg) \"Uniform Commercial Code\" shall mean the Pennsylvania Uniform Commercial Code, as amended and supplemented from time to time.\n(bh) \"Unsecured Funding Program\" shall mean the program of unsecured credit facilities acquired by the Companies from various banks, financial institutions, insurance companies, corporations or other entities, the proceeds of which are to be used primarily to finance or refinance, directly or indirectly, the acquisition or making of Contracts and which programs\nshall be evidenced by documentation substantially similar to this Agreement, the Suretyship and other documentation referred to herein.\nARTICLE 2\nCREDIT FACILITY AND FACILITY PROCEDURES\n2.1 Prior Agreements\/Prior Notes. This Agreement replaces and supersedes each of the Prior Agreements which are hereby terminated. Notwithstanding the termination of each of the Prior Agreements, all Prior Notes issued pursuant thereto shall remain in full force and effect and shall be deemed to have been issued pursuant to this Agreement and all Existing Indebtedness shall be paid by the Company designated as obligor in such Prior Note pursuant to the terms thereof.\n2.2 Term. The Initial Term of this Agreement shall be for the period of time beginning as of the date of this Agreement and terminating on the First Renewal Date. Following the Initial Term, this Agreement shall be automatically renewed for successive Renewal Terms of one (1) year each, each such Renewal Term to begin as of the First Renewal Date or any subsequent Renewal Date, as applicable, unless the Companies shall notify the Lender or the Lender shall notify the Companies of the intention not to renew this Agreement, such notice to be given at least ten (10) days prior to the end of the Initial Term or any Renewal Term, as applicable, and to provide therein that this Agreement shall not be renewed but shall terminate at the end of the Initial Term or Renewal Term, as applicable. Except as otherwise provided in this Agreement, including to the extent that either of the Companies shall exercise the prepayment rights set forth herein, in the event that either of the Companies or the Lender elects not to renew this Agreement at the end of either the Initial Term or any Renewal Term, each Loan made by the Lender prior to the termination of the Initial Term or any Renewal Term, as applicable, shall be repaid by the Company named as obligor designated in such Note in accordance with the provisions thereof.\n2.3 Credit Facility.\n(a) The Lender hereby establishes the Credit Facility which may be accessed by both AEL and ACCC for the Term of this Agreement, the aggregate outstanding principal balance of which, together with the aggregate outstanding principal balance owing on all Existing Indebtedness by AEL or ACCC, shall not at any one time exceed Ten Million Five Hundred Thousand Dollars ($10,500,000.00).\n(b) During the Term hereof, AEL and ACCC shall each have the right to make Draws upon the Credit Facility in accordance with the provisions of this Agreement.\n(c) In the event that the making by AEL or ACCC of a Draw in the amount set forth in Section 2.8 of this Agreement would result in the aggregate outstanding principal balance owing by AEL and ACCC on the Credit Facility, including the aggregate outstanding principal balance owing by AEL and ACCC on account of their respective Existing Indebtedness, being in excess of the amount set forth in Section 2.3(a) hereof, then the applicable Draw shall be reduced to such amount as is necessary in order that such aggregate outstanding principal balance owing by AEL and ACCC to the Lender under the Credit Facility shall not exceed the amount set forth in Subsection (a) hereof.\n2.4 Determination of Available Borrowing Base. On a monthly basis throughout the Term of this Agreement, each of the Companies shall determine its Available Borrowing Base in accordance with the following formula:\nGross Qualifying Assets.................................... Less: Appropriate Deferred Income........................ Accounts Payable to Suppliers...................... Security Deposits..................................\nNet Qualifying Assets...................................... Time of factor of Gross Borrowing Base................. .9 Less: Outstanding Senior Debt............................ Outstanding Subordinated Intercompany Debt......... Available Borrowing Base...........................\n2.5 Nature of Draw. Except as otherwise modified in accordance with the provisions of this Agreement, each Draw by each Company on the Credit Facility shall be comprised of several separate Loans not to exceed four (4) in number as determined by the applicable Company, which Loans shall have Loan Terms of not fewer than eighteen (18) months nor more than fifty-four (54) months. Each such Draw shall be evidenced by a Note setting forth the provisions of such borrowing, including the principal amount of such Draw, the fixed rate of interest applicable thereto, and the method of repayment. Each Note shall be in substantially the form of Exhibit \"A\", a copy of which is attached hereto and incorporated herein by reference thereto, and shall provide that the principal amount of the Note together with interest thereon at the rate set forth therein shall be paid by AEL or ACCC, as applicable, in monthly payments of principal and interest as set forth therein.\n2.6 Initial Draw. Presently and until modified in accordance with this Agreement, each Draw by each Company on the Credit Facility shall consist of three (3) Loans. The original amount of each of the three (3) Loans comprising each such Draw for each Company shall consist of the percentages set forth on Exhibit \"B\" which is attached hereto and incorporated herein by reference.\n2.7 Empirical Study. From time to time during the Term of this Agreement, each of the Companies shall conduct Empirical Studies and shall have the right to modify the number of Loans comprising future Draws on the Credit Facility, the Loan Terms of such Loans and the proportions which the original principal amounts of such Loans bear to the total amount of the applicable Draw to which the same pertain, provided, however:\n(a) That neither of the Companies shall make such modification more often than two (2) times in any calendar year.\n(b) That such modification shall not become effective until the applicable Company shall have sent a Modification Notice to the Lender setting forth the nature of such modification, which Modification Notice shall be in substantially the form of Exhibit \"C\", a copy of which is attached hereto and incorporated herein by reference thereto.\n(c) That no Loan Term shall have a duration of fewer than eighteen (18) months or more than fifty-four (54) months.\n(d) That in no event shall the number of Loans comprising any Draw exceed four (4).\n2.8 Amount\/Timing of Draw.\n(a) Subject to the provisions of Section 2.3, AEL and ACCC may each make one (1) Draw on the Credit Facility in each three (3) month period of the Term hereof, which Draw shall be in an amount not to exceed Seven Hundred Fifty Thousand Dollars ($750,000.00), unless AEL or ACCC, as applicable, and the Lender shall otherwise agree, in which event the Draw shall be in the amount agreed.\n(b) Each of the Companies may make additional Draws on the Credit Facility with the consent of the Lender.\n2.9 Accessing the Credit Facility. With respect to each Draw made on the Credit Facility, the applicable Company shall deliver to the Lender:\n(a) Its Loan Certificate executed by an Officer of the Company, which Loan Certificate shall be in substantially the form of Exhibit \"D\", a copy of which is attached hereto and incorporated herein by reference thereto, and which Loan Certificate shall set forth, inter alia, the principal amount of the Draw and the respective original principal amounts of the Loans comprising the Draw.\n(b) An original Note pertaining to the Draw, which shall be executed by an Officer of the Company and the principal amount of which shall be equal to the principal amount of the Draw.\n(c) An amortization schedule setting forth the amortization of the Note evidencing the respective Loans to which the applicable Draw pertains.\n(d) A Borrowing Base Certificate setting forth the applicable Available Borrowing Base for the month to which the applicable Draw pertains and the approximate aggregate Draw of the Company for the said month from all Participant Lenders, which Borrowing Base Certificate shall be in substantially the form of Exhibit \"E\", a copy of which is attached hereto and incorporated herein by reference thereto.\n2.10 Transfer of Funds. Upon receipt by the Lender of the documents pertaining to any Draw referred to in this Agreement, the Lender shall, no later than the close of the second banking day following its receipt of the said documents:\n(a) Determine whether the said documents are appropriately executed and otherwise in conformity with the provisions of this Agreement.\n(b) In the event that the said documents or any of them are not appropriately executed or not otherwise in conformity with the provisions of this Agreement, notify an Officer of the applicable Company by telephone of such determination and immediately return all of the said documents to such Company by regular mail.\n(c) In the event that the said documents or any of them are appropriately executed and otherwise in conformity with the provisions of this Agreement, and the conditions set forth in Section 2.11 hereof have been fulfilled, wire transfer funds equal to the total amount of the Draw in conformity with the instructions contained in the Loan Certificate.\n2.11 Conditions to Draw. The obligation of the Lender to make Loans on account of each Draw is subject to fulfillment of the following conditions:\n(a) That the Lender shall have received the Note, Loan Certificate, amortization schedule and Borrowing Base Certificate required by Section 2.9 of this Agreement.\n(b) That the Draw shall not contravene any provision of applicable law or the articles of incorporation or by-laws of the Company making the Draw or of any agreement binding upon the said Company.\n(c) That the representations of the applicable Company which are contained in Article 3 of this Agreement shall be true in all material respects on and as of the date of such Draw as though made on and as of such date.\n(d) That, immediately prior to and immediately after the making of the Loans pursuant to the Draw, no Event of Default shall have occurred and be continuing.\n(e) That the making of a Draw will not result in a breach or default of any other agreement or instrument to which the applicable Company is a party or by which it is bound.\nEach Draw shall be deemed to be a representation by the Company making the Draw as of the date of such Draw as to the facts specified in Subsections (a) through and including (e) hereof.\n2.12 Note Validity. Notwithstanding anything to the contrary, in no event shall the Company making a Draw on the Credit Facility have any obligation on account of any Note included in such Draw unless the Lender shall have advanced funds in the amount of such Note as required by Section 2.10 of this Agreement.\n2.13 Rate of Interest. All Loans made by the Lender to either of the Companies pursuant to any applicable Draw on the Credit Facility shall be subject to an annual interest rate agreed to by the Lender and the applicable Company at the time the Loan is made as evidenced by the documents referred to in this Article. The applicable rate of interest shall remain fixed for the period of such Loan.\n2.14 Computation of Interest. Interest on the principal balance of each Loan shall be computed for the actual period of time such principal balance is outstanding using a year of three hundred sixty\/three hundred sixty (360\/360) days. For purposes of computing the date on which interest shall begin to accrue on any Loan made by the Lender pursuant to any Draw on the Credit Facility, each such Loan shall be deemed to have been made on the date upon which the Lender wire transfers the funds pertaining to such Loan to the account of the applicable Company in accordance with the provisions of Section 2.10 of this Agreement.\n2.15 Place of Payment. All payments to be made pursuant to this Agreement or on account of any Note issued pursuant hereto, including any Prior Note, shall be made to the Lender at the address set forth for the Lender in Section 8.1 of this Agreement or at such other address as the Lender shall hereafter specify by notice to the Company.\n2.16 Prepayment. Each of the Companies shall have the right to prepay all or any portion of its indebtedness under the Unsecured Funding Program, including Existing Indebtedness, without premium or penalty therefor:\n(a) In the event that prepayment shall be made in accordance with the provisions of Section 7.1 of this Agreement; or\n(b) In the event that any payment shall be made as a result of the exercise by the Lender of any of its rights under Section 7.2 of this Agreement.\nIn all other events, each of the Companies shall have the right to prepay all or any portion of its indebtedness under its Unsecured Funding Program only if such prepayment is accompanied by payment of a prepayment penalty in an amount equal to two percent (2%) of such prepayment.\n2.17 Proportionate Prepayment. In the event of any prepayment by either of the Companies under this Agreement other than by reason of exercise by either of the Companies of its rights under Section 2.16 hereof, the Company making such prepayment shall do so proportionately to each Participant Lender based upon the then outstanding principal balances owing to each Participant Lender under the Credit Facility. Each such prepayment shall be applied by each Participant Lender to the oldest outstanding Loans which such Participant Lender holds.\n2.18 Use of Proceeds. The proceeds of all Loans shall be used for the business purposes of the Company which shall have borrowed such monies, or for the business purposes of any of its Subsidiaries or for any other purposes permitted by this Agreement, and the Company shall have the right to transfer all or any portion of such proceeds to its Subsidiaries on any basis which it deems appropriate.\n2.19 Additional Documentation. Concurrently with the execution of this Agreement, the Companies shall deliver to the Lender the following documents:\n(a) The Suretyship duly executed by the Surety, which Suretyship shall be in substantially the form as Exhibit \"F\" which is attached hereto and incorporated herein by reference thereto.\n(b) The opinion, subject to certain limitations and conditions therein contained, of Kozloff, Diener, Payne & Fegley, a professional corporation, counsel to each of the Companies, addressed to the Lender with respect to the representations set forth in Sections 3.1(a) and (b), 3.2, 3.3 and 3.4 hereof and to the effect that:\n(i) This Agreement has been duly authorized, executed and delivered by each of the Companies and constitutes the legal, valid and binding obligation of each of the Companies enforceable in accordance with its provisions.\n(ii) The suretyship has been duly authorized, executed and delivered by the Surety and constitutes the legal, valid and binding obligation of the Surety enforceable in accordance with its provisions.\n(c) A copy of the resolution of the Board of Directors of the Company, certified as to authenticity by the Secretary or Assistant Secretary thereof, or a copy of a consent in writing signed by all of the members of the Board of Directors of the Company, authorizing the execution, delivery and performance of this Agreement and the Notes to be issued pursuant thereto.\n(d) A copy of the resolution of the Board of Directors of the Surety, certified as to authenticity by the Secretary or Assistant Secretary thereof, or a copy of a consent in writing duly signed by all of the members of the Board of Directors of the Surety, authorizing the execution, delivery and performance of the Suretyship.\n(e) A certificate of the Secretary or Assistant Secretary of the Company as to the incumbency and signature of the Officers of the Company signing this Agreement and any documentation referred to herein, including but not limited to the Notes.\n(f) The certificate of the Secretary or Assistant Secretary of the Surety as to the incumbency and signature of the Officers of the Surety signing the Suretyship.\nARTICLE 3\nREPRESENTATIONS AND WARRANTIES\nEach of the Companies represents and warrants to the Lender that as of the date of this Agreement the following representations are true and correct, and shall be true and correct as of the date of each Draw:\n3.1 Organization. The Companies and each of their respective Subsidiaries:\n(a) Are corporations duly incorporated, validly existing and in good standing under the laws of their respective states of incorporation.\n(b) Have the corporate power and authority to own their respective assets and to carry on their respective businesses as now conducted.\n(c) Are duly qualified to do business in every jurisdiction where the nature of their respective assets owned or their operations conducted make such qualification necessary except where the failure to so qualify would not have a material adverse effect upon their financial condition.\n3.2 Corporate Power. Each of the Companies has the corporate power to execute, deliver and perform this Agreement, to borrow monies pursuant hereto and to execute and deliver Notes in accordance herewith.\n3.3 Authority. The execution, delivery and performance of this Agreement by each of the Companies, the borrowing of monies hereunder, and the execution and delivery of Notes pursuant hereto have been duly authorized by all requisite corporate action on the part of each Company and shall not:\n(a) To the knowledge of either Company contravene any provision of law or any order of any court or other agency of government.\n(b) Contravene the articles of incorporation or by-laws of either Company or any agreement, indenture or instrument binding upon either Company.\n(c) Be in conflict with, result in the breach of or constitute, with due notice, lapse of time, or both, a default under any agreement, indenture or instrument binding upon either Company.\n(d) Result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the assets of either Company.\n3.4 Consent. To the knowledge of each Company, no action or consent of, or registration or filing with, any governmental instrumentality or other agency is required under existing law in connection with the execution, delivery and performance by each of the Companies of this Agreement, the borrowing of monies hereunder or the execution and delivery of Notes pursuant hereto.\n3.5 Proceedings. To the knowledge of each Company, there are no actions, suits or proceedings at law or in equity or by or before any governmental instrumentality or other agency now pending or threatened against or affecting either of the Companies or any of its assets which, if adversely determined, would, individually or in the aggregate, have a material adverse effect upon the financial condition of either Company.\n3.6 Financial Statements. Each Company has heretofore furnished its Balance Sheet and Statement of Operations on the Consolidating Schedules of the Horrigan American, Inc. and Subsidiaries Consolidated Financial Statements as of December 31, 1992, and the related statement of income and retained earnings and changes in financial position for the fiscal year then ended. Such statements are correct and complete and fairly present the financial position of the Company as of the date thereof and the results of the Company's operations for the period then ended; such statements were prepared in accordance with generally accepted accounting principles and practices consistently applied; and from December 31, 1992, to the date of this Agreement there has not been any material adverse change in the financial condition of either Company.\n3.7 Judgments. To the knowledge of each Company, there are no judgments or other judicial or administrative orders outstanding against either Company nor, to the Company's knowledge, any action, suit or proceeding at law or in equity or by or before any governmental or administrative instrumentality or agency now pending or threatened which, if adversely determined, might reasonably be expected to adversely and materially impair the right of either Company to carry on its business as it is now conducted or materially and adversely affect the financial condition of either Company.\n3.8 Contracts. Subject to the rights of the other parties to suchContracts, each Company owns its Contracts free and clear of any and all liens except Permitted Liens.\n3.9 Equipment. Subject to the rights of the other parties to suchContracts, each Company owns its Equipment free and clear of any and all liens except permitted Liens.\n3.10 Environmental Matters. Neither of the Companies has received any citation or complaint relating to its making, storing, handling, generating or transporting of any hazardous substances.\n3.11 ERISA. Each of the Companies is in compliance in all material respects with the applicable provisions of ERISA and all regulations thereunder and no Reportable Event has occurred with respect to any Plan maintained in whole or in part for employees of either Company.\n3.12 Group Health Plan. Each of the Companies provides COBRA continuation coverage under group health plans for separating employees in accordance with the provisions of Section 4980B(f) of the Internal Revenue Code and is in compliance with the provisions of Section 1862(b)(1) of the Social Security Act.\n3.13 Investment Company Act. Neither of the Companies is an \"investment company\" as that term is defined in, and is not otherwise subject to regulation under, the Investment Company Act.\n3.14 Burdensome Documents. Neither of the Companies is a party to, or bound by, any agreement, indenture, instrument, judgment, decree or order of any court or other governmental body which, if performed or observed by such Company, would have a material and adverse effect on the business or financial condition of such Company or the ability of such Company to perform its obligations under this Agreement.\n3.15 Taxes. Except to the extent to which either of the Companies has contested the same by appropriate proceedings, or where the failure to file or pay shall not have a material, adverse effect on the business or financial condition of either of the Companies:\n(a) Each Company has filed all federal and state tax returns which it was required to file, and has paid or made adequate provision for the payment of all taxes which have become due pursuant to said returns.\n(b) To the best of each Company's knowledge, there are no claims pending or threatened against either Company for past federal or state taxes, except those, if any, as to which proper reserves are reflected in the financial statements of the Company.\n3.16 Laws.\n(a) To the knowledge of each Company, and except as otherwise provided in Section 3.15 as pertains to the filing of tax returns and the payment of taxes, each Company is in compliance with all laws applicable to such Company.\n(b) Except as otherwise disclosed to the Lender in writing, neither Company has received any notice, not heretofore complied with, from any federal, state or local governmental authority or commission to the effect that it is not in compliance with any law applicable to the Company.\n3.17 Regulation U. Neither of the Companies is engaged principally in, nor is one of its important activities, the business of extending credit for the purpose of purchasing or carrying any margin stock within the meaning of Regulation U of the Board of Governors of the Federal Reserve System of the United States.\n3.18 No Event of Default. No Event of Default has occurred and is continuing.\nARTICLE 4\nFINANCIAL STATEMENTS\nEach of the Companies covenants that, from the date of this Agreement until the termination of the Credit Facility and payment in full of the principal and interest on all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n4.1 Books of Account. Each of the Companies shall maintain proper books of account in accordance with generally accepted accounting principles and practices consistently applied.\n4.2 Quarterly Financial Statements. As soon as available, but in any event within sixty (60) days after the end of each of the first three (3) fiscal quarterly periods, each of the Companies shall deliver to the Lender a consolidated and consolidating balance sheet of the Surety and its Subsidiaries, including each of the Companies, as of the last day of each such quarter, a consolidated and consolidating statement of operations and a consolidated statement of cash flows for such fiscal quarter, each prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, and certified by an Officer of each Company as fairly presenting the financial position and the results of operations of the Surety and its Subsidiaries as of its date and for such quarter and as having been prepared in accordance with generally accepted accounting principles consistently applied (subject to year-end audit adjustments).\n4.3 Annual Financial Statements. Annually, as soon as available, but in any event within one hundred twenty (120) days after the last day of its fiscal year, each of the Companies shall deliver to the Lender a consolidated and consolidating balance sheet of the Surety and its Subsidiaries, including each of the Companies, as of such last day of the fiscal year, a consolidated and consolidating statement of operations, consolidated retained earnings, and a consolidated statement of cash flows for such fiscal year, each prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, and certified without qualification by a recognized firm of independent certified public accountants reasonably acceptable to the\nLender as fairly presenting the financial position and the results of operations of the Surety and its Subsidiaries, including each of the Companies, as of and for the year ending on its date and as having been prepared in accordance with generally accepted accounting principles consistently applied.\n4.4 Other Information. Promptly after a written request therefor, each of the Companies shall provide to the Lender such other financial data and information evidencing compliance with the requirements of this Agreement, the Notes and the Suretyship as the Lender may reasonably request from time to time.\n4.5 Compliance Certificate. Concurrently with the delivery of the financial statements referred to in Sections 4.2 and 4.3 of this Agreement, each of the Companies shall deliver to the Lender a Compliance Certificate, in substantially the form of Exhibit \"G\" which is attached hereto and incorporated herein by reference, such Compliance Certificate to be executed by an Officer of each of the Companies and of the Surety.\nARTICLE 5\nAFFIRMATIVE COVENANTS\nEach of the Companies covenants that, from the date of this Agreement until the termination of the Credit Facility and payment in full of all amounts owing under all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n5.1 Corporate Existence. Each of the Companies shall, and shall cause each of its Subsidiaries to, do or cause to be done all things necessary to preserve and keep in full force and effect their respective corporate existences and comply with all laws applicable thereto except where the failure to do so shall not have a material adverse effect upon the financial condition of such Company.\n5.2 Subsidiary. In the event that either of the Companies shall acquire or create any Subsidiary subsequent to the date of this Agreement, such Company shall notify the Lender thereof, which notice shall set forth the corporate name of such Subsidiary and the registered address thereof.\n5.3 Trade Names. Each of the Companies shall maintain, preserve and protect all franchises and trade names, or the failure to do so shall not have a material adverse effect upon the financial condition of such Company.\n5.4 Insurance. Each Company shall keep its assets, other than personal property subject to Contracts, insured against fire with extended coverage, and liability, dishonesty, disappearance and destruction coverage to the extent that such insurance is usually carried by companies of a similar size engaged in similar activities as such Company.\n5.5 Indebtedness. Except to the extent to which such Company shallcontest the same in good faith, each of the Companies shall pay all of its indebtedness and obligations promptly and in accordance with normal terms.\n5.6 Taxes and Claims. Except to the extent to which such Company contests the same by appropriate proceedings, or where the failure to file or pay shall not have a material, adverse effect on the business or financial condition of such Company, each of the Companies shall pay and discharge, or shall cause to be paid and discharged, all taxes and other governmental charges and assessments imposed upon it or upon its income or upon its assets, before the same shall become in default, as well as all lawful claims for labor, materials, supplies or otherwise which, if unpaid, might become a lien or charge upon such assets or any part thereof.\n5.7 Increased Cost. In the event that any future law shall:\n(a) change the basis of taxation of any amounts payable to the Lender under this Agreement or the Notes issued by either of the Companies (other than taxes imposed on the\noverall net income of the Lender) by the United States or the jurisdiction in which the Lender has its principal offices; or\n(b) impose or modify any reserve, Federal Deposit Insurance Corporation premium or assessment, special deposit, minimum capital, capital ratio or similar requirements relating to any extensions of credit or other assets of, or any deposits with or liabilities of, the Lender;\nand the result of any such event referred to in Subsection (a) or (b) above shall be to increase the Lender's costs of making or maintaining any Loan, or to reduce any amount receivable by the Lender from such Company in respect of any Loan, then, upon demand made by the Lender as promptly as practicable after it obtains knowledge that such aforesaid costs exist but in no event later than ninety (90) days after obtaining such knowledge, such Company shall pay to the Lender additional fees in an amount which shall be sufficient to compensate the Lender for such costs. In the event that the Lender shall make any demand for additional fees as hereinabove set forth, the Company upon which demand shall have been made shall be entitled to receive from the Lender documentation reasonably substantiating the occurrence of any event referred to in Subsection (a) or (b) above and a determination of how the increased costs to the Lender and the amount of additional fees to the Companies have been determined.\n5.8 Event of Default. In the event that any Officer of either of the Companies knows of any Event of Default which shall have occurred or knows of any occurrence of any event which, upon notice or lapse of time or both, would constitute an Event of Default, such Company shall promptly furnish to the Lender a statement as to such occurrence specifying the nature and extent thereof and the action, if any, which is proposed to be taken with respect thereto.\n5.9 Examination. Each of the Companies shall permit the representatives of the Lender to visit the Company to examine and make extracts from the books of account of the Company and its Subsidiaries and to discuss the affairs, finances and accounts of the Company and its Subsidiaries with, and to be advised as to the same by its and their Officers at all such reasonable times and intervals as the Lender shall desire; provided, however, that the Lender shall at all times preserve the confidentiality of all information and documents which it obtains or which come into its possession pertaining to each of the Companies, shall use such information and documents only with respect to its management of the lending relationship with the Companies and shall not share, disclose, divulge or otherwise publish or make known such information or documents to any other Person nor use such information or documents to compete in any manner with either of the Companies.\n5.10 Minimum Tangible Net Worth. The Surety and the Companies shall maintain on a consolidated basis a minimum Tangible Net Worth of Twenty-One Million Dollars ($21,000,000.00).\n5.11 Debt\/Tangible Net Worth Ratio. The total debt of each Company to the Tangible Net Worth of such Company shall not exceed a ratio of seven to one (7.0 to 1.0).\n5.12 Cash Flow Ratio. The Surety and its Subsidiaries, including the Companies, on a consolidated basis, shall maintain a Cash Flow Ratio of at least one to one (1.0 to 1.0) as measured for the immediately preceding four (4) fiscal quarters.\n5.13 Compliance with Laws. Each of the Companies shall comply with all laws, rules, regulations and decrees to which such Company is subject and a violation of which would have a material, adverse effect on the financial condition of such Company.\nARTICLE 6\nNEGATIVE COVENANTS\nEach of the Companies covenants that, from the date of this Agreement until termination of the Credit Facility and payment in full of all amounts owing under all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n6.1 Subordinated Intercompany Debt. Neither Company, nor any of its Subsidiaries, shall at any time borrow any funds from HAI, the Surety, the other Company or any Subsidiary of either the Surety or the other Company which shall not constitute Subordinated Intercompany Debt.\n6.2 Limitation on Senior Debt\/Subordinated Intercompany Debt. Neither Company shall at any time permit the sum of its Senior Debt and its Subordinated Intercompany Debt to exceed its Gross Borrowing Base.\n6.3 Limitation on Draw. Neither Company shall at any time permit its aggregate monthly Draw against all Participant Lenders to exceed its Available Borrowing Base.\n6.4 Liens. Neither Company shall, nor shall it permit any Subsidiary to, create, incur, assume or suffer to exist any lien upon any of the Contracts or Equipment now owned or hereafter acquired by the Company or by any of its Subsidiaries, other than Permitted Liens.\n6.5 Merger. Neither Company shall enter into any merger or consolidation with any Person; provided, however, that if no Event of Default shall have occurred and be continuing, either may merge or consolidate with the Surety, or any Subsidiary of either of the Companies or the Surety.\n6.6 Transfer of Assets. Neither of the Companies shall sell, lease or otherwise transfer or dispose of all of its assets nor shall such Company sell, lease or otherwise transfer or dispose of any substantial part of its assets except in the usual and ordinary course of its business; as used in this Subsection, the words \"substantial part of its assets\" shall mean at least twenty-five percent (25%) of the assets of the Company computed on the basis of the applicable book value thereof.\n6.7 Loans\/Investments\/Guaranties. On or after the date hereof, neither Company shall make, nor permit any Subsidiary to make, any loans to or investments in any other Person or to guarantee the obligation of or otherwise become liable for the indebtedness of any other Person except:\n(a) either Company or any Subsidiary of either Company may:\n(i) make Contracts in the ordinary course of business;\n(ii) make loans to or investments in, or guarantee the obligation of the Surety, the other Company or any Subsidiary of the Surety or either of the Companies which has as its principal activity the acquisition or purchase of Contracts;\n(iii) make loans to or investments in, or guarantee the obligation of any other Person acquired by the Surety or any of its Subsidiaries which has as its principal activity the acquisition or purchase of Contracts;\n(iv) make investments in interest bearing obligations of, or obligations guaranteed by, the United States of America;\n(b) AELH shall be permitted to make loans to AEL and shall be permitted to make investments in marketable securities, which investments in the aggregate at any one time do not exceed five percent (5%) of the consolidated assets of the Surety and its Subsidiaries.\n6.8 Related Persons. Except as set forth in Section 6.6 hereof, on or after the date hereof, neither Company shall:\n(a) make any loan to, investment in or any Contract with any Related Person;\n(b) guarantee, become a surety for or otherwise become liable for the indebtedness of any Related Person.\n6.9 Prohibited Uses. Neither Company shall use the proceeds of any Draw nor any part thereof:\n(a) Directly or indirectly to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock or to refund indebtedness originally incurred for such purpose.\n(b) For any purpose that violates or is inconsistent with the provisions of Regulations T, U or X of the Board of Governors of the Federal Reserve System.\nARTICLE 7\nEVENTS OF DEFAULT AND REMEDIES\n7.1 Events of Default. The occurrence of any of the following shall constitute an Event of Default by each of the Companies under this Agreement:\n(a) Failure by either of the Companies to pay to the Lender any amount due pursuant to this Agreement or any Note issued pursuant hereto or any Prior Note and the continuance of such failure for a period of ten (10) days after receipt by the Company of notice from the Lender pertaining thereto.\n(b) The creation by either of the Companies of any lien upon any of the Contracts except Permitted Liens.\n(c) The incorrectness in any material and adverse respect of any representation by either of the Companies contained in Article 3 of this Agreement or any certificate issued pursuant to this Agreement other than with respect to the creation by either of the Companies of any security interest, lien or encumbrance upon any of the Contracts, as of the date when such representation shall have been deemed to have been made pursuant to the provisions of this Agreement, and the failure by the applicable Company to cure such incorrectness within fifteen (15) days of receipt by the Company of notice from the Lender pertaining thereto.\n(d) Failure by either of the Companies to maintain and observe the covenants contained in Subsections 5.10, 5.11, 5.12, 6.2 or 6.3 of this Agreement or the failure by the Surety to maintain and observe the covenants contained in Subsections 5.9, 5.10 or 5.11 of the Suretyship and the failure by the applicable Company or Surety to appropriately cure the same or cause the same to be cured by prepaying such of its indebtedness under the Unsecured Funding Program or taking such other steps or causing such steps to be taken as are necessary to effect such cure, such prepayment or other steps to be completed within fifteen (15) days of receipt of knowledge by the applicable Company of such failure to maintain and observe the said covenants or receipt by the applicable Company of notice from the Lender pertaining thereto, whichever shall first occur.\n(e) Failure by either of the Companies to perform or observe any of the provisions contained in this Agreement other than those referred to in Subsections (a) through and including (d) of this Section which the Company is required to perform or observe, and the continuance of such failure for a period of thirty (30) days following receipt by the Company of notice with respect thereto from the Lender.\n(f) Other than as a result of any Public Offering:\n(i) HAI ceases to be the owner of more than fifty percent (50%) of the issued and outstanding capital stock of the Surety; or\n(ii) the Surety ceases to be the owner of more than fifty percent (50%) of the then issued and outstanding capital stock of either of the Companies.\n(g) Filing by either of the Companies of a voluntary petition in bankruptcy or a voluntary petition or application seeking reorganization, arrangement or readjustment of its debts or for any other relief under the Bankruptcy Code, or under any other insolvency act or law, state or federal, now or hereafter existing, or any formal written consent to, approval of, or acquiescence in any such petition or proceeding by the applicable Company; the application by the applicable Company for the appointment of, or the appointment by consent of the applicable Company, or acquiescence by the applicable Company in the appointment of, a receiver or\ntrustee for the applicable Company or for all or any substantial part of its assets; or the making by the applicable Company of an assignment for the benefit of its creditors.\n(h) The filing of an involuntary petition against the applicable Company in bankruptcy or seeking reorganization, arrangement or readjustment of its debts or for any other relief under the Bankruptcy Code or under any other insolvency act or law, state or federal, now or hereafter existing; or the involuntary appointment of a receiver or trustee for the applicable Company or for all or any substantial part of its assets; and the continuance of any such event set forth above in this Subsection undismissed, unbounded, undischarged or otherwise uncontested for a period of thirty (30) days following receipt by the Company of notice with respect thereto.\n(i) Any breach, violation or default by either of the Companies under any agreement, contract, note or document to which it is a party pertaining to monies borrowed by it and the failure of the applicable Company to cure the same within any applicable grace period which results in the acceleration of such indebtedness in an amount in excess of an amount equal to one percent (1%) of the value of the consolidated assets of the applicable Company and its Subsidiaries.\n(j) Any Default under the Suretyship.\n(k) The revocation or attempted revocation by the Surety of any of its obligations to the Lender under the Suretyship.\n7.2 Remedies. If an Event of Default shall have occurred and be continuing, the Lender shall have the right to exercise any one or more of the following remedies against each of the Companies:\n(a) To be immediately relieved of any obligation to make any further Loans to either of the Companies pursuant to the Credit Facility.\n(b) To declare any and all existing Loans to be immediately due and payable.\n(c) To exercise such other rights and remedies as are by law, equity or statute permitted.\nNotwithstanding anything to the contrary contained in this Agreement, should an Event of Default referred to in Sections 7.1(g) or (h) occur, the remedies of the Lender set forth in Subsections (a) and (b) of this Section shall be deemed to have been exercised by the Lender concurrently with the occurrence of such Event of Default and without further action on behalf of the Lender.\n7.3 Remedies Cumulative. All rights and remedies of the Lender hereunder or by law, equity or statute permitted are cumulative and may, to the extent permitted by applicable law, be exercised concurrently or separately. The exercIse of any one right or remedy shall not be deemed to be an exclusive election of such right or remedy.\n7.4 Waiver of Default. The Lender may, at any time and from time to time, execute and deliver to the Companies or either of them a written instrument waiving, on such terms and conditions as the Lender may specify in such written instrument, any of the requirements of this Agreement or any Event of Default and its consequences, provided that any such waiver shall be for such period of time and subject to such conditions as shall be specified in any such instrument. No such waiver shall extend to any subsequent or other Event of Default, or impair any right consequent thereto and shall be effective only in the specific instance and for the specific purpose for which given.\nARTICLE 8\nMISCELLANEOUS PROVISIONS\n8.1 Notice. Except as set forth in Section 2.10(b) of this Agreement, all notices relating hereto shall be in writing. All notices referred to in Section 7.1 of this Agreement shall be delivered\nin person, shall be mailed by certified mail, postage prepaid, or shall be sent by nationally recognized overnight courier to an Officer of the Company. All other notices, except the notice referred to in Section 2.10(b) hereof, shall be delivered in person to the party to which such notice is being given or shall be mailed to such party by regular mail or certified mail, postage prepaid in each case, or shall be sent by nationally recognized overnight courier, to such party. The applicable addresses for all notices shall be:\nTo AEL: AEL Leasing Co., Inc. Flying Hills Corporate Center P.O. Box 13428 Reading, PA 19612 Attention: Chief Funding Officer\nTo ACCC: American Commercial Credit Corp. Flying Hills Corporate Center P.O. Box 13428 Reading, PA 19612 Attention: Chief Funding Officer\nTo the Lender: Maryland National Bank P.O. Box 987, MS 021604 Baltimore, MD 21202 Attention: Laura L. Gamble, Vice President\nunless the same shall be changed by like notice by any party to the others. Each of the Companies shall deliver all of the documentation referred to in Section 2.10 of this Agreement to the Lender at its address set forth above.\n8.2 Accounting Principles. Except as otherwise provided, all computations which are to be made under this Agreement shall be in accordance with generally accepted accounting principles and practices.\n8.3 Waiver of Jury Trial. EACH OF THE COMPANIES WAIVES TRIAL BY JURY IN ANY LITIGATION IN ANY COURT WITH RESPECT TO, IN CONNECTION WITH OR ARISING OUT OF THIS AGREEMENT AND THE NOTES OR THE VALIDITY, INTERPRETATION AND ENFORCEMENT HEREOF OR THEREOF.\n8.4 Gender\/Number. When the sense so requires, words which are used in this Agreement or the documentation referred to herein shall be deemed to be applicable to all genders and when used in the singular number shall be held to include the plural and vice versa.\n8.5 Construction. This Agreement and the documents referred to herein are entered into subsequent to negotiations among the parties and shall not be strictly construed against the preparing party.\n8.6 Additional Documents\/Assurances. At any time, and from time to time, upon request by any of the parties hereto, the other parties hereto shall execute, deliver and acknowledge or cause to be executed, delivered and acknowledged such further documents and shall do such other acts and things as the requesting party may reasonably require in order to fully effect the purposes and intent of this Agreement.\n8.7 Benefit. This Agreement and the documents referred to herein shall be binding upon and inure to the benefit of each of the Companies and the Lender and their respective successors and, to the extent herein permitted, assigns, but no successor of either of the Companies may borrow hereunder without the Lender's prior written consent.\n8.8 Assignment. Neither of the Companies nor the Lender shall have the right to assign or delegate this Agreement or the documents referred to herein or any rights or duties hereunder or thereunder without the prior written consent of the other, which consent shall not be unreasonably withheld; provided, however, that the Lender, if a bank, may assign or participate all or any part of its interest herein to any other bank which is a subsidiary of any entity of which the Lender is also a subsidiary without the prior written consent of the applicable Company, provided, however, that notwithstanding such assignment or participation, in no event shall the applicable Company be required to issue more than one (1) repayment check per month on account of all Notes issued pursuant to this Agreement.\n8.9 Severability. If any provision of this Agreement or any documents referred to herein, or the application thereof to any party or circumstance, be held invalid or unenforceable, the remainder of this Agreement and the documentation referred to herein, and the application of such provision to other parties or circumstances, shall not be affected thereby and to this end, the provisions of this Agreement and the documentation referred to herein are declared severable.\n8.10 Integration. This Agreement and the documents referred to herein contain the entire understanding among the Companies and the Lender with respect to the subject matter hereof and such understanding shall not be amended, modified or terminated except in writing and duly executed on behalf of the Company and the Lender.\n8.11 Captions. The captions of each of the Sections of this Agreement do not constitute a part of this Agreement but are for informational purposes only.\n8.12 Counterparts. This Agreement may be executed in two (2) or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute but one and the same instrument.\n8.13 Jurisdiction. Each Company irrevocably submits to the jurisdiction of any state or federal court sitting in the State of Maryland over any proceeding arising out of this Agreement and irrevocably waives, to the fullest extent permitted by law, any objection that it may ever have to the laying of jurisdiction or venue in any such proceeding in any such court and any claim that any such proceeding brought in any such court has been brought in an inconvenient forum.\n8.14 Law. This Agreement and the documentation referred to herein shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. AEL LEASING CO., INC.\nBy: ______________________________________ Attest: ______________________________________\nAMERICAN COMMERCIAL CREDIT CORP.\nBy: ______________________________________ Attest: ______________________________________\nMARYLAND NATIONAL BANK\nBy: ______________________________________ Attest: ______________________________________\nEXHIBIT A\nNOTE\n$ --------- Dated:\n(hereinafter referred to as \"Company\"), a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having a registered office at Flying Hills Corporate Center No. 6, Reading, Pennsylvania, hereby promises to pay to the order of Maryland National Bank (hereinafter referred to as \"Lender\") at the offices of the Lender at P.O. Box 987, MS 021604, Baltimore, MD, 21202, the principal sum of and 00\/ 100 Dollars ($ ) together with interest thereon at the rate of percent ( %) per annum, such interest to remain fixed for the term three hundred sixty\/three hundred sixty (360\/360) days.\nThe Company shall repay the principal amount of this Note together with interest thereon at the annual rate set forth above until paid in full as follows:\na. On 199 , the sum of and \/100 dollars ($ );\nb. Beginning on , 199 , and continuing on the same date of each of the next fifteen (15) months thereafter, the sum of and \/100 dollars ($ );\nc. On , 199 , the sum of and \/100 dollars ($ );\nd. Beginning on , 199 , and continuing on the same date of each of the next ten (10) months thereafter, the sum of and \/100 dollars ($ );\ne. On , 199 , the sum of and \/100 dollars ($ );\nf. Beginning on , 199 , and continuing on the same date of each of the next ten (10) months thereafter, the sum of and \/100 dollars ($ );\ng. On , 199 , the sum of and \/100 dollars ($ ).\nEach of such installments shall be applied first to the payment of accrued and unpaid interest and then to the payment of principal. Any payment received on a day other than its due date will be applied as aforesaid on the date received and the final payment will be recalculated and adjusted to reflect the actual interest accrued on the outstanding principal hereof. All payments shall be in lawful money of the United States of America.\nThis Note is given by the Company to the Lender to evidence a Loan to be made by the Lender to the Company pursuant to the provisions of a certain Loan Agreement dated June 28, 1993, among the Company, and the Lender.\nThe Maker has certain rights of prepayment of the principal of this Note, which prepayment rights are more fully set forth in the Loan Agreement.\nAn Event of Default by the Company under the Loan Agreement shall be an event of default under this Note and the holder hereof shall be entitled to all of the rights and remedies set forth in the Loan Agreement.\nPresentment for payment, protest or notice of dishonor are hereby waived by the Company.\nIN WITNESS WHEREOF, the Company has caused this Note to be executed on the day and year first above written.\nBy:--------------------------------------- Title:---------------------------------------\nEXHIBIT B\nAEL LEASING CO., INC.\n18 Months - 20% 30 Months - 65% 42 Months - 15% 54 Months - -0- Ave. Maturity 29.4 Months\nAMERICAN COMMERCIAL CREDIT CORP.\n18 Months - 30% 30 Months - 52% 42 Months - 18% 54 Months - -0- Ave. Maturity 28.6 Months\nEXHIBIT C\nMODIFICATION NOTICE\nDear Ms. Gamble:\nPursuant to the provisions of the Loan Agreement among AEL Leasing Co., Inc. and American Commercial Credit Corp. and Maryland National Bank (\"Lender\") dated June 28, 1993, you are hereby given notice that the nature of the Draw by each of the Companies on the Credit Facility supplied by the Lender is hereby modified and shall be as follows:\nAS TO AEL LEASING CO., INC.\n1. Each Draw shall be comprised of three (3) Loans.\n2. The principal amount of each such Loan comprising the applicable Draw shall constitute the following proportion of the total amount of the Draw:\na. Loan having a Loan Term of eighteen (18) months -- ( %) percent of the total amount of the Draw.\nb. Loan having a Loan Term of thirty (30) months -- ( %) percent of the total amount of the Draw.\nc. Loan having a Loan Term of forty-two (42) months -- ( %) percent of the total amount of the Draw.\nUntil otherwise modified in accordance with the provisions of the Loan Agreement, all Draws made by AEL Leasing Co., Inc. on or after the date hereof shall be as set forth herein.\nAS TO AMERICAN COMMERCIAL CREDIT CORP.\n1. Each Draw shall be comprised of three (3) Loans.\n2. The principal amount of each such Loan comprising the applicable Draw shall constitute the following proportion of the total amount of the Draw:\na. Loan having a Loan Term of eighteen (18) months -- ( %) percent of the total amount of the Draw.\nb. Loan having a Loan Term of thirty (30) months -- ( %) percent of the total amount of the Draw.\nc. Loan having a Loan Term of forty-two (42) months -- ( %) percent of the total amount of the Draw.\nUntil otherwise modified in accordance with the provisions of the Loan Agreement, all Draws made by American Commercial Credit Corp. on or after the date hereof shall be as set forth herein.\nVery truly yours,\nAEL LEASING CO., INC.\nBy: ______________________________________ Title: ______________________________________\nAMERICAN COMMERCIAL CREDIT CORP.\nBy: ______________________________________ Title: ______________________________________\nEXHIBIT D\nLOAN CERTIFICATE\nDate\nDear Ms. Gamble:\nPursuant to a Loan Agreement among AEL Leasing Co., Inc. and American Commercial Credit Corp. and Maryland National Bank dated June 28, 1993, is hereby submitting this Certificate to you and making a Draw against its Credit Facility, the Draw to be composed of three (3) loans having original principal amounts and loan terms as follows:\nDraw in the amount of dollars ($ ). Loan Original Principal Loan Term Amount 1 $ 18 Months 2 $ 30 Months 3 $ 42 Months\nThe original Note evidencing such loans is enclosed herewith. Please wire transfer the total amount of the Draw to the Company's account at Meridian Bank having offices at Philadelphia, Pennsylvania. The applicable deposit account number is Horrigan American, Inc. Concentration Account, number 0905- 6602 to the attention of Barbara H. Pattison, Vice President.\nVery truly yours,\n(INSERT COMPANY NAME)\nBy:--------------------------------------- Title:---------------------------------------\nEXHIBIT E\nBORROWING BASE CERTIFICATE\nDate\nAttention: Ms. Laura L. Gamble, Vice President\nDear Ms. Gamble:\nPursuant to a Loan Agreement between AEL Leasing Co., Inc. and American Commercial Credit Corp. and Maryland National Bank dated June 28, 1993, we are hereby advising you that the Available Borrowing Base for the month of for the (\"Company\") is and 00\/100 dollars ($ ) and the aggregate Draw of the Company for the said month from all Participant Lenders will be approximately and 00\/100 dollars ($ ).\nThe Available Borrowing Base as of , for the month of takedown, has been computed as follows: Gross Qualifying Assets xxxxxx Less: xxxxxx Appropriate Deferred Income xxxx Accounts Payable to Suppliers xxxx Security Deposits xxxxxx -------\nNet Qualifying Assets xxxxxx Times a factor of .9 Gross Borrowing Base xxxxxx Less: Outstanding Senior Debt xxxxxx Outstanding Subordinated Intercompany Debt xxxxxx ------- Available Borrowing Base xxxxxx\nVery truly yours,\n(INSERT COMPANY NAME)\nBy:--------------------------------------- Title:---------------------------------------\nEXHIBIT F\nSURETYSHIP\nBETWEEN\nAMERICAN EQUIPMENT LEASING CO., INC.\nAND\nMARYLAND NATIONAL BANK\nDATED: JUNE 28, 1993\nEXHIBIT F\nSURETYSHIP\nBETWEEN\nAMERICAN EQUIPMENT LEASING CO., INC.\nAND\nMARYLAND NATIONAL BANK\nPAGE BACKGROUND............................................................... 1\nARTICLE 1 DEFINITIONS.................................................... 1 1.1 General Provisions............................................. 1 1.2 Defined Terms.................................................. 2\nARTICLE 2 ASSURANCE AND GUARANTY......................................... 5 2.1 Prior Suretyship............................................... 5 2.2 Assurance...................................................... 5 2.3 Liability...................................................... 5 2.4 Waiver......................................................... 5 2.5 Consent........................................................ 5 2.6 Waiver of Claim; Survival...................................... 6 2.7 Reinstatement.................................................. 6\nARTICLE 3 REPRESENTATIONS AND WARRANTIES................................. 6 3.1 Organization................................................... 6 3.2 Corporate Power................................................ 6 3.3 Authority...................................................... 6 3.4 Consent........................................................ 7 3.5 Proceedings.................................................... 7 3.6 Judgments...................................................... 7 3.7 Investment Company Act......................................... 7 3.8 Burdensome Documents........................................... 7 3.9 Taxes.......................................................... 7 3.10 Laws........................................................... 7 3.11 Regulation U................................................... 7 3.12 No Default..................................................... 7\nARTICLE 4 FINANCIAL STATEMENTS........................................... 7 4.1 Books of Account............................................... 8 4.2 Quarterly Financial Statements................................. 8 4.3 Annual Financial Statements.................................... 8 4.4 Other Information.............................................. 8 4.5 Compliance Certificate......................................... 8\nARTICLE 5 AFFIRMATIVE COVENANTS.......................................... 8 5.1 Corporate Existence............................................ 8 5.2 Subsidiary..................................................... 8 5.3 Trade Names.................................................... 8 5.4 Insurance...................................................... 9 5.5 Indebtedness................................................... 9 5.6 Taxes and Claims............................................... 9\ni\nPAGE 5.7 Default........................................................ 9 5.8 Examination.................................................... 9 5.9 Minimum Tangible Net Worth..................................... 9 5.10 Debt\/Tangible Net Worth Ratio.................................. 9 5.11 Cash Flow Ratio................................................ 9 5.12 Compliance with Laws........................................... 9\nARTICLE 6 NEGATIVE COVENANTS............................................. 9 6.1 Subordinated Intercompany Debt................................. 10 6.2 Merger......................................................... 10 6.3 Transfer of Assets............................................. 10 6.4 Loans\/Investments\/Guaranties................................... 10 6.5 Related Persons................................................ 10\nARTICLE 7 DEFAULT AND REMEDIES........................................... 10 7.1 Default........................................................ 10 7.2 Remedies....................................................... 11 7.3 Remedies Cumulative............................................ 12 7.4 Waiver of Default.............................................. 12\nARTICLE 8 MISCELLANEOUS PROVISIONS....................................... 12 8.1 Place of Payment............................................... 12 8.2 Notice......................................................... 12 8.3 Accounting Principles.......................................... 12 8.4 Waiver of Jury Trial........................................... 12 8.5 Gender\/Number.................................................. 12 8.6 Construction................................................... 13 8.7 Additional Documents\/Assurances................................ 13 8.8 Benefit........................................................ 13 8.9 Assignment..................................................... 13 8.10 Severability................................................... 13 8.11 Integration.................................................... 13 8.12 Captions....................................................... 13 8.13 Counterparts................................................... 13 8.14 Jurisdiction................................................... 13 8.15 Law............................................................ 13\nii\nEXHIBIT F\nSURETYSHIP\nThis Suretyship is made as of this 28th day of June, 1993, by and between AMERICAN EQUIPMENT LEASING CO., INC., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania having its principal offices at Flying Hills Corporate Center, Flying Hills, Reading, Pennsylvania,\nAND\nMARYLAND NATIONAL BANK, a national banking association having its principal offices at P.O. Box 987, Baltimore, MD, 21202.\nBACKGROUND\nThe Surety is the sole shareholder of the capital stock of each of the Companies. The Companies are engaged in various business activities, including the offering of various financial services. From time to time in the course of its business activities, each of the Companies acquires and makes Contracts. Each of the Companies presently maintains a separate Unsecured Funding Program pursuant to which from time to time each of the Companies makes periodic borrowings, primarily in order to finance or refinance, directly or indirectly, the acquisition and making of Contracts.\nEach Participant Lender has agreed to modify the Unsecured Funding Program to permit, inter alia, a single Credit Facility which may be accessed by each of the Companies.\nIn order to re-document the Unsecured Funding Program of each of the Companies, each Participant Lender, including the Lender, has been requested to enter into documentation substantially similar to the Agreement and the documentation referred to therein, and each Participant Lender, including the Lender, has agreed thereto.\nConcurrently herewith, each of the Companies and the Lender have entered into and executed the Agreement. One of the conditions of the Agreement is that the Surety execute and deliver this Suretyship to the Lender.\nNOW, THEREFORE, INTENDING TO BE LEGALLY BOUND HEREBY, the Surety and the Lender agree as follows:\nARTICLE 1\nDEFINITIONS\n1.1 General Provisions. Unless the context clearly requires otherwise:\n(a) Words and phrases used in this Suretyship or in any of the documents referred to herein which are not specifically defined in this Suretyship or in any of the documents referred to herein but which are defined in the Uniform Commercial Code shall have the meanings assigned to them in the Uniform Commercial Code.\n(b) All accounting terms used in this Suretyship or in the documents referred to herein which are not specifically defined in this Suretyship or in any of the documents referred to herein shall have the meanings assigned to them in accordance with generally accepted accounting principles and practices.\n(c) The word \"including\" shall be a word of enlargement rather than a word of limitation and shall be deemed to mean \"including but not limited to\" rather than \"including only\".\n1.2 Defined Terms. Unless the context clearly requires otherwise, the following words and phrases whenever used in the singular or the plural form and capitalized shall have the following meanings for the purposes of this Suretyship and all documents referred to herein:\n(a) \"ACCC\" shall mean American Commercial Credit Corp., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(b) \"AEL\" shall mean AEL Leasing Co., Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(c) \"Agreement\" shall mean the Agreement dated this date among AEL, ACCC and the Lender, and all amendments and modifications thereto.\n(d) \"Bankruptcy Code\" shall mean the federal Bankruptcy Code, as amended and supplemented from time to time.\n(e) \"Cash Flow Ratio\" shall mean the ratio of Ratio Cash Receipts to Ratio Cash Disbursements for any fiscal period\n(f) \"Company\" shall mean, as applicable, either AEL or ACCC in its capacity as borrower under the Credit Facility.\n(g) \"Companies\" shall mean, collectively, AEL and ACCC.\n(h) \"Compliance Certificate\" shall mean the document referred to in section 4.5 of this Suretyship.\n(i) \"Contract\" shall mean any conditional sales contract, installment sales contract, commercial loan agreement, security agreement, lease, mortgage, other title retention instrument, promissory note or other evidence of indebtedness, whether secured or unsecured, arising out of:\n(i) the making of any commercial loan by either of the Companies or any of their respective Subsidiaries to any Person other than to any Related Person,\n(ii) the acquisition, by purchase, merger or otherwise, by either of the Companies or any of their respective subsidiaries of the lender's rights with respect to any commercial loan to any Person other than to any Related Person,\n(iii) the sale or lease by either of the Companies or any of their respective subsidiaries of any Equipment or other personal property to any Person other than to any Related Person, or\n(iv) the acquisition, by purchase, merger or otherwise, by either of the Companies or any of their respective subsidiaries of the seller's or lessor's rights with respect to the sale or lease of any Equipment to any Person other than to any Related Person.\n(j) \"Controlling Interest\" shall mean, if applicable to a corporation, the right under ordinary circumstances to elect a majority of the members of the board of directors of such corporation, and if a partnership, general or limited, the ownership of fifty percent (50%) or more of the general partnership interests of such partnership.\n(k) \"Credit Facility\" shall mean the credit facility herein established by the Lender for the benefit of AEL and ACCC.\n(l) \"Default\" shall mean any of the events specified in section 7.1 of this Suretyship, provided that any requirement set forth in this Suretyship or the documentation referred to herein for notice, lapse of time or both, or any other condition has been satisfied.\n(m) \"Draw\" shall mean the periodic borrowing by either of the Companies of funds from the Lender by means of the making by the Lender to such Company of one (l) or more simultaneous Loans.\n(n) \"Equipment\" shall mean all equipment and other personal property, including software and all other general intangibles, which either of the Companies leases or sells to any Person pursuant to any Contract.\n(o) \"Event of Default\" shall mean any event specified in Section 7.1 of the Agreement provided that any requirement set forth in the Agreement or the documentation referred to therein for notice, lapse of time or both, or any other condition, has been satisfied.\n(p) \"HAI\" shall mean Horrigan American, Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania.\n(q) \"Indebtedness\" shall mean all indebtedness of each of the Companies to the Lender which is outstanding pursuant to the Credit Facility and which is evidenced by any Note or any Prior Note.\n(r) \"Investment Company Act\" shall mean the Investment Company Act of 1940, as amended and supplemented from time to time.\n(s) \"Lender\" shall mean Maryland National Bank, a national banking association.\n(t) \"Loan\" shall mean a borrowing by either Company from the Lender pursuant to the Credit Facility which, together with other such borrowings made on such date, shall constitute a Draw by such Company on the Credit Facility.\n(u) \"Note\" shall mean the promissory note referred to in Section 2.5 of the Agreement.\n(v) \"Officer\" shall mean the Chairman of the Board of Directors, the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer, the Vice President of Funds Management or such other executive employee of the Surety whom the Surety shall designate by resolution of the Board of Directors of the Surety, certified as to authenticity by the Secretary or Assistant Secretary thereof, or by a consent in writing signed by all of the members of the Board of Directors of the Surety, a copy of which has been delivered to the Lender.\n(w) \"Participant Lender\" shall mean any bank, financial institution, insurance company, corporation or other entity which is participating or shall hereafter become a participant in the Unsecured Funding Program.\n(x) \"Person\" shall mean any individual, corporation, partnership, association, trust or other entity or organization, including but not limited to a governmental or political subdivision or agency or instrumentality thereof.\n(y) \"Prior Agreement\" shall mean any Unsecured Funding Program Agreement heretofore executed by either of the Companies and the Lender establishing or continuing an Unsecured Funding Program for the benefit of such Company, and all amendments and modifications thereto.\n(z) \"Prior Note\" shall mean any promissory note heretofore issued by either of the Companies pursuant to any Prior Agreement.\n(aa) \"Prior Suretyship\" shall mean the Suretyship between HAI and the Lender, and all amendments and modifications thereto.\n(ab) \"Public Offering\" shall mean the offering of any class of equity securities of the Surety or of either of the Companies pursuant to a registration statement under the Securities Act.\n(ac) \"Ratio Cash Disbursements\" for any fiscal period shall mean the sum of the following items, all as determined in accordance with generally accepted accounting principles as applied to the Surety's financial statements and as set forth in the Surety's Consolidated Balance Sheet and the Surety's Consolidated Statement of Cash Flows:\n(i) principal repayments of long-term Senior Debt;\n(ii) dividends paid;\n(iii) cost of acquired treasury stock;\n(iv) acquisition of investments;\n(v) acquisition of property and equipment (i.e. fixed assets);\n(vi) thirty-three and one-third percent (331\/3%) of the fiscal period ending net subordinated Intercompany Debt outstanding; and\n(vii) thirty-three and one-third percent (331\/3%) of the fiscal period ending short-term Senior Debt borrowings.\n\"At its election, the Surety may exclude from (i) above any prepayments of principal which are not required to be made pursuant to the terms of the instruments and other documents governing such Senior Debt or any repayments which are concurrently refinanced in the ordinary course of business by a substantially equal amount of new Senior Debt.\n(ad) \"Ratio Cash Receipts\" for any fiscal period shall mean the sum of the following items, all as determined in accordance with generally accepted accounting principles as applied to the Surety's financial statements and as set forth in the Surety's Consolidated Statement of Cash Flows:\n(i) net cash provided by operating activities;\n(ii) principal collections of finance receivables;\n(iii) proceeds from issuance of capital stock; (iv) proceeds from sale of investments;\n(v) proceeds from sale of property and equipment (i.e. fixed assets);\n(vi) proceeds from sale of finance receivables; and\n(vii) proceeds from sale of Equipment applicable to operating leases.\n(ae) \"Related Person\" shall mean HAI, the Surety, either Company, any Subsidiary or any other Person in which HAI, the Surety, either Company or any Subsidiary has a Controlling Interest.\n(af) \"Securities Act\" shall mean the Securities Act of 1933, as amended and supplemented from time to time.\n(ag) \"Senior Debt\" of the Surety shall mean the sum total of all amounts owing with respect to funds borrowed by the Surety or any of its Subsidiaries from banks, financial institutions, insurance companies, corporations and other entities other than Related Persons.\n(ah) \"Subordinated Intercompany Debt\" of the Surety shall mean the sum total of all amounts owing with respect to funds borrowed by the Surety or any of its Subsidiaries from HAI, either of the Companies or any Subsidiary of either the Surety or either of the Companies, the repayment of which by its terms is subordinated to the repayment of Senior Debt of the Surety.\n(ai) \"Subsidiary\" shall mean any corporation in which HAI, the Surety, either Company or any subsidiary of any of the foregoing, as applicable, directly or indirectly, owns or hereafter acquires a sufficient amount of capital stock having general voting power so as to permit HAI, the Surety, either Company or any subsidiary of any of the foregoing, as applicable, under ordinary circumstances to elect a majority of the members of the board of directors of such corporation.\n(aj) \"Surety\" shall mean American Equipment Leasing Co., Inc., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its registered office at Flying Hills Corporate Center, Flying Hills, Reading, Pennsylvania, 19607.\n(ak) \"Suretyship\" shall mean this Suretyship, and all amendments and modifications hereto.\n(al) \"Tangible Net Worth\" of the Surety shall mean the aggregate amount of equity of the stockholders of the Surety as determined in accordance with generally accepted accounting principles, less the aggregate amount of intangible assets of the Surety, which shall include goodwill, organization costs, franchises and trademarks.\n(am) \"Uniform Commercial Code\" shall mean the Pennsylvania Uniform Commercial Code, as amended and supplemented from time to time.\n(an) \"Unsecured Funding Program\" shall mean the program of unsecured credit facilities acquired by the Companies from various banks, financial institutions, insurance companies, corporations or other entities, the proceeds of which are to be used primarily to finance or refinance, directly or indirectly, the acquisition or making of Contracts and which programs shall be evidenced by documentation substantially similar to the Agreement, this Suretyship and other documentation referred to herein.\nARTICLE 2\nASSURANCE AND GUARANTY\n2.1 Prior Suretyship. This Suretyship replaces and supersedes the Prior Suretyship which is hereby terminated.\n2.2 Assurance. The Surety hereby irrevocably assures and guarantees to the Lender the payment of the Indebtedness in accordance with the provisions of this Suretyship. This Suretyship is a continuing one and is irrevocable. This Suretyship is a guarantee of payment and not of collection.\n2.3 Liability. The amount of the Surety's liability hereunder is unlimited. The Lender may apply any payment received from the Surety on account of this Suretyship to the Indebtedness in such order as the Lender may elect, without regard to the date upon which such Indebtedness was incurred. The obligations of the Surety under this Suretyship shall not be subject to any counterclaim, set-off, reduction or defense based on any claim that the surety may have against either Company or any other creditor of either Company, and shall not be conditioned or contingent upon the pursuit or enforcement by the Lender of any remedy it may have against either Company under the Agreement, any Note or Prior Note, or otherwise. Any modification, limitation or discharge of the Indebtedness or any other obligations of either company to the Lender arising out of any bankruptcy or insolvency proceeding involving either Company shall not modify, limit, reduce, discharge or otherwise affect the liability of the Surety hereunder, and this Suretyship shall remain in full force and effect.\n2.4 Waiver. The Surety waives the following notices to it with respect to this Suretyship and its liability hereunder:\n(a) Of the acceptance hereof and reliance hereon.\n(b) Of the present existence or future incurring of Indebtedness.\n(c) Of the amount, terms and conditions of such Indebtedness.\n(d) Of any Event of Default by either of the Companies under the Agreement.\n2.5 Consent. The Surety consents to the form of the Agreement and any documentation referred to therein and to the modification of the form of the Agreement and any of the documentation referred to therein, provided such modification is agreed upon in writing by the Companies and the Lender. In addition, the Surety consents to any arrangement, renewal, extension, postponement, compromise, waiver or release with respect to the Indebtedness, and this Suretyship shall\nnot be released by any such arrangement, renewal, extension, postponement, waiver or release with respect to the Indebtedness.\n2.6 Waiver of Claim; Survival. As a material inducement to the Lender to enter into the Agreement and this Suretyship, the Surety irrevocably waives and relinquishes any claim (as defined in 11 U.S.C. Section 101) it may now or hereafter have against either Company (including any right of subrogation, indemnification or reimbursement) on account of or arising out of any payment or transfer made by the Surety, or any payment or transfer which the Surety is obligated to make, to the Lender under this Suretyship or under any other agreement with a creditor of either Company. The Surety's obligations under this Suretyship shall survive the payment in full of all indebtedness until such payment has become final and is no longer subject to being set aside or recovered in any legal proceeding.\n2.7 Reinstatement. If any payment applied by Lender to any Indebtedness is thereafter set aside, recovered, rescinded or required to be returned for any reason (including bankruptcy, insolvency or reorganization of either Company), the Indebtedness to which such payment was applied shall, for the purposes of this Suretyship, be deemed to have continued in existence notwithstanding such application, and this Suretyship shall be enforceable as to such of the Indebtedness as fully as if such application had never been made.\nARTICLE 3\nREPRESENTATIONS AND WARRANTIES\nThe Surety represents and warrants to the Lender that as of the date of this Suretyship, the following representations are true and correct and shall be true and correct as of the date of each Draw:\n3.1 Organization. The Surety and each of the Companies:\n(a) Are corporations duly incorporated, validly existing and in good standing under the laws of their respective states of incorporation.\n(b) Have the corporate power and authority to own their respective assets and to carry on their respective businesses as now conducted.\n(c) Are duly qualified to do business in every jurisdiction where the nature of their respective assets owned or their operations conducted make such qualification necessary except where the failure to so qualify would not have a material adverse effect upon their financial condition.\n3.2 Corporate Power. The Surety has the corporate power to execute, deliver and perform this Suretyship.\n3.3 Authority. The execution, delivery and performance of thisSuretyship by the Surety has been duly authorized by all requisite corporate action on the part of the Surety and shall not:\n(a) To the knowledge of the Surety contravene any provision of law or any order of any court or other agency of government.\n(b) Contravene the articles of incorporation or by-laws of the Surety or any agreement, indenture or instrument binding upon the Surety.\n(c) Be in conflict with, result in the breach of or constitute, with due notice, lapse of time, or both, a default under any agreement, indenture or instrument binding upon the Surety.\n(d) Result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the assets of the Surety.\n3.4 Consent. To the knowledge of the Surety, no action or consent of, or registration or filing with, any governmental instrumentality or other agency is required under existing law in connection with the execution, delivery and performance by the Surety of this Suretyship.\n3.5 Proceedings. To the knowledge of the Surety, there are no actions, suits or proceedings at law or in equity or by or before any governmental agency or other instrumentality now pending or threatened against or affecting the Surety or any of its assets which, if adversely determined, would individually or in the aggregate have a material adverse effect upon the financial condition of the Surety.\n3.6 Judgments. To the knowledge of the Surety, there are no judgments or other judicial or administrative orders outstanding against the Surety nor, to the Surety's knowledge, any action, suit or proceeding at law or in equity or by or before any governmental agency or instrumentality now pending or threatened which, if adversely determined, might reasonably be expected to adversely and materially impair the right of the Surety to carry on its business as it is now conducted or materially and adversely affect the financial condition of the Surety.\n3.7 Investment Company Act. The Surety is not an \"investment company\" as that term is defined in, and is not otherwise subject to regulation under, the Investment company Act.\n3.8 Burdensome Documents. The Surety is not a party to, nor bound by, any agreement, indenture, instrument, judgment, decree or order of any court or other governmental body which, if performed or observed by the Surety, would have a material and adverse effect on the business or financial condition of the Surety or the ability of the Surety to perform its obligations under this Suretyship.\n3.9 Taxes. Except to the extent to which the Surety has contested the same by appropriate proceedings, or where the failure to file or pay shall not have a material, adverse effect on the business or financial condition of the Surety:\n(a) The Surety has filed all federal and state tax returns which it was required to file, and has paid or made adequate provision for the payment of all taxes which have become due pursuant to said returns.\n(b) To the best of the Surety's knowledge, there are no claims pending or threatened against the Surety for past federal or state taxes, except those, if any, as to which proper reserves are reflected in the financial statements of the Surety.\n3.10 Laws.\n(a) To the knowledge of the Surety, and except as otherwise provided in Section 3.9 as pertains to the filing of tax returns and the payment of taxes, the Surety is in compliance with all laws applicable to the Surety.\n(b) Except as otherwise disclosed to the Lender in writing, the Surety has not received any notice, not heretofore complied with, from any federal, state or local governmental instrumentality or agency to the effect that it is not in compliance with any law applicable to the Surety.\n3.11 Regulation U. The Surety is not engaged principally in, nor is one of its important activities, the business of extending credit for the purpose of purchasing or carrying any margin stock within the meaning of Regulation U of the Board of Governors of the Federal Reserve System of the United States.\n3.12 No Default. No Default has occurred and is continuing.\nARTICLE 4\nFINANCIAL STATEMENTS\nThe Surety covenants that, from the date of this Suretyship until the termination of the Credit Facility and payment in full of the principal and interest on all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n4.1 Books of Account. The Surety shall maintain proper books of account in accordance with generally accepted accounting principles and practices consistently applied.\n4.2 Quarterly Financial Statements. As soon as available, but in any event within sixty (60) days after the end of each of the first three (3) fiscal quarterly periods, the Surety shall deliver to the Lender a consolidated and consolidating balance sheet of the Surety and its Subsidiaries, including each of the Companies, as of the last day of each such quarter, a consolidated and consolidating statement of operations and a consolidated statement of cash flows for such fiscal quarter, each prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, and certified by an Officer of the Surety as fairly presenting the financial position and the results of operations of the Surety and its Subsidiaries as of its date and for such quarter and as having been prepared in accordance with generally accepted accounting principles consistently applied (subject to year-end audit adjustments).\n4.3 Annual Financial Statements. Annually, as soon as available, but in any event within one hundred twenty (120) days after the last day of its fiscal year, the Surety shall deliver to the Lender a consolidated and consolidating balance sheet of the Surety and its Subsidiaries, including each of the Companies, as of such last day of the fiscal year, a consolidated and consolidating statement of operations, consolidated retained earnings, and a consolidated statement of cash flows for such fiscal year, each prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, and certified without qualification by a recognized firm of independent certified public accountants reasonably acceptable to the Lender as fairly representing the financial position and the results of operations of the Surety and its Subsidiaries, as of and for the year ending on its date and as having been prepared in accordance with generally accepted accounting principles consistently applied.\n4.4 Other Information. Promptly after a written request therefor from time to time, the Surety shall provide to the Lender such other financial data and information evidencing compliance with the requirements of this Suretyship as the Lender may reasonably request.\n4.5 Compliance Certificate. Concurrently with the delivery of the financial statements referred to in Sections 4.2 and 4.3 of this Suretyship, the Surety shall deliver to the Lender a Compliance Certificate, in substantially the form of Exhibit \"G\" of the Agreement which is attached thereto and incorporated therein by reference, such Compliance Certificate to be executed by an Officer of each of the Companies and of the Surety.\nARTICLE 5\nAFFIRMATIVE COVENANTS\nThe Surety covenants that, from the date of this Suretyship until the termination of the Credit Facility and payment in full of all amounts owing under all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n5.1 Corporate Existence. The Surety shall, and shall cause each of the Companies to, do or cause to be done all things necessary to preserve and keep in full force and effect their respective corporate existences and comply with all laws applicable thereto except where the failure to do so shall not have a material adverse effect upon the financial condition of the Surety.\n5.2 Subsidiary. In the event that the Surety shall acquire or create any Subsidiary subsequent to the date of this Suretyship, the Surety shall notify the Lender thereof, which notice shall set forth the corporate name of such Subsidiary and the registered address thereof.\n5.3 Trade Names. The Surety shall maintain, preserve and protect all franchises and trade names except where the failure to do so shall not have a material adverse effect upon the financial condition of the Surety.\n5.4 Insurance. The Surety shall keep its assets insured against fire with extended coverage, and liability, dishonesty, disappearance and destruction coverage to the extent that such insurance is usually carried by companies of a similar size engaged in similar activities as the Surety.\n5.5 Indebtedness. Except to the extent to which the Surety shall contest the same in good faith, the Surety shall pay all of its debts and obligations promptly and in accordance with normal terms.\n5.6 Taxes and Claims. Except to the extent to which the Surety contests the same by appropriate proceedings, or where the failure to file or pay shall not have a material, adverse effect on the financial condition of the Surety, the Surety shall pay and discharge, or shall cause to be paid and discharged, all taxes and other governmental charges and assessments imposed upon it or upon its income or assets, before the same shall come in default, as well as lawful claims for labor, materials, supplies or otherwise which, if unpaid, might become a lien or charge upon such assets or any part thereof.\n5.7 Default. In the event that any Officer of the Surety knows of any Default which shall have occurred or knows of any occurrence of any event which, upon notice or lapse of time or both, would constitute a Default, the Surety shall promptly furnish to the Lender a statement as to such occurrence specifying the nature and extent thereof and the action, if any, which is proposed to be taken with respect thereto.\n5.8 Examination. The Surety shall permit the representatives of the Lender to visit the Surety to examine and make extracts from the books of account of the Surety and its Subsidiaries and to discuss the affairs, finances and accounts of the Surety and its Subsidiaries with, and to be advised as to the same by, its and their Officers at all such reasonable times and intervals as the Lender shall desire; provided, however, that the Lender shall at all times preserve the confidentiality of all information and documents which it obtains or which come into its possession pertaining to the Surety and its Subsidiaries, shall use such information and documents only with respect to its management of the lending relationship with the Companies and shall not share, disclose, divulge or otherwise publish or make known such information or documents to any other Person nor use such information or documents to compete in any manner with the Surety or either of the Companies.\n5.9 Minimum Tangible Net Worth. The Surety and the Companies shall maintain on a consolidated basis a minimum Tangible Net Worth of Twenty-One Million Dollars ($21,000,000.00).\n5.10 Debt\/Tangible Net Worth Ratio. The consolidated total debt of the Surety and the Companies to the Tangible Net Worth of the Surety and the Companies shall not exceed a ratio of seven to one (7.0 to 1.0).\n5.11 Cash Flow Ratio. The Surety and its Subsidiaries, including the Companies, on a consolidated basis, shall maintain a Cash Flow Ratio of at least one to one (1.0 to 1.0) as measured for the immediately preceding four (4) fiscal quarters.\n5.12 Compliance with Laws. The Surety shall comply with all laws, rules, regulations and decrees to which the Surety is subject and a violation of which would have a material, adverse effect on the financial condition of the Surety.\nARTICLE 6\nNEGATIVE COVENANTS\nThe Surety covenants that, from the date of this Suretyship until the termination of the Credit Facility and payment in full of all amounts owing under all Notes and Prior Notes, unless the Lender shall otherwise consent in writing:\n6.1 Subordinated Intercompany Debt. Neither the Surety, nor any of its Subsidiaries, shall at any time borrow any funds from HAI, either of the Companies or any Subsidiary of either the Surety or either of the Companies which shall not constitute Subordinated Intercompany Debt.\n6.2 Merger. The Surety shall not enter into any merger or consolidation with any Person; provided, however, that if no Default shall have occurred and be continuing, the Surety may merge or consolidate with either Company or any Subsidiary of either Company or the Surety.\n6.3 Transfer of Assets. The Surety shall not sell, lease or otherwise transfer or dispose of all of its assets nor shall the Surety sell, lease or otherwise transfer or dispose of any substantial part of its assets except in the usual and ordinary course of its business; as used in this Subsection, the words \"substantial part of its assets\" shall mean at least twenty-five percent (25%) of the assets of the Surety computed on the basis of the applicable book value thereof.\n6.4 Loans\/Investments\/Guaranties. On or after the date hereof, the Surety shall not make, nor permit any Subsidiary to make, any loans to or investments in any other Person or to guarantee the obligation of or otherwise become liable for the indebtedness of any other Person except:\n(a) either the Surety or any Subsidiary of the Surety may:\n(i) make Contracts in the ordinary course of business;\n(ii) make loans to or investments in, or guarantee the obligation of, either of the Companies or any Subsidiary of the Surety or either of the Companies which has as its principal activity the acquisition or purchase of Contracts;\n(iii) make loans to or investments in, or guarantee the obligation of, any other Person acquired by the Surety or any of its Subsidiaries which has as its principal activity the acquisition or purchase of Contracts;\n(iv) make investments in interest bearing obligations of, or obligations guaranteed by, the United States of America;\n(b) AELH shall be permitted to make loans to AEL and shall be permitted to make investments in marketable securities, which investments in the aggregate at any one (1) time do not exceed five percent (5%) of the consolidated assets of the Surety and its Subsidiaries.\n6.5 Related Persons. Except as set forth in Section 6.6 hereof, on or after the date hereof, the Surety shall not:\n(a) make any loan to, investment in or any Contract with any Related Person;\n(b) guarantee, become a surety for or otherwise become liable for the indebtedness of any Related Person.\nARTICLE 7\nDEFAULT AND REMEDIES\n7.1 Default. The occurrence of any of the following shall constitute a Default by the Surety under this Suretyship:\n(a) Failure by the Surety to pay to the Lender any amount due pursuant to this Suretyship, and the continuance of such failure for a period of ten (10) days after receipt by the Surety of notice from the Lender pertaining thereto.\n(b) The incorrectness in any material and adverse respect of any representation by the Surety, and the failure by the Surety to cure such incorrectness within fifteen (15) days of receipt by the Surety of notice from the Lender pertaining thereto.\n(c) The failure by either of the Companies to maintain and observe the covenants contained in Subsections 5.10, 5.11, 5.12, 6.2 or 6.3 of the Agreement or the failure by the Surety\nto maintain and observe the covenants contained in Subsections 5.9, 5.10 or 5.11 of this Suretyship and the failure by either of the Companies or the Surety, as applicable, to appropriately cure the same or cause the same to be cured by prepaying such of its indebtedness under the Unsecured Funding Program or taking such other steps or causing such steps to be taken as are necessary to effect such cure, such prepayment or other steps to be completed within fifteen (15) days of receipt of knowledge by either of the Companies or the Surety, as applicable, of such failure to maintain and observe the said covenants, or receipt by either of the Companies or the Surety, as applicable, of such failure to maintain and observe the said covenants, or receipt by either of the Companies or Surety, as applicable, of notice from the Lender pertaining thereto, whichever shall first occur.\n(d) Failure by the Surety to observe or perform any of the provisions contained in this Suretyship other than those referred to in Subsections (a) through and including (c) of this Section which the Surety is required to observe or perform, and the continuance of such failure for a period of thirty (30) days following receipt by the Surety of notice with respect thereto from the Lender.\n(e) Filing by the Surety of a voluntary petition in bankruptcy or a voluntary petition or application seeking reorganization, arrangement or readjustment of its debts or for any other relief under the Bankruptcy Code, or under any other insolvency act or law, state or federal, now or hereafter existing, or any formal written consent to, approval of, or acquiescence in any such petition or proceeding by the Surety; the application by the Surety for the appointment of, or the appointment by consent of the Surety of, or acquiescence by the Surety in the appointment of, a receiver or trustee for the Surety or for all or any substantial part of its assets; the making by the Surety of an assignment for the benefit of its creditors.\n(f) Other than as a result of any Public Offering:\n(i) HAI ceases to be the owner of more than fifty percent (50%) of the issued and outstanding capital stock of the Surety; or\n(ii) the Surety ceases to be the owner of more than fifty percent (50%) of the then issued and outstanding capital stock of either of the Companies.\n(g) The filing of an involuntary petition against the Surety in bankruptcy or seeking reorganization, arrangement or readjustment of its debts or for any other relief under the Bankruptcy Code or under any other insolvency act or law, state or federal, now or hereafter existing; or the involuntary appointment of a receiver or trustee for the Surety or for all or any substantial part of its assets; and the continuance of any such event set forth above in this Subsection undismissed, unbonded, undischarged or otherwise uncontested for a period of thirty (30) days following receipt by the Surety of notice with respect thereto.\n(h) Any breach, violation or default by the Surety under any agreement, note or other instrument to which it is a party pertaining to monies borrowed by it and the failure of the Surety to cure the same within any applicable grace period which results in the acceleration of such indebtedness in an amount in excess of an amount equal to one percent (1%) of the value of the consolidated assets of the Surety and its Subsidiaries.\n(i) Any Event of Default under the Agreement.\n(j) The revocation or attempted revocation by the Surety of any of its obligations to the Lender under this Suretyship.\n7.2 Remedies. If a Default shall have occurred and be continuing, the Lender shall have the right to exercise any one or more of the following remedies against the Surety:\n(a) To declare any and all existing Loans to be immediately due and payable.\n(b) To exercise such other rights and remedies as are by law, in equity or by statute permitted.\nNotwithstanding anything to the contrary contained in this Suretyship, should a Default referred to in Section 7.1(e) or 7.1(g) occur, the remedy of the Lender set forth in Subsection (a) hereof shall be deemed to have been exercised by the Lender concurrently with the occurrence of such Default and without further action on behalf of the Lender.\n7.3 Remedies Cumulative. All rights and remedies of the Lender hereunder or by law, equity or statute permitted are cumulative and may, to the extent permitted by applicable law, be exercised concurrently or separately. The exercise of any one right or remedy shall not be deemed to be an exclusive election of such right or remedy.\n7.4 Waiver of Default. The Lender may, at any time and from time to time, execute and deliver to the Surety a written instrument waiving, on such terms and conditions as the Lender may specify in such written instrument, any of the requirements of this Suretyship or any Default and its consequences, provided that any such waiver shall be for such period of time and subject to such conditions as shall be specified in any such instrument. No such waiver shall extend to any subsequent or other Default, or impair any right consequent thereto and shall be effective only in the specific instance and for the specific purpose for which given.\nARTICLE 8\nMISCELLANEOUS PROVISIONS\n8.1 Place of Payment. All payments to be made by the Surety pursuant to this Suretyship shall be made to the Lender at the address set forth in Section 8.2 hereof or at such other address as the Lender shall hereafter specify by notice to the Surety.\n8.2 Notice. All notices referred to in this Suretyship shall be in writing and delivered in person, shall be mailed by certified mail, postage prepaid, or shall be sent by nationally recognized overnight courier to such party. The applicable addresses for all notices shall be:\nTo Surety:\nAmerican Equipment Leasing Co., Inc. Flying Hills Corporate Center P.O. Box 13428 Reading, PA 19612-3428 Attn: Chief Funding Officer\nTo Lender:\nMaryland National Bank P.O. Box 987, MS 021604 Baltimore, MD 21202 Attention: Laura L. Gamble, Vice President\nunless the same shall be changed by like notice by any party to the other.\n8.3 Accounting Principles. Except as otherwise provided, all computations which are to be made under this Suretyship shall be in accordance with generally accepted accounting principles and practices.\n8.4 Waiver of Jury Trial. THE SURETY WAIVES TRIAL BY JURY IN ANY LITIGATION IN ANY COURT WITH RESPECT TO, IN CONNECTION WITH OR ARISING OUT OF THIS SURETYSHIP OR THE VALIDITY, INTERPRETATION AND ENFORCEMENT HEREOF OR THEREOF.\n8.5 Gender\/Number. When the sense so requires, words which are used in this Suretyship or the documentation referred to herein shall be deemed to be applicable to all genders and when used in the singular number shall be held to include the plural and vice versa.\n8.6 Construction. This Suretyship and the documents referred to herein are entered into subsequent to negotiations among the parties and shall not be strictly construed against the preparing party.\n8.7 Additional Documents\/Assurances. At any time, and from time to time, upon request by any of the parties hereto, the other parties hereto shall execute, deliver and acknowledge, or cause to be executed, delivered and acknowledged, such further documents and shall do such other acts and things as the requesting party may reasonably require in order to fully effect the purposes and intent of this Suretyship.\n8.8 Benefit. This Suretyship and the documents referred to herein shall be binding upon and inure to the benefit of the Surety and the Lender and their respective successors and, to the extent permitted herein, assigns.\n8.9 Assignment. Neither the Surety nor the Lender shall have the right to assign or delegate this Suretyship or the documents referred to herein or any rights or duties hereunder or thereunder without the prior written consent of the other, which consent shall not be unreasonably withheld; provided, however, that the Lender, if a bank, may assign or participate all or any part of its interest herein to any other bank which is a subsidiary of any entity of which the Lender is also a subsidiary without the prior written consent of the Surety.\n8.10 Severability. If any provision of this Suretyship or any document referred to herein, or the application thereof to any party or circumstance, be held invalid or unenforceable, the remainder of this Suretyship and the documents referred to herein, and the application of such provision to other parties or circumstances, shall not be affected thereby and to this end, the provisions of this Agreement and the documentation referred to herein are declared severable.\n8.11 Integration. This Suretyship and the documents referred to herein contain the entire understanding between the Surety and the Lender with respect to the subject matter hereof and such understanding shall not be amended, modified or terminated except in writing and duly executed on behalf of the Surety and the Lender.\n8.12 Captions. The captions of each of the Sections of this Suretyship do not constitute a part of this Suretyship but are for informational purposes only.\n8.13 Counterparts. This Suretyship may be executed in two (2) or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute but one and the same instrument.\n8.14 Jurisdiction. The Surety irrevocably submits to the jurisdiction of any state or federal court sitting in the State of Maryland over any proceeding arising out of this Suretyship and irrevocably waives, to the fullest extent permitted by law, any objection that it may ever have to the laying of jurisdiction or venue in any such proceeding in any such court and any claim that any such proceeding brought in any such court has been brought in an inconvenient forum.\n8.15 Law. This Suretyship and the documentation referred to herein shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania.\nIN WITNESS WHEREOF, the parties hereto have executed this Suretyship as of the day and year first above written.\nAMERICAN EQUIPMENT LEASING CO., INC.\nBy:---------------------------------------\nAttest:---------------------------------------\nMARYLAND NATIONAL BANK\nBy:---------------------------------------\nAttest:---------------------------------------\nEXHIBIT G\nCOMPLIANCE CERTIFICATE\nThe undersigned hereby certifies that he is of American Equipment Leasing Co., Inc. (Surety), AEL Leasing Co., Inc. (AEL), and American Commercial Credit Corp. (ACCC) (AEL and ACCC being hereinafter individually referred to as \"Company\" and collectively referred to as \"Companies\"), and, as such, is authorized to execute this Compliance Certificate on behalf of each Company, pursuant to Loan Agreements among AEL, ACCC and each of the Participant Lenders. Each capitalized term used herein which is defined in the applicable Loan Agreement (\"Loan Agreement\") or the applicable Suretyship (\"Suretyship\") shall have the meaning set forth in the Loan Agreement or Suretyship, as applicable. The undersigned hereby certifies, to the best of his knowledge and belief, based upon a review made under his supervision, that:\nI. Each Company has performed and observed all of its obligations under the Loan Agreement, the Notes or any of the other loan documents applicable to the Company. No Event of Default under the Loan Agreement or Default under the Suretyship has occurred.\nII. Set forth below are the calculations necessary to demonstrate each Company's compliance with the financial covenants contained in the Loan Agreement, in each case as of the date of the balance sheet furnished contemporaneously with this Certificate (the \"Balance Sheet Date\"):\nAMERICAN EQUIPMENT LEASING CO., INC.:\n(A) Cash Flow Ratio.\nSee Section 5.11 of the Suretyship.\n(B) Ratio of Total Consolidated Debt to Consolidated Tangible Net Worth.\nSee Section 5.10 of the Suretyship.\n(C) Minimum Consolidated Tangible Net Worth.\nSee Section 5.9 of the Suretyship.\nAEL LEASING CO., INC.:\n(D) Ratio of Total Debt to Tangible Net Worth.\nSee Section 5.11 of the Loan Agreement.\nAMERICAN COMMERCIAL CREDIT CORP.:\n(E) Ratio of Total Debt to Tangible Net Worth.\nSee Section 5.11 of the Loan Agreement.\nThe undersigned has issued this Certificate to the Lender under the Loan Agreements, knowing that the Lender will rely upon the accuracy of the statements made herein.\nIN WITNESS WHEREOF, the undersigned has signed and sealed this Certificate this day of , 199 .\nAMERICAN EQUIPMENT LEASING CO., INC. AEL LEASING CO., INC. AMERICAN COMMERCIAL CREDIT CORP.\nBy: --------------------------------------- Title: ---------------------------------------\nEXHIBIT 10.1\nEMPLOYMENT AGREEMENT\nTHIS AGREEMENT, made this first (1st) day of January 1994, by and between Horrigan American, Inc. (hereinafter called \"Company\") and Arthur A. Haberberger (hereinafter called \"Officer\").\nBackground\nThe Company is presently engaged primarily in the business of diversified financial services. The Officer is presently serving as President and Chief Executive Officer of the Company.\nDuring the course of his employment by the Company, the Officer has acquired valuable experience, knowledge, expertise, and management skills. It is the desire of both the Company and the Officer that the employment relationship existing between them continue to the mutual benefit of each.\nW I T N E S S E T H :\n1. Employment and Duties. The Company hereby employs the Officer to perform such duties as may be determined and assigned to him by his immediate supervisor.\n2. Performance. The Officer agrees to devote all of his working time and best efforts to the performance of his duties as President and Chief Executive Officer and to the performance of other such duties as are assigned to him from time to time by his immediate supervisor.\n3. Term. Except in the case of earlier termination, as hereinafter specifically provided, the term of this Agreement shall be from January 1, 1994, through December 31, 1994; provided, however, that this Agreement shall be extended by one calendar day for each expired calendar day after January 1, 1994, until December 31, 1994, with the alternate termination of this Agreement not later than December 31, 1995. Notwithstanding the foregoing extension of the Agreement, the Company and the Officer may mutually agree to renegotiate this Agreement or enter into a new Agreement after December 31, 1994.\n4. Compensation. Compensation, wherever used in this Agreement, shall mean all base compensation and all earned incentive compensation.\n(a) For all the services to be rendered by the Officer in any capacity hereunder, including services as an officer, member of any committee, or any other duties assigned to him by his immediate supervisor, the Company agrees to pay the Officer a base salary of $125,000 per annum, payable in equal semi-monthly installments on the fifteenth (15th) and last day of each month. The Company, at its option, may increase the Officer's compensation at any time at its convenience.\n(b) The Company further agrees to pay the Officer incentive compensation according to the following program:\nHAI Super Hurdle Plan HAI Hurdle Plan AEL\/ACC\/AELH Hurdle Plan ARE, AEL Funding, and HAI Investment Hurdle Plan Phantom Stock Plan\n5. Life Insurance. The Officer agrees that the Company, at its discretion, may apply for and procure in its own name and for its own benefit, life insurance in any amount or amounts considered advisable and that the Officer shall have no right, title, or interest therein; and, further, he agrees to submit to any reasonable medical or other examination and to execute and deliver any application or other instrument, in writing, necessary to effectuate such insurance.\n6. Business Expenses. Consistent with established Company policy, the Company will compensate the Officer for his eligible business expenses to include: travel, meals, and miscellaneous expenses incurred locally; and travel, meals, lodging, and miscellaneous expenses incurred while the Officer is away on business. Such reimbursement shall be made by the Company upon submission of a signed statement by the Officer itemizing such expenses.\n7. Termination.\n(a) Voluntary Company Termination: The Company may terminate this Agreement at any time upon two (2) months' notice to the Officer; and the Company shall be obligated to pay the Officer two (2) months' compensation plus one (1) month's compensation pro-rated for each two (2) years of continuous service as an Officer (vice president or above) of the Company or any affiliated sister company, up to a maximum of ten (10) additional months' compensation. A month's compensation shall be determined as the greater of:\n(1) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six (6) month period and one-twelfth (1\/12) of any incentive compensation which was paid to the Officer during the prior twelve (12) month period or\n(2) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six-month period and a pro rata share, based upon the number of full weeks worked, of any incentive compensation due and owing for the year in which the Officer is terminated.\nIf the Officer is separated by the Company in accordance with Paragraph 7(a), it is expressly understood that it is not a termination of employment as defined in 7(c) herein.\n(b) Voluntary Officer Termination: The Officer may terminate this Agreement at any time upon two (2) months' notice to the Company, and the Company shall be obligated to pay to the Officer two (2) months' compensation. A month's compensation shall be determined as defined in 7(a).\n(c) Involuntary Company Termination: The Company may also terminate this Agreement on one (1) day's notice, if the termination is for any of the following employment-related causes, and, in that event, the Company shall not be obligated to pay the Officer any further compensation:\n(c-1) Willful failure or refusal of the Officer to adequately perform the duties and obligations of his employment, if such willful failure or refusal is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-2) Any breach by the Officer of the provisions of this Agreement, if such breach is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-3) Conviction of the Officer for any felony or other criminal offense involving dishonesty or moral turpitude which is related to his employment with the Company or to his duties as an Officer;\n(c-4) Other just cause, if such just cause is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n8. Death.\n(a) In the event of the Officer's death during the term of this Agreement, it shall terminate immediately. Unless the Officer has left a different designation on file with the Company, the Officer's surviving spouse or, if there is no surviving spouse, the minor children (to include all children who are full-time students regardless of age) or, if there are no surviving children, the Officer's estate shall be entitled to receive six (6) months' compensation due the Officer. A month's compensation shall be determined as defined in paragraph 7(a). This compensation shall be paid in equal monthly installments, commencing the first of the month following the Officer's death, and shall be paid proportionately over a period of eighteen (18) months.\n(b) In addition, should the Officer at any time die while a party to this Agreement, the Company shall pay within three (3) months after the date of the Officer's death, a death benefit of Five Thousand Dollars ($5,000.00) to the Officer's surviving spouse or, if there is no surviving spouse, to the surviving children in equal shares or, if there are no surviving children, to the Officer's estate, unless the Officer has left a different designation on file with the Company.\n9. Disability. If, during the term of this Agreement, the Officer should fail to perform his duties hereunder on account of illness or other incapacity, and such illness or incapacity shall continue for a period of six (6) months, the Company shall have the right to terminate this Agreement. In that event, the Company shall be obligated to pay the Officer his compensation up to the date of termination. Such compensation may be reduced by the amount of any proceeds received by the Officer from any Company-funded program such as disability insurance, Worker's Compensation, or Social Security, during the six (6) month period.\n10. Discontinuance of Business. If, during the term of this Agreement, the Company should involuntarily discontinue or interrupt the operation of its business for a period of one (1) month, this Agreement shall automatically terminate without further liability on the part of either the parties hereto.\n11. Restrictions.\n(a) The Officer acknowledges that:\n(a-1) During the course of his employment with the Company and during the term of this Agreement, the Officer has and shall continue to have access to learn, be provided with, prepare, or create Confidential Information, all of which is of substantial value to the Company's business and the disclosure of which would be harmful to the Company.\n(a-2) In the event, either during the term of this Agreement or any time thereafter, the Officer should disclose to any other person or entity any such Confidential Information, use for the Officer's own benefit or for the benefit of any other person or entity any such Confidential Information, or make copies or notes of any such Confidential Information except as may be required in the normal course of the Officer's duties, such conduct would be inconsistent with and a breach of the confidence and trust inherent in the Officer's position with the Company, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(b) During the term of this Agreement, the Officer agrees to devote all of his working time and best efforts to further the interests of the Company, and he shall not directly or indirectly, alone or as a partner, officer, director, or stockholder of any other institution, be engaged in any other commercial activity whatsoever, or continue or assume any other corporate affiliations without the consent of the Board of Directors of the Company.\nEXCEPTION: It shall not be deemed a violation of this Agreement for the Officer to engage in independent consulting activities including Corporate Directorships for third party companies and individuals, and to retain the compensation therefore for his individual use, providing such consultation does not involve services and advice given to any firm or company on the activities and business of this Company or any of its subsidiaries or affiliates, and further provided such consultation is not with a customer or competitor of the Company without the prior written approval of the Board of Directors of Company. It is further understood that such consulting shall be on personal time.\n(c) The Officer acknowledges:\n(c-1) The Company's products and services are highly specialized items.\n(c-2) The Company has a proprietary interest in the identity of its customers and customer lists.\n(c-3) During the term of this Agreement, the Officer will have access to and become familiar with various trade secrets and highly confidential information of the Company, including but not necessarily limited to, documents and information regarding the Company's services, systems, lease and financing programs, re-marketing programs, sales, pricing, costs, specialized requirements of customers, prospective applicants for employment, current employees, information recorded on present or past credit applications, current or past financing vehicles or products by and between the Company and the banking community or related community, internal managerial accounting systems, and information systems. The Officer acknowledges that such confidential information and trade secrets are owned and shall continue to be owned solely by the Company.\n(d) The Officer covenants to the Company that for a period of one (1) year following the date of Termination of Employment, as defined in Paragraph 7 of this Agreement, he shall not, either directly or indirectly, or through any person or other entity, or by any other means:\n(d-1) Use confidential information or trade secrets for any purpose whatsoever or divulge such information to any person other than the Company or persons to whom the Company has given consent, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(d-2) Directly or indirectly solicit or sell any of the Company's products or services to any person, company, firm, or corporation who is or was a customer of the Company (customer is defined as dealer, manufacturer, vendor, borrower, lessee, or any other person or entity who deals with the Company in its normal course of business) at the time of termination of the Officer's employment. The Officer agrees not to solicit such customers on behalf of himself or any other person, company, firm, or corporation.\n(e) In the event that a court of competent jurisdiction determines that the provisions of paragraph 11(c) and 11(d), or any part thereof, are invalid or unenforceable by reason of overly broad territorial or excessive time restrictions or otherwise, then the parties to the Agreement request such court to modify such restrictions or paragraph to the extent necessary in order that the same shall be valid and enforceable and to enforce the same to that extent.\n(f) Upon his separation of employment for any reason, the Officer shall immediately deliver to the Company all documentation and other property which belongs to the Company which pertains to the business or financial affairs of the Company.\n(g) The parties to this Agreement acknowledge that any breach, violation, or default by the Officer of the provisions contained in paragraphs 11(d) and 11(f) of this Agreement would result in irreparable harm and damage to the Company, which harm and damage would be extremely difficult to quantify and, accordingly, the Officer consents to the jurisdiction of a court of equity and (1) the entry of an injunction, temporary or permanent, enjoining the Officer from competing with the Company in violation of the provisions of paragraph 11(d) hereof, and (2) the entry by said court of an order requiring the Officer to deliver to the Company documentation or other property which belongs to the Company as required in paragraph 11(f).\n12. Benefits. The Company agrees to provide the Officer during the term of this Agreement such additional benefits, commonly known as \"employee benefits,\" which are generally extended by the Company to its Officers. Notwithstanding the foregoing and provided the Officer remains employed by the Company, all employee benefits received by the Officer at the time of the effective date of this Agreement shall be maintained throughout the term of this Agreement, unless expressly prohibited by law or unless any or all such employee benefits are discontinued, decreased, or in any way modified by the Company for all Officers, for all persons serving in a capacity similar to that of the Officer, or for all employees of the Company. Employee benefits include, but are not limited to, holidays, vacations, health insurance, life\/accidental death insurance, long-term disability insurance, short-term disability benefits, expense supplement plan, educational assistance program, employee assistance program, health maintenance organization, sick leave, Christmas cash bonus, and service recognition awards. Any intended modification of employee benefits as defined herein will be in writing.\n13. Stock Options. If this Agreement is terminated for any reason, the Company will extend to the Officer a period of sixty (60) calendar days, during which the Officer shall have the right to exercise any stock options, in whole or in part, as may have been granted under the Horrigan American, Inc., Stock Option Agreements.\n14. Effect of Waiver. The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof.\n15. Arbitration. Any controversy arising from or related to this Agreement shall be determined by arbitration in the City of Reading in accordance with the rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having jurisdiction.\n16. Notice. Any and all notices referred to herein shall be sufficient if furnished in writing and sent by registered mail to the representative parties at the address subscribed below following their signatures to this Agreement.\n17. Assignment. The rights and benefits of the Company under this Agreement shall be transferable, and all covenants and agreements hereunder shall inure to the benefits of and be enforceable by or against its successors and assigns.\n____________________________ _________________________ Horrigan American, Inc. Officer Flying Hills Corporate Center Reading, Pennsylvania 19607\nEXHIBIT 10.2 EMPLOYMENT AGREEMENT\nTHIS AGREEMENT, made this first (1st) day of January 1994, by and between Horrigan American, Inc. (hereinafter called \"Company\") and J. F. Horrigan, Jr. (hereinafter called \"Officer\").\nBackground\nThe Company is presently engaged primarily in the business of diversified financial services. The Officer is presently serving as Chairman of the Board.\nDuring the course of his employment by the Company, the Officer has acquired valuable experience, knowledge, expertise, and management skills. It is the desire of both the Company and the Officer that the employment relationship existing between them continue to the mutual benefit of each.\nW I T N E S S E T H :\n1. Employment and Duties. The Company hereby employs the Officer to perform such duties as may be determined and assigned to him by his immediate supervisor.\n2. Performance. The Officer agrees to devote all of his working time and best efforts to the performance of his duties as Chairman of the Board and to the performance of other such duties as are assigned to him from time to time by his immediate supervisor.\n3. Term. Except in the case of earlier termination, as hereinafter specifically provided, the term of this Agreement shall be from January 1, 1994, through December 31, 1994; provided, however, that this Agreement shall be extended by one calendar day for each expired calendar day after January 1, 1994, until December 31, 1994, with the alternate termination of this Agreement not later than December 31, 1995. Notwithstanding the foregoing extension of the Agreement, the Company and the Officer may mutually agree to renegotiate this Agreement or enter into a new Agreement after December 31, 1994.\n4. Compensation. Compensation, wherever used in this Agreement, shall mean all base compensation and all earned incentive compensation.\n(a) For all the services to be rendered by the Officer in any capacity hereunder, including services as an officer, member of any committee, or any other duties assigned to him by his immediate supervisor, the Company agrees to pay the Officer a base salary of $120,000 per annum, payable in equal semi-monthly installments on the fifteenth (15th) and last day of each month. The Company, at its option, may increase the Officer's compensation at any time at its convenience.\n(b) The Company further agrees to pay the Officer incentive compensation according to the following program:\nHAI Super Hurdle Plan HAI Hurdle Plan AEL\/ACC\/AELH Hurdle Plan ARE, AEL Funding, and HAI Investment Hurdle Plan Phantom Stock Plan\n5. Life Insurance. The Officer agrees that the Company, at its discretion, may apply for and procure in its own name and for its own benefit, life insurance in any amount or amounts considered advisable and that the Officer shall have no right, title, or interest therein; and, further, he agrees to submit to any reasonable medical or other examination and to execute and deliver any application or other instrument, in writing, necessary to effectuate such insurance.\n6. Business Expenses. Consistent with established Company policy, the Company will compensate the Officer for his eligible business expenses to include: travel, meals, and miscellaneous expenses incurred locally; and travel, meals, lodging, and miscellaneous expenses incurred while the Officer is away on business. Such reimbursement shall be made by the Company upon submission of a signed statement by the Officer itemizing such expenses.\n7. Termination.\n(a) Voluntary Company Termination: The Company may terminate this Agreement at any time upon two (2) months' notice to the Officer; and the Company shall be obligated to pay the Officer two (2) months' compensation plus one (1) month's compensation pro-rated for each two (2) years of continuous service as an Officer (vice president or above) of the Company or any affiliated sister company, up to a maximum of ten (10) additional months' compensation. A month's compensation shall be determined as the greater of:\n(1) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six (6) month period and one-twelfth (1\/12) of any incentive compensation which was paid to the Officer during the prior twelve (12) month period or\n(2) The combined of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six-month period and a pro rata share, based upon the number of full weeks worked, of any incentive compensation due and owing for the year in which the Officer is terminated. If the Officer is separated by the Company in accordance with Paragraph 7(a), it is expressly understood that it is not a termination of employment as defined in 7(c) herein.\n(b) Voluntary Officer Termination: The Officer may terminate this Agreement at any time upon two (2) months' notice to the Company, and the Company shall be obligated to pay to the Officer two (2) months' compensation. A month's compensation shall be determined as defined in 7(a).\n(c) Involuntary Company Termination: The Company may also terminate this Agreement on one (1) day's notice, if the termination is for any of the following employment-related causes, and, in that event, the Company shall not be obligated to pay the Officer any further compensation:\n(c-1) Willful failure or refusal of the Officer to adequately perform the duties and obligations of his employment, if such willful failure or refusal is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-2) Any breach by the Officer of the provisions of this Agreement, if such breach is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-3) Conviction of the Officer for any felony or other criminal offense involving dishonesty or moral turpitude which is related to his employment with the Company or to his duties as an Officer;\n(c-4) Other just cause, if such just cause is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n8. Death.\n(a) In the event of the Officer's death during the term of this Agreement, it shall terminate immediately. Unless the Officer has left a different designation on file with the Company, the Officer's surviving spouse or, if there is no surviving spouse, the minor children (to include all children who are full-time students regardless of age) or, if there are no surviving children, the Officer's estate shall be entitled to receive six (6) months' compensation due the Officer. A month's compensation shall be determined as defined in paragraph 7(a). This compensation shall be paid in equal monthly installments, commencing the first of the month following the Officer's death, and shall be paid proportionately over a period of eighteen (18) months.\n(b) In addition, should the Officer at any time die while a party to this Agreement, the Company shall pay within three (3) months after the date of the Officer's death, a death benefit of Five Thousand Dollars ($5,000.00) to the Officer's surviving spouse or, if there is no surviving spouse, to the surviving children in equal shares or, if there are no surviving children, to the Officer's estate, unless the Officer has left a different designation on file with the Company.\n9. Disability. If, during the term of this Agreement, the Officer should fail to perform his duties hereunder on account of illness or other incapacity, and such illness or incapacity shall continue for a period of six (6) months, the Company shall have the right to terminate this Agreement. In that event, the Company shall be obligated to pay the Officer his compensation up to the date of termination. Such compensation may be reduced by the amount of any proceeds received by the Officer from any Company-funded program such as disability insurance, Worker's Compensation, or Social Security, during the six (6) month period.\n10. Discontinuance of Business. If, during the term of this Agreement, the Company should involuntarily discontinue or interrupt the operation of its business for a period of one (1) month, this Agreement shall automatically terminate without further liability on the part of either the parties hereto.\n11. Restrictions.\n(a) The Officer acknowledges that:\n(a-1) During the course of his employment with the Company and during the term of this Agreement, the Officer has and shall continue to have access to learn, be provided with, prepare, or create Confidential Information, all of which is of substantial value to the Company's business and the disclosure of which would be harmful to the Company.\n(a-2) In the event, either during the term of this Agreement or any time thereafter, the Officer should disclose to any other person or entity any such Confidential Information, use for the Officer's own benefit or for the benefit of any other person or entity any such Confidential Information, or make copies or notes of any such Confidential Information except as may be required in the normal course of the Officer's duties, such conduct would be inconsistent with and a breach of the confidence and trust inherent in the Officer's position with the Company, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(b) During the term of this Agreement, the Officer agrees to devote all of his working time and best efforts to further the interests of the Company, and he shall not directly or indirectly, alone or as a partner, officer, director, or stockholder of any other institution, be engaged in any other commercial activity whatsoever, or continue or assume any other corporate affiliations without the consent of the Board of Directors of the Company.\nEXCEPTION: It shall not be deemed a violation of this Agreement for the Officer to engage in independent consulting activities including Corporate Directorships for third party companies and individuals, and to retain the compensation therefore for his individual use, providing such consultation does not involve services and advice given to any firm or company on the activities and business of this Company or any of its subsidiaries or affiliates, and further provided such consultation is not with a customer or competitor of the Company without the prior written approval of the Board of Directors of Company. It is further understood that such consulting shall be on personal time.\n(c) The Officer acknowledges:\n(c-1) The Company's products and services are highly specialized items.\n(c-2) The Company has a proprietary interest in the identity of its customers and customer lists.\n(c-3) During the term of this Agreement, the Officer will have access to and become familiar with various trade secrets and highly confidential information of the Company, including but not necessarily limited to, documents and information regarding the Company's services, systems, lease and financing programs, re-marketing programs, sales, pricing, costs, specialized requirements of customers, prospective applicants for employment, current employees, information recorded on present or past credit applications, current or past financing vehicles or products by and between the Company and the banking community or related community, internal managerial accounting systems, and information systems. The Officer acknowledges that such confidential information and trade secrets are owned and shall continue to be owned solely by the Company.\n(d) The Officer covenants to the Company that for a period of one (1) year following the date of Termination of Employment, as defined in Paragraph 7 of this Agreement, he shall not, either directly or indirectly, or through any person or other entity, or by any other means:\n(d-1) Use confidential information or trade secrets for any purpose whatsoever or divulge such information to any person other than the Company or persons to whom the Company has given consent, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(d-2) Directly or indirectly solicit or sell any of the Company's products or services to any person, company, firm, or corporation who is or was a customer of the Company (customer is defined as dealer, manufacturer, vendor, borrower, lessee, or any other person or entity who deals with the Company in its normal course of business) at the time of termination of the Officer's employment. The Officer agrees not to solicit such customers on behalf of himself or any other person, company, firm, or corporation.\n(e) In the event that a court of competent jurisdiction determines that the provisions of paragraph 11(c) and 11(d), or any part thereof, are invalid or unenforceable by reason of overly broad territorial or excessive time restrictions or otherwise, then the parties to the Agreement request such court to modify such restrictions or paragraph to the extent necessary in order that the same shall be valid and enforceable and to enforce the same to that extent.\n(f) Upon his separation of employment for any reason, the Officer shall immediately deliver to the Company all documentation and other property which belongs to the Company which pertains to the business or financial affairs of the Company.\n(g) The parties to this Agreement acknowledge that any breach, violation, or default by the Officer of the provisions contained in paragraphs 11(d) and 11(f) of this Agreement would result in irreparable harm and damage to the Company, which harm and damage would be extremely difficult to quantify and, accordingly, the Officer consents to the jurisdiction of a court of equity and (1) the entry of an injunction, temporary or permanent, enjoining the Officer from competing with the Company in violation of the provisions of paragraph 11(d) hereof, and (2) the entry by said court of an order requiring the Officer to deliver to the Company documentation or other property which belongs to the Company as required in paragraph 11(f).\n12. Benefits. The Company agrees to provide the Officer during the term of this Agreement such additional benefits, commonly known as \"employee benefits,\" which are generally extended by the Company to its Officers. Notwithstanding the foregoing and provided the Officer remains employed by the Company, all employee benefits received by the Officer at the time of the effective date of this Agreement shall be maintained throughout the term of this Agreement, unless expressly prohibited by law or unless any or all such employee benefits are discontinued, decreased, or in any way modified by the Company for all Officers, for all persons serving in a capacity similar to that of the Officer, or for all employees of the Company. Employee benefits include, but are not limited to, holidays, vacations, health insurance, life\/accidental death insurance, long-term disability insurance, short-term disability benefits, expense supplement plan, educational assistance program, employee assistance program, health maintenance organization, sick leave, Christmas cash bonus, and service recognition awards. Any intended modification of employee benefits as defined herein will be in writing.\n13. Stock Options. If this Agreement is terminated for any reason, the Company will extend to the Officer a period of sixty (60) calendar days, during which the Officer shall have the right to exercise any stock options, in whole or in part, as may have been granted under the Horrigan American, Inc., Stock Option Agreements.\n14. Effect of Waiver. The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof.\n15. Arbitration. Any controversy arising from or related to this Agreement shall be determined by arbitration in the City of Reading in accordance with the rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having jurisdiction.\n16. Notice. Any and all notices referred to herein shall be sufficient if furnished in writing and sent by registered mail to the representative parties at the address subscribed below following their signatures to this Agreement.\n17. Assignment. The rights and benefits of the Company under this Agreement shall be transferable, and all covenants and agreements hereunder shall inure to the benefits of and be enforceable by or against its successors and assigns.\n_______________________________ _______________________________ Horrigan American, Inc. Officer Flying Hills Corporate Center Reading, Pennsylvania 19607\nEXHIBIT 10.3 EMPLOYMENT AGREEMENT\nTHIS AGREEMENT, made this first (1st) day of January 1994, by and between American Real Estate Investment and Development Co. (hereinafter called \"Company\") and John F. Horrigan, III (hereinafter called \"Officer\").\nBackground\nThe Company is presently engaged primarily in the business of commercial real estate investment and development. The Officer is presently serving as President and Chief Operating Officer of the Company.\nDuring the course of his employment by the Company, the Officer has acquired valuable experience, knowledge, expertise, and management skills. It is the desire of both the Company and the Officer that the employment relationship existing between them continue to the mutual benefit of each.\nW I T N E S S E T H :\n1. Employment and Duties. The Company hereby employs the Officer to perform such duties as may be determined and assigned to him by his immediate supervisor.\n2. Performance. The Officer agrees to devote all of his working time and best efforts to the performance of his duties as President and Chief Operating Officer and to the performance of other such duties as are assigned to him from time to time by his immediate supervisor.\n3. Term. Except in the case of earlier termination, as hereinafter specifically provided, the term of this Agreement shall be from January 1, 1994, through December 31, 1994; provided, however, that this Agreement shall be extended by one calendar day for each expired calendar day after January 1, 1994, until December 31, 1994, with the alternate termination of this Agreement not later than December 31, 1995. Notwithstanding the foregoing extension of the Agreement, the Company and the Officer may mutually agree to renegotiate this Agreement or enter into a new Agreement after December 31, 1994.\n4. Compensation. Compensation, wherever used in this Agreement, shall mean all base compensation and all earned incentive compensation.\n(a) For all the services to be rendered by the Officer in any capacity hereunder, including services as an officer, member of any committee, or any other duties assigned to him by his immediate supervisor, the Company agrees to pay the Officer a base salary of $86,800 per annum, payable in equal semi-monthly installments on the fifteenth (15th) and last day of each month. The Company, at its option, may increase the Officer's compensation at any time at its convenience.\n(b) The Company further agrees to pay the Officer incentive compensation according to the following program:\nHAI Super Hurdle Plan HAI Hurdle Plan AEL\/ACC\/AELH Hurdle Plan ARE, AEL Funding, and HAI Investment Hurdle Plan Phantom Stock Plan\n5. Life Insurance. The Officer agrees that the Company, at its discretion, may apply for and procure in its own name and for its own benefit, life insurance in any amount or amounts considered advisable and that the Officer shall have no right, title, or interest therein; and, further, he agrees to submit to any reasonable medical or other examination and to execute and deliver any application or other instrument, in writing, necessary to effectuate such insurance.\n6. Business Expenses. Consistent with established Company policy, the Company will compensate the Officer for his eligible business expenses to include: travel, meals, and miscellaneous expenses incurred locally; and travel, meals, lodging, and miscellaneous expenses incurred while the Officer is away on business. Such reimbursement shall be made by the Company upon submission of a signed statement by the Officer itemizing such expenses.\n7. Termination.\n(a) Voluntary Company Termination: The Company may terminate this Agreement at any time upon two (2) months' notice to the Officer; and the Company shall be obligated to pay the Officer two (2) months' compensation plus one (1) month's compensation pro-rated for each two (2) years of continuous service as an Officer (vice president or above) of the Company, up to a maximum of ten (10) additional months' compensation. A month's compensation shall be determined as the greater of:\n(1) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six (6) month period and one-twelfth (1\/12) of any incentive compensation which was paid to the Officer during the prior twelve (12) month period or:\n(2) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six-month period and a pro rata share, based upon the number of full weeks worked, of any incentive compensation due and owing for the year in which the Officer is terminated.\nIf the Officer is separated by the Company in accordance with Paragraph 7(a), it is expressly understood that it is not a termination of employment as defined in 7(c) herein.\n(b) Voluntary Officer Termination: The Officer may terminate this Agreement at any time upon two (2) months' notice to the Company, and the Company shall be obligated to pay to the Officer two (2) months' compensation. A month's compensation shall be determined as defined in 7(a).\n(c) Involuntary Company Termination: The Company may also terminate this Agreement on one (1) day's notice, if the termination is for any of the following employment-related causes, and, in that event, the Company shall not be obligated to pay the Officer any further compensation:\n(c-1) Willful failure or refusal of the Officer to adequately perform the duties and obligations of his employment, if such willful failure or refusal is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-2) Any breach by the Officer of the provisions of this Agreement, if such breach is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-3) Conviction of the Officer for any felony or other criminal offense involving dishonesty or moral turpitude which is related to his employment with the Company or to his duties as an Officer;\n(c-4) Other just cause, if such just cause is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n8. Death.\n(a) In the event of the Officer's death during the term of this Agreement, it shall terminate immediately. Unless the Officer has left a different designation on file with the Company, the Officer's surviving spouse or, if there is no surviving spouse, the minor children (to include all children who are full-time students regardless of age) or, if there are no surviving children, the Officer's estate shall be entitled to receive six (6) months' compensation due the Officer. A month's compensation shall be determined as defined in paragraph 7(a). This compensation shall be paid in equal monthly installments, commencing the first of the month following the Officer's death, and shall be paid proportionately over a period of eighteen (18) months.\n(b) In addition, should the Officer at any time die while a party to this Agreement, the Company shall pay within three (3) months after the date of the Officer's death, a death benefit of Five Thousand Dollars ($5,000.00) to the Officer's surviving spouse or, if there is no surviving spouse, to the surviving children in equal shares or, if there are no surviving children, to the Officer's estate, unless the Officer has left a different designation on file with the Company.\n9. Disability. If, during the term of this Agreement, the Officer should fail to perform his duties hereunder on account of illness or other incapacity, and such illness or incapacity shall continue for a period of six (6) months, the Company shall have the right to terminate this Agreement. In that event, the Company shall be obligated to pay the Officer his compensation up to the date of termination. Such compensation may be reduced by the amount of any proceeds received by the Officer from any Company-funded program such as disability insurance, Worker's Compensation, or Social Security, during the six (6) month period.\n10. Discontinuance of Business. If, during the term of this Agreement, the Company should involuntarily discontinue or interrupt the operation of its business for a period of one (1) month, this Agreement shall automatically terminate without further liability on the part of either the parties hereto.\n11. Restrictions.\n(a) The Officer acknowledges that:\n(a-1) During the course of his employment with the Company and during the term of this Agreement, the Officer has and shall continue to have access to learn, be provided with, prepare, or create Confidential Information, all of which is of substantial value to the Company's business and the disclosure of which would be harmful to the Company.\n(a-2) In the event, either during the term of this Agreement or any time thereafter, the Officer should disclose to any other person or entity any such Confidential Information, use for the Officer's own benefit or for the benefit of any other person or entity any such Confidential Information, or make copies or notes of any such Confidential Information except as may be required in the normal course of the Officer's duties, such conduct would be inconsistent with and a breach of the confidence and trust inherent in the Officer's position with the Company, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(b) During the term of this Agreement, the Officer agrees to devote all of his working time and best efforts to further the interests of the Company, and he shall not directly or indirectly, alone or as a partner, officer, director, or stockholder of any other institution, be engaged in any other commercial activity whatsoever, or continue or assume any other corporate affiliations without the consent of the Board of Directors of the Company.\nEXCEPTION: It shall not be deemed a violation of this Agreement for the Officer to engage in independent consulting activities including Corporate Directorships for third party companies and individuals, and to retain the compensation therefore for his individual use, providing such consultation does not involve services and advice given to any firm or company on the activities and business of this Company or any of its subsidiaries or affiliates, and further provided such consultation is not with a customer or competitor of the Company without the prior written approval of the Board of Directors of Company. It is further understood that such consulting shall be on personal time.\n(c) The Officer acknowledges:\n(c-1) The Company's products and services are highly specialized items.\n(c-2) The Company has a proprietary interest in the identity of its customers and customer lists.\n(c-3) During the term of this Agreement, the Officer will have access to and become familiar with various trade secrets and highly confidential information of the Company, including but not necessarily limited to, documents and information regarding the Company's services, systems, lease and financing programs, re-marketing programs, sales, pricing, costs, specialized requirements of customers, prospective applicants for employment, current employees, information recorded on present or past credit applications, current or past financing vehicles or products by and between the Company and the banking community or related community, internal managerial accounting systems, and information systems. The Officer acknowledges that such confidential information and trade secrets are owned and shall continue to be owned solely by the Company.\n(d) The Officer covenants to the Company that for a period of one (1) year following the date of Termination of Employment, as defined in Paragraph 7 of this Agreement, he shall not, either directly or indirectly, or through any person or other entity, or by any other means:\n(d-1) Use confidential information or trade secrets for any purpose whatsoever or divulge such information to any person other than the Company or persons to whom the Company has given consent, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(d-2) Directly or indirectly solicit or sell any of the Company's products or services to any person, company, firm, or corporation who is or was a customer of the Company (customer is defined as dealer, manufacturer, vendor, borrower, lessee, or any other person or entity who deals with the Company in its normal course of business) at the time of termination of the Officer's employment. The Officer agrees not to solicit such customers on behalf of himself or any other person, company, firm, or corporation.\n(e) In the event that a court of competent jurisdiction determines that the provisions of paragraph 11(c) and 11(d), or any part thereof, are invalid or unenforceable by reason of overly broad territorial or excessive time restrictions or otherwise, then the parties to the Agreement request such court to modify such restrictions or paragraph to the extent necessary in order that the same shall be valid and enforceable and to enforce the same to that extent.\n(f) Upon his separation of employment for any reason, the Officer shall immediately deliver to the Company all documentation and other property which belongs to the Company which pertains to the business or financial affairs of the Company.\n(g) The parties to this Agreement acknowledge that any breach, violation, or default by the Officer of the provisions contained in paragraphs 11(d) and 11(f) of this Agreement would result in irreparable harm and damage to the Company, which harm and damage would be extremely difficult to quantify and, accordingly, the Officer consents to the jurisdiction of a court of equity and (1) the entry of an injunction, temporary or permanent, enjoining the Officer from competing with the Company in violation of the provisions of paragraph 11(d) hereof, and (2) the entry by said court of an order requiring the Officer to deliver to the Company documentation or other property which belongs to the Company as required in paragraph 11(f).\n12. Benefits. The Company agrees to provide the Officer during the term of this Agreement such additional benefits, commonly known as \"employee benefits,\" which are generally extended by the Company to its Officers. Notwithstanding the foregoing and provided the Officer remains employed by the Company, all employee benefits received by the Officer at the time of the effective date of this Agreement shall be maintained throughout the term of this Agreement, unless expressly prohibited by law or unless any or all such employee benefits are discontinued, decreased, or in any way modified by the Company for all Officers, for all persons serving in a capacity similar to that of the Officer, or for all employees of the Company. Employee benefits include, but are not limited to, holidays, vacations, health insurance, life\/accidental death insurance, long-term disability insurance, short-term disability benefits, expense supplement plan, educational assistance program, employee assistance program, health maintenance organization, sick leave, Christmas cash bonus, and service recognition awards. Any intended modification of employee benefits as defined herein will be in writing.\n13. Stock Options. If this Agreement is terminated for any reason, the Company will extend to the Officer a period of sixty (60) calendar days, during which the Officer shall have the right to exercise any stock options, in whole or in part, as may have been granted under the Horrigan American, Inc., Stock Option Agreements.\n14. Effect of Waiver. The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof.\n15. Arbitration. Any controversy arising from or related to this Agreement shall be determined by arbitration in the City of Reading in accordance with the rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having jurisdiction.\n16. Notice. Any and all notices referred to herein shall be sufficient if furnished in writing and sent by registered mail to the representative parties at the address subscribed below following their signatures to this Agreement.\n17. Assignment. The rights and benefits of the Company under this Agreement shall be transferable, and all covenants and agreements hereunder shall inure to the benefits of and be enforceable by or against its successors and assigns.\n_______________________________ ______________________________ American Real Estate Investment Officer and Development Co. c\/o Horrigan American, Inc. Flying Hills Corporate Center Reading, Pennsylvania 19607\nEXHIBIT 10.4 EMPLOYMENT AGREEMENT\nTHIS AGREEMENT, made this first (1st) day of January 1994 by and between AEL Leasing Co., Inc., and American Commercial Credit Corp. (hereinafter called \"Company\") and Vincent A. Faino (hereinafter called \"Officer\").\nBackground\nThe Company is presently engaged primarily in the business of equipment leasing and commercial lending. The Officer is presently serving as President, American Legal Funding, and Senior Vice President, American Reli Financial, of the Company.\nDuring the course of his employment by the Company, the Officer has acquired valuable experience, knowledge, expertise, and management skills. It is the desire of both the Company and the Officer that the employment relationship existing between them continue to the mutual benefit of each.\nW I T N E S S E T H :\n1. Employment and Duties. The Company hereby employs the Officer to perform such duties as may be determined and assigned to him by his immediate supervisor.\n2. Performance. The Officer agrees to devote all of his working time and best efforts to the performance of his duties as President, American Legal Funding, and Senior Vice President, American Reli Financial, and to the performance of other such duties as are assigned to him from time to time by his immediate supervisor.\n3. Term. Except in the case of earlier termination, as hereinafter specifically provided, the term of this Agreement shall be from January 1, 1994, through December 31, 1994; provided, however, that this Agreement shall be extended by one calendar day for each expired calendar day after January 1, 1994, until December 31, 1994, with the alternate termination of this Agreement not later than December 31, 1995. Notwithstanding the foregoing extension of the Agreement, the Company and the Officer may mutually agree to renegotiate this Agreement or enter into a new Agreement after December 31, 1994.\n4. Compensation. Compensation, wherever used in this Agreement, shall mean all base compensation and all earned incentive compensation.\n(a) For all the services to be rendered by the Officer in any capacity hereunder, including services as an officer, member of any committee, or any other duties assigned to him by his immediate supervisor, the Company agrees to pay the Officer a base salary of $72,000 per annum, payable in equal semi-monthly installments on the fifteenth (15th) and last day of each month. The Company, at its option, may increase the Officer's compensation at any time at its convenience.\n(b) The Company further agrees to pay the Officer incentive compensation according to the following program:\n(b-1) HAI Super Hurdle\n(b-1) Phantom Stock Plan\n(b-3) Originations\n.00043 of Monthly Accounts Payable up to $62,136,000 .00050 of Monthly Accounts Payable over $62,136,000\nPayment will be made monthly in conjunction with the pay period following the final determination of accounts payable for the month.\n(b-3) Profit\n.005 of Monthly Profit After Tax and GAAP Adjustments up to $2,800,000\n.006 of Monthly Profit After Tax and GAAP Adjustments over $2,800,000\nPayment will be made monthly in conjunction with the pay period following the final determination of profit after tax and GAAP adjustments for the month.\n(b-4) Portfolios\n$3,000 for each $5,000,000 of cash advances generated by the Officer\n(c) It is understood that the minimum combined base and incentive compensation, exclusive of the HAI Super Hurdle, paid to the Officer will be $100,000 per year.\nNote: Projected earnings at budgeted volume and budgeted profit and assuming attainment of Hurdle bonus = $114,718.\n5. Life Insurance. The Officer agrees that the Company, at its discretion, may apply for and procure in its own name and for its own benefit, life insurance in any amount or amounts considered advisable and that the Officer shall have no right, title, or interest therein; and, further, he agrees to submit to any reasonable medical or other examination and to execute and deliver any application or other instrument, in writing, necessary to effectuate such insurance.\n6. Business Expenses. Consistent with established Company policy, the Company will compensate the Officer for his eligible business expenses to include: travel, meals, and miscellaneous expenses incurred locally; and travel, meals, lodging, and miscellaneous expenses incurred while the Officer is away on business. Such reimbursement shall be made by the Company upon submission of a signed statement by the Officer itemizing such expenses.\n7. Termination.\n(a) Voluntary Company Termination: The Company may terminate this Agreement at any time upon two (2) months' notice to the Officer; and the Company shall be obligated to pay the Officer two (2) months' compensation plus one (1) month's compensation pro-rated for each two (2) years of continuous service as an Officer (vice president or above) of the Company or any affiliated sister company, up to a maximum of ten (10) additional months' compensation. A month's compensation shall be determined as the greater of:\n(1) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six (6) month period and one-twelfth (1\/12) of any incentive compensation which was paid to the Officer during the prior twelve (12) month period or\n(2) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six-month period and a pro rata share, based upon the number of full weeks worked, of any incentive compensation due and owing for the year in which the Officer is terminated.\nIf the Officer is separated by the Company in accordance with Paragraph 7(a), it is expressly understood that it is not a termination of employment as defined in 7(c) herein.\n(b) Voluntary Officer Termination: The Officer may terminate this Agreement at any time upon two (2) months' notice to the Company, and the Company shall be obligated to pay to the Officer two (2) months' compensation. A month's compensation shall be determined as defined in 7(a).\n(c) Involuntary Company Termination: The Company may also terminate this Agreement on one (1) day's notice, if the termination is for any of the following employment-related causes, and, in that event, the Company shall not be obligated to pay the Officer any further compensation:\n(c-1) Willful failure or refusal of the Officer to adequately perform the duties and obligations of his employment, if such willful failure or refusal is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-2) Any breach by the Officer of the provisions of this Agreement, if such breach is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-3) Conviction of the Officer for any felony or other criminal offense involving dishonesty or moral turpitude which is related to his employment with the Company or to his duties as an Officer;\n(c-4) Other just cause, if such just cause is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer. 8. Death.\n(a) In the event of the Officer's death during the term of this Agreement, it shall terminate immediately. Unless the Officer has left a different designation on file with the Company, the Officer's surviving spouse or, if there is no surviving spouse, the minor children (to include all children who are full-time students regardless of age) or, if there are no surviving children, the Officer's estate shall be entitled to receive six (6) months' compensation due the Officer. A month's compensation shall be determined as defined in paragraph 7(a). This compensation shall be paid in equal monthly installments, commencing the first of the month following the Officer's death, and shall be paid proportionately over a period of eighteen (18) months.\n(b) In addition, should the Officer at any time die while a party to this Agreement, the Company shall pay within three (3) months after the date of the Officer's death, a death benefit of Five Thousand Dollars ($5,000.00) to the Officer's surviving spouse or, if there is no surviving spouse, to the surviving children in equal shares or, if there are no surviving children, to the Officer's estate, unless the Officer has left a different designation on file with the Company.\n9. Disability. If, during the term of this Agreement, the Officer should fail to perform his duties hereunder on account of illness or other incapacity, and such illness or incapacity shall continue for a period of six (6) months, the Company shall have the right to terminate this Agreement. In that event, the Company shall be obligated to pay the Officer his compensation up to the date of termination. Such compensation may be reduced by the amount of any proceeds received by the Officer from any Company-funded program such as disability insurance, Worker's Compensation, or Social Security, during the six (6) month period.\n10. Discontinuance of Business. If, during the term of this Agreement, the Company should involuntarily discontinue or interrupt the operation of its business for a period of one (1) month, this Agreement shall automatically terminate without further liability on the part of either the parties hereto.\n11. Restrictions.\n(a) The Officer acknowledges that:\n(a-1) During the course of his employment with the Company and during the term of this Agreement, the Officer has and shall continue to have access to learn, be provided with, prepare, or create Confidential Information, all of which is of substantial value to the Company's business and the disclosure of which would be harmful to the Company.\n(a-2) In the event, either during the term of this Agreement or any time thereafter, the Officer should disclose to any other person or entity any such Confidential Information, use for the Officer's own benefit or for the benefit of any other person or entity any such Confidential Information, or make copies or notes of any such Confidential Information except as may be required in the normal course of the Officer's duties, such conduct would be inconsistent with and a breach of the confidence and trust inherent in the Officer's position with the Company, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(b) During the term of this Agreement, the Officer agrees to devote all of his working time and best efforts to further the interests of the Company, and he shall not directly or indirectly, alone or as a partner, officer, director, or stockholder of any other institution, be engaged in any other commercial activity whatsoever, or continue or assume any other corporate affiliations without the consent of the Board of Directors of the Company.\nEXCEPTION: It shall not be deemed a violation of this Agreement for the Officer to engage in independent consulting activities including Corporate Directorships for third party companies and individuals, and to retain the compensation therefore for his individual use, providing such consultation does not involve services and advice given to any firm or company on the activities and business of this Company or any of its subsidiaries or affiliates, and further provided such consultation is not with a customer or competitor of the Company without the prior written approval of the Board of Directors of Company. It is further understood that such consulting shall be on personal time.\n(c) The Officer acknowledges:\n(c-1) The Company's products and services are highly specialized items.\n(c-2) The Company has a proprietary interest in the identity of its customers and customer lists.\n(c-3) During the term of this Agreement, the Officer will have access to and become familiar with various trade secrets and highly confidential information of the Company, including but not necessarily limited to, documents and information regarding the Company's services, systems, lease and financing programs, re-marketing programs, sales, pricing, costs, specialized requirements of customers, prospective applicants for employment, current employees, information recorded on present or past credit applications, current or past financing vehicles or products by and between the Company and the banking community or related community, internal managerial accounting systems, and information systems. The Officer acknowledges that such confidential information and trade secrets are owned and shall continue to be owned solely by the Company.\n(d) The Officer covenants to the Company that for a period of one (1) year following the date of Termination of Employment, as defined in Paragraph 7 of this Agreement, he shall not, either directly or indirectly, or through any person or other entity, or by any other means:\n(d-1) Use confidential information or trade secrets for any purpose whatsoever or divulge such information to any person other than the Company or persons to whom the Company has given consent, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(d-2) Directly or indirectly solicit or sell any of the Company's products or services to any person, company, firm, or corporation who is or was a customer of the Company (customer is defined as dealer, manufacturer, vendor, borrower, lessee, or any other person or entity who deals with the Company in its normal course of business) at the time of termination of the Officer's employment. The Officer agrees not to solicit such customers on behalf of himself or any other person, company, firm, or corporation.\n(e) In the event that a court of competent jurisdiction determines that the provisions of paragraph 11(c) and 11(d), or any part thereof, are invalid or unenforceable by reason of overly broad territorial or excessive time restrictions or otherwise, then the parties to the Agreement request such court to modify such restrictions or paragraph to the extent necessary in order that the same shall be valid and enforceable and to enforce the same to that extent.\n(f) Upon his separation of employment for any reason, the Officer shall immediately deliver to the Company all documentation and other property which belongs to the Company which pertains to the business or financial affairs of the Company.\n(g) The parties to this Agreement acknowledge that any breach, violation, or default by the Officer of the provisions contained in paragraphs 11(d) and 11(f) of this Agreement would result in irreparable harm and damage to the Company, which harm and damage would be extremely difficult to quantify and, accordingly, the Officer consents to the jurisdiction of a court of equity and (1) the entry of an injunction, temporary or permanent, enjoining the Officer from competing with the Company in violation of the provisions of paragraph 11(d) hereof, and (2) the entry by said court of an order requiring the Officer to deliver to the Company documentation or other property which belongs to the Company as required in paragraph 11(f).\n12. Benefits. The Company agrees to provide the Officer during the term of this Agreement such additional benefits, commonly known as \"employee benefits,\" which are generally extended by the Company to its Officers. Notwithstanding the foregoing and provided the Officer remains employed by the Company, all employee benefits received by the Officer at the time of the effective date of this Agreement shall be maintained throughout the term of this Agreement, unless expressly prohibited by law or unless any or all such employee benefits are discontinued, decreased, or in any way modified by the Company for all Officers, for all persons serving in a capacity similar to that of the Officer, or for all employees of the Company. Employee benefits include, but are not limited to, holidays, vacations, health insurance, life\/accidental death insurance, long-term disability insurance, short-term disability benefits, expense supplement plan, educational assistance program, employee assistance program, health maintenance organization, sick leave, Christmas cash bonus, and service recognition awards. Any intended modification of employee benefits as defined herein will be in writing.\n13. Stock Options. If this Agreement is terminated for any reason, the Company will extend to the Officer a period of sixty (60) calendar days, during which the Officer shall have the right to exercise any stock options, in whole or in part, as may have been granted under the Horrigan American, Inc., Stock Option Agreements.\n14. Effect of Waiver. The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof.\n15. Arbitration. Any controversy arising from or related to this Agreement shall be determined by arbitration in the City of Reading in accordance with the rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having jurisdiction.\n16. Notice. Any and all notices referred to herein shall be sufficient if furnished in writing and sent by registered mail to the representative parties at the address subscribed below following their signatures to this Agreement.\n17. Assignment. The rights and benefits of the Company under this Agreement shall be transferable, and all covenants and agreements hereunder shall inure to the benefits of and be enforceable by or against its successors and assigns.\n_______________________________ _______________________________ AEL Leasing Co., Inc. Officer American Commercial Credit Corp. Flying Hills Corporate Center Reading, Pennsylvania 19607\nEXHIBIT 10.5 EMPLOYMENT AGREEMENT\nTHIS AGREEMENT, made this first (1st) day of January 1994, by and between AEL Leasing Co., Inc., and American Commercial Credit Corp. (hereinafter called \"Company\") and W. Michael Horrigan (hereinafter called \"Officer\").\nBackground\nThe Company is presently engaged primarily in the business of commercial leasing and lending. The Officer is presently serving as Executive Vice President and Chief Administrative Officer of the Company.\nDuring the course of his employment by the Company, the Officer has acquired valuable experience, knowledge, expertise, and management skills. It is the desire of both the Company and the Officer that the employment relationship existing between them continue to the mutual benefit of each.\nW I T N E S S E T H :\n1. Employment and Duties. The Company hereby employs the Officer to perform such duties as may be determined and assigned to him by his immediate supervisor.\n2. Performance. The Officer agrees to devote all of his working time and best efforts to the performance of his duties as Executive Vice President and Chief Administrative Officer and to the performance of other such duties as are assigned to him from time to time by his immediate supervisor.\n3. Term. Except in the case of earlier termination, as hereinafter specifically provided, the term of this Agreement shall be from January 1, 1994, through December 31, 1994; provided, however, that this Agreement shall be extended by one calendar day for each expired calendar day after January 1, 1994, until December 31, 1994, with the alternate termination of this Agreement not later than December 31, 1995. Notwithstanding the foregoing extension of the Agreement, the Company and the Officer may mutually agree to renegotiate this Agreement or enter into a new Agreement after December 31, 1994.\n4. Compensation. Compensation, wherever used in this Agreement, shall mean all base compensation and all earned incentive compensation.\n(a) For all the services to be rendered by the Officer in any capacity hereunder, including services as an officer, member of any committee, or any other duties assigned to him by his immediate supervisor, the Company agrees to pay the Officer a base salary of $87,200 per annum, payable in equal semi-monthly installments on the fifteenth (15th) and last day of each month. The Company, at its option, may increase the Officer's compensation at any time at its convenience.\n(b) The Company further agrees to pay the Officer incentive compensation according to the following programs:\nHAI Super Hurdle AEL\/ACC\/AELH Hurdle Phantom Stock Plan\n5. Life Insurance. The Officer agrees that the Company, at its discretion, may apply for and procure in its own name and for its own benefit, life insurance in any amount or amounts considered advisable and that the Officer shall have no right, title, or interest therein; and, further, he agrees to submit to any reasonable medical or other examination and to execute and deliver any application or other instrument, in writing, necessary to effectuate such insurance.\n6. Business Expenses. Consistent with established Company policy, the Company will compensate the Officer for his eligible business expenses to include: travel, meals, and miscellaneous expenses incurred locally; and travel, meals, lodging, and miscellaneous expenses incurred while the Officer is away on business. Such reimbursement shall be made by the Company upon submission of a signed statement by the Officer itemizing such expenses.\n7. Termination.\n(a) Voluntary Company Termination: The Company may terminate this Agreement at any time upon two (2) months' notice to the Officer; and the Company shall be obligated to pay the Officer two (2) months' compensation plus one (1) month's compensation pro-rated for each two (2) years of continuous service as an Officer (vice president or above) of the Company or any affiliated sister company, up to a maximum of ten (10) additional months' compensation. A month's compensation shall be determined as the greater of:\n(1) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six (6) month period and one-twelfth (1\/12) of any incentive compensation which was paid to the Officer during the prior twelve (12) month period or\n(2) The combined total of one-sixth (1\/6) of the base compensation which was paid to the Officer during the prior six-month period and a pro rata share, based upon the number of full weeks worked, of any incentive compensation due and owing for the year in which the Officer is terminated.\nIf the Officer is separated by the Company in accordance with Paragraph 7(a), it is expressly understood that it is not a termination of employment as defined in 7(c) herein.\n(b) Voluntary Officer Termination: The Officer may terminate this Agreement at any time upon two (2) months' notice to the Company, and the Company shall be obligated to pay to the Officer two (2) months' compensation. A month's compensation shall be determined as defined in 7(a).\n(c) Involuntary Company Termination: The Company may also terminate this Agreement on one (1) day's notice, if the termination is for any of the following employment-related causes, and, in that event, the Company shall not be obligated to pay the Officer any further compensation:\n(c-1) Willful failure or refusal of the Officer to adequately perform the duties and obligations of his employment, if such willful failure or refusal is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-2) Any breach by the Officer of the provisions of this Agreement, if such breach is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n(c-3) Conviction of the Officer for any felony or other criminal offense involving dishonesty or moral turpitude which is related to his employment with the Company or to his duties as an Officer;\n(c-4) Other just cause, if such just cause is determined upon review by an arbitration committee of three (3) Officers appointed by the Chief Human Resources Officer.\n8. Death.\n(a) In the event of the Officer's death during the term of this Agreement, it shall terminate immediately. Unless the Officer has left a different designation on file with the Company, the Officer's surviving spouse or, if there is no surviving spouse, the minor children (to include all children who are full-time students regardless of age) or, if there are no surviving children, the Officer's estate shall be entitled to receive six (6) months' compensation due the Officer. A month's compensa- tion shall be determined as defined in paragraph 7(a). This compensation shall be paid in equal monthly installments, commencing the first of the month following the Officer's death, and shall be paid proportionately over a period of eighteen (18) months.\n(b) In addition, should the Officer at any time die while a party to this Agreement, the Company shall pay within three (3) months after the date of the Officer's death, a death benefit of Five Thousand Dollars ($5,000.00) to the Officer's surviving spouse or, if there is no surviving spouse, to the surviving children in equal shares or, if there are no surviving children, to the Officer's estate, unless the Officer has left a different designation on file with the Company.\n9. Disability. If, during the term of this Agreement, the Officer should fail to perform his duties hereunder on account of illness or other incapacity, and such illness or incapacity shall continue for a period of six (6) months, the Company shall have the right to terminate this Agreement. In that event, the Company shall be obligated to pay the Officer his compensation up to the date of termination. Such compensation may be reduced by the amount of any proceeds received by the Officer from any Company-funded program such as disability insurance, Worker's Compensation, or Social Security, during the six (6) month period.\n10. Discontinuance of Business. If, during the term of this Agreement, the Company should involuntarily discontinue or interrupt the operation of its business for a period of one (1) month, this Agreement shall automatically terminate without further liability on the part of either the parties hereto.\n11. Restrictions.\n(a) The Officer acknowledges that:\n(a-1) During the course of his employment with the Company and during the term of this Agreement, the Officer has and shall continue to have access to learn, be provided with, prepare, or create Confidential Information, all of which is of substantial value to the Company's business and the disclosure of which would be harmful to the Company.\n(a-2) In the event, either during the term of this Agreement or any time thereafter, the Officer should disclose to any other person or entity any such Confidential Information, use for the Officer's own benefit or for the benefit of any other person or entity any such Confidential Information, or make copies or notes of any such Confidential Information except as may be required in the normal course of the Officer's duties, such conduct would be inconsistent with and a breach of the confidence and trust inherent in the Officer's position with the Company, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(b) During the term of this Agreement, the Officer agrees to devote all of his working time and best efforts to further the interests of the Company, and he shall not directly or indirectly, alone or as a partner, officer, director, or stockholder of any other institution, be engaged in any other commercial activity whatsoever, or continue or assume any other corporate affiliations without the consent of the Board of Directors of the Company.\nEXCEPTION: It shall not be deemed a violation of this Agreement for the Officer to engage in independent consulting activities including Corporate Directorships for third party companies and individuals, and to retain the compensation therefore for his individual use, providing such consultation does not involve services and advice given to any firm or company on the activities and business of this Company or any of its subsidiaries or affiliates, and further provided such consultation is not with a customer or competitor of the Company without the prior written approval of the Board of Directors of Company. It is further understood that such consulting shall be on personal time.\n(c) The Officer acknowledges:\n(c-1) The Company's products and services are highly specialized items.\n(c-2) The Company has a proprietary interest in the identity of its customers and customer lists.\n(c-3) During the term of this Agreement, the Officer will have access to and become familiar with various trade secrets and highly confidential information of the Company, including but not necessarily limited to, documents and information regarding the Company's services, systems, lease and financing programs, re-marketing programs, sales, pricing, costs, specialized requirements of customers, prospective applicants for employment, current employees, information recorded on present or past credit applications, current or past financing vehicles or products by and between the Company and the banking community or related community, internal managerial accounting systems, and information systems. The Officer acknowledges that such confidential information and trade secrets are owned and shall continue to be owned solely by the Company.\n(d) The Officer covenants to the Company that for a period of one (1) year following the date of Termination of Employment, as defined in Paragraph 7 of this Agreement, he shall not, either directly or indirectly, or through any person or other entity, or by any other means: (d-1) Use confidential information or trade secrets for any purpose whatsoever or divulge such information to any person other than the Company or persons to whom the Company has given consent, unless such information has already become common knowledge, or unless the Officer is compelled to disclose such information by governmental process.\n(d-2) Directly or indirectly solicit or sell any of the Company's products or services to any person, company, firm, or corporation who is or was a customer of the Company (customer is defined as dealer, manufacturer, vendor, borrower, lessee, or any other person or entity who deals with the Company in its normal course of business) at the time of termination of the Officer's employment. The Officer agrees not to solicit such customers on behalf of himself or any other person, company, firm, or corporation.\n(e) In the event that a court of competent jurisdiction determines that the provisions of paragraph 11(c) and 11(d), or any part thereof, are invalid or unenforceable by reason of overly broad territorial or excessive time restrictions or otherwise, then the parties to the Agreement request such court to modify such restrictions or paragraph to the extent necessary in order that the same shall be valid and enforceable and to enforce the same to that extent.\n(f) Upon his separation of employment for any reason, the Officer shall immediately deliver to the Company all documentation and other property which belongs to the Company which pertains to the business or financial affairs of the Company.\n(g) The parties to this Agreement acknowledge that any breach, violation, or default by the Officer of the provisions contained in paragraphs 11(d) and 11(f) of this Agreement would result in irreparable harm and damage to the Company, which harm and damage would be extremely difficult to quantify and, accordingly, the Officer consents to the jurisdiction of a court of equity and (1) the entry of an injunction, temporary or permanent, enjoining the Officer from competing with the Company in violation of the provisions of paragraph 11(d) hereof, and (2) the entry by said court of an order requiring the Officer to deliver to the Company documentation or other property which belongs to the Company as required in paragraph 11(f).\n12. Benefits. The Company agrees to provide the Officer during the term of this Agreement such additional benefits, commonly known as \"employee benefits,\" which are generally extended by the Company to its Officers. Notwithstanding the foregoing and provided the Officer remains employed by the Company, all employee benefits received by the Officer at the time of the effective date of this Agreement shall be maintained throughout the term of this Agreement, unless expressly prohibited by law or unless any or all such employee benefits are discontinued, decreased, or in any way modified by the Company for all Officers, for all persons serving in a capacity similar to that of the Officer, or for all employees of the Company. Employee benefits include, but are not limited to, holidays, vacations, health insurance, life\/accidental death insurance, long-term disability insurance, short-term disability benefits, expense supplement plan, educational assistance program, employee assistance program, health maintenance organization, sick leave, Christmas cash bonus, and service recognition awards. Any intended modification of employee benefits as defined herein will be in writing.\n13. Stock Options. If this Agreement is terminated for any reason, the Company will extend to the Officer a period of sixty (60) calendar days, during which the Officer shall have the right to exercise any stock options, in whole or in part, as may have been granted under the Horrigan American, Inc., Stock Option Agreements.\n14. Effect of Waiver. The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof.\n15. Arbitration. Any controversy arising from or related to this Agreement shall be determined by arbitration in the City of Reading in accordance with the rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having jurisdiction.\n16. Notice. Any and all notices referred to herein shall be sufficient if furnished in writing and sent by registered mail to the representative parties at the address subscribed below following their signatures to this Agreement.\n17. Assignment. The rights and benefits of the Company under this Agreement shall be transferable, and all covenants and agreements hereunder shall inure to the benefits of and be enforceable by or against its successors and assigns.\n_______________________________ __________________________ AEL Leasing Co., Inc. Officer American Commercial Credit Corp. Flying Hills Corporate Center Reading, Pennsylvania 19607\nEXHIBIT 10.12\nHorrigan American, Inc. 401(k) Retirement Plan\nORIGINALLY EFFECTIVE JANUARY 1, 1963\nAS AMENDED AND RESTATED EFFECTIVE JANUARY 1, 1989\nHorrigan American, Inc. 401(k) Retirement Plan\nThis amended and restated plan, executed on the date indicated at the end hereof, is made effective as of January 1, 1989, except as provided otherwise in Section 1.3(c), by Horrigan American, Inc., a Corporation, with its principal office located in Reading, PA.\nW I T N E S S E T H :\nWHEREAS, effective January 1, 1963, the employer established the plan for its employees and desires to continue to maintain a permanent qualified plan in order to provide its employees and their beneficiaries with financial security in the event of retirement, disability or death; and\nWHEREAS, it is desired to amend said plan;\nNOW THEREFORE, the premises considered, the original plan is hereby replaced by this amended and restated plan, and the following are the provisions of the qualified plan of the employer as restated herein; provided, however, that each employee who was previously a participant shall remain a participant, and no employee who was a participant in the plan before the date of amendment shall receive a benefit under this amended plan which is less than the benefit he was then entitled to receive under the plan as of the day prior to the amendment.\nARTICLE I DEFINITIONS\nSection 1.1 References\n(a) Code means the Internal Revenue Code of 1986, as it may be amended from time to time.\n(b) ERISA means the Employee Retirement Income Security Act of 1974, as amended.\nSection 1.2 Compensation\n(a) Compensation means, except as provided in paragraph (b) hereof, any earnings reportable as W-2 wages for Federal income tax withholding purposes and earned income, plus elective contributions, for the plan year.\nElective contributions are amounts excludible from the employee's gross income and contributed by the employer, at the employee's election to:\n(1) A cafeteria plan (excludible under Code Section 125); (2) A Code Section 401(k) arrangement (excludible under Code Section 402(a)(8)); (3) A simplified employee pension (excludible under Code Section 402(h)); or (4) A tax sheltered annuity (excludible under Code Section 403(b)).\n\"Earned Income\" means net earnings from self-employment in the trade or business with respect to which the employer has established the plan, provided that personal services of the individual are a material income producing factor. Net earnings shall be determined without regard to items excluded from gross income and the deductions allocable to those items. Net earnings shall be determined after the deduction allowed to the self-employed individual for all contributions made by the employer to a qualified plan and, for plan years beginning after December 31, 1989, the deduction allowed to the self-employed under Code Section 164(f) for self-employment taxes.\nAny reference in this plan to compensation shall be a reference to the definition in this Section 1.2, unless the plan reference specifies a modification to this definition. The plan administrator shall take into account only compensation actually paid by the employer for the relevant period. A compensation payment includes compensation by the employer through another person under the common paymaster provisions in Code Sections 3121 and 3306. Compensation from an employer which is not a participating employer under this plan shall be excluded.\n(b) Exclusions From Compensation - Notwithstanding the provisions of paragraph 1.2(a), the following types of remuneration shall be excluded from the participant's compensation:\nKey Management Bonuses\n(c) Limitations on Compensation -\n(1) Compensation Dollar Limitation - For any plan year beginning after December 31, 1988, the plan administrator shall take into account only the first $200,000 (or beginning January 1, 1990, such larger amount as the Commissioner of Internal Revenue may prescribe) of any participant's compensation for determining all benefits provided under the plan. The compensation dollar limitation for a plan year shall be the limitation amount in effect on January 1 of the calendar year in which the plan year begins. For any plan year beginning before January 1, 1989, this $200,000 limitation (but not the family aggregation requirement described in the next paragraph) applies only if the plan is top-heavy for such plan year or operates as a deemed top-heavy plan for such plan year. If the plan should determine compensation on a period of time that contains fewer than 12 calendar months (such as for a short plan year), the annual compensation dollar limitation shall be an amount equal to the compensation dollar limitation for the plan year multiplied by the ratio obtained by dividing the number of full months in the period by 12.\n(2) Application of Compensation Limitation to Certain Family Members - The $200,000 compensation limitation applies to the combined compensation of the employee and of any family member aggregated with the employee under Code Section 414(q)(6) who is either (A) the employee's spouse, or (B) the employee's lineal descendant under the age of 19. If, for a plan year, the combined compensation of the employee and such family members who are participants entitled to an allocation for that plan year exceeds the compensation dollar limitation, compensation for each such participant, for purposes of the contribution and allocation provisions of Article III, means his adjusted compensation.\nAdjusted compensation is the amount which bears the same ratio to the compensation dollar limitation as the affected participant's compensation (without regard to the compensation dollar limitation) bears to the combined compensation of all the affected participants in the family unit. If the plan uses permitted disparity, the plan administrator first shall determine the integration level of each affected family member participant using actual compensation. The total of the affected participants' compensations equal to or less than the applicable integration levels may not exceed the compensation dollar limitation. The combined excess compensation of the affected participants in the family unit may not exceed the compensation dollar limitation minus the amount determined under the preceding sentence. If the combined excess compensation exceeds this limitation, the plan administrator will prorate the limitation on the excess compensation among the affected participants in the family unit in proportion to each such individual's actual compensation minus his integration level.\n(d) Compensation for Nondiscrimination Test - For purposes of determining whether the plan discriminates in favor of highly compensated employees, compensation means compensation as defined in this Section 1.2, except that the employer will not give effect to any exclusion from compensation specified in Section 1.2(b). Notwithstanding the above, the employer may elect to exclude from this nondiscrimination definition of compensation any items of compensation excludible under Code Section 414(s) and the applicable Treasury regulations, provided such adjusted definition conforms to the nondiscrimination requirements of those regulations.\n(e) Compensation for Compliance with Section 5.6 - For purposes of conducting the actual deferral percentage test or the average contribution percentage test, compensation means compensation as defined in Section 1.2(a) for the entire plan year except that for the plan year in which the employee first becomes a participant, compensation means the employee's compensation for the portion of the plan year in which the employee actually is a participant.\nSection 1.3 Dates\n(a) Accounting Date means the date(s) on which investment results are allocated to participants' accounts, including the allocation date for the profit sharing contribution and any interim accounting date(s) noted below:\nMarch 31, June 30, September 30, interim investment allocation dates.\n(b) Allocation Date means the date(s) on which any contribution is allocated to participants' accounts. The profit sharing contribution shall be allocated as of the last day of the plan year. Employer matching contributions shall be allocated as of the last day of each month.\n(c) The Effective Date of the plan is January 1, 1963.\nThe effective date of this amendment and restatement is January 1, 1989; provided, however that the plan provisions required to comply with the Tax Reform Act of 1986 (TRA '86), the Omnibus Budget Reconciliation Act of 1986 (OBRA '86), the Omnibus Budget Reconciliation Act of 1987 (OBRA '87), and the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) shall generally be effective on the first day of the plan year beginning after December 31, 1988, except as specified otherwise in this plan or in TRA '86, OBRA '86, OBRA '87 or TAMRA. The plan provisions required to comply with the 1989 Revenue Reconciliation Act shall generally be effective on the first day of the plan year beginning after December 31, 1989, except as specified otherwise in this plan or in said Act.\nNotwithstanding anything herein to the contrary, the provisions noted below shall become effective on the alternate effective date indicated. If the alternate effective date is subsequent to the effective date of this amendment, the prior provisions of the plan shall continue in effect until such alternate effective date.\n(d) Plan Entry Date means the participation date(s) specified in Article II.\n(e) Plan Year means the 12-consecutive month period beginning on January 1 and ending on December 31.\n(f) Limitation Year (for purposes of limitations on benefits and contributions under Code Section 415) means the plan year.\nSection 1.4 Employee\n(a) (1) Employee means any person employed by the employer, including an owner-employee or other self-employed individual (as defined in paragraph (3)). The term employee shall include any employee of the employer maintaining the plan or of any other employer required to be aggregated with such employer under Code Sections 414(b), (c), (m) or (o). The term employee shall also include any leased employee deemed to be an employee of any employer as provided in Code Sections 414(n) or (o) and as defined in paragraph (2).\n(2) Leased Employee means an individual (who otherwise is not an employee of the employer) who, pursuant to a leasing agreement between the employer and any other person, has performed services for the employer (or for the employer and any persons related to the employer within the meaning of Code Section 144(a)(3)) on a substantially full time basis for at least one year and who performs services historically performed by employees in the employer's business field. If a leased employee is treated as an employee by reason of this Section 1.4(a)(2), compensation from the leasing organization which is attributable to services performed for the employer shall be considered as compensation under the plan. Contributions or benefits provided a leased employee by the leasing organization which are attributable to services performed for the employer shall be treated as provided by the employer.\nSafe harbor plan exception - The plan shall not treat a leased employee as an employee if the leasing organization covers the employee in a safe harbor plan and, prior to application of this safe harbor plan exception, 20% or less of the employer's employees (other than highly compensated employees) are leased employees. A safe harbor plan is a money purchase pension plan providing immediate participation, full and immediate vesting, and a nonintegrated contribution formula equal to at least 10% of the employee's compensation without regard to employment by the leasing organization on a specified date. The safe harbor plan must determine the 10% contribution on the basis of compensation as defined in Code Section 415(c)(3) plus elective contributions.\n(3) Owner-Employee\/Self Employed Individual - Owner-employee means a self-employed individual who is a sole proprietor, (if the employer is a sole proprietorship) or who is a partner (if the employer is a partnership) owning more than 10 percent of either the capital or profits interest of the partnership. Self-employed individual means an individual who has earned income for the taxable year from the trade or business for which the plan is established, or who would have had earned income but for the fact that the trade or business had no net profits for the taxable year.\n(b) Highly Compensated Employee means an employee who, during the plan year or during the preceding 12-month period:\n(1) is a more than 5% owner of the employer (applying the constructive ownership rules of Code Section 318, and applying the principles of Code Section 318, for an unincorporated entity);\n(2) has compensation in excess of $75,000 (as adjusted by the Commissioner of Internal Revenue for the relevant year);\n(3) has compensation in excess of $50,000 (as adjusted by the Commissioner of Internal Revenue for the relevant year) and is part of the top-paid 20% group of employees (based on compensation for the relevant year); or\n(4) has compensation in excess of 50% of the dollar amount prescribed in Code Section 415(b)(1)(A) (relating to defined benefit plans) and is an officer of the employer.\nIf the employee satisfies the definition in clause (2), (3) or (4) in the plan year but did not satisfy clause (2), (3) or (4) during the preceding 12-month period and does not satisfy clause (1) in either period, then the employee is a highly compensated employee only if he is one of the 100 most highly compensated employees for the plan year. The number of officers taken into account under clause (4) shall not exceed the greater of 3 or 10% of the total number (after application of the Code Section 414(q) exclusions) of employees, but no more than 50 officers. If no employee satisfies the compensation requirement in clause (4) for the relevant year, the highest paid officer will be treated as satisfying clause (4) for that year.\nThe term highly compensated employee also includes any former employee who separated from service (or has a deemed separation from service, as determined under Treasury regulations) prior to the plan year, performs no service for the employer during the plan year, and was a highly compensated employee either for the separation year or any plan year ending on or after his 55th birthday. If the former employee's separation from service occurred before January 1, 1987, he is a highly compensated employee only if he satisfied clause (1) of this Section 1.4(b) or received compensation in excess of $50,000 during the year of his separation from service (or the prior year), or during any year ending after his 54th birthday.\nFor purposes of determining who is a highly compensated employee under this Section 1.4(b), compensation means compensation as defined in Section 1.2, except that any exclusions from compensation specified in Section 1.2 (b) shall not apply. The plan administrator shall make the determination of who is a highly compensated employee, including the determinations of the number and identity of the top paid 20% group, the top 100 paid employees, the number of officers includible in clause (4) and the relevant compensation, consistent with Code Section 414(q) and regulations issued under that Code Section. The employer may make a calendar year election to determine the highly compensated employees for the plan year, as prescribed by Treasury regulations. A calendar year election must apply to all plans and arrangements of the employer.\nFor purposes of applying any nondiscrimination test required under the plan or Code, in a manner consistent with applicable Treasury regulations, the plan administrator will treat a highly compensated employee and all family members (a spouse, a lineal ascendant or descendant, or a spouse of a lineal ascendant or descendant) as a single highly compensated employee, but only if the highly compensated employee is a more than 5% owner or is one of the 10 highly compensated employees with the greatest compensation for the plan year. This aggregation rule applies to a family member even if that family member is a highly compensated employee without family aggregation.\nSection 1.5 Employer\nEmployer means Horrigan American, Inc. or any successor entity by merger, purchase, consolidation, or otherwise; or an organization affiliated with the employer which may assume the obligations of this plan with respect to its employees by becoming a party to this plan. Another employer whether or not it is affiliated with the sponsor employer may adopt this plan to cover its employees by filing with the sponsor employer a written resolution adopting the plan, upon which the sponsor employer shall indicate its acceptance of such employer as an employer under the plan. Each such employer shall be deemed to be the employer only as to persons who are on its payroll.\nThe following employers have adopted this plan and have been accepted by the sponsor employer on or before the date this amendment and restatement is executed:\nParticipating Employer EIN AEL Leasing Co., Inc. 23-1720013 American Real Estate Investment and Development Co. 23-2294785 The Business Outlet, Inc. 23-2347549 Horrigan Companies, Inc. 23-1636676\nSection 1.6 Fiduciaries\n(a) Named Fiduciary means the person or persons having fiduciary responsibility for the management and control of plan assets.\n(b) Plan administrator means the person or persons appointed by the named fiduciary to administer the plan.\n(c) Trustee means the trustee named in the trust agreement executed pursuant to this plan, or any duly appointed successor trustee.\n(d) Investment Manager means a person or corporation other than the trustee appointed for the investment of plan assets.\nSection 1.7 Participant\/Beneficiary\n(a) Participant means an eligible employee of the employer who becomes a member of the plan pursuant to the provisions of Article II, or a former employee who has an accrued benefit under the plan.\n(b) Beneficiary means a person designated by a participant who is or may become entitled to a benefit under the plan. A beneficiary who becomes entitled to a benefit under the plan remains a beneficiary under the plan until the trustee has fully distributed his benefit to him. A beneficiary's right to (and the plan administrator's, or a trustee's duty to provide to the beneficiary) information or data concerning the plan shall not arise until he first becomes entitled to receive a benefit under the plan.\nSection 1.8 Participant Accounts\n(a) Profit Sharing Account means the balance of the separate account derived from profit sharing employer contributions, including forfeitures (if any) (if so provided under Section 3.2).\n(b) Qualified Non-elective Contribution Account means the balance of the separate account derived from employer's qualified non-elective contributions (if so provided under Section 3.3).\n(c) Employee 401(k) Elective Deferral Account means the balance of the separate account derived from the participant's elective deferrals (if so provided under Section 3.4).\n(d) Employee Nondeductible Contribution Account means the balance of the separate account derived from the participant's non-deductible employee contributions (if so provided under Section 3.5).\n(e) Employer Matching Contribution Account means the balance of the separate account derived from employer's matching contributions (if so provided under Section 3.6).\n(f) Rollover\/Transfer Account means the balance of the separate account derived from rollover contributions and\/or transfer contributions (if so provided under Section 3.7).\n(g) Recharacterized Funds Account means the balance of the separate account derived from recharacterized amounts treated as being contributed by the participant (if so provided under Section 3.5(c)).\n(h) Accrued Benefit means the total of the participant's account balances as of the accounting date falling on or before the day on which the accrued benefit is being determined.\nSection 1.9 Plan\nPlan means Horrigan American, Inc.401(k) Retirement Plan as set forth herein and as it may be amended from time to time.\nSection 1.10 Service\n(a) Service means any period of time the employee is in the employ of the employer, including any period the employee is on an unpaid leave of absence authorized by the employer under a uniform, nondiscriminatory policy applicable to all employees. Separation from service means that the employee no longer has an employment relationship with the employer.\n(b) (1) Hour of Service means:\n(A) Each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer. These hours shall be credited to the employee for the computation period in which the duties are performed; and\n(B) Each hour for which an employee is paid, or entitled to payment, by the employer on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. No more than 501 hours of service shall be credited under this paragraph for any single continuous period (whether or not such period occurs in a single computation period). An hour of service shall not be credited to an employee under this paragraph if the employee is paid, or entitled to payment, under a plan maintained solely for the purpose of complying with applicable worker's compensation or unemployment compensation or disability insurance laws. Hours under this paragraph shall be calculated and credited pursuant to Section 2530.200b-2 of the Department of Labor Regulations which are incorporated herein by this reference; and\n(C) Each hour for which back pay, irrespective of mitigation of damages, is either awarded or agreed to by the employer. The same hours of service shall not be credited both under paragraph (A) or paragraph (B), as the case may be, and under this paragraph (C). These hours shall be credited to the employee for the computation period or periods to which the award or agreement pertains rather than the computation period in which the award, agreement or payment is made.\nHours of service shall be determined on the basis of actual hours for which an employee is paid or entitled to payment. The above provisions shall be construed so as to resolve any ambiguities in favor of crediting employees with hours of service.\n(2) Solely for purposes of determining whether a break in service for participation and vesting purposes has occurred in a computation period, an individual who is absent from work for maternity or paternity reasons shall receive credit for the hours of service which would otherwise have been credited to such individual but for such absence, or in any case in which such hours cannot be determined, 8 hours of service per day of such absence. For purposes of this paragraph, an absence from work for maternity or paternity reasons means an absence (A) by reason of the pregnancy of the individual, (B) by reason of a birth of a child of the individual, (C) by reason of the placement of a child with the individual in connection with the adoption of such child by such individual, or (D) for purposes of caring for such child for a period beginning immediately following such birth or placement. The hours of service credited under this paragraph shall be credited: (A) in the computation period in which the absence begins if the crediting is necessary to prevent a break in service in that period, or (B) in all other cases, in the following computation period.\n(3) Hours of service shall be credited for employment with other members of an affiliated service group (under Code Section 414(m)), a controlled group of corporations (under Code Section 414(b)), or a group of trades or businesses under common control (under Code Section 414(c)), of which the adopting employer is a member. Hours of service shall also be credited for any leased employee who is considered an employee for purposes of this plan under Code Section 414(n) or Code Section 414(o).\n(c) (1) Year of Service means a 12-consecutive month computation period during which the employee completes the required number of hours of service with the employer as specified in Sections 2.1 or 4.1.\n(2) Predecessor Service - If the employer maintains the plan of a predecessor employer, service with such predecessor employer shall be treated as service for the employer. If the employer does not maintain the plan of a predecessor employer, then service as an employee of a predecessor employer shall not be considered as service under the plan, except as noted below:\n- Service as an employee of American Amdev Hospitality, Inc. (predecessor employer) shall be considered as service under the plan for the purposes of determining eligibility years of service (under Section 2.1) and vesting years of service (under Section 4.1).\nService as an employee of a predecessor employer shall be considered as service for the employer hereunder for the purposes of applying the limitations on benefits and allocations under Code Section 415.\n(d) Break in Service (or One Year Break in Service) means a 12-consecutive month computation period during which a participant or former participant does not complete the specified number of hours of service with the employer as set forth in Sections 2.1(b) and 4.1(b).\nSection 1.11 Trust\n(a) Trust means the qualified trust created under the employer's plan.\n(b) Trust Fund means all property held or acquired by the plan.\nARTICLE II PARTICIPATION\nSection 2.1 Eligibility Service\n(a) Eligibility Year of Service means an eligibility computation period during which the employee completes at least 1,000 hours of service with the employer.\n(b) One Year Break in Service means for the purposes of this Article II an eligibility computation period during which the participant or former participant does not complete more than 500 hours of service with the employer.\n(c) Eligibility Computation Period - The initial eligibility computation period shall be the 12-consecutive month period beginning with the day on which the employee first performs an hour of service with the employer (employment commencement date).\nSucceeding eligibility computation periods shall coincide with the plan year, beginning with the first plan year which commences prior to the first anniversary of the employee's employment commencement date regardless of whether the employee is credited with the required number of hours of service during the initial eligibility computation period. An employee who is credited with the required number of hours of service in both the initial eligibility computation period and the first plan year which commences prior to the first anniversary of the employee's employment commencement date shall be credited with two years of service for purposes of eligibility to participate.\nSection 2.2 Plan Participation\n(a) Eligibility\n(1) Age\/service requirements - An employee who is a member of the eligible class of employees shall be eligible for plan participation after he has satisfied the following participation requirements:\n(A) Completion of 1 year of service, and\n(B) Attainment of age 21.\n(2) Eligible class of employees - All employees of the employer shall be eligible to be covered under the plan; provided, however, that leased employees who are considered employees under the plan shall not be eligible for participation, unless such exclusion would cause the plan to fail to satisfy the participation test or the coverage test of Code Section 410 or the nondiscrimination requirements of Code Section 401(a)(4).\n(b) Entry Date - An eligible employee shall participate in the plan on the earlier of the January 1 or July 1 entry date coinciding with or immediately following the date on which he has met the age and service requirements. If an employee who is not a member of the eligible class of employees becomes a member of the eligible class, such employee shall participate immediately, if he has satisfied the age and service requirements and would have otherwise previously become a participant.\nSection 2.3 Termination of Participation\nA participant shall continue to be an active participant of the plan so long as he is a member of the eligible class of employees and he does not incur a one-year break in service due to termination of employment. He shall become an inactive participant when he incurs a one-year break in service due to termination of employment, or at the end of the plan year during which he ceases to be a member of the eligible class of employees. He shall cease participation completely upon the later of his receipt of a total distribution of his nonforfeitable account balance(s) under the plan or the forfeiture of the nonvested portion of the account balance(s).\nSection 2.4 Re-Participation (Break In Service Rules)\n(a) Vested Participant - A former participant who had a nonforfeitable right to all or a portion of his account balance derived from employer contributions at the time of his termination from service shall become a participant immediately upon returning to the employ of the employer, if he is a member of the eligible class of employees.\n(b) Nonvested Participant - In the case of a former participant who did not have any nonforfeitable right to his account balance derived from employer contributions at the time of his termination from service, years of service before a period of consecutive one-year breaks in service shall not be taken into account in computing service if the number of consecutive one-year breaks in service in such period equals or exceeds the greater of 5 or the aggregate number of years of service before such breaks in service. Such aggregate number of years of service shall not include any years of service disregarded under the preceding sentence by reason of prior breaks in service.\nIf such former participant's years of service before termination from service are disregarded pursuant to the preceding paragraph, he shall be considered a new employee for eligibility purposes. If such former participant's years of service before termination from service may not be disregarded pursuant to the preceding paragraph, he shall participate immediately upon returning to the employ of the employer, if he is a member of the eligible class of employees.\n(c) Return to Eligible Class - If a participant becomes an inactive participant, because he is no longer a member of the eligible class of employees, but does not incur a break in service; such inactive participant shall become an active participant immediately upon returning to the eligible class of employees. If such participant incurs a break in service, eligibility shall be determined under the re-participation rules in paragraphs (a) and (b) above.\nARTICLE III ALLOCATIONS TO PARTICIPANT ACCOUNTS\nSection 3.1 General Provisions\n(a) Maintenance of Participant Accounts - The plan administrator shall maintain separate accounts covering each participant under the plan as herein described. Such accounts shall be increased by contributions, reallocation of forfeitures (if any), investment income, and market value appreciation of the fund. They shall be decreased by market value depreciation of the fund, forfeiture of nonvested amounts, benefit payments, withdrawals and expenses.\n(b) Amount and Payment of Employer Contribution\n(1) Amount of Contribution - For each plan year, the employer contribution to the plan shall be the amount which is determined under the provisions of this Article; provided, however, that the employer may not make a contribution to the plan for any plan year to the extent the contribution would exceed the participants' maximum permissible amounts under Code Section 415. Further, the employer contribution shall not exceed the maximum amount deductible under Code Section 404.\nThe employer contributes to this plan on the conditions that its contribution is not due to a mistake of fact and that the Internal Revenue Service will not disallow the deduction for its contribution. The trustee, upon written request from the employer, shall return to the employer the amount of the employer's contribution made due to a mistake of fact or the amount of the employer's contribution disallowed as a deduction under Code Section 404. The trustee shall not return any portion of the employer's contribution under the provisions of this paragraph more than one year after the earlier of: (A) The date on which the employer made the contribution due to a mistake of fact; or (B) The time of disallowance of the contribution as a deduction, and then, only to the extent of the disallowance. The trustee will not increase the amount of the employer contribution returnable under this Section for any earnings attributable to the contribution, but the trustee will decrease the employer contribution returnable for any losses attributable to it. The trustee may require the employer to furnish whatever evidence it deems necessary to confirm that the amount the employer has requested be returned is properly returnable under ERISA.\n(2) Payment of Contribution - The employer shall make its contribution to the plan within the time prescribed by the Code or applicable Treasury regulations. Subject to the consent of the trustee, the employer may make its contribution in property rather than in cash, provided the contribution of property is not a prohibited transaction under the Code or ERISA.\n(c) Limitations and Conditions - Notwithstanding the allocation procedures set forth in this Article, the allocations to participants' accounts shall be limited or modified to the extent required to comply with the provisions of Article V (limitations on allocations under Code Section 415, related employer provisions under Code Section 414 and top-heavy provisions under Code Section 416).\nIn any limitation year in which the allocation to one or more participants' accounts would be in excess of the limitations on allocations under Code Section 415, the annual additions under this plan will be reduced to the extent necessary to comply with such limitations first. If any further reduction is required, the annual additions or benefits under any other plan which the employer also sponsors will then be reduced with respect to such participants.\nSection 3.2 Profit Sharing Contributions\n(a) Amount of Contribution - The employer shall determine, in its sole discretion, the amount of profit sharing employer contribution to be made to the plan each year; provided, however, that the employer shall contribute such amount as may be required for restoration of a forfeited amount under Section 4.2.\n(b) Conditions for Allocations - An active participant shall be eligible for an allocation of the employer profit sharing contribution and forfeitures as of an allocation date, provided that he satisfies the following conditions:\n(1) He completed at least 1,000 hours of service during the current plan year, except that the hours of service requirement shall not apply with respect to any minimum top heavy allocation as provided in Section 5.5.,\nAND\n(2) He is employed by the employer on the last day of the plan year.\nNotwithstanding the above conditions for allocation of contributions, if the plan would otherwise fail to satisfy the participation test or coverage test of Code Section 410 or the nondiscrimination requirements of Code Section 401(a)(4), the plan administrator shall amend the plan in a nondiscriminatory manner to provide for the participation of additional employees and\/or to cause additional active participants to be eligible for an allocation.\n(c) (1) Allocation Formula\nThe employer profit sharing contribution and forfeitures for the plan year shall be allocated to the account of each eligible participant in the ratio that such participant's compensation bears to the compensation of all participants.\n(2) Top-Heavy Plan Years\nIn any year in which this plan is top-heavy (as defined in Section 5.5(e)(2)) when aggregated with the prior Horrigan American, Inc. Employee Stock Ownership Plan which the employer also sponsors, the top-heavy minimum benefit requirement shall be met under this plan.\nThe top-heavy minimum benefit with respect to a participant shall first be met by any allocation to the Qualified Non-elective Contribution Account for the plan year. Then the contributions and forfeitures allocable to the profit sharing account shall be adjusted as necessary for compliance. The total of the contributions and forfeitures allocated to such accounts of each participant shall not be less than an amount equal to 3% of such participant's compensation or the largest percentage of employer contribution and forfeiture allocated under both plans on behalf of any key employee for that year, whichever is less.\nIf a participant only participates in this plan, his Qualified Non-elective Contribution Account and profit sharing account will receive a cumulative allocation that is not less than an amount equal to 3% of his compensation or the largest percentage of employer contribution and forfeiture allocated under both plans on behalf of any key employee for that year, whichever is less.\n(3) Compensation - For purposes of the allocation of the employer profit sharing contribution, compensation means compensation as defined in Section 1.2 for the entire plan year, except that for the plan year in which the employee first becomes a participant, compensation means the employee's compensation for the portion of the plan year in which the employee actually is a participant.\nSection 3.3 Qualified Non-Elective Contributions\nThe employer may make qualified non-elective contributions on behalf of either the non-highly compensated active participants or all active participants that are sufficient to satisfy either the actual deferral percentage test or the average contribution percentage test, or both, pursuant to regulations under the Code in lieu of distributing excess contributions as provided in Section 5.6(b)(2) of the plan, or excess aggregate contributions as provided in Subsection 5.6(c)(2) of the plan.\nQualified non-elective contributions are contributions (other than profit sharing contributions or employer matching contributions) which are made by the employer and allocated to participants' qualified non-elective contribution accounts and any forfeitures which are so applied that the participants may not elect to receive in cash until distributed from the plan; that are nonforfeitable when made; and that are distributable only in accordance with the distribution provisions that are applicable to elective deferrals and qualified matching contributions.\n(a) Amount of Contribution - The amount of such contributions for each plan year shall be an amount determined by the employer, in its sole discretion, after the plan administrator has determined the amount needed to satisfy test requirements, the test or tests to be satisfied with such contributions, and the classification of active participants (all or only the non-highly compensated) to receive the contribution.\n(b) Allocation of Contribution -\n(1) Allocation of such contributions shall be made under one of the following methods to either all active participants or all non-highly compensated active participants as determined by the plan administrator for the plan year:\n(A) In the ratio which each eligible participant's compensation for the plan year bears to the total compensation of all eligible participants for such plan year.\n(B) In the ratio which each eligible participant's compensation not in excess of a specified dollar amount for the plan year bears to the total compensation of all eligible participants not in excess of such specified dollar amount for such plan year. The plan administrator shall set the specified dollar amount at the level necessary to enable the plan to satisfy the test or tests being met through the contribution.\n(C) The contribution shall be allocated to those non-highly compensated employees earning the least compensation during the plan year as needed to enable the plan to meet the test requirements the contribution is being used to meet.\n(2) Top-Heavy Plan Years\nThe top-heavy minimum benefit requirements shall be met as provided under Section 3.2(c)(2) concerning profit sharing and qualified non-elective contribution allocations.\nSection 3.4 Employee 401(k) Elective Deferral Contributions\n(a) Amount of Contribution - The employer shall contribute each plan year on behalf of each active participant who elects salary deferral a sum equal to the amount which the participant has elected to defer under a salary reduction arrangement or under a cash or deferred arrangement. The contribution shall be credited to the participant's employee 401(k) elective deferral account.\n(b) Salary Reduction Election\n(1) Availability of Election - An active participant may effect a salary reduction agreement with the employer under which an employer contribution will be made to the plan on behalf of such participant only if he elects to reduce his compensation or to forgo an increase in his compensation. The amount of salary deferral may range from 1% to 10% of compensation.\nThe plan administrator may limit the amount of salary reduction at any time, if he determines that such limitation is necessary to meet Internal Revenue Service requirements for a [qualified cash or deferred arrangement] under Code Section 401(k) and regulations issued pursuant thereto and as set forth in Section 5.6.\n(2) Election Procedures - A written notice of a participant's salary reduction election shall be given to the employer and to the plan administrator upon such forms as may be provided by the plan administrator. The written notice shall be given at least 30 days before January 1, April 1, July 1, or October 1 on which it is to be effective. However, in no event shall such notice be given or be effective before the adoption of the employee 401(k) election deferral contribution provision under the plan. A participant electing salary reduction will be deemed to desire to continue at the same rate, unless he notifies the plan administrator at least 30 days before the applicable date of his desire to change the amount of salary reduction. The revised election shall be effective on the applicable date. A salary reduction may be discontinued at any time upon 30 days notice on the required form. A participant who has declined or suspended salary reduction may elect salary reduction at a subsequent election date by written notification to the plan administrator in the manner and on the forms as provided under this paragraph.\nHowever, if a participant receives a hardship distribution, his right to elect a salary reduction shall be suspended for 12 months after the receipt of such distribution. Further, the participant may not elect a salary reduction for his taxable year immediately following the taxable year of the hardship distribution in excess of the applicable limit under Code Section 402(g) for such taxable year less the amount of such participant's salary reduction for the taxable year of the hardship distribution.\n(3) Conditions - The participant's salary reduction election shall apply only to compensation which becomes currently available to the employee after the effective date of the election. The employer shall apply the salary reduction election to all of the participant's compensation (and to increases in compensation), unless the participant's salary reduction election specifies that the election is to be limited to certain compensation.\n(c) Cash or Deferred Election -\nNo contribution shall be made under this plan pursuant to a cash or deferred election. All elective deferrals shall be made under a salary deferral election.\nSection 3.5 Employee Nondeductible Contributions\nEmployee nondeductible contributions are not permitted under this plan and no amount shall be credited to the employee nondeductible contribution account. A participant may not treat his excess contributions as an amount distributed to him and then contributed by him to the plan as an employee nondeductible contribution as described in Section 5.6(b)(3).\nSection 3.6 Employer Matching Contributions\nEmployer matching contributions shall be made under the provisions of this Section. Such contributions shall be credited to the employer matching contribution account.\n(a) Qualified Matching Contributions\nThe employer matching contribution shall not be treated as a qualified matching contribution. A qualified matching contribution means matching contributions which are subject to the distribution and nonforfeitability requirements under Code Section 401(k) when made.\n(b) Contributions Subject to Matching - Employer matching contributions shall be made with respect to any contributions made under a salary reduction agreement to the extent provided below. The contributions shall be credited to the employer matching contribution account of each eligible participant.\n(c) Conditions for Allocation - An active participant shall be eligible for an allocation of an employer matching contribution as of an allocation date, provided that he made a contribution which is subject to matching during the current plan year.\n(d) Allocation Formula - The employer matching contribution and any applicable forfeitures shall be equal to the employer matching percentage applied to the participant's contributions for the current plan year which are subject to matching; provided that a participant's contributions in excess of 6% of his compensation for the allocation period shall be disregarded for purposes of allocating the employer matching contributions. Further, the participant's contributions for the current plan year which are subject to matching shall be reduced by any such contributions withdrawn during the plan year. The employer matching percentage shall be equal to 50%.\n(e) Forfeitures of Excess Aggregate Contributions\nExcess aggregate contributions which are determined under the average contribution percentage test and which are attributed to employer matching contributions shall be distributed to the extent vested with a proportional amount of the nonvested employer matching contribution being forfeited as of the last day of the plan year in which the excess arose. Also, any forfeitures required for compliance with Code Section 401(a)(4) shall occur as of such date. The forfeitures shall be treated in the manner described in Section 4.2(c)(2).\nThe forfeitures shall be applied to reduce any employer matching contribution or any qualified non-elective contribution.\nSection 3.7 Rollover\/Transfer Contributions\n(a) Rollover Contributions - A participant may contribute to his rollover\/transfer account any amounts which he previously received either as a lump sum distribution (as defined in Code Section 402(d)(4)) or within one taxable year as a distribution from another qualified plan on account of termination of that plan provided that:\n(1) He transferred such distribution to an Individual Retirement Account or Annuity within sixty (60) days after receipt, or\n(2) He transferred such distribution to this plan within sixty (60) days after receipt.\nBefore accepting a rollover contribution, the trustee may require an employee to furnish satisfactory evidence that the proposed transfer is in fact a [rollover contribution] which the Code permits an employee to make to a qualified plan.\n(b) Transfer Contributions - With the consent of the plan administrator, the participant may have funds transferred directly to this plan from another qualified plan. Consent shall not be given if the optional forms of payment to which the funds are subject under the prior plan are not properly disclosed by the prior plan or cannot be accommodated by this plan and trust.\nFurther, this plan shall not accept any direct or indirect transfers (in a transfer after December 31, 1984) from a defined benefit plan, money purchase plan (including a target benefit plan), stock bonus or profit sharing plan which would otherwise have provided for a life annuity form of payment to the participant.\n(c) Contributions Before Plan Entry Date - An employee, (who is in the eligible class of employees) prior to satisfying the plan's eligibility conditions, may make a rollover or transfer contribution to the plan to the same extent and in the same manner as a participant. If an employee makes a rollover or transfer contribution to the plan before satisfying the plan's eligibility conditions, the plan administrator and trustee will treat the employee as a participant for all purposes of the plan, except the employee is not a participant for purposes of contributions or forfeitures under the plan until he actually becomes a participant in the plan. If the employee has a separation from service prior to becoming a participant, the trustee will distribute his rollover or transfer contribution account to him.\n(d) Distribution - The rollover\/transfer account shall be subject to distribution in the same manner as an employer-derived contribution. Withdrawals may be made from a rollover\/transfer account under the terms and conditions of Section 4.4 if this plan permits any such in-service withdrawals.\nTo the extent that a distribution is attributable to a direct transfer from another qualified plan, the Joint and Survivor Requirements of Section 5.3 shall be met as if the distribution were being made from such prior plan.\nSection 3.8 Allocation of Investment Results\n(a) General Allocation Procedures\nInvestment income and market value appreciation or depreciation shall be allocated to each account of each participant who has accrued benefits in proportion to the respective account balances on each accounting date. For this purpose, each account balance shall be equal to the average balance for the period commencing on the day following the prior accounting date and ending on the current accounting date.\n(b) Investment Elections\nA participant may elect to have all of his accounts invested in such investment fund or combination of investment funds as may be established by the trustee and made available for the benefit of participants; provided, however, that in no event may the participant direct that any portion of his account(s) be invested in collectibles (as defined in Code Section 408(m)). A participant's investment election shall not apply to any portion of any account which may be invested in a participant loan sub-account established under Section 4.4. The investment results shall be allocated to the participant's account(s) based upon earnings and losses on the participant's share in such investment fund or funds. Participant investment elections shall be in writing on a form provided by the plan administrator and signed by the participant. An election must be received by the plan administrator at least 15 days before the accounting date as of which it will be effective. An election may be revoked only by another election and will remain in effect until such revocation.\nARTICLE IV PAYMENT OF PARTICIPANT ACCOUNTS\nSection 4.1 Vesting Service Rules\n(a) Vesting Year of Service means a vesting computation period during which the employee completes at least 1,000 hours of service with the employer. All of an employee's years of service with the employer shall be counted to determine the nonforfeitable percentage in the employee's account balance(s) derived from employer contributions, except:\n(1) Years of service disregarded under the break in service rules in paragraph (d) below. (Post-ERISA break in service rules)\n(2) Years of service before the effective date of ERISA if such service would have been disregarded under the break in service rules of the prior plan in effect from time to time before such date. For this purpose, break in service rules are rules which result in the loss of prior vesting or benefit accruals, or which deny an employee eligibility to participate, by reason of separation or failure to complete a required period of service within a specified period of time. (Pre-ERISA break in service rules)\n(b) One Year Break in Service means for the purposes of this Article IV a vesting computation period during which the participant or former participant does not complete more than 500 hours of service with the employer.\n(c) Vesting Computation Period means the 12-consecutive month period coinciding with the plan year.\n(d) Break in Service Rules\n(1) Vested Participant - A former participant who had a nonforfeitable right to all or a portion of his account balance(s) derived from employer contributions at the time of his termination from service shall retain credit for all vesting years of service prior to a break in service.\n(2) Nonvested Participant - In the case of a former participant who did not have any nonforfeitable right to his account balance(s) derived from employer contributions at the time of his termination from service, years of service before a period of consecutive one-year breaks in service shall not be taken into account in computing service if the number of consecutive one-year breaks in service in such period equals or exceeds the greater of 5 or the aggregate number of years of service before such breaks in service. Such aggregate number of years of service shall not include any years of service disregarded under the preceding sentence by reason of prior breaks in service.\n(3) Vesting for Pre-Break and Post-Break Accounts - In the case of a participant who has 5 or more consecutive one-year breaks in service, all years of service after such breaks in service shall be disregarded for the purpose of vesting the employer-derived account balance(s) that accrued before such breaks in service. Whether or not such participant's pre-break service counts in vesting the post-break employer-derived account balance(s) shall be determined according to the rules set forth in sub-paragraphs (1) and (2) above. Separate accounts shall be maintained for each of the participant's pre-break and post-break employer-derived account balance(s). All accounts shall share in the investment earnings and losses of the fund.\nSection 4.2 Vesting of Participant Accounts\n(a) Determination of Vesting\n(1) Normal Retirement - A participant's right to his account balance(s) shall be 100% vested and nonforfeitable upon the attainment of 65, the normal retirement age. If the employer enforces a mandatory retirement age, the normal retirement age shall be the lesser of the mandatory age or the age specified herein.\n(2) Late Retirement - If a participant remains employed after his normal retirement age, his account balance(s) shall remain 100% vested and nonforfeitable. Such participant shall continue to receive allocations to his account as he did before his normal retirement age.\n(3) Early Retirement - In the case of a participant who has attained age 55 and completed 7 years of service before his normal retirement age, the participant's right to his account balance(s) shall be 100% vested and nonforfeitable. Such participant may retire before his normal retirement age without the consent of the employer and receive payment of benefits from the plan. If a participant separates from service before satisfying the age requirement for early retirement, but has satisfied the service requirement, the participant shall be entitled to elect an early retirement benefit upon satisfaction of such age requirement.\n(4) Disability - If a participant separates from service due to disability, such participant's right to his account balance(s) as of his date of disability shall be 100% vested and nonforfeitable. Disability means inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. The permanence and degree of such impairment shall be supported by medical evidence. Notwithstanding such definition, a participant who is eligible for Social Security disability benefits shall automatically satisfy the definition of disability. Disability shall be determined by the plan administrator after consultation with a physician chosen by the administrator. In the administration of this section, all employees shall be treated in a uniform manner in similar circumstances.\n(5) (A) Death - In the event of the death of a participant who has an accrued benefit under the plan, (whether or not he is an active participant), 100% of the participant's account balance(s) as of the date of death shall be paid to his surviving spouse; except that, if there is no surviving spouse, or if the surviving spouse has already consented in a manner which is (or conforms to) a qualified election under the joint and survivor annuity provisions of Code Section 417(a) and regulations issued pursuant thereto and as set forth in Section 5.3, then such balance(s) shall be paid to the participant's designated beneficiary.\n(B) Beneficiary Designation - Subject to the spousal consent requirements of Section 5.3, the participant shall have the right to designate his beneficiaries, including a contingent death beneficiary, and shall have the right at any time to change such beneficiaries. The designation shall be made in writing on a form signed by the participant and supplied by and filed with the plan administrator. If the participant fails to designate a beneficiary, or if the designated person or persons predecease the participant, \"beneficiary\" shall mean the spouse, children, parents, brothers and sisters, or estate of the participant, in the order listed.\n(6) Termination From Service - If a participant separates from the service of the employer other than by retirement, disability or death, his vested interest in his accounts shall be equal to the account balance multiplied by the vesting percentage determined below:\n(A) Profit Sharing Account - The vesting percentage applicable to the participant's profit sharing account shall be determined based on his vesting years of service as follows:\nYears of Service Vesting Percentage\n0-2 Years 0% 3 20% 4 40% 5 60% 6 80% 7 or More Years 100%\n(B) Employer Matching Contribution Account - The vesting percentage applicable to the participant's employer matching contribution account shall be determined as follows:\nYears of Service Vesting Percentage\n0-2 Years 0% 3 20% 4 40% 5 60% 6 80% 7 or More Years 100%\n(C) Other Accounts - The participant shall always be 100% vested in his following accounts: employee 401(k) elective deferral account; employee nondeductible contribution account; employer matching contribution account, if the contributions are being treated as qualified matching contributions under Section (3.6); qualified non-elective contribution account; rollover\/transfer account and recharacterized funds account. The accrued benefit in such accounts shall be nonforfeitable.\n(b) Forfeitures\n(1) Time of Forfeiture - If a participant terminates employment before his account balances derived from employer contributions are fully vested, the nonvested portion of his accounts shall be forfeited on the earlier of:\n(A) The last day of the vesting computation period in which the participant first incurs 5 consecutive one-year breaks in service, or\n(B) The date the participant receives his entire vested accrued benefit.\n(2) Cashout Distributions and Restoration\n(A) Cashout Distribution - If an employee terminates service and the value of his vested account balances derived from employer and employee contributions are not greater than $3,500, the employee shall receive a distribution of the value of the entire vested portion of such account balances and the nonvested portion will be treated as a forfeiture. For purposes of this section, if the value of an employee's vested account balances is zero, he shall be deemed to have received a distribution of such vested account balances. An employee's vested account balance shall not include accumulated deductible employee contributions within the meaning of Code Section 72(o)(5)(B) for plan years beginning prior to January 1, 1989.\nIf an employee terminates service and the value of his vested account balances exceeds $3,500, he may elect to receive the value of his vested account balances after such termination as provided in Section 4.3. The nonvested portion shall be treated as a forfeiture as of the date of distribution. If the employee elects to have distributed less than the entire vested portion of the account balances derived from employer contributions, the part of the nonvested portion that will be treated as a forfeiture is the total nonvested portion multiplied by a fraction, the numerator of which is the amount of the distribution attributable to employer contributions and the denominator of which is the total value of the vested employer-derived account balances.\n(B) Restoration of Accounts - If an employee receives a cashout distribution pursuant to this section and resumes employment covered under this plan before he incurs 5 consecutive one-year breaks in service, his employer-derived account balances shall each be restored to the amount on the date of distribution, if he repays to the plan the full amount of the distribution attributable to employer contributions before the earlier of 5 years after the first date on which he is subsequently re-employed by the employer, or the date he incurs 5 consecutive one-year breaks in service following the date of the distribution. If an employee is deemed to receive a distribution pursuant to this Section 4.2(b)(2), and he resumes employment covered under this plan before he incurs 5 consecutive one-year breaks in service, upon the reemployment of such employee his employer-derived account balances will be restored to the amount on the date of such deemed distribution.\nAny amount required to restore such forfeitures shall be deducted from forfeitures (including forfeitures of excess aggregate contributions) occurring in the plan year of restoration. If forfeitures are insufficient for the restoration, the employer may make a contribution to the plan for such plan year to satisfy the restoration. However, by the end of the plan year following the plan year of restoration, sufficient forfeitures or employer contributions shall be credited to the account to satisfy the restoration.\n(c) Disposition of Forfeitures\n(1) Profit Sharing Account -\nForfeitures of profit sharing accounts shall be reallocated among the eligible active participants at the end of the plan year in which such forfeitures occur in accordance with the allocation procedures set forth in Section 3.2.\n(2) Employer Matching Contribution Account -\nForfeitures of employer matching contribution accounts shall be used to reduce the employer matching contribution for the plan year in which such forfeitures occur.\n(d) Withdrawal of Employee Nondeductible Contributions - No forfeitures shall occur solely as a result of an employee's withdrawal of employee nondeductible contributions.\n(e) Unclaimed Benefits\n(1) Forfeiture - The plan does not require the trustee or the plan administrator to search for, or to ascertain the whereabouts of, any participant or beneficiary. At the time the participant's or beneficiary's benefit becomes distributable under the plan, the plan administrator, by certified or registered mail addressed to his last known address of record, shall notify any participant or beneficiary that he is entitled to a distribution under this plan. If the participant or beneficiary fails to claim his distributive share or make his whereabouts known in writing to the plan administrator within twelve months from the date of mailing of the notice, the plan administrator shall treat the participant's or beneficiary's unclaimed payable accrued benefit as forfeited and shall reallocate such forfeiture in accordance with paragraph (c). A forfeiture under this paragraph shall occur at the end of the notice period or, if later, the earliest date applicable Treasury regulations would permit the forfeiture. These forfeiture provisions apply solely to the participant's or beneficiary's accrued benefit derived from employer contributions.\n(2) Restoration - If a participant or beneficiary who has incurred a forfeiture of his accrued benefit under the provisions of this subsection makes a claim, at any time, for his forfeited accrued benefit, the plan administrator shall restore the participant's or beneficiary's forfeited accrued benefit to the same dollar amount as the dollar amount of the accrued benefit forfeited, unadjusted for any gains or losses occurring after the date of the forfeiture. The plan administrator shall make the restoration during the plan year in which the participant or beneficiary makes the claim from forfeitures occurring in that plan year. If forfeitures are insufficient for the restoration, the employer shall make a contribution to the plan to satisfy the restoration. The plan administrator shall direct the trustee to distribute the participant's or beneficiary's restored accrued benefit to him not later than 60 days after the close of the plan year in which the plan administrator restores the forfeited accrued benefit.\nSection 4.3 Payment of Participant Accounts\n(a) Time of Payment\n(1) Commencement of Benefits - Unless the participant elects otherwise, distribution of benefits shall begin no later than the 60th day after the latest of the close of the plan year in which:\n(A) The participant attains age 65 (or the plan's normal retirement age, if earlier);\n(B) Occurs the 10th anniversary of the year in which the participant commenced participation in the plan; or\n(C) the participant terminates service with the employer, (i.e. late retirement).\n(2) Payment Upon Retirement, Disability, or Death - Subject to the provisions set forth in Section 4.3(a)(1), in the Joint and Survivor Requirements of Section 5.3 and in the Distribution Requirements of Section 5.4, if the participant terminates employment due to retirement, disability or death, his account(s) shall be paid as soon as administratively possible after the end of the calendar quarter of occurrence of the event creating the right to a distribution.\n(3) Payment Upon Other Termination of Employment - Subject to the provisions set forth in Section 4.3(a)(1), in the Joint and Survivor Requirements of Section 5.3, and in the Distribution Requirements of Section 5.4, if the participant terminates employment other than by retirement, disability or death, his account(s) shall be paid as soon as administratively possible after the end of the calendar quarter in which severance of employment occurs.\n(4) Notwithstanding the foregoing, the failure of a participant (and spouse where the spouse's consent is required) to consent to a distribution while a benefit is immediately distributable, within the meaning of Section 5.3(c), shall be deemed to be an election to defer commencement of payment of any benefit sufficient to satisfy this section.\n(b) Optional Form(s) of Payment - A participant or beneficiary may elect to receive distribution of his account(s) in one of the optional forms of payment outlined below, provided that such distribution complies with the Distribution Requirements of Section 5.4 and the Joint and Survivor Requirements of Section 5.3. However, the Joint and Survivor Requirements other than the provisions of Section 5.3(c) and (f) shall not apply to a distribution unless a life annuity of any type is elected by the participant or unless this plan is, with respect to the participant, a direct or indirect transferee of a defined benefit plan, money purchase pension plan (including a target benefit plan), or a stock bonus or profit sharing plan which would otherwise have provided for a qualified joint and survivor life annuity as the normal form of payment to the participant.\nThe participant or beneficiary shall file a written request for benefits with the plan administrator before payments will commence. If a participant fails to elect a form of payment, the trustee shall pay the benefit in installment payments (or as a joint and survivor annuity payments if the requirements of Section 5.3 apply) which meet the requirements of Section 5.4.\nOptional forms of payment include:\n(1) A lump sum payment - If the vested accrued benefit is no more than $3,500, benefits shall automatically be paid in a lump sum.\nA lump sum benefit payment may be made in cash from the fund or by distribution of assets in kind, provided that the participant or beneficiary agrees to such distribution in kind and the trustee determines a current fair market value of the assets to be distributed.\n(2) Installment payments over a period of years which meets the Distribution Requirements of Section 5.4. Installment payments may be made in cash from the fund or by distribution of an annuity term certain contract.\n(3) A life annuity of any type issued by an insurance company on the life of the participant or beneficiary for such amount as the vested account(s) will purchase, provided that the Joint and Survivor Annuity Requirements of Section 5.3 and the Distribution Requirements of Section 5.4 are met.\n(c) General Payment Provisions\n(1) All distributions due to be made under this plan shall be made on the basis of the amount to the credit of the participant as of the accounting date coincident with or immediately preceding the occurrence of the event calling for a distribution.\nIf a distributable event occurs after an allocation date and before allocations have been made to the account of the participant, the distribution shall also include the amounts allocable to the account as of such allocation date.\n(2) If any person entitled to receive benefits hereunder is physically or mentally incapable of receiving or acknowledging receipt thereof, and if a legal representative has been appointed for him, the plan administrator may direct the benefit payment to be made to such legal representative.\n(3) Each optional form of benefit provided under the plan shall be made available to all participants on a nondiscriminatory basis. The plan may not retroactively reduce or eliminate optional forms of benefits and any other Code Section 411(d)(6) protected benefits. Any reduction or elimination of optional forms of benefits shall apply only to benefits accrued after the effective date of such change.\n(4) Any annuity contract distributed herefrom shall be nontransferrable. The terms of any such annuity contract purchased and distributed by the plan shall comply with the requirements of this plan. The ownership of the annuity contract shall reside with the participant. Any dividend, refund or recovery on an annuity contract shall be credited to the participant or beneficiary for whom the annuity contract was purchased.\n(d) Eligible Rollover Distributions\nEffective for distributions made on or after January 1, 1993, notwithstanding the optional forms of payment listed in Section 4.3(b), a distributee may elect, at the time and in the manner prescribed by the plan administrator, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover.\n(1) Eligible Rollover Distribution - An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee's designated beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Code Section 401(a)(9) and the portion of any distribution that is not includible in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities).\n(2) Eligible Retirement Plan - An eligible retirement plan is an individual retirement account described in Code Section 408(a), an individual retirement annuity described in Code Section 408(b), an annuity plan described in Code Section 403(a), or a qualified trust described in Code Section 401(a), that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity.\n(3) Distributee - A distributee includes an employee or former employee. In addition, the employee's or former employee's surviving spouse and the employee's or former employee's spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Code Section 414(p), are distributees with regard to the interest of the spouse or former spouse.\n(4) Direct Rollover - A direct rollover is a payment by the plan to the eligible retirement plan specified by the distributee.\nSection 4.4 In-Service Payments\n(a) Withdrawals - A participant may withdraw amounts from his account(s) before his separation from service only under the circumstances and only to the extent provided below.\nThe Joint and Survivor Requirements of Section 5.3 shall not apply to a withdrawal (except for the provisions of Section 5.3(c) and (f)) unless this plan is, with respect to the participant, a direct or indirect transferee of a defined benefit plan, money purchase pension plan (including a target benefit plan), or a stock bonus or profit sharing plan which would otherwise have provided for a qualified joint and survivor life annuity as the normal form of payment to the participant.\nHardship Withdrawals from Employee 401(k) Elective Deferral Account\n(1) Availability of Withdrawal Privilege - A participant who has a financial hardship may request a withdrawal from his employee 401(k) elective deferral account, subject to the consent of the plan administrator and subject to the limitations and conditions set forth herein.\n(2) Amount of Withdrawal - The amount which an eligible participant may withdraw from his account shall not exceed the cumulative amount of his 401(k) salary deferral contributions. Earnings thereon may not be withdrawn.\n(3) Request for Withdrawal - The participant's request to withdraw must be made in writing to the plan administrator and shall be subject to his consent. The basis for the plan administrator's consenting to or refusing to consent to the participant's request shall be demonstrated financial hardship of the participant.\nHardship Withdrawals\nFor the purpose of this Section 4.4, a distribution will be made on account of hardship if the distribution is necessary in light of immediate and heavy financial need of the participant. A distribution based upon financial hardship cannot exceed the amount required to meet the immediate financial need created by the hardship and not reasonably available from other resources of the participant. The determination of the existence of financial hardship and the amount required to be distributed to meet the need created by the hardship must be made in accordance with uniform and non-discriminatory standards established by the plan administrator under these plan provisions.\nAn immediate and heavy financial need may be determined to exist under certain facts and circumstances including the following: (1) expenses incurred or necessary for medical care described in Code Section 213(d) of the employee, the employee's spouse, children, or dependents; (2) the purchase (excluding mortgage payments) of a principal residence for the employee; (3) payment of tuition and related educational fees for the next twelve months of post-secondary education for the employee, the employee's spouse, children or dependents; or (4) the need to prevent the eviction of the employee from, or a foreclosure on the mortgage of, the employee's principal residence.\nA distribution will be considered as necessary to satisfy an immediate and heavy financial need of the employee only if:\n1. The employee has obtained all distributions, other than hardship distributions, and all nontaxable loans under all plans maintained by the employer;\n2. All plans maintained by the employer provide that the employee's elective deferrals (and employee nondeductible contributions) will be suspended for twelve months after the receipt of the hardship distribution;\n3. The distribution is not in excess of the amount of an immediate and heavy financial need (including amounts necessary to pay any federal, state or local income taxes or penalties reasonably anticipated to result from the distribution); and\n4. All plans maintained by the employer provide that the employee may not make elective deferrals for the employee's taxable year immediately following the taxable year of the hardship distribution in excess of the applicable limit under Code Section 402(g) for such taxable year less the amount of such employee's elective deferrals for the taxable year of the hardship distribution.\n(b) Participant Loans\nNo participant loans shall be permitted under this plan.\nSection 4.5 Distributions under Domestic Relations Orders\nNothing contained in this plan prevents the trustee, in accordance with the direction of the plan administrator, from complying with the provisions of a qualified domestic relations order (as defined in Code Section 414(p)).\nA distribution will not be made to an alternate payee until the participant attains (or would have attained) his earliest retirement age. For this purpose, earliest retirement age means the earlier of: (1) the date on which the participant is entitled to a distribution under this plan; or (2) the later of the date the participant attains age 50 or the earliest date on which the participant could begin receiving benefits under this plan if the participant separated from service.\nNothing in this Section gives a participant a right to receive distribution at a time otherwise not permitted under the plan nor does it permit the alternate payee to receive a form of payment not otherwise permitted under the plan.\nThe plan administrator shall establish reasonable procedures to determine the qualified status of a domestic relations order. Upon receiving a domestic relations order, the plan administrator promptly will notify the participant and any alternate payee named in the order, in writing, of the receipt of the order and the plan's procedures for determining the qualified status of the order. Within a reasonable period of time after receiving the domestic relations order, the plan administrator shall determine the qualified status of the order and shall notify the participant and each alternate payee, in writing, of its determination. The plan administrator shall provide notice under this paragraph by mailing to the individual's address specified in the domestic relations order, or in a manner consistent with Department of Labor regulations.\nIf any portion of the participant's nonforfeitable accrued benefit is payable during the period the plan administrator is making its determination of the qualified status of the domestic relations order, the plan administrator shall make a separate accounting of the amounts payable. If the plan administrator determines the order is a qualified domestic relations order within 18 months of the date amounts first are payable following receipt of the order, it shall direct the trustee to distribute the payable amounts in accordance with the order. If the plan administrator does not make its determination of the qualified status of the order within the 18-month determination period, it shall direct the trustee to distribute the payable amounts in the manner the plan would distribute if the order did not exist and will apply the order prospectively if it later determines the order is a qualified domestic relations order.\nTo the extent it is not inconsistent with the provisions of the qualified domestic relations order, the plan administrator may direct the trustee to invest any partitioned amount in a segregated subaccount or separate account and to invest the account in Federally insured, interest-bearing savings account(s) or time deposit(s) (or a combination of both), or in other fixed income investments. A segregated subaccount remains a part of the trust, but it alone shares in any income it earns, and it alone bears any expense or loss it incurs. The trustee will make any payments or distributions under this section by separate benefit checks or other separate distribution to the alternate payee(s).\nARTICLE V ADDITIONAL QUALIFICATION RULES\nSection 5.1 Limitations on Allocations under Code Section 415\n(a) Single Plan Limitations\n(1) If the participant does not participate in, and has never participated in another qualified plan maintained by the employer or a welfare benefit fund, as defined in Code Section 419(e) maintained by the employer, or an individual medical account, as defined in Code Section 415(1)(2), maintained by the employer, which provides an annual addition as defined in Section 5.1(d)(1), the amount of annual additions which may be credited to the participant's account for any limitation year will not exceed the lesser of the maximum permissible amount or any other limitation contained in this plan. If the employer contribution that would otherwise be contributed or allocated to the participant's account would cause the annual additions for the limitation year to exceed the maximum permissible amount, the amount contributed or allocated will be reduced so that the annual additions for the limitation year will equal the maximum permissible amount.\n(2) Prior to determining the participant's actual compensation for the limitation year, the employer may determine the maximum permissible amount for a participant on the basis of a reasonable estimation of the participant's compensation for the limitation year, uniformly determined for all participants similarly situated.\n(3) As soon as is administratively feasible after the end of the limitation year, the maximum permissible amount for the limitation year will be determined on the basis of the participant's actual compensation for the limitation year.\n(4) If pursuant to Section 5.1(a)(3) or as a result of either the allocation of forfeitures or a reasonable error in determining the amount of elective deferrals that may be made with respect to a participant, there is an excess amount, the excess will be disposed of as follows:\n(A) Any employee nondeductible contributions, to the extent they would reduce the excess amount, will be returned to the participant.\n(B) If after the application of paragraph (A) an excess amount still exists, any elective deferrals, to the extent they would reduce the excess amount, will be distributed to the participant.\n(C) If after the application of paragraph (B) an excess amount still exists, the excess amount shall be allocated and reallocated to the profit sharing account or qualified non-elective contribution account of the other participants in the plan to the extent permissible under the limitations of this Section 5.1.\n(D) If after the application of paragraph (C) an excess amount still exists, the excess amount will be held unallocated in a suspense account. The suspense account will be applied to reduce future employer contributions for all active participants in the next limitation year, and each succeeding limitation year if necessary.\n(E) If a suspense account is in existence at any time during a limitation year pursuant to this Section 5.1(a)(4), it will not participate in the allocation of the trust's investment gains and losses. If a suspense account is in existence at any time during a particular limitation year, all amounts in the suspense account must be allocated and reallocated to participants' accounts before any employer, elective deferral or employee nondeductible contributions may be made to the plan for that limitation year. Excess amounts may not be distributed to participants or former participants.\n(b) Combined Limitations - Other Defined Contribution Plan\n(1) This Subsection applies if, in addition to this plan, the participant is covered under another qualified defined contribution plan maintained by the employer, a welfare benefit fund, as defined in Code Section 419(e) maintained by the employer, or an individual medical account, as defined in Code Section 415(1)(2), maintained by the employer, which provides an annual addition as defined in Section 5.1(d)(1), during any limitation year. The annual additions which may be credited to a participant's account under this plan for any such limitation year will not exceed the maximum permissible amount reduced by the annual additions credited to a participant's account under the other plans and welfare benefit funds for the same limitation year. If the annual additions with respect to the participant under other defined contribution plans and welfare benefit funds maintained by the employer are less than the maximum permissible amount and the employer contribution that would otherwise be contributed or allocated to the participant's account under this plan would cause the annual additions for the limitation year to exceed this limitation, the amount contributed or allocated will be reduced so that the annual additions under all such plans and funds for the limitation year will equal the maximum permissible amount. If the annual additions with respect to the participant under such other defined contribution plans and welfare benefit funds in the aggregate are equal to or greater than the maximum permissible amount, no amount will be contributed or allocated to the participant's account under this plan for the limitation year.\n(2) Prior to determining the participant's actual compensation for the limitation year, the employer may determine the maximum permissible amount for a participant in the manner described in Section 5.1(a)(2).\n(3) As soon as is administratively feasible after the end of the limitation year, the maximum permissible amount for the limitation year will be determined on the basis of the participant's actual compensation for the limitation year.\n(4) If, pursuant to Section 5.1(b)(3) or as a result of the allocation of forfeitures, a participant's annual additions under this plan and such other plans would result in an excess amount for a limitation year, the excess amount will be deemed to consist of the annual additions last allocated, except that annual additions attributable to a welfare benefit fund or individual medical account will be deemed to have been allocated first regardless of the actual allocation date.\n(5) If an excess amount was allocated to a participant on an allocation date of this plan which coincides with an allocation date of another plan, the excess amount will be disposed of in the manner provided in Section 3.1(c).\n(6) Any excess amount attributed to this plan will be disposed of in the manner described in Section 5.1(a)(4).\n(c) Combined Limitations - Other Defined Benefit Plan\nIf the employer maintains, or at any time maintained, a qualified defined benefit plan covering any participant in this plan, the sum of the participant's defined benefit plan fraction and defined contribution plan fraction will not exceed 1.0 in any limitation year. Any excess amounts shall be disposed of in the manner provided in Section 3.1(c). Any excess amount attributed to this plan will be disposed of in the manner described in Section 5.1(a)(4).\n(d) Definitions (Code Section 415 Limitations)\n(1) Annual Additions - The sum of the following amounts credited to a participant's account for the limitation year:\n(A) employer contributions,\n(B) employee contributions,\n(C) forfeitures, and\n(D) amounts allocated, after March 31, 1984, to an individual medical account, as defined in Code Section 415(l)(2), which is part of a pension or annuity plan maintained by the employer are treated as annual additions to a defined contribution plan. Also amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date, which are attributable to post-retirement medical benefits, allocated to the separate account of a key employee, as defined in Code Section 419A(d)(3), under a welfare benefit fund, as defined in Code Section 419(e), maintained by the employer are treated as annual additions to a defined contribution plan.\nFor this purpose, any excess amount applied under Section 5.1(a)(4) or (b)(6) in the limitation year to increase the accounts of participants who did not have an excess amount or to reduce employer contributions will be considered annual additions for such limitation year.\n(2) Compensation - A participant's earned income and any earnings reportable as W-2 wages for Federal income tax withholding purposes as described in Section 1.2(a).\nFor limitation years beginning after December 31, 1991, for purposes of applying the limitations of this Section 5.1, compensation for a limitation year is the compensation actually paid or includible in gross income during such limitation year.\nNotwithstanding the preceding sentence, compensation for a participant in a defined contribution plan who is permanently and totally disabled (as defined in Code Section 22(e)(3)) is the compensation such participant would have received for the limitation year if the participant had been paid at the rate of compensation paid immediately before becoming permanently and totally disabled; such imputed compensation for the disabled participant may be taken into account only if the participant is not a highly compensated employee (as defined in Code Section 414(q)) and contributions made on behalf of such participant are nonforfeitable when made.\n(3) Defined Benefit Fraction - A fraction, the numerator of which is the sum of the participant's projected annual benefits under all the defined benefit plans (whether or not terminated) maintained by the employer, and the denominator of which is the lesser of 125 percent of the dollar limitation determined for the limitation year under Code Sections 415(b) and (d) or 140 percent of the highest average compensation, including any adjustments under Code Section 415(b).\nNotwithstanding the above, if the participant was a participant as of the first day of the first limitation year beginning after December 31, 1986, in one or more defined benefit plans maintained by the employer which were in existence on May 6, 1986, the denominator of this fraction will not be less than 125 percent of the sum of the annual benefits under such plans which the participant had accrued as of the close of the last limitation year beginning before January 1, 1987, disregarding any changes in the terms and conditions of the plan after May 5, 1986. The preceding sentence applies only if the defined benefit plans individually and in the aggregate satisfied the requirements of Code Section 415 for all limitation years beginning before January 1, 1987.\n(4) Defined Contribution Dollar Limitation - $30,000 or if greater, one-fourth of the defined benefit dollar limitation set forth in Code Section 415(b)(1) as in effect on January 1 of each calendar year with respect to the limitation year ending with or within such calendar year.\n(5) Defined Contribution Fraction - A fraction, the numerator of which is the sum of the annual additions to the participant's account under all the defined contribution plans (whether or not terminated) maintained by the employer for the current and all prior limitation years (including the annual additions attributable to the participant's nondeductible employee contributions to all defined benefit plans, whether or not terminated, maintained by the employer, and the annual additions attributable to all welfare benefit funds, as defined in Code Section 419(e), and individual medical accounts, as defined in Code Section 415(l)(2), maintained by the employer), and the denominator of which is the sum of the maximum aggregate amounts for the current and all prior limitation years of service with the employer (regardless of whether a defined contribution plan was maintained by the employer). The maximum aggregate amount in any limitation year is the lesser of 125 percent of the dollar limitation determined under Code Sections 415(b) and (d) in effect under Code Section 415(c)(1)(A) or 35 percent of the participant's compensation for such year.\nIf the employee was a participant as of the end of the first day of the first limitation year beginning after December 31, 1986, in one or more defined contribution plans maintained by the employer which were in existence on May 6, 1986, the numerator of this fraction will be adjusted if the sum of this fraction and the defined benefit fraction would otherwise exceed 1.0 under the terms of this plan. Under the adjustment, an amount equal to the product of (1) the excess of the sum of the fractions over 1.0 times (2) the denominator of this fraction, will be permanently subtracted from the numerator of this fraction. The adjustment is calculated using the fractions as they would be computed as of the end of the last limitation year beginning before January 1, 1987, and disregarding any changes in the terms and conditions of the plan made after May 5, 1986, but using the Code Section 415 limitation applicable to the first limitation year beginning on or after January 1, 1987.\nThe annual addition for any limitation year beginning before January 1, 1987, shall not be recomputed to treat all employee contributions as annual additions.\n(6) Employer - For purposes of this Section 5.1, employer shall mean the employer that adopts this plan, and all members of a controlled group of corporations (as defined in Code Section 414(b) as modified by Section 415(h)), all commonly controlled trades or businesses (as defined in Code Section 414(c) as modified by Section 415(h)) or affiliated service groups (as defined in Code Section 414(m)) of which the adopting employer is a part, and any other entity required to be aggregated with the employer pursuant to regulations under Code Section 414(o).\n(7) Excess Amount - The excess of the participant's annual additions for the limitation year over the maximum permissible amount.\n(8) Highest Average Compensation - The average compensation for the three consecutive years of service with the employer that produces the highest average. A year of service with the employer is the 12-consecutive month period coinciding with the plan year.\n(9) Limitation Year - A calendar year, or the 12-consecutive month period coinciding with the plan year, unless the employer adopts another 12-consecutive month period by means of a written resolution. All qualified plans maintained by the employer must use the same limitation year. If the limitation year is amended to a different 12-consecutive month period, the new limitation year must begin on a date within the limitation year in which the amendment is made.\n(10) Maximum Permissible Amount - The maximum annual addition that may be contributed or allocated to a participant's account under the plan for any limitation year shall not exceed the lesser of:\n(A) the defined contribution dollar limitation as defined in Subsection (d)(4); or\n(B) 25 percent of the participant's compensation for the limitation year.\nThe compensation limitation referred to in (B) shall not apply to any contribution for medical benefits (within the meaning of Code Section 401(h) or Code Section 419A(f)(2)) which is otherwise treated as an annual addition under Code Section 415(l)(1) or 419A(d)(2).\nIf a short limitation year is created because of an amendment changing the limitation year to a different 12-consecutive month period, the maximum permissible amount will not exceed the defined contribution dollar limitation multiplied by the following fraction:\nNumber of months in the short limitation year 12\n(11) Projected Annual Benefit - The annual retirement benefit (adjusted to an actuarially equivalent straight life annuity if such benefit is expressed in a form other than a straight life annuity or qualified joint and survivor annuity) to which the participant would be entitled under the terms of the plan assuming:\n(A) the participant will continue employment until normal retirement age under the plan (or current age, if later); and\n(B) the participant's compensation for the current limitation year and all other relevant factors used to determine benefits under the plan will remain constant for all future limitation years.\nSection 5.2 Control of Trades or Businesses by Owner-Employee\nIf this plan provides contributions or benefits for one or more owner-employees who control both the business for which this plan is established and one or more other trades or businesses, this plan and the plan established for other trades or businesses must, when looked at as a single plan, satisfy Code Sections 401(a) and (d) for the employees of this and all other trades or businesses.\nIf the plan provides contributions or benefits for one or more owner-employees who control one or more other trades or businesses, the employees of the other trades or businesses must be included in a plan which satisfies Code Sections 401(a) and (d) and which provides contributions and benefits not less favorable than those provided for owner-employees under this plan.\nIf an individual is covered as an owner-employee under the plans of two or more trades or businesses which are not controlled and the individual controls a trade or business, then the contributions or benefits of the employees under the plan of the trades or businesses which are controlled must be as favorable as those provided for him under the most favorable plan of the trade or business which is not controlled.\nFor purposes of the preceding paragraphs, an owner-employee, or two or more owner-employees, will be considered to control a trade or business if the owner-employee, or two or more owner-employees together:\n(1) own the entire interest in an unincorporated trade or business; or\n(2) in the case of a partnership, own more than 50 percent of either the capital interest or the profits interest in the partnership.\nFor purposes of the preceding sentence, an owner-employee, or two or more owner-employees shall be treated as owning any interest in a partnership which is owned, directly or indirectly, by a partnership which such owner-employee, or such two or more owner-employees, are considered to control within the meaning of the preceding sentence.\nSection 5.3 Joint and Survivor Annuity Requirements\nThe provisions of this Section 5.3 shall apply to any participant who is credited with at least one hour of service with the employer on or after August 23, 1984, and such other participants as provided in Paragraph (g). However, with respect to any participant meeting the conditions of Section 5.3(f), only Section 5.3(c) and (f) shall apply.\n(a) Qualified Joint and Survivor Annuity - Unless an optional form of benefit is selected pursuant to a qualified election within the 90-day period ending on the annuity starting date, a married participant's vested account balance will be paid in the form of a qualified joint and survivor annuity and an unmarried participant's vested account balance will be paid in the form of a life annuity with a ten year guaranteed period. The participant may elect to have such annuity distributed upon attainment of the earliest retirement age under the plan.\n(b) Qualified Preretirement Survivor Annuity - Unless an optional form of benefit has been selected within the election period pursuant to a qualified election, if a participant dies before the annuity starting date, the participant's vested account balance shall be applied toward the purchase of an annuity for the life of the surviving spouse. The surviving spouse may elect to have such annuity distributed within a reasonable period after the participant's death.\n(c) Restrictions on Immediate Distributions - If the value of a participant's vested account balance derived from employer and employee contributions exceeds (or at the time of any prior distribution exceeded) $3,500, and the account balance is immediately distributable, the participant and the participant's spouse (or where either the participant or the spouse has died, the survivor) must consent to any distribution of such account balance. The consent of the participant and the participant's spouse shall be obtained in writing within the 90-day period ending on the annuity starting date. The annuity starting date is the first day of the first period for which an amount is paid as an annuity or any other form. The plan administrator shall notify the participant and the participant's spouse of the right to defer any distribution until the participant's account balance is no longer immediately distributable. Such notification shall include a general description of the material features, and an explanation of the relative values of, the optional forms of benefit available under the plan in a manner that would satisfy the notice requirements of Code Section 417(a)(3), and shall be provided no less than 30 days and no more than 90 days prior to the annuity starting date.\nNotwithstanding the foregoing, only the participant need consent to the commencement of a distribution in the form of a qualified joint and survivor annuity while the account balance is immediately distributable. Furthermore, if payment in the form of a qualified joint and survivor annuity is not required with respect to the participant pursuant to Paragraph (f) of this Subsection 5.3, only the participant need consent to the distribution of an account balance that is immediately distributable. Neither the consent of the participant nor the participant's spouse shall be required to the extent that a distribution is required to satisfy Code Section 401(a)(9) or Section 415. In addition, upon termination of this plan if the plan does not offer an annuity option (purchased from a commercial provider) and if the employer or any entity within the same controlled group as the employer does not maintain another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)), the participant's account balance may, without the participant's consent, be distributed to the participant. However, if any entity within the same controlled group as the employer maintains another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)), the participant's account balance will be transferred, without the participant's consent, to the other plan if the participant does not consent to an immediate distribution.\nAn account balance is immediately distributable if any part of the account balance could be distributed to the participant (or surviving spouse) before the participant attains (or would have attained if not deceased) the later of normal retirement age or age 62.\n(d) Definitions (Code Section 417 Requirements)\n(1) Election Period - The period which begins on the first day of the plan year in which the participant attains age 35 and ends on the date of the participant's death. If a participant separates from service prior to the first day of the plan year in which age 35 is attained, with respect to the account balance as of the date of separation, the election period shall begin on the date of separation.\n(2) Pre-age 35 Waiver - A participant who will not yet attain age 35 as of the end of any current plan year may make a special qualified election to waive the qualified preretirement survivor annuity for the period beginning on the date of such election and ending on the first day of the plan year in which the participant will attain age 35. Such election shall not be valid unless the participant receives a written explanation of the qualified preretirement survivor annuity in such terms as are comparable to the explanation required under Paragraph (e)(1). Qualified preretirement survivor annuity coverage will be automatically reinstated as of the first day of the plan year in which the participant attains age 35. Any new waiver on or after such date shall be subject to the full requirements of this Subsection 5.3.\n(3) Earliest Retirement Age - The earliest date on which, under the plan, the participant could elect to receive retirement benefits.\n(4) Qualified Election - A waiver of a qualified joint and survivor annuity or a qualified preretirement survivor annuity. Any waiver of a qualified joint and survivor annuity or a qualified preretirement survivor annuity shall not be effective unless: (a) the participant's spouse consents in writing to the election; (b) the election designates a specific beneficiary, including any class of beneficiaries or any contingent beneficiaries, which may not be changed without spousal consent (or the spouse expressly permits designations by the participant without any further spousal consent); (c) the spouse's consent acknowledges the effect of the election; and (d) the spouse's consent is witnessed by a plan representative or notary public. Additionally, a participant's waiver of the qualified joint and survivor annuity shall not be effective unless the election designates a form of benefit payment which may not be changed without spousal consent (or the spouse expressly permits designations by the participant without any further spousal consent). If it is established to the satisfaction of a plan representative that there is no spouse or that the spouse cannot be located, a waiver will be deemed a qualified election.\nAny consent by a spouse obtained under this provision (or establishment that the consent of a spouse may not be obtained) shall be effective only with respect to such spouse. A consent that permits designations by the participant without any requirement of further consent by such spouse must acknowledge that the spouse has the right to limit consent to a specific beneficiary, and a specific form of benefit where applicable, and that the spouse voluntarily elects to relinquish either or both of such rights. A revocation of a prior waiver may be made by a participant without the consent of the spouse at any time before the commencement of benefits. The number of revocations shall not be limited. No consent obtained under this provision shall be valid unless the participant has received notice as provided in Paragraph (e).\n(5) Qualified Joint and Survivor Annuity - An immediate annuity for the life of the participant with a survivor annuity for the life of the spouse which is not less than 50 percent and not more than 100 percent of the amount of the annuity which is payable during the joint lives of the participant and the spouse and which is the amount of benefit which can be purchased with the participant's vested account balance. The percentage of the survivor annuity under the plan shall be 50% (unless a different percentage is elected by the participant).\n(6) Spouse (Surviving Spouse) - The spouse or surviving spouse of the participant, provided that a former spouse will be treated as the spouse or surviving spouse and a current spouse will not be treated as the spouse or surviving spouse to the extent provided under a qualified domestic relations order as described in Code Section 414(p).\n(7) Annuity Starting Date - The first day of the first period for which an amount is paid as an annuity or any other form.\n(8) Vested Account Balance - The aggregate value of the participant's vested account balances derived from employer and employee contributions (including rollovers), whether vested before or upon death, including the proceeds of insurance contracts, if any, on the participant's life. The provisions of this Subsection 5.3 shall apply to a participant who is vested in amounts attributable to employer contributions, employee contributions (or both) at the time of death or distribution.\n(e) Notice Requirements\n(1) In the case of a qualified joint and survivor annuity, the plan administrator shall no less than 30 days and no more than 90 days prior to the annuity starting date provide each participant a written explanation of: (i) the terms and conditions of a qualified joint and survivor annuity; (ii) the participant's right to make and the effect of an election to waive the qualified joint and survivor annuity form of benefit; (iii) the rights of a participant's spouse; and (iv) the right to make, and the effect of, a revocation of a previous election to waive the qualified joint and survivor annuity.\n(2) In the case of a qualified preretirement survivor annuity as described in Paragraph (b) of this Subsection, the plan administrator shall provide each participant within the applicable period for such participant a written explanation of the qualified preretirement survivor annuity in such terms and in such manner as would be comparable to the explanation provided for meeting the requirements of Paragraph (e)(1) applicable to a qualified joint and survivor annuity.\nThe applicable period for a participant is whichever of the following periods ends last: (i) the period beginning with the first day of the plan year in which the participant attains age 32 and ending with the close of the plan year preceding the plan year in which the participant attains age 35; (ii) a reasonable period ending after the individual becomes a participant; (iii) a reasonable period ending after Paragraph (e)(3) ceases to apply to the participant; (iv) a reasonable period ending after this Subsection 5.3 first applies to the participant. Notwithstanding the foregoing, notice must be provided within a reasonable period ending after separation from service in the case of a participant who separates from service before attaining age 35.\nFor purposes of applying the preceding paragraph, a reasonable period ending after the enumerated events described in (ii), (iii) and (iv) is the end of the two-year period beginning one year prior to the date the applicable event occurs, and ending one year after that date. In the case of a participant who separates from service before the plan year in which he attains age 35, notice shall be provided within the two-year period beginning one year prior to separation and ending one year after separation. If such a participant thereafter returns to employment with the employer, the applicable period for such participant shall be redetermined.\n(3) Notwithstanding the other requirements of this Paragraph (e), the respective notices prescribed by this Paragraph need not be given to a participant if (1) the plan \"fully subsidizes\" the costs of a qualified joint and survivor annuity or qualified preretirement survivor annuity, and (2) the plan does not allow the participant to waive the qualified joint and survivor annuity or qualified preretirement survivor annuity and does not allow a married participant to designate a nonspouse beneficiary. For purposes of this Subparagraph (e)(3), a plan fully subsidizes the costs of a benefit if no increase in cost, or decrease in benefits to the participant may result from the participant's failure to elect another benefit.\n(f) Safe Harbor Rules\nThis Paragraph (f) shall apply to a participant in a profit-sharing plan, and to any distribution, made on or after the first day of the first plan year beginning after December 31, 1988, from or under a separate account attributable solely to accumulated deductible employee contributions, as defined in Code Section 72(o)(5)(B), and maintained on behalf of a participant in a money purchase pension plan, (including a target benefit plan) if the following conditions are satisfied: (1) the participant does not or cannot elect payments in the form of a life annuity; and (2) on the death of a participant, the participant's vested account balance will be paid to the participant's surviving spouse, but if there is no surviving spouse, or if the surviving spouse has consented in a manner conforming to a qualified election, then to the participant's designated beneficiary. The surviving spouse may elect to have distribution of the vested account balance commence within the 90-day period following the date of the participant's death. The account balance shall be adjusted for gains or losses occurring after the participant's death in accordance with the provisions of the plan governing the adjustment of account balances for other types of distributions. This Paragraph (f) shall not be operative with respect to a participant in a profit-sharing plan if the plan is a direct or indirect transferee of a defined benefit plan, money purchase plan, a target benefit plan, stock bonus, or profit-sharing plan which is subject to the survivor annuity requirements of Code Section 401(a)(11) and section 417. If this Paragraph (f) is operative, then the provisions of this Subsection 5.3, other than Paragraphs (c) and (g) shall be inoperative.\n(1) The participant may waive the spousal death benefit described in this Paragraph (f) at any time provided that no such waiver shall be effective unless it satisfies the conditions of Paragraph (d)(4) (other than the notification requirement referred to therein) that would apply to the participant's waiver of the qualified preretirement survivor annuity.\n(2) For purposes of this Paragraph (f), vested account balance shall mean, in the case of a money purchase pension plan or a target benefit plan, the participant's separate account balance attributable solely to accumulated deductible employee contributions within the meaning of Code Section 72(o)(5)(B). In the case of a profit-sharing plan, vested account balance shall have the same meaning as provided in Paragraph (d)(8).\n(g) Transitional Rules\n(1) Any living participant not receiving benefits on August 23, 1984, who would otherwise not receive the benefits prescribed by the previous Paragraphs of this Subsection 5.3 must be given the opportunity to elect to have the prior Paragraphs of this Subsection apply if such participant is credited with at least one hour of service under this plan or a predecessor plan in a plan year beginning on or after January 1, 1976, and such participant had at least 10 years of vesting service when he or she separated from service.\n(2) Any living participant not receiving benefits on August 23, 1984, who was credited with at least one hour of service under this plan or a predecessor plan on or after September 2, 1974, and who is not otherwise credited with any service in a plan year beginning on or after January 1, 1976, must be given the opportunity to have his or her benefits paid in accordance with Subparagraph (4).\n(3) The respective opportunities to elect (as described in Subparagraphs (1) and (2)) must be afforded to the appropriate participants during the period commencing on August 23, 1984, and ending on the date benefits would otherwise commence to said participants.\n(4) Any participant who has elected pursuant to Subparagraph (2) and any participant who does not elect under Subparagraph (1) or who meets the requirements of Subparagraph (1) except that such participant does not have at least 10 years of vesting service when he or she separates from service, shall have his or her benefits distributed in accordance with all of the following requirements if benefits would have been payable in the form of a life annuity:\n(A) Automatic joint and survivor annuity - If benefits in the form of a life annuity become payable to a married participant who:\n(i) begins to receive payments under the plan on or after normal retirement age; or\n(ii) dies on or after normal retirement age while still working for the employer; or\n(iii) begins to receive payments on or after the qualified early retirement age; or\n(iv) separates from service on or after attaining normal retirement age (or the qualified early retirement age) and after satisfying the eligibility requirements for the payment of benefits under the plan and thereafter dies before beginning to receive such benefits;\nthen such benefits will be received under this plan in the form of a qualified joint and survivor annuity, unless the participant has elected otherwise during the election period. The election period must begin at least 6 months before the participant attains qualified early retirement age and end not more than 90 days before the commencement of benefits. Any election hereunder will be in writing and may be changed by the participant at any time.\n(B) Election of early survivor annuity - A participant who is employed after attaining the qualified early retirement age will be given the opportunity to elect, during the election period, to have a survivor annuity payable on death. If the participant elects the survivor annuity, payments under such annuity must not be less than the payments which would have been made to the spouse under the qualified joint and survivor annuity if the participant had retired on the day before his or her death. Any election under this provision will be in writing and may be changed by the participant at any time. The election period begins on the later of (1) the 90th day before the participant attains the qualified early retirement age, or (2) the date on which participation begins, and ends on the date the participant terminates employment.\n(C) For purposes of this Subparagraph (4), qualified early retirement age is the latest of:\n(i) the earliest date, under the plan, on which the participant may elect to receive retirement benefits;\n(ii) the first day of the 120th month beginning before the participant reaches normal retirement age; or\n(iii) the date the participant begins participation.\nFurther, for purposes of this Subparagraph (4), a qualified joint and survivor annuity is an annuity for the life of the participant with an survivor annuity for the life of the spouse as described in Paragraph (d)(5).\n(h) Loans\nIf required under Section 4.4(b)(1)(A) of the plan, a participant must obtain the consent of his spouse, if any, to use his account balances as security for a loan. Spousal consent shall be obtained no earlier than the beginning of the 90-day period that ends on the date on which the loan is to be so secured. The consent must be in writing, must acknowledge the effect of the loan, and must be witnessed by a plan representative or notary public. Such consent shall thereafter be binding with respect to the consenting spouse or any subsequent spouse with respect to that loan. A new consent shall be required if the account balances are used for renegotiation, extension, renewal, or other revision of the loan.\nOnce a valid spousal consent has been obtained in compliance with this provision, then, notwithstanding any other provision of this plan, the portion of the participant's vested account balances used as a security interest held by the plan by reason of a loan outstanding to the participant shall be taken into account for purposes of determining the amount of the account balances payable at the time of death or distribution, but only if the reduction is used as repayment of the loan. If less than 100% of the participant's vested account balances (determined without regard to the preceding sentence) is payable to the surviving spouse, then the account balances shall be adjusted by first reducing the vested account balances by the amount of the security used as repayment of the loan, and then determining the benefit payable to the surviving spouse.\nSection 5.4 Distribution Requirements\nSubject to Subsection 5.3 Joint and Survivor Annuity Requirements, the requirements of this Subsection 5.4 shall apply to any distribution of a participant's interest and will take precedence over any inconsistent provisions of this plan. Unless otherwise specified, the provisions of this Subsection apply to calendar years beginning after December 31, 1984.\nAll distributions required under this Subsection shall be determined and made in accordance with the proposed regulations under Code Section 401(a)(9), including the minimum distribution incidental benefit requirement of Section 1.401(a)(9)-2 of the Proposed Regulations.\n(a) Required Beginning Date - The entire interest of a participant must be distributed or begin to be distributed no later than the participant's required beginning date.\n(b) Limits on Distribution Periods - As of the first distribution calendar year, distributions, if not made in a single-sum, may only be made over one of the following periods (or a combination thereof):\n(1) the life of the participant;\n(2) the life of the participant and a designated beneficiary;\n(3) a period certain not extending beyond the life expectancy of the participant; or\n(4) a period certain not extending beyond the joint and last survivor expectancy of the participant and a designated beneficiary.\n(c) Determination of Amount to Be Distributed Each Year - If the participant's interest is to be distributed in other than a single sum, the following minimum distribution rules shall apply on or after the required beginning date.\n(1) Individual Account -\n(A) If a participant's benefit is to be distributed over (1) a period not extending beyond the life expectancy of the participant or the joint life and last survivor expectancy of the participant and the participant's designated beneficiary or (2) a period not extending beyond the life expectancy of the designated beneficiary, the amount required to be distributed for each calendar year, beginning with distributions for the first distribution calendar year, must at least equal the quotient obtained by dividing the participant's benefit by the applicable life expectancy.\n(B) For calendar years beginning before January 1, 1989, if the participant's spouse is not the designated beneficiary, the method of distribution selected must assure that at least 50% of the present value of the amount available for distribution is paid within the life expectancy of the participant.\n(C) For calendar years beginning after December 31, 1988, the amount to be distributed each year, beginning with distributions for the first distribution calendar year shall not be less than the quotient obtained by dividing the participant's benefit by the lesser of (1) the applicable life expectancy or (2) if the participant's spouse is not the designated beneficiary, the applicable divisor determined from the table set forth in Q&A-4 of Section 1.401(a)(9)-2 of the Proposed Regulations. Distributions after the death of the participant shall be distributed using the applicable life expectancy in Paragraph (c)(1)(A) above as the relevant divisor without regard to Proposed Regulations Section 1.401(a)(9)-2.\n(D) The minimum distribution required for the participant's first distribution calendar year must be made on or before the participant's required beginning date. The minimum distribution for other calendar years, including the minimum distribution for the distribution calendar year in which the employee's required beginning date occurs, must be made on or before December 31 of that distribution calendar year.\n(2) Other Forms - If the participant's benefit is distributed in the form of an annuity purchased from an insurance company, distributions thereunder shall be made in accordance with the requirements of Code Section 401(a)(9) and the proposed regulations thereunder.\n(d) Death Distribution Provisions\n(1) Distribution beginning before death - If the participant dies after distribution of his or her interest has begun, the remaining portion of such interest will continue to be distributed at least as rapidly as under the method of distribution being used prior to the participant's death.\n(2) Distribution beginning after death - If the participant dies before distribution of his or her interest begins, distribution of the participant's entire interest shall be completed by December 31 of the calendar year containing the fifth anniversary of the participant's death except to the extent that an election is made to receive distributions in accordance with (A) or (B) below:\n(A) If any portion of the participant's interest is payable to a designated beneficiary, distributions may be made over the life or over a period certain not greater than the life expectancy of the designated beneficiary commencing on or before December 31 of the calendar year immediately following the calendar year in which the participant died;\n(B) If the designated beneficiary is the participant's surviving spouse, the date distributions are required to begin in accordance with (A) above shall not be earlier than the later of (i) December 31 of the calendar year immediately following the calendar year in which the participant died and (ii) December 31 of the calendar year in which the participant would have attained age 70 1\/2.\nIf the participant has not made an election pursuant to this Paragraph (d)(2) by the time of his or her death, the participant's designated beneficiary must elect the method of distribution no later than the earlier of (1) December 31 of the calendar year in which distributions would be required to begin under this Paragraph, or (2) December 31 of the calendar year which contains the fifth anniversary of the date of death of the participant. If the participant has no designated beneficiary, or if the designated beneficiary does not elect a method of distribution, distribution of the participant's entire interest must be completed by December 31 of the calendar year containing the fifth anniversary of the participant's death.\n(3) For purposes of Paragraph (d)(2) above, if the surviving spouse dies after the participant, but before payments to such spouse begin, the provisions of Paragraph (d)(2) with the exception of paragraph (B) therein, shall be applied as if the surviving spouse were the participant.\n(4) For purposes of this Paragraph (d), any amount paid to a child of the participant will be treated as if it had been paid to the surviving spouse if the amount becomes payable to the surviving spouse when the child reaches the age of majority.\n(5) For the purposes of this Paragraph (d), distribution of a participant's interest is considered to begin on the participant's required beginning date (or, if Subparagraph (3) above is applicable, the date distribution is required to begin to the surviving spouse pursuant to Subparagraph (2) above). If distribution in the form of an annuity irrevocably commences to the participant before the required beginning date, the date distribution is considered to begin is the date distribution actually commences.\n(e) Definitions (Code Section 401(a)(9) Requirements)\n(1) Applicable Life Expectancy - The life expectancy (or joint and last survivor expectancy) calculated using the attained age of the participant (or designated beneficiary) as of the participant's (or designated beneficiary's) birthday in the applicable calendar year reduced by one for each calendar year which has elapsed since the date life expectancy was first calculated. If life expectancy is being recalculated, the applicable life expectancy shall be the life expectancy as so recalculated. The applicable calendar year shall be the first distribution calendar year, and if life expectancy is being recalculated such succeeding calendar year.\n(2) Designated Beneficiary - The individual who is designated as the beneficiary under the plan in accordance with Code Section 401(a)(9) and the proposed regulations thereunder.\n(3) Distribution Calendar Year - A calendar year for which a minimum distribution is required. For distributions beginning before the participant's death, the first distribution calendar year is the calendar year immediately preceding the calendar year which contains the participant's required beginning date. For distributions beginning after the participant's death, the first distribution calendar year is the calendar year in which distributions are required to begin pursuant to Paragraph (d) above.\n(4) Life Expectancy - Life expectancy and joint and last survivor expectancy are computed by use of the expected return multiples in Tables V and VI of Section 1.72-9 of the Income Tax Regulations.\nUnless otherwise elected by the participant (or spouse, in the case of distributions described in Paragraph (d)(2)(B) above) by the time distributions are required to begin, life expectancies shall be recalculated annually. Such election shall be irrevocable as to the participant (or spouse) and shall apply to all subsequent years. The life expectancy of a nonspouse beneficiary may not be recalculated.\n(5) Participant's Benefit -\n(A) The account balance as of the last valuation date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any contributions or forfeitures allocated to the account balance as of dates in the valuation calendar year after the valuation date and decreased by distributions made in the valuation calendar year after the valuation date.\n(B) Exception for second distribution calendar year. For purposes of Subparagraph (5)(A) above, if any portion of the minimum distribution for the first distribution calendar year is made in the second distribution calendar year on or before the required beginning date, the amount of the minimum distribution made in the second distribution calendar year shall be treated as if it had been made in the immediately preceding distribution calendar year.\n(6) Required Beginning Date - The required beginning date of a participant is the first day of April of the calendar year following the calendar year in which the participant attains age 70 1\/2.\n(A) The required beginning date of a participant who attains age 70 1\/2 before January 1, 1988, shall be determined in accordance with (i) or (ii) below.\n(i) Non-5-percent owners. The required beginning date of a participant who is not a 5-percent owner is the first day of April of the calendar year following the calendar year in which the later of retirement or attainment of age 70 1\/2 occurs.\n(ii) 5-percent owners. The required beginning date of a participant who is a 5-percent owner during any year beginning after December 31, 1979, is the first day of April following the later of :\na. the calendar year in which the participant attains age 70 1\/2; or\nb. the earlier of the calendar year with or within which ends the plan year in which the participant becomes a 5-percent owner, or the calendar year in which the participant retires.\nThe required beginning date of a participant who is not a 5-percent owner who attains age 70 1\/2 during 1988 and who has not retired as of January 1, 1989, is April 1, 1990.\n(B) 5-percent owner. A participant is treated as a 5-percent owner for purposes of this Paragraph (e) if such participant is a 5-percent owner as defined in Code Section 416(i) (determined in accordance with Section 416 but without regard to whether the plan is top-heavy) at any time during the plan year ending with or within the calendar year in which such owner attains age 66 1\/2 or any subsequent plan year.\n(C) Once distributions have begun to a 5-percent owner under this Paragraph, they must continue to be distributed, even if the participant ceases to be a 5-percent owner in a subsequent year.\n(f) Transitional Rule\n(1) Notwithstanding the other requirements of this Section 5.4 and subject to the requirements of Section 5.3, Joint and Survivor Annuity Requirements, distribution on behalf of any employee, including a 5-percent owner, may be made in accordance with all of the following requirements (regardless of when such distribution commences).\n(A) The distribution by the trust is one which would not have disqualified such trust under Code Section 401(a)(9) as in effect prior to amendment by the Deficit Reduction Act of 1984.\n(B) The distribution is in accordance with a method of distribution designated by the employee whose interest in the trust is being distributed or, if the employee is deceased, by a beneficiary of such employee.\n(C) Such designation was in writing, was signed by the employee or the beneficiary, and was made before January 1, 1984.\n(D) The employee had accrued a benefit under the plan as of December 31, 1983.\n(E) The method of distribution designated by the employee or the beneficiary specifies the time at which distribution will commence, the period over which distributions will be made, and in the case of any distribution upon the employee's death, the beneficiaries of the employee listed in order of priority.\nA distribution upon death will not be covered by this transitional rule unless the information in the designation contains the required information described above with respect to the distributions to be made upon the death of the employee.\n(2) For any distribution which commences before January 1, 1984, but continues after December 31, 1983, the employee, or the beneficiary, to whom such distribution is being made, will be presumed to have designated the method of distribution under which the distribution is being made if the method of distribution was specified in writing and the distribution satisfies the requirements in this Paragraph.\n(3) If a designation is revoked any subsequent distribution must satisfy the requirements of Code Section 401(a)(9) and the proposed regulations thereunder. If a designation is revoked subsequent to the date distributions are required to begin, the trust must distribute by the end of the calendar year following the calendar year in which the revocation occurs the total amount not yet distributed which would have been required to have been distributed to satisfy Code Section 401(a)(9) and the proposed regulations thereunder, but for the Code Section 242(b)(2) election. For calendar years beginning after December 31, 1988, such distributions must meet the minimum distribution incidental benefit requirements in Section 1.401(a)(9)-2 of the Proposed Regulations. Any changes in the designation will be considered to be a revocation of the designation. However, the mere substitution or addition of another beneficiary (one not named in the designation) under the designation will not be considered to be a revocation of the designation, so long as such substitution or addition does not alter the period over which distributions are to be made under the designation, directly or indirectly (for example, by altering the relevant measuring life). In the case in which an amount is transferred or rolled over from one plan to another plan, the rules in Proposed Regulation Section 1.401(a)(9)-1 Q&A J-2 and Q&A J-3 shall apply.\nSection 5.5 Top Heavy Provisions\n(a) Application of Provisions - If the plan is or becomes top-heavy in any plan year beginning after December 31, 1983, the provisions of Subsection 5.5 will supersede any conflicting provisions in the plan.\n(b) Minimum Allocation\n(1) Except as otherwise provided in (3) and (4) below, the employer contributions and forfeitures allocated on behalf of any participant who is not a key employee shall not be less than the lesser of three percent of such participant's compensation or in the case where the employer has no defined benefit plan which designates this plan to satisfy Code Section 401, the largest percentage of employer contributions and forfeitures, as a percentage of the first $200,000 of the key employee's compensation, allocated on behalf of any key employee for that year. For this purpose, amounts contributed to the key employee's employee 401(k) elective deferral account shall be included as allocations on his behalf for that year. This minimum allocation shall be made even though, under other plan provisions, the participant would not otherwise be entitled to receive an allocation, or would have received a lesser allocation for the year because of (i) the participant's failure to complete 1,000 hours of service (or any equivalent provided in the plan), or (ii) the participant's failure to make mandatory employee contributions to the plan, or (iii) compensation less than a stated amount.\n(2) For purposes of computing the minimum allocation, compensation shall mean compensation as defined in Section 1.2(a) of the plan.\n(3) The provision in (1) above shall not apply to any participant who was not employed by the employer on the last day of the plan year.\n(4) The provision in (1) above shall not apply to any participant to the extent the participant is covered under any other plan or plans of the employer and the employer has provided in Section 3.2 or 3.3 that the minimum allocation or benefit requirement applicable to top-heavy plans will be met in the other plan or plans. If this plan is intended to meet the minimum allocation or benefit requirement applicable to another plan or plans, the employer shall so provide in Section 3.2 or 3.3, as appropriate.\n(5) The minimum allocation required (to the extent required to be nonforfeitable under Code Section 416(b)) may not be forfeited under Code Section 411(a)(3)(B) or 411(a)(3)(D).\n(c) Adjustments in Code Section 415 Limits - If the plan is top-heavy, the defined benefit fraction and the defined contribution fraction shall be computed by applying a factor of 1.0 (instead of 1.25) to the applicable dollar limits under Code Section 415(b)(1)(A) and 415(c)(1)(A) for such year, unless the plan meets both the following conditions:\n(1) Such plan would not be a top-heavy plan if [90%] were substituted for [60%] in the top-heavy tests; and\n(2) The minimum employer contribution percentage under paragraph (b) is 4 percent instead of 3 percent.\nHowever, the reduced Code Section 415 factor of 1.0 shall not apply under a top-heavy plan with respect to any individual so long as there are no employer contributions, forfeitures, or voluntary employee non-deductible contributions allocated to such individual.\n(d) Minimum Vesting Schedules - For any plan year in which this plan is top-heavy, the following minimum vesting schedule shall automatically apply to the plan, if this schedule is more liberal than the schedule(s) provided in Section 4.2(a)(6).\nYears of Service Vesting Percentage\n0-1 Year 0% 2 20% 3 40% 4 60% 5 80% 6 or More Years 100%\nThe minimum vesting schedule shall apply to all benefits within the meaning of Code Section 411(a)(7) except those attributable to employee contributions, including benefits accrued before the effective date of Code Section 416 and benefits accrued before the plan became top-heavy. Further, no decrease in a participant's nonforfeitable percentage may occur in the event the plan's status as top-heavy changes for any plan year, and the provisions of Section 7.2(d) shall apply. However, this Section does not apply to the account balances of any employee who does not have an hour of service after the plan has initially become top-heavy and such employee's account balance attributable to employer contributions and forfeitures will be determined without regard to this Section.\n(e) Definitions (Code Section 416 Requirements)\n(1) Key Employee - Any employee or former employee (and the beneficiaries of such employee) who at any time during the determination period was an officer of the employer if such individual's annual compensation exceeds 50 percent of the dollar limitation under Code Section 415(b)(1)(A), an owner (or considered an owner under Code Section 318) of one of the ten largest interests in the employer if such individual's compensation exceeds 100 percent of the dollar limitation under Code Section 415(c)(1)(A), a 5-percent owner of the employer, or a 1-percent owner of the employer who has an annual compensation of more than $150,000. Annual compensation means compensation as defined in Code Section 415(c)(3), but including amounts contributed by the employer pursuant to a salary reduction agreement which are excludable from the employee's gross income under Code Section 125, Section 402(a)(8), Section 402(h) or Section 403(b). The determination period is the plan year containing the determination date and the four (4) preceding plan years.\nThe determination of who is a key employee will be made in accordance with Code Section 416(i)(1) and the regulations thereunder.\n(2) Top-Heavy Plan - For any plan year beginning after December 31, 1983, this plan is top-heavy if any of the following conditions exists:\n(A) If the top-heavy ratio for this plan exceeds 60 percent and this plan is not part of any required aggregation group or permissive aggregation group of plans.\n(B) If this plan is a part of a required aggregation group of plans but not part of a permissive aggregation group and the top-heavy ratio for the group of plans exceeds 60 percent.\n(C) If this plan is a part of a required aggregation group and part of a permissive aggregation group of plans and the top-heavy ratio for the permissive aggregation group exceeds 60 percent.\n(3) Top-Heavy Ratio -\n(A) If the employer maintains one or more defined contribution plans (including any Simplified Employee Pension Plan) and the employer has not maintained any defined benefit plan which during the 5-year period ending on the determination date(s) has or has had accrued benefits, the top-heavy ratio for this plan alone or for the required or permissive aggregation group as appropriate is a fraction, the numerator of which is the sum of the account balances of all key employees as of the determination date(s) (including any part of any account balance distributed in the 5-year period ending on the determination date(s)), and the denominator of which is the sum of all account balances (including any part of any account balance distributed in the 5-year period ending on the determination date(s)), both computed in accordance with Code Section 416 and the regulations thereunder. Both the numerator and denominator of the top-heavy ratio are increased to reflect any contribution not actually made as of the determination date, but which is required to be taken into account on that date under Code Section 416 and the regulations thereunder.\n(B) If the employer maintains one or more defined contribution plans (including any Simplified Employee Pension Plan) and the employer maintains or has maintained one or more defined benefit plans which during the 5-year period ending on the determination date(s) has or has had any accrued benefits, the top-heavy ratio for any required or permissive aggregation group as appropriate is a fraction, the numerator of which is the sum of account balances under the aggregated defined contribution plan or plans for all key employees, determined in accordance with (A) above, and the present value of accrued benefits under the aggregated defined benefit plan or plans for all key employees as of the determination date(s), and the denominator of which is the sum of the account balances under the aggregated defined contribution plan or plans for all participants, determined in accordance with (A) above, and the present value of accrued benefits under the defined benefit plan or plans for all participants as of the determination date(s), all determined in accordance with Code Section 416 and the regulations thereunder. The accrued benefits under a defined benefit plan in both the numerator and denominator of the top-heavy ratio are increased for any distribution of an accrued benefit made in the five-year period ending on the determination date.\n(C) For purposes of (A) and (B) above the value of account balances and the present value of accrued benefits will be determined as of the most recent valuation date that falls within or ends with the 12-month period ending on the determination date, except as provided in Code Section 416 and the regulations thereunder for the first and second plan years of a defined benefit plan. The account balances and accrued benefits of a participant (1) who is not a key employee but who was a key employee in a prior year, or (2) who has not been credited with at least one hour of service with any employer maintaining the plan at any time during the 5-year period ending on the determination date will be disregarded. The calculation of the top-heavy ratio, and the extent to which distributions, rollovers, and transfers are taken into account will be made in accordance with Code Section 416 and the regulations thereunder. Deductible employee contributions will not be taken into account for purposes of computing the top-heavy ratio. When aggregating plans the value of account balances and accrued benefits will be calculated with reference to the determination dates that fall within the same calendar year.\nThe accrued benefit of a participant other than a key employee shall be determined under (1) the method, if any, that uniformly applies for accrual purposes under all defined benefit plans maintained by the employer, or (2) if there is no such method, as if such benefit accrued not more rapidly than the slowest accrual rate permitted under the fractional rule of Code Section 411(b)(1)(C).\n(4) Permissive Aggregation Group - The required aggregation group of plans plus any other plan or plans of the employer which, when considered as a group with the required aggregation group, would continue to satisfy the requirements of Code Sections 401(a)(4) and 410.\n(5) Required Aggregation Group - (1) Each qualified plan of the employer in which at least one key employee participates or participated at any time during the determination period (regardless of whether the plan has terminated), and (2) any other qualified plan of the employer which enables a plan described in (1) to meet the requirements of Code Sections 401(a)(4) or 410.\n(6) Determination Date - For any plan year subsequent to the first plan year, the last day of the preceding plan year. For the first plan year of the plan, the last day of that year.\n(7) Valuation Date - The last day of the plan year shall be the date as of which account balances or accrued benefits are valued for purposes of calculating the top-heavy ratio.\n(8) Present Value - Present value shall be based only on the interest and mortality rates specified in the employer's defined benefit plan.\n(9) Non-Key Employee - Any employee who is not a key employee. Non-key employees include employees who are former key employees.\nSection 5.6 Limitations and Conditions Regarding Contributions under Code Sections 402(g), 401(k) and 401(m)\n(a) (1) Limit Maximum Amount of Elective Deferrals under Code Section 402(g)\nNo participant shall be permitted to have elective deferrals made under this plan, or any other qualified plan maintained by the employer, during any taxable year, in excess of the dollar limitation contained in Code Section 402(g) in effect at the beginning of such taxable year.\n(2) Distribution of Excess Elective Deferrals\nA participant may assign to this plan any excess elective deferrals made during a taxable year of the participant by following the claim procedure set forth in Subsection (a)(3). Also, the employer may notify this plan on behalf of a participant who has excess deferrals for the taxable year calculated by taking into account only elective deferrals under the plans maintained by the employer.\nNotwithstanding any other provision of the plan, excess elective deferrals, plus any income and minus any loss allocable thereto, shall be distributed no later than April 15 to any participant to whose account excess elective deferrals were assigned for the preceding year and for whom excess elective deferrals have been claimed for such taxable year.\n(3) Claims\nThe participant's claim shall be in writing; shall be submitted to the plan administrator no later than March 1; shall specify the participant's excess deferral amount for the preceding calendar year; and shall be accompanied by the participant's written statement that if such amounts are not distributed, such excess deferral amount, when added to amounts deferred under other plans or arrangements described in Code Sections 401(k), 408(k), 457, or 403(b), exceeds the limit imposed on the participant by Code Section 402(g) for the year in which the deferral occurred.\n(4) Definitions (Code Section 402(g) Limitations)\n(A) Elective Deferrals shall mean any employer contributions made to the plan at the election of the participant, in lieu of cash compensation, and shall include contributions made pursuant to a salary reduction agreement or other deferral mechanism. With respect to any taxable year, a participant's elective deferral is the sum of all employer contributions made on behalf of such participant pursuant to an election to defer under any qualified cash or deferred arrangement as described in Code Section 401(k), any simplified employee pension cash or deferred arrangement as described in Section 402(h)(1)(B), any eligible deferred compensation plan under Section 457, any plan as described under Section 501(c)(18), and any employer contributions made on the behalf of a participant for the purchase of an annuity contract under Section 403(b) pursuant to a salary reduction agreement. Elective deferrals shall not include any deferrals properly distributed as excess annual additions.\n(B) Excess Elective Deferrals shall mean those elective deferrals that are includible in a participant's gross income under Code Section 402(g) to the extent such participant's elective deferrals for a taxable year exceed the dollar limitation under such Code Section. Excess elective deferrals shall be treated as annual additions under the plan, unless such amounts are distributed no later than the first April 15 following the close of the participant's taxable year.\n(5) Determination Of Income Or Loss\nExcess elective deferrals shall be adjusted for any income or loss for the participant's taxable year. The income or loss allocable to excess elective deferrals is the income or loss allocable to the participant's employee 401(k) elective deferral account for the taxable year multiplied by a fraction, the numerator of which is such participant's excess elective deferrals for the year and the denominator is the participant's account balance attributable to elective deferrals without regard to any income or loss occurring during such taxable year.\n(b) (1) Actual Deferral Percentage Test\nThe actual deferral percentage (hereinafter \"ADP\") for participants who are highly compensated employees for each plan year and the ADP for participants who are non-highly compensated employees for the same plan year must satisfy one of the following tests: 1) The ADP for participants who are highly compensated employees for the plan year shall not exceed the ADP for participants who are non-highly compensated employees for the same plan year multiplied by 1.25; or 2) The ADP for participants who are highly compensated employees for the plan year shall not exceed the ADP for participants who are non-highly compensated employees for the same plan year multiplied by 2.0, provided that the ADP for participants who are highly compensated employees does not exceed the ADP for participants who are non-highly compensated employees by more than two (2) percentage points.\n(A) Special Rules Applying to ADP Test\n(i) The ADP for any participant who is a highly compensated employee for the plan year and who is eligible to have elective deferrals (and qualified non-elective contributions or qualified matching contributions, or both, to the extent treated as elective deferrals for purposes of the ADP test) allocated to his or her accounts under two or more arrangements described in Code Section 401(k), that are maintained by the employer, shall be determined as if such elective deferrals (and, to the extent taken into account, such qualified non-elective contributions or qualified matching contributions, or both) were made under a single arrangement. If a highly compensated employee participates in two or more cash or deferred arrangements that have different plan years, all cash or deferred arrangements ending with or within the same calendar year shall be treated as a single arrangement. Notwithstanding the foregoing, certain plans shall be treated as separate if mandatorily disaggregated under regulations under Code Section 401(k).\n(ii) In the event that this plan satisfies the requirements of Code Sections 401(k), 401(a)(4), or 410(b) only if aggregated with one or more other plans, or if one or more other plans satisfy the requirements of such sections only if aggregated with this plan, then this Section 5.6(b)(1) shall be applied by determining the ADP of employees as if all such plans were a single plan. For plan years beginning after December 31, 1989, plans may be aggregated in order to satisfy Code Section 401(k) only if they have the same plan year.\n(iii) For purposes of determining the ADP of a participant who is a 5-percent owner or one of the ten most highly-paid highly compensated employees, the elective deferrals (and qualified non-elective contributions or qualified matching contributions, or both, to the extent treated as elective deferrals for purposes of the ADP test) and compensation of such participant shall include the elective deferrals (and, to the extent taken into account, qualified non-elective contributions and qualified matching contributions, or both) and compensation for the plan year of family members (as defined in Code Section 414(q)(6)). Family members, with respect to such highly compensated employees, shall be disregarded as separate employees in determining the ADP both for participants who are non-highly compensated employees and for participants who are highly compensated employees.\n(iv) For purposes of determining the ADP test, elective deferrals, qualified non-elective contributions and qualified matching contributions must be made before the last day of the twelve-month period immediately following the plan year to which contributions relate. An elective deferral shall be taken into account only if it relates to compensation that either (a) would have been received by the participant in the plan year but for the deferral election, or (b) is attributable to services performed by the participant in the plan year and would have been received by the participant within 2 1\/2 months after the last day of the plan year but for the deferral election.\n(v) The plan administrator shall maintain records sufficient to demonstrate satisfaction of the ADP test and the amount of qualified non-elective contributions or qualified matching contributions, or both, used in such test.\n(vi) Qualified non-elective contributions may be taken into account as elective deferrals only to the extent needed to meet the ADP test. Qualified matching contributions may be taken into account only to the extent such contributions are not needed to meet the average contribution percentage test unless it is the intention of the plan administrator to test all qualified non-elective and matching contributions under the ADP test.\n(vii) The determination and treatment of the ADP amounts of any participant shall satisfy such other requirements as may be prescribed by the Secretary of the Treasury.\n(B) Actual Deferral Percentage shall mean, for a specified group of participants for a plan year, the average of the ratios (calculated separately for each participant in such group) of (1) the amount of employer contributions actually paid over to the trust on behalf of such participant for the plan year to (2) the participant's compensation as defined in Section 1.2(e). Employer contributions on behalf of any participant shall include: (1) any elective deferrals made pursuant to the participant's deferral election, including excess elective deferrals of highly compensated employees, but excluding (a) excess elective deferrals of nonhighly compensated employees that arise solely from elective deferrals made under the plan or plans of this employer and (b) elective deferrals that are taken into account in the average contribution percentage test (provided the ADP test is satisfied both with and without exclusion of these elective deferrals); and (2) at the election of the employer, qualified non-elective contributions and qualified matching contributions. For purposes of computing actual deferral percentages, an employee who would be a participant but for the failure to make elective deferrals shall be treated as a participant on whose behalf no elective deferrals are made. Amounts distributed under Section 5.1(a)(4)(B) shall not be included in the calculation.\n(2) Distribution Of Excess Contributions\nNotwithstanding any other provision of this plan, excess contributions, plus any income and minus any loss allocable thereto, shall be distributed no later than the last day of each plan year to participants to whose accounts such excess contributions were allocated for the preceding plan year. If such excess amounts are distributed more than 2 1\/2 months after the last day of the plan year in which such excess amounts arose, a ten (10) percent excise tax will be imposed on the employer maintaining the plan with respect to such amounts. Such distributions shall be made to highly compensated employees on the basis of the respective portions of the excess contributions attributable to each of such employees. Excess contributions of participants who are subject to the family member aggregation rules shall be allocated among the family members in proportion to the elective deferrals (and amounts treated as elective deferrals) of each family member that is combined to determine the combined ADP.\nExcess contributions (including the amounts recharacterized) shall be treated as annual additions under the plan.\n(A) Determination of Income or Loss - Excess contributions shall be adjusted for any income or loss for the plan year. The income or loss allocable to excess contributions is the income or loss allocable to the participant's employee 401(k) elective deferral account (and, if applicable, the qualified non-elective contribution account or the qualified employer matching contribution account or both) for the plan year multiplied by a fraction, the numerator of which is such participant's excess contributions for the year and the denominator is the participant's account balance(s) attributable to elective deferrals (and qualified non-elective contributions or qualified matching contributions, or both, if any of such contributions are included in the ADP test) without regard to any income or loss occurring during such plan year.\n(B) Accounting for Excess Contributions - Excess contributions shall be distributed from the participant's employee 401(k) elective deferral account and qualified employer matching contribution account (if applicable) in proportion to the participant's elective deferrals and qualified matching contributions (to the extent used in the ADP test) for the plan year. Excess contributions shall be distributed from the participant's qualified non-elective contribution account only to the extent that such excess contributions exceed the balance in the participant's employee 401(k) elective deferral account and employer matching contribution account.\n(C) Excess Contributions shall mean, with respect to any plan year, the excess of: 1) The aggregate amount of employer contributions actually taken into account in computing the ADP of highly compensated employees for such plan year, over 2) The maximum amount of such contributions permitted by the ADP test (determined by reducing contributions made on behalf of highly compensated employees in order of the ADPs, beginning with the highest of such percentages).\nSuch determination shall be made after first determining excess elective deferrals pursuant to Section 5.6(a).\n(3) Recharacterization\nA participant may treat his or her excess contributions as an amount distributed to the participant and then contributed by the participant to the plan as an employee nondeductible contribution. Recharacterized amounts will remain nonforfeitable and subject to the same distribution requirements as elective deferrals. Therefore, such recharacterized amounts shall be held in a recharacterized funds account which shall be invested and otherwise accounted for in the same manner as an employee 401(k) elective deferral account but which shall be subject to the ADP test. Amounts may not be recharacterized by a highly compensated employee to the extent that such amount in combination with other employee nondeductible contributions made by that employee would exceed any stated limit under the plan on employee nondeductible contributions.\nRecharacterization must occur no later than two and one-half months after the last day of the plan year in which such excess contributions arose and is deemed to occur no earlier than the date the last highly compensated employee is informed in writing of the amount recharacterized and the consequences thereof. Recharacterized amounts will be taxable to the participant for the participant's tax year in which the participant would have received them in cash under a cash or deferred arrangement.\n(c) (1) Limitations on Employee Contributions and Matching Contributions Under Code Section 401(m)\nThe average contribution percentage (hereinafter \"ACP\") for participants who are highly compensated employees for each plan year and the ACP for participants who are non-highly compensated employees for the same plan year must satisfy one of the following tests: 1) The ACP for participants who are highly compensated employees for the plan year shall not exceed the ACP for participants who are non-highly compensated employees for the same plan year multiplied by 1.25; or 2) The ACP for participants who are highly compensated employees for the plan year shall not exceed the ACP for participants who are non-highly compensated employees for the same plan year multiplied by two (2), provided that the ACP for participants who are highly compensated employees does not exceed the ACP for participants who are non-highly compensated employees by more than two (2) percentage points.\n(A) Special Rules For Limitations Under Code Section 401(m)\n(i) Multiple Use: If one or more highly compensated employees are subject to both the ADP test and the ACP test and the sum of the ADP and ACP of those highly compensated employees subject to either or both tests exceeds the aggregate limit, then either the ADP or the ACP of those highly compensated employees who are subject to both tests will be reduced (beginning with such highly compensated employee whose percentage is the highest) so that the limit is not exceeded. The plan administrator shall determine whether the ADP or the ACP for the plan will be reduced for the plan year. The amount by which each highly compensated employee's percentage is reduced shall be treated as either an excess contribution or an excess aggregate contribution, as appropriate. The ADP and ACP of the highly compensated employees are determined after any corrections required to meet the ADP and ACP tests. Multiple use does not occur if both the ADP and ACP of the highly compensated employees does not exceed 1.25 multiplied by the ADP and ACP of the non-highly compensated employees.\n(ii) For purposes of this Section 5.6(c)(1), the contribution percentage for any participant who is a highly compensated employee and who is eligible to have contribution percentage amounts allocated to his or her account under two or more plans described in Code Section 401(a), or arrangements described in Code Section 401(k) that are maintained by the employer, shall be determined as if the total of such contribution percentage amounts were made under each plan. If a highly compensated employee participates in two or more cash or deferred arrangements that have different plan years, all cash or deferred arrangements ending with or within the same calendar year shall be treated as a single arrangement. Notwithstanding the foregoing, certain plans shall be treated as separate if mandatorily disaggregated under regulations under Code Section 401(m).\n(iii) In the event that this plan satisfies the requirements of Code Sections 401(m), 401(a)(4) or 410(b) only if aggregated with one or more other plans, or if one or more other plans satisfy the requirements of such sections only if aggregated with this plan, then this Section 5.6(c)(1) shall be applied by determining the contribution percentage of employees as if all such plans were a single plan. For plan years beginning after December 31, 1989, plans may be aggregated in order to satisfy Code Section 401(m) only if they have the same plan year.\n(iv) For purposes of determining the contribution percentage of a participant who is a five-percent owner or one of the ten most highly-paid highly compensated employees, the contribution percentage amounts and compensation of such participant shall include the contribution percentage amounts and compensation for the plan year of family members (as defined in Code Section 414(q)(6)). Family members, with respect to highly compensated employees, shall be disregarded as separate employees in determining the contribution percentage both for participants who are non-highly compensated employees and for participants who are highly compensated employees.\n(v) For purposes of determining the contribution percentage test, employee contributions are considered to have been made in the plan year in which contributed to the trust. Matching contributions and qualified non-elective contributions will be considered made for a plan year if made no later than the end of the twelve-month period beginning on the day after the close of the plan year.\n(vi) The plan administrator shall maintain records sufficient to demonstrate satisfaction of the ACP test and the amount of qualified non-elective contributions or qualified matching contributions, or both, used in such test.\n(vii) Employee 401(k) elective deferral contributions may be taken into account; however, the ADP test shall be met before any elective deferrals are used in the ACP test and the elective deferrals needed to meet the ADP test shall not be used to meet the ACP test. Qualified non-elective contributions shall be taken into account to the extent such contributions are not used to meet the ADP test.\n(viii) The determination and treatment of the contribution percentage of any participant shall satisfy such other requirements as may be prescribed by the Secretary of the Treasury.\n(B) Definitions: (Code Section 401(m) Limitations)\n(i) Aggregate Limit shall mean the sum of (i) 125 percent of the greater of the ADP of the non-highly compensated employees for the plan year or the ACP of non-highly compensated employees under the plan subject to Code Section 401(m) for the plan year beginning with or within the plan year of the 401(k) plan and (ii) the lesser of 200% or two plus the lesser of such ADP or ACP. \"Lesser\" is substituted for \"greater\" in (i) above, and \"greater\" is substituted for \"lesser\" after \"two plus the\" in (ii) if it would result in a larger aggregate limit.\n(ii) Average Contribution Percentage shall mean the average of the contribution percentages of the eligible participants in a group.\n(iii) Contribution Percentage shall mean the ratio (expressed as a percentage) of the participant's contribution percentage amounts to the participant's compensation as defined in Section 1.2(e).\n(iv) Contribution Percentage Amounts shall mean the sum of the employee nondeductible contributions, employer matching contributions and employee 401(k) elective deferrals (to the extent not taken into account for purposes of the ADP test) made under the plan on behalf of the participant for the plan year. Such contribution percentage amounts shall not include matching contributions that are forfeited either to correct excess aggregate contributions or because the contributions to which they relate are excess deferrals, excess contributions, or excess aggregate contributions. Qualified non-elective contributions may be included in the contribution percentage amounts. Employee 401(k) elective deferrals may also be used in calculating the contribution percentage amounts so long as the ADP test is met before the elective deferrals are used in the ACP test and the ADP test continues to be met following the exclusion of those elective deferrals that are used to meet the ACP test. Amounts distributed under Section 5.1(a)(4)(A) and (B) shall not be included in the calculation.\n(v) Eligible Participant shall mean any employee who is eligible to make an employee nondeductible contribution, or an elective deferral (if the employer takes such contributions into account in the calculation of the contribution percentage), or to receive an employer matching contribution (including forfeitures). If an employee nondeductible contribution is required as a condition of participation in the plan, any employee who would be a participant in the plan if such employee made such a contribution shall be treated as an eligible participant on behalf of whom no employee contributions are made.\n(vi) Employee Nondeductible Contribution (or employee contribution) shall mean any contribution made under Section 3.5 to the plan by or on behalf of a participant that is included in the participant's gross income in the year in which made and that is maintained under a separate account to which earnings and losses are allocated.\n(vii) Matching Contribution shall mean an employer contribution made to this or any other defined contribution plan on behalf of a participant on account of an employee nondeductible contribution made by such participant, or on account of a participant's elective deferral, under a plan maintained by the employer.\n(2) Distribution of Excess Aggregate Contributions\nNotwithstanding any other provision of this plan, excess aggregate contributions, plus any income and minus any loss allocable thereto, shall be forfeited, if forfeitable, or if not forfeitable, distributed no later than the last day of each plan year to participants to whose accounts such excess aggregate contributions were allocated for the preceding plan year. Excess aggregate contributions of participants who are subject to the family member aggregation rules shall be allocated among the family members in proportion to the employee nondeductible contributions and matching contributions (or amounts treated as matching contributions) of each family member that is combined to determine the combined ACP. If such excess aggregate contributions are distributed more than 2 1\/2 months after the last day of the plan year in which such excess amounts arose, a ten (10) percent excise tax will be imposed on the employer maintaining the plan with respect to those amounts. Excess aggregate contributions shall be treated as annual additions under the plan.\n(A) Determination of Income or Loss - Excess aggregate contributions shall be adjusted for any income or loss for the plan year. The income or loss allocable to excess aggregate contributions is the income or loss allocable to the participant's employee nondeductible contribution account, employer matching contribution account (if any, and if all amounts therein are not used in the ADP test) and, if applicable, qualified non-elective contribution account and employee 401(k) elective deferral account for the plan year multiplied by a fraction, the numerator of which is such participant's excess aggregate contributions for the year and the denominator is the participant's account balance(s) attributable to contribution percentage amounts without regard to any income or loss occurring during such plan year.\n(B) Forfeitures of Excess Aggregate Contributions - Forfeitures of excess aggregate matching contributions may either be reallocated to the accounts of non-highly compensated employees or applied to reduce employer contributions, as provided in Section 3.6(e).\n(C) Accounting for Excess Aggregate Contributions - Excess aggregate contributions shall be forfeited, if forfeitable or distributed on a pro-rata basis from the participant's employee nondeductible contribution account and employer matching contribution account (and, if applicable, the participant's qualified non-elective contribution account or employee 401(k) elective deferral account, or both).\n(D) Excess Aggregate Contributions shall mean, with respect to any plan year, the excess of: 1) The aggregate contribution percentage amounts taken into account in computing the numerator of the contribution percentage actually made on behalf of highly compensated employees for such plan year, over 2) The maximum contribution percentage amounts permitted by the ACP test (determined by reducing contributions made on behalf of highly compensated employees in order of their contribution percentages beginning with the highest of such percentages).\nSuch determination shall be made after first determining excess elective deferrals pursuant to Section 5.6(a) and then determining excess contributions pursuant to Section 5.6(b)(2).\n(d) Top-Heavy Requirements\nNeither elective deferrals nor any matching contributions will be taken into account for the purpose of satisfying the minimum top-heavy contribution requirement. However, qualified non-elective contributions may be taken into account for this purpose as provided in Section 3.2(c)(2) or 3.3(b)(2), as appropriate.\n(e) Restrictions on Payment of Certain Accounts\nElective deferrals, qualified non-elective contributions, and qualified matching contributions, and income allocable to each are not distributable to a participant or his beneficiary in accordance with such person's election, earlier than upon separation from service, death, or disability.\nSuch account balances may also be distributed upon:\n(A) Termination of the plan without the establishment of another defined contribution plan, other than an employee stock ownership plan (as defined in Code Section 4975(e) or 409) or a simplified employee pension plan (as defined in Code Section 408(k)).\n(B) The disposition by a corporation to an unrelated corporation of substantially all of the assets (within the meaning of Code Section 409(d)(2)) used in a trade or business of such corporation if such corporation continues to maintain this plan after the disposition, but only with respect to employees who continue employment with the corporation acquiring such assets.\n(C) The disposition by a corporation to an unrelated entity of such corporation's interest in a subsidiary (within the meaning of Code Section 409(d)(3)) if such corporation continues to maintain this plan, but only with respect to employees who continue employment with such subsidiary.\n(D) The attainment of age 59 1\/2.\n(E) The hardship of the participant as described in Section 4.4(a).\nAll distributions that may be made pursuant to one or more of the foregoing distributable events are subject to the spousal and participant consent requirements as described in Section 5.3(c). In addition, distributions after March 31, 1988, that are triggered by any of the first three events enumerated above must be made in a lump sum.\nSection 5.7 Deductible Voluntary Employee Contributions\nThe plan administrator will not accept deductible employee contributions which are made for a taxable year beginning after December 31, 1986. Contributions made prior to that date will be maintained in a separate account which will be nonforfeitable at all times. The account will share in the gains and losses of the trust in the same manner as described in Section 3.8 of the plan. No part of the deductible voluntary contribution account will be used to purchase life insurance. Subject to Section 5.3, Joint and Survivor Requirements (if applicable), the participant may withdraw any part of the deductible voluntary contribution account by making a written application to the plan administrator.\nARTICLE VI ADMINISTRATION OF THE PLAN\nSection 6.1 Fiduciary Responsibility\n(a) Fiduciary Standards - A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and -\nFor the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan;\nWith the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;\nBy diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and\nIn accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of ERISA.\n(b) Allocation of Fiduciary Responsibility\n(1) It is intended to allocate to each fiduciary, either named or otherwise, the individual responsibility for the prudent execution of the functions assigned to him. None of the allocated responsibilities or any other responsibilities shall be shared by two or more fiduciaries unless specifically provided for in the plan.\n(2) When one fiduciary is required to follow the directions of another fiduciary, the two fiduciaries shall not be deemed to share such responsibility. Instead, the responsibility of the fiduciary giving the directions shall be deemed to be his sole responsibility and the responsibility of the fiduciary receiving directions shall be to follow those directions insofar as such instructions on their face are proper under applicable law.\n(3) Any person or group of persons may serve in more than one fiduciary capacity with respect to this plan.\n(4) A fiduciary under this plan may employ one or more persons, including independent accountants, attorneys and actuaries to render advice with regard to any responsibility such fiduciary has under the plan.\n(c) Indemnification by Employer - Unless resulting from the gross negligence, willful misconduct or lack of good faith on the part of a fiduciary who is an officer or employee of the employer, the employer shall indemnify and save harmless such fiduciary from, against, for and in respect of any and all damages, losses, obligations, liabilities, liens, deficiencies, costs and expenses, including without limitation, reasonable attorney's fees and other costs and expenses incident to any suit, action, investigation, claim or proceedings suffered in connection with his acting as a fiduciary under the plan.\n(d) Named Fiduciary - The person or persons named by the employer as having fiduciary responsibility for the management and control of plan assets shall be known as the \"named fiduciary\" hereunder. Such responsibility shall include the appointment of the plan administrator (Section 6.2(a)), the trustee (Section 6.4(a)) and the investment manager (Section 6.4(b)), and the deciding of benefit appeals (Section 6.3).\nSection 6.2 Plan Administrator\n(a) Appointment of Plan Administrator\nThe named fiduciary shall appoint a plan administrator who may be an individual or an administrative committee consisting of no more than five members. Vacancies occurring upon resignation or removal of a plan administrator or a committee member shall be filled promptly by the named fiduciary. Any administrator may resign at any time by giving notice of his resignation to the named fiduciary, and any administrator may be removed at any time by the named fiduciary. The named fiduciary shall review at regular intervals the performance of the administrator(s) and shall re-evaluate the appointment of such administrator(s). After the named fiduciary has appointed the administrator and has received a written notice of acceptance, the fiduciary responsibility for administration of the plan shall be the responsibility of the plan administrator or administrative committee.\n(b) Duties and Powers of Plan Administrator\nThe plan administrator shall have the following duties and discretionary powers and such other duties and discretionary powers as relate to the administration of the plan:\n(1) To determine in a non-discriminatory manner all questions relating to the eligibility of employees to become participants.\n(2) To determine in a non-discriminatory manner eligibility for benefits and to determine and certify the amount and kind of benefits payable to participants.\n(3) To authorize all disbursements from the fund.\n(4) To appoint or employ any independent person to perform necessary plan functions and to assist in the fulfillment of administrative responsibilities as he deems advisable, including legal and actuarial counsel.\n(5) When appropriate, to select an insurance company and annuity contracts which, in his opinion, will best carry out the purposes of the plan.\n(6) To construe and interpret the plan and to make, publish, interpret, alter, amend or revoke rules for the regulation of the plan which are consistent with the terms of the plan and with ERISA.\n(7) To prepare and distribute, in such manner as determined to be appropriate, information explaining the plan.\n(c) Allocation of Fiduciary Responsibility Within Administrative Committee\nIf the plan administrator is an administrative committee, the committee shall choose from its members a chairman and a secretary. The committee may allocate responsibility for those duties and powers listed in Section 6.2(b)(1) and (2) (except determination of qualification for disability retirement) and other purely ministerial duties to one or more members of the committee. The committee shall review at regular intervals the performance of any committee member to whom fiduciary responsibility has been allocated and shall re-evaluate such allocation of responsibility. After the committee has made such allocations of responsibilities and has received written notice of acceptance, the fiduciary responsibilities for such administrative duties and powers shall then be considered as the responsibilities of such committee member(s).\n(d) Miscellaneous Provisions\n(1) Administrative Committee Actions - The actions of such committee shall be determined by the vote or other affirmative expression of a majority of its members. Either the chairman or the secretary may execute any certificate or other written direction on behalf of the committee. A member of the committee who is a participant shall not vote on any question relating specifically to himself. If the remaining members of the committee, by majority vote thereof, are unable to come to a determination of any such question, the named fiduciary shall appoint a substitute member who shall act as a member of the committee for the special vote.\n(2) Expenses - The plan administrator shall serve without compensation for service as such. All reasonable expenses of the plan administrator shall be paid by the employer or from the fund.\n(3) Examination of Records - The plan administrator shall make available to any participant for examination during business hours such of the plan records as pertain only to the participant involved.\n(4) Information to the Plan Administrator - To enable the plan administrator to perform the administrative functions, the employer shall supply full and timely information to the plan administrator on all participants as the plan administrator may require.\nSection 6.3 Claims Procedure\n(a) Notification - The plan administrator shall notify each participant in writing of his determination of benefits. If the plan administrator denies any benefit, such written denial shall include:\n- The specific reasons for denial; - Reference to provisions on which the denial is based; - A description of and reason for any additional information needed to process the claim; and - An explanation of the claims procedure.\n(b) Appeal - The participant or his duly authorized representative may:\n- Request a review of the participant's case in writing to the named fiduciary; - Review pertinent documents; - Submit issues and comments in writing.\nThe written request for review must be submitted no later than 60 days after receiving written notification of denial of benefits.\n(c) Review - The named fiduciary must render a decision no later than 60 days after receiving the written request for review, unless circumstances make it impossible to do so; but in no event shall the decision be rendered later than 120 days after the request for review is received.\nSection 6.4 Trust Fund\n(a) Appointment of Trustee\nThe named fiduciary shall appoint a trustee for the proper care and custody of all funds, securities and other properties in the trust, and for investment of plan assets (or for execution of such orders as it receives from an investment manager appointed for investment of plan assets). The duties and powers of the trustee shall be set forth in a trust agreement executed by the employer, which is incorporated herein by reference. The named fiduciary shall review at regular intervals the performance of the trustee and shall re-evaluate the appointment of such trustee. After the named fiduciary has appointed the trustee and has received a written notice of acceptance of its responsibility, the fiduciary responsibility with respect to the proper care and custody of plan assets shall be considered as the responsibility of the trustee. Unless otherwise allocated to an investment manager, the fiduciary responsibility with respect to investment of plan assets shall likewise be considered as the responsibility of the trustee.\n(b) Appointment of Investment Manager\nThe named fiduciary may appoint an investment manager who is other than the trustee, which investment manager may be a bank or an investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. Such investment manager, if appointed, shall have sole discretion in the investment of plan assets, subject to the funding policy. The named fiduciary shall review at regular intervals no less frequently than annually, the performance of such investment manager and shall re-evaluate the appointment of such investment manager. After the named fiduciary has appointed an investment manager and has received a written notice of acceptance of its responsibility, the fiduciary responsibility with respect to investment of plan assets shall be considered as the responsibility of the investment manager.\n(c) Funding Policy\nThe named fiduciary shall determine and communicate in writing to the fiduciary responsible for investment of plan assets the funding policy for the plan. The funding policy shall set forth the plan's short-range and long-range financial needs, so that said fiduciary may coordinate the investment of plan assets with the plan's financial needs.\n(d) Valuation of the Fund\nThe fund shall be valued by the trustee on the first day of each plan year and as of any interim allocation date determined by the plan administrator. The valuation shall be made on the basis of the current fair market value of all property in the fund.\nARTICLE VII AMENDMENT AND TERMINATION OF PLAN\nSection 7.1 Right to Discontinue and Amend\nIt is the expectation of the employer that it will continue this plan indefinitely and make the payments of its contributions hereunder, but the continuance of the plan is not assumed as a contractual obligation of the employer and the right is reserved by the employer, at any time, to reduce, suspend or discontinue its contributions hereunder.\nSection 7.2 Amendments\nExcept as herein limited, the employer shall have the right to amend this plan at any time to any extent that it may deem advisable. Such amendment shall be stated in writing and executed by the employer.\nThe employer's right to amend the plan shall be limited as follows:\n(a) No amendment shall increase the duties or liabilities of the plan administrator, the trustee, or other fiduciary without their respective written consent.\n(b) No amendments shall have the effect of vesting in the employer any interest in or control over any contracts issued pursuant hereto or any other property in the fund.\n(c) No amendment to the plan shall be effective to the extent that it has the effect of decreasing a participant's accrued benefit. Notwithstanding the preceding sentence, a participant's account balance may be reduced to the extent permitted under Code Section 412(c)(8). For purposes of this paragraph, a plan amendment which has the effect of decreasing a participant's account balance or eliminating an optional form of benefit, with respect to benefits attributable to service before the amendment shall be treated as reducing an accrued benefit. Furthermore, if the vesting schedule of a plan is amended, in the case of an employee who is a participant as of the later of the date such amendment is adopted or the date it becomes effective, the nonforfeitable percentage (determined as of such date) of such employee's right to his employer-derived accrued benefit will not be less than his percentage computed under the plan without regard to such amendment.\n(d) No amendment to the vesting schedule adopted by the employer hereunder shall deprive a participant of his vested portion of his employer contribution accounts to the date of such amendment. If the plan's vesting schedule is amended, or the plan is amended in any way that directly or indirectly affects the computation of the participant's nonforfeitable percentage or if the plan is deemed amended by an automatic change to or from a top-heavy vesting schedule, each participant with at least 3 years of service with the employer may elect, within a reasonable period after the adoption of the amendment or change, to have the nonforfeitable percentage computed under the plan without regard to such amendment or change. For participants who do not have at least one hour of service in any plan year beginning after December 31, 1988, [5 years of service] shall be substituted for [3 years of service] in the preceding sentence. The period during which the election may be made shall commence with the date the amendment is adopted or deemed to be made and shall end on the latest of:\n(1) 60 days after the amendment is adopted;\n(2) 60 days after the amendment becomes effective; or\n(3) 60 days after the participant is issued written notice of the amendment by the employer or plan administrator.\nSection 7.3 Protection of Benefits in Case of Plan Merger\nIn the event of a merger or consolidation with, or transfer of assets to any other plan, each participant will receive a benefit immediately after such merger, consolidation or transfer (if the plan then terminated) which is at least equal to the benefit the participant was entitled to immediately before such merger, consolidation or transfer (if the plan had terminated).\nSection 7.4 Termination of Plan\n(a) When Plan Terminates - This plan shall terminate upon the happening of any of the following events: legal adjudication of the employer as bankrupt; a general assignment by the employer to or for the benefit of its creditors; the legal dissolution of the employer; or termination of the plan by the employer.\n(b) Allocation of Assets - Upon termination, partial termination or complete discontinuance of employer contributions, the account balance(s) of each affected participant who is an active participant or who is not an active participant but has neither received a complete distribution of his vested accrued benefit nor incurred five one-year breaks in service shall be 100% vested and nonforfeitable. The amount of the fund assets shall be allocated to each participant, subject to provisions for expenses of administration of the liquidation, in the ratio that such participant's account(s) bears to all accounts. If a participant under this plan has terminated his employment at any time after the first day of the plan year in which the employer made his final contribution to the plan, and if any portion of any account of such terminated participant was forfeited and reallocated to the remaining participants, such forfeiture shall be reversed and the forfeited amount shall be credited to the account of such terminated participant.\nARTICLE VIII MISCELLANEOUS PROVISIONS\nSection 8.1 Exclusive Benefit - Non-Reversion\nThe plan is created for the exclusive benefit of the employees of the employer and shall be interpreted in a manner consistent with its being a qualified plan as defined in Section 401(a) of the Internal Revenue Code and with ERISA. The corpus or income of the trust may not be diverted to or used for other than the exclusive benefit of the participants or their beneficiaries (except for defraying reasonable expenses of administering the plan).\nNotwithstanding the above, a contribution paid by the employer to the trust may be repaid to the employer under the following circumstances:\n(a) Any contribution made by the employer because of a mistake of fact must be returned to the employer within one year of the contribution.\n(b) In the event the deduction of a contribution made by the employer is disallowed under Code Section 404, such contribution (to the extent disallowed) must be returned to the employer within one year of the disallowance of the deduction.\n(c) If the Commissioner of Internal Revenue determines that the plan is not initially qualified under the Internal Revenue Code, any contribution made incident to that initial qualification by the employer must be returned to the employer within one year after the date the initial qualification is denied, but only if the application for the qualification is made by the time prescribed by law for filing the employer's return for the taxable year in which the plan is adopted, or such later date as the Secretary of the Treasury may prescribe.\nSection 8.2 Inalienability of Benefits\nNo benefit or interest available hereunder including any annuity contract distributed herefrom shall be subject to assignment or alienation, either voluntarily or involuntarily. The preceding sentence shall also apply to the creation, assignment, or recognition of a right to any benefit payable with respect to a participant pursuant to a domestic relations order, unless such order is determined to be a qualified domestic relations order as defined in Code Section 414(p), or any domestic relations order entered before January 1, 1985. A loan made to a participant and secured by his nonforfeitable account balance(s) under Section 4.4(b) will not be treated as an assignment or alienation and such securing account balance(s) shall be subject to attachment by the plan in the event of default.\nSection 8.3 Employer-Employee Relationship\nThis plan is not to be construed as creating or changing any contract of employment between the employer and its employees, and the employer retains the right to deal with its employees in the same manner as though this plan had not been created.\nSection 8.4 Binding Agreement\nThis plan shall be binding on the heirs, executors, administrators, successors and assigns as such terms may be applicable to any or all parties hereto, and on any participants, present or future.\nSection 8.5 Separability\nIf any provision of this plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision hereof and this plan shall be construed and enforced as if such provision had not been included.\nSection 8.6 Construction\nThe plan shall be construed in accordance with the laws of the state in which the employer was incorporated (or is domiciled in the case of an unincorporated employer) and with ERISA.\nSection 8.7 Copies of Plan\nThis plan may be executed in any number of counterparts, each of which shall be deemed as an original, and said counterparts shall constitute but one and the same instrument which may be sufficiently evidenced by any one counterpart.\nSection 8.8 Interpretation\nWherever appropriate, words used in this plan in the singular may include the plural or the plural may be read as singular, and the masculine may include the feminine.\nIN WITNESS WHEREOF, the Employer has caused this Plan to be executed this day of , 19 .\nEMPLOYER: Horrigan American, Inc.\nBy: Title:\nEXHIBIT 10.15\nPHANTOM STOCK PLAN OF\nHORRIGAN AMERICAN, INC.\nAND AFFILIATED COMPANIES\nPHANTOM STOCK PLAN OF HORRIGAN AMERICAN, INC. AND AFFILIATED COMPANIES\n1. Purpose of Plan . . . . . . . . . . . . . . . . . . . . . . . . . 1\n2. General Provisions. . . . . . . . . . . . . . . . . . . . . . . . 1\n3. Defined Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 1\n4. Administration. . . . . . . . . . . . . . . . . . . . . . . . . . 4\n5. Phantom Stock Unit Ledger . . . . . . . . . . . . . . . . . . . . 5\n6. Aggregate Number of Phantom Stock Units . . . . . . . . . . . . . 5\n7. Credits to Participant's Accounts . . . . . . . . . . . . . . . . 5\n8. Vesting of Credits. . . . . . . . . . . . . . . . . . . . . . . . 6\n9. Severance of Employment . . . . . . . . . . . . . . . . . . . . . 7\n10. Termination of Plan . . . . . . . . . . . . . . . . . . . . . . . 8\n11. Payment of Benefits . . . . . . . . . . . . . . . . . . . . . . . 9\n12. Designation of Beneficiary. . . . . . . . . . . . . . . . . . . . 10\n13. Independence. . . . . . . . . . . . . . . . . . . . . . . . . . . 10\n14. Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10\n15. Conditions Precedent. . . . . . . . . . . . . . . . . . . . . . . 11\n16. Limitation of Rights. . . . . . . . . . . . . . . . . . . . . . . 11\n17. Adjustment in Number of Phantom Stock Units . . . . . . . . . . . 12\n18. Non-alienation of Benefits. . . . . . . . . . . . . . . . . . . . 12\n19. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . 12\n20. Amendment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12\n21. Effective Date. . . . . . . . . . . . . . . . . . . . . . . . . . 13\n22. Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13\n23. Captions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13\n24. Severability. . . . . . . . . . . . . . . . . . . . . . . . . . . 13\n25. Tax Consequences. . . . . . . . . . . . . . . . . . . . . . . . . 13\n26. Arbitration . . . . . . . . . . . . . . . . . . . . . . . . . . . 13\n27. Applicable Law. . . . . . . . . . . . . . . . . . . . . . . . . . 13\nPHANTOM STOCK PLAN OF HORRIGAN AMERICAN, INC. AND AFFILIATED COMPANIES\nHORRIGAN AMERICAN, INC., AEL LEASING CO., INC., AMERICAN COMMERCIAL CREDIT CORP. and AMERICAN REAL ESTATE INVESTMENT AND DEVELOPMENT CO. hereby adopt a plan, to be known as the \"Phantom Stock Plan of Horrigan American, Inc. and Affiliated Companies\", a deferred compensation program to be administered and governed by and in accordance with the following terms and provisions:\n1. Purpose of Plan. The purpose of this Plan is to enable the Companies to attract and retain key Officers of outstanding competence, to promote the shareholder point of view among key Officers and to provide an incentive to, and a reward for, key Officers of the Companies by granting to such key Officers certain deferred compensation rights pursuant to the terms and provisions hereof. Neither the adoption of this Plan nor any of the terms or provisions hereof shall be construed as entitling any Officer to any employment rights arising hereunder or to any of the rights of a stockholder in any of the Companies, it being the intention hereof only to adopt a plan of incentive deferred compensation and to measure such compensation as herein set forth, but in no respect to alter the relationship between any Officer and any of the Companies except as specifically set forth herein.\n2. General Provisions. Unless the context of this Plan clearly requires otherwise:\n(a) All accounting terms used in this Plan which are not specifically defined in this Plan shall have the meanings assigned to them in accordance with generally accepted accounting principles and practices.\n(b) The word \"including\" shall be a word of enlargement rather than a word of limitation and shall be deemed to mean \"including but not limited to\" rather than \"including only\".\n3. Defined Terms. Unless the context clearly requires otherwise, the following words and phrases whenever used in the singular or the plural form and capitalized shall have the following meanings for the purposes of this Plan:\n(a) \"Account\" shall mean the account of the Participant contained in the Phantom Stock Unit Ledger.\n(b) \"Acknowledgment\" shall mean the document, in form satisfactory to the Administrative Committee, referred to in Paragraph 15(a) hereof pursuant to which each Participant shall acknowledge and confirm to the Administrative Committee the Participant's willingness to participate in and to be bound by the Plan.\n(c) \"Administrative Committee\" shall mean the committee established by the Board of Directors of Horrigan American, Inc. pursuant to Paragraph 4(a) hereof.\n(d) \"Affiliated Companies\" shall mean AEL Leasing Co., Inc. and American Commercial Credit Corp., corporations the capital stock of which is wholly owned by American Equipment Leasing Co., Inc., the capital stock of which is wholly owned by Horrigan American, Inc., and American Real Estate Investment and Development Co., a corporation the capital stock of which is wholly owned by Horrigan American, Inc.\n(e) \"Bankruptcy Code\" shall mean the federal Bankruptcy Code, as amended and supplemented from time to time, and any statutory successor thereto.\n(f) \"Beneficiary\" shall mean the Person referred to in Paragraph 12 hereof designated by the Participant to receive payments in the event of the Participant's death.\n(g) \"Board of Directors\" shall mean the duly elected directors of the applicable Company.\n(h) \"Cause\" shall mean and be the failure or refusal of the Participant to perform his or her duties and obligations to any Company, the occurrence of any breach or default by the Participant under any agreement between any Company and the Participant, including any employment agreement, the failure of the Participant to conform to the highest ethical standards in representing any Company, or the commission by the Participant of any criminal act or criminal misconduct, regardless of whether such act or misconduct is prosecuted by applicable law enforcement authorities.\n(i) \"Common Stock\" shall mean shares of common stock of Horrigan American, Inc.\n(j) \"Company\" shall mean Horrigan American, Inc. or any of the Affiliated Companies and any successor to any of the foregoing by merger, consolidation, liquidation, division or other reorganization which has made provision for adoption of this Plan and the assumption of the obligations of Horrigan American, Inc. or any of the Affiliated Companies, as applicable.\n(k) \"Companies\" shall mean Horrigan American, Inc. and the Affiliated Companies and any successor to any of the foregoing by merger, consolidation, liquidation, division or other reorganization which has made provision for adoption of this Plan and the assumption of the obligations of Horrigan American, Inc. or any of the Affiliated Companies, as applicable.\n(l) \"Credit\" shall mean any credit expressed in dollars and cents which is recorded in the Phantom Stock Unit Ledger in accordance with the provisions of Section 7(a) or 7(b).\n(m) \"Customer\" shall mean any Person, including but not limited to any dealer, manufacturer, vendor, borrower or lessee, who deals with or does business with any Company or any direct or indirect subsidiary of any Company in such Company's normal course of business.\n(n) \"Effective Date\" shall mean the date selected by the Board of Directors of each of the Companies on which the Plan shall become effective.\n(o) \"ESOP\" shall mean the Employee Stock Option Plan of Horrigan American, Inc. adopted by the Board of Directors thereof effective as of January 1, 1984, as amended from time to time.\n(p) \"Excess Dividend\" shall mean an amount equal to the excess, if any, by which the aggregate dividend paid by Horrigan American, Inc., in the then current fiscal year of Horrigan American, Inc., exceeds twenty percent (20%) of the consolidated net earnings of Horrigan American, Inc. for the immediately preceding fiscal year of Horrigan American, Inc. divided by the number of issued and outstanding shares of Common Stock with respect to which such aggregate dividend is issued.\n(q) \"Excess Value\" shall mean the difference in the fair market value of a share of Common Stock as of the date when a Participant is awarded Phantom Stock Units by the Administrative Committee under this Plan and the fair market value of a share of Common Stock as of the Participant's Termination Date. Fair market value with respect to a share of Common Stock as contemplated herein shall be determined by independent appraisal in conjunction with the ESOP as more fully set forth in Section 7(c) hereof.\n(r) \"Officer\" shall mean any officer of any Company (whether or not he or she is also a director thereof) who is employed by such Company on a full-time basis and who, in the sole opinion of the Administrative Committee, is one of the key personnel of such Company in a position to contribute materially to its continued growth and development and to its future financial success. The term shall not include Persons who are retained by any Company as consultants only.\n(s) \"Participant\" shall mean an Officer who is selected by the Administrative Committee for participation in this Plan and who is awarded Phantom Stock Units hereunder.\n(t) \"Person\" shall mean any individual, corporation, partnership, joint venture, trust, unincorporated organization, joint stock company or other entity or organization.\n(u) \"Phantom Stock Plan of Horrigan American, Inc. and Affiliated Companies\" shall mean the Plan set forth herein.\n(v) \"Phantom Stock Unit\" shall mean a unit awarded to a Participant by the Administrative Committee pursuant to this Plan.\n(w) \"Phantom Stock Unit Ledger\" shall mean the ledger referred to in Paragraph 5 hereof.\n(x) \"Plan\" shall mean the Phantom Stock Plan of Horrigan American, Inc. and Affiliated Companies set forth herein.\n(y) \"Plan Termination Date\" shall mean the date selected by the Board of Directors of any of the Companies on which the Plan terminates as to such Company.\n(z) \"Plan Rate\" shall mean an annual rate of interest equal to the applicable annual rate of interest for treasury bills having a one (1) year maturity which were most recently issued by the United States Department of the Treasury prior to the applicable Participant's Termination Date.\n(aa) \"Retirement\" shall mean a severance from employment of any Participant with the Company which employs such Participant, other than for Cause, upon or after attainment of age sixty-two (62) in accordance with the then-applicable retirement policies of such Company.\n(bb) \"Termination Date\" shall mean the date of a Participant's severance from employment with the Company which employs such Participant by reason of the Participant's Retirement, Total Disability, death or termination of employment by the applicable Company for or without Cause, or by reason of the termination of employment by the Participant or for any other reason or in any other manner.\n(cc) \"Total Disability\" shall mean the disability of a Participant by reason of injury or sickness which renders the Participant unable to perform all of the Participant's essential duties and obligations to the Company which employs such Participant.\n4. Administration.\n(a) There is hereby established an Administrative Committee which shall consist of three (3) persons, each of whom shall be a member of the Board of Directors of Horrigan American, Inc., each of whom shall be ineligible to become a Participant and each of whom shall serve at the pleasure of the Board of Directors of Horrigan American, Inc. to administer, construe and interpret this Plan. No person serving as a member of the Administrative Committee shall receive any compensation for his or her services. The Administrative Committee shall act by majority vote.\n(b) The construction and interpretation by the Administrative Committee of any provision of this Plan, the administration thereof by the Administrative Committee and all decisions and determinations made by the Administrative Committee pursuant hereto, including all determinations with respect to the amount of any Excess Dividend and of fair market value of the Common Stock, if made in good faith, shall be final, binding and conclusive for all purposes. Subject to the provisions of this Plan, the Administrative Committee shall have the sole and exclusive power:\n(i) to determine the Officers who shall participate in the Plan from time to time;\n(ii) to determine the number of Phantom Stock Units to be set aside for each Participant;\n(iii) to determine the number of Credits to be entered in the Phantom Stock Unit Ledger to each Participant's Account; and\n(iv) to make such other determinations as shall from time to time be reasonably necessary to effectuate this Plan.\n(c) In performing its duties hereunder, including the selection of Participants, the Administrative Committee shall make such inquiry of the Officers and other employees of each of the Companies as it, in its sole discretion, deems appropriate.\n(d) The Administrative Committee may, in its sole discretion, delegate its duties to an Officer or other employee of any of the Companies, or a committee composed of Officers or other employees of any of the Companies, but may not delegate its authority to construe and interpret this Plan, or to make the determinations specified in clauses (i), (ii) and (iii) of Subparagraph (b) of this Paragraph 4.\n5. Phantom Stock Unit Ledger. The Administrative Committee shall establish a Phantom Stock Unit Ledger and thereafter from time to time as appropriate enter therein the name of each Participant, the number of Phantom Stock Units awarded to him or her by the Administrative Committee, the date of such award, an amount which shall be equal to the aggregate fair market value on the date of such award of an equal number of shares of Common Stock and such other information as the Administrative Committee shall deem appropriate. The Administrative Committee shall advise in writing each Participant and the Company which employs such Participant of the foregoing as it pertains to such Participant in such manner as the Administrative Committee shall deem appropriate.\n6. Aggregate Number of Phantom Stock Units. The aggregate number of Phantom Stock Units standing in the Phantom Stock Unit Ledger for all Participants at any one time shall not exceed one hundred twenty-five thousand (125,000); provided, however, that upon severance of any Participant from employment with any of the Companies (and provided that immediately thereafter such Participant does not become an employee of any other Company), any Phantom Stock Units theretofore awarded to such Participant shall no longer be considered outstanding for the purposes of this Paragraph 6.\n7. Credits to Participant's Accounts.\n(a) So long as this Plan remains in effect and subject to the other terms and provisions herein contained, the Administrative Committee shall enter Credits in the Phantom Stock Unit Ledger to each Participant's Account effective as of the dividend payment date applicable to the Common Stock, the number of such Credits so entered to be in an amount equal to the Excess Dividend, if any, multiplied by the number of Phantom Stock Units standing in such Participant's Account on such date; provided, however, that no such Credits shall be entered in the Phantom Stock Unit Ledger to any Participant's Account with respect to any Excess Dividend paid by the Company after the Participant's Termination Date or after any date of termination of this Plan, even though the record date is prior thereto. By way of illustration only, in the event that Participant X shall have been awarded ten thousand (10,000) Phantom Stock Units by the Administrative Committee and the Excess Dividend shall have been determined by the Administrative Committee to be twenty cents ($0.20) per Phantom Stock Unit, the Administrative Committee shall enter Credits in the amount of Two Thousand Dollars ($2,000.00) (i.e., ten thousand (10,000) Phantom Stock Units multiplied by twenty cents ($0.20) per Phantom Stock Unit) to the Participant's Account in the Phantom Stock Unit Ledger.\n(b) So long as this Plan remains in effect and subject to the other terms and provisions herein contained, on the Participant's Termination Date the Administrative Committee shall enter Credits in the Phantom Stock Unit Ledger to such Participant's Account, the number of such Credits so entered to be in an amount equal to the Excess Value, if any, multiplied by the number of Phantom Stock Units standing in such Participant's Account on the Participant's Termination Date. No such Credits shall be entered in the Phantom Stock Unit Ledger to any Participant's Account with respect to any Excess Value realized after the Participant's Termination Date or after any date of termination of this Plan. By way of illustration only, in the event that on the Termination Date of Participant X there shall be in such Participant's Account ten thousand (10,000) Phantom Stock Units, the Participant shall be fully vested pursuant to the provisions of this Plan and the Administrative Committee shall have determined that the Excess Value is Two Dollars ($2.00) per Phantom Stock Unit, the Administrative Committee shall enter Credits in the amount of Twenty Thousand Dollars ($20,000.00) (i.e., ten thousand (10,000) Phantom Stock Units multiplied by Two Dollars ($2.00) per Phantom Stock Unit) to the Participant's Account in the Phantom Stock Unit Ledger.\n(c) For purposes of this Plan, the fair market value of the Common Stock as of any date shall be equal to the fair market value of the Common Stock as set forth in the then most recent valuation of the Common Stock which was made for purposes of valuing the Common Stock for the ESOP.\n8. Vesting of Credits. So long as this Plan remains in effect and subject to the other terms and provisions of this Plan, for the purposes of the Credits referred to in Paragraph 7 hereof, each Participant shall be deemed to be vested with respect to all Credits (regardless of the date awarded) based upon each full year of service rendered by the Participant to any of the Companies subsequent to becoming a Participant with respect to this Plan as follows:\nFull Years of Service Vesting\nUnder 5 years 0% 5 years 50% 6 years 60% 7 years 70% 8 years 80% 9 years 90% 10 years 100%\n9. Severance of Employment.\n(a) When a Participant's employment with any of the Companies is severed by reason of the Participant's Retirement, Total Disability or death:\n(i) The Credits in the Participant's Account pursuant to the provisions of Paragraph 7(a) hereof shall be deemed to be completely vested in favor of the Participant without reference to the provisions of Paragraph 8 hereof.\n(ii) The Credits applicable to the Participant's Account by reason of the application of Paragraph 7(b) hereof shall be deemed completely vested in favor of the Participant without reference to the provisions of Paragraph 8 hereof.\n(b) When any Participant's employment with any of the Companies is severed by the applicable Company without Cause:\n(i) The Credits in the Participant's Account pursuant to the provisions of Paragraph 7(a) hereof shall be deemed vested in favor of the Participant to the extent provided in Paragraph 8 hereof.\n(ii) The Credits applicable to the Participant's Account by reason of the application of Paragraph 7(b) hereof shall be deemed vested in favor of the Participant to the extent provided in Paragraph 8 hereof.\n(c) When any Participant's employment with any of the Companies is severed by the applicable Company for Cause, is severed by the Participant or is severed for any reason or in any manner other than those referred to in Paragraphs 9(a) or (b) hereof, such Participant shall be entitled to no benefits or payments of any nature under or with respect to this Plan irrespective of the number of Credits which may be in such Participant's Account on such Participant's Termination Date, the extent to which the Participant is vested, or any other provision of this Plan.\n(d) The phrase \"severance of employment\" shall mean the cessation of employment of the Participant by any of the Companies, provided that such Participant is not immediately thereafter employed by any other Company. Notwithstanding anything to the contrary, in the event that the employment of any Participant by any of the Companies is terminated for any reason and such Participant is immediately thereafter employed by any other Company, for purposes of this Plan, including the vesting provisions contained in Section 8 hereof, such Participant's employment shall not be deemed to have been severed.\n(e) Notwithstanding anything to the contrary, all determinations made in good faith by the Administrative Committee as to the nature and reason with respect to the severance of any Participant's employment with any of the Companies and as to any entitlement of any Participant to benefits or payments hereunder shall be final, binding and conclusive for all purposes.\n10. Termination of Plan.\n(a) The Board of Directors of any of the Companies may terminate this Plan at any time as to such Company and without the concurrence of any Participant.\n(b) Except as expressly set forth in this Plan, no termination of this Plan shall affect the right of any Participant or Beneficiary to receive payments under this Plan.\n(c) If the Board of Directors of any of the Companies shall elect to terminate this Plan at any time, the Plan shall be deemed terminated with respect to such Company and each of the Participants employed by such Company (and not employed by any other Company) as of the effective date of termination as established by the Board of Directors of the Company so electing, but shall not be deemed to have been terminated with respect to any other Company or with respect to any Participant employed by any other Company. In the event that any Participant shall be employed by more than one Company and, as of the effective date of termination, one or more, but not all, of the Companies employing such Participant terminate this Plan as aforesaid, such termination shall not affect such Participant or his or her status under the Plan and such Participant shall continue as a Participant under this Plan.\n(d) If this Plan shall be terminated with respect to any Participant within five (5) years subsequent to its Effective Date:\n(i) Fifty percent (50%) of the Credits in the Participant's Account pursuant to the provisions of Paragraph 7(a) hereof as of the Plan Termination Date shall be deemed vested, notwithstanding the provisions of Paragraph 8 hereof.\n(ii) For the purposes of this Plan and the determination of Excess Value hereunder, the Plan Termination Date shall be deemed to be the Termination Date applicable to such Participant, and the Administrative Committee shall award to such Participant's Account in the Phantom Stock Unit Ledger fifty percent (50%) of the Credits which would otherwise be applicable to such Participant's Account by reason of the application of Paragraph 7(b) hereof, notwithstanding the provisions of Paragraph 8 hereof.\n(e) If this Plan shall be terminated with respect to any Participant more than five (5) years subsequent to its Effective Date:\n(i) For the purposes of this Plan and the determination of Credits pursuant to the provisions of Paragraph 7(a) hereof, the Plan Termination Date shall be deemed to be the Termination Date applicable to such Participant, and the Credits in such Participant's Account pursuant to the provisions of Paragraph 7(a) hereof shall be deemed vested to the extent provided in Paragraph 8 hereof.\n(ii) For the purposes of this Plan and the determination of Excess Value hereunder, the Plan Termination Date shall be the Termination Date applicable to such Participant and, notwithstanding the provisions of Paragraph 8 hereof, the Administrative Committee shall award to such Participant's Account in the Phantom Stock Unit Ledger the Credits which would otherwise be applicable to such Participant's Account by reason of the application of Paragraph 7(b) hereof multiplied by the vesting percentage which would be applicable to such Participant were the Plan Termination Date such Participant's Termination Date.\n11. Payment of Benefits.\n(a) Upon severance of any Participant from employment with the Companies, and except as otherwise set forth in this Plan, there shall be paid to such Participant, or in the event of such Participant's death, to the Beneficiary, to the extent that such Participant shall be vested under the provisions of this Plan, an amount equal to the aggregate Credits in the Participant's Account in the Phantom Stock Unit Ledger, plus any Credits thereafter awarded to such Participant under the provisions of Paragraph 7(b) hereof.\n(b) (i) In the event that severance of any Participant from employment with the Companies shall be by reason of death, Total Disability or Retirement, the amounts payable under this Plan, at the election of the Administrative Committee, shall be paid in a lump sum payment to be made within nine (9) months following the Termination Date or in quarter-annual installments, together with interest at the Plan Rate on the unpaid aggregate amounts owing to the Participant under this Plan over a ten (10) year period immediately following such Participant's Termination Date, the first such payment to be made within three (3) months immediately following such Participant's Termination Date. Notwithstanding anything to the contrary, interest on the unpaid aggregate amounts owing to the Participant under this Plan shall accrue beginning as of the Participant's Termination Date and shall not bear interest prior to such time.\n(ii) In the event that severance of any Participant from employment with the Companies shall be by reason of termination by the applicable Company without Cause (and not by reason of death, Total Disability or Retirement), the amounts payable under this Plan, at the election of the Administrative Committee, shall be paid in a lump sum payment to be made within nine (9) months following the Participant's sixty-second (62) birthday or in quarter-annual installments, together with interest at the Plan Rate on the unpaid aggregate amounts owing to the Participant under this Plan over a ten (10) year period immediately following such Participant's sixty- second (62) birthday, the first such payment to be made within three (3) months immediately following such Participant's sixty-second (62) birthday. Notwithstanding anything to the contrary, interest on the unpaid aggregate amounts owing to the Participant under this Plan shall accrue beginning as of the Participant's sixty-second (62) birthday and shall not bear interest prior to such time.\n(c) The Administrative Committee in its absolute discretion may at any time accelerate the payment of benefits in whole or in part under this Plan to the Participant or to the Beneficiary.\n(d) In the event that any Participant shall die prior to payment in full of any amount owing under this Plan, the unpaid balance of such amount shall be paid to the Participant's Beneficiary in the same manner and at the same times as such payments would have been paid to the Participant.\n(e) To the extent that any Participant shall have been employed by more than one of the Companies, all benefits paid under this Plan shall be equitably apportioned between or among the applicable Companies which employed such Participant in such manner as the Administrative Committee shall deem appropriate based upon the period of time which such Participant was employed by each of the Companies and the benefits which have accrued to such Participant under this Plan during such time period. In such event, each such Company shall be solely obligated to pay its proportionate share of such benefits and none of the Companies shall be obligated to pay the proportionate share of any other Company.\n(f) Notwithstanding anything to the contrary, the payment of any amount under this Plan is expressly subordinated as hereinafter set forth to the prior payment of all existing and future indebtedness of each of the Companies. Upon the occurrence of any receivership, insolvency, assignment for the benefit of creditors, bankruptcy, reorganization or liquidation, or upon the occurrence of any event which entitles any creditor of any of the Companies to declare any material indebtedness of any of the Companies to be due and payable prior to the stated maturity thereof, no amounts owing under this Plan shall be paid to any Participant or Beneficiary unless and until all other indebtedness of the Companies shall have been paid in full. For purposes of this Subparagraph, the term \"material indebtedness\" shall mean indebtedness in excess of One Hundred Thousand Dollars ($100,000.00).\n12. Designation of Beneficiary. Each Officer, upon becoming a Participant, shall file with the Administrative Committee a notice in writing designating one or more Beneficiaries to whom payments otherwise due the Participant shall be made in the event of such Participant's death while employed with the Companies or after severance therefrom subject, however, to the other provisions of this Plan. The Participant shall have the right to change the Beneficiary from time to time; provided, however, that any change shall not become effective until written notice, in form reasonably satisfactory to the Company, is received by the Administrative Committee.\n13. Independence. The benefits provided under this Plan shall be independent of, and in addition to, any benefits provided under any other agreements that may exist from time to time between the Company and the Participant, and any other compensation payable by the Company to the Participant.\n14. Insurance. Any Company employing any Participant, at its election, may apply for and procure in its own name and for its own benefit life and\/or disability insurance in any amount or amounts considered advisable by the applicable Board of Directors, and the Participant shall have no right, title or interest therein; and further, as a condition precedent to participation or continued participation in the Plan and the award of any Phantom Stock Units hereunder, the Participant shall submit from time to time to any reasonable medical or other examination and shall execute and deliver all applications and other instruments necessary to effect such policies of insurance. The failure of the Participant to fully abide by the provisions of this Paragraph shall result in the forfeiture of any Credits which are or may thereafter be applicable to such Participant's Account and the Participant's right to receive any payments or benefits under this Plan. Nothing herein contained shall be construed to require the Company to use any proceeds of, cash value of or other monies derived from life or disability insurance for the purpose of funding or paying any benefit to be paid or which is payable to the Participant, the Beneficiary or any other Person under this Plan.\n15. Conditions Precedent.\n(a) As a condition precedent to the participation and continued participation in this Plan and the award of any Phantom Stock Units hereunder, the Participant shall execute and deliver to the Administrative Committee an Acknowledgment which shall acknowledge Participant's participation in the Plan and confirm the Participant's willingness to be bound by the Plan.\n(b) As a condition precedent to the receipt of any payments or benefits under this Plan, the Participant shall, upon severance of the Participant's employment with the Companies, execute a written agreement with the Company in form and substance reasonably satisfactory to the Administrative Committee pursuant to which the Participant shall covenant, inter alia, to the Company by which the Participant was employed that the Participant:\n(i) Shall not use any information which is confidential or proprietary to any of the Companies or any trade secrets of any of the Companies for any purpose whatsoever or divulge or disclose such information to any Person other than the Companies and Persons to whom any of the Companies has given consent, unless such information and secrets have already become common knowledge or unless the Participant is compelled to disclose such information or secrets by applicable governmental process.\n(ii) For one (1) year following the Participant's Termination Date, shall not directly or indirectly solicit or sell any of the products or services of any of the Companies to any Person who is or was a Customer of any of the Companies on the Termination Date.\n(iii) For one (1) year following the Participant's Termination Date, shall not directly or indirectly solicit any Customer of any of the Companies.\n16. Limitation of Rights. Nothing contained in this Plan shall be construed to:\n(a) give any Officer or other employee of any of the Companies any right to be awarded any Phantom Stock Units other than in the sole discretion of the Administrative Committee;\n(b) give a Participant any rights whatsoever with respect to any shares of Common Stock;\n(c) limit in any way the right of any of the Companies to terminate a Participant's employment with the Companies at any time; or\n(d) be evidence of any agreement or understanding, express or implied, that any of the Companies shall employ a Participant in any particular position or at any particular rate of remuneration or for any particular period of time.\n17. Adjustment in Number of Phantom Stock Units. In the event of any stock dividend on the Common Stock, any split-up or combination of shares of the Common Stock, any reverse stock split with respect to the Common Stock, or any other reorganization of any nature involving the Common Stock, an equitable adjustment shall be made by the Administrative Committee with respect to this Plan, including the aggregate number of Phantom Stock Units which may be awarded under this Plan and the number of Phantom Stock Units in the Participant's Account in the Phantom Stock Unit Ledger; provided, however, that the Administrative Committee shall not be required to establish any fractional Phantom Stock Units.\n18. Non-alienation of Benefits. To the extent permitted by applicable law, no right or benefit under this Plan shall be subject to anticipation, alienation, assignment, pledge, encumbrance, garnishment, charge, sale, transfer or other disposition, and any attempt to anticipate, alienate, assign, pledge, encumber, charge, sell, transfer or otherwise dispose of the same shall be void and of no effect. No right or benefit hereunder shall in any manner be liable for or subject to the debts, contracts, liabilities, or torts of the Participant or any Beneficiary entitled to such benefits. If any Participant or Beneficiary hereunder should become bankrupt, insolvent, a debtor under the Bankruptcy Code or attempt to anticipate, alienate, assign, pledge, encumber, charge, sell, transfer or otherwise dispose of any right or benefit hereunder, then such right or benefit, in the discretion of the Administrative Committee, shall cease and determine, and in such event, the applicable Company may hold or apply the same or any part thereof for the benefit of the Participant or Beneficiary, his or her spouse, children, or other dependents, or any of them, in such manner and in such proportion as the Administrative Committee may deem proper.\n19. Indemnification. To the extent permitted by applicable law, and in addition to any right of indemnification by the Companies which any member of the Administrative Committee might otherwise have, each of the Companies shall indemnify each member of the Administrative Committee of and from any and all loss, damage, cost and expense, including reasonable attorneys' fees, suffered or incurred by such member for any act or determination made in good faith with respect to this Plan.\n20. Amendment.\n(a) This Plan may not be amended except in writing.\n(b) This Plan may be amended by the Boards of Directors of all of the Companies without the consent of the Participants provided that such amendment does not materially and adversely affect any benefit to which any Participant is entitled as of the date of such amendment.\n(c) Except as set forth in Subparagraph (b) of this Paragraph, this Plan may not be amended without the consent of the Boards of Directors of all of the Companies and of each Participant who, as of the effective date of such amendment, shall be employed by any of the Companies.\n(d) The addition of another corporation or corporations as an Affiliated Company shall be deemed to be an amendment to this Plan which is governed by Subparagraph (b) hereof and which does not materially and adversely affect any benefit to which any Participant is entitled.\n21. Effective Date. This Plan shall become operative and in effect on such date as shall be fixed by the Board of Directors of each of the Companies, in their discretion.\n22. Waiver. No failure on the part of the Administrative Committee to exercise, and no delay in exercising, any right under this Plan or permitted or provided by statute, at law or in equity shall operate as a waiver thereof nor an estoppel thereto, nor shall any single or partial exercise of any such right or remedy preclude any other or future exercise thereof, or the exercise of any other right or remedy.\n23. Captions. The caption or heading of each Paragraph of this Plan does not constitute a part of this Plan but is for informational purposes only.\n24. Severability. If any provision of this Plan or the application thereof to any party or circumstance be held invalid or unenforceable, the remainder of this Plan, and the application of such provisions to other parties or circumstances, shall not be affected thereby and to this end, the provisions of this Plan are declared severable.\n25. Tax Consequences. None of the Companies makes any representation as to the tax consequences of this Plan or with respect to any benefits or payments received by any Participant hereunder.\n26. Arbitration. Any controversy arising from or related to this Plan shall be determined by arbitration in the City of Reading, Berks County, Pennsylvania, in accordance with the Rules of the American Arbitration Association, and judgment upon any such determination or award may be entered in any court having applicable jurisdiction.\n27. Applicable Law. This Plan and all controversies hereunder shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania.\nCERTIFICATION\nThis is to certify that the Phantom Stock Plan of Horrigan American, Inc. and Affiliated Companies was duly adopted by the Boards of Directors of Horrigan American, Inc., AEL Leasing Co., Inc., American Commercial Credit Corp. and American Real Estate Investment and Development Co., respectively, at their regularly scheduled meetings on ________________, 1993, to have an Effective Date of _______________, 1993.\n_________________________________ Secretary of Horrigan American, Inc. DATED: ______________, 1993\n__________________________________ Secretary of AEL Leasing Co., Inc. DATED: ______________, 1993\n__________________________________ Secretary of American Commercial Credit Corp. DATED: ______________, 1993\n__________________________________ Secretary of American Real Estate Investment and Development Co. DATED: ______________, 1993\nEXHIBIT 11\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nSTATEMENT OF COMPUTATION OF PER SHARE EARNINGS (LOSS)\nEXHIBIT 12\nHORRIGAN AMERICAN, INC. AND SUBSIDIARIES\nSTATEMENT OF COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES\nThe Company guaranteed $2,400,000 of debt of unconsolidated real estate partnerships as of December 31, 1993. The amount of fixed charges associated with this guaranteed debt was $223,000 for 1993. The computation of the ratio of earnings to fixed charges does not include the fixed charges associated with the guaranteed debt because the Company has not been required to honor the guarantees nor is it probable that the Company will be required to honor the guarantees.\nIn 1992, earnings from continuing operations were inadequate to cover fixed charges by $269,000. However, the ratio of earnings to fixed charges is not intended to disclose cash flow from operations. In addition to the normal noncash expenses, such as depreciation and provision for possible lease and loan losses, the provision for write-down of real estate negatively affects the ratio for 1992. The ratio of earnings to fixed charges would be 1.35 if the provision for write-down of real estate were excluded.\nEXHIBIT 22\nSUBSIDIARIES OF THE REGISTRANT\nSTATE OF NAMES UNDER WHICH SUBSIDIARY SUBSIDIARY INCORPORATION DOES BUSINESS ------- ------------- ------------------------------- American Equipment Leasing Pennsylvania Co., Inc...................... AEL Leasing Co., Inc.......... Pennsylvania American Equipment Leasing American Legal Funding American Municipal Funding American Rental Services American Reli Financial Information Systems Funding Group American Commercial Credit Pennsylvania Corp.......................... Horrigan American Securities, Pennsylvania Inc........................... AEL Holdings, Inc............. Delaware The Business Outlet, Inc...... Pennsylvania American Real Estate Pennsylvania Investment and Development Co............................ American Hotel Management, Pennsylvania Inc...........................\nSUBSIDIARY PARTNERSHIPS STATE OF ----------------------- -------- REGISTRATION ------------ (Each partnership does business under its legal name only) ARE Moorestown Partners........................ Pennsylvania ARE Amcare One Partners........................ Pennsylvania ARE Amcare Two Partners........................ Pennsylvania ARE Amcare Three Partners...................... Pennsylvania ARE Amcare Four Partners....................... Pennsylvania ARE Norfolk Partners........................... Pennsylvania ARE Pittsburgh V.M. Partners................... Pennsylvania ARE Flying Hills One Partners.................. Pennsylvania ARE Lehigh Valley Partners..................... Pennsylvania ARE Fleetwood Partners......................... Pennsylvania ARE Cincinnati Three Limited Partnership....... Pennsylvania ARE Pottsville Partners........................ Pennsylvania ARE Wadsworth Partners......................... Pennsylvania American AMDEV Limited Partnership I........... Michigan ARE Florida One Limited Partnership............ Pennsylvania ARE South Fifth Street Partners................ Pennsylvania ARE Tallahassee Limited Partners............... Pennsylvania ARE Dayton Limited Partnership................. Pennsylvania ARE West Reading Partnership................... Pennsylvania ARE Riverfront Partnership..................... Pennsylvania ARE Wyomissing Partners........................ Pennsylvania AA & G Partners................................ Pennsylvania ARE Sikeston Limited Partnership............... Pennsylvania ARE Middleton Limited Partnership.............. Pennsylvania ARE Old Bridge Limited Partnership............. Pennsylvania ARE Mentor Limited Partnership................. Pennsylvania ARE Amcare Five Limited Partnership............ Pennsylvania S. G. Development Limited Partnership.......... Michigan Eastern Boulevard Associates................... Pennsylvania\nSUBSIDIARY PARTNERSHIPS STATE OF ----------------------- -------- REGISTRATION ------------ (Each partnership does business under its legal name only) ARE Houston One Limited Partnership............ Pennsylvania ARE Central Texas Limited Partnership.......... Pennsylvania ARE Central Florida Limited Partnership........ Pennsylvania ARE Sarasota Limited Partnership............... Pennsylvania ARE Royal Palm Limited Partnership............. Pennsylvania ARE Delray Limited Partnership................. Pennsylvania ARE St. Marys Limited Partnership.............. Pennsylvania ARE Haddonfield Limited Partnership............ Pennsylvania ARE Central Florida Two Limited Partnership.... Pennsylvania\nEXHIBIT 27 FINANCIAL DATA SCHEDULE\nThis schedule contains summary financial information extracted from Horrigan American, Inc. and Subsidiaries and is qualified in its entirety by reference to such financial statements.\nAPPENDIX A TO ITEM 601(C) OF REGULATION S-K COMMERCIAL AND INDUSTRIAL COMPANIES ARTICLE S OF REGULATION S-X\nITEM NUMBER ITEM DESCRIPTION AMOUNTS - -------- ---------- ------ 5-02(1) cash and cash items $2,160,000 5-02(2) marketable securities 2,697,000 5-02(3)(a)(1) notes and accounts receivable trade 127,582,000 5-02(4) allowances for doubtful accounts 5,438,000 5-02(6) inventory N\/A 5-02(9) total current assets N\/A 5-02(13) property, plant and equipment 41,696,000 5-02(14) accumulated depreciation 7,764,000 5-02(18) total assets 164,953,000 5-02(21) total current liabilities N\/A 5-02(22) bonds, mortgages and similar debt 129,620,000 5-02(28) preferred stock--mandatory redemption N\/A 5-02(29) preferred stock--no mandatory redemption 195,000 5-02(30) common stock 3,112,000 5-02(31) other stockholders\" equity 25,350,000 5-02(32) total liabilities and stockholders' equity 164,953,000 5-03(b)1(a) net sales of tangible products 694,000 5-03(b)1 total revenues 24,963,000 5-03(b)2(a) cost of tangible goods sold N\/A 5-03(b)2 total costs and expenses applicable to sales and 9,978,000 revenues 5-03(b)3 other costs and expenses N\/A 5-03(b)5 provision for doubtful accounts and notes 1,573,000 5-03(b)(8) interest and amortization of debt discount 9,028,000 5-03(b)(10) income before taxes and other items 5,078,000 5-03(b)(11) income tax expense 1,900,000 5-03(b)(14) income\/loss continuing operations 3,047,000 5-03(b)(15) discontinued operations N\/A 5-03(b)(17) extraordinary items N\/A 5-03(b)(18) cumulative effect--changes in accounting principles 0 5-03(b)(19) net income or loss 3,047,000 5-03(b)(20) earnings per share--primary 0.92 5-03(b)(20) earnings per share--fully diluted 0.92","section_15":""}
{"filename":"49648_1993.txt","cik":"49648","year":"1993","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nGeneral -\nIdaho Power Company (Company) is an electric public utility incorporated under the laws of the state of Idaho in 1989 as successor to a Maine corporation organized in 1915. The Company is engaged in the generation, purchase, transmission, distribution and sale of electric energy in an approximate 20,000- square-mile area in southern Idaho, eastern Oregon and northern Nevada, with an estimated population of 670,000 people. The Company holds franchises in approximately 70 cities in Idaho and 10 cities in Oregon, and holds certificates from the respective public utility regulatory authorities to serve all or a portion of 28 counties in Idaho, 3 counties in Oregon and 1 county in Nevada. The Company's results of operations, like those of certain other utilities in the Northwest, can be significantly affected by weather and streamflow conditions. Variations in energy usage by ultimate customers occur from year to year, from season to season and from month to month within a season, primarily as a result of weather conditions. With the recent implementation of a power cost adjustment mechanism in the Idaho jurisdiction, which includes a major portion of the operating expenses with the largest variation potential (net power supply costs), the Company's future operating results will be more dependent upon general regulatory, economic, and temperature conditions and less on precipitation and streamflow conditions. As of December 31, 1993, the Company supplied electric energy to 317,772 general business customers and employed 1,729 people in its operations (1,654 full-time).\nThe Company operates 17 hydro power plants and shares ownership in three coal-fired generating plants (see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's system includes 17 hydroelectric generating plants located in southern Idaho and eastern Oregon (detailed below) and an interest in three coal-fired steam electric generating plants. The system also includes approximately 4,654 miles of high voltage transmission lines; 21 step-up transmission substations located at power plants; 17 transmission transformer substations; 7 transmission switching stations; and 196 energized distribution substations (excludes mobile substations and dispatch centers). Refer to Item 1 - \"Construction Program\" for facilities under construction.\nThe Company holds licenses under the Federal Power Act for 13 hydroelectric projects from the FERC. These and the other generating stations and their capacities are listed below:\nMaximum Non-Coincident Operating Nameplate License Project Capacity KW Capacity KW Expiration\nProperties Subject to Federal Licenses:\nLower Salmon 70,000 60,000 1997 Bliss 80,000 75,000 1998 Upper Salmon 39,000 34,500 1998 Shoshone Falls 12,500 12,500 1999 C J Strike 89,000 82,800 2000 Upper Malad 9,000 8,270 2004 Lower Malad 15,000 13,500 2004 Brownlee-Oxbow-Hells Canyon 1,398,000 1,166,500 2005 Swan Falls 11,100 9,465 2010 American Falls 112,420 92,340 2025 Cascade 14,000 12,420 2031 Twin Falls 10,000 8,437 2041 Milner 59,448 59,448 2038\nOther Generating Plants:\nOther Hydroelectric 10,400 11,300 Jim Bridger (Coal-Fired 693,333 678,077 Station) Valmy (Coal-Fired Station) 260,650 260,650 Boardman (Coal-Fired Station) 53,000 53,000\nOn December 31, 1993, the composite average ages of the principal parts of the Company's system, based on dollar investment, were: production plant, 15.9 years; transmission system and substations, 17.7 years; and distribution lines and substations, 13.9 years. The Company considers its properties to be well maintained and in good operating condition.\nThe Company owns in fee all of its principal plants and other important units of real property, except for portions of certain projects licensed under the Federal Power Act and reservoirs and other easements, subject to the lien of its Mortgage and Deed of Trust and the provisions of its project licenses, and to minor defects common to properties of such size and character that do not materially impair the value to, or the use by, the Company of such properties.\nAs a result of various federal legislative actions and proposals (such as the Electric Consumers Protection Act of 1986, Energy Policy Act of 1992, Clean Water Act Reauthorization and Endangered Species Act Reauthorization), a major issue facing the Company is the relicensing of its hydro facilities. Because the federal licenses for the majority of the Company's hydroelectric projects expire during the next 10 to 15 years, the Company has established an internal task force to vigorously pursue the relicensing process. The relicensing of these projects is not automatic under federal law. The Company must demonstrate comprehensive usage of the facilities, that it has been a conscientious steward of the natural resource entrusted to it and that there is a strong public interest in the Company continuing to hold the federal licenses. The Company cannot anticipate what type of environmental or operational requirements may be placed on the projects in the relicensing process, nor can it estimate what the eventual cost will be for relicensing. However, the Company anticipates that its efforts in this matter for all of the hydro facilities will be successful.\nIdaho Energy Resources Co. owns a one-third interest in certain coal leases near the Jim Bridger generating plant in Wyoming from which coal is mined and supplied to the plant.\nIda-West owns a 50 percent interest in five PURPA-qualified facilities that have a total generating capacity of approximately 34 MW. The energy from these facilities is sold to the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in a Superfund case entitled United States of America vs. Pacific Hide & Fur Depot, et al., Civil No. 83-4062, pending in the United States District Court for the District of Idaho. The suit involves PCB contamination at a scrap metal\/recycling facility near Pocatello, Idaho. The Company entered into a Partial Consent Decree which was signed by the District Judge on September 26, 1989, wherein the Company agreed to remediate PCBs at the site.\nAfter completion of certain Initial Tasks and the Final Remedial Design, by letter dated October 4, 1990, EPA notified the Company of the discovery of lead and other metals contamination at levels of concern at the site, and instructed the Company to suspend further remedial action at the site until further notice.\nOn April 24, 1991, the Company initiated discussions with EPA in an effort to facilitate the commencement and completion of PCB remediation. On July 16, 1991, the Company submitted a proposal whereby the PCB and lead\/other metal contaminants would be divided into at least two operable units for purposes of site remediation. On January 20, 1992, a Final Operable Unit Focused Feasibility Study was submitted by the Company to EPA.\nOn January 4, 1992, EPA issued a Proposal to Amend Record of Decision which proposed to divide the site into \"operable units\" to allow for immediate cleanup of PCB contamination at the site through the removal of the PCB and PCB mixed with lead contaminated soils from the site and disposal of the soils at an EPA approved waste facility.\nAn Amended Record of Decision authorizing the foregoing was issued on April 29, 1992.\nRemedial Design Documents were approved by EPA on July 8, 1992.\nIn order to facilitate the commencement\/completion of remedial activities during 1992, an \"interim\" Administrative Order directing the Company to undertake remedial activities was issued on July 13, 1992.\nRemediation activities commenced on July 27, 1992, and were completed on October 21, 1992.\nA Certification of Completion for the Operable Unit Remedial Action dated March 31, 1993, was issued by EPA to the Company. The Amended Partial Consent Decree which will supersede EPA's \"Interim\" Administrative Order has not yet been completed.\nOn August 30, 1993, Notice of the Lodging of the Amended consent Decree was published in the Federal Register, creating a 30-day period for public comment.\nOn September 30, 1993, the Company was advised that the public comment period would be extended until October 21, 1993, at which time, barring any disclosure of facts or considerations which indicate that the proposed settlement is inappropriate, improper or inadequate, the District Court for the District of Idaho should enter a final judgment in the matter resolving the government's claims against the Company.\nPursuant to the Request for Public Comment, a number of Potentially Responsible Parties involved with the lead contamination at the site filed objections to the proposed Amended Consent Decree. The objections generally contend that the government's information relating to the Company's contribution to the lead contaminations at the site is erroneous, and that the Company's proposed settlement is disproportionately low in relation to its liability. On November 19, 1993, the Company provided the Department of Justice with its responses to the objections.\nThe government is continuing to prepare its responsive comments to the objections. The Company was advised on February 8, 1994, that the government anticipated the filing of its responsive summary with the court by the end of February 1994.\nThis matter has been previously reported in Form 10-K dated March 9, 1989, March 8, 1990, March 14, 1991, March 16, 1992, March 12, 1993, and other reports filed with the Commission.\nOn February 16, 1994, an action for declaratory relief and breach of contract entitled Idaho Power Company vs. Underwriters at Lloyds London, et al., was filed by the Company in Federal District Court in Pocatello, Idaho, against its solvent liability insurers in the period of 1969 to 1974, arising out of the insurer's denial of coverage for the Company's environmental remediation of a hazardous waste site in Pocatello. The action seeks a declaratory judgment that the policies cover the Company's costs of defending claims related to the site and of site remediation, and damages for the insurers' breach of the insurance contracts based on their failure to pay such costs, which at the present time are approximating $6.9 million.\nOn December 6, 1991, a complaint entitled Nez Perce Tribe, Plaintiff, v. Idaho Power Company, Defendant, Civil No. CIV 91- 0517-S-EJL, was filed against the Company in the United States District Court for the District of Idaho. The Company was served with the Complaint on March 26, 1992. In the Complaint, the Tribe contends that pursuant to treaties with the United States Government including the Treaty of June 11, 1855, 12 Stat. 957, and the Treaty of June 9, 1863, 14 Stat. 647, the right to take fish at all usual and accustomed fishing places outside the Nez Perce Reservation and the exclusive right to take fish in all streams running through or bordering the reservation were reserved for the Tribe in said treaties. The Complaint further states that the Snake River supported substantial runs of anadromous fish and that the construction of Brownlee, Oxbow and Hells Canyon Dams in 1958, 1961 and 1967, respectively, created total barriers to the migration of the anadromous fish, thereby destroying the fish runs and violating the reserved fishing rights stated in the above-described treaties. In the Complaint, the Tribe seeks actual, incidental and consequential damages in amounts to be proven at trial together with $150,000,000 in punitive damages as well as pre- and post-judgment interest and costs and attorney fees.\nOn September 11, 1992, the Tribe filed an Amended Complaint in which it amplified its original Complaint by asserting that Brownlee, Oxbow and Hells Canyon Dams were \"constructed, operated and maintained in such a manner as to damage plaintiff's rights\" to harvest fish, which rights the Tribe asserts to be \"present, possessory property right(s)\". As the basis for its alleged right to recover damages from the Company, the Tribe asserts that the Company negligently constructed, operated and maintained Brownlee, Oxbow and Hells Canyon Dams, that the Company negligently failed to prevent or mitigate harm to the Tribe, that the Company intentionally and willfully destroyed, interfered with, and dispossessed the Tribe of its property rights, and that the Company improperly exercised dominion over the Tribe's property, thus depriving the Tribe of its possession. The Tribe has requested to try its case to a jury. As was true for the Tribe's original Complaint, the Tribe seeks through its Amended Complaint to secure actual, incidental, and consequential damages in amounts to be proven at trial, together with pre and post- judgment interest, costs and disbursements of the action, attorney fees and witness fees. The Amended Complaint restates the Tribe's claim for punitive damages, but omits the prior reference to a sum certain in favor of requesting punitive damages in an \"amount sufficient to punish the defendant and deter others\".\nOn September 18, 1992, the Company filed a motion for summary judgment in the hope of securing dismissal of the Tribe's action. On January 19, 1993, a federal court hearing was held before a federal magistrate on the Company's motion for summary judgment. On July 30, 1993, the magistrate issued a Report and Recommendation to the District Judge wherein it was recommended that the Company's motion for summary judgment be granted. The Tribe filed briefing in which it urged the District Court to reject the Magistrate's Report and Recommendation, and the Company responded with a request that the District Court enter summary judgment in accordance with the Magistrate's opinion.\nOn November 30, 1993, the District Court entered a second order of reference, in which the court sent the case back to the Magistrate for the Magistrate to make additional findings with respect to the Tribe's contention that it is entitled to compensation based on physical exclusion from its usual and accustomed fishing places. The Magistrate ordered the parties to brief this issue. That briefing was concluded, and oral argument was held before the Magistrate on February 11, 1994. On February 28, 1994, the Magistrate issued a Second Report and Recommendation wherein it was recommended that the District Court deny the Company's motion for summary judgment as to the tribes claim for damages arising from precluding the tribe access to its usual and accustomed fishing places and reaffirmed its recommendation in the original Report and Recommendation to grant the Company's motion for summary judgment as to all other claims.\nThe lawsuit is still in the early stages, and the Company is unable to predict the outcome of this case. However, the Company believes its actions were lawful and intends to vigorously defend this suit.\nThis matter has been previously reported in Form 10-K dated March 16, 1992, March 12, 1993, and other reports filed with the Commission.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages and positions of all of the executive officers of the Company are listed below along with their business experience during the past five years. Officers are elected annually by the Board of Directors. There are no family relationships among these officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was elected.\nBusiness Experience During Past Five Name, Age and Position (5) Years\nJ. W. Marshall, 55 Appointed August 18, 1989. Chairman of the Board Mr. Marshall was Executive Vice and Chief Executive President prior to August 18, 1989. Officer\nL. R. Gunnoe, 58 Appointed July 12, 1990. President and Chief Mr. Gunnoe was Vice President - Operating Officer Distribution prior to July 12, 1990.\nDaniel K. Bowers, 46 Appointed July 10, 1986. Vice President and Treasurer\nJ. LaMont Keen, 41 Appointed November 14, 1991. Vice President and Mr. Keen was Controller prior to Chief Financial Officer November 14, 1991.\nDouglas H. Jackson, 57 Appointed July 12, 1990. Vice President - Mr. Jackson was Senior Manager of Distribution Corporate Services prior to July 12, 1990, and Assistant to the Chairman and Chief Executive Officer prior to August 21, 1989.\nPaul L. Jauregui, 52 Appointed June 4, 1988. Vice President - Human Resources\nC. N. Olson, 44 Appointed July 11, 1991. Mr. Olson Vice President - was Senior Manager - Corporate Corporate Services Services prior to July 11, 1991, Senior Manager - Administrative Services prior to September 1, 1990, Distribution Engineering and Construction Manager prior to February 1, 1990, and Division Electrical Superintendent prior to May 29, 1989.\nJ. B. Packwood, 50 Appointed July 13, 1989. Vice President - Mr. Packwood was Senior Manager - Power Supply Power Supply, prior to July 13, 1989.\nRobert W. Stahman, 49 Appointed July 13, 1989. Vice President, General Mr. Stahman was General Counsel and Counsel and Secretary Secretary prior to July 13, 1989.\nHarold J. Hochhalter, 58 Appointed January 9, 1992. Controller and Chief Mr. Hochhalter was Manager of Accounting Officer Corporate Accounting and Reporting prior to January 9, 1992.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company has paid cash dividends on its common stock in each year since 1918. For the years of 1991, 1992 and 1993, cash dividends per share of common stock were $1.86. At the July 1993 meeting, the Board of Directors voted to maintain the annual common dividend at $1.86 per share. It is the intention of the Board of Directors to continue to pay dividends quarterly on the common stock, but such dividends in the future will depend on earnings, cash requirements of the Company and other factors.\nThe common stock is listed on the New York and Pacific stock exchange. For the years of 1992 and 1993, the following table indicates the reported high and low sale price of the Company's common stock as reported by the Wall Street Journal as composite tape transactions. The holders of record of the Company's common stock as of December 31, 1993 was 26,870.\n1992 (Quarters) Common Stock, $2.50 par value: 1st 2nd 3rd 4th High $28 3\/4 $26 3\/8 $27 1\/4 $28 1\/8 Low 24 3\/8 24 3\/4 25 1\/4 25 1\/2 Dividends paid per share (cents) 46.5 46.5 46.5 46.5\n1993 (Quarters) Common Stock, $2.50 par value: 1st 2nd 3rd 4th High $30 3\/8 $31 1\/2 $33 $32 7\/8 Low 27 1\/4 27 7\/8 31 29 1\/8 Dividends paid per share (cents) 46.5 46.5 46.5 46.5\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIdaho Power Company's consolidated, wholly-owned subsidiaries consist of Idaho Energy Resources Co. (IERCO), Ida-West Energy Company (Ida-West), IDACORP, INC, and Idaho Utility Products Company (IUPCO). Together, Idaho Power and these subsidiaries are referred to herein as the Company.\nEARNINGS PER SHARE\nEarnings per share of common stock increased to $2.14 in 1993 as compared to $1.55 in 1992 and $1.56 in 1991. The lower earnings per share in 1991 and 1992 resulted from drought conditions and accompanying low streamflows. The improved 1993 earnings reflect more favorable hydroelectric conditions and a gain on the sale of the Wood River turbine to offset the impact of the 1993 federal income tax increase. The Company also recorded income tax reserve adjustments relating to the settlement of prior years' returns (1983-1990) during the fourth quarter. The two actions combined to increase the year's earnings approximately $6.0 million over 1992. The 1993 earnings equate to an 11.8 percent earned return on year-end common equity compared to the 8.7 percent earned in 1992 and 9.1 percent earned in 1991. Book value per share of common stock was $17.86 at December 31, 1993.\nRESULTS OF OPERATIONS\nPrecipitation and Streamflows\nHeavy spring precipitation and cool summer temperatures in the Company's service territory coupled with near normal accumulations of snow last winter propelled the 1993 water year to more than three times that of 1992. Streamflows into Brownlee Reservoir (which provides water to the three dam Hells Canyon complex which generates about half of the electricity produced by the Company in a normal water year) were 5.97 million acre-feet (MAF) compared to only 1.8 MAF during 1992. Inflows into Brownlee during 1993 were nearly 25 percent above the 63-year median of 4.81 MAF.\nEnergy Requirements\nEven though streamflows were much improved, hydro generation did not fully return to normal levels during 1993. The major adverse factors were the carryover effects of six years of drought conditions on reservoirs and the aquifer and the inability to fully utilize hydro generation capability during the first few months of 1993, as the Company was restoring and then maintaining Brownlee reservoir levels for later use. The Company's hydroelectric output accounted for 52 percent of its total energy requirements in 1993, a substantial increase from 35 percent in 1992 and 41 percent in 1991. Thermal generation accounted for 40 percent of total energy requirements with purchased power and other exchanges accounting for 8 percent during 1993. Under normal conditions the Company's hydro system would contribute approximately 58 percent with thermal generation providing approximately 36 percent and the remaining 6 percent from purchased power and other interchanges.\nAlthough it is too early to predict with certainty what hydroelectric conditions will be during 1994, preliminary reports indicate the mountain snowpack is again below normal. However, carryover reservoir storage is above average throughout the Snake River Basin. The Company expects to meet projected energy loads during the coming year by utilizing its hydro and coal-fired facilities and strategic geographic location - which provides excellent opportunities to purchase, sell, exchange and transmit Northwest energy - even if below normal streamflow conditions prevail.\nEconomy\nFor the fifth year the state of Idaho and the Company's service territory continued to experience extraordinary economic growth. For the state, nonagricultural employment gains of an expected 3.0 percent in 1993 were preceded by 4.6 percent in 1992 and 3.3 percent in 1991. The Company's service area exceeded state-wide results with expected gains in non-agricultural employment of nearly 4.0 percent in 1993 with 5.3 percent and 5.4 percent in 1992 and 1991.\nPopulation growth in the Company's service area remains strong. Residential customer growth increased by 2.0 percent in 1991, 3.4 percent in 1992 and 3.4 percent in 1993. New households in the service area are forecasted to grow at a 3 percent annual average rate during the next five years with population growth estimated to exceed 2.2 percent per year over the same period.\nPower Cost Adjustment\nIn 1992, the Company asked the Idaho Public Utilities Commission (IPUC) to adopt a Power Cost Adjustment (PCA) mechanism that would enable the Company to collect, or require it to refund, all or a portion of the difference between net power supply costs actually incurred and those allowed in the base rates of the Company. The PCA is intended to avoid the need for temporary rate increases during low water years and will return benefits to customers in high water years. For the current year (May 1993 through April 1994) the PCA will be applied to 60 percent of the power cost deviations from normalized rates. After the Company's next general revenue requirement case is completed, the PCA will be raised to 90 percent of power supply costs.\nOn March 29, 1993, the IPUC approved a PCA mechanism in substantially the form proposed by the Company. Under the approved PCA, customers' power rates will be adjusted annually to reflect forecasted changes in the Company's net power supply costs in the current year and to true-up any deviation between forecasted and actual costs for the previous year.\nIn May 1993, the Company implemented its first PCA rate increase of $5.0 million. The current balance is adjusted monthly as actual conditions are compared to the forecasted net power supply costs. The final cumulative PCA amount as of May 15, 1994 will be included in the true-up portion of the 1994 PCA.\nRevenue\nFor the three-year period 1991, 1992, and 1993, an average of 87 percent of the Company's operating revenues were derived from electric sales in Idaho, 5 percent in Oregon, less than 1 percent in Nevada and 8 percent from the wholesale market. For the same three year period, residential customers averaged 34 percent of the Company's total operating revenues. Commercial and industrial customers with less than 750 Kw demand combined with irrigation and street lighting customers averaged 30 percent and commercial and industrial customers with 750 Kw demand and over averaged 19 percent. Sales to other utilities and interchange arrangements averaged 12 percent, and miscellaneous revenues averaged 5 percent.\nEnergy sales to the Company's general business customers increased 1.6 percent in 1991, 3.0 percent in 1992 but decreased 1.7 percent in 1993. These increases reflect the strong economic growth in the Company's service territory and varied temperature, precipitation and energy usage patterns. The decrease for 1993 resulted from a wet spring which reduced irrigation sales by 28.8 percent and temporary changes in operations at two of the Company's large industrial customers which lowered consumption during 1993. FMC Corporation's (FMC) elemental phosphorus production plant reduced operations at times during 1993 due to market conditions for the sale of its manufactured product. FMC also intends to maintain this reduced production level for a portion of 1994. The Idaho National Engineering Laboratory's (INEL) 1993 electrical use was down and can be volatile due to federal regulatory mandates and maintenance schedules. The INEL estimates a steady growth in the amount of consumption during 1994 and beyond.\nGeneral business revenues constitute approximately 84 percent of total operating revenues and were $409.5 million in 1991, $431.8 million in 1992 and $428.7 million in 1993. The increase in 1992 reflects an increase in irrigation revenues due to the drought and an increase in the number of customers served along with the temporary rate relief granted by the IPUC in May 1992. The decrease in 1993 results from the 27.9 percent decrease in irrigation revenue due to the wet spring which was partially offset by increases in residential revenues (9.3 percent) and small commercial revenues (4.0 percent). The number of general business customers served increased by 8.9 percent (or 25,972 customers) during the three year period. Energy usage per residential customer was 14,845 Kwh in 1991 versus 13,856 Kwh in 1992 and 14,587 Kwh in 1993.\nTotal operating revenues increased $18.3 million or 3.9 percent in 1991, $14.9 million or 3.1 percent in 1992, and $42.3 million or 8.5 percent in 1993. The increase for 1992 was due in part to the temporary rate relief granted by the IPUC in May 1992, along with an increase in customers served, while the increase for 1993 was due to increased opportunity sales to other utilities resulting from improved hydroelectric conditions and an increase in the number of general business customers.\nRegulatory Action\nDrought-Related Temporary Rate Increases\nIn response to drought conditions which reduced streamflows and increased power supply costs, the Company requested temporary rate relief several times during the three year period. In May 1992, the IPUC issued an order which authorized the Company to put in place for a twelve-month period a temporary rate increase of 3.9 percent or $15.0 million in additional revenues. At the same time the temporary rate increase ceased in May 1993, the Company implemented its first PCA rate increase of $5.0 million, combining for a net decrease of $10.0 million in rates.\nIn 1992 the Company received Oregon Public Utility Commission (OPUC) authority to defer with interest 33.5 percent of Oregon's share of increased power production costs starting on March 23, 1992 and continuing through December 31, 1992. The Company subsequently filed a request and received approval from the OPUC for a 24 month amortization period of an annual rate increase of $526,360 or 2.57 percent effective July 1, 1993.\nThe Company also submitted a rate increase request to the Federal Energy Regulatory Commission (FERC) to increase rates to certain wholesale customers. The FERC granted a $547,900 rate increase for a twelve-month period effective November 10, 1992.\nOn January 8, 1993, the IPUC authorized the Company to suspend five and one-half months (January 1, 1993, through June 15, 1993) of the revenue deferral associated with the Afton generation facility for a total of $1,225,707. This allowed the Company to defer additional 1992 reserve capacity (purchased generation available to meet load if needed) costs of $1,225,707 against the suspension of revenue deferral in 1993.\nGeneral Revenue Requirement Case\nThe Company intends to file a general revenue requirements case in its Idaho retail jurisdiction during 1994 and may also file in its Oregon retail jurisdiction. The purpose of the filing is to bring all of the Company's cost components to a current level in response to concerns expressed by the IPUC and various customer groups in recent regulatory proceedings regarding the length of time since the Company's costs were reviewed on a composite basis. In these proceedings the Company indicated that an opportunity for such a review would occur in the 1993\/1994 time frame and full implementation of the PCA will not occur until such a proceeding is completed. The amount of any additional revenue requirement to be requested has not yet been determined.\nWhen a case is filed the Company's allowed return on common equity will, among other things, be subject to review. Recent allowed returns on equity granted nationally have declined as a result of the current low interest rate environment. Low allowed returns on equity are a concern because they have created a contrast with dividend payout levels set during periods of higher interest rates for some utilities. The Company will seek an allowed return on equity above its present dividend yield on year- end book value sufficient to provide current earnings to cover dividend payments, but cannot predict the final outcome of such rate proceedings in the current low interest rate environment.\nOff-System Sales\nRevenues from sales to other utilities increased $8.2 million in 1991, decreased $10.6 million in 1992 but increased $44.5 million in 1993. These deliveries are comprised of firm sales, which are long-term contractual arrangements, and opportunity sales which are made on a when available basis. The volume and price of these sales depend on the Company's firm energy demand, hydrogeneration conditions in the Company's service area, and market conditions throughout the West. Revenues from firm sales to other utilities amounted to $41.5 million in 1991, $37.5 million in 1992 and $45.4 million in 1993. The decrease for 1992 was due to the termination at the end of 1991 of a short-term firm sales agreement and a reduction in the amount of energy taken by another customer pursuant to contract agreements. Revenues from opportunity sales to other utilities amounted to $11.0 million for 1991, decreased to $4.5 million in 1992 but increased to $41.1 million in 1993. For the years 1991 and 1992, the drought's adverse effect on the Company's hydrogeneration resulted in reduced sales, while in 1993 the return to more normal hydro conditions increased dramatically the volume of sales and revenue.\nExpenses\nTotal operating expenses increased $25.2 million in 1991, $16.4 million in 1992 and $5.3 million in 1993. The increases for 1991 and 1992 reflect the drought conditions which increased reliance on thermal generation and purchased power. The increase in operating expenses for 1993 reflects the deferral of certain net power supply costs to 1993 from 1992 to better match drought related expenses with surcharge revenues. Maintenance expense for 1993 increased reflecting more normal operating conditions.\nPurchased power expenses were high and fluctuated during the last three years reflecting necessity purchases from neighboring utilities during the drought periods and increased purchases from cogeneration and small power production (CSPP) projects during 1993 as a result of the improved hydro conditions. The estimated annualized cost for the 61 CSPP projects on-line as of December 31, 1993, is currently $40.6 million. The Company increased utilization of its thermal facilities by operating at high capacity factors during the drought which increased fuel expense for 1992 by $21.5 million. In 1993 fuel expense decreased $8.9 million as a direct result of increased availability of hydro facilities to meet customer demand.\nAll other operation and maintenance expenses increased $30.3 million over the same three year period. These increases were due, in part, to an increase in payroll and benefits ($10.1 million and 80 new employees), an increase in maintenance expense ($7.2 million) due to a return to more normal operating conditions and an increase in thermal operations ($6.0 million).\nDepreciation expense increased for the three year period by $3.6 million or 6.6 percent due to a greater plant investment base. Taxes other than income taxes increased $1.4 million or 6.6 percent due to increased property taxes and taxes on increased generation and sale of hydro power.\nInterest Charges\nInterest charges on long-term debt fluctuated during the three- year period, ultimately increasing by $2.7 million reflecting the maturity, early redemption, and issuance of several series of first mortgage bonds. The Company took advantage of the declining interest rate environment and refinanced several higher cost bond issues. These refinancings reduced the overall cost of debt and annual interest expense which largely offset the cost of additional financing (see Note 6 of Notes to Consolidated Financial Statement). Interest on short-term debt fluctuated due to varying interest rates on short-term debt during the period and changes in the level of short-term debt borrowings (see Notes 7 of Notes to Consolidated Financial Statement). The Company purchased Prairie Power Cooperative's (PPC) assets on July 24, 1992 and under the terms of the acquisition agreement with PPC, assumed the Cooperative's long-term debt (REA notes) of approximately $1,914,000. Income Taxes\nIn August 1993, Congress enacted the \"Omnibus Budget Reconciliation Act of 1993\" which, among other things, changed the statutory corporate federal income tax rate from 34 percent to 35 percent retroactive to January 1, 1993. Accordingly, taxes on current income were computed at the new higher rate. The Company requested and received from the IPUC permission to offset these higher taxes against a portion of the gain from the disposition of the Wood River Turbine recorded in 1993. The actual rates charged for electric service will not change due to the tax increase until the next general revenue requirement case is finalized. Also during 1993, the Company settled federal tax liabilities on the 1987 through 1990 tax years except for immaterial amounts that relate to a partnership.\nIda-West\nIda-West Energy Company (Ida-West), a wholly owned subsidiary of the Company, through various partnerships, has completed construction of the Hazelton B Project, the Wilson Lake Project and the Falls River Project. Third parties unaffiliated with Ida- West own 50 percent of each of these projects and the South Forks Project (which an Ida-West subsidiary and its partner acquired as an operating project in March 1992), thus satisfying \"qualifying facility\" status under PURPA guidelines. These partnerships have obtained project financing (non-recourse to the Company) having recently procured the initial permanent financing for the Hazelton B and Wilson Lake Projects from a single institutional investor and for the Falls River Project from a commercial lending institution.\nConstruction of both the Hazelton B and Wilson Lake Projects started in July 1991, and commenced commercial operation in May 1993. Construction of the Falls River Project began in August 1991, and started commercial operation in August 1993.\nAs a result of a construction-related incident involving the Falls River Project in 1992, the cost to complete the project increased from $15 million to $28.1 million, net after recovery of $2.56 million from insurance carriers. To help defray a portion of these additional costs, the project entity obtained an increase in project financing from $11.5 million to $18 million.\nOn June 16, 1993, the FERC issued a notice proposing civil penalties of no more than $500,000 for alleged license and FERC regulation violations in connection with the construction of the Falls River Project. The project entity is currently negotiating with the FERC for a reduction of these penalties and has recorded a portion of them as a liability.\nOn August 13, 1993, the state of Idaho appealed to the Ninth Circuit the FERC's June 16 denial of the state's request for rehearing of the FERC's January 13 order allowing resumption of construction. On November 24, 1993, the project entity reached a settlement with the state. Under the settlement, the project entity paid the state $150,000 for deposit into a fund to be used for studies and mitigation activities in the project vicinity, and the state dropped the appeal and released the project entity from any further liability arising out of past construction incidents.\nAs part of its Resource Contingency Program, the Bonneville Power Administration (BPA) requested proposals to provide up to 800 average megawatts of energy options. Ida-West along with two partners submitted a proposal for a 227 megawatt gas-fired cogeneration project to be located near Hermiston, Oregon, which was one of ten projects being given final consideration by BPA. On June 4, 1993, BPA selected the partnership's project, together with two other projects, to participate in the program. The partnership and BPA have signed an option development agreement which grants BPA an option to acquire energy from the project at any time during a five year option hold period after all option development period tasks, including permitting, have been completed. The partnership expects these development period tasks to be completed by year-end 1995.\nThe Company made an additional investment of $8.0 million in Ida- West during 1993 bringing its total equity investment to $20 million. Ida-West continues to actively seek or develop new projects.\nLIQUIDITY AND CAPITAL RESOURCES\nCash Flow\nNet cash generation from operations for the three-year period amounted to $365.4 million. After deductions for both common and preferred dividends ($212.3 million), net cash generation from operating activities provided approximately $153.1 million for the Company's construction program and other capital requirements.\nInternal cash generation after dividends provided 33 percent of the total capital requirements in 1991, 30 percent in 1992, 54 percent in 1993, and is projected to provide approximately 53 percent in 1994 and 73 percent during the five-year period 1994- 1998. The Company expects to continue financing its construction program using both internally generated funds, and to the extent required, externally financed capital. Drought conditions have negatively impacted the Company's internal cash generation in two of the last three years. In its 1994-1998 five-year forecast the Company anticipates issuing additional common stock and first mortgage bonds. During the forecast period, the Company also has first mortgage bond refundings of $20 million in 1996 and $30.0 million in 1998. At January 1, 1994 the total lines of credit maintained by the Company with various banks amounted to $70 million. (See Note 7 of Notes to Consolidated Financial Statements.)\nCash Construction Expenditures\nThe Company's consolidated cash construction expenditures were $133.7 million in 1991, $118.0 million in 1992, and $122.9 million in 1993. During 1992, in response to the ongoing drought conditions, the Company's cash construction budget was reduced. Approximately 44 percent of these expenditures were spent on generation facilities, 9 percent for transmission facilities, 32 percent for distribution facilities and 15 percent on general plant and equipment. Principal additions during the period to the Company's plant investment base include the completion of the Milner Powerhouse in October 1992. Testing at the Milner project was completed and the units were declared available for commercial operation during the fall of 1992. The total cost of construction at December 31, 1993 is $56.3 million including allowance for funds used during construction.\nPrairie Power\nOn June 30, 1992, the Company received approval from the IPUC to acquire the Prairie Power Cooperative (PPC) and provide service to its customers. Under the terms of the acquisition agreement, which was consummated on July 24, 1992, the Company acquired PPC's assets by assuming the cooperative's long-term debt of approximately $1.9 million. The Company agreed also to implement over the next ten years a $2.0 million rehabilitation of the distribution system and reduced those PPC customers' rates by 15 percent from PPC rates effective at the time of the acquisition. The new reduced rates will remain frozen at that level for 10 years and are higher than the Company's present rates for other Idaho retail customers.\nWood River Turbine Sale\nIn 1993 the Company sold a 50-megawatt gas fired turbine generator for $8.0 million. The Company's after-tax gain was $4.2 million ($3.6 applicable to the Idaho jurisdiction). The Company requested and received from the IPUC permission to use a portion of the gain from the turbine sale as an offset to the increased revenue requirement resulting from the additional income taxes for 1993.\nConstruction Program\nThe Company's construction program (as detailed below) for the 1994-1998 period includes the rebuild of the Swan Falls hydro facility and expansion of the Twin Falls hydro facility. The Company's 1994 cash construction expenditures are expected to be approximately $119.5 million with the 1994-1998 total presently estimated at $580.9 million.\nSwan Falls\nConstruction started in 1991 to rebuild the Swan Falls powerhouse and increase its generating capacity from 12 megawatts to 25 megawatts. The amended FERC license provides for the retirement of the present powerhouse and construction of a new powerhouse containing two generating units of 12.5 megawatts each with completion scheduled in 1994. The total cash expenditures of the rebuild are presently estimated at $53.6 million with total construction costs at $60.0 million including an allowance for funds used during construction.\nTwin Falls\nIn January 1991, the Company received a 50-year license from the FERC for the Twin Falls Project that approves increasing the generating capacity from 10 megawatts to 53 megawatts. The Company received approval from the IPUC to rebuild the Twin Falls hydroelectric facility as proposed in its application. Construction started in July 1993 with completion scheduled in mid 1995. The total cash expenditures of the expansion are presently estimated at $32.3 million with total construction costs at $34.2 million including allowance for funds used during construction.\nSouthwest Intertie Project\nCapitalizing on the Company's strategic location between the Intermountain West and the Pacific Northwest, the Company is considering the construction and operation of a new transmission line which could serve as a major artery for regional transfers of power between north and south. The Southwest Intertie Project (SWIP) is a proposed 520-mile, 500 Kv transmission line which would interconnect the Company's system with utilities in the Southwest. The Bureau of Land Management (BLM) has completed the Final Environmental Impact Statement\/Proposed Plan Amendment (EIS) for the SWIP. Approval of the EIS from the BLM is expected during the second quarter of 1994. After approval of the EIS, the economic feasibility of the line will be validated prior to the time the Company proceeds with construction. The Company has received preliminary commitments from various utilities and electric providers for financial participation in the project. It is the Company's intention to retain up to a 20 percent ownership in the line.\nSolar\nThe Company has joined Southern California Edison, the U. S. Department of Energy and others in retrofitting an existing 10- megawatt solar thermal experimental power plant called Solar 2. The Company will contribute $630,500 over the next three years and the Electric Power Research Institute, of which the Company is a member, will contribute an additional $630,500 of matching funds, bringing the Company's credited contribution to approximately $1.3 million. The project is located near Barstow, California, and should begin generating electricity in 1995.\nPhotovoltaic Systems\nIn August 1992, the Company proposed a $5 million three-year pilot program to design, install, and maintain solar-powered photovoltaic systems for remote locations that would otherwise require costly line extensions. It is the Company's intent to service only those inquiries located in its service territory. The IPUC approved the proposal during September 1993 with the OPUC giving its approval in October 1993 and the Nevada Public Service Commission in June 1993.\nFinancing Program\nCapital Structure\nThe Company's capital structure (as illustrated in Selected Financial Data) has fluctuated during the three year period with common equity remaining stable at 44 percent, preferred increasing to 9 percent and debt decreasing to 47 percent. It is the Company's objective to maintain capitalization ratios of approximately 45 percent common equity, 8 to 10 percent preferred stock and the balance long-term debt. The Company's strategy is to achieve this target structure through accumulated earnings and issuance of new equity. The Company's pre-tax interest coverage ratios were 2.34 times in 1991, 2.50 times in 1992, and 3.14 times in 1993. The Company has on file a shelf registration statement for the issuance of first mortgage bonds and\/or preferred stock with the total aggregate principal not to exceed $200.0 million. The primary financial commitments at year-end 1993 are related to contracts and purchase orders for the Company's program for construction and operation of facilities.\nCommon Stock\nOn July 8, 1992, the Company sold 1,250,000 shares of Common Stock. The net proceeds of $30,706,250 were used for payment of $4.0 million of short-term debt and the Company's ongoing construction program.\nIn 1992, the Company also resumed issuing original issue shares to its Employee Savings Plan, the Dividend Reinvestment and Stock Purchase Plan and the Employee Stock Ownership Plan. During the twelve months ended December 31, 1993 and 1992, common shares totaling 898,528 and 959,527 were issued producing $26.7 million and $25.5 million in proceeds to the Company, which were used for its on-going construction program. Preferred Stock\nDuring 1991, the Company issued $25.0 million of serial preferred stock which was used to retire an existing $25.0 million of serial preferred stock. Also, in November 1991, the Company issued $50.0 million of Auction Preferred Stock which proceeds were used to retire early $32.5 million of first mortgage bonds, to retire at maturity $10.0 million of first mortgage bonds and other corporate purposes. On July 1, 1993 the Company utilized its remaining preferred stock shelf registration and issued $25 million of serial preferred stock. The net proceeds of the issuance were used for the Company's ongoing construction program.\nLong-Term Debt\nOn January 14, 1991, the Company issued $75,000,000 principal amount of first mortgage bonds due January 1, 2021. The net proceeds were used for payment of $48,280,000 of short-term borrowings. The remainder of the funds were invested in temporary cash investments until needed for general corporate purposes.\nOn August 19, 1991, the Company issued $25,000,000 principal amount of first mortgage bonds due August 2031. This series of bonds was issued on a private placement basis and the net proceeds were used for payment of $21,950,000 of short-term borrowings with the remainder used for construction and general corporate purposes.\nOn March 25, 1992, the Company issued $100,000,000 principal amount of first mortgage bonds, $50,000,000 due in 2004, and $50,000,000 due in 2027. The net proceeds were used to pay down $36,000,000 of outstanding commercial paper notes, the early redemption of $50,000,000 of existing first mortgage bonds due 2004, and for the Company's ongoing construction program.\nOn April 28, 1993 the Company issued $160,000,000 principal amount of secured medium term notes, $80,000,000 due in 2003 and $80,000,000 due in 2023. In May, the net proceeds were used to retire early four series of first mortgage bonds totaling $155,000,000 plus premiums and accrued interest. On September 1, 1993 the Company issued $30,000,000 principal amount of secured medium term notes due in 1998. In October 1993, the net proceeds were used to retire early, first mortgage bonds of $30,000,000 plus premiums and accrued interest.\nEnvironmental Issues\nPacific Hide & Fur\nDuring 1989, a Partial Consent Decree was filed with the United States District Court for the District of Idaho wherein the Company agreed to clean up the PCBs at a superfund site (Pacific Hide & Fur Depot) and further agreed to pay for three years of operation and maintenance of the site after the Certification of Completion is issued by the Environmental Protection Agency (EPA). Remediation activities were completed in 1992 by moving the PCB contaminated soil to an EPA approved off-site disposal facility.\nThe EPA is conducting an investigation regarding parties responsible for lead contamination at the site. Information indicates that the Company may have contributed a very small amount of lead to the site. However, the EPA has presently indicated the Company's involvement in the lead contamination at the site is insignificant and that the Company may not be required to participate in the lead clean-up.\nAt present, the Company has expensed approximately $6.9 million to cover the estimated total cost of implementing remediation of the PCBs and lead contaminated soil and scrap at the site.\nMountaineer\nIn May 1993, the Company was notified that Bridger Coal Company (BCC), a joint venture, which is one-third owned by Idaho Energy Resources Co (IERCO), a wholly-owned subsidiary of the Company, was a potential contributor to a superfund site involving waste motor oil delivered to a refinery (Mountaineer Refinery) in Wyoming. In November 1993, BCC agreed to be included on the potentially responsible party list for this site. The current estimated cost for clean up is from $2.6 million to $5.0 million. BCC's portion of the clean up, based on the amount of oil delivered to the site, is estimated to be approximately 9 percent, or $234,000 to $450,000. IERCO would be liable for one- third of the BCC portion, or approximately $78,000 to $150,000. This liability has not been recorded in the Company's consolidated financials because it does not have a material effect on the results of operations.\nPCB Program\nThe Company has a program to make the 200-plus substations on its system non-PCB. The costs for this disposal program were $0.9 million, $0.3 million and $0.1 million for 1991, 1992, and 1993 respectively. While the Company's use of equipment containing PCBs falls well within the federal safety standards, the Company has voluntarily decided to virtually eliminate these compounds from the substation sites. This program will save costs associated with the long-term monitoring and testing of substation equipment and grounds for PCB contamination as well as being good for the environment today.\nSalmon Recovery Plans\nThe Company continues to be actively involved with the long-term survival of anadromous fish runs on the Columbia and Lower Snake Rivers. The Company fully supports and actively participates in the regional effort to develop a comprehensive and scientifically credible recovery program for the salmon.\nThe Snake River Salmon Recovery Team submitted its Draft Recovery Plan to the National Marine Fisheries Service (NMFS) detailing its draft recommendations for restoring the listed Snake River salmon runs. The Company has concluded a review of the 500-page report and believes it sets forth a course of action that, if fully implemented, could lead to a successful recovery. The Draft Plan details comments regarding some institutional changes and responsibility for management of the recovery efforts. It suggests reductions in the ocean and in-river harvest rates, calls for significant improvements in transportation and collection systems, supports flow augmentation and habitat improvements, calls for a test drawdown of the Lower Granite Reservoir on the Snake River and suggests habitat, hatchery and predation improvements. The Company will continue to closely monitor the finalization of the Recovery Plan which is expected to be released in 1994.\nIt is possible the final recovery plan could have a material impact on the Company, as well as every other person, community and industry in the Northwest that depend on the Snake and Columbia Rivers. The Company is hopeful that the anadromous fish runs can be restored to the level that society demands without undue hardship placed upon the Company and those who benefit from its service.\nNez Perce Tribe\nOn December 6, 1991, the Nez Perce Tribe filed a civil action against the Company in the United States District Court for the District of Idaho. The Tribe alleges that the Company's construction, operation and maintenance of the Hells Canyon Project, consisting of the Brownlee, Oxbow and Hells Canyon Dams, prevented anadromous fish from reaching their traditional spawning areas, and destroyed certain runs of those fish. This allegedly deprived the Nez Perce Tribe of its treaty right to take fish from the Snake and Columbia Rivers. The Nez Perce Tribe is seeking compensatory and punitive damages, each in an amount to be proven at trial. The Company maintains the suit is without merit and has asked the federal court to enter a summary judgment dismissing the action. The Company believes responsibility for the concerns the Nez Perce Tribe has identified lies with the United States. The Company's Hells Canyon Project was licensed by the federal government and built in accordance with federally approved plans. Since its inception, the Project has been operated subject to federal regulation. The Company has complied with all governmental requirements for mitigation of any impacts the Project may have had on the fisheries. On January 19, 1993, a hearing was held in Federal Court on the Company's motion for summary judgment and the Court took the matter under advisement. On July 30, 1993, the magistrate issued a Report and Recommendation to the District Judge wherein it is recommended that the Company's motion for summary judgment be granted. Following briefing by the parties the District Judge by order dated November 30, 1993, referred to the magistrate for additional findings the tribes claim for compensation based on exclusion from its usual and accustomed fishing places resulting from the construction of the Hells Canyon Project. This issue has been fully briefed by the parties and oral argument was held on February 11, 1994.\nSnake River Mollusk\nIn mid-December 1992, five Snake River mollusks were listed as endangered and threatened species. This possibility has been a part of all the Company's discussions regarding relicensing and new hydro development since that time. The listing could influence the way the Company operates its existing mid-Snake River hydro facilities.\nThe listing specifically mentions the impact fluctuating water levels related to hydro operations may have on the snails' habitat. While most of the facilities on that stretch of the river are baseload facilities, some do provide load-following capability. There is uncertainty on exactly what impact, if any, water fluctuations caused by the facilities have on the snails. The Company intends to testify to the U. S. Fish and Wildlife Service, the listing agency, that there is little data in this area and that it proposes to study these operations. While there is potential the listing could impact the way the Company operates these facilities, the Company believes such changes will be minor and not present any undue hardship.\nClean Air\nThe Company has analyzed the Clean Air Act legislation and its effects upon the Company and its ratepayers. The Company's coal- fired plants in Nevada and Oregon already meet the federal emission rate standards and the Company's coal-fired plant in Wyoming meets that state's even more stringent regulations. The Company anticipates no material adverse effect upon its operations.\nElectric and Magnetic Fields\nWhile scientific research has yet to establish any conclusive link between electric and magnetic fields and human disease, the possibility of a connection has caused public concern both nationally and internationally. Electric and magnetic fields are found wherever there is electric current, whether it be in a high- voltage transmission line or the simplest of household electrical appliances. Concern over possible health effects already has prompted regulatory efforts to limit human exposure to electric and magnetic fields in several areas of the nation. Depending on what researchers ultimately discover and what regulations may be deemed necessary, it is an issue that could impact a number of industries, including electric utilities. At this time it is difficult to estimate what impact, if any, the issue could have on the Company and its operations.\nCompetition\nThe electric utility industry in general has become, and is expected to be, increasingly competitive due to a variety of regulatory, economic and technological developments. The Energy Policy Act of 1992 was designed, among other things, to foster competition in the wholesale market (a) through amendments to the Holding Company Act, facilitating the ownership and operation of generating facilities by \"exempt wholesale generators\" (which may include independent power producers as well as affiliates of electric utilities) and (b) through amendments to the Power Act, authorizing the FERC under certain conditions to order utilities which own transmission facilities to provide wholesale transmission services to or for other utilities and other entities generating electric energy for sale or resale.\nWith the passage of the Energy Policy Act and the advent of a more competitive electric utility environment, the Company has intensified its ongoing strategic planning process. The Company's goal is to anticipate and fully integrate into its operations any legislative, regulatory, environmental, competitive and technological changes. The Company is well positioned to succeed in a more competitive environment with its low cost of energy production and is taking action to preserve its competitive advantage. A major action area identified is the Company's resource acquisition policies.\nIn September the Company submitted a detailed position paper to its state regulators and other interested parties outlining proposed resource acquisition policy changes. With the potential deregulation of the electric utility industry and a more competitive power supply market place, the Company believes that current resource acquisition policies must be changed to avoid burdening the Company and customers with unnecessary future power supply costs. The Company wants to establish that future supply additions are both needed at the time of development and are the least-cost market alternative. Accordingly, in December 1993, the Company filed with the IPUC for permission to approve new lower prices for CSPP purchases. The Company believes existing rates are no longer appropriate and that prices paid to CSPP developers should be based upon need for the power and current market conditions.\nAt the same time, in its position paper the Company proposes to abandon planned development or expansion of several of its own hydroelectric projects ahead of need. Expansion of existing projects will only proceed if the price of the incremental capacity is competitive within the regional marketplace or unless required to do so under federal licensing rules. Accordingly, the Company will forego relicense upgrades to its Shoshone Falls and Upper Salmon hydro plants (unless necessitated by relicensing requirements) and anticipates requesting permission from regulators to abandon the proposed A. J. Wiley Project on the Snake River. The remaining costs associated with the A.J. Wiley Project to be written off will be immaterial.\nRelicensing\nAs a result of various federal legislative actions and proposals (such as the Electric Consumers Protection Act of 1986, Energy Policy Act of 1992, Clean Water Act Reauthorization and Endangered Species Act Reauthorization) a major issue facing the Company is the relicensing of its hydro facilities. Because the federal licenses for the majority of the Company's hydroelectric projects expire during the next 10 to 15 years, the Company has established an internal task force to vigorously pursue the relicensing process. The relicensing of these projects is not automatic under federal law. The Company must demonstrate comprehensive usage of the facilities, that it has been a conscientious steward of the natural resource entrusted to it and that there is a strong public interest in the Company continuing to hold the federal licenses. The Company can not anticipate what type of environmental or operational requirements may be placed on the projects in the relicensing process, nor can it estimate what the eventual cost will be for relicensing. However, the Company anticipates that its efforts in this matter for all of the hydro facilities will prove to be successful.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAND FINANCIAL STATEMENT SCHEDULES\nPAGE\nManagement's Responsibility for Financial Statements 57\nConsolidated Financial Statements:\nConsolidated Balance Sheets as of December 31, 1993, 1992 and 1991 58-59\nConsolidated Statements of Income for the Years Ended December 31, 1993, 1992 and 1991 60\nConsolidated Statements of Retained Earnings for the Years Ended December 31, 1993, 1992 and 1991 61\nConsolidated Statements of Capitalization as of December 31, 1993, 1992 and 1991 62\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1992 and 1991 63\nNotes to Consolidated Financial Statements 64-79\nIndependent Auditors' Report 80\nSupplemental Financial Information (Unaudited) 81\nSupplemental Schedules for the Years Ended December 31, 1993, 1992 and 1991:\nSchedule V- Property, Plant and Equipment 89-91\nSchedule VI- Accumulated Depreciation and Amortization of Property, Plant and Equipment 92-94\nSchedule VIII- Valuation and Qualifying Accounts 95\nSchedule X- Supplementary Income Statement Information 96\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe management of Idaho Power Company is responsible for the preparation and presentation of the information and representations contained in the accompanying financial statements. The financial statements have been prepared in conformance with generally accepted accounting principles for a rate regulated enterprise. Where estimates are required to be made in preparing the financial statements, management has applied its best judgment as to the adequacy of the estimates based upon all available information.\nThe Company maintains a system of internal accounting controls and related policies and procedures designed to provide reasonable assurance that all assets are protected against loss or unauthorized use and that transactions are executed in accordance with management's authorization and properly recorded to permit preparation of reliable financial statements. The systems are supported by a staff of corporate accountants and internal auditors who, among other duties, evaluate and monitor the systems of internal accounting control in coordination with the independent auditors. The staff of internal auditors conduct special and operational audits in support of these accounting controls throughout the year.\nThe Board of Directors, through its Audit Committee comprised entirely of outside directors, meets periodically with management, internal auditors and the Company's independent auditors to discuss auditing, internal control and financial reporting matters. To ensure their independence, both the internal auditors and independent auditors have full and free access to the Audit Committee.\nThe financial statements have been audited by Deloitte & Touche, the Company's independent auditors, who were responsible for conducting their audit in accordance with generally accepted auditing standards.\nBy:__\/s\/__Joseph W. Marshall__ By:__\/s\/__J. LaMont Keen__ Joseph W. Marshall J. LaMont Keen Chairman and Vice President and Chief Chief Executive Officer Financial Officer\nBy:__\/s\/__Harold J. Hochhalter__ Harold J. Hochhalter Controller and Chief Accounting Officer\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION _ The consolidated financial statements include the accounts of the Company and its wholly- owned subsidiaries, Idaho Energy Resources Co (IERCO), Idaho Utility Products Company (IUPCO), IDACORP, INC. and Ida-West Energy Company (Ida-West). All significant intercompany transactions and balances have been eliminated in consolidation.\nSYSTEM OF ACCOUNTS _ The Company is an electric utility and its accounting records conform to the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission and adopted by the public utility commissions of Idaho, Oregon, Nevada and Wyoming.\nELECTRIC PLANT _ The cost of additions to electric plant in service represents the original cost of contracted services, direct labor and material, allowance for funds used during construction and indirect charges for engineering, supervision and similar overhead items. Maintenance and repairs of property and replacements and renewals of items determined to be less than units of property are charged to operations. For property replaced or renewed the original cost plus removal cost less salvage is charged to accumulated provision for depreciation while the cost of related replacements and renewals is added to electric plant.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFDC) _ The allowance, a non-cash item, represents the composite interest costs of debt, shown as a reduction to interest charges, and a return on equity funds, shown as an addition to other income, used to finance construction. While cash is not realized currently from such allowance, it is realized under the ratemaking process over the service life of the related property through increased revenues resulting from higher rate base and higher depreciation expense. Based on the uniform formula adopted by the Federal Energy Regulatory Commission (FERC), the Company's weighted average monthly AFDC rates for 1993, 1992 and 1991 were 9.6%, 8.7% and 9.4%, respectively.\nREVENUES _ In order to match revenues with associated expenses, the Company accrues unbilled revenues for electric services delivered to customers but not yet billed at month- end.\nRATE RELIEF _ On May 4, 1992, the Idaho Public Utilities Commission (IPUC) issued an order which authorized the Company to put in place for a twelve-month period temporary rate relief of 3.9 percent or $15.0 million effective May 6, 1992. The Company also filed and received an accounting order from the Oregon Public Utility Commission (OPUC) for permission to begin deferring with interest 33.5 percent of Oregon's share of increased power production costs starting on March 23, 1992 and continuing through December 31, 1992. The Company filed a request and received approval from the OPUC for a 24 month amortization period of an annual rate increase of $526,360 or 2.57 percent effective July 1, 1993. The Company also submitted a rate increase request to the FERC for approval to increase rates to its wholesale customers. The FERC granted a $547,900 rate increase for a twelve-month period effective November 10, 1992. All of these rate actions were requested due to drought related effects during 1991 and 1992, which reduced water flows and increased net power supply costs.\nOn October 9, 1992, the Company filed an application with the IPUC which would allow the Company to suspend the deferral of certain revenue items to partially offset the increase in 1992 power supply costs. On January 8, 1993, the IPUC authorized the Company to suspend five and one-half months (January 1, 1993 through June 15, 1993) of the revenue deferral associated with the Afton cogeneration facility for a total of $1,225,707. This allowed the Company to defer additional 1992 reserve capacity costs of $1,225,707 against this suspension of revenue deferrals in 1993.\nOn March 29, 1993, the IPUC approved a power cost adjustment (PCA) mechanism for the Company, pursuant to the Company's application requesting authority to implement a PCA. Under the PCA, customer's rates will be adjusted annually to reflect the Company's forecasted net power supply costs. Deviations from predicted costs are deferred with interest and then adjusted (trued-up) in the subsequent year. A transition period was established providing for inclusion of 60% of power cost deviations from normalized rates in the PCA until conclusion of the Company's next general rate case when the allowed percentage will increase to 90%.\nOn May 16, 1993, the Company implemented its first PCA after the IPUC approved a $5.0 million revenue increase to base rates for the period May 16, 1993 through May 15, 1994. At the same time the one-year temporary rate relief granted in May 1992 ceased and the combined effect was a decrease of $10.0 million in rates.\nDEPRECIATION _ Effective April 1, 1993, the Company revised its depreciation methodology on certain generation plants from the five percent present worth method to the straight- line method. This change and the extention of the service lives of certain plants resulted in a minimal change in depreciation expense. All electric plant is now depreciated using the straight-line method. Annual depreciation provisions as a percent of average depreciable electric plant in service approximated 2.92% in 1993, 2.91% in 1992 and 2.93% in 1991 and are considered adequate to amortize the original cost over the estimated service lives of the properties.\nINCOME TAXES _ Consistent with orders and directives of the IPUC, the regulatory authority having principal jurisdiction, deferred income taxes (commonly referred to as normalized accounting) are provided for the difference between income tax depreciation and straight-line depreciation on coal-fired generation facilities and properties acquired after 1980. On other facilities, deferred income taxes are provided for the difference between accelerated income tax depreciation and straight-line depreciation using tax guideline lives on assets acquired prior to 1981. Deferred income taxes are not provided for those income tax timing differences where the prescribed regulatory accounting methods do not provide for current recovery in rates. The Company adopted SFAS No. 109 \"Accounting for Income Taxes\" on January 1, 1993 which had no material effect on the earnings of the Company (see Note 2).\nThe state of Idaho allows a three percent investment tax credit upon certain plant additions. Investment tax credits are deferred and amortized to income over the estimated service lives of the related properties.\nPURCHASED POWER _ The Company has contracts to purchase the energy from five PURPA Qualified Facilities which are 50 percent owned by Ida-West (a wholly-owned subsidiary of the Company). Power purchased from these facilities amounted to $5,975,093 in 1993.\nCASH AND CASH EQUIVALENTS _ For purposes of reporting cash flows, cash and cash equivalents include cash on hand and highly liquid temporary investments with original maturity dates of three months or less. The Company has changed the Statements of Cash Flows from the indirect method to the direct method. Previous year's presentations have been restated to conform with the new method.\nOTHER ACCOUNTING POLICIES _ Debt discount, expense and premium are being amortized over the terms of the respective debt issues.\nRECLASSIFICATIONS _ Certain items previously reported for years prior to 1993 have been reclassified to conform with the current year's presentation. Net income was not affected by these reclassifications.\n2. INCOME TAXES:\nA reconciliation between the statutory federal income tax rate and the effective rate for the years 1993, 1992 and 1991 is as follows:\nDuring 1993, the Company settled federal tax liabilities on the 1987 through 1990 tax years except for immaterial amounts that relate to a partnership. Federal income tax returns for years 1991 and 1992 are under examination by the Internal Revenue Service and the Company believes that a final settlement of its federal income tax liabilities for these years will not have a material effect on its results of operation or financial position.\nThe Company adopted SFAS No. 109 \"Accounting for Income Taxes\" on January 1, 1993 which had no material effect on the earnings of the Company. SFAS 109, among other things, (i) requires the liability method be used in computing deferred taxes on all temporary differences between book and tax basis of assets and liabilities; (ii) requires that deferred tax liabilities and assets be adjusted for an enacted change in tax laws or rates; and (iii) prohibits net-of-tax accounting and reporting. Regulated enterprises are required to recognize such adjustments as regulatory assets or liabilities if it is probable that such amounts will be recovered from or returned to customers in future rates. As of December 31, 1993, the Company has recorded regulatory assets of $176.5 million and regulatory liabilities in the amount of $35.0 million which were offset by an equal amount of accumulated deferred income tax provision. The regulatory asset is primarily based upon differences between the book and tax basis of the electric plant in service and the accumulated reserve for depreciation.\nIn August 1993, Congress passed the Revenue Reconciliation Act of 1993 which retroactively to January 1, 1993 increased the Federal tax rate from 34% to 35%. The Company requested and received from the IPUC permission to recover the higher taxes by realizing a portion of the gain on the sale of the Wood River Turbine as income in 1993.\n3. COMMON STOCK:\nChanges in shares of the common stock of the Company for 1993, 1992 and 1991 were as follows:\nCommon Stock Premium $2.50 on Shares Par Capital Value Stock (Thousands of Dollars)\nBalance at December 31, 1990 33,977,000 $84,942 $275,802 Gain on reacquired 4% preferred stock (Note 4) - - 283 Preferred stock redemption (Note 4) - - (580)\nBalance at December 31, 1991 33,977,000 84,942 275,505 Gain on reacquired 4% preferred stock (Note 4) - - 152 Stock purchase plans 959,527 2,399 23,101 Public offering (July 1992) 1,250,000 3,125 27,580 Balance at December 31, 1992 36,186,527 90,466 326,338 Gain on reacquired 4% preferred stock (Note 4) - - 50 Stock purchase plans 898,528 2,247 24,494\nBalance at December 31, 1993 37,085,055 $92,713 $350,882\nDuring the first quarter of 1992 the Company reinstated issuing original issue shares of common stock for its Dividend Reinvestment and Stock Purchase Plan, the Employee Savings Plan and the Employee Stock Ownership Plan. During 1993 and 1992, common shares totaling 898,528 and 959,527, respectively, have been issued to these plans.\nOn July 8, 1992, the Company issued 1,250,000 shares of its common stock. The net proceeds of $30,706,250 were received and used for the payment of $4.0 million of short-term debt with the remainder used for the Company's ongoing construction program.\nAs of December 31, 1993, the Company had 2,151,078 of its authorized but unissued shares of common stock reserved for future issuance under its Dividend Reinvestment and Stock Purchase Plan, Employee Savings Plan and Employee Stock Ownership Plan.\nOn January 11, 1990, the Board of Directors adopted a Shareowner Rights Plan (Plan). Under the Plan, the Company declared a distribution of one Preferred Stock Right (Right) for each of the Company's outstanding Common shares held on January 29, 1990 or issued thereafter. The Rights are currently not exercisable and will be exercisable only if a person or group (Acquiring Person) either acquires ownership of 20 percent or more of the Company's Voting Stock or commences a tender offer that would result in ownership of 20 percent or more. The Company may redeem the Rights at a price of $0.01 per Right anytime prior to acquisition by an Acquiring Person of a 20 percent position.\nFollowing the acquisition of a 20 percent position, each Right will entitle its holder, subject to regulatory approval, to purchase for $85 that number of shares of Common Stock or Preferred Stock having a market value of $170.\nIf after the Rights become exercisable, the Company is acquired in a merger or other business combination, 50 percent or more of its consolidated assets or earnings power are sold or the Acquiring Person engages in certain acts of self-dealing, each Right entitles the holder to purchase for $85, shares of the acquiring company's Common Stock having a market value of $170. Any Rights that are or were held by an Acquiring Person become void if either of these events occurs. The Rights expire on January 11, 2000.\n4. PREFERRED STOCK:\nThe number of shares of preferred stock outstanding at December 31, 1993, 1992 and 1991 was as follows:\nShares Outstanding at December 31, Call Price 1993 1992 1991 Per Share\nPreferred stock: Cumulative, $100 par value:\n4% preferred stock (authorized 215,000 shares) 177,506 178,735 181,913 $104.00\nSerial preferred stock, 7.68% Series (authorized 150,000 shares) 150,000 150,000 150,000 $102.97\nSerial preferred stock, cumulative, without par value; total of 3,000,000 shares authorized:\n8.375% Series, $100 stated value, (authorized 250,000 shares)(a) 250,000 250,000 250,000 $105.58 to $100.37\n7.07% Series, $100 stated value, (authorized 250,000 shares)(b) 250,000 - - $103.535 to $100.354\nAuction rate preferred stock, $100,000 stated value, (authorized 500 shares)(c) 500 500 500 $100,000.00\nTotal 828,006 579,235 582,413 [FN] (a) The preferred stock is not redeemable prior to October 1, 1996. (b) The preferred stock is not redeemable prior to July 1, 2003. (c) Dividend rate at December 31, 1993 was 3.04% and ranged between 2.62% and 3.21% during the year.\nDuring 1993, 1992 and 1991 the Company reacquired and retired 1,229; 3,178 and 5,697 shares of 4% preferred stock resulting in a net addition to premium on capital stock of $50,151; $151,891 and $282,431, respectively. As of December 31, 1993 the overall effective cost of all outstanding preferred stock was 5.70 percent.\nOn July 1, 1993 the Company utilized the remaining preferred stock shelf registration and issued $25,000,000 of 7.07% Series, Serial Preferred Stock ($100 stated value). The net proceeds of the issuance were used for the Company's ongoing construction program.\n5. FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe estimated fair value of the Company's financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nCash and cash equivalents, customer and other receivables, notes payable, accounts payable, interest accrued, and taxes accrued are reported at their carrying value as these are a reasonable estimate of their fair value. The total estimated fair value of long-term debt was approximately $733,251,000 for 1992 and $762,575,000 for 1993. The estimated fair values for long-term debt are based upon quoted market prices of the same or similar issues.\n6. LONG-TERM DEBT:\nThe amount of first mortgage bonds issuable by the Company is limited to a maximum of $900,000,000 and by property, earnings and other provisions of the mortgage and supplemental indentures thereto. Substantially all of the electric utility plant is subject to the lien of the indenture. Pollution Control Revenue Bonds, Series 1984, due December 1, 2014, are secured by First Mortgage Bonds, Pollution Control Series A, which were issued by the Company and are held by a Trustee for the benefit of the bondholders.\nOn March 25, 1992, the Company issued $50,000,000 principal amount of First Mortgage Bonds, 8% Series, due 2004, and $50,000,000 principal amount of First Mortgage Bonds, 8 3\/4% Series, due 2027. The net proceeds were used initially to pay down $36,000,000 of outstanding commercial paper notes and the remainder was used for the early redemption of $50,000,000 First Mortgage Bonds, 10% Series, due 2004, and for the Company's ongoing construction program.\nOn April 28, 1993 the Company issued $80,000,000 principal amount of Secured Medium Term Notes, Series A, 6.40% Series due 2003 and $80,000,000 principal amount of Secured Medium Term Notes, Series A, 7.50% Series due 2023. In May, the net proceeds were used to retire early four series (7 3\/4% Series due 2002, 8 3\/8% Series due 2004, 8 1\/2% Series due 2006 and 9% Series due 2008) of first mortgage bonds totaling $155,000,000 plus premiums and accrued interest. On September 1, 1993 the Company issued $30,000,000 principal amount of Secured Medium Term Notes, Series A, 5.33% Series due 1998. On October 1, 1993, the net proceeds were used to retire early the 6 1\/8% Series, First Mortgage Bonds of $30,000,000 plus premiums and accrued interest. The early redemption of these first mortgage bonds reduced the Company's overall cost of long-term debt and reduced the Company's annual interest expense by approximately $2.3 million.\nThe only first mortgage bonds maturing during the five-year period ending 1998 are $20,000,000 in 1996 and $30,000,000 in 1998. Sinking fund requirements for the first mortgage bonds outstanding at December 31, 1993 are $5,398,000 per year. These requirements may be met by the deposit of cash, deposit of bonds, or by certification of property additions at the rate of 167% of requirements. The Company's practice is to certify additional property to meet the sinking fund requirements. In September 1991, 1992 and 1993, $350,000, $350,000, and $400,000 respectively, of the 5.90% Series, Pollution Control Revenue Bonds, were retired pursuant to sinking fund requirements for those years. Sinking fund requirements during the five-year period ending 1998 for pollution control bonds outstanding at December 31, 1993 are $400,000 in 1994, $450,000 in 1995 and 1996, and $500,000 in 1997 and 1998. As of December 31, 1993, the overall effective cost of all outstanding first mortgage bonds and pollution control revenue bonds was 8.02 percent in comparison to 8.33 percent in 1992 and 8.43 percent in 1991.\nOn February 10, 1992, $11,700,000 principal amount of 8.95% Guaranteed Notes due 2017 were issued by Milner Dam, Inc., an Idaho Corporation, in which the Twin Falls Canal Company and the North Side Canal Company have assigned their interest in the Milner Dam Rehabilitation Project. The Company, pursuant to an agreement signed with Milner Dam. Inc., executed a guarantee of these notes and agreed to make royalty (falling water) payments to Milner Dam, Inc. for use of water released from the Milner Dam Rehabilitation Project beginning in 1993.\n7. NOTES PAYABLE:\nAt January 1, 1994, the Company had regulatory authority to incur up to $150,000,000 of short-term indebtedness. Under this authority, total lines of credit maintained with various banks amounted to $70,000,000. Under annual borrowing arrangements with these banks, the Company is required to pay a fee of 3\/16 of 1% on the available and committed lines of credit. Commercial paper may be issued in an amount not to exceed 25% of revenues for the latest twelve-month period and are supported by bank lines of credit of an equal amount.\nBalances and interest rates of short-term borrowings were as follows:\nYear Ended December 31, 1993 1992 1991 (Thousands of Dollars)\nBalance at end of period: Banks $4,000 $2,000 $10,500 Commercial paper - 4,000 38,000\nEffective annual interest rate at end of period: Banks 6.9% (a) 5.9% 5.3% Commercial paper - 5.9 5.3\nMaximum balance during period: Banks $10,500 $37,500 $25,000 Commercial paper 14,000 47,400 48,280\nAverage daily balance during period: Banks $1,800 $3,600 $6,700 Commercial paper 900 8,300 7,200\nEffective annual interest rate during period: Banks 7.6% (a) 5.5% 6.5% Commercial paper 9.1 (a) 5.4 6.9 [FN] (a) Effective rates have been inflated by the commitment fees being larger than the interest paid for the year. If the commitment fees were excluded the effective annual interest rate at end of period would have been 3.6%. The effective annual interest rate during period for banks and commercial paper would have been 3.1% and 3.5%, respectively.\n8. COMMITMENTS AND CONTINGENT LIABILITIES:\nCommitments under contracts and purchase orders relating to the Company's program for construction and operation of facilities amounted to approximately $25,300,000 at December 31, 1993. The commitments are generally revocable by the Company subject to reimbursement of manufacturers' expenditures incurred and\/or other termination charges.\nThe Company is party to various legal claims, actions, and complaints, certain of which involve material amounts. Although the Company is unable to predict with certainty whether or not it will ultimately be successful in these legal proceedings or, if not, what the impact might be, based upon the advice of legal counsel, management presently believes that disposition of these matters will not have a material adverse effect on the Company's results of operations.\n9. BENEFIT PLANS:\nPension Plan - The Company maintains a trusteed noncontributory defined benefit pension plan for all employees who work 1,000 hours or more during a calendar year. The benefits under the plan are based on years of service and the employee's final average earnings. The Company's policy is to fund with an independent corporate trustee at least the minimum required under the Employee Retirement Income Security Act of 1974 but not more than the maximum amount deductible for income tax purposes. The Company funded $5.0 million in 1993, and $5.1 million in 1992. The plan's assets held by the trustee consist primarily of listed stocks (both U.S. and foreign), fixed income securities and investment grade real estate.\nDeferred Compensation Plan - The Company has a nonqualified, deferred compensation plan for certain senior management employees and directors that provides for benefit payments over a fifteen-year period to the participant and his or her family upon retirement or death. The plan is being funded by life insurance policies, of which the Company is the beneficiary, with premiums being paid by the Company and each participant. These policies have accumulated cash values of $42.4 million and $36.4 million at December 31, 1993 and 1992, respectively, which do not qualify as plan assets in the actuarial computation of the funded status. Based upon SFAS No. 87, Paragraphs 36-38, the Company has recorded an additional liability of $10.8 million.\nThe following tables set forth the amounts recognized in the Company's financial statements and the funded status of both plans in accordance with accounting standard SFAS No. 87, \"Employers' Accounting for Pensions.\"\nPlan Costs for the Year 1993 1992 1991 (Thousands of Dollars)\nPension plan: Service cost $ 4,496 $ 3,762 $ 3,440 Interest cost 11,688 10,926 9,848 Actual return on plan assets (23,322) (10,877) (31,871) Deferred gain (loss) on plan assets 9,848 (1,861) 21,715\nNet cost $ 2,710 $ 1,950 $ 3,132 Approximate percentage included in operating expenses 66% 64% 64%\nNet deferred compensation plan costs charged to other income (including life insurance and SFAS No. 87 liability accrual)(a) $ 1,372 $ 1,276 $ 959\n[FN] (a) These charges to the Income Statement have been reduced by gains from the Company-Owned Life Insurance (COLI) of $1,638,000; $1,607,000; and $1,663,000 for 1993, 1992 and 1991, respectively.\nSavings Plan _ The Company has an Employee Savings Plan whereby, for each $1 of employee contribution up to 6% of their salary the Company will match 100% of the first 2% employee contribution and 50% of the next 4% employee contribution, all such amounts to be invested by a trustee to any or all of seven investment options. The Company's contribution amounted to $2,283,200 in 1993, $2,046,100 in 1992 and $1,733,300 in 1991. As of December 31, 1993, a total of 3,078,663 common shares were held in this plan. An additional 955,969 common shares were held by an Employee Stock Ownership Plan as of December 31, 1993.\nPostretirement Benefits _ The Company maintains a defined benefit postretirement plan (consisting of health care and life insurance) that covers all employees who were enrolled in the active group plan at the time of retirement, their spouses and qualifying dependents. The plan provides for payment of hospital services, physician services, prescription drugs, dental services and various other health services, some of which have annual or lifetime limits, after subtracting payments by Medicare or other providers and after a stated deductible and co-payments have been met. Participants become eligible for the benefits if they retire from the Company after reaching age 55 with 15 years of service or after 30 years of service. The plan is contributory with retiree contributions adjusted annually. For those retirees that were age 65 or older at December 31, 1992 the plan is noncontributory. The Company also provides life insurance of one times salary for pre-65 retirees and $20,000 for post-65 retirees with the retirees paying a portion of the cost.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" as of January 1, 1993. This new standard requires that the expected costs of postretirement benefits be charged to expense during the years that the employees render service. The Company has elected to amortize the transition obligation of $41.4 million that was measured as of January 1, 1993 over a period of 20 years.\nThe following tables set forth the amounts to be recognized in the Company's financial statements for year-end 1993 and the funded status of the plan in accordance with accounting standard SFAS No. 106 as of January 1, 1993 and December 31, 1993 (thousands of dollars).\nPostretirement Benefit Cost for 1993: Service cost $ 750 Interest cost 3,610 Actual return on plan assets (860) Amortization of transition obligation 2,040 Net amortization and deferral - Regulatory asset (3,548) Net cost $ 1,992 (a) [FN] (a) Postretirement benefit costs charged to expense in 1992 and 1991 were $2,622,300 and $2,449,800\nDecember 31, 1993 January 1, 1993\nFunded Status: Accumulated postretirement benefit obligation (APBO) $(48,290) $(41,400)\nPlan assets at fair value 11,840 8,200\nAPBO in excess of plan assets (36,450) (33,200) Unrecognized gain\/losses 4,670 - Unrecognized transition obligaton 38,760 40,800 Prepaid postretirement benefit cost $ 6,980 $ 7,600\nDiscount rate 7.25% 8.5% Medical and dental inflation rate 6.75 8.0 Long-term plan assets expected 9.0 9.0 return\nA one percent change in the medical inflation rate would change the APBO by five percent and the postretirement expense for 1993 by seven percent.\nThe Company established a retiree medical benefits funding program in 1990. This program consists of life insurance policies on active employees of which the Company is the beneficiary, and a qualified Voluntary Employees Beneficiary Association (VEBA) Trust. The net charge to other income for the life insurance policies was $632,500 in 1993, $1,733,000 in 1992, and $768,000 in 1991. The funding to the VEBA was $2,692,000 in 1993, $2,977,400 in 1992, and $3,295,400 in 1991 and recorded as a prepayment. The VEBA trust represents plan assets which are invested in variable life insurance policies, Trust Owned Life Insurance (TOLI), on active employees. Inside buildup in the TOLI policies is tax deferred and tax free if the policy proceeds are paid to the Trust as death benefits. The investment return assumption reflects an expectation that investment income in the VEBA will be substantially tax free.\nThe IPUC issued an order approving the appropriateness of applying accrual accounting to postretirement benefit expense for ratemaking and revenue requirement purposes. The IPUC also approved the deferral of the difference between the accrual amount and the pay-as-you-go amount until the Company's next general rate case subject to an earnings test, but not to exceed two years or $6,000,000. The Public Utility Commission of Oregon and the FERC have also approved accrual accounting to postretirement benefit expense for ratemaking, and FERC has approved the deferral of the difference between accrual and pay- as-you-go not to exceed three years. The amount deferred, as a regulatory asset, at December 31, 1993 is $3.5 million. Preliminary indications are that the Company will meet the earnings test prescribed by the IPUC and will be allowed the full deferral for 1993.\nPostemployment Benefits _ The Company provides certain benefits to former or inactive employees, their beneficiaries, and covered dependents after employment but before retirement. The Company has recognized its portion of the cost of providing these benefits as an expense during the period in which the costs were incurred.\nThe Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" as of January 1, 1993. The statement requires accrual of postemployment benefits. These benefits include salary continuation and related heath care and life insurance for both long and short-term disability plans, workmen's compensation and healthcare for surviving spouse and dependent plan. The adoption of SFAS 112 is a change of accounting principal; but since the Company is a regulated utility, a deferred asset was established which represents future revenue expected to be realized at the time the postemployment benefits are included in the Company's rates. The Company recorded a liability and a regulatory asset of $3.9 million which represents the costs associated with postemployment benefits at December 31, 1993.\n10. JOINTLY-OWNED PROJECTS:\nThe Company is involved in the ownership and operation of three jointly-owned generating facilities. The Consolidated Statements of Income include the Company's proportionate share of direct operations and maintenance expenses applicable to the projects.\nEach facility and extent of Company participation as of December 31, 1993 are as follows:\nCompany Ownership Electric Accumulated Plant In Provision For Name of Plant Location Service Depreciation % MW (Thousands of Dollars)\nJim Bridger Rock Springs, Units 1-4 WY $370,653 $141,515 33 693 Boardman Boardman, OR 58,690 22,233 10 53 Valmy Units 1 & 2 Winnemucca, NV 298,265 90,224 50 261\nThe Company's wholly-owned subsidiary, IERCO, is a joint venturer in Bridger Coal Company, which operates the mine supplying coal for the Jim Bridger steam generation plant. Coal purchased by the Company from the joint venture amounted to $45,424,000 in 1993, $42,291,000 in 1992 and $40,988,500 in 1991.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareowners Idaho Power Company Boise, Idaho\nWe have audited the accompanying consolidated financial statements of Idaho Power Company and its subsidiaries listed in the accompanying index to financial statements and financial statement schedules at Item 8. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Idaho Power Company and subsidiaries at December 31, 1993, 1992 and 1991, and the results of their operations and their cash flows for each of the years then ended, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Notes 2 and 9 to the consolidated financial statements, the Company changed its method of accounting for income taxes and postretirement benefits in the year ended December 31, 1993.\nDELOITTE & TOUCHE\nPortland, Oregon January 31, 1994\nIDAHO POWER COMPANY SUPPLEMENTAL FINANCIAL INFORMATION, UNAUDITED\nQUARTERLY FINANCIAL DATA:\nThe following unaudited information is presented for each quarter of 1993, 1992 and 1991 (in thousands of dollars, except for per share amounts). In the opinion of the Company, all adjustments necessary for a fair statement of such amounts for such periods have been included. The results of operation for the interim periods are not necessarily indicative of the results to be expected for the full year. Accordingly, earnings information for any three month period should not be considered as a basis for estimating operating results for a full fiscal year. Amounts are based upon quarterly statements and the sum of the quarters may not equal the annual amount reported.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nPart III has been omitted because the registrant will file a definitive proxy statement pursuant to Regulation 14A, which involves the election of Directors, with the Commission within 120 days after the close of the fiscal year portions of which are hereby incorporated by reference (except for information with respect to executive officers which is set forth in Part I hereof).\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Please refer to Item 8, \"Financial Statements and Supplementary Data\" for a complete listing of all consolidated financial statements and financial statement schedules.\n(b) Reports on SEC Form 8-K. The following report on Form 8-K was filed during the three months ended December 31, 1993.\nItems Reported Date of Report 1. Item 7, Financial Statements and Exhibits December 17, 1993 (Exhibits)\n(c) Exhibits.\n* Previously Filed and Incorporated Herein by Reference\nFile As Exhibit Number Exhibit\n*3(a) 33-00440 4(a)(xiii) Restated Articles of Incorporation of the Company as filed with the Secretary of State of Idaho on June 30, 1989.\n*3(a)(i) 33-65720 4(a)(i) Statement of Resolution Establishing Terms of 8.375% Serial Preferred Stock, Without Par Value (cumulative stated value of $100 per share), as filed with the Secretary of State of Idaho on September 23, 1991.\n*3(a)(ii) 33-65720 4(a)(ii) Statement of Resolution Establishing Terms of Flexible Auction Series A, Serial Preferred Stock, Without Par Value (cumulative stated value of $100,000 per share), as filed with the Secretary of State of Idaho on November 5, 1991.\n*3(a)(iii) 33-65720 4(a)(iii) Statement of Resolution Establishing Terms of 7.07% Serial Preferred Stock, Without Par Value (cumulative stated value of $100 per share), as filed with the Secretary of State of Idaho on June 30, 1993.\n*3(b) 33-41166 4(b) Waiver resolution to Restated Articles of Incorporation adopted by Shareholders on May 1, 1991.\n*3(c) 33-00440 4(a)(xiv) By-laws of the Company amended on June 30, 1989, and presently in effect.\n*4(a)(i) 2-3413 B-2 Mortgage and Deed of Trust, dated as of October 1, 1937, between the Company and Bankers Trust Company and R. G. Page, as Trustees.\n*4(a)(ii) Supplemental Indentures to Mortgage and Deed of Trust:\nNumber Dated\n1-MD B-2-a First July 1, 1939 2-5395 7-a-3 Second November 15, 1943 2-7237 7-a-4 Third February 1, 1947 2-7502 7-a-5 Fourth May 1, 1948 2-8398 7-a-6 Fifth November 1, 1949 2-8973 7-a-7 Sixth October 1, 1951 2-12941 2-C-8 Seventh January 1, 1957 2-13688 4-J Eighth July 15, 1957 2-13689 4-K Ninth November 15, 1957 2-14245 4-L Tenth April 1, 1958 2-14366 2-L Eleventh October 15, 1958 2-14935 4-N Twelfth May 15, 1959 2-18976 4-O Thirteenth November 15, 1960 2-18977 4-Q Fourteenth November 1, 1961 2-22988 4-B-16 Fifteenth September 15, 1964 2-24578 4-B-17 Sixteenth April 1, 1966 2-25479 4-B-18 Seventeenth October 1, 1966 2-45260 2(c) Eighteenth September 1, 1972 2-49854 2(c) Nineteenth January 15, 1974 2-51722 2(c)(i) Twentieth August 1, 1974 2-51722 2(c)(ii) Twenty-first October 15, 1974 2-57374 2(c) Twenty-second November 15, 1976 2-62035 2(c) Twenty-third August 15, 1978 33-34222 4(d)(iii) Twenty-fourth September 1, 1979 33-34222 4(d)(iv) Twenty-fifth November 1, 1981 33-34222 4(d)(v) Twenty-sixth May 1, 1982 33-34222 4(d)(vi) Twenty-seventh May 1, 1986 33-00440 4(c)(iv) Twenty-eighth June 30, 1989 33-34222 4(d)(vii) Twenty-ninth January 1, 1990\n33-65720 4(d)(iii) Thirtieth January 1, 1991\n33-65720 4(d)(iv) Thirty-first August 15, 1991\n33-65720 4(d)(v) Thirty-second March 15, 1992\n33-65720 4(d)(vi) Thirty-third April 16, 1993\n1-3198 4 Thirty-fourth December 1, 1993 Form 8-K Dated 12\/17\/93\n*4(b) Instruments relating to American Falls bond guarantee. (See Exhibits 10(f) and 10(f)(i)).\n*4(c) 33-65720 4(f) Agreement to furnish certain debt instruments.\n*4(d) 33-00440 2(a)(iii) Agreement and Plan of Merger dated March 10, 1989, between Idaho Power Company, a Maine Corporation, and Idaho Power Migrating Corporation.\n*4(e) 33-65720 4(e) Rights Agreement dated January 11, 1990, between the Company and First Chicago Trust Company of New York, as Rights Agent (The Bank of New York, successor Rights Agent).\n*10(a) 2-51762 5(a) Agreement, dated April 20, 1973, between the Company and FMC Corporation.\n*10(a)(i) 2-57374 5(b) Letter Agreement, dated October 22, 1975, relating to agreement filed as Exhibit 10(a).\n*10(a)(ii) 2-62034 5(b)(i) Letter Agreement, dated December 22, 1976, relating to agreement filed as Exhibit 10(a).\n*10(a)(iii) 33-65720 10(a) Letter Agreement, dated December 11, 1981, relating to agreement filed as Exhibit 10(a).\n*10(b) 2-49584 5(b) Agreements, dated September 22, 1969, between the Company and Pacific Power & Light Company relating to the operation, construction and ownership of the Jim Bridger Project.\n*10(b)(i) 2-51762 5(c) Amendment, dated February 1, 1974, relating to operation agreement filed as Exhibit 10(b).\n*10(c) 2-49584 5(c) Agreement, dated as of October 11, 1973, between the Company and Pacific Power & Light Company.\n*10(d) 2-49584 5(d) Agreement, dated as of October 24, 1973, between the Company and Utah Power & Light Company.\n*10(d)(i) 2-62034 5(f)(i) Amendment, dated January 25, 1978, relating to agreement filed as Exhibit 10(d).\n*10(e) 33-65720 10(b) Coal Purchase Contract, dated as of June 19, 1986, among the Company, Sierra Pacific Power Company and Black Butte Coal Company.\n*10(f) 2-57374 5(k) Contract, dated March 31, 1976, between the United States of America and American Falls Reservoir District, and related Exhibits.\n*10(f)(i) 33-65720 10(c) Guaranty Agreement, dated March 1, 1990, between the Company and West One Bank, as Trustee, relating to $21,425,000 American Falls Replacement Dam Bonds of the American Falls Reservoir District, Idaho.\n*10(g) 2-57374 5(m) Agreement, effective April 15, 1975, between the Company and The Washington Water Power Company.\n*10(h) 2-62034 5(p) Bridger Coal Company Agreement, dated February 1, 1974, between Pacific Minerals, Inc., and Idaho Energy Resources Co.\n*10(i) 2-62034 5(q) Coal Sales Agreement, dated February 1, 1974, between Bridger Coal Company and Pacific Power & Light Company and the Company.\n*10(i)(i) 33-65720 10(d) Second Restated and Amended Coal Sales Agreement, dated March 7, 1988, among Bridger Coal Company and PacifiCorp (dba Pacific Power & Light Company) and the Company.\n*10(j) 2-62034 5(r) Guaranty Agreement, dated as of August 30, 1974, with Pacific Power & Light Company.\n*10(k) 2-56513 5(i) Letter Agreement, dated January 23, 1976, between the Company and Portland General Electric Company.\n*10(k)(i) 2-62034 5(s) Agreement for Construction, Ownership and Operation of the Number One Boardman Station on Carty Reservoir, dated as of October 15, 1976, between Portland General Electric Company and the Company.\n*10(k)(ii) 2-62034 5(t) Amendment, dated September 30, 1977, relating to agreement filed as Exhibit 10(k).\n*10(k)(iii) 2-62034 5(u) Amendment, dated October 31, 1977, relating to agreement filed as Exhibit 10(k).\n*10(k)(iv) 2-62034 5(v) Amendment, dated January 23, 1978, relating to agreement filed as Exhibit 10(k).\n*10(k)(v) 2-62034 5(w) Amendment, dated February 15, 1978, relating to agreement filed as Exhibit 10(k).\n*10(k)(vi) 2-68574 5(x) Amendment, dated September 1, 1979, relating to agreement filed as Exhibit 10(k).\n*10(l) 2-68574 5(z) Participation Agreement, dated September 1, 1979, relating to the sale and leaseback of coal handling facilities at the Number One Boardman Station on Carty Reservoir.\n*10(m) 2-64910 5(y) Agreements for the Operation, Construction and Ownership of the North Valmy Power Plant Project, dated December 12, 1978, between Sierra Pacific Power Company and the Company.\n*10(n)1 33-65720 10(e) Nonqualified, deferred, compensation plan for certain senior management employees and directors of the Company.\n*10(o) 33-65720 10(f) Residential Purchase and Sale Agreement, dated August 22, 1981, among the United Stated of America Department of Energy acting by and through the Bonneville Power Administration, and the Company.\n*10(p) 33-65720 10(g) Power Sales Contact, dated August 25, 1981, including amendments, among the United States of America Department of Energy acting by and through the Bonneville Power Administration, and the Company.\n*10(q) 33-65720 10(h) Framework Agreement, dated October 1, 1984, between the State of Idaho and the Company relating to the Company's Swan Falls and Snake River water rights.\n*10(q)(i) 33-65720 10(h)(i) Agreement, dated October 25, 1984, between the State of Idaho and the Company relating to the agreement filed as Exhibit 10(q).\n*10(q)(ii) 33-65720 10(h)(ii) Contract to Implement, dated October 25, 1984, between the State of Idaho and the Company relating to the agreement filed as Exhibit 10(q).\n*10(r) 33-65720 10(i) Agreement for Supply of Power and Energy, dated February 10, 1988, between the Utah Associated Municipal Power Systems and the Company.\n*10(s) 33-65720 10(j) Agreement Respecting Transmission Facilities and Services, dated March 21, 1988 among PC\/UP&L Merging Corp. and the Company including a Settlement Agreement between PacifiCorp and the Company.\n*10(s)(i) 33-65720 10(j)(i) Restated Transmission Services Agreement, dated February 6, 1992, between Idaho Power Company and PacifiCorp. [FN] ___________________ 1 Compensatory Plan\n*10(t) 33-65720 10(k) Agreement for Supply of Power and Energy, dated February 23, 1989, between Sierra Pacific Power Company and the Company.\n*10(u) 33-65720 10(l) Transmission Services Agreement, dated May 18, 1989, between the Company and the Bonneville Power Administration.\n*10(v) 33-65720 10(m) Agreement Regarding the Ownership, Construction, Operation and Maintenance of the Milner Hydroelectric Project (FERC No. 2899), dated January 22, 1990, between the Company and the Twin Falls Canal Company and the Northside Canal Company Limited.\n*10(v)(i) 33-65720 10(m)(i) Guaranty Agreement, dated February 10, 1992, between the Company and New York Life Insurance Company, as Note Purchaser, relating to $11,700,000 Guaranteed Notes due 2017 of Milner Dam Inc.\n*10(w) 33-65720 10(n) Agreement for the Purchase and Sale of Power and Energy, dated October 16, 1990, between the Company and The Montana Power Company.\n12 Statement Re: Computation of Ratio of Earnings to Fixed Charges.\n12(a) Statement Re: Computation of Supplemental Ratio of Earnings to Fixed Charges.\n12(b) Statement Re: Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n12(c) Statement Re: Computation of Supplemental Ratio of Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n21 Subsidiaries of Registrant.\n23 Independent Auditors' Consent.\nIDAHO POWER COMPANY SCHEDULE X - CONSOLIDATED SUPPLEMENTARY INCOME STATEMENT INFORMATION\nColumn A Column B Charged to Costs and Expenses Year Ended December 31, Item 1993 1992 1991 (Thousands of Dollars) Taxes other than income taxes are as follows: Property $16,168 $15,467 $15,081 State kilowatt-hour 1,834 1,158 1,273 Social security and unemployment 5,814 5,564 5,197 Miscellaneous 1,129 1,793 1,807\nTotal $24,945 $23,982 $23,358\nCharged to: Operating expenses - taxes $22,129 $20,562 $21,170 Other income 41 54 30 Construction, clearing and sundry 2,775 3,366 2,158\nTotal $24,945 $23,982 $23,358\nSIGNATURES\nPursuant 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.\nIDAHO POWER COMPANY (Registrant)\nMarch 10, 1994 By:__\/s\/ __Joseph W.Marshall__ Joseph W. Marshall Chairman of the Board and Chief Executive Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nBy:__\/s\/__Joseph W. Marshall__ Chairman of the Board and March 10, 1994 Joseph W. Marshall Chief Executive Officer and Director\nBy:__\/s\/__Larry R. Gunnoe__ President and Chief Operating \" Larry R. Gunnoe Officer and Director\nBy:__\/s\/__J. LaMont Keen___ Vice President and Chief Financial \" J. LaMont Keen Officer (Principal Financial Officer)\nBy:__\/s\/__Harold J. Hochhalter_ Controller and Chief Accounting Officer \" Harold J. Hochhalter (Principal Accounting Officer)\nBy:__\/s\/__Robert D. Bolinder__ By:__\/s\/__Evelyn Loveless__ \" Robert D. Bolinder Evelyn Loveless Director Director\nBy:__\/s\/__Roger L. Breezley__ By:__\/s\/__James A. McClure__ \" Roger L. Breezley James A. McClure Director Director\nBy:__\/s\/__John B. Carley__ By:__\/s\/__ Jon H. Miller__ \" John B. Carley Jon H. Miller Director Director\nBy:__\/s\/__George L. Coiner__ By:__\/s\/__Richard T. Norman__ \" George L. Coiner Richard T. Norman Director Director\nBy:__\/s\/__Gene C. Rose__ By:__\/s\/__Phil Soulen__ \" Gene C. Rose Phil Soulen Director Director\nBy:__\/s\/__Peter T. Johnson__ \" Peter T. Johnson Director\nEXHIBIT INDEX\nExhibit Page Number Number\n12 Statement Re: Computation of Ratio of 99 Earnings to Fixed Charges.\n12(a) Statement Re: Computation of 100 Supplemental Ratio of Earnings to Fixed Charges.\n12(b) Statement Re: Computation of Ratio of 101 Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n12(c) Statement Re: Computation of 102 Supplemental Ratio of Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n21 Subsidiaries of Registrant. 103\n23 Independent Auditors' Consent. 104","section_15":""}
{"filename":"82267_1993.txt","cik":"82267","year":"1993","section_1":"ITEM 1. BUSINESS GENERAL\nRaytheon is a diversified, international, multi-industry, technology- based company. Its principal business is the design, manufacture and sale of electronic devices, equipment and systems for government and commercial use. Through a diversification program begun in 1964, Raytheon has expanded into aircraft products, energy and environmental services, major appliances and textbook publishing. In recent years, the Company's strategy has been to strengthen its commercial businesses through consolidation, operational improvement and acquisitions and to diversify core defense technologies into commercial markets while remaining a strong defense company.\nSales to the United States Government (the \"Government\"), principally to the Department of Defense, were $4.501 billion in 1993 and $4.666 billion in 1992 representing 48.9% of total sales in 1993 and 51.5% in 1992. Of these sales, $779 million in 1993 and $579 million in 1992 represented purchases made by the Government on behalf of foreign governments.\nRaytheon's businesses are organized into four segments: Electronics, Aircraft Products, Energy and Environmental and Major Appliances.\nELECTRONICS SEGMENT\nThe Electronics segment consists of several business units that work primarily on government contracts: Missile Systems Division, Equipment Division, Electromagnetic Systems Division, Research Division and the Advanced Device Center. The principal contributor to electronic sales and earnings in recent years has been and continues to be sales to the United States and foreign governments of air defense missile systems, subsystems and components. The Patriot Air Defense System, the Company's largest program, had sales of $1.248 billion, $1.209 billion and $1.265 billion, in 1993, 1992 and 1991, respectively.\nOther products and services sold directly or indirectly to the Government include: ship and land based radar systems for surveillance, target identification, tracking, fire control, navigation, air traffic control and weather observation; sonar systems; communications systems; electronic countermeasures systems and electronic components (see Backlog Discussion, p. 6). Some of the Government's procurement is for non- military use such as air traffic control and weather observation.\nRaytheon acts as a prime contractor or major subcontractor for many different Government programs including those that involve the development and production of new or improved weapons or other types of electronics systems or major components of such systems. Over its lifetime, a program may be implemented by the award of many different individual contracts and subcontracts.\nThe funding of Government programs is usually subject to congressional appropriations. Although multi-year contracts may be authorized in connection with major procurements, Congress generally appropriates funds on a fiscal year basis even though a program may continue for many years. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations. The Government is required to adjust equitably a contract price for additions or reductions in scope or other changes ordered by it.\nGenerally, Government contracts have provisions for audit, price redetermination and other profit and cost controls and limitations and may be terminated, in whole or in part, without prior notice at the Government's convenience upon the payment of compensation only for work done and commitments made at the time of termination. In the event of termination, the contractor may also receive some allowance for profit on the work performed. The right to terminate for convenience has not had any significant effect upon Raytheon's business in light of its total Government business.\nRaytheon's Government business is performed under both cost reimbursement and fixed price prime contracts and subcontracts. Cost reimbursement contracts provide for the reimbursement of allowable costs plus the payment of a fee. These contracts fall into two basic types: (i) cost plus fixed fee contracts which provide for the payment of a fixed fee irrespective of the final cost of performance, and (ii) cost plus incentive fee contracts which provide for increases or decreases in the fee, within specified limits, based upon actual results as compared to contractual targets relating to such factors as cost, performance and delivery schedule. Under cost reimbursement type contracts, Raytheon is reimbursed periodically for allowable costs and is paid a portion of the fee based on contract progress. Some costs incident to performing contracts have been made partially or wholly unallowable by statute or regulation. Examples are charitable contributions, travel costs in excess of government rates and certain litigation defense costs.\nRaytheon's fixed price contracts are either firm fixed price contracts or fixed price incentive contracts. Under firm fixed price contracts, Raytheon agrees to perform the contract for a fixed price and as a result benefits from cost savings and carries the burden of cost overruns. Under fixed price incentive contracts, Raytheon shares with the Government savings accrued from contracts performed for less than target costs and costs incurred in excess of targets up to a negotiated ceiling price (which is higher than the target cost) and carries the entire burden of costs exceeding the negotiated ceiling price. Under such incentive contracts, Raytheon's profit may also be adjusted up or down depending upon whether specified performance objectives are met. Under firm fixed price and fixed price incentive type contracts, Raytheon usually receives progress payments monthly from the Government generally in amounts equalling 85% of costs incurred under the contract. For contracts and modifications issued after November 11, 1993, progress payments may not exceed 75% of incurred costs. This rate may be adjusted from time to time on the basis of the Short Term Commercial Borrowing Rate published by the\nFederal Reserve. The remaining amount, including profits or incentive fees, is billed upon delivery and final acceptance of end items under the contract.\nRaytheon's Government business is subject to specific procurement regulations and a variety of socio-economic and other requirements. Failure to comply with such regulations and requirements could lead to suspension or debarment, for cause, from Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various statutes, including those related to employment practices, the protection of the environment, the accuracy of records and the recording of costs. Raytheon has not, at any time, been debarred or suspended.\nUnder many Government contracts, Raytheon is required to maintain facility and personnel security clearances complying with Department of Defense (\"DOD\") requirements.\nCompanies such as Raytheon, which are engaged in supplying defense- related equipment to the Government, are subject to certain business risks peculiar to that industry. Among these are: the cost of obtaining trained and skilled employees; the uncertainty and instability of prices for raw materials and supplies; the problems associated with advanced designs, which may result in unforeseen technological difficulties and cost overruns; and the intense competition and the constant necessity for improvement in facilities and personnel training. Sales to the Government may be affected by changes in procurement policies, budget considerations, changing concepts of national defense, political developments abroad and other factors.\nAs a result of the 1985 Balanced Budget and Emergency Deficit Reduction Control Act, the federal deficit and changing world order conditions, DOD budgets have been subject to increasing pressure resulting in an uncertainty as to the future effects of DOD budget cuts. Raytheon has, nonetheless, maintained a solid foundation of tactical defense systems which meet the needs of the United States and its allies, as well as serving a broad government program base and wide range of commercial electronics businesses. These factors lead management to believe that there is high probability of continuation of Raytheon's current major tactical defense programs.\nDuring the first quarter of 1994 the Company's Board of Directors approved a company-wide restructuring plan designed to help maintain the Company's competitive position in a shrinking defense market and improve productivity in its commercial businesses. The plan will be implemented over a two-year period and will result in a one-time, pre-tax charge of $250 million ($162 million after tax). The major elements of the plan include the costs of employee separations and relocations, facility consolidations and facility and equipment disposals.\nThe Electronics segment's commercial group consists of Raytheon Marine Company, Seiscor Technologies, the Semiconductor Division, Switchcraft, Inc., BSG-Schalttechnik GmbH & Company and REMCO, S.A. In addition,\nD.C.Heath and Company is part of the group. Electronic products sold to commercial customers include: marine collision avoidance systems; marine radiotelephones, radars, autopilots and \"Fathometer \" depth sounders; and components such as semiconductor devices, transistors, diodes, integrated circuits, electronic controls for automobiles and appliances, switches, jacks and plugs. Some electronic products are manufactured and assembled for Raytheon outside of the United States.\nRaytheon's D.C. Heath and Company division publishes school and college textbooks and educational software.\nAIRCRAFT PRODUCTS SEGMENT\nRaytheon's Aircraft Products segment consists of Raytheon Corporate Jets, Inc. and Beech Aircraft Corporation. Raytheon Corporate Jets was formed in 1993 to acquire the assets of the Corporate Jets business of British Aerospace plc, and Beech was acquired in 1980.\nRaytheon Corporate Jets designs, manufactures, services and supports the \"Hawker(TM)\" 800 and \"Hawker(TM)\" 1000 medium-sized business jets, which are sold in domestic and international markets. More than 850 Hawker aircraft of various models have been sold throughout the world since the product line was introduced in 1960 as the de Havilland 125.\nBeech, founded in 1932, designs, manufactures, services and supports piston-powered, jetprop and light jet aircraft for the world's business, military and regional airline markets. The single engine piston-powered Beechcraft Bonanza introduced in 1947 enjoys the distinction of the longest continuous production of any aircraft in history. Beech also produces the twin-engine piston-powered Baron, several models of turbine- powered aircraft in the Starship and King Air jetprop product lines, and the Beechjet light business jet and its military counterpart, the T-1A Jayhawk Trainer sold to the United States Air Force. The Beech 1900D is a stand-up cabin 19-passenger aircraft sold to commuter airlines and corporate customers. Beech also produces two missile target drones for the United States and its allied forces. Beech operates fixed base operations at airports throughout the United States and supports military aircraft throughout the world.\nENERGY AND ENVIRONMENTAL SEGMENT\nThe Energy and Environmental segment is comprised of operating subsidiaries of Raytheon Engineers & Constructors International, Inc., including Raytheon Engineers & Constructors, Inc., Raytheon Service Company and Cedarapids, Inc. Raytheon Engineers & Constructors -- formed in 1993 to consolidate the operations of United Engineers & Constructors and The Badger Company -- designs, constructs and maintains petroleum, petrochemical, chemical processing, cogeneration facilities, electrical generating and industrial plants, and infrastructure projects.\nThe former Badger operations, both domestically and through subsidiaries in The Netherlands and elsewhere, specialize in the engineering, design and construction of petroleum refining, lube oil, petrochemical,\nfertilizer, chemical, plastics, synthetic fuels and environmental treatment plants. Customers include many of the world's largest petroleum, petrochemical and chemical companies.\nThe former United Engineers operations, domestically and internationally, are engaged in the design, construction and maintenance of electricity generating fossil fuel and nuclear plants, electrical substations, metals manufacturing and processing plants and other types of heavy industrial plants. In addition, Raytheon Engineers & Constructors provides engineering services relating to facility and site planning, environmental assessment and design studies. It also designs and constructs specialty process, pharmaceutical and biotechnology plants. Customers include a number of major utility companies, industrial concerns and the Department of Energy.\nRaytheon Engineers & Constructors undertakes some engineering and construction projects on a firm fixed price basis (\"lump sum turnkey\"), and as a result benefits from cost savings and carries the burden of cost overruns.\nDuring 1993 Raytheon Engineers & Constructors acquired selected assets of Gibbs & Hill, Harbert Construction Company and Ebasco Services, Inc., providing additional resources in power, infrastructure, construction and quality assurance.\nCedarapids, Inc. designs and manufactures a wide range of stationary and portable aggregate producing equipment, asphalt paving equipment, mixing plants and soil remediation systems.\nRaytheon Service Company offers worldwide engineering, construction, installation, operation, maintenance, environmental and training services and supports and maintains other complex military and industrial systems.\nMAJOR APPLIANCES SEGMENT\nThe Major Appliances segment, which consists of Amana Refrigeration, Inc. and Speed Queen Company, manufactures and sells household and commercial appliances under the Amana, Speed Queen, Caloric, Modern Maid, Sunray and Menumaster brand names. Products include refrigerators, freezers, microwave ovens, gas and electric ranges, washing machines, dryers, and other laundry products as well as other central heating and air conditioning products and home appliances. These products are sold to dealers, distributors and home builders for resale to the customer or for incorporation into new homes and apartments.\nFinancial information about Operations by Business Segments and Operations by Geographic Areas is contained on page 41 of Raytheon's 1993 Annual Report to Stockholders and is incorporated herein by reference.\nBACKLOG\nRaytheon's backlog of orders at December 31, 1993 was $7.756 billion\ncompared with $7.273 billion at the end of 1992. The 1993 amount includes funded backlog of $4.519 billion from the Government compared with $5.311 billion at the end of 1992. Normally, the Government funds its major programs only to the dollar level appropriated annually by Congress, even though the total estimated program values are considerably greater. Accordingly, Raytheon's Government funded backlog represents only that amount which has been appropriated and against which Raytheon can be reimbursed for work performed.\nApproximately $996 million of the overall backlog figure represents the unperformed portion of multi-year direct orders from foreign governments, principally for air defense systems or components thereof and related services. Approximately $713 million of the overall backlog represents non-government foreign backlog, $604 million of which relates to Raytheon Engineers and Constructors' Rayong refinery project.\nAircraft Products backlog was to $1.082 billion at the end of 1993 versus $1.028 billion at the end of 1992.\nBacklog in the Energy and Environmental segment was $1.824 billion at the end of 1993 compared with $906 million at the end of 1992. The increase was due primarily to the Ebasco acquisition. Design and construction contracts in this segment typically take from eighteen months to several years to perform.\nApproximately $2.292 billion of the $7.756 billion 1993 year-end backlog is not expected to be filled during the following twelve months.\nRESEARCH AND DEVELOPMENT\nDuring 1993, Raytheon derived net sales of $686.2 million ($672.6 million in 1992 and $586.2 million in 1991) pursuant to Government contracts for research and development. In addition, during 1993 Raytheon expended $279.4 million on research and development efforts compared with $289.9 million in 1992 and $278.5 million in 1991. These expenditures principally have been for product development for the Government and for aircraft products. Approximately 10,100 employees (10,400 for 1992), of whom 4,600 (4,800 for 1992) hold engineering or scientific degrees, were actively engaged in research and development at the end of 1993.\nSUPPLIERS\nDelivery of raw materials and supplies to Raytheon is generally satisfactory. Raytheon is sometimes dependent, for a variety of reasons, upon sole-source suppliers for procurement requirements. However, Raytheon has experienced no significant difficulties in meeting production and delivery obligations because of delays in delivery or reliance on such suppliers.\nCOMPETITION\nThe military and commercial industries in which Raytheon operates are\nhighly competitive in both military and commercial areas. Raytheon's competitors range from highly resourceful small concerns, which engineer and produce specialized items, to large, diversified firms. Products are subject to an unpredictable and often high degree of obsolescence. The Electronics segment is a direct participant in most major areas of development in the defense, space, information gathering, data reduction and automation fields. Technical superiority and reputation, price, delivery schedules, financing and reliability are principal competitive factors considered by electronics customers. About half of the 50 largest defense contractors in the United States are competitors in the Electronics segment. At the present time, the Office of the Secretary of Defense (the undersecretary of Defense for Acquisition) is reviewing the Army's selection of the ERINT missile to satisfy the requirements of the Patriot Advanced Capability - 3 (PAC-3). If this decision is upheld, it is expected that Patriot's multimode development by the Company would continue as a risk reduction measure for the Army. The Company would continue to produce the Patriot Ground and Support equipment and would remain as Patriot System integrator.\nCompetition in the Aircraft Products segment comes from a number of domestic and foreign jet, turboprop and piston aircraft manufacturers. Principal elements of competition in the industry are price, operating costs, reliability, cabin size and comfort, product quality, speed and service support.\nIn the Energy and Environmental segment it is estimated that about 15 firms compete for major business opportunities worldwide. Competition is based primarily upon technical superiority, project experience and price. The ability to arrange or otherwise provide financing to customers is sometimes significant in attracting or retaining clients.\nIn the Major Appliances segment, quality, warranty, price, advertising and marketing are all competitive factors. Approximately 24 firms compete with Raytheon in the appliance field. Of these, Raytheon considers four firms to be significant competitors.\nPATENTS AND LICENSES\nIn most of the businesses in which Raytheon is engaged, patents are prevalent. Raytheon and its subsidiaries own a large number of United States and foreign patents and patent applications. In addition, rights under the patents and inventions of others have been acquired through licenses.\nRaytheon's patent position is deemed adequate for the conduct of its businesses. Should additional rights be desirable, Raytheon believes that in most instances they can be acquired on reasonable terms. It is Raytheon's policy to enforce its own patent rights and to respect the rights of others. Typically there are a number of infringement claims pending or threatened both by and against Raytheon. In the opinion of management, these claims will be disposed of in a satisfactory manner.\nEMPLOYMENT\nAt December 31, 1993, Raytheon had 63,800 employees compared with 63,900 employees at the end of 1992. During 1993 the employment level declined by 5,800 people and 5,700 people were added as a result of acquisitions. Subsidiaries of Raytheon Engineers & Constructors International, Inc. and certain other subsidiaries have craft employees engaged for individual projects not included in Raytheon's employee count. Raytheon considers its employee relations to be generally satisfactory. Raytheon has, for the most part, successfully negotiated labor agreements without significant work stoppages. Over the past ten years, Raytheon has experienced only one work stoppage: a two-week stoppage at its Amana, Iowa facility.\nFOREIGN SALES\nOf total sales, Raytheon's sales to customers outside the United States were 18.4%, 18.7% and 17.7% in 1993, 1992 and 1991, respectively. These sales were principally in the fields of air defense systems, air traffic control systems, sonar systems, aircraft products, petrochemical power and industrial plant design and construction, electronic equipment, computer software and systems, personnel training, equipment maintenance, and microwave communication. Financing, to the extent needed for foreign manufacturing and sales, is generally sought in the countries concerned. Sales and income from international operations are subject to changes in currency values, domestic and foreign government policies (including requirements to expend a portion of program funds in-country) and regulations, embargoes and international hostilities. Exchange restrictions imposed by various countries could restrict the transfer of funds between countries and between Raytheon and its subsidiaries. Raytheon generally has been able to protect itself against most undue risks through insurance, foreign exchange contracts, contract provisions, government guarantees or progress payments.\nOn occasion Raytheon utilizes the services of sales representatives and distributors in connection with foreign sales. Such representatives and distributors normally are paid either commissions or granted resale discounts in return for services rendered in connection with obtaining orders.\nLicenses are required from Government agencies under the Export Administration Act, the Trading with the Enemy Act of 1917 and the Arms Export Control Act of 1976 (formerly the Foreign Military Sales Act) for export from the United States of many of Raytheon's products. In the case of certain sales of defense equipment and services to foreign governments, the Government's Executive Branch must notify Congress at least 30 days prior to authorizing such sales. During that time, Congress may take action to block the proposed sale.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRaytheon and its subsidiaries operate in a number of plants,\nlaboratories and office facilities in the United States and abroad.\nRaytheon's manufacturing, engineering, research, administrative, sales and storage floor space aggregated approximately 30.2 million square feet at December 31, 1993, more than 90% of which was located in the United States. Of such total, 59% was owned, 30% was held pursuant to long-term leases, 5% was held pursuant to short-term leases and 6% was Government- owned. Raytheon's facilities are suitable and adequate for its current level of business. In connection with a recently announced restructuring plan, certain facilities will be disposed of following consolidation.\nRaytheon maintains a wide-spread energy conservation effort in cooperation with Federal and state agencies. While Raytheon's businesses generally utilize clean manufacturing processes, such processes at times utilize chemicals, solvents, gases and other materials which could be hazardous. Several states have adopted \"right-to-know\" legislation entitling employees and, to a lesser extent, the public to information concerning such materials. Discharge of effluents and smoke particles are regulated by Federal and state agencies and frequently require permits. Discharge in excess of permit limitations may result in fines. Enforcement proceedings may be brought by citizen groups as well as government agencies. In the opinion of management, Raytheon complies with these regulations in all material respects.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various stages of investigation and cleanup relative to remediation of various sites. All appropriate costs incurred in connection therewith have been expensed. Due to the complexity of environmental laws and regulations, the varying costs and effectiveness of alternative cleanup methods and technologies, the uncertainty of insurance coverage and the unresolved extent of the Company's responsibility, it is not possible to determine the ultimate outcome of these matters. However, in the opinion of management, any liability will not have a material effect on the Company's financial position or results of operations after giving effect to provisions already recorded.\nAs previously reported, in 1989 Beech was cited by the EPA, Region VII (Kansas City Office) for its failure to comply with a Wastewater Discharge Permit and applicable regulations. Beech has entered into a Consent Decree pursuant to which it will pay a civil penalty of $521,735 and install paint booth centrifuges at its Wichita facility.\nAccidents involving personal injuries and property damage occur in general aviation travel. When permitted by appropriate government agencies, Beech investigates accidents related to Beech products involving fatalities or serious injuries. Through a relationship with FlightSafety International, Beech provides initial and recurrent pilot and maintenance training services to reduce the frequency of accidents involving its products.\nBeech is a defendant in a number of product liability lawsuits which allege personal injury and property damage and seek substantial recoveries\nincluding, in some cases, punitive and exemplary damages. Beech maintains partial insurance coverage against such claims and maintains a level of uninsured risk determined by management to be prudent. (See Note J to Raytheon's Financial Statements for the years ended December 31, 1993, 1992 and 1991.)\nThe insurance policies for product liability coverage held by Beech do not exclude punitive damages, and it is the position of Beech and its counsel that punitive damage claims are therefore covered. Historically, the defense of punitive damage claims has been undertaken and paid by insurance carriers. Under the law of some states, however, insurers are not required to respond to judgments for punitive damages. Nevertheless, to date there have been no judgments for punitive damages sustained against Beech.\nDefense contractors are subject to many levels of audit and investigation. Among agencies which oversee contract performance are: the Defense Contract Audit Agency, the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, and the Department of Justice and Congressional Committees. The Department of Justice from time to time has convened grand juries to investigate possible irregularities by Raytheon in governmental contracting.\nVarious claims and legal proceedings generally incidental to the normal course of business are pending or threatened against the Company. While the Company cannot predict the outcome of any of these matters, in the opinion of management, any liability arising from them will not have a material effect on the Company's financial position, liquidity or results of operations after giving effect to provisions already recorded.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nSUBSTITUTE ITEM 4. EXECUTIVE OFFICERS OF REGISTRANT AS OF MARCH 1, 1994\nMax E. Bleck. Director since November 1990 and President since March 1991. Prior to assuming his present position, Mr. Bleck served as President and Chief Executive Officer - Beech Aircraft Corporation from 1987. Age: 66\nPhilip W. Cheney. Vice President - Engineering since February 1990. Prior to assuming his present position, Dr. Cheney served as Program Manager - AMRAAM, Missile Systems Division from January 1985. Age: 58\nStanley L. Clark. Vice President and Group Executive - Commercial Electronics Group since May 1992. Prior to assuming his present position, Mr. Clark served as Group Executive - Commercial Electronics Group from January 1992 and as President of Raytheon Marine Company from February 1983. Age: 50\nPeter R. D'Angelo. Vice President - Corporate Controller since February\n1992. Prior to assuming his present position, Mr. D'Angelo served as Controller - Missile Systems Division from 1984. Age: 55\nHerbert Deitcher. Senior Vice President - Treasurer since November 1989. Age: 60\nDavid S. Dwelley. Vice President - Strategic Business Development since April 1991. Prior to assuming his present position, Mr. Dwelley served as Vice President - President, Raytheon Europe Limited from 1989. Age: 54\nJohn F. Harding. Vice President - Contracts since October 1988. Age: 55\nChristoph L. Hoffmann. Senior Vice President - Law, Human Resources and Corporate Administration, and Secretary since February 1994. Prior to assuming his present position, Mr. Hoffmann served as Vice President, Secretary and General Counsel from July 1991 and as Senior Vice President, General Counsel and Secretary of Pneumo Abex Corporation from 1986. Age:\nThomas D. Hyde. Vice President and General Counsel since February 1994. Prior to assuming his present position, Mr. Hyde served as Assistant General Counsel from August 1992, as Senior Vice President, General Counsel and Chief Financial Officer of MNC Financial Inc. Special Assets Bank from 1991, and as Vice President, Finance Manville Sales Corporation from 1988. Age: 45\nCharles Q. Miller. Senior Vice President and Group Executive - Chairman and Chief Executive Officer of Raytheon Engineers & Constructors International, Inc. since March 1993. Prior to assuming his present position, Mr. Miller served as President, United Engineers & Constructors, Inc. from 1990 and as Vice President-General Manager of Stearns-Rogers Division from 1989. Age: 48\nJohn R. Pasquariello. Vice President - President and Chief Executive Officer of Cedarapids Inc. since September 1993. Prior to assuming his present position, Mr. Pasquariello served as Vice President - Environmental Quality from 1992, as Vice President-Manufacturing and Environmental Quality from April 1990 and as Vice President-Manufacturing from 1979. Age: 64\nDennis J. Picard. Director since 1989 and Chairman and Chief Executive Officer since March 1991. Prior to assuming his present position, Mr. Picard served as President from 1989. Age: 61\nC. Dale Reis. Vice President and General Manager - Equipment Division since September 1993. Prior to assuming his present position, Mr. Reis served as Vice President-General Manager, Submarine Signal Division from October 1990 and Manager-Equipment Development Laboratories, Equipment Division from 1988. Age: 48\nSheldon Rutstein. Senior Vice President - Chief Financial Officer since February 1992. Mr. Rutstein also serves as Chief Accounting Officer.\nPrior to assuming his present position, Mr. Rutstein served as Senior Vice President-Controller from 1989. Age: 59\nRobert A. Skelly. Vice President - Assistant to the Executive Office. Prior to assuming his present position, Mr. Skelly served as Vice President-Administration, Environmental Quality and Procurement since September 1992, as Vice President-Public and Financial Relations from January 1991 and as Assistant to the President from August 1989. Age: 51\nRobert L. Swam. Senior Vice President, Group Executive - Appliance Group since January 1992. Prior to assuming his present position, Mr. Swam was an independent consultant from 1989. Age 53\nWilliam H. Swanson. Senior Vice President - General Manager, Missile Systems Division since August 1990. Prior to assuming his present position, Mr. Swanson served as Vice President - Assistant General Manager-Operations, Missile Systems Division from 1989. Age: 45\nArthur E. Wegner. Senior Vice President - Chairman and Chief Executive Officer of Beech Aircraft Corporation since July 1993. Prior to assuming his present position, Mr. Wegner served as Executive Vice President and President of the Aerospace\/Defense Sector of United Technologies Corporation from 1989. Age: 56\nEdmund B. Woollen. Vice President - Government Marketing since December 1992. Prior to assuming his present position, Mr. Woollen served as Vice President-Corporate Marketing from October 1990 and as Director of Marketing, Government Group from 1986. Age: 49\nEach executive officer was elected by the Board of Directors to serve for a term of one year and until his successor is elected and qualified or until his earlier removal, resignation or death.\nPART II\nItem 5.","section_5":"Item 5. Market For Registrant's Common Equity and Related Stockholder Matters\nThis information is contained in the Annual Report to Stockholders for the year ended December 31, 1993 on page 1, on page 40 under the caption \"Quarterly Financial Data\" and on the back cover and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThis information is included in the \"Ten Year Statistical Summary\" contained in the Annual Report to Stockholders for the year ended December 31, 1993 on pages 42 and 43 and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis information is contained in the Annual Report to Stockholders for the year ended December 31, 1993 on pages 35 through 40 and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplemental Data\nFinancial statements and supplementary data of the Registrant are contained in the Annual Report to Stockholders for the year ended December 31, 1993 on pages 44 through 59 and are incorporated herein by reference. Schedules required under Regulation S-X are filed as \"Financial Statement Schedules\" pursuant to Item 14 hereof.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants and Financial Disclosure\nNone.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation regarding the directors of the Registrant is contained in the definitive proxy statement of the Registrant for the annual meeting of stockholders to be held May 25, 1994 on pages 2 and 3 under the caption \"Election of Directors\" and is incorporated herein by reference. See Part I, Substitute Item 4 of this Form 10-K for information regarding the executive officers of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nThis information is contained in the definitive proxy statement of the Registrant for the annual meeting of stockholders to be held May 25, 1994 beginning with the caption \"Executive Compensation\" on pages 6 through 9 and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is contained in the definitive proxy statement of the Registrant for the annual meeting of stockholders to be held May 25, 1994 under the caption \"Security Ownership\" on pages 4 and 5 and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThis information is contained in the definitive proxy statement of the Registrant for the annual meeting of stockholders to be held May 25, 1994 under the caption \"Other Information\" on page 15 and is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements and Schedules\n(1) The following financial statements of Raytheon Company and Subsidiaries Consolidated, as contained in Raytheon's 1993 Annual Report to Stockholders, are hereby incorporated by reference:\nBalance Sheets at December 31, 1993 and 1992\nStatements of Income for the Years Ended December 31, 1993, 1992 and 1991\nStatements of Stockholders' Equity for the Years Ended December 31, 1993, 1992 and 1991\nStatements of Cash Flows for the Years Ended December 31, 1993, 1992 and 1991\n(2) The following schedules are included in this report:\nSchedule II - Amounts Receivable from Employees for the Three Years Ended December 31, 1993\nSchedule V - Property, Plant and Equipment for the Three Years Ended December 31, 1993\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment for the Three Years Ended December 31, 1993\nSchedule VIII - Reserves for the Three Years Ended December 31, 1993\nSchedule IX - Short-Term Borrowing for the Three Years Ended December 31, 1993\nSchedules I, III, IV, VII, X, XI, XII and XIII are omitted because they are not required, not applicable, or the information is otherwise included.\n(b) Reports on Form 8-K\nOn June 9, 1993, the Company filed a Form 8-K reporting the acquisition by Raytheon Company of the business of Corporate Jets Inc.\n(c) Exhibits\n(3.1) Raytheon Company Certificate of Incorporation, as amended through\nJuly 1, 1987, heretofore filed as an Exhibit to Registration Statement No. 33-15396, is hereby incorporated by reference.\n(3.2) Raytheon Company By-Laws, as amended through August 22, 1990, heretofore filed as an Exhibit to Raytheon's Form 10-K for the year ended December 31, 1990, are hereby incorporated by reference.\n(4) On July 3, 1986, the Company filed a registration statement on Form 8-A, which form was amended on June 28, 1988, describing certain rights that may accrue to stockholders in the event that a person or group acquires beneficial ownership of 20% or more of the Company's outstanding capital stock or commences a tender or exchange offer that would result in such person or group owning 25% or more of such outstanding capital stock. Said Registration Statement is hereby incorporated by reference.\n(10.1) Raytheon's 1976 Stock Option Plan, filed as an exhibit to Raytheon's Registration Statement No. 33-23449 on Form S-8, is hereby incorporated by reference.\n(10.2) Raytheon's 1991 Stock Plan, filed as an exhibit to Raytheon's 1991 Form 10-K, is hereby incorporated by reference.\n(13) Raytheon's 1993 Annual Report to Stockholders (furnished for the information of the Commission and not to be deemed \"filed\" as part of this Report except to the extent that portions thereof are expressly incorporated by reference).\n(22) Subsidiaries of Raytheon Company\n(24.1) Consent of Independent Accountants\n(24.2) Report of Independent Accountants\n(28.1) Annual Report on Form 11-K for the (To be filed at a Raytheon Savings and Investment Plan later date under Form 8)\n(28.2) Annual Report on Form 11-K for the (To be filed at a Raytheon Savings and Investment Plan later date under for Specified Hourly Payroll Employees Form 8)\n(28.3) Annual Report on Form 11-K for the (To be filed at a Caloric Savings and Investment Plan later date under Form 8)\n(28.4) Annual Report on Form 11-K for the (To be filed at a Badger Company, Inc. Savings and later date under Investment Plan Form 8)\nSIGNATURE\nPursuant 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.\nRAYTHEON COMPANY\nBy: \/s\/ Thomas D. Hyde Thomas D. Hyde Vice President and General Counsel for the Registrant\nDated: March 23, 1994\nSIGNATURES\nPursuant 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 and on the dates indicated.\nSIGNATURES TITLE DATE\nChairman of the Board Dennis J. Picard and Director (Principal March 23, 1994 (Dennis J. Picard) Executive Officer)\nMax E. Bleck President and Director March 23, 1994 (Max E. Bleck)\nCharles F. Adams Director March 23, 1994 (Charles F. Adams)\nFrancis H. Burr Director March 23, 1994 (Francis H. Burr)\nFerdinand Colloredo-Mansfeld Director March 23, 1994 (Ferdinand Colloredo-Mansfeld)\nTheodore L. Eliot, Jr. Director March 23, 1994 (Theodore L. Eliot, Jr.)\nBarbara B. Hauptfuhrer Director March 23, 1994 (Barbara B. Hauptfuhrer)\nRichard D. Hill Director March 23, 1994 (Richard D. Hill)\nJames N. Land, Jr. Director March 23, 1994 (James N. Land, Jr.)\nThomas L. Phillips Director March 23, 1994 (Thomas L. Phillips)\nWarren B. Rudman Director March 23, 1994 (Warren B. Rudman)\nJoseph J. Sisco Director March 23, 1994 (Joseph J. Sisco)\nAlfred M. Zeien Director March 23, 1994 (Alfred M. Zeien)\nSheldon Rutstein Senior Vice President - March 23, 1994 (Sheldon Rutstein) Chief Financial Officer (Chief Accounting Officer)\nRAYTHEON COMPANY AND SUBSIDIARIES CONSOLIDATED ----------------------------------------------- SCHEDULE II - AMOUNTS RECEIVABLE FROM EMPLOYEES FOR THE THREE YEARS ENDED DECEMBER 31, 1993 --------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\nBalance at Deductions Balance at close of period beginning Amounts Amounts Name of debtor of period Additions collected written off Current Non-current --------------------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1993\nElizabeth H. Allen (4) $ - $475 $475 $ - $ - $ - Max E. Bleck (1) 800 - - - 800 - Tom B. Burgher (2) 23 - 7 - 7 9 Larry R. Capps (3) 31 - 31 - - - Kenneth A. Dickerson (4) 430 - 430 - - - James V. DiLorenzo (5) 155 - 19 - 21 115 Edward C. Douglas (6) 288 - 11 - 12 265 S. Robert Foley (7) 141 - 141 - - - David W. Gerety (9) 64 - 27 - 12 25 Ronald J. Lazarto (10) 5 - 5 - - - Charles Q. Miller (20) - 175 - - 175 - C. Dale Reis (11) 100 - 100 - - - Gerard A. Smith (7) 70 - 70 - - - Robert L. Swam (13) 250 - 30 - 40 180 Frank D. Umanzio (14) 189 - - - 189 -\n(continued next page)\nSCHEDULE II - AMOUNTS RECEIVABLE FROM EMPLOYEES --------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\nBalance at Deductions Balance at close of period beginning Amounts Name of debtor of period Additions collected written off Current Non-current --------------------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1992\nMax E. Bleck (1) $800 $ - $ - $ - $800 $ - Tom B. Burgher (2) 255 - 232 - 8 15 Larry R. Capps (3) - 130 99 - 31 - Kenneth A. Dickerson (4) 430 - - - 430 - James V. DiLorenzo (5) 172 - 17 - 19 136 Edward C. Douglas (6) 299 - 11 - 11 277 S. Robert Foley (7) 175 - 34 - 25 116 Chet E. Foraker (8) 136 - 136 - - - David W. Gerety (9) 150 - 86 - 10 54 Richard B. Johnston (8) - 155 155 - - - Ronald J. Lazarto (10) 150 - 145 - 5 - C. Dale Reis (11) 120 - 20 - 20 80 Richard A. Rom (12) 24 - 24 - - - Gerard A. Smith (7) 102 - 32 - 34 36 Robert L. Swam (13) - 250 - - 30 220 Frank D. Umanzio (14) 189 - - - 189 -\n(continued next page)\nSCHEDULE II - AMOUNTS RECEIVABLE FROM EMPLOYEES ---------------------------------------------- (continued)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\nBalance at Deductions Balance at close of period beginning Amounts Name of debtor of period Additions collected written off Current Non-current --------------------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1991\nMax E. Bleck (1) $ - $ 800 $ - $ - $800 $ - Jay T. Bluestein (15) 120 - - 120 - - Tom B. Burgher (4) - 255 - - 255 - Kenneth A. Dickerson (4) 430 - - - 430 - James V. DiLorenzo (5) 187 - 15 - 17 155 Edward C. Douglas (6) 302 - 3 - 15 284 Richard J. Foley (8) - 400 400 - - - S. Robert Foley (7) - 305 130 - 26 149 Chet E. Foraker (8) - 136 - - 136 - Thomas M. Gallagher (8) 160 - 160 - - - David W. Gerety (9) - 150 - - 38 112 Ronald D. Kalp (16) 178 - 128 50 - - Ronald J. Lazarto (4) 150 - - - 150 - Robert J. Minton (17) 104 - - 104 - - C. Dale Reis (11) 168 287 335 - 20 100 Richard A. Rom (12) 34 - 10 - 11 13 John T. Rowntree (8) 65 - 65 - - - Gerard A. Smith (7) 131 - 29 - 32 70 Frank D. Umanzio (14) - 189 - - 189 -\n(continued next page)\nSCHEDULE II - AMOUNTS RECEIVABLE FROM EMPLOYEES ---------------------------------------------- (continued)\n1. Non-interest bearing loan for the purchase of employee's home in Massachusetts, repayable upon the employee selling the home or ending his employment. Raytheon holds a mortgage on the home.\n2. Non-interest bearing loan made on a demand note was reduced by a partial principal payment and converted to a non-interest bearing installment term loan commencing in January 1993. Raytheon holds a mortgage on the home of this employee.\n3. Non-interest bearing loan made on a demand note was reduced by a partial principal payment. Raytheon holds a mortgage on the home of this employee.\n4. Non-interest bearing loan made on a demand note to be paid on the sale of the first home.\n5. Non-interest bearing installment loan with annual installments commencing February 15, 1990 and continuing through February 15, 1999. Raytheon Company holds a mortgage on the home of this employee.\n6. Interest bearing loan made on a demand note to be paid on the sale of the first home. Raytheon Company holds mortgages on both homes of this employee. Employee pays $2600 per month as partial payment of principal and interest until sale of either home is completed.\n7. Non-interest bearing interim loan was reduced by the proceeds from the sale of the employee's home and converted to a non-interest bearing installment loan with annual installments. The balance was prepaid when the employee left the company.\n8. Non-interest bearing loan made on a demand note to be paid upon the sale of the first home. Raytheon Company held a mortgage on the homes of these employees.\n9. Interest bearing loan made on a demand note was reduced by partial principal payment and converted to a non-interest bearing installment term loan commencing February 1992 and maturing in March 1997 which was modified in 1993 as a result of the prepayment of part of the principal. Raytheon holds a mortgage on the home of this employee.\n(continued next page)\nSCHEDULE II - AMOUNTS RECEIVABLE FROM EMPLOYEES ----------------------------------------------- (continued)\n10. Interest bearing loan made on a demand note which was paid on the sale of the first home. Raytheon Company held a mortgage on the home of this employee.\n11. Borrowing on a non-interest bearing line of credit enabled relocated employee to build a new home. Upon completion of construction, the loan was converted to an interest free installment term loan with a value of $117,170 and with annual installments commencing in 1992 and continuing through 1996. The loan was liquidated in 1993.\n12. Non-interest bearing loan made on a demand note was reduced by partial principal payment and converted to a non-interest bearing installment term loan with monthly payments commencing in September, 1990 and was paid in full in 1992. Raytheon Company held a mortgage on the home of this employee.\n13. Non-interest bearing installment term loan maturing in February 1997. Raytheon holds a mortgage on the home of this employee.\n14. Relocation loan, part of which is interest bearing, was made to the employee to be repaid in January, 1994, unless either home is sold earlier. Raytheon Company holds mortgages on two homes of this employee.\n15. Non-interesting bearing loans made on demand notes and involving employee relocations. Amount was written off in 1991 based upon multiple relocation agreements made with employee.\n16. Non-interest bearing 10-year installment loan was partially repaid in July, 1991 with the balance being written off pursuant to a severance agreement with the employee. Raytheon Company held a mortgage on the two homes of this former employee.\n17. Interest bearing loan made on a demand note to be paid on the sale of the first home. Raytheon Company held a mortgage on the home in Georgia of this former employee. Amount was charged to a reserve in 1991.\n18. Non-interest bearing installment loan with balance due paid in February 1990. Raytheon Company held a mortgage on the home of this employee.\n19. Non-interest bearing 8-year installment loan with balance due paid in May 1990. Raytheon Company held a mortgage on the home of this employee.\n20. Non-interest bearing loan made on a demand note. In January 1994, the employee's home was sold and the loan reduced to an installment term loan. The remaining installment in the amount of $17,279 is payable in January 1995.\nRAYTHEON COMPANY AND SUBSIDIARIES CONSOLIDATED ---------------------------------------------- SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE THREE YEARS ENDED DECEMBER 31, 1993 ------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F\nBalance at Other changes Balance beginning Additions add (deduct) at end Classification of period at cost Retirements Note (1) of period ------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 1993:\nLand $ 46,254 $ 1,642 $ 350 $ <50> $ 47,496 Building and leasehold improvements 888,039 29,847 12,368 <719> 904,799 Machinery and equipment 2,482,229 256,135 158,203 <1,766> 2,578,395 Equipment leased to others 61,636 22,678 24,671 - 59,643 ---------- -------- -------- --------- ---------- $3,478,158 $310,302(2) $195,592 $ <2,535> $3,590,333 ========== ======== ======== ========= ==========\nYear ended December 31, 1992:\nLand $ 47,082 $ 290 $ 674 $ <444> $ 46,254 Building and leasehold improvements 870,458 33,324 9,709 <6,034> 888,039 Machinery and equipment 2,614,297 227,726 337,883 <21,911> 2,482,229 Equipment leased to others 67,518 46,386 52,268 - 61,636 ---------- --------- -------- --------- ---------- $3,599,355 $ 307,726 $400,534 $ <28,389> $3,478,158 ========== ========= ======== ========= ==========\nYear ended December 31, 1991:\nLand $ 47,892 $ 184 $ 587 $ <407> $ 47,082 Building and leasehold improvements 877,908 19,796 22,610 <4,636> 870,458 Machinery and equipment 2,512,663 297,347 165,944 <29,769> 2,614,297 Equipment leased to others 46,400 31,209 10,091 - 67,518 ---------- --------- -------- --------- ---------- $3,484,863 $ 348,536 $199,232 $ <34,812> $3,599,355 ========== ========= ======== ========= ==========\nNote (1) - Includes foreign exchange translation adjustments.\nNote (2) - Includes additions from acquisitions recorded under the purchase method. See Note Q of Notes to Financial Statements on page 58 of the Company's 1993 Annual Report to Stockholders.\nRAYTHEON COMPANY AND SUBSIDIARIES CONSOLIDATED ---------------------------------------------- SCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE THREE YEARS ENDED DECEMBER 31, 1993 -------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F\nAdditions Balance at charged to Other changes Balance beginning costs and add (deduct) at end Description of period expenses Retirements Note (1) of period ----------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1993:\nLand $ - $ - $ - $ - $ - Building and leasehold improvements 328,501 38,859 7,866 <1,594> 357,900 Machinery and equipment 1,721,062 243,555 162,311 187 1,802,493 Equipment leased to others 8,550 4,704 5,400 - 7,854 ---------- --------- --------- ----------- ---------- $2,058,113 $ 287,118 $ 175,577 $ <1,407> $2,168,247 ========== ========= ========= =========== ==========\nYear ended December 31, 1992:\nLand $ - $ - $ - $ - $ - Building and leasehold improvements 298,205 39,105 6,151 <2,658> 328,501 Machinery and equipment 1,763,159 255,981 281,819 <16,259> 1,721,062 Equipment leased to others 21,473 7,047 19,970 - 8,550 ---------- --------- --------- ----------- ---------- $2,082,837 $ 302,133 $ 307,940 $ <18,917> $2,058,113 ========== ========= ========= =========== ==========\nYear ended December 31, 1991:\nLand $ - $ - $ - $ - $ - Building and leasehold improvements 273,776 38,073 12,434 <1,210> 298,205 Machinery and equipment 1,657,644 263,658 136,987 <21,156> 1,763,159 Equipment leased to others 21,362 4,386 4,275 - 21,473 ---------- --------- -------- ---------- ----------- $1,952,782 $ 306,117 $153,696 $ <22,366> $ 2,082,837 ========== ========= ======== ========== ===========\nNote (1) - Includes foreign exchange translation adjustments.\nNote (2) - See Note A of Notes to Financial Statements on page 48 of the Company's 1993 Annual Report to Stockholders, which is hereby incorporated by reference, for discussion on method of depreciation and amortization.\nRAYTHEON COMPANY AND SUBSIDIARIES CONSOLIDATED ---------------------------------------------- SCHEDULE VIII - RESERVES FOR THE THREE YEARS ENDED DECEMBER 31, 1993 ------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\nAdditions Balance at Balance at beginning Charged to costs Charged to other Deductions end of Description of period and expenses accounts Note (1) period\n-------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1993:\nAllowance for doubtful $20,023 $ 4,586 - $(1,282) $25,891 accounts receivable\nYear ended December 31, 1992:\nAllowance for doubtful $19,229 $10,336 - $ 9,542 $20,023 accounts receivable\nYear ended December 31, 1991:\nAllowance for doubtful $16,916 $ 7,651 - $ 5,338 $19,229 accounts receivable\nNote (1) - Uncollectible accounts and adjustments, less recoveries\nRAYTHEON COMPANY AND SUBSIDIARIES CONSOLIDATED --------------------------------------------- SCHEDULE IX - SHORT TERM BORROWINGS FOR THE THREE YEARS ENDED DECEMBER 31, 1993 ------------------------------------------- (In thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F\nCategory of Maximum month- Average amount Weighted average aggregate Balance Weighted average end amount out- outstanding interest rate short-term at end interest rate at standing during during the during the borrowings of period end of period (2) the period period (3) period (3) ------------------------------------------------------------------------------------------------------------------------ 1993:\nNotes Payable $ 27,187 (1) 6.01% $ 42,593 $ 25,966 6.77% Commercial Paper 844,990 3.35 1,063,570 851,799 3.09 All categories 872,177 3.43 1,084,252 877,765 3.20\n1992:\nNotes Payable $ 16,492 (1) 8.71% $ 35,527 $ 35,039 8.03% Commercial Paper 688,297 3.42 1,245,025 1,080,670 3.74 All categories 704,789 3.54 1,305,460 1,115,709 3.87\n1991:\nNotes Payable $ 56,493 (1) 10.05% $ 103,135 $ 72,245 10.15% Commercial Paper 1,043,973 4.83 1,453,244 1,356,778 5.96 All categories 1,100,466 5.10 1,567,627 1,429,023 6.17\nNote (1) - In addition to this amount, lines of credit with certain commercial banks exist as a standby facility to support the issuance of commercial paper by the company. These lines of credit were $1.108 billion, $1.120 billion, and $1.440 billion as of December 31, 1993, 1992, and 1991, respectively. Through December 31, 1993, there have been no borrowings under these lines of credit.\n(2) - The weighted average interest rate at the end of each year is calculated by multiplying the actual interest rate times the principal amounts of all short-term debt instruments outstanding at December 31. This total calculated interest amount is then divided by the total outstanding debt to arrive at the weighted average interest rate.\n(3) - The weighted average interest rate during each year is determined by dividing the interest expense for the year by the average short-term debt during the year. The average short-term bank debt is determined by averaging the outstanding balances at the beginning of the year and at the end of each quarter (a five point weighted average). The average balance in commercial paper is determined based on amounts outstanding at the end of each day. \/TABLE","section_15":""}
{"filename":"700949_1993.txt","cik":"700949","year":"1993","section_1":"ITEM 1. BUSINESS\nAll references to \"Notes\" are to Notes to Consolidated Financial Statements contained in this report.\nThe registrant, Carlyle Real Estate Limited Partnership - XII (the \"Partnership\"), is a limited partnership formed in late 1981 and currently governed by the Revised Uniform Limited Partnership Act of the State of Illinois to invest in improved income-producing commercial and residential real property. The Partnership sold $160,000,000 in Limited Partnership Interests (the \"Interests\"), to the public pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-76443). A total of 160,000 Interests have been sold to the public at $1,000 per Interest. The offering closed on April 19, 1983. No Limited Partner has made any additional capital contribution after such date. The Limited Partners of the Partnership share in their portion of the benefits of ownership of the Partnership's real property investments according to the number of Interests held.\nThe Partnership is engaged solely in the business of the acquisition, operation and sale and disposition of equity real estate investments. Such equity investments are held by fee title, leasehold estates and\/or through joint venture partnership interests. The Partnership's real property investments are located throughout the nation and it has no real estate investments located outside of the United States. A presentation of information about industry segments, geographic regions, raw materials or seasonality is not applicable and would not be material to an understanding of the Partnership's business taken as a whole. Pursuant to the Partnership agreement, the Partnership is required to terminate on or before December 31, 2032. Accordingly, the Partnership intends to hold the real properties it acquires for investment purposes until such time as sale or other disposition appears to be advantageous. Unless otherwise described, the Partnership expects to hold its properties for long-term investment where, due to current market conditions, it is impossible to forecast the expected holding period. At sale of a particular property, the proceeds, if any, are generally distributed or reinvested in existing properties rather than invested in acquiring additional properties.\nThe Partnership has made the real property investments set forth in the following table:\nThe Partnership's real property investments are subject to competition from similar types of properties (including in certain areas properties owned or advised by affiliates of the General Partners) in the respective vicinities in which they are located. Such competition is generally for the retention of existing tenants. Additionally, the Partnership is in competition for new tenants in markets where significant vacancies are present. Reference is made to Item 7 below for a discussion of competitive conditions and future renovation and capital improvement plans of the Partnership and certain of its significant investment properties. Approximate occupancy levels for the properties are set forth in the table set forth in Item 2","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not subject to any pending material legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during 1992 and 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nAs of December 31, 1993, there were 16,628 record holders of Interests of the Partnership. There is no public market for Interests and it is not anticipated that a public market for Interests will develop. Upon request, the Corporate General Partner may provide information relating to a prospective transfer of Interests to an investor desiring to transfer his Interests. The price to be paid for the Interests, as well as any other economic aspects of the transaction, will be subject to negotiation by the investor.\nReference is made to Item 6","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nOn June 21, 1982, the Partnership commenced an offering of $160,000,000 pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. All Interests were subscribed and issued between June 21, 1982 and April 19, 1983 from which the Partnership received gross proceeds of $160,000,000.\nAfter deducting selling expenses and other offering costs, the Partner- ship had approximately $141,004,000 with which to make investments in income- producing commercial and residential real property, to pay legal fees and other costs (including acquisition fees) related to such investments and to satisfy working capital requirements. Portions of the proceeds were utilized to acquire the properties described in Item 1 above.\nAt December 31, 1993, the Partnership and its consolidated ventures had cash and cash equivalents of approximately $2,790,000. Such funds and short- term investments of approximately $6,866,000 are available for capital improvements, future distributions to partners, and for working capital requirements, including capital improvements and leasing costs currently being incurred at the National City Center Office Building. Certain of the Partnership's investment properties currently operate in overbuilt markets which are characterized by lower occupancies and\/or reduced rent levels. The Partnership currently has adequate cash and cash equivalents to maintain the operations of the Partnership. The Partnership has taken steps to preserve its working capital by deciding to suspend distributions to the Limited and General Partners effective as of the first quarter of 1992. The Partnership had also deferred cash distributions and partnership management fees, payable to the Corporate General Partner related to the third and fourth quarters of 1991. In addition, as of December 31, 1993, the General Partners and their affiliates have deferred payment of certain property management and leasing fees of approximately $3,523,000 (approximately $22 per Interest) as more fully described in Note 9. These amounts do not bear interest and are expected to be paid in future periods.\nThe Partnership and its consolidated ventures have currently budgeted for 1994 approximately $3,555,000 for tenant improvements and other capital expenditures. The Partnership's share of such items in 1994 is currently budgeted to be approximately $3,029,000. Included in this amount is the roof and parking lot at the Permian Mall which are currently in need of repair. To fund the Permian Mall improvements, the Partnership intends to initiate discussions with the mortgage lender regarding a modification to the loan. There can be no assurance that a loan modification can be obtained. Actual amounts expended in 1994 may vary depending on a number of factors including actual leasing activity, results of operations, liquidity considerations and other market conditions over the course of the year. The source of capital for such items and for both short-term and long-term future liquidity and distributions is expected to be through net cash generated by the Partnership's investment properties and through the sale of such investments. In addition, the Partnerships does not consider the remaining mortgage note receivable (related to San Mateo Fashion Island) to be a source of future liquidity. Reference is made to Note 7(b). The Partnership's and its Ventures' mortgage obligations are all non-recourse. Therefore, the Partnership and its Ventures are not obligated to pay mortgage indebtedness unless the related property produces sufficient net cash flow from operations or sale.\nAs described more fully in Note 4, the Partnership has received mortgage note modifications on certain of its properties which expire on various dates commencing June 30, 1994. One of the long-term mortgage lenders on the Country Square Apartments would not modify or extend its mortgage which became due January 1, 1993. Based upon current market conditions, the Partnership decided not to commit additional funds to the Country Square Apartments. In February 1993, the lender realized upon its security by obtaining title to the property. Therefore, the Partnership no longer has an ownership interest in the property. The above noted transaction resulted in a gain for financial reporting purposes of approximately $1,521,000 and a gain for Federal income tax purposes with no corresponding distributable proceeds. The mortgage on Stonybrook Apartments II matures October 1, 1994 (Stonybrook Apartments I is not subject to a mortgage loan) with an outstanding balance of approximately $5,633,000 at December 31, 1993. The Partnership intends to initiate discussions with the mortgage lender regarding an extension or modification to the mortgage loan. If the Partnership is unable to secure an extension or modification to the loan, based upon current market conditions, the Partnership would likely not commit any significant additional amounts to the property. This would result in the Partnership no longer having an ownership interest in the property. Such a decision could result in a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds.\nThe lease for Carrara Place Office Building's major tenant, which represented 46% of the building's leasable area and provided for rental payments that were significantly greater than current market rental rates, expired in December 1992. The Denver, Colorado region has been adversely affected by increased competition for tenants as a result of overbuilding in the area. As a result of the current market rental rates, the cash flow generated by the property would have been significantly less than the payments required under the original mortgage note even if the space was re-leased. Further, re-leasing the space requires significant re-leasing costs. Additionally, the lease for a tenant occupying approximately 17% of the building's leasable area was scheduled to expire in June 1994. The venture has reached an agreement with the tenant to extend their lease for an additional five years. The Carrara venture initiated discussions with the mortgage lender regarding a modification to the mortgage loan and in September 1993 reached an agreement to modify the loan retroactive to January 1, 1993. Under the modification, the maturity date is extended from June 30, 1994 until January 1, 1998. Interest continues to accrue at 9.875% from January 1, 1993 until January 1, 1998. Effective January 1, 1993, the net cash flow of the property, subject to certain reserves, will be paid to the lender and applied toward the payment of accrued and unpaid interest, current interest and principal balance of the loan, respectively. Any capital costs, including re- leasing costs, are to be funded by the lender, subject to their approval, and such costs added to the principal balance of the loan. Approximately $203,900 has been funded by the lender as of December 31, 1993.\nConcurrent with the modification, the Carrara venture was reorganized such that the Partnership became the sole general partner of the venture, with its venture partner becoming a limited partner of the venture. In addition, the property manager (an affiliate of the unaffiliated venture partner) was replaced effective September 1993. Based upon an analysis of current and anticipated market conditions, the Partnership has decided not to commit additional funds to the Carrara Place Office Building. There must be a significant improvement in market and property conditions in order for the value of the property to be greater than the mortgage payoff amount at any point in time, including accrued interest. Therefore, it is unlikely that any significant proceeds would be received by the Partnership in the event the property were sold or refinanced.\nIn conjunction with the modification, the Carrara venture has agreed to transfer title to the lender if the venture fails to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined).\nRegarding the First Interstate Center, although new construction in the Seattle office market has virtually ceased, the overall office market remains very competitive due to significant amount of sublease space on the market. In May 1989, an initiative was passed in Seattle to limit future development of downtown office space. Over time, this initiative (which is effective for ten years) may have a favorable impact on the Seattle office market. Although the occupancy (97% at December 31, 1993) at First Interstate Center has not been adversely affected to date by the competitive office market, effective rental rates have decreased as a result. Due to the competitive market conditions and the significant amounts of expiring square footage over the next several years, the property will reserve a portion of its cash flow in order to cover the re-leasing costs required. The first mortgage loan secured by the property is scheduled to mature in December 1995. The venture anticipates approaching the mortgage lender regarding an extension or modification of the existing mortgage loan. There can be no assurance that any such extension or modification will be obtained.\nAt the National City Center Office Building located in Cleveland, Ohio, a major tenant (Baker & Hostetler) extended its lease term to 2001, but reduced its space leased by approximately 18,000 square feet as of January 1993. The extended lease requires tenant improvement costs of approximately $92,000 per year through the expiration of the lease with an additional amount to paid in 1996 of approximately $730,000. The Partnership received a lease termination fee of approximately $1,100,000 from another tenant (KPMG Peat Marwick) for vacating approximately 19,700 square feet (which was subsequently leased to National City Bank). In addition, the Partnership has signed a lease with a law firm to occupy approximately 20,400 square feet and the leasing costs required under the lease for this new tenant will result in the property incurring a slight deficit for 1994. In January 1994, the debt service payments under the existing mortgage are scheduled to increase from 9-5\/8% to 11-7\/8% until the maturity of the loan in December 1995. The Partnership reached an agreement in principle with the current mortgage lender to refinance the existing mortgage which would be effective February 1, 1994, with an interest rate of 8.5%. The loan would be amortized over 22 years with a balloon payment due in seven years. The Partnership paid a refundable loan commitment fee of $1,164,000 in 1993. The Partnership also expects to pay a prepayment penalty of approximately $600,000, based on the outstanding mortgage balance at the time of refinancing. In addition, the lender would require an escrow account of approximately $610,000 to be established at the inception of the refinancing which would be supplemented from time to time for scheduled future tenant improvements costs at the property. Real estate taxes payable in 1994 are expected to increase due to a 25% reduction of a real estate tax abatement that was received when the property was purchased. The remaining 25% abatement expires in 1998 for taxes payable in 1999.\nDuring 1992, the Partnership entered into a contract (that was subsequently terminated) to sell the Sierra Pines Apartments subject to certain contingencies. Based upon the proposed sales price, the Partnership would not have recovered the net carrying value of the investment property. The Partnership, therefore, as a matter of prudent accounting practice, made a provision for value impairment on such investment property of $2,682,822. Such provision was recorded in September 1992 to effectively reduce the net carrying value of the investment property concurrently based upon the proposed sale price. On July 29, 1993, the Partnership sold the Sierra Pines and Crossing Apartments to an unaffiliated buyer. After the deduction of additional interest and normal costs of sale, the Partnership received proceeds of approximately $950,000 (including $288,000 in advisory fees) in the aggregate.\nIn connection with the San Francisco earthquake experienced on October 17, 1989, the Yerba Buena office building incurred some structural and cosmetic damage which was repaired. Five tenants (approximately 54% of the building) vacated the building and withheld substantially all of their rent (commencing at various times) since November 1989. The Partnership concluded not to pursue legal recourse against said tenants based on, among other things, the costs of pursuing its remedies, competing demands on the Partnership's resources and the prospects of any material return to the Partnership in light of recent events. Reference is made to Note 3(c) for further discussion.\nBased upon the conditions at Yerba Buena, the joint venture had not made the debt service payments to the underlying lender, commencing with the January 1990 payment. Accordingly, the joint venture received a default notice from the underlying lender in late February 1990. The Partnership and Affiliated Partners had decided, based upon analysis of current market conditions and the probability of large future cash deficits, not to fund future joint venture cash deficits. The joint venture had been negotiating with the underlying lender to obtain a loan modification to pay for expected future cash deficits. The joint venture was unable to negotiate a loan modification whereby the joint venture retained ownership of the property and in June, 1992 the joint venture transferred title to the property to the lender in return for an opportunity to share in future sale or refinancing proceeds above certain specified levels. In order for the joint venture to share in such proceeds, there must be a significant improvement in current market and property operating conditions resulting in a significant increase in value of the property. In addition, during a certain period of time, the joint venture will have a right of first opportunity to purchase the property if the lender chooses to sell. An affiliate of the Partnership's Corporate General Partner continues to manage and lease the property for the lender. As a result of the transfer of title to the lender as discussed above, the Partnership no longer has an ownership interest in the property and recognized a gain for financial reporting and Federal income tax purposes during 1992 of $2,261,223 and $1,350,845, respectively with no corresponding distributable proceeds.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.\nIn response to the weakness of the economy and the general security of credit in the real estate industry financing in particular, the Partnership is taking steps to preserve its working capital. Therefore, the Partnership is carefully scrutinizing the appropriateness of any discretionary expenditures, particularly in relation to the amount of working capital it has available. By conserving working capital, the Partnership will be in a better position to meet future needs of its properties without having to rely on external financing sources.\nDue to the factors discussed above and the general lack of buyers of real estate today, it is likely that the Partnership may hold some of its investment properties longer than originally anticipated in order to maximize the return to the Limited Partners. Also, in light of the current severely depressed real estate markets, it currently appears that the Partnership's goal of capital appreciation will not be achieved. Although the Partnership expects to distribute from sale proceeds some portion of the Limited Partners' original capital, without a dramatic improvement in market conditions the Limited Partners will not receive a full return of their original investment.\nRESULTS OF OPERATIONS\nThe increase in short-term investments as of December 31, 1993 as compared to December 31, 1992 is primarily due to (i) the Partnership suspending cash distributions from operations effective with the first quarter of 1992 as discussed above, and (ii) the Partnership withholding the proceeds from the Sierra Pines Apartments and The Crossing Apartments sales for future capital requirements.\nThe increase in loan commitment fee as of December 31, 1993 as compared to December 31, 1992 is due to the payment of a refundable loan commitment fee (approximately $1,164,000) for the National City Center Building mortgage refinancing in 1993 (see Note 4(e)).\nThe decrease in escrow deposits as of December 31, 1993 as compared to December 31, 1992, primarily reflects the refund in 1993 of an escrow account of approximately $477,000 established for capital improvements at Sierra Pines and Crossing Apartments at the time the Partnership obtained replacement loans for previously existing long-term mortgage notes. This decrease is partially offset by the increase of escrow accounts at the Carrara Place Office Building for operating reserves and real estate taxes required by the mortgage loan modification. Reference is made to Note 4.\nThe decrease in investment properties, current portion of long-term debt and tenant security deposits as of December 31, 1993 as compared to December 31, 1992 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square Apartments in February 1993 and the sales of the Sierra Pines and Crossing Apartments in July 1993. (See Notes 4(b) and 7(c)). In addition, the decrease in current portion of long-term debt and corresponding increase in long-term debt, less current portion is primarily due to the reclassification of the mortgage at the Carrara Place Office Building due to the Partnership no longer being in default as more fully described in Note 3(d). The current portion of long-term debt in 1993 primarily reflects the Stonybrook-II apartment complex mortgage and second mortgage obligations payable in October 1994. Reference is made to Note 4.\nThe decrease in deferred expenses at December 31, 1993 as compared to December 31, 1992 is primarily due to amortization of leasing commissions and lease assumptions in 1993 at First Interstate Office Building.\nThe increase in accrued interest as of December 31, 1993 as compared to December 31, 1992 reflects the cumulative unpaid interest attributable to the Carrara Place Office Building mortgage. Reference is made to Note 4.\nThe decrease in accounts payable and accrued real estate taxes as of December 31, 1993 as compared to December 31, 1992 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square Apartments in February 1993 and the sale of the Sierra Pines and Crossing Apartments in July 1993.\nThe decrease in rental income for the year ended December 31, 1993 as compared to the years ended December 31, 1992 and 1991 is primarily due to decreased occupancy at the Carrara Place Office Building, the second mortgage lender's realization upon its security represented by the Country Square Apartments in February 1993 and the sale of the Sierra Pines and Crossing Apartments in July 1993. This decrease is partially offset by a lease termination fee received in January 1993 at the National City Center Office Building.\nThe decrease in interest income for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to a decrease in interest income recognized on the promissory note receivable for San Mateo Fashion Island (reference is made to Note 7(b)). The decrease in interest income for the year ended December 31, 1992 as compared to 1991 is primarily due to a decrease in interest income recognized on the wrap-around notes receivable for Arbor Town Apartments-I and Arbor Town Apartments-II (reference is made to Note 7(a)).\nThe decrease in mortgage and other interest, depreciation and property operating expenses for the year ended December 31, 1993 as compared to 1992 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square Apartments in February 1993 and the sale of the Sierra Pines and Crossing Apartments in July 1993. In addition, the decrease in mortgage and other interest is also due to the lenders realizing upon their security in the Arbor Town Apartments-I and Arbor Town Apartments- II in December 1992. (See Notes 4(b), 4(d), 7(a) and 7(c)). The decrease in mortgage and other interest for the year ended December 31, 1992 as compared to 1991 is primarily due to a decrease in interest expense recognized on the underlying mortgage notes payable at the Arbor Town Apartments-I and Arbor Town Apartments-II in 1992 (as described above).\nThe decrease in management fees to the Corporate General Partner for the year ended December 31, 1993 as compared to 1992 and 1991 is due to the Partnership reducing the Limited Partners cash distribution effective as of the third and fourth quarters of 1991 and suspending distributions to the Limited and General Partners effective as of the first quarter 1992 (reference is made to Note 9).\nThe provision for value impairment for the year ended December 31, 1992 is due to the Partnership recording a provision to reduce the net carrying value of the Sierra Pines Apartments, based upon a proposed sales price (see Note 1).\nThe provision for uncollectible note receivable for the year ended December 31, 1991 is due to the Partnership's reserve on the note receivable on the San Mateo Fashion Island shopping center. (See Note 7(b).)\nThe increase in Partnership's share of operations of unconsolidated venture for the year ended December 31, 1993 as compared to 1992 is due to the transfer of title to the property to the lender of the Yerba Buena West Office Building in June 1992.\nThe increase in venture partners' share of ventures' operations for the year ended December 31, 1993 as compared to 1992 and 1992 as compared to 1991 and the corresponding increase in venture partners' deficits in venture as of December 31, 1993 as compared to 1992, is primarily due to decreased rental income at the Carrara Place Office Building primarily due to decreased occupancy.\nThe gain on sale or disposition of investment properties for the year ended December 31, 1993 is due to the second mortgage lender's realization upon its security represented by the Country Square Apartments in February 1993 of $1,520,734 and the $2,570,949 gain on sale of the Sierra Pines and Crossing Apartments in July 1993. The gain on disposition of investment property for the year ended December 31, 1992 is due to the transfer of title to the property to the lender of the Yerba Buena West Office Building in June 1992. In addition, the lenders of Arbor Town Apartments - I and Arbor Town Apartments - II realized upon their security and took title to the properties in December 1992. The gain on disposition in 1991 is due to the lender realizing upon its security in Summerfield\/Oakridge Apartments and taking title to the properties in January 1991. Reference is made to Note 7.\nINFLATION\nDue to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.\nTo the extent that inflation in future periods does have an adverse impact on property operating expenses, the effect will generally be offset by amounts recovered from tenants, as many of the long-term leases at the Partnership's commercial properties have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, there should be little effect on operating earnings if the properties remain substantially occupied. In addition, substantially all of the leases at the Partnership's shopping center investment contain provisions which entitle the Partnership to participate in gross receipts of tenants above fixed minimum amounts.\nFuture inflation may also cause capital appreciation of the Partnership's investment properties over a period of time to the extent that rental rates and replacement costs of properties increase.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nINDEX\nIndependent Auditors' Report\nConsolidated Balance Sheets, December 31, 1993 and 1992\nConsolidated Statements of Operations, years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Partners' Capital Accounts (Deficit), years ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Cash Flows, years ended December 31, 1993, 1992 and 1991\nNotes to Consolidated Financial Statements\nSCHEDULE --------\nSupplementary Income Statement Information X Consolidated Real Estate and Accumulated Depreciation XI\nSCHEDULES NOT FILED:\nAll schedules other than those indicated in the index have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII:\nWe have audited the consolidated financial statements of Carlyle Real Estate Limited Partnership - XII (a limited partnership) and consolidated ventures as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partners of the Partnership, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Carlyle Real Estate Limited Partnership - XII and consolidated ventures at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK\nChicago, Illinois March 25, 1994\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993, 1992 AND 1991\n(1) BASIS OF ACCOUNTING\nThe accompanying consolidated financial statements include the accounts of the Partnership and its ventures Carlyle Seattle Associates (\"Carlyle Seattle\"), Stonybrook Partners Limited Partnership (\"Stonybrook\"), Carrara Place Limited (\"Carrara\"), Carlyle\/P.M. Apartments Partnership (\"Carlyle\/P.M.\"), Carlyle Carrollton Associates (\"Carlyle Carrollton\"), and Carlyle\/National City Associates (\"Carlyle\/National City\"), Carlyle Seattle's venture, Wright-Carlyle Seattle (\"First Interstate\"), Carlyle Carrollton's venture, Country Square, Ltd. (\"Country Square\"), and Carlyle\/P.M.'s venture, Oakridge Apartments Partnership (\"Oakridge\"). The effect of all transactions between the Partnership and the ventures has been eliminated.\nThe equity method of accounting has been applied in the accompanying consolidated financial statements with respect to the Partnership's interest in Carlyle Yerba Buena Limited Partnership (\"Yerba Buena\"), through the date of its disposition (note 3(c)). Accordingly, the accompanying consolidated financial statements do not include the accounts of Yerba Buena.\nThe Partnership records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying consolidated financial statements have been prepared from such records after making appropriate adjustments to present the Partnership's accounts in accordance with generally accepted accounting principles (\"GAAP\") and to consolidate the accounts of the ventures as described above. Such adjustments are not recorded on the records of the Partnership. The net effect of these items is summarized as follows:\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe net earnings (loss) per limited partnership interest is based upon the limited partnership interests outstanding at the end of each year (160,005). Deficit capital accounts will result, through the duration of the Partnership, in net gain for financial reporting and income tax purposes.\nStatement of Financial Accounting Standards No. 95 requires the Partnership to present a statement which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The required information has been segregated and accumulated according to the classifications specified in the pronouncement. Partnership distributions from unconsolidated ventures are considered cash flow from operating activities only to the extent of the Partnership's cumulative share of net earnings. In addition, the Partnership records amounts held in U.S. Government obligations and certificates of deposit at cost which approximates market. Therefore, for the purposes of these statements, the Partnership's policy is to consider all such amounts held with original maturities of three months or less (none held at December 31, 1993 and 1992) as cash equivalents with any remaining amounts reflected as short-term investments.\nDeferred expenses are comprised principally of deferred leasing commissions and deferred lease assumption costs which are amortized over the lives of the related leases and deferred mortgage costs which are amortized over the term of the related notes.\nAlthough certain leases of the Partnership provide for tenant occupancy during periods for which no rent is due and\/or increases in minimum lease payments over the term of the lease, the Partnership accrues rental income for the full period of occupancy on a straight-line basis.\nStatement of Financial Accounting Standards No. 107, (\"SFAS 107\"),\"Disclosures about Fair Value of Financial Instruments\", requires entities with total assets exceeding $150 million at December 31, 1993 to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its financial instruments classified as current assets and liabilities (excluding current portion of long-term debt) approximates SFAS 107 value due to the relatively short maturity of these instruments. There is no quoted market value available for any of the Partnership's other instruments. The debt, with a carrying balance of $201,201,952, has been calculated to have an SFAS 107 value of $213,686,333 by discounting the scheduled loan payments to maturity. Due to restrictions on transferability and prepayment, and the inability to obtain comparable financing due to previously modified debt terms or other property specific competitive conditions, the Partnership would be unable to refinance these properties to obtain such calculated debt amounts reported. (See note 4.) The Partnership has no other significant financial instruments.\nDuring 1992, the Partnership entered into a contract (that was subsequently terminated) to sell the Sierra Pines Apartments subject to certain contingencies. Based upon the proposed sales price, the Partnership would not have recovered the net carrying value of the investment property. The Partnership, therefore, as a matter of prudent accounting practice, made a provision for value impairment on such investment property of $2,682,822. Such provision was recorded in September 1992, to effectively reduce the net carrying value of the investment property, based upon the proposed sale price.\nThe Sierra Pines Apartments was sold in July 1993 (note 7(c)). CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNo provision for State or Federal income taxes has been made as the liability for such taxes is that of the Partners rather than the Partnership. However, in certain instances, the Partnership has been required under applicable law to remit directly to the taxing authorities amounts representing withholding from distributions paid to partners.\n(2) INVESTMENT PROPERTIES\nThe Partnership has acquired, either directly or through joint ventures, ten apartment complexes, four office buildings, and two enclosed shopping malls. During 1984, the Partnership sold its interest in the Arbor Town Apartments-I and the Arbor Town Apartments-II complexes. Subsequently, in 1992, the lenders on the Arbor Town Apartments-I and Arbor Town Apartments-II complexes realized upon their security and obtained title to the properties resulting in the Partnership no longer having a security interest in the properties (note 4(d)). In 1986, the Partnership conveyed its interest in the Presidio West Apartments-II and sold its interest in the San Mateo shopping center. In 1990, the Partnership disposed of its interest in the Timberline Apartments and sold its interest in the Meadows Southwest Apartments. In 1991, the Partnership, through its joint venture, disposed of its interest in the Summerfield\/Oakridge Apartments. In 1992, the Yerba Buena venture transferred title to the property to the lender (note 3(c)). In 1993, the Partnership sold its interest in the Sierra Pines Apartments and The Crossing Apartments, and disposed of its interest in the Country Square Apartments (note 7). The five properties owned at December 31, 1993 were completed and in operation.\nDepreciation on the operating properties has been provided over estimated useful lives of 5 to 40 years using the straight-line method.\nAll investment properties are pledged as security for long-term debt, for which there is no recourse to the Partnership. The second mortgage on the Stonybrook apartment complex represented a mortgage loan which was subordinate to an existing senior mortgage loan. The Stonybrook second mortgage note was assigned to the Partnership during 1987.\nThe mortgage loans secured by Stonybrook Apartment II mature in October 1994. The Partnership intends to initiate discussions with the mortgage lender regarding an extension or modification to the mortgage loan. If the Partnership is unable to secure an extension or modification to the loan, based upon current market conditions, the Partnership would likely not commit any significant additional amounts to the property. This would result in the Partnership no longer having an ownership interest in the property. Such a decision could result in a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds. As of December 31, 1993 the outstanding balances are reflected in the current portion of long- term debt in the accompanying consolidated financial statements.\nMaintenance and repair expenses are charged to operations as incurred. Significant betterments and improvements are capitalized and depreciated over their estimated useful lives.\n(3) VENTURE AGREEMENTS\n(a) General\nThe Partnership, at December 31, 1993, is a party to four operating joint venture agreements. Pursuant to such agreements, the Partnership made aggregate capital contributions of $99,276,831. In general, the joint venture partners, who are either the sellers (or their affiliates) of the property CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\ninvestments being acquired, or parties which have contributed an interest in the property being developed, or were subsequently admitted to the ventures, make no cash contributions to the ventures, but their retention of an interest in the property, through the joint venture, is taken into account in determining the purchase price of the Partnership's interest, which is determined by arm's-length negotiations. Under certain circumstances, either pursuant to the venture agreements or due to the Partnership's obligations as a general partner, the Partnership may be required to make additional cash contributions to the ventures.\nThe Partnership has acquired, through the above ventures, one apartment complex and three office buildings. In some instances, the properties were acquired (as completed) for a fixed purchase price. In other instances, properties were developed by the ventures and, in those instances, the contributions of the Partnership were generally fixed. The joint venture partners (who were primarily responsible for constructing the properties) contributed any excess of cost over the aggregate amount available from Partnership contributions and financing and, to the extent such funds exceeded the aggregate costs, were to retain such excess. The venture properties have been financed under various long-term debt arrangements as described in note 4.\nThe Partnership has a cumulative preferred interest in net cash receipts (as defined) from two of the Partnership's venture properties-Carrara Place Office Building and First Interstate Center. Such preferential interest relates to a negotiated rate of return on contributions made by the Partnership. After the Partnership receives its preferential return, the venture partner is generally entitled to a non-cumulative return on its interest in the venture; additional net cash receipts are generally shared in a ratio relating to the various ownership interests of the Partnership and its venture partners. One of the ventures' properties produced net cash receipts during 1993, two in 1992. In general, operating profits and losses are shared in the same ratio as net cash receipts. If there are no net cash receipts, substantially all profits or losses are allocated in accordance with the partners' respective economic interests. The Partnership generally has preferred positions (related to the Partnership's cash investment in the ventures) with respect to distribution of sale or refinancing proceeds from the ventures.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.\n(b) First Interstate Center\nDuring 1982, the Partnership acquired, through a joint venture (\"First Interstate\") between an affiliated joint venture (\"Carlyle Seattle\") described below and the developer, a fee ownership of improvements and a leasehold interest in an office building in Seattle, Washington. Carlyle Seattle is a joint venture between the Partnership and Carlyle Real Estate Limited Partnership-X, an affiliated partnership sponsored by the Corporate General Partner of the Partnership. Under the terms of the First Interstate venture agreement, Carlyle Seattle made initial cash contributions aggregating $30,000,000.\nThe terms of the Carlyle Seattle venture agreement provide that all the capital contributions will be made in the proportion of 73.3% by the Partner- ship and 26.7% by the affiliated partner. The initial required contribution by the Partnership to the Carlyle Seattle venture was $22,000,000. The Carlyle Seattle venture agreement further provides that all of the venture's\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nshare of the First Interstate joint venture's annual cash flow, sale or refinancing proceeds, operating profits and losses, and tax items will be allocated 73.3% to the Partnership and 26.7% to the affiliated partner.\nCarlyle Seattle will generally be entitled to receive a preferred distribution (on a cumulative basis) of annual cash flow equal to 8% of its capital contributions to the First Interstate joint venture. Cash flow in excess of this preferred distribution will be distributable to the First Interstate joint venture partner up to the next $400,000 and any remaining annual cash flow will be distributable 50% to Carlyle Seattle and 50% to the First Interstate joint venture partner. Operating deficits, if any, will be shared 50% by Carlyle Seattle and 50% by the First Interstate joint venture partner. Operating profits or losses of the First Interstate joint venture generally are allocated in the same ratio as the allocation of annual cash flow, however, the joint venture partner will be allocated not less than 25% of such profits and losses. As of December 31, 1993, $20,049,000 of cumulative preferred distributions due to Carlyle Seattle were unpaid.\nThe First Interstate joint venture agreement provides that upon sale of the property, Carlyle Seattle will be, in general, entitled to receive the first $39,000,000 of net sale proceeds plus an amount equal to any deficiencies (on a cumulative basis) in distributions of Carlyle Seattle's preferred return of annual cash flow. The First Interstate joint venture partner will be entitled to receive the next $5,000,000 and any remaining proceeds will be distributable 50% to Carlyle Seattle and 50% to the First Interstate joint venture partner.\nThe office building is managed by an affiliate of the First Interstate joint venture partner for a fee computed at 2% of base and percentage rents.\n(c) Yerba Buena West Office Building\nIn August 1985, the Partnership acquired, through the Carlyle Yerba Buena Limited Partnership (\"Yerba Buena\"), an interest in an existing six-story office building known as Yerba Buena West Office Building in San Francisco, California. The Partners of Yerba Buena include Carlyle Real Estate Limited Partnership-XI and Carlyle Real Estate Limited Partnership-XIV, two public partnerships sponsored by the Corporate General Partner of the Partnership (the \"Affiliated Partners\") and four limited partners unaffiliated with the Partnership or its General Partners (the \"Unaffiliated Partners\").\nThe Partnership and the Affiliated Partners purchased an 80% interest in the property from the sellers and simultaneously formed Yerba Buena with the Unaffiliated Partners. The Partnership was generally entitled to 32.72% of Yerba Buena's annual net cash flow, net sale or refinancing proceeds and profits and losses.\nAs has been previously reported, in connection with the October 17, 1989 San Francisco earthquake, the Yerba Buena office building incurred some structural and cosmetic damage which has been repaired. In addition, five tenants (approximately 54% of the building), based upon concerns over the structural integrity of the building, moved out of the building after the earthquake and have withheld all or portions of their rent commencing at various times since November 1989. The Partnership concluded not to pursue legal recourse against said tenants based on, among other things, the costs of pursuing its remedies, competing demands on the Partnership's resources and the prospects of any material return to the Partnership in light of recent events.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nBased upon the conditions at Yerba Buena and the probability of large future cash deficits, the Partnership and its Affiliated Partners had decided not to fund future deficits and, therefore, the joint venture has not made the debt service payments to the underlying lender commencing with the January 1990 payment. Accordingly, the joint venture received a default notice from the underlying lender in late February 1990.\nThe joint venture had been negotiating with the underlying lender to obtain a loan modification to pay for expected future cash deficits. The joint venture was unable to negotiate a loan modification whereby the joint venture retained ownership of the property and in June 1992, the joint venture transferred title to the property to the lender in return for an opportunity to share in future sale or refinancing proceeds above certain specified levels. In order for the joint venture to share in such proceeds, there must be a significant improvement in current market and property operating conditions resulting in a significant increase in value of the property. In addition, during a certain period of time, the joint venture will have a right of first opportunity to purchase the property if the lender chooses to sell. An affiliate of the Partnership's Corporate General Partner continues to manage and lease the property for the lender. As a result of the transfer of title to the lender as discussed above, the Partnership no longer has an ownership interest in the property and recognized a gain for financial reporting and Federal income tax purposes of $2,261,223 and $1,350,845, respectively, in 1992 with no corresponding distributable proceeds.\n(d) Carrara\nThe Carrara joint venture agreement provides that operating profits and losses of the venture are allocated 50% to the venture and 50% to the venture partner. Gain arising from the sale or other disposition of the property would be allocated to the venture partner or partners then having a deficit balance in its or their respective capital accounts in accordance with the terms of the venture agreement. Any additional gain would be allocated in accordance with the distribution of sales proceeds. The lease for Carrara Place Office Building's major tenant, which represented 46% of the building's leasable area and provided for rental payments that were significantly greater than current market rental rates, expired in December 1992 and the tenant vacated. The Carrara venture initiated discussions with the mortgage lender regarding a modification to the mortgage loan and in September 1993 reached an agreement to modify the loan retroactive to January 1, 1993. Under the modification, the maturity date has been extended from June 30, 1994 until January 1, 1998. Interest continues to accrue at 9.875% from January 1, 1993 until January 1, 1998. Effective January 1, 1993, the net cash flow of the property (after the required minimum interest payments of $8,333 monthly or $100,000 annually), subject to certain reserves including a $350,000 operating reserve to fund deficits, will be paid to the lender and applied toward the payment of accrued and unpaid interest, current interest and principal balance of the loan, respectively. Any capital costs, including re-leasing costs, are to be funded by the lender, (subject to their approval) and will be added to the principal balance of the loan. Approximately $203,900 has been funded by the lender as of December 31, 1993.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nConcurrent with the modification, the Carrara venture has been reorganized such that the Partnership became the sole general partner of the venture, with its venture partner becoming a limited partner of the venture. In addition, the property manager (an affiliate of the unaffiliated venture partner) was replaced effective September 1993. Based upon an analysis of current and anticipated market conditions, the Partnership has decided not to commit additional funds to the Carrara Place Office Building. There must be a significant improvement in market and property conditions in order for the value of the property to be greater than the mortgage pay off amount at any point in time, including accrued interest. Therefore, it is unlikely that any significant proceeds would be received by the Partnership from a sale of the property or that the mortgage loan could be refinanced when it becomes due.\nIn conjunction with the modification, the venture has agreed to transfer title to the lender if the venture fails to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined).\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIncluded in the above total long-term debt is $2,055,549 and $3,418,549 at December 31, 1993 and 1992, respectively, which represents mortgage interest accrued but not currently payable pursuant to the terms of the notes (as modified).\nFive year maturities of long-term debt (exclusive of amortization of discount) are as follows:\n1994 . . . . . . . . . .$ 6,489,518 1995 . . . . . . . . . . 155,348,654 1996 . . . . . . . . . . 720,851 1997 . . . . . . . . . . 795,347 1998 . . . . . . . . . . 23,640,728 ============\n(b) Debt Modifications\nThe Partnership modified the $5,800,000 second mortgage note secured by the Country Square apartment complex in Carrollton, Texas effective June 1, 1989. The pay rate was raised from 4% per annum to 5% per annum (payable in monthly installments of interest only) through December 1, 1992. Interest accrued and was deferred at a rate of 11% per annum from June 1, 1989 through December 31, 1990 and 12% per annum from January 1, 1991 through December 31, 1992; payable each April 30 to the extent of any annual cash flow (as defined) or upon the earlier of subsequent sale of the property or the January 1, 1993 maturity of the note. The lender notified the Partnership that it would not modify the existing terms of the second mortgage. The Partnership was unable to secure new or additional modifications or extensions to the loan, therefore as of December 31, 1992, the outstanding balance of $7,163,000 was reflected in the current portion of long-term debt in the accompanying consolidated financial statements. On February 2, 1993, the second mortgage lender concluded proceedings to realize upon its security and took title to the property. As a result, the Partnership recognized a gain for financial reporting purposes of $1,520,734 and a gain for Federal income tax purposes of $5,633,431 in 1993 with no corresponding distributable proceeds.\nThe long-term mortgage notes secured by the Summerfield\/Oakridge Apart- ments, located in Aurora, Colorado were modified, effective August 1, 1986. Beginning October 1, 1990, the scheduled monthly payments to the lender were not made. The lender provided the venture with a notice of default and placed the property in receivership October 16, 1990. Negotiations for further debt relief were not successful. In January 1991, the lender concluded proceedings to realize upon its security and took title to the property resulting in the Partnership recognizing a gain of $1,637,840 (net of venture partners' share of $270,551) for financial reporting purposes. Although no distributable proceeds were realized on this transaction, a gain of approximately $7,493,000 for Federal income tax purposes was recognized in 1991.\nAs of December 31, 1992, the outstanding loan balance of the long-term mortgage note secured by the Carrara Place Office Building was reflected in the current portion of long-term debt due to the venture not making the scheduled debt service payments beginning January 1, 1993. The note was subsequently modified effective January 1, 1993. Under the modification, the maturity date has been extended from June 30, 1994 until January 1, 1998. Interest continues to accrue at 9.875% from January 1, 1993 until maturity. Effective January 1, 1993, the net cash flow of the property (after the required minimum interest payments of $8,333 monthly or $100,000 annually), subject to certain reserves including a $350,000 operating reserve to fund deficits, will be paid to the lender and applied toward the payment of accrued and unpaid interest, current interest and principal balance of the loan,\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nrespectively. Any capital costs, including re-leasing costs, are to be funded by the lender, (subject to their approval) and will be added to the principal balance of the loan.\nIn conjunction with the modification, the venture has agreed to transfer title to the lender if the venture fails to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined).\n(c) Refinancings\nEffective December 27, 1990, the Partnership obtained replacement loans from an institutional lender to retire in full satisfaction, at an aggregated discount, the previously modified existing long-term mortgage notes secured by the Sierra Pines Apartments and the Crossings Apartments. The new lender required the establishment of escrow accounts, of approximately $253,000 and $291,000, to be used toward the purchase of capital items at the Sierra Pines Apartments and the Crossings Apartments, respectively. As of the date of sale (see note 7(c)) approximately $62,000 and $6,000 were used for such purposes for the respective properties. The new mortgage loans, which were cross- collateralized, required interest only payments at 9.5% plus contingent interest (as defined) until January 1, 1999, when the remaining balance was payable. In 1993 and 1992, $176,334 and $145,029 were paid for 1992 and 1991 contingent interest, respectively for the properties. $107,945 was paid in 1993 for 1993 contingent interest for both properties through the date of sale. In the event that these properties were sold before the maturity date of the loan, the lender was to receive additional interest of 6% of the mortgage principal and, in general, the higher of 65% of the sale proceeds (as defined) or ten times the highest contingent interest (as defined) amount in any of the three full fiscal years preceding the sale. In 1993, the Partnership sold its interest in the Sierra Pines Apartments and The Crossing Apartments (see note 7(c)).\n(d) Arbor Town Apartments-I and Arbor Town Apartments-II\nIn 1984, the Arbor Town Apartments-I and Arbor Town Apartments-II were sold, at which time the Partnership received $12,400,000 in wrap-around notes receivable. The Partnership elected to retain the original mortgages and planned to ultimately pay off the outstanding original mortgage balances from proceeds of the wrap-around notes receivable. The buyer voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code in May 1988. In April 1989, the United States Bankruptcy Court approved a plan of reorganization whereby the underlying mortgage notes payable were allowed to be modified. The subsequent modifications on the underlying mortgage notes payable were made retroactively effective to April 24, 1989 and September 1, 1988. The wrap-around notes receivable held by the Partnership had been modified to the extent the Partnership had agreed that the buyer make payments directly to the lenders (note 7(a)).\n(e) National City Center Office Building\nIn January 1994, the debt service payments under the existing mortgage for the National City Center Office Building are scheduled to increase from 9- 5\/8% to 11-7\/8% until the maturity of the loan in December 1995. The Partnership reached an agreement in principle with the current mortgage lender to refinance the existing mortgage which would be effective February 1, 1994, with an interest rate of 8.5%. The loan would be amortized over 22 years with a balloon payment due in seven years. The Partnership paid a refundable loan commitment fee of $1,164,000 in 1993 in conjunction with the proposed refinancing. The Partnership also expects to pay a prepayment penalty of approximately $600,000, based on the outstanding mortgage balance at the time\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nof refinancing. In addition, the lender would require an escrow account of approximately $610,000 to be established at the inception of the refinancing which would be supplemented from time to time for scheduled future tenant improvements costs at the property. There can be no assurance that the loan refinancing can be obtained.\nThe buyer retroactively modified the terms of the mortgage note payable and related accrued interest secured by the Arbor Town Apartments-I under the reorganization mentioned above. The modified principal balance (including deferred fees) was determined to be $3,261,865. Monthly payments of interest only at 9.875% per annum were due until August 1991. Beginning September 1, 1991, through the scheduled maturity date of December 20, 1994, monthly payments of principal and interest were due at 9.875%. The maturity date of the mortgage note payable could have been extended to August 31, 1998, at the option of the buyer.\nThe buyer also retroactively modified the terms of the mortgage note payable and related accrued interest secured by the Arbor Town Apartments-II under the reorganization mentioned above. Monthly payments of interest only of 8%, 8.5% and 9% were effective September 1, 1990, 1991 and 1992, respectively. The interest accrual rate was reduced from 14.5% per annum to 9% per annum. The difference between the accrual interest rate and the pay rates was added to the outstanding principal balance which would have been due January 1, 1993.\nThe buyer was in default on the underlying first mortgage payments made directly to the lenders. As a result, the lenders provided the Partnership with letters of default. In December 1992, the lenders concluded proceedings to realize upon their security and obtained title to the properties resulting in the Partnership no longer having a security interest in the properties. Although the Partnership received no cash proceeds from the transfer of its security interest; it did, however, recognize a gain for financial reporting purposes and a loss for Federal income tax purposes in 1992 of $1,556,577 and $275,509, respectively.\n(5) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement, net profits and losses of the Partnership from operations are allocated 96% to the Limited Partners and 4% to the General Partners. Profits from the sale or other disposition of investment properties will be allocated first to the General Partners in an amount equal to the greater of the amount distributable to the General Partners as sale or refinancing proceeds from sale or other disposition of investment properties (as described below) or 1% of the profits from the sale or refinancing. Losses from the sale or other disposition of investment properties will be allocated 1% to the General Partners. The remaining sale or other disposition of investment properties profits and losses will be allocated to the Limited Partners.\nAn amendment to the Partnership Agreement, effective January 1, 1991, generally provides that notwithstanding any allocation contained in the Agreement, if at any time profits are realized by the Partnership, any current or anticipated event that would cause the deficit balance in absolute amount in the Capital Account of the General Partners to be greater than their share of the Partnership's indebtedness (as defined) after such event, then the allocation of Profits to the General Partners shall be increased to the extent necessary to cause the deficit balance in the Capital Account of the General Partners to be no less than their respective shares of the Partnership's indebtedness (as defined) after such event. In general, the effect of this amendment is to allow the deferral of the recognition of taxable gain to the Limited Partners.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe General Partners are not required to make any capital contributions except under certain limited circumstances upon dissolution and termination of the Partnership. Distributions of \"net cash receipts\" of the Partnership will be allocated 90% to the Limited Partners and 10% to the General Partners (of which 6.25% constitutes a management fee to the Corporate General Partner for services in managing the Partnership). Distributions of \"sale proceeds\" and \"financing proceeds\" are to be allocated 99% to the Limited Partners and 1% to the General Partners until receipt by the Limited Partners of their initial contributed capital plus a stipulated return thereon. Thereafter, distributions of \"sale proceeds\" and \"financing proceeds\" are to be allocated to the General Partners until the General Partners have received an amount equal to 3% of the gross sales prices of any properties sold, then the balance 85% to the Limited Partners and 15% to the General Partners.\n(6) MANAGEMENT AGREEMENTS\nThe Partnership has entered into agreements with sellers or affiliates of the sellers for the operation and management of several properties. Such agreements provided that, during the term of these agreements, the managers paid all expenses of the properties and retained the excess, if any, of cash revenues from operations over costs and expenses, as defined, as a management fee. Upon termination of the agreements, an affiliate of the General Partners assumed management under agreements providing for management fees calculated at a percentage of the gross income from the properties.\nAn affiliate of the General Partners of the Partnership manages the following properties for a fee calculated at a percentage of gross income from the following properties:\nSierra Pines Apartments, Houston, Texas (through July 29, 1993) Country Square Apartments, Carrollton, Texas (through February 1, 1993) Permian Mall, Odessa, Texas National City Center, Cleveland, Ohio Crossing Apartments, Houston, Texas (through July 29, 1993) Stonybrook Apartments-I & II, Tucson, Arizona\n(7) SALE OF INVESTMENT PROPERTIES\n(a) Arbor Town Apartments-I and Arbor Town Apartments-II\nDuring November 1984, the Partnership concurrently sold the land and related improvements of the Arbor Town Apartments-I and Arbor Town Apartments-II located in Arlington, Texas for $15,500,000, consisting of $3,100,000 in cash and $12,400,000 of wrap-around notes receivable. The purchase wrap-around notes were subject to existing mortgage notes (note 4).\nThe sale was accounted for by the installment method whereby the gain on sale of $2,724,491 (net of discount on the notes receivable of $890,413) was recognized as collections of principal were received. No profit was recognized by the Partnership in 1992 and 1991.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Partnership did not receive the scheduled interest only payments of approximately $2,000,000 on the wrap-around notes receivable from January 1988 through May 1989 and, therefore, the Partnership did not make the corresponding scheduled monthly payments on the underlying indebtedness. The buyer voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code in May 1988. In April 1989, the United States Bankruptcy Court approved a plan of reorganization, whereby scheduled payments on the wrap-around notes receivable and related underlying mortgage notes payable were allowed to be modified by the buyer. Under the terms of the Bankruptcy Reorganization Plan, the Partnership's wrap-around notes receivable and underlying non-recourse mortgage notes payable remained outstanding. The buyer subsequently negotiated the modification of the underlying non-recourse mortgage notes payable directly with the lenders while the wrap-around notes receivable had been modified to the extent the Partnership had agreed that the buyer make payments directly to the lender. These modifications modified the terms of the original underlying loan agreements resulting in permanent interest expense reductions. For financial reporting purposes, these interest expense reductions had been offset by adjustments to the wrap-around notes receivable. No reserve for collectibility had been established previously due to the existence of deferred gain exceeding the net equity in the wrap-around notes receivable, with the underlying indebtedness being non-recourse to the Partnership. The Partnership recognized interest income on the wrap-around notes receivable only to the extent interest had been paid by the buyer on the modified underlying indebtedness. In December 1992, the lenders concluded proceedings to realize upon their security and obtained title to the properties resulting in the Partnership no longer having a security interest in the properties (see note 4(d)).\n(b) San Mateo Fashion Island\nOn December 31, 1986, the Partnership sold its right, title and interest in the land, leasehold interest and related improvements of the San Mateo Fashion Island shopping center for $44,202,559 and recognized profit in full of $9,528,813. The sale price consisted of $950,000 in cash at closing, the assumption of the existing mortgage note having an unpaid principal balance of $39,302,559 (for financial reporting purposes the principal balance was $28,895,264) and an additional promissory note in the amount of $3,950,000 ($950,000 paid in March 1988) secured by a subordinated deed of trust on the property. In addition to the sale price, the Partnership received $7,600,000 from the venture partner during 1986 under the terms of the venture agreement.\nDuring the first quarter of 1992, the Partnership was advised by the buyer (in which the Corporate General Partner has an interest) that it had initiated discussions directly with the first mortgage lender regarding a modification to the first mortgage note. The buyer is currently making reduced payments to the first mortgage lender and has discontinued making payments to the Partnership as of March 1992. Due to uncertainty regarding the value of the underlying collateral, the Partnership reserved for the entire outstanding principal balance and accrued interest ($3,720,000) on the note receivable as of December 31, 1993 and 1992 in the accompanying consolidated financial statements. In addition, the entire outstanding principal balance and accrued interest was written off for Federal income tax purposes in 1992.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(c) Sierra Pines and Crossing Apartments\nOn July 29, 1993, the Partnership sold the land, buildings, related improvements and personal property of the Sierra Pines and Crossing Apartments located in Houston, Texas. The purchaser is not affiliated with the Partnership or its General Partners and the sale price was determined by arm's-length negotiations. The sale prices of the land, buildings, related improvements and personal property for Sierra Pines and Crossing Apartments were $4,880,000 and $9,535,000, respectively. A portion of the cash proceeds was utilized to retire the first mortgage notes with outstanding balances of $4,380,000 and $7,600,000, respectively, secured by the properties. The Partnership paid additional interest of $1,230,923 in the aggregate in connection with the retirement of the mortgage notes. The Partnership received in connection with these sales, after additional interest and normal costs of sale, a net amount of cash of approximately $950,000 (including $288,000 in advisory fees) in the aggregate. As a result of these sales, the Partnership recognized gains for financial reporting purposes of $44,030 and $2,526,916, respectively, and recognized a gain for Federal income tax purposes of $1,510,727 and $6,164,118, respectively.\n(8) LEASES\n(a) As Property Lessor\nAt December 31, 1993, the Partnership and its consolidated ventures' principal assets are one apartment complex, one enclosed shopping mall and three office buildings. The Partnership has determined that all leases relating to these properties are properly classified as operating leases; therefore, rental income is reported when earned and the cost of each of the properties, excluding cost of land, is depreciated over the estimated useful life.\nLeases with commercial tenants range in term from one to thirty years and provide for fixed minimum rent and partial reimbursement of operating costs. In addition, leases with shopping center tenants provide additional rent based upon percentages of tenants' sales volumes. With respect to the Partnership's shopping center investment, a substantial portion of the ability of retail tenants to honor their leases is dependent upon the retail economic sector. Apartment complex leases in effect at December 31, 1993 are generally for a term of one year or less and provide for annual rents of approximately $1,762,376.\nCost and accumulated depreciation of the leased assets are summarized as follows at December 31, 1993:\nShopping mall: Cost. . . . . . . . . . . . $ 24,294,375 Accumulated depreciation. . (7,666,062) ------------ 16,628,313 ------------ Office buildings: Cost. . . . . . . . . . . . 221,682,710 Accumulated depreciation. . (71,337,019) ------------ 150,345,691 ------------\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nApartment complex: Cost. . . . . . . . . . . . 8,022,749 Accumulated depreciation. . (3,543,125) ------------ 4,479,624 ------------\nTotal. . . . . . . . . . $171,453,628 ============\nMinimum lease payments, including amounts representing executory costs (e.g., taxes, maintenance, insurance) and any related profit in excess of specific reimbursements, to be received in the future under the above commercial operating lease agreements, are as follows:\n1994 . . . . . . . . . . . $ 29,940,250 1995 . . . . . . . . . . . 26,817,970 1996 . . . . . . . . . . . 24,999,921 1997 . . . . . . . . . . . 22,656,470 1998 . . . . . . . . . . . 22,120,863 Thereafter . . . . . . . . 114,672,214 ------------ Total. . . . . . . . . $241,207,688 ============\n(b) As Property Lessee\nThe First Interstate venture owns a net leasehold interest (which expires in 2052) in the land underlying the Seattle, Washington office building, subject to a 20-year extension. The lease provides for an annual rent of $670,000 and has been determined to be an operating lease.\n(9) TRANSACTIONS WITH AFFILIATES\nFees, commissions and other expenses required to be paid by the Partnership to the General Partners and their affiliates as of December 31, 1993 and for the years ended December 31, 1993, 1992 and 1991 are as follows:\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED\nThe General Partners and their affiliates have deferred through June 30, 1988 payment of certain property management and leasing fees of $3,522,816. In addition, the Partnership deferred the General Partners' cash distribution and management fee of $19,666 and $33,334, respectively, for the third and fourth quarters of 1991. These deferred amounts (approximately $22 per Interest in the aggregate) and amounts currently payable do not bear interest and are expected to be paid in future periods. SCHEDULE X\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nCHARGED TO COSTS AND EXPENSES ---------------------------------------------- 1993 1992 1991 ------------ ------------ ------------\nMaintenance and repairs. $4,852,082 5,068,044 4,825,845\nDepreciation . . . . . . 9,144,746 9,598,560 9,476,084\nTaxes:\nReal estate. . . . . . 4,747,734 5,198,223 5,009,727\nOther. . . . . . . . . 11,727 459,393 7,009\nAdvertising. . . . . . . 289,171 363,351 380,435 ========== ========= =========\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes of or disagreements with accountants during fiscal year 1993 and 1992.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nThe Corporate General Partner of the Partnership is JMB Realty Corporation (\"JMB\"), a Delaware corporation. JMB, as the Corporate General Partner, has responsibility for all aspects of the Partnership's operations, subject to the requirement that sales of real property must be approved by the Associate General Partner of the Partnership, Realty Associates-XII, L.P., an Illinois limited partnership with JMB as the sole general partner. The Associate General Partner shall be directed by a majority in interest of its limited partners (who are generally officers, directors and affiliates of JMB or its affiliates) as to whether to provide its approval of any sale of real property (or any interest therein) of the Partnership. Various relationships of the Partnership to the Corporate General Partner and its affiliates are described under the caption \"Conflicts of Interest\" at pages 9-14 of the Prospectus, which description is hereby incorporated herein by reference to exhibit 3-A to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\nThe names, positions held and length of service therein of each director and executive officer and certain officers of the Corporate General Partner are as follows:\nSERVED IN NAME OFFICE OFFICE SINCE ---- ------ ------------\nJudd D. Malkin Chairman 5\/03\/71 Director 5\/03\/71 Neil G. Bluhm President 5\/03\/71 Director 5\/03\/71 Jerome J. Claeys III Director 5\/09\/88 Burton E. Glazov Director 7\/01\/71 Stuart C. Nathan Executive Vice President 5\/08\/79 Director 3\/14\/73 A. Lee Sacks Director 5\/09\/88 John G. Schreiber Director 3\/14\/73 H. Rigel Barber Chief Executive Officer 8\/02\/93 Jeffrey R. Rosenthal Chief Financial Officer 8\/01\/93 Gary Nickele Executive Vice President and 1\/01\/92 General Counsel 2\/27\/84 Ira J. Schulman Executive Vice President 6\/01\/88 Gailen J. Hull Senior Vice President 6\/01\/88 Howard Kogen Senior Vice President 1\/02\/86 Treasurer 1\/01\/91 There is no family relationship among any of the foregoing directors or officers. The foregoing directors have been elected to serve one-year terms until the annual meeting of the Corporate General Partner to be held on June 7, 1994. All of the foregoing officers have been elected to serve one-year terms until the first meeting of the Board of Directors held after the annual meeting of the Corporate General Partner to be held on June 7, 1994. There are no arrangements or understandings between or among any of said directors or officers and any other person pursuant to which any director or officer was elected as such.\nJMB is the corporate general partner of Carlyle Real Estate Limited Partnership-VII (\"Carlyle-VII\"), Carlyle Real Estate Limited Partnership-IX (\"Carlyle-IX\"), Carlyle Real Estate Limited Partnership-X (\"Carlyle-X\"), Carlyle Real Estate Limited Partnership-XI (\"Carlyle-XI\"), Carlyle Real Estate Limited Partnership-XIII (\"Carlyle-XIII\"), Carlyle Real Estate Limited Partnership-XIV (\"Carlyle-XIV\"), Carlyle Real Estate Limited Partnership-XV (\"Carlyle-XV\"), Carlyle Real Estate Limited Partnership-XVI (\"Carlyle-XVI\"), Carlyle Real Estate Limited Partnership-XVII (\"Carlyle-XVII\"), JMB Mortgage Partners, Ltd. (\"Mortgage Partners\"), JMB Mortgage Partners, Ltd.-II (\"Mortgage Partners-II\"), JMB Mortgage Partners, Ltd.-III (\"Mortgage Partners-III\"), JMB Mortgage Partners, Ltd.-IV (\"Mortgage Partners-IV\"), Carlyle Income Plus, Ltd. (\"Carlyle Income Plus\") and Carlyle Income Plus, Ltd.-II (\"Carlyle Income Plus-II\") and the managing general partner of JMB Income Properties, Ltd.-IV (\"JMB Income-IV\"), JMB Income Properties, Ltd.-V (\"JMB Income-V\"), JMB Income Properties, Ltd.-VI (\"JMB Income-VI\"), JMB Income Properties, Ltd.-VII (\"JMB Income-VII\"), JMB Income Properties, Ltd.-VIII (\"JMB Income-VIII\"), JMB Income Properties, Ltd.-IX (\"JMB Income-IX\"), JMB Income Properties, Ltd.-X (\"JMB Income-X\"), JMB Income Properties, Ltd.-XI (\"JMB Income-XI\"), JMB Income Properties, Ltd.-XII (\"JMB Income-XII\") and JMB Income Properties, Ltd.-XIII (\"JMB Income-XIII\"). Most of the foregoing directors and officers are also officers and\/or directors of various affiliated companies of JMB including Arvida\/JMB Managers, Inc. (the general partner of Arvida\/JMB Partners, L.P. (\"Arvida\")), Arvida\/JMB Managers-II, Inc. (the general partner of Arvida\/JMB Partners, L.P.-II (\"Arvida-II\")) and Income Growth Managers, Inc. (the corporate general partner of IDS\/JMB Balanced Income Growth, Ltd. (\"IDS\/BIG\")). Most of such directors and officers are also partners of certain partnerships which are associate general partners in the following real estate limited partnerships: Carlyle-VII, Carlyle-IX, Carlyle-X, Carlyle-XI, Carlyle-XIII, Carlyle-XIV, Carlyle-XV, Carlyle-XVI, Carlyle-XVII, JMB Income-VI, JMB Income-VII, JMB Income-VIII, JMB Income-IX, JMB Income-X, JMB Income-XI, JMB Income-XII, JMB Income-XIII, Mortgage Partners, Mortgage Partners-II, Mortgage Partners-III, Mortgage Partners-IV, Carlyle Income Plus, Carlyle Income Plus-II and IDS\/BIG.\nThe business experience during the past five years of each such director and officer of the Corporate General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 56) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Malkin has been associated with JMB since October, 1969. He is a Certified Public Accountant.\nNeil G. Bluhm (age 56) is an individual general partner of JMB Income-IV, JMB Income-V. Mr. Bluhm has been associated with JMB since August, 1970. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nJerome J. Claeys III (age 51) (Chairman and Director of JMB Institutional Realty Corporation) has been associated with JMB since September, 1977. He holds a Masters degree in Business Administration from the University of Notre Dame.\nBurton E. Glazov (age 55) has been associated with JMB since June, 1971 and served as an Executive Vice President of JMB until December 1990. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nStuart C. Nathan (age 52) has been associated with JMB since July, 1972. He is a member of the Bar of the State of Illinois.\nA. Lee Sacks (age 60) (President and Director of JMB Insurance Agency, Inc.) has been associated with JMB since December, 1972.\nJohn G. Schreiber (age 47) has been associated with JMB since December, 1970 and served as an Executive Vice President of JMB until December 1990. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business.\nH. Rigel Barber (age 44) has been associated with JMB since March, 1982. He holds a J.D. degree from the Northwestern Law School and is a member of the Bar of the State of Illinois.\nJeffrey R. Rosenthal (age 42) has been associated with JMB since December, 1987. He is a Certified Public Accountant.\nGary Nickele (age 41) has been associated with JMB since February, 1984. He holds a J.D. degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nIra J. Schulman (age 42) has been associated with JMB since February, 1983. He holds a Masters degree in Business Administration from the University of Pittsburgh.\nGailen J. Hull (age 45) has been associated with JMB since March, 1982. He holds a Masters degree in Business Administration from Northern Illinois University and is a Certified Public Accountant.\nHoward Kogen (age 58) has been associated with JMB since March, 1973. He is a Certified Public Accountant. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no officers or directors. The Partnership is required to pay a management fee to the Corporate General Partner and the General Partners are entitled to receive a share of cash distributions, when and as cash distributions are made to the Limited Partners, and a share of profits or losses as described under the caption \"Compensation and Fees\" at pages 6-9, \"Cash Distributions\" at pages 138-139, \"Allocation of Profits or Losses for Tax Purposes\" at page 137 and \"Distributions and Compensations; Allocations of Profits and Losses\" at pages A-6 to A-11 of the Prospectus, which descriptions are hereby incorporated herein by reference to Exhibit 3-A to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0- 12433) dated March 19, 1993. Reference is also made to Notes 5 and 9 for a description of such transactions, distributions and allocations. In 1993, 1992 and 1991, cash distributions of $0, $0 and $55,002 were paid, respectively, to the General Partners. Effective as of the third and fourth quarters of 1991, the Partnership deferred the General Partner's cash distribution and deferred management fees. The General Partners received a share of the Partnership's long-term capital gain for tax purposes aggregating $1,456,799 in 1993. In addition, the General Partners received a share of the Partnership's operating losses aggregating $354,098. Such losses may benefit the General Partners to the extent that such losses may be offset against taxable income from the Partnership or other sources.\nThe Partnership is permitted to engage in various transactions involving affiliates of the Corporate General Partner of the Partnership, as described under the captions \"Compensation and Fees\" at pages 6-9, \"Conflicts of Interest\" at pages 9-14 and \"Powers, Rights and Duties of the General Partners\" at pages A-13 to A-19 of the Prospectus, which are hereby incorporated herein by reference to Exhibit 3-A to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993. The relationship of the Corporate General Partner (and its directors and officers) to its affiliates is set forth above in Item 10.\nJMB Properties Company, an affiliate of the Corporate General Partner, provided property management services to the Partnership for all or part of 1993 for the Sierra Pines Apartments, and Crossing Apartments in Houston, Texas, the Country Square Apartments in Carrollton, Texas, the Stonybrook Apartments - I & II in Tucson, Arizona, the Permian Mall in Odessa, Texas and National City Center Office Building in Cleveland, Ohio at fees calculated at a percentage of gross income from the properties. In 1993, such affiliate earned property management fees amounting to $1,055,773 for such services, all of which were paid as of December 31, 1993. As set forth in the Prospectus of the Partnership, the Corporate General Partner must negotiate such agreements on terms no less favorable to the Partnership than those customarily charged for similar services in the relevant geographical area (but in no event at rates greater than specified in the Prospectus), and such agreements must be terminable by either party thereto, without penalty, upon 60 days' notice.\nJMB Insurance Agency, Inc., an affiliate of the Corporate General Partner, earned insurance brokerage commissions in 1993 aggregating approximately $50,000, all of which were paid in 1993 in connection with the providing of insurance coverage for certain of the real property investments of the Partnership. Such commissions are at rates set by insurance companies for the classes of coverage provided.\nThe General Partners of the Partnership or their affiliates may be reimbursed for their direct expenses or out-of-pocket expenses relating to the administration of the Partnership and the operation of the Partnership's real property investments. In 1993, the Corporate General Partner of the Partnership was due reimbursement for such out-of-pocket expenses in the amount of $219,787, of which $77 was unpaid as of December 31, 1993.\nAdditionally, the General Partners may be reimbursed for salaries and direct expenses of officers and employees of the Corporate General Partner and its affiliates while directly engaged in the administration of the Partnership and in the operation of the Partnership's real property investments. In 1993, such costs were $40,427, all of which were unpaid at December 31, 1993. The General Partners earned no disbursement agent fees in 1993.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Corporate General Partner, affiliates or their management other than those described in Items 10 and 11 above (see Note 3(c) to the accompanying Notes to Consolidated Financial Statements).\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this annual report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22, 1982 and February 18, 1983, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 are incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, is incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n4-A. Mortgage loan agreement between Wright-Carlyle Seattle and The Prudential Insurance Company dated October 16, 1985, relating to the First Interstate Center is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n4-B. Mortgage loan agreement between Carlyle\/National City Associates and New York Life Insurance Company dated November 15, 1983, relating to the National City Center Office Building is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-A.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the First Interstate Center in Seattle, Washington are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-76443), dated June 21, 1982.\n10-B.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the National City Center Office Building in Cleveland, Ohio are hereby incorporated by reference to the Partnership's Report on Form 8-K, dated August 8, 1983.\n10-C.Bargain and Sale Deed relating to the Partnership's disposition of the Timberline Apartments in Denver, Colorado, dated July 25, 1990 is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Meadows Southwest Apartments in Houston, Texas are hereby incorporated herein by reference to the Partnership's Report on Form 8- K, dated January 11, 1991 by reference.\n10-E.Non-Merger Quit Claim Deeds relating to the Partnership's disposition of the Summerfield\/Oakridge Apartments in Aurora, Colorado, dated January 7, 1991 are hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n21. List of Subsidiaries.\n24. Powers of Attorney.\n___________\nAlthough certain additional long-term debt instruments of the Registrant have been excluded from Exhibit 4 above, pursuant to Rule 601(b)(4)(iii), the Registrant commits to provide copies of such agreements to the SEC upon request.\n(b) No report on Form 8-K was filed since the beginning of the last quarter of the period covered by this report.\nNo annual report for the year 1993 or proxy material has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date:March 25, 1994\nPursuant 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 and on the dates indicated.\nBy: JMB Realty Corporation Corporate General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Director Date:March 25, 1994\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date:March 25, 1994\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date:March 25, 1994\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date:March 25, 1994\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date:March 25, 1994\nA. LEE SACKS* By: A. Lee Sacks, Director Date:March 25, 1994\nSTUART C. NATHAN* By: Stuart C. Nathan, Executive Vice President and Director Date:March 25, 1994\n*By:GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date:March 25, 1994\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 of the Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22,1982 and February 28, 1983Yes\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus Yes\n4-A. Mortgage loan agreement related to the First Interstate Center Yes\n4-B. Mortgage loan agreement related to the National City Center Office Building Yes\n10-A. Acquisition documents related to First Interstate Center Yes\n10-B. Acquisition documents related to National City Center Office Building Yes\n10-C. Bargain and Sale Deed related to Timberline Apartments Yes\n10-D. Sale documents related to the Meadows Southwest Apartments Yes\n10-E. Non-Merger Quit Claim Deeds related to the Summerfield\/Oakridge Apartments Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Corporate General Partner, affiliates or their management other than those described in Items 10 and 11 above (see Note 3(c) to the accompanying Notes to Consolidated Financial Statements).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this annual report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22, 1982 and February 18, 1983, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 are incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, is incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n4-A. Mortgage loan agreement between Wright-Carlyle Seattle and The Prudential Insurance Company dated October 16, 1985, relating to the First Interstate Center is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n4-B. Mortgage loan agreement between Carlyle\/National City Associates and New York Life Insurance Company dated November 15, 1983, relating to the National City Center Office Building is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-A.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the First Interstate Center in Seattle, Washington are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-76443), dated June 21, 1982.\n10-B.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the National City Center Office Building in Cleveland, Ohio are hereby incorporated by reference to the Partnership's Report on Form 8-K, dated August 8, 1983.\n10-C.Bargain and Sale Deed relating to the Partnership's disposition of the Timberline Apartments in Denver, Colorado, dated July 25, 1990 is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Meadows Southwest Apartments in Houston, Texas are hereby incorporated herein by reference to the Partnership's Report on Form 8- K, dated January 11, 1991 by reference.\n10-E.Non-Merger Quit Claim Deeds relating to the Partnership's disposition of the Summerfield\/Oakridge Apartments in Aurora, Colorado, dated January 7, 1991 are hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n21. List of Subsidiaries.\n24. Powers of Attorney.\n___________\nAlthough certain additional long-term debt instruments of the Registrant have been excluded from Exhibit 4 above, pursuant to Rule 601(b)(4)(iii), the Registrant commits to provide copies of such agreements to the SEC upon request.\n(b) No report on Form 8-K was filed since the beginning of the last quarter of the period covered by this report.\nNo annual report for the year 1993 or proxy material has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date:March 25, 1994\nPursuant 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 and on the dates indicated.\nBy: JMB Realty Corporation Corporate General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Director Date:March 25, 1994\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date:March 25, 1994\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date:March 25, 1994\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date:March 25, 1994\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date:March 25, 1994\nA. LEE SACKS* By: A. Lee Sacks, Director Date:March 25, 1994\nSTUART C. NATHAN* By: Stuart C. Nathan, Executive Vice President and Director Date:March 25, 1994\n*By:GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date:March 25, 1994\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 of the Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22,1982 and February 28, 1983Yes\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus Yes\n4-A. Mortgage loan agreement related to the First Interstate Center Yes\n4-B. Mortgage loan agreement related to the National City Center Office Building Yes\n10-A. Acquisition documents related to First Interstate Center Yes\n10-B. Acquisition documents related to National City Center Office Building Yes\n10-C. Bargain and Sale Deed related to Timberline Apartments Yes\n10-D. Sale documents related to the Meadows Southwest Apartments Yes\n10-E. Non-Merger Quit Claim Deeds related to the Summerfield\/Oakridge Apartments Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No","section_15":""}
{"filename":"4672_1993.txt","cik":"4672","year":"1993","section_1":"ITEM 1 - BUSINESS\nGeneral\nAmerican Business Products was incorporated under the laws of Delaware in December 1967 to acquire the stock of Curtis 1000 Inc., a producer of envelopes and forms which has operated since 1882. Hereinafter, American Business Products, Inc. and its subsidiaries are collectively referred to as the \"Company.\" In April 1986, the Company was reincorporated under the laws of Georgia. The Company is one of the nation's leading producers of printed business supplies, principally envelope products and custom business forms. Additionally, the Company manufactures and distributes books for the publishing industry and also is engaged in specialty extrusion coating and laminating of papers, films, and nonwoven fabrics for packaging.\nOn September 1, 1993, the Company acquired all of the stock of Home Safety Equipment, Inc., d\/b\/a Discount Labels for $26,745,000. Discount Labels is located in New Albany, Indiana and is engaged in the manufacture and sale of custom-printed labels. In addition, on October 28, 1993, the Company acquired certain assets of International Envelope Company for $15,125,000. Located principally in Exton, Pennsylvania, International Envelope Company is engaged in the manufacture of envelopes. (See \"Item 1 - Business - Business Segments.\")\nBusiness Segments\nThe Company's product line is among the broadest in the industry and is composed of three business segments: business supplies printing, book manufacturing, and specialty extrusion coating and laminating.\nBusiness supplies printing consists principally of the manufacture of specialty mailers and envelopes of all kinds, and the printing and production of business forms. The manufacture and distribution of specialty labels is a growing part of this segment. The Company produces a complete line of standard and special types and sizes of commercial mailing products including specialty mailers, which utilize multi-part forms and envelopes. Business forms include customized continuous forms for computer printers and word processors, snap-apart forms and checks, statements and invoices as well as other forms, with several thousand types of forms produced. Business supplies printing accounted for 74% of the Company's sales in 1993, 74% in 1992, and 77% in 1991.\nBook manufacturing consists of the printing and binding of both hard cover and soft cover books for the publishing industry. In addition, the Company provides storage and order fulfillment services by shipping orders to publishers' customers from a large, centrally located distribution center. This business segment accounted for 9% of the Company's sales in 1993, 9% in 1992, and 9% in 1991.\nSpecialty extrusion coating and laminating, the Company's newest business segment, consists of applying plastic coatings in varying degrees of thickness to rolls of paper, film or fabric. The Company also prints and metalizes certain of these products for customers. The materials produced by this segment are used primarily for packaging consumer products such as individual servings of sugar, salt and pepper, sugar substitutes, and candy and ice cream bars, as well as medical and pharmaceutical products. These materials also are used for composite can liners and release liner papers for pressure sensitive products such as labels. This business\nsegment accounted for 17% of the Company's sales in 1993, 17% in 1992, and 14% of sales in 1991.\nFinancial information regarding the Company's three business segments is presented in the Notes to Consolidated Financial Statements under the heading \"Business Segment Information\" on page 24 of the Company's 1993 Annual Report, which information is incorporated herein by reference. Portions of the 1993 Annual Report are filed as Exhibit 13 to this Annual Report on Form 10-K.\nProduction\nSubstantially all of the Company's products are manufactured by wholly owned subsidiaries of the Company in 41 manufacturing facilities located throughout the United States. (See \"Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company's executive offices are located in approximately 21,400 square feet of space at 2100 RiverEdge Parkway, Suite 1200, Atlanta, Georgia 30328. The offices are leased from an unaffiliated party under a lease expiring on January 26, 2003.\nThe principal properties of the Company include production facilities, administrative\/sales offices and warehouses. The Company operates 41 production facilities throughout the United States encompassing approximately 1,975,844 square feet. The Company owns 30 of these facilities while 11 are leased facilities. In addition, the Company and a European joint venture\/partner operate production facilities which are owned or leased by the joint venture in Germany, Poland, England, and Luxembourg. The facilities in Germany and Poland are owned by the joint venture, and the facilities in England and Luxembourg are leased.\nThe Company leases 60 administrative\/sales offices and 6 warehouses, all of which are located in the United States. All of the Company's production facilities, administrative\/sales offices and warehouses are used in the Company's business supplies printing business except for three of such facilities which are used in the Company's book manufacturing business and one which is used in the extrusion coating and laminating business.\nCertain properties owned by the Company are held subject to mortgages. See the information set forth under the heading \"Long Term Debt\" in the Notes to Consolidated Financial Statements on page 20 in the Company's 1993 Annual Report, which information is incorporated herein by reference.\nThe Company believes that all of its properties and equipment are in good condition, fully utilized and suitable for the purposes for which they are being used.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nAs of March 25, 1994, there were no material pending legal proceedings, other than routine litigation incidental to the business, to which the Company or its subsidiaries was a party or of which any of their properties were the subject and none are expected by management to materially effect the Company's financial position and results of operations.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of the shareholders of the Company during the fourth quarter of 1993.\nITEM 4 (A) - EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is information as of March 25, 1994 regarding the executive officers of the Company:\nTHOMAS R. CARMODY, 60, has served as President and Chief Executive Officer of the Company since July 1988. From July 1985 until July 1988, he served as President and Chief Operating Officer and he served as Executive Vice President and Chief Operating Officer from July 1982 until July 1985. He has been a director since 1983 and has served with the Company or Curtis 1000 Inc. for over 38 years.\nWILLIAM C. DOWNER, 57, has served as Vice President-Finance and Chief Financial and Accounting Officer of the Company since August 1982. He has served with the Company or Curtis 1000 Inc. for over 26 years.\nDAWN M. GRAY, 49, has served as Secretary of the Company since July 1989. She served as Assistant Secretary from October 1976 to June 1989. She has served with the Company or Curtis 1000 Inc. for over 27 years.\nROBERT W. GUNDECK, 51, has served as Executive Vice President and Chief Operating Officer of the Company since January 1993. He served as Vice President-Corporate Development of the Company from July 1990 to December 1992. He served as Director of Corporate Development from March 1988 to June 1990. He has served with the Company for over 6 years.\nRICHARD A. LEFEBER, 58, has served as Vice President-Administration of the Company since January 1980. He served as Secretary of the Company from August 1982 to June 1989. He has served with the Company or Curtis 1000 Inc. for over 36 years.\nBOBBY ROGERS, 60, has served as Vice President-Information Systems of the Company since January 1981. He has served with the Company or Curtis 1000 Inc. for over 32 years.\nThe Board of Directors elects officers annually in April for one year terms or until their successors are elected and qualified. Officers are subject to removal by the Board of Directors at any time.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation relating to the market for, holders of and dividends paid on the Company's Common Stock is set forth under the captions \"Stock Exchange Listing,\" \"Shareholders of Record,\" \"Quarterly Data 1993\" and \"Quarterly Data 1992\" on the inside front cover and pages 14 and 15 of the Company's 1993 Annual Report, which information is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nSelected consolidated financial data for the Company for each year of the eleven year period ended December 31, 1993 is set forth under the caption \"Eleven Year Financial Review\" on pages 14 and 15 in the Company's 1993 Annual Report, which information is incorporated herein by reference.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nA discussion of the Company's financial condition and results of operations at and for the dates and periods covered by the consolidated financial statements set forth in the Company's 1993 Annual Report is set forth under the caption \"Management's Discussion and Analysis\" on pages 25 through 27 of the Company's 1993 Annual Report. Such discussion is incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following Consolidated Financial Statements of the Company and its subsidiaries, together with the Independent Auditors' Report, which are set forth on pages 16 through 24 in the Company's 1993 Annual Report, are incorporated herein by reference:\nConsolidated Statements of Income for each of the three years in the period ended December 31, 1993\nConsolidated Balance Sheets as of December 31, 1993 and 1992\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1993\nNotes to Consolidated Financial Statements\nThe supplementary consolidated financial information regarding the Company which is required by Item 302 of Regulation S-K is set forth under the caption \"Quarterly Data 1993\" on page 14 and \"Quarterly Data 1992\" on page 15 of the Company's 1993 Annual Report. Such information is incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no change of independent accountants by the Company in the past two fiscal years or subsequently.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to the directors of the Company is set forth in \"Proposal 1 - Election of Directors\" under the captions \"Nominees,\" \"Information Regarding Nominees and Directors\" and \"Meetings and Committees of the Board of Directors\" in the Company's definitive Proxy Statement for its 1994 Annual Meeting of Shareholders to be held on April 27, 1994 (the \"Proxy Statement\"). Such information is incorporated herein by reference. Pursuant to Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K, information relating to the executive officers of the Company is set forth in Part I, Item 4(A) of this Report under the caption \"Executive Officers of the Registrant.\" Information regarding compliance by directors and executive officers of the Company and owners of more than ten percent of the Company's Common Stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, is set forth in the Proxy Statement under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934.\" Such information is incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation relating to compensation of the executive officers and directors of the Company is set forth in \"Proposal 1 - Election of Directors\" under the caption \"Director Compensation\" and in \"Executive Compensation\" in the Proxy Statement. Such information is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding ownership of the Company's $2.00 par value Common Stock by certain persons is set forth in \"Voting\" under the caption \"Principal Shareholders\" and in \"Proposal 1 - Election of Directors\" under the caption \"Information Regarding Nominees and Directors\" and under the caption \"Executive Compensation\" in the Proxy Statement. Such information is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company is aware of no relationships or transactions between the Company and affiliates of the Company which are required to be reported under this Item 13.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this Report:\n1. Financial Statements\nThe Consolidated Financial Statements and the Independent Auditors' Report thereon which are required to be filed as part of this Report are included in the Company's 1993 Annual Report and are set forth in and incorporated by reference in Part II, Item 8 hereof. These Consolidated Financial Statements are as follows:\nConsolidated Statements of Income for each of the three years in the period ended December 31, 1993\nConsolidated Balance Sheets as of December 31, 1993 and 1992\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe financial statement schedules filed as part of this Report pursuant to Article 12 of Regulation S-X and the Independent Auditors' Report in connection therewith are contained in the Index of Financial Statement Schedules on page S-1 of this Report. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions or are inapplicable or because the information required is included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits\nThe exhibits required to be filed as part of this Report are set forth in the Index of Exhibits on page E-1 of this Report.\n(b) Reports on Form 8-K:\nOn October 29, 1993, the Company filed a Current Report on Form 8-K to report the acquisition of International Envelope Company of Exton, PA.\nOn November 5, 1993, the Company filed a Current Report on Form 8-K\/A which amended a Current Report on Form 8-K filed September 13, 1993, and contained required Item 7 Financial Statements and Exhibits.\n(c) The exhibits required to be filed as part of this Report are set forth in the Index of Exhibits on page E-1 of this Report.\n(d) The financial statement schedules required to be filed as part of this Report are set forth in the Index of Financial Statement Schedules on page S-1 of this Report.\nSIGNATURES\nPursuant 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.\nAMERICAN BUSINESS PRODUCTS, INC.\nBY: \/s\/ Thomas R. Carmody ------------------------------------ Thomas R. Carmody President and Chief Executive Officer\nDATE: March 25, 1994\nPursuant 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 and on the date indicated.\nAMERICAN BUSINESS PRODUCTS, INC.\nINDEX OF FINANCIAL STATEMENT SCHEDULES\nS-1 INDEPENDENT AUDITORS' REPORT\nAmerican Business Products, Inc.:\nWe have audited the consolidated financial statements of American Business Products, Inc. and subsidiaries as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated February 25, 1994; such financial statements and report are included in your 1993 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of American Business Products, Inc. and subsidiaries listed in Item 14. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE\nAtlanta, Georgia February 25, 1994\nS-2\nSCHEDULE V AMERICAN BUSINESS PRODUCTS, INC. AND SUBSIDIARIES PLANT AND EQUIPMENT (IN THOUSANDS)\n(1) Cost of assets acquired from Discount Labels, Inc. on September 1, 1993, $7,600. Cost of assets acquired from International Envelope Co. on October 28, 1993, $6,760.\nS-3 SCHEDULE VI\nAMERICAN BUSINESS PRODUCTS, INC. AND SUBSIDIARIES ACCUMULATED DEPRECIATION AND AMORTIZATION OF PLANT AND EQUIPMENT (IN THOUSANDS)\nS-4 SCHEDULE VIII\nAMERICAN BUSINESS PRODUCTS, INC. AND SUBSIDIARIES VALUATION RESERVES (IN THOUSANDS)\n(1) Reserve assumed from Discount Labels, Inc. on September 1, 1993. (2) Deductions represent uncollectible accounts charged off, less recoveries.\nS-5\nAMERICAN BUSINESS PRODUCTS, INC. INDEX OF EXHIBITS\nWhere an exhibit is filed by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parentheses.","section_15":""}
{"filename":"107203_1993.txt","cik":"107203","year":"1993","section_1":"ITEM 1. BUSINESS\nWillcox & Gibbs, Inc. (the \"Company\" or \"W&G\") is a New York corporation that was incorporated in 1866. It is the fifth largest distributor of electrical parts and supplies in the United States, based on 1993 pro forma sales.\nDuring the last several years, the Company has undertaken a major restructuring. On April 22, 1992, the Company, Rexel, S.A. (formerly known as Compagnie de Distribution de Materiel Electrique) (\"Rexel\"), International Technical Distributors, Inc. (\"ITD\"), a subsidiary of Rexel, and Southern Electric Supply Company, Inc. (\"SES\"), a subsidiary of ITD engaged in the distribution of electrical materials, entered into a Purchase Agreement (the \"Purchase Agreement\"). Pursuant to the Purchase Agreement, the Company issued to Rexel and ITD 6,284,301 shares of Company Common Stock in exchange for all of the stock of SES and approximately $10 million in cash. In addition, pursuant to the Purchase Agreement, the Company declared a dividend consisting of one share of common stock of the Company's subsidiary Worldtex, Inc. (\"Worldtex\") for each share of Company Common Stock outstanding on November 23, 1992 (the \"Distribution\"). In August 1992, the Company transferred to Worldtex all of the stock of the Company's subsidiaries engaged in the manufacture of covered elastic yarn.\nAlso during 1992, the Company disposed of its data communications equipment distribution business, conducted by Data Net, Inc. and Dataspan Systems, Inc., and its Montrose Supply and Equipment Division, which distributed equipment to the knitting trade.\nIn April 1993, the Company acquired Sacks Electrical Supply Co. (\"Sacks\"), a distributor of electrical supplies and components with three locations in Ohio, for $13,635,000. On December 17, 1993, the Company acquired Summers Group Inc. (\"Summers\") for $60,000,000 in cash and a $25,000,000 three year note issued to the seller, plus contingent consideration to be determined based on Summers' profits before interest and taxes for 1993 and 1994, subject to a maximum purchase price of $120,000,000. Summers is a distributor of electrical parts and supplies with locations principally in Texas, Oklahoma, Louisiana, California and Arkansas.\nThe Company has also decided to sell its remaining apparel parts and supplies distribution business and has engaged an investment banking firm to seek a purchaser. Accordingly, this business is shown as a discontinued operation in the Company's Consolidated Financial Statements included elsewhere in this report.\nOn March 1, 1994, the Company sold 3,491,280 newly-issued shares of Company Common Stock to Rexel for $31,421,520 in cash. In connection with that sale, the size of the Company's Board of Directors was reduced to nine and two additional nominees of Rexel became directors of the Company. As a result, five of the Company's nine current directors are nominees of Rexel.\nELECTRICAL DISTRIBUTION OPERATIONS\nThe Company operates 170 electrical distribution centers in 18 states, principally in the southern tier of the United States. The Company conducts its electrical distribution operations through four principal divisions: the Consolidated Electric Supply group (\"Consolidated\"), Sacks, SES and Summers.\nConsolidated, which was acquired by the Company in January 1984, has been engaged in the wholesale distribution of electrical materials since 1947. Headquartered in Miami, Consolidated operates 61 distribution centers, of which 33 are located in Florida, 11 in Ohio, three in Delaware, two in Maryland, one in Washington, D.C., four in the Atlanta, Georgia area, six in Southern California and one in Freeport, Grand Bahamas. Thirty-four of the distribution centers have been added during the time the Company has owned Consolidated.\nSacks, acquired by the Company in April 1993, distributes electrical materials through three locations in Ohio.\nSES, acquired by the Company in November 1992, is engaged in the wholesale distribution of electrical materials through 29 distribution centers in six states, consisting of six distribution centers in Alabama, seven in Florida, four in Louisiana, nine in Mississippi, two in Tennessee and one in Oklahoma.\nSummers, acquired by the Company in December 1993, distributes electrical materials through 79 locations in 10 states, consisting of thirty-six in Texas, eleven in Louisiana, eight in Oklahoma, eight in California, seven in Arkansas, four in Missouri, two in Arizona, and one in each of Colorado, Illinois and New Mexico. Unless otherwise expressly stated below, the statistical information discussed below concerning the Company's electrical distribution business does not include Summers' operations.\nEach of the Company's electrical distribution centers serves an area with approximately a 50 mile radius and specializes in serving the needs of small-to medium-sized electrical contractors engaged in construction work on plants, schools, utilities, office buildings, hotels, condominiums, town houses and single family homes. In 1993, the Company's electrical distribution subsidiaries served over 23,000 customers with no single customer accounting for more than 1.9% of total annual sales. The Company's ten largest customers in 1993 represented less than 6% of sales.\nManagement believes that approximately 60% of the sales of the Company's electrical distribution subsidiaries are from products used in new construction. The remainder are sold for maintenance and residential remodeling and to original equipment manufacturers.\nManagement believes that the Company is the fifth largest distributor of electrical parts and supplies in the United States, although there are other companies which account for significantly greater national volume. The Company's subsidiaries compete with national chains (some of which are affiliated with manufacturing companies) and other independent distributors operating single or multiple outlets. Because the electrical supply business is fragmented and highly competitive, service and price are essential components of success. In order to achieve a competitive advantage in serving its customers, the Company's subsidiaries maintain an inventory of approximately 15,000 items at each distribution center, employ a sales staff that calls on customers and works with architects, engineers and manufacturers' representatives on major construction projects, provide next day and same day on-site delivery with its truck fleet and endeavor to obtain volume discounts to maintain profit margins while being competitive in price.\nThe extensive product line of the Company's subsidiaries includes electrical supplies, including wire, cable, cords, boxes, covers, wiring devices, conduit, raceway duct, safety switches, motor controls, breakers, panels, lamps, fuses and related supplies and accessories, residential, commercial and industrial electrical fixtures and other special use fixtures, as well as materials and special cables for computers and advanced communications systems. The products sold by the Company's subsidiaries are purchased from over 5,000 manufacturers and other suppliers, the three largest of which accounted in the aggregate for approximately 13% of the total purchases by the Company's electrical distribution subsidiaries during 1993, with none of the remainder accounting for more than three percent.\nDISCONTINUED OPERATIONS\nAPPAREL PARTS AND SUPPLIES DISTRIBUTION -- SUNBRAND\nThe Company's Sunbrand Division markets to the apparel industry a wide range of sewing equipment parts, supplies and other equipment, including pressing and finishing equipment, fabric spreading machines and reconditioned equipment. Its product line includes needles, tools, electric and electronic devices and warehouse equipment. Sunbrand's executive offices are located in Atlanta and it catalogs over 140,000 items. Sunbrand has seven office\/distribution centers located near major apparel manufacturing areas in Atlanta, El Paso, Fall River (Massachusetts), Miami, Mexico City, Nashville, and Santo Domingo (Dominican Republic).\nFor over 20 years, Sunbrand has been a major distributor of a number of name brand (\"genuine\") parts to the apparel industry. It has agreements for the importation and sale of genuine sewing equipment parts manufactured by G.M. Pfaff AG of Germany (\"Pfaff\") and Pegasus Sewing Machine Mfg. Co., Ltd. of Japan (\"Pegasus\") for the United States and Puerto Rico which extend through 1998 and which are exclusive (with certain exceptions) through 1994.\nSunbrand services over 13,000 customers, the largest of which accounted for approximately 5.4% of total 1993 sales. Its ten largest customers accounted, in the aggregate, for approximately 17.5% of Sunbrand's sales for 1993.\nSunbrand is well known for its 1,200 page catalog, which serves as a reference standard for the industry. This catalog, which is published once every three years, is a valuable marketing tool that is used by many existing and potential buyers of parts and supplies.\nProducts sold by Sunbrand are purchased from some 1,200 different companies, of which Pfaff and Pegasus account for the largest volume. In 1993, Pfaff accounted for 12.4% and Pegasus accounted for 10.0% of purchases from suppliers. The five largest suppliers accounted for 36.8% of total purchases in 1993.\nThere is strong competition throughout the marketing areas served by Sunbrand. Most of its competitors are small regional distributors, though there are two national competitors. The principal competitive factors in Sunbrand's business are availability of parts and timely delivery. Customers rely on Sunbrand to supply parts that minimize downtime. Sunbrand's management believes that it is one of the largest distributors of its type in the United States.\nOTHER APPAREL PARTS AND SUPPLIES DISTRIBUTION\nIn addition to Sunbrand, during 1993 the Company was engaged in three other operations involving distribution to the apparel and textile trades.\nThe Company's Unity Sewing Supply Division (\"Unity\"), which the Company believes is one of the two largest importers and distributors of non-trademarked (\"generic\") parts for industrial sewing machines, is headquartered in New York with branch offices in Los Angeles and Miami. It sells to dealers, not to manufacturers or end users. Generic parts have become increasingly popular in the needle trades as a method to reduce manufacturing costs. In recent years, Unity has emphasized its export business to South and Central America and the Caribbean. The majority of Unity's parts are manufactured in Japan, Germany and the United States.\nWillcox & Gibbs, Ltd., a wholly-owned United Kingdom subsidiary, markets sewing equipment in certain Common Market countries and sells generic sewing equipment parts in the United Kingdom.\nThe Company's subsidiary, Leadtec Systems, Inc. (\"Leadtec\"), distributes to the apparel industry a computer-based real-time production control system, marketed under the name \"Satellite Plus\", which utilizes hardware manufactured by others and proprietary software designed by Leadtec.\nIn the markets in which Unity, Willcox & Gibbs, Ltd. and Leadtec operate, there is vigorous competition both in the United States and abroad.\nCOVERED ELASTIC YARN\nPrior to 1993, the Company owned Worldtex and its subsidiaries, which engaged in the manufacture of covered elastic yarn. These operations were disposed of by the Company pursuant to the Distribution on November 12, 1992. While owned by the Company, Worldtex's principal product was nylon covered spandex used in the manufacture of women's pantyhose, which accounted for 58% of Worldtex's 1992 sales. Worldtex also sold covered spandex and covered latex rubber for use in the manufacture of men's, women's and children's socks.\nEMPLOYEES\nAs of December 31, 1993, the Company had a total of approximately 3,100 employees, including approximately 2,800 who were employed by Consolidated, SES, Sacks and Summers, and approximately 300 who were employed by Sunbrand and the Company's other distribution divisions. Approximately 45 employees of Summers and Sacks are covered by collective bargaining agreements. The Company has experienced no significant labor problems during recent years and considers that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located in leased office space at 530 Fifth Avenue, New York, New York.\nConsolidated's headquarters in Miami, Florida, and most of Consolidated's distribution centers are in facilities owned by subsidiaries of the Company. Leases of remaining premises, which are classified as operating leases, expire in various years through 2001.\nSES' headquarters in Meridian, Mississippi, and eleven of its locations are leased from Robert Merson, a Vice President of the Company and President of SES, and\/or members of his or his wife's family, for terms extending through 2002 (except for one lease expiring in 1994). The Company believes that these leases are on terms at least as favorable as SES could have obtained from an unaffiliated third party. The remainder of SES' locations are leased for terms expiring in various years through 1999.\nSummers' headquarters in Dallas, Texas, is leased, as are 67 of its distribution centers. Summers owns 12 of its distribution centers.\nThe Sunbrand Division's headquarters in Atlanta consists of approximately 110,000 square feet under a lease which runs through 1994. The other Sunbrand branches also occupy leased space. The Company's other parts and equipment distribution divisions operate from leased premises in London, England, Long Island, New York, Los Angeles and Miami.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings as of the date of this Report to which the Company or any of its subsidiaries is a party or to which any of their property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the last quarter of the Company's fiscal year, no matters were submitted to a vote of the Company's security holders.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe officers of the Company are elected annually by the Board of Directors.\nMr. Viry also serves as a director of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is listed on the New York Stock Exchange and the Pacific Stock Exchange. The following table sets forth the high and low per share sales prices for the Common Stock on the New York Stock Exchange as reported by the Dow Jones Historical Stock Quote Reporter Service for each quarter since December 31, 1991. The trading price of the Company's Common Stock was affected by the Distribution, which was declared on November 12, 1992.\nAt March 25, 1994, there were approximately 1,448 holders of record of Common Stock.\nNo dividends have been paid on the Company's Common Stock since the last quarter of 1991. Future payment of cash dividends by the Company will be dependent on such factors as business conditions, earnings and the financial condition of the Company.\nThe Company's Note Agreement, dated as of April 2, 1991, as amended, restricts dividends and certain other payments with respect to the Company's capital stock if the sum thereof for the period since December 31, 1992, exceeds the sum of (i) 35% of net cash proceeds from the sale of stock and certain subordinated debt for such period, plus (ii) 35% of consolidated net income (as defined) for such period. In addition, the Note Agreement and the Company's Revolving Credit and Reimbursement Agreement, dated as of December 17, 1993, require that the Company meet certain financial tests that could have the effect of restricting the Company's ability to pay dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nWILLCOX & GIBBS, INC. AND SUBSIDIARIES\nThe following tables set forth certain consolidated financial data of the Company and its subsidiaries for the five fiscal years ended December 31, 1993, which has been derived from the Company's audited financial statements, and should be read in conjunction with the Consolidated Financial Statements and Notes thereto of the Company appearing elsewhere in this Report on Form 10-K.\nThe selected financial data of the Company for the years set forth below are not directly comparable due to acquisitions and dispositions during such periods.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSIGNIFICANT TRANSACTIONS\nDuring the last several years, the Company has undertaken a major restructuring. On April 22, 1992, the Company, Rexel, S.A. (formerly known as Compagnie de Distribution de Materiel Electrique) (\"Rexel\"), International Technical Distributors, Inc. (\"ITD\"), a subsidiary of Rexel, and Southern Electric Supply Company, Inc. (\"SES\"), a subsidiary of ITD engaged in the distribution of\nelectrical materials, entered into a Purchase Agreement (the \"Purchase Agreement\"). Pursuant to the Purchase Agreement, the Company issued to Rexel and ITD 6,284,301 shares of Company Common Stock in exchange for all of the stock of SES and approximately $10 million in cash. In addition, pursuant to the Purchase Agreement, the Company declared a dividend consisting of one share of common stock of the Company's subsidiary Worldtex, Inc. (\"Worldtex\") for each share of Company Common Stock outstanding on November 23, 1992 (the \"Distribution\" and, together with such transactions with Rexel, the \"1992 Transactions\"). In August 1992, the Company transferred to Worldtex all of the stock of the Company's subsidiaries engaged in the manufacture of covered elastic yarn. Accordingly, these businesses are reflected as discontinued operations in the Company's Consolidated Financial Statements.\nAlso during 1992, the Company sold its data communications equipment distribution business and an apparel related unit.\nIn April 1993, the Company acquired Sacks Electrical Supply Co. (\"Sacks\"), a distributor of electrical supplies and components with three locations in Ohio, for $13.6 million. On December 17, 1993, the Company acquired Summers Group Inc. (\"Summers\") for $60 million in cash and a $25 million three year note issued to seller, plus contingent consideration to be determined based on Summers' profits before interest and taxes for 1993 and 1994, subject to a maximum purchase price of $120 million. Summers is a distributor of electrical parts and supplies with locations principally in Texas, Louisiana, Oklahoma, California and Arkansas.\nThe Company has also decided to sell its remaining apparel parts and supplies distribution businesses (the \"Apparel Division\") and has engaged an investment banking firm to seek a purchaser. Accordingly, the Apparel Division is shown as a discontinued operation in the Company's Consolidated Financial Statements.\nOn March 1, 1994, the Company sold 3,491,280 newly-issued shares of Company Common Stock to Rexel for $31.4 million in cash, which the Company has used to reduce short-term debt.\nAs a result of the aforementioned transactions and discontinuances, the Company is now engaged in only one business segment: the distribution of electrical parts and supplies, principally in the southern tier of the United States. If the above-mentioned acquisitions had occurred as of January 1, 1992, the Company's unaudited pro forma sales would have been $958.5 million and $907.3 million in 1993 and 1992, respectively.\nRESULTS OF CONTINUING OPERATIONS\nThe following table sets forth the percentages which certain income and expense items bear to net sales:\n1993 V. 1992\nThe Company's sales increased by $162.4 million in 1993, to $521.5 million. Excluding the impact of the acquisitions of SES, Sacks and Summers, full-year sales were up about 3.8%. The Company's Consolidated Electric Supply division (\"CES\") increase resulted primarily from the improving housing market, although commercial construction continues to lag. Full-year sales for SES, Sacks, and Summers as a group were up in 1993 compared with 1992, reflecting the continued market-share strength of these units in their respective geographic areas. Sales for these divisions totalled $601.3 million in 1993. Certain geographic regions showed an upturn in 1993. However, no assurance can be given that this trend will continue. Declining copper prices and strong competition for market share continue to put pressure on the Company's gross margin, which increased slightly in 1993, to 20.6%.\nSelling and administrative expenses increased $24.4 million in 1993, reflecting the additional operations added through the above-mentioned acquisitions. However, as a percentage of sales such expenses decreased to 17.3% in 1993 as compared to 18.3% in 1992, reflecting cost containment programs and a higher level of sales.\nInterest expense in 1993 was $5.9 million, compared with $5.4 million a year ago. Although the Company reduced its debt at the end of 1992 in connection with the 1992 Transactions, it increased its borrowings in 1993 to fund the acquisitions of Sacks and Summers. Other income-net in 1993 was $.7 million, compared to $0.1 million in 1992, reflecting principally earnings from short-term investments during the first half of 1993.\nIncome from continuing operations increased $19.3 million to $6.9 million in 1993, reflecting principally the costs for 1992 Transactions and restructuring charges that were accrued in 1992.\n1992 V. 1991\nSales in 1992 decreased $11.0 million, or 3.0%, to $359.1 million. The 1991 period includes results of two data communications units that the Company sold during 1992. 1992 sales included $14.9 million from SES from mid-November.\nExcluding sales of units sold, electrical supply sales, including SES, increased by $11.9 million, or 3.4%, to $359.1 million. Excluding SES, sales decreased by $3.0 million or 0.9%. The business continued to be impacted during the year by the softness in the housing market and the effect of tightened Company credit policies. Strong competition for market share continued to put pressure on profit margins, but margins held when compared to the prior period. SES sales for 1992 totalled $114.5 million.\nSelling and administrative expenses for the Company were 18.3% of sales for 1992 as compared with 19.1% for 1991, reflecting the absence of expenses related to units sold and cost containment programs instituted in 1991. Such expenses in 1992 decreased $4.5 million, or 6.4%, to $66.0 million.\nIn connection with the 1992 Transactions, including the Worldtex spin-off, the Company incurred costs totalling $15.3 million, principally relating to certain investment advisor services, legal and accounting fees and executive incentive payments.\nRestructuring actions ($4.3 million and $5.5 million in 1992 and 1991, respectively) included principally the disposal of two data communications units which no longer related to the Company's core business. In 1992 and 1991, certain restructuring actions initiated in 1991 and 1990 required more costs to implement than originally expected. The additional costs, included in restructuring charges for these periods, changed based on the revised estimates and experience to date.\nThe decrease in interest expense of $1.3 million for 1992 as compared to 1991 reflects the net effect of the sale of the $50 million 9.78% Senior Notes in April, 1991, the redemption of the $23 million 13% Senior Subordinated Notes in August, 1991 and changing levels of borrowing under the Company's prior revolving credit arrangement.\nLoss from continuing operations increased $8.0 million to $12.4 million in 1992, reflecting principally the impact of transaction costs relating to the 1992 Transactions, partially offset by the absence of operating losses from units sold, certain cost containment measures, and reduced restructuring charges and interest expense.\nDISCONTINUED OPERATIONS\nAs discussed above, the results of the Apparel Division and Worldtex are included in the financial statements as discontinued operations. Summarized results are as follows (000's):\nSales for the Apparel Division decreased $2.1 million for 1993 compared with 1992. Excluding units sold, sales increased 4.3%. 1992 sales (excluding the units sold) increased $9.6 million, or 13.9%, compared to 1991. These year over year increases resulted from increased market share, particularly in foreign markets such as Mexico, Central and South America and the Caribbean.\nCovered yarn sales increased $1.6 million in 1992 compared to 1991, reflecting growth in each of covered yarn's markets, offset somewhat by inclusion of such sales in the Company's results only through mid-November 1992.\nINCOME TAXES\nThe Company had effective income tax rates of 43%, (6.3)% and 62.5% in 1993, 1992 and 1991. The 1993 rate reflects the impact of state and local taxes, non-deductible goodwill amortization and increase in the deferred tax asset valuation allowance, reduced by the impact of the utilization of federal capital loss carryforwards, the increase in the federal corporate income tax rate and the current deductibility of certain prior year transaction costs. The 1992 rate reflects the benefit of the Company's operating loss, reduced by the impact of state and local taxes, goodwill amortization, and certain transaction costs.\nEffective January 1, 1993, the Company changed its method of accounting from the deferred method to the liability method required by SFAS No. 109, \"Accounting for Income Taxes\" (see Note 10 of the Notes to the Consolidated Financial Statements). As permitted under Statement 109, prior years' financial statements have not been restated. The cumulative effect of adopting Statement 109 as of January 1, 1993 was to increase net income by $660 or $.03 per share.\nAt December 31, 1993, the Company had state net operating loss carryforwards for tax purposes of approximately $16.5 million that expire between 1998 and 2008.\nUnder Statement 109 the Company has recognized deferred tax assets of $11.3 million, arising primarily from basis differences between the recorded value for financial reporting purposes and tax basis of accounts receivable, inventory and various liabilities and reserves, including restructuring and transaction costs. Such deferred tax assets have been reduced by a valuation allowance of $1.1 million. In addition, the Company has recognized deferred tax liabilities totalling $7.8 million arising principally from a higher recorded value over tax basis of property, plant and equipment and certain acquisitions. It is management's belief that the net deferred tax asset as reflected on the consolidated financial statements will be realized based upon forecasted future pretax earnings and\ntaxable income as well as utilization of certain carryback and\/or carryforward opportunities. Such forecasts reflect the disposals of operations that do not relate to the Company's core business as well as the expected results of the Company's most recent acquisitions.\nNET INCOME (LOSS)\nThe Company reported net income (loss) of $9.1 million, ($4.9) million, and $0.2 million in 1993, 1992, and 1991. Earnings per share was 43 cents in 1993 compared with a loss per share of 33 cents in 1992 and earnings per share of 2 cents in 1991. Results during this three-year period were significantly impacted by the 1992 Transactions and restructuring charges in 1992 and 1991.\nLIQUIDITY; CAPITAL RESOURCES\nAt December 31, 1993, the Company had $19.1 million in cash and cash equivalents, compared to $15.6 million at December 31, 1992, and had $196.7 million of indebtedness for borrowed money (including current installments and short-term debt), compared to $109.6 million at December 31, 1992. Total assets increased $143.5 million at year end 1993 to $428.8 million, due almost entirely to the acquisitions as discussed below.\nDuring 1993, the Company generated $5.8 million in cash from its operating activities compared to $14.4 million in 1992, reflecting primarily changes in various working capital items. Net cash used in investing activities totalled $62.8 million and $17.6 million in 1993 and 1992, respectively. The increase in cash usage in 1993 reflected the Company's acquisitions of Sacks and Summers ($68.3 million), offset partially by proceeds from sales of short-term investments ($12.9 million). Capital expenditures decreased $5.8 million in 1993 to $5.4 million, reflecting primarily the absence of historical expenditures related to Worldtex. Net cash provided by financing activities in 1993 totalled $60.6 million compared to $10.7 million in 1992. The $49.9 million increase reflects borrowings under the Company's current credit arrangements to fund acquisitions.\nIn April 1993, the Company acquired Sacks for $13.6 million in cash, and in December 1993 the Company acquired Summers for $60 million in cash and a $25 million three year note, plus contingent consideration, subject to a maximum purchase price of $120 million. The Company regularly reviews possible acquisitions of businesses, and may from time to time in the future acquire other businesses. The Company otherwise currently expects that its capital expenditures during 1994 will be consistent with historical requirements for the electrical distribution business.\nIn connection with the acquisition of Summers, the Company terminated its $20 million line of credit and entered into the Revolving Credit and Reimbursement Agreement, dated as of December 17, 1993 (the \"Credit Agreement\"), with NationsBank of Florida, N.A., and Credit Lyonnais New York Branch. The Credit Agreement provides for borrowings from time to time through December 1997 of up to the lesser of (i) $70 million and (ii) the sum of 80% of eligible accounts receivable and 50% of eligible inventory. The Company borrowed $60 million under the Credit Agreement in December 1993 to fund the cash purchase price for Summers. On March 1, 1994, the Company sold 3,491,280 shares of newly issued Company Common Stock to Rexel for $31.4 million, which was applied to repay debt under the Credit Agreement. Borrowings under the Credit Agreement bear interest at NationsBank's prime rate or at a rate based on rates in the certificate of deposit market or LIBOR plus a margin, which margin varies depending on the Company's financial performance. The Credit Agreement includes various covenants, including restrictions on liens, debt and lease obligations and requirements that certain financial ratios be maintained. As of March 1, 1994, $26.8 million was outstanding under the Credit Agreement and $43.2 million was available for future borrowings. It is expected that any cash proceeds from the sale of the Apparel Division will be used to repay borrowings under the Credit Agreement. Upon the closing of such sale, the $70 million amount available for borrowings under the Credit Agreement must be reduced to $50 million.\nThe Company's working capital requirements are generally met by internally generated funds and short-term borrowings. Management believes sufficient cash resources will be available to support its long-term growth strategies through internally generated funds, credit arrangements and the\nability of the Company to obtain additional financing. However, no assurance can be given that financing will continue to be available on attractive terms. In addition, any issuance by the Company, of its capital stock or securities convertible into its capital stock prior to December 31, 1994 must be approved by Rexel.\nTHREE-YEAR COMPARISONS\nThe following financial data were impacted by the distribution of Worldtex and acquisitions of SES, Sacks and Summers, as discussed in Notes 2, 3 and 4 of the Notes to Consolidated Financial Statements. The Net assets of the Apparel Division are shown as \"Net assets of discontinued operations\" as of December 31, 1993. The balance sheet at December 31, 1992 has not been reclassified.\nTotal long-term debt was $126.0 million, $109.2 million and $113.4 million, respectively, at December 31, 1993, 1992 and 1991.\nWorking capital was $71.3 million, $122.3 million and $84.4 million, respectively, at December 31, 1993, 1992 and 1991, reflecting a decrease of $51.0 million and an increase of $37.9 million, respectively, in 1993 and 1992 and a current ratio of 1.34, 2.40 and 1.61 at the end of 1993, 1992 and 1991. Working capital is impacted by the fact that the net assets of the discontinued Apparel Division are included as noncurrent assets as of December 31, 1993, including $37.0 of net current assets. Any cash proceeds from the sale of the Apparel Division will be used to repay short-term debt.\nNet worth was $92.5 million, $84.2 million and $111.9 million, respectively, at December 31, 1993, 1992 and 1991, with the decrease in 1992 attributable to the charge to retained earnings for the distribution of Worldtex ($58.5 million), partially offset by adjustments to common stock and capital surplus in connection with the stock issuance to Rexel as discussed in Notes 2, 3 and 4 of the Notes to the Consolidated Financial Statements. (See the Consolidated Statement of Changes in Stockholders' Equity for additional information).\nThe ratio of net worth to long-term debt was .73 to 1 at December 31, 1993, .77 to 1 at December 31, 1992 and .99 to 1 at December 31, 1991. On a pro forma basis, had the additional equity investment by Rexel been made as of December 31, 1993, the ratio of net worth to long-term debt would have been .98 to 1.\nThe number of days sales represented by accounts receivable was 51.8, 59.1 and 59.1, respectively, at December 31, 1993, 1992 and 1991. Inventories, as a percentage of cost of sales, were 20.5%, 25.2% and 23.8%, at December 31, 1993, 1992 and 1991. These differences for 1993 as compared to prior years are principally due to the increase in the Company's receivables and inventories attributable to the electrical distribution business in 1993.\nThe Company continually reviews the impact of inflation. Pricing policies are reviewed regularly and, to the extent permitted by competition, the Company passes increased costs on by increasing sales price. The Company will continue to monitor the impact of inflation and will consider these matters in setting its pricing policies.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements, supplementary financial information and schedules are filed as part of this Report:\nReport of Independent Accountants\nFinancial Statements:\nConsolidated Balance Sheets, December 31, 1993 and 1992 Consolidated Statements of Income, Years Ended December 31, 1993, 1992 and 1991 Consolidated Statement of Changes in Stockholders' Equity, Years Ended December 31, 1993, 1992 and 1991 Consolidated Statements of Cash Flows, Years Ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements\nSupplementary Financial Information\nFinancial Statement Schedules:\nSchedule II -- Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties, Years Ended December 31, 1993, 1992 and 1991 Schedule VIII -- Valuation and Qualifying Accounts, Years Ended December 31, 1993, 1992 and 1991 Schedule IX -- Short-Term Borrowings, Years Ended December 31, 1993, 1992 and 1991\nAll schedules not mentioned above are omitted for the reason that they are not required or are not applicable, or the information is included in the Consolidated Financial Statements or the Notes thereto.\nThe foregoing financial statements are incorporated by reference in certain registration statements on Form S-8 of the Company and the prospectuses relating thereto in reliance upon the report of Coopers & Lybrand pertaining to such financial statements given upon the authority of such firm as experts in accounting and auditing.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Willcox & Gibbs, Inc.:\nWe have audited the accompanying consolidated balance sheets of Willcox & Gibbs, Inc. as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 1993, 1992 and 1991. We have also audited the financial statement schedules as noted in the accompanying index listed in Item 8 of this Form 10-K for the years ended December 31, 1993, 1992 and 1991. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Willcox & Gibbs, Inc. as of December 31, 1993 and 1992 and the consolidated results of its operations and cash flows for the years ended December 31, 1993, 1992 and 1991 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 10 of the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes.\n\/s\/ Coopers & Lybrand -------------------------------------- Coopers & Lybrand\nNew York, New York March 4, 1994 except as to the information presented in the last paragraph of Note 11 for which the date is March 18, 1994.\nWILLCOX & GIBBS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1993 AND 1992 (DOLLARS IN THOUSANDS) ASSETS\nSee accompanying notes to consolidated financial statements.\nWILLCOX & GIBBS, INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nWILLCOX & GIBBS, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nWILLCOX & GIBBS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany transactions and balances have been eliminated.\n(b) CASH EQUIVALENTS\nHighly liquid investments with a maturity of three months or less when purchased are generally considered to be cash equivalents.\n(c) SHORT-TERM INVESTMENTS\nShort-term investments are stated at cost plus accrued interest, which approximates market, and consist of direct obligations of the U.S. Government.\n(d) INVENTORIES\nInventories are stated at the lower of cost (determined by LIFO for continuing operations or FIFO for discontinued operations) or market.\nThe cost of inventories determined on a LIFO basis comprised 80.9% and 68.9% of total inventories at December 31, 1993 and 1992, respectively. Had the FIFO method been used to value all inventories, total inventories would have increased $5,884 and $6,569 at December 31, 1993 and 1992, respectively.\n(e) INVESTMENTS AND NONCURRENT RECEIVABLES\nInvestments and noncurrent receivables are carried at cost, which approximates market, except for investments in companies over which the Company has significant influence, but not a controlling interest, which are carried under the equity method, and noncurrent marketable securities, which are carried at the lower of quoted market value or cost. Unrealized losses are accumulated in the marketable equity securities adjustment component of stockholders' equity.\n(f) DEPRECIATION AND AMORTIZATION\nDepreciation, computed by means of straight-line and accelerated methods, is based on the estimated useful lives of the related assets. Leasehold improvements are amortized over their respective lease terms or their estimated useful lives, if shorter.\nCost in excess of net assets of acquired businesses (\"goodwill\") is amortized over 40 years. The Company periodically reviews the carrying value of goodwill in relation to current and expected operating results of the businesses which benefit therefrom in order to assess whether there has been a permanent impairment of goodwill.\n(g) FORWARD EXCHANGE CONTRACTS\nThe Company enters into forward exchange contracts as a hedge against accounts payable denominated in foreign currency. These contracts are used by the Company to minimize exposure and reduce risk from exchange rate fluctuations in the regular course of its foreign business. Gains and losses on forward contracts are deferred and included in the measurement of the related foreign currency transaction. Cash provided and used for forward contracts is included in the cash flows resulting from changes in accounts and notes payable - trade. Contracts amounting to $128 were outstanding at December 31, 1993.\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (h) INCOME TAXES\nNo provision is made for income taxes which may be payable if undistributed earnings of foreign subsidiaries were to be paid as dividends to the Company, since the Company intends that such earnings will continue to be invested in those countries. At December 31, 1993, the cumulative amount of foreign undistributed earnings amounted to approximately $6,312. Foreign tax credits may be available as a reduction of United States income taxes in the event of such distributions.\n(i) EARNINGS PER SHARE\nPrimary earnings per share are based on the weighted average number of common and common equivalent shares outstanding during the year.\n(j) RECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform with the 1993 presentation.\n2. SIGNIFICANT TRANSACTIONS On November 12, 1992, pursuant to a Purchase Agreement dated April 22, 1992 among the Company, Rexel, S.A. (formerly known as Compagnie de Distribution de Materiel Electrique) (\"Rexel\"), International Technical Distributors, Inc. (\"ITD\"), a subsidiary of Rexel, and Southern Electric Supply Company (\"SES\"), a subsidiary of ITD engaged in the distribution of electrical components and supplies, the Company issued to Rexel and ITD 6,284,301 shares of the Company's common stock. In exchange for such stock issuance, the Company received $9,885 in cash and all the capital stock of SES. The SES acquisition was accounted for by the purchase method (see Note 3). Common stock and capital surplus have been adjusted for the proceeds received from the common stock issuance less issue costs of $2,056.\nPursuant to the Purchase Agreement (including an Investment Agreement), Rexel had agreed to certain limitations on its ownership of the outstanding common stock of the Company and to certain other restrictions during the five years after closing. However, the Company, Rexel and ITD executed an amendment to the Investment Agreement which, among other things, permits Rexel to increase its beneficial ownership of Company common stock to 45% and provides for termination of the Investment Agreement on December 31, 1994. On March 1, 1994, the Company sold to Rexel 3,491,280 newly issued shares of Company common stock for a total cash purchase price of $31,422 which was used to repay short-term debt (see Note 5). As a result, Rexel increased its beneficial ownership of the outstanding common stock of the Company from 30% to 40%.\nIn connection with the November 12, 1992 transaction, the Company distributed Worldtex, Inc. (\"Worldtex\"), its covered yarn manufacturing segment, as a dividend to its stockholders during the fourth quarter of 1992. Worldtex owns the former subsidiaries of the Company engaged in the manufacture of covered yarn. Effective with the dividend, retained earnings was charged $58,547 for the book value of the net assets distributed, including assets of $152,407 and liabilities of $93,860. Liabilities included $32,000 of debt assumed by Worldtex which was previously outstanding under the Company's prior revolving credit arrangement. The results of the covered yarn operation for 1992 and 1991 are included in the Consolidated Statements of Income as discontinued operations (see Note 4).\nResults for 1992 include transaction-related costs of $15,344, including certain investment advisor services, legal and accounting fees and executive incentive payments, in connection with these transactions.\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n3. ACQUISITIONS On April 12, 1993 the Company acquired the common stock of Sacks Electrical Supply Co. (\"Sacks\"), a distributor of electrical supplies and components with three locations in Ohio, for $13.9 million (including $0.3 million of acquisition costs).\nOn December 17, 1993, the Company acquired the common stock of Summers Group, Inc. (\"Summers\") for $60.7 million in cash (including $0.7 million of acquisition costs) and a $25 million three-year note issued to the seller, plus contingent consideration to be determined based on defined profits of Summers, subject to a maximum purchase price of $120 million. Summers is a distributor of electrical parts and supplies with locations principally in Texas, Oklahoma, Louisiana, California and Arkansas.\nEach of these 1993 acquisitions has been recorded as a purchase, and the excess of the total purchase price over the fair value of the net assets acquired ($6.9 million for Sacks and $11.5 million for Summers) is being amortized over 40 years. Sacks' and Summers' results of operations are included in the Company's financial statements from the respective dates of acquisition.\nAs discussed in Note 2 of the Notes to Consolidated Financial Statements, the Company acquired all of the issued capital stock of SES in exchange for the issuance of 4,636,994 shares of the Company's common stock. The total purchase price was $21,370, representing market value of the shares and certain closing costs. The shares include 628,430 shares issued in 1993. SES' results of operations are included in the Company's financial statements from the date of acquisition. The acquisition has been recorded as a purchase and the excess of the total purchase price over the fair value of the net assets acquired ($10,475) is being amortized over 40 years.\nThe following table summarizes the effect on consolidated sales and income (loss) from continuing operations of the Company, on an unaudited pro forma basis, assuming the Sacks and Summers acquisitions had been consummated as of January 1, 1992 and the SES acquisition had been consummated as of January 1, 1991.\nThe pro forma results above are not necessarily indicative of what actually would have occurred if the acquisitions had been in effect at the beginning of each period or are they necessarily indicative of future consolidated results.\n4. DISCONTINUED OPERATIONS The Company has decided to sell its apparel parts and supplies distribution business (\"Apparel\") and has engaged an investment banking firm, of which a director of the Company is president, to seek a purchaser. Accordingly, this business is included in the Consolidated Statements of Income as\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n4. DISCONTINUED OPERATIONS (CONTINUED) discontinued operations for all periods presented. As discussed in Note 2, the covered yarn operation is included as discontinued operations in 1992 and 1991. Summarized results of the discontinued operations are as follows:\nInterest expense of $3,927, $4,078 and $3,634 for the years ended December 31, 1993, 1992 and 1991, respectively, have been allocated to apparel operation results based upon net assets of the apparel operation. Interest expense of $1,148 and $1,162 for the years ended December 31, 1992 and 1991, respectively, has been allocated to covered yarn operation results determined by applying the Company weighted average borrowing rate during the respective periods to weighted average levels of the Company corporate debt to be assumed by Worldtex.\nThe assets of the apparel operations at December 31, 1993 are included in the accompanying Consolidated Balance Sheet as \"Net assets of discontinued operations.\" The assets and liabilities of the apparel operation included in the Consolidated Balance Sheets at December 31, 1993 and 1992 are as follows:\nThe Company's continuing operations consist solely of the distribution of electrical parts and supplies, principally in the southern tier of the United States.\n5. SHORT-TERM DEBT In connection with the acquisition of Summers, the Company terminated its $20 million line of credit and entered into the Revolving Credit and Reimbursement Agreement, dated as of December 17, 1993 (the \"Credit Agreement\"), with NationsBank of Florida, N.A., and Credit Lyonnais New York Branch. At December 31, 1993, $61.5 million was outstanding under this agreement at a weighted average interest rate of 4.57%. The $31.4 million cash received March 1, 1994 from the sale of common stock to Rexel was applied to repay debt under this agreement. The Credit Agreement provides for borrowings from time to time through December 1997 of up to the lesser of (i) $90 million\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n5. SHORT-TERM DEBT (CONTINUED) ($70 million as of March 1, 1994) and (ii) the sum of 80% of eligible accounts receivable and 50% of eligible inventory. Borrowings under the Credit Agreement bear interest at NationsBank's prime rate or at a rate based on rates in the certificate of deposit market or LIBOR plus a margin, which varies depending on the Company's financial performance. The Credit Agreement includes various covenants, including restrictions on liens, debt and lease obligations and requirements that certain financial ratios be maintained. The Company pays a fee of 1\/4 of 1% of the total unused portion of the line of credit. Upon the sale of the apparel operation, the $70 million amount available for borrowings under the Credit Agreement must be reduced to $50 million.\n6. LONG-TERM DEBT Long-term debt, less current installments, consists of:\nIn April 1991, the Company sold $50,000 of Senior Notes in a private placement. The notes are payable ratably over a seven-year period commencing March 15, 1995 with interest payable semiannually at a rate of 9.78% per annum. Based on borrowing rates currently available to the Company for long-term debt with similar terms and average maturities, the fair value of the notes is approximately $54,055. Under the terms of the Senior Notes (as amended), the Company may pay dividends and make other restricted payments (as defined) to the extent of 35% of consolidated net income (as defined) plus certain other amounts and is subject to certain restrictions on the incurrence of additional debt and other transactions and to other covenants calling for minimum levels of working capital and certain financial ratios.\nThe 7% Convertible Subordinated Debentures are due August 1, 2014 with interest payable semiannually on February 1 and August 1. The debentures are convertible into common stock of the Company at $9.57 per share, as adjusted in connection with the dividend of Worldtex, and are subject to a sinking fund, commencing August 1, 2000, calculated to retire 70% of the debentures prior to final maturity. The debentures are subordinated to present and future senior indebtedness (as defined) of the Company. In certain circumstances involving the occurrence of a Risk Event (as defined) prior to August 1, 1999, the Company will be required to offer to repurchase all or part of the debentures at 100% of their principal amount plus accrued interest. The Company has the option to pay the repurchase price in cash or shares of its common stock. At December 31, 1993, approximately 6,452,000 shares would have been necessary to repurchase the debentures. At December 31, 1993, the debentures, which trade on the New York Stock Exchange, had a fair market value of $49,000.\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n6. LONG-TERM DEBT (CONTINUED) The Senior Note due December 17, 1996 was issued to the seller in connection with the Summers acquisition and is payable in three annual installments commencing on December 17, 1994 with interest at 4.375% per annum.\nThe mortgage notes payable are due in monthly installments of $59, including interest at 9.5% through December 31, 1996. The principal balance outstanding on December 31, 1996 is due in one payment on that date. The notes are collateralized by a mortgage and security agreement and a collateral assignment of rents and leases relative to various property located in Florida. Based on borrowing rates currently available to the Company for long-term debt with similar terms and average maturities, the fair value of the notes is approximately $7,036.\nLong-term debt maturities during the next five years are as follows:\n7. STOCKHOLDERS' EQUITY The authorized capital stock of the Company is 37,600,000 shares, consisting of 600,000 shares of Preferred Stock with a par value of $12 per share, 2,000,000 shares of Preference Stock with a par value of $1 per share and 35,000,000 shares of Common Stock with a par value of $1 per share. The Board of Directors may issue the Preference Stock from time to time in one or more series and fix the dividend rates, voting rights and liquidation preferences and establish redemption, sinking fund, conversion, exchange and other relative rights, preferences and limitations of a particular series.\nOn January 10, 1989, the Board of Directors declared a dividend distribution of one preference stock purchase right (the \"Rights\") for each share of common stock outstanding. Each right entitles the holder to purchase one one-hundredth of a share of newly created Junior Participating Preference Stock, par value $1.00 per share. The Rights Agreement was amended on November 12, 1992 pursuant to the agreement with Rexel and the dividend discussed in Note 2 of the Notes to Consolidated Financial Statements and was amended on March 1, 1994, in connection with the purchase by Rexel of additional shares of common stock of the Company. The Rights will become exercisable upon the occurrence of certain events at an exercise price of $15 for each one one-hundredth of a preference share. In the event a person or group acquires 20% or more of the Company's outstanding common stock, each right shall entitle the holder to purchase, by paying the $15 exercise price, stock of the Company with a value of twice the exercise price provided that ownership of the Company's stock by Rexel and its Affiliates (as such term is defined in the Rights Agreement) will not trigger such exercise right so long as Rexel and all its Affiliates do not own, in the aggregate, voting securities of the Company which, on a fully exercised basis, are in excess of 45% of the aggregate number of votes which may be cast by holders of outstanding voting securities of the Company. In addition, if the Company is acquired in a merger or other business combination, the rightholder shall be entitled to purchase, by paying the $15 exercise price, common stock of the acquiring company with a value of twice the exercise price, except as otherwise provided in the Rights Agreement. The Rights are redeemable by the Company at $.01 per Right under certain circumstances and will expire December 31, 1994. 500,000 shares of preference stock have been reserved for issuance upon exercise of the Rights.\nWILLCOX & GIBBS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n7. STOCKHOLDERS' EQUITY (CONTINUED) Shares of common stock as at December 31, 1993 are reserved for:\n8. STOCK OPTION PLANS, STOCK ACQUISITION PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN Under the Company's 1988, 1985 and 1982 Stock Option Plans, options to purchase up to 1,266,667 shares, 829,630 shares and 379,259 shares of common stock, respectively, were available to be granted to key employees of the Company. The 1988 Plan also provides that each director of the Company, other than one who is an officer or employee, be granted a non-qualified stock option to purchase 10,000 shares of Company common stock. For each plan, the option period is either ten or eleven years from the date of grant, and no option may be exercised prior to the first anniversary of the date of grant.\nInformation regarding the Company's stock option plans is summarized below:\nAll options were granted at market value on the date of grant.\nAs of December 31, 1993, options for the purchase of 218,753 shares and 15,262 shares were available for future grant under the 1988 and 1985 plans, respectively.\nThe Company's Stock Acquisition Plan provides for the issuance of up to 237,037 shares of common stock to key employees over specified employment periods. As of December 31, 1993, 229,889 shares of common stock have been issued, and 7,148 shares are available for award.\nThe Company's Employee Stock Ownership Plan, which became effective in 1981, provides eligible employees with an opportunity to purchase the Company's common stock through payroll deductions, which are matched by the Company, subject to certain limitations. Contributions to the plan are invested by an independent trustee in common stock of the Company. Stock attributable to Company contributions vests at the rate of 10% for each twelve months of contributions by the employee, with 100% vesting after five years of service. The Company's contributions to the plan, net of forfeitures, charged to income for 1993, 1992 and 1991 were $695, $758 and $393, respectively.\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n9. PENSION AND PROFIT-SHARING PLANS AND POSTRETIREMENT BENEFIT PLANS The Company has two qualified noncontributory defined benefit pension plans covering certain eligible domestic employees. The Company's funding policy is to contribute annually the maximum amount that can be deducted for Federal income tax purposes. The Company also has a non-qualified defined benefit supplemental retirement plan covering key employees, which is not funded. The benefits of both plans are based on years of service and defined levels of compensation.\nThe Company also has a defined benefit plan maintained for eligible employees of certain United Kingdom subsidiaries included in the apparel operation. The plan is funded annually for the maximum amount permitted by statute. The benefits are based on years of service and defined levels of compensation.\nUnder the collective bargaining agreement of the textile industry in France, employees of a subsidiary Worldtex are entitled to a lump-sum payment at retirement based on their length of service at retirement and final pay. All obligations under this plan were assumed by Worldtex in connection with the dividend.\nThe following table sets forth the plans' funded status at December 31, 1993 and 1992:\nThe qualified domestic plan assets include guaranteed investment contracts, mutual and money market funds, government securities, whole life insurance policies and common stock of the Company and Worldtex (such stock with a combined market value of $520 and $515 at December 31, 1993 and 1992, respectively). The United Kingdom plan assets are comprised of certain deferred annuity contracts.\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n9. PENSION AND PROFIT-SHARING PLANS AND POSTRETIREMENT BENEFIT PLANS (CONTINUED) Net periodic pension cost for 1993, 1992 and 1991 included the following components:\nFor both the qualified domestic plans, the weighted average discount used in determining the actuarial present value of the projected benefit obligation was 7.25% at December 31, 1993 and the rates of increase in future compensation used were 4.5% and 4.0% at December 31, 1993. The weighted average discount rate and the rate of increase in future compensation levels used at December 31, 1992 and 1991 for the one plan were 8.25% and 6.0%, respectively. The expected long-term rates of return on assets were 8.0% and 8.5% for 1993 and 9.5% for all other years.\nFor the non-qualified domestic plan, the weighted average discount rate used was 7.5% at December 31, 1993 and 9.5% for all other years. For 1993 and 1992, no salary increase was assumed as the Company has frozen salaries under the plan at current levels. The rate of increase in future compensation in 1991 was 5.0%. Liabilities under this plan attributable to Worldtex employees were assumed by Worldtex in connection with the dividend of Worldtex.\nFor the United Kingdom plan, the assumed discount rate at December 31, 1993 was 9.0% and for all other years the rate was 10.0%. The rate of increase in future compensation levels was 9.0% for all years and the expected long-term rate of return on assets was 9.0% at December 31, 1993 and 10.0% for all other years.\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n9. PENSION AND PROFIT-SHARING PLANS AND POSTRETIREMENT BENEFIT PLANS (CONTINUED) For the French plan, the assumed discount rate and rate of increase in future compensation levels were 9.0% and 5.0%, respectively.\nCertain subsidiaries have noncontributory profit-sharing plans and defined contribution pension plans providing for minimum contributions based upon defined levels of subsidiary income or employee compensation.\nPension and profit-sharing expense for the years ended December 31, 1993, 1992 and 1991 amounted to approximately $1,338, $2,141 and $1,234, respectively.\nA subsidiary of the Company, acquired in 1993 provides certain health care benefits for eligible retired employees. The status of the plan at December 31, 1993 is as follows:\nThe postretirement benefit cost in 1993 consisted of interest cost of $39 on the accumulated postretirement benefit obligation (\"APBO\"). The plan is unfunded. The discount rate used in determining APBO was 7.25%. Increasing assumed health care trends one percentage point will increase the APBO by $66 as of December 31, 1993.\n10. INCOME TAXES Effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" Under Statement 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of Statement 109, income tax expense was determined using the deferred method. Deferred tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. The effect of the change on pretax income from continuing operations for the year ended December 31, 1993 was not material; however, the cumulative effect of the change as of January 1, 1993 increased net income by $660 or $.03 per share.\nThe Company and its U.S. subsidiaries file Federal income tax returns on a consolidated basis. The provision (benefit) for income taxes has been classified as follows in the consolidated statements of income:\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n10. INCOME TAXES (CONTINUED) The provision (benefit) for income taxes is comprised of the following:\nDeferred income taxes result from temporary differences in the recognition of revenue and expenses for financial statement and income tax reporting purposes. The tax effects of each as of December 31, 1993 are as follows:\nIncome (loss) before income taxes is comprised of the following:\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n10. INCOME TAXES (CONTINUED) A reconciliation for 1993, 1992 and 1991 between the amount computed using the Federal income tax rate and the effective rate of tax on income (loss), including discontinued operations, but excluding extraordinary charge, is as follows:\nAt December 31, 1993, the Company had state net operating loss carryforwards for tax purposes of approximately $16,500. These loss carryforwards will expire from years 1998 to 2008.\n11. COMMITMENTS AND CONTINGENCIES At December 31, 1993, annual minimum rental commitments under noncancelable operating leases, primarily for real property, are summarized as follows:\nThe minimum annual commitments include amounts payable to an officer of the Company and\/or members of his and his wife's family and amounts payable to an officer of a subsidiary as follows: 1994 -- $841; 1995 -- $820; 1996 -- $710; 1997 -- $658; 1998 -- $630; thereafter -- $2,519.\nTotal rent expense charged to operations for the years ended December 31, 1993, 1992 and 1991 amounted to approximately $6,589, $5,148 and $5,447, respectively.\nAt December 31, 1993, the Company was contingently liable for outstanding letters of credit in the amount of $1,001.\nWILLCOX & GIBBS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n11. COMMITMENTS AND CONTINGENCIES (CONTINUED) In the normal course of business, the Company is sometimes named as a defendant in litigation. In the opinion of management, based upon the advice of counsel, any uninsured liability which may result from the resolution of any present litigation or asserted claim will not have a material effect on the Company's financial position or results of operations.\nIn connection with the resignation of an executive of the Company on March 18, 1994, the Company has entered into an agreement with such executive which provides, among other things, certain payments and acceleration of certain other payments in connection with the executive's related employment agreement. As of December 31, 1993, the Company's remaining commitments under this agreement total approximately $1.1 million.\n12. ACCOUNTS AND NOTES PAYABLE -- TRADE, AND OTHER LIABILITIES Accounts and notes payable -- trade and other liabilities consist of the following:\n13. RESULTS OF OPERATIONS The Company has recorded charges to operations of $5,586 and $6,508 for the years ended December 31, 1992 and 1991, respectively, related to certain restructuring actions initiated by the Company ($1,248 and $959 for the years ended December 31, 1992 and 1991, respectively, are included in discontinued apparel operations.)\nIn 1992, the Company sold its data communications equipment distribution business and an apparel-related unit in return for $3,350 in cash, $1,858 of short and long-term notes and a marketable equity security with a fair market value of $1,500. The disposal of these businesses relate to actions originally initiated in 1991. The Company also initiated other restructuring actions, including the disposal of other operations, that do not relate to the Company's core business.\nIn 1991, the Company initiated certain restructuring actions, including the disposal of certain operations, that did not relate to the Company's core business. These operations included the above-mentioned data communications and apparel-related businesses.\nIn 1992 and 1991, certain restructuring actions initiated in 1991 and 1990 required more costs to implement than originally expected. The additional costs, included in the restructuring charges for these periods, changed based on the revised estimates and experience to date.\nOn August 16, 1991, the Company redeemed all of the outstanding 13% Senior Subordinated Notes due April 15, 1997 at a redemption price of 100% of the principal amount thereof ($23,000) together with accrued interest to the redemption date. An extraordinary charge of $1,436, net of a tax benefit of $794, was recorded to reflect the write-off of unamortized discount and expense.\nWILLCOX & GIBBS, INC. SUPPLEMENTARY FINANCIAL INFORMATION YEARS ENDED DECEMBER 31, 1993 AND 1992 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSCHEDULE II\nWILLCOX & GIBBS, INC. AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nSCHEDULE VIII\nWILLCOX & GIBBS, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nSCHEDULE IX\nWILLCOX & GIBBS, INC. SHORT-TERM BORROWINGS YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the information responsive to the Items comprising this Part III that is contained in the Company's definitive proxy statement for its 1994 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, which is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS AND SCHEDULES\nThe financial statements and financial statement schedules included in this Report are listed in the introductory portion of Item 8.\nEXHIBITS\nThe following exhibits are filed as part of this Report (for convenience of reference, exhibits are listed according to numbers assigned in the exhibit tables of Item 601 of Regulation S-K under the Securities Exchange Act of 1934 and management contracts and compensatory plans are indicated by an asterisk):\n8-K REPORTS\nDuring the last quarter of the Company's 1993 fiscal year, the Company did not file a Current Report on Form 8-K.\nSIGNATURES\nPursuant 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.\nDated: March 30, 1994 WILLCOX & GIBBS, INC.\nBy: \/s\/ Allan M. Gonopolsky\n----------------------------------- Allan M. Gonopolsky VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND CORPORATE CONTROLLER\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 30, 1994 by the following persons on behalf of the registrant and in the capacities indicated.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"34891_1993.txt","cik":"34891","year":"1993","section_1":"ITEM 1. BUSINESS\nFederal Paper Board Company, Inc. (the \"Registrant\") was incorporated in the State of New York in 1916. The term \"Company\" used in this report means the Registrant and its consolidated subsidiaries unless the context indicates otherwise. The Company's products have been grouped into the following three industry segments: Paper, Paperboard and Pulp, consisting of bleached and recycled paperboard, bleached softwood and hardwood pulp and uncoated free-sheet paper; Wood Products, consisting of dimensional lumber, wood chips and land management activities; and Converting Operations, consisting of paper and plastic cups and specialty packaging products. Financial information regarding industry segments is included on pages 22 and 23 of the Company's 1993 Annual Report to Shareholders (the \"Annual Report\"), which information is incorporated herein by reference.\nDuring the fourth quarter of 1993, a special meeting of security holders was held to vote upon a proposal to change the State in which the Company is incorporated. This proposal was approved by the shareholders and the Company has filed an Agreement of Merger with the State of New York, for which it is awaiting approval before the merger may be completed. This merger will not result in any change of the Company's Board of Directors, management, operations or financial condition. A further discussion of the merger is contained in Item 4, Submission of Matters to a Vote of Security Holders on page 7 of this Annual Report on Form 10-K.\nIn 1991, the Company sold or leased four of its eight folding carton plants and its mechanical packaging operation. The folding carton plants located in Palmer, MA, Versailles, CT, and York, PA were sold to a group of former employees. In this transaction, the Company received a note for approximately $20.5 million. In 1993, this note was settled and the Company received cash and preferred stock. The folding carton plant located in Marseilles, IL was leased with the option for the lessee to purchase the facility at the end of the lease term. The mechanical packaging operation was sold and the Company received cash in this transaction. In 1990, the Company acquired Continental Bondware, Inc., a manufacturer of paper cups with plants located in Chicago and Shelbyville, IL, for approximately $146.5 million. In 1989, the Company acquired Imperial Cup Corp., a manufacturer of paper and plastic cups with plants located in Kenton, OH, LaFayette, GA, Salisbury, MD and Visalia, CA, for approximately $95 million. These two businesses were combined and operate under the name of Imperial Bondware Corp.. In 1989, the Company acquired Thomas Tait & Sons, Ltd., an integrated producer of uncoated free-sheet paper, located in Inverurie, Scotland. In this transaction, the Company paid $23.1 million in cash and issued common stock.\nPAPER, PAPERBOARD AND PULP\nThe principal products of this business segment are bleached and recycled paperboard, hardwood and softwood pulp and uncoated free-sheet paper. Bleached paperboard is produced on three paperboard machines at the Augusta, GA mill and on two paperboard machines at the Riegelwood, NC mill. Recycled paperboard is produced on one paperboard machine at the Sprague, CT mill. The majority of the paperboard produced at the Company's mills is converted into packaging for various consumer goods and used in printing applications including menus, greeting cards and brochure covers. Bleached paperboard produced at the Augusta and Riegelwood mills is also used by the Company's Converting Operations to produce folding cartons and paper cups. Recycled paperboard produced at the Sprague mill is converted into packaging products by outside customers and the Company's folding carton plants. The Company's mills sold approximately 1,066,000 tons of paperboard and this product accounted for 44% of total sales.\nThe Company produces hardwood and softwood market pulp at the Riegelwood mill, which is sold in both the domestic and export markets. The Augusta mill produces softwood pulp which is sold, in slush form, to a neighboring newsprint mill under a long-term supply contract. In 1993, of the 1,403,000 tons of pulp produced, approximately 847,000 tons were used to produce paperboard at the Company's mills and the remaining 566,000 tons were available for sale as market pulp. Approximately 68% of market pulp shipped was sold in the export market. The Company's mills sold 530,000 tons of market pulp and this product accounted for 9% of total sales.\nThe Company produces uncoated free-sheet paper at one mill located in Inverurie, Scotland. Paper is produced on two paper machines and is marketed and sold throughout Europe. The mill uses bleached pulp as its primary raw material which it purchases from the Company's Riegelwood mill and outside producers. In 1993, the mill sold approximately 179,000 metric tons and this product accounted for 8% of total sales.\nAlso in this business segment, the Company operates five sheeting distribution centers and one extrusion coating plant. These facilities receive paperboard from the Company's mills which is then sheeted to customer specifications. The extrusion coating plant provides poly-coated board to the Company's cup operations and also sells this product to outside customers. These facilities are geographically located throughout the United States so the Company's customers may be serviced quickly and efficiently.\nFurther information regarding the Paper, Paperboard and Pulp business is included in the Review of Operations on pages 6 to 9 of the Annual Report and is incorporated herein by reference.\nWOOD PRODUCTS\nThe principal products of this business segment are dimensional lumber, wood chips and land management activities. The Company produces both dimensional lumber and wood chips at five lumber plants which are located near the Company's paperboard and pulp mills. Two of the plants, located in Augusta, GA and Johnston, SC, are within a 60 mile radius of the Augusta paperboard and pulp mill and supply the majority of their softwood chips to the mill. The plant located in Washington, GA supplies approximately 7% of its chips to the Augusta paperboard and pulp mill. The plant located in Newberry, SC is between the Augusta and Riegelwood paperboard and pulp mills and supplies approximately 30% of its chips to those mills with the balance being sold to outside customers. The plant located in Armour, NC is two miles from the Riegelwood paperboard and pulp mill and provides 100% of its softwood chips to such mill. The Company also owns five chip mills that process round wood into wood chips which supply the Company's paperboard and pulp mills.\nThe Company presently owns or controls under long-term leases approximately 693,000 acres of timberland. In the vicinity of its Riegelwood paperboard and pulp mill, the Company directly owns 260,000 acres and holds 116,000 acres under long-term leases with purchase options. In the vicinity of the Augusta paperboard and pulp mill, the Company owns 308,000 acres and has lease rights to 9,000 acres.\nFurther information regarding the Wood Products business is included in the Review of Operations on pages 9 and 10 of the Annual Report and is incorporated herein by reference.\nCONVERTING OPERATIONS\nThe principal products of this business segment are paper and plastic cups, plastic lids, containers and packaging products. The Company's cup operations manufacture paper and plastic disposable drinking cups and food containers at six locations. These products are marketed for use by industrial vending operations, fast food restaurants, soft drink bottlers, paper distributors, theaters and convenience stores. Its primary raw materials are paperboard and plastic. In 1993, approximately 84% of the paperboard consumed in the Company's cup operations was obtained from the Company's own paperboard mills.\nThe Company also produces folding cartons, used in the packaging of products such as food, laundry soap, tobacco, medical products, drug and health aids, consumer paper products, hardware and toys, at four folding carton plants. In 1991, the Company sold or leased four folding carton plants and its mechanical packaging operation as part of a plan to reduce its presence in the packaging industry. The Company's folding carton plants are equipped with lithographic, gravure, and flexographic printing, giving the Company the capability of producing high quality multi-colored packaging. The packaging products produced are specially designed to serve the packaging and marketing needs of individual customers, which include manufacturers of numerous nationally known consumer goods. Approximately 80% of the paperboard consumed in the Company's packaging operations was obtained from the Company's own recycled and bleached paperboard mills.\nFurther information regarding the Converting Operations is included in the Review of Operations on pages 10 and 11 of the Annual Report and is incorporated herein by reference.\nCOMPETITION AND CUSTOMERS\nThe Company's businesses are highly competitive. There are a number of companies involved in these businesses whose total assets and sales are substantially greater than those of the Company, although the Company is a nationally recognized market participant in pulp, recycled paperboard, paper and plastic cups and folding cartons and enjoys a leadership position in the bleached paperboard market.\nThe principal method of selling the Company's products is through its own sales force. Customers may place orders with the Company for various reasons which may include one or more of the considerations of price, service and quality and the ability of the Company to deliver and service the customers' needs on a timely basis. Bleached and recycled paperboard, market pulp and paper cups are also sold overseas through the Company's sales force and\/or through agents. Competition in export markets is based on the same considerations mentioned above. The sale of market pulp is highly competitive and subject to wide fluctuations in price. No single customer accounted for more than 10% of the Company's consolidated sales in any of the last three fiscal years.\nENERGY AND RAW MATERIALS\nThe Company is a large user of electricity and steam in its manufacturing operations. At the Riegelwood mill, steam and electricity are produced by its own power plant which utilizes black liquor (spent pulping chemicals), oil, natural gas and waste wood (bark and sawdust) as fuels. In 1993, approximately 75% of the Riegelwood mill's energy requirements were self-generated. The Company's Augusta mill also generates steam and electricity by its own power plant which utilizes similar fuels (including coal) as described above for Riegelwood. In 1993, approximately 62% of the Augusta mill's energy requirements were self-generated. At the Sprague mill, steam and electric power are produced by the mill's own power plant utilizing oil or natural gas. In 1993, the Sprague mill completed a capital program which involved installing a natural gas pipeline allowing the mill to substitute natural gas for oil, used in the generation of steam in its power boiler and for propane in its paperboard coating drying process. In 1992, the Company's Inverurie mill reduced energy costs by replacing a coal fired power plant with a new natural gas power plant. Electricity is purchased to some degree at all plants to satisfy total demand.\nThe Company believes its sources of supply with respect to oil, natural gas and purchased power, to be generally adequate. The Company's annual wood needs supplied from other than Company lands are available in ample quantities from sources within an economical transportation area and are believed to be adequate to meet both the present and future needs of the Company at its Riegelwood and Augusta mills. The Company also believes that the Sprague mill has an adequate supply of wastepaper available from sources within an economical transportation area to meet both present and future needs.\nENVIRONMENTAL CONSIDERATIONS\nThe Company is subject to various laws and regulations relating to the environment in the countries in which the Company operates. These regulations require the Company to obtain permits and licenses from appropriate governmental authorities with respect to its facilities. The Company has obtained, has applied for, or in the future will apply for such permits and authorizations and believes that it is in compliance with all existing material environmental regulations.\nIn order to meet the standards established by environmental laws and regulations, the Company has made substantial capital and operating expenditures and plans to make substantial expenditures in the future. In 1993, environmental capital expenditures totaled $17.2 million. Capital expenditures for environmental purposes are estimated to be approximately $25 million and $70 million for fiscal years 1994 and 1995, respectively. However, spending on these environmental projects may be undertaken in years beyond 1995.\nAdditional amounts to be incurred for environmental purposes in future years will depend on new laws and regulations, other changes in legal requirements, changes in environmental control technology and changes in the economic environment. In the latter part of 1993, the United States Environmental Protection Agency (\"EPA\") issued regulations which could result in significant expenditures being incurred in the paper industry in future years. The Company is not yet in a position to establish a meaningful estimate of such costs or predict what potential financial impact changes to other existing regulations would have on the Company. All companies operating in the Company's industry are subject to the same or similar environmental laws and regulations and the Company does not believe that compliance with the laws and regulations that apply to the Company will materially affect its competitive position.\nThe Company's Riegelwood, NC mill operates its waste water treatment and disposal facilities under a NPDES (National Pollutant Discharger Elimination System) permit issued by the State of North Carolina and an administrative Consent Order which provides temporary relief of the BOD (biochemical oxygen demand) limitations contained in the NPDES permit. The Consent Order requires studies and improvements be completed at various times extending to October 1995. The Company and the State of North Carolina have agreed that a new waste water holding pond will be constructed at the Riegelwood mill by October 1995 at a cost of approximately $25 million. The Augusta, GA mill is under an administrative Consent Order requiring construction of a new landfill. The Company has received approval from the State of Georgia to build a new landfill which is expected to be completed by April 1994 at a cost of approximately $13 million. The projects discussed above are included in the Company's estimates of future environmental capital expenditures.\nThe process of manufacturing bleached kraft pulp produced at both the Riegelwood and Augusta mills has been found to produce small amounts of dioxin as an unintended by-product. The Riegelwood mill has a permitted effluent limit for dioxin of 0.9 parts per quadrillion (\"PPQ\"). The effluent dioxin found at the Riegelwood mill is below the limits of detection (10 PPQ) and therefore it is not known whether the contamination exceeds the permitted level. The Company has voluntarily entered into a judicial Consent Order for the Riegelwood mill which gives the mill relief of its permitted effluent limit until December 1996, while additional mill facilities are being constructed to assure compliance. The Augusta mill is in compliance with its permitted effluent limit for dioxin of 180 PPQ. Steps are being taken by the Company to further reduce dioxin at both the Riegelwood and Augusta mills.\nThe Company has filed for a new waste water discharge permit for its Sprague, CT mill and is awaiting approval from the Connecticut Department of Environmental Protection (\"DEP\"). In the meantime, the Company's Sprague mill discharges its waste waters under an administrative Consent Order from the Connecticut DEP which allows the mill to continue to discharge under a previously issued NPDES permit until a new permit is issued. The Sprague mill has also entered into an administrative Consent Order with the Connecticut DEP to evaluate and control sporadic odors originating from the mill site. The Company has submitted a plan to the Connecticut DEP to increase the capacity of its waste water treatment system and thereby reduce odor generation potential and is awaiting approval.\nThe Company will also incur further costs at certain of its other properties as the result of soil contamination from chemical or solvent spills including sites of former folding carton plants which are now inactive. In some cases, the remediation projects are subject to Consent Orders with the state environmental agencies.\nThe Company has been notified that it is a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 and by certain state agencies under applicable state laws, with respect to the cleanup of hazardous substances at approximately 11 sites which are not owned or controlled by the Company. The Company cannot predict with certainty the total costs of cleanup, the Company's share of the total costs or the extent to which contributions will be available from other parties, the amount of time necessary to complete the cleanups, or the availability of insurance coverage. However, based upon its experience with such matters, the Company does not believe that its expected share of such known actual and potential cleanup costs will have a materially adverse effect on its financial condition and results of operations.\nThe Company has recorded accruals in the Consolidated Balance Sheet for the environmental costs, referred to above, of $4.7 million and $3.8 million, at January 1, 1994 and January 2, 1993, respectively. In the opinion of management, these accruals are sufficient to cover probable and estimable environmental costs.\nEMPLOYEES\nThe Company employed approximately 6,850 employees as of February 26, 1994 and February 27, 1993. Approximately one-half of the employees are covered by collective bargaining agreements, the majority of which are at the Company's four mills: the agreement at the Inverurie mill expired in December 1993 and was renegotiated, the new agreement expires in December 1995; the agreement at the Riegelwood, NC paperboard and pulp mill expires in September 1995; and the agreements at the Augusta, GA pulp and paperboard mill and the Sprague, CT recycled paperboard mill expire in August 1996 and July 1996, respectively.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following table sets forth the location and use of each of the principal facilities of the Company. All of the facilities are owned by the Company except as indicated in the table.\n(a) Leased through 1997.\n(b) Leased through 1997 with the option to purchase the facility.\nThe Company believes that its facilities are in good working condition and are suitable for its current operations. While the productive capacity is deemed adequate for each business unit, the Company continually invests in projects that are designed to improve both the quality and quantity of goods produced. In some cases, facilities have the ability to expand productive capacity through additional work shifts as opposed to additional capital requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a party to any significant legal proceedings other than those matters discussed in Item 1, under \"Environmental Considerations.\"\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nDuring the fourth quarter of the fiscal year ended January 1, 1994, one matter was submitted to a vote of security holders. A special meeting of shareholders was held on November 16, 1993. Shareholders voted on a proposal to change the state of incorporation of the Company from New York to North Carolina. The reorganization will be accomplished pursuant to an Agreement of Merger, under which the Company, which is a New York Corporation, would be merged into a wholly owned subsidiary, Fedco, Inc., organized under the laws of North Carolina. Fedco, Inc. would be the surviving corporation and would subsequently change its name to Federal Paper Board Company, Inc.. The number of votes cast for, against and withheld were 33,284,044, 1,966,376 and 115,967, respectively.\nSPECIAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY.\nThe following table sets forth the name, age, principal occupation and business experience during the last five years for each of the executive officers of the Company.\nJOHN R. KENNEDY(a), 63, Director, President and Chief Executive Officer. President and Chief Executive Officer from 1975 to date.\nQUENTIN J. KENNEDY(a), 60, Director, Executive Vice President and Secretary. Executive Vice President and Secretary from 1983 to date.\nROBERT D. BALDWIN, 56, Director and Senior Vice President, Marketing, Forest Products Division. Senior Vice President, Marketing, Forest Products Division from 1985 to date.\nW. MARK MASSEY, JR., 55, Director and Senior Vice President, Manufacturing, Forest Products Division. Senior Vice President, Manufacturing, Forest Products Division from 1990 to date; Vice President and General Manager, Augusta Operations from 1987 to 1990.\nJOHN E. ABODEELY, 50, Vice President and General Manager Packaging Operations from November 1991 to date; Vice President, Manufacturing, Packaging & Printing Operations from 1986 to November 1991.\nMICHAEL J. BALDUINO, 43, Vice President and General Manager Imperial Bondware Corp. from February 1992 to date; Vice President of Marketing, Commercial Products, James River Corp. from September 1990 to February 1992; Director of Consumer Marketing and Support, James River Corp. from June 1989 to September 1990; Director of Regional Business Development, James River Corp. from September 1987 to June 1989.\nCARL L. BUMGARDNER, III, 36, Vice President, Printing Paper Sales from July 1993 to date; General Manager, Bleached Paperboard Printing Sales from November 1991 to July 1993; Marketing and Sales Manager, Bleached Paperboard Packaging from July 1991 to November 1991; National Marketing Manager from 1989 to July 1991.\nTHOMAS L. COX, 46, Vice President and Treasurer from November 1991 to date; Treasurer from 1989 to November 1991; Controller from 1988 to 1989; Director of Finance and Administration, Augusta Mill from 1981 to 1988.\nMICHAEL G. CULBRETH, 45, Vice President, Employee Relations from April 1991 to date; Director, Employee Relations, Forest Products Division from August 1989 to April 1991; Manager, Employee Relations, Augusta Mill from 1978 to August 1989.\nROBERT F. DANSBY, 54, Vice President, Augusta Operations from May 1990 to date; Manager, Manufacturing Services, Augusta Mill from 1987 to May 1990.\nTHOMAS F. GRADY, JR., 51, Vice President, Sales, Imperial Bondware Corp. from November 1991 to date; Vice President, Paperboard Sales from May 1989 to November 1991; Marketing Manager, Bleached Board Sales, National Accounts from 1987 to May 1989.\nLOUIS O. GRISSOM, 47, Vice President, Riegelwood Operations from 1991 to date; Assistant Resident Manager, Riegelwood Mill from May 1990 to 1991; Production Manager, Augusta Mill from 1987 to May 1990.\nRICHARD W. HUGHES, 54, Vice President, Woodlands from 1987 to date.\nSTEWART MONROE, JR., 60, Vice President, Pulp Sales from 1986 to date.\nROGER L. SANDERS, II, 49, Controller from 1989 to date; Director of Finance and Administration, Augusta Mill from 1988 to 1989.\nF. JOHN SECURCHER, 49, Vice President, Manufacturing Imperial Bondware Corp. from December 1992 to date; Vice President and General Manager, Sherry Cup from January 1991 to December 1992; Vice President, Systems and Technology, Imperial Bondware Corp. from October 1990 to January 1991; Vice President, Manufacturing, Continental Bondware, Inc. (acquired by the Registrant in 1990) from September 1986 to October 1990.\nL. KIRK SEMKE, 57, Vice President, Manufacturing Technology from 1991 to date; Vice President, Riegelwood Operations from 1987 to 1991.\nWILLIAM R. SNELLINGS, JR., 45, Vice President, Paperboard Sales from April 1991 to date; General Sales Manager, Bleached Board Packaging from August 1989 to April 1991; Manager, Marketing from September 1987 to August 1989.\nTHOMAS J. TAIT, O.B.E., 46, Vice President, Managing Director, Thomas Tait & Sons, Ltd. from 1989 to date; Chairman and Managing Director, Thomas Tait & Sons, Ltd. (acquired by the Registrant in 1989) from 1970 to 1989.\nJ. RONALD TILLMAN, 49, Vice President, Wood Products from 1991 to date; General Manager, Wood Products from 1990 to 1991; General Operations Manager from 1987 to 1990.\nIVAN D. WILSON, 57, Vice President, Service Distribution Centers, from April 1992 to date; Controller, Riegelwood Operations from 1973 to April 1992.\nMessrs. J. R. Kennedy, Q. J. Kennedy, R. D. Baldwin, and W. M. Massey, Jr. have Employment Agreements with the Company by the terms of which Mr. J. R. Kennedy will act as President, Mr. Q. J. Kennedy will act as Executive Vice President, and Messrs. R. D. Baldwin and W. M. Massey, Jr. will act as Senior Vice Presidents for the Company or in such other capacities as the Board of Directors shall determine. The agreement with Mr. J. R. Kennedy extends through 1995. The agreement with Mr. Q. J. Kennedy extends through 1998. The Agreement with Mr. R. D. Baldwin extends through 1997. The Agreement with Mr. W. M. Massey, Jr. extends through 1996. All other Executive Officers are elected to their respective offices annually by the Board of Directors.\n(a) Messrs. J. R. Kennedy and Q. J. Kennedy are brothers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required by Item 5 is included on page 36 of the Annual Report and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by Item 6 is included on page 37 of the Annual Report and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by Item 7 is included on pages 18 through 21 of the Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by Item 8 is included on pages 22 through 36 of the Annual Report and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe directors of the Company and their business experience are set forth on pages 3 through 5 of the Company's Notice of Annual Meeting and Proxy Statement, dated March 15, 1994 (the \"Proxy Statement\") and are incorporated herein by reference. The discussion of executive officers of the Company is included in Part I under \"Executive Officers of the Company.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nA description of the compensation of the Company's executive officers is set forth on pages 5 through 15 of the Proxy Statement, and with the exception of the section headed \"Compensation Committee Report\" on pages 12 and 13, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nA description of the security ownership of certain beneficial owners and management is set forth on pages 2 and 3 of the Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone, other than those described under Items 11 and 12.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nEXHIBITS:\nA list of the exhibits required to be filed as part of this Report on Form 10-K is set forth in the \"Exhibit Index\", which immediately precedes such exhibits, and is incorporated herein by reference.\nREPORTS ON FORM 8-K:\nNo reports on Form 8-K were filed for the sixteen weeks ended January 1, 1994.\nFINANCIAL STATEMENT SCHEDULES:\nThe consolidated balance sheets as of January 1, 1994 and January 2, 1993, and related consolidated statements of income, cash flows and shareholders' equity for each of the three fiscal years in the period ended January 1, 1994 and the related notes to financial statements, together with the Independent Auditors' Report thereon of Deloitte & Touche, dated February 7, 1994, appearing on pages 22 through 35 of the Annual Report, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1 and 5 through 8, the Annual Report is not to be deemed filed as part of this report. The following additional financial data should be read in conjunction with the financial statements in the Annual Report. Schedules not included with this additional financial data have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nADDITIONAL FINANCIAL DATA\nFISCAL YEARS 1993, 1992, AND 1991\nINDEPENDENT AUDITORS' REPORT - ----------------------------\nTo the Shareholders and Board of Directors of Federal Paper Board Company, Inc.\nWe have audited the consolidated financial statements of Federal Paper Board Company, Inc. and its subsidiary companies as of January 1, 1994 and January 2, 1993 and for each of the three fiscal years in the period ended January 1, 1994, and have issued our report thereon dated February 7, 1994, which report includes an explanatory paragraph as to changes in the method of accounting for income taxes and in the method of accounting for postretirement benefits other than pensions; such financial statements and report are included in your 1993 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of Federal Paper Board Company, Inc. and its subsidiary companies, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ DELOITTE & TOUCHE Parsippany, New Jersey February 7, 1994\nSCHEDULE II\nFEDERAL PAPER BOARD COMPANY, INC. AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (IN THOUSANDS)\nSCHEDULE II (Continued)\nFEDERAL PAPER BOARD COMPANY, INC. AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (IN THOUSANDS)\nNote\nBalances at January 1, 1994 and January 2, 1993 represent relocation notes or moving advances. Prior to October 1, 1992, these amounts represented shared appreciation loans, moving advances, interest bearing promissory notes and non-interest bearing promissory notes. As of October 1, 1992, all loans were revised as follows: All loans are secured and will extend for a period of up to twenty years. During the first ten year period, no interest is charged, but 15% of any bonus paid must be applied to reduce the outstanding principal. Thereafter, the loans bear interest at the long-term Federal Government Rate, and the principal is amortized over such term.\nSCHEDULE V FEDERAL PAPER BOARD COMPANY, INC. PROPERTY, PLANT AND EQUIPMENT (IN THOUSANDS)\n(1) Includes additions from acquisitions. (2) Includes ($2,920) for foreign currency translation adjustments and ($3,515) for the write-down of assets, other adjustments and reclassifications. (3) Represents cost of timber harvested credited directly to the asset. (4) Includes ($26,869) for foreign currency translation adjustments, $71,688 for the adjustment of carrying amounts of previous acquisitions as a result of adopting SFAS No. 109 \"Accounting for Income Taxes\", and ($2,745) for the write-down of assets, other adjustments and reclassifications. (5) Includes ($6,786) adjustment to purchase accounting estimate, ($3,036) for the utilization of a pre-acquisition net operating loss carryforward and $106 for foreign currency translation adjustments.\nSCHEDULE VI\nFEDERAL PAPER BOARD COMPANY, INC. ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (IN THOUSANDS)\n(1) Includes ($761) for foreign currency translation adjustments and $183 for the write-down of assets and other adjustments.\n(2) Includes ($3,159) for foreign currency translation adjustments and ($2,365) for the write-down of assets and other adjustments.\nSCHEDULE VIII\nFEDERAL PAPER BOARD COMPANY, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n(1) Includes recoveries on accounts previously written-off, purchase accounting adjustments, reclassifications and foreign currency translation adjustments.\n(2) Represents accounts written-off.\nSCHEDULE IX\nFEDERAL PAPER BOARD COMPANY, INC. SHORT-TERM BORROWINGS (IN THOUSANDS)\n(1) Includes amounts which may be classified as long-term debt.\n(2) The weighted average interest rate at the end of the year was computed by dividing annualized interest expense in each year by the balance outstanding at the fiscal year-end.\n(3) The average amount outstanding during the year is based on period end balances.\n(4) The weighted average interest rate during the year was computed by dividing actual interest expense in each year by average short-term borrowings in such year.\nSCHEDULE X\nFEDERAL PAPER BOARD COMPANY, INC. SUPPLEMENTARY INCOME STATEMENT INFORMATION (IN THOUSANDS)\nFor the Fiscal Years Ended January 1, 1994, January 2, 1993 and - --------------------------------------------------------------- December 28, 1991 - -----------------\nRoyalties, advertising costs and amortization of intangible assets do not exceed one percent of total sales.\nFor the purposes of complying with amendments to the rules governing Form S-8 under the Securities Act of 1933, the undersigned Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into Registrant's Registration Statements on Form S-8 Nos. 33-64258 and 33-64256 (filed June 11, 1993), 2-56623 (filed June 23, 1983), 33-34440 (filed April 17, 1990) and 33-48654 (filed June 22, 1992).\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, or in their behalf by their duly appointed attorney-in-fact, on behalf of the Company in the capacities and on the date indicated.\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFEDERAL PAPER BOARD COMPANY, INC.\nMarch 25, 1994 By \/s\/ QUENTIN J. KENNEDY ----------------------- Quentin J. Kennedy Director, Executive Vice President and Secretary\nFederal Paper Board Company, Inc. Exhibit Index\nFederal Paper Board Company, Inc. Exhibit Index (Continued)","section_15":""}
{"filename":"808369_1993.txt","cik":"808369","year":"1993","section_1":"ITEM 1. BUSINESS\nGeneral. The registrant, ML\/EQ Real Estate Portfolio, L.P. (the \"Partnership\"), is a limited partnership formed on December 2, 1986 under the Revised Uniform Limited Partnership Act of the State of Delaware.\nThe Partnership's two general partners are EREIM Managers Corp., a Delaware corporation (the \"Managing General Partner\"), and MLH Real Estate Associates Limited Partnership, a Delaware limited partnership (the \"Associate General Partner\" and, together with the Managing General Partner the \"General Partners\"). The Managing General Partner is an indirect, wholly-owned subsidiary of The Equitable Life Assurance Society of the United States (\"Equitable\") and the general partner of the Associate General Partner is an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. (\"Merrill Lynch\").\nThe Partnership offered to the public $150,000,000 of Beneficial Assignee Certificates (the \"BACs\"), which evidence the economic rights attributable to limited partnership interests in the Partnership (the \"Interests\"), in an offering which commenced in 1987. The offering was made pursuant to a Prospectus dated April 23, 1987, as supplemented by Supplements dated December 29, 1987 (the \"December Supplement\"), March 3, 1988 (the \"March 3 Supplement\") and March 17, 1988 (the \"March 17 Supplement\"), filed with the Securities and Exchange Commission (the \"SEC\") in connection with a Registration Statement on Form S-11 (No. 33-11064). The Prospectus as supplemented is hereinafter referred to as the \"Prospectus.\" Capitalized terms used in this annual report and that are not defined herein have the same meaning as in the Prospectus. The offering terminated on March 29, 1988. On March 10, 1988, the Partnership's initial investor closing occurred at which time the Partnership received $92,190,120, representing the proceeds from the sale of 4,609,506 BACs. On May 3, 1988, the Partnership's final investor closing occurred at which time the Partnership received $16,294,380, representing the proceeds from the sale of an additional 814,719 BACs. In total, the Partnership realized gross proceeds of $108,484,500 from the public offering, representing the sale of 5,424,225 BACs.\nBusiness of the Partnership. The Partnership was formed to invest in a diversified portfolio of properties and mortgage loans and considers its business to represent one industry segment, investment in real property. The Partnership does not segregate revenues by geographic region and such a presentation is not required as it would not be material to an understanding of the Partnership's business taken as a whole. The Partnership has no employees.\nAs expected, following its investor closings, the Partnership contributed the net proceeds of its offering to EML Associates (the \"Venture\"), a joint venture with EREIM LP Associates, a New York general partnership between Equitable and EREIM LP Corp., a wholly-owned subsidiary of Equitable. The Venture was formed in March 1988. The capital of the Venture was provided approximately 80% by the Partnership and approximately 20% by EREIM LP Associates.\nThe Venture has completed its acquisition of a diversified portfolio of real properties and mortgage loans secured by real properties. Based on acquisition prices, approximately 52% of the Venture's original contributed capital was invested in existing income-producing real\nproperties acquired without permanent mortgage indebtedness (the \"Properties\"), approximately 25% in zero coupon or similar mortgage notes (the \"Zero Notes\"), and the balance was invested in fixed-rate first mortgage loans (the Zero Notes and the fixed rate first mortgage loans are hereinafter referred to as the \"Mortgage Loans\"). The Properties and the properties securing Mortgage Loans include commercial, industrial, residential and warehouse\/distribution properties.\nAt December 31, 1993, the Venture owned nine Properties (one of which consists of two adjacent office buildings) purchased at an aggregate cost of approximately $68.1 million. In addition, the Venture owned interests in two Zero Notes representing principal and accrued interest on the dates of acquisition of approximately $33.1 million, and had two remaining fixed-rate first mortgage loans in the aggregate principal amount of $15.5 million. The Partnership accepted an early $10.5 million pay-off in November 1993 of a third fixed-rate first mortgage loan which had an original principal amount of $14 million and which would have matured in 1998. (Amounts identified, in each case, are exclusive of closing costs.) Reference is made to ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nSet forth below is a brief description of each of the Venture's investments at December 31, 1993 which includes, where applicable, the percentage of space covered by leases which are scheduled to expire in 1994, 1995, and 1996. Reference is made to Notes 3-5 and 9 of the Notes to Consolidated Financial Statements in ITEM 8. FINANCIAL STATEMENTS, the relevant provisions of which are incorporated herein by reference, for additional descriptive information concerning the investments.\nPROPERTIES\nPROPERTIES (CONTINUED)\nANNUAL AGGREGATE LEASE PAYMENTS (IN DOLLARS)*\n* Lease payments to be received under noncancelable operating leases in effect as of December 31, 1993.\nRANGE OF LEASE EXPIRATIONS\nMAJOR TENANTS\nThe following lists major tenants for certain properties together with percentage of space used:\nAll of the remaining properties are leased in their entirety to their respective tenants. Information concerning tenants occupying Properties not otherwise listed above follows.\nProperties\n1200 Whipple Road is a one-story warehouse\/distribution property located in the Hayward-Fremont market area, approximately 25 miles southeast of San Francisco. At December 31, 1993, the property was 100% leased to Permer Control, Inc. under a lease which runs through August 2003. The property is used as a distribution center for the Emporium Capwell and Weinstocks divisions of Carter Hawley Hale Stores, Inc. (\"CHH\") and is described in the March 17 Supplement, which is included as an exhibit to this annual report and is incorporated herein by reference. As noted in that description, the Permer Control lease is assignable to CHH or a subsidiary thereof at any time during the lease, in which event Permer Control is released from liability. On February 11, 1991, CHH filed for protection from creditors under Chapter 11 of the Federal bankruptcy law. CHH's plan of reorganization was approved by the bankruptcy court on September 14, 1992 and became effective on October 8, 1992. As part of the plan, Zell\/Chillmark purchased approximately 85% of CHH's indebtedness which was subsequently exchanged for approximately 75% of CHH's equity. All payments due under the lease to date have been made.\nRichland Mall is a one-level enclosed mall shopping center located in Richland Township, Pennsylvania. Tenants include Hess Department Store, Clemens Market, Footlocker, Kinney Shoes and Radio Shack. At December 31, 1993, the mall was approximately 97.4% leased with approximately 4,700 square feet vacant as of December 31, 1993. Excluding the two anchor stores, the Mall was 92.6% leased. Leases covering approximately 3.2%, 0.5%, and 22.5% of the space are scheduled to expire in 1994, 1995, and 1996, respectively. Richland Mall is described in the Partnership's Current Report on Form 8-K dated July 19, 1988 (the \"July Report\"), which is included as an exhibit to this annual report and is incorporated herein by reference. Over the past three years, the general economic recession has severely hampered the property's leasing efforts. During this period Richland Mall suffered from lease expirations as well as cancellations by virtue of tenant bankruptcies. During 1993 the property began to show signs of recovery. Potential retail tenants began to show interest in leasing space again which enabled Management to improve store occupancy. Management continues to aggressively pursue tenants for the\nremaining vacant space. Wal-Mart Stores, a national discount retailer, has announced that it is planning to locate a new store within 2-1\/2 miles of Richland Mall; however, zoning for the proposed shopping center which was to include Wal-Mart was rejected by Richland Township in June 1992. The Partnership cannot predict the extent to which the Wal-Mart project, if completed, would affect Richland Mall. Should Wal-Mart enter the local market, its size and advertising strength will undoubtedly affect the business of the Hess Department Store and other specialty retail stores within Richland Mall. In addition, the Partnership has been advised that as a result of the downturn in retailing generally, and same store sales, specifically, the Hess Department Store chain suffered reduced earnings requiring it to obtain working capital revolver loans from a consortium of lenders (including Equitable) in the first quarter of 1992. These loans were repaid in late 1993. The loans provided Hess with the time needed to restructure and reorganize its operations, which includes selling or closing of stores in certain locations. Although the Managing General Partner has been advised that the Hess Department Store at the Richland Mall is performing positively, there can be no assurance that such store will not be sold or closed prior to the termination of its lease (which is scheduled to expire in 2006). The current competitive leasing environment and weak retail economy create significant obstacles to maintaining the past level of performance of this Property.\n16\/18 Sentry Park West are two four-story office buildings that together contain approximately 190,616 rentable square feet. Tenants include Martin Marietta (formerly General Electric), The Prudential Insurance Company and Liberty Mutual Insurance Company. Martin Marietta acquired General Electric's defense related operations in the first quarter 1993. At December 31, 1993, the property was approximately 60% leased. Leases covering approximately 18.7%, 9.2%, and 7.4% of the space are scheduled to expire in 1994, 1995, and 1996, respectively. Martin Marietta decided not to renew 70,836 square feet of space under a lease which expired in December 1993. In addition to the reduction of rental revenue until a new tenant is secured, reletting of this space will likely require the Venture to incur expenditures for tenant improvements and leasing commissions in its releasing efforts. The Venture has been building reserves for such a contingency. The 16\/18 Sentry Park West Property is described in the Partnership's Current Report on Form 8-K dated December 2, 1988, which is included as an exhibit to this annual report and is incorporated herein by reference.\n701 Maple Lane, 733 Maple Lane and 7550 Plaza Court are three one-story office\/warehouse buildings located in the Chicago metropolitan area. At December 31, 1993, all of the buildings were 100% leased. Tenants include Triangle Engineered Products, Co., Nema Industries, Inc. and Precise Data Service. One lease comprising 18% of available space is scheduled to expire in 1994. These properties are described in the Partnership's Current Report on Form 8-K dated December 27, 1988 (the \"December Report\"), which is included as an exhibit to this annual report and is incorporated herein by reference.\n1850 Westfork Drive is a one-story warehouse\/distribution facility located approximately 15 miles west of the Atlanta central business district. At December 31, 1993 the Property was 100% leased to Treadway Exports Limited. Prior to this, the property was 100% leased to Saab-Scania of America, Inc. (\"Saab\"), however, as part of an effort to consolidate its parts distribution facilities, Saab vacated the property in January 1991. In late February, 1992, the Venture and Saab entered into an agreement, pursuant to which Saab agreed to pay to the Venture $1,100,000 in return for release from the remaining term of its lease. The Partnership's share of this amount constituted Sale or Financing Proceeds (as defined in the Partnership Agreement) and was distributed to BAC Holders and Limited Partners\ntogether with the semi-annual distribution on August 31, 1992. The lease with Treadway commenced on September 1, 1992 and is for an initial term of three years with two renewal options for total of an additional three years. The 1850 Westfork Drive Property is described in the December Report, which is included as an exhibit to this annual report and is incorporated herein by reference.\n1345 Doolittle Drive is a one-story warehouse\/distribution property located in San Leandro, California approximately one mile south of Oakland International Airport. At December 31, 1993 the property was 93.1% leased to Gruner & Jahr Printing and Publishing, Stericycle, Inc., National Distribution Agency and Jay-N Company. The Venture continues to actively market the remaining vacant space which consists of 22,500 square feet. The Gruner & Jahr lease covering approximately 44% of the rentable square feet was renewed in 1992 for a five year term commencing in August, 1993. The 1345 Doolittle Drive Property is described in the Partnership's Current Report on Form 8-K dated May 18, 1989, which is included as an exhibit to the annual report and is incorporated herein by reference.\n800 Hollywood Avenue is a one-story warehouse\/office building located in Itasca, Illinois. The building contains 2,500 rentable square feet of office space and 47,837 rentable square feet of warehouse space. The property is 100% leased to Concentric, Inc. through May 31, 1997 at a rate of $3.90 per square foot through May 31, 1994, to $4.00 per square foot for the remainder of the term. This reflects a renewal of the previous lease which otherwise would have expired in January 1994 at a rate of $4.09 per square foot. The lease requires the tenant to pay 100% of real estate taxes, insurance, and certain maintenance costs. The property is used for the production and distribution of automotive parts and the manufacture, sale and distribution of extruded plastics and cast-iron parts.\nMORTGAGE LOANS\nMORTGAGE LOANS (CONTINUED)\n____________________\n* Effective implicit rate, compounded semiannually. These notes are zero coupon notes and provide that borrowers may elect to pay interest currently. However, as expected, all interest payments have been deferred and it is expected that interest payments will continue to be deferred until maturity, subject to the transaction described below.\nMortgage Loans\nNorthland and Brookdale Zero Notes are first mortgage notes secured by the Northland and Brookdale Centers, two regional shopping malls located outside Detroit, Michigan and Minneapolis, Minnesota, respectively. The Venture owns a 71.66% interest in each of the Zero Notes under the terms of participation agreements with Equitable. A portion of the interest acquired by the Venture in each of the Notes was contributed by EREIM LP Associates in exchange for its interest in the Venture, and the balance was purchased by the Venture from Equitable. The borrower under the Zero Notes is Equitable Real Estate Shopping Centers, L.P. (\"ERESC\"), a public limited partnership not affiliated with Equitable. The parent company of the Managing General Partner, Equitable Real Estate Investment Management, Inc, (\"EREIM\"), serves as an asset manager. The terms of the Zero Notes permit the borrower to defer payment of principal and interest on the Zero Notes until June 30, 1995, and all such payments have been deferred to date. The Zero Notes may each be redeemed at any time at a redemption price of 100% of its accreted amount at maturity. Since the value of the assets securing the Northland Zero Note did not support its carrying value, the Venture has not accrued additional interest on the Northland Zero Note on its books since June 30, 1993. As of December 31, 1993, the Venture recognized a loss of $7,628,000 and reduced the value of the asset on its books from $35,145,363 to $27,517,363 to reflect its carrying value. For additional information concerning the Northland and Brookdale Notes and the Northland and Brookdale Centers, reference is made to the information under \"REAL PROPERTY INVESTMENTS -- The Zero Notes\" and \"REAL PROPERTY INVESTMENTS --Brookdale and Northland Zero Notes\" in the Prospectus, \"REAL PROPERTY INVESTMENTS -- The Zero Notes\" in the March 17 Supplement, and Note 1 to Notes to Financial Statements to the Partnership's Current Report on Form 10-Q for the Quarter ended June 30, 1988, all of which information is included as an exhibit to this annual report and incorporated herein by reference.\nERESC is subject to the informational requirements under the Securities Exchange Act of 1934, as amended, and in accordance therewith files reports and other information, including financial statements, with the Securities Exchange Commission under Commission File No. 1-9331. Such reports and other information filed by ERESC can be inspected and copied at the public reference facilities maintained by the SEC in Washington, D.C. and at certain of its Regional Offices, and copies may be obtained from the Public Reference Section of the SEC, Washington, D.C. 20549, at prescribed rates.\nBrookdale Center is located approximately five miles northwest of the central business district of Minneapolis. At December 31, 1993, Brookdale Center was 83% leased\n(excluding its anchor stores all of which are in operation). Although one of the anchors, the Carson Pirie and Scott chain, has recently entered bankruptcy, it continues to operate its store in the Brookdale Center and is, to date, fulfilling its lease obligations.\nNorthland Center is a regional shopping mall located approximately 11 miles northwest of the central business district of Detroit. At December 31, 1993, Northland Center was approximately 71% leased (excluding its anchor stores all of which are in operation). One of the anchor stores, Hudson, has notified ERESC that it intends to discontinue operations at the Northland Center. Discussions are underway with Hudson to continue its tenancy. Managment believes that significant capital improvements to the Northland Center are needed to maintain the value and marketability of the Property. ERESC has declined to incur such expenses. On March 25, 1994 Equitable entered into an agreement with ERESC (the \"ERESC Agreement\") in connection with the Zero Notes, which agreement reflected a letter of intent between the parties dated January 19, 1994. The ERESC Agreement provides Equitable and the Venture, in proportion to their respective interests in the Zero Notes, would (a) accept a deed-in-lieu of foreclosure of the Northland Center effective as of January 1, 1994, (b) pay the owner $6.6 million, which amount is the present value of the anticipated cash flow of the Northland Center for the period from January 1, 1994 through June 30, 1995, the maturity date of the Zero Notes and (c) upon the sale of the Brookdale Center, to an unaffiliated third party, permit the owner to prepay the Zero Note secured by the Brookdale Center at the then accreted amount of such Note, plus a defeasance fee equal to 75% of the sale price in excess of $45,000,000 up to the amount of the defeasance fee provided in the Brookdale Note.\nThe consummation of the transactions is subject to certain conditions, including the following: (a) Hudson agreeing to continue to operate as an anchor at the Northland Center on terms acceptable to the Venture and Equitable, (b) Montgomery Ward entering into agreements to operate as an additional anchor at the Northland Center on terms acceptable to the Venture and Equitable, (c) the Venture's agreement to participate in the transaction, and (d) receipt of approval of ERESC's limited partners to the proposed transaction. Under the terms of the ERESC Agreement, EREIM was terminated as asset manager of the Northland Center and Brookdale Center and EREIM released its right of first offer to purchase the Brookdale Center.\nManagement is currently considering this transaction to determine if it is in the best interest of the Partnership. In connection with its determination the Managing General Partner retained Arthur Andersen & Co. S.C. to analyze the proposed transaction to determine whether it is fair from a financial point of view to the Partnership and the BAC Holders. Such analysis considered the effect of the proposed transaction both with and without the benefit of the Guaranty Agreement. Based upon certain assumptions contained in its report, Arthur Andersen & Co. S.C. has rendered an opinion that such transaction is fair from a financial point of view to the Partnership and to its BAC Holders. Since the consummation of the transaction is dependent upon numerous conditions, most of which are beyond the control of the Partnership, there can be no assurance that this transaction as presently described will be consummated, nor that such transaction, if consummated, will be consummated on the terms described herein.\n201 Merritt Seven Loan is a first mortgage loan made jointly by the Venture and Equitable and is secured by an eight-story office building in Norwalk, Connecticut. On November 22, 1993, the Venture received cash of $10.5 million reflecting the Venture's 50% share of a $21 million pay-off on the note. The Venture had a 50% participation interest in a loan made by Equitable to the Second Merritt Seven Joint Venture (borrower). The borrower had approached Equitable and the Venture to renegotiate the terms of the nonrecourse 10-1\/4%\ninterest-only loan which bore a maturity date in 1998. In November 1993, it was agreed that borrower would have a six-month option to purchase the loan at an amount not less than the fair market value of the property securing such mortgage loan, as determined by an independent appraisal, but in no event less than $21 million. Adequate reserves had been established by the Partnership during the first and third quarters of 1993 to reflect the diminution of value of the underlying security for such mortgage loan. In receiving $8.4 million, its 80% share of the $10.5 million payment, the Partnership realized the carrying value of the mortgage loan on its books. The Partnership's share of the amount represents Sale or Financing Proceeds (as defined in the Partnership Agreement). To the extent those proceeds were not used to augment reserves with regard to the proposed Northland transaction, a $0.10 per unit distribution characterized as Sale or Financing Proceeds was paid in February 1994 to BAC Holders of record as of December 31, 1993. Management believes that accepting the pay-off was in the best interest of the Partnership, given the prospects for the property in a difficult leasing environment. The 201 Merritt Seven Loan and the property which secures it are described in the Partnership's Current Report on Form 8-K dated September 27, 1988, which is included as an exhibit to this annual report and incorporated herein by reference.\nJericho Village Loan is a first mortgage loan secured by an apartment complex in Weston, Massachusetts. Interest-only payments on the loan in the amount of $51,250 are due monthly in arrears during the term of the loan, with the full principal amount of the loan due upon expiration of the term of the loan. The loan may not be prepaid for three years. After the third year, the borrower may prepay the loan in full subject to a prepayment penalty based on a yield maintenance formula, but not less than 2% of the principal balance of the loan. The property which secures the loan consists of 22 free-standing one and two-story apartment buildings, containing a total of 99 apartment units. At December 31, 1993 the property was approximately 98% leased. The Jericho Village Loan and the property which secures it are described in the December Report, which is included as an exhibit to this annual report and incorporated herein by reference.\nBank of Delaware Building Loan is a first mortgage loan secured by a 17-story office building in the Wilmington central business district. Interest-only payments on the loan in the amount of $82,135 are due monthly in arrears during the term of the loan, with the full principal amount of the loan due upon expiration of the term of the loan. The loan may not be prepaid for five years. After the fifth year, the borrower may prepay the loan in full subject to a prepayment penalty based on a yield maintenance formula, but not less that 1\/2% of the principal balance of the loan. The property which secures the loan contains approximately 314,000 rentable square feet. At December 31, 1993 such property was approximately 67.7% leased. The borrower approached the Venture in November, 1992 regarding the potential restructure of this loan. The borrower referred to significant lease rollover exposure in late 1993 and the resultant capital expenditures potentially necessary to renew or release this space. The lease with DuPont, a major tenant in the building, leasing approximately 27% of the property, expired in December, 1993. The borrower stated in its third quarter 1993 report to its investors that it has been notified that DuPont will not renew any of its space. The report continued to state:\n\"...the Partnership estimates that the costs associated with re-leasing any space which becomes available during the next few years including those costs to remove the remaining asbestos in tenant space, will be substantial. In this regard, the Partnership is carefully analyzing whether or not it is economically wise to allocate additional capital to this building based upon the likelihood of ultimately recovering any additional amounts required to\ncover these re-leasing costs, asbestos removal costs and other capital improvements which may be required. If it is determined that recovery of such additional amounts is unlikely, the Partnership may decide not to commit any additional amounts to the property beyond those costs which may be required in the future to remove asbestos in the building, which represent a recourse obligation to the Partnership. This would result in the Partnership no longer having an ownership interest in the property.. \"\nNo specific terms of a restructure have been discussed with the borrower, nor is it certain that a restructure will occur. Management continues to monitor this situation, especially considering the statement of the borrower that it may not fund expenditures necessary to maintain the building's occupancy. It is Management's belief that the property remains adequate security for the mortgage. Discussions with the borrower are continuing; however, Management is willing to consider foreclosure on this property if it is in the Venture's best interest to do so. In February 1994, the owner of the Bank of Delaware Building defaulted on the Mortgage Loan. At this time Management does not believe that foreclosure, if required, would result in a material loss. The Bank of Delaware Building Loan and the property which secures it are described in the December Report, which is included as an exhibit to this annual report and incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no pending legal proceedings material to the Partnership to which the Partnership, the Venture, any of the Properties, or to the knowledge of the Managing General Partner, the properties that secure the Mortgage Loans are subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted during the fourth quarter of the fiscal year to a vote of BAC Holders.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCK HOLDER MATTERS.\nNo public trading market for BACs or Interests exists nor is it expected that one will develop. Accordingly, accurate information as to the market value of a BAC at any given date is not available. Effective November 9, 1992, the Partnership was advised that Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\") introduced a new limited partnership secondary service through the Merrill Lynch Limited Partnership Secondary Transaction Department (\"LPSTD\"). This service assists MLPF&S clients wishing to buy or sell Partnership BACs or interests. The LPSTD has replaced the Merrill Lynch Investor Service, a service which was designed to match interested buyers and sellers of partnership interests, but which had been suspended since September 1991 for transactions involving the Partnership's BACs or Interests.\nBACs are transferable as provided in Article Seven of the Partnership's Amended and Restated Agreement of Limited Partnership, as amended (the \"Partnership Agreement\"), which is incorporated by reference herein. Subject to certain restrictions, the General Partners are authorized to impose restrictions on the transfer of BACs or Interests (or take such other action as they deem necessary or appropriate) so that the Partnership is not treated as a \"publicly-traded partnership\" as defined in Section 7704(b) of the Internal Revenue Code of 1986 (or any similar provision of succeeding law) which could result in adverse tax consequences. See \"AMENDMENTS TO PARTNERSHIP AGREEMENT - -- TRANSFER OF INTERESTS\" in the March 3 Supplement.\nThe number of BAC Holders at December 31, 1993 was 12,659.\nThe Partnership is a limited partnership and, accordingly, does not pay dividends. It does, however, make distributions of cash to its BAC Holders and General Partners. BAC Holders will be entitled to receive cash distributions, allocations of taxable income and tax loss and guaranty proceeds as provided in Article Four of the Partnership Agreement, which is included as an exhibit to this annual report and incorporated herein by reference. For additional information regarding the Guaranty Agreement, see ITEM 1. BUSINESS. The Partnership has on February 28, 1993, made cash distributions to BAC Holders in the amount of $0.40 per BAC in respect of the fiscal semi-annual period ended December 31, 1992. The Partnership withheld its semi-annual distribution in August 1993 in anticipation of the capital needs of the Partnership. The Partnership made a cash distribution to BAC Holders on February 28, 1994, in the amount of $0.10 per BAC to Holders of record at December 31, 1993. The Partnership reduced the February 1994 distribution to supplement reserves. This distribution constitutes a distribution of Sale or Financing Proceeds derived from a portion of the proceeds from the pay-off of the Second Merritt Seven mortgage loan. Reference is made to ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for further information regarding cash distributions, which information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following sets forth a summary of the selected financial data for the Partnership for the years ended December 31, 1989, 1990, 1991, 1992 and 1993:\nThe above selected financial data for the years 1991 through 1993 should be read in conjunction with the financial statements and the related notes appearing elsewhere in this annual report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLiquidity and Capital Resources\nAt December 31, 1993, the Partnership had cash and short-term investments of approximately $3.0 million. Such cash and short-term investments are expected to be utilized for general working capital requirements including, to the extent that scheduled lease expirations occur, shortfalls associated with such lease expirations on the Properties until such time as such leases can be replaced, and for participation with Equitable in the proposed Northland Center transaction. In addition, to the extent that cash distributions from the Partnership's interest in the Venture are insufficient, the payment or reimbursement of fees and expenses to the General Partners and their affiliates will be paid out of such cash and short term investments. Amounts which the Managing General Partner determines are not needed for general working capital requirements will be available for distribution. The Partnership's policy is to maintain adequate cash reserves (taking into consideration reserves of the Venture) to enable it to meet short and long-term requirements. The Partnership's working capital reserves may be increased or decreased, from time to time, depending on the Managing General Partner's determination as to their adequacy. However, working capital reserves may not be decreased below 1% of gross offering proceeds prior to the time that the Partnership enters its liquidation phase.\nIn addition, the Partnership owns an 80% interest in the Venture. At December 31, 1993, the Venture's portfolio was fully invested and included interests in nine real properties and four first mortgage loans on real properties (including the two Zero Notes) representing an aggregate acquisition cost of approximately $116.7 million (exclusive of closing costs). At December 31, 1993, the Venture also had approximately $18.8 million in cash and short-term investments which is intended to be utilized primarily to create reserves to consummate the proposed Northland Center transaction and thereafter to fund capital improvements at the Northland Center, fund capital improvements at the Venture's other Properties and cover general working capital requirements. Remaining funds are available for distribution to Venture partners. All of the Venture's properties were acquired without mortgage indebtedness, and neither the Venture nor the Partnership has incurred any borrowings. All of the Venture's Properties as well as its Mortgage Loans (other than the Zero Notes) are currently producing cash flow to the Venture which, net of expenses of the Venture and the establishment or increase of reserves, is being distributed 80% to the Partnership and 20% to EREIM LP Associates. The Venture's Brookdale Zero Note does not provide current cash flow to the Venture but is accruing interest at an implicit rate of 10.2% per annum. Since the value of the assets securing the Northland Zero Note did not support the carrying value of the such note, the Venture has not accrued additional interest on the Northland Zero Note on its books since June 30, 1993. Under the terms of the Zero Notes, principal and interest in the aggregate amount of $68,227,857 is due in June 1995. If the Northland transaction is consummated, Equitable and the Venture will acquire the property securing the Loan and the Venture's $42,882,504 share will not be received in June 1995. Proceeds are expected to be received at a later date upon the disposition of the Property.\nAlthough it was contemplated and disclosed at the time of the Partnership's offering of BACs that all of the Partnership's cash flow for 1990 would be utilized to pay various deferred fees and expenses, cash flow exceeded the amount necessary to fully pay such fees and expenses,\nenabling the Partnership to make its first distribution of Distributable Cash to BAC Holders in the first quarter of 1991. For 1992 and 1993, the Partnership's distributions received from the Venture totaled $7,176,400, and $3,040,000 respectively.\nCash received from tenant-related revenues decreased approximately $1.0 million in comparison to the same period last year. This decrease is due to the $1.1 million payment received pursuant to an agreement between Saab and the Venture regarding the termination of its lease. The Partnership's share of the proceeds were distributed to the BAC Holders and limited partners as Sale or Financing Proceeds as defined in the Partnership Agreement.\nDistributable Cash from operations will be distributed in accordance with the terms of the Partnership Agreement which in general provide that such amounts will be distributed 95% to the BAC Holders and Limited Partners and 5% to the General Partners with the BAC Holders and limited partners entitled to a non-cumulative preferred 6% simple return on their adjusted capital contribution during each period. The first semi-annual distribution of Distributable Cash reflecting the portion of the Partnership's cash flow that was available for distribution after payment of the fees and expenses referred to above and other Partnership obligations for the period ended December 31, 1990, was also made on February 28, 1991, at the rate of $0.25 per BAC. A semi-annual distribution of Distributable Cash, for the period ended June 30, 1991, was also made on August 30, 1991, at the rate of $0.50 per BAC and another semi-annual distribution of Distributable Cash, for the period ended December 31, 1991 was made on February 28, 1992 at the rate of $0.50 per BAC. In addition, a semi-annual distribution of Distributable Cash, for the period ended June 30, 1992, was made on August 31, 1992, at the rate of $0.50 per BAC, and another semi-annual distribution of Distributable Cash for the period ended December 31, 1992 was made on February 28, 1993 at the rate of $0.40 per BAC. The Partnership withheld the distribution for the semi-annual period that would have been made in August 1993. The determination to withhold such distributions at that time was based upon the then anticipated needs of the Venture to fund capital improvements to the Northland Center in order to preserve the Venture's equity in the Northland Zero Note in addition to other working capital needs of the Venture. The levels of future cash distributions principally will be dependent on the distributions to the Partnership by the Venture, which in turn will be dependent on returns from the Venture's investments and future reserve requirements.\nIt is anticipated that the Partnership will not make distributions of Distributable Cash from operations in 1994 which will equal or exceed the amount distributed in 1993, and such distributions will probably be less. Amounts distributed to BAC Holders fluctuate from time to time based on changes in occupancy, rental and expense rates at the Venture's Properties and other factors. The Partnership has increased its working capital reserves, and reduced distributions of Distributable Cash in connection with its efforts to relet vacant space at certain of its Properties, most significantly at Sentry Park West and the property secured by the Bank of Delaware Mortgage Loan, and future distributions are expected to be reduced by amounts to be contributed by the Partnership in connection with the consummation of the proposed Northland transaction and the renovation of the Northland Center. The Partnership would be required to contribute $3.8 million upon the consummation of the proposed Northland transaction and thereafter contribute approximately $6.7 million towards the renovation of the Northland Center. There can be no assurance that distributions of Distributable Cash from operations will be made at any particular level or at all. As a result of the increase in reserves and the continued accretion of interest on the Brookdale Zero Note, the tax liability of the BAC Holders arising from taxable\nincome allocated to a BAC Holder may substantially exceed the amounts, if any, distributed to such BAC Holder.\nAs discussed, the Partnership's share of Sale or Financing Proceeds in the amount of $0.162 per BAC associated with the termination of the lease with Saab at 1850 Westfork Drive was distributed to BAC Holders and Limited Partners on August 31, 1992. In addition, the Partnership's share of Sale or Financing Proceeds, to the extent the funds were not allocated to increase reserves, in the amount of $0.10 per BAC associated with the pay-off of the 201 Merritt Seven Loan was distributed to BAC Holders and Limited Partners on February, 28, 1994. The amount and timing of distributions from Sale or Financing Proceeds depend upon payments of the Mortgage Loans and maturity schedules, the timing of disposition of Properties as well as the need to allocate such funds to increase reserves.\nAt December 31, 1993, approximately 91.8% of the aggregate rentable square feet of the Venture's Properties was leased. Leases covering approximately 5.2%, 13.8%, and 10.6% of the Properties rentable square feet are scheduled to expire in 1994, 1995, and 1996, respectively. The Properties and the properties that secure the Mortgage Loans will compete for, among other things, desirable tenants with other properties in the areas in which they are located which may include properties owned or managed directly or indirectly by Equitable or its subsidiaries and affiliates. Currently, many areas of the country including some in which one or more of the Properties or properties that secure Mortgage Loans are located are experiencing relatively high vacancy rates and competition which may adversely impact the ability of the Venture and the owners of the properties that secure the Mortgage Loans to retain or attract tenants as leases expire or may adversely affect the level of rents which may be obtained (or increase the levels of concessions that may have to be granted). Some of the tenants have recently experienced serious financial difficulties. See Item 2. PROPERTIES - 1200 Whipple Road and Richland Mall.\nManagement believes that the value of the Venture's equity in the Northland Zero Note, and the value of the underlying asset, is likely to decline if the Northland Center is not upgraded. ERESC has declined to undertake such steps. This led to negotiations between ERESC and Equitable resulting in the ERESC Agreement described under ITEM 2. PROPERTIES - Mortgage Loans. As discussed above, Management is considering whether the proposed Northland transaction is in the best interests of the Partnership. If Hudson agrees to continue to occupy its anchor space and Montgomery Ward agrees to become the fourth anchor, and the renovations are completed as contemplated, Management believes the market value of the Northland Center, and the Venture's interest therein, would be increased from its current value. The expected increase in value of the Northland Center as upgraded over its current market value may be less than the amount that is expected to be contributed towards renovations. Management believes, however, that the increase in the future value of the Northland Center if none of the upgrading actions are undertaken is expected to be significantly greater than the amounts contributed toward the renovations. Management believes that the expected increase in value of Northland Center would be of benefit to the BAC Holders. It would also have the effect of reducing the liability of EREIM LP Associates under the Guarantee Agreement.\nThe Partnership is intended to be self-liquidating in nature, meaning that proceeds from the sale of properties or principal repayments of loans will not be reinvested but instead will be distributed to BAC Holders and partners, subject to certain limitations. Under the terms of the Guaranty Agreement which has been assigned to the Partnership, following the earlier of the sale\nor other disposition of all of the Properties and Mortgage Loans or the liquidation of the Partnership, EREIM LP Associates has guaranteed to pay an amount which, when added to all distributions from the Partnership to the BAC Holders, will enable the Partnership to provide the BAC Holders with the Minimum Return equal to their Capital Contributions plus a simple annual return equal to 9.75% multiplied by their adjusted capital contributions from time to time calculated from the investor closing at which an investor acquired his BACs, subject to certain limitations.\nThe distribution declared as of December 31, 1993, paid on February 28, 1994, was $542,448 ($0.10 per BAC). This brings the total distributions to BAC Holders and limited partners to $13,083,776. The cumulative minimum return (computed at 9.75% simple return per annum on the limited partners' adjusted capital contributions) less the distributions to date total that portion of guarantee liability payable to date. As of December 31, 1993, the cumulative minimum return resulting from the Guarantee Agreement is $61,129,209. Assuming that the last Property is sold on December 31, 2002, upon the expiration of the Partnership, EREIM LP Associate's maximum liability under the Guarantee Agreement as of December 31, 1993, is $251,496,465.\nFinancial Condition\nThe Partnership's financial statements include the consolidated statements of the Partnership and the Venture, through which the Partnership conducts its business of investment in real property. Although the Partnership was formed in 1986, it did not commence operations until March, 1988, following receipt of the first proceeds of its offering of BACs. Thereafter, utilizing the net proceeds of the Partnership's offering of BACs, the Partnership, through the Venture, began its acquisition of real estate investments. The Partnership substantially completed its acquisition phase in 1989.\nTotal real estate investments decreased in 1993 as compared to 1992 primarily as a result of the pay-off of the 201 Merritt Seven Loan, the $7,628,000 loss recognized on the Northland Zero Note and depreciation. Such decrease is offset somewhat by the increase in the balance of the Zero Notes due to the accretion of interest thereon. Other assets (primarily cash and short-term investments) increased in 1993 as compared to 1992 due to the receipt of the pay-off of the 201 Merritt Seven Loan and Management's decision to withhold the semi-annual distribution that would have been made in August 1993. Total liabilities decreased in 1993 as compared to 1992 primarily due to a reduction in the distributions declared to the limited partners. The Partnership had a net loss of $1,533,890 for the year ended December 31, 1993 as compared to net income of $9,517,222 for the year ended December 31, 1992. The net loss is attributable to the realized loss on the 201 Merritt Seven Loan and the write-down on the Northland Zero Note.\nInflation has been at relatively low levels during the periods presented in the financial statements and, as a result, has not had a significant effect on the operations of the Partnership, the Venture or their investments. Although the spread is small, inflation is continuing to exceed the rise in market rental rates at many of the Venture's properties. In fact, at several of the Venture's properties, market rental rates are decreasing. If this trend continues, the increase in real estate operating expenses may exceed increases in rental income.\nResults of Operations\nRental income for 1993 decreased approximately $1.1 million as compared to 1992. As stated above, this change is primarily a result of the receipt of $1.1 million pursuant to an agreement between Saab and the Venture regarding the termination of its lease. Operating expenses increased from 1992 to 1993 primarily due to the loss realized on the pay-off of the 201 Merritt Seven Loan and the loss on write-down of the Northland Zero Note. Rental income increased in 1992 as compared to 1991 as a result of the termination of lease income received from Saab. Real estate operating expenses remained consistent from 1992 to 1991. Interest on short-term investments remained relatively constant between 1992 and 1993. Interest earned on the Zero Notes decreased from 1992 to 1993 due to the non-accrual of interest in June 1993 on the Northland Zero Note. The non-accrual of interest offset an increase in interest attributable to the compounding effect typical of these types of investments for Brookdale for the full year and for Northland during the first half of the year. Interest income on the Zero Notes increased from 1991 to 1992 as a result of the interest compounding effect.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSchedules Not Filed:\nAll schedules except those indicated above have been omitted as the required information is not applicable or the information is shown in the financial statements or notes thereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nINDEPENDENT AUDITORS' REPORT\nML\/EQ REAL ESTATE PORTFOLIO, L.P.:\nWe have audited the accompanying consolidated balance sheets of ML\/EQ Real Estate Portfolio L.P. (the \"Partnership\") as of December 31, 1993 and 1992, and the related consolidated statements of operations, partners' capital, and cash flows for each of the three years ended December 31, 1993, 1992 and 1991. These financial statements and the supplemental schedules discussed below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ML\/EQ Real Estate Portfolio, L.P. at December 31, 1993 and 1992 and the results of its operations and its cash flows for each of the three years ended December 31, 1993, 1992 and 1991 in conformity with generally accepted accounting principles.\nOur audits also comprehended the consolidated supplemental schedules of the Partnership as of December 31, 1993 and for each of the three years ended December 31, 1993, 1992 and 1991. In our opinion, such consolidated supplemental schedules, when considered in relation to the basic consolidated financial statements, present fairly in all material respects the information shown therein.\n\/s\/ Deloitte & Touche - ---------------------\nMarch 18, 1994 Atlanta, Georgia\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1993 and 1992\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n(Continued)\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSUPPLEMENTAL INFORMATION REGARDING NONCASH INVESTING AND FINANCING ACTIVITIES\nThe partnership accrued $225,000 in capital expenditures that were not paid before December 31, 1993.\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION\nML\/EQ Real Estate Portfolio, L.P., a Delaware limited partnership (the \"Partnership\"), was formed on December 22, 1986. The Partnership was formed to invest in existing income-producing real properties, zero coupon or similar mortgage notes and fixed rate mortgage loans through a joint venture, EML Associates (the \"Venture\").\nThe Venture was formed on March 10, 1988 with EREIM LP Associates, an affiliate of the Equitable Life Assurance Society of the United States (\"Equitable\"). The Partnership owns an 80% interest in the Venture. The Managing General Partner of the Partnership is EREIM Managers Corp., (the \"Managing General Partner\"), an affiliate of the Equitable, and the Associate General Partner is MLH Real Estate Associates Limited Partnership (the \"Associate General Partner\"), an affiliate of Merrill Lynch, Hubbard Inc. The initial limited partner is MLH Real Estate Assignor, Inc., an affiliate of Merrill Lynch, Hubbard Inc.\nThe Partnership's Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\") authorized the sale of up to 7,500,000 Beneficial Assignee Certificates (\"BACs\") at $20 per BAC. The BACs evidence the economic rights attributable to limited partners hip interests in the Partnership. On March 10, 1988, the Partnership's initial investor closing occurred, at which time the Partnership received $92,190,120 representing the proceeds from the sale of 4,609,506 BACs. On May 3, 1988, the Partnership had its second and final investor closing. The Partnership received $16,294,380 representing the proceeds from the sale of an additional 814,719 BACs.\nTotal capital contributions to the Partnership are summarized as follows:\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Accounting\nThe Partnership utilizes the accrual basis of accounting for financial accounting and tax reporting purposes.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Partnership and the Venture. EREIM LP Associates' 20% ownership in the Venture is reflected as a minority interest in the Partnership's consolidated financial statements. All significant intercompany accounts are eliminated in consolidation.\nAllocation of Partnership Income\nPartnership net income was allocated 99% to the limited partners as a group and 1% to the general partners until 1990 at which time the Partnership paid the final portion of the acquisition\/syndication fees to the general partners. Partnership net income is now allocated 95% to the limited partners as a group and 5% to the general partners, consistent with the provision in the limited partnership agreement for the allocation of distributable cash.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nRental Properties\nRental properties are stated at cost. Cost is allocated between land and buildings based upon preacquisition appraisals of each property. Impairment is determined by calculating the sum of undiscounted future cash flows including the projected future undiscounted net proceeds from sale of the property. In the event such sum is less than the depreciated cost of the property, the property will be recorded on the financial statements at the lower amount.\nDepreciation\nDepreciation of buildings and building improvements is provided using the straight-line method over estimated useful lives of forty years. Tenant improvements are amortized using the straight-line method over the life of the related lease.\nRental Income\nRental income is recognized on a straight-line basis over the terms of the leases.\nOther Real Estate Assets\nOther real estate assets represent the fair market value of the underlying collateral of the Northland zero coupon loan receivable and the Bank of Delaware mortgage loan receivable at the date such receivables were considered to be in-substance foreclosures (see Notes 4 and 5).\nZero Coupon Mortgage Notes Receivable\nZero coupon mortgage notes receivable are carried at their present value which is equal to the discounted principal plus accrued interest. Interest income is recognized ratably over the term of the notes using the constant rate of interest implicit in the notes (Note 4). In 1993, the Partnership recorded a write-down and stopped accruing interest on the Northland zero coupon note since the value of the underlying collateral was less than the carrying value (see Note 4).\nMortgage Loans Receivable\nMortgage loans receivable are stated at cost (Note 5).\nOrganization and Offering Costs\nOrganization costs incurred in the organization and formation of the Partnership are amortized over five years. Offering costs, including the acquisition\/syndication fee payable to the general partners and other offering and issuance costs of the BACs, totaling $11,037,537, were charged against the limited partners' capital in accordance with the provisions of the Partnership Agreement, following the investor closings in 1988.\nGuaranty Fees\nGuaranty fees are being recognized as expense over the estimated life of the Partnership through a combination of the amortization of the nonrecurring portion of the fees incurred during the first three years of the Partnership and the expense of the recurring portion of the fees as incurred (Note 7).\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nCash Equivalents\nCash equivalents include cash, demand deposits, money market accounts and highly liquid short-term investments purchased with a maturity of three months or less. The short-term investments are stated at cost.\nIncome Taxes\nNo provisions for income taxes have been made since all income and losses are allocated to the partners for inclusion in their respective tax returns.\nReclassifications\nCertain prior year amounts have been reclassified to conform with the 1993 presentation.\nFair Value of Financial Instruments\nManagement has reviewed the various assets and liabilities of the Partnership in accordance with the Statement of Financial Accounting Standards No. 107 \"Disclosures about Fair Value of Financial Instruments\" (which is not applicable to real estate assets). Management has concluded that the fair value of its financial instruments, principally the zero coupon note receivable, the mortgage loan receivables and other real estate assets, approximates the fair market value of the underlying collateral. Considerable judgement is required in developing estimates of fair value and accordingly, the use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts. The actual market value of the underlying collateral can be determined only by negotiation between parties in an arms length sale transaction. See Note 4 regarding the write-down of the Northland zero coupon mortgage note.\n3. RENTAL PROPERTIES\nAs of December 31, 1993, the Partnership's rental properties consisted of the following:\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe costs related to the rental properties are summarized as follows:\n4. ZERO COUPON MORTGAGE NOTES RECEIVABLE\nIn 1988, The Venture acquired two zero coupon mortgage notes with fair value (including accrued interest) of $33,053,870, which represents the Venture's 71.66 ownership percentage. Equitable Life Assurance Society of the United States owns the remaining 28.34%. These notes provide financing for Equitable Real Estate Shopping Centers L.P. (\"ERESC\") and are secured by nonrecourse first mortgages on the two properties owned by ERESC: Brookdale Center and Northland Center. ERESC is not affiliated with the Venture. The notes have an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $68,227,857 due June 1995. The notes provide that the borrowers may elect to pay interest currently; however, it is expected that interest payments will be deferred until maturity. Management discontinued the accrual of interest during the quarter ended June 30, 1993 on the Northland zero coupon mortgage as the accreted value of such mortgage approximates the underlying value.\nOn January 19, 1994, the Equitable entered into a letter of intent with Equitable Real Estate Shopping Centers L.P. (ERESC) to obtain, together with the Venture, Northland Mall from ERESC by means of a surrender of deed in lieu of foreclosure. The letter of intent provides that if the transaction is consummated, ERESC will be released from the existing first mortgage and receive $6,600,000. Such transaction is accounted for as an in-substance foreclosure at December 31, 1993 and is classified as an other real estate asset. The Partnership recognized a loss of $7,628,000 as of December 31, 1993 to record the mall at its fair market value. Such loss includes a $4,730,000 provision in anticipation of a payment to terminate the mortgage to be made at closing during 1994.\nThe unaudited financial position and results of operations of ERESC for fiscal year ended December 31, 1993 are summarized as follows:\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. ZERO COUPON MORTGAGE NOTES RECEIVABLE (CONTINUED)\nEQUITABLE REAL ESTATE SHOPPING CENTERS L.P.\nUNAUDITED Summary Statement of Financial Position\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. MORTGAGE LOANS RECEIVABLE\nIn 1988, the Venture and Equitable jointly invested in a $28,000,000 nonrecourse first mortgage loan to Second Merritt Seven Joint Venture, a Connecticut General Partnership. The Venture, Equitable and Second Merritt Seven Joint Venture agreed to a $21,000,000 pay-off of the loan by Second Merritt Seven Joint Venture in the fourth quarter of 1993. The Venture received $10,500,000 for its 50% share of the loan resulting in a realized loss of $3.5 million. Adequate reserves had been established by the Partnership during the first and third quarters of 1993 to reflect the diminution of value of the underlying security for the loan. In receiving $8,400,000, the Partnership's 80% share of the $10,500,000 payment, the Partnership realized the carrying value of the mortgage on its books. Management believes that accepting a pay-off was in the best interest of the Venture, given the prospects for the property in a difficult leasing environment.\nIn 1989, the Venture made a $6,000,000 nonrecourse first mortgage loan to the Wilcon Company. The loan is collateralized by an apartment complex in Weston, Massachusetts. The loan bears interest at 10.25% per annum with interest only of $51,250 due monthly to the maturity date of February 1999.\nIn 1989, the Venture made a $9,500,000 nonrecourse first mortgage loan to Three Hundred Delaware Avenue Associates. This loan is collateralized by a seventeen-story office building in Wilmington, Delaware. The loan bears interest at 10.375% per annum with interest only of $82,135 due monthly to the maturity date of March 1999. Subsequent to year-end, the owner of the Bank of Delaware Building defaulted on the mortgage loan receivable. As such, at year-end, the Partnership accounted for this transaction as an in-substance foreclosure. The mortgage loan receivable was reclassified to other real estate assets at its current fair market value.\n6. GUARANTY AGREEMENT\nEREIM LP Associates has entered into a guaranty agreement with the Venture to provide a minimum return to the Partnership's limited partners on their contributions. The Venture has assigned its rights under the guaranty agreement to the Partnership. The guaranty, if necessary, will be paid ninety days following the earlier of the sale or other disposition of all the properties and mortgage loans and notes or the liquidation of the Partnership. The minimum return will be an amount which, when added to the cumulative distributions to the limited partners, will enable the Partnership to provide the limited partners with a minimum return equal to their capital contributions plus a simple annual return of 9.75% on their adjusted capital contributions, as defined in the Partnership Agreement, calculated from the dates of the investor closings. Adjusted capital contributions are the limited partners' original cash contributions less distributions of guaranty proceeds, sale or financing proceeds, and liquidation proceeds, as defined in the Partnership Agreement. The limited partners' original cash contributions have been adjusted by that portion of distributions paid through December 31, 1993, resulting from cash available to the Partnership as a result of sale or financing proceeds paid to the Venture. The minimum return is subject to reduction in the event that certain taxes, other than local property taxes, are imposed on the Partnership or the Venture, and is also subject to certain other limitations set forth in the prospectus. Based upon the assumption that the last property is sold on December 31, 2002, upon expiration of the term of the Partnership, the maximum liability of EREIM LP Associates to the Venture to fund cash deficits under the guaranty agreement as of December 31, 1993 is limited to $251,496,465, plus the value of EREIM LP Associates.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. GUARANTY AGREEMENT (Continued)\nAs of December 31, 1993 and 1992, the cumulative minimum return (computed at 9.75% per annum) on ML\/EQ's limited partners' capital contributions was $61,129,209 and $50,637,645, respectively. The guarantee amount is the minimum return reduced by the semi-annual distributions of cash to the limited partners of the Partnership, other than cash distributed to the limited partners as a result of sale or financing proceeds, guaranty proceeds, and liquidation proceeds, as defined in the Partnership Agreement. As of December 31, 1993, the cumulative amount of cash distributions paid other than cash distributions paid as a result of sale or financing proceeds was $11,662,621. As of December 31, 1993, the cumulative amount of cash distributions paid as a result of sale or financing proceeds received by the Venture was $878,707. Distributions constituting sale or financing proceeds declared as of December 31, 1993 and paid in February 1994 total $542,448.\n7. COMPENSATION AND FEES\nAcquisition\/Syndication Fee\nThe acquisition\/syndication fee was paid to the general partners for initial acquisition, management and administrative services to the Partnership. The fee was 8.7% of the proceeds from the offering of BACs, which amounted to $9,438,152 based upon the total number of BACs sold and has been included in the offering costs charged to limited partners' capital. The outstanding balance of this fee was paid to the general partners in August 1990.\nVenture Supervisory Fee\nThe Venture supervisory fee is payable to the Managing General Partner for supervising the Partnership's investment in the Venture. The fee is payable semiannually in an amount equal to .75% per annum of the Partnership's allocable share of the acquisition price of properties owned by the Venture. For each of the years ended December 31, 1993, 1992 and 1991, the total expense for this fee was $409,710.\nMortgage Loan Servicing Fee\nThe mortgage loan servicing fee is payable to the Managing General Partner for servicing mortgage loans owned by the Venture. The fee is payable semiannually in an amount equal to .20% per annum of the outstanding principal amount of the Partnership's allocable share of fixed rate first mortgage loans and .20% per annum of the Partnership's allocable share of the accreted amount of zero coupon mortgage notes at the time of acquisition or contribution to the venture. For each of the years ended December 31, 1993, 1992 and 1991 the total expense for this fee was $100,086.\nPartnership Administration Fee\nThe partnership administration fee is payable to the Associate General Partner as compensation for providing investor services limited to processing investor information and disseminating Partnership reports and tax information. The fee is payable on a semiannual basis at an annual rate of .15% per annum of the average annual adjusted capital contributions of the offering of BACs. For the years ended December 31, 1993, 1992 and 1991, the total expense for this fee was $161,409, $162,066 and $162,727, respectively.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. COMPENSATION AND FEES (Continued)\nGuaranty Fee\nThe guaranty fee is payable to the Venture in consideration of the assignment of the guaranty agreement. The fee was initially paid in six semiannual installments, which commenced on June 30, 1988 and ended on December 31, 1990, at an annual rate of 1.15% of gross proceeds plus .35% of average annual adjusted capital contributions. Subsequent to December 31, 1990, the fee is payable on a semiannual basis at an annual rate of .35% of the average annual adjusted capital contributions of the offering of BACs. The guaranty fee is assigned to EREIM LP Associates. For the years ended December 31, 1993, 1992 and 1991, the total expense for this fee was $644,871, $646,405 and $647,947, respectively. Each of these totals include $268,251 of amortization expense on the nonrecurring portion of the fee.\nDisposition Fee\nThe disposition fee is payable to the Managing General Partner in the case of a sale of a property. Upon distribution of the proceeds of the sale to the limited partners, the fee is payable in the amount of 1.50% of the aggregate gross proceeds received by the Partnership. The Managing General Partner will not receive any portion of the disposition fee which, when combined with amounts paid to all other entities as real estate brokerage commissions in connection with the sale, exceeds 6% of the aggregate gross sale proceeds.\n8. PARTNERSHIP AGREEMENT\nThe general partners are liable for all general obligations of the Partnership to the extent not paid by the Partnership. The limited partners are not liable for the obligations of the Partnership beyond the amount of their contributed capital.\nAfter payment of the acquisition\/syndication fee to the general partners, which has been charged to the limited partners' capital, distributable cash from operations, less any amounts set aside for Reserves, will be allocated semiannually on the basis of 95% to the BAC holders and limited partners as a group and 5% to the general partners. Distributions to the general partners for any semiannual period will be deferred until the limited partners have received a 6% per annum simple return on their adjusted capital contribution during the period. During 1993, the Partnership declared a distribution in the amount of $542,448 ($0.10 per BAC) which was paid in February 1994.\nTaxable income and loss will generally be allocated 1% to the general partners and 99% to the limited partners.\nDistributions from sale or financing proceeds, if applicable during a period, will be distributed on a semiannual basis with priority return given to the limited partners. An exception in the agreement provides that the distribution of sale or financing proceeds may be delayed if the purpose for withholding such a distribution is to supplement cash reserves. Subsequent to a complete return of the limited partners' capital contributions and the receipt of the minimum return by the limited partners, as defined in the Partnership Agreement, sales proceeds will be allocated to the general partners to the extent of any distributable cash that has been deferred, net of disposition fees paid to the Managing General Partner. The balance will be allocated 85% to the limited partners and 15% to the general partners.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. LEASES\nFuture minimum rentals to be received for the properties under noncancelable operating leases in effect as of December 31, 1993 are as follows:\nIn addition to the minimum lease amounts, certain leases provide for escalation charges to tenants for common area maintenance, real estate taxes and, in the case of retail tenants, rent concessions and percentage rents. The amount of escalation charges, rent concessions and percentage rents included in rental income totaled $1,632,857, $1,811,905 and $1,740,010 for the years ended December 31, 1993, 1992 and 1991, respectively.\nInformation with respect to significant individual leases is as follows:\nPermer Control, Inc. occupies all (257,500 square feet) of 1200 Whipple Road at a current annual base rent of $807,469 under a lease which expires in August 2003. The lease agreement calls for increases in annual rent to $1,009,340 in September 1993 and $1,261,675 in September 1998. Martin Marietta (formerly General Electric) occupied all (96,386 square feet) of 16 Sentry Park West at an annual base rent of $1,453,512 under a lease which expired in December 1993. Martin Marietta decided not to renew 70,836 square feet of space under the lease. Martin Marietta acquired General Electric's defense related operations in the first quarter of 1993.\nLiberty Mutual Insurance Group occupies approximately 12.4% (23,685 square feet) of 18 Sentry Park West at an annual base rent of $358,236 under a lease which expires in May 1999.\nPursuant to an agreement with Saab-Scania of America, Inc. (\"Saab\"), the former tenant of 1850 Westfork Drive, in connection with the termination of its lease, Saab paid to the Venture $1.1 million in the first quarter of 1992. This agreement released Saab from the lease obligation at 1850 Westfork Drive, which had been scheduled to terminate in June 1998. The Partnership recognized such proceeds as income in 1992. During the third quarter of 1992, the Westfork Drive property was leased in its entirety to Treadway Exports Limited. This lease is for an initial term of three years at an annual base rent of $219,689 with two renewal options for a total of an additional three years.\nGruner & Jahr Printing Company occupies approximately 44.6% (143,852 square feet) of Doolittle Drive at an annual base rent of $477,816. The lease was renewed in 1992 for a five year term commencing in August 1993.\nThe buildings located at 701 Maple Lane, 733 Maple Lane, 7550 Plaza Court are 100% leased as of December 31, 1993. One lease comprising 18% of the available space is scheduled to expire in 1994.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. TAXABLE NET INCOME AND TAX NET WORTH\nThe following is a reconciliation of the Partnership's financial net income to taxable net income and a reconciliation of partners' capital for financial reporting purposes to net worth on a tax basis.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. SELECTED QUARTERLY FINANCIAL DATA (Unaudited)\nQuarterly financial data for 1993 and 1992 is summarized as follows:\n(A) Note: In the fourth quarter, a write-down of $7,628,000 was taken against one of the zero coupon mortgage notes since the value of underlying collateral was less than the carrying value of the mortgage.\n(a) Acquisition\/syndication fees and partnership administration fees.\n(b) Acquisition\/syndication fees, management fees and costs related to the offering including reimbursable legal, accounting and printing costs.\n(c) Guaranty fees.\n(d) Equitable Legal Department to reimburse legal expenses incurred in connecti on with the organization and offering of the Partnership and ongoing Partnership operations.\nSCHEDULE XI ML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1993\nSCHEDULE XII ------------ ML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED SCHEDULE OF MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1993 ------------------------------------------------------\nNotes:\n(a) Interest at the imputed rate shown is compounded semi-annually and added to the note balance.\n(b) None of the loans are subject to any delinquencies.\n(c) EREIM LP Associates, an affiliate, contributed a total of $26,443,097 of zero coupon mortgage notes to the Venture, including principal plus interest at the contribution date.\n(d) The aggregate cost for book purposes is equal to the tax basis.\n(e) Represents the Venture's 71.66% interest in the original face amount of the note excluding compounded interest.\n(f) Payments of interest only of $51,250 are due monthly until the maturity date of February 1999.\nPART III. ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Partnership is a limited partnership and has no directors or officers.\nFor informational purposes, certain information regarding the General Partners and their respective directors and officers is set forth below.\nManaging General Partner\nThe Managing General Partner is a wholly-owned subsidiary of Equitable Real Estate Investment Management, Inc. (\"Equitable Real Estate\"). Equitable Real Estate is a wholly-owned subsidiary of Equitable Investment Corporation, which is a wholly-owned subsidiary of Equitable Holding Corporation, which is a wholly-owned subsidiary of Equitable.\nThe names and dates of election of the directors and officers of the Managing General Partner as of March 15, 1994 are as follows:\n___________________________________\n* Named Director on December 12, 1986. ** Elected Vice President on December 19, 1986.\nThe business experience of the directors and executive officers of the Managing General Partner is set forth below.\nGeorge R. Puskar has been Chairman and Chief Executive Officer of Equitable Real Estate since August 1988. Before that he was President and Chief Operating Officer of Equitable Real Estate since its formation in 1984. He is also a Vice President of Equitable.\nPaul J. Dolinoy is a Senior Executive Vice President of Equitable Real Estate in charge of the Institutional Accounts and Portfolio Management area. He is responsible for Equitable Real Estate's corporate, public and union pension fund business and also oversees the development of institutional-grade real estate investment products for individual investors. He is also a Vice President of Equitable.\nEugene F. Conway is an Executive Vice President of Equitable Real Estate responsible for institutional accounts\/retail markets. He also serves as portfolio manager for approximately $1.8 billion of assets. Prior to becoming an Executive Vice President of Equitable Real Estate in 1989, he was a Senior Vice President since 1986 and a Vice President since 1984.\nHarry D. Pierandri is a Senior Executive Vice President of Equitable Real Estate responsible for overseeing all of its discretionary portfolio management activities, in addition to overseeing its Capital Markets, Asset Management and Valuation divisions. Prior to becoming a Senior Executive Vice President in 1988, he was an Executive Vice President since 1984.\nEdward G. Smith is an Executive Vice President of Equitable Real Estate responsible since 1988 for overseeing the $14 billion real estate portfolio of Equitable's General Account. Prior to becoming an Executive Vice President in 1988, he was a Senior Vice President since 1984. From 1986 to 1988 he was responsible for development, management and administration at Equitable Real Estate's home office in Atlanta.\nTimothy J. Welch is a Senior Executive Vice President of Equitable Real Estate in charge of its New York regional office. Prior to assuming his current responsibilities, he was responsible for Investment Sales and International Marketing.\nPeter F. Arata is an Executive Vice President and has been Chief Financial Officer of Equitable Real Estate since 1984. Since 1992, he has also been a Director of Equitable Agri-Business, an Equitable Real Estate affiliate, one of the nation's leading agricultural property investment organizations with more than $2 billion in assets under management. From 1990 to 1992, he was Chairman and Chief Executive Officer of Equitable Agri-Business.\nTommy V. Clinton is an Executive Vice President of Equitable Real Estate responsible for new mortgage loan origination and mortgage sourcing. Prior to becoming an Executive Vice President in 1988, he was Senior Vice President since 1984.\nRichard R. Dolson is an Executive Vice President of Equitable Real Estate and is in charge of asset management. Prior to becoming an Executive Vice president in 1988, Mr. Dolson was a Senior Vice President since 1984.\nB. Stanton Breon joined Equitable Real Estate in 1982 and was elected a Vice President in 1993. He is currently responsible for the management of portfolios aggregating approximately $1 billion of assets.\nPeter J. Urdanick is Senior Vice President and Treasurer of Equitable Real Estate. Prior to becoming Senior Vice President and Treasurer in 1992, Mr. Urdanick was Vice President and Controller since 1985. He is responsible for its corporate finance department, including its treasury operations.\nAssociate General Partner\nThe general partner of the Associate General Partner is MLH Real Estate Inc., a wholly-owned subsidiary of MLH Group Inc., which is a wholly-owned subsidiary of Merrill Lynch, Hubbard Inc. (\"MLH\"). MLH is a wholly-owned subsidiary of Merrill Lynch Group, Inc., which is a wholly-owned subsidiary of Merrill Lynch.\nThe names and dates of election of the directors and executive officers of the general partner of the Associate General Partner as of March 15, 1994 are as follows:\nThe business experience of the directors and executive officers of the general partner of the Associate General Partner is set forth below.\nD. Bruce Brunson joined Merrill Lynch in 1986 and was elected Chairman and Chief Executive Officer of MLH in August 1991. He has been Senior Vice President of Merrill Lynch since 1986. From 1986 to 1990, he served as Treasurer of Merrill Lynch and subsequently he coordinated Merrill Lynch's restructuring activities.\nJames A. Vinson joined MLPF&S, a subsidiary of Merrill Lynch, in 1971 and has been President and Chief Operating Officer of MLH since 1984 and a Director of MLH since 1978. Mr. Vinson has been involved since 1971 in real property acquisitions and structuring the equity financing of limited partnerships formed for the purpose of acquiring properties.\nThomas J. Brown joined MLPF&S in 1971 and has been involved since 1972 in real property acquisitions and structuring the equity financing of limited partnerships formed for the purpose of acquiring properties. He has been responsible for real estate management since 1984. Mr. Brown became a director of MLH in 1987 and has been Executive Vice President since 1985.\nJack A. Cuneo joined MLPF&S in 1975 and is a Senior Vice President of MLH and Manager of its Real Estate Acquisitions and Dispositions Group. Mr. Cuneo is involved in real property acquisitions and sales.\nBruce S. Fenton joined MLH in 1981 and is a Vice President of MLH and Manager of its Product Development and Investor Services Group.\nRonald J. Solotruk joined MLH in 1988 and is a Vice President and the Chief Financial Officer of MLH and the Manager of its Financial and Investment Services Group.\nThere is no family relationship among any of the above-listed directors and officers of the Managing General Partner and the general partner of the Associate General Partner. All of the directors have been elected to serve until the next annual meeting of the shareholder of the Managing General Partner or general partner of the Associate General Partner, respectively, or until their successors are elected and qualify. All of the officers have been elected to serve until their successors are elected and qualify.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe General Partners are entitled to receive a share of cash distributions and a share of taxable income or tax loss as provided in Article Four of the Partnership Agreement which is incorporated herein by reference.\nThe General Partners and their affiliates may be paid certain fees and commissions and reimbursed for certain out-of-pocket expenses. Information concerning such fees, commissions and reimbursements is set forth under \"Compensation and Fees\" in the Prospectus and in Schedule IV and Note 7 to notes to Consolidated Financial Statements in ITEM 8: FINANCIAL STATEMENTS, which is incorporated herein by reference.\nAll of the directors and officers of the Managing General Partner are employees of Equitable or its subsidiaries and are not separately compensated for services provided to the Managing General Partner or, on behalf of the Managing General Partner, to the Partnership. All of the directors and officers of the general partner of the Associate General Partner are employees of Merrill Lynch or its subsidiaries and are not separately compensated for services provided to the Associate General Partner or, on behalf of the Associate General Partner, to the Partnership.\nThe Partnership Agreement indemnifies the General Partners and the Initial Limited Partner against liability for losses resulting from errors in judgment or other action or inaction, whether or not disclosed, if such course of conduct did not constitute negligence or misconduct (see Section 5.7 of the Partnership Agreement which is incorporated herein by reference). As a result of such indemnification provisions, a purchaser of BACs may have a more limited right of legal action than he would have if such provision were not included in the Partnership Agreement. In the opinion of the Securities and Exchange Commission, indemnification for liabilities arising under the Federal Securities laws is against public policy and therefore unenforceable. Indemnification of general partners involves a developing and changing area of the law and since the law relating to the rights of assignees of limited partnership interests, such as BAC Holders, is largely undeveloped, investors who have questions concerning the duties of the General Partners should consult their own counsel.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe Initial Limited Partner, an affiliate of the Associate General Partner, is the record owner of substantially all of the Interests in the Partnership, although it has assigned such Interests to BAC Holders. In its capacity as record owner of the Interests, the Initial Limited Partner has no authority to transact business for, or to participate in the activities and decisions of, the Partnership. Merrill Lynch, Pierce, Fenner & Smith, Incorporated is the record owner of approximately 84% of the BACs, holding such BACs in a nominee capacity and having no beneficial interest in the BACs. Otherwise, there is no person known to the Partnership who owns beneficially or of record more than five percent of the BACs of the Partnership. Neither of the General Partners owns any BACs of the Partnership. The directors and officers of the Managing General Partner and the general partner of the Associate General Partner, as a group, own no BACs.\nThere are no arrangements known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities indicated on March 25,1994.\nSIGNATURES\nPursuant to requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 25th day of March, 1994.\nML\/EQ REAL ESTATE PORTFOLIO, L.P.\nEREIM MANAGERS CORP. (Managing General Partner)\nBy: \/s\/ Eugene F. Conway -------------------- Eugene F. Conway Executive Vice President","section_14":"","section_15":""}
{"filename":"98677_1993.txt","cik":"98677","year":"1993","section_1":"ITEM 1. BUSINESS.\nTootsie Roll Industries, Inc. and its consolidated subsidiaries (the \"Company\") are engaged in the manufacture and sale of candy. This is the only industry segment in which the Company operates and is its only line of business. A majority of the Company's products are sold under the registered trademarks \"Tootsie,\" \"Tootsie Roll,\" or \"Tootsie Pop.\" The principal product of the Company is the familiar \"Tootsie Roll,\" a chocolate-flavored candy of a chewy consistency, which is sold in several sizes and which is also used as a center for other products in the line including \"Tootsie Pops,\" a spherical fruit or chocolate-flavored shell of hard candy with a center of \"Tootsie Roll\" candy on a paper safety stick, and \"Tootsie Pop Drops,\" a smaller sized version of the \"Tootsie Pop\" without the stick. The Company and its predecessors have manufactured the \"Tootsie Roll\" product to substantially the same formula and sold it under the same name for over 90 years. The Company's products also include \"Tootsie Roll Flavor Rolls\" and \"Tootsie Frooties,\" multiflavored candies of chewy consistency.\nThe Company also manufactures and sells molded candy drop products under the registered trademark \"Mason\" and \"Tootsie,\" including \"Mason Dots,\" and \"Mason Crows.\"\nThe Company's wholly owned subsidiary, Cella's Confections Inc., produces a chocolate covered cherry under the registered trademark \"Cella's.\"\nIn 1988, the Company acquired the Charms Company. This candy manufacturer produces lollipops, including bubble gum-filled lollipops, and hard candy. The majority of the Company's products are sold under the registered trademarks \"Charms,\" \"Blow-Pop,\" \"Blue Razz,\" and \"Zip-A-Dee-Doo-Da-Pops.\"\nOn October 15, 1993, the Company acquired Cambridge Brands, Inc. which was the former Chocolate\/Caramel Division of Warner Lambert. Cambridge Brands, Inc. produces various confectionery products under the registered trademarks \"Junior Mint,\" \"Charleston Chew,\" \"Sugar Babies,\" \"Sugar Daddy,\" and \"Pom Poms.\"\nThe Company's products are marketed in a variety of packages designed to be suitable for display and sale in different types of retail outlets and vending machines and fund-raising religious and charitable organizations. They are distributed through approximately 100 candy and grocery brokers and by the Company itself to approximately 15,000 customers throughout the\nUnited States. These customers include wholesale distributors of candy and groceries, supermarkets, variety stores, chain grocers, drug chains, discount chains, cooperative grocery associations, warehouse and membership club stores, vending machine operators, and fund-raising religious and charitable organizations.\nThe Company's principal markets are in the United States, Canada and Mexico. The Company's Mexican plant supplies a very small percentage of the products marketed in the United States and Canada.\nThe Company has advertised nationally for many years. Although nearly all advertising media have been used at one time or another, at present most of the Company's advertising expenditures are for the airing of network and syndicated TV and cable and spot television on major markets throughout the country.\nThe domestic candy business is highly competitive. The Company competes primarily with other manufacturers of bar candy and candy of the type sold in variety, grocery and convenience stores. Although accurate statistics are not available, the Company believes it is among the ten largest domestic manufacturers in this field. In the markets in which the Company competes, the main forms of competition comprise brand recognition as well as a fair price for our products at various retail price points.\nSale of candy products may be influenced to some extent by discussions of and effect on dental health and weight.\nThe Company did not have a material backlog of firm orders at the end of the calendar years 1993 or 1992.\nAll raw materials used by the Company are readily obtainable from a number of suppliers at competitive prices. The average cost of most major raw materials remained relatively stable in 1993 compared to 1992. It is not possible to project future changes in the price of raw materials. The Company has engaged in hedging transactions in sugar and corn and may do so in the future if and when advisable. From time to time the Company changes the size of certain of its products, which are usually sold at standard retail prices, to reflect significant changes in raw material costs.\nThe Company does not hold any material patents, licenses, franchises or concessions. The Company's major trademarks are registered in the United States and in many other countries. Continued trademark protection is of material importance to the Company's business as a whole.\nThe Company does not expend significant amounts on research or development activities.\nCompliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect on the capital expenditures, earnings or competitive position of the Company nor does the Company anticipate any such material effects from presently enacted or adopted regulations.\nThe Company employs approximately 1,700 persons.\nThe Company has found that its sales normally maintain a consistent level throughout the year except for a substantial upsurge in the third quarter which reflects sales in anticipation of Halloween. In anticipation of this high sales period, the Company generally begins its Halloween inventory build up in the second quarter of each year. The Company historically offers extended credit terms for sales made under Halloween sales programs. Each year, after Halloween receivables have been paid, the Company invests funds in various temporary cash investments.\nFor a summary of sales, net earnings and assets of the Company by geographic area and additional information regarding the foreign subsidiaries of the Company, see Note 11 of the Notes to Consolidated Financial Statements on Page 15 of the Company's Annual Report to Shareholders for the year ended December 31, 1993 (the \"1993 Report\") and on Page 4 of the 1993 Report under the section entitled \"International.\" Note 11 and the aforesaid section are incorporated herein by reference. Portions of the 1993 Report are filed as an exhibit to this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns its principal plant and offices which are located in Chicago, Illinois in a building consisting of approximately 2,200,000 square feet. The Company utilizes approximately 1,800,000 square feet for offices, manufacturing and warehousing facilities and leases, or has available to lease to third parties, approximately 400,000 square feet.\nIn addition to owning the principal plant and warehousing facilities mentioned above, the Company leases manufacturing and warehousing facilities at a second location in Chicago which comprises 80,600 square feet. The lease is renewable by the Company every five years through June, 2011. The Company also periodically leases additional warehousing space at this second location as needed on a month to month basis.\nCella's Confections, Inc., a subsidiary, owns a facility in New York City, containing approximately 43,000 square feet. This facility consists of manufacturing, warehousing and office space on three floors containing approximately 33,200 square feet with a below surface level of approximately 9,800 square feet.\nCharms Company, a subsidiary, owns a facility in Covington, Tennessee, containing approximately 267,000 square feet of manufacturing, warehousing and office space.\nCambridge Brands, Inc., a subsidiary, owns a facility in Cambridge, Massachusetts, containing approximately 145,000 square feet. The facility consists of manufacturing, warehousing and office space on five floors.\nThe Company also owns property and a plant with manufacturing, warehousing and office space in Mexico City, Mexico, consisting of approximately 57,000 square feet plus parking lot and yard area comprising approximately 25,000 square feet.\nThe Company owns the production machinery and equipment located in the plants in Chicago, New York, Covington (Tennessee), Cambridge (Massachusetts) and Mexico City, except for approximately $7 million of equipment in Covington, Tennessee under an operating lease. The Company considers that all of its facilities are well maintained, in good operating condition and adequately insured.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings known to the Company to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of the Company's shareholders through the solicitation of proxies or otherwise during the fourth quarter of 1993.\nADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.\nSee the information on Executive Officers set forth in the table in Part III, Item 10, Page 6 of this report, which is incorporated herein by reference.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Shares are traded on the New York Stock Exchange.The Company's Class B Common Shares are subject to restrictions on transfer and no market exists for such shares. The Class B Common Shares are convertible at the option of the holder into Common Shares on a share for share basis. As of March 11, 1994, there were approximately 9,500 holders of record of Common and Class B Common Shares. For information on the market price of, and dividends paid with respect to, the Company's Common Shares, see the section entitled \"1993-1992 Quarterly Summary of Tootsie Roll Industries, Inc. Stock Prices and Dividends\" which appears on Page 16 of the 1993 Report.\nThis section is incorporated herein by reference and filed as an exhibit to this report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSee the section entitled \"Five Year Summary of Earnings and Financial Highlights\" which appears on Page 17 of the 1993 Report. This section is incorporated herein by reference and filed as an exhibit to this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nSee the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on Pages 5-7 of the 1993 Report. This section is incorporated herein by reference and filed as an exhibit of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements, together with the report thereon of Price Waterhouse dated February 17, 1994, appearing on Pages 8-15 of the 1993 Report and the Quarterly Financial Data on Page 16 of the 1993 Report are incorporated by reference in this report. With the exception of the aforementioned information and the information incorporated in Items 1, 5, 6 and 7, the 1993 Report is not to be deemed filed as part of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nSee the information with respect to the Directors of the Company which is set forth in the section entitled \"Election of Directors\" of the Company's Definitive Proxy Statement to be used in connection with the Company's 1994 Annual Meeting of Shareholders (the \"1994 Proxy Statement\"). Except for the last paragraph of this section relating to the compensation of Directors, this section is incorporated herein by reference. The 1994 Proxy Statement will be filed with the Securities and Exchange Commission on or before April 30, 1994.\nThe following table sets forth the information with respect to the executive officers of the Company:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSee the information set forth in the section entitled \"Executive Compensation and Other Information\" of the Company's 1994 Proxy Statement. Except for the \"Report on Executive Compensation\" and \"Performance Graph,\" this section of the 1994 Proxy Statement is incorporated herein by reference. See the last paragraph of the section entitled \"Election of Directors\" of the 1994 Proxy Statement, which paragraph is incorporated herein by reference. The 1994 Proxy Statement will be filed with the Securities and Exchange Commission on or before April 30, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nFor information with respect to the beneficial ownership of the Company's Common and Class B Common shares by the beneficial owners of more than 5% of said shares and by the management of the Company, see the sections entitled \"Ownership of Common Stock and Class B Common Stock by Certain Beneficial Owners\" and \"Ownership of Common Stock and Class B Common Stock by Management\" of the 1994 Proxy Statement. These sections of the 1994 Proxy Statement are incorporated herein by reference. The 1994 Proxy Statement will be filed with the Securities and Exchange Commission on or before April 30, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nDaniel G. Ross, a director of the Company, is a member of the law firm of Becker, Ross, Stone, DeStefano & Klein, which has served as general counsel to the Company for many years.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial Statements.\nThe following financial statements and schedules are filed as part of this report:\n(1) Financial Statements (filed herewith as part of Exhibit 13):\nReport of Independent Accountants\nConsolidated Statements of Earnings and Retained Earnings for the three years ended December 31, 1993\nConsolidated Statements of Cash Flows for the three years ended December 31,\nConsolidated Statements of Financial Position at December 31, 1993 and 1992\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedules:\nReport of Independent Accountants on Financial Statement Schedules\nFor the year ended December 31, 1993-\nI - Marketable Securities - Other Investments\nFor the three years ended December 31, 1993-\nV- Property, Plant and Equipment VI- Accumulated Depreciation and Amortization of Property, Plant and Equipment VIII- Valuation and Qualifying Accounts IX- Short-Term Borrowings X- Supplementary Income Statement Information\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) Exhibits required by Item 601 of Regulation S-K:\nSee Index to Exhibits which appears following Financial Schedule X.\n(b) Reports on Form 8-K\nThe Company filed a Report on Form 8-K dated October 15, 1993 and a Report on Form 8-K\/A (Amendment No. 1) dated October 15, 1993, which described the acquisiton by the Company of the chocolate\/caramel division of Warner-Lambert Company. The Report on Form 8-K\/A filed the financial statements of the acquired company and unaudited pro forma financial statements of the Company.\nNo other reports on Form 8-K were filed during the quarter ended December 31, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Tootsie Roll Industries, Inc., has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTOOTSIE ROLL INDUSTRIES, INC.\nBy S\/ MELVIN J. GORDON ------------------------------- Melvin J. Gordon, Chairman of the Board of Directors and Chief Executive Officer\nDate: March 28, 1994 -----------------------\nPursuant 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 and on the dates indicated.\nS\/MELVIN J. GORDON - ------------------ Chairman of the Board Melvin J. Gordon of Directors and Chief Executive Office (principal executive officer) March 28, 1994\nS\/ELLEN R. GORDON - ----------------- Director, President, Ellen R. Gordon and Chief Operating Officer March 28, 1994\nS\/DANIEL G. ROSS - ----------------- Director March 28, 1994 Daniel G. Ross\n- ------------------- Charles W. Seibert Director March 28, 1994\nS\/WILLIAM TOURETZ - ----------------- Director & Secretary William Touretz March 28, 1994\n- -------------------- Lana Jane Lewis-Brent Director March 28, 1994\nG.HOWARD EMBER JR. - -------------------- Vice President, Finance G. Howard Ember Jr. (principal financial officer and principal accounting officer) March 28, 1994\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Directors and Shareholders of Tootsie Roll Industries, Inc.\nOur audit of the consolidated financial statements referred to in our report dated February 17, 1994 appearing on Page 15 of the 1993 Annual Report to Shareholders of Tootsie Roll Industries, Inc., (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 14(a) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated Financial Statements Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ PRICE WATERHOUSE\nPRICE WATERHOUSE Chicago, Illinois February 17, 1994\nFINANCIAL SCHEDULES\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS AT DECEMBER 31, 1993\nSCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS AT DECEMBER 31, 1993\nSCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS AT DECEMBER 31, 1993\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1993, 1992 AND 1991\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE IX - SHORT-TERM BORROWINGS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 and 1991\nTOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARY COMPANIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nINDEX TO EXHIBITS\n2.1 Asset Sale Agreement dated September 29, 1993 between Warner-Lambert Company and the Company, including a list of omitted exhibits and schedules. Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated October 15, 1993; Commission File No. 1-1361.\nThe Company hereby agrees to provide the Commission, upon request, copies of any omitted exhibits or schedules required by Item 601(b)(2) of Regulation S-K.\n3.1 Articles of Incorporation. Incorporated by reference to Exhibit 2.1 to Company's Registration Statement on Form 8-A dated February 29, 1988.\n3.1.1 Articles of Amendment of the Articles of Incorporation dated May 2, 1988. Incorporated by reference to Exhibit 3.1.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1988; Commission File No. 1-1361.\n3.1.2 Articles of Amendment of the Articles of Incorporation dated May 7, 1990. Incorporated by reference to Exhibit 3.1.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1990; Commission File No. 1-1361.\n3.2 By-Laws. Incorporated by reference to Exhibit 2.2 to Company's Registration Statement of Form 8-A dated February 29, 1988.\n3.3 Specimen Class B Common Stock Certificate. Incorporated by reference to Exhibit 1.1 to Company's Registration Statement on Form 8-A dated February 29, 1988.\n10.5* Consultation Agreement between the Company and William Touretz dated December 21, 1979. Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 1992; Commission File No. 1-1361.\nINDEX TO EXHIBITS (CONTINUED)\n10.5.1* Modification Agreement between the Company and William Touretz dated as of December 5, 1984. Incorporated by reference to Exhibit 10.5.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1984; Commission File No. 1-1361.\n10.5.2* Modification Agreement between the Company and William Touretz dated as of December 13, 1985. Incorporated by reference to Exhibit 10.5.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1985; Commission File No. 1-1361.\n10.5.3* Modification Agreement between the Company and William Touretz dated as of December 17, 1986. Incorporated by reference to Exhibit 10.5.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 1986; Commission File No. 1-1361.\n10.8.1* Excess Benefit Plan. Incorporated by reference to Exhibit 10.8.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1990; Commission File No. 1-1361.\n10.8.2* Career Achievement Plan of the Company.\n10.17* Family Security Agreement between the Company and G. Howard Ember dated March 5, 1992. Incorporated by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the year ended December 31, 1991; Commission File No. 1-1361.\nINDEX TO EXHIBITS (CONTINUED)\n10.12* Split Dollar Agreements (Special Trust and Daughters Revocable Trust) between the Company and trustee of Trust dated July 10, 1993.\n10.18* Family Security Agreement between the Company and John W. Newlin dated October 30, 1986. Incorporated by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the year ended December 31, 1986; Commission File No. 1-1361.\n10.19* Family Security Agreement between the Company and Thomas E. Corr dated November 18, 1986. Incorporated by reference to Exhibit 10.19 of the Company's Annual Report on Form 10-K for the year ended December 31, 1986; Commission File No. 1-1361.\n10.20* Family Security Agreement between the Company and James M. Hunt dated August 26, 1993.\n13 The following items incorporated by reference herein from the Company's 1993 Annual Report to Shareholders for the year ended December 31, 1993 (the \"1993 Report\"), are filed as Exhibits to this report:\n(i) Information under the section entitled \"International\" set forth on Page 4 of the 1993 Report;\n(ii) Information under the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" set forth on Pages 5-7 of the 1993 Report;\n(iii) Consolidated Statements of Earnings and Retained Earnings for the three years ended December 31, 1993 set forth on Page 8 of the 1993 Report;\nINDEX TO EXHIBITS (CONTINUED)\n(iv) Consolidated Statements of Financial Position at December 31, 1993 and 1992 set forth on Pages 9-10 of the 1993 Report;\n(v) Consolidated Statements of Cash Flow for the three years ended December 31, 1993 set forth on Page 11 of the 1993 Report;\n(vi) Notes to Consolidated Financial Statements set forth on Pages 12-15 of the 1993 Report;\n(vii) Report of Independent Accountants set forth on Page 15 of the 1993 Report;\n(viii) Quarterly Financial Data set forth on Page 16 of the 1993 Report;\n(ix) Information under the section entitled \"1993-1992 Quarterly Summary of Tootsie Roll Industries, Inc. Stock Prices and Dividends\" set forth on Page 16 of the 1993 Report; and\n(x) Information under the section entitled \"Five Year Summary of Earnings and Financial Highlights\" set forth on Page 17 of the 1993 Report.\n21 List of Subsidiaries of the Company.\n- ------------------\n* Executive compensation plan or arrangement.","section_15":""}
{"filename":"775748_1993.txt","cik":"775748","year":"1993","section_1":"ITEM 1. BUSINESS - ------- --------\nCountrywide Mortgage Obligations III, Inc. (the \"Registrant\" or the \"Company\"), a Delaware corporation, was organized in the State of Delaware on March 26, 1987 as a qualified real estate investment trust (\"REIT\") subsidiary of its parent, Countrywide Mortgage Investments, Inc. (\"CMI\" or the \"Parent\"). CMI, incorporated in Maryland on July 16, 1985 and reincorporated in Delaware on March 6, 1987, is a publicly traded REIT which prior to 1993 was primarily a passive investor in single-family, first-lien, residential mortgage loans and mortgage-backed securities. In 1993, the Parent adopted a new operating plan which established another subsidiary as a jumbo and nonconforming mortgage loan conduit. As part of its new plan, the Parent has also commenced warehouse lending operations which provide short-term revolving financing to certain mortgage bankers.\nThe Registrant was organized for the purpose of issuing and selling collateralized mortgage obligations (\"CMOs\") which may be collateralized by any of the following instruments (the \"Collateral\"):\n(i) mortgage loans, certificates or other securities issued or guaranteed by the Government National Mortgage Association (\"GNMA Certificates\");\n(ii) mortgage loans, certificates or other securities issued or guaranteed by the Federal National Mortgage Association (\"FNMA Certificates\");\n(iii) mortgage loans, certificates or other Federal Home Loan Mortgage Corporation (\"FHLMC securities issued or guaranteed by the Certificates\"); and\n(iv) mortgage loans or other types of mortgage-related securities.\nPursuant to a transfer agreement, dated May 1, 1987, the Registrant became the depositor and holder of 100% of the equity interest in Countrywide Mortgage Trust 1987-I (the \"Trust\"), a Delaware common law business trust established for the sole purpose of issuing its Collateralized Mortgage Obligations, Series W-2, in the aggregate principal amount of $47.6 million. The previous depositor and equity holder was Countrywide Mortgage Obligations II, Inc., a limited purpose finance corporation whose stock is wholly owned by CMI.\nOn September 15, 1987, Countrywide Mortgage Obligations, Inc. (\"CMO\"), a limited purpose subsidiary of CMI, merged with the Registrant. CMO, a Maryland corporation, was a REIT organized for the purpose of issuing and selling CMOs. As a result of the merger, the Registrant assumed all of the rights, privileges, powers, franchises, debts, liabilities and duties of CMO.\nCMO was, and the Registrant as successor to CMO is, the issuer of 15 series of CMOs with an aggregate initial principal amount of $1.7 billion. One of these series was redeemed in 1992 and two were redeemed in 1993. In connection with the merger, the Registrant entered into Indenture Supplements, each dated September 1, 1987 (the \"Indenture Supplements\"), by and among the Registrant, CMO and each of the trustees under the Indentures pursuant to which the CMOs were issued and outstanding (the \"Indentures\"). Under the Indenture Supplements, the Registrant, as successor issuer, assumed all the representations, warranties, covenants and agreements of CMO contained in each Indenture, each series supplement with respect to each Indenture, and each CMO issued thereunder and agreed to be bound by and to comply with the terms thereof.\nOn November 20, 1990, the Registrant entered into a Trust Agreement with Wilmington Trust Company creating the Countrywide Cash Flow Bond Trust (the \"CCFBT\"). The CCFBT is a Delaware common law business trust created for the purpose of issuing cash flow bonds secured by the residual cash flows and\nother property of certain of the outstanding series of CMOs (the \"Cash Flow Bonds\"). (The CMOs and the Cash Flow Bonds are sometimes referred to collectively as the \"CMOs.\") The residual cash flows, which prior to transfer to the CCFBT belonged to the Registrant, represent the funds remaining after the payment of the principal and interest on and certain other obligations with respect to a series of CMOs. On November 21, 1990, the CCFBT issued bonds with an aggregate principal amount of $28.1 million secured by the residual cash flows and certain other property from the Registrant's Collateralized Mortgage Obligations Bonds Series E, F, G, I, J, K, and L. The Registrant as the sole beneficiary of the CCFBT received the proceeds from the issuance of the Cash Flow Bonds and loaned the proceeds to CMI.\nEach series of CMOs issued by the Registrant as successor to CMO, or the Trust, is secured by FNMA Certificates, FHLMC Certificates (collectively \"Certificates\") or whole mortgage loans which were received from CMI at the time of issuance of each series. Substantially all of such Certificates or whole mortgage loans were subject to certain indebtedness incurred by CMI in connection with the acquisition of the Certificates, the acquisition of the mortgage loans underlying the Certificates, and the acquisition of the whole mortgage loans. Concurrently with the issuance of each series of CMOs, substantially all of the net proceeds from the sale of each series of CMOs were used to repay the indebtedness incurred by CMI and to release the respective liens on the Certificates or whole mortgage loans pledged to secure each series of CMOs. The pool of Certificates or whole mortgage loans were then pledged to a trustee under an indenture pursuant to which a series of CMOs was issued, free and clear of any liens and encumbrances, as collateral for the CMOs.\nEach series of CMOs is fully payable from the principal and interest payments on the underlying Certificates or whole mortgage loans collateralizing such series, any cash or other collateral required to be pledged as a condition to receiving the desired rating on the CMOs, plus any investment income on such collateral. Distributions of principal and interest on the Certificates are made directly to the appropriate trustee for payment to the holders of such CMOs. Payments of principal and interest on whole mortgage loans are collected by the servicer and subsequently remitted to the trustee. Although the CMOs are recourse obligations of the Registrant, the Registrant does not have, nor does it anticipate having, any significant assets not pledged as collateral for specific series of CMOs.\nIn general, each series of CMOs consists of various classes. Except in certain circumstances relating to optional redemption of CMOs, the classes of CMOs are retired in order of maturity. The class of CMOs with the earliest maturity receives all principal payments until it is paid in full so that no payment of principal will be made on a particular class of CMOs until all classes of CMOs with earlier maturities are retired.\nThe table below gives additional information with respect to each series of CMOs (Dollar amounts in thousands):\n*Collateralized by residual cash flows and remaining property of Series E, F, G, I, J, K, and L.\nPursuant to an agreement (the \"Management Agreement\") between CMI and Countrywide Asset Management Corporation (\"CAMC\"), an affiliate of Countrywide Funding Corporation (\"CFC\"), CAMC provides certain managerial services and activities for the Registrant, subject to supervision by CMI's Board of Directors. For 1992, CAMC received a management fee equal to 1\/32 of 1% of such Registrant's average invested assets, with such fee being no less than $10,000 annually for each series of CMOs. There were no such fees in 1993 due to a change in the Management Agreement. Pursuant to agreements with Wilmington Trust Company as owner-trustee of the Trust and the CCFBT, CAMC manages the Trust and the CCFBT. CAMC receives no additional fee under the agreement with respect to the Trust and receives an annual fee of $1,000 under the agreement with respect to the CCFBT.\nThe Company has entered into servicing agreements appointing CFC as servicer of two series of CMOs that are collateralized by pools of whole mortgage loans. CFC receives an annual servicing fee of up to .32% of the aggregate unpaid balance of such whole mortgage loans. These servicing fees are deducted from interest payments on the mortgage loans prior to their remittance to the trustee for the holders of the CMOs secured thereby.\nThe Registrant's remaining activities consist solely of reporting activities required by the Indentures and routine corporate administration.\nThe Registrant has no salaried employees. All accounting and managerial services are provided by the Parent.\nCompetition - -----------\nIn issuing the CMOs, the Registrant competes with thrifts, banks, mortgage bankers, insurance companies, other lenders, mutual funds, investment bankers, the Government National Mortgage Association, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, many of which have greater financial resources than the Registrant. Additionally, the CMOs face competition from other investment opportunities available to prospective investors.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe Registrant does not own any real property for use in connection with its operations. The executive and administrative offices of the Registrant and CMI are located at 35 North Lake Avenue, Pasadena, California 91101-1857, telephone (800) 669-2300.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nNot required pursuant to General Instruction J(2)(c) of Form 10-K.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY - ------- ------------------------------------- AND RELATED STOCKHOLDER MATTERS -------------------------------\nAll 1,000 shares of the Registrant's common stock are owned by CMI. There is no established public trading market for these securities. Because the Registrant is a qualified REIT subsidiary, it is required, in effect, to distribute annually at least 95% of its otherwise taxable income, subject to certain adjustments, to the sole owner of its common stock, CMI.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe financial data presented below should be read in conjunction with the Financial Statements and related notes set forth in Item 8.\n- --------------------------------------------------------------------------------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF - ------- --------------------------------------- FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------------------------------------------\nGENERAL - -------\nThe Company's principal source of earnings is net interest income generated from its investments. Investments that collateralize CMOs are fixed interest rate mortgage loans and mortgage-backed securities. The amount of net interest earned on these investments financed by CMOs is directly related to the rate of principal repayments (including prepayments) of the related mortgage loans.\nWhen interest rates decline (as they did in 1992 and 1993), prepayments on the underlying mortgage loans generally tend to increase as mortgagors refinance their existing loans. The cash flow generated by these unanticipated prepayments is ultimately used by the Company to repay the CMOs.\nSeveral factors cause the net yield to the Company to decline from the yield that would have been realized if the mortgage loans had not been prepaid. These are discussed below.\nA time lag of from 24 to 45 days exists from the date the underlying mortgage is prepaid to the date the Company actually receives the cash related to the prepayment. During this interim period, the Company does not earn interest income on the portion of the mortgage loans or mortgage-backed security that has been prepaid. The prepayment, as well as scheduled principal and interest, is deposited in a guaranteed investment contract (\"GIC\"), as required by certain of the indentures relating to the CMOs, pending the next bond payment date. The GIC earns interest at a substantially lower rate than the mortgage loans and mortgage-backed securities.\nThe amount of the prepayment is ultimately (after a period ranging from approximately 5 to 65 days) used to repay the CMOs. The class of each series of CMOs with the shortest maturity receives all principal payments until it is repaid in full. After the first class is fully retired, the second class will receive all principal payments until retired and so forth. The CMOs were structured with the shortest maturity class generally having the lowest interest rate and with interest rates increasing as the maturity of the class increases. Therefore, prepayments are generally applied to the bond class with the lowest interest rate. This has the effect of repaying CMOs with relatively low interest rates and of increasing the weighted average interest rate of the remaining outstanding bonds payable.\nAs prepayments occur, therefore, mortgage loans and mortgage-backed securities which may have relatively high interest rates are reduced and the proceeds are used to repay CMOs with relatively low interest rates. This decreases the interest rate spread earned from investments financed by CMOs in future periods. On the other hand, if interest rates increase (as occurred in certain prior years), prepayments on the underlying mortgage loans tend to decrease. This has the effect of lengthening the time (toward the contractual due dates) in which the Company realizes favorable interest spreads.\nThe Company has incurred certain costs in connection with acquiring its portfolio of fixed-rate mortgage loans and mortgage-backed securities and issuing its CMOs. These items, mortgage loan premium, bond issuance costs and original issue discount, are amortized over the period of repayment of the related asset or liability. As unanticipated prepayments increase, the rate of amortization of these costs increases. This has the effect of decreasing the interest yield from originally anticipated levels. In an increasing interest rate environment, however, the likely decline in prepayment rates tends to maximize the period over which the mortgage loan premium, deferred bond issuance costs and original issue discount are amortized.\nRESULTS OF OPERATIONS 1993 COMPARED TO 1992 - -------------------------------------------\nThe Company's net loss for 1993 was $5.1 million compared to a net loss of $8.2 million for 1992. The Company's primary source of revenue is interest income from the Company's Collateral for CMOs. Interest income totaled $31.7 million for 1993 versus $64.7 million for 1992. This 51% decrease in interest income resulted primarily from the principal repayments (including prepayments) of the Company's Collateral for CMOs, which reduced the average outstanding principal balance from $698.2 million for 1992 to $360.6 million for 1993, combined with a decrease in the effective yield earned on the collateral from 9.27% in 1992 to 8.78% in 1993.\nThe Company incurred interest expense of $37.3 million with respect to CMOs outstanding for 1993, representing a 49% decrease from the $73.5 million of interest expense for 1992. This decrease was primarily due to a decrease in outstanding CMOs from December 31, 1992, partially offset by an increase in the weighted average cost of CMOs from 10.01% in 1992 to 11.05% in 1993. The average outstanding principal balance of CMOs was $338.1 million for 1993 compared to $734.4 million for 1992.\nGeneral and administrative expenses declined to $334,000 from $403,000 for 1993 and 1992, respectively. This decline is attributable to lower legal and professional fees in the administration of the CMOs. Management fees for 1992 were $227,000. There were no such fees in 1993 due to a change in the Management Agreement.\nRESULTS OF OPERATIONS 1992 COMPARED TO 1991 - -------------------------------------------\nThe Company's net loss for 1992 was $8.2 million, compared to net earnings of $2.5 million for 1991. Interest income totaled $64.7 million for 1992 versus $99.0 million for 1991. This decrease in interest income resulted primarily from the principal repayments (including prepayments) of the Company's Collateral for CMOs which reduced the average outstanding principal balance from $1.0 billion for 1991 to $698.2 million for 1992, combined with a decrease in the effective yield earned on the collateral from 9.56% in 1991 to 9.27% in 1992.\nThe Company incurred interest expense of $73.5 million with respect to CMOs outstanding for 1992, representing a 23% decrease from the $95.8 million of interest expense for 1991. This decrease was due to a decrease in outstanding CMOs, partially offset by an increase in the weighted average interest rate on the CMOs from 9.37% in 1991 to 10.01% in 1992. The average outstanding principal balance of CMOs was $734.4 million for 1992 compared to $1.0 billion for 1991.\nGeneral and administrative expenses declined to $403,000 from $417,000 for 1992 and 1991, respectively. This decline is attributable to lower legal and professional fees in the administration of the CMOs. Management fees for 1992 declined to $227,000 from $323,000 for 1991. This decrease resulted principally from the decrease in average invested assets pledged to secure CMOs.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Company's source of funds for repayment of the CMOs are the payments of interest and principal on the mortgage loans and mortgage-backed securities securing the CMOs and income from reinvestment thereof. Management believes that the Company will have sufficient liquidity and capital resources to pay principal and interest on the CMOs as they become due and all other anticipated expenses of the Company.\nINFLATION - ---------\nInflation affects the Company to the extent that it influences interest rates. Interest rates generally will tend to increase during periods of high inflation. High levels of interest rates generally will tend to decrease the rate at which existing investments in mortgage loans prepay. A decrease in the rate of prepayments may lengthen the estimated average life of CMOs resulting in a higher positive net spread between the yield on the investments in mortgage loans pledged to secure the CMOs and the interest cost of the respective CMOs for a longer period of time than originally anticipated.\nPROSPECTIVE TRENDS - ------------------\nDuring 1993, lower long-term interest rates resulted in a high rate of mortgage refinancings. As discussed above, this adversely affects the Company's financial results. Sustained high levels of refinancings and the resulting prepayments could continue to adversely affect the Company's earnings.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nThe information called for by this Item 8 is hereby incorporated by reference to the Registrant's Financial Statements beginning at page of this Form 10-K.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------- ----------------------------------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------\nNot required pursuant to General Instruction J(2)(c) of Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nNot required pursuant to General Instruction J(2)(c) of Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN - -------- ----------------------------- BENEFICIAL OWNERS AND MANAGEMENT --------------------------------\nNot required pursuant to General Instruction J(2)(c) of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nNot required pursuant to General Instruction J(2)(c) of Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES - -------- ---------------------------------------- AND REPORTS ON FORM 8-K -----------------------\n(a) (1) and (2): Financial Statements and Schedules:\nThe information called for by these sections of Item 14 is set forth in the Index to Financial Statements beginning at page of this Form 10-K.\n(a) (3) and (c): Exhibits\nThe information called for by these sections of Item 14 is set forth beginning at page E-1 of this Form 10-K.\n(b): Reports on Form 8-K\nNone.\nSIGNATURES\nPursuant 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, in the City of Pasadena, State of California, on March 30, 1994.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC.\nBY: STANFORD L. KURLAND ----------------------------------- Stanford L. Kurland Director\nBY: GERALD L. BAKER ----------------------------------- Gerald L. Baker Director\nBY: MARSHALL M. GATES ----------------------------------- Marshall M. Gates Director\nBY: MICHAEL W. PERRY ----------------------------------- Michael W. Perry Chief Executive Officer (Principal Financial and Accounting Officer)\nCONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nDECEMBER 31, 1993, 1992 AND 1991\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993, 1992 AND 1991\nAll other schedules have been omitted since the required information is not applicable or not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Shareholders Countrywide Mortgage Investments, Inc.\nWe have audited the accompanying consolidated balance sheets of Countrywide Mortgage Obligations III, Inc. (a wholly owned subsidiary of Countrywide Mortgage Investments, Inc.) as of December 31, 1993 and 1992, and the related consolidated statements of earnings, shareholder's equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Countrywide Mortgage Obligations III, Inc. as of December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nWe have also audited Schedule XII of Countrywide Mortgage Obligations III, Inc. as of December 31, 1993. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nGRANT THORNTON\nLos Angeles, California February 28, 1994\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY Of COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nCONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nCONSOLIDATED STATEMENTS OF EARNINGS (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nCONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of this statement.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA summary of the Company's significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows:\n1. BASIS OF PRESENTATION ---------------------\nCertain amounts for 1992 and 1991 have been reclassified to conform to the 1993 presentation.\n2. INCOME TAXES ------------\nThe Company is a qualified real estate investment trust subsidiary (\"QRS\") of Countrywide Mortgage Investments, Inc. (the \"Parent\") which operates as a real estate investment trust (\"REIT\") under the provisions of the Internal Revenue Code. As a QRS, the Company is not treated as a separate corporation for income tax purposes and all assets, liabilities and items of income, deductions and credits of the Company are treated as such items of the REIT. Accordingly, no provision for income taxes on the net earnings of the Company has been made in the accompanying financial statements.\nIf in any tax year the Company fails to continue to qualify as a QRS, then the Parent would be disqualified as a REIT and, therefore, the Parent would be subject to income taxes on its and the Company's earnings.\n3. COLLATERAL FOR CMOS -------------------\nCollateral for CMOs consist of mortgage loans and mortgage-backed securities and is carried at the outstanding principal balances net of unamortized purchase discounts or premiums.\n4. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) AND DEFERRED BOND ISSUANCE COSTS ---------------------------------------------------------------------------\nCollateralized mortgage obligations are carried at their outstanding principal balances net of unamortized original issue discounts or premiums. Issuance costs have been deferred and are amortized to expense over the estimated life of the CMOs using the straight-line method with effect given to principal reductions.\n5. REVENUE RECOGNITION -------------------\nInterest is recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectable. Premiums paid and discounts obtained on collateral for CMOs are amortized to interest income over the estimated life of the mortgage loans using the interest method with effect given to principal reductions. CMO discounts or premiums are amortized to interest expense using the interest method with effect given to principal reductions.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEAR ENDED DECEMBER 31, 1993, 1992 AND 1991\n6. FAIR VALUE OF FINANCIAL INSTRUMENTS -----------------------------------\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires that the Company disclose estimated fair values for its financial instruments.\nCollateral for CMOs cannot be sold until the related obligations mature or are otherwise paid or redeemed. In addition, early redemption of a CMO series is restricted by the respective indenture. Accordingly, due to the nature of Collateral for CMOs and CMOs, such market values are not disclosed. As a REIT, the Company's ability to sell these assets for gain also is subject to restrictions under the Internal Revenue Code and any such sale may result in substantial additional tax liability.\nFair values of guaranteed investment contracts (\"GICs\"), accrued interest receivable, deferred bond issuance costs, due from affiliate, other assets, accrued interest payable and accounts payable and accrued liabilities are not separately disclosed as such values approximate carrying amounts because of the nature of the underlying asset of liability.\nNOTE B - COLLATERAL FOR CMOS\nCollateral for CMOs consists of fixed-rate mortgage loans secured by first liens (enforceable through foreclosure proceedings) on one-to-four family residential real estate and mortgage-backed securities.\nAll principal and interest on the collateral is remitted to a trustee, and together with any reinvestment income earned thereon, is available for payment on the CMOs. Generally, any default of a mortgage loan which is the basis for a foreclosure action is covered (up to an aggregate benefit limit) under a pool insurance policy provided by a private mortgage insurer. Furthermore, the Company's mortgage-backed securities are guaranteed as to the repayment of principal and interest of the underlying mortgages by the Federal Home Loan Mortgage Corporation. The maximum amount of credit risk related to the Company's Collateral is represented by the outstanding principal balance of the mortgage loans plus accrued interest.\nCollateral for CMOs is summarized as follows:\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nThe mortgage loans and mortgage-backed securities, together with GICs, which are all held by trustees, collateralized 14 series of CMOs at December 31, 1993. A time lag of 24 to 45 days exists from the date the underlying mortgage is prepaid to the date the Company actually receives the cash related to the prepayment. During this interim period, the Company does not earn interest income on the portion of the mortgage loan or mortgage-backed security that has been prepaid. The weighted average coupon on collateral for CMOs, net of the related servicing fees, was 9.71% at December 31, 1993.\nNOTE C - COLLATERALIZED MORTGAGE OBLIGATIONS\nCollateralized mortgage obligations are secured by a pledge of mortgage loans, mortgage-backed securities or residual cash flows from such loans or securities. As required by the Indentures relating to the CMOs, the pledged collateral is in the custody of a trustee. The trustee also holds investments in GICs amounting to $18.6 million and $39.8 million as of December 31, 1993 and 1992, respectively, as additional collateral which is legally restricted to use in servicing the CMOs. The trustee collects principal and interest payments on the underlying collateral, reinvests such amounts in the GICs and makes corresponding principal and interest payments on the CMOs to the bondholders. The separate assets of the Company, included in the consolidated financial statements of the Parent, substantially all of which collateralize the CMOs, are generally not available for the satisfaction of the creditors of the Parent. In addition, the contributed capital of the Company which amounted to $83.3 million at December 31, 1993, is generally not available for transfer in the form of cash dividends, loans or advances.\nIn general, each series of CMOs consists of various classes which are retired in order of maturity with the shortest maturity class receiving all principal payments until it is paid in full. After the first class is fully retired, the second class will receive principal until retired and so forth. Each series is also subject to redemption according to specific terms of the respective indentures. As a result, the actual maturity of any class of a CMO series is likely to occur earlier than its stated maturity.\nInterest is payable quarterly for all classes other than deferred interest classes. Interest on deferred interest classes is accrued and added to the principal balance and will not be paid until all other classes in the series have been paid in full. The weighted average coupon on CMOs was 9.22% at December 31, 1993.\nCMOs are summarized as follows:\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nDuring 1993, the Company redeemed two series of CMOs (the \"Series\"), in accordance with the terms of the indentures governing the Series. The mortgage- backed securities that collateralized the Series were sold and the Company recognized a gain of $917,000.\nNOTE D - RELATED PARTY TRANSACTIONS\nThe Parent has entered into an agreement (the \"Management Agreement\") with Countrywide Asset Management Corporation (the \"Manager\") to advise the Parent on various facets of its business and manage its operations, subject to supervision by the Parent's Board of Directors. The Manager has entered into a subcontract with its affiliate, Countrywide Funding Corporation (\"CFC\"), to perform such services for the Parent as the Manager deems necessary.\nFor performing these services in 1992, the Manager received a management fee equal to 1\/32 of 1% of such average invested assets, with such fee being no less than $10,000 annually for each series of CMOs, except the CCFBT, for which the annual fee is $1,000. In 1992, the Manager earned management fees from the Company totaling $227,000. There were no such fees in 1993 due to a change in the Management Agreement. The Management Agreement is renewable annually and expires May 15, 1994.\nThe Company has entered into servicing agreements appointing CFC as servicer of two series of CMOs that are collateralized by pools of whole mortgage loans. CFC is entitled under each agreement to an annual fee up to .32% of the aggregate unpaid principal balance of the pledged mortgage loans. Net servicing fees paid to CFC under such agreements were $61,000, $181,000 and $318,000 for 1993, 1992 and 1991, respectively.\nThe Manager and CFC are wholly owned subsidiaries of Countrywide Credit Industries, Inc., a diversified financial services company whose shares of common stock are traded on the New York Stock Exchange.\nIn connection with the issuance in 1990 of bonds secured by residual cash flows from Collateral for CMOs (the cash flow bonds), the Company received the proceeds of $22.9 million and loaned such amount to the Parent. For each year, the Company earned interest of $2.4 million on this receivable. The principal and interest receivable totaling $30.5 at December 31, 1993 is included in due from affiliate in the accompanying consolidated balance sheet.\nCOUNTRYWIDE MORTGAGE OBLIGATIONS III, INC. (A WHOLLY OWNED SUBSIDIARY OF COUNTRYWIDE MORTGAGE INVESTMENTS, INC.)\nSCHEDULE XII - MORTGAGE LOANS ON REAL ESTATE (DOLLAR AMOUNTS IN THOUSANDS)\nDecember 31, 1993\n- ---------------- (1) All mortgage loans are fixed-rate, conventional mortgage loans secured by single (one-to-four) family residential properties.\n(2) Information with respect to the geographic breakdown of first mortgages on single-family residential housing as of December 31, 1993 is as follows: California 49% with no other state comprising more than 14%.\n(3) The aggregate cost for federal income tax purposes is $9,277.\n(4) Interest earned on mortgages by range of carrying amounts is not reasonably obtainable.\n(5) Generally, any default of a mortgage loan which is the basis of a foreclosure action is covered (up to an aggregate benefit limit) under a pool insurance policy provided by a private mortgage insurer.\n(6) Balance at beginning of period $29,056 Additions during period - ------- 29,056 Deductions during period: Collections of principal 19,839 ------- Balance at close of period $9,217 =======\nEXHIBIT INDEX -------------\n___________ * Incorporated by reference herein.","section_15":""}
{"filename":"30371_1993.txt","cik":"30371","year":"1993","section_1":"ITEM 1. BUSINESS. Duke Power Company (the Company) is engaged in the generation, transmission, distribution and sale of electric energy in the central portion of North Carolina and the western portion of South Carolina, comprising the area in both States known as the Piedmont Carolinas. Its service area, approximately two-thirds of which lies in North Carolina, covers about 20,000 square miles with an estimated population of 4.8 million and includes a number of cities, of which the largest are Charlotte, Greensboro, Winston-Salem and Durham in North Carolina and Greenville and Spartanburg in South Carolina. During 1993, the Company's electric revenues amounted to approximately $4.3 billion, of which about 70 percent was derived from North Carolina and about 30 percent from South Carolina. The Company ranks sixth in the United States among investor-owned utilities in kilowatt-hour sales. Its executive offices are located in the Power Building, 422 South Church Street, Charlotte, North Carolina 28242-0001 (Telephone No. 704-594-0887). THE STATISTICS PRESENTED HEREIN DO NOT INCLUDE INFORMATION RELATING TO THE COMPANY'S UTILITY SUBSIDIARY, NANTAHALA POWER AND LIGHT COMPANY, UNLESS OTHERWISE INDICATED. (SEE \"ENERGY REQUIREMENTS AND CAPABILITY.\") SERVICE AREA The Company supplies electric service directly to approximately 1.7 million residential, commercial and industrial customers in more than 200 cities, towns and unincorporated communities in North Carolina and South Carolina. Electricity is sold at wholesale to nine incorporated municipalities and to several private utilities. In addition, in 1993 approximately 9% of total sales were made through contractual arrangements to former wholesale municipal or cooperative customers of the Company who had purchased portions of the Catawba Nuclear Station (collectively, the \"Other Catawba Joint Owners\") (See \"Joint Ownership of Generating Facilities.\") The Company's service area is undergoing increasingly diversified industrial development. The textile, manufacture of machinery and equipment, chemical and chemical related industries are of major significance to the economy of the area. Other industrial activity includes the paper and allied products, rubber and plastic products and various other light and heavy manufacturing and service businesses. The largest industry served by the Company is the textile industry, which accounted for approximately $488 million of the Company's revenues for 1993, representing 11 percent of electric revenues and 40 percent of electric industrial revenues. ENERGY REQUIREMENTS AND CAPABILITY The following table sets forth the Company's generating capability at December 31, 1993, its sources of electric energy for 1993, and certain information presently projected for 1994:\n(a) The data relating to capability does not reflect the possible unavailability or reduction of capability of facilities at any given time because of scheduled maintenance, repair requirements or regulatory restrictions. (b) Nuclear capability and related generation for 1993 and projected for 1994 give no effect to the joint ownership of the Catawba Nuclear Station. (See \"Joint Ownership of Generating Facilities.\")\n(c) Includes Bad Creek and Jocassee pumped storage hydroelectric stations at licensed generating capabilities of 1,065,000 KW and 610,000 KW, respectively. (d) Excludes firm purchases. (See \"Energy Management and Future Power Needs.\") Nantahala Power and Light Company (NP&L), which operates 11 hydroelectric stations and buys supplemental power to provide service to its 51,000 mostly residential customers located in five counties in western North Carolina, operates as a separate subsidiary of the Company. The Company is supplying supplemental power to NP&L under the terms of an interconnect agreement approved by the Federal Energy Regulatory Commission (FERC). The Company has a bulk power sales agreement with Carolina Power & Light Company (CP&L) to provide CP&L 400 megawatts of capacity as well as associated energy when needed for a six-year period which began July 1, 1993. Electric rates in all regulatory jurisdictions were reduced by adjustment riders to reflect capacity revenues received from this agreement. According to industry statistics published in 1993, the Company ranked first in the nation in terms of efficiency of its steam-fossil generating system as measured by the conversion of fuel energy to electric energy. Published rankings indicate that individual units at Marshall Steam Station ranked first, second and sixth most efficient in the nation in 1992. The Company's nuclear system continued its tradition of operating efficiency, operating at 78 percent of capacity for the year, in comparison with the industry's most current average capacity factor of 71 percent for 1992. The Company normally experiences seasonal peak loads in summer and winter which are relatively in balance. The Company currently forecasts a 2.1 percent compound annual growth in peak load through 2008. This amount is not reduced by those future demand-side management program contributions considered resources for meeting peak demand (See \"Energy Management and Future Power Needs\"). The 1992-1993 winter peak load of 13,314,000 KW occurred on February 19, 1993. On July 29, 1993, the Company experienced its summer peak load of 15,720,000 KW during unusually hot weather. A new all-time peak load of 16,070,000 KW occurred on January 19, 1994 during extremely cold weather. RATE MATTERS The North Carolina Utilities Commission (NCUC) and The Public Service Commission of South Carolina (PSCSC) must approve the Company's rates for retail sales within the respective states. FERC must approve the Company's rates for sales to wholesale customers, including the contractual arrangements between the Company and the Other Catawba Joint Owners. Rate requests filed by the Company in its most recent general rate case in 1991 with the NCUC, PSCSC and FERC were principally designed to reflect the Company's investment in the Bad Creek Hydroelectric Station. Rate orders issued by the NCUC and PSCSC in November, 1991 recognized costs of the Bad Creek Hydroelectric Station, including an amortization of costs deferred between commercial operation and the rate order, which the Company had requested. The Company's wholesale customers challenged its proposed rate increase and in 1991 FERC issued an order that accepted the Company's proposed rates for filing. A negotiated settlement with these customers, which provided for an increase in wholesale rates consistent with the increase in retail rates, was approved by FERC and became effective in April 1992 (See \"Management's Discussion and Analysis of Results of Operations and Financial Condition, Liquidity and Resources -- RATE MATTERS\"). In its most recent general rate case, the NCUC authorized a jurisdictional rate of return on common equity of 12.50 percent and the PSCSC authorized a jurisdictional rate of return on common equity of 12.25 percent. The North Carolina Supreme Court, on April 22, 1992, remanded for the second time the Company's 1986 rate order to the NCUC. In its ruling, the Court held that the record from the 1986 proceedings failed to support the rate of return of 13.2 percent on common equity authorized by the NCUC after the initial decision of the Court remanding the 1986 rate order. The NCUC issued a final order dated October 26, 1992, authorizing a 12.8 percent return on common equity for the period October 31, 1986 through November 11, 1991, that resulted in a refund to North Carolina retail customers in 1992 of approximately $95 million, including interest. FUEL COST ADJUSTMENT PROCEDURES. The Company has procedures in all three of its regulatory jurisdictions to adjust rates for fluctuations in fuel expense. The NCUC ordered the Company to follow these procedures in its\nAugust 1986 order, which was effective for periods beginning January 1, 1986. The prospective adjustment in rates of past over- or under-recovery of fuel costs was challenged in the North Carolina courts. North Carolina adopted legislation assuring the legality of such adjustments, which contains a sunset provision effective June 30, 1997. CONSTRUCTION WORK IN PROGRESS (CWIP). The NCUC is permitted in its discretion to include CWIP in rate base after giving consideration to the public interest and the Company's financial stability. The PSCSC may include CWIP in rate base in its discretion. ENERGY MANAGEMENT AND FUTURE POWER NEEDS The Company's strategy for meeting customers' present and future energy needs is composed of three components: demand-side resources, purchased power resources and supply-side resources. By utilizing these resources, the Company expects to maintain a reserve margin of approximately 20 to 25 percent of its anticipated peak load requirements through 1996. Demand-side management programs are a part of meeting the Company's future power needs. These programs benefit the Company and its customers by providing for load control through interruptible control features, shifting usage to off-peak periods, increasing usage during off-peak periods, and by promoting energy efficiency. In return for participation in demand-side management programs, customers may be eligible to receive various incentives which help to reduce their electric bills. Demand-side management programs such as Industrial Interruptible Service and Residential Load Control can be used to manage capacity availability problems. Energy-efficiency programs such as high-efficiency chillers, high-efficiency heat pumps and high-efficiency air conditioners are other examples of current demand-side management programs. The November 1991 rate orders of the NCUC and the PSCSC provided for recovery in rates of a designated level of costs for demand-side management programs and allowed the deferral for later recovery of certain demand-side management costs that exceed the level reflected in rates, including a return on the deferred costs. As additional demand-side costs are incurred, the Company ultimately expects recovery of associated costs, which are currently being deferred, through rates. The annual costs deferred, including the return, were approximately $26 million in 1993 and $18 million in 1992. The Company continues to engage in a comprehensive energy management program as part of its Integrated Resource Plan. Integrated Resource Planning is the process used by utilities to evaluate a variety of resources. The goal is to provide adequate and reliable electricity in an environmentally responsible manner through cost-effective power management. In January 1993, the PSCSC issued an order approving the Company's 1992 Integrated Resource Plan as reasonable, and approving a \"shared savings\" proposal for accomplishments made in the Company's demand-side management programs. In June 1993, the NCUC approved the 1992 plan, including the shared savings mechanism. The Company's current plan reduces supply side requirements in excess of 1,900 megawatts by the year 2000 due to the Company's effective use of demand side options. The purchase of capacity and energy is also an integral part of meeting future power needs. The Company currently has under contract 500 megawatts of capacity from other generators of electricity. The Company's construction program and the estimated construction costs set forth below are subject to continuing review and are revised from time to time in light of changes in load forecasts, the Company's financial condition (including cash flow, earnings and levels of rates), changing regulatory and environmental standards (See \"Regulation -- ENVIRONMENTAL MATTERS\") and other factors.\nProjected construction and nuclear fuel costs, excluding costs related to portions of the Catawba Nuclear Station owned by the Other Catawba Joint Owners, for each of 1994, 1995 and 1996 and for the three-year period 1994-1996, as now scheduled, are as follows (in millions of dollars):\nThe Company's procedures for estimating construction costs (which include allowance for funds used during construction) utilize, among other things, past construction experience, current construction costs and allowances for inflation. The Company is building a combustion turbine facility in Lincoln County, North Carolina to provide capacity at periods of peak demand. The Lincoln Combustion Turbine Station will consist of 16 combustion turbines with a total generating capacity of 1,184 megawatts. The estimated total cost of the project is approximately $500 million. Current plans are for ten units to begin commercial operation by the end of 1995 and the remaining six to begin commercial operation before the end of 1996. During 1991, the NCUC granted the Certificate of Public Convenience and Necessity and the North Carolina Division of Environmental Management issued a final air permit for the facility. The issuance of the final air permit for the facility has been appealed. Legal proceedings with regard to the appeal are ongoing. The Company believes the permit will be upheld. The Company has nearly completed a Plant Modernization Program (PMP) to improve the efficiency and reliability of 15 older coal-fired generating units. These units, once modernized, will help the Company meet anticipated future demand. The cost of this program is estimated to average approximately $200-$300 per installed KW, a fraction of the cost of building new plants. As of December 31, 1993, eleven coal-fired units with a nameplate generating capability of 1,241,000 KW had been returned to the system. It is anticipated that three additional coal-fired generating units with nameplate generating capability of 160,000 KW will be returned to the system during 1994. The Company expects the final unit remaining in the PMP after 1994, which unit has 40,000 KW of nameplate generating capability, to be returned to the system in 1995. JOINT OWNERSHIP OF GENERATING FACILITIES In order to reduce its need for external financing, the Company, through several transactions beginning in 1978, sold an 87 1\/2 percent undivided interest in the Catawba Nuclear Station to the Other Catawba Joint Owners. These transactions contemplate that the Company will operate the facility, interconnect its transmission system, wheel a certain portion of the capacity and energy of such facility to the respective participants, provide back-up services for such capacity, buy for its own use (whether or not the facility is generating electricity) that portion of the capacity not then contractually required by the respective participants, and provide supplemental power as required by the purchasers to enable them to provide service on a firm basis. The transactions also include a reliability exchange between the Catawba Nuclear Station and the McGuire Nuclear Station of the Company, which provides for an exchange of 50 percent of each Other Catawba Joint Owner's retained capacity from its ownership interest in the Catawba units for like amounts of capability and output from units of the McGuire Nuclear Station. The implementation of the reliability exchange has not had nor does the Company anticipate that such implementation will have a material effect on earnings. The Other Catawba Joint Owners and the Company are involved in various proceedings related to the Catawba joint ownership contractual agreements. The basic contention in each proceeding is that certain calculations affecting bills under these agreements should be performed differently. These items are covered by the agreements between the Company and the Other Catawba Joint Owners which have been previously approved by the Company's retail regulatory commissions (See Note 3, \"Notes to Consolidated Financial Statements\"). The Company and two of the four Other Catawba Joint Owners have entered into a proposed settlement agreement\nwhich, if approved by the regulators, will resolve all issues in contention in such proceedings between the Company and these owners. The Company recorded a liability as an increase to Other current liabilities on its Consolidated Balance Sheets of approximately $105 million in 1993 to reflect this proposed settlement. In addition, future estimated obligations in connection with the settlement are reflected in estimates of purchased capacity obligations in Note 3, \"Notes to Consolidated Financial Statements\". As the Company expects the costs associated with this settlement will be recovered as part of the purchased capacity levelization, the Company has included approximately $105 million as an increase to Purchased capacity costs on its Consolidated Balance Sheets. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company. Although the two Other Catawba Joint Owners, who are not parties to the above settlement, have not fully quantified the dollars associated with their claims in the presently outstanding proceedings, information associated with these proceedings indicates that the amount in contention could be as high as $110 million, through December 31, 1993. Arbitration hearings were held in 1992 involving substantially all of the disputed amounts, and a decision interpreting the language of the agreements on certain of these matters was issued on October 1, 1993. Further proceedings will be required to determine the amounts associated with this decision as it relates to these owners, some of which may involve refunds. However, the Company expects the costs associated with this decision will be included in and recovered as part of the purchased capacity levelization consistent with prior orders of the retail regulatory commissions. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company. FUEL SUPPLY The Company presently relies principally on nuclear and coal for the generation of electric energy. The Company's reliance on oil and gas is minimal. Information regarding the utilization of sources of power and cost of fuels is set forth in the following table:\n* Generating figures are net of that output required to replenish pumped storage units during off-peak periods. COAL. The Company obtains a large amount of its coal under long-term supply contracts with mining operators utilizing both underground and surface mining. The Company has on hand an adequate supply of coal. The Company's long-term supply contracts, all of which have price adjustment and price renegotiation provisions, have expiration dates ranging from 1995 to 2003. The Company believes that it will be able to renew such contracts as they expire or to enter into similar contractual arrangements with other coal suppliers for quantities and qualities of coal required. However, due to the Clean Air Act Amendments of 1990, fuel premiums may be required as contracts are renewed. The coal covered by the Company's long-term supply contracts is produced from mines located in eastern Kentucky, southern West Virginia and southwestern Virginia. The Company's short-term requirements have been and will be fulfilled with spot market purchases. The average sulfur content of coal being purchased by the Company is approximately 1 percent. Such coal satisfies the current emission limitation for sulfur dioxide for existing facilities. (See \"Management's Discussion and Analysis of Results of Operations and Financial Condition, Current Issues -- The Clean Air Act Amendments of 1990.\") NUCLEAR. Generally, the supply of fuel for nuclear generating units involves the mining and milling of uranium ore to produce uranium concentrates, the conversion of uranium concentrates to uranium hexafluoride, enrichment of that gas and fabrication of the enriched uranium hexafluoride into usable fuel assemblies. After a region (approximately one-third of the nuclear fuel assemblies in the reactor at any time) of spent fuel is removed\nfrom a nuclear reactor, it is placed in temporary storage for cooling in a spent fuel pool at the nuclear station site. The Company has contracted for uranium materials and services required to fuel the Oconee, McGuire and Catawba Nuclear Stations. Based upon current projections, these contracts will meet the Company's requirements through the following years:\nUranium material requirements will be met through various supplier contracts, with uranium material produced primarily in the U.S., Canada and Australia. The Company believes that it will be able to renew contracts as they expire or to enter into similar contractual arrangements with other nuclear fuel materials and services suppliers. Short-term requirements have been and will be fulfilled with uranium spot market purchases. The Company purchased uranium material during 1993 at an average price of approximately $28 per pound. The Company's material nuclear supply contracts generally contain FORCE MAJEURE provisions. The Nuclear Waste Policy Act of 1982 requires that the Department of Energy (DOE) begin disposing of spent fuel no later than January 31, 1998. The Company has entered into the required contracts with the DOE for the disposal of nuclear fuel and began making payments in July 1983 for disposal costs of fuel currently being utilized. These payments, combined with a one-time payment for disposal costs of fuel consumed prior to April 7, 1983, have totaled about $525 million through 1993. In November 1989, the DOE released a report which indicated that it expects that a facility for spent fuel disposal will not be available until the year 2010. The DOE stated further that it planned an initiative to establish a monitored retrievable storage facility, with a target operation date of 1998, for earlier acceptance of spent fuel from utilities. The Company believes that it will be able to provide adequate on-system storage capacity until such time as the DOE begins receiving spent fuel. REGULATION The Company is subject to the jurisdiction of the NCUC and the PSCSC which, among other things, must approve the issuance of securities. The Company also is subject, as to some phases of its business, to the jurisdiction of FERC, the Environmental Protection Agency (EPA) and state environmental agencies and to the jurisdiction of the Nuclear Regulatory Commission (NRC) as to design, construction and operation of its nuclear power facilities. The Company is exempt from regulation as a holding company under the Public Utility Holding Company Act of 1935 (PUHCA), except with respect to the acquisition of the securities of other public utilities. ENVIRONMENTAL MATTERS. The Company is subject to federal, state, and local regulations with regard to air and water quality, hazardous and solid waste disposal, and other environmental matters. North Carolina has enacted a declaration of environmental policy requiring all state agencies to administer their responsibilities in accordance with such policy. The NCUC has adopted rules requiring consideration of environmental effects in determining whether certificates of public convenience and necessity will be granted for proposed generation facilities. South Carolina law also requires consideration by the PSCSC of environmental effects in determining whether certificates of public convenience and necessity will be granted for proposed major utility facilities, which include certain generation and transmission facilities. All of the Company's facilities which are currently under construction have been designed to comply with presently applicable environmental regulations. Such compliance has, however, increased the cost of electric service by requiring changes in the design and operation of existing facilities, as well as changes or delays in the design, construction and operation of new facilities. In 1993, the Company's construction costs for environmental protection totaled approximately $18 million, while the on-going environmental operation costs were approximately $20 million. The Company's 1994 -- 1996 construction program includes costs for environmental protection which are estimated to be approximately $101 million, including $22.3 million in 1994, $41.8 million in 1995 and $36.9 million in 1996. These costs include expenditures to begin compliance with the Clean Air Act Amendments of 1990. However, governmental regulations establishing environmental protection standards are continually evolving and have not, in some cases, been fully established. Therefore, the Company may have to revise the estimates in response to developments in these and other areas.\nAIR QUALITY. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition, Current Issues -- The Clean Air Act Amendments of 1990\" for a discussion of the Company's plans for compliance with federal clean air standards. WATER QUALITY. The Federal Water Pollution Control Act Amendments of 1987 (otherwise known as the \"Clean Water Act\") require permits for facilities that discharge into waters, to ensure compliance with its provisions. The Company holds numerous such permits, and such permits are reissued periodically. The Federal Water Pollution Control Act is scheduled for reauthorization by Congress in 1994. Until Congress acts upon the reauthorization, management will be unable to assess what effect, if any, such reauthorization will have on the Company's operations. OTHER ENVIRONMENTAL REGULATIONS. Contingencies associated with environmental matters are principally related to possible obligations to remove or mitigate the effects on the environment resulting from the disposal of certain substances at contamination sites. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), commonly known as \"Superfund\", requires any individual or entity which may have owned or operated a contaminated site, as well as transporters or generators of hazardous wastes which were sent to such site, to assume joint and several responsibility for remediation of the site. Such parties are known as \"potentially responsible parties\" (PRPs). In 1993, Duke as a PRP, resolved litigation at a Superfund site in West Virginia, and is currently participating in a PRP group with regard to a Superfund site in Concord, North Carolina. Additionally, the Company is a DE MINIMUS contributor at two sites in Pennsylvania. The Company is also a PRP at contamination sites in Charlotte, North Carolina and Lenoir, North Carolina, which will likely be remediated in accordance with state acts which are similar to CERCLA. While the total cost of remediation at these federal and state contamination sites may be substantial, the Company shares probable liability with other PRPs, many of which have substantial assets. Other contamination sites relate to the Company's operation of manufactured gas plant (MGP) sites prior to the early 1950s, some of which are still owned by the Company and some of which are now owned by third parties. The Company is participating in a state-sponsored program which will result in the investigation and, where appropriate, remediation of MGP sites. Management is of the opinion that resolution of these matters will not have a material adverse effect on the results of operations or financial position of the Company. CERCLA is scheduled for reauthorization by Congress in 1994. Until Congress acts upon the reauthorization, management will be unable to assess what effect, if any, such reauthorization will have on the Company's operations. GENERAL. Over the past few decades, the issue of the possible health effects of electric and magnetic fields has generated a number of generally inconclusive studies, some public concern and litigation as well as legislative action in some states regarding high voltage transmission lines. The impact of this issue on the Company cannot presently be determined. NUCLEAR FACILITIES. The Company's nuclear facilities are subject to continuing regulation by the NRC. The steam generators at the McGuire and Catawba Nuclear Stations have experienced stress corrosion cracking in their tubes. Stress corrosion cracking is a phenomenon that typically occurs in tight U-bends, at tube support plates, and where tubes are attached to the tube sheets. Stress corrosion cracking has been identified as a problem in steam generators of certain designs, including those at the McGuire and Catawba Stations. The Company believes that the stress corrosion cracking is caused by defective design, workmanship and materials used by the manufacturer of the steam generators. Both primary side and secondary side cracking and corrosion have been observed in the steam generators at the McGuire and Catawba Stations. In addition, recent inspections at McGuire Units 1 and 2 have revealed a different type of secondary side stress corrosion cracking in the free-span area of the steam generator tubes located on the \"cold-leg\" side of those Units (cold-leg free-span cracking). The Company conducts tests at each refueling outage to determine the extent of stress corrosion cracking during the preceding fuel cycle. The steam generators at Catawba Unit 2 have certain design differences from those at Catawba Unit 1 or either McGuire Unit, but it is too early in the life of Catawba Unit 2 to determine the extent to which stress corrosion cracking will be a problem.\nAlthough the Company has taken steps to mitigate the effects of stress corrosion cracking in the McGuire and Catawba steam generator tubes, including examining the steam generator tubes at each refueling outage, tube plugging, tube sleeving, more stringent water chemistry control, shot peening, and tight U-bend heat treatment, further stress corrosion cracking in the McGuire Units 1 and 2 and Catawba Unit 1 steam generators appears likely. Potential consequences of future stress corrosion cracking include extensive tube plugging and sleeving, additional water chemistry control, additional inspections and testing resulting in longer outages, mid-cycle outages, reduction in plant output, and requests for license amendments. The Company has compared the cost of continued repair of the steam generators with the cost of early steam generator replacement and has determined that for McGuire Units 1 and 2 and Catawba Unit 1, the most cost-effective alternative is to replace the steam generators as soon as it is feasible to do so. The Company has begun planning for the replacement of steam generators and has set the following schedule to begin the process: McGuire Unit 1 -- 1995; Catawba Unit 1 -- 1996; McGuire Unit 2 -- 1997. The order of replacement is subject to change based on performance of the existing steam generators and on the overall performance of the three units. The Company has signed an agreement with Babcock & Wilcox International to purchase 12 replacement steam generators for the McGuire and Catawba Stations. Each unit's steam generator replacement is expected to take approximately four months and cost approximately $170 million, excluding the cost of replacement power and without consideration of reimbursement of applicable costs by the Other Catawba Joint Owners of Catawba Unit 1. Stress corrosion problems are excluded under the nuclear insurance policies. The Company anticipates that the replacement of the steam generators should not have a material adverse effect on the Company's results of operations or financial position. Because Catawba Unit 2 has not shown the degree of stress corrosion cracking which has occurred in McGuire Units 1 and 2 and Catawba Unit 1, the Catawba Unit 2 steam generators have not been scheduled for replacement. The Company in connection with its McGuire and Catawba stations and on behalf of the Other Catawba Joint Owners commenced a legal action on March 22, 1990, in the United States District Court for the District of South Carolina (Charleston Division) seeking damages from Westinghouse Electric Corporation (Westinghouse) for supplying to the McGuire and Catawba Stations steam generators that were alleged to be defective in design, workmanship and materials, and that will require replacement well short of their stated design life. In the action, the Company sought a judgment against Westinghouse for damages of approximately $600 million, including the cost of necessary remedial measures, the cost of replacement of steam generators and payment for replacement power during the outages to accomplish replacement. In addition to these damages, the Company sought punitive or treble damages and attorneys' fees. The lawsuit was settled on March 17, 1994. (See \"Subsequent Events.\") NUCLEAR DECOMMISSIONING COSTS. Estimated site-specific nuclear decommissioning costs, including the cost of decommissioning plant components not subject to radioactive contamination, total approximately $955 million stated in 1990 dollars. This amount includes the Company's 12.5 percent ownership in the Catawba Nuclear Station. The Other Catawba Joint Owners are liable for providing decommissioning related to their ownership interest in the Catawba Nuclear Station. Both the NCUC and the PSCSC have granted the Company recovery of the estimated site-specific decommissioning costs through retail rates over the expected remaining service periods of the Company's nuclear plants. Such estimates presume that units will be decommissioned as soon as possible following the end of their license life. Although subject to extension, the current operating licenses for the Company's nuclear units expire as follows: Oconee 1 and 2 -- 2013, Oconee 3 -- 2014; McGuire 1 -- 2021, McGuire 2 -- 2023; and Catawba 1 -- 2024, Catawba 2 -- 2026. The Nuclear Regulatory Commission (NRC) issued a rulemaking in 1988 which requires an external mechanism to fund the estimated cost to decommission certain components of a nuclear unit subject to radioactive contamination. In addition to the required external funding, the Company maintains an internal reserve to provide for decommissioning costs of plant components not subject to radioactive contamination. During 1993, the Company expensed approximately $52.5 million which was contributed to the external funds and accrued an additional $5 million to the internal reserve. The balance of the external funds as of December 31, 1993, was $118.5 million. The balance of the internal reserve as of December 31, 1993, was $200 million and is reflected in Accumulated depreciation and amortization on the Consolidated Balance Sheets. Management's opinion is that the estimated site-specific decommissioning costs being recovered through rates, when coupled with assumed after-tax fund earnings of 4.5 percent to 5.5 percent, are currently sufficient to provide for the cost of decommissioning based on Company's current decommissioning schedule.\nA provision in the Energy Policy Act of 1992 established a fund for the decontamination and decommissioning of the DOE's uranium enrichment plants. Licensees are subject to an annual assessment for 15 years based on their pro rata share of past enrichment services. The annual assessment is recorded as fuel expense. The Company paid approximately $8.3 million during 1993 related to its ownership interest in nuclear plants. The Company has reflected the remaining liability and regulatory asset of approximately $117 million in the Consolidated Balance Sheets. NUCLEAR INSURANCE. For a discussion of the Company's nuclear insurance coverage, see \"Notes to Consolidated Financial Statements, Note 13 -- Commitments and Contingencies -- Nuclear Insurance.\" HYDROELECTRIC LICENSES. The principal hydroelectric projects of the Company are licensed by FERC under Part I of the Federal Power Act. Eleven developments on the Catawba-Wateree River in North Carolina and South Carolina, with a nameplate rating of 804,940 KW, are licensed for a term expiring in 2008. The Company also holds a license for the Keowee-Toxaway Project for a term expiring in 2016, covering the Keowee Hydro Station and the Jocassee Pumped Storage Station for a combined total of 769,500 KW, on the upper tributaries of the Savannah River in northwestern South Carolina. Additionally, the Company is the licensee through 2027 for the Bad Creek Hydroelectric Station which uses Lake Jocassee as its lower reservoir and has a nameplate rating of 1,065,000 KW. The Federal Power Act provides, among other things, that, upon the expiration of any license issued thereunder, the United States may (a) grant a new license to the licensee for the project, (b) take over the project upon payment to the licensee of its \"net investment\" in the project (but not in excess of the fair value thereof) plus severance damages, or (c) grant a license for the project to a new licensee subject to payment to the former licensee of the amount specified in (b) above. INTERCONNECTIONS The Company has major interconnections and arrangements with its neighboring utilities which it considers adequate for coordinated planning, emergency assistance, exchange of capacity and energy, and reliability of power supply. COMPETITION The Company currently is subject to competition in some areas from government-owned power systems, municipally-owned electric systems, rural electric cooperatives and, in certain instances, from other private utilities. Statutes in North Carolina and South Carolina provide for the assignment by the NCUC and the PSCSC, respectively, of all areas outside municipalities in such states to power companies and rural electric cooperatives. Substantially all of the territory comprising the Company's service area has been so assigned. The remaining areas have been designated as unassigned and in such areas the Company remains subject to competition. A decision of the North Carolina Supreme Court limits, in some instances, the right of North Carolina municipalities to serve customers outside their corporate limits. In South Carolina there continues to be competition between municipalities and other electric suppliers outside the corporate limits of the municipalities, subject, however, to the regulation of the PSCSC. In addition, the Company is engaged in continuing competition with various natural gas providers. The Energy Policy Act of 1992 has far-reaching implications for the Company by moving utilities toward a more competitive environment. The Act reformed certain provisions of the Public Utility Holding Company Act of 1935 (PUHCA) and removed certain regulatory barriers. For example, the Act allows utilities to develop independent electric generating plants in the United States for sales to wholesale customers, as well as to contract for utility projects internationally, without becoming subject to registration under PUHCA as an electric utility holding company. The Act requires transmission of power for third parties to wholesale customers, provided that the reliability of service to the utility's local customer base is protected and the local customer base does not subsidize the third-party service. Although the Act does not require transmission access to retail customers, states can authorize such transmission access to and for retail electric customers. The electric utility industry is predominantly regulated on a basis designed to recover the cost of providing electric power to its retail and wholesale customers. If cost-based regulation were to be discontinued in the industry for any reason, including competitive pressure on the price of electricity, utilities might be forced to reduce their assets to reflect market basis if such basis is less than cost. Discontinuation of cost-based regulation could also require some utilities to write off their regulatory assets. Management cannot predict the potential impact, if\nany, of these competitive forces on the future financial position and results of operations of the Company. However, the Company is continuing to position itself to effectively meet these challenges by maintaining prices that are regionally and nationally competitive. NON-UTILITY ACTIVITIES The Company is engaged in a variety of non-utility operations, including real estate development and forest management, marketing of electrical appliances, management of passive financial investments, developing and investing in electric generation and transmission facilities outside the Company's service area and providing engineering and technical services. Most of the Company's non-utility operations are organized in separate subsidiaries. Subsidiary and diversified operations contributed $22 million after tax to corporate earnings in 1993. A major part of the future growth in the electric power market is anticipated to be outside the traditional regulated framework and, to a large extent, outside the United States. The Company, through its subsidiaries, is participating in these international opportunities and continues participating in domestic opportunities to provide additional value to its shareholders. Internationally, the Company is seeking opportunities to provide engineering consulting services, construction, operation and maintenance of generating facilities, and ownership of transmission and generating facilities. Although these opportunities are concentrated in areas that utilize the Company's expertise, they present different and greater risks than the Company's core business. The Company considers only opportunities in which the expected return is commensurate with the risks, and makes efforts to mitigate such risks. In March 1993, Duke Energy Group (DEG) invested $25 million in convertible preferred stock of J. Makowski & Company (Makowski), a developer of natural gas-fired electric projects, and is providing $10.2 million in credit support for a Makowski project. Additionally, DEG has one seat on the Board of Directors of Makowski. In June 1993, after a competitive bidding process, the Argentine government awarded the right to buy 65 percent of the stock of Compania de Transporte de Energia Electrica en Alta Tension S. A. (Transener) to a consortium led by DEG. Transener is Argentina's primary transmission company. It employs about 1,100 persons, and has 6,867 kilometers of 500 kilovolt lines, 284 kilometers of 220 kilovolt lines, and 27 substations. The consortium assumed ownership and operation of the system on July 16, 1993. Another consortium, also led by DEG, was awarded the majority ownership and operation of Hidroelectrica Piedra del Aguila S.A. on November 29, 1993. Hidroelectrica Piedra del Aguila S.A. owns a hydroelectric facility located in southwestern Argentina. When fully operational in 1995, the facility will have a capacity of 1,400 megawatts. The consortium assumed ownership of 59 percent of the stock of Hidroelectrica Piedra del Aguila S.A., and took over operation of the hydroelectric complex on December 29, 1993. EMPLOYEES At December 31, 1993, the Company employed 18,274 full-time persons, which includes 789 full-time employees of subsidiaries and affiliates. About 2,000 electrical operating employees are represented by the International Brotherhood of Electrical Workers (IBEW). The Company reached a new labor agreement with the IBEW, effective October 1, 1993, for a one year term. The Company has been engaged in a concentrated effort to more efficiently and effectively utilize its resources through better work practices. During the first quarter of 1993, the Company offered a Limited Period Separation Opportunity Program (LPSO) which gave employees the option of leaving the Company for a lump sum severance payment and, for qualifying employees, enhanced retirement benefits. On March 15, 1994, the Company announced plans to offer Enhanced Voluntary Separation (EVS), a severance package, for employees who choose to leave the Company voluntarily during the second quarter of 1994. Implementing programs such as LPSO, EVS and other efficiency practices has resulted in continued workforce reduction and in streamlined workflows. The number of full-time employees has decreased to the present level from 19,945 at year-end 1990. The 1990 amount included 496 employees of subsidiaries and affiliates.\nSUBSEQUENT EVENTS On January 25, 1994, the Board of Directors selected William H. Grigg, Vice Chairman of the Board, to succeed William S. Lee as Chairman of the Board, President and Chief Executive Officer, effective at the Annual Meeting of Shareholders to be held on April 28, 1994. Mr. Lee will serve the Company as a consultant after that date until his retirement following his 65th birthday in June 1994. On March 2, 1994, the Duke Endowment announced its intention to diversify its investment portfolio by selling up to 16 million shares of its Duke Power Common Stock. A registration statement was filed with the Securities and Exchange Commission on that day and underwriting agreements were entered into on March 29, 1994 relating to the sale of 14 million of such shares, with over-allotment options of up to 2 million shares. The Duke Endowment will retain approximately 10 million shares after the sale (assuming the over-allotment options are exercised), and has announced that it has no present intention to dispose of any additional shares of Common Stock. On March 17, 1994, the Company, together with the Other Catawba Joint Owners, settled the lawsuit initiated by the Company on March 22, 1990 against Westinghouse Electric Corporation seeking damages for supplying to the McGuire and Catawba Nuclear Stations steam generators that were alleged to be defective in design, workmanship and materials and that would require replacement well short of their stated design life. While the terms of the settlement may not be disclosed pursuant to court order, the Company believes the litigation was settled on terms that provided satisfactory consideration to the Company. Such settlement will not have a material effect on the Company's results of operations or financial position. (See \"Regulation -- Nuclear Facilities\" and \"Management's Discussion and Analysis of Results of Operations and Financial Condition, Current Issues -- Stress Corrosion Cracking.\")\n(graphic--full page map showing the Duke Power Service Area)\nDUKE POWER COMPANY OPERATING STATISTICS\n(a) Includes 100% of Catawba generation. (b) 1991 includes KWH of the Bad Creek Hydroelectric Station prior to commercial operation. (c) Kilowatt-hour sales, Electric revenues and Net interchange and purchased power for the years 1989 and 1990 include a reclassification for certain power transactions previously classified as Net interchange and purchased power prior to a 1990 FERC order. (d) Does not reflect operating statistics, kilowatt-hour sales and revenues of Nantahala Power and Light Company. (e) Includes sales to Nantahala Power and Light Company. (f) 1991 restated to eliminate certain duplicate customers.\nEXECUTIVE OFFICERS OF THE COMPANY\nOTHER OFFICERS\n* As of February 1, 1994. **Member of the Management Committee.\nExecutive officers are elected annually by the Board of Directors and serve until the first meeting of the Board of Directors following the next annual meeting of shareholders and until their successors are duly elected. There are no family relationships between any of the executive officers nor any arrangement or understanding between any executive officer and any other person pursuant to which the officer was selected. All of the above executive officers have held responsible positions with the Company for the past five years. There have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any executive officer during the past five years. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. The map on page 12 shows the location of the Company's service area and generating stations. Reference is made to Schedule V -- Property, Plant and Equipment for information concerning the Company's investment in utility plant. Substantially all electric plant is mortgaged under the Indenture relating to the First and Refunding Mortgage Bonds of the Company. For additional information concerning the properties of the Company, see \"Business -- Energy Management and Future Power Needs\". ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. Reference is made to \"Notes to Consolidated Financial Statements, Note 13 -- Commitments and Contingencies\", \"Business -- Regulation -- NUCLEAR FACILITIES\" and \"Subsequent Events\". ITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's security holders during the last quarter of 1993. PART II. ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Common Stock of the Company is traded on the New York Stock Exchange. At December 31, 1993, there were approximately 127,688 holders of shares of such Common Stock. The following table sets forth for the periods indicated the dividends paid per share of Common Stock and the high and low sales prices of such shares reported by the New York Stock Exchange Composite Transactions:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(a) Electric revenues, Electric expenses, Kilowatt-hour sales and Net interchange and purchased power for the years 1989 and 1990 include a reclassification for certain power transactions previously classified as Net interchange and purchased power prior to a 1990 FERC order. (b) All common stock data reflects the two-for-one split of common stock on September 28, 1990.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition\nResults of Operations Earnings and Dividends Earnings per share increased 27 percent from $2.21 in 1992 to $2.80 in 1993. The increase was primarily due to higher kilowatt-hour sales and a one-time charge taken in 1992 related to a rate refund to North Carolina retail customers of $.32 per share. (For additional information on the refund, see Liquidity and Resources \"Rate Matters,\" page 18.) The increase was partially offset by higher operating and maintenance expenses, additional charitable contributions to the Duke Power Company Foundation and an increase in the federal income tax rate caused by the Omnibus Budget Reconciliation Act of 1993. Higher general taxes also decreased earnings.\nEarnings per share increased from $2.60 in 1991 to $2.80 in 1993, indicating an average annual growth rate of 4 percent. Total Company earned return on average common equity was 13.6 percent in 1993 compared to 11.1 percent in 1992 and 13.5 percent in 1991.\nThe Company continued its practice of increasing the common stock dividend annually. Common dividends per share increased from $1.68 in 1991 to $1.84 in 1993, rising at an average annual rate of 5 percent. Indicated annual dividends per share increased to $1.88.\nRevenue and Sales Revenues increased at an average annual rate of 6 percent from 1991 to 1993, primarily because of increased overall kilowatt-hour sales and the November 1991 rate increases.\nKilowatt-hour sales for 1993 increased 7 percent compared to 1992. Sales to residential customers increased by 9 percent reflecting colder winter weather and a hotter-than-normal summer. General service customer kilowatt-hour sales increased by 7 percent as a result of both continued economic growth and weather trends cited above. Sales to other-industrial customers and textile customers increased by 6 percent and 2 percent, respectively, as a result of the continued economic growth in the Company's service area.\nOperating Expenses From 1992 to 1993, non-fuel operating and maintenance expenses rose 4 percent. Administrative and general expenses increased partly because of increased pension expenses to reflect more conservative investment return assumptions and one-time costs associated with a voluntary separation option offered during the first quarter of 1993. A winter storm during the first quarter of 1993 also increased non-fuel operating and maintenance expenses. These increases from 1992 to 1993 were partially offset by lower nuclear and fossil maintenance expenses resulting from lower outage costs.\nNon-fuel operating and maintenance expenses increased at an average annual rate of 5 percent from 1991 to 1993. Administrative and general expenses increased over this period because of the implementation of a new accounting standard in January 1992 that reflects accrual basis accounting for certain postretirement health care and life insurance benefits, in addition to the reasons cited in the preceding paragraph. Operating and maintenance expenses for fossil and hydro plants also increased from 1991 to 1993. Fossil increases were caused by bringing refurbished units back on-line, and hydro increases were the result of the completion of the Bad Creek Hydroelectric Station in late 1991.\nNet interchange and purchased power decreased at an average annual rate of 1 percent from 1991 to 1993. A slight decline in the amount of purchased power from the other Catawba joint owners as recognized on the income statement was substantially offset by increased purchases from other utilities. (For additional information on the Catawba purchase power agreements, see Note 3 to the Consolidated Financial Statements.)\nFuel expense increased at an average annual rate of 6 percent from 1991 to 1993. The increase was due primarily to higher system production requirements that were satisfied by increased fossil generation. A continued decline of fuel prices over this period helped to offset the overall increase in fuel expenses.\nFrom 1991 to 1993, depreciation and amortization expense increased at an average annual rate of 6 percent primarily because of the completion of the Bad Creek Hydroelectric Station in 1991 and added investment in distribution property.\nOther Income and Interest Deductions Allowance for funds used during construction (AFUDC) represented 5 percent of earnings for common stock in 1993 compared to 13 percent in 1991. The decrease is primarily the result of the completion of the Bad Creek Hydroelectric Station in 1991. AFUDC is expected to represent less than 10 percent of total earnings during the next three years.\nThe carrying charge, net of associated taxes, on the purchased capacity levelization deferral related to the joint ownership of the Catawba Nuclear Station represented 6 percent of total earnings in 1993, compared to 6 percent in 1992 and 5 percent in 1991. This carrying charge and the related tax benefits are included in Other, net and Income taxes -- other, net, respectively. The growth in this carrying charge is due to the increasing cumulative impact of the Company's funding of purchased power costs which current rates are expected to collect in future periods. The Company recovers the accumulated balance, including the carrying charge, when the declining purchased capacity payments drop below the levelized revenues. (For additional information on purchased capacity levelization, see Capital Needs \"Purchased Capacity Levelization,\" page 19.)\nInterest on long-term debt decreased at an average annual rate of 3 percent from 1991 to 1993. The decrease is due to the Company's refinancing of higher cost debt beginning in late 1991 and continuing throughout 1993. From 1992 to 1993, Other interest decreased as a result of the one-time impact in 1992 of approximately $27 million in interest paid to North Carolina retail customers due to a rate refund.\nIncome provided by diversified activities and the Company's subsidiaries was $22.0 million in 1993 compared to $25.7 million in 1992 and $23.6 million in 1991. The activities of Crescent Resources, Inc., the Company's real estate development and forest management subsidiary, generated the majority of subsidiary and non-electric earnings. Other components include subsidiary investment income, fees for engineering services, construction and operation of generation and transmission\nfacilities outside the Company's service area, water operations and merchandising.\nLiquidity and Resources Rate Matters During 1991, the Company filed in both the North Carolina and South Carolina retail jurisdictions its only requests for general rate increases since 1986. The rate increases were primarily needed to recover costs associated with the construction of the Bad Creek Hydroelectric Station. In North Carolina, the Company requested a 9.22 percent rate increase and was granted a 4.15 percent increase, which resulted in additional annual revenues of $100.1 million. In South Carolina, a 7.29 percent increase was requested and a 3.0 percent rate increase was granted, resulting in additional annual revenues of $30.2 million.\nAlso in 1991, the Company filed a request for a wholesale rate increase with the Federal Energy Regulatory Commission (FERC). A negotiated settlement between the Company and the wholesale customers was approved by the FERC on March 31, 1992. The approved agreement, effective April 1, 1992, provided for a 3.3 percent rate increase, resulting in $2.1 million in additional annual revenues.\nThe North Carolina Supreme Court on April 22, 1992, remanded for the second time the Company's 1986 rate order to the North Carolina Utilities Commission (NCUC). In this ruling, the Court held that the record from the 1986 proceedings failed to support the rate of return on common equity of 13.2 percent authorized by the NCUC after the initial decision of the Court remanding the 1986 rate order. The NCUC issued a final order dated October 26, 1992, authorizing a 12.8 percent return on common equity for the period October 31, 1986, through November 11, 1991. This order resulted in a 1992 refund to North Carolina retail customers of approximately $95 million, including interest.\nThe Company has a bulk power sales agreement with Carolina Power & Light Company (CP&L) to provide CP&L 400 megawatts of capacity as well as associated energy when needed for a six-year period which began July 1, 1993. Electric rates in all regulatory jurisdictions were reduced by adjustment riders to reflect capacity revenues received from this CP&L bulk power sales agreement.\nThe other joint owners of the Catawba Nuclear Station and the Company are involved in various proceedings related to the Catawba joint ownership contractual agreements. The basic contention in each proceeding is that certain calculations affecting bills under these agreements should be performed differently. These items are covered by the agreements between the Company and the other Catawba joint owners which have been previously approved by the Company's retail regulatory commissions. (For additional information on Catawba joint ownership, see Note 3 to the Consolidated Financial Statements.) The Company and two of the four joint owners have entered into a proposed settlement agreement which, if approved by the regulators, will resolve all issues in contention in such proceedings between the Company and these owners. The Company recorded a liability as an increase to Other current liabilities on its Consolidated Balance Sheets of approximately $105 million in 1993 to reflect this proposed settlement. In addition, future estimated obligations in connection with the settlement are reflected in estimates of purchased capacity obligations in Note 3. As the Company expects the costs associated with this settlement will be recovered as part of the purchased capacity levelization, the Company has included approximately $105 million as an increase to Purchased capacity costs on its Consolidated Balance Sheets. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company.\nAlthough the two other Catawba joint owners, who are not parties to the above settlement, have not fully quantified the dollars associated with their claims in the presently outstanding proceedings, information associated with these proceedings indicates that the amount in contention could be as high as $110 million, through December 31, 1993. Arbitration hearings were held in 1992 involving substantially all the disputed amounts, and a decision interpreting the language of the agreements on certain of these matters was issued on October 1, 1993. Further proceedings will be required to determine the amounts associated with this decision as it relates to these owners, some of which may involve refunds. However, the Company expects the costs associated with this decision will be included in and recovered as part of the purchased capacity levelization consistent with prior orders of the retail regulatory commissions. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company.\nThe Company is also involved in legal, tax and regulatory proceedings before various courts, regulatory commissions and governmental agencies regarding matters arising in the ordinary course of business, some of which involve substantial amounts. Management is of the opinion that the final disposition of these proceedings will not have a material adverse effect on the results of operations or the financial position of the Company.\nCash From Operations In 1993, net cash provided by operating activities accounted for 46 percent of total cash from operating, financing and investing activities compared to 50 percent in 1992 and 77 percent in 1991. For 1993 and 1992, essentially all the Company's capital needs, exclusive of refinancing activities, were met by cash generated from operations.\nFinancing and Investing Activities The Company's capital structure, including subsidiary capitalization, at year- end 1993 was 52 percent common equity, 39 percent long-term debt and 9 percent preferred stock. This structure is consistent with the Company's target to maintain an \"AA\" credit rating. As of December 31, 1993, the Company's bonds were rated \"AA\" by Fitch Investors Service, \"Aa2\" by Moody's Investors Service, and \"AA-\" by Standard & Poor's Ratings Group and Duff & Phelps.\nAs a result of favorable market conditions, the Company continued refinancing activities to retire higher cost debt and preferred stock. During 1993, the Company obtained proceeds from the issuance of $1.5 billion in long-term debt and $220 million in preferred stock, most of which were used to retire $1.4 billion of long-term debt and $216 million of preferred stock.\nIn 1992, the Company issued $940 million in long-term debt. Most of these proceeds, combined with the proceeds from bonds issued in late 1991, were used to redeem $884 million of long-term debt. During 1992, the Company also issued $284 million of preferred stock, most of which was used to redeem $229 million of preferred stock.\nAlso on April 6, 1992, the Company redeemed all outstanding shares of the Cumulative Preference Stock 6 3\/4 percent Convertible Series AA at its par value of $100 per share.\nThe Company's embedded cost of long-term debt for 1993 decreased to 8.01 percent compared to 8.39 percent in 1992 and 8.72 percent in 1991. The embedded cost of preferred stock declined to 6.76 percent in 1993 from 7.05 percent in 1992 and 7.48 percent in 1991. These decreases are primarily the result of the Company's refinancing activities. Downward trends in embedded costs may level off because of fewer refinancing opportunities.\nFixed Charges Coverage Fixed charges coverage using the SEC method increased to 4.68 times for 1993 compared to 3.48 and 3.85 times, respectively, in 1992 and 1991. Fixed charges coverage, excluding AFUDC and the return on purchased capacity levelization, was 4.40 times in 1993 compared to 3.27 in 1992 and 3.46 in 1991 and the Company goal of 3.5 times. In 1992, the coverage under both methods was lower because of the impact of the rate refund.\nCapital Needs Property Additions and Retirements Additions to property and nuclear fuel of $676 million and retirements of $312 million resulted in an increase in gross plant of $364 million in 1993.\nSince January 1, 1991, additions to property and nuclear fuel of $2.1 billion and retirements of $780 million have resulted in an increase in gross plant of $1.3 billion.\nConstruction Expenditures Plant construction costs for generating facilities, including AFUDC, decreased from $232 million in 1991 to $182 million in 1993. Completion of the Bad Creek Hydroelectric Station in 1991 was a significant part of the decrease. Construction costs for distribution plant, including AFUDC, decreased from $275 million in 1991 to $240 million in 1993.\nProjected construction and nuclear fuel costs, both including AFUDC, are $2.3 billion and $394 million, respectively, for 1994 through 1996. Total projected construction costs include expenditures for the construction of the Lincoln Combustion Turbine Station and replacement of certain steam generators at the McGuire Nuclear Station and the Catawba Nuclear Station. (For additional information on steam generator replacement, see Current Issues \"Stress Corrosion Cracking,\" page 21.) For 1994 through 1996, the Company anticipates funding its projected construction and nuclear fuel costs through the internal generation of funds and, to a lesser extent, through the issuance of securities, primarily First and Refunding Mortgage Bonds.\nPurchased Capacity Levelization The rates established in the Company's retail jurisdictions permit the Company to recover its investment in both units of the Catawba Nuclear Station and the costs associated with contractual purchases of capacity from the other Catawba joint owners. The contracts relating to the sales of portions of the station obligate the Company to purchase a declining amount of capacity from the other joint owners. In the North Carolina retail jurisdiction, regulatory treatment of these contracts provides revenue for recovery of the capital costs and the fixed operating and maintenance costs of purchased capacity on a levelized basis. In the South Carolina retail jurisdiction, revenues are provided for the recovery of the capital costs of purchased capacity on a levelized basis, while current rates include recovery of fixed operating and maintenance expenses.\nThese rate treatments require the Company to fund portions of the purchased power payment until these costs, including carrying charges, are recovered at a later date. The Company recovers the accumulated costs and carrying charges when the declining purchased capacity payments drop below the levelized revenues. In the North Carolina and wholesale jurisdictions, purchased capacity payments continue to exceed levelized revenues. In the South Carolina jurisdiction, cumulative levelized revenues have exceeded purchased capacity payments. Jurisdictional levelizations are intended to recover total costs, including allowed returns, and are subject to adjustments, including final true-ups.\nMeeting Future Power Needs The Company's strategy for meeting customers' present and future energy needs is composed of three components: supply-side resources, demand-side resources and purchased power resources. To assist in determining the optimal combination of these three resources, the Company uses its integrated resource planning process. The goal is to provide adequate and reliable electricity in an environmentally responsible manner through cost-effective power management.\nThe Company is building a combustion turbine facility in Lincoln County, North Carolina. The Lincoln Combustion Turbine Station will consist of 16 combustion turbines with a total generating capacity of 1,184 megawatts. The estimated total cost of the project is approximately $500 million. Current plans are for ten units to begin commercial operation by the end of 1995 and the remaining six to begin commercial operation before the end of 1996. The Lincoln facility will provide capacity at periods of peak demand.\nDemand-side management programs are a part of meeting the Company's future power needs. These programs benefit the Company and its customers by providing for load control through interruptible control features, shifting usage to off-peak periods, increasing usage during off-peak periods, and by promoting energy efficiency. In return for participation in demand-side management programs, customers may be eligible to receive various incentives which help to reduce their electric bills. Demand-side management programs such as Industrial Interruptible Service and Residential Load Control can be used to manage capacity availability problems. Energy-efficiency programs such as high-efficiency chillers, high-efficiency heat pumps and high-efficiency air conditioners are other examples of current demand-side management programs. The November 1991 rate orders of the NCUC and The Public Service Commission of South Carolina (PSCSC) provided for recovery\nin rates of a designated level of costs for demand-side management programs and allowed the deferral for later recovery of certain demand-side management costs that exceed the level reflected in rates, including a return on the deferred costs. As additional demand-side costs are incurred, the Company ultimately expects recovery of associated costs, which are currently being deferred, through rates. The annual costs deferred, including the return, were approximately $26 million in 1993 and $18 million in 1992.\nThe purchase of capacity and energy is also an integral part of meeting future power needs. The Company currently has under contract 500 megawatts of capacity from other generators of electricity.\nCurrent Issues While the Company improved its financial performance in 1993 compared to 1992, the ability to maintain and improve its current level of earnings will depend on several factors. Future trends in the Company's earnings will depend on the continued economic growth in the Piedmont Carolinas, the Company's ability to contain costs, its ability to maintain competitive prices, the outcome of various legislative and regulatory actions and the success of the Company's diversified activities.\nResource Optimization. The Company has been engaged in a concentrated effort to more efficiently and effectively use its resources through better work practices. During the first quarter of 1993, the Company offered a Limited Period Separation Opportunity program (LPSO) which gave employees the option of leaving the Company for a lump sum severance payment and, for qualifying employees, enhanced retirement benefits. Implementing programs such as LPSO and other efficiency practices has resulted in a continued workforce reduction and in streamlined workflows. The number of full-time employees has decreased from 19,945 at year-end 1990 to 18,274 at year-end 1993. Included in these amounts are 496 and 789 employees of subsidiaries and affiliates for 1990 and 1993, respectively.\nIncome Tax Accounting Change. In January 1993, the Company implemented a standard as required by the Financial Accounting Standards Board (FASB) that requires a liability approach for financial accounting and reporting for income taxes. While classification of certain items on the Consolidated Balance Sheets has changed, principally because certain items previously reported net of tax are now being reported on a gross basis, there is no material effect on the Company's results of operations.\nNuclear Decommissioning Costs. Estimated site-specific nuclear decommissioning costs, including the cost of decommissioning plant components not subject to radioactive contamination, total approximately $955 million stated in 1990 dollars. This amount includes the Company's 12.5 percent ownership in the Catawba Nuclear Station. The other joint owners of the Catawba Nuclear Station are liable for providing decommissioning related to their ownership interests in the station. Both the NCUC and the PSCSC have granted the Company recovery of the estimated site-specific decommissioning costs through retail rates over the expected remaining service periods of the Company's nuclear plants. Such estimates presume that units will be decommissioned as soon as possible following the end of their license life. Although subject to extension, the current operating licenses for the Company's nuclear units expire as follows: Oconee 1 and 2 - 2013, Oconee 3 - 2014; McGuire 1 - 2021, McGuire 2 - 2023; and Catawba 1 - 2024, Catawba 2 - 2026.\nThe Nuclear Regulatory Commission (NRC) issued a rule-making in 1988 which requires an external mechanism to fund the estimated cost to decommission certain components of a nuclear unit subject to radioactive contamination. In addition to the required external funding, the Company maintains an internal reserve to provide for decommissioning costs of plant components not subject to radioactive contamination. During 1993, the Company expensed approximately $52.5 million which was contributed to the external funds and accrued an additional $5.0 million to the internal reserve. The balance of the external funds as of December 31, 1993, was $118.5 million. The balance of the internal reserve as of December 31, 1993, was $200.0 million and is reflected in Accumulated depreciation and amortization on the Consolidated Balance Sheets. Management's opinion is that the estimated site-specific decommissioning costs being recovered through rates, when coupled with assumed after-tax fund earnings of 4.5 percent to 5.5 percent, are currently sufficient to provide for the cost of decommissioning based on the Company's current decommissioning schedule.\nEnvironmental Update. The Company is subject to federal, state and local regulations with regard to air and water quality, hazardous and solid waste disposal, and other environmental matters. The Company was an operator of manufactured gas plants prior to the early 1950s. The Company is entering into a cooperative effort with the State of North Carolina and other owners of certain former manufactured gas plant sites to investigate and, where necessary, remediate these contaminated sites. The State of South Carolina has expressed interest in entering into a similar arrangement. The Company is considered by regulators to be a potentially responsible party and may be subject to liability at two federal Superfund sites and two comparable state sites. While the cost of remediation of these sites may be substantial, the Company will share in any liability associated with remediation of contamination at such sites with other potentially responsible parties. Management is of the opinion that resolution of these matters will not have a material adverse effect on the results of operations or financial position of the Company.\nThe Clean Air Act Amendments of 1990. The Clean Air Act Amendments of 1990 require a two-phase reduction by electric utilities in the aggregate annual emissions of sulfur dioxide and nitrogen oxide by the year 2000. The Company currently meets all requirements of Phase I. The Company supports the national objective of clean air in the most cost-effective manner and has already reduced emissions through the use of low-sulfur coal in its fossil plants, through efficient operations and by using nuclear generation. The sulfur dioxide provisions of the Act allow utilities to choose among various alternatives for compliance. The Company is currently developing a detailed\ncompliance plan for Phase II requirements which must be filed with the Environmental Protection Agency (EPA) by 1996. A preliminary strategy, which allows for varying options, indicates that one-time costs associated with bringing the Company into compliance with the Act could be as high as $1 billion, and that approximately $75 million in additional annual operating and maintenance expenses will be incurred as well. These one-time costs could be less depending on favorable developments in the emissions allowance market, future regulatory and legislative actions, and advances in clean air technology. All options within the preliminary strategy allow for full compliance of Phase II requirements by the year 2000.\nStress Corrosion Cracking (SCC). Stress corrosion cracking has occurred in the steam generators of Units 1 and 2 at the McGuire Nuclear Station and Unit 1 at the Catawba Nuclear Station. The Company is of the opinion that the SCC is caused by the defective design, workmanship and materials used by the manufacturer of the steam generators. Catawba Unit 2, which has certain design differences and came into service at a later date, has not yet shown the degree of SCC which has occurred in McGuire Units 1 and 2 and Catawba Unit 1. It is, however, too early in the life of Catawba Unit 2 to determine the extent to which SCC will be a problem. Although the Company has taken steps to mitigate the effects of SCC, the inherent potential for future SCC in the Catawba and McGuire steam generators still exists. The Company has begun planning for the replacement of steam generators and has set the following schedule to begin the process: McGuire Unit 1 - 1995, Catawba Unit 1 - 1996, McGuire Unit 2 - 1997. The Catawba Unit 2 steam generators have not been scheduled for replacement. The order of replacement is subject to change based on performance of the existing steam generators and on the overall performance of the three units. The Company has signed an agreement with Babcock & Wilcox International to purchase replacement steam generators. Steam generator replacement at each unit is expected to take approximately four months and cost approximately $170 million, excluding the cost of replacement power and without consideration of reimbursement of applicable costs by the other joint owners of Catawba Unit 1. Stress corrosion problems are excluded under the nuclear insurance policies.\nThe Company in connection with its McGuire and Catawba stations and on behalf of the other joint owners of the Catawba Station--North Carolina Municipal Power Agency Number 1, North Carolina Electric Membership Corporation, Piedmont Municipal Power Agency and Saluda River Electric Cooperative, Inc.-- commenced a legal action on March 22, 1990. This action alleges that Westinghouse Electric Corporation (Westinghouse), the supplier of the steam generators, knew, or recklessly disregarded information in its possession, that the steam generators supplied to McGuire and Catawba stations would be susceptible to SCC and that Westinghouse deliberately concealed such information from the Company. The Company is seeking a judgment against Westinghouse for damages of approximately $600 million, including the cost of necessary remedial measures, the cost of replacement steam generators and payment for replacement power during the outages to accomplish the replacement. In addition to these damages, the Company is seeking punitive or treble damages and attorneys' fees. A trial date has been set for March 14, 1994.\nCompetition. The Energy Policy Act of 1992 has far-reaching implications for the Company by moving utilities toward a more competitive environment. The Act reformed certain provisions of the Public Utility Holding Company Act of 1935 (PUHCA) and removed certain regulatory barriers. For example, the Act allows utilities to develop independent electric generating plants in the United States for sales to wholesale customers, as well as to contract for utility projects internationally, without becoming subject to registration under PUHCA as an electric utility holding company. The Act requires transmission of power for third parties to wholesale customers, provided the reliability of service to the utility's local customer base is protected and the local customer base does not subsidize the third-party service. Although the Act does not require transmission access to retail customers, states can authorize such transmission access to and for retail electric customers.\nThe electric utility industry is predominantly regulated on a basis designed to recover the cost of providing electric power to its retail and wholesale customers. If cost-based regulation were to be discontinued in the industry, for any reason, including competitive pressure on the price of electricity, utilities might be forced to reduce their assets to reflect their market basis if such basis is less than cost. Discontinuance of cost-based regulation could also require some utilities to write off their regulatory assets. Management cannot predict the potential impact, if any, of these competitive forces on the Company's future financial position and results of operations. However, the Company is continuing to position itself to effectively meet these challenges by maintaining prices that are regionally and nationally competitive.\nSubsidiary Activities. A major part of the future growth in the electric power market is anticipated to be outside the traditional regulated framework and, to a large extent, outside the United States. The Company, through its subsidiaries, is participating in these international opportunities and continues participating in domestic opportunities to provide additional value to its shareholders. Internationally, the Company is seeking opportunities to provide engineering consulting services, construction, operation and maintenance of generation facilities, and ownership of transmission and generation facilities. Although these opportunities are concentrated in areas that utilize the Company's expertise, they present different and greater risks than does the Company's core business. The Company considers only opportunities in which the expected returns are commensurate with the risks and makes efforts to mitigate such risks. At December 31, 1993, the Company had equity investments of $84.5 million in international transmission and generation facilities and $17.1 million in electric assets within the United States, but outside its current service area. The Company is actively pursuing additional international and domestic opportunities to capitalize on the future potential growth of this market.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. DUKE POWER COMPANY INDEX\nCONSOLIDATED STATEMENTS OF INCOME\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED BALANCE SHEETS ASSETS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF CAPITALIZATION AND RETAINED EARNINGS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nNotes To Consolidated Financial Statements\nNote 1. Summary of Significant Accounting Policies A. Revenues\nRevenues are recorded as service is rendered to customers. \"Receivables\" on the Consolidated Balance Sheets include $175,726,000 and $167,610,000 as of December 31, 1993 and 1992, respectively, for service that has been rendered but not yet billed to customers.\nB. Additions to Electric Plant\nThe Company capitalizes all construction-related direct labor and materials as well as indirect construction costs. Indirect costs include general engineering, taxes and the cost of money (allowance for funds used during construction). The cost of renewals and betterments of units of property is capitalized. The cost of repairs and replacements representing less than a unit of property is charged to electric expenses. The original cost of property retired, together with removal costs less salvage value, is charged to accumulated depreciation.\nC. Allowance for Funds Used During Construction (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. AFUDC, a non- cash item, is recognized as a cost of \"Construction work in progress\" (CWIP), with offsetting credits to \"Other income\" and \"Interest deductions.\" After construction is completed, the Company is permitted to recover these construction costs, including a fair return, through their inclusion in rate base and in the provision for depreciation. The 1993 AFUDC rate of 9.29 percent reflects \"Allowance for borrowed funds used during construction\" calculated using a pre-tax cost of debt. The rates for 1992 and 1991 of 8.07 percent and 8.86 percent have been calculated using a net of tax cost of debt. Rates for all periods are compounded semiannually. The change in calculation from a net of income tax to a pre-tax basis is a result of the adoption of Statement of Financial Accounting Standards No. 109 (SFAS 109). (See Note 4.)\nD. Depreciation and Amortization\nProvisions for depreciation are recorded using the straight-line method. The year-end composite weighted-average depreciation rates were 3.47 percent for 1993 and 3.48 percent for 1992 and 1991. Effective with the implementation of new retail rates in November 1991, all coal-fired generating units are depreciated at a rate of 2.57 percent and all nuclear units are depreciated at a rate of 4.70 percent, of which 1.61 percent is for decommissioning. (See Note 16.) Amortization of nuclear fuel is included in \"Fuel used in electric generation\" in the Consolidated Statements of Income. The amortization is recorded using the units-of-production method. Under provisions of the Nuclear Waste Policy Act of 1982, the Company has entered into contracts with the Department of Energy (DOE) for the disposal of spent nuclear fuel. Payments made to the DOE for disposal costs are based on nuclear output and are included in \"Fuel used in electric generation\" in the Consolidated Statements of Income. A provision in the Energy Policy Act of 1992 established a fund for the decontamination and decommissioning of the DOE's uranium enrichment plants. Licensees are subject to an annual assessment for 15 years based on their pro rata share of past enrichment services. The annual assessment is recorded as fuel expense. The Company paid $8,338,000 during 1993 related to its ownership interest in nuclear plants. The Company has reflected the remaining liability and regulatory asset of $116,731,000 in the Consolidated Balance Sheets.\nE. Subsidiaries\nThe Company's consolidated financial statements reflect consolidation of all of its wholly-owned subsidiaries. Intercompany transactions have been eliminated in consolidation. (See Note 11 and \"Subsidiary Highlights,\" page 41.)\nF. Income Taxes\nThe Company implemented SFAS 109, \"Accounting for Income Taxes,\" effective January 1, 1993. (See Note 4.) The Company and its subsidiaries file a consolidated federal income tax return. Income taxes have been allocated to each company based on its separate company taxable income or loss. Income taxes are allocated to non-electric operations under \"Other income\" and to electric operating expense. The \"Income taxes - credit\" classified under \"Other income\" results from tax deductions of interest costs relating primarily to deferred purchased capacity costs and CWIP. Deferred income taxes have been provided for temporary differences between book and tax income, principally resulting from accelerated tax depreciation and levelization of purchased power costs. Investment tax credits have been deferred and are being amortized over the estimated useful lives of the related properties.\nG. Unamortized Debt Premium, Discount and Expense\nExpenses incurred in connection with the issuance of presently outstanding long-term debt, and premiums and discounts relating to such debt, are being amortized over the terms of the respective issues. Also, any expenses or call premiums associated with refinancing higher-cost debt obligations are being amortized over the lives of the new issues of long-term debt.\nH. Fuel Cost Adjustment Procedures\nFuel costs are reviewed semiannually in the wholesale and South Carolina retail jurisdictions, with provisions for changing such costs in base rates. In the North Carolina retail jurisdiction, a review of fuel costs in rates is required annually and during general rate case proceedings. All jurisdictions allow the Company to adjust rates for past over- or under-recovery of fuel costs. Therefore, the Company reflects in revenues the difference between actual fuel costs incurred and fuel costs recovered through rates. The North Carolina legislature ratified a bill in July 1987 assuring the legality of such adjustments in rates. In 1991, the statute was extended through June 30, 1997.\nI. Consolidated Statements of Cash Flows\nFor purposes of the Consolidated Statements of Cash Flows, the Company's investments in highly liquid debt instruments, with an original maturity of three months or less, are included in cash flows from investing activities and thus are not considered cash equivalents. Total income taxes paid were $352,697,000, $215,465,000 and $245,945,000 for years ended December 31, 1993, 1992 and 1991, respectively. Interest paid, net of amount capitalized, was $244,829,000, $298,455,000 and $269,330,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nNote 2. Rate Matters\nThe North Carolina Utilities Commission (NCUC) and The Public Service Commission of South Carolina (PSCSC) must approve rates for retail sales within their respective states. The Federal Energy Regulatory Commission (FERC) must approve the Company's rates for sales to wholesale customers. Sales to the other joint owners of the Catawba Nuclear Station, which represent a substantial majority of the Company's wholesale revenues, are set through contractual agreements. (See Note 3.) During 1991, the Company filed in both the North Carolina and the South Carolina retail jurisdictions its only requests for general rate increases since 1986. The rate increase requested by the Company in North Carolina was 9.22 percent; a 4.15 percent increase was granted resulting in $100.1 million in additional annual revenues. In South Carolina, a rate increase of 7.29 percent was requested; a 3.0 percent increase was granted resulting in $30.2 million in additional annual revenues. These increases were requested primarily to recover costs associated with the Bad Creek Hydroelectric Station. In 1991, the Company filed a request with the FERC seeking a 7.47 percent rate increase for its wholesale customers, who represent approximately 2 percent of the Company's total revenues. A negotiated settlement between the Company and the wholesale customers was approved by the FERC on March 31, 1992. The approved agreement, effective April 1, 1992, provided for a 3.3 percent rate increase, resulting in $2.1 million in additional annual revenues. The North Carolina Supreme Court on April 22, 1992, remanded for the second time the Company's 1986 rate order to the NCUC. In this ruling, the Court held that the record from the 1986 proceedings failed to support the rate of return of 13.2 percent on common equity authorized by the NCUC after the initial decision of the Court remanding the 1986 rate order. The NCUC issued a final order dated October 26, 1992, authorizing a 12.8 percent return on common equity for the period October 31, 1986, through November 11, 1991, that resulted in a refund to North Carolina retail customers in 1992 of approximately $95 million, including interest. The Company has a bulk power sales agreement with Carolina Power & Light Company (CP&L) to provide CP&L 400 megawatts of capacity as well as associated energy when needed for a six-year period which began July 1, 1993. Electric rates in all regulatory jurisdictions were reduced by adjustment riders to reflect capacity revenues received from this CP&L bulk power sales agreement.\nNote 3. Joint Ownership of Generating Facilities\nThe Company has sold interests in both units of the Catawba Nuclear Station. The other owners of portions of the Catawba Nuclear Station and supplemental information regarding their ownership are as follows:\nEach participant has provided its own financing for its ownership interest in the plant. The Company retains a 12.5 percent ownership interest in the Catawba Nuclear Station. As of December 31, 1993, $498,930,000 of Electric plant in service and Nuclear fuel\nrepresents the Company's investment in Units 1 and 2. Accumulated depreciation and amortization of $152,698,000 associated with Catawba had been recorded as of year-end. The Company's share of operating costs of Catawba are included in the corresponding electric expenses in the Consolidated Statements of Income. In connection with the joint ownership, the Company has entered into contractual agreements with the other joint owners to purchase declining percentages of the generating capacity and energy from the plant. These agreements were effective beginning with the commercial operation of each unit. Unit 1 and Unit 2 began commercial operation in June 1985 and in August 1986, respectively. Such agreements were established for 15 years for NCMPA and PMPA and 10 years for NCEMC and Saluda River. Energy cost payments are based on variable operating costs, a function of the generation output. Capacity payments are based on the fixed costs of the plant. The estimated purchased capacity obligations through 1998 are $392,000,000 for 1994, $293,000,000 for 1995, $55,000,000 for 1996, $44,000,000 for 1997 and $32,000,000 for 1998. Payment obligations include the terms of a proposed settlement agreement between the Company and two of the four joint owners of the Catawba Nuclear Station which was executed in January 1994 and is subject to regulatory approval. (See Note 13.) Effective in its November 1991 rate order, the North Carolina Utilities Commission (NCUC) reaffirmed the Company's recovery, on a levelized basis, of the capital costs and fixed operating and maintenance costs of capacity purchased from the other joint owners. The new NCUC rate order changed the levelized basis to a 15-year period ending 2001 for all of the other joint owners compared to the previous 15-year levelization period for NCMPA and PMPA and 10-year levelization period for NCEMC and Saluda River. The Public Service Commission of South Carolina (PSCSC), in its November 1991 rate order, reaffirmed the Company's recovery on a levelized basis of the capital costs of capacity purchased from the other joint owners. The new PSCSC rate order retained the levelized basis of a 7 1\/2-year period for PMPA and NCMPA; for NCEMC and Saluda River, the new levelized basis reflects the projected purchased capacity payments for the twelve-month period ended October 1992. The Federal Energy Regulatory Commission granted the Company recovery on a levelized basis of the capital costs and fixed operating and maintenance costs of capacity purchased from the other joint owners over their contractual purchased power buyback periods. As currently provided in rates in all jurisdictions, the Company recovers the costs of purchased energy and a portion of purchased capacity. The portion of costs not currently recovered through rates is being accumulated, and the Company is recording a carrying charge on the accumulated balance. The Company recovers the accumulated balance including the carrying charge when the capacity payments drop below the levelized revenues. In the North Carolina and wholesale jurisdictions, purchased capacity payments continue to exceed levelized revenues. In the South Carolina jurisdiction, cumulative levelized revenues have exceeded purchased capacity payments. Jurisdictional levelizations are intended to recover total costs, including allowed returns, and are subject to adjustments, including final true-ups. For the years ended December 31, 1993, 1992 and 1991, the Company recorded purchased capacity and energy costs from the other joint owners of $547,900,000, $514,300,000 and $536,500,000, respectively. These amounts, adjusted for the cost of capacity purchased not reflected in current rates, are included in \"Net interchange and purchased power\" in the Consolidated Statements of Income. As of December 31, 1993 and 1992, $768,099,000 pre-tax and $378,095,000 net of income tax, respectively, associated with the costs of capacity purchased but not reflected in current rates had been accumulated in the Consolidated Balance Sheets as \"Purchased capacity costs.\" Accumulated deferred income taxes associated with \"Purchased capacity costs\" were $254,789,000 as of December 31, 1993. As of December 31, 1992, deferred income taxes reduced \"Purchased capacity costs\" on the Consolidated Balance Sheet by $265,255,000. The change in presentation from a net of tax to pre-tax basis is a result of the adoption of SFAS 109. (See Note 4.)\nNote 4. Income Tax Expense\nThe Company implemented Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" effective January 1, 1993. No prior periods have been restated. SFAS 109 requires a liability approach for financial accounting and reporting of income taxes. While classification of certain items on the Consolidated Balance Sheets has changed, principally because of certain items previously reported net of tax now being reported on a gross basis, there is no material effect on the Company's results of operations. As a result of implementing SFAS 109, the December 1993 Consolidated Balance Sheet reflects an increase of $778 million in both Total assets and Accumulated deferred income taxes (ADIT). The increase was primarily because of a change in presentation from a net of tax to pre-tax basis which resulted in an increase in \"Purchased capacity costs\" of $255 million and in the creation of the \"Regulatory asset related to income taxes\" of $486 million. Effective January 1, 1993, \"Allowance for borrowed funds used during construction\" on the Consolidated Statement of Income reflects a pre-tax cost of debt. Accumulated deferred income taxes after implementation of SFAS 109 consist primarily of the following temporary differences (dollars in thousands):\n* The net regulatory asset related to income taxes is $486,440,000.\nTotal deferred income tax liability was $2,701,374,000 as of December 31, 1993. Total deferred income tax asset was $493,666,000 as of December 31, 1993.\nIncome tax expense consisted of the following (dollars in thousands):\nTotal current income taxes were $354,366,000 for 1993, $258,800,000 for 1992 and $268,686,000 for 1991. Of these amounts, state income taxes were $61,237,000 for 1993, $44,149,000 for 1992 and $48,671,000 for 1991. Total deferred income taxes were $67,572,000 for 1993, $55,780,000 for 1992 and $38,664,000 for 1991. Of these amounts, deferred state income taxes were $14,279,000 for 1993, $13,786,000 for 1992 and $10,833,000 for 1991.\nIncome taxes differ from amounts computed by applying the statutory tax rate to pre-tax income as follows (dollars in thousands):\nOn August 10, 1993, President Clinton signed the Omnibus Budget Reconciliation Act of 1993 which includes an increase in the federal corporate income tax rate from 34% to 35%, retroactive to January 1, 1993. Accordingly, the Company's income tax expense reflects an increase of approximately $10 million for 1993.\nNote 5. Short-Term Borrowings and Compensating-Balance Arrangements\nTo support short-term obligations, the Company had credit facilities of $324,980,000, $329,385,000 and $340,385,000 as of December 31, 1993, 1992 and 1991, with 29, 49 and 52 commercial banks, respectively. Included in these facilities is a three-year, $300,000,000 revolving credit agreement with the balance in separate, annually-renewable lines of credit. These facilities are on a fee or compensating-balance basis. No short-term debt resulting from these credit facilities was outstanding as of December 31, 1993, 1992 and 1991. Cash balances maintained at the banks on deposit were $12,988,000 and $7,243,000 as of December 31, 1993 and 1992, respectively. Cash balances and fees compensate banks for their services, even though the Company has no formal compensating-balance arrangements. To compensate certain banks for credit facilities, the Company maintained balances of $49,000 and $509,000 as of December 31, 1993 and 1992, respectively. The Company retains the right of withdrawal with respect to the funds used for compensating-balance arrangements.\nA summary of short-term borrowings is as follows (dollars in thousands):\nNote 6. Common Stock and Retained Earnings\nCommon Stock Effective April 1, 1991, the Company began issuing common stock in lieu of purchasing shares on the open market for its various stock purchase plans. The Company discontinued issuances of common stock, effective December 1, 1991, and resumed open market purchases to satisfy the requirements of the various stock purchase plans. Except as discussed earlier, open market purchases were used to satisfy the requirements of the Company's various stock plans from 1991 through 1993. During 1991 and through April 6, 1992, the Company issued common stock to satisfy the conversion rights of preference stock. (See Note 7.) As of December 31, 1993, a total of 7,004,659 shares was reserved for issuance to stock plans.\nRetained Earnings As of December 31, 1993, none of the Company's retained earnings were restricted as to the declaration or payment of dividends.\nNote 7. Preferred and Preference Stock Without Sinking Fund Requirements\nThe following shares of stock were authorized with or without sinking fund requirements as of December 31, 1993 and 1992:\nOn April 6, 1992, the Company redeemed all outstanding shares of the Cumulative Preference Stock, 63\/4% Convertible Series AA at its par value of $100 per share.\nIn 1992 and 1991, shares of preference stock were converted into shares of common stock as follows:\nPreferred and preference stock without sinking fund requirements as of December 31, 1993 and 1992, were as follows (dollars in thousands):\nNote 8. Preferred Stock With Sinking Fund Requirements\nThe following shares of stock were authorized with or without sinking fund requirements as of December 31, 1993 and 1992:\nPreferred stock with sinking fund requirements as of December 31, 1993 and 1992, was as follows (dollars in thousands):\nThe annual sinking fund requirements through 1998 are $1,500,000 in 1994, 1995, 1996 and 1997 and $5,750,000 in 1998. Some additional redemptions are permitted at the Company's option. The Company reacquired 15,000 shares of 7.12% Series Q Preferred Stock in 1992 to satisfy 1993 sinking fund requirements. The call provisions for the outstanding preferred stock specify various redemption prices not exceeding 105 percent of par value, plus accumulated dividends to the redemption date.\nNote 9. Long-Term Debt\nLong-term debt outstanding as of December 31, 1993 and 1992, was as follows (dollars in thousands):\n(a) Substantially all the Company's electric plant was mortgaged as of December 31, 1993. (b) Substantial amounts of Crescent Resources, Inc.'s real estate development projects, land and buildings are pledged as collateral. (c) Nantahala Power and Light's loan agreements impose net worth restrictions and limitations on disposal of assets and payment of cash dividends.\nAs of December 31, 1993 and 1992, the Company had $40,000,000 in pollution-control revenue bonds backed by an unused, two-year revolving credit facility of $40,000,000 and $130,000,000 in commercial paper backed by an unused, three-year $130,000,000 revolving credit facility. These facilities are on a fee basis. Both the $40,000,000 in pollution-control bonds and the $130,000,000 in commercial paper are included in long-term debt.\nAs of December 31, 1993, Crescent Resources, Inc. had $52,064,000 in mortgage loans which mature in 1997 and require monthly payments of principal. Interest rates are variable and ranged from 4.21 percent to 5.08 percent as of December 31, 1993. Nantahala Power and Light had $33,000,000 in senior notes maturing in 2011 and 2012 as of December 31, 1993. The two notes carry fixed interest rates of 9.21 percent and 7.45 percent and require prepayments beginning 1997 and 1998, respectively.\nThe annual maturities of consolidated long-term debt, including capitalized lease principal payments through 1998, are $90,398,000 in 1994; $89,888,000 in 1995; $13,264,000 in 1996; $223,810,000 in 1997 and $54,522,000 in 1998.\nNote 10. Fair Value of Financial Instruments\nEstimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. Judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates determined as of December 31, 1993, are not necessarily indicative of the amounts that the Company could realize in a current market exchange.\nCash, Short-term investments and Notes payable The carrying amount approximates fair value because of the short maturity of these instruments.\nLong-term debt (excluding Capitalized leases) and Preferred stock with sinking fund requirements Fair value is based on market price estimates. As a result of substantial refinancing activity in 1993 and 1992, the Company's book value of consolidated long-term debt and preferred stock is not materially different from fair market value as of December 31, 1993.\nNuclear decommissioning trust funds External funds have been established, as required by the Nuclear Regulatory Commission, as a mechanism to fund certain costs of nuclear decommissioning. (See Note 16.) These nuclear decommissioning trust funds are primarily invested in intermediate-term municipal bonds. As of December 31, 1993, the Company's book value of its nuclear decommissioning trust funds is not materially different from fair market value.\nNote 11. Investment in Joint Ventures\nCertain investments in joint ventures are accounted for by the equity method. The Company's ownership in domestic and international joint ventures is 50 percent or less. Total assets of these joint ventures as of December 31, 1993 and 1992, were $972 million and $433 million, respectively. The Company's proportionate share of these assets was $241 million and $163 million, respectively. Total liabilities of these joint ventures as of December 31, 1993 and 1992, were $413 million and $321 million, respectively. The Company's proportionate share of the liabilities was $139 million and $132 million, respectively. Of the $413 million total liabilities outstanding at December 31, 1993, $290 million represents non-recourse debt for which the Company bears no responsibility in the event the joint venture defaults on the debt. The Company's portion of net income from the joint ventures for the years ended December 31, 1993 and 1992, was $2,601,000 and ($1,179,000).\nNote 12. Retirement Benefits A. Retirement Plan\nThe Company and its operating subsidiaries, with the exception of Nantahala Power and Light Company, which maintains its own retirement plans, have a non-contributory, defined benefit retirement plan covering substantially all their employees. The benefit is based on years of creditable service and the employee's average compensation based on the highest compensation during a consecutive sixty-month period. Prior to 1992, benefits have been reduced by a Social Security adjustment for employees age sixty-five and over and for early retirees with no creditable service prior to September 1, 1980. During 1991, the Company amended its plan for employees who retire after December 31, 1991. The effect of this amendment was to reduce benefits by a Social Security adjustment for all retirees. The plan was amended in 1992 to permit participants with 30 years of creditable service to retire as early as age 51. The Company's policy is to fund pension costs as accrued. During 1993, the Company made a one-time contribution of $50,000,000 to enhance the funded position of the plan.\nNet periodic pension cost for the years ended December 31, 1993, 1992 and 1991, include the following components (dollars in thousands):\nA reconciliation of the funded status of the plan to the amounts recognized in the Consolidated Balance Sheets as of December 31, 1993 and 1992, is as follows (dollars in thousands):\nIn determining the projected benefit obligation, the weighted-average assumed discount rate used was 7.50 percent in 1993 and 8.25 percent in 1992 and 1991. The assumed increase in future compensation level for determining the projected benefit obligation is based on an age-related basis. The weighted-average salary increase was 4.50 percent in 1993, 5.40 percent in 1992 and 5.65 percent in 1991. The expected long-term rate of return on plan assets used in determining pension cost was 8.40 percent in 1993 and 9.25 percent in 1992 and 1991. During 1993 the Company offered an enhanced early retirement option, Limited Period Separation Opportunity (LPSO), for eligible employees. The Company recorded an additional one-time expense for special termination benefits associated with LPSO of approximately $7,611,000.\nB. Postretirement Benefits\nThe Company and its operating subsidiaries, with the exception of Nantahala Power and Light Company, which maintains its own postretirement benefit plans, currently provides certain health care and life insurance benefits for retired employees. Employees become eligible for these benefits if they retire at age 55 or greater with 10 years of service; or if they retire as early as age 51 with 30 years or more of service. Employees retiring after January 1, 1992, receive a fixed Company allowance, based on years of service, to be used to pay medical insurance premiums. The Company reserves the right to terminate, suspend, withdraw, amend or modify the plans in whole or in part at any time. In 1992, the Company commenced funding the maximum amount allowable under section 401(h) of the Internal Revenue Code, which provides for tax deductions for contributions and tax-free accumulation of investment income. Such amounts partially fund the Company's medical and dental postretirement benefits. The Company has also established a Retired Lives Reserve, which has tax attributes similar to 401(h) funding, to partially fund its postretirement life insurance obligation. The Company contributed $14,648,000 into these funding mechanisms in 1993 and $19,338,000 in 1992. In 1992, the Company implemented a new accounting standard that requires postretirement benefits to be recognized as earned by employees rather than recognized as paid. Prior to 1992, the cost of retiree benefits was recognized as the benefits were paid. Amounts paid by the Company for 1991 amounted to $11,900,000.\nNet periodic postretirement benefit cost for the years ended December 31, 1993 and 1992, include the following components (dollars in thousands):\nA reconciliation of the funded status of the plan to the amounts recognized in the Consolidated Balance Sheets as of December 31, 1993 and 1992, is as follows (dollars in thousands):\nIn determining the accumulated postretirement benefit obligation (APBO), the weighted-average assumed discount rate used was 7.50 percent in 1993 and 8.25 percent in 1992. The assumed increase in future compensation level is determined on an age-related basis. The weighted-average salary increase was 4.50 percent in 1993, 5.40 percent in 1992 and 5.65 percent in 1991. The expected long-term rate of return on 401(h) assets used in determining postretirement benefits cost was 8.40 percent in 1993 and 9.25 percent in 1992. For Retired Lives Reserve assets, 7.125 percent was used in 1993 and 1992. The assumed medical inflation rate was approximately 13 percent in 1993. This rate decreases by 0.5 percent to 1.0 percent per year until a rate of 5.5 percent is achieved in the year 2002, which remains fixed thereafter. A 1.0 percent increase in the medical and dental trend rates produces a 6.25 percent ($1,903,213) increase in the aggregate service and interest cost. The increase in the APBO attributable to a 1.0 percent increase in the medical and dental trend rates is 6.69 percent ($23,483,182) as of December 31, 1993.\nNote 13. Commitments and Contingencies A. Construction Program\nProjected construction and nuclear fuel costs, both including allowance for funds used during construction, are $2.3 billion and $394 million, respectively, for 1994 through 1996. The program is subject to periodic review and revisions, and actual construction costs incurred may vary from such estimates. Cost variances are due to various factors, including revised load estimates, environmental matters and cost and availability of capital.\nB. Nuclear Insurance\nThe Company maintains nuclear insurance coverage in three areas: liability coverage, property, decontamination and decommissioning coverage, and extended accidental outage coverage to cover increased generating costs and\/or replacement power purchases. The Company is being reimbursed by the other joint owners of the Catawba Nuclear Station for certain expenses associated with nuclear insurance premiums paid by the Company. Pursuant to the Price-Anderson Act, the Company is required to insure against public liability claims resulting from nuclear incidents to the full limit of liability of approximately $9.4 billion. The maximum required private primary insurance of $200 million has been purchased along with a like amount to cover certain worker tort claims. The remaining amount, currently $9.2 billion, which will be increased by $75.5 million as each additional commercial nuclear reactor is\nlicensed, has been provided through a mandatory industry-wide excess secondary insurance program of risk pooling. The $9.2 billion could also be reduced by $75.5 million for certain nuclear reactors that are no longer operational and may be exempted from the risk pooling insurance program. Under this program, licensees could be assessed retrospective premiums to compensate for damages in the event of a nuclear incident at any licensed facility in the nation. If such an incident occurs and public liability damages exceed primary insurances, licensees may be assessed up to $75.5 million for each of their licensed reactors, payable at a rate not to exceed $10 million a year per licensed reactor for each incident. The $75.5 million amount is subject to indexing for inflation. This amount is further subject to a surcharge of 5 percent (which is included in the above $9.4 billion figure) if funds are insufficient to pay claims and associated costs. If retrospective premiums were to be assessed, the other joint owners of the Catawba Nuclear Station are obligated to assume their pro rata share of such assessment. The Company is a member of Nuclear Mutual Limited (NML), which provides $500 million in primary property damage coverage for each of the Company's nuclear facilities. If NML's losses ever exceed its reserves, the Company will be liable, on a pro rata basis, for additional assessments of up to $42 million. This amount represents 5 times the Company's annual premium to NML. The Company is also a member of Nuclear Electric Insurance Limited (NEIL) and purchases $1.4 billion of insurance through NEIL's excess property, decontamination and decommissioning liability insurance program. If losses ever exceed the accumulated funds available to NEIL for the excess property, decontamination and decommissioning liability program, the Company will be liable, on a pro rata basis, for additional assessments of up to $46 million. This amount is limited to 7.5 times the Company's annual premium to NEIL for excess property, decontamination and decommissioning liability insurance. The other joint owners of Catawba are obligated to assume their pro rata share of any liability for retrospective premiums and other premium assessments resulting from the NEIL policies applicable to Catawba. The Company has also purchased an additional $400 million of excess property damage insurance for its Oconee and McGuire plants and $800 million for its Catawba plant through a pool of stock and mutual insurance companies. The Company participates in a NEIL program that provides insurance for the increased cost of generation and\/or purchased power resulting from an accidental outage of a nuclear unit. Each unit of the Oconee, McGuire and Catawba Nuclear Stations is insured for up to approximately $3.5 million per week, after a 21-week deductible period, with declining amounts per unit where more than one unit is involved in an accidental outage. Coverages continue at 100 percent for 52 weeks, and 67 percent for the next 104 weeks. If NEIL's losses for this program ever exceed its reserves, the Company will be liable, on a pro rata basis, for additional assessments of up to $30 million. This amount represents 5 times the Company's annual premium to NEIL for insurance for the increased cost of generation and\/or purchased power resulting from an accidental outage of a nuclear unit. The other joint owners of Catawba are obligated to assume their pro rata share of any liability for retrospective premiums and other premium assessments resulting from the NEIL policies applicable to the joint ownership agreements.\nC. Other\nThe other joint owners of the Catawba Nuclear Station and the Company are involved in various proceedings related to the Catawba joint ownership contractual agreements. The basic contention in each proceeding is that certain calculations affecting bills under these agreements should be performed differently. These items are covered by the agreements between the Company and the other Catawba joint owners which have been previously approved by the Company's retail regulatory commissions. (For additional information, see Note 3.) The Company and two of the four joint owners have entered into a proposed settlement agreement which, if approved by the regulators, will resolve all issues in contention in such proceedings between the Company and these owners. The Company recorded a liability as an increase to Other current liabilities on its Consolidated Balance Sheets of approximately $105 million in 1993 to reflect this proposed settlement. In addition, future estimated obligations in connection with the settlement are reflected in estimates of purchased capacity obligations in Note 3. As the Company expects the costs associated with this settlement will be recovered as part of the purchased capacity levelization, the Company has included approximately $105 million as an increase to Purchased capacity costs on its Consolidated Balance Sheets. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company. Although the two other Catawba joint owners, who are not parties to the above settlement, have not fully quantified the dollars associated with their claims in the presently outstanding proceedings, information associated with these proceedings indicates that the amount in contention could be as high as $110 million through December 31, 1993. Arbitration hearings were held in 1992 involving substantially all the disputed amounts, and a decision interpreting the language of the agreements on certain of these matters was issued on October 1, 1993. Further proceedings will be required to determine the amounts associated with this decision as it relates to these owners, some of which may involve refunds. However, the Company expects the costs associated with this decision will be included in and recovered as part of the purchased capacity levelization consistent with prior orders of the retail regulatory commissions. Therefore, the Company believes the ultimate resolution of these matters should not have a material adverse effect on the results of operations or financial position of the Company. The Company is also involved in legal, tax and regulatory proceedings before various courts, regulatory commissions and governmental agencies regarding matters arising in the ordinary course of business, some of which involve substantial amounts. Management is of the opinion that the final disposition of these proceedings will not have a material adverse effect on the results of operations or the financial position of the Company.\nNote 14. Other Income\nFor the years ended December 31, 1993, 1992 and 1991, the Company reported carrying charges on purchased capacity levelization deferral related to the joint ownership of the Catawba Nuclear Station of $32,180,000, $28,820,000 and $28,765,000 (net of taxes), respectively, as components of \"Other, net\" and \"Income taxes - other, net\"on the Consolidated Statements of Income. (For additional information on purchased capacity levelization, see Note 3.) Also included in \"Other, net\" and \"Income taxes - other, net\" on the Consolidated Statements of Income is income provided by diversified activities and the Company's subsidiaries of $21,996,000, $25,728,000 and $23,587,000 (net of taxes) for years ended December 31, 1993, 1992 and 1991, respectively. The activities of Crescent Resources, Inc., the Company's real estate development and forest management subsidiary, generated the majority of subsidiary and non-electric earnings. Other components include subsidiary investment income, fees for engineering services, construction and operation of generation and transmission facilities outside the Company's current service area, water operations and merchandising. For the year ended December 31, 1991, the Company recorded a net of tax carrying charge of $36,765,000 on costs incurred on the Bad Creek Hydroelectric Station after commercial operation but prior to recovery of costs through rates. This carrying charge is a component of \"Other, net\" in the Consolidated Statements of Income.\nNote 15. Reclassification\nIn the Consolidated Statements of Cash Flows, Consolidated Balance Sheets and the Consolidated Statements of Capitalization, certain prior-year information has been reclassified to conform with 1993 classifications.\nNote 16. Nuclear Decommissioning Costs\nEstimated site-specific nuclear decommissioning costs, including the cost of decommissioning plant components not subject to radioactive contamination, total approximately $955 million stated in 1990 dollars. This amount includes the Company's 12.5 percent ownership in the Catawba Nuclear Station. The other joint owners of the Catawba Nuclear Station are liable for providing decommissioning related to their ownership interests in the station. Both the NCUC and the PSCSC have granted the Company recovery of the estimated site-specific decommissioning costs through retail rates over the expected remaining service periods of the Company's nuclear plants. Such estimates presume that units will be decommissioned as soon as possible following the end of their license life. Although subject to extension, the current operating licenses for the Company's nuclear units expire as follows: Oconee 1 and 2 - 2013, Oconee 3 - 2014; McGuire 1 - 2021, McGuire 2 - 2023; and Catawba 1 - 2024, Catawba 2 - 2026. The Nuclear Regulatory Commission (NRC) issued a rule-making in 1988 which requires an external mechanism to fund the estimated cost to decommission certain components of a nuclear unit subject to radioactive contamination. In addition to the required external funding, the Company maintains an internal reserve to provide for decommissioning costs of plant components not subject to radioactive contamination. During 1993, the Company expensed approximately $52.5 million which was contributed to the external funds and accrued an additional $5.0 million to the internal reserve. The balance of the external funds as of December 31, 1993, was $118.5 million. The balance of the internal reserve as of December 31, 1993, was $200.0 million and is reflected in Accumulated depreciation and amortization on the Consolidated Balance Sheets. Management's opinion is that the estimated site-specific decommissioning costs being recovered through rates, when coupled with assumed after-tax fund earnings of 4.5 percent to 5.5 percent, are currently sufficient to provide for the cost of decommissioning based on the Company's current decommissioning schedule.\nIndependent Auditors' Report\nDuke Power Company:\nWe have audited the consolidated financial statements of Duke Power Company and subsidiaries (the Company) listed in the accompanying index on page 22. Our audits also included the consolidated financial statement schedules listed in the accompanying index on page 22. These financial statements and consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and consolidated financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 4 to the consolidated financial statements, in 1993, the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\nDELOITTE & TOUCHE Deloitte & Touche Charlotte, North Carolina February 11, 1994\nResponsibility for Financial Statements\nThe financial statements of Duke Power Company are prepared by management, which is responsible for their integrity and objectivity. The statements are prepared in conformity with generally accepted accounting principles appropriate in the circumstances to reflect in all material respects the substance of events and transactions which should be included. The other information in the annual report is consistent with the financial statements. In preparing these statements, management makes informed judgments and estimates of the expected effects of events and transactions that are currently being reported.\nThe Company's system of internal accounting control is designed to provide reasonable assurance that assets are safeguarded and transactions are executed according to management's authorization. Internal accounting controls also provide reasonable assurance that transactions are recorded properly, so that financial statements can be prepared according to generally accepted accounting principles. In addition, the Company's accounting controls provide reasonable assurance that errors or irregularities which could be material to the financial statements are prevented or are detected by employees within a timely period as they perform their assigned functions. The Company's accounting controls are continually reviewed for effectiveness. In addition, written policies, standards and procedures, and a strong internal audit program augment the Company's accounting controls.\nThe Board of Directors pursues its oversight role for the financial statements through the audit committee, which is composed entirely of directors who are not employees of the Company. The audit committee meets with management and internal auditors periodically to review the work of each group and to monitor each group's discharge of its responsibilities. The audit committee also meets periodically with the Company's independent auditors, Deloitte & Touche. The independent auditors have free access to the audit committee and the Board of Directors to discuss internal accounting control, auditing and financial reporting matters without the presence of management.\nDAVID L. HAUSER David L. Hauser Controller\nSELECTED QUARTERLY FINANCIAL DATA\nGenerally, quarterly earnings fluctuate with seasonal weather conditions, timing of rate changes and maintenance of electric generating units, especially nuclear units.\nSUBSIDIARY HIGHLIGHTS The earnings contribution of the Company's diversified activities and subsidiaries was $22.0 million in 1993, $25.7 million in 1992 and $23.6 million in 1991. (a)(b) Highlights of selected subsidiaries are presented below. (dollars in thousands) ELECTRIC POWER SUPPLY Nantahala Power and Light Company provides service to a five-county area in the western North Carolina mountains by its operation of 11 hydroelectric stations and purchases of supplemental power.\nFUNDS MANAGEMENT Church Street Capital Corp. (CSCC) manages investment of funds for the Company and is the parent company of several subsidiaries. CSCC has no full-time employees.\nHighlights of CSCC's subsidiaries are presented below: REAL ESTATE MANAGEMENT, LAND DEVELOPMENT Crescent Resources, Inc. is engaged in forest management, real estate development, and sales and leasing.\nENGINEERING, CONSTRUCTION, TECHNICAL SERVICES AND POWER DEVELOPMENT Engineering, construction, technical services and power development opportunities are pursued nationally and internationally. Duke Engineering & Services, Inc. markets engineering, construction, quality assurance, consulting and other engineering-related services for utility facilities other than coal-fired plants. Duke\/Fluor Daniel, a joint venture with Fluor Daniel, Inc., provides design, construction, operation and maintenance support primarily for coal-fired generating plants. Duke Energy Group, parent of Duke Energy Corp., structures, finances and manages investments in electric generation and transmission facilities.\n(a) 1991 EXCLUDES THE CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE OF $6,727,000, AFTER TAX. (b) THE EARNINGS CONTRIBUTION OF THE COMPANY'S SUBSIDIARIES AND NON-ELECTRIC OPERATIONS INCLUDES ELIMINATION OF INTERCOMPANY PROFIT OF $509,000 AND $1,211,000, AFTER TAX, IN 1993 AND 1992, RESPECTIVELY. (c) FULL-TIME EMPLOYEES.\nDUKE POWER COMPANY SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT (DOLLARS IN THOUSANDS)\nDUKE POWER COMPANY SCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (DOLLARS IN THOUSANDS)\nDUKE POWER COMPANY SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DOLLARS IN THOUSANDS)\n(1) Principally consists of Injuries and Damages reserves and Property Insurance reserve which are included in \"Deferred credits and other liabilities\" in the Consolidated Balance Sheets. SCHEDULE X -- SUPPLEMENTARY CONSOLIDATED INCOME STATEMENT INFORMATION\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. No events necessary to be disclosed by the Company under this item have occurred. PART III. ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information for this item concerning directors of the Company is set forth in the sections entitled \"Election of Directors\" and \"Information Regarding the Board of Directors\" in the proxy statement of the Company relating to its 1994 annual meeting of shareholders, which is being incorporated herein by reference. Information concerning the executive officers of the Company is set forth under the section entitled \"Executive Officers of the Company\" in this annual report. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. Information for this item is set forth in the section entitled \"Executive Compensation\" in the proxy statement of the Company relating to its 1994 annual meeting of shareholders, which is being incorporated herein by reference. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information for this item is set forth in the sections entitled \"Voting Securities Outstanding\" and \"Election of Directors\" in the proxy statement of the Company relating to its 1994 annual meeting of shareholders, which is being incorporated herein by reference. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information for this item is set forth in the section entitled \"Election of Directors\" in the proxy statement of the Company relating to its 1994 annual meeting of shareholders, which is being incorporated herein by reference. PART IV. ITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Consolidated Financial Statements, Supplemental Financial Data and Consolidated Financial Statement Schedules included in Part II of this annual report are as follows:\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of 1993. (c) Exhibits -- See Exhibit Index on page 48.\nSIGNATURES 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, IN THE CITY OF CHARLOTTE AND STATE OF NORTH CAROLINA ON THE 29TH DAY OF MARCH, 1994. DUKE POWER COMPANY (REGISTRANT) By: W. S. LEE CHAIRMAN OF THE BOARD AND PRESIDENT 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 AND ON THE DATE INDICATED.\nELLEN T. RUFF, by signing her name hereto, does hereby sign this document on behalf of the registrant and on behalf of each of the above-named persons pursuant to a power of attorney duly executed by the registrant and such persons, filed with the Securities and Exchange Commission as an exhibit hereto. \/s\/ ELLEN T. RUFF ELLEN T. RUFF, ATTORNEY-IN-FACT\nEXHIBIT INDEX The following exhibits indicated by an asterisk preceding the exhibit number are filed herewith. The balance of the exhibits have heretofore been filed with the Securities and Exchange Commission and pursuant to Rule 12b-32 are incorporated herein by reference.\n(dagger) Compensatory plan or arrangement required to be filed as an exhibit, and filed with Form 10-K for the year ended December 31, 1992, File No. 1-4928, under the same exhibit number as listed herein.","section_15":""}
{"filename":"97476_1993.txt","cik":"97476","year":"1993","section_1":"ITEM 1. Business.\nGeneral - ------- Texas Instruments Incorporated (hereinafter the \"Registrant,\" including subsidiaries except where the context indicates otherwise) is engaged in the development, manufacture and sale of a variety of products in the electrical and electronics industry for industrial, government and consumer markets. These products consist of components, defense electronics and digital products. The Registrant also produces metallurgical materials. In addition, the Registrant s patent portfolio has been established as an ongoing contributor to the Registrant s revenues. The Registrant's business is based principally on its broad semiconductor technology and application of this technology to selected electronic end-equipment markets. The Registrant from time to time considers acquisitions and divestitures which may alter its business mix. The Registrant may effect one or more such transactions at such time or times as the Registrant determines to be appropriate.\nThe information with respect to net revenues, profit and identifiable assets of the Registrant's industry segments and operations outside the United States, which is contained in the note to the financial statements captioned \"Industry Segment and Geographic Area Operations\" on pages 30-31 of the Registrant's 1993 annual report to stockholders, is incorporated herein by reference to such annual report.\nComponents - ---------- Components consist of semiconductor integrated circuits (such as microprocessors\/microcontrollers, applications processors, memories, and digital and linear circuits), semiconductor discrete devices, semiconductor subassemblies (such as custom modules for specific applications), and electrical and electronic control devices (such as motor protectors, starting relays, circuit breakers, thermostats, sensors, and radio-frequency identification systems).\nThese components are used in a broad range of products for industrial end-use (such as computers, data terminals and peripheral equipment, telecommunications, instrumentation, and industrial motor controls and automation equipment), consumer end-use (such as televisions, cameras, automobiles, home appliances, and residential air conditioning and heating systems) and government end-use (such as defense and space equipment). The Registrant sells these components primarily to original equipment manufacturers principally through its own marketing organizations and to a lesser extent through distributors.\nDefense Electronics - ------------------- Defense electronics consist of radar systems, navigation systems, infrared surveillance and fire control systems, defense suppression missiles, other weapon systems (including antitank and interdiction weapons), missile guidance and control systems, electronic warfare systems, and other defense electronic equipment. Sales are made primarily to the U.S. government either directly or through prime contractors.\nDigital Products - ---------------- Digital products include software productivity tools, integrated enterprise information solutions, notebook computers, printers, electronic calculators and learning aids, and custom engineering and manufacturing services.\nDigital products are used in a broad range of enterprise-wide, work group and personal information-based applications. The Registrant markets these products through various channels, including system suppliers, business equipment dealers, distributors, retailers, and direct sales to end- users and original equipment manufacturers.\nMetallurgical Materials - ----------------------- Metallurgical materials include clad metals, precision-engineered parts and electronic connectors for use in a variety of applications such as appliances, automobiles, electronic components, and industrial and telecommunications equipment. These metallurgical materials are primarily sold directly to original equipment manufacturers. This segment also includes development costs associated with solar cells.\nCompetition - ----------- The Registrant is engaged in highly competitive businesses. Its competitors include several of the largest companies in the United States, East Asia, particularly Japan, and elsewhere abroad as well as many small, specialized companies. The Registrant is a significant competitor in each of its principal businesses. Generally, the Registrant's businesses are characterized by rapidly changing technology which has, throughout the Registrant's history, intensified the competitive factors, primarily performance and price.\nGovernment Sales - ---------------- Net revenues directly from federal government agencies in the United States, principally related to the defense electronics segment, accounted for approximately 12% of the Registrant's net revenues in 1993.\nContracts for government sales generally contain provisions for cancellation at the convenience of the government. In addition, companies engaged in supplying military equipment to the government are dependent on congressional appropriations and administrative allotment of funds, and may be affected by changes in government policies resulting from various military and political developments. See \"ITEM 3. Legal Proceedings.\"\nBacklog - ------- The dollar amount of backlog of orders believed by the Registrant to be firm was $3805 million as of December 31, 1993 and $3733 million as of December 31, 1992. Approximately 25% of the 1993 backlog (involving defense electronics) is not expected to be filled within the current fiscal year. The backlog is significant in the business of the Registrant only as an indication of future revenues which may be entered on the books of account of the Registrant.\nRaw Materials - ------------- The Registrant purchases materials, parts and supplies from a number of suppliers. In addition, the Registrant produces some materials, parts and supplies, such as silicon wafers used in the manufacture of semiconductors, for its own use. The materials, parts and supplies essential to the Registrant's business are generally available at present and the Registrant believes at this time that such materials, parts and supplies will be available in the foreseeable future.\nPatents and Trademarks - ---------------------- The Registrant owns many patents in the United States and other countries in fields relating to its businesses. The Registrant has developed a strong, broad-based patent portfolio. The Registrant also has several agreements with other companies involving license rights and anticipates that other licenses may be negotiated in the future. The Registrant does not consider its business materially dependent upon any one patent or patent license, although taken as a whole, the rights of the Registrant and the products made and sold under patents and patent licenses are important to the Registrant's business. As noted above, the Registrant's patent portfolio has been established as an ongoing contributor to the revenues of the Registrant. The Registrant continues to earn a significant ongoing stream of royalty revenue. See \"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"ITEM 3. Legal Proceedings.\"\nThe Registrant owns trademarks that are used in the conduct of its business. These trademarks are valuable assets, the most important of which are \"Texas Instruments\" and the Registrant's corporate monogram.\nResearch and Development - ------------------------ Expenditures for research and development were $981 million in 1993 compared with $891 million in 1992 and $915 million in 1991. Of these amounts, $590 million was company funded in 1993, ($470 million in 1992 and $527 million in 1991), and $391 million in 1993 ($421 million in 1992 and $388 million in 1991) was funded by others, principally the U. S. government.\nSeasonality - ----------- The Registrant's revenues are subject to some seasonal variation.\nEmployees - --------- The information concerning the number of persons employed by the Registrant at December 31, 1993 on page 34 of the Registrant's 1993 annual report to stockholders is incorporated herein by reference to such annual report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nThe Registrant's principal offices are located at 13500 North Central Expressway, Dallas, Texas. The Registrant owns and leases plants in the United States and 17 other countries for manufacturing and related purposes. The following table indicates the general location of the principal plants of the Registrant and the industry segments which make major use of them. Except as otherwise indicated, the principal plants are owned by the Registrant.\nThe Registrant's facilities in the United States contained approximately 19,424,675 square feet as of December 31, 1993, of which approximately 4,848,720 square feet were leased. The Registrant's facilities outside the United States contained approximately 6,644,166 square feet as of December 31, 1993, of which approximately 1,845,190 square feet were leased.\nThe Registrant believes that its existing properties are in good condition and suitable for the manufacture of its products. The Registrant's facilities in Denton, northwest Houston and Abilene, Texas are being marketed for sale. Otherwise, at the end of 1993, the Registrant utilized substantially all of the space in its facilities.\nLeases covering the Registrant's leased facilities expire at varying dates generally within the next 15 years. The Registrant anticipates no difficulty in either retaining occupancy through lease renewals, month-to- month occupancy or purchases of leased facilities, or replacing the leased facilities with equivalent facilities.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nOn July 19, 1991, the Registrant filed a lawsuit in Tokyo District Court against Fujitsu Limited ( Fujitsu ) seeking injunctive relief, alleging that Fujitsu's manufacture and sale of certain DRAMs infringe the Registrant's Japanese patent on the invention of the integrated circuit (the Kilby patent). Concurrently, Fujitsu brought a lawsuit in the same court against the Registrant, seeking a declaration that Fujitsu is not infringing the Kilby patent. See \"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Registrant is included among a number of U.S. defense contractors which are currently the subject of U.S. government investigations regarding alleged procurement irregularities. The Registrant is unable to predict the outcome of the investigations at this time or to estimate the kinds or amounts of claims or other actions that could be instituted against the Registrant. Under present government procurement regulations, such investigations could lead to a government contractor's being suspended or debarred from eligibility for awards of new government contracts for an initial period of up to three years. In the current environment, even matters that seem limited to disputes about contract interpretation can result in criminal prosecution. While criminal charges against contractors have resulted from such investigations, the Registrant does not believe such charges would be appropriate in its case and has not, at any time, lost its eligibility to enter into government contracts or subcontracts under these regulations.\nThe Registrant is involved in various investigations and proceedings conducted by the federal Environmental Protection Agency and certain state environmental agencies regarding disposal of waste materials. Although the factual situations and the progress of each of these matters differ, the Registrant believes that in each case its liability will be limited to sharing clean-up or other remedial costs with other potentially responsible parties, in amounts that will not have a material adverse effect upon its financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Registrant\nThe following is an alphabetical list of the names and ages of the executive officers of the Registrant and the positions or offices with the Registrant presently held by each person named:\nThe term of office of each of the above listed officers is from the date of his election until his successor shall have been elected and qualified. Messrs. Brookes, Clubb, Engibous, Hayes, Martin, Mitchell and Weber were elected to their respective offices of the Registrant on December 2, 1993; the most recent date of election of the other officers was April 15, 1993. Messrs. Agnich, Aylesworth, Junkins, Lane, Martin, Mitchell, Weber and Zimmerman have served as officers of the Registrant for more than five years. Messrs. Hayes, Nielson and Skiles have served as officers of the Registrant since 1991, 1990 and 1992, respectively; and they and Messrs. Brookes, Clubb and Engibous have been employees of the Registrant for more than five years.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe information which is contained under the caption \"Common Stock Prices and Dividends\" on page 38 of the Registrant's 1993 annual report to stockholders, and the information concerning the number of stockholders of record at December 31, 1993 on page 34 of such annual report, are incorporated herein by reference to such annual report.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\nThe \"Summary of Selected Financial Data\" for the years 1989 through 1993 which appears on page 34 of the Registrant's 1993 annual report to stockholders is incorporated herein by reference to such annual report.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe Letter to the Stockholders on pages 3-5 of the Registrant's 1993 annual report to stockholders and the information contained under the caption Management Discussion and Analysis of Financial Condition and Results of Operations on pages 35-38 of such annual report are incorporated herein by reference to such annual report.\nOn March 1, 1994, the Registrant announced it expects the worldwide semiconductor market to grow 17 percent to $91 billion in 1994, compared to $77 billion in 1993. The market grew 29 percent in 1993.\nOn March 9, 1994, the Registrant announced that it had reached semiconductor patent-license agreements with Micron Technology Inc. and Goldstar Electron Co., Ltd. Payments to the Registrant under the agreements include catch-up payments, which will be reflected in the Registrant's first- quarter 1994 results, and ongoing royalties throughout the terms of the licenses (which run through 1998). By reaching agreement with Micron, Goldstar and 24 other semiconductor companies throughout the world, the Registrant has substantially completed the \"1990 round\" of its semiconductor industry licensing program and can begin to focus on the 1995 round of renewal discussions which will begin next year.\nThe agreement with Micron ends litigation between the Registrant and Micron, reducing the Registrant's semiconductor patent litigation to two conflicts, that with Fujitsu Limited over the Kilby Patent in Japan and with four semiconductor manufacturers in the United States over the Registrant's plastic encapsulation patents.\nThe litigation in Japan is proceeding to a conclusion, although the timing of action on the plastic encapsulation lawsuit remains uncertain. The record in the Fujitsu litigation has been closed and no new arguments will be heard by the court. A decision is expected before mid-1994. The Registrant believes the Kilby patent should be enforced by the court. It has to be recognized, however, that litigation is uncertain by its nature as to timing and outcome, and that this litigation is in a country which has yet to establish a clear record for protecting intellectual property.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements of the Registrant at December 31, 1992 and 1993 and for each of the three years in the period ended December 31, 1993 and the report thereon of the independent auditors, on pages 20-33 of the Registrant's 1993 annual report to stockholders, are incorporated herein by reference to such annual report.\nThe \"Quarterly Financial Data\" on page 38 of the Registrant's 1993 annual report to stockholders is also incorporated herein by reference to such annual report.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant.\nThe information with respect to directors' names, ages, positions, term of office and periods of service, which is contained under the caption \"Nominees for Directorship\" in the Registrant's proxy statement for the 1994 annual meeting of stockholders, and the information contained in the first two paragraphs under the caption \"Other Matters\" in such proxy statement, are incorporated herein by reference to such proxy statement.\nInformation concerning executive officers is set forth in Part I hereof under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nThe information which is contained under the captions \"Directors Compensation\" and \"Executive Compensation\" in the Registrant's proxy statement for the 1994 annual meeting of stockholders is incorporated herein by reference to such proxy statement.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information concerning (a) the only persons that have reported beneficial ownership of more than 5% of the common stock of the Registrant, and (b) the ownership of the Registrant's common stock by the Chief Executive Officer and the four other most highly compensated executive officers, and all executive officers and directors as a group, which is contained under the caption Voting Securities in the Registrant's proxy statement for the 1994 annual meeting of stockholders, is incorporated herein by reference to such proxy statement. The information concerning ownership of the Registrant's common stock by each of the directors, which is contained under the caption Nominees for Directorship in such proxy statement, is also incorporated herein by reference to such proxy statement.\nThe aggregate market value of voting stock held by non-affiliates of the Registrant shown on the cover page hereof excludes the shares held by the Registrant's directors, some of whom disclaim affiliate status, executive vice presidents and senior vice presidents. These holdings were considered to include shares credited to certain individuals' profit sharing accounts.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1 and 2. Financial Statements and Financial Statement Schedules\nThe financial statements and financial statement schedules are listed in the index on page 15 hereof.\n3. Exhibits\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\nSchedule I\nTEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES MARKETABLE SECURITIES - OTHER INVESTMENTS (In Millions of Dollars) Year Ended December 31, 1993\nSchedule V\nTEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT (In Millions of Dollars) Years Ended December 31, 1993, 1992 and 1991\nSubstantially all depreciation is computed by either the declining balance method (primarily 150-percent declining method) or the sum-of-the-years-digits method. Depreciable lives used to calculate depreciation for buildings and improvements are 5-40 years, and for machinery and equipment 3-10 years.\nSchedule VI\nTEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT (In Millions of Dollars) Years Ended December 31, 1993, 1992 and 1991\nSchedule VIII\nTEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES ALLOWANCE FOR LOSSES (In Millions of Dollars) Years Ended December 31, 1993, 1992 and 1991\nAllowance for losses from uncollectible accounts, returns, etc., are deducted from accounts receivable in the balance sheet.\nSchedule X\nTEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES SUPPLEMENTARY INCOME STATEMENT INFORMATION (In Millions of Dollars) Years Ended December 31, 1993, 1992 and 1991\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX","section_15":""}
{"filename":"717867_1993.txt","cik":"717867","year":"1993","section_1":"ITEM 1. BUSINESS.\nJefferies Group, Inc. is a holding company which, through its four primary subsidiaries, Jefferies & Company, Inc., Investment Technology Group, Inc., Jefferies International Limited and Jefferies Pacific Limited, is engaged in securities brokerage and trading, corporate finance and other financial services. The term \"Company\" refers, unless the context requires otherwise, to Jefferies Group, Inc., its subsidiaries, predecessor entities, and W & D Securities, Inc. The Company was originally incorporated in 1973 as a holding company for Jefferies & Company, Inc. and was reincorporated in Delaware on August 10, 1983. The Company and its various subsidiaries maintain offices in Los Angeles, New York, Short Hills, Chicago, Dallas, Boston, Atlanta, New Orleans, Houston, San Francisco, Stamford, London and Hong Kong.\nAs of December 31, 1993, the Company and its subsidiaries had 610 full-time employees, including 339 representatives registered with the National Association of Securities Dealers, Inc. (\"NASD\"). The Company's executive offices are located at 11100 Santa Monica Boulevard, Los Angeles, California 90025, and its telephone number is (310) 445-1199.\nJEFFERIES & COMPANY, INC.\nJefferies & Company, Inc. (\"Jefferies\") was founded in 1962 and is engaged in equity, convertible debt and taxable fixed income securities brokerage and trading and corporate finance. Jefferies is one of the leading national firms engaged in the distribution and trading of blocks of equity securities and conducts such activities primarily in the \"third market.\" The term \"third market\" refers to transactions in listed equity securities effected away from national securities exchanges. Jefferies' revenues are derived primarily from commission revenues and market-making or trading as principal in equity, taxable fixed income and convertible securities with or on behalf of institutional investors, with the balance generated by corporate finance and other activities.\nINVESTMENT TECHNOLOGY GROUP, INC.\nInvestment Technology Group, Inc. (\"ITG\") is a leading provider of automated securities trade execution and analysis services to institutional equity investors. ITG's two principal services are POSIT(R), the largest automated stock crossing system operated during trading hours, and QuantEX(R), a proprietary decision support system with integrated trade analysis, routing and management capabilities. These services employ proprietary software to enhance customers' trading efficiencies, access to market liquidity and portfolio analysis capabilities. To supplement ITG's POSIT(R) and QuantEX(R) services, ITG's ISIS service uses a database of securities, price and liquidity information to provide enhanced decision support in all aspects of its customers' trade execution and analysis activities.\nPOSIT(R), which is accessed through direct computer links or by communicating with ITG's trading desk, allows customers to place confidential buy and sell orders on approximately 7,000 different equity securities and portfolios of equity securities. POSIT(R) analyzes these buy and sell orders and determines the maximum number of securities which may be matched or \"crossed\" among participants. After determining the optimal cross, POSIT(R) executes trades at the midpoint of the primary market best bid and offer for each security at the time of the cross. Participants using direct computer links are automatically notified of completed crosses. ITG currently offers three scheduled daily crosses and can also accommodate additional crosses in response to customer demand. The system operates on a confidential basis, allowing customers to trade large blocks of equity securities at reduced transaction fees while minimizing the price impact of the trade. ITG derives revenue by collecting transaction fees on each share which is crossed through the system.\nAverage daily share volume on POSIT(R) has grown from approximately 288,000 shares in 1988 to approximately 6.3 million shares in 1993. During the last quarter of 1993, average daily share volume was approximately 8.3 million shares. In addition to its traditional customer base of quantitative and passive investors, POSIT(R) has recently begun to serve fundamental institutional investors, broker-dealers and international institutional investors. The system is currently used by approximately 200 customers, including\ncorporate and government pension plans, insurance companies, bank trust departments, investment advisors and mutual funds.\nQuantEX(R) is a proprietary trade execution and analysis system that operates on Sun Microsystems workstations provided to customers by ITG. The integrated trade analysis, routing and management capabilities of QuantEX(R) provide valuable support to investment managers in the development and implementation of portfolio trading strategies and allow securities traders to organize, process and manage large trading lists. The automation of these functions enables users to analyze and trade large portfolios of securities faster and more effectively than by other traditional means. QuantEX(R) allows an investment manager to develop a series of rules based upon the manager's strategy for trading equity securities and applies these rules to a continuous flow of current market information in order to generate real-time decision support. Through its direct routing capabilities, QuantEX(R) also allows investment managers and securities traders to route orders to POSIT(R), major national and regional stock exchanges, OTC market makers, ITG's trading desk or selected broker-dealers. QuantEX(R)'s trade management function automatically tracks and summarizes trades routed through QuantEX(R). ITG generally derives revenue by collecting a transaction fee on each share which is routed for trading through QuantEX(R).\nIn March, 1994, the Company formed a new subsidiary, Investment Technology Group, Inc. (the \"ITG Holding Company\") for the purpose of eventually holding 100% of the stock of the broker-dealer subsidiary Investment Technology Group, Inc. whose name was then changed to ITG Inc.\nOn March 15, 1994, the ITG Holding Company filed with the Securities and Exchange Commission a Registration Statement with respect to the offer of 3,700,000 shares of its common stock (which includes 450,000 shares subject to an over-allotment option granted to the underwriters), in an initial public offering (the \"Offering\"). The filing indicated an anticipated offering price of between $12 and $14 per share. Immediately prior to the consummation of the offering, the ITG Holding Company will issue 15,000,000 shares of its common stock in exchange for all of the issued and outstanding shares of common stock of ITG held by the Company. As a result of these transactions, ITG will become a wholly-owned subsidiary of the ITG Holding Company which will become a wholly-owned subsidiary of the Company. ITG has conducted, and will continue to conduct, the business activities of the ITG Holding Company. Following the offering, the Company will own 80.2% of the outstanding common stock of the ITG Holding Company.\nIn addition, immediately prior to the offering, the ITG Holding Company will enter into an intercompany borrowing agreement with the Company permitting the borrowing by the ITG Holding Company of up to $15,000,000. Any outstanding balance will be due March 31, 1999, and will accrue interest at 1.75% above the one month London Interbank Offering Rate.\nImmediately prior to the Offering, the ITG Holding Company will declare a dividend payable to its sole stockholder, the Company, in an amount of approximately $17.0 million, which dividend will be paid by the issuance of a note in the full amount of such dividend and may be increased or decreased based on the actual proceeds of the Offering. Any future payment of dividends will be at the discretion of the ITG Holding Company's Board of Directors and will depend on the ITG Holding Company's financial condition, results of operations, capital requirements and other factors deemed relevant by such Board of Directors. However, the ITG Holding Company anticipates that all future earnings will be retained by the ITG Holding Company for working capital and that the ITG Holding Company will not pay any dividends to its stockholders.\nJEFFERIES INTERNATIONAL LIMITED AND JEFFERIES PACIFIC LIMITED\nJefferies International Limited (\"JIL\"), a broker-dealer subsidiary of the Company, was incorporated in 1986 in England. JIL is a member of The International Stock Exchange and The Securities and Futures Authority. JIL introduces customers trading in U.S. securities to Jefferies and also trades as a broker-dealer in international equity and convertible securities and American Depositary Receipts (\"ADRs\").\nJefferies Pacific Limited (\"JPL\"), a broker subsidiary of the Company, was incorporated in 1992 in Hong Kong. JPL presently introduces foreign customers trading in U.S. securities to Jefferies. JPL commenced operations in 1993 and has not yet generated material revenues.\nW & D SECURITIES, INC.\nW & D Securities, Inc. (\"W & D\") provides execution services primarily on the NYSE and other exchanges to Jefferies and ITG. In order to comply with regulatory requirements of the NYSE that generally prohibit NYSE members and their affiliates from executing, as principal and, in certain cases, as agent, transactions in NYSE-listed securities off the NYSE, the Company gave up its formal legal control of W & D, effective January 1, 1983, by exchanging all of the W & D common stock owned by it for non-voting preferred stock of W & D. The common stock of W & D is presently held by an officer of W & D who has agreed with the Company that, at the option of the Company, he will sell such stock to the Company for nominal consideration. In the event that the Company were to regain ownership of such common stock, the Company believes that the NYSE would assert that W & D would be in violation of the NYSE's rules unless similar arrangements satisfactory to the NYSE were made with respect to the ownership of the common stock.\nWhile the NYSE has generally approved the above arrangements, there can be no assurance that it will not raise objections in the future. In light of these arrangements and the high proportion of the equity of W & D represented by the non-voting preferred stock held by the Company, W & D is consolidated as a subsidiary of the Company for financial purposes. The Company believes that it can make satisfactory alternative arrangements for executing transactions in listed securities on the NYSE if it were precluded from doing so through W & D.\nCOMMISSION BUSINESS\nA substantial portion of the Company's revenues is derived from customer commissions on brokerage transactions in equity (primarily listed) and debt securities for domestic and international investors such as investment advisors, banks, mutual funds, insurance companies and pension and profit sharing plans. Such investors normally purchase and sell securities in block transactions, the execution of which requires special marketing and trading expertise. The Company is one of the leading national firms in the execution of equity block transactions, and believes that its institutional customers are attracted by the quality of the Company's execution (with respect to considerations of quantity, timing and price) and its competitive commission rates, which are negotiated on the basis of market conditions, the size of the particular transaction and other factors. In addition to domestic equity securities, the Company executes transactions in taxable fixed income securities, domestic and international convertible securities, international equity securities, ADRs, options, preferred stocks, financial futures and other similar products.\nMost of the Company's equity account executives are electronically interconnected through a system permitting simultaneous verbal and graphic communication of trading and order information by all participants. The Company believes that its execution capability is significantly enhanced by this system, which permits its account executives to respond to each other and to negotiate order indications directly with customers rather than through a separate trading department.\nPRINCIPAL TRANSACTIONS\nIn the regular course of business, the Company takes securities positions as a market-maker to facilitate customer transactions and for investment purposes. In making markets and when trading for its own account, the Company exposes its own capital to the risk of fluctuations in market value. Trading profits (or losses) depend primarily upon the skills of the employees engaged in market-making and position taking, the amount of capital allocated to positions in securities and the general trend of prices in the securities markets.\nThe Company monitors its risk by maintaining its securities positions at or below certain pre-established levels. These levels reduce certain opportunities to realize profits in the event that the value of such securities increases. However, they also reduce the risk of loss in the event of a decrease in such value and result in controlled interest costs incurred on funds provided to maintain such positions.\nEquities. The Equities Division makes markets in over 400 over-the-counter equity and ADR securities, operates six specialist posts on the Pacific Stock Exchange (\"PSE\") and two specialist posts on the Boston\nStock Exchange (\"BSE\"), and trades securities for its own account, as well as to accommodate customer transactions.\nTaxable Fixed Income. The Taxable Fixed Income Division trades high grade and non-investment grade public and private debt securities. The Division specializes in trading and making markets in over 300 unrated or less than investment grade corporate debt securities and accounts for these positions at market value. At December 31, 1993, the aggregate long and short market value of these positions was $34.1 million and $5.2 million, respectively. Risk of loss upon default by the borrower is significantly greater with respect to unrated or less than investment grade corporate debt securities than with other corporate debt securities. These securities are generally unsecured and are often subordinated to other creditors of the issuer. These issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. There is a limited market for some of these securities and market quotes are generally available from a small number of dealers.\nConvertible Securities and Warrants. The Company also trades domestic and international convertible securities and warrants and assists corporate and institutional clients in identifying attractive investments in these securities and warrants.\nArbitrage. The Company engages in arbitrage for its own account. The Company currently conducts arbitrage activities through a relationship with an independent management firm pursuant to which the Company delegates to the manager investment decisions involving the purchase and\/or sale of securities in one of the Company's proprietary trading accounts. The manager receives a fee equal to a percentage of the profits in the account after a deduction of all costs, expenses, commissions and interest charges applicable to the trading activity in the account. The Company also engages in international arbitrage involving securities listed or traded in both domestic and foreign markets. In addition, the Company has invested in a limited partnership which conducts arbitrage activity.\nCORPORATE FINANCE\nJefferies' Corporate Finance Department offers corporations a full range of advisory as well as debt and equity financing services which include private placements and public offerings of debt and equity securities, debt refinancings, recapitalizations, mergers and acquisitions advice, exclusive sales advice, structured financings and securitizations, consent and waiver solicitations, and company and bondholder representations in corporate restructurings.\nInvestment banking activity involves both economic and regulatory risks. An underwriter may incur losses if it is unable to sell the securities it is committed to purchase or if it is forced to liquidate its commitments at less than the agreed-upon purchase price. In addition, under the Securities Act of 1933 and other laws and court decisions with respect to underwriters' liability and limitations on indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. Further, underwriting commitments constitute a charge against net capital and the Company's underwriting commitments may be limited by the requirement that it must, at all times, be in compliance with the Uniform Net Capital Rule 15c3-1 of the Securities and Exchange Commission (the \"Commission\").\nThe Company intends to continue to pursue opportunities for its corporate customers which may require it to finance and\/or underwrite the issuance of securities. Under circumstances where the Company is required to act as an underwriter or to trade on a proprietary basis with its customers, the Company may assume greater risk than would normally be assumed in certain other principal transactions.\nINTEREST\nThe Company earns interest on its securities portfolio and on its operating and segregated balances. The Company also derives net interest income in connection with its stock borrow\/stock loan and margin lending activities.\nStock Borrow\/Stock Loan. In connection with both its trading and brokerage activities, the Company borrows securities to cover short sales and to complete transactions in which customers have failed to deliver securities by the required settlement date, and lends securities to other brokers and dealers for similar purposes. The Company also has a stock borrow versus stock loan business with other brokers. From this activity, the Company derives interest revenues and interest expenses.\nMargin Lending. Customers' transactions are executed on either a cash or margin basis. In a margin transaction, the Company extends credit to the customer, collateralized by securities and cash in the customer's account, for a portion of the purchase price, and receives income from interest charged on such extensions of credit.\nIn permitting a customer to purchase securities on margin, the Company is subject to the risk that a market decline could reduce the value of its collateral below the amount of the customer's indebtedness and that the customer might otherwise be unable to repay the indebtedness.\nIn addition to monitoring the creditworthiness of its customers, the Company also considers the trading liquidity and volatility of the securities it accepts as collateral for its margin loans. Trading liquidity and volatility may be dependent, in part, upon the market on which the security is traded, the number of outstanding shares of the issuer, events affecting the issuer and\/or securities markets in general, and whether or not there are any legal restrictions on the sale of the securities. Certain types of securities have historical trading patterns which may assist the Company in making its evaluation. Historical trading patterns, however, may not be good indicators over relatively short time periods or in markets which are affected by unusual or unexpected developments. The Company considers all of these factors at the time it agrees to extend credit to customers and continues to review its extensions of credit on an ongoing basis.\nThe majority of the Company's margin loans are made to United States citizens or to corporations which are domiciled in the United States. The Company may extend credit to investors or corporations who are citizens of foreign countries or who may reside outside the United States. The Company believes that should such foreign investors default upon their loans with the Company and should the collateral for those loans be insufficient to satisfy the investors' obligations to the Company, the Company may experience more difficulty in collecting investors' outstanding indebtedness than would be the case if investors were citizens or residents of the United States.\nAlthough the Company attempts to minimize the risk associated with the extension of credit in margin accounts, there is no assurance that the assumptions on which the Company bases its decisions will be correct or that the Company is in a position to predict factors or events which will have an adverse impact on any individual customer or issuer, or the securities markets in general.\nCOMPETITION\nAll aspects of the business of the Company are intensely competitive. The Company competes directly with numerous other brokers and dealers, investment banking firms and banks. In addition to competition from firms currently in the securities business, there has been increasing competition from others offering financial services. These developments and others have resulted, and may continue to result, in significant additional competition for the Company.\nMember firms of the NYSE generally are prohibited from effecting transactions when acting as principal and, in certain cases, as agents, in listed equity securities off the NYSE, and therefore, unlike Jefferies and ITG, are precluded from effecting such transactions in the third market. Such firms may execute certain transactions in listed equity securities in the third market for customers, although typically they do not do so. Since firms which the Company regards as its major competitors in the execution of transactions in equity securities for institutional investors are members of the NYSE, any removal of these prohibitions could adversely affect the Company's business.\nREGULATION\nThe securities industry in the United States is subject to extensive regulation under both federal and state laws. The Commission is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally the NASD and the securities exchanges, are actively involved in the regulation of broker-dealers. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the Commission. Securities firms are also subject to regulation by state securities commissions in those states in which they do business. Jefferies is registered as a broker-dealer in 50 states and the District of Columbia. ITG is registered as a broker-dealer in 49 states and the District of Columbia. W & D is registered as a broker-dealer in 23 states.\nBroker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers' funds and securities, capital structure of securities firms, record-keeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the Commission and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. The Commission, self-regulatory organizations and state securities commissions may conduct administrative proceedings which can result in censure, fine, suspension, expulsion of a broker-dealer, its officers or employees, or revocation of broker-dealer licenses. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of broker-dealers.\nAs registered broker-dealers, Jefferies, ITG and W & D are required by law to belong to the Securities Investor Protection Corporation (\"SIPC\"). In the event of a member's insolvency, the SIPC fund provides protection for customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances.\nNet Capital Requirements. Every registered broker-dealer doing business with the public is subject to the Commission's Uniform Net Capital Rule (the \"Rule\"), which specifies minimum net capital requirements. Jefferies Group, Inc. is not a registered broker-dealer and is therefore not subject to the Rule; however, its United States broker-dealer subsidiaries are subject thereto.\nThe Rule provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its adjusted net capital (the \"primary method\") or, alternatively, that it not permit its adjusted net capital to be less than 2% of its aggregate debit balances (primarily receivables from customers and broker-dealers) computed in accordance with such Rule (the \"alternative method\"). Jefferies, ITG and W & D use the alternative method of calculation.\nCompliance with applicable net capital rules could limit operations of Jefferies or ITG, such as underwriting and trading activities, that require use of significant amounts of capital, and may also restrict loans, advances, dividends and other payments by Jefferies or ITG to the Company. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of Jefferies or ITG to expand or even maintain their present level of business. Net capital changes from day to day, but as of December 31, 1993, Jefferies' net capital of $76.0 million exceeded its minimum net capital requirements by $66.8 million. ITG's net capital of $1.9 million exceeded its minimum net capital requirements by $1.7 million. W & D's net capital of $821,000 exceeded its minimum net capital requirements by $671,000. See note 12 of Notes to Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company maintains sales offices in Los Angeles, New York, Short Hills, Chicago, Dallas, Boston, Atlanta, New Orleans, Houston, San Francisco, Stamford, London and Hong Kong. In addition, the Company maintains operations offices in Los Angeles and New York. The Company leases all of its office space which management believes is adequate for the Company's business. For information concerning leasehold improvements and rental expense, see notes 1, 5 and 10 of Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nMany aspects of the Company's business involve substantial risks of liability. In the normal course of business, the Company and its subsidiaries have been named as defendants or co-defendants in lawsuits involving primarily claims for damages. The Company's management believes that pending litigation will not have a material adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's Common Stock trades in the NASDAQ National Market System under the symbol JEFG. The following table sets forth for the periods indicated, the range of high and low representative bid prices per share for the Common Stock as reported by NASDAQ, which prices do not include retail mark-ups, mark-downs or commissions and represent prices between dealers and not necessarily actual transactions.\nThere were approximately 283 holders of record of the Company's Common Stock at December 31, 1993.\nIn 1988, the Company instituted a policy of paying regular quarterly cash dividends. There are no restrictions on the Company's present ability to pay dividends on Common Stock, other than the applicable provisions of the Delaware General Corporation Law.\nDividends per Common Share (declared and paid):\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected data presented below as of and for each of the years in the five-year period ended December 31, 1993, are derived from the consolidated financial statements of Jefferies Group, Inc. and subsidiaries, which financial statements have been audited by KPMG Peat Marwick, independent auditors. Such data should be read in connection with the consolidated financial statements contained on pages 14 through 31.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company's principal activities, securities brokerage and the trading of and market-making in securities, are highly competitive and extremely volatile.\nTotal assets increased $857.4 million from $531.0 million at December 31, 1992 to $1,388.4 million at December 31, 1993. The increase is mostly due to an increase in receivables from brokers and dealers related to stock borrow balances. The increased stock borrow balances are a result of an increase in payable to customers and payable to brokers and dealers (related to stock loan).\nTotal liabilities increased $840.4 million from $393.5 million at December 31, 1992 to $1,233.9 million at December 31, 1993. The increase is mostly due to the before-mentioned increases in payable to customers and payable to brokers and dealers. In addition, accrued expenses and other liabilities increased $45.9 million to $92.8 million in 1993 due to bonuses, accruals related to deferred compensation and accrued federal and state taxes.\nThe earnings of the Company are subject to wide fluctuations since many factors over which the Company has little or no control, particularly the overall volume of trading and the volatility and general level of market prices, may significantly affect its operations. The following provides a summary of revenues by source for the past three years.\n1993 COMPARED TO 1992\nTotal revenues for 1993 increased $82.7 million, or 35%, as compared to 1992. The increase was primarily due to a $48.6 million, or 203%, increase in corporate finance activity and a $18.7 million, or 65%, increase in ITG activity. Commission revenues increased $31.4 million, or 29%, interest revenues increased $4.9 million, or 29%, and other revenues increased $880,000, or 54%, while principal transactions decreased $3.0 million, or 3%. The increase in corporate finance was due to increased activity in underwriting, private placement and financial advisory fees, including approximately $16 million in fees from one underwriting transaction. The increase in commissions was mostly attributable to increases in transactions conducted through POSIT(R) and QuantEX(R), two of the Company's investment technology products. Interest revenues increased primarily due to an increase in stock borrow balances. The increase in other revenues was mostly due to income related to the termination of an office lease and foreign currency transaction gains. Principal trading decreased mostly due to a reduction in trading gains of the Taxable Fixed Income Division partially offset by the improved performance of the Company's Over-The-Counter Division.\nTotal expenses for 1993 increased $69.0 million, or 34%, as compared to 1992. The increase in total expenses was due to an increase of $49.3 million, or 42%, in compensation and benefits, an increase of $10.8 million, or 40%, in other expense, an increase of $4.2 million, or 32%, in interest expense, an increase of $2.1 million, or 15%, in floor brokerage and clearing fees, and an increase of $2.0 million, or 12%, in telecommunications and data processing services. Compensation and benefits increased mostly due to an increase in profitability-based compensation (including a $4 million increase in expense related to ITG's performance share plan. See notes 9 and 14 of Notes to Consolidated Financial Statements.), payouts related to higher commission revenues and additional personnel. Other expense increased mostly due to increases in four items; travel and entertainment expenses, soft dollar expenses, research and consulting and royalties related to POSIT(R) revenues. These four items not only represent the majority of the increase from 1992 to 1993, but these items also represent the majority of other expense. Interest expense increased due to increases in customer credit balances and stock loan balances related to the increase in stock borrow balances. Floor brokerage and clearing fees increased due to increased volumes of business executed on the various exchanges. Telecommunications and data processing services increased due to an increase in the number of offices. Occupancy and equipment rental expenses remained relatively unchanged as compared to the 1992 period.\nAs a result of the above, earnings before income taxes and cumulative effect of change in accounting principle increased from $33.7 million in 1992 to $47.3 million in 1993. The $13.7 million increase was chiefly due to the increase in revenues from corporate finance activity and investment technology commissions.\nEarnings before cumulative effect of change in accounting principle were up 47% to $27.6 million, as compared to $18.7 million in the 1992 period. The effective tax rate was approximately 42% for 1993 compared to 44% for the 1992 period. An adjustment of prior years' estimated tax liabilities, to actual, resulted in the lower tax rate for the 1993 period.\nThe cumulative effect of the change in accounting for income taxes required by Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\" was a $1.4 million benefit. This increased net earnings to $28.9 million, which represents an increase of $10.2 million, or 55%, over the 1993 period.\nPrimary earnings per share were $5.63 on 5.1 million shares in 1993 compared to $3.82 on 4.9 million shares in 1992. Fully diluted earnings per share were $4.88 on 6.2 million shares in 1993 compared to $3.08 on 6.7 million shares in 1992. The cumulative effect of the change in accounting principle increased earnings per share in 1993 by $.26 on primary shares and $.22 on fully diluted shares.\n1992 COMPARED TO 1991\nTotal revenues for 1992 increased $39.5 million, or 20%, as compared to 1991. The increase was primarily due to a $22.4 million, or 27%, increase in commission revenues. Principal transactions increased $16.4 million, or 23%, and corporate finance increased $7.1 million, or 43%, while interest revenues decreased $7.1 million, or 30%. The increase in commissions was across the board with notable increases in POSIT(R) and\nQuantEX(R), the Company's computerized investment technology products. The increase in principal trading was mostly due to the Company's Over-The-Counter and International Convertible Departments. The increase in corporate finance resulted primarily from participation in a greater number of transactions. The decrease in interest revenues was due primarily to a decrease in interest rates, although customer margin debit balances also decreased.\nTotal expenses for 1992 increased $23.7 million, or 13%, as compared to 1991. The increase in total expenses was due to an increase of $26.0 million, or 28%, in compensation and benefits, an increase of $2.2 million, or 19%, in floor brokerage and clearing fees, and an increase of $1.0 million, or 6%, in telecommunications and data processing services. These were partially offset by a decrease of $2.7 million, or 17%, in interest expense, a decrease of $2.2 million, or 7%, in other expense, and a decrease of $641,000, or 5%, in occupancy and equipment rental. Compensation and benefits increased mostly due to profitability-based compensation. In connection with the acquisition of Integrated Analytics Corporation (\"IAC\") in 1991, the Company hired certain employees of IAC. Several of these employees participate in a performance share plan consisting of a phantom equity interest in ITG as determined by a formula based primarily on ITG earnings and vesting requirements. The Company expensed approximately $3.6 million under this plan in 1992. For more information on the performance share plan, see notes 9 and 14 of Notes to Consolidated Financial Statements. Additionally, the increase in compensation and benefits related to increased commission revenues and increased headcount. Floor brokerage and clearing fees increased primarily because of increased volumes of business executed on the various exchanges. Telecommunications and data processing services increased due to increased trade volume and ongoing system development. Interest expense decreased due to lower interest rates. Other expense decreased mostly due to a reduction in bad debt and legal expenses. Occupancy and equipment rental decreased primarily due to a reduction in moving related expenses.\nAs a result of the above, earnings before income taxes increased from $17.8 million in 1991 to $33.7 million in 1992. The $15.8 million increase in earnings was chiefly due to the increase in revenues from commissions and principal transactions.\nNet earnings were $18.7 million, an increase of $8.9 million, or 90%, compared to 1991. The effective tax rate was 44.4% in 1992 and 44.7% in 1991.\nPrimary earnings per share were $3.82 on 4.9 million shares in 1992 compared to $1.74 on 5.7 million shares in 1991. Fully diluted earnings per share were $3.08 on 6.7 million shares in 1992 compared to $1.57 on 7.5 million shares in 1991.\nLIQUIDITY AND CAPITAL RESOURCES\nA substantial portion of the Company's assets are liquid, consisting of cash or assets readily convertible into cash. The majority of securities positions (both long and short) in the Company's trading accounts are readily marketable and actively traded. Receivables from brokers and dealers are primarily current open transactions or securities borrowed transactions which can be settled or closed out within a few days. Receivables from customers, officers and directors include margin balances and amounts due on uncompleted transactions. Most of the Company's receivables are secured by marketable securities.\nThe Company's assets are financed by equity capital, subordinated debt, customer free credit balances, bank loans and other payables. Bank loans represent secured and unsecured short-term borrowings (usually overnight) which are generally payable on demand. Secured bank loans are collateralized by a combination of customer, noncustomer and firm securities. The Company has always been able to obtain necessary short-term borrowings in the past and believes that it will continue to be able to do so in the future. Additionally, the Company has letters of credit outstanding which are used in the normal course of business to satisfy various collateral requirements in lieu of depositing cash or securities.\nJefferies is subject to the net capital requirements of the Commission, the NASD, the BSE, and the PSE, which are designed to measure the general financial soundness and liquidity of broker-dealers. Jefferies consistently has operated in excess of the minimum requirements. At December 31, 1993, Jefferies had regulatory net capital, after adjustments as required by the Commission's Uniform Net Capital Rule, of\n$76.0 million, which exceeded the minimum net capital requirements by $66.8 million. At December 31, 1993, ITG had regulatory net capital, after adjustments as required by the Commission's Uniform Net Capital Rule, of $1.9 million, which exceeded the minimum net capital requirements by $1.7 million. At December 31, 1993, W & D had regulatory net capital, after adjustments as required by the Commission's Uniform Net Capital Rule, of $821,000, which exceeded the minimum net capital requirements by $671,000. Jefferies, ITG and W & D use the alternative method of calculating their regulatory net capital.\nIn 1992, the Company repurchased 479,339 shares of its Common Stock at prices ranging from $14.375 to $19. Also in 1992, the Company exchanged $10.7 million of new subordinated 8 7\/8% non-convertible notes, due 1997, for $10.7 million face amount of its 7% convertible subordinated notes due 2010, which were convertible into 466,521 shares of the Company's Common Stock. The new notes provide for mandatory redemption in 1995 and 1996 of one-third of the principal face amount, respectively. Although the exchange did not reduce the number of primary shares outstanding, it reduced the Company's fully diluted shares outstanding by approximately 7%.\nIn October 1993, the Company called for redemption all of its 8 1\/2% Convertible Subordinated Debentures and all of its 7% Convertible Subordinated Notes. Holders of $29,731,000 aggregate principal amount of 8 1\/2% Convertible Subordinated Debentures and $1,690,000 aggregate principal amount of 7% Convertible Subordinated Notes elected to convert their securities into an aggregate of 1,366,092 shares of the Company's Common Stock. Also in 1993, the Company repurchased 351,837 shares of its Common Stock at prices ranging from $23.375 to $36.50.\nThe repurchased shares of Common Stock are presently being held as treasury shares.\nEFFECTS OF INFLATION\nBecause the Company's assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. Increases in the Company's expenses, such as employee compensation, rent and communications, due to inflation may not be readily recoverable in the prices of services offered by the Company. In addition, to the extent that inflation results in rising interest rates and has other adverse effects on securities markets and on the value of securities held in the inventory, it may adversely affect the Company's financial position and results of operations.\nEFFECTS OF CHANGES IN FOREIGN CURRENCY RATES\nThe Company maintains a foreign securities business in its foreign offices (London and Hong Kong) as well as in some of its domestic offices. Most of these activities are hedged by related foreign currency liabilities or by forward exchange contracts. However, the Company is still subject to some foreign currency risk. A change in the foreign currency rates could create either a foreign currency transaction gain\/loss (recorded in the Company's Consolidated Statement of Earnings) or a foreign currency translation adjustment to the Stockholders' Equity section of the Company's Consolidated Statement of Financial Condition.\nFor an assessment of risk, see Part I, Item 1, Business sections \"Principal Transactions,\" \"Corporate Finance,\" \"Interest,\" and \"Competition\" and see Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations sections \"Effects of Inflation\" and \"Effects of Changes in Foreign Currency Rates.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS REPORT\nThe Board of Directors and Stockholders JEFFERIES GROUP, INC.:\nWe have audited the accompanying consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of earnings, changes in stockholders equity and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jefferies Group, Inc. and subsidiaries as of December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in note 1 to the consolidated financial statements, the Company changed its accounting for income taxes in 1993 to adopt the provisions of the Financial Accounting Standard Boards Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nLos Angeles, California KPMG PEAT MARWICK January 28, 1994, except as to note 14 to the consolidated financial statements, which is as of March 15, 1994.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1993 AND 1992 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF EARNINGS THREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)\nSupplemental disclosure of noncash financing activities: In September 1993, the Company called for redemption of all of its then outstanding convertible subordinated debentures and notes. Holders of $29,731,000 face value of 8 1\/2% Convertible Subordinated Debentures and $1,690,000 face value of 7% Convertible Subordinated Notes elected to convert their debentures and notes into 1,366,092 shares of the Company's Common Stock. In 1993, the Company recognized an additional minimum pension liability of $1,063,000 related to the Company's pension plan, which resulted in an increase to accrued expenses and other liabilities and an offsetting decrease in stockholders' equity.\nSee accompanying notes to consolidated financial statements.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993 AND 1992\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of Jefferies Group, Inc. (Company) and all wholly owned subsidiaries, including Jefferies & Company, Inc. (Jefferies) and Investment Technology Group, Inc. (ITG). The accounts of W & D Securities, Inc. (W & D) are also consolidated because of the nature and extent of the Company's ownership interest in W & D. The Company and its subsidiaries are primarily engaged in equity and taxable fixed income securities brokerage and trading. Operations of the Company include agency and principal transactions and other securities-related financial services.\nAll significant intercompany accounts and transactions are eliminated in consolidation.\nSECURITIES TRANSACTIONS\nStarting January 1, 1993, all securities transactions (related commission revenue and expense) are recorded on a trade-date basis, which does not materially differ from the Company's previously used settlement-date basis.\nRECEIVABLE FROM, AND PAYABLE TO, CUSTOMERS, OFFICERS AND DIRECTORS\nReceivable from, and payable to, customers includes amounts receivable and payable on cash and margin transactions. Securities owned by customers and held as collateral for these receivables are not reflected in the accompanying consolidated financial statements. Receivable from officers and directors represents balances arising from their individual security transactions. Such transactions are subject to the same regulations as customer transactions.\nSECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED\nSecurities owned and securities sold, not yet purchased, are valued at market value, and unrealized gains and losses are reflected in revenues from principal transactions.\nPREMISES AND EQUIPMENT\nPremises and equipment are depreciated using the straight-line method over the estimated useful lives of the related assets (generally five to ten years). Leasehold improvements are amortized using the straight-line method over the term of related leases or the estimated useful lives of the assets, whichever is shorter.\nAMORTIZATION OF INTANGIBLES\nThe excess of cost over net assets acquired is amortized on a straight-line basis over ten years.\nINCOME TAXES\nThe Company files a consolidated U.S. Federal income tax return which includes all qualifying subsidiaries. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable. Deferred income taxes are provided for temporary differences in reporting certain items, principally state income taxes, depreciation, deferred compensation and unrealized gains and losses on securities owned. Tax credits are recorded as a reduction of income tax expense when realized.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Statement 109 requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEffective January 1, 1993, the Company adopted Statement 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 statement of earnings.\nPursuant to the deferred method under APB Opinion 11 which was applied in 1992 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.\nCASH AND CASH EQUIVALENTS\nThe Company generally invests its excess cash in U.S. Treasury notes purchased under agreements to resell to a financial institution. At December 31, 1993 and 1992, such cash equivalents amounted to $4,500,000 and $4,000,000, respectively, and were held in the Company's safekeeping account at a bank. Cash equivalents are part of the cash management activities of the Company and generally mature within 90 days.\nEARNINGS PER COMMON SHARE\nPrimary earnings per share of common stock are computed by dividing net earnings by the average number of shares of common stock and common stock equivalents outstanding during the period. Fully diluted earnings per share of common stock have been further adjusted for conversion of convertible subordinated debt, if dilutive.\nFOREIGN CURRENCY TRANSLATION\nIn accordance with SFAS 52, \"Accounting for Foreign Currency Translation,\" the Company's foreign revenues, costs and expenses are translated at average current rates during each reporting period. Foreign currency transaction gains and losses are currently included in the statement of earnings. Gains and losses resulting from translation of financial statements are excluded from the statement of earnings and are recorded directly to a separate component of stockholders' equity.\nRECLASSIFICATIONS\nCertain reclassifications have been made to the prior year's amounts to conform to the current year's presentation.\n(2) ACQUISITION\nIn 1991, the Company completed the acquisition of a controlling interest in Integrated Analytics Corporation (IAC), a developer and marketer of computer software for use in the securities industry, through stock purchases for $6,100,000 in cash. Excess of purchase price over the fair value of net assets acquired of $6,300,000 is being amortized using the straight-line method over ten years. At December 31, 1993, excess of\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npurchase price over net assets acquired remaining was $4,271,000 and is included in other assets. In connection with the acquisition, the Company also entered into an agreement with certain IAC employees providing for payment of compensation tied to the earnings of the Company's technology group. For more information regarding the agreement, see note 9.\n(3) RECEIVABLE FROM, AND PAYABLE TO, CUSTOMERS, OFFICERS AND DIRECTORS\nThe following is a summary of the major categories of receivables from customers, officers and directors as of December 31, 1993 and 1992 (in thousands of dollars):\nInterest is paid on free credit balances in accounts of customers who have indicated that the funds will be used for investment at a future date. The rate of interest paid on such free credit balances varies between the thirteen-week treasury bill rate and 1% below that rate, depending upon the size of the customers' free credit balances.\nUncollectible accounts expense amounted to $708,000, $1,080,000 and $2,338,000 for the years ended December 31, 1993, 1992 and 1991, respectively, and is included in other expense.\n(4) SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED\nThe following is a summary of the market value of major categories of securities owned and securities sold, not yet purchased, as of December 31, 1993 and 1992:\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(5) PREMISES AND EQUIPMENT\nThe following is a summary of premises and equipment as of December 31, 1993 and 1992 (in thousands of dollars):\nDepreciation and amortization expense amounted to $4,350,000, $4,909,000 and $4,524,000 for the years ended December 31, 1993, 1992 and 1991, respectively.\nIncluded in furniture, fixtures and equipment is leased computer and office equipment totaling $5,046,000 and related accumulated amortization of $2,927,000.\n(6) BANK LOANS\nBank loans represent short-term borrowings that are payable on demand and generally bear interest at the brokers' call loan rate. At December 31, 1993, secured and unsecured firm loans amounted to $25,928,000 and $20,000,000, respectively. The secured loans were fully collateralized by firm securities having a market value of $41,888,000. The Company did not have any loans outstanding at December 31, 1992.\n(7) SUBORDINATED DEBT\nThe following summarizes subordinated debt outstanding at December 31, 1993 and 1992 (in thousands of dollars):\nIn 1992, the Company issued $10,730,000 face value of 8 7\/8% Subordinated Notes in exchange for 7% Convertible Subordinated Notes having the same face value.\nIn September 1993, the Company called for redemption of all of its then outstanding convertible subordinated debentures and notes. Holders of $29,731,000 face value of 8 1\/2% Convertible Subordinated Debentures and $1,690,000 face value of 7% Convertible Subordinated Notes elected to convert their debentures and notes into 1,366,092 shares of the Company's Common Stock.\nBeginning October 1, 1995, the 8 7\/8% Notes have sinking fund requirements to redeem $3,577,000 annually through October 1, 1997.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(8) INCOME TAXES\nAs discussed in note 1, the Company adopted Statement 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $1,358,000 is determined as of January 1, 1993 and is reported separately in the consolidated statement of earnings for the year ended December 31, 1993. Prior years financial statements have not been restated to apply the provisions of Statement 109.\nTotal income tax expense for the year ended December 31, 1993 was allocated as follows (in thousands of dollars):\nIncome tax expense for the years ended December 31, 1993, 1992 and 1991 consists of the following:\nIncome tax expense differed from the amounts computed by applying the Federal income tax rate of 35% for 1993 and 34% for 1992 and 1991 as a result of the following:\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFor the years ended December 31, 1993, 1992 and 1991, deferred tax benefits of $7,438,000, $1,103,000 and $1,533,000 resulted from temporary differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax effects of those timing differences are presented below:\nThe deferred tax benefit of $7,438,000 for the year ended December 31, 1993 included a $101,000 benefit from adjustments to deferred tax assets and liabilities for enacted changes in tax laws and rates.\nThe cumulative tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1993 are presented below (in thousands of dollars):\nThere was no valuation allowance for deferred tax assets as of January 1, 1993 and no allowance added during the year ended December 31, 1993.\nManagement believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. However, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCertain subsidiaries have net operating losses which cannot be used by other members of the consolidated group in the aggregate amount of $720,000. For Federal tax purposes, all net operating losses are due to expire in 2006.\n(9) BENEFIT PLANS\nPENSION PLAN\nThe Company has a defined benefit pension plan which covers substantially all employees of the Company and its subsidiaries. The plan is subject to the provisions of the Employee Retirement Income Security Act of 1974.\nThe following table sets forth the plans funded status and amounts recognized in the Company's accompanying consolidated statement of financial condition:\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.50% and 5.00%, respectively, in 1993 and 8.25% and 5.00%, respectively, in 1992. The expected long-term rate of return on assets was 8.40%.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSTOCK OPTION PLANS\nThe Company has a qualified stock option plan pursuant to which it has reserved an aggregate of 700,000 shares of common stock for issuance upon the exercise of options to be granted under the plan to employees of the Company and its subsidiaries. Pursuant to a voluntary exchange in 1987, substantially all of the options originally issued under this plan were exchanged for nonqualified replacement options. Options under the plan are granted for terms of up to ten years at a price not less than 100% of fair market value at the date of the grant (five years and 110% of fair market value in the case of an employee owning more than 10% of the combined voting power of all classes of stock of the Company). Options granted under the qualified stock option plan are intended to qualify as incentive stock options within the meaning of Section 422A of the Internal Revenue Code of 1954.\nThe Company has a nonqualified stock option plan pursuant to which it has reserved an aggregate of 650,000 shares of common stock for issuance upon the exercise of options granted under the plan to employees of the Company and its subsidiaries. The option price and period is determined by the Board of Directors or committee thereof and is not limited by the qualified stock option plan. Options granted under the nonqualified stock option plan are not intended to qualify as incentive stock options.\nUnder the qualified and nonqualified stock option plans, tandem stock appreciation rights may be granted, permitting an employee to receive, in lieu of exercise of the related option, an amount equal to the difference between the value covered by the related option and the option exercise price.\nThe following is a summary of the transactions under the stock option plans for the years ended December 31, 1993 and 1992:\nAt December 31, 1993, 475,460 options were exercisable, and 116,039 options were available for future grants under the stock option plans. As of December 31, 1993, of the total options outstanding, 487,126 are nonqualified.\nIn April 1992, ITG granted an option to certain key employees which allows the purchase of up to 10% of the equity interest in ITG for $2,000,000 through May 1995. This grant did not give rise to any compensation expense.\nAdditionally, each director, who is not also an employee of the Company, has a nonqualified option to purchase 5,000 shares of the Company's Common Stock at exercise prices of $13.25 through $35.25 per share.\nOTHER BENEFIT PLANS\nThe Company incurs expenses related to various benefit plans covering substantially all employees, including an Employee Stock Ownership Plan (ESOP), an Employee Stock Purchase Plan (ESPP) and a\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nprofit sharing plan, which includes a salary reduction feature designed to qualify under Section 401(k) of the Internal Revenue Code.\nDuring 1988, the Company established an ESOP which purchased 856,327 shares of its common stock for $9,000,000 funded by a loan from the Company. As of December 31, 1992, the balance of the loan had been paid. The loan was being repaid over five years at an annual interest rate of 8.02%. The Company made contributions to the ESOP sufficient to fund principal and interest payments. During 1992 and 1991, the ESOP repaid $1,301,000 and $1,458,000, respectively, of the outstanding balance substantially through a Company contribution.\nIn 1993, the Parent created a Capital Accumulation Plan for certain officers and key employees of the Company. Participation in the plan is optional, with those who elect to participate agreeing to defer graduated percentages of their compensation.\nThe Company made employee benefit plan contributions of $3,945,000 in 1993 and $1,654,000 and $1,799,000 in 1992 and 1991, respectively, which include the ESOP contributions as described above.\nPERFORMANCE SHARE PLAN\nIn connection with the 1991 acquisition of IAC, the Company has a Performance Share Plan awarding ownership in ITG in the form of a phantom equity interest to key employees, of which a 12.7% interest is outstanding at December 31, 1993. The plan covers a ten-year period ending December 31, 2001. The plan award, and related compensation expense, is calculated based on 9.6 times adjusted ITG earnings, less a strike price based on a total ITG valuation of $5.8 million. Employees can initiate redemption of up to 25% of granted shares per year on a noncumulative basis. The Company can call up to 15% of granted shares per year on a noncumulative basis, at a value based on 12 times adjusted ITG earnings.\nAdjusted ITG earnings consist of current year ITG net earnings ($3,389,000 in 1993) plus the after-tax effect of Performance Share Plan expense ($4,233,000 in 1993) and certain other items ($706,000 in 1993) and amounted to $8,328,000 in 1993. The Company has expensed approximately $7,559,000 under this plan in 1993, of which approximately $64,000 has been paid out for early redemption. The plan is fully vested at December 31, 1993.\nAssuming the Company does not intend to call the shares and there is no change in the amount of phantom shares outstanding, future compensation expense under the Performance Share Plan in any given year through 2001, net of tax, will be approximately 68% of the change in adjusted ITG earnings from the previous years adjusted ITG earnings. Therefore, in any given year between 1994 and 2001 there will only be additional compensation expense to the extent that adjusted earnings in that year exceed the previous years adjusted earnings. If the Company should decide to call some shares, compensation expense would increase, reflecting an adjusted earnings multiple equal to 12 times rather than 9.6 times earnings. See note 14 for subsequent event.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(10) LEASES\nAs lessee, the Company leases certain premises and equipment under noncancelable agreements expiring at various dates through 2004. Assets under capitalized leases are capitalized using interest rates appropriate at the inception of the lease. Future minimum lease payments for assets under capital leases at December 31, 1993 follow:\nFuture minimum lease payments for all noncancelable operating leases at December 31, 1993 are as follows:\nRental expense, net of subleases, for the Company was $5,118,000 in 1993, $5,110,000 in 1992 and $4,628,000 in 1991.\n(11) OFF-BALANCE SHEET RISK\nIn the normal course of business, the Company is involved in the execution, settlement and financing of various customer and principal securities transactions. Customer activities are transacted on a cash, margin or delivery-versus-payment basis. Securities transactions are subject to the risk of counterparty or customer nonperformance. However, transactions are collateralized by the underlying security, thereby reducing the associated risk to change in the market value of the security through settlement date or to the extent of margin balances.\nThe Company also has contractual commitments arising in the ordinary course of business for bank loans, stock loaned, securities sold, not yet purchased, repurchase agreements, future purchases and sales of foreign currency, securities transactions on a when-issued basis and underwriting. Each of these financial instruments contains varying degrees of off-balance sheet risk whereby the market values of the securities underlying the financial instruments may be in excess of the contract amount. The settlement of these transactions is not expected to have a material effect upon the Company's accompanying consolidated financial statements.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn the normal course of business, Jefferies had letters of credit outstanding aggregating $21,145,000 at December 31, 1993 to satisfy various collateral requirements in lieu of depositing cash or securities.\n(12) NET CAPITAL REQUIREMENTS\nAs registered broker-dealers, Jefferies, ITG and W & D are subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. Jefferies, ITG and W & D have elected to use the alternative method permitted by the Rule, which requires that they each maintain minimum net capital, as defined, equal to the greater of $150,000 or 2% of the aggregate debit balances arising from customer transactions, as defined.\nAt December 31, 1993, Jefferies had net capital of $75,966,000, which was 17% of aggregate debit balances and $66,815,000 in excess of required net capital. At December 31, 1993, ITG had net capital of $1,852,000, which was $1,702,000 in excess of required net capital. At December 31, 1993, W & D had net capital of $821,000, which was $671,000 in excess of required net capital.\n(13) CONTINGENCIES\nThe Company is involved in various legal actions arising in the normal course of business. After taking into consideration legal counsel's evaluation of such actions, management is of the opinion that their outcome will not have a significant effect on the Company's financial statements.\n(14) SUBSEQUENT EVENTS\nThe Company formed a new subsidiary (the ITG Holding Company) in March 1994 for the purpose of eventually holding 100% of the stock of ITG (stockholders' equity at December 31, 1993 of $13,049,000). On March 15, 1994, the ITG Holding Company filed with the Securities and Exchange Commission a Registration Statement for the offer of 3,700,000 shares of its common stock (which includes 450,000 shares subject to an overallotment option granted to the underwriters) in an initial public offering. The filing indicated an anticipated offering price of between $12 and $14 per share. Immediately prior to the consummation of the offering, the ITG Holding Company will issue 15,000,000 shares of its common stock in exchange for all 10,000,000 shares issued and outstanding of ITG common stock held by the Company. Following the offering, the Company will own 80.2% of the outstanding common stock of the ITG Holding Company.\nIn addition, immediately prior to the offering, the ITG Holding Company will also issue a note in the amount of approximately $17,000,000 in payment of a dividend to the Company.\nIn conjunction with the offering, certain management employment agreements, the Performance Share Plan and noncompensatory ITG stock options (as described in note 9), will be terminated in exchange for $40,500,000 in cash and the Company's Common Stock, based on an assumed offering price of $13.00 per share, of which $9,400,000 has been accrued at December 31, 1993. Any increase or decrease in the net proceeds of the offering upon determination of the actual offering price will result in an increase or decrease in such amount. Additionally, noncompensatory options to purchase 2,684,000 shares of the ITG Holding Company's common stock will be granted to senior management and other employees at an exercise price equal to the initial public offering price. The Company believes expense from the termination of the Performance Share Plan will be offset by gain from the offering.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSummarized financial information of ITG as of December 31, 1993 follows:\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to this item will be contained in the Proxy Statement for the 1994 Annual Meeting of Stockholders, which is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to this item will be contained in the Proxy Statement for the 1994 Annual Meeting of Stockholders, which is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to this item will be contained in the Proxy Statement for the 1994 Annual Meeting of Stockholders, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to this item will be contained in the Proxy Statement for the 1994 Annual Meeting of Stockholders, which is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\nAll other Schedules are omitted because they are not applicable or because the required information is shown in the financial statements or notes thereto.\n- ---------------\n*Filed herewith.\nALL OTHER EXHIBITS ARE OMITTED BECAUSE THEY ARE NOT APPLICABLE.\n(b) No reports on Form 8-K have been filed by the Registrant.\n(c) Index to Exhibits.\nSee list of exhibits at Item 14(a)3 above and exhibits following.\nExhibits 10.1 to and including 10.11 are management contracts or compensatory plans or arrangements.\n(d) Financial Statement Schedules\nSee list of Schedules at Item 14(a)2 above and schedules following.\nJEFFERIES GROUP, INC. AND SUBSIDIARIES\nSCHEDULE IX -- SHORT-TERM BORROWINGS DECEMBER 31, 1993, 1992 AND 1991\n- ---------------\n(1) Computed by dividing the sum of the daily average balances for each month by 12 months in the year.\n(2) Computed by dividing the actual interest expenses by the average amount outstanding during the period.\nSIGNATURES\nPursuant 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.\nJEFFERIES GROUP, INC.\nBy FRANK E. BAXTER ----------------------------------- Dated: March 31, 1994 Frank E. Baxter, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.\nINDEX TO EXHIBITS\n- ---------------\n*Filed herewith.","section_15":""}
{"filename":"92232_1993.txt","cik":"92232","year":"1993","section_1":"ITEM 1. BUSINESS\nThe principal business of Southern Natural Gas Company (\"Southern\"), which is a wholly owned subsidiary of Sonat Inc. (\"Sonat\"), is the transmission of natural gas in interstate commerce. Southern, including its subsidiaries, owns approximately 9,230 miles of interstate pipeline. Its pipeline system has a certificated daily delivery capacity of approximately 2.4 billion cubic feet (\"Bcf\") of natural gas. Southern's pipeline system extends from gas fields in Texas, Louisiana, Mississippi, Alabama, and the Gulf of Mexico to markets in Louisiana, Mississippi, Alabama, Florida, Georgia, South Carolina, and Tennessee. Southern also has pipeline facilities offshore Texas connecting gas supplies to other pipelines that transport such gas to Southern's system. A map of Southern's pipeline system, including pipelines of its subsidiaries, appears on page I-8.\nSouthern owns and operates Muldon Storage Field (\"Muldon\"), a large underground natural gas storage field in Mississippi connected to its pipeline system. Based on operating experience, Southern recently sought to have the working storage capacity of Muldon reduced from 52 to 31 billion cubic feet of gas. The Federal Energy Regulatory Commission (\"FERC\") approved this reduction for a one-year period ending November 1, 1994, subject to a further review of Muldon's operations during the 1993-94 winter period.\nBear Creek Storage Company (\"Bear Creek\"), an unincorporated joint venture between wholly owned subsidiaries of Southern and Tenneco Inc., each of which is a 50-percent participant, owns a large underground natural gas storage field located in Louisiana that is operated by Southern and provides storage service to Southern and Tennessee Gas Pipeline Company, a subsidiary of Tenneco Inc. The Bear Creek Storage Field has a total certificated working storage capacity of approximately 65 billion cubic feet of gas, half of which is committed to Southern. At December 31, 1993, Bear Creek's gross facilities cost was approximately $246,923,000 and its participants' equity was $90,907,000. Southern had an investment in Bear Creek, including its equity in undistributed earnings, of $45,453,000 at December 31, 1993.\nUnder the terms of Order No. 636, discussed below, effective November 1, 1993, Southern commenced providing contract storage services as part of its unbundled and restructured services. Consequently, most of Southern's working storage capacity at Muldon and its half of Bear Creek are now used for such services. As a part of making this new service available, effective November 1, 1993, Southern sold at its cost $123 million of its working storage gas inventory to its new storage customers.\nSouthern's interstate pipeline business is subject to regulation by the FERC, the U.S. Department of Energy's Economic Regulatory Administration (the \"ERA\"), and the U.S. Department of Transportation under the terms of the Natural Gas Policy Act of 1978 (the \"NGPA\"), the Natural Gas Act, and various pipeline safety and environmental laws. See \"Governmental Regulation\" below for information concerning the regulation of natural gas transmission operations.\nSouthern's business is subject to the usual operating risks associated with the transmission of natural gas through a pipeline system, which could result in property damage and personal injury. Sonat maintains broad insurance coverage on behalf of Southern limiting financial loss resulting from these operating risks.\nAdditional business information concerning Southern and its wholly owned subsidiaries is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to Consolidated Financial Statements in Part II of this report and is hereby incorporated herein by reference.\nAt January 1, 1994, Southern and its subsidiaries employed approximately 1,170 persons.\nSouthern's principal executive offices are located at 1900 Fifth Avenue North, AmSouth-Sonat Tower, Birmingham, Alabama 35203, and its telephone number is (205) 325-7410.\nI-1\nOrder No. 636 Restructuring\nIn 1992 the FERC issued its Order No. 636 (the \"Order\"). As required by the Order, interstate natural gas pipeline companies, including Southern and South Georgia Natural Gas Company (\"South Georgia\"), a wholly owned interstate pipeline subsidiary of Southern, have made significant changes in the way they operate. The Order required pipelines, among other things, to (1) separate (unbundle) their sales, transportation, and storage services; (2) provide a variety of transportation services, including a \"no-notice\" service pursuant to which the customer is entitled to receive gas from the pipeline to meet fluctuating requirements without having previously scheduled delivery of that gas; (3) adopt a straight-fixed-variable method for rate design (which assigns more costs to the demand component of the rates than do other rate-design methodologies previously utilized by pipelines); and (4) implement a pipeline capacity release program under which firm customers have the ability to \"broker\" the pipeline capacity for which they have contracted. The Order also authorizes pipelines to offer unbundled sales services at market-based rates and allows for pregranted abandonment of some services.\nInterstate pipeline companies, including Southern, are incurring certain costs (\"transition costs\") as a result of the Order, the principal one being costs related to amendment or termination of existing gas purchase contracts, which are referred to as gas supply realignment (\"GSR\") costs. The Order provides for the recovery of 100 percent of the GSR costs and other transition costs to the extent the pipeline can prove that they are eligible, that is, incurred as a result of customers' service choices in the implementation of the Order, and were incurred prudently.\nIn its restructuring settlement discussions, Southern has advised its customers that the amount of GSR costs that it actually incurs will depend on a number of variables, including future natural gas and fuel oil prices, future deliverability under Southern's existing gas purchase contracts, and Southern's ability to renegotiate certain of these contracts. While the level of GSR costs is impossible to predict with certainty because of these numerous variables, based on current spot-market prices, a range of estimates of future oil and gas prices, and recent contract renegotiations, the amount of GSR costs would be approximately $275-$325 million on a present-value basis. This amount includes the payments made to amend or terminate gas purchase contracts described below.\nOn September 3, 1993, the FERC generally approved a compliance plan for Southern and directed Southern to implement its restructured services pursuant to the Order on November 1, 1993 (the \"September 3 order\"). Pursuant to Southern's compliance plan, GSR costs that are eligible for recovery include payments to reform or terminate gas purchase contracts. Where Southern can show that it can minimize transition costs by continuing to purchase gas under the contract (i.e., it is more economic to continue to perform), eligible GSR costs would also include the difference between the contract price and the higher of (a) the sales price for gas purchased under the contract or (b) a price established by an objective index of spot-market prices. Recovery of these latter costs is permitted for an initial period of two years.\nSouthern's compliance plan contains two mechanisms pursuant to which Southern is permitted to recover 100 percent of its GSR costs. The first mechanism is a monthly fixed charge designed to recover 90 percent of the GSR costs from Southern's firm transportation customers. The second mechanism is a volumetric surcharge designed to collect the remaining ten percent of such costs from Southern's interruptible transportation customers. This funding will continue until the GSR costs are fully recovered or funded. The FERC also indicated that Southern could file to recover any GSR costs not recovered through the volumetric surcharge after a period of two years. In addition, Southern's compliance plan provides for the recovery of other transition costs as they are incurred and any remaining transition costs may be recovered through a regular rate filing. Southern's customers have generally opposed the recovery of its GSR costs.\nThe September 3 order rejected the argument of certain customers that a 1988 take-or-pay recovery settlement bars Southern from recovering GSR costs under gas purchase contracts executed before March 31, 1989, which comprise most of Southern's GSR costs. Those customers subsequently filed motions urging the FERC to reverse its ruling on that issue. On December 16, 1993, the FERC affirmed its September 3 ruling with respect to the 1988 take-or-pay recovery settlement (the \"December 16 order\"). The December 16 order generally approved Southern's restructuring tariff submitted pursuant to the September 3 order. Various parties have filed motions urging the FERC to modify the December 16 order and have sought judicial review\nI-2\nof the September 3 order. Southern and its customers engaged in settlement discussions regarding Southern's restructuring filing prior to the September 3 order, but the parties were unable to reach a settlement. Those discussions are continuing.\nDuring 1993 Southern reached agreements to reduce significantly the price payable under a number of high cost gas purchase contracts in exchange for payments of approximately $114 million. On December 1, 1993, Southern filed with the FERC to recover such costs and approximately $3 million of prefiling interest (the \"December 1 filing\"). On December 30, 1993, the FERC accepted such filing to become effective January 1, 1994, subject to refund, and subject to a determination through a hearing before an administrative law judge that such costs were prudently incurred and eligible under Order No. 636. Southern's customers are opposing its recovery of these GSR costs in this proceeding. The December 30 order rejected arguments of various parties that a pipeline's payments to affiliates, in this case Southern's payment to a subsidiary of Sonat Exploration Company, that represented approximately $34 million of the December 1 filing, may not be recovered under Order No. 636.\nIn December 1993 Southern reached agreement to reduce the price under another contract in exchange for payments having a present value of approximately $52 million. Payments will be made in equal monthly installments over an eight-year period ending December 31, 2001. On February 14, 1994, Southern made a rate filing to recover, beginning March 1, 1994, those costs as well as approximately $2 million of other settlement costs and $800,000 of prefiling interest. Southern also incurred approximately $17.5 million of GSR costs, plus prefiling interest, from November 1, 1993, through January 31, 1994, from continuing to purchase gas under contracts that are in excess of current market prices. On March 1, 1994, Southern made a rate filing to recover those costs beginning April 1, 1994. Southern plans to make additional rate filings quarterly to recover these \"price differential\" costs and any other GSR costs.\nSouthern is unable to predict all of the elements of the ultimate outcome of its Order No. 636 restructuring proceeding, its settlement discussions with its customers regarding all of the pending issues arising in connection with the proceeding, or its rate filings to recover its transition costs.\nIn requiring that Southern provide unbundled storage service, the Order resulted in a substantial reduction of Southern's working storage gas inventory and consequently a reduction in its rate base. This reduction was effective on November 1, 1993, when Southern restructured pursuant to the Order and sold at its cost $123 million of its working storage gas inventory to its customers. The Order also resulted in rates that are less seasonal, thereby shifting revenues and earnings for Southern out of the winter months.\nMarkets -- Transportation and Sales\nAs described above, effective November 1, 1993, Southern and South Georgia restructured their services in compliance with FERC Order No. 636 by separating their transportation, storage, and merchant services. With the exception of some limited sales necessary to dispose of its gas supply remaining under contract, Southern essentially became solely a transporter of natural gas. Effective May 5, 1992, South Georgia had converted all its sales service to transportation-only service and Southern had begun to provide a gas sales service to South Georgia's former sales customers.\nSouthern transports or sells gas at wholesale for distribution for domestic, commercial, and industrial uses to nine gas distributing companies, to 114 municipalities and gas districts, and to nine connecting interstate pipeline companies. Southern also transported or sold gas directly to 55 industrial end-users in 1993. Southern principally transports gas to resale and industrial customers and to other pipelines, sells some limited volumes of gas at wholesale for distribution, and sells very minimal volumes of gas directly to industrial customers. The principal industries served directly by Southern's pipeline system and indirectly through its resale customers' distribution systems include the chemical, pulp and paper, textile, primary metals, stone, clay and glass industries.\nTransportation volumes in 1993 were 763 Bcf or 91 percent of Southern's total throughput of 836 Bcf, compared with 733 Bcf or 87 percent of Southern's total 1992 throughput of 842 Bcf. Sales to resale distribution customers, including municipalities and gas districts, accounted for virtually all of 1993 sales of\nI-3\n73 Bcf (excluding the sale of storage inventory) and 1992 sales of 109 Bcf. Southern's sales to direct sales customers and interstate pipeline companies in both years were negligible. Southern had sales of 19 Bcf during November and December 1993 (following implementation of its Order No. 636 restructuring) that were made at receipt points where the gas entered its pipeline system; consequently, those volumes are included within the 763 Bcf of transportation volumes for 1993.\nTransportation service is rendered by Southern for its resale customers, direct industrial customers and other end-users, gas producers, other gas pipelines, and gas marketing and trading companies. Southern provides transportation service in both its gas supply and market areas. Transportation service is provided under rate schedules that are subject to FERC regulatory authority. Rates for transportation service depend on whether such service is on a firm or interruptible basis and the location of such service on Southern's pipeline system. Transportation rates for interruptible service (i.e., service of a lower priority than firm transportation) are charged for actual volumes transported. Firm transportation service also includes a demand charge designed so that the customer pays for a significant portion of the service each month based on a contract demand volume regardless of the actual volume transported. Rates for transportation service are discounted by Southern in individual instances to respond to competition in the markets it serves. Continued discounting could, under certain circumstances, increase the risk that Southern may not recover all of its costs allocated to transportation services.\nSales by Southern are anticipated to continue only until Southern's remaining supply contracts expire, are terminated, or are assigned. As a result of Order No. 636 Southern is attempting to terminate its remaining gas purchase contracts through which it had traditionally obtained its long-term gas supply. Some of these contracts contain clauses requiring Southern either to purchase minimum volumes of gas under the contract or to pay for it (\"take-or-pay\" clauses). Although Southern currently is incurring essentially no take-or-pay liabilities under these contracts, the annual weighted average cost of gas under these contracts is in excess of current spot-market prices. Pending the termination of these remaining supply contracts, Southern has agreed to sell a portion of its remaining gas supply to a number of its firm transportation customers for a one-year term that began November 1, 1993. Recently, the sales agreements with Atlanta Gas Light Company and its subsidiary, Chattanooga Gas Company (collectively \"Atlanta\") were extended through March 31, 1995. The rest of Southern's remaining supply will be sold on a month-to-month basis. Southern will file to recover as a GSR cost pursuant to Order No. 636 the difference between the cost associated with the gas supply contracts and the revenue from the sale agreements and month-to-month sales and also any cost incurred to reduce the price under or to terminate Southern's remaining gas supply contracts.\nWhen long-term sales service agreements with substantially all of Southern's resale customers expired or were terminated in 1989, Southern entered into a series of short-term agreements on an annual basis with virtually all of such customers. Prior to the implementation of Order No. 636, several customers had already reduced their firm sales contract demand volumes or converted a portion of their firm sales volumes to firm transportation volumes. From 1988 until Southern's implementation of Order No. 636, total daily delivery obligations under firm sales contracts (the \"contract demand\" upon which monthly demand charges are based) were reduced by approximately 689 million cubic feet (\"MMcf\") from their level at the end of 1987 of approximately 2.1 Bcf. Prior to Southern's implementation of Order No. 636, approximately 74 percent of this reduction had been replaced with firm transportation volumes under contracts of varying terms and durations, which also provided for fixed monthly charges.\nIn accordance with the September 3 order approving Southern's Order No. 636 compliance plan, Southern solicited service elections from its customers in order to implement its restructured services on November 1, 1993. Southern's largest customer, Atlanta, bid for firm transportation service on Southern at prices significantly below Southern's filed tariff rates. Southern rejected Atlanta's bids. Southern and Atlanta subsequently entered into an interim agreement under which Atlanta signed firm transportation service agreements with transportation demands of 582 million cubic feet per day for a minimum term of four months beginning November 1, 1993, and 118 million cubic feet per day for a term extending until April 30, 2007, at the maximum FERC-approved rates. This represented an aggregate reduction of 100 million cubic feet per day from Atlanta's level of service prior to November 1, 1993. In January 1994 Atlanta provided notice that it had elected to continue that level of firm service until October 31, 1994. Southern's other customers elected in\nI-4\naggregate to obtain an amount of firm transportation services that represented a slight increase from their level of firm sales and transportation services from Southern prior to Southern's implementation of Order No. 636, at the maximum FERC-approved tariff rates, for terms ranging from one to ten or more years.\nAlthough management believes that most of Southern's former resale customers ultimately will commit to some type of new long-term firm transportation agreements with Southern under its restructuring program, it is unable to predict at what total volume level or for what duration such commitments will be made.\nTransportation and sales by Southern to three unaffiliated distribution customers, Atlanta, Alabama Gas Corporation, and South Carolina Pipeline Corporation, accounted for approximately 40 percent, 18 percent, and nine percent, respectively, of Southern's 1993 consolidated revenues. Atlanta and Alabama Gas Corporation were the only two customers that accounted for ten percent or more of Southern's consolidated revenues for 1993.\nSouthern is continuing to pursue growth opportunities to expand the level of services in its traditional market area and to connect new gas supplies. On May 13, 1993, Southern and South Georgia received approval from the FERC for a $27 million expansion of South Georgia's pipeline system into northern Florida and southwestern Georgia that will increase firm daily capacity by 40 million cubic feet per day. Construction on this project is under way and should be completed in mid-1994. In January 1994 Southern reached tentative agreement with a group of new customers to expand its service in the growing eastern Tennessee area. The proposed project entails a 20-mile pipeline extension that would deliver approximately nine million cubic feet of natural gas per day to a delivery point near Chattanooga.\nFor additional information regarding Southern's transportation and sales of gas, see Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II of this report.\nGas Supplies\nDuring 1993 Southern purchased its gas supply from the following areas: 51 percent from southern Louisiana and from the Gulf of Mexico, offshore Louisiana, and Texas; three percent from northern Louisiana and Texas; and 46 percent from Mississippi and Alabama. Southern has approximately 60 gas purchase contracts remaining with gas producers that commit proved recoverable reserves to Southern. As described above, pursuant to Order No. 636, Southern is attempting to terminate its remaining gas purchase contracts.\nThe following table contains information as to Southern's gas supply and the general sources from which that supply was obtained during the years 1991 through 1993.\n- ---------------\n* As used in this report, the term \"Mcf\" means thousand cubic feet; the term \"MMcf\" means million cubic feet; and the term \"Bcf\" means billion cubic feet. All volumes of natural gas referred to in this report are stated at a pressure base of 14.73 pounds per square inch absolute (\"psia\") and at 60 degrees Fahrenheit.\nSouthern entered into no new long-term gas purchase agreements in 1993, due to the cessation of its merchant role because of Order No. 636 as discussed above. Since Order No. 636 prohibits Southern from providing its traditional bundled merchant service, Southern does not anticipate at this time that it will need to contract for the long-term purchase of any additional natural gas supplies in the future. Southern will purchase minimal volumes of gas from time to time as may be required for system management purposes. Southern does expect, however, that adequate gas supplies will need to continue to be available to its system; consequently, Southern has continued its efforts to have new gas supplies attached to its system.\nI-5\nPotential Royalty Claims\nIn connection with its settlements of take-or-pay claims made by producers over the past few years, Southern has in certain limited instances indemnified, to varying degrees, the producer from certain potential claims made by royalty owners. Southern has thus far been notified of 12 potential royalty claims under the indemnity provisions of various settlement agreements. The claims for which Southern may have to indemnify these producers have been asserted by both private lessors with respect to onshore leases and the Minerals Management Service Division of the U.S. Department of the Interior (the \"MMS\") with respect to offshore and Indian leases. Southern settled four of these claims during 1993 for approximately $1.2 million.\nIn addition to the claims for which Southern has been put on notice, it is possible that other producers may make future claims against Southern for royalty indemnification. The June 26, 1992 decision of the Louisiana Supreme Court in Frey v. Amoco, in which the court held that royalty was due on take-or-pay payments, may form a basis for royalty claims for a share of take-or-pay settlements by private lessors in Louisiana and in other states that may follow the Frey decision. Because courts typically require that interest be paid on the royalty back to the date of settlement, the amount owed can substantially exceed the royalty amount. Management believes that Southern's maximum exposure under all of its various royalty indemnities in onshore take-or-pay settlements, including interest, approximates $15 million. Management is unable to state whether any additional royalty claims based on Southern's indemnification provisions in its take-or-pay settlements will be asserted or to predict the outcome of any such claims or resulting litigation.\nIn addition to the potential royalty claims related to onshore production, Southern also faces exposure in connection with indemnifications in take-or-pay settlements with producers who have federal offshore or Indian leases. The MMS issued a policy statement and guidelines on May 3, 1993, declaring its intention to collect royalty payments for contract buy-downs, buy-outs, pricing disputes, and on any portion of take-or-pay settlement payments that are subject to future recoupment. In June 1993 the MMS began to issue letters to producers requiring payment of royalty on all such payments received under take-or-pay settlements, along with interest back to the date of payment. The MMS has been aggressively auditing producers since this time and issuing orders to pay. A lawsuit filed by the Independent Petroleum Association of America against the MMS and others challenging the validity of the MMS' new policy is pending in federal district court for the District of Columbia. Management is unable to predict the outcome of this litigation or the ultimate outcome of any collection efforts by the MMS.\nManagement believes that Southern's maximum exposure for all royalty claims related to offshore production, including interest, approximates $10 million if no recovery from its customers is allowed. Under the terms of a 1988 take-or-pay recovery settlement with Southern's customers, Southern is entitled to seek recovery of these costs under the FERC's Order No. 500 cost-sharing procedures. The customers, however, are entitled to challenge any effort by Southern to recover those costs. Management is unable to predict the outcome of the efforts of the MMS to collect royalty on a portion of any offshore settlement or of Southern's efforts to recover any amounts it may ultimately pay from its customers.\nSouthern believes that it is adequately reserved for any royalty claims that it may ultimately have to pay or to settle and that, in any event, such claims will not have a material adverse effect on its financial condition or results of operations.\nSouthern Energy Company\nSouthern Energy Company (\"Southern Energy\"), a wholly owned subsidiary of Southern, owns a liquefied natural gas (\"LNG\") receiving terminal near Savannah, Georgia, which was constructed for a project, now terminated, to import LNG from Algeria. The terminal has been inactive since the early 1980s. On July 22, 1992, the FERC issued an order approving a settlement relating to Southern Energy's LNG facilities. The settlement resolved a number of outstanding rate and accounting issues on a favorable basis and preserved an option for customers of Southern Energy to obtain LNG through this facility at least through the year 1999.\nI-6\nSea Robin Pipeline Company\nFor many years Southern was a 50-percent participant, through a wholly owned subsidiary, with a wholly owned subsidiary of United Gas Pipe Line Company (\"United\"), in Sea Robin Pipeline Company (\"Sea Robin\"), an unincorporated gas supply pipeline joint venture. Sea Robin was originally constructed to obtain Gulf of Mexico gas supplies for Southern's and United's respective pipeline systems and was operated by United. In December 1990 Southern, through a newly formed subsidiary, acquired the 50-percent interest in Sea Robin formerly owned by the subsidiary of United. As a result of the acquisition, two wholly owned subsidiaries of Southern own 100 percent of Sea Robin, which is now being operated by Southern. Sea Robin has a 436-mile pipeline system located in the Gulf of Mexico through which it transports gas for others under its FERC-regulated tariffs. Sea Robin is a transportation-only pipeline that has restructured in compliance with FERC Order No. 636. Sea Robin's compliance filing has been accepted by the FERC. Sea Robin transported approximately 287 Bcf of natural gas in 1993. These Sea Robin volumes are included within the Southern transportation volumes discussed earlier. See Note 8 of the Notes to Consolidated Financial Statements in Part II of this report for additional information regarding Sea Robin.\nCompetition and Current Business Conditions\nThe natural gas transmission industry, although regulated, is very competitive. During the period from the mid-1980s until the Order No. 636 restructuring, customers had switched much of their volumes from a bundled merchant service to transportation service, reflecting an increased willingness to rely on gas supply under unregulated arrangements. Southern competes with several pipelines for the transportation business of its customers and at times discounts its transportation rates in order to maintain market share. Southern continues to provide a limited merchant service with gas supply remaining under contract and, in this capacity, competes with other suppliers, pipelines, gas producers, marketers, and alternate fuels.\nNatural gas is sold in competition principally with fuel oil, coal, liquefied petroleum gases, and electricity. An important consideration in Southern's markets is the ability of natural gas to compete with alternate fuels. Residual fuel oil, the principal competitive alternate fuel in Southern's market area, was at certain times in 1993, and currently is, priced at or below the comparable price of natural gas in industrial and electric generation markets. Some parts of Southern's market area are also served by one or more other pipeline systems that can provide transportation as well as sales service in competition with Southern. Southern's two largest customers are both able to obtain a portion of their natural gas requirements through transportation by other pipelines.\nI-7\n[SOUTHERN NATURAL PIPELINE MAP GOES HERE]\nI-8\nGovernmental Regulation\nSouthern is subject to regulation by the FERC and by the Secretary of Energy under the Natural Gas Act, the NGPA, and the Department of Energy Organization Act of 1977 (the \"DOE Act\"). Southern's operating subsidiaries are also subject to such regulation.\nThe Natural Gas Act, modified by the DOE Act, grants to the FERC authority to regulate the construction and operation of pipeline and related facilities utilized in the transportation and sale of natural gas in interstate commerce, including the extension, enlargement, or abandonment of such facilities. Southern and its operating subsidiaries hold required certificates of public convenience and necessity issued by the FERC authorizing them to construct and operate all pipelines, facilities, and properties now in operation for which certificates are required, and to transport and sell natural gas in interstate commerce.\nThe FERC also has authority to regulate the transportation of natural gas in interstate commerce and the sale of natural gas in interstate commerce for resale. Although the FERC still retains jurisdiction over their resale rates, following the implementation of Order No. 636, Southern and other interstate pipeline companies are now permitted to charge market-based rates for gas sold in interstate commerce for resale. Gas sold by marketing companies is not regulated by the FERC. Transportation rates remain fully regulated. The price at which gas is sold to direct industrial customers is not subject to the FERC's jurisdiction. As necessary, Southern and its operating subsidiaries file with the FERC applications for changes in their transportation rates and charges designed to allow them to recover fully their costs of providing such service to their customers, including a reasonable rate of return. These rates are normally allowed to become effective, subject to refund, until such time as the FERC rules on the actual level of rates. See \"Rate and Regulatory Proceedings\" below.\nThe Natural Gas Wellhead Decontrol Act of 1989, enacted on July 26, 1989, phased in decontrol of the wellhead price of all gas then remaining subject to maximum lawful price limitations by January 1, 1993. Thus, the price of all gas sold at the wellhead is no longer regulated.\nRegulation of the importation of natural gas is vested in the Secretary of Energy, who has delegated various aspects of this import jurisdiction to the FERC and the ERA.\nSouthern and its operating subsidiaries are subject to the Natural Gas Pipeline Safety Act of 1968, as amended, which regulates pipeline and LNG plant safety requirements, and to the National Environmental Policy Act and other environmental legislation. Southern and its operating subsidiaries have a continuing program of inspection designed to keep all of their facilities in compliance with pollution control and pipeline safety requirements and believe that they are in substantial compliance with applicable requirements. Southern's capital expenditures to comply with environmental and pipeline safety regulations were approximately $14 million in 1993. It is anticipated that such expenditures will be approximately $11 million in 1994 and approximately $10 million in 1995. For more information regarding environmental matters, see the discussion below.\nRate and Regulatory Proceedings. Various matters pending before the FERC, or before the courts on appeal from the FERC, relating to, or that could affect, Southern or one or more of its subsidiaries are described in Part II of this report in Note 8 of the Notes to Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations, which are incorporated herein by reference. As described in Note 8, several general rate changes have been implemented by Southern and remain subject to refund.\nEnvironmental Matters\nSouthern and certain of its subsidiaries are subject to extensive federal, state, and local environmental laws and regulations that affect their operations. Governmental authorities may enforce these laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties, assessment and remediation requirements, and injunctions as to future activities. Southern and certain of its subsidiaries' use and disposal of hazardous materials and toxic substances are subject to the requirements of the federal Toxic Substances Control Act (\"TSCA\") and the federal Resource Conservation and Recovery\nI-9\nAct (\"RCRA\"), among others, and comparable state and local statutes. The Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), also known as \"Superfund,\" imposes liability, without regard to fault or the legality of the original act, for release of a \"hazardous substance\" into the environment.\nSouthern is named as a potentially responsible party (\"PRP\") at three Superfund sites, at two of which it is a de minimis party. Based on the number of other financially responsible PRPs at each of the sites, the estimated relative volume of material contributed to the sites by Southern, the information that it currently possesses regarding the expected costs required to remediate the sites, and the amounts already contributed to remediation, Southern currently estimates that it should not ultimately be required to contribute in excess of $200,000 in the aggregate to the costs of remediation of all three sites.\nIn addition, Southern has been advised by a joint defense group of PRPs (\"JDG\") at another Superfund site that the JDG might seek to add it as a PRP, but Southern has received no notification from the Environmental Protection Agency (\"EPA\") asserting that it is a PRP. Southern has been informed by representatives of the JDG that no characterization of soil or groundwater contamination at this site has yet taken place and, therefore, the extent of such contamination, if any, is not currently known. Southern has thus far elected not to join the JDG, because it believes that it has significant potential defenses to liability for this site and that, in any event, it shipped de minimis amounts of material to this site. Based on the number of other financially responsible PRPs and other information that it currently possesses, Southern currently estimates that it will not incur liabilities related to this site in an amount material to Southern.\nLiability under CERCLA (and applicable state law) can be joint and several with other PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability at any of these sites could be substantially greater than the amounts described above. Southern does not believe that its status as a PRP at any of these sites will have a material adverse effect on its financial condition or results of operations.\nSouthern has in the past used lubricating oils containing polychlorinated biphenyls (\"PCBs\") in conjunction with auxiliary compressed air systems at Southern's natural gas compressor stations. Although the use of such oils was discontinued in the early 1970's, Southern has discovered residual PCB contamination at certain of its gas compressor station sites. For some time, Southern has had an ongoing internal project to identify and deal with the presence of PCBs at these sites. A total of thirteen stations evidenced some level of on-site PCB contamination ranging from low to moderate. Southern has completed the characterization and clean-up of twelve of these sites based on the guidelines of the TSCA at a total cost of approximately $6 million. Southern has partially completed the characterization and clean-up of the remaining site and believes that it should be able to complete the remediation of this site for a total cost of less than $5 million.\nIn the operation of their natural gas pipeline systems, Southern and South Georgia have used, and continue to use at several locations, gas meters containing elemental mercury. Many of these meters have been removed from service. Southern and South Georgia plan to remove the remaining mercury meters during the course of regularly scheduled facilities upgrades, but until such time, the meters are handled pursuant to established procedures that protect employees and comply with Occupational Safety and Health Administration standards. It is generally believed in the natural gas pipeline industry that, in the course of normal maintenance and replacement operations, elemental mercury may have been released from mercury meters. Although at this time neither the EPA nor any state in which Southern or South Georgia operates has yet issued clean-up levels or guidelines with respect to contamination from past releases or spills of mercury, Southern expects that guidelines will be forthcoming. Southern and South Georgia have nonetheless begun preliminary efforts to address this situation and plan to begin remediation if contamination is detected upon characterization of these sites. Because the number of sites involved and the extent of contamination at any site are not yet known, Southern is unable at this time to estimate the cost of remediation. Based on its experience with other remediation projects, the industry experience to date with remediation of mercury, and its preliminary analysis of the possible extent of the contamination, however, Southern believes that its remediation of any mercury contamination will not have a material adverse effect on its financial condition or results of operations.\nI-10\nSouthern generally considers environmental assessment and remediation costs and costs associated with compliance with environmental standards incurred by Southern and South Georgia to be recoverable through rates since they are prudent costs incurred in the ordinary course of business and, accordingly, will seek recovery of such costs through rate filings, although no assurance can be given with regard to their ultimate recovery.\nSouthern and its subsidiaries are subject to the federal Clean Air Act and the federal Clean Air Act Amendments of 1990 (\"1990 Amendments\"), which added significantly to the existing requirements established by the federal Clean Air Act. The 1990 Amendments require that the EPA issue new regulations, mainly related to mobile sources, air toxics, ozone non-attainment areas, acid rain, permitting, and enhanced monitoring. While it will not be possible to estimate the additional costs of compliance with these new requirements until the EPA and the states complete their regulations, management expects that the regulations when issued may require significant capital spending to modify certain of the facilities of Southern and its subsidiaries, particularly with regard to modifications that may be required for certain natural gas compressor stations to reduce their emission of oxides of nitrogen.\nIn the opinion of management, based on information currently possessed by Southern, the probability is remote that Southern or any of its subsidiaries will incur a liability as a result of the presently identified environmental contingencies described above in an amount material to Southern. While the nature of environmental contingencies makes complete evaluation impractical, Southern is currently aware of no other environmental matter that could reasonably be expected to have a material impact on its results of operations or financial condition. Southern has an active and ongoing environmental program at all levels of its organization and believes responsible environmental management is integral to its business. Southern believes that it and its subsidiaries have conducted their operations in substantial compliance with applicable environmental laws and regulations governing their activities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nA description of Southern's and its subsidiaries' properties is included under Item 1. Business above and is hereby incorporated by reference herein.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFor information regarding certain proceedings pending before federal regulatory agencies, see Note 8 of the Notes to Consolidated Financial Statements in Part II of this report.\nArcadian Corporation v. Southern Natural Gas Company and Atlanta Gas Light Company was filed in January 1992 in the U.S. District Court for the Southern District of Georgia. In this lawsuit against Southern and Atlanta Gas Light Company for alleged violation of the antitrust laws in connection with Southern's refusal to provide direct service to the Plaintiff, Arcadian Corporation (\"Arcadian\"), Arcadian claims actual damages of at least $15 million, which could be trebled under the antitrust laws. Southern and Arcadian executed an agreement settling this lawsuit on November 30, 1993. The settlement provides that the lawsuit will be dismissed with prejudice upon final, nonappealable approval by the FERC of the direct connection and transportation service requested by Arcadian. Pending such approval, the lawsuit has been stayed. While management believes it has meritorious defenses and intends to defend the suit vigorously if the stay were to be lifted, given the inherently unpredictable nature of litigation and the relatively early state of discovery in the case, management is unable to predict the ultimate outcome of the proceeding if it were to go forward, but believes that it will not have a material adverse effect on Southern's financial position.\nExxon Corporation v. Southern Natural Gas Company was filed in February 1994 in the U.S. District Court for the Southern District of Texas. Exxon Corporation (\"Exxon\"), the plaintiff in this suit, asked the court to declare that Southern has no right to terminate a gas purchase contract with Exxon providing for the sale and purchase of gas produced from Mississippi Canyon and Ewing Bank Area Blocks, offshore Louisiana (the \"Contract\"), which Southern gave notice of termination effective March 1, 1994. In the alternative, Exxon alleged that Southern has repudiated and breached the Contract and asked for an unspecified amount\nI-11\nof monetary damages. Management is unable to predict the outcome of this litigation and whether its position that it has the right to terminate this contract will be sustained.\nSouthern and its subsidiaries are involved in several other lawsuits, all of which have arisen in the ordinary course of business. Southern does not believe that any ultimate liability resulting from any of these other pending lawsuits will have a material adverse effect on the financial position or results of operations of Southern.\nI-12\n` PART II\nItem 5.","section_4":"","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the common stock of Southern is held by its parent company, Sonat Inc.; accordingly, there is no market for the stock. The following table shows the quarterly dividends paid on Southern's common stock during the past two years.\n(1) In May 1992, Southern completed the restructuring of its capital structure by issuing $100 million in Notes and dividending the proceeds to Sonat.\nII-1 Item 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nShown below is selected consolidated financial data for Southern and its subsidiaries.\nII-2 Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nSOUTHERN NATURAL GAS COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nSouthern Natural Gas Company and its subsidiaries (Southern) participate in the interstate transmission and sale of natural gas in the southeastern United States and are regulated by the Federal Energy Regulatory Commission (FERC). The natural gas transmission industry, although regulated, is very competitive. Effective November 1, 1993, Southern separated its transportation, storage and merchant services to comply with Order No. 636 (see following discussion) and essentially became solely a gas transporter. Even before the Order No. 636 restructuring, customers had switched much of their volumes from a bundled merchant service to transportation service, reflecting an increased willingness to rely on gas supply under unregulated arrangements. Southern competes with several pipelines for the transportation business of its customers and at times discounts its transportation rates in order to maintain market share. Although it is now predominantly a transporter of gas, Southern continues to provide a limited merchant service with gas supply remaining under contract and, in this capacity, competes with other suppliers, gas producers, marketers and alternate fuels.\nSouthern is pursuing growth opportunities to expand the level of services in its traditional market area and to connect new gas supplies. South Georgia Natural Gas Company, a wholly owned subsidiary of Southern, received approval from the FERC on May 13, 1993, for an expansion of its pipeline system into northern Florida and southwestern Georgia that will increase firm daily capacity by 40 million cubic feet per day. Construction on this project is under way and should be completed by mid-1994. Southern has entered into an agreement in principle to expand its system to Chattanooga, Tennessee.\nII-3 OPERATIONS\n1993 Versus 1992. Southern's operating results for 1993 were down primarily due to a favorable settlement of $9.6 million in 1992 relating to Southern Energy Company's idle liquified natural gas (LNG) facility. A settlement at Sea Robin Pipeline Company increased 1993 results by $4.5 million. General and administrative expenses were up in 1993 due to a $4 million increase in health insurance expense and an increase in stock-based employee compensation.\nGas sales revenue and gas cost increased at Southern due to the sale of $123 million of storage gas inventory pursuant to the implementation of Order No. 636 on November 1, 1993. Total market throughput increased 2 percent; however, Order No. 636 resulted in a shift in volumes from sales to market transportation. Supply transportation volumes decreased due to competition from other pipelines.\n1992 Versus 1991. Operating income for 1992 includes the effect of a favorable settlement of $9.6 million relating to Southern Energy's LNG facility, while 1991 was negatively affected by one-time charges totaling $11 million related to a cost-containment program and the cancellation of the Mobile Bay project. Excluding these items, operating income was lower primarily as a result of a $7 million increase in stock-based employee compensation.\nII-4 Southern's total volumes increased 8 percent in 1992. Market throughput was higher because of colder weather and new markets, offsetting the loss of a competitive load to coal that was served in 1991 when gas prices were substantially lower and losses to other pipeline competition. The 18 percent increase in supply transportation is primarily the result of higher deliverability and an aggressive program of hooking up new gas supply to the Sea Robin system.\nORDER NO. 636\nIn 1992 the FERC issued its Order No. 636 (the Order). As required by the Order, interstate natural gas pipeline companies have made significant changes in the way they operate. The Order required pipelines, among other things, to: (1) separate (unbundle) their sales, transportation and storage services; (2) provide a variety of transportation services, including a \"no- notice\" service pursuant to which the customer will be entitled to receive gas from the pipeline to meet fluctuating requirements without having previously scheduled delivery of that gas; (3) adopt a straight fixed variable (SFV) method for rate design (which assigns more costs to the demand component of the rates than do other rate design methodologies previously utilized by pipelines); and (4) implement a pipeline capacity release program under which firm customers will have the ability to \"broker\" the pipeline capacity for which they have contracted. The Order also authorizes pipelines to offer unbundled sales services at market-based rates and allowed for pregranted abandonment of some services.\nAs discussed in Note 8 of the Notes to Consolidated Financial Statements, Southern is incurring certain transition costs as a result of implementing Order No. 636, and for Southern, those are primarily gas supply realignment (GSR) costs relating to existing gas purchase contracts. In its restructuring settlement discussions, Southern has advised its customers that the amount of GSR costs that it actually incurs will depend on a number of variables, including future natural gas and fuel oil prices, future deliverability under Southern's existing gas purchase contracts and Southern's ability to renegotiate certain of these contracts. While the level of GSR costs is impossible to predict with certainty because of these numerous variables, based on current spot-market prices, a range of estimates of future oil and gas prices, and recent contract renegotiations, the amount of GSR costs would be approximately $275 million-$325 million on a present value basis. This includes the $168 million of settlements discussed below.\nIn requiring that Southern provide unbundled storage service, the Order resulted in a substantial reduction of Southern's working storage gas inventory and consequently a reduction in its rate base. The reduction in rate base was effective on November 1, 1993, when Southern restructured pursuant to the Order and sold $123 million of its storage gas inventory to its customers. The Order also resulted in rates that are less seasonal, thereby shifting revenues and earnings for Southern out of the winter months.\nThe FERC issued an order on September 3, 1993 (the September 3 order), that generally approved a compliance plan for Southern and directed it to implement restructured services on November 1, 1993. In accordance with the September 3 order, Southern solicited service elections from its customers in\nII-5 order to implement its restructure services on November 1, 1993. Southern's largest customer, Atlanta Gas Light Company and its subsidiary, Chattanooga Gas Company (collectively Atlanta), bid for firm transportation service on Southern at prices significantly below Southern's filed tariff rates. Southern rejected Atlanta's bids. Southern and Atlanta subsequently entered into an interim agreement under which Atlanta signed firm transportation service agreements with transportation demands of 582 million cubic feet per day for a minimum term of four months beginning November 1, 1993, and 118 million cubic feet per day for a term extending until April 30, 2007, at the maximum FERC-approved rates. This represented an aggregate reduction of 100 million cubic feet per day from Atlanta's level of services prior to November 1, 1993. In January 1994, Atlanta provided notice that it had elected to continue that level of firm service until October 31, 1994. Southern's other customers elected in aggregate to obtain an amount of firm transportation services that represented a slight increase from their previous level of firm sales and transportation services from Southern, at the maximum FERC-approved tariff rates, for terms ranging from one to 10 or more years.\nSouthern is unable to predict all of the elements of the ultimate outcome of its Order No. 636 restructuring proceeding, its settlement discussions with Atlanta and its other customers, and the limited rate filings to recover its transition costs.\nNATURAL GAS SALES AND SUPPLY\nAs a result of Order No. 636, Southern is attempting to terminate its remaining gas purchase contracts through which it had traditionally obtained its long-term gas supply. Some of these contracts contain clauses requiring Southern either to purchase minimum volumes of gas under the contract or to pay for it (take-or-pay clauses). Although Southern currently is incurring essentially no take-or-pay liabilities under these contracts, the annual weighted average cost of gas under these contracts is in excess of current spot-market prices. Pending the termination of these remaining supply contracts, Southern has agreed to sell a portion of its remaining gas supply to a number of its firm transportation customers for a one-year term which began November 1, 1993. The rest of Southern's remaining supply will be sold on a month-to-month basis. The difference between the cost associated with the gas supply contracts and the revenue from the sale agreements and month-to-month sales should be recoverable as a GSR cost pursuant to Order No. 636. In addition, any cost to terminate or reduce the price under Southern's remaining contracts should also be recoverable as a GSR cost pursuant to Order No. 636.\nDuring 1993 Southern reached agreements to reduce significantly the price payable under a number of high-cost gas purchase contracts in exchange for payments with a present value of approximately $168 million.\nII-6 Southern's purchase commitments under its remaining gas supply contracts for the years 1994 through 1998 are estimated as follows:\nThese estimates are subject to significant uncertainty due both to the number of assumptions inherent in these estimates and to the wide range of possible outcomes for each assumption. None of the three major factors which determine purchase commitments (underlying reserves, future deliverability and future price) is known today with certainty. As explained above, Southern expects to recover all of these costs, including its costs to terminate these purchase commitments, either through the sale of the gas or as a GSR cost.\nRATE MATTERS\nSeveral general rate changes have been implemented by Southern and remain subject to refund. See Note 8 of the Notes to Consolidated Financial Statements for a discussion of rate matters.\n________________________\n1993 Versus 1992. Interest income was higher in 1993 due to an increase in average levels and rates on notes from affiliates. The increase in interest income was largely offset by an increase in accrued interest expense of $8 million provided on certain income tax issues and to higher average debt levels.\n1992 Versus 1991. Interest expense on debt increased due to an increase in average debt outstanding, resulting from the restructuring of Southern's capital structure in May 1992, partially offset by lower average interest rates.\nII-7\n1993 Versus 1992. Income taxes were lower in 1993 due to tax adjustments.\n1992 Versus 1991. Income taxes were higher primarily due to higher pretax income.\nFINANCIAL CONDITION\nCASH FLOWS\n1993 Versus 1992. Net cash provided by operating activities increased due to the sale of storage gas inventory pursuant to Order No. 636 and lower cash outflows relating to gas imbalances. Partially offsetting the increase were GSR payments of approximately $128 million made in 1993.\n1992 Versus 1991. Net cash provided by operating activities decreased as a result of lower cash outflows relating to gas imbalances.\n1993 Versus 1992. Net cash used in investing activities was higher due to a $17 million increase in capital expenditures and increased loans to Southern's parent.\n1992 Versus 1991. Net cash used in investing activities was lower due primarily to a $62 million decrease in capital expenditures partially offset by an increase in notes to Southern's parent.\n1993 Versus 1992. Net cash used in financing activities increased slightly due to scheduled loan repayments. Southern did not refinance any debt during 1993.\nII-8 1992 Versus 1991. Net cash used in financing activities in 1992 was flat with 1991. In May 1992, Southern completed the restructuring of its capital structure by issuing $100 million in Notes and dividending the proceeds to Sonat. As a result, the debt to capitalization ratio increased 8 percent when compared to December 31, 1991.\nCAPITAL EXPENDITURES\nCapital expenditures for 1994, including joint ventures, are expected to be approximately $68 million, primarily for pipeline additions and replacements and other projects, some of which have not yet received regulatory approval.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1993, Southern had available $50 million under lines of credit. Southern expects to use cash from operations, borrowing in the public or private markets or loans from affiliates to finance future capital or other corporate expenditures.\nCAPITALIZATION INFORMATION\nINFLATION AND THE EFFECT OF CHANGING ENERGY PRICES\nAlthough the rate of inflation in the United States has been moderate over the past several years, its potential impact should be considered when analyzing historical financial information. In past times of high general inflation, oil and gas prices have increased at comparable, and at times, higher rates. The changing regulatory environment in which the natural gas business operates, along with other competitive factors, would currently make it difficult to increase prices enough to recover significantly higher costs of operations. Southern's results of operations will be affected by future changes in domestic and international oil and gas prices and the interrelationship between oil, gas and other energy prices.\nENVIRONMENTAL ISSUES\nSouthern is involved in various environmental compliance and cleanup activities, and has been notified that it is one of many potentially responsible parties at certain federal Superfund sites. Southern does not expect costs relating to these activities, including any responsibility for cleanup of such sites, to be material, taken either separately or in the aggregate, with respect to the financial position or results of operations of Southern.\nIn addition, Southern has taken steps to test for the presence of polychlorinated biphenyls (PCB) at its natural gas compressor stations. A total of 13 stations evidenced some level of on-site PCB contamination ranging\nII-9 from low to moderate. Southern has completed the characterization and cleanup of 12 of these sites at a cost of approximately $6 million. Southern has partially completed the characterization and cleanup of the 13th site and believes that it should be able to complete the remediation of this site for a total cost of less than $5 million, approximately half of which had been incurred at December 31, 1993.\nSouthern generally considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates since they are prudent costs incurred in the ordinary course of business, and accordingly, will seek recovery of such costs through rate filings, although no assurance can be given with regard to their ultimate recovery.\nSouthern has an active and ongoing environmental program and believes responsible environmental management is integral to its business.\nII-10 Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReport of Ernst & Young, Independent Auditors\nThe Board of Directors Southern Natural Gas Company\nWe have audited the accompanying consolidated balance sheets of Southern Natural Gas Company and Subsidiaries as of December 31, 1993 and 1992, and the related statements of income, changes in retained earnings and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southern Natural Gas Company and Subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ Ernst & Young\nERNST & YOUNG\nBirmingham, Alabama January 20, 1994\nII-11 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992\nSee accompanying notes.\nII-12 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992\nSee accompanying notes.\nII-13 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1993, 1992 and 1991\nCONSOLIDATED STATEMENTS OF CHANGES IN RETAINED EARNINGS Years Ended December 31, 1993, 1992 and 1991\nSee accompanying notes.\nII-14 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1993, 1992 and 1991\nSee accompanying notes.\nII-15 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Significant Accounting Policies\nPrinciples of Consolidation - The Consolidated Financial Statements include the accounts of Southern Natural Gas Company and its subsidiaries, which is a wholly owned subsidiary of Sonat Inc. Intercompany transactions and accounts have been eliminated in consolidation. The equity method of accounting is used for investments in joint ventures owned 50 percent or less.\nCertain amounts in the 1992 and 1991 Consolidated Financial Statements have been reclassified to conform with the 1993 presentation.\nInventories - At December 31, 1993, inventories consist primarily of materials and supplies, and are carried at cost.\nGas Imbalance Receivables and Payables - Gas imbalances represent the difference between gas receipts from and gas deliveries to Southern's transportation and storage customers. Gas imbalances arise when these customers deliver more or less gas into the pipeline than they take out. Under the provisions of Order No. 636, these amounts are settled monthly.\nPlant, Property and Equipment, and Depreciation - Plant, property and equipment is carried at cost. Southern generally provides for depreciation on a composite basis. (See Note 5.)\nRevenue Recognition - Southern recognizes revenue from both natural gas sales and transportation in the period the service is provided. Reserves are provided on revenues collected subject to refund when appropriate.\nIncome Taxes - Southern and its subsidiaries file federal income tax returns on a consolidated basis with its parent and other members of its affiliated group. For financial statement purposes, income taxes are provided as though Southern and its subsidiaries file separate income tax returns; however, those companies incurring losses are allocated the tax benefit of such losses due to the consolidated return.\nSouthern and its subsidiaries follow an asset and liability approach in accounting for income taxes. Deferred tax assets and liabilities are determined using the tax rate for the period in which those amounts are expected to be received or paid.\nII-16 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. Financial Instruments\nThe carrying amounts and fair values of Southern's financial instruments are as follows:\nThe following methods and assumptions were used by Southern in estimating its fair value disclosures for financial instruments:\nNotes receivable from affiliates, gas supply realignment costs and recoverable natural gas purchase contract settlement costs: The carrying amount reported in the balance sheets approximates its fair value.\nLong-term debt: The fair values of Southern's long-term debt are based on quoted market values.\nII-17 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. Inventories\nThe table below shows the values of various categories of Southern's inventories.\nSouthern sold its inventory of gas stored underground pursuant to the implementation of Order No. 636 on November 1, 1993. (See Note 8.)\n4. Joint Venture\nSouthern owns 50 percent of Bear Creek Storage Company, an underground gas storage company. At December 31, 1993, Southern's investment in Bear Creek, accounted for by the equity method, equaled its share of underlying equity in net assets of the investee. Through December 31, 1993, Southern's cumulative equity in earnings of its joint venture was $126.2 million and cumulative dividends received from it totaled $117.3 million.\nII-18 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. Joint Ventures (Cont'd)\nThe following is summarized financial information for Bear Creek. No provision for income taxes has been included since its income taxes are paid directly by the joint-venture participants.\nII-19 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. Plant, Property and Equipment and Depreciation\nA summary of plant, property and equipment by classification follows:\nPlant, property and equipment includes construction work in progress of $23.3 million and $4.1 million at December 31, 1993 and 1992, respectively.\nThe annual depreciation rates and the accumulated depreciation and amortization amounts by classification are as follows:\nII-20 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. Long-Term Debt and Lines of Credit\nLong-Term Debt - Long-term debt consisted of:\nII-21 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. Long-Term Debt and Lines of Credit (Cont'd)\nSouthern had no restrictions on the payment of dividends at December 31, 1993.\nAnnual maturities of long-term debt at December 31, 1993, are as follows:\nLines of Credit and Credit Agreement - As part of Sonat's cash management program, Southern regularly loans funds to or borrows funds from Sonat. Notes receivable and payable are in the form of demand notes with rates reflecting Sonat's return on funds loaned to its subsidiaries, average short-term investment rates and cost of borrowed funds. In certain circumstances, these notes are subordinated in right of payment to amounts payable by Sonat under certain long-term credit agreements.\nOn May 31, 1993, Southern renewed its short-term lines of credit of $50 million for a period of 364 days. Borrowings are in the form of unsecured promissory notes and bear interest at rates based on the banks' prevailing prime, international or money-market lending rates.\nII-22 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. Income Taxes\nAn analysis of Southern's income tax expense (benefit) is as follows:\nNet deferred tax liabilities are comprised of the following:\nSouthern and its subsidiaries have not provided a valuation allowance to offset deferred tax assets because, based on the weight of available evidence, it is more likely than not that all deferred tax assets will be realized.\nII-23 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. Income Taxes (Cont'd)\nConsolidated income tax expense is different from the amount computed by applying the U.S. federal income tax rate to income before income tax. The reasons for this difference are as follows:\nThe effect of the deferred tax rate increase to 35 percent due to the Omnibus Budget Reconciliation Act of 1993 has been reduced by the effect of the reduction of liabilities established for excess deferred income taxes expected to be returned over future periods to customers.\nII-24 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. Commitments and Contingencies\nLeases - Southern has operating lease commitments expiring at various dates, principally for office space and equipment. Southern has no significant capital leases.\nRental expense for all operating leases is summarized below:\nAt December 31, 1993, future minimum payments for non-cancelable operating leases for the years 1994 through 1998 are less than $4 million per year.\nRate Matters - Periodically, Southern and its subsidiaries file general rate filings with the FERC to provide for the recovery of cost of service and a return on equity. The FERC normally allows the filed rates to become effective, subject to refund, until it rules on the approved level of rates. Southern and its subsidiaries provide reserves relating to such amounts collected subject to refund, as appropriate, and make refunds upon establishment of the final rates.\nOn September 1, 1989, Southern implemented new rates, subject to refund, reflecting a general rate decrease of $6 million. In January 1991, Southern implemented new rates, subject to refund, that restructured its rates consistent with a FERC policy statement on rate design and increased its sales and transportation rates by approximately $65 million annually. These two proceedings have been consolidated for hearing. On October 7, 1993, the presiding administrative law judge certified to the FERC a contested offer of settlement pertaining to the consolidated rate cases which (1) resolved all outstanding issues in the rate decrease proceeding, (2) resolved the cost of service, throughput, billing determinant and transportation discount issues in the rate increase proceeding, and (3) provided a method to resolve all other issues in the latter proceeding, including the appropriate rate design. On December 16, 1993, the FERC issued an order (December 16 Order) approving the settlement, but with modifications. On December 22, 1993, Southern filed a letter with the FERC that outlined certain objections with respect to the FERC's modifications to the terms and conditions of the settlement. Southern advised the FERC that the December 16 Order undercut the economic compromise achieved in the settlement. Southern also filed a request for rehearing of the December 16 Order but is unable to determine at this time if or to what extent rehearing will be granted by the FERC.\nOn September 1, 1992, Southern implemented another general rate change. The rates reflected the continuing shift in the mix of throughput volumes away from sales and toward transportation and a $5 million reduction in annual revenues. On April 30, 1993, Southern submitted a proposed settlement in the proceeding which, if approved by the FERC, would resolve the throughput and certain cost of\nII-25 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. Commitments and Contingencies (Cont'd)\nservice issues. On June 4, 1993, the presiding administrative law judge certified the settlement to the FERC. In another order issued on December 16, 1993, the FERC also approved this settlement, but with modifications. Southern objects to these modifications and has also requested rehearing of this order, but is unable to determine at this time if rehearing will be granted by the FERC.\nIn 1992 Southern placed in service certain facilities constructed to connect to its pipeline system gas reserves produced from certain Mississippi Canyon and Ewing Bank Area Blocks, offshore Louisiana. By order dated May 15, 1991, the FERC had authorized Southern, subject to certain conditions affecting Southern's ability to include the cost of the facilities in its rates, to construct and operate the pipeline, compression, and related facilities necessary to connect these reserves. Southern sought rehearing of the unacceptable certificate conditions, but in an order issued on January 13, 1993, the FERC left intact the conditions contained in its 1991 order. It deferred the specific application of the conditions to Southern's pending rate case implemented September 1, 1992. The certificate order itself is now on appeal. Southern is unable to predict the ultimate rate treatment of the $45 million cost of these facilities, but does not expect such treatment to have a material adverse effect on its financial position.\nOn May 1, 1993, Southern implemented a general rate change, subject to refund, which increased its sales and transportation rates by approximately $57 million annually. The filing is designed to recover increased operating costs and to reflect the impact of competition on both Southern's level and mix of services. A hearing regarding various cost allocation and rate design issues in this proceeding is set for June 14, 1994.\nSea Robin Pipeline Company has previously filed under the provisions of Order No. 500 to recover $83.1 million in gas purchase contract settlement payments from its former pipeline sales customers, Koch Gateway Pipeline Company, successor to United Gas Pipe Line Company (United), and Southern. Those filings remain subject to refund pending the outcome of any prudence challenges in the proceedings. Although the eligibility issues have been resolved, one party has reserved its rights to challenge prudence until such time as certain take-or-pay allocation issues are resolved with respect to the flow-through of costs billed to United.\nSouthern is authorized to flow through to its jurisdictional customers $38.1 million of the costs allocated to it by Sea Robin as well as the $32.7 million in Order No. 500 costs allocated to it by United. Southern's flow-through of United and Sea Robin's costs remains subject to refund pending the outcome of any challenges to the costs or allocation of the costs in those pipelines' Order No. 500 proceedings. Southern does not believe that the outcome of any such challenges will have a material adverse effect on its financial position.\nII-26 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. Commitments and Contingencies (Cont'd)\nOn July 2, 1993, the FERC issued an order reaffirming its approval of the non-take-or-pay aspects of a settlement filed by United in 1988, which included Southern's phased abandonment of its contract demand with United. The order rejected the take-or-pay aspects of the settlement, including United's proposed Order No. 528 allocation methodology. As a consequence, various parties that had originally supported the settlement are now contesting it. United has evidenced its intention to honor the non-take-or-pay aspects of the 1988 settlement and has induced several of the parties to withdraw their judicial appeals of the July 2 order. Southern does not believe that the final resolution of this matter will have a material adverse effect on its financial position.\nGas Purchase Contracts - Gas purchase contract settlement payments (other than the gas supply realignment payments discussed below) made by Southern and not previously recovered or expensed are included on the Consolidated Balance Sheet at December 31, 1993, in \"Current Assets\". Pursuant to a final and nonappealable FERC order, Southern is entitled to collect these amounts from its customers over the remainder of a five-year period which commenced May 1, 1989. Southern currently is incurring essentially no take-or-pay liabilities under its gas purchase contracts. Southern regularly evaluates its position relative to gas purchase contract matters, including the likelihood of loss from asserted or unasserted take-or-pay claims or above-market prices. When a loss is probable and the amount can be reasonably estimated, it is accrued.\nOrder No. 636 - In 1992 the FERC issued its Order No. 636 (the Order). The Order requires significant changes in interstate natural gas pipeline services. Interstate pipeline companies, including Southern, are incurring certain costs (transition costs) as a result of the Order, the principal one being costs related to amendment or termination of existing gas purchase contracts, which are referred to as gas supply realignment (GSR) costs. The Order provides for the recovery of 100 percent of the GSR costs and other transition costs arising out of the implementation of the Order to the extent that the pipeline can prove that they were prudently incurred. Numerous parties have appealed the Order to the Circuit Courts of Appeal.\nOn September 3, 1993, the FERC generally approved a compliance plan for Southern and directed Southern to implement its restructured services pursuant to the Order on November 1, 1993 (the September 3 order). Pursuant to Southern's compliance plan, GSR costs that are eligible for recovery include payments to reform or terminate gas purchase contracts or, for contracts where Southern can show that it can minimize transition costs by continuing to purchase gas under the contract (i.e., it is more economic to continue to perform), the difference between the contract price and the higher of (a) the sales price for gas purchased under the contract, or (b) a price established by an objective index of spot-market prices. Recovery of these latter costs is permitted for an initial period of two years.\nSouthern's compliance plan contains two mechanisms pursuant to which Southern is permitted to recover 100 percent of its GSR costs. The first mechanism is a monthly fixed charge designed to recover 90 percent of the GSR costs from Southern's firm transportation customers. The second mechanism is a volumetric surcharge designed to collect the remaining 10 percent of such costs\nII-27 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. Commitments and Contingencies (Cont'd)\nfrom Southern's interruptible transportation customers. This funding will continue until the GSR costs are fully recovered or funded. The FERC also permitted Southern to file to recover any GSR costs not recovered through the volumetric surcharge after a period of two years. In addition, Southern's compliance plan provides for the recovery of other transition costs as they are incurred and any remaining transition costs may be recovered through a regular rate filing.\nThe September 3 order rejected the argument of certain customers that a 1988 take-or-pay recovery settlement bars Southern from recovering GSR costs under gas purchase contracts executed before March 31, 1989. Those customers have filed motions urging the FERC to reverse its ruling on that issue. On December 16, 1993, the FERC affirmed its September 3 ruling with respect to the 1988 take-or-pay recovery settlement. The December 16 Order generally approved Southern's restructuring tariff submitted pursuant to the September 3 order. Various parties have filed motions urging the FERC to modify the December 16 Order and have sought judicial review of the September 3 order. Southern and its customers engaged in settlement discussions regarding Southern's restructuring filing prior to the September 3 order, but the parties were unable to reach a settlement. Those discussions are continuing.\nDuring 1993 Southern reached agreements to reduce significantly the price payable under a number of high cost gas purchase contracts in exchange for payments of approximately $114 million. On December 1, 1993, Southern filed to recover such costs and approximately $3 million of prefiling interest. On December 30, 1993, the FERC accepted such filing to become effective January 1, 1994, subject to refund, and subject to a determination that such costs were prudently incurred and eligible under Order No. 636. The December 30 order rejected arguments of various parties that a pipeline's payments to affiliates, which represented approximately $34 million of the December 1, 1993 filing, may not be recovered under Order No. 636.\nIn December 1993, Southern reached agreement to reduce the price under another contract in exchange for payments having a present value of approximately $52 million which is included in \"Deferred Credits and Other\" in the Consolidated Balance Sheet. Payments will be made in equal monthly installments over an eight-year period ending December 31, 2001. Southern expects to make a limited rate filing by mid-February 1994 to recover such costs beginning April 1, 1994. Southern has also incurred approximately $11 million of costs during November and December 1993 from continuing to purchase gas under contracts that are in excess of current market prices. Southern will make additional rate filings to recover these costs quarterly. The total costs of $180 million accrued through December 31, 1993, are included in current and long-term gas supply realignment costs in the Consolidated Balance Sheet.\nSouthern is unable to predict all of the elements of the ultimate outcome of its Order No. 636 restructuring proceeding, its settlement discussions with its customers, and the limited rate filings to recover its transition costs.\nII-28 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. Transactions with Major Customers and Affiliates\nRevenues and accounts receivable relate to business conducted with gas distribution companies, municipalities, gas districts, industrial customers and other interstate pipeline companies in the Southeast. Southern performs ongoing credit evaluations of its customers' financial condition, and in some circumstances, requires collateral from its customers.\nThe following table shows revenues from major unaffiliated customers.\nSouthern and its subsidiaries enter into transactions with other Sonat subsidiaries and unconsolidated affiliates to transport, sell and purchase natural gas. Services provided by these affiliates for the benefit of Southern and its subsidiaries are billed accordingly.\nThe following table shows revenues and charges from Southern's affiliates.\nII-29 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. Employee Benefit Plans\nRetirement Plans - Sonat has a trusteed, non-contributory, tax qualified defined benefit retirement plan (the Retirement Plan) covering substantially all employees of Southern. A supplemental benefit plan (the Supplemental Plan) that provides retirement benefits in excess of those allowed under Sonat's tax qualified retirement plan is also in effect. Benefits under the plans are based on a combination of years of service and a percentage of compensation. Benefits are vested over five years.\nSonat determines the amount of funding to the Retirement Plan on a year-to-year basis, with amounts consistent with minimum and maximum funding requirements established by various governmental bodies.\nSouthern's net periodic pension cost consists of the following components:\nFor a limited period during 1993 and 1991, Sonat offered special early retirement programs to certain employees of Southern. The total cost of the programs applicable to Southern was $5.5 and $6.3 million, respectively. All of the 1993 costs have been deferred to be collected in future rates.\nII-30 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. Employee Benefit Plans (Cont'd)\nThe following table sets forth Southern's allocated portion of the assets and liabilities of Sonat's plans and the amount of the net pension asset or liability recognized in Southern's Consolidated Balance Sheets.\n(1) The Retirement Plan. (2) The Supplemental Plan. (3) Plan assets consist of equity securities, commingled funds and debt securities. (4) Amortization periods for unrecognized net (asset) or obligation are 16.5 years for the Retirement Plan and 15 years for the Supplemental Plan. (5) Amortization periods for early retirement termination benefits are 10 years for the Retirement Plan and five years for the Supplemental Plan.\nII-31 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. Employee Benefit Plans (Cont'd)\nUntil July 1993, Sonat set aside assets in fixed income securities such that values of those assets equal or exceed the present value of benefit obligations to current retirees (immunized obligations). After that date, a separate immunized portfolio has not been maintained. The assumed rates used to measure the projected benefit obligations and the expected earnings of plan assets are:\nOther Post Employment Benefits - Southern participates in plans of Sonat that provide for postretirement health care and life insurance benefits to its employees when they retire. Southern adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" for all plans as of January 1, 1993. SFAS No. 106 requires companies to accrue the cost of postretirement health care and life insurance benefits within the employees' active service periods. Southern has elected to amortize the transition obligation over a 20-year period. Southern previously expensed the cost of its retiree medical benefits as they were paid. Expense for retiree life insurance benefits was recognized as Southern funded its Retiree Life Insurance Plan.\nThe annual net periodic cost for postretirement health care and life insurance benefits for the year ended December 31, 1993, includes the following components:\nPrior to the adoption of SFAS No. 106, the cost of providing health care and life insurance benefits was $3.9 million in 1992 and 1991.\nSouthern implemented rates effective May 1, 1993, which provide for the recovery of its SFAS No. 106 costs. Costs incurred in 1993 prior to that date, amounting to $2.6 million, were deferred to be amortized over a three-year period commencing when Southern's next rate case becomes effective.\nII-32 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. Employee Benefit Plans (Cont'd)\nSouthern funds its Retiree Life Insurance Plan with the amount of funding determined on a year-to-year basis with the objective of having assets equal plan liabilities. In addition, during 1993 Southern initiated funding of postretirement health care benefits in an amount generally equal to its SFAS No. 106 expense.\nThe following table sets forth the funded status at December 31, 1993, and at the date of SFAS No. 106 adoption, January 1, 1993, for Southern's postretirement health care and life insurance plans:\n(1) Plan assets are held in a life insurance reserve account and consist primarily of fixed income securities.\nThe assumed rates used to measure the projected benefit obligation and the expected earnings of plan assets are:\nThe rate of increase in the per capita costs of covered health care benefits is assumed to be 12.3 percent in 1994, decreasing gradually to 6 percent by the year 2002. Increasing the assumed health care cost trend rate by 1 percentage point would increase the accumulated postretirement benefit obligation as of December 31, 1993, by approximately $7.5 million and increase the service cost and interest cost components of the net periodic postretirement benefit cost by approximately $.6 million.\nII-33 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. Employee Benefit Plans (Cont'd)\nExecutive Award Plan - Sonat has an Executive Award Plan that provides awards to certain key employees in the form of stock options, restricted stock, and stock appreciation rights (SARs) in tandem with any or all stock options. In years prior to 1991, tax offset payments were also generally provided in conjunction with these awards. SARs permit the holder of an exercisable option to surrender that option for an amount equal to the excess of the market price of the common stock on the date of exercise over the option price (appreciation). The appreciation is payable in cash, common stock, or a combination of both. SARs are subject to the same terms and conditions as the options to which they are related. No SARs have been issued since 1990. At December 31, 1993, 75,000 SARs were outstanding to employees of Southern. Sonat issued 7,000 shares of restricted stock to employees of Southern during 1993. The shares generally vest 10 years from the date of grant, unless the closing price of Sonat's common stock achieves certain specified levels. At December 31, 1993, 7,328 of the 29,400 cumulative restricted shares issued have vested. Stock-based employee compensation decreased Southern's pretax income in 1993 by $5.1 million, decreased Southern's pretax income in 1992 by $1.8 million and increased Southern's pretax income in 1991 by $2.3 million.\nII-34 SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. Quarterly Results (Unaudited)\nShown below are selected unaudited quarterly data.\n(1) Net income for the third quarter of 1992 includes favorable adjustments of $6 million, related to a settlement regarding Southern Energy Company's idle liquified natural gas facilities.\nII-35 Item 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThe Company has not had a change in accountants within twenty-four months prior to the date of its most recent financial statements or in any period subsequent to such date.\nII-36\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Index to Financial Statements, Financial Statement Schedules, and Exhibits\n1. FINANCIAL STATEMENTS\n2. FINANCIAL STATEMENT SCHEDULES\nAll other schedules have been omitted as the subject matter is either not present or is not present in amounts sufficient to require submission of the schedule, in accordance with the instructions contained in Regulation S-X, or the required information is included in the financial statements or notes thereto.\nFinancial statements of 50-percent or less owned companies and joint ventures are not presented herein because such companies and joint ventures do not meet the significance test.\nIV-1\n3. EXHIBITS (1)\n- ---------------\n(1) Southern will furnish to requesting security holders any exhibit on this list upon the payment of a fee of 10 cents per page up to a maximum of $5.00 per exhibit. Requests must be in writing and should be addressed to R. David Hendrickson, Secretary, Southern Natural Gas Company, P. O. Box 2563, Birmingham, Alabama 35202.\nIV-2\nExhibit 21, Subsidiaries of the Registrant, has been omitted in reliance upon Instruction J(2)(b) of Form 10-K.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission, which were physically filed as noted above, are hereby incorporated herein by reference pursuant to Rule 12b-32 under the Securities Exchange Act of 1934 and made a part hereof with the same effect as if filed herewith.\nCertain instruments relating to long-term debt of Southern and its subsidiaries have not been filed as exhibits since the total amount of securities authorized under any such instrument does not exceed 10% of the total assets of Southern and its subsidiaries on a consolidated basis. Southern agrees to furnish a copy of each such instrument to the Commission upon request.\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed during the quarter ended December 31, 1993.\n(c) Exhibits\nExhibits required by Item 601 of Regulation S-K and filed with this report on Form 10-K accompany this report in a separate exhibit volume.\nIV-3\nSIGNATURES\nPURSUANT 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.\nSOUTHERN NATURAL GAS COMPANY\nBy: \/s\/ WILLIAM A. SMITH ---------------------------- WILLIAM A. SMITH CHAIRMAN AND PRESIDENT\nDated: March 25, 1994\nPURSUANT 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 AND ON THE DATES INDICATED.\nIV-4\nIV-5\nSOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE V - PLANT, PROPERTY AND EQUIPMENT YEAR ENDED DECEMBER 31, 1993\nNotes: (a) Additions include $739,000 of funds capitalized. (b) Reflect the transfer of current working storage to noncurrent pursuant to Order No. 636 (See Notes 3 and 8 of the Notes to Consolidated Financial Statement located in Item 8.) SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE V - PLANT, PROPERTY AND EQUIPMENT - (CONTINUED) YEAR ENDED DECEMBER 31, 1992\nNotes: (a) Additions include $692,000 of funds capitalized. (b) Other changes include transfers and reclassifications between plant and property and other accounts. SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE V - PLANT, PROPERTY AND EQUIPMENT - (CONTINUED) YEAR ENDED DECEMBER 31, 1991\nNotes: (a) Additions include $3,386,000 of funds capitalized. (b) Other changes include transfers and reclassifications between plant and property and other accounts. SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PLANT, PROPERTY AND EQUIPMENT (a) YEAR ENDED DECEMBER 31, 1993\nNotes: (a) Depreciation is provided as described in Note 1 and Note 5 of the Notes to Consolidated Financial Statements located in Item 8. (b) Other changes are either transfers or amounts received as reimbursement for alterations of facilities. SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PLANT, PROPERTY AND EQUIPMENT (a) - (CONTINUED) YEAR ENDED DECEMBER 31, 1992\nNotes: (a) Depreciation is provided as described in Note 1 and Note 5 of the Notes to Consolidated Financial Statements located in Item 8. (b) Other changes are either transfers or amounts received as reimbursement for alterations of facilities. (c) Includes an adjustment of $9.6 million for a settlement relating to Southern Energy Company's idle liquefied natural gas facilities. SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PLANT, PROPERTY AND EQUIPMENT (a) - (CONTINUED) YEAR ENDED DECEMBER 31, 1991\nNotes: (a) Depreciation is provided as described in Note 1 and Note 5 of the Notes to Consolidated Financial Statements located in Item 8. (b) Other changes are either transfers or amounts received as reimbursement for alterations of facilities.\nSOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED DECEMBER 31, 1993, 1992 and 1991\nCharged to Costs and Expenses -------------------------------------------- 1993 1992 1991 ---- ---- ----\n(In Thousands)\nMaintenance and Repairs $21,776 $22,474 $21,547 ======= ======= =======\nAd Valorem Taxes $11,794 $11,869 $10,533 ======= ======= =======\nNo other information is required to be disclosed because amounts are less than 1% of consolidated revenues or the information has been included elsewhere herein.\nAPPENDIX TO ANNUAL REPORT ON FORM 10-K\nOF SOUTHERN NATURAL GAS COMPANY\nFOR THE YEAR ENDED DECEMBER 31, 1993\nIn compliance with Section 304 of Regulation S-T, the following information describes pictorial and\/or graphic materials contained herein:\nPAGE DESCRIPTION\nI-8 Map of the Southeastern United States showing the approximate location of the pipeline systems of Southern and its subsidiaries and the underground storage facilities of Southern (each described on page I-1); and the approximate location of Southern Energy's LNG terminal, as discussed on page I-6.","section_15":""}
{"filename":"314661_1993.txt","cik":"314661","year":"1993","section_1":"ITEM 1. BUSINESS - -----------------\nINTRODUCTION\nSanta Anita Realty Enterprises, Inc. (\"Realty\") and Santa Anita Operating Company (\"Operating Company\") are two separate companies, the stocks of which trade as a single unit under a stock-pairing arrangement on the New York Stock Exchange. Realty and Operating Company were each incorporated in 1979 and are the successors of a corporation originally organized in 1934 to conduct thoroughbred horse racing in Southern California. As used herein, the terms \"Realty\" and \"Operating Company\" include wholly owned subsidiaries of Realty and Operating Company, respectively, unless the context requires otherwise. This document constitutes the annual report on Form 10-K for both Realty and Operating Company.\nREALTY\nRealty is incorporated under the laws of the State of Delaware. Realty's principal executive offices are located at 363 San Miguel Drive, Suite 100, Newport Beach, California 92660-7805.\nRealty operates as a real estate investment trust (\"REIT\") under the provisions of the Internal Revenue Code of 1986 (the \"Code\"). As such, Realty is principally engaged in investing in and holding real property, including Santa Anita Racetrack, 622,000 square feet of industrial space, the real estate underlying the Santa Anita Fashion Park shopping center (\"Fashion Park\"), a 50 percent interest in the operation of Fashion Park and a 32.5 percent interest in Towson Town Center (major regional shopping centers), and a number of neighborhood shopping centers and office buildings. Until February 18, 1994, Realty also owned 2,654 apartment units and an additional 185,000 square feet of industrial space. Realty is a self-administered equity REIT.\nPACIFIC GULF PROPERTIES INC.\nIn June 1993, Realty's Board of Directors approved management's recommendation to recapitalize certain assets of Realty. Pursuant to this recapitalization, in November 1993, Realty entered into a Purchase and Sale Agreement to sell its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), in conjunction with Pacific's proposed public offering of common stock. The transaction was structured into two parts: (1) Realty would sell all of its apartments and industrial properties to Pacific with the exception of Realty's interest in the Baldwin Industrial Park joint venture; and (2) Pacific would enter into a binding agreement to buy Realty's interest in Baldwin Industrial Park.\nOn February 18, 1994, Realty completed the first part of this transaction by selling to Pacific ten multifamily properties, containing 2,654 apartment units, located in Southern California, the Pacific Northwest, and Texas and three industrial properties, containing an aggregate of 185,000 leasable square feet of industrial space, located in the State of Washington (the \"Transferred Properties\"). Realty's corporate headquarters building and related assets were also acquired by Pacific. The sale of the Transferred Properties followed the public offerings of common stock and convertible subordinated debentures by Pacific.\nPursuant to the Purchase and Sale Agreement, Pacific agreed to buy Realty's interest in Baldwin Industrial Park subject to satisfaction of certain conditions, for a minimum price of $8.9 million payable in additional shares of Pacific common stock, with the final price dependent upon completion of negotiations with other owners of Baldwin Industrial Park and an appraisal process. Management believes the sale of Realty's interest in Baldwin Industrial Park will be completed in the second half of 1994. Pacific is required to issue to Realty non-refundable letters of credit totaling up to $2.5 million by March 31, 1994 to secure its obligation to\nITEM 1. BUSINESS (CONTINUED) - ----------------\nacquire Realty's interest in Baldwin Industrial Park and pay for the corporate headquarters building and other assets related to the Transferred Properties.\nIn consideration of the sale of the Transferred Properties, Realty received approximately $44.4 million in cash and 149,900 shares of the common stock of Pacific. In addition, Realty was relieved of approximately $44.3 million of mortgage debt on the Transferred Properties. Realty will also receive, at the time the acquisition of Baldwin Industrial Park is completed, up to $1.2 million in additional common stock of Pacific as consideration for its corporate headquarters and other net assets related to the Transferred Properties.\nThe two parts of the above transaction will result in a loss of $10,974,000. This loss has been reflected in the Realty and Realty and Operating Company combined statements of operations for the year ended December 31, 1993. If the Baldwin Industrial Park portion of the transaction described above does not occur, an additional loss of approximately $5,900,000 will be recognized by Realty in 1994. (See \"Notes to Financial Statements - Note 2 - Disposition of Multifamily and Industrial Properties Subsequent to Year End.\")\nIn connection with the sale, the executive officers, various managers and most other employees of Realty resigned and became officers and employees of Pacific on February 18, 1994.\nRealty and Pacific have also entered into a one-year management agreement whereby Pacific has agreed to provide management services to Realty. Finally, with respect to the common stock of Pacific owned by Realty, Pacific has entered into a registration rights agreement with Realty which, under certain circumstances, allows Realty to require the registration of the Pacific stock it owns.\nAs a result of the February 18, 1994 sale to Pacific, Realty owns approximately 3.6% of Pacific's outstanding common shares. Upon completion of Pacific's acquisition of Baldwin Industrial Park assuming a price per share equal to $18.25 (the public offering price of Pacific's common shares) and the minimum price for Realty's interest in Baldwin Industrial Park and the corporate headquarters building and certain other assets related to the Transferred Properties, Realty will own approximately 14.9% of Pacific's outstanding common shares. The February 18, 1994 sale also accomplished the following objectives: (1) the transaction de-leveraged Realty by paying down its lines of credit by $44.4 million and transferring certain debt in the amount of $44.3 million related to the apartment and industrial properties to Pacific; (2) Realty's existing shareholders' interest in Santa Anita Racetrack and Fashion Park was not diluted; and (3) Realty shareholders will participate in the potential growth of Pacific through Realty's ownership position.\nItem 1. Business (continued) - ----------------\nSUMMARY FINANCIAL INFORMATION\nThe following table sets forth certain unaudited financial information with respect to Realty:\n- ------------------------- (a) See Item 1. \"Business - Realty - Pacific Gulf Properties.\" (b) Calculated in accordance with the definition of funds from operations as defined by the National Association of Real Estate Investment Trusts (\"NAREIT\"), except 1993 which excludes $5,734,000 received from the California Franchise Tax Board related to the settlement of certain state tax issues. Net income (computed in accordance with generally accepted accounting principles), excluding gains (losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated joint ventures were calculated by adding distributions from unconsolidated joint ventures net of equity in the earnings (losses) of the venture and excluding distributions associated with the sale of property by the venture. (c) Pro forma funds from operations for the year ended December 31, 1993, after giving effect to the Pacific transaction, was $16,151,000.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nREAL ESTATE INVESTMENTS AND POLICIES\nRealty's portfolio of real estate investments is outlined below. Information with respect to the real estate investments subject to the Pacific transaction are separately listed:\nSUMMARY OF REAL ESTATE INVESTMENTS AS OF DECEMBER 31, 1993\n- ------------------------------------- (a) Square feet except as indicated. (b) Net book value (total cost of project less accumulated depreciation) at December 31, 1993. Amounts represent 100% of project net book value. (c) Amounts represent 100% of project encumbrances. (d) Subsequent to December 31, 1993, the loan was refinanced (see Item 1. \"Business - Realty - Regional Malls - Santa Anita Fashion Park\"). (e) A major shopping center which was expanded into a 980,000 square foot regional mall. Expanded mall area opened in October 1991. Additional anchor tenant opened in fall of 1992. (f) Realty is entitled to receive a preferred return on its equity investment. (g) A retail building adjacent to the Towson Town Center project that is expected to become part of the regional mall described in (e) above. (h) Pacific has an option to acquire this property (see Item 1. \"Business - Realty - Land\"). (i) Corporate offices of Realty and Pacific. (j) Pacific has agreed to acquire this property during 1994 (see Item 1. \"Business - Realty - Pacific Gulf Properties\").\nITEM 1. BUSINESS (CONTINUED) - -----------------\nThe following table presents information with respect to Realty's wholly owned and consolidated joint venture projects, other than Santa Anita Racetrack, by type as of December 31, 1993. Information with respect to the projects subject to the Pacific transaction is separately listed. Information on the consolidated joint venture projects represents 100% of the projects' leasable area and net operating income.\n- ---------------------- (a) Rental property revenues less rental property operating expenses for all wholly owned properties and consolidated joint venture properties. (b) Does not include square footage in Towson Town Center (980,000 square feet) or Joppa Associates (240,000 square feet), or land underlying Fashion Park of 73 acres. (c) Net operating income includes only actual number of months of activity for each project. (d) Includes - property Pacific has agreed to acquire during 1994 (see Item 1. \"Business - Realty - Pacific Gulf Properties\").\nThe disposition of the multifamily and industrial operations to Pacific is consistent with Realty's plan to focus its efforts on the Santa Anita Racetrack and related property in Arcadia. Realty's current investment policy is to focus its efforts on the Santa Anita Racetrack and related property in Arcadia. Realty's investment policies are subject to ongoing review by its Board of Directors and may be changed in the future depending on various factors, including the general climate for real estate investments.\nSANTA ANITA RACETRACK\nSanta Anita Racetrack, which is leased by Realty to the Los Angeles Turf Club, Incorporated (\"LATC\"), a subsidiary of Operating Company, is located on approximately 312 acres, 14 miles northeast of downtown Los Angeles, adjacent to major transportation routes. LATC conducts one of the largest thoroughbred horse racing meets in the United States in terms of both average daily attendance and average daily pari-mutuel wagering.\nThe Santa Anita Racetrack was opened for thoroughbred horse racing in 1934 by a group of investors led by Dr. Charles H. Strub. The Santa Anita Meet has been held at Santa Anita Racetrack each year since its founding except for three years during World War II. Over the years, the racetrack facilities have been expanded. At present, the physical plant consists of a large grandstand structure, stalls for approximately 2,000 horses, and a parking area covering approximately 128 acres which can accommodate approximately 20,000 automobiles. The grandstand facilities include clubhouse and Turf Club accommodations, a general admission\nItem 1. Business (continued) - ----------------\narea, and food and beverage facilities, which range from fast food stands to restaurants, both at outdoor terrace tables and indoor dining areas. The grandstand has seating capacity for 25,000 as well as standing room for additional patrons. The structure also contains Operating Company's executive and administrative offices. The grounds surrounding the grandstand are extensively landscaped and contain a European-style paddock and infield accommodations, including picnic facilities for special groups and the general public.\nThe lease rental payable to Realty by LATC is 1.5% of total live on-track wagering at Santa Anita Racetrack, including live on-track wagering during the meet conducted by the Oak Tree Racing Association (\"Oak Tree\"). In addition, Realty receives 40% of LATC's revenues from satellite wagering (not to exceed 1.5% of such wagering) and the simulcasting of races originating from Santa Anita Racetrack after mandated payments to the State, to horse owners and to breeders. Accordingly, the rental income which Realty receives from Santa Anita Racetrack is directly affected by and dependent upon the racing activities and the wagering by patrons (see Item 1. \"Business -- Operating Company -- Santa Anita Racetrack\").\nBased upon the rental formula for the year ended December 31, 1993, Realty received approximately $11.6 million in rental income from horse racing. The lease expires in December 1994 at which time it is expected to be renewed on terms to be renegotiated by Realty and LATC which, in light of Operating Company's declining profitability, may result in reduced revenue to Realty (see Item 1. \"Business -- Operating Company\" and Item 6. \"Selected Financial Data - - - Operating Company\").\nThe following table shows rental earned by Realty under the LATC lease for the last five years:\n- ------------------------- (a) Oak Tree races five weeks in even-numbered years and six weeks in odd- numbered years.\nFor a further description of the Santa Anita Meet and the Oak Tree Meet, see Item 1. \"Business -- Operating Company -- Santa Anita Racetrack.\"\nREGIONAL MALLS\nSANTA ANITA FASHION PARK\nSanta Anita Fashion Park is a completely enclosed, climate-controlled regional mall located adjacent to Santa Anita Racetrack with approximately 900,000 square feet of leasable area. Fashion Park is owned and operated by a partnership, Anita Associates, of which Realty is a 50% limited partner. The general partner of Anita Associates is Hahn-UPI, which in turn is a limited partnership of which The Hahn Company, a developer of shopping centers, is the general partner.\nFashion Park is currently undergoing an expansion which is anticipated to be completed in the fall of 1994. In addition to the existing major tenants, Robinsons\/May, J.C. Penney and Broadway, a new 146,000 square foot Nordstrom store is being added. During 1993, the Robinsons\/May store was expanded by\nItem 1. Business (continued) - ----------------\napproximately 40,000 square feet. In 1994, an additional 45,000 square feet of mall stores will be completed with the Nordstrom expansion. During 1993, a food court of approximately 13,000 square feet was completed and opened.\nIn January 1994, the partnership refinanced its existing debt by entering into a loan agreement with an insurance company whereby a maximum of $62,355,000 may be borrowed, bearing interest at 9%, with repayment over ten years. On January 25, 1994, $46,577,193 of the total loan amount was drawn.\nThere are currently 116 tenants operating mall stores with original lease terms varying up to 10 years. New leases are generally seven to ten years with clauses providing for escalation of the basic rent every three years. Typically, leases with mall tenants are structured to provide Anita Associates with overage rents upon attainment by the tenant of certain sales levels, which are specified under the individual leases of the various stores. Overage rents represent a fixed percentage of the gross sales of a tenant less its base rent.\nRealty has leased the land underlying Fashion Park to Anita Associates and to the major tenants of Fashion Park until 2037, with two additional ten-year option periods and one additional five-year option period. The ground rent is $527,000 annually until 1996 when the annual rent will increase to $794,000 through 2007. During the remaining 30-year term and the three additional option periods, the annual ground rent may be increased up to 25% based upon the appraised value of the land. Under the provisions of the ground leases, Anita Associates is responsible for real estate taxes and other operating expenses. Robinsons\/May, J. C. Penney and The Broadway pay their own real estate taxes.\nThe following table contains certain information pertaining to the mall stores in Fashion Park (excluding major tenants):\n- ------------------- (a) Decline due primarily to certain leases not being renewed in anticipation of the expansion discussed above.\nThe land underlying Fashion Park is security for a loan maturing in 2009 with a balance at December 31, 1993 of $4,100,000. Payments on this indebtedness, which is without recourse to Realty, are approximately $473,000 annually. The security to the lender also includes an assignment of the ground rents received by Realty and a collateral assignment of the ground leases.\nTOWSON TOWN CENTER\nTowson Town Center located in Towson, Maryland, is a 563,000 square foot (excluding major tenants) regional mall which opened in 1991. Realty is a 50% partner with The Hahn Company in H-T Associates, a joint venture which owns a 65% interest in a partnership which owns the Towson Town Center. Realty has invested a total of $7.5 million in H-T Associates. The major tenants at Towson Town Center are Nordstrom and Hecht's department stores.\nThere are 183 other tenants operating mall stores with original lease terms varying up to 15 years. The average annual rental rate per square foot including overage rents was $28.23 per square foot for the operating mall stores. The mall tenant leases generally provide for escalation of the basic rent every three years and are structured to provide Towson Town Center with overage rents upon attainment by the tenant of certain sales levels, which are specified under the individual leases of the various stores. Overage rents represent a fixed percentage of the gross sales of a tenant less its base rent.\nITEM 1. BUSINESS (CONTINUED) - -----------------\nRealty is a joint and several guarantor of loans used to expand the Towson Town Center and a department store and land adjacent to the Towson Town Center in the amount of $82,630,000. In 1993 the guarantee amount was reduced by $93,337,000. Annually, the guarantors may request a reduction in the amount of the guaranty based on the economic performance of the regional mall (see \"Notes to Financial Statements -- Note 3 -- Investments in Joint Ventures\").\nSHOPPING CENTERS\nRealty owns a portfolio of six neighborhood shopping centers. The shopping centers typically consist of a major supermarket, retail store or drugstore as a major tenant and often include a variety or general merchandise store and smaller service store tenants. The major tenant in two centers owns its building and the underlying land, while in the four other centers, the land or improvements are leased to the major tenant. Leases on the properties range from two to ten years in duration, but typically are from three to five years. They are generally triple net leases (tenant pays all operating costs, insurance and property taxes) and provide for future rental increases. At December 31, 1993, the average occupancy of the three shopping centers located in California was 88% and the average occupancy of the three shopping centers located in Arizona was 90%.\nOFFICE BUILDINGS\nRealty owns interests in four office buildings located in Arcadia, Santa Ana, Upland and Newport Beach, California. The office buildings in Santa Ana and Upland are for general office use, the building in Arcadia is a medical office building and the building in Newport Beach was occupied by Realty in March 1993 and was sold to Pacific on February 18, 1994. Office leases are typically for a period of five to ten years and are offered on a full-service gross basis. In addition, tenants are given a tenant improvement allowance and rental concessions in the form of additional tenant improvement allowances or free rent. At December 31, 1993, the occupancy of the office buildings, was 82%.\nEffective as of December 31, 1993, Realty acquired the minority partnership interest in the office building located in Santa Ana. The partnership interest was acquired in consideration for the cancellation of certain receivables from the minority partner, payment of $250,000 and the assumption of the minority partner's capital account.\nLAND\nRealty is a 50% partner in French Valley Ventures, a partnership which acquired 24 acres of unimproved land located in Temecula, California. The partnership is actively seeking the necessary entitlements on the property and is reviewing the possibility of developing an industrial project on the site.\nSubsequent to year-end, Realty granted to Pacific an option to acquire this partnership interest in the undeveloped parcel of land for $1,957,000. The option is exercisable beginning March 1, 1994 and expires December 31, 1994.\nAPARTMENTS\nOn July 1, 1993, Realty acquired a 256-unit apartment complex located in Austin, Texas, which was subsequently sold to Pacific. Realty acquired the project for $6,750,000. At December 31, 1993 the complex was 96% leased.\nDuring 1993, prior to the sale of its apartments to Pacific, Realty acquired the minority partnership interests in Applewood Village Partners and SAREFIM, partnerships which owned 406 and 504 units, respectively, from the minority partners. The partnership interests were acquired in consideration for cash, the cancellation of certain receivables from the minority partners and the assumption of the minority partners' share of the excess of partnership liabilities over assets.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nINDUSTRIAL\nBALDWIN INDUSTRIAL PARK\nRealty is a 50% limited partner in a partnership formed to develop an industrial park on a 45-acre parcel of land in Baldwin Park, California. The land is leased from one of the partners for a period of 55 years. The industrial park is comprised of a total of approximately 622,000 square feet of office and industrial space in a complex of buildings ranging in size from 25,000 to 65,000 square feet. The park is currently 90% leased to tenants which include Gerber's Foods, Federal Express and Home Savings of America (\"Home\"). Home, the current lessee of a ten-acre parcel in the industrial park and of a 55,656 square foot building in the industrial park, has options to purchase both the ten-acre parcel and the building and land underlying the building under the terms of its leases. Home has exercised its options under both agreements.\nUnder the partnership agreement, Realty is entitled to receive 80% of the cash flow from the partnership in order to provide Realty with a cumulative return of 12% per annum on its invested capital. To the extent there is sufficient cash flow for Realty to receive its 12% cumulative return, the remaining partners are entitled to 80% of the excess cash flow to provide them with a cumulative annual return equal to that received by Realty. Additional cash flow is to be divided equally between Realty and the remaining partners.\nThe partnership exercised an option to buy the land underlying the Home parcel in 1991 and has the option to acquire the remaining parcels in 1994. If the partnership does not exercise any portion of its option to acquire the land, Realty then has the right to exercise that portion of the option under the same terms as the partnership. In addition to the above-mentioned partnership option, Realty has an option to purchase the partnership interests of the other partners in 1994 at the fair market value of the interests in 1994.\nSubsequent to year-end, Realty agreed to sell its interest in the partnership and assigned its option to purchase the partnership interest of the other partners to Pacific. (See Item 1. \"Business - Realty-Pacific Gulf Properties Inc.\" and \"Notes to Financial Statements - Note 2 - Disposition of Multifamily and Industrial Operations Subsequent to Year End\"). Pacific has exercised this option to purchase the partnership interest of the other partners.\nSEATTLE INDUSTRIAL BUILDINGS\nDuring 1993, prior to the sale of its industrial properties to Pacific, Realty acquired the minority partnership interest in SARESAM Ventures, a partnership which owned 185,000 square feet of industrial buildings located in the Seattle, Washington area. The partnership interest was acquired in consideration for the cancellation of certain receivables from the minority partners and the assumption of the minority partners' share of the excess of partnership liabilities over assets.\nMANAGEMENT OF PROPERTIES\nRealty manages its shopping centers (other than the regional malls) and office buildings directly. Based on a normal property management fee charged by outside managers, Realty believes it realizes an economic benefit as well as the benefits of direct control by managing the properties directly.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nCOMPETITIVE AND OTHER CONDITIONS\nThe industrial buildings, regional shopping malls, shopping centers and office buildings owned by Realty encounter significant competition from similar or larger industrial buildings, regional shopping malls, shopping centers and office buildings developed and owned by other companies.\nRealty's income from its real estate assets is also affected by general economic conditions. The current recession has adversely affected vacancy rates in office buildings and industrial parks generally. The current recession and other competitive conditions have also affected the rent payable by LATC (see Item 1. \"Business -- Operating Company -- Competitive and Other Conditions\"). Continuation of the recession could adversely impact vacancy rates, the nature of Realty's tenants, the rents Realty is able to obtain from its tenants and its financial results.\nSome of Realty's properties are located in Southern California, which is an area prone to earthquakes. To date, none of Realty's projects have sustained any significant damage as a result of earthquakes. However, there can be no assurance that any potential earthquakes will not damage Realty's properties or negatively impact the financial position or results of Realty.\nEMPLOYEES\nAt December 31, 1993, Realty employed 58 persons on a full-time basis. In connection with the sale to Pacific, the executive officers, various managers and most other employees of Realty resigned and became officers and employees of Pacific on February 18, 1994. Realty has entered into a one-year management agreement with Pacific to assure an orderly transaction, and, as of March 16, 1994, appointed a new Chief Executive Officer (see Item 4a. \"Executive Officers of Realty and Operating Company\"). Realty believes that relations with its employees are satisfactory.\nItem 1. Business (continued)\nSEASONAL VARIATIONS IN BUSINESS\nRealty is subject to significant seasonal variation in revenues due primarily to the seasonality of thoroughbred horse racing. The following table presents unaudited quarterly results of operations for Realty during 1993 and 1992:\nITEM 1. BUSINESS (CONTINUED) - ----------------\nOperating Company\nSanta Anita Operating Company (\"Operating Company\") is organized under the laws of the State of Delaware. Operating Company's principal executive offices are located at Santa Anita Racetrack, 285 West Huntington Drive, Post Office Box 60014, Arcadia, California 91066-6014.\nOperating Company is engaged in thoroughbred horse racing. The thoroughbred horse racing operation is conducted by a subsidiary of Operating Company, Los Angeles Turf Club, Incorporated (\"LATC\"), which leases Santa Anita Racetrack from Realty. The lease expires in December 1994 when its terms will be renegotiated (see Item 1. \"Business -- Realty -- Santa Anita Racetrack\").\nSANTA ANITA RACETRACK\nLATC conducts an annual 17-week thoroughbred horse racing meet which commences immediately after Christmas and continues through mid-April. LATC conducts one of the largest thoroughbred racing meets in the United States in terms of both average daily attendance and average daily pari-mutuel wagering.\nLATC leases the racetrack from Realty for the full year under a master lease for a fee of 1.5% of the total live on-track wagering at Santa Anita Racetrack, which includes the Oak Tree meet. In addition, LATC pays to Realty 40% of its revenues from satellite wagering (not to exceed 1.5% of such wagering) and the simulcasting of races originating from Santa Anita Racetrack after mandated payments to the State, to horse owners and to breeders. When LATC operates as a satellite for Hollywood Park Racetrack (\"Hollywood Park\") and Del Mar Racetrack (\"Del Mar\"), LATC does not pay any additional rent to Realty. LATC has sublet the racetrack to Oak Tree to conduct its annual thoroughbred horse racing meet (31 days in 1993), which commences in late September or early October. Oak Tree races five weeks in even-numbered years and six weeks in odd- numbered years.\nUnder a sublease which expires in 2000, Oak Tree makes annual rental payments to LATC equal to 1.5% of the total live on-track pari-mutuel wagering from its racing meet and 25% of its satellite and simulcast revenues after mandated payments to the State, to horse owners and to breeders. LATC pays to Realty 40% of all satellite and simulcast revenues received from Oak Tree. Because the rental received from Oak Tree's on-track pari-mutuel wagering is identical to the rental paid to Realty, LATC does not reflect these amounts in its financial statements. In addition, Oak Tree reimburses LATC an amount equal to 0.8% of its on-track pari-mutuel wagering for certain expenses of operating Santa Anita Racetrack on behalf of Oak Tree. LATC also receives supplemental rent representing Oak Tree's adjusted profits above an agreed-upon level and will rebate rent to Oak Tree if Oak Tree's adjusted profits fall below such level (see Item 1. \"Business -- Operating Company -- Santa Anita Racetrack -- Pari-Mutuel Wagering\").\nThe number of racing days at the Santa Anita meet declined from 90 in 1989 to 83 in 1993. Total pari-mutuel wagering on the Santa Anita meet decreased from $654.1 million in 1989 to $613.5 million in 1993. For all years prior to 1989, all of Santa Anita pari-mutuel wagering was conducted on-track. In 1989, $122.1 million of the total amount wagered was wagered at satellite locations with $532.0 million being wagered on-track. In 1993, $362.8 million of the total amount wagered was wagered at satellite locations with $250.7 million being wagered on-track.\nTotal attendance was 2.9 million in 1989, of which 621,000 was at satellite locations. By 1993, on-track attendance had declined to 1.2 million, down from 1.5 million in 1992. Although 1,332,126 and 1,576,763 patrons attended satellite locations during the Santa Anita meets in 1993 and 1992, respectively, LATC does not share in the revenues from admissions, parking and food and beverage sales at the satellite locations.\nItem 1. Business (continued) - ----------------------------\nThe following tables summarize key operating statistics for the 1989-1993 Santa Anita meets and the 1989-1993 Oak Tree meets, together with the attendance and wagering statistics relating to the transmission of the Del Mar and Hollywood Park signals to Santa Anita Racetrack.\n- ------------------\n(a) Total handle or total attendance divided by the number of race days will produce a different average daily result due to the fact that satellite locations may not have operated from the beginning of the Santa Anita meet, therefore, average daily attendance and wagering is calculated based upon the number of days each satellite location is open. (b) Includes simulcast wagering on races originating at other racetracks. (c) Satellite wagering expanded to include Hollywood Park and Los Alamitos effective with the 1991 Oak Tree meet. (d) Interstate wagering (common pooling) began in October 1990. (e) Oak Tree races five weeks in even-numbered years and six weeks in odd- numbered years.\n- ------------------- (a) Began in November 1991.\nManagement anticipates that the general trend of increases in off-track wagering will continue and the decrease experienced in on-track attendance and on-track wagering will also continue albeit at a slower rate.\nDuring the last five years, 54% of the annual revenues of LATC resulted from pari-mutuel and other wagering commissions. The remaining revenues resulted from admissions, parking, food and beverage sales, sale of programs and interest and other income.\nThe following table sets forth certain unaudited financial information with respect to LATC:\nThe mix of revenues has changed significantly from 1989 to 1993 primarily as a result of the introduction of satellite wagering on races originating at Santa Anita Racetrack, operating as a satellite location for Del Mar and Hollywood Park, changes in average daily pari-mutuel wagering, selective price increases, the introduction of additional exotic wagering opportunities on which the retention amount is higher than on conventional wagering and a new lease with Oak Tree, all of which have largely offset declines in commissions from on- track wagering. In addition, LATC recognized $400,000 in 1990 and $1,000,000 in 1991 from the 1990 sale of the Canterbury Downs management consulting contract. Also, interest income has fluctuated as a function of cash balances available for investments and changing interest rates.\nLATC's total expenses decreased from $63.8 million in 1989 to $61.5 million in 1993. The majority of these expenses are pari-mutuel wagering or attendance- related, the result of operating as a satellite location for Del Mar and Hollywood Park and the aggregate effect of a new lease with Oak Tree. In 1991, costs and expenses included $1.1 million in earthquake damage. From 1991 to 1992, total costs and expenses increased by $2,064,000 primarily due to the fact that LATC operated as a satellite location for the first time for Hollywood Park's spring thoroughbred meet, the engagement of outside consultants in the amount of $660,000 to review the company's operations, and additional rent paid to Realty in the amount of $1,027,000. From 1992 to 1993, total costs and expenses decreased primarily due to fewer race days and lower on-track attendance and wagering.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nFor further information regarding operating results, see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Santa Anita Operating Company.\"\nPARI-MUTUEL WAGERING\nPari-mutuel means literally a mutual wager, or wagering by individuals against each other. The racetrack acts as the broker for the wagers made by the public and deducts a \"take-out\" or gross commission which is fixed by the State and shared with the State, the racetrack operator, the horse owners and breeders, and the municipality in which the racetrack is located. The racetrack operator has no interest in which horse wins a given race.\nAs a condition of the issuance of a racing license, California law requires that a certain number of racing days be conducted as charity days. The net proceeds from these charity days are distributed to beneficiaries through a nonprofit organization approved by the California Horse Racing Board (the \"Horse Racing Board\"). LATC is required to conduct five charity days.\nON-TRACK WAGERING\nThe State has vested administrative authority for racing and wagering at horse racing meets with the Horse Racing Board. The Horse Racing Board, which consists of seven members appointed by the governor of the State, is charged with the responsibility of regulating the form of wagering, the length and conduct of meets and the distribution of the pari-mutuel wagering within the limits set by the California legislature. The Horse Racing Board is also charged with the responsibility of licensing horse racing associations on an annual basis to conduct horse racing meets and of licensing directors, officers and persons employed by the associations to operate such meets.\nCalifornia law specifies the percentage distribution of pari-mutuel wagering with the percentage varying based upon the total wagering for the meet, breed of horse and type of wager. The following table sets forth the allocation of the total pari-mutuel wagering, on- and off-track, by percentage and dollar amount during the 1992-93 Santa Anita meet:\nITEM 1. BUSINESS (CONTINUED) - ----------------\nSATELLITE WAGERING - CALIFORNIA\nLATC and Oak Tree send televised racing signals to other southern California racetracks, wagering facilities on Indian reservation land in California and non-racing fair sites in central and southern California. Pari- mutuel wagering at a satellite facility is included in the pari-mutuel pools at the host racing associations. LATC's and Oak Tree's share of the satellite wagering was approximately 4.3% of the satellite pari-mutuel wagering on races originating at Santa Anita Racetrack.\nIn the fall of 1993, California law permitted LATC and Oak Tree to send and receive televised racing signals on races with purses exceeding $20,000 to and from northern California racetracks and nonracing fairs. In 1993, Bay Meadows, San Mateo, California became an additional satellite location during the Santa Anita meet. LATC's commission on the northern California satellite wagering was about 3.3%.\nLATC has been advised that other Indian tribes are planning satellite wagering facilities on reservation land in southern California. Any other facilities opened by an Indian tribe must obtain approval from the State and must enter into an agreement with the racing associations with respect to the pari-mutuel operations.\nDuring the Hollywood Park and Del Mar meets, LATC and other Southern California racing associations and fairs operate as satellite facilities. In addition to retaining 2% of the pari-mutuel wagering at Santa Anita Racetrack as its commission, LATC receives income from admissions, parking and food and beverage sales. In 1993, Santa Anita Racetrack operated 141 days as a satellite for Hollywood Park and Del Mar.\nSATELLITE WAGERING - INTERSTATE\nLegislation has been enacted in certain states permitting the transmission of pari-mutuel wagers across state lines. This format permits patrons wagering in those states on races held at Santa Anita Racetrack to participate in the same pari-mutuel pool payouts available to LATC's on-track patrons and Southern California satellite patrons. LATC currently participates in satellite wagering with numerous sites in Nevada, and additional locations in Alabama, Arizona, Colorado, Connecticut, Delaware, Florida, Idaho, Iowa, Kansas, Louisiana, Maryland, Massachusetts, Montana, Nebraska, New Hampshire, New Jersey, New York, North Dakota, Oregon, Pennsylvania, Rhode Island, Texas, Washington and West Virginia and receives a negotiated percentage of the pari-mutuel wagering at such sites.\nInterstate satellite wagering started in 1991 with total pari-mutuel wagering of $39,445,000 which increased to $95,411,000 for 1993. LATC's share of the commissions from interstate satellite wagering was $1,811,000 for 1993.\nSIMULCASTING\nIn 1993, LATC and Oak Tree transmitted their live racing signals (simulcast) to numerous locations in the United States, Mexico and Canada. LATC's share of the commissions for transmitting its racing signal, was $1,280,000 in 1993 and $1,416,000 in 1992. During the Oak Tree meet, LATC receives 25% of Oak Tree's share of simulcasting revenues. LATC is pursuing the opportunity to transmit its signal to other locations.\nCANTERBURY DOWNS\nIn 1984, LATC entered into a management consulting contract with Minnesota Racetrack, Inc. (\"MRI\"). MRI developed and owned a horse racing facility, Canterbury Downs, in the Minneapolis area of Minnesota, which opened in June 1985. In 1990, LATC sold its interest in the management consulting contract with Canterbury Downs and recognized $400,000 as income. In 1991, LATC recognized an additional $1,000,000 as income.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nCOMPETITIVE AND OTHER CONDITIONS\nThe southern California area offers a wide range of leisure time spectator activities, including professional and college teams which participate in all major sports. LATC and Oak Tree compete with such sporting events for their share of the leisure time market and with other numerous leisure time activities available to the community, some of which are broadcast on television.\nAs an outdoor activity, horse racing is more susceptible to inclement weather than some other leisure time activities. This is particularly true of the Santa Anita meet which is held during the winter. Prior to the 1992-1993 meet, LATC had never lost a race due to inclement weather. During the 1992-1993 meet, LATC lost two full days and two partial days of racing because of inclement weather. A local Arcadia ordinance presently limits live horse racing to daylight hours but allows the importation of a horse racing broadcast signal one evening per week.\nThe Horse Racing Board has annually licensed LATC and Oak Tree to conduct racing meets at Santa Anita Racetrack. At present, the Horse Racing Board has not licensed other thoroughbred racetracks in Southern California to conduct racing during these meets. Since 1972, however, night harness racing and night quarterhorse meets have been conducted at other racetracks in Southern California during portions of these meets. LATC and Oak Tree could be adversely affected by legislative or Horse Racing Board action which would increase the number of competitive racing days, reduce the number of racing days available to LATC and Oak Tree, or authorize other forms of wagering.\nThe California State Lottery Act of 1984, which provides for the establishment of a state-operated lottery, was implemented in 1985. In the opinion of management, the State lottery has had an adverse impact and will continue to have an adverse impact on total attendance and pari-mutuel wagering at Santa Anita Racetrack (see Item 1 \"Business -- Operating Company -- Santa Anita Racetrack\"). Although it is unaware of any empirical studies, management believes that the State lottery has had and will continue to have an adverse impact on many other businesses in the State of California.\nIn the future, legislation could be enacted to allow casino gaming or other forms of gaming which are competitive with pari-mutuel wagering at Santa Anita Park. Under federal law, certain types of gaming are lawful on Indian lands if conducted in conformance with a Tribal-State compact, which the applicable state must negotiate with an Indian tribe in good faith. Certain Indian tribes seeking to establish gaming in California have instituted litigation against the State of California to compel the State to permit them to do so. In 1993, one court held that California has a public policy prohibiting casino gaming and need not negotiate a compact with respect to casino gaming. However, the court also held that certain other forms of gaming were the proper subject of a compact. Other courts are not bound by that decision and may hold differently. If the Indian tribes are successful in establishing casino gaming or other forms of gaming in California, such gaming could have an adverse impact on LATC.\nDEPENDENCE ON LIMITED NUMBER OF CUSTOMERS\nNo material part of Operating Company's business is dependent upon a single customer or a few customers; therefore, the loss of any one customer would not have a materially adverse effect on the business of Operating Company.\nEMPLOYEE AND LABOR RELATIONS\nDuring the year ended December 31, 1993, LATC regularly employed approximately 1,600 employees. Substantially all are employed on a seasonal basis in connection with live thoroughbred horse racing or satellite meets at Santa Anita Racetrack. During the relatively short periods when live or satellite racing meets at Santa Anita Racetrack are not being conducted, LATC maintains a staff of approximately 260 employees, most of\nwhom are engaged in maintaining or improving the physical facilities at Santa Anita Racetrack or are engaged in preparing for the next live or satellite meet.\nAll of LATC's employees, except for approximately 70 full-time management and clerical employees, are covered by collective bargaining agreements with labor unions. A majority of the current labor agreements covering racetrack employees will expire in April 1995 after the Santa Anita meet.\nSEASONAL VARIATIONS IN BUSINESS\nOperating Company is also subject to significant seasonal variation. LATC conducts an annual meet commencing immediately after Christmas and continuing through mid-April. This seasonal variation is indicated by the following unaudited quarterly results of operations for Operating Company during 1993 and 1992:\nIn 1993, revenues and cost of sales from food and beverage operations have been reflected as a separate component in Operating Company's and Combined Realty and Operating Company's statement of operations. In prior years these operations were in horse racing revenues. All prior year and interim financial statements and disclosures for Operating Company and Combined Realty and Operating Company have been restated to reflect this reclassification.\nOperating Company has adopted an accounting practice whereby the revenues associated with thoroughbred horse racing at Santa Anita Racetrack are reported as they are earned. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those interim periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nINCOME TAX MATTERS\nIn the opinion of management, Realty has operated in a manner which has qualified it as a REIT under Sections 856 through 860 of the Code. Realty intends to continue to operate in a manner which will allow it to qualify as a REIT under the Code. Under these sections, a corporation that is principally engaged in the business of investing in real estate and that, in any taxable year, meets certain requirements that qualify it as a REIT generally is not subject to federal income tax on its taxable income and gains that it distributes to its shareholders. Income and gains that are not so distributed will be taxed to a REIT at regular corporate rates. In addition, a REIT is subject to certain taxes on net income from \"foreclosure property\" as defined in the Code, income from the sale of property held primarily for sale to customers in the ordinary course of business and excessive unqualified income.\nREIT REQUIREMENTS\nTo qualify for tax treatment as a REIT under the Code, Realty at a minimum must meet the following requirements:\n(1) At least 95% of Realty's gross income each taxable year (excluding gains from the sale of property other than foreclosure property held primarily for sale to customers in the ordinary course of its trade or business) must be derived from:\n(a) rents from real property;\n(b) gain from the sale or disposition of real property that is not held primarily for sale to customers in the ordinary course of business;\n(c) interest on obligations secured by mortgages on real property (with certain minor exceptions);\n(d) dividends or other distributions from, or gains from the sale of, shares of qualified REITs that are not held primarily for sale to customers in the ordinary course of business;\n(e) abatements and refunds of real property taxes;\n(f) income and gain derived from foreclosure property;\n(g) most types of commitment fees related to either real property or mortgage loans;\n(h) gains from sales or dispositions of real estate assets that are not \"prohibited transactions\" under the Code;\n(i) income attributable to stock or debt instruments acquired with the proceeds from the sale of stock or certain debt obligations (\"new capital\") of Realty received during a one-year period beginning on the day such proceeds were received (\"qualified temporary investment income\");\n(j) dividends;\n(k) interest on obligations other than those secured by mortgages on properties; and\n(l) gains from sales or dispositions of securities not held primarily for sale to customers in the ordinary course of business.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nIn addition, at least 75% of Realty's gross income each taxable year (excluding gains from the sale of property other than foreclosure property held primarily for sale to customers in the ordinary course of its trade or business) must be derived from items (a) through (i) above. For purposes of these requirements, the term \"rents from real property\" is defined in the Code to include charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated, and rent attributable to incidental personal property that is leased under, or in connection with, a lease of real property, provided that the rent attributable to such personal property for the taxable year does not exceed 15% of the total rent for the taxable year attributable to both the real and personal property leased under such lease. The term \"rents from real property\" is also defined to exclude: (i) any amount received or accrued with respect to real property, if the determination of such amount depends in whole or in part on the income or profits derived by any person from the property (except that any amount so received or accrued shall not be excluded from \"rents from real property\" solely by reason of being determined on the basis of a fixed percentage of receipts or sales); (ii) any amount received or accrued, directly or indirectly, from any person or corporation if ownership of a 10% or greater interest in the stock, assets or net profits of such person or corporation is attributed to Realty; (iii) any amount received or accrued from property that Realty manages or operates or for which Realty furnishes services to the tenants, which would constitute unrelated trade or business income if received by certain tax-exempt entities, either itself or through another person who is not an \"independent contractor\" (as defined in the Code) from whom Realty does not derive or receive income; and (iv) any amount received or accrued from property with respect to which Realty furnishes (whether or not through an independent contractor) services not customarily rendered to tenants in properties of a similar class in the geographic market in which the property is located.\nIf Realty should fail to satisfy the foregoing income tests but otherwise satisfies the requirements for taxation as a REIT and if such failure is held to be due to reasonable cause and not willful neglect and if certain other requirements are met, then Realty would continue to qualify as a REIT but would be subject to a 100% tax on the excessive unqualified income reduced by an approximation of the expenses incurred in earning that income.\n(2) Less than 30% of Realty's gross income during any taxable year can be derived from the sale or disposition of: (i) stock or securities held for less than one year; (ii) property held primarily for sale to customers in the ordinary course of business (other than foreclosure property); and (iii) real property (including interests in mortgages on each property) held for less than four years (other than foreclosure property and gains arising from involuntary conversions).\n(3) At the end of each calendar quarter, at least 75% of the value of Realty's total assets must consist of real estate assets (real property, interests in real property, interests in mortgages on real property, shares in qualified real estate investment trusts and stock or debt instruments attributable to the temporary investment of new capital), cash and cash items (including receivables) and government securities. With respect to securities that are not included in the 75% asset class, Realty may not at the end of any calendar quarter own either (i) securities representing more than 10% of the outstanding voting securities of any one issuer or (ii) securities of any one issuer having a value that is more than 5% of the value of Realty's total assets. Realty's share of income earned or assets held by a partnership in which Realty is a partner will be characterized by Realty in the same manner as they are characterized by the partnership for purposes of the assets and income requirements described in this paragraph (3) and in paragraphs (1) and (2) above.\n(4) The shares of Realty must be \"transferable\" and beneficial ownership of them must be held by 100 or more persons during at least 335 days of each taxable year (or a proportionate part of a short taxable year). More than 50% of the outstanding stock may not be owned, directly or indirectly, actually or constructively, by or for five or fewer \"individuals\" at any time during the last half of any taxable year. For the purpose of such determination, shares owned directly or indirectly by or for a\nITEM 1. BUSINESS (CONTINUED) - ----------------\ncorporation, partnership, estate or trust are considered as being owned proportionately by its shareholders, partners or beneficiaries; an individual is considered as owning shares directly or indirectly owned by or for members of his family; and the holder of an option to acquire shares is considered as owning such shares. In addition, because of the lessor- lessee relationship between Realty and LATC, no person may own, actually or constructively, 10% or more of the outstanding voting power or total number of shares of stock of the two companies. The bylaws of Operating Company and Realty preclude any transfer of shares which would cause the ownership of shares not to be in conformity with the above requirements. Each year Realty must demand written statements from the record holders of designated percentages of its shares disclosing the actual owners of the shares and must maintain, within the Internal Revenue District in which it is required to file its federal income tax return, permanent records showing the information it has thus received as to the actual ownership of such shares and a list of those persons failing or refusing to comply with such demand.\n(5) Realty must distribute to its shareholders dividends in an amount at least equal to the sum of 95% of its \"real estate investment trust taxable income\" before deduction of dividends paid (i.e., taxable income less any net capital gain and less any net income from foreclosure property or from property held primarily for sale to customers, and subject to certain other adjustments provided in the Code); plus (i) 95% of the excess of the net income from foreclosure property over the tax imposed on such income by the Code; less (ii) a portion of certain noncash items of Realty that are required to be included in income, such as the amounts includable in gross income under Section 467 of the Code (relating to certain payments for use of property or services). The distribution requirement is reduced by the amount by which the sum of such noncash items exceeds 5% of real estate investment trust taxable income. Such undistributed amount remains subject to tax at the tax rate then otherwise applicable to corporate taxpayers. During 1993, Realty has, or will be deemed to have, distributed at least 95% of its real estate investment trust taxable income as adjusted.\nFor this purpose, certain dividends paid by Realty after the close of the taxable year may be considered as having been paid during the taxable year. However, if Realty does not actually distribute each year at least the sum of (i) 85% of its real estate investment taxable income, (ii) 95% of its capital gain net income and (iii) any undistributed taxable income from prior periods, then the amount by which such sums exceed the actual distributions during the taxable year will be subject to a 4% excise tax.\nIf a determination (by a court or by the Internal Revenue Service) requires an adjustment to Realty's taxable income that results in a failure to meet the percentage distribution requirements (e.g., a determination that increases the amount of Realty's real estate investment taxable income), Realty may, by following the \"deficiency dividend\" procedure of the Code, cure the failure to meet the annual percentage distribution requirement by distributing a dividend within 90 days after the determination, even though this deficiency dividend is not distributed to the shareholders in the same taxable year as that in which income was earned. Realty will, however, be liable for interest based on the amount of the deficiency dividend.\n(6) The directors of Realty must have authority over the management of Realty, the conduct of its affairs and, with certain limitations, the management and disposition of Realty's property.\n(7) Realty must have the calendar year as its annual accounting period.\n(8) Realty must satisfy certain procedural requirements.\nTAXATION OF REALTY AS A REIT\nIn any year in which Realty qualifies under the requirements summarized above, it generally will not be taxed on that portion of its ordinary income or net capital gain that is distributed to shareholders, other than net income from foreclosure property, excess unqualified income and gains from property held primarily for sale.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nRealty will be taxed at applicable corporate rates on any undistributed taxable income or net capital gain and will not be entitled to carry back any net operating losses. It also will be taxed at the highest rate of tax applicable to corporations on any net income from foreclosure property and, subject to the safe harbor described below, at the rate of 100% on any income derived from the sale or other disposition of property, other than foreclosure property, held primarily for sale. In computing its net operating losses and the income subject to these latter taxes, Realty will not be allowed a deduction for dividends paid or received.\nAlthough Realty will also be subject to a 100% tax on the gain derived from the sale of property (other than foreclosure property) held primarily for sale, a safe harbor is provided such that gains from the sale of real property are excluded from this 100% tax for a given year if each of the following conditions is satisfied:\n(a) the property has been held by Realty for at least four years;\n(b) total capital expenditures with respect to the property during the four-year period preceding the date of sale do not exceed 30% of the net selling price of the property;\n(c) either (i) Realty does not make more than seven sales of properties (other than foreclosure property) during the taxable year or (ii) the aggregate adjusted bases (as determined for purposes of computing earnings and profits) of property (other than foreclosure property) sold by Realty during the taxable year do not exceed 10% of the aggregate adjusted bases (as so determined) of all of the assets of Realty as of the beginning of the taxable year;\n(d) if the property has not been acquired through foreclosure or lease termination, the property has been held by Realty for the production of rental income for at least four years; and\n(e) if the requirement of paragraph (c)(i) is not satisfied, substantially all of the marketing and development expenditures with respect to the sold properties were made through independent contractors from whom Realty does not derive or receive any income.\nTERMINATION OR REVOCATION OF REIT STATUS\nIf, in any taxable year after it has filed an election with the Internal Revenue Service to be treated as a REIT, Realty fails to so qualify, Realty's election will be terminated, and Realty will not be permitted to file a new election to obtain such tax treatment until the fifth taxable year following the termination. However, if Realty's failure to qualify was due to reasonable cause and not due to willful neglect and if certain other requirements are met, Realty would be permitted to file a new election to be treated as a REIT for the year following the termination. If Realty voluntarily revokes its election for any year, it will not be eligible to file a new election until the fifth taxable year following such revocation.\nIf Realty fails to qualify for taxation as a REIT in any taxable year and the above relief provisions do not apply, then Realty would be subject to tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Distributions to shareholders of Realty with respect to any year in which Realty failed to qualify would not be deductible by Realty nor would they be required to be made. In such event, distributions to shareholders, to the extent out of current or accumulated earnings and profits, would be taxed as ordinary income and subject to certain limitations of the Code, eligible for the dividends-received deduction for corporations (see \"Taxation of Realty's Shareholders\"). Failure to qualify could result in Realty incurring substantial indebtedness (to the extent borrowings are feasible) or disposing of substantial investments, in order to pay the resulting taxes or, in the discretion of Realty, to maintain the level of Realty's distributions to its shareholders.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nTAXATION OF REALTY'S SHAREHOLDERS\nSo long as Realty qualifies for taxation as a REIT, distributions made to its shareholders out of current or accumulated earnings and profits (or deemed to be from current or accumulated earnings or profits), other than capital gain dividends (discussed below), will be dividends taxable as ordinary income. Distributions to shareholders of a REIT are not eligible for the dividends- received deduction for a corporation. Dividends to shareholders that are properly designated by Realty as capital gain dividends generally will be treated as long-term capital gain (to the extent they do not exceed Realty's actual net capital gain for the taxable year) regardless of how long a shareholder has owned his or her shares. However, corporate shareholders may be required to treat up to 20% of certain capital gain dividends as ordinary income. In general, any gain or loss realized upon a taxable disposition of shares will be treated as long-term capital gain or loss if the shares have been held for more than twelve months and otherwise as short-term capital gain or loss. However, if a shareholder receives a long-term capital gain dividend and such shareholder has held his or her stock for six months or less, any loss realized on the subsequent sale of the shares will, to the extent of the gain, be treated as long-term capital loss. Certain constructive ownership rules apply to determine the holding period.\nIn the event that Realty distributes cash generated by its activities which exceeds its net earnings, and provided there are no undistributed current or accumulated earnings and profits and the distribution does not qualify as a \"deficiency dividend,\" such distributions will constitute a return of capital to the extent they do not exceed a shareholder's tax basis for the shareholder's shares and will be tax free to the shareholder. In such event, the tax basis of the shares held by each shareholder must be reduced correspondingly by the amount of such distributions. If such distributions exceed the tax basis of the shares of a shareholder, the shareholder will recognize capital gain in an amount equal to such excess, provided the shareholder holds the shares as a capital asset. Shareholders may not include on their own returns any of Realty's ordinary or capital losses. Realty will notify each shareholder after the close of its taxable year as to the portions of the distributions that constitute ordinary income, return of capital and capital gain. For this purpose, any dividends declared in October, November or December of a year, which are payable to shareholders of record on any day of such a month, shall be treated as if they had been paid and received on December 31 of such year, provided such dividends are actually paid in January of the following year. Shareholders are required to include on their own returns any ordinary dividends in the taxable year in which such dividends are received.\nIf in any taxable year Realty does not qualify as a REIT, it will be taxed as a corporation, and distributions to its shareholders will neither be required to be made nor will they be deductible by Realty in computing its taxable income, with the result that the assets of Realty and the amounts available for distribution to shareholders would be reduced to the extent of any tax payable. Disqualification as a REIT could occur even though Realty had previously distributed to its shareholders all of its income for such year, or years, in which it did not qualify as a REIT. In such circumstances, distributions, to the extent made out of Realty's current or accumulated earnings and profits, would be taxable to the shareholders as dividends, but, subject to certain limitations of the Code, would be eligible for the dividends-received deduction for corporations.\nTAX-EXEMPT INVESTORS\nThe Internal Revenue Service has ruled that amounts distributed by a REIT to a tax-exempt employee's pension trust do not constitute ''unrelated trade or business income\" and should therefore be nontaxable to such trust. This ruling does not apply to the extent the tax-exempt investor has borrowed to acquire shares of the REIT's stock. Moreover, the application of this ruling is subject to additional limitations that are beyond the scope of this disclosure.\nITEM 1. BUSINESS (CONTINUED) - ----------------\nSTATE AND TERRITORIAL TAXES\nThe state or territorial income tax treatment of Realty and its shareholders may not conform to the federal income tax treatment above. As a result, prospective shareholders should consult their own tax advisors for an explanation of the effect of state and territorial tax laws on their investment in Realty.\nFOREIGN INVESTORS\nThe preceding discussion does not address the federal income tax consequences to foreign investors of an investment in Realty. Foreign investors should consult their own tax advisors concerning the federal income tax considerations to them of the ownership of shares in Realty.\nBACKUP WITHHOLDING\nThe Code imposes a modified form of \"backup withholding\" for payments of interest and dividends. This withholding applies only if a shareholder, among other things: (i) fails to furnish Realty with a properly certified taxpayer identification number; (ii) furnishes Realty with an incorrect taxpayer identification number; (iii) fails to report properly interest or dividends from any source or; (iv) under certain circumstances, fails to provide Realty or his or her securities broker with a certified statement, under penalty of perjury, that he or she is not subject to backup withholding. The backup withholding rate is 31% of \"reportable payments\" which include dividends. Shareholders should consult their tax advisors as to the procedure for ensuring that Realty distributions to them will not be subject to backup withholding.\nTAXATION OF OPERATING COMPANY\nOperating Company pays ordinary corporate income taxes on its taxable income. Any income, net of taxes, will be available for retention in Operating Company's business or for distribution to shareholders as dividends. Any dividends distributed by Operating Company will be subject to tax at ordinary rates and generally will be eligible for the dividends received deduction for corporate shareholders to the extent of Operating Company's current or accumulated earnings and profits. Distributions in excess of current or accumulated earnings and profits are treated first, as a return of investment and then, to the extent that such distribution excludes a shareholder's investment, as gain from the sale or exchange of such shares. However, there is no tax provision which requires Operating Company to distribute any of its after-tax earnings and Operating Company does not expect to pay cash dividends in the foreseeable future.\nFUTURE LEGISLATION\nIt should be noted that future legislation could be enacted or regulations promulgated, the nature and likelihood of which cannot be predicted, that might change in whole or in part, the income tax consequences summarized herein and reduce or eliminate the advantages which may be derived from the ownership of paired common stock.\nThe foregoing is a summary of some of the more significant provisions of the Code as it relates to REITs and is qualified in its entirety by reference to the Code and regulations promulgated thereunder.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nInformation concerning property owned by Realty and Operating Company may be found under Item 1. \"Business.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -------------------------\nCertain claims, suits and complaints arising in the ordinary course of business have been filed or were pending against Realty and\/or Operating Company and its subsidiaries at December 31, 1993. In the opinion of the managements of Realty and Operating Company, all such matters are adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts, as would not have a significant effect on the financial position or results of operations of Realty and Operating Company if disposed of unfavorably.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -----------------------------------------------------------\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF REALTY AND OPERATING COMPANY - -----------------------------------------------------------\n(a) The names, ages and business experience of Realty's executive officers during the past five years are set forth below:\nEach executive officer of Realty is appointed by the Board of Directors annually and holds office until his successor is duly appointed.\n(b) The names, ages and business experience of Operating Company's executive officers during the past five years are set forth below:\nEach executive officer of Operating Company is appointed by the Board of Directors annually and holds office until a successor is duly appointed.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED SHAREHOLDER - -------------------------------------------------------------------------- MATTERS - -------\nThe paired Common Stock of Realty and Operating Company is traded on the New York Stock Exchange as Santa Anita Realty Enterprises under the symbol SAR. The following table sets forth the high and low closing prices for the paired Common Stock on the New York Stock Exchange Composite Tape and the cash dividends declared by Realty for the periods indicated. Operating Company has not declared cash dividends.\n- ---------- (a) $.56 of the dividends paid per share during 1992 represented a return of capital. (b) $.56 of the dividends paid per share during 1993 represented a return of capital.\nA regular quarterly dividend of $.34 per share is payable on April 8, 1994 to shareholders of record on March 8, 1994. The closing price of the paired Common Stock on the New York Stock Exchange Composite Tape on March 8, 1994 was $17- 5\/8 per share. As of March 8, 1994, there were approximately 22,000 holders of the paired Common Stock, including the beneficial owners of shares held in nominee accounts.\nRealty intends to pay regular quarterly dividends based upon a percentage of management's estimate of funds from operations for the entire year and, if necessary, to pay special dividends after the close of the year to effect distribution of at least 95% of its taxable income (other than net capital gains) (see item 1. \"Business -- Income Tax Matters -- REIT Requirements\").\nIn order to retain earnings to finance its capital improvement program and for the growth of its business, Operating Company has not paid cash dividends since its formation and does not expect to pay cash dividends in the foreseeable future.\nITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED SHAREHOLDER - -------------------------------------------------------------------------- MATTERS (CONTINUED) - -------\nThe statement on the face of this annual report on Form 10-K regarding the aggregate market value of paired voting stock of Realty and Operating Company held by nonaffiliates is based on the assumption that all directors and officers of Realty and Operating Company were, for purposes of this calculation only (and not for any other purpose), affiliates of Realty or Operating Company.\nITEM 6.","section_6":"Item 6. \"Selected Financial Data - Operating Company\").\nRental revenues from other real estate investments for the year ended December 31, 1993 were $38,953,000, an increase of 10.4% from those reported in 1992 of $35,290,000. The 1993 increases are due primarily to additional revenues from a new multifamily property acquisition in 1993 and the full year inclusion of several multifamily properties acquired in 1992.\nInterest and other income increased 115.3% to $4,991,000 for the year ended December 31, 1993 from $2,318,000 reported for 1992. The increase is primarily attributable to $3,211,000 of interest income in 1993 on a tax settlement from the California Franchise Tax Board. The settlement was for tax years prior to 1980 related to Realty's predecessor. In addition to the interest earned on the settlement, Realty recorded a $2,523,000 income tax benefit.\nCosts and expenses of $55,482,000 for the year ended December 31, 1993 increased 38.4% from those reported for 1992 of $40,080,000. The increase is primarily due to the loss on the disposition of the multifamily and industrial operations to Pacific and increases in depreciation and rental property operating expenses associated with the acquisitions of real estate projects noted above.\nIn June 1993, Realty's Board of Directors approved management's recommendation to recapitalize certain assets of Realty. Pursuant to this recapitalization, in November 1993, Realty entered into a Purchase and Sale Agreement to sell its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), in conjunction with its proposed public offering of common stock. The transaction was scheduled to be completed in two parts: (1) Realty would sell all of its apartments and industrial properties to Pacific with the exception of Realty's interest in the Baldwin Industrial Park joint venture; and (2) Pacific would enter into a binding agreement to buy Realty's interest in Baldwin Industrial Park.\nOn February 18, 1994, Realty completed the first part of this transaction by selling to Pacific ten multifamily properties, containing 2,654 apartment units, located in Southern California, the Pacific Northwest, and Texas and three industrial properties, containing an aggregate of 185,000 leasable square feet of industrial\nITEM 7.","section_7":"ITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ----------------------------------------------------------------------- RESULTS OF OPERATIONS (continued) ---------------------\nspace, located in the State of Washington (the \"Transferred Properties\"). Realty's corporate headquarters building and related assets were also acquired by Pacific. The sale of the Transferred Properties followed the public offerings of common stock and convertible subordinated debentures by Pacific.\nPursuant to the Purchase and Sale Agreement, Pacific agreed to buy Realty's interest in Baldwin Industrial Park subject to satisfaction of certain conditions, for a minimum price of $8.9 million payable in additional shares of Pacific common stock with the final price dependent upon completion of negotiations with other owners of Baldwin Industrial Park and an appraisal process. Management believes the sale of Realty's interest in Baldwin Industrial Park will be completed in the second half of 1994. Pacific is required to issue to Realty non-refundable letters of credit totaling up to $2.5 million by March 31, 1994 to secure its obligation to acquire Realty's interest in Baldwin Industrial Park and pay for the corporate headquarters building and other assets related to the Transferred Properties.\nIn consideration of the sale of the Transferred Properties, Realty received approximately $44.4 million in cash and 149,900 shares of the common stock of Pacific. In addition, Realty was relieved of approximately $44.3 million of mortgage debt on the Transferred Properties. Realty will also receive, at the time the acquisition of Baldwin Industrial Park is completed, up to $1.2 million in additional common stock of Pacific as consideration for its corporate headquarters and other net assets related to the Transferred Properties.\nThe two parts of the above transaction will result in a loss of $10,974,000. This loss has been reflected in the Realty and Realty and Operating Company combined statements of operations for the year ended December 31, 1993. If the Baldwin Industrial Park portion of the transaction described above does not occur, an additional loss of approximately $5,900,000 will be recognized by Realty in 1994. (See \"Notes to Financial Statements - Note 2 - Disposition of Multifamily and Industrial Properties Subsequent to Year End.\")\nIn connection with the sale, the executive officers, various managers and most other employees of Realty resigned and became officers and employees of Pacific on February 18, 1994.\nRealty and Pacific have also entered into a one-year management agreement whereby Pacific has agreed to provide management services to Realty. Finally, with respect to the common stock of Pacific owned by Realty, Pacific has entered into a registration rights agreement with Realty which, under certain circumstances, allows Realty to require the registration of the Pacific stock it owns.\nNet income for the year ended December 31, 1993 was $2,619,000, a decrease of 74.4% compared with the $10,211,000 reported in 1992 due to the factors described above.\nRESULTS OF OPERATIONS -- 1992 COMPARED WITH 1991\nRealty's revenues were derived principally from the rental of real property. Total revenues for the year ended December 31, 1992 were $50,291,000 compared with $45,408,000 reported for the year ended December 31, 1991, a 10.8% increase.\nRental revenue from real estate properties amounted to $47,973,000 for the year ended December 31, 1992, up 12.4% from the year-earlier level of $42,699,000.\nIn 1992, the most significant source of rental revenue was the lease with Santa Anita Racetrack. Revenues for 1992 rose to $12,683,000, up 7.3% from $11,817,000 reported in 1991. The increase resulted from an increase in total wagering at Santa Anita Racetrack due to six additional racing days during 1992 and increases in out-of-state simulcast revenues.\nRental revenues from other real estate investments for 1992 increased to $35,290,000, up 14.3% from $30,882,000 in 1991. This increase was due primarily to additional revenues from new property\nITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ----------------------------------------------------------------------- RESULTS OF OPERATIONS (continued) ---------------------\nacquisitions, the receipt of previously reserved past due rents and increased revenues from Santa Anita Fashion Park.\nInterest and other income declined 14.4% to $2,318,000 in 1992 from $2,709,000 in 1991. The decrease is due to reduced funds held for investment and lower interest rates on funds held for investment, offset in part by the sale of a neighborhood shopping center in Phoenix, Arizona, net of a loss on a lease agreement, which generated a net gain of $646,000 (net of cost of $4,475,000). Realty reported a gain of $177,000 (net of cost of $223,000) in 1991 from the sale of a small land parcel in Southern California.\nCosts and expenses increased 12.2 percent to $40,080,000 in 1992, up from $35,709,000 in 1991. The increase is due primarily to higher levels of depreciation, interest and rental property operating expenses associated with the acquisition of 1,109 new apartment units, and the expensing in 1992 of $580,000 of nonrecurring charges for the engagement of consultants to review the operations of the Realty and to assist in preparing a long range strategic plan. Realty reported a loss of $1,446,000 from the Towson Town Center unconsolidated joint venture primarily due to depreciation (the project was under construction in the prior periods).\nNet income for the year ended December 31, 1992 increased 5.3% to $10,211,000 compared with income of $9,699,000 reported in 1991 due to the factors described above.\nLIQUIDITY AND CAPITAL RESOURCES\nRealty had liquidity available from a combination of short- and long- term sources. Short-term sources included cash of $7,633,000 at December 31, 1993.\nIn connection with the sale of properties to Pacific, Realty paid down its lines of credit by $44.4 million and transferred to Pacific $44.3 million of indebtedness associated with the multifamily and industrial properties. As of December 31, 1993, Realty was not in compliance with certain covenants contained in its credit agreements. The banks have waived such noncompliance through April 30, 1994 conditioned, among other things, on no additional borrowings under the credit agreements (at December 31, 1993, $78,361,000 loans and letters of credit were outstanding under these agreements). Realty is in the process of renegotiating these credit agreements. Management is of the opinion that Realty has sufficient liquidity from other sources to assure that its operations will not be adversely affected pending this renegotiation.\nRealty had approximately $13,591,000 of long-term receivables at December 31, 1993, with maturities ranging from 1994 to 2002. For the year ended December 31, 1993, long-term receivables earned interest income of $996,000.\nIn the opinion of management, as of December 31, 1993 Realty's real estate investments had a market value substantially in excess of the historical costs and indebtedness related to such real estate investments. Management believes that this provides significant additional borrowing capacity.\nIMPACT OF INFLATION\nRealty's management believes that, for the foreseeable future, revenues and income from Santa Anita Racetrack, Fashion Park and its other real estate should not be adversely affected in a material way by inflationary pressures. Leases at Fashion Park include clauses enabling Realty to participate in tenants' future increases and gross revenues. Tenant leases on many other properties include provisions which tie the lease payments to the Consumer Price Index or include step-up provisions.\nITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (continued) - ---------------------\nSANTA ANITA OPERATING COMPANY\nOperating Company is engaged in thoroughbred horse racing through its wholly owned subsidiary, Los Angeles Turf Club, Incorporated (\"LATC\") which leases the Santa Anita Racetrack (\"Santa Anita\") from Realty.\nThe following narrative discusses Operating Company's results of operations for the years ended December 31, 1993, 1992 and 1991 together with liquidity and capital resources as of December 31, 1993.\nRESULTS OF OPERATIONS -- 1993 COMPARED WITH 1992\nOperating Company derives its revenues from thoroughbred horse racing activities. Total revenues were $61,347,000 in 1993, down 9.3% from $67,654,000 in 1992. In 1993, live thoroughbred horse racing at Santa Anita Racetrack totaled 83 days compared with 94 days in 1992. Total and average daily on- track attendance at the live racing events in 1993 were down 20.4% and 9.8%, respectively, from 1992. Total wagering at the live racing events was down 10.6% while average daily wagering increased 1.2% in 1993 compared with 1992. On-track wagering and inter-track wagering declined 20.2% and 13.6%, respectively, while interstate wagering increased 43.8% in 1993 compared with 1992.\nIn addition to a weak California economy and the continued negative effect of inter-track wagering on the on-track attendance and wagering, management believes the declines in average daily attendance and wagering were the result of inclement weather (in excess of 41 inches of rain, three times normal) during much of the 1992-1993 race meet, which caused the cancellation of two full race days and two partial race days in January.\nAlso, Santa Anita Racetrack operated 42 days in 1993 and 43 days in 1992 as a satellite wagering facility for Del Mar and 99 days in 1993 and 101 days in 1992 as a satellite wagering facility for Hollywood Park. Total attendance and wagering as a satellite wagering facility were down 3.5% and 2.5%, respectively, in 1993 compared with 1992. Average daily attendance and wagering were down 1.4% and 0.4%, respectively, in 1993 compared with 1992.\nHorse racing revenues and direct operating costs declined in 1993 compared with 1992 due to fewer race days, lower attendance and lower wagering at both the live racing events and as a satellite wagering facility. Horse racing revenues in 1993 were $49,081,000 down 8.6% from $53,683,000 in 1992. Direct horse racing operating costs in 1993 were $40,981,000, down 9.1% from $45,089,000 in 1992.\nFood and beverage revenues and cost of sales were also lower in 1993 compared with 1992 due to the factors described above. As a percentage of sales, cost of sales increased to 29.2% in 1993 compared with 27.5% in 1992.\nGeneral and administrative expenses were $6,693,000 in 1993, down 19.9% from $8,361,000 in 1992 due to administrative staff reductions in 1993 and to the costs related to the engagement of outside consultants in the prior year to review the Operating Company's operations. Partially offsetting the declines in general and administrative expenses, however, was the one-time charge of $759,000 in 1993 for the post-retirement benefits payable as a result of the death of the former Chairman of the Board of Operating Company.\nInterest expense increased to $493,000 in 1993 from $194,000 in 1992 due to a higher level of debt at LATC.\nRental expense to Realty was $9,233,000 in 1993 compared with $10,955,000 in 1992. The decrease in rental expense of $1,722,000 reflects the decline in wagering.\nITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (continued) - ---------------------\nDue to the revenue and expense items previously discussed, Operating Company reported a net loss of $2,232,000 or $.20 per share in 1993 compared with a net loss of $2,896,000 or $.26 per share in 1992.\nRESULTS OF OPERATIONS -- 1992 COMPARED WITH 1991\nIn 1992, the expansion of intertrack wagering within Los Angeles and Orange Counties caused intertrack revenues to increase $7,657,000 while on-track revenues decreased $7,246,000. On-track attendance-related revenues declined as a result of a 24.0% drop in on-track attendance at the 1991-1992 Santa Anita race meet and a decline in on-track wagering of $147,248,000, or 31.3 percent at the same meet. The on-track attendance and wagering decreases were, in part, caused by the continuing economic recession in Southern California. These changes, combined with a decline in interest income of $1,842,000 as a result of declining interest rates, primarily account for the total decline of $899,000 in total revenues to $67,654,000 for the year ended December 31, 1992.\nThe decline in revenues from live racing events was partially offset by an increase in revenue by Santa Anita Racetrack operating as a satellite location, selected price increases and increased interstate simulcasting revenues. Santa Anita Racetrack operated as a satellite location for Hollywood Park for an additional 69 days in 1992.\nDirect operating costs related to horse racing operations were $45,089,000 in 1992, virtually equal with $45,093,000 reported in 1991, in spite of the fact Santa Anita Racetrack operated as a satellite location for Hollywood Park for an additional 69 days.\nGeneral and administrative expenses were $8,361,000 for 1992, an increase of $1,493,000 or 21.7 percent, compared with the $6,868,000 in 1991. The increase resulted primarily from the expanded satellite racing season at Santa Anita Racetrack and the engagement of outside consultants ($660,000) to review the company's operations, including cost efficiencies, and to identify opportunities to enhance revenue.\nDepreciation and amortization expenses were $2,732,000 for 1992, an increase of $98,000 or 3.7 percent, compared with $2,634,000 reported for 1991. These non-cash charges resulted from the ongoing capital improvement program at Santa Anita Racetrack.\nTotal rent paid to Realty was $10,955,000 for the year ended December 31, 1992, compared with $9,928,000 in 1991. The increase of $1,027,000 reflects increases in interstate simulcast revenues offset by decreases in the on-track and intertrack wagering.\nDue to the revenue and expense items previously discussed, Operating Company reported a net loss of $2,896,000 or $.26 per share in 1992 compared with net income of $259,000 or $.02 per share in 1991.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1993, Operating Company's sources of liquidity included cash and short-term investments of $14,388,000 and an unsecured line of credit with Realty of $10,000,000, of which approximately $3,500,000 was utilized in connection with a guarantee of a capital lease. Operating Company's ability to utilize Realty's line of credit is dependent upon Realty's liquidity and capital resources. As a result of Realty's noncompliance with certain covenants contained within its credit agreements, Realty is currently unable to borrow additional moneys under its lines of credit. Accordingly, borrowings by Realty under these agreements would not provide a source of liquidity for Operating Company. Realty is in the process of renegotiating its credit agreements. (See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Realty - Liquidity and Capital Resources\"). For the year ended December 31, 1993, short-term investments earned interest income of $326,000.\nITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (continued) - ---------------------\nThe cash balances and related interest income from short-term investments reflect seasonal variations associated with the Santa Anita meet. During the meet, large cash balances and short-term investments are maintained by LATC, including amounts to be disbursed, for payment of license fees payable to the state, purses payable to horse owners and uncashed winning pari-mutuel tickets payable to the public.\nIMPACT OF INFLATION\nLATC's expenses are heavily labor-intensive with labor rates being covered by negotiated contracts with labor unions. Labor contracts with the pari- mutuel, service and operational employees were successfully renegotiated in April 1992. These new contracts expire in 1995. Management continues to address cost containment and labor productivity in all areas.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nSee Index to Financial Statements for a listing of the financial statements and supplementary data filed with this report.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - -------------------------------------------------------------\nNot applicable.\nPART III\nPursuant to General Instruction G(3) to Form 10-K, the information called for by this part of Form 10-K is incorporated herein by reference to the registrants' definitive joint proxy statement to be filed, pursuant to Regulation 14A, with the Securities and Exchange Commission not later than 120 days after the end of the year ended December 31, 1993.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------\n(a) The following documents are filed as part of this report:\n1. Financial Statements See Index to Financial Statements\n2. Financial Statement Schedules See Index to Financial Statement Schedules\n3. Exhibits See Exhibit Index\n(b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of the fiscal year ended December 31, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Realty and Operating Company have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.\nSANTA ANITA REALTY ENTERPRISES, INC. SANTA ANITA OPERATING COMPANY\nBy: \/s\/ SHERWOOD C. CHILLINGWORTH By: \/s\/ STEPHEN F. KELLER ----------------------------- ---------------------------- Sherwood C. Chillingworth Stephen F. Keller Vice Chairman of the Board and Chairman of the Board, President Chief Executive Officer and Chief Executive Officer (Principal Executive Officer) (Principal Executive Officer)\nMarch 29, 1994 March 29, 1994 ---------------------------- ---------------------------- Date Date\nBy: \/s\/ GLENNON E. KING \/s\/ RICHARD D. BRUMBAUGH ---------------------------- ---------------------------- Glennon E. King Richard D. Brumbaugh Acting Chief Financial Officer Vice President-Finance (Principal Financial and (Principal Financial and Accounting Officer) Accounting Officer)\nMarch 29, 1994 March 29, 1994 ---------------------------- ----------------------------- Date Date\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrants and in the capacity and on the date indicated.\nDate: March 29, 1994 ---------------\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nThe schedules listed below relate to Realty and Operating Company as indicated:\nSchedules not listed above have been omitted because either the conditions under which they are required are absent, not applicable, or the required information is included in the financial statements and related notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Board of Directors Santa Anita Realty Enterprises, Inc. and Santa Anita Operating Company\nWe have audited the financial statements and the related financial statement schedules, listed on pages 42 and 43 of:\n(a) Santa Anita Realty Enterprises, Inc.;\n(b) Santa Anita Operating Company and Subsidiaries; and\n(c) Santa Anita Realty Enterprises, Inc. and Santa Anita Operating Company and Subsidiaries Combined.\nThese financial statements and financial statement schedules are the responsibility of the companies' management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the above-listed entities at December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Further, it is our opinion that the financial statement schedules referred to above present fairly, in all material respects, the information set forth therein.\nKENNETH LEVENTHAL & COMPANY\nNewport Beach, California March 1, 1994\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1993 AND 1992\nASSETS\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1993 AND 1992\nASSETS\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31 ,1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCOMBINED BALANCE SHEETS\nDECEMBER 31, 1993 AND 1992\nASSETS\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCOMBINED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCOMBINED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCOMBINED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31 , 1993, 1992 AND 1991\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nSanta Anita Realty Enterprises, Inc. (\"Realty\") and Santa Anita Operating Company and Subsidiaries (\"Operating Company\") are two separate companies, the stock of which trades as a single unit under a stock-pairing arrangement on the New York Stock Exchange. Realty and Operating Company were each incorporated in 1979 and are the successors of a corporation originally organized in 1934 to conduct thoroughbred horse racing in Southern California.\nRealty is principally engaged in holding and investing in retail, commercial, industrial and multifamily real property located primarily in the western United States. Subsequent to year-end Realty disposed of its multifamily and industrial properties (Note 2). Realty operates as a real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986 and, accordingly, pays no income taxes on earnings distributed to shareholders.\nOperating Company is engaged in thoroughbred horse racing. The thoroughbred horse racing operation is conducted by a subsidiary of Operating Company, Los Angeles Turf Club, Incorporated (\"LATC\"), which leases the Santa Anita Racetrack from Realty.\nSeparate and combined financial statements have been presented for Realty and Operating Company. Realty and Combined Realty and Operating Company use an unclassified balance sheet presentation.\nThe separate results of operations and the separate net income per share of Realty and Operating Company cannot usually be added together to total the combined results of operations and net income per share because of adjustments and eliminations arising from inter-entity transactions. All significant intercompany and inter-entity balances and transactions have been eliminated in consolidation and combination.\nREAL ESTATE ASSETS\nInvestment properties are carried at cost and consist of land, buildings, and related improvements. Depreciation is provided on a straight-line basis over the estimated useful lives of the properties, ranging primarily from 15 to 40 years.\nINVESTMENTS IN JOINT VENTURES\nAll joint ventures in which Realty exercises significant control and has a 50% or greater ownership interest are consolidated. The ownership interests of outside partners in Realty's consolidated joint ventures are reflected as minority interest (excess of liabilities over assets) on the balance sheets for Realty and Combined Realty and Operating Company.\nInvestments in unconsolidated joint ventures are accounted for using the equity method of accounting.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nCASH AND CASH EQUIVALENTS\nHighly liquid short-term investments, with maturities of three months or less, at the date of acquisition, are considered cash equivalents.\nPROPERTY, PLANT AND EQUIPMENT\nDepreciation of property, plant and equipment and the capital lease obligation is provided primarily on the straight-line method generally over the following estimated useful lives:\nBuilding and improvements 25 to 45 years Machinery and other equipment 5 to 15 years Leasehold improvements 5 to 32 years\nExpenditures which materially increase property lives are capitalized. The cost of maintenance and repairs is charged to expense as incurred. When depreciable property is retired or disposed of, the related cost and accumulated depreciation is removed from the accounts and any gain or loss is reflected in current operations.\nINCOME TAXES\nRealty and Operating Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. The new standard of accounting replaces SFAS No. 96 which the company adopted in 1988. The cumulative effect of adopting Statement 109 was immaterial for the year ended December 31, 1993.\nDEFERRED REVENUES\nOperating Company's deferred revenues consist of prepaid admission tickets and parking, which are recognized as income ratably over the period of the related race meets. Also, deferred revenue includes prepaid rent from Oak Tree which is recognized over the remaining term of the lease.\nSHAREHOLDERS' EQUITY\nThe outstanding shares of Realty common stock and Operating Company common stock are only transferable and tradable in combination as a paired unit consisting of one share of Realty common stock and one share of Operating Company common stock.\nOPERATING COMPANY'S REVENUES AND COSTS\nOperating Company has adopted an accounting policy whereby the revenues associated with thoroughbred horse racing at Santa Anita Racetrack are reported as they are earned. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year. The rental fee paid by Operating Company to Realty is recognized by both Realty and Operating Company as it is earned.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nRENTAL PROPERTY REVENUES\nRental property revenues are recorded on a straight-line basis over the related lease term. As a result, deferred rent is created when rental income is recognized during free rent periods of a lease. The deferred rent is included in prepaid expenses and other assets, evaluated for collectibility and amortized over the remaining term of the lease.\nHORSE RACING REVENUES AND DIRECT OPERATING COSTS\nOperating Company's horse racing revenues and direct operating costs are shown net of state and local taxes, stakes, purses and awards.\nCONCENTRATION OF CREDIT RISK\nFinancial instruments which potentially subject Realty and Operating Company to concentrations of credit risk are primarily cash investments and receivables. Realty and Operating Company place their cash investments in investment grade short-term instruments and limit the amount of credit exposure to any one commercial issuer. Concentrations of credit risk with respect to accounts receivable are limited due to the number of retail, commercial and residential tenants, and Santa Anita catering patrons. Real estate receivables are secured by first trust deeds on commercial real estate located in Southern California, and Phoenix, Arizona. Advances to unconsolidated joint ventures are unsecured and due from partnerships in which Realty is a 50% or less general partner.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK\nRealty is an issuer of financial instruments with off-balance sheet risk in the normal course of business which exposes Realty to credit risks. These financial instruments include commitments to extend credit, financial guarantees and letters of credit.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nManagement has estimated the fair value of its financial instruments using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimated values for Realty and Operating Company as of December 31, 1993 are not necessarily indicative of the amounts that could be realized in current market exchanges.\nFor those financial instruments for which it is practicable to estimate value, management has determined that the carrying amounts of Realty's and Operating Company's financial instruments approximate their fair value as of December 31,1993.\nDIVIDEND REINVESTMENT PLAN\nIn November 1992 Realty and Operating Company terminated their dividend reinvestment and stock purchase plan (the \"Plan\") which had enabled shareholders to reinvest dividends and purchase shares of Realty and Operating Company stock. Since October 1990, shares issued under the terms of the Plan had been purchased in the open market. Prior to that date, new shares had been issued.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nCOMMON STOCK AND NET INCOME (LOSS) PER COMMON SHARE\nNet income (loss) per common share is computed based upon the weighted average number of common shares outstanding during each period for each company. Stock options have not been included in the computation since they have no material dilutive effect.\nOperating Company holds shares of Realty's common stock which are unpaired pursuant to a stock option plan approved by the shareholders. The shares held totaled 115,500 as of December 31, 1993, 1992 and 1991, respectively. These shares affect the calculation of Realty's net income per common share but are eliminated in the combined calculation of net income per common share.\nRECLASSIFICATIONS\nCertain prior year amounts have been restated to conform to current year presentation.\nNOTE 2 - DISPOSITION OF MULTIFAMILY AND INDUSTRIAL PROPERTIES SUBSEQUENT TO YEAR END\nIn November 1993, Realty entered into a Purchase and Sale Agreement to sell its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), in conjunction with Pacific's proposed public offering of common stock and debentures. The transaction was structured into two parts: (1) Realty would sell all of its apartments and industrial properties to Pacific with the exception of Realty's interest in the Baldwin Industrial Park joint venture; and (2) Pacific would enter into a binding agreement to buy Realty's interest in Baldwin Industrial Park.\nOn February 18, 1994, Realty completed the first part of this transaction by selling to Pacific ten multifamily properties, containing 2,654 apartment units, located in Southern California, the Pacific Northwest, and Texas and three industrial properties, containing an aggregate of 185,000 leasable square feet of industrial space, located in the State of Washington (the \"Transferred Properties\"). Realty's corporate headquarters building and related assets were also acquired by Pacific. The sale of the Transferred Properties followed the public offerings of common stock and convertible subordinated debentures by Pacific.\nPursuant to the Purchase and Sale Agreement, Pacific agreed to buy Realty's interest in Baldwin Industrial Park subject to satisfaction of certain conditions, for a minimum price of $8.9 million payable in additional shares of Pacific common stock, with the final price dependent upon completion of negotiations with the other owners of Baldwin Industrial Park and an appraisal process. Management believes the sale of Realty's interest in Baldwin Industrial Park will be completed in the second half of 1994. Pacific is required to issue to Realty non-refundable letters of credit totaling $2.5 million by March 31, 1994 to secure its obligation to acquire Realty's interest in Baldwin Industrial Park and pay for the corporate headquarters building and other assets related to the Transferred Properties.\nIn consideration of the sale of the Transferred Properties, Realty received approximately $44.4 million in cash and 149,900 shares of the common stock of Pacific. In addition, Realty was relieved of approximately $44.3 million of mortgage debt on the Transferred Properties. Realty will also receive, at the time the acquisition of Baldwin Industrial Park is completed, up to $1.2 million in additional common stock of Pacific as consideration for its corporate headquarters and other net assets related to the Transferred Properties.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - DISPOSITION OF MULTIFAMILY AND INDUSTRIAL OPERATIONS SUBSEQUENT TO YEAR END (CONTINUED)\nThe two parts of the above transaction will result in a loss of $10,974,000. This loss has been reflected in the Realty and Realty and Operating Company combined statements of operations for the year ended December 31, 1993. If the Baldwin Industrial Park portion of the transaction described above does not occur, an additional loss will be recognized by Realty in 1994. The loss could approximate $5,900,000, depending upon whether the $2.5 million in letters of credit are drawn.\nRealty and Pacific have also entered into a one-year management agreement whereby Pacific has agreed to provide management services to Realty. Finally, with respect to the common stock of Pacific owned by Realty, Pacific has entered into a registration rights agreement with Realty which, under certain circumstances, allows Realty to require the registration of the Pacific stock it owns.\nThe following unaudited pro forma condensed balance sheets of Realty and Realty and Operating Company combined are presented as if both parts of the transaction had occurred on December 31, 1993. The unaudited pro forma condensed balance sheets are not necessarily indicative of what the actual financial position of Realty or Realty and Operating Company combined would have been at December 31, 1993 nor do they purport to represent the future financial position of Realty or Realty and Operating Company combined.\nThe accompanying notes are an integral part of this pro forma balance sheet.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - DISPOSITION OF MULTIFAMILY AND INDUSTRIAL OPERATIONS SUBSEQUENT TO YEAR END (CONTINUED)\nNotes: - ------\n(a) Reflects the disposition of the assets and liabilities of the Multifamily and Industrial Operations as if both parts of the transaction had occurred on December 31, 1993. The amounts reflected represent the assets and liabilities directly identifiable with the Multifamily and Industrial Operations transferred by Realty to Pacific.\n(b) As a result of the February 18, 1994 sale to Pacific, Realty will have an investment in the common shares of Pacific totaling $2,738,000. Upon completion of Realty's disposition of Baldwin Industrial Park, assuming a price per share equal to $18.25 (the initial public offering price of Pacific's common shares) and the minimum price for Realty's interest in Baldwin Industrial Park and the corporate headquarters building and certain other assets related to the Transferred Properties, Realty will receive additional Pacific stock totaling approximately $10,064,000.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - DISPOSITION OF MULTIFAMILY AND INDUSTRIAL OPERATIONS SUBSEQUENT TO YEAR END (CONTINUED)\nThe following unaudited pro forma statements of operation of Realty and Realty and Operating Company combined are presented as if both parts of the transaction had occurred on January 1, 1993. The unaudited pro forma statements of operation are not necessarily indicative of what the actual results of operations would have been if the transaction had been consummated on January 1, 1993 nor do they purport to represent the results of operations of Realty or Realty and Operating Company combined for any future period.\nThe accompanying notes are an integral part of this pro forma statement of operations.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - DISPOSITION OF MULTIFAMILY AND INDUSTRIAL OPERATIONS SUBSEQUENT TO YEAR END (CONTINUED)\nNotes: - ------\n(1) Reflects the operations for the year ended December 31, 1993 of the Multifamily and Industrial Operations directly identifiable with, and allocations of other costs and expenses related to, the Multifamily and Industrial Operations being transferred by Realty to Pacific.\n(2) Estimated annual distributions to be received on Realty's investment in Pacific ($1.56 per common share) less the amount of such distributions estimated to represent the return of capital ($.56 per common share).\n(3) Elimination of interest expense on real estate and other loans payable repaid or assumed by Pacific.\n(4) Elimination of the minority interest in earnings of joint ventures resulting from Realty's acquisition of the Partnership interests and subsequent transfer to Pacific.\nNOTES TO FINANCIAL STATEMENTS (continued)\nNote 3 - Investments in Joint Ventures\nRealty's real estate properties include investments in the following consolidated real estate joint ventures:\nThe financial condition and operations of the above-listed joint ventures are consolidated with the financial statements of Realty and Combined Realty and Operating Company.\nCombined condensed financial information for consolidated joint ventures as of December 31, 1993, 1992 and 1991 and for the years then ended is as follows:\nNOTE 3 - INVESTMENTS IN JOINT VENTURES (CONTINUED)\nDuring 1993, Realty acquired the partnership interests of its minority partners in the following joint ventures: SARESAM, SAREFIM, Applewood Village Partners and Hubanita. The partnership interests were acquired in consideration for cash, the cancellation of certain receivables from the minority partners and the assumption of the minority partners' capital account and payment of $250,000 related to Hubanita. The financial statements of Realty and Combined Realty and Operating Company reflect the acquisition of the minority interests.\nRealty's investments in unconsolidated joint ventures include investments in the following commercial real estate ventures:\nUnaudited combined condensed financial statement information for unconsolidated joint ventures as of December 31, 1993, 1992 and 1991 and for the years then ended is as follows:\nNOTE 3 - INVESTMENTS IN JOINT VENTURES (CONTINUED)\nRealty is a joint and several guarantor of loans issued to expand the Towson Town Center located in Towson, Maryland (owned 65% by H-T Associates) and a department store and land (owned 100% by Joppa Associates) adjacent to Towson Town Center in the amount of $82,630,000. The maximum loan balance to which the guarantees relate is $188,500,000. Realty's two partners in the ventures have also each executed repayment guarantees, although one of the partners has a limited repayment guaranty. Annually, the guarantors may request a reduction in the amount of the guaranty based on the economic performance of the regional mall.\nNOTE 4 - REAL ESTATE LOANS AND ADVANCES RECEIVABLE\nRealty's real estate loans and advances receivable as of December 31, 1993 and 1992 consist of the following:\nContractual principal repayments on real estate loans and advances receivable as of December 31, 1993 are due as follows:\nThe prime rate was 6.0% during 1993 and at December 31, 1993.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5 - LOANS PAYABLE\nRealty's real estate loans payable related to real estate as of December 31, 1993 and 1992 consist of the following:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5 - LOANS PAYABLE (CONTINUED)\nRealty's other loans payable as of December 31, 1993 and 1992 consist of the following:\nAs of December 31, 1993, Realty was not in compliance with certain covenants contained in its credit agreements. The banks have waived such noncompliance through April 30, 1994 conditioned, among other things, on no additional borrowings under the credit agreements. Realty is in the process of renegotiating these credit agreements. Management is of the opinion that Realty has sufficient liquidity from other sources to assure that its operations will not be adversely affected pending this renegotiation.\nUnder the terms of these agreements, Realty may borrow funds, at Realty's option, based upon prime rates, LIBOR (London Interbank Offered Rate) based rates or Certificate of Deposit rates. At December 31, 1993, all funds are borrowed on prime or LIBOR-based rates. LIBOR-based rates ranged from 2.80% to 3.84% and the prime rate was 6.0% at December 31, 1993.\nThe revolving lines of credit require certain compensating balances. Under the lines of credit agreements, the compensating balance requirements at December 31, 1993, which represent cash balances that are not available for withdrawal, amounted to $1,000,000. In addition, Realty is required to pay annual commitment fees ranging from 0.15% to 0.25% on the unused portion of these lines of credit.\nOperating Company entered into a sale-leaseback transaction related to the financing of certain television, video monitoring and production equipment under a five-year lease expiring in December 1997. This financing arrangement is accounted for as a capital lease. Accordingly, the equipment and related lease obligation are reflected as machinery and other equipment and other loans payable, respectively, on Operating Company's and Realty and Operating Company's combined balance sheets. Realty has guaranteed $3,500,000 of the lease obligation.\nNOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 5 - LOANS PAYABLE (CONTINUED)\nThe assets recorded under this capital lease are:\nTotal future minimum lease payments under this capital lease and the present value of the minimum lease payments as of December 31, 1993 consist of the following:\nFor the year ending December 31,\nInterest costs for the years ended December 31, 1993, 1992 and 1991 are as follows:\nNOTES TO FINANCIAL STATEMENTS (COINTINUED)\nNOTE 5 - LOANS PAYABLE (CONTINUED)\nNOTE 6 - OTHER LIABILITIES\nOther liabilities as of December 31, 1993 and 1992 consist of the following:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6 - OTHER LIABILITIES (CONTINUED)\nAdvances payable represent amounts due to Realty's other partner in Anita Associates. The amount is expected to be repaid from the proceeds of the refinancing of Anita Associates' existing debt. The advances bear interest at 10% and are unsecured.\nNOTE 7 - INCOME TAXES\nAs a REIT, Realty is taxed only on undistributed REIT income. During each of the years ended December 31, 1993, 1992 and 1991, Realty distributed at least 95% of its REIT taxable earnings to its shareholders. For the years ended December 31, 1993, 1992 and 1991, 41.2%, 41.2% and 52.9%, respectively, of the dividends distributed to shareholders represented a return of capital. None of the dividends distributed to shareholders during 1993, 1992 and 1991 represented capital gains.\nThe composition of Combined Realty and Operating Company's income tax provision (benefit) and income taxes paid for the years ended December 31, 1993, 1992 and 1991 is as follows:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - INCOME TAXES (CONTINUED)\nDeferred income taxes arise from temporary differences in the recognition of certain items of revenues and expenses for financial statement and tax reporting purposes. The sources of temporary differences and their related tax effect for the years ended December 31, 1993, 1992 and 1991 are as follows:\nA reconciliation of Combined Realty and Operating Company's total income tax provision for the years ended December 31, 1993, 1992 and 1991 to the statutory federal corporate income tax rate of 34% follows:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - INCOME TAXES (CONTINUED)\nThe deferred tax assets (liabilities) as of December 31, 1993 and 1992 consist of the following:\nIn prior years, Realty had filed claims with the California Franchise Tax Board for refunds with respect to the 1970 through 1979 tax years; LATC was assessed California franchise tax and interest for the years 1980 through 1982; and, Operating Company was assessed additional franchise tax for the years 1983 through 1985. In 1993, a refund of interest and taxes in the amount of $6,082,000 was received from the California Franchise Tax Board in the settlement of the above claims. Realty has recognized $3,211,000 of interest income, net of expenses of $120,000 and an income tax benefit in the amount of $2,523,000. Operating Company has recorded additional deferred taxes payable in the amount of $228,000.\nThe Franchise Tax Board has audited the 1986 through 1988 tax years of Operating Company. Operating Company has protested these proposed assessments. The additional assessment has been accrued by Operating Company.\nIn February 1994, the Franchise Tax Board initiated an audit of Operating Company's 1989 through 1991 tax years.\nAt December 31, 1993, for federal income tax purposes, Operating Company's net operating loss carryforward is approximately $6,504,000 which substantially expires in 2004.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8 - COMMITMENTS AND CONTINGENCIES\nRealty's wholly owned and consolidated real estate investments consist of Santa Anita Racetrack, Fashion Park (a regional mall), various neighborhood shopping centers, industrial parks, apartment complexes and office buildings. The racetrack is leased to LATC (Note 11); the land underlying Fashion Park has been ground leased for 65 years; each of the various neighborhood shopping centers has been leased to non-anchor tenants with terms ranging from three to five years; and, the office buildings have been leased with terms generally ranging from two to ten years.\nThe minimum future lease payments to be received from Realty's wholly owned and consolidated real estate investments (excluding rentals relating to the Santa Anita Racetrack which are paid by LATC to Realty) for the five years ending December 31, are as follows:\nSubstantially all of the retail leases provide for additional contingent rentals based upon the gross income of the tenants in excess of stipulated minimums. Realty's share of these contingent rentals totaled $258,000 in 1993, $337,000 in 1992 and $362,000 in 1991.\nRealty leases the Santa Anita Racetrack to Operating Company's subsidiary, LATC. The lease provides for a rental fee of 1.5% of the total gross on-track pari-mutuel wagering generated at the racetrack. The lease, which is subject to renewal, expires in 1994. Realty also receives 40% of LATC's revenues from satellite wagering and the simulcasting of races originating from the Santa Anita Racetrack after mandated payments to the State of California and to horse owners. The lease amounts are eliminated in combination.\nRealty has entered into several general and limited partnerships to own and operate real estate. As of December 31, 1993, Realty has committed to invest an additional $307,000 in these partnerships.\nRealty has obtained a standby letter of credit totaling $448,000 related to financing on a real estate investment.\nIn 1992, Realty and Operating Company entered into severance agreements with certain officers. Under certain circumstances, the severance agreements provide for a lump sum payment if there is a \"change in control\" of the entities. No provision under these severance agreements has been accrued or funded.\nCertain other claims, suits and complaints arising in the ordinary course of business have been filed or are pending against Realty and Operating Company. In the opinion of management, all such matters are adequately covered by insurance or, if not so covered, are without merit or are of such kind or involve such amounts as would not have a significant effect on the financial position or results of operations if disposed of unfavorably.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - STOCK OPTION PROGRAM AND EMPLOYEE DEFINED BENEFIT PLANS\nSTOCK OPTION PROGRAM\nDuring 1984, Realty reserved 400,000 shares of common stock for sale under its Stock Incentive Plan. During 1984, Operating Company also reserved 400,000 shares for sale under its Stock Option Program. Each company also reserved 400,000 shares for issuance under the other company's plan. During 1993, Operating Company reserved an additional 222,820 shares for sale. The shares are to be issued either as Incentive Stock Options or Non-Qualified Stock Options.\nThe options, which are contingent upon continuous employment, are exercisable at any time once vested, for up to three years after the date of retirement or death and for up to 90 days after resignation. For both Realty and Operating Company, Incentive Stock Options and Non-Qualified Stock Options expire in 1995 through 2003.\nInformation with respect to shares under option as of December 31, 1993, 1992 and 1991 is as follows:\n(a) In connection with the disposition of the multifamily and industrial operations (Note 2), the executive officers of Realty resigned effective February 18, 1994. In accordance with the stock option program, the nonvested portion of their stock options terminated on February 18, 1994. The nonvested stock options totaled 41,200 as of December 31, 1993. The unexercised vested portion of their stock options still outstanding 90 days subsequent to the resignation date will be terminated on that date. As of December 31, 1993 the vested portion of their stock options totaled 33,800.\nCertain officers and\/or directors of Realty and Operating Company have exercised stock options. At the time of the exercise, the individuals signed notes for the purchase price of the stock (Note 11).\nAt the time of exercise of Realty options, employees also have to buy directly from Operating Company shares of Operating Company stock at its fair market value per share to pair with Realty shares.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - STOCK OPTION PROGRAM AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nIn addition, Operating Company is required to purchase Realty shares to pair with the Operating Company shares being purchased by its employees. In 1984, Operating Company purchased 200,000 shares of Realty stock for this purpose.\nRETIREMENT INCOME PLAN\nRealty and Operating Company have a defined benefit retirement plan for year-round employees who are at least 21 years of age with one or more years of service and who are not covered by collective bargaining agreements. Plan assets consist of investments in a life insurance group annuity contract. Plan benefits are based primarily on years of service and qualifying compensation during the final years of employment. Funding requirements comply with federal requirements that are imposed by law.\nThe net periodic pension cost for 1993 for Realty and Operating Company was $104,000 and $367,000 respectively; for 1992 was $109,000 and $339,000, respectively; and for 1991 was $87,000 and $300,000, respectively. The provisions include amortization of past service cost over 30 years. Based upon an actuarial valuation date of January 1, 1993, the present value of accumulated plan benefits (calculated using a rate of return of 8.5%) at December 31, 1993 was $6,280,000, and the plan's net assets available for benefits were $5,607,000.\nThe combined net periodic pension cost for the years ended December 31, 1993, 1992 and 1991 for the retirement income plan included the following components:\nNOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 9 - STOCK OPTION PROGRAM AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nThe following table sets forth the funded status of Realty's and Operating Company's retirement income plan and amounts recognized in the balance sheets at December 31, 1993 and 1992:\nAssumptions used in determining the funded status of the retirement income plan are as follows:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - STOCK OPTION PROGRAM AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nDEFERRED COMPENSATION PLAN\nRealty and Operating Company have defined benefit deferred compensation agreements which provide selected management employees with a fixed benefit at retirement. Plan benefits are based primarily on years of service and qualifying compensation during the final years of employment.\nThe net periodic pension cost for 1993 for Realty and Operating Company was $263,000 and $860,000, respectively; for 1992 was $93,000 and $243,000, respectively; and for 1991 was $98,000 and $233,000 respectively. During 1993, Realty and Operating Company recorded a combined $961,000 of pension expense, net of $793,000 of life insurance proceeds as a nonrecurring charge to the plan resulting from the death of an officer. It is the policy of Realty and Operating Company to fund only amounts sufficient to cover current deferred compensation benefits payable to retirees. The present value of unfunded benefits at December 31, 1993, based upon an actuarial valuation date of January 1, 1993, was $4,280,000 (calculated using a rate of return of 10%) and Realty's and Operating Company's combined accrued liability totaled $3,792,000.\nNet periodic pension cost for the years ended December 31, 1993, 1992 and 1991 for the deferred compensation plan included the following components:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - STOCK OPTION PROGRAM AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nThe following table sets forth the funded status of Realty's and Operating Company's deferred compensation plan and amounts recognized in the balance sheets at December 31, 1993 and 1992:\nAssumptions used in determining the funded status of the deferred compensation plan are as follows:\nNOTE 10 - SHAREHOLDER RIGHTS PLAN\nIn June 1989, the Board of Directors of Realty adopted a shareholder rights plan and declared the distribution of one right for each outstanding share of common stock. The distribution was made in August 1989. Each right entitles the holder to purchase from Realty, initially, one one-hundredth of a share of junior participating preferred stock at a price of $100 per share, subject to adjustment. The rights are attached to all outstanding common shares, and no separate rights certificates will be distributed. The rights are not exercisable or transferable apart from the common stock until the earlier of ten business days following a public announcement that a person or group has acquired beneficial ownership of 10% or more of Realty's general voting power or ten business days following the commencement of, or announcement of the intention to commence, a tender or exchange offer that would result in a person or group beneficially owning 10% or more of Realty's general voting power.\nUpon the occurrence of certain other events related to changes in the ownership of Realty's outstanding common stock or business combinations involving a holder of more than 10% of Realty's general voting power, each holder of a right would be entitled to purchase shares of Realty's common stock, or an acquiring corporation's common stock, having a market value of two times the exercise price of the right.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10 - SHAREHOLDER RIGHTS PLAN (CONTINUED)\nDuring such time as the stock-pairing arrangement between Realty and Operating Company shall remain in effect, Operating Company will issue, on a share-for-share basis, Operating Company common shares, or, as the case may be, Operating Company junior participating preferred shares to each person receiving Realty common shares or preferred shares upon exercise or in exchange for one or more rights.\nRealty is entitled to redeem the rights in whole, but not in part, at a price of $.001 per right prior to the earlier of the expiration of the rights in August 1999 or the close of business ten days after the announcement that a 10% position has been acquired.\nNOTE 11 - RELATED PARTY TRANSACTIONS\nLATC leases the Santa Anita Racetrack from Realty. Rent is based upon 1.5% of the aggregate live on-track wagering and 40% of LATC's revenues received from simulcast and satellite wagering on races originating at Santa Anita Racetrack. For the years ended December 31, 1993, 1992 and 1991, LATC paid Realty (including charity days) $11,634,000, $12,683,000 and $11,817,000, respectively, in rent, of which $9,233,000, $10,955,000 and $9,928,000, respectively, were attributable to the Santa Anita meets (exclusive of charity days), with the remainder being attributable to the Oak Tree meets and charity days. The lease arrangement between LATC and Realty requires LATC to assume costs attributable to taxes, maintenance and insurance.\nBoth Realty and Operating Company have notes receivable from certain officers, former officers and\/or former directors resulting from their exercise of stock options (Note 9). Notes receivable from officers, former officers and\/or former directors as of December 31, 1993 and 1992, for Realty were $81,000 and $184,000, respectively, and for Operating Company were $393,000 and $ 890,000, respectively.\nNOTE 12 - COMBINED QUARTERLY FINANCIAL INFORMATION - UNAUDITED\nCondensed combined unaudited quarterly results of operations for Combined Realty and Operating Company are as follows:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 - COMBINED QUARTERLY FINANCIAL INFORMATION - UNAUDITED (CONTINUED)\nIn 1993, revenues and cost of sales from food and beverage operations have been reflected as a separate component in Operating Company's and Combined Realty and Operating Company's statements of operations. In prior years these operations were reflected in horse racing revenues. All prior year and interim financial statements and disclosures for Operating Company and Combined Realty and Operating Company have been restated to reflect this reclassification.\nOperating Company adopted an accounting practice whereby the revenues associated with thoroughbred horse racing at Santa Anita Racetrack are reported as they are earned. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those interim periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year.\nThe total of the amounts shown above as quarterly net income per common share may differ from the amount shown on the Combined Statements of Operations because the annual computation is made separately and is based upon the average number of shares outstanding for the year.\nRealty and Operating Company are subject to significant seasonal variations in revenues and net income (loss) due primarily to the seasonality of thoroughbred horse racing.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- -------------- (a) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1993, arising from the exercise of stock options of Realty. (b) Resigned effective December 27, 1993. (c) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1994, arising from the exercise of stock options of Realty. (d) Note receivable at 7% interest, payable in five annual installments through 1992, arising from the exercise of stock options of Realty.\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- -------------- (a) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1993, arising from the exercise of stock options of Realty. (b) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1994, arising from the exercise of stock options of Realty. (c) Note receivable at 7% interest, payable in five annual installments through 1992, arising from the exercise of stock options of Realty.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- -------------- (a) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1995, arising from the exercise of stock options of Operating Company. (b) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1993, arising from the exercise of stock options of Operating Company. (c) Decreased May 5, 1993. (d) The balance of Mr. Strub's note will be reduced at the rate of $5,000 per month by his widow, Mrs. Elizabeth Strub, who has personally guaranteed the note. Additionally, irrevocable escrow instructions have been executed by the trustee of Mr. Strub's estate wherein escrow proceeds arising from the sale of a single family residence will be applied to the outstanding balance.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\n- -------------- (a) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1992, arising from the exercise of stock options of Operating Company.\n(b) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1995, arising from the exercise of stock options of Operating Company.\n(c) Note receivable at the prime rate, adjusted annually, payable in five annual installments through 1993, arising from the exercise of stock options of Operating Company.\n(d) Note receivable at 7% interest, payable in five annual installments through 1992, arising from the exercise of stock options of Operating Company.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 31, 1993\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSANTA ANITA REALTY ENTERPRISES, INC. SCHEDULE XI - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1993\nThe accompanying notes are an integral part of this schedule.\nSANTA ANITA REALTY ENTERPRISES, INC. SCHEDULE XI - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1993 (CONTINUED)\n- ------------ Notes\n(a) Initial costs December 31, 1979 book value (b) Component depreciation used (c) All dollar figures represent 100% of amounts attributable to the property (d) Initial costs December 31, 1987 book value (e) Property subject to Pacific transaction (Note 2)\nINDEPENDENT AUDITORS' REPORT -----------------------------\nTo the Partners H-T Associates\nWe have audited the accompanying consolidated balance sheet of H-T Associates (a Maryland general partnership) and subsidiary (a Maryland general partnership) as of December 31, 1993, and the related consolidated statements of operations, partners' capital and cash flows for the year then ended. These consolidated financial statements are the responsibility of H-T Associates' management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of H-T Associates and subsidiary as of December 31, 1993, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK\nSan Diego, California February 11, 1994\nINDEPENDENT AUDITORS' REPORT -----------------------------\nTo the Partners H-T Associates San Diego, California\nWe have audited the accompanying consolidated balance sheet of H-T Associates (a Maryland general partnership) and subsidiary (a Maryland general partnership) as of December 31, 1992, and the related consolidated statements of operations, partners' capital and cash flows for the year then ended. These financial statements are the responsibility of H-T Associates' management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the 1992 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of H-T Associates and subsidiary as of December 31, 1992, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.\nKENNETH LEVENTHAL & COMPANY\nNewport Beach, California January 28, 1993\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Partners H-T Associates San Diego, California\nWe have audited the accompanying consolidated statements of operations, partners' capital and cash flows of H-T Associates (a Maryland general partnership) and subsidiary (a Maryland general partnership) for the year ended December 31, 1991. These financial statements are the responsibility of H-T Associates' management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such 1991 consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of H-T Associates and subsidiary for the year ended December 31, 1991, in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE\nSan Diego, California February 3, 1992\nH-T ASSOCIATES (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED BALANCE SHEETS ---------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL --------------------------------------------\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 --------------------------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\n(Continued)\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\nDECEMBER 31, 1993, 1992 AND 1991 --------------------------------\nA. Organization and Accounting Policies: ------------------------------------\nH-T Associates (the \"Partnership\") is a Maryland general partnership formed on July 28, 1987. Its primary asset is a 65% ownership in Towson Town Center Associates (\"TTCA\"), formed to develop and operate a regional shopping center near Baltimore, Maryland. The general partners of the Partnership are Ernest W. Hahn, Inc. and Santa Anita Realty Enterprises, Inc. The Partnership is to continue until December 31, 2087, unless terminated earlier. Profits and losses are shared as follows:\nErnest W. Hahn, Inc. (\"Hahn\") 50% Santa Anita Realty Enterprises, Inc. (\"Santa Anita\") 50%\nThe consolidated financial statements of the Partnership include the accounts of the Partnership and TTCA. TTCA is a Maryland general partnership comprised of the Partnership and DeChiaro Associates (\"DeChiaro\") as 65% and 35% general partners, respectively. All significant intercompany balances and transactions have been eliminated.\nCertain reclassifications of prior year amounts have been made in order to conform with the current year presentation.\nThe Partnership's accounting policies are as follows:\n1. Shopping center property is recorded at cost and includes direct construction costs, interest, construction loan fees, property taxes and related costs capitalized during the construction period, as these amounts are expected to be recovered from operations.\n2. The costs of shopping center buildings and improvements, less a 5% salvage value, are depreciated using the straight-line method over the estimated useful life of 40 years.\n3. Direct costs of obtaining leases and permanent financing are deferred and are being amortized over the lease and loan periods, respectively.\n4. Maintenance and repairs are charged to operations as incurred.\n5. Expenditures for betterments are capitalized and depreciated over the remaining depreciable life of the property.\n6. Costs incurred in connection with early termination of a tenant lease are amortized over the life of the lease with the replacement tenant. To the extent payments received from an incoming tenant do not represent future rentals or cost recoveries for tenant improvements, they are recorded as income when received.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) ------------------------------------------------------\nA. Organization and Accounting Policies: (continued) ------------------------------------\n7. Taxable income or loss of the Partnership is reported by, and is the responsibility of, the respective partners. Accordingly, the Partnership makes no provision for income taxes.\n8. The Partnership recognizes scheduled rent increases on a straight-line basis. Accordingly, a deferred receivable for rents which are to be received in subsequent years is reflected in the accompanying consolidated balance sheets.\n9. The differential to be paid or received under interest rate swap agreements is accrued as interest rates change, and is recognized over the life of the agreements (Note B).\nB. Notes payable: -------------\nIn 1990, TTCA entered into a building loan agreement with a commercial bank, secured by an indemnity deed of trust encumbering the property. In connection with the loan, Hahn and Santa Anita executed a repayment guaranty of $66,135,000 each and DeChiaro executed a limited repayment guaranty of $4,513,000. TTCA can borrow up to $170,000,000. The principal balance of the loan is due May 1999. The agreement provides that TTCA can: (1) obtain funds at the then current prime rate of the commercial bank; (2) obtain funds based on the then current London Interbank Offered Rate (\"LIBOR\") plus a spread (as defined); or, (3) obtain funds through the issuance of commercial paper at rates based upon the interest rates offered in the commercial paper market plus letter of credit fees. For the years ended December 31, 1993 and 1992, all funds were obtained under the commercial paper option for a total outstanding balance of $164,641,000 and $159,473,000, respectively. Interest is payable monthly. The variable interest rate in effect on the outstanding balance as of December 31, 1993 and 1992 was 3.2% and 3.7%, respectively.\nTTCA has also entered into interest rate swap agreements to reduce the impact of changes in interest rates on its loan. As of December 31, 1993 and 1992, TTCA had two interest rate swap agreements outstanding with a commercial bank which have a total notional principal amount of $82,000,000.\nThe agreements provide for TTCA to pay fixed rates of interest of 9.3% and 8.8% on swaps of $45,000,000 and $37,000,000, respectively, and to receive floating interest based on 30 day commercial paper rates. The effective variable rate of interest on the swap agreements as of December 31, 1993 is 3.2%. The interest rate swap agreements mature at the time the building loan matures. TTCA is exposed to credit loss in the event of nonperformance by the commercial bank with the interest rate swap agreements.\nThe net effective interest rates on amounts outstanding under the building loan agreement at December 31, 1993, 1992 and 1991, after giving effect to the interest rate swaps, was 6.9%, 6.4% and 8.3%, respectively.\nH-T ASSOCIATES (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nB. Notes payable: (continued) -------------\nThe differential between the amounts paid and received under the interest rate contract is included as either an addition to, or a reduction in, interest incurred. Total interest incurred was $11,383,329, $11,420,746, and $10,419,887 of which $0, $3,491,669 and $8,515,010 was capitalized, for the years ended December 31, 1993, 1992, and 1991, respectively.\nC. Commitments: ------------\nPartnership as Lessor: ---------------------\nTTCA leases space to tenants in the shopping center for which it charges minimum rents and receives reimbursement for real estate taxes and certain other operating expenses. The terms of the leases range from 5 to 30 years and generally provide for additional overage rents during any year that tenants' gross sales exceed stated amounts.\nFuture minimum rental revenues to be received under leases in force at December 31, 1993 are as follows:\nProperty Under Development: ---------------------------\nDuring 1991, TTCA completed a major expansion and renovation of the previously existing shopping center. Pursuant to the Development Manager's Agreement between TTCA and Hahn, Hahn is to receive an estimated $5.1 million as compensation for managing the development of the project. Of this amount $5,080,619, $5,041,792 and $4,682,015 were incurred as of December 31, 1993, 1992 and 1991, respectively.\nH-T ASSOCIATES -------------- (a Maryland general partnersip) AND SUBSIDIARY (A Maryland general partnership)\nD. Advances from Partners: ----------------------\nHahn and Santa Anita have both made advances to the Partnership to finance certain construction funding requirements and other cash flow needs. These advances bear interest at 1% above the prime rate and they are required to be repaid prior to any distributions to the partners, other than distributions of Net Cash Flow from Operations (Note E). Interest incurred on the advances totaled $540,555, $558,918 and $702,773 for the years ended December 31, 1993, 1992 and 1991, respectively. The prime rate was 6.0%, 6.0% and 6.5% at December 31, 1993, 1992 and 1991, respectively.\nE. Partnership Distributions: -------------------------\nDistributions of Net Cash flow from Operations of the Partnership (as defined by the Amended and Restated Partnership Agreement) are subject to certain priorities. The period from inception of the Partnership through October 16, 1991 (the Grand Opening Date of the shopping center) is referred to as the Initial Term. During the Initial Term, both partners were entitled to a cumulative, compounded return (at the Prime Rate, as defined) on their capital contributions. A $500,000 distribution was made during the Initial Term. The \"Primary Term\" follows the Initial Term, and ends when cash flow for a consecutive 12-month period exceeds the sum of $1,192,000 plus any unpaid cumulative returns. During the \"Primary Term,\" Santa Anita receives a cumulative return of $447,000 for the first year, $521,500 for the second year, and $596,000 for each year thereafter. Hahn receives non-cumulative returns of the same amounts. Following the Primary Term, distributions of Net Cash Flow from Operations are made to the partners in accordance with their percentage interests.\nF. Related Party Transactions: --------------------------\nHahn and its wholly owned subsidiary, Hahn Property Management Corporation (\"HMPC\"), provide property management, leasing and various legal services to TTCA. A summary of costs and fees incurred by Hahn and HMPC by TTCA during 1993, 1992 and 1991 is presented below:\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) ------------------------------------------------------\nF. Related Party Transactions: (continued) --------------------------\nRelated Property: -----------------\nCertain property adjacent to TTCA's regional shopping center is owned by Joppa Associates (\"Joppa\"). The partners of TTCA are also the partners of Joppa. TTCA has benefitted from Joppa's ownership of the adjacent property. The partners consider the two properties one project.\nG. Disclosures About the Fair Value of Financial Instruments: ---------------------------------------------------------\nIn the opinion of management, the carrying amounts of TTCA's financial instruments approximate fair value except:\nInterest Rate Swaps (Note B): ----------------------------\nThe fair value of interest rate swaps (used for hedging purposes) is the estimated amount that TTCA would pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current credit worthiness of the swap counterparties. The fair value of the interest rate swaps is a net payable of $13,593,031.\nEXHIBIT INDEX\nEXHIBIT INDEX (CONTINUED)\nEXHIBIT INDEX (CONTINUED)\nEXHIBIT INDEX (CONTINUED)","section_15":""}
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{"filename":"81381_1993.txt","cik":"81381","year":"1993","section_1":"ITEM 1. BUSINESS.\nQuaker State Corporation (\"Quaker State\"), a Delaware corporation formed in 1931, has its principal place of business at 255 Elm Street, Oil City, Pennsylvania. Quaker State's principal business is the manufacture and sale of brand name motor oils and lubricants and the sale of products and services in the automotive aftermarket (see \"Motor Oil Division\" below). Quaker State's business segments also include the production of natural gas and crude oil, fast lube operations, insurance operations, the manufacture and sale of safety lighting equipment and docking operations (see \"Natural Gas Exploration and Production Division,\" \"Fast Lube Operations,\" \"Insurance Operations,\" \"Truck-Lite\" and \"Docking Operations\" below). Quaker State is no longer engaged in coal operations (see \"Discontinued Coal Operations\" below).\nMOTOR OIL DIVISION\nQuaker State manufactures and sells lubricants (primarily motor oils for automobiles and trucks) and fuels. The lubricants include transmission fluids, gear lubricants and greases as well as specialty lubricants designed for other types of vehicles, such as marine craft, motorcycles and snowmobiles. All the lubricants are sold under Quaker State's brand name. The fuels include gasoline, fuel oils (diesel fuel and heating oils) and kerosene. Quaker State also purchases and resells automotive consumer products.\nThe manufacture of the lubricants and fuels, the purchase and gathering of crude oil and all marketing, sales, distribution and research and development activities relating to the lubricants, fuels and automotive consumer products are the responsibility of Quaker State's Motor Oil Division.\nManufacturing. Motor oils are made by blending additives with lubricant stocks refined from crude oil. Quaker State's motor oils are made from lubricant stocks produced at its Congo refinery located at Newell, West Virginia or from lubricant stocks produced by other refiners and purchased. The Congo refinery is specially designed to maximize the production of lubricant stocks for motor oils from Pennsylvania Grade crude oil. Although it was built in 1971, the Congo refinery remains one of the newest lubricant stock refineries in the United States. Quaker State sold its crude oil refineries located at St. Mary's, West Virginia and at Farmers Valley, Pennsylvania in December 1987 and May 1990, respectively.\nDuring the three years ended December 31, 1993, the number of barrels of Pennsylvania Grade crude oil processed at the Congo refinery has been: 1993-3,710,000; 1992-3,743,000; and 1991-3,634,000. The Congo refinery operates at near capacity. Most of the crude oil is purchased. Purchases are made from numerous independent producers with whom, for the most part, Quaker State has been doing business for many years. During 1993, Quaker State purchased crude oil from approximately 1,550 producers, including one producer which accounted for approximately 14.73% of the crude oil purchases. Purchases are made pursuant to informal arrangements which may be terminated at any time or under joint venture, operating, farm-out or similar agreements under which Quaker State has the contractual right to purchase the crude oil if produced. During the three years ended December 31, 1993, the weighted average price per barrel of crude oil purchased by Quaker State has been: 1993-$16.17; 1992-$17.32 and 1991-$17.53. Some of the crude oil processed by Quaker State at the Congo refinery is produced by Quaker State itself (see \"Natural Gas Exploration and Production Division-Crude Oil\" below).\nDuring 1993 and 1992, approximately 44% and 45%, respectively, of the lubricant stocks used in Quaker State motor oils was produced at the Congo refinery. Certain lubricant stocks produced at the Congo refinery are sold to third parties.\nThe lubricant stocks produced by Quaker State are blended with additives to produce motor oils at facilities at the Congo refinery or, after transportation in bulk, at a blending and packaging plant owned and operated by Quaker State at Vicksburg, Mississippi. The lubricant stocks produced by other refiners and purchased by Quaker State are blended with additives to produce motor oils at a blending and packaging plant owned and operated by Quaker State in Carson, California (near Los Angeles), and to a limited extent at the\nCongo refinery and the Vicksburg plant. Quaker State also operated a leased blending plant in St. Louis, Missouri until it was closed in December 1993.\nQuaker State's Canadian motor oil subsidiary, Quaker State, Inc., owns and operates a packaging plant in Burlington, Ontario (near Toronto). During 1993, the Congo refinery supplied blended motor oils in bulk to satisfy the packaging requirements of the Canadian subsidiary.\nThe majority of the motor oils sold by Quaker State is packaged; however, a significant amount of the motor oils is also sold in bulk. Packaged motor oils are sold primarily in one quart plastic bottles. In the United States, the plastic bottles are made by others to Quaker State's specifications at facilities adjacent to the Congo refinery and the Vicksburg and Carson plants. In Canada, the plastic bottles are made by Quaker State, Inc. at the Burlington, Ontario facility.\nGreases and some of the specialty lubricants are made for Quaker State by others in accordance with specifications established by Quaker State.\nGasoline, fuel oils and kerosene, which account for approximately 65% of the output of the Congo refinery, as well as wax, are unavoidable by-products of the refining process for a motor oil manufacturer like Quaker State. In the case of some of these products, some additional processing and blending is required.\nRaw materials (exclusive of crude oil and containers), primarily the lubricant stocks produced by other refiners, chemicals, fuels and additives, are available from a number of sources. Availability of Pennsylvania Grade crude oil depends primarily on the price which purchasers, including Quaker State, are willing to pay. In turn, the price depends on prevailing market conditions which include the purchase price for non-Pennsylvania Grade crude oil. The available supply of Pennsylvania Grade crude oil has been declining for some time and is expected to continue to decline. Although Quaker State believes that an adequate supply of Pennsylvania Grade crude oil will be available for the Congo refinery for the near future, it is studying whether, should a shortage occur, non-Pennsylvania grade crude oils are available for processing at the Congo refinery and the amount of capital expenditures required for refinery modifications, as well as other available alternatives.\nQuaker State owns and operates a fleet of tank trucks to gather crude oil produced in eastern Ohio and western Pennsylvania and transport it to the Congo refinery or to a Quaker State owned and operated crude oil terminal and storage complex at Magnolia, Ohio. From there, crude oil flows through a pipeline to the Congo refinery. Other crude oil is gathered by regulated pipeline companies and barged to the Congo refinery.\nDomestic Sales. Quaker State is one of the major branded motor oil sellers in the United States. The motor oils and other lubricants are sold directly to customers and through independent distributors.\nAs of December 31, 1993, approximately 170 full time employees were engaged in the direct sales effort. Direct sales are made to national and regional chain stores, to certain fast lube centers and to other resellers and end users primarily in large metropolitan areas. The resellers include wholesalers and retailers, and the end users include industrial and commercial accounts and fleet customers.\nAs of December 31, 1993, there were 120 independent distributors selling in all 50 states. The independent distributors resell to service stations, retailers, automobile dealers, repair shops, fast lube centers, automobile parts stores, retail food chains, fleet and commercial customers and wholesale outlets. During the three years ended December 31, 1993, the independent distributors accounted for the following percentages of Quaker State's total branded motor oil sales revenues in the United States: 1993-35.3%; 1992-33.6% and 1991-31%. The increased percentages represent primarily a transfer of certain direct sales areas to independent distributors.\nDistribution of motor oils and other lubricants to the resellers, end users and independent distributors is made from the Congo refinery, the blending and packaging plants and bulk storage and warehouse facilities owned or leased by Quaker State. Distribution is made primarily by truck, including trucks owned and operated by a Quaker State subsidiary which is an irregular route common carrier operating throughout the United States. This unit primarily delivers products in bulk.\nGasoline, fuel oils and kerosene are sold to wholesalers located for the most part in Ohio, Pennsylvania and West Virginia. Distribution is made primarily by delivery F.O.B. at the Congo refinery.\nSales of the automotive consumer products are made to the same entities to which lubricant sales are made. The leading products are oil, air and fuel filters, but antifreeze, brake and power steering fluids, fuel additives, spray lubricants and cleaners and automotive undercoatings are also sold.\nQuaker State's U.S. branded motor oil market share has declined in recent years and declined in 1993 as well. The branded motor oil sales volume decreased each quarter of 1993 from the prior year's corresponding quarter except for the fourth quarter when sales volume increased by 13% over the corresponding 1992 period. This increase was due in part to an aggressive consumer promotion from August through November 1993 under which a $4.20 cash rebate was offered for every case of Quaker State motor oil purchased by consumers during the promotion period. In computing its market share percentage, Quaker State includes the installed and packaged (do-it-yourself) markets.\nForeign and Export Sales. Quaker State, Inc. has sold Quaker State branded motor oils in Canada for many years. Sales in Canada are made directly to customers but primarily through independent distributors under contract with the Canadian subsidiary. Canadian sales increased during 1993 as a result of Canadian Tire Company, the largest marketer of motor oil in Canada, electing to sell Quaker State motor oil alongside its own brand it formerly sold exclusively. Quaker State believes that its motor oils are the largest selling branded motor oil in Canada.\nSales of Quaker State branded motor oils are made in Japan by a Quaker State subsidiary formed in 1990 and in Mexico by Comercial Importadora, a Quaker State licensee. Quaker State believes that its motor oils are the largest selling independent branded motor oil in Mexico.\nExport sales of Quaker State branded motor oils are made by Quaker State in 57 foreign countries. These sales are made through independent distributors. Export sales have increased significantly during the 1990's and efforts are being made to further increase these sales. The country to which the largest amount of export sales is made is the Dominican Republic. During 1993, a significant part of the export sales was also made to Poland, Sweden, Guatemala and Taiwan.\nSmall amounts of greases, gear lubes and automotive consumer products such as filters and chemicals are exported to certain foreign countries.\nDuring the three years ended December 31, 1993, total revenues from the foreign operations, including the export sales, have been as follows: 1993-$55,436,000; 1992-$47,389,000 and 1991-$40,932,000. The largest component of the revenues is attributable to Canada.\nMarketing. Quaker State aggressively markets its brand name lubricants and automotive consumer products. In particular, Quaker State relies heavily on media advertising to project the quality image of its motor oils and other products sold under its brand name and to maintain its competitive position.\nIn addition to media advertising, total marketing costs include sponsorship of automobile racing teams, participation in consumer and special automotive trade shows and distribution of point of sale materials. Quaker State also provides marketing allowances to its customers and has incentive programs for its direct retail customers and independent distributors. For 1993, total marketing costs included the cost of the $4.20 cash rebate promotion.\nQuaker State has trademark registrations in effect covering the use of its brand name \"Quaker State\" and other product names, logos and designs utilized in connection with the sale of its products. These registrations, which Quaker State believes have been effective in preventing the use of the name \"Quaker State\" and of the other trademarks by third parties in connection with the sale of petroleum products, expire at various dates, but in each case may be renewed.\nOperating Profit. During the three years ended December 31, 1993, the operating profit for the Motor Oil Division (including the foreign operations) has been: 1993-$17,484,000; 1992-$23,336,000 and 1991-$36,785,000. The operating profit was lower during each quarter of 1993 than for the corresponding\nquarter of 1992. This resulted from lower motor oil sales volumes, increased costs and a decline in the average price of gasoline and fuel oil.\nNATURAL GAS EXPLORATION AND PRODUCTION DIVISION\nNatural Gas--Quaker State owns interests in and explores for and develops natural gas production properties, primarily in the Pennsylvania Grade crude oil producing area (see \"Natural Gas Exploration and Production Division--Crude Oil\" below). As of December 31, 1993, 1992 and 1991, Quaker State had 364, 334 and 302 net productive natural gas wells, respectively, and during the three years ended December 31, 1993, Quaker State's net natural gas production has been: 1993-5,841,000 mcf; 1992-5,635,000 mcf. and 1991-4,610,000 mcf. Quaker State acts as operator of most of the wells.\nSubstantially all the natural gas is sold, and during the three years ended December 31, 1993, the weighted average price per mcf. received by Quaker State for natural gas has been: 1993-$2.30; 1992-$2.26 and 1991-$2.35. Most natural gas is sold directly to industrial customers or to brokers who resell to industrial customers and is transported to these customers from producing areas by common carrier pipelines. Traditionally, wellhead prices for gas produced in the Appalachian Basin reflect the relative proximity of producing areas to large eastern markets. As of December 31, 1993, Quaker State had 43,590,000 mcf. and 23,766,000 mcf. of developed and undeveloped natural gas reserves, respectively.\nCapital expenditures for exploration and development of natural gas production properties have been significant throughout the 1990's. The success of these activities is reflected in the increased production shown above. During 1993, 30.8 net productive developmental and 7.5 net productive exploratory natural gas wells were drilled.\nThe most extensive exploratory drilling has been in the Stagecoach Field in south central New York and north central Pennsylvania where Quaker State has a strong lease position. In January 1994, Quaker State completed an additional gas feeder pipeline in the Stagecoach Field which should increase natural gas sales from this area in 1994.\nCrude Oil--Quaker State produces Pennsylvania Grade crude oil from its own crude oil producing properties. The Pennsylvania Grade crude oil producing area includes parts of southwestern New York, eastern Ohio, western Pennsylvania and West Virginia on the western slopes of the Appalachian Mountains. As of December 31, 1993, 1992 and 1991, Quaker State had 1,208, 1,278 and 1,332 net productive oil wells, respectively, and during the three years ended December 31, 1993 Quaker State's net crude oil production in barrels has been: 1993-423,000; 1992-438,000 and 1991-444,000. Quaker State also acts as operator of most of these wells.\nQuaker State has ceased all exploration for and development of oil wells in New York and northwest Pennsylvania and presently only explores for and develops oil wells elsewhere in the Pennsylvania Grade crude oil producing area on a limited basis. During 1993, 7 net productive developmental oil wells were drilled. As of December 31, 1993, Quaker State had 2,776,000 barrels and 30,000 barrels of developed and undeveloped Pennsylvania Grade crude oil reserves, respectively.\nDuring 1993, crude oil produced by Quaker State accounted for approximately 6.26% of the crude oil processed by the Congo refinery. For segment reporting purposes, crude oil is sold by the Natural Gas Exploration and Production Division to the Motor Oil Division at the same daily market price at which Pennsylvania Grade crude oil is purchased by Quaker State. Certain crude oil produced by Quaker State is sold to third parties.\nOther--Quaker State also receives income from: (i) transporting third party gas through gas gathering systems in which Quaker State has an ownership interest, (ii) overhead fees for operating natural gas and oil wells for others and (iii) timber sales from properties acquired by Quaker State in past years in conjunction with oil and gas activities.\nOperating Profit--During the three years ended December 31, 1993, the operating profit for the Natural Gas Exploration and Production Division has been: 1993-$3,103,000; 1992-$3,835,000 and 1991-$2,762,000.\nThe decline in operating profit in 1993 was due almost entirely to additional dry hole expense. Increased natural gas sales revenues were offset by decreased crude oil sales revenues.\nFAST LUBE OPERATIONS\nQuaker State, through its subsidiaries Quaker State Minit-Lube, Inc. (\"Quaker State Minit-Lube\") and McQuik's Oilube, Inc. (\"McQuik's\"), is one of the largest operators and franchisors of fast service automobile oil change and lubrication centers (i.e., fast lube centers) in the United States. Quaker State Minit-Lube was acquired in November 1985 and McQuik's in May 1989. The administrative offices of Quaker State Minit-Lube and McQuik's are located in Salt Lake City, Utah.\nA typical fast lube center offers 14 services in approximately 15 minutes, including changing the motor oil; replacing filters; lubricating the chassis; adding, if necessary, fluids for the battery, brakes, power steering system, transmission, differential and windshield washer; checking the air filter and windshield wiper blades; checking the level of the antifreeze overflow container; washing the windshield and checking the air pressure in the tires and inflating the tires if necessary.\nAs of December 31, 1993, there were 421 Quaker State Minit-Lube and McQuik's centers in the United States, of which 273 and 34 are owned or leased and operated by Quaker State Minit-Lube and McQuik's, respectively, and of which 58 and 56 are operated by franchisees of Quaker State Minit-Lube and McQuik's, respectively. The McQuik's centers do business under the McQuik's name but do not compete directly with the Quaker State Minit-Lube centers because they are in different locations.\nThe fast lube centers of Quaker State Minit-Lube and its franchisees are located in 19 states primarily in the West, Midwest and Southeast. The fast lube centers of McQuik's and its franchisees are located in 5 states but primarily in Indiana and Ohio. There are also 25 fast lube centers in the Province of Ontario which are owned and operated or franchised by a joint venture between Quaker State Minit-Lube and another company.\nQuaker State Minit-Lube and McQuik's together are one of Quaker State's largest customers. Quaker State supplies most of the motor oils used and sold in the Quaker State Minit-Lube and McQuik's centers, and these centers are the largest users of Quaker State motor oils sold in bulk. For segment reporting purposes, the Quaker State motor oils and other automotive consumer products, such as filters, are sold by the Motor Oil Division to Quaker State Minit-Lube and McQuik's at prices comparable to the prices the Motor Oil Division charges to other customers.\nDuring 1992, Quaker State Minit-Lube converted certain of its company-operated fast lube centers to the name Q Lube, featuring heightened Quaker State identification. In two test markets, sales volumes at stores converted to Q Lube increased 23% over the previous year. The result of these successful conversions was that Quaker State Minit-Lube determined to re-identify virtually all its company-operated fast lube centers as Q Lube centers. As of December 31, 1993, approximately 26% of the company-operated centers were operated under the Q Lube name. Most of the remaining company-operated centers will be converted over time. Consistent with these conversions, effective January 1, 1994 Quaker State Minit-Lube changed its corporate name to Q Lube, Inc. Quaker State believes the conversion to Q Lube centers should contribute higher sales and profits in 1994. As a result of the change of name, Quaker State Minit-Lube is hereinafter referred to in this annual report as Q Lube, Inc.\nOperating Profit. During the three years ended December 31, 1993, the operating profit (loss) for the fast lube operations has been: 1993-$3,045,000; 1992-$1,958,000 and 1991-($1,113,000). The increase in operating profit for 1993 was attributable primarily to the result of disposition during the first quarter by Q Lube, Inc. of 16 fast lube centers in unprofitable markets and reductions in operating costs. The 1992 operating profit is before a one-time charge of $3,200,000 for a reserve for the future replacement of signage and other assets impaired by the planned conversion to Q Lube centers. The operating loss for 1991 has been the only operating loss for the fast lube operations and was primarily attributable to lower car counts per store as a result of the economic climate during 1991 and an environmental charge of $1,600,000.\nINSURANCE OPERATIONS\nQuaker State is engaged in the insurance business through its subsidiary, Heritage Insurance Group, Inc., which in turn is an insurance holding company for members of the Heritage Insurance Group. The Heritage Insurance Group was acquired by Quaker State in July 1984. The administrative offices of the Heritage Insurance Group are located in Agoura Hills, California (near Los Angeles).\nThe principal members of the Heritage Insurance Group are Heritage Life Insurance Company (\"Heritage Life\") and Heritage Indemnity Company (\"Heritage Indemnity\").\nHeritage Life writes credit life insurance and credit accident and health insurance coverages which are issued in connection with the purchase of automobiles and other durable consumer goods. The credit policies insure consumer debtors with the creditor as primary beneficiary. Credit life insurance pays the balance of the consumer loan if the debtor should die, while credit accident and health insurance provides for payment of a consumer's loan installments during the time the consumer is disabled by sickness or accident. Heritage Life, which commenced business in 1957, is licensed to do business in the District of Columbia, Guam and every state except New York.\nHeritage Indemnity Company writes specialty indemnity coverages primarily for automobiles and consumer appliances. Service contract reimbursement insurance is purchased by automobile dealers who are contractually obligated to make repairs under extended warranty service contracts sold to purchasers by the automobile dealers, and mechanical breakdown insurance is purchased by the consumer to cover the cost of mechanical repairs. Heritage Indemnity, which commenced business in 1981, is licensed to do business in the District of Columbia and every state except New York and Connecticut. It operates in New York as a surplus lines carrier.\nHeritage Life and Heritage Indemnity use a general agency system whereby independent salesmen are used to market the insurance products. As of December 31, 1993, Heritage Life and Heritage Indemnity were using approximately 90 and 80 general agents, respectively, throughout the United States. Many of the general agents serve both companies.\nThe primary customers of the general agents are automobile dealerships, many of which also sell Quaker State motor oils and automotive consumer products. Sales of insurance products are made through licensed policy issuing agents who are full-time employees of the automobile dealerships. Other customers of the general agents are boat and motorcycle dealerships, appliance and furniture stores and banks, savings and loan associations and other lending institutions whose employees also act as policy issuing agents. In recent years, increased emphasis has been placed on these customers so as to lessen the dependence of the Heritage Insurance Group on the cyclical automobile sales market.\nHeritage Life and Heritage Indemnity also sell insurance to cover funeral costs and homeowner's insurance, respectively. Heritage Indemnity expects to receive claims in 1994 under homeowner's insurance policies as a result of the January 1994 California earthquake; however, Heritage Indemnity reinsures most of the liability under these policies.\nThe general agents supervise the policy issuing agents. The policy premiums and commissions are generally paid at the time the insurance is sold.\nDuring the three years ended December 31, 1993, direct premiums written by the Heritage Insurance Group have been as follows: 1993-$137,144,000; 1992-$115,670,000 and 1991-$104,146,000.\nDuring the three years ended December 31, 1993, direct premiums written by Heritage Life represented 1993-59.7%; 1992-63.3% and 1991-60.3% of the total direct premiums written.\nFor further information regarding the insurance operations, see Note 5 of the Notes to Consolidated Financial Statements in Quaker State's 1993 Annual Report to Stockholders and the Insurance Schedules filed as a part of this annual report.\nOperating Profit. During the three years ended December 31, 1993, the operating profit for the insurance operations has been: 1993-$3,524,000; 1992-$6,130,000 and 1991-$3,012,000. During 1993, revenues from\nthe insurance operations increased substantially. Premiums earned during each quarter exceeded premiums earned during each corresponding quarter of the prior year. Realized investment gains for each quarter increased as well. Total sales during the third quarter of 1993 were a company record. The decline in operating profit for 1993 is due primarily to the cost of settlement of litigation (see \"Wescal Litigation\" under Item 3 of this annual report).\nTRUCK-LITE\nQuaker State's subsidiary, Truck-Lite Co., Inc. (\"Truck-Lite\"), manufactures vehicular safety lighting equipment, which is sold to original equipment manufacturers and through replacement parts distributors. Truck-Lite's product line consists of custom designed safety and interior lights for passenger cars, light trucks and vans; shock-mounted sealed beam headlamps and sealed and bulb replaceable stop, turn and indicator lights for heavy-duty trucks; and sealed wiring harness systems for heavy-duty truck trailers. The administrative offices of Truck-Lite are located in Falconer, New York.\nTruck-Lite's products for passenger cars, light trucks and vans are generally manufactured in Falconer, New York. The products for the heavy-duty trucks and truck trailers are generally manufactured in McElhattan, Pennsylvania (near Lock Haven). The Falconer facilities are owned; the McElhattan facilities are leased. Products for passenger cars, light trucks and vans are distributed from the Falconer facility. Distribution centers for the products for heavy-duty trucks and truck trailers are located in McElhattan and Sacramento, California. These distribution centers are leased. Truck-Lite also manufactures and sells specially designed heavy-duty lighting products in Europe through a subsidiary formed for this purpose.\nPrior to 1992, all of the Truck-Lite products were manufactured at the Falconer facility. During 1990 and 1991, this facility was expanded to permit construction of new and larger rear-deck lighting assemblies for certain passenger vehicles and the heavy-duty truck and truck trailer operations were transferred to McElhattan. Neither 1991 nor 1992 turned out to be good years for Truck-Lite. In 1991, there was a sharp decline in sales to automakers during part of the year as a result of the recession in the auto industry, there were development and engineering expenses to prepare to manufacture the new rear-deck lighting assemblies and there were costly start-up problems and delays at the new heavy-duty plant. In 1992, automotive losses overwhelmed a strong showing by the heavy-duty division. The automotive losses resulted from higher than anticipated start-up costs associated with the new rear-deck lighting assemblies, lower than anticipated shipments related to the start-up problems and a write-off for unrecoverable development costs primarily associated with the new assemblies.\nThe year 1993 was another story. Strong orders for a variety of automotive safety lights, better than expected replacement demand for heavy-duty truck lights and manufacturing efficiencies resulted in improved sales and operating results throughout the year.\nDuring the three years ended December 31, 1993, Truck-Lite's operating profit (loss) has been: 1993-$5,731,000; 1992-($3,665,000) and 1991-($323,000). Total sales and operating profit for 1993 were company records.\nIn January 1993, Quaker State announced that it intended to offer Truck-Lite for sale and this decision was reported in last year's annual report on Form 10-K. Early in the second quarter of 1993, Quaker State decided to continue to operate Truck-Lite as a manufacturer of vehicular lighting products and ceased its efforts to sell Truck-Lite. The decision was based on a revised view of Truck-Lite's prospects as well as management's conclusion that the value of Truck-Lite was not fully reflected in the offers received.\nDOCKING OPERATIONS\nQuaker State's subsidiary, Valley Camp, Inc., operates iron ore pellet and potash terminals and a bulk materials handling dock accessible to Lake Superior at Thunder Bay, Ontario.\nDuring the three years ended December 31, 1993, the operating profit of the docks business has been: 1993-$1,138,000; 1992-$2,137,000 and 1991-$1,962,000. The figures for 1991 and 1992 include the operating profit of a subsidiary engaged in docking operations which was sold at the end of 1992.\nDISCONTINUED COAL OPERATIONS\nFrom 1976 to 1992, Quaker State was engaged in coal operations through its subsidiary, The Valley Camp Coal Company (\"Valley Camp\"), and Valley Camp's subsidiaries. In December 1992, Valley Camp discontinued its coal operations and, accordingly, its operating results were segregated and reported as discontinued coal operations in Quaker State's 1992 Consolidated Statement of Operations. As of December 31, 1992, assets held for sale related to the discontinued coal operations of approximately $17,400,000 were classified in the Quaker State Consolidated Balance Sheet as \"other current assets\".\nThe cessation of the coal operations continued throughout 1993. On February 11, 1993, Valley Camp's subsidiary, The Helen Mining Company (\"Helen Mining\"), signed an agreement with Pennsylvania Electric Company and New York State Electric and Gas Company which terminated the coal supply contract between Helen Mining and the utilities for the utilities' Homer City Generating Station and resulted in the announcement of the closure of the subsidiary's Homer City Mine. Helen Mining supplied over 100,000 tons of stockpiled coal to the generating station and, as a result of the termination of the coal supply contract, removed its mining equipment for disposal. Another Valley Camp subsidiary, Donaldson Mine Company, delivered 300,000 tons of coal to its customer and then ceased operation of its Donaldson Mines on March 30, 1993. Reclamation work is in process at the Homer City Mine and the Donaldson Mines. Finally, on September 16, 1993 the assets of Valley Camp's subsidiary, Valley Camp of Utah, Inc., were sold for $3,175,000. The financial effects of terminating the Helen Mining coal supply contract, closing and ceasing to operate the mines and the sale of the Utah assets, including the estimated results of operations through the disposal dates, were included in the loss on disposition of the coal operations provided for in the fourth quarter of 1992. As a result of the 1993 transactions, as of December 31, 1993 assets held for sale related to the discontinued coal operations of approximately $4,400,000 remained classified in the Quaker State Consolidated Balance Sheet as \"other current assets\".\nAs of December 31, 1992, Valley Camp and its subsidiaries had 555 employees. Hourly employees were covered by a pension plan of the United Mine Workers of America. Salaried employees are covered by Quaker State's salaried pension plan. As of December 31, 1993, Valley Camp and its subsidiaries had 17 employees.\nFor further information with respect to the discontinued coal operations, see Notes 3 and 12 of the Notes to Consolidated Financial Statements contained in Quaker State's 1993 Annual Report to Stockholders.\nFINANCIAL INFORMATION BY BUSINESS SEGMENT\nFinancial information as to Quaker State's operations by business segments (i.e., Motor Oil Division, Natural Gas Exploration and Production Division, fast lube operations, insurance operations, Truck-Lite and docking operations) is set forth in the segment information table which appears on page 20 of Quaker State's 1993 Annual Report to Stockholders as well as under the heading \"Management's Discussion and Analysis\" which appears on pages 17 through 19 of such Annual Report to Stockholders. This financial information is incorporated in this item by reference.\nCertain information (identifiable assets, capital expenditures and depreciation, depletion and amortization) relating to the discontinued coal operations is included in the segment information table and is incorporated in this item by reference.\nCAPITAL EXPENDITURES\nDuring the three years ended December 31, 1993, total capital expenditures, including capital expenditures of the discontinued coal operations, were as follows: 1993-$29,760,000; 1992-$25,706,000 and 1991-$32,037,000. In 1993, 1992 and 1991, 36.6%, 38% and 35.9% of the capital expenditures, respectively, were by the Natural Gas Exploration and Production Division and 38.5%, 29.3% and 26.8% of the capital expenditures, respectively, were by the Motor Oil Division. The expenditures by the Natural Gas Exploration and Production Division were for exploration for and development of natural gas production and in 1993 and 1992 construction of the additional gas feeder pipeline in the Stagecoach Field. In the Motor Oil Division, an oxygenate injection system for gasoline was installed at the Congo refinery and expenditures were incurred for\na new one quart motor oil container in 1993, equipment for increased oil dewaxing capacity was installed at the Congo refinery in 1992 and a gas desulphurization unit was installed at the Congo refinery in 1991. Expenditures by the fast lube operations increased from 13.6% of total capital expenditures in 1992 to 18.6% in 1993 as a result of the conversion of Quaker State Minit-Lube centers to Q Lube centers.\nCapital expenditures for 1994 are estimated to be approximately $37,000,000, of which approximately 28% is anticipated to be used for natural gas development and approximately 26% for further fast lube store conversions.\nENVIRONMENTAL EXPENDITURES\nCapital expenditures for pollution control facilities during the three years ended December 31, 1993 included in the capital expenditures referred to above were as follows: 1993-$1,823,000; 1992-$1,950,000 and 1991-$3,777,000. Capital expenditures for pollution control facilities during 1994 are expected to amount to approximately $4,800,000.\nThe capital expenditures for pollution control facilities in 1993 and 1992 included upgrading and replacing underground storage tanks in the fast lube operations and in 1991 included installation of the gas desulphurization unit at the Congo refinery. In all three years, expenditures were also made in connection with new drilling in the Natural Gas Exploration and Production Division. Anticipated expenditures in 1994 for pollution control facilities include installation of a new isomerization unit and a platformer revamp at the Congo refinery, expenditures related to new drilling in the Natural Gas Exploration and Production Division, continued upgrading and replacement of underground storage tanks in the fast lube operations and installation of air emission monitoring equipment at the Truck-Lite facilities.\nQuaker State and certain of its subsidiaries have received notices from the United State Environmental Protection Agency and a similar state agency that they may be responsible for response and cleanup costs with respect to certain Superfund sites (see Item 3 of this annual report).\nQuaker State sold its crude oil refinery at St. Mary's, West Virginia in December 1987. The purchaser filed for bankruptcy in December 1988 and in August 1991 the bankruptcy trustee sold the refinery to a second purchaser. In connection with this transaction, Quaker State provided certain indemnities with respect to the environmental conditions at the refinery. In May 1990, Quaker State sold its crude oil refinery at Farmers Valley, Pennsylvania and a wax plant (formerly also a crude oil refinery) at Emlenton, Pennsylvania and provided the purchaser with similar indemnities. Quaker State expects that it will incur some expenditures related to these indemnities and also expects that it will incur some expenditures for environmental conditions associated with its discontinued coal operations.\nFor further information with respect to environmental expenditures, see the information under the heading \"Management's Discussion and Analysis\", and Notes 1, 3 and 9 of the Notes to Consolidated Financial Statements, contained in Quaker State's 1993 Annual Report to Stockholders.\nCASH DIVIDENDS\nQuaker State reduced the quarterly dividend on the Quaker State Capital Stock payable on September 15, 1993 to $.10 per share. Quarterly dividends of $.20 per share had been declared regularly since 1986. The reason for the decrease was that Quaker State had paid out more in cash dividends than it had earned after-tax in five of the preceding six calendar years. The dividends declared by the Board of Directors payable December 15, 1993 and March 15, 1994 were also $.10 per share.\nCOMPETITION\nThe branded motor oil business is highly competitive. In the United States, the major competitors of Quaker State are Pennzoil Company (Pennzoil), Ashland Oil, Inc. (Valvoline), Texaco, Inc. (Havoline) and Burmah Castrol Limited (Castrol). In foreign countries, Quaker State competes with foreign manufacturers (including some that are government owned) as well as most of its major competitors in the United States. Many of the competitors, particularly the major integrated oil companies, have substantially greater finished\nmotor oil capacities and financial resources than Quaker State. The principal methods of competition are product quality, distribution capability, advertising and sales promotion. Quaker State also competes with Pennzoil Company, Ashland Oil, Inc. and Witco Chemical Corporation in the purchase of Pennsylvania Grade crude oil.\nThe fast lube operations are also highly competitive. The major competitors of Quaker State are Jiffy Lube International, Inc. (a subsidiary of Pennzoil) and Ashland Oil, Inc. through its Valvoline Instant Oil Change centers. In addition to competing with other fast lube centers, Quaker State's subsidiaries Q Lube, Inc. and McQuik's compete with local automobile dealers, service stations and garages. The principal methods of competition are quality of service, price and sales promotion.\nThe Heritage Insurance Group competes with many stock and mutual insurance companies, many of which offer more diversified insurance coverages. In addition, some large lenders to the consumer market and some large automobile manufacturers have established credit insurance subsidiaries. The principal methods of competition are service to customers and agents, expertise in tailoring insurance programs to the specific needs of clients and personal involvement by key executives.\nTruck-Lite competes with other independent manufacturers as well as with companies owned by truck and automobile manufacturers. The principal methods of competition are quality, price and technical innovation.\nEMPLOYEES\nAs of December 31, 1993, Quaker State and its subsidiaries had 3,831 full-time employees (excluding employees of its discontinued coal operations) as follows: Quaker State-1,056, Q Lube, Inc. and McQuik's-1,966, the Heritage Insurance Group-180 and Truck-Lite-629. The 118 employees engaged in natural gas and crude oil production are included in the number for Quaker State. The year-end 1993 total compares with 3,715 full-time employees as of December 31, 1992 (excluding employees of its discontinued coal operations). As of December 31, 1993, there were also 346 part-time employees, of which 319 were employed by Q Lube, Inc. and McQuik's.\nThe principal unions are the Oil, Chemical and Atomic Workers International Union (\"OCAW\") which represents employees at the Congo refinery and the International Association of Machinists and Aerospace Workers which represents Truck-Lite employees. The labor agreements with OCAW and the Truck-Lite union expire in January 1996 and in June 1995, respectively. Other unions include the International Brotherhood of Electrical Workers, which represents employees at the blending and packaging plant at Vicksburg, Mississippi, and local unions of the International Brotherhood of Teamsters which represent employees at a number of locations.\nQuaker State and its subsidiaries have non-contributory pension plans covering substantially all of their employees. Plans covering salaried employees provide pension benefits that are generally based on the employees' compensation and length of service. Plans covering hourly employees provide benefits of stated amounts for each year of service. Quaker State and certain of its subsidiaries also provide substantially all retired salaried and hourly employees with certain postretirement benefits, principally health care and life insurance. For more information regarding pension and other postretirement benefits, see Note 12 of the Notes to Consolidated Financial Statements contained in Quaker State's 1993 Annual Report to Stockholders.\nRESEARCH AND DEVELOPMENT\nResearch and development activities relate primarily to the Motor Oil Division where continued improvement of Quaker State motor oils and other lubricants and the development of new or improved automotive consumer products are emphasized. Research and development personnel develop quality control programs to assure the continuous production of high quality products and provide extensive technical services in the manufacturing, packaging and sales and marketing operations as well as to customers.\nIn 1993, the complete Quaker State passenger car motor oil line was reformulated to a new API category, SH\/CD, to provide improved performance.\nAlthough Quaker State believes research and development activities are vitally important to its Motor Oil Division, the dollar amount expended on these activities is not material. Research and development activities are also important to Truck-Lite, although the amount expended on these activities is also not material.\nGOVERNMENT REGULATION\nEnvironmental--Quaker State and certain of its subsidiaries are subject to various Federal, state and local air, water, land use and waste management laws and regulations. In particular, these laws and regulations affect the motor oil manufacturing operations, the natural gas and crude oil producing activities and the fast lube operations. In the motor oil manufacturing area, permits are required for the discharge of water used in operations into navigable waters and for certain hazardous waste activities. Air pollution regulations apply to emissions from boilers. In the natural gas and crude oil producing activities, the laws and regulations relate principally to the prohibited discharge of crude oil into navigable waters, the disposal of wastes such as brine from drilling operations and the cleanup and plugging of wells upon abandonment of producing properties. In the fast lube operations, waste management regulations apply to the disposition of used motor oil and other petroleum products.\nInsurance--The Heritage Insurance Group, in common with the insurance industry generally, is subject to regulation and supervision in all jurisdictions in which its members are licensed to transact business. This regulation and supervision is designed primarily to protect policyholders. The method of insurance regulation varies from state to state, but generally, regulation has been delegated to state insurance commissioners who are granted broad administrative powers relating to the licensing of insurers and their agents, the nature of and limitations on investments, approval of policy forms, reserve requirements and trade practices. Many classes of insurance, including most of the insurance offered by the Heritage Insurance Group, are subject to premium rate regulations which require that premiums be reasonable, adequate and not unfairly discriminatory. In certain states, minimum loss ratios required for credit insurance indirectly limit the premiums that can be charged by an insurer. Commissions are also often governed by state laws, with maximum commission levels, commission structures and timing of payment subject to regulation. In addition, certain state laws establish minimum statutory capital and surplus requirements for insurance companies and restrict the amount of dividends that can be paid by an insurance company without regulatory approval (see Note 5 of the Notes to Consolidated Financial Statements in Quaker State's 1993 Annual Report to Stockholders).\nTruck-Lite--Truck-Lite's products are subject to regulations of the Federal Department of Transportation which govern the brightness, placement and physical durability of lighting.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation with respect to the location and general character of the materially important principal properties of Quaker State and its subsidiaries, identified by the business segments utilizing such properties, is included in Item 1 of this annual report and is incorporated in this Item by reference thereto.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nCongo Refinery Environmental Litigation. In December 1993, the United States of America commenced a lawsuit against Quaker State in the United States District Court for the Northern District of West Virginia. The Complaint alleges, inter alia, that Quaker State has violated the federal Resource Conservation and Recovery Act and the federal Clean Air Act at its Congo, West Virginia refinery. The Complaint alleges that several units that are part of the plant wastewater treatment system also receive hazardous waste and should properly be characterized and permitted as hazardous waste surface impoundments. Quaker State has contended that these units are tanks and are exempt from federal hazardous waste regulation as part of a federally permitted wastewater treatment system, and under other exemptions. If characterized as surface impoundments, the United States alleges that the structures have not had interim permit status since 1980, that Quaker State has violated various regulations relating to testing, operation and closure of the structures\nand that Quaker State's management of the units has constituted improper treatment and disposal of hazardous wastes at the Congo refinery at various dates after 1990. The Complaint also alleges that Quaker State has failed to provide proper notice to the United States Environmental Protection Agency (the \"USEPA\") and failed to use proper emission controls and techniques during asbestos removal operations at the Congo refinery during 1990, 1991 and 1992. The Complaint requests injunctive relief and civil penalties not exceeding $25,000 for each day of violation of the Resource Conservation and Recovery Act and of the Clean Air Act. Quaker State intends to vigorously defend this lawsuit but the ultimate outcome of the lawsuit cannot be predicted. For further information with respect to this lawsuit, see the information under the heading \"Management's Discussion and Analysis\", and Note 9 of the Notes to Consolidated Financial Statements, contained in Quaker State's 1993 Annual Report to Stockholders.\nSuperfund Matters. In December 1988, Q Lube, Inc. received a notice from the USEPA pursuant to the Comprehensive Environmental Response, Compensation and Liability Act, as amended, that Q Lube, Inc. might be a \"potentially responsible party\" responsible for response and cleanup costs with respect to a waste disposal site known as the Petrochem\/Ekotek Superfund Site in Salt Lake City, Utah. In August 1989, Q Lube, Inc. and 34 other respondents entered into a Consent Order under which the respondents agreed to fund the costs of the cleanup of the surface of the contaminated property. The respondents have advanced $10,000,000 toward these costs, of which Q Lube, Inc.'s share has amounted to approximately $500,000. The respondents, in conjunction with the USEPA, are continuing to investigate the extent of contamination at the property and further remedial action by the respondents is contemplated. As of December 31, 1993, Q Lube, Inc. had an accrual of $1,700,000 for this matter.\nQuaker State and certain of its subsidiaries have received similar notices from the USEPA under the same legislation to the effect that each may be a \"potentially responsible party\" responsible for cleanup costs with respect to a waste disposal site identified by the USEPA. In addition, Quaker State has received a similar notice from the California Department of Toxic Substances Control (the \"DTSC\") under the same legislation as well as a California statute. The USEPA and DTSC are conducting investigations regarding alleged releases or threatened releases of hazardous substances from these sites and have contacted all parties who may have arranged for the disposal, treatment or transportation of hazardous substances to the sites.\nFor further information with respect to Superfund matters, see the information under the heading \"Management's Discussion and Analysis,\" and Note 9 of the Notes to Consolidated Financial Statements, contained in Quaker State's 1993 Annual Report to Stockholders.\nOil Express Litigation. In October 1990, Quaker State commenced an action in the Circuit Court of the Eighteenth Judicial Circuit, Du Page County, Illinois against Oil Express National, Inc. (\"Oil Express\") and certain of its franchisees and principals. Oil Express is an operator and franchisor of fast lube centers in Illinois, Indiana and Tennessee. The Complaint alleges breaches of contract by the defendants in failing to repay certain loans made by Quaker State and in failing to comply with their contractual obligations for the purchase of Quaker State motor oils, and a conspiracy among the defendants to induce breaches of their contracts with Quaker State. Quaker State is seeking compensatory damages and lost profits in the amount of approximately $275,000 and punitive damages of $500,000.\nIn April 1992, Oil Express filed a counterclaim and a third party claim in the proceeding against Quaker State and its subsidiary Q Lube, Inc. alleging breach of and a conspiracy to breach an alleged marketing agreement to pay a portion of the advertising and promotional expenses of Oil Express, breach of and a conspiracy to breach an alleged agreement not to compete with Oil Express or its franchisees in the fast lube business in the Chicago metropolitan area and a conspiracy to damage a competitor. Oil Express seeks damages of $525,000 on the counts alleging breach of and a conspiracy to breach the alleged marketing agreement and damages of $8,000,000 on the counts alleging breach of and a conspiracy to breach the alleged agreement not to compete and seeks compensatory and punitive damages of $18,000,000 on the count alleging a conspiracy to damage a competitor.\nIn June 1992, Quaker State and Q Lube, Inc. filed motions to dismiss the counterclaim and third party claim which were denied. The litigation has progressed through discovery and will be tried before a jury. A late 1994 trial date is anticipated. Quaker State has vigorously prosecuted its action against the defendants and\nboth Quaker State and Q Lube, Inc. have vigorously defended the counterclaim and third party claim against them. Quaker State and Q Lube, Inc. believe that all the claims against them are without merit and that the damages sought by Oil Express are grossly exaggerated in the pleadings solely to provide the defendants with leverage to defend Quaker State's action against the defendants.\nEmployment Litigation. In October 1993, Larry Tucker and 13 other former salaried supervisory employees of Donaldson Mine Company, a subsidiary of Quaker State's subsidiary The Valley Camp Coal Company (\"Valley Camp\"), instituted an action in the Circuit Court of Kanawha County, West Virginia against Quaker State, Valley Camp and Donaldson Mine Company. The suit alleges that each of the plaintiffs had a verbal and\/or written contract of employment with the defendants which was breached by termination of the plaintiffs' employment, that the defendants intentionally and unlawfully discriminated against the plaintiffs because of their age in violation of state law, that the plaintiffs were not paid their rightful compensation and earned fringe benefits at the time of termination of employment and that the defendants breached an expressed and implied covenant of good faith and fair dealing with respect to the plaintiffs. Each plaintiff claims damages in the amount of $1,250,000 for loss of income and benefits, impairment of earning capacity and emotional distress, $1,250,000 for punitive damages and in addition the costs of a search for new employment, attorneys fees and costs of suit. In March 1994, the plaintiffs filed a motion to amend the Complaint to add similar claims on behalf of five additional individuals. Quaker State, Valley Camp and Donaldson Mine Company intend to vigorously defend this proceeding.\nQuaker State is also a defendant in several other proceedings brought by individual plaintiffs seeking damages as a result of termination of employment. These proceedings are being vigorously defended as well.\nWindfall Profit Tax Litigation. In prior annual reports on Form 10-K, Quaker State has referred to this litigation under which the United States Government sought payment by Quaker State of additional Federal windfall profit taxes for the third and fourth quarters of 1983 on the ground that during the period Quaker State was an integrated oil company instead of an independent producer. In August 1991, the United States Claims Court held that Quaker State was an integrated oil company and not an independent producer because it qualified as a retailer during 1983, and in July 1992 the Claims Court entered judgment for the Government against Quaker State in the amount of $456,851 for each of the third and fourth quarters of 1983, plus interest. Quaker State then appealed the decision of the Claims Court to the United States Court of Appeals for the Federal Circuit. The appeal was argued during March 1993 and on June 2, 1993 the decision of the Claims Court was affirmed by the Court of Appeals. A petition for rehearing by the Court of Appeals was denied. Had Quaker State been successful in the appeal, Quaker State would have been entitled to file claims for refund of Federal windfall profit taxes paid for the first and second quarters of 1983 as well as for 1984 and 1985. As of December 31, 1992, Quaker State had accrued for the Claims Court judgment and related interest in its consolidated financial statements. The amount of the judgment and related interest have been paid and this litigation has been concluded.\nWescal Litigation. In November 1989, Jerrald Axelrod and Theodore E. Dahl doing business as Wescal Credit Insurance (\"Wescal\") commenced an action in the Superior Court of California, County of Orange, against Heritage Life Insurance Company (\"Heritage\"), a subsidiary of Quaker State's subsidiary The Heritage Insurance Group, Inc., and against Quaker State. Quaker State was subsequently dismissed from the suit. Wescal is engaged in the business of selling credit life and disability insurance in connection with mortgages and other long term loans. Heritage and Wescal entered into an agreement in 1984, under which Wescal agreed to produce insurance business for Heritage in return for several forms of compensation. The contract was subsequently amended in 1988, and notice of termination of this agreement was given by Heritage in 1990. The Complaint in this matter was amended six times and ultimately alleged breach by Heritage of the 1984 agreement, as amended, by competing with Wescal, by failing to pay on a timely basis commissions due Wescal, by failure to provide reports to Wescal, and by failing to process credit life insurance business produced by Wescal. The Complaint also alleged fraud, intentional interference with prospective economic advantage, negligent interference with prospective economic advantage, and conspiracy to interfere with contractual relations. Compensatory and punitive damages in unspecified amounts were sought in the Complaint as amended. Heritage denied the allegations of the amended Complaint. Trial before a jury commenced in July 1993 and the jury returned a verdict in favor of Wescal and against Heritage in the\namount of $5,130,900 for breach of contract, $13,136,458 for intentional and negligent interference with prospective economic advantage and for $1,000,000 for punitive damages. Pre-judgment interest of approximately $2,400,000 was added to the verdict by the Court. Heritage filed motions for a new trial and for judgment notwithstanding the verdict but the motions were denied. The litigation was then settled and concluded by Heritage paying Wescal $6,500,000 in December 1993 and agreeing to pay an additional $3,450,000 to Wescal in December 1994. The settlement was made without any admission by Heritage of any liability on its part. For further information with respect to this litigation, see Note 5 of the Notes to Consolidated Financial Statements contained in Quaker State's 1993 Annual Report to Stockholders.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the fourth quarter of 1993.\nEXECUTIVE OFFICERS OF QUAKER STATE\nThe executive officers of Quaker State are set forth below:\nMr. Baum has been Chairman of the Board and Chief Executive Officer and a Director of Quaker State since June 1993. He was Executive Vice President of Campbell Soup Company from November 1989 to June 1993, President, Campbell North and South America, Campbell Soup Company's largest operating division, from January 1992 to June 1993 and Senior Vice President of Campbell Soup Company from prior to 1989 to November 1989. The Motor Oil Division reports directly to Mr. Baum.\nMr. Conrad has been President and Chief Operating Officer of Quaker State since February 1990. He has been a Director of Quaker State since January 1988. He was Vice President, Finance and Chief Financial Officer of Quaker State from prior to 1989 to February 1990. The Natural Gas Exploration and Production Division, the fast lube operations, the insurance operations and Truck-Lite report directly to Mr. Conrad.\nMr. Ellenburg has been Executive Vice President of Quaker State since August 1993. He was Vice President of Quaker State from prior to 1989 to August 1993 and has also been the President and Chief Operating Officer of the Motor Oil Division since February 1990. He has been a Director of Quaker State since December 1990. The Motor Oil Division is responsible for the manufacture of Quaker State's lubricants\nand fuels, the purchase and gathering of crude oil and all marketing, sales, distribution and research and development activities relating to Quaker State's lubricants, fuels and automotive consumer products.\nMr. Callahan has been Vice President, General Counsel and Secretary of Quaker State since June 1993; he was Vice President, Counsel and Corporate Secretary of Quaker State from prior to 1989 to June 1993.\nMr. Keefer has been Vice President, Finance and Chief Financial Officer of Quaker State since February 1990; he was also Treasurer of Quaker State from prior to 1989 through May 1992.\nMr. Hogue has been Controller of Quaker State since May 1992. He was Corporate Accounting Manager of Quaker State from April 1991 to May 1992 and Manager of Reporting Accounting of Quaker State from prior to 1989 to April 1991.\nMr. McCauley has been Treasurer of Quaker State since May 1992. He was Assistant Treasurer of Quaker State from January 1989 to May 1992.\nMr. Noel has been Vice President, Chief Purchasing Officer of Quaker State since January 1994. He was Marketing Director, Specialty Products of the Motor Oil Division from September 1990 to January 1994 and General Manager, Blending and Packaging of Quaker State from prior to 1989 to September 1990.\nMr. Smith has been Vice President, Human Resources of Quaker State since December 1993. He was Director, Human Resources of Quaker State from prior to 1989 to December 1993.\nMrs. White has been Vice President, Environmental and Government Affairs of Quaker State since August 1993. She was Corporate Environmental Director of Quaker State from January 1991 to August 1993, Manager of Environmental Affairs of Quaker State from January 1990 to January 1991 and Manager of Administration Operations for the Natural Gas Exploration and Production Division from prior to 1989 to January 1990.\nMr. Bechtel has been Executive Vice President, Sales of the Motor Oil Division since November 1993. He was President of Bechtel and Associates, a sales consulting firm, from October 1992 to November 1993 and Executive Vice President, Sales of 21st Century Foods, Inc. from September 1992 to November 1993. Before that, he was Executive Vice President and Chief Operating Officer of Old Fashioned Kitchens, Inc. from August 1991 to September 1992, Executive Vice President, Sales and Marketing of Slim-Fast Foods, Inc. and President of the Powdered Drink Division of Slim-Fast Foods, Inc. from August 1989 to August 1991 and Vice President, New Business Development of Campbell Soup Company from prior to 1989 to August 1989.\nMr. Cohen has been Executive Vice President, Marketing of the Motor Oil Division since September 1993. He was President of Marketcom, Inc. and Senior Managing Partner of Vendmark Ltd., an affiliate of Marketcom, Inc., from prior to 1989 to September 1993.\nMr. Chickering has been Vice President, Installed Motor Oil Business of the Motor Oil Division since January 1994. He was Vice President, Marketing Services of the Motor Oil Division from August 1993 to January 1994, Vice President, Marketing of the Motor Oil Division from May 1990 to August 1993, Vice President, Southern Region of the Motor Oil Division from June 1989 to May 1990 and Sales Manager, Southwest Region of the Motor Oil Division from prior to 1989 to June 1989.\nMr. Fleischer has been Vice President, Refining and Manufacturing of the Motor Oil Division since August 1993. He was Plant Manager of the Congo refinery from August 1989 to August 1993 and Plant Manager of Quaker State's former Farmers Valley refinery from prior to 1989 to August 1989.\nMr. LaFave has been Vice President, Western Region Sales of the Motor Oil Division since January 1994. He was Manager, National Account Sales Coordination of the Motor Oil Division from prior to 1989 to January 1994.\nMr. Marshall has been Vice President, Northern Region Sales of the Motor Oil Division since December 1993. He was Executive Vice President, Sales of the Motor Oil Division from January 1993 to\nDecember 1993, Vice President, Northern Region of the Motor Oil Division from June 1989 to January 1993 and Vice President, Sales of Quaker State from prior to 1989 to June 1989.\nMr. McArdle has been Vice President, Packaged Motor Oil Marketing of the Motor Oil Division since January 1994. He was Director of Retail Sales Development of the Motor Oil Division from September 1993 to January 1994, Vice President, Advertising and Marketing of Pennzoil Products Company from November 1990 to September 1993 and Director of Marketing of Castrol, Inc. from prior to 1989 to November 1990.\nMr. McConnell has been Vice President, Southern Region Sales of the Motor Oil Division since October 1990. He was Charlotte, North Carolina Regional Manager of Hunter Engineering Company, a manufacturer of wheel service equipment, from prior to 1989 to October 1990.\nMr. Murphy has been Vice President, National Accounts and New Business Development of the Motor Oil Division since January 1994. He was Assistant to the Executive Vice President, Sales of the Motor Oil Division from December 1993 to January 1994, owner of Marken, Inc., an operator of a retail grocery store, from June 1989 to October 1993 and Director of Sales Planning of Campbell Soup Company from prior to 1989 to June 1989.\nThere is no family relationship between any executive officer of Quaker State and any Director or other executive officer of Quaker State.\nThe executive officers of Quaker State and of the Motor Oil Division are elected annually by the Board of Directors immediately after each Annual Meeting of Stockholders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Quaker State Capital Stock is listed on the New York Stock Exchange and the Pacific Stock Exchange and trades under the trading symbol KSF. The information required by this Item 5 insofar as market prices of Quaker State Capital Stock are concerned appears under the caption \"Quaker State (KSF) Market Prices by Quarter\" on page 36 of Quaker State's 1993 Annual Report to Stockholders, insofar as dividends declared on the Quaker State Capital Stock are concerned appears in Note 13 of the Notes to Consolidated Financial Statements contained in Quaker State's 1993 Annual Report to Stockholders and insofar as the number of holders of record of the Quaker State Capital Stock is concerned appears under the caption \"Five-Year Summary of Net Income and Comparative Statistical Data\" on page 21 of Quaker State's 1993 Annual Report to Stockholders. All such information is incorporated in this annual report by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this Item 6 appears under the caption \"Five-Year Summary of Net Income and Comparative Statistical Data\" on page 21 of Quaker State's 1993 Annual Report to Stockholders and is incorporated in this annual report by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Discussion and Analysis of Results of Operations and Financial Condition required by this Item 7 appears on pages 17 through 19 of Quaker State's 1993 Annual Report to Stockholders and is incorporated in this annual report by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS.\nThe following financial statements and related report on the consolidated financial statements of Quaker State and its subsidiaries for the years ended December 31, 1993, 1992 and 1991 required by this Item 8 appear on the pages indicated in Quaker State's 1993 Annual Report to Stockholders and are incorporated in this annual report by reference:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were no such events and therefore this Item is not applicable.\nPART III\nITEMS 10 THROUGH 13.\nIn accordance with the provisions of General Instruction G to Form 10-K, the information required by Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) FINANCIAL STATEMENTS:\nThe consolidated financial statements of Quaker State and its subsidiaries, together with the report of Coopers & Lybrand, dated January 25, 1994, appearing on pages 22 through 35 and on page 36, respectively, of Quaker State's 1993 Annual Report to Stockholders are incorporated in this annual report by reference (see Item 8 above).\n(a)(2) FINANCIAL STATEMENT SCHEDULES:\nThe financial statement schedules and related report listed below are filed as part of this annual report:\nAll other financial statement schedules are omitted either because they are not applicable or are not material, or the information required therein is contained in the consolidated financial statements or notes thereto set forth in Quaker State's 1993 Annual Report to Stockholders.\n(a)(3) EXHIBITS:\nThe exhibits listed below are filed as a part of this annual report:\n- - ---------\n* Management contract or compensatory plan, contract or arrangement required to be filed by Item 601(b)(10)(iii) of Regulation S-K.\nQuaker State agrees to furnish to the Commission upon request copies of all instruments not listed above which define the rights of holders of long-term debt of Quaker State and its subsidiaries.\nCopies of the above exhibits are available at a cost of $.20 per page to any stockholder upon written request to the Secretary, Quaker State Corporation, 255 Elm Street, Oil City, Pennsylvania 16301.\n(B) REPORTS ON FORM 8-K:\nNo events which resulted in the filing of a current report on Form 8-K occurred during the fourth quarter of 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Quaker State has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 23, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Quaker State in the capacities indicated on March 23, 1994.\nLeonard M. Carroll, Laurel Cutler, C. Fred Fetterolf, Thomas A. Gardner, H. Bryce Jordan, W. Craig McClelland, Delbert J. McQuaide and Raymond A. Ross, Jr.\n\/S\/ GERALD W. CALLAHAN By __________________________ Gerald W. Callahan, Attorney-In-Fact\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo Stockholders Quaker State Corporation:\nOur report on the consolidated financial statements of Quaker State Corporation and Subsidiaries has been incorporated by reference in this Form 10-K from page 36 of the 1993 Annual Report to Stockholders of Quaker State Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 19 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND Pittsburgh, Pennsylvania January 25, 1994\nS-1\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE II. AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - ---------\n(A) One year promissory note with interest rate of 3.59%. Note repaid within 60 days of issuance.\nS-2\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE V. PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - --------- (A) Interdivisional and\/or intercompany transfers and adjustments.\n(B) Includes the sale of certain coal assets of $33,178,000 at December 30, 1992. Assets of $113,995,000 were written off due to the classification of coal as discontinued operations. Coal property of $11,016,000 at December 31, 1992 was transferred to other current assets on the Consolidated Balance Sheet as assets held for sale. At December 31, 1993, $3,870,000 of coal property is included in other current assets on the Consolidated Balance Sheet as assets held for sale. See Note 3 of Notes to Consolidated Financial Statements.\n(C) Includes a reclassification of approximately $4,100,000 to intangible assets.\nThe following table summarizes the years over which assets (other than oil and gas producing properties and mineral lands) are generally depreciated:\nS-3\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE VI. ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - --------- (A) Interdivisional and\/or intercompany transfers and adjustments.\n(B) Charge to accelerate depreciation for replacement of certain assets. See Note 2 of Notes to Consolidated Financial Statements.\n(C) Includes the sale of certain coal assets of $27,733,000 at December 30, 1992. Depreciation reserves of $66,060,000 were written off due to the classification of coal as discontinued operations. See Note 3 of Notes to Consolidated Financial Statements.\n(D) Includes a reclassification of approximately $1,000,000 to intangible assets.\nS-4\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - --------- (A) Accounts and notes receivable written off during the year.\nSCHEDULE X. SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\nS-5\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE I. SUMMARY OF INSURANCE INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 1993 (THOUSANDS OF DOLLARS)\nS-6\nQUAKER STATE CORPORATION AND SUBSIDIARIES\nSCHEDULE V. SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - ---------\n(1) The allocation of net investment income and other operating expenses for life and accident and health insurance is based on their respective pro-rata percent of unearned premium reserves. Net investment income and other operating expenses for mechanical breakdown insurance and other are based on actual amounts. Net investment income excludes intercompany interest on loan to Quaker State.\n(2) Represents policy acquisition costs expensed when incurred.\nNote: Premiums written do not agree with premium revenue on the income statement due to income recognition policy. See Note 1 of Notes to Consolidated Financial Statements. Additionally, effective January 1, 1993, the company adopted Statement of Financial Accounting Standard No. 113, \"Accounting for Reinsurance of Short-Duration and Long-Duration Contracts.\" See Note 5 of Notes to Consolidated Financial Statements.\nS-7\nQUAKER STATE CORPORATION AND SUBSIDIARIES SCHEDULE VI. REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (THOUSANDS OF DOLLARS)\n- - --------- (A) Amount does not agree with income statement due to the income recognition policy. See Note 1 of Notes to Consolidated Financial Statements.\nNote: Prior year ceded and assumed accident and health insurance premiums have been restated to eliminate the effect of reinsurance transactions with one reinsurer with no impact to earned premiums.\nS-8\nFORM 10-K\nQuaker State Corporation EXHIBIT INDEX\nThe following exhibits are required to be filed with this annual report on Form 10-K. Exhibits are incorporated herein by reference to other documents pursuant to Rule 12b-23 under the Securities Exchange Act of 1934, as amended, as indicated in the index. Exhibits not incorporated herein by reference follow this index.\n- - ---------------- * Management contract or compensatory plan, contract or arrangement required to be filed by Item 601(b)(10)(iii) of Regulation S-K.","section_15":""}
{"filename":"827165_1993.txt","cik":"827165","year":"1993","section_1":"ITEM 1. BUSINESS (Continued)\nSeverance of Relationship With Southmark Corporation (Continued)\nIn exchange for the assets transferred to the Company, the Company transferred to Southmark mortgage notes guaranteed by Southmark and several of its affiliates, under a keepwell agreement, which represented a substantial portion of the Company's mortgage notes receivable portfolio and approximately 34% of the Company's total assets. A participation in another mortgage note owned by the Company was also transferred to Southmark. Many of the mortgage notes so transferred were either in default or expected by the Company's management to go into default. See ITEM 3. \"LEGAL PROCEEDINGS - Settlement of Southmark Adversary Proceedings.\"\nManagement of the Company\nAlthough the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\"), a contractual advisor under the supervision of the Company's Board of Directors. The duties of the Advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources for the Company. The Advisor also serves as a consultant in connection with the Company's business plan and investment policy decisions made by the Company's Board of Directors.\nBCM is a corporation beneficially owned by a trust for the benefit of the children of Gene E. Phillips, the Chairman of the Board and a Director of the Company until November 16, 1992. Ryan T. Phillips, the son of Gene E. Phillips and a Director of the Company, is also a director of BCM and a trustee of the trust for the benefit of the children of Gene E. Phillips which owns BCM. Mr. Phillips served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of the trust for the benefit of his children that owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company. As of March 31, 1994, BCM owned 1,105,951 shares of the Company's Common Stock, approximately 38% of the shares then outstanding. BCM is more fully described in ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\" BCM has provided advisory services to the Company since February 6, 1989. BCM also serves as advisor to CMET, IORT and TCI. BCM resigned as advisor to NIRT effective March 31, 1994. The officers of the Company are also officers of CMET, IORT and TCI. Oscar W. Cashwell, a Director of the Company serves as President of BCM, CMET, IORT and TCI and as President and a director of Syntek Asset Management, Inc. (\"SAMI\"), the managing general partner of SAMLP , the general partner of NRLP and NOLP. Mr. Phillips is also a general partner of SAMLP. BCM performs certain administrative functions for NRLP and NOLP on a cost reimbursement basis.\nITEM 1. BUSINESS (Continued)\nManagement of the Company (Continued)\nSince February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides such property management services. In many cases, Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management of the Company's shopping center to Carmel Realty, Inc. (\"Carmel Realty\") which is owned by SWI. Affiliates of the Advisor are also entitled to receive real estate brokerage commissions in accordance with the terms of the Advisory Agreement as discussed in ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\"\nThe Company has no employees. Employees of the Advisor render services to the Company.\nCompetition\nThe real estate business is highly competitive and the Company competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\"), some of which may have greater financial resources than those of the Company. The Company's management believes that success against such competition is dependent upon the geographic location of the property, the performance of property managers in areas such as marketing, collections and the ability to control operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartment properties, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Company's management believes that general economic circumstances and trends and the development of new properties in the vicinity of each of the Company's properties are also competitive factors.\nTo the extent that the Company seeks to sell any of its real estate portfolio, the sales prices for such properties may be affected by competition from governmental and financial institutions seeking to liquidate foreclosed properties.\nAs described above and in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions,\" the officers of the Company also serve as officers of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to the Company's. The Advisor owes fiduciary duties to such other entities as\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\nwell as to the Company under applicable law. In determining to which entity a particular investment opportunity will be allocated, the Advisor considers the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity's existing real estate and mortgage notes receivable portfolios. To the extent that any particular investment opportunity is appropriate to more than one of such entities, such investment opportunity will be allocated to the entity which has had uninvested funds for the longest period of time or, if appropriate, the investment may be shared among all or some of such entities.\nIn addition, also as described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships,\" the Company also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Company's and that may compete with the Company in purchasing, selling, leasing and financing real estate and real estate- related investments. In resolving any potential conflicts of interest which may arise, the Advisor has informed the Company that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.\nCertain Factors Associated with Real Estate and Related Investments\nThe Company is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and availability of permanent mortgage financing which may render the acquisition, sale or refinancing of a property difficult or unattractive and which may make debt service burdensome; changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes and other acts of God and other factors beyond the control of the Advisor or the Company. The illiquidity of real estate investments generally may impair the ability of the Company to respond promptly to changing circumstances. The Company's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Company's real estate and mortgage notes receivable portfolios. However, to the extent new property acquisitions and mortgage lending are concentrated in any particular region the advantages of geographic diversification may be mitigated.\nVirtually all of the Company's mortgage notes receivable, real estate and equity securities of CMET, IORT, TCI and NRLP are held subject to secured indebtedness. Such borrowings increase the Company's risks of loss because they represent a prior claim on the Company's assets and require fixed payments regardless of profitability. If the Company defaults on such secured indebtedness, the lender may foreclose on the Company's assets securing such indebtedness, and the Company could lose its investment in the pledged assets.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal offices are located at 10670 North Central Expressway, Suite 300, Dallas, Texas 75231. In the opinion of the Company's management, the Company's offices are adequate for its present operations.\nDetails of the Company's real estate and mortgage notes receivable portfolios at December 31, 1993, are set forth in Schedules XI and XII, respectively, to the Consolidated Financial Statements included at ITEM 8. \"CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\" The discussions set forth below under the headings \"Real Estate\" and \"Mortgage Loans\" provide certain summary information concerning the Company's real estate and mortgage notes receivable portfolios.\nAt December 31, 1993, the mortgage notes receivable secured by the Continental Hotel and Casino and by the Las Vegas Plaza Shopping Center, both of which are in Las Vegas, Nevada, net of applicable premiums, discounts, interest and deferred gains, accounted for 13% and 12%, respectively, of the Company's total assets. No other single asset of the Company accounted for 10% or more of its total assets. At December 31, 1993, 34% of the Company's assets consisted of real estate, 33% consisted of notes and interest receivable and 29% consisted of investments in the equity securities of CMET, IORT and TCI and NRLP. The remaining 4% of the Company's assets were invested in cash, cash equivalents and other assets. It should be noted, however, that the percentage of the Company's assets invested in any one category is subject to change and no assurance can be given that the composition of the Company's assets in the future will approximate the percentages listed above.\nThe Company's real estate is located in various geographic regions of the continental United States, with a concentration in the Southeast region, as shown more specifically in the table under \"Real Estate\" below. The Company also holds mortgage notes receivable secured by real estate located in various geographic regions of the continental United States, with a concentration in the Mountain and Midwest regions, as shown more specifically in the table under \"Mortgage Loans\" below.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nITEM 2. PROPERTIES (Continued)\nGeographic Regions\nThe Company has divided the continental United States into the following six geographic regions.\nNortheast region comprised of the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia.\nSoutheast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia.\nSouthwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas.\nMidwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin.\nMountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming.\nPacific region comprised of the states of California, Oregon and Washington.\nReal Estate\nAt December 31, 1993, approximately two-thirds of the Company's assets were invested in real estate and real estate entities. The Company invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. The Company's real estate portfolio consists of properties held for investment, investments in partnerships, properties held for sale (primarily obtained through foreclosure) and investments in equity securities of CMET, IORT, TCI and NRLP.\nTypes of Real Estate Investments. The Company's real estate consists of commercial properties, primarily office buildings and shopping centers, and apartment complexes or similar properties having established income-producing capabilities. In selecting real estate, the location,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nage and type of property, gross rentals, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are considered. The Company may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its real estate. The Company's Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of the Company's stockholders.\nAt December 31, 1993, the Company was completing significant capital improvements to the Park Plaza Shopping Center in Manitowoc, Wisconsin, and considering major improvements to the KC Holiday Inn, if construction financing can be obtained.\nIn the opinion of the Company's management, the real estate owned by the Company is adequately covered by insurance.\nThe following table sets forth the percentages, by property type and geographic region, of the Company's owned real estate (excluding land and two hotels described below) at December 31, 1993.\nThe foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Company, and does not reflect the value of the Company's investment in each region. Excluded from the above table are two residential subdivisions in Texas with a total of 74 developed lots, 3.5 acres of undeveloped land in downtown Atlanta, Georgia, 1.84 acres of undeveloped land in Maricopa County, Arizona, 34 acres of land in Denver, Colorado subject to a ground lease, a hotel located in Kansas City, Missouri and a shut down hotel located in Lihue, Hawaii. See Schedule XI to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for a more detailed description of the Company's real estate portfolio.\nA summary of activity in the Company's owned real estate portfolio during 1993 is as follows:\nOwned properties in real estate portfolio at January 1, 1993.................................... 19* Property acquired through purchase....................... 1 Property obtained through foreclosure.................... 1 Property sold............................................ (1) --- Owned properties in real estate portfolio at December 31, 1993.................................. 20* ___________________________________\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n* Includes two residential subdivisions with a total of 212 developed lots at January 1, 1993 and 74 developed lots at December 31, 1993.\nProperties Held for Investment. Set forth below are the Company's properties held for investment (excluding land subject to ground lease in Denver, Colorado) and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1993 and 1992:\n___________________________\n* Property was acquired in 1993.\nOccupancy presented above and through this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.\nIn May 1992, the Company acquired Fox City, a shopping center in Culver City, California for $5.7 million subject to first and second lien mortgage debt equal to the purchase price. In August 1993, the Company sold the shopping center for net cash of $416,000 with the buyer assuming first and second lien mortgage debt aggregating $5.5 million. The Company incurred a loss of $85,000 on the sale. A 3% sales commission of $180,000 was paid to Carmel Realty, based upon the $6.0 million sales price of the property.\nIn June 1992, the Company purchased the Park Plaza Shopping Center in Manitowoc, Wisconsin. The $4.2 million mortgage secured by the shopping center was scheduled to mature on May 1, 1995. Effective June 1, 1993 the mortgage was amended extending its maturity date to May 10, 2003, providing for a variable interest rate of 6% to 8% per annum and requiring monthly payments of principal and interest.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn addition, the same lender made a second loan, also effective June 1, 1993, in the amount of up to $1.0 million to be used for capital and tenant improvements to the shopping center. The new loan required monthly interest only payments at the prime rate plus 2% per annum with principal and accrued but unpaid interest due at maturity. Cash was advanced by the lender upon costs being incurred for the improvements. In the event that all sums advanced on the new loan were repaid by May 31, 1994, the principal balance of the first mortgage was to be reduced by the lesser of $500,000 or one-half of the amount advanced on the new loan. The outstanding balance of the new loan, $887,000, was paid in full on December 23, 1993, with the Company receiving a credit of $443,000 against the first mortgage reducing its balance to $3.7 million at December 31, 1993. The Company also deposited $105,000 into an escrow account to complete remaining parking lot and exterior renovations at the shopping center. The Company is also to receive a credit against the first mortgage for one-half of these monies as expended.\nOn December 23, 1993, the Company refinanced Watersedge III Apartments in the amount of $4.2 million. The Company realized net refinancing proceeds of $924,000 after the payoff of the existing mortgage of $3.0 million and payment of associated refinancing costs. The new mortgage matures January 1, 2019, bears interest at 8.73% per annum through December 31, 2003, and at a variable rate thereafter through maturity. Monthly payments of principal and interest are required. The balance of principal and accrued but unpaid interest is due at maturity. The Company paid a loan arrangement fee of $12,000 to BCM on the $4.1 million refinancing.\nAlso on December 23, 1993, the Company refinanced the Edgewater Gardens Apartments in the amount of $2.9 million. The Company realized net refinancing proceeds of $728,000 after the payoff of the existing mortgage of $1.9 million and payment of associated refinancing costs. The new mortgage contains the same interest, repayment terms and maturity date as the Watersedge III mortgage described above. The Company paid a loan arrangement fee of $9,000 to BCM on the $2.9 million refinancing.\nIn May 1993, the Company obtained a $1.8 million first mortgage secured by the Rosedale Towers Office Building in Minneapolis, Minnesota, which was previously unencumbered. The Company pledged as additional collateral for the loan 141,176 newly issued shares of the Company's Common Stock. The mortgage bears an effective annual interest rate of 25% and calls for monthly payments of $25,000, with the balance of principal and accrued but unpaid interest due at maturity on May 4, 1994. The Company paid a loan arrangement fee of $21,000 to BCM on the $1.8 million financing.\nIn 1992, a mortgage note receivable with an original principal balance of $1.0 million, secured by a second lien on the Boulevard Villas Apartments in Las Vegas, Nevada, became nonperforming. Subsequently,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nthe borrower on the note filed for bankruptcy protection. In October 1992, the Company reached an agreement with the first lienholder to acquire its first mortgage of $8.3 million for $6.8 million, paying $1.0 million upon signing the purchase agreement with the balance due in June 1993. In June 1993, the Company and the first lienholder modified the note purchase agreement to allow the Company to become the owner of the first mortgage and foreclose on the collateral property. The first lienholder provided purchase money financing for the then balance owed under the note purchase agreement. The Company foreclosed on the collateral property in July 1993. In October 1993, the Company refinanced the property in the amount of $6.0 million. The Company realized net refinancing proceeds of $280,000 after the payoff of the existing mortgage of $5.3 million and the establishment of required repair and tax escrows and the payment of associated refinancing costs. The new mortgage bears interest at 9% per annum, matures November 1996, and requires monthly payments of principal and interest of $63,984. The Company acquired the first mortgage with the intent of acquiring the collateral property, hence the Boulevard Villas Apartments are classified as held for investment. The Company paid a loan arrangement fee of $60,000 to BCM on the $6.0 million refinancing.\nProperties held for sale. At December 31, 1993, the Company owned two residential subdivisions in Texas with a total of 74 developed lots, as discussed below, 3.5 acres of undeveloped land in downtown Atlanta, Georgia, 1.84 acres of undeveloped land in Maricopa County, Arizona, two hotels, one in Hawaii that is closed and the KC Holiday Inn in Kansas City, Missouri, obtained through foreclosure, also as described below, an office building in St. Louis, Missouri and a restaurant site in California, all of which are held for sale. See Schedule XI to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nIn April 1991, the Company paid $208,000 in cash to acquire all of the capital stock of a corporation which owned 181 developed residential lots in Fort Worth, Texas subject to $1.2 million of mortgage debt owed to CMET. The loan was paid in full in August 1993. During 1993, 56 of the residential lots were sold for an aggregate gain of $220,000. At December 31, 1993, 44 lots remained to be sold. As of March 31, 1994, the Company owned approximately 30% of CMET's outstanding shares of beneficial interest and CMET owned approximately 7% of the outstanding shares of the Company's Common Stock.\nIn 1991, the Company purchased for $930,000 in cash, all of the capital stock of Denton Road Investment Corporation (\"Denton Road\"), a corporation which owns a 60% interest in a joint venture which in turn owned 113 partially developed residential lots in Denton, Texas. Proceeds from lot sales were applied to reduce the debt secured by the lots until March 30, 1993, when the debt was repaid in full. During 1993, 37 of the residential lots were sold for an aggregate gain of $356,000. At December 31, 1993, 30 lots remained to be sold.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nAt December 31, 1992, the Company held a first lien leasehold mortgage note receivable with an outstanding principal balance of $7.0 million secured by the KC Holiday Inn, in Kansas City, Missouri. The borrower failed to make the required March 1993 interest payment and at March 31, 1993, the Company recorded the insubstance foreclosure of the hotel. In April 1993, title to the hotel was conveyed to a wholly-owned subsidiary of the Company subject to the Company's note receivable. The KC Holiday Inn had an estimated fair value (minus estimated costs of sale) of $5.2 million at the date of foreclosure. The Company incurred no loss on foreclosure in excess of the amounts previously provided. The Company's note receivable is pledged as collateral for a $3.0 million loan to the Company from a financial institution.\nAs of December 31, 1993, the Company recorded a provision for losses of $2.0 million to reduce the carrying value of 3.5 acres of undeveloped land in downtown Atlanta, Georgia to its then estimated fair value based on an independent appraisal completed in March 1994.\nMortgage Loans\nIn addition to real estate, a substantial portion of the Company's assets have been and are expected to continue to be invested in mortgage notes receivable, principally those secured by income-producing properties. The Company's mortgage notes receivable consist of first, wraparound, and junior mortgage loans.\nTypes of Mortgage Activity. In addition to originating its own mortgage loans, the Company has acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. BCM, in its capacity as a mortgage servicer, services the Company's mortgage notes receivable.\nTypes of Properties Subject to Mortgages. The types of properties securing the Company's mortgage notes receivable portfolio at December 31, 1993 consisted of office buildings, apartment complexes, shopping centers, single-family residences, hotels and developed land. The Company's Board of Directors may alter the types of properties subject to mortgages in which the Company invests without a vote of the Company's stockholders.\nAt December 31, 1993, the obligors on $5.5 million or 10% of the Company's mortgage notes receivable portfolio were affiliates of the Company. Also at that date, $27.3 million or 49% of the Company's mortgage notes receivable portfolio was in default.\nThe following table sets forth the percentages (based on the outstanding mortgage note balance at December 31, 1993), by both property type and geographic region, of the properties that serve as collateral for the Company's mortgage notes receivable at December 31, 1993. See Schedule\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nXII to the Consolidated Financial Statements included at ITEM 8. \"CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for additional details of the Company's mortgage notes receivable portfolio.\nA summary of the activity in the Company's mortgage notes receivable portfolio during 1993 is summarized as follows:\nLoans in mortgage notes receivable portfolio at January 1, 1993................................ 20* Loan originated......................................... 1 Loans paid in full...................................... (2) Loans foreclosed........................................ (2) Loan settlement......................................... (1) Loans written off as uncollectible...................... (2) --- Loans in mortgage notes receivable portfolio at December 31, 1993.............................. 14* ____________________________\n* Includes a mortgage note receivable collateralized by two condominium mortgage loans.\nDuring 1993, the Company collected $4.6 million in interest and $1.5 million in principal on its mortgage notes receivable. The Company plans, for the foreseeable future, to hold, to the extent its liquidity permits, rather than to sell in the secondary market, the mortgage notes in its portfolio.\nFirst Mortgage Loans. The Company may invest in first mortgage loans, with either short-, medium- or long-term maturities. These loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate or negative amortization of principal and a \"balloon\" principal payment at maturity. With respect to first mortgage notes, it is the Company's general policy to require that the borrower provide a mortgagee's title policy or an acceptable legal opinion of title as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. The Company may grant to other lenders participations in first mortgage loans originated by the Company.\nThe following discussion briefly describes the events that affected previously funded first mortgage loans during 1993.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nIn September 1989, the Company entered into a participation agreement in the amount of $20.0 million in a pool of various assets with the Collecting Bank, National Association, a bank in liquidation (\"Collecting Bank\"). On the same date, the Company entered into a term loan in the same amount with First City, Texas-Dallas, N.A. (\"First City\"), a sister association of Collecting Bank. The Company pledged to First City its interest in the participation agreement with Collecting Bank as collateral for the term loan. The principal and interest on the participation and the term loan were each due in 20 quarterly installments through October 1994. In October 1992, both Collecting Bank and First City were placed under the receivership of the Federal Deposit Insurance Corporation (\"FDIC\"). In October 1993, the Company and the FDIC agreed to terminate both the participation and term loan agreements each having a principal balance of $7.6 million. The Company recorded a $58,000 gain on the termination of the agreements.\nIn June 1991, the Company entered into an asset sales agreement with an insurance company whereby the Company sold real estate and participations in various of its assets in an effort to develop a potential source for future financing and to generate cash from otherwise illiquid assets. The sales agreement, as amended, included a guarantee by each of the parties of a 10% rate of return on the assets transferred. Assets transferred by the Company pursuant to the asset sales agreement included a retail shopping center in Lubbock, Texas, with a carrying value of $2.0 million prior to transfer, a $1.5 million senior participation in a second lien mortgage note secured by a retail shopping center in Las Vegas, Nevada, with a carrying value of $18.8 million prior to transfer, a $315,000 participation in a first mortgage note on unimproved land in Virginia Station, Virginia and a $799,000 participation in a second lien mortgage note secured by apartments in Flagstaff, Arizona. In return, the Company received a $1.9 million participation in a first mortgage note secured by a hotel property in Lihue, Hawaii, a $1.0 million assignment in a first mortgage note secured by land in Maricopa County, Arizona, a $118,000 first mortgage note secured by a single-family residence in Silver Creek, Colorado and $1.5 million in cash. The asset sales agreement contained put and guaranty provisions whereby, at any time, either party could demand that the seller reacquire any asset sold pursuant to the terms of the asset sales agreement for the consideration originally received within fifteen days of exercising its put option. In March 1992, the Company received payment in full on the $118,000 note secured by the single-family residence in Silver Creek, Colorado.\nIn March 1992, the insurance company was placed in receivership and in June 1992, the Company provided notice to the insurance company, under the terms of the put and guaranty provisions of the asset sales agreement, of its desire to divest itself of all assets received. The Receiver has refused to allow the enforcement of the put and guaranty provisions of the asset sales agreement. On September 3, 1992, the court approved the Receiver's Petition of Order of Liquidation for the insurance company.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nIn March 1992, the Company recorded a provision for loss of $496,000 to reduce the note receivable secured by land in Maricopa County, Arizona to its then estimated fair value. The Company foreclosed on the land securing the note in June 1992. In December 1992, the Company recorded an additional provision for loss on such land of $349,000, to reduce the carrying value of the land to its then estimated fair value. During September 1992, the Company recorded the insubstance foreclosure of a hotel in Lihue, Hawaii, which secured a $1.9 million first mortgage participation received by the Company. Subsequently, the hotel suffered severe hurricane damage and was shut down. The Company is continuing to evaluate its options with regard to these assets and is also in settlement negotiations with the Receiver and does not expect to incur any loss in excess of the amounts previously provided.\nThe borrower on a $1.7 million first mortgage note receivable secured by land in Osceola, Florida failed to make the required March 1, 1993 payment of principal and interest. The Company accelerated the note and instituted foreclosure proceedings. In April 1993, the borrower brought the note current and the note was reinstated. Concurrent with reinstatement, the note was modified, the maturity date of October 1, 1995 was changed to November 1, 1993 and the interest rate was increased to 12% per annum. The borrower was also given two six month extension options. The borrower failed to make the May 1 through August 1 interest payments on the modified note when due. On August 10, 1993, the borrower again brought the note current. The borrower has made no payments on the note subsequent to that date, including the payment of principal and interest due at the note's November 1, 1993 maturity. The note had a principal balance of $1.6 million at December 31, 1993. The Company instituted judicial foreclosure proceedings and was awarded a summary judgment in January 1994. On March 8, 1994, the borrower paid a nonrefundable fee of $50,000 to delay the sale of the property at foreclosure for 45 days. The Company does not expect to incur any loss upon foreclosure as the estimated fair value of the collateral property exceeds the carrying value of the note.\nThe borrower on a $1.9 million first mortgage note receivable failed to make the principal payment due on December 31, 1992, the note's maturity date. The note is secured by a vacant property, formerly a hotel, in Shaker Heights, Ohio, which the borrower plans to convert into a nursing home. The Company has granted several extensions on the note, with the most recent extension expiring on December 31, 1992. The borrower has requested another extension, which the Company is considering. On March 26, 1994, the borrower's \"certificate of need,\" which is required to accomplish the nursing home conversion, expired. The borrower has applied for a renewal of such certificate, however, there is no assurance that the renewal will be granted. If extension negotiations with the borrower are unsuccessful, and the Company forecloses the collateral property, no loss is anticipated in excess of the amounts previously provided.\nAs discussed in \"Real Estate\" above, in March 1993, the Company recorded the insubstance foreclosure of the KC Holiday Inn, the collateral\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nsecuring a first mortgage note receivable with a principal balance of $7.0 million at the date of foreclosure.\nThe Company did not receive the payment due on October 1, 1991 on the first mortgage note receivable, secured by the 386 Ocean Parkway Co-op. In February 1994, the Company agreed to reinstate and modify its note in exchange for the pledge to the Company, as additional collateral, of 21 shares in the co-op equating to 21 unsold apartment units. The reinstated note reduces the principal balance from $900,000 to $750,000, waives all defaults on the note prior to the execution of the reinstatement documents, and extends the maturity date of the note to September 15, 1999, with interest only payments at 7% per annum for the first two years, 8% per annum for the second two years and 9% per annum for the balance of the term with the principal balance due at maturity. The Company is negotiating the sale of its first mortgage note and as of December 31, 1993, recorded a provision for losses of $300,000 to reduce the carrying value of its note to its estimated sales price. No additional loss is anticipated in excess of the amount provided.\nWraparound Mortgage Loans. The Company may invest in wraparound mortgage notes, sometimes called all-inclusive notes, made on real estate subject to prior mortgage indebtedness. A wraparound mortgage note is a mortgage note having an original principal amount equal to the outstanding balance under the prior existing mortgage debt plus the amount actually advanced under the wraparound mortgage note.\nWraparound mortgage notes may provide for full, partial or no amortization of principal. The Company's policy is to make wraparound mortgages in amounts and on properties as to which it would otherwise make a first mortgage loan. The following discussion briefly describes events that affected previously funded wraparound mortgage loans during 1993.\nIn August 1990, the Company foreclosed on its fourth lien note receivable secured by the Continental Hotel and Casino in Las Vegas, Nevada. The note had an outstanding principal balance as of the date of foreclosure of $9.2 million. The Company acquired the hotel and casino property at foreclosure subject to first and second lien mortgages totaling $10.0 million and a disputed third lien mortgage. In June 1992, the Company sold the hotel and casino to the third lienholder for a $22 million wraparound mortgage note receivable, a $500,000 unsecured note receivable, and $100,000 in cash. The $22 million note bears interest at 11%, matures June 19, 1995, and calls for monthly interest payments of $175,000 through December 1993, $250,000 through June 1, 1995 and a balloon payment at maturity. The $500,000 note was paid off on July 30, 1993. The Company recorded a deferred gain of $4.3 million in connection with the sale of the hotel and casino resulting from the disputed third lien mortgage being subordinated to the Company's wraparound mortgage note receivable. Payments of interest and principal on the Company's wraparound note receivable were made directly by the borrower to the holder of the first and second lien mortgages and were\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\napplied against interest and principal thereon. Since October 1993, the borrower has failed to make the monthly payments required by the Company's wraparound mortgage note receivable to the holder of the first and second lien mortgages. The Company and the underlying lienholder have accelerated their notes. The Company's wraparound mortgage note receivable had a principal balance of $22.7 million at December 31, 1993, including compounded interest. The Company is negotiating with the borrower and the underlying lienholder to modify and extend both the Company's wraparound mortgage note receivable and the underlying first and second liens. The Company expects to be successful in such negotiations, however, if it should lose the collateral property to the underlying lienholder it would incur a loss of $12.4 million.\nJunior Mortgage Loans. The Company may invest in junior mortgage notes. Such notes are secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such notes ordinarily includes the real estate which secures the note, other collateral and personal guarantees of the borrower.\nThe following discussion briefly describes the events that affected previously funded junior mortgage notes, during 1993.\nAs discussed in \"Real Estate\" above, in October 1992 the Company acquired the first mortgage secured by the Boulevard Villas Apartments, a property that also secured a second lien mortgage owed to the Company of $1.4 million. In June 1993, the Company foreclosed on the collateral property.\nAt December 31, 1992, the Company held a mortgage note receivable which it had acquired in 1989, with a principal balance of $590,000 secured by a third lien on a commercial property in South Carolina and personal guaranties of several individuals. In May 1992, a settlement was entered into between the Company and the guarantors. In accordance with the terms of the settlement, (i) the borrower made a principal reduction payment of $127,812, (ii) monthly interest payments at a rate of 10% per annum began on June 1, 1992 and (iii) the maturity date was extended to May 11, 1993. Effective May 11, 1993, the Company and the guarantors of the note entered into a modification to the settlement agreement. The note was modified to bear interest at 18% per annum, have a maturity date of October 1, 1993, and provide for monthly principal payments of $200,000 July 1, 1993 through October 1, 1993. The Company received none of the payments required by the modified note. Effective September 1, 1993, the Company and the guarantors entered into a second modification. The guarantors paid $100,000, reducing the note's principal balance by $68,000 and bringing interest current to September 1, 1993. The second modification extends the note's maturity date to September 1, 1995, requires monthly interest payments at 12% per annum beginning October 1, 1993 and a $25,000 principal reduction payment every ninety days beginning December 1, 1993. The principal balance of the note was $497,000 at December 31, 1993 and the note was current. The Company does not expect to incur a loss in excess of the amounts previously provided.\nITEM 2. PROPERTIES (Continued)\nOther Loans\nIn April 1990, SAMLP made a $1.4 million unsecured loan to Equity Health and Finance Corporation (\"Equity Health\"), an entity affiliated with BCM, the Company's advisor. The Company owns a 76.8% limited partner interest in SAMLP which it consolidates for financial statement purposes. The Equity Health note bears interest at 12% per annum, originally matured on April 10, 1991 and has been subsequently extended to May 9, 1994. In June 1991, Equity Health merged into BCM and BCM assumed the note. The outstanding balance of the note was $477,000 at December 31, 1993, including accrued but unpaid interest.\nIn May 1990, the Company guaranteed up to $3.0 million of a $14.0 million loan secured by a hotel in California. In return for such guarantee, the borrower was required to pay an annual fee to the Company of $45,000 of which only the fee due in 1990 was paid. Because it located the financing for the hotel and a party to guarantee the loan, an entity beneficially owned by Mr. Phillips was granted a profits participation by the borrower and was to receive certain other consideration. The guarantee was to continue in effect until all of the guaranteed obligations had been paid, performed, satisfied and discharged. In April 1991, the Company advanced $357,000 on a note secured by the hotel, pursuant to the guarantee and an additional $101,000 was advanced in June 1991, also on a note secured by the hotel.\nIn January 1992, the Company received notice that the lender had declared an event of default on the $14.0 million loan and in June 1993 that the lender had foreclosed on the hotel securing the loan. In January 1994, the Company and the lender reached an agreement in principle relating to the Company's performance under its guarantee. Under the proposed agreement the Company will pay a total of $750,000 to the lender, payable $100,000 upon completion of documentation and the balance of $650,000 due within 120 days of the date of first payment. The Company also agreed to transfer any other rights or assets the Company held in the hotel to the lender in return for cancellation of the guarantee. The Company wrote off its two notes receivable secured by the foreclosed hotel as uncollectible as of December 31, 1993. The Company did not incur a loss with respect to either its guarantee or the notes in excess of the amounts previously provided.\nInvestments in Real Estate Investment Trusts and Real Estate Partnerships\nThe Company's investment in real estate entities includes equity securities of three publicly traded real estate investment trusts (collectively the \"Trusts\"), CMET, IORT and TCI, units of limited partner interest of NRLP and a general partnership interest in NRLP and NOLP, through its 76.8% limited partner interest in SAMLP and 50% interests in real estate joint venture partnerships. Mr. Phillips, Chairman of the Board and a Director of the Company until November 16, 1992, is a general partner of SAMLP, which serves as general partner of NRLP and NOLP. BCM serves as advisor to the Trusts, and performs certain administrative and management functions for NRLP and NOLP on behalf of SAMLP.\nITEM 2. PROPERTIES (Continued)\nInvestments in Real Estate Investment Trusts and Real Estate Partnerships (Continued)\nIn addition to the equity securities of the Trusts and NRLP acquired from Southmark in connection with the Southmark Separation Agreements, the Company has made additional investments through private and open market purchases of the equity securities of each of such entities. The Company's cost with respect to shares of the Trusts at December 31, 1993 totaled $18.5 million, and its cost with respect to units of limited partner interest in NRLP totaled $23.0 million. The aggregate carrying value (cost plus\/minus equity in income\/losses and less distributions received) of such equity securities of the Trusts and NRLP at December 31, 1993 was $31.1 million and the aggregate market value of such equity securities was $44.3 million. The aggregate investee book value of the equity securities of the Trusts and the Company's share of NRLP's revaluation equity based upon the December 31, 1993 financial statements of each entity was $48.5 million and $113.0 million, respectively. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nIn 1990, the Company's Board of Directors authorized and in May 1993 reaffirmed the expenditure by the Company of up to an aggregate of $17.0 million to acquire additional units of NRLP and shares of the Trusts. As of March 31, 1994, the Company had expended $11.3 million to acquire units of NRLP and an aggregate of $4.2 million to acquire shares of the Trusts in accordance with this authorization. The Company expects to make additional investments in the equity securities of such entities to the extent permitted by its liquidity.\nIn September 1992, the Company agreed to sell its entire holdings in NIRT at the then market price to Mr. Friedman, the President and a Director of the Company until December 31, 1992, members of his family and his affiliates. Until March 31, 1994, NIRT had the same advisor as the Company. The agreement provided for the Company to sell its 741,592 NIRT shares at the then market price of $6.875 per share. As of December 31, 1993, the Company had transferred all of its NIRT shares to Mr. Friedman and his affiliates, the Company having received as payment $2.9 million in cash ($657,000 in 1992) and $2.2 million in securities of NRLP (42,260 units at $20.50 per unit), TCI (118,500 shares at $5.25 per share), IORT (10,075 shares at $5.375 per share) and CMET (105,095 shares at $6.625 per share). In September 1992, the Company wrote the carrying value of its NIRT shares down to their agreed sales price and discontinued accounting for its investment in NIRT under the equity method.\nAt December 31, 1993, SAMLP, the general partner of NRLP and NOLP, owned 17,650 shares of TCI. The Company owns a 76.8% limited partnership interest in SAMLP which the Company consolidates for financial statement purposes.\nThe purchases of the equity securities of the Trusts and NRLP were made for the purpose of investment and were based principally on the opinion of the Company's management that the equity securities of each were and are currently undervalued. The determination by the Company to purchase additional equity securities of the Trusts and NRLP is made on an\nITEM 2. PROPERTIES (Continued)\nInvestments in Real Estate Investment Trusts and Real Estate Partnerships (Continued)\nentity-by-entity basis and depends on the market price of each entity's equity securities relative to the value of its assets, the availability of sufficient funds and the judgment of the Company's management regarding the relative attractiveness of alternative investment opportunities.\nBecause the Company may be considered to have the ability to exercise significant influence over the operating and investing policies of these entities, the Company accounts for its investment in the Trusts, NRLP, and the joint venture partnerships under the equity method of accounting. Substantially all of the Company's equity securities of the Trusts and NRLP are pledged as collateral for borrowings.\nPertinent information regarding the Company's investment in the equity securities of the Trusts and NRLP, entities, which are accounted for under the equity method at December 31, 1993, is summarized below (dollar amounts in thousands):\n____________________\n* At December 31, 1993, NRLP reported a deficit partners' capital. The Company's share of NRLP's revaluation equity, however, was $113.0 million. Revaluation equity is defined as the difference between the appraised value of the partnership's real estate, adjusted to reflect the partnership's estimate of disposition costs, and the amount of the mortgage notes payable and accrued interest encumbering such property as reported in NRLP's Annual Report on Form 10-K for the year ended December 31, 1993.\nEach of the Trusts and NRLP own a considerable amount of real estate, much of which, particularly in the case of NRLP, has been held for many years. Because of depreciation, these entities may earn substantial amounts in quarters in which they sell real estate and will probably incur losses in quarters in which they do not. The Company's reported income or loss attributable to these entities will differ materially from its cash flow attributable to them.\nITEM 2. PROPERTIES (Continued)\nInvestments in Real Estate Investment Trusts and Real Estate Partnerships (Continued)\nThe Company does not have a controlling equity interest in any of the investees set forth in the table above and therefore it cannot, acting by itself, determine either the individual investments or the overall investment policies of such investees. However, due to the Company's equity investments in, and the existence of common officers with, each of the Trusts, and that Mr. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP, and that the Trusts have the same advisor as the Company and that Mr. Cashwell, a Director of the Company, is also the President of the Trusts and BCM, the Company's advisor, and the President and a director of SAMI, the managing general partner of NRLP and NOLP, the Company may be considered to have the ability to exercise significant influence over the operating and investing policies of these entities. Accordingly, the Company accounts for its investment in these entities under the equity method. Under the equity method, the Company recognizes its proportionate share of the income or loss from the operations of these entities currently, rather than when realized through dividends or on sale. The carrying value of these entities, set forth in the table above, is the original cost of each such investment adjusted under the equity method for the Company's proportionate share of each entity's income or loss and distributions received.\nThe following is a summary description of each of NRLP and the Trusts, based upon information publicly reported by such entities.\nNRLP. NRLP is a publicly traded master limited partnership which was formed under the Delaware Uniform Limited Partnership Act on January 29, 1987. It commenced operations on September 18, 1987 when, through NOLP, it acquired all of the assets, and assumed all of the liabilities, of 35 public and private limited partnerships sponsored by or otherwise related to Southmark. NRLP is the sole limited partner of NOLP and owns 99% of the beneficial interest in NOLP. NRLP and NOLP operate as an economic unit and, unless the context otherwise requires, all references herein to \"NRLP\" shall constitute references to NRLP and NOLP as a unit. The general partner and owner of 1% of the beneficial interest in each of NRLP and NOLP is SAMLP, a Delaware limited partnership. In November 1992, NOLP transferred 52 apartment complexes and a wraparound mortgage note receivable to Garden Capital, L.P. (\"GCLP\"), a Delaware limited partnership in which NOLP owns a 99.3% limited partnership interest. Concurrent with such transfer sale, GCLP refinanced all of the mortgage debt associated with the transferred properties and the wraparound mortgage note under a new first mortgage of $223 million.\nThe Company is a limited partner in SAMLP, holding a 76.8% limited partner interest therein, which the Company consolidates for financial statement purposes. The Company has an option which expires December 27, 1994 to acquire Southmark's 19.2% limited partner interest in SAMLP for $2.4 million, less any distributions received by Southmark. See ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSettlement of Southmark Adversary Proceedings\nDuring 1990 and 1991, several adversary proceedings were initiated against the Company and others by Southmark and its affiliates. On December 27, 1991, an agreement to settle all claims in connection with the Southmark adversary proceedings was executed by Southmark and the Company. The settlement covers all claims between Southmark and its affiliates and Messrs. Phillips and Friedman, SWI, NRLP, IORT, TCI, CMET, NIRT, VPT and the Company. The final settlement of such litigation concludes all suits in which the Company was a defendant. Pursuant to the settlement agreement, Southmark will receive $13.2 million from the various settling defendants. Payments totaling $11.9 million were made in 1992 and 1993 and the remaining $1.3 million is scheduled to be paid by June 27, 1994.\nThe Company paid Southmark $1.0 million in each of 1992 and 1993, and will pay Southmark an additional $435,000 by June 27, 1994. In addition, on February 25, 1992, the Company assigned Southmark a 19.2% limited partner interest in SAMLP, the general partner of NRLP and NOLP, and the Company received Southmark's interest in Novus Nevada. The Company has an option which expires on December 27, 1994, to reacquire Southmark's 19.2% interest in SAMLP for $2.4 million, less any distributions received by Southmark. On May 1, 1992, the Company received from Southmark, land subject to a ground lease in Denver, Colorado, land in Forest Park, Georgia, a mortgage note secured by land in Tabonia, Utah and a participation in a mortgage note secured by a retail property in Forest Park, Georgia. The Company believes these assets have an aggregate value at least equal to the consideration the Company has agreed to pay Southmark.\nTo secure the settlement payment obligations to Southmark, the Company issued 390,000 new shares of its Common Stock to ATN Equity Partnership (\"ATN\") which pledged such shares to Southmark along with securities of TCI and NRLP, as described below. The Company intends to cancel its collateral shares as they are released from the pledge to Southmark and returned to it by ATN. Voting rights to the Company's collateral shares are held by the Company's Board of Directors. ATN is a general partnership of which the Company and NRLP are general partners. ATN was formed solely to hold title to the securities issued by each partner and TCI and to pledge such securities to Southmark. As of December 31, 1993, Southmark had released 195,000 of the Company's shares of Common Stock which were returned to the Company by ATN and canceled. The unpaid settlement balance of $1.3 million is secured by a pledge of Common Stock of the Company having a minimum value of 145% of the unpaid balance and by the Company's remaining limited partner interest in SAMLP.\nIn addition to the pledge of the Company's Common Stock securing the payment to Southmark, Messrs. Phillips and Friedman, the Company and SWI have each executed and delivered separate, final, nonappealable judgments in favor of Southmark, each in the amount of $25 million. In the event of default, Southmark is entitled to entry of those judgments and to recover from the parties an aggregate of $25 million, subject to\nITEM 3. LEGAL PROCEEDINGS\nSettlement of Southmark Adversary Proceedings\nreduction for any amounts previously paid. If the settlement obligations are met, the judgments will be returned to the defendants.\nOn February 25, 1992, the Company entered into an agreement with Messrs. Phillips and Friedman, SWI, CMET, IORT, NIRT and TCI relating to their settlement of litigation with Southmark. Pursuant to the agreement, TCI obtained the right to acquire four apartment complexes, five mortgage notes, two commercial properties and four parcels of developed land from Southmark and its affiliates.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company held its annual meeting of stockholders on December 13, 1993, at which meeting the Company's stockholders elected the following as Class II Directors of the Company:\nShares Voting ------------------------- Withheld Director For Authority -------------------- --------- -----------\nAl Gonzalez....................... 2,560,023 22,004 G. Wayne Watts.................... 2,560,481 21,545\nThe Directors whose terms did not expire in 1993 and therefore did not stand for reelection were Oscar W. Cashwell, Class I Director, and Tilmon Kreiling, Jr. and Ryan T. Phillips, Class III Directors.\n___________________________________\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange using the symbol \"ARB\". The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the New York Stock Exchange.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (Continued)\nAs of March 31, 1994, the closing market price of the Company's Common Stock on the New York Stock Exchange was $12.75 per share.\nAs of March 31, 1994, the Company's Common Stock was held by 3,129 stockholders of record.\nOn December 6, 1988, the Company's Board of Directors authorized the repurchase of up to $5.0 million of the Company's Common Stock. As of March 31, 1994, no shares had been repurchased pursuant to such authorization. See ITEM 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources.\"\nThe Company's dividend policy provides for an annual determination of dividend distributions, after the Company's year end. No dividends were declared or paid in 1993. The Company last paid dividends in 1990.\nIn April 1990, the Company's Board of Directors adopted a Preferred Share Purchase Rights Plan (the \"Rights Plan\") and approved the distribution to stockholders of a dividend of one share purchase right (the \"Rights\") for each then outstanding share of the Company's Common Stock. Each Right will entitle stockholders to purchase one one- hundredth of a share of a new series of preferred stock at an exercise price of $25.00.\nThe Rights will generally be exercisable only if a person or group (the \"Adverse Group\") increases its then current ownership in the Company by more than 25% or commences a tender offer for 25% or more of the Company's Common Stock. If any person or entity actually increases its current ownership in the Company by more than 25% or if the Company's Board of Directors of the Company determines that any 10% stockholder is adversely affecting the business of the Company, holders of the Rights, other than the Adverse Group, will be entitled to buy, at the exercise price, Common Stock of the Company with a market value of twice the exercise price. Similarly, if the Company is acquired in a merger or other business combination, each Right will entitle its holder to purchase, at the Right's exercise price, the number of shares of the surviving company having a market value of twice the Right's exercise price. In connection with the one-for-three reverse share split effected in December 1990, the Rights were proportionately adjusted so that each post-split share certificate represents three Rights, each of which permit the holder thereof to purchase one one-hundredth of a preferred share for $25.00 under such circumstances. The Rights expire in 2000 and may be redeemed at the Company's option for $.01 per Right under certain circumstances.\nOn March 5, 1991, the Company's Board of Directors approved an amendment to the Rights Plan. The amendment excludes the Company, the Company's subsidiaries, and the Advisor or its officers and directors from the class of persons who may cause the Rights to become exercisable by increasing their ownership of the Company's Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA (Continued)\nShares and per share data have been restated to give effect to the one-for-three reverse stock split that was effected December 10, 1990.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nAmerican Realty Trust, Inc. (the \"Company\") was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income.\nLiquidity and Capital Resources\nGeneral. Cash and cash equivalents at December 31, 1993 aggregated $843,000, compared with $510,000 at December 31, 1992. Although the Company anticipates that during 1994 it will generate excess funds from operations, as discussed below, such excess funds are not expected to be sufficient to discharge all of the Company's debt obligations as they mature. The Company will therefore again rely on externally generated funds, including borrowings against its investments in various real estate entities, mortgage notes receivable and unencumbered properties, the sale or refinancing of properties and, to the extent available and necessary, borrowings from its advisor to meet its debt service obligations, pay taxes, interest and other non-property related expenses.\nNotes payable totaling $10.7 million are scheduled to mature during 1994. Subsequent to year end, the Company reached agreement with the lender on a note payable with a balance of $10.4 million at December 31, 1993 which was scheduled to mature in December 1994 to extend the note to December 18, 1997. The Company also has an agreement with the lender on a note payable with a principal balance of $950,000 at December 31, 1993 and that had matured August 1, 1993, to extend the note's maturity date to July 1, 1995. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\" The non-current portion of both notes has been excluded from scheduled 1994 maturities, above. The extension terms for these notes payable are discussed in more detail under \"Loans Payable,\" below. The Company intends to either extend the maturity dates or obtain alternate financing for the remainder of its debt obligations that mature in 1994. There can be no assurance, however, that these efforts to obtain alternate financing or debt extensions will be successful.\nThe Company refinanced a mortgage with a principal balance of $5.3 million at September 30, 1993, that was scheduled to mature December 31, 1993 with a new $6.0 million mortgage that matures November 1, 1996 and is secured by the Boulevard Villas Apartments, as described below. See NOTE 4. \"NOTES AND INTEREST RECEIVABLE.\" The Company also obtained mortgage financing on an unencumbered commercial property in May 1993 which provided net cash to the Company of $1.7 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nIn June 1992, the Company sold 397,359 newly issued shares of its Common Stock to a private investor for $1.9 million in cash. From March 1993 to March 1995, the purchaser can require the Company to repurchase 360,000 of such shares at $6.11 per share or a total of $2.2 million. See NOTE 9. \"REDEEMABLE COMMON STOCK.\"\nThe Company expects an increase in cash flow from property operations in 1994 from an increase in both occupancy and rental rates at the Company's apartment complexes and from a full year's operations of the properties acquired through foreclosure in March and July 1993. The Company is also expecting continued lot sales at its two unencumbered Texas residential subdivisions generating additional cash flow. In August 1993, the Company sold the Fox City Shopping Center, with the purchaser assuming mortgage debt totaling $5.5 million. The Company realized net cash of $416,000 from the sale.\nThe Company expects that funds from existing cash resources, collections on mortgage notes receivable, sales or refinancing of real estate, and borrowings against its investments in real estate entities, mortgage notes receivable, and to the extent available and necessary borrowings from the Company's advisor, which totaled $3.6 million at December 31, 1993, will be sufficient to meet the cash requirements associated with its current and anticipated level of operations, maturing debt obligations and existing commitments in the foreseeable future. To the extent that the Company's liquidity permits, the Company may make investments in real estate, additional investments in real estate entities and fund or acquire mortgage notes.\nNotes Receivable. Scheduled principal maturities of notes receivable are $5.4 million in 1994. However, at December 31, 1993, notes receivable with scheduled 1994 maturities of $4.5 million were in default. The majority of the Company's mortgage notes receivable are due over the next one to ten years and provide for \"balloon\" payments by the borrowers. It may be necessary for the Company to consider extending certain notes if the borrowers do not have the resources to repay the loans, are unable to sell the property securing such loans, or are unable to refinance the debt owed.\nIn December 1992, the Company entered into an agreement to purchase the first mortgage secured by Boulevard Villas Apartments, a property on which the Company held a second lien mortgage note that was in default. The Company made a $1.0 million down payment at the time it executed the purchase agreement. In June 1993, the Company and the first lienholder modified the note purchase agreement to allow the Company to become the owner of the first mortgage and foreclose on the Boulevard Villas, the collateral securing the note in exchange for short-term purchase money financing from the first lienholder for the then balance owed under the note purchase agreement. In October 1993, the property was refinanced under a new mortgage of $6.0 million, with a maturity date of November 1, 1996. The Company received net refinancing proceeds of $280,000\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nafter payoff of the existing first mortgage, the establishment of required repair and tax escrows and the payment of costs associated with the refinancing.\nIn August 1990, the Company foreclosed on its fourth lien note receivable secured by the Continental Hotel in Las Vegas, Nevada. The Company acquired the hotel and casino property at foreclosure subject to first and second lien mortgages totaling $10.0 million and a disputed third lien mortgage. In June 1992, the Company sold the hotel and casino to the third lienholder for a $22 million wraparound mortgage note receivable, a $500,000 unsecured note receivable, and $100,000 in cash. The $500,000 note was paid off on July 30, 1993. Payments of interest and principal on the Company's wraparound note receivable were made directly by the borrower to the holder of the first and second lien mortgages and were applied against interest and principal thereon. Since October 1993, the borrower has failed to make the monthly payments required by the Company's wraparound mortgage note receivable to the holder of the first and second lien mortgages. The Company and the underlying lienholder have accelerated their notes. The Company's wraparound mortgage note receivable had a principal balance of $22.7 million at December 31, 1993, including compounded interest and the underlying liens totaled $6.1 million at December 31, 1993. The Company is negotiating with the borrower and the underlying lienholder to modify and extend both the Company's wraparound mortgage note receivable and the underlying liens. The Company expects to be successful in such negotiations, however, if it should lose the collateral property to the underlying lienholder it would incur a loss of $12.4 million.\nThe Company anticipates a continued improvement in the operations of the properties securing its mortgage notes receivable in certain regions of the continental United States, in particular the Southwest region. In spite of this anticipated improvement in the real estate market in general and the Southwest in particular, the Company can give no assurance that it will not continue to experience further deterioration in cash flow due to new problem loans.\nLoans Payable. The Company has margin arrangements with various brokerage firms which provide for borrowings up to 50% of the market value of marketable equity securities. The borrowings under such margin arrangements are secured by such equity securities and bear interest rates ranging from 4.50% to 7.75%. Margin borrowings were $16.1 million (approximately 36% of market value) at December 31, 1993, an increase of $6.4 million from December 31, 1992.\nIn May 1993, the Company obtained mortgage financing of $1.8 million on the theretofore unencumbered Rosedale Towers, an office building in Minneapolis, Minnesota. The Company realized net financing proceeds of $1.7 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nOn December 23, 1993, the Company refinanced the Watersedge III and Edgewater Gardens Apartments. The Company received refinancing proceeds totaling $1.7 million after the payoff of existing mortgage debt totaling $4.9 million and associated refinancing costs.\nIn June 1993, the Company modified the $4.2 million first mortgage secured by the Park Plaza Shopping Center, extending the maturity date to May 10, 2003. At the same time, the Company obtained an additional loan of up to $1.0 million also secured by the shopping center from the same lender for capital and tenant improvements to the shopping center. The new loan was also scheduled to mature June 1, 2003. Advances on the new loan were made by the lender as the improvements were completed. Included in the modification of the first mortgage is a \"forgiveness of debt\" clause, allowing a forgiveness of an amount equal to the lesser of $500,000 or one- half of the amount advanced on the new loan, if paid off by May 31, 1994. The principal balance of the new loan, $887,000, was paid off December 23, 1993, the Company receiving a credit of $443,000 against the first mortgage reducing the balance to $3.7 million at December 31, 1993. The Company also deposited $105,000 in an escrow account to complete remaining parking lot and exterior renovations at the shopping center. The Company is also to receive a credit against the first mortgage for one half of these monies as expended.\nIn March 1992, the Company obtained a $1.3 million working capital loan from a financial institution which matured April 1, 1993. The lender extended the maturity date to April 1, 1994. In January 1994, the Company made a $100,000 principal paydown, bringing the balance of the note to $350,000 at January 31, 1994. The Company paid off the balance of the loan at maturity.\nA loan with a principal balance of $950,000 at December 31, 1993 matured in February 1993. The lender agreed to extend the maturity date of the note to August 1, 1993 in exchange for an April 1, 1993 principal paydown of $200,000 and monthly principal paydowns of $50,000 per month, beginning May 1, 1993. The Company did not payoff the loan at maturity, but has continued to make monthly principal reduction payments of $50,000 in accordance with the expired loan agreement. The Company has reached an agreement with the lender to extend the maturity date to July 1995, with the Company continuing its $50,000 monthly principal reduction payments.\nEquity Investments. During the fourth quarter of 1988, the Company began purchasing shares of five real estate investment trusts, at the time having the same advisor as the Company, and units of limited partner interest in National Realty, L.P. (\"NRLP\"). It is anticipated that additional equity securities of NRLP and three of the trusts, Continental Mortgage and Equity Trust (\"CMET\"), Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Investors, Inc. (\"TCI\"), and NRLP will be acquired in the future through open-market and\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nnegotiated transactions to the extent the Company's liquidity permits. In September 1992, the Company agreed to sell its entire shareholdings in the other two trusts, to William S. Friedman, members of his family or affiliates. Mr. Friedman is the President and a trustee of these trusts and served as President and Director of the Company until December 31, 1992 and until May 1, 1993, served as President of the Company's advisor. As of December 31, 1992, the Company had completed the sale of all of its shares in one of the trusts, Vinland Property Trust, to Mr. Friedman's wife for cash. In 1993, the Company completed the sale of all of its shares in the other trust, National Income Realty Trust (\"NIRT\") to Mr. Friedman and his affiliates. The Company received $2.9 million in cash ($657,000 in 1992), 42,260 units of NRLP, 105,096 shares of CMET, 118,500 shares of TCI and 10,075 shares of IORT.\nEquity securities of CMET, IORT, TCI and NRLP held by the Company may be deemed to be \"restricted securities\" under Rule 144 of the Securities Act of 1933 (\"Securities Act\"). Accordingly, the Company may be unable to sell such equity securities other than in a registered public offering or pursuant to an exemption under the Securities Act for a period of two years after they are acquired. Such restrictions may reduce the Company's ability to realize the full fair market value of such investments if the Company attempted to dispose of such securities in a short period of time.\nThe Company's cash flow from these investments is dependent on the ability of each of the entities to make distributions. TCI's distribution policy provides for an annual determination of distributions after year end, and then only to the extent of its taxable income, if any. In March 1993, CMET and IORT resumed the payment of regular quarterly distributions and in December 1993 NRLP also resumed regular distributions. In 1993, the Company received distributions totaling $506,000 from CMET and IORT and $170,000 from NRLP and anticipates receiving distributions totaling $615,000 from CMET and IORT and $749,000 from NRLP in 1994.\nThe Company's management, on a quarterly basis, reviews the carrying value of the Company's mortgage loans, properties held for investment and properties held for sale. Generally accepted accounting principles require that the carrying value of an investment held for sale cannot exceed the lower of its cost or its estimated net realizable value. In those instances in which estimates of net realizable value of the Company's properties or loans are less than the carrying value thereof at the time of evaluation, a provision for loss is recorded by a charge against operations. The estimate of net realizable value of the mortgage loans is based on management's review and evaluation of the collateral properties securing such notes. The review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of the maintenance requirements, discussions with the manager of the property and a review of the surrounding area.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations\n1993 Compared to 1992. The Company reported a net loss of $4.4 million in 1993 as compared to a net loss of $9.6 million in 1992. The primary factors contributing to the decrease in Company's net loss are discussed in the following paragraphs.\nNet rental income (rental income less property operating expenses) increased from $1.4 million in 1992 to $2.6 million in 1993. This increase was attributable to an increase of $388,000 from improved occupancy and rents at the Company's commercial properties and $271,000 and $296,000 from the 1993 acquisitions of Boulevard Villas Apartments and KC Holiday Inn. Offsetting these increases were an additional $124,000 of property taxes and hazard insurance premiums incurred in 1993 on land owned by the Company. The Company is expecting an increase in net rental income in 1994 from a full year of operations of the Boulevard Villas Apartments and the KC Holiday Inn and from increased rental rates at its apartment complexes.\nInterest income decreased from $5.7 million in 1992 to $5.0 million in 1993. This decrease is primarily due to a $639,000 decrease from the settlement of a note receivable and related note payable. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\" Decreases of $262,000 due to mortgage notes receivable foreclosed or restructured in 1992 or 1993, $192,000 due to nonperforming, nonaccruing loans, and $339,000 due to principal payoffs and paydowns, and\/or sales of notes receivable during 1992 or 1993 were offset in part by a $277,000 increase in interest income from the 1992 mid-year sale of the Continental Hotel. The Company expects a decrease in interest income in 1994 if the nonperforming Continental Hotel mortgage note receivable is not successfully restructured.\nEquity in losses of investees increased from a loss of $3.4 million in 1992 to a loss of $4.0 million in 1993. This increase in equity losses is primarily attributable to the Company's increased share ownership in each of TCI and NRLP during 1993, increasing the Company's proportionate share of loss from operations of each such entity.\nInterest expense decreased from $7.2 million in 1992 to $6.5 million in 1993. This decrease is attributable to payoffs of notes and principal reductions in 1992 and 1993 reducing interest expense by $2.0 million and a decrease of $449,000 due to the settlement of a note payable and related note receivable in August 1993. These decreases were offset in part by new loans obtained in 1992 and 1993 increasing interest expense by $1.6 million and increased margin borrowings in 1993 increasing interest expense by $119,000.\nAdvisory and mortgage servicing fees in 1992 and 1993 were comparable at $1.3 million.\nGeneral and administrative expenses decreased from $2.3 million in 1992 to $1.8 million in 1993. The decrease is primarily attributable to\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nlegal costs incurred in 1992 in connection with the Continental Hotel bankruptcy and Southmark litigation. See NOTE 17. \"COMMITMENTS AND CONTINGENCIES.\"\nProvision for losses decreased from $3.7 million in 1992 to $2.3 million in 1993. The 1993 provision for losses is comprised of a $2.0 million reserve against the carrying value of undeveloped land in downtown Atlanta, Georgia and a $300,000 reduction in the estimated fair value of the collateral securing a mortgage note receivable. The 1992 provision for losses is comprised of a $800,000 reduction in the estimated fair value of the collateral securing a mortgage note receivable subsequently foreclosed, $404,000 to reserve against the carrying value of a mortgage note receivable subsequently sold, $1.3 million to reserve against the carrying value of first mortgage note and $771,000 related to the Company's agreement to sell its NIRT shares.\nGains on sales of real estate decreased from $566,000 in 1992 to $481,000 in 1993. The decrease is due to the $85,000 loss recorded on the sale of the Fox City Shopping Center and a $10,000 loss recorded on the sale of a condominium unit. The gains from the sale of residential lots in 1992 and 1993 were comparable. See NOTE 5. \"REAL ESTATE.\"\nThe Company recognized an income tax benefit of $921,000 in 1992 from the reversal of tax expense previously recognized on installment sales.\nThe Company recognized $3.8 million extraordinary gain in 1993 as compared to no extraordinary gain in 1992. $3.4 million of the extraordinary gain represents the Company's share of an equity investee's reported extraordinary gain of $9.0 million from the acquisition at a discount of its mortgage debt and the $443,000 forgiveness of the Company's debt as discussed in \"Liquidity and Capital Resources,\" above.\n1992 Compared to 1991. The Company had a net loss of $9.6 million in 1992, as compared to a net loss of $2.9 million in 1991. The primary factors contributing to the increase in Company's net loss are discussed in the following paragraphs.\nInterest income from mortgage notes receivable decreased from $7.2 million in 1991 to $5.7 million in 1992. This decrease is primarily attributable to a reduction of $314,000 in interest income due to notes receivable paid off during 1991, a reduction of $1.0 million due to notes receivable foreclosed or restructured during 1992, a reduction of $933,000 from principal reductions, and a decrease of $695,000 due to nonperforming loans. These decreases were partially offset by an increase in interest income of $1.3 million resulting from the Company's sale of the Continental Hotel in June 1992 for a $22 million wraparound note receivable.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nNet rental income (rental income less property operating expenses) decreased from $2.4 million in 1991 to $1.4 million in 1992. This decrease is attributable to the transfer of the Porticos Apartments to IORT in November 1991, in satisfaction of the Company's note repurchase obligation.\nEquity in losses of investees increased from a loss of $1.1 million in 1991 to a loss of $3.4 million in 1992. This increase in equity losses from 1991 to 1992 is primarily attributable to the Company's increased share of ownership in each of CMET, IORT, TCI and NRLP during 1992, increasing the Company's proportionate share of equity in results of operations of each such entity. Also, the Company ceased recognizing equity earnings attributable to NIRT on September 1, 1992, due to the Company's agreement to sell all of its NIRT shares.\nInterest expense decreased from $8.8 million in 1991 to $7.2 million in 1992. This decrease is attributable to a $1.2 million reduction in interest expense due to the transfer of the Porticos Apartments to IORT in November 1991, a further $1.7 million reduction relates to a line of credit which was paid in full in December 1991, and a $507,000 decrease is due to principal paydowns on other borrowings in 1991. These decreases were offset in part by an increase in interest expense of $2.3 million related to new mortgage debt incurred as a result of property refinancings in 1992 as well as debt assumed or incurred on properties purchased in 1992 and a $401,000 increase in interest expense due to increased margin borrowings during 1992.\nAdvisory and mortgage servicing fees decreased from $2.6 million in 1991 to $1.3 million in 1992. This decrease is due to a fifty percent reduction in the advisor's base fee effective October 1, 1991.\nGeneral and administrative expenses decreased from $3.8 million in 1991 to $2.3 million in 1992. This decrease is primarily due to legal fees of $740,000 incurred in 1991 in connection with the Southmark Corporation adversary proceedings and $175,000 for consulting fees related to the Continental Hotel foreclosure and bankruptcy in 1991. See NOTE 4. \"NOTES AND INTEREST RECEIVABLE.\" and NOTE 17. \"COMMITMENTS AND CONTINGENCIES - Settlement of Southmark Adversary Proceedings.\"\nThe provision for losses in 1992 was $3.7 million compared to $5.3 million in 1991. The 1992 provision for losses is comprised primarily of a $800,000 reduction in the estimated fair value of the collateral securing a mortgage note receivable subsequently foreclosed, $404,000 to reserve against the carrying value of a mortgage note receivable subsequently sold, $1.3 million to reserve against the carrying value of first mortgage note and $771,000 related to the Company's agreement to sell its NIRT shares. The 1991 provision for losses is comprised of the write-off of two mortgage notes secured by a commercial property in\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nSouth Carolina, a mortgage receivable secured by an apartment complex in Alabama and $3.5 million related to performance obligations of the Company.\nGains on real estate sales were $566,000 in 1992 as compared to $1.3 million in 1991. The 1992 gain resulted from the sale of 84 residential lots in Texas. The gain in 1991 resulted primarily from the sale of four restaurant properties in California and 50 residential lots in Texas.\nThe Company reported no extraordinary gain in 1992 as compared to $7.6 million in 1991. The extraordinary gain in 1991 is the result of the Company's discounted payoff of a bank line of credit.\nIncome tax benefit of $921,000 was recorded in 1992 compared to a benefit of $1.2 million in 1991. The benefit in both years is due to the reversal of tax expense previously recognized on installment sales of real estate.\nCommitments\nIn June 1992, the Company sold 397,359 newly issued shares of its Common Stock to a private investor for $1.9 million cash. Terms of the sale agreement provide the purchaser with an option to require the Company to reacquire up to 360,000 of the shares at $6.11 per share, a total of $2.2 million. Such option is exercisable for a two year period which began in March 1993. To secure its payment obligations under the option agreement, the Company assigned its interest in the $22 million note receivable secured by the Continental Hotel and Casino in Las Vegas, Nevada.\nAlso, in June 1992, the Company obtained a $3.3 million loan from the same investor, collateralized by an assignment of the Company's interest in a partnership which owns residential lots in Fort Worth, Texas and the Company's interest in undeveloped land in downtown Atlanta, Georgia. The loan provides for the lender's participation in the proceeds from either the sale or refinancing of the Atlanta land to the extent of 15.57% of the net proceeds, as defined, in excess of $10.0 million. The lender also had the right during a period beginning eighteen months from the date of the loan and continuing ninety days thereafter to put his participation to the Company in exchange for a payment of $623,000. On December 2, 1993, the lender exercised his put which required full payment by the Company within 30 days. The Company has recognized such obligation by accruing additional interest on the $3.3 million loan. The lender has agreed to extend the payment date to January 2, 1995, and BCM and the trust that beneficially owns BCM, have agreed to guarantee the Company's obligation, as well as the Company's obligation to purchase up to 360,000 shares of the Company's Common Stock pursuant to the option held by the lender. As of March 31, 1994, BCM owned approximately 38% of the outstanding shares of the Company's Common Stock. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\"\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nCommitments (Continued)\nIn October 1993, NRLP, Syntek Asset Management, L.P. (\"SAMLP\"), the NRLP oversight committee and the Company reached an agreement evidenced by a detailed Term Sheet to nominate a candidate to succeed SAMLP as general partner of NRLP and National Operating, L.P. (\"NOLP\"), the operating partnership of NRLP, and to consummate the 1990 settlement of a class action suit. The Term Sheet also sets forth an agreement in principle to effect a restructuring of NRLP and the spinoff by NRLP to its unitholders of shares of a newly- formed subsidiary which would qualify as a Real Estate Investment Trust (\"REIT\") for federal tax purposes. The Company is NRLP's largest unitholder and a 76.8% limited partner of SAMLP. SAMLP currently serves as the general partner of NRLP and NOLP and a newly formed subsidiary of SAMLP is to be nominated as successor general partner. The Term Sheet further provides that within nine months of the spinoff transaction, the Company will make a cash tender offer to purchase up to 60% of NRLP's units of limited partner interest held by unitholders unaffiliated with the Company or SAMLP for $12.00 per unit (an estimated maximum purchase price of $8.0 million), unless the NRLP units have traded at an appreciably higher average price for the prior thirty days. See NOTE 17. \"COMMITMENTS AND CONTINGENCIES.\"\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Company may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos- containing materials into the air, and third parties may seek recovery from the Company for personal injury associated with such materials.\nThe Company's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Company's business, assets or results of operations.\nInflation\nThe effects of inflation on the Company's operations are not quantifiable. Revenues from property operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and, correspondingly, the ultimate gains to be realized by the Company from property sales. Moreover, the Company frequently lends at fixed rates while it borrows at floating rates. In periods of falling interest rates, this could result in the Company's mortgage loan portfolio yielding above-market rates while the cost of borrowing decreases.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nTax Matters\nOn October 23, 1991, the Company's Board of Directors determined that the benefits of maintaining the Company's qualification as a REIT for federal tax purposes were no longer significant and that maintaining REIT status would restrict the Company's financial flexibility and opportunities in the current real estate markets. The Company therefore allowed its REIT status to lapse in 1991 and as a consequence will be taxed on its current and future earnings at the federal tax rate for corporations and will no longer be allowed a deduction for dividends paid.\nFor the year ended December 31, 1990, the Company elected and, in the opinion of the Company's management, qualified as a REIT as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Code requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, all as defined in Section 857 of the Code, on an annual basis to stockholders.\nSee NOTE 14. \"INCOME TAXES\" for a further discussion of income taxes.\nRecent Accounting Pronouncement\nThe Financial Accounting Standards Board (\"FASB\") has recently issued Statement of Financial Accounting Standards (\"SFAS\") No. 114 - \"Accounting by Creditors for Impairment of a Loan\", which amends SFAS No. 5 - \"Accounting for Contingencies\" and SFAS No. 15 - \"Accounting by Debtors and Creditors for Troubled Debt Restructurings.\" The statement requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. SFAS No. 114 is effective for fiscal years beginning after December 15, 1994. The Company's management has not fully evaluated the effects of implementing this statement, but expects that they will not be material as the statement is applicable to debt restructurings and loan impairments after the earlier of the effective date of the statement or the Company's adoption of the statement.\nAt its January 26, 1994 meeting, the FASB directed its staff to prepare an exposure draft, that if approved, would eliminate the provisions of SFAS No. 114 that describe how a creditor should recognize income on an impaired loan and add disclosure requirements on income recognized on impaired loans. The effective date of SFAS No. 114 is not anticipated to change.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage -----\nReport of Independent Certified Public Accountants..... 45\nConsolidated Balance Sheets - December 31, 1993 and 1992........................... 46\nConsolidated Statements of Operations - Years Ended December 31, 1993, 1992 and 1991........ 47\nConsolidated Statements of Stockholders' Equity - Years Ended December 31, 1993, 1992 and 1991......... 49\nConsolidated Statements of Cash Flows - Years Ended December 31, 1993, 1992 and 1991......... 50\nNotes to Consolidated Financial Statements............. 53\nSchedule I - Marketable Securities..................... 84\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties...................................... 85\nSchedule IX - Short-term Borrowings.................... 86\nSchedule X - Supplementary Statement of Operations Information.......................................... 87\nSchedule XI - Real Estate and Accumulated Depreciation. 88\nSchedule XII - Mortgage Loans on Real Estate........... 90\nAll other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors of American Realty Trust, Inc.\nWe have audited the accompanying consolidated balance sheets of American Realty Trust, Inc. and Subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Realty Trust, Inc. and Subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.\nFor the three years ended December 31, 1993, the Company had operating cash flow deficits totaling $7.2 million and net losses totaling $16.9 million. As discussed in Note 18, the Company's operating cash flow has not been sufficient to pay mortgages and other obligations as they come due without advances from affiliates, asset sales, refinancings and debt extensions. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 18. The financial statements and schedules do not include any adjustments that might result from the outcome of this uncertainty.\nBDO SEIDMAN\nDallas, Texas April 11, 1994\nAMERICAN REALTY TRUST, INC. CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of American Realty Trust, Inc. and consolidated entities (the \"Company\") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 1. \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\" These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.\nCertain balances for 1991 and 1992 have been reclassified to conform to the 1993 presentation.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and company business. American Realty Trust, Inc. (\"ART\") is a Georgia corporation that primarily invests in real estate and real estate-related entities and purchases and originates mortgage loans.\nBasis of consolidation. The Consolidated Financial Statements include the accounts of ART, and all majority-owned subsidiaries and partnerships. All significant intercompany transactions and balances have been eliminated.\nInterest recognition on notes receivable. It is the Company's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the realizable value of underlying collateral exceeds the carrying value of the receivable.\nAllowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable and properties held for sale to the extent that the investment in the notes or properties exceeds the Company's estimate of net realizable value of the property or the collateral securing such note, or fair value of the collateral if foreclosure is probable. In estimating net realizable value, consideration is given to the current estimated collateral or property value adjusted for costs to complete or improve, hold and dispose. The cost of funds, one of the criteria used in the calculation of estimated net realizable value (approximately 4.8% and 5.1% as of December 31, 1993 and 1992, respectively), is based on the average cost of all capital. The provision for losses is based on estimates, and actual losses may vary from current estimates. Such estimates are reviewed periodically, and any additional provision determined to be necessary is charged against earnings in the period in which it becomes reasonably estimable.\nForeclosed real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nfair value minus estimated costs of sale. After foreclosure, the excess of new cost, if any, over fair value minus estimated costs of sale is recognized in a valuation allowance. Subsequent changes in fair value either increase or decrease such valuation allowance. See \"Allowance for estimated losses\" above. Properties held for sale are depreciated in accordance with the Company's established depreciation policies. See \"Real estate and depreciation\" below.\nAnnually, all foreclosed properties held for sale are reviewed by the Company's management and a determination is made if the held for sale classification remains appropriate. The following are among the factors considered in determining that a change in classification to held for investment is appropriate: (i) the property has been held for at least one year; (ii) Company management has no intent to dispose of the property within the next twelve months; (iii) property improvements have been funded, and (iv) the Company's financial resources are such that the property can be held long-term. The subsequent classification of property previously held for sale to held for investment does not result in a restatement of previously reported revenues, expenses or net (loss).\nInvestment in real estate entities. Because the Company may be considered to have the ability to exercise significant influence over the operating and investment policies of certain of its investees, the Company accounts for such investments by the equity method. Under the equity method, the Company's initial investment, recorded at cost, is increased by the Company's proportionate share of the investees' income and any additional investment and decreased by the Company's proportionate share of the investees' losses and distributions received.\nReal estate and depreciation. Real estate is carried at the lower of cost or estimated net realizable value, except that foreclosed properties held for sale, which are initially recorded at the lower of original cost or fair value. Depreciation is provided by the straight-line method over the estimated useful lives of the assets, which range from 10 to 40 years.\nPresent value premiums\/discounts. The Company provides for present value premiums and discounts on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and amortizes such premiums and discounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for receivables include the borrower's credit standing, nature of the collateral and payment terms of the notes.\nRevenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"SFAS No. 66\"). Until the requirements of SFAS No. 66 for full\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nprofit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.\nLoan fees. In connection with lending activities, the Company periodically receives origination, commitment and extension fees. These fees are recognized in accordance with Statement of Financial Accounting Standards No. 91 \"Accounting for Non-refundable Fees and Costs Associated with Originating or Acquiring Loans.\"\nFair value of financial instruments. The Company used the following assumptions in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable the estimated fair value of the Company's interest in the collateral property was used. For marketable equity securities fair value was based on the year end closing market price of each security. The estimated fair values presented do not purport to present amounts to be ultimately realized by the Company. The amounts ultimately realized may vary significantly from the estimated fair values presented. For notes payable the fair value was estimated using current rates for mortgages with similar terms and maturities.\nCash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nEarnings per share. Loss per share is computed based upon the weighted average number of shares of Common Stock and redeemable Common Stock outstanding during each year.\nNOTE 2. SEVERANCE OF RELATIONSHIP WITH SOUTHMARK CORPORATION\nGene E. Phillips, a Director and Chairman of the Board of the Company until November 16, 1992, and William S. Friedman, the President and a Director of the Company until December 31, 1992, were also directors and executive officers of Southmark Corporation (\"Southmark\") until January 1989. Messrs. Phillips and Friedman entered into certain agreements (the \"January Agreements\") with Southmark which among other things settled certain disputes and provided for the severance of their relationship with Southmark. In February 1989, the Company terminated its advisory agreement with a subsidiary of Southmark and appointed as advisor, Basic Capital Management, Inc. (\"BCM\" or \"the Advisor\"). Mr. Friedman served as President of BCM until May 1, 1993. Mr. Phillips served as Chief Executive Officer of BCM until September 1, 1992. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Ryan T. Phillips, a Director of the Company, is a director of BCM and a trustee of the trust which beneficially owns BCM. Since January 1,\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. SEVERANCE OF RELATIONSHIP WITH SOUTHMARK CORPORATION (Continued)\n1994, Oscar W. Cashwell, a Director of the Company has served as President of BCM. Mr. Phillips serves as a representative of the trust for the benefit of his children that beneficially owns BCM and, in such capacity, Mr. Phillips has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company. See NOTE 11. \"ADVISORY AGREEMENT.\"\nOn July 12, 1989, the Company closed a set of related agreements (collectively the \"Southmark Separation Agreements\") with its then largest stockholder, Southmark, essentially terminating the Company's relationship with Southmark. Under the Southmark Separation Agreements the Company acquired an aggregate of 1,502,595 shares of its Common Stock, Southmark's interest in various real estate entities, a 96% limited partnership interest in Syntek Asset Management, L.P. (\"SAMLP\"), and a release of asserted indebtedness to Southmark of at least $3.3 million. In addition, Southmark relinquished an option to acquire up to 50.5% of the Company's Common Stock. The Company also acquired, subject to any required regulatory approval, all of the outstanding common stock of Novus Nevada, Inc., (\"Novus Nevada\"). As part of the settlement of the Southmark adversary proceedings the Novus Nevada common stock was transferred to the Company on February 25, 1992. See NOTE 17. \"COMMITMENTS AND CONTINGENCIES - Settlement of Southmark Adversary Proceedings\".\nIn return, the Company conveyed to Southmark mortgage notes substantially all of which the Company had previously purchased from Southmark and its affiliates and which were covered by an agreement pursuant to which Southmark had guaranteed the payment of principal and interest on such notes.\nOn July 14, 1989, Southmark filed a voluntary petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code. At Southmark's request, the Bankruptcy Court appointed an examiner to review pre-Chapter 11 transactions and potential causes of action on behalf of the Southmark bankruptcy estate. The examiner concluded that Southmark should seek to recover assets which he valued in excess of $50.0 million, most of which were transferred to the Company in connection with the Southmark Separation Agreements. The examiner's conclusion was based upon his opinion that such transfer was made at a time when Southmark was insolvent and that Southmark did not receive fair value in return for the assets transferred. The examiner also concluded that $1.4 million remitted to the Company by Southmark in respect of the Company's participation in certain loans from an insurance subsidiary of Southmark could be recovered as a preferential transfer and that $250,000 remitted to the Company by Southmark as an annual mortgage payment on a Novus Nevada loan could also be recovered as a preferential transfer. See NOTE 17. \"COMMITMENTS AND CONTINGENCIES - Settlement of Southmark Adversary Proceedings,\" for a discussion of the actions brought against the Company by Southmark and the subsequent settlement of all such matters.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 3. SYNTEK ASSET MANAGEMENT, L.P.\nAs part of the Southmark Separation Agreements, the Company acquired Southmark's 96% limited partner interest in SAMLP, the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), the operating partnership of NRLP. Mr. Phillips is a general partner, and until March 4, 1994, Mr. Friedman was a general partner of SAMLP. In accordance with the provisions of the settlement of the Southmark adversary proceedings, on February 25, 1992, the Company assigned to Southmark a 19.2% limited partner interest in SAMLP. The Company has an option which expires on December 27, 1994, to reacquire Southmark's 19.2% interest in SAMLP for $2.4 million, less any distributions received by Southmark. See NOTE 2. \"SEVERANCE OF RELATIONSHIP WITH SOUTHMARK CORPORATION\" and NOTE 17. \"COMMITMENTS AND CONTINGENCIES - Settlement of Southmark Adversary Proceedings.\"\nNRLP, SAMLP and Messrs. Phillips and Friedman were among the defendants in a class action lawsuit arising from the formation of NRLP. An agreement settling such lawsuit for the above mentioned defendants became effective on July 5, 1990. The settlement agreement provides for, among other things, the appointment of an NRLP oversight committee; the establishment of specified annually increasing targets for five years relating to the price of NRLP's units of limited partner interest; a limitation and deferral or waiver of NRLP's reimbursement to SAMLP of certain future salary costs; a deferral or waiver of certain future compensation to SAMLP; the required distribution to unitholders of all of NRLP's cash from operations in excess of certain renovation costs unless the NRLP oversight committee approves alternative uses for such cash from operations; the issuance of unit purchase warrants to members of the plaintiff class; and the contribution by the then individual general partners of $2.5 million to NRLP over a four- year period. In accordance with the indemnification provisions of SAMLP's agreement of limited partnership, SAMLP agreed to indemnify Messrs. Phillips and Friedman, the individual general partners, at the time, of SAMLP, for the $2.5 million payment to NRLP. The final annual installment of principal and interest in the amount of $631,000 is due in May 1994.\nIf unit price targets are not met for any two successive years, or for the final year of the settlement plan, SAMLP will be required to withdraw as general partner of NRLP and NOLP. The targets began at $44.00 per unit for May 9, 1991, and increase thereafter to $120.00 per unit for May 9, 1995, adjusted for distributions, if any, to unitholders. NRLP did not achieve either the first or the second annual target. Accordingly, SAMLP expects to resign as general partner of NRLP and NOLP.\nThe withdrawal of SAMLP as general partner would require NRLP to purchase SAMLP's general partner interest (the \"Redeemable General Partner Interest\") at its then fair value, and to pay certain fees and other compensation as provided in the partnership agreement. Syntek Asset Management, Inc. (\"SAMI\"), the managing general partner of SAMLP,\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 3. SYNTEK ASSET MANAGEMENT, L.P. (Continued)\nhas calculated the fair value of such Redeemable General Partner Interest to be $25.8 million at December 31, 1993, before reduction for the principal balance ($4.2 million at December 31, 1993) and accrued interest ($3.5 million at December 31, 1993) on the note receivable from SAMLP for its original capital contribution to NRLP. There can be no assurance that such amount at the time of any such withdrawal will not be substantially higher or lower. The NRLP oversight committee has calculated such Redeemable General Partner Interest, to be $20.0 million at December 31, 1993, before reduction for the principal balance and accrued interest on the note receivable from SAMLP for its original capital contribution to NRLP. Such Redeemable General Partner Interest may be paid to SAMLP at the option of the NRLP oversight committee over three years pursuant to a secured promissory note bearing interest at a financial institution's prime rate. NRLP's purchase of the Redeemable General Partner Interest could have an adverse effect on NRLP's financial condition and on the Company's investment in limited partner units of NRLP ($12.0 million at December 31, 1993).\nIn October 1993, SAMLP and the NRLP oversight committee reached an agreement in principle, evidenced by a detailed Term Sheet, to nominate a candidate for successor general partner of NRLP and NOLP and to consummate the settlement of the class action lawsuit. The nominee for successor general partner will be a newly-formed corporation which will be a wholly-owned subsidiary of SAMLP. Pursuant to the Term Sheet, NRLP will be relieved of any obligation to purchase the Redeemable General Partner Interest or to pay any other fees or compensation to SAMLP upon SAMLP's withdrawal as general partner of NRLP and NOLP.\nThe Term Sheet also sets forth an agreement in principle to effect a restructuring of NRLP and the spinoff by NRLP to its unitholders, shares of a newly-formed subsidiary which would qualify as a Real Estate Investment Trust (\"REIT\") for federal tax purposes. The Company was also a party to the Term Sheet which provides that within nine months of the spinoff transaction, the Company will make a cash tender offer to purchase up to 60% of NRLP's units of limited partner interest held by unitholders unaffiliated with the Company or SAMLP for $12.00 per unit (an estimated maximum purchase price of $8.0 million), unless the NRLP units have traded at an appreciably higher average price for the prior thirty days. The Company is NRLP's largest unitholder and a 76.8% limited partner of SAMLP.\nThe parties are preparing the agreement and other documents contemplated by the Term Sheet. Upon execution of an agreement embodying the provisions of the Term Sheet, the NRLP oversight committee and SAMLP will petition the supervising judge for his approval of the agreement. The proposed formation and spinoff of the REIT and the election of the new general partner require the approval of NRLP's unitholders.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE\nThe Company does not recognize interest income on nonperforming notes receivable. Notes receivable are considered to be nonperforming when they become 60 days or more delinquent. For the years 1993, 1992 and 1991 unrecognized interest income on such nonperforming notes receivable totaled $3.1 million, $943,000 and $1.2 million, respectively.\nNotes receivable at December 31, 1993, mature from 1994 to 2014 with interest rates ranging from 6.7% to 14.0% and the weighted average rate of 7.39%. A small percentage of these notes receivable carry a variable interest rate. Notes receivable include notes generated from property sales which have interest rates adjusted at the time of sale to yield rates ranging from 6% to 14%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $5.4 million are due in 1994 of which $4.5 million is due on nonperforming notes receivable.\nNonrecourse participations totaling $2.6 million at both December 31, 1993 and 1992, have been deducted from notes receivable.\nIn September 1989, the Company entered into a participation agreement in the amount of $20.0 million in a pool of various assets with the Collecting Bank, National Association, a bank in liquidation (\"Collecting Bank\"). On the same date, the Company entered into a term loan in the same amount with First City, Texas-Dallas, N.A. (\"First City\"), a sister association of Collecting Bank. The Company pledged to First City its interest in the participation agreement with Collecting Bank as collateral for the term loan. The principal and interest on the participation and the term loan were each due in 20 quarterly installments through October 1994. In October 1992, both Collecting Bank and First City were placed under the receivership of the Federal Deposit Insurance Corporation (\"FDIC\"). In October 1993, the Company\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE (Continued)\nand the FDIC agreed to terminate both the participation and term loan agreements each having a principal balance of $7.6 million. The Company recorded a $58,000 gain on the termination of the agreements.\nIn June 1991, the Company entered into an asset sales agreement with an insurance company whereby the Company sold real estate and participations in various of its assets in an effort to develop a potential source for future financing and to generate cash from otherwise illiquid assets. The sales agreement, as amended, included a guarantee by each of the parties of a 10% rate of return on the assets transferred. Assets transferred by the Company pursuant to the asset sales agreement included a retail shopping center in Lubbock, Texas with a carrying value of $2.0 million at the date of transfer, a $1.5 million senior participation in a second lien mortgage note secured by the Las Vegas Plaza, a retail shopping center in Las Vegas, Nevada with a carrying value of $18.8 million prior to transfer, a $315,000 participation in a first mortgage note on unimproved land in Virginia Station, Virginia and a $799,000 participation in a second lien mortgage note on the Country Club Apartments in Flagstaff, Arizona. In return, the Company received a $1.9 million participation in a first mortgage note on the Kauai Inn, a hotel property in Lihue, Hawaii, a $1.0 million participation in a first mortgage note secured by land in Maricopa County, Arizona, a $118,000 first lien mortgage note secured by a single-family residence in Silver Creek, Colorado and $1.5 million in cash. The asset sales agreement contained put and guaranty provisions whereby, at any time, either party could demand that the seller reacquire any asset sold pursuant to the terms of the asset sales agreement for the consideration originally received within fifteen days of exercising its put option. In March 1992, the Company received payment in full on the $118,000 note secured by the single-family residence in Silver Creek, Colorado.\nIn March 1992, the insurance company was placed in receivership and in June 1992, the Company provided notice to the insurance company, under the terms of the put and guaranty provisions, of the asset sales agreement, of its desire to divest itself of all assets received. The Receiver has refused to allow the enforcement of the put and guaranty provisions of the asset sales agreement. On September 3, 1992, the Court approved the Receiver's Petition of Order of Liquidation for the insurance company.\nIn March 1992, the Company recorded a provision for loss of $496,000 to reduce the note receivable secured by land in Maricopa County, Arizona, to its then estimated fair value. The Company foreclosed on the land securing the note in June 1992. In December 1992, the Company recorded an additional provision for loss on such land of $349,000 to reduce the land's carrying value to its then estimated fair value. During September 1992, the Company recorded the insubstance foreclosure of the Kauai Inn, which secured the $1.9 million first mortgage participation\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE (Continued)\nreceived by the Company. Subsequently, the hotel suffered severe hurricane damage and was shut down. The Company is continuing to evaluate its options with regard to these assets and is also in settlement negotiations with the Receiver and does not expect to incur any loss in excess of the amounts previously provided.\nThe borrower on a $1.7 million first mortgage note receivable secured by land in Osceola, Florida failed to make the required March 1, 1993 payment of principal and interest. The Company accelerated the note and instituted foreclosure proceedings. In April 1993, the borrower brought the note current and the note was reinstated. Concurrent with reinstatement, the note was modified, the maturity date of October 1, 1995 was changed to November 1, 1993 and the interest rate was increased to 12% per annum. The borrower was also given two six month extension options. The borrower failed to make the May 1 through August 1 interest payments on the modified note when due. On August 10, 1993, the borrower again brought the note current. The borrower has made no payments on the note subsequent to that date, including the payment of principal and interest due at the note's November 1, 1993 maturity. The note had a principal balance of $1.6 million at December 31, 1993. The Company instituted judicial foreclosure proceedings and was awarded a summary judgment in January 1994. On March 8, 1994, the borrower paid a nonrefundable fee of $50,000 to delay the sale of the property at foreclosure for 45 days. The Company does not expect to incur any loss upon foreclosure as the estimated fair value of the collateral property exceeds the carrying value of the note.\nThe borrower on a $1.9 million first mortgage note receivable failed to make the principal payment due on December 31, 1992, the note's maturity date. The note is secured by a vacant property, formerly a hotel, located in Shaker Heights, Ohio, which the borrower plans to convert into a nursing home. The Company has granted several extensions on the note, with the most recent extension expiring on December 31, 1992. The borrower has requested another extension, which the Company is considering. On March 26, 1994, the borrower's \"certificate of need\", which is required to accomplish the nursing home conversion expired. The borrower has applied for a renewal of such certificate, however, there is no assurance that the renewal will be granted. In December 1992, the Company recorded a provision for loss of $1.3 million to reduce the carrying value of the note to the estimated fair value of the collateral, as a hotel. If extension negotiations with the borrower are unsuccessful, and the Company forecloses the collateral property, no loss is anticipated in excess of the amounts provided.\nThe Company did not receive the payment due on October 1, 1991 on the first mortgage note receivable secured by the 386 Ocean Parkway Co-op. In February 1994, the Company agreed to reinstate and modify its note\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE (Continued)\nin exchange for the pledge to the Company, as additional collateral, of 21 shares in the co-op equating to 21 unsold apartment units. The reinstated note reduces the principal balance from $900,000 to $750,000, waives all defaults on the note prior to the execution of the reinstatement documents, and extends the maturity date of the note to September 15, 1999, with interest only payments at 7% per annum for the first two years, 8% per annum for the second two years and 9% per annum for the balance of the term with principal due at maturity. The Company is negotiating the sale of its first mortgage note and as of December 31, 1993, recorded a provision for losses of $300,000 to reduce the carrying value of the note to its estimated sales price. No additional loss is anticipated in excess of the amount provided.\nIn August 1990, the Company foreclosed on its fourth lien note receivable secured by the Continental Hotel and Casino in Las Vegas, Nevada. The note had an outstanding principal balance as of the date of foreclosure of $9.2 million. The Company acquired the hotel and casino property at foreclosure subject to first and second lien mortgages totaling $10.0 million and a disputed third lien mortgage. In June 1992, the Company sold the hotel and casino to the third lienholder for a $22 million wraparound mortgage note receivable, a $500,000 unsecured note receivable, and $100,000 in cash. The $22 million note bears interest at 11%, matures June 19, 1995, and calls for monthly interest payments of $175,000 through December 1993, $250,000 through June 1, 1995 and a balloon payment at maturity. The $500,000 note was paid off in July 30, 1993. The Company recorded a deferred gain of $4.3 million in connection with the sale of the hotel and casino resulting from the disputed third lien mortgage being subordinated to the Company's wraparound mortgage note receivable. Payments of interest and principal on the Company's wraparound note receivable were made directly by the borrower to the holder of the first and second lien mortgages and were applied against interest and principal thereon. Since October 1993, the borrower has failed to make the monthly payments required by the Company's wraparound mortgage note receivable to the holder of the first and second lien mortgages. The Company and the underlying lienholder have accelerated their notes. The Company's wraparound mortgage note receivable had a principal balance of $22.7 million at December 31, 1993, including compounded interest. The Company is negotiating with the borrower and the underlying lienholder to modify and extend both the Company's wraparound mortgage note receivable and the underlying liens. The Company expects to be successful in such negotiations, however, if it should lose the collateral property to the underlying lienholder it would incur a loss of $12.4 million.\nAs discussed in NOTE 5. \"REAL ESTATE\", in March 1993, the Company recorded the insubstance foreclosure of the KC Holiday Inn, the collateral securing a first mortgage receivable with a principal balance of $7.0 million at the date of foreclosure. In June 1993, the Company\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE (Continued)\nacquired the first mortgage secured by Boulevard Villas Apartments foreclosing on the collateral property in July 1993. The Company held a second lien mortgage that was in default at December 31, 1992.\nIn 1992, the wraparound mortgage note receivable secured by a shopping center in Snellville, Georgia was paid off. The Company received net cash of $242,000 after satisfaction of the underlying $743,000 note payable. The Company wrote off a fully reserved $1.0 million note receivable as uncollectible in 1992. The collateral for the note was the general partner's interest in a limited partnership which owned an apartment complex in Birmingham, Alabama.\nAlso in 1992, the Company sold its $3.9 million first lien mortgage note secured by a 123 unit apartment complex in Brooklyn, New York. The note was sold subject to the $3.0 million hypothecation note payable, for $500,000.\nAt December 31, 1992, the Company held a mortgage note receivable with a principal balance of $590,000 secured by a third lien on a commercial property in South Carolina and personal guaranties of several individuals. In May 1992, a settlement was entered into between the Company and the guarantors. In accordance with the terms of the settlement, (i) the borrower made a principal reduction payment of $127,812, (ii) monthly interest payments at a rate of 10% per annum began June 1, 1992 and (iii) the maturity date was extended to May 11, 1993. Effective May 11, 1993, the Company and the guarantors of the note entered into a modification to the settlement agreement. The note was modified to bear interest at 18% per annum, have a maturity date of October 1, 1993, and provide for monthly principal payments of $200,000 July 1, 1993 through October 1, 1993. The Company received none of the payments required by the modified note. Effective September 1, 1993, the Company and the guarantors entered into a second modification. The guarantors paid $100,000, reducing the note's principal balance by $68,000 and bringing interest current to September 1, 1993. The second modification extends the note's maturity date to September 1, 1995, requires monthly interest payments at 12% per annum beginning October 1, 1993 and a $25,000 principal reduction payment every ninety days beginning December 1, 1993. The principal balance of the note was $497,000 at December 31, 1993, and the note was current. The Company does not expect to incur a loss in excess of the amounts previously provided.\nRelated party. In April 1990, SAMLP made a $1.4 million unsecured loan to Equity Health and Finance Corporation (\"Equity Health\"), an entity affiliated with BCM, the Company's advisor. The Company owns a 76.8% limited partner interest in SAMLP which it consolidates for financial statement purposes. The Equity Health note bears interest at 12% per annum, originally matured on April 10, 1991 and has been subsequently extended to May 9, 1994. In June 1991, Equity Health merged into BCM,\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES AND INTEREST RECEIVABLE (Continued)\nand BCM assumed the note. The outstanding balance of the note was $477,000 at December 31, 1993, including accrued but unpaid interest.\nNOTE 5. REAL ESTATE\nIn May 1992, the Company acquired Fox City, a shopping center in Culver City, California for $5.7 million subject to first and second lien mortgage debt equal to the purchase price. In August 1993, the Company sold the shopping center for net cash of $416,000 with the buyer assuming the first and second lien mortgage debt aggregating $5.5 million. The Company incurred a loss on the sale of $85,000.\nAt December 31, 1992, the Company held a first lien leasehold mortgage note receivable with an outstanding principal balance of $7.0 million secured by the KC Holiday Inn in Kansas City, Missouri. The borrower failed to make the required March 1993 interest payment and at March 31, 1993, the Company recorded the insubstance foreclosure of the hotel. In April 1993, title to the hotel was conveyed to a wholly-owned subsidiary of the Company subject to the Company's note receivable. The KC Holiday Inn had an estimated fair value (minus estimated costs of sale) of $5.2 million at the date of foreclosure. The Company incurred no loss on foreclosure in excess of the amounts previously provided. The Company's note receivable is pledged as collateral for a $3.0 million loan to the Company from a financial institution.\nIn May 1993, the Company obtained a $1.8 million first mortgage secured by the previously unencumbered Rosedale Office Towers Office Building. In December 1993, the Company refinanced the first mortgage debt secured by the Watersedge III and Edgewater Gardens Apartments in the aggregate amount of $6.1 million. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\"\nDuring the first quarter of 1992, a mortgage note receivable with an original principal balance of $1.0 million, secured by the Boulevard Villas Apartments in Las Vegas, Nevada, became nonperforming. Subsequently, the borrower on the note filed for bankruptcy protection. In October 1992, the Company reached an agreement with the first lienholder to acquire its first mortgage of $8.3 million for $6.8 million, paying $1.0 million upon signing the purchase agreement with the balance due in June 1993. In June the Company and the first lienholder modified the note purchase agreement to allow the Company to become the owner of the first mortgage and foreclose on the collateral property. The first lienholder provided purchase money financing for the then balance owed under the note purchase agreement. The Company foreclosed on the collateral property in July 1993. In October 1993, the Company refinanced the property in the amount of $6.0 million. The Company realized net financing proceeds of $280,000 after the payoff of the existing mortgage of $5.3 million and the establishment of required\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. REAL ESTATE (Continued)\nrepair and tax escrows and the payment of associated refinancing costs. The new mortgage bears interest at the rate of 9% per annum, matures November 1996, and requires monthly payments of principal and interest of $63,984. The Company acquired the first mortgage with the intent of acquiring the collateral property, hence the Boulevard Villas Apartments are classified as held for investment.\nIn April 1991, the Company acquired for $208,000 in cash all of the capital stock of a corporation which owned 181 developed residential lots in Fort Worth, Texas subject to $1.2 million of mortgage debt owed to Continental Mortgage and Equity Trust (\"CMET\"). The loan was paid in full August 1993. During 1991, 50 of the residential lots were sold for an aggregate gain of $250,000. During 1992, 37 of the residential lots were sold for an aggregate gain of $190,000. During 1993, 56 of the residential lots were sold for an aggregate gain of $220,000. At December 31, 1993, 44 lots remained to be sold. CMET is an entity having the same advisor as the Company and at March 31, 1994, the Company owned approximately 30% of CMET's outstanding shares of beneficial interest and CMET owned approximately 7% of the outstanding shares of the Company's Common Stock.\nIn 1991, the Company purchased for $930,000 in cash, all of the capital stock of Denton Road Investment Corporation (\"Denton Road\"), a corporation which owns a 60% interest in a joint venture which in turn owned 113 partially developed residential lots in Denton, Texas. Proceeds from the lot sales were applied to reduce the debt secured by the lots until March 30, 1993 when the debt was paid in full. During 1992, 47 of the residential lots were sold for an aggregate gain of $423,000. During 1993, 37 of the residential lots were sold for an aggregate gain of $356,000. At December 31, 1993, 30 lots remained to be sold.\nAs of December 31, 1993, the Company recorded a provision for losses of $2.0 million to reduce the carrying value of 3.5 acres of undeveloped land in downtown Atlanta, Georgia to its then estimated fair value based on an independent appraisal completed in March 1994.\nNOTE 6. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 6. ALLOWANCE FOR ESTIMATED LOSSES (Continued)\nIn addition to the provision for losses in the table above, the provision for losses in the accompanying Consolidated Statements of Operations includes $771,000 in 1992 and $23,000 in 1991 of direct charges against earnings. The direct charge in 1992 of $771,000 relates to the write down of the Company's investment in National Income Realty Trust (\"NIRT\") to an agreed sales price. (See NOTE 7. \"INVESTMENTS IN REAL ESTATE ENTITIES.\")\nNOTE 7. INVESTMENTS IN REAL ESTATE ENTITIES\nThe Company's investment in real estate entities at December 31, 1993, includes equity securities of three publicly traded real estate investment trusts (collectively the \"Trusts\"), CMET, Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Investors, Inc. (\"TCI\"), and NRLP, a general partnership interest in NRLP and NOLP, the operating partnership of NRLP, through its 76.8% limited partner interest in SAMLP and 50% interests in real estate joint venture partnerships. Mr. Phillips, a former Director of the Company, is a general partner of SAMLP, NRLP's and NOLP's general partner. Oscar W. Cashwell, a Director of the Company serves as President of BCM, the Trusts and as President and as a director of SAMI, the managing general partner SAMLP. In addition, BCM serves as advisor to the Trusts, and performs certain administrative and management functions for NRLP and NOLP on behalf of SAMLP.\nThe Company accounts for its investment in the Trusts, NRLP and the joint venture partnerships under the equity method as more fully described in NOTE 1. \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Investment in real estate entities.\"\nSubstantially all of the Company's equity securities of the Trusts and NRLP are pledged as collateral for borrowings. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\"\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. INVESTMENTS IN REAL ESTATE ENTITIES (Continued)\nThe Company's investment in real estate entities, accounted for under the equity method, at December 31, 1993 was as follows:\n____________________\n* At December 31, 1993, NRLP reported a deficit partners' capital. The Company's share of NRLP's revaluation equity, however, was $113.0 million (unaudited). Revaluation equity is defined as the difference between the appraised value of the partnership's real estate, adjusted to reflect the partnership's estimate of disposition costs, and the amount of the mortgage notes payable and accrued interest encumbering such property as reported in NRLP's Annual Report on Form 10-K for the year ended December 31, 1993.\nThe Company's investment in real estate entities, accounted for under the equity method, at December 31, 1992 was as follows:\n___________________________\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. INVESTMENTS IN REAL ESTATE ENTITIES (Continued)\n* At December 31, 1992, NRLP reported a deficit partners' capital. The Company's share of NRLP's revaluation equity was $69.2 million (unaudited). Revaluation equity is defined as the difference between the appraised value of the partnership's real estate, adjusted to reflect the partnership's estimate of disposition costs, and the amount of the mortgage notes payable and accrued interest encumbering such property as reported in NRLP's Annual Report on Form 10-K for the year ended December 31, 1992.\nThe Company's management continues to believe that the market value of each of the Trusts and NRLP undervalues their assets and the Company has, therefore, continued to increase its ownership in these entities in 1993, as its liquidity has permitted.\nOn February 25, 1992, in connection with the settlement of Southmark adversary proceedings, the Company assigned a 19.2% limited partner interest in SAMLP, the general partner of NRLP and NOLP, to Southmark. The Company has an option which expires on December 27, 1994, to reacquire Southmark's 19.2% interest in SAMLP for $2.4 million, less any distributions received by Southmark. See NOTE 17. \"COMMITMENTS AND CONTINGENCIES - Settlement of Southmark Adversary Proceedings\".\nIORT is scheduled, unless and until its shareholders decide on a contrary course of action, to begin liquidation of its assets prior to October 24, 1996. IORT's Declaration of Trust calls for the distribution to shareholders of (i) the net cash proceeds from sale or refinancing of equity investments received, and (ii) the net cash proceeds from the satisfaction of mortgage notes receivable received after October 24, 1996. However, IORT's board of trustees has discretionary authority to hold any investment past October 24, 1996, should circumstances so dictate.\nIn addition to the equity securities of the Trusts and NRLP, the Company also owned significant amounts of equity securities of two other publicly traded real estate investment trusts having, at the time, the same advisor as the Company and which the Company had previously accounted for under the equity method.\nIn September 1992, the Company agreed to sell its entire share holdings in Vinland Property Trust (\"VPT\") to Lucy N. Friedman, the wife of William S. Friedman, the President and a trustee of VPT. Mr. Friedman was also the President and a Director of the Company until December 31, 1992. The agreement provided for the Company to sell the 831,620 VPT shares which it owned at the then current market price of $0.415 per share. The Company recognized a gain of $71,000 on the disposition of its VPT shares. As of December 31, 1992, the Company had transferred all of its VPT shares to Mrs. Friedman for $345,000 in cash. BCM, the Company's advisor, resigned as advisor to VPT effective February 28, 1994.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. INVESTMENTS IN REAL ESTATE ENTITIES (Continued)\nAlso, in September 1992, the Company agreed to sell its entire holdings in NIRT to Mr. Friedman, the President and a trustee of NIRT, members of his family and his affiliates. The agreement provided for the Company to sell its 741,592 NIRT shares at the then market price of $6.875 per share. As payment for the NIRT shares, the Company received $2.9 million in cash ($657,000 in 1992) and $2.2 million in securities of CMET (105,096 shares at $6.625 per share), IORT (10,075 shares at $5.375 per share), TCI (118,500 shares at $5.25 per share) and NRLP (42,260 units at $20.50 per unit). In September 1992, the Company wrote the carrying value of its NIRT shares down to their agreed sales price, recorded a provision for loss of $771,000 and discontinued accounting for its investment in NIRT under the equity method. As of December 31, 1993, the Company had transferred all of its NIRT shares to Mr. Friedman and his affiliates and had received payment in full. BCM, the Company's advisor, resigned as advisor to NIRT effective March 31, 1994.\nIn January 1992, the Company entered into a partnership agreement with an entity affiliated with Donald C. Carter, the owner of in excess of 14% of the Company's outstanding Common Stock, to acquire 287 developed residential lots adjacent to the Company's other residential lots in Fort Worth, Texas. The Company paid $717,000 in cash for its 50% general partnership interest. The partnership agreement designates the Company as managing general partner. The partnership agreement also provides that Mr. Carter is guaranteed a 10% return on his investment. In 1993, 18 residential lots were sold, no lots were sold in 1992. At December 31, 1993, 269 lots remained to be sold. See NOTE 8. \"NOTES AND INTEREST PAYABLE\" and NOTE 9. \"REDEEMABLE COMMON STOCK.\"\nThe following information summarizes the combined financial position and results of operations of the real estate entities the Company accounts for using the equity method (unaudited):\n1993 1992 --------- --------- Property and notes receivable, net............ $ 647,049 $ 783,153 Other assets.................. 80,680 116,662 Notes payable................. (547,364) (630,366) Other liabilities............. (63,212) (59,627) --------- --------- Equity........................ $ 117,153 $ 209,822 ========= =========\n1993 1992 1991 --------- --------- -------- Revenues.................... $ 166,050 $ 178,145 $186,464 Depreciation................ (18,984) (20,374) (21,483) Provision for losses........ (1,094) (8,759) (24,448) Interest.................... (50,661) (57,529) (57,160) Operating expenses.......... (112,975) (107,109) (127,637) Gains on sale of real estate 389 - - Extraordinary gains......... 11,446 - - --------- --------- -------- Net (loss).................. $ (5,829) $ (15,626) $(44,264) ========= ========= ========\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. INVESTMENTS IN REAL ESTATE ENTITIES (Continued)\nThe difference between the carrying value of the Company's investment and the equivalent investee book value is being amortized over the life of the properties held by each investee.\nThe Company's cash flow from the Trusts and NRLP is dependent on the ability of each of the entities to make distributions. TCI's distribution policy provides for an annual determination of distributions after year end, and then only to the extent of its REIT (as defined below) taxable income, if any. In December 1993, NRLP resumed regular distributions at a rate of $0.20 per unit. In March 1993, CMET and IORT resumed regular quarterly distributions at the current rate of $0.15 per share. The Company received distributions from CMET and IORT totaling $506,000 in 1993 and $170,000 from NRLP in December 1993. No distributions were received in 1992.\nThe Company's investments in the Trusts and NRLP were initially acquired in 1989. In 1993, the Company purchased an additional $3.9 million of equity securities of the Trusts and NRLP.\nNOTE 8. NOTES AND INTEREST PAYABLE\nNotes and interest payable consisted of the following:\nScheduled principal payments on notes payable are due as follows:\n1994............................................... $10,715 1995............................................... 8,395 1996............................................... 6,980 1997............................................... 9,270 1998............................................... 345 Thereafter......................................... $13,571 ------- $49,276 =======\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 8. NOTES AND INTEREST PAYABLE (Continued)\nStated interest rates on notes payable ranged from 6.0% to 25% at December 31, 1993, and mature in varying installments between 1994 and 2019. At December 31, 1993, notes payable were collateralized by mortgage notes receivable with a net carrying value of $36.2 million and by deeds of trust on real estate with a net carrying value of $32.6 million.\nBorrowings from financial institutions at December 31, 1992 included borrowings under a term loan from First City. The term loan was collateralized by a participation agreement in a pool of assets in a like amount. In October 1993, the participation and term loan were both terminated. Both the term loan and the participation each had a principal balance of $7.6 million at the date of termination. The Company recorded a $58,000 gain on the termination of the agreements. See NOTE 4. \"NOTES AND INTEREST RECEIVABLE.\"\nIn March 1992, the Company obtained a $1.3 million working capital loan from a financial institution. The loan is secured by equity securities of the Trusts and NRLP. The loan required monthly interest only payments at 1\/2% above the lender's prime lending rate and originally matured April 1, 1993, and was extended to April 1, 1994. The loan extension required the Company to make a principal paydown of $275,000 by May 1, 1993 and $250,000 on each of June 1 and July 1, 1993 and $100,000 in January 1994 with the interest rate increasing to the prime rate plus 2%, at no time to be less than 8% per annum. All other terms of the loan remained unchanged. The balance of this note was $350,000 after the January 1994 principal payment. The Company paid off the balance of the loan at maturity.\nAnother borrowing from a financial institution of $10.4 million at December 31, 1993 ($11.5 million at December 31, 1992) was scheduled to mature on December 18, 1994. The borrowing is collateralized by a note receivable with an outstanding principal balance of $17.3 million at December 31, 1993. The Company has reached an agreement to further extend the note's maturity to December 18, 1997. The extended note bears interest at the prime rate plus 2%, requires monthly principal payments of $75,000 and requires the Company to pledge as additional collateral units of NRLP with a market value of $2.0 million. Such borrowing is excluded from 1994 maturities in the table above.\nThe Company has also reached agreement with another lender whose loan to the Company, with a principal balance of $950,000 at December 31, 1993, matured in August 1993. The Company did not payoff the loan at maturity, but continued to make monthly principal reduction payments of $50,000 in accordance with the expired loan agreement. This note extension provides for a maturity date of July 1995, and requires the Company to continue to make monthly principal reduction payments of $50,000. All other terms remain unchanged.\nNotes payable to affiliates at December 31, 1993 and 1992 include a $4.2 million note due to NRLP as payment for SAMLP's general partner interest\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 8. NOTES AND INTEREST PAYABLE (Continued)\nin NRLP. The note bears interest at 10% per annum compounded semi-annually and is due at the earlier of September 2007, the liquidation of NRLP or the withdrawal of SAMLP as general partner of NRLP. See NOTE 3. \"SYNTEK ASSET MANAGEMENT, L.P.\"\nIn June 1992, the Company obtained a $3.3 million loan from Donald C. Carter, the owner of in excess of 14% of the Company's outstanding shares of Common Stock. The note bears interest at 10% and matures in May 1995. Interest payments are made monthly in addition to ten quarterly principal payments of $330,000 which commenced March 1, 1993. The note is collateralized by an assignment of the Company's interest in a partnership which owns residential lots in Fort Worth, Texas and the Company's interest in undeveloped land in downtown Atlanta, Georgia. The loan also provides for Mr. Carter's participation in the proceeds from either the sale or refinancing of the Company's land in Atlanta, Georgia to the extent of 15.57% of the net proceeds, as defined, in excess of $10.0 million. Mr. Carter also had the right during a period beginning eighteen months from the date of the loan and continuing ninety days thereafter to put his participation to the Company in exchange for a payment of $623,000. On December 2, 1993, Mr. Carter exercised his put which required full payment by the Company within 30 days. The Company has recognized such payment obligation as additional interest on the $3.3 million loan. Mr. Carter has agreed to extend the payment date to January 2, 1995, and BCM and the trust that beneficially owns BCM, have agreed to guarantee the Company's payment obligation, as well as the Company's obligation to purchase up to 360,000 shares of the Company's Common Stock pursuant to an option held by Mr. Carter. As of March 31, 1994, BCM owned approximately 38% of the outstanding shares of the Company's Common Stock. Such put obligation is included in accrued interest payable in the accompanying Consolidated Balance Sheet. See NOTE 7. \"INVESTMENTS IN REAL ESTATE ENTITIES\" and NOTE 10. \"REDEEMABLE COMMON STOCK.\"\nIn May 1993, the Company obtained a $1.8 million first mortgage secured by the previously unencumbered Rosedale Towers Office Building in Minneapolis, Minnesota. The Company received net financing proceeds of $1.7 million after payment of associated closing costs. The Company pledged as additional collateral for the loan 141,176 newly issued shares of the Company's Common Stock. The mortgage bears an effective annual interest rate of 25% and calls for monthly payments of $25,000 with balance of principal and accrued but unpaid interest due at maturity on April 30, 1994.\nIn October 1993, the Company refinanced the Boulevard Villas Apartments for $6.0 million paying off an existing mortgage of $5.3 million, as discussed in NOTE 5. \"REAL ESTATE.\"\nIn June 1992, the Company purchased the Park Plaza Shopping Center in Manitowoc, Wisconsin. The $4.2 million mortgage secured by the shopping center was scheduled to mature on May 1, 1995. Effective June 1, 1993,\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 8. NOTES AND INTEREST PAYABLE (Continued)\nthe mortgage was amended extending its maturity date to May 10, 2003, providing for a variable interest rate of 6% to 8% per annum and requiring monthly payments of principal and interest.\nIn addition, the same lender made a second loan, also effective June 1, 1993, in the amount of up to $1.0 million to be used for capital and tenant improvements to the shopping center. The new loan required monthly interest only payments at the prime rate plus 2% per annum with principal and accrued but unpaid interest due at maturity. Cash was advanced by the lender upon costs being incurred for the improvements. In the event that all sums advanced on the new loan were repaid by May 31, 1994, the principal balance of the first mortgage was to be reduced by the lesser of $500,000 or one-half of the amount advanced on the new loan. The balance of the new loan, $887,000, was paid in full on December 23, 1993, with the Company receiving a credit of $443,000 against the first mortgage reducing its balance to $3.7 million at December 31, 1993. The Company also deposited into an escrow account $105,000 to complete remaining parking lot and exterior renovations at the shopping center. The Company is also to receive a credit against the first mortgage for one-half of these monies as expended.\nOn December 23, 1993, the Company refinanced Watersedge III Apartments in the amount of $4.2 million. The Company realized net refinancing proceeds of $924,000 after the pay off of the existing mortgage of $3.0 million and payment of associated refinancing costs. The new mortgage matures January 1, 2019, bears interest at 8.73% per annum through December 31, 2003, and at a variable rate through maturity. Monthly payments of principal and interest are required. The principal balance and accrued but unpaid interest are due at maturity.\nAlso on December 23, 1993, the Company refinanced the Edgewater Gardens Apartments in the amount of $2.9 million. The Company realized net refinancing proceeds of $728,000 after the pay off the existing mortgage of $1.9 million and payment of associated refinancing costs. The new mortgage contains the same interest; repayment terms and maturity date as the Watersedge III mortgage described above.\nThe Company has margin arrangements with various brokerage firms which provide for borrowings of up to 50% of the market value of the Company's marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of the Trusts and NRLP and bear interest rates ranging from 4.50% to 7.75%. Margin borrowings at December 31, 1993 were $16.1 million and $9.7 million at December 31, 1992 36% and 39%, respectively, of the market values of such equity securities at such dates.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. REDEEMABLE COMMON STOCK\nIn June 1992, the Company sold 397,359 newly issued shares of its Common Stock to Donald C. Carter for $1.9 million in cash. Terms of the sale agreement provide Mr. Carter with the option of requiring the Company to reacquire up to 360,000 of the purchased shares at a price of $6.11 per share, a total of $2.2 million. Such option is exercisable by Mr. Carter for a two year period expiring in March 1995. The Company has accreted the difference between the issuance price and the redemption price using the \"interest method\". As of December 31, 1993, the balance of the Redeemable Common Stock account was $2.2 million. To secure its payment obligation under the option agreement, the Company assigned to Mr. Carter its interest in the $22 million note receivable secured by the Continental Hotel and Casino. In addition, BCM, the Company's advisor, and the trust that owns BCM have agreed to guarantee the Company's payment obligation to purchase such shares. See NOTE 4. \"NOTES AND INTEREST RECEIVABLE\" and NOTE 8. \"NOTES AND INTEREST PAYABLE.\"\nNOTE 10. RIGHTS PLAN\nIn April 1990, the Company adopted a Preferred Share Purchase Rights Plan (the \"Rights Plan\") and approved the distribution to stockholders of a dividend of one share purchase right (the \"Rights\") for each then outstanding share of the Company's Common Stock. Each Right will entitle stockholders to purchase one one-hundredth of a share of a new series of preferred stock at an exercise price of $25.00. The Rights will generally be exercisable only if a person or group (the \"Adverse Group\") increases its then current ownership in the Company by more than 25% or commences a tender offer for 25% or more of the Company's Common Stock. If any person or entity actually increases its then current ownership in the Company by more than 25% or if the Company's Board of Directors determines that any 10% stockholder is adversely affecting the business of the Company, holders of the Rights, other than the Adverse Group, will be entitled to buy, at the exercise price, the Common Stock of the Company with a market value of twice the exercise price. Similarly, if the Company is acquired in a merger or other business combination, each Right will entitle its holder to purchase, at the Right's exercise price, the number of shares of the surviving company having a market value of twice the Right's exercise price. In connection with the one-for-three reverse share split effected in December 1990, the Rights were proportionately adjusted so that each post-split share certificate represents three Rights, each of which permit the holder thereof to purchase one-hundredth of a preferred share for $25.00 under such circumstances. The Rights expire in 2000 and may be redeemed at the Company's option for $.01 per Right under certain circumstances.\nOn March 5, 1991, the Company's Board of Directors approved an amendment to the Rights Plan. The amendment excludes the Company, the Company's subsidiaries, and the Company's advisor or its officers and Directors from the class of persons who may cause the Rights to become exercisable by increasing their ownership of the Company's stock.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. ADVISORY AGREEMENT\nAlthough the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by BCM, a contractual advisor under the supervision of the Company's Board of Directors. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage loan investment and sales opportunities as well as financing and refinancing sources for the Company. BCM as advisor also serves as a consultant in connection with the Company's business plan and investment policy decisions made by the Company's Board of Directors.\nBCM has been providing advisory services to the Company since February 6, 1989. BCM is beneficially owned by a trust for the benefit of the children of Mr. Phillips. Mr. Phillips served as the Chairman of the Board and a Director of the Company until November 16, 1992. Mr. Phillips served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of the trust for the benefit of his children that beneficially owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company. Ryan T. Phillips, a Director of the Company is a director of BCM and a trustee of such trust. Mr. Cashwell, a Director of the Company, serves as president of BCM.\nThe Advisory Agreement provides that BCM shall receive base compensation at the rate of .125% (1.5% on an annualized basis) of the Company's Average Invested Assets. On October 23, 1991, based on the recommendation of BCM, the Company's Board of Directors approved a reduction in BCM's base advisory fee by 50% effective October 1, 1991. This reduction remains in effect until the Company's earnings for the four preceding quarters equals or exceeds $2.00 per share.\nIn addition to base compensation, BCM,or an affiliate of BCM, receives the following forms of additional compensation:\n(a) an acquisition fee for locating, leasing or purchasing real estate for the Company in an amount equal to the lesser of (i) the amount of compensation customarily charged in similar arm's-length transactions or (ii) up to 6% of the costs of acquisition, inclusive of commissions, if any, paid to non-affiliated brokers;\n(b) a disposition fee for the sale of each equity investment in real estate in an amount equal to the lesser of (i) the amount of compensation customarily charged in similar arm's-length transactions or (ii) 3% of the sales price of each property, exclusive of fees, if any, paid to non-affiliated brokers;\n(c) a loan arrangement fee in an amount equal to 1% of the principal amount of any loan made to the Company arranged by BCM;\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. ADVISORY AGREEMENT (Continued)\n(d) an incentive fee equal to 10% of net income for the year in excess of a 10% return on stockholders' equity, and 10% of the excess of net capital gains over net capital losses, if any, realized from sales of assets made under contracts entered into after April 15, 1989; and\n(e) a mortgage placement fee, on mortgage loans originated or purchased, equal to 50%, measured on a cumulative basis, of the total amount of mortgage origination and placement fees on mortgage loans advanced by the Company for the fiscal year.\nThe Advisory Agreement further provides that BCM shall bear the cost of certain expenses of its employees, excluding fees paid to the Company's Directors; rent and other office expenses of both BCM and the Company (unless the Company maintains office space separate from that of BCM); costs not directly identifiable to the Company's assets, liabilities, operations, business or financial affairs; and miscellaneous administrative expenses relating to the performance by BCM of its duties under the Advisory Agreement.\nIf and to the extent that the Company shall request BCM, or any director, officer, partner or employee of BCM, to render services to the Company other than those required to be rendered by BCM under the Advisory Agreement, such additional services, if performed, will be compensated separately on terms agreed upon between such party and the Company from time to time. The Company has requested that BCM perform loan administration functions, and the Company and BCM have entered into a separate agreement, as described below.\nThe Advisory Agreement automatically renews from year to year unless terminated in accordance with its terms. The Company's management believes that the terms of the Advisory Agreement are at least as fair as could be obtained from unaffiliated third parties.\nBCM is the loan administration\/servicing agent for the Company, under an agreement dated as of October 4, 1989, and terminable by either party upon thirty days' notice, under which BCM services most of the Company's mortgage notes and receives as compensation a monthly fee of .125% of the month-end outstanding principal balances of the mortgage notes serviced.\nNOTE 12. PROPERTY MANAGEMENT\nSince February 1, 1990, affiliates of BCM, have provided property management services to the Company. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. In many cases, Carmel, Ltd. subcontracts with other entities for the property-level management services to the Company at\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 12. PROPERTY MANAGEMENT (Continued)\nvarious rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management of the Company's shopping center to Carmel Realty, Inc., which is owned by SWI.\nNOTE 13. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.\nFees and cost reimbursements to BCM, the Company's advisor, and its affiliates were as follows:\n1993 1992 1991 ---------- ---------- ---------- Fees Advisory and mortgage servicing............... $1,258 $1,340 $2,616\nBrokerage commissions...... 180 596 - Property management*....... 45 49 27 Loan arrangement........... 102 76 - ------ ------ ------ $1,585 $2,061 $2,643 ====== ====== ======\nCost reimbursements........ $ 288 $ 299 $ 373 ====== ====== ======\n_________________________________\n* Net of property management fees paid to subcontractors.\nNOTE 14. INCOME TAXES\nFinancial statement income varies from taxable income, principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. At December 31, 1993, the Company had a tax net operating loss carryforward of $12.7 million expiring through 2008.\nAt December 31, 1993, the Company recognized a deferred tax benefit of $4.0 million due to tax deductions available to it in future years. However, due to, among other factors, the Company's inconsistent earnings history, the Company was unable to conclude that the future realization of such deferred tax benefit, which requires the generation of taxable income, was more likely than not. Accordingly, a valuation allowance for the entire amount of the deferred tax benefit has been recorded.\nIn 1987 the Company provided deferred income taxes for certain capital gains (which were reported under the installment method for tax purposes) because the Company did not anticipate distributing these gains to stockholders. In 1992 and 1991, the portion of the deferred gains which became taxable were offset by the Company's tax loss for each year. Accordingly, applicable deferred taxes of $939,000 and $1.2 million were reversed in 1992 and 1991, respectively.\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. INCOME TAXES (Continued)\nThe components of tax expense are as follows:\n1993 1992 1991 ------ ------ ------ Income tax provision (benefit) Current....................... $ 11 $ 18 $ 8\nReversal of deferred tax liability................... - (939) (1,163) ---- ----- ------- $ 11 $(921) $(1,155) ==== ===== =======\nA reconciliation of the federal statutory tax rate (34%) with the income tax provision (benefit) in the Consolidated Financial Statements is as follows: 1993 1992 1991 -------- -------- -------- Income tax at statutory rate... $(1,450) $(3,572) $(1,372)\nCarryforward of net operating loss income tax benefit...... 1,450 3,572 1,372\nReversal of deferred tax liability.................... - (939) (1,163)\nState income tax, net of federal benefit.............. 11 18 8 ------- ------- ------- Income tax provision (benefit). $ 11 $ (921) $(1,155) ======= ======= =======\nNOTE 15. EXTRAORDINARY GAIN\nIn 1993, the Company recognized a $3.4 million extraordinary gain representing its equity share of NRLP's extraordinary gain of $9.0 million from its acquisition at a discount of certain of its mortgage debt and $443,000 from the forgiveness of debt. See NOTE 8. \"NOTES AND INTEREST PAYABLE.\nIn 1992, NOLP transferred 52 apartment complexes and a wraparound mortgage note receivable to Garden Capital, L.P. (\"GCLP\"), a Delaware limited partnership in which NOLP owns a 99.3% limited partnership interest. Concurrent with such transfer, GCLP refinanced all of the mortgage debt associated with the transferred properties and the wraparound note receivable, under a new first mortgage of $223.0 million. NOLP recognized an extraordinary gain of $1.6 million from the early or discounted payoff of the old mortgage debt, of which the Company's equity share was $534,000, which is included in \"Equity in (losses) of investees,\" in the Accompanying Consolidated Statement of Operations.\nIn 1991, the Company paid off at a discount, a line of credit from First City recognizing an extraordinary gain of $7.6 million.\nNOTE 16. RENTALS UNDER OPERATING LEASES\nThe Company's rental operations include the leasing of an office building and a shopping center. The leases thereon expire at various dates through\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 16. RENTALS UNDER OPERATING LEASES (Continued)\n2009. The following is a schedule of minimum future rentals on non-cancelable operating leases as of December 31, 1993:\n1994.................................. $1,353 1995.................................. 940 1996.................................. 724 1997.................................. 547 1998.................................. 445 Thereafter............................ 2,574 ------ $6,583 ======\nNOTE 17. COMMITMENTS AND CONTINGENCIES\nSettlement of Southmark Adversary Proceedings. During 1990 and 1991, several adversary proceedings were initiated against the Company and others by Southmark and its affiliates. On December 27, 1991, an agreement to settle all claims in connection with the Southmark adversary proceedings was executed by Southmark and the Company. The settlement covers all claims between Southmark and its affiliates and Messrs. Phillips and Friedman, SWI, NRLP, CMET, IORT, NIRT, TCI, VPT and the Company. The final settlement of such litigation concludes all suits in which the Company was a defendant. Pursuant to the settlement agreement, Southmark will receive $13.2 million from the various settling defendants. Payments were made totaling $11.9 million in 1992 and 1993, and the remaining balance of $1.3 million is scheduled to be paid on June 27, 1994.\nThe Company paid Southmark of $1.0 million in each of 1992 and 1993, and will pay Southmark an additional $435,000 by June 27, 1994. In addition, on February 25, 1992, the Company assigned Southmark a 19.2% limited partner interest in SAMLP, the general partner of NRLP and NOLP, and the Company received Southmark's interest in Novus Nevada, Inc. The Company has an option which expires December 27, 1994, to reacquire Southmark's 19.2% interest in SAMLP for $2.4 million, less any distributions received by Southmark. On May 1, 1992, the Company received from Southmark certain real estate and mortgage notes that the Company believes have an aggregate value at least equal to the consideration the Company has agreed to pay Southmark.\nTo secure the settlement payment obligations to Southmark, the Company issued 390,000 new shares of its Common Stock to ATN Equity Partnership (\"ATN\") which pledged such shares to Southmark along with securities of TCI and NRLP. The Company intends to cancel its collateral shares as they are released from the pledge to Southmark and returned to it by ATN. As of December 31, 1993, 195,000 shares had been returned by ATN to the Company and canceled. Voting rights to the Company's collateral shares are held by the Company's Board of Directors. ATN is a general partnership of which the Company and NRLP are general partners. ATN was formed solely to hold title to the securities issued by each partner and TCI and to pledge such securities to Southmark. At December 31, 1993, the\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 17. COMMITMENTS AND CONTINGENCIES (Continued)\nunpaid settlement balance of $1.3 million was secured by a pledge of securities of the Company having a minimum value of 145% of the unpaid balance and by the Company's remaining limited partnership interest in SAMLP.\nIn addition to the pledge of securities securing the payment to Southmark, Messrs. Phillips and Friedman, the Company and SWI have each executed and delivered separate, final, nonappealable judgments in favor of Southmark, each in the amount of $25 million. In the event of a default, Southmark is entitled to entry of those judgments and to recover from the parties an aggregate of $25 million, subject to reduction for any amounts previously paid. If the settlement obligations are met, the judgments will be returned to the defendants.\nOn February 25, 1992, the Company entered into an agreement with Messrs. Phillips and Friedman, SWI, CMET, IORT, NIRT and TCI relating to their settlement of litigation with Southmark. Pursuant to the agreement, TCI obtained the right to acquire four apartment complexes, five mortgage notes, two commercial properties and four parcels of developed land from Southmark and its affiliates.\nOther Litigation. The Company is also involved in various lawsuits arising in the ordinary course of business. Management of the Company is of the opinion that the outcome of these lawsuits would have no material impact on the Company's financial condition.\nGuarantees. In May 1990, the Company guaranteed up to $3.0 million of a $14.0 million loan secured by a hotel in California. In return for such guarantee, the borrower was required to pay an annual fee to the Company of $45,000 of which only the fee due in 1990 was paid. Because it located the financing for the hotel and a party to guarantee the loan, an entity that is beneficially owned by Mr. Phillips was granted a profits participation by the borrower and was to receive certain other consideration. The guarantee was to continue in effect until all of the guaranteed obligations had been paid, performed, satisfied and discharged. In April 1991, the Company advanced $357,000 on a note secured by the hotel, pursuant to the guarantee and an additional $101,000 was advanced in June 1991, also on a note secured by the hotel.\nIn January 1992, the Company received notice that the lender had declared an event of default on the $14.0 million loan and in June 1993 that the lender foreclosed on the hotel securing the loan. In January 1994, the Company and the lender reached an agreement in principle relating to the Company's performance under its guarantee. Under the proposed agreement the Company will pay a total of $750,000 to the lender; payable $100,000 upon completion of documentation and the balance of $650,000 due within 120 days of the date of first payment. The Company also agreed to transfer any other rights or assets the Company held in the hotel, to the lender in return for cancellation of the guarantee. The Company wrote off its two notes\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 17. COMMITMENTS AND CONTINGENCIES (Continued)\nreceivable secured by the foreclosed hotel as uncollectible as of December 31, 1993. The Company did not incur a loss with respect to either its guarantee or the notes in excess of the amounts previously provided.\nIn June 1992, the Company sold 397,359 newly issued shares of its Common Stock to Donald C. Carter for $1.9 million cash. Terms of the sale agreement provide Mr. Carter with the option of requiring the Company to reacquire up to 360,000 of the purchased shares at $6.11 per share, a total of $2.2 million. Such option is exercisable for a two year period expiring in March 1995. See NOTE 9. \"REDEEMABLE COMMON STOCK.\"\nIn October 1993, SAMLP, the NRLP oversight committee and the Company reached an agreement evidenced by a detailed Term Sheet to nominate a candidate for successor general partner of NRLP and NOLP, and to consummate the 1990 settlement of a class action suit related to the formation of NRLP. The Term Sheet also sets forth an agreement in principle to effect a restructuring of NRLP and the spinoff by NRLP to its unitholders of shares of a newly-formed subsidiary which would qualify as a REIT for federal tax purposes. The Company is NRLP's largest unitholder and a 76.8% limited partner of SAMLP. SAMLP currently serves as the general partner of NRLP and NOLP and a newly formed subsidiary of SAMLP is to be nominated as the successor general partner. The Term Sheet provides that within nine months of the spinoff transaction, the Company will make a cash tender offer to purchase up to 60% of NRLP's units of limited partner interest held by unitholders unaffiliated with the Company or SAMLP for $12.00 per unit (an estimated maximum purchase price of $8.0 million), unless the NRLP units have traded at an appreciably higher average price for the prior thirty days. See NOTE 7. \"INVESTMENTS IN REAL ESTATE ENTITIES.\"\nNOTE 18. LIQUIDITY\nThe Company's principal sources of cash flow have been and will continue to be from property operations, collection of mortgage notes receivable, sales of real estate and externally generated funds. Externally generated funds include borrowings against marketable equity securities, proceeds from the issuance of debt secured by real estate and notes receivable, borrowings from BCM, the Company's advisor, as well as a possible equity offering.\nThe Company continues to experience liquidity problems and expects that cash flow from operations together with externally generated funds will be sufficient to meet its various cash needs only if the Company is able to renew and extend mortgage financings as they mature or obtain mortgage financing on its unencumbered properties. If the Company were unsuccessful in obtaining new financings or refinancings, the Company anticipates it could obtain additional advances from BCM in amounts sufficient to satisfy its cash requirements. Advances from BCM totaled $3.6 million at December 31, 1993. In 1994, notes payable totaling $10.7 million come due. See NOTE 8. \"NOTES AND INTEREST PAYABLE,\" for a\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 18. LIQUIDITY (Continued)\ndiscussion of debt maturities where the Company has reached extension agreements with the lender. It is the Company's intention to either pay the debt when due or seek to extend the due dates one or more years while attempting to obtain other long-term financing. Due to the limited long- term financing available to the Company, there can be no assurance that the Company will be successful in extending such \"balloon\" payments or that it will not ultimately lose certain of its assets to foreclosure. However, the Company's management believes it will continue to be successful in obtaining at least the minimum amount of extensions or other proceeds or advances to enable it to maintain anticipated levels of property operations, existing commitments and ownership of all properties in which it has equity.\nNOTE 19. QUARTERLY FINANCIAL DATA (unaudited)\nThe following is a tabulation of the quarterly results of operations for the years 1993 and 1992:\nAMERICAN REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 19. QUARTERLY FINANCIAL DATA (unaudited) (Continued)\nRevenue includes equity in losses of investees of $798,000, $424,000, $1.3 million and $1.5 million in the first, second, third and fourth quarters of 1993, respectively. Expenses includes provision for losses of $2.3 million in the fourth quarter of 1993.\nRevenue includes equity in losses of investees of $452,000, $1.2 million, $1.6 million and $125,000 in the first, second, third and fourth quarters of 1992, respectively. Expense includes provision for losses of $537,000, $404,000, $736,000 and $2.1 million in the first, second, third and fourth quarters of 1992, respectively. Fourth quarter expense has been reduced by $939,000 for the reversal of the Company's deferred tax liability.\nSCHEDULE I\nAMERICAN REALTY TRUST, INC. MARKETABLE SECURITIES December 31, 1993\nSCHEDULE II\nAMERICAN REALTY TRUST, INC. AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\n__________________________\n(1) Note is due May 7, 1994, bears interest at 12%, and is unsecured. This amount has been netted against other amounts payable to affiliates and classified as accounts payable and other liabilities in the accompanying Consolidated Balance Sheets. The current balance includes accrued but unpaid interest. (2) A subsidiary of the Company became the general partner of Williamsburg Associates, L.P. in November 1990. (3) Note was due to mature on January 15, 1993, bore interest at 12%, and was collateralized by certain notes receivable of the borrower. The borrower was in nonmonetary default and on April 8, 1992, the Company completed foreclosure on the underlying collateral notes. In September 1992, the Company sold the collateral notes for $4.1 million. (4) Note is due March 31, 1994, bears interest at 14% and is collateralized by substantially all assets of the borrower. The note was charged against earnings during 1990 in accordance with SFAS No. 68, which requires expensing of research and development loans. The borrower filed for bankruptcy protection on March 18, 1992. (5) Note matured December 1, 1991, bore interest at 12% and was collateralized by a second lien on real estate.\nSCHEDULE IX\nAMERICAN REALTY TRUST, INC. SHORT-TERM BORROWINGS\n________________________\n(1) Computed by weighing the interest rate according to balances outstanding over the life of the loans.\n(2) Computed as the amount borrowed divided by the number of days outstanding.\n(3) Computed by weighing the interest rate according to balances outstanding.\nSCHEDULE XI AMERICAN REALTY TRUST, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1993\n____________________________ (1) The aggregate cost for federal income tax purposes is $66,578. (2) Property is pledged as additional collateral for a note payable with a princial balance of $2.3 million.\nSCHEDULE XII\nAMERICAN REALTY TRUST, INC. MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1993\nSCHEDULE XII (Continued)\nAMERICAN REALTY TRUST, INC. MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1993\n____________________________ (1) Interest rates and maturity dates shown are as stipulated in the loan documents at December 31, 1993. Where applicable, these rates have been adjusted at issuance to yield between 8% and 12%. (2) The aggregate cost for federal income tax purposes is $54,303. (3) Note is pledged as additional collateral for a note payable with a principal balance of $2.3 million. (4) Mortgage note is receivable from a related party and is also listed at Schedule II.\nSCHEDULE X\nAMERICAN REALTY TRUST, INC. SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION\n______________________\n(1) Item is less than one percent of the total revenue.\nSCHEDULE XI (Continued)\nAMERICAN REALTY TRUST, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION\nSCHEDULE XII (Continued)\nAMERICAN REALTY TRUST, INC. MORTGAGE LOANS ON REAL ESTATE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\n______________________________________\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\nDirectors\nThe affairs of American Realty Trust, Inc. (the \"Company\" or the \"Registrant\") are managed by a five-member Board of Directors. The Company's By-laws provide for three classes of Directors to serve for staggered three-year terms. The Directors are elected at the annual meeting of stockholders or are appointed by the Company's incumbent Board of Directors and serve until their respective terms expire or until a successor has been elected or appointed.\nThe Directors of the Company are listed below, together with their ages, terms of service, all positions and offices with the Company or its advisor, Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\"), their principal occupations, business experience and directorships with other companies during the last five years or more. The designation \"Affiliate\" when used below with respect to a Director means that the Director is an officer, director or employee of the Advisor or an officer or employee of the Company. The designation \"Independent\", when used below with respect to a Director, means that the Director is neither an officer or employee of the Company nor a director, officer or employee of the Advisor, although the Company may have certain business or professional relationships with such Director, as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships.\"\nOSCAR W. CASHWELL: Age 66, Director (Class I) (Affiliated) (since November 1992).\nPresident (since February 1994) of Continental Mortgage and Equity Trust (\"CMET\"), Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Investors, Inc. (\"TCI\"); President and Director of Property and Asset Management (since January 1994) of BCM; Assistant to the President, Real Estate Operations (July 1989 to December 1993) of BCM; President (since February 1994) and Director (since March 1994) of Syntek Asset Management, Inc. (\"SAMI\"), the managing general partner of Syntek Asset Management, L.P. (\"SAMLP\"), which in turn is the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), and a corporation owned by BCM; and Assistant to the President, Real Estate Operations (March 1982 to June 1989) of Southmark Corporation (\"Southmark\").\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nAL GONZALEZ: Age 57, Director (Class II) (Independent) (since 1989).\nPresident (since March 1991) of AGE Refining, Inc. (formerly Al Gonzalez Enterprises, Inc.), a petroleum refining and marketing firm; President (January 1988 to March 1991) of Moody-Day Inc., which sells and leases construction equipment and supplies; owner and President of Gulf-Tex Construction Company (\"Gulf-Tex\"); owner and lessor of two restaurant sites in Dallas, Texas; Director (since April 1990) of Avacelle, Inc. (\"Avacelle\"); Director (1988 to 1992) of Medical Resource Companies of America; and member (1987 to 1989) of the Dallas City Council.\nOn January 20, 1989, Gulf-Tex filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code which proceeding was dismissed on July 25, 1989 upon the motion of Gulf-Tex. On March 18, 1992, Avacelle filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code. Avacelle was reorganized effective November 15, 1993.\nTILMON KREILING, JR.: Age 48, Director (Class III) (Independent) (since 1992).\nPresident of Kreiling Associates & Co. (since 1990); registered investment advisor (since 1990) and registered trading advisor (1985 to 1993); and member of the Chicago Mercantile Exchange (1983 to 1987).\nRYAN T. PHILLIPS: Age 24, Director (Class III) (Affiliated) (since 1992).\nReal Estate Investor (since March 1993); Real Estate Analyst with Kelley, Lundeen & Crawford in Dallas, Texas (1991 to March 1993); graduate of Southern Methodist University School of Business (May 1991); and trustee of a trust for the benefit of the children of Gene E. Phillips. Such trust is the 100% beneficial owner of BCM, the advisor to the Company. Ryan T. Phillips is the son of Gene E. Phillips, and has served as a Director of BCM since February 1991.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nG. WAYNE WATTS: Age 51, Director (Class II) (Independent) (since 1984).\nPresident (since December 1993) of Palmetto Industries, Inc., manufacturer of industrial products; Director (since 1988) of International Operations of Harkness International; Director (since 1987) of Southmark California; Marketing Manager (1985 to 1988) of Steel Heddle Manufacturing Company, manager (1983 to 1985) of its Rolled Products Division, and manager of its International Division. Steel Heddle is a manufacturer and major supplier of textile machinery and industrial replacement parts. Director of Syntek Finance Corporation (\"SFC\") (1983 to 1989); and Vice President of Sales and owner of Fountain Industries, a manufacturer of automotive parts and assemblies and metal stampings (1989 to March 1994).\nOn November 1, 1993, Fountain Industries filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code. In January 1994, the Chapter 11 proceedings were converted to Chapter 7 liquidation proceedings. Liquidation is currently in process.\nSeparation of Certain Members of Management from Southmark Corporation. Gene E. Phillips, a Director and Chairman of the Board of the Company until November 16, 1992, and William S. Friedman, the President and a Director of the Company until December 31, 1992, were directors and executive officers of Southmark until January 17, 1989. Messrs. Phillips and Friedman entered into a series of agreements, (collectively the \"January Agreements\"), which, among other things, involved their resignation from their positions with Southmark and certain of its affiliates. However, Messrs. Phillips and Friedman remained Directors and executive officers of the Company and certain other entities.\nAs further described in ITEM 1. \"BUSINESS - Severance of Relationship With Southmark Corporation\", on July 12, 1989, the Company closed a set of related agreements (collectively the \"Southmark Separation Agreements\") with its then largest stockholder, Southmark, essentially terminating the Company's relationship with Southmark and resulting in a substantial restructuring of the Company's balance sheet.\nSouthmark filed a voluntary petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code on June 14, 1989. Southmark requested that the Bankruptcy Court appoint an examiner to investigate and review pre-Chapter 11 third-party transactions and relations and potential causes of action on behalf of the Southmark bankruptcy estate and on September 8, 1989, the court appointed an examiner.\nThe examiner issued a series of five separate reports in Southmark's bankruptcy proceeding. In his Final Report, filed on July 9, 1990, the examiner recommended that Southmark pursue claims against Messrs. Phillips and Friedman for their conduct that allegedly caused, in whole\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nor in part, the losses reported in the examiner's Final and Interim Reports. The Final Report expressed the examiner's conclusion that (i) \"poor business practices (were) employed in the acquisition and management of many of Southmark's subsidiaries,\" (ii) Southmark's real estate assets were overvalued by as much as $800 million, (iii) repeated transactions by Southmark while it was controlled by Messrs. Phillips and Friedman produced only paper or \"phantom\" profits, (iv) the independent directors of Southmark were \"basically yes men,\" (v) Southmark \"engaged in many transactions with related entities\" and these transactions \"often resulted in substantial benefits for Messrs. Phillips and Friedman and their affiliates at Southmark's expense,\" and (vi) Messrs. Phillips and Friedman as well as Southmark had \"many business dealings with high-powered figures, many of whom have been convicted, indicted or are under investigation in connection with savings and loan fraud and were in a position to assist (Messrs.) Phillips and Friedman in their numerous real estate ventures,\" and that the \"number of transactions between these individuals were . . . extensive.\"\nMessrs. Phillips and Friedman have emphatically denied the examiner's allegations, and believe that the examiner's Final Report contained material factual errors and unsubstantiated allegations and misleading innuendos. Moreover, based on the fact that the examiner made no attempt to depose or interview them concerning his investigation, they believe that the Final Report was not based on an objective analysis and exemplified the examiner's abject disregard of elementary fairness in eschewing the opportunity to consider facts which refute his biased contentions.\nLitigation Relating to Southmark Bankruptcy. During 1990 and 1991, several adversary proceedings were initiated against the Company and others by Southmark and its affiliates. On December 27, 1991, an agreement to settle all claims in connection with the Southmark adversary proceedings was executed by Southmark and the Company. The settlement covers all claims between Southmark and its affiliates and Messrs. Phillips and Friedman, Syntek West, Inc. (\"SWI\"), NRLP, CMET, IORT, National Income Realty Trust (\"NIRT\"), TCI, Vinland Property Trust (\"VPT\") and the Company. The final settlement of such litigation concludes all suits in which the Company was a defendant. Pursuant to the settlement agreement, Southmark will receive $13.2 million from the various settling defendants. Payments were made totaling $11.9 million in 1992 and 1993, and the remaining balance of $1.3 million is scheduled to be paid on June 27, 1994.\nThe Company paid Southmark $1.0 million in each of 1992 and 1993, and will pay Southmark an additional $435,000 by June 27, 1994. In addition, on February 25, 1992, the Company assigned Southmark a 19.2% limited partnership interest in SAMLP, the general partner of NRLP and NOLP, and the Company received Southmark's interest in Novus Nevada, Inc. The Company has an option which expires December 27, 1994, to\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nreacquire Southmark's 19.2% interest in SAMLP for $2.4 million, less any distributions received by Southmark. On May 1, 1992, the Company received from Southmark land and a ground lease in Denver, Colorado, land in Forest Park, Georgia, a mortgage note secured by land in Tabonia, Utah and a participation in a mortgage note secured by a retail property in Forest Park, Georgia. The Company believes these assets have an aggregate value at least equal to the consideration the Company has agreed to pay Southmark.\nTo secure the settlement payment obligations to Southmark, the Company issued 390,000 new shares of its Common Stock to ATN Equity Partnership (\"ATN\") which pledged such shares to Southmark along with securities of TCI and NRLP. The Company intends to cancel its collateral shares as they are released from the pledge to Southmark and returned to it by ATN. As of December 31, 1993, 195,000 shares had been returned by ATN to the Company and canceled. Voting rights to the Company's collateral shares are held by the Company's Board of Directors. ATN is a general partnership of which the Company and NRLP are general partners.\nATN was formed solely to hold title to the securities issued by each partner and TCI and to pledge such securities to Southmark. The Company has also pledged to Southmark its remaining limited partner interest in SAMLP.\nIn addition to the pledge of securities securing the payment to Southmark, Messrs. Phillips and Friedman, the Company and SWI have each executed and delivered separate, final, nonappealable judgments in favor of Southmark, each in the amount of $25 million. In the event of default, Southmark is entitled to entry of those judgments and to recover from the parties an aggregate of $25 million, subject to reduction for any amounts previously paid. If the settlement obligations are met, the judgments will be returned to the defendants.\nOn February 25, 1992, the Company entered into an agreement with Messrs. Phillips and Friedman, SWI, CMET, NIRT, IORT and TCI relating to their settlement of litigation with Southmark. Pursuant to the agreement, TCI obtained the right to acquire four apartment complexes, five mortgage notes, two operating commercial properties and four parcels of developed land from Southmark and its affiliates.\nSan Jacinto Savings Association. On November 30, 1990, San Jacinto Savings Association (\"SJSA\"), a savings institution that had been owned by Southmark since 1983 and for which Mr. Phillips served as a director from 1987 to January 1989, was placed under conservatorship of the Resolution Trust Corporation (\"RTC\") by federal banking authorities. On December 14, 1990, SJSA was converted into a Federal Association and placed in receivership. The government has reportedly alleged that SJSA's poor financial condition was attributable in part to \"a pattern of high-risk real estate investments made after Southmark bought it in 1983,\" and that it had \"poor procedures for determining loss reserves\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nand relied 'excessively' on deposits gathered through brokerage houses that enable(d) it to grow rapidly.\" The RTC is conducting an investigation of matters involving SJSA during the period in which it was owned by Southmark. On November 26, 1993, the RTC filed lawsuits in Dallas and New York City against Mr. Phillips, six former directors, auditors and lawyers of SJSA, alleging that the auditors and former directors could and should have stopped SJSA's poor lending practice during the period it was owned by Southmark and that the former directors abdicated their responsibility for reviewing loans during the same period. The Office of Thrift Supervision is also conducting a formal examination of SJSA and its affiliates.\nLitigation Against Southmark and its Affiliates Alleging Fraud or Mismanagement. In addition to the litigation related to the Southmark bankruptcy, there were several lawsuits pending against Southmark, its former officers and directors (including Messrs. Phillips and Friedman) and others alleging, among other things, that such persons and entities engaged in conduct designed to defraud and mislead the investing public by intentionally misrepresenting the financial condition of Southmark. In so far as such allegations relate to them, Messrs. Phillips and Friedman deny them. Those lawsuits in which Messrs. Phillips and Friedman were also defendants are summarized below. THE COMPANY IS NOT A DEFENDANT IN ANY OF THESE LAWSUITS.\nIn Burt v. Grant Thornton, Gene E. Phillips and William S. Friedman, the plaintiff, a purchaser of Southmark preferred stock, alleged that the defendants disseminated false and misleading corporate reports, financial analysis and news releases in order to induce the public to continue investing in Southmark. Grant Thornton served as independent certified public accountants to Southmark and prior to 1990, the Company. The plaintiff sought actual and punitive damages in the amount of less than $10,000, treble damages and punitive damages in an unspecified amount, plus attorneys' fees and costs. This case was settled in October 1993.\nConsolidated actions entitled Salsitz v. Phillips, et al., purportedly brought as class actions on behalf of purchasers of Southmark securities during specified periods, were pending before the United States District Court for the Northern District of Texas. These actions alleged violations of the federal securities laws and state laws, based upon claims of fraud, deceit and negligent misrepresentations made in connection with the sale of Southmark securities. The plaintiffs sought unspecified damages, attorneys' fees and costs. The defendants included Messrs. Phillips and Friedman, among others. Messrs. Phillips and Friedman entered into a settlement agreement with the plaintiffs which was approved by the court October 1993.\nMessrs. Phillips and Friedman also served as directors of Pacific Standard Life Insurance Company (\"PSL\"), a wholly-owned subsidiary of Southmark, from October 1984 to January 1989. In a proceeding brought\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nby the California Insurance Commissioner, a California Superior Court appointed a conservator for PSL on December 11, 1989, and directed that PSL cease doing business. On October 12, 1990, the California Insurance Commissioner filed suit in the Superior Court for the State of California, County of Yolo, against Messrs. Phillips and Friedman and other former directors of PSL seeking damages of $12 million and additional punitive damages. Such lawsuit alleged, among other things, that the defendants knowingly and wilfully conspired among themselves to breach their duties as directors of PSL and to loot and waste corporate assets of PSL to benefit Southmark and its other subsidiaries and certain of the defendants (including Messrs. Phillips and Friedman), resulting in a required write-down of $25 million, PSL's insolvency and conservatorship. Such suit further alleged that the defendants caused PSL to make loans to, or enter into transactions with, Southmark, Southmark affiliates and others in violation of applicable state laws and to make loans and investments that could not be included as assets on PSL's balance sheet to entities controlled by Charles H. Keating, Jr. It was also alleged that PSL's board of directors failed to convene meetings and delegated to Mr. Phillips authority to make decisions regarding loans, investments and other transfers and exchanges of PSL assets. In August 1993, five former directors of PSL, including Messrs. Phillips and Friedman, settled this lawsuit without admitting any liability.\nLitigation Relating to Lincoln Savings and Loan Association, F.A. In an action filed in the United States District Court for the District of Arizona on behalf of Lincoln Savings and Loan Association, F.A. (\"Lincoln\"), and captioned RTC v. Charles H. Keating, Jr., et al., the RTC alleges that Charles H. Keating, Jr. and other persons, including Mr. Phillips, fraudulently diverted funds from Lincoln.\nThe RTC alleges that Mr. Phillips aided and abetted the insider defendants in a scheme to defraud Lincoln and its regulators; that Southmark, its subsidiaries and affiliates, including SJSA, facilitated and concealed the use of Lincoln funds to finance the sale, at inflated prices, of assets of Lincoln's parent, American Continental Corp. (\"ACC\"), in return for loans from Lincoln and participations in contrived transactions; and that the insider defendants caused Southmark to purchase ACC assets at inflated prices. The RTC alleges that Lincoln and\/or ACC engaged in three illegal transactions with Southmark or its affiliates while Mr. Phillips was affiliated with Southmark. Neither Mr. Friedman nor Southmark is a defendant in this action.\nThe RTC alleges nine separate causes of action against Mr. Phillips, including aiding and abetting the violation of, and conspiracy to violate, federal and state Racketeer Influenced and Corrupt Organization Act (\"RICO\") statutes, violations of Arizona felony statutes, common law fraud, civil conspiracy and breach of fiduciary duty. The RTC seeks to recover from the defendants more than $1 billion, as well as treble damages under the federal RICO statutes, punitive damages of at least\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\n$100 million and attorneys' fees and costs. Mr. Phillips' motion to dismiss for failure to state a cause of action and for summary judgment was heard in February 1992. The motion was denied in June 1992. Trial was scheduled to begin in 1993. However, the case was taken off the trial docket to facilitate settlement negotiations.\nIt has also been reported that the Justice Department and the Securities and Exchange Commission have been asked to investigate Lincoln's possible links to Southmark.\nSouthmark Partnership Litigation. One of Southmark's principal businesses was real estate syndication and from 1981 to 1987 Southmark raised over $500 million in investments from limited partners of several hundred partnerships. Several lawsuits have been filed by investors which name Messrs. Phillips and Friedman as defendants. The following actions relate to and involve such activities.\nIn an action filed in November 1990 in the District Court, 150th Judicial District, Bexar County, Texas, captioned Adkisson, et al. v. Friedman et al., the plaintiffs, who invested approximately $50,000 in a limited partnership sponsored by Southmark, alleged breach of the partnership agreement, breach of fiduciary duty, violations of state consumer protection laws, negligence and fraud. The defendants included Messrs. Phillips and Friedman. In addition to actual damages in an unspecified amount, punitive and statutory damages, and attorneys' fees and court costs, the plaintiffs also sought to rescind the partnership agreement and to obtain restitution of their capital contributions. This case was settled in July 1993 for a nominal payment.\nIn a class action suit filed in December 1990 in the United States District Court for the Southern District of New York captioned Sable, et al. v. Southmark\/Envicon Capital Corp., et al the plaintiffs, limited partners in nine Southmark-sponsored limited partnerships, alleged several claims, including conspiracy, fraud and violation of the federal and state RICO statutes. The plaintiffs sought to recover actual damages in an unspecified amount, treble damages pursuant to RICO, costs and injunctive relief. The defendants included, among others, Messrs. Phillips and Friedman. In April 1993, the court granted defendants' motion to dismiss for failure to state a claim, and awarded sanctions against plaintiffs' counsel.\nIn an action filed in May 1992 in a Texas state court captioned HCW Pension Real Estate Fund, et al. v. Phillips et al., the plaintiffs, fifteen former Southmark related public limited partnerships, allege that the defendants violated the partnership agreements by charging certain administrative costs and expenses to the plaintiffs. The complaint alleges claims for breach of fiduciary duty, fraud and conspiracy to commit to fraud and seeks to recover actual damages of approximately $12.6 million plus punitive damages and attorneys' fees and costs. The defendants include, among others, Messrs. Phillips and\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nFriedman. In October 1993, the court granted partial summary judgment in favor of Messrs. Phillips and Friedman on the plaintiffs' breach of fiduciary duty claims. The plaintiffs have not pursued the remaining claims.\nIn an action filed in May 1992 in a Texas state court captioned Cedarwood Hills Associates, Ltd., et al. v. Phillips, et al., the plaintiffs, six former Southmark related private limited partnerships, alleged that the defendants charged the plaintiff partnerships for Southmark's corporate overhead and operating costs. The complaint alleged claims for breach of fiduciary duty, fraud and conspiracy to commit fraud and seeks to recover actual damages in an unspecified amount, plus punitive damages and attorneys' fees and costs. The defendants included, among others, Messrs. Phillips and Friedman. Notice of non-suit in favor of all defendants was entered on January 10, 1994.\nIn an action filed in June 1992 in a Georgia state court captioned Southmark\/CRCA Healthcare Fund VIII, L.P. v. Southmark Investment Group 87, Inc., et al., the plaintiff, a former Southmark related public limited partnership, alleged that in 1988 the defendants caused the plaintiff to purchase five nursing homes in violation of the partnership agreement and for the sole purpose of benefitting the defendants. The complaint alleged claims for breach of fiduciary duty and conspiracy to cause the plaintiff to acquire the properties so as to obtain improper financial benefits for the defendants. The plaintiff sought to recover actual damages in an unspecified amount, plus punitive damages and attorneys' fees and costs. The defendants included, among others, Messrs. Phillips and Friedman and TCI, which provided the financing for the plaintiff's purchase of the properties. The case was settled in October 1993.\nIn an action filed in January 1993 in a Michigan state court captioned Van Buren Associates Limited Partnership, et al. v. Friedman, et al., the plaintiff, a former Southmark sponsored limited partnership, alleges a claim for breach of fiduciary duty in connection with the 1988 transfer of certain property by the partnership. The plaintiff seeks damages in an unspecified amount, plus costs and attorneys' fees. The plaintiff also seeks to quiet title to the property at issue. The defendants include, among others, Messrs. Phillips and Friedman.\nBoard Meetings and Committees\nThe Company's Board of Directors held six meetings during 1993. For such year, no incumbent Director attended fewer than 75% of (i) the total number of meetings held by the Board of Directors during the period for which he had been a Director and (ii) the total number of meetings held by all committees of the Board of Directors on which he served during the periods that he served, except that Messrs. Gonzalez and Kreiling each attended only four of the Board meetings held in 1993.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nBoard Meetings and Committees (Continued)\nThe Company's Board of Directors has an Audit Committee the function of which is to review the Company's operating and accounting procedures. The members of the Audit Committee are Messrs. Watts (Chairman) and Gonzalez. The Audit Committee met twice during 1993.\nThe Board of Directors has a Stock Option Committee to administer its 1987 Stock Option Plan. The function of the Stock Option Committee is, among other things, to determine which persons will be granted options, the number of shares to be covered by the options and the exercise period of the options within the terms of the 1987 Stock Option Plan. The members of the Stock Option Committee are Messrs. Watts and Gonzalez. The Stock Option Committee did not meet in 1993.\nIn January 1993, the Company's Board of Directors established an Executive Committee to act as the liaison with the Advisor on the Company's business plan and investment policy decisions. The members of the Executive Committee are Messrs. Cashwell, Phillips and Watts. The Executive Committee held two formal meetings during 1993. In October 1993, the Board elected a President of the Company who will perform the duties formerly the responsibility of the Executive Committee.\nThe Company's Board of Directors does not have nominating or compensation committees.\nExecutive Officers\nThe following persons currently serve as executive officers of the Company: Karl L. Blaha, President; Hamilton P. Schrauff, Executive Vice President and Chief Financial Officer; and Thomas A. Holland, Senior Vice President and Chief Accounting Officer. Their positions with the Company are not subject to a vote of the Company's stockholders. The age, terms of service, all positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more is set forth below.\nKARL L. BLAHA: Age 45, President (since October 1993) and Executive Vice President and Director of Commercial Management (April 1992 to September 1993).\nExecutive Vice President and Director of Commercial Management (since April 1992) of BCM, SAMI, CMET, IORT and TCI; Executive Vice President and Director of Commercial Management (April 1992 to February 1994) of NIRT and VPT; Partner - Director of National Real Estate Operations of First Winthrop Corporation (August 1988 to March 1992); Corporate Vice President of Southmark (April 1984 to August 1988); and President of Southmark Commercial Management (March 1986 to August 1988).\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nExecutive Officers (Continued)\nHAMILTON P. SCHRAUFF: Age 58, Executive Vice President and Chief Financial Officer (since October 1991).\nExecutive Vice President and Chief Financial Officer (since October 1991) of SAMI, BCM, CMET, IORT and TCI; Executive Vice President and Chief Financial Officer (October 1991 to February 1994) of NIRT and VPT; Vice President Finance - Partnership Investments, Hallwood Group (December 1990 to October 1991); Vice President - Finance and Treasurer (October 1980 to October 1990) and Vice President - Finance (November 1976 to September 1980) of Texas Oil & Gas Corporation; and Assistant Treasurer - Finance Manager (February 1975 to October 1976) of Exxon U.S.A.\nTHOMAS A. HOLLAND: Age 51, Senior Vice President and Chief Accounting Officer (since July 1990).\nSenior Vice President and Chief Accounting Officer (since July 1990) of SAMI, BCM, CMET, IORT and TCI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller of Southmark (December 1986 to June 1990); Vice President-Finance of Diamond Shamrock Chemical Company (January 1986 to December 1986); Assistant Controller of Maxus Energy Corporation (formerly Diamond Shamrock Corporation) (May 1976 to January 1986); Trustee of Arlington Realty Investors (August 1989 to June 1990); and Certified Public Accountant (since 1970).\nOfficers\nAlthough not executive officers of the Company, the following persons currently serve as officers of the Company: Drew D. Potera, Treasurer; and Robert A. Waldman, Vice President and Secretary. Their positions with the Company are not subject to a vote of the Company's stockholders. Their ages, terms of service, all positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nDREW D. POTERA: Age 34, Treasurer (since August 1991) and formerly Assistant Treasurer (December 1990 to August 1991).\nTreasurer (since December 1990) of CMET, IORT and TCI; Treasurer (December 1990 to February 1994) of NIRT and VPT; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith, Incorporated (June 1985 to June 1990).\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers (Continued)\nROBERT A. WALDMAN: Age 41, Secretary (since December 1989) and Vice President (since January 1993).\nVice President (since December 1990) and Secretary (since December 1993) of CMET, IORT and TCI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; Vice President, Corporate Counsel and Secretary (since November 1989) of BCM; Director (February 1987 to October 1989), General Counsel and Secretary (1985 to October 1989) of Red Eagle Resources Corporation (oil and gas); Assistant General Counsel, Senior Staff Attorney and Staff Attorney (1981 to 1985) of Texas International Company (oil and gas) and Staff Attorney (1979 to 1981) of Iowa Beef Processors, Inc.\nIn addition to the foregoing officers, the Company has several vice presidents and assistant secretaries who are not listed herein.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nUnder the securities laws of the United States, the Company's Directors, executive officers, and any persons holding more than ten percent of the Company's shares of Common Stock are required to report their ownership of the Company's shares and any changes in that ownership to the Securities and Exchange Commission (the \"Commission\"). Specific due dates for these reports have been established and the Company is required to report any failure to file by these dates during 1993. All of these filing requirements were satisfied by the Company's Directors and executive officers and ten percent holders. In making these statements, the Company has relied on the written representations of its incumbent Directors and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.\nThe Advisor\nAlthough the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by BCM, a contractual advisor under the supervision of the Company's Board of Directors. The duties of the advisor include, among other things, investigating, evaluating and recommending real estate and mortgage loan investment and sales opportunities as well as financing and refinancing sources for the Company. The advisor also serves as consultant in connection with the Company's business plan and investment policy decisions made by the Company's Board of Directors.\nAmerican Realty Advisors, Inc., an affiliate of Southmark, was the advisor of the Company from July 1, 1987 to February 6, 1989. In February 1989, the Company's Board of Directors voted to retain BCM as the Company's advisor. BCM is a corporation beneficially owned by a trust for the benefit of the children of Gene E. Phillips, who served as\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nthe Chairman of the Board and a Director of the Company until November 16, 1992. Ryan T. Phillips, the son of Mr. Phillips and a Director of the Company, is also a director of BCM and a trustee of the trust for the benefit of the children of Gene E. Phillips which owns BCM. Mr. Cashwell, a Director of the Company, serves as President of BCM. Gene E. Phillips served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Gene E. Phillips serves as a representative of the trust for the benefit of his children which beneficially owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company. As of March 31, 1994, BCM owned 1,105,951 shares of the Company's Common Stock, approximately 38% of the shares then outstanding.\nThe Advisory Agreement provides for the advisor to receive monthly base compensation at the rate of .125% (1.5% on an annualized basis) of Average Invested Assets. On October 23, 1991, based on the recommendation of BCM, the Company's Advisor, the Company's Board of Directors approved a reduction in the advisor's base fee by 50% effective October 1, 1991. This reduction remains in effect until the Company's earnings for the four preceding quarters equals or exceeds $2.00 per share.\nIn addition to base compensation, BCM, or an affiliate of BCM, receives the following forms of additional compensation:\n(a) an acquisition fee for locating, leasing or purchasing real estate for the Company in an amount equal to the lesser of (i) the amount of compensation customarily charged in similar arm's-length transactions or (ii) up to 6% of the costs of acquisition, inclusive of commissions, if any, paid to non-affiliated brokers;\n(b) a disposition fee for the sale of each equity investment in real estate in an amount equal to the lesser of (i) the amount of compensation customarily charged in similar arm's-length transactions or (ii) 3% of the sales price of each property, exclusive of fees, if any, paid to non-affiliated brokers;\n(c) a loan arrangement fee in an amount equal to 1% of the principal amount of any loan made to the Company arranged by BCM;\n(d) an incentive fee equal to 10% of net income for the year in excess of a 10% return on stockholders' equity, and 10% of the excess of net capital gains over net capital losses, if any, realized from sales of assets made under contracts entered into after April 15, 1989; and\n(e) a mortgage placement fee, on mortgage loans originated or purchased, equal to 50%, measured on a cumulative basis, of the total amount of mortgage origination and placement fees on mortgage loans advanced by the Company for the fiscal year.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nThe Advisory Agreement further provides that BCM shall bear the cost of certain expenses of its employees, excluding fees paid to the Company's Directors; rent and other office expenses of both BCM and the Company (unless the Company maintains office space separate from that of BCM); costs not directly identifiable to the Company's assets, liabilities, operations, business or financial affairs; and miscellaneous administrative expenses relating to the performance by BCM of its duties under the Advisory Agreement.\nIf and to the extent that the Company shall request BCM, or any director, officer, partner or employee of BCM, to render services to the Company other than those required to be rendered by BCM under the Advisory Agreement, such additional services, if performed, will be compensated separately on terms agreed upon between such party and the Company from time to time. The Company has requested that BCM perform loan administration functions, and the Company and BCM have entered into a separate agreement, as described below.\nThe Advisory Agreement automatically renews from year to year unless terminated in accordance with its terms. The Company's management believes that the terms of the Advisory Agreement are at least as fair as could be obtained from unaffiliated third parties.\nPursuant to the Advisory Agreement, BCM is the loan administration\/ servicing agent for the Company, under an agreement dated as of October 4, 1989, and terminable by either party upon thirty days' notice, under which BCM services most of the Company's mortgage notes and receives as compensation a monthly fee of .125% of the month-end outstanding principal balances of the mortgage loans serviced.\nSituations may develop in which the interests of the Company are in conflict with those of one or more Directors or officers in their individual capacities or of BCM, or of their respective affiliates. In addition to services performed for the Company, as described above, BCM actively provides similar services as agent for, and advisor to, other real estate enterprises, including persons and entities involved in real estate development and financing, including CMET, IORT and TCI. BCM also performs certain administrative services for NRLP and NOLP, the operating partnership of NRLP, on behalf of NRLP's and NOLP's general partner, SAMLP. The Advisory Agreement provides that BCM may also serve as advisor to other entities. As advisor, BCM is a fiduciary of the Company's public investors. In determining to which entity a particular investment opportunity will be allocated, BCM will consider the respective investment objectives of each entity and the appropriateness of a particular investment in light of each such entity's existing mortgage note and real estate portfolios and which entity has had uninvested funds for the longest period of time. To the extent any particular investment opportunity is appropriate to more than one such entity, such investment opportunity will be allocated to the entity that\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nhas had uninvested funds for the longest period of time, or, if appropriate, the investment may be shared among various entities. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships.\"\nThe directors and principal officers of BCM are set forth below:\nMICKEY NED PHILLIPS: Director\nRYAN T. PHILLIPS: Director\nOSCAR W. CASHWELL: President and Director of Property and Asset Management\nKARL L. BLAHA: Executive Vice President and Director of Commercial Management\nHAMILTON P. SCHRAUFF: Executive Vice President and Chief Financial Officer\nCLIFFORD C. TOWNS, JR.: Executive Vice President, Finance\nTHOMAS A. HOLLAND: Senior Vice President and Chief Accounting Officer\nDREW D. POTERA: Vice President, Treasurer and Securities Manager\nROBERT A. WALDMAN: Vice President, Corporate Counsel and Secretary\nMickey Ned Phillips is the brother of Gene E. Phillips and Ryan T. Phillips is the son of Gene E. Phillips. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, Mr. Phillips has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.\nProperty Management\nSince February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under management. In many cases, Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcon-\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nProperty Management (Continued)\ntracts the property-level management of the Company's shopping center to Carmel Realty, Inc., which is owned by SWI.\nReal Estate Brokerage\nAffiliates of BCM provide real estate brokerage services to the Company and receive brokerage commissions in accordance with the Advisory Agreement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Company. The Directors and executive officers of the Company who are also officers or employees of the Company's Advisor are compensated by the Advisor. Such affiliated Directors and executive officers of the Company perform a variety of services for the Advisor and the amount of their compensation is determined solely by the Advisor. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\" for a more detailed discussion of compensation payable to BCM by the Company.\nThe only direct remuneration paid by the Company is to those Directors who are not officers or employees of BCM or its affiliated companies. The Company compensates such Independent Directors at a rate of $5,000 per year, plus $500 per meeting attended and $300 per Audit Committee meeting attended. During 1993, $35,450 was paid to Independent Directors in total Directors' fees for all meetings as follows: Al Gonzalez, $7,600; Tilmon Kreiling, Jr., $7,000; Ryan T. Phillips, $8,100; G. Wayne Watts, $11,000; and David Kipper, $1,750, a director through April 1993.\nIn July 1987, the Company's Board of Directors, including all of the Independent Directors, approved the Company's 1987 Stock Option Plan (the \"Plan\"). The Plan was approved by the Company's Stockholders at the Company's annual meeting of stockholders held on June 8, 1988. The Plan was intended principally as an incentive for, and as a means of encouraging ownership of the Company's Common Stock by, eligible persons, including certain Directors and officers of the Company. Options may be granted either as incentive stock options (which qualify for certain favorable tax treatment), or as non-qualified stock options. Incentive stock options can not be granted to, among others, persons who are not employees of the Company, or to persons who fail to satisfy certain criteria concerning ownership of less than 10% of the Company's shares of Common Stock. The Plan is administered by the Stock Option Committee, which currently consists of two Independent Directors of the Company. The exercise price per share of an option can not be less than 100% of the fair market value per share on the date of grant. The Company receives no consideration for the grant of an option. As of March 31, 1994, there were no stock options outstanding under the Plan.\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following graph compares the cumulative total shareholder return on the Company's shares of Common Stock with the Dow Jones Equity Market Index (\"DJ Equity Index\") and the Dow Jones Real Estate Investment Index (\"DJ Real Estate Index\"). The comparison assumes that $100 was invested on December 31, 1988 in the Company's shares of Common Stock and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Company's Common Stock both beneficially and of record, both individually and in the aggregate, for those persons or entities known by the Company to be the owner of more than 5% of the shares of the Company's Common Stock as of the close of business on March 31, 1994.\n_________________________\n(1) Based on 2,884,164 shares outstanding as of March 31, 1994.\n(2) Includes 204,522 shares owned by CMET over which Oscar W. Cashwell may be deemed to be beneficial owner by virtue of his position as President of CMET. Also includes 48,931 shares owned by NRLP over which Mr. Cashwell may be deemed to be beneficial owner by virtue of his positions as President and director of SAMI, the managing general partner of SAMLP, the general partner of NRLP. Mr. Cashwell disclaims beneficial ownership of such shares.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\n(3) Includes 1,105,951 shares owned by BCM over which Mr. Cashwell and Ryan T. Phillips may be deemed to be the beneficial owners by virtue of their positions as President and director, respectively, of BCM. Messrs. Cashwell and Phillips disclaim beneficial ownership of such shares.\n(4) Includes 24,583 shares owned by the Gene E. Phillips Children's Trust of which Ryan T. Phillips is a beneficiary.\n(5) Includes 445 shares owned by Ryan T. Phillips.\nSecurity Ownership of Management. The following table sets forth the ownership of shares of the Company's Common Stock, both beneficially and of record, both individually in the aggregate, for the Directors and executive officers of the Company, as of the close of business on March 31, 1994.\n___________________________\n(1) Based on 2,884,164 shares outstanding as of March 31, 1994.\n(2) Includes 1,105,951 shares owned by BCM over which Ryan T. Phillips and Oscar W. Cashwell may be deemed to be beneficial owners by virtue of their positions as a director and President, respectively, of BCM. Also includes 48,931 shares owned by NRLP over which Mr. Cashwell may be deemed to be beneficial owner by virtue of his position as President and director of SAMI, the managing general partner of SAMLP, the general partner of NRLP and 204,522 shares owned by CMET over which Mr. Cashwell may be deemed to be beneficial owner by virtue of his position as President of CMET.\n(3) Includes 24,583 shares owned by the Gene E. Phillips Children's Trust of which Ryan T. Phillips is a beneficiary.\n(4) Includes 445 shares owned by Ryan T. Phillips.\n(5) Includes 608 shares owned directly over which Thomas A. Holland and his wife jointly hold voting and dispositive power, and 83 shares held by Mr. Holland in an individual retirement account.\n(6) Includes 195,000 shares issued to ATN Equity Partnership (\"ATN\"). Such shares are pledged as collateral to Southmark securing the payment obligations to Southmark. As payments are made, shares are released and returned to the Company by ATN. ATN is a general partnership of which the Company and NRLP are the general partners. Pursuant to the partnership agreement the Board of Directors of the Company retains all voting and (subject to the pledge) dispositive power over such shares.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\n(7) Includes 141,176 shares issued to Rosedale Equities, Inc., a wholly-owned subsidiary of the Company. Such shares are pledged as additional collateral for a loan secured by the Rosedale Towers Office Building.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPolicies with Respect to Certain Activities\nThe By-laws of the Company as amended, provide, in accordance with Georgia law, that no contract or transaction between the Company and one or more of its Directors or officers, or between the Company and any other corporation, partnership, association or other organization in which one or more of its Directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for that reason, or solely because the Director or officer is present at or participates in the meeting of the Company's Board of Directors or committee thereof which authorizes the contract or transaction, or solely because his or her votes are counted for such purpose, if one or more of the following three conditions are met: (i) the material facts as to his or her interest and as to the contract or transaction are disclosed or are known to the Company's Board of Directors or the committee, and Board or committee in good faith authorizes the contract or transaction by the affirmative vote of a majority of the disinterested Directors, even though the disinterested Directors constitute less than a quorum; (ii) the material facts as to his or her interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved or ratified in good faith by vote of such stockholders; or (iii) the contract or transaction is fair to the Company as of the time it is authorized, approved or ratified by the Company's Board of Directors, a committee thereof, or the stockholders.\nThe Company's policy is to have such contracts or transactions approved or ratified by a majority of the disinterested Directors of the Company with full knowledge of the character of such transactions, as being fair and reasonable to the stockholders at the time of such approval or ratification under the circumstances then prevailing. Such Directors also consider the fairness of such transactions to the Company. The Company's management believes that, to date, such transactions have represented the best investments available at the time and that they were at least as advantageous to the Company as other investments that could have been obtained.\nThe Company expects to enter into future transactions with entities the officers, trustees, directors or shareholders of which are also officers, Directors or stockholders of the Company, if such transactions would be beneficial to the operations of the Company and consistent with the Company's then-current investment objectives and policies, subject to approval by a majority of disinterested Directors as discussed above.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nPolicies with Respect to Certain Activities (Continued)\nThe Company does not prohibit its officers, Directors, stockholders or related parties from engaging in business activities of the types conducted by the Company.\nCertain Business Relationships\nAs mentioned above, BCM is a corporation of which Messrs. Cashwell, Blaha, Schrauff, Holland, Potera and Waldman, serve as officers. BCM is beneficially owned by a trust for the benefit of the children of Gene E. Phillips, the trustees of which are Mickey Ned Phillips and Ryan T. Phillips. Mickey Ned Phillips and Ryan T. Phillips (a Director of the Company), brother and son, respectively, of Gene E. Phillips, are also directors of BCM.\nMr. Cashwell is the President of CMET, IORT and TCI, and owes fiduciary duties to such entities as well as to BCM under applicable law. CMET, IORT, and TCI have the same relationship with BCM as does the Company. In addition, BCM has been engaged to perform certain administrative functions for NRLP and NOLP. Mr. Phillips is a general partner of SAMLP, NRLP's and NOLP's general partner, and is an officer and director of SAMLP's managing general partner, SAMI. BCM is the sole shareholder of SAMI. The Company is a limited partner and a 76.8% owner of SAMLP. Al Gonzalez, a Director of the Company, is the father of Randall K. Gonzalez, who is a trustee or director of CMET, IORT and TCI, and President and Managing Partner of TMC Realty Advisors, Inc. (\"TMC\"), an entity which provides property-level management services to certain properties owned by the Company. In 1993, TMC earned fees of $110,700 from the Company for performing such services.\nIn August 1991, BCM funded a loan in the amount of $100,000 to Al Gonzalez. The note is secured by a residence and bears interest at 2% above the prime rate. The note matured on December 31, 1992. BCM is in negotiations with Mr. Gonzalez to extend such loan.\nSince February 1, 1990, the Company has contracted with affiliates of BCM for property management services. Currently, Carmel, Ltd. provides such property management services. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, a company of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management of the Company's shopping center to Carmel Realty, Inc., which is owned by SWI.\nAffiliates of BCM provide real estate brokerage services to the Company and receive brokerage commissions in accordance with the Advisory Agreement.\nAs of March 31, 1994, BCM owned 1,105,951 shares of the Company's Common Stock, approximately 38% of the shares then outstanding.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nCertain Business Relationships (Continued)\nThe Company owns a beneficial interest in each of CMET, IORT, TCI, NRLP and SAMLP. In addition, CMET and NRLP own a beneficial interest in the Company and SAMLP owns a beneficial interest in TCI. See ITEM 1. \"PROPERTIES - Investments in Real Estate Investment Trusts and Real Estate Partnerships.\"\nRelated Party Transactions\nIn April 1990, SAMLP made a $1.4 million unsecured loan to Equity Health and Finance Corporation (\"Equity Health\"), an entity affiliated with BCM. The Equity Health note bears interest at 12% per annum, originally matured on April 10, 1991, and has been subsequently extended to May 9, 1994. In June 1991, Equity Health merged into BCM, and BCM assumed the note. The outstanding balance of the note was $477,000 at December 31, 1993, including accrued but unpaid interest.\nIn 1990, SAMLP executed a settlement agreement in a class action lawsuit arising from the formation of NRLP. Among other things, the settlement required that Messrs. Phillips and Friedman make a capital contribution to NRLP of $2.0 million in the form of a promissory note which is guaranteed by SAMLP. In addition, SAMLP paid $500,000 to NRLP under the settlement on behalf of Messrs. Phillips and Friedman pursuant to the indemnification provisions under the SAMLP agreement of limited partnership and indemnified them for their obligations under the $2.0 million promissory note. In May 1991, 1992 and 1993, SAMLP made the annual installments of principal and interest on such note in the amount of $631,000. The final payment of $631,000 is due in May 1994. See ITEM 2. \"PROPERTIES -Investments in Real Estate Investment Trusts and Real Estate Partnerships.\"\nIn April 1991, the Company acquired for $208,000 in cash all of the capital stock of a corporation which owned 181 developed residential lots located in Fort Worth, Texas subject to $1.2 million of mortgage debt owed to CMET. The loan was repaid in full in August 1993. CMET is an entity having the same advisor as the Company and at March 31, 1994, the Company owned approximately 30% of CMET's outstanding shares of beneficial interest and CMET owned approximately 7% of the outstanding shares of the Company's Common Stock.\nIn June 1992, the Company sold 397,359 newly issued shares of its Common Stock to Donald C. Carter, a private investor for $1.9 million cash. Terms of the sale agreement provide Mr. Carter with the option of requiring the Company to reacquire up to 360,000 of the purchased shares at a price of $6.11 per share, a total of $2.2 million. Such option is exercisable by Mr. Carter for a two- year period expiring in March 1995. To secure its payment obligations under the option agreement, the Company assigned its interest in the $22 million note receivable secured by the Continental Hotel and Casino in Las Vegas, Nevada. In addition, BCM and the trust that beneficially owns BCM have agreed to guarantee the Company's payment obligation to purchase such shares.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRelated Party Transactions (Continued)\nIn January 1992, the Company entered into a partnership agreement with an entity affiliated with Mr. Carter to acquire 287 developed residential lots adjacent to the Company's other residential lots in Fort Worth, Texas. The Company paid $717,000 in cash for its 50% general partnership interest. The partnership agreement designates the Company as managing general partner. The partnership agreement also provides that Mr. Carter is guaranteed a 10% return on his investment. During 1993, 18 of the lots were sold and at December 31, 1993, 269 lots remained to be sold.\nIn June 1992, the Company obtained a $3.3 million loan from Mr. Carter. The note bears interest at 10% and matures in May 1995. Interest payments are made monthly in addition to ten quarterly principal payments of $330,000 which commenced March 1, 1993. The note is collateralized by an assignment of the Company's interest in a partnership which owns residential lots in Fort Worth, Texas and the Company's interest in undeveloped land in downtown Atlanta, Georgia. The loan also provides for Mr. Carter's participation in the proceeds from either the sale or refinancing of the Company's land in Atlanta, Georgia, to the extent of 15.57% of the net proceeds, as defined, in excess of $10 million. Mr. Carter also had the right during a period beginning eighteen months from the date of the loan and continuing ninety days thereafter to put his participation to the Company in exchange for a payment of $623,000. On December 2, 1993, Mr. Carter exercised his put which required full payment by the Company within 30 days. Mr. Carter has agreed to extend the payment date to January 2, 1995, and BCM and the trust that beneficially owns BCM, have agreed to guarantee the Company's payment obligation.\nIn September 1992, the Company agreed to sell its entire holdings in NIRT to Mr. Friedman, the President and a trustee of NIRT, and at the time the President of the Company, and members of his family and his affiliates. At the time, NIRT had the same advisor as the Company. BCM resigned as advisor to NIRT effective March 31, 1994. The agreement provided for the Company to sell its 741,592 NIRT shares at the then market price of $6.875 per share. As of December 31, 1993, the Company had transferred all of its NIRT shares to Mr. Friedman and his affiliates in exchange for cash of $2.9 million ($657,000 in 1992), and $2.2 million in securities comprised of 42,260 limited partner units of NRLP, 105,096 shares of CMET, 10,075 shares of IORT and 118,500 shares of TCI.\nIn 1993, the Company paid BCM and its affiliates $1.2 million in advisory and mortgage servicing fees, $180,000 in real estate brokerage commissions, $102,000 in loan arrangement fees and $45,000 in property management fees. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements from the Company of $288,000 in 1993.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report:\n1. Consolidated Financial Statements\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - December 31, 1993 and 1992\nConsolidated Statements of Operations - Years Ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Stockholders' Equity - Years Ended December 31, 1993, 1992 and 1991\nConsolidated Statements of Cash Flows - Years Ended December 31, 1993, 1992 and 1991\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nSchedule I - Investments\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees other than Related Parties\nSchedule IX - Short-term Borrowings\nSchedule X - Supplementary Statement of Operations Information\nSchedule XI - Real Estate and Accumulated Depreciation\nSchedule XII - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the financial statements or the notes thereto.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n3. Incorporated Financial Statements\nConsolidated Financial Statements of National Realty, L.P. (Incorporated by reference to Item 8 of National Realty, L.P.'s Annual Report on Form 10-K for the year ended December 31, 1993).\nConsolidated Financial Statements of Continental Mortgage and Equity Trust (Incorporated by reference to Item 8 of Continental Mortgage and Equity Trust's Annual Report on Form 10-K for the year ended December 31, 1993).\nConsolidated Financial Statements of Income Opportunity Realty Trust (Incorporated by reference to Item 8 of Income Opportunity Realty Trust's Annual Report on Form 10-K for the year ended December 31, 1993).\nConsolidated Financial Statements of Transcontinental Realty Investors, Inc. (Incorporated by reference to Item 8 of Transcontinental Realty Investors, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993).\n4. Exhibits\nThe following documents are filed as Exhibits to this Report:\nExhibit Number Description - ------- ----------- 3.1 Articles of Incorporation dated November 24, 1987 and By-laws dated December 30, 1987 for American Realty Trust, Inc. (Incorporated by reference to Exhibits No. 3.1 and No. 3.1(a), respectively, of Registrant's Registration Statement No. 33-19636 on Form S-4).\n3.2 Amendment to Articles of Incorporation dated September 15, 1989 (Incorporated by reference to Exhibit No. 3.2 of the Registrant's Registration Statement No. 33-19920 on Form S-11).\n3.3 Articles of Amendment setting forth Certificate of Designation of Series A Cumulative Participating Preferred Stock dated as of April 11, 1990 (Incorporated by reference to Exhibit No. 3-1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990).\n3.4 Articles of Amendment dated December 10, 1990 to Articles of Incorporation (Incorporated by reference to Exhibit No. 3.4 of Registrant's Current Report on Form 8-K dated December 5, 1990).\n3.5 Amended By-laws of American Realty Trust, Inc., dated December 11, 1991. (Incorporated by reference to Exhibit No. 3.5 of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991).\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\nExhibit Number Description - ------- -----------\n4.1 Rights Agreement dated April 11, 1990 between American Realty Trust, Inc. and American Stock Transfer and Trust Company, as Rights Agent (Incorporated by reference to Registrant's Current Report on Form 8-K dated April 20, 1990).\n4.2 Amendment No. 1 to Rights Agreement dated March 5, 1991 between American Realty Trust, Inc. and American Stock Transfer and Trust Company, as Rights Agent (Incorporated by reference to Registrant's Amendment No. 1 on Form 8 dated March 27, 1991).\n4.3 Amendment No. 2 to Rights Agreement dated June 23, 1992 between American Realty Trust, Inc. and American Stock Transfer and Trust Company, as Rights Agent (Incorporated by reference to Registrant's Amendment No. 2 on Form 8 dated June 30, 1992).\n10.1 Agreement of Merger by and among American Realty Trust, Inc., Novus Property Company and ART Maryland, Inc. dated September 22, 1986 (Incorporated by reference to Exhibit No. 2.1 to Registrant's Registration Statement No. 33-8837 on Form S-4).\n10.2 1987 Stock Option Plan (Incorporated by reference to Appendix E to Proxy Statement\/Prospectus filed as part of Registration Statement No. 33-19636 on Form S-4).\n10.3 Promissory notes executed by American Realty Trust, Inc. to First City, Texas-Dallas dated as of September 29, 1989 (Incorporated by reference to Exhibit No. 10.12 to the Registrant's Registration Statement No. 33-19920 on Form S-11).\n10.4 Collateral Assignment of Participation Agreement between American Realty Trust, Inc. and First City, Texas-Dallas, dated as of September 29, 1989 (Incorporated by reference to Exhibit No. 10.13 to the Registrant's Registration Statement No. 33-19920 on Form S-11).\n10.5 Participation Agreement between Collecting Bank, National Association and American Realty Trust, Inc., dated as of September 29, 1989 (Incorporated by reference to Exhibit No. 10.14 to the Registrant's Registration Statement No. 33-19920 on Form S-11).\n10.6 Advisory Agreement between American Realty Trust, Inc. and Basic Capital Management, Inc., formerly National Realty Advisors, Inc., dated as of October 4, 1989 (Incorporated by reference to Exhibit No. 10.15 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989).\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\nExhibit Number Description - ------- -----------\n10.7 Amendment No. 1 to the Advisory Agreement between American Realty Trust, Inc. and Basic Capital Management, Inc., formerly National Realty Advisors, Inc., dated as of December 5, 1989 (Incorporated by reference to Exhibit No. 10.17 to the Registrant's Registration Statement No. 33-19920 on Form S-11).\n10.8 Amendment No. 2 to the Advisory Agreement between American Realty Trust, Inc. and Basic Capital Management, Inc., formerly National Realty Advisors, Inc., dated August 1, 1990 (Incorporated by reference to Exhibit No. 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990).\n10.9 Loan Servicing Agreement between American Realty Trust, Inc. and Basic Capital Management, Inc., formerly National Realty Advisors, Inc., dated as of October 4, 1989 (Incorporated by reference to Exhibit No. 10.16 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989).\n22.1 Subsidiaries of the Registrant.\n28.1 Settlement Agreement and Mutual Release, dated as of December 27, 1991, between Southmark Corporation, et al and Gene E. Phillips, et al (Incorporated by reference to Exhibit No. 28.1 to the Registrant's Current Report on Form 8-K dated December 27, 1991).\n28.2 Agreement dated as of February 25, 1992, between Gene E. Phillips, William S. Friedman, American Realty Trust, Inc., Syntek West, Inc., National Realty Advisors, Inc., Transcontinental Realty Investors, Inc., Continental Mortgage and Equity Trust, National Income Realty Trust and Income Opportunity Realty Trust (Incorporated by reference to Exhibit No. 28.1 to the Registrant's Current Report on Form 8-K dated February 25, 1992).\n28.3 Term Sheet, dated October 6, 1993, among National Realty, L.P., Syntek Asset Management, L.P., National Realty, L.P. Oversight Committee and American Realty Trust, Inc. (incorporated by reference to Exhibit No. 2 to the Registrant's Current Report on Form 8-K, dated October 8, 1993).\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n(b) Reports on Form 8-K:\nA Current Report on Form 8-K, dated October 8, 1993, was filed with respect to Item 5, which reports that the Registrant, Syntek Asset Management, L.P., the general partner of National Realty, L.P. and the National Realty, L.P. Oversight Committee reached an agreement in principle evidenced by a detailed Term Sheet to nominate a candidate for successor general partner for National Realty, L.P. and to consummate the 1990 settlement of a class action lawsuit.\n(THIS SPACE INTENTIONALLY LEFT BLANK.)\nSIGNATURES\nPursuant 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.\nAMERICAN REALTY TRUST, INC.\nDated: April 14, 1994 By: \/s\/ KARL L. BLAHA Karl L. Blaha President\nPursuant 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 and on the date indicated.\nBy: \/s\/ OSCAR W. CASHWELL By: \/s\/ TILMON KREILING, JR. Oscar W. Cashwell Tilmon Kreiling, Jr. Director Director\nBy: \/s\/ AL GONZALEZ By: \/s\/ RYAN T. PHILLIPS Al Gonzalez Ryan T. Phillips Director Director\nBy: \/s\/ G. WAYNE WATTS G. Wayne Watts Director\nBy: \/s\/ HAMILTON P. SCHRAUFF By: \/s\/ THOMAS A. HOLLAND Hamilton P. Schrauff Thomas A. Holland Executive Vice President and Senior Vice President and Chief Financial Officer Chief Accounting Officer\nDated: April 14, 1994\nANNUAL REPORT ON FORM 10-K\nEXHIBIT INDEX\nFOR THE YEAR ENDED DECEMBER 31, 1993\nExhibit Page Number Description Number - ------- ----------- ------ 22.1 Subsidiaries of Registrant. 123","section_15":""}
{"filename":"92259_1993.txt","cik":"92259","year":"1993","section_1":"ITEM 1.BUSINESS. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2.PROPERTIES. ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n-------------------------\nSouthern Pacific Transportation Company (\"SPT\" or the \"Company\") is a wholly- owned subsidiary of Southern Pacific Rail Corporation (formerly Rio Grande Industries, Inc.) (\"SPRC\"). Unless the content otherwise requires, references herein to the Company include SPT and its subsidiaries, including St. Louis Southwestern Railway Company (\"SSW\") and SPCSL Corp. (\"SPCSL\"), and references to SPRC include SPRC and its subsidiaries, including SPT and its subsidiaries and Rio Grande Holding, Inc. (\"RGH\") and its subsidiaries, which include The Denver and Rio Grande Western Railroad Company (\"D&RGW\") and its subsidiaries. References herein to SPRC prior to August 18, 1993 include SPTC Holding, Inc. (\"SPTCH\"), a wholly-owned subsidiary of SPRC and the parent of SPT that was merged into SPRC on such date.\n-------------------------\nPART I\nITEMS 1 AND 2. BUSINESS AND PROPERTIES\nGENERAL\nThe Company transports freight over approximately 12,600 route miles of track throughout the western United States. The Company operates in 14 states over five main routes described in \"--Service Territory.\" The Company serves most west coast ports and large population centers west of the Mississippi and connects with eastern railroads at all major gateways at Chicago, St. Louis, Kansas City, Memphis and New Orleans. The Company's rail lines reach the principal Gulf ports south from Chicago and east from the Los Angeles basin. In addition, the Company's rail lines connect with those of the D&RGW at Ogden, Utah and Herington, Kansas and together constitute continuous routes, one from the Pacific Coast through the Southwestern United States to East St. Louis and on to Chicago and the other from the Pacific Coast through the Midwestern United States to East St. Louis and on to Chicago. It interchanges with Mexican railroads at six gateways into Mexico, which is more than any other U.S. railroad.\nThe Company's lines provide the extensive distribution network needed by its customers to deliver their products to a wide range of major industrial markets. The principal commodities hauled in its carload operations are chemicals and petroleum products, food and agricultural products, forest products (including paper, paper products and lumber) and coal. Intermodal container and trailer operations continue to be the Company's largest single traffic unit. The Company is the industry leader in the U.S. for container traffic, based on both containers originated and total container traffic handled.\nNearly all of the Company's traffic either originates on or is destined to points served directly by the Company. In addition, nearly half of the Company's traffic both originates and terminates on its lines and is not interchanged with another rail carrier, thus enabling the Company to provide service without the need to coordinate the commercial and operational aspects of freight movements with other railroads.\nThe Company was acquired by SPRC in October 1988 from Santa Fe Pacific Corporation (\"Santa Fe\"). In 1989 and 1990, the Company acquired access to Chicago from St. Louis and Kansas City, respectively. For the five years preceding its acquisition by SPRC, SPT had been held in trust pending the decision of the Interstate Commerce Commission (the \"ICC\") that denied Santa Fe's requested merger with SPT. During this period, SPT fell significantly behind other Class I railroads that were then consolidating, streamlining and strengthening their railroads. At the time of its acquisition SPT was burdened with excess, unprofitable and low density track, inefficient operation and a generally higher and less competitive cost structure than other Class I railroads.\nIn addition to its rail business, the Company historically has received substantial cash flow from \"traditional\" real estate sales and leasing activities. More recently, transit corridor sales have become a dominant component of the Company's asset sales program, with the Company usually retaining operating rights over these corridors to continue freight rail service to its customers. Many of the Company's urban and intercity corridors are unique, and in turn valuable, properties in terms of their geographic composition and ready availability for transit use. Real estate sales have been in the past, and for the next several years will continue to be, necessary for the Company to meet its capital expenditure, debt service and other cash needs. Management considers the Company's extensive supply of assets available for sale to be sufficient for that purpose, although sales for 1993 declined sharply from levels for the preceding four years. The supply of properties that may be sold diminishes as sales occur and the timing of sales cannot be accurately predicted.\nBUSINESS STRATEGY\nBased on the experience gained since SPRC's acquisition of SPT, and the addition of key management personnel during the past three years, including the Company's President and Chief Executive Officer, Edward L. Moyers, who joined the Company in July 1993, the Company has developed and is implementing a strategy to improve the Company's operating results by improving customer service and increasing revenues while lowering the cost and improving the productivity of its railroad operations.\nSignificant elements of the Company's strategy, similar to those implemented by other railroads, include the following:\nCost Reductions and Operating Efficiencies\nThe Company's cost reduction strategy is focused principally on the continued reduction of surplus employees; increased efforts to rationalize its physical plant through the sale or lease of low-density, high cost lines, the consolidation of rail yards and other facilities and the sharing of rail line and facilities with other railroads; the implementation of programs to reduce derailments, accidents and personal injuries; and the enhancement of its operating efficiency and asset utilization.\n. Labor Productivity. A critical element of the Company's cost reduction strategy is to lower labor expenses by continuing to improve labor productivity. From January 1, 1993 to December 31, 1993 the Company reduced the number of its employees (both labor and management) by approximately 3,525, including a reduction of approximately 2,785 employees achieved from July 1, 1993 through December 31, 1993. Revenue ton-miles per employee increased approximately 15 percent in 1993 as compared to 1992.\n. Locomotive Fleet Upgrades. A key to improving the Company's customer service is increasing the Company's reliability and on time performance, which have generally lagged behind competitors. To improve transit time consistency the Company plans to continue to improve the reliability and utilization of its locomotive fleet through the acquisition of new and remanufactured locomotives and an extensive program to rebuild and perform heavy repairs on locomotives it already owns. The Company has ordered and has financed through capital leases (i) 50 new locomotives, 17 of which were delivered in the last quarter of 1993 and the balance of which are to be delivered by the end of the first half of 1994, and (ii) 133 remanufactured locomotives to be delivered in 1994. The Company also has ordered an additional 100 new locomotives for delivery in 1994, of which 50 are expected to be delivered in May and June 1994. The Company expects that financing for these acquisitions will be arranged in the near future.\n. Operating Efficiencies. The Company has developed programs to improve the efficiency and productivity of its rail operations including the centralization of certain functions, the computerization of its operations management system and the standardization of certain operating procedures. In November 1993, the Company and Integrated Systems Solutions Corporation (\"ISSC\"), a subsidiary of International Business Machines Corp. (\"IBM\"), entered into an agreement under which ISSC will handle all of the Company's management information services (\"MIS\") functions. Outsourcing MIS is expected to reduce the Company's MIS costs while improving the Company's information systems. In addition, the Company is taking steps to implement more scheduled train operations. The Company's intermodal services were operating on a scheduled system during 1993, and a scheduled system of operations was implemented for moving most of its carload traffic on its five major corridors by the end of March 1994.\n. Plant Rationalization. Through the rationalization of physical plant, which involves disposition (by sale, lease or abandonment) of low- density, high cost branch lines and concentration on core routes, the Company expects to reduce on-going operating costs. At January 1, 1993, the Company had identified approximately 2,300 miles of branch lines for disposition, of which 833 miles were sold, leased or abandoned as of December 31, 1993. The Company will continue in its efforts to dispose of the balance of these branch lines and will continue to identify additional properties, including other branch lines, rail yards and terminals, that can be made available for sale, lease or abandonment. The Company is also taking steps to identify opportunities to share rail line and facility capacity with other railroads. In addition, the Company has instituted a program to eliminate unnecessary double track and reuse the rails and ties to reduce the Company's maintenance of way costs.\n. Improved Safety Record and Reduced Personal Injury. In 1992 the Company implemented expanded safety programs designed to reduce accidents and personal injuries. The Company believes the\ninitiatives it has undertaken, including enhanced employee safety education and training programs, increased use of protective equipment, the implementation of improved standardized operating procedures and the establishment of safety improvement goals for which managers are held accountable, should enable it to reduce the incidence of injury and thereby better contain future cost increases.\nMarketing Efforts\nThe Company seeks to capitalize on the strategic advantages of its route structure, which provides access for service between many key industrial centers, eastern gateways and Mexico, to serve customers in commodity areas such as chemicals and forest products and in intermodal transport. In its intermodal business, the Company has long-standing relationships and multi-year contracts and other shipping arrangements with major steamship companies which use the Company's west coast intermodal facilities and has established marketing arrangements with premier nationwide truckload companies. The Company is placing additional emphasis on attracting new business in Mexico and Canada and adding business to specific routes where carload capacity is not fully utilized. The Company believes these efforts will benefit to some extent from the recent passage of the North American Free Trade Agreement (\"NAFTA\"). The Company has implemented programs to improve its customer service and responsiveness including the establishment of centralized transportation and customer service centers and increased training and standardized procedures.\nCustomer Service\nFundamental to the Company's business strategy to increase revenues is improving customer services. Through the quality management system implemented in 1991, the Company has identified specific areas for improvement and continues to benchmark the Company's performance against the industry leader in each area. The quality improvement programs include detailed annual objectives together with monthly cross functional management reviews and ongoing performance appraisals. A critical element in improving the Company's customer service is increasing the Company's reliability and on-time performance, which have generally lagged behind those of its competitors. The locomotive improvement initiative and efforts to improve the efficiency of the Company's terminal operations are intended to improve the Company's transit time consistency. The Company is continuing a multi-year program implemented in 1991 to refurbish approximately 9,000 railcars. Since 1991 the Company has almost doubled the number of customer service representatives, increased training and standardized procedures, and organized its customer service efforts to serve the needs of specific customer groups.\nInvestment in Plant and Equipment\nA key element of the Company's strategy is the continued investment in its plant and equipment in order to enhance its long-term operating performance. The condition of the physical plant plays an important role in transit time reliability. The Company believes its physical plant is in excellent condition as a result of the significant investments it has made during the past decade.\nOperations at the Company's expanded and upgraded Burnham locomotive repair facility in Denver, Colorado will have a substantial role in the Company's locomotive upgrade program. In 1993, a total of 53 locomotives were rebuilt and 273 locomotives underwent heavy repairs, 53 and 166 of which, respectively, were completed at Burnham. Through an increase in the number of crew shifts and personnel and improved operating efficiencies, management believes that the Burnham facility will be in a position to rebuild or perform heavy repairs on up to 300 locomotives a year as part of an ongoing scheduled maintenance program.\nThe Company has embarked on rail car refurbishment and purchase and lease programs designed to improve the efficiency and reliability of the Company's rail car fleet, as well as meet the specialized needs of its customers. The Company has an agreement with a leading rail car manufacturer to refurbish approximately 9,000 rail cars and lease them back to the Company or third parties under a full maintenance\nlease agreement. From 1990 through 1993, approximately 5,700 cars were refurbished, with the balance of the program to be completed in 1994 and 1995. To complement its rail car refurbishment program, the Company purchases and leases rail cars on an ongoing basis. In 1993, the Company leased 345 aluminum coal cars, 177 steel coil flatcars, 30 double stack intermodal cars (with an additional 70 to be delivered in 1994) and approximately 125 specialized cars for various uses.\nAsset Sales\nA key component of the Company's strategy has been and will continue to be the sale of assets non-essential to its railroad operations. The Company possesses sizeable holdings that fall into two distinct types: \"transit corridors\" and \"traditional\" real estate. Each type of property has significant value for different classes of buyers. Historically, the Company has received substantial cash flow from \"traditional\" real estate sales and leasing activities involving industrial and commercial properties located in developed areas on the Company's system. Many of these properties are targeted for sale to fit the specific purpose of potential buyers, such as locating a facility near a customer or supplier or taking advantage of the availability of transportation service, while others are suited for large scale industrial or commercial development. More recently, transit corridor sales have become a dominant component of the Company's asset sales program. The Company expects that increasing highway congestion and other transportation problems will continue to create demand for both passenger corridors and, to a lesser extent, consolidated freight corridors and facilities. The Company has substantial remaining property which it is in the process of selling, preparing to sell or holding for an appropriate time to sell. In addition, the Company continues to release property from its rail business and has a substantial portfolio of leased properties.\nCAPITAL AND DEBT TRANSACTIONS\nOn August 17, 1993 SPRC closed the offering and sale of 30,783,750 shares of common stock and issued and sold $375 million principal amount of 9 3\/8 percent Senior Notes due 2005.\nIn connection with the foregoing transactions, the Company issued 200 shares of common stock for total consideration of $445.5 million from SPRC. The proceeds from this transaction were used to repay $169 million outstanding under the SPT Term Loan, to purchase $107.7 million of D&RGW property including principally the Burnham locomotive repair facility and certain non-operating properties, to purchase for $99.1 million equipment operated pursuant to operating leases, to pay fees and expenses of $3.8 million and for general corporate purposes. In addition, as part of the foregoing transactions, the Company entered into a $200 million three-year unsecured credit agreement (the \"Credit Agreement\") replacing its then existing secured bank credit facility.\nOn March 2, 1994, SPRC closed an offering of 25,000,000 shares of common stock. In connection with this transaction, the Company issued 150 shares of common stock for consideration of $294.5 million from SPRC. The proceeds were used to repay the $175 million then outstanding balance on the Credit Agreement and to purchase $118.9 million of D&RGW rail properties. The proceeds of the purchase from D&RGW were used to repay the amounts outstanding under the RGH credit facilities.\nSERVICE TERRITORY\nThe Company's routes and service territory are briefly described below.\nCentral Corridor Route. The Central Corridor Route links northern California and the Pacific Northwest with the nation's heartland, traversing the Rocky Mountain states (via the D&RGW), Kansas, Missouri and Illinois. The eastern end of this route reaches the key gateway cities of Kansas City, St. Louis and Chicago. This route handles a diverse mix of traffic including eastbound forest products, perishables and processed foods as well as significant volumes of finished automobiles and other manufactured goods.\nPacific Coast Route. This north-south route is the most direct and efficient rail line connecting the forest product resource base of the Pacific Northwest with the major consuming markets in California and Arizona.\nThe Company enjoys a strong position in this key corridor. It is the only railroad with operations which extend from the Oregon border through the state of California to Mexico.\nSunset Route. The Company's Sunset Route is well-positioned as the shortest, most direct line from the Los Angeles Basin to Houston and other Gulf Coast ports. As the only single-line rail carrier in the Southern Corridor between Los Angeles and the key eastern gateways of Memphis and New Orleans, this route is favored by international container shippers and carload shippers alike. This route structure advantage creates an excellent fit with the Company's strong presence in carload originations of chemicals and plastics in the Gulf region.\nGolden State Route. This route connects Southern California and Arizona with the industrial midwest and the major rail gateways of Kansas City, St. Louis and Chicago. A wide range of products is handled in the corridor including intermodal, metals and ores, agricultural products and miscellaneous manufactured products.\nMid-America Route. The Mid-America Route (also known as the \"Cotton Belt Route\") links the petrochemical producing region along the Gulf of Mexico with industrial users and consuming markets in the midwest and northeast. The Cotton Belt serves the cities of Dallas\/Ft. Worth, Shreveport, Memphis and St. Louis.\nMexico. The Company serves Mexico through interchanges with Mexican railroads at six gateways in California, Texas and Arizona.\nRAILROAD OPERATIONS\nThe following table sets forth certain freight and operating statistics relating to the Company's rail operations for the periods indicated. The operating ratios show consolidated operating expenses expressed as a percentage of operating revenues. The indicated increases in revenue ton-miles and carloads in part reflect implementation in 1992 and 1993 of the Company's business strategy. The decrease in revenue per ton-mile evidences the intense competitive pressures under which the Company operates, particularly those affecting its intermodal activities.\n- -------- (1) Includes intermodal carloads with an assumed two containers per carload. Intermodal carloads hold from two to ten containers. (2) Includes a special charge of $270.0 million. The operating ratio excluding the special charge would have been 103.3%.\nAs the results in the table below show, crew size reductions on Company lines and efforts initiated in 1992 and continued in 1993 to rehabilitate and upgrade the Company's locomotive fleet and improve locomotive utilization have resulted in increased labor productivity.\nIn addition to improvements in labor productivity, the Company's initiatives in rehabilitating and upgrading the quality of its locomotive fleet and improving locomotive utilization are also intended to achieve improvements in fuel efficiency. The following table provides information concerning the Company's diesel fuel consumption for the periods indicated.\nImprovements in labor productivity and overall efficiency of operations have not translated directly into operating ratio decreases because revenue per ton- mile has been affected by continued pressure for lower rates, increased competition for new traffic and a shift in traffic mix from automotive and lumber products to traffic that historically generates lower rates on a revenue per ton-mile basis. In addition, the 1993 midwest flooding adversely affected the operating ratio.\nTRAFFIC\nThe Company's marketing strategy is implemented by business development groups, each of which is organized to serve a particular customer or commodity base. The Company seeks to maintain and enhance its competitive position by tailoring its service capabilities to fit each customer base in terms of equipment availability, loading facilities, scheduling and contract terms. In 1993, the largest five shippers accounted for less than 16 percent of the Company's gross freight revenues, with no shipper providing more than five percent of such revenue. Set out below is a comparison of volumes and gross freight revenues (before contract allowances and adjustments) by commodity groups in 1993. A more detailed discussion of the traffic generated by each group follows the table.\nIntermodal. The intermodal freight business consists of hauling freight containers or truck trailers by a combination of water, rail and motor carriers, with rail carriers serving as the link between motor carriers and between ports and motor carriers. Intermodal traffic accounted for $706.4 million of gross freight revenues for 1993 or 27.4 percent of total gross freight revenues. The Company's intermodal revenues are derived in large part from goods produced in the Pacific Rim and shipped by rail from west coast ports to east coast markets. This traffic is carried on the Company's lines from its terminals at Portland, Oakland or Los Angeles\/Long Beach to Chicago, St. Louis, New Orleans or Houston, or, through connecting carriers, beyond to the U.S. eastern seaboard.\nChemical and Petroleum Products. The Company transports a wide range of industrial chemical and plastic products, which constitute the primary commodity and product groups included in this traffic. Total chemical and petroleum products accounted for $598.0 million of gross freight revenues for 1993 or 23.2 percent of total gross freight revenues. Most of the traffic originates within Texas, where the Company\ndirectly serves chemical and plastics plants. The Company's routes enable it to transport these products from Texas directly to end-user markets on the west coast and through interchanges at major gateways to end-user markets on the east coast.\nFood and Agricultural Products. Grain and grain products constitute the primary commodity groups included in this traffic. Total food and agricultural products accounted for gross freight revenues of $352.9 million for 1993 or 13.7 percent of total gross freight revenues. The Company primarily receives, rather than originates, shipments of grain and grain products for delivery to feed lots and poultry farms located along its routes. It also is a major transporter of grain products to Mexico. Shipper demand is affected by competition among sources of grain and grain products as well as price fluctuations in international markets for key commodities. Other food and consumer goods included in this traffic tend to be more stable flows from sources in California to consumer markets in the eastern part of the United States.\nForest Products. This traffic includes lumber stock, plywood and various paper products. It accounted for $362.8 million of gross freight revenues for 1993 or 14.1 percent of total gross freight revenues. Most of the traffic originates in Oregon and Northern California. However, certain product sources in the Pacific Northwest have been adversely affected by environmental concerns. In response, the Company is developing alternative Canadian sources as well as developing a significant presence in the market as a transporter, through interchange at eastern gateways, of lumber and paper products from the southeastern United States to end-user markets in the western United States. The transportation market for lumber is affected by housing starts and remodeling activity, while the transportation market for paper products is driven by end-user demand for packaging and newsprint.\nCoal. Coal accounted for gross freight revenues of $100.2 million for 1993 or 3.9 percent of total gross freight revenues. The traffic is subject to intense competition from other coal sources, particularly the Powder River Basin in Wyoming.\nMetals and Ores. Metals and ores accounted for $199.6 million of gross freight revenues for 1993 or 7.7 percent of total gross freight revenues. This traffic includes both ferrous and non-ferrous metals and is concentrated on the origination of shipments from copper mines and smelters in Arizona and steel mini-mills in the West. These transportation markets are sensitive to end-user demand for automobiles, appliances and other consumer goods with substantial metal components. The markets also are affected by commodity prices in international markets and subject to the substitution of imported metals.\nOther. The traffic generated by the business development groups discussed above amounted to approximately 90.0 percent of the Company's gross freight revenues for 1993. Other commodity and product groups included in the Company's traffic mix include automobiles, automotive parts, construction materials, non- metallic minerals and government traffic. All are subject to fluctuations in end-user demand and competition from other railroads and motor carriers.\nMexico. The Company's Mexico Group, headquartered in Houston, serves as a marketing and service link between the Company's business development groups and markets in Mexico. The Company maintains a strong working relationship with FNM. Approximately $213.7 million of the Company's gross freight revenues for 1993 or 8.3 percent of total gross freight revenues were attributable to shipments to and from Mexico. The Company works closely with FNM's \"El Maquiladora\" train between Ciudad Juarez and Chihuahua. FNM and the Company are working on establishing through rates for carload shipments of selected commodities through all six of the gateways to Mexico served by the Company.\nPHYSICAL PLANT AND EQUIPMENT\nRoadway, Yards and Structures. At December 31, 1993, the Company had approximately 19,500 miles of track in operation, consisting of approximately 12,580 miles of first main track (route miles) and approximately 6,940 miles of additional main track, passing track, way switching track and yard switching track. Route miles include operating rights on 1,787 miles of track owned by other railroads. Sales and\nabandonments are intended to increase the density (gross ton-miles per route mile operated) of the Company's railroad system and eliminate maintenance costs for underutilized track.\nPrincipal railroad yard facilities owned by the Company are located at Eugene, Oregon; Sacramento, Roseville, Oakland, Los Angeles and West Colton, California; Houston, Texas; Pine Bluff, Arkansas; and Kansas City, Kansas. As part of its effort to rationalize operations, the Company is identifying and assessing opportunities for consolidation of its railroad yard facilities. In August 1993, the Company acquired the Burnham locomotive repair facility in Denver, Colorado from the D&RGW.\nEquipment. At December 31, 1993, the Company owned or leased equipment described in the table below. The table excludes equipment held under short- term leases. At December 31, 1993 there were 295 locomotives subject to short- term leases. At December 31, 1993, there were approximately 3,850 non- serviceable freight cars in storage, which included approximately 1,000 freight cars awaiting sale to a third party for rehabilitation and leaseback, 750 previously leased freight cars awaiting return to the lessor, 775 freight cars scheduled for repair and the remainder awaiting retirement.\nIn addition to the locomotive program described below, the Company has embarked on rail car refurbishment and purchase and lease programs designed to improve the efficiency and reliability of the Company's rail car fleet, as well as meet the specialized needs of its customers. The Company has an agreement with a leading rail car manufacturer to refurbish approximately 9,000 rail cars and lease them back to the Company or third parties under a full maintenance lease agreement. From 1990 through 1993, approximately 5,700 cars were refurbished, with the balance of the program to be completed in 1994 and 1995. To complement its rail car refurbishment program, the Company purchases and leases rail cars on an ongoing basis. In 1993, the Company leased 345 aluminum coal cars, 177 steel coil flatcars, 30 double stack intermodal cars (with an additional 70 to be delivered in 1994) and approximately 125 specialized cars for various uses.\nThe Company also has an extensive program to enhance the quality of the locomotives it already owns. The Company plans to rebuild 207 locomotives and perform heavy repairs on 93 locomotives in 1994, of which all 207 locomotives are expected to be rebuilt and 41 locomotives are to undergo heavy repairs at Burnham. Thereafter, in order to maintain high locomotive availability, the Company plans to rebuild or perform heavy repairs on approximately 300 locomotives each year at its Burnham facility as part of an ongoing scheduled program to rebuild and perform heavy repairs on the Company's locomotive fleet. Pending the acquisition (through capital and operating leases and by purchase) of new and remanufactured locomotives, the Company has substantially increased the number of locomotives it leases on a short-term basis in order to meet the anticipated demands of its customers.\nCapital Expenditures and Maintenance. Improvement and ongoing maintenance of roadway, structures and equipment are essential components of the Company's efforts to improve service and reduce operating costs. The Company has made the following railroad capital expenditures (exclusive of capital leases) in order to maintain and improve train service (in millions of dollars):\nCAPITAL EXPENDITURES\n- -------- (1) Excludes equipment previously under operating leases purchased with $65.3 million of the proceeds of capital and debt transactions ($30.1 million for locomotives and $35.2 million for freight cars). Also excludes $107.7 million of D&RGW property purchased by the Company in 1993 with proceeds provided to the Company in connection with the SPRC Common Stock and Debt Transactions.\nThe Company's capital expenditures for railroad operations for 1994 are expected to be approximately $230 million (exclusive of capital leases) including $159 million for roadway and structures and $71 million for railroad equipment and other items. In addition, in connection with the recent decision to consolidate the Company's dispatching, crew calling and other operations, the Company expects to incur approximately $30 million of capitalized costs for facility improvements and communication equipment. The Company has ordered and has financed through capital leases 50 new locomotives, 17 of which were delivered in the last quarter of 1993 and 33 of which will be delivered by the end of the first half of 1994, and 133 remanufactured locomotives to be delivered in 1994. These 183 locomotives will be financed by capital leases (which are expected to have a total present value of minimum lease payments of approximately $131 million) and therefore are not included in the 1994 capital expenditure budget. The Company also has ordered an additional 100 new locomotives for delivery in 1994 at a cost of approximately $135 million (which amount also is not included in the 1994 capital expenditure budget because final determination regarding the method of financing (e.g. capital lease or purchase) has not been made). The Company acquired 1,651 freight cars in 1993 under capital leases with a total present value of minimum lease payments of approximately $43 million and expects to acquire more by capital lease in 1994.\nThe following table shows the Company's expenses for ongoing maintenance and repairs of roadway and structure and railroad equipment (including administrative and inspection costs) for the periods indicated (in millions of dollars):\nMAINTENANCE EXPENDITURES\nTRANSIT CORRIDOR AND REAL ESTATE SALES\nThe disposition of urban and intercity transit corridors and surplus real estate, mostly in metropolitan areas along the Company's rights of way, is a major component of the Company's business strategy and is\nconducted as a part of the Company's ordinary course of business. While SPT historically has sold property not required for its core transportation operations, the Company's new management aggressively markets a large portfolio of properties that are classified generally into two distinct types: \"transit corridors,\" which are typically sold to public agencies, and \"traditional\" real estate, which is typically sold to different groups of potential buyers. The Company had gains from the sale of property and real estate of $24.5 million, $301.3 million and $469.8 million in 1993, 1992 and 1991, respectively.\nTransit Corridors. The Company's sales efforts focus particularly on, and most of the proceeds since January 1, 1989 resulted from, the sale of transit corridor properties that consist of the Company's rights of way and related tracks and rail stations that provide a natural corridor over which a metropolitan, regional or other geographic area can establish and operate public transportation systems or consolidated freight corridors (for use by more than one railroad). Many of the Company's urban and intercity corridors are unique, and in turn valuable, properties in terms of their geographic composition and ready availability for transit use. The Company expects that increasing highway congestion and other transportation problems will continue to create demand for both passenger corridors and, to a lesser extent, consolidated freight corridors and facilities. The Company usually retains freight operating rights over these corridors to continue rail service to its customers. The Company obtains other benefits as a part of these sales, such as reduced ongoing maintenance costs for the lines and creating higher traffic density on substitute lines. The Company has identified a number of additional urban and intercity line sale opportunities which it will pursue as part of its normal course of business. Past sales include the Los Angeles County Transportation Commission's purchase of over $400 million of SPT's property and the Peninsula Corridor Joint Powers Board's purchase of SPT's Peninsula Corridor for approximately $220 million, with an additional $110 million of property covered by purchase options.\nThe funding to purchase transit corridors often comes through either accumulated funds from past taxes or new bond issues. Recent federal and some state legislation is encouraging development of public transit lines by, among other things, creating an awareness on the part of local, state and regional entities of the availability of funds and the opportunities for projects. The timing of corridor sales is difficult to predict and varies from period to period depending on market conditions at the time, differences or delays in targeted or scheduled sales dates and other factors, such as political considerations that are typically involved in negotiations with public agencies. As a result of these and other variables, an effective program for the sale of the Company's inventory of transit corridors and other facilities involves patient and careful work with city and county governments, relevant state agencies and various interested local community organizations. In the future, in order to facilitate sales or otherwise enhance values of transit corridors and other facilities, the Company may form joint ventures with private partners or public entities or engage in other innovative transactions.\nTraditional Real Estate. In addition to transit corridors, the Company sells traditional real estate that consists principally of industrial and commercial properties located in developed areas on the Company's system. Many of these properties are targeted for sale to fit the specific purpose of potential buyers, such as locating a facility near a customer or supplier or taking advantage of the availability of transportation services, while others are suited for large scale industrial or commercial development. The Company also owns buildings and other facilities that can be made available for sale or other disposition as the Company further rationalizes its operations. The Company's supply of properties includes several thousand parcels that are available or could be made available for sale within the next few years (without including properties currently leased by the Company to tenants). In order to enhance the value of certain properties and facilitate their disposition, the Company has in the past and may in the future participate with others in the development of such properties by contributing the property and funding to joint ventures or other entities, participating in sale and leaseback arrangements and engaging in other transactions that do not involve immediate cash proceeds.\nEMPLOYEES AND LABOR\nLabor and related expenses accounted for approximately 40 percent of the Company's railroad operating expenses in 1993. At December 31, 1993, the Company employed 16,894 persons, which represents a reduction of approximately 3,525 from January 1, 1993 (including a reduction of over 2,785 employees\nachieved from July 1, 1993 through December 31, 1993). SPRC expects to further reduce the number of its employees (both labor and management) by approximately 900 employees through 1994 (a substantial portion of which will come from the Company), subject to certain temporary increases from time to time. These reductions resulted from attrition and voluntary separations, severance, early retirement programs and furloughs.\nAt December 31, 1993, approximately 86 percent of the Company's railroad employees were covered by collective bargaining agreements with railway labor organizations that are organized along craft lines, where employees are grouped together by job and historical practice. Historically, many collective bargaining agreements in the railroad industry have been negotiated on a nationwide basis with the national railways represented by a bargaining committee.\nLabor relations in the railroad industry are subject to extensive governmental regulation under the RLA. The most recent national collective bargaining agreements with the major railway labor organizations and the railroads, including the Company, expired in 1988, and negotiations failed to resolve the wage and work rule issues. After various presidential and legislative actions in 1991, because of its constrained financial condition, the Company was authorized to negotiate separately with certain of its employee unions, rather than on a nationwide basis with the railroads being represented by a bargaining committee, as is typically the case. These negotiations resulted in wage rates that are lower than the national rates for most of the Company's union employees and relieved the Company of the requirement to make certain lump sum payments to employees. These concessions represent a substantial savings to the Company in terms of the labor costs it would have otherwise incurred. In total, new agreements covering over 15,400 union employees of SPRC have been reached. In addition, the Company was able to avoid the establishment of reserve boards (employees who are paid a percentage of salary but stay at home awaiting recall) on all of the Company's lines except the Western Lines, in connection with reductions in its train crew size from three to two.\nOn November 16, 1993 the Company's employees ratified a new four-year labor agreement with the United Transportation Union, which represents approximately 2,300 trainman and switchmen on the Company's Western Lines. The agreement provided for a reduction of 210 surplus employees, the elimination of the reserve board for the Western Lines, and a wage freeze through the end of 1997. As a result, the Company became the only Class I railroad without reserve boards for any of its lines. Also in November 1993, the Company withdrew from the National Railway Labor Conference, indicating it would negotiate wage and work-rule agreements separately from any nationwide negotiations conducted by other Class I railroads.\nIn total, new agreements covering all but approximately 150 union employees of the Company have been reached, most of which are open for modification in 1995, except that the agreement related to employees on the Company's Western Lines is open for modification in 1998. The Company will be required to renegotiate its labor agreements at those times.\nWages for approximately half of the Company's employees covered by these new agreements (other than the agreement related to employees on the Company's Western Lines) are required to return to wage levels prevailing under nationwide railway collective bargaining agreements in 1995. Wages for the other employees covered by the new agreements (including the Western Lines) do not require restoration to national wage levels and will be subject to resolution in the next round of negotiations scheduled to begin in late 1994 (1997 for the Western Lines). No assurance can be given as to the terms of any of the Company's new agreements. In addition, all of the Company's labor agreements (except for the agreement related to employees on the Company's Western Lines) provide for cost of living increases on a semi-annual basis beginning July 1, 1995. The additional cost to the Company of these automatic increases could be substantial.\nIn 1992, the Company completed the reduction of all through freight train crew sizes to an engineer and one conductor (instead of an engineer and two or three train service employees) on all of its lines. Through arbitration the Company was also able to settle certain issues relating to surplus employees, resulting in, among other things, the Company's exemption from the establishment of reserve boards on all lines except the Western Lines. As part of the Company's labor agreement relating to the Western Lines entered into in November 1993, the Company is now exempt from the establishment of reserve boards on all of its lines. As\na result of its arbitration efforts and its recent labor agreement with respect to the Western Lines, 307 employees accepted voluntary severance effective April 1992 and an additional 210 employees accepted voluntary severance effective by the end of 1993, at an aggregate cost to the Company of approximately $37 million.\nUnder the RLA, labor agreements are renegotiated when they become open for modification, but their terms remain in effect until new agreements are reached. Typically neither management nor labor is permitted to take economic action until extended procedures are exhausted.\nRailroad industry personnel are covered by the Railroad Retirement Act (\"RRA\") instead of the Social Security Act. Employer contributions under the RRA are currently substantially higher than those under the Social Security Act and may rise further because of the increasing proportion of retired employees receiving benefits relative to the number of working employees.\nRailroad industry personnel are also covered by the Federal Employer's Liability Act (\"FELA\") rather than by state workers' compensation systems. FELA is a fault-based system, with compensation for injuries settled by negotiation and litigation. By contrast, most other industries are covered under state- administered no-fault plans with standard compensation schedules.\nGOVERNMENTAL REGULATION\nThe Company is subject to environmental, safety, health and other regulations generally applicable to all businesses. In addition, the Company, like other rail common carriers, is subject to regulation by the ICC, the Federal Railroad Administration, state departments of transportation and some state and local regulatory agencies.\nThe ICC has jurisdiction over, among other things, rates charged by rail carriers for certain traffic movements, service levels, car rental payments and issuance or guarantee of railroad securities. It also has jurisdiction over the situations and terms under which one railroad may gain access to another railroad's traffic or facilities, extension or abandonment of rail lines, consolidation, merger or acquisition of control of rail common carriers and of other carriers by rail, and labor protection provisions in connection with the foregoing. Its power to exercise its jurisdiction is limited in certain circumstances. The Federal Railroad Administration has jurisdiction over railroad safety and equipment standards. State and local regulatory agencies also have jurisdiction over certain local safety and operating matters and these agencies are becoming more aggressive in their exercise of jurisdiction. State legislatures also recently have enacted new laws that are intended to regulate railroads more extensively.\nGovernment regulation of the railroad industry is a significant determinant of the competitiveness and profitability of railroads. Deregulation of certain rates and services under the Staggers Act has substantially increased the flexibility of railroads to respond to market forces, while the deregulated environment has resulted in highly competitive and steadily decreasing rates. Various interests have sought and continue to seek reimposition of government controls on the railroad industry in areas deregulated in whole or in part by the Staggers Act. Additional regulation, changes in regulation and re- regulation of the industry through legislative, administrative, judicial or other action could materially affect the Company.\nCOMPETITION\nThe Company's business is intensely competitive, with competition for freight traffic coming from other major railroads and motor carriers depending upon the particular market served. Principal railroad competitors include the Union Pacific Railroad Company (\"Union Pacific\") in the central corridor and The Atchison, Topeka and Santa Fe Railway Company (\"ATSF\") in the southern corridor. Competition with other railroads and modes of transportation is generally based on the rates charged, as well as the quality and reliability of the service provided. Some rail competitors have substantially greater financial and other resources than the resources of the Company. This factor and other competitive pressures have resulted in a\ndownward pressure on rates. In addition, the consolidation in recent years of major western rail systems has resulted in particularly strong competition in the service territory of the Company among the Company's rail system, Union Pacific, ATSF and the Burlington Northern Railroad Company (\"BN\"). Further consolidation of its rail competitors could adversely affect the Company's competitive position. For example, such further consolidation could result from the acquisition of control of the Chicago and North Western Holdings Corp. by the Union Pacific if its pending application is approved by the ICC. Continuing competitive pressures and declining margins could have a material adverse effect on the Company's operating results.\nCertain segments of the Company's freight traffic, notably intermodal, face highly price sensitive competition from trucks, although improvements in railroad operating efficiencies are tending to lessen the truckers' cost advantages. Trucks are not obligated to provide or to maintain rights of way and they do not have to pay real estate taxes on their routes. In recent years, the trucking industry diverted a substantial amount of freight from the railroads as truck operators' efficiency over long distances increased. Because fuel costs constitute a larger percentage of the trucking industry's costs, declining fuel prices disproportionately benefit trucking operations as compared to railroad operations. Truck competition has also increased because of legislation removing many of the barriers to entry into the trucking business and allowing the use of wider, longer and heavier trailers and multiple trailer combinations in many areas.\nWhile deregulation of freight rates under the Staggers Act has enhanced the ability of railroads to compete with each other and alternate forms of transportation, the resulting intense competition has pushed rates downward. In addition, changes in the structure of governmental regulation could significantly affect the Company's competitive position and profitability.\nThe railroad industry in general is susceptible to changes in the economic conditions of the industries and metropolitan areas that produce and consume the freight they transport. Because the end users of most of the freight shipped by the Company are primarily industrial and home consumers, and because the Company lacks a single large commodity base (such as grain or coal), changes in general economic conditions particularly affect the Company's operating results.\nENVIRONMENTAL MATTERS\nThe Company's operations are subject to extensive federal, state and local regulation under environmental laws and regulations concerning, among other things, emissions to the air, discharges to waters and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. Inherent in the railroad operations and the real estate ownership and sales activity of the Company is the risk of environmental liabilities as a result of both current and past operations. The Company regularly transports chemicals and other hazardous materials for shippers, as well as using hazardous materials in its own operations. Environmental liability can extend to previously owned properties, leased properties and properties owned by third parties, as well as properties currently owned and used by the Company. Environmental liabilities can be asserted by adjacent landowners or other third parties in toxic tort litigation. Also, the Company has indemnified certain property purchasers as to environmental contingencies.\nIn addition to costs incurred on an ongoing basis associated with regulatory compliance in its businesses, the Company may have environmental liability in three general situations. First, it might have liability for having disposed of wastes at waste disposal sites that are believed to pose threats to the public health or the environment. CERCLA imposes liability, without regard to fault or the legality of waste generation or of the original disposal, on certain classes of persons, including the current and certain prior owners or operators of the disposal site and persons that arranged for the disposal or treatment of hazardous substances found at the site at which problems are alleged to exist. CERCLA also authorizes the Environmental Protection Agency (\"EPA\"), the states and in some circumstances third parties to take actions in response to public health or environmental threats and to seek to recover certain clean-up and legal costs they incur from the same classes of persons. Governmental authorities can also seek recovery for damages to natural resources. Second, under CERCLA and applicable state statutes, the current owner or operator of any real property, not just waste disposal sites, may incur liability for hazardous substances located on the property, or that\nhave migrated to adjoining properties, even though such wastes were deposited by a prior owner, operator or tenant. A former owner or operator of real property may incur liability for hazardous substances located on the property even though such wastes were deposited by another owner, operator or tenant; and a former owner or operator of real property may incur liability after the sale of the property for hazardous wastes disposed on the property during the time that it owned, operated or leased the property. The third general area is that associated with the accidental release of hazardous materials or substances during a transportation incident, such as a derailment. Federal, state and local laws and regulations may impose (again, without regard to fault), requirements for clean-up of contaminated soils and surface or groundwater resulting from a derailment; and there may also be long-term monitoring requirements to evaluate the impacts on the environment and natural resources. Certain federal and state laws also require that the discharger of hazardous substances reimburse agencies for certain costs in responding to a hazardous materials incident (also without regard to fault). In addition, adjacent land owners or other third parties sometimes initiate toxic tort litigation against the type of sites described above.\nState and local agencies, particularly in California where the Company has extensive operations, have become increasingly active in the environmental area. The increased regulation by multiple agencies can be expected to increase the Company's future environmental costs. In particular, properties under federal and state scrutiny frequently result in significant clean-up costs and litigation expenses related to a party's clean-up obligation.\nThe Company has made and will continue to make substantial expenditures relating to the assessment and remediation of environmental conditions on its properties, including properties held for sale. During 1993 and 1992 the Company spent approximately $16.2 million and $15.7 million, respectively, relating to the assessment and remediation of environmental conditions of operating properties and non-operating properties not held for sale, excluding the effects of the 1991 derailment at Dunsmuir, California. In 1993 and 1992, the Company also incurred and expensed approximately $12.4 million and $17.6 million, respectively, for environmental matters relating to properties held for sale. Costs associated with environmental remediation of properties held for sale may be deferred to the extent such costs, together with estimated future costs and the existing cost basis of the property do not exceed, in the aggregate, the amount expected to be realized upon sale.\nIn assessing its potential environmental liabilities, the Company typically causes ongoing examinations of newly identified sites and evaluations of existing clean-up efforts to be performed by environmental engineers employed both by it and by consulting engineering firms. These assessments, which usually consider a combination of factors such as the engineering reports, site visits, area investigations and other steps, are reviewed periodically by counsel. The Company's analysis includes, among other things, the number of potentially responsible parties (\"PRPs\") at many sites that the Company considers to be financially viable participants with the Company; considerations such as the estimated allocation of liability among such PRPs, the selected method of remediation, the timing of work, the effect of inflation, the ability to recover costs from former and current insurance carriers and the development of new remediation technologies; information contained in the Company's historical, operating and compliance files; regulatory guidelines and the regulatory comment and approval process; information contained in regulatory agency files regarding certain sites; settlements made at some sites; the volume and nature of wastes attributable to the Company at certain sites; and decisions that have been made regarding clean-up at some of the sites.\nThe Company owns or previously owned two properties and has a partial interest in four properties that are on the national priorities list (\"NPL\") under CERCLA, the federal \"superfund\" statute. The Company has been informed that it is or may be a PRP, together with multiple other PRPs, with respect to the remediation of eight other properties on such list. Certain other Company properties are included on lists of sites maintained under similar state laws. Inclusion of a site on such lists would allow federal or state \"superfund\" monies to be spent on clean-up at the sites if PRPs do not perform the clean- up. The law governing \"superfund\" sites provides that PRPs may be jointly and severally liable for the total costs of remediation. In some instances, liability may be allocated through litigation or negotiation among the PRPs based on equitable factors, including volume contribution. Of its properties, including the NPL and PRP\nproperties described above, the Company has only three sites that individually involved future cost estimates for environmental matters as of December 31, 1993 in excess of $5 million. None of such estimates exceeded $10 million at that date.\nThe Company's total costs for its environmental matters cannot be predicted with certainty; however, the Company has accrued reserves for environmental matters with respect to operating and non-operating properties not held for sale, as well as certain properties previously sold, based on the costs estimated to be incurred when such estimated amounts (or at least a minimum amount) can be reasonably determined based on information available. At December 31, 1993 and 1992, the Company had accrued reserves for environmental contingencies of $58.8 million and $67.8 million, respectively. Based on the Company's assessments described above, other available information and the amounts of the Company's established reserves, management does not believe that disposition of environmental matters known to the Company will have a material adverse effect on the Company's financial condition. However, there can be no assurance that material liabilities or costs related to environmental matters will not be incurred in the future. See Note 12 to the Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nUnion Pacific--Missouri Pacific, Western Pacific Control; ICC Finance Docket No. 30,000, 366 ICC 462 (October 20, 1982). On October 20, 1982, the ICC approved the consolidation of Union Pacific, Missouri Pacific Railroad Company (\"MP\") and Western Pacific Railroad Company, over vigorous opposition of SPT and others. As a condition to its approval, the ICC awarded SSW trackage rights to operate over the MP lines between Kansas City and St. Louis, which operations commenced on January 6, 1983. The ICC's initial decision did not fix the compensation SSW would pay for the trackage rights.\nIn a series of decisions the ICC set forth new principles to govern the computation of the \"rent\" portion of the trackage charges (payment for maintenance expenses has not been a major issue). Court appeals from those decisions were concluded, and Union Pacific filed a collection action for rent in Federal District Court. Union Pacific claims approximately $60 million (including interest) as of December 31, 1993, representing Union Pacific's calculation of the effect of the ICC decisions. SPT has contested the amount claimed as overstated, and further has asserted that Union Pacific failed to provide the service ordered by the Commission, specifically, equal treatment of the trains of the two companies on the trackage rights lines, a different issue from the previously-litigated issue of rent. On October 29, 1993, the ICC issued an order holding in abeyance, pending action from the District Court, SPT's petition to modify or further interpret its order. On December 6, 1993, the District Court dismissed Union Pacific's action without prejudice. Union Pacific requested the District Court reconsider and set aside its decision; and on March 14, 1994, the District Court vacated its order dismissing Union Pacific's complaint. The amount that SPT may ultimately owe Union Pacific will be substantial, but management has made provision that it believes to be adequate for this matter in current liabilities in its financial statements.\n1991 Dunsmuir Derailment. In July 1991, a derailment near Dunsmuir, California resulted in the escape from a tank car of metam sodium (a weed killer) into the Sacramento River. The derailment allegedly resulted in environmental damage, particularly the loss of fish, plants and other organisms in approximately 38 miles of the Sacramento River. Certain individuals and businesses have alleged that they incurred costs or damages for medical expenses, personal injuries, property damage and other losses resulting from the incident.\nOriginally there were approximately 46 lawsuits by private plaintiffs pending against SPT and others in connection with the July 1991 derailment. Most of these cases were consolidated before a single judge in San Francisco Superior Court and certified as class actions. After the certification, approximately 3,350 claimants completed claims forms as members of the class. In June 1993, the class action plaintiffs and SPT entered into an agreement to settle the class action litigation and, on September 17, 1993, the coordinating trial judge issued his final approval of that settlement agreement. Under the terms of the agreement the class action plaintiffs and their counsel will receive a total of $14 million from SPT and the other remaining defendants\n(GATX, Huber, Trinity Chemical and Transmatrix). Thirteen class action plaintiffs have filed timely appeals. Unless settled earlier, the appeals will be determined by the California Court of Appeals for the First District. The only remaining civil cases arising from the derailment involve six personal injury-only cases against SPT of which four have been brought by class members who opted out of the class and are pursuing their individual claims.\nIn addition, the State of California and the United States filed separate suits against SPT and other parties in the United States District Court in Sacramento, California. The State asserted claims for natural resource damages under federal and state environmental statutes and state common law, civil penalties under state statutory law and requests injunctive relief. The federal suit asserted claims for natural resource damages, penalties, recovery of costs, and other relief under federal environmental statutes and for damages pursuant to theories of common law negligence and ultrahazardous activity liability. Several environmental and angling advocacy groups intervened in the federal suit, seeking both injunctive relief and the creation of a fund to cover environmental restoration costs. Prior to the institution of the State and federal cases, SPT instituted litigation in the United States District Court in Los Angeles against the State, the United States and private parties (including the manufacturer of the metam sodium and the manufacturer of the tank car), seeking declaratory relief with respect to issues of potential CERCLA liability and damages and other relief against certain potentially responsible private parties involved in the incident. By judicial directive and by stipulation of the parties, all claims between and among the parties were transferred to the United States District Court in Sacramento, California. In late 1993, that court stayed all litigation among the parties to facilitate settlement negotiations. Those negotiations recently culminated in a settlement between the governments and all defendants in the form of two consent decrees that were lodged with the federal court on March 14, 1994. The consent decree provides that the Company will pay $30 million and the other defendants collectively will pay $8 million in settlement of all of the government claims. The settlement, however, is subject to the condition that the intervenors' claims are dismissed with prejudice and the court approves the consent decrees after public comment. The governments and the Company have filed supplemental motions to dismiss the intervenors' claims, which the Company expects will be decided shortly. If the motions to dismiss are granted, and the court approves the consent decrees after public comment, the settlement will be final and the litigation terminated, except for any appeals. The California Public Utilities Commission also instituted an investigation into the causes of the derailment.\nWhile the total amount of damages and related costs cannot be determined at this time, SPT is insured against most types of damages and related costs involved with the Dunsmuir derailment to the extent they exceed $10.0 million. As of December 31, 1993, SPT had paid approximately $44.7 million related to the Dunsmuir derailment, of which $12 million was charged to expense primarily to cover the $10 million deductible. The balance has been or is in the process of being collected from insurance carriers. As of December 31, 1993, approximately $24.9 million had been recovered by SPT from insurers. SPT expects to recover substantially all additional damages and costs under its insurance policies (including amounts payable pursuant to the settlement of private suits described above, as well as amounts payable pursuant to settlement of the federal court action described above, except for $750,000 which constitutes penalties). As a result, disposition of these matters is not expected to have a material adverse effect on the Company's financial condition.\nHouston--Metro. In 1992, SPT received $45 million from the sale of property to the Metropolitan Transit Authority (Metro) in Houston, Texas. SPT believes that the contract of sale in 1992 also requires Metro to acquire an additional $30 million of SPT right-of-way properties. Metro, on the other hand, has indicated that it believes an adjustment or credit should be made with respect to the purchase price for the property it already purchased. Negotiations between SPT and Metro to resolve the matter have been unsuccessful. On March 29, 1994, SPT filed a lawsuit in the U.S. District Court in Houston, Texas seeking damages and\/or specific performance in connection with Metro's decision not to purchase the additional $30 million of SPT right-of-way properties and further seeking a declaratory judgment that SPT is not required to refund any amounts to Metro under the 1992 sales contract. On the same day, Metro filed a lawsuit in the U.S. District Court in Houston, Texas seeking a refund from SPT of $19.7 million under the 1992 sales contract between SPT and Metro.\nGeneral. SPT is involved in certain income tax cases relating to prior periods, but pursuant to an agreement with SPT's former parent as part of the Company's acquisition of SPT, the former parent has assumed the liability for any adjustments to taxes due or reportable on or before October 13, 1988, the date of acquisition. Accordingly, the Consolidated Financial Statements of the Company do not make provision for any taxes and interest of SPT that may have been due or reportable relating to periods ending on or before October 13, 1988.\nAlthough the Company has purchased insurance, the Company has retained certain risks (consisting principally of a substantial deductible per occurrence) with respect to losses for third-party liability and property claims. In addition, various claims, lawsuits and contingent liabilities are pending against the Company. Management has made provisions for these matters which it believes to be adequate. As a result, the ultimate disposition of these matters is not expected to have any material adverse effect on the Company's financial condition.\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll issued and outstanding Common Stock of the Company is owned by SPRC.\nNo dividends were declared or paid in 1993, 1992 or 1991. As of December 31, 1993, there were certain restrictions on the payment of dividends by the Company and net worth covenants. See Notes 6 and 8 to the Consolidated Financial Statements.\nThe advances to SPRC of $684.2 million at December 31, 1993 are not interest bearing. It is anticipated that the Company will make dividend payments or advances in the future to SPRC in order for SPRC to meet its debt service obligation.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in connection with the Consolidated Financial Statements and related Notes.\nRESULTS OF OPERATIONS\nYear Ended December 31, 1993 Compared to Year Ended December 31, 1992\nThe Company had a net loss of $204.8 million for 1993 compared to a net income of $109.5 million for 1992. The 1993 amount includes a $98.9 million after-tax charge for the cumulative effect of a change in accounting for post- retirement benefits other than pensions under Statement of Financial Accounting Standards (\"FAS\") No. 106 adopted by the Company effective January 1, 1993. See \"--Accounting Matters.\" The Company had an operating loss of $53.9 million for 1993 compared to an operating loss of $24.7 million for 1992. Operating results for 1993 were adversely affected by severe weather and flooding in certain western states during the first quarter of the year and in certain midwestern states during the third and fourth quarters of the year. In addition, the Company experienced a significant decline in automotive shipments, a shortage of power due to a temporary reduction in the number of locomotives leased by the Company and a slower than anticipated recovery in certain segments of the economy. The Company addressed the power shortage by continuing to lease additional locomotives on a short-term basis. Management of SPRC estimates that the midwest floods in the second half of 1993, which caused delays, detours and additional repair costs, resulted in additional costs and revenue shortfalls of approximately $60 million to $65 million for 1993, much of which occurred on Company-owned and used rail lines. The foregoing estimate is based on a number of assumptions and the actual amount of additional costs and revenue shortfalls is uncertain. Partially offsetting an increase in operating expenses for 1993 were reduced joint facility rent expense of approximately $10.0 million as a result of the negotiated settlement of a joint facility case, as well as reduced property tax expense of approximately $16.7 million due to revised state property tax assessments and to the favorable settlement of prior years' disputed property taxes in California.\nOperating Revenues. In 1993, railroad operating revenues increased $14.8 million compared to 1992. Railroad freight operating revenues increased $26.6 million primarily due to increased intermodal and coal carloads partially offset by decreased automobile and food and agricultural carloads. Other railroad revenues (primarily passenger, switching and demurrage) decreased $11.8 million compared to 1992. Passenger revenues decreased because the Company discontinued operating commuter service in 1992, following the sale of the Company's peninsula corridor in the San Francisco Bay Area (the \"Peninsula Corridor\"). There was a similar decrease in commuter operating expense. Partially offsetting this decline were increased demurrage and other incidental revenues associated with increased traffic volume. For 1993, carloads increased 3.8 percent and revenue ton-miles increased 6.9 percent compared to 1992. The average freight revenue per ton-mile declined by 5.4 percent compared to 1992 due to continued competitive pressures on\nrates and changes in traffic to lower revenue per ton-mile commodities and routes. In 1993 lower than average revenue per ton-mile coal traffic carloads increased by 39.5 percent, while higher than average revenue per ton-mile automobile traffic carloads decreased by 30.0 percent principally due to a plant closing and the loss of a major contract, contributing to the decline in average freight revenue per ton-mile.\nThe following table compares traffic volume (in carloads), gross freight revenues (before contract allowances and adjustments) and gross freight revenues per carload by commodity group for 1993 compared to 1992.\nCARLOAD AND GROSS FREIGHT REVENUE COMPARISON YEARS ENDED DECEMBER 31, 1993 AND 1992\n. Both segments of the intermodal business, container-on-flatcar (\"COFC\") and trailer-on-flatcar (\"TOFC\"), contributed to the increase in 1993 intermodal volume and revenue over 1992 levels. COFC growth primarily came from increased business with major steamship customers and increases in domestic doublestack business. TOFC volumes grew primarily as a result of increased business with motor carriers.\n. Chemical and petroleum products carloads were down 1.8% in 1993 due to reduced demand by Company-served plastics shippers, a corresponding reduction in plastic feedstocks, reduced carloads of soda ash and crude oil and completion of an environmental waste contract in 1992. Revenue per carload increased due to an increase in long-haul traffic and yield improvement strategies, particularly in plastics.\n. Coal carloads and revenue increased in 1993 due in large part to the United Mine Workers strike affecting eastern mine operations between June and December 1993, which increased demand for coal from Company-served mines. The strike was settled in December 1993. The increased coal carloads and revenues in 1993 were also due to strong summer demand by utilities and continued demand for western coal to be used in utility test burns. The Company expects that settlement of the coal strike, which was a significant factor in the increase in coal carloads and revenues in 1993, will result in reductions or eliminations of coal shipments for certain customers, but the Company cannot predict the effect of such settlement on total coal carloads in the future.\n. Carload volume in forest products increased in 1993 through growth in shipments of paper products, while lumber product carloadings maintained 1992 levels primarily due to weak construction markets. Revenue for forest products grew at a slower rate than carloads due to a reduction in revenue per carload which was brought about by changes in product and market mix.\n. Automobile traffic declined in 1993 as compared to 1992 because of the closing of a General Motors plant in California and the loss of a contract for transportation of finished automobiles.\nOperating Expenses. Railroad operating expenses for 1993 increased $41.6 million, or 1.7 percent, compared to 1992. Management of SPRC estimates that approximately $50 million to $55 million of increased operating expenses were associated with the severe flooding that occurred in the midwest during the third and fourth quarters of 1993, much of which occurred on Company-owned and used rail lines.\nThe foregoing estimate is based on a number of assumptions and the actual amount of additional operating expenses is uncertain. Equipment rental costs and fuel costs also increased in 1993, while labor and fringe benefits costs and materials and supplies costs decreased in 1993 compared to 1992 as discussed below.\nThe following table sets forth a comparison of the Company's operating expenses for 1993 and 1992.\nRAILROAD OPERATING EXPENSE COMPARISON YEARS ENDED DECEMBER 31, 1993 AND 1992\n. Labor and fringe benefit expenses decreased $24.7 million, or 2.4 percent, for 1993 compared to 1992. At December 31, 1993 Company employment had substantially declined compared to December 31, 1992, primarily due to a decline in roadway maintenance employees during the last four months of 1993 resulting in reduced labor costs for day-to-day repair and maintenance activities, as well as to a decline in transportation employees in December 1993 resulting from the November 1993 ratification of a UTU agreement. During 1993, train crew starts declined by 2.1 percent compared to 1992, even though adversely impacted by the midwest floods in the third and fourth quarters of 1993, contributing to the overall decline in labor costs. In addition, included in the expense reduction above is reduced payroll tax expense due to reduced employment and the elimination in 1993 of the railroad unemployment insurance repayment tax.\n. Fuel expense increased $14.8 million, or 7.5 percent, due primarily to increased fuel consumption associated with increased traffic volume, partially offset by a 2.1 percent decline in the average cost per gallon of fuel from $.61 in 1992 to $.59 in 1993.\n. Materials and supplies expenses decreased $27.9 million, or 14.7 percent, for 1993 compared to 1992 due primarily to reduced running repairs on locomotives, reduced roadway repair and maintenance activity, the use of recycled and reconditioned second-hand materials, as well as to reduced purchases of material during the first quarter of 1993 in response to reduced revenues in that quarter compared to 1992. There was also a $5.0 million non-recurring inventory adjustment during 1993. During the year, the Company rebuilt or performed heavy repairs on 203 locomotives compared to heavy repairs on 141 locomotives in 1992. Costs associated with the rebuilding of 60 locomotives in 1993 were capitalized.\n. Equipment rental costs increased $42.3 million, or 14.9 percent, due to a combination of the effects of the midwest floods causing increased equipment cycle time and increased short-term locomotive lease costs associated with increased traffic volume and a shortage of locomotives in certain areas. Included in the increase is a $19.1 million increase in net car hire, and a $13.4 million increase in locomotive lease costs over 1992.\n. Depreciation and amortization expense increased $1.0 million, or 0.4 percent, due primarily to an increased depreciable property base in 1993.\n. Other expenses increased $36.1 million, or 6.4 percent, for 1993 compared to 1992. This category of expense includes purchased repairs and services, joint facility rent and maintenance costs, casualty\ncosts and property and other taxes. The 1993 increase is due primarily to detour fees and joint facility maintenance and operations costs associated with the midwest floods which SPRC estimated to be approximately $27 million, much of which occurred on Company-owned and used rail lines. The foregoing estimate is based on a number of assumptions and the actual amount of additional flood-related costs is uncertain. Also showing an increase for 1993 were casualty costs (due in part to the fact that 1992 casualty costs were reduced by insurance recoveries received with respect to claims accrued in 1992 and prior years), environmental cost accruals, data processing equipment rental costs as well as an increase in taxes on fuel beginning in the fourth quarter of 1993. Partially offsetting the expense increases in this category were reduced joint facility rent expense of approximately $10.0 million as a result of the negotiated settlement of a joint facility case earlier in the year, as well as reduced property tax expense of approximately $16.7 million due to revised state property tax assessments and to a favorable settlement of prior years' disputed property taxes in California.\nOther Income and Interest Expense. Other income in total was $8.6 million in 1993 compared to $292.1 million in 1992, a decrease of $283.5 million. Gains on sales of property and real estate decreased $276.8 million to a total of $24.5 million in 1993. Rental income increased $3.7 million due in part to non- recurring rental income associated with a fiber optic conduit easement with Southern Pacific Telecommunications Company (\"SP Telecom\"). Interest income remained relatively stable with a decrease of $0.6 million during 1993. The remaining portion of other income was an expense of $41.1 million in 1993 compared to an expense of $31.3 million in 1992, an increased expense of $9.8 million. This increase is due in part to the write-off of $12.3 million of deferred loan costs and to increased expenses of $10.6 million in 1993 associated with the sale of accounts receivable which were partially offset by reduced expenses associated with properties held for sale. In addition, in November 1993, the Company received $27.1 million in cash from SP Telecom in full redemption of the SP Telecom preferred stock owned by the Company plus accrued dividends on the preferred stock, resulting in other income of $14.9 million. Interest expense was $101.5 million in 1993 compared to $89.2 million in 1992, an increase of $12.3 million due primarily to a higher level of outstanding debt during 1993.\nENERGY TAX\nOn August 10, 1993, the President signed into law legislation which imposes a tax on certain fuels. The tax is expected to increase the Company's fuel costs for 1994 by approximately $10 million to $15 million. However, certain of the Company's freight contracts have escalation clauses that would help to offset such increased fuel costs. The Company also posted certain rate increases effective October 1, 1993 that represent a surcharge intended to mitigate the impact of the fuel tax.\nINFLATION\nIn prior years, the Company has experienced increased costs due to the effect of inflation on the cost of compensation and benefits, and in the replacement of or additions to property and equipment. A portion of the increased labor costs directly affects expenses through increased operating costs. Fuel costs have fluctuated with market conditions and have directly affected operating results. Operating efficiencies have, however, partially offset this impact. Competition and other market factors have adversely affected the Company's ability to price services to fully recover cost increases. Certain of the wage agreements obtained in 1991, 1992 and 1993 have reduced the effects of inflation on future operating costs until they expire and become subject to renegotiation in 1995 (1998 with respect to the agreement covering the Western Lines).\nACCOUNTING MATTERS\nIn 1991, the Company recorded the 1991 Special Charge of $270.0 million. The 1991 Special Charge provided for employee separation and relocation related primarily to labor agreements reached in 1991, sale, lease or abandonment of low density lines, restoration and clean-up costs and certain legal matters. See Note 2 to the Consolidated Financial Statements included elsewhere herein.\nThe Company adopted FAS 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1993, thus incurring an after-tax charge of $98.9 million for the cumulative effect of change in accounting principle relating to the Company's retiree welfare plan. The Company has amended its retiree benefit policies and estimates that its liability for such retiree benefits at January 1, 1993 was approximately $160.1 million before tax, after reflecting these policy amendments. See Note 10 to the Company's Consolidated Financial Statements included elsewhere herein.\nIn February 1992, FAS 109 \"Accounting for Income Taxes\" was issued. Through December 31, 1992, the Company accounted for income taxes under the asset and liability method prescribed by FAS 96, \"Accounting for Income Taxes\". Management adopted FAS 109 prospectively in the first quarter of 1993. The impact of adoption of FAS 109 did not have a material effect on the Company's Consolidated Financial Statements.\nUnder both FAS 96 and FAS 109, deferred tax liabilities and assets are recorded based on the enacted income tax rates which are expected to be in effect in the periods in which the deferred tax liability or asset is expected to be settled or realized. A change in the tax laws or rates results in adjustments to the deferred tax liabilities and assets. The effect of such adjustments shall be included in income in the period in which the tax laws or rates are changed.\nIn November 1992, FAS 112 \"Employers' Accounting for Postemployment Benefits\" was issued. FAS 112 requires employers to recognize the obligation to provide benefits to former or inactive employees after employment but before retirement, if certain conditions are met. The initial effect of applying FAS 112 is to be reported as the effect of a change in accounting method and previously issued financial statements are not to be restated. The Company will adopt FAS 112 and take a pre-tax charge of approximately $6.6 million in the first quarter of 1994 as required by FAS 112. See Note 1 to the Company's Consolidated Financial Statements included elsewhere herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements, including supplementary data, and accompanying report of independent auditors are listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules filed as part of this annual report.\nSSW, a 99.9% owned subsidiary of SPT has not filed an annual report on Form 10-K by reason of its guarantee of the Senior Secured Notes of SPT because:\n(a) summarized financial information concerning SSW as required by Rule 1-02(aa) of Regulation S-X is contained in Note 16 to SPT's Consolidated Financial Statements on pages to; and\n(b) SPT and SSW are jointly and severally liable with respect to the Senior Secured Notes and the aggregate of total assets, net earnings and net equity of SPT and SSW constitute a substantial portion of the total assets, net earnings and net equity of SPT on a consolidated basis.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nA. Documents filed as part of this report:\n1. Financial statements and schedules:\nThe financial statements, financial statement schedules and accompanying report of independent auditors are listed in the Index to Financial Statements and Financial Statement Schedules filed as part of this Annual Report.\n2. Exhibits:\nThe Registrant will furnish to a requesting security holder any Exhibit requested upon payment of the Registrant's reasonable copying charges and expenses in furnishing the Exhibit. - -------- * Management contract or compensatory plan, contract or arrangement required to be filed as an Exhibit pursuant to Item 14(c).\nB. Reports on Form 8-K:\nThe Company did not file any reports on Form 8-K during the three months ended December 31, 1993.\nC. Other Exhibits:\nNo exhibits in addition to those previously filed or listed in Item 14(a)(3) are filed herein.\nD. Other Financial Statement Schedules:\nNo additional financial statement schedules are required.\nSIGNATURES\nPURSUANT 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.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY\n\/s\/ B.C. Kane By: _________________________________ B.C. Kane Controller (Principal Accounting Officer) Date: March 24, 1994\nPURSUANT 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 IN THE CAPACITIES AND ON THE DATES INDICATED.\nDate: March 24, 1994 \/s\/ Edward L. Moyers By: _________________________________ Edward L. Moyers Chairman, President, Chief Executive Officer and Director (Principal Executive Officer)\nDate: March 24, 1994 \/s\/ Robert F. Starzel By: _________________________________ Robert F. Starzel Vice Chairman and Director\nDate: March 24, 1994 \/s\/ Donald C. Orris By: _________________________________ Donald C. Orris Executive Vice President-- Distribution Services and Director\nDate: March 24, 1994 \/s\/ Thomas J. Matthews By: _________________________________ Thomas J. Matthews Vice President--Administration and Director\nDate: March 24, 1994 \/s\/ Glenn P. Michael By: _________________________________ Glenn P. Michael Vice President--Operations and Director\nDate: March 24, 1994 \/s\/ Lawrence C. Yarberry By: _________________________________ Lawrence C. Yarberry Vice President--Finance (Principal Financial Officer)\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted because they are not applicable or because the required information is shown in the financial statements or the notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable.\nFinancial statements and summarized financial information of companies accounted for by the equity method have been omitted because considered in the aggregate, or individually, they would not constitute a significant subsidiary.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Southern Pacific Transportation Company:\nWe have audited the accompanying consolidated balance sheets of Southern Pacific Transportation Company and Subsidiary Companies as of December 31, 1993 and 1992, and the related consolidated statements of operations, stockholder's equity, and cash flows for each of the years in the three year period ended December 31, 1993. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules V, VI, VIII and X as of and for the years ended December 31, 1993, 1992 and 1991. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southern Pacific Transportation Company and Subsidiary Companies as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1993 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, as of and for the years ended December 31, 1993, 1992 and 1991, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1 to the financial statements, effective January 1, 1993 the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nKPMG Peat Marwick\nSan Francisco, California February 17, 1994, except as to the third paragraph of Note 15, which is as of March 2, 1994\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED BALANCE SHEETS\n(Continued)\nSee accompanying notes to consolidated financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nSee accompanying notes to consolidated financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nSee accompanying notes to consolidated financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOwnership, Principles of Consolidation and Basis of Presentation--Southern Pacific Transportation Company (\"SPT\") was a wholly-owned subsidiary of SPTC Holding, Inc. (\"SPTCH\") until August 1993 at which time, SPTCH, a wholly-owned subsidiary of Southern Pacific Rail Corporation (\"SPRC\") (formerly Rio Grande Industries, Inc.) was merged into SPRC; therefore, per share data are not shown in the accompanying consolidated financial statements. As used in this document, the Company refers to SPT together with its subsidiaries. The consolidated financial statements are prepared on the historical cost basis of accounting and include the accounts of SPT and all significant subsidiary companies, including St. Louis Southwestern Railway Company (\"SSW\") and SPCSL Corp. (\"SPCSL\"), on a consolidated basis. SPRC also owns Rio Grande Holding, Inc. (\"RGH\") which owns The Denver and Rio Grande Western Railroad Company (\"D&RGW\"). SPRC management continues to review and consider the placement of various subsidiaries within the corporate structure of SPRC.\nCash and Cash Equivalents--For statement of cash flows purposes, the Company considers commercial paper, municipal securities and certificates of deposit with original maturities when purchased of three months or less to be cash equivalents.\nInvestments--Investments in affiliated companies (those in which the Company has a 20 percent to 50 percent ownership interest) are accounted for by the equity method. Other investments are stated at cost which does not exceed market.\nProperty--Property accounting procedures followed by the Company and its railroad subsidiaries are prescribed by the ICC. In accordance with the Company's definition of unit of property, all costs associated with the installation of rail, ties, ballast and other track improvements are capitalized. Other costs are capitalized to the extent they increase asset values or extend useful lives. Retirements are generally recorded using a system wide first-in first-out basis. The cost of property and equipment (including removal and restoration costs) is depreciated on the straight line composite group method, generally based on estimated service lives. Pursuant to ICC regulation, periodic depreciation studies are required and changes in service life estimates are subject to the review and approval of the ICC. Gains or losses from disposition of depreciable railroad operating property are credited or charged to accumulated depreciation except for significant disposals of equipment. Certain railroad properties that are not essential to transportation operations are being held for sale. Gains or losses resulting from sales of real estate no longer required for railroad operations are recognized as other income in the consolidated statement of operations.\nRevenues--Freight revenues from rail transportation operations are recognized based on the percentage of completed service method. Other railroad revenues and other revenues are recognized as earned.\nRetiree Welfare Benefits--Prior to January 1, 1993, the Company expensed retiree welfare benefits when paid. Effective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and recorded the estimate of its liability under Statement No. 106 of $160.1 million, which net of income taxes resulted in a charge to earnings of $98.9 million (See Note 10). Statement No. 106 requires that all employers sponsoring a retiree welfare plan use a single actuarial cost method as is required for pension plan accounting and that they disclose specific information about their plan in their financial statements.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPostemployment Benefits--In November 1992, Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" was issued. Statement No. 112 requires employers to recognize the obligation to provide benefits to former or inactive employees after employment but before retirement, if certain conditions are met. The initial effect of applying Statement No. 112 is to be reported as the effect of a change in accounting method and previously issued financial statements are not to be restated. The Company will adopt Statement No. 112 and take a pre-tax charge of approximately $6.6 million in the first quarter of 1994.\nIncome Taxes--Prior to January 1, 1993 income taxes were reported using the liability method prescribed by Statement of Financial Accounting Standards No. 96 \"Accounting for Income Taxes.\" Under Statement No. 96, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.\nEffective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The impact of adoption of Statement No. 109 was not material to the Company's consolidated financial statements.\nUnder both Statement No. 96 and Statement No. 109, deferred tax liabilities and assets are recorded based on the statutory income tax rates which are expected to be settled or realized. A change in the tax laws or rates results in adjustments to the deferred tax liabilities and assets. The effect of such adjustments shall be included in income in the period in which the tax laws or rates are changed.\nReclassifications--Certain of the amounts previously reported have been reclassified to conform to the current consolidated financial statement presentation.\n2. SPECIAL CHARGE\nIn the fourth quarter of 1991, the Company recorded a $270 million Special Charge. Approximately $125 million of the Special Charge is related to labor agreements then recently concluded and then in progress which have resulted in crew size reduction and payments to approximately 1,000 employees and relocation costs over the next several years. Approximately $55 million of the Special Charge was credited to accumulated depreciation to reserve for 1,200 miles of low density rail lines identified for sale or abandonment. The remainder of the charge was to provide for restoration and clean up costs on certain properties ($74 million) and for various legal matters ($16 million).\nExpenditures in 1993 and 1992 applied against the reserves were $54.7 million and $72.2 million for employee separation and relocation and $16.2 million and $15.7 million for restoration and cleanup costs, respectively.\n3. SALE OF RECEIVABLES\nBeginning in 1989, the Company began selling certain net recievables (including interline accounts), without recourse, to Rio Grande Receivables, Inc. (\"RGR\"), a subsidiary of SPRC. Also in 1989, RGR began selling the receivables purchased from the Company, with certain limited recourse provisions, to ABS Commercial Paper, Inc. (\"ABS\"), an unaffiliated third party, on a continuing basis for a period of up to five years subject to certain terms and conditions. The Company has agreed to service the receivables sold and is paid a fee for such services. The sale price for the receivables sold is based upon the face amount of the receivables and is reduced by discounts for expected defaults, servicing costs and anticipated collection periods. The Company retains a residual interest in the receivables should actual collections exceed the projected collections upon which the default discounts are calculated.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nABS purchases an undivided interest in the receivables up to an aggregate amount of approximately $300.0 million, net of discounts, at any one time, for a period up to five years subject to certain conditions. ABS finances its purchases by the sale of its commercial paper, secured by the receivables it purchases, up to a maximum aggregate principal amount of $300.0 million at any time outstanding. The ability of ABS to sell commercial paper is supported by certain banks which have agreed to provide liquidity to ABS on an as-needed basis. The liquidity banks must maintain a P-1 rating or there would need to be one or more replacement banks or a reduction in the maximum amount of commercial paper which ABS could issue. During 1991, one bank's rating was reduced and additional bank commitments were obtained from the remaining banks.\nAs of December 31, 1993, 1992 and 1991, the Company had sold $338.3 million, $317.9 million and $369.2 million of net outstanding receivables, respectively, and had notes receivables from RGR for receivables sold of $51.9 million, $42.5 million and $81.5 million, of which $27.8 million were interest bearing at December 31, 1993, 1992 and 1991, and are included in other assets. Included in other income (expense), net is approximately ($37.9) million in 1993, ($27.8) million in 1992, and ($58.0) million in 1991 of discounts and other expenses associated with the sales of accounts receivable. The initial term of the agreements expire on October 31, 1994. The Company has obtained commitments of the banks to extend the facility for a period of one year.\n4. PROPERTY\nThe average depreciation rates for the Company's property and equipment were approximately 3.1 percent for roadway and structures, 4.9 percent for locomotives and 4.2 percent for freight cars for 1993.\nThe Company received cash proceeds from sales and retirements of real estate and property of $28.1 million, $322.9 million and $513.4 million in 1993, 1992 and 1991, respectively. The 1992 amount includes $124.0 million from sales to the Peninsula Corridor Joint Powers Board (\"JPB\"), $45.0 million from sales to Metro Transit of Houston, Texas and $83.0 million from sales to the Los Angeles County Transportation Commission (\"LACTC\"). The 1991 amount includes $321.7 million from sales to the LACTC and $91.9 million from sales to the JPB. The Company incurred and capitalized approximately $12 million in 1993 and $18 million in each of 1992 and 1991 in costs relating to environmental conditions on properties held for sale.\nThe Company has granted the JPB options to purchase additional rights-of-way and land within five years after the closing of the sale of the Peninsula Main Line for approximately $110 million. The Company will retain exclusive freight rights on the sold properties.\n5. OTHER CURRENT LIABILITIES AND OTHER LIABILITIES\nOther current liabilities include the following amounts at December 31, 1993 and 1992:\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIncluded in other non-current liabilities are $312.7 million and $299.6 million for casualty and freight-related claims and $35.3 million and $66.0 million for employee separation and relocation at December 31, 1993 and 1992, respectively, in addition to $140.6 million for post-retirement benefits other than pensions at December 31, 1993.\n6. LONG-TERM DEBT\nLong-term debt is summarized as follows (in millions):\nOn May 12, 1992, SPT completed a refinancing of its $525 million bank loan and other credit facilities and obtained a $450 million credit facility from a group of banks (the \"Bank Credit Facility\"), which consisted of a $325 million four-year amortizing term loan (the \"SPT Term Loan\") and a $125 million four- year non-amortizing revolver (the \"SPT Revolver\"). On August 17, 1993, the Bank Credit Facility was repaid as part of the SPRC common stock and debt transactions and the issuance of 200 shares of common stock by the Company to SPRC.\nSPT closed $290 million of 10 1\/2% Senior Secured Notes on April 6, 1993. The Notes are secured by the rail lines of SSW and are required to be repaid over the three-year period 1997-1999. Proceeds of the financing were used to make a $100 million payment on the SPT Term Loan, a $125 million payment on the SPT Revolver, and for general corporate purposes. The Notes contain certain covenants and restrictions on dividends, loans and affiliate transactions, and provided registration rights to their holders. The registration rights were satisfied by an exchange offer of substantially identical notes completed in November 1993.\nIn August 1993 SPT entered into a $200 million three-year unsecured credit agreement (the \"Credit Agreement\") (replacing the SPT Revolver) and made an initial $125 million drawdown thereunder. The Credit Agreement contains several quarterly financial covenants including, subject to certain exceptions, required minimum tangible net worth; a maximum funded debt to tangible net worth ratio; and a minimum fixed charge coverage ratio. As a result of delays in asset sales and the continuing effects of severe midwestern floods, SPT was required to obtain waivers of compliance with certain financial covenants applicable as of September 30,1993 contained in the Credit Agreement. Further, because of the delays in asset sales and continuing effects of the flooding, SPT entered into amendments to the Credit Agreement with its banking group in December 1993 to modify certain financial covenant tests.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAs part of an on-going program to improve its locomotive fleet, the Company acquired through capital lease 15 new locomotives in 1993 and borrowed a total of $103.8 million in 1991 and 1992 to purchase a total of 55 new and 45 remanufactured locomotives.\nContractual maturities of long-term debt (including capital lease obligations) during each of the five years subsequent to 1993 and thereafter are as follows (in millions):\nManagement estimates the fair value of the Company's debt at December 31, 1993 and 1992 was approximately $1,067 million and $944 million, respectively, based on interest rates for similar issues and financings.\nAt December 31, 1993 the Company is a party to interest rate swap agreements with an aggregate notional amount of $100 million, which is used to hedge its interest rate exposure and is accounted for as an adjustment of interest expense over the life of the debt.\nA significant portion of railroad equipment and certain railroad property is subject to liens securing the mortgage bonds, equipment obligations, or other debt.\n7. INCOME TAXES\nThe following summarizes income tax expense (benefit) for the years indicated:\nDeferred tax expense in 1993 includes $18.7 million related to the change in the Federal tax rate.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nTotal income tax expense (benefit) from continuing operations differed from the amounts computed by applying the statutory federal income tax rate to income before income taxes as a result of the following for the years ended December 31, 1993, 1992 and 1991:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993 and January 1, 1993 are presented below (in millions):\nThe Company has analyzed the sources and expected reversal periods of its deferred tax assets and liabilities. The Company believes that the tax benefits attributable to deductible temporary differences and operating loss carryforwards will be realized by the recognition of future taxable amounts related to taxable temporary differences for which deferred tax liabilities have been recorded. Accordingly, the Company believes a valuation allowance for its deferred tax assets is not necessary.\nThe former parent of the Company has agreed to indemnify SPRC, SPT and its subsidiaries against any federal income tax liability that may be imposed on the Company or its 80%-owned subsidiaries for tax periods ending on or prior to October 13, 1988 (the \"Acquisition Date\"). Years prior to 1984 are closed. SPRC agreed to pay or cause SPT and its subsidiaries to pay to the former parent any refund of federal income taxes attributable to the 80%-owned subsidiaries received by SPRC, SPT or its subsidiaries after the Acquisition Date for any tax period ending on or prior to the Acquisition Date. Further, the former parent will also indemnify SPRC, SPT and its subsidiaries, at least in part, for state, local and other taxes in respect of periods to and including the Acquisition Date, but only to the extent that such taxes are due or reportable for periods prior to the Acquisition Date.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe intercompany tax allocation agreement among the Company and SPRC, which became effective following the closing of the Acquisition, was amended effective January 1, 1992 to provide that the Company will pay to SPRC the lessor of either the amount equal to that which the Company would have paid (or received) had the Company filed a separate consolidated tax return or which SPRC would pay as current taxes.\nAs of December 31, 1993 the Company had approximately $1.3 billion of net operating loss carryforwards (\"NOLs\") which expire in 2003 through 2008. The NOLs are subject to review and potential disallowance, in whole or in part, by the Internal Revenue Service (\"IRS\") upon audit of the federal income tax returns of the Company. SPRC's consolidated federal income tax returns, in which the Company is included, are currently being examined for the period October 14, 1988 through 1990. Management believes adequate provision has been made for any potential adverse result.\n8. REDEEMABLE PREFERENCE SHARES OF A SUBSIDIARY\nSSW, a 99.9 percent owned subsidiary of SPT, originally issued $53.5 million ($48.5 million Series A and $5 million Series B) of SSW's non-voting redeemable preference shares. The current carrying amount on the balance sheets at December 31, 1993 and 1992 reflects the outstanding balances of the redeemable preference shares of $46.0 million and $48.2 million, respectively.\nThe Series A shares are subject to mandatory redemption at face value over a 20-year period commencing in 1991, at which time mandatory dividends shall be declared and paid over the same period. The overall effective interest rate since the date of issue is approximately 2.0%. The Series B shares are subject to mandatory redemption at face value over a 15-year period commencing in 1989. Mandatory dividends shall be declared and paid over a 10-year period commencing in 1994. The overall effective interest rate since the date of issue is approximately 4.9%.\nMandatory redemptions and mandatory dividends of Series A and Series B shares scheduled for payment during each of the five years subsequent to 1993 are as follows (in millions):\nThe Series A and Series B shares restrict certain dividend payments by SSW to its common and preferred shareholders. Under these provisions, at December 31, 1993, $35.5 million of SSW's historical cost basis retained income was not restricted. No estimate of the fair value of the preference shares was made by the Company.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n9. LEASES\nThe Company leases certain freight cars, locomotives, data processing equipment and other property. Future minimum lease payments under noncancellable leases as of December 31, 1993 are summarized as follows:\nRental expense for noncancellable operating leases with terms over one year was $146.7 million, $106.3 million and $138.2 million for the years ended December 31, 1993, 1992 and 1991, respectively. Contingent rentals and sublease rentals were not significant.\nDuring the fourth quarter of 1993, the Company committed to a capital lease financing for 50 new locomotives. The locomotives will be leased for a term of 21 years. The first 17 locomotives were delivered in the fourth quarter, 1993, with the remainder to be delivered in the first half of 1994. In addition, the Company committed to acquire 133 remanufactured locomotives in 1994 to be financed with a capital lease. The total present value of minimum lease payments relating to the 183 locomotives is expected to be approximately $131 million.\nIn 1984, the Company entered into a long-term lease agreement with the Ports of Los Angeles and Long Beach. Under the terms of the lease, the Company is obligated to make certain future minimum lease payments and is subject to additional contingent rentals which are based on the annual volume of container movement at the Intermodal Container Transfer Facility. The minimum lease payments, ranging from approximately $3.0 million to $4.5 million per year for 1994 to 1998 are included in the table above. However, for each 5-year period from 1998 through 2036, the amount of the annual minimum lease payments and contingent rentals will be determined by the Ports based on independent appraisals of the fair rental value of the property, and therefore, no amounts are included in the above table for such years. The 1993 expense was $6.5 million.\nIn late 1990, the Company entered into an agreement to sell up to 9,000 of its freight cars to a company which would recondition the cars and lease them back to the Company or third parties under a full-maintenance lease agreement. As of December 31, 1993, approximately 5,680 freight cars have been sold under the agreement for approximately $43 million in cash and notes receivable. The Company realized a gain of $19.3 million from these sales, which has been deferred and is being amortized over the terms of the leases. Annual rental for the reconditioned freight cars leased back to the Company under operating leases for periods up to 10 years is expected to be approximately $30.9 million in 1994. In 1993, the Company entered into a capital lease covering 1,651 freight cars with a total present value of minimum lease payments of approximately $43 million.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn 1992, the Company commenced a sale\/leaseback transaction consisting of 100 locomotives which were sold to a rebuilder for their net book value of approximately $10.2 million, and were leased back (when rebuilt) under an operating lease agreement over a term of nine years.\nThe Company leases operating rights on track owned by other railroads and shares costs of transportation facilities and operations with other railroads. These include rights on Union Pacific lines between Kansas City and St. Louis and on Burlington Northern Railroad Company lines between Kansas City and Chicago. The Company has the right to terminate its usage with certain notice periods. Net rent expense for trackage rights was a benefit of $2.2 million in 1993, $8.7 million in 1992, and $15.0 million in 1991. The 1993 amount includes the benefit of the negotiated settlement of a joint facility case of approximately $10 million.\nThe Company pays for the use of transportation equipment owned by others and receives income from others for the use of its equipment. It also shares the cost of other transportation facilities with other railroads. Rental expense and income from equipment and the operation of joint facilities are included in operating expenses on a net basis. Total net equipment lease, rent and car hire expense was $326 million, $283 million and $255 million for 1993, 1992 and 1991, respectively.\n10. EMPLOYEE BENEFIT AND COMPENSATION PLANS\nPension Plan. The Company is a participating employer under the SPRC Pension Plan (the \"SPRC Pension Plan\"). The SPRC Pension Plan is a defined benefit noncontributory pension plan covering employees not covered by a collective bargaining agreement. The SPRC Pension Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974 (\"ERISA\"). Pension benefits for normal retirement are calculated under a formula which utilizes average compensation, years of benefit service, and Railroad Retirement and Social Security pay levels. The Company's funding policy is to contribute each year an amount not less than the minimum required contribution under ERISA nor greater than the maximum tax deductible contribution. The assets of the SPRC Pension Plan consist of a variety of investments including U.S. Government and agency securities, corporate stocks and bonds and money market funds.\nThe following summarizes the components of SPRC's net periodic pension cost under the provisions of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (in millions):\nThe Company's pension expenses related to its participation in the SPRC Pension Plan were $6.1 million in 1993, $6.2 million in 1992 and $7.3 million in 1991.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following summarizes the funded status and amounts recognized in SPRC's consolidated balance sheets for the SPRC Pension Plan at December 31, 1993 and 1992 (in millions):\nAt December 31, 1993 and 1992, the Company's consolidated balance sheets included pension liabilities of $35.9 million and $29.9 million, respectively.\nThe following summarizes the significant assumptions used in accounting for the SPRC Pension Plan:\nThrift Plan. SPRC has established a defined contribution plan (the \"SPRC Thrift Plan\") as an individual account savings and investment plan for employees of SPRC who are not subject to a collective bargaining agreement. Eligible participants may contribute a percentage of their compensation and the Company also contributes using a formula based on participant contributions.\nPostretirement Benefits Other Than Pensions. The Company sponsors several plans which provide health care and life insurance benefits to retirees who have met age and service requirements. The contribution rates that are paid by retirees are adjusted annually to offset increases in health care costs, if any, and fix the amounts payable by the Company. The life insurance plans provide life insurance benefits for certain retirees. The amount of life insurance is dependent upon length of service, employment dates, and several other factors, and increases in coverage beyond certain minimum levels are borne by the employee. Prior to January 1, 1993, the Company's policy was to expense and fund the cost of all retiree welfare benefits only as the benefits were payable. The Company charged to expense $21.8 million and $18.9 million in 1992 and 1991, respectively, for these benefits.\nThe Company adopted Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective January 1, 1993. The effect of adopting Statement No. 106 on net income and the net periodic benefit cost (expense) for 1993 was a charge to earnings of $160.1\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) million (less income taxes of $61.2 million) and an increase in expense of $0.8 million, respectively. The Company's policy continues to be to fund the cost of all retiree welfare benefits only as the benefits are payable. Accordingly, there are no plan assets.\nThe following table summarizes the plan's accumulated postretirement benefit obligation at December 31, 1993 (in millions):\nAs of December 31, 1993, the current portion of accrued post-retirement benefit cost was approximately $19.9 million and the long-term portion was approximately $140.4 million.\nThe net periodic post-retirement benefit costs for 1993 includes the following components (in millions):\nFor measurement purposes, the Company has not assumed an annual rate of increase in the per capita cost of covered benefits for future years, since the Company has limited its future contributions to current levels. The weighted average discount rate used in determining the benefit obligation was 7.25 percent.\n1990-1994 Long Term Earnings Growth Incentive Plan and Annual Incentive Compensation Plans. Certain officers of the Company participate in the 1990- 1994 Long Term Earnings Growth Incentive Plan of the Company. The 1992 and 1993 Incentive Compensation Plans covered all exempt employees of the Company. Based on the provisions of these plans, no amounts were charged to expense in 1993, 1992 or 1991.\nExecutive Compensation Plans. SPRC has an employment agreement with its chief executive officer (\"CEO\") which provides for an annual base salary and provides that, if SPRC achieves an operating ratio of 89.5% for 1994, 88.0% for 1995 or 85.0% for 1996, the CEO will receive 200,000 shares, 300,000 shares and 350,000 shares of SPRC Common Stock, respectively, as a stock bonus under SPRC's Equity Incentive Plan. If the required SPRC operating ratio for any year is not achieved, the SPRC Compensation Committee of the Board of Directors may in its discretion award a portion of such shares.\nThe SPRC Compensation Committee has authorized the grant of stock bonuses covering up to 1,375,000 shares of SPRC Common Stock, in the aggregate, to 27 additional key executive employees of the Company in addition to the CEO, contingent upon the attainment of certain pre-established corporate financial and individual performance objectives based on many of the same criteria as the CEO's agreement. A portion of each stock bonus grant is subject to the achievement of such corporate financial and individual performance objectives during each of 1994, 1995, 1996 and 1997.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n11. RELATED PARTIES\nSPRC has maintained separate accountability for the operating activities of its principal railroad subsidiaries as to the sharing of freight revenues and charges for use of railroad equipment and joint facilities. Interline accounts receivable and payable continue to be settled through the traditional clearing process between railroads. The railroads are coordinating and, where considered appropriate, consolidating the marketing, administration, transportation and maintenance operations of the railroads.\nIn 1992 the Company started using D&RGW's new locomotive repair facility in Denver, Colorado for major locomotive repair work. D&RGW charged the Company $33.8 in 1993 and $35.8 million in 1992 for locomotive repairs performed for the Company. In addition, D&RGW charged the Company $2.0 million, $2.4 million and $1.1 million for locomotives leased to the Company in 1993, 1992 and 1991, respectively. At December 31, 1993, the Company owed D&RGW approximately $8.4 million for such items. Commencing in 1990, the Company charges D&RGW for a portion of costs incurred relating to the marketing and administrative functions of the railroads. Such charges amounted to $16.4 million, $14.3 million and $9.5 million in 1993, 1992 and 1991, respectively.\nAs part of the capital and debt transactions completed in August 1993 and March 1994, the Company purchased a total of $226.6 million of D&RGW property, including the Burnham locomotive repair facility in Denver, Colorado (See Note 15).\nThe Company paid $6.8 million, $4.2 million and $4.1 million in 1993, 1992 and 1991, respectively, to SP Environmental Systems, Inc. (\"SPES\"), a wholly owned subsidiary of SPRC, for professional services regarding environmental matters, excluding services provided by third parties billed through SPES.\nThe Company and The Anschutz Corporation (\"TAC\") have engaged in a variety of transactions primarily related to administration and equipment owned and used by the companies for which amounts are billed to and from the Company and functions relating to the purchase of fuel and entering fuel futures contracts on behalf of the Company. Such transactions are based on the usage or services performed. In addition, the Company has entered into an arrangement with TAC whereby TAC administers the Company's mineral interests, including but not limited to oil and gas and hard mineral estates. The Company believes that the terms of these transactions are comparable to those that could be obtained from unaffiliated parties.\n12. COMMITMENTS AND CONTINGENCIES\nIt is anticipated that the Company will pay dividends or make advances to SPRC in order for SPRC to make principal and interest payments relating to the $375 million 9 3\/8% Senior Notes due 2005. In addition, in order for the Company to meet its consolidated debt obligations and to make payments to buy- out surplus employees and make capital expenditures expected to be required, the Company must improve operating results and sell property, real estate and other assets with substantial values that are not necessary to its transportation operations.\nThe various debt agreements of the Company contain restrictions as to payment of dividends to SPRC. The Company is permitted to make advances or dividends to its parent in order for certain specified interest to be paid by its parent.\nOn November 4, 1993 the Company and Integrated Systems Solutions Corporation (\"ISSC\"), a subsidiary of IBM, entered into a ten-year agreement under which ISSC will handle all of the Company's management information services (\"MIS\") functions. These include systems operations, application\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) development and implementation of a disaster recovery plan. Pursuant to the agreement, the Company is obligated to pay annual base charges of between $45 million and $50 million (which covers, among other things, payments for MIS equipment) over a ten year period, subject to adjustments for cost of living increases and variations in the levels of service provided under the agreement.\nInherent in the operations of the transportation and real estate business is the possibility that there may exist environmental conditions as a result of current and past operations which might be in violation of various federal and state laws relating to the protection of the environment. In certain instances, the Company has received notices of asserted violation of such laws and regulations and has taken or plans to take steps to address the problems cited or to contest the allegations of violation. The Company has recorded reserves to provide for environmental costs on certain operating and non-operating properties as a result of past operations. Environmental costs include site remediation and restoration on a site-by-site basis as well as costs for initial site surveys and environmental studies of potentially contaminated sites. The Company has made and will continue to make substantial expenditures relating to environmental conditions on its properties, including properties held for sale. In assessing its potential environmental liabilities, the Company typically causes ongoing examinations of newly identified sites and evaluations of existing clean-up efforts to be performed by environmental engineers. These assessments, which usually consider a combination of factors such as the engineering reports, site visits, area investigations and other steps, are reviewed periodically by counsel. Due to uncertainties as to various issues such as the required level of remediation and the extent of participation in clean-up efforts by others, the Company's total clean-up costs for environmental matters cannot be predicted with certainty. The Company has accrued reserves for environmental matters with respect to operating and non- operating properties not held for sale, as well as certain properties previously sold, based on the costs estimated to be incurred when such estimated amounts (or at least a minimum amount) can be reasonably determined based on information available. During the years ended December 31, 1993, 1992 and 1991, the Company recognized expenses of $10.5 million, $5.0 million and $74.0 million, respectively, related to environmental matters. At December 31, 1993 and 1992, the Company had accrued reserves for environmental contingencies of $58.8 million and $67.8 million, respectively, which includes $13.6 million and $15.8 million, respectively, in current liabilities. These reserves relate to estimated liabilities for operating and non-operating properties not held for sale and certain properties previously sold, and were exclusive of any significant future recoveries from insurance carriers. Based on the Company's assessments described above, other available information and the amounts of the Company's established reserves, management does not believe that disposition of environmental matters known to the Company will have a material adverse effect on the Company's financial position. However, there can be no assurance that material liabilities or costs related to environmental matters will not be incurred in the future.\nA substantial portion of the Company's railroad employees are covered by collective bargaining agreements with national railway labor organizations that are organized along craft lines. These agreements are generally negotiated on a multi-employer basis, with the railroad industry represented by a bargaining committee. The culmination of various Presidential and legislative events in 1992 resulted in the Company negotiating most of its labor agreements separately. Certain of the completed agreements allowed the Company not to make lump sum payments previously accrued and to incur smaller wage increases in the future than other railroads. A substantial number of the labor agreements expire in 1995.\nAs a condition to its approval of the consolidation of Union Pacific, Missouri Pacific Railroad Company (\"MP\") and Western Pacific Railroad Company in 1982, the ICC awarded SSW trackage rights to operate over the MP lines between Kansas City and St. Louis. The ICC's initial decision did not fix the compensation SSW would pay for the trackage rights, which commenced in January 1983. After a series of hearings, the ICC set forth new principles to govern the computation of charges. Union Pacific has asserted a claim for\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) additional amounts due against the Company of approximately $60 million (including interest) as of December 31, 1993 and has filed a collection action in Federal District Court. SPT has contested the amounts claimed for various reasons. Union Pacific has requested the District Court to reconsider and set aside its decision. Whether or not the Company's position is sustained, the amount owed Union Pacific will be substantial. Management has made provision that it believes to be adequate for this matter in current liabilities in its financial statements.\nIn July 1991, a derailment near Dunsmuir, California, occurred. While certain litigation continues and the total amount of damages and related costs cannot be determined at this time, SPT is insured against most types of damages and related costs involved with the Dunsmuir derailment to the extent that they exceed $10 million. As of December 31, 1993, SPT had paid approximately $44.7 million related to the Dunsmuir derailment, of which $12 million was charged to expense primarily to cover the $10 million deductible. The balance has been or is in the process of being collected from insurance carriers. As of December 31, 1993, approximately $24.9 million had been recovered by SPT from insurers. SPT expects to recover substantially all additional damages and costs under its insurance policies. As a result, disposition of these matters is not expected to have a material adverse effect on the Company's financial condition.\nAlthough the Company has purchased insurance, the Company has retained certain risks with respect to losses for third-party liability and property claims. In addition, various claims, lawsuits and contingent liabilities are pending against the Company. Management has made provisions for these matters which it believes to be adequate. As a result, the ultimate disposition of these matters is not expected to have a material adverse effect on the Company's consolidated financial position.\n13. SUPPLEMENTAL CASH FLOW INFORMATION\nSupplemental cash flow information for the years ended December 31, 1993, 1992, and 1991 is as follows (in millions):\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n14. QUARTERLY DATA (UNAUDITED)\n- -------- (a) First quarter 1993 data includes an extraordinary charge of $98.9 million (net of taxes) for the change in accounting for postretirement benefits other than pensions.\n15. CAPITAL AND DEBT TRANSACTIONS\nOn August 17, 1993 SPRC closed the offering and sale of 30,783,750 shares of common stock and issued and sold $375 million principal amount of 9 3\/8 percent Senior Notes due 2005.\nIn connection with the foregoing transactions, the Company issued 200 shares of common stock for total consideration of $445.5 million from SPRC. The proceeds from this transaction were used to repay $169 million outstanding under the SPT Term Loan, to purchase $107.7 million of D&RGW property including principally the Burnham locomotive repair facility and certain non-operating properties, to purchase for $99.1 million equipment operated pursuant to operating leases, to pay fees and expenses of $3.8 million and for general corporate purposes. In addition, as part of the foregoing transactions, the Company entered into a $200 million three-year unsecured Credit Agreement replacing its then existing secured bank credit facility.\nOn March 2, 1994, SPRC closed an offering of 25,000,000 shares of common stock. In connection with this transaction, the Company issued 150 shares of common stock for consideration of $294.5 million from SPRC. The proceeds were used to repay the $175 million then outstanding balance on the Credit Agreement and to purchase $118.9 million of D&RGW rail properties. The proceeds of the purchase from D&RGW were used to repay the amounts outstanding under the RGH credit facilities.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n16. SUPPLEMENTAL CONDENSED COMBINING FINANCIAL INFORMATION\nThe following presents supplemental condensed combining financial information (in millions).\nSUPPLEMENTAL CONDENSED COMBINING BALANCE SHEETS--DECEMBER 31, 1993\nSUPPLEMENTAL CONDENSED COMBINING BALANCE SHEETS--DECEMBER 31, 1992\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1993\nSUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1992\nSUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1991\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED) SUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF CASH FLOWS--YEAR ENDED DECEMBER 31, 1993\nSUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF CASH FLOWS--YEAR ENDED DECEMBER 31, 1992\nSUPPLEMENTAL CONDENSED COMBINING STATEMENTS OF CASH FLOWS--YEAR ENDED DECEMBER 31, 1991\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE V. PROPERTY AND EQUIPMENT\n- -------- (a) Equipment acquired under capitalized lease agreement. (b) Locomotives delivered in 1991 and paid for in 1992. (c) Property acquired in connection with the acquisition of SPCSL.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE VI. ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\n- -------- (a) Amount reserved for 1,200 miles of low density rail lines identified for sale or abandonment as part of the 1991 Special Charge.\nSOUTHERN PACIFIC TRANSPORTATION COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE VIII. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nSOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES\nSCHEDULE X. SUPPLEMENTARY INCOME STATEMENT INFORMATION","section_15":""}
{"filename":"82329_1993.txt","cik":"82329","year":"1993","section_1":"Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 3.","section_3":"Item 3. Legal Proceedings\nThe Company is one of the defendants in certain litigation brought in July 1984 by the Cheyenne-Arapaho Tribes of Oklahoma in the U.S. District Court for the Western District of Oklahoma, seeking to set aside two communitization agreements with respect to three leases involving tribal lands in which the Company previously owned interests and to have those leases declared expired. In June 1989, the U.S. District Court entered an interim order in favor of the plaintiffs. On appeal, the U.S. Court of Appeals for the Tenth Circuit upheld the decision of the trial court and petitions for rehearing of that decision were denied. Petitions for writs of certiorari filed by the parties with the U.S. Supreme Court have been denied, and the case has been remanded to the trail court for determination of damages.\nIn November 1988, a lawsuit was filed in the U.S. District Court for the Southern District of West Virginia against Reading & Bates Coal Co., a wholly owned subsidiary of the Company, by SCW Associates, Inc. claiming breach of an alleged agreement to purchase the stock of Belva Coal Company, a wholly owned subsidiary of Reading & Bates Coal Co. with coal properties in West Virginia. When those coal properties were sold in July 1989 as part of the disposition of the Company's coal operations, the purchasing joint venture indemnified Reading & Bates Coal Co. and the Company against any liability Reading & Bates Coal Co. might incur as the result of this litigation. A judgment for the plaintiff of $32,000 entered in February 1991 was satisfied and Reading & Bates Coal Co. was indemnified by the purchasing joint venture. On October 31, 1990, SCW Associates, Inc., the plaintiff in the above-referenced action, filed a separate ancillary action in the Circuit Court, Kanawha County, West Virginia against the Company and a wholly owned subsidiary of Reading & Bates Coal Co., Caymen Coal, Inc. (former owner of the Company's West Virginia coal properties), as well as the joint venture, Mr. William B. Sturgill personally (former President of Reading & Bates Coal Co.), three other companies in which the Company believes Mr. Sturgill holds an equity interest, two employees of the joint venture, First National Bank of Chicago and First Capital Corporation. The lawsuit seeks to recover compensatory damages of $50 million and punitive damages of $50 million for alleged tortious interference with the contractual rights of the plaintiff and to impose a constructive trust on the proceeds of the use and\/or sale of the assets of Caymen Coal, Inc. as they existed on October 15, 1988. The Company and its indirect subsidiary intend to defend their interests vigorously. The Company believes the damages alleged by the plaintiff in this action are highly exaggerated. In any event, the Company believes that it has valid defenses and that it will prevail in this litigation.\nOn January 26, 1993, Kerr-McGee Corporation (\"Kerr-McGee\") filed an action against the Company and Reading & Bates Drilling Co., a subsidiary of the Company, in the U.S. District Court, Western District of Louisiana. On March 23, 1993, the complaint was amended to add Mobil Oil Exploration & Producing Southeast, Inc. as an additional party plaintiff in this action. In this action the plaintiffs are seeking to recover an unspecified amount for damages to a two well platform and related production equipment, facilities and pipelines, in South Timbalier Island Block 34, allegedly caused by the Company's semisubmersible drilling unit \"JACK BATES\" (ex \"ZANE BARNES\") after that drilling unit had been set adrift in the Gulf of Mexico by Hurricane Andrew in August 1992. The Company also has received notice that Tennessee Gas Pipeline Company has asserted a claim with respect to damage to a gas riser pipe and related equipment also located at Kerr-McGee's platform in South Timbalier Island Block 34. On April 8, 1993, Murphy Exploration & Production Company (\"Murphy\"), a subsidiary of Murphy Oil Corporation, filed a similar claim in the U. S. District Court, Eastern District of Louisiana, with respect to its 12 well platform located in South Timbalier Island Block 86. The Court has granted the Company's motion to transfer and has entered an order transferring this case to the U. S. District Court, Western District of Louisiana. The Murphy action has now been consolidated with the Kerr-McGee action. The Company and its subsidiary believe they have valid defenses with respect to the claims asserted and intend to defend their interests vigorously. In December 1992, the Company provided a $10 million letter of undertaking from the Company's protection and indemnity association and a $34 million bond (secured to the extent of approximately $32.3 million by indemnities from the Company's excess liability underwriters and approximately $1.7 million by a standby letter of credit issued for account of the Company) to Kerr-McGee and Murphy to secure their claims and avoid the attachment of the \"JACK BATES\" prior to its departure from the United States for a drilling contract with Agip S.p.A. The Company is not aware of any other claims that may arise against it as a result of Hurricane Andrew. The Company believes it has adequate liability insurance to protect the Company and its subsidiary from any material liability that might result from these claims.\nOn April 13, 1993, the All American Marine Slip, acting as managing general agent on behalf of the lead underwriters on the Company's primary loss of hire insurance policy, denied the Company's loss of hire claim with respect to the damages to the \"JACK BATES\" caused by Hurricane Andrew amounting to approximately $9.1 million, demanded arbitration under the policy with respect to the policy coverage dispute and filed an action in the U. S. District Court, Southern District of New York (the \"New York action\"), seeking a declaratory judgment and order compelling the Company to arbitrate the dispute. On April 16, 1993, the Company filed an action in the U. S. District Court, Southern District of Texas (the \"Texas action\"), seeking compensatory and punitive damages for bad faith and unfair dealing by the All American Marine Slip under the Texas Insurance Code and Texas Deceptive Practices Act. On April 23, 1993, the All American Marine Slip amended its complaint in the New York Action to seek damages for alleged tortious interference with contract and abuse of process by the Company's having filed the Texas action. On July 7, 1993, the Company and the All American Marine Slip agreed to submit all claims in the New York action and the Texas action to arbitration in New York, preserving all rights of both parties (other than the right to a jury trial). As a result the New York action and the Texas action (the latter having been transferred to New York pursuant to court order) have been placed on the suspense docket pending arbitration. On August 6, 1993, the Company agreed with certain underwriters at Lloyds and ILU companies, representing 57.5% of the insurers on the Company's primary loss of hire insurance policy, to settle their respective shares of the Company's loss of hire claim in exchange for payment to the Company of an aggregate of approximately $3.4 million. The effect of that settlement leaves the All American Marine Slip representing lead underwriters with respect to the remaining 42.5% of the Company's loss of hire claim subject to arbitration. On December 6, 1993, the arbitration panel entered an interim award that the Company had proved a valid claim under its loss of hire policy and on December 30, 1993 entered a final award holding that the amount of the Company's claim under the policy was $7,296,000 and that the amount owed by the remaining 42.5% of insurers was $3,100,800, plus interest at the rate of 6.5% per annum from August 1, 1993 until paid. In its final award the arbitration panel also held there was no bad faith on the part of the insurers and that each party bear its own legal costs. The court in the New York action has entered an order confirming the award and is expected to enter a judgment shortly.\nThe Company is involved in these and various other legal actions arising in the normal course of business. After taking into consideration the evaluation of such actions by counsel for the Company, management is of the opinion that outcome of known claims and litigation will not have a material adverse effect on the Company's business or consolidated financial position or results of operations. See Note F of Notes to Consolidated Financial Statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted to a vote of security holders of the Company during the fourth quarter of fiscal year 1993.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Company's Common Stock is traded on the New York and Pacific Stock Exchanges under the symbol \"RB\". The following table shows for the periods indicated the high and low sales prices of the Common Stock as reported on the New York Stock Exchange Composite Transactions Tape.\nThere were approximately 7,812 holders of record of the Company's Common Stock as of February 28, 1994.\nThe Company's Non-voting Convertible Class B Common Stock (the \"Class B Stock\") was issued to the Company's bank debt holders and lease lenders in conjunction with the restructuring in 1989 (the \"1989 Restructuring\") and to The Dow Chemical Company in the settlement relating to Scotdril Offshore Company. As a result of the 1991 Recapitalization, all of the Company's outstanding Class B Stock was converted into Common Stock, leaving none of the remaining 41.1 million authorized shares issued or outstanding at December 31, 1993 and 1992.\nThe Company has not paid dividends on the Common Stock since the first quarter of 1986 and management does not expect any dividends will be declared or paid in the foreseeable future. The Company's credit facility agreement with ING Bank prohibits the Company from declaring or paying dividends on the Common Stock in any one year in excess of 50% of its cumulative net income subsequent to March 29, 1991, the date of the first drawdown under such financing.\nItem 6.","section_6":"Item 6. Selected Financial Data\nREADING & BATES CORPORATION AND SUBSIDIARIES\n(in thousands except per share amounts)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFINANCIAL CONDITION\n1989 Restructuring and 1991 Recapitalization\nSince September 1989, the Company has completed a series of transactions restructuring and substantially reducing its long-term debt and lease obligations, disposing of business lines unrelated to offshore contract drilling and rebuilding its equity capital. In September 1989, the Company effected a financial and business restructuring (the \"1989 Restructuring\"), which involved (i) the conversion of approximately $462.6 million of the Company's existing bank and lease obligations into the Company's Class B Stock, (ii) the restructuring of approximately $363 million face amount of remaining bank and lease obligations, (iii) the dispositions of the Company's non-drilling petroleum and coal operations, with the proceeds used to repay additional bank and lease obligations, (iv) the reclassification into Common Stock of all of the Company's outstanding preferred stock and (v) an exchange offer which reduced the Company's existing obligations in respect of certain outstanding subordinated debentures by approximately $32.4 million.\nIn March 1991, the Company effected a further recapitalization (the \"1991 Recapitalization\"), which involved (i) the issuance of approximately 39.6 million shares of Common Stock and the incurrence of approximately $76.2 million in new or restructured bank and lease obligations to replace approximately $364.6 million in existing bank and lease obligations remaining after the 1989 Restructuring, (ii) the conversion into Common Stock of all outstanding Class B Stock and (iii) the settlement of the Company's remaining obligations under its Supplemental Executive Retirement Plan for cash and shares of Common Stock (the \"SERP Settlement\"). See Notes B and C of Notes to Consolidated Financial Statements.\nPostretirement Benefits\nEffective January 1, 1991, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The statement requires employers to recognize the cost of providing postretirement benefits to employees over the employees' service periods. The Company elected to expense the entire \"Accumulated Projected Benefit Obligation\" at January 1, 1991, of $18,860,000, or $.50 per share as shown separately in the Consolidated Statement of Operations under \"Cumulative effect of change in accounting principle\". The Company's policy had been to expense retiree benefit costs as they were paid. Effective April 1, 1992, the Company modified its postretirement benefits. The effect of these modifications significantly reduced the Company's postretirement benefit costs and accumulated benefit obligation, and resulted in a $6.8 million curtailment gain recognized in the Company's results of operations (included in Other, net) for the year ended December 31, 1992. Postretirement benefit cost for the years ended December 31, 1993, 1992 and 1991 was $658,000, $567,000 and $22,126,000, respectively. See Note K of Notes to Consolidated Financial Statements.\nIran Settlement\nIn June 1991, the Company received $3.7 million for the settlement of a claim filed by a subsidiary of the Company against the National Iranian Oil Company pertaining to seven land rigs which were located in Iran. The settlement has been accounted for as an extraordinary gain in the Consolidated Statement of Operations. See Note A of Notes to Consolidated Financial Statements.\nSale of RCC\nIn August 1991, the Company sold all of the stock of its wholly owned subsidiary Resources Conservation Company (\"RCC\"), the water treatment segment of its business, for a sales price of $9.7 million. As a result of the sale, the Company recorded a gain of $3.2 million which is included in discontinued operations. The net assets and results of operations of RCC have been reclassified in the consolidated financial statements as discontinued operations. The divestment of RCC allows the Company to concentrate on its core business, offshore drilling. See Note I of Notes to Consolidated Financial Statements.\nPrivate Placement\nIn September 1991, the Company effected a private placement (the \"1991 Placement\") of approximately 1.7 million shares of Common Stock Subject to Redemption and approximately 6,857 shares of a new class of preferred stock (the \"Redeemable Preferred Stock\") pursuant to which the Company raised proceeds of approximately $27.1 million in cash. The proceeds were utilized to fund a portion of the Arcade Acquisition. The 1991 Placement was effected at a price of $8.75 per share of Common Stock Subject to Redemption and $1,750 per share of Redeemable Preferred Stock. In June 1992, each share of the Redeemable Preferred Stock was converted into Common Stock in accordance with its terms.\nPursuant to the Subscription Agreements entered into in connection with the 1991 Placement, as amended (the \"Subscription Agreements\"), the Company agreed to use its best efforts to register for resale the shares so issued and guaranteed in effect that any selling holder of such shares would receive a specified minimum net share price upon resale, if any, during the 90-day period following the effectiveness of such registration. In October 1992, without registering the 1991 Placement shares for resale, the Company entered into agreements with the holders of such shares that superseded the provisions of the Subscription Agreements, under which the Company would repurchase all such shares at $11.05 per share. All of the shares issued in the 1991 Placement were repurchased using approximately $34.3 million of the proceeds of the Company's October 1992 public offering. See Note L of Notes to Consolidated Financial Statements.\nCarnegie\/\"SONNY VOSS\" Financing\nIn 1991, the Company entered into a NOK 150 million ($24.6 million using the then prevailing exchange rate of NOK 5.9579 = US$1.00) margin loan from Carnegie International Limited (\"Carnegie\"). The loan proceeds were utilized to fund a portion of the Arcade Acquisition. The loan, as extended, was repaid when due on March 31, 1992 with substantially all of the proceeds realized from the sale\/leaseback of one of the Company's jack-up drilling units, the \"SONNY VOSS\". As part of this transaction the Company received approximately $27.7 million in cash and agreed to lease the drilling unit for 42 months. The leaseback is accounted for as an operating lease and a deferred gain of $6.3 million was recorded and is being amortized over the life of the lease.\nIncome Tax Refund\nIn August 1992, the Company received cash of $14.2 million and recognized interest income of $10.6 million and income tax benefits of $1.9 million, net of $1.7 million of income tax benefits that had been previously recognized. The Company's consolidated federal tax returns for the tax years from September 30, 1974 to December 31, 1981 were then examined by the Internal Revenue Service (the \"IRS\").\nThe Joint Committee on Taxation approved a settlement agreement between the Company and the IRS for those years which provided the Company with such tax refund. See Note J of Notes to Consolidated Financial Statements.\nReverse Stock Split\nOn October 2, 1992, the Company effected a one-for-five reverse stock split of the Common Stock. On the Consolidated Balance Sheet, \"Common Stock\" was reduced and \"Capital in excess of par value\" was increased to reflect this change. All share and per share amounts have been restated. See Note M of Notes to Consolidated Financial Statements.\nPublic Offerings\nIn October 1992, the Company completed a public offering (the \"1992 Offering\") of 8 million shares of its Common Stock (including shares issued pursuant to an underwriter's over-allotment) pursuant to which the Company raised gross proceeds of approximately $40 million in cash (net proceeds of approximately $38.1 million). The proceeds were utilized to repurchase 272,123 shares of Common Stock issued in the SERP Settlement and 3,102,857 shares of Common Stock issued in the 1991 Placement and accounted for as Common Stock Subject to Redemption in the Company's financial statements and for general corporate purposes. See Note M of Notes to Consolidated Financial Statements.\nIn July 1993, the Company effected a public offering (the \"1993 Offering\") of 2,990,000 shares of $1.625 Convertible Preferred Stock, par value $1.00 per share (the \"Preferred Stock\"), pursuant to which the Company raised gross proceeds of approximately $74.7 million in cash (net proceeds of approximately $71.2 million). A portion of the proceeds was utilized to repay indebtedness under Facilities C and F of the ING Facility, approximately $5.5 million and $11.6 million, respectively. The remaining proceeds will be used by the Company for working capital and general corporate purposes. The Preferred Stock is convertible at the option of the holder at any time into shares of the Company's Common Stock at a conversion rate of 2.899 shares of Common Stock for each share of Preferred Stock (equivalent to a conversion price of $8.625 per share of Common Stock), subject to adjustment in certain events. Annual dividends are $1.625 per share and are cumulative and are payable quarterly commencing September 30, 1993. The Preferred Stock is redeemable at any time on and after September 30, 1996, a option of the Company, in whole or in part, at a redemption price of $26.1375 per share, and thereafter at prices decreasing ratably annually to $25.00 per share on and after September 30, 2003, plus accrued and unpaid dividends. The holders of the Preferred Stock do not have any voting rights, except as required by applicable law, and except that, among other things, whenever accrued and unpaid dividends on the Preferred Stock are equal to or exceed the equivalent of six quarterly dividends payable on the Preferred Stock, the holders of the Preferred Stock will be entitled to elect two directors to the Board until the dividend arrearage has been paid in full. The term of office of all directors so elected will terminate immediately upon such payment. The Preferred Stock has a liquidation preference of $25.00 per share, plus accrued and unpaid dividends. The Company has declared and paid all cumulative dividends accrued on the Preferred Stock through December 31, 1993.\nTender Offer\nConsistent with the Company's strategy to acquire Drilling and Shipping, during the first quarter of 1993, the Company acquired additional shares of Shipping which, together with the shares already owned, exceeded 45% of the total outstanding shares of Shipping, and as a result the Company was obligated under Norwegian securities law to make and the Company made a tender offer for the remaining outstanding shares of Shipping at NOK 1.0 per share. The tender offer expired April 7, 1993 with approximately 20 million shares being tendered. The Company also acquired an additional 6% of Drilling's outstanding shares and an additional 18.8% of Shipping's outstanding shares in the second, third and fourth quarters of 1993. As of December 31, 1993, the Company, directly and indirectly, controlled 67.7% and 82.6% of the outstanding shares of Drilling and Shipping, respectively. The Company had obtained an additional borrowing capacity from ING Bank, Facility F, to finance the tender offer and the additional purchases of Shipping and Drilling shares. Facility F was repaid in July 1993 from a portion of the proceeds of the 1993 Offering, see above. See \"Business Developments\".\nShelf Registration\nIn October 1993, pursuant to a registration rights agreement entered into in connection with the 1991 Recapitalization, the Company effected a shelf registration of 31,533,614 shares of its outstanding Common Stock, par value $.05 per share, held by certain stockholders. Pursuant to such registration rights agreement, the Company is generally obligated to maintain such shelf registration continuously in effect for a period of one year following initial effectiveness (currently, through October 1994). To the Company's knowledge, as of February 28, 1994, a total of 23,834,957 shares were registered for resale at any time pursuant to such shelf registration statement. The Company will not receive any proceeds from any sale of such shares by any selling stockholder.\nMiscellaneous\nOn March 19, 1992, and at the Annual Meeting of Stockholders held on May 20, 1992, the Company's Board of Directors and stockholders, respectively, approved the Company's 1992 Long-Term Incentive Plan (the \"1992 Plan\"). The 1992 Plan provides for grants of stock options, stock appreciation rights, stock awards and cash awards, which may be granted singularly, in combination or in tandem. The 1992 Plan is unfunded insofar as the plan provides for awards of cash, Common Stock or rights thereto. An aggregate of 1,000,000 shares of Common Stock are available for awards granted wholly or partly in Common Stock. The Company has granted restricted stock awards under the 1992 Plan to each of Messrs. Angel, Loyd and Rhein, of 90,000 shares, 120,000 shares and 90,000 shares of Common Stock, respectively. Such shares awarded are restricted as to transfer until vested pursuant to a schedule whereby 1\/24th of the total number of shares is vested per calendar quarter from June 30, 1992 through March 31, 1998 (subject to certain conditions). See Note N of Notes to Consolidated Financial Statements.\nThe Company changed its method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 96, Accounting for Income Taxes (\"SFAS 96\"), effective January 1, 1991. The cumulative effect of the accounting change at January 1, 1991 was not material. In February 1992, Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") was issued and supersedes substantially all existing income tax pronouncements. The Company adopted SFAS 109 effective January 1, 1993. The cumulative effect of the accounting change at January 1, 1993 was not material to the Company's consolidated results of operations or financial position. See Note A of Notes to Consolidated Financial Statements.\nIn October 1993, the Company announced that Mr. J. T. Angel, President and Chief Operating Officer, as well as a member of the Board of Directors, resigned from those positions in order to pursue other business interests. In the fourth quarter of 1993, the Company recorded a charge of approximately $1.1 million against earnings related to a severance agreement with Mr. Angel.\nFor a discussion of certain legal proceedings see Part I, Item 3.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity\nFollowing the 1991 Recapitalization, the Company has met all of its financial obligations through funds from cash provided by operations, drawings under the ING Facility, the proceeds of the 1991 Placement subsequently retired with the proceeds from the 1992 Offering, short-term borrowings repaid with the proceeds of asset sales or sale\/leaseback transactions, proceeds from the 1993 Offering and certain other nonrecurring cash items. Cash provided by operating activities during 1993 amounted to approximately $26.5 million, a decrease of $11.1 million from 1992. Cash provided by operating activities during 1992 amounted to approximately $37.6 million, an increase of $33.2 million from 1991, primarily due to the consolidation of the results of Drilling, receipt of certain nonrecurring cash items and increased utilization of the tender fleet, offset by decreased utilization of the semisubmersible fleet.\nCash used in investing activities during 1993 amounted to approximately $29.4 million compared to cash provided from investing activities in 1992 of approximately $47.1 million and cash used in investing activities in 1991 of approximately $78.8 million. During 1993, the Company used approximately $20.6 million of cash to purchase additional shares of stock in Shipping and Drilling. Since the first quarter of 1992, the Company has consolidated the results of Shipping and Drilling, which resulted in an increase in cash of $47.3 million (which is subject to restrictions on availability as described below under \"Drilling\"). Also, in March 1992, the Company entered into a sale\/leaseback transaction of the \"SONNY VOSS\" drilling unit that provided approximately $27.7 million of cash.\nCash provided by financing activities was approximately $30.1 million during 1993, compared to cash used in financing activities of approximately $32.5 million in 1992. During 1993, the Company received approximately $71.2 million of net proceeds from the 1993 Offering, received approximately $11.6 million from the ING Facility and made principal payments of approximately $50.6 million and paid dividends of $2.1 million on the Preferred Stock. Cash used in financing activities was approximately $32.5 million during 1992, compared to cash provided by financing activities of approximately $59.6 million in 1991. During 1992, the Company made principal payments of approximately $34.8 million, repurchased and retired Common Stock Subject to Redemption (issued in the 1991 Placement) using approximately $35.7 million and received approximately $38.1 million net proceeds from the 1992 Offering. See \"Financial Condition\".\nLiquidity of the Company should be considered in light of the significant fluctuations in demand experienced by drilling contractors as rapid changes in oil and gas producers' expectations and budgets occur. These fluctuations can rapidly impact the Company's liquidity as supply and demand factors directly affect utilization and dayrates, which are the primary determinants of cash flow from the Company's operations. Despite continued weakness in the offshore drilling business, the Company's management currently expects that its cash flow from operations, in combination with cash on hand, will be sufficient to satisfy the Company's 1994 working capital needs, dividends on the Preferred Stock, planned investments, capital expenditures, debt, lease and other obligations. At December 31, 1993, approximately $23.6 million of total consolidated cash and cash equivalents of $80.4 million were restricted from the Company's use outside of Drilling's activities.\nCapital Expenditures and Deferred Charges\nPlanned capital expenditures and deferred charges (including mobilization, demobilization and contract preparation costs not recoverable from the Company's customers or claim proceeds from insurance underwriters) for 1994 are expected to aggregate approximately $15 million principally for upgrades or replacement of equipment either to fulfill obligations under existing contracts or to improve the marketability of certain of the Company's drilling units and for mobilization of the Company's drilling units between drilling sites. Certain projects currently being considered by the Company would require, if they materialize, capital expenditures or other cash requirements not included in the above estimate. In addition to planned capital expenditures referred to above, the Company will also continue to review acquisitions of drilling units from time to time and will also consider further investments in floating production equipment. See \"Item 1. Business - Business Strategy\".\nING Facility and Continuing Leases\nThe ING Facility, as amended, includes a term loan with an original balance of approximately $30 million (\"Facility A\") which provides for payment of principal in eight equal semiannual installments of $3.75 million beginning on June 30, 1993, with interest payments at a varying rate equal to the London Interbank Offered Rate (\"LIBOR\") plus 1.5% (LIBOR was 3.5% as of December 31, 1993). In addition to Facility A, the ING Facility also includes up to $30 million of working capital financing in the form of three credit facilities (\"Facility C\", \"Facility D\" and \"Facility E\"), and pursuant to an amendment (described below), financing for additional purchases of shares of Shipping and Drilling (\"Facility F\"). Facility C is in the form of an overdraft account, available until June 1, 1994, up to a maximum of $15 million ($2.7 million was utilized as of December 31, 1993). Interest on amounts outstanding under Facility C is paid quarterly at the prime rate of Citibank, N.A. (6.00% as of December 31, 1993) plus 1.25%. Facility D is in the form of a $5 million stand-by letter of credit which collateralizes a $15 million note payable relating to the \"HARVEY H. WARD\" drilling unit. Facility E is in the form of stand-by letters of credit aggregating $10 million, which support bid, performance and other bonds needed by the Company in the ordinary course of its business. Facility F consisted of revolving credit and\/or stand-by letters of credit that were to be available to the Company until January 1, 1995, in an amount not to exceed $15.5 million, for the purchase of shares of Shipping and Drilling. In March 1993, the Company received approximately $11.6 million from Facility F and in July 1993 the Company repaid Facility F from proceeds from the 1993 Offering. In August 1993, ING Bank agreed to provide a temporary $10 million letter of credit facility, available until June 30, 1997, to cover import duties for drilling equipment in Indonesia. At December 31, 1993, no amounts had been drawn down by the Company. See Notes B, D and E of Notes to Consolidated Financial Statements.\nIn addition to the credit facilities described above, in June 1991, ING Bank acquired certain interests in two promissory notes issued in connection with the sale and leaseback to the Company of the \"C. E. THORNTON\" and the \"GEORGE H. GALLOWAY\" drilling units (the \"Continuing Leases\"). Those interests entitle ING Bank, effective June 28, 1991, to receive the charter hire payable by the Company under the basic terms of the operating leases covering those drilling units. The present value of the Company's obligations under the Continuing Leases at such date amounted to approximately $45 million. The charter hire payable under the Continuing Leases, which provide for use of the two rigs by the Company through 1995, is measured by a deemed principal amount of $45 million, payable in nine equal semiannual installments of approximately $4.4 million, commencing in June 1993 and a final installment in December 1997 of approximately $5.2 million, bearing interest quarterly at LIBOR plus 1.9375%. See Notes B and F of Notes to Consolidated Financial Statements.\nPursuant to the Company's request and upon payment of fees to ING Bank totalling $1 million by the Company, the ING Facility and the Continuing Leases were amended (a) as of June 30, 1992, to (i) defer the principal installments on Facility A of $3 million each, and the principal elements of the lease payments of approximately $3.7 million each, that would otherwise have been due in June and December of 1992 (such principal installments and principal elements being added, on a pro-rata basis, to the remaining principal installments of Facility A of the ING Facility and principal elements of the Continuing Leases, respectively), and (ii) reduce certain consolidated net worth covenants, and (b) as of February 23, 1993, upon the pledging of additional security, to add Facility F and extend Facility C from June 1, 1993 to June 1, 1994, as described above.\nSubstantially all of the Company's assets that do not serve as collateral for other obligations of the Company collateralize the ING Facility. Also, the Company has pledged to ING Bank all of its shares of Drilling and Shipping to collateralize the Company's obligations to ING Bank under the ING Facility. The terms of the amended ING Facility, among other things (i) require the Company to meet certain financial covenants, (ii) prohibit the encumbrance of the Company's assets, (iii) restrict the declaration or payment of dividends by the Company to not more than 50% of cumulative net income from the date of the first drawdown under the ING Facility, (iv) prohibit the Company from engaging in any merger or consolidation or the sale of all or substantially all of its assets or the acquisition of all or substantially all of the assets of any entity, (v) prohibit the Company from incurring indebtedness (with certain exceptions including unsecured debt subordinated to the ING Facility), (vi) prohibit the Company from creating or acquiring new subsidiaries, (vii) prohibit the Company from prepaying indebtedness other than to ING Bank, (viii) prohibit the sale, transfer or assignment of any of the rigs and (ix) restrict the Company's ability to advance funds to, guarantee obligations of, or under certain circumstances, acquire additional shares of, Shipping or Drilling. It is also an event of default under the ING Facility if there should occur a material adverse change in the financial or business condition of the Company or certain of its subsidiaries. Thus, the Company has very limited means of securing additional working capital through additional borrowings or credit facilities without the consent of ING Bank. At the present time the Company anticipates that it will meet all of such covenants or obtain necessary waivers, with the amendments to the ING Facility and Continuing Leases described above, for 1994. The ability of the Company to meet all of its financial covenants under the ING Facility on an ongoing basis or obtain waivers in the future will be subject to economic conditions then prevailing in the offshore drilling industry and the Company's relative performance.\nDrilling\nAs of December 31, 1993, Drilling had a $61.5 million term loan payable to The Chase Manhattan Bank, N.A. as agent for a syndicate of banks (including itself). The payment terms of this bank obligation currently provide for repayment of principal in 19 semiannual installments which commenced in August 1991. The Company has not guaranteed repayment of such obligation. Drilling has also entered into an interest rate swap agreement, which is combined with the bank credit facility for payment purposes (as set forth below). The principal amount of the loan, when combined with the swap agreement, bears interest at a rate of 10.69% on an amount of principal equal to $42.1 million currently, such amount reducing on a semiannual basis to $30.6 million in 1996, and at LIBOR plus 1.75% on the remaining balance. The loan is collateralized by the drilling units \"HENRY GOODRICH\" and \"SONAT ARCADE FRONTIER\". The loan agreement requires Drilling to meet certain financial conditions, including maintaining current assets of at least twice the level of current liabilities and liquid assets of at least $10 million, maintaining a ratio of operating cash flow (including actual and projected cash flows) to interest charges of at least 1.75 to 1 and maintaining a ratio of total liabilities to tangible net worth of no more than 1 to 1. Additionally, the loan agreement (i) restricts the payment of dividends by Drilling to not more than 50% of net earnings after tax per year, (ii)prohibits Drilling from making loans, granting credit, giving any guarantee or indemnity to or for the benefit of any other person or assuming any liability with respect to any obligation of any other person, (iii) prohibits Drilling from engaging in any merger or consolidation and (iv) prohibits the encumbrance of Drilling's assets or the sale of such assets other than at fair market value, in each case without the prior written consent of the banks party to the loan agreement holding a majority of the outstanding balance. It is also an event of default if there should occur a material adverse change in the financial or business condition of Drilling. Pursuant to a series of waivers, for the period from May 1, 1992 to May 1, 1993, the bank syndicate waived the requirement that Drilling comply with the actual operating cash flow ratio covenant. For the period from January 1, 1992, to April 30, 1993, the bank syndicate waived the requirement that Drilling comply with the projected operating cash flow ratio covenant. In connection with the most recent waiver, Drilling was required to (i) pay a fee to the bank syndicate of approximately $.1 million on April 30, 1993 and (ii) prepay the last two semiannual installments (totalling $8 million), and the interest rate was increased to LIBOR plus 1.875% for the remainder of the loan. Since May 1, 1993, Drilling has not requested any additional waivers. Drilling expects to meet its repayment obligations under the facility through cash flow generated from operations and current working capital. At December 31, 1993, Drilling held $23.6 million in cash and cash equivalents available to satisfy such obligations, but otherwise subject to the restrictions on use of such cash and cash equivalents set out in such loan agreement. The ability of Drilling to meet all of its financial covenants under its obligations on an ongoing basis or obtain waivers thereof in the future will be subject to economic conditions then prevailing in the offshore drilling industry and Drilling's relative performance. See Note D of Notes to Consolidated Financial Statements.\nShipping\nThe near term liquidity of Shipping is directly dependent on the shipping market. In the event that shipping revenues are not sufficient to cover Shipping's working capital requirements, Shipping will have to seek additional working capital financing. The Company has extended working capital loans amounting to approximately $12.3 million as of December 31, 1993 to Shipping, on an intercompany loan basis, in order for Shipping to repay a $4.3 million short- term bank facility in October 1992 and to meet its current obligations. The Company anticipates it may be necessary to extend additional working capital loans and\/or guaranties to Shipping (which would require the consent of ING Bank if the aggregate amount extended exceeds $15 million including the loans referred to above) in order for Shipping to meet its obligations as they become due. As of December 31, 1993, a wholly owned subsidiary of Shipping had a $19.5 million loan payable to Scandinaviska Enskilda Banken, London Branch (70%) and Den norske Bank (30%). The payment terms of this bank obligation provide for repayment of principal in eleven semiannual installments of approximately $.9 million each which commenced in March 1992 and a final installment of approximately $13.3 million due September 1997. The note bears interest at LIBOR plus 1.625% and is collateralized by the vessel \"IRON MASTER\", a guarantee by Shipping and a pledge of the shares of Gade Shipping Corporation, a subsidiary of Shipping and the owner of such vessel. The loan agreement requires that Shipping maintain a minimum tangible net worth of NOK 200 million and that the ratio of total debt to total assets be no more than 60%. The loan agreement also contains a provision that permits the majority banks thereunder to accelerate the maturity of the debt if, in the reasonable opinion of such banks, a material adverse change occurs in the financial condition of Shipping. In May and June 1992, Shipping received correspondence from the majority banks asserting the existence of a material adverse change in the financial condition of Shipping. Shipping responded in June 1992 to the effect that there has been no such material adverse change and supplied additional financial information requested by the banks. No action was taken to accelerate the indebtedness and no further correspondence asserting the existence of a material adverse change has been received. Based on current and reasonably foreseeable circumstances, the Company believes that the likelihood of acceleration based on this provision of the loan agreement is remote. Also at December 31, 1993, Shipping had two capitalized lease obligations to a subsidiary of Unibank totalling approximately $17.6 million relating to the vessels \"ARCADE EAGLE\" and \"ARCADE FALCON\". Under the terms of the captial leases, Shipping must maintain a value-adjusted tangible net worth greater than NOK 300 million and the ratio of debt to such value-adjusted tangible net worth must be less than 1.5 to 1. Payments on the obligations are due quarterly and the effective yield on the obligations is the Unibank Eurodeposit rate (3.1875% at December 31, 1993) plus 1.5%. Aggregate principal payments under the capital leases are $1.8 million for 1994; $2.1 million for 1995; $2.4 million for 1996; $3 million for 1997 and $3.4 million for 1998. As of December 31, 1993, $37.1 million of long-term debt of Shipping (including current portion) is included in the Company's Consolidated Financial Statements as a component of net liabilities of discontinued operations included in other noncurrent liabilities. No assurance can be given that Shipping will be able to meet all of its financial covenants under its obligations on an ongoing basis in the future (or obtain waivers thereof) based on economic conditions then prevailing in the shipping and offshore drilling industries.\nRESULTS OF OPERATIONS\nThe Company reported net income for 1993 of $4.7 million ($.05 earnings per share after preferred stock dividends of $2.1 million) compared to net income of $3.4 million ($.04 loss per share after $5.3 million of accretion in redemption price of redeemable stocks) for 1992. The results for 1993 and 1992 include net losses of $2.7 million and $5.9 million, respectively, from the results of Drilling and Shipping (with its shipping operation being accounted for as a discontinued operation).\nThe Company reported a net loss for 1991 of $30.4 million ($.85 per share after $1.9 million of accretion in redemption price of redeemable stocks), which included an extraordinary gain of $3.7 million ($.10 per share) and a cumulative effect of change in accounting principle of $18.9 million ($.50 per share). In August 1991, the Company sold its water treatment segment, Resources Conservation Company.\nOperating revenues are primarily a function of dayrates and utilization. The $27.1 million increase in 1993 over 1992 is primarily due to the increased utilization of the semisubmersible and jack-up fleets.\nThe $29.9 million increase in 1992 over 1991 is primarily due to the consolidation of Drilling and the increased utilization of the tender fleet, offset by decreased utilization of the semisubmersible fleet. Average dayrates for the Company's drilling units for the years ended December 31, 1993, 1992 and 1991 are shown below by class (in thousands):\nDrilling unit utilization measured in terms of the number of days the units were earning revenues to the total days the units were owned or leased by the Company (the operating method) for the years ended December 31, 1993, 1992 and 1991 is shown below by class:\nThe utilization trends experienced by the Company are generally consistent with those experienced by the industry.\nOperating expenses as a percentage of revenues decreased by 8.8% in 1993 compared to 1992 due to revenues increasing by 17.3% while operating expenses increased by 3.1%, primarily due to improved operating leverage, as described below.\nOperating expenses as a percentage of revenues increased by 7.1% in 1992 compared to 1991 primarily due to the consolidation of Drilling and increased labor costs which were partially offset by a $3.8 million net gain relating to a crane accident on the \"W. D. KENT\" drilling tender.\nOperating expenses do not necessarily fluctuate in proportion to changes in operating revenues due to the continuation of personnel on board and equipment maintenance when the Company's drilling units are stacked. It is only during prolonged stacked periods that the Company is significantly able to reduce labor costs and equipment maintenance expense. Additionally, labor costs fluctuate due to the geographic diversification of the Company's drilling units and the mix of labor between expatriates and nationals as stipulated in the drilling contracts. Labor costs have increased in the last three fiscal years primarily due to higher salary levels, inflation and the decline of the U.S. dollar relative to certain foreign currencies of countries where the Company operates. Equipment maintenance expenses fluctuate depending upon the type of activity the drilling unit is performing and the age and condition of the equipment. Scheduled maintenance of equipment and overhauls are performed on a basis of number of hours operated in accordance with the Company's preventive maintenance program.\nDepreciation and amortization expense decreased $3.2 million in 1993 compared to 1992 despite an increase in fleet utilization. The decrease is primarily due to a change in the estimated useful lives of the fourth generation semisubmersible fleet from an average 16 years to 25 years which resulted in a decrease in depreciation expense of approximately $6.8 million for the year ended December 31, 1993. This change was made to reflect the estimated period during which such assets will remain in service.\nDepreciation and amortization expense increased $10.8 million in 1992 compared to 1991 primarily due to the consolidation of Drilling and the increased utilization of the tender fleet, offset by lower utilization of the semisubmersible fleet.\nGeneral and administrative expenses increased $1.3 million in 1993 compared to 1992 primarily due to $1.1 million of termination benefits that were incurred in 1993.\nGeneral and administrative expenses increased $.6 million in 1992 compared to 1991 primarily due to a $2.6 million increase due to the consolidation of Drilling offset by $3.2 million of termination benefits that were accrued in 1991.\nInterest expense decreased $2.4 million in 1993 compared to 1992 primarily due to the decrease in the average principal debt balance outstanding during each year as a result of the repayment of scheduled principal payments on the Company's long-term obligations. Noncash interest expense attributable to amortization of discount and deferrals associated with the Company's 8% Senior Subordinated Convertible Debentures due 1998 and the 8% Convertible Subordinated Debentures due 1995 of Reading & Bates Energy Corporation N.V., a subsidiary of the Company, for the year ended December 31, 1993 was $3.1 million.\nInterest expense decreased $.8 million in 1992 compared to 1991 primarily as a result of the 1991 Recapitalization. Offsetting this reduction is a $7.5 million increase due to the consolidation of Drilling. Noncash interest expense attributable to amortization of discount and deferrals associated with the Company's 8% Senior Subordinated Convertible Debentures due 1998 and the 8% Convertible Subordinated Debentures due 1995 of Reading & Bates Energy Corporation N.V., a subsidiary of the Company, for the year ended December 31, 1992 was $2.7 million.\nThe increase in interest income for 1992 is primarily due to the receipt of $10.6 million in 1992 of interest on a United States federal income tax refund and a $2.1 million increase due to the consolidation of Drilling.\nThe decrease in equity in earnings from 1991 is due to the inclusion of the Company's equity in earnings of Drilling and Shipping of $1.5 million in 1991. The Company began consolidating Drilling's and Shipping's results of operations as of January 1, 1992.\nFor 1992, other, net included a $6.8 million curtailment gain as a result of the Company modifying its postretirement benefits.\nFor 1991, other, net included $5.4 million of expenses related to the 1991 Recapitalization offset by a net of $.5 million of other income.\nThe reduction in income tax expense for 1992 is primarily due to a $1.9 million United States federal income tax refund received in 1992 and a deferred income tax benefit of $1.2 million recognized as a result of consolidating Drilling.\nIncome tax expense was recognized for the years ended December 31, 1992 and 1991 despite losses from continuing operations before income taxes of $5.3 million and $14.2 million, respectively. These expenses resulted from income tax expense incurred with respect to certain foreign operations.\nThe impact of inflation on the Company's operations for the three years ended December 31, 1993 has not been material.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREADING & BATES CORPORATION AND SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nWe have audited the accompanying consolidated balance sheets of Reading & Bates Corporation (a Delaware corporation) and Subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, cash flows and stockholders' equity (deficit) for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Reading & Bates Corporation and Subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/Arthur Andersen & Co.\nHouston, Texas February 14, 1994\nREADING & BATES CORPORATION AND SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nWe have audited the consolidated statement of operations, cash flows and stockholders' equity (deficit) of Reading & Bates Corporation and Subsidiaries for the year ended December 31, 1991. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Reading & Bates Corporation and Subsidiaries for the year ended December 31, 1991 inconformity with generally accepted accounting principles.\nAs discussed in Note K to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106 in 1991.\n\/s\/Coopers & Lybrand\nHouston, Texas March 25, 1992\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET December 31, 1993 and 1992 (dollars in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET December 31, 1993 and 1992 (dollars in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS (in thousands except per share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)\nFor the Three Years Ended December 31, 1993 (in thousands)\nThe accompanying notes are an interal part of the consolidated financial statement\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(A) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of Reading & Bates Corporation (\"Reading & Bates\") and its subsidiaries, including Arcade Shipping AS (\"Shipping\") and Arcade Drilling AS (\"Drilling\") (collectively, the \"Company\"). All significant intercompany accounts and transactions have been eliminated.\nIn 1992, Reading & Bates acquired control of Shipping and Drilling, former- ly unconsolidated investees. As a result, effective with the first quarter of 1992, Reading & Bates began to consolidate the accounts of the drilling operations of Shipping and Drilling into its consolidated financial statements. At December 31, 1993, Reading & Bates owned approximately 82.6% of the outstanding stock entitled to vote of Shipping and approximately 21.4% of the outstanding stock of Drilling. Shipping owns approximately 46.2% of the outstanding stock of Drilling (see Note G).\nCASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash and cash equivalents. At December 31, 1993, $23.6 million of the cash and cash equivalents balance related to Drilling. Such cash and cash equivalents balance is available to Drilling for all purposes subject to certain debt covenants under a credit facility provided by The Chase Manhattan Bank, N.A. which require the maintenance of a minimum of $10 million in liquid assets and, under certain circumstances, prohibit Drilling from paying dividends or granting loans (including to the Company). Financing activities associated with the 1991 Recapitalization (see Notes B and C) and revolving credit agreements are presented on a net basis in the Consolidated Statement of Cash Flows.\nMATERIALS AND SUPPLIES INVENTORY - Materials and supplies are stated at the lower of average cost or market.\nINVESTMENTS AND ADVANCES - The Company uses the equity method of accounting for earnings (losses) of unconsolidated investees.\nPROPERTY AND EQUIPMENT - Property and equipment are recorded at historical cost as adjusted at August 31, 1989 in the quasi- reorganization. Reading & Bates' drilling units are depreciated under the units-of-production method. Drilling's drilling units are depreciated under the straight-line method. Estimated useful lives for drilling equipment range from three to twenty-five years. Gain (loss) on disposal of properties is credited (charged) to income. Effective January 1, 1993, the Company changed its estimate of the useful lives of its fourth generation semisubmersible fleet from an average of 16 years to 25 years. This change was made to reflect the estimated period during which such assets will remain in service. For the year ended December 31, 1993, the change had the effect of reducing depreciation expense by approximately $6.8 million and increasing net income by approximately $6.8 million or $.12 per share.\nEXCESS COSTS OVER NET ASSETS ACQUIRED - Excess costs over net assets acquired represented the cost of the Shipping and Drilling acquisitions exceeding the values assigned to their net tangible assets and was being amortized on a straight-line basis over 20 years. At December 31, 1992, accumulated amortization was $.5 million. Excess costs over net assets acquired has been eliminated primarily as a result of the Company purchasing shares of Shipping and Drilling at a lower average cost per share than their net book value per share.\nINCOME TAXES - Deferred income taxes are recognized for revenues and expenses reported in different years for financial statement purposes and income tax purposes. In accordance with Statement of Financial Accounting Standards No. 96, Accounting for Income Taxes, the Company changed its method of accounting for income taxes effective January 1, 1991. The cumulative effect of the accounting change at January 1, 1991 was not material. In February 1992, Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") was issued and supersedes substantially all existing income tax pronouncements. The Company adopted SFAS 109 effective January 1, 1993. The cumulative effect of the accounting change at January 1, 1993 was not material to the Company's consolidated results of operations or financial position.\nREVENUE RECOGNITION - Revenues from drilling contracts are recognized as they are earned. Proceeds associated with the early termination of a contract for a drilling unit are recorded as deferred income and recognized as drilling contract revenues over the remaining term of the contract or until such time as the drilling unit begins a new contract. There were no such amounts deferred at December 31, 1993 or 1992.\nCAPITALIZED INTEREST - The Company capitalizes interest applicable to the construction of assets. No interest was capitalized during 1993 or 1992.\nFOREIGN CURRENCY TRANSACTIONS - The Company may enter into forward exchange contracts to hedge various commitments and anticipated transactions. The net gains and losses resulting from these and other foreign currency transactions included in determining income amounted to a net gain of $.1 million in 1993, a net loss of $1.2 million in 1992 and a net loss of $.2 million in 1991.\nEXTRAORDINARY GAIN - In June 1991, the Company received $3.7 million for the settlement of a claim filed by a subsidiary of the Company against the National Iranian Oil Company pertaining to seven land rigs which were located in Iran. The settlement has been accounted for as an extraordinary gain in the Consolidated Statement of Operations.\nEARNINGS (LOSS) PER SHARE - Net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the year. Net income (loss) applicable to common stockholders has been adjusted for dividends on preferred stock and accretion in redemption price of redeemable stocks. The effects of common equivalent shares were antidilutive and, accordingly, no adjustment was made for these common equivalent shares. Common shares and per share amounts for all periods presented have been adjusted to reflect the one-for-five reverse stock split on October 2, 1992. The computation of fully diluted earnings per share is not presented as the results are antidilutive.\nCONCENTRATION OF CREDIT RISK - The Company maintains cash balances with commercial banks throughout the world. The Company also invests in commercial paper of companies with strong credit ratings, in interest-bearing deposits with major banks and in U.S. government backed securities. These investments generally mature within three months and, therefore, bear minimal risk. At December 31, 1993, the Company had investments in commercial paper of one company, certificates of deposit with three banks and an investment in U.S. government backed securities. At December 31, 1992, the Company had investments in certificates of deposit with three banks. The Company has not incurred any material losses related to these investments in either 1993 or 1992.\nThe Company's revenues were generated primarily from its eighteen drilling units. Revenues can be generated from a small number of customers which are primarily major U.S. oil and gas companies or their subsidiaries and foreign government-owned oil and gas companies. The Company performs ongoing credit evaluations of its customers' financial conditions and generally requires no collateral from its customers. The Company's allowance for doubtful accounts was $373,000 and $308,000 at December 31, 1993 and 1992, respectively.\nINDUSTRY CONDITIONS - Results of operations and financial condition of the Company should be considered in light of the significant fluctuations in demand experienced by drilling contractors as rapid changes in oil and gas producers' expectations, budgets and drilling plans occur. These fluctuations can rapidly impact the Company's results of operations and financial condition as supply and demand factors directly affect utilization and dayrates, which are the primary determinants of cash flow from the Company's operations.\nLIQUIDITY - As of December 31, 1993, the Company's total consolidated cash and cash equivalents were $80.4 million. Of this amount, approximately $23.6 million is restricted from the Company's use outside of Drilling. The Company's management currently expects that its cash flow from operations, in combination with cash on hand, will be sufficient to satisfy the Company's 1994 working capital needs, dividends on preferred stock, planned investments, capital expenditures, debt, lease and other obligations.\nNONCASH INVESTING AND FINANCING ACTIVITIES - Noncash activities in 1991 associated with the Company's 1991 Recapitalization and related quasi-reorganization are discussed in Notes B and C.\n(B) RECAPITALIZATION\nThe Company's plan of recapitalization (the \"1991 Recapitalization\") was approved by the stockholders at a special meeting held on March 26, 1991, and the 1991 Recapitalization was closed on March 29, 1991. As a result of the 1991 Recapitalization, approximately 39.6 million shares of Common Stock and approximately $76.2 million in newly issued senior secured obligations were issued to replace the approximately $364.6 million in obligations issued under the Master Restructuring Agreement in the Company's 1989 restructuring that were outstanding on March 28, 1991. A $50 million contingent obligation under the Master Restructuring Agreement was eliminated. The new senior secured obligations consisted of a note for approximately $31.2 million and $45 million in lease obligations. The $31.2 million note was issued to ING Bank under a newly established credit facility (the \"ING Facility\") whereby the proceeds of the new loan were used to pay cash in such amount to certain creditors. The $45 million in collateralized lease rental obligations resulting from amendments to long-term operating leases for two of the Company's offshore drilling units (the \"Continuing Leases\") continue to be classified as operating leases. Certain interests of the lease parties in the Continuing Leases were assigned to ING Bank during the second quarter of 1991. Substantially all of the Company's assets that do not serve as collateral for other obligations of the Company collateralize the Company's obligations resulting from the 1991 Recapitalization.\nThe debt incurred under the ING Facility together with the restructured obligations under the Continuing Leases, totalling $76.2 million, represented all of the Company's long-term obligations as of March 29, 1991, other than $33.7 million in face amount of obligations on the Company's 8% Senior Subordinated Convertible Debentures due 1998 and the Company's 8% Convertible Subordinated Debentures due 1995 and $21.5 million of other long-term obligations.\nAssuming the 1991 Recapitalization had occurred at the beginning of the year, January 1, 1991, the net loss per share for 1991 would have been $.49 per share.\n(C) QUASI-REORGANIZATION\nThe 1991 Recapitalization was accounted for as a quasi-reorganization. In accordance with quasi-reorganization accounting principles, the Company adjusted certain debt obligations and transferred the accumulated deficit to \"Capital in excess of par value\" as of March 31, 1991. Following is a summary of significant adjustments resulting from the 1991 Recapitalization and quasi-reorganization accounting (in thousands):\n(D) LONG-TERM OBLIGATIONS\nLong-term obligations at December 31, 1993 and 1992 consisted of the following (in thousands):\nIn February 1993, the ING Facility with ING Bank was amended and an additional credit facility was created (\"Facility F\") to finance the purchase of additional shares of Shipping and Drilling. Facility F consisted of revolving credit and\/or stand-by letters of credit that were to be available to the Company until January 1, 1995, in an amount not to exceed $15.5 million. In March 1993, the Company received approximately $11.6 million from Facility F and in July 1993 the Company repaid Facility F from proceeds from a preferred stock offering (see Note M). In August 1993, ING Bank agreed to provide a temporary $10 million letter of credit facility, available until June 30, 1997, to cover import duties for drilling equipment in Indonesia. At December 31, 1993, no amounts had been drawn down by the Company.\nAggregate annual maturities of long-term obligations, excluding the unamortized discount on the New and Old Debentures, for the five years ending December 31, 1998 and thereafter are as follows: 1994, $20,234,000; 1995, $36,229,000; 1996, $18,250,000; 1997, $15,015,000; 1998, $31,605,000 and $8,000,000 thereafter.\n(E) SHORT-TERM OBLIGATIONS\nShort-term obligations at December 31, 1993 and 1992 consisted of the following (in thousands):\nThe Company has a $15 million revolving credit facility in the form of an overdraft account maintained with ING Bank (\"Facility C\"). A substantial portion of collections on the Company's receivables is paid into the account and is applied automatically against any outstanding balance. Facility C is used primarily for working capital requirements. Overdraft borrowing is available under Facility C (as amended) through June 1, 1994. Facility C bears interest at prime (6.00% at December 31, 1993) plus 1.25%. The amount of unused revolving credit borrowing available under Facility C at December 31, 1993 was approximately $12.3 million.\n(F) COMMITMENTS AND CONTINGENCIES\nCAPITAL EXPENDITURES - At December 31, 1993, the Company had purchase commitments of $5.3 million for equipment on drilling units.\nOPERATING LEASES - Aggregate future minimum rental payments relating to operating leases for the five years ending December 31, 1998 and thereafter are as follows (in thousands):\nThe Continuing Leases expire December 31, 1995, yet payments continue through December 31, 1997 as a result of the terms negotiated under the 1991 Recapitalization. The amended payment terms of the Continuing Leases provide for repayment of principal in nine equal semiannual installments of $4.4 million which commenced on June 30, 1993, one payment of $5.2 million on December 31, 1997 and quarterly interest payments at LIBOR (3.5% at December 31, 1993) plus 1.9375%.\nDuring 1992, the Company entered into a sale\/leaseback of the \"SONNY VOSS\". Proceeds received of $27.7 million resulted in a gain of $6.3 million which was deferred and is being amortized over the lease term of 42 months.\nTotal rent expense for the years ended December 31, 1993, 1992 and 1991 was as follows (in thousands):\nCertain operating leases contain renewal options and have options to purchase the asset at fair market value at the end of the lease term.\nLITIGATION - The Company is one of the defendants in certain litigation brought in July 1984 by the Cheyenne-Arapaho Tribes of Oklahoma in the U.S. District Court for the Western District of Oklahoma, seeking to set aside two communitization agreements with respect to three leases involving tribal lands in which the Company previously owned interests and to have those leases declared expired. In June 1989, the U.S. District Court entered an interim order in favor of the plaintiffs. On appeal, the U.S. Court of Appeals for the Tenth Circuit upheld the decision of the trial court and petitions for rehearing of that decision were denied. Petitions for writs of certiorari filed by the parties with the U.S. Supreme Court have been denied, and the case has been remanded to the trial court for determination of damages.\nIn November 1988, a lawsuit was filed in the U.S. District Court for the Southern District of West Virginia against Reading & Bates Coal Co., a wholly owned subsidiary of the Company, by SCW Associates, Inc. claiming breach of an alleged agreement to purchase the stock of Belva Coal Company, a wholly owned subsidiary of Reading & Bates Coal Co. with coal properties in West Virginia. When those coal properties were sold in July 1989 as part of the disposition of the Company's coal operations, the purchasing joint venture indemnified Reading & Bates Coal Co. and the Company against any liability Reading & Bates Coal Co. might incur as the result of this litigation. A judgment for the plaintiff of $32,000 entered in February 1991 was satisfied and Reading & Bates Coal Co. was indemnified by the purchasing joint venture. On October 31, 1990, SCW Associates, Inc., the plaintiff in the above-referenced action, filed a separate ancillary action in the Circuit Court, Kanawha County, West Virginia against the Company and a wholly owned subsidiary of Reading & Bates Coal Co., Caymen Coal, Inc. (former owner of the Company's West Virginia coal properties), as well as the joint venture, Mr. William B. Sturgill personally (former President of Reading & Bates Coal Co.), three other companies in which the Company believes Mr. Sturgill holds an equity interest, two employees of the joint venture, First National Bank of Chicago and First Capital Corporation. The lawsuit seeks to recover compensatory damages of $50 million and punitive damages of $50 million for alleged tortious interference with the contractual rights of the plaintiff and to impose a constructive trust on the proceeds of the use and\/or sale of the assets of Caymen Coal, Inc. as they existed on October 15, 1988. The Company and its indirect subsidiary intend to defend their interests vigorously. The Company believes the damages alleged by the plaintiff in this action are highly exaggerated. In any event, the Company believes that it has valid defenses and that it will prevail in this litigation.\nOn January 26, 1993, Kerr-McGee Corporation (\"Kerr-McGee\") filed an action against the Company and Reading & Bates Drilling Co., a subsidiary of the Company, in the U.S. District Court, Western District of Louisiana. On March 23, 1993, the complaint was amended to add Mobil Oil Exploration & Producing Southeast, Inc. as an additional party plaintiff in this action. In this action the plaintiffs are seeking to recover an unspecified amount for damages to a two well platform and related production equipment, facilities and pipelines, in South Timbalier Island Block 34, allegedly caused by the Company's semisubmersible drilling unit \"JACK BATES\" (ex \"ZANE BARNES\") after that drilling unit had been set adrift in the Gulf of Mexico by Hurricane Andrew in August 1992. The Company also has received notice that Tennessee Gas Pipeline Company has asserted a claim with respect to damage to a gas riser pipe and related equipment also located at Kerr-McGee's platform in South Timbalier Island Block 34. On April 8, 1993, Murphy Exploration & Production Company (\"Murphy\"), a subsidiary of Murphy Oil Corporation, filed a similar claim in the U. S. District Court, Eastern District of Louisiana, with respect to its 12 well platform located in South Timbalier Island Block 86. The Court has granted the Company's motion to transfer and has entered an order transferring this case to the U. S. District Court, Western District of Louisiana. The Murphy action has now been consolidated with the Kerr-McGee action. The Company and its subsidiary believe they have valid defenses with respect to the claims asserted and intend to defend their interests vigorously. In December 1992, the Company provided a $10 million letter of undertaking from the Company's protection and indemnity association and a $34 million bond (secured to the extent of approximately $32.3 million by indemnities from the Company's excess liability underwriters and approximately $1.7 million by a standby letter of credit issued for account of the Company) to Kerr-McGee and Murphy to secure their claims and avoid the attachment of the \"JACK BATES\" prior to its departure from the United States for a drilling contract with Agip S.p.A. The Company is not aware of any other claims that may arise against it as a result of Hurricane Andrew. The Company believes it has adequate liability insurance to protect the Company and its subsidiary from any material liability that might result from these claims.\nOn April 13, 1993, the All American Marine Slip, acting as managing general agent on behalf of the lead underwriters on the Company's primary loss of hire insurance policy, denied the Company's loss of hire claim with respect to the damages to the \"JACK BATES\" caused by Hurricane Andrew amounting to approximately $9.1 million, demanded arbitration under the policy with respect to the policy coverage dispute and filed an action in the U.S. District Court, Southern District of New York (the \"New York action\"), seeking a declaratory judgment and order compelling the Company to arbitrate the dispute. On April 16, 1993, the Company filed an action in the U. S. District Court, Southern District of Texas (the \"Texas action\"), seeking compensatory and punitive damages for bad faith and unfair dealing by the All American Marine Slip under the Texas Insurance Code and Texas Deceptive Practices Act. On April 23, 1993, the All American Marine Slip amended its complaint in the New York Action to seek damages for alleged tortious interference with contract and abuse of process by the Company's having filed the Texas action. On July 7, 1993, the Company and the All American Marine Slip agreed to submit all claims in the New York action and the Texas action to arbitration in New York, preserving all rights of both parties (other than the right to a jury trial). As a result the New York action and the Texas action (the latter having been transferred to New York pursuant to court order) have been placed on the suspense docket pending arbitration. On August 6, 1993, the Company agreed with certain underwriters at Lloyds and ILU companies, representing 57.5% of the insurers on the Company's primary loss of hire insurance policy, to settle their respective shares of the Company's loss of hire claim in exchange for payment to the Company of an aggregate of approximately $3.4 million. The effect of that settlement leaves the All American Marine Slip representing lead underwriters with respect to the remaining 42.5% of the Company's loss of hire claim subject to arbitration. On December 6, 1993, the arbitration panel entered an interim award that the Company had proved a valid claim under its loss of hire policy and on December 30, 1993 entered a final award holding that the amount of the Company's claim under the policy was $7,296,000 and that the amount owed by the remaining 42.5% of insurers was $3,100,800, plus interest at the rate of 6.5% per annum from August 1, 1993 until paid. In its final award the arbitration panel also held there was no bad faith on the part of the insurers and that each party bear its own legal costs. The court in the New York action has entered an order confirming the award and is expected to enter a judgment shortly.\nThe Company is involved in these and various other legal actions arising in the normal course of business. After taking into consideration the evaluation of such actions by counsel for the Company, management is of the opinion that the outcome of known claims and litigation will not have a material adverse effect on the Company's business or consolidated financial position or results of operations.\nEMPLOYMENT CONTRACTS - The Company has committed under employment contracts to provide two key executives with severance benefits totalling approximately $3.2 million which vest in September 2003 or earlier if the executive both reduces his ownership of the Company's common stock below a specified level and resigns. The Company amortizes the cost of the severance benefits over the ten year period from September 1993 to September 2003, unless the executive reduces his stock ownership and resigns prior to September 2003 in which case the unamortized severance cost would be expended.\nLETTERS OF CREDIT - The Company has a $15 million letter of credit facility obtained in connection with the 1991 Recapitalization. At December 31, 1993 and 1992, $14.3 million and $11.4 million of the facility, respectively, had been drawn down by the Company. The Company also had an additional $4.9 million and $1.7 million letter of credit outstanding at December 31, 1993 and 1992, respectively.\n(G)INVESTMENT IN ARCADE\nARCADE ACQUISITION - In June 1991, as part of its strategy of emphasizing geographic diversification, \"fourth generation\" semisubmersible drilling technology and consolidation of the offshore drilling industry, the Company began acquiring the stock of Shipping and Drilling (the \"Arcade Acquisition\"). Both Shipping and Drilling are Norwegian companies listed on the Oslo Stock Exchange. Drilling owns the \"HENRY GOODRICH\" and the \"SONAT ARCADE FRONTIER\", two fourth generation semisubmersible drilling units. Shipping has two principal lines of operations, the shipping operations which includes owning and chartering vessels and the drilling operations which principally consist of the ownership of approximately 46.2% of the outstanding stock of Drilling. The Company is pursuing its plan to dispose of Shipping's shipping operations (see Note I). The Arcade Acquisition has been funded through a margin loan from Carnegie International Limited, a private placement of both preferred and common stocks (see Note L), the Company's working capital and a revolving credit facility from ING Bank. The Company has obtained majority representation on the board of directors of both Shipping and Drilling, and Paul B. Loyd, Jr. the Company's Chairman and Chief Executive Officer, has been elected chairman of each board. Beginning with the first quarter of 1992, the Company began to consolidate the accounts of Drilling and Shipping into the consolidated financial statements of the Company. As of December 31, 1993, the Company had acquired approximately 82.6% of the outstanding stock of Shipping and directly acquired approximately 21.4% of the outstanding stock of Drilling, at an accumulated cost of approximately $88.6 million. In January 1994, the Company purchased additional shares of Drilling increasing the Company's direct ownership of Drilling to 21.9%.\nThe following unaudited pro forma selected financial data for the three years ended December 31, 1993 show the consolidated data as if the investments, as of December 31, 1993, in Drilling and Shipping, related financing activities and the 1991 Recapitalization had occurred on January 1, 1991, (in thousands except per share amounts):\n(H) ACCRUED LIABILITIES AND OTHER NONCURRENT LIABILITIES\nThe components of \"Accrued liabilities\" at December 31, 1993 and 1992 were as follows (in thousands):\nThe components of \"OTHER NONCURRENT LIABILITIES\" at December 31, 1993 and 1992 were as follows (in thousands):\n(I) DISCONTINUED OPERATIONS\nSHIPPING - As discussed in Note G, the Company began to consolidate the accounts of Shipping's continuing operations and Drilling in the first quarter of 1992. Shipping is engaged in two principal business segments, shipping operations and drilling operations. The Company is pursuing its plan to dispose of Shipping's shipping operations. Shipping's assets held for sale at December 31, 1993, consisting of vessels, tankers and chartering contracts, were $55.3 million and related liabilities totalled $59.5 million, including $37.1 million of long-term obligations and a $17.3 million reserve for losses on ultimate disposal and operations until disposal. Accordingly, the net position of the shipping operations in the accompanying balance sheet at December 31, 1993 and 1992 was $4.2 million and $.9 million, respectively. Operating revenues and net loss of discontinued operations not included in the Consolidated Statement of Operations for the year ended December 31, 1993 were $14.8 million and $4.6 million, respectively. Operating revenues and net loss of discontinued operations not included in the Consolidated Statement of Operations for the year ended December 31, 1992 were $34.1 million and $3.2 million, respectively.\nWATER TREATMENT - On August 30, 1991, the Company sold all of the stock of its wholly owned subsidiary Resources Conservation Company (\"RCC\"), the water treatment segment of its business, for a sales price of $9.7 million. As a result of the sale, the Company recorded a gain of $3.2 million which is included in discontinued operations. The results of operations of RCC have been reclassified in the accompanying consolidated financial statements as discontinued operations.\nFor the year ended December 31, 1991, income from discontinued operations consisted of the following (in thousands):\n(J) INCOME TAXES\nThe Company's consolidated federal tax returns for the tax years from September 30, 1974 to December 31, 1981 have been examined by the Internal Revenue Service (the \"IRS\"). A settlement agreement between the Company and the IRS for those tax years provided the Company with a tax refund of approximately $3.6 million plus related interest of approximately $10.6 million. The Company received cash of $14.2 million and as a result recognized interest income and income tax benefits of $12.5 million in the third quarter of 1992.\nIncome taxes for the years ended December 31, 1993, 1992 and 1991 consisted of the following (in thousands):\nComponents of loss before income taxes for the years ended December 31, 1993, 1992 and 1991 were as follows (in thousands):\nThe effective tax rate, as computed on income before taxes and including discontinued operations, differs from the statutory U.S. income tax rate for the years ended December 31, 1993, 1992 and 1991 due to the following:\nIncome taxes of $4,008,000, $102,000 and $3,208,000 were recognized in 1993, 1992 and 1991, respectively, despite losses from continuing operations before income taxes. The expense resulted primarily from income tax expense incurred with respect to certain foreign operations. The Company was limited in utilization of tax benefits from investment tax credits prior to 1986 and operating losses in 1993, 1992 and 1991.\nDeferred income taxes result from those transactions which affect financial and taxable income in different years. The nature of these transactions (all of which were long-term) and the income tax effect of each as of December 31, 1993 and 1992 was as follows (in thousands):\nValuation allowance is necessary to reflect the anticipated expiration of net operating loss carryforwards prior to their utilization.\nThe 1991 Recapitalization resulted in an ownership change for federal income tax purposes. As a result of this ownership change, the amount of net operating loss and other tax attribute carryforwards generated prior to the ownership change which may be utilized to offset federal taxable income is limited by the Internal Revenue Code to approximately $2.7 million annually. Net tax operating losses of $13,615,000 arising in 1991 subsequent to the ownership change are not subject to this limitation. Any tax benefits due to the utilization of carryforwards which were generated prior to the 1991 Recapitalization will be reported as a credit to \"Capital in excess of par value\".\n(K) 1991 CHANGE IN ACCOUNTING PRINCIPLE\nIn addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees. The Company's employees may become eligible for these benefits if they reach normal or early retirement age while working for the Company and if they have accumulated fifteen years of service. Health care costs are paid as they are incurred. Life insurance benefits are provided through an insurance company whose premiums are based on benefits paid during the year. The Company's policy had been to expense retiree health care costs as they were incurred. Effective January 1, 1991, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS 106\"). The statement requires employers to recognize the cost of providing postretirement benefits to employees over the employees' service periods. The Company elected to expense the entire \"Accumulated Projected Benefit Obligation\" at January 1, 1991, of $18,860,000, or $.50 per share as shown separately in the Consolidated Statement of Operations under \"Cumulative effect of change in accounting principle\".\nEffective April 1, 1992, the Company modified its postretirement benefits. The effect of these modifications significantly reduced the Company's postretirement benefit costs and accumulated benefit obligation, and resulted in a $6.8 million curtailment gain recognized in the Company's results of operations (included in Other, net) for the year ended December 31, 1992 primarily due to the change in attribution period. Other modifications include employee cost-sharing through increases in deductibles and out-of-pocket limits and increased service period requirements.\nPostretirement benefit costs for the years ended December 31, 1993 and 1992 included the following (in thousands):\nThe health care cost trend rates used to measure the expected cost in 1994 for medical, dental and vision benefits were 12%, 8% and 6%, respectively, each graded down to an ultimate trend rate of 5.5% to be achieved in the year 2021. The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 7.5% and 4.5%, respectively. The effect of a one-percentage- point increase in health care cost trend rates for future periods would increase the service cost and interest cost portion of net periodic postretirement benefit cost approximately 15.4%. The accumulated postretirement benefit obligation would increase by approximately 15%.\nThe amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1993 and 1992 was as follows (in thousands):\n(L) PRIVATE PLACEMENT\nIn September 1991, the Company effected a private placement of approximately 1.7 million shares of Common Stock Subject to Redemption and approximately 6,857 shares of a new class of preferred stock (10,000 shares authorized) (the \"Redeemable Preferred Stock\") pursuant to which the Company raised proceeds of approximately $27.1 million in cash. The proceeds were utilized to fund a portion of the Arcade Acquisition (see Note G). Each share of the Redeemable Preferred Stock was convertible into 200 shares of Common Stock, was entitled to dividend rights equal to those of the common shares into which it was convertible and had one vote per share. The private placement was effected at a price of $8.75 per share of Common Stock Subject to Redemption and $1,750 per share of Redeemable Preferred Stock. In June 1992, each share of the Redeemable Preferred Stock (6,857.143 shares) was converted into 200 shares of Common Stock Subject to Redemption (1,371,428 shares). Pursuant to the Subscription Agreements entered into in connection with the private placement, as amended (the \"Subscription Agreements\"), the Company had agreed to use its best efforts to cause a registration statement with respect to Common Stock Subject to Redemption, including shares to be issued upon the conversion of the Redeemable Preferred Stock (the \"Private Placement Shares\") to become effective under the federal securities laws no later than May 29, 1992 and had guaranteed that any selling holder of Private Placement Shares would receive a specified minimum net share price on resale. In October 1992, without registering the Private Placement Shares, the Company entered into agreements with the holders of the Private Placement Shares that superseded the provisions of the Subscription Agreements under which the Company would repurchase all of such shares at $11.05 per share. All of the outstanding Private Placement Shares were repurchased by the Company in the fourth quarter of 1992 with approximately $34.3 million of the proceeds from a public offering of common stock (see Note M). The carrying value of the Redeemable Preferred Stock and the Common Stock Subject to Redemption was initially recorded at the issue price (net of issuance costs) and was being increased by periodic accretions to retained earnings, based on the interest method, of the difference between the issuance price ($8.75 per common share equivalent) and the estimated redemption value.\n(M) CAPITAL SHARES\nCONVERTIBLE PREFERRED STOCK - In July 1993, the Company effected a public offering of 2,990,000 shares of $1.625 Convertible Preferred Stock, par value $1.00 per share (the \"Preferred Stock\"), pursuant to which the Company raised gross proceeds of approximately $74.7 million in cash (net proceeds of approximately $71.2 million). The proceeds were utilized to repay indebtedness under Facilities C and F of the ING Facility, approximately $5.5 million and $11.6 million, respectively. The remaining proceeds will be used by the Company for working capital and general corporate purposes. The Preferred Stock is convertible at the option of the holder at any time into shares of the Company's Common Stock at a conversion rate of 2.899 shares of Common Stock for each share of Preferred Stock (equivalent to a conversion price of $8.625 per share of Common Stock), subject to adjustment in certain events. Annual dividends are $1.625 per share and are cumulative and are payable quarterly commencing September 30, 1993. The Preferred Stock is redeemable at any time on and after September 30, 1996, at the option of the Company, in whole or in part, at a redemption price of $26.1375 per share, and thereafter at prices decreasing ratably annually to $25.00 per share on and after September 30, 2003, plus accrued and unpaid dividends. The holders of the Preferred Stock do not have any voting rights, except as required by applicable law and except that, among other things, whenever accrued and unpaid dividends on the Preferred Stock are equal to or exceed the equivalent of six quarterly dividends payable on the Preferred Stock, the holders of the Preferred Stock will be entitled to elect two directors to the Board until the dividend arrearage has been paid in full. The term of office of all directors so elected will terminate immediately upon such payment. The Preferred Stock has a liquidation preference of $25.00 per share, plus accrued and unpaid dividends.\nCOMMON STOCK - At the Company's Annual Meeting of Stockholders held on May 20, 1992, the Company's stockholders approved an increase in the number of authorized shares of Common Stock of the Company from 275,000,000 to 425,000,000, which was effected on September 16, 1992.\nOn October 2, 1992, following stockholder approval, the Company effected a one-for-five reverse stock split. On the Consolidated Balance Sheet, \"Common Stock\" was reduced and \"Capital in excess of par value\" was increased to reflect this change.\nIn October 1992, the Company effected a public offering of 8 million shares of Common Stock pursuant to which the Company raised gross proceeds of approximately $40 million in cash (net proceeds of approximately $38.1 million). The proceeds were utilized to repurchase 272,123 shares of Common Stock which had been issued for the settlement of the Company's Supplemental Executive Retirement Plan obligation (the \"SERP Shares\"), to repurchase 3,102,857 Private Placement Shares (See Note L) and for general corporate purposes. As of November 6, 1992, all of the 272,123 SERP Shares and all of the 3,102,857 Private Placement Shares had been repurchased by the Company. Supplemental earnings per share for the year ended December 31, 1992 would have been $.06 per share which assumes the public offering and the repurchase of the SERP Shares and the Private Placement Shares, described above, both occurred on January 1, 1992.\nAs of December 31, 1993, authorized, unissued shares of Common Stock were reserved for issuance as follows:\nNON-VOTING CONVERTIBLE CLASS B COMMON STOCK - At December 31, 1993 and 1992, none of the remaining 41.1 million authorized shares were outstanding.\nClass A (Cumulative Convertible) Capital Stock (the \"Class A Stock\") has been included with \"Capital in excess of par value\" due the $880 outstanding at December 31, 1993 and 1992.\n(N) CAREER STOCK AND STOCK OPTION PLANS\nOn March 19, 1992, and at the Annual Meeting of Stockholders on May 20, 1992, the Company's Board of Directors and stockholders, respectively, approved the Company's 1992 Long-Term Incentive Plan (the \"1992 Plan\"). The 1992 Plan provides for grants of stock options, stock appreciation rights, stock awards and cash awards, which may be granted singly, in combination or in tandem. The 1992 Plan is unfunded insofar as the plan provides for awards of cash, Common Stock or rights thereto. An aggregate of 1,000,000 shares of Common Stock is available for awards granted wholly or partly in Common Stock. The Company has granted Restricted Stock Awards under the 1992 Plan totalling 300,000 shares of Common Stock. Such shares awarded are restricted as to transfer until vested pursuant to a schedule whereby 1\/24th of the total number of shares is vested per calendar quarter from June 30, 1992 through March 31, 1998 (subject to certain conditions). The market value at the date of grant of the Common Stock granted was recorded as unearned compensation and is amortized to expense over the periods during which the restrictions lapse or shares vest. Unearned compensation is shown as a reduction of stockholders' equity.\nOn November 29, 1990, and at a special meeting on March 26, 1991, the Company's Board of Directors and stockholders, respectively, approved the Company's 1990 Stock Option Plan. The plan is intended to provide an incentive that will allow the Company to retain in its employ, persons of the training, experience and ability necessary for the development and financial success of the Company. The plan authorized options with respect to 1,966,000 shares of Common Stock to be granted to certain employees of the Company at an option price of $9.65625 per share. On May 18, 1993, the option price was adjusted to $7.375. On September 25, 1991, options with respect to all 1,966,000 shares were granted. As of December 31, 1993, 33,700 options had been exercised and 1,155,100 shares were vested. Total adjusted compensation under the plan of approximately $1,581,000 represents the excess of market price at the measurement dates over the option price multiplied by the number of options granted. This amount is to be recognized as expense over the four year vesting period which commenced in March 1991. Compensation recognized under the plan for the three years ending December 31, 1993, 1992 and 1991 totalled approximately $507,000, $117,000 and $293,000, respectively. The plan will terminate on March 29, 2001.\n(O) RETIREMENT AND SAVINGS PLANS\nPENSION PLANS - The Company has three noncontributory pension plans. Substantially all of its employees are covered by one or more of these plans. Plan benefits are primarily based on years of service and average high thirty-six month compensation.\nThe Reading & Bates Pension Plan (the \"Domestic Plan\") is qualified under the Employee Retirement Income Security Act (ERISA). It is the Company's policy to fund this plan not less than the minimum required by ERISA. It is the Company's policy to contribute to the Reading & Bates Offshore Pension Plan (the \"Offshore Plan\") an amount equal to the normal cost plus amounts sufficient to amortize the initial unfunded actuarial liability and subsequent unfunded liability caused by plan or assumption changes over thirty years. The unfunded liability arising from actuarial gains and losses is funded over fifteen years. The Offshore Plan is a nonqualified plan and is not subject to ERISA funding requirements. The Domestic and Offshore Plans invest in cash equivalents, fixed income and equity securities.\nThe Reading & Bates Retirement Benefit Replacement Plan (the \"Replacement Plan\") is a self-administered unfunded excess benefit plan. All members of the Domestic Plan or the Reading & Bates Savings Plan are potential participants in the Replacement Plan.\nPension costs, including discontinued operations, for the years ended December 31, 1993, 1992 and 1991 was $534,000, $111,000, and $16,000, respectively. The 1991 sale of the Company's water treatment operations reduced the number of active employees covered under the Domestic and Replacement Plans. This reduction also resulted in a curtailment of these plans. When a curtailment occurs, the pension liability associated with the future service of the terminated employees is immediately recognized as a gain. A net curtailment gain of $410,000 associated with the sale of the water treatment operations was included in discontinued operations in 1991.\nPension costs (benefit) for the years ended December 31, 1993, 1992 and 1991 included the following components (in thousands):\nThe funded status of the plans at December 31, 1993 was as follows (in thousands):\nThe additional minimum liability is shown as a reduction of stockholders' equity.\nEmployees of discontinued operations are covered under the plans from their employment dates through the date of sale of the discontinued operation.\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations was 7.5% and 4.5%, respectively. The weighted average expected long-term rate of return on assets was 10.25%.\nSAVINGS PLANS - The Company established a thrift plan in 1969 for salaried and hourly paid employees. Effective August 1, 1988, the plan was amended and restated creating two plans and the name was changed to the Reading & Bates Savings Plan and the Reading & Bates Offshore Savings Plan. Under the plans, an employee may contribute up to 10% of base salary (subject to certain limitations) and the Company will make matching contributions at a rate of $.50 for each dollar contributed by the employee up to 6% of the employee's base salary. Employees may direct the investment of their contributions and the contributions of the Company in various plan options.\nTwenty-five percent of the Company's contribution vests after two years of an employee's service with the Company, 50% after three years, 75% after four years and 100% after five years. Compensation costs (including discontinued operations) under the plans amounted to $502,000 in 1993, $381,000 in 1992 and $940,000 in 1991.\n(P) RELATED PARTY TRANSACTIONS\nDrilling has a rig management agreement with Sonat Offshore Drilling Inc. (\"Sonat\"), a major shareholder of Drilling, for the operation and marketing of both of its drilling units. For each of the years ending December 31, 1993 and 1992, Drilling paid to Sonat approximately $2.5 million for such management services. In addition, Drilling has a bareboat charter agreement with Sonat for one of its drilling units. For the years ended December 31, 1993 and 1992, Drilling received from Sonat approximately $14.7 million and $3.8 million, respectively for such bareboat charter. At December 31, 1993 and 1992, Drilling had a net receivable from Sonat of $6 million and $5.2 million, respectively.\nCertain principal stockholders of the Company and entities related thereto were investors in the Company's private placement in September 1991 (see Note L). BCL Investment Partnership, L.P. (\"BCL\") purchased 114,285 shares of Common Stock Subject to Redemption for $1 million, and Danielson Holding Corporation (\"Danielson\") and its affiliate, National American Insurance Company of California (\"NAICC\"), together purchased all of the Redeemable Preferred Stock for $4 million and $8 million, respectively. BCL owned, as of December 31, 1993, approximately 33.9% of the Common Stock, and Paul B. Loyd, Jr., the Company's Chairman and Chief Executive Officer controls one of the five general partners of BCL. Danielson and NAICC may be deemed affiliates of R&B Investment Partnership, L.P. (the \"WHR Partnership\") which beneficially owned, as of December 31, 1993, approximately 20.8% of the Common Stock. C. Kirk Rhein, Jr., the Company's Vice Chairman, is a general partner of the general partner of various partnerships which are stockholders of the Company, including the WHR Partnership. Upon the repurchase of the Private Placement Shares in November 1992, BCL, Danielson and NAICC received approximately $1.3 million, $5.1 million and $10.1 million, respectively, for the Private Placement Shares held by each of them.\nFees totalling approximately $700,000 and $167,000, respectively, were paid by the Company in October 1991 to an investment firm, a principal of which is a member of the Board of Directors of the Company and an affiliate of the WHR Partnership, and to Venture Capital Investors, an affiliate of an entity with an indirect interest in BCL, for their efforts in securing unaffiliated participating investors in the private placement of the Company's Redeemable Preferred Stock and Common Stock Subject to Redemption (see Note L).\nIn 1991, the Company paid to ING Bank an arrangement fee of $1.8 million, of which $900,000 was payable as a finder's fee to Capercaillie Holdings, Inc., an affiliate of BCL, in connection with a credit facility extended to the Company by ING Bank.\n(Q) OPERATIONS BY GEOGRAPHIC AREA\nThe Company, together with its 50% or less owned unconsolidated investees, operates principally in international offshore contract drilling of oil and gas wells. For the year ended December 31, 1993, revenues from three customers of $39.6 million, $37.7 million and $20.3 million accounted for 22%, 20% and 11%, respectively, of the Company's total operating revenues. For the year ended December 31, 1992, revenues from two customers of $40.9 million and $27.8 million accounted for 26% and 18%, respectively, of the Company's total operating revenues. For the year ended December 31, 1991, revenues from three customers of $38.6 million, $27.9 million and $14.1 million accounted for 30%, 22% and 11%, respectively, of the Company's total operating revenues. Results of operations of the water treatment and shipping segments are not included in the geographic information as they have been included in discontinued operations.\nGEOGRAPHIC AREAS (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL CONSOLIDATED FINANCIAL INFORMATION\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for the two years ended December 31, 1993, are as follows (in thousands except for per share amounts):\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nOn November 25, 1992 the Company engaged Arthur Andersen & Co. as its independent public accountants replacing Coopers & Lybrand. There were no disagreements with Coopers & Lybrand regarding accounting principles and practices for the two fiscal years ended December 31, 1991, and the subsequent interim period, however, its report for the year ended December 31, 1990 contained a paragraph regarding the Company's ability to continue as a going concern. That qualification was removed in Coopers & Lybrand's report for the year ended December 31, 1991. The decision to change accountants was approved by the Company's audit committee of the board of directors.\nPART III\nThe information called for by Part III of Form 10-K is incorporated by reference from the Registrant's Proxy Statements relating to its annual meeting of Stockholders to be held May 10, 1994, which will be filed by the Registrant with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year. Also reference is made to the information contained under the captioned \"Executive Officers of Registrant\" contained in Part I hereof.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements, Schedules and Exhibits\n1. Financial Statements:\nReports of Independent Public Accountants Consolidated Balance Sheet as of December 31, 1993 and 1992 Consolidated Statement of Operations for the years ended December 31, 1993, 1992 and 1991 Consolidated Statement of Cash Flows for the years ended December 31, 1993, 1992 and 1991 Consolidated Statement of Stockholders' Equity (Deficit) for the years ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements Supplemental Consolidated Financial Information (unaudited)\n2. Schedules:\nReports of Independent Public Accountants Schedule II - Amounts Receivable from Related Parties Schedule V - Property and Equipment Schedule VI - Accumulated Depreciation and Amortization of Property and Equipment Schedule IX - Short-term Obligations Schedule X - Supplementary Consolidated Statement of Operations Information All other schedules are omitted because they are not required or are not applicable.\n3. Exhibits:\nExhibit 3.1 - The Registrant's Restated Certificate of Incorporation, as amended through October 2, 1992. (Filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 3.2 - The Registrant's Certificate of Designations of $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit (a) to Amendment No. 1 to the Registrant's Form 8-A\/A dated July 22, 1993 and incorporated herein by reference.)\nExhibit 3.3 - The Registrant's Bylaws. (Filed as Exhibit 4.2 to the Company's Registration No. 33-44237 and incorporated herein by reference.)\nExhibit 4.1 - Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for 1989 and incorporated herein by reference.)\nExhibit 4.2 - Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3 - Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4 - Indenture dated as of December 1, 1980 among Reading & Bates Energy Corporation N.V., the Registrant, as Guarantor, and U.S. Trust Company, as Successor Trustee, relating to the 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.4 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.5 - Form of 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.5 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.6 - Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.7 - Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.8 - Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.9 - Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.10 - Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.11 - Agreement dated as of March 27, 1991 among the Registrant, R&B Rig Investment Partners, L.P., R&B MODU Investment Associates, L.P., M&W Investment Partners, L.P., and BCL Investment Partners, L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.12 - Termination Agreement dated as of September 14, 1993 between the Registrant and BCL Investment Partners, L.P.\nExhibit 4.13 - Agreement dated March 29, 1991 between the Registrant and R&B Investment Partnership, L.P. (Filed as Exhibit 4.25 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.14 - Amendment No. 1 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.15 - Amendment No. 2 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.16 - Termination Agreement dated as of September 14, 1993 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.17 - Preferred Stock Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.12 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.18 - Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.14 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.19 - Agreement dated as of October 15, 1992 between the Registrant and the Subscribers as defined therein. (Filed as Exhibit 10.63 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.20 - Common Stock Issuance Agreement dated April 19, 1991 between the Company and J. W. Bates, Jr., as amended. (Filed as Exhibit 4.15 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.21 - Common Stock Issuance Agreement dated April 15, 1991 between the Company and R. A. Tappmeyer, as amended. (Filed as Exhibit 4.16 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.22 - Common Stock Issuance Agreement dated April 1991 between the Company and C. E. Thornton, as amended. (Filed as Exhibit 4.17 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.1 - Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and \t\t\t\t\t\t the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2 - Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3 - Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4 - Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5 - Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.30 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.6 - Amendment No. 1, dated as of May 24, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.32 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.7 - Amendment No. 2, dated as of June 28, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.33 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.8 - Amendment No. 3, dated as of August 30, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.9 - Amendment No. 4, dated as of June 30, 1992, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co. and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.61 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.10 - Amendment No. 5, dated as of February 23, 1993, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.11 - Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.12 - Pledge Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.13* - Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.14* - 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.15* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian.\nExhibit 10.16* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean.\nExhibit 10.17* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer.\nExhibit 10.18* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster.\nExhibit 10.19 - Pledge of shares of stock of Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading and Bates, Inc., to NMB Postbank Groep N.V. and\/or its affiliates or trustees acting on behalf of any of the foregoing. (Filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.20 - Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.21* - Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.22* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr.\nExhibit 10.23* - Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.24* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle.\nExhibit 10.25* - Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.26* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner.\nExhibit 10.27* - Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.28* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire.\nExhibit 10.29* - Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.30* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin.\nExhibit 10.31* - Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.32* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.33* - Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.34* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr.\nExhibit 10.35* - Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.36* - Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel.\nExhibit 10.37 - Galloway Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.45 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.38 - Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.39 - Galloway Rescission Agreement dated as of June 28, 1991 among Reading & Bates Drilling Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.47 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.40 - Galloway Assignment Agreement dated as of June 28, 1991 between the Holders named therein and the NMB Postbank Groep N.V. (Filed as Exhibit 10.48 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.41 - Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.42 - Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.43 - Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.44 - Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.45 - HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.46 - Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.47 - Credit Facility Letter dated May 12, 1992 between Arcade Shipping AS and The Chase Manhattan Bank, N.A., as amended on May 14, 1992. (Filed as Exhibit 10.55 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.48 - Letter Agreement dated May 12, 1992 between the Registrant and The Chase Manhattan Bank, N.A. regarding undertakings with respect to a credit facility issued as of the same date to Arcade Shipping AS. (Filed as Exhibit 10.56 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.49 - Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.50 - Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.51 - Floating Rate Loan Facility Agreement dated September 19, 1991 between Gade Shipping Corporation, Skandinaviska Enskilda Banken, London Branch and Den norske Bank AS. (Filed as Exhibit 10.58 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.52 - Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE FALCON\"). (Filed as Exhibit 10.59 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.53 - Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE EAGLE\"). (Filed as Exhibit 10.60 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.54 - ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between the Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 11 - Computation of Earnings Per Common Share\nExhibit 16 - Letter re Change in Certifying Accountant (filed as Exhibit 16.1 to the Company's Form 8-K dated December 2, 1992 and incorporated herein by reference).\nExhibit 21 - Schedule of Subsidiaries of the Company\nExhibit 23.1 - Consent of Arthur Andersen & Co.\nExhibit 23.2 - Consent of Coopers & Lybrand\nExhibit 99 - Annual Report on Form 11-K with respect to Reading & Bates Savings Plan.\nInstruments with respect to certain long-term obligations of the Company are not being filed as exhibits hereto as the securities authorized thereunder do not exceed 10% of the Company's total assets. The Company agrees to furnish a copy of each such instrument to the Securities and Exchange Commission upon its request.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K\nDuring the three months ending December 31, 1993 five Current Reports on Form 8-K were filed. A Current Report on Form 8-K dated October 12, 1993 announcing the resignation of J.T. Angel, dated October 21, 1993 announcing the Company's 3rd quarter 1993 earnings, dated November 5, 1993 announcing that AGIP S.p.A. did not exercise their remaining options under a contract with the \"JACK BATES\", dated November 18, 1993 announcing the mobilization of the \"M.G. HULME, JR.\" from the Mediterranean Sea to the Gulf of Mexico, and dated December 9, 1993 announcing that the Company had received a letter of intent for a drilling contract in the Gulf of Mexico for the \"M.G. HULME, JR.\".\nREADING & BATES CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nSchedule Number Description - -------- ------------------------------------------------\nReports of Independent Public Accountants\nII. Amounts Receivable from Related Parties\nV. Property and Equipment\nVI. Accumulated Depreciation and Amortization of Property and Equipment\nIX. Short-term Obligations\nX. Supplementary Consolidated Statement of Operations Information\nNote: All other schedules are omitted because they are not applicable or not required.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Reading & Bates Corporation as of and for the years ended December 31, 1993 and 1992 included in this Form 10-K and have issued our report thereon dated February 14, 1994. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index of financial statement schedules set forth in item 14(a)(2) hereof for the years ended December 31, 1993 and 1992, are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\n\/s\/ARTHUR ANDERSEN & CO.\nHouston, Texas February 14, 1994\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nOur report on the consolidated financial statements of Reading & Bates Corporation and Subsidiaries is included on page 31 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14(a)(2) of this Form 10-K as of and for the year ended December 31, 1991.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/Coopers & Lybrand\nHouston, Texas March 25, 1992\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE V - PROPERTY AND EQUIPMENT\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM OBLIGATIONS\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY CONSOLIDATED STATEMENT OF OPERATIONS INFORMATION\nFor the Three Years Ended December 31, 1993 (in thousands)\nDepreciation and amortization of intangible assets, taxes other than payroll and income taxes and advertising costs were each less than 1% of consolidated revenues.\nSIGNATURES\nPursuant 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 by the undersigned, thereunto duly authorized on March 9, 1994.\nREADING & BATES CORPORATION\nBy \/s\/Paul B. Loyd, Jr. ------------------------ Paul B. Loyd, Jr. President, Chief Executive Officer, Chairman and Director\nPursuant to the requirements of Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on March 9,1994.\nBy \/s\/ Paul B. Loyd Jr. By \/s\/ Willem Cordia ------------------------- ------------------------- Paul B. Loyd, Jr. Willem Cordia President, Chief Executive Officer, Director Chairman and Director\nBy \/s\/ C. Kirk Rhein, Jr. By \/s\/ Charles A. Donabedian -------------------------- ------------------------- C. Kirk Rhein, Jr. Charles A. Donabedian Vice Chairman and Director Director\nBy \/s\/ T. W. Nagle By \/s\/ J. W. McLean ------------------------- ------------------------- T. W. Nagle J. W. McLean Vice President and Chief Director Financial Officer Principal Accounting Officer\nBy \/s\/ Ted Kalborg By \/s\/ A. L. Chavkin ------------------------- ------------------------- Ted Kalborg A. L. Chavkin Director Director\nBy \/s\/ Steven A. Webster By \/s\/ Robert L. Sandmeyer ------------------------- ------------------------- Steven A. Webster Robert L. Sandmeyer Director Director\nEXHIBIT INDEX\nExhibit Number Description\nExhibit 3.1 The Registrant's Restated Certificate of Incorporation, as amended through October 2, 1992. (Filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 3.2 The Registrant's Certificate of Designations of $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit (a) to Amendment No. 1 to the Registrant's Form 8-A\/A dated July 22, 1993 and incorporated herein by reference.)\nExhibit 3.3 The Registrant's Bylaws. (Filed as Exhibit 4.2 to the Company's Registration No. 33-44237 and incorporated herein by reference.)\nExhibit 4.1 Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for 1989 and incorporated herein by reference.)\nExhibit 4.2 Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3 Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4 Indenture dated as of December 1, 1980 among Reading & Bates Energy Corporation N.V., the Registrant, as Guarantor, and U.S. Trust Company, as Successor Trustee, relating to the 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.4 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.5 Form of 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.5 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.6 Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.7 Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.8 Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.9 Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.10 Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.11 Agreement dated as of March 27, 1991 among the Registrant, R&B Rig Investment Partners, L.P., R&B MODU Investment Associates, L.P., M&W Investment Partners, L.P., and BCL Investment Partners, L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.12 Termination Agreement dated as of September 14, 1993 between the Registrant and BCL Investment Partners, L.P.\nExhibit 4.13 Agreement dated March 29, 1991 between the Registrant and R&B Investment Partnership, L.P. (Filed as Exhibit 4.25 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.14 Amendment No. 1 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.15 Amendment No. 2 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.16 Termination Agreement dated as of September 14, 1993 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.17 Preferred Stock Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.12 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.18 Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.14 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.19 Agreement dated as of October 15, 1992 between the Registrant and the Subscribers as defined therein. (Filed as Exhibit 10.63 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.20 Common Stock Issuance Agreement dated April 19, 1991 between the Company and J. W. Bates, Jr., as amended. (Filed as Exhibit 4.15 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.21 Common Stock Issuance Agreement dated April 15, 1991 between the Company and R. A. Tappmeyer, as amended. (Filed as Exhibit 4.16 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.22 Common Stock Issuance Agreement dated April 1991 between the Company and C. E. Thornton, as amended. (Filed as Exhibit 4.17 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.1 Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2 Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3 Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4 Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5 Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.30 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.6 Amendment No. 1, dated as of May 24, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.32 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.7 Amendment No. 2, dated as of June 28, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.33 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.8 Amendment No. 3, dated as of August 30, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.9 Amendment No. 4, dated as of June 30, 1992, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co. and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.61 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.10 Amendment No. 5, dated as of February 23, 1993, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.11 Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.12 Pledge Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.13 Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.14 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.15 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian.\nExhibit 10.16 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean.\nExhibit 10.17 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer.\nExhibit 10.18 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster.\nExhibit 10.19 Pledge of shares of stock of Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading and Bates, Inc., to NMB Postbank Groep N.V. and\/or its affiliates or trustees acting on behalf of any of the foregoing. (Filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.20 Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.21 Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.22 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr.\nExhibit 10.23 Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 andincorporated hereinby reference.)\nExhibit 10.24 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle.\nExhibit 10.25 Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.26 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner.\nExhibit 10.27 Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.28 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire.\nExhibit 10.29 Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.30 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin.\nExhibit 10.31 Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.32 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.33 Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.34 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr.\nExhibit 10.35 Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.36 Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel.\nExhibit 10.37 Galloway Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.45 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.38 Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.39 Galloway Rescission Agreement dated as of June 28, 1991 among Reading & Bates Drilling Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.47 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.40 Galloway Assignment Agreement dated as of June 28, 1991 between the Holders named therein and the NMB Postbank Groep N.V. (Filed as Exhibit 10.48 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.41 Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.42 Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.43 Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.44 Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.45 HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.46 Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.47 Credit Facility Letter dated May 12, 1992 between Arcade Shipping AS and The Chase Manhattan Bank, N.A., as amended on May 14, 1992. (Filed as Exhibit 10.55 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.48 Letter Agreement dated May 12, 1992 between the Registrant and The Chase Manhattan Bank, N.A. regarding undertakings with respect to a credit facility issued as of the same date to Arcade Shipping AS. (Filed as Exhibit 10.56 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.49 Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.50 Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.51 Floating Rate Loan Facility Agreement dated September 19, 1991 between Gade Shipping Corporation, Skandinaviska Enskilda Banken, London Branch and Den norske Bank AS. (Filed as Exhibit 10.58 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.52 Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE FALCON\"). (Filed as Exhibit 10.59 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.53 Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE EAGLE\"). (Filed as Exhibit 10.60 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.54 ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between the Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 11 Computation of Earnings Per Common Share\nExhibit 16 Letter re Change in Certifying Accountant (filed as Exhibit 16.1 to the Company's Form 8-K dated December 2, 1992 and incorporated herein by reference).\nExhibit 21 Schedule of Subsidiaries of the Company\nExhibit 23.1 Consent of Arthur Andersen & Co.\nExhibit 23.2 Consent of Coopers & Lybrand\nExhibit 99 Annual Report on Form 11-K with respect to Reading & Bates Savings Plan. (To be filed by amendment.)","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements, Schedules and Exhibits\n1. Financial Statements:\nReports of Independent Public Accountants Consolidated Balance Sheet as of December 31, 1993 and 1992 Consolidated Statement of Operations for the years ended December 31, 1993, 1992 and 1991 Consolidated Statement of Cash Flows for the years ended December 31, 1993, 1992 and 1991 Consolidated Statement of Stockholders' Equity (Deficit) for the years ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements Supplemental Consolidated Financial Information (unaudited)\n2. Schedules:\nReports of Independent Public Accountants Schedule II - Amounts Receivable from Related Parties Schedule V - Property and Equipment Schedule VI - Accumulated Depreciation and Amortization of Property and Equipment Schedule IX - Short-term Obligations Schedule X - Supplementary Consolidated Statement of Operations Information All other schedules are omitted because they are not required or are not applicable.\n3. Exhibits:\nExhibit 3.1 - The Registrant's Restated Certificate of Incorporation, as amended through October 2, 1992. (Filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 3.2 - The Registrant's Certificate of Designations of $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit (a) to Amendment No. 1 to the Registrant's Form 8-A\/A dated July 22, 1993 and incorporated herein by reference.)\nExhibit 3.3 - The Registrant's Bylaws. (Filed as Exhibit 4.2 to the Company's Registration No. 33-44237 and incorporated herein by reference.)\nExhibit 4.1 - Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for 1989 and incorporated herein by reference.)\nExhibit 4.2 - Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3 - Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4 - Indenture dated as of December 1, 1980 among Reading & Bates Energy Corporation N.V., the Registrant, as Guarantor, and U.S. Trust Company, as Successor Trustee, relating to the 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.4 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.5 - Form of 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.5 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.6 - Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.7 - Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.8 - Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.9 - Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.10 - Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.11 - Agreement dated as of March 27, 1991 among the Registrant, R&B Rig Investment Partners, L.P., R&B MODU Investment Associates, L.P., M&W Investment Partners, L.P., and BCL Investment Partners, L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.12 - Termination Agreement dated as of September 14, 1993 between the Registrant and BCL Investment Partners, L.P.\nExhibit 4.13 - Agreement dated March 29, 1991 between the Registrant and R&B Investment Partnership, L.P. (Filed as Exhibit 4.25 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.14 - Amendment No. 1 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.15 - Amendment No. 2 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.16 - Termination Agreement dated as of September 14, 1993 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.17 - Preferred Stock Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.12 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.18 - Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.14 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.19 - Agreement dated as of October 15, 1992 between the Registrant and the Subscribers as defined therein. (Filed as Exhibit 10.63 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.20 - Common Stock Issuance Agreement dated April 19, 1991 between the Company and J. W. Bates, Jr., as amended. (Filed as Exhibit 4.15 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.21 - Common Stock Issuance Agreement dated April 15, 1991 between the Company and R. A. Tappmeyer, as amended. (Filed as Exhibit 4.16 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.22 - Common Stock Issuance Agreement dated April 1991 between the Company and C. E. Thornton, as amended. (Filed as Exhibit 4.17 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.1 - Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and \t\t\t\t\t\t the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2 - Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3 - Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4 - Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5 - Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.30 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.6 - Amendment No. 1, dated as of May 24, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.32 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.7 - Amendment No. 2, dated as of June 28, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.33 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.8 - Amendment No. 3, dated as of August 30, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.9 - Amendment No. 4, dated as of June 30, 1992, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co. and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.61 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.10 - Amendment No. 5, dated as of February 23, 1993, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.11 - Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.12 - Pledge Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.13* - Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.14* - 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.15* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian.\nExhibit 10.16* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean.\nExhibit 10.17* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer.\nExhibit 10.18* - Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster.\nExhibit 10.19 - Pledge of shares of stock of Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading and Bates, Inc., to NMB Postbank Groep N.V. and\/or its affiliates or trustees acting on behalf of any of the foregoing. (Filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.20 - Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.21* - Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.22* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr.\nExhibit 10.23* - Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.24* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle.\nExhibit 10.25* - Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.26* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner.\nExhibit 10.27* - Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.28* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire.\nExhibit 10.29* - Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.30* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin.\nExhibit 10.31* - Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.32* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.33* - Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.34* - Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr.\nExhibit 10.35* - Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.36* - Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel.\nExhibit 10.37 - Galloway Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.45 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.38 - Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.39 - Galloway Rescission Agreement dated as of June 28, 1991 among Reading & Bates Drilling Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.47 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.40 - Galloway Assignment Agreement dated as of June 28, 1991 between the Holders named therein and the NMB Postbank Groep N.V. (Filed as Exhibit 10.48 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.41 - Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.42 - Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.43 - Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.44 - Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.45 - HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.46 - Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.47 - Credit Facility Letter dated May 12, 1992 between Arcade Shipping AS and The Chase Manhattan Bank, N.A., as amended on May 14, 1992. (Filed as Exhibit 10.55 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.48 - Letter Agreement dated May 12, 1992 between the Registrant and The Chase Manhattan Bank, N.A. regarding undertakings with respect to a credit facility issued as of the same date to Arcade Shipping AS. (Filed as Exhibit 10.56 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.49 - Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.50 - Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.51 - Floating Rate Loan Facility Agreement dated September 19, 1991 between Gade Shipping Corporation, Skandinaviska Enskilda Banken, London Branch and Den norske Bank AS. (Filed as Exhibit 10.58 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.52 - Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE FALCON\"). (Filed as Exhibit 10.59 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.53 - Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE EAGLE\"). (Filed as Exhibit 10.60 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.54 - ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between the Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 11 - Computation of Earnings Per Common Share\nExhibit 16 - Letter re Change in Certifying Accountant (filed as Exhibit 16.1 to the Company's Form 8-K dated December 2, 1992 and incorporated herein by reference).\nExhibit 21 - Schedule of Subsidiaries of the Company\nExhibit 23.1 - Consent of Arthur Andersen & Co.\nExhibit 23.2 - Consent of Coopers & Lybrand\nExhibit 99 - Annual Report on Form 11-K with respect to Reading & Bates Savings Plan.\nInstruments with respect to certain long-term obligations of the Company are not being filed as exhibits hereto as the securities authorized thereunder do not exceed 10% of the Company's total assets. The Company agrees to furnish a copy of each such instrument to the Securities and Exchange Commission upon its request.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K\nDuring the three months ending December 31, 1993 five Current Reports on Form 8-K were filed. A Current Report on Form 8-K dated October 12, 1993 announcing the resignation of J.T. Angel, dated October 21, 1993 announcing the Company's 3rd quarter 1993 earnings, dated November 5, 1993 announcing that AGIP S.p.A. did not exercise their remaining options under a contract with the \"JACK BATES\", dated November 18, 1993 announcing the mobilization of the \"M.G. HULME, JR.\" from the Mediterranean Sea to the Gulf of Mexico, and dated December 9, 1993 announcing that the Company had received a letter of intent for a drilling contract in the Gulf of Mexico for the \"M.G. HULME, JR.\".\nREADING & BATES CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nSchedule Number Description - -------- ------------------------------------------------\nReports of Independent Public Accountants\nII. Amounts Receivable from Related Parties\nV. Property and Equipment\nVI. Accumulated Depreciation and Amortization of Property and Equipment\nIX. Short-term Obligations\nX. Supplementary Consolidated Statement of Operations Information\nNote: All other schedules are omitted because they are not applicable or not required.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Reading & Bates Corporation as of and for the years ended December 31, 1993 and 1992 included in this Form 10-K and have issued our report thereon dated February 14, 1994. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index of financial statement schedules set forth in item 14(a)(2) hereof for the years ended December 31, 1993 and 1992, are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\n\/s\/ARTHUR ANDERSEN & CO.\nHouston, Texas February 14, 1994\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nOur report on the consolidated financial statements of Reading & Bates Corporation and Subsidiaries is included on page 31 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14(a)(2) of this Form 10-K as of and for the year ended December 31, 1991.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/Coopers & Lybrand\nHouston, Texas March 25, 1992\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE V - PROPERTY AND EQUIPMENT\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM OBLIGATIONS\nFor the Three Years Ended December 31, 1993 (in thousands)\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY CONSOLIDATED STATEMENT OF OPERATIONS INFORMATION\nFor the Three Years Ended December 31, 1993 (in thousands)\nDepreciation and amortization of intangible assets, taxes other than payroll and income taxes and advertising costs were each less than 1% of consolidated revenues.\nSIGNATURES\nPursuant 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 by the undersigned, thereunto duly authorized on March 9, 1994.\nREADING & BATES CORPORATION\nBy \/s\/Paul B. Loyd, Jr. ------------------------ Paul B. Loyd, Jr. President, Chief Executive Officer, Chairman and Director\nPursuant to the requirements of Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on March 9,1994.\nBy \/s\/ Paul B. Loyd Jr. By \/s\/ Willem Cordia ------------------------- ------------------------- Paul B. Loyd, Jr. Willem Cordia President, Chief Executive Officer, Director Chairman and Director\nBy \/s\/ C. Kirk Rhein, Jr. By \/s\/ Charles A. Donabedian -------------------------- ------------------------- C. Kirk Rhein, Jr. Charles A. Donabedian Vice Chairman and Director Director\nBy \/s\/ T. W. Nagle By \/s\/ J. W. McLean ------------------------- ------------------------- T. W. Nagle J. W. McLean Vice President and Chief Director Financial Officer Principal Accounting Officer\nBy \/s\/ Ted Kalborg By \/s\/ A. L. Chavkin ------------------------- ------------------------- Ted Kalborg A. L. Chavkin Director Director\nBy \/s\/ Steven A. Webster By \/s\/ Robert L. Sandmeyer ------------------------- ------------------------- Steven A. Webster Robert L. Sandmeyer Director Director\nEXHIBIT INDEX\nExhibit Number Description\nExhibit 3.1 The Registrant's Restated Certificate of Incorporation, as amended through October 2, 1992. (Filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 3.2 The Registrant's Certificate of Designations of $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit (a) to Amendment No. 1 to the Registrant's Form 8-A\/A dated July 22, 1993 and incorporated herein by reference.)\nExhibit 3.3 The Registrant's Bylaws. (Filed as Exhibit 4.2 to the Company's Registration No. 33-44237 and incorporated herein by reference.)\nExhibit 4.1 Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for 1989 and incorporated herein by reference.)\nExhibit 4.2 Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3 Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4 Indenture dated as of December 1, 1980 among Reading & Bates Energy Corporation N.V., the Registrant, as Guarantor, and U.S. Trust Company, as Successor Trustee, relating to the 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.4 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.5 Form of 8% Convertible Subordinated Debentures due 1995 issued by Reading & Bates Energy Corporation N.V., and guaranteed by the Registrant. (Filed as Exhibit 4.5 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.6 Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.7 Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.8 Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.9 Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.10 Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.11 Agreement dated as of March 27, 1991 among the Registrant, R&B Rig Investment Partners, L.P., R&B MODU Investment Associates, L.P., M&W Investment Partners, L.P., and BCL Investment Partners, L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.12 Termination Agreement dated as of September 14, 1993 between the Registrant and BCL Investment Partners, L.P.\nExhibit 4.13 Agreement dated March 29, 1991 between the Registrant and R&B Investment Partnership, L.P. (Filed as Exhibit 4.25 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.14 Amendment No. 1 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.15 Amendment No. 2 dated as of January 1, 1992 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.16 Termination Agreement dated as of September 14, 1993 between the Registrant and R&B Investment Partnership, L.P.\nExhibit 4.17 Preferred Stock Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.12 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.18 Subscription Agreement dated as of September 3, 1991 between Registrant and the subscribers, as amended. (Filed as Exhibit 4.14 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.19 Agreement dated as of October 15, 1992 between the Registrant and the Subscribers as defined therein. (Filed as Exhibit 10.63 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.20 Common Stock Issuance Agreement dated April 19, 1991 between the Company and J. W. Bates, Jr., as amended. (Filed as Exhibit 4.15 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.21 Common Stock Issuance Agreement dated April 15, 1991 between the Company and R. A. Tappmeyer, as amended. (Filed as Exhibit 4.16 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.22 Common Stock Issuance Agreement dated April 1991 between the Company and C. E. Thornton, as amended. (Filed as Exhibit 4.17 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.1 Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2 Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3 Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4 Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5 Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.30 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.6 Amendment No. 1, dated as of May 24, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.32 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.7 Amendment No. 2, dated as of June 28, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.33 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.8 Amendment No. 3, dated as of August 30, 1991, to the Credit Facility Agreement dated as of March 29, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading & Bates, Inc. and Resources Conservation Company, subsidiaries of the Registrant, and NMB Postbank Groep, N.V. (Filed as Exhibit 4.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.9 Amendment No. 4, dated as of June 30, 1992, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co. and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.61 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.10 Amendment No. 5, dated as of February 23, 1993, to the Credit Facility Agreement dated as of March 27, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., and Reading and Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.11 Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.12 Pledge Agreement dated August 18, 1993 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.13 Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.14 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.15 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian.\nExhibit 10.16 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean.\nExhibit 10.17 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer.\nExhibit 10.18 Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster.\nExhibit 10.19 Pledge of shares of stock of Reading & Bates Drilling Co., Reading & Bates Exploration Co., and Reading and Bates, Inc., to NMB Postbank Groep N.V. and\/or its affiliates or trustees acting on behalf of any of the foregoing. (Filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.20 Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.21 Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.22 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr.\nExhibit 10.23 Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 andincorporated hereinby reference.)\nExhibit 10.24 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle.\nExhibit 10.25 Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.26 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner.\nExhibit 10.27 Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.28 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire.\nExhibit 10.29 Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.30 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin.\nExhibit 10.31 Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.32 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.33 Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.34 Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr.\nExhibit 10.35 Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.36 Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel.\nExhibit 10.37 Galloway Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.45 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.38 Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.39 Galloway Rescission Agreement dated as of June 28, 1991 among Reading & Bates Drilling Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.47 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.40 Galloway Assignment Agreement dated as of June 28, 1991 between the Holders named therein and the NMB Postbank Groep N.V. (Filed as Exhibit 10.48 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.41 Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.42 Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.43 Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.44 Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.45 HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.46 Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.47 Credit Facility Letter dated May 12, 1992 between Arcade Shipping AS and The Chase Manhattan Bank, N.A., as amended on May 14, 1992. (Filed as Exhibit 10.55 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.48 Letter Agreement dated May 12, 1992 between the Registrant and The Chase Manhattan Bank, N.A. regarding undertakings with respect to a credit facility issued as of the same date to Arcade Shipping AS. (Filed as Exhibit 10.56 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.49 Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.50 Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.51 Floating Rate Loan Facility Agreement dated September 19, 1991 between Gade Shipping Corporation, Skandinaviska Enskilda Banken, London Branch and Den norske Bank AS. (Filed as Exhibit 10.58 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.52 Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE FALCON\"). (Filed as Exhibit 10.59 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.53 Bareboat Charter dated September 4, 1991 between K\/S UL Arcade and Arcade Shipping AS (regarding motorvessel \"ARCADE EAGLE\"). (Filed as Exhibit 10.60 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.54 ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between the Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 11 Computation of Earnings Per Common Share\nExhibit 16 Letter re Change in Certifying Accountant (filed as Exhibit 16.1 to the Company's Form 8-K dated December 2, 1992 and incorporated herein by reference).\nExhibit 21 Schedule of Subsidiaries of the Company\nExhibit 23.1 Consent of Arthur Andersen & Co.\nExhibit 23.2 Consent of Coopers & Lybrand\nExhibit 99 Annual Report on Form 11-K with respect to Reading & Bates Savings Plan. (To be filed by amendment.)","section_15":""}
{"filename":"814071_1993.txt","cik":"814071","year":"1993","section_1":"ITEM 1. DESCRIPTION OF BUSINESS:\nHistory\nSunlite Technologies Corp. (the \"Company\"), formerly known as Hospitality Concepts, Inc., is a Delaware Corporation which was organized on December 10, 1986 for the purpose of obtaining capital to participate in business ventures which have potential for profit. The Company's name was changed on March 16, 1990.\nOn December 10, 1986, the Company issued 4.5 million shares of common stock par value $.0001. to officers and directors for $7,350 in cash which is approximately $.001633 per share.\nIn October 1987, the Company successfully completed a public offering of 3,000,000 equity units at a price of $.10, this raised the Company $300,000. Each unit consisted of one share $.0001 par value common stock, one class \"A\" redeemable warrant, and one class \"B\" redeemable warrant.\nIn March 1988, the Company, decided to enter into the Restaurant\/Bakery business, and exchanged all the shares of Bedford Street Bakers Corp. for 4,000,000 shares of its common stock. Bedford Street Bakers Corp. was a restaurant\/bakery which operated under a franchise agreement with \"The Glass Oven International,\" thus becoming a wholly owned subsidiary of the Company. The on going operations were not up to expectations with a shortage of available key personnel, the store shortened its hours of operations and even closed for periods of time when help was not available. This became an unprofitable business venture, and in June 1988, the Company decided to sell its business to a former employee so as to prevent further losses to the Company.\nBedford was originally incorporated and, organized by Fast N' Fancy Foods Inc.. Mr. Scala who since June 1990, has served as President of Sunlite, was also an officer director and principal shareholder of Fast N' Fancy Foods Inc.\nFast N' Fancy Foods Inc. established the operations of Bedford including negotiating the franchise agreement with The Glass Oven International, two years prior to being purchased by Sunlite. The stock of Bedford was, distributed to Fast N' Fancy shareholders.\nOn October 1, 1988, the Company sold an additional one million unregistered common shares, at $.05 per share, to a group of four individuals for an aggregate $50,000. The purpose of this sale was to replenish the Company's available working capital so as to allow it to continue operations and explore other potential business opportunities.\nOn October 18, 1988, the Company found another business opportunity and entered into a license agreement with MJR Co., pursuant to this agreement, the Company would attempt to market a new solar rechargeable battery (\"SRB.\") The Company paid $20,000 to the MJR Company and its principal owners Raymond F. and Mary J. Curiel as a non-refundable deposit on an exclusive licensing agreement for the (\"SRB\") invention, developed by the MJR Company. The parties consummated this agreement on January 6, 1989. At that time the Company Issued 20,000,000 shares of its common stock to Raymond F. and Mary J. Curiel. This original agreement was superseded by a new agreement which became effective on November 30, 1989. The Company had attempted to manufacture and market the (\"SRB\"), first under a licensing agreement with MJR and then in November 1990, the Company purchased all the Issued U.S. Patents and foreign applications pending thereby canceling any, and all agreements with MJR Co. and\/or Raymond Curiel. The success of this endeavor would ultimately depend on the Company's ability to manufacture and market this item as well as obtaining sufficient capital to fund an appropriate business plan. Furthermore, there was no assurance that other products would not be developed by other companies that would be competitive to the Company's \"SRB\" or even render the solar battery obsolete.\nOn May 15, 1991, the Company entered into a manufacturing and joint marketing agreement with Burbud Management Corp. This agreement was to provide the Company with the necessary manufacturing facility in the Dominican Republic. Burbud was to assist Sunlite in developing and coordinating a comprehensive marketing campaign and overall strategy for developing the most effective sales outlets for the product.\nUnder the Burbud agreement, the Company was to issue Burbud Management Corp. 8,000,000 shares of its common stock in lieu of payment for cost of raw materials, tooling up charges, and labor costs for the assembly of the initial production of 20,000 SRB'S. These shares were also intended to cover any future technical improvements to the product developed by Burbud. Since August 1992, the Company issued only 500,000 shares of the 8,000,000 shares of its common stock as partial payment under its agreement with Burbud.\nThrough fiscal year ended November 30, 1993, Burbud had not delivered any additional batteries against its agreement. The Company had tried to obtain the necessary capital to continue its efforts to manufacture and market its \"SRB.\" The Company had explored a few possible licensing arrangements with other Companies and individuals, but nothing had developed from these discussions. However, the Company would pursue this avenue if it were unable to raise the necessary funding needed to continue manufacturing and marketing its \"SRB.\"\nSubsequent to November 30, 1993\nIn August 1995, the Company declared its contract with Burbud void due to the non-performance of the original contract commitment to deliver 20,000 SBR's. However, at present certain disputes continue between the Company and Burbud whereby Burbud has made demands which could obligate the Company to issue up to an additional 1,500,000 shares of its common stock to Burbud for services performed during the term of the contract. Management plans to vigorously fight the issuance of these shares due to damages sustained by the Company in the form of lost \"SRB\" sales. Burbud has not complied with many of the terms of the agreement and management continues to resist any claims by Burbud for additional compensation.\nOn August 30, 1995, the Company entered into a licensing agreement with an individual and received a $5,000 non refundable initial licensing fee. Under the terms of the licensing agreement the Company will also receive a royalty equal to 5% of the gross selling price on such items manufactured and sold by the licensee for all sales up to $1,000,000 and 2% of sales more than $1,000,000. However, the Company will receive a minimum royalty of $1000 per month for a term of sixty months which began in January 1996.\nBetween August 1995 and December 1995, the Company began to look for other business opportunities to enter. In December 1995, the Company purchased from Lewis Scala all the necessary hardware equipment, Galacticomm's World Group software, and all existing telephone connections to run an Online Bulletin Board Service that provides Internet connectivity. The service can handle up to 256 simultaneous users. The most common need for Internet access is to allow users to \"surf the web\" with software such as Netscape, Microsoft explorer and many other \"web\" browsers. The Worldgroup software provides a pass-through SLIP, CSLIP and PPP connections for authorized users. The agreed price was $5,000.\nFrom November 1993 to May 1996, the company has sold 560,000 shares of common unregistered stock to nine individuals at $.025 per share and had raised an additional $14,000.\nPatents.\nThe Company owns three patents in the United States for the \"SRB.\" Patent No. 4,563,727 was issued on January 7, 1986 and Patent No. 4,648,013 was issued on March 3, 1987. These patents together cover all claims for the battery and its applications and adaptations. Patent No. 291,798 was issued September 8, 1987 which covers the ornamental design for the \"D\" size type battery. In addition to the U.S. patents obtained the company has a patent in Mexico.\nTrademark, Service Marks, Trade name and Copyrights.\nThe Company does not have any registered trademarks, service marks, trade names or copyrights in connection with its products.\nEmployees.\nThe Company's only full time personnel is its President.\nCompetition.\nCompetition for the \"SRB\" in the battery business primarily consists of the standard Ni-Cad \"D\" Size batteries as sold nationwide in a wide variety of retail stores. Producers of electrically rechargeable batteries include such established and well-financed companies as General Electric, Saft, Panasonic and Eveready. In addition, there are producers of private-label batteries sold primarily in discount retail outlets. Products and devices have also been designed and are being sold, which provide a recharging capability by use of electricity. The Company believes its \"SRB\" is superior to other chargeable and non chargeable batteries in that the \"SRB\" has the capability of being recharged solely by the sun, or other light source, to maintain its usability while keeping the ability to be recharged electrically and does not require an external power source.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company is occupying office space under an agreement with Lewis Scala, the Company's President to use its present facilities. The Company is paying $500.00 per month rent at this time.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has one legal proceeding threatened by Mr. Gerald Webner, Phoenix, Arizona. Mr. Webner lent the Company $15,000 and has threatened legal action if the money's were not returned to him. The Company has repaid $3000 to date. However, to date, no legal proceedings have been commenced. The Company knows of no other litigation pending, threatened or contemplated, or unsatisfied judgments against it. The Company knows of no legal action pending or threatened or judgments entered against any officers or directors of the Company in their capacity as such.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO a VOTE OF SECURITY HOLDERS\nNo matters were submitted during the fourth quarter of the fiscal year ended November 30, 1993 to a vote of security holders through the solicitation of proxies or otherwise.\nPART 11\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON AND RELATED STOCKHOLDER MATTERS\nThe Company currently has one class of stock outstanding which had been offered to the public in the form of Units. Each Unit had consisted of one share of Common Stock, par value $.0001, one Class A Redeemable Common Stock Purchase Warrant and one Class B Redeemable Common Stock Purchase Warrant. Each Class A Warrant entitles the holder to purchase one share of Common Stock at a price of $.10 per share until November 30, 1996. Each Class B Warrant entitles the holder to purchase one share of Common Stock at a price of $.15 per share until November 30, 1996. These warrants have been extended by approval of the Board of Directors.\nThe Company's securities are not listed in any known quote publication. There is no known trading market for its Units, common and\/or Class \"A\" and \"B\" Warrants.\nThe following table sets forth a range of high low bid quotations as reported by the Market Makers of the Company's stock in 1992:\nFiscal year 1993 Fiscal year 1992\nHigh Bid Low Bid High Bid Low Bid\n1st Quarter $.0 $.0 $.10 $.04\n2nd Quarter .0 $.0 .08 .02\n3rd Quarter .0 $.0 .08 .04\n4th Quarter .0 $.0 .08 .03\nThe above market quotations reflect interdealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nThe number of record holders of Common Stock as of: November 30, 1993 was approximately 275. None of the warrants have been exercised and no trading market exists.\nNo dividends have been declared with respect to the Common Stock since the Company's inception, and the Company does not anticipate paying dividends in the foreseeable future.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS:\nDuring the year ended Nov. 30, 1993, the Company had no gross revenue, as compared to $2,616 gross revenue for the year ending Nov. 30, 1992. During fiscal year 1993 the Company had not received any product against its manufacturing agreement. The total operating expenses were $59,000, of which interest expense amounted to $22,305 as compared to operating expenses of $66,668 in fiscal 1992, of which interest expense amounted to $17,900 for year ended November 30, 1992. The Company had continued its efforts to raise the necessary capital to marketing and manufacture its product. In subsequent events after year ended November 30, 1993 the Company in August 1995, canceled its agreement with BURBUD for the manufacture and marketing of its product. Burbud had not delivered any product during fiscal 1993 and fiscal 1994. In August 1995, the Company entered into a license agreement with an individual for the exclusive marketing and manufacturing rights for the technology covered by the Company's patents. See subsequent notes in financial statements.\nLIQUIDITY AND CAPITAL RESOURCES:\nDuring fiscal 1993, the Company continued to seek the necessary funds for its daily operating expenses. The Company in a private transaction sold stock to two individuals and raised additional working capital, the Company continually tried to raise the necessary capital to produce and assemble the \"SRB.\"\nLate in 1995 the Company decided to explore an alternative way to utilize its \"SRB\" technology. Then in August 1995, the Company entered into a licensing agreement with an individual and has received a $5,000 non refundable initial licensing fee. The Company, under the terms of the agreement, will also receive a royalty equal to 5% of the gross selling price on such items manufactured and sold by the licensee for all sales up to $1,000,000 and 2% of sales over $1,000,000. However, the Company will receive a minimum royalty of $1000 per month for a term of sixty months which began in January, 1996.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements of the Company are included in this Form 10-K:\nFinancial Statements Page\nAuditors' Opinion- -F2\nBalance Sheet-\nStatement of Operations-\nStatement of Stockholder Equity- -F6\nStatement of Cash Flows-\nNotes to Financial Statements- to\nSupplementary Data: None\nITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART 111\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers and directors of the Company are as follows:\nName Age Position\nLewis Scala 49 President and Director\nJohn Somma 41 Secretary-Chairman of the Board of Directors\nAll officers and Directors hold office for one year or until their successors are elected and qualified, unless otherwise specified by the Board of Directors; provided, however, that any officer is subject to removal with or without cause, at any time, by a vote of majority of the Board of Directors.\nPrincipal occupations of the directors and executive officers for at least five years are as follows:\nLewis Scala has served as President and member of the Board of Directors since June 19, 1990. From 1985 to November 1986, Mr. Scala was a stockbroker and security trader with Norbay Securities, Inc. From November 1986 to March 1990 he was employed by Douglas Bremen & Co. Inc., as a stockbroker and security trader. Mr. Scala was President of Fast N' Fancy Foods, Inc. which had operated a fast food restaurant in Stamford, Ct. from Feb. 1983 until Oct. 1990. In Oct. 1990, Fast N' Fancy Foods, Inc., filed for protection under Chapter 11 of The Federal Bankruptcy Law, and on January 11, 1991 the case was dismissed from Chapter 11 proceedings.\nJohn Somma has served as Secretary and Chairman of the Board of Directors from November 13, 1990 to the present, Mr. Somma also served on the board of directors from September 1988 to November 1988. Mr. Somma is currently devoting about 25% of his time to the business affairs of Sunlite, and manages his own personal real estate holdings. From 1979 to 1990, Mr. Somma served as President of Logo Realty Inc. which was a real estate holding Co. Prior to that Mr. Somma has been a consultant to several restaurants.\nITEM 11. EXECUTIVE COMPENSATION\nIn fiscal 1993 Mr. Scala was compensated in the amount of $15,600. No other officers or directors were compensated during fiscal 1993.\nThe Company has no agreement or understanding, express or implied, with any officer or director, or any other person regarding employment with the Company or compensation for services. Compensation of officers and directors is determined by the Company's Board of Directors and is not subject to shareholder approval.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the holdings of common stock by each person who, as of November 30, 1992, held of record or was known by the Company to hold beneficially or of record, more than 5% of the Company's common stock, by each officer and director, and by all officers and directors as a group.\nLewis Scala 8,050,000 shares 21 % John Somma 8,130,000 shares 22 %\nOfficers & Directors as a group ( 3 persons ) 16,180,000 shares 43 %\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn fiscal 1993 the Company leased office space from Mr. Scala at the rate of $500 per month. In October 1993, the Company sold Mr. Scala 1,250,000 of common unregistered stock at the rate of $.01 per share and reduced its total debt liability to Mr. Scala by $12,500.\nPART 1V\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS FORM 8-K\n(a) All financial statements are included commencing on page\nReports on Form 8-K\nNone\nSIGNATURES\nPursuant 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.\nSunlite Technologies Corp.\nBy: \/s\/Lewis Scala Lewis Scala DATE: August 05, 1996 President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDATE: August 05, 1996 By: \/s\/Lewis Scala Lewis Scala President Director\nDATE: August 05, 1996 By: \/s\/John Somma John Somma Secretary Chairman of Board of Directors\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nShareholders and Board of Directors Sunlite Technologies Corp. (a development stage company) Douglaston, New York\nWe have audited the financial statements of Sunlite Technologies Corp. (Delaware Corporation in the development stage) listed in the accompanying index to financial statements and schedules (Item 14 (a)). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nThe financial statements of Sunlite Technologies Corp. As of November 30, 1988 were audited by other auditors whose report dated December 22, 1988 expressed an unqualified opinion on those statements, and has been furnished to us, and our opinion expressed herein so far as it relates to amounts from inception (December 10, 1986) to November 30, 1993 is based in part upon the report of other auditors for the period from inception (December 10, 1986) to November 30, 1988.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion and based upon the report of other auditors, the financial statements listed in the accompanying index to financial statements (ITEM 14 (a)) present fairly in all material respects, the financial position of Sunlite Technologies Corp. As of November 30, 1993 and 1992 and the results of operations and cash flows for each of the three years in the period ended November 30, 1993 and for the period from inception (December 10, 1986) to November 30, 1993 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note (1) to the financial statements, the Company has suffered recurring losses from operations and unaudited information subsequent to November 30, 1993 indicates that losses from operations, primarily from development stage activities are continuing. These losses together with the Company's inability to obtain additional financing, raise a substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note (1). The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.\nRonald Seroda, P.C., C.P.A. Dix Hills, New York January 6, 1996\nBlumenthal Squire & Company Certified Public Accountants 419 Whalley Avenue New Haven, Connecticut 06511\nINDEPENDENT AUDITOR'S REPORT\nTo Sunlite Technologies Corp. (A Development Stage Company)\nWe have audited the statement of Sunlite Technologies Corp. (a Delaware corporation in the development stage) as of November 30, 1988, and the related statements of changes in stockholders' equity, and cash flows for the year ended November 30, 1988 and for the period from inception (December 10, 19986) to November 30, 1988, which are not separtely presented herein. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about weather the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial referred to above present fairly in all material respects, the results of operations, cash flows and changes in stockholders' equity of Sunlite Technologies Corp. for the year ended November 30, 1988 and for the period from inception (December 10, 1086) to November 30, 1988 in conformity with generally accepted accounting principles.\nThe financial statements referred to above have been prepared assuming that the Company will continue as a going concern. Communications with management and with the successor auditor indicate that the Company has suffered recurring losses which raise substantial doubt the Company's ability to continue as a going concern. These financial statements do not include any adjustments that might result should the Company be unable to continue as a going concern.\nBLUMENTHAL SQUIRE & COMPANY\nNew Haven, Connecticut December 22, 1988 and February 27, 1993 as to Subsequent Events\nRef: Letters.4 (Pg. 18)\nSunlite Technologies Corp. (a development stage company) BALANCE SHEETS\nASSETS NOVEMBER 30, 1993 1992\nCurrent assets: Cash $ 19 $ - Accounts receivable - 1,176 Inventory - 137 Prepaid expenses - 1.286 ----- ------ Total current assets 19 2,599\nProperty, plant and equipment: Equipment and fixtures 6,500 6,500 Less accumulated depreciation 4,675 3,375 ----- ----- Property, plant, & equip. net 1,825 3,125\nIntangible assets: Patents at cost 62,030 62,030 Less accumulated amortization 18,670 13,898 ------ ------ Patents, net 43,360 48,132 ------ ------ $ 45,204 $ 53,856 ====== ======\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)\nCurrent liabilities: Accounts payable $ 13,837 $ 21,168 Accrued interest 44,950 28,170 Accrued interest (related parties) 11,879 6,632 Accrued rent (related parties) 1,644 1,500 Payroll taxes payable 2,737 - Notes payable 108,634 123,134 Notes payable (related parties) 50,796 46,525 ------- ------- Total current liabilities 234,477 227,129\nStockholder's equity (deficiency): Common stock $.0001 par value; 500,000,000 shares authorized; 37,000,000 & 34,000,000 shares issued & outstanding in 93 & 92 3,700 3,400 Additional paid in capital 553,820 511,120 Deficit accumulated during development stage (746,793) (687,793) ------- ------- (189,273) (173,273) ------- ------- $ 45,204 $ 53,856 ====== ======\nSunlite Technologies Corp. (a development stage company) STATEMENT OF OPERATIONS For the Years Ended November 30,\nPeriod from Inception Dec. 10, 1986 Through 1993 1992 1991 Nov. 30, 1993 ---- ---- ---- -------------\nRevenues: Sales $ - $ 2,616 $ - $ 12,614 Interest income - - - 3,756 ----- ----- ---- ------ - 2,616 - 16,370 Cost and expenses: Cost of sales 135 2,140 - 22,204 Selling & administrative expenses 58,865 67,144 64,163 341,106 ------ ------ ------ ------- 59,000 66,668 64,163 363,310\nIncome (Loss) before taxes & discontinued operations (59,000) (66,668) (64,163) (346,940)\nIncome taxes - - - 1,269 ------ ----- ------ ------- Income (Loss) from continuing operations (59,000) (66,668) (64,163) (348,209)\nDiscontinued operations: Operating (Loss) from discontinued operations - - - (205,060)\nNet (loss) from sale of discontinued operations - - - (193,524) ------ ------ ------ ------- - - - (398,584) ------- ------ ------ ------- Net loss $(59,000) $(66,668) $(64,163) $(746,793) ====== ====== ====== ======= (Loss) per share from continuing operations $ nil $ nil $ nil $ (.01)\nNet (loss) per share $ nil $ nil $ nil $ (.03)\nSunlite Technologies Corp. (a development stage company) STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)\nSunlite Technologies Corp. (a development stage company) STATEMENT OF CASH FLOWS For The Years Ended November 30,\nSunlite Technologies Corp. (a development stage company) (NOTES TO FINANCIAL STATEMENTS)\nNOTE 1- Organization, History, and going concern assumptions:\nSunlite Technologies Corp., (hereafter referred to as the \"Company\") was incorporated in Delaware on December 10, 1986, for the purpose of obtaining capital to participate in business ventures which have a potential for profit. The Company's name was changed on March, 16, 1990. The Company had attempted to market and manufacture a solar rechargeable battery (\"SRB\") under three patents it purchased (NOTE 5). Subsequent to November 30, 1993, the Company entered into a licencing agreement with an individual (NOTE 11). The success of this endeavor will ultimately depend on the Company's and\/or Licensee's (NOTE 11) ability to market and manufacture this item as well as obtaining sufficient capital to fund an appropriate business plan. Furthermore, there is no assurance that other products would not be developed by other Companies that would be competitive to the Company's \"SRB\" or even render the solar battery obsolete. Also, the Company subsequent to November 30, 1993 has entered into the \"Internet\" business (NOTE 11).\nOn December 10, 1986, the Company issued 4.5 million shares of common stock par value $.0001 to officers and directors for $7,350 in cash which is approximately $.001633 per share.\nOn October 30, 1987, the Company successfully completed a sale of three million equity units at $.10 per unit. The gross proceeds to the Company was $300,000. Each unit consisted of one share of $.0001 par value common stock, one class a redeemable warrant, and one class B redeemable warrant. (NOTE 7) The underwriters compensation in connection with this offering was equal to 10% of the gross proceeds and a non-accountable expense allowance of 3% of the gross proceeds. These items have been charged against paid in capital. In addition, the underwriters received 300,000 warrants to purchase 300,000 shares of the Company's common stock at $.12 per share. These warrants expired July 16, 1992.\nOn March 18 1988, the Company exchanged four million shares of its common stock for all the outstanding shares of Bedford Street Bakers Corp., thus becoming a wholly owned subsidiary of the Company. Management assigned a value of $.05 per share for the four million shares exchanged. Bedford Street Bakers Corp. was a restaurant\/Bakery which operated under a franchise agreement with \"The Glass Oven International\".\nBedford Street Bakers Corp. was originally incorporated and organized by Fast N' Fancy Foods, Inc. Mr. Scala who in June 1990 became a shareholder and president of Sunlite Technologies Corp., was also an Officer and Director and principal shareholder of Fast N' Fancy Foods Inc.\nFast N' Fancy Foods Inc., established the operations of Bedford Street Bakers Corp., two years prior to being purchased by Sunlite. The stock of Bedford was distributed to Fast N' Fancy shareholders.\nFor the period March 18 1988 through June 30 1988, Bedford's on going operations were not as expected. The Bakery\/Restaurant was located in a business district and when the districts main office building lost its major tenant store sales plummeted. Not only were sales off, but with shortage of available key personnel, the store shortened its hours of operation and even closed for periods of time when help was not available. During this period, the Company incurred an operating loss from discontinued operations of $205,060.\nBy the end of May 1988, the Bedford store was placed on the market for sale privately and through several brokers. On June 30 1988, the management with the consent of the Board of Directors of the Company, sold Bedford to a former employee, so as to prevent further losses to the Company. The consideration for the sale was the assumption of all its debt in exchange for the return of its assets and an agreement to indemnify and hold the Company harmless for any and all matters arising from the Company's ownership of Bedford. In addition, the new owners had promised to repay the advances made by the parent in the amount of $221,524 of which $13,000 had been repaid as of November 30, 1988 and an additional $15,000 was repaid in 1989. However, management currently believes that the balance in the amount of $193,524 is currently uncollectible resulting in a loss on disposal of discontinued operations in the amount of $193,524. (Note 4)\nThe Company, on October 1, 1988, sold an additional one million unregistered common shares at $.05 per share to a group of four individuals for an aggregate $50,000. The purpose of this sale was to replenish the Company's available working capital so as to allow it to continue operations and explore other potential business opportunities. Accordingly, on October 18, 1988 the Company found another business opportunity and entered into an agreement with Raymond Curiel and Mary Curiel d\/b\/a MJR Company (NOTE 5.) The Company subsequently purchased three patents from MJR Co. These patents cover certain features which was then the Company's only product: a size \"D\" solar rechargeable battery.\nThe Company at this time remained in the development stage, and entered into several agreements with MJR Company including a licensing agreement, option to purchase the \"SRB\" patents, lease of office space in Scottsdale Arizona and a employment agreement with Mr. Curiel. During fiscal 1989, the Company moved its base of operations from Connecticut to Arizona and paid MJR Co. $11,500 in rent, and did not comply with the terms of the employment agreement (Note 3.) However, late in fiscal 1989, control of the Company had changed. All prior agreements with the Curiels were modified and the Company moved its base of operations to Long Island N.Y. The above resulted in a write off and abandonment of office equipment. Furthermore, all costs, incurred by the Company in the amount of approximately $27,000 during the Curiel's term of management relating to its attempt to raise capital for the manufacture and marketing of the \"SRB\" have been expended and in November 1990, the Company purchased the patents from Raymond Curiel (See NOTE 5.)\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements the Company has suffered recurring losses of approximately $746,793 from inception through November 30, 1993. As of November 30 1993, total liabilities exceeded total assets by $189,273 and the Company had defaulted in note payments and interest due on these notes in the amount of $216,259. These factors as well as the uncertainty that the Company's licensing agreement and new business venture will ultimately be profitable raise an uncertainty about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recovery and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.\nIn response, the Company in a subsequent event has licensed its technology to an individual (NOTE 11) The minimum royalty payment will give the Company a temporary cash flow and will allow the Company to pursue its new business venture. The Company is also considering a debt equity swap to its note holders but no definite terms have been formulated as yet. It is impossible to determine if any of the above will be successful and management has not ruled out the possibility to seek protection under chapter 11 of the Federal Bankruptcy act.\nNOTE 2- Significant Accounting Policies:\nThe financial statements presented herein are of a development stage company. Therefore, the form and context conform to the accounting principles governing a development stage company.\nStock Offering Costs: Stock offering costs incurred in connection with the sale of common stock have been charged against paid in capital.\nRevenue recognition: Revenue and accounts receivable are recorded only when products are shipped (Accrual basis)\nInventory: Inventory is carried at cost on a first in first out basis.\nNet Loss per Common share: Net loss per common share has been computed based on the weighted average number of shares outstanding during each period.\nReclassifications: Certain amounts in prior years have been reclassified to conform to the current year's presentation.\nFixed Assets: Fixed assets are stated at cost. Maintenance and repairs are expended as incurred. When fixed assets are disposed, the related cost and reserve for depreciation are removed from the respective accounts, and any gains or losses are included in income.\nDepreciation: is computed on the straight line-method.\nPatent License & Purchase Agreement (NOTE 5): The patent was purchased in fiscal year November 30, 1990 and is recorded at cost plus the unamortized cost of the license agreement and the cost of the option. Amortization is provided on a straight line basis over 13 years.\nFair value: Assets and liabilities are recorded at cost with the exception of the patent (note 5) and the historical cost approximates fair value. However, if the Company was forced to liquidate it would be very unlikely that the Company would realize any of the unamortized patent cost of $43,360.\nNOTE 3- Employment contract- termination:\nIn fiscal year ending November 30, 1989, the Company had advanced $32,407 to MJR Co. The company had defaulted on the original licensing agreement dated October 18, 1988 (Note 5,) and an employment agreement dated January 6, 1989. In settlement and consideration to the MJR Co. for entering a new and final license agreement dated November 30, 1989 as fully described in Note 5, the above amount of $32,407 was applied by management against a two year employment contract in which Mr. Curiel was to receive $5,000 per month.\nNOTE 4- Loss on Discontinued Operations:\nOn March 18, 1988, the Company acquired all the shares of Bedford Street Bakers Corp. in exchange for four million shares of its own common stock valued at $.05 per share. On June 30, 1988, the Company disposed of its investment by transferring to a former employee all of the issued and outstanding shares of Bedford for the consideration of $1.00 and the promise to be indemnified and held harmless against any and all matters arising from the Company's ownership of Bedford. In addition, Bedford promised to repay $221,524 of advances made by the Company to Bedford.\nFrom the period March 18, 1988 through June 30, 1988, the Company incurred an operating loss from discontinued operations in the amount of $205,060, which approximately equals the Company's investment in Bedford, and a loss on the sale from discontinued operations in the amount of $193,524 when the Company only received $28,000 of the original $221,524 Bedford promised to repay. The amount of $193,524 management currently believes to be uncollectible.\nNOTE 5- Licensing Agreement and Purchase of Patents:\nOn October 18, 1988, the Company paid $20,000 to Raymond and Mary Curiel d\/b\/a MJR Company of Scottsdale, Arizona as a non-refundable deposit on an exclusive licensing agreement for a patented invention (Solar Rechargeable Battery) developed and invented by Raymond Curiel. The parties consummated an agreement in January, 1989. This agreement called for the issuance of 20,000,000 shares of the Company's stock to MJR Co. for this exclusive license, and an option to purchase all the patents issued, and foreign applications then pending in connection with the solar rechargeable battery. The shares issued in the above agreement were valued at par value and resulted in a nominal increase in stockholders equity of $2,000. Management assigned a nominal value to the shares issued in the above transaction for the following reasons:\n1) During fiscal year November 30, 1989, unlike in fiscal year 1987, no ready market existed for the registrant's common shares compounded by the fact that the shares issued were restricted and unregistered. Therefore, the fair market value of the consideration given in this transaction could not be readily determined.\n2) Furthermore, management could not reasonably ascertain the fair market value of the licensing agreement, and option to purchase the patent since no similar product currently exists.\nThe value of the above assets depend largely on how well the Company manufacturers and markets this product in the future. Therefore, these assets were recorded on the Company's balance sheet at cost in cash plus par value of the stock issued. This required the Company\nto pay an additional $20,000 in licensing fees to MJR Co. until the option to purchase the patent was exercised. The agreement of November 30, 1989 was revised on November 23, 1990. The Company under this agreement purchased all the issued U.S. Patents and all foreign applications pending from MJR for a cash payment of $40,000 and the issuance of 300,000 shares of its common unregistered stock. The Company valued these shares at par value for the same reason as stated earlier when the Company issued its common shares in consideration for the license agreement. Furthermore, all prior agreements by and between the Company and MJR and\/or the Curiels were canceled.\nThe patent cost is determined as follows:\nCash paid for deposit $ 20,000 Par value common shares issued for option to purchase patents 2,000 Cash paid for purchase of patents 40,000 Par value common shares issued for purchase of patents 30 ------ Total cost $ 62,030 ======\nNOTE 6 - Notes Payable: 1993 1992 ---- ---- Due and in default as of March 31, 1990. Interest at 18% per annum.. $ 12,000 $ 12,000\nDue shareholder in default as of August 30, 1990 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 12% per annum.. 50,000 50,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 5,000 5,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 2,000 2,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 4,945 4,945\nDue shareholder June 30, 1993 Interest at 10% per annum.. 4,689 19,189 ------- ------- $ 108,634 $ 123,134 ======= =======\nDuring 1993, only one note holder agreed to extend its due date until June 30, 1993. The balance of the notes are in default.\nNotes Payable-Related Parties\nDue and payable to Officers & Directors June 30, 1993 (John Somma) Interest at 10% per annum.. $ 13,850 $ 12,850\nDue and payable to Officers & Directors June 30, 1993 (Lew Scala) Interest at 10 % per annum 36,946 32,675 ----- ------ $ 50,796 $ 46,525 ====== ======\nInterest expense totaled $22,305, $17,900 and $14,623 in 1993, 1992 and 1991, respectively. The average effective rate of interest was 12%, 11% and 11% in 1993, 1992 and 1991, respectively.\nNOTE 7- Common Stock- Warrants:\nThe Company currently has one class of stock outstanding which had been offered to the public in the form of a unit. Each unit consisted of one share common stock, par value $.0001, one class a redeemable common stock purchase warrant and one class B redeemable common stock purchase warrant. Each class a warrant entitles the holder to purchase one share of common stock at a price of $.10 until Nov. 30, 1993. Each class B warrant entitles the holder to purchase one share of common stock at a price of $.15 until Nov. 30, 1994. The Redeemable Warrants are redeemable by the Company upon 30 days prior written notice. The redemption price is $.0001 per Warrant for both the Class a and Class B warrants.\nNOTE 8- Income Taxes:\nAt November 30, 1993, the Company had a net operating loss carry forward for financial accounting purposes of approximately $746,192. Theses carry forwards expire through the year 2008. Such carry forwards for federal income tax purpose are approximately only $281,541, and will be available to offset future \"ordinary\" taxable income. In addition, the Company had a capital loss carry forward for federal income tax of approximately $440,991 which had expired. The difference between the accounting loss and that for federal income taxes is due to the fact that the write off of Bedford is a capital transaction for federal tax purposes and therefore could only be used to offset capital gains. Since the capital loss in the amount of $430,991 expired for federal income tax purposes, no other material timing difference exists between accounting and tax income. The Company did not pay any federal income tax during fiscal years ending November 30, 1993, 1992, and 1991 and the tax expense, as reflected herein, is for state and local taxes only.\nStatements of Financial Accounting Standards (SFAS) No. 109 has been issued regarding accounting for income taxes. The statement, as amended, is effective for fiscal years beginning after December 15, 1992. The Company is required to implement SFAS No. 109 for its fiscal year ending November 30, 1994. The effect on the Company's reported financial position and results of operations resulting from the implementation of SFAS No. 96 has not yet been quantified by the Company.\nNOTE 9- Commitments:\nOn May 15, 1991, the Company entered into an agreement with Burbud Management Corp.(\"Burbud\") Burbud is organized under the laws of Panama and its U.S. location is New Rochelle, NY. Pursuant to this agreement, the Company will issue 8,000,000 shares of its common unregistered stock to \"Burbud\" in lieu of payment for the initial production of 20,000 solar rechargeable batteries(\"SRB\") In addition \"Burbud\" will provide future research and product development of the \"SRB\" as well as assisting in the marketing of the product. As of November 30, 1993, the Company received 1,250 \"SRB'S\" from Burbud and in partial consideration for the above the Company issued 500,000 shares of its common unregistered stock. The Company values the transaction at the fair market value of the consideration received and estimates the cost of each battery at the cost the Company could have purchased and assembled them in the United States (Replacement costs) During fiscal year ending November 30, 1993 Burbud did not deliver any product against its commitment. (See Note 11)\nNOTE 10- Other Related Party Transactions:\nIn fiscal 1993 the Company leased office space from Mr. Scala at a rate of $500.00 per month. Mr. Scala was compensated during fiscal year 1993 in the amount of $15,600. The Company continues to borrow money from Mr. Somma and Mr. Scala to fund the daily operations of the Company. Mr. Somma and Mr. Scala are officers, directors and principal shareholders of the Company. In October 1993 the Company sold Mr. Scala 1,250,000 of common stock at the rate of $.01 per share and reduced its total debt liability to Mr. Scala by $12,500.\nNOTE 11- Subsequent Events:\nIn August 1995, the Company considered it's contract with Burbud void and has terminated it due to the no performance clause in the original contract. However, the Company may be obligated to issue an additional 1,500,000 shares of it's common unregistered stock to Burbud for services performed during the duration of the contract. The Company would vigorously fight the issuance of these shares due to damages in the form of lost \"SRB\" sales. Burbud has not substantially complied with many of the terms of the entire agreement.\nOn August 30, 1995, the Company entered into a licensing agreement with an individual and has received a $5,000 non refundable initial licensing fee. The Company, under the terms of the agreement, will also receive a royalty equal to 5% of the gross selling price on such items manufactured and sold by the licensee for all sales up to $1,000,000 and 2% of sales over $1,000,000. However, the Company will receive a minimum royalty of $1000 per month for a term of sixty months which began in January, 1996.\nBetween August 1995 and December 1995, the Company began to look for other business opportunities to enter. In December 1995, the Company purchased from Lewis Scala all the necessary hardware equipment, Galacticomm's WorldGroup software, and all existing telephone connections to run an Online Bulletin Board Service that provides Internet connectivity. The service can handle up to 256 simultaneous users. The most common need for Internet access is to allow users to \"surf the web\" with software such as Netscape, Microsoft explorer and many other \"web\" browsers. The Worldgroup software provides a pass-through SLIP, CSLIP and PPP connections for authorized users. The agreed price was $5,000.\nFrom November 1993 to May 1996, the company has sold 560,000 shares of common unregistered stock to 9 individuals at $.025 per share and had raised an additional $14,000.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS:\nDuring the year ended Nov. 30, 1993, the Company had no gross revenue, as compared to $2,616 gross revenue for the year ending Nov. 30, 1992. During fiscal year 1993 the Company had not received any product against its manufacturing agreement. The total operating expenses were $59,000, of which interest expense amounted to $22,305 as compared to operating expenses of $66,668 in fiscal 1992, of which interest expense amounted to $17,900 for year ended November 30, 1992. The Company had continued its efforts to raise the necessary capital to marketing and manufacture its product. In subsequent events after year ended November 30, 1993 the Company in August 1995, canceled its agreement with BURBUD for the manufacture and marketing of its product. Burbud had not delivered any product during fiscal 1993 and fiscal 1994. In August 1995, the Company entered into a license agreement with an individual for the exclusive marketing and manufacturing rights for the technology covered by the Company's patents. See subsequent notes in financial statements.\nLIQUIDITY AND CAPITAL RESOURCES:\nDuring fiscal 1993, the Company continued to seek the necessary funds for its daily operating expenses. The Company in a private transaction sold stock to two individuals and raised additional working capital, the Company continually tried to raise the necessary capital to produce and assemble the \"SRB.\"\nLate in 1995 the Company decided to explore an alternative way to utilize its \"SRB\" technology. Then in August 1995, the Company entered into a licensing agreement with an individual and has received a $5,000 non refundable initial licensing fee. The Company, under the terms of the agreement, will also receive a royalty equal to 5% of the gross selling price on such items manufactured and sold by the licensee for all sales up to $1,000,000 and 2% of sales over $1,000,000. However, the Company will receive a minimum royalty of $1000 per month for a term of sixty months which began in January, 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements of the Company are included in this Form 10-K:\nFinancial Statements Page\nAuditors' Opinion- -F2\nBalance Sheet-\nStatement of Operations-\nStatement of Stockholder Equity- -F6\nStatement of Cash Flows-\nNotes to Financial Statements- to\nSupplementary Data: None\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART 111\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers and directors of the Company are as follows:\nName Age Position\nLewis Scala 49 President and Director\nJohn Somma 41 Secretary-Chairman of the Board of Directors\nAll officers and Directors hold office for one year or until their successors are elected and qualified, unless otherwise specified by the Board of Directors; provided, however, that any officer is subject to removal with or without cause, at any time, by a vote of majority of the Board of Directors.\nPrincipal occupations of the directors and executive officers for at least five years are as follows:\nLewis Scala has served as President and member of the Board of Directors since June 19, 1990. From 1985 to November 1986, Mr. Scala was a stockbroker and security trader with Norbay Securities, Inc. From November 1986 to March 1990 he was employed by Douglas Bremen & Co. Inc., as a stockbroker and security trader. Mr. Scala was President of Fast N' Fancy Foods, Inc. which had operated a fast food restaurant in Stamford, Ct. from Feb. 1983 until Oct. 1990. In Oct. 1990, Fast N' Fancy Foods, Inc., filed for protection under Chapter 11 of The Federal Bankruptcy Law, and on January 11, 1991 the case was dismissed from Chapter 11 proceedings.\nJohn Somma has served as Secretary and Chairman of the Board of Directors from November 13, 1990 to the present, Mr. Somma also served on the board of directors from September 1988 to November 1988. Mr. Somma is currently devoting about 25% of his time to the business affairs of Sunlite, and manages his own personal real estate holdings. From 1979 to 1990, Mr. Somma served as President of Logo Realty Inc. which was a real estate holding Co. Prior to that Mr. Somma has been a consultant to several restaurants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIn fiscal 1993 Mr. Scala was compensated in the amount of $15,600. No other officers or directors were compensated during fiscal 1993.\nThe Company has no agreement or understanding, express or implied, with any officer or director, or any other person regarding employment with the Company or compensation for services. Compensation of officers and directors is determined by the Company's Board of Directors and is not subject to shareholder approval.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the holdings of common stock by each person who, as of November 30, 1992, held of record or was known by the Company to hold beneficially or of record, more than 5% of the Company's common stock, by each officer and director, and by all officers and directors as a group.\nLewis Scala 8,050,000 shares 21 % John Somma 8,130,000 shares 22 %\nOfficers & Directors as a group ( 3 persons ) 16,180,000 shares 43 %\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn fiscal 1993 the Company leased office space from Mr. Scala at the rate of $500 per month. In October 1993, the Company sold Mr. Scala 1,250,000 of common unregistered stock at the rate of $.01 per share and reduced its total debt liability to Mr. Scala by $12,500.\nPART 1V\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS FORM 8-K\n(a) All financial statements are included commencing on page\nReports on Form 8-K\nNone\nSIGNATURES\nPursuant 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.\nSunlite Technologies Corp.\nBy: \/s\/Lewis Scala Lewis Scala DATE: August 05, 1996 President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDATE: August 05, 1996 By: \/s\/Lewis Scala Lewis Scala President Director\nDATE: August 05, 1996 By: \/s\/John Somma John Somma Secretary Chairman of Board of Directors\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nShareholders and Board of Directors Sunlite Technologies Corp. (a development stage company) Douglaston, New York\nWe have audited the financial statements of Sunlite Technologies Corp. (Delaware Corporation in the development stage) listed in the accompanying index to financial statements and schedules (Item 14 (a)). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nThe financial statements of Sunlite Technologies Corp. As of November 30, 1988 were audited by other auditors whose report dated December 22, 1988 expressed an unqualified opinion on those statements, and has been furnished to us, and our opinion expressed herein so far as it relates to amounts from inception (December 10, 1986) to November 30, 1993 is based in part upon the report of other auditors for the period from inception (December 10, 1986) to November 30, 1988.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion and based upon the report of other auditors, the financial statements listed in the accompanying index to financial statements (ITEM 14 (a)) present fairly in all material respects, the financial position of Sunlite Technologies Corp. As of November 30, 1993 and 1992 and the results of operations and cash flows for each of the three years in the period ended November 30, 1993 and for the period from inception (December 10, 1986) to November 30, 1993 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note (1) to the financial statements, the Company has suffered recurring losses from operations and unaudited information subsequent to November 30, 1993 indicates that losses from operations, primarily from development stage activities are continuing. These losses together with the Company's inability to obtain additional financing, raise a substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note (1). The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.\nRonald Seroda, P.C., C.P.A. Dix Hills, New York January 6, 1996\nBlumenthal Squire & Company Certified Public Accountants 419 Whalley Avenue New Haven, Connecticut 06511\nINDEPENDENT AUDITOR'S REPORT\nTo Sunlite Technologies Corp. (A Development Stage Company)\nWe have audited the statement of Sunlite Technologies Corp. (a Delaware corporation in the development stage) as of November 30, 1988, and the related statements of changes in stockholders' equity, and cash flows for the year ended November 30, 1988 and for the period from inception (December 10, 19986) to November 30, 1988, which are not separtely presented herein. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about weather the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial referred to above present fairly in all material respects, the results of operations, cash flows and changes in stockholders' equity of Sunlite Technologies Corp. for the year ended November 30, 1988 and for the period from inception (December 10, 1086) to November 30, 1988 in conformity with generally accepted accounting principles.\nThe financial statements referred to above have been prepared assuming that the Company will continue as a going concern. Communications with management and with the successor auditor indicate that the Company has suffered recurring losses which raise substantial doubt the Company's ability to continue as a going concern. These financial statements do not include any adjustments that might result should the Company be unable to continue as a going concern.\nBLUMENTHAL SQUIRE & COMPANY\nNew Haven, Connecticut December 22, 1988 and February 27, 1993 as to Subsequent Events\nRef: Letters.4 (Pg. 18)\nSunlite Technologies Corp. (a development stage company) BALANCE SHEETS\nASSETS NOVEMBER 30, 1993 1992\nCurrent assets: Cash $ 19 $ - Accounts receivable - 1,176 Inventory - 137 Prepaid expenses - 1.286 ----- ------ Total current assets 19 2,599\nProperty, plant and equipment: Equipment and fixtures 6,500 6,500 Less accumulated depreciation 4,675 3,375 ----- ----- Property, plant, & equip. net 1,825 3,125\nIntangible assets: Patents at cost 62,030 62,030 Less accumulated amortization 18,670 13,898 ------ ------ Patents, net 43,360 48,132 ------ ------ $ 45,204 $ 53,856 ====== ======\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)\nCurrent liabilities: Accounts payable $ 13,837 $ 21,168 Accrued interest 44,950 28,170 Accrued interest (related parties) 11,879 6,632 Accrued rent (related parties) 1,644 1,500 Payroll taxes payable 2,737 - Notes payable 108,634 123,134 Notes payable (related parties) 50,796 46,525 ------- ------- Total current liabilities 234,477 227,129\nStockholder's equity (deficiency): Common stock $.0001 par value; 500,000,000 shares authorized; 37,000,000 & 34,000,000 shares issued & outstanding in 93 & 92 3,700 3,400 Additional paid in capital 553,820 511,120 Deficit accumulated during development stage (746,793) (687,793) ------- ------- (189,273) (173,273) ------- ------- $ 45,204 $ 53,856 ====== ======\nSunlite Technologies Corp. (a development stage company) STATEMENT OF OPERATIONS For the Years Ended November 30,\nPeriod from Inception Dec. 10, 1986 Through 1993 1992 1991 Nov. 30, 1993 ---- ---- ---- -------------\nRevenues: Sales $ - $ 2,616 $ - $ 12,614 Interest income - - - 3,756 ----- ----- ---- ------ - 2,616 - 16,370 Cost and expenses: Cost of sales 135 2,140 - 22,204 Selling & administrative expenses 58,865 67,144 64,163 341,106 ------ ------ ------ ------- 59,000 66,668 64,163 363,310\nIncome (Loss) before taxes & discontinued operations (59,000) (66,668) (64,163) (346,940)\nIncome taxes - - - 1,269 ------ ----- ------ ------- Income (Loss) from continuing operations (59,000) (66,668) (64,163) (348,209)\nDiscontinued operations: Operating (Loss) from discontinued operations - - - (205,060)\nNet (loss) from sale of discontinued operations - - - (193,524) ------ ------ ------ ------- - - - (398,584) ------- ------ ------ ------- Net loss $(59,000) $(66,668) $(64,163) $(746,793) ====== ====== ====== ======= (Loss) per share from continuing operations $ nil $ nil $ nil $ (.01)\nNet (loss) per share $ nil $ nil $ nil $ (.03)\nSunlite Technologies Corp. (a development stage company) STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)\nSunlite Technologies Corp. (a development stage company) STATEMENT OF CASH FLOWS For The Years Ended November 30,\nSunlite Technologies Corp. (a development stage company) (NOTES TO FINANCIAL STATEMENTS)\nNOTE 1- Organization, History, and going concern assumptions:\nSunlite Technologies Corp., (hereafter referred to as the \"Company\") was incorporated in Delaware on December 10, 1986, for the purpose of obtaining capital to participate in business ventures which have a potential for profit. The Company's name was changed on March, 16, 1990. The Company had attempted to market and manufacture a solar rechargeable battery (\"SRB\") under three patents it purchased (NOTE 5). Subsequent to November 30, 1993, the Company entered into a licencing agreement with an individual (NOTE 11). The success of this endeavor will ultimately depend on the Company's and\/or Licensee's (NOTE 11) ability to market and manufacture this item as well as obtaining sufficient capital to fund an appropriate business plan. Furthermore, there is no assurance that other products would not be developed by other Companies that would be competitive to the Company's \"SRB\" or even render the solar battery obsolete. Also, the Company subsequent to November 30, 1993 has entered into the \"Internet\" business (NOTE 11).\nOn December 10, 1986, the Company issued 4.5 million shares of common stock par value $.0001 to officers and directors for $7,350 in cash which is approximately $.001633 per share.\nOn October 30, 1987, the Company successfully completed a sale of three million equity units at $.10 per unit. The gross proceeds to the Company was $300,000. Each unit consisted of one share of $.0001 par value common stock, one class a redeemable warrant, and one class B redeemable warrant. (NOTE 7) The underwriters compensation in connection with this offering was equal to 10% of the gross proceeds and a non-accountable expense allowance of 3% of the gross proceeds. These items have been charged against paid in capital. In addition, the underwriters received 300,000 warrants to purchase 300,000 shares of the Company's common stock at $.12 per share. These warrants expired July 16, 1992.\nOn March 18 1988, the Company exchanged four million shares of its common stock for all the outstanding shares of Bedford Street Bakers Corp., thus becoming a wholly owned subsidiary of the Company. Management assigned a value of $.05 per share for the four million shares exchanged. Bedford Street Bakers Corp. was a restaurant\/Bakery which operated under a franchise agreement with \"The Glass Oven International\".\nBedford Street Bakers Corp. was originally incorporated and organized by Fast N' Fancy Foods, Inc. Mr. Scala who in June 1990 became a shareholder and president of Sunlite Technologies Corp., was also an Officer and Director and principal shareholder of Fast N' Fancy Foods Inc.\nFast N' Fancy Foods Inc., established the operations of Bedford Street Bakers Corp., two years prior to being purchased by Sunlite. The stock of Bedford was distributed to Fast N' Fancy shareholders.\nFor the period March 18 1988 through June 30 1988, Bedford's on going operations were not as expected. The Bakery\/Restaurant was located in a business district and when the districts main office building lost its major tenant store sales plummeted. Not only were sales off, but with shortage of available key personnel, the store shortened its hours of operation and even closed for periods of time when help was not available. During this period, the Company incurred an operating loss from discontinued operations of $205,060.\nBy the end of May 1988, the Bedford store was placed on the market for sale privately and through several brokers. On June 30 1988, the management with the consent of the Board of Directors of the Company, sold Bedford to a former employee, so as to prevent further losses to the Company. The consideration for the sale was the assumption of all its debt in exchange for the return of its assets and an agreement to indemnify and hold the Company harmless for any and all matters arising from the Company's ownership of Bedford. In addition, the new owners had promised to repay the advances made by the parent in the amount of $221,524 of which $13,000 had been repaid as of November 30, 1988 and an additional $15,000 was repaid in 1989. However, management currently believes that the balance in the amount of $193,524 is currently uncollectible resulting in a loss on disposal of discontinued operations in the amount of $193,524. (Note 4)\nThe Company, on October 1, 1988, sold an additional one million unregistered common shares at $.05 per share to a group of four individuals for an aggregate $50,000. The purpose of this sale was to replenish the Company's available working capital so as to allow it to continue operations and explore other potential business opportunities. Accordingly, on October 18, 1988 the Company found another business opportunity and entered into an agreement with Raymond Curiel and Mary Curiel d\/b\/a MJR Company (NOTE 5.) The Company subsequently purchased three patents from MJR Co. These patents cover certain features which was then the Company's only product: a size \"D\" solar rechargeable battery.\nThe Company at this time remained in the development stage, and entered into several agreements with MJR Company including a licensing agreement, option to purchase the \"SRB\" patents, lease of office space in Scottsdale Arizona and a employment agreement with Mr. Curiel. During fiscal 1989, the Company moved its base of operations from Connecticut to Arizona and paid MJR Co. $11,500 in rent, and did not comply with the terms of the employment agreement (Note 3.) However, late in fiscal 1989, control of the Company had changed. All prior agreements with the Curiels were modified and the Company moved its base of operations to Long Island N.Y. The above resulted in a write off and abandonment of office equipment. Furthermore, all costs, incurred by the Company in the amount of approximately $27,000 during the Curiel's term of management relating to its attempt to raise capital for the manufacture and marketing of the \"SRB\" have been expended and in November 1990, the Company purchased the patents from Raymond Curiel (See NOTE 5.)\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements the Company has suffered recurring losses of approximately $746,793 from inception through November 30, 1993. As of November 30 1993, total liabilities exceeded total assets by $189,273 and the Company had defaulted in note payments and interest due on these notes in the amount of $216,259. These factors as well as the uncertainty that the Company's licensing agreement and new business venture will ultimately be profitable raise an uncertainty about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recovery and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.\nIn response, the Company in a subsequent event has licensed its technology to an individual (NOTE 11) The minimum royalty payment will give the Company a temporary cash flow and will allow the Company to pursue its new business venture. The Company is also considering a debt equity swap to its note holders but no definite terms have been formulated as yet. It is impossible to determine if any of the above will be successful and management has not ruled out the possibility to seek protection under chapter 11 of the Federal Bankruptcy act.\nNOTE 2- Significant Accounting Policies:\nThe financial statements presented herein are of a development stage company. Therefore, the form and context conform to the accounting principles governing a development stage company.\nStock Offering Costs: Stock offering costs incurred in connection with the sale of common stock have been charged against paid in capital.\nRevenue recognition: Revenue and accounts receivable are recorded only when products are shipped (Accrual basis)\nInventory: Inventory is carried at cost on a first in first out basis.\nNet Loss per Common share: Net loss per common share has been computed based on the weighted average number of shares outstanding during each period.\nReclassifications: Certain amounts in prior years have been reclassified to conform to the current year's presentation.\nFixed Assets: Fixed assets are stated at cost. Maintenance and repairs are expended as incurred. When fixed assets are disposed, the related cost and reserve for depreciation are removed from the respective accounts, and any gains or losses are included in income.\nDepreciation: is computed on the straight line-method.\nPatent License & Purchase Agreement (NOTE 5): The patent was purchased in fiscal year November 30, 1990 and is recorded at cost plus the unamortized cost of the license agreement and the cost of the option. Amortization is provided on a straight line basis over 13 years.\nFair value: Assets and liabilities are recorded at cost with the exception of the patent (note 5) and the historical cost approximates fair value. However, if the Company was forced to liquidate it would be very unlikely that the Company would realize any of the unamortized patent cost of $43,360.\nNOTE 3- Employment contract- termination:\nIn fiscal year ending November 30, 1989, the Company had advanced $32,407 to MJR Co. The company had defaulted on the original licensing agreement dated October 18, 1988 (Note 5,) and an employment agreement dated January 6, 1989. In settlement and consideration to the MJR Co. for entering a new and final license agreement dated November 30, 1989 as fully described in Note 5, the above amount of $32,407 was applied by management against a two year employment contract in which Mr. Curiel was to receive $5,000 per month.\nNOTE 4- Loss on Discontinued Operations:\nOn March 18, 1988, the Company acquired all the shares of Bedford Street Bakers Corp. in exchange for four million shares of its own common stock valued at $.05 per share. On June 30, 1988, the Company disposed of its investment by transferring to a former employee all of the issued and outstanding shares of Bedford for the consideration of $1.00 and the promise to be indemnified and held harmless against any and all matters arising from the Company's ownership of Bedford. In addition, Bedford promised to repay $221,524 of advances made by the Company to Bedford.\nFrom the period March 18, 1988 through June 30, 1988, the Company incurred an operating loss from discontinued operations in the amount of $205,060, which approximately equals the Company's investment in Bedford, and a loss on the sale from discontinued operations in the amount of $193,524 when the Company only received $28,000 of the original $221,524 Bedford promised to repay. The amount of $193,524 management currently believes to be uncollectible.\nNOTE 5- Licensing Agreement and Purchase of Patents:\nOn October 18, 1988, the Company paid $20,000 to Raymond and Mary Curiel d\/b\/a MJR Company of Scottsdale, Arizona as a non-refundable deposit on an exclusive licensing agreement for a patented invention (Solar Rechargeable Battery) developed and invented by Raymond Curiel. The parties consummated an agreement in January, 1989. This agreement called for the issuance of 20,000,000 shares of the Company's stock to MJR Co. for this exclusive license, and an option to purchase all the patents issued, and foreign applications then pending in connection with the solar rechargeable battery. The shares issued in the above agreement were valued at par value and resulted in a nominal increase in stockholders equity of $2,000. Management assigned a nominal value to the shares issued in the above transaction for the following reasons:\n1) During fiscal year November 30, 1989, unlike in fiscal year 1987, no ready market existed for the registrant's common shares compounded by the fact that the shares issued were restricted and unregistered. Therefore, the fair market value of the consideration given in this transaction could not be readily determined.\n2) Furthermore, management could not reasonably ascertain the fair market value of the licensing agreement, and option to purchase the patent since no similar product currently exists.\nThe value of the above assets depend largely on how well the Company manufacturers and markets this product in the future. Therefore, these assets were recorded on the Company's balance sheet at cost in cash plus par value of the stock issued. This required the Company\nto pay an additional $20,000 in licensing fees to MJR Co. until the option to purchase the patent was exercised. The agreement of November 30, 1989 was revised on November 23, 1990. The Company under this agreement purchased all the issued U.S. Patents and all foreign applications pending from MJR for a cash payment of $40,000 and the issuance of 300,000 shares of its common unregistered stock. The Company valued these shares at par value for the same reason as stated earlier when the Company issued its common shares in consideration for the license agreement. Furthermore, all prior agreements by and between the Company and MJR and\/or the Curiels were canceled.\nThe patent cost is determined as follows:\nCash paid for deposit $ 20,000 Par value common shares issued for option to purchase patents 2,000 Cash paid for purchase of patents 40,000 Par value common shares issued for purchase of patents 30 ------ Total cost $ 62,030 ======\nNOTE 6 - Notes Payable: 1993 1992 ---- ---- Due and in default as of March 31, 1990. Interest at 18% per annum.. $ 12,000 $ 12,000\nDue shareholder in default as of August 30, 1990 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 12% per annum.. 50,000 50,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 5,000 5,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 10,000 10,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 2,000 2,000\nDue shareholder in default as of June 30, 1992 Interest at 10% per annum.. 4,945 4,945\nDue shareholder June 30, 1993 Interest at 10% per annum.. 4,689 19,189 ------- ------- $ 108,634 $ 123,134 ======= =======\nDuring 1993, only one note holder agreed to extend its due date until June 30, 1993. The balance of the notes are in default.\nNotes Payable-Related Parties\nDue and payable to Officers & Directors June 30, 1993 (John Somma) Interest at 10% per annum.. $ 13,850 $ 12,850\nDue and payable to Officers & Directors June 30, 1993 (Lew Scala) Interest at 10 % per annum 36,946 32,675 ----- ------ $ 50,796 $ 46,525 ====== ======\nInterest expense totaled $22,305, $17,900 and $14,623 in 1993, 1992 and 1991, respectively. The average effective rate of interest was 12%, 11% and 11% in 1993, 1992 and 1991, respectively.\nNOTE 7- Common Stock- Warrants:\nThe Company currently has one class of stock outstanding which had been offered to the public in the form of a unit. Each unit consisted of one share common stock, par value $.0001, one class a redeemable common stock purchase warrant and one class B redeemable common stock purchase warrant. Each class a warrant entitles the holder to purchase one share of common stock at a price of $.10 until Nov. 30, 1993. Each class B warrant entitles the holder to purchase one share of common stock at a price of $.15 until Nov. 30, 1994. The Redeemable Warrants are redeemable by the Company upon 30 days prior written notice. The redemption price is $.0001 per Warrant for both the Class a and Class B warrants.\nNOTE 8- Income Taxes:\nAt November 30, 1993, the Company had a net operating loss carry forward for financial accounting purposes of approximately $746,192. Theses carry forwards expire through the year 2008. Such carry forwards for federal income tax purpose are approximately only $281,541, and will be available to offset future \"ordinary\" taxable income. In addition, the Company had a capital loss carry forward for federal income tax of approximately $440,991 which had expired. The difference between the accounting loss and that for federal income taxes is due to the fact that the write off of Bedford is a capital transaction for federal tax purposes and therefore could only be used to offset capital gains. Since the capital loss in the amount of $430,991 expired for federal income tax purposes, no other material timing difference exists between accounting and tax income. The Company did not pay any federal income tax during fiscal years ending November 30, 1993, 1992, and 1991 and the tax expense, as reflected herein, is for state and local taxes only.\nStatements of Financial Accounting Standards (SFAS) No. 109 has been issued regarding accounting for income taxes. The statement, as amended, is effective for fiscal years beginning after December 15, 1992. The Company is required to implement SFAS No. 109 for its fiscal year ending November 30, 1994. The effect on the Company's reported financial position and results of operations resulting from the implementation of SFAS No. 96 has not yet been quantified by the Company.\nNOTE 9- Commitments:\nOn May 15, 1991, the Company entered into an agreement with Burbud Management Corp.(\"Burbud\") Burbud is organized under the laws of Panama and its U.S. location is New Rochelle, NY. Pursuant to this agreement, the Company will issue 8,000,000 shares of its common unregistered stock to \"Burbud\" in lieu of payment for the initial production of 20,000 solar rechargeable batteries(\"SRB\") In addition \"Burbud\" will provide future research and product development of the \"SRB\" as well as assisting in the marketing of the product. As of November 30, 1993, the Company received 1,250 \"SRB'S\" from Burbud and in partial consideration for the above the Company issued 500,000 shares of its common unregistered stock. The Company values the transaction at the fair market value of the consideration received and estimates the cost of each battery at the cost the Company could have purchased and assembled them in the United States (Replacement costs) During fiscal year ending November 30, 1993 Burbud did not deliver any product against its commitment. (See Note 11)\nNOTE 10- Other Related Party Transactions:\nIn fiscal 1993 the Company leased office space from Mr. Scala at a rate of $500.00 per month. Mr. Scala was compensated during fiscal year 1993 in the amount of $15,600. The Company continues to borrow money from Mr. Somma and Mr. Scala to fund the daily operations of the Company. Mr. Somma and Mr. Scala are officers, directors and principal shareholders of the Company. In October 1993 the Company sold Mr. Scala 1,250,000 of common stock at the rate of $.01 per share and reduced its total debt liability to Mr. Scala by $12,500.\nNOTE 11- Subsequent Events:\nIn August 1995, the Company considered it's contract with Burbud void and has terminated it due to the no performance clause in the original contract. However, the Company may be obligated to issue an additional 1,500,000 shares of it's common unregistered stock to Burbud for services performed during the duration of the contract. The Company would vigorously fight the issuance of these shares due to damages in the form of lost \"SRB\" sales. Burbud has not substantially complied with many of the terms of the entire agreement.\nOn August 30, 1995, the Company entered into a licensing agreement with an individual and has received a $5,000 non refundable initial licensing fee. The Company, under the terms of the agreement, will also receive a royalty equal to 5% of the gross selling price on such items manufactured and sold by the licensee for all sales up to $1,000,000 and 2% of sales over $1,000,000. However, the Company will receive a minimum royalty of $1000 per month for a term of sixty months which began in January, 1996.\nBetween August 1995 and December 1995, the Company began to look for other business opportunities to enter. In December 1995, the Company purchased from Lewis Scala all the necessary hardware equipment, Galacticomm's WorldGroup software, and all existing telephone connections to run an Online Bulletin Board Service that provides Internet connectivity. The service can handle up to 256 simultaneous users. The most common need for Internet access is to allow users to \"surf the web\" with software such as Netscape, Microsoft explorer and many other \"web\" browsers. The Worldgroup software provides a pass-through SLIP, CSLIP and PPP connections for authorized users. The agreed price was $5,000.\nFrom November 1993 to May 1996, the company has sold 560,000 shares of common unregistered stock to 9 individuals at $.025 per share and had raised an additional $14,000.","section_15":""}
{"filename":"201493_1993.txt","cik":"201493","year":"1993","section_1":"ITEM 1. BUSINESS.\nColtec Industries Inc and its consolidated subsidiaries (together referred to as \"Coltec\") manufacture and sell a diversified range of highly-engineered aerospace, automotive and industrial products in the United States and, to a lesser extent, abroad. Coltec's operations are conducted through three principal segments: Aerospace\/Government, Automotive and Industrial. Set forth below is a description of the business conducted by the respective divisions within Coltec's three industry segments. The tabular five-year presentation of financial information in respect of each industry segment under the caption \"Industry Segment Information\" of Coltec's 1993 Annual Report to its shareholders and the information in Note 11 of the Notes to Financial Statements of Coltec's 1993 Annual Report to its shareholders are incorporated herein by reference.\nAEROSPACE\/GOVERNMENT\nThrough its Aerospace\/Government segment, Coltec is a leading manufacturer of landing gear systems, engine fuel controls, turbine blades, fuel injectors, nozzles and related components for commercial and military aircraft, and also produces high-horsepower diesel engines for naval ships and diesel, gas and dual-fuel engines for electric power plants. The divisions, principal products and principal markets of the Aerospace\/Government segment are as follows:\nWith reductions in domestic military spending, Coltec has placed an increasing emphasis on sales by its Aerospace\/Government segment to commercial aircraft manufacturers. In addition to producing landing gear for various Boeing, McDonnell Douglas and other aircraft, Coltec has been awarded a contract to supply main landing gear for the Boeing 737-700 aircraft. In the case of Coltec's successful bid to become the supplier of landing gear for the Boeing 777 aircraft, Coltec developed and delivered the first landing gear set ahead of schedule in August 1993. Coltec has also been successful in increasing its penetration of the commercial aircraft engine market, including the commuter aircraft and general aviation markets, through its Chandler Evans Control Systems, Walbar and Delavan Gas Turbine Divisions. See \"Aerospace Controls\", \"Aircraft Engine Components\" and \"Gas Turbine Products\" below.\nIn most of the divisions in this segment, Coltec is a leading manufacturer in the markets it services and has focused its efforts on manufacturing quality products involving a high engineering content or proprietary technology. In many cases in which Coltec developed components for use in a specific aircraft, Coltec has become the primary source for replacement parts and, in some cases, service for these products in the aftermarket. Many of the programs for which Coltec has been awarded a contract or for which Coltec has been selected as a manufacturer are subject to termination or modification. See \"--Contract Risks\".\nLANDING GEAR SYSTEMS\nColtec, through its Menasco Aerosystems and Menasco Overhaul Divisions and its Canadian subsidiary, Menasco Aerospace Ltd. (collectively referred to as \"Menasco\"), designs, manufactures and markets landing gear systems, parts and components for medium-to-heavy commercial aircraft and for military aircraft and provides spare parts and overhaul services for these products. Menasco is one of the leading suppliers of landing gear for medium-to-heavy commercial and military aircraft. It also designs and manufactures aircraft flight control actuation systems and is a team leader in a flight control systems research and development program directed toward the design, validation and implementation of advanced \"fly-by-wire\/fly-by-light\" flight control technology. Landing gear, including components, parts, and overhaul services for landing gear, accounted for approximately 87% of Menasco's sales and 11% of Coltec's sales during 1993. For the years 1993, 1992 and 1991, commercial sales accounted for 62%, 73% and 70%, respectively, of Menasco's total sales.\nMenasco has been awarded contracts to supply the main and nose landing gear for the Boeing 777 aircraft. Delivery of landing gear for the Boeing 777 aircraft commenced in 1993. The Boeing Company (\"Boeing\") has announced that 147 firm orders and options for an additional 108 of its 777 aircraft have been placed as of December 31, 1993. Menasco has been selected to replace a competitor as the supplier of the main landing gear for the Fokker Fo-100 aircraft as well as to supply the main landing gear and flight controls for the Fokker Fo-70. Menasco has supplied most of the flight controls for the Fo-100 since this aircraft was introduced. Other commercial programs for which Menasco is currently producing landing gear and flight controls include the main and nose landing gear for the Boeing 757 aircraft, the main landing gear for the Boeing 737 aircraft, the nose landing gear for the Boeing 767 aircraft, the main landing gear for the McDonnell Douglas MD-80\/90 aircraft, the flight controls for the Canadair RJ-601 aircraft and landing gear components for the Airbus Industrie A-320 and A-330\/340 aircraft.\nMenasco is supplying the main and nose landing gear for the Taiwanese Indigenous Defense Fighter being built for the Taiwanese government and is developing the main and nose landing gear for the Lockheed\/Boeing Advanced Tactical Fighter. Other military programs for which Menasco is currently producing landing gear and flight controls include the main and tail landing gear for the McDonnell Douglas AH-64 Apache helicopter, the nose landing gear and flight controls for the McDonnell Douglas C-17 military transport, the main and nose landing gear for the aircraft produced by Lockheed Corp. (\"Lockheed\") and the Lockheed C-130 military transport.\nLanding gear and flight controls are designed for specific aircraft and produced by a single manufacturer. Menasco has been the sole supplier of this equipment for each program it has been awarded. The price of landing gear constitutes approximately 2% of the total cost of an aircraft.\nMenasco joined with Messier-Bugatti for the development and production of landing gear for the Boeing 777 and the Airbus 330\/340 aircraft and has agreed to cooperate on future ventures where appropriate, which may include Airbus and McDonnell Douglas programs, although no major commercial programs are currently formalized.\nIn addition to manufacturing and marketing aircraft landing gear and flight controls, Menasco provides complete overhaul services on a worldwide basis for landing gear and actuation systems through its overhaul facilities in the United States and Canada.\nIn view of the relatively small number of medium-to-heavy aircraft manufacturers, Menasco's commercial sales of landing gear have historically been concentrated among a limited number of purchasers, primarily Boeing, McDonnell Douglas and Lockheed in the United States and Fokker in Europe.\nThe market for landing gear is highly competitive, with a small number of airframe manufacturers evaluating potential suppliers based on design, price and record of past performance. Menasco has made significant investments in long-term marketing to promote working relationships with customers and to enhance Menasco's engineering department's understanding of customer requirements. Menasco believes it is this engineering expertise, together with its record of on-time delivery, quality and price, which has made Menasco one of the leading producers of medium-to heavy-aircraft landing gear worldwide. Menasco's primary domestic competitors are Cleveland Pneumatic Division of The B.F. Goodrich Company and Bendix Brake and Strut Division of Allied-Signal Inc. (\"Allied-Signal\"). Foreign competitors include Messier-Bugatti, Dowty of England and Dowty Canada Ltd. The overhaul business has become increasingly competitive. Menasco believes its competitive strengths in the overhaul business include its name, which carries a reputation for quality and service.\nRaw materials and finished products essential to Menasco's manufacturing operations are available in sufficient quantity from various sources.\nAEROSPACE CONTROLS\nColtec, through its Chandler Evans Control Systems Division (\"Chandler Evans\"), manufactures a variety of aircraft engine fuel control systems and fuel pumps and engine and aircraft components for the aerospace industry. Chandler Evans' products are highly engineered and contain proprietary technology. Principal customers for these products include gas turbine engine manufacturers, aircraft manufacturers, domestic and foreign airlines, commercial fleet operators and the military services. For the years 1993, 1992 and 1991, commercial sales accounted for 67%, 71% and 63%, respectively, of Chandler Evans' total sales.\nChandler Evans produces for sale to the commercial aircraft engine market the main fuel pump for certain models of the General Electric CF-6 and CF-34 engines, both used on various commercial aircraft, and the Textron Lycoming LF-507 engine used on the British Aerospace BAe 146 aircraft. Chandler Evans also produces for sale to the military aircraft engine market the main fuel pump for certain models of the United Technologies engine used on the McDonnell Douglas aircraft, the main and afterburner fuel pumps for the General Electric engine used on the McDonnell Douglas aircraft and fuel control systems for the Textron Lycoming T-53 engine used on the Bell UH-1 Utility and Cobra attack helicopters. The main and afterburner pump for the GE-414 engine is currently in development. Except for the General Electric CF-6 and the United Technologies (for which different manufacturers supply components for specific engine versions having different thrust), Chandler Evans is the sole source of the pumps and fuel control systems that it supplies for the engine programs described above.\nChandler Evans was selected to develop and manufacture a full authority digital electronic control (\"FADEC\") for the Allison 250 engine. Delivery of this system is scheduled to begin in late 1994. Also, Chandler Evans has developed a FADEC for the T800-LHT helicopter engine, a joint venture of Allison Engine Company and Allied-Signal Garrett, which has commercial and military applications. Chandler Evans is likely to remain the sole source of these components for the life of these programs.\nChandler Evans also supports its products with aftermarket sales of spare units, parts and overhaul service. For the year 1993, 52% of Chandler Evans' revenues were attributable to the aftermarket. Aftermarket sales are very significant, since proprietary programs allow Chandler Evans to realize favorable operating margins.\nChandler Evans competes with Argo-Tech and the Aviation Division of Sundstrand Corporation in fuel pumps and with the Bendix Control Division of Allied-Signal and the Hamilton Standard Division of United Technologies Corporation in fuel controls. Due to the highly engineered, proprietary nature of its products, Chandler Evans maintains a substantial portion of aftermarket sales, with competition limited to a small number of imitation parts manufacturers.\nAIRCRAFT ENGINE COMPONENTS\nColtec, through its Walbar Inc subsidiary and its Canadian subsidiary, Walbar Canada Inc. (together referred to as \"Walbar\"), manufactures turbine components, compressor airfoils, and turbine and compressor rotating parts primarily for aircraft gas turbine engines and, to a lesser extent, for land-based, marine and industrial gas turbine applications, and performs services including repairs and protective coatings for these products. Coltec believes that Walbar is one of the leading independent manufacturers of blades, impellers and rotating components for jet engines. Although Walbar does not typically design the products it manufactures, its manufacturing processes are highly sophisticated.\nWalbar manufactures products for commercial engines including the Pratt & Whitney 100 used on the deHavilland Dash 8, Alenia ATR 40 and Alenia ATR 72 aircraft, the Pratt & Whitney 200 used on the McDonnell Douglas Helicopter MDX, the Pratt & Whitney 300 used on the British Aerospace BAe 1000 aircraft, the Pratt & Whitney PT6 used on various commercial and military aircraft, and the Garrett Auxiliary Power Units used on various commercial aircraft. Walbar's original equipment and replacement components are also utilized in a number of other commercial aircraft, including the Boeing 727, 737, 747, 757 and 767; the Airbus A300, A310 and A320; and the McDonnell Douglas DC-8, DC-9, DC-10 and MD-80. Walbar's blades, vanes and discs are employed on many of the leading models of turboprop, business jet and commuter aircraft currently in service. Walbar supplies a number of different compressor and turbine blades for the new Allison 3007\/2100\/T406 engine family. These engines are designed for use on several business and regional commuter aircraft and also have military applications. Targeting the commuter aircraft market is part of Walbar's strategy of emphasizing the production of turbine engine components for commercial aircraft applications. Turbine blades for Rolls Royce engines are produced for commercial and military aircraft. For the years 1993, 1992 and 1991, commercial sales accounted for approximately 85%, 74% and 60%, respectively, of Walbar's total sales.\nWalbar manufactures products for military engines, including the General Electric used on the McDonnell Douglas aircraft, the General Electric used on the Grumman aircraft, the McDonnell Douglas aircraft and the Lockheed aircraft, the GE LM\n2500 used on the U.S. Navy's Spruance class destroyers, the Textron Lycoming AGT 1500 used on the U.S. Army M-1 Abrams main battle tank, the Volvo RM12 engine for the SAAB JAS39 aircraft and Turbo Union RB199 engine for the Panavia Tornado aircraft.\nWalbar's market has become increasingly competitive over the past several years as airlines have sought to limit parts inventories and defense procurement has been reduced. Although Walbar does not typically design its own products, management believes that its highly sophisticated applied manufacturing technology, responsive production capabilities and focus on cost reduction have made Walbar one of the leading independent manufacturers of blades, impellers and rotating components for jet engines. Chromalloy American Corporation and Howmet Turbine Components Corporation provide competition in all aspects of this industry. In addition, Walbar's principal customers possess, in varying degrees, integrated production capacity for producing and servicing the components that Walbar supplies.\nGAS TURBINE PRODUCTS\nColtec, through its Delavan Inc subsidiary operating as the Delavan Gas Turbine Products Division (\"Delavan\"), manufactures highly engineered fuel injectors, spraybars and other components for commercial and military aircraft gas turbine engines. Coltec believes that Delavan is the leading producer of these products for small-to-medium size aircraft engines. These products are made to design specifications using sophisticated production processes and are marketed directly to engine manufacturers pursuant to production contracts. The principal customers include General Electric Company, Allied-Signal Engines, Pratt & Whitney Canada Inc., Textron Lycoming and the Allison Engine Company. Delavan also supports its products with aftermarket sales of spare units and overhaul services. For the years 1993, 1992 and 1991, commercial sales accounted for 69%, 58% and 66%, respectively, of Delavan's total sales. The market for Delavan products is considered highly competitive. Competitive pressure is focused on price at the manufacturing level and on service and price in the aftermarket segment. Coltec believes that Delavan has achieved its leading position as a supplier of fuel injectors, spraybars and other components to producers of small-to-medium size aircraft engines due essentially to superior product performance, development support and a leadership role in the use of computer modeling in the design of nozzles. Delavan competes worldwide with Textron Fuel Systems Division of Textron Inc. and Parker-Hannifin Corporation.\nAIRCRAFT INSTRUMENTATION\nColtec, through its Lewis Engineering Operation, designs, develops and produces electro-mechanical and electronic instrumentation for aircraft cockpits and temperature sensors for aircraft and engine systems. Lewis competes with several manufacturers of aircraft instruments.\nENGINES\nColtec, through its Fairbanks Morse Engine Division (\"Fairbanks Morse\"), manufactures and markets large, heavy-duty diesel, gas and dual-fuel engines and parts for such engines. Fairbanks Morse manufactures engines in conventional \"V\" and in-line opposed piston configurations which are used as power drives for compressors, large pumps and other industrial machinery, for marine propulsion and for stationary and marine power generation. Engines are offered from 4 to 18 cylinders, ranging from 640 to 29,320 horsepower. Such products are sold in the domestic market primarily through regional sales offices and field sales engineers and in foreign markets through the domestic sales network and foreign sales representatives. Parts are sold primarily through factory and regional sales offices. Approximately 50% of Fairbanks Morse's sales are for replacement parts and service for Fairbanks Morse engines.\nLarge heavy-duty diesel engines are sold to the U.S. Navy and Coast Guard and to electric utilities, municipal power plants, oil and gas producers, firms engaged in ship and tug operations, offshore drilling activities and local, state and federal governments.\nUnder a license agreement with Societe d'Etudes de Machines Thermiques, S.A. groupe Alsthom, a French company, Fairbanks Morse has the right to manufacture the Colt-Pielstick PC2 and PC4 lines of large diesel engines, which operate on oil fuel (including heavy oil) and, in the case of the PC2, dual-fuel, and range in size from 4,400 to 29,320 horsepower. Engines manufactured under this license are used for primary power by electric utilities, standby power for nuclear electric generating plants and ship propulsion.\nOver the last several years, Fairbanks Morse has supplied each of the ships in the U.S. Navy Landing Ship Dock (\"LSD\") program with four 16-cylinder PC2.5 engines, each delivering 8,500 horsepower for main propulsion, and four 12-cylinder opposed piston engines for shipboard power generation. The LSD ships hold amphibious craft and troops for close deployment in emergencies. Engines for 11 LSD and LSD Cargo Variant ships have been delivered and engines for one additional ship are scheduled for delivery in 1995. Another major program for Fairbanks Morse is the TAO fleet oiler program. These ships are powered by two 10-cylinder PC4.2 engines, each delivering 16,290 horsepower. A total of 15 ships of this series have been ordered by the U.S. Navy. Engines for 14 ships have been delivered and the remaining shipset is in production. Fairbanks Morse has also received a firm order to produce four 10-cylinder PC4.2 engines for the first new ship in the nation's Sealift Program with options for an additional five to eight ships. The four engines for the first ship are scheduled to be delivered in 1995. If the options are converted to firm orders by the U.S. Navy, four engines would be delivered each year beginning in 1996.\nContracts are awarded in the heavy-duty diesel engine market based on price and successful operation in similar applications. Coltec attributes its strong position in this market to its history as a supplier to the U.S. Navy in a variety of propulsion and generator set applications and its ability to meet the U.S. Navy's military specification requirements. Management believes that Fairbanks Morse and its primary competitor, the Cooper-Bessemer Reciprocating Division of Cooper Industries, Inc., lead the field of four domestic manufacturers serving the market for heavy-duty diesel engines in power ranges from 5,000 to 30,000 horsepower. Fairbanks Morse competes with six domestic manufacturers in the medium speed (1,000 to 5,000 horsepower) engine market, dominated by General Motors Corporation (\"General Motors\") and Caterpillar Inc., and with several foreign manufacturers. Numerous domestic and foreign manufacturers compete in the under 1,500 horsepower engine market.\nIn the first quarter of 1994, Fairbanks Morse acquired equipment and other assets related to the Alco engine business from General Electric Transportation Systems (\"GE Transportation\"). Under the terms of the agreement, Fairbanks Morse will manufacture and sell engines and aftermarket parts for Alco diesel engines used in power plants and marine markets. GE Transportation will retain the rights to sell and market Alco engines and aftermarket parts for its locomotive markets. Fairbanks Morse has been issued a preferred supplier contract to manufacture these engines and parts for General Electric's locomotive needs. Fairbanks Morse expects to begin producing Alco engines and aftermarket parts in April 1994.\nAUTOMOTIVE\nColtec's Automotive segment manufactures and markets a selected line of high value-added products, including fuel injection system assemblies and components, transmission controls, suspension controls, emission control air pumps, oil pumps and seals for domestic original equipment manufacturers and the replacement parts market. The divisions, principal products and principal markets of the Automotive segment are as follows:\nColtec's principal automotive products have strong brand name recognition. Coltec has targeted the development of highly-engineered components for fuel injection systems, transmission controls, suspension controls and air and oil pumps. By forming close, interactive relationships with the domestic automotive manufacturers, Coltec has taken advantage of a shift by these manufacturers from internal sourcing to procurement of components from outside suppliers.\nAUTOMOTIVE PRODUCTS\nColtec, through its Holley Automotive Division, designs and manufactures fuel injection components, electrohydraulic control devices for transmissions and suspensions, transmission modulators and other automotive products used in passenger cars and trucks. Holley has been recognized for its engineering excellence and has strategically changed its structure and product line to accommodate the evolving automotive market. These products are sold directly to original equipment manufacturers, Chrysler Corporation (\"Chrysler\"), Ford Motor Company (\"Ford\") and General Motors.\nHolley currently produces all of the multi-point throttle bodies used on Chrysler imported 3.0 liter engines and the Chrysler-manufactured 3.3 liter engines. These six-cylinder engines propel the LeBaron Convertible, Shadow, Sundance and Acclaim, as well as the Minivan. Holley also is the sole source of the upper intake module and throttle body for the Chrysler 3.5 liter engine used on the Chrysler LH mid-size sedans (the Chrysler Concorde, Dodge Intrepid and Eagle Vision) and also the Chrysler New Yorker and LHS.\nIn the non-fuel area, significant business has been established in transmission control devices. Holley supplies high volumes of aneroid and non-aneroid modulators to the General Motors Powertrain Division. Holley has expanded its design capabilities to include electronic solenoids for automatic transmission control. Holley's first electronic transmission solenoid application was introduced by Chrysler in 1989. Applications were expanded to Saturn in 1991, and to Ford and General Motors in 1992 with additional applications for Ford for the 1994 model year. Holley has increased design and manufacturing capabilities further in development and sales of suspension solenoids to a major suspension manufacturer selling to Ford.\nColtec, through its Coltec Automotive Division, produces a mechanical air pump that supplies additional air to the exhaust system which enhances the oxidation process and reduces pollutants emitted into the atmosphere. Coltec Automotive is the sole independent domestic supplier of automotive mechanical air pumps. Major customers are Ford and Chrysler and, with the acquisition of the assets of the General Motors air pump manufacturing business, Coltec Automotive will become the sole source of these components to General Motors' North American operations. Coltec Automotive has also developed an advanced electric air pump designed to cope with increasingly stringent emission standards. In early 1994, Coltec Automotive began supplying mechanical air pumps to Isuzu Motors Limited for use in its Rodeo and Trooper sport utility models and one of its truck models. Coltec expects to ship 30,000 air pumps a year to Isuzu, half for the Japanese market, and half for the U.S. market.\nColtec Automotive has also developed a line of engine oil pumps for use in many of Ford's cars and light trucks. Applications have expanded to Ford's Modular and Zetec engines.\nColtec, through its Holley Replacement Parts Division, manufactures and markets fuel injection components and other fuel metering devices and controls such as intake manifolds, electric fuel pumps, emission control devices, and engine and road speed governors, new and remanufactured automotive and marine carburetors, remanufactured automotive air conditioning compressors, carburetor parts and repair kits, mechanical fuel pumps, valve covers and related engine components under the Holley name. Holley carburetors and components are used in domestic and foreign vehicles and marine engines and are sold directly to original equipment manufacturers, principally Chrysler, Ford, General Motors and Outboard Marine Corporation, and, through distributors and mass merchandisers to the parts and replacement market.\nIn the domestic market, this segment competes principally with Ford, General Motors and several independent manufacturers. To date, Coltec has not been a significant supplier to foreign vehicle manufacturers.\nTRUCK PRODUCTS AND SEALING SYSTEMS\nColtec, through its Stemco Inc subsidiary operating as the Stemco Truck Products Division (\"Stemco\"), is one of the leading domestic manufacturers of wheel lubrication systems for heavy-duty trucks. Stemco also produces mileage recording devices (hubodometers) and exhaust systems for the heavy-duty truck, medium-duty truck and school bus markets and manufactures moisture ejectors and other related products for vehicle and stationary air systems. Approximately 80% of Stemco revenues are derived from replacement parts. Stemco, through its Performance Friction Products Operation, manufactures a line of asbestos-free fluorocarbon friction materials, a line of carbon-based friction materials and synchronizers and clutch plates for transmissions, transfer cases and wet brakes for use in trucks, off highway equipment and passenger cars. Coltec, through its Farnam Sealing Systems Division, manufactures and markets automotive and industrial gaskets, seals and other sealing system products for engines, fuel systems and transmissions. Stemco's truck products and Coltec's sealing systems include highly-engineered proprietary products.\nINDUSTRIAL\nIn the Industrial segment, Coltec, through its Garlock Inc subsidiary (\"Garlock\"), is a leading manufacturer of industrial seals, gaskets, packing products and self-lubricating bearings and, through its Delavan-Delta, Inc. subsidiary, is a producer of technologically advanced spray nozzles for agricultural, home heating and industrial applications. Coltec also produces air compressors for manufacturers. The divisions, principal products and principal markets of the Industrial segment are as follows:\nColtec's Industrial segment manufactures and markets a wide range of products for use in various industries. In this segment, Coltec's strategy has involved developing high quality products, capitalizing on brand name recognition, targeting specific, well-defined markets and building good distribution systems.\nIn January 1994, Coltec sold its Central Moloney Transformer Division.\nSEALS, PACKINGS AND GASKETING MATERIAL\nColtec, under the Garlock name, is a leading manufacturer of industrial seals, gasketing material and gasket assemblies and packing products. Through its France Compressor Products Division of Garlock (\"France\"), Coltec manufactures and markets rod packings, piston rings,\nvalves and components for reciprocating gas and air compressors used primarily in the hydrocarbon processing industry. These products withstand high temperature, corrosive environments, prevent leakage and exclude contaminants from rotating and reciprocating machinery and seal joints.\nManufacturing processes involve plastics, rubbers, metals, textiles, chemicals, aramid fibers, carbon fibers, or a combination of the same. Garlock has been a leader in using advancements in materials technology to develop new products, including its GYLON line of products, and in converting to asbestos-free products. Approximately 95% of the gasketing and packing materials currently manufactured by Garlock worldwide are asbestos-free. Because the raw materials for Garlock's products are widely available, the seals, gasketing materials and packings business of Garlock is not dependent on a limited number of suppliers.\nGarlock's seals, gasketing material and packings are marketed through sales personnel, sales representatives, agents and distributors to numerous industrial customers involved principally in the petroleum, steel, chemical, food processing, power generation and pulp and paper industries.\nMost seals, gasketing material and packings wear out during the life of the product in which they are incorporated. Accordingly, the service and replacement market for these products is significant. In 1993, the service and replacement market accounted for approximately 80% of Garlock's sales of seals, gasketing material and packings.\nManufacturers in this market compete on the basis of price and aftermarket services. Garlock's extensive distribution network, and its leadership in product development, have contributed to the establishment of what Coltec believes to be its leading position in the market for seals, gasketing products and packings. France believes it is a leading supplier of premium components in the aftermarket, where it competes primarily with C. Lee Cook and Cook Manley, subsidiaries of Dover Corporation, and Hoerbinger Corporation of America Inc.\nBEARINGS, VALVES, PLASTICS, NOZZLES, CYLINDERS, FORMING TOOLS, IGNITION SYSTEMS AND LEVEL CONTROLS\nColtec, through Garlock, is a leading manufacturer of steel-backed and fiberglass-backed self-lubricating bearings and bearing materials primarily for the automotive, truck, agricultural and construction markets. Garlock also manufactures polytetrafluoroethylene (\"PTFE\") lined butterfly and plug valves and components and PTFE tapes.\nColtec, through its Delavan-Delta, Inc. subsidiary operating as the Delavan Commercial Products Division, manufactures and markets spray nozzles and accessories for the agricultural, industrial and home heating markets. These products are sold to original equipment manufacturers, distributors and other end-users throughout the world.\nColtec, through Garlock's Ortman Fluid Power operation, manufactures hydraulic and pneumatic cylinders in bore diameter sizes from 1 1\/2 to 24 inches. Coltec, under the Sterling and Haber names, manufactures and markets a wide variety of metal cutting and metal forming tools. Sales of these products are primarily made directly to consumers. Competition for such products is provided by numerous companies.\nColtec, through its FMD Electronics Operation, manufactures magnetos, ignition systems and level control instruments. These products are sold to original equipment manufacturers and through factory and regional sales forces to various accounts for resale.\nAIR COMPRESSORS\nColtec, through its Quincy Compressor Division (\"Quincy\"), manufactures and markets reciprocating and helical screw air compressors and vacuum pumps. Helical screw air compressors are manufactured and sold under a non-exclusive license and technical assistance agreement with Svenska Rotor Maskiner Aktiebolag, a Swedish licensor.\nReciprocating and helical screw air compressors have a wide range of industrial applications, providing compressed air for general plant services, pneumatic climate and instrument control, dry-type sprinkler systems, air loom weaving, paint spray processes, diesel and gas engine starting, pressurization, pneumatic tools and other air-actuated equipment. Engine-driven skid-mounted models of helical screw air compressors are used in energy related services, such as air-assisted deep-hole drilling, both on offshore drilling platforms and in tertiary recovery schemes involving on-site combustion approaches. Quincy air compressors are marketed through a well-developed distribution network consisting of field sales personnel and distributors to original equipment manufacturers located in major industrial centers throughout the United States, Canada, Mexico and the Pacific Rim.\nIn the domestic market for small, industrial and reciprocating air compressors, management believes that Ingersoll-Rand is the major competitor, with Champion Pneumatic Machinery Co., Inc. and the Campbell-Hausfeld division of Scott Fetzer as other competitors. In the domestic market for helical screw air compressors, management believes that Ingersoll-Rand and Sullair are the dominant competitors, with Gardner-Denver Division of Cooper Industries, Inc. and Atlas Copco Corporation as other competitors.\nINTERNATIONAL OPERATIONS\nColtec's international operations, mainly in Canada, are conducted through foreign-based manufacturing or sales subsidiaries, or both, and by export sales of domestic divisions to unrelated foreign customers. Export sales of products of the Automotive segment and diesel engines are made either directly or through foreign representatives. Compressors are sold through foreign distributors. Certain products of the Industrial segment are sold in foreign countries through salesmen and sales representatives or sales agents.\nColtec's manufacturing and marketing activities in Canada are carried on through subsidiaries. Menasco Aerospace Ltd., an indirect wholly owned subsidiary of Coltec, manufactures landing gear systems and aircraft flight controls and provides overhaul service for Canadian and other customers. Walbar Canada Inc., a wholly owned subsidiary of Walbar, manufactures jet engine compressor blades, vanes and turbine components in Canada. Garlock of Canada Ltd., a wholly owned subsidiary of Garlock, manufactures and markets seals, gasketing material, packings and truck products. It also markets parts for Fairbanks Morse diesel engines and accessories as well as other products for use in Canada and for export to other countries.\nThrough wholly owned or majority controlled foreign subsidiaries, Coltec operates 15 plants in Canada, Mexico, France, the United Kingdom, Australia and Germany. In addition, Coltec occupies leased office and warehouse space in various foreign countries.\nDevaluations or fluctuations relative to the United States dollar in the exchange rates of the currency of any country where Coltec has foreign operations could adversely affect the profitability of such operations in the future.\nFor financial information on operations by geographic segments, see Note 11 of the Notes to Financial Statements of Coltec's 1993 Annual Report to its shareholders incorporated herein by reference.\nColtec's contracts with foreign nations for delivery of military equipment, including components, are subject to deferral or cancellation by United States Government regulation or orders regulating sales of military equipment abroad. Any such action on the part of the United States Government could have a material effect on Coltec's results of operations and financial condition.\nSALES TO THE MILITARY AND BY CLASS OF PRODUCTS\nSales to the military and other branches of the United States Government, primarily in the Aerospace\/Government segment, were 14%, 15% and 16% of total Coltec sales in 1993, 1992 and 1991, respectively. During the last three fiscal years, landing gear systems was the only class of similar products that accounted for at least 10% of total Coltec sales. In 1993, 1992 and 1991, sales of landing gear systems constituted 11%, 12% and 14%, respectively, of total Coltec sales.\nBACKLOG\nAt December 31, 1993, Coltec's backlog of firm unfilled orders was $669.7 million compared with $709.1 million at December 31, 1992. Of the $669.7 million backlog at December 31, 1993, approximately $255.2 million is scheduled to be shipped after 1994.\nCONTRACT RISKS\nColtec, through its various divisions, primarily Menasco, Chandler Evans, Walbar and Delavan Gas Turbine Products, produces products for manufacturers of commercial aircraft pursuant to contracts that generally call for deliveries at predetermined prices over varying periods of time and that provide for termination payments intended to compensate for certain costs incurred in the event of cancellation. In addition, certain commercial aviation contracts contain provisions for termination for convenience similar to those contained in United States Government contracts described below. Longer-term agreements normally provide for price adjustments intended to compensate for deferral of delivery depending upon market conditions.\nA significant portion of the business of Coltec's Menasco, Chandler Evans, Walbar and Delavan Gas Turbine Products divisions has been as a subcontractor and as a prime contractor in supplying products in connection with military programs. Substantially all of Coltec's government contracts are firm fixed-price contracts. Under firm fixed-price contracts, Coltec agrees to perform certain work for a fixed price and, accordingly, realizes all the benefit or detriment occasioned by decreased or increased costs of performing the contracts. From time to time, Coltec accepts fixed-price contracts for products that have not been previously developed. In such cases, Coltec is subject to the risk of delays and cost over-runs. Under United States Government regulations, certain costs, including certain financing costs, portions of research and development costs, and certain marketing expenses related to the preparation of competitive bids and proposals, are not allowable. The Government also regulates the methods under which costs are allocated to Government contracts. With respect to Government contracts that are obtained pursuant to an open bid process and therefore result in a firm fixed price, the Government has no right to renegotiate any profits earned thereunder. In Government contracts where the price is negotiated at a fixed price rather than on a cost-plus basis, as long as the financial and pricing information supplied to the Government is current, accurate and complete, the Government similarly has no right to renegotiate any profits earned thereunder. If the Government later conducts an audit of the contractor and determines that such data were inaccurate or incomplete and that the contractor thereby made an excessive profit, the Government may take action to recoup the amount of such excessive profit, plus treble damages, and take other enforcement actions.\nUnited States Government contracts are, by their terms, subject to termination by the Government either for its convenience or for default of the contractor. Fixed-price-type contracts\nprovide for payment upon termination for items delivered to and accepted by the Government, and, if the termination is for convenience, for payment of the contractor's costs incurred plus the costs of settling and paying claims by terminated subcontractors, other settlement expenses, and a reasonable profit on its costs incurred. However, if a contract termination is for default, (a) the contractor is paid such amount as may be agreed upon for completed and partially-completed products and services accepted by the Government, (b) the Government is not liable for the contractor's costs with respect to unaccepted items, and is entitled to repayment of advance payments and progress payments, if any, related to the terminated portions of the contracts, and (c) the contractor may be liable for excess costs incurred by the Government in procuring undelivered items from another source.\nIn addition to the right of the Government to terminate, Government contracts are conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds on a fiscal-year basis even though contract performance may take many years. Consequently, at the outset of a major program, the contract is usually partially funded, and additional monies are normally committed to the contract by the procuring agency only as appropriations are made by Congress for future fiscal years.\nA substantial portion of Coltec's automotive products are sold pursuant to the terms and conditions (including termination for convenience provisions) of the major domestic automotive manufacturers' purchase orders, and deliveries are subject to periodic authorizations which are based upon the production schedules of such automotive manufacturers.\nRESEARCH AND PATENTS\nMost divisions of Coltec maintain staffs of manufacturing and product engineers whose activities are directed at improving the products and processes of Coltec's operations. Manufactured and development products are subject to extensive tests at various divisional plants. Total research and development cost, including product development, was $22.1 million for 1993, $22.9 million for 1992 and $23.8 million for 1991. Coltec presently has approximately 370 employees engaged in research, development and engineering activities.\nColtec owns a number of United States and other patents and trademarks and has granted licenses under some of such patents and trademarks. Management does not consider the business of Coltec as a whole to be materially dependent upon any patent, patent right or trademark.\nEMPLOYEE RELATIONS\nAs of December 31, 1993, Coltec had approximately 10,000 employees, of whom approximately 4,000 were salaried. Approximately 40% of the hourly employees are represented by unions for collective bargaining purposes. Union agreements relate, among other things, to wages, hours and conditions of employment, and the wages and benefits furnished are generally comparable to industry and area practices.\nNine collective bargaining agreements covering approximately 2,500 hourly employees which expired in 1993 have been renegotiated. In 1994, four collective bargaining agreements covering approximately 400 hourly employees are due to expire. Coltec considers the labor relations of Coltec to be satisfactory, although Coltec does experience work stoppages from time to time.\nColtec is subject to extensive Government regulations with respect to many aspects of its employee relations, including increasingly important occupational health and safety and equal employment opportunity matters. Failure to comply with certain of these requirements could\nresult in ineligibility to receive Government contracts. These conditions are common to the various industries in which Coltec participates and entail the risk of financial and other exposure.\nFor litigation relating to labor and other matters, see Item 3. \"Legal Proceedings.--Other Litigation.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nColtec operates 60 manufacturing plants in 21 states and in Canada, Mexico, France, the United Kingdom, Australia and Germany. In addition, Coltec has other facilities throughout the United States and in various foreign countries, which include sales offices, repair and service shops, light manufacturing and assembly facilities, administrative offices and warehouses.\nCertain information with respect to Coltec's principal manufacturing plants that are owned in fee, all of which (other than Palmyra, New York) are encumbered pursuant to the 1994 Credit Agreement between Coltec and certain banks and related security documents, is set forth below:\nIn addition to above facilities, certain manufacturing activities of some industry segments are conducted within leased premises, the largest of which is approximately 173,000 square feet. The Automotive segment has significant manufacturing facilities on leased premises in Water Valley, Mississippi (lease expires in 1994) and Longview, Texas (lease expires in 1997). The Industrial segment has leased facilities located in Quincy, Illinois (lease expires in 1998). Some of these leases provide for options to purchase or to renew the lease with respect to the leased premises.\nColtec's total manufacturing facilities presently being utilized aggregate approximately 6,500,000 square feet of floor area of which approximately 5,800,000 square feet of area are owned in fee and the balance is leased.\nColtec leases approximately 39,000 square feet at 430 Park Avenue, New York, New York, for its executive offices, and has renewal options under such lease through 2001.\nIn the opinion of management, Coltec's principal properties, whether owned or leased, are suitable and adequate for the purposes for which they are used and are suitably maintained for such purposes. See Item 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ASBESTOS LITIGATION\nAs of December 31, 1993, two subsidiaries of Coltec were among a number of defendants (typically 15 to 40) in approximately 68,500 actions (including approximately 6,100 actions in advanced stages of processing) filed in various states by plaintiffs alleging injury or death as a result of asbestos fibers. As of December 31, 1992, the number of such actions approximated that as of December 31, 1993. Through December 31, 1993, approximately 94,600 of the approximately 163,100 total actions brought have been settled or otherwise disposed of.\nThe damages claimed for personal injury or death vary from case to case and in many cases plaintiffs seek $1 million or more in compensatory damages and $2 million or more in punitive damages. Although the law in each state differs to some extent, management believes that liability for compensatory damages would be shared among all responsible defendants, thus limiting the potential monetary impact of such judgments on any individual defendant.\nFollowing a decision of the Pennsylvania Supreme Court, in a case in which neither Coltec nor any of its subsidiaries were parties, that held insurance carriers are obligated to cover asbestos-related bodily injury actions if any injury or disease process, from first exposure through manifestation, occurred during a covered policy period (the \"continuous trigger theory of coverage\"), Coltec settled litigation with its primary and most of its first level excess insurance carriers, substantially on the basis of the Court's ruling. Coltec is currently negotiating with its remaining excess carriers to determine, on behalf of its subsidiaries, how payments will be made with respect to such insurance coverage for asbestos claims. Coltec believes that agreement can be achieved without litigation, and on substantially the same basis that it has resolved the issues with its primary and first-level excess carriers. On this basis, Coltec will have available to it a significant amount of coverage from its solvent carriers for asbestos claims.\nSettlements are generally made on a group basis with payments made to individual claimants over periods of one to four years. In 1993, two subsidiaries of Coltec received approximately 27,400 new lawsuits with a comparable number of lawsuits received in 1992 and 1991. The subsidiaries made payments with respect to asbestos liability and related costs aggregating $38.7 million in 1993, $39.8 million in 1992 and $48.4 million in 1991, substantially all of which were covered by insurance. In accordance with Coltec's internal procedures for the processing of asbestos product liability actions and due to the proximity to trial or settlement, certain outstanding actions have progressed to a stage where Coltec can reasonably estimate the cost to dispose of these actions. As of December 31, 1993, Coltec estimates that the aggregate remaining cost of the disposition of the settled actions for which payments remain to be made and actions in advanced stages of processing, including associated legal costs, is approximately $52.6 million and Coltec expects that this cost will be substantially covered by insurance.\nWith respect to the 62,400 outstanding actions as of December 31, 1993 which are in preliminary procedural stages, Coltec lacks sufficient information upon which judgments can be made as to the validity or ultimate disposition of such actions, thereby making it difficult to estimate with reasonable certainty the liability or costs to Coltec. When asbestos actions are received they are typically forwarded to local counsel to ensure that the appropriate preliminary procedural response is taken. The complaints typically do not contain sufficient information to\npermit a reasonable evaluation as to their merits at the time of receipt, and in jurisdictions encompassing a majority of the outstanding actions, the practice has been that little or no discovery or other action is taken until several months prior to the date set for trial. Accordingly, Coltec generally does not have the information necessary to analyze the actions in sufficient detail to estimate the ultimate liability or costs to Coltec, if any, until the actions appear on a trial calendar. A determination to seek dismissal, to attempt to settle or to proceed to trial is typically not made prior to the receipt of such information.\nIt is also difficult to predict the number of asbestos lawsuits that Coltec's subsidiaries will receive in the future. Coltec has noted that, with respect to recently settled actions or actions in advanced stages of processing, the mix of the injuries alleged and the mix of the occupations of the plaintiffs are changing from those traditionally associated with Coltec's asbestos-related actions. Coltec is not able to determine with reasonable certainty whether this trend will continue. Based upon the foregoing, and due to the unique factors inherent in each of the actions, including the nature of the disease, the occupation of the plaintiff, the presence or absence of other possible causes of a plaintiff's illness, the availability of legal defenses, such as the statute of limitations or state of the art, and whether the lawsuit is an individual one or part of a group, management is unable to estimate with reasonable certainty the cost of disposing of outstanding actions in preliminary procedural stages or of actions that may be filed in the future. However, Coltec believes that it is in a favorable position compared to many other defendants because, among other things, the asbestos fibers in its asbestos-containing products were encapsulated. Considering the foregoing, as well as the experience of Coltec's subsidiaries and other defendants in asbestos litigation, the likely sharing of judgments among multiple responsible defendants, and the significant amount of insurance coverage that Coltec expects to be available from its solvent carriers, Coltec believes that pending and reasonably anticipated future claims are not likely to have a material effect on Coltec's results of operations and financial condition.\nAlthough the insurance coverage that Coltec has is substantial, insurance coverage for asbestos claims is not available to cover exposures initially occurring on and after July 1, 1984.\nIn addition to claims for personal injury, the subsidiaries were among 40 named defendants in a class action seeking recovery of the cost of asbestos removal from school buildings. Twenty-nine similar school building cases have been dismissed without prejudice to the plaintiffs and without payment by Coltec's subsidiaries. Coltec's subsidiaries continue to be named as defendants in new cases.\nENVIRONMENTAL REGULATIONS\nColtec and its subsidiaries are subject to numerous federal, state and local environmental laws, many of which are becoming increasingly stringent, giving rise to increased compliance costs. For example, the Clean Air Amendments will require abatement of chemical air emissions that were previously unregulated and will require certain existing, and many newly constructed or modified, facilities to obtain air emission permits that were not previously required. Because many of the regulations under the Clean Air Amendments have not yet been promulgated, Coltec cannot estimate their impact at this time. Coltec, however, believes that it will not be at a competitive disadvantage in complying with the Clean Air Amendments and that any increase in costs to comply with the Clean Air Amendments will not have a material effect on its results of operations and financial condition.\nColtec's annual expenditures (including capital expenditures) relating to environmental matters over the three years ended December 31, 1993 ranged from $4 million to $6 million, and Coltec expects such expenditures to range from $8 million to $11 million in each of 1994 and 1995.\nMany of the facilities of Coltec and its subsidiaries are subject to the federal Resource Conservation and Recovery Act of 1976 (\"RCRA\"), and its analogous state statutes. Although the costs under RCRA for the treatment, storage and disposal of hazardous materials generated at Coltec's facilities are increasing, Coltec does not believe that such costs will have a material effect on Coltec's results of operations and financial condition.\nColtec has been notified that it is among the Potentially Responsible Parties (\"PRPs\") under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), or similar state laws, for the costs of investigating and in some cases remediating contamination by hazardous materials at several sites. CERCLA imposes joint and several liability for the costs of investigating and remediating properties contaminated with hazardous materials. Liability for these costs can be imposed on present and former owners or operators of the properties or on parties who generated the wastes that contributed to the contamination. The process of investigating and remediating contaminated properties can be lengthy and expensive. The process is also subject to the uncertainties occasioned by changing legal requirements, developing technological applications and liability allocations among PRPs. Among the sites where Coltec or its subsidiaries have been designated a PRP are: Acme Solvents, Winnebago, Illinois; Clare Water Supply, Clare, Michigan; Stringfellow Acid Pits, Riverside, California; Quincy Municipal Landfill #2 and #3, Quincy, Illinois; Water Valley, Mississippi; Byron Barrel and Drum, Byron, New York; Operating Industries, Monterey Park, California; Fulton Terminal Site, Oswego, New York; Parker Landfill, Lyndonville, Vermont; Solvents Recovery Service of New England, Southington, Connecticut; San Fernando Valley Site, Glendale, California; Acqua-Tech Site, Greer, South Carolina; and Hardage, Criner, Oklahoma. Based on the progress to date in the investigation, cleanup and allocation of responsibility for these sites, Coltec does not believe that its costs in connection with these sites will have a material effect on Coltec's results of operations and financial condition. Progress toward the investigation, cleanup and responsibility allocation at the Liberty Industrial Finishing site, Farmingdale, New York has not been sufficient to allow Coltec at this time to determine the extent of any potential financial responsibility for this site; however, Coltec does not believe that its costs in connection with Liberty Industrial Finishing will have a material effect on Coltec's results of operations and financial condition.\nOTHER LITIGATION\nIn September 1983, the local employees' union at Menasco Canada Ltee. (now Menasco Aerospace Ltd.) (\"Menasco Canada\"), a federation of trade unions and several member-employees filed a complaint in the Province of Quebec Superior Court against Menasco Canada, alleging, among other things, an illegal lock-out, failure to negotiate in good faith, interference with the affairs of the union and various violations of local law. The plaintiffs are collectively seeking approximately Cdn. $14 million in damages, and Menasco Canada has filed a cross-claim for Cdn. $21 million and has closed its operations in Quebec Province. Coltec does not believe that this action will have a material effect on Coltec's results of operations and financial condition.\nOn September 24, 1986, approximately 150 former salaried employees of Crucible Inc (a former subsidiary of Coltec) commenced an action claiming benefits under a plant shutdown plan that had been created in 1969 (George Henglein v. Colt Industries Operating Corporation Informal Plan for Plant Shutdown Benefits for Salaried Employees, U.S. District Court for the\nWestern District of Pennsylvania, C.A. 86-2021). Future eligibility of any employee for such Plan was eliminated by Crucible Inc in November 1972. Plaintiffs claim that they did not receive notice of such termination and therefore were entitled to benefits in 1982 when the Midland steel-making facility closed. Following a non-jury trial in the U.S. District Court for the Western District of Pennsylvania, defendant's motion to dismiss was granted and the plaintiffs appealed. The Court of Appeals for the Third Circuit remanded the case to the District Court directing it to make specific findings of fact and conclusions of law and also found for the defendant on the jurisdiction of the District Court. The defendants' motion to dismiss was granted by the District Court, appealed to the Third Circuit Court of Appeals and remanded to the District Court for additional findings of fact. On February 10, 1994, the District Court dismissed the plaintiffs' complaint and the plaintiffs have appealed to the Third Circuit Court of Appeals. Coltec does not believe that this action will have a material effect on Coltec's results of operations and financial condition.\nIn an alleged class action filed in June 1984, a group of former salaried employees whose employment had been terminated due to the closing of the Midland steelmaking facility have asserted claims for damages in amounts equal to the present value of the collective bargaining unit's pension plan, insurance and unemployment benefits (Donald A. Nobers v. Crucible Inc, Court of Common Pleas of Beaver County, Pennsylvania, Civil Action No. 843-1984). The case was dismissed by the Common Pleas Court due to the preemptive provisions of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"). The Pennsylvania Superior Court reversed the lower court and held that the plaintiffs' claim was based upon an alleged contract. The Pennsylvania Supreme Court refused to hear the appeal and reinstated the case in the Court of Common Pleas. On February 16, 1993, the Court of Common Pleas granted defendants' motion for summary judgment because the Court concluded that it lacked jurisdiction of the subject matter. On January 19, 1994, the Superior Court of Pennsylvania affirmed the Court of Common Pleas grant of defendant's motion for summary judgment. The plaintiffs have appealed to the Supreme Court of Pennsylvania. Coltec does not believe that this action will have a material effect on Coltec's results of operations and financial condition.\nOn January 19, 1993, the Official Committee of Unsecured Creditors of Colt's Manufacturing Company, Inc. filed a fraudulent conveyance action against Coltec and other defendants (The Official Committee of Unsecured Creditors of Colt's Manufacturing Company, Inc., Plaintiff, v. Coltec Industries Inc et al., U.S. Bankruptcy Court for the District of Connecticut, Case No. 93-2020) in connection with the sale on March 22, 1990 of substantially all the assets of the Colt Firearms Division to a company formed by a group of private investors. Coltec does not believe that this action will have a material effect on Coltec's results of operations and financial condition.\nIn addition to the litigation described above, there are various pending legal proceedings involving Coltec which are routine in nature and incidental to the business of Coltec. Some product liability cases pending against Coltec involve claims for large amounts of compensatory damages (the coverage for which is subject to substantial deductibles) as well as, in some instances, punitive damages (which insurance carriers uniformly contend are not covered by product liability insurance).\nThe United States Government conducts investigations into procurement of defense contracts as a part of a continuing process. Under current federal law, if such investigations establish such improper activities, among other matters, debarment or suspension of a company from participating in the procurement of defense contracts could result. These conditions are\ncommon to the aerospace and government industries in which Coltec participates and entail the risk of financial and other exposure. Coltec is not aware of any such investigation, nor is Coltec aware of any facts which, if known to investigators, might prompt any investigation.\nPRODUCT LIABILITY INSURANCE\nColtec has product liability insurance coverage for liabilities arising from aircraft products which Coltec believes to be in adequate amounts. In addition, with respect to other products, (exclusive of liability for exposure to asbestos products) Coltec has product liability insurance in amounts exceeding $2.5 million per occurrence, which Coltec believes to be adequate.\nColtec has been self-insured with respect to liability for exposure to asbestos products since third party insurance became unavailable in July 1984.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nColtec's Common Stock (symbol COT) is listed on the New York and Pacific Stock Exchanges. The high and low prices of the stock since it began trading on March 25, 1992, based on the Composite Tape, were as follows:\nAt December 31, 1993, there were 591 shareholders of record. No dividends were paid in 1993 and 1992, and no dividends are expected to be paid in 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe five year tabular presentation under the caption \"Selected Financial Data\" of Coltec's 1993 Annual Report to its shareholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.\nThe information under the caption \"Financial Review\" of Coltec's 1993 Annual Report to its shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe \"Quarterly Sales and Earnings\" information in Note 14 of the Notes to Financial Statements of Coltec's 1993 Annual Report to its shareholders and the Consolidated Balance Sheet, the Consolidated Statement of Earnings, the Consolidated Statement of Cash Flows, the Consolidated Statement of Shareholders' Equity, the Notes to Financial Statements and the Report of Independent Public Accountants of Coltec's 1993 Annual Report to its shareholders are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table provides certain information about each of the current directors and executive officers of Coltec. Directors are indicated by an asterisk. Unless otherwise indicated, each occupation set forth opposite an individual's name refers to employment with Coltec.\nThe initial dates of election of the directors are as follows: Mr. Brennan, November 1991; Mr. Cozzolino, May 1985; Mr. Guffey, May 1991; Dr. Hilton, May 1985; Mr. Hoffen, March 1990; Mr. Margolis, May 1963; Messrs. J. Bradford Mooney, Jr. and Joel Moses, June 1992; and Mr. Sica, November 1991. Pursuant to a Registration and Management Rights Agreement, among other things, The Morgan Stanley Leveraged Equity Fund II, L.P. is permitted to designate a person to be nominated for election to the Board of Directors of Coltec.\nAll officers serve at the pleasure of the Board. None of the executive officers or directors of Coltec is related to any other executive officer or director by blood, marriage or adoption.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSUMMARY OF CASH AND CERTAIN OTHER COMPENSATION\nThe following table provides certain summary information concerning compensation of Coltec's Chief Executive Officer and each of the four other most highly compensated executive officers of Coltec (determined as of December 31, 1993) (hereinafter referred to as the \"named executive officers\") for the fiscal years ended December 31, 1993, 1992 and 1991:\nSUMMARY COMPENSATION TABLE\nSTOCK OPTIONS\nThe following table contains information concerning 1993 grants of stock options under Coltec's 1992 Stock Option and Incentive Plan to the named executive officers and the potential realizable value of these option grants based on assumed rates of stock appreciation of 5% and 10% per year over the 10-year term of the options.\nOPTION GRANTS IN 1993\nOPTION EXERCISES AND HOLDINGS\nThe following table provides information with respect to the named executive officers concerning the options held as of December 31, 1993 (none of the named executive officers exercised options during 1993):\nAGGREGATED OPTION EXERCISES IN 1993 AND DECEMBER 31, 1993 OPTION VALUES\nPENSION PLAN\nThe following table shows the estimated annual pension benefits payable to a covered participant at normal retirement age (age 65) on a single life annuity basis under Coltec's qualified defined benefit plan, as well as nonqualified supplemental pension plans that provide benefits that would otherwise be denied participants by reason of certain Internal Revenue Code limitations on qualified plan benefits, based for the most part on five-year average final compensation (salary and bonus during the 60 highest-paid consecutive months out of the last 120 months) and years of service with Coltec and its subsidiaries and not subject to deduction for Social Security or other payments:\nPENSION PLAN TABLE\nAs of December 31, 1993, the five-year average final compensation and current years of credited service for each of the following persons were: Mr. Margolis, $2,620,816 and 31 years; Mr. Guffey, $877,655 and 15 years (including 7 years of additional credited service as an employee of one of Coltec's subsidiary corporations); Mr. Cozzolino, $1,363,302 and 24 years; Dr. Hilton, $1,363,302 and 31 years; and Mr. diBuono, $722,680 and 23 years. Compensation covered under the pension plans includes amounts reported in columns (c) and (d) of the Summary Compensation Table (other than accrued but unpaid amounts under the Performance Plan reported in column (d) of the table). Coltec has agreed to calculate Mr. Guffey's pension benefits as if his prior credited service with the subsidiary were provided under the plan (the benefits of which are set forth in the above table) with payments to be made to him from the qualified plan, non-qualified plans and from Coltec.\nDESCRIPTION OF THE 1994 INCENTIVE PLAN. On January 12, 1994, the Compensation Committee and the Board of Directors adopted the 1994 Long-Term Incentive Plan (the \"1994 Incentive Plan\"), subject to the approval of the 1994 Incentive Plan by the shareholders of Coltec. The 1994 Incentive Plan will be submitted to the shareholders of Coltec for approval at the 1994 annual meeting of shareholders.\nThe summary of the 1994 Incentive Plan which follows is not intended to be complete and is qualified in its entirety by reference to the text of the 1994 Incentive Plan which has been filed as Exhibit 10.16 to this Form 10-K.\nThe 1994 Incentive Plan provides for annual grants of performance units (\"Units\") to officers and senior operations management employees of Coltec who are selected for grants of Units by the Compensation Committee. Approximately 15 officers and senior operations management employees of Coltec and its subsidiaries are eligible to participate in the 1994 Incentive Plan. The 1994 Incentive Plan is intended to replace the 1977 Long-Term Performance Plan.\nThe value of each Unit is determined on the basis of Coltec's cumulative operating profit measured over a three-year performance cycle. Operating profit for each fiscal year in a performance cycle is generally defined as the net earnings of Coltec and its consolidated subsidiaries, plus interest expense and provisions for income taxes, minus interest income and excluding nonrecurring items, extraordinary items, accounting principle changes and discontinued operations (as such terms are defined under United States generally accepted accounting principles).\nFor each three-year performance cycle, the threshold target for cumulative operating profit is $600 million. If that target is achieved, each Unit will have an award value of $36.00 (for the performance cycle beginning January 1, 1994) and $12.00 (for each performance cycle beginning after 1994 (the \"1994 Cycle\")). The award value of each Unit granted for a performance cycle will increase by $.10 (with respect to the 1994 Cycle) and by $.0333 (with respect to later cycles) for each $1 million that cumulative operating profit for the award cycle exceeds $600 million. There is no maximum limit on the award value which may be earned for a Unit. No amounts are payable for a Unit if cumulative operating profit for the performance cycle is less than $600 million.\nThe 1994 Incentive Plan provides that no more than 300,000 Units may be awarded for any performance cycle, and that no more than 50,000 Units may be awarded to any participant for a given cycle. The 1994 Incentive Plan is administered by the Compensation Committee which has responsibility for the selection of participants, for construing the terms of the 1994 Incentive Plan and for certifying that the targets for each performance cycle have been achieved. Under the terms of the 1994 Incentive Plan, the Compensation Committee also has the discretion to adjust the targets for operating profit prior to the inception of a performance cycle or to\nadjust the targets after the inception of a cycle to take into account extraordinary corporate transactions.\nThe award value earned in respect of Units is generally payable following the press release announcing Coltec's unaudited annual financial results for the last fiscal year in the applicable performance cycle. Two-thirds of the award value of the Units will generally be paid in cash; and one-third of such award value will be paid in shares of Common Stock (the \"Restricted Shares\"). The 1994 Incentive Plan permits participants to elect, prior to the start of the third year of a performance cycle, to have some or all of the portion of the award value that would otherwise be paid in cash be paid in Restricted Shares. As an incentive to encourage participants to make share elections, the 1994 Incentive Plan increases by 15% the number of Restricted Shares which would otherwise have been awarded to a participant in lieu of the foregone cash payment. The 1994 Incentive Plan limits the number of Restricted Shares that may be awarded in any calendar year to .5% (1% for 1997) of the number of shares of Common Stock issued and outstanding on January 1 of such year.\nPerformance Units are forfeited if a participant's employment ends for any reason other than death, disability or retirement. In the event a participant's employment ends as a result of death, disability or retirement, a pro rata portion of the award value will generally be paid to the participant (or, in the event of death, the participant's beneficiary) following the completion of the performance cycle (although, in appropriate circumstances, the Compensation Committee may accelerate the payment in settlement of these outstanding Units).\nRestricted Shares awarded in payment of Units vest in one third increments on each of the first through third anniversaries of the end of the applicable performance cycle. Unvested Restricted Shares are forfeited if a participant's employment ends for any reason other than death, disability or retirement. Subject to certain limited exceptions set forth in the 1994 Incentive Plan, a participant will be fully vested in all Restricted Shares in the event the participant's employment ends as a result of death, disability or retirement.\nDESCRIPTION OF THE 1992 STOCK PLAN. On January 12, 1994, the Board of Directors authorized an amendment to the 1992 Stock Option and Incentive Plan (the \"1992 Stock Plan\") to increase the number of shares of Common Stock that may be issued under the 1992 Stock Plan from 3,000,000 to 7,360,000. The amendment further provides that no employee may be awarded in any 36-month period beginning on or after January 1, 1994 options or stock appreciation rights in excess of 15% of the number of shares of Common Stock which are authorized for awards under the 1992 Stock Plan immediately after the 1994 annual meeting of shareholders. Both such changes are subject to the approval of the amendment to the 1992 Stock Plan by the shareholders of Coltec. The amendment to the 1992 Stock Plan will be submitted to the shareholders of Coltec for approval at the 1994 annual meeting of shareholders. The full text of the amendment has been filed as Exhibit 10.15 to this Form 10-K.\nThe 1992 Stock Plan is administered by the Compensation Committee. The Compensation Committee has authority under the 1992 Stock Plan to adopt rules and regulations with respect thereto, to select the employees to whom awards will be made, to determine the nature and size of each award and to interpret, construe and implement the 1992 Stock Plan. Approximately 250 employees of Coltec and its subsidiaries are eligible to participate in the 1992 Stock Plan.\nThe 1992 Stock Plan provides for grants of stock options, restricted shares, incentive stock rights, stock appreciation rights and dividend equivalents, the making of loans to participants to accomplish the purposes of the 1992 Stock Option Plan and other equity incentive awards established under the plan. The number of stock options, restricted shares, incentive stock rights, stock appreciation rights, dividend equivalents or other incentive benefits granted to any\nindividual, the periods during which they vest or otherwise become exercisable or remain outstanding, and the other terms and conditions with respect to awards under the 1992 Stock Plan are set by the Compensation Committee.\nShares issued under the 1992 Stock Plan may be in whole or in part, as the Compensation Committee shall from time to time determine, authorized and unissued shares or issued shares that may have been reacquired by Coltec.\nAwards under the 1992 Stock Plan may be made only to salaried employees who are officers or who are employed in an executive, administrative, operations, sales or professional capacity by Coltec or its subsidiaries or to those other employees with potential to contribute to the future success of Coltec or its subsidiaries. Such awards may be made to a director of Coltec provided that the director is also an officer or salaried employee of Coltec or a subsidiary thereof.\nThe 1992 Stock Plan provides for equitable adjustments with respect to awards made thereunder upon the occurrence of any increase in, decrease in or exchange of the outstanding shares of Common Stock through merger, consolidation, recapitalization, reclassification, stock split, stock dividend or similar capital adjustment. In addition, the 1992 Stock Plan allows the Compensation Committee, in the event of a Change in Control (as defined in the 1992 Stock Plan), to protect the holders of awards granted under the 1992 Stock Plan by taking certain actions which it deems equitable and in the best interests of Coltec.\nDESCRIPTION OF THE ANNUAL INCENTIVE PLAN. On March 15, 1994, the Compensation Committee and the Board of Directors adopted an amended and restated version of the Coltec Annual Incentive Plan (the \"Annual Incentive Plan\"), subject to the approval of the Annual Incentive Plan by the shareholders of Coltec. The Annual Incentive Plan will be submitted to the shareholders of Coltec for approval at the 1994 annual meeting of shareholders.\nThe summary of the Annual Incentive Plan which follows is not intended to be complete and is qualified in its entirety by reference to the text of the Annual Incentive Plan which has been filed as Exhibit 10.17 to this Form 10-K.\nThe Annual Incentive Plan is an amended and restated version of the prior Coltec annual incentive plan which was previously approved by the shareholders of Coltec in 1965 and, as amended, in 1986. The principal purpose of the amended and restated version of the Annual Incentive Plan is to permit amounts paid under the plan to qualify as performance-based compensation which is deductible for federal income tax purposes. Under recently enacted federal tax law changes, a public company is generally precluded from deducting annual compensation in excess of $1 million that is paid to an executive officer named in the summary compensation table of the proxy statement for that year unless, among other things, the compensation qualifies as performance-based compensation. Amounts paid under the amended and restated Annual Incentive Plan are generally intended to qualify as performance-based compensation, which is excluded from the $1 million limit on deductible compensation.\nThe Annual Incentive Plan provides for an annual bonus pool for cash incentive awards for any year equal to 6% of operating profit of Coltec and its consolidated subsidiaries. For purposes of the Annual Incentive Plan, operating profit is generally defined in the same manner as in the 1994 Incentive Plan. SEE \"Description of the 1994 Incentive Plan.\" The Annual Incentive Plan provides that no award may be paid to executive officers of Coltec unless operating profit for the year exceeds $100 million and that the two executive officers at the end of such year who have the highest base salary for such year may each receive no more than 20% of the bonus pool for any year. As the bonus pool is determined as a percentage of operating profit, there is no maximum limit on the size of the pool for any year.\nOnly officers of Coltec and senior executive employees who are not covered by an annual incentive plan of one of Coltec's divisions or subsidiaries are eligible to participate in the Annual Incentive Plan. Approximately 50 officers and senior executive employees of Coltec and its subsidiaries are eligible to participate in the Annual Incentive Plan. The Annual Incentive Plan is administered by the Compensation Committee which has discretion under the plan to select plan participants from among the class of eligible persons and, subject to the limits noted above, to determine the amount of the award paid to plan participants. The Compensation Committee may require that the payment of some or all of an award be deferred until a later date or dates specified by the committee.\nAmounts paid under the Annual Incentive Plan (as in effect on December 31, 1993) are included in column (d) of the Summary Compensation Table.\nCOMPENSATION OF DIRECTORS\nDirectors who are not also employees of Coltec or of Morgan Stanley receive a retainer at the annual rate of $25,000 ($30,000 if Chairperson of a Committee) and receive $1,250 per meeting for attendance at meetings of the Board of Directors and its committees with a maximum of $2,000 for more than one meeting on the same day ($2,500 if Chairperson of one of the meetings). The Board of Directors of Coltec has established a retirement age policy which provides that a director shall not be eligible for nomination to the Board of Directors if such person has attained the age of 70. In connection therewith, the Board of Directors also established a pension arrangement for directors who are not affiliated with Morgan Stanley or not entitled to a pension from Coltec or any subsidiary thereof, with payments for life commencing at the later of retirement or age 70. The annual amount of such payment is calculated on the basis of the number of years of service as a director and would equal $10,000 for five years of service plus an additional $2,000 for each additional year of service up to a maximum annual amount of $20,000.\nA director may defer payment of any portion of any retainer, committee or attendance fees in any year, upon advance notice to Coltec, to such time as he or she may determine. Balances of such deferred compensation accrue additional compensatory amounts quarterly at the average cost of United States borrowings of Coltec and its consolidated subsidiaries during the preceding calendar year. Such borrowing cost in 1992 was 7.2%. There are no amounts being deferred at the present time.\nIn addition to the foregoing amounts, on March 15, 1994, the Board of Directors adopted the 1994 Stock Option Plan for Outside Directors (the \"1994 Directors Option Plan\"), subject to the approval of the 1994 Directors Option Plan by the shareholders of Coltec. The 1994 Directors Option Plan will be submitted to the shareholders of Coltec for approval at the 1994 annual meeting of shareholders.\nThe summary of the 1994 Directors Option Plan which follows is not intended to be complete and is qualified in its entirety by reference to the text of the 1994 Directors Option Plan which has been filed as Exhibit 10.18 to this Form 10-K.\nThe 1994 Directors Option Plan provides for automatic grants of stock options to each member of the Board of Directors who is not an employee of Coltec or any of its subsidiaries (\"Outside Directors\"). Each individual elected as an Outside Director at the 1994 annual shareholders meeting (or who is initially elected as a director by the shareholders at an annual or special meeting of shareholders occurring after the 1994 annual meeting) will be granted an option to purchase 10,000 shares of Common Stock (an \"Initial Option\"). On each subsequent Alternate Re-Election Date, as defined in the 1994 Directors Option Plan, each Outside Director will be granted an additional option to purchase 2,000 shares of Common Stock (a \"Subsequent\nOption\"). The date of grant of each Initial or Subsequent Option will be the date of the applicable annual or special meeting. The per share exercise price of each option will be the average closing price of a share of Common Stock as reported on the New York Stock Exchange Composite Tape for the date of grant and the four preceding trading days.\nThe Initial Options will vest 20% per year beginning on the first anniversary date of the date of grant. The Subsequent Options will vest 50% per year beginning on the first anniversary date of the date of grant. Each option granted under the 1994 Directors Option Plan will terminate on the tenth anniversary of the date of grant of the option. In the event of an Outside Director's resignation, removal (other than for cause) or termination as a member of the Board, the unvested portion of any option granted to an Outside Director will terminate as of the date of such event, but the vested portion of the option will remain exercisable until the first anniversary of the date of such event. In the event of the removal of the Outside Director from the Board of Directors for cause, the option (including the vested portion thereof) will terminate in its entirety as of the date of such removal.\nThe maximum number of shares of Common Stock that may be awarded under the 1994 Directors Option Plan will not exceed 108,000 shares. The 1994 Directors Option Plan is administered by the Chief Executive Officer (\"CEO\") of Coltec. The CEO has authority under the 1994 Directors Option Plan to interpret, administer and apply the Plan, and to execute and deliver option certificates on behalf of Coltec.\nSubject to certain limitations set forth in the plan document, the Board of Directors has the right to amend or terminate the 1994 Directors Option Plan at any time. Unless earlier terminated by the Board of Directors, the 1994 Directors Option Plan will terminate on July 1, 2004 and no further options under the plan will be awarded after that date.\nEMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS\nAll currently outstanding agreements granting restricted stock or stock options to the named executive officers in the Summary Compensation Table above contain change-in-control provisions. In the case of the restricted stock, in the event of a change-in-control, all restrictions on assignment, transfer or other disposition of the restricted stock lapse. In the case of stock options, in the event of a change-in-control, the options become fully exercisable or, in the alternative, the executive officer may surrender all or part of the option to Coltec during a one-year period after the change-in-control in exchange for a cash payment for each option surrendered equal to the excess of the fair market value of the Common Stock on the date of surrender over the option price. Fair market value for this purpose equals the last sales price of the Common Stock on the exercise date on the New York Stock Exchange Composite Tape (or, if no such sale occurred on such date, the last date preceding such date on which a sale was reported), except that in the case of a change of ownership of more than 35% of the outstanding shares of Common Stock, it shall mean the amount of cash and fair market value of other consideration tendered for such outstanding shares.\nAs of June 10, 1988, Coltec entered into an employment contract (the \"Employment Contract\") with Mr. Margolis which by its terms is scheduled to terminate on January 24, 1995. The Employment Contract provides for certain severance payments and continuation of benefits for the remaining term of the Employment Contract following termination of employment. The amount of the payments that may be made will vary depending upon the level of compensation and benefits at the time employment terminates and whether such employment is terminated prior to the end of the term by Coltec for \"cause\" or by Mr. Margolis for \"good reason\" or otherwise during the term of the contract. In the event that termination of employment is by\nMr. Margolis for \"good reason\" or by Coltec without \"cause\", such payments are to consist of amounts equal to full salary, bonus payments on each January based on an average of the three prior annual bonus payments pro rated for partial years, an additional one-time payment at the time of termination of the bonus amount pro rated for a partial year, either continuation of participation in compensation and benefit plans or the provision of comparable benefits, reimbursement for any legal fees expended in connection with the termination of employment and gross-up payments for any golden parachute excise taxes paid. Mr. Margolis is required to seek other employment and any amounts paid as a result of such employment offset amounts otherwise payable under the Employment Contract. The Employment Contract includes multi-year non-compete provisions.\nAs of July 1, 1991, Coltec entered into employment agreements with Messrs. Guffey and diBuono. Mr. Guffey's agreement expires on July 1, 1996 and Mr. diBuono's agreement expires on October 13, 1995. Compensation payable thereunder is at salary rates not less than those in effect on July 1, 1991 and with comparable participation in incentive and employee benefit plans at the discretion of the Board of Directors. However, if during the term of the agreement a change of control (as defined in the agreement) occurs, (a) the executive's functions, duties and responsibilities shall not be subject to change, (b) in the event the executive in good faith determines that his functions, duties or responsibilities or any aspect of his employment has been changed adversely, he may elect to serve for a terminal employment period of two years or, if earlier, until the executive attains age 65, and (c) the terminal employment period is followed by a consulting period of two years. During the terminal employment period, the executive is entitled to salary not less than that in effect prior to this period and comparable participation in benefits plans. During the consulting period, the executive is entitled to consulting fees at an annual rate no less than the annual rate of his salary on July 1, 1991 and to participation in all Coltec life and medical insurance programs or comparable benefits.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSet forth below is certain information (as of February 25, 1994) with respect to persons known to Coltec to be the beneficial owners of more than five percent of the Common Stock. This information is based on statements on Schedules 13D or 13G filed by beneficial owners with the Securities and Exchange Commission and other information available to Coltec.\nSet forth below is information as of February 25, 1994, concerning ownership of Common Stock by all directors, individually, the executive officers named in the Summary Compensation Table above and all present executive officers and directors of Coltec as a group:\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe members of the Stock Option and Compensation Committee are Joel Moses (Chairman), Donald P. Brennan, Howard I. Hoffen and J. Bradford Mooney, Jr. None of the members was formerly an officer of Coltec or any of its subsidiaries. Mr. Brennan was an officer and director and Mr. Hoffen was a director of Coltec Holdings Inc. (\"Holdings\") before it became a wholly owned subsidiary of Coltec in November 1993.\nMr. Brennan is a managing director and Mr. Hoffen is a vice president of Morgan Stanley and they along with another managing director of Morgan Stanley, Frank V. Sica, constituted all of the directors of Holdings, the owner of 100% of the outstanding shares of Common Stock from June 1988 to the recapitalization of Coltec effected in April 1992, which included the public offering by Coltec of 44,275,000 shares of Common Stock (the \"1992 Recapitalization\"). At the time of the 1992 Recapitalization, Holdings owned 36.1% of the outstanding shares of Common Stock.\nIn the 1992 Recapitalization, Morgan Stanley was sole underwriter of a debt offering for which it received an underwriting commission of $11,250,000 and was one of several underwriters of an equity offering for which it received a portion of the total underwriting commission of $36,527,000. Also, as one of the dealer managers for a tender offer by Holdings for the outstanding Holdings 14 3\/4% senior discount debentures, a part of the 1992 Recapitalization, Morgan Stanley received fees of $1,049,000 from Holdings. In October 1992, Morgan Stanley acted as sole underwriter in connection with the issuance by Coltec of $150 million of its 9 3\/4% Senior Notes due 1999 for which it received an underwriting commission of $2,625,000. In connection with an industrial revenue bond refinancing in 1993, Morgan Stanley received a fee of $309,000.\nAs of November 18, 1993, pursuant to a Reorganization Agreement, Coltec and Holdings completed a stock-for-stock exchange that resulted in Holdings' stockholders holding directly shares of Coltec Common Stock and Holdings became a wholly owned subsidiary of Coltec.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this report:\n(b) Coltec filed a Form 8-K dated October 13, 1993 reporting under Item 1. Changes in Control of Registrant, the approval of a stock-for-stock exchange between Coltec and Coltec Holdings Inc.\n(c) Exhibits 4.7, 4.8, 4.9, 4.10, 4.11, 4.12, 4.13, 4.14, 10.3, 10.13, 10.15, 10.16, 10.17, 10.18, 12.1, 13.1, 21.1 and 23.1 are filed herewith.\nSIGNATURES\nPursuant 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.\nColtec Industries Inc (Registrant)\nDate: March 22, 1994 By: ________\/s\/_PAUL G. SCHOEN_______ Paul G. Schoen Executive Vice President Finance and Treasurer\nPursuant 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 in the capacities noted on March 22, 1994.\nINDEX TO EXHIBITS\nI-1\nI-2\nI-3\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF COLTEC INDUSTRIES INC:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Coltec Industries Inc and subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 24, 1994. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index to financial statement schedules are the responsibility of the company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO. New York, N.Y. January 24, 1994\nS-1\nSCHEDULES V AND VI\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES SCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nSCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nS-2\nSCHEDULES V AND VI\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES SCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1992 (IN THOUSANDS)\nSCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1992 (IN THOUSANDS)\nS-3\nSCHEDULES V AND VI\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES SCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1991 (IN THOUSANDS)\nSCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1991 (IN THOUSANDS)\nS-4\nSCHEDULE VII\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES SCHEDULE VII--GUARANTEES OF SECURITIES OF OTHER ISSUERS DECEMBER 31, 1993 (IN THOUSANDS)\nS-5\nSCHEDULE VIII 1993, 1992 AND\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nS-6","section_15":""}
{"filename":"706270_1993.txt","cik":"706270","year":"1993","section_1":"Item 1. Business. ------ --------\nOverview. --------\nAmerica West Airlines, Inc. (\"America West\" or the \"Company\"), a Delaware corporation, began operations in 1983. The Company is a full- service passenger airline which serves 43 destinations in the continental United States and Mexico City, including its hubs in Phoenix, Arizona and Las Vegas, Nevada and a mini-hub in Columbus, Ohio. In 1992, the Company established a code sharing relationship with Mesa Airlines, Inc. for commuter service, operating under the name \"America West Express\", permitting the Company to serve an additional 23 destinations as of December 31, 1993.\nOn June 27, 1991, America West filed a voluntary petition in the United States Bankruptcy Court for the District of Arizona (the \"Bankruptcy Court\") to reorganize under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\"). The Company is currently operating as a debtor- in-possession (\"D.I.P.\") under the supervision of the Bankruptcy Court. The Company is authorized to operate its business but may not engage in transactions outside the ordinary course of business without the approval of the Bankruptcy Court.\nBankruptcy And Reorganization Events. ------------------------------------\nSince June 27, 1991, the date America West filed the voluntary petition with the Bankruptcy Court to reorganize, the Company has obtained D.I.P. financing, reduced expenses and overhead and restructured its routes and aircraft fleet. On February 24, 1994, America West selected an investment proposal pursuant to which it intends to develop a plan of reorganization.\nBankruptcy Events. As a result of the Chapter 11 filing, the ----------------- prosecution of all actions and claims against America West was automatically stayed pursuant to Section 362 of the Bankruptcy Code. America West promptly obtained from the Bankruptcy Court a series of Orders (\"First Day Orders\") authorizing America West to pay certain critical vendors and suppliers, and also authorizing the payment of employee wages and benefits, as necessary to ensure that America West's passenger flight operations were not disrupted and that the Company's ongoing enterprise value would be preserved. Approximately $55 million of what otherwise would have been pre-petition unsecured debt was authorized by the Bankruptcy Court to be paid pursuant to the First Day Orders.\nIn addition, certain stipulations between the Company and providers of aircraft and aircraft-related equipment were negotiated and approved by the Bankruptcy Court pursuant to Section 1110 and Section 365 of the Bankruptcy Code. These stipulations resulted in America West receiving certain deferrals, concessions and other payment term modifications in return for the assumption and\/or conversion of the debts arising from the agreements to post-petition administrative expense priority status under Section 503 and Section 507 of the Bankruptcy Code. For further information on the effect of the stipulations, and subsequent events relating thereto, see Bankruptcy And Reorganization Events -- Route Structure and Aircraft Fleet Reductions, below.\nSubsequent to the case being filed, the United States Trustee for the District of Arizona appointed an Official Committee of Unsecured Creditors (the \"Creditors' Committee\") and an Official Committee of Equity Security Holders (the \"Equity Committee\") as provided by Section 1102 of the Bankruptcy Code. Each of these committees has certain rights and obligations provided for by the Bankruptcy Code and other applicable law, and have continued as active participants in the bankruptcy case since their appointment. Each of the committees has retained professional advisors to assist them in the bankruptcy proceedings, including attorneys and accountants, as well as financial and industry advisors. The expenses associated with the committees and their advisors, as allowed by the Bankruptcy Court, must be paid by the Company as administrative expenses pursuant to certain orders of the Bankruptcy Court providing for the payment of professional fees and expenses. The Company anticipates that each of the committees will continue to be actively involved in the bankruptcy proceedings on behalf of their respective constituents, particularly with respect to the development, negotiation and confirmation of a plan of reorganization for the Company.\nThe Company anticipates that the reorganization process will result in the restructuring, cancellation and\/or replacement of the interests of its existing common and preferred stockholders. Because of the \"absolute priority rule\" of Section 1129 of the Bankruptcy Code, which requires that the Company's creditors be paid in full (or otherwise consent) before equity holders can receive any value under a plan of reorganization, the Company previously disclosed that it anticipated that the reorganization process would result in the elimination of the Company's existing equity interests. However, due to recent events, including sustained improvement in the Company's operating results as a result of the general improvement in the condition of the United States' economy and airline industry, some form of distribution to the equity interests pursuant to Section 1129 may occur. However, there can be no assurances in this regard.\nOn February 24, 1994, the Company selected an investment proposal as the basis for developing the Company's plan of reorganization, which proposal might result in a potential distribution to the Company's current equity holders as part of a plan of reorganization, however, there can be no assurances in this regard. See also Bankruptcy and Reorganization Events -- Plan of Reorganization, below.\nThe Company has incurred and will continue to incur significant costs associated with the reorganization. The amount of these costs, which are being expensed as incurred, has affected and is expected to continue to affect the results of operations.\nDebtor-in-Possession Financing. In 1991, affiliates of Guinness Peat ------------------------------ Aviation (\"GPA\"), Northwest Airlines, Inc. (\"Northwest\") and Kawasaki Leasing International Inc. (\"Kawasaki\") provided $78 million of D.I.P. financing to the Company. In September 1992, America West received an additional $53 million in D.I.P. financing, bringing the total outstanding D.I.P. financing at December 31, 1992, to $110.8 million which consisted of $69.8 million from GPA, $23 million from Kawasaki, $10 million from Ansett Worldwide Aviation Services (\"Ansett\") and $8 million from several Arizona- based entities. The D.I.P. financing is collateralized by substantially all of the Company's assets.\nThe financing provided by Northwest was repaid in full at the time of the September 1992 D.I.P. financing. America West also reconstituted its board of directors concurrent with\nthe September 1992 D.I.P. financing. In September 1993, the D.I.P. lenders extended the maturity date of the D.I.P. financing from September 30, 1993 to June 30, 1994. At the time of the September 1993 extension, the financing provided by Ansett was repaid in full.\nInterest on all funds advanced under the D.I.P. facility accrues at 3.5 percent over the 90-day London Interbank Offered Rate (\"LIBOR\") and is payable quarterly. Principal repayments in the amount of $5.54 million were made on March 1993 and June 1993. As a result of the September 1993 extension of the D.I.P. financing maturity date, the Company is required to repay $5 million of principal on March 31, 1994. The remaining outstanding balance will be due upon the earlier of June 30, 1994, or upon the effective date of a confirmed Chapter 11 plan of reorganization (the \"Reorganization Date\"). The amended terms of the D.I.P. financing require the Company to notify the D.I.P. lenders if the unrestricted cash balance of the Company exceeds $125 million. Upon receipt of such notice, the D.I.P. lenders may require the Company to prepay the D.I.P. financing by the amount of such excess. During the first quarter of 1994, the Company notified the D.I.P. lenders that the Company's unrestricted cash exceeded $125 million; however, to date, the D.I.P. lenders have not exercised their prepayment rights.\nAs a condition to extending the maturity date of the D.I.P. financing in September 1993, the Company also agreed to pay a facility fee of $627,000 to the D.I.P. lenders on September 30, 1993 and to pay an additional facility fee equal to 1\/4 percent of the then outstanding balance of the D.I.P. financing on March 31, 1994. As of December 31, 1993, the outstanding amount due under the D.I.P. financing was approximately $83.6 million. Presently, the Company does not possess sufficient liquidity to satisfy the D.I.P. financing nor does it appear that new equity capital will be obtained and a plan of reorganization confirmed prior to June 30, 1994. Consequently, the Company will be required to obtain alternative repayment terms from its current D.I.P. lenders. Although there can be no assurance that alternative repayment terms will be obtained, the Company believes that any required extension of the D.I.P. financing would be for a short period of time and would be concurrent with the implementation of a plan of reorganization.\nIn connection with the D.I.P. financing provided by Kawasaki, the Company agreed to convert advanced cash credits for 24 Airbus A320 aircraft (the \"Kawasaki Aircraft\") previously advanced by Kawasaki into an unsecured priority term loan (the \"Kawasaki Term Loan\"). At December 31, 1993, the amount of the Kawasaki Term Loan was $68.4 million, including accrued interest of $21.9 million. Until the Reorganization Date, the Kawasaki Term Loan will accrue interest at 12 percent per annum and such interest will be added to principal. On the Reorganization Date, 85 percent of the Kawasaki Term Loan will be converted into an eight-year term loan which will accrue interest at 2 percent over 90-day LIBOR and will be secured by substantially all the assets of the Company if the D.I.P. financing is fully repaid. Principal on such loan will be due and payable in equal quarterly installments, plus interest, commencing after the Reorganization Date. The Company has the right to prepay the Kawasaki Term Loan if the D.I.P. financing is fully repaid. The remaining 15 percent of the Kawasaki Term Loan will be treated as a general unsecured claim without priority status under the Company's plan of reorganization. In the first quarter of 1994, the Company received information that the Kawasaki Term Loan was purchased by a third party.\nRoute Structure and Aircraft Fleet Reductions. Since its bankruptcy --------------------------------------------- filing, the Company has reviewed its route structure and flight schedules and the resulting requirements for aircraft. In September 1991, America West reduced the size of its fleet from 123 to 101 aircraft. The Company further reduced its fleet in September 1992 and, as of December 1993, the Company operated 85 aircraft. In connection with such fleet reductions, the Company renegotiated many of its aircraft lease and loan agreements. The Company returned aircraft to those providers whose aircraft were not consistent with the Company's revised business strategy and to those providers who were unwilling or unable to accept the revised terms proposed by the Company. Aircraft providers whose aircraft were returned to them in connection with the Company's fleet reduction and restructuring efforts may be entitled to unsecured pre-petition claims and\/or administrative claims in the bankruptcy case for damages arising from the return of the aircraft. See Bankruptcy And Reorganization Events -- Claims, below.\nIn general, the Company received rent deferrals in 1991 and further rent deferrals and rent reductions in 1992 from many of its aircraft providers. The rent reductions in 1992 reduced the rents on the affected aircraft to better reflect what the Company believed to be the fair market rent of the affected aircraft at the time of the reduction. In order to induce the lessors to accept rent reductions, the Company agreed that the rent on certain Boeing 737-300 and 757-200 aircraft would be readjusted to the current market rent effective August 1, 1994 and, if elected by the lessor, would be readjusted at two other times during the remaining term of the lease; however, such readjustments may not occur within two years of one another. The Company also agreed in certain cases that lessors could call the aircraft upon 180 days notice if the lessor had a better lease proposal from another party which the Company was unwilling to match. During the period August 1, 1994 through July 31, 1995, certain of these lessors may call their aircraft without first giving the Company the right to match any competing offer. Call rights with a right of first refusal affect 16 aircraft and call rights without a right of first refusal affect 10 aircraft. In addition, in order to induce several lessors to extend the lease terms of their aircraft, the Company agreed that the aircraft could be called by the lessors at the end of the original lease term. One lessor of 11 aircraft has the right to terminate each lease at the end of the original lease term of each aircraft. Such lessor also has the right to call its aircraft on 90 days notice at any time prior to the end of the amended lease term. America West has no right of first refusal with respect to such aircraft. To date, no lessor has exercised its call rights.\nPrincipal payments on certain loans secured by aircraft were deferred for the period August 1, 1992 through January 31, 1993 and will be repaid over the remaining terms of five to nine years. Interest payments due in July and August 1992, on such loans were deferred until the first quarter of 1993 and were repaid in three equal monthly installments without interest. A more comprehensive description of the rent deferrals and reductions as well as the loan deferrals is set forth herein in Item 7. ------ Management's Discussion and Analysis of Financial Condition and Results of Operations and in Item 8. Financial Statements and Supplementary Data - ------ Note 1 of Notes to Financial Statements.\nClaims. The reorganization process is expected to result in the ------ cancellation and\/or restructuring of substantial debt obligations of the Company. Under the Bankruptcy Code, the Company's pre-petition liabilities are subject to settlement under a plan of reorganization. The Bankruptcy Code also requires that all administrative claims be paid on the effective date of a plan of reorganization unless the respective claimants agree to different treatment. There are differences between the amounts at which claims liabilities are recorded in the financial\nstatements and the amounts claimed by the Company's creditors and such differences are material. Significant litigation may be required to resolve any disputes.\nThe Bankruptcy Court set February 28, 1992, as the last date for the filing of proofs of claim under the Bankruptcy Code and the Company's creditors have submitted claims for liabilities not paid and for damages incurred. Claims for administrative expenses (administrative claims) were not required to be filed by that date.\nDue to the uncertain nature of many of the potential claims, America West is unable to project the magnitude of such claims with any degree of certainty. However, the claims (pre-petition claims and administrative claims) that have been filed against the Company are in excess of $2 billion. Such aggregate amount, includes claims of all character, including, but not limited to, unsecured claims, secured claims, claims that have been scheduled but not filed, duplicative claims, tax claims, claims for leases that were assumed, and claims which the Company believes to be without merit; however, claims filed for which an amount was not stated, are not reflected in such amount. The Company is unable to estimate the potential amount of such unstated claims; however, the amount of such claims could be material.\nThe Company is in the process of reviewing the general unsecured claims asserted against the Company. In many instances, such review process will include the commencement of Bankruptcy Court proceedings in order to determine the amount at which such claims should be allowed. The Company has accrued its estimate of claims that will be allowed or the minimum amount at which it believes the asserted general unsecured claims will be allowed if there is no better estimate within the range of possible outcomes. However, the ultimate amount of allowed claims will be different and such differences could be material. The Company is unable to estimate the amount of such difference with any reasonable degree of certainty at this time.\nThe Bankruptcy Code requires that all administrative claims be paid on the effective date of a plan of reorganization unless the respective claimants agree to different treatment. Consequently, depending on the ultimate amount of administrative claims allowed by the Bankruptcy Court, the Company may be unable to obtain confirmation of a plan of reorganization. The Company is actively negotiating with claimants to achieve mutually acceptable dispositions of these claims. Since the commencement of the bankruptcy proceeding, claims alleging administrative expense priority totaling more than $153 million have been filed and an additional claim of $14 million has been alleged. As of February 28, 1994, $115 million of the filed claims have been allowed and settled for $50.2 million in the aggregate. The Company is currently negotiating the resolution of the remaining $38 million filed administrative expense claim (which relates to a rejected lease of a Boeing 737-300 aircraft) and the $14 million alleged administrative expense claim (which relates to a rejected lease of a Boeing 757-200 aircraft). Claims have been or may be asserted against the Company for alleged administrative rent and\/or breach of return conditions (i.e. maintenance standards), guarantees and tax indemnity agreements related to aircraft or engines abandoned or rejected during the bankruptcy proceedings. Additional claims may be asserted against the Company and allowed by the Bankruptcy Court. The amount of such unidentified administrative claims may be material.\nAs part of its claims administration procedure, the Company is reviewing potential claims that could arise as a result of the Company's rejection of executory contracts. The Company's\nplan of reorganization will provide for the status of any executory contract not theretofore assumed by either affirming or rejecting such contracts. The assumption or rejection of certain executory contracts could result in additional claims against the Company.\nPlan of Reorganization. Under the Bankruptcy Code, the Company's pre- ---------------------- petition liabilities are subject to settlement under a plan of reorganization. Pursuant to an extension granted by the Bankruptcy Court on February 2, 1994, the Company has the partially exclusive right, until June 10, 1994 (unless extended by the Bankruptcy Court), to file a plan of reorganization. Each of the official committees has also been approved to submit a plan of reorganization. The exclusivity period may be extended by the Bankruptcy Court upon a showing of cause after notice has been given and a hearing has been held, although no assurance can be given that any additional extensions will be granted if requested by the Company. The Company has agreed not to seek additional extensions of the exclusivity period without the advance consent of the Creditors' Committee and the Equity Committee.\nOn December 8, 1993 and February 16, 1994, the Bankruptcy Court entered certain orders which provided for a procedure pursuant to which interested parties could submit proposals to participate in a plan of reorganization for America West. The Bankruptcy Court also set February 24, 1994 as the date for America West to select a \"Lead Plan Proposal\" from the proposals submitted.\nOn February 24, 1994, America West selected as its Lead Plan Proposal an investment proposal submitted by AmWest Partners, L.P., a limited partnership (\"AmWest\"), which includes Air Partners II, L.P., Continental Airlines, Inc., Mesa Airlines, Inc. and Fidelity Management Trust Company. On March 11, 1994, the Company and AmWest entered into a revised investment agreement which substantially incorporates the terms of the AmWest investment proposal (the \"Investment Agreement\"). The Investment Agreement provides that AmWest will purchase from America West equity securities representing a 37.5 percent ownership interest in the Company for $120 million and $100 million in new senior unsecured debt securities. The Investment Agreement also provides that, in addition to the 37.5 percent ownership interest in the Company, AmWest would also obtain 72.9 percent of the total voting interest in America West after the Company is reorganized. The terms of the Investment Agreement will be incorporated into a plan of reorganization to be filed with the Bankruptcy Court; however, modifications to the Investment Agreement may occur prior to the submission of a plan of reorganization and such modifications may be material. There can be no assurance that a plan of reorganization based upon the Investment Agreement will be accepted by the parties entitled to vote thereon or confirmed by the Bankruptcy Court.\nIn addition to the interest in the reorganized America West that would be acquired by AmWest pursuant to the Investment Agreement, the Investment Agreement also provides for the following:\n1. The D.I.P. financing would be repaid in full with cash on the Reorganization Date.\n2. On the Reorganization Date, unsecured creditors would receive 45 percent of the new common equity in the reorganized Company, with the potential to receive up to 55 percent of such equity if within one year after the Reorganization Date, the\nvalue of the securities distributed to them has not provided them with a full recovery under the Bankruptcy Code. In addition, unsecured creditors would have the right to elect to receive cash at $8.889 per share up to an aggregate maximum amount of $100 million, through a repurchase by AmWest of a portion of the shares to be issued to unsecured creditors under a plan of reorganization.\n3. Holders of equity interests would have the right to receive up to 10 percent of the new common equity of the Company, depending on certain conditions principally involving a determination as to whether the unsecured creditors had received a full recovery on account of their claims. In addition, holders of equity interests would have the right to purchase up to $15 million of the new common equity in the Company for $8.296 per share from AmWest, and would also receive warrants entitling them to purchase, together with AmWest, up to five percent of the reorganized Company's common stock, at a price to be set so that the warrants would have value only after the unsecured creditors receive full recovery on their claims.\n4. In exchange for certain concessions principally arising from cancellation of the right of GPA affiliates to put to America West 10 Airbus A320 aircraft at fixed rates, GPA, or certain affiliates thereof, would receive (i) 7.5 percent of the new common equity in the reorganized Company, (ii) warrants to purchase up to 2.5 percent of the reorganized Company's common stock on the same terms as the AmWest warrant, (iii) $3 million in new senior unsecured debt securities, and (iv) the right to require the Company to lease up to eight aircraft of types operated by the Company from GPA prior to June 30, 1999 on terms which the Company believes to be more favorable those currently applicable to the put aircraft. For an additional discussion of the put rights, see Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ------ ----------\nFacilities. ----------\nIn February 1988, the Company opened its maintenance and technical support facility at Phoenix Sky Harbor International Airport. The 660,000 square foot facility is comprised of four hangar bays, hangar shops, a flight simulator building as well as warehouse and commissary facilities.\nThe Company owns the 68,000 square foot America West Corporate Center at 222 South Mill Avenue in Tempe, Arizona. At December 31, 1993, the Company leased approximately 650,000 square feet of general office and other space in Phoenix and Tempe, Arizona. As a result of the reduction in aircraft fleet size in 1991 and 1992, a portion of the leased space became surplus to the Company's operational requirements. Negotiations with lessors occurred during 1993 with the assistance of a consulting firm in an effort to develop a consolidation plan. Such plan was completed at the end of 1993 and its implementation commenced in the first quarter of 1994. The consolidation plan generally provides for a reduction in leased space by approximately 150,000 square feet.\nIn 1990, the Company's Phoenix passenger service facilities were relocated to Terminal 4 of Phoenix Sky Harbor International Airport, where the Company leases approximately 258,200 square feet at December 31, 1993. The Company presently has 28 gates with 27 of such gates having enclosed passenger loading bridges at its two concourse facilities located in Terminal 4. The Company also leases approximately 25,000 square feet of other space at the airport for administrative offices and pilot training.\nAt December 31, 1993, the Company leased approximately 106,000 square feet of space at McCarran International Airport in Las Vegas, Nevada. Included in this property at Terminal B are 13 gates (all equipped with enclosed passenger boarding bridges) and adjoining holding room areas. In February 1993, the Company vacated approximately 26,000 square feet at Terminal B, including six gates.\nAt the Company's Columbus, Ohio mini-hub, the Company leased approximately 30,000 square feet of space at December 31, 1993. The Company also leased two gates from the Columbus airport authority and has the ability to sublease additional gates from other airlines as the need arises.\nSpace for ticket counters, gates and back offices has also been obtained at each of the other airports served by the Company, either by lease from the airport operator or by sublease\nfrom another airline. Some of the Company's airport sublease agreements include requirements that the Company purchase various ground services at the airport from the lessor airline at rates in excess of what it would cost the Company to provide those services itself.\nAircraft. --------\nAt December 31, 1993, the Company's 85 aircraft fleet consisted of three types of aircraft (56 Boeing 737s, 18 Airbus A320s and 11 Boeing 757s). America West's fleet has an average aircraft age of 8.1 years.\nThe table below sets forth certain information regarding the Company's aircraft fleet at December 31, 1993:\nEach of the aircraft that is designated as owned serves as collateral for a loan pursuant to which the aircraft was acquired by the Company or serves as collateral for a non-purchase money loan.\nAt December 31, 1993, the Company had on order a total of 93 aircraft of the types currently comprising the Company's fleet, of which 51 are firm and 42 are options. The table below details such deliveries.\nThe current estimated aggregate cost for these firm commitments and options is approximately $5.2 billion. Future aircraft deliveries are planned in some instances for incremental additions to the Company's existing aircraft fleet and in other instances as replacements for aircraft with lease terminations occurring during this period. The purchase agreement to acquire 24 Boeing 737-300 aircraft had been affirmed in the Company's bankruptcy proceeding. With timely notice to the manufacturer, all or some of these deliveries may be converted to Boeing 737-400 aircraft. As of December 31, 1993, eight Boeing 737 delivery positions had been eliminated due to the lack of a required reconfirmation notice by the Company to Boeing resulting in the 16 Boeing 737-300 aircraft total reflected in the table above. The failure to reconfirm these delivery positions exposes the Company to loss of pre-delivery deposits and other claims which may be asserted by Boeing in the Bankruptcy proceeding. The purchase agreements for the remaining aircraft types have not been assumed and, the Company has not yet determined which of the other aircraft purchase agreements, if any, will be affirmed or rejected.\nAs part of the Kawasaki Term Loan, the Company terminated an agreement to lease 24 Airbus A320 aircraft from Kawasaki, and ultimately replaced it with a put agreement to lease up to four such aircraft. Kawasaki is under no obligation to lease such aircraft to the Company and has the right to remarket these aircraft to other parties. Prior to its bankruptcy filing, the Company also entered into a similar arrangement with GPA, whereby the Company terminated its agreement to lease 10 Airbus A320 aircraft from GPA and replaced it with a put agreement to lease up to 10 Airbus A320 aircraft from GPA.\nThe put agreement with Kawasaki requires Kawasaki to notify the Company prior to July 1, 1994 if it intends to require the Company to lease any of its put aircraft. GPA's put agreement requires 180 days prior notice of the delivery of a put aircraft. The agreement also provides that GPA may not put more than five aircraft to the Company in any one calendar year. No more than nine put aircraft (GPA and Kawasaki combined) may be put to the Company in one calendar year. GPA's put right expires on December 31, 1996. The Kawasaki and the GPA put aircraft are reflected in the \"Firm Order\" section of the table above.\nThe Investment Agreement provides that as partial consideration for the cancellation of the GPA put rights, GPA will receive the right to require the Company to lease up to eight aircraft of types operated by the Company from GPA prior to June 30, 1999. See Item 1. Business -- Bankruptcy And ------ Reorganization Events -- Plan of Reorganization.\nThe Company does not have firm lease or debt financing commitments with respect to the future scheduled aircraft deliveries (other than for the Kawasaki put aircraft and the GPA put aircraft referred to above).\nIn addition to the aircraft set forth in the chart above, the Company also has a pre-petition executory contract under which the Company holds delivery positions for four Boeing 747-400 aircraft under firm orders and another four under options. The contract allows the Company, with the giving of adequate notice, to substitute other Boeing aircraft types for the Boeing 747-400 in these delivery positions. As a result, the Company is still evaluating its future fleet needs and is currently unable to determine if it will substitute other aircraft types or reject this agreement.\nOver the next four years, leases are scheduled to terminate on eight aircraft (six Boeing 737-200s and two Boeing 757-200s). In addition, leases for two Airbus A320-200s are scheduled to terminate during 1994; however, the Company has extended one lease for an additional twelve months. The other Airbus A320 aircraft will be returned to the lessor at the end of the lease term during 1994 and will be replaced by a Boeing 757 aircraft which has been leased for a term of three years. In addition, certain of the aircraft lessors have the right to call their respective aircraft upon (in most cases) 180 days prior notice to the Company. The Company, in turn (with some exceptions), may retain such aircraft via a right of first refusal by agreeing to the bona fide terms offered by a third party interested in leasing or purchasing the aircraft. See also Item 1. Business -- Bankruptcy And Reorganization Events -- Route Structure ------ and Fleet Reductions.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------ -----------------\nOn June 27, 1991, the Company filed a voluntary petition in the United States Bankruptcy Court for the District of Arizona to reorganize under Chapter 11 of Title 11 of the United States Bankruptcy Code. Since the Bankruptcy filing, several entities have filed administrative claims requesting that the Bankruptcy Court order the Company to reimburse or compensate such entities for goods, taxes and services they allege that the Company has received or collected, but for which they claim the Company has not paid. Entities which have or may file administrative claims, include aircraft maintenance organizations, municipal airports and certain financial or governmental institutions. In addition, aircraft providers whose aircraft were returned to them in connection with the Company's fleet reduction and restructuring efforts in September 1991 and September 1992 may be entitled to general unsecured pre-petition claims and\/or administrative claims in the Bankruptcy case for damages arising from the return of the aircraft. See also Item 1. Business -- Bankruptcy And ------ Reorganization Events.\nIn August 1991, the Securities and Exchange Commission (\"SEC\") informally requested that the Company provide the SEC with certain information and documentation underlying disclosures made by the Company in annual and quarterly reports filed with the SEC by the Company in 1991. The Company has cooperated with the SEC's informal inquiry. On March 29, 1994, the Company's Board of Directors approved the submission of an offer of settlement for the purpose of resolving the inquiry through the entry of a consent decree pursuant to which the Company would, while neither admitting nor denying any violation of the securities laws, agree to comply with its future reporting obligations under Section 13 of the Securities Exchange Act of 1934. The SEC has not yet acted on the Company's offer of settlement and\nthere can be no assurance that such offer of settlement will be accepted by the SEC. If the settlement is not accepted by the SEC, the offer will be of no force and effect.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ------ ---------------------------------------------------\nNo matter was submitted to a vote of the stockholders during the fourth quarter of the fiscal year ended December 31, 1993, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder ------ ------------------------------------------------------------- Matters. -------\nThe Company's Common Stock has been publicly traded since February 25, 1983 and is currently listed on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol AWAQC. The Common Stock has also been listed on the Pacific Stock Exchange since December 20, 1988 under the symbol AWA. From February 14, 1984 to January 17, 1992, the Common Stock was listed on NASDAQ\/National Market System (\"NASDAQ\/NMS\"). Due to the bankruptcy filing and the Company's inability to satisfy certain NASDAQ\/NMS listing requirements, the Common Stock listing was moved from NASDAQ\/NMS to NASDAQ on January 20, 1992. The following table sets forth the high and low bid quotations for the years 1992 and 1993 as reported by NASDAQ.\nThe number of record holders of the Company's Common Stock at December 31, 1993 was approximately 18,728.\nCash dividends have never been paid on the Company's Common Stock. Various credit agreements between the Company and its lenders restrict the ability of the Company to pay cash dividends.\nIn April 1986, the Company redeemed all outstanding shares of its Series A Preferred Stock. In September 1993, the holder of all the Company's Series B Preferred Stock converted such stock into 1,164,596 shares of Common Stock. The Company's Series C Preferred Stock is the only remaining outstanding class of preferred stock of the Company. A discussion of the Company's Preferred Stock is contained on pages 14 through 16 of the Company's Form S-3 Registration Statement No. 33-27416, incorporated herein by this reference. There is no public trading market for the Preferred Stock.\nThe Company filed a motion with the Bankruptcy Court on February 10, 1994 to prohibit the sale or other transfers of any general unsecured claims, the convertible subordinated debentures or shares of any class of stock. The motion attempted to preserve the Company's tax assets as such sales and transfers in sufficient numbers and amounts could, under current tax law, jeopardize the preservation of the Company's net operating loss and general business tax credit carryforwards. At the request of the official committees, the Company withdrew its motion without prejudice on February 16, 1994. On March 11, 1994, the Company again filed a motion with the Bankruptcy Court to prohibit the sale or other transfer of shares of any class of the Company's stock to or from five percent or more shareholders. This motion is more limited in scope than the motion filed on February 10, 1994 in that it seeks only to restrict transfers of stock which could have an adverse effect on the Company's ability to fully utilize its NOL carryforwards. On March 15, 1994, the Bankruptcy Court ordered that this motion be converted to an adversary proceeding under the Bankruptcy rules. As of March 29, 1994, no hearing on such proceeding has been held. There can be no assurance that the Company will continue to pursue this matter and, if the Company continues to pursue this matter, that it will be successful. See Item 7. Management's Discussion and ------ Analysis of Financial Condition and Results of Operations -- Overview and Item 8. Financial Statements and Supplementary Data -- Note 5 of Notes to ------ Financial Statements.\nItem 6.","section_6":"Item 6. Selected Financial Data. ------ -----------------------\nSELECTED FINANCIAL DATA\n(In thousands except per share amounts and ratio of earnings to fixed charges)\nThe information set forth below should be read in conjunction with the Financial Statements and related Notes to Financial Statements included elsewhere herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and ------ --------------------------------------------------------------- Results of Operations. ---------------------\nOverview --------\nOn June 27, 1991 the Company filed a voluntary petition in the United States Bankruptcy Court for the District of Arizona (the \"Bankruptcy Court\") to reorganize under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\"). The Company is currently operating as a debtor- in-possession (\"D.I.P.\") under the supervision of the Bankruptcy Court. As a debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside its ordinary course of business without approval of the Bankruptcy Court.\nThe accompanying financial statements have been prepared on a going concern basis which assumes continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. As a result of the reorganization proceedings, there are uncertainties relating to the ability of the Company to continue as a going concern. The financial statements do not include any adjustments that might be necessary as a result of the outcome of the uncertainties discussed herein including the effects of any plan of reorganization.\nDue to the bankruptcy proceedings, current economic conditions and the competitive nature of the airline industry, no measure of comparability can be drawn from past results in order to measure those that may occur in the future. Among the uncertainties which might adversely impact the Company's future operations are: economic recession; changes in the cost of fuel, labor, capital and other operating items; increased level of competition resulting in significant discounting of fares; changes in capacity, load factors and yields; or reduced levels of passenger traffic due to war or terrorist activities.\nIn addition, the following significant bankruptcy related events occurred during 1993.\nD.I.P. Loan. The Bankruptcy Court approved an amendment to the D.I.P. ----------- loan agreement extending the maturity date of the loan from September 30, 1993 to June 30, 1994. Concurrent with the extension of the maturity date, $8.3 million of the principal balance was repaid to one of the participants who did not agree to the amendment. The amended D.I.P. loan agreement requires the payment of a facility fee of $627,000 and defers all principal payments to June 30, 1994 with the exception of $5 million that will be due on March 31, 1994. An additional facility fee equal to 1\/4 percent of the then outstanding D.I.P. loan is required to be paid on March 31, 1994.\nThe amended terms of the D.I.P. financing require the Company to notify the D.I.P. lenders if the unrestricted cash balance of the Company exceeds $125 million. Upon receipt of such notice, the D.I.P. lenders may require the Company to prepay the D.I.P. financing by the amount of such excess. During the first quarter of 1994, the Company notified the D.I.P. lenders that the Company's unrestricted cash exceeded $125 million; however, to date, the D.I.P. lenders have not exercised their prepayment rights. See Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -- Note 5 of Notes to ------ Financial Statements.\nResults of Operations ---------------------\nThe Company realized net income of $37.2 million ($1.50 per common share) for 1993 compared to net losses of $131.8 million ($5.58 per common share) and $222 million ($10.39 per common share) for 1992 and 1991, respectively. The results for 1993 include reorganization expenses of $25 million and losses aggregating $4.6 million primarily resulting from the disposition of surplus spare aircraft parts and equipment. During 1992, the Company recorded restructuring charges of $31.3 million, reorganization expenses of $16.2 million and a gain of $15 million from the sale of its Honolulu to Nagoya, Japan route, while the 1991 results were affected by reorganization expenses of $58.4 million. The Company was only one of two major U.S. airlines to report a profit in each quarter of 1993.\nThe Company began to realize significant improvement in its operating results commencing the fourth quarter of 1992. During 1993, the level of operating income improved each quarter as shown in the table below.\nThe improvement in operating results for 1993 compared to 1992 and 1991 is attributable to several factors, the most significant of which are noted below.\n* A gradually improving economic climate, and a more stable environment relative to fare competition within the airline industry.\n* The reduction in fleet size from 123 aircraft in July 1991 to the current fleet of 85 aircraft has facilitated a better matching of capacity to demand. In addition, the consolidation of the fleet from five to three aircraft types has enabled the Company to further reduce its level of costs including those related to maintenance, training and inventories of parts.\n* In addition to reducing or eliminating certain routes as part of the aircraft fleet downsizing, the Company implemented certain enhancements to its revenue management system in an effort to optimize the level of passenger revenues generated on each flight. Such enhancements enable the Company to more effectively allocate seats within various fare categories.\n* The implementation of numerous cost reduction programs since 1991 including a Company-wide pay reduction in August of 1991 and reductions of aircraft lease rentals to fair market rates in the fall of 1992.\n* The elimination of the Company's commuter operation and the introduction of three code sharing agreements have enabled the Company to expand its scope of service and attract a broader passenger base.\nThe effect of these programs and the other factors described above resulted in operating income of $121.1 million for 1993 compared to operating losses of $74.8 million and $104.7 million for 1992 and 1991, respectively.\nTotal operating revenues were $1.3 billion in 1993, an increase of 2.4 percent compared to the prior year and 6.3 percent less than 1991 primarily due to the significant reduction in capacity. On April 1, 1993, the Company ceased service to Hawaii. Passenger revenues for 1993, 1992 and 1991 were $1.2 billion, $1.2 billion and $1.3 billion, respectively. Summarized below are certain capacity and traffic statistics for the years ended December 31, 1993, 1992 and 1991.\nIn spite of the significant decline in capacity in 1993 compared to the two previous years, passenger revenues per available seat mile improved by 15.1 percent and 12.2 percent compared to 1992 and 1991, respectively. This improvement was primarily attributable to the combination of the following factors.\n* An improved climate relative to the economy and industry fare competition.\n* The reduction in aircraft fleet size in conjunction with the implementation of enhancements to the Company's revenue management systems.\n* The elimination of \"fare simplification\" in 1993 and 50 percent-off sales that occurred on an industry-wide basis in the second and third quarters of 1992.\n* The 50 percent-off sale conducted by the Company on a system-wide basis in February 1991.\nRevenues from sources other than passenger fares decreased during 1993 to $78.8 million compared to $79.3 million and $81.7 million for 1992 and 1991, respectively. Freight and mail revenues comprised 51.0 percent, or $40.2 million, of other revenues for 1993. This represents a decrease of 4.6 percent compared to 1992 and 8.0 percent compared to 1991. For the years 1993, 1992 and 1991, the Company carried 110.7 million, 116.4 million and 119.8 million pounds of freight and mail, respectively. The decline in freight and mail revenues during the last three years is a direct result of capacity reductions, the most significant of which relate to the cessation of service to Hawaii and Nagoya, Japan. The balance of other revenues includes revenues generated from: pilot training; contract services provided to other airlines for maintenance and ground handling; reduced rate fares; alcoholic beverage and headset sales; and service charges assessed for refunds, reissues and prepaid ticket advices.\nIn spite of the significant reductions in capacity which have occurred since the filing of protection under Chapter 11, operating expense per available seat mile has declined to 7.01 cents for 1993 from 7.10 cents for 1992 and 7.36 cents for 1991. The table below sets forth the major categories of operating expense per available seat mile for 1993, 1992 an 1991:\nThe changes in the components of operating expense per available seat mile should be considered in relation to the decline in available seat miles of 10.8 percent and 16.7 percent from 1992 and 1991, respectively, and are explained as follows:\n* The 6.0 percent increase in salaries and related costs compared to 1992 is a result of the decline in capacity as well as the implementation of a transition pay program in the second quarter of 1993. The transition pay program was designed to restore a portion of the 10 percent wage reduction that was effected company-wide on August 1, 1991 (officers and other management personnel received wage reductions of 10 percent to 25 percent commencing in February 1991). All wages have been frozen at such levels since 1991. The program, which is to be in effect for the earlier of four fiscal quarters or until the confirmation of a plan of reorganization, provides for the following payments on a quarterly basis to all active employees during the quarter.\na. Commencing the second quarter of 1993, performance award distributions have been made based upon the Company meeting or exceeding its operating income target for a given quarter as incorporated in its business plan. The aggregate award for 1993 amounted to approximately $6.5 million including applicable payroll taxes.\nb. Commencing the third quarter of 1993, employment award distributions have been made based on the greater of .5 percent of an employee's annual base wage, or $125, which ever is higher, on a quarterly basis. The aggregate award for 1993 amounted to approximately $2.6 million including applicable payroll taxes.\nThe favorable variance compared to the 1991 level was primarily attributable to the reduction in payroll costs related to the decline in capacity as well as overhead and the Company-wide wage reduction instituted in August 1991.\n* Rentals and landing fees decreased due to the reduction in fleet size to 85 aircraft as well as the reduction in rental rates to fair market for certain aircraft commencing in August 1992 for a period of two years.\n* Aircraft fuel decreased due to the decline in the average price per gallon to 61.05 cents from 62.70 cents for 1992 and 67.10 cents for 1991.\n* The increase in the level of agency commission expense is primarily due to the significant increase in passenger revenue per available seat mile from 6.30 cents and 6.46 cents for 1992 and 1991, respectively, to 7.25 cents for 1993.\n* The decrease in aircraft maintenance materials and repairs is primarily due to the change in the composition of the aircraft fleet.\n* Restructuring charges incurred in 1992 consisted of the following:\nThe restructuring charges were necessitated by aircraft fleet reductions and other operational changes. The Company reduced its fleet to 87 aircraft at the end of 1992 as well as eliminated two of five aircraft types it operated. Additionally, employee headcount was reduced by approximately 1,500 employees and service was terminated to ten cities through the end of 1992.\n* The increase in depreciation and amortization is primarily attributable to increased heavy engine overhauls.\n* Other operating expenses increased 3.8 percent compared to 1992 but was lower by 3.5 percent compared to 1991. The increase compared to the prior year is primarily attributable to the 10.8 percent decline in capacity.\nNon-operating expenses (net of non-operating income) for 1993, 1992 and 1991 were $83.1 million, $56.9 million and $117.4 million, respectively. Interest expense decreased to $54.2 million in 1993 from $55.8 million in 1992 and $61.9 million in 1991. In conformity with Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization under the Bankruptcy Code\", issued by the American Institute of Certified Public Accountants, the Company has ceased accruing and paying interest on unsecured pre-petition long-term debt. Had the Company continued to accrue interest on such debt, interest expense for 1993, 1992 and 1991 would have been $73.0 million, $73.9 million and $79.3 million, respectively. See Item 8. Financial Statements and Supplementary Data -- Notes 3a and 4 of ------ Notes to Financial Statements.\nThe Company incurred expenses of $25 million in 1993, $16.2 million in 1992 and $58.4 million in 1991 in connection with its efforts to reorganize under Chapter 11. Such expenses for 1993 include net charges aggregating $18.2 million in accruals for unsecured claims and settlements of administrative claims primarily relating to leased aircraft which were returned to the lessors. Reorganization related expenses are expected to significantly affect future results and to continue until such time as the Company has obtained approval for its plan of reorganization.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes, (SFAS 109). --------------------------- Since there was no cumulative effect of this change in accounting, prior year financial statements have not been restated.\nAdditionally, Statements of Financial Accounting Standards No. 106 Post ---- Retirement Benefits Other Than Pensions, (SFAS 106) became effective --------------------------------------- January 1, 1993. The Company does not provide any post retirement benefits, thus, the standard has no impact. Statement of Financial Accounting Standard No. 112, Employer's Accounting for Post Employment ----------------------------------------- Benefits, (SFAS 112) becomes effective January 1, 1994. This statement -------- requires that post employment benefits be treated as part of compensation provided to an employee in exchange for service. Previously, most employers expensed the cost of these benefits as the benefits were provided. The Company is still reviewing the impact of SFAS 112, but does not believe it will have a material effect.\nLiquidity And Capital Resources -------------------------------\nAt December 31, 1993, the Company had a working capital deficiency of $124.4 million and net shareholders' deficiency of $254.3 million. The 1993 working capital deficiency decreased from the 1992 deficiency of $201.6 million primarily as result of principal repayments on obligations and significantly improved operating results.\nCash and cash equivalents amounted to $99.6 million at December 31, 1993 compared to $74.4 million at December 31, 1992. Net cash provided by operating activities increased to $153.4 million for 1993 compared to $76.7 million for 1992 and $19.9 million for 1991. During 1993, the Company incurred capital expenditures of $54.3 million compared to $69.2 million in 1992. The capital expenditures for 1993 consisted largely of aircraft modifications and heavy airframe and engine overhauls.\nThe Company's transition pay program which was implemented in the second quarter of 1993 is scheduled to terminate in the second quarter of 1994. The Company announced certain amendments to its compensation program on March 24, 1994. Effective April 1, 1994, employee base wages will be increased between two percent to eight percent depending on the employee's length of service with the Company. Generally, each employee whose anniversary date occurs between April and December 1994 will also receive an additional increase on such date approximating 4% with certain exceptions. The Chairman of the Board and the President will not participate in the salary increase program. Due to the current collective bargaining process with the representatives of the pilots, increases in pilots' salaries will not be paid but will be accrued. The distribution of such amounts will be determined through the collective bargaining discussions. The Company is currently in the process of revising its entire compensation program and anticipates implementing such program effective January 1, 1995.\nThe Company has also announced that, effective April 1, 1994, matching contributions by the Company under the America West 401(k) plan will be increased from 25 percent to 50 percent of the first six percent contributed by the employees, subject to certain limitations. This change restores the Company's matching contribution to the level that existed prior to the Chapter 11 filing.\nThe Company estimates that the implementation of the increases in pay and the 401(k) matching contributions will result in increased costs of approximately $18 million during the last nine months of 1994.\nUnder Delaware law, as well as the Company's D.I.P. loan agreement and the bankruptcy process, the Company is precluded from paying dividends on its outstanding preferred stock until such time as the total shareholders' deficiency is eliminated. During 1993 the Series B 10.5 percent convertible preferred stock (291,149 shares) with a liquidation preference of $15 million was converted into 1,164,596 shares of common stock of the Company.\nIn 1991, affiliates of Guinness Peat Aviation (\"GPA\"), Northwest Airlines, Inc. (\"Northwest\") and Kawasaki Leasing International Inc. (\"Kawasaki\") provided $78 million in D.I.P. financing to the Company. In September 1992, America West received an additional $53 million in D.I.P. financing, bringing the total outstanding D.I.P. financing at December 31, 1992, to $110.8 million which consisted of $69.8 million from GPA, $23 million from Kawasaki, $10 million from Ansett Worldwide Aviation Services (\"Ansett\") and $8 million from several Arizona-based entities. The D.I.P. financing is collateralized by substantially all of the Company's assets.\nThe financing provided by Northwest was repaid in full at the time of the September 1992 D.I.P. financing. America West also reconstituted its board of directors concurrent with the September 1992 D.I.P. financing. In September 1993, the D.I.P. lenders extended the maturity date of the D.I.P. financing from September 30, 1993 to June 30, 1994. At the time of the September 1993 extension, the financing provided by Ansett was repaid in full. The principal terms of the September 1993 extension are discussed below.\nInterest on all funds advanced under the D.I.P. financing accrues at 3.5 percent over the 90-day London Interbank Offered Rate (\"LIBOR\") and is payable quarterly. Principal repayments in the amount of $5.54 million were made on March 1993 and June 1993. As a result of the September 1993 extension of the D.I.P. financing maturity date, the Company is required to repay $5 million of the D.I.P. financing on March 31, 1994. The remaining outstanding balance will be due upon the earlier of June 30, 1994 or upon the effective date of a confirmed Chapter 11 plan of reorganization (the \"Reorganization Date\"). As a condition to extending the maturity date of the D.I.P. financing in September 1993, the Company also agreed to pay a facility fee of $627,000 to the D.I.P. lenders on September 30, 1993 and to pay an additional facility fee equal to 1\/4 percent of the then outstanding balance of the D.I.P. financing on March 31, 1994. As of December 31, 1993, the outstanding amount due under the D.I.P. financing was approximately $83.6 million. Presently, the Company does not possess sufficient liquidity to satisfy the D.I.P. financing nor does it appear that new equity capital will be obtained and a plan of reorganization confirmed prior to June 30, 1994. Consequently, the Company will be required to obtain alternative repayment terms from its current D.I.P. lenders. Although there can be no assurance that alternative repayment terms will be obtained, the Company believes that any required extension of the D.I.P. financing would be for a short period of time and would be concurrent with the implementation of a plan of reorganization. During the first quarter of 1994, the Company notified the D.I.P. lenders that the Company's unrestricted cash exceeded $125 million; however, to date, the D.I.P. lenders have not exercised their prepayment rights.\nAs a condition to the closing of the September 1992 D.I.P. financing, the Company was required to reduce its aircraft fleet to 86 aircraft and the number of aircraft types from five to three. Consequently, the Company reached certain agreements with third parties, which included the following:\n1. With the exception of four lessors (two of which participated in the September 1992 D.I.P. financing), aircraft lessors whose aircraft were retained in the fleet and whose payments were deferred during July and August 1992, were required to waive any default which occurred as a result of such non-payments and to defer these payments without interest until the first calendar quarter of 1993. In addition, effective August 1, 1992, the rental rates on these retained aircraft were reduced to fair market rental rates for a period of two years or longer. The August 1992 payments were deferred at the reduced interest rates.\nOf the remaining two lessors, one accepted rental payment reductions and the other agreed to a deferral of the rents from July through October 1992. Repayment of this deferral is monthly over seven years beginning November 1992 at level principal and interest at 90 day LIBOR plus 3.5 percent.\n2. The aircraft lessors who accepted rent reductions and agreed to waive any administrative claims arising from the reductions stipulated that, if prior to July 31, 1994, the Company defaults on any of these leases and the aircraft are repossessed, the lessors are entitled to fixed damages ranging from $500,000 to $2,000,000 (depending on the type of aircraft) as well as any other damages that can be claimed for breach of their leases, all of which will be afforded priority as administrative claims. Lessors of 12 aircraft have the option, beginning August 1, 1994, to reset the rents to the then current fair market rental rates (additionally, certain of these leases call for multiple resets subsequent to the August 1, 1994 reset date). In February 1994, the Company commenced negotiations with certain lessors with respect to determining the requisite reset rates.\nLessors of 16 aircraft have call rights which generally provide for the acceleration of the lease termination to the 180th day after receipt by the Company of notice from the lessor that the lessor has a bona fide written offer to lease the aircraft to an unrelated third party. The Company in turn has a ten day right of first refusal after receipt of such notice to match the written offer. Lessors of 10 of aircraft also have the right to call their aircraft during specified periods without having received a bona fide offer to lease their aircraft and without offering the Company a right of first refusal. The lessor of 11 aircraft has the right to call its aircraft on 90 days notice after to the end of the original lease term of the aircraft. If a lessor exercises its call option, and 1991 deferred rents are still outstanding under the terminated lease, repayment of this deferral is not accelerated. Such deferral will continue to amortize over its original term; however, at a reduced interest rate of 90 day LIBOR plus 3.5 percent. See also Item 1. Business -- Bankruptcy And ------ Reorganization Events -- Route Structure and Aircraft Fleet Reductions.\n3. Certain principal and interest payments on owned aircraft due in July 1992 were deferred without interest and were repaid by March 31, 1993. Additionally, certain other principal and interest payments due from August 1992 through January 1993 were deferred and are being repaid beginning February 1993 over terms of five to nine years with interest at approximately 10.25 percent.\nIn lieu of payment deferrals, two aircraft lenders agreed to interest rate reductions of approximately three percent on their outstanding aircraft loans to the Company, resulting in interest rates of approximately 7.25 percent.\n4. Two of the current D.I.P. lenders, amended their existing rights to put up to ten aircraft each to the Company such that a total of fourteen aircraft may be put to the Company beginning in 1994 through 1996. Such aircraft would be put to the Company under prearranged lease agreements. As of February 28, 1994, the Company has not received any notification from the parties exercising any of their put rights.\nIn September 1993, the D.I.P. loan agreement was amended and the maturity date was extended from September 30, 1993 to June 30, 1994. The principal financial terms of the amended D.I.P. loan agreement include the following:\n1. The repayment of $8.3 million to the loan participant who did not agree to the maturity date extension.\n2. The outstanding principal balance at September 30, 1993 becomes due on June 30, 1994 or the confirmation of a plan of reorganization, whichever occurs earlier, with the exception of a principal repayment of $5 million on March 31, 1994.\n3. The amended terms of the D.I.P. financing require the Company to notify the D.I.P. lenders if the unrestricted cash balance of the Company exceeds $125 million. Upon receipt of such notice, the D.I.P. lenders may require the Company to prepay the D.I.P. financing by the amount of such excess. During the first quarter of 1994, the Company notified the D.I.P. lenders that the Company's unrestricted cash exceeded $125 million; however, to date, the D.I.P. lenders have not exercised their prepayment rights.\n4. Certain of the financial covenants were revised which the Company believes provide it with increased flexibility. In general, such covenants relate to operating results, liquidity, capital expenditures, collateral values and lease payments.\n5. A facility fee of 3\/4 percent of the outstanding balance, or $627,000, was paid to the participants on September 30, 1993. In addition, an additional 1\/4 percent of the then outstanding balance must be paid on March 31, 1994.\nPresently, the Company does not possess sufficient liquidity to satisfy its D.I.P. loan obligation nor does it appear that a plan of reorganization could be confirmed prior to June 30, 1994. Consequently, the Company will be required to obtain alternative repayment terms from its current D.I.P. lenders, but there can be no assurances that such alternative repayment terms will be agreed to by the D.I.P. lenders.\nDuring 1993, the Company repaid approximately $18.4 million of scheduled aircraft lease payments which were deferred in 1991 and 1992 as well as $27.2 million of principal repayment related to the D.I.P. loan.\nAs a condition of the D.I.P. financing, the Company obtained from most of its aircraft providers rent or principal and interest deferrals in excess of $100 million for the six-month period of June through November 1991. In general, the deferred amounts accrue interest at 10.5 percent. In December 1991, the Company began repaying such deferred amounts. See Item 8. Financial Statements and Supplementary Data -- Note 11 of Notes to ------ Financial Statements.\nUnder the terms of the D.I.P. financing, Northwest acquired the Company's Honolulu to Nagoya, Japan route for $15 million in 1992. Upon the completion of the sale of the Nagoya route, $10 million of the proceeds from the sale were paid to Northwest to reduce the Company's obligation to Northwest under the D.I.P. financing. The balance of the proceeds from the sale of the Nagoya route were added to the Company's working capital.\nIn connection with the D.I.P. financing provided by Kawasaki, the Company agreed to convert advanced cash credits for 24 Airbus A320 aircraft (the \"Kawasaki Aircraft\") previously advanced by Kawasaki into an unsecured priority term loan (the \"Kawasaki Term Loan\"). At December 31, 1993, the amount of the Kawasaki Term Loan was $68.4 million, including accrued interest of $21.9 million. Until the Reorganization Date, the Kawasaki Term Loan will accrue interest at 12 percent per annum and such interest will be added to principal. On the Reorganization Date, 85 percent of the Kawasaki Term Loan will be converted into an eight-year term loan which will accrue interest at 2 percent over 90-day LIBOR and will be secured by substantially all the assets of the Company if the D.I.P. financing is fully repaid. Principal on such loan will be due and payable in equal quarterly installments, plus interest commencing after the Reorganization Date. The Company has the right to prepay the Kawasaki Term Loan if the D.I.P. financing is fully repaid. The remaining 15 percent of the Kawasaki Term Loan will be treated as a general unsecured claim without priority status under the Company's plan of reorganization. In the first quarter of 1994, the Company received information that the Kawasaki Term Loan was purchased by a third party.\nAs part of the Kawasaki Term Loan, the Company terminated an agreement to lease 24 Airbus A320 aircraft from Kawasaki, and ultimately replaced it with a put agreement to lease up to four such aircraft. Kawasaki is under no obligation to lease such aircraft to the Company and has the right to remarket these aircraft to other parties. Prior to its bankruptcy filing, the Company also entered into a similar arrangement with GPA, whereby the Company terminated its agreement to lease 10 Airbus A320 aircraft from GPA and replaced it with a put agreement to lease up to 10 Airbus A320 aircraft from GPA.\nThe put agreement with Kawasaki requires Kawasaki to notify the Company prior to July 1, 1994 if it intends to require the Company to lease any of its put aircraft. GPA's put agreement requires 180 days prior notice of the delivery of a put aircraft. The agreement also provides that GPA may not put more than five aircraft to the Company in any one calendar year. No more than nine put aircraft (GPA and Kawasaki combined) may be put to the Company in one calendar year. GPA's put right expires on December 31, 1996.\nThe Investment Agreement provides that as partial consideration for the cancellation of the GPA put rights, GPA will receive the right to require the Company to lease up to eight aircraft of types operated by the Company from GPA prior to June 30, 1999.\nThe reorganization process is expected to result in the cancellation and\/or restructuring of substantial debt obligations of the Company. Under the Bankruptcy Code, the Company's pre-petition liabilities are subject to settlement under a plan of reorganization. The Bankruptcy Code also requires that all administrative claims be paid on the effective date of a plan of reorganization unless the respective claimants agree to different treatment. There are differences between the amounts at which claims liabilities are recorded in the financial statements and the\namounts claimed by the Company's creditors and such differences are material. Significant litigation may be required to resolve any disputes.\nDue to the uncertain nature of many of the potential claims, America West is unable to project the magnitude of such claims with any degree of certainty. However, the claims (pre-petition claims and administrative claims) that have been filed against the Company are in excess of $2 billion. Such aggregate amount, includes claims of all character, including, but not limited to, unsecured claims, secured claims, claims that have been scheduled but not filed, duplicative claims, tax claims, claims for leases that were assumed, and claims which the Company believes to be without merit; however, claims filed for which an amount was not stated, are not reflected in such amount. The Company is unable to estimate the potential amount of such unstated claims; however, the amount of such claims could be material.\nThe Company is in the process of reviewing the general unsecured claims asserted against the Company. In many instances, such review process will include the commencement of Bankruptcy Court proceedings in order to determine the amount at which such claims should be allowed. The Company has accrued its estimate of claims that will be allowed or the minimum amount at which it believes the asserted general unsecured claims will be allowed if there is no better estimate within the range of possible outcome. However, the ultimate amount of allowed claims will be different and such differences could be material. The Company is unable to estimate the amount of such difference with any reasonable degree of certainty at this time.\nThe Bankruptcy Code requires that all administrative claims be paid on the effective date of a plan of reorganization unless the respective claimants agree to different treatment. Consequently, depending on the ultimate amount of administrative claims allowed by the Bankruptcy Court, the Company may be unable to obtain confirmation of a plan of reorganization. The Company is actively negotiating with claimants to achieve mutually acceptable dispositions of these claims. Since the commencement of the bankruptcy proceeding, claims alleging administrative expense priority totaling more than $153 million have been filed and an additional claim of $14 million has been alleged. As of February 28, 1994, $115 million of the filed claims have been allowed and settled for $50.2 million in the aggregate. The Company is currently negotiating the resolution of the remaining $38 million filed administrative expense claim (which relates to a rejected lease of a Boeing 737-300 aircraft) and the $14 million alleged administrative expense claim (which relates to a rejected lease of a Boeing 757-200 aircraft). Claims have been or may be asserted against the Company for alleged administrative rent and\/or breach of return conditions (i.e. maintenance standards), guarantees and tax indemnity agreements related to aircraft or engines abandoned or rejected during the bankruptcy proceedings. Additional claims may be asserted against the Company and allowed by the Bankruptcy Court. The amount of such unidentified administrative claims may be material.\nAs part of its claims administration procedure, the Company is reviewing potential claims that could arise as a result of the Company's rejection of executory contracts. The Company's plan of reorganization will provide for the status of any executory contract not theretofore assumed by either affirming or rejecting such contracts. The assumption or rejection of certain executory contracts could result in additional claims against the Company.\nAt December 31, 1993, the Company had a total of 93 aircraft on order, of which 51 are firm and 42 are options. The current estimated aggregate cost for these firm commitments and options is approximately $5.2 billion. Future aircraft deliveries are planned in some instances for incremental additions to the Company's existing aircraft fleet and in other instances as replacements for aircraft with lease terminations occurring during this period. The purchase agreement to acquire 24 Boeing 737-300 aircraft had been affirmed in the Company's bankruptcy proceeding. With timely notice to the manufacturer, all or some of these deliveries may be converted to Boeing 737-400 aircraft. As of December 31, 1993, eight Boeing 737 delivery positions had been eliminated due to the lack of a required reconfirmation notice by the Company to Boeing. The failure to reconfirm these delivery positions exposes the Company to loss of pre-delivery deposits and other claims which may be asserted by Boeing in the Bankruptcy proceeding. The purchase agreements for the remaining aircraft types have not been assumed and, the Company has not yet determined which of the other aircraft purchase agreements, if any, will be affirmed or rejected. The Company also has a pre-petition executory contract under which the Company holds delivery positions for four Boeing 747-400 aircraft under firm orders and another four under options. The contract allows the Company, with the giving of adequate notice, to substitute other Boeing aircraft types for the Boeing 747-400 in these delivery positions. As a result, the Company is still evaluating its future fleet needs and is currently unable to determine if it will substitute other aircraft types or reject this agreement. The Company believes it will be successful in negotiating new aircraft purchase agreements that will meet its needs. However, there can be no assurances that the Company will enter into such agreements. As of December 31, 1993, the Company had deposits on aircraft orders of approximately $52 million of which approximately $21 million were financed.\nDuring 1994, leases relating to four Boeing 737-200 aircraft, two Airbus A320 aircraft and two Boeing 757 aircraft are scheduled to expire. The Company has negotiated extensions of the leases for all but one of the Airbus A320 aircraft for terms ranging from one to three years. The Airbus A320 aircraft to be returned to the lessor will be replaced by a Boeing 757 aircraft which has been leased for a term of three years. In addition, up to nine Airbus A320 aircraft may be put to the Company should GPA and\/or Kawasaki elect to exercise its put options. As of February 28, 1994, none of the put options have been exercised. Lease agreements have been arranged for such put aircraft for terms of five to eighteen years at specified monthly lease rate factors.\nItem 8. Financial Statements and Supplementary Data. ------ -------------------------------------------\nFinancial statements of the Company as of December 31, 1993 and 1992, and for each of the years in the three-year period ended December 31, 1993, together with the related notes and the Report of KPMG Peat Marwick, independent certified public accountants, are set forth on the following pages. Other required financial information and schedules are set forth herein, as more fully described in Item 14 hereof.\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders America West Airlines, Inc., D.I.P.:\nWe have audited the accompanying balance sheets of America West Airlines, Inc., D.I.P. (the Company) as of December 31, 1993 and 1992, and the related statements of operations, cash flows and stockholders' equity (deficiency) for each of the years in the three-year period ended December 31, 1993. In connection with our audits of the financial statements, we also have audited the financial statement schedules V, VI, VIII and X for each of the years in the three-year period ended December 31, 1993. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of America West Airlines, Inc., D.I.P. as of December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles. Also in our opinion, the financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nThe accompanying financial statements and financial statement schedules have been prepared assuming that the Company will continue as a going concern. As discussed in note 1 to the financial statements, on June 27, 1991 the Company filed a voluntary petition seeking to reorganize under Chapter 11 of the federal bankruptcy laws. This event and circumstances relating to this event, including the Company's significant losses, accumulated deficit and highly leveraged capital structure, raise substantial doubt about its ability to continue as a going concern. Although the Company is currently operating as debtor-in-possession under the jurisdiction of the Bankruptcy Court, the continuation of the business as a going concern is contingent upon, among other things, the ability to (1) file a Plan of Reorganization which will gain approval of the creditors and stockholders and confirmation by the Bankruptcy Court, (2) maintain compliance with all debt covenants under the debtor-in-possession financing agreements, (3) achieve satisfactory levels of future operating results and cash flows and (4) obtain additional debt and equity. Also, as discussed in note 1 to the financial statements, as part of the Company's bankruptcy proceeding there is uncertainty as to the amount of claims that will be allowed and as to a number of disputed claims which are materially in excess of amounts reflected in the accompanying financial statements. The accompanying financial statements and financial statement schedules do not include any adjustments that might result from the outcome of these uncertainties.\nKPMG PEAT MARWICK\nPhoenix, Arizona March 18, 1994\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements December 31, 1993, 1992 and 1991\n(1) Reorganization Under Chapter 11, Liquidity, Financial Condition and ------------------------------------------------------------------- Subsequent Events -----------------\nOn June 27, 1991, America West Airlines, Inc., D.I.P. (the \"Company\" or \"America West\") filed a voluntary petition in the United States Bankruptcy Court for the District of Arizona (the \"Bankruptcy Court\") to reorganize under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\"). The Company is currently operating as a debtor-in-possession (\"D.I.P.\") under the supervision of the Bankruptcy Court. As a debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside its ordinary course of business without the approval of the Bankruptcy Court.\nSubject to certain exceptions under the Bankruptcy Code, the Company's filing for reorganization automatically enjoined the continuation of any judicial or administrative proceedings against the Company. Any creditor actions to obtain possession of property from the Company or to create, perfect or enforce any lien against the property of the Company are also enjoined. As a result, the creditors of the Company are precluded from collecting pre-petition debts without the approval of the Bankruptcy Court.\nThe Company had the exclusive right for 120 days after the Chapter 11 filing on June 27, 1991 to file a plan of reorganization and 60 additional days to obtain necessary acceptances of such plan. Such periods may be extended at the discretion of the Bankruptcy Court, but only on a showing of good cause, and extensions have been obtained such that the Company has until June 10, 1994 to file its plan of reorganization with the Court or obtain an additional extension. Subject to certain exceptions set forth in the Bankruptcy Code, acceptance of a plan of reorganization requires approval of the Bankruptcy Court and the affirmative vote (i.e. 50% of the number and 66- 2\/3% of the dollar amount) of each class of creditors and equity holders whose claims are impaired by the plan.\nCertain pre-petition liabilities have been paid after obtaining the approval of the Bankruptcy Court, including certain wages and benefits of employees, insurance costs, obligations to foreign vendors and governmental agencies, travel agent commissions and ticket refunds. The Company has also been allowed to honor all tickets sold prior to the date it filed for reorganization. In addition, the Company is authorized to pay pre-petition liabilities to essential suppliers of fuel, food and beverages and to other vendors providing critical goods and services. Subsequent to filing and with the approval of the Bankruptcy Court, the Company assumed certain executory contracts of essential suppliers.\nParties to executory contracts may, under certain circumstances, file motions with the Bankruptcy Court to require the Company to assume or reject such contracts. Unless otherwise agreed, the assumption of a contract will require the Company to cure all prior defaults under the related contract, including all pre-petition liabilities unless terms can be negotiated. Unless otherwise agreed, the rejection of a contract is deemed to constitute a breach of the agreement as of the moment immediately preceding Chapter 11 filing, giving the other party to the contract a right to assert a general unsecured claim for damages arising out of the breach.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nFebruary 28, 1992 was set as the last date for the filing of proof of claims under the Bankruptcy Code and the Company's creditors have submitted claims for liabilities not paid and for damages incurred. There may be differences between the amounts at which any such liabilities are recorded in the financial statements and the amount claimed by the Company's creditors. Significant litigation may be required to resolve any such disputes.\nThe Company has incurred and will continue to incur significant costs associated with the reorganization. The amount of these costs, which are being expensed as incurred, is expected to significantly affect results of operations.\nAs a result of its filing for protection under Chapter 11 of the Bankruptcy Code, the Company is in default of substantially all of its debt agreements. All outstanding pre-petition unsecured debt of the Company has been presented in these financial statements within the caption Estimated Liabilities Subject to Chapter 11 Proceedings.\nAdditional liabilities subject to the proceedings may arise in the future as a result of the rejection of executory contracts, including leases, and from the determination by the Bankruptcy Court (or agreement by parties in interest) of allowed claims for contingencies and other disputed amounts. Conversely, the assumption of executory contracts and unexpired leases may convert liabilities shown as subject to Chapter 11 proceedings to post-petition liabilities.\nSubstantially all of the aircraft, engines and spare parts in the Company's fleet are subject to lease or secured financing agreements that entitle the Company's aircraft lessors and secured creditors to rights under Section 1110 of the Bankruptcy Code. Pursuant to Section 1110, the Company had 60 days from the date of its Chapter 11 filing, or until August 26, 1991, to bring its obligations to these aircraft lessors and secured creditors current and\/or reach other mu- tually satisfactory negotiated arrangements. In September 1991, as a condition to the borrowings under the initial $55 million D.I.P. facility, the Company arranged for rent, principal and interest payment deferrals from a majority of its aircraft providers as a condition to the assumption of the related lease or secured borrowing by the Company. As a result of these arrangements, the Company was able to assume the executory contracts associated with 83 aircraft in its fleet without having to bring its obligations to these aircraft providers current. In addition, as part of the initial D.I.P. facility, the Company assumed and brought current lease agreements for 16 Airbus A320 aircraft, three CFM engines, a Boeing 757-200 and a Boeing 737-300. Twenty-two aircraft were deemed surplus to the Company's needs and the associated executory contracts were rejected. Included in 1991 reorganization costs is $35.2 million in write-offs of leasehold improvements, security deposits, accrued maintenance, accrued rents and other costs to return the aircraft which were subject to the rejected aircraft agreements. In certain cases, final agreements were reached with such aircraft providers and no further claims by such providers will be pursued as a result of the rejections. In other instances, the aircraft providers have filed claims in the normal course of the bankruptcy and as of December 31, 1993 significant claims for rejected aircraft have not yet been settled.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nDue to the uncertain nature of many of the potential claims, the Company is unable to project the magnitude of such claims with any degree of certainty. However, the claims (pre-petition claims and administrative claims) that have been filed against the Company are in excess of $2 billion. Such aggregate amount includes claims of all character, including, but not limited to, unsecured claims, secured claims, claims that have been scheduled but not filed, duplicative claims, tax claims, claims for leases that were assumed, and claims which the Company believes to be without merit; however, claims filed for which an amount was not stated, are not reflected in such amount. The Company is unable to estimate the potential amount of such unstated claims; however, the amount of such claims could be material.\nThe Company is in the process of reviewing the general unsecured claims asserted against the Company. In many instances, such review process will include the commencement of Bankruptcy Court proceedings in order to determine the amount at which such claims should be allowed. The Company has accrued its estimate of claims that will be allowed or the minimum amount at which it believes the asserted general unsecured claims will be allowed if there is no better estimate within the range of possible outcomes. However, the ultimate amount of allowed claims will be different and such differences could be material. The Company is unable to estimate the amount of such differences with any reasonable degree of certainty at this time.\nThe Bankruptcy Code requires that all administrative claims be paid on the effective date of a plan of reorganization unless the respective claimants agreed to different treatment. Consequently, depending on the ultimate amount of administrative claims allowed by the Bankruptcy Court, the Company may be unable to obtain confirmation of a plan of reorganization. The Company is actively negotiating with claimants to achieve mutually acceptable dispositions of these claims. Since the commencement of the bankruptcy proceeding, claims alleging administrative expense priority totaling more than $153 million have been filed and an additional claim of $14 million has been alleged. As of February 28, 1994, $115 million of the filed claims have been allowed and settled for $50.2 million in the aggregate. The Company is currently negotiating the resolution of the remaining $38 million filed administrative expense claim (which relates to a rejected lease of a Boeing 737-300 aircraft) and the alleged $14 million administrative claim (which relates to a rejected lease of a Boeing 757-200 aircraft). Claims have been or may be asserted against the Company for alleged administrative rent and\/or breach of return conditions (i.e. maintenance standards), guarantees and tax indemnity agreements related to aircraft or engines abandoned or rejected during the bankruptcy proceedings. Additional claims may be asserted against the Company and allowed by the Bankruptcy Court. The amount of such unidentified administrative claims may be material.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nPlan of Reorganization ----------------------\nUnder the Bankruptcy Code, the Company's pre-petition liabilities are subject to settlement under a plan of reorganization. Pursuant to an extension granted by the Bankruptcy Court on February 2, 1994, the Company has the partially exclusive right, until June 10, 1994 (unless extended by the Bankruptcy Court), to file a plan of reorganization. Each of the official committees has also been approved to submit a plan of reorganization. The exclusivity period may be extended by the Bankruptcy Court upon a showing of cause after notice has been given and a hearing has been held, although no assurance can be given that any additional extensions will be granted if requested by the Company. The Company has agreed not to seek additional extensions of the exclusivity period without the advance consent of the Creditors' Committee and the Equity Committee.\nOn December 8, 1993 and February 16, 1994, the Bankruptcy Court entered certain orders which provided for a procedure pursuant to which interested parties could submit proposals to participate in a plan of reorganization for America West. The Bankruptcy Court also set February 24, 1994 as the date for America West to select a \"Lead Plan Proposal\" from the proposals submitted.\nOn February 24, 1994, America West selected as its Lead Plan Proposal an investment proposal submitted by AmWest Partners, L.P., a limited partnership (\"AmWest\"), which includes Air Partners II, L.P., Continental Airlines, Inc., Mesa Airlines, Inc. and Fidelity Management Trust Company. On March 11, 1994, the Company and AmWest entered into a revised investment agreement which substantially incorporates the terms of the AmWest investment proposal (the \"Investment Agreement\"). The Investment Agreement provides that AmWest will purchase from America West equity securities representing a 37.5% ownership interest in the Company for $120 million and $100 million in new senior unsecured debt securities. The Investment Agreement also provides that, in addition to the 37.5% ownership interest in the Company, AmWest would also obtain 72.9% of the total voting interest in America West after the Company is reorganized. The terms of the Investment Agreement will be incorporated into a plan of reorganization to be filed with the Bankruptcy Court; however, modifications to the Investment Agreement may occur prior to the submission of a plan of reorganization and such modifications may be material. There can be no assurance that a plan of reorganization based upon the Investment Agreement will be accepted by the parties entitled to vote thereon or confirmed by the Bankruptcy Court.\nIn addition to the interest in the reorganized America West that would be acquired by AmWest pursuant to the Investment Agreement, the Investment Agreement also provides for the following:\n1. The D.I.P. financing would be repaid in full with cash on the date a plan of reorganization is confirmed (\"Reorganization Date\").\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n2. On the Reorganization Date, unsecured creditors would receive 45% of the new common equity in the reorganized Company, with the potential to receive up to 55% of such equity if within one year after the Reorganization Date, the value of the securities dis- tributed to them has not provided them with a full recovery under the Bankruptcy Code. In addition, unsecured creditors would have the right to elect to receive cash at $8.889 per share up to an aggregate maximum amount of $100 million, through a repurchase by AmWest of a portion of the shares to be issued to unsecured creditors under a plan of reorganization.\n3. Holders of equity interests would have the right to receive up to 10% of the new common equity of the Company, depending on certain conditions principally involving a determination as to whether the unsecured creditors had received a full recovery on account of their claims. In addition, holders of equity interests would have the right to purchase up to $15 million of the new common equity in the Company for $8.296 per share from AmWest, and would also receive warrants entitling them to purchase, together with AmWest, up to 5% of the reorganized Company's common stock, at a price to be set so that the warrants would have value only after the unsecured creditors would have received full recovery on their claims.\n4. In exchange for certain concessions principally arising from cancellation of the right of Guinness Peat Aviation (\"GPA\") affiliates to put to America West 10 Airbus A320 aircraft at fixed rates, GPA, or certain affiliates thereof, would receive (i) 7.5% of the new common equity in the reorganized Company, (ii) warrants to purchase up to 2.5% of the reorganized Company's common stock on the same terms as the AmWest warrants, (iii) $3 million in new senior unsecured debt securities, and (iv) the right to require the Company to lease up to eight aircraft of types operated by the Company from GPA prior to June 30, 1999 on terms which the Company believes to be more favorable than those currently applicable to the put aircraft. See note 11 for an additional discussion of the put rights.\n5. Continental Airlines, Inc., Mesa Airlines, Inc. and America West would enter into certain alliance agreements which would include code-sharing, schedule coordination and certain other relationships and agreements. A condition to proceeding with a plan of reorganization based upon the Investment Agreement would be that these agreements be in form and substance satisfactory to America West, including the Company's reasonable satisfaction that such alliance agreements when fully implemented will result in an increase in pre-tax income of not less than $40 million per year.\n6. The expansion of the Company's board of directors to 15 members. Nine members would be designated by AmWest and other members reasonably acceptable to AmWest would include four members designated by representatives of the Company, the Equity Committee and the Creditors' Committee and two members designated by GPA.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n7. The Investment Agreement also provides for many other matters, including the disposition of the various types of claims asserted against the Company, the adherence to the Company's aircraft lease agreements, the amendment of the Company's aircraft pur- chase agreements and release of the Company's employees from all currently existing obligations arising under the Company's stock purchase plan in consideration for the cancellation of the shares of Company stock securing such obligations.\nThe Company has also entered into a Revised Interim Procedures Agreement (the \"Procedures Agreement\") with AmWest. The Procedures Agreement is subject to the approval of the Bankrupty Court and sets forth terms and conditions upon which the Company must operate prior to the effective date of a confirmed plan of reorganization based upon the terms of the Investment Agreement. The Procedures Agreement provides for the reimbursement of AmWest's expenses (up to a maximum of $3.6 million) as well as a termination fee of up to $8 million under certain conditions. The Procedures Agreement has not yet been approved by the Bankruptcy Court.\nThe Company is currently developing with AmWest a plan of reorganization based upon the foregoing terms. The Equity Committee has agreed to support the plan. The Creditors' Committee has indicated that it does not support the current terms of the Investment Agreement. Another group interested in developing a plan of reorganization with the Company has proposed to invest $155 million in equity securities and $65 million in new senior unsecured debt securities. The proponent of this proposal would receive a 33.5% ownership interest in the reorganized Company, current equity holders would receive a 4% ownership interest in the reorganized Company and the unsecured creditors would receive a 62.5% ownership interest in the reorganized company.\nAny plan of reorganization must be approved by the Bankruptcy Court and by specified majorities of each class of creditors and equity holders whose claims are impaired by the plan. Alternatively, absent the requisite approvals, the Company may seek Bankruptcy Court approval of its reorganization plan under Section 1129(b) of the Bankruptcy Code, assuming certain tests are met. The Company cannot predict whether any plan submitted by it will be approved.\nThe Company is currently unable to predict when it may file a plan of reorganization based upon the Investment Agreement, but intends to do so as soon as practicable. Once a plan with a disclosure statement is filed by any party, the Bankruptcy Court will hold a hearing to determine the adequacy of the information contained in such disclosure statement. Only upon receiving an order from the Bankruptcy Court providing that the disclosure statement accompanying any such plan contains adequate information as required by Section 1125 of the Bankruptcy Code, may a party solicit acceptances or rejections of any such plan of reorganization. Following entry of an order approving the disclosure statement, the plan will be sent to creditors and equity holders for voting pursuant to both the Bankruptcy Code and orders that will be entered by the Bankruptcy Court. Following submission of the plan to holders of claims and equity interests, the Bankruptcy Court will hold a hearing to consider confirmation of the plan pursuant to Section 1129 of the Bankruptcy Code. Although the Bankruptcy Code provides for certain minimum time periods for these events, the Company is unable to reasonably estimate when a plan based on the Investment Agreement might be submitted for voting and confirmation.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nIf at any time the Creditors' Committee, the Equity Committee or any creditor of the Company or equity holder of the Company believes that the Company is or will not be in a position to sustain operations, such party can move in the Bankruptcy Court to compel a liquidation of the Company's estate by conversion to Chapter 7 bankruptcy proceedings or otherwise. In the event that the Company is forced to sell its assets and liquidate, it is unlikely that unsecured creditors or equity holders will receive any value for their claims or interests.\nThe Company anticipates that the reorganization process will result in the restructuring, cancellation and\/or replacement of the interest of its existing common and preferred stockholders. Because of the \"absolute priority rule\" of Section 1129 of the Bankruptcy Code, which requires that the Company's creditors be paid in full (or otherwise consent) before equity holders can receive any value under a plan of reorganization, the Company previously disclosed that it anticipated that the reorganization process would result in the elimination of the Company's existing equity interests. Due to recent events, including sustained improvement in the Company's operating results as well as general improvement in the condition of the United States' economy and airline industry, some form of distribution to the equity interests pursuant to Section 1129 may occur. However, there can be no assurances in this regard.\nThe accompanying financial statements have been prepared on a going concern basis which assumes continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. As a result of the reorganization proceedings, there are significant uncertainties relating to the ability of the Company to continue as a going concern. The financial statements do not include any adjustments that might be necessary as a result of the outcome of the uncertainties discussed herein including the effects of any plan of reorganization.\n(2) Estimated Liabilities Subject to Chapter 11 Proceedings and ----------------------------------------------------------- Reorganization Expense ----------------------\nUnder Chapter 11, certain claims against the Company in existence prior to the filing of the petitions for relief under the Code are stayed while the Company continues business operations as debtor-in- possession. These pre-petition liabilities are expected to be settled as part of the plan of reorganization and are classified as \"Estimated liabilities subject to Chapter 11 proceedings.\"\nEstimated liabilities subject to Chapter 11 proceedings as of December 31, 1993 and 1992 consists of the following:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nThe debt balance included above consists of unsecured and secured obligations and other obligations that have not been affirmed by the Company through the Bankruptcy Court (note 4).\nReorganization expense is comprised of items of income, expense, gain or loss that were realized or incurred by the Company as a result of reorganization under Chapter 11 of the Federal Bankruptcy Code. Such items consists of the following:\n(3) Summary of Significant Accounting Policies ------------------------------------------\n(a) Financial Reporting for Bankruptcy Proceedings ----------------------------------------------\nOn November 19, 1990, the American Institute of Certified Public Accountants issued Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"). SOP 90-7 provides guidance for financial reporting by entities that have filed petitions with the Bankruptcy Court and expect to reorganize under Chapter 11 of the Code.\nSOP 90-7 recommends that all such entities report consistently while reorganizing under Chapter 11, with the objective of reflecting their financial evolution. To achieve such objectives, their financial statements should distinguish transactions and events that are directly associated with the reorganization from those of the operations of the ongoing business as it evolves.\nSOP 90-7 became effective for financial statements of enterprises that filed petitions under the Code after December 31, 1990, although earlier application was encouraged. The Company has implemented the guidance provided by SOP 90-7 in the accompanying financial statements.\nPursuant to SOP 90-7, pre-petition liabilities are reported on the basis of the expected amounts of such allowed claims, as opposed to the amounts for which those allowed claims may be settled. Under an approved final plan of reorganization, those claims may be settled at amounts substantially less than their allowed amounts.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(b) Cash Equivalents ----------------\nCash equivalents consist of all highly liquid debt instruments purchased with original maturities of three months or less and are carried at cost which approximates market.\n(c) Restricted Cash ---------------\nRestricted cash includes cash held in Company accounts, but pledged to an institution which processes credit card sales transactions and cash deposits securing certain letters of credit.\n(d) Expendable Spare Parts and Supplies -----------------------------------\nFlight equipment expendable spare parts and supplies are valued at average cost. Allowances for obsolescence are provided, over the estimated useful life of the related aircraft and engines, for spare parts expected to be on hand at the date the aircraft are retired from service.\n(e) Property and Equipment ----------------------\nProperty and equipment is stated at cost or, if acquired under capital leases, at the lower of the present value of minimum lease payments or fair market value at the inception of the lease. Interest capitalized on advance payments for aircraft acquisitions and on expenditures for aircraft improvements is part of the cost. Property and equipment is depreciated and amortized to residual values over the estimated useful lives or the lease term using the straight-line method. The Company discontinued capitalizing interest on June 27, 1991 due to the Chapter 11 filing.\nThe estimated useful lives for the Company's property and equip- ment range from three to twelve years for owned property and equipment and to thirty years for the reservation and training center and technical support facilities. The estimated useful lives of the Company's owned aircraft, jet engines, flight equipment and rotable parts range from eleven to twenty-two years. Leasehold improvements relating to flight equipment and other property on operating leases are amortized over the life of the lease or the life of the asset, whichever is shorter.\nRoutine maintenance and repairs are charged to expense as incurred. The cost of major scheduled airframe, engine and certain component overhauls are capitalized and amortized over the periods benefited and included in depreciation and amortization expense. Additionally, a provision for the estimated cost of scheduled airframe and engine overhauls required to be performed on leased aircraft prior to their return to the lessors has been provided.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(f) Revenue Recognition -------------------\nPassenger revenue is recognized when the transportation is provided. Ticket sales for transportation which has not yet been provided are reflected in the financial statements as air traffic liability.\n(g) Passenger Traffic Commissions and Related Fees ----------------------------------------------\nPassenger traffic commissions and related fees are expensed when the transportation is provided and the related revenue is recognized. Passenger traffic commissions and related fees not yet recognized are included as a prepaid expense.\n(h) Income Taxes ------------\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.\nAs more fully discussed at note 5, adoption of the new standard changes the Company's method of accounting for income taxes from the deferred approach to an asset and liability approach.\nAs with the prior standard, the Company continues to account for its investment tax credits and general business credits by use of the flow-through method.\n(i) Per Share Data --------------\nPrimary earnings (loss) per share is based upon the weighted average number of shares of common stock outstanding and dilutive common stock equivalents (stock options and warrants). Primary earnings per share reflect net income adjusted for interest on borrowings effectively reduced by the proceeds from the assumed conversion of common stock equivalents.\nFully diluted earnings per share in 1993 is based on the average number of shares of common stock and dilutive common stock equivalents outstanding adjusted for conversion of outstanding convertible preferred stock and convertible debentures. Fully diluted earnings per share reflects net income adjusted for interest on borrowings effectively reduced by the proceeds from the assumed conversion of common stock equivalents.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(j) Frequent Flyer Awards ---------------------\nThe Company maintains a frequent travel award program known as \"FlightFund\" that provides a variety of awards to program members based on accumulated mileage. The estimated cost of providing the free travel, using the incremental cost method as adjusted for estimated redemption rates, is recognized as a liability and charged to operations as program members accumulate mileage.\n(k) Manufacturers' and Deferred Credits -----------------------------------\nIn connection with the acquisition of certain aircraft and engines, the Company receives various credits. Such manufacturers' credits are deferred until the aircraft and engines are delivered, at which time they are either applied as a reduction of the cost of acquiring owned aircraft and engines, resulting in a reduction of future depreciation expense, or amortized as a reduction of rent expense for leased aircraft and engines.\n(l) Fair Value of Financial Instruments -----------------------------------\nThe fair value estimates and assumptions used in developing the estimates of the Company's financial instruments are as follows:\nCash and Cash Equivalents -------------------------\nThe carrying amount approximates fair value because of the short maturity of those instruments.\nAccounts Receivable and Accounts Payable ----------------------------------------\nThe carrying amount of accounts receivable and accounts payable approximates fair value as they are expected to be collected or paid within 90 days of year-end.\nLong-term Debt and Estimated Liabilities Subject to Chapter 11 -------------------------------------------------------------- Proceedings -----------\nThe fair value of long-term debt and estimated liabilities subject to Chapter 11 proceedings cannot readily be estimated as quoted market prices are not available. Additionally, future cash flows cannot be estimated as the repayment of these in- struments is subject to disposition within the bankruptcy proceedings.\n(m) Reclassifications -----------------\nCertain prior year reclassifications have been made to conform to the current year presentation.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(4) Long-term Debt --------------\nLong-term debt consists of the following:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nLong-term debt included in estimated liabilities subject to Chapter 11 proceedings consists of the following:\nAs part of the Chapter 11 reorganization process, the Company is required to notify all known or potential claimants for the purpose of identifying all pre-petition claims against the Company. Additional bankruptcy claims and pre-petition liabilities may arise by termina- tion of various contractual obligations and as certain contingent and\/or potentially disputed bankruptcy claims are allowed for amounts which may differ from those shown on the balance sheet.\nAs discussed in note 1, payment of these liabilities, including maturity of debt obligations, is stayed while the debtor continues to operate as a debtor-in-possession. As a result, contractual terms have been suspended with respect to debt subject to the Chapter 11 proceedings. The following paragraphs include discussion of the original contractual terms of the long-term debt; however, the maturity and terms of the long-term debt subsequent to the petition date may differ as a result of negotiations that take place as part of the plan of reorganization.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nNo principal or interest may be paid on pre-petition debt without the approval of the Bankruptcy Court. The Company has continued to accrue and pay interest on its long-term debt related to D.I.P. financing, affirmed long-term debt and secured debt included in estimated liabilities subject to Chapter 11 proceedings only to the extent that, in the Company's opinion, the value of underlying collateral exceeds the principal amount of the secured claim. The Company believes it is probable such interest will be an allowed secured claim as part of the bankruptcy proceeding. Except as otherwise stated above, the Company ceased accruing interest on pre-petition debt as of June 27, 1991, due to uncertainties relating to a final plan of reorganization.\n(a) In September 1991, the Company completed arrangements for a $55 million D.I.P. credit facility. The D.I.P. credit facility is secured by a first priority lien senior to all other liens on substantially all existing assets of the Company, except that such lien is junior in priority to Permitted First Liens (as such term is defined in the D.I.P. credit facility documents) with respect to the property encumbered thereby. In December 1991, the Company completed arrangements for an additional $23 million of D.I.P. financing under terms and conditions substantially the same as those associated with the $55 million D.I.P. credit facility. Quarterly interest payments for the D.I.P. financings commenced in the quarter ending December 31, 1991 at the 90-day London Interbank Offered Rate (LIBOR) plus 3.5% and quarterly principal repayments of $3.9 million were to commence in September 1992 with the balance due in September 1993, or earlier upon confirmation of an approved plan of reorganization.\nIn connection with the $23 million of D.I.P. financing, the Company agreed to convert advanced cash credits for 24 Airbus A320 aircraft previously provided to the Company into an unsecured priority term loan. At December 31, 1993, the amount of the term loan was $68.4 million including accrued interest of $21.9 million. Until the Reorganization Date, the term loan will accrue interest at 12% per annum and such interest will be added to the principal balance. On the Reorganization Date, 85% of the outstanding balance will be converted into an eight-year term loan which will accrue interest at 2% over 90-day LIBOR and will be secured by substantially all the assets of the Company if the D.I.P. financing is fully repaid. Principal payments will be made in equal quarterly installments, plus interest, commencing after the Reorganization Date. The Company has the right to prepay the loan if the D.I.P. financing is fully repaid. The remaining 15% of the term loan will be treated as a general unsecured claim without priority status under the Company's plan of reorganization. In the first quarter of 1994, the Company received information that the term loan was purchased by a third party.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nIn connection with the D.I.P. financing, a D.I.P. lender agreed to acquire the Company's Honolulu to Nagoya, Japan route for $15 million. The Nagoya route sale was finalized in March 1992, resulting in a gain of $15 million, which is included in other non-operating income in the accompanying statement of operations. Upon the completion of the sale of the Nagoya route, $10 million of the proceeds from the sale were paid to the lender to reduce the Company's obligation to the lender under the D.I.P. fi- nancing. The balance of the proceeds from the sale of the Nagoya route were added to the Company's working capital. The remaining D.I.P. balance was paid to this lender in connection with the September 1992 D.I.P. Facility.\nIn September 1992, the Company completed arrangements to expand its existing D.I.P. financing by an additional $53 million (the \"September 1992 D.I.P. Facility\").\nAs a condition to the closing of the September 1992 D.I.P. Facility, the Company was required to reduce its aircraft fleet and the number of aircraft types from five to three pursuant to certain agreements with third parties, including the following:\n1. With the exception of four lessors (two of which participated in the September 1992 D.I.P. Facility and did not defer or reduce their lease payments), aircraft lessors whose aircraft were retained in the fleet and who agreed to payment deferrals during July and August 1992, were required to waive any default which occurred as a result of such non- payments and to defer these payments without interest until the first calendar quarter of 1993. In addition, effective August 1, 1992, the rental rates on these retained aircraft were reduced to fair market lease rates for a two-year period. The rental rates adjust to market rates effective August 1, 1994.\nOf the remaining two lessors, one accepted rental payment reductions and the other agreed to a deferral of the rents from July through October 1992. Repayment of this deferral is monthly over seven years beginning November 1992 at level principal and interest at 90-day LIBOR plus 3.5%.\n2. The aircraft lessors who accepted rent reductions and agreed to waive any administrative claims arising from the reductions stipulated that, if prior to July 31, 1994, the Company defaults on any of these leases and the aircraft are repossessed, the lessors are entitled to fixed damages which will be afforded priority as administrative claims. Lessors of 11 aircraft have the option, beginning August 1, 1994, to reset the rents to the current fair market rental rates and, if elected by the lessor, to readjust at two other two-year intervals during the remaining term of the lease.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nThe Company also agreed in certain cases that lessors could call the aircraft upon 180 days notice if the lessor had a better lease proposal from another party which the Company was unwilling to match. During the period August 1, 1994 through July 31, 1995, certain of these lessors may call their aircraft without first giving the Company the right to match any competing offer. Call rights with a right of first refusal affect 16 aircraft and call rights without a right of first refusal affect 10 aircraft. In addition, in order to induce several lessors to extend the lease terms of their aircraft, the Company agreed that the aircraft could be called by the lessors at the end of the original lease term. One lessor of 11 aircraft has the right to terminate each lease at the end of the original lease term of each aircraft. Such lessor also has the right to call its aircraft on 90 days notice at any time prior to the end of the amended lease term. America West has no right of first refusal with respect to such aircraft. To date, no lessor has exercised its call rights.\n3. Certain principal and interest payments relating to owned aircraft due in July 1992 were deferred without interest and were repaid by March 31, 1993. Additionally, certain other principal and interest payments due from August 1992 through January 1993 were deferred and repaid beginning February 1993 over five to nine years with interest at approximately 10.25%. In lieu of payment deferrals, two of the aircraft lenders agreed to adjust the interest rates based on 90-day LIBOR plus 3.5% per annum.\nIn September 1993, the Bankruptcy Court approved an amendment to the D.I.P. loan agreement extending the maturity date of the loan from September 30, 1993 to June 30, 1994. Concurrent with the extension of the maturity date, $8.3 million of the principal balance was repaid to one of the participants who did not agree with the amendment. Interest on all funds advanced under the D.I.P. facility accrues at 3.5% per annum, over 90-day LIBOR and is payable quarterly. The amended D.I.P. loan agreement defers all principal payments to the earlier of June 30, 1994 or the effective date of a confirmed Chapter 11 plan of reorganization with the exception of $5 million that will be due on March 31, 1994. The amended terms of the D.I.P. financing require the Company to notify the D.I.P. lenders if the unrestricted cash balance of the Company exceeds $125 million. Upon receipt of such notice, the D.I.P. lenders may require the Company to prepay the D.I.P. financing by the amount of such excess. Subsequent to December 31, 1993, the Company notified the D.I.P. lenders that the Company's unrestricted cash exceeded $125 million; however, the D.I.P. lenders have not exercised their prepayment rights. The D.I.P. financings contain a minimum unencumbered cash balance requirement of $55 million at December 31, 1993 and other financial covenants. At December 31, 1993, the Company was in compliance with these covenants.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nAs a condition to extending the maturity date of the D.I.P. financing in September 1993, the Company also agreed to pay a facility fee of $627,000 to the D.I.P. lenders on September 30, 1993 and to pay an additional facility fee equal to 1\/4% of the then outstanding balance of the D.I.P. financing on March 31, 1994. Consequently, the outstanding balance of $83.6 million is classified as a current liability as of December 31, 1993. Presently, the Company does not possess sufficient liquidity to satisfy the D.I.P. financing nor does it appear likely that new equity capital will be obtained and a plan of reorganization confirmed prior to June 30, 1994. Consequently, the Company will be required to obtain alternative repayment terms from the D.I.P. lenders. There can be no assurance that alternative repayment terms will be obtained. The Company believes that any extension of the D.I.P. financing will be for a short period of time and would be concurrent with the implementation of a plan of reorganization.\nThe D.I.P. financings contain a minimum unencumbered cash balance requirement of $55 million at December 31, 1993 and other financial covenants. At December 31, 1993, the Company was in compliance with these covenants.\n(b) These notes from financial institutions, secured by seventeen aircraft with a net book value of $327.6 million, are payable in semi-monthly, monthly, quarterly and semi-annual installments ranging from $75,000 to $1,637,000 plus interest at 30-day LIBOR plus 3.5% (6.88% at December 31, 1993) to 10.79%, with maturities ranging from 1999 to 2008. Approximately $105.3 million of these secured notes have provisions providing for the reset of interest rates at various future dates based on fluctuations in indices such as the Eurodollar rate. Additionally, interest rates and principal payments for certain of these notes were modified, as discussed above, in connection with the September 1992 D.I.P. Facility.\n(c) The Company has a $40 million line of credit that extends to December 31, 1997 for which no borrowing can occur after December 31, 1994. The purpose of the line is to provide for the initial provisioning of spare parts for Airbus A320 aircraft. The loan is repaid quarterly with level principal payments of $970,000 each and interest at LIBOR plus 4%. At December 31, 1993 and 1992, the Company had borrowings outstanding of $15.5 million and $20.4 million, respectively, under this credit facility. However, the lender will not make the unused credit of $24.5 million available at December 31, 1993 as a result of the Chapter 11 filing. This loan was affirmed in December 1991 by the Bankruptcy Court under Section 1110 of the Bankruptcy Code.\nThe Company also has a $25 million line of credit that extends to September 1997 under which no borrowing could occur after September 1992. The credit line was used for spare engine parts and has an interest rate of LIBOR plus 4%. At December 31, 1993 and 1992, the Company had borrowings outstanding of $3.1 million and $4.6 million, respectively, under this credit facility. In connection with the financing by this same lender of two aircraft flight simulators in October 1992 (see (e)), this loan was affirmed in the bankruptcy proceeding. Consequently, the outstanding balance at December 31, 1993 is included in long-term debt.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(d) This note from an aircraft engine manufacturer was originally made for $30 million in September 1990. The note is secured by two aircraft, spare engine parts and other equipment. Interest on the note began to accrue at its inception at 90-day LIBOR plus 2.0%, compounded quarterly, until September 1993 when all such accrued interest, or approximately $6 million, was paid. Interest is currently paid quarterly at the same interest rate. In October 1992, this lender financed two new flight simulators which were securing this note (see (e)), and this loan was reduced by the amount of such financing, or approximately $22.8 million. Repayment of the balance of this loan is dependent on the future delivery of certain firm ordered aircraft scheduled to begin in November 1996 (however, the related aircraft purchase agreement has been neither affirmed nor rejected at December 31, 1993). In connection with the above financing of the two flight simulators, this note was affirmed in the bankruptcy proceedings, and the outstanding balances at December 31, 1993 and 1992 are included in long-term debt.\n(e) In October 1992, the Company acquired two flight simulators and executed two notes secured by the simulators. The notes are payable in 84 equal monthly principal installments, plus accrued interest at LIBOR plus 2%. However, the Company has the right, upon the giving of notice to the lender, to fix the interest rate at the greater of the then current LIBOR plus 2% or 6.375%. In connection with this financing, the Company affirmed in the bankruptcy proceedings the agreements for a certain note payable (see (d) above) and a line of credit (see (c) above).\n(f) In 1993, the Company settled three administrative claims with three four-year promissory notes totaling $9.6 million with quarterly principal payments and interest at 6%. At December 31, 1993, the outstanding balance of these promissory notes was $8.7 million.\nAlso in 1993, the Company renegotiated a note for certain ground equipment for $2 million as part of an administrative claim settlement which takes effect upon the confirmation of a plan of reorganization. The Company is required to make adequate protection payments of $8,000 per month from the settlement date until plan confirmation, at which time, the note term is 5 years with interest at 6%.\n(g) The Company's 7-3\/4% convertible subordinated debentures are convertible into common stock at $13.50 per share. The debentures are redeemable at prices ranging from 101.55% of the principal amount at December 31, 1993 to 100% of the principal amount in 1995 and thereafter. Annual sinking fund payments of $1.5 million are required beginning in 1995.\n(h) The Company's 7-1\/2% convertible subordinated debentures are convertible into common stock at $14.00 per share. The debentures are redeemable at prices ranging from 102.25% of the principal amount at December 31, 1993 to 100% of the principal amount in 1996 and thereafter. Annual sinking fund payments of $1.6 million are required beginning in 1996.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(i) The Company's 11-1\/2% convertible subordinated debentures are convertible into common stock at $10.50 per share. The debentures are redeemable at prices ranging from 105.75% of the principal amount from January 1, 1994 to 100% of the principal amount in 1999 and thereafter. Annual sinking fund payments of $5.8 million are required beginning in 1999.\nDuring 1991, certain bondholders converted $22.1 million of the 11-1\/2% convertible subordinated debentures into common stock. The conversion of the 11-1\/2% subordinated debentures resulted in a charge to other non-operating expense of $875,000 for incremental shares issued upon conversion. Certain bondholders converted $1.4 million of the 7-1\/2% convertible subordinated debentures and $4.4 million of the 7-3\/4% convertible subordinated debentures into common stock.\nDuring 1992, certain bondholders converted $95,000 of the 7-1\/2% convertible subordinated debentures, $100,000 of the 7-3\/4% convertible subordinated debentures and $3.5 million of the 11-1\/2% convertible subordinated debentures into common stock.\nDuring 1993, certain bondholders converted $360,000 of the 7-1\/2% convertible subordinated debentures, $275,000 of the 7-3\/4% convertible subordinated debentures and $1.3 million of the 11-1\/2% convertible subordinated debentures into common stock.\nAll of the convertible subordinated debenture interests will be subject to settlement of their stated amounts in a plan of reorganization, thereby eliminating the need for continued deferral of the debt issuance costs. Therefore, the unamortized debt issuance costs of $2.8 million for these convertible subordinated debentures were charged to operations as reorganization expense in 1991. The Company ceased accruing interest on all of these debentures as of June 27, 1991 in accordance with SOP 90-7.\n(j) This note from an aircraft manufacturer for deferred pre-delivery payments was required under a purchase agreement entered into in 1990. The deferred pre-delivery payments will accrue interest at one year LIBOR plus 4% with both principal and interest due upon delivery of the aircraft. The Company has ceased accruing interest on the outstanding balance in accordance with SOP 90-7. The acquisition of the aircraft associated with these deferred pre-delivery payments is subject to the affirmation or rejection of the respective aircraft purchase agreement by the Company in the reorganization proceeding.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(k) The Company has a $20 million secured revolving credit facility with a group of financial institutions that expired on April 17, 1993. Borrowings under this credit facility were either made i) at the federal funds rate plus 1%, ii) based on a CD rate or iii) 90-day LIBOR two business days prior to the first day of the interest period. The borrowings are secured by certain assets. The Company is obligated to pay a commitment fee equal to 1\/4% per annum on the average daily amount by which the aggregate commitments exceed the applicable borrowing base and 1\/2% per annum on the average daily amount by which the lower of the aggregate commitments or applicable borrowing base exceeds the aggregate principal amount on all outstanding loans. At December 31, 1993 and 1992, the Company had an outstanding balance of $9.9 million and $11 million, respectively, under the revolving credit agreement. Proceeds from sales of assets securing the loan were used to prepay the loan during 1993. The Company ceased accruing interest on the outstanding balance as of June 27, 1991 in accordance with SOP 90-7.\n(l) The holders of industrial development revenue bonds have the right to put the bonds back to the Company at various times. If such a put occurs, the Company has an agreement with the underwriters to remarket the bonds. Any bonds not remarketed will be retired utilizing a letter of credit. Any funding under the letter of credit will be in the form of a two-year term loan at prime plus 2%. During the first quarter of 1991, the Company redeemed $14.5 million of the $44 million of industrial develop- ment revenue bonds issued and outstanding and agreed to a seven- year amortization schedule for the redemption of the remaining balance. In July and August 1991, $29.5 million in the aggregate was drawn against the letter of credit facility that supported these bonds. The Company intends to remarket the bonds in the future. Such draws were made on behalf of holders of such bonds who exercised their right to put the bonds back to the Company for purchase. The bonds are currently held in trust for the benefit of the Company. These bonds were issued in connection with the Company's technical support facility.\n(m) These draws on a letter of credit from a financial institution, secured by spare rotable parts with a net book value of $35.8 million, are payable in quarterly installments of $1.3 million plus interest at prime plus 4.5%. The Company has ceased accruing interest as of June 27, 1991 on the outstanding balance in accordance with SOP 90-7.\nMaturities of long-term debt, excluding $225 million included in estimated liabilities subject to Chapter 11 proceedings, for the years ending December 31 are as follows:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(5) Income Taxes ------------\nAdoption of New Accounting Standard -----------------------------------\nAs of January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 is a fundamental change in the manner used to account for income taxes in that the deferred method has been replaced with an asset and liability approach. Under SFAS 109, deferred tax assets (subject to a possible valuation allowance) and liabilities are recognized for the expected future tax consequences of events that are reflected in the Company's financial statements or tax returns.\nIn the year of adoption, SFAS 109 permits an enterprise to record in its current year financial statements, the cumulative effect (if any) of the change in accounting principle. Upon adoption, the Company did not need to record a cumulative effect adjustment.\nIncome Tax Expense ------------------\nFor the year ended December 31, 1993, the Company recorded income tax expense as follows:\nFor the year ended December 31, 1993, income tax expense is solely attributable to income from continuing operations. The difference in income taxes at the federal statutory rate (\"expected taxes\") to those reflected in the financial statements (the \"effective rate\") results from the effect of the benefit of net operating loss carryforwards of $12.6 million and state income tax expense, net of federal tax benefit of $55,000, for an effective tax rate of 2%. In 1992 and 1991, the tax benefits at the federal statutory rate of 34% were offset by the generation of net operating loss carryforwards.\nAt December 31, 1993, the Company has available net operating loss, business tax credit and alternative minimum tax credit carryforwards for federal income tax purposes of $530.3 million, $12.7 million and $700,000, respectively. The net operating loss carryforwards expire during the years 1999 through 2007 while the business credit carryforwards expire during the years 1997 through 2006. However, such carryforwards are not fully available to offset federal (and, in certain circumstances, state) alternative minimum taxable income. Accordingly, income tax expense recognized for the year ended December 31, 1993, is attributable to the Company's expected net current liability for federal and various state alternative minimum taxes. The alternative minimum tax credit carryforward does not expire and is available to reduce future income tax payable.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nAs of December 31, 1993, to the best of the Company's knowledge, it has not undergone a statutory \"ownership change\" (as defined in Section 382 of the Internal Revenue Code) that would result in any material limitation of the Company's ability to use its net operating loss and business tax credit carryforwards in future tax years. Should an \"ownership change\" occur prior to confirmation of a plan of reor- ganization, the Company's ability to utilize said carryforwards would be significantly restricted. Further, the net operating loss and business tax credit carryforwards may be limited as a result of the Company's reorganization under the United States Bankruptcy Code.\nComposition of Deferred Tax Items ---------------------------------\nThe Company has not recognized any net deferred tax items for the year ended December 31, 1993. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1993 are a result of the temporary differences related to the items described as follows:\nSFAS 109 requires a \"more likely than not\" criterion be applied when evaluating the realizability of a deferred tax asset. Given the Company's history of losses for income tax purposes, the volatility of the industry within which the Company operates and certain other factors, the Company has established a valuation allowance for the portion of its net operating loss carryforwards that may not be available due to expirations after considering the net reversals of future taxable and deductible differences occurring in the same periods. In this context, the Company has taken into account prudent and feasible tax planning strategies. After application of the valuation allowance, the Company's net deferred tax assets and liabilities are zero.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(6) Employee Stock Purchase Plans and Other Employee Benefit Programs -----------------------------------------------------------------\nThe Company has a stock purchase plan covering its directors, officers and employees and certain other persons providing service to the Company, as well as a separate plan covering its California resident employees. At December 31, 1993, the number of shares authorized under the plans is 10,450,000. Each participating employee is required to purchase a number of shares having an aggregate purchase price equivalent to 20% of such employee's annual base wage or salary on the date of purchase. Each participating employee has the option of simultaneously purchasing additional shares having an aggregate purchase price not exceeding 20% of such wage or salary. California resident employees electing to participate in the plan may purchase a number of shares having an aggregate purchase price not exceeding 40% of their annual base wage or salary on the date of purchase at a specified price.\nParticipating employees can elect to finance their purchase through the Company for up to 20% of their annual base wage or salary over a five-year period at an interest rate of 9.5%. Employee notes receivable of $17.6 million existed at December 31, 1993 and were classified in the stockholders' deficiency section. Shares issued under the plans cannot be sold, transferred, assigned, pledged or encumbered in any way for a period of two years from the date such shares are paid for and delivered to participating employees. The employees' purchase price is 85% of the market price on the date of purchase. The difference between the employees' purchase price and the market price is recorded as deferred compensation and is amortized over five years.\nThe plans provide for the purchase of additional shares of common stock up to 10% of the employee's annual base wage during the first year of employment and 20% of the employee's annual base wage during each subsequent calendar year. Such purchases may be financed through the Company at the same terms as indicated above, as long as total outstanding amounts previously financed do not exceed 10% of the employee's annual base compensation.\nEffective August 1, 1991, the Company suspended the mandatory portion of the Employee Stock Purchase Plan for 60 days. Subsequent to the expiration of the 60-day period, the Company indefinitely suspended the Employee Stock Purchase Plan. The Company also suspended payroll deductions related to the Employee Stock Purchase Plan as a result of a 10% across the board reduction in wages which commenced August 1, 1991 for all employees whose wages had not been previously reduced. The unpaid employee stock purchase notes continue to accrue interest. The Company anticipates that the reorganization process will result in the restructuring, cancellation and\/or replacement of the interests of its existing common and preferred stockholders.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nThe Bankruptcy process has caused the suspension of the Company's profit sharing plan which covers all personnel. The plan provided for the distribution of 15% of annual pre-tax profits to employees based on each individual's base wage. The Company made no distributions under the plan in 1993, 1992 or 1991.\nThe Company implemented a 401(k) defined contribution plan on January 1, 1989, covering essentially all employees of the Company. Participants may contribute from 1% to 10% of their pre-tax earnings to a maximum of $8,994. The Company will match 25% of a participant's contributions up to 6% of the participant's annual pre-tax earnings. The Company's contribution expense to the plan totaled $2.1 million, $2 million and $4.9 million in 1993, 1992 and 1991, respectively.\nThe Company provides no post-retirement benefits to its former employees other than the continuation of flight benefits on a stand- by, non-revenue basis; the cost of which is not material. Additionally, no material post-employment benefits are provided.\n(7) Convertible Preferred Stock ---------------------------\nAnnual dividends of $5.41 per share are payable quarterly on the 291,149 shares of voting Series B 10.5% convertible preferred stock. Each preferred share is entitled to four votes and may be converted into four shares of common stock subject to certain anti-dilution provisions. The preferred shares are redeemable at the Company's election, if the price of common stock is at least $19.32 per share, at $51.52 per share plus unpaid accrued dividends plus a redemption premium starting at 3% during 1991 and decreasing 1% per year to zero during and after 1994. During 1993, the Series B convertible preferred stock was converted into 1,164,596 shares of common stock.\nAnnual dividends of $1.33 per share are payable quarterly on the 73,099 shares of voting Series C 9.75% convertible preferred stock. Such shares may be converted into an equal number of shares of common stock subject to certain anti-dilution provisions. The preferred shares are redeemable at the Company's election at $13.68 per share plus unpaid accrued dividends plus a redemption premium starting at 4% during 1991 and decreasing 1% per year to zero during and after 1995.\nUnder Delaware law, the Company is precluded from paying dividends on its outstanding preferred stock until such time as the Company's stockholder deficiency has been eliminated.\nAt December 31, 1993, the Company was delinquent in the payment of its sixth consecutive dividends on the Preferred Stock. See note 1 for a discussion of the potential effects of the Company's reorganization upon preferred stock.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(8) Common Stock ------------\nCertain \"Rights\" have been distributed to certain shareholders of record on August 25, 1986. The Rights, which entitle the holder to purchase one one-hundredth (1\/100th) of a share of Series D Participating Preferred Stock at a price of $200, are not exercisable unless certain conditions relating to a possible attempt to acquire the Company are met. In the event of an acquisition or merger, the Rights will entitle the holder of a Right to purchase that number of common shares of the acquiring or surviving entity having twice the market value of the exercise price of each Right. The Rights expire on August 24, 1996 and are redeemable at a price of $.03 per Right under certain conditions.\nThe Board of Directors has authorized the purchase of up to 700,000 shares of the Company's common stock from time to time in open market transactions. The Company has purchased and retired 348,410 shares as of December 31, 1993 at an average per share price of $8.31.\n(9) Stock Options and Warrants --------------------------\nThe Company has an Incentive Stock Option Plan and has reserved 13,225,000 shares of common stock for issuance upon the exercise of stock options granted under the plan. Of the total shares reserved, 10,350,000 shares are restricted for issuance to employees other than certain management employees. Options are granted at fair market value on the date of grant and generally become exercisable over a five-year period, and ultimately lapse if unexercised at the end of ten years.\nActivity under the Incentive Stock Option Plan is as follows:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nAt December 31, 1993, options to purchase 3,731,608 shares were exercisable at prices ranging from $0.94 to $13.06 per share under the Incentive Stock Option Plan. Effective March 13, 1992, additional grants under the Plan were suspended.\nThe Company has a Nonstatutory Stock Option Plan under which options to purchase 3,785,880 shares of common stock at prices ranging from $5.06 to $10.25 per share (fair market value on date of grant) have been granted, of which 1,961,410 stock options are outstanding as of December 31, 1993. During 1991, 40,000 options were granted at $6.00 per share. During 1993, 1992 and 1991, no options were exercised. At December 31, 1993, all options were exercisable. Options expire 10 years from date of grant.\nThe Company had granted warrants and options to purchase 227,500 shares of common stock to members of the Board of Directors who are not employees of the Company. At December 31, 1993, 110,000 options are outstanding and exercisable through February 4, 1996 at prices of $6.00 to $9.00 per share (fair market value at date of grant). No warrants or options were granted or exercised during 1993, 1992 or 1991.\nThe Company has adopted a Restricted Stock Plan and has reserved 250,000 shares of common stock for issuance at no cost to key employees. Grants that are issued will vest over a three to five-year period. As of December 31, 1993, the Company granted 93,870 shares and the related unamortized deferred compensation was $5,320. In 1991, the operation of the Restricted Stock Plan was suspended due to the Company's reorganization.\n(10) Supplemental Information to Statements of Cash Flows ----------------------------------------------------\nCash paid for interest, net of amounts capitalized, during the years ended December 31, 1993, 1992 and 1991 was approximately $44 million, $46 million and $33 million, respectively.\nCash paid for income taxes during the year ended December 31, 1993 was $537,000.\nCash flows from reorganization items in connection with the Chapter 11 proceedings during the years ended December 31, 1993, 1992 and 1991 were as follows:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nIn addition, during the years ended December 31, 1993, 1992 and 1991, the Company had the following non-cash financing and investing activities:\n(11) Commitments and Contingencies -----------------------------\n(a) Leases ------\nDuring 1991, the Company restructured its lease commitment for Airbus A320 aircraft with the lessors. As a result of the restructuring, the Company's obligation to lease ten A320 aircraft was canceled and the basic rental rate for twelve aircraft was revised to provide for the repayment to the lessor over a ten-year period of certain advanced credits received by the Company which relate to the ten canceled aircraft.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nIn the third quarter of 1991, the Company requested a deferral of rent and other periodic payments from its aircraft providers. The deferral was requested in an effort to conserve cash and improve the Company's liquidity position. As a condition of securing the $78 million D.I.P. financing, the Company was required to obtain from most aircraft providers rent, principal and interest payment deferrals in excess of $100 million covering the six-month period of June through November 1991. These deferrals will generally be repaid with interest at 10.5% over the remaining term of the lease or secured borrowing with repayment commencing December 1991. At December 31, 1993 and 1992, the remaining unpaid deferrals are reported as follows:\nIn the third quarter of 1992, the Company requested an additional deferral of rent and other periodic payments from its aircraft providers. The deferral was requested to assure sufficient liquidity to sustain operations while additional debtor-in- possession financing was obtained (note 4). The 1992 deferrals will generally be repaid either without interest during the first quarter of 1993 or with interest over a period of seven years. At December 31, 1993 and 1992, the remaining unpaid deferrals are reported as follows:\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nAs of December 31, 1993, the Company had 66 aircraft under operating leases with remaining terms ranging from four months to 20 years. The Company has options to purchase most of the aircraft at fair market value at the end of the lease term. Certain of the agreements require security deposits and maintenance reserve payments. The Company also leases certain terminal space, ground facilities and computer and other equipment under noncancelable operating leases.\nFuture minimum rental payments for years ending December 31 under noncancelable operating leases with initial terms of more than one year are as follows:\nCollectively, the operating lease agreements require security de- posits with lessors of $8.1 million and bank letters of credit of $17.7 million. The letters of credit are collateralized by certain spare rotable parts with a net book value of $35.8 million and $17.6 million in restricted cash.\nRent expense (excluding landing fees) was approximately $245 million in 1993, $307 million in 1992 and $319 million in 1991.\n(b) Revenue Bonds -------------\nSpecial facility revenue bonds have been issued by a municipality used for leasehold improvements at the airport which have been leased by the Company. Under the operating lease agreements, which commenced in 1990, the Company is required to make rental payments sufficient to pay principal and interest when due on the bonds. The Company ceased rental payments in June 1991. The principal amount of such bonds outstanding at December 31, 1992 and 1991 was $40.7 million. In October 1993, the Company and the bondholder agreed to reduce the outstanding balance of the bonds to $22.5 million and adjust the related operating lease payments sufficient to pay principal and interest on the reduced amount effective upon the confirmation of a plan of reorganization. The remaining principal balance of $18.2 million will be accorded the same treatment under the plan of reorganization as a pre-petition unsecured claim. The Company also agreed to make adequate protection payments in the amount of $150,000 per month from August 1993 to plan confirmation.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(c) Aircraft Acquisitions ---------------------\nAt December 31, 1993, the Company had on order a total of 93 aircraft of the types currently comprising the Company's fleet, of which 51 are firm and 42 are options. The table below details such deliveries.\nThe current estimated aggregate cost for these firm commitments and options is approximately $5.2 billion. Future aircraft deliveries are planned in some instances for incremental additions to the Company's existing aircraft fleet and in other instances as replacements for aircraft with lease terminations occurring during this period. The purchase agreements to acquire 24 Boeing 737-300 aircraft had been affirmed in the Company's bankruptcy proceeding. With timely notice to the manufacturer, all or some of these deliveries may be converted to Boeing 737-400 aircraft. At December 31, 1993, eight Boeing 737 delivery positions had been eliminated due to the lack of a required reconfirmation notice by the Company to Boeing leaving 16 delivery positions as reflected above. The failure to reconfirm such delivery positions exposes the Company to loss of pre-delivery deposits and other claims which may be asserted by Boeing in the bankruptcy proceeding. The purchase agreements for the remaining aircraft types have not been assumed, and the Company has not yet determined which of the other aircraft pur- chase agreements, if any, will be affirmed or rejected.\nAs part of the $68.4 million term loan (see note 4(a)), the Company terminated an agreement to lease 24 Airbus A320 aircraft and ultimately replaced it with a put agreement to lease up to four such aircraft. The lessor is under no obligation to lease such aircraft to the Company and has the right to remarket these aircraft to other parties. Prior to its bankruptcy filing, the Company also entered into a similar arrangement with another lessor, whereby the Company terminated its agreement to lease 10 Airbus A320 aircraft and replaced it with a put agreement to lease up to 10 Airbus A320 aircraft.\nThe put agreement related to the term loan requires the lessor to notify the Company prior to July 1, 1994 if it intends to require the Company to lease any of its put aircraft. The other put agreement requires 180 days prior notice of the delivery of a put aircraft. The agreement also provides that the lessor may not put more than five aircraft to the Company in any one calendar year. This put right expires on December 31, 1996. No more than nine put aircraft (from both lessors combined) may be put to the Company in one calendar year. The put aircraft are reflected in the \"Firm Orders\" section of the table above.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nThe Investment Agreement provides that as partial consideration for the cancellation of certain put rights, the lessor will receive the right to require the Company to lease up to eight aircraft prior to June 30, 1999.\nThe Company does not have firm lease or debt financing commitments with respect to the future scheduled aircraft deliveries (other than for the put aircraft referred to above).\nIn addition to the aircraft set forth in the chart above, the Company also has a pre-petition executory contract under which the Company holds delivery positions for four Boeing 747-400 aircraft under firm orders and another four under options. The contract allows the Company, with the giving of adequate notice, to substitute other Boeing aircraft types for the Boeing 747-400 in these delivery positions. As a result, the Company is still evaluating its future fleet needs and is currently unable to determine if it will substitute other aircraft types or reject this agreement.\n(d) Concentration of Credit Risk ----------------------------\nThe Company does not believe it is subject to any significant concentration of credit risk. At December 31, 1993, approximately 82% of the Company's receivables related to tickets sold to individual passengers through the use of major credit cards or to tickets sold by other airlines and used by passengers on America West. These receivables are short-term, generally being settled shortly after sale or in the month following usage. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts.\n(12) Related Party Transactions --------------------------\nDuring 1989, the Company sold 486,219 shares of common stock at $6.31 and $9.79 to the stockholder that purchased 3,029,235 shares of common stock at $10.50 in 1987 and $1 million of the Series C preferred stock in 1985. This stockholder has the right to maintain a 20% voting interest through the purchase of common stock from the Company at a price per share which is the average market price per share for the preceding six months. In 1990, the stockholder made direct purchases on the open market to maintain its 20% voting interest. On February 15, 1991, the stockholder purchased 253,422 shares of common stock from the Company at $5.50 per share. No such purchases occurred in 1993 or 1992.\nThe Company has entered into various aircraft acquisition and leasing agreements with this stockholder at terms comparable to those obtained from third parties for similar transactions. The Company leases 11 aircraft from this stockholder and the rental payments for such leases amounted to $33.7 million in 1993, $33.8 million in 1992 and $18.1 million in 1991. At December 31, 1993, the Company was obligated to pay $232 million under these leases through August 2003 unless terminated earlier at the stockholder's option. In 1991, the stockholder drew upon a $7.5 million letter of credit which had been issued in its favor in lieu of a cash reserve for periodic heavy maintenance overhauls. This cash deposit is included in other assets at December 31, 1993 and 1992.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\nIn addition, the stockholder participated as a lender in the September 1992 D.I.P. Facility and advanced $10 million of the $53 million in total D.I.P. financing. In September 1993, the stockholder was repaid the then outstanding balance of $8.3 million as a result of not participating in the extension of the maturity date of the debt financing.\nIn order to assist the Chairman of the Board with certain costs associated with his service as chairman, the Company pays an office overhead allowance of $4,167 per month to a company owned by the chairman. During 1993 and 1992, such payments totaled approximately $50,000 and $16,000, respectively.\nAdditionally, a former member of the Board of Directors provided consulting services to the Company during 1993 and 1992 for which he received fees of approximately $39,000 and $47,000, respectively.\n(13) Restructuring Charges ---------------------\nRestructuring charges consist of the following:\nThe restructuring charges were necessitated by aircraft fleet reductions and other operational changes. The Company has reduced its fleet to 85 aircraft and has reduced the number of aircraft types in the fleet from five to three.\n(Continued)\nAMERICA WEST AIRLINES, INC., D.I.P.\nNotes to Financial Statements\n(14) Quarterly Financial Data (Unaudited) ------------------------------------\nSummarized quarterly financial data for 1993 and 1992 are as follows (in thousands of dollars except per share amounts):\n(a) During the third quarter of 1992, restructuring charges for employee separation costs, losses related to returning aircraft to lessors, write-off of assets related to the restructuring and a loss provision related to spare parts expected to be sold amounting to $31.3 million was recorded.\n(b) During the first quarter of 1992, a gain of $15 million was recorded for the transfer of the Honolulu\/Nagoya route to another carrier.\nItem 9","section_9":"Item 9 Changes in and Disagreements with Accountants on Accounting and ------ --------------------------------------------------------------- Financial Disclosure. --------------------\nDuring the last two fiscal years, the Company has not filed a Form 8-K to report a change in accountants because of a disagreement over accounting principles or procedures, financial statement disclosure, or otherwise.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. ------- --------------------------------------------------\nInformation respecting the names, ages, terms, positions with the Company and business experience of the executive officers and the directors of the Company as of February 28, 1994, is set forth below. Each director has served continuously with the Company since his first election.\nWilliam A. Franke was named Chairman of the Board of Directors in ----------------- September 1992. On December 31, 1993, Mr. Franke was elected to also serve as the Company's Chief Executive Officer. In addition to his responsibilities at America West, Mr. Franke serves as president of the financial services firm, Franke & Co., a company he has owned since May 1987. From November 1989 until June 1990, Mr. Franke served as the Chairman of Circle K Corporation's executive committee with the responsibility for Circle K Corporations's restructure. In May 1990, the Circle K Corporation filed a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code. From June 1990 until August 1993, Mr. Franke served as the chairman of a special committee of directors overseeing the reorganization of the Circle K Corporation. Mr. Franke has also served in various other capacities at Circle K Corporation since 1990. Mr. Franke was also involved in the restructuring of the Valley National Bank of Arizona (now Bank One Arizona). Mr. Franke also serves as a director of Phelps Dodge Corp. and Central Newspapers Inc.\nA. Maurice Myers was named president and chief operating officer on ---------------- December 31, 1993 and was named to the Board of Director in 1994. Prior to joining America West, Mr. Myers was the president and chief executive officer of Aloha Airgroup, Inc. an aviation services corporation which owns and operates Aloha Airlines and Aloha IslandAir. Mr. Myers joined Aloha in 1983 as vice president of marketing and became its president and chief executive officer in June 1985. Mr. Myers is a member of the boards of directors of Air Transport Association of America and Hawaiian Electric Industries.\nThomas P. Burns has served as Senior Vice President-Sales and Marketing --------------- since August 1987. Mr. Burns joined the Company in April 1985 as Vice President-Sales. Mr. Burns was employed for 25 years by Continental Airlines in various sales and passenger service positions. From 1982 to 1983, he was employed as North American Manager of Sales for UTA, a French airline. Mr. Burns returned to Continental from 1983 through March 1985, where he served as Director of International Sales prior to joining the Company.\nAlphonse E. Frei has been Senior Vice President-Finance and Chief ---------------- Financial Officer since April 1985. He joined the Company in April 1983 as Vice President-Controller. Prior to that time he had 23 years of experience at Continental Airlines where he held a variety of management positions in finance and data processing. Mr. Frei served as a member of the Company's Board of Directors from 1986 to 1992. Mr. Frei is also a member of the board of directors of Swift Transportation Co., Inc.\nMartin J. Whalen has been Senior Vice President-Administration and ---------------- General Counsel of the Company since July 1986. From 1980 until July 1986, Mr. Whalen was employed by McDonnell Douglas Helicopter Company and its predecessors, most recently as Vice President of Administration. He also held positions in labor relations, personnel and legal affairs at Hughes Airwest and Eastern Airlines.\nFrederick W. Bradley, Jr. has served as a member of the Board of ------------------------- Directors since September 1992. Immediately prior to joining the Board of Directors, Mr. Bradley was a senior advisor with Simat, Helliesen & Eichner, Inc. Mr. Bradley formerly served as senior vice president of Citibank\/Citicorp's Global Airline and Aerospace business. Mr. Bradley joined Citibank\/Citicorp in 1958. In addition, Mr. Bradley serves as a member of the board of directors of Shuttle, Inc. (USAir Shuttle) and the Institute of Air Transport, Paris, France. Mr. Bradley also serves as chairman of the board of directors of Aircraft Lease Portfolio\nSecuritization 92-1 Ltd. and as President of IATA's International Airline Training Fund of the United States.\nO. Mark De Michele has served as a member of the Board of Directors ------------------ since 1986 and is president, chief executive officer and a director of Arizona Public Service Company. Mr. De Michele joined Arizona Public Service Company in 1978 as vice president of corporate relations, and also served as its chief operating officer and an executive vice president. Mr. De Michele is also a member of the board of directors of the Pinnacle West Capital Corporation.\nSamuel L. Eichenfield has served as a member of the Board of Directors --------------------- since September 1992 and is chairman of the board of directors and chief executive officer of GFC Financial Corporation. Mr. Eichenfield has also served as chief executive officer of Greyhound Financial Corporation, a subsidiary of GFC Financial Corporation, since joining GFC in 1987.\nRichard C. Kraemer has served as a member of the Board of Directors ------------------ since September 1992 and is president and chief operating officer of UDC Homes, Inc. Mr. Kraemer is also a member of the UDC Homes, Inc. board of directors. Prior to joining UDC Homes, Inc. in 1975, Mr. Kraemer held a variety of positions at American Cyanamid Company.\nJames T. McMillan has served as a member of the Board of Directors since ----------------- December 1993. Mr. McMillan joined McDonnell Douglas Finance Corporation as its president in 1968 and retired as its chairman of the board in 1991. Mr. McMillan also served in various capacities for the McDonnell Douglas Corporation from August 1954 until August 1990, most recently as a Senior Vice President and Group Executive.\nJohn R. Norton III has served as a member of the Board of Directors ------------------ since September 1992 and was former Deputy Secretary of the United States Department of Agriculture from 1985 to 1986. Mr. Norton is currently a principal of J.R. Norton Company, an agricultural and real estate. Mr. Norton is also a member of the board of directors of Aztar Corp., Pinnacle West Capital Corporation, Arizona Public Service Company and Terra Industries, Inc.\nJohn F. Tierney has served as a member of the Board of Directors since --------------- December 1993. Mr. Tierney is the Assistant Chief Executive and Finance Director of GPA Group plc, an Irish aircraft leasing concern, and has served GPA Group plc in various such capacity since 1981. See Certain Relationships and Related Transactions.\nDeclan Treacy has served as a member of the Board of Directors since ------------- December 1993. Mr. Tierney is the General Manager - Corporate Finance of GPA Group plc, an Irish aircraft leasing concern, and has served GPA Group plc in various such capacity since 1988. See Certain Relationships and Related Transactions.\nIn February 1993, the Company and its debtor-in -possession lenders amended the terms of D.I.P. financing and in connection therewith the Company and certain of such lenders entered into an Amended and Restated Management Letter Agreement pursuant to which such lenders shall have a right to approve the membership of the Company's Board of Directors. Under the terms of such letter agreement GPA has the right to appoint two members to the Board of Directors, the remaining D.I.P. lenders (except Kawasaki) have the right to appoint five members to the Board of Directors, one member of the Board must be a member of America West management and two members must be independent.\nThe Compensation Committee of the Board of Directors, which met ten times during 1993 reviews all aspects of compensation of executive officers of the Company and makes recommendations on such matters to the full Board of Directors. In addition, the Compensation Committee reviews and approves all compensation and employee benefit plans, the Company's organizational structure and plans for the development of successors to corporate officers and other key members of management.\nThe Audit Committee, which met nine times during 1993, makes recommendations to the Board concerning the selection of outside auditors, reviews the financial statements of the Company and considers such other matters in relation to the internal and external audit of the financial affairs of the Company as may be necessary or appropriate in order to facilitate accurate and timely financial reporting. The Company does not maintain a standing nominating committee or other committee performing similar functions.\nDuring the fiscal year ended December 31, 1993, the Board of Directors of the Company met on twenty-nine occasions. During the period in which he served as director, each of the directors attended 75 percent or more of the meetings of the Board of Directors and of the meetings held by committees of the Board on which he served.\nItem 11.","section_11":"Item 11. Executive Compensation. ------- ----------------------\nThe table below sets forth information concerning the annual and long- term compensation for services in all capacities to the corporation for the fiscal years ended December 31, 1993, 1992 and 1991, of those persons who were, at December 31, 1993 (i) the chief executive officer and (ii) the other four most highly compensated executive officers of the Corporation (the \"Named Officers\"):\nOption Plan Information -----------------------\nDuring the fiscal year ended December 31, 1993, none of the Named Officers exercised any options. All options held by the Named Officers have exercise prices greater than the fair market value of the Common Stock on December 31, 1993.\nThe following table sets forth information with respect to the Company's Restated Nonstatutory Stock Option Plan (\"NSOP\") and Incentive Stock Option Plan (\"ISO\") as of the fiscal year ended December 31, 1993 with respect to the Named Officers.\nTermination of Employment Arrangements --------------------------------------\nThe Company has made certain Termination of Employment Arrangements in keeping with its practice under its July 26, 1991 Termination of Employment Guidelines, as amended:\nIn connection with the termination of employment of Mr. Michael J. Conway as an officer of the Company, the Company agreed to pay Mr. Conway $503,000 in termination allowances, payable as an initial severance payment in the amount of $304,200, an additional $163,800 in six monthly installments of $27,300 each, and a $35,000 transition expense allowance. The Company also agreed to continue the payment until December 31, 1994, of premiums aggregating about $33,000 on certain life insurance policies owned by Mr. Conway. The foregoing payments were in addition to continuation of medical insurance benefits and certain other fringe benefit arrangements.\nIn connection with the termination of employment of Mr. Don Monteath as an officer of the Company, the Company agreed to pay Mr. Monteath a severance payment of $168,862. This payment was in addition to continuation of medical insurance benefits and certain other fringe benefit arrangements.\nDirector Compensation ---------------------\nEach non-employee director at December 31, 1993, is compensated as follows: an annual retainer of $25,000 plus $1,000 for each Board meeting attended, $1,000 for each committee meeting attended and reimbursement for expenses incurred in attending the meetings. Directors are also entitled to certain air travel benefits.\nOther Agreements ----------------\nMr. Franke, Chairman of the Board of Directors, is also the president of the financial services firm, Franke & Co. In order to assist Mr. Franke with certain costs associated with his service as Chairman and Chief Executive Officer, the Company pays Franke & Co. an office overhead allowance of $4,167 per month.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. ------- --------------------------------------------------------------\nThe following table sets forth information, as of March 15, 1994, concerning the capital stock beneficially owned by each director of the Company, by each of the named executive officers, by the directors and executive officers of the Company as a group, and by each Stockholder known by the Company to be the beneficial owner of more than five percent of the Common Stock or Preferred Stock.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ------- ----------------------------------------------\nTranspacific Enterprises, Inc., an affiliate of Ansett Airlines of Australia (\"Ansett Airlines\"), holds all the Company's Series C Preferred Stock and certain shares of Common Stock. Pursuant to the terms of an agreement between the Company and Transpacific, Transpacific has the right to maintain a 20 percent voting interest in the Company through the purchase of Common Stock from the Company. See Item 12. Security Ownership ------- of Certain Beneficial Owners and Management. The Company presently leases or subleases a total of eleven Boeing 737 aircraft from Ansett Airlines or its affiliates for terms expiring at various dates through August 2003 (unless terminated earlier at Ansett's option). All of these leases were renegotiated in 1992 resulting in reduced rents and extended terms (Ansett may upon 90 days notice to the Company terminate any lease during the extension periods). As of December 31, 1993, the Company was obligated to pay approximately $232 million over the respective terms of these aircraft leases.\nAnsett Worldwide Aviation U.S.A. (\"Ansett\"), an affiliate of Transpacific and Ansett, provided the Company with $10 million of the September 1992 D.I.P. financing. In connection with such loan, Ansett received the right to designate one member to the Company's Board of Directors. Ansett was repaid in full in September 1993 and Tibor Sallay, Ansett's designated director, resigned from the Company's Board of Directors concurrent with such repayment.\nAffiliates of GPA Group, plc (\"GPA\") have loaned the Company approximately $70 million of D.I.P. financing. Under the terms of the D.I.P. financing documents, GPA has the right to designate two members to the Company's board of directors. John F. Tierney and Declan Treacy currently serve as GPA's designated directors. The Company presently leases or subleases a total of sixteen Airbus A320 aircraft from GPA or its affiliates for terms expiring at various dates through July 2013. As of December 31, 1993, the Company was obligated to pay approximately $1.136 billion over the respective terms of these aircraft leases.\nEffective January 1, 1994, Mr. A. Maurice Myers left his position as President and Chief Executive Officer of Aloha Airlines, Inc. to join the Company as President and Chief Operating Officer. The Employment Agreement between the Company and Mr. Myers provides an initial two year term at a base salary of $375,000 per year. Mr. Myers also received a $100,000 transition allowance. The Company has agreed to assist Mr. Myers in purchasing a residence in Phoenix, Arizona by a loan of up to $200,000 and to loan to Myers up to $500,000 if he elects to exercise options to acquire stock of Aloha Airlines, Inc. The loans would be nonrecourse to Mr. Myers but would be secured by such residence and stock. Upon confirmation of a plan of reorganization during the term of Mr. Myers' employment, the Company has agreed to seek Bankruptcy Court approval of payment to Mr. Myers of a reorganization success bonus, and grant, pursuant to the plan of reorganization, options to acquire shares of common stock in the reorganized Company. The Company has also agreed to provide to Mr. Myers certain retirement benefits, reduced for vested accrued benefits payable under plans maintained by his former employer. If Mr. Myers' employment with the Company is terminated or his responsibilities are materially altered following a change in control, he is entitled to receive a severance payment equal to 200% of his base salary and, for a period of 12 months, medical and life insurance coverages as provided immediately prior to such termination. Mr. Myers is entitled to participate in any incentive plans or other fringe benefits provided by the Company to other key employees.\nThe Board of Directors has discussed and continues to discuss change of control severance arrangements and a reorganization success bonus with Mr. William A. Franke. It also has discussed and continues to discuss reorganization success bonuses for other key employees of the Company.\nIt is the policy of the Company that transactions with affiliates be on terms no less favorable to the Company than those obtainable from unaffiliated third parties.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. ------- ---------------------------------------------------------------\n(a) Financial Statements. --------------------\n(1) Report of KPMG Peat Marwick\n(2) Financial Statements and Notes to Financial Statements of the Company, including Balance Sheets as of December 31, 1993 and 1992 and related Statements of Operations, Cash Flows and Stockholders' Equity (Deficiency) for each of the years in the three-year period ended December 31, 1993\n(b) Financial Statement Schedules. -----------------------------\n(1) Schedule V. Property, Plant and Equipment\n(2) Schedule VI. Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment\n(3) Schedule VIII. Valuation and Qualifying Accounts\n(4) Schedule X. Supplementary Income Statement Information\nSchedules not listed above and columns within certain Schedules have been omitted because of the absence of conditions under which they are required or because the required material information is included in the Financial Statements or Notes to the Financial Statements included herein.\n(c) Exhibits --------\nExhibit Number Description and Method of Filing ------ --------------------------------\n3-A(1) Restated Certificate of Incorporation of the Company, dated May 19, 1988 - Incorporated by reference to Exhibit 3-A to the Company's Schedule 13E-4 Issuer Tender Offer Statement (SEC File No. 5-34444 (\"13E-4\")\n3-A(2) Amendment to Restated Certificate of Incorporation of the Company - Incorporated by reference to Exhibit 3-A(2) to the Company's Report on Form 10-K for the year ended December 31, 1989 (the \"1989 10-K\")\n3-B Restated Bylaws of the Company, as amended through December 31, 1993 - Filed herewith --------------\n4-A(1) Certificate of Designation, Voting Powers, Preferences and Rights of the Series of Preferred Stock of the Company, Designated Series B Convertible Preferred Stock, dated March 15, 1984 - Incorporated by reference to Exhibit 3-D of the Company's Form S-1 Registration Statement (SEC File No. 2-89212)\n4-B(1) Certificate of Designation, Voting Powers, Preferences and Rights of the Series of Preferred Stock of the Company Designated Series C 9.75% Convertible Preferred Stock, dated October 8, 1985 - Incorporated by reference to Exhibit 3-E(1) of the Company's Form S-1 Registration Statement (SEC File No. 33-3800) (\"S-1 No. 33-3800\")\n4-B(2) Series C 9.75% Convertible Preferred Stock Certificate No. 1 for 73,099 Shares issued to Transpacific Enterprises, Inc., dated October 9, 1985 - Incorporated by reference to Exhibit 3-E(2) to S-1 No. 33-3800\n4-C Form of Certificate of Designation, Voting Powers, Preferences and Rights of the Series of Preferred Stock of the Company's Designated Series D Participating Preferred Stock, dated July 23, 1986 - Incorporated by reference to Exhibit 1 of the Company's Form 8-A Registration Statement (SEC File No. 0-12337) (\"Form 8-A No. 0-12337\")\n4-D Indenture dated as of August 1, 1985, between the Company and First Interstate Bank of Arizona, N.A., as Trustee, including form of 7 3\/4% Convertible Subordinated Debenture due 2010 - Incorporated by reference to Exhibit 4 to the Company's Form S-1 Registration Statement (SEC File No. 2-99206)\nExhibit Number Description and Method of Filing ------ --------------------------------\n4-E Form of Indenture dated as of March 15, 1986, between the Company and First Interstate Bank of Arizona, N.A., as Trustee, including form of 7-1\/2% Convertible Subordinated Debenture due 2011 - Incorporated by reference to Exhibit 4-B to S-1 No. 33-3800\n4-F Form of Indenture, dated as of December 15, 1988, between the Company and First Interstate Bank of Arizona, N.A., as Trustee, including form of 11 1\/2% Convertible Subordinated Debenture due 2009 - Incorporated by reference to Exhibit T3C to the Company's Form T-3 Application for Qualification of Indenture Under Trust Indenture Act of 1939 (SEC File No. 22-19024)\n4-G Amended and Restated Rights Agreement, effective as of July 23, 1986 and dated as of June 17, 1988, between the Company and First Interstate Bank of Arizona, N.A., as Rights Agent - Incorporated by reference to Exhibit 2 to Amendment No. 1 to Form 8-A filed on Form 8 (SEC File No. 0-12337)\n10-A(1)* America West Airlines, Inc. Stock Purchase Plan, as amended through February 26, 1991 - Incorporated by reference to Exhibit 10-A(1) to the Company's Report on Form 10-K for the year ended December 31, 1990 (the \"1990 10-K\")\n10-A(2)* America West Airlines, Inc. Stock Purchase Plan for California and Alberta Resident Employees, as amended through February 26, 1991 - Incorporated by reference to Exhibit 10-A(2) to the 1990 Form 10-K\n10-A(3)* America West Airlines, Inc. Incentive Stock Option Plan, as amended through February 27, 1990 - Incorporated by reference to Exhibit 10-A(3) to the 1989 Form 10-K\n10-A(4)* Restated Nonstatutory Stock Option Plan, as of February 27, 1990 - Incorporated by reference to Exhibit 10-A(4) to the 1989 Form 10-K\n10-A(5)* Non-Employee Directors Stock Option Plan, as of June 27, 1989 - Incorporated by reference to Exhibit 10-A(5) to the 1989 Form 10-K\n10-A(6)* Restricted Stock Plan - Incorporated by reference to Exhibit 10-A(6) to the 1989 Form 10-K\n10-A(7)* 1991 Incentive Stock Option Plan - Incorporated by reference to Exhibit 10-A(7) to the 1990 Form 10-K\n10-C(1)* Stock Purchase and Sale Agreement dated October 9, 1985, between the Company and Transpacific Enterprises, Inc. - Incorporated by reference to Exhibit 10-H to S-1 No. 33-3800\nExhibit Number Description and Method of Filing ------- --------------------------------\n10-C(2)* Stock Purchase and Sale Agreement dated July 31, 1987, between the Company and Transpacific Enterprises, Inc. - Incorporated by reference to Exhibit 10-E(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1987\n10-D(1) Second Restated and Amended Letter of Credit Reimbursement Agreement, dated as of April 27, 1990 among the Company, the Industrial Bank of Japan, Participating Banks and Bank of America National Trust and Savings Association - Incorporated by reference to Exhibit 10-D(3) to the 1990 Form 10-K\n10-D(2) Third Amendment to Second Restated and Amended Letter of Credit Reimbursement Agreement - Incorporated by reference to Exhibit 10-D(4) to the 1990 Form 10-K\n10-E Official Statement dated August 11, 1986 for the $54,000,000 Variable Rate Airport Facility Revenue Bonds - Incorporated by reference to Exhibit 10.e to the Company's Report on Form 10-Q for the quarter ended September 30, 1986\n10-F(1) Trust Indenture dated July 1, 1989 between The Industrial Development Authority of the City of Phoenix, Arizona and First Interstate Bank of Arizona, N.A. - Incorporated by Reference to Exhibit 10-D(8) to 1989 Form 10-K\n10-F(2) Airport Use Agreement dated as of July 1, 1989 among the City of Phoenix, The Industrial Development Authority of the City of Phoenix, Arizona and the Company - Incorporated by reference to Exhibit 10-D(9) to 1989 Form 10-K\n10-F(3) First Amendment dated as of August 1, 1990 to Airport Use Agreement dated as of July 1, 1989 among the City of Phoenix and the Industrial Development Authority of the City of Phoenix, Arizona and the Company - Incorporated by reference to Exhibit 10-(D)(9) to the Company's Report on Form 10-Q for the quarter ended September 30, 1990 (the \"9\/30\/90 10-Q\")\n10-G(1) Revolving Loan Agreement dated as of April 17, 1990, by and among the Company, the Bank signatories thereto, and Bank of America National Trust and Savings Association, as Agent for the Banks (the \"Revolving Loan Agreement\") - Incorporated by reference to Exhibit 10-1 to Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990\n10-G(2) First Amendment dated as of April 17, 1990 to Revolving Loan Agreement - Incorporated by reference to Exhibit 10-(D)(10) to the 9\/30\/90 10-Q\nExhibit Number Description and Method of Filing ------- --------------------------------\n10-G(3) Second Amendment dated as of September 28, 1990 to Revolving Loan Agreement - Incorporated by reference to Exhibit 10-(D)(11) to the 9\/30\/90 10-Q\n10-G(4) Third Amendment dated as of January 14, 1991 to Revolving Loan Agreement - Incorporated by reference to Exhibit 10-D(13) to the 1990 Form 10-K\n10-H Airbus A320 Purchase Agreement (including exhibits thereto), dated as of September 28, 1990 between AVSA, S.A.R.L. (\"AVSA\") and the Company, together with Letter Agreement Nos. 1-10, inclusive - Incorporated by reference to Exhibit 10-(D)(1) to the 9\/30\/90 10-Q\n10-I Loan Agreement, dated as of September 28, 1990, among the Company, AVSA and AVSA, as agent - Incorporated by reference to Exhibit 10-(D)(2) to the 9\/30\/90 10-Q\n10-J V2500 Support Contract Between the Company and IAE International Aero Engines AG (\"IAE\"), dated as of September 28, 1990, together with Side Letters Nos. 1-4, inclusive - Incorporated by reference to Exhibit 10-(D)(3) to the 9\/30\/90 10-Q\n10-K Spares Credit Agreement, dated as of September 28, 1990, Between the Company and IAE - Incorporated by reference to Exhibit 10-(D)(4) to the 9\/30\/90 10-Q\n10-L Master Credit Modification Agreement, dated as of October 1, 1992, among the Company, IAE International Aero Engines AG, Intlaero (Phoenix A320) Inc., Intlaero (Phoenix B737) Inc., CAE Electronics Ltd., and Hughes Rediffusion Simulation Limited - Incorporated by reference to Exhibit 10-L to the Company's Report on Form 10-K for the year ended December 31, 1992 (the \"1992 10-K\")\n10-M(1) Credit Agreement, dated as of September 28, 1990 Between the Company and IAE - Incorporated by reference to Exhibit 10-(D)(5) to the 9\/30\/90 10-Q\n10-M(2) Amendment No. 1 to Credit Agreement, dated March 1, 1991 - Incorporated by reference to Exhibit 10-M(2) to the Company's 1992 10-K\n10-M(3) Amendment No. 2 to Credit Agreement, dated May 15, 1991 - Incorporated by reference to Exhibit 10-M(3) to the Company's 1992 10-K\n10-M(4) Amendment No. 3 to Credit Agreement, dated October 1, 1992 - Incorporated by reference to Exhibit 10-M(4) to the Company's 1992 10-K\nExhibit Number Description and Method of Filing ------- --------------------------------\n10-N(1) Form of Third Amended and Restated Credit Agreement dated as of September 30, 1993, among the Company, various lenders, and BT Commercial Corp. as Administrative Agent (without exhibits) - Filed herewith --------------\n10-N(2) Form of Amended and Restated Management Letter Agreement, dated as of September 30, 1993 from the Company to the Lenders - Filed herewith --------------\n10-N(3) Form of Amendment to Amended and Restated Management Letter Agreement; Consent to Amendment of Bylaws dated February 8, 1994 from the Company to the Lenders - Filed herewith --------------\n10-0(1) Cash Management Agreement, dated September 28, 1991, among the Company, BT and First Interstate of Arizona, N.A. - Incorporated by reference to Exhibit 10-D(21) to the 1991 10-K\n10-O(2) First Amendment to Cash Management Agreement, dated December 1, 1991, among the Company, BT and First Interstate of Arizona, N.A. - Incorporated by reference to Exhibit 10-D(22) to the 1991 10-K\n10-O(3) Second Amendment to Cash Management Agreement, dated September 1, 1992, among the Company, BT, and First Interstate Bank of Arizona, N.A. - Incorporated by reference to Exhibit 10-O(3) to the Company's 1992 10-K\n10-P Loan Restructuring Agreement, dated as of December 1, 1991 between the Company and Kawasaki - Incorporated by reference to Exhibit 10-D(23) to the 1991 10-K\n10-Q Restructuring Agreement, dated as of December 1, 1991 between the Company and Kawasaki - Incorporated by reference to Exhibit 10- D(24) to the 1991 10-K\n10-R(1) A320 Put Agreement, dated as of December 1, 1991 between the Company and Kawasaki - Incorporated by reference to Exhibit 10- D(25) to the 1991 10-K\n10-R(2) First Amendment to A320 Put Agreement, dated September 1, 1992 - Incorporated by reference to Exhibit 10-R(2) to the Company's 1992 10-K\n10-S(1) A320 Put Agreement, dated as of June 25, 1991 between the Company and GPA Group plc - Incorporated by reference to Exhibit 10-D(26) to the 1991 10-K\n10-S(2) First Amendment to Put Agreement, dated as of September 1, 1992 - Incorporated by reference to Exhibit 10-S(2) to the Company's 1992 10-K\nExhibit Number Description and Method of Filing ------- --------------------------------\n10-T Restructuring Agreement, dated as of June 25, 1991 among GPA Group, plc, GPA Leasing USA I, Inc., GPA Leasing USA Sub I, Inc. and the Company - Incorporated by reference to Exhibit 10-D(27) to the 1991 10-K\n10-U Form of Interim Procedures Agreement dated as of March 11, 1994 between America West Airlines and AmWest Partners, L.P. - Filed herewith --------------\n10-V For of Investment Agreement dated as of March 11, 1994 between America West Airlines and AmWest Partners, L.P. - Filed herewith --------------\n11 Statement re: computation of net income (loss) per common share - Filed herewith --------------\n12 Statement re: computation of ratio of earnings to fixed charges - Filed herewith --------------\n23 Consent of KPMG Peat Marwick (regarding Form S-8 Registration Statements) - Filed herewith --------------\n24 Powers of Attorney - See Signature Page\n- ----------------\n* Indicates management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.\n(d) Reports on Form 8-K -------------------\n1. The Company filed with the Securities and Exchange Commission a Form 8-K dated October 6, 1993 reporting information concerning the extension of the D.I.P Financing to June 30, 1994 and the resignation of board members.\n2. On October 26, 1993, the Company filed with the Securities and Exchange Commission a Form 8-K reporting information that the pilots voted in favor of being represented by the Air Line Pilots Associations (ALPA).\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICA WEST AIRLINES, INC.\nDate: March 30, 1994 By \/s\/ A. E. Frei --------------------------------------- Alphonse E. Frei Senior Vice President - Finance\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints William A. Franke, A. Maurice Myers and Alphonse E. Frei, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K Annual Report, and to file the same, with all exhibits thereto, and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ William A. Franke Chairman of the Board of March 30, 1994 --------------------------- Director and Chief William A. Franke Executive Officer\n\/s\/ A. Maurice Myers President, Chief March 30, 1994 --------------------------- Operating Officer and A. Maurice Myers Director\nSignature Title Date --------- ----- ----\n\/s\/ A. E. Frei Senior Vice President-- March 30, 1994 --------------------------- Finance (Principal Alphonse E. Frei Financial and Accounting Officer)\n\/s\/ O. Mark De Michele Director March 30, 1994 --------------------------- O. Mark De Michele\n\/s\/ Frederick W. Bradley Director March 30, 1994 --------------------------- Frederick W. Bradley\n\/s\/ Samuel L. Eichenfield Director March 30, 1994 --------------------------- Samuel L. Eichenfield\n\/s\/ Richard C. Kraemer Director March 30, 1994 --------------------------- Richard C. Kraemer\n\/s\/ James T. McMillan Director March 30, 1994 --------------------------- James T. McMillan\n\/s\/ John R. Norton Director March 30, 1994 --------------------------- John R. Norton\n\/s\/ John F. Tierney Director March 30, 1994 --------------------------- John F. Tierney\n\/s\/ Declan Treacy Director March 30, 1994 --------------------------- Declan Treacy","section_15":""}
{"filename":"49792_1993.txt","cik":"49792","year":"1993","section_1":"ITEM 1. BUSINESS - -----------------\nBACKGROUND\nIllinois Central Railroad Company (the \"Railroad\"), traces its origin to 1851, when the Railroad was incorporated as the nation's first land grant railroad. Today, the Railroad operates 2,700 miles of main line track between Chicago and the Gulf of Mexico, primarily carrying chemicals, coal and paper north, with coal, grain and milled grain products moving south along its lines. The Railroad has been significantly downsized and restructured from its peak of nearly 10,000 miles of track operated in 13 states, rebuilding its main line and converting to a single-track main line with a centralized traffic control system and divesting major east-west segments. The Railroad is a wholly-owned subsidiary and a principal asset of Illinois Central Corporation (\"IC\").\nIn 1989, the Railroad was acquired by The Prospect Group, Inc. (\"Prospect\") by means of a public tender offer that resulted in the Railroad becoming highly leveraged. Prospect distributed the stock of the Railroad to Prospect's stockholders in 1990, and the Railroad again became publicly owned. Improved operating performance, combined with sales of non-operating assets and proceeds from equity and lower-cost debt financings since 1990 have resulted in a substantial reduction in the Railroad's leverage. Between December 31, 1989 and December 31, 1993, the Railroad reduced its debt to capitalization ratio from 89% to approximately 49%.\nThe principal executive office of the Railroad is located at 455 North Cityfront Plaza Drive, Chicago, Illinois 60611-5504 and its telephone number is (312) 755-7500.\nGENERAL\nThe Railroad is in the midst of a four year plan designed to increase its revenues and lower its operating ratio and interest costs. The plan is in sharp contrast to the Railroad's primary focus for the four years ended December 31, 1992 of significantly reducing costs and improving service offerings.\nWith 1992 as its base, the plan will focus on capitalizing on the Railroad's leading operating ratio among Class I railroads (operating expenses divided by operating revenues) which was 68.6% at December 31, 1993. The components of the plan are: - increase annual revenues by $100 million by the end of 1996 - reduce the operating ratio by one percentage point per year for a total of four (4) points below the 1992 base - reduce annual interest expense by $10 million\nTo accomplish this plan, revenues must grow at a compounded rate of 4.3% per year while operating expenses must not exceed a compounded annual growth rate of 2.5% per year.\nManagement has identified the sources of planned revenue growth as economic expansion, new and expanded plants on line and market share growth. Economic expansion is the combination of industrial production improvement and freight rate increases. Market share growth is volume gained from competition, (i.e., other railroads, trucklines and barges) facilitated by being a low cost producer. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of the progress made in 1993.\nTo foster achievement of these goals, the Railroad reorganized its marketing and sales effort (see below), restructured its safety and claims group into a Risk Management Group and streamlined the operating organization. The latter effectively created teams of engineering, maintenance and transportation experts who share the common goal of moving trains safely and efficiently. As a result of these changes, decision-making authority and accountability are now at lower and more localized levels, in line with the Railroad's systematic efforts to examine and refine all aspects of its service offering to customers.\nCOMMODITIES AND CUSTOMERS\nThe Railroad's customers are engaged in a wide variety of businesses and ship a number of different products that can be classified into commodity groups: chemicals, coal, grain, paper, grain mill and food products and other commodities. In 1993, two customers accounted for approximately 7% and 6%, respectively, of revenues (no other customer exceeded 5%) and the ten largest customers accounted for approximately 37% of revenues.\nIn order to address more effectively the diversity of the Railroad's customer base and move toward attainment of the four year growth plan, the Railroad's marketing department was re-organized in 1993 along major commodity groups. The new business units are chemicals and bulk, grain and grain mill, forest products, coal and coke and metals, and intermodal. The formation of separate units enables a fully integrated sales and marketing effort. Specialization allows employees to anticipate and respond to customer needs more quickly, to attract customers who previously used trucks or barges for their service needs, and to establish business relationships with new shippers. These new units work with current and prospective customers to develop customized shipping solutions. Management believes that this commitment to improved customer service has enhanced relations with shippers.\nThe formation of the Intermodal Business Unit underscores the Railroad's commitment to intermodal through long-term relationships with major participants in this strategic market. By forming a separate business unit, the Railroad has fully integrated its intermodal hub operation with sales and marketing for unmatched control of this highly specialized, customer-oriented service.\nIn 1993, the Railroad invested in 800 new trailers and upgraded facilities to position itself for intermodal growth, dedicated its newest, state- of-the-art terminal, just south of Chicago at the intersections of major expressways, and initiated a major expansion at the Memphis facility with completion anticipated for the first quarter of 1994.\nTo enhance service within its corridor, the Railroad entered into several joint operating agreements in 1992 and 1993 with trucklines and other intermodal carriers. Management anticipates that these relationships will provide better service to customers and seamless transportation of goods for shippers and customers.\nIn 1993, approximately 75% of the Railroad's freight traffic originated on its own lines, of which approximately 29% was forwarded to other carriers. Approximately 20% of the Railroad's freight traffic was received from other carriers for final delivery by the Railroad, and the balance of approximately 5% represented bridge or through traffic.\nThe respective percentage contributions by principal commodity group to the Railroad's freight revenues and revenue ton miles during the past five years are set forth below:\n- -----------------\n(1) A new car tracking system installed in late 1990 affects the comparability of 1993's, 1992's and 1991's ton mile data with that of the prior years, thus prior years are not presented.\nSome of the elements contained in these commodity groupings are as follows:\nCHEMICALS ................... A wide variety of chemicals and related products such as chlorine, caustic soda, potash, soda ash, vinyl chloride monomer, carbon dioxide, synthetic resins, alcohols, glycols, styrene monomer, plastics, sulfuric acid, muriatic acid, anhydrous ammonia, phosphates, mixed fertilizer compounds and carbon blacks.\nCOAL......................... Bituminous and metallurgical coal.\nGRAIN ....................... Corn, wheat, soybeans, sorghum, barley and oats.\nPAPER........................ Pulpboard, fiberboard, woodpulp, printing paper, newsprint and scrap or waste paper.\nGRAIN MILL & FOOD PRODUCTS .. Products obtained by processing grain and other farm products such as feed, soybean meal, corn syrup, flour and middlings, animal packinghouse by-products (tallow), canned food, corn oil, soybean oil, vegetable oils, malt liquors, sugar and molasses.\nINTERMODAL................... A wide variety of products shipped either in containers or trailers on specially designed cars.\nOTHER........................ Pulpwood and chips, lumber and other wood products; sand, gravel and stone, coke and petroleum products, metallic ores and other bulk commodities; primary and scrap metals, machinery and metal products, appliances, automobiles and parts, transportation equipment and farm machinery; glass and clay products, ordnance and explosives, rubber and plastic products, and general commodities.\n- ---------------\n(1) Ton mile data for years subsequent to December 31, 1990, are not comparable with prior years because of the installation of a new car tracking system in late 1990. As a result, this information is not meaningful (NM) for 1990 and 1989. (2) Freight train miles equals the total number of miles traveled by the Railroad's trains in the movement of freight. (3) Revenue ton miles of freight traffic equals the product of the weight in tons of freight carried for hire and the distance in miles between origin and destination. (4) Revenue per ton mile equals net freight revenue divided by revenue ton miles of freight traffic. (5) Gallons per ton mile equals the amount of fuel required to move one ton of freight one mile.\nThe following tables summarize operating expense-to-revenue ratios of the Railroad for each of the past four years, excluding the effect of the $8.9 million pretax special charge in 1992. The ratios for 1989 are not comparable to subsequent years because of the March 17, 1989, change in control and are not presented. The first table analyzes the various components of operating expenses based on the line items appearing on the income statements, whereas the second table is based on functional groupings.\n- ---------------------\n(1) Operating ratio means the ratio of operating expenses before special charge over operating revenues. (2) Transportation ratio means the ratio of transportation expenses (such as expenses of operating, servicing, inspecting, weighing, assembling and switching trains) over operating revenues. (3) Maintenance of way ratio means the ratio of maintenance of way expenses (such as the expense of repairing, maintaining, leasing, depreciating and retiring right-of-way and trackage structures, buildings and facilities) over operating revenues. (4) Maintenance of equipment ratio means the ratio of maintenance of equipment expenses (such as the expense of repairing, maintaining, leasing, depreciating and retiring transportation and other operating equipment) over operating revenues.\nEMPLOYEES; LABOR RELATIONS\nRailroad industry personnel are covered by the Railroad Retirement System instead of Social Security. Employer contribution rates under the Railroad Retirement System are currently more than double those in other industries, and may rise further because of the increasing proportion of retired employees receiving benefits relative to the shrinking number of working employees.\nLabor relations in the railroad industry are subject to extensive governmental regulation under the Railway Labor Act. Railroad industry personnel are also covered by the Federal Employer's Liability Act (\"FELA\") rather than by state no-fault workmen's compensation systems. FELA is a fault-based system, with compensation for injuries determined by individual negotiation or litigation.\nThe Railroad is a party to several national collective bargaining agreements which establish the wages and benefits of its union workers -- 90% of all Railroad employees. These agreements are subject to renegotiation beginning November 1, 1994, however, cost of living allowance provisions and other terms in each agreement continue until new agreements are reached. Despite being part of a national bargaining group, the Railroad has expressed a desire to negotiate separate distinct agreements with each of its unions on a local basis. Management has been exploring that position and has held several discussions with representatives from most of its unions. It is too early to determine if separate agreements will be reached. Thus, the Railroad has not taken steps to withdraw formally from the national bargaining group. The following table shows the average annual employment levels of the Railroad:\n1993 1992 1991 1990 1989 Total employees.. 3,306 3,421 3,611 3,688 3,942\nA significant portion of the decline from the 1992 level is the result of a separate agreement between the Railroad and the United Transportation Union, reached in November 1991. This agreement permits the Railroad to reduce the size of all crews on all trains operated. In accordance with this agreement, 158 crew members were severed at a cost of $9.6 million to date. No further dramatic reductions in the current crew size of approximately 2.75 at December 31, 1993 is anticipated.\nManagement believes that additional jobs in all areas may be eliminated over the next several years primarily through attrition and retirements though additional severances are possible.\nREGULATORY MATTERS; FREIGHT RATES; ENVIRONMENTAL CONSIDERATIONS\nThe Railroad is subject to significant governmental regulation by the ICC and other federal, state and local regulatory authorities with respect to rates, service, safety and operations.\nThe jurisdiction of the ICC encompasses, among other things, rates charged for certain transportation services, issuance of securities, assumption of certain liabilities by railroads, mergers or the acquisition of control of one carrier by another carrier and extension or abandonment of rail lines or services.\nThe Federal Railroad Administration, the Occupational Safety and Health Administration and certain state transportation agencies have jurisdiction over railroad safety matters. These agencies prescribe and enforce regulations concerning car and locomotive safety equipment, track safety standards, employee work conditions and other operating practices.\nThe amount of coal transported by the Railroad is expected to decline somewhat as the Clean Air Act is fully implemented. Much of the coal from mines currently served by the Railroad will not meet the environmental standards of the Clean Air Act without blending or installation of air scrubbers. On the other hand, the Railroad expects to participate in additional movements of Western coal. Overall, management believes that implementation of the Clean Air Act is unlikely to have a material adverse effect on the results of the Railroad.\nThe Railroad is and will continue to be subject to extensive regulation under environmental laws and regulations concerning, among other things, discharges into the environment and the handling, storage, transportation and disposal of waste and hazardous materials. Inherent in the operations and real estate activities of the Railroad and other railroads is the risk of environmental liabilities. As discussed in Item 3. \"Legal Proceedings,\" several properties on which the Railroad currently or formerly conducted operations are subject to governmental action in connection with environmental degradation. Additional expenditures by the Railroad may be required in order to comply with existing and future environmental and health and safety laws and regulations or to address other sites which may be discovered.\nEnvironmental regulations and remediation processes are subject to future change and cannot be determined at this time. Based on present information, in the opinion of management, the Railroad has adequate reserves for the costs of environmental investigation and remediation. However, there can be no assurance that environmental conditions will not be discovered which might individually or in the aggregate have a material adverse effect on the Railroad's financial condition.\nCOMPETITION\nThe Railroad faces intense competition for freight traffic from motor, water, and pipeline carriers and, to a lesser degree, from other railroads. Competition with other railroads and other modes of transportation is generally based on the quality and reliability of the service provided and the rates charged. Declining fuel prices disproportionately benefit trucking operations over railroad operations. The trucking industry frequently is more cost and transit-time competitive than railroads, particularly for distances of less than 500 miles. While deregulation of freight rates under the Staggers Act has greatly increased the ability of railroads to compete with each other and alternate forms of transportation, changes in governmental regulations (particularly changes to the Staggers Act) could significantly affect the Railroad's competitive position.\nTo a greater degree than other rail carriers the Railroad is vulnerable to barge competition because its main routes are parallel to the Mississippi River system. The use of barges for some commodities, particularly coal and grain, sometimes represents a lower cost mode of transportation. As a result, the Railroad's revenue per ton-mile has generally been lower than industry averages for these commodities. Barge competition and barge rates are affected by navigational interruptions from ice, floods and droughts. These interruptions cause widely fluctuating rates. The Railroad's ability to maintain its market share of the available freight has traditionally been affected by its response to the navigational conditions on the river.\nMost of the Railroad's operations are conducted between points served by one or more competing carriers. The consolidation in recent years of major midwestern and eastern rail systems has resulted in strong competition in the service territory of the Railroad.\nLIENS ON PROPERTIES\nSee Note 8 of Notes to Consolidated Financial Statements.\nLIABILITY INSURANCE\nThe Railroad is self-insured for the first $5 million of each loss. The Railroad carries $295 million of liability insurance per occurrence, subject to an annual cap of $370 million in the aggregate for all losses. This coverage is considered by the Railroad's management to be adequate in light of the Railroad's safety record and claims experience.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nPHYSICAL PLANT AND EQUIPMENT\nSystem. As of December 31, 1993, the Railroad's total system consisted of approximately 4,700 miles of track comprised of 2,700 miles of main line, 300 miles of secondary main line and 1,700 miles of passing, yard and switching track. The Railroad owns all of the track except for 190 miles operated by agreements over track owned by other railroads.\nTrack Structures. During the five years ended December 31, 1993, the Railroad has spent $305.3 million on track structure to maintain its rail lines, as follows ($ in millions):\nCAPITAL Expenditures Maintenance Total ------------ ----------- ----- 1993 ................ $ 50.3 $ 25.1 $ 75.4 1992 ................ 46.4 23.0 69.4 1991 ................ 36.3 20.7 57.0 1990 ................ 34.6 20.0 54.6 1989 ................ 19.1 29.8 48.9 ------ ------ ------\nTotal.............. $186.7 $118.6 $305.3\nThese expenditures concentrated primarily on track roadway and bridge rehabilitation in 1993 and 1992. Approximately 1,300 miles and 1,400 miles of road were resurfaced in 1993 and 1992, respectively. Over the last two years, a total of $8.4 million was spent to construct new or expanded intermodal facilities in Chicago and Memphis. Expenditures in 1991 and 1990 benefited from the use of reclaimed rail, cross ties, ballast and other track materials from the second main line when the Railroad's double-track mainline was converted to a single-track mainline with centralized traffic control. Most reclaimed material has now been used and future expenditures will reflect the purchase of new materials. The reduced number of miles of track and the general good condition of the track structure should result in future expenditures approximately equal to the average of 1993 and 1992.\nFleet. The Railroad's fleet has undergone significant rationalization and upgrading from its peak in 1985 of 862 locomotives and 28,616 freight cars. Over the last two years older, less efficient locomotives were replaced with newer larger horsepower and more efficient equipment.\nThe Railroad is leasing 61 locomotives and approximately 650 cars from other subsidiaries of IC. When those leases expire, the Railroad has first right of refusal to lease the equipment. As these cars are leased to the Railroad other leased equipment will be returned to the independent, third-party lessors or short-term car hire agreements will be terminated. In 1993, the Railroad acquired 4 SD-40-2 locomotives and also upgraded its highway trailer fleet with 800 newly built trailers which replaced 880 older leased trailers.\nThe following is the overall fleet at December 31:\nTotal Units: 1993 1992 1991 1990 1989 Locomotives(1).... 468 449 470 471 516 Freight cars ..... 15,112 15,877 16,381 16,526 17,141 Work equipment.... 745 902 881 934 1,000 Highway trailers(2) 898 203 124 67 70\n- ------------------\n(1) Approximately 100 locomotives need repair before they can be returned to service. This equipment is repaired if needed on an ongoing basis or sold. In 1993 and 1992, the Railroad sold 23 and 66 surplus locomotives, respectively. The active fleet is 322 as of December 31, 1993.\n(2) Excludes trailers being accumulated for return to lessors.\nThe components of the Railroad's fleet and in total for 1993 and in total for 1992 are shown below:\n(1) In addition, approximately 2,735 freight cars and 696 highway trailers were being used by the Railroad under short-term car hire agreements.\n(2) May be subject to Conditional Sales Agreements.\n(3) Excludes trailers being accumulated for return to lessor. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nState of Alabama, et al. v. Alabama Wood Treating Corporation, Inc., et al., S.D. Ala. No. 85-0642-C\nThe State of Alabama and Alabama State Docks (\"ASD\") filed suit in 1985 seeking damages for alleged pollution of land in Mobile, Alabama, stemming from creosoting operations over several decades. Defendants include the Railroad, which owned the land until 1976, Alabama Wood Treating Corporation, Inc., and Reilly Industries, Inc. (\"RII\"), which leased the land from the Railroad and conducted creosote operations on the site. In December 1976, the Railroad sold the premises to ASD. The complaint sought payment for the clean-up cost together with punitive and other damages.\nIn 1986, ASD, RII and the Railroad agreed to form a joint technical committee to clean the site sharing equally the cost of clean-up, and in October 1986, the court stayed further proceedings in the suit. Under the agreement the joint technical committee has spent approximately $6.6 million and has been authorized to expend up to a total of $6.9 million. The Railroad has contributed $2.2 million and has agreed to increase its contribution to a total of $2.3 million. Further clean-up activities are anticipated.\nUnder the agreement, if any party disagrees with the amount determined by the joint technical committee to be expended or otherwise disagrees with any aspect of the clean-up, such party may decline further participation and recommence legal proceedings. However, amounts already contributed by any party will be credited against that party's eventual liability and may not be recovered from any other party.\nIselin Yard, Jackson, Tennessee\nIn 1991, the Iselin Rail Yard in Jackson, Tennessee was placed on the Tennessee Superfund list. In May 1993, the United States Environmental Protection Agency (\"EPA\") proposed to add a number of sites, including Iselin Rail Yard to the National Priorities List. The Railroad operated a rail yard and locomotive repair facility at the site. The shop facility was sold in 1986 and the rail yard was sold in 1988. Trichloroethylene (\"TCE\") has been found in several municipal water wells near the site. TCE is a common component of solvents similar to those believed to have been used at the Iselin shop. In addition, concentrations of metals and organic chemicals have been identified on the surface of the site. No order has been issued by any regulatory agency but the State of Tennessee is monitoring work at the site. The Railroad expects to cooperate with the agencies and other Potentially Responsible Parties to conduct any necessary studies and clean-up activities. The Railroad has commenced a remedial investigation and feasibility study of the site.\nMcComb, Mississippi\nElevated levels of lead and other soil contamination has been discovered at the Railroad's facility in McComb, Mississippi. The site was used for many years for sandblasting lead-based paint off freight cars. The Railroad has commenced a formal site investigation under the supervision of the Mississippi Department of Environmental Quality. The Remedial Investigation has disclosed the presence of lead in the soil and further testing of the surface and subsurface soil and groundwater is underway to assess the scope of the contamination. No order has been issued by any regulatory agency. The Railroad expects to cooperate with the State of Mississippi to conduct any necessary studies and clean-up activities.\nWaste Oil Generation\nThe Railroad was notified in September 1992 that it had been identified as a Potentially Responsible Party at a federal superfund site in West Memphis, Arkansas. The Railroad is alleged to have generated waste oil which was collected by a waste oil refiner who in turn disposed of sludge at the West Memphis landfill. In December 1992, the successor to the refiner initiated legal proceedings to preserve testimony in anticipation of a future contribution action against multiple Potentially Responsible Parties including the Railroad. Similar actions have been taken by the EPA or third parties with respect to waste oil allegedly generated by the Railroad and disposed of in landfills at Livingston, LA, Griffith, IN and Nashville, TN.\nBased on information currently available, the Railroad believes it has substantial defenses to liability for any contamination at these sites, and that any contribution to the contamination by the Railroad was de minimis.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIntentionally omitted. See Index page of this Report for explanation.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the outstanding common stock of the Railroad (100 shares) is owned by IC and therefore is not traded on any market. Various credit agreements limit the Railroad's ability to pay cash dividends to IC. However, the Railroad was able to declare $36.0 million in dividends in 1993 and $12.8 million in dividends in 1992. At December 31, 1993, approximately $76 million of the Railroad's equity was in excess of the limitation and available for dividend to IC.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nIntentionally omitted. See Index page of this Report for explanation. ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGROWTH PLAN\nFor the four years ended December 31, 1992, the Railroad's primary drivers were reducing costs and improving service offerings. The result was the best operating ratio among Class I railroads, 68.6% at December 31, 1993. While costs continue to be scrutinized, a new direction was initiated in 1993. With 1992 as its base, a new plan was outlined as follows:\n- increase annual revenues by $100 million by the end of 1996. - reduce the operating ratio by one percentage point per year for a total of four (4) points below the 1992 base. - reduce annual interest expense by $10 million.\nTo accomplish this plan, revenues must grow at a compounded annual rate of 4.3% while operating expenses must not exceed a compounded annual growth rate of 2.5% per year.\nManagement has identified the sources of planned revenue growth as economic expansion, new and expanded plants on our line and market share growth. Economic expansion is the combination of industrial production improvement and freight rate increases. Market share growth is volume gained from competition i.e., other railroads, trucklines and barges, facilitated by being a low cost producer.\nIn 1993, the first year of the growth plan, significant strides were made in accomplishing the plan as total revenues increased 3.1%. Two major unplanned events had an impact on revenues. In May 1993, the United Mine Workers began a strike against several companies affecting six mines served by the Railroad. As a result, approximately 35,000 carloads of coal were lost. The strike was settled in December 1993, and full production resumed in January 1994. Partially offsetting the lost coal loads was a gain of approximately 15,000 carloads of grain and grain mill products. This traffic was diverted to the Railroad as a result of the flooding of the upper Mississippi River in July and August 1993. Additionally, over 500 trains from several other Class I railroads were detoured over the Railroad's system. The result was a significant increase in traffic density over the Railroad's routes.\nCarloadings of paper recorded their fourth consecutive annual increase (3% for 1993). The increase was a result of the improved economy and growth in recycling. In 1993, chemical traffic increased 6%, reversing a two-year recessionary trend. While not benefiting for the full year from various truckline partnerships, intermodal traffic grew at 15% in the second half of 1993 versus the second half of 1992.\nWhile 1993 revenue lagged behind the plan compound rate of 4.3%, management believes the Railroad is positioned well for 1994. The targeted revenue growth in 1994 is 5%.\nFor 1993, the Railroad exceeded its operating ratio goal. Actual improvement was 2.3 percentage points and the full year operating ratio was 68.6%. More efficient train crew and train scheduling coupled with reduced costs contributed to this achievement.\nThe tender offer for and retirement of the Railroad's $145 million 14-1\/8% Debentures, in the second quarter of 1993, effectively resulted in the achievement of the third goal of the growth plan as interest expense, net declined $10.5 million in 1993 to $33.1 million. Interest expense, net is expected to be below $30 million in 1994.\nRESULTS OF OPERATIONS\nThe discussion below takes into account the financial condition and results of operations of the Railroad for the years presented in the consolidated financial statements.\n1993 COMPARED TO 1992\nRevenues for 1993 increased from the prior year by $17.3 million or 3.1% to $564.7 million. The increase was a result of a 2.9% increase in average gross freight revenue per carload, resulting from an improved commodity mix and modest rate increases. The 1993 revenue increase was attributable in part to the gain in carloads when the upper Mississippi River flooding affected barge traffic and also disrupted rail operations of other carriers which diverted traffic to the Railroad's system. Additionally, chemical loads were up 6% and paper was up 3%. Intermodal was up 5%, reflecting the Railroad's commitment to increase this aspect of operation, as evidenced by the new Chicago-area intermodal facility and expansions in Memphis. These gains were offset by lost carloads of coal resulting from the United Mine Workers strike of certain coal producers. For the year, carloadings declined .5% (or 4,400 carloads) to 847,900 carloads.\nOperating expenses for 1993 decreased $1.1 million, or .3% as compared to 1992, excluding the special charge recorded in 1992. Labor expense decreased $1.1 million as a result of on-going cost control programs, including the reduction in train crews, and an overall improvement in efficiency. This decrease was accomplished despite the additional expense incurred because of the flood- related detours of other railroads' trains over the Railroad's track and a 3% wage increase which was effective July 1, 1993 for union employees. Fuel expense reflects the increased traffic in 1993 and 1992 coupled with a total of $1.5 million for increased fuel taxes resulting from the Omnibus Budget Reconciliation Act of 1993 and for the costs associated with fuel hedges. The more fuel efficient locomotives acquired over the last two years partially offset the rise in fuel costs. Materials and supplies increased $3.6 million primarily as a result of track material purchases. The surplus from the single track project was substantially depleted necessitating purchase of new materials.\nOperating income for 1993 increased 18.2% ($27.3 million) to $177.6 million compared to $150.3 million for 1992, as a result of increased revenues cited above and decreased expenses (including the 1992 special charge). Excluding the special charge, the increase in operating income was 11.6% ($18.4 million).\nNet interest expense decreased by 25.9% to $31.8 million compared to $42.9 million in 1992. The issuance of new notes at 6.75% to replace the 14-1\/8% Senior Subordinated Debentures (the \"Debentures\") and lower interest rates on floating debt account for the reduced interest expense in 1993. The Debentures were retired via a tender offer which resulted in an extraordinary loss of $23.4 million, net of $12.6 million in tax benefits. The extraordinary loss covers the costs associated with the tender (i.e., premium on repurchase, the write-off of unamortized financing fees and debt discount and the costs associated with calling the untendered Debentures).\nSee \"Liquidity and Capital Resources\" for discussion of the impact of the Omnibus Budget Reconciliation Act of 1993.\nEffective January 1, 1993, the Railroad adopted both the Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\") and the Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"). SFAS No. 106 requires that future costs associated with providing postretirement benefits be recognized as expense over the employees' requisite service period. The pay-as-you-go method used prior to 1993 recognized the expense on a cash basis. SFAS No. 112 establishes accounting standards for employers who provide postemployment benefits and clarifies when the expense is to be recognized. As a result of adopting these two standards the Railroad recorded a decrease to net income of $84,000 (net of taxes of $46,000) as a cumulative effect of changes in accounting principles. In accordance with each standard, years prior to 1993 have not been restated.\nFor 1993, the adoption of these two standards had no significant effect on income before cumulative effect of changes in accounting principles as compared to the Railroad's prior pay-as-you-go method of accounting for such benefits. The Railroad has no plans to fund these liabilities and will continue to pay these costs on a pay-as-you-go basis, as was done in prior years.\n1992 COMPARED TO 1991\nRevenues for 1992 decreased from the prior year by $2.3 million or .4% to $547.4 million. The decrease resulted from a 1.6% (or 13,900 carloads) decrease in the number of freight carloads to 852,300, offset by a 1.1% increase in the average gross revenue per carload. Net freight revenue ton miles decreased 3.2% to 18.7 billion. Gross freight revenue per thousand ton miles increased 2.7% to $28.89 from $28.12. The increase in average revenue per carload was caused by an improved commodity mix, in which a greater volume of higher revenue per carload commodities was hauled, and modest rate increases.\nOperating expense for 1992 decreased by $7.5 million, or 1.9% as compared to 1991, even though the Railroad recorded an $8.9 million pretax special charge in 1992. Reductions in labor expense ($5.5 million), lease and car hire expense ($5.2 million), diesel fuel expense ($3.1 million) and a favorable litigation settlement in the first quarter more than offset the special charge. The special charge covered certain organizational and other expenses associated with the retirement of E. L. Moyers, the Railroad's Chairman, President and Chief Executive Officer until February 1993, as well as various unrelated asset revaluations.\nOperating income for 1992 increased by 3.6% to $150.3 million compared to $145.1 million for 1991, as a result of decreased expenses cited above offset by the aforementioned pretax special charge and decreased revenues. Excluding the special charge, the Railroad's 1992 operating income was $159.2 million, an increase of $14.1 million (9.7%) as compared to 1991. This increase is a result of on-going cost reduction programs, including the reduction in train crew sizes and the overall emphasis on efficiency.\nNet interest expense decreased by 23.5% from $56.1 million to $42.9 million. The full year effect of the August 1991 refinancing of the Series K Mortgage Bonds and the repayment of approximately $34.0 million of the Term Facility accounted for approximately $4.0 million and $8.0 million, respectively, in reduced interest expense for 1992.\nEffective January 1, 1992, the Railroad adopted SFAS No. 109, \"Accounting for Income Taxes.\" As a result, the Railroad recorded a $23.7 million reduction of its accrued deferred income tax liabilities. The Railroad elected to report this change as the cumulative effect of change in accounting principle. Therefore, prior period amounts have not been restated.\nLIQUIDITY AND CAPITAL RESOURCES\nOPERATING DATA: 1993 1992 1991 ---- ---- ---- Cash flows provided by (used for): Operating activities... $121.7 $ 124.1 $ 61.1 Investing activities... (54.1) (45.5) (25.2) Financing activities... (85.1) (67.9) (34.5) ------ ------- ------ Net change in cash and temporary cash investments. $(17.5) $ 10.7 $ 1.4\nCash from operating activities was primarily net income before depreciation, deferred taxes, extraordinary item and the cumulative effect of changes in accounting principles. A significant source of cash in 1992 ($26.4 million) was the realization of settlement proceeds with numerous insurance carriers in connection with asbestos and hearing loss casualty claims. Most of the settlements were for prior claims but some cover future claims related to prior periods. As part of the settlements, the Railroad agreed to release the carriers from liability for future hearing loss claims. An additional $6.3 million was received in 1993.\nDuring 1993, additions to property of $57.1 million included approximately $36.6 million for track and bridge rehabilitation and approximately $.6 million for the purchase of 4 locomotives. During 1992, additions to property of $50.8 million included approximately $46.4 million for track and bridge rehabilitation including approximately $5 million for the construction of a new intermodal facility in the Chicago area. The funds for this new facility were provided by advance rentals on a three-year lease agreement for the Railroad's old intermodal yard in Chicago by another railroad. The other railroad also paid for an option to acquire the old yard for cash at any time during the three-year lease period. Proceeds from the sales of excess materials generated by the single-track project ($4.1 million in 1992) partially offset the cost of property additions. Property retirements and removals unrelated to the single-track project generated proceeds of $5.3 million and $3.5 million in 1993 and 1992, respectively.\nThe Railroad anticipates that base capital expenditures for 1994 will be approximately $50 million and will concentrate on track maintenance, renewal of track structures such as bridges, and upgrading the locomotive fleet. If additional opportunities such as lease conversions or market-driven expansions occur in 1994, the total capital spending could be approximately $70 million. These expenditures are expected to be met from current operations or other available sources.\nOver the last three years, management has concentrated on reducing leverage, expanding funding sources, lowering funding costs and upgrading the debt ratings issued by the rating services. During that time frame, the Railroad's public debt has moved from being designated a \"Highly Leveraged Transaction\" to being rated Baa3 by Moody's Investors Service (\"Moody's\") and BBB by Standard & Poor's Corporation (\"S&P\"). Likewise, the Railroad's debt has also gone from fully collateralized to unsecured. A further step in this process was the initiation of a public commercial paper program in November 1993.\nThe commercial paper, issued by the Railroad, is rated A2 by S&P, by Fitch Investors Service, Inc. (\"Fitch\") and P3 by Moody's and is supported by a $100 million Revolver with the Railroad's bank lending group. At December 31, 1993, $38.1 million of commercial paper was outstanding with various maturities. The interest rates ranged from 3.45% to 3.75%. The Railroad views this program as a significant long-term funding source and intends to issue replacement notes as each existing issue matures. Therefore, the $38.1 million is classified as long-term.\nTwice during 1993, the Railroad renegotiated its lending arrangements with its bank lending group and the private placement noteholders. In April 1993, in connection with the Tender Offer for the $145 million 14- 1\/8% Senior Subordinated Debentures (the \"Debentures\") (see below), the banks converted the previous Permanent Facility to a $180 million Revolving Credit Facility due 1996 at LIBOR plus 100 basis points. The banks and the holders of the $160 million senior secured notes (\"Senior Notes\") issued in 1991 agreed to release all collateral and continue to lend on an unsecured basis. In November 1993, the banks again modified this arrangement in connection with the commercial paper program. The new bank agreements consist of a new $100 million Revolver, due 1996 and a $50 million 364-day facility due in October 1994 (the \"Bank Line\"). The new Revolver will be used primarily for backup for the commercial paper but can be used for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. The $100 million was limited to $57.9 million because $38.1 million in commercial paper was outstanding and $4.0 million in letters of credit had been issued. The Bank Line was structured as a 364-day renewal instrument and the Railroad intends to renew it on an on-going basis. The $40 million borrowed at December 31, 1993, has therefore been classified as long-term.\nThe Company believes that its available cash, cash generated by its operations and cash available via commercial paper, the Revolver and the Bank Line will be sufficient to meet foreseeable liquidity requirements. Various borrowings of the Railroad are governed by agreements which contain financial and operating covenants. The Railroad was in compliance with these covenant requirements at December 31, 1993, and management does not anticipate any difficulty in maintaining such compliance.\nIn 1993, conditions in the financial markets provided an opportunity for the Railroad to replace its outstanding Debentures. As a result, the Railroad initiated a tender offer for the Debentures. The tender offer, costs associated with calling the $10.3 million untendered portion and the refinancing of the Permanent Facility Term Loan resulted in a $23.4 million extraordinary loss, net of $12.6 million in tax benefits.\nIn connection with the tender offer for the Debentures, the Railroad issued $100 million of 6.75% non-callable, 10-year notes due 2003 (the \"Notes\") and irrevocably placed funds with a trustee to cover principal, a 6% premium and interest through the first call date of October 1, 1994, for the untendered Debentures. Additionally, the Railroad's bank lending group agreed to the termination and replacement of the previous Permanent Facility with a new $180 million unsecured Revolving Credit Facility expiring December 31, 1996 (see above). Likewise, the Senior Note holders agreed to release all the collateral specified in their original agreement and continue on an unsecured basis.\nCertain covenants of the Railroad's debt agreements restrict the level of dividends it may pay to IC. In 1993 and 1992, the Railroad paid dividends to IC of $27.4 million and $6.4 million, respectively. In November 1993, the Railroad declared a $15.0 million dividend which was paid in January 1994. At December 31, 1993, approximately $76 million of Railroad equity was free of such restrictions.\nThe Railroad has paid approximately $8 million, $10 million and $18 million in 1993, 1992 and 1991, respectively, for severance and lump sum signing awards associated with the various agreements signed in 1992 and 1991. The Railroad anticipates that an additional $7 million will be required in 1994 related to all such agreements. These requirements are expected to be met from current operating activities or other available sources.\nThe Railroad has entered into various hedge agreements designed to mitigate significant changes in fuel prices. As a result, approximately 93% of the Railroad's short-term diesel fuel requirements through March 1995 and 46% through June 1995 are protected against significant price changes.\nFederal Deficit Reduction Package\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993, which contains a deficit reduction package, became law. Certain aspects of the legislation increased taxes directly affecting the Railroad. Most significantly, the new law increased the maximum corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. This change required the Railroad to record additional deferred income tax expense of approximately $3.1 million in the third quarter of 1993 to reflect the new tax rate's impact on net deferred income tax liability as of January 1, 1993. The higher corporate rate did not significantly affect the Railroad's cash flow.\nIn addition, the legislation increased the federal tax on diesel fuels by 4.3 cents per gallon effective October 1, 1993. This tax increased the fuel expense of the Railroad, which purchases approximately 4.3 million gallons of diesel fuel each month, by $.5 million in 1993.\nOther\nThe Railroad is and will continue to be subject to extensive regulation under environmental laws and regulations concerning, among other things, discharges into the environment and the handling, storage, transportation and disposal of waste and hazardous materials. Inherent in the operations and real estate activities of the Railroad and other railroads is the risk of environmental liabilities. Several properties on which the Railroad currently or formerly conducted operations are subject to governmental action in connection with environmental damage. In the opinion of management, the Railroad has adequate reserves to cover the costs for investigation and remediation. However, there can be no assurance that environmental conditions will not be discovered which might individually or in the aggregate have a material adverse effect on the Railroad's financial condition.\nRecent Accounting Pronouncements\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS No. 114\") and Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\").\nSFAS No. 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. This statement applies to financial statements for fiscal years beginning after December 31, 1994, with earlier adoption encouraged. The Railroad is currently evaluating the impact of this statement, if any, on its reported results. Early adoption is not anticipated.\nSFAS No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. This statement is effective for fiscal years beginning after December 15, 1993. Adoption is not anticipated to have an adverse impact on reported results.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index to Consolidated Financial Statements on page 27 of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS IN ACCOUNTING FINANCIAL DISCLOSURES\nNONE PART III\nITEM 10, 11, 12 and 13 - ----------------------\nIntentionally omitted. See the Index page of this Report for explanation.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements:\nSee Index to Consolidated Financial Statements on page 27 of this Report.\n2. Financial Statement Schedules:\nSee Index to Financial Statement Schedules on page of this Report.\n3. Exhibits:\nSee items marked with \"*\" on the Exhibit Index beginning on page E-1 of this Report. Items so marked identify management contracts or compensatory plans or arrangements as required by Item 14.\n(b) 1. Reports on Form 8-K:\nDuring the fourth quarter of 1993 the Registrant filed with the Securities and Exchange Commission the following reports on Form 8-K on the dates indicated to report the events described:\nNONE\n(c) Exhibits:\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Exhibit Index beginning on page E-1.\n(d) Financial Statement Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this Report.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, there unto duly authorized.\nIllinois Central Railroad Company\nBy: \/s\/ DALE W. PHILLIPS Dale W. Phillips Vice President and Chief Financial Officer Date: March 16, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated.\nSIGNATURE Title(s) Date\n\/s\/ GILBERT H. LAMPHERE Chairman of the Gilbert H. Lamphere Board and Director March 16, 1994\n\/s\/ E. HUNTER HARRISON President and Chief E. Hunter Harrison Executive Officer (principal executive officer), Director March 16, 1994\n\/s\/ DALE W. PHILLIPS Vice President Dale W. Phillips and Chief Financial Officer (principal financial officer) March 16, 1994\n\/s\/ JOHN V. MULVANEY Controller John V. Mulvaney (principal accounting officer) March 16, 1994\n\/s\/ RONALD A. LANE Director Ronald A. Lane March 16, 1994\n\/s\/ GERALD F. MOHAN Director Gerald F. Mohan March 16, 1994\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n------------------\n----------------------------\nF O R M 10-K\nFINANCIAL STATEMENTS\nSUBMITTED IN RESPONSE TO ITEM 8\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage\nReport of Independent Public Accountants....\nConsolidated Statements of Income for the three years ended December 31, 1993........\nConsolidated Balance Sheets at December 31, 1993 and 1992.................\nConsolidated Statements of Cash Flows for the three years ended December 31, 1993....\nConsolidated Statements of Stockholder's Equity and Retained Income for the three years ended December 31, 1993..............\nNotes to Consolidated Financial Statements for the three years ended December 31, 1993.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Illinois Central Railroad Company:\nWe have audited the accompanying consolidated balance sheets of Illinois Central Railroad Company (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, cash flows and stockholder's equity and retained income for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Illinois Central Railroad Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 9 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement health care and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index to financial statement schedules herein are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nChicago, Illinois January 19, 1994\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Statements of Income ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Balance Sheets ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nConsolidated Statements of Stockholder's Equity\nThe following notes are an integral part of the consolidated financial statements.\n1. THE RAILROAD\nIllinois Central Corporation, a holding company, (hereinafter, \"IC\") was formed originally for the purpose of acquiring, through a wholly-owned subsidiary, the outstanding common stock of Illinois Central Transportation Company (\"ICTC\"). Following a tender offer and several mergers, the Illinois Central Railroad Company (\"Railroad\") is the surviving corporation and the successor to ICTC and now a wholly-owned subsidiary of the IC.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Railroad and its subsidiaries. Significant investments in affiliated companies are accounted for by the equity method. Transactions between consolidated companies have been eliminated in the accompanying consolidated financial statements.\nPROPERTIES\nDepreciation is computed by the straight-line method and includes depreciation on properties under capital leases. Depreciation for track structure, other road property, and equipment is calculated using the composite method. In the case of routine retirements, removal cost less salvage recovery is charged to accumulated depreciation. Expenditures for maintenance and repairs are charged to operating expense.\nThe Interstate Commerce Commission (\"ICC\") approves the depreciation rates used by the Railroad. In 1991, the Railroad completed a study which resulted in revised depreciation rates for road properties (excluding track properties) and equipment. The revised rates did not and will not have a significant effect on operating results. The approximate ranges of annual depreciation rates for major property classifications are as follows:\nRoad properties .................1% - 8% Transportation equipment ........1% - 7%\nIn 1989, the Railroad initiated a program to convert approximately 500 miles of double track main line to a single track main line, with a centralized traffic control system. This program was completed successfully in 1991.\nREVENUES\nRevenues are recognized based on services performed and include estimated amounts relating to movements in progress for which the settlement process is not complete. Estimated revenue amounts for movements in progress are not significant.\nINCOME TAXES\nEffective January 1, 1992, the Railroad adopted the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). Under SFAS No. 109, deferred income taxes are accounted for on the asset and liability method by applying enacted statutory tax rates to differences (\"temporary differences\") between the financial statement carrying amounts and the tax bases of assets and liabilities. The resulting deferred tax assets and liabilities represent taxes to be collected or paid in the future when the related assets and liabilities are recovered and settled, respectively. See Note 10 for discussion of the 1992 impact of adopting SFAS No. 109.\nCASH AND TEMPORARY CASH INVESTMENTS\nCash in excess of operating requirements is invested in certain funds having original maturities of three months or less. These investments are stated at cost, which approximates market value.\nINCOME PER SHARE\nIncome per share has been omitted as the Railroad is a wholly-owned subsidiary of IC.\nFUTURES, OPTIONS, CAPS, FLOORS AND FORWARD CONTRACTS\nIn March 1990, the FASB issued Statement of Financial Accounting Standards No. 105 \"Disclosure of Information about Financial Instruments with Off Balance Sheet Risk and Financial Instruments with Concentration of Credit Risk\" (\"SFAS 105\"). Disclosures required by SFAS 105 are found in various notes where the financial instruments or related risks are discussed. See specifically Notes 6, 7, 8, and 12.\nCASUALTY AND FREIGHT CLAIMS\nThe Railroad accrues for injury and damage claims outstanding based on actual claims filed and estimates of claims incurred but not filed. Estimated amounts expected to be settled within one year are classified as current liabilities in the accompanying Consolidated Balance Sheets.\nEMPLOYEE BENEFIT PLANS\nAll employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contribution costs of the plan are funded currently.\nMr. E. L. Moyers, former Chairman, President and Chief Executive Officer (\"Mr. Moyers\") is covered by a supplemental plan which is discussed in Note 9.\nEffective January 1, 1993, the Railroad adopted both the Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\") and the Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"). SFAS No. 106 requires that future costs associated with providing postretirement benefits be recognized as expense over the employees' requisite service period. The pay-as-you-go method used prior to 1993 recognized the expense on a cash basis. SFAS No. 112 establishes accounting standards for employers who provide postemployment benefits and clarifies when the expense is to be recognized. In accordance with the provisions of these standards, years prior to 1993 have not been restated. See Note 9 for discussion of the impact of adopting SFAS No. 106 and SFAS No. 112.\nRECLASSIFICATIONS\nCertain items relating to prior years have been reclassified to conform to the presentation in the current year.\n3. EXTRAORDINARY ITEM AND REFINANCING\nThe 1993 extraordinary loss resulted from the retirement of the Railroad's 14-1\/8% Senior Subordinated Debentures (the \"Debentures\") and refinancing the Permanent Facility. The loss was $23.4 million, net of tax benefits of $12.6 million. The loss resulted from the premium paid, the write-off of unamortized financing fees and debt discount and costs associated with the calling of the $10.3 million of Debentures not tendered. The net proceeds of the 6.75% Notes (see Note 8), borrowings under the $180 million Revolving Credit Facility and other available cash were used to fund the retirement of the Debentures.\n4. OTHER INCOME, NET\nOther Income, Net consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991 ---- ---- ---- Rental income, net...... $ 3.9 $ 3.8 $ 3.0 Net gains on real estate sales.................. .8 .4 .7 Net gain (loss) on disposal of rolling stock....... (2.3) - - Equity in undistributed earnings of affiliates. .5 .3 .4 Net gain on Series K.... - - 3.6 Other, net.............. (.1) (.9) (.7) ------ ------ ------ Other Income, Net..... $ 2.8 $ 3.6 $ 7.0\n5. SUPPLEMENTAL CASH FLOW INFORMATION\nCash changes in components of working capital, exclusive of Current Maturities of Long-Term Debt, included in the Consolidated Statements of Cash Flows were as follows ($ in millions):\nIncluded in changes in Other Liabilities and Reserves is approximately $6.3 million and $23.4 million for the years ended December 31, 1993 and 1992, respectively, reflecting proceeds from the settlement of casualty claims with numerous insurance carriers.\nIn 1993, the Railroad entered into a capital lease for 200 covered hoppers. The lease expires in 2003. See Note 7 for a recap of the present value of the minimum lease payments.\nIn 1991, the Railroad retired several Long-Term Debt obligations, most significantly its $150 million 15.5% Series K First Mortgage Bonds (\"Series K\"). These retirements resulted in non-cash reductions of debt balances of $4.6 million. Also, in 1991 the balance of a long term investment was reduced by $2.5 million.\n6. MATERIALS AND SUPPLIES\nMaterials and Supplies, valued using the average cost method, consist of track material, switches, car and locomotive parts and fuel. The Railroad entered into various hedge agreements designed to mitigate significant changes in fuel prices. As a result, approximately 93% of the short-term diesel fuel requirements through March 1995 and 46% through June 1995 are protected against significant price changes based on the average near-by contract for Heating Oil #2 traded on the New York Mercantile Exchange.\n7. LEASES\nAs of December 31, 1993, the Railroad leased 6,709 of its cars and 227 of its locomotives. The majority of these leases have original terms of 15 years and expire between 1994 and 2001. Under the terms of the majority of its leases, the Railroad has the right of first refusal to purchase, at the end of the lease terms, certain cars and locomotives at fair market value. Other leases include office and computer equipment, vehicles and office facilities.\nNet obligations under capital leases at December 31, 1993 and 1992, included in the Consolidated Balance Sheets are $5.4 million and $.2 million, respectively.\nAt December 31, 1993, minimum rental payments under capital and operating leases that have initial or remaining noncancellable terms in excess of one year were as follows ($ in millions):\nCapital Operating Leases Leases\n1994 ..................... $ .9 $ 34.6 1995 ..................... .9 28.4 1996 ..................... .8 19.3 1997 ..................... .8 7.8 1998 ..................... .8 4.2 Thereafter ............... 3.1 17.4 Total minimum lease ---- ------ payments............... 7.3 $111.7\nLess: Imputed interest ... 1.9 Present value of minimum ---- payments............... $5.4\nTotal rent expense applicable to noncancellable operating leases amounted to $48.2 million in 1993, $48.4 million for 1992 and $49.4 million for 1991. Most of the leases provide that the Railroad pay taxes, maintenance, insurance and certain other operating expenses.\n8. LONG-TERM DEBT AND INTEREST EXPENSE\nLong-Term Debt at December 31, consisted of the following ($ in millions):\nAt December 31, 1993, the aggregate annual maturities and sinking fund requirements for debt payments for 1994 through 1999 and thereafter are $1.1 million, $.8 million, $78.9 million, $.9 million, $55.6 million, $55.6 million and $155.5 million, respectively. The weighted-average interest rate for 1993 and 1992 on total debt excluding the effect of discounts, premiums and related amortization was 9.1% and 10.8%, respectively.\nIn November 1993, the Railroad initiated a public commercial paper program. The commercial paper is rated A2 by S&P, by Fitch and P3 by Moody's and is supported by a new $100 million Revolver with the Railroad's bank lending group. The Railroad views this program as a significant long-term funding source and intends to issue replacement notes as maturities occur. Therefore, the $38.1 million outstanding at December 31, 1993 has been classified as long-term.\nIn connection with the commercial paper program, the bank lending group agreed to replace the $180 million Revolving Credit Facility (see below) with (i) a new $100 million Revolver, due 1996 and (ii) a $50 million 364-day facility due October 1994 (\"Bank Line\"). The new Revolver will be used primarily for backup for the commercial paper but can be used for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. The $100 million was limited to $57.9 million because $38.1 million in commercial paper was outstanding and $4.0 million in letters of credit had been issued. The Bank Line was structured as a 364-day renewable instrument and the Railroad intends to renew it on an on- going basis. The $40 million outstanding at December 31, 1993, has therefore been classified as long-term.\nDuring April 1993, IC and the Railroad reached an agreement with its bank lending group and the holders of the privately placed $160 million Senior Secured Notes (\"Senior Notes\") for a release of all collateral and those instruments are now unsecured. The bank agreed to replace the Permanent Facility with a $180 million Revolving Credit Facility. This was done in connection with the tender offer made by the Railroad for all of the Debentures.\nThe tender offer was funded by issuance of new $100 million 6.75% Notes, due 2003 (the \"Notes\"), borrowing under a $180 million Revolving Credit Facility negotiated with the banks which replaced the Permanent Facility and cash on hand. See Note 3 for discussion of the extraordinary loss incurred upon tender for the Debentures. The Railroad irrevocably placed $12.6 million on deposit with a trustee to cover principal, a 6% premium and interest through the first call date of October 1, 1994, for the untendered Debentures.\nThe Notes (issued at a slight discount 1.071%) pay interest semiannually in May and November and are covered by an Indenture. Of the Senior Notes, $109.8 million bears interest at a rate of 10.02% and $50 million at 10.4%. Principal payments of $55 million are due in each of 1998 and 1999, and $25 million in each of 2000 and 2001. The Senior Notes are governed by a Note Purchase Agreement.\nVarious borrowings of the Railroad are governed by agreements which contain certain affirmative and negative covenants customary for facilities of this nature including restrictions on additional indebtedness, investments, guarantees, liens, distributions, sales and leasebacks, and sales of assets and capital stock. Some also require the Railroad to satisfy certain financial tests, including a leverage ratio, an earnings before interest and taxes to interest charges ratio, debt service coverage, and minimum consolidated tangible net worth requirements. The Railroad may be required to apply 100% of net after-tax proceeds of sales aggregating $2.5 million or greater of certain assets to reduce Revolver commitments. The holders of the Senior Notes can elect to receive a pro-rata share of after-tax proceeds.\nInterest Expense, Net consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991 Interest expense ..... $33.8 $45.1 $59.7 Less: Interest capitalized..... .8 .6 .4 Interest income....... 1.2 1.6 3.2 ----- ----- ----- Interest Expense, Net. $31.8 $42.9 $56.1\n9. EMPLOYEE BENEFIT PLANS\nRetirement Plans. All employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contributions under the plan vest immediately. Expenses relating to the defined contribution plan were $.4 million for each of the years ended December 31, 1993, 1992 and 1991.\nMr. Moyers is covered by a non-qualified, unfunded supplemental retirement benefit agreement which provides for a defined benefit payable annually, commencing upon death, permanent disability or retirement (with benefits arising from retirement commencing upon his attaining age 65 and compliance with certain non-competition agreements), in the amount of $250,000 per year for a maximum of 15 years. In accordance with the term of the agreement, no payments will be made while Mr. Moyers is employed by another Class I railroad. The present value of this agreement was included in the 1992 special charge. See Note 14.\nPostretirement Plans. In addition to the Railroad's defined contribution plan for management employees, the Railroad has three benefit plans which provide some postretirement benefits to most former full-time salaried employees and selected former union represented employees. The medical plan for salaried retirees is contributory, with retiree contributions adjusted annually if expected inflation rate exceeds 9.5%, and contains other cost sharing features such as deductibles and co-payments. The Railroad's contribution will be fixed at the 1999 year end rate for all subsequent years. Salaried retirees are covered by a life insurance plan which provides a nominal death benefit and is non- contributory. The medical plan for locomotive engineers who retired under a special early retirement program in 1987 provides non-contributory coverage until age 65. All benefits under this plan terminate in 1998.\nThere are no plan assets and the Railroad will continue to fund these benefits as claims are paid as was done in prior years.\nPostemployment Benefit Plans. The Railroad provides certain postemployment benefits such as long-term salary continuation and waiver of medical and life insurance co- payments while on long-term disability.\nSFAS No. 106 and SFAS No.112. As described in Note 2 effective January 1, 1993 the Railroad adopted SFAS No. 106 and SFAS No. 112. With respect to SFAS No. 106, the Railroad elected to immediately recognize the transition asset associated with adoption which resulted because the Railroad had previously recorded an amount under purchase accounting to reflect the estimated liability for such benefits as of the acquisition date of ICTC.\nAs a result of adopting these two standards, the Railroad recorded a decrease to net income of $84,000 (net of taxes of $46,000) as a cumulative effect of changes in accounting principles ($ in millions):\nPostretirement Benefits (SFAS No. 106): APBO at January 1, 1993: Medical.................... $36.5 Life....................... 2.3 Total APB........... 38.8 Liability previously recorded (40.3) Transition Asset....... 1.5 Postemployment Benefits Obligation at January 1, 1993 (SFAS 112) (1.6) Pre-tax Cumulative Effect of Changes in Accounting Principles..... (.1) Related tax benefit............... - ----- Cumulative Effect of Changes in Accounting Principles..... $ (.1)\nPer Share Impact.................. $ -\nIn accordance with each standard, years prior to 1993 have not been restated. For 1993, the adoption of these two standards had no significant effect on income before cumulative effect of changes in accounting principles as compared to the Railroad's prior pay-as- you-go method of accounting for such benefits.\nThe accumulated postretirement benefit obligations (\"APBO\") of the postretirement plans were as follows ($ in millions):\nJanuary December 31, 1993 1, 1993 Medical Life Total Total ------- ---- ----- ------- Accumulated post- retirement benefit obligation: Retirees......... $26.4 $ 2.4 $28.8 $33.4 Fully eligible active plan participants.... .7 - .7 .7 Other active plan participants.... 4.7 - 4.7 4.7 ----- ----- ----- ----- Total APBO... $31.8 $ 2.4 34.2 38.8\nUnrecognized net gain 5.0 - ----- ----- Accrued liability for postretirement benefits $39.2 $38.8\nThe weighted-average discount rate used in determining the accumulated post-retirement benefit obligation was 8.0% at January 1, 1993. As a result of the Railroad's improved financial condition and recognizing the overall shift in the financial community, the Railroad lowered the weighted-average discount rate to 7.25% as of December 31, 1993. The change in rates resulted in approximately $2.0 million actuarial loss. The loss was offset by actual experience gains, primarily fewer claims and lower medical rate inflation, which resulted in a $5.0 million unrecognized net gain as of December 31, 1993.\nThe components of the net periodic postretirement benefits cost for 1993 were as follows ($ in millions):\nService costs............................. $ .1 Interest costs............................ 3.0 Net amortization of Corridor excess....... - Net periodic postretirement ----- benefit costs........................... $ 3.1\nThe weighted-average annual assumed rate of increase in the per capital cost of covered benefits (e.g., health care cost trend rate) for the medical plans is 14.0% for 1993 and is assumed to decrease gradually to 6.25% by 2001 and remain at that level thereafter. The health care cost trend rate assumption normally has a significant effect on the amounts reported; however, as discussed, the plan limits annual inflation for the Railroad's portion of such costs to 9.5% each year. Therefore, an increase in the assumed health care cost trend rates by one percentage point in each year would have no impact on the Railroad's accumulated postretirement benefit obligation for the medical plans as of December 31, 1993, or the aggregate of the service and interest cost components of net periodic postretirement benefit expense in future years.\n10. PROVISION FOR INCOME TAXES\nEffective January 1, 1992, the Railroad adopted the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). As a result, the Railroad recorded a $23.7 million reduction in its accrued net deferred income tax liability as of January 1, 1992. The gain recorded upon adoption could not be recognized previously in accordance with SFAS No. 96 which the Railroad had adopted in 1988.\nThe Railroad elected to report this change as the cumulative effect of a change of accounting principle. Therefore, prior year amounts were not restated.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993, which contains a deficit reduction package, became law. Certain aspects of the Act directly affect the Railroad. Most significantly, the new law increased the maximum corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. This change required the Railroad to record additional deferred income tax expense of approximately $3.1 million to reflect the new tax rate's impact on net deferred income tax liability as of January 1, 1993. The higher corporate rate is not anticipated to significantly affect the Railroad's cash flow.\nThe Provision for Income Taxes for continuing operations consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991\nCurrent income tax: Federal............ $23.8 $15.4 $ 9.4 State.............. .9 1.6 1.0 Deferred income taxes 31.9 20.7 20.3 Provision for Income ----- ----- ----- Taxes.............. $56.6 $37.7 $30.7\nThe effective income tax rates for the years ended December 31, 1993, 1992 and 1991, were 38%, 34% and 32%, respectively. See Note 3 for the tax benefits associated with the extraordinary loss.\nThe items which gave rise to differences between the income taxes provided for continuing operations in the Consolidated Statements of Income and the income taxes computed at the statutory rate are summarized below ($ in millions):\nTemporary differences between book and tax income arise because the tax effects of transactions are recorded in the year in which they enter into the determination of taxable income. As a result, the book provisions for taxes differ from the actual taxes reported on the income tax returns. The net results of such differences are included in Deferred Income Taxes in the Consolidated Balance Sheets. The Railroad has an Alternative Minimum Tax (\"AMT\") carryforward credit of $.1 million at December 31, 1993. This excess of AMT over regular tax can be carried forward indefinitely to reduce future U.S. Federal income tax liabilities. At December 31, 1993, this credit was used to reduce the recorded deferred tax liability.\nAt December 31, 1993, the Railroad, for tax or financial statement reporting purposes, had no net operating loss carryovers.\nDeferred Income Taxes consisted of the following ($ in millions):\nDecember 31, 1993 1992\nDeferred tax assets.......... $ 82.2 $ 114.4\nLess: Valuation allowance.... (2.2) (3.3) -------- -------- Deferred tax assets, net of valuation allowance. 80.0 111.1\nDeferred tax liabilities...... (257.8) (257.1) -------- -------- Deferred Income Taxes......... $ (177.8 $ (146.0)\nThe valuation allowance is comprised of the portion of state tax net operating loss carryforwards expected to expire before they are utilized and non-deductible expenses incurred with the previous merger of wholly- owned subsidiaries.\nMajor types of deferred tax assets are: reserves not yet deducted for tax purposes ($64.0 million) and safe harbor leases ($11.8 million). Major types of deferred tax liabilities are: accelerated depreciation ($203.5 million), land basis differences ($10.3 million) and debt marked to market ($2.1 million).\nIC and the Railroad have a tax sharing agreement whereby the Railroad's federal tax liability and combined state tax liabilities (if any) are the lesser of (i) the Railroad's separate consolidated liability as if it were not a member of IC's consolidated group or (ii) IC's consolidated liability computed without regard to any other subsidiaries of the IC.\n11. EQUITY AND RESTRICTIONS ON DIVIDENDS\nCertain covenants of the Railroad's debt restrict the level of dividends it may pay to IC. At December 31, 1993, approximately $76 million was free of such restrictions. The Railroad was able to pay dividends of $27.4 million and $6.4 million in 1993 and 1992, respectively. In November 1993, the Railroad declared a $15.0 million dividend which was paid in January 1994.\nIn 1993 and 1992, IC made capital contributions of $2.8 million and $3.6 million respectively, to the Railroad which was equivalent to the vested portion of the restricted IC Common Stock granted to various Railroad employees, including Mr. Moyers, in accordance with an IC benefit plan. Such restricted stock vests in equal installments through May 1, 1996. In 1991, IC made a $50 million capital contribution from proceeds of a $63 million public Common Stock offering.\n12. CONTINGENCIES, COMMITMENTS AND CONCENTRATION OF RISKS\nThe Railroad is self-insured for the first $5 million of each loss. The Railroad carries $295 million of liability insurance per occurrence, subject to an annual cap of $370 million in the aggregate for all losses. This coverage is considered by the Railroad's management to be adequate in light of the Railroad's safety record and claims experience.\nAs of December 31, 1993, the Railroad had $4.0 million of letters of credit outstanding as collateral primarily for surety bonds executed on behalf of the Railroad. Such letters of credit expire in 1994 and are automatically renewable for one year. The letters of credit reduced the maximum amount that could be borrowed under the Revolver (see Note 8).\nThe Railroad has guaranteed repayment of certain indebtedness of a jointly owned company aggregating $7.8 million. The Railroad's primary share is $1.0 million; the remainder is a primary obligation of other unrelated owner companies.\nThere are various regulatory proceedings, claims and litigation pending against the Railroad. While the ultimate amount of liability that may result cannot be determined, in the opinion of the Railroad's management, based on present information, adequate provisions for liabilities have been recorded. See \"Management's Discussion and Analysis - Other\" for a discussion of environmental matters.\n13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and temporary cash investments. The carrying amount approximates fair value because of the short maturity of those instruments.\nInvestments. The Railroad has investments of $9.1 million in 1993 and $11.1 million in 1992 for which there are no quoted market prices. These investments are in joint railroad facilities, railroad terminal associations, switching railroads and other transportation companies. For these investments, the carrying amount is a reasonable estimate of fair value. The Railroad's remaining investments ($5.4 million in 1993 and $3.9 million in 1992) are accounted for by the equity method.\nLong-term debt. The fair value of the Railroad's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Railroad for debt of the same remaining maturities.\nFuel hedge agreements. The fair value of fuel hedging agreements is the estimated amount that the Railroad would receive or pay to terminate the agreements as of year end, taking into account the current credit worthiness of the agreement counterparties. At December 31, 1993 and 1992, the fair value was a liability of $4.6 million and less than $.1 million, respectively.\nThe estimated fair values of the Railroad's financial instruments at December 31, are as follows ($ in millions):\n1993 1992 Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- ------- -----\nCash and temporary cash Investments... $ 8.1 $ 8.1 $ 25.6 $ 25.6 Investments......... 9.1 9.1 11.1 11.1 Debt................ (348.4) (368.9) (368.8) (418.2)\n14. SPECIAL CHARGE\nIn 1992, the Railroad recorded a pretax special charge of $8.9 million as part of operating expense. The special charge reduced Net Income by $5.9 million.\nThe special charge consisted of $7 million for various costs associated with the retirement of Mr. Moyers and the related organizational changes. The costs associated with Mr. Moyers' retirement include the present value of his pension, accelerated vesting of a portion of his restricted stock award and certain costs of a non-competition agreement. The remaining $1.9 million was for the disposition costs of railcars and a building and its adjacent land.\n- ----------------\n(a) Includes the special charge recorded in the fourth quarter of 1992, see Note 14.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n-----------------\n---------------------------\nF O R M 10-K\nFINANCIAL STATEMENT SCHEDULES\nSUBMITTED IN RESPONSE TO ITEM 14(a)\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n-------------- --------------\nI N D E X\nT O FINANCIAL STATEMENT SCHEDULES SUBMITTED IN RESPONSE TO ITEM 14(a)\nSchedules for the three years ended December 31, 1993:\nV-Property, plant and equipment..........\nVI-Accumulated depreciation and amortization of property, plant and equipment.......\nVII-Guarantees of securities of other issuers\nVIII-Valuation and qualifying accounts......\nPursuant to Rule 5.04 of General Rules of Regulation S-X, all other schedules are omitted because they are not required or because the required information is set forth in the financial statements or related notes thereto.\n(1) Reclassification of properties from \"Other Assets.\" (2) Reclassification of properties from \"Assets Held For Disposition.\"\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nSCHEDULE VII--GUARANTEES OF SECURITIES OF OTHER ISSUERS\nAS OF DECEMBER 31, 1993, 1992 AND 1991 ($ IN MILLIONS)\nColumn A Column B Column C Column D - -------- -------- -------- --------\nName of Title of Issue Total Amount Issuer of of Class of Guaranteed Nature of Securities Securities and Guarantee Guaranteed Guaranteed Outstanding by Person for Which Statement is Filed\nTerminal Refunding and Railroad Improvement Association Mortgage 4% Principal of St. Bonds, Series and Louis \"C\", due annual 7\/1\/2019 $7.8 interest\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n3.1 Articles of Incorporation of Illinois Central Railroad, as amended. (Incorporated by reference to Exhibit 3.1 to the Registration Statement of Illinois Central Railroad on Form S-1. (SEC File No. 33- 29269))\n3.2 By-Laws of Illinois Central Railroad, as amended. (Incorporated by reference to Exhibit 3.2 to the Registration Statement of Illinois Central Railroad on Form S-1. (SEC File No. 33-29269))\n4.1 Form of 14-1\/8% Senior Subordinated Debenture Indenture dated as of September 15, 1989 (the \"Senior Subordinated Debenture Indenture\") between Illinois Central Railroad and United States Trust Railroad of New York, Trustee (including the form of 14-1\/8% Senior Subordinated Debenture included as Exhibit A therein). (Incorporated by reference to Exhibit 4.1 to the Registration Statement of Illinois Central Railroad on Form S-1, as amended. (SEC File No. 33- 29269))\n4.2 Form of the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad and the Banks named therein (including the Form of the Restated Revolving Credit Note, the Form of the Restated Term Note, the Form of the Intercreditor Agreement, the Form of the Security Agreement Amendment No. 1 dated as of February 28, 1992, to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Annual Report on Form 10-K for the year ended December 31, 1991, for the Illinois Central Railroad filed March 12, 1992. (SEC File No. 1-7092))\n4.4 Form of Guaranty dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1- 10720))\n- ------------------\n* Used herein to identify management contracts or compensation plans or arrangements as required by Item 14 of Form 10-K.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n4.5 Form of Pledge Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad and the Banks named therein and the Senior Note Purchasers that are parties to the Note Purchase Agreement dated as of July 23, 1991. (Incorporated by reference to Exhibit 4.4 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))\n4.6 Form Supplemental Indenture dated July 23, 1991, between Illinois Central Railroad and Morgan Guaranty Trust Railroad of New York relating to First Mortgage Adjustable Rate Bonds,Series M. (Incorporated by reference to Exhibit 4.2 to the Quarterly Report of Illinois Central Railroad on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))\n4.7 Form of Note Purchase Agreement dated as of July 23, 1991, among Illinois Central Railroad, as issuer, and Illinois Central Railroad Company, as guarantor, for 10.02% Guaranteed Senior Secured Series A Notes due 1999 and for 10.4% Guaranteed Senior Secured Series B Notes due 2001 (including the Form of Series A Note and Series B Note included as Exhibits A-1 and A-2, respectively, therein). (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of the Illinois Central Railroad on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1- 7092))\n4.8 Form of the Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of the Competitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept\/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein).\n4.9 Form of the Amended and Restated Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of theCompetitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept\/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein).\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n4.10 Form of Commercial Paper Dealer Agreement between Illinois Central Railroad Company and Lehman Commercial Paper, Inc. dated as of November 19, 1993.\n4.11 Form of Issuing and Paying Agency Agreement of the Illinois Central Railroad Company related to the Commercial Paper Program between Illinois Central Railroad Company and Bank America National Trust Company dated as of November 19, 1993, (including Exhibit A the Form of Certificated Commercial Paper Note included therein).\n10.1* Form of supplemental retirement and savings plan. (Incorporated by reference to Exhibit 10C to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))\n10.2 * Form of management incentive compensation plan. (Incorporated by reference to Exhibit 10D to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))\n10.3 Consolidated Mortgage dated November 1, 1949 between Illinois Central Railroad and Guaranty Trust Railroad of New York, Trustee, as amended. (Incorporated by reference to Exhibit 10.8 to the Registration Statement of Illinois Central Railroad on Form S-1, as amended. (SEC File No. 33-29269))\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n10.4 Form of indemnification agreement dated as of January 29, 1991, between Illinois Central Railroad Company and certain officers and directors. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1990, for the Illinois Central Railroad Company filed on April 1, 1991. (SEC File No. 1- 10720))\n10.5 Railroad Locomotive Lease Agreement between IC Leasing Corporation I and Illinois Central Railroad dated as of September 5, 1991. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1991 for the Illinois Central Railroad filed March 12, 1992. (SEC File No. 1-7092))\n10.6 Railroad Locomotive Lease Agreement between IC Leasing Corporation II and Illinois Central Railroad dated as of January 14, 1993. (Incorporated by reference to Exhibit 10.6 to the Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Railroad filed March 5, 1993. (SEC File No. 1-7092))\n21 Subsidiaries of Registrant (Included at E-5) (A) Included herein but not reproduced.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements:\nSee Index to Consolidated Financial Statements on page 27 of this Report.\n2. Financial Statement Schedules:\nSee Index to Financial Statement Schedules on page of this Report.\n3. Exhibits:\nSee items marked with \"*\" on the Exhibit Index beginning on page E-1 of this Report. Items so marked identify management contracts or compensatory plans or arrangements as required by Item 14.\n(b) 1. Reports on Form 8-K:\nDuring the fourth quarter of 1993 the Registrant filed with the Securities and Exchange Commission the following reports on Form 8-K on the dates indicated to report the events described:\nNONE\n(c) Exhibits:\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Exhibit Index beginning on page E-1.\n(d) Financial Statement Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this Report.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, there unto duly authorized.\nIllinois Central Railroad Company\nBy: \/s\/ DALE W. PHILLIPS Dale W. Phillips Vice President and Chief Financial Officer Date: March 16, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated.\nSIGNATURE Title(s) Date\n\/s\/ GILBERT H. LAMPHERE Chairman of the Gilbert H. Lamphere Board and Director March 16, 1994\n\/s\/ E. HUNTER HARRISON President and Chief E. Hunter Harrison Executive Officer (principal executive officer), Director March 16, 1994\n\/s\/ DALE W. PHILLIPS Vice President Dale W. Phillips and Chief Financial Officer (principal financial officer) March 16, 1994\n\/s\/ JOHN V. MULVANEY Controller John V. Mulvaney (principal accounting officer) March 16, 1994\n\/s\/ RONALD A. LANE Director Ronald A. Lane March 16, 1994\n\/s\/ GERALD F. MOHAN Director Gerald F. Mohan March 16, 1994\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n------------------\n----------------------------\nF O R M 10-K\nFINANCIAL STATEMENTS\nSUBMITTED IN RESPONSE TO ITEM 8\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage\nReport of Independent Public Accountants....\nConsolidated Statements of Income for the three years ended December 31, 1993........\nConsolidated Balance Sheets at December 31, 1993 and 1992.................\nConsolidated Statements of Cash Flows for the three years ended December 31, 1993....\nConsolidated Statements of Stockholder's Equity and Retained Income for the three years ended December 31, 1993..............\nNotes to Consolidated Financial Statements for the three years ended December 31, 1993.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Illinois Central Railroad Company:\nWe have audited the accompanying consolidated balance sheets of Illinois Central Railroad Company (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, cash flows and stockholder's equity and retained income for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Illinois Central Railroad Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 9 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement health care and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index to financial statement schedules herein are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nChicago, Illinois January 19, 1994\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Statements of Income ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Balance Sheets ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows ($ in millions)\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nConsolidated Statements of Stockholder's Equity\nThe following notes are an integral part of the consolidated financial statements.\n1. THE RAILROAD\nIllinois Central Corporation, a holding company, (hereinafter, \"IC\") was formed originally for the purpose of acquiring, through a wholly-owned subsidiary, the outstanding common stock of Illinois Central Transportation Company (\"ICTC\"). Following a tender offer and several mergers, the Illinois Central Railroad Company (\"Railroad\") is the surviving corporation and the successor to ICTC and now a wholly-owned subsidiary of the IC.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Railroad and its subsidiaries. Significant investments in affiliated companies are accounted for by the equity method. Transactions between consolidated companies have been eliminated in the accompanying consolidated financial statements.\nPROPERTIES\nDepreciation is computed by the straight-line method and includes depreciation on properties under capital leases. Depreciation for track structure, other road property, and equipment is calculated using the composite method. In the case of routine retirements, removal cost less salvage recovery is charged to accumulated depreciation. Expenditures for maintenance and repairs are charged to operating expense.\nThe Interstate Commerce Commission (\"ICC\") approves the depreciation rates used by the Railroad. In 1991, the Railroad completed a study which resulted in revised depreciation rates for road properties (excluding track properties) and equipment. The revised rates did not and will not have a significant effect on operating results. The approximate ranges of annual depreciation rates for major property classifications are as follows:\nRoad properties .................1% - 8% Transportation equipment ........1% - 7%\nIn 1989, the Railroad initiated a program to convert approximately 500 miles of double track main line to a single track main line, with a centralized traffic control system. This program was completed successfully in 1991.\nREVENUES\nRevenues are recognized based on services performed and include estimated amounts relating to movements in progress for which the settlement process is not complete. Estimated revenue amounts for movements in progress are not significant.\nINCOME TAXES\nEffective January 1, 1992, the Railroad adopted the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). Under SFAS No. 109, deferred income taxes are accounted for on the asset and liability method by applying enacted statutory tax rates to differences (\"temporary differences\") between the financial statement carrying amounts and the tax bases of assets and liabilities. The resulting deferred tax assets and liabilities represent taxes to be collected or paid in the future when the related assets and liabilities are recovered and settled, respectively. See Note 10 for discussion of the 1992 impact of adopting SFAS No. 109.\nCASH AND TEMPORARY CASH INVESTMENTS\nCash in excess of operating requirements is invested in certain funds having original maturities of three months or less. These investments are stated at cost, which approximates market value.\nINCOME PER SHARE\nIncome per share has been omitted as the Railroad is a wholly-owned subsidiary of IC.\nFUTURES, OPTIONS, CAPS, FLOORS AND FORWARD CONTRACTS\nIn March 1990, the FASB issued Statement of Financial Accounting Standards No. 105 \"Disclosure of Information about Financial Instruments with Off Balance Sheet Risk and Financial Instruments with Concentration of Credit Risk\" (\"SFAS 105\"). Disclosures required by SFAS 105 are found in various notes where the financial instruments or related risks are discussed. See specifically Notes 6, 7, 8, and 12.\nCASUALTY AND FREIGHT CLAIMS\nThe Railroad accrues for injury and damage claims outstanding based on actual claims filed and estimates of claims incurred but not filed. Estimated amounts expected to be settled within one year are classified as current liabilities in the accompanying Consolidated Balance Sheets.\nEMPLOYEE BENEFIT PLANS\nAll employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contribution costs of the plan are funded currently.\nMr. E. L. Moyers, former Chairman, President and Chief Executive Officer (\"Mr. Moyers\") is covered by a supplemental plan which is discussed in Note 9.\nEffective January 1, 1993, the Railroad adopted both the Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\") and the Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"). SFAS No. 106 requires that future costs associated with providing postretirement benefits be recognized as expense over the employees' requisite service period. The pay-as-you-go method used prior to 1993 recognized the expense on a cash basis. SFAS No. 112 establishes accounting standards for employers who provide postemployment benefits and clarifies when the expense is to be recognized. In accordance with the provisions of these standards, years prior to 1993 have not been restated. See Note 9 for discussion of the impact of adopting SFAS No. 106 and SFAS No. 112.\nRECLASSIFICATIONS\nCertain items relating to prior years have been reclassified to conform to the presentation in the current year.\n3. EXTRAORDINARY ITEM AND REFINANCING\nThe 1993 extraordinary loss resulted from the retirement of the Railroad's 14-1\/8% Senior Subordinated Debentures (the \"Debentures\") and refinancing the Permanent Facility. The loss was $23.4 million, net of tax benefits of $12.6 million. The loss resulted from the premium paid, the write-off of unamortized financing fees and debt discount and costs associated with the calling of the $10.3 million of Debentures not tendered. The net proceeds of the 6.75% Notes (see Note 8), borrowings under the $180 million Revolving Credit Facility and other available cash were used to fund the retirement of the Debentures.\n4. OTHER INCOME, NET\nOther Income, Net consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991 ---- ---- ---- Rental income, net...... $ 3.9 $ 3.8 $ 3.0 Net gains on real estate sales.................. .8 .4 .7 Net gain (loss) on disposal of rolling stock....... (2.3) - - Equity in undistributed earnings of affiliates. .5 .3 .4 Net gain on Series K.... - - 3.6 Other, net.............. (.1) (.9) (.7) ------ ------ ------ Other Income, Net..... $ 2.8 $ 3.6 $ 7.0\n5. SUPPLEMENTAL CASH FLOW INFORMATION\nCash changes in components of working capital, exclusive of Current Maturities of Long-Term Debt, included in the Consolidated Statements of Cash Flows were as follows ($ in millions):\nIncluded in changes in Other Liabilities and Reserves is approximately $6.3 million and $23.4 million for the years ended December 31, 1993 and 1992, respectively, reflecting proceeds from the settlement of casualty claims with numerous insurance carriers.\nIn 1993, the Railroad entered into a capital lease for 200 covered hoppers. The lease expires in 2003. See Note 7 for a recap of the present value of the minimum lease payments.\nIn 1991, the Railroad retired several Long-Term Debt obligations, most significantly its $150 million 15.5% Series K First Mortgage Bonds (\"Series K\"). These retirements resulted in non-cash reductions of debt balances of $4.6 million. Also, in 1991 the balance of a long term investment was reduced by $2.5 million.\n6. MATERIALS AND SUPPLIES\nMaterials and Supplies, valued using the average cost method, consist of track material, switches, car and locomotive parts and fuel. The Railroad entered into various hedge agreements designed to mitigate significant changes in fuel prices. As a result, approximately 93% of the short-term diesel fuel requirements through March 1995 and 46% through June 1995 are protected against significant price changes based on the average near-by contract for Heating Oil #2 traded on the New York Mercantile Exchange.\n7. LEASES\nAs of December 31, 1993, the Railroad leased 6,709 of its cars and 227 of its locomotives. The majority of these leases have original terms of 15 years and expire between 1994 and 2001. Under the terms of the majority of its leases, the Railroad has the right of first refusal to purchase, at the end of the lease terms, certain cars and locomotives at fair market value. Other leases include office and computer equipment, vehicles and office facilities.\nNet obligations under capital leases at December 31, 1993 and 1992, included in the Consolidated Balance Sheets are $5.4 million and $.2 million, respectively.\nAt December 31, 1993, minimum rental payments under capital and operating leases that have initial or remaining noncancellable terms in excess of one year were as follows ($ in millions):\nCapital Operating Leases Leases\n1994 ..................... $ .9 $ 34.6 1995 ..................... .9 28.4 1996 ..................... .8 19.3 1997 ..................... .8 7.8 1998 ..................... .8 4.2 Thereafter ............... 3.1 17.4 Total minimum lease ---- ------ payments............... 7.3 $111.7\nLess: Imputed interest ... 1.9 Present value of minimum ---- payments............... $5.4\nTotal rent expense applicable to noncancellable operating leases amounted to $48.2 million in 1993, $48.4 million for 1992 and $49.4 million for 1991. Most of the leases provide that the Railroad pay taxes, maintenance, insurance and certain other operating expenses.\n8. LONG-TERM DEBT AND INTEREST EXPENSE\nLong-Term Debt at December 31, consisted of the following ($ in millions):\nAt December 31, 1993, the aggregate annual maturities and sinking fund requirements for debt payments for 1994 through 1999 and thereafter are $1.1 million, $.8 million, $78.9 million, $.9 million, $55.6 million, $55.6 million and $155.5 million, respectively. The weighted-average interest rate for 1993 and 1992 on total debt excluding the effect of discounts, premiums and related amortization was 9.1% and 10.8%, respectively.\nIn November 1993, the Railroad initiated a public commercial paper program. The commercial paper is rated A2 by S&P, by Fitch and P3 by Moody's and is supported by a new $100 million Revolver with the Railroad's bank lending group. The Railroad views this program as a significant long-term funding source and intends to issue replacement notes as maturities occur. Therefore, the $38.1 million outstanding at December 31, 1993 has been classified as long-term.\nIn connection with the commercial paper program, the bank lending group agreed to replace the $180 million Revolving Credit Facility (see below) with (i) a new $100 million Revolver, due 1996 and (ii) a $50 million 364-day facility due October 1994 (\"Bank Line\"). The new Revolver will be used primarily for backup for the commercial paper but can be used for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. The $100 million was limited to $57.9 million because $38.1 million in commercial paper was outstanding and $4.0 million in letters of credit had been issued. The Bank Line was structured as a 364-day renewable instrument and the Railroad intends to renew it on an on- going basis. The $40 million outstanding at December 31, 1993, has therefore been classified as long-term.\nDuring April 1993, IC and the Railroad reached an agreement with its bank lending group and the holders of the privately placed $160 million Senior Secured Notes (\"Senior Notes\") for a release of all collateral and those instruments are now unsecured. The bank agreed to replace the Permanent Facility with a $180 million Revolving Credit Facility. This was done in connection with the tender offer made by the Railroad for all of the Debentures.\nThe tender offer was funded by issuance of new $100 million 6.75% Notes, due 2003 (the \"Notes\"), borrowing under a $180 million Revolving Credit Facility negotiated with the banks which replaced the Permanent Facility and cash on hand. See Note 3 for discussion of the extraordinary loss incurred upon tender for the Debentures. The Railroad irrevocably placed $12.6 million on deposit with a trustee to cover principal, a 6% premium and interest through the first call date of October 1, 1994, for the untendered Debentures.\nThe Notes (issued at a slight discount 1.071%) pay interest semiannually in May and November and are covered by an Indenture. Of the Senior Notes, $109.8 million bears interest at a rate of 10.02% and $50 million at 10.4%. Principal payments of $55 million are due in each of 1998 and 1999, and $25 million in each of 2000 and 2001. The Senior Notes are governed by a Note Purchase Agreement.\nVarious borrowings of the Railroad are governed by agreements which contain certain affirmative and negative covenants customary for facilities of this nature including restrictions on additional indebtedness, investments, guarantees, liens, distributions, sales and leasebacks, and sales of assets and capital stock. Some also require the Railroad to satisfy certain financial tests, including a leverage ratio, an earnings before interest and taxes to interest charges ratio, debt service coverage, and minimum consolidated tangible net worth requirements. The Railroad may be required to apply 100% of net after-tax proceeds of sales aggregating $2.5 million or greater of certain assets to reduce Revolver commitments. The holders of the Senior Notes can elect to receive a pro-rata share of after-tax proceeds.\nInterest Expense, Net consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991 Interest expense ..... $33.8 $45.1 $59.7 Less: Interest capitalized..... .8 .6 .4 Interest income....... 1.2 1.6 3.2 ----- ----- ----- Interest Expense, Net. $31.8 $42.9 $56.1\n9. EMPLOYEE BENEFIT PLANS\nRetirement Plans. All employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contributions under the plan vest immediately. Expenses relating to the defined contribution plan were $.4 million for each of the years ended December 31, 1993, 1992 and 1991.\nMr. Moyers is covered by a non-qualified, unfunded supplemental retirement benefit agreement which provides for a defined benefit payable annually, commencing upon death, permanent disability or retirement (with benefits arising from retirement commencing upon his attaining age 65 and compliance with certain non-competition agreements), in the amount of $250,000 per year for a maximum of 15 years. In accordance with the term of the agreement, no payments will be made while Mr. Moyers is employed by another Class I railroad. The present value of this agreement was included in the 1992 special charge. See Note 14.\nPostretirement Plans. In addition to the Railroad's defined contribution plan for management employees, the Railroad has three benefit plans which provide some postretirement benefits to most former full-time salaried employees and selected former union represented employees. The medical plan for salaried retirees is contributory, with retiree contributions adjusted annually if expected inflation rate exceeds 9.5%, and contains other cost sharing features such as deductibles and co-payments. The Railroad's contribution will be fixed at the 1999 year end rate for all subsequent years. Salaried retirees are covered by a life insurance plan which provides a nominal death benefit and is non- contributory. The medical plan for locomotive engineers who retired under a special early retirement program in 1987 provides non-contributory coverage until age 65. All benefits under this plan terminate in 1998.\nThere are no plan assets and the Railroad will continue to fund these benefits as claims are paid as was done in prior years.\nPostemployment Benefit Plans. The Railroad provides certain postemployment benefits such as long-term salary continuation and waiver of medical and life insurance co- payments while on long-term disability.\nSFAS No. 106 and SFAS No.112. As described in Note 2 effective January 1, 1993 the Railroad adopted SFAS No. 106 and SFAS No. 112. With respect to SFAS No. 106, the Railroad elected to immediately recognize the transition asset associated with adoption which resulted because the Railroad had previously recorded an amount under purchase accounting to reflect the estimated liability for such benefits as of the acquisition date of ICTC.\nAs a result of adopting these two standards, the Railroad recorded a decrease to net income of $84,000 (net of taxes of $46,000) as a cumulative effect of changes in accounting principles ($ in millions):\nPostretirement Benefits (SFAS No. 106): APBO at January 1, 1993: Medical.................... $36.5 Life....................... 2.3 Total APB........... 38.8 Liability previously recorded (40.3) Transition Asset....... 1.5 Postemployment Benefits Obligation at January 1, 1993 (SFAS 112) (1.6) Pre-tax Cumulative Effect of Changes in Accounting Principles..... (.1) Related tax benefit............... - ----- Cumulative Effect of Changes in Accounting Principles..... $ (.1)\nPer Share Impact.................. $ -\nIn accordance with each standard, years prior to 1993 have not been restated. For 1993, the adoption of these two standards had no significant effect on income before cumulative effect of changes in accounting principles as compared to the Railroad's prior pay-as- you-go method of accounting for such benefits.\nThe accumulated postretirement benefit obligations (\"APBO\") of the postretirement plans were as follows ($ in millions):\nJanuary December 31, 1993 1, 1993 Medical Life Total Total ------- ---- ----- ------- Accumulated post- retirement benefit obligation: Retirees......... $26.4 $ 2.4 $28.8 $33.4 Fully eligible active plan participants.... .7 - .7 .7 Other active plan participants.... 4.7 - 4.7 4.7 ----- ----- ----- ----- Total APBO... $31.8 $ 2.4 34.2 38.8\nUnrecognized net gain 5.0 - ----- ----- Accrued liability for postretirement benefits $39.2 $38.8\nThe weighted-average discount rate used in determining the accumulated post-retirement benefit obligation was 8.0% at January 1, 1993. As a result of the Railroad's improved financial condition and recognizing the overall shift in the financial community, the Railroad lowered the weighted-average discount rate to 7.25% as of December 31, 1993. The change in rates resulted in approximately $2.0 million actuarial loss. The loss was offset by actual experience gains, primarily fewer claims and lower medical rate inflation, which resulted in a $5.0 million unrecognized net gain as of December 31, 1993.\nThe components of the net periodic postretirement benefits cost for 1993 were as follows ($ in millions):\nService costs............................. $ .1 Interest costs............................ 3.0 Net amortization of Corridor excess....... - Net periodic postretirement ----- benefit costs........................... $ 3.1\nThe weighted-average annual assumed rate of increase in the per capital cost of covered benefits (e.g., health care cost trend rate) for the medical plans is 14.0% for 1993 and is assumed to decrease gradually to 6.25% by 2001 and remain at that level thereafter. The health care cost trend rate assumption normally has a significant effect on the amounts reported; however, as discussed, the plan limits annual inflation for the Railroad's portion of such costs to 9.5% each year. Therefore, an increase in the assumed health care cost trend rates by one percentage point in each year would have no impact on the Railroad's accumulated postretirement benefit obligation for the medical plans as of December 31, 1993, or the aggregate of the service and interest cost components of net periodic postretirement benefit expense in future years.\n10. PROVISION FOR INCOME TAXES\nEffective January 1, 1992, the Railroad adopted the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). As a result, the Railroad recorded a $23.7 million reduction in its accrued net deferred income tax liability as of January 1, 1992. The gain recorded upon adoption could not be recognized previously in accordance with SFAS No. 96 which the Railroad had adopted in 1988.\nThe Railroad elected to report this change as the cumulative effect of a change of accounting principle. Therefore, prior year amounts were not restated.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993, which contains a deficit reduction package, became law. Certain aspects of the Act directly affect the Railroad. Most significantly, the new law increased the maximum corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. This change required the Railroad to record additional deferred income tax expense of approximately $3.1 million to reflect the new tax rate's impact on net deferred income tax liability as of January 1, 1993. The higher corporate rate is not anticipated to significantly affect the Railroad's cash flow.\nThe Provision for Income Taxes for continuing operations consisted of the following ($ in millions):\nYears Ended December 31, 1993 1992 1991\nCurrent income tax: Federal............ $23.8 $15.4 $ 9.4 State.............. .9 1.6 1.0 Deferred income taxes 31.9 20.7 20.3 Provision for Income ----- ----- ----- Taxes.............. $56.6 $37.7 $30.7\nThe effective income tax rates for the years ended December 31, 1993, 1992 and 1991, were 38%, 34% and 32%, respectively. See Note 3 for the tax benefits associated with the extraordinary loss.\nThe items which gave rise to differences between the income taxes provided for continuing operations in the Consolidated Statements of Income and the income taxes computed at the statutory rate are summarized below ($ in millions):\nTemporary differences between book and tax income arise because the tax effects of transactions are recorded in the year in which they enter into the determination of taxable income. As a result, the book provisions for taxes differ from the actual taxes reported on the income tax returns. The net results of such differences are included in Deferred Income Taxes in the Consolidated Balance Sheets. The Railroad has an Alternative Minimum Tax (\"AMT\") carryforward credit of $.1 million at December 31, 1993. This excess of AMT over regular tax can be carried forward indefinitely to reduce future U.S. Federal income tax liabilities. At December 31, 1993, this credit was used to reduce the recorded deferred tax liability.\nAt December 31, 1993, the Railroad, for tax or financial statement reporting purposes, had no net operating loss carryovers.\nDeferred Income Taxes consisted of the following ($ in millions):\nDecember 31, 1993 1992\nDeferred tax assets.......... $ 82.2 $ 114.4\nLess: Valuation allowance.... (2.2) (3.3) -------- -------- Deferred tax assets, net of valuation allowance. 80.0 111.1\nDeferred tax liabilities...... (257.8) (257.1) -------- -------- Deferred Income Taxes......... $ (177.8 $ (146.0)\nThe valuation allowance is comprised of the portion of state tax net operating loss carryforwards expected to expire before they are utilized and non-deductible expenses incurred with the previous merger of wholly- owned subsidiaries.\nMajor types of deferred tax assets are: reserves not yet deducted for tax purposes ($64.0 million) and safe harbor leases ($11.8 million). Major types of deferred tax liabilities are: accelerated depreciation ($203.5 million), land basis differences ($10.3 million) and debt marked to market ($2.1 million).\nIC and the Railroad have a tax sharing agreement whereby the Railroad's federal tax liability and combined state tax liabilities (if any) are the lesser of (i) the Railroad's separate consolidated liability as if it were not a member of IC's consolidated group or (ii) IC's consolidated liability computed without regard to any other subsidiaries of the IC.\n11. EQUITY AND RESTRICTIONS ON DIVIDENDS\nCertain covenants of the Railroad's debt restrict the level of dividends it may pay to IC. At December 31, 1993, approximately $76 million was free of such restrictions. The Railroad was able to pay dividends of $27.4 million and $6.4 million in 1993 and 1992, respectively. In November 1993, the Railroad declared a $15.0 million dividend which was paid in January 1994.\nIn 1993 and 1992, IC made capital contributions of $2.8 million and $3.6 million respectively, to the Railroad which was equivalent to the vested portion of the restricted IC Common Stock granted to various Railroad employees, including Mr. Moyers, in accordance with an IC benefit plan. Such restricted stock vests in equal installments through May 1, 1996. In 1991, IC made a $50 million capital contribution from proceeds of a $63 million public Common Stock offering.\n12. CONTINGENCIES, COMMITMENTS AND CONCENTRATION OF RISKS\nThe Railroad is self-insured for the first $5 million of each loss. The Railroad carries $295 million of liability insurance per occurrence, subject to an annual cap of $370 million in the aggregate for all losses. This coverage is considered by the Railroad's management to be adequate in light of the Railroad's safety record and claims experience.\nAs of December 31, 1993, the Railroad had $4.0 million of letters of credit outstanding as collateral primarily for surety bonds executed on behalf of the Railroad. Such letters of credit expire in 1994 and are automatically renewable for one year. The letters of credit reduced the maximum amount that could be borrowed under the Revolver (see Note 8).\nThe Railroad has guaranteed repayment of certain indebtedness of a jointly owned company aggregating $7.8 million. The Railroad's primary share is $1.0 million; the remainder is a primary obligation of other unrelated owner companies.\nThere are various regulatory proceedings, claims and litigation pending against the Railroad. While the ultimate amount of liability that may result cannot be determined, in the opinion of the Railroad's management, based on present information, adequate provisions for liabilities have been recorded. See \"Management's Discussion and Analysis - Other\" for a discussion of environmental matters.\n13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and temporary cash investments. The carrying amount approximates fair value because of the short maturity of those instruments.\nInvestments. The Railroad has investments of $9.1 million in 1993 and $11.1 million in 1992 for which there are no quoted market prices. These investments are in joint railroad facilities, railroad terminal associations, switching railroads and other transportation companies. For these investments, the carrying amount is a reasonable estimate of fair value. The Railroad's remaining investments ($5.4 million in 1993 and $3.9 million in 1992) are accounted for by the equity method.\nLong-term debt. The fair value of the Railroad's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Railroad for debt of the same remaining maturities.\nFuel hedge agreements. The fair value of fuel hedging agreements is the estimated amount that the Railroad would receive or pay to terminate the agreements as of year end, taking into account the current credit worthiness of the agreement counterparties. At December 31, 1993 and 1992, the fair value was a liability of $4.6 million and less than $.1 million, respectively.\nThe estimated fair values of the Railroad's financial instruments at December 31, are as follows ($ in millions):\n1993 1992 Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- ------- -----\nCash and temporary cash Investments... $ 8.1 $ 8.1 $ 25.6 $ 25.6 Investments......... 9.1 9.1 11.1 11.1 Debt................ (348.4) (368.9) (368.8) (418.2)\n14. SPECIAL CHARGE\nIn 1992, the Railroad recorded a pretax special charge of $8.9 million as part of operating expense. The special charge reduced Net Income by $5.9 million.\nThe special charge consisted of $7 million for various costs associated with the retirement of Mr. Moyers and the related organizational changes. The costs associated with Mr. Moyers' retirement include the present value of his pension, accelerated vesting of a portion of his restricted stock award and certain costs of a non-competition agreement. The remaining $1.9 million was for the disposition costs of railcars and a building and its adjacent land.\n- ----------------\n(a) Includes the special charge recorded in the fourth quarter of 1992, see Note 14.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n-----------------\n---------------------------\nF O R M 10-K\nFINANCIAL STATEMENT SCHEDULES\nSUBMITTED IN RESPONSE TO ITEM 14(a)\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\n-------------- --------------\nI N D E X\nT O FINANCIAL STATEMENT SCHEDULES SUBMITTED IN RESPONSE TO ITEM 14(a)\nSchedules for the three years ended December 31, 1993:\nV-Property, plant and equipment..........\nVI-Accumulated depreciation and amortization of property, plant and equipment.......\nVII-Guarantees of securities of other issuers\nVIII-Valuation and qualifying accounts......\nPursuant to Rule 5.04 of General Rules of Regulation S-X, all other schedules are omitted because they are not required or because the required information is set forth in the financial statements or related notes thereto.\n(1) Reclassification of properties from \"Other Assets.\" (2) Reclassification of properties from \"Assets Held For Disposition.\"\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nSCHEDULE VII--GUARANTEES OF SECURITIES OF OTHER ISSUERS\nAS OF DECEMBER 31, 1993, 1992 AND 1991 ($ IN MILLIONS)\nColumn A Column B Column C Column D - -------- -------- -------- --------\nName of Title of Issue Total Amount Issuer of of Class of Guaranteed Nature of Securities Securities and Guarantee Guaranteed Guaranteed Outstanding by Person for Which Statement is Filed\nTerminal Refunding and Railroad Improvement Association Mortgage 4% Principal of St. Bonds, Series and Louis \"C\", due annual 7\/1\/2019 $7.8 interest\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n3.1 Articles of Incorporation of Illinois Central Railroad, as amended. (Incorporated by reference to Exhibit 3.1 to the Registration Statement of Illinois Central Railroad on Form S-1. (SEC File No. 33- 29269))\n3.2 By-Laws of Illinois Central Railroad, as amended. (Incorporated by reference to Exhibit 3.2 to the Registration Statement of Illinois Central Railroad on Form S-1. (SEC File No. 33-29269))\n4.1 Form of 14-1\/8% Senior Subordinated Debenture Indenture dated as of September 15, 1989 (the \"Senior Subordinated Debenture Indenture\") between Illinois Central Railroad and United States Trust Railroad of New York, Trustee (including the form of 14-1\/8% Senior Subordinated Debenture included as Exhibit A therein). (Incorporated by reference to Exhibit 4.1 to the Registration Statement of Illinois Central Railroad on Form S-1, as amended. (SEC File No. 33- 29269))\n4.2 Form of the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad and the Banks named therein (including the Form of the Restated Revolving Credit Note, the Form of the Restated Term Note, the Form of the Intercreditor Agreement, the Form of the Security Agreement Amendment No. 1 dated as of February 28, 1992, to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Annual Report on Form 10-K for the year ended December 31, 1991, for the Illinois Central Railroad filed March 12, 1992. (SEC File No. 1-7092))\n4.4 Form of Guaranty dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1- 10720))\n- ------------------\n* Used herein to identify management contracts or compensation plans or arrangements as required by Item 14 of Form 10-K.\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n4.5 Form of Pledge Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad and the Banks named therein and the Senior Note Purchasers that are parties to the Note Purchase Agreement dated as of July 23, 1991. (Incorporated by reference to Exhibit 4.4 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))\n4.6 Form Supplemental Indenture dated July 23, 1991, between Illinois Central Railroad and Morgan Guaranty Trust Railroad of New York relating to First Mortgage Adjustable Rate Bonds,Series M. (Incorporated by reference to Exhibit 4.2 to the Quarterly Report of Illinois Central Railroad on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))\n4.7 Form of Note Purchase Agreement dated as of July 23, 1991, among Illinois Central Railroad, as issuer, and Illinois Central Railroad Company, as guarantor, for 10.02% Guaranteed Senior Secured Series A Notes due 1999 and for 10.4% Guaranteed Senior Secured Series B Notes due 2001 (including the Form of Series A Note and Series B Note included as Exhibits A-1 and A-2, respectively, therein). (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of the Illinois Central Railroad on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1- 7092))\n4.8 Form of the Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of the Competitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept\/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein).\n4.9 Form of the Amended and Restated Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of theCompetitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept\/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein).\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n4.10 Form of Commercial Paper Dealer Agreement between Illinois Central Railroad Company and Lehman Commercial Paper, Inc. dated as of November 19, 1993.\n4.11 Form of Issuing and Paying Agency Agreement of the Illinois Central Railroad Company related to the Commercial Paper Program between Illinois Central Railroad Company and Bank America National Trust Company dated as of November 19, 1993, (including Exhibit A the Form of Certificated Commercial Paper Note included therein).\n10.1* Form of supplemental retirement and savings plan. (Incorporated by reference to Exhibit 10C to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))\n10.2 * Form of management incentive compensation plan. (Incorporated by reference to Exhibit 10D to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))\n10.3 Consolidated Mortgage dated November 1, 1949 between Illinois Central Railroad and Guaranty Trust Railroad of New York, Trustee, as amended. (Incorporated by reference to Exhibit 10.8 to the Registration Statement of Illinois Central Railroad on Form S-1, as amended. (SEC File No. 33-29269))\nILLINOIS CENTRAL RAILROAD COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit Sequential No. Descriptions Page No. - ------- ------------ ----------\n10.4 Form of indemnification agreement dated as of January 29, 1991, between Illinois Central Railroad Company and certain officers and directors. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1990, for the Illinois Central Railroad Company filed on April 1, 1991. (SEC File No. 1- 10720))\n10.5 Railroad Locomotive Lease Agreement between IC Leasing Corporation I and Illinois Central Railroad dated as of September 5, 1991. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1991 for the Illinois Central Railroad filed March 12, 1992. (SEC File No. 1-7092))\n10.6 Railroad Locomotive Lease Agreement between IC Leasing Corporation II and Illinois Central Railroad dated as of January 14, 1993. (Incorporated by reference to Exhibit 10.6 to the Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Railroad filed March 5, 1993. (SEC File No. 1-7092))\n21 Subsidiaries of Registrant (Included at E-5) (A) Included herein but not reproduced.","section_15":""}
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{"filename":"18734_1993.txt","cik":"18734","year":"1993","section_1":"ITEM 1. BUSINESS.\nThe Company. The Company, a Texas corporation, is a public utility engaged in generating, purchasing, transmitting, distributing and selling electricity in south Texas. It is a wholly owned subsidiary of CSW, a registered holding company under the Holding Company Act.\nAt December 31, 1993, the Company supplied electric service to approximately 589,000 retail customers in a 44,000 square mile area with an estimated population of 1,945,000. It supplied at wholesale all or a portion of the electric energy requirements of two municipalities and five rural electric cooperatives. The three largest metropolitan areas served by the Company are Corpus Christi, Laredo and McAllen, which have estimated populations of 265,000, 133,000 and 88,000, respectively.\nThe economic base of the territory served by the Company includes manufacturing, metal refining, petroleum, petrochemical, agriculture and tourism.\nIn 1993, industrial customers accounted for approximately 23% of the Company's total operating revenues. Contracts with substantially all industrial customers provide for both demand and energy charges. Demand charges continue under such contracts even during periods of reduced industrial activity, thus mitigating the effect of reduced activity on operating income.\nRegulation and Rates\nRegulation. The Company, as a subsidiary of CSW, is subject to the jurisdiction of the SEC under the Holding Company Act with respect to the issuance, acquisition and sale of securities, acquisition and sale of certain assets or any interest in any business, including certain aspects of fuel exploration and development programs, accounting practices and other matters.\nThe FERC has jurisdiction under the Federal Power Act over certain of the Company's electric utility facilities and operations, wholesale rates and certain other matters.\nThe Texas Commission has jurisdiction over accounts, certification of utility service territories, sale or acquisition of certain utility property, mergers and certain other matters. Neither the Texas Commission nor the governing bodies of incorporated municipalities have jurisdiction over the issuance of securities.\nNational Energy Policy Act of 1992. The Energy Policy Act, adopted in October 1992, significantly changed U.S. energy policy, including that governing the electric utility industry. The Energy Policy Act allows the FERC, on a case-by-case basis and with certain restrictions, to order wholesale transmission access and to order electric utilities to enlarge their transmission systems. The Energy Policy Act does, however, prohibit FERC- ordered retail wheeling, including \"sham\" wholesale transactions. Further, under the Energy Policy Act a FERC transmission order requiring a transmitting utility to provide wholesale transmission services must include provisions generally that permit the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services, any enlargement of the transmission system and associated services.\nIn addition, the Energy Policy Act revised the Holding Company Act to permit utilities, including registered holding companies, and non-utilities to form exempt wholesale generators. An exempt wholesale generator is a new category of non-utility wholesale power producer that is free from most federal and state regulation, including the principal restrictions of the Holding Company Act. These provisions enable broader participation in wholesale power markets by reducing regulatory hurdles to such participation. Management believes that this Act will make wholesale markets more competitive. However, the Company is unable to predict the extent to which the Energy Policy Act will affect its operations.\nSee ITEM 1. BUSINESS -- Environmental Matters, for information relating to Environmental regulation.\nRates. The Texas Commission has original jurisdiction over retail rates in the unincorporated areas of Texas. The governing bodies of incorporated municipalities have such jurisdiction over rates within their incorporated limits. Municipalities may elect, and some have elected, to surrender this jurisdiction to the Texas Commission. The Texas Commission has appellate jurisdiction over rates set by incorporated municipalities.\nSee NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS, Rate Case Filings in ITEM 8, for further information with respect to current rate proceedings.\nElectric utilities in Texas are not allowed to make automatic adjustments to recover changes in fuel costs from retail customers. A utility is allowed to recover its known or reasonably predictable fuel costs through a fixed fuel factor. The Texas Commission established procedures effective May 1, 1993, subject to certain transition rules, whereby each utility under its jurisdiction may petition to revise its fuel factors every six months according to a specified schedule. Fuel factors may also be revised in the case of an emergency or in a general rate proceeding. Under the revised procedures, a utility will remain subject to the prior rules until after its first fuel reconciliation, or in some instances a general rate proceeding including a fuel reconciliation, subject to the new rules. Management does not believe that the new rules substantially change the manner in which the Company will recover retail fuel costs.\nFuel factors are in the nature of temporary rates, and the utility's collection of revenues by such is subject to adjustment at the time of a fuel reconciliation proceeding. At the utility's semi-annual adjustment date, a utility is required to petition the Texas Commission for a surcharge or to make a refund when it has materially under- or over-collected its fuel costs and projects that it will continue to materially under- or over-collect. Material under- or over-collections including interest are defined as four percent of the most recent Texas Commission adopted annual estimated fuel cost for the utility, which is approximately $10.4 million for the Company. A utility does not have to revise its fuel factor when requesting a surcharge or refund. An interim emergency fuel factor order must be issued by the Texas Commission within 30 days after such petition is filed by the utility.\nFinal reconciliation of fuel costs are made through a reconciliation proceeding, which may contain a maximum of three years and a minimum of one year of reconcilable data, and must be filed with the Texas Commission no later than six months after the end of the period to be reconciled. In addition, a utility must include a reconciliation of fuel costs in any general rate proceeding regardless of the time since its last fuel reconciliation proceeding. Any fuel costs which are determined unreasonably incurred in a reconciliation proceeding must be refunded to customers. In the event that the Company does not recover all of its fuel costs under the above procedures, the Company could experience an adverse impact on its results of operations.\nAll of the Company's contracts with its wholesale customers contain FERC approved fuel-adjustment provisions that permit it to automatically pass actual fuel costs through to its customers.\nSee NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS, in ITEM 8, for further information with respect to regulation and rates.\nSTP\nThe ownership of a nuclear generating unit exposes the Company to significant special risks. Under the Atomic Energy Act of 1954 and Energy Reorganization Act of 1974, operation of nuclear plants is intensively regulated by the NRC, which has broad power to impose licensing and safety-related requirements. Along with other federal and state agencies, the NRC also has extensive regulations pertaining to the environmental aspects of nuclear reactors. The NRC has the authority to impose fines and\/or shutdown a unit until compliance is achieved, depending upon its assessment of the severity of the situation.\nThe high degree of regulatory monitoring and controls to assure safe operation could cause the STP units to be out of service for long periods of time. Outages are also necessary approximately every 18 months for refueling. Because STP's fuel costs currently are lower than any of the Company's other units, the Company's average fuel costs are expected to be higher whenever an STP unit is down or operates below the prior period's average capacity.\nRisks of substantial liability arise from the operation of nuclear-fueled generating units and from the use, handling, and possible radioactive emissions associated with nuclear fuel. While the Company carries insurance, the availability, amount and coverage thereof is limited and may become more limited in the future. The available insurance will not cover all types or amounts of loss expense which may be experienced in connection with the ownership of STP. See NOTE 10, COMMITMENTS AND CONTINGENCIES - Nuclear Insurance, in ITEM 8 for further information.\nSee NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS, in ITEM 8 for a discussion of the STP outage.\nOperations\nPeak Loads and System Capabilities. The following table sets forth for the years 1991 through 1993 the net system capabilities of the Company (including the net amounts of contracted purchases and contracted sales) at the time of peak demand, the maximum coincident system demand on a one-hour integrated basis (exclusive of sales to other electric utilities) and the respective amounts and percentages of peak demand generated by the Company and net purchases and sales: Percent Increase Maximum (Decrease) Net Purchases Coincident In Peak Generation at (Sales) at Net System System Demand Time of Peak Time of Peak Capabilities(a) Demand(b) Over Prior Year Mw Mw Period Mw % Mw %\n1991 4,005 3,291 5.8 3,424 104.0 (133) (4.0) 1992 4,165 3,347 1.7 3,003 89.7 344 10.3 1993 4,480 3,518 5.1 2,943 83.7 575 16.3 ___________________\n(a) Does not include 452 Mw of system capability in long-term storage in 1991 and 310 Mw in 1992 and 1993 as described under \"ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nFacilities. At December 31, 1993, the Company owned the following electric generating plants (or portions thereof in the cases of the jointly owned plants).\n(See \"ITEM 1. BUSINESS -- Fuel Supply.\")\nNet Dependable Type of Fuel Capability Plant Name and Location Primary\/Secondary Mw\nBarney M. Davis gas\/oil(a) 339 Corpus Christi, Texas gas\/oil 340\nColeto Creek coal 604 Goliad, Texas\nLon C. Hill gas\/oil(a) 549 Corpus Christi, Texas\nNueces Bay gas\/oil(a) 512(b) Corpus Christi, Texas\nVictoria gas\/oil(a) 258(b) Victoria, Texas\nLa Palma gas\/oil 47 San Benito, Texas gas\/oil(a) 156(b)\nE. S. Joslin gas\/oil(a) 252 Point Comfort, Texas\nJ. L. Bates gas\/oil(a) 182 Mission, Texas\nLaredo gas\/oil(a) 66 Laredo, Texas gas\/oil 106\nEagle Pass Eagle Pass, Texas hydro 6\nOklaunion coal 53(c) Vernon, Texas\nSTP nuclear 630(d) Bay City, Texas\nTotal 4,100\n_______________________\n(a) For extended periods of operation, oil can be used only in combination with gas. Use of oil in facilities primarily designed to burn gas results in increased maintenance expense and a reduction of approximately 15% in capability.\n(b) Excludes units in long-term storage - 34 Mw at Nueces Bay, 228 Mw at Victoria and 48 Mw at La Palma.\n(c) The Company owns 7.81% of the 676 Mw unit operated by WTU.\n(d) The Company owns 25.2% of the two 1,250 Mw units operated by HLP.\nAll of the generating plants described above are located on land owned by the Company or jointly with the other participants in jointly owned plants. The Company's electric transmission and distribution facilities are for the most part located over or under highways, streets and other public places or property owned by others, for which permits, grants, easements or licenses (which the Company believes to be satisfactory, but without examination of underlying land titles) have been obtained. The principal plants and properties of the Company are subject to the lien of the first mortgage indenture under which the Company's first mortgage bonds are issued.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSee ITEM 1. BUSINESS - Environmental Matters, for information relating to environmental and certain other proceedings.\nSee NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS, in ITEM 8, for information relating to regulatory and legal proceedings.\nThe Company is party to various other legal claims, actions and complaints arising in the normal course of business. Management does not expect disposition of these matters to have a material adverse effect on the Company's results of operations or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll of the outstanding shares of Common Stock of the Company are owned by its parent company, CSW.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND\nRESULTS OF OPERATIONS.\nReference is made to the Company's Financial Statements and related Notes and Selected Financial Data in ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nStatements Of Income\nCENTRAL POWER AND LIGHT COMPANY For the Years Ended December 31, 1993 1992 1991 (thousands)\nElectric Operating Revenues Residential $ 474,426 $ 432,295 $ 435,860 Commercial 369,426 342,201 343,437 Industrial 281,247 240,341 221,885 Sales for resale 45,369 50,342 48,834 Other 53,060 48,244 48,714 --------- --------- --------- 1,223,528 1,113,423 1,098,730 --------- --------- --------- Operating Expenses and Taxes Fuel 350,268 306,939 303,428 Purchased power 64,025 17,160 15,041 Other operating 225,034 184,514 196,817 Restructuring charges 29,365 - - Maintenance 81,352 61,399 68,092 Depreciation and amortization 131,825 129,131 127,341 Taxes, other than Federal income 86,394 70,343 62,453 Federal income taxes 65,186 77,272 75,985 --------- --------- --------- 1,033,449 846,758 849,157 --------- --------- --------- Operating Income 190,079 266,665 249,573 --------- --------- --------- Other Income and Deductions Mirror CWIP liability amortization 75,702 82,527 96,671 Other 2,737 1,298 3,590 --------- --------- --------- 78,439 83,825 100,261 --------- --------- --------- Income Before Interest Charges 268,518 350,490 349,834 --------- --------- --------- Interest Charges Interest on long-term debt 112,939 125,476 124,987 Interest on short-term debt and other 10,449 6,503 7,641 --------- --------- --------- 123,388 131,979 132,628 --------- --------- --------- Income Before Cumulative Effect of Changes in Accounting Principles 145,130 218,511 217,206\nCumulative Effect of Changes in Accounting Principles 27,295 - - --------- --------- --------- Net Income 172,425 218,511 217,206 Preferred stock dividends 14,003 16,070 19,844 --------- --------- --------- Net Income for Common Stock $ 158,422 $ 202,441 $ 197,362 ========= ========= =========\nStatements Of Retained Earnings\nFor the Years Ended December 31, 1993 1992 1991 (thousands)\nRetained Earnings at Beginning of Year $863,988 $854,659 $875,521 Net income for common stock 158,422 202,441 197,362 Deduct: Common stock dividends 172,000 193,000 215,000 Preferred stock redemption costs 103 112 3,224\n-------- -------- -------- Retained Earnings at End of Year $850,307 $863,988 $854,659 ======== ======== ========\nThe accompanying notes to financial statements are an integral part of these statements.\nBalance Sheets\nCENTRAL POWER AND LIGHT COMPANY As of December 31,\n1993 1992 (thousands)\nASSETS Electric Utility Plant Production $3,061,911 $3,051,969 Transmission 351,584 329,400 Distribution 765,266 715,633 General 209,170 210,204 Construction work in progress 168,421 94,736 Nuclear fuel 160,326 152,494 ---------- ---------- 4,716,678 4,554,436 Less - Accumulated depreciation 1,263,372 1,148,348 ---------- ---------- 3,453,306 3,406,088 ---------- ---------- Current Assets Cash and temporary cash investments 2,435 3,666 Special deposits 1,967 151,589 Accounts receivable 23,850 20,296 Materials and supplies, at average cost 64,359 58,839 Fuel inventory, at average cost 16,934 29,259 Deferred income taxes 4,831 31,289 Unrecovered fuel costs 52,959 - Prepayments and other 2,255 2,198 ---------- ---------- 169,590 297,136 ---------- ---------- Deferred Charges and Other Assets Deferred STP costs 489,773 490,458 Mirror CWIP asset 331,845 341,865 Income tax related regulatory assets 266,597 - Other 70,634 48,113 ---------- ---------- 1,158,849 880,436 ---------- ---------- $4,781,745 $4,583,660 ========== ==========\nCAPITALIZATION AND LIABILITIES\nCapitalization Common stock, $25 par value, authorized 12,000,000 shares, issued and outstanding 6,755,535 shares $ 168,888 $ 168,888 Paid-in capital 405,000 405,000 Retained earnings 850,307 863,988 ---------- ---------- Total Common Stock Equity 1,424,195 1,437,876 ---------- ---------- Preferred stock Not subject to mandatory redemption 250,351 250,351 Subject to mandatory redemption 22,021 28,393 Long-term debt 1,362,799 1,347,887 ---------- ---------- Total Capitalization 3,059,366 3,064,507 ---------- ---------- Current Liabilities Long-term debt and preferred stock due within twelve months 3,928 143,900 Advances from affiliates 171,165 91,766 Accounts payable 79,604 60,392 Accrued taxes 33,769 27,224 Accrued interest 24,683 25,729 Accrued restructuring charges 29,365 - Other 28,020 31,047 ---------- ---------- 370,534 380,058 ---------- ---------- Deferred Credits Income taxes 1,057,453 727,953 Investment tax credits 164,322 170,128 Mirror CWIP liability and other 130,070 241,014 ---------- ---------- 1,351,845 1,139,095 ---------- ---------- $4,781,745 $4,583,660 ========== ========== The accompanying notes to financial statements are an integral part of these statements.\nStatements of Cash Flows\nCENTRAL POWER AND LIGHT COMPANY For the Years Ended December 31, 1993 1992 1991 (thousands)\nOPERATING ACTIVITIES Net Income $172,425 $218,511 $217,206 Non-cash Items Included in Net Income Depreciation and amortization 140,223 154,716 148,012 Deferred income taxes and investment tax credits 84,714 42,773 30,990 Mirror CWIP liability amortization (75,702) (82,527) (96,671) Restructuring charges 29,365 - - Cumulative effect of changes in accounting principles (27,295) - - Changes in Assets and Liabilities Accounts receivable (3,554) (6,415) 12,473 Fuel inventory 12,325 (3,137) 1,175 Accounts payable 19,151 6,209 7,057 Accrued taxes (9,311) (2,165) 17,065 Unrecovered fuel costs (57,386) (1,195) 5,001 Other (6,388) (23,020) (23,199) -------- -------- -------- 278,567 303,750 319,109 -------- -------- -------- INVESTING ACTIVITIES Construction expenditures (177,120) (100,805) (98,199) Other (1,544) (763) (1,056) -------- -------- -------- (178,664) (101,568) (99,255) -------- -------- -------- FINANCING ACTIVITIES Proceeds from issuance of long-term debt 441,131 435,497 - Retirement of long-term debt (431) (405) (168) Reacquisition of long-term debt (573,776) (304,650) (210) Retirement of preferred stock (6,578) (7,050) (7,050) Special deposits for reacquisition of long-term debt 145,482 (145,482) - Change in short-term debt 79,399 29,618 21,523 Payment of dividends (186,361) (209,196) (235,674) -------- -------- -------- (101,134) (201,668) (221,579) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS (1,231) 514 (1,725) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,666 3,152 4,877 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,435 $ 3,666 $ 3,152 ======== ======== ========\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $116,664 $130,078 $125,760 Income taxes paid 3,631 45,314 35,715 ======== ======== ========\nThe accompanying notes to financial statements are an integral part of these statements.\nStatements of Capitalization\nCENTRAL POWER AND LIGHT COMPANY As of December 31, 1993 1992 (thousands) COMMON STOCK EQUITY\n$1,424,195 $1,437,876 ---------- ---------- PREFERRED STOCK Cumulative $100 Par Value, Authorized 3,035,000 Shares Number Current of Shares Redemption Series Outstanding Price Not Subject to Mandatory Redemption 4.00% 100,000 $105.75 10,000 10,000 4.20% 75,000 103.75 7,500 7,500 7.12% 260,000 101.00 26,000 26,000 8.72% 500,000 102.91 50,000 50,000 Auction Money Market 750,000 100.00 75,000 75,000 Auction Series A 425,000 100.00 42,500 42,500 Auction Series B 425,000 100.00 42,500 42,500 Issuance Expense (3,149) (3,149) -------- --------\n250,351 250,351 -------- -------- Subject to Mandatory Redemption 10.05% 223,750 104.76 22,375 28,850 Issuance Expense (354) (457) -------- --------\n22,021 28,393 -------- -------- LONG-TERM DEBT First Mortgage Bonds Series J, 6 5\/8%, due January 1, 1998 28,000 28,000 Series L, 7%, due February 1, 2001 36,000 36,000 Series M, 8%, due November 1, 2003 - 46,000 Series O, 8 1\/4%, due October 1, 2007 - 75,000 Series T, 7 1\/2%, due December 15, 2014 111,700 111,700 Series U, 9 3\/4%, due July 1, 2015 31,765 81,700 Series Y, 9 3\/4%, due June 1, 1998 - 150,000 Series Z, 9 3\/8%, due December 1, 2019 140,000 148,000 Series AA, 7 1\/2%, due March 1, 2020 50,000 50,000 Series BB, 6%, October 1, 1997 200,000 200,000 Series CC, 7 1\/4%, October 1, 2004 100,000 100,000 Series DD, 7 1\/8%, December 1, 1999 25,000 25,000 Series EE, 7 1\/2%, December 1, 2002 115,000 115,000 Series FF, 6 7\/8%, due February 1, 2003 50,000 -\nSeries GG, 7 1\/8%, due February 1, 2008 75,000 -\nSeries HH, 6%, due April 1, 2000 100,000 - Series II, 7 1\/2%, due April 1, 2023 100,000 -\nInstallment Sales Agreements - PCRBs Series 1974A, 7 1\/8%, due June 1, 2004 8,700 8,955 Series 1977, 6%, due November 1, 2007 34,235 34,235 Series 1984, 7 7\/8%, due September 15, 2014 6,330 6,330 Series 1984, 10 1\/8%, due October 15, 2014 68,870 139,200 Series 1986, 7 7\/8%, due December 1, 2016 60,000 60,000 Series 1993, 6%, due July 1, 2028 120,265 -\nNotes Payable, 6 1\/2%, due December 8, 1995 448 651 Unamortized Discount (12,265) (17,923) Unamortized Costs of Reacquired Debt (86,249) (49,961) --------- ---------\n1,362,799 1,347,887\n--------- --------- TOTAL CAPITALIZATION $3,059,366 $3,064,507 ========= =========\nThe accompanying notes to financial statements are an integral part of these statements.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCentral Power and Light Company is subject to regulation by the SEC, under the Holding Company Act, and by the FERC, under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. The Company is subject to further regulation for rates and other matters by the Texas Commission. The Company, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System. The most significant accounting policies are summarized below.\nElectric Utility Plant. Electric utility plant is stated at the original cost of construction which includes the cost of contracted services, direct labor, materials, overhead items and allowances for borrowed and equity funds used during construction.\nDepreciation. Provisions for depreciation of utility plant are computed using the straight-line method generally at individual rates applied to the various classes of depreciable property. The annual composite rates averaged 3.0% for each of the years 1993, 1992 and 1991.\nNuclear Decommissioning. The Company's portion of the estimated costs of decommissioning STP is $85 million in 1986 dollars based on a site specific study completed in 1986. The Company will continue to review and update this cost estimate and a new study will be completed in 1994. The Company is recovering decommissioning costs through rates over the 38 year life of STP. The $4.2 million annual cost of decommissioning is reflected on the income statement as other operating expense. The funds received from customers applicable to decommissioning are paid to an irrevocable external trust and as such are not reflected on the Company's balance sheet. At December 31, 1993, the trust balance was $15.2 million.\nAt the end of STP's 38 year life, decommissioning is expected to be accomplished using the decontamination method, which is one of three techniques acceptable by the NRC. Using this method the decontamination activities occur as soon as possible after the end of plant operation. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nElectric Revenues and Fuel. Prior to January 1, 1993, electric revenues generally were recorded at the time billings were made to customers on a cycle- billing basis. Electric service provided subsequent to billing dates through the end of each calendar month became part of electric revenues of the next month. To conform to general industry standards the Company in 1993 began accruing unbilled base revenues for electricity used by customers but not yet billed. This adjustment was recorded in 1993 as a cumulative effect of a change in accounting principle. The effect of this change on the Company's net income for 1993 was an increase of $45.4 million, or $29.5 million net of taxes. If this change in accounting method was applied retroactively, the effect on net income for 1992 and 1991 would have been immaterial.\nThe cost of fuel is charged to expense as consumed. The cost of nuclear fuel is amortized to fuel expense based on a ratio of the estimated Btu's used and available to generate electric energy, and includes a provision for the disposal of spent nuclear fuel.\nThe Company recovers fuel costs applicable to sales to wholesale customers, regulated by the FERC, through an automatic fuel adjustment clause.\nThe Company recovers fuel costs in Texas as a fixed component of base rates. The difference between fuel revenues billed and fuel expense incurred is recorded as an addition to or a reduction of revenues, with a corresponding entry to unrecovered fuel cost or other current liabilities as appropriate. Over-recoveries of fuel are payable to customers, and under-recoveries may be billed to customers after Texas Commission approval.\nAccounts Receivable. The Company sells its accounts receivable, without recourse, to CSW Credit, Inc., a wholly owned subsidiary of CSW.\nDeferred STP Costs. In accordance with Texas Commission orders, the Company deferred plant costs for STP Units 1 and 2 incurred subsequent to their commercial operation dates until retail rates which included the units in rate base became effective. The deferred plant costs are amortized and recovered through rates over the life of the plant in increasing amounts. See NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS for further discussion of the deferred accounting proceedings.\nMirror CWIP. In accordance with Texas Commission orders, the Company previously recorded Mirror CWIP, which is being amortized over the life of STP, as more fully discussed in NOTE 9, LITIGATION AND REGULATORY PROCEEDINGS.\nStatements of Cash Flows. Cash equivalents are considered to be highly liquid debt instruments purchased with a maturity of three months or less. Accordingly, temporary cash investments and advances to affiliates are considered cash equivalents.\nReclassification. Certain financial statement items for prior years have been reclassified to conform to the 1993 presentation.\nAccounting Changes. Effective January 1, 1993, the Company adopted SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, SFAS No. 112, Employers' Accounting for Postemployment Benefits (See NOTE 8, BENEFITS PLANS), and SFAS No. 109, Accounting for Income Taxes (See NOTE 2, FEDERAL INCOME TAXES). The Company also changed its method of accounting for unbilled revenues (See Electric Revenues and Fuel above).\nThe adoption of SFAS No. 109 had no effect on the Company's results of operations. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect (thousands)\nSFAS No. 112 $(3,371) $ 1,180 $(2,191) Unbilled revenues 45,363 (15,877) 29,486 ------ ------- ------ Total $41,992 $(14,697) $27,295 ====== ======= ====== Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts previously reported for prior years.\n2. FEDERAL INCOME TAXES\nThe Company, together with other members of the CSW System, files a consolidated Federal income tax return and participates in a tax sharing agreement.\nThe Company adopted the provisions of SFAS No. 109, effective January 1, 1993. This standard had no impact on the Company's results of operations.\nSFAS No. 109 requires the recognition of deferred tax liabilities for income customers associated with temporary differences previously passed through to rate payers and the equity component of allowance for funds used during construction. In addition, SFAS No. 109 requires reclassification of certain deferred income tax liabilities to reflect the Company's obligation to reduce revenue requirements for deferred income taxes provided at rates higher than the current 35% Federal income tax rate.\nAs a result, the Company recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to customers in amounts equal to future revenues or the reduction in future revenues that will be required when the income tax temporary differences reverse and are recovered or settled in rates.\nComponents of Federal income taxes are as follows:\n1993 1992 1991 (thousands) Included in Operating Expenses and Taxes Current $(19,690) $ 34,336 $ 44,832 Deferred 90,682 48,773 36,984 Deferred ITC (5,806) (5,837) (5,831) ------- ------- ------- 65,186 77,272 75,985 ------- ------- ------- Included in Other Income and Deductions Current 736 390 (1,963) Deferred (162) (163) (163) ------- ------- ------- 574 227 (2,126) ------- ------- ------- Tax Effects of Cumulative Effects of Changes in Accounting Principles 14,697 - - ------- ------- ------- $ 80,457 $ 77,499 $ 73,859 ======= ======= =======\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences are as follows:\n1993 % 1992 % 1991 %\n(dollars in thousands)\nTax at statutory rates $ 88,509 35.0 $100,643 34.0 $ 98,962 34.0 Differences Amortization of ITC (5,806) (2.3) (5,789) (2.0) (5,789) (2.0) Mirror CWIP (22,989) (9.1) (24,652) (8.3) (29,463) (10.1) Prior period adjustments 19,101 7.6 - - - - Other 1,642 .6 7,297 2.5 10,149 3.5 ------- ---- ------- ---- ------- ---- $ 80,457 31.8 $ 77,499 26.2 $ 73,859 25.4 ======= ==== ======= ==== ======= ====\nITC deferred in prior years are included in income over the lives of the related properties.\nThe significant components of the net deferred income tax liability are as follows:\nDecember 31, January 1, 1993 1993 (thousands) Deferred Tax Liabilities Property related book\/tax basis differences $ 745,164 $ 640,275 Income tax related regulatory assets 178,984 172,657 Mirror CWIP asset 116,146 116,234 Deferred STP costs 171,421 166,756 Other 37,989 38,061 --------- --------- Total Deferred Tax Liabilities $1,249,704 $1,133,983 --------- --------- Deferred Tax Assets Income tax related regulatory liabilities (85,675) (105,370) Mirror CWIP liability (38,150) (62,799) Unamortized ITC (57,513) (57,843) Alternative minimum tax (15,744) (13,402) --------- --------- Total Deferred Tax Assets (197,082) (239,414) --------- --------- Net Accumulated Deferred Income Taxes-Total $1,052,622 $ 894,569 ========= ========= Net Accumulated Deferred Income Taxes-Noncurrent $1,057,453 $ 925,858 Net Accumulated Deferred Income Taxes-Current (4,831) (31,289) --------- --------- Net Accumulated Deferred Income Taxes-Total $1,052,622 $ 894,569 ========= ========= 3. LONG-TERM DEBT\nThe mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by the Company, constitutes a direct first mortgage lien on substantially all electric utility plant.\nAnnual Requirements. Certain series of the Company's outstanding first mortgage bonds have annual sinking fund requirements which are generally one percent of the greatest amount outstanding at any time of each series of first mortgage bonds issued. These requirements may be, and have historically been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. Series J, L, and Z first mortgage bonds are subject to this annual sinking fund requirement.\nAt December 31, 1993, the annual sinking fund requirements exclusive of maturities, and the annual aggregate maturities including sinking fund requirements, of long-term debt are as follows:\nAnnual Sinking Annual Aggregate Fund Requirements Maturities (thousands) 1994 2,120 3,299 1995 2,120 3,563 1996 2,120 3,135 1997 2,120 203,155 1998 1,840 30,895\nDividends. The Company's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common stock dividends. At December 31, 1993, $630 million of retained earnings were available for the payment of cash dividends to CSW.\nReacquired Long-Term Debt. During 1993, the Company issued first mortgage bonds, the proceeds of such offerings were used to refinance higher cost debt in order to lower the embedded cost of long-term debt.\nThe premiums and reacquisition costs of reacquired long-term debt are included in long-term debt on the balance sheets and are being amortized over 5 to 35 years. Reference is made to ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, for additional information on reacquired long-term debt.\nDue Within Twelve Months. In December 1992, the Company issued Series DD and EE first mortgage bonds in the aggregate amount of $140 million to reacquire Series K, N and P first mortgage bonds in January 1993. Accordingly, at December 31, 1992, the Company reclassified these bonds totaling $140 million from long-term debt on the balance sheet to current liabilities, long-term debt and preferred stock due within twelve months.\n4. PREFERRED STOCK\nThe dividends on the Company's $160 million auction preferred stocks are adjusted every 49 days, based on current market rates. The dividend rate averaged 2.7%, 3.6%, and 5.5% during 1993, 1992 and 1991.\nThe Company's 10.05%, $100 par value preferred stock requires a mandatory sinking fund sufficient to retire 35,250 shares annually until January 31, 2001, and a specified number of shares in each 12-month period thereafter. The sinking fund redemption price is $100 per share. The portion to be retired within twelve months is reflected as such on the balance sheet under current liabilities.\nEach series of preferred stock, with the exception of the 10.05% Series and the auction preferred stock, is redeemable at the option of the Company upon 30 days notice at the current redemption price per share. Redemption prices of the 8.72% and 10.05% Series decline at specified intervals in future years. The 10.05% Series is redeemable as of February 1, 1994. The Company's three issues of auction preferred stock may be redeemed at par on any dividend payment date.\nThe premiums and reacquisition costs of reacquired preferred stock are treated as a reduction to retained earnings.\n5. SHORT-TERM FINANCING\nThe Company, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings through the issuance of CSW's commercial paper. Money pool borrowings are shown as advances from affiliates on the balance sheet. At December 31, 1993, the CSW System had bank lines of credit aggregating $797 million, including the Company's lines of credit, to back up its commercial paper program. Short-term cash surpluses transferred to the money pool receive interest income in accordance with the money pool arrangement.\n6. FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value:\nCash, temporary cash investments, special deposits and short-term debt. The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for the debt of the same or similar remaining maturities.\nPreferred stock subject to mandatory redemption. The fair value of this preferred stock is estimated based on the quoted market prices for the same or\nsimilar issues or on the current rates offered to the Company for preferred stock with the same or similar remaining redemption provisions.\nThe estimated fair values of the Company's financial instruments are as follows:\n1993 1992\nCarrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 2,435 $ 2,435 $ 3,666 $ 3,666 Special deposits 1,967 1,967 151,589 151,589 Short-term debt 171,165 171,165 91,766 91,766 Long-term debt 1,362,799 1,456,533 1,347,887 1,424,128 Preferred stock subject to mandatory redemption 22,021 23,086 28,393 29,766 Long-term debt and preferred stock due within twelve months 3,928 4,096 143,900 149,632\n7. BENEFIT PLANS\nDefined Benefit Pension Plan. The Company, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all of its employees. Participants in the plan during 1993 included approximately 2,300 active employees, 1,200 retirees and beneficiaries and 300 terminated employees with vested benefits. Benefits are based on employees' years of service, age at retirement and final average annual earnings with an offset for the participant's primary Social Security benefit. The CSW System's funding policy is based on actuarially determined contributions, taking into account amounts deductible for income tax purposes and minimum contributions required by ERISA. Contributions to the plan for the years ended December 31, 1993, 1992 and 1991 were $11.0 million, $11.7 million and $10.1 million, respectively. Pension plan assets consist primarily of common stocks and short- and intermediate-term fixed income investments.\nThe components of net periodic pension cost and the assumptions used in accounting for pensions are as follows:\n1993 1992 1991 (thousands) Net Periodic Pension Cost Service cost $ 5,228 $ 4,834 $ 4,324 Interest cost on projected benefit obligation 14,878 13,686 12,072 Actual return on plan assets (18,079) (11,750) (26,785) Net amortization and deferral 68 (5,330) 12,269 ------ ------ ------ $ 2,095 $ 1,440 $ 1,880 ====== ====== ====== Assumptions: Discount rate 7.75% 8.50% 8.50% Long-term compensation increase 5.46% 5.96% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAs of December 31, 1993 and 1992, the plan's net assets exceeded the total actuarial present value of accumulated benefit obligations.\nPostretirement Benefits Other Than Pensions. The Company adopted SFAS No. 106, Employer's Accounting for Postretirement Benefits Other Than Pensions, January 1, 1993. The adoption resulted in an increase in operating of $5.9 million for 1993. The Company's accumulated postretirement benefit obligation was $66.5 million. The transition obligation was $58.0 million and is being amortized over twenty years. In prior years the Company accounted for these benefits on a pay-as-you-go basis. Expenses for 1992 and 1991 were $3.8 million and $3.5 million, respectively. The CSW System's funding policy is based on actuarially determined contributions taking into account amounts which are\ndeductible income tax purposes. The Company contributed approximately $8.6 million in 1993.\nThe components of net periodic postretirement benefit cost and the assumptions used in accounting for postretirement benefits are as follows:\n(thousands) Net Periodic Postretirement Benefit Cost Service cost $2,257 Interest cost on accumulated postretirement benefit obligation 5,505 Actual return on plan assets (249) Amortization of transition obligation 2,900 Net amortization and deferral (703) ----- $9,710 ===== Assumptions: Discount rate 7.75% Return on plan assets 9.00%\nHealth Care Cost Trend Rate Assumptions: Pre-65 Participants: 1993 Rate of 12.50% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1993 Rate of 12.00% grading down .75% per year to an ultimate rate of 6.0% in 2001.\nIncreasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO as of December 31, 1993 by $8.8 million and increase the aggregate of the service and interest cost components of net postretirement benefits by $1.2 million.\nPostemployment Benefits. In November 1992, the Financial Accounting Standards Board issued SFAS No. 112, Employers' Accounting for Postemployment Benefits. This statement requires the accrual method of accounting for certain types of postemployment benefits provided to former or inactive employees after employment, but before retirement. This new standard requires that the expected costs of these benefits be accrued during the period employees render service to qualify for benefits. The most significant costs for the Company are the continued medical and salary benefits during long-term disability. Effective January 1, 1993, the Company adopted SFAS No. 112 and the effect of the change on 1993 income was $2.2 million reflected in cumulative effect of changes in accounting principles.\nRestructuring Charges. The Company recently announced an early retirement program as a part of the Company's restructuring efforts in order to streamline operations and reduce future costs. It is anticipated that this restructuring will affect employee benefit costs incurred by the Company in future periods. Due to the timing of the implementation of the program, many variables regarding specific costs cannot be identified until mid-1994. As a result, no adjustments have been made to the employee benefit cost data presented above.\n8. JOINTLY OWNED ELECTRIC UTILITY PLANT\nThe Company is party to joint ownership agreements with nonaffiliated entities. Such agreements provide for the joint ownership and operation of STP consisting of two nuclear generating units. The Company also has a joint ownership agreement with other members of the CSW System and nonaffiliated entities to provide for the joint ownership and operation of Oklaunion and its related facilities. The statements of income reflect the Company's portion ofoperating costs associated with jointly owned plant in service. At December 31, 1993, the Company had interests in the generating stations and related facilities as shown below:\nSTP Oklaunion (dollars in thousands) Plant in service $2,340,336 $36,045 Accumulated depreciation $318,101 $7,058 Plant capacity - mw 2,500 676 Participation 25.2% 7.8% Share of capacity - mw 630 53\n9. LITIGATION AND REGULATORY PROCEEDINGS\nSTP Introduction. The Company owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition to the Company, HLP, the Project Manager, owns 30.8%, San Antonio owns 28.0%, and Austin owns 16.0%. STP Unit 1 was placed in service in August 1988 and STP Unit 2 was placed in service in June 1989.\nSTP Final Orders. In October 1990, the Texas Commission issued a final order (STP Unit 1 Order) which fully implemented a stipulated agreement filed in February 1990 to resolve dockets then pending before the Texas Commission. In December 1990, the Texas Commission issued a final order (STP Unit 2 Order) which fully implemented a stipulated agreement to resolve all issues regarding the Company's investment in STP Unit 2.\nThe STP Unit 1 Order allowed the Company to increase retail base rates by $144 million. This base rate increase made permanent a $105 million interim base rate increase placed into effect in March 1990 and a $39 million interim base rate increase placed into effect in September 1989. The STP Unit 2 Order provided for a retail base rate increase of $120 million effective January 1, 1991. The STP Unit 1 Order also provided for the deferral of operating expenses and carrying costs on STP Unit 2. A prior Texas Commission order (see \"Deferred Accounting\" below) had authorized deferral of STP Unit 1 costs. Such costs are being recovered through rates over the remaining life of STP. Also, the STP Unit 1 Order authorized use of Mirror CWIP, pursuant to which the Company recognized $360 million of carrying costs as deferred costs, and established a corresponding liability to customers recorded in Mirror CWIP liability and other deferred credits on the balance sheets. In compliance with the order, carrying costs collected through rates during periods when CWIP was included in rate base were recognized as a loan from customers. The loan is being repaid through lower rates from 1991 through 1995, which approximates the length of time during which the carrying costs were collected from customers. The Mirror CWIP liability is being reduced by the recognition of non-cash income during the period 1991 through 1995.\nThe STP Unit 1 and 2 Orders resolved all issues pertaining to the reasonable original costs of STP and the appropriate amount to be included in rate base. Pursuant to the Texas Commission orders, the original cost of the Company's total investment in STP is included in rate base.\nAs part of the stipulated agreement, the Company has agreed to freeze base rates from January 1, 1991 through 1994, subject to certain force majeure events including double-digit inflation, major tax increases, extraordinary increases in operating expenses or serious declines in operating revenues. The Company may file for increases in base rates, which would be effective after 1994 and subject to certain limitations. The fuel portion of customers' bills is subject to adjustment following the normal review and approval by the Texas Commission.\nThe stipulated agreements, as discussed above, were entered into by the Company, the Texas Commission Staff and a majority of intervenors including major cities in the Company's service territory and major industrial customers. These intervenors represent a significant majority of the Company's customers. The Company and the TSA reached agreements, which were subsequently approved by the Texas Commission Staff and other signatories, whereby TSA agreed not to oppose the stipulated agreements in any respect, except with regard to deferred accounting and rate design issues in the STP Unit 1 Order. OPUC and a coalition of low-income customers declined to enter into the stipulated agreements.\nIn January 1991, the TSA, OPUC and the coalition of low-income customers filed appeals of the STP Unit 1 Order in District Court requesting reversal of the deferred accounting for STP Unit 2 and other aspects of that order. In March 1991, the TSA, OPUC and the coalition of low-income customers filed appeals of the STP Unit 2 Order in the District Court requesting reversal of that order. These appeals are pending before the District Court. If these orders are ultimately reversed on appeal, the stipulated agreements would be nullified and the Company could experience a significant adverse effect on its results of operations. However, the parties to the stipulated agreement, should it be nullified, are bound to renegotiate and try to reach a revised agreement that would achieve the same results. Management believes that the STP Unit 1 and 2 Orders will be upheld.\nDeferred Accounting. The Company was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed the Company to defer post-in-service operating and maintenance costs, including taxes and depreciation, and carrying costs until these costs were reflected in retail rates. Deferred accounting had an immediate positive effect on net income in the years allowed, but cash earnings were not increased until rates went into effect reflecting STP in service (see \"STP Final Orders\" above). The total deferrals for the periods affected were approximately $492 million with an after-tax net income effect of approximately $325 million. This total deferral included approximately $270 million of pre-tax debt carrying costs. Pursuant to the STP Unit 1 and 2 Orders, the Company's retail rates include recovery of all STP Unit 1 and 2 deferrals over the remaining life of the plant.\nIn July 1989, OPUC and the TSA filed appeals of the Texas Commission's final order in District Court requesting reversal of deferred accounting for STP Unit 1. In September 1990, the District Court issued a judgment affirming the Texas Commission's order for STP Unit 1, which was subsequently appealed to the Court of Appeals by OPUC and the TSA. The hearing of the Company's STP Unit 1 deferred accounting order was combined by the Court of Appeals with similar appeals of HLP deferred accounting orders.\nIn September 1992, the Court of Appeals issued a decision that allows the Company to include STP Unit 1 deferred post-in-service operating and maintenance costs in rate base. However, the Court of Appeals held that deferred post-in- service carrying costs could not be included in rate base, thereby prohibiting the Company from earning a return on such costs.\nAfter the Court of Appeal's denial of each party's motion for rehearing of the decision, the Company and the Texas Commission in December 1992 filed Applications for Writ of Error petitioning the Supreme Court of Texas to review the September 1992 decision denying rate base treatment of deferred post-in- service carrying costs by the Court of Appeals. Additionally, the TSA and OPUC filed Applications for Writ of Error petitioning the Supreme Court of Texas to reverse the Court of Appeal's decision, challenging generally the legality of deferred accounting for or rate base treatment of any deferred costs. In May 1993, the Supreme Court of Texas granted the Company's application for writ of error. The Company's case was consolidated with the deferred accounting cases of El Paso Electric Company and HLP. Oral arguments were heard in September 1993 and the Supreme Court's decision is pending.\nIf the Company's orders granting deferred accounting were ultimately reversed and not favorably revised, the Company could experience a material adverse effect on its results of operations. While management cannot predict the ultimate outcome of the deferred accounting appeal, management believes the Company will successfully receive approval of its deferred accounting orders or will be successful in renegotiation of its rate orders, so that there will be no material adverse effect on the Company's results of operations or financial condition.\nSTP Outage. In February 1993, Units 1 and 2 of STP were shut down by HLP, the Project Manager, in an unscheduled outage resulting from mechanical problems relating to two auxiliary feedwater pumps. HLP determined that the units would not be restarted until the equipment failures had been corrected and the NRC briefed on the causes of these failures and the corrective actions that were taken. The NRC formalized that commitment in a confirmatory action letter, and sent an Augmented Inspection Team to STP to review the matter. In March 1993, the NRC began a diagnostic evaluation of STP. Conducted infrequently, diagnostic evaluations are broad-based evaluations of overall plant operations and are intended to review the strengths and weaknesses of the licensee's performance and to identify the root cause of performance problems. During and subsequent to the June 1993 completion of the evaluation, the NRC supplemented its confirmatory action letter to identify additional issues to be resolved and verified by the NRC before restart of STP. Such issues included the need to reduce backlogs of engineering and maintenance work and to simplify work processes which placed excessive burdens on operating and other plant personnel. The report also identified the need to strengthen management communications, oversight and teamwork as well as the capability to identify and correct the root causes of problems.\nThe NRC announced in June 1993 that STP was placed on its \"watch list\" of plants with \"weaknesses that warrant increased NRC attention.\" Plants on the watch list are subject to closer NRC oversight. STP will remain on the NRC's watch list until both units return to service and a period of good performance is demonstrated.\nDuring the outage, the necessary improvements have been made by HLP to address the issues in the confirmatory action letter, as supplemented. On February 15, 1994, the NRC agreed that the confirmatory action letter issues had been resolved with respect to Unit 1, and that it supported HLP's recommendation that Unit 1 was ready to restart. Unit 1 restarted in late February 1994 and operated at low power for three days. The Project Manager then shut down Unit 1 due to a problem with a steam generator feedwater valve and a steam generator tube leak. The Project Manager expects to make the necessary repairs and restart Unit 1 in late March 1994, although additional delays may occur.\nWhile many of the corrective actions taken are common to both units, HLP must demonstrate to the NRC that these issues are also resolved with respect to Unit 2 before it is restarted. HLP estimates that Unit 2 will restart during the second quarter of 1994 after the completion of refueling, which began in March 1993 but was delayed in order to focus on the issues discussed above. The outage has not affected the Company's ability to meet customer demands because of existing capacity and the Company's ability to purchase additional energy from affiliates and nonaffiliates.\nDuring 1993, the NRC imposed a total of $500,000 in fines against HLP in connection with violations of NRC requirements that occurred prior to the February 1993 shut down. No fines have been imposed for activities subsequent to the shut down. The Company has paid its portion (25.2%) of the cost of fines.\nThe Company's share of increased non-fuel operation and maintenance costs in 1993, related to the outage at STP, necessary to effect the needed improvements were approximately $29 million, and were expensed as incurred. Included in these expenses were detailed inspections of both units' steam generators, and the acceleration of certain maintenance activities from 1994 to 1993. This acceleration is expected to eliminate the need for any planned outages for either unit in 1994. The 1994 budgeted STP non-fuel operation and maintenance expenses are expected to be significantly lower than the 1993 actual expenses; but even though lower, they are expected to be sufficient to continue enhancements that will result in improved long-term performance of STP.\nPursuant to the substantive rules of the Texas Commission, the Company generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and the Company's collection of revenues by such fuel factors is subject to adjustment at the time of a fuel reconciliation proceeding before the Texas Commission. The difference between fuel revenues billed and fuel expense incurred is recorded as an addition to or a reduction of revenues, with a corresponding entry to unrecovered fuel cost or other current liabilities, as appropriate. Any fuel costs (not limited to under- or over-recoveries) which the Texas Commission determines as unreasonable in a reconciliation proceeding are not recoverable from customers.\nDuring the outage, the Company's fuel and purchased power costs have been, and are expected to continue to be, increased as the power normally generated by STP must be replaced through sources with higher costs. It is unclear how the Texas Commission will address the reasonableness of higher costs associated with the outage. At January 31, 1993, before the start of the STP outage, the Company had an over-recovered fuel balance of $5.2 million, exclusive of interest. At January 31, 1994, the Company's under-recovered fuel balance was $55.7 million, exclusive of interest. This under-recovery of fuel costs, while due primarily to the STP outage, was also affected by changes in fuel prices and timing differences. The Company cannot accurately estimate the amount of any future under- or over-recoveries due to the unpredictable nature of the above factors. Although there is the potential for disallowance of fuel-related costs, such determination cannot be made until fuel costs are reconciled with the Texas Commission. If a significant portion of fuel costs were disallowed by the Texas Commission, the Company could experience a material adverse effect on its results of operations in the year of any disallowance. The Company is required by Texas Commission's rules to file a reconciliation of its fuel costs by May 1, 1994. However, the Texas Commission Staff is proposing a revised filing deadline that would not require the Company to file before the fourth quarter of 1994.\nIn July 1993, the Company filed a fuel surcharge petition, which is separate from a fuel reconciliation proceeding, with the Texas Commission to comply with the mandatory provisions of the Texas Commission's fuel rules. The petition requested approval of a customer surcharge to recover under-recovered fuel and purchased power costs resulting from the STP outage, increased natural gas costs and other factors. The petition also requested that the Texas Commission postpone consideration of the surcharge until the STP outage concluded or at the time fuel costs are next reconciled as discussed above. In August 1993, a Texas Commission ALJ granted the Company's request to postpone consideration of the surcharge. In January 1994, the Company updated its fuel surcharge petition to reflect amounts of under-recovery through November 1993. Likewise, the Company requested and was granted postponement of the updated petition until the STP outage concluded or at the time fuel costs are next reconciled.\nManagement believes that the operating outage at STP will not have a material effect on its financial condition or on its results of operations.\nRate Case Filings. During December 1993 and January 1994, several cities (Cities) in the Company's service territory exercised their rights to require the Company to file rate cases to determine if its rates are fair, just and reasonable. The Cities, together, account for approximately 40% of the Company's base revenues. The governing bodies of these Cities have original jurisdiction over rates only within their incorporated limits. The Cities have ordered the Company to file rate cases by various dates from February 17 through March 18, 1994, with hearings scheduled in February and March 1994.\nThe Cities have informed the Company that this rate review was precipitated by the outage at STP leading the Cities to question whether STP should continue to be included in the Company's rate base. Further, the Cities question whether the Company is earning an excessive return on equity. In February 1994, a consultant for the Cities filed its report with the Cities. The consultant recommended that STP Unit 2 be removed from the Company's rate base, resulting in a reduction of the Company's total base revenues of $106.5 million. The consultant did not recommend a reduction in revenues relating to STP Unit 1, nor did it suggest a revenue reduction for its contention that the Company's earnings have been excessive, but it suggested that those issues be reserved for future proceedings if circumstances warrant action. Furthermore, the consultant made no recommendations concerning STP operation and maintenance expenses.\nThe Company contends that both units of STP belong in rate base because of the long-term benefits nuclear generation provides to customers. The Company is not aware of any Texas Commission precedent directly supporting the removal of a nuclear plant from rate base because of outages of the duration experienced by Unit 1 and expected for Unit 2. The Company also believes that its return on equity is below the level specified for the rate freeze period in accordance with the stipulated agreement entered into by the Company and parties to its last rate order, including the Cities. This rate order does not restrict the Cities from exercising their original jurisdiction over rates during the rate freeze period. The Texas Commission has appellate jurisdiction over rates set by municipalities.\nIn February and early March 1994, some of the Cities passed resolutions ordering the Company to reduce rates by $73 million, if applied on a total company basis. These Cities' revenues represent approximately 20% of the Company's total base revenues. The orders only affect the rates of customers who take service within these Cities' limits. The orders call for rates to be reduced in April unless, on appeal, the Texas Commission takes action which would stay their effectiveness. The Company has appealed these orders to the Texas Commission seeking the actions necessary to stay their effectiveness. The Company cannot predict if other cities acting in their capacity as regulatory authorities will initiate similar proceedings.\nIn December 1993, a complaint was filed at the Texas Commission by a customer of the Company who takes service outside of municipal limits, where the Texas Commission has original jurisdiction. The complaint seeks a review of the Company's rates due to the outage at STP. The Texas Commission has docketed the proceeding, but has taken no other action in the matter. In March 1994, the OPUC and General Counsel petitioned the Texas Commission to review the Company's rates. Any rate orders which might ultimately be entered as a result of these filings would affect customers served by the Company in all areas where individual city regulatory authorities do not have original jurisdiction.\nManagement cannot predict the ultimate outcome of these rate filings, although management believes that their ultimate resolution will not have a material adverse effect on the Company's results of operations or financial condition.\nWestinghouse Litigation. The Company and other owners of STP are plaintiffs in a lawsuit filed October 1990 in the District Court in Matagorda County, Texas against Westinghouse, seeking damages and other relief. The suit alleges that Westinghouse supplied STP with defective steam generator tubes that are susceptible to stress corrosion cracking. Westinghouse filed an answer to the suit in March 1992, denying the plaintiff's allegations. The suit is currently in the discovery phase.\nInspections during the current STP outage have detected early signs of stress corrosion cracking in tubes at STP Unit 1, but the resulting remedial measures to date have not resulted in a material expense to the Company. Management believes that any additional problems would develop gradually and could be monitored by the operators of STP. An accurate estimate of the costs of remedying any further problems currently is unavailable due to many uncertainties, including among other things, the timing of repairs, which may coincide with scheduled outages, and the recoverability of amounts from Westinghouse and any insurers. Management believes that the ultimate resolution of this matter will not have a material adverse effect on the Company's results of operations.\nGeneral. The Company is party to various other legal claims, actions and complaints arising in the normal course of business. Management does not expect disposition of these matters to have a material adverse effect on the Company's results of operations or financial condition.\n10. COMMITMENTS AND CONTINGENT LIABILITIES\nIt is estimated that the Company will spend approximately $187 million for construction purposes in 1994. Substantial commitments have been made in connection with the construction program.\nTo supply a portion of the fuel requirements of its generating plants, the Company has entered into various commitments for the procurement of fuel.\nNuclear Insurance\nIn connection with the licensing and operation of STP, the owners have purchased the maximum limits of nuclear liability insurance, as required by law, and have executed indemnification agreements with the NRC in accordance with the financial protection requirements of the Price-Anderson Act.\nThe Price-Anderson Act, a comprehensive statutory arrangement providing limitations on nuclear liability and governmental indemnities is in effect until August 1, 2002. The limit of liability under the Price-Anderson Act for licensees of nuclear power plants is $9.3 billion per incident effective February 1994. The owners of STP are insured for their share of this liability through a combination of private insurance amounting to $200 million and a mandatory industry-wide program for self-insurance totaling $9.1 billion. The maximum amount that each licensee may be assessed for each licensed reactor under the industry-wide program of self-insurance following a nuclear incident at an insured facility is $75.5 million which may be adjusted for inflation plus a five percent charge for legal expenses, but not more than $10 million per reactor for each nuclear incident in any one year. The Company and each of the other STP owners are subject to such assessments, which the Company and the other owners have agreed will be borne on the basis of their respective ownership interests in STP. For purposes of these assessments, STP has two licensed reactors.\nThe owners of STP currently maintain on-site decontamination liability and property damage insurance in the amount of $2.7 billion provided by American Nuclear Insurers (ANI) and the Nuclear Electric Insurance Limited (NEIL) II program. Policies of insurance issued by ANI and NEIL II stipulate that policy proceeds must be used first to pay decontamination and clean-up costs, before being used to cover direct losses to property. The Company and the other owners of STP have entered into an agreement that provides for the total cost of decontamination liability and property insurance for STP (including premiums and assessments) to be shared pro rata based upon each owner's respective ownership interests in STP.\nThe Company purchases, for its own account, business interruption and extra expense insurance under the NEIL I Business Interruption and\/or Extra Expense Program. This insurance will reimburse the Company for extra expenses incurred, up to $1.7 million per week, for replacement generation or purchased power as the result of a covered accident that shuts down production at STP for more than 21 weeks. The maximum amount recoverable for Unit 1 is $103.4 million and for Unit 2 is $105.9 million. The Company is subject to an additional assessment up to approximately $2.2 million for the current policy year in the event that losses as a result of a covered accident at a nuclear facility insured under NEIL I exceeds the accumulated funds available under the NEIL I Business Interruption and\/or Extra Expense Program.\n11. QUARTERLY INFORMATION (UNAUDITED)\nThe following unaudited quarterly information includes, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such amounts:\nElectric Operating Operating Net Revenues Income Income Quarter Ended (thousands)\nMarch 31 $240,910 $41,346 $28,598 Adjustment (2,656) (1,753) 25,962 ------- ------ ------ March 31 Restated $238,254 $39,593 $54,560 ======= ====== ======\nJune 30 298,863 55,400 42,334 Adjustment 17,190 11,345 11,345 ------- ------ ------ June 30 Restated $316,053 $66,745 $53,679 ======= ====== ======\nSeptember 30 383,087 85,916 75,510 Adjustment 4,103 2,522 2,102 ------- ------ ------ September 30 Restated $387,190 $88,438 $77,612 ======= ====== ======\nDecember 31 (1) $282,031 $(4,697) $(13,426) ======= ====== ====== March 31 $227,513 $46,838 $34,022 June 30 267,959 60,984 47,527 September 30 338,215 95,474 83,426 December 31 279,736 63,369 53,536\n(1) Operating and net income includes the effect of a pre-tax charge of $29 million related to the Company's restructuring as discussed in ITEM 7. MANAGEMENTS'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Restructuring.\nQuarterly information for 1993 has been restated to reflect the change in accounting for unbilled revenues and the adoption of SFAS No. 112, Employers' Accounting for Postemployment Benefits See NOTE 1, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. These changes were made in December 1993, but were effective January 1, 1993.\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Central Power and Light Company:\nWe have audited the accompanying balance sheets and statements of capitalization of Central Power and Light Company (a Texas corporation and wholly owned subsidiary of Central and South West Corporation) as of December 31, 1993 and 1992, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Central Power and Light Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In 1993, as discussed in the Notes to the financial statements, the Company changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits. Our audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental schedules V, VI, IX, X and Exhibit 12 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules and exhibit have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nArthur Andersen & Co.\nDallas, Texas February 25, 1994\nREPORT OF MANAGEMENT\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of Central Power and Light Company as well as all other information contained in this report. The financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, in some cases, reflect amounts based on the best estimates and judgments of management, giving due consideration to materiality. Financial information contained elsewhere in this report is consistent with that in the financial statements. The Company maintains an adequate system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the Company are properly safeguarded. The system of internal controls is documented, evaluated and tested by the Company's internal auditors on a continuing basis. Due to the inherent limitations of the effectiveness of internal controls no internal control system can provide absolute assurance that errors and irregularities will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived. No material internal control weaknesses have been reported to management. Arthur Andersen & Co. was engaged to audit the financial statements of the Company and issue a report thereon. Their audit was conducted in accordance with generally accepted auditing standards. Such standards require an examination of selected transactions and other procedures sufficient to provide reasonable assurance that the financial statements are not misleading and do not contain material errors. The Report of Independent Public Accountants does not limit the responsibility of management for information contained in the financial statements and elsewhere in the report.\nRobert R. Carey President and Chief Executive Officer\nMelanie J. Richardson Vice President and Treasurer\nDavid P. Sartin Controller and Secretary\nREPORT OF AUDIT COMMITTEE\nThe Audit Committee of the Board of Directors is composed of six outside directors. The members of the Audit Committee are: Robert A. McAllen, Chairman, Jim L. Peterson, Ruben M. Garcia, H. Lee Richards, Pete Morales, Jr. and S. Loyd Neal, Jr. The Committee held two meetings during 1993. The Committee oversees the Company's financial reporting process on behalf of the Board of Directors. The Committee discusses with the internal auditors and the independent public accountants the overall scope and specific plans for their respective audits. The Committee also discusses the Company's financial statements and the adequacy of internal controls. The Committee meets regularly with the Company's internal auditors and independent public accountants to discuss the results of their audits, their evaluations of internal controls, and the overall quality of the Company's financial reporting. The meetings are designed to facilitate any private communication with the Committee desired by the internal auditors or independent public accountants.\nRobert A. McAllen Chairman, Audit Committee\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone. PART III\nCSW common stock amounts in ITEM 11 and ITEM 12 reflect the two-for-one common stock split, effected by a 100% common stock dividend paid March 6, 1992 to shareholders of record on February 10, 1992.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\n(a) The following is a list of directors of the Company, together with certain information with respect to each of them:\nName, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nE. R. BROOKS. . . . . . . . . . . . . . . . . . . AGE - 56 1991\nChairman, President and CEO of CSW since February 1991. President of CSW from September 1990 to February 1991. President and Chief Operating Officer of CSW from January 1990 to September 1990 and Executive Vice President of CSW from 1987 to 1989. Director of CSW and each of its subsidiaries. Director of Hubbell, Electric, Inc. and of Baylor University Medical Center, Dallas, Texas.\nROBERT R. CAREY. . . . . . . . . . . . . . . . . .AGE - 56 1989\nPresident and CEO of the Company since January 1990. Executive Vice President and Chief Operating Officer of the Company from 1989 to 1990. Vice President, Operations of the Company from 1988 to 1989. Director of Corpus Christi National Bank, Corpus Christi, Texas.\nRUBEN M. GARCIA. . . . . . . . . . . . . . . . . .AGE - 62 1981\nPresident or principal of several firms engaged primarily in construction and land development in the Laredo, Texas area.\nHARRY D. MATTISON (1). . . . . . . . . . . . . . .AGE - 57 1994\nExecutive Vice President of CSW since September 1990 and Chief Executive Officer of CSWS since December 1993. Chief Operating Officer of CSW from September 1990 to December 1993. President and Chief Executive Officer of SWEPCO from September 1988 to September 1990. Director of each of CSW's wholly owned subsidiaries.\nROBERT A. McALLEN. . . . . . . . . . . . . . . . .AGE - 59 1983\nRobert A. McAllen Investments, Inc., Weslaco, Texas. Consultant to First National Bank, Edinburg, Texas.\nPETE MORALES, JR. . . . . . . . . . . . . . . . . AGE - 53 1990\nPresident and General Manager of Morales Feed Lots, Inc., Devine, Texas. Director of Devine State Bank, Devine, Texas.\nS. LOYD NEAL, JR. . . . . . . . . . . . . . . . . AGE - 56 1990\nPresident of Hilb, Rogal and Hamilton Company of Corpus Christi, an insurance agency, Corpus Christi, Texas.\nName, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nJIM L. PETERSON. . . . . . . . . . . . . . . . . .AGE - 58 1989\nPresident and CEO of Whataburger, Inc. from 1974 to 1993. Director of Mercantile Bank of Corpus Christi.\nH. LEE RICHARDS. . . . . . . . . . . . . . . . . .AGE - 60 1987\nChairman of the Board of Hygeia Dairy Company, Harlingen, Texas. Director of Harlingen National Bank, Harlingen, Texas.\nMELANIE J. RICHARDSON. . . . . . . . . . . . . . .AGE - 37 1993\nVice President, Administration and Treasurer of the Company since 1993. Vice President, Corporate Services and Treasurer of the Company from 1992 to 1993. Treasurer of the Company since March 1992. Director of Internal Audits of the Company 1991 to 1992. Manager of Personnel Services of the Company 1990 to 1991. Manager of Financial Audits of the Company 1986 to 1990.\nJ. GONZALO SANDOVAL. . . . . . . . . . . . . . . .AGE - 45 1992\nVice President, Operations\/Engineering of the Company since 1993. Vice President, Regional Operations of the Company from 1992 to 1993. Vice President, Corporate Services of the Company from 1991 to 1992. General Manager of the Southern Region from 1988 to 1991.\nB. W. TEAGUE. . . . . . . . . . . . . . . . . . . AGE - 55 1984\nVice President, Marketing and Business Development of the Company since 1991. Vice President, Corporate Services of the Company from 1988 to 1991. Senior Vice President, District Operations of the Company from 1986 to 1988.\nGERALD E. VAUGHN. . . . . . . . . . . . . . . . . AGE - 51 1993\nVice President, Nuclear of CSWS since January 1994. Vice President, Nuclear Affairs of the Company since July 1993. Vice President for Nuclear Services of Carolina Power and Light Company, Raleigh, North Carolina, from 1990 to 1993. Vice President of Nuclear Operations at HLP from 1987 to 1990. __________________________\n(1) Mr. Mattison was elected to the Board effective February 1, 1994, replacing Dale E. Ward. Mr. Ward resigned from the Board in January 1994 upon his transfer to CSWS as Vice President of Production Engineering.\nAll outside directors have engaged in their respective principal occupations listed above for a period of more than five years, unless otherwise indicated.\n(b) The following is a list of the executive officers who are not directors of the Company, together with certain information with respect to each of them:\nYear First Elected to Present Name Age Present Position Position\nDavid P. Sartin 37 Controller and Secretary 1991\n__________________________\nEach of the directors and executive officers of the Company is elected to hold office until the first meeting of the Company's Board of Directors after the 1994 annual meeting of stockholders, presently scheduled to be held on April 14, 1994. Each of the executive officers listed in the table above has been employed by the Company or an affiliate in the CSW System in an executive or managerial capacity for at least the last five years except for Mr. Vaughn.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nCash and Other Forms of Compensation\nThe following table sets forth the aggregate cash and other compensation for services rendered for the fiscal years of 1993, 1992, and 1991 paid or awarded by the Company to the Named Executive Officers.\nOption\/SAR Grants\nNo grants of CSW common stock options or CSW SARs were made in 1993.\nOption\/SAR Exercises and Year-End Value Table\nShown below is information regarding CSW common stock option\/SAR exercises during 1993 and unexercised CSW common stock options\/SARs at year-end for the Named Executives Officers.\nLong-term Incentive Plan Awards Table\nThe following table shows information concerning awards made to the Named Executive Officers during 1993 under CSW's Long-Term Incentive Plan (\"LTIP\"):\nLong-Term Incentive Plan Awards Made in 1993\nPerformance Estimated Future or Payouts under Number of CSW Other Period Non-Stock Price Based Plans\nUntil Shares, Units or Maturation Threshold Target Maximum Name Other Rights (#) or Payout ($) ($) ($)\nRobert R. Carey 1 2 years - 137,238 205,857 Dale E. Ward 1 2 years - 28,105 42,158 B. W. Teague 1 2 years - 28,105 42,158 J. Gonzalo Sandoval 1 2 years - 28,105 42,158 C. Wayne Stice 1 - - - -\nPayouts of the awards are contingent upon CSW's achieving a specified level of total shareholder return, relative to a peer group of utility companies, for the three-year period ended December 1995. Such return must also exceed the average six-month treasury bill rate for the same period in order for any payout to be made. If the Named Executive Officer's employment is terminated during the performance period for any reason other than death, total and permanent disability or retirement, then the award is generally canceled.\nThe LTIP contains a provision accelerating awards upon a change in control of CSW. If a change in control of CSW occurs, (a) all options and SARs become fully exercisable, (b) all restrictions, terms and conditions applicable to all restricted stock are deemed lapsed and satisfied and (c) all performance units are deemed to have been fully earned, as of the date of the change in control. Awards which have been granted and outstanding for less than six months as of the date of change in control are not then exercisable, vested or earned on an accelerated basis. The LTIP also contains provisions designed to prevent circumvention of the above acceleration provisions generally through coerced termination of an employee prior to the change in control of CSW.\nRetirement Plans Pension Plan Table\nAnnual Benefits After Average Compensation Specified Years of Credited Service 20 25 30 or more $100,000 . . . . . . . . . . . . . . . $ 33,333 $ 41,667 $ 50,000 150,000 . . . . . . . . . . . . . . . 50,000 62,500 75,000 200,000 . . . . . . . . . . . . . . . 66,667 83,333 100,000 250,000 . . . . . . . . . . . . . . . 83,333 104,167 125,000 300,000 . . . . . . . . . . . . . . . 100,000 125,000 150,000 350,000 . . . . . . . . . . . . . . . 116,333 145,833 175,000\nExecutive officers are eligible to participate in the tax-qualified, CSW Pension Plan like other employees of the Company. Certain executive officers, including the Named Executive Officers, are also eligible to participate in the CSW Special Executive Retirement Plan (SERP), a non-qualified ERISA excess benefit plan. Such pension benefits depend upon years of credited service, age at retirement and amount of covered compensation earned by a participant. The annual normal retirement benefits payable under the pension and the SERP are based on 1.67% of \"average compensation\" times the number of years of credited service (reduced by (i) no more than 50% of a participant's age 55 Social Security benefit, and (ii) certain other offset benefits).\n\"Average compensation\" means the average covered compensation (salary as reported in the Summary Compensation Table) during the 36 consecutive months of highest pay during the 120 months prior to retirement. The combined benefit levels in the table above, which include both the pension and SERP, are based on assumed retirement at age 65, the years of credited service shown, continued existence of the plans without substantial change, and payment in the form of a single life annuity.\nRespective years of credited service and ages, as of December 31, 1993, for the Named Executive Officers are as follows: Mr. Carey, 26 and 56; Mr. Stice, 30 and 56; Mr. Ward, 21 and 46; Mr. Sandoval, 20 and 45, and Mr. Teague, 30 and 55.\nMeetings and Compensation. The Board of Directors held four meetings during 1993. Directors who are not also executive officers and employees of the Company or its affiliates receive annual directors' fees of $6,000 for serving on the Board and a fee of $300 plus expenses for each meeting of the Board or committee attended.\nThose directors who are not also officers of the Company are eligible to participate in a deferred compensation plan. Under this plan such directors may elect to defer payment of annual directors' and meeting fees until they retire from the Board or as they otherwise direct.\nCompensation Committee Interlocks and Insider Participation. No person serving during 1993 as a member of the Executive Compensation Committee of the Board of Directors of CSW served as an officer or employee of the Company during or prior to 1993. No person serving during 1993 as an executive officer of the Company serves or has served on the compensation committee or as a director of another company, one of whose executive officers serves as a member of the Executive Compensation Committee of CSW or as a director of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nAll 6,755,535 shares of the Company's outstanding Common Stock, $25 par value, per share, are owned beneficially and of record by CSW, 1616 Woodall Rodgers Freeway, Dallas, Texas 75202.\nSecurity Ownership of Management\nThe following table shows CSW common stock beneficially owned as of December 31, 1993, by each director, the Named Executive Officers and, as a group, all directors and executive officers of the Company. Share amounts shown in this table include restricted stock, options exercisable within 60 days after year-end shares of CSW common stock credited to Central and South West Corporation Thrift plan accounts, and all other shares of CSW common stock beneficially owned by the listed persons. Each person has a sole voting and investment power with respect to all shares listed in the table below unless otherwise indicated.\nBeneficial Ownership as of December 31, 1993 Name CSW Common Stock (1)(2)\nE. R. Brooks 60,959 Robert R. Carey 10,734 Ruben M. Garcia - Robert A. McAllen 2,000 Pete Morales, Jr. - S. Loyd Neal, Jr. 323 Jim L. Peterson - H. Lee Richards - Melanie J. Richardson 757 J. Gonzalo Sandoval 6,225 C. Wayne Stice 4,087 B. W. Teague 2,701 Gerald E. Vaughn 500 Dale E. Ward 8,659\nAll of the above and other executive officers as a group 99,192 ____________________\n(1) Included in these amounts for Mr. Brooks, Mr. Carey, Mr. Mattison, Mr. Stice, Mr. Ward, Mr. Teague and Mr. Sandoval are restricted stock of 7,172, 3,963, 4,708, 0, 948, 726 and 264, respectively. These individuals have voting power, but not investment power with respect to these shares. The above shares also include 9,531, 5,643, 6,176, 1,015, 1,045, 0, 971, and 938 shares underlying immediately exercisable options held by Mr. Brooks, Mr. Carey, Mr. Mattison, Mr. Stice, Mr. Ward, Mr. Teague, Mr. Sandoval and the directors and executive officers as a group, respectively.\n(2) All directors' and executive officers' shares owned as of January 1, 1994, as indicated are owned directly and aggregate less than one percent of the outstanding shares of such class.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nPage Reference\n(a) Financial Statements (Included under \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\"):\nReport of Independent Public Accountants. 42\nStatements of Income for the years ended 24 December 31, 1993, 1992 and 1991.\nStatements of Retained Earnings for the 24 years ended December 31, 1993, 1992 and 1991.\nBalance Sheets as of December 31, 1993 25 and 1992.\nStatements of Cash Flows for the years 26 ended December 31, 1993, 1992 and 1991.\nStatements of Capitalization as of 27 December 31, 1993 and 1992.\nNotes to Financial Statements. 28-41\n(b) Reports on Form 8-K:\nThe Company filed a report on Form 8-K dated March 10, 1994, reporting ITEM 5. OTHER EVENTS relating to the STP outage and current rate case proceedings.\n(c) Exhibits:\n3. (a) Restated Articles of Incorporation, as - amended, of the Company (incorporated herein by reference to Exhibit 4(a) to the Company's Registration Statement No. 33-4897, Exhibits 5 and 7 to Form U-1 File No. 70-7171, Exhibits 5, 8.1, 8.2 and 19 to Form U-1 File No. 70-7472 and the Company's Form 10-Q for the quarterly period ended September 30, 1992, ITEM 6, Exhibit 1).\n(b) Bylaws, as amended, of the Company. - (Incorporated herein by reference to Exhibit 3(b) to the Company's 1991 Form 10-K, file No. 0-346.)\nPage Reference\n4. Indenture of Mortgage or Deed of - Trust dated November 1, 1943, executed by the Company to The First National Bank of Chicago and Robert L. Grinnell, as Trustees, as amended through October 1, 1977 (incorporated herein by reference to Exhibit 5.01 in File No. 2-60712), and the Supplemental Indentures of the Company dated September 1, 1978 (incorporated herein by reference to Exhibit 2.02 in File No. 2-62271) and December 15, 1984, July 1, 1985, May 1, 1986 and November 1, 1987 (incorporated herein by reference to Exhibit 17 to Form U-1 File No. 70-7003, Exhibit 4(b) in File No. 2-98944, Exhibit 4 to Form U-1 File No. 70-7236 and Exhibit 4 to Form U-1 File No. 70-7249) and June 1, 1988, December 1, 1989, March 1, 1990, October 1, 1992, December 1, 1992, February 1, 1993 and April 1, 1993 (incorporated herein by reference to Exhibit 2 to Form U-1 File No. 70-7520, Exhibit 3 to Form U-1 File No. 70-7721, Exhibit 10 to Form U-1 File No. 70-7735 and Exhibit 10(a), 10(b), 10(c) and 10(d), respectively, to Form U-1 File No. 70-8053).\n12. Statement re computation of Ratio of 61 Earnings to Fixed Charges for the five years ended December 31, 1993.\n18. Letter from Independent Public Accountants 62 for change in accounting principle.\n23. Consent of Independent Public 63 Accountants.\n24. (a) Powers of Attorney. 64\n(b) Powers of Attorney. 65\n(c) Powers of Attorney. 66\nPage Reference\n(d) Schedules:\nReport of Independent Public 42 Accountants on Supplemental Schedules and Exhibit.\nV. Property, Plant and Equipment for the 56 years ended December 31, 1993, 1992 and 1991.\nVI. Accumulated Depreciation, Depletion 57 and Amortization of Property, Plant and Equipment for the years ended December 31, 1993, 1992 and 1991.\nIX. Short-Term Borrowings for the years 58 ended December 31, 1993, 1992 and 1991.\nX. Supplementary Income Statement 59 Information for the years ended December 31, 1993, 1992 and 1991.\nAll other exhibits and schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements and related notes to financial statements.\nSIGNATURES\nPursuant 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, on March 15, 1994.\nCENTRAL POWER AND LIGHT COMPANY\nBy: David P. Sartin Controller and Secretary\nPursuant 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 March 15, 1994.\nSignature Title\nRobert R. Carey President and CEO and Director (Principal executive officer)\nMelanie J. Richardson Vice President, Treasurer and Director (Principal financial officer)\nDavid P. Sartin Controller and Secretary (Principal accounting officer)\n*E. R. Brooks Director *Ruben M. Garcia Director *Harry D. Mattison Director *Robert A. McAllen Director *Pete Morales, Jr. Director *S. Loyd Neal, Jr. Director *Jim L. Peterson Director *H. Lee Richards Director *J. Gonzalo Sandoval Director *B. W. Teague Director *Gerald E. Vaughn Director\n*Melanie J. Richardson, by signing her name hereto, does sign this document on behalf of the persons indicated above pursuant to a power of attorney duly executed by each such person.\n*By: Melanie J. Richardson Attorney-in-Fact\nSCHEDULE X\nCENTRAL POWER AND LIGHT COMPANY SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED DECEMBER 31\n1993 1992 1991 (thousands)\nReal estate and personal property taxes $55,255 $41,003 $38,817 State gross receipts taxes 14,173 13,685 13,099 Payroll taxes 8,300 7,288 7,032 Franchise taxes 6,420 6,284 1,265(a) State utility commission assessments 1,913 1,822 1,784 Other taxes 333 261 456\n$86,394 $70,343 $62,453\n____________________\n(a) A refund of approximately $3.6 million related to prior years was received in 1991.\nThe amounts of taxes, depreciation and maintenance charged to accounts other than income and expense accounts were not significant. Rents, royalties, advertising and research and development costs during these years were not significant.\nINDEX TO EXHIBITS Exhibit Transmission Number Exhibit Method\n3(a) Restated Articles of Incorporation, as Incorporated amended, of the Company (incorporated by Reference herein by reference to Exhibit 4(a) to the Company's Registration Statement No. 33-4897, Exhibits 5 and 7 to Form U-1 File No. 70-7171, Exhibits 5, 8.1, 8.2 and 19 to Form U-1 File No. 70-7472 and the Company's Form 10-Q for the quarterly period ended September 30, 1992, ITEM 6, Exhibit 1).\n3(b) Bylaws, as amended, of the Company. Incorporated (Incorporated herein by reference to by Reference Exhibit 3(b) to the Company's 1990 Form 10-k, File No. 0-346).\n4 Indenture of Mortgage or Deed of Trust Incorporated dated November 1, 1943, executed by the by Reference Company to The First National Bank of Chicago and Robert L. Grinnell, as Trustees, as amended through October 1, 1977 (incorporated herein by reference to Exhibit 5.01 in File No. 2-60712), and the Supplemental Indentures of the Company dated September 1, 1978 (incorporated herein by reference to Exhibit 2.02 in File No. 2-62271) and December 15, 1984, July 1, 1985, May 1, 1986 and November 1, 1987 (incorporated herein by reference to Exhibit 17 to Form U-1 File No. 70-7003, Exhibit 4(b) in File No. 2-98944, Exhibit 4 to Form U-1 File No. 70-7236 and Exhibit 4 to Form U-1 File No. 70-7249) and June 1, 1988, December 1, 1989, March 1, 1990, October 1, 1992, December 1, 1992, February 1, 1993 and April 1, 1993, (incorporated herein by reference to Exhibit 2 to Form U-1 File No. 70-7520 and Exhibit 3 to Form U-1 File No. 70-7721, Exhibit 10 to Form U-1 File No. 70-7725 and Exhibit 10(a), 10(b), 10(c) and 10(d), respectively, to Form U-1 File No. 70-8053).\n12 Statement re computation of Ratio of Electronic Earnings to Fixed Charges for the five years ended December 31, 1992.\n18 Letter from Independent Public Accountants for change in accounting principle. Electronic\n23 Consent of Independent Public Accountants. Electronic\n24(a) Powers of Attorney. Electronic\n24(b) Powers of Attorney. Electronic\n24(c) Powers of Attorney. Electronic\nEXHIBIT 12","section_15":""}
{"filename":"883702_1993.txt","cik":"883702","year":"1993","section_1":"ITEM 1. BUSINESS\n(a) General description of business\nAcme Metals Incorporated, based in Riverdale, Illinois, is the successor to the original Acme Steel Company which merged with the Interlake Iron Company in 1964 to form Interlake Steel Corporation. The company's name was changed to Interlake, Inc. and was subsequently reincorporated in Delaware on December 19, 1969.\nAs a result of a reorganization in 1986, The Interlake Corporation (\"new Interlake\") became the parent company of Interlake, Inc. (\"old Interlake\"). Old Interlake transferred all but its iron, steel and domestic steel strapping assets and businesses to new Interlake. Old Interlake was again renamed Acme Steel Company, and pursuant to the reorganization, was spun off from new Interlake as a public company in May, 1986.\nIn connection with the spin-off from new Interlake, Acme Steel Company entered into certain indemnification agreements with new Interlake. As discussed in Item 3, Legal Proceedings, significant environmental and tax matters are subject to indemnification by new Interlake under these agreements. To date Interlake has met its obligations with respect to all matters covered by these agreements. The inability of new Interlake to fulfill its obligations, for any reason, under these indemnification agreements could result in increased future obligations for the Acme Steel Company.\nAcme Steel Company undertook a further reorganization in May, 1992 when Acme Metals Incorporated (\"Company\") was formed and became the parent of Acme Steel Company (\"Acme\"), and Acme's former subsidiaries, Acme Packaging Corporation (\"Packaging\"), Alpha Tube Corporation (\"Alpha\"), and Universal Tool & Stamping Co., Inc. (\"Universal\"). The Company has been publicly traded on NASDAQ since 1986.\nThe principal business activities of the Company consist of two separate industry segments namely:\nSTEEL MAKING SEGMENT\nAcme Steel Company - an integrated iron and steel producer\nSTEEL FABRICATING SEGMENT\nAcme Packaging Corporation - steel strapping and strapping products\nAlpha Tube Corporation - welded steel tube products\nUniversal Tool & Stamping Co., Inc. - auto and light truck jack products.\n(b) Financial information about industry segments\nThe Company is reporting its operations by two industry segments, Steel Making and Steel Fabricating, for the first time. Financial information about the Company's industry segments is contained in the BUSINESS SEGMENTS section of the Notes to the Consolidated Financial Statements on page 48.\n(c) Narrative description of business\nSTEEL MAKING SEGMENT\nAcme Steel Company (\"Acme\") is a fully integrated producer of steel products. Acme's line of products is concentrated on the manufacture of flat-rolled steels, including sheet and strip steel. In the flat-rolled steel market Acme specializes in producing carbon steels, especially high carbon steels, alloy steels, and high strength steels. The principal markets served by Acme include the agricultural equipment, automotive components, industrial equipment, industrial fastener, pipe and tube, processor, and tool manufacturing industries. The Company's Steel Fabricating Segment consumes approximately 40% - 45% of Acme's steel production. Acme's focus on external customers is centered around customers whose demand levels and metallurgical requirements are for the small production quantities available from Acme's facilities. Acme's sales represented about 41%, 37% and 37% of total Company sales in 1993, 1992 and 1991 respectively.\nAcme's facilities are located in Riverdale and Chicago, Illinois, and include the following plant facilities: coke ovens, blast furnaces, pigging machines, basic oxygen furnaces, slab, rolling mill, a slab grinder, hot strip mill, pickle lines, cold mill, annealing furnaces, slitter lines, and cut-to-length lines.\nAcme is the smallest integrated steel producer in the U.S. with annual shipping capability of approximately 720,000 tons. This compares with total U.S. shipments of all steel products of approximately 82 million tons.\nSTEEL FABRICATING SEGMENT\nAcme Packaging Corporation (\"Packaging\"), which was incorporated as a separate entity in December 1991, is one of the two major domestic producers of steel strapping and strapping tools in North America and shares approximately 80% of the domestic market equally with its primary competitor. Strapping is currently produced at four plants located throughout the U.S. and represented approximately 33%, 36% and 38% of the Company's sales in 1993, 1992 and 1991, respectively. Principal markets served by Packaging include the agricultural, automotive, brick, construction, fabricated and primary metals, forest products, paper and wholesale industries. Packaging receives all of its steel supply from Acme.\nPackaging currently manufactures its products in four steel strapping plants, located in Riverdale, Illinois; New Britain, Connecticut; Leeds, Alabama and Pittsburg, California.\nPackaging operates in a market estimated to use 420,000 tons of steel strapping annually. The most significant end users of steel strapping include steel and other primary metal producers; lumber and wood products; brick, concrete and clay products; fabricated metals and machinery; textiles and synthetic fibers; and paper mills. These end user industries typically have a low growth rate and are cyclical in nature. Consequently, the steel strapping market is expected to grow at an annual rate of only 1.5% to 2.0% during the next several years.\nPlastic strapping, especially the higher strength polyester products, will continue to penetrate the traditional steel strapping markets of lumber, paper, textiles, wood and synthetic fibers, primarily due to improvements in product strength characteristics. While the balance of the users remain relatively immune to penetration by plastic strapping the increasing market share of this product will continue to limit the growth of the steel strapping market.\nThe U.S. steel strapping market has also experienced continued pricing pressure due to the commodity nature of the product as well as the overcapacity in the industry. The pricing scenario is tied to the flat-rolled steel markets such that increases in flat-rolled steel prices during economic upswings may squeeze the gross margin until price increases can be implemented and accepted by the customer base.\nAlpha Tube Corporation (\"Alpha\"), which was acquired in May, 1989, is a leading producer of high quality welded carbon steel tubing used for furniture, recreational, contractors and automotive applications. Alpha receives the majority of its steel supply from Acme. Alpha markets its products to the appliance, automotive, construction, heating and cooling equipment, household and leisure furniture, material handling, recreational products, and warehouse industries. Alpha's sales represented approximately 16% of total sales for the Company in each of the last three years.\nAlpha operates three facilities in Toledo, Ohio, including two manufacturing facilities equipped with rolling mills for the production of steel tube and pipe, and a plant for slitting steel.\nAlpha operates in a highly competitive market characterized by numerous participants with widely varying capabilities. Many of the producers compete only on price and generally offer little or no technical service.\nThe tubing industry is trending toward products with increased formability, greater gauge control, lighter weight in combination with higher strength and different steel chemistries. Customers, especially automotive, are increasingly demanding just-in-time inventory delivery which is increasing the inventory carrying costs at the tubing manufacturer level.\nUniversal Tool & Stamping Co., Inc. (\"Universal\"), acquired in May 1987, produces automotive and light truck jacks, tire wrenches and accessories for the original equipment manufacturer (\"OEM\") market in North America. Management estimates that it currently holds a 40% share of the OEM market for auto and\nlight truck jacks in North America. Universal receives virtually all its flat-rolled steel supply from Acme. Universal markets its products to domestic and foreign transplant automotive manufacturers and the automotive aftermarket. Universal's sales were approximately 10%, 11% and 9% of total Company sales in 1993, 1992 and 1991, respectively.\nUniversal's production facilities, located in Butler, Indiana, include a computer assisted design and manufacturing system, automated stamping and assembly lines.\nUniversal operates principally in the automotive OEM and aftermarket in the U.S. This market is experiencing several trends including a continuing need by automotive for product development capability and leadership among their suppliers; a continuing trend toward global sourcing capability; continuing pressure by customers for reduced per unit pricing while maintaining or increasing the quality of each unit; and research and development for alternative materials used in manufacturing the product.\nEMPLOYEE RELATIONS\nThe Company has a work force of 2,772 employees, of which 649 are salaried and 2,123 are paid hourly. The unionized work force totals 1,979, or 71% of total employment. None of the salaried work force is unionized and the hourly work force at one site (Alpha) is non-union as well. The Company's relationships with the unions are good. There have been no strikes or work stoppages at any location since the Company's purchase of the plants. The last strike at the Riverdale and Chicago locations was in 1959 during the major steel industry work stoppage. In addition, the Company instituted Labor Management Participation Teams in 1982 as a vehicle for problem solving in a team environment and a Total Quality Improvement Program in 1991 to establish standards to achieve the highest quality product from the existing facilities. Union members participate extensively in these two programs.\nDuring the year the Company reached an agreement with the United Steelworkers on a new labor contract covering approximately 1,500 employees at Acme and Packaging operations in Chicago. The agreement is for six years, contains a no-strike provision, and a wage reopener subject to binding arbitration. The contract was ratified on October 1, 1993.\nRAW MATERIALS\nAcme's principal raw materials are iron ore and coal. Iron ore requirements are expected to continue to be satisfied through an equity interest in Wabush Mines in Newfoundland (Labrador) and Quebec, Canada and through term contracts and purchases on the open market. Acme is obligated to purchase iron ore from Wabush at the higher of production cost or market. Production cost currently approximates market; however, there can be no assurance that the mine's cost structure will not increase in the future in excess of world market prices. During 1993, Acme acquired approximately 56% of its iron ore needs from Wabush under this agreement with the balance of ore requirements at a competitive delivered cost. Coal requirements are expected to be satisfied through term contracts and purchases on the open market. The Company believes Acme's sources of iron ore, coal and other raw materials are adequate to provide for its foreseeable needs.\nENVIRONMENTAL COMPLIANCE\nThe operations of the Company and its subsidiary companies are subject to numerous Federal, state and local laws and regulations providing a comprehensive program of controlling the discharge of materials into the environment and remediation of certain waste disposal sites by responsible parties for the protection of public health and the environment. In addition, various federal and state occupational safety and health laws and regulations apply to the work place environment.\nThe current environmental control requirements are comprehensive and reflect a long-term trend towards increasing stringency as these laws and regulations are subject to periodic renewal and revision. The Company expects these requirements will continue to become even more stringent in future years. The 1990 Federal Clean Air Act amendment, for example, imposed significant additional environmental control requirements upon Acme's coke plant facilities.\nIn prior years, the Company has made substantial capital investments in environmental control facilities to achieve compliance with these laws, incurring expenditures of $9.8 million for environmental projects in the period from 1991 through 1993. The Company anticipates making further capital expenditures of approximately $6 million for environmental projects during 1994 and $7 million in 1995 to maintain\ncompliance with these laws (exclusive of any such expenditures related to the Project (see Item 1(e) for a description of the Project)). In addition, maintenance, depreciation and operating expenses attributable to installed environmental control facilities are having, and will continue to have, an adverse effect upon the Company's earnings. Although all of the Company's subsidiary operating companies are affected by these laws and regulations, similar to other steel manufacturing operations, they have had, and are expected to continue to have, a greater impact upon the Company's steel manufacturing subsidiary than on the Company's other operating subsidiaries.\nThe Company, principally through its operating subsidiaries, is and, from time to time, in the future will be involved in administrative proceedings involving the issuance, or renewal, of environmental permits relating to the conduct of its business. The final issuance of these permits have been resolved on terms satisfactory to the Company and, in the future, the Company expects such permits will be similarly resolved on satisfactory terms; however, from time to time, the Company is required to pursue administrative and\/or judicial appeals prior to achieving a resolution of the terms of such permits.\nFrom time to time, the Company may be involved in administrative or judicial proceedings with various regulatory agencies or private parties in connection with claims the Company's operations have violated certain environmental laws, conditions of existing permits or with respect to the disposal of materials at waste disposal sites. The resolution of such matters may involve the payment of civil penalties, damages, remediation expenses and\/or the expenditure of funds to add or modify pollution control equipment (see Item 3, Legal Proceedings, for a complete description of environmental proceedings).\nBACKLOG; TRADEMARKS; PATENTS\nNone of the Company's subsidiaries had a significant amount of backlog at December 26, 1993 and neither the Company nor its subsidiaries hold any patents, trademarks, licenses or franchises which are deemed material to its overall business.\n(d) Competitive Conditions in the Integrated Steel Industry\nGENERAL STEEL MARKET\nThe U.S. integrated steel industry has suffered economically in the past decade due to increased competition from mini-mills, lack of investment in newer steelmaking technologies, foreign competition (often government subsidized), increasing costs associated with government-mandated environmental regulations and high labor and benefit costs compared to its competition.\nU.S. domestic shipments for all steel products have averaged approximately 80 million tons per year for the last several years. While total U.S. shipments of steel have grown by an average of 2.4% per year since 1982, steel exports by U.S. producers have accounted for most of that growth. Domestic steel consumption has been essentially flat over the past ten years.\nThe industry has total raw steel production capacity estimated to be 110 to 115 million tons. In addition, nearly 85% of current U.S. steel production is continuously cast. These two factors together with the industry's ongoing successful efforts to improve productivity and reduce costs have contributed to significant downward pressure on the price of steel in the marketplace. Real steel selling prices have fallen at an annual rate of 3.5% over the past decade although during 1993, steel prices increased on average. The Company believes the trend toward lower real steel prices will continue, although at a slower rate.\nOver the long term, steel prices will be set by the lowest cost producers, and the lowest costs will be attained through the implementation of new technologies. The flat-rolled steel market provides strong evidence of this downward trend in real steel prices due to decreasing costs. Technological innovation is likely to continue in the steel industry and producers will be required to achieve significant, sustainable cost reductions to succeed.\nSPECIAL GRADE MARKET\nThis component of the flat-rolled market represents the medium carbon, high carbon, high strength low alloy (HSLA) and alloy markets. The total annual specialty market is approximately 3 million tons, of which Acme's share is estimated to be 6% to 7%. However, in the portion of the market where Acme is not\nfacility-limited (where customers can use narrow widths and have no continuous cast requirement), it holds a 30% share. Acme's principal customer markets are agricultural equipment, industrial fasteners, hand and power tools, rerollers, automotive components and construction.\nLOW CARBON FLAT-ROLLED MARKET\nFlat-rolled products comprise approximately 50% of the U.S. steel market, or about 40-45 million tons per year, of which the majority is in low carbon sheet and strip. Acme's share is estimated to be less than 1%. The key end users are automotive OEMs, automotive stampers, can and container manufacturers, the construction industry, appliance makers, tubing manufacturers and steel service centers.\nACME'S COMPETITIVE POSITION\nFor commercial sales to unaffiliated customers, Acme currently competes principally in the mid-and high-carbon and alloy steel markets. Acme has numerous competitors composed principally of steel service centers and, to a lesser extent, small integrated mills.\nAcme faces the same challenges as the rest of the steel industry. It has reported operating losses for 2 of its last 3 years. While Acme has generally outperformed the industry on average over the last 3 years, because of Acme's high overall cost structure resulting from its outmoded steel finishing process and the competitive forces affecting the entire steel industry, steelmaking has proven to be only marginally profitable even at the upper end of the business cycles. Management believes that Acme, and the U.S. steel industry as a whole, benefitted during 1993 from an upturn in the business cycle and increases in steel prices on average over the past year. There can be no assurance that this upturn in the business cycle will continue or that the industry will be successful in maintaining current price levels.\n(e) The Project\nAcme's current rolling mill facilities cannot produce a coil which is large and wide (more than 30 inches) enough to satisfy the needs of many users of flat-rolled steel. In addition, the existing physical limitations of the mill facilities do not allow Acme to fully utilize its existing raw steel manufacturing capability. Further, large users increasingly demand continuously cast materials, and many other users prefer such materials.\nSince 1982, a number of U.S. steel mills have constructed conventional thick slab continuous casting production facilities. There are eleven of such known facilities, which have a combined estimated capacity of 37.1 million tons of flat-rolled steel per year. One additional company is installing conventional thick slab continuous casting production facilities which will have a combined estimated capacity of 2.1 million tons per year.\nThe conventional thick slab facilities are a technological step behind the new continuous thin slab casting facilities, which eliminate the extra heating and rolling necessary to flatten thick slabs to an appropriate dimension. At present there are 2 operating thin slab casting facilities in North America, which have a combined estimated capacity of 2 million tons per year. In addition, thin slab casting facilities are under construction with an estimated combined capacity of 3 million tons. Of the companies currently using or constructing continuous thin slab casters, none have or will have the facilities to use basic oxygen furnace steel as would Acme. Instead, these new installations will use scrap steel as their raw material.\nIn response to these and other competitive concerns, in July 1992, the Company announced that it was conducting a feasibility study of a new continuous thin slab caster\/hot strip rolling mill complex (\"Project\") at the Company's Riverdale, Illinois plant. The study concluded that successful implementation of the Project should result in significantly more favorable financial results for the Company beginning in 1997 than those it would achieve if it continued its steelmaking business with its existing facilities. This improved financial performance would result from increased sales due to increased production capability and product range, higher yields, lower costs, increased efficiency, and more consistent product quality.\nThe Board of Directors of the Company is now in the process of deciding whether to proceed with the Project. The final cost of the Project, including equipment, ancillary facilities and construction, is not yet known and the available estimates vary depending upon various factors including type of equipment selected, costs of financing and general contractor fees. At this time, however, the Company believes the cost of the Project will be between $300 million and $350 million.\nIf constructed, the Project will include facilities for both the continuous casting of thin steel slabs (approximately 2\" in thickness and 60\" in width) (\"Caster\") and the hot rolling of those slabs into steel strip (\"Mill\"). The Project will eliminate the processes Acme now employs for ingot pouring, processing, heating and rolling of ingots into slabs, slab conditioning, and the transportation and storage of ingots and slabs. If completed, the Caster will be the first facility, known to the Company, which utilizes a continuous thin slab casting process in conjunction with cleaner steel produced in a basic oxygen furnace.\nThe Mill would be configured with seven tandem-coupled rolling stands. Each stand sequentially would reduce the thickness of the slab being rolled. At the exit of the seventh stand, the slab's thickness would have been reduced from 2 inches to the final gauge required for the customer's order. With 7 rolling stands, the Mill would be the largest hot strip mill constructed to date for use with a continuous thin slab caster. The Mill's seven stand configuration should allow the Company to produce wider and thinner products, across all steel grades, than any existing continuous thin slab caster\/hot strip mill facility.\nThe Project would be constructed in a new building on a site adjacent to Acme's current steelmaking facilities. Steel production at Acme's existing facilities will continue during the construction of the Project without disruption or reduction of product available for supply to customers. When fully operational, the Project should be capable of producing Acme's anticipated product mix of approximately 970,000 tons of finished steel per year. The limiting factor on annual capacity would be the Caster. The Mill should be capable of producing over two million tons of finished steel annually. Accordingly, if the Project proves to be successful, the Company may consider an expansion of the steelmaking and casting facilities in order to supply a sufficient quantity of thin slabs to more fully utilize the Mill.\nIf undertaken, the Project would involve substantial costs in addition to those for the construction of the facility itself. The new Caster and Mill will eliminate several labor-intensive operations Acme now must employ. The efficiencies resulting from the elimination of these operations will result in a reduction of Acme's workforce of between 250 and 300 people. The Company would be required to take an approximately $4.8 million charge to income in 1994 to account for the costs associated with this workforce reduction. The Company would also be required to take an approximately $8.3 million charge to income in 1994 to reflect a reduction of the useful life of the existing steel finishing facilities which would be replaced by the Project. Further, during the Project's final completion phase, including initial testing, the Company anticipates incurring approximately $15 million of start-up related costs, some of which may be capitalized as part of the Project. In addition, the Company would be required to capitalize the interest expenses associated with the Project during the construction period. This expense is estimated to be approximately $30 - 35 million depending on the nature and amount of the debt used to finance the Project, which amount would be added to the cost of the Project and amortized over the life of the related assets.\nThe Board of Directors of the Company will decide to proceed or not to proceed with the Project based on whether, within the next five months, the Company is able to obtain satisfactory commitments (1) from a manufacturer for the supply of the equipment needed for the Project, (2) from a general contractor for assumption of \"turnkey\" responsibility for the Project, and (3) from credit sources for the financing needed for the Project.\nThe Company is currently studying the advantages and disadvantages of alternative casting equipment configurations for the Project which is manufactured by several different suppliers. One type of equipment under consideration has not yet successfully cast all grades of steel in Acme s projected product mix in commercial applications. Another type of equipment under consideration is not currently operating in any commercial plant. The Company believes after extensive research, and based on pilot plant testing together with successful experience with thick slab casting, that all grades in Acme's product mix can be cast and rolled to reasonable commercial standards; however, there can be no guarantee that the equipment the Company selects will perform in accordance with the feasibility studies.\nThe Company is in discussions with several internationally recognized general contracting firms about their assumption of \"turnkey\" responsibility for the Project. The Company's decision to proceed with the Project depends upon the negotiation of a satisfactory contract with one of these general contractors or a general contractor of similar reputation, capability, and financial resources.\nWith respect to financing, on March 3, 1994, the Company agreed to sell an issue of securities at a price of $21.00 per security on a private placement basis exclusively in Canada. Upon the closing of this transaction, expected to occur on or before August 25, 1994, the securities will be exchangeable on a one-for-one basis, subject to certain conditions, for 5,600,000 common shares of the Company. Conditions for the exchange of the securities for common stock and the Company's receipt of the proceeds of the sale of the securities include confirmation of the availability of not less than 85% of the remaining financing needed for construction of the Project and approval of such construction by the Company's Board of Directors, which approval will occur only after selection of an equipment manufacturer and a general contractor. The securities and the underlying common shares have not been registered under the Securities Act of 1933 (the \"Securities Act\") and may not be offered or sold in the United States or to a U.S. person, as defined in Regulation S under the Securities Act, absent registration or an applicable exemption from registration requirements.\nThere can be no assurances at this time that the conditions to the exchange of the securities for common stock will be satisfied by the August 25, 1994 date (which may be extended by the Company, with the purchasers consent, for a period of up to 20 additional days for further consideration of $27,500 for each extended day) or that the Project will otherwise proceed. If the Project does proceed, the Company believes Acme's existing steel manufacturing operations will continue during construction with minimal disruption. The Project and the activities of the general contractor will be monitored by a project management team composed primarily of existing officers and employees. In the event there are significant problems with the construction of the Project, senior management may have to devote substantial time to those problems and, as a result, may devote substantially less time than is normal to existing operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company, through its subsidiaries, has facilities throughout the United States.\nAcme's principal properties consist of an iron-producing plant in Chicago, Illinois and a steel producing plant in Riverdale, Illinois. These facilities include blast furnaces, coke ovens, pigging machines for the production of molten iron and pig iron, basic oxygen furnaces and rolling mills for the production of flat-rolled steel. Acme also owns equity interests in raw material mining ventures in Newfoundland (Labrador) and Quebec, Canada (iron ore).\nPackaging's principal properties consist of steel strapping plants, which include slitting and painting equipment, in Riverdale, Illinois, New Britain, Connecticut and Leeds, Alabama and a steel strapping plant in Pittsburg, California.\nAlpha's three facilities are located in the Toledo, Ohio metropolitan area. Alpha's facilities include two manufacturing and office buildings and rolling mills for the production of welded steel tubing. Alpha has a third plant at which steel is slit.\nUniversal's facilities are located in Butler, Indiana. Universal's facilities include a manufacturing and office building, a computer assisted design and manufacturing system, and automated forming and assembly lines.\nAll of these plants are owned in fee except for the Alpha facilities which are leased through 1994, and are renewable at the option of the Company.\nIn the opinion of management, the manufacturing facilities of the Company's subsidiaries are properly maintained and their productive capacity is adequate to meet their requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(a) General\nPursuant to an Agreement and Plan of Reorganization as of March 5, 1986, the Company (prior to the Company's 1992 reorganization, the Company was Acme Steel Company, now a subsidiary and formerly called Interlake, Inc. hereinafter referred to as the \"Company\") and Interlake, its former parent company entered into a Tax Indemnification Agreement (\"TIA\"). The TIA generally provides for Interlake to indemnify the Company for certain tax matters. Per the TIA, Interlake is solely responsible for any additional income taxes it is assessed related to adjustments relating to all tax years prior to 1982. With respect to any additional\nincome taxes that are finally determined to be due with respect to the tax years beginning in 1982 through the date of the \"Spin-Off\" (as said term is identified in the Reorganization documents), the Company is responsible for taxes relating to \"Timing Differences\" related to the Company's \"Continuing Operations.\" A \"Timing Difference\" is defined generally as an adjustment to income, deductions or credits which is required to be reported in a tax year beginning subsequent to 1981 through the Spin-Off, but which will reverse in a subsequent year. \"Continuing Operations\" is defined generally as any business and operations conducted by the Company as of the Spin-Off date. Interlake is principally responsible for any additional income taxes the Company is assessed relating to all other adjustments prior to the Spin-Off.\nWhile certain issues have been negotiated and settled between the Company, Interlake and the Internal Revenue Service for the tax years beginning 1982 through the date of the Spin-Off, certain significant issues for the tax years beginning 1985 through the Spin-Off remain unresolved; and on March 17, 1994, the Company received a Statutory Notice of Deficiency (\"Notice\") in the amount of $16.9 million in tax as a result of the Internal Revenue Service's examination of the 1982 through 1984 tax years. Interlake has been principally responsible, pursuant to the TIA, for representing the Company before the Internal Revenue Service for the 1982 through 1984 tax years. Should the government sustain its position as proposed for those unresolved issues and those contained in the Notice, substantial interest would also be due (potentially in an amount greater than the tax claimed). The taxes claimed relate principally to adjustments for which the Company is indemnified by Interlake pursuant to the TIA. The Company has adequate reserves to cover that portion of the tax for which it believes it may be responsible per the TIA. The Company intends to contest the unresolved issues and the Notice.\nTo date Interlake has met its obligations under the TIA with respect to all matters covered. In the event, Interlake, for any reason, was unable to fulfill its obligations under the TIA, the Company could have increased future obligations.\nThe Company's subsidiaries also have various other litigation matters pending which arise out of the ordinary course of their businesses. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the financial position of the Company.\n(b) Environmental\nIn addition to the general matters noted above, the operations of the Company and its subsidiary companies are subject to numerous Federal, state and local laws and regulations providing a comprehensive program of controlling the discharge of materials into the environment and remediation of certain waste disposal sites by responsible parties for the protection of public health and the environment. In addition, various federal and state occupational safety and health laws and regulations apply to the work place environment.\nThe current environmental control requirements are comprehensive and reflect a long-term trend towards increasing stringency as these laws and regulations are subject to periodic renewal and revision. The Company expects these requirements will continue to become even more stringent in future years. The 1990 Federal Clean Air Act amendment, for example, imposed significant additional environmental control requirements upon Acme's coke plant facilities.\nIn prior years, the Company has made substantial capital investments in environmental control facilities to achieve compliance with these laws, incurring expenditures of $9.8 million for environmental projects in the period from 1991 through 1993. The Company anticipates making further capital expenditures of approximately $6 million for environmental projects during 1994 and $7 million in 1995 to maintain compliance with these laws (exclusive of any such expenditures related to the continuous thin slab caster and hot strip mill project should this project be approved by the Company's Board of Directors). In addition, maintenance, depreciation and operating expenses attributable to installed environmental control facilities are having, and will continue to have, an adverse effect upon the Company's earnings. Although all of the Company's subsidiary operating companies are affected by these laws and regulations, similar to other steel manufacturing operations, they have had, and are expected to continue to have, a greater impact upon the Company's steel manufacturing subsidiary than on the Company's other operating subsidiaries.\nThe Company, principally through its operating subsidiaries, is and, from time to time, in the future will be involved in administrative proceedings involving the issuance, or renewal, of environmental permits\nrelating to the conduct of its business. The final issuance of these permits have been resolved on terms satisfactory to the Company and, in the future, the Company expects such permits will be similarly resolved on satisfactory terms; however, from time to time, the Company is required to pursue administrative and\/or judicial appeals prior to achieving a resolution of the terms of such permits.\nFrom time to time, the Company may be involved in administrative or judicial proceedings with various regulatory agencies or private parties in connection with claims the Company's operations have violated certain environmental laws, conditions of existing permits or with respect to the disposal of materials at waste disposal sites. The resolution of such matters may involve the payment of civil penalties, damages, remediation expenses and\/or the expenditure of funds to add or modify pollution control equipment.\nWASTE REMEDIATION MATTERS\nPursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C., Section 9601 ET SEQ. (\"Superfund\") and similar state statutes, liability for remediation of property, including waste disposal sites, contaminated by hazardous materials may be imposed on present and former owners or operators of such property and generators or transporters of such materials to a waste disposal site (i.e., Potentially Responsible Parties, \"PRPs\"). The Company and its operating subsidiaries have been named as PRPs with respect to several such sites. In each instance, the Company's investigation has evidenced either i) the Company had not disposed of waste materials at the site and was not properly named as a PRP; or, ii) the Company's proportion of materials disposed of at such sites is of sufficiently small volume to qualify the Company as a DE MINIMIS contributor of waste material at such sites. This DE MINIMIS status has been confirmed at essentially all of the applicable sites. The following are Superfund sites in which the Company's operating subsidiaries have been identified and to which the Company's investigation discloses the Company i) did not ship waste materials; or ii) the Company is a DE MINIMIS PRP: U.S. Scrap Site, Chicago, Illinois; 9th Avenue Dump Site, Gary, Indiana; MIDCO I and MIDCO II Site, Gary, Indiana; American Chemical Services Site, Griffith, Indiana; Calumet Containers Site, Hammond, Indiana; Aqua-Tech Site, Greer, South Carolina; PSC Resources Site, Palmer, Massachusetts; U.S. Lead Refinery Site, East Chicago, Indiana; Thermo-Chem Site, Muskegon County, Michigan; Port Monroe Landfill Site, Monroe County, Michigan; and Peoples Gas Light and Coke Company Site, Chicago, Illinois.\nAlthough no assurances can be given that new information will not be uncovered which would cause the Company's subsidiary companies to lose their DE MINIMIS status at these sites, or, that the Company, or its subsidiary companies would not be named as PRPs at additional sties, the Company presently believes its total costs for the sites named above will not be material.\nIn addition to the foregoing Superfund sites, the following waste remediation matters relating to the Company's subsidiary companies are currently pending:\nUNIVERSAL TOOL AND STAMPING COMPANY, INC. - CLOSURE PLAN\nA hazardous waste permit application under the Interim Status provision of RCRA was filed on behalf of the Company's Universal Tool & Stamping Company, Inc. subsidiary (\"Universal\") with U.S. EPA and the Indiana Department of Environmental Management (\"IDEM\") for several small temporary storage areas utilized to hold hazardous waste prior to shipment to a permanent, off-site, approved disposal area. A permit was issued categorizing Universal as a Temporary Storage and\/or Disposal facility (\"TSD\") which required a statutory showing of financial responsibility.\nRCRA amendments, which were passed following the issuance of the permit, eliminated the Interim Status classification and Universal attempted to recategorize itself as a Generator of hazardous waste rather than a TSD facility. To be reclassified as a Generator, Universal must meet a statutorily prescribed closure procedure (\"Closure Plan\") for areas where hazardous materials have been temporarily stored. This Closure Plan was submitted by Universal to the Indiana Department of Environmental Management (\"IDEM\"). Closure of area 1 was separated from closure of area 2, 3 and 3-Extended.\nOn September 14, 1989 a complaint was filed by the U.S. EPA pursuant to Section 3008(a)(1) of RCRA as amended, 42 U.S.C. Section 6928 and the U.S. EPA's Consolidated Rules of Practice Governing the Administrative Assessment of Civil Penalties and the Revocation or Suspension of Permits, 40 C.F.R. Part 22.\nThis complaint was resolved pursuant to a Consent Agreement and Final Order whereby Universal, through the Company, provided financial assurances and agreed to cease all treatment, storage or disposal of any hazardous waste. Universal paid a civil penalty in the amount of $9,500.\nIn 1988 Universal submitted a Closure Plan (the \"Plan\") to IDEM following a Notice of Violation arising out of the storage of hazardous wastes for longer than ninety (90) days. This Plan was revised in 1992 and again in 1993. The revised estimated cost of remediation of Area 1 is approximately $25,000. The Plan also provided for remediation of Areas 2, 3 and 3-Extended. The revised estimated cost of remediation of Closure Areas 2, 3 and 3-Extended is estimated at less than $40,000.\nUniversal intends to complete the Closure Plan for those areas where materials were temporarily stored. The costs associated with the remediation of these areas have either been paid or reserved for by Universal; however, while there are no assurances the final costs may not exceed these estimates, they are not expected to be significant.\nENVIRONMENTAL REMEDIATION AT THE PACKAGING FACILITY LOCATED AT 855 NORTH PARKSIDE DRIVE, PITTSBURG, CALIFORNIA\nOn or about March 31, 1988, the Company's Acme Steel Company subsidiary entered into an Asset Purchase Agreement for the acquisition of assets associated with a strapping facility located in Pittsburg East, California (the \"Pittsburg Facility\"). Pursuant to the Company's 1992 reorganization, the Pittsburg Facility was conveyed to the Company's Acme Packaging Corporation subsidiary (\"Packaging\"). During the course of the Company's due diligence investigation conducted prior to the acquisition of the Pittsburg Facility, the Company identified contamination in the soil and groundwater at the Pittsburg Facility. As part of the acquisition, the seller undertook obligations in connection with environmental contamination at the Pittsburg Facility and these obligations were guaranteed by the seller and its parent company. The Company made a demand on prior owners of the Pittsburg Facility and when no satisfactory resolution was achieved, the Company commenced litigation.\nThe litigation was settled in 1990 by agreement among the Company and the prior owners and operators of the Pittsburg Facility. The Settlement required a prior owner to remediate contamination detected in the groundwater, soil or subsurface soil on, under or near the Pittsburg Facility and to investigate and remediate other contamination on, under or near the Pittsburg Facility caused by prior owners of that facility and to investigate and remove contamination brought to the Pittsburg Facility during the remediation program. The prior owner is responsible for preparation of a Remedial Action Plan (the \"Plan\") and to verify that the appropriate local, state and federal agencies have no objection to the Plan as completed. The remediation levels are subject to local, state and federal laws, rules and regulations. The Packaging's participation includes observation of the former owner's actions and to contribute to the funding of the Plan costs in a non-material amount.\nWhile the facility has been closed for business reasons, the remediation, principally in the form of a groundwater extraction and treatment system which discharges the treated water to a nearby sanitary sewer under permit continues. Based on the information available to date, the Packaging's level of financial commitments have not been significant and the balance of its commitment is not anticipated to be significant.\nLEEDS, ALABAMA - ELEVATED LEVELS OF LEAD\nIn September, 1992, the Company's Acme Packaging Corporation subsidiary (\"Packaging\") hired a consulting engineering firm for the purpose of providing soil sampling and analysis in connection with an application for a stormwater permit for its Leeds, Alabama, plant. Pursuant to an investigation conducted by the consultant, elevated levels of lead were discovered on the property, including one area of the property wherein buried drums were discovered containing lead.\nIn January, 1993, Packaging advised the seller of this plant site that the sampling program was initiated in conjunction with filing a Notice of Intent for the plant for coverage under the Alabama Department of Environmental Management's General Stormwater Discharge Permit. The seller was advised that the results of the sampling program showed runoff from the west parking lot area contained elevated concentrations of lead in the samples. Pursuant to Packaging's investigation, Packaging advised the seller that all evidence indicates these conditions were present on the property at the time the seller owned the property\nand were present at the time the Leeds, Alabama, facility was sold to the Company on March 29, 1989; and, pursuant to the terms of the purchase and sale agreements relating to this property, the seller is responsible for remediating any lead or other contaminants located on this property. Without admitting or denying its liability, the seller has retained a consultant to conduct a full investigation, sampling and analysis of the property.\nPackaging is cooperating with the seller regarding the investigation of the contamination of this property by lead, and\/or other substances; however, Packaging intends to vigorously pursue its remedies under the purchase and sale agreements with the seller.\nADMINISTRATIVE AND LITIGATION MATTERS\nThe Company, or its operating subsidiaries are currently involved in the following matters relating to administrative regulations which affect, or may affect, the operations, the permits or the issuance of permits; or litigation relating to the Company:\nACME STEEL COMPANY - NPDES PERMIT\nIn 1991, the Illinois Environmental Protection Agency (\"IEPA\"), issued the Company's Acme Steel Company subsidiary (\"Acme\") a permit, pursuant to the National Pollution Discharge Elimination System (\"NPDES\") regulating non-contact water discharges to the Calumet River from Acme's coke and blast furnace plant facilities. The NPDES permit contains strict temperature and stormwater discharge limitations. Acme filed an appeal of certain conditions of the permit with the Illinois Pollution Control Board (\"IPCB\"). Acme is proceeding to resolve this matter through the administrative proceedings which allow for the filing of a Petition for an Adjusted Standard and a request the IPCB grant Acme an adjusted standard and relief from the temperature limitations. Further, through modification of certain provisions in the permit and the implementation of best management practices, Acme anticipates achieving control of the Acme's stormwater discharge to an the extent that it will achieve compliance with permit conditions.\nIn the event these matters are not resolved through the administrative process as outlined above, Acme will petition the IPCB for a variance from the General Use Water Quality Standards. If issued, a variance will provide temporary relief. Future compliance with permit conditions would be achieved at an estimated capital expenditure of approximately $4.0 million and operating expenses would be incurred at an annual rate of approximately $600,000. In the event Acme's Petition for an Adjusted Standard is denied and a variance is denied, Acme may be subject to penalties until compliance is achieved.\nWhile the Company believes Acme has demonstrated it is entitled to the issuance of an Adjusted Standard, or absent an Adjusted Standard, a variance allowing the Company sufficient time to install additional capital equipment to achieve compliance, there are no assurances the same will be granted. If such relief is not granted, and penalties are assessed, the Company does not have sufficient information to estimate its liabilities for such penalties, if any, which may be assessed.\nREMOVAL CREDITS AND PRETREATMENT\nThe Metropolitan Water Reclamation District of Greater Chicago (\"MWRD\") is a publicly owned treatment works (\"POTW\"). The MWRD applied to the U.S. EPA for authority to revise categorical pretreatment standards to reflect the actual treatment provided by the MWRD for waste water discharged to the MWRD's POTW by industrial users (\"Removal Credits\"). These revised categorical standards, reflecting Removal Credits are essential for the Company's Acme Steel Company subsidiary (\"Acme\") to avoid expenditures for control of 4AAP phenol found in discharges from its coke by-products plant and for control of certain other pollutants. In 1987, the MWRD's application was denied by the U.S. EPA and the denial was upheld by the United States Court of Appeals for the Seventh Circuit. The U.S. EPA maintained that under the Clean Water Act and decisions of U.S. District Courts, that it could not approve Removal Credits until it promulgated \"sludge criteria.\"\nIn 1993, the U.S. EPA promulgated sludge criteria which included the possibility of granting Removal Credits for phenols in certain circumstances. Acme petitioned the MWRD for Removal Credits. Following this petition, the MWRD again applied to the U.S. EPA for authority to grant Removal Credits. While this application was denied, the U.S. EPA stated that if the Agency amends its regulations with respect to phenol 4AAP either as a result of the petition filed by the MWRD or independently, that the MWRD may then resubmit its application.\nAcme filed Comments and a Request for Reconsideration and Clarification concerning U.S. EPA's Standards for Disposal of Sludges with the U.S. EPA and filed a Petition for Review of the U.S. EPA's decision with the Court of Appeals for the DC Circuit. Both the Comments and Request for Reconsideration and the Petition for Review are pending. While Acme continues to challenge the U.S. EPA's denial of the Removal Credits application and is pursuing administrative and legal remedies, Acme could be subject to allegations it is in violation of currently applicable pretreatment standards and could be required to negotiate appropriate resolutions with the U.S. EPA and the MWRD which could result in the payment of penalties. In the event Acme is unsuccessful in its challenge of U.S. EPA's actions, capital expenditures required to bring its discharges to the MWRD into compliance with the current applicable pretreatment standards are estimated at approximately $6.0 million.\nAlthough Acme is vigorously pursuing its administrative and judicial remedies and would vigorously contest any action to assess civil penalties against Acme, the Company does not have sufficient information to estimate its potential liability, if any, if Acme's efforts to obtain such relief, or contest such penalty assessments, are not successful.\nACME STEEL COMPANY CONSENT DECREE (BOF)\nThe Illinois Environmental Protection Agency (\"IEPA\"), through the Illinois Attorney General's Office, filed an enforcement action against the Company's Acme Steel Company subsidiary (\"Acme\") in the Circuit Court of Cook County, Illinois. The IEPA claimed violations of the Illinois Environmental Protection Act and the state of Illinois Air Pollution Control Regulations arising out of the discharge of particulate matter and dust from the Acme's basic oxygen furnace located at its Riverdale facility. During 1993, Acme and the Attorney General for the State of Illinois entered into a Consent Decree which was filed with the Circuit Court of Cook County. The Consent Decree required Acme to improve certain operating and maintenance practices, upgrade certain equipment and pay a civil penalty of $17,500. Acme has completed all requirements of the Consent Decree and is in substantial compliance with all continuing obligations of the Consent Decree.\nUNIVERSAL TOOL & STAMPING COMPANY, INC. CONSENT DECREE COMPLIANCE\nThe Company's Universal Tool & Stamping Company, Inc. subsidiary (\"Universal\") owns and operates a Class B industrial waste water treatment plant (\"WWTP\") subject to a federal Clean Water Act National Pollution Discharge Elimination System (\"NPDES\") permit. The State of Indiana issued a Notice of Violation to Universal in 1985 resulting from violations of the terms and conditions of Universal's NPDES permit. In 1987 Universal entered into a Final Consent Order which provided a schedule for Universal to come into compliance with the NPDES permit affluent limitations and contained additional limitations on Universal's discharge from the WWTP. Compliance with effluent limitations was not achieved until February, 1993. Settlement conferences were held in September, 1993 and a Consent Order was entered into wherein Universal was assessed a Civil Penalty in the amount of $59,175 and which subjected Universal to continued penalties in the event of a violation of the terms of its NPDES permit occurring during a six (6) month period following execution of the Consent Order. Universal continues to operate in compliance with the Consent Order and has not experienced any reportable violations of its NPDES permit or any term of the Consent Order as of this date.\nOTHER MATTERS\nGREAT LAKES INITIATIVE\nThe U.S. EPA and the eight Great Lakes States are currently developing guidelines for discharge standards in the Great Lakes basin pursuant to the Great Lakes Critical Programs Act (\"guidelines\"). These guidelines were due to be issued in 1991; however, due to the complexity of the process and subject, these guidelines have not yet been published. When finalized, these guidelines are expected to require substantially more stringent limitations on industrial discharges to the water of, or entering, the Great Lakes than those currently applicable to such industrial waste waters. After publication of the Guidelines, each state would revise its water discharge regulations to incorporate the substance of the contents of the Guidelines.\nAll of the process waste waters from the Company's Acme Steel Company subsidiary (\"Acme\") are discharged to the Metropolitan Water Reclamation District of Greater Chicago's (\"MWRD\") sewerage system\nfor treatment by the MWRD's municipal sewerage plant. Until such time as the final guidelines are published by U.S. EPA and specific water effluent limitations for the MWRD's public sewerage plants are adopted by the Illinois EPA, the Company is unable to determine whether or not Acme will be subjected to further restrictions on its process water discharges to the MWRD's sewerage system or the cost of implementing such requirements, if any.\n1986 REORGANIZATION MATTERS\nPursuant to an Agreement and Plan of Reorganization dated as of March 5, 1986, (the \"Reorganization\") between the Company (prior to the Company's 1992 reorganization, the Company was Acme Steel Company, now a subsidiary and formerly called Interlake, Inc.; hereinafter referred to as the \"Company\") and its former parent company, The Interlake Corporation (\"Interlake\"), the Company became a separate, publicly held corporation with separate management. In connection with this Reorganization, Interlake and the Company entered into a Cross-Indemnification Agreement, dated May 29, 1986, (the \"Agreement\") more specifically described in Exhibit 10.2 to the Company's Annual Report\/Form 10K filed with the U.S. Securities Exchange Commission for the fiscal year 1992.\nPursuant to the terms of this Agreement, for a period of ten (10) years following the date of the \"Spin-Off\" (as said term is identified in the Reorganization documents), the Company undertook to defend, indemnify and hold Interlake and its affiliates harmless from and against any and all \"Claims,\" as that term is defined in the Agreement, occurring either before or after the date of the Reorganization and which arose out of or are related to the \"Acme Business.\" The Acme Business is more specifically defined in the Agreement as the iron and steel and domestic U.S. steel strapping business as conducted by the Company on or about May 29, 1986. The indemnification by the Company of Interlake with respect to any claims includes, but is not limited to, all claims asserted in connection with the Company's interests or obligations with respect to: Wabush Iron Company, Ltd.; Wabush Mines; Erie Mining Company; Olga Coal Company; assets and liabilities related to qualified welfare and benefit plans with respect to retired, current and future employees of the Company; certain environmental matters relating to the Acme Business, whether brought by a governmental agency or a private entity; workers' compensation matters and occupational safety, health and administration matters; and product liability and general liability matters related to the Acme Businesses. The Agreement designated certain mineral property interests retained by the Company, including land held for the account of the Company by Syracuse Mining Company, a subsidiary of Pickands Mather and Company; stock held in Tilden Iron Mining Company; and, lands owned in Bruce County, Ontario, Canada, as being within the scope of the indemnification.\nSimilarly, and for the same period of time, Interlake undertook to defend, indemnify and hold the Company and its affiliates harmless from and against all \"Claims,\" as that term is defined in the Agreement, occurring either before or after the date of the Reorganization related to the operation of all businesses and properties currently owned, directly or indirectly, by Interlake or any subsidiary of Interlake (other than the Company and its affiliates) and relating to the Transferred Property, as that term is defined in the Reorganization Agreement (but excluding the Acme Business), and, any business and properties discontinued or sold by Interlake or Interlake, Inc. prior to May 29, 1986, including any discontinued or sold businesses or property which, if continued, would be part of the Acme Business. The indemnification by Interlake with respect to any Claims incurred in connection with or arising out of or related to Interlake Business, as that term is defined more specifically in the Agreement, includes but is not limited to: those claims asserted in connection with certain stock options, rights, awards and programs; certain deferred compensation matters; certain matters arising under qualified welfare and benefit plans and post-retirement income plans; and, environmental matters relating to Interlake Businesses whether brought by governmental agencies or private entities. These environmental matters include, without limitation, the lawsuit captioned PEOPLE OF THE STATE OF ILLINOIS V. WASTE MANAGEMENT OF ILLINOIS, INTERLAKE, INC. AND FIRST NATIONAL BANK OF WESTERN SPRINGS, Circuit Court of Cook County, Illinois (No. 85 L 30162); the disposal of materials at the landfill operated by Conservation Chemical located at Gary, Indiana, to the extent such materials originated at the plant of Gary Steel Company; operation of facilities by predecessors of Interlake, Inc. at Duluth, Minnesota; workers' compensation, occupational safety and health matters relating to the Interlake Business; general products liability and general litigation matters related to Interlake's Business; and, the matters arising from Lake Mining Company, Mauthe Mining Company, Odanah Iron Company, Vermillion Mining Company and Western Mining Company.\nPursuant to this Agreement, Interlake has provided the defense and paid all costs in the matter of CITY OF TOLEDO V. BEAZER MATERIALS AND SERVICES, INC., SUCCESSOR-IN-INTEREST TO KOPPERS COMPANY, INC., TOLEDO COKE CORPORATION, THE INTERLAKE CORPORATION, SUCCESSOR-IN-INTEREST TO INTERLAKE, INC., THE INTERLAKE COMPANIES, INC., SUCCESSOR-IN-INTEREST TO INTERLAKE, INC., ACME STEEL COMPANY, SUCCESSOR-IN-INTEREST TO INTERLAKE, INC., United States District Court, Northern District of Ohio, Western Division, Case No. 3:90 CV 7344, which is an action for declaratory and injunctive relief by the City of Toledo (the \"City\") to recover its past and future costs and damages associated with the presence of and release of hazardous substances, hazardous wastes, solid waste, industrial waste and other waste at or about property located on Front Street in Toledo, Ohio. The City seeks relief pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), the Resource Conservation Recovery Act (\"RCRA\") and on the basis of nuisance. City claims that the defendants owned and\/or operated facilities located on Front Street in Toledo, Ohio which generated, transported and\/or treated, stored or disposed of hazardous substances, hazardous wastes, solid wastes and industrial wastes or other wastes which were released at and from the facility by defendants or successors-in-interest to the entities which owned, operated, generated, transported and\/or treated, stored or disposed of said substances. Interlake also has and continues to provide indemnification to the Company for the Duluth, Minnesota, facility which has been designated as a Superfund Site pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C. Section 9601, ET SEQ.\nTo date Interlake has met its obligations under the Cross-Indemnification Agreement with respect to all matters covered therein affecting the Company, including those matters related to litigation and environmental matters. The Company does not have sufficient information to determine the potential liability of the Company, if any, for the matters covered by the Agreement in the event Interlake fails to meet its obligations thereunder in the future. In the event, Interlake, for any reason, was unable to fulfill its obligations under the Cross-Indemnification Agreement, the Company could have increased future obligations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's security holders during the last quarter of the last fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe information relating to the market for the Company's common stock and related shareholder matters appears in the note to consolidated financial statements titled LONG-TERM DEBT and REVOLVING CREDIT AGREEMENT, page 45, and on the inside back cover of the Annual Report under the captions STOCK MARKET INFORMATION and DIVIDEND POLICY which is incorporated by reference in this Form 10-K Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCertain amounts have been reclassified to conform with the 1993 presentation. A ten-year presentation is provided. Acme Metals Incorporated, formerly Acme Steel Company, became a public company in 1986 when, following the reorganization of Interlake, Inc., the shares of the company were distributed to shareholders of The Interlake Corporation, pursuant to a reorganization of Interlake, Inc. Financial data for 1984 and 1985 have been reconstructed.\nTEN YEARS IN REVIEW (dollars in thousands except for per share data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBUSINESS ENVIRONMENT\nIn 1993, Acme enjoyed an improvement in orders and pricing that benefitted the steel industry as a whole. Order rates for all products increased significantly during the year. The Steel Making Segment increased its average selling price for commercial steel by $40 per ton (approximately 10%) over the course of 1993. However, in comparison to the prior year, selling prices were up only 3 percent as Acme, like most steel producers, did not feel the impact of the price hike until the second half of the year due to the gradual phase-in period of the price increase. Average selling prices for the Steel Fabricating Segments' products were higher in 1993 with steel strapping and welded steel tube prices increasing largely in response to price increases by suppliers of raw materials as well as competitors.\nThe Steel Making Segment operates in a highly competitive market with lower cost steel-making techniques and intensifying competition from other steel producers, foreign imports and substitute materials, severely limiting the steel industry's ability to achieve and sustain higher prices. In fact, even with the price increases instituted in 1993, average steel prices remain only slightly higher than the average price levels in 1988. Because of this intensifying competition and price stagnation for our products, the Company's management and its Board of Directors are evaluating the costs and benefits of building a continuous thin-slab caster\/hot strip mill complex (the \"Project\") at Acme Steel Company's Riverdale, Illinois steel plant. If approved, the Project would involve the largest capital outlay in the Company's history. See Item 1(e) for a discussion of the Project. See Liquidity and Capital Resources for a discussion of certain financial aspects of the Project.\nCONSOLIDATED RESULTS OF OPERATIONS\nSEVENTEEN PERCENT INCREASE IN SALES OVER 1992\nIn 1993, the Company benefitted from the strengthening economy in terms of increased shipments and higher average selling prices. As a result of an improving economy and price increases, the Company experienced the highest quarterly net sales in its history in 1993's fourth quarter achieving sales of $120.5 million. For the year, consolidated sales totaled $457.4 million, up $65.8 million over 1992 sales. Shipments of products were strong, representing a $57.5 million increase from last year's volume levels. Average selling prices were 2 percent higher than in 1992 with all of the increase coming in the second half of the year. The improvement in selling prices added $8.3 million to 1993 net sales.\nCOMPARING 1992 TO 1991 SALES\nAs a result of the modest economic recovery that began in 1992, net sales of $391.6 million were $14.6 million, or 4 percent, higher than prior year sales. Shipments of products rebounded, representing a $22 million increase from 1991 levels. However, selling prices on average declined 2 percent from prior year's prices. The weakness in selling prices, particularly for steel and steel strapping products, had a $7.4 million negative effect on 1992 sales.\nCOMPARATIVE SALES BY SEGMENT\nThe table below presents the percentage make-up of the products comprising our business segments, for the past three years.\nHIGHER NET SALES LEADS TO IMPROVED GROSS PROFIT PERCENTAGE\nGross profit as a percent of sales in 1993 equaled 9.9 percent, the highest percentage since 1989. The gross profit percentages in 1992 and 1991 were 7.5 percent and 7.4 percent, respectively. Increased sales volume and higher average selling prices were the primary determinants for the significant increase in gross margin over last year. Operating costs, however, were higher in 1993. Labor costs increased due to a combination of higher overtime premiums and incentive bonuses, a negotiated bonus payment to the Company's union workers for ratifying the one year labor contract that ended August, 1993 of $0.8 million and a union signing bonus and lump sum payments negotiated as part of the current labor contract resulting in charges of $0.3 million during the year. Unplanned expenditures to repair Acme's basic oxygen furnace and primary rolling mill also reduced gross profit in 1993. Pension expense was $1.5 million higher than in 1992 as the Company recorded a $0.3 million expense in 1993 versus a $1.2 million pension benefit in the prior year. Depreciation has increased in $0.5 million increments over the last two years due partially to a major relining of Acme's blast furnace in 1990.\nSelling and administrative expenses in 1993 were $1.7 million higher than a year ago. However, on a percentage of sales basis, selling and administrative expenses improved over last year as expenses totaled 6.7 percent of sales in 1993 versus 7.4 and 7.8 percent in 1992 and 1991, respectively. The Company began to benefit from lower labor costs resulting from a program, initiated in the 1992 third quarter and substantially completed by year end, to reduce our salaried employee work-force by 10 percent. The 1993 savings from this program were sufficient to offset higher medical costs for selling and administrative employees.\nDuring 1992, the Company recorded a $2.7 million restructuring charge in connection with its 10 percent salaried work force reduction which was completed during 1993. This charge covered additional pension liability and extra vacation pay as part of an early retirement offer and severance payments for involuntary separations. See the note to the financial statements titled RESTRUCTURING CHARGE for further specific components of the charge.\nThe Company recorded a $1.9 million non-recurring charge in 1993 for equipment impairments in connection with the $1.3 million write-off Acme's No. 3 Hot Strip Mill and Billet Mill and a $0.6 million expense to close Packaging's Pittsburg-East facility in California and write-off a strapping line at its New Britain, Connecticut, facility.\nInterest expense was slightly lower than the prior year. The decrease resulted from a reduced balance on our long-term debt as the result of a $3.5 million principal payment in May. Interest income was $0.1 million lower than in 1992 due mainly to reduced returns on cash balances. Earnings before interest expense, taxes and cumulative effect of changes in accounting principles were 2.9 times interest expense in 1993 as compared to .2 times in 1992 and .5 times in 1991.\nIn 1993, the Company recorded a $1.2 million pre-tax gain as the result of a settlement of prior claims against LTV Steel Company (LTV) by Wabush Iron, in an iron ore mine equity interest held by Acme pursuant to the finalization of LTV's plan of reorganization. The sale of all of the Company's interests in a coal producing property located in West Virginia added approximately $1 million to pre-tax income in 1992. In 1991, the Company benefitted from a one-time gain of $1.2 million from the assignment to a third party of Acme's rights in certain claims allowed in the LTV Steel bankruptcy.\nNonoperating income in 1993 was consistent with a year earlier because royalty income in the current year was offset by a loss on the disposal of fixed assets recorded in 1992.\nThe income tax expense for 1993 equaled $4.2 million based on a 40 percent effective tax rate. Because of losses in 1992 and 1991, the Company recognized income tax benefits of $1.7 million in 1992, based on a 37 percent effective tax rate and $0.7 million in 1991, based on a 24 percent effective tax rate.\n1993 NET INCOME OF $6.3 MILLION BEST EARNINGS PERFORMANCE SINCE 1989\nFor 1993, the Company registered net income of $6.3 million, or $1.15 per share. In 1992, the Company incurred a net loss of $2.8 million, or 53 cents per share, before the cumulative effect of changes in accounting principles. In 1991, the Company incurred a net loss of $2.3 million, equal to 43 cents per share. The improvement in net income was due primarily to increased shipments, and to a lesser extent, higher average selling prices for steel, steel strapping and welded steel tube.\nIn 1992, the Company adopted both Financial Accounting Standards (FAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and FAS No. 109, \"Accounting for Income Taxes.\" The transition effect of adopting FAS No. 106 resulted in a $67.6 million charge to 1992 earnings, partially offset by $25.4 million in income tax effects. The cumulative effect of the adoption of FAS No. 109 increased the 1992 net loss by $8.1 million.\nOUTLOOK\nIf the Board of Directors approves the construction of the Project (see Item 1(e)), the estimated capital cost will approximate $300 million to $350 million. It is expected that the Project will be financed by a combination of existing cash, new equity and debt. An investment banker has been retained to assist the Company in its financing activities. If the Project is approved, there will be a one-time, non-cash charge to earnings to write down those assets that will be replaced because of the new technology, and a provision to record estimated costs related to the associated restructuring of operations. The financial impact of the asset write-down and restructuring charge would total approximately $13 million, pre-tax. (See Liquidity and Capital Resources.) Additionally, the Company will benefit from using the higher statutory federal tax rate to value its deferred tax accounts. The effect of this change will be to lower the Company's effective tax rate from 40% to 34% in 1994.\nThe Company is well positioned in terms of labor stability for the next several years due to its new long-term agreements with the United Steelworkers of America (USWA). The new contracts cover approximately 1,500 hourly employees at the Chicago and Riverdale operations and are slated to run through 1999 with a reopener on wages only, subject to binding arbitration in 1996.\nFinancial results in 1994 should improve in comparison with 1993, if the economy continues to strengthen and the Company receives the full year benefit of the 1993 price increases for commercial steel, steel strapping and welded steel tubing. The Company expects to derive additional gains from the recently announced price increases scheduled to take effect in January and July of 1994. In addition, cost reduction efforts and the benefits of facility rationalization undertaken in 1993 will enhance the gains derived from increased sales.\nIn November 1992, the Financial Accounting Standards Board issued Statement No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires accrual basis accounting for Postemployment benefits, and must be adopted not later than fiscal 1994. Postemployment benefits include all benefits paid after employment but before retirement, such as layoff and disability benefits. The Company has not yet determined the impact, if any, or the timing of this change on the financial statements.\nThere are several factors, however, which will partially negate the projected gain in net sales and cost reductions in 1994. The Company will face increased employment costs in 1994 (estimated to be $5 million higher than in 1993) in the form of higher pension and medical expenses. The increased costs are the result of lowering the interest income assumptions related to post-retirement obligations of the Company and continued higher expenses for its active and retired employees' medical expenses. In addition, 1994 will see significant expenditures associated with Acme's compliance with the Clean Air Act.\nSeveral uncertainties face the Company in 1994. Imports of foreign steel into the U.S. could, in all likelihood, increase in 1994 as a result of the unfavorable ruling by the International Trade Commission in July, 1993 regarding alleged dumping and subsidies by foreign steel producers. It is unclear what impact, if any, an increased supply of foreign steel might have on domestic steel prices. Of\ncourse, the biggest uncertainty is the state of the U.S. economy. Although the economy is apparently on the upswing, it is impossible to gauge how the higher personal tax rates levied in 1993 and the proposed reforms coming out of Washington in 1994 will affect consumer spending. Also, it is unclear what impact the Federal Reserve Board's decision to increase short-term interest rates will have on the economy in 1994.\nOverall, we are optimistic about 1994. If the economy continues to improve as we expect, and assuming we continue to benefit from the higher steel selling prices and continue to control operating costs, the Companies' business plans call for a significant improvement over our 1993 results.\nSTEEL MAKING SEGMENT\nSales for the Steel Making Segment advanced to $187.8 million in 1993, a $42.1 million, or 29 percent, improvement over the prior year. The increase was principally the result of a 25 percent jump in shipments. Steel selling prices, on average, were 3 percent higher than last year. Nearly all of the price increases materialized in the second half of the year as we began to benefit from two $20 per ton (5 percent) increases initiated in the second and third quarters of 1993. Sales of $145.6 million for the Steel Making Segment in 1992 were up modestly (3 percent) over the year earlier due entirely to increased shipments as average selling prices were 2 percent lower than 1991 price levels.\nSales of sheet and strip steel, which accounted for 91 percent of the segment's sales in 1993, advanced $40.3 million, or 31 percent over last year. Semi-finished steel sales increased $3.3 million, or 45 percent over last year while sales of iron products fell $1.5 million, or 18 percent, as compared to a year earlier.\nOperating income for the Steel Making group totaled $0.7 million, a significant improvement over the $9.4 million and $4.1 million losses from operations recorded in 1992 and 1991, respectively. The earnings improvement was driven by increased shipments and higher average selling prices. Shipments to external customers in 1993 increased 87,000 tons over the prior year while shipments to the Steel Fabricating Segment were 5,600 tons lower than in 1992. Approximately 60 percent of 1993's shipments and gross margin was attributable to external customers while the remaining 40 percent of gross margin was generated by shipments to the Steel Fabricating Segment. In 1992, the Steel Making group shipped 55 percent of its products to external customers which generated 52 percent of its margin while shipments to the Fabricating segment produced the remaining 48 percent of gross margin. The increased percentage of shipments to external customers in 1993 is consistent with the Company's two-pronged strategy to obtain the highest possible margin on flat-rolled steel and obtain the highest earnings for the Company as a whole. In total, the increased shipments generated $8.6 million in increased revenue while a 3 percent increase in average selling prices contributed $5.9 million to the improvement over last year's results. Partially offsetting the Steel Making Segment's sales related gains were increased labor costs in connection with overtime and union negotiated payments, unexpected repairs to its basic oxygen furnace and primary rolling mill and a $1.3 million write-off of the #3 hot strip mill recorded in the fourth quarter.\nLooking ahead to 1994, sales are expected to increase as a result of the full-year effects of price increases instituted during 1993 and price increases planned for 1994. Shipments are projected to continue on an upward trend under the assumption that the current economic expansion that began in 1992 will continue into 1994. Results should also benefit from cost savings from the permanent idling of its #3 hot strip mill. These benefits will be partially offset by increased pension and medical costs in the coming year which are expected to increase approximately $4 million over the expense for these items recorded in 1993.\nSTEEL FABRICATING SEGMENT\nSteel Fabricating Segment sales of $270 million were $23.7 million, or 10 percent, higher than the prior year. Higher shipments accounted for $20 million of the improvement while a 2 percent increase in average selling prices generated the remainder of the increase over a year earlier.\nSales of steel strapping and strapping tools totaled $152.4 million in 1993, a $11.1 million, or 8 percent, increase over a year earlier. Increased volume accounted for $8.9 million, or 80 percent, of the improvement over last year's results. Average selling prices were 2 percent higher than last year's levels with all of the increase coming in the latter part of the year. Steel strapping sales of $141 million in 1992 were unchanged from the prior year.\nSteel tube sales for 1993 reached $74.1 million, up 17 percent from the prior year. The $10.7 million improvement in sales was due mainly to increased volume. Selling prices rose 4 percent during the year with most of the increase in the last half of 1993. Comparing 1992 to 1991, sales of steel tubing amounted to $63.4 million in 1992, up 4 percent from a year earlier.\nSales of jacks and lifting tools for cars and light trucks totaled $43.1 million, 5 percent higher than the prior year. The improvement in sales was due entirely to increased volume as selling prices, on average, were slightly below last year's levels. Auto and truck jack sales of $41 million in 1992 increased 20 percent over the prior year.\nOperating income for the Steel Fabricating Segment of $11.9 million in 1993 was $4.6 million and $9.3 million higher than the results recorded in 1992 and 1991, respectively. The group benefitted from the improving economy and increased average selling prices in 1993. Packaging, which sells steel strapping used to secure various finished products to pallets or within shipping containers during transportation, was helped by higher demand for its products in connection with increased domestic industrial output. Alpha's results advanced due to the improvement in the housing and recreational product markets. Alpha's business also benefitted from higher margins due to increased demand for its more technologically advanced products and gains in product quality and manufacturing productivity. Despite downward pressure on its selling prices in 1993, Universal's business achieved record results due to improved manufacturing productivity. Partially offsetting the Steel Fabricating Segment's sales and productivity related gains were increased raw material costs in the form of higher flat-rolled steel prices and a $0.6 million expense to close Acme Packaging's Pittsburg-East facility and the write-off of a strapping line at its New Britain Connecticut facility.\nResults for the Steel Fabricating Segment are expected to improve over the prior year with sales advancing modestly. Packaging's results should improve due to increased sales, driven primarily by increased selling prices, and the expected realization of savings related to the closure of the Pittsburg East facility and the increased utilization of its Leeds, Alabama, facility. Results for Alpha should improve in 1994 bolstered by increased market penetration in its target markets. Universal's sales are expected to decline moderately in 1994 leading to slightly reduced results in comparison with 1993 results. The projected sales reduction is in line with continuing price pressures and the anticipated reduction in orders from a major U.S. automobile manufacturer.\nLIQUIDITY AND CAPITAL RESOURCES\nLIQUIDITY REMAINS STRONG\nWorking capital of $93.2 million increased $3.8 million in 1993. Current assets increased $21.5 million, or 15 percent, driven primarily by increased receivable and inventory balances. The increase in the Company's receivable balance reflects the sales improvement in 1993. The build-up of inventories at the end of 1993 is in anticipation of increased orders in the first quarter of 1994. Current liabilities increased $17.7 million, or 30 percent. The higher current liability balance was caused by increases to the accounts payable, accrued expense and income tax payable accounts and a $3.2 million increase from the net effect of long-term debt entries. In 1993, a portion of long-term debt became current (a $6.7 million principal payment is due October, 1994) and a principal payment of $3.5 million was made reducing the current maturities of long-term debt balance at the end of 1992. The current ratio decreased from 2.5 at the end of 1992 to 2.2 at the end of 1993.\nDeferred income taxes and other assets increased significantly due primarily to an additional minimum pension adjustment recorded in 1993. The pension adjustment was recorded net of tax, thereby increasing our long-term deferred tax asset by $8.2 million in 1993. Other balance sheet accounts affected by the minimum pension adjustment include a $4.1 million increase to the long-term intangible pension asset account and a $25.4 million increase to our long-term pension liability.\nLong-term debt was reduced by $6.7 million to $49.3 million due to the current classification of a principal payment due October 30, 1994. The Company currently has available a $60 million unsecured revolving credit agreement with various commercial banks. It has not been necessary to borrow against this credit agreement during the past three years.\nSHAREHOLDERS EQUITY REDUCED BY MINIMUM PENSION ADJUSTMENT\nShareholders' equity at year end 1993 was $83.2 million, or $15.29 per share, compared with $89.3 million, or $16.55 per share at the end of 1992. The decline in equity was due to a minimum pension adjustment recorded in 1993. The additional minimum pension liability was primarily the result of a more current actuarial assumption involving the discount rate used to calculate estimated future retirement benefits. The change in the discount rate caused several of our defined benefit pension plans to fall further into an underfunded position at December 26, 1993. Accordingly, to reflect this underfunded position, we recorded a $13.1 million non-cash charge, net of deferred taxes, to shareholders' equity in 1993. An adjustment of $8.2 million to reflect the underfunded status at December 27 was recorded in 1992. (See the note to the financial statements titled RETIREMENT BENEFIT PLANS for further discussion of this minimum pension liability adjustment.)\nFINANCING ALTERNATIVES FOR THE CASTER PROJECT\nIn the event the Board of Directors of the Company decides to proceed with the Project (see Item 1(e) for a discussion of the Project), the Company will be committed to a construction and engineering project that will involve direct costs of approximately $300 to $350 million over an approximately 30 month period. The Company will be required to fund these costs almost exclusively from external financing sources, including new credit facilities.\nOn March 3, 1994, the Company agreed to sell an issue of securities at a price of $21.00 per security on a private placement basis exclusively in Canada. Subject to certain conditions, within 150 days of the closing of this transaction (expected on March 28, 1994), the securities will be exchangeable on a one-for-one basis, for 5,600,000 shares of the Company's common stock. The conditions for the exchange of the securities for common stock and the Company's receipt of the proceeds of the sale of the securities include assurance that not less than 85% of the reasonably estimated funds needed for construction of the Project (inclusive of the Company's cash on hand) will be available to the Company and approval of such construction by the Company's Board of Directors. The securities and the underlying common shares have not been registered under the Securities Act and may not be offered or sold in the United States or to a U.S. person, as defined in Regulation S under the Securities Act, absent registration or an applicable exemption from registration requirements.\nIn the event the conditions for completion of the privately placed Canadian financing are satisfied, the Company's outstanding shares of common stock will increase from 5,407,527 to 11,007,537, and the Company's total shareholders equity will increase by approximately $112 million. The Company anticipates that substantially all of this additional equity will be used to pay costs associated with the Project.\nIn addition to the funds to be raised from the privately placed Canadian financing, the Company will need to raise approximately $190 million to $240 million from other financing sources. To date, the Company has not received commitments from any such financing source. The Company is exploring the sale of additional equity securities, the sale of debt securities, and the opening of new credit facilities. At present, there can be no assurance that the Company will be able to obtain any such funds nor are the terms and conditions known on which such funds may be available.\nTo the extent the Company decides and is able to raise the additional funds needed for construction of the Project (exclusive of the funds to be raised through the privately placed Canadian financing) through debt financing, the Company's interest expense and debt-to-equity ratio will increase accordingly. Although neither the availability nor the characteristics of such debt are known at this time, the Company will not proceed with the Project until it is assumed that adequate sources of liquidity are available to cover foreseeable interest costs through construction, start-up and operation of the Project. The Company's current debt-to-total capitalization ratio is .4 to 1 and its coverage of its outstanding debt (expressed as times interest earned before interest, taxes and unusual items) is 2.35 to 1. These ratios are expected to be .46 to 1 and .68 to 1, respectively at the end of 1996.\nThe Company currently has outstanding Senior notes in the principal amount of $50 million. The terms of these notes would preclude the Company from increasing its indebtedness by more than approximately $75 million. To the extent the Company wishes to increase its debt by more than this amount, these notes would have to be renegotiated or prepaid. Prepayment of the notes would trigger a penalty of approximately $4 million. The Company also has an unused $60 million revolving credit agreement. This agreement would terminate upon the approval of the Project by the Company's Board of Directors. If the Project is approved, the Company believes it can secure an adequate working capital credit facility; however, there can be no assurances the Company would be able to obtain a new credit facility or that it would be otherwise able to fund its working capital needs from external sources if these needs cannot be met from continuing operation of the existing facilities.\nOPERATING ACTIVITIES CONTINUE TO GENERATE CASH\nCash balances totaled $50.4 million at December 26, 1993, up $1.2 million over December 1992's ending balance. The amount of cash generated in 1993 was smaller than the increases of $17.5 million and $10.7 million in 1992 and 1991, respectively, due to higher inventory and receivable balances, a $3.5 million principal payment on long-term debt in May and higher capital expenditures.\nOperating activities generated $16 million of cash in 1993. A combination of our net income of $6.3 million for the year and the addition of $15.2 million non-cash depreciation more than offset a reduction in cash from working capital and non-current accounts.\nDuring 1993, we invested $11.7 million in capital projects, $4.2 million higher than a year earlier. The increase in expenditures can be attributed in part to environmental related expenditures of $3.2 million in connection with the Environmental Protection Agency's emission compliance program for our coke ovens located at the Steel subsidiary's Chicago plant. The remainder of the capital project expenditures were primarily for replacement and rehabilitation of our productive capabilities throughout the Company.\nIn 1994, the Company is planning capital project expenditures of approximately $18 million, not including the Project. About $6 million of the planned capital projects relate to environmental expenditures. The balance of the planned projects are primarily devoted to capital maintenance items at our steelmaking operations. Cash flows from operations should be sufficient to meet these planned projects.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to Item 8 is submitted in a separate section of this Annual Report on Form 10-K. See the audited Consolidated Financial Statements and Schedules of The Company Metals Incorporated attached hereto and listed in the index on page 32 of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nInformation with respect to directors of the Company is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 28, 1994 under the caption ELECTION OF DIRECTORS.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth, as of March 15, 1994, with respect to each executive officer of the Company, his name and all positions held during the last five years. Executive officers are elected annually by the Board of Directors of the Company to serve for a term of office of one year and until their successors are elected.\nAs a result of a Reorganization effected May 25, 1992, Acme Steel Company became and continues to be a subsidiary of the Company. Prior to the Reorganization the executive officers listed below were executive officers of Acme Steel Company and, at the time of the reorganization, were elected to similar positions within the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 28, 1994 under the caption EXECUTIVE COMPENSATION.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation relating to security ownership of certain beneficial owners and management is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 28, 1994 under the caption SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements:\nThe response to this portion of Item 14 is submitted in a separate section of this report. See the audited Consolidated Financial Statements and Schedules of Acme Metals Incorporated attached hereto and listed on the index on page 32 of this report.\n(2) Financial Statement Schedules:\nThe response to this portion of Item 14 is submitted in a separate section of this report. See the audited Consolidated Financial Statements and Schedules of Acme Metals Incorporated attached hereto and listed on the index on page 32 of this report.\n(3) Exhibits\n(1) Filed pursuant to Item 14 of Form 10-K\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed in the fourth quarter of 1993.\nNo financial statements were filed.\n(1) Filed pursuant to Item 14 of Form 10-K (2) Also see Amendment and Assignment Agreement filed with Exhibit 10.13 to the 1992 10-K.\nSIGNATURES\nPursuant 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.\nACME METALS INCORPORATED\nPursuant 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 and on the dates indicated.\nSIGNATURES (continued)\nACME METALS INCORPORATED Form 10-K - Item 8 and Items 14 (a) (1) and 14 (a) (2) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nThe following Consolidated Financial Statements of Acme Metals Incorporated and the related Report of Independent Accountants are included in Item 8 and Item 14 (a) (1):\nThe following Consolidated Financial Statement Schedules of Acme Metals Incorporated are included in Item 14 (a) (2):\nAll other schedules have been omitted because they are not applicable, or not required, or because the required information is shown in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Acme Metals Incorporated\nIn our opinion, the accompanying consolidated financial statements listed in the index appearing on page 32 present fairly, in all material respects, the financial position of Acme Metals Incorporated and its subsidiaries at December 26, 1993 and December 27, 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 26, 1993, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in the Notes to Consolidated Financial Statements, Acme Metals Incorporated changed its method of accounting for postretirement benefits other than pensions and income taxes in 1992.\nMarch 21, 1994 Chicago, Illinois\nREPORT OF MANAGEMENT\nThe management of Acme Metals Incorporated has prepared and is responsible for the consolidated financial statements and other financial information included in this Form 10-K Annual Report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based upon informed judgments and estimates by management. The other financial information in this annual report is consistent with the consolidated financial statements.\nThe Company maintains a system of internal accounting controls. Management believes the internal accounting controls provide reasonable assurance that transactions are executed and recorded in accordance with Company policy and procedures and that the accounting records may be relied on as a basis for preparation of the consolidated financial statements and other financial information.\nThe financial statements have been audited by Price Waterhouse, the Company's independent accountants, whose report is included herein. In addition, the Company has a professional staff of internal auditors who coordinate their financial audits with the procedures performed by the independent accountants and conduct operational and special audits. The Audit Review Committee of the Board of Directors, composed of directors who are not employees of the Company, meets periodically with management, the internal auditors and the independent accounts to discuss the adequacy of internal accounting controls and the quality of financial reporting. Both the independent accountants and internal auditors have full and free access to the Audit Review Committee.\nACME METALS INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Acme Metals Incorporated (the Company) and its majority-owned subsidiaries. Investments in mining ventures are accounted for by the equity method. All intercompany transactions have been eliminated.\nThe Company's fiscal year ends on the last Sunday in December.\nINVENTORIES\nInventories are stated at the lower of cost or market. The primary method used to determine inventory costs is the last-in, first-out (LIFO) method.\nPROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION\nProperty, plant and equipment are stated at cost. Depreciation of plant and equipment is computed principally on a straight-line basis over the estimated useful lives of the assets. Expenditures for maintenance, repairs and minor renewals and betterments are charged to expense as incurred. Furnace relines and major renewals and betterments are capitalized.\nUpon disposition of property, plant and equipment, the cost and related accumulated depreciation are removed from the accounts, and the resulting gain or loss is recognized.\nThe Company from time to time reviews the carrying value of certain of its assets and recognizes impairments when appropriate.\nRETIREMENT BENEFIT PLANS\nPension costs include service cost, interest cost, return on plan assets and amortization of the unrecognized initial net asset. The Company's policy is to fund not less than the minimum funding required under ERISA.\nThe Company has postretirement health care and life insurance plans. The provision for postretirement costs in 1991 includes current costs, amortization of prior service costs over periods not exceeding twenty-five years and interest on the accrued liability. The provisions for postretirement costs in 1993 and 1992 were determined pursuant to the provisions of Financial Accounting Standards Board Statement (FAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Under this statement, the annual expense represents a combination of interest and service cost provisions of the annual accrual. The postretirement benefits are not funded.\nINCOME TAXES\nThe credit for deferred income taxes in 1993 and 1992 were determined pursuant to the provisions of FAS No. 109, \"Accounting for Income Taxes.\" Under this statement, the provision for deferred income taxes represents the tax effect of temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. In 1991, the provision for deferred income taxes represents the tax effect of differences in the timing of income and expense recognition for tax and financial reporting purposes.\nPER SHARE DATA\nAmounts per common share are based on the weighted average number of common and dilutive common equivalent shares outstanding during the year: 5,439,784 in 1993, 5,396,311 in 1992 and 5,373,564 in 1991.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFor purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nRECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRESTRUCTURING CHARGE:\nDuring 1992, the Company substantially completed its program to reduce its salaried work force by 10% which was completed during 1993. Voluntary retirement offers which included an increased pension benefit and extra vacation pay, were extended to a number of employees for a limited period of time. Other employees were terminated with severance pay. The pre-tax reserve of $2.7 million established by the Company included $1.1 million related to the increased pension benefits and acceleration of the payment of pension benefits, a special postretirement termination charge of $1.3 million, a postretirement plan curtailment gain of $0.4 million and $0.7 million related to increased vacation benefits, severance pay and a reserve for contingencies related to the program.\nNONRECURRING CHARGE:\nThe Company recorded a $1.9 million non-recurring charge in 1993 including $1.3 million in connection with a decision made during the year to permanently idle Acme Steel s No. 3 Hot Strip Mill and Billet Mill; a $0.6 million charge to close Acme Packaging's Pittsburg-East facility in California; and, the elimination of a strapping line at its New Britain, Connecticut facility following a determination made during the year to consolidate production facilities and eliminate unprofitable lines.\nUNUSUAL INCOME ITEM:\nIn 1993, the Company recorded a benefit in connection with its investment in Wabush Iron Company (WabIron). As a result of the finalization of a plan of reorganization for LTV Steel Company, a former participant in WabIron, Acme was awarded $1.2 million (market value) of LTV securities in a settlement of a bankruptcy claim filed by all of the participants in the Wabush Mines Project joint venture.\nDuring 1992, the Company sold all of its interests in certain coal producing property located in West Virginia. This transaction added approximately $1 million of pre-tax income to 1992 results.\nIn 1991, the Company recorded a benefit from an unusual item related to the assignment of it's rights in claims allowed in the LTV Steel Company, Inc. bankruptcy to a third party. This transaction added $1.2 million of pre-tax income to 1991 results.\nINVENTORIES:\nInventories are summarized as follows:\nOn December 26, 1993 and December 27, 1992, inventories valued on the LIFO method were less than the current costs of such inventories by $57.4 million and $55.4 million, respectively.\nIn 1992, inventory quantities decreased from the prior year, the effect of which decreased cost of products sold and net loss by $0.4 million and $0.2 million, respectively.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment consisted of the following:\nThe difference between depreciation expense presented in the Consolidated Statement of Cash Flows and the Consolidated Statement of Operations represents that portion of depreciation expense that is classified in selling and administrative expense on the Consolidated Statement of Operations.\nRETIREMENT BENEFIT PLANS:\nThe Company has various retirement benefit plans covering substantially all salaried and hourly employees. Certain salaried employees with one full calendar quarter of service are eligible to participate in the Company's defined contribution plan and employee stock ownership plan (ESOP). Company contributions to the defined contribution plan and employee stock ownership plan are based upon 7.5% and 3.5% (the ESOP contribution was reduced from 6.5% to 3.5% in the second quarter of 1993), respectively, of eligible compensation. Amounts charged to operations under these plans were $3.4 million in 1993, $4.1 million in 1992 and $3.6 million in 1991.\nSalaried employees who joined the Company prior to December 31, 1981 and certain hourly employees participate in defined benefit retirement plans which provide benefits based upon either years of service and final average pay or fixed amounts for each year of service.\nThe net defined benefit pension credit (expense) included the following components:\nPension plan curtailment losses of $1.1 million are included in the 1992 restructuring charge.\nActuarial assumptions used to calculate the defined benefit pension credits (costs) were:\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe following table sets forth the funded status of the Company's defined benefit retirement plans and amounts recognized in the balance sheet.\nIn accordance with FAS No. 87, the Company has recorded an adjustment, as shown in the table above, to recognize a minimum pension liability relating to certain under-funded pension plans. The additional $25.2 million adjustment arose at the end of 1993 primarily as a result of a lowering of the discount rate to 7.5 percent from 8.5 percent. Accordingly, for pension plans with accumulated benefits in excess of the fair value of plan assets at December 26, 1993, the accompanying consolidated balance sheet includes an additional long-term pension liability of $40.1 million, a long-term intangible asset of $5.8 million and a charge to shareholders' equity of $21.3 million, net of a deferred tax benefit, representing the excess of the additional long-term liability over unrecognized prior service cost.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS:\nThe Company and its subsidiaries sponsor several unfunded defined benefit postretirement plans that provide medical, dental, and life insurance for retirees and eligible dependents.\nIn 1993 and 1992 the cost for all plans, calculated pursuant to FAS No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" amounted to $7.9 million and $7.8 million, respectively. The cost in 1991, which was calculated under the previous accounting method totalled $6.4 million.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe net periodic postretirement benefit cost for 1993 and 1992, net of retiree contributions of approximately 10% of costs, included the following components:\nThe following table sets forth the plans' combined status at December 26, 1993 and December 27, 1992:\nThe accrued postretirement obligation was determined by application of the terms of medical, dental, and life insurance plans, together with relevant actuarial assumptions and health care cost trend rates projected at annual rates ranging ratably from 12 percent in 1992 to 5 percent through 1999. The effect of a 1 percent annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $10.9 million; the annual service costs would increase by approximately $1.2 million. The obligation for postretirement benefits was remeasured as of January 1, 1994 using a 7.5% discount rate, as compared to the 8.5% discount rate used for the January 1, 1993 valuation.\nThe reduction in the discount rate contributed to a net increase in the obligations of approximately $5 million. As the measurement of net periodic postretirement benefits cost is based on beginning of the year assumptions, the higher revalued obligation at the end of fiscal 1993 did not have any impact on the expense recorded for 1993.\nIn accordance with the new labor agreement with the hourly workers effective January 1, 1994, individuals retiring on or after January 1, 1993 will be covered by a new managed care medical plan (PPO). This new plan is expected to help control future medical costs to be paid by the Company.\nPOSTEMPLOYMENT BENEFITS:\nIn November 1992, the Financial Accounting Standards Board issued Statement No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires accrual basis accounting for Postemployment benefits, and must be adopted not later than fiscal 1994. Postemployment benefits include all benefits paid after employment but before retirement, such as layoff and disability benefits. The Company has not yet determined the impact, if any, or the timing of this change on the financial statements.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nACCRUED EXPENSES:\nIncluded in the Consolidated Balance Sheet caption Accrued expenses are the following:\nINVESTMENTS IN ASSOCIATED COMPANIES\nThe Company has a 31.7 percent interest in an iron ore mining venture. In 1993, 1992 and 1991, the Company made iron ore purchases of $18.3 million, $21.7 million, and $26.8 million, respectively from the venture. At December 26, 1993, $4.2 million was owed to the venture for iron ore purchases; amounts owed to the venture for such ore purchases were $3.6 million at December 27, 1992.\nThe Company has a 37% interest in Olga Coal Company. In 1987, Olga Coal Company filed for protection under Chapter 11 of the U.S. Bankruptcy Act and the coal mining operation was idled. The coal mining investment is carried at no value in the Consolidated Balance Sheet.\nINCOME TAXES:\nThe provision (credit) for taxes consisted of the following:\nIn 1992, the Company adopted FAS No. 109, \"Accounting for Income Taxes,\" and reported the cumulative effect of the change in the method of accounting for income taxes as of the beginning of the 1992 fiscal year in the consolidated statement of operations. The cumulative effect of the change in accounting for income taxes increased the 1992 net loss by $8.1 million or $1.50 per share and was reported separately in the consolidated statement of operations for the year ended December 27, 1992. The change in accounting for income taxes increased the credit for taxes in 1992 by $0.9 million.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSignificant components of the Company's deferred tax liabilities and assets at December 26, 1993 and December 27, 1992 is summarized below.\nThe Company believes it is more likely than not to realize the net deferred tax asset and accordingly no valuation allowance has been provided. This conclusion is based on, (i) reversing deductible temporary differences (excluding postretirement amounts) being offset by reversing taxable temporary differences, (ii) the extremely long period that is available to realize the future tax benefits associated with the postretirement related deductible temporary differences and, (iii) the Company's expected future profitability.\nIn 1993 and 1992, the change in the deferred income tax liability primarily represents the effect of changes in the amounts of temporary differences from December 27, 1992 to December 26, 1993 and December 29, 1991 to December 27, 1992, respectively. For 1991, the deferred income tax liability results from timing differences, created principally by the use of accelerated tax depreciation, in the recognition of income and expense for tax and financial reporting purposes.\nThe Company's federal tax liability is the greater of its regular tax or alternative minimum tax. At December 26, 1993, the Company had available alternative minimum tax credits of $1.5 million. This amount can be carried forward indefinitely and utilized as a tax credit to reduce, to a certain extent, regular tax liabilities of future years.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe effective income tax rates for 1993, 1992 and 1991 are reconciled to the federal statutory tax rate in the following table:\nThere are currently certain federal tax matters that, upon resolution, could enable the Company to carryback its entire 1986 net operating loss.\nIn 1993, cash flows were reduced by $4.5 million resulting from income tax payments of $5.0 million and income tax refunds of $0.5 million in connection with net operating loss carryback claims. In 1992, cash flows were increased by $4.8 million resulting from $6.0 million of income tax refunds in connection with net operating loss carryback claims and income tax payments of $1.2 million. No cash payments for income taxes were made in 1991.\nLONG-TERM DEBT AND REVOLVING CREDIT AGREEMENT:\nThe Company's long-term debt at December 26, 1993 and December 27, 1992 is summarized as follows:\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe maturities during the five years ending December 27, 1998 are $6.7 million in 1994 and 1995, $16.7 million in 1996, $6.7 million in 1997 and $7.2 million in 1998. Cash flows from operating activities were reduced by cash paid for interest on debt by $5.2 million in 1993 and $5.6 million in 1992 and 1991.\nThe Company has a revolving credit agreement with a group of banks which provides aggregate commitments of $60 million. At December 26, 1993 and December 27, 1992, no amounts were outstanding under the credit agreement. The Company pays an annual commitment fee ranging from three-eighths to one-half percent on the unused portion of the credit line. The credit agreement includes a covenant that restricts the payment of dividends. At December 26, 1993, retained earnings available for the payment of dividends amounted to $10 million.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nCASH AND SHORT-TERM INVESTMENTS\nThe carrying amount approximates fair value because of the short maturity of those instruments.\nLONG-TERM DEBT\nThe fair value of the Company's long-term debt is estimated by calculating the present value of the remaining interest and principal payments on the debt to maturity. The present value computation uses a discount rate equal to the prime rate at the end of the reporting period plus or minus the spread between the prime rate and the rate negotiated on the debt at the inception of the loan.\nCOMMON STOCK:\nThe Company has a stock incentive program which provides, among other benefits, for the granting of stock options and stock awards to officers and key employees. Stock options for the Company's common stock are granted at prices not less than the market price at date of grant and no option may be exercised more than ten years from the grant date.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nInformation regarding stock options is summarized below:\nAt December 26, 1993, 490,850 options were exercisable; 447,650 options were exercisable at December 27, 1992.\nStock awards granted in 1993 totaled 15,400 shares at a value of either $16.00 or $16.75 per share depending on the grant date. Stock awards granted in 1992 totaled 18,650 shares at a value of either $ 15.00 or $ 18.75 per share depending on the grant date. Stock awards granted in 1991 totaled 60,900 shares at a value of either $ 11.75 or $ 13.563 per share depending on the grant date.\nCOMMITMENTS AND CONTINGENCIES:\nThe Company's interest in an iron ore mining joint venture requires payment of its proportionate share of all fixed operating costs, regardless of the quantity of ore received, plus the variable operating costs of minimum ore production for the Company's account. Normally, the Company reimburses the joint venture for these costs through its purchase of ore at the higher of cost or market prices. During 1993, the Company obtained approximately 56% of its iron ore needs from the joint venture and purchases during 1993 generally approximated market prices.\nThe Company is subject to various federal, state and local environmental statutes and regulations which provide a comprehensive program for controlling the release of materials into the environment and require responsible parties to remediate certain waste disposal sites. In addition, various health and safety statutes and regulations apply to the work-place environment. Administrative, civil and criminal penalties may be applicable for failure to comply with these laws.\nThese environmental laws and regulations are subject to periodic revision and modification. The United States Congress, by example, has recently completed a major overhaul of the federal Clean Air Act which is a major component of the federal environmental statutes affecting the Company's operations.\nFrom time to time, the Company is also involved in administrative proceedings involving the issuance, or renewal, of environmental permits relating to the conduct of its business. The final issuance of these permits have been resolved on terms satisfactory to the Company; and, in the future, the Company expects such permits will similarly be resolved on satisfactory terms.\nAlthough management believes it will be required to make further substantial expenditures for pollution abatement facilities in future years, because of the continuous revision of these regulatory and statutory requirements, the Company is not able to reasonably estimate the specific pollution abatement\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) requirements, the amount or timing of such expenditures to maintain compliance with these environmental laws. While such expenditures in future years may be substantial, management does not presently expect they will have a material adverse effect on the Company's future ability to compete within its markets.\nIn those cases where the Company has been identified as a Potentially Responsible Party (\"PRP\") or is otherwise made aware of a possible exposure to incur costs associated with an environmental matter, management determines (i) whether, in fact, the Company has been properly named or is otherwise obligated, (ii) the extent to which the Company may be responsible for costs associated with the site in question, (iii) an assessment as to whether another party may be responsible under various indemnification agreements the Company is a party to, and (iv) an estimate, if one can be made, of the costs associated with the clean-up efforts or settlement costs. It is the Company's policy to make provisions for environmental clean-up costs at the time that a reasonable estimate can be made. At December 26, 1993, the Company had recorded reserves of less than $0.3 million for environmental clean-up matters. While it is not possible to predict the ultimate costs of resolving environmental related issues facing the Company, based upon information currently available, they are currently not expected to have a material effect on the consolidated financial condition of the Company.\nIn connection with the spin-off from new Interlake, Acme Steel Company entered into certain indemnification agreements with new Interlake. As discussed in Item 3, Legal Proceedings, significant environmental and tax matters are subject to indemnification by new Interlake under these agreements. To date Interlake has met its obligations with respect to all matters covered by these agreements. The inability of new Interlake to fulfill its obligations, for any reason, under these indemnification agreements could result in increased future obligations for the Acme Steel Company.\nBUSINESS SEGMENTS:\nCommencing in 1993, the Company has elected to present its operations in two segments, Steel Making and Steel Fabricating. Prior year amounts have been restated for comparison purposes.\nSteel Making operations include the manufacture of sheet, strip and semifinished steel in low-, mid-, and high-carbon alloy and special grades. Principal markets include agricultural, automotive, industrial equipment, industrial fasteners, welded steel tubing, processor and tool manufacturing industries.\nThe Steel Fabricating business segment processes and distributes steel strapping, strapping tools and industrial packaging (Acme Packaging Corporation), welded steel tube (Alpha Tube Corporation) and auto and light truck jacks (Universal Tool & Stamping). The Steel Fabricating Segment sells to a number of markets.\nAll sales between segments are recorded at current market prices. Income from operations consists of total sales less operating expenses. Operating expenses include an allocation of expenses incurred at the Corporate Office that are considered by the Company to be operating expenses of the segments rather than general corporate expenses. Income (loss) from operations does not include other non-operating income or expense, interest income or expense, the cumulative effect of changes in accounting principles, or income taxes. Identifiable assets are those that are associated with each business segment. Corporate assets are principally investments in cash equivalents and deferred income taxes.\nThe products and services of the Steel Making and Steel Fabricating Segments are distributed through their own respective sales organizations which have sales offices at various locations in the United States. Export sales are insignificant for the years presented.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSEGMENT INFORMATION (IN THOUSANDS)\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSUBSEQUENT EVENT:\nOn March 3, 1994, Acme Metals Incorporated (the \"Company\") agreed to sell an issue of securities on a private placement basis exclusively in Canada. Within 160 days of the closing of this transaction (expected on March 28, 1994), the securities will be exchangeable for 5,000,000 common shares of the Company (5,600,000 common shares if an over-allotment option for the securities is exercised before closing) subject to the fulfillment of certain conditions. Conditions include the approval by the Board of Directors of the Company of the construction of a continuous thin slab caster-hot rolled mill and confirmation of the availability of debt financing sufficient for such construction.\nThe securities and the underlying common shares have not been registered under the Securities Act of 1933 (the \"Securities Act\") and may not be offered or sold in the United States or to a U.S. person, as defined in Regulation S under the Securities Act, absent registration or an applicable exemption from registration requirements.\nACME METALS INCORPORATED\nQUARTERLY RESULTS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe fourth quarter of 1993 includes a $1.2 million benefit related to Acme's investment in Wabush Mines, a $1.3 million expense to write-off the Steel subsidiary's No. 3 Hot Strip Mill and Billet Mill, and $0.6 million of expense associated with the closure of the Packaging subsidiary's Pittsburg-East facility in California and the write-off of a strapping line at the Packaging subsidiary's New Britain, Connecticut facility.\nThe third quarter of 1992 includes a $3.1 million restructuring charge in connection with the Company's work force reduction plan.\nThe fourth quarter of 1992 includes a $1 million gain on the sale of all the Company's interests in a coal producing property in West Virginia, and a postretirement plan curtailment gain of $0.4 million related to the restructuring charge was included in fourth quarter results.\nThe second quarter of 1991 includes an unusual item related to the assignment of Acme's rights in claims allowed in the LTV Steel Company, Inc. bankruptcy to a third party which added $1.2 million to pre-tax income.\n(1) Reflects the adoption of Financial Accounting Standards (FAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and FAS No. 109, \"Accounting for Income Taxes\" in the first quarter of 1992.\nACME METALS INCORPORATED SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT (in thousands)\nACME METALS INCORPORATED SCHEDULE VI - ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT (in thousands)\nACME METALS INCORPORATED SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)\nSCHEDULE X - SUPPLEMENTAL INCOME STATEMENT INFORMATION (in thousands)\nOther items requiring disclosure are not shown as they individually are less than 1% of net sales.","section_15":""}
{"filename":"897732_1993.txt","cik":"897732","year":"1993","section_1":"Item 1. Business. - ------ -------- and Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - ------ ---------- GENERAL. On July 1, 1993, pursuant to an Agreement and Plan of ------- Merger approved by the shareholders of Consolidated Rail Corporation on May 26, 1993, each share of Consolidated Rail Corporation common stock that was issued and outstanding or held in the treasury, and each outstanding share of Consolidated Rail Corporation preferred stock, all of which were held by the Non-union Employee Stock Ownership Plan (the \"ESOP\"), were automatically converted into one share of common stock and preferred stock, respectively, of Conrail Inc., which was incorporated in Pennsylvania on February 12, 1993 to be the holding company of Consolidated Rail Corporation. On July 1, 1993, Conrail Inc. became the publicly held entity and holding company of Consolidated Rail Corporation, which remains Conrail Inc.'s only significant subsidiary and primary asset.\nConsolidated Rail Corporation is a Pennsylvania corporation incorporated on February 10, 1976 to acquire, pursuant to the Regional Rail Reorganization Act of 1973, the rail properties of many of the railroads in the northeast and midwest region of the United States which had gone bankrupt during the early 1970's, the largest of which was the Penn Central Transportation Company.\nReports on Form 10-K for years prior to 1993 were filed by Consolidated Rail Corporation, and historic data presented herein and therein reflect the results of Consolidated Rail Corporation for those time periods. Unless otherwise indicated, references to Conrail prior to July 1, 1993 denote Consolidated Rail Corporation and its consolidated subsidiaries, and references to Conrail after July 1, 1993 denote Conrail Inc. and its consolidated subsidiaries.\nRAIL OPERATIONS. Conrail, through its wholly-owned subsidiary --------------- Consolidated Rail Corporation, provides freight transportation services within the northeast and midwest United States. Conrail interchanges freight with other United States and Canadian railroads for transport to destinations within and outside Conrail's service region. Conrail operates no significant line of business other than the freight railroad business and does not provide common carrier passenger or commuter train service.\nConrail serves a heavily industrial region that is marked by dense population centers which constitute a substantial market for consumer durable and non-durable goods, and a market for raw materials used in manufacturing and by electric utilities. Conrail's traffic levels are substantially affected by its ability to compete with trucks, the economic strength of the industries and metropolitan areas that produce and consume the freight Conrail\nhauls, and the traffic generated by Conrail's connecting railroads. Conrail remains dependent on non-bulk traffic, which tends to generate higher revenues than bulk commodities, but also involves higher costs and is more vulnerable to truck competition. Conrail expects the national economy to continue to grow slowly and its traffic levels to reflect such growth. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations - 1994 Outlook.\"\nConrail's significant freight commodity groups include chemicals and related products, coal, intermodal, automotive parts and finished vehicles, metals and related products, food and grain products, and forest products. Revenues for these freight commodity groups for 1989 through 1993, together with total annual traffic volumes, are set forth in the following tables.\nChemicals and Related Products. This group consists of a wide ------------------------------ variety of commodities, including agricultural and organic chemicals, fertilizers, plastic pellets, soda ash, construction minerals, and petroleum products. The majority of traffic is joint- line and the primary flows are between Louisiana and Texas, on the one hand, and Delaware, New Jersey, and Pennsylvania on the other. This segment's customer base and origin\/destination pair mix are both large and diverse, with none occupying a dominant position in terms of Conrail's traffic volume or revenues. Conrail's chemical traffic fluctuated moderately from 1989 through 1993, but has increased in each of the last two years. In 1993, a 6.4% increase in volume resulted in a 3.5% increase in revenues compared with 1992.\nConrail's chemical traffic includes chlorine, smaller volumes of other hazardous chemicals and non-hazardous substances which, if spilled or released into the atmosphere, could be dangerous and could result in significant liability to Conrail. Under catastrophic circumstances, such liability could exceed Conrail's $250 million in insurance coverage for such accidents. It is impossible to eliminate the risk of such liability; however, Conrail has not experienced any significant liability as a result of an accident involving chlorine or any other such substance and has safety procedures designed to prevent the occurrence of such accidents, or limit their impact should they occur.\nIncreasing regulation by federal, state and local governments of the transportation and handling of hazardous and non-hazardous substances and waste has increased the administrative burden and costs of transporting certain commodities in this group.\nCoal. In 1993, revenues for this group declined from 1992 by ---- 13.9%, reflecting a 9.2% decline in traffic volume. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Strategic Business Plan.\"\nUtility coal traffic makes up the majority of Conrail's coal business and was adversely affected by decreased coal production resulting from an eight month strike at unionized coal mines. Utility coal moves from mines located on and off Conrail's system to electric utilities located on Conrail. Annual traffic volumes fluctuate with the inventory practices of the electric utilities, their use of alternative sources of energy and the weather. In 1993, coal traffic decreased as utilities depleted much of their coal stockpiles and did not replenish them due to the strike. In addition, the utilities in Conrail's service territory increased their use of nuclear fuel to near capacity levels.\nThe federal acid rain legislation enacted in October 1990, which requires electric utilities to significantly limit sulphur dioxide emissions from their generating plants by burning lower sulphur coal or installing emissions control devices, has reduced demand for the higher sulphur coal from mines on Conrail's system, particularly in central Pennsylvania. However, the decline in the volume of coal from mines located on Conrail is being offset, in part, by an increase in Conrail's handling of lower sulphur coal from sources on Conrail lines formerly owned by The Monongahela Railway Company (now merged into Conrail) and from off-line sources to utilities located on Conrail's system.\nMetallurgical, industrial\/cogeneration and export coal represent the three remaining segments of Conrail's coal traffic with volumes essentially equal in each of these areas. Conrail's traffic volume and revenue from metallurgical coal increased slightly in 1993 due to gains in market share, after having declined in each year since 1989 as the domestic steel industry eliminated inefficient production capacity.\nConrail's traffic volume and revenue for industrial\/cogenera- tion coal also increased slightly in 1993, although growth in this area is not expected to be as strong as originally projected, as a result of slow growth by cogeneration facilities.\nExport coal traffic declined approximately 35% from 1992, a year in which export volumes had declined 16% from the record levels of 1991. The 1993 declines were, in significant part, the result of the coal strike, which created increased domestic demand for coal historically used for export, as well as continuing competition by exports from South Africa and the former Soviet republics.\nIntermodal. Conrail continues to be one of the rail industry's ---------- leaders in handling intermodal traffic, with revenues increasing 9% in 1993 and significantly higher volumes, 11.2%, over 1992. For the sixth consecutive year, Conrail handled over 1 million units of intermodal traffic.\nConrail's intermodal traffic consists of three segments. The first segment is Conrail's premium service traffic which principally involves shipments for the U.S. Postal Service, United Parcel Service and less-than-truck-load companies. The four-year U.S. Postal Service contracts for over 1,000 origin-destination points, which were awarded in July 1989, were renewed in July 1993 for a period extending to July 1995. During 1991, the Postal Service implemented incentive rates permitting its bulk mail customers to receive discounts for providing their own transportation to destination Postal Service facilities. This change has reduced Conrail's postal traffic; however, Conrail has offset this decline, in part, by increased traffic directly from bulk mailers.\nThe second segment is domestic traffic, which includes a variety of commodities and customers. Most of the 15% growth in this segment in 1993 was attributable either to market share gains through new partnerships with major nationwide truckload carriers, or to RoadRailer growth through Triple Crown Services Company, a joint venture with Norfolk Southern Corporation.\nInternational container traffic constitutes the third segment of Conrail's intermodal traffic. International container traffic chiefly involves goods produced in the Pacific Basin and shipped by rail from west coast ports to east coast markets. Conrail and its western railroad connections are able to participate in this traffic because they have established superior transit times compared with the all-water route through the Panama Canal. Conrail also participates in traffic moving through Atlantic ports for import and export trade with European and Mediterranean markets. Conrail's Atlantic traffic increased 14% over 1992 levels.\nAutomotive Parts and Finished Vehicles. Conrail's automotive -------------------------------------- parts and finished vehicles traffic continues to benefit from the strengthening domestic economy and the approximately 10% increase in North American vehicle production in 1993 over 1992. Reflecting this increase in domestic production, finished vehicles volume increased 21%, while automotive parts volume increased 4.5%. Total 1993 volume increased 13.4% from 1992, with 1993 revenues 14.3% higher than 1992. In terms of revenues, General Motors and Ford were among Conrail's five largest customers in 1993; Chrysler was among Conrail's ten largest customers.\nThis commodity group, especially the automotive parts segment, is subject to vigorous truck competition. The increase in automotive parts traffic represents, in addition to increased production, Conrail's gain in market share through the use of new products and logistics services.\nIn 1993, Conrail's automotive parts and finished vehicles traffic was favorably affected by the increased strength of the yen against the U.S. dollar, which created incentives for foreign-based domestic manufacturers to shift additional production to the United States and to export domestically produced vehicles. Conrail also expects the enactment of the North American Free Trade Agreement to continue to increase its automotive parts and vehicle traffic to and from Mexico.\nMetals and Related Products. This commodity group includes --------------------------- metals (such as iron, steel, and aluminum), iron ores, scrap metal, and coke from coal. An increase in traffic volume in 1993 of 5.1% resulted in increased revenue of 7.5% from 1992 levels. Revenue from metals traffic, which accounted for approximately $310 of the $399 million for this group, increased approximately 13% on increased volume of approximately 16.5%. Increases in volume due to gains in market share from trucks were partially offset by declining revenues from shorter hauls.\nConrail serves directly, or via short line switching carriers, many of the nation's largest active integrated steel production facilities, as well as the major sources of scrap, the raw material used by mini-mills located both on and off Conrail to make steel. Although a significant portion of the active domestic steel industry is along the Cleveland-Chicago corridor on Conrail's system, the traditional domestic steel industry (using integrated steel production facilities) continues to eliminate inefficient production capacity, which has adversely affected the volume of raw materials for steel production handled by Conrail, and could continue to do so. In 1993, coke and iron ore revenue declined approximately 9% on decreased volumes of 11% compared to 1992 levels.\nFood and Grain Products. This commodity group includes fresh ----------------------- and processed food products moving primarily in boxcars, and grain and grain products moving in covered hopper and tank cars. In 1993, food and grain revenue increased 3.7% on increased volume of 3.6%, primarily as the result of substantial increases in export grain traffic. Grain and grain products generated $240 million of the $345 million in revenue in 1993. Export grain traffic, which is highly variable and depends on the value of the U.S. dollar and the size of domestic and international grain harvests, increased significantly (approximately 60%) over 1992, a year in which traffic declined 25% from 1991 levels. Food products revenue and volume declined approximately 4.5%.\nForest Products. This commodity group includes paper and wood --------------- products moving in boxcars and certain lumber and related products moving on flatcars. These commodities generated $286 million in revenue in 1993, representing increased revenue of 3.0% on increased volume of 6.5% over 1992 levels.\nOther. Other commodity groups include miscellaneous ----- commodities that are transported in boxcars, such as general manufactured goods, and stone and construction materials. These commodities generated $73 million in revenue in 1993. Volume remained stable compared with 1992 levels.\nThe Service Group System. In late 1993, Conrail announced the ------------------------ reorganization of its Marketing and Sales and Operating Departments into four service networks: Intermodal Service, Automotive Service, Unit Trains Service and Core Service. The Unit Trains network will handle coal and ore traffic, with the remaining commodities, other than automobiles and intermodal, to be handled by the Core network. Effective in 1994, each of these groups controls the integrated planning, pricing and operating functions that will enable them to tailor services, develop products and make capital investments directed toward the special requirements of their respective customers. Beginning in 1994, Conrail's traffic and revenue statistics will be reported on a service group basis.\nCertain Statistics. The following tables provide various ------------------ measurements relating to Conrail's rail operations from 1989 through 1993:\nCOMPETITION. Conrail's rail operations face significant ----------- competition from trucks, from the availability of the same or substitute goods made by producers located at points not served by Conrail, and from other railroads. The trucking industry is especially competitive in this part of the country because, on average, freight in this region is moved shorter distances than in the West, and the cost characteristics of the railroad and trucking industries generally make trucks more competitive over shorter distances.\nPrice and service competition from trucks is especially evident in the movement of intermodal freight, auto parts, and finished steel. Competition from trucks has been increased by the passage of legislation removing certain barriers to entry into the trucking business and allowing the use of wider, longer, and heavier trailers and multiple trailer combinations. The introduction of larger trailers and multiple trailer combinations in recent years has substantially increased productivity in the trucking industry. Any future legislation permitting further increases in truck capacity could have a substantial adverse effect on the competitiveness of railroads.\nCSX Corporation and Norfolk Southern Corporation are Conrail's principal railroad competitors. Conrail is also subject to competi- tion from smaller, regional railroads. The assets of the Delaware & Hudson Railway Company (\"D&H\"), a regional competitor of Conrail's, have been purchased by a subsidiary of CP Rail, a large Canadian railroad. CP Rail's use of D&H's former tracks, coupled with addi- tional trackage rights it has obtained, has resulted in increased rail competition in Conrail's service area. The consummation of a merger or joint cooperation agreement between CP Rail and Canadian National Railroad could result in increased competition in certain portions of Conrail's service territory, depending upon the nature and terms of any such arrangement. In addition, certain of Conrail's railroad competitors have become multi-modal transportation companies by purchasing previously independent water carriers or small shipment motor carriers, or both, and have thereby extended their operations into Conrail's service area.\nAn important influence on Conrail's competitive position is government regulation as administered by the Interstate Commerce Commission (\"ICC\"). Prior to 1980, regulation significantly inhibited the ability of railroads to respond to changing transportation markets. The Staggers Rail Act of 1980 (\"Staggers Act\") substantially reduced the restrictions of regulation. In particular, railroads were given more freedom to reduce costs and adjust prices, which enabled them to compete more effectively and to raise prices for traffic previously carried at a loss or at below market prices. Under the Staggers Act, the ICC also has deregulated a significant amount of railroad traffic, including intermodal and most boxcar traffic, finished vehicles and miscellaneous commodities moving in other types of equipment.\nThe Staggers Act further enhanced railroads' competitive options by permitting the use of railroad-shipper contracts for traffic still regulated by the ICC, under which the parties can set the price, service standards and term for a special transportation movement. These contracts generally provide for prices lower than tariff rates and usually do not guarantee that any given amount of freight will be shipped during their term. As of December 31, 1993, Conrail was a party to 3,962 such contracts for regulated traffic, which Conrail estimates accounted for 35% of its line-haul revenues in 1993. Although some contracts have a term longer than one year, most contracts are for one year or less. The majority of Conrail's multi-year contracts are subject to cost-related adjustments that provide for flat percentage increases. The cost-based provisions in certain of these contracts are tied to indices under the jurisdiction of the ICC. Action by the ICC to adjust these indices for productivity gains by the railroads has had an adverse impact on Conrail's ability to recover costs under such contracts, which accounted for less than 3% of Conrail's line haul revenues in 1993. For a discussion of regulation of the railroad industry, see \"Government Regulation\" and Item 3","section_3":"Item 3. Legal Proceedings. References to Conrail in \"Item 3. Legal - ------ ----------------- Proceedings\" shall denote Consolidated Rail Corporation unless otherwise expressly noted.\nOccupational Disease Litigation. Conrail has been named as a ------------------------------- defendant in lawsuits filed pursuant to the provisions of the Federal Employers' Liability Act (\"FELA\") by persons alleging (1) personal injury or death caused by exposure to asbestos in connection with railroad employment; (2) complete or partial loss of hearing caused by exposure to excessive noise in the course of railroad employment; and (3) repetitive motion injury in connection with railroad employment. As of December 31, 1993, Conrail is a defendant in 694 pending asbestosis suits, 1,262 pending hearing loss suits and 16 pending repetitive motion injury suits, and had notice of 609 potential asbestosis claims, 4,746 potential hearing loss claims and 1,049 potential repetitive motion injury claims.\nConrail expects to be named as a defendant in a significant number of occupational disease cases in the future.\nStructure and Crossing Removal Disputes in Connection With ---------------------------------------------------------- Lines Abandoned Under NERSA. Conrail may be responsible, in whole - --------------------------- or in part, for the costs of removal of several hundred overhead and underpass crossings located on railroad lines it has abandoned under the Northeast Rail Service Act of 1981 (\"NERSA\") (and, in some instances, responsible for the removal of the lines of railroad themselves as well as appurtenant structures). Conrail's liability for the removal of such lines, crossings and structures will be determined on a case-by-case basis. Some states have imposed upon Conrail the obligation to remove certain crossings.\nIn 1989, an organization of interests that own property under and adjacent to Conrail's elevated West 30th Street rail line running along the west side of lower Manhattan filed a petition with the ICC seeking to force Conrail to abandon the line and finance its removal, which could cost in excess of $30 million. The ICC voted in January 1992 to grant the property owners' petition, subject to the owners posting a bond indemnifying Conrail for any demolition costs exceeding $7 million. The property owners have refused to post the bond. The parties have appealed to the United States Court of Appeals for the District of Columbia.\nConrail Withdrawal from RCAF Master Tariff. The Rail Cost ------------------------------------------ Adjustment Factor (\"RCAF\") is an index of rail costs issued by the ICC according to which railroads may adjust their regulated rates for inflation and cost increases free of regulatory interference. In March 1989, the ICC decided to offset the quarterly RCAF by the\nentirety of the average rail industry productivity gain, in a proceeding previously disclosed by Conrail in its quarterly report on Form 10-Q for the period ended June 30, 1992 (\"Productivity Adjustment to Cost Recovery Process\").\nOn January 1, 1990, Conrail ceased applying RCAF increases to its regulated rates, by ending its participation in the RCAF master tariff. Effective July 1, 1990, Conrail published a series of inde- pendent rate increases approximately equal to its increases in costs as reflected by the RCAF. Conrail's action was contested, but was upheld by the ICC. Since July 1, 1990, Conrail has continued to make independent selective increases to its regulated rates. These regulated rates will continue to be subject to individual challenge to the extent the levels of the increases exceed those previously permitted pursuant to the RCAF and no other statutory provisions bar ICC jurisdiction.\nIn January 1991, the ICC commenced a proceeding at the request of a shippers' organization to clarify the legal effect of Conrail's (and other railroads') withdrawal from the RCAF master tariff, including the shippers' assertion that railroads thereby lose protection from challenge for rates previously adjusted under these procedures. In April 1991, Conrail individually opposed and participated in the rail industry's opposition to the petition. A decision is awaited.\nEngelhart v. Conrail. In connection with the Special Voluntary -------------------- Retirement Program offered to certain employees in late 1989 and early 1990, Conrail used surplus funds in its overfunded Supplemental Pension Plan (\"Plan\") to fund certain aspects of that program. In December 1992, certain former Conrail employees brought suit challenging the use of surplus Plan funds (i) to pay administrative Plan expenses previously paid by Conrail, (ii) to fund the Special Voluntary Retirement Program, and (iii) to pay life insurance and medical insurance premiums of former employees as improper and unlawful, and alleging that employees who have made contributions to the Plan or its predecessor plans are entitled to share in the surplus assets of the Plan. In August 1993, the federal district court granted Conrail's Motion to Dismiss the majority of counts in the complaint, but declined to dismiss the issue of Conrail's use of Plan assets to pay administrative expenses of the Plan, which are estimated to be approximately $25 million as of December 31, 1993. However, Conrail believes that the use of surplus Plan assets for this purpose is lawful and proper. Conrail intends to use surplus Plan assets in a similar manner in connection with the 1994 early retirement program. (See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - 1994 Outlook.\")\nEnvironmental Litigation. Conrail is subject to various ------------------------ federal, state and local laws and regulations regarding environmental matters. In certain instances, Conrail has received\nnotices of violations of such laws and regulations and either has taken or plans to take appropriate steps to address the problems cited or to contest the allegations of violation. As of December 31, 1993, Conrail had received inquiries from governmental agencies or had been identified, together with other companies, as a potentially responsible party for cleanup and\/or removal costs due to its status as an alleged transporter, generator or property owner at 114 locations throughout the country. However, Conrail, through its own investigations and assessments, believes it may have some potential responsibility at only 54 of these sites. (See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters.\") The significant environmental proceedings, including Superfund sites, are discussed below.\nUnited States v. Southeastern Pennsylvania Transportation --------------------------------------------------------- Authority (\"SEPTA\"), National Railroad Passenger Corporation - ------------------------------------------------------------ (\"Amtrak\"), and Consolidated Rail Corporation. In March 1986, the - --------------------------------------------- United States Environmental Protection Agency (\"EPA\") filed an action in the United States District Court for the Eastern District of Pennsylvania for cost recovery, injunctive relief, and a declaratory judgment against Conrail, Southeastern Pennsylvania Transportation Authority (\"SEPTA\") and National Railroad Passenger Corp. (\"Amtrak\") under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (\"CERCLA\" or \"Superfund Law\"), as amended. In 1990, the Pennsylvania Department of Environmental Resources intervened as a plaintiff. Suit is based on the release or threatened release at the Paoli Railroad Yard, Paoli, Chester County, Pennsylvania, of polychlorinated biphenyls (\"PCBs\"), a listed hazardous substance under CERCLA. Conrail is sued in its capacity as the operator of the rail yard from April 1, 1976 through December 31, 1982, under an agreement with SEPTA to provide commuter rail service. In March 1992, Penn Central brought suit before the Special Court arguing that the terms of the transfer of its properties to Conrail did not contemplate environmental liability for conditions existing at the time of the transfer. The Special Court has determined it has jurisdiction to hear the matter. In February 1993, Penn Central petitioned the district court to stay all proceedings with respect to it pending the outcome of the proceeding before the Special Court. The EPA has responded by filing a petition to stay the district court proceeding in its entirety pending resolution of the Special Court proceeding. Motions and cross-motions for summary judgment by the parties are pending.\nPursuant to a series of partial preliminary consent decrees, defendants have performed a series of cleanup actions both on and off-site and have conducted a Remedial Investigation\/Feasibility Study (\"RI\/FS\"). As of December 31, 1993, the cost of the RI\/FS and of the interim cleanup measures performed by the three defendants is approximately $9 million. Those costs have been shared equally among the three defendants but are subject to reallocation. All\nwork done to date has been performed subject to a denial of liability and without waiving any defense to the governmental claim for cleanup costs or other relief.\nOn September 16, 1992, the EPA issued a Special Notice Letter to Conrail, SEPTA, Amtrak and Penn Central Corporation requesting the parties to provide, within 60 days, a good-faith offer to perform all necessary remediation of the Paoli rail yard site, as well as reimbursement of approximately $2.6 million in past response costs of the EPA. The EPA estimates that its remediation plan as set forth in its Record of Decision will cost approximately $28 million. On November 16, 1992, the parties submitted an offer to pay a portion of the estimated cost of the remediation action selected by the EPA. On January 8, 1993, the EPA rejected the parties' offer on several bases, including that the proposal addressed only a portion of the EPA's recommended remedy for the site. The EPA may now issue an administrative order directing any party to carry out its remediation plan, subject to treble damages and daily penalties for failure to comply without sufficient cause. The estimated cost of Conrail's portion of the parties' proposed remedy was included in the 1991 special charge and subsequent adjustments to accruals.\nUnited States v. Conrail. The EPA has listed Conrail's ------------------------ Elkhart Yard in Indiana on the National Priorities List. The EPA contends that chemicals have migrated from the yard and contaminated drinking wells in the area. On February 14, 1990, the EPA filed a civil action against Conrail in the U.S. District Court for the Northern District of Indiana seeking recovery of approximately $345,000 for costs incurred in protecting the water supply. In addition, the EPA seeks a declaratory judgment against Conrail for all future costs incurred in responding to the release or threatened release of hazardous substances from the site. Conrail believes it is not the sole source and may not be a contributing source to the contamination alleged by the EPA. Conrail filed a third-party action joining Penn Central as a defendant, to which Penn Central has responded by filing a declaratory judgment action in Special Court. (See previous discussion regarding the Special Court under \"United States v. SEPTA, et al\"). On July 7, 1992, the EPA issued an order requiring Conrail and Penn Central to implement the interim remedy set forth in the Record of Decision. Conrail is performing the interim remedy in compliance with the EPA order and is simultaneously in litigation with the EPA over the implementation of the remedy. Penn Central has declined to participate. The estimated cost of remediation was included in Conrail's 1991 special charge and subsequent adjustments to accruals.\nUnited States v. Conrail, et al. Conrail has been identified ------------------------------- as the fifth largest generator of waste oil at the Berks Associates Superfund site in Douglasville, Pennsylvania. In addition, Conrail has become aware that it and its predecessor, Penn Central, owned a small portion of land that was leased to the operator of the Berks\nsite. As such, Conrail's liability could increase due to its ques- tionable status as both an owner and a generator. In August 1991, the EPA issued an administrative order against Conrail and thirty- five other entities mandating the implementation of an approximately $2 million partial remedy and filed a complaint in the U.S. District Court for the recovery of approximately $8 million in costs incurred by the government. The parties have negotiated an administrative order with the EPA and have filed an answer to the civil action. A group of potentially responsible parties (including Conrail) undertook compliance with the administrative order. Conrail and the 35 other defendants have filed a third-party complaint against approximately 630 entities seeking contribution for the costs of the remedy and government costs. Conrail, along with other defendants, is negotiating a settlement with the EPA. On June 30, 1993, the EPA issued another administrative order against Conrail and 33 other entities, mandating the remediation of the southern portion of the site. The effective date of the order has been delayed in light of the negotiations.\nThe most expensive aspect of the remediation of the site is the clean-up of Source Area 2, which the government estimates at between $45 and $55 million. This Source Area was closed prior to Conrail's incorporation, and therefore Conrail has maintained that it is not liable for the cost of remediating Source Area 2.\nUnited States v. Conrail, et al. Conrail is a potentially ------------------------------- responsible party (\"PRP\"), along with more than 50 other parties, in the United Scrap Lead federal Superfund action in Troy, Ohio, where substantial quantities of batteries were disposed of over a period of several years. The EPA sued Conrail and nine other parties in August 1991 in the Southern District of Ohio for the recovery of approximately $2 million in past costs. Conrail and other PRP's have commissioned treatability studies. The court has imposed a stay to discuss whether this matter can be settled. The parties are negotiating over the nature of the remediation to be undertaken at the site.\nCommonwealth of Massachusetts v. Conrail. On April 21, 1992, ---------------------------------------- the Massachusetts Attorney General filed suit in Superior Court of Massachusetts alleging Conrail's violation of the Massachusetts Clean Air Act and its implementing regulations by allowing diesel engines to idle unnecessarily and\/or in excess of thirty minutes. On May 4, 1992, the court entered a preliminary injunction, the terms of which are substantially consistent with Conrail's existing idling policy. The Attorney General subsequently filed a complaint alleging Conrail's violation of the preliminary injunction. On February 2, 1993, the parties entered into a partial settlement agreement; however, the Attorney General has alleged that Conrail has failed to comply with certain provisions of the settlement.\nUnited States v. Consolidated Rail Corporation, The Monongahela --------------------------------------------------------------- Railway Company, et al. On September 30, 1992, Region VIII of the - ---------------------- EPA filed an administrative action for civil penalties against Conrail and its former wholly-owned subsidiary, The Monongahela Railway Company (now merged into Conrail), under the Toxic Substances Control Act for allegedly improper handling of a shipment of PCB contaminated soil. The other railroads in the movement and the shipper were served with similar complaints. Conrail is currently negotiating with EPA.\nNew York State Department of Environmental Conservation Order ------------------------------------------------------------- On Consent. On February 18, 1993, the New York State Department of - ---------- Environmental Conservation (\"NYSDEC\") served Conrail with a draft Order on Consent requiring the payment of fines in connection with its inspection of Selkirk Yard. The order also seeks compensation for the hiring of three full-time NYSDEC employees to monitor Conrail's compliance at Selkirk and two other rail yards in New York. Conrail is negotiating the terms of the Order with NYSDEC.\nConway Yard, Pittsburgh. In 1991, Conrail received Notices of ----------------------- Violation (\"NOV\") from the Pennsylvania Department of Environmental Resources (\"PADER\") alleging violations of the Clean Streams Act for discharges of oil into the Ohio River. In September 1993, PADER sent to Conrail a draft Consent Order and Agreement requiring a comprehensive site remediation for soil, ground water, surface waters and sediments at the Conway rail yard and requiring the payment of an undisclosed amount of civil fines in connection with violations at the yard, including continuing ground water contamination. Conrail and PADER are negotiating the extent of the investigation and remediation to be undertaken at the yard.\nOther. In addition to the above proceedings, Conrail has been ----- named in various legal proceedings arising out of its activities as an employer and as an operator of a freight railroad, including personal injury actions brought by its employees under FELA, as well as administrative proceedings with and investigation by government agencies.\nIn view of the inherent difficulty of predicting the outcome of legal proceedings, particularly in certain matters described above in which substantial damages are or may be sought, Conrail cannot state what the eventual outcomes of such legal proceedings will be. Certain of these matters, if determined adversely to Conrail, could result in the imposition of substantial damage awards against, or increased costs to, Conrail that could have a material adverse effect on Conrail's results of operations and financial position. Conrail's management believes, however, based on current knowledge, that such legal proceedings will not have a material adverse effect on Conrail's financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. - ------ --------------------------------------------------- There were no matters submitted to a vote of security holders during the fourth quarter of 1993.\nExecutive Officers of the Registrant. - ------------------------------------ Conrail's officers are elected annually by the Board of Directors at its first meeting held after the meeting of shareholders at which directors are elected, and they hold office until their successors are elected. There are no family relationships among the officers or directors, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information, as of March 1, 1994, relating to the executive officers of Conrail and Consolidated Rail Corporation. An asterisk (*) indicates that such individual is an officer of Consolidated Rail Corporation only:\nName, Age, Present Position Business Experience During - --------------------------- Past 5 Years ---------------------------------------- James A. Hagen, 61, Present position since May 18, 1989. Chairman, Served as President - CSX Distribution President and Chief Services, Inc. from March 1988 to April Executive Officer 1989.\nDavid M. LeVan, 48, Present position since December 1993. Executive Vice President Served as Senior Vice President - Operations between July 1992 and December 1993. Served as Senior Vice President-Operating Systems and Strategies between November 1991 and June 1992. Served as Senior Vice President - Corporate Systems between November 1990 and November 1991. Served as Vice President - Corporate Strategy between September 1988 and November 1990.\nH. William Brown, 55, Senior Present position since April 1992. Served Vice President - Finance as Senior Vice President - Finance and Administration between April 1986 and April 1992.\nGordon H. Kuhn, 43, Senior Present position since December 1993. Vice President - Core Served as Senior Vice President - Marketing and Service Group Sales between January 1990 and December 1993. Served as Vice President - Marketing between August 1987 and January 1990.\nCharles N. Marshall, 52, Present position since January 1990. Senior Vice President - Served as Senior Vice President - Development Marketing and Sales between March 1985 and January 1990.\nBruce B. Wilson, 58, Senior Present position since April 1987. Vice President - Law\nJohn T. Bielan, Jr., 46, Present position since March 1992. Vice President - Continuous Served as Assistant Vice President - Automotive Quality Improvement* between April 1989 and March 1992.\nRonald J. Conway, 50, Vice Present position since December 1993. President - Intermodal Served as Assistant Vice President - Service Group* Petrochemicals and Minerals between April 1992 and December 1993. Served as General Manager - Philadelphia Division between 1989 and April 1992.\nTimothy P. Dwyer, 44, Vice Present position since December 1993. President - Unit Trains Served as General Manager - Philadelphia Service Group* Division between April 1992 and December 1993. Served as Assistant Vice President - Metals between 1989 and April 1992.\nGerald T. Gates, 40, Vice Present position since December 1993. President - Mechanical* Served as Assistant Vice President - Operations Planning and Administration between July 1992 and December 1993. Served as General Manager - Indianapolis Division between September 1990 and July 1992. Served as Assistant General Manager - Albany Division between 1989 and September 1990.\nDonald W. Mattson, 51, Vice Present position since May 1993. Served as President - Treasurer Vice President - Controller between August 1988 and May 1993.\nJohn A. McKelvey, 42, Vice Present position since May 1993. Served as President - Controller Vice President - Treasurer between 1988 and May 1993.\nWilliam B. Newman, Jr., 43, Present position since 1981. Vice President and Washington Counsel*\nFrank H. Nichols, 47, Vice Present position since February 1993. President - Resource Served as Assistant Vice President - Development* Finance between November 1988 and February 1993.\nTimothy T. O'Toole, 38, Vice Present position since May 1989. President and General Served as an attorney in the Law Counsel Department prior to that time.\nRichard S. Pyson, 52, Vice Present position since March 1992. President - Served as Vice President - Engineering Transportation* between March 1991 and March 1992. Served as Assistant Vice President - Engineering and Maintenance between March 1990 and March 1991. Served as Chief Engineer - Communications and Signals between 1988 and March 1990.\nJohn M. Samuels, 50, Vice Present position since March 1992. President - Engineering* Served as Vice President - Continuous Quality Improvement between April 1990 and March 1992. Served as Assistant Vice President - Industrial Engineering between 1980 and April 1990.\nAllan Schimmel, 53, Vice Present position since November 1990. President - Administrative Served as Corporate Secretary and Services and Corporate Assistant to the Chairman since 1980. Secretary\nRobert E. Swert, 67, Vice Present position since 1981. President - Labor Relations*\nGeorge P. Turner, 52, Vice Present position since December 1993. President - Automotive Served as Assistant Vice President - Service Group* Automotive between April 1992 and December 1993. Served as Assistant Vice President- Petrochemicals and Minerals between March 1990 and April 1992. Served as Assistant Vice President - Sales between 1987 and March 1990.\nRalph von dem Hagen, 49, Present position since September 1989. Vice President - Customer Served as Assistant Vice President - Car Service* Management between September 1984 and September 1989.\nRobert O. Wagner, 57, Present position since June 1991. Vice President - Served as Vice President - Information Information Systems* Services for Pan American World Airways, Inc. between 1983 and May 1991. (1)\nJeremy T. Whatmough, 59, Present position since 1979. Vice President - Materials and Purchasing*\nGery M. Williams, Jr., 52, Present position since January 1990. Vice President - State Served as Vice President - Sales between and Local Affairs* March 1985 and January 1990. ______________________________ (1) On January 8, 1991, Pan American World Airways, Inc. and its subsidiaries filed petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity - ------ ------------------------------------- and Related Stockholder Matters. -------------------------------\nConrail's common stock is listed for trading on the New York Stock Exchange and the Philadelphia Stock Exchange. The number of holders of record of Conrail common stock on March 4, 1994 was 19,735. For the high and low sales prices of Conrail's common stock on the New York Stock Exchange and the frequency and amount of cash dividends for 1993 and 1992. (See Note 13 to the Consolidated Financial Statements included elsewhere in this Annual Report.)\nItem 6.","section_6":"Item 6. Selected Financial Data. - ------ ----------------------- The selected consolidated financial data included in the following tables have been derived from Conrail's Consolidated Financial Statements. The consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993 and the consolidated balance sheets as of December 31, 1993 and 1992 appear elsewhere in this Annual Report and have been audited by Coopers & Lybrand, independent accountants, as indicated in their report thereon. For purposes of the following selected consolidated financial data, references to Conrail reflect the consolidated entities of Consolidated Rail Corporation for periods prior to July 1, 1993 and Conrail Inc. for subsequent periods.\nThe selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and related notes and other financial information included elsewhere in this Annual Report.\nNOTES TO SELECTED CONSOLIDATED FINANCIAL DATA\n1. Conrail adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\"), and Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), effective January 1, 1993. As a result, in the first quarter of 1993 Conrail recorded cumulative after-tax charges of $22 million and $52 million, respectively. In addition, as a result of the increase in the federal corporate income tax rate from 34% to 35%, effective January 1, 1993, income tax expense includes $34 million of a retroactive nature, primarily for the effects of adjusting deferred income taxes and the special income tax obligation for the rate increase as required under SFAS 109. See Notes 1, 7 and 8 to the Consolidated Financial Statements included elsewhere in this Annual Report.\n2. In 1990, Conrail completed a financial restructuring plan which included a Dutch auction tender offer, the establishment of an employee stock ownership plan for non-union employees (\"Non-union ESOP\") and a related open market common stock purchase program. Through the Dutch auction tender offer, Conrail purchased 44.64 million shares of its outstanding common stock at a price of $24.50 per share, or an aggregate of $1.094 billion. In March 1990, Conrail issued 9,979,562 shares of Series A ESOP Convertible Junior Preferred stock to the Non-union ESOP in exchange for a promissory note of $288 million. In connection with its restructuring, Conrail acquired 8,715,902 shares of its common stock in the open market for $200 million. The cost of the restructuring was financed with approximately $450 million of available funds, $50 million in short-term borrowings (commercial paper) and with proceeds from the sale of $250 million principal amount of 9 3\/4% Notes due 2000 and $550 million principal amount of 9 3\/4% Debentures due 2020.\n3. Included in 1991 operating expenses is a special charge totalling $719 million, which reduced net income by $447 million. Without the special charge, net income would have been $240 million ($2.73 and $2.48 per share, primary and fully diluted, respectively). The 1989 special charge of $234 million reduced net income by $147 million ($1.08 per share). The 1991 special charge is described in Note 10 to the Consolidated Financial Statements included elsewhere in this Annual Report. The 1989 special charge included $109 million related to a non- union employee reduction program; a $92 million increase in casualty reserves based on an actuarial valuation; and $33 million for realignment and consolidation of certain administrative and operating functions.\n4. In 1993, Conrail committed to a plan for the disposition of its investment in Concord Resources Group, Inc. Pursuant to this plan, Conrail recorded an estimated loss of $80 million for the\ndisposition of its investment, including $19 million for operating losses expected to be incurred during the phase-out period and disposition costs. Conrail also recorded estimated federal tax benefits of $30 million relating to the disposition. See Note 3 to the Consolidated Financial Statements included elsewhere in this Annual Report.\n5. Net income (loss) and dividends per common share include the effects of the common stock split which is described in Note 2 to the Consolidated Financial Statements included elsewhere in this Annual Report. The calculations of income (loss) per common share for 1993, 1992 and 1991 are shown in Exhibit 11, Part IV included elsewhere in this Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Overview - -------- For 1993, Conrail's net income was $160 million compared with net income of $282 million for 1992, and a net loss of $207 million for 1991. Results for 1993 include the effects of recording one- time after tax charges of $74 million for adoption of required changes in accounting for income taxes and postretirement benefits other than pensions; the estimated net loss on the planned disposition of Concord Resources Group, Inc. (\"Concord\"), $50 million; and the one-time effects on deferred taxes of the increase in the 1993 federal corporate income tax rate, $34 million (see Notes 1, 3, 7 and 8 to the Consolidated Financial Statements elsewhere in this Annual Report). Absent these charges, Conrail's net income for 1993 would have been $318 million. The results for 1991 included the effects of a $719 million special charge ($447 million after income taxes); without the special charge, net income for 1991 would have been $240 million.\nThe 1993 results were favorably affected by an improvement in traffic volume (5.0%) and operating revenues (3.2%) compared with 1992, primarily due to the improvement in the economy and an increase in Conrail's market share. In addition, effective cost reduction and containment programs enabled Conrail to limit the increase in its operating expenses to 1.8% over 1992.\nTraffic volume and operating revenues increased in 1992 compared with 1991 (3.8% and 2.9%, respectively), and the increase in Conrail's operating expenses (excluding the 1991 special charge) was less than one percent over 1991, despite higher traffic volume.\nHolding Company Formation - ------------------------- In May 1993, the shareholders of Consolidated Rail Corporation approved a plan for the adoption of a holding company structure. Under the plan, each share of Consolidated Rail Corporation common stock that was issued and outstanding or held in the treasury and each share of Consolidated Rail Corporation Series A ESOP Convertible Junior Preferred Stock (\"ESOP Stock\") held by the Non- union Employee Stock Ownership Plan were automatically converted on July 1, 1993 into one share of common stock and one share of ESOP Stock, respectively, of a newly created holding company, Conrail Inc. As a result, Conrail Inc. became the publicly held entity effective July 1, 1993. The change in corporate structure does not represent a change in operations or Strategic Business Plan (see Strategic Business Plan). On July 1, 1993, Conrail Inc. had the - ----------------------- same consolidated operations, assets, liabilities and stockholders' equity as Consolidated Rail Corporation had on June 30, 1993. In this Annual Report, references to the \"Company\" or \"Conrail\" will denote the consolidated entities Consolidated Rail Corporation for periods prior to July 1, 1993 and Conrail Inc. for subsequent periods (see Note 2 to the Consolidated Financial Statements elsewhere in this Annual Report).\nStrategic Business Plan - ----------------------- Conrail's Strategic Business Plan (the \"Plan\") for the five year period 1992-1996 set specific 1996 financial goals of an operating ratio (operating expenses as a percent of revenues) of 80% and a return on funded assets at least equal to Conrail's cost of capital. The Plan also targeted revenue growth of $1 billion for that time period. During the second quarter of 1993, Conrail reevaluated the Plan's assumptions, including changes that had occurred or were expected to occur in economic conditions, demand for products of customers served by Conrail and Conrail's market share in each of the industry segments served. Consequently, Conrail revised its revenue growth target to $600 million by 1996. About half of the difference was due to a change in the anticipated demand for coal attributable to slower growth in electrical demand than previously expected, fewer cogeneration plants planned and delays in the start-up of others, and the impact of world competitive market conditions on U.S. coal exports. Changes in the general forecast for the U.S. economy accounted for the remaining difference. Conrail expects an average real annual growth rate for industrial production of 2.8% for the 1991-1996 period, versus the 3.3% originally projected, and inflation is projected at 2.4% annually for the period, compared to an original projection of 3.4%. Industrial production growth affects freight traffic volume, and annual inflation affects freight revenue. Despite the lower revenue target, Conrail's financial goal for 1996 of a return on funded assets equal to its cost of capital remains unchanged, which, if achieved, will require an operating ratio of 78.5% in 1996, based on current assumptions.\nFor 1993, Conrail achieved an operating ratio of 82.9% and a return on funded assets of approximately 9.0% compared to its cost of capital of 11%.\n1994 Outlook - ------------ Conrail expects the 1994 economy to continue its slow growth. Despite signs of a strengthening economy in the fourth quarter of 1993, there is still uncertainty as to whether that pace can be sustained throughout 1994. Conrail's 1994 plans are based on an assumption of 3.0% growth in real gross domestic product and 3.4% growth in industrial production. A key Conrail goal for 1994 is to achieve an operating ratio of 81.5%, excluding any one-time charges.\nOn December 15, 1993, the Board of Directors approved a voluntary early retirement program for eligible members of its non- union workforce. Eligible employees had until February 28, 1994 to elect to retire under the program, and the cost of the program is expected to have a material adverse effect on the results of operations for the first quarter of 1994. The transaction will not significantly affect Conrail's cash position as approximately 85% of the cost will be paid from the Company's overfunded pension plan (see Notes 8 and 12 to the Consolidated Financial Statements elsewhere in this Annual Report). Conrail has announced that 330 employees, or 80% of those eligible, accepted the voluntary retirement program for non-union employees. Preliminary estimates of the cost of the program were between $75 million and $85 million before taxes. In addition, the Company expects the extreme winter weather in January, February and early March of 1994 to have a substantial adverse effect on first quarter earnings.\nConrail expects to implement the service group structure without replacing most of the employees who elected to retire under the non-union employee retirement program. The Company is also reviewing its current utilization of assets required to support the new structure with the goal of identifying excess assets. If identified, certain of such assets may be written down to their realizable values, resulting in a charge to operations. (See Item 1 - \"Business - The Service Group System.\")\nResults of Operations - --------------------- 1993 Compared with 1992\nNet income for 1993 was $160 million ($1.82 per share, primary and $1.70 per share, fully diluted) compared with 1992 net income of $282 million ($3.28 per share, primary and $2.99 per share, fully diluted). The decrease in net income is attributable primarily to the following unusual or one-time charges in 1993: one-time after tax charges of $74 million for adoption of required changes in accounting for income taxes and postretirement benefits other than pensions; the recording of the estimated net loss on the disposition\nof Concord, $50 million; and the one-time effects on deferred taxes of the increase in the 1993 federal corporate income tax rate, $34 million (see Notes 1, 3, 7 and 8 to the Consolidated Financial Statements elsewhere in this Annual Report). Absent these charges, Conrail's net income for 1993 would have been $318 million ($3.78 per share, primary and $3.43 per share, fully diluted).\nOperating revenues (primarily freight line haul revenues, but also including switching, demurrage and incidental revenues) increased $108 million, or 3.2%, from $3,345 million in 1992 to $3,453 million in 1993. A 5.0% increase in traffic volume, as measured in units (freight cars and intermodal trailers and containers), resulted in a $160 million increase in revenues that was partially offset by a 1.6% decrease in average revenue per unit which reduced revenues $54 million. The decline in average revenue per unit is attributable to decreases in average rates which reduced revenue by $62 million, partially offset by a favorable mix of traffic which increased revenues $8 million. Traffic volume increases occurred in the following freight commodity groups: automotive parts and finished vehicles, 13.4%; intermodal, 11.2%; forest products, 6.5%; chemicals and related products, 6.4%; metals and related products, 5.1%; and food and grain products, 3.6%. Coal traffic decreased 9.2%. Switching, demurrage and incidental revenues increased $2 million.\nOperating expenses increased $51 million, or 1.8%, from $2,811 million in 1992 to $2,862 million in 1993. The following table sets forth the operating expenses for the two years:\nCompensation and benefits costs decreased $8 million, or 0.6%, with relatively stable employment levels. The decrease is attributable primarily to a decrease in payroll taxes, partially offset by increases in fringe benefit costs and increased wage rates. Compensation and benefits as a percent of revenues was 35.6% in 1993 compared with 37.0% in 1992.\nThe increase of $15 million, or 5.2%, in equipment rents reflects the effects of new operating leases for equipment and the increase in traffic volume, partially offset by improvement in equipment utilization.\nDepreciation and amortization expense decreased $11 million, or 3.7%, primarily due to lower depreciation rates for locomotives and freight cars as a result of a depreciation study required by the Interstate Commerce Commission.\nOther operating expenses increased $55 million, or 11.3%, primarily due to increases in property and corporate taxes, increases in write-downs of uncollectible accounts, and a reduction in 1992 due to reducing accruals related to the 1991 special charge with no corresponding reduction in 1993.\nConrail's operating ratio was 82.9% for 1993 compared with 84.0% for 1992.\nInterest expense increased $13 million, or 7.6%, from $172 million in 1992 to $185 million in 1993 due to the net addition of long-term debt in 1993.\nThe loss on disposition of subsidiary, $80 million, represents Conrail's estimated gross loss on the planned disposition of Concord (see Note 3 to the Consolidated Financial Statements elsewhere in this Annual Report).\nOther income, net, (representing interest and rental income, property sales and other non-operating items, net) increased $16 million, or 16.3%, from $98 million in 1992 to $114 million in 1993, principally due to higher gains from property sales and increased equity income as a result of higher net income of Conrail's affiliated companies.\n1992 Compared with 1991\nNet income for 1992 was $282 million ($3.28 per share, primary and $2.99 per share, fully diluted) compared with a 1991 net loss of $207 million ($2.70 loss per share, primary and fully diluted). The net loss for 1991 included the effects of a $719 million special charge which reduced after-tax earnings by $447 million (see Note 10 to the Consolidated Financial Statements elsewhere in this Annual Report). Without the special charge, net income for 1991 would have been $240 million, and net income per common share would have been $2.73 primary and $2.48 fully diluted. Based on events which occurred in the third quarter of 1992, certain accruals related to the 1991 special charge were adjusted, reducing 1992 operating expenses by $11 million.\nOperating revenues increased $93 million, or 2.9%, from $3,252 million in 1991 to $3,345 million in 1992. A 3.8% increase in traffic volume resulted in a $119 million increase in revenues. The increase in traffic volume was partially offset by a 1.1% decrease in average revenue per unit, attributable to both decreases in average rates and an unfavorable traffic mix, which reduced revenues $37 million. Traffic volume increases occurred in the following freight\ncommodity groups: automotive parts and finished vehicles, 10.3%; intermodal, 10.1%; food and grain products, 4.6%; metals and related products, 3.2%; and chemicals and related products, 2.1%. Coal traffic decreased 4.9%. Switching, demurrage and incidental revenues increased $11 million.\nOperating expenses decreased $702 million from $3,513 million in 1991, which included a $719 million special charge, to $2,811 million in 1992. Excluding the 1991 special charge, operating expenses increased $17 million, or 0.6%. The following table sets forth the operating expenses for the two years:\nAlthough there was only a $4 million increase in compensation and benefits, the results were affected by the settlement in 1992 of labor contracts covering the majority of Conrail's union employees. Increased wage rates were partially offset by reduced fringe benefit costs and lower employment levels principally attributable to reduced crew sizes under the new labor agreement with the United Transportation Union. Compensation and benefits as a percent of revenues was 37.0% in 1992 compared with 37.9% in 1991.\nFuel costs decreased $14 million, or 7.5%, principally as a result of significantly lower average fuel prices, primarily in the first six months of 1992, $23 million. Prices in 1991 had been adversely affected by the war in the Persian Gulf. An increase in consumption due to increased traffic levels, $9 million, partially offset the lower fuel prices.\nThe increase of $17 million, or 9.4%, in material and supplies costs was due to a planned increase in programs for repairs and maintenance of locomotives and freight cars, and, to a lesser extent, increased traffic volumes.\nThe increase of $11 million, or 3.9%, in equipment rents reflects the effects of new operating leases for equipment and the increase in traffic volume.\nDepreciation and amortization expense decreased $12 million, or 3.9%, due principally to asset reductions relating to lease expirations and property sales, partially offset by an increase in\ndepreciable assets in 1992.\nThe increase in casualties and insurance of $11 million, or 9.0%, was primarily due to an increase in occupational health claims expense based on an assessment of both the total number of expected claims and the anticipated costs to settle such claims.\nThe special charge of $719 million included in 1991 operating expenses is discussed more fully in Note 10 to the Consolidated Financial Statements elsewhere in this Annual Report.\nConrail's operating ratio was 84.0% for 1992 compared with 108.0% for 1991. The 1991 operating ratio would have been 85.9% in the absence of the special charge.\nThe reduction in interest expense, $9 million, or 5.0%, from $181 million in 1991 to $172 million in 1992, was due to capital lease expirations and lower interest rates. Other income, net also decreased $9 million, or 8.4%, from $107 million in 1991 to $98 million in 1992, primarily due to losses of Concord (see Note 3 to the Consolidated Financial Statements elsewhere in this Annual Report), and a decrease in interest income, partially offset by an increase in rental income.\nLiquidity and Capital Resources - ------------------------------- Conrail's cash and cash equivalents decreased $2 million, from $40 million at December 31, 1992 to $38 million at December 31, 1993. Cash generated from operations, principally from its wholly- owned subsidiary, Consolidated Rail Corporation, and borrowings are Conrail's principal sources of liquidity and are used primarily for capital expenditures, debt service, and dividends. Operating activities provided cash of $504 million in 1993, compared with $496 million in 1992 and $570 million in 1991. Issuance of long- term debt provided cash of $485 million in 1993. The principal uses of cash in 1993 were for property and equipment acquisitions, $566 million, payment of long-term debt including capital lease and equipment obligations, $195 million, the repurchase of common stock, $64 million, net repayment of commercial paper, $48 million, and cash dividends on preferred and common stock, $117 million.\nA working capital (current assets less current liabilities) deficiency of $13 million existed at December 31, 1993, compared with a deficiency of $489 million at December 31, 1992. The decrease in the deficiency is attributable primarily to the increase of $52 million in accounts receivable; the recording of $227 million of current deferred tax assets as a result of adopting SFAS 109 (see Note 7 to the Consolidated Financial Statements elsewhere in this Annual Report); and reductions in short-term borrowings, $48 million, current maturities of long-term debt, $61 million, and accrued and other current liabilities, $63 million. Management believes that Conrail's financial position allows it sufficient\naccess to credit sources on investment grade terms, and, if necessary, additional intermediate or long-term debt could be issued for working capital requirements.\nIn July 1992, Conrail began a common stock repurchase program of up to $100 million. At December 31, 1992, Conrail had acquired 1,208,004 shares for $50 million under this program. This program was completed in September 1993, at a total of 2,150,293 shares. In July 1993, Conrail's Board of Directors authorized a new $100 million repurchase program, under which Conrail had acquired 237,855 shares for approximately $14 million through December 31, 1993.\nDuring 1993, Conrail issued an additional $114 million of commercial paper and repaid $162 million. Of the remaining $179 million outstanding at December 31, 1993, $100 million is classified as long-term debt since it is expected to be refinanced through subsequent issuances of commercial paper and is supported by a long- term credit facility.\nIn February 1993, Conrail issued $94 million of Pass Through Certificates to finance the acquisition of equipment. Of these certificates, $54 million are direct obligations of Conrail and are secured by the acquired equipment. The remaining $40 million of certificates were issued to finance equipment which Conrail will utilize under a capital lease, and while such certificates are not direct obligations of or guaranteed by Conrail, the amounts payable by Conrail under the lease will be sufficient to pay principal and interest on the certificates.\nConrail issued $79 million of medium-term notes during the first quarter of 1993 under a shelf registration statement filed in April 1990. In May 1993, Conrail sold $250 million of 7 7\/8% Debentures due 2043 under the same shelf registration statement. During 1993, Conrail redeemed $85 million of medium-term notes that were issued in 1988 and 1989.\nIn June 1993, Conrail and Consolidated Rail Corporation filed a new shelf registration statement on Form S-3 which will enable Consolidated Rail Corporation to issue up to $500 million in debt securities or Conrail to issue up to $500 million in convertible debt or equity securities. Consolidated Rail Corporation issued approximately $63 million of 1993 Equipment Trust Certificates, Series A, in September 1993, under this registration statement. The certificates were used to finance approximately 80% of the cost of certain rebuilt and new freight cars, which Consolidated Rail Corporation will utilize under an operating lease. Although the certificates are not direct obligations of, or guaranteed by\nConsolidated Rail Corporation, the amounts payable by Consolidated Rail Corporation under the lease will be sufficient to pay principal and interest on the certificates.\nIn November 1993, Consolidated Rail Corportion issued $102 million of 1993 Equipment Trust Certificates, Series B, to finance approximately 85% of the cost of 80 new locomotives. These certificates are direct obligations of Consolidated Rail Corporation and were not issued pursuant to the 1993 shelf registration statement.\nDuring the third quarter of 1993, Conrail reached a settlement with the Internal Revenue Service related to the audit of Conrail's consolidated federal income tax returns for the fiscal years 1987 through 1989. Under the settlement, Conrail paid $51 million, including interest (see Note 7 to the Consolidated Financial Statements elsewhere in this Annual Report).\nCapital Expenditures - -------------------- Capital expenditures totalled $650 million, $491 million and $398 million in 1993, 1992 and 1991, respectively. Of these capital expenditures, Conrail directly financed $232 million in 1993, $13 million in 1992, and $76 million in 1991 through private third-party financing. In addition, the proceeds of notes and debentures sold in those years, $329 million, $80 million, and $30 million, respectively, were available to fund capital expenditures.\nCapital expenditures for 1993, $650 million, exceeded planned expenditures by $100 million principally due to the accelerated acquisition of locomotives originally expected to be acquired in 1994. Capital expenditures for 1994 are expected to be approximately $490 million.\nInflation - --------- Generally accepted accounting principles require the use of historical costs in preparing financial statements. This approach does not consider the effects of inflation on the costs of replacing assets. The replacement cost of Conrail's property and equipment is substantially higher than its historical cost basis. Similarly, depreciation expense on a replacement cost basis would be substantially in excess of the amount recorded under generally accepted accounting principles.\nEnvironmental Matters - --------------------- Conrail's operations and property are subject to various federal, state and local laws regulating the environment. Consolidated Rail Corporation is a party to numerous proceedings brought by regulatory agencies and private parties under federal, state and local laws, including Superfund laws, and has also received\ninquiries from governmental agencies with respect to other potential environmental issues. As of December 31, 1993, Consolidated Rail Corporation had received, together with other companies, notices of its involvement as a potentially responsible party or requests for information under the Superfund laws with respect to cleanup and\/or removal costs due to its status as an alleged transporter, generator or property owner at 114 locations throughout the country. However, based on currently available information, Conrail believes Consolidated Rail Corporation may have some potential responsibility at only 54 of these sites. Due to the number of parties involved at many of these sites, the wide range of costs of the possible remediation alternatives, changing technology and the length of time over which these matters develop, it is not always possible to estimate Consolidated Rail Corporation's liability for the costs associated with the assessment and remediation of contaminated sites. At December 31, 1993 Conrail had accrued $77 million for estimated future environmental expenses. Although Conrail's operating results and liquidity could be significantly affected in any quarterly or annual reporting period in which Consolidated Rail Corporation was held principally liable in certain of these actions, Conrail believes the ultimate liability for these matters will not materially affect its financial condition. (See Note 12 to the Consolidated Financial Statements elsewhere in this Annual Report). Consolidated Rail Corporation spent $7 million in each of 1992 and 1993 for environmental remediation and anticipates spending a similar amount in 1994. In addition, Consolidated Rail Corporation's capital expenditures for environmental control and abatement projects were approximately $2 million in 1993, and are anticipated to be approximately $6 million in 1994.\nConrail has an Environmental Quality Department, the mission of which is to institute and promote compliance with environmentally sound operating practices and to monitor and assess the status of sites where liability under environmental laws may exist.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - ------ ------------------------------------------- REPORT OF INDEPENDENT ACCOUNTANTS\nThe Stockholders and Board of Directors Conrail Inc.\nWe have audited the consolidated financial statements and financial statement schedules of Conrail Inc. and subsidiaries listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Conrail Inc. and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its methods for accounting for income taxes and postretirement benefits other than pensions in 1993.\nCOOPERS & LYBRAND\nCOOPERS & LYBRAND\n2400 Eleven Penn Center Philadelphia, Pennsylvania January 24, 1994\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies ------------------------------------------ Industry -------- Conrail Inc. (\"Conrail\") is a holding company of which the principal subsidiary is Consolidated Rail Corporation (\"CRC\"), a freight railroad which operates in the Northeast-Midwest quadrant of the United States and the Province of Quebec.\nPrinciples of Consolidation --------------------------- The consolidated financial statements include Conrail and majority- owned subsidiaries. Investments in 20% to 50% owned companies are accounted for by the equity method.\nCash Equivalents ---------------- Cash equivalents consist of commercial paper, certificates of deposit and other liquid securities purchased with a maturity of three months or less, and are stated at cost which approximates market value.\nMaterial and Supplies --------------------- Material and supplies consist mainly of fuel oil and items for maintenance of property and equipment, and are valued at the lower of cost, principally weighted average, or market.\nProperty and Equipment ---------------------- Property and equipment are recorded at cost. Depreciation is provided using the composite straight-line method. The cost (net of salvage) of depreciable property retired or replaced in the ordinary course of business is charged to accumulated depreciation and no gain or loss is recognized.\nRevenue Recognition ------------------- Revenue is recognized proportionally as a shipment moves on the Conrail system from origin to destination.\nEarnings Per Share ------------------ Primary earnings (loss) per share are based on net income (loss) adjusted for the effects of preferred dividends net of income tax benefits, divided by the weighted average number of shares outstanding during the period including the dilutive effect of stock options. Fully diluted earnings (loss) per share assume\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nconversion of Series A ESOP Convertible Junior Preferred Stock (\"ESOP Stock\") into Conrail common stock unless they are antidilutive as they were in 1991. Net income amounts applicable to fully diluted earnings per share in 1993 and 1992 have been adjusted by the increase, net of income tax benefits, in ESOP- related expenses assuming conversion of all ESOP Stock to common stock. The weighted average number of shares of common stock outstanding (Note 2) during each of the most recent three years ended December 31, 1993 are as follows:\n1993 1992 1991 ---------- ---------- ---------- Primary weighted average shares 80,646,495 81,743,648 81,883,970 Fully diluted weighted average shares 90,835,982 91,856,193 81,883,970\nRatio of Earnings to Fixed Charges ---------------------------------- Earnings used in computing the ratio of earnings to fixed charges represent income before income taxes plus fixed charges, less equity in undistributed earnings of 20% to 50% owned companies. Fixed charges represent interest expense together with interest capitalized and a portion of rent under long-term operating leases representative of an interest factor. In 1991, when CRC recorded a special charge (Note 10), earnings were insufficient to cover fixed charges.\nNew Accounting Standards ------------------------ Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") (Note 8) and Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") (Note 7). As a result, the Company recorded cumulative after tax charges of $22 million and $52 million for SFAS 106 and SFAS 109, respectively.\nIn November 1992, the Financial Accounting Standards Board issued a standard (\"SFAS 112\") related to accounting for postemployment benefits, which is effective January 1994. This standard requires employers to recognize their obligation to provide salary continuation, supplemental unemployment benefits, and other benefits provided after employment but before retirement when certain conditions are met. The Company has determined that this standard would not have a material effect on its financial statements.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n2. Corporate Structure and Presentation ------------------------------------ In May 1993, the shareholders of CRC approved a plan for the adoption of a holding company structure. Under the plan, each share of CRC common stock that was issued and outstanding or held in the treasury of CRC, and each share of CRC ESOP Stock, all of which were held by the Non-union Employee Stock Ownership Plan (the \"Non-union ESOP\"), were automatically converted on July 1, 1993, into one share of common stock and one share of ESOP Stock, respectively, of a newly created holding company, Conrail Inc. As a result, Conrail Inc. became the publicly held entity effective July 1, 1993.\nThe change in corporate structure does not represent a change in the operations or financial position of the consolidated entity. On July 1, 1993, Conrail had the same consolidated operations, assets, liabilities and stockholders' equity as CRC had on June 30, 1993. In this report, references to the \"Company\" will denote the consolidated entities Consolidated Rail Corporation for periods prior to July 1, 1993 and Conrail Inc. for subsequent periods.\nIn 1992, the Company's Board of Directors authorized a two-for-one common stock split which was effected in the form of a common stock dividend. An amount equal to the par value of the common shares issued was transferred from additional paid-in capital to the common stock account. In addition, a stock dividend on the ESOP Stock in the amount of one share of ESOP Stock for each share of ESOP Stock outstanding was also distributed, and the number of authorized shares of ESOP Stock was increased from 7.5 million to 10 million shares.\nAll references in the financial statements with regard to the number of shares, and related dividends and per share amounts for both common stock (including treasury shares) and ESOP Stock have been restated to reflect the stock split. Stock compensation and other plans that provide for the issuance of common stock, ESOP Stock, or an amount equivalent to their respective fair market values, have also been amended to reflect the stock split.\n3. Disposition of Subsidiary ------------------------- In 1992, the Company acquired additional common shares of its affiliate, Concord Resources Group, Inc. (\"Concord\") increasing its ownership from 50% to 81.25%. In 1993, the Company committed to a plan for the disposition of its investment in Concord. Pursuant to this plan, the Company recorded the estimated loss of $80 million in September 1993 for the disposition of its investment, including $19 million for operating losses expected to be incurred during the phase-out period and disposition costs. The Company also recorded estimated federal tax benefits of $30 million relating to the disposition.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n4. Property and Equipment ----------------------\nConrail acquired equipment and incurred related long-term debt under various capital leases of $75 million in 1993, $13 million in 1992, and $76 million in 1991.\n5. Accrued and Other Current Liabilities -------------------------------------\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n6. Long-Term Debt -------------- Long-term debt outstanding, including the weighted average interest rates at December 31, 1993, is composed of the following:\nUsing current market prices when available, or a valuation based on the yield to maturity of comparable debt instruments having similar characteristics, credit rating and maturity, the total fair value of the Company's long-term debt, including the current portion, but excluding capital leases, is $1,782 million in 1993 and $1,310 million in 1992, compared with carrying values of $1,544 million and $1,200 million in 1993 and 1992, respectively.\nThe Company's noncancelable long-term leases generally include options to purchase at fair value and to extend the terms. Capital leases have been discounted at rates which average 8.3% and are collateralized by assets with a net book value of $439 million at December 31, 1993.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nMinimum commitments, exclusive of executory costs borne by the Company, are:\nOperating lease rent expense was $88 million in 1993, $71 million in 1992, and $50 million in 1991.\nThe Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission in April 1990 for $1.25 billion of debt securities. In May 1993, the Company issued $250 million of 7 7\/8% Debentures Due 2043, and has $11 million remaining to be issued under this shelf registration at December 31, 1993. In June 1993, the Company and CRC filed a new shelf registration statement on Form S-3 which will enable CRC to issue up to $500 million in debt securities or the Company to issue up to $500 million in convertible debt or equity securities.\nIn February 1993, the Company issued $94 million of Pass Through Certificates, Series 1993-A1 and 1993-A2 to finance the acquisition of equipment. The Series 1993-A1 certificates, $41 million, have an interest rate of 5.71%, and Series 1993-A2 certificates, $53 million, have an interest rate of 6.86%. Certificates issued in the amount of $54 million are direct obligations of the Company and are secured by the acquired equipment. The remaining certificates, $40 million, were issued to finance equipment which the Company will utilize under a capital lease, and while such certificates are not direct obligations of, or guaranteed by the Company, the amounts payable by the Company under the lease will be sufficient to pay principal and interest on the certificates.\nIn September 1993, CRC issued approximately $63 million of 5.98% 1993 Equipment Trust Certificates, Series A, due 2013, pursuant to the 1993 registration statement. The certificates were used to finance approximately 80% of the cost of certain rebuilt and new freight cars, which CRC will utilize under an operating\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nlease. Although the certificates are not direct obligations of, or guaranteed by CRC, amounts payable by CRC under the lease will be sufficient to pay principal and interest on the certificates. In November 1993, CRC issued $102 million of 1993 Equipment Trust Certificates, Series B, with interest rates ranging from 3.57% to 5.90%, maturing annually from 1994 through 2008. These certificates are obligations of CRC issued for the purchase of locomotives which will serve as collateral for the obligations.\nEquipment and other obligations mature in 1994 through 2013 and are collateralized by assets with a net book value of $200 million at December 31, 1993. Maturities of long-term debt other than capital leases and commercial paper are $74 million in 1994, $62 million in 1995, $95 million in 1996, $10 million in 1997, $40 million in 1998, and $1,163 million in total from 1999 through 2043.\nConrail had $179 million of commercial paper outstanding at December 31, 1993. Of the total amount outstanding, $100 million is classified as long-term since it is expected to be refinanced through subsequent issuances of commercial paper and is supported by the long-term credit facility mentioned below.\nThe Company maintains a $300 million uncollateralized revolving credit facility with a group of banks under which no borrowings were outstanding at December 31, 1993. The credit facility, which expires in 1995, requires interest to be paid on borrowings at rates based on various defined short-term market rates and an annual maximum fee of .1% of the facility amount. The credit facility contains, among other conditions, restrictive covenants relating to leverage ratio, debt, and consolidated tangible net worth.\nInterest payments were $164 million in 1993, $162 million in 1992, and $167 million in 1991.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n7. Income Taxes ------------ The provisions for (benefits from) income taxes are composed of the following:\nEffective January 1, 1993, the Company adopted the provisions of SFAS 109 which requires a liability approach for measuring deferred tax assets and liabilities based on differences between the financial statement and tax bases of assets and liabilities at each balance sheet date using enacted tax rates in effect when those differences are expected to reverse. As a result, the Company recorded a cumulative adjustment of $52 million. The primary effects of the adoption of this standard on the balance sheet were the recording of a current deferred tax asset of $147 million with a corresponding increase in the long-term deferred income tax liability and the net deferred income tax liabilities related to the cumulative accounting adjustment for the adoption of SFAS 109 and SFAS 106 (Note 8). Prior years' financial statements have not been restated to apply the provisions of the new standard.\nIn conjunction with the public sale in 1987 of the 85% of the Company's common stock owned by the U.S. Government, federal legislation was enacted which resulted in a reduction of the tax basis of certain of the Company's assets, particularly property and equipment, thereby substantially decreasing tax depreciation deductions and increasing future federal income tax payments. Also, net operating loss and investment tax credit carryforwards were cancelled. As a result of the sale-related transactions, a special income tax obligation was recorded in 1987 based on an estimated effective federal and state income tax rate of 37.0%.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nAs a result of the increase in the federal corporate income tax rate from 34% to 35% enacted August 10, 1993, and effective January 1, 1993, income tax expense for 1993 was increased by $38 million, of which $34 million related to the effects of adjusting deferred income taxes and the special income tax obligation for the rate increase.\nDuring the third quarter of 1993, the Company reached a settlement with the Internal Revenue Service related to the audit of the Company's consolidated federal income tax returns for the fiscal years 1987 through 1989. Under the settlement, the Company paid $51 million, including interest, all of which had been previously provided for in prior years resulting in no income statement effect in 1993. Federal and state income tax payments were $39 million in 1993 (excluding tax settlement), $31 million in 1992, and $45 million in 1991.\nSignificant components of the Company's special income tax obligation and deferred income tax liabilities and (assets) as of December 31, 1993 are as follows:\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe tax effects of each source of deferred income taxes and special income tax obligation (disclosure for 1993 is not required nor applicable under SFAS 109)are as follows:\nAs of December 31, 1993, the Company has approximately $77 million of alternative minimum tax credits available to offset future U.S. federal income taxes on an indefinite carryforward basis.\nDeferred income taxes and the special income tax obligation for 1991 include reductions of $159 million and $113 million, respectively, related to the 1991 Special Charge (Note 10).\nReconciliations of the U.S. statutory tax rates with the effective tax rates follow: 1993 1992 1991 ----- ----- ----- Statutory tax rate 35.0% 34.0% (34.0)% State income taxes, net of federal benefit 5.1 3.9 (3.5) Effect of federal tax increase on deferred taxes 7.7 Other (1.0) .8 (.7) ----- ----- ----- Effective tax rate 46.8% 38.7% (38.2)% ===== ===== ===== 8. Employee Benefits ----------------- Pension Plans ------------- The Company and certain subsidiaries maintain defined benefit pension plans which are noncontributory for all non-union employees and generally contributory for participating union employees. Benefits are based primarily on credited years of service and the level of compensation near retirement. Funding is based on the minimum amount required by the Employee\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nRetirement Income Security Act of 1974.\nPension credits include the following components:\n1993 1992 1991 ----- ----- ---- (In Millions)\nService cost - benefits earned during the period $ 8 $ 7 $ 6 Interest cost on projected benefit obligation 46 45 42 Return on plan assets - actual (124) (66) (175) - deferred 42 (13) 100 Net amortization and deferral (15) (15) (18) ---- ---- ---- $(43) $(42) $(45) ==== ==== ====\nThe funded status of the pension plans and the amounts reflected in the balance sheets are as follows:\n1993 1992 ------ ------ (In Millions)\nAccumulated benefit obligation ($532 million and $505 million vested, respectively) $ 537 $ 506 ====== ======\nMarket value of plan assets 1,043 977 Projected benefit obligation (632) (580) ------ ------ Plan assets in excess of projected benefit obligation 411 397 Unrecognized prior service cost 43 61 Unrecognized transition net asset (159) (179) Unrecognized net gain (101) (124) ------ ------\nNet prepaid pension cost $ 194 $ 155 ====== ======\nThe assumed weighted average discount rates used in 1993 and in 1992 are 7.25% and 8.0%, respectively, and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation as of December 31, 1993 and 1992 is 6.0%. The expected long-term rate of return on plan assets (primarily equity securities) in 1993 and 1992 is 9.0%.\nSavings Plans ------------- The Company and certain subsidiaries also provide 401(k) savings plans for union and non-union employees. Under the Non-union ESOP, 100% of employee contributions are matched in the form of ESOP Stock for the first 6% of a participating employee's base pay. Under the union employee plan, employee contributions are not matched by the Company. Savings plan expense, including Non- union ESOP expense, was $5 million in 1993 and $4 million in 1992 and 1991.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIn connection with the Non-union ESOP, the Company issued 9,979,562 of the authorized 10 million shares of its ESOP Stock to the Non-union ESOP in exchange for a 20 year promissory note with interest at 9.55% from the Non-union ESOP in the principal amount of $288 million. In addition, unearned ESOP compensation of $288 million was recognized as a charge to stockholders' equity coincident with the Non-union ESOP's issuance of its $288 million promissory note to the Company. The debt of the Non-union ESOP was recorded by the Company and offset against the promissory note from the Non-union ESOP. Unearned ESOP compensation is charged to expense as shares of ESOP Stock are allocated to participants. An amount equivalent to the preferred dividends declared on the ESOP Stock partially offsets compensation and interest expense related to the Non-union ESOP.\nThe Company is obligated to make dividend payments at a rate of 7.51% on the ESOP Stock and additional contributions in an aggregate amount sufficient to enable the Non-union ESOP to make the required interest and principal payments on its note to the Company.\nInterest expense incurred by the Non-union ESOP on its debt to the Company was $29 million in 1993, and $28 million in 1992 and 1991. Compensation expense related to the Non-union ESOP was $10 million in 1993, $9 million in 1992, and $8 million in 1991. Preferred dividends paid to the Non-union ESOP were $21 million in 1993, 1992 and 1991. The Company received debt service payments from the Non-union ESOP of $26 million in 1993, and $21 million in 1992 and 1991.\nPostretirement Benefits Other Than Pensions ------------------------------------------- The Company provides health and life insurance benefits to certain eligible retired non-union employees. Certain non-union employees are eligible for retiree medical benefits, while substantially all non-union employees are eligible for retiree life insurance benefits. Generally, company-provided health care benefits terminate when covered individuals reach age 65.\nRetiree medical benefits are funded by a combination of Company and retiree contributions. The cost of medical benefits provided by the Company as self-insurer was previously recognized as claims and administrative expenses were paid. Retiree life insurance benefits are provided by insurance companies whose premiums are based on claims paid during the year and the cost of such benefits was previously recognized as the annual insurance premium. The expense of providing both non-union retiree medical and life insurance benefits for 1992 and 1991 was $5 million and $2 million, respectively.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nRetiree life insurance plan assets consist of a retiree life insurance reserve held in the Company's group life insurance policy. There are no plan assets for the retiree health benefits plan.\nEffective January 1, 1993, the Company adopted SFAS 106, which requires that the cost of retiree benefits other than pensions be accrued during the period of employment rather than when benefits are paid. The Company elected the immediate recognition method allowed under the statement and accordingly recorded a cumulative, one-time charge of $22 million (net of tax benefits of $14 million). This accrual was in addition to the remaining balance of $21 million which had been accrued for postretirement health benefits for employees who participated in the Company's 1989 non-union voluntary retirement program. The accumulated postretirement obligation at January 1, 1993 was $41 million for the medical plan and $21 million for the life insurance plan. Plan assets attributed to the life insurance plan at January 1, 1993 totalled $5 million.\nThe following sets forth the plan's funded status reconciled with amounts reported in the Company's balance sheet at December 31, 1993: Life Medical Insurance Plan Plan ------- --------- (In Millions) Accumulated postretirement benefit obligation: Retirees $31 $16 Fully eligible active plan participants 9 1 Other active plan participants 2 6 --- --- Accumulated benefit obligation 42 23 Market value of plan assets (6) --- --- Accumulated benefit obligation in excess of plan 42 17 assets Unrecognized losses (3) (2) Accrued benefit cost recognized in the --- --- Consolidated Balance Sheet $39 $15 === === Net periodic postretirement benefit cost for 1993, primarily interest cost $ 3 $ 1 === === An 11.5% rate of increase in per capita costs of covered health care benefits was assumed for 1994, gradually decreasing to 6% by the year 2008. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $4 million and would have an immaterial effect on the service cost and interest cost components of net periodic postretirement benefit cost for 1993. A discount rate of 7.0% was used to determine the accumulated postretirement benefit\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nobligations for both the medical and life insurance plans. The assumed rate of compensation increase is 5.0%.\n9. Capital Stock ------------- The Company is authorized to issue 25 million shares of preferred stock with no par value. The Board of Directors has the authority to divide the preferred stock into series and to determine the rights and preferences of each.\nThe Company cannot pay dividends on its common stock unless full cumulative dividends have been paid on its ESOP Stock, and no distributions can be made to the holders of common stock upon liquidation or dissolution of the Company unless the holders of the ESOP Stock have received a cash liquidation payment of $28.84375 per share, plus unpaid dividends up to the date of such payment. The ESOP Stock is convertible into common stock on a share-for-share basis and is entitled to one vote per share, voting together as a single class with common stock on all matters.\nIn September 1993, the $100 million 1992 stock repurchase program was completed at a total of 2,150,293 shares. On July 21, 1993, the Board of Directors authorized an additional $100 million repurchase program. At December 31, 1993, the Company had acquired 237,855 shares for approximately $14 million under this program.\nDuring 1993, the Company reclassified 4,787,579 shares of repurchased common stock (treasury stock) as authorized but unissued.\nThe activity and status of treasury stock follow:\n1993 1992 1991 --------- --------- ------- Shares, beginning of year 3,690,002 546,400 Acquired 1,181,322 3,143,602 546,400 Reclassified as authorized but unissued (4,787,579) --------- --------- ------- Shares, end of year 83,745 3,690,002 546,400 ========= ========= =======\nThe Company's 1987 Long-Term Incentive Plan (the \"1987 Incentive Plan\") authorizes the granting to officers and key employees of up to 4 million shares of common stock through stock options, stock appreciation rights, and awards of restricted or performance shares. A stock option is exercisable for a specified term commencing after grant at a price not less than the fair market value of the stock on the date of grant. The\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1987 Incentive Plan also provides for the granting of stock to employees, contingent on either a specified period of employment or achievement of certain financial or performance goals.\nThe Company's 1991 Long-Term Incentive Plan (the \"1991 Incentive Plan\") authorizes the granting to officers and key employees of up to 3.2 million shares of common stock, through stock options, stock appreciation rights and awards of restricted or performance shares. The Company has granted 169,005 shares of restricted stock under its incentive plans through December 31, 1993.\nThe activity and status of stock options under the incentive plans follow:\nIn 1989, the Company declared a dividend of one common share purchase right (the \"Right\") on each outstanding share of common stock. The Rights are not exercisable or transferable apart from the common stock until the occurrence of certain events arising out of an actual or potential acquisition of 10% or more of the Company's common stock, and would at such time provide the holder with certain additional entitlements. If the Rights become exercisable, each Right will entitle stockholders to\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\npurchase one share of common stock at an exercise price of $52.50. At the Company's option, the Rights are redeemable prior to becoming exercisable at one-half cent ($.005) per Right. The Rights expire in July 1999 and do not have any voting privileges or rights to receive dividends.\n10.1991 Special Charge ------------------- In 1991, the Company recorded in operating expenses a special charge totalling $719 million which was composed of $362 million for disposition of certain under-utilized rail lines and other facilities, $212 million for labor settlements primarily representing certain expected costs associated with a new labor agreement that reduced the size of train crews, $57 million for certain environmental clean up costs, and $88 million for legal matters including settlement of the Amtrak-Conrail collision at Chase, Maryland in January 1987. The 1991 special charge reduced net income by $447 million, and without the special charge net income would have been $240 million ($2.73 and $2.48 per share, primary and fully diluted, respectively).\n11.Other Income, Net -----------------\n1993 1992 1991 ---- ---- ---- (In Millions)\nInterest income $ 39 $ 40 $ 48 Rental income 56 60 53 Property sales 20 6 9 Other, net (1) (8) (3) ---- ---- ---- $114 $ 98 $107 ==== ==== ==== 12.Commitments and Contingencies ----------------------------- Non-union Voluntary Retirement Program -------------------------------------- On December 15, 1993, the Board of Directors approved a voluntary early retirement program for eligible members of its non-union workforce. The eligible employees had until February 28, 1994 to elect to retire under the program, and based on the results of a similar program completed in 1990, the cost of the program is expected to have a material effect on the income statement for the first quarter of 1994. The transaction will not significantly affect the Company's cash position as approximately 85% of the cost will be paid from the Company's overfunded pension plan (Note 8).\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nEnvironmental ------------- The Company is subject to various federal, state and local laws and regulations regarding environmental matters. CRC is a party to various proceedings brought by both regulatory agencies and private parties under federal, state and local laws, including Superfund laws, and has also been named as a potentially responsible party in many governmental investigations and actions for the cleanup and removal of hazardous substances due to its alleged involvement as either a transporter, generator or property owner. Due to the number of parties involved at many of these sites, the wide range of costs of possible remediation alternatives, the changing technology and the length of time over which these matters develop, it is often not possible to estimate CRC's liability for the costs associated with the assessment and remediation of contaminated sites. Although the Company's operating results and liquidity could be significantly affected in any quarterly or annual reporting period if CRC were held principally liable in certain of these actions, at December 31, 1993, the Company had accrued $77 million, an amount it believes is sufficient to cover the probable liability and remediation costs that will be incurred at Superfund sites and other sites based on known information and using various estimating techniques. The Company believes the ultimate liability for these matters will not materially affect its consolidated financial condition.\nThe Environmental Quality Department of the Company is charged with promoting the Company's compliance with laws and regulations affecting the environment and instituting environmentally sound operating practices. The department monitors the status of the sites where the Company is alleged to have liability and continually reviews the information available and assesses the adequacy of the recorded liability.\nOther Contingencies ------------------- The Company is involved in various legal actions, principally relating to occupational health claims, personal injuries, casualties, property damage and loss and damage. The Company has recorded liabilities on its balance sheet for amounts sufficient to cover the expected payments for such actions. At December 31, 1993 these liabilities are presented net of estimated insurance recoveries of approximately $80 million.\nConrail may be contingently liable for approximately $102 million at December 31, 1993 under indemnification provisions related to sales of tax benefits.\nCONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n13.Condensed Quarterly Data (Unaudited) -----------------------------------\nEffective January 1, 1993, the Company adopted SFAS 106 and SFAS 109, related to the accounting for postretirement benefits other than pensions and income taxes, respectively. As a result, the Company recorded cumulative after tax charges totalling $74 million ($.91 per share, primary and fully diluted) in the first quarter of 1993 (Notes 1, 7 and 8).\nDuring the third quarter of 1993, the Company recorded an estimated loss for the disposition of its investment in its subsidiary, Concord Resources Group, Inc. (Note 3). As a result, net income for the quarter was reduced by the loss of $80 million less the estimated tax benefits of $30 million. Also, in the third quarter, as a result of the increase in the federal corporate income tax rate enacted August 10, 1993 and effective January 1, 1993, income tax expense for the third quarter of 1993, includes a charge of $36 million, primarily related to the adjustment of deferred taxes and the special income tax obligation as required by SFAS 109 (Note 7). Without these two charges, net income per common share for the third quarter of 1993 would have been $1.00 on a primary basis and $.91 on a fully diluted basis.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants - ------ --------------------------------------------- on Accounting and Financial Disclosure. -------------------------------------- Previously reported in Conrail's Current Report on Form 8-K, filed February 18, 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers - ------- -------------------------------- of the Registrant. -----------------\nItem 11.","section_11":"Item 11. Executive Compensation. - ------- ----------------------\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial - ------- ---------------------------------------- Owners and Management. --------------------- and\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - ------- ----------------------------------------------\nIn accordance with General Instruction G(3), the information called for by Part III is incorporated herein by reference from Conrail's definitive Proxy Statement for the Conrail Annual Meeting of Shareholders to be held on May 18, 1994, which definitive Proxy Statement will be filed with the Commission pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I under \"Executive Officers of the Registrant.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement - ------- ----------------------------- Schedules, and Reports on Form 8-K. ---------------------------------- (a) The following documents are filed as a part of this report:\n1. Financial Statements: Page ----\nReport of Independent Accountants..................... 37 Consolidated Statements of Income for each of the three years in the period ended December 31, 1993... 38 Consolidated Balance Sheets at December 31, 1993 and 1992 ........................................... 39 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1993...................... 40 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1993 .................................. 41 Notes to Consolidated Financial Statements............ 42\n2. Financial Statement Schedules:\nThe following financial statement schedules should be read in connection with the financial statements listed in Item 14(a)1 above.\nIndex to Financial Statement Schedules -------------------------------------- Page ----\nSchedule V - Property, Plant and Equipment...... S-1 Schedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment.... S-2 Schedule VIII - Valuation and Qualifying Accounts... S-3 Schedule X - Supplementary Income Statement Information...................... S-4\nSchedules other than those listed above are omitted for reasons that they are not required, are not applicable, or the information is included in the financial statements or related notes.\n3. Exhibits:\nExhibit No. ---------- 2. Agreement and Plan of Merger among Consolidated Rail Corporation, Conrail Inc. and Conrail Subsidiary Corporation dated as of February 17, 1993, filed as Appendix A to the Proxy Statement of Consolidated Rail Corporation, dated April 16, 1993 and incorporated herein by reference.\n3.1 Articles of Incorporation of the Registrant filed as Appendix B to the Proxy Statement of Consolidated Rail Corporation, dated April 16, 1993 and incorporated herein by reference.\n3.2 By-Laws of the Registrant, filed as Exhibit 3.3(ii) to the Registrant's Form 8-B, dated July 13, 1993 and incorporated herein by reference.\n4.1 Articles of Incorporation of the Registrant filed as Appendix B to the Proxy Statement of Consolidated Rail Corporation, dated April 16, 1993 and incorporated herein by reference.\n4.2 Form of Certificate of Common Stock, par value $1.00 per share, of the Registrant, filed as Exhibit 3.4(i)(c) to the Registrant's Form 8-B dated July 13, 1993 and incorporated herein by reference.\n4.3 Form of Certificate of Series A ESOP Convertible Junior Preferred Stock, no par value, of the Registrant filed as Exhibit 3.4(i)(d) to the Registrant's Form 8-B dated July 13, 1993 and incorporated herein by reference.\n4.4 Rights Agreement dated as of July 19, 1989, between Consolidated Rail Corporation and First Chicago Trust Company of New York, together with Form of Right Certificate and Summary of Rights to Purchase Common Shares as exhibits thereto, filed as Exhibit 1 to Consolidated Rail Corporation's Form 8-K dated July 31, 1989 and incorporated herein by reference.\n4.5 Amendment to Rights Agreement dated as of March 21, 1990, filed as Exhibit 4.5 to Consolidated Rail Corporation's Report on Form 8-K dated March 27, 1990 and incorporated herein by reference.\n4.6 Amendment, Assignment and Assumption Agreement, dated as of February 17, 1993, with respect to the Rights\nAgreement, filed as Exhibit 3.4(i)(g) to the Registrant's Form 8-B dated July 13, 1993 and incorporated herein by reference.\n4.7 Form of Indenture between Consolidated Rail Corporation and The First National Bank of Chicago, as Trustee, with respect to the issuance of up to $1.25 billion aggregate principal amount of Consolidated Rail Corporation's debt securities, filed as Exhibit 4 to Consolidated Rail Corporation's Registration Statement on Form S-3 (Registration No. 33-34040) and incorporated herein by reference.\nIn accordance with Item 601(b)(4)(iii) of Regulation S- K, copies of instruments of the Registrant and its subsidiaries with respect to the rights of holders of certain long-term debt are not filed herewith, or incorporated by reference, but will be furnished to the Commission upon request.\n10.1 Second Amended and Restated Northeast Corridor Freight Operating Agreement dated October 1, 1986 between National Railroad Passenger Corporation and Consolidated Rail Corporation, filed as Exhibit 10.1 to Consolidated Rail Corporation's Registration Statement on Form S-1 (Registration No. 33-11995) and incorporated herein by reference.\n10.2 Letter agreements dated September 30, 1982 and July 19, 1986 between Consolidated Rail Corporation and The Penn Central Corporation, filed as Exhibit 10.5 to Consolidated Rail Corporation's Registration Statement on Form S-1 (Registration No. 33-11995) and incorporated herein by reference.\n10.3 Letter agreement dated March 16, 1988 between Consoli- dated Rail Corporation and Penn Central Corporation re- lating to hearing loss litigation, filed as Exhibit 19.1 to Consolidated Rail Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1988 and incorporated herein by reference.\nManagement Compensation Plans and Contracts ------------------------------------------- 10.4 Consolidated Rail Corporation Annual Profit Incentive Plan for 1991, filed as Exhibit 10.6 to Consolidated Rail Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 and incorporated herein by reference.\n10.5 Consolidated Rail Corporation 1992 Annual Performance Achievement Reward Plan, filed as Exhibit 10.6 to Consolidated Rail Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference.\n10.6 Consolidated Rail Corporation 1993 Annual Performance Achievement Reward Plan, filed as Exhibit 3.10(v) to the Registrant's Form 8-B dated July 13, 1993 and incorporated herein by reference.\n10.7 Conrail 1987 Long-Term Incentive Plan, filed as Exhibit 4.4 to Consolidated Rail Corporation's Registration Statement on Form S-8 (Registration No. 33-19155) and incorporated herein by reference.\n10.8 Conrail 1991 Long-Term Incentive Plan, filed as Exhibit 4.8 to Consolidated Rail Corporation's Registration Statement on Form S-8 (Registration No. 33-44140) and incorporated herein by reference.\n10.9 Employment Agreement between James A. Hagen and Consolidated Rail Corporation, dated as of April 3, 1989, filed as Exhibit 10.11 to Consolidated Rail Corporation's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.\n10.10 Agreement for Supplemental Employee Retirement Plan between James A. Hagen and Consolidated Rail Corporation, dated as of January 17, 1990, filed as Exhibit 10.12 to Consolidated Rail Corporation's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.\n10.11 Form of Continuation Agreement between Consolidated Rail Corporation and each of its officers other than James A. Hagen, dated as of January 15, 1990, filed as Exhibit 10.14 to Consolidated Rail Corporation's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.\n11 Statement of earnings (loss) per share computations.\n12 Computation of the ratio of earnings to fixed charges.\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n24 Each of the officers and directors signing this Annual Report on Form 10-K has signed a power of attorney, contained on page 66 hereof, with respect to amendments to this Annual Report.\n(b) Reports on Form 8-K.\nCurrent Report on Form 8-K dated October 7, 1993, filed in connection with Consolidated Rail Corporation's issuance of $63,156,000 of 5.98% 1993-A Equipment Trust Certificates Due 2013 pursuant to its current Registration Statement on Form S-3 (No. 33-64670).\n(c) Exhibits.\nThe Exhibits required by Item 601 of Regulation S-K as listed in Item 14(a)3 are filed herewith or incorporated herein by reference.\n(d) Financial Statement Schedules.\nFinancial statement schedules and separate financial state ments specified by this Item are included in Item 14(a)2 or are otherwise omitted for reasons that they are not required or are not applicable.\nPOWER OF ATTORNEY ----------------- Each person whose signature appears below under \"SIGNATURES\" hereby authorizes H. William Brown and Bruce B. Wilson, or either of them, to execute in the name of each such person, and to file, any amendment to this report and hereby appoints H. William Brown and Bruce B. Wilson, or either of them, as attorneys-in-fact to sign on his or her behalf, individually and in each capacity stated below, and to file any and all amendments to this report.\nSIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act 1934, Conrail Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCONRAIL INC.\nDate: March 16, 1994\nBy James A. Hagen ----------------------------- James A. Hagen Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 16th day of March, 1994, by the following persons on behalf of Conrail Inc. and in the capacities indicated.\nSignature Title - --------- ----- James A. Hagen Chairman, President and Chief - ------------------------ Executive Officer and Director James A. Hagen (Principal Executive Officer)\nH. William Brown Senior Vice President - Finance - ------------------------ and Administration H. William Brown (Principal Financial Officer)\nJohn A. McKelvey Vice President - Controller - ------------------------ (Principal Accounting Officer) John A. McKelvey\nH. Furlong Baldwin Director - ------------------------ H. Furlong Baldwin\nClaude S. Brinegar Director - ------------------------ Claude S. Brinegar\nDaniel S. Burke Director - ------------------------ Daniel B. Burke\nKathleen Foley Feldstein Director - ------------------------ Kathleen Foley Feldstein\nRoger S. Hillas Director - ------------------------ Roger S. Hillas\nE. Bradley Jones Director - ------------------------ E. Bradley Jones\nDavid B. Lewis Director - ------------------------ David B. Lewis\nJohn C. Marous Director - ------------------------ John C. Marous\nWilliam G. Milliken Director - ------------------------ William G. Milliken\nRaymond T. Schuler Director - ------------------------ Raymond T. Schuler\nDavid H. Swanson Director - ------------------------ David H. Swanson\nE-1 EXHIBIT INDEX\nPage Number in SEC Sequential Numbering Exhibit No. System - ----------- --------------------\n11 Statement of earnings (loss) per share computations\n12 Computation of the ratio of earnings to fixed charges\n21 Subsidiaries of the Registrant\n23 Consent of Independent Accountants\nExhibits 2, 3.1, 3.2, 4.1, 4.2, 4.3, 4.4, 4.5, 4.6, 4.7, 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, 10.10 and 10.11 are incorporated herein by reference. Powers of attorney with respect to amendments to this Annual Report are contained on page 66.","section_15":""}
{"filename":"64978_1993.txt","cik":"64978","year":"1993","section_1":"ITEM 1. BUSINESS.\nMerck & Co., Inc. is a worldwide organization engaged primarily in the business of discovering, developing, producing and marketing products and services for the maintenance or restoration of health. The Company's business is divided into two industry segments: Human and Animal Health Products and Services and Specialty Chemical Products. The Human and Animal Health Products and Services segment includes Medco Containment Services, Inc. (\"Medco\"), which was acquired in November 1993. Medco principally provides services designed to reduce prescription drug benefit costs through managed prescription drug programs and managed mental health-care services for health benefit plans. Financial information about industry segments of the Company's business is incorporated by reference to page 50 of the Company's 1993 Annual Report to stockholders.\nHUMAN AND ANIMAL HEALTH PRODUCTS AND SERVICES SEGMENT\nHuman and animal health products include therapeutic and preventive agents for the treatment of human disorders, which are generally sold by prescription, and for the control and alleviation of disease in livestock, small animals and poultry. Human and animal health products also include poultry breeding stock and crop protection products. This segment contributed $9,987.9 million, $9,067.6 million and $8,019.5 million to Company sales in 1993, 1992 and 1991, respectively.\nHuman health products include cardiovascular products, of which Vasotec (enalapril maleate), Mevacor (lovastatin), Zocor (simvastatin), Prinivil (lisinopril) and Vaseretic (enalapril maleate-hydrochlorothiazide) are the largest-selling; anti-ulcerants, of which Pepcid (famotidine) and Prilosec (omeprazole) are the largest-selling; antibiotics, of which Primaxin (imipenem-cilastatin sodium), Noroxin (norfloxacin) and Mefoxin (cefoxitin sodium) are the largest-selling; vaccines\/biologicals, of which M-M-R II (measles, mumps and rubella virus vaccine live) and Recombivax HB (hepatitis B vaccine recombinant) are the largest-selling; ophthalmologicals, of which Timoptic (timolol maleate) is the largest-selling; anti-inflammatory\/analgesic products, of which Indocin (indomethacin), Clinoril (sulindac) and Dolobid (diflunisal) are the largest-selling; and other human health products which include antiparkinsonism products, psychotherapeutics, a muscle relaxant and Proscar (finasteride), a treatment for symptomatic benign prostate enlargement. Human health services include health-care cost containment services, principally managed prescription drug programs.\nAnimal health\/crop protection products include antiparasitics, of which Ivomec (ivermectin) for the control of internal and external parasites in livestock and Heartgard-30 (ivermectin) for the prevention of canine heartworm disease are the largest-selling; crop protection products, of which abamectin-based miticides\/insecticides are the largest-selling; coccidiostats for the treatment of poultry disease; and poultry breeding stock.\nThe following table shows the sales of various classes of the Company's human and animal health products and services:\n- --------------- * Sales by therapeutic class include Medco sales of Merck products. Medco sales of non-Merck products and Medco services are included in Other Medco sales.\nIn November 1993, the Company acquired all of the outstanding shares of Medco for approximately $6.6 billion. The purchase price consisted of $2.4 billion in cash, 114.0 million common shares with a market value of $3.8 billion and 36.1 million options valued at $387.1 million, net of tax. Martin J. Wygod, Chairman of the Board of Directors of Medco and a stockholder of Medco prior to the merger, was elected to the Board of Directors of the Company effective November 1993. Medco principally provides services designed to reduce prescription drug benefit costs through managed prescription drug programs, and also provides managed mental health-care services. Medco provides these services to corporations, labor unions, insurance companies, Blue Cross and Blue Shield organizations, Federal and state employee plans, and health maintenance and other similar organizations.\nA new human health product cleared for marketing in the United States by the Federal Food and Drug Administration (\"FDA\") in November 1993 is Timoptic-XE (timolol maleate ophthalmic gel-forming solution), a once-a-day treatment to reduce intraocular pressure in certain glaucoma patients, and sales of the product began in the United States in January 1994. Also in 1993, the FDA cleared for marketing the use of Vasotec to reduce the rate of development of symptomatic heart failure and decrease the need for related hospitalization in asymptomatic patients with left ventricular dysfunction.\nIn May 1993, the Company and Pasteur Merieux Serums & Vaccins (\"Pasteur Merieux\"), which is part of the Rhone-Poulenc group, signed an agreement to form a joint venture to market human vaccines and to collaborate in the development of new combination vaccines for distribution in the European Union (\"EU\") (formerly referred to as the European Community) and the European Free Trade Association. The establishment of this joint venture, which would be equally owned by the Company and Pasteur Merieux, is subject to various approvals, including that of the European Commission.\nEffective April 1992, the Company, through the Merck Vaccine Division, and Connaught Laboratories, Inc. (\"Connaught\"), an affiliate of Pasteur Merieux, agreed to collaborate on the development and marketing of combination pediatric vaccines and to promote selected vaccines in the United States. The research and marketing collaboration will enable the companies to pool their resources to expedite the development of vaccines combining several different antigens to protect children against a variety of diseases, including Haemophilus influenzae type b, hepatitis B, diphtheria, tetanus, pertussis and poliomyelitis. In addition, the Company and Connaught have agreed to promote a number of each other's vaccine products.\nEffective January 1991, the Company and E. I. du Pont de Nemours and Company (\"Du Pont\") entered into a joint venture to form a worldwide pharmaceutical company for the research, marketing, manufacturing and sale of pharmaceutical and imaging agent products. Du Pont contributed its entire worldwide pharmaceutical and radiopharmaceutical imaging agents businesses to the joint venture and is providing administrative services. The Company's contribution includes rights to Sinemet (carbidopa-levodopa), Sinemet CR (sustained-release formulation), Moduretic (amiloride HCl-hydrochlorothiazide), Prinivil and Prinzide (lisinopril and hydrochlorothiazide) in the United Kingdom, France, Germany, Italy and Spain, research and development expertise, development funds, international industry expertise and cash. The joint venture co-promotes Vasotec in the United States.\nUnder separate agreements between the Company and Du Pont for which the joint venture carries out Du Pont's obligations, commencing in 1993 marketing applications were submitted worldwide for Cozaar (losartan potassium) and Hyzaar (losartan potassium and hydrochlorothiazide), the first of a new class of drugs for treatment of high blood pressure and heart failure. The joint venture has rights under these agreements to Sinemet and Sinemet CR in North America and Vaseretic in the United States and Canada.\nIn January 1993, the Company and Johnson & Johnson finalized an agreement to extend into Europe the U.S. joint venture that was formed in 1989. This new European extension is intended to market and sell over-the-counter pharmaceutical products in Europe. In October 1991, as a first step toward the establishment of the European business, the two companies acquired certain assets of Woelm Pharma G.m.b.H., a leading German self-medication business owned by Rhone-Poulenc Rorer, including a topical cough\/cold product, two laxatives and a line of vitamins. In January 1993, the Company contributed its existing over-the-counter medication business in Spain to a new joint venture company. In September 1993, Johnson & Johnson and the Company established a new company in the United Kingdom to market the Company's and Johnson & Johnson's over-the-counter medications. In January 1994, the Company and Johnson & Johnson acquired all\nof the stock of Laboratoires J.P. Martin, a leading self-medication business in France. In January 1993, the Company submitted a New Drug Application (\"NDA\") to the FDA for an over-the-counter form of the Company's ulcer medication Pepcid, to be marketed in the United States by the joint venture. Beginning January 1993, marketing approval applications for over-the-counter Pepcid were filed in 15 European countries and 3 other countries, in addition to the U.S. filing. In February 1994, the marketing license for an over-the-counter formulation of Pepcid was cleared in the United Kingdom.\nIn 1982, the Company entered into an agreement with AB Astra (\"Astra\") to develop and market Astra products in the United States. Currently, under the first phase of the agreement, the Company markets three Astra products, Prilosec, Plendil (felodipine) and Tonocard (tocainide hydrochloride), in exchange for a royalty. An NDA which had been submitted to the FDA in January 1993 for Roxiam (remoxipride), an Astra product being developed for the treatment of acute and chronic schizophrenia, was withdrawn in January 1994.\nIn July 1993, the Company's total sales of Astra products reached the level that triggered the first step in the establishment of a separate entity to market Astra products under the Company's agreement with Astra. The Company is now building the infrastructure and developing various capabilities to develop and market Astra products within a separate company. The Company expects to fully transfer its Astra-related business and assets to the joint venture company owned by the Company and Astra by early 1995. Astra has the right to obtain a 50 percent ownership of the business and assets transferred by compensating the Company with a payment roughly equivalent to U.S. sales of Astra products over a 12-month period beginning September 1, 1993. The result of these actions is not expected to have a significant impact on financial results in the near term.\nIn 1992, the Company entered into agreements to (i) establish a new manufacturing, sales and promotion entity in Turkey; (ii) restructure Merck Human Health Division operations in Taiwan; (iii) acquire a 100 percent interest in its Mexican subsidiary, Laboratorios Prosalud, which engages in the manufacture, marketing, promotion and sale of the Company's human pharmaceutical, animal health and crop protection products in Mexico; and (iv) develop and market with CSL Limited of Australia combination pediatric vaccines in Australia, New Zealand and major markets in the Far East. In 1992, the Company entered into agreements to acquire certain assets of TTV Limited and Mervest Limited, the entities formerly used to market the Company's product line in the People's Republic of China. In 1992, a new entity was established in Hong Kong for the purpose of carrying on the Company's business in China via representative offices in Beijing, Shanghai and Guangzhou. In 1993, 1992 and 1991, the Company established local organizations for sales and promotion in the Russian Federation, the Ukraine, the Czech and Slovak republics, Slovenia, Bulgaria, Romania, Poland and Hungary.\nCompetition -- The markets in which this segment's business is conducted are highly competitive. Such competition involves an intensive search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well prepared to compete in the search for technological innovations. Additional resources to meet competition include quality control, flexibility to meet exact customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through joint ventures and licenses and has been expanding its sales and marketing efforts to further address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product replacements, even for products protected by patents. For example, the number of compounds available to treat each disease entity has increased during the past several years and has resulted in slowing the growth in sales of certain of the Company's products.\nIn addition, particularly in the area of human pharmaceutical products, legislation enacted in all states allows, encourages or, in a few instances, in the absence of specific instructions from the prescribing physician, mandates the use of \"generic\" products (those containing the same active chemical as an innovator's product) rather than \"brand-name\" products. Governmental and other pressures toward the dispensing of generic products have reduced significantly the sales of certain of the Company's products no longer protected by patents, such as Clinoril and Aldomet (methyldopa), and slowed the growth of certain other products. In 1992, the Company formed a new division, West Point Pharma, to market the generic form of its product\nDolobid. In 1993, West Point Pharma began marketing an additional 11 off-patent Company drugs in more than 20 different packages. See also the description of the effect upon competition of the Drug Price Competition and Patent Term Restoration Act of 1984 (\"PTRA\") on page 6. It is generally the Company's position to limit individual product price increases of its pharmaceutical products in the United States to the Consumer Price Index plus 1 percent on an annual basis.\nMedco's pharmacy benefit management business is highly competitive. Medco competes with other pharmacy benefit managers, retail prescription drug claims processors, other mail service pharmacies, insurance companies, chain pharmacies and other providers of health-care and\/or administrators of health-care programs. Medco competes primarily on the basis of its ability to design and administer innovative programs which contain a plan sponsor's overall prescription drug costs, its flexibility in handling integrated prescription drug programs resulting from its ability to dispense drugs through mail service and act as retail prescription drug manager, and the sophistication and quality of its systems, procedures and services.\nDistribution -- Human health products are sold primarily to drug wholesalers and retailers, hospitals, clinics, governmental agencies, managed health-care providers such as health maintenance organizations and other institutions. Customers for animal health\/crop protection products include veterinarians, distributors, wholesalers, retailers, feed manufacturers, veterinary suppliers and laboratories. Marketing support is provided by professional representatives who call on physicians, hospitals, veterinarians and others throughout the world. This promotional activity is supplemented by direct mail and journal advertising. Medco markets its health-care cost containment services to plan sponsors principally through internal marketing and sales personnel.\nRaw Materials -- Raw materials and supplies are normally available in quantities adequate to meet the needs of this segment.\nGovernment Regulation and Investigation -- The pharmaceutical industry is subject to global regulation by country, state and local agencies. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States, although revised regulations are designed to reduce somewhat the time for approval of new products. In 1992, the Prescription Drug User Fee Act was passed, under which the FDA will collect revenues through user fees. The FDA has pledged to devote these revenues to its process for reviewing and approving applications for new drugs, antibiotics and biological products.\nIn recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that would effect major changes in the health-care system, either nationally or at the state level. In November 1993, President Clinton's Health Security Act was introduced into Congress with moderate Democratic sponsorship. The Clinton plan would guarantee to all Americans health insurance coverage for a Federally-determined set of benefits, which includes pharmaceuticals. The plan is highly regulatory and mandates that employers offer and fund health insurance coverage for their employees. Among other things, the plan also provides for (1) the Secretary of Health and Human Services to establish an Advisory Council on Breakthrough Drugs to make recommendations to the Secretary as to the reasonableness of new drug prices and (2) a mandatory 17 percent rebate on outpatient pharmaceuticals reimbursed by Medicare. Also pending in Congress is the Cooper\/Grandy Managed Competition Act of 1993, a bipartisan health-care reform bill, which relies primarily on market-based competition and insurance reform to reduce health-care costs. The debate to reform the health-care system is expected to be protracted and intense. Although the Company is positioned to do business in a managed competition environment and respond to evolving market forces, it cannot predict the outcome or effect of legislation resulting from the reform process.\nFor some years the pharmaceutical industry has been under Federal and state oversight with the new drug approval system, drug safety, advertising and promotion, drug purchasing and reimbursement programs and formularies variously under review. The Company believes that it will continue to be able to bring new drugs to market in this regulatory environment. One Federal initiative to contain costs is the prospective payment\nsystem, established under the Social Security Amendments of 1983 to hold down the growth of Medicare payments to hospitals, which provides a flat rate for reimbursement to hospitals in advance of the care for patients. The system establishes a number of patient classifications -- Diagnosis Related Groups (\"DRG's\"). A hospital receives the flat rate as full payment for each Medicare patient treated within a given DRG regardless of whether the hospital's actual costs are higher or lower than the flat rate. This system and other cost-cutting programs have caused hospitals and other customers of the Company to be more cost conscious in their treatment programs and to implement cost-containment measures, including cost containment for the drugs they administer.\nAdditionally, Congress and the regulatory agencies have sought to reduce the cost of drugs paid for with Federal funds. In 1990, the Company initiated its Equal Access to Medicines Program (\"EAMP\") on its single source products, under which it generally offered its \"best price\" discount to state Medicaid programs that grant open access to the Company's products. The Omnibus Budget Reconciliation Act of 1990 (\"OBRA\") largely reflects the Company's best price approach. As a result of a national agreement, effective January 1, 1991, signed by the Company with the Secretary of Health and Human Services and administered by the Health Care Financing Administration (\"HCFA\") pursuant to OBRA, Medicaid received a minimum rebate of 12.5 percent off average manufacturer's price (\"AMP\") through September 30, 1992, received a minimum rebate of 15.7 percent off AMP through 1993, and will receive a minimum rebate of 15.4 percent off AMP through 1994, on the Company's outpatient drugs reimbursed under Medicaid. In conjunction with implementation of the Federal program under OBRA, the Company's separate EAMP agreements with individual states have been permitted to lapse or have been terminated. Effective in 1992, the terms of the Federal HCFA rebate agreement were generally substituted for the EAMP agreements.\nIn January 1992, the Company announced that it would provide discounts on its single-source prescription medicines to non-profit health centers for the poor that are Federally funded under sections 329-330 of the Public Health Service Act that qualify for the Company's program and agree to assure access to the Company's drugs. The discounts were largely based on those that the Company provided Medicaid under the Federal \"best price\" legislation. The discounts were ultimately provided to such centers for single-source, out-patient prescription drugs (not reimbursed by Medicaid) purchased directly from the Company by the centers for their patients.\nThe Federal Veterans Health Care Act of 1992 was enacted on November 4, 1992, superceding the Company's Public Health Service initiative and mandating Medicaid rebate-equivalent discounts on covered outpatient drugs purchased by certain Public Health Service entities and \"disproportionate share hospitals\" (hospitals meeting certain qualification criteria). The Act further mandates minimum discounts of 24 percent off non-Federal AMP to the Veterans Administration, Federal Supply Schedule and certain other Federal sector purchasers on their pharmaceutical drug purchases.\nThe Company encounters similar regulatory and legislative issues in most of the foreign countries where it does business. There, too, the primary thrust of governmental inquiry and action is toward determining drug safety and effectiveness, often with mechanisms for controlling the prices of prescription drugs and the profits of prescription drug companies. The EU has adopted directives concerning the classification, labeling, advertising and wholesale distribution of medicinal products for human use. The Company's policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Company's business.\nThe Company is subject to the jurisdiction of various regulatory agencies and is, therefore, subject to potential administrative action. Such actions may include product recalls, seizures of products and other civil and criminal sanctions. Under certain circumstances, the Company may deem it advisable to initiate product recalls voluntarily. Although it is difficult to predict the ultimate effect of these activities and legislative, administrative and regulatory requirements and proposals, the Company believes that its development of new and improved products should enable it to compete effectively within this environment.\nThere are extensive Federal and state regulations applicable to the practice of pharmacy and the administration of managed health-care programs. Each state in which Medco operates a pharmacy has laws and regulations governing its operation and the licensing of and standards of professional practice by its\npharmacists. These regulations are issued by an administrative body in each state (typically, a pharmacy board), which is empowered to impose sanctions for non-compliance.\nPatents, Trademarks and Licenses -- Patent protection is considered, in the aggregate, to be of material importance in the Company's marketing of human and animal health products in the United States and in most major foreign markets. Patents may cover products per se, pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the date of grant and the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage.\nPatent portfolios developed for products introduced by the Company normally provide marketing exclusivity. This is the case with products in the United States such as Timoptic, Mefoxin, Timolide (timolol maleate-hydrochlorothiazide), Ivomec, Tonocard in its oral form, Mevacor, Vasotec, Primaxin, Noroxin, Prilosec in its oral form, Vaseretic, PedvaxHIB (the Company's pediatric vaccine for prevention of Haemophilus influenzae type b infections), Pepcid, Zocor, Plendil, Chibroxin (norfloxacin) and Proscar. Prinivil is subject to a license to a third party and is not marketed exclusively by the Company.\nProduct patent protection in the United States has expired for the following human and animal pharmaceutical products: Diuril (chlorothiazide), Aldomet, Aldoril (methyldopa and hydrochlorothiazide), TBZ and Thibenzole (thiabendazole), Amprol (amprolium), Blocadren (timolol maleate), Flexeril (cyclobenzaprine hydrochloride), Moduretic, Decadron (dexamethasone), Indocin, Clinoril, Dolobid, HydroDiuril (hydrochlorothiazide), Triavil (amitriptyline hydrochloride-perphenazine) and Sinemet.\nWhile the expiration of a product patent normally results in the loss of marketing exclusivity for the covered product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to special compositions and formulations; and (iv) marketing exclusivity that may be available under the PTRA. The effect of product patent expiration also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries.\nThe PTRA in the United States permits restoration of up to five years of the patent term for new products to compensate for patent term lost during the regulatory review process. Additionally, under the PTRA new chemical entities approved after September 24, 1984 receive a period of five years' exclusivity from the date of NDA approval, during which time an \"abbreviated NDA\" or \"paper NDA\" may not be submitted to the FDA. Similarly, in the case of non-new chemical entities approved after September 24, 1984, the applications for which include the new data of clinical investigations conducted or sponsored by the applicant essential to approval, no abbreviated NDA or paper NDA may become effective before three years from NDA approval. However, the PTRA has also resulted in a general increase in the number and use of generic products marketed in the United States because the regulatory requirements for approval of generic versions of off-patent pioneer drugs have significantly lessened. Additionally, the PTRA has increased the incentive for abbreviated NDA applicants to challenge the validity of the United States patents claiming pioneer drugs because such a challenge could result in an earlier effective approval date for the generic version of the pioneer drug and a six-month period during which other generic versions of the pioneer drug could not be marketed.\nIn Japan, a patent term restoration law, which was enacted in 1988, provides, under specific conditions, up to five years of additional patent life for pharmaceuticals. In 1992, the Council of the European Communities published a regulation which created supplementary protection certificates for medicinal products. Thus, as of January 1993, certain medicinal products sold in the EU became eligible for up to five years of market exclusivity after patent expiration. However, this market exclusivity will expire throughout the EU 15 years after the first product approval in the EU. In February 1993, Canada enacted Bill C91 which significantly modified Canadian patent law by eliminating compulsory licensing of pharmaceutical products\nafter December 20, 1991. Thus, patented pharmaceutical products will have market exclusivity for the full 20-year patent life in Canada.\nThe North American Free Trade Agreement was passed in November 1993. This agreement requires Mexico to improve its patent law to meet international standards and to provide full patent protection to pharmaceutical products. The General Agreement on Tariff and Trade negotiations were concluded in December 1993. This agreement requires developing countries to upgrade their intellectual property laws to meet minimum international standards and to provide full patent protection for pharmaceutical products not later than the end of a ten-year transition period.\nThe Generic Animal Drug and Patent Term Restoration Act, enacted in November 1988, provides for the extension of term of patents claiming new animal drugs approved after enactment. This legislation also establishes a process by which generic versions of new animal drugs can be approved via an Abbreviated New Animal Drug Application procedure. The provisions of this legislation, in general, are parallel to those found in the PTRA covering human health products.\nWorldwide, all of the Company's important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely.\nRoyalties received during 1993 on patent and know-how licenses and other rights amounted to $63.2 million. The Company also paid royalties amounting to $230.7 million in 1993 under patent and know-how licenses it holds.\nSPECIALTY CHEMICAL PRODUCTS SEGMENT\nThe Company's specialty chemical products have a wide variety of applications such as use in health care, food processing, oil exploration, paper, textiles and personal care. This segment contributed $510.3 million, $594.9 million and $583.2 million to Company sales in 1993, 1992, and 1991, respectively. The decrease in 1993 sales in this segment is attributable to the Company's sale in June 1993 of the Calgon Water Management business for $307.5 million to English China Clays plc.\nCompetition -- The markets in which this segment's business is conducted are highly competitive. An important factor in such competition is the degree of success in the search for technological innovations. The introduction of new products and processes by competitors may render the Company's products obsolete and may result in price reductions and product replacements. With its long-standing emphasis on research and development, the Company is well prepared to compete in the search for technological innovations and in the conception of expanded applications for existing products. Additional resources utilized by the Company to meet competition include quality control, flexibility to meet exact customer specifications, an efficient distribution system and a strong technical information service.\nDistribution -- Sales of products and related services are made to industrial users, health-care providers and distributors.\nRaw Materials -- Raw materials and supplies are normally available in quantities sufficient to meet the needs of this segment.\nPatents and Trademarks -- Although the Company has United States and foreign patents on apparatus, products, uses and processes relating to specialty chemical products, the patent protection afforded is not considered material in the aggregate. Worldwide, all of the Company's important products are sold under trademarks. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Trademarks are considered in the aggregate to be of material importance.\nRESEARCH AND DEVELOPMENT\nThe Company's business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. Approximately 6,400 people are employed in the Company's research activities. Expenditures for the Company's research and development programs were\n$1,172.8 million in 1993, $1,111.6 million in 1992 and $987.8 million in 1991 and are expected to exceed $1.3 billion in 1994, an increase of 12 percent over 1993. These increases reflect the Company's ongoing commitment to research over a broad range of therapeutic areas and clinical development in support of new products. Total expenditures for the period 1980 through 1993 exceeded $8.5 billion with a compound annual growth rate of 14 percent. Costs incurred by the joint ventures in which the Company participates, totalling $311.3 million in 1993, are not included in the Company's consolidated research and development expenses.\nThe Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. Projects related to human and animal health are being carried on in various fields such as bacterial and viral infections, cardiovascular functions, cancer, diabetes, inflammation, ulcer therapy, kidney function, mental health, the nervous system, ophthalmic research, prostate therapy, the respiratory system, bone diseases, animal nutrition and production improvement, endoparasitic and ectoparasitic diseases and poultry genetics. Other programs are in the areas of food additives and wound dressings.\nIn the development of human and animal health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through animal tests and controlled clinical evaluation. Before a new drug may be marketed in the United States, recorded data on the experience so gained are included in the NDA, biological Product License Application or the New Animal Drug Application to the FDA for the approval required. The development of certain other products, such as insecticides and food additives, is also subject to government regulations covering safety and efficacy in the United States and many foreign countries. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed.\nA potential new product for the Human and Animal Health segment resulting from this research and development program for which a Product License Application was submitted to the FDA in 1992 is Varivax (live attenuated chickenpox vaccine), a vaccine for the prevention of chickenpox. In January 1994, the FDA's External Advisory Committee on Biologics favorably reviewed Varivax. In 1993, the Company submitted NDAs for an over-the-counter form of the Company's ulcer medication Pepcid, to be marketed by the Johnson & Johnson - Merck Consumer Pharmaceuticals Co., and for Trusopt (dorzolamide hydrochloride), a treatment to reduce intraocular pressure associated with glaucoma, Cozaar and Hyzaar.\nEMPLOYEES\nAt the end of 1993, the Company had 47,100 employees worldwide, with 30,200 employed in the United States, including Puerto Rico. Approximately 26 percent of the Company's worldwide employees are represented by various collective bargaining groups. In 1993, the Company offered a voluntary retirement program in areas of the Company where it was determined that a reduction in workforce was appropriate.\nENVIRONMENTAL MATTERS\nThe Company believes that it is in compliance in all material respects with applicable environmental laws and regulations. The Company has maintained a leadership role in supporting environmental initiatives and fostering pollution prevention by actions including the elimination of, or application of best available technology to, air emissions of carcinogens or suspect carcinogens by the Company, which was accomplished in 1993. Projects are currently underway to reduce all environmental releases of toxic chemicals by 90 percent by the end of 1995. In 1993, the Company incurred capital expenditures of approximately $122.4 million for environmental control facilities. Capital expenditures for this purpose are forecasted to exceed $400.0 million for the years 1994 through 1998. In addition, the Company's operating and maintenance expenditures for pollution control were approximately $40.0 million in 1993. Expenditures for this purpose for the years 1994 through 1998 are forecasted to exceed $200.0 million. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Remediation expenditures were $26.3 million in 1993 and are estimated at $170.0 million for the years 1994 through 1998. The Company has been accruing for these costs. Management does not believe that these expenditures should ultimately result in\na material adverse effect on the Company's financial position, results of operations, liquidity or capital resources.\nGEOGRAPHIC AREA INFORMATION\nThe Company's operations outside the United States are conducted primarily through subsidiaries. Sales by subsidiaries outside the United States were 44 percent of sales in 1993 and 46 percent of sales in 1992 and 1991.\nThe Company's worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations, particularly in less developed countries, and adopts strategies responsive to changing economic and political conditions.\nThe ongoing integration of the European market is impacting businesses operating within the EU, particularly on businesses such as the Company's that maintain research facilities, manufacturing plants and marketing and sales organizations in several different countries in the EU. The Company is in the process of rationalizing its operations within the EU so as to continue to meet the needs of its customers in the most efficient manner possible. The Company believes it will continue to be well positioned to compete successfully in this market, although it is not now possible to predict the extent to which the Company might be affected in the future by this development.\nFinancial information about geographic areas of the Company's business is incorporated by reference to page 50 of the Company's 1993 Annual Report to stockholders.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's corporate headquarters is located in Whitehouse Station, New Jersey. The human and animal health business is conducted through divisional or subsidiary headquarters located in Montvale, New Jersey; Rahway, New Jersey; Walpole, New Hampshire; West Point, Pennsylvania; and Woodbridge, New Jersey. Divisional or subsidiary headquarters in San Diego, California and St. Louis, Missouri are used in the Specialty Chemical Products segment. Principal research facilities for human and animal health products are located in Rahway and West Point and for specialty chemical products in San Diego and St. Louis. The Company also has production facilities for human and animal health products at 12 locations in the United States and for specialty chemical products at 4 locations in the United States. Branch warehouses are conveniently located to serve markets throughout the country. Medco operates its primary businesses through owned or leased facilities in various locations throughout the United States. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in most major countries of the free world.\nCapital expenditures for 1993 were $1,012.7 million compared with $1,066.6 million for 1992. In the United States, these amounted to $759.7 million for 1993 and $784.0 million for 1992. Abroad, such expenditures amounted to $253.0 million for 1993 and $282.6 million for 1992.\nThe Company and its subsidiaries own their principal facilities and the manufacturing plants under titles which they consider to be satisfactory. The Company considers that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products for both segments are suitable for their intended purposes and have capacities adequate for current and projected needs for existing Company products. Some capacity of the human and animal health products plants is being converted, with any needed modification, to the requirements of newly introduced and future products.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company, including Medco, is party to in excess of 20 antitrust suits (some of which purport to be class actions) instituted by retail pharmacies, alleging conspiracies in restraint of trade and challenging the pricing and purchasing practices of the Company and Medco, respectively. A significant number of other pharmaceutical companies have also been sued in the same or similar litigation. The Company, including\nMedco, was also sued prior to the Company's merger with Medco by a retail pharmacy, which sought and continues to seek an injunction of the merger (the \"merger case\"). Most of these actions, except for the merger case and several actions pending in California state court, have been consolidated for pretrial purposes in the United States District Court for the Northern District of Illinois (\"Illinois Federal Court\"). A number of similar antitrust complaints were filed subsequent to the consolidation, and the Company will request consolidation and transfer of these actions to Illinois Federal Court. While it is not feasible to predict the outcome of these proceedings, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the Company.\nThe Company is a party to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the Government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the Government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Company's potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the Company. The Company has accrued for these costs and such accruals do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties.\nIn March 1991, the Company reached agreement with the New Jersey Department of Environmental Protection (\"DEP\") to settle a proceeding, commenced in September 1989, regarding alleged violations by the Company of discharge limitations in two permits for its Rahway, New Jersey site. The agreement provided for the Company to pay a fine of $575,188 for alleged past violations and enter into a consent order under which it will undertake specific operational and equipment improvements to its Rahway facility's discharges of waste water and storm water. The consent order also provided for payment to DEP of stipulated penalties for discharge permit violations occurring after June 1990 until the improvements to the site's discharge system are complete, scheduled in the consent order to be no later than November 1, 1994. The Company has paid approximately $420,000 in additional stipulated penalties for discharge violations occurring after June 30, 1990.\nA consent decree was entered into in July 1993 between Kelco Division and the State of California in settlement of allegations by the State that Kelco's San Diego facility had violated its wastewater discharge permit pH limits. The consent decree provides that Kelco will pay penalties of $200,000 for alleged past violations and that the San Diego facility will continuously monitor its wastewater discharges to the sewerage authority and will demonstrate continuous compliance with its permit pH limits for a period of one year. The consent decree also provides that the definition of \"continuous compliance\" will not include exceedences whose monthly total does not exceed 1 percent of the operating time of the system. The facility has already undertaken improvements to its wastewater discharge system that will improve the quality and control of the discharges.\nThere are various other legal proceedings, principally product liability and intellectual property suits, which are pending against the Company. While it is not feasible to predict the outcome of these proceedings, in the opinion of the Company, all such proceedings are either adequately covered by insurance or, if not so covered, should not ultimately result in any liability which would have a material adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable. ---------------------\nEXECUTIVE OFFICERS OF THE REGISTRANT (AS OF MARCH 1, 1994)\nP. ROY VAGELOS -- Age 64\nJuly, 1993 -- Chairman of the Board, President and Chief Executive Officer\nJanuary, 1993 -- Chairman of the Board and Chief Executive Officer\nApril, 1986 -- Chairman of the Board, President and Chief Executive Officer\nDAVID W. ANSTICE -- Age 45\nJanuary, 1994 -- President, Human Health-Europe\nJanuary, 1993 -- Senior Vice President, Merck Human Health Division (MHHD)-Europe\nApril, 1991 -- Senior Vice President, MHHD and President, U.S. Human Health\nJuly, 1989 -- Vice President, Marketing, Merck Sharp & Dohme Division\nAugust, 1988 -- Vice President, International Human Health Marketing, Merck Sharp & Dohme International Division\nMICHAEL G. ATIEH -- Age 40\nJanuary, 1994 -- Vice President, Public Affairs\nApril, 1990 -- Treasurer\nAugust, 1988 -- Vice President, Government Relations\nCELIA A. COLBERT -- Age 37\nNovember, 1993 -- Secretary and Assistant General Counsel\nSeptember, 1993 -- Secretary\nFebruary, 1993 -- Secretary, New Products Committee\nOctober, 1992 -- Counsel, Corporate Staff\nMay, 1991 -- Associate Counsel, Corporate Staff\nNovember, 1988 -- Senior Attorney, Corporate Staff\nSTEVEN M. DARIEN -- Age 51\nApril, 1990 -- Vice President, Human Resources\nMay, 1989 -- Vice President, Worldwide Personnel\nFebruary, 1985 -- Vice President, Employee Relations\nCAROLINE DORSA -- Age 34\nJanuary, 1994 -- Treasurer\nJuly, 1993 -- Executive Director, Customer Marketing, U. S. Human Health (USHH)\nJune, 1992 -- Executive Director, Pricing and Strategic Planning, USHH\nApril, 1990 -- Executive Director, Financial Evaluation and Analysis\nJune, 1989 -- Director, Pension and Benefits Investment\nJanuary, 1989 -- Manager, Pension and Benefits Investment\nJERRY T. JACKSON -- Age 52\nJanuary, 1994 -- Executive Vice President -- responsible for marketing and sales operations outside of the United States and Canada and the activities of Merck AgVet and Merck Vaccine Divisions and the Astra\/Merck Group\nJanuary, 1993 -- Executive Vice President and President, Merck Human Health Division -- responsible for worldwide human health business\nApril, 1991 -- Senior Vice President -- responsible for activities of Merck AgVet and Merck Vaccine Divisions, Merck Specialty Chemicals and Merck Consumer Healthcare Groups and liaison with AB Astra and The Du Pont Merck Pharmaceutical Company\nAugust, 1988 -- President, Merck Sharp & Dohme International Division\nBERNARD J. KELLEY -- Age 52\nDecember, 1993 -- President, Merck Manufacturing Division (MMD)\nAugust, 1993 -- Senior Vice President, Operations, MMD\nSeptember, 1991 -- Senior Vice President, Administration, Planning and Quality, MMD\nSeptember, 1989 -- Vice President, Business Affairs, Merck AgVet Division\nJuly, 1986 -- President, Hubbard Farms, Inc.\nRICHARD J. LANE -- Age 42\nJanuary, 1994 -- President, Human Health-North America\nJanuary, 1993 -- Senior Vice President, Merck Human Health Division (MHHD) and President, U.S. Human Health\nApril, 1991 -- Senior Vice President, MHHD-Europe\nOctober, 1990 -- Vice President, Merck Sharp & Dohme (Europe) Inc. and Managing Director, Merck Sharp & Dohme Limited\nJanuary, 1990 -- Executive Director, Marketing, Merck Sharp & Dohme Limited\nJanuary, 1987 -- Executive Director, Marketing Planning, Merck Sharp & Dohme Division\nJUDY C. LEWENT -- Age 45\nDecember, 1993 -- Senior Vice President and Chief Financial Officer -- responsible for financial and public affairs functions and philanthropic activities\nJune, 1993 -- Senior Vice President, Chief Financial Officer and Controller\nJanuary, 1993 -- Senior Vice President and Chief Financial Officer\nApril, 1990 -- Vice President, Finance and Chief Financial Officer\nOctober, 1987 -- Vice President and Treasurer\nHENRI LIPMANOWICZ -- Age 55\nJanuary, 1994 -- President, Human Health-Mid-Intercontinental Region (MIR)\/Japan\nJune, 1991 -- Senior Vice President, MIR, Merck Human Health Division\nApril, 1989 -- Vice President, Mid-Europe, Merck Sharp & Dohme International Division (MSDI)\nOctober, 1981 -- Vice President, Economic and Strategic Planning, MSDI\nPER G. H. LOFBERG -- Age 46\nJanuary, 1994 -- President, Merck-Medco U.S. Managed Care Division\nApril, 1991 -- Senior Executive Vice President, Strategic Planning and Marketing, Medco Containment Services, Inc. (Medco)\nPrior to April, 1991, Mr. Lofberg was an executive officer of Medco for more than five years.\nMARY M. MCDONALD -- Age 49\nJanuary, 1993 -- Senior Vice President and General Counsel\nApril, 1991 -- Vice President and General Counsel\nMay, 1990 -- Assistant General Counsel and Counsel, Merck Sharp & Dohme International Division\nNovember, 1986 -- Assistant General Counsel, Corporate Staff\nPETER E. NUGENT -- Age 51\nSeptember, 1993 -- Vice President, Controller\nJuly, 1989 -- Vice President, Corporate Taxes\nDecember, 1987 -- Director -- Senior Tax Counsel\nEDWARD M. SCOLNICK -- Age 53\nDecember, 1993 -- Executive Vice President, Science and Technology and President, Merck Research Laboratories (MRL) -- responsible for worldwide research function and activities of Merck Manufacturing Division and computer resources\nJanuary, 1993 -- Executive Vice President and President, MRL -- responsible for worldwide research function and activities of Merck AgVet Division and computer resources\nApril, 1991 -- Senior Vice President and President, MRL -- responsible for worldwide research function and activities of Merck Frosst Canada, Inc.\nMay, 1985 -- President, Merck Sharp & Dohme Research Laboratories Division\nFRANCIS H. SPIEGEL, JR. -- Age 58\nDecember, 1993 -- Executive Vice President -- responsible for human resources, internal auditing and corporate planning, development and licensing functions, activities of the Merck Consumer Healthcare Group, Kelco Division and liaison with The Du Pont Merck Pharmaceutical Company\nJanuary, 1993 -- Executive Vice President -- responsible for human resources, internal auditing and corporate planning, development and licensing functions, activities of the Merck Consumer Healthcare Group and liaison with The Du Pont Merck Pharmaceutical Company\nApril, 1991 -- Senior Vice President -- responsible for financial, human resources, internal auditing and corporate planning, development and licensing functions\nOctober, 1987 -- Senior Vice President -- responsible for financial, internal auditing and corporate planning, development and licensing functions\nPAUL C. SUTHERN -- Age 42\nNovember, 1992 -- President and Chief Operating Officer, Medco Containment Services, Inc. (Medco)\nDecember, 1991 -- Assistant to the Chairman, Medco\nPrior to December 1991, Mr. Suthern was Vice President -- Operations of Medco for more than five years\nMARTIN J. WYGOD -- Age 54\nJanuary, 1993 -- Chairman of the Board, Medco Containment Services, Inc. (Medco)\nMr. Wygod has been Chairman of the Board of Medco for more than five years. Mr. Wygod also has been Chief Executive Officer of Medco for more than five years, other than January 1993 through October 1993.\nAll officers listed above serve at the pleasure of the Board of Directors. None of these officers was selected pursuant to any arrangement or understanding between the officer and the Board. There are no family relationships among the officers listed above except that Martin J. Wygod and Paul C. Suthern are brothers-in-law.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required for this item is incorporated by reference to pages 39 and 52 of the Company's 1993 Annual Report to stockholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required for this item is incorporated by reference to the data for the last five fiscal years of the Company included under Results for Year and Year-End Position in the Selected Financial Data included on page 52 of the Company's 1993 Annual Report to stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required for this item is incorporated by reference to pages 32 through 39 of the Company's 1993 Annual Report to stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\n(A) FINANCIAL STATEMENTS\nThe consolidated balance sheet of Merck & Co., Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1993 and the report dated January 25, 1994 of Arthur Andersen & Co., independent public accountants, are incorporated by reference to pages 40 through 50 and page 51 of the Company's 1993 Annual Report to stockholders.\n(B) SUPPLEMENTARY DATA\nSelected quarterly financial data for 1993 and 1992 are incorporated by reference to page 39 of the Company's 1993 Annual Report to stockholders.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe required information on directors and nominees is incorporated by reference to pages 2 (beginning with the caption \"Election of Directors\")-5 of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 1994. Information on executive officers is set forth in Part I of this document on pages 11-14.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required for this item is incorporated by reference to pages 7 and 13-18 of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required for this item is incorporated by reference to pages 8-9 of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required for this item is incorporated by reference to page 7 (under the caption \"Relationships with Outside Firms\") of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(A) DOCUMENTS FILED AS PART OF THIS FORM 10-K\n(i) Financial Statements:\nConsolidated statement of income for the years ended December 31, 1993, 1992 and 1991\nConsolidated statement of retained earnings for the years ended December 31, 1993, 1992 and 1991\nConsolidated balance sheet, December 31, 1993 and 1992\nConsolidated statement of cash flows for the years ended December 31, 1993, 1992 and 1991\nNotes to financial statements\nReport of independent public accountants\nThis information is incorporated by reference to the Company's 1993 Annual Report to stockholders, as noted on page 15 of this document.\n(ii) Financial Statement Schedules:\nReport of independent public accountants on schedules\nII -- Amounts receivable from related parties and underwriters, promoters and employees other than related parties for the years ended December 31, 1993, 1992 and 1991\nV -- Property, plant and equipment for the years ended December 31, 1993, 1992 and 1991\nVI -- Accumulated depreciation of property, plant and equipment for the years ended December 31, 1993, 1992 and 1991\nIX -- Short-term borrowings for the years ended December 31, 1993, 1992 and 1991\nThe registrant is primarily an operating company and all of the subsidiaries included in the consolidated financial statements filed are wholly owned except for minority interests in six consolidated subsidiaries.\nSchedules other than those listed above are omitted because they are either not required, not applicable or the information is included in the consolidated financial statements or notes thereto.\n(B) EXHIBITS\n- --------------- * Incorporated by reference to Form 10-K Annual Report for the fiscal year ended December 31, 1992.\n** Incorporated by reference to Post Effective Amendment No. 1 to Registration Statement on Form S-8 to Form S-4 Registration Statement (No. 33-50667).\n*** Incorporated by reference to Form 10-K Annual Report of Medco Containment Services, Inc. for the fiscal year ended June 30, 1993.\nNone of the instruments defining the rights of holders of long-term debt of the Company and its subsidiaries (Exhibit Number 4) are being filed since the total amount of securities authorized under any of such instruments taken individually does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of such instruments to the Commission upon request.\nCopies of the exhibits may be obtained by stockholders upon written request directed to the Stockholder Services Department, Merck & Co., Inc., P.O. Box 100--WS 3AB-40, Whitehouse Station, New Jersey 08889-0100 accompanied by check in the amount of $5.00 payable to Merck & Co., Inc. to cover processing and mailing costs.\n(C) REPORTS ON FORM 8-K\nDuring the three-month period ending December 31, 1993, one report was filed on Form 8-K, under Item 2 - Acquisition or Disposition of Assets, relative to the acquisition of Medco Containment Services, Inc. This report was dated November 18, 1993 and filed December 3, 1993, and amended February 1, 1994.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Merck & Co., Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Merck & Co., Inc.'s 1993 Annual Report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 25, 1994. Our audits were made for the purpose of forming an opinion on those basic financial statements taken as a whole. The schedules listed in Item 14 are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nNew York, New York January 25, 1994\nSCHEDULE II\nMERCK & CO., INC. AND SUBSIDIARIES\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\n($ IN MILLIONS)\n- --------------- (1) 1993 additions are a result of the Medco acquisition on November 18, 1993.\n(2) Does not include applicable accrued interest.\n(a) Represents a loan to an officer collateralized by his principal residence with interest at 6%, payable no later than July 13, 1997.\n(b) Represents a loan to an officer collateralized by stock options with interest at 6%. Payable with the proceeds on the date or dates on which the officer sells all or part of Medical Marketing Group common stock or the exercise of Medical Marketing Group stock options.\n(c) Represents a loan to an officer which is collateralized by his principal residence with interest at 10%, payable no later than May 4, 2005.\n(d) Represents loans to an officer collateralized by shares of the Company's common stock, payable on April 30, 1996.\n(e) Represents a loan to an officer collateralized by his principal residence with interest at 6.5%, payable no later than September 4, 1997.\n(f) Represents a loan to an officer which is collateralized by stock options with interest at 6% and payable on demand.\n(g) Represents a loan to an officer collateralized by stock options with interest at 6% and payable on demand.\n(h) Represents a loan to an officer collateralized by stock options with interest at 6%, payable no later than May 11, 1998.\n(i) Represents a loan to an officer collateralized by stock options with interest at 6%, repaid on December 27, 1993.\n(j) Represents a loan to an employee which is collateralized by his principal residence with interest at 7% and payable over 30 years ending December 1, 2022.\n(k) Represents a loan to purchase stock which was payable in February 1992 with interest at 8%. The loan was fully repaid in February 1992.\n(l) Represents a loan to purchase stock which was payable in March 1991 with interest at 10%. The loan was fully repaid in January 1991.\nSCHEDULE V\nMERCK & CO., INC. AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\n($ IN MILLIONS)\n- --------------- (a) Additions, at cost, to construction in progress are net of transfers to other plant and equipment classifications for those construction projects completed during the year.\n(b) 1993 and 1992 include sales of assets related to divestitures and 1993 includes dispositions associated with restructurings.\n(c) Represents balances at date of acquisition for assets acquired and accounted for as a purchase transaction.\nSCHEDULE VI\nMERCK & CO., INC. AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT\n($ IN MILLIONS)\n- ---------------\n(a) 1993 and 1992 include sales of assets related to divestitures and 1993 includes dispositions associated with restructurings.\nNOTE: Depreciation is provided over the estimated lives of the assets, principally using the straight-line method. The estimated useful lives are 10 to 50 years for Buildings, and 3 to 20 years for Machinery, Equipment and Office Furnishings.\nSCHEDULE IX\nMERCK & CO., INC. AND SUBSIDIARIES\nSCHEDULE IX -- SHORT-TERM BORROWINGS\n($ IN MILLIONS)\n- --------------- (a) The weighted average interest rates were calculated on the basis of month-end borrowings.\n(b) Amounts exclude the current portion of long-term debt.\n(c) Principally short-term tax-exempt borrowings and U.S. dollar denominated borrowings.\nSIGNATURES\nPURSUANT 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. MERCK & CO., INC. Dated: March 22, 1994 By P. ROY VAGELOS (CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER)\nBy \/s\/ CELIA A. COLBERT CELIA A. COLBERT (ATTORNEY-IN-FACT)\nPURSUANT 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 AND ON THE DATE INDICATED.\nCELIA A. COLBERT, BY SIGNING HER NAME HERETO, DOES HEREBY SIGN THIS DOCUMENT PURSUANT TO POWERS OF ATTORNEY DULY EXECUTED BY THE PERSONS NAMED, FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AS AN EXHIBIT TO THIS DOCUMENT, ON BEHALF OF SUCH PERSONS, ALL IN THE CAPACITIES AND ON THE DATE STATED, SUCH PERSONS INCLUDING A MAJORITY OF THE DIRECTORS OF THE COMPANY.\nBy \/s\/ CELIA A. COLBERT CELIA A. COLBERT (ATTORNEY-IN-FACT)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports included in or incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (Nos. 33-21087, 33-21088, 33-36101, 33-40177 and 33-51235), on Form S-4 (No. 33-50667) and on Form S-3 (Nos. 33-39349, 33-60322 and 33-51785). It should be noted that we have not audited any financial statements of the Company subsequent to December 31, 1993 or performed any audit procedures subsequent to the date of our reports.\nARTHUR ANDERSEN & CO.\nNew York, New York March 22, 1994\nEXHIBIT INDEX\n- --------------- * Incorporated by reference to Form 10-K Annual Report for the fiscal year ended December 31, 1992.\n** Incorporated by reference to Post Effective Amendment No. 1 to Registration Statement on Form S-8 to Form S-4 Registration Statement (No. 33-50667).\n*** Incorporated by reference to Form 10-K Annual Report of Medco Containment Services, Inc. for the fiscal year ended June 30, 1993.","section_15":""}
{"filename":"56583_1993.txt","cik":"56583","year":"1993","section_1":"Item 1. Business.\n(a) General. Kollmorgen Corporation, incorporated in the State of New York in 1916, has operations in two industry segments: the motion technologies group and electro-optical instruments. The term the \"Company\" as used herein refers to Kollmorgen Corporation and its subsidiaries.\n(b) Financial Information about Industry Segments. The following table includes certain financial information relating to each of the Company's industry segments in each of its last three fiscal years:\nThe operating profit and loss in the above table is defined as total revenue less operating expense and represents operating segment income before general corporate expense and income taxes. Identifiable assets by segment are those assets used exclusively in the operation of that industry segment.\nCorporate expenses, which include interest (net of investment income) and general and administrative expenses, are not allocated to respective segments. Corporate assets consist principally of cash and investments, as well as net assets held for disposition.\nThe loss from operations in 1992 includes a restructuring charge of $10.0 million taken primarily to consolidate several motor operations. The charge is allocated as follows:\nMotion Technologies Group $ 8,000 Corporate $ 2,000\nThe loss from operations in 1991 includes restructuring and other charges of $26.3 million consisting primarily of employee severance costs, additional costs estimated to complete several large long-term military development contracts, and the write-off of certain inventories and non- performing long-term receivables, as follows:\nMotion Technologies Group $ 5,800 Electro-Optical Instruments $11,100 Corporate $ 9,400\n(c) Narrative Description of Business\nMotion Technologies Group.\nThe Company believes that it is one of the major worldwide manufacturers of specialty direct current (\"d.c.\") permanent magnet motors with associated electronic servo amplifiers and servo feedback components. These products are manufactured in the United States by the Company's Inland Motor and Industrial Drives\/PMI Divisions. In addition, the Company's foreign subsidiary, Kollmorgen Artus in France, serves the European markets. The Inland Motor Division designs and manufactures specialty d.c. torque motors, servo motors, tachometer generators, electromechanical actuators and associated high technology drive electronics used worldwide in aerospace, defense, process control, medical, machine tool, and computer peripheral applications. The Industrial Drives\/PMI Division manufactures a line of specialty drive motors and related electronic amplifiers which are used in a variety of industrial applications including industrial automation, process control, machine tools, underwater equipment, and robotics. This Division also designs, manufactures and distributes a line of low inertia, high speed of response, d.c. motors and associated electronics plus feedback devices under the U.S. registered trademark \"PMI\" used primarily in industrial automation and medical applications. In addition, Industrial Drives\/PMI sells a line of stepper motors used for office and factory automation, instrumentation and medical applications. Kollmorgen Artus manufactures and sells d.c. servo and torque motors, electromechanical actuators and drive electronics, synchros, and resolvers, which are sold primarily into the\nEuropean avionics and aerospace market. This subsidiary also manufactures and sells a line of fault detection instruments for the electric utility industry as well as calibration equipment for air traffic control navigation aids.\nIn the specialty motor and drive business, competitive advantage is gained by the ability of the Company to design new or adapt existing motors and drive systems to meet relatively stringent packaging and performance requirements of customers, most of whom are original equipment manufacturers purchasing the motors and drives for inclusion in their end product. While meeting these stringent technical specifications, the motors and drives must also be price competitive. The number and identity of the competitors in this segment varies depending upon the particular industry and product application. In recent years, a number of large European and Japanese manufacturers, either directly or through joint ventures with American companies, have been able to compete successfully in the United States machine tool and industrial automation marketplaces, including the market for industrial motors of the type that the Company's Industrial Drives\/PMI Division manufactures. In other markets, there are relatively few competitors for each marketplace or application, and generally they are specialized domestic or foreign motor manufacturers.\nIn the United States, the industrial\/commercial products manufactured in this segment are marketed and sold by the Company's Industrial and Commercial Products Group, and the defense and aerospace products are marketed by the Aerospace and Defense Products Group. Depending upon the particular motor product or control system in question, the products of the Company's motion technologies group are marketed and sold directly through qualified technical personnel employed by the Company, or through manufacturer's representatives or distributors, or by a combination of the foregoing.\nThe backlog of the motion technologies group at the end of 1993 was $52.2 million of which approximately 80% is expected to be shipped in 1994.\nElectro-Optical Instruments.\nThe Company's electro-optical business is conducted principally by one domestic division and two subsidiaries: the Electro-Optical Division, Kollmorgen Instruments Corporation, and Proto-Power Corporation. The products of this industry segment serve two broad customer groups: military and industrial\/commercial. The Company serves the military market primarily through the Electro-Optical Division located in Northampton, Massachusetts. This Division has been the primary designer and major supplier of submarine periscopes and related spare parts to the United States Navy since 1916. The only other supplier of submarine periscopes to the United States Navy is Sperry Marine, Inc. In addition, the Electro-Optical Division markets and sells submarine periscopes to navies throughout the world.\nIn January 1993, the Company received a contract for $24.7 million from the U.S. Navy to produce 16 optronic sights for the DDG-51 Arleigh-Burke class of guided-missile destroyers. In July 1993, the Company was also awarded a $10 million contract from the U.S. Navy for 19 submarine periscopes systems. Both contract awards have delivery schedules through 1996. This Division also has been an important supplier of other electro-optical\ninstruments for various weapon systems, including sights for the U.S. Army's Abrams tank. These instruments often possess highly advanced servo-driven optical systems and may use lasers, infrared detectors, or low-light level television imaging systems for night vision. This Division also manufactures and sells diamond-machined optical components and air bearing assemblies.\nThe Company serves the industrial\/commercial marketplace for electro- optical instruments through a wholly-owned subsidiary, Kollmorgen Instruments Corporation, which operates through its Macbeth and Photo Research Divisions. The Macbeth Division, located in New Windsor, New York, designs, manufactures and sells worldwide specialized instruments and materials used for the measurement of color and light. This Division also manufactures and sells a line of spectrophotometers which measure color and are used in the textile, paint, paper, plastics and many other industries where the measurement of color is important. It is also a manufacturer of densitometers, which are instruments that are used to control photographic and printing processes by measuring the opacity or density of materials, such as films, inks, and dyes. In addition, this Division manufactures specialized lighting devices for the inspection and comparision of transparencies and prints in the photographic and printing industries. The Macbeth Division also manufactures standard lighting sources used in evaluating color and produces a line of color standards sold under the U.S. registered trademark \"Munsell\". The on-line version of the spectrophotometers manufactured by this Division permits the measurement of spectral characteristics on a production line in a broad range of industrial processes without interrupting production flow. Kollmorgen Instruments GmbH, a German subsidiary of Kollmorgen Instruments Corporation, designs and manufactures a product line of transportable spectrophotometers.\nThe Photo Research Division located in Chatsworth, California, manufactures and sells specialized photometers and spectroradiometers, instruments which make very precise color and brightness measurements of displays (such as CRTs and lighted panels) and are used in both industrial and military applications. This Division also manufactures and sells on-line inspection and alignment systems for CRT displays used in the computer and medical industries.\nThe Company believes that its businesses which manufacture industrial\/ commercial electro-optical instruments are highly regarded in their respective markets. This position has been built upon high quality products which provide uniform results and meet specialized needs and standards, upon proprietary software, and upon superior after-sales service. The Company's competition in this field consists of a number of domestic and foreign privately held companies and divisions or subsidiaries of publicly held corporations. Depending upon the product and customers in question, the Company's industrial products are sold through dealers and independent sales representatives, distributors or systems houses and directly through the divisions' own sales forces. In Europe, these products are distributed through Kollmorgen Instruments GmbH, Kollmorgen (U.K.) Limited, the Company's wholly-owned English subsidiary, and through independent representatives and dealers.\nProto-Power Corporation, a wholly-owned subsidiary of the Company, is an applications engineering company that primarily provides services for the modification and upgrade of nuclear and fossil energy plants of domestic electric utility companies.\nWithin this segment, military products represented 47% of sales in 1993, 45% of sales in 1992, and 47% of sales in 1991. Generally speaking, the Company's military business is characterized by long-term contracts which call for the delivery of products over more than one year and progress payments during the manufacture of the product. Competition is generally limited to divisions of large multinational companies which specialize in military contracting. To date, the Company has been able to compete effectively against these larger companies because of the Company's experience and expertise in the specialized areas which it serves.\nThe backlog of the electro-optical instruments segment at the end of 1993 was $58.3 million of which approximately 50% is expected to be shipped in 1994.\nCustomer Base.\nExcept to the extent that sales to the U.S. government under numerous prime and sub-contracts may be considered as sales to a single customer, the Company's business is not characterized by dependence upon one customer or a few customers, the loss of any of which would have a materially adverse effect on its total business. Typical of all engineered or custom-made component businesses, the Company's motion technologies group is characterized by a customer base founded upon a number of large key accounts, the importance of any one of which can vary from year to year. During 1993, no customer accounted for 10% or more of the Company's consolidated revenues.\nGovernment Sales.\nIn 1993, sales to the U.S. Government or for U.S. Government end-use represented approximately 21% of revenues, of which 14% were generated from the electro-optical instruments segment and 7% was from the motion technologies group.\nPatents.\nThe Company has either applied for or been granted a number of domestic and foreign patents pertaining to the motion technologies group and electro- optical instruments segments. The Company believes that these patents are and will be important to the Company's continued leadership position in these business segments and, when necessary, has and will continue to enforce its legal rights against alleged infringements of its patent estate.\nRaw Materials.\nThe raw materials essential to the Company's business are generally available in the open market, and neither segment of the Company's business experienced any significant shortages in such materials during the past three years. The Company believes that it has adequate sources of raw materials available for use and does not anticipate any significant shortages.\nIn the past, the Company has occasionally encountered rapid increases of the prices of certain isolated materials used in parts of its business, but such increases have not materially affected its ability to procure such materials or to pass on the consequent cost increases to its customers.\nHowever, in some circumstances, there is generally a slight lag between the time these higher costs are incurred and the time they can be reflected in price increases to customers. During 1993, the Company did not encounter such rapid price increases in raw materials.\nResearch and Development.\nDuring 1993, the Company spent $9.3 million or approximately 5.0% of its consolidated sales on research activities related to the development of new products. This compares to $10.6 million or 5.5% in 1992 and $10.3 million or 5.2% in 1991. Substantially all of this amount was sponsored by the Company.\nEnvironmental Regulations.\nThe Company's operations are subject to a variety of federal environmental laws and regulations. The most significant of these laws are the Clean Air Act, the Clean Water Act and the Resource Conservation and Recovery Act, all of which are administered by the United States Environmental Protection Agency. These statutes and the regulations impose certain controls on atmospheric emissions, discharges into sewers and domestic waters, and the handling and disposal of hazardous wastes. In addition, certain state and local jurisdictions have adopted environmental laws and regulations that are more stringent than federal regulations. Compliance with these federal and state laws and regulations has resulted in expenditures by the Company to improve or replace pollution control equipment. The Company's estimated capital expenditures for environmental control facilities are not expected to be material.\nEmployees.\nAs of December 31, 1993, the Company employed approximately 1,660 employees. The Company is a party to two collective bargaining agreements. In August 1993, the Company's Electro-Optical Division entered into a three- year agreement with the International Association of Machinists and Aerospace Workers currently covering 38 employees. On March 4, 1994, the Macbeth Division of Kollmorgen Instruments Corporation entered into a three-year contract with the International Brotherhood of Electrical Workers currently covering 24 employees at that Division. The Company believes that it enjoys good relations with its employees, including those covered by collective bargaining agreements.\nFinancial Information About Foreign and Domestic Operations and Export Sales.\nFinancial information on the Company's foreign and domestic operations and export sales is contained in the response to Item 14(a) of this Report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's corporate office is located in Waltham, Massachusetts. The table which follows sets forth a current summary of the locations of the Company's principal operating plants and facilities, and other pertinent\nfacts concerning them. The Company's facilities are substantially utilized, well maintained and suitable for its products and services. In addition, the Company maintains approximately 150,000 sq.ft. of unutilized space due to prior business segment dispositions and consolidations of facilities.\nThe building in Nashua, New Hampshire, is an asset remaining from the Company's disposition of a business segment in 1989. This facility is currently being leased and is approximately 80% occupied.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company has various legal proceedings arising from the ordinary conduct of its business; however, they are not expected to have a material adverse effect on the consolidated financial position of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Company.\nThe following is a list of the Company's executive officers, their ages and their positions as of February 25, 1994:\nPresent Business Experience During Name Age Office Past Five Years\nGideon Argov 37 President President and Chief Executive and Officer since November 1991; Chief Director since May 1991. From Executive March 1988 to May 1991, Officer President and Chief Executive Officer and Director of High Voltage Engineering Company. Prior to that date, for five years a manager and senior consultant with Bain & Company.\nRobert J. Cobuzzi 52 Senior Senior Vice President (since Vice February 1993), Treasurer and President, Chief Financial Officer since Treasurer July 1991. From April 1989 to and July 1991, Vice President and Chief Treasurer of High Voltage Financial Engineering Company. Prior to Officer April 1989, Vice President and Chief Financial Officer of Ausimont N.V.\nJames A. Eder 48 Vice Vice President since January President, 1990; General Counsel since Secretary December 1991, and Secretary and since 1983. Previously he had General been Assistant Corporate Counsel Counsel from 1977 to 1982.\nRobert W. Woodbury, Jr. 37 Vice Vice President since May 1993; President, Controller and Chief Accounting Controller Officer of the Company since and Chief February 1992. From May 1990 to Accounting February 1992, he was the Chief Officer Financial Officer of Kidde- Fenwal, a Division of Williams Holdings, PLC. Prior to that, from 1988 to 1990 he was the Controller of Unitrode Corporation.\nAll officers are elected annually for one-year terms at the organizational meeting of the Board of Directors held immediately following the annual meeting of shareholders.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Equity and Related Shareholder Matters.\nThe Company's Common Stock is traded on the New York Stock Exchange. There were approximately 2,300 registered holders of the Company's Common Stock on February 25, 1994. The following table sets forth the high and low sales price for shares of the Company's Common Stock within the last two fiscal years and the dividends paid during each quarterly period.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following table sets forth selected consolidated financial data for the Company for each of the five fiscal years 1989 through 1993. All dollar amounts are in thousands except per share data.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nFor the year ended December 31, 1993, the Company had sales of $185.5 million and net income of $4.8 million or $.25 per share. These results compare with 1992 sales of $194.9 million and a net loss of $8.7 million or a loss of $1.14 per share, and 1991 sales of $200.5 million and a net loss of $35.9 million or a loss of $3.97 per share. Earnings (loss) per share are calculated after payment of preferred dividends.\nThe Company's 1993 sales decrease of 5% from the prior period is attributable to both business segments. The decrease in sales of 3% in the motion technologies group was primarily caused by a decline in spending in the military\/aerospace portion of the business and changes in foreign exchange rates. Increased sales of 4% in the commercial portion of the segment offset some of the 1993 revenue decline. In the Company's electro- optical instruments segment sales were down 7% from the prior year primarily as a result of a decline in sales in the Company's commercial light and color instrumentation businesses as the markets for these products were impacted by the worldwide recession.\nOperating results for 1992 included a $10 million charge primarily for the consolidation of the Company's French motor facilities and the consolidation of several redundant functions in the domestic motion technologies businesses. Operating results for 1991 included a restructuring charge of $16.7 million primarily for employee severance costs and to write- off non-performing assets. In addition, $9.6 million was charged to operations in 1991 for estimates to complete long-term military contracts. By the end of 1993 the Company had completed most of its restructuring activities which began in 1991 and the actual requirements were consistent with the original reserve amounts. As a result, the Company's work force was reduced by approximately 850 people and a substantial portion of the facilities consolidation was complete by the end of 1993. The Company had a reserve balance of approximately $6.4 million at December 31, 1993, principally for the completion of its facilities consolidation.\nResearch and development expense was $9.3 million in 1993 or 5.0% of sales as compared to $10.6 million in 1992 (5.5% of sales) and $10.3 million in 1991 (5.2% of sales). The reduction between 1993 and 1992 is primarily a result of decreased spending at the Company's French motor business due to the consolidation of its facilities.\nIn 1993, interest expense, net, decreased to $4.1 million compared to $5.2 million in 1992 and $6.0 million in 1991. The decrease in both periods is due to lower average outstanding borrowings in the Company's French facilities, higher interest income from cash investments due to larger cash balances, and a lower outstanding balance on long-term debt. The use of funds is more fully discussed under \"Liquidity and Capital Resources.\"\nThe Company recognized tax benefits on income of $.8 million, $.8 million and $1.6 million in 1993, 1992 and 1991, respectively. In 1993, the recognition of the income tax benefit resulted from resolutions of certain prior year tax assessments. The Company also recognized the income tax benefits of applicable net operating losses and tax credits in 1992 and 1991 as a reduction in the provision for income taxes. The benefit of unutilized net operating losses and tax credits will be carried over to future periods to reduce income taxes otherwise payable.\nLiquidity and Capital Resources\nThe Company's consolidated cash, restricted cash and short-term investments decreased by $4.8 million during 1993. Operations provided $10.9 million, while $9.7 million was used for capital expenditures and investing activities other than short-term investments. Financing activities used $6.9 million.\nThe most significant changes in working capital included a decrease of recoverable amounts on long-term contracts of $6.2 million as several contracts were completed during the course of the year. Inventories were reduced by $1.2 million and accounts and notes receivable reduced by $2.1 million as result of increased efforts towards reducing working capital requirements. Accounts payable and accrued liabilities decreased by $8.5 million primarily as a result of expenses related to the Company's restructurings which were paid during the year consisting primarily of severance payouts.\nThe Company's investing activities included expenditures of $5.5 million for property, plant and equipment. In addition, the Company purchased an unutilized leased facility for $4.3 million in cash as consideration for the termination of a 20-year lease having 13 years remaining. In addition, the Company assumed a $2.0 million mortgage for the property and the net realizable value of the property of $3.0 million is included in assets held for sale. The estimated loss in value of the property was recorded in the 1992 restructuring.\nThe Company's financing activities used $6.9 million of cash during the year of which dividends, both common and preferred, accounted for $3.0 million while repayments under existing credit lines and long-term debt accounted for $3.9 million.\nUnder the terms of the current bank agreement, the Company maintains a cash balance equal to approximately 50% of the outstanding standby letters of credit. The cash is held in custody by the issuing bank in an interest- bearing account and is restricted to withdrawal or use. Accordingly, the Company has classified these funds as restricted cash of $6.7 million. At December 31, 1993, the Company was contingently liable for $9.4 million for outstanding standby letters of credit issued principally to secure advance payments received from customers on long-term military contracts.\nIn accordance with the terms of the Company's two convertible subordinated debentures, the Company is required to pay $3.8 million in sinking fund payments during 1994 and additional amounts in future years.\nCapital spending in 1994 is expected to be at similar levels to 1993. The Company believes that with the cash generated from operations and with its current borrowing capacity it will be able to finance 1994 capital expenditures and contribute the mandatory sinking fund payments.\nIn January 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The Company elected to amortize the transition obligation over 20 years. The financial statements include an expense of $.8 million in 1993.\nIn February 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). The adoption of FAS 109 did not have a material effect on results of operations or financial position.\nThe Company will adopt Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Post-Employment Benefits\" (\"FAS 112\") in 1994. FAS 112 requires that benefits to be paid to former or inactive employees after employment but prior to retirement must be accrued if certain criteria are not met. The adoption of FAS 112 is not expected to have a material financial impact on the Company.\nMotion Technologies Group\nRevenues in the motion technologies group decreased to $112.8 million, down 3% from $116.6 million in 1992 and down 7% from $120.6 million in 1991. The effect of foreign exchange rates accounted for 2% of the decrease in sales in 1993. Reduced sales in the military\/aerospace portion of the business were offset by an increase in volume in the domestic commercial motors businesses. The operating income was $9.2 million for 1993, compared to a loss in 1992 of $2.5 million which included an $8 million restructuring charge. The increase in operating income is a result of improved gross margins in the commercial and industrial businesses, reduced administrative and research and development expenses as a result of the consolidation of various domestic and French facilities. These spending reductions were slightly offset by increased spending in sales and marketing expenses in our commercial motors businesses as the Company expanded its sales organization by opening regional sales offices during the year in order to increase its direct sales efforts under the reorganized structure. Operating income was $.1 million in 1991 which included a restructuring charge of $5.8 million.\nNew orders for this segment were up 3% in 1993 over 1992 as orders for commercial and industrial motors increased. New orders for military and aerospace products were essentially unchanged compared to 1992 results. Backlog at the end of 1993 was $52.2 million compared to $49.9 million in 1992.\nCapital expenditures in 1993 and 1992 for this segment was $3.3 million and $3.1 million, respectively, most of which was for replacement of existing equipment and investments in new equipment to improve efficiency and quality of products.\nElectro-Optical Instruments\nRevenues in the electro-optical instruments segment decreased to $72.8 million, down 7% from $78.3 million in 1992, and down 9% from $79.9 million in 1991. The decrease in 1993 was principally due to reduced sales in the commercial light and color instrumentation businesses. The decrease in 1992 over 1991 was due primarily to reduced sales in the Company's Electro-Optical Division as receipts of long-term orders were delayed, but were partially offset by increased revenues at our Proto-Power subsidiary. Operating income in this segment was $3.1 million, compared to a $4.1 million in 1992 and a $13.4 million loss in 1991, including an $11.1 million restructuring charge. The decrease in operating profit in 1993 is due to lower margins on reduced sales in the commercial color and light measurement products businesses and lower gross margins on military contracts at the Electro-Optical Division. Reductions in operating expenses of $1 million between 1993 and 1992 helped offset the decline in margins.\nThe backlog for the electro-optical instruments segment was $58.3 million at the end of 1993 up 21% from $48.1 million at the end of the previous year. The backlog increase is due to long-term orders at the Electro-Optical Division for periscopes and optronic sights received during the year.\nDuring 1993 the electro-optical instruments segment spent $2.1 million on capital equipment primarily for replacement and maintenance of existing equipment.\nThe Company's leased facility in Chatsworth, California, which manufactures high-end light measurement products, was damaged during the earthquake on January 17, 1994. The damage caused portions of the operations to be temporarily interrupted. Due to this disruption the Company anticipates a lower sales volume at this facility during the first quarter of 1994. The Company maintains an adequate amount of property and business interruption insurance to cover all assessed damages and, therefore, does not anticipate the impact on earnings in the first quarter of 1994 to be material.\nGeneral corporate expenses included interest expense (net of investment income), and general and administrative expenses. In addition, the general corporate amounts include restructuring and other non-recurring costs of $2 million in 1992, $9.4 million in 1991. General corporate assets consist principally of cash and investments, as well as net assets held for disposition.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe information required by this Item 8 is included in Item 14(a) of this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nAs previously reported by the Company on a Form 8-K dated September 11, 1992, upon the recommendation of the Audit Committee, the Board of Directors in September 1992 appointed Coopers & Lybrand, One International Place, Boston, Massachusetts, as independent accountants to examine the Corporation's financial statements for the fiscal year ended December 31, 1992 and thereafter. Coopers & Lybrand was appointed the Corporation's independent accountants by the Board of Directors after the Board had terminated the engagement of the accounting firm of KPMG Peat Marwick. During the fiscal year ending December 31, 1991, and the interim period preceding the termination of the engagement of KPMG Peat Marwick, the Corporation had no disagreements with such accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure or any reportable events which disagreements, if not resolved to the satisfaction of KPMG Peat Marwick, would have caused it to make reference to the subject matter of such disagreements in connection with its reports. Furthermore, the KPMG Peat Marwick report on the Corporation's financial statements for the year ended December 31, 1991, presented in Item 14(a) of this report, contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company.\nThe information required by this Item 10 of Form 10-K relating to directors who are nominees, and to directors continuing in office after the Company's Annual Meeting of Shareholders to be held on May 11, 1994, is contained in the definitive proxy statement to be filed with the Securities and Exchange Commission (the \"Commission\") on or before April 5, 1994, under the headings \"Nominees\", and \"Continuing Directors\", and such information is incorporated herein by reference in response to this item.\nThe information required by this Item 10 of Form 10-K with respect to executive officers is set forth in Part I of this Form 10-K under the heading \"Executive Officers of the Company\".\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this Item 11 of Form 10-K is contained in the Company's definitive proxy statement to be filed with the Commission on or before April 5, 1994, under the heading \"Executive Compensation\" and such information is incorporated herein by reference in response to this item.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this Item 12 of Form 10-K is contained in the definitive proxy statement to be filed with the Commission on or before April 5, 1994, under the headings \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" and such information is incorporated herein by reference in response to this item.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required by this Item 13 of Form 10-K is contained in the Company's definitive proxy statement to be filed with the Commission on or before April 5, 1994, under the heading \"Certain Relationships and Related Transactions\" and such information is incorporated herein by reference in response to this item.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K.\n(a) The following documents are filed as part of this report:\n(1) Financial Statements. See Index to Financial Statements on page 18.\n(2) Financial Statements Schedules. See Index to Financial Statements Schedules on page 42.\n(3) Exhibits. See Exhibit Index on page 46.\n(b) Reports on Form 8-K. There were no reports on Form 8-K filed by the Company.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Kollmorgen Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKOLLMORGEN CORPORATION\n\/s\/ Robert J. Cobuzzi Robert J. Cobuzzi Its: Senior Vice President, Treasurer and Chief Financial Officer March 3, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:\n\/s\/ Gideon Argov Gideon Argov March 3, 1994 President and Chief Executive Officer\/Director\n\/s\/ Robert J. Cobuzzi Robert J. Cobuzzi March 3, 1994 Senior Vice President, Treasurer and Chief Financial Officer\n\/s\/ Robert W. Woodbury, Jr. Robert W. Woodbury, Jr. March 3, 1994 Vice President, Controller and Chief Accounting Officer\n\/s\/ James A. Eder James A. Eder March 3, 1994 Vice President and Secretary and Attorney-in-Fact For:\nAllan M. Doyle, Jr., Director Robert N. Parker, Director\nJames H. Kasschau, Director Eric M. Ruttenberg, Director\nJ. Douglas Maxwell, Jr., Director George P. Stephan, Director\nThe following consolidated financial statements of the Company and its subsidiaries are included in response to Item 8.\nPage(s) in Form 10-K -----------\nReport of Independent Accountants - Coopers & Lybrand 19\nIndependent Auditors' Report - KPMG Peat Marwick 20\nConsolidated Balance Sheets as of December 31, 1993 and 1992. 21-22\nConsolidated Statements of Operations for the years ended December 31, 1993, 1992 and 1991. 23\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1993, 1992 and 1991. 24\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991. 25-26\nNotes to Consolidated Financial Statements. 27-41\nIndex to Financial Statements Schedules 42\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders Kollmorgen Corporation:\nWe have audited the accompanying consolidated balance sheets of Kollmorgen Corporation as of December 31, 1993 and 1992, and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements of Kollmorgen Corporation for the year ended December 31, 1991, were audited by other independent accountants whose report dated February 19, 1992, expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kollmorgen Corporation as of December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ Coopers & Lybrand\nCOOPERS & LYBRAND\nBoston, Massachusetts January 31, 1994\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders Kollmorgen Corporation:\nWe have audited the accompanying consolidated statements of operations, shareholders' equity, and cash flows of Kollmorgen Corporation and subsidiaries for the year ended December 31, 1991. In connection with our audit of the consolidated financial statements, we also have audited the 1991 financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Kollmorgen Corporation and subsidiaries for the year ended December 31, 1991, in conformity with generally accepted accounting principles. Also in our opinion, the related 1991 financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick\nKPMG PEAT MARWICK\nShort Hills, New Jersey February 19, 1992\nKOLLMORGEN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1993, 1992, and 1991 (Dollars in thousands, except per share amounts) _________________________________________________________________\nNote 1. Summary of significant accounting policies\nA summary of the significant accounting policies followed by Kollmorgen Corporation is presented below. Certain reclassifications have been made to the prior years' financial statements to conform to 1993 classifications. For purposes of the Notes to Consolidated Financial Statements, the term the \"Company\" refers to Kollmorgen Corporation and its subsidiaries.\nPrinciples of Consolidation The consolidated financial statements include the accounts of the Company and all of its majority-owned subsidiaries.\nIn 1993, the Company's wholly-owned subsidiary, Kollmorgen Artus, prospectively changed its financial reporting year from a fiscal year ending on October 31 to December 31. The consolidated statements of income are presented for the year ended December 31, 1993, excluding the results of operations for November and December, 1992, which were immaterial.\nCash and Cash Equivalents Cash equivalents are stated at cost which approximates fair value. The Company considers all highly liquid investments purchased within an original maturity of three months or less to be cash equivalents.\nRecoverables Recoverable amounts on long-term contracts represent revenues recognized on a percentage-of-completion basis less progress billings.\nInventories Inventories are stated at the lower of cost or market, principally using the first-in, first-out method. Progress payments received on contracts other than major long-term contracts are deducted from inventories.\nProperty, Plant and Equipment and Accumulated Depreciation Property, plant and equipment are carried at cost and include expenditures for major improvements which substantially increase their useful life. Repairs and maintenance are expensed as incurred. When assets are retired or otherwise disposed of, the assets and related allowances for depreciation and amortization are eliminated from the accounts and any resulting gain or loss is recognized.\nFor financial reporting purposes, depreciation is provided generally on a straight-line basis over the estimated useful lives of the buildings (10 to 50 years) and the machinery and equipment (3 to 12 years). Leasehold improvements are depreciated over the remaining period of the existing leases. For income tax purposes, depreciation is computed by using various accelerated methods and, in some cases, different useful lives than those used for financial reporting.\nNotes to Consolidated Financial Statements - continued\nGoodwill and Intangibles Goodwill consists of amounts by which the cost of acquisitions exceeded the values assigned to net tangible assets. Intangible assets consist principally of patents. All of the intangible assets are being amortized on a straight-line basis over periods of up to 40 years.\nCumulative Translation Adjustments Assets and liabilities of foreign subsidiaries are translated at year-end exchange rates. The effects of these translation adjustments are reported in a separate component of shareholders' equity. The effect of exchange rates on cash flows is not material.\nSales Sales, other than revenues from major long-term contracts, are recorded as products are shipped. Major programs that are performed under long-term contracts are accounted for using the percentage-of-completion method. Revenues recognized under this method were $24.5 million, $29.3 million, and $29.1 million in 1993, 1992, and 1991, respectively. In most cases the contracts also provide for progress billings over the life of the program.\nEarnings (Loss) Per Common Share Earnings (loss) per common share is based on net income less the dividends and interest accretion on redeemable preferred stock divided by the average number of common shares outstanding. Fully diluted net income assumes full conversion of all convertible securities into common stock which include the convertible subordinated debentures and redeemable preferred stock. The fully diluted calculation does not result in dilution of net income per common share and, accordingly, is not presented.\nIncome Taxes Effective January 1, 1993 the Company adopted Statement of Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). The adoption of FAS 109 had no material effect on results of operations or financial position.\nPostretirement Benefits Other Than Pensions Effective January 1, 1993, the Company adopted Statement of Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"). Under FAS 106, the Company is required to accrue the expected benefit obligation for postretirement benefits during the employees' active service periods. The Company previously expensed the cost of these benefits, which are principally health care, as claims were incurred.\nThe Company has elected the delayed recognition method in which the cost for employees hired prior to January 1, 1992, is being amortized over 20 years. The Company paid approximately $.8 million in 1993 for post- retirement benefits to current retirees.\nNote 2. Restricted cash\nThe restricted cash balance of $6.7 million in 1993 serves as collateral for an irrevocable standby and documentary letter of credit facility at the Company's lead bank.\nNotes to Consolidated Financial Statements - continued\nPursuant to the terms of this agreement, the cash is held in custody by the issuing bank and is restricted as to withdrawal or use, and is currently being invested in short-term money market instruments for the benefit of the Company.\nNote 3. Inventories\nInventories at December 31 consist of the following:\n1993 1992 --------- --------- Raw materials $ 11,530 $ 11,431 Work in process 7,847 9,634 Finished goods 2,641 3,268 --------- --------- $ 22,018 $ 24,333 ========= =========\nNote 4. Property, Plant and Equipment\nProperty, plant and equipment at December 31 consists of the following:\n1993 1992 --------- --------- Land $ 1,459 $ 1,474 Leasehold improvements 669 988 Buildings 34,650 34,877 Machinery and equipment 70,369 70,470 --------- --------- 107,147 107,809 Less accumulated depreciation and amortization 76,686 76,051 --------- --------- $ 30,461 $ 31,758 ========= =========\nNote 5. Accrued Liabilities\nAccrued liabilities at December 31 consist of the following:\n1993 1992 --------- --------- Restructuring and related costs $ 6,390 $ 19,938 Salaries, wages, commissions 5,100 4,728 Pension\/supplemental retirements 3,912 2,736 Insurance 3,169 1,898 Other accrued liabilities 13,990 13,746 --------- --------- $ 32,561 $ 43,046 ========= =========\nNotes to Consolidated Financial Statements - continued\nNote 6. Lines of credit and notes payable\nAt December 31 the Company had approximately $2.9 million or approximately 17 million French francs of unused lines of credit.\nNotes payable consist of the following at December 31:\n1993 1992 -------- -------- Foreign $ 3,545 $ 5,450 Domestic 1,987 - -------- -------- $ 5,532 $ 5,450 ======== ========\nIn July 1993, the Company amended its existing agreement with its lead bank which provides for a one-year $18 million domestic standby letter of credit facility and extended the terms of the existing 21 million French franc revolving credit facility (approximately $4 million). Under the terms of the agreement, the Company maintains a cash collateral balance equal to approximately 50% of the outstanding letters of credit in an interest-bearing account. At December 31, 1993, the Company had $9.4 million of standby letters of credit outstanding at this bank. The agreement also requires the Company to maintain, among other things, certain financial ratios, the most restrictive of which is net worth, and contains other affirmative and negative covenants. The Company was in compliance with all covenants at December 31, 1993.\nNote 7. Long-term debt\nLong-term debt consists of the following:\n1993 1992 -------- -------- 8 3\/4% Convertible subordinated debentures due 2009 $ 39,840 $ 39,840 10 1\/2% Convertible subordinated debentures due 1997 8,000 10,000 Term loans, 10.5% due through 1997 152 686 Capital lease obligations - 149 Other - 45 -------- -------- 47,992 50,720 Less current maturities 3,872 2,452 -------- -------- $ 44,120 $ 48,268 ======== ========\nThe 8 3\/4% Convertible Subordinated Debentures are convertible at any time prior to maturity, unless previously redeemed, into 1,159,825 shares of common stock of the Company at a conversion price of $34.35 per share,\nsubject to adjustment in certain events. The Company is required to make annual sinking fund payments sufficient to retire $1.75 million principal amount of debentures commencing in 1994 through 2008. The debentures are currently redeemable at the option of the Company at certain premiums through April, 1994, and at face value thereafter, with accrued interest to the redemption date.\nThe 10-1\/2% Convertible Subordinated Debentures issued in a private placement, are convertible into 320,000 shares of the Company's common stock at a price of $25 per share at any time prior to maturity, unless previously redeemed. The debentures are subject to mandatory sinking fund payments which commenced on August 1, 1993, and each year thereafter including August 1, 1997, in the amount of $2 million of principal reduction together with interest accrued and unpaid thereon to the date fixed for redemption.\nThe Company incurred $5.1 million, $5.8 million, and $6.0 million of interest expenses on debt in 1993, 1992, and 1991, respectively.\nLong-term debt at December 31, 1993, matures as follows:\nDate Maturities ---- ---------- 1994 $ 3,872 1995 3,764 1996 3,764 1997 3,752 1998 1,750 Thereafter 31,090 -------- $47,992 ========\nNote 8. Preferred Stock\nThe Company's Restated Certificate of Incorporation provides that the Corporation is authorized to issue 500,000 shares of preferred stock, $1.00 par value, in series. Currently, there are 23,187.5 shares of preferred stock issued and outstanding.\nIn March, 1990, the Company sold 23,187.5 shares of a new issue of Series D convertible preferred stock (the \"Series D Stock\") for $1,000 per share, or an aggregate of approximately $23.2 million, to a group of investors led by Tinicum Enterprises, Inc. (\"Tinicum Group\"). The stock has a cumulative dividend rate of 9.5 percent per year and is convertible into an aggregate of 1,717,591 shares of Kollmorgen common stock, subject to antidilution provisions. Under the agreement between the Company and the Tinicum Group, two representatives of the Tinicum Group were elected to the Company's Board of Directors. The Series D Stock is entitled to vote together with the Company's common stock based on the number of shares of the Company's common stock into which the Series D Stock is convertible. While the Series D Stock is outstanding, the Company has agreed, among other things, not to issue any capital stock of the Company other than the Company's common stock and securities issuable under the Company's Shareholder Rights Plan without first obtaining the consent of a majority of the outstanding Series D Stock. The Company is required to redeem all\nNotes to Consolidated Financial Statements - continued\noutstanding Series D Stock on April 1, 2000, at $1,000 per share, in each case plus accrued and unpaid dividends. The Series D Stock purchase agreement also includes certain financial covenants applicable to the Company, and certain restrictions applicable to the purchasers on the disposition, acquisition or the taking of other specified actions with respect to the voting securities of the Company.\nThe balance of the preferred stock is shown net of the unamortized preferred stock discount. The unamortized amount in 1993 and 1992 is $781 and $906, respectively.\nNote 9. Common Stock, Additional Paid-in Capital and Treasury Stock\nPursuant to the By-Laws of the Corporation, directors who are not employees of the Corporation receive an annual retainer of $12,000. Under the terms of the 1992 Stock Ownership Plan for Non-Employee Directors, each non-employee director receives at least 50% of his annual retainer in shares of common stock. The number of shares of common stock is based on the fair market value of such shares at the end of each quarterly period. Also, each non-employee director automatically receives an option to purchase an additional 2,000 shares of common stock every other year. At the implementaion of the Plan, 150,000 shares were reserved for issuance.\nThe Company maintains a Shareholder Rights Plan which provides one Preferred Stock Purchase Right (Right) for each outstanding share of Common Stock of the Company. Each Right entitles the registered holder, subject to the terms of a Rights Agreement, to purchase one one-thousandth of a share (Unit) of Series B Preferred Stock, par value $1.00 per share (Preferred Stock), at a purchase price of $50 per Unit. The units of preferred stock are non-redeemable, voting, and are entitled to certain preferential dividend rights. The exercise price and the number of units issuable are subject to adjustment to prevent dilution.\nThe Rights are not exercisable until the earlier to occur of (i) 10 days following a public announcement (the date of such announcement being the \"Stock Acquisition Date\") that a person or group has acquired beneficial ownership of 20% or more of the then outstanding shares of capital stock of the Company entitled to vote (\"Acquiring Party\") or (ii) a date determined by the Board of Directors following the commencement of a tender or exchange offer which would result in a party beneficially owning 30% or more of the shares of voting stock of the Company.\nThe Board of Directors of the Company may redeem the Rights at any time on or prior to the tenth day following the Stock Acquisition Date at a price of $0.01 per Right. Unless earlier redeemed, the Rights will expire on December 20, 1998.\nCommon stock reserved for issuance at December 31, 1993 and 1992, were as follows: conversion of debentures and redeemable preferred stock -- 3,197,416 and 3,277,416, respectively; and stock options and other awards -- 1,236,111 and 1,394,628, respectively.\nNotes to Consolidated Financial Statements - continued\nAs a result of the Company's losses in previous years, there was not a sufficient amount of retained earnings from which to pay dividends and, accordingly, dividends paid on common and preferred stock were charged to \"Additional Paid-in Capital.\"\nNote 10. Employee stock option and purchase plans\nThe Company maintains two stock option plans under which grants have been made to officers and key employees. Options are generally first exercisable after one year but before ten years from date of grant.\nA summary of changes during 1993, 1992, and 1991 in shares of common stock authorized for grant to officers and key employees under the stock option plans are as follows: Number of Shares 1993 1992 1991 -------- -------- -------- Shares under option at January 1 892,337 1,044,189 551,239 Options granted 185,000 115,000 537,000 Options canceled (204,517) (266,852) (44,050) ---------- ---------- ---------- Shares under option at December 31 872,820 892,337 1,044,189 ========== ========== ========== Options exercisable at December 31 300,220 347,887 418,854\nPrice per share of options granted $ 6.00 to $ 4.50 to $ 5.38 to $ 7.75 $ 8.50 $ 8.38\nOption prices at December 31, 1993, ranged from $4.50 to $20.00 per share.\nOptions available for grant at December 31, 1993, 1992 and 1991 were 213,291, 352,291 and 815,102, respectively.\nNote 11. Taxes on income\nThe components of income (loss) before income taxes were as follows:\n1993 1992 1991 -------- -------- -------- Domestic $ 5,819 $ (3,526) $(34,554) Foreign (1,915) (5,971) (2,984) -------- -------- -------- Total $ 3,904 $ (9,497) $(37,538) ======== ======== ========\nFAS 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the\nNotes to Consolidated Financial Statements - continued\nfinancial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nThe provision (benefit) for income taxes consists of the following (in thousands):\n1993 1992 1991 -------- -------- -------- Current provision (benefit): U.S. federal $ (703) $ 20 $ (1,444) Foreign - (196) (191) State - 50 35 -------- -------- -------- (703) (126) (1,600) -------- -------- -------- Deferred provision (benefit): U.S. federal - 20 - Foreign (145) (746) - State - 80 - -------- -------- -------- (145) (646) - -------- -------- -------- Total $ (848) $ (772) $ (1,600) ======== ======== ========\nDeferred tax provisions (benefits) result from differences in the years in which certain elements of income or expense are included in financial statements and income tax returns. Deferred taxes related to the following temporary differences:\n1993 1992 1991 -------- -------- -------- Unrecognized future tax benefits $ 7,304 $ 1,891 $ 3,745 Gross margins on long-term contracts 245 309 (1,163) Depreciation expense 864 (350) (411) Provision for costs not currently deductible (8,079) (1,457) (2,089) Cash basis accounting - - (250) Installment sale (364) (793) 8 Other items (115) (246) 160 -------- -------- -------- $ (145) $ (646) $ - ======== ======== ========\nThe U.S. effective income tax rate from operations is different from the U.S. federal statutory rate for the following reasons:\nNotes to Consolidated Financial Statements - continued\n1993 1992 1991 -------- -------- -------- Income tax provision (benefit) if computed at U.S. federal rates $ 1,378 $ (3,229) $(12,776) Benefit of net operating loss carryforwards (1,534) - - Unutilized net operating losses and tax credits - 2,249 7,837 Carryback of net operating losses at less than statutory rates - - 2,695 State income taxes net of federal benefit - 86 23 Foreign tax rate variances - 9 822 Recognition of deferred tax asset due to carryback (703) - - Other 11 113 (201) -------- -------- -------- $ (848) $ (772) $ (1,600) ======== ======== ========\nThe deferred tax assets and liabilities are comprised of the following:\n12\/31\/93 12\/31\/92 ---------- ---------- Restructuring reserve $ 483 $ 1,011 Bad debt reserve 300 454 Other 2,430 3,549 Employee benefit reserves 2,376 2,095 Allowance for doubtful accounts 1,090 1,680 Reserve for net realizable value of real estate 2,564 2,581 Other 1,093 1,371\nNet operating losses and credits 17,024 13,920\nProperty, plant and equipment (2,526) (2,526) Other (195) - --------- --------- 24,639 24,135 --------- --------- Valuation allowance (24,639) (24,135) --------- --------- Net deferred tax asset $ - $ - ========= =========\nFor Federal income tax purposes,the Company has domestic regular tax net operating loss carryforwards of approximately $20 million and alternative minimum tax net operating loss carryforwards of $17.0 million as of December 31, 1993, which may be used to offset future taxable income. The\nNotes to consolidated Financial Statements - continued\nCompany also has foreign net operating losses of approximately $5.0 million. These net operating losses expire beginning in 2002. Additionally, the Company has available $5.7 million of investment tax credit carryforwards which will expire beginning in 2002.\nNote 12. Restructuring costs and asset disposition\nIn 1992 the Company recorded a $10 million restructuring charge principally for the consolidation of facilities in France and the elimination of redundant functions in the Company's motion technologies group. In 1991, the Company implemented a restructuring resulting in a charge of $16.7 million to, among other things, reduce the Company's domestic and foreign work force. In addition, the Company charged $9.6 million in 1991 to operations primarily to provide for unanticipated costs in completing several large, fixed-price military contracts.\nIn November 1992 the Company sold certain assets of its proprietary MICRO-FLIR(R) thermal imaging products business to the Electronic Systems Group of Westinghouse Electric Corporation located in Baltimore, Maryland.\nNote 13. Leases\nThe Company leases certain of its facilities and equipment under various operating lease arrangements. Such arrangements generally include fair market value renewal and\/or purchase options.\nRent expense for operating leases amounted to $3.0 million in 1993 (excluding $.9 million which was provided for in the prior restructuring provisions), $5.2 million in 1992, and $4.9 million in 1991. Future minimum rental payments required under non-cancellable operating leases having a lease term in excess of one year, together with the present value of the net minimum lease payments at December 31, 1993, are as follows:\n1994 $ 2,606 1995 2,292 1996 1,794 1997 1,194 1998 1,029 Thereafter 7,871 -------- Total minimum lease payments $ 16,786 ========\nNote 14. Contingencies\nThe Company has various lawsuits, claims, commitments and contingent liabilities arising from the ordinary conduct of its business; however, they are not expected to have a material adverse effect on its consolidated financial position.\nNotes to Consolidated Financial Statements - continued\nIn doing business with the U.S. Government, the Company is subject to routine audits and, in certain circumstances, to inquiry, review, or investigation by the U.S. Government Agencies relating to the Company's compliance with Government Procurement policies and practices. The Company's policy has been and continues to be to conduct its activities in compliance with all applicable rules and regulations. Management believes that any such potential audits or investigations, individually and in the aggregate, will not have any material adverse effect upon the financial condition of the Company.\nThe Company is engaged primarily in the manufacture and sale of highly diversified lines of commercial, industrial, and military products into both domestic and international markets. The Company generally does not require collateral from its customers on the basis of ongoing reviews and evaluations of their credit and financial condition.\nNote 15. Retirement plans\nThe Company maintains three non-conributory qualified defined benefit pension plans covering substantially all domestic employees. Plans covering most employees provide pension benefits based generally on the employee's years of service and final five-year or career average compensation. Due to full funding, the Plans currently have no required contribution by the Company.\nThe net periodic pension cost for the years 1993, 1992 and 1991, including amounts related to discontinued operations, included the following components:\n1993 1992 1991 -------- -------- -------- Service cost $ 2,146 $ 2,235 $ 2,609 Interest cost 3,058 3,289 3,030 Actual return on plan assets (6,376) (4,280) (10,389) Net amortization and deferral (65) (2,419) 4,748 -------- -------- -------- Net periodic pension cost (credit) $ (1,237) $ (1,175) $ (2) ======== ======== ========\nThe assumptions used in determining the end of year benefit obligations included a discount rate of 7.25% and 7.75% in 1993 and 1992, respectively, an expected investment return of 10% and compensation increases of 5%. During 1993 and 1992, the Company had pension curtailments resulting from the larger than expected reductions in the number of employees who would otherwise be eligible to participate in a defined benefit pension plan. Accordingly, the net amortization and deferral component of the credit includes a curtailment gain of $1.3 million for 1993 and $1.0 million for 1992. The Plan assets consist principally of cash, common stocks, and bonds.\nNotes to Consolidated Financial Statements - continued\nThe Plans' funded status together with the amounts recognized in the Company's Balance Sheet at December 31 are as follows:\n1993 1992 -------- -------- Actuarial present value of benefit obligations: Vested $ 29,991 $ 28,770 ======== ======== Accumulated 30,885 29,726 ======== ======== Projected 44,333 40,925 Plan assets at fair value 49,625 47,610 -------- -------- Plan assets in excess of projected benefit obligation 5,292 6,685 Unrecognized net (gain) loss 1,661 (839) Unrecognized net asset at January 1 (6,421) (6,993) Unrecognized prior service cost 2,081 2,523 -------- -------- Prepaid pension cost $ 2,613 $ 1,376 ======== ========\nThe Salaried Employees' Retirement Plan provides that in the event of a termination of that Plan following a change in control of the Company, any assets of the Plan remaining after provision is made for all benefits thereunder will be employed to supplement such benefits.\nThe Company also maintains a Supplemental Retirement Income Plan (\"SERP\") for key employees. Eligibility is restricted to individuals designated by the Personnel and Compensation Committee of the Board who, in its sole discretion, have made outstanding long-term contributions to the Company. The SERP is designed to provide each designated participant with an increased level of retirement income commencing the month following his 65th birthday. Under the SERP, a supplemental amount is paid to each participant so that, together with any amounts payable under the Company's qualified retirement plans, any long-term disability insurance payments and any social security benefits, the participant receives a monthly benefit equal to 60% of his salary at the date of inclusion in the plan. Amounts payable under the SERP are subject to adjustment for inflation. The Company has accrued an actuarially determined liability of $2.8 million at December 31, 1993 ($2.3 million at December 31, 1992), in anticipation of the payment of such benefits in the future to seven former employees who were designated as eligible by the Personnel and Compensation Committee for participation in the SERP program. No one of these former employees is receiving benefits currently. The Company incurred a pension expense of $.3 million and $.2 million in 1993 and 1992, respectively, in additional funding for the SERP.\nNotes to Consolidated Financial Statements - continued\nNote 16. Postretirement medical insurance benefits\nThe Company maintains a postretirement medical benefits plan covering substantially all domestic employees hired prior to January 1, 1992. The plan is contributory, retiree contributions are based on the difference between total cost and the employer contribution and are adjusted annually. The Company's contribution towards retiree medical benefits for employees retiring after January 1, 1992, are capped at 1991 levels. FAS 106 was implemented on a delayed recognition basis, resulting in amortization of the transition obligation amount over 20 years. The Company currently funds the plan as claims are paid.\nNet periodic postretirement benefit cost for 1993 included the following components:\nService cost $ 125 Interest cost 412 Actual return on plan assets - Amortization of obligation at transition 278 ------- Net periodic postretirement benefit cost $ 815 =======\nFor measurement purposes, a 12% annual rate of increase in the per capital cost of covered medical benefits was assumed for 1993; the rate was assumed to decrease gradually to 6% for 1999 and remain at that level thereafter. Increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of January 1, 1993, by $246 thousand and the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost by $20 thousand.\nThe plan's funded status together with the amounts recognized in the Company's Balance Sheet at December 31, 1993, are as follows:\nAccumulated postretirement benefit obligation: Retirees $ 4,166 Fully eligible plan participants 368 Other active plan participants 1,953 ------- Total 6,487 Plan assets at fair value - ------- Accumulated postretirement benefit obligation in excess of plan assets (6,487) Unrecognized net (gain) loss 805 Unrecognized prior service cost - Unrecognized transition obligation 5,282 ------- Accrued postretirement benefit cost $ (400) =======\nNotes to Consolidated Financial Statements - continued\nThe Company's postretirement benefit plans are unfunded. As of January 1, 1993, the accumulated postretirement benefit obligation was $5.6 million and the value of the plan assets was $0.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation are 7.25% and 7.75% as of December 31, 1993 and 1992, respectively.\nNote 17. Foreign Operations and Geographic Segments, and Export Sales\nThe impact of the Company's foreign operations upon the consolidated financial statements are summarized as follows (in thousands):\nForeign 1993 Consolidated Eliminations Domestic Operations - ---- ------------ ------------ --------- ---------- Net sales $185,538 $ (4,113) $150,260 $ 39,391 ======== ======== ======== ======== Net income (loss) from continuing operations $ 4,752 $ 325 $ 6,938 $ (2,511) ======== ======== ======== ======== Identifiable assets $ 95,943 $ (72) $ 66,814 $ 29,201 Corporate assets 38,065 - 38,065 - -------- -------- -------- -------- Total assets $134,008 $ (72) $104,879 29,201 ======== ======== ======== Liabilities 21,635 -------- Equity in foreign subsidiaries $ 7,566 ========\nForeign 1992 Consolidated Eliminations Domestic Operations - ---- ------------ ------------ --------- ---------- Net sales $194,859 $ (3,693) $150,914 $ 47,638 ======== ======== ======== ======== Net income (loss) from continuing operations $ (8,725) $ 316 $ (4,064) $ (4,977) ======== ======== ======== ======== Identifiable assets $110,691 $ (683) $ 77,372 $ 34,002 Corporate assets 38,877 - 38,877 - -------- -------- -------- -------- Total assets $149,568 $ (683) $116,249 34,002 ======== ======== ======== Liabilities 26,725 -------- Equity in foreign subsidiaries $ 7,277 ========\nNotes to Consolidated Financial Statements - continued\nForeign 1991 Consolidated Eliminations Domestic Operations - ---- ------------ ------------ --------- ---------- Net sales $200,457 $ (2,968) $153,946 $ 49,479 ======== ======== ======== ======== Net income (loss) from continuing operations $(35,938) $ - $(33,082) $ (2,856) ======== ======== ======== ======== Identifiable assets $137,675 $ (7,901) $104,599 $ 40,977 Corporate assets 16,768 (3,495) 15,474 4,789 -------- -------- -------- -------- Total assets $154,443 $(11,396) $120,073 45,766 ======== ======== ======== Liabilities 32,097 -------- Equity in foreign subsidiaries $ 13,669 ========\nThe Company's principal foreign operations include a d.c. motor manufacturing facility in France, together with sales subsidiaries in England and Germany. The sales eliminations are transfers at prevailing wholesale selling prices, principally from the domestic electro-optical instruments segment to a sales subsidiary in England.\nIn addition to foreign operations, export sales amounted to $27.6 in 1993, $54.0 million in 1992, and $34.9 million in 1991.\nSales to the U.S. Government or for U.S. Government end-use amounted to $39.4 in 1993, $38.9 million in 1992, and $40.9 million in 1991.\nNote 18. Other Financial Statement Data\nThe following sections should be considered integral parts of the Notes to Consolidated Financial Statements:\nPage\nLines of Credit (see Liquidity and Capital Resources) 12 Segments of Business Information 2\nINDEX TO FINANCIAL STATEMENTS SCHEDULES\nPage in Schedule Form 10-K\nIX Short Term Borrowings at December 31, 1993, 1992 and 1991. 43\nX Supplementary Income Statement Information - Years Ended December 31, 1993, 1992 and 1991. 44\nReport of Independent Accountants on Financial Statement Schedules - Coopers & Lybrand 45\nSchedules and Statements other than those enumerated above have been omitted because they are not required or are not applicable, or because the required information is set forth in the financial statements and notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders Kollmorgen Corporation:\nOur report on the consolidated financial statements of Kollmorgen Corporation is included on page 19 of this Form 10-K. In connection with our audit of such financial statements, we have also audited the related financial statement schedules for 1993 and 1992 listed in the index on page 42 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand\nCOOPERS & LYBRAND\nBoston, Massachusetts January 31, 1994\nEXHIBIT INDEX\nPage in this Exhibit No. Description of Exhibit Form 10-K\n3(a) Restated Certificate of Incorporation, as N\/A amended, incorporated by reference to Exhibit 3(a) of the Form SE filed on April 2, 1990.\n3(b) By-Laws, as amended. 50\n4(a) Debenture Purchase Agreement dated as of N\/A July 30, 1982, with respect to 10-1\/2% Convertible Subordinated Debentures Due 1997 incorporated by reference to Exhibit 4 to the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 1982.\n4(b) Indenture dated as of May 1, 1984, with respect N\/A to 8-3\/4% Convertible Subordinated Debentures Due 2009 incorporated by reference to Exhibit 4 to Registration Statement on Form S-3 (2-90655)\n4(c) Rights Agreement dated as of December 20, 1988, N\/A as amended and restated as of March 27, 1990, between the Company and the First National Bank of Boston, as Rights Agent, incorporated by reference to Exhibit 4(d) of the Form SE filed on April 2, 1990.\n4(d) Stock purchase agreement dated March 27, 1990, N\/A with Annex II, Registration Rights, with respect to the issue of Series D Convertible Preferred Stock, par value $1.00, of the Company, incorporated by reference to Exhibit 4(e) of the Form SE filed on April 2, 1990.\n10(a) Letter of Credit Facility Agreement dated N\/A July 24, 1992, among Kollmorgen Corporation, The First National Bank of Boston, Certain Other Financial Institutions Listed on Schedule 1, and The First National Bank of Boston, as Agent, incorporated by reference to Ex-10 of the Form SE to Form 10-Q filed on August 11, 1992.\n10(b) Fourth Amendment to Exhibit 10(a), incorporated N\/A by reference to Ex-10 of the Form SE to Form 10-Q filed on November 10, 1993.\nPage in this Exhibit No. Description of Exhibit Form 10-K\n10(c) Kollmorgen Stock Option Plan, as amended, N\/A incorporated by reference to Exhibit A of the Company's Proxy Statement dated March 24, 1987, for the Annual Meeting of Shareholders held on April 22, 1987.\n10(d) Kollmorgen 1991 Long Term Incentive Plan, N\/A incorporated by reference to Exhibit A of the Company's Proxy Statement dated April 29, 1991, for the Annual Meeting of Shareholders held on May 23, 1991.\n10(e) Form of 1983 Incentive Stock Option Agreement N\/A for James A. Eder. Said agreement is incorporated by reference to Exhibit 10(e) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1987.\n10(f) Form of 1988 Non-Qualified Stock Option N\/A Agreement for James A. Eder. Said agreement is incorporated by reference to Exhibit 10(g) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1988.\n10(g) Form of 1990 Non-Qualified Stock Option N\/A Agreement for James A. Eder. Said agreement is incorporated by reference to Exhibit 10(h) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1991.\n10(h) Form of 1991, 1992, and 1993 Non-Qualified Stock N\/A Option Agreement under the Long-Term Incentive Plan and\/or Kollmorgen Stock Option Plan for Gideon Argov, Robert J. Cobuzzi, James A. Eder and Robert W. Woodbury, Jr. Each agreement is identical except for the number of shares and the date of grant. Said agreement is incorporated by reference to Exhibit 10(j) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1991.\n10(i) Kollmorgen 1992 Stock Ownership Plan for N\/A Non-Employee Directors incorporated by reference to Exhibit A of the Company's Proxy Statement dated April 6, 1992, for the Annual Meeting of Shareholders held on May 13, 1992.\n10(j) Form of 1992 Non-Qualified Stock Option N\/A Agreement between each non-employee director and the Company pursuant to the Kollmorgen 1992 Stock Ownership Plan for Non-Employee Directors.\nPage in this Exhibit No. Description of Exhibit Form 10-K\n10(k) Bonus Plan for Corporate Officers and other N\/A key corporate employees.\n10(l) Employment Agreement dated May 10, 1991, as N\/A amended, for James A. Eder. Said Agreement is incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1991.\n10(m) Letter employment agreement dated May 21, N\/A 1991, for Gideon Argov. Said Agreement is incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1991.\n10(n) Letter employment agreement dated July 1, N\/A 1991, for Robert J. Cobuzzi. Said Agreement is incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1991.\n10(o) Form of severance agreement for each of the N\/A following persons: Allan M. Doyle, Jr. and George P. Stephan. Said agreement is incorporated by reference to Exhibit 10(i) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1989.\n10(p) Form of Indemnification Agreement for each of the N\/A Company's executive officers, directors and director emeritus. Each agreement is identical to this exhibit except for the name and title of each individual. Said agreement is incorporated by reference to Exhibit 10(f) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1987.\n10(q) Description of Post-Retirement Arrangement for N\/A Non-Employee Directors. Said agreement is incorporated by reference to Exhibit 10(i) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1988.\n10(r) Participation Agreement between Allan M. Doyle, Jr. N\/A and the Corporation with respect to Mr. Doyle's service as a director of Millitech Corporation.\n10(s) Supplemental Retirement Income Plan for key N\/A executives. Said plan is incorporated by reference to Exhibit 10(n) to the Annual Report on Form 10-K of the Company for the year ended December 31, 1990.\nPage in this Exhibit No. Description of Exhibit Form 10-K\n11 Calculations of Earnings Per Share. 62\n16 Copy of the letter dated September 15, 1992, N\/A from KPMG Peat Marwick. Said letter is incorporated by reference to Exhibit 16 of Form 8-K dated September 11, 1992.\n21 Subsidiaries of the Company. 63\n23(a) Consent of Independent Accountants - 64 Coopers & Lybrand\n23(b) Independent Auditors' Consent - 65 KPMG Peat Marwick\n24 Powers of Attorney 66","section_15":""}
{"filename":"79259_1993.txt","cik":"79259","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nMortgage and Realty Trust (the \"Trust\") is a Maryland real estate investment trust engaged in the business of managing its portfolio of mortgage loans and real estate investments. The Trust was organized in 1970 as PNB Mortgage and Realty Investors. In 1979, Sutro Mortgage Investment Trust combined into the Trust. In 1984, the Trust changed its name to Mortgage and Realty Trust. The Trust is organized under a Declaration of Trust as amended through February 17, 1993 and conducts its business in such a fashion as to qualify as a real estate investment trust under Sections 856-860 of the Internal Revenue Code of 1986, as amended. The Trust is currently managed by seven Trustees, each of whom is elected annually by the Trust's shareholders at the annual meeting of shareholders. Although the annual meeting of shareholders is customarily held in February of each year, the Trust has determined for 1994 to delay the meeting so that it can be held in combination with the shareholder meeting to be called to consider any restructuring agreed upon with the holders of the Trust's Senior Secured Uncertificated Notes due 1995 (the \"Senior Notes\") and thereby spare the expense of having two shareholder meetings. The Trust has six executive officers, two of whom are also Trustees.\nPREVIOUS CHAPTER 11 PROCEEDING AND PLAN OF REORGANIZATION\nOn April 12, 1990, the Trust filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Central District of California. The decision of the Trustees of the Trust to file a voluntary petition for reorganization was reached following a series of events commencing on March 12, 1990, when Standard & Poor's Corporation downgraded the rating for the commercial paper of the Trust from A-2 to A-3. As a result of this downgrading, the Trust was unable to access the commercial paper markets, resulting in a series of defaults under the Trust's outstanding indebtedness.\nAfter unsuccessfully negotiating with a group of lenders to establish a replacement credit arrangement, the Trustees of the Trust decided on April 12, 1990, that the interests of shareholders and other parties in interest would be better served by filing for reorganization under Chapter 11.\nOn November 21, 1990, a Joint Plan of Reorganization (the \"1991 Plan\") proposed by the Trust, the official creditors' committee and the official equity security holders' committee was filed with the bankruptcy court pursuant to section 1121 of the Bankruptcy Code. The 1991 Plan was confirmed by the bankruptcy court by an order entered February 27, 1991. The 1991 Plan was filed as Exhibit 4.4 to the Trust's Annual Report on Form 10-K for the fiscal year ended September 30, 1991. An amendment to the 1991 Plan effected as part of the 1992 Restructuring (discussed below) was filed as Exhibit 4.4 to the Trust's Annual Report on Form 10-K for the fiscal year ended September 30, 1992.\nThe 1991 Plan provided that the holders of claims against the Trust were to receive payments in installments over a period ending on June 30, 1995 with the right of the Trust to defer certain principal amounts for up to 24 months, up to December 31, 1995. Interest was payable initially at Bank of America N.T. & S.A.'s reference rate plus one percent, increasing by 0.25% every six months, with interest on deferred amounts at the adjusted rate plus two percent. The 1991 Plan also included numerous financial, affirmative and negative covenants, including covenants relating to the ratio of the Trust's outstanding debt to its capital base, the ratio of earning assets to outstanding debt and the amount of non-earning assets, and covenants severely limiting the Trust's ability to make new investments or to incur new indebtedness.\nThe forecast upon which the 1991 Plan was based assumed that the real estate markets would begin to improve in fiscal 1992. However, notwithstanding this forecast, the markets continued to materially deteriorate in an unforeseen manner. Despite these conditions, the Trust was able to make all required interest payments and to exceed the required amortization payments, reducing the debt\nto $374,000,000 at June 30, 1991 as opposed to the requirement of $380,000,000 and to $329,000,000 at January 3, 1992 as opposed to the requirement of $340,000,000 at December 31, 1991. These results were achieved through liquidating Trust assets at substantial discounts from their recorded cost.\nThe continued deterioration of the real estate markets made it impossible for the Trust to meet the amortization payment at June 30, 1992, which was required to reduce the Trust's debt to $291,250,000, taking into account deferrals permitted under the 1991 Plan. The deterioration also precluded the Trust from being able to meet the financial covenants of the 1991 Plan. One of these covenants was previously amended, effective September 30, 1991, with the approval of the official creditors' committee for the period ending June 29, 1992, but the Trust felt that it would not be in compliance with such covenant after that date.\nTo adjust its operations to current market conditions, by 1992 the Trust had redirected its focus. The Trust had historically emphasized earnings growth, and the accompanying asset acquisitions. Because of changes in the economy and the financial and real estate markets which adversely affected the Trust's business and asset values, management moved to an emphasis on improving cash flow in order to meet its obligations under the 1991 Plan and then to provide an opportunity for growth and increased shareholder value in the future when the United States real estate markets would, eventually, stabilize and return to a more traditional environment. Meeting the interest and principal payments required under the 1991 Plan was one of the Trust's important objectives. Management focused efforts on generating sufficient liquidity through active and asset-specific management of its overall portfolio to meet those payments, while at the same time maximizing future shareholder value. However, in light of the impending June 30, 1992 interest and principal payments, which aggregated approximately $44.4 million under the 1991 Plan, and the continued stagnation in the real estate market, in late 1991 and early 1992 the Trust determined that it was necessary to defer a portion of the principal payments of the outstanding debt and limit certain future cash interest payments to allow sufficient time for liquidity to return to the United States real estate markets.\nAs part of the ongoing effort to strengthen the Trust's capital structure, of which the 1992 Restructuring (as defined below) was to be an important element, the Trust also considered raising cash through structured financings such as asset securitizations. However, the Trust was ultimately unable to generate funds through such transactions in an efficient manner and therefore did not pursue any such transactions.\nAt the end of the Trust's fiscal year ending September 30, 1991, it was evident to the Trust that conditions in the real estate markets were continuing to deteriorate. Commencing in the first quarter of fiscal 1992, the Trust held discussions with its official creditors' committee to discuss a rescheduling of the debt obligations under the 1991 Plan. Throughout the balance of the first quarter of fiscal 1992 and during the second and third quarters of fiscal 1992, the Trust negotiated with its official creditors' committee to develop a prudent rescheduling of such debt. The result of these negotiations was the 1992 Restructuring.\n1992 RESTRUCTURING\nPursuant to the Trust's negotiations with its official creditors' committee, on June 15, 1992 the Trust commenced a solicitation of acceptances to certain modifications (the \"1992 Modifications\") to the outstanding debt obligations of the Trust and to a prepackaged plan of reorganization (the \"Proposed 1992 Plan\") to effect the same 1992 Modifications. In order to effect the 1992 Modifications without implementing the Proposed 1992 Plan, the Trust was required to obtain acceptances from holders of 100% of the outstanding debt obligations. The proposed modifications to the outstanding debt were identical under the proposed out-of-court restructuring and the Proposed 1992 Plan. The Trust received 100% acceptance of the 1992 Modifications and, on July 15, 1992, the Trust successfully restructured its outstanding debt in accordance with the proposed 1992 Modifications (the \"1992 Restructuring\").\nPursuant to the 1992 Restructuring, the outstanding debt was restructured in the form of the Senior Notes. The 1992 Modifications provided, among other things, for (i) an increase in the amounts of required principal payments which could be deferred (while retaining the final payment date for deferred payments at December 31, 1995), (ii) an extension of the permitted repayment period of such deferred amounts from 24 months to 30 months from the date a deferral is utilized, (iii) the establishment of a limit on the maximum rate of interest to be paid in cash on a current basis at 9% through June 30, 1994, with any excess being accrued and paid at December 31, 1995, (iv) changes in certain required financial covenants to reflect the then-existing financial condition of the Trust and the then-existing real estate markets, (v) with the approval of the holders of 66 2\/3% of the Senior Notes, the release of collateral for certain financings by the Trust, provided such financings would result in the reduction in the amount of Senior Notes, and (vi) the payment of additional consideration to the holders of the Senior Notes equal to one percent of the principal amount of the Senior Notes, payable in four semi-annual installments commencing on the date the 1992 Restructuring became effective.\nPursuant to the 1992 Restructuring, the Trust entered into the Indenture (the \"Indenture\") governing the Senior Notes with Wilmington Trust Company, as trustee (the \"Indenture Trustee\"), entered into a second amendment to the Trust's outstanding collateral and security agreement dated as of February 21, 1991 with the Indenture Trustee and William J. Wade as collateral agents (as amended, the \"Collateral Agreement\") and amended the 1991 Plan.\nCURRENT DEBT SERVICE REQUIREMENTS AND DEFAULTS AND FORECAST SHORTFALL IN OPERATING CASH FLOW\nThe face amount of the Senior Notes at June 30, 1993 was $290,000,000. The Senior Notes provide that the holders of Senior Notes will receive semi-annual payments of principal on June 30 and December 31 of each year until June 30, 1995 when all undeferred principal is due. The Senior Note Indenture also provides for quarterly additional payments of principal in an amount equal to available cash (as defined in the Indenture) held by the Trust at the end of each quarter in excess of $10 million, less certain dividend overpayments, if any. The Trust has the right to defer certain principal payments for up to 30 months until December 31, 1995 at which time no more principal payments may be deferred and all deferred amounts are due. The Senior Notes provide for payments of interest quarterly on March 31, June 30, September 30 and December 31 of each year. Interest on the Senior Notes was payable initially in 1991 at Bank of America N.T. & S.A.'s reference rate plus one percent, increasing 0.25% every six months. The interest rate spread over such reference rate in effect on September 30, 1993 was 2.25%, with the next scheduled date for an increase in the rate being January 1, 1994. Interest on deferred principal is payable at such adjusted rate plus two percent. The Senior Note Indenture also contains numerous financial, affirmative and negative covenants as described above.\nThe financial forecast upon which the 1992 Restructuring was based assumed that the real estate markets in which the Trust holds assets would stop or slow their decline by 1993 with some improvement in 1994. Instead, since the effective date of the 1992 Restructuring, these markets have continued to deteriorate. The Trust's business, including its ongoing efforts to refinance and sell property, did not generate cash flow sufficient to service the Senior Notes during the fiscal year ended September 30, 1993 and the Trust does not anticipate that the business will generate cash flow sufficient to service the Senior Notes in fiscal 1994. In any event, the Senior Notes will need to be refinanced on or about June 30, 1995.\nBecause its operating income has declined due to the continued deterioration of the real estate markets, the Trust was not able to meet its scheduled June 30, 1993 principal payment on the Senior Notes of $20,000,000, which was required to reduce the principal amount of the Senior Notes to $270,000,000, taking into account deferrals permitted under the Senior Note Indenture. The Trust's failure to make the June 30 principal payment constituted an event of default under the Senior Note Indenture. The deterioration of the real estate markets also precluded the Trust from being able to meet certain ratios set forth in the financial covenants of the Senior Note Indenture effective March 31, June 30, and September 30, 1993, constituting additional events of default. Certain of these\ncovenants were previously amended in or prior to the 1992 Restructuring. On May 26, 1993, the Trust received from the holders of more than 66 2\/3% in principal amount of Senior Notes a waiver relating to the March 31 financial covenant default.\nThe Trust timely paid the June 30 and September 30, 1993 interest payments of $6.8 million and $6.6 million, respectively. The Trust also paid the final payment of the restructuring fee of $812,500 on September 30, 1993. An additional $33.8 million in principal (taking into account permitted deferrals) and $6.6 million in interest was due on December 31, 1993. Because the Trust did not make otherwise required payments on June 30 and December 31, 1993, at the end of the first quarter of 1994 (ending December 31, 1993) the Trust held approximately $17.8 million in available cash (as defined in the Indenture). Assuming no other payment defaults, the Trust would have been obligated to pay the excess of such available cash over $10 million to Senior Note holders as an additional principal payment. However, pursuant to the agreement in principle with certain of the principal holders of Senior Notes reached in August 1993 (discussed below), the Trust agreed to pay on September 30, 1993 the interest payment due September 30, 1993 and certain restructuring fees due December 31, 1993, but not to pay the interest or principal due December 31, 1993. Although it presently appears unlikely that the terms of the August 1993 agreement in principle will be implemented, consistent with the ongoing negotiations with the principal holders of the Senior Notes, the Trust did not pay the interest or principal due at December 31, 1993, constituting additional events of default under the Senior Note Indenture. The Trust forecasts that it will have continuing difficulty meeting its obligations under the Senior Note Indenture without a substantial restructuring of such debt.\nNotwithstanding the uncured events of default, neither the Indenture Trustee nor any holders of the Senior Notes have accelerated the Senior Notes. On July 2, 1993 holders of approximately 81% of the Senior Notes agreed, subject to certain conditions, not to accelerate the Senior Notes or take any other remedial or enforcement action during a defined standstill period (the \"Standstill Period\") initially expiring July 31, 1993. The Standstill Period was extended by holders of more than 66 2\/3% of the Senior Notes on August 3, August 20, September 23, October 5 and November 23, 1993. However, the Standstill Period expired on December 3, 1993. At the present time, it appears unlikely that any further extensions of the Standstill Period will be granted. Subsequent to the expiration of the Standstill Period, on or about December 8, 1993, the Indenture Trustee notified the Trust's bank of the Indenture Trustee's security interest in the Trust's deposit accounts and instructed the bank to freeze the Trust's cash until otherwise instructed by the Indenture Trustee. Since that date, the Trust has operated on an ad hoc basis with the Indenture Trustee in administering its cash, with all cash use subject to review and approval by the Indenture Trustee. There can be no assurance that the Indenture Trustee will not take further remedial or enforcement action with respect to the Trust's bank accounts or other properties, including acceleration of the Senior Notes and foreclosure. Such action, or the failure of the Indenture Trustee to consent to necessary use of cash or releases of collateral in the conduct of the Trust's business would have a material adverse effect on the Trust's operations and could cause the Trust to seek relief under Chapter 11 of the United States Bankruptcy Code.\nLack of liquidity for real estate has continued since the end of the Trust's fiscal year. The Trust's operating cash flow has declined as it has been forced to sell assets currently yielding higher returns. Approximately half of the Trust's portfolio is in California where the general economy and the real estate markets continue to be in recession. See \"Investments\" below.\nNEGOTIATIONS WITH CREDITORS\nDuring the second fiscal quarter of 1993, it became apparent to the Trust and its financial advisors that the Trust's projected cash flow would not be adequate to meet its obligations in the future. In February 1993 the Trust contacted its official creditors' committee to apprise the official creditors' committee and its advisors of the Trust's forecast difficulties. In or about February 1993,\nthe Trust and its advisors met with its official creditor's committee and its advisors to discuss the Trust's condition and prospects. Thereafter, in March 1993, the Trust and the official creditors' committee commenced negotiations regarding a restructuring of the Senior Notes.\nBeginning with the initial formal meeting in March 1993, throughout the period from March through August 1993, the Trust and its advisors met with the official creditors' committee and its advisors to negotiate a restructuring. In August 1993, the Trust and the official creditors' committee met and agreed to the broad outlines of the economic terms of a restructuring, subject to the approval of the Trustees of the Trust. Under the agreement in principle, the Senior Notes would be exchanged for approximately $195 million of new senior secured notes and common shares representing 85% of the equity of the Trust. Thereafter, on August 18, 1993, the Trustees of the Trust approved the economic terms of the restructuring of the Senior Notes subject to, among other things, receipt of indications of support for the restructuring from individual members of the official creditors' committee and other holders of the Senior Notes reasonably sufficient to effect the restructuring pursuant to a prepackaged plan of reorganization (typically holders of at least two-thirds in principal amount and one half in number of claims). On August 19, 1993, the Trust announced that it had reached a non-binding agreement in principle with the official creditors' committee (representing approximately 43% of the Senior Notes) to restructure the indebtedness represented by the Senior Notes.\nWhile the Trust was negotiating with the official creditors' committee, the Trust was also discussing possible third-party investment in the restructuring. Although all potential third-party investors were offered an opportunity to propose restructuring alternatives, only two such investors made proposals to the Trust. The official creditors' committee advised the Trust that the offers were not acceptable and they did not believe that it was in their or the Trust's best interests in the restructuring to pursue such third-party participation. As a result, the Trust suspended the solicitation of interested parties, and the Trust and the official creditors' committee agreed on the internal restructuring contained in the August 1993 agreement in principle. Commencing again in November 1993, as the prospects for implementing the August 1993 agreement in principle waned, the Trust resumed responding to inquiries from third parties about participation in a restructuring of the Trust.\nCommencing at about the time of the agreement in principle between the Trust and the official creditors' committee, certain of the Senior Notes began to trade. Interest in the trading of Senior Notes increased after announcement of the terms of the restructuring and, by December 1993, in excess of 50% of the principal amount of the Senior Notes had traded.\nIncluded in the Senior Notes initially traded were all of the Senior Notes held by two of the five members of the official creditors' committee who had negotiated the August 1993 agreement in principle. In or about October 1993 four of the holders who had acquired Senior Notes and who then held a significant amount of Senior Notes signed confidentiality letters with the Trust and requested to be named to the official creditors' committee and receive financial and operating information relating to the Trust. The three then-remaining members of the official creditors' committee did not grant committee membership to the holders but acquiesced in the Trust's delivery of confidential information to the investing holders. Subsequently, another member of the official creditors' committee sold all of its Senior Notes, part to a member of the official creditors' committee and the balance to other persons. That sale left the official creditors' committee with two members, one of whom held, as a result of secondary claims purchases, at December 31, 1993 in excess of 33 1\/3% of the Senior Notes.\nIn October 1993, the investing holders commenced their due diligence review of the Trust, which included financial and other information provided by the Trust. At the request of the investing holders, the Trust agreed to pay certain fees and expenses of a financial advisor to the investing holders. In or about November 1993, the investing holders retained Smith Barney Shearson Inc. (\"Smith Barney\") as their financial advisor. Smith Barney immediately commenced its analysis of the financial condition and operations of the Trust and the proposed agreement in principle.\nBecause of the substantial trading in the Senior Notes and the inability of the Trust to obtain satisfactory indications of support for the August 1993 agreement in principle from any holders of\nSenior Notes, any action to implement the Trust's original agreed restructuring has been postponed. The Trust's management is continuing discussions with the principal holders of the Senior Notes and their representatives to explore various alternatives for restructuring the Senior Notes. If agreement on such a restructing cannot be reached, or if the holders of Secured Notes or the Trustee take action or fail to cooperate with the Trust in such a manner that the business or operations of the Trust are jeopardized, the Trust will consider other alternatives, including the filing of a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code.\nINVESTMENTS\nAlthough the Trust has continued to fund previously existing investment commitments and to fund limited tenant improvements and similar investments necessary to retain or obtain tenants, the Trust has not made any new investments since its Chapter 11 filing, but it has continued to manage its investment portfolio. The Trust's future investment strategy cannot be formulated until the Trust's debt restructuring terms are finalized. The Trust's investments include short and intermediate-term construction and standing loans, long-term participating loans and investments in real estate.\nLoans may be secured by first or junior mortgages as well as mortgages secured by leaseholds. Loans made by the Trust are secured by mortgages on income-producing properties, including office buildings, shopping centers, industrial projects, apartments and condominium projects. When the Trust made investments, it abided by various restrictions consisting principally of loan-to-value ratios, investment ranges and percentage of total assets invested in loans to a single borrower.\nThe Trust's investments are primarily located in major metropolitan areas throughout the United States. As of September 30, 1993, the Trust held investments in mortgage loans, investments in real estate and other interests in real properties located in 21 states.\nTotal loans and investment commitments outstanding at September 30, 1993 were $349,637,000 of which $1,632,000 remained to be disbursed.\nThe following pages contain summaries of the Trust's commitments and investments at September 30, 1993 and certain information pertaining to non-earning loans, delinquent earning loans, non-earning in-substance foreclosures and non-earning foreclosed properties.\nMORTGAGE AND REALTY TRUST SUMMARY OF INVESTMENTS AT SEPTEMBER 30, 1993\nMORTGAGE AND REALTY TRUST NON-EARNING LOANS, NON-EARNING IN-SUBSTANCE FORECLOSURES AND NON-EARNING FORECLOSED PROPERTY HELD FOR SALE (BY GEOGRAPHIC DISTRIBUTION AND PROPERTY TYPE) SEPTEMBER 30, 1993 (000 OMITTED)\nMORTGAGE AND REALTY TRUST GEOGRAPHIC DISTRIBUTION OF INVESTMENTS BY COMMITTED AMOUNTS SEPTEMBER 30, 1993\nNON-EARNING INVESTMENTS, DELINQUENT EARNING LOANS AND FORECLOSED PROPERTIES\nEARNING MORTGAGE LOANS MORE THAN 60 DAYS DELINQUENT -- The Trust generally considers loans as delinquent if payment of interest and\/or principal, as required by the term of the note, is more than 60 days past due. At September 30, 1993, there were no loans which were so delinquent as to principal and\/or interest.\nNON-EARNING MORTGAGE LOANS -- At September 30, 1993, there was one loan of $5,244,000 classified as non-earning. A description is as follows:\n(1) The Trust has a first mortgage loan on 12 industrial buildings containing 130,969 square feet located in Chino, California. This loan was placed on non-earning status in June 1992. The occupancy level is currently 91%.\nNON-EARNING IN-SUBSTANCE FORECLOSURES -- A loan is considered an in-substance foreclosure if (1) the debtor has little or no equity considering the fair value of the collateral, (2) proceeds for the repayment can be expected to come only from operation or sale of the collateral, and (3) the debtor has either formally or effectively abandoned control of the collateral. At September 30, 1993, there were five loans classified as non-earning in-substance foreclosed which totalled $17,559,000. Descriptions of the five investments are as follows:\n(1) The Trust has a second mortgage loan on a warehouse building containing 115,196 square feet located in Boston, Massachusetts. The loan was placed on non-earning status and reclassified as non-earning in-substance foreclosed in March 1991. The property is currently 44% leased and occupied.\n(2) The Trust has a first mortgage loan on an industrial building containing 139,500 square feet located in Chester County, Pennsylvania. The loan was placed on non-earning status and was reclassified as non-earning in-substance foreclosed in September 1991. The project is currently 100% leased and occupied.\n(3) The Trust has a first mortgage loan on a warehouse\/distribution building containing 104,531 square feet located in Chino, California. The loan was placed on non-earning status and was reclassified as non-earning in-substance foreclosed in June 1993. The project is currently 100% leased and occupied.\n(4) The Trust has a first mortgage loan on six 2 and 3 story office buildings containing 108,693 square feet located in Blue Bell, Pennsylvania. The loan was placed on non-earning status and was reclassified as non-earning in-substance foreclosed in June 1993. The project is currently 77% leased and occupied.\n(5) The Trust has a first mortgage loan on a shopping center containing 97,394 square feet located in Napa, California. The project was placed on non-earning status in June 1993 and reclassified as non-earning in-substance foreclosed in September 1993. The project is currently 72% leased and occupied. This loan was paid off in December 1993.\nNON-EARNING PROPERTIES ACQUIRED THROUGH FORECLOSURE AND HELD FOR SALE -- At September 30, 1993, there were eleven non-earning properties acquired through foreclosure and held for sale which totalled $36,134,000. Descriptions of the eleven investments are as follows:\n(1) The Trust had a first mortgage loan on a 26,976 square foot multi-level retail center located in Denver, Colorado. The Trust acquired title to this property in February 1986. The property was sold for $1.4 million in November 1993.\n(2) The Trust had a first mortgage loan on an office\/warehouse building containing 119,000 square feet located in Hopkinton, Massachusetts. The Trust acquired title to this property in January 1991. The project is currently unleased.\n(3) The Trust had a first mortgage loan on a retail shopping center containing 111,339 square feet located in Fairhaven, Massachusetts. The Trust acquired title to this property in April 1991. The project is currently 30% leased and occupied.\n(4) The Trust had a first mortgage loan on a 3-story office building containing 37,800 square feet located in Piscataway, New Jersey. The Trust acquired title to this property in August 1991. The project is currently 78% leased and occupied.\n(5) The Trust had first and second mortgage loans on two office\/industrial buildings containing 91,710 square feet and a 33,600 square foot warehouse building located in Salem, New Hampshire. The Trust acquired title to this property in August 1992. The project is currently 25% leased and occupied.\n(6) The Trust had a first mortgage loan on a manufacturing\/warehouse building containing 251,090 square feet located in Moreno Valley, California. The Trust acquired title to this property in November 1992. The Trust is in the process of finalizing a lease to one tenant who is anticipated to be taking occupancy in early 1994.\n(7) The Trust had a first mortgage loan on a 4-story office building containing 99,666 square feet located in Cherry Hill, New Jersey. The Trust acquired title to this property in November 1992. The project is currently 48% leased and occupied.\n(8) The Trust had a first mortgage loan on an industrial building containing 120,000 square feet located in Willow Grove, Pennsylvania. The Trust acquired title to this property in June 1993. The project is currently unleased.\n(9) The Trust had a first mortgage loan on an industrial building containing 124,928 square feet located in Chino, California. The Trust acquired title to this property in June 1993. The project is currently unleased. The property was sold for $2.9 million in December 1993.\n(10) The Trust had a first mortgage loan on a two-story office building containing 30,000 square feet located in Sudbury, Massachusetts. The Trust acquired title to this property in June 1993. The project is currently 26% leased and occupied.\n(11) The Trust had a first mortgage loan on a retail shopping center containing 75,593 square feet located in Sacramento, California. The Trust acquired title to this property in September 1993. The project is currently 83% leased and occupied.\nADDITIONAL NON-EARNING LOANS AS OF DECEMBER 1, 1993 -- At December 1, 1993, there was one additional loan of $4,300,000 classified as non-earning.\nALLOWANCE FOR LOSSES\nAn allowance for losses is maintained based upon the Trustees' evaluation of the Trust's investments. A review of all investments is made quarterly to determine the adequacy of the allowance for losses. During the Trust's fiscal year ended September 30, 1993, there were additions of $37,000,000 to the allowance for losses and there were charges of $44,545,000 against the allowance. The amount of the allowance for losses at September 30, 1993 was $11,808,000 (3.4% of the Trust's invested assets). For a description of the Trust's method of determining the allowance for losses, see Notes 1 and 3 of Notes to the Financial Statements.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe officers of the Trust serve a one-year term of office and are elected to their positions each year by the Trustees at the annual organization meeting of Trustees which immediately follows the annual meeting of shareholders. All of the foregoing were last elected as officers at such meeting on February 10, 1993, with Mr. Eckard being promoted from Vice President to Senior Vice President on August 17, 1993. Messrs. Schlesinger, Strong and Hennessey have served as officers of the Trust for more than the past five years. Messrs. Dalton and Eckard were first elected as officers of the Trust on September 20, 1989 in connection with the Trust becoming self-administered. Mr. Burnes was first elected as an officer of the Trust on February 14, 1990. From 1982 to 1989, Mr. Dalton was the President of GMAC Realty Advisors. From 1984 to 1989, Mr. Eckard was a Vice President of GMAC Realty Advisors. GMAC Realty Advisors advised the Trust prior to its becoming a self-administered REIT in 1989. From 1981 to August 1989 Mr. Burnes was a Senior Vice President of Heller Financial Incorporated. From August 1989 to December 1989 Mr. Burnes was a Vice President at Sun State Savings in Arizona.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Trust does not own any real property for use in connection with its day-to-day operations. Office space for the Trust's principal office at 8380 Old York Road, Suite 300, Elkins Park, Pennsylvania is leased for a three-year term ending August 31, 1995. The Trust's only other office, located at 3500 West Olive Avenue, Suite 600, Burbank, California, is leased for a five-year term ending October 31, 1995. The total rental expense for the fiscal year ended September 30, 1993 for both\nproperties was $341,000. The Trust has become, and may from time to time become, the owner or lessor of real estate in connection with its investment and lender activities. See Item 1, \"Business -- Investments.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe consolidated class and derivative actions pending in the United States District Court for the Eastern District of Pennsylvania filed in March 1990 against certain of the Trust's present and former Trustees and officers and the Class 5 claims against the Trust remaining in the Chapter 11 proceeding in the United States Bankruptcy Court for the Central District of California were settled effective September 17, 1993. The class actions and claims alleged violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and negligent misrepresentation under the common law by reason of misleading statements in the Trust's reports filed with the SEC and other information disseminated to the public. The derivative action alleged mismanagement on the part of the Trustees which resulted in the bankruptcy.\nUnder the terms of the settlement: (1) the Trust contributed 150,000 Common Shares to the settlement of the class claims; (2) the director and officer liability insurance carrier contributed $860,000 on behalf of the individual defendants in the class actions; and (3) the insurance carrier paid on behalf of the individual defendants in the derivative action $65,000 to counsel for the derivative plaintiffs. The settlement was approved by both courts after notice to the class members and the shareholders of the Trust.\nAs described above, the Trust made no cash payments in connection with the settlement. While the Trust and the individual defendants continue to believe that their actions were entirely proper and violated no laws, the Trustees decided to settle the claims in order to avoid additional legal expense and the diversion of management's time and energy at a time when the operations of the Trust demanded their undivided attention.\nA discussion of events surrounding the Trust's bankruptcy filing and an explanation of the material terms of the Trust's reorganization under the 1991 Plan are set forth in the section entitled \"Previous Chapter 11 Proceeding and the 1991 Plan\" under Item 1 above. Notwithstanding the confirmation of the 1991 Plan, the bankruptcy court continues to have jurisdiction to, among other things, resolve disputes that may arise under the 1991 Plan.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS.\n(a) MARKET PRICE AND DIVIDENDS\nThe Trust's Common Shares are listed for trading on the New York Stock Exchange and the Pacific Stock Exchange under the symbol MRT. The following table shows the high and low sales prices for each fiscal quarter during the past two years and dividends declared attributable to such quarters:\nThe Trust incurred net operating losses for tax purposes in fiscal 1991, 1992 and 1993, all of which will be available as a loss carryforward to future years' taxable income. (See Note 1 of Notes to the Financial Statements -- \"Income Taxes\" regarding limitation of net operating losses.)\n(b) HOLDERS OF COMMON SHARES\nThere were approximately 5,744 record holders of the Trust's Common Shares at December 31, 1993.\n(c) The Trust did not declare or pay any dividends during the fiscal year ended September 30, 1993 or the fiscal year ended September 30, 1992. In addition, the Indenture governing the Senior Notes prohibits the Trust from paying any dividends to shareholders other than dividends required for the Trust to maintain its REIT status and inadvertent overpayments of such dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nMORTGAGE AND REALTY TRUST SELECTED FINANCIAL DATA YEARS ENDED SEPTEMBER 30\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLIQUIDITY AND CAPITAL RESOURCES -- A Plan of Reorganization under Chapter 11 of the Bankruptcy Code was confirmed at a hearing held in the Bankruptcy Court in Los Angeles, California, on February 21, 1991, and an order was entered February 27, 1991, confirming the Plan. As a result of the liquidity problems in the commercial real estate markets, the Trust was not able to meet the required amortization at June 30, 1992 and the debt was restructured in July 1992 with the unanimous consent of the creditors. The debt is now governed by an indenture dated as of July 15, 1992. At December 31, 1992, debt outstanding was reduced to $290 million, the maximum debt level permitted under the Plan on that date.\nDue to continued lack of liquidity in the real estate marketplace, the Trust did not have sufficient funds to meet its $20 million required principal payment due June 30, 1993. The Trust has, however,\npaid all of the interest and fees due through September 30, 1993 on its outstanding debt. See Item 1, \"Business\" for additional information regarding certain other required payments not made subsequent to June 30, 1993 and other events of default.\nUnder the financial covenants of the Indenture governing the Senior Notes, the Trust was required to maintain a ratio of outstanding securities to its capital base (as defined in the Indenture) of 515% at March 31, 1993. In addition, under the Indenture the Trust was required to maintain a ratio of outstanding securities to its capital base of 438% and a ratio of earning assets to outstanding securities of 113% at June 30, 1993 and September 30, 1993. The Trust failed to meet each of these ratios, constituting events of default under the Indenture. However, on May 26, 1993, the Trust received from the holders of more than 66-2\/3% in principal amount of Senior Notes a waiver relating to the March 31 default.\nManagement is continuing discussions with the representatives of the creditors to explore various alternatives for restructuring the outstanding debt obligations. The Trust's present intention is to reach a consensual restructuring agreement. If such an agreement cannot be reached with the Trust's debt holders, the Trust will have to consider other alternatives, including the filing of a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code. The holders of more than 66-2\/3% of the Trust's debt securities had agreed with the Trust to temporarily forebear further creditor action on the defaults for a period that expired on December 3, 1993. At the present time, it appears unlikely that a further extension of the standstill will be granted. The Trust intends, therefore, to continue to operate its business and seek Senior Note holder consent on an ad hoc basis as such consent is required. Although the Trust believes that such consents, if requested, would be in the best interest of Mortgage and Realty Trust, its shareholders and the Senior Note holders, there can be no assurance that the Trust will obtain sufficient consents as they are required. If it becomes impossible for the Trust to continue operations under such circumstances, it may be necessary for Mortgage and Realty Trust to explore other alternatives, including seeking relief under Chapter 11.\nAt September 30, 1993, the Trust had cash and cash equivalents of $11.5 million. Included in cash and cash equivalents are $1.3 million of restricted cash which represents the funding of the employee retention plan and $1.5 million related to borrowers' deposits. The Trust's unfunded loan commitments totalled $1.6 million at September 30, 1993. Under the Plan, the Trust has been permitted to fund its existing contractual obligations, but may not make new investments. See Item 1, \"Business\" for additional information regarding the enforcement of the Indenture Trustee's security interest in the deposit accounts of the Trust and the Trust's obligation to pay the excess of available cash (as defined in the Indenture) over $10 million to Senior Note holders.\nRESULTS OF OPERATIONS -- The Trust reported a net loss for fiscal 1993 of $54.0 million or $4.87 per share compared to a net loss of $37.5 million or $3.38 per share for fiscal 1992 and a net loss of $35.7 million or $3.22 per share for fiscal 1991. The 1993 loss includes a provision for losses of $37 million or $3.34 per share and net expense for reorganization and debt restructuring items of $5.8 million or $.53 per share compared to a provision for losses of $32 million or $2.89 per share and net expense for reorganization and debt restructuring items of $934,000 or $.08 per share for the 1992 loss and a provision for losses of $33 million or $2.98 per share and net expense for reorganization and debt restructuring items of $4.4 million or $.40 per share for the 1991 loss.\nInterest and fee income on mortgage loans was $19.0 million for fiscal 1993 compared to $26.2 million in fiscal 1992. The decrease results primarily from a reduction in average earning mortgage loans which decreased from $286.9 million in 1992 to $197.6 in 1993. The decrease in average earning mortgage loans was due to (a) repayment of earning mortgage loans (net of advances) of $24.0 million and (b) transfer of $110.2 million of mortgage loans to in-substance foreclosure, foreclosed properties and investment in partnerships. Interest income decreased from $41.9 million in fiscal 1991 to $26.2 million in fiscal 1992. The decrease resulted primarily from repayment of earning mortgage loans and transfer of mortgage loans to in-substance foreclosure and foreclosed properties.\nRental income was $19.0 million for fiscal 1993 compared to $15.0 million in fiscal 1992 and $13.5 million in fiscal 1991. Operating expenses and depreciation and amortization on rental properties increased to $15.7 million for fiscal 1993 compared to $12.3 million for fiscal 1992 and $11.4 million for fiscal 1991. The increases in income and expenses on rental properties results from continued growth in real estate equities and properties acquired through foreclosure and held for sale.\nFor fiscal 1993, 1992 and 1991, additional interest and fee income from participating mortgage loans was $30,000, $26,000 and $29,000, respectively, which was generated from participating in gross income produced by the properties securing these loans.\nInterest expense decreased from $37.3 million in 1991 and $29 million in 1992 to $28.5 million in 1993 as a result of a decrease in average borrowings which went from $391.1 million in 1991 and $336.4 million in 1992 to $293.2 million in 1993. Offsetting the decrease, the average interest rate increased from 9.51% in fiscal 1991 and 8.34% in fiscal 1992 to 9.23% in fiscal 1993. At September 30, 1993, the blended interest rate on the Senior Notes was 9.87%, composed of interest at 9.25% on $200 million of Senior Notes (including default interest at 1%) and 11.25% on $90 million of deferred amounts of Senior Notes (including default interest at 1%). The entire unamortized cost of restructuring of the Senior Notes was charged off during fiscal 1993 as a result of the monetary default. The Trust expensed $3.4 million in fiscal 1993, of which $2.4 million related to the acceleration of costs due to the June 1993 monetary default. Prior to the default, these costs were being amortized using the interest method over the term of the debt.\nOther operating expenses were $5.3 million for both fiscal 1993 and 1992. Other operating expenses decreased to $5.3 million for the fiscal year ended September 30, 1992 from $6.2 million at September 30, 1991 due to decreases in professional fees and expenses and administrative expenses.\nReorganization expenses related to the Chapter 11 filing and debt restructuring expenses were $5.8 million for the fiscal year ended September 30, 1993, which reflects professional fees incurred by the Creditors' Committee, the Shareholders' Committee and the Trust, as well as restructuring fees related to the 1992 restructuring. Reorganization expenses were $934,000 for the fiscal year ended September 30, 1992, which reflects professional fees and restructuring fees related to the 1992 restructuring. Reorganization expenses were $4.4 million for the fiscal year ended September 30, 1991, which reflects $5.8 million of professional fees incurred, offset by interest income of $1.4 million on accumulated cash.\nA $37 million provision for losses was established in the current fiscal year compared to a provision of $32 million in 1992. A $33 million provision for losses was established in fiscal 1991. Continued deterioration in many real estate markets during the past years, the continuing liquidity crisis in the real estate industry and the Trust's requirement to generate cash and liquidate investments have contributed to the establishment of the large provision for losses based on the Trust's regular analysis of the portfolio. The Trustees believe the allowance for losses to be adequate at September 30, 1993. The Trustees review the investment portfolio quarterly using current estimates and assumptions to determine the adequacy of the allowance for losses. The estimates and assumptions used in the valuation process are subject to changes which may be material.\nNon-earning loans (including non-earning in-substance foreclosures) and non-earning properties acquired through foreclosure and held for sale were $58.8 million at September 30, 1993 compared to $76.3 million at September 30, 1992 and $77.4 million at September 30, 1991.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary data are as set forth in the \"Index to Financial Statements\" on page 25.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. TRUSTEES AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following biographical information is furnished as to each of the current Trustees of the Trust.\nFor information required under this item with respect to executive officers of the Trust, see \"Executive Officers of the Registrant\" under Item 1 above.\nITEM 11.","section_11":"ITEM 11. TRUSTEE AND EXECUTIVE COMPENSATION.\nCOMPENSATION OF NON-OFFICER TRUSTEES\nDuring the fiscal year ended September 30, 1993, the Trustees, other than Messrs. Strong and Schlesinger, received as compensation for their services as Trustees an annual retainer of $10,000 plus $800 for each Trustee meeting attended and $600 for each committee meeting attended (or $400 for any Trustee or committee meeting convened by telephone conference), provided that no additional compensation was paid for attendance at any committee meeting held on the same day as any Trustee meeting. An additional $100 fee was payable per meeting to the chairman of any committee.\nOn September 20, 1989, the Trustees adopted the Pension Plan for Trustees, effective October 1, 1989. Trustees become eligible for plan benefits upon completion of five years of service as Trustee, including years served prior to the plan's effective date. Under the plan, each eligible Trustee will be entitled to a normal retirement benefit equal to the annual retainer for Trustees at the rate in effect on the Trustee's normal retirement date or, if earlier, the Trustee's last day of board membership. For purposes of this plan, normal retirement date is the first day of the month following the Trustee's 75th birthday. Plan benefits will generally begin on the normal retirement date, but eligible former Trustees may elect to have reduced payments commence up to five years earlier. The reduction will be 10 percent for each year by which commencement precedes the normal retirement date. Plan benefits will be paid for a period equal to the number of years served as Trustee after January 1, 1980, except that payments will cease upon the death of the Trustee. No other death benefits shall become payable on behalf of any Trustee under the plan.\nThe following table sets forth, for the fiscal years ended September 30, 1993, 1992 and 1991, the compensation paid by the Trust to its chief executive officer and its four next most highly compensated executive officers.\nSUMMARY COMPENSATION TABLE\nThe following table sets forth aggregate option exercises during the fiscal year ended September 30, 1993 and option values for the chief executive officer and the four next most highly compensated executive officers as of September 30, 1993.\nAGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED SEPTEMBER 30, 1993 AND FY-END OPTION VALUES\nEMPLOYEES' RETIREMENT PLAN\nOn September 20, 1989, the Trustees adopted an Employees' Retirement Plan effective September 30, 1989. On December 16, 1992, the Trustees amended and restated the Employees' Retirement Plan effective January 1, 1992 (as amended, the \"Retirement Plan\"). The Retirement Plan continues the benefits provided to employees of the Trust who were formerly employees of GMAC Realty Advisors, Inc. All other employees are eligible to participate in the Retirement Plan provided that they are at least 21 years of age and have been employed for twelve consecutive months, during which period the employee has completed at least 1000 hours of service. Under the Retirement Plan, each eligible employee after completing five years of vesting service becomes 100% vested and entitled to a retirement pension. Benefits are paid as an annual retirement income for life equal to the greater of (a) the sum of (i) 1.3% of the highest five-year average annual base salary, multiplied by the number of years of credited service up to and including 35 thereof and (ii) 0.4% of the highest five-year average annual base salary in excess of Social Security covered compensation (as adjusted every five years), multiplied by the number of years of credited service up to and including thereof or (b) the sum of (i) 1.3% of the highest five-year average annual base salary, multiplied by the number of credited service up to and including 15 thereof; (ii) 1.5% of the highest five-year average annual base salary, multiplied by the number of years of credited service from 16 to 25 years inclusive; (iii) 0.5% of the highest five-year average annual base salary, multiplied by the number of years of credited service from 26 to 35 years inclusive; and (iv) 0.4% of the highest five-year average annual base salary in excess of Social Security covered compensation (as adjusted every five years), multiplied by the number of years of credited service up to and including 25 thereof.\nUnreduced retirement benefits may begin to be paid at normal retirement (age 65 and five years of participation in the Retirement Plan), late retirement, or five years prior to Social Security retirement age with 20 years of service.\nThe table below shows the estimated annual benefits payable upon retirement under the Trust's Retirement Plan. Retirement benefits shown are based upon retirement at age 65 and the payment of a straight life annuity to the employee. The annual benefit under the Retirement Plan shall not exceed the lesser of $112,221 or 100% of the participant's average compensation for three consecutive Fiscal Years (as defined in the Retirement Plan) in which such eligible employee is an active participant in the Retirement Plan.\nPENSION PLAN TABLE ESTIMATED ANNUAL RETIREMENT BENEFIT\nFor the fiscal year ended September 30, 1993, the base salary for purposes of the Retirement Plan for the executive officers named in the Summary Compensation Table is set forth in the salary column of the Summary Compensation Table. Officers named in the Summary Compensation Table have been credited with years of service under the Retirement Plan as follows: Mr. Dalton, 11 years; Mr. Hennessey, 22 years; Mr. Burnes, 4 years. Mr. Schlesinger and Mr. Strong do not participate in the Retirement Plan.\nThe benefits listed in the Pension Plan Table are not subject to reduction for Social Security or other offset amounts.\nSAVINGS INCENTIVE PLAN\nOn September 20, 1989, the Trustees adopted a Savings Incentive Plan effective September 30, 1989, to provide retirement benefits for eligible employees of the Trust. On December 16, 1992, the Trustees amended and restated the Savings Incentive Plan effective January 1, 1992 (as amended, the \"Savings Plan\"). The Savings Plan continues the benefits provided under the GMAC Mortgage Corporation Savings Incentive Plan to employees of the Trust who were formerly employees of the Adviser. All other employees of the Trust are eligible to participate in the Savings Plan provided that they have been employed for twelve consecutive months, during which period the employee has completed at least 1,000 hours of service. Under the Savings Plan, each eligible employee may authorize payroll deductions not less than 1% nor more than 15% of the employee's earnings before bonus income, not to exceed the dollar limit permissible under the Code ($8,994 in 1993). The Trust will match each employee's contribution for the payroll period, subject to a limitation of 6% of the employee's compensation for the payroll period, with the maximum amount of contribution by the Trust in any year being $3,000.\nBenefits will be paid to terminating participants as soon as possible following the participant's date of termination. Participants have a 100% nonforfeitable right to their contributions to the Savings Plan and the Trust's matching contributions vest at the rate of 20% for each year of service, but will, in any event, be 100% vested at the later of age 65 or after five years of participation in the Savings Plan, or in the event of disability or death. Subject to certain limitations, hardship distributions of a participant's fully vested account balance are permitted on account of a demonstrable, immediate and heavy financial need.\nEMPLOYEE RETENTION PLAN\nThe Trustees have adopted an Employee Retention Plan (the \"Retention Plan\"), dated October 17, 1990, as amended January 16, 1991 and March 20, 1991, designed to provide a financial incentive for key employees to successfully restructure the organization and maximize the net worth of the Trust. The Retention Plan was approved by the Bankruptcy Court by order dated February 26, 1991.\nThe Retention Plan is administered by the Compensation and Nominating Committee which determines the allocation of amounts among the participants. All full-time employees of the Trust except the Chairman and the President and Chief Executive Officer are eligible to participate in the Retention Plan.\nThe first portion of the Retention Plan provides for a termination pay plan which will remain in effect during the period that the Class 3 Creditor Obligations (as defined in the 1991 Plan, and as amended, the Senior Notes) are outstanding. Any employee who is terminated without cause during this period shall be entitled to termination pay of not less than three and not more than 18 months salary depending on the employee's years of employment and position with the Trust. The number of months salary for Messrs. Dalton, Hennessey and Burnes are 18, 18 and 12, respectively. Medical and dental coverage will be continued during the termination pay period. An employee who is terminated for cause, voluntarily leaves, dies or becomes disabled during the plan period will not be entitled to benefits under this plan. The benefits which may be payable under this plan have been funded in a separate trust.\nThe second portion of the Retention Plan included a retention bonus plan which provided for the aggregate payment of up to $350,000 to employees who remained in the employ of the Trust until February 27, 1992, a period of one year from the date of the confirmation of the Plan of Reorganization. A separate trust was funded for the payment of these benefits.\nThe third portion of the Retention Plan provided for the grant under the Trust 1984 Share Option Plan of non-qualified stock options for up to an aggregate of 200,000 Shares of the Trust to participants. On March 29, 1991, options for 197,500 shares were granted at an exercise price of $4.15 per share which was the greater of (i) the average of the closing price of the Trust's Shares on the New York Stock Exchange for the last five days of the 30 day period after the effective date of the 1991 Plan and (ii) the fair market value of the Shares on the date of grant. Options will not vest to employees until three years after the date of grant and any employee who leaves voluntarily or is discharged for cause during the three year period will forfeit his or her rights under the option. After vesting, options can be exercised any time up to five years from the date of grant except that an employee with a vested option who leaves the employ of the Trust must exercise within a three month period after resignation. If a change in control of the Trust occurs, all options which have not previously been forfeited will vest immediately.\nThe final portion of the Retention Plan is an incentive program which may provide total incentive payments during the period the Class 3 Creditor Obligations (Senior Notes) are outstanding of not more than $1,250,000. For calendar year 1991, the program was based on an incentive pool calculated as follows: At June 30, 1991, if the Class 3 Creditor Obligations (Senior Notes) were no greater than $380,000,000 (the maximum amount allowed under the 1991 Plan without any deferrals), $75,000 would be deposited in the pool with an added $5,000 for each full $1,000,000 that the Class 3 Creditor Obligations (Senior Notes) were reduced before that amount. There was eliminated from this calculation voluntary repayments by the Trust which reduced cash on hand below $15,000,000. As a result, $95,000 was deposited in the pool. At December 31, 1991, if the Class 3 Creditor Obligations (Senior Notes) were no greater than $340,000,000, $125,000 would be deposited in the pool with an added $5,000 for each full $1,000,000 that the Class 3 Creditor Obligations (Senior Notes) are below that amount after deducting any amounts credited at June 30, 1991. As a result, $125,000 was deposited in the pool. On September 16, 1992, the Compensation and Nominating Committee approved a continuation of the incentive program for calendar year 1993 based on a similar formula for reducing the outstanding Senior Notes. Under this incentive program, because the Senior Notes were no greater than $290,000,000 at December 31, 1992, $125,000 was deposited in the pool. The amounts paid from the pool to the named executive officers for the fiscal years ended September 30, 1993, 1992 and 1991 are included in the Summary Compensation Table. The form and amount of this program for future years will be at the discretion of the Compensation and Nominating Committee.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nMessrs. Bucher, Colwell, Gassaway, Krout and Rostvold served as members of the Trust's Compensation and Nominating Committee during the Trust's fiscal year ended September 30, 1993. None of such individuals was, during such fiscal year, an officer or employee of the Trust, was formerly an officer of the Trust or had any relationship requiring disclosure by the Trust under Item 404 of Regulation S-K promulgated under the Securities Exchange Act of 1934.\nTERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS\nUnder the Employee Retention Plan, Messrs. Dalton, Hennessey and Burnes are entitled to termination pay equal to 18, 18 and 12 months salary, respectively, if they are terminated without cause during the period that the Class 3 Creditor Obligations (as defined in the Plan of Reorganization, as amended) are outstanding. In addition, all options granted to such individuals under the Employee Retention Plan that have not otherwise vested will vest automatically upon the occurrence of a change-in-control of the Trust. See \"Employee Retention Plan.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nAs of December 10, 1993, to the Trust's knowledge, no person or group (as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) owned beneficially 5% or more of the Common Shares of the Trust (the \"Shares\").\nThe table below sets forth the number of Shares beneficially owned: by each Trustee; by each executive officer named in the summary compensation table; and by the Trustees and officers as a group as of December 10, 1993. As of such date, no individual Trustee or officer had beneficial ownership of 1% or more of the outstanding Shares and all Trustees and officers as a group beneficially owned 2.6% of the outstanding Shares. Except as indicated by footnote, the Trustees and named executive officers have sole voting and investment power with respect to any Shares beneficially owned by them.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) DOCUMENTS FILED AS A PART OF THE REPORT.\nThe following documents are filed as part of this report.\n1. Financial Statements.\nThe financial statements of the Trust are set forth in the \"INDEX TO FINANCIAL STATEMENTS\" on page 25.\n2. Financial Statement Schedules.\n3. Exhibits.\n(a) Exhibits are as set forth in the \"INDEX TO EXHIBITS\" on pages 47-48.\n(b) REPORTS ON FORM 8-K. On July 13, 1993, August 30, 1993 and on September 28, 1993, the Registrant filed current reports on Form 8-K regarding the failure to make a scheduled debt payment, an agreement in principle with an official committee of holders of Senior Notes, and extensions of standstill arrangements.\n(c) EXHIBITS, INCLUDING THOSE INCORPORATED BY REFERENCE. Exhibits are set forth in the \"INDEX TO EXHIBITS\" on pages 47-48. Where so indicated by footnote in the index, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses. Copies of the exhibits are available to Shareholders upon payment of $.25 per page fee to cover the Trust's expenses in furnishing the exhibits. For copies contact: Mortgage and Realty Trust, 8380 Old York Road, Suite 300, Elkins Park, Pennsylvania 19117.\n(d) Financial Statement Schedules, except those indicated in the \"INDEX TO FINANCIAL STATEMENTS\" on page 25, have been omitted because the required information is included in the financial statements or notes thereto, or the amounts are not significant.\nSIGNATURES\nPursuant 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.\nMORTGAGE AND REALTY TRUST\nPursuant 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 and on the dates indicated.\nEach person in so signing also makes, constitutes and appoints Victor H. Schlesinger, Chairman of Mortgage and Realty Trust, and each of them, his true and lawful attorney-in-fact, in his name, place and stead to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this report.\nMORTGAGE AND REALTY TRUST\nREPORT OF INDEPENDENT AUDITORS\nTrustees and Shareholders Mortgage and Realty Trust\nWe have audited the accompanying balance sheets of Mortgage and Realty Trust at September 30, 1993 and 1992, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended September 30, 1993. Our audits also included the financial statement schedules referenced at Item 14(a). These financial statements and schedules are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mortgage and Realty Trust at September 30, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material aspects the information set forth therein.\nThe accompanying financial statements and schedules have been prepared assuming that Mortgage and Realty Trust will continue as a going concern. As more fully described in Note 1, the Trust was not able to comply with certain financial covenants related to the Restructured Joint Plan of Reorganization dated July 15, 1992. In addition, the Trust was not able to generate sufficient cash flow from normal operations and could not further liquidate mortgage loans and real estate investments in order to meet scheduled amortization on its Senior Notes. These uncertainties raise substantial doubt about the Trust's ability to continue as a going concern. The financial statements and schedules do not include any adjustments to reflect the possible future effects on the classification, realization or amounts of assets or liabilities that may result from the outcome of these uncertainties.\nERNST & YOUNG\nPhiladelphia, Pennsylvania January 3, 1994\nSTATEMENT OF OPERATIONS YEARS ENDED SEPTEMBER 30\nSee accompanying notes.\nBALANCE SHEET YEARS ENDED SEPTEMBER 30\nSee accompanying notes.\nSTATEMENT OF CASH FLOWS YEARS ENDED SEPTEMBER 30\nSee accompanying notes.\nSTATEMENT OF SHAREHOLDERS' EQUITY\nSee accompanying notes.\nNOTES TO THE FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF FINANCIAL STATEMENT PRESENTATION AND PLAN OF REORGANIZATION\nOn April 12, 1990, Mortgage and Realty Trust (the \"Trust\") filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. On February 27, 1991, the United States Bankruptcy Court for the Central District of California entered an order confirming the Trust's Plan of Reorganization (the \"1991 Plan\"). As a result of the liquidity problems in the commercial real estate markets, the Trust was not able to meet the required amortization at June 30, 1992 and the debt was restructured in July 1992 with the unanimous consent of the creditors. The debt is now governed by an Indenture dated as of July 15, 1992 between the Trust and Wilmington Trust Company (the \"Indenture Trustee\") and the debt is denominated as the Trust's Senior Secured Uncertificated Notes due 1995 (the \"Senior Notes\").\nAt September 30, 1992 the Trust's debt obligation under the Indenture aggregated $312 million. The Senior Notes are secured by all properties and interests in properties of the Trust. At December 31, 1992, the principal balance of the Senior Notes was reduced to $290 million, the maximum debt level permitted under the Indenture at that date, and remains at that amount at September 30, 1993.\nUnder the financial covenants of the Indenture governing the Senior Notes, the Trust was required to maintain a ratio of outstanding indenture securities to its capital base (as defined in the Indenture) of 515% at March 31, 1993. In addition, under the Indenture the Trust was required to maintain a ratio of outstanding securities to its capital base of 438% and a ratio of earning assets to outstanding securities of 113% at June 30, 1993 and September 30, 1993. The Trust failed to meet each of these ratios, constituting events of default under the Indenture. However, on May 26, 1993, the Trust received from the holders of more than 66-2\/3% in principal amount of Senior Notes a waiver relating to the March 31 default.\nDue to continued lack of liquidity in the real estate marketplace, the Trust did not have sufficient funds to meet its $20 million required principal payment due June 30, 1993. However, the Trust timely paid the June 30 and September 30, 1993 interest payments of $6.8 million and $6.6 million, respectively. The Trust also paid the final payment of the restructuring fee of $812,500 on September 30, 1993. An additional $33.8 million in principal (taking into account permitted deferrals) and $6.6 million in interest was due on December 31, 1993. Because the Trust did not make otherwise required payments on June 30 and December 31, 1993, at the end of the first quarter of 1994 (ending December 31, 1993) the Trust held approximately $17.8 million in available cash (as defined in the Indenture). Assuming no other payment defaults, the Trust would have been obligated to pay the excess of such available cash over $10 million to Senior Note holders as an additional principal payment. However, pursuant to the agreement in principle with certain of the principal holders of Senior Notes reached in August 1993, the Trust agreed to pay on September 30, 1993 the interest payment due September 30, 1993 and certain restructuring fees due December 31, 1993, but not to pay the interest or principal due December 31, 1993. Although it presently appears unlikely that the terms of the August 1993 agreement in principle will be implemented, consistent with the ongoing negotiations with the principal holders of the Senior Notes, the Trust did not pay the interest or principal due at December 31, 1993, constituting additional events of default under the Senior Note Indenture. The Trust forecasts that it will have continuing difficulty meeting its obligations under the Senior Note Indenture without a substantial restructuring of such debt.\nNotwithstanding the uncured events of default, neither the Indenture Trustee nor any holders of the Senior Notes have accelerated the Senior Notes. On July 2, 1993 holders of approximately 81% of the Senior Notes agreed, subject to certain conditions, not to accelerate the Senior Notes or take any other remedial or enforcement action during a defined standstill period (the \"Standstill Period\") initially expiring July 31, 1993. The Standstill Period was extended by holders of more than 66 2\/3% of the Senior Notes on August 3, August 20, September 23, October 5 and November 23, 1993. However,\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) the Standstill Period expired on December 3, 1993. At the present time, it appears unlikely that any further extensions of the Standstill Period will be granted. Subsequent to the expiration of the Standstill Period, on or about December 8, 1993, the Indenture Trustee notified the Trust's bank of the Indenture Trustee's security interest in the Trust's deposit accounts and instructed the bank to freeze the Trust's cash until otherwise instructed by the Indenture Trustee. Since that date, the Trust has operated on an ad hoc basis with the Indenture Trustee in administering its cash, with all cash use subject to review and approval by the Indenture Trustee. There can be no assurance that the Indenture Trustee will not take further remedial or enforcement action with respect to the Trust's bank accounts or other properties, including acceleration of the Senior Notes and foreclosure. Such action, or the failure of the Indenture Trustee to consent to necessary use of cash or releases of collateral in the conduct of the Trust's business would have a material adverse effect on the Trust's operations and could cause the Trust to seek relief under Chapter 11 of the United States Bankruptcy Code.\nManagement is continuing discussions with the representatives of the creditors to explore various alternatives for restructuring the Senior Notes. The Trust's present intention is to reach a consensual restructuring agreement. If such an agreement cannot be reached with the Senior Note holders, the Trust will have to consider other alternatives, including the filing of a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code.\nThe financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) applicable to a company on a \"going concern\" basis, which contemplates the realization of assets and the liquidation of liabilities in the ordinary course of business. These financial statements include adjustments and reclassifications that have been made to reflect indebtedness as extended under the 1991 Plan and the Senior Note Indenture. These financial statements do not include any adjustments that would be required should the Trust be unable to continue as a going concern. The conditions noted above raise substantial doubt about the Trust's ability to continue as a going concern.\nADOPTION OF AUTHORITATIVE STATEMENTS\nIn fiscal 1993, the Trust adopted Statement of Financial Accounting Standards No. 107, \"Disclosure About Fair Value of Financial Instruments\" (\"SFAS 107\"). This statement requires disclosure of the fair value of all financial instruments, both assets and liabilities recognized and not recognized in the balance sheet. The adoption of SFAS 107 resulted only in additional disclosure requirements and had no effect on the Trust's financial position or results of operations.\nAlso in fiscal 1993, the Trust adopted The American Institute of Certified Public Accountants' Statement of Position 92-3, \"Accounting for Foreclosed Assets\" (\"SOP 92-3\"). SOP 92-3 requires foreclosed assets held for sale to be carried at the lower of (a) fair value less estimated costs to sell or (b) cost. Fair value was determined by discounting expected cash flows using a risk-adjusted discount rate. Prior to adopting SOP 92-3, the Trust carried its foreclosed assets held for sale at the lower of (a) net realizable value or (b) cost. Net realizable value was determined using the Trust's cost of funds rate. See also Note 1, \"Allowance for Losses.\"\nRECLASSIFICATION OF PRIOR PERIODS\nCertain amounts in prior year statements have been reclassified to conform with the current year presentation.\nINCOME TAXES\nThe Trust is a real estate investment trust that has elected to be taxed under Sections 856-860 of the Internal Revenue Code of 1986, as amended. Accordingly, no provision has been made for income taxes in the financial statements.\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) For the fiscal years ended September 30, 1993, 1992 and 1991, there were significant differences between taxable net loss and net loss as reported in the financial statements. The differences were primarily temporary differences related to the recognition of bad debt deductions and accounting for reorganization costs. For financial accounting purposes, these items are expensed currently, while for tax purposes some portion of these items may be deferred to future periods.\nThe Trust incurred net operating losses of $31 million and $12 million for tax purposes in fiscal 1992 and 1991, respectively. The Trust estimates a net operating loss of approximately $38 million in fiscal 1993. These net operating losses will be available for fifteen years as a loss carryforward to future years' taxable income. The Trust's goal is to preserve its net operating losses, but the transfer of more than 50% of the ownership of the Trust to its creditors in a reorganization (as was provided in the August 1993 agreement in principle and as is likely in any alternate restructuring) will limit the future use of its net operating losses under Internal Revenue Code Section 382.\nINTEREST INCOME\nInterest income on each loan is recorded as earned. Interest income is not recognized if, in the opinion of the Trustees, collection is doubtful. The Trust generally considers loans as delinquent if payment of interest and\/or principal, as required by the terms of the note, is more than 60 days past due. At this point, accrual of interest income is generally terminated and foreclosure proceedings are started.\nLOAN FEE INCOME\nLoan fees are recorded as income using the \"interest method\". Accordingly, loan fees are deferred when received and are recorded as income over the term of the loan in relation to outstanding loan balances.\nALLOWANCE FOR LOSSES\nThe allowance for losses on mortgage loans and related investments is determined in accordance with the AICPA Statement of Position on Accounting Practices of Real Estate Investment Trusts 75-2, as amended. This statement requires adjustment of the carrying value of mortgage loans to the lower of their carrying value or estimated net realizable value. Estimated net realizable value is the estimated selling price of a property offered for sale in the open market allowing a reasonable time to find a buyer, reduced by the estimated cost to complete and hold the property (including the estimated cost of capital), net of estimated cash income. The cost of capital was computed at 9.0% at September 30, 1993 and 7.0% at September 30, 1992. Additional provisions for losses on mortgage loans and related investments may be necessary if the deterioration in real estate markets continues, or there is a significant increase in the Trust's cost of capital. See also Note 1, \"Adoption of Authoritative Statements.\"\nPROPERTIES ACQUIRED THROUGH FORECLOSURE AND HELD FOR SALE\nProperties acquired through foreclosure and held for sale are recorded at the lower of cost or fair value at acquisition, which becomes the cost basis for accounting purposes. The fair value of the asset acquired, in accordance with FASB Statement 15, is the amount that the Trust could reasonably expect to receive in a current sale between a willing buyer and a willing seller. Such properties are thereafter accounted for in the same manner as any similar asset acquired for investment as to depreciation and gain or loss upon sale. Subsequent to foreclosure, the properties are carried at the lower of cost or fair value less estimated costs to sell, as set forth in The American Institute of Certified Public Accountants' Statement of Position 92-3, \"Accounting for Foreclosed Assets\". See also Note 1, \"Adoption of Authoritative Statements.\"\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Those properties acquired through foreclosure and held for sale are reclassified from non-earning to earning status if they produce and maintain for a minimum of two consecutive quarters an annualized return of 5% or greater cash flow yield.\nIN-SUBSTANCE FORECLOSURE\nA loan is considered an in-substance foreclosure if: (1) the debtor has little or no equity considering the fair value of the collateral, (2) proceeds for repayment can be expected to come only from operation or sale of the collateral, and (3) the debtor has either formally or effectively abandoned control of the collateral. Loans meeting the criteria for in-substance foreclosure are reclassified and recorded at the lower of cost or fair value of the collateral, which establishes a new cost basis in the same manner as a legal foreclosure.\nNET LOSS PER SHARE\nNet loss per share for fiscal years ended 1993, 1992 and 1991 is computed using the weighted average common shares outstanding during each period.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization are computed on the straight-line method over an estimated useful life of 40 years for buildings and three to five years for other property and lease commissions.\nCASH AND CASH EQUIVALENTS\nCash and cash equivalents include short-term investments (high grade commercial paper of $9.6 million at September 30, 1993) with maturities ranging from 1 to 34 days.\nIncluded in cash and cash equivalents is $1.3 million of restricted cash which represents the funding of the employee retention plan (see Note 8) and $1.5 million related to borrowers' deposits. See Item 1, \"Business\" for additional information regarding the enforcement of the Indenture Trustee's security interest in the deposit accounts of the Trust and the Trust's obligation to pay the excess of available cash as defined in the Indenture) over $10 million to Senior Note holders.\n2. MORTGAGE LOANS AND INVESTMENT IN REAL ESTATE The following table summarizes the Trust's mortgage loan portfolio:\nAt September 30, 1993, the Trust had undisbursed commitments of $1,632,000, all of which represents additional advances on partially funded mortgage loans.\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n2. MORTGAGE LOANS AND INVESTMENT IN REAL ESTATE (CONTINUED) As of September 30, 1993, there were no earning loans delinquent (more than 60 days past due) as to principal and\/or interest.\nThe Trust has had a significant increase in the number of loans being restructured as its borrowers continue to face deteriorating conditions in the real estate market. It is expected that these conditions may continue for an additional period of time requiring the Trust, where appropriate, to continue restructuring loans.\nAt September 30, 1993 and 1992, loans totalling $33,403,000 and $50,911,000, respectively, were extended beyond their original contractual maturity dates. Loan terms are extended in the normal course of business for various reasons, such as delays in construction, slower leasing than originally anticipated or delay in obtaining permanent financing.\nAt September 30, 1992, earning mortgage loans totalling $60,028,000 had been subject to contractual interest rate modification due to financial difficulties of the borrower. During fiscal 1993, one loan totalling $1,608,000 was reinstated at a rate above the original contractual rate. The remaining loans totalling $58,420,000 were transferred to in-substance foreclosure. No interest rate modifications were made on mortgage loans during fiscal 1993.\nAt September 30, 1993 and 1992, mortgage loans outstanding consisted of fixed rate loans of $21,268,000 and $67,806,000, floating rate loans of $70,745,000 and $125,924,000 and participating loans of $12,180,000 and $43,698,000, respectively. Non-earning loans (including non-earning in-substance foreclosures) and non-earning properties acquired through foreclosure and held for sale were $60,248,000 at September 30, 1993 compared to $76,316,000 at September 30, 1992.\nThe following table summarizes the Trust's investment in in-substance foreclosures at September 30, 1993 and September 30, 1992:\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n2. MORTGAGE LOANS AND INVESTMENT IN REAL ESTATE (CONTINUED) The following table summarizes the Trust's investment in real estate equities, net of accumulated depreciation of $7,800,000 at September 30, 1993 and $5,686,000 at September 30, 1992:\nThe following table summarizes the Trust's investment in properties acquired through foreclosure and held for sale, net of accumulated depreciation of $6,143,000 at September 30, 1993 and $4,524,000 at September 30, 1992:\n3. ALLOWANCE FOR LOSSES The changes in the allowance for losses for the years ended September 30, 1993, 1992 and 1991 were as follows:\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n3. ALLOWANCE FOR LOSSES (CONTINUED) Approximately $6,394,000, $4,488,000 and $2,804,000 of the allowance at September 30, 1993, 1992 and 1991, respectively, are applicable to properties acquired through foreclosure and held for sale.\n4. SENIOR NOTES\nSENIOR SECURED NOTES\nThe lack of liquidity in the commercial real estate markets continued during the fiscal year. Although the Trust was able to meet the required principal payment at December 31, 1992, reducing the principal balance of the Senior Notes to $290 million, it did not have sufficient funds to meet the $20 million required principal payment due June 30, 1993. The average borrowing rate for fiscal 1993 and 1992, respectively, was 9.23% and 8.34%. At September 30, 1993, the blended interest rate on the Senior Notes was 9.87%, composed of interest at 9.25% on $200 million of Senior Notes (including default interest at 1%) and 11.25% on $90 million of deferred amounts of Senior Notes (including default interest at 1%). The entire unamortized cost of restructuring of the Senior Notes was charged off during fiscal 1993 as a result of the monetary default. The Trust expensed $3.4 million in fiscal 1993, of which $2.4 million related to the acceleration of costs due to the June 1993 montary default. Prior to the default, these costs were being amortized using the interest method over the term of the debt. See Item 1, \"Business\" for additional information regarding certain other required payments not made subsequent to June 30, 1993 and other events of default.\nPayment of the Senior Notes is secured by liens against all real and personal properties of the Trust as required by the 1991 Plan and the Indenture.\nLOAN ON EQUITY INVESTMENT\nIn November 1991, the Trust acquired full ownership of a retail center in which it had a partnership interest. The Trust has a construction borrowing commitment of $18.7 million of which $17.6 million was outstanding at September 30, 1993. The contractual interest rate on this loan is 7-1\/2% (Prime +1 1\/2%, floor of 9%) at September 30, 1993, and the loan matures in April 1994.\n5. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 107 requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Trust.\nThe carrying value of cash and cash equivalents approximates their fair value because of the liquidity and short-term maturities of these instruments. The fair value of mortgage loans is estimated by discounting cash flows at what is considered a market interest rate for loans with similar terms to borrowers of similar credit quality.\nThe fair value of the Senior Notes at September 30, 1993 is based on a significant trade which occurred in August 1993 and for which the Trust obtained pricing information. The secondary market for this debt has a limited number of participants which may result in significant volatility in this debt.\nLoan on equity investment is a variable rate loan that reprices frequently, thus fair value is based on the carrying amount of the loan.\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n5. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The estimated fair values of the Trust's financial instruments at September 30, 1993 are as follows:\n6. SHARE OPTION PLAN As of September 30, 1993, options to purchase 452,500 Common Shares were outstanding under the 1984 Share Option Plan. The exercise price per share varies from $2.50 to $14.50. Options granted, other than those granted in fiscal 1991, expire five years from the date of grant and may be exercised at any time six months after the date of grant, subject to the limitation that the aggregate fair market value (determined as of the time the Option is granted) of the Shares with respect to which Incentive Stock Options are exercisable for the first time by any participant during any calendar year shall not exceed $100,000. Options granted during fiscal 1991, pursuant to the Employee Retention Plan described in Note 8, expire five years from the date of grant but do not vest until three years from the date of grant. During the fiscal year ended September 30, 1993, no options were granted. During the fiscal year ended September 30, 1992, options to purchase 181,000 Common Shares at a price of $2.50 were granted to Trustees and certain officers of the Trust. Options to purchase 132,000 Common Shares at prices from $4.15 to $18.625 terminated during the fiscal year ended September 30, 1993.\nIn addition to cash, options may be exercised by exchanging the Trust's Common Shares valued at the market price on the date of exercise of the options. During the fiscal year ended September 30, 1993, no options were exercised.\n7. PENSION PLANS\nEMPLOYEES\nOn September 20, 1989, the Trustees adopted an Employees' Retirement Plan effective September 30, 1989. On December 16, 1992, the Trustees amended and restated the Employees' Retirement Plan effective January 1, 1992 to conform to amended regulations.\nThe Trust maintains this non-contributing, defined benefit pension plan for all eligible employees. Benefits under the plan are generally based on years of service and average annual base salary rate. Pension costs are accrued and funded annually from entry date in the plan to projected retirement date and include service costs for benefits earned during the period and interest costs on the projected benefit obligation less the return on plan assets. Pension expense was $60,000 for the year\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n7. PENSION PLANS (CONTINUED) ended September 30, 1993 and $136,000 for the year ended September 30, 1992. The actual return on plan assets was $53,465 for the year ended September 30, 1993 and $72,492 for the year ended September 30, 1992. The funding status of the pension plan is:\nTRUSTEES\nEffective October 1, 1989, the Trust established a pension plan for Trustees. All Trustees on or after the effective date (including Trustees who are employees of the Trust) are eligible to receive the basic normal retirement benefit under the plan upon completion of five years of credited board service. Benefits under the plan are based on the annual retainer in effect at the time the Trustee retires or otherwise terminates service. Plan benefits will be paid for a period equal to the number of years served as Trustee after January 1, 1980, except that payments will cease upon the death of the Trustee.\nThe benefit provided by the plan is a contractual obligation on behalf of the Trust and is payable out of assets of the Trust that are subject to the claims of creditors of the Trust. It is not intended that the plan be funded.\nAccrued pension expense was $60,000 for each of the years ended September 30, 1993 and 1992. The total accumulated benefit obligation at September 30, 1993 was $433,000.\n8. EMPLOYEE RETENTION PLAN The Trust established an Employee Retention Plan, to be administered by the Compensation and Nominating Committee (the \"Committee\"), in order to assure the continuity and performance of employees of the Trust. The Plan contains four categories of benefits: an incentive program, stock options, termination pay and a retention bonus.\nThe Committee established an incentive program for calendar year 1991. The incentive pool was calculated based on the reduction of the Trust's outstanding debt (the Senior Notes). On January 3, 1992, the principal balance of the Senior Notes was reduced to $329 million resulting in an incentive bonus pool of $160,000. On September 16, 1993, the Committee approved a continuation of the incentive program for 1992 based on a similar formula for reducing the principal balance of the Senior Notes. At December 31, 1992, the principal balance of the Senior Notes was reduced to $290 million resulting in an incentive bonus pool of $125,000.\nOn March 29, 1991, the Committee awarded stock options for the purchase of 197,500 Common Shares at an option price of $4.15. The options do not vest until three years from the date of grant.\nA termination pay plan has been established to cover termination of employment without cause during the period that the Senior Notes are outstanding. Employees will be entitled to compensation ranging from a minimum of twelve weeks to a maximum of eighteen months pay. In addition, certain health benefits will continue to be paid by the Trust over a period of time equal to the period used in\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n8. EMPLOYEE RETENTION PLAN (CONTINUED) calculating severance pay. The Trust estimates that the maximum cost of the termination pay plan would be approximately $1.3 million and the cost is charged to expense at date of termination (as defined in the termination pay plan).\nThe retention bonus, which totalled $350,000, was paid on February 28, 1992 to certain employees who remained with the Trust one year after the Effective Date of the 1991 Plan (February 27, 1991).\n9. ISSUANCE OF SHARES Effective April 1, 1992, the Trust terminated its Dividend Reinvestment and Share Purchase Plan.\nIn January 1985, the Trust issued 2,200,000 warrants for the right to purchase 3,300,000 Common Shares at a price of $20.50 per share. The warrants expired on January 15, 1992.\nThe Trust is authorized to issue up to 3,500,000 Preferred Shares on terms to be established by the Trustees. No preferred shares have been issued to date.\nSee also Note 10, \"Litigation.\"\n10. LITIGATION The consolidated class and derivative actions pending in the United States District Court for the Eastern District of Pennsylvania filed in March 1990 against certain of the Trust's present and former Trustees and officers and the Class 5 claims against the Trust remaining in the Chapter 11 proceeding in the United States Bankruptcy Court for the Central District of California were settled effective September 17, 1993. The class actions and claims alleged violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and negligent misrepresentation under the common law by reason of misleading statements in the Trust's reports filed with the SEC and other information disseminated to the public. The derivative action alleged mismanagement on the part of the Trustees which resulted in the bankruptcy.\nUnder the terms of the settlement: (1) the Trust contributed 150,000 Common Shares to the settlement of the class claims; (2) the director and officer liability insurance carrier contributed $860,000 on behalf of the individual defendants in the class actions; and (3) the insurance carrier paid on behalf of the individual defendants in the derivative action $65,000 to counsel for the derivative plaintiffs. The settlement was approved by both courts after notice to the class members and the shareholders of the Trust.\nAs described above, the Trust made no cash payments in connection with the settlement. While the Trust and the individual defendants continue to believe that their actions were entirely proper and violated no laws, the Trustees decided to settle the claims in order to avoid additional legal expense and the diversion of management's time and energy at a time when the operations of the Trust demanded their undivided attention.\nNOTES TO THE FINANCIAL STATEMENTS (CONTINUED)\n10. LITIGATION (CONTINUED) The quarterly results of operations for fiscal 1993 and 1992 are summarized as follows:\nMORTGAGE AND REALTY TRUST SCHEDULE XI REAL ESTATE AND ACCUMULATED DEPRECIATION AND AMORTIZATION SEPTEMBER 30, 1993\nMORTGAGE AND REALTY TRUST SCHEDULE XI (CONTINUED) REAL ESTATE AND ACCUMULATED DEPRECIATION AND AMORTIZATION SEPTEMBER 30, 1993\nNOTES:\n(a) Cost for federal income tax purposes $64,433,000.\n(b) The changes in gross carrying amounts during the year ended September 30, 1993 are summarized as follows:\nMORTGAGE AND REALTY TRUST SCHEDULE XI (CONTINUED) REAL ESTATE AND ACCUMULATED DEPRECIATION AND AMORTIZATION SEPTEMBER 30, 1993\nMORTGAGE AND REALTY TRUST SCHEDULE XII MORTGAGE LOANS ON REAL ESTATE SEPTEMBER 30, 1993\nMORTGAGE AND REALTY TRUST SCHEDULE XII (CONTINUED) MORTGAGE LOANS ON REAL ESTATE SEPTEMBER 30, 1993\nNOTES:\n(a) Consists of 107 mortgage end loans on 10 projects.\n(b) The aggregate cost for federal income tax purposes is $104,632,000.\n(c) The change in carrying value of mortgage loans during the year ended September 30, 1993 were as follows:\nMORTGAGE AND REALTY TRUST INDEX TO EXHIBITS","section_15":""}
{"filename":"202763_1993.txt","cik":"202763","year":"1993","section_1":"ITEM 1. BUSINESS.\nUnless otherwise indicated, the term \"SYNCOR\" or the \"COMPANY\" as used in this report refers to Syncor International Corporation incorporated in 1985 under the laws of the state of Delaware or Syncor International Corporation and one or more of its consolidated subsidiaries.\nGENERAL DEVELOPMENT OF BUSINESS\nThe general development of the Company's business for the seven-month transition period ended December 31, 1993 (the \"TRANSITION PERIOD\") is covered in the President's letter to the Company's shareholders in the Company's Annual Report to Shareholders for said period and is hereby incorporated by reference. A copy of the Company's Annual Report to Shareholders is attached hereto as Exhibit 13.\nDESCRIPTION OF BUSINESS\nPrincipal Products Produced and Services Rendered\nThe Company is a high-tech pharmacy services company which is primarily engaged in compounding, dispensing and distributing radiopharmaceutical products to hospitals and clinics through its nationwide network of 109 pharmacies. Three of the pharmacies also include Positron Emission Tomography (\"PET\") pharmacy services. The radiopharmaceuticals provided by the Company are principally used for diagnostic imaging of physiological functions and organ systems. In addition, the Company provides various services in connection with the sale of radiopharmaceuticals, including radiopharmaceutical record keeping required by federal and state government agencies, and radiopharmaceutical technical consulting. The Company estimates that in the United States its pharmacies service approximately 7,000 hospitals and clinics in 36 states throughout the country. During each of the last two fiscal years and the Transition Period, the pharmacies contributed more than 95 percent of the consolidated net sales of the Company.\nOther activities of the Company include the marketing and distribution of imaging cold kits, isotopes, and medical reference sources in addition to nuclear and pharmacy equipment and accessories. The Company also is involved in a pilot program designed to deliver unit dose chemotherapeutic solutions directly to oncologist's offices and clinics (\"SOS\"). Early indications point to an acceptance of the concept by oncologists. However, management believes that it should test this concept for an additional period of time before attempting to expand this line of business.\nThe description of Syncor's various activities in the Company's Annual Report to Shareholders for the Transition Period are hereby incorporated by reference.\nSources and Availability of Raw Materials\nThe Company pharmacies dispense approximately 50 different radiopharmaceutical products which are obtained primarily from five suppliers. Management believes that, if any one of the suppliers of radiopharmaceuticals failed to supply products then the other suppliers would be able to supply most of those products. If two or more suppliers were unable to provide products at a particular time, it could have an adverse effect on the Company's business. During the quarter ending August 31, 1993 supply of Indium-111 oxine, a proprietary product of one supplier, has been sporadic. However, such problem appears to have been resolved. Otherwise, to date, the pharmacies have not experienced any difficulty in securing supplies of radiopharmaceutical products.\nPatents, Trademarks, Licenses and Distribution Agreements\nThe Company owns a number of trademarks and has a variety of license agreements. In addition, the Company has entered into exclusive radio- pharmacy distribution agreements with two suppliers of certain proprietary radiopharmaceutical products. While certain of the foregoing items are considered to be of value to the Company, management believes at present its competitive position is dependent principally on the efficient operation of its pharmacies and high quality of its customer service.\nOn December 3, 1993 the Company entered into a new long-term distribution agreement with its principal supplier of radiopharmaceutical products, The Radiopharmaceutical Division of The DuPont Merck Pharmaceutical Company. The agreement became effective February 1, 1994, replacing an existing supply agreement between the companies which has been in place since 1988.\nDependence on Customers\nThe Company's operations are such that none of its business is dependent upon a single customer or a very few customers to the extent that the loss of such would have a material impact on operations.\nCompetitive Conditions\nThe Company's pharmacies compete primarily with the large manufacturers of radiopharmaceuticals, which directly supply radiopharmaceutical products to the hospitals. Two of such manufacturers have set-up their own centralized radiopharmacies to supply customers. The Company also competes with a number of other independent entities, each of which operate one or more radiopharmacies. In certain markets, there is competition with universities which own and operate centralized radiopharmacies. The principal competitive practices of the manufacturers and others involve price and service. The management believes that, the advantages to a hospital of using a centralized radiopharmacy rather than preparing its own radiopharmaceutical products include: (I) reduced risk of radiation exposure to hospital personnel; (II) cost savings due to Syncor's volume purchasing power; (III) better utilization of the time sensitive products purchased from the radiopharmaceutical manufacturers; and, (IV) reduction in the time needed to maintain extensive records required by the regulatory agencies. In addition, the Company's pharmacies provide quality controlled unit dose radiopharmaceuticals, comprehensive nuclear medicine product-line availability, professional consultation and delivery services, and specialized computer hardware and proprietary software products for nuclear medicine operations.\nGovernment Regulation\nEach of the Company's domestic pharmacies is licensed by and must comply with the regulations of the United States Nuclear Regulatory Commission (\"NRC\") or corresponding state agencies. In addition, each such pharmacy is licensed and regulated by the Board of Pharmacy in the state where it is located.\nPeriodic inspections of the Company's pharmacies are conducted by the NRC and various other federal and state agencies. Inspection results which lead to escalated enforcement action could lead to the imposition of fines or the suspension, revocation or denial of renewal of the licenses for the location inspected. The Company devotes substantial human and financial resources to ensure continued regulatory compliance and believes that it is currently in compliance with all material rules and regulations.\nIn addition to the Company being subject to the various federal and state regulations relating to occupational safety and health, and the use and disposal of biohazardous materials, the Company's products are subject to the federal and state regulations relating to drugs and medical devices.\nCompliance with the applicable environmental control laws or regulations, such as those regulating the use and disposal of radioactive materials, is inherent to the normal operations of the pharmacies and has not had a material adverse effect on the capital expenditures, earnings or competitive position of the Company.\nForeign Operations\nSyncor owns and operates nuclear pharmacies in Taipei, Taiwan and Hong Kong. In 1993, the Company entered into joint venture agreements with various parties in the Republic of China to open and operate pharmacies in Beijing and Shanghai. The Company anticipates expanding its operations in other Pacific Rim countries in the future.\nEmployees\nAs of December 31, 1993, Syncor employed approximately 2,088 people. However, the full time equivalent for the same period was approximately 1,363 people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company and its consolidated subsidiaries lease (and in one location own) and operate a number of pharmacies in the United States whose locations are set forth in the following table(1):\nSTATE LOCATION _____ ________\nALABAMA Birmingham Mobile ARIZONA Gilbert (Mesa) Phoenix* Tucson ARKANSAS Little Rock CALIFORNIA Bakersfield Berkeley Colton Fresno Los Angeles* Modesto Orange Torrance Sacramento* San Diego San Jose So. San Francisco** Van Nuys (Los Angeles) COLORADO Colorado Springs Denver CONNECTICUT Glanstonbury (Hartford) Stamford FLORIDA Fort Myers Gainesville Hialeah (Miami Lakes) Jacksonville Jupiter (Palm Beach) Pensacola Pompano Beach (Ft.Lauderdale) St. Petersburg Tampa Winter Park (Orlando) GEORGIA Augusta Columbus Doraville (Atlanta) ILLINOIS Des Plaines Chicago Springfield INDIANA Ft. Wayne Indianapolis Munster (Dyer) IOWA Des Moines KENTUCKY Lexington Louisville LOUISIANA Metairie (New Orleans) MARYLAND Lanham (Washington DC) Timonium (Baltimore) MASSACHUSETTS Woburn (Boston) MICHIGAN Grand Rapids Southfield (Detroit) Swartz Creek (Flint) MINNESOTA Moorhead (Fargo ND) St. Paul MISSISSIPPI Flowood (Jackson) Gulfport MISSOURI Kansas City Overland (St. Louis) NEBRASKA Lincoln Omaha NEVADA Las Vegas Reno NEW JERSEY Fairfield (Newark) NEW MEXICO Albuquerque NEW YORK Cheektowaga (Buffalo) Troy (Albany) Franklin Square (Long Island) Rochester Syracuse NORTH CAROLINA Charlotte OHIO Akron Cincinnati Cleveland Columbus Girard (Youngstown) Holland (Toledo) Miamisburg (Dayton) Youngstown (Girard) OKLAHOMA Oklahoma City Tulsa OREGON Portland PENNSYLVANIA Allentown Bristol (N. Philadelphia) Sharon Hill (Philadelphia) Hummelstown (Harrisburg) Pittsburgh SOUTH CAROLINA Columbia TENNESSEE Chattanooga Knoxville Memphis Nashville TEXAS Amarillo Austin Beaumont Corpus Christi Dallas El Paso Fort Worth Houston Lubbock North Dallas San Antonio VIRGINIA Richmond Virginia Beach WASHINGTON Seattle Spokane WEST VIRGINIA Huntington WISCONSIN Appleton Wauwatosa (Milwaukee)\n(1) The Company also owns an interest in pharmacies in Salt Lake City, Utah; Midland, Texas; and Huntsville, Alabama. * Cities where the Company has both a nuclear and PET pharmacy. ** Cities where the Company has both a nuclear and SOS pharmacy.\nPharmacy lease terms vary from less than one year up to approximately ten years, and average approximately five years. Leased areas average approximately 4,500 square feet each.\nThe Company leases its Corporate Office facilities in Chatsworth, California, pursuant to a lease that commenced on March 1, 1987. The lease is for the term of ten years with two successive five year renewal options. Presently, the Company leases approximately 76,464 square feet at such location.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are various litigation proceedings in which the Company and its subsidiaries are involved. Many of the claims asserted against the Company in these proceedings are covered by insurance. The results of litigation proceedings cannot be predicted with certainty. However, in the opinion of the Company's General Counsel, such proceedings either are without merit or do not have a potential liability which would materially affect the financial condition of the Company and its subsidiaries on a consolidated basis.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the last month of the Transition Period.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe stock information which appears in the Company's Annual Report to Shareholders under the heading of \"QUARTERLY STOCK PRICE DATA\", included in this Form 10-K Annual Report as EXHIBIT 13, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial data which appears in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1993, under the heading of \"SELECTED FINANCIAL DATA\", included in this Form 10-K Transition Report as EXHIBIT 13, is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nManagement's discussion and analysis of financial condition and results of operations which appears in the Company's Annual Report to Shareholders for the Transition Period, under the heading of \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" included in this Form 10-K Transition Report as EXHIBIT 13, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.\nThe consolidated financial statements and the notes thereto which appear in the Company's Annual Report to Shareholders for the Transition Period under the headings of \"CONSOLIDATED STATEMENTS OF INCOME\" and \"CONSOLIDATED BALANCE SHEETS\" included in this Form 10-K Transition Report as EXHIBIT 13, are incorporated herein by reference. Schedules containing certain supporting information are also included. See Index to Financial Statement Schedules on page 7.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nExcept as noted below in this Item, the information called for in\/by Item 10 of Form 10-K is incorporated by reference from the Company's definitive Proxy Statement for its Annual Meeting of Shareholders, to be held on May 10, 1994, which will be filed with the Commission pursuant to Regulation 14A within 120 days from December 31, 1993.\nThe Form 3 of Director Dr. Gail R. Wilensky, Chief Operation Officer Robert G. Funari and Chief Financial Officer Michael A. Piraino were filed a few days late due to the error of the Company's Legal Department who filed the same on their behalf.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. The information called for in\/by Item 11 of Form 10-K is incorporated by reference from the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 10, 1994, which will be filed with the Commission pursuant to Regulation 14A within 120 days from December 31, 1993.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information called for in\/by Item 12 of Form 10-K is incorporated by reference from the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 10, 1994, which will be filed with the Commission pursuant to Regulation 14A within 120 days from December 31, 1993.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information called for in\/by Item 13 of Form 10-K is incorporated by reference from the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 10, 1994, which will be filed with the Commission pursuant to Regulation 14A within 120 days from December 31, 1993.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. CONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated financial statements listed below, together with the report thereon of KPMG Peat Marwick, dated March 10, 1994, appear in the Company's Annual Report to Shareholders for the Transition Period, included in this Form 10-K Tran- sition Report as EXHIBIT 13, is incorporated herein by reference.\nIndependent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES.\nThe following schedules supporting the financial statements of the Company are included herein:\nPage ____ Schedule II Amounts Receivable from Employees Other than Related Parties...........10 Schedule VIII Valuation and Qualifying Accounts......11 Schedule IX Short-Term Borrowings..................12 Schedule X Supplementary Income Statement Information................13\nAll other schedules and Financial Statements of the Company are omitted because they are not applicable, not required or because the required information is included in the consolidated financial statements or notes thereto.\n3. INDEX TO EXHIBITS\nThe list of exhibits filed as part of this report on Form 10-K or incorporated herein be reference appear as Index to Exhibits on page 14.\n(b) REPORTS ON FORM 8-K FILED IN THE LAST PERIOD ENDING DECEMBER 31,\nOn December 15, 1993 a Form 8-K Report was filed reporting: (I) the proposal submitted to the shareholders at the Annual Meeting held on November 15, 1993, to amend the 1990 Master Stock Incentive Plan which would increase the authorized number of shares by 500,000 shares and make other changes to the Plan, which was approved by shareholders; (II) the execution on December 3, 1993 of a new long-term distribution agreement with its principal supplier of radiopharmaceutical products, The Radiopharmaceutical Division of The DuPont Merck Pharmaceutical Company; and (III) the change of its fiscal year to December 31 from May 31, beginning with the seven-months ended December 31, 1993.\n(c) EXHIBITS\nThe exhibits required by Item 601 of Regulation S-K are filed herewith or are incorporated by reference and the list of the Index to Exhibits on page 14.\nSIGNATURES\nPursuant 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.\nSYNCOR INTERNATIONAL CORPORATION\nBy \/s\/ Gene R. McGrevin ____________________ Gene R. McGrevin President, Chief Executive Officer Date: 3\/30\/94\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the regis- trant and in the capacities and on the dates indicated.\n\/s\/ Monty Fu ____________________________________________________ Monty Fu, Chairman of the Board and Director Date: 3\/30\/94\n\/s\/ Gene R. McGrevin ____________________________________________________ Gene R. McGrevin, President, Chief Executive Officer (Principal Executive Officer) and Director Date: 3\/30\/94\n\/s\/ Michael A. Piraino ____________________________________________________ Michael A. Piraino, Senior Vice-President, (Principal Financial and Accounting Officer) Date: 3\/30\/94\n\/s\/ George S. Oki ____________________________________________________ George S. Oki, Director Date: 3\/30\/94\n\/s\/ Joseph Kleiman ____________________________________________________ Joseph Kleiman, Director Date: 3\/30\/94\n\/s\/ Arnold E. Spangler ____________________________________________________ Arnold E. Spangler, Director Date: 3\/30\/94\n\/s\/ Steven B. Gerber ____________________________________________________ Steven B. Gerber, Director Date: 3\/30\/94\n\/s\/ Henry N. Wagner, Jr. ____________________________________________________ Henry N. Wagner, Jr., Director Date: 3\/30\/94\n\/s\/ Gail R. Wilensky ____________________________________________________ Gail R. Wilensky, Director Date: 3\/30\/94\nSYNCOR INTERNATIONAL CORPORATION AND SUBSIDIARIES SCHEDULE II. AMOUNTS RECEIVABLE FROM EMPLOYEES OTHER THAN RELATED PARTIES\n(In Thousands) =========================================================================== Balance Balance at Beginning Additions at End Name of Debtor of Period (Deletions) of Period ===========================================================================\nSeven Months Ended December 31, 1993:\nRobert G. Funari Chief Operating Officer $ -- $ 200 $200 =============================================\nYear Ended May 31, 1993:\nJohn Schulze - Executive Director of Marketing 250 (250) -- =============================================\nYear Ended May 31, 1992:\nJohn Schulze - Executive Director of Marketing 250 -- 250\nGreg Hiatt - Director, Western Zone 250 (250) -0- ______________________________________________\n$500 $(250) $250 ==============================================\nYear Ended May 31, 1991:\nJohn Schultze - Executive Director of Marketing $250 $ -- $250\nGreg Hiatt Director, Western Zone 250 -- 250 ______________________________________________\n$500 $ -- $500 ==============================================\nSYNCOR INTERNATIONAL CORPORATION AND SUBSIDIARIES SCHEDULE VIII. VALUATION AND QUALIFYING ACCOUNTS\n(In Thousands) ============================================================================ Balance Charged Balance at to Costs at End Beginning and Deductions of Description of Period Expenses (a) Period ============================================================================\nSeven Months Ended December 31, 1993: Allowance for doubtful accounts $1,502 $ 224 $ 526 $1,200\nYear Ended May 31, 1993: Allowance for doubtful accounts $1,681 $1,123 $1,302 $1,502\nYear Ended May 31, 1992: Allowance for doubtful accounts $2,071 $ 605 $ 995 $1,681\nYear Ended May 31, 1991: Allowance for doubtful accounts $2,141 $ 611 $ 681 $2,071\n(a) Uncollectible accounts written off, net of recoveries, and reduction of reserve.\nSYNCOR INTERNATIONAL CORPORATION AND SUBSIDIARIES SCHEDULE IX. SHORT-TERM BORROWINGS\n(In Thousands) =============================================================================== During the Period ______________________________ Weighted Maximum Average Weighted Balance Average Amount Amount Average Category of Aggregate at End of Interest Out- Out- Interest Short-Term Borrowings Period Rate standing standing(a) Rate (b) =============================================================================== Note Payable to Bank:\nSeven Months Ended December 31, 1993 $ -- -- $ -- $ -- --\nYear Ended May 31, 1993 $ -- 6.04% $3,700 $1,019 6.07%\nYear Ended May 31, 1992 $1,000 7.04% $3,500 $1,799 7.16%\nYear Ended May 31, 1991 $ -- 9.14% $1,000 $ 667 9.12%\n(a) Based upon actual daily amounts outstanding during the period.\n(b) Average interest rate for the year is computed by dividing the actual short-term interest expense by the average short-term debt outstanding.\nSYNCOR INTERNATIONAL CORPORATION AND SUBSIDIARIES SCHEDULE X. SUPPLEMENTARY INCOME STATEMENT INFORMATION\n(In Thousands) ========================================================================= Year Ended May 31, Seven Months Ended _______________________ December 31, 1993 1993 1992 1991 ========================================================= Maintenance and repairs $813 $1,552 $1,686 $1,544 =========================================================\nAmortization of intangible assets, taxes other than payroll and income taxes, advertising and royalties are less than 1% of total net sales for all periods shown.\nINDEX TO EXHIBITS\nExhibit No.\n3. Certificate of Incorporation and By-Laws\n3.1 Restated Certificate of Incorporation of the Company filed as Exhibit 3.1 to the 8\/28\/87 Form 10-K and incorporated herein by reference.\n3.2 Restated By-Laws of the Company filed as Exhibit 3.2 to the 8\/28\/87 Form 10-K and incorporated herein by reference.\n4. Instruments Defining The Rights of Security Holders\n4.1 Stock Certificate for Common Stock of the Company filed as Exhibit 4.1 to the 8\/26\/86 Form 10-K and incorporated herein by reference.\n4.2 Rights Agreement dated as of 11\/8\/89 between the Company and American Stock Transfer & Trust Company filed as Exhibit 2.1 to the Registration Statement on Form 8-A dated 11\/3\/89 and incorporated herein by reference.\n10. Material Contracts\n10.1 Employment Agreement dated 2\/1\/89, between the Company and Gene R. McGrevin filed as Exhibit 10.2 to 1\/27\/89 Form 8-K and incorporated herein by reference.\n10.2 First Amendment dated 7\/11\/89 to Employment Agreement dated 2\/1\/89 between the Company and Gene R. McGrevin filed as Exhibit 10.5 to 8\/30\/90 Form 10-K and incorporated herein by reference.\n10.3 Second Amendment dated 10\/16\/89 to Employment Agreement dated 2\/1\/89 between the Company and Gene R. McGrevin filed as Exhibit 10.6 to 8\/30\/90 Form 10-K and incorporated herein by reference.\n10.4 Third amendment dated 1\/1\/91 to Employment Agreement dated 2\/1\/89 between the Company and Gene R. McGrevin filed as Exhibit 10.7 to 8\/29\/91 Form 10-K and incorporated herein by reference.\n10.5 Syncor International Corporation 1981 Master Stock Option Plan as amended filed as part of Company's Proxy Statement dated 11\/5\/85, for its Annual Meeting of Shareholders held 11\/26\/85 and incorporated herein by reference.\n10.6 Stock Option Agreement of Gene R. McGrevin dated 1\/2\/92 filed as Exhibit 10.16 to 8\/27\/92 Form 10-K and incorporated herein by reference.\n10.7 Form of Indemnity Agreement substantially as entered into between Company and each Director and Officer filed as Exhibit 3.2 Appendix A to the 8\/28\/87 Form 10-K and incorporated herein by reference.\n10.8 Form of Benefits Agreement substantially as entered into between Company and each Director filed as Exhibit 10.31 to 8\/30\/90 Form 10- K and incorporated herein by reference.\n10.9 Form of Benefits Agreement substantially as entered into between Company and certain employees see Exhibit 10.8.\n10.10 Syncor International Corporation 1990 Master Stock Incentive Plan As Amended and Restated filed as part of Company's Proxy Statement dated 10\/4\/93 for its Annual Meeting of Shareholders held 11\/15\/93 and incorporated herein by reference.\n10.11 Syncor International Corporation Deferred Compensation Plan effective July 1, 1991 as Amended and Restated effective April 19, 1993.**\n10.12 Employment Agreement dated July 21, 1993 between the Company and Robert G. Funari.**\n10.13 Syncor International Corporation McGrevin Deferred Compensation Plan effective June 10, 1993.**\n10.14 Split Ownership\/Split Dollar Life Insurance Assignment Agreement effective June 10, 1993 between the Company and Gene R. McGrevin.**\n10.15 Form of Stock Option Agreement substantially as entered into between Company and certain employee Directors and employees.**\n10.16 Form of Stock Option Agreement substantially as entered into between Company and certain non-employee Directors.**\n11. Statement Re: Computation of Per Share Earnings\nComputation can be clearly determined from the material contained in Company's Annual Report to Shareholders for fiscal year ended December 31, 1993.\n13. Annual Report to Security Holders (P)\nSyncor International Corporation Annual Report to Shareholders for the fiscal year ended December 31, 1993, except for specific information in such Annual Report expressly incorporated herein by reference, is furnished for the information of the Commission and is not to be deemed \"filed\" as part hereof. (P)\n21. Subsidiaries of the Registrant\nState of Name of Company Incorporation ___________________ _____________\nSyncor Michigan Corp. Michigan Syncor Corp. New York New York Syncor Management Corporation California Syncor Hong Kong Limited Hong Kong Syncor Taiwan, Inc. Taiwan Syncor Midland, Inc. Texas\n23. Consents of Experts and Counsel\nConsent of KPMG Peat Marwick.**\n** Included herewith (P) Filed on paper\nEXHIBIT 23\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES AND CONSENT\nThe Board of Directors and Stockholders Syncor International Corporation:\nThe audits referred to in our report dated March 10, 1994, included the related financial statement schedules as of December 31, 1993, May 31, 1993 and 1992, and for the seven-month period ended December 31, 1993 and for each of the years in the three-year period ended May 31, 1993, included in the registra- tion statement of Syncor International Corporation. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nWe consent to incorporation by reference in registration statement (No. 33-44395) on Form S-3 and registration statement (No.'s 33-7325, 33-39251, 33-43692, 33-57762 and 33-52607) on Form S-8 of Syncor International Corpora- ion of our report dated March 10, 1994, relating to the consolidated balance sheets of Syncor International Corporation and subsidiaries as of December 31, 1993, May 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity and cash flows and related schedules for the seven-month period ended December 31, 1993 and for each of the years in the three-year period ended May 31, 1993, which report appears in the December 31, 1993 transition report on Form 10-K of Syncor International Corporation. Our report refers to a change in the method of accounting for income taxes.\nLos Angeles, California KPMG Peat Marwick March 29, 1994","section_15":""}
{"filename":"49601_1993.txt","cik":"49601","year":"1993","section_1":"ITEM 1. BUSINESS\nGENERAL\nICN Pharmaceuticals, Inc., its subsidiaries and a 39% owned equity investment (\"ICN\" or the \"Company\") develop, manufacture, distribute and sell pharmaceutical and nutritional products, research chemical and cell biology products and related services, biomedical instrumentation and immunodiagnostic reagents and instrumentation. The Company's pharmaceuticals group is composed of a subsidiary and an equity investment: (i) Viratek, Inc. (\"Viratek\") (ICN's 63%-owned subsidiary, as of March 17, 1994), which conducts clinical research and development on compounds derived from nucleic acids, including ribavirin (VirazoleR), a broad spectrum antiviral agent, and (ii) SPI Pharmaceuticals, Inc. (\"SPI\") (ICN's 39%-owned equity investment, as of March 17, 1994), which manufactures, distributes and sells over 1,000 pharmaceutical and nutritional products, including anti-infectives, dermatologicals, medicated nutritionals and vitamins, anticholinesterases and vision care products in the United States, Yugoslavia, Mexico, Canada and Western Europe. The Company's biomedicals group consists of ICN Biomedicals, Inc. (\"Biomedicals\") (ICN's 69%-owned subsidiary as of March 17, 1994), which manufactures and distributes research chemicals, cell biology products, chromatography materials, immunology instrumentation, environmental technology products, precision liquid delivery instrumentation and immunodiagnostic reagents and instrumentation in the United States, Canada, Mexico, Europe, Australia and Japan. Biomedicals also purchases research chemicals from other manufacturers, in bulk, for repackaging and distributes biomedical instrumentation manufactured by others.\nThe shares of ICN's common stock, $1.00 par value (\"Common Stock\"), are traded on the New York and Pacific Stock Exchanges under the symbol ICN. The shares of common stock of Viratek, SPI and Biomedicals are traded on the American Stock Exchange under the symbols VRA, SPI and BIM, respectively.\nThe Company and its then consolidated subsidiaries changed their fiscal year end from November 30 to December 31, effective for the twelve months ended December 31, 1991. All fiscal years prior to 1991 have not been restated and are shown as the twelve months ended November 30.\nICN controls Viratek and Biomedicals through stock ownership, voting control and board representation and is affiliated with SPI. Certain officers of ICN occupy similar positions with Viratek, SPI and Biomedicals. In addition, certain officers and directors of ICN own common stock or have options to purchase substantial numbers of shares of common stock of Viratek, SPI and Biomedicals. ICN, Viratek, SPI and Biomedicals have engaged in, and will continue to engage in, certain transactions with each other. Viratek and SPI have entered into certain licensing and marketing agreements with each other. Viratek, SPI and Biomedicals sublease space from ICN, and are parties to certain financial arrangements with ICN. There are potential conflicts of interest inherent in such relations and transactions. An Oversight Committee of the Boards of Directors of ICN, Viratek, Biomedicals and SPI was formed to review transactions between or among the four corporations to determine whether a conflict of interest exists among them with respect to a particular transaction and the manner in which such conflict should be resolved. The Oversight Committee consists of one non-management director of each corporation and a non-voting chairman. The Oversight Committee has advisory authority only. See Notes 2, 3, 4, 5 and 6 of Notes to Consolidated Financial Statements.\nDuring 1993, 1992 and 1991, the Company sold 272,500, 348,000 and 200,000 shares, respectively, of Viratek common stock for an aggregate sales price of $3,325,000, $5,243,000 and $2,790,000, respectively, in open market and privately negotiated transactions. In addition, in February and March, 1993, Viratek successfully completed an offering in which Viratek issued 1,581,250 shares (including the exercise of overallotments). In August 1993, a total of 1,366,642 shares were issued by Viratek upon the exercise of warrants. Due to the above transaction and the exercise of employee stock options, ICN's ownership of Viratek has been reduced from 83% at January 1, 1991 to 63% at December 31, 1993.\nAs a result of sales by the Company of shares of SPI common stock during 1992 and 1993, its ownership has dropped from 57% at January 1, 1992, to 48% at December 31, 1992, and to 39% at December 31, 1993. Accordingly, SPI was deconsolidated effective December 31, 1992, and the investment is accounted for by using the equity method of accounting. The Statements of Operations for 1992 and 1991 include the results of SPI on a consolidated basis. See \"Item 1: Business-Recent Events\" and Note 18 of Notes to Consolidated Financial Statements.\nThe Company has been named as a defendant in certain consolidated class action lawsuits relating to ribavirin and the Company's businesses. See \"Item 3. Legal Proceedings.\"\nICN was incorporated under the laws of California in 1960 and in October 1986 reincorporated under the laws of Delaware. ICN's principal executive offices are located at 3300 Hyland Avenue, Costa Mesa, California 92626, telephone (714) 545-0100.\nRECENT EVENTS\nDuring 1991, ICN sold 2,978,250 shares of SPI common stock for an aggregate sales price of $50,863,000, resulting in a net gain of $27,239,000 and used 1,468,000 shares in the acquisition of Galenika (see Note 6 of Notes to Consolidated Financial Statements). During 1992, ICN sold 690,400 shares of SPI common stock and Galenika sold 1,200,000 shares of SPI common stock, transferred in 1991, for an aggregate sales price of $44,608,000, resulting in a net gain to ICN of $32,952,000. During 1993, ICN sold 1,618,200 shares of SPI common stock for an aggregate sales price of $19,995,000. The above noted sales of SPI stock have reduced ICN's ownership of SPI from 57% at January 1, 1992, to 39% at December 31, 1993. Accordingly, SPI was deconsolidated from the Company as of December 31, 1992, the approximate time ICN's ownership fell below 50%. The continuing investment in SPI was classified in the consolidated balance sheet as a long-term investment of the Company at December 31, 1992, and income or loss was recognized using the equity method of accounting during 1993. Prior year results have not been restated.\nOn October 21, 1992, SPI announced that it had concluded an agreement with the Leningrad Industrial Chemical and Pharmaceutical Association to form a pharmaceutical joint venture in Russia, ICN Oktyabr, in which SPI will have a 75% interest. The new joint venture was registered with the Russian Federation on March 9, 1993. The joint venture represents a new business, and not the acquisition of the existing business or assets of Oktyabr. Business operations of the joint venture will commence on the completion of a business plan. Oktyabr, which recently was privatized, will contribute output from its current production facilities. SPI's contribution will be management expertise, technology, equipment, intellectual property, training and technical assistance to the new joint venture. Because of the transition of the Russian economy into a free market oriented economy, SPI plans for a gradual phase-in of the joint venture in 1994 and 1995. During this phase-in period, the joint venture will develop training and marketing strategies and begin constructing a new manufacturing facility in 1995 that is scheduled to be fully operational in 1996. Because of this phase-in period, SPI does not expect any current material effects on its operating results, as well as, its capital resources and liquidity.\nIn addition to the joint venture, on March 24, 1994, SPI entered into an Agreement with the City of St. Petersburg to acquire 15% of the outstanding shares of its joint venture partner, Oktyabr, in exchange for approximately 30,000 shares of SPI's common stock. As part of this Agreement, SPI may qualify to receive newly issued shares of Oktyabr pursuant to Russian privatization regulations that will raise its total investment in Oktyabr to 43%. The issuance of these additional shares is subject to approval and completion of an \"investment plan.\" The completion of the investment plan will not require any additional financial resources of SPI. SPI has also extended an offer to the employees of Oktyabr to exchange their Oktyabr shares for SPI shares. The Oktyabr employees currently own approximately 33% of the outstanding shares, however, the number of employees that will exchange their shares is uncertain. In the event that SPI qualifies under the investment plan to raise its investment to 43%, it is possible that a sufficient number of employees might exchange their Oktyabr shares for SPI shares so that total SPI investment in Oktyabr would exceed 50%. If this event occurs, SPI would be required to consolidate the financial results of Oktyabr into the financial statements of SPI.\n50% of the outstanding shares of Oktyabr, which would require consolidation of Oktyabr into the financial statements of SPI.\nEffective May 1, 1991, SPI formed a new joint company with Galenika Pharmaceuticals headquartered in Belgrade, Yugoslavia. The joint company, ICN Galenika (\"Galenika\") is 75%-owned by SPI and 25%-owned by Galenika Holding (\"Galenika Holding\"). In connection with the joint venture, SPI contributed cash of $14,453,000, an obligation to pay $13,550,000 and ICN, on behalf of SPI, contributed 1,468,000 shares of common stock of SPI, which was owned by ICN, and intangible assets, including pharmaceutical compounds and related patents and licenses. The fair value of the SPI shares transferred to Galenika was $38,528,000, which was recorded as a liability due to the Company. The cost basis of the SPI shares transferred to Galenika were $11,555,000.\nDuring 1992 and 1991, Biomedicals initiated a restructuring program designed to reduce costs and improve operating efficiencies. (See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 14 of Notes to Consolidated Financial Statements.)\nRIBAVIRIN\nRibavirin is a broad spectrum antiviral agent with demonstrated clinical utility against a variety of both DNA-containing and RNA-containing viruses. As of December 31, 1993, ribavirin has been approved for commercial sale in over 40 countries in various formulations for various indications. Within the United States, Canada, and most of Europe, the approved form and use is presently limited to aerosol treatment of hospitalized infants and young children with severe lower respiratory tract infections due to respiratory syncytial virus (\"RSV\"). In other countries, ribavirin has been approved for treatment of one or more of the following: herpes simplex virus, varicella zoster virus (which causes both chicken pox and shingles), exanthemas diseases (chicken pox, measles), influenza, hepatitis, human immuno-deficiency virus (\"HIV\"), and hemorrhagic fever with renal syndrome.\nThe mechanism of action of ribavirin appears to involve more than one process, the importance of which varies depending on the specific virus-host interaction involved. In general, the action of ribavirin is virustatic, leading to interruption of viral replication, rather than virucidal in which the virus would be killed directly. Depending upon the virus involved, virustasis is accomplished through inhibition of proper mRNA capping, direct inhibition of certain virus-specific enzymes, or both.\nViral mRNA capping is required by many viruses for efficient binding of viral genomic \"message\" to host cell polysomes and therefore for efficient mRNA translation into proteins. Test results indicate that viral protein synthesis is significantly reduced in the presence of ribavirin at therapeutic levels with no observed effect on normal host cell protein synthesis.\nCertain viruses encode enzymes in their genome which are required for the virus to replicate. Direct inhibition of such enzymes without affecting host cell enzymes prevents or inhibits viral replication. Examples of viral enzymes inhibited by ribavirin are influenza encoded RNA dependent RNA polymerase, and HIV encoded reverse transcriptase.\nTo date, the Company is aware of no reports of virus mutants that are resistant to inhibition by ribavirin. The emergence of resistant strains of micro-organisms and viruses to widely used therapeutic drugs is a common problem and the Company believes that the apparent lack of this development is an important beneficial feature of ribavirin, particularly when considering possible long-term therapy for diseases such as hepatitis C.\nManagement believes that the most commercial potential for ribavirin in the near term is in the treatment of hepatitis C, RSV, and influenza.\nACQUISITIONS\nSince 1982, the Company has engaged in an ongoing review of potential acquisitions of compatible businesses. The table below summarizes acquisitions completed during the past five fiscal years by the Company. For additional information regarding acquisitions, see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\" and Note 6 of Notes to Consolidated Financial Statements.\nINDUSTRY SEGMENTS\nICN operates in two industry segments: pharmaceuticals and biomedicals. For financial information about industry segments, see Note 12 of Notes to Consolidated Financial Statements.\nFOREIGN OPERATIONS\nThe Company operates in the United States, Yugoslavia, Mexico, Western Europe, Canada and Asia Pacific. For financial information about domestic and foreign operations and export sales, see Note 12 of Notes to Consolidated Financial Statements.\nForeign operations are subject to certain risks, including price and exchange controls, limitations on foreign participation in local enterprises, possible nationalization or expropriation, potential default on the payment of government obligations with attendant impact on private enterprise, political instability, health-care regulation and other restrictive governmental actions. Changes in the relative value of currencies take place from time to time and in the past have affected ICN's results of operations and financial condition. The future effects of these fluctuations on the operations of ICN and its subsidiaries are not predictable. See \"Management's Discussion and Analysis of Financial Condition and Results of Operation--Foreign Currency Translation.\"\nSPI has a 75% interest in ICN Galenika, a Yugoslav joint venture. A substantial majority of ICN Galenika's business is conducted in the Federal Republic of Yugoslavia (Serbia and Montenegro). The current political and economic circumstances in Yugoslavia create certain risks particular to that country. Yugoslavia has been operating under sanctions imposed by the United Nations since May 1992, which have severely limited the ability to import raw materials for manufacturing and have prohibited all exports. In addition, certain risks such as hyperinflation, currency devaluations, wage and price controls, potential government action and a rapidly deteriorating economy could have a material effect on the Company's results of operations.\nINVESTMENT ACCOUNTED FOR USING THE EQUITY METHOD OF ACCOUNTING:\nSPI\nSPI manufactures, distributes and sells over 1,000 pharmaceutical and nutritional products, primarily in the United States, Yugoslavia, Mexico, Western Europe and Canada through independent sales representatives and its own marketing and sales staff. Major product lines as described below include anti-infectives (including antibiotics), medicated nutritionals and vitamins, anticholinesterases and dermatologicals. SPI was organized by ICN in November 1981. Effective January 1983, the Company transferred to SPI, in exchange for all the outstanding shares of common stock of SPI, all the outstanding shares of the Company's wholly-owned Canadian and Mexican subsidiaries and certain assets net of certain liabilities of the Company's operating division in Covina, California. ICN currently owns 39% of SPI.\nPRODUCTS\nAnti-Infectives\nGeneral. SPI currently sells approximately 65 anti-infective pharmaceutical products primarily in North America, Latin America, Western Europe and Eastern Europe. Anti-infective products are used primarily for the therapy of, or prophylaxis against, infections resulting from viruses, bacteria and parasites. SPI manufactures most of these products, and contracts with third parties for the manufacture of the remainder. Anti-infectives constituted 31%, 37% and 36% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively. The more important anti-infective products and their major market territories are as follows:\nVirazole(R). Virazole(R) is currently approved for sale in various pharmaceutical formulations in over 40 countries for the treatment of several different human viral diseases. In North America, Virazole(R) has been approved for hospital use in aerosolized form to treat infants and young children who have severe lower respiratory infections caused by RSV. Substantially similar approvals for Virazole(R) treatment of RSV have been granted by governmental authorities in 22 other countries. The Virazole(R) trademark is used in North America and certain European countries. The product is sold in Latin America as Vilona(R) and Virazid,(R) where it has been commercially available for over 14 years, and is approved for the treatment of hepatitis, herpes infections, influenza, and exhanthemous viral diseases such as measles and chicken pox, as well as RSV. In June 1990, Virazole(R) was approved in the Republic of Ireland for the management of the early stages of human immunodeficiency virus (\"HIV\") infection and in November 1991, the Hungarian government also approved Virazole(R) for early management of the disease in HIV positive patients.\nThe commercial sale of VirazoleR for other indications and presentations will require regulatory authorization in the United States and other countries. There can be no assurance that authorization of the commercial sale of VirazoleR for any other indication or presentation will be obtained in the United States or any other country, or that, if such authorization is secured, the drug will be commercially successful.\nVirazole(R), Vilona(R) and Virazid(R) collectively constituted 7%, 6%, and 16% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nOther Anti-Infectives. Alfacet and Palitrex are cephalosporons manufactured by SPI under license from Eli Lilly while Pentrexl (ampicillin) is licensed from Bristol-Myers Squibb. Anapenil, Trimexazol, Hidro, Rofat, and Yectamicina(R) are standard antibiotics while Dicorvin is a new macrolide antibiotic.\nMedicated Nutritionals and Vitamins\nSPI manufactures, subcontracts, and markets approximately 870 nutritional and vitamin products, in North America, Latin America, Western Europe and Eastern Europe. In Mexico, SPI manufactures and markets injectable and oral multi-vitamins and supplements under the Bedoyecta-Tri(R), Dextrevit(R), M.V.I.(R), and Vi-Syneral(R) trade names. In Yugoslavia, Galenika manufactures and markets Oligovit(R), Beviplex, Bedoxin, and Chymoral 100 Forte. In the United States, SPI markets nutritional and vitamin products under the RichLife(R), Plus(R), Nutri-dyn(R) and Dartell(R) trade names.\nMedicated nutritionals and vitamins constituted 9%, 8%, and 10% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nAnticholinesterases\nSPI markets three anticholinesterase product lines under the trade names Mestinon(R), Prostigmin(R) and Tensilon(R), in North America. These products are used in treating myasthenia gravis, a disease characterized by muscle weakness and atrophy, and in reversing the effects of certain muscle relaxants. These products, for which SPI received a distribution sublicense from ICN in 1988, are manufactured by Hoffmann-LaRoche, Inc. Mestinon(R), Prostigmin(R), and Tensilon(R) collectively constituted 3%, 2%, and 3% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nDermatologicals\nSPI currently manufactures and markets approximately 75 dermatological products, primarily in North America and Eastern Europe. SPI's dermatological line, marketed under the ICN label, consists primarily of products used for the treatment of psoriasis and bleaching agents indicated for the treatment of hyperpigmented skin. These products include Oxsoralen-ultra(R), Solaquin(R), Trisoralen(R) and Eldoquin(R). A related product introduced in fiscal 1988, 8-MOP(R), is indicated for the treatment of cutaneous T-cell lymphoma, a form of skin cancer. Multi-tar(R) is a family of medicated shampoo products. Duonalc(R) is a dermatological solution for the prevention of acne. Dermatological products constituted 7%, 7%, and 6% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nVision Care Products\nSPI manufactures and markets the Unicare(R) line of contact lens and lens care products primarily in Latin America and Western Europe. Vision care products constituted 2%, 2%, and 2% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nOther Products\nSPI also manufactures and markets approximately 200 other pharmaceutical products, including cardiovascular agents, antirheumatics, insulins, analgesics and psychotropics in Eastern Europe, lithium-based products for the treatment of manic depressive syndromes, anti-ulcer medicines, products for hormonal supplementation and various generic pharmaceuticals and surgical products. These products collectively constituted 48%, 44%, and 29% of SPI's consolidated net sales for the years ended December 31, 1993, 1992, and 1991, respectively.\nMARKETING AND CUSTOMERS\nSPI has a marketing and sales staff of approximately 1,320 persons, including sales representatives in North America, Latin America, Western Europe and Eastern Europe, who call on physicians, pharmacists, distributors and other health-care professionals. As part of its marketing program, SPI does direct mailings, advertises in trade and medical periodicals, exhibits products at medical conventions, sponsors medical education symposiums and sells through distributors in countries where it does not have its own marketing staff.\nIn the United States, SPI sells its pharmaceutical products through approximately 400 drug wholesalers who, in turn, distribute them to drug stores and hospitals. SPI's nutritional product line is sold directly and through distributors to various retail outlets and to certain health-care professionals.\nIn Mexico, SPI serves an estimated 18,000 pharmacies through a network of 105 distributors. It also sells directly to approximately 870 pharmacists and 160 hospitals in Mexico.\nIn Western Europe, SPI markets vision care products in the Netherlands through hospitals and pharmacies and to retail customers through optical shops. SPI's Spanish subsidiary sells pharmaceuticals and blood fractionation products via its own sales force to approximately 530 hospitals and retail outlets, 5,000 pharmacies and 200 wholesalers.\nIn Canada, SPI sells VirazoleR for RSV to approximately 1,300 hospitals directly and through wholesalers. The other pharmaceutical products are sold to approximately 5,000 drug stores and are distributed through multiple wholesalers.\nSPI's newest subsidiary, Galenika, is Yugoslavia's largest pharmaceutical manufacturer with an estimated 43% share of the total pharmaceutical market in that country. Galenika sells a broad range of approximately 250 human drugs and approximately 200 veterinary, dental and other over the counter products. Galenika sells products through approximately 30 wholesalers, 6 representative offices and 85 sales representatives countrywide. Prior to the imposition of sanctions in May 1992, over 10% of the total production was exported, mainly to Russia and other Eastern European countries, as well as to many countries in Africa, the Middle East and the Far East. (See Note 18 of Notes to Consolidated Financial Statements.)\nCONSOLIDATED SUBSIDIARIES:\nVIRATEK\nViratek is principally engaged in the development of therapeutic pharmaceutical compounds derived from nucleic acids, including the broad spectrum antiviral agent ribavirin that is marketed in the United States, Canada and most of Europe under the trade name VirazoleR. Viratek was formed in August 1980 for the purpose of continuing the Company's research and development efforts on such compounds. In November 1980, the Company transferred to Viratek all its rights to the compounds developed at a former division of the Company, including the broad spectrum antiviral agent ribavirin. Management believes that ribavirin is the most developed and promising of the many chemical compounds owned by Viratek. See \"Ribavirin\" and \"SPI\" for additional information concerning ribavirin.\nViratek will incur expenses over the next several years for clinical trials in pursuit of FDA authorization of the commercial sale of ribavirin for various indications or presentations, in addition to treatment in aerosolized form of RSV in infants, as well as for foreign government authorizations. To fund these expenditures, Viratek may use cash flow from operations, if available, and may seek to raise additional capital through financing, licensing, joint venture or other arrangements. In February and March 1993, Viratek successfully completed a public offering in which it sold units consisting of one share of Common Stock and one warrant to purchase one share of Common Stock. 1,375,000 units plus the overallotment of 206,250 units were sold for net proceeds of approximately\n$10,265,000. In August 1993, 1,366,642 warrants were exercised resulting in net proceeds to Viratek of $13,472,000. The above transactions along with the sale of ICN owned Viratek shares, reduced ICN's ownership percentage to 63% at December 31, 1993. See Note 3 of Notes to Consolidated Financial Statements.\nThe only product marketed by Viratek was ribavirin. Prior to 1991, Viratek sold ribavirin to SPI, who marketed it to third parties under various licensing and supply agreements with Viratek. During 1991, Viratek transferred its remaining ribavirin inventory to SPI for its net book value of $2,943,000. Since 1991, SPI has procured its ribavirin inventories from other manufacturers. Effective December 1, 1990, SPI and Viratek entered into a new royalty agreement. Under this agreement, SPI acts as Viratek's exclusive distributor of ribavirin and pays Viratek a royalty of 20 % on sales worldwide. SPI intends to pursue its marketing efforts in most countries through existing or future license or distribution arrangements which would minimize SPI's investment in these countries and would generally provide for the sale of ribavirin in bulk or finished form to the licensees or distributors for resale in the specified country.\nBeginning in fiscal 1990, management made the decision to substantially reduce the research and development activities to support the goal of a reduction in the number of research projects and a concentration on compounds and indications showing the most promise for commercial development, such as ribavirin and certain anticancer and immune stimulator agents. This decision was due in part to a reduction in the amount of funds available for research and development. In conjunction with this decision, it was determined that the Company's only operating function would be to receive royalties on worldwide sales of ribavirin. Accordingly, the Company significantly reduced the number of its employees and the level of management involvement. In 1992, Viratek made a decision to increase research and development activities which included developing pharmaceutical products derived from nucleic acids and the development of in vitro commercial diagnostics products. Currently the Company is focusing on clinical testing of VirazoleR in the treatment of hepatitis C and initiating research to develop new biomedical and diagnostic products.\nDuring 1990 and 1991, two phase II studies were being performed by the Karolinska Institute and the National Institutes of Health (\"NIH\") regarding the efficacy of ribavirin in the treatment of chronic hepatitis C. Once the results from the studies were completed, indicating positive results, the Company made the decision to move forward with phase III studies. In addition, the amount of funds available for research and development activities had increased and the Company made the decision to increase these activities. This includes a new research program focused on the detection and measurement of a group of human peptide hormones or regulators and in vitro commercial diagnostics.\nDuring 1993, Viratek substantially completed clinical testing of Virazole for the treatment of chronic hepatitis C and started up a new discovery program using gene specific technology to target diseases such as cancer, chronic viral infections and psoriasis.\nBIOMEDICALS\nBiomedicals develops, manufactures and sells research chemical products, cell biology products, biomedical instrumentation, diagnostic reagents and radiation monitoring services. Major product lines of the research chemical products group include biochemicals, radiochemicals and cell biology products and chromatography materials. Major product lines of the biomedical instrumentation group include microplate instrumentation, environmental technology products and precision liquid delivery instrumentation. The diagnostic reagents group provides diagnostic reagents and instrumentation, including enzyme and radio- immunoassay kits and immunoassay systems. Biomedicals also purchases research chemicals from other manufacturers, in bulk, for repackaging and distributes biomedical instrumentation manufactured by others. Biomedicals' principal customers are life science researchers, including those engaged in molecular biology, genetic engineering and other areas of biotechnology, biochemical research laboratories and clinical laboratories. These customers are located in the United States, Canada, Mexico, South America, Eastern and Western Europe, Australia and Japan. Biomedicals' products are sold through\nCompany-produced catalogs, direct mail advertising, a direct sales force and selected independent distributors and agents.\nBiomedicals was incorporated in September 1983 as a Delaware corporation by ICN and has since operated as an ICN subsidiary. Effective January 1, 1984, ICN transferred to Biomedicals, in exchange for all of the then outstanding shares of common stock of Biomedicals, certain assets and liabilities comprising the Life Sciences Group of ICN. Some of the operations of that group had been conducted by ICN since ICN's inception in 1960. Since 1984, several businesses and product lines have been acquired by ICN on behalf of Biomedicals and subsequently transferred to Biomedicals.\nPRODUCTS\nResearch Chemical Products Group\nBiomedical's research products group markets more than 55,000 chemical, radiochemical, biochemical and immunochemical compounds. These compounds result from chemical synthesis, biochemical (enzymatic) synthesis, and\/or are isolated from natural sources such as micro-organisms, plant, and animal tissues. In addition, the biomedical group offers laboratory plastic ware, medias for cell culture, and materials for chromatography.\nBiochemicals. Biochemicals are chemicals that occur in or result from any life process. The major biochemicals in the research laboratory market include proteins, peptides, amino acids, carbohydrates, enzymes, nucleic acids and their derivatives. Biomedicals repackages and sells, primarily through catalog, spot mailings and telephone solicitation, approximately 35,000 chemical items (including rare and fine chemicals) to customers in approximately 1,500 laboratories worldwide who are largely engaged in organic, inorganic and biochemical experimentation and synthesis. Major products include ammonium sulfate, cesium chloride, guanidine hydrochloride, L-glutamine and ultra-pure tris.\nIn recent years, there has been an increasing demand for ultra-pure biochemicals, particularly for use in molecular biology and medically-oriented research work. Biomedicals has since further expanded its ultra-pure line through the addition of modifying and restriction enzymes, reagents for gel electrophoresis and other chemicals used in various phases of genetic engineering. This includes materials used in recombinant technology such as growth factors, restriction endonucleases (enzymes which \"cut\" DNA material at a specific point) and polynucleotide \"linkers\" which are used to rejoin divided segments of DNA molecules.\nUnder the K&K Laboratories trade name, Biomedicals offers 23,000 rare and fine chemicals consisting principally of organic chemicals, inorganic chemicals, organometallics, rare earth metals and specialty intermediates. These products are used in the chemical, pharmaceutical, aerospace, electronic and educational fields.\nRadiochemicals. Radiochemicals are produced through the combination of radioactive raw materials with non-radioactive chemical intermediates, the resulting products, referred to as \"labeled\" or \"tagged,\" possess one or more radioactive atoms. These isotopes are used by researchers in conjunction with sophisticated measuring instruments to follow or trace the chemical through a biochemical system. Such work helps to determine the mechanisms by which molecules are transformed within living systems, furthering knowledge of genetics, biological and physiological disorders, including hormonal deficiencies, physical abnormalities and a range of organ and endocrinological disorders.\nUsing a variety of multi-step chemical and biochemical procedures, Biomedicals produces in excess of 800 different \"radio active\" or \"labeled\" compounds. The Irvine, California facility uses phosphorus-32, Sulfur-35, Tritium, and Carbon-14 to produce organic molecules for use in a large number of biomedical research applications.\nBiomedicals produces and supplies reactor-produced radionuclides but does not, at this time, refine such products for human use radiopharmaceuticals.\nCell Biology Products Group\nBiomedicals sells a wide range of components for the culturing of cells in an artificial environment under specially controlled conditions. Prior to the sale of the Scottish manufacturing facility in April 1993, Biomedicals manufactured most cell biology products in-house. Biomedicals now procures these products at a lower cost from third party suppliers. Cell culture has become an increasingly important technique for the study of cell behavior, the study of viruses and viral infections, the development and production of vaccines and the testing of new drugs, chemicals, food and toxic substances.\nBiomedicals is a supplier of materials for cell culture and offers a comprehensive range of media, growth factors and sera, as well as a variety of disposable plastic labware and ancillary equipment. Biomedicals chemically defined growth media, which nourish living cells, are used by customers in maintaining or growing cells in the laboratory. Biomedicals also markets processed animal sera (used to enrich media) and uses both raw and processed sera to formulate other products. The availability and costs of raw animal sera may vary and is largely beyond Biomedicals control.\nOther cell biology products include the Titertek-PlusTM family of pipettes and disposable plastic labware.\nChromatography Products. Chromatography products include chemicals known as adsorbents as well as other consumable products, such as nylon membranes, which are used for chromatography, (a scientific method employing sophisticated instrumentation to separate chemical solutions in order to analyze their components). Biomedicals distributes adsorbent products worldwide which are produced for it in Germany.\nBiomedical Instrumentation Group\nBiomedicals biomedical instrumentation group markets microplate instruments, a wide range of precision liquid delivery systems, and gamma counters.\nMicroplate Instrumentation. These products are laboratory instruments serving the needs of all applications utilizing the microtitration plate (microplate) format. Microplates are 96-well trays, about the size of a postcard, that offer a convenient, economical space-saving alternative to test tubes and have become the vessel of choice for biomedical tests. The preeminent microplate application is immunoassays used in diagnostics, public health screening, quality control and research. Biomedicals' TitertekTM product lines offer instruments that address all steps in using microplates including dispensing samples and reagents, reagent displacement (known as microplate \"washing\"), and measurement calorimetric, fluorescent and luminescent test results. The products range from hand operated pipettes to integrated analytical systems.\nPrecision Liquid Delivery Systems. Biomedicals' instrument manufacturing facility in Huntsville, Alabama, produces high precision liquid delivery systems starting with general purpose bench-top stations and extending to customized automated systems incorporating process control, test measurement and data reduction. The liquid delivery products are all complimentary to, and compatible with, the microplate instruments, (both those manufactured in Huntsville and own-label products obtained from third- parties), and this integration of the product lines enhances Biomedicals' ability to offer users a flexible system approach to meeting their evolving laboratory equipment needs.\nGamma Counters. The Huntsville facility also produces gamma counters (instruments that quantify the amount of radioactive \"labels\" incorporated into a sample) used in diagnostics and research. Biomedicals offers a choice of automatic sample-feed and manually loaded batch processing machines, all with a common data analysis and reduction software package.\nAll instrumentation sold by Biomedicals is supported by field and factory service capability. Service contracts are actively sold to the large customer base of long-term users of Biomedicals' instruments.\nDiagnostic Reagents Group\nBiomedicals provides diagnostic reagents and instrumentation to hospitals, clinics and biomedical research laboratories. Immunoassay is a diagnostic technique used to determine the quantity of biological substances present in very low concentrations in body fluids. In the United States alone, more than 5,000 laboratories use the technique in routine clinical diagnostic applications. Biomedicals manufactures both Enzyme-Immunoassay and Radio-Immunoassay kits at its Costa Mesa, California facility and markets these kits under the IMMUCHEM product line. In 1993, Biomedicals developed a line of non-isotopic enzyme-immunoassay used for screening newborns for inherited genetic diseases (\"Neonatal line\"). Biomedicals' strategy is to develop a complete line of reagents to address its strength in the endocrinology and newborn screening product segments. Biomedicals has developed instruments which allow their assays to be automated for moderate to high volume applications in which ease of use and labor productivity are competitive advantages. Biomedicals will continue to add more internally developed products to its Neonatal line in 1994 including a new fully-automated analyzer.\nRadiation Monitoring Services Group\nBiomedicals provides an analytical monitoring service to determine personal occupational exposure to ionizing radiation.\nSince 1973, ICN has provided dosimetry services to dentists, veterinarians, chiropractors, podiatrists, hospitals, universities, governmental institutions, and power plants. ICN's services include both film and Thermo Luminescent (\"TL\") badges in several configurations to accommodate a broad scope of users. This service includes the manufacture of badges, distribution to and from clients, analysis of badges and a radiation report indicating the exposure.\nMarketing and Customers\nBiomedicals marketing operations are headquartered at the corporate offices in Costa Mesa, California. Sales and marketing methods vary according to product group and include direct sales through a field sales force, catalog sales, direct mail campaigns and independent agents\/distributors. Biomedicals has a field sales and marketing organization of 141 persons in the United States and Canada, 73 in Europe, 9 in Australia and 6 in Japan.\nBiomedicals customer group for research products is principally composed of biomedical research institutions, such as universities, the National Institutes of Health, pharmaceutical companies, and, to a lesser extent, hospitals. Customers for diagnostic reagents and instruments are generally clinics, medical offices and hospitals. Customers for Biomedicals' other biomedical instruments include both biomedical research institutions and clinics, medical offices and hospitals. Biomedicals is not materially dependent upon any one customer or a small group of customers and does not believe the loss of any one customer would have a material adverse effect on Biomedicals. However, since a large portion of medical research in both the United States and other countries is funded by governmental agencies, Biomedicals results of operations could be adversely affected by cancellation or curtailment of governmental expenditures for medical research.\nICN currently owns approximately 69% of Biomedicals outstanding common stock as of March 17, 1994.\nCOMPETITION\nBoth segments of the Company operate within highly competitive industries. The competitive position of the Company's products is significantly affected by their acceptance among physicians and scientists and by the development of new products by competitors. A number of companies, both in the United States and abroad, are\nactively engaged in marketing similar products and developing new products similar to those currently under development or proposed for future development by the Company. Most of these companies have substantially greater capital resources, marketing capabilities and larger research and development staffs and facilities than those of the Company. The pharmaceutical industry is characterized by extensive and on-going research efforts. Others may succeed in developing products superior to those presently marketed or proposed for development by the Company. Progress by other researchers in areas similar to those being explored by the Company may result in further competitive challenges.\nBACKLOG\nThe Company does not consider backlog to be a material factor in its pharmaceuticals segment because, as is customary in the industry, its products are sold on an \"open order\" basis. Backlog is not a significant factor for the biomedicals segment as most orders received are filled and shipped promptly after receipt. No single customer accounted for more than 10% of the Company's consolidated net sales during the year ended December 31, 1993.\nRAW MATERIALS\nIn general, raw materials used by the Company in the manufacture of its products are obtainable from multiple sources in the quantities desired. However, the availability and costs of raw animal sera for distribution and for manufacturing certain of Biomedicals cell biology products may vary from time to time and is largely beyond Biomedicals' control. Additionally in the last decade, the number of reactor sites producing radioactive raw materials has diminished.\nDuring 1992, The United Nations Security Council and the United States adopted a resolution that imposed economic sanctions on the Federal Republic of Yugoslavia (Serbia and Montenegro). The sanctions specify that specific authorization in the form of a license must be granted on a transaction by transaction basis from the country of origin and the United Nations before the shipment of raw materials and finished goods can be made into Yugoslavia. Currently, few licenses have been granted for the import of raw materials. It is the policy of the United Nations Sanctions Committee to grant licenses for finished goods, but only for raw materials in exceptional cases. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nLICENSES PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS\nThe Company owns a number of domestic and foreign patents now in force, some of which pertain to products currently being marketed by both the pharmaceuticals and biomedicals segments. The Company may be materially dependent on the protection afforded by their respective patents. No assurance can be given as to the breadth or degree of protection which these patents will afford the Company.\nIn addition, the Company has filed applications for United States and foreign patents based on inventions resulting from the development of its technology. The Company expects to be issued patents in the future, although there can be no assurance as to the breadth or the degree of protection which these patents, if issued, will afford it. In addition to the Company, universities and other public and private concerns have filed patent applications and may be issued patents on inventions (or otherwise possess proprietary rights to technology) useful to the Company. The extent to which the Company may be required to license such patents or other proprietary rights, and the cost and availability of such licenses, are presently unknown. In addition, the Company intends to rely to an extent on unpatented proprietary know-how. However, there can be no assurance that others will not independently develop such know-how or otherwise obtain access to the Company's know-how.\nSPI has acquired from Viratek the rights to market Virazole(R) in Mexico, Canada, the United States and in other countries for all uses. The technology related to these uses of Virazole(R) is broadly covered by a United States patent expiring in 1999. Licensed technology from Viratek relating to Virazole(R) is also covered by United\nStates patents expiring between 1994 and 1999 and Canadian patents expiring between 1994 and 2006. The Company may be materially dependent on the protection afforded by Viratek's patents relating to VirazoleR, and no assurance can be given as to the breadth or degree of protection which these patents will afford Viratek.\nGOVERNMENT REGULATION\nPrior to marketing or manufacturing new products for use by humans, the Company must obtain United States Food and Drug Administration (\"FDA\") approval in the United States and approval from comparable agencies in other countries. Obtaining FDA approval for new products and manufacturing processes can take a number of years and involve the expenditure of substantial resources. The Company must satisfy numerous requirements, including preliminary testing programs on animals and subsequent clinical testing programs on humans, to establish product safety and efficacy. No assurance can be given that authorization of the commercial sale by the Company or its affiliates of any new drugs or compounds for any application will be secured in the United States or any other country, or that, if such authorization is secured, those drugs or compounds will be commercially successful. The FDA and other regulatory agencies in other countries also periodically inspect manufacturing facilities.\nThe Company is subject to licensing and other regulatory control by the FDA, other federal and state agencies and comparable foreign governmental agencies. In addition, Biomedicals is subject to the regulatory control of the Nuclear Regulatory Commission.\nProvisions enacted or adopted by United States federal, state and local agencies regulating the discharge of waste into the environment do not currently have a material effect upon the Company's capital expenditures, earnings or competitive position.\nThe Company has not experienced any material effect on the capital expenditures, earnings or competitive position of the Company as a result of compliance with any federal, state or local provisions regarding the protection of the environment.\nEMPLOYEES\nThe Company currently employs approximately 5,969 persons, which includes 5,420 SPI employees, 4,500 of whom are covered by collective bargaining agreements. The Company has not experienced any significant work stoppage, slowdown or other serious labor problems which have materially impeded its business operations. The Company's management considers its relations with its employees to be satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following are the principal facilities of the Company, its subsidiaries and SPI:\nThe Company's leased facilities are leased for various terms ranging from one to twenty-two years. The Company does not anticipate any difficulty in renewing such leases on expiration, or leasing substitute facilities at reasonable terms. ICN also subleases office and manufacturing space in Costa Mesa, California, to Viratek, SPI and Biomedicals. The High Wycombe facility is currently vacant and available for sublease (See Note 16 of Notes to Consolidated Financial Statements).\nThe Company currently has facilities in Portland, Oregon and Dublin, Virginia which are held for sale and are recorded at the lower of cost or net realizable value in the accompanying financial statements.\nDuring the fourth quarter of 1993, the Company moved its Italian operation from Cassina de Pecchi, a leased facility, back to Opera, an owned facility. The Opera facility was classified as an asset held for sale for the year ended December 31, 1992 and has been reclassified to Property, Plant and Equipment in December 1993.\nIn the opinion of the Company's management, all facilities occupied by the Company are considered adequate for present and expected requirements, and the equipment in use is considered to be in good condition and suitable for the operations involved.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLitigation\nThe Company is a defendant in certain consolidated class actions pending in the United States District Court for the Southern District of New York entitled In re Paine Webber Securities Litigation (Case No. 86 Civ. 6776 (VLB); In re ICN\/Viratek Securities Litigation (Case No. 87 Civ. 4296 (VLB)). The plaintiffs represent alleged classes of persons who purchased ICN, Viratek or SPI common stock during the period January 7, 1986 to and including April 15, 1987. In their memorandum of law, dated February 4, 1994, the ICN Defendants argue that class certification may only be granted for purchasers of ICN common stock for the period August 12, 1986 through February 20, 1987 and for purchasers of Viratek common stock for the period December 9, 1986 through February 20, 1987. The ICN Defendants assert that no class should be certified for purchasers of the common stock of SPI for any period. The plaintiffs allege that during such period the defendants made, or aided and abetted other defendants in making, misrepresentations of material fact and omitted to state material facts concerning the business, financial condition and future prospects of ICN, Viratek and SPI in certain public announcements, Paine Webber, Inc. research reports and filings with the Commission. The alleged misstatements and omissions primarily concern developments regarding VirazoleR, including the efficacy and safety of the drug and the market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. The plaintiffs seek an unspecified amount of monetary damages, together with interest thereon, and their costs and expenses incurred in the action, including reasonable attorneys' and experts' fees. The ICN defendants moved to dismiss the consolidated complaint in March 1988, for failure to state a claim upon which relief may be granted and for failure to plead the allegations of fraud and misrepresentation with sufficient particularity. On September 18, 1992, the Court denied the ICN defendants' motion to dismiss and for summary judgment. The ICN defendants filed their answer on February 17, 1993. On October 20, 1993, plaintiffs informed the Court that they had reached an agreement to settle with co-defendant Paine Webber, Inc. and that they would submit a proposed settlement stipulation to the Court. Expert discovery, which commenced in September 1993, is expected to conclude by the end of April 1994. Plaintiffs' damages expert, utilizing assumptions and methodologies that the ICN Defendants' damages experts find to be inappropriate under the circumstances, has testified that, assuming that classes were certified for purchasers of ICN, Viratek and SPI common stock for the entire class periods alleged by plaintiffs, January 7, 1986 through April 15, 1987, and further assuming that all of the plaintiffs' allegations were proven, potential damages against ICN, Viratek and SPI would, in the aggregate, amount to $315,000,000. The ICN Defendants' four damages' experts have testified that damages are zero. Management believes, having extensively reviewed the issues in the above referenced matters, that there are strong defenses and that the Company intends to defend the litigation vigorously. While the ultimate outcome of these lawsuits cannot be predicted with certainty, and an unfavorable outcome could have an adverse effect on the Company, at this time management does not expect that these matters will have a material adverse effect on the financial position, result of operations or liquidity of the Company. The attorney's fees and other costs of the litigation are allocated equally between ICN and Viratek.\nIn August 1992, an action was filed in United States District Court for the Southern District of New York, entitled Rossi v. ICN Pharmaceuticals, Inc. (Case No. 92 Cir. 4819 (CL6)). The plaintiffs, citing theories of product liability, negligence and strict liability in tort, allege that birth defects in an infant were caused by the mother's exposure to ribavirin during pregnancy. The plaintiff's counsel agreed to place the case on the courts \"suspense calendar\" pending completion of ICN's investigation of the underlying facts. Based on such investigation,\nthe case was dismissed with prejudice pursuant to stipulation by the parties in December 1993. Per the License Agreement, SPI has indemnified Viratek and ICN for lawsuits involving the use of VirazoleR.\nOn September 27, 1993, ICN and Biomedicals filed a complaint in the California State Superior Court for Orange County, California, against GRC International Inc., alleging fraud, negligent misrepresentation in the sale of securities in California and violations of state and federal securities laws. The precise amount of damages is unknown at this time. The lawsuit arises out of the acquisition of all of the issued and outstanding shares of Flow Laboratories, Inc. (\"Flow\") and Flow Laboratories B.V. by Biomedicals in November 1989 from GRC International Inc., (formerly known as Flow General Inc.). Defendant GRC's motion to compel arbitration was granted as to the Biomedicals claims. The action is stayed until April 7, 1994, as to ICN's causes of action.\nOn April 5, 1993, ICN and Viratek filed suit against Rafi Khan (\"Khan\") in the United States District Court for the Southern District of New York. The complaint alleges, inter alia, that Khan violated numerous provisions of the securities laws and breached his fiduciary duty to ICN and Viratek by attempting to effectuate a change in control of ICN while acting as an agent and fiduciary of ICN and Viratek. As relief, ICN and Viratek, among other things, sought an injunction enjoining Khan from effectuating a change in control of ICN and compensatory and punitive damages in the amount of $25,000,000.\nKhan filed a counterclaim on April 12, 1993, naming the then ICN directors and ICN, as a nominal defendant sued only in a derivative capacity.\nThe counterclaim contains causes of action for slander, interference with economic relations, and a shareholders' derivative action for breach of fiduciary duties. Khan seeks compensatory damages for interest in an unspecified amount, and exemplary damages of $29,000,000.\nOn May 13, 1993, following a four-day preliminary injunction hearing, the Court granted ICN and Viratek's motion for a preliminary injunction enjoining \"Khan, directly or indirectly, or anyone acting on his behalf or with him, from seeking to effect a changeover of [ICN], by consent[, proxy solicitation,] or otherwise,\" and also ordered that \"future [SEC] filings should be cleared with the plaintiff and with the Court before they are issued. . . .\"\nOn May 20, 1993, Khan moved in the United States Court of Appeals for the Second Circuit for a stay pending appeal. That motion was denied on the conditions that, pending decision on appeal, \"[the ICN Companies] do not take any steps other than in the normal course of business\" and \"that the shareholders meeting shall be deferred.\" On August 24, 1993, the Appellate Court issued its opinion in which it (i) upheld all findings of fact made by the District Court, (ii) vacated the injunction to the extent it provided for a permanent bar against Khan that prohibited him from effecting a change in control of ICN and required Khan to pre-clear his SEC filings with ICN, and (iii) upheld those partions of the injunction which prevented Khan from going forward with his attempt to effect a change in control of ICN unless and until he filed a 13(d) statement disclosing the existence of a group and filed corrective proxy materials.\nOn September 29, 1993, ICN filed an amended complaint against Khan alleging, among other things, that Khan had violated the Racketeer Influenced and Corrupt Organization Act (\"RICO\") and the securities laws of the United States.\nOn November 26, 1993, following the conclusion of the hearing and oral argument by counsel for the parties, the District Court granted the ICN Companies' fourth application for a preliminary injunction.\nThe District Court denied Khan's request for a stay of the decision pending appeal to the Second Circuit but stayed the decision pending issuance of a written order.\nOn December 10, 1993, the District Court issued a preliminary injunction (the \"Second Preliminary Injunction\") prohibiting Khan from proceeding with his efforts to replace the Board of Directors of the Company by solicitation of proxies or consents or by any other means until such time as Khan filed revised soliciting materials disclosing the District Court findings that (a) Khan's testimony before the District was \"untruthful\" and \"incredible\"; (b) Khan was involved and participated in a scheme to obtain British Gas shares in a manner not permitted by British law; (c) Khan knew he was a subject of the criminal investigation by British law enforcement authorities at the time the criminal investigation began in 1986 or 1987 and has known it throughout his involvement with the Company and his attempts to take it over; (d) Khan participated in the illegal conduct that gave rise to the criminal investigation by British law enforcement authorities; (e) Khan was and is a subject of a criminal investigation by British law enforcement authorities; (f) the British law enforcement authorities obtained and executed a search warrant on or about February 1987 for the search of a house in which Khan had an ownership interest in London, England; and (g) the District Court has made a reference to the United States Attorney's Office for the Southern district of New York to conduct a criminal investigation regarding Khan based on the evidence elicited at the November 1993 evidentiary hearing. The Second Preliminary Injunction also denied Khan's motion for a preliminary injunction without prejudice, held that proxies and consents obtained by Khan prior to corrective disclosure were null and void and ordered the Company to adjourn the stockholders meeting from December 15, 1993 to February 1, 1994.\nOn February 1, 1994, the Company held its 1993 Annual Meeting of Shareholders. The Khan proposals were soundly defeated; the Company received over 90% of the votes cast.\nOn December 22, 1993, Khan filed a notice of appeal from a prior injunction granted by the court, to the Court of Appeals for the Second Circuit. On March 13, 1994, that appeal was dismissed on the grounds that Khan had defaulted for failure to comply with the Court's scheduling order. Management believes that Khan's counterclaim is without merit and the Company intends to vigorously defend this matter.\nThe Company is a party to a number of other pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. In the opinion of management, these other pending lawsuits will not have a material adverse effect on the consolidated financial position or operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of ICN are as follows:\nExecutive officers are elected annually and serve at the pleasure of the Board of Directors. Certain officers of ICN are also officers of Viratek, SPI and Biomedicals. The Company has adopted a charter provision which limits the monetary liability under certain circumstances of its directors and, as a matter of policy, enters into indemnification agreements with certain of its officers and directors to the full extent permitted under Delaware law.\nICN has entered into Employment Agreements with certain senior executives of ICN and its subsidiaries, including certain employees of the Company. Mr. Milan Panic has an Employment Agreement with ICN which expires in November 1994. Messrs. Jerney, Giordani, Watt, and MacDonald have Employment Agreements which are intended to retain the services of these executives for continuity of management in the event of any actual or threatened change in control. Each agreement has an initial term of three years and is automatically extended for one year terms unless either the employee or the Company elects not to extend it.\nMr. Panic is the founder of the Company and has been Chairman of the Board, President and Chief Executive Officer since the Company's inception in 1960, except he did not serve as President from October 16, 1979 to June 30, 1980. Mr. Panic is also Chairman of the Board and Chief Executive Officer of SPI, Biomedicals and Viratek. On July 14, 1992, Mr. Panic became Prime Minister of Yugoslavia and, with the approval of the Company's Board of Directors, took a leave of absence from all duties at the Company while retaining his title as Chairman of the Board. Mr. Panic, with the approval of the respective Boards of Directors of those companies, has taken similar leaves of absence from SPI, Viratek and Biomedicals. Mr. Panic and each of the companies, ICN, SPI, Viratek and Biomedicals, entered into an agreement providing for Mr. Panic's reemployment as Chief Executive Officer upon termination of the leave of absence. Under a license from the United States government, Mr. Panic, an American citizen, was permitted to serve as Prime Minister of Yugoslavia without violating applicable United States laws and regulations concerning sanctions imposed against the Federal Republic of Yugoslavia (Serbia and Montenegro). The license restricted Mr. Panic from engaging in any business with the Company and its affiliates. On March 4, 1993, Mr. Panic completed his service as Prime Minister and returned to the Company as President and Chief Executive Officer.\nMr. Jerney is the Company's Executive Vice President. From July 14, 1992 through March 4, 1993, Mr. Jerney served as interim President and Chief Executive Officer during Mr. Panic's absence. He joined ICN in 1973 as Director of Marketing Research in Europe, and assumed the position of general manager of ICN Netherlands in 1975. In December 1978, he was appointed President of the European Pharmaceutical Group. In May 1981, he was elected Vice President-Operations and in March 1987, President of SPI. Prior to joining ICN he spent four years with F. Hoffmann-LaRoche & Company. Mr. Jerney's primary duties are as President of SPI. He devotes insubstantial time as an officer of the Company.\nMr. Giordani is the Company's Executive Vice President--Finance and Chief Financial Officer. He is also Senior Vice President and Chief Financial Officer of Biomedicals and Vice President--Finance and Chief Financial Officer of Viratek. He joined the Company in June 1986 after serving as Vice President and Corporate Controller of Revlon, Inc. in New York, New York since February 1982. From 1978 until February 1982 he held Deputy and Assistant Corporate Controller positions with Revlon, Inc. He was with Peat, Marwick, Mitchell & Co. from 1969 to 1978. Mr. Giordani's primary duties are as Chief Financial Officer of the Company. The time devoted to Biomedicals and Viratek is insubstantial.\nMr. MacDonald is the Company's Executive Vice President of Taxes and Corporate Development. He is also President of Biomedicals, effective March 18, 1993 which is currently his primary responsibility. He joined the Company in March 1982 as Director of Taxes, has been a Vice President since 1982 and Senior Vice President since 1982. From 1980 to 1982, he served as the Tax Manager of Pertec Computer Corporation. From 1973 to 1980, he was Tax Manager and Assistant Treasurer of Republic Corporation.\nMr. Watt is the Company's Senior Vice President, General Counsel and Secretary. He joined the Company in March 1987 as Assistant General Counsel and Secretary. He was elected Vice-President--Law and Secretary in December 1988. In 1989, Mr. Watt became General Counsel and Secretary of SPI. In January 1992, Mr. Watt was promoted to Senior Vice President at ICN and SPI. From 1986 to 1987, he was President and Chief Executive Officer of Unitel Corporation. He also served as Executive Vice President and General Counsel and Secretary of Unitel during 1986. From 1983 to 1986, he served with ICA Mortgage Corporation as Vice President, General Counsel and Corporate Secretary. Prior to that time, he served with Central Savings Association as Assistant Vice President and Associate Counsel from 1981 to 1983 and as Assistant Vice President from 1980 to 1981. Mr. Watt's primary responsibilities are devoted to SPI. He devotes a portion of time to ICN and an insignificant amount of time to Viratek.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Common Stock is listed and traded on the New York Stock Exchange (Symbol: ICN) and the Pacific Stock Exchange. The following table sets forth the high and low sale prices of the Common Stock for the periods indicated, as reported by the New York Stock Exchange--Composite Tape.\nAs of March 30, 1994, there were 5,383 record holders of the Company's Common Stock.\nThe Company has never paid cash dividends on the Common Stock. The Company anticipates that for the foreseeable future its earnings, if any, will be retained for use in its business and no cash dividends will be paid on the Common Stock. The Board of Directors of the Company will continue to review its dividend policy, and the amount and timing of any future dividends will depend on profitability, the need to retain earnings for use in the development of its business and other factors.\nThe Indentures pursuant to which the 12 7\/8% Sinking Fund Debentures due July 15, 1998 (the \"12 7\/8% Debentures\") and the 12 1\/2% Senior Subordinated Debentures due in 1999 (the \"12 1\/2% Debentures\") were issued, restrict the ability of ICN to declare cash dividends on, and to repurchase, shares of Common Stock and future issuances of Preferred Stock. Under the most restrictive provisions of the Indentures (related to the 12 7\/8% Debentures) the Company may not pay dividends or make distributions on its stock (other than dividends or distributions payable solely in shares of its stock), or purchase, redeem or otherwise acquire or retire any of its stock or permit any of its publicly owned subsidiaries to purchase, redeem or otherwise acquire any of the Company's stock (a) if an event of default (as defined in the Indenture) exists under the Indenture, or (b) if, after giving effect thereto, the aggregate amount of all such dividends, distributions, purchases and payments declared or made after July 24, 1986 would exceed the sum of (i) 20% of the Company's consolidated net income (as defined in the Indenture) subsequent to May 31, 1986, (ii) the net proceeds to the Company from the issuance or sale after July 24, 1986, of any shares of its Common Stock and capital stock of its subsidiaries and of any convertible securities which have been converted into its Common Stock, and (iii) $10,000,000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain selected consolidated financial data for the years ended December 31, 1993, 1992 and 1991, the one month ended December 31, 1990, and for each of the years in the two-year period ended November 30, 1990. The financial information set forth below should be read in conjunction with, and is qualified in its entirety by, the detailed information and financial statements contained elsewhere in this Form 10-K (in thousands, except per share data).\nBALANCE SHEET DATA (IN THOUSANDS):\n(1) As a result of the decline in ICN's percentage of ownership in SPI, the balance sheet of SPI was deconsolidated, effective December 31, 1992, and the investment is included as a long-term investment accounted for using the equity method of accounting. Results of operations of SPI are included for the entire 1992 year as ICN's ownership fell below 50% in December of 1992. See Note 17 of Notes to Consolidated Financial Statements.\n(2) Includes the results of Galenika, a subsidiary of SPI, from the effective date of acquisition.\n(3) The Company changed its fiscal year end from November 30 to December 31, effective December 31,1991. For financial statement purposes, the Company's separate results of operations for the monthof December 1990 are not reflected in the Statement of Operations but have been charged directly to retained earnings.\n(4) See Note 11 of Notes to Consolidated Financial Statements for details.\n(5) See Note 14 of Notes to Consolidated Financial Statements for details.\n(6) Includes, in 1993, $17,698,000 of cash and certificates of deposit which is to be used exclusively Viratek for research and development and its general working capital requirements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nINTRODUCTION\nEffective December 31, 1992, ICN's ownership percentage of SPI fell below 50% resulting in the deconsolidation of SPI in the Company's consolidated financial statements effective as of December 31, 1992. The investment in SPI is currently accounted for using the equity method of accounting. The prior year results of operations have not been restated. Unless otherwise indicated, all references in this Management's Discussion to 1992 and 1991 include the consolidated results of operations of SPI.\nThe Company has reported net losses for 1993 and 1992 of $11,270,000 and $64,802,000, respectively, and net income for 1991 of $5,855,000. The loss in 1993 was lower than in 1992 primarily as a result of the absence of a restructuring charge in 1993. The net loss in 1992 compared to net income in 1991 was primarily due to restructuring charges of $63,032,000 in 1992, related to the write-off of intangibles associated with Flow and other acquisitions and other charges associated with the Biomedicals restructuring, including the increase in 1992 over 1991 of foreign translation losses of $17,131,000.\nRESULTS OF OPERATION--1993, 1992 AND 1991\nFollowing are the 1993 results of operations and a proforma ICN statement of operations for 1992 as if SPI had been accounted for using the equity method of accounting (000's omitted):\nThe following discussions of the results of operations gives effect to the deconsolidation of SPI as if it had occurred at January 1, 1992.\nPharmaceuticals Group\nNet royalties from the sales of Virazole by SPI were $5,903,000 for the year 1993 compared to $5,448,000 for the year 1992. The increase in royalty income was due to increased sales in Mexico resulting from the introduction of ribavirin creme used for the treatment of herpes and additional marketing efforts by SPI in 1993, which included offering volume discounts.\nThe equity in earnings of SPI decreased to $11,646,000 in 1993 compared to $20,773,000 in 1992. This reduction was due to a reduction in SPI's net income in 1993 compared to 1992 of $12,993,000 coupled with a reduction in the Company's ownership interest in SPI, 48% at December 31, 1992 compared to 39% at December 31, 1993.\nThe reduction in the net income of SPI in 1993 was primarily due to lower results at Galenika. The income before provision for income taxes and minority interest of Galenika was $310,000 in 1993 compared to $38,518,000 in 1992. The United Nations sanctions on Yugoslavia and price controls imposed by the Yugoslavian government have impacted the sales at Galenika, both in terms of a decrease in unit sales and a change in product mix. Additionally, sales have been adversely impacted by inflation and by larger and more frequent devaluations in 1993 compared to the prior year. The raw materials that Galenika imports are primarily used in the production of drugs. Due to shortages of these materials, Galenika has shifted its production and sales efforts to its veterinary and parapharmaceutical product lines. For the year ended December 31, 1993, sales of drugs represented 73% of Galenika total sales compared to 81% in the prior year. Additionally, cost of sales and other expenses at Galenika have increased as a percentage of sales due to the impact of price controls in Yugoslavia, higher labor costs and hyperinflation.\nConsolidated net sales for 1992 rose to $476,118,000, an increase of $111,760,000, or 31% over 1991. The majority of this increase, $101,121,000 was due to a full year of operations for Galenika, a 75% owned Yugoslav subsidiary of SPI (\"Galenika\"), compared to only eight months results of operations in 1991.\nDuring 1991 and the first half of 1992, Galenika was able to increase its prices in anticipation of inflation and currency devaluations, resulting in higher sales levels when compared to the levels of inflation in Yugoslavia. Thus, during this period, Galenika sales on a dollar basis were not significantly impacted. However, beginning in the second half of 1992, sales at Galenika have been somewhat depressed due to the effects of sanctions and price controls in Yugoslavia. See Note 17 of Notes to Consolidated Financial Statements.\nDuring 1992, most of SPI's subsidiaries recorded improved sales over the prior year. Sales in Mexico increased $6,963,000 or 17% compared to 1991, primarily resulting from improved sales of injectable vitamins, Bedoyecta and other key products. Sales in Spain increased $3,526,000 or 16% compared to 1991, due primarily to the introduction of new product lines.\nGross profit as a percentage of SPI net sales increased to 56% in 1992 from 52% in 1991. While SPI experienced gross profit increases in all of its major subsidiaries, the largest increase was recorded at Galenika whose gross profit increased to 53% in 1992 from 47% in 1991. The 1991 Galenika gross profit was adversely impacted by the increase in cost of sales resulting from a purchase accounting adjustment to inventory. Without this item, Galenika's gross profit percentage remained constant in 1992 and 1991 at 53%. Excluding the results of Galenika, the gross profit increased to 62% in 1992 from 60% in 1991 due primarily from improved product mix resulting from increased Virazole(R) sales.\nBiomedicals Group\nIntroduction. At the time of the 1989 acquisition of Flow Laboratories, Inc. and Flow Laboratories B.V., together with their respective subsidiaries (\"Flow\"), Biomedicals believed that the distribution outlets acquired would substantially increase Biomedicals' ability to compete in international markets where it had no significant direct representation. Following the acquisition, Biomedicals attempted to centralize the European marketing and distribution, discontinue certain low margin product lines and shut down excess manufacturing and distribution facilities. These efforts continued in 1992, at which time Biomedicals completed a major restructuring plan. (See Restructuring Costs and Special Charges, below).\nDuring the latter part of 1992 and throughout 1993, Biomedicals realigned its European operations including the distribution network and manufacturing, resulting in reductions in selling, general and administrative costs. Integration of Biomedicals' higher margin \"core\" product lines and elimination of lower gross margin products have contributed to the increase in the overall gross profit margins; however, such actions have not fully mitigated the continuing decline in European sales. Biomedicals' North American sales have remained stable.\nBiomedicals is actively working on the introduction of new products, primarily related to its diagnostic and instrumentation product lines and will be introducing its Dosimetry product line in Europe and Canada. Biomedicals expects these strategies to contribute to increased sales in 1994 and beyond. Absent improvements in the 1994 European operating results, Biomedicals will need to reassess its business strategy and prospects for its European business.\nNet Sales. Net sales were $59,076,000, $75,648,000, and $96,007,000 in 1993, 1992 and 1991, respectively. Net sales were 22% lower in 1993 than in 1992 and 22% lower in 1992 than in 1991. The continuing decline in sales can be attributed primarily to Biomedicals' European operations. This declining trend is due to a variety of factors including the transition from a marketing effort focused on an agency\/distributor network to one based upon catalog distribution, discontinuance of low gross profit margin product lines, competitive pressures, delays in getting new products to markets, and a continuing weakness in government funding for capital equipment purchases.\nCost of Sales. Product cost as a percentage of sales decreased to 47% in 1993 from 59% in 1992 and 54% in 1991. The decrease in product costs in 1993 reflects actions taken by Biomedicals to reduce costs beginning in the latter part of 1992, as discussed further in Restructuring Costs and Special Charges, below. Additionally during 1993, high cost products with lower margins were eliminated, certain production facilities were consolidated or sold, other excess manufacturing facilities were closed down and Biomedicals continued to focus on improving purchasing and manufacturing processes. The increase in product costs in 1992 as compared to 1991 is the result of a writedown of slow moving inventory due to lower than anticipated sales volume. In addition during 1992, the Biomedicals' production facilities and warehousing costs were spread over a reduced sales volume thereby increasing cost of sales as a percentage of sales.\nGross Profit. Gross profit as a percentage of sales was 53%, 41% and 46% in 1993, 1992 and 1991, respectively. Actions taken by Biomedicals in 1992, as described above, resulted in an increase in gross profit as a percentage of sales during 1993. The impact of declining sales increasing product costs, and a writedown of slow moving inventory, as described above, reduced gross profit in 1992 as compared to 1991.\nRestructuring Costs and Special Charges. During 1991, Biomedicals initiated a restructuring program designed to reduce cost and improve operating efficiencies. Accordingly, restructuring costs of $6,087,000 were recorded in 1991. The program included, among other items, the consolidation, relocation and closure of certain manufacturing and distribution facilities, primarily in Milan, Italy and Costa Mesa, California. Those measures, including a fifteen percent reduction in work force, were initiated in 1991 and continued through 1992.\nBiomedicals' sales continued to decline during the first three quarters of 1992 over the same periods in 1991 despite the restructuring program initiated in 1991. The significant decreases were primarily due to operations in\nItaly and other European subsidiaries acquired as part of the Flow acquisition. A further decline in sales of 19.3% or $4,009,000, occurred in the fourth quarter of 1992 compared to the fourth quarter of 1991.\nIn prior years and the first three quarters of 1992, recoverability of goodwill associated with the Flow acquisition was focused, to a major extent, on the European operations, as Biomedicals had only a limited presence in Europe prior to the Flow acquisition. Biomedicals used the expected operating income of the European operations in evaluating the recoverability of the Flow goodwill.\nDuring the fourth quarter of 1992, as a result of the continuing decline in sales and other factors, Biomedicals reassessed its business plan and prospects for 1993 and beyond which included, among other things, the decision to sell the last remaining major European manufacturing facility and to restructure the previously acquired distribution network and European operations in line with the revised sales estimates. Consequently, based upon the continuing decline in European revenue and profitability relating to Flow, Flow facility closures and an ineffective distribution network, Biomedicals' management concluded that there was no current or expected future benefit associated from the Flow acquisition. Accordingly, Biomedicals wrote off the goodwill and other intangibles, primarily from the Flow acquisition, in the amount of $37,714,000.\nIn addition, Biomedicals determined that future benefit could be realized if the distribution activities in Irvine, Scotland, Brussels, Belgium, Cleveland, Ohio, and Horsham, Pennsylvania, were consolidated with other distribution centers in Europe and the U.S., as these operations did not support the costs of maintaining separate facilities. Estimated costs associated with this consolidation effort were included in lease termination costs of $1,434,000, employee termination costs of $1,961,000, facility shut down costs of $357,000 and writedowns to net realizable value totalling $1,106,000 of facilities held for disposition.\nThe Irvine, Scotland facility was vacated in March 1993 and subsequently sold for a gain of $278,000. During the first quarter of 1993, the Horsham, Pennsylvania and Cleveland, Ohio facilities moved to Aurora, Ohio.\nAdditionally, Biomedicals reviewed the ability of the Flow product lines to be effectively integrated into Biomedicals' \"core\" product lines and vice versa. As a result, it was concluded that Flow's distribution network, product lines and business operations were not effectively integrated into Biomedicals' global strategy. Low margin product lines such as cell biology and instruments had become technologically obsolete given the other competitive products on the market. As sales continued to decline the amount of slow moving and potentially obsolete inventory increased. Accordingly, Biomedicals recorded a provision for abnormal writedowns of inventory to estimated realizable value of $9,924,000 and discontinued products of $3,377,000.\nIn addition, Biomedicals determined that the unamortized costs of the catalog marketing program would not be recovered within a reasonable period of time, therefore, it was determined that costs totaling $6,659,000 were written off in the fourth quarter of 1992. Despite the general shortfall in catalog related sales, the catalog marketing approach has firmly established Biomedicals' \"core\" products in the European and Asian-Pacific markets. During 1993, Biomedicals' strategy to redefine the form and use of the catalog to specifically customer focused or \"product-line\" catalogs is believed to be more effective in light of current market conditions. Additionally, radiochemical and cell biology \"mini\" catalogs have been developed. During 1993 and 1994 Biomedicals will continue to use general catalogs and associated direct mail programs for sales activities in biochemical, enzyme immunobiological products and reagents for electrophoresis, but with more focus on product movement and customer needs. The diagnostic instrument and reagent lines will be promoted by media advertising and direct sales activities.\nDiagnostic product development activities are organized to provide an enhanced range of non-isotopic tests, complimenting the existing radio-immuno assays and microplate instrumentation. Biomedicals intends to remain a leader in neonatal screening, and a significant supplier of endocrinology assay kits, test reagents, and infectious disease diagnostics.\nThe Company\nSelling, general and administrative expenses. Selling, general and administrative expenses were $43,690,000 (70% of net sales), $224,235,000 (41% of net sales), and $152,947,000 (33% of net sales) for 1993, 1992 and 1991, respectively. Selling, general and administrative expenses (not including SPI) decreased from $53,859,000 in 1992 to $43,690,000 in 1993. The decrease reflects Biomedicals' efforts to reduce expenses through consolidation of operations and distribution centers and cost controls. This was partially offset by the increased legal costs in defense of the consolidated class action suit and costs associated with the proxy fight initiated in 1993. The increased expenses for 1992 (including SPI) compared to 1991 were primarily a result of provisions for doubtful accounts of $48,279,000 (described below) and termination of employees and early retirement costs at Galenika of $21,065,000. Excluding these provisions, selling, general and administrative costs in 1992 were 28% of net sales. This decrease is primarily due to the lower selling costs and wages at Galenika.\nIn hyperinflationary countries such as Yugoslavia, a devaluation will result in a reduction of accounts receivable and a proportionate reduction in the accounts receivable allowance. The reduction of accounts receivable is recorded as a foreign currency translation loss and the reduction of the allowance is recorded as a translation gain. After a devaluation the level of accounts receivable will rise as a result of subsequent price increases. In conjunction with the rise in receivables, additions to the allowance for receivables will be made for existing doubtful accounts. This process will repeat itself for each devaluation that occurs during the year. The effect of this process results in a high level of bad debt expense that does not necessarily reflect credit risk or difficulties in collecting receivables. In 1992, general and administrative expenses increased significantly due primarily to provisions for doubtful accounts at Galenika of $48,279,000. The reduction of the accounts receivable allowance from devaluations resulted in a translation gain of $40,191,000 resulting in a net expense from bad debts and bad debt translation gain of $8,088,000.\nResearch and development costs. Research and development costs were $5,571,000, $10,718,000, and $6,588,000 for 1993, 1992 and 1991, respectively. Research and development costs increased from $2,882,000 (not including SPI) in 1992 to $5,571,000 in 1993. The increase relates to the higher costs incurred for the hepatitis C clinical trials during 1993 and the additional research and development activities which involve a new pharmaceutical discovery program aimed at developing therapeutic drugs to inhibit disease-causing genes. Research and development costs rose in 1992 (including SPI) compared to 1991 due to expanded research at Galenika and, in 1992, the phase III clinical trials of Viratek relating to hepatitis C.\nWrite-off of goodwill. During 1992, based upon the continuing evaluation of the carrying value of goodwill, the Company made the determination to write off pre November 1970 goodwill, relating primarily to Biomedicals, of $12,062,000. In addition, as a result of the continuing decline in sales at Biomedicals, the Company made the determination to write off $3,300,000 of goodwill relating to purchased subsidiaries.\nGain on Sales of Subsidiaries Stock. During 1993, the Company sold 1,618,200 shares of SPI's common stock and 272,500 shares of Viratek common stock for an aggregate sales price of $19,995,000 and $3,325,000, respectively, in open market and privately negotiated transactions resulted in a gain of $8,345,000. During 1992, the Company sold 1,890,000 shares of SPI's common stock and 348,000 shares of Viratek common stock for an aggregate sales price of $44,608,000 and $5,243,000, respectively, in open market and privately negotiated transactions which resulted in a gain of $37,744,000. During 1991, the Company sold 2,978,250 shares of SPI's common stock and 200,000 shares of Viratek common stock for an aggregate sales price of $50,863,000 and $2,790,000, respectively in open market and privately negotiated transactions which resulted in a gain of $29,797,000.\nTranslation and exchange (gains) losses, net. Translation (gains) losses, net were $(1,292,000), $21,648,000 and $4,517,000 in 1993, 1992 and 1991, respectively. Translation and exchange gains were $1,292,000 in 1993 compared to $3,391,000 (without SPI) in 1992. The decrease is due primarily from the company's conversion of Swiss Franc, Dutch Guilder and ECU debt. During 1992, translation and exchange losses,\nnet (including SPI) increased $17,131,000 over 1991 due to Galenika, a subsidiary of SPI, operating in a highly inflationary economy, coupled with reductions in the level of hard currency as a result of sanctions and the current political and economic unrest.\nInterest income and expense.\nInterest expense decreased from $23,406,000 (not including SPI) in 1992 to $19,589,000 in 1993. The decrease resulted from a reduced level of outstanding debt. Interest expense, remained fairly constant between 1992 and 1991 (including SPI) as a result of a decrease in debt at ICN and Biomedicals offset by an increase in debt at SPI. Interest income (not including SPI) in 1992 was $630,000 which was consistent with 1993. Interest income increased in 1992 from 1991 (including SPI) due primarily to Galenika's cash on deposit outside of Yugoslavia.\nExtraordinary Income. During the second quarter of 1993, Biomedicals' Italian operation negotiated settlements with certain of its suppliers and banks resulting in an extraordinary income of $627,000 or $.03 per share.\nOther, net. A summary of other (income) and expense is as follows (1992 and 1991 includes SPI):\nLitigation. Litigation settlement costs were $1,247,000 in 1992 and $7,143,000 in 1991. The 1992 costs relate to the Baylor College of Medicine arbitration award of $466,000 and additional costs of the Delagrange award. The 1991 charge is attributed to the Delagrange arbitration award against the Company of $7,143,000.\nWrite-Down of Assets. The Company consolidated certain of its operations which resulted in the Company having several idle facilities which the Company intends to sell. The facilities have been written down to their estimated net realizable value which resulted in a charge to operations of $1,000,000 in 1992. In addition, in 1992 due to declining sales relating to Brown Pharmaceutical products the Company wrote off $1,000,000 relating to the Brown Trademark.\nWrite-downs and Other Costs for Domestic Nutritional Group. During 1991 the Company continued to reassess its domestic nutritional business, which had a sales decline of 78% from 1988 to 1991. As a result, SPI wrote off $10,878,000 of assets, principally goodwill and intangibles.\nGain on Lease Termination. During 1993, Biomedicals' Italian operation realized a gain of $938,000 on the favorable termination of certain leasing contracts.\nFavorable Settlement of a Foreign Non-Income Tax Related Tax Dispute and Accrued Liabilities. During 1993, Biomedicals recognized a gain of $430,000 representing a favorable settlement of a foreign non-income tax related tax dispute and a gain of $1,250,000 relating to certain liabilities accrued during 1992 which were settled for less than the original estimate.\nLease Vacancy Costs. During 1993, Biomedicals vacated its High Wycombe facility in England and moved to a facility more suitable to Biomedicals' operating needs in Thames, England. Biomedicals pursued various subleasing agreements for which none were consummated as of December 31, 1993. Consequently, Biomedicals accrued approximately $1,200,000 which represents management's best estimate of the net present value of future leasing costs to be incurred for High Wycombe. During 1993, Biomedicals expensed an additional $236,000 of leasing costs related to High Wycombe.\nWORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES\nCash and marketable securities. At December 31, 1993 and 1992, the Company had cash, including restricted cash, certificates of deposit, and marketable securities of $24,170,000 and $2,622,000, respectively, included in current assets. Included in cash at December 31, 1993 is $17,698,000 which is to be used exclusively by Viratek for research and development and its general working capital requirements. In addition, included in non-current assets at December 31, 1993 and 1992, respectively, are investments in non-current marketable securities of $201,000 and $198,000. At December 31, 1993, the Company had $5,823,000 of margin borrowings collateralized by stock of the Company's subsidiaries owned by ICN.\nDuring 1993, ICN sold 1,618,200 shares of SPI common stock for an aggregate sales price of $19,995,000. During 1992, ICN sold 690,400 shares of its SPI common stock and Galenika sold 1,200,000 shares of SPI common stock, transferred in 1991, for an aggregate sales price of $44,608,000, resulting in a net gain to ICN of $32,952,000. During 1993 and 1992, ICN sold 272,500 and 348,000 shares of Viratek common stock for an aggregate sales price of $3,324,000 and $5,243,000, respectively, resulting in a gain of $2,647,000 and $4,792,000, respectively.\nIn February 1993, Viratek successfully completed an offering in which it sold 1,375,000 units for net proceeds of $8,897,000. Each unit consisted of one share of common stock and one warrant to purchase one unit of common stock at $10.075. In March 1993, the underwriters exercised their option to purchase the overallotment (206,250 units) in connection with the public offering for net proceeds of $1,368,000. The warrants became\nseparately transferable on July 29, 1993 and were exercisable until August 30, 1993 and redeemable by the Company on August 31, 1993 at $.05 per warrant, if not previously exercised. Of the total outstanding warrants, 1,366,642 were exercised resulting in net proceeds to the Company of $13,472,000. Viratek intends to use the net proceeds for research and development activities to fund phase III clinical trials and related project costs to evaluate Virazole in the treatment of hepatitis C and to continue development of certain other anti-cancer and immune-stimulatory compounds of which $7,485,000 has been spent through December 31, 1993, respectively. The balance of the net proceeds will be used for additional research and development activities and general working capital purposes. The additional research and development involves a new pharmaceutical discovery program aimed at developing therapeutic drugs to inhibit disease-causing genes. This research activity, which involves 15 new scientists, is based on antisense technology and is focused on designing new pharmaceuticals to combat cancer, viral diseases and skin disorders.\nDuring 1993 and 1992, the Company issued 3,000,000 and 4,198,000 shares of its common stock for net proceeds of $21,861,000 and $30,608,000, respectively.\nDuring 1993 and 1992, the Company received cash payments from SPI totalling $13,662,000 and $14,987,000, respectively.\nDuring 1993, the Company's primary uses of cash were for the reduction of long-term debt ($32,087,000), interest on its publicly traded debt ($15,628,000), legal and proxy fight expenses ($7,136,000), payments to Biomedicals ($6,783,000), representing Biomedicals operating cash deficiency and Viratek's research and development costs discussed above.\nDuring 1994, the Company anticipates meeting its cash requirements through royalty payments on the sales of ribavirin by SPI, dividends from SPI and collection of the advances due from SPI and the remainder through the use as collateral or additional sales of its common stock or common stock of its subsidiaries or equity investment in order to meet its short term cash requirements or other corporate goals. Management believes that these proceeds, will be sufficient to meet its operating needs during 1994.\nCapital Expenditures. Capital expenditures for property, plant and equipment totaled $2,548,000 in 1993, $12,554,000 (including SPI) in 1992, and $21,046,000 (including SPI) in 1991. The expenditures in 1992 primarily relate to facility improvements of $2,556,000 at Galenika and facility expansion of $4,700,000 at SPI's Mexican subsidiary. The expenditures in 1991 are primarily related to the purchase and improvement of SPI's facility in Spain. The Company does not expect significant capital expenditures through the end of 1994.\nTaxes. The Company has not been required to pay regular federal income taxes in recent years due to the availability of tax loss carryforwards. However, in 1992, the Company was required to pay alternative minimum tax (AMT) due to limitations on the utilization of net operating loss (NOL) carryforwards for AMT purposes. The Company files its federal tax return on a stand-alone basis. In prior years, the Company filed on a consolidated basis with its subsidiaries until the following dates:\nProduct Liability Insurance. In December 1985, after reviewing costs, availability and related factors, management decided not to continue to maintain product liability insurance in the United States subsequent to that time. While the Company has never experienced a material adverse claim for personal injury resulting from allegedly defective products, a substantial claim, if successful, could have a material adverse effect on the Company's liquidity and financial performance. See \"Item 3. Legal Proceedings.\"\nINFLATION AND CHANGING PRICES\nForeign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, fluctuations in the relative values of currencies, political instability and other restrictive governmental actions. Changes in the relative value of currencies occur from time to time and may, in certain instances, materially affect the Company's results of operations.\nFOREIGN CURRENCY TRANSLATION\nThe Company's Consolidated Statements of Operations reflect translation (gains) losses of $(915,000), $21,648,000, and $4,517,0000, in 1993, 1992 and 1991 which are a result of the Company's foreign currency denominated borrowings and investments and relative changes in the value of the U.S. Dollar versus the Swiss Franc, West German Mark, British Pound, Dutch Guilder, Finland Markka, and European Currency Unit in 1993. In addition to these currencies, 1992 and 1991 included the translation effects of the Yugoslavian Dinar.\nACCOUNTING PRONOUNCEMENTS\nDuring November 1992, the Financial Accounting Standards Board (\"FASB\") issued a new accounting standard for employers who provide benefits to former or inactive employees after employment but before retirement, SFAS No. 112 (\"Employers' Accounting for Postemployment Benefits\") which must be implemented for fiscal years beginning after December 15, 1993. This standard is not applicable to the Company as it does not offer benefits after employment but before retirement.\nDuring May 1993, the FASB issued a new accounting standard for accounting for investments, SFAS No. 115 (\"Accounting for Certain Investments in Debt and Equity Securities\"), which must be implemented for fiscal years beginning after December 15, 1993. This standard is currently not applicable to the Company as they do not have debt or equity securities as defined in SFAS No. 115.\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nFollowing is a summary of quarterly financial data for the years ended December 31, 1993 and 1992 (in thousands, except per share amounts):\n(1) Includes a pre-tax restructuring charge of $63,032,000 in the fourth quarter 1992.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES DECEMBER 31, 1993 PAGE ---- REGISTRANT:\nAll other schedules are not submitted because either they are not applicable, not required or because the information required is included in the Consolidated Financial Statements, including the notes thereto.\nSEPARATE FINANCIAL STATEMENTS OF 50 PERCENT OR LESS OWNED COMPANY:\nSchedules supporting the financial statements for the years ended December 31, 1993, 1992 and 1991:\nAll other schedules are not submitted because they are not applicable, not required or because the information required is included in the Consolidated Financial Statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nTo ICN Pharmaceuticals, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedules of ICN Pharmaceuticals, Inc. (a Delaware corporation) and subsidiaries listed on the index on page 33 of this Form 10-K. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nThe Company has had certain transactions with its majority owned subsidiaries and affiliates as more fully described in Notes 2, 3, 4, 5 and 6 to the consolidated financial statements. Whether the terms of these transactions would have been the same had they been between wholly unrelated parties cannot be determined.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ICN Pharmaceuticals, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 1, effective December 31, 1992, the Company changed to the equity method of accounting for a previously consolidated subsidiary.\nCOOPERS & LYBRAND\nLos Angeles, California March 30, 1994\nICN PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nThe accompanying notes are an integral part of these consolidated financial statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nReclassifications\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nPrinciples of consolidation\nThe accompanying consolidated financial statements include ICN Pharmaceuticals, Inc. (\"ICN\"), its 69%-owned subsidiary ICN Biomedicals, Inc. (\"Biomedicals\"), its 63%-owned subsidiary Viratek, Inc. (\"Viratek\") and its 39%-owned equity investment in SPI Pharmaceuticals, Inc. (\"SPI\"). The sale of approximately 9% of SPI's common stock by ICN throughout 1992 reduced ICN's ownership interest in SPI and resulted in the deconsolidation of SPI at December 31, 1992, the approximate time at which ICN's ownership fell below 50%. The continuing investment in SPI was classified as a long-term asset in the consolidated balance sheet and income or loss was, commencing January 1, 1993, recognized using the equity method of accounting. Prior year results have not been restated (see Note 17). All significant intercompany account balances and transactions have been eliminated.\nGoodwill\nThe difference between the purchase price and the fair value of net assets purchased at the date of acquisition is included in the accompanying consolidated balance sheets as Goodwill. Goodwill amortization periods range from 5 to 40 years for acquired businesses and from 10 to 20 years for its publicly-traded subsidiaries and is based on an estimate of future periods to be benefitted. The Company periodically evaluates the carrying value of goodwill including the amortization periods. The Company determines whether there has been permanent impairment in goodwill, as well as, the amount of such impairment, if any, by comparing the anticipated undiscounted future operating income of the acquired entity with the carrying value of the Goodwill. During 1992, the Company wrote off a substantial portion of its goodwill, primarily related to the acquisition by Biomedicals of Flow, as more fully described in Note 14. In addition, on certain portions of goodwill, the amortization period was reduced to primarily five years, which reflects the estimated recovery period.\nAccumulated amortization for goodwill related to purchased businesses was $2,901,000 and $2,548,000 at December 31, 1993 and 1992, respectively. Accumulated amortization for goodwill related to publicly traded subsidiaries was $4,625,000 and $3,413,000 at December 31, 1993 and 1992, respectively.\nCash\nFor purposes of the statements of cash flows, the Company considers highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The carrying amount of those assets approximates fair value due to the short-term maturity of these instruments. Included in cash and certificates of deposit at December 31, 1993, is $9,698,000 and $8,000,000, respectively, which is to be used exclusively by Viratek for research and development and its general working capital requirements.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nMarketable securities\nMarketable securities, which consist of investments in common stocks and bonds, are carried at the lower of aggregate cost or market. The Company realized net (gains) losses of $(139,000), $228,000, and $354,000 related to marketable securities sold during 1993, 1992 and 1991, respectively. Unrealized (gains) losses of $(200,000), $446,000 and $(475,000) were recorded in 1993, 1992 and 1991, respectively.\nInventories\nInventories, which include material, direct labor and factory overhead, are stated at the lower of cost or market. Cost is determined based on a first-in, first-out (FIFO) basis.\nCatalog Costs\nThe initial costs of design, production and distribution of the Company's product catalog are deferred and amortized over its service life, approximately one year. However, for the year ended December 31, 1992, due to the lower than expected sales results, Biomedicals wrote-off these costs in the fourth quarter of 1992. (See Note 14.)\nProperty, plant and equipment\nThe Company uses primarily the straight-line method for depreciating property, plant and equipment over their estimated useful lives. Buildings and related improvements are depreciated from 20-40 years, machinery and equipment over 2-10 years, furniture and fixtures over 1-10 years, and leasehold improvements, including property under capital leases, are amortized over their useful lives limited to the life of the lease.\nThe Company follows the policy of capitalizing expenditures that significantly increase the life of the related assets and charging maintenance and repairs to expense. Upon sale or retirement, the costs and related accumulated depreciation or amortization are eliminated from the respective accounts, and the resulting gain or loss is included in income.\nNotes Payable\nThe Company classifies bank borrowings with initial terms of one year or less as Notes Payable. These notes bear interest at rates of 6.0% to 16.2%. The carrying amount of Notes Payable approximates fair value due to the short-term maturity of these instruments.\nForeign Currency Translation\nThe assets and liabilities of the Company's foreign operations, except those in highly inflationary economies, are translated at the end of period exchange rates. Revenues and expenses are translated at the average exchange rates prevailing during the period. The effects of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated in stockholders' equity. The monetary assets and liabilities of foreign subsidiaries in highly inflationary economies are remeasured into U.S. dollars at the year-end exchange rates and non-monetary assets and liabilities at historical rates. In\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\naccordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation,\" the Company has included in operating income all foreign exchange gains and losses arising from foreign currency transactions and the effects of foreign exchange rate fluctuations on subsidiaries operating in highly inflationary economies. The (gains) losses included in operations from foreign exchange translation and transactions for 1993, 1992 and 1991 were $(1,292,000), $21,648,000 (including SPI), and $4,517,000 (including SPI), respectively.\nIncome Taxes\nIn January 1993, the Company adopted Statement of Financial Accounting Standards No. 109, (SFAS 109) \"Accounting for Income Taxes\". SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactment of changes in the tax law or rates. Previously, the Company used the SFAS 96 asset and liability approach that gave no recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. The adoption of SFAS 109 did not result in a cumulative effect adjustment in the statement of operations.\nPer share information\nPer share information is based on the weighted average number of common shares outstanding and dilutive common share equivalents (19,813,000 in 1993, 14,010,000 in 1992 and 12,829,000 in 1991). Common share equivalents in 1991 represent shares issuable for outstanding options and warrants, on the assumption that the proceeds would be used to repurchase shares in the open market. Shares issuable for outstanding options and warrants in 1993 and 1992 were excluded since the effect would have been antidilutive. For purposes of calculating per share information, ICN's share of the income of subsidiaries has been reduced to give effect to the dilution in earnings which would result upon the exercise of options and warrants currently outstanding to purchase subsidiaries' common shares.\n2. SPI PHARMACEUTICALS, INC.\nSPI develops, manufactures, sells and distributes pharmaceutical and nutritional products and services in the United States, Yugoslavia, Canada, Mexico and Western Europe.\nDuring 1991, ICN sold 2,978,250 shares of SPI common stock for an aggregate sales price of $50,863,000, resulting in a net gain of $27,239,000 and used 1,468,000 shares in the acquisition of Galenika (see Note 6). During 1992, ICN sold 690,400 shares of SPI common stock and Galenika sold 1,200,000 shares of SPI common stock, transferred in 1991, for an aggregate sales price of $44,608,000, resulting in a net gain of $32,952,000. During 1993, ICN sold 1,618,200 shares of SPI common stock for an aggregate sales price of $19,995,000, resulting in a net gain of $5,698,000. The above noted 1992 and 1993 sales of SPI stock have reduced ICN's ownership of SPI from 57% at December 31, 1991 to 48% at December 31, 1992 and 39% at December 31, 1993. As a result, effective December 31, 1992, SPI is accounted for by using the equity method of accounting.\nAt December 31, 1993, the investment in SPI exceeded the equity in net assets of SPI by $11,024,000, which amount, is being amortized over 40 years.\nOn November 15, 1993, SPI exchanged $3,075,000 of debt owed to ICN for 200,000 shares of SPI's common stock issued to ICN at a price of $15.38 per share which represented the closing market price of SPI's stock on that date.\nSPI has granted options for the purchase of 2,508,315 shares of its common stock. At December 31, 1993, ICN's percentage ownership of SPI would have decreased from 39% to 35% if these options were exercised.\nAt December 31, 1993, ICN owned 7,853,454 shares of SPI common stock which had an aggregate value of approximately $113,875,000, based upon the quoted market price per share of SPI common stock at that date. This amount, however, is not necessarily indicative of the realizable value in the open market.\n3. VIRATEK, INC.\nViratek's primary purpose is to conduct research and development on compounds derived from nucleic acids and to develop new biomedical and diagnostic products.\nDuring 1993, 1992 and 1991, ICN sold 272,500, 348,000 and 200,000 shares of Viratek common stock for an aggregate sales price of $3,325,000, $5,243,000 and $2,790,000, respectively, resulting in a gain of $2,647,000, $4,792,000 and $2,558,000, respectively. These sales, in addition to shares issued in connection with the exercise of employee stock options and the shares issued in the offering discussed below, have reduced ICN's ownership from 83% at January 1, 1991, to 63% at December 31, 1993.\nIn February 1993, Viratek successfully completed an offering in which it sold 1,375,000 units for net proceeds of approximately $8,897,000. Each unit consists of one share of common stock and one warrant to purchase one unit of common stock at $10.075. On March 19, 1993, the underwriters exercised their option to purchase the overallotment (206,250 units) in connection with the public offering for net proceeds of $1,368,000. The warrants became separately transferable on July 29, 1993 and were exercisable until August 30, 1993 and redeemable by the Company on August 31, 1993 at $.05 per warrant if not previously exercised. A total of 1,366,642 warrants were exercised resulting in net proceeds to the Company of $13,472,000.\nGoodwill related to publicly traded subsidiaries at December 31, 1993 includes $6,677,000, net of amortization, related to purchases of Viratek common stock.\nViratek has granted options for the purchase of 877,222 shares of its common stock. At December 31, 1993, ICN's percentage ownership of Viratek would have decreased from 63% to 60% if these options were exercised. In December 1993, Viratek declared a stock dividend of 5%.\n4. ICN BIOMEDICALS, INC.\nBiomedicals manufactures and distributes research chemical products, cell biology products, chromatography materials, immunology instrumentation, environmental technology products, precision liquid delivery instrumentation and immunodiagnostic reagents and instrumentation in the United States, Canada, Mexico, South America, Eastern and Western Europe, Australia and Japan. Biomedicals also purchases research chemicals from other manufacturers, in bulk, for repackaging and distributes biomedical instrumentation manufactured by others.\nDuring the second quarter of 1993, Biomedicals' Italian operation negotiated settlements with certain of its suppliers and banks resulting in an extraordinary income of $627,000 or $.03 per share.\nOn December 31, 1992, Biomedicals exchanged, in a non-cash transaction, $11,250,000 of debt owed to ICN in exchange for 3,214,286 shares of Biomedicals' common stock issued to ICN at a price of $3.50 per share which represented the closing market price of the stock at that date.\nOn December 31, 1992, Biomedicals transferred $5,747,000 of debt owed to a major supplier to ICN. ICN became primarily liable for the debt and Biomedicals became guarantor.\nOn April 1, 1992, Biomedicals transferred, in a non-cash transaction, $13,072,000 of debt with First City Bank of Texas- Houston N.A., to ICN. Biomedicals, in exchange, issued 2,412,449 shares of Biomedicals' common stock at a price of $5.42 per share which represented the closing market price of the stock at that date less a discount of 15%.\nOn March 31, 1992, Biomedicals transferred, in a non-cash transaction, $2,711,000 of debt owed to Skopbank of Finland to ICN. Biomedicals, in exchange, issued 500,334 shares of Biomedicals' common stock at a price of $5.42 per share which represented the closing market price of Biomedicals' stock on that date less a discount of 15%. ICN became primarily liable for the debt and Biomedicals became guarantor.\nOn March 31, 1992 Biomedicals exchanged, in a non-cash transaction, $4,837,000 of debt owed to ICN for 892,703 shares of Biomedicals' common stock issued to ICN at a price of $5.42 per share which represented the closing market price of the stock at that date less a discount of 15%.\nOn December 31, 1991, Biomedicals issued, in a non-cash transaction, 3,363,298 shares of Biomedicals' common stock to ICN at a price of $6.25 which represented the fair market value of Biomedicals' stock at that date in exchange for debt owed ICN in the amount of $18,167,523.\nOn March 1, 1991, Biomedicals, pursuant to a fairness opinion, exchanged, in a non-cash transaction, $3,833,000 of advances due to ICN into 538,000 shares of Biomedicals' common stock, issued at a price of $7.125 which represented the fair market value of Biomedicals' stock at that date less a discount of 22%.\nOn August 30, 1993, Biomedicals issued 300,000 shares of a new series \"A\" of its non-convertible, non-voting, preferred stock valued pursuant to a fairness opinion, at $30,000,000 to the Company. In exchange, the Company delivered 4,983,606 shares of Biomedicals' common stock that ICN owned and exchanged intercompany debt owed to ICN by Biomedicals in the amount of $11,000,000.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nIn addition, on August 30, 1993, Biomedicals issued 390,000 shares of a new series \"B\" of its non-convertible, non-voting, preferred stock valued pursuant to a fairness opinion, at $32,000,000 to the Company. In exchange, ICN delivered to Biomedicals 8,384,843, shares of Biomedicals' common stock that ICN owned.\nAs a result of this exchange, Biomedicals had 9,033,623 common shares issued and outstanding.\nSubject to declaration by Biomedicals' Board of Directors, the new series \"A\" preferred stock pays an annual dividend of $8, noncumulative, payable quarterly and the new series \"B\" preferred stock pays an annual dividend of $10, noncumulative, payable quarterly. Both series \"A\" and \"B\" preferred stock become cumulative in respect to dividends upon certain events deemed to be a change in control, as defined by the certificates of designation. The series \"B\" preferred dividends are subject to the prior rights of the holders of the series \"A\" preferred stock and any other preferred stock ranking prior to the series \"B\" preferred.\nThe series \"A\" preferred stock is senior in ranking to the series \"B\" preferred stock and the series \"B\" preferred stock is senior to Biomedicals' common stock as to voluntary or involuntary liquidation, dissolution or winding up of the affairs of Biomedicals, after payment or provision for payment of the debts and other liabilities of Biomedicals. The holders of the series \"A\" preferred shares are entitled to receive an amount in cash or in property, including securities of another corporation, equal to $100 per share in involuntary liquidation or $106 per share in voluntary liquidation prior to August 31, 1994 and declining ratably per year to $100 per share after 1998, plus dividends, in the event dividends have become cumulative. the holders of the series \"B\" preferred shares are entitled to receive an amount in cash or in property, including securities of another corporation equal to $100 per share in voluntary or involuntary liquidation, plus dividends, in the event dividends have become cumulative.\nThe series \"A\" and \"B\" preferred shares are redeemable, for cash or property, including securities of another corporation, in whole or in part, at the option of Biomedicals only, subject to approval by a vote of a majority of the independent directors of Biomedicals. The series \"A\" preferred shares are redeemable at $106 per share prior to August 31, 1994 and declining ratably per year to $100 in 1998, plus dividends, in the event dividends have become cumulative. The series \"B\" shares are redeemable at $100 per share, plus dividends, in the event dividends have become cumulative.\nNo dividends were declared on the series \"A\" or series \"B\" preferred stock during 1993.\nGoodwill related to publicly traded subsidiaries at December 31, 1993 includes $3,975,000, net of amortization, related to purchases of Biomedicals' stock.\nBiomedicals has granted options for the purchase of 2,419,830 shares of its common stock. At December 31, 1992, ICN's percentage ownership of Biomedicals would have decreased from 69% to 44% assuming exercise of all options and exchange of all the Bio Capital Holding Exchangeable Certificates (see Note 7).\n5. RELATED PARTY TRANSACTIONS\nGeneral\nICN controls Biomedicals and Viratek through stock ownership, voting control and board representation and is affiliated with SPI. Certain officers of ICN occupy similar positions with SPI,\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nBiomedicals and Viratek. ICN, SPI, Biomedicals and Viratek (collectively, the \"Affiliated Corporations\") have engaged in, and will continue to engage in, certain transactions with each other.\nAn Oversight Committee of the Boards of Directors of the Affiliated Corporations reviews transactions between or among the Affiliated Corporations to determine whether a conflict of interest exists among the Affiliated Corporations with respect to a particular transaction and the manner in which such conflict can be resolved. The Oversight Committee has advisory authority only and makes recommendations to the Boards of Directors of each of the Affiliated Corporations. The Oversight Committee consists of one non-management director of each Affiliated Corporation and a non-voting chairman. The significant related party transactions have been reviewed and recommended for approval by the Oversight Committee, and approved by the respective Boards of Directors.\nRoyalty agreements\nEffective December 1, 1990, SPI and Viratek entered into a new royalty agreement. Under this agreement, SPI continued to act as Viratek's exclusive distributor of ribavirin and pays Viratek a royalty of 20% on sales worldwide for a term of 10 years with an option by either party to extend it for an additional 10 years. Royalties to Viratek under this agreement for 1993, 1992 and 1991 were $5,903,000, $5,448,000 and $4,263,000, respectively. Included in royalties for 1993, 1992 and 1991 are royalties earned on foreign sales by SPI totalling $2,107,000, $1,472,000 and $1,189,000, respectively.\nDuring 1991, SPI purchased $235,000 of ribavirin from Viratek and also transferred $2,943,000 of VirazoleR from Viratek at its cost.\nUnder an agreement between ICN and the employer of a director of Viratek, SPI is required to pay a 2% royalty to the employer on all sales of VirazoleR in aerosolized form. Such royalties for 1993, 1992 and 1991 were $422,000, $430,000, and $313,000, respectively.\nIn July 1988, SPI began marketing products under license from ICN for the treatment of myasthenia gravis, a disease characterized by muscle weakness and atrophy. ICN charged SPI royalties at 9% of net sales. Effective September 1, 1990, SPI prepaid royalties to ICN in the amount of $9,590,000. There are no future royalties due to ICN for these products.\nBeginning December 1986, SPI began selling Brown Pharmaceuticals, Inc. products under license from ICN. ICN charges SPI royalties at 8 1\/2% of net sales. During 1993, 1992 and 1991 SPI paid ICN $218,000, $65,000 and $93,000, respectively, in royalties under this arrangement.\nCost allocations\nThe Affiliated Corporations occupy ICN's facility in Costa Mesa, California. In each of 1993, 1992 and 1991, ICN charged facility costs of $279,000, $310,000 and $30,000 to SPI, Biomedicals and Viratek, respectively. The costs of common services such as maintenance, purchasing and personnel are paid by SPI and allocated to ICN, Biomedicals and Viratek based on services utilized. The total of such costs were $2,584,000 in 1993, $2,556,000 in 1992 and $2,617,000 in 1991 of which $1,733,000, $1,679,000 and $1,568,000 were allocated to the Affiliated Corporations, respectively. Effective January 1, 1993, ICN reimburses Biomedicals for those allocations which are in excess of the amounts determined by Biomedicals' management\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nusing competitive data, as reviewed and recommended by the Oversight Committee, that would have been incurred by the Company if it operated in a facility suited solely to its requirements. During 1993, such reimbursements totalled $772,000.\nDuring 1991, Viratek began renting certain office equipment to ICN for use at the Costa Mesa facility. Rent is being charged at the rate of $20,000 per month through 1993, renewable annually. During 1993, 1992 and 1991 Viratek charged ICN $240,000, $240,000 and $120,000, respectively.\nIt is management's belief that the methods used and amounts allocated for facility costs and common services are reasonable based upon the usage by the respective companies.\nInvestment policy\nICN and its affiliates have a policy covering intercompany advances and interest rates, and the types of investments (marketable equity securities, high-yield bonds, etc.) to be made by ICN and its affiliates. As a result of this policy, excess cash is transferred to ICN. The affiliates are credited with interest income based on prime (6% at December 31, 1993) less 1\/2% and are charged interest at the prime rate plus 1\/2% on the amounts invested or advanced.\nSPI had outstanding borrowings from ICN in the amount of $18,313,000 and $30,433,000 as of December 31, 1993 and 1992. During 1993, 1992 and 1991, ICN charged (credited) SPI interest of $800,000, $1,195,000 and ($2,486,000), respectively. During 1993 and 1992, SPI reclassified its Biomedicals intercompany receivable of $2,333,000 and $3,631,000 and its Viratek intercompany payable of $5,228,000 and $6,332,000, respectively, to SPI's ICN intercompany account resulting in a net increase in SPI's liability to ICN of $2,895,000 and $2,701,000, respectively.\nDuring 1993 and 1992, Viratek reclassified $272,000 and $536,000 of intercompany payables to Biomedicals to ICN and reclassified $5,228,000 and $6,332,000 of intercompany receivables from SPI to ICN, which resulted in a receivable of $15,528,000 and $9,325,000 due from ICN at December 31, 1993 and 1992, respectively. Viratek earned interest income of $714,000, $239,000 and $271,000 from ICN on the average balance outstanding during 1993, 1992 and 1991.\nDuring the year ended December 31, 1993 and 1992, Biomedicals reclassified its SPI intercompany payable of $2,333,000 and $3,631,000, and its Viratek intercompany receivables of $272,000 and $536,000 to ICN, resulting in intercompany payables of $5,932,000 and $8,414,000 to ICN as of December 31, 1993 and 1992, respectively. ICN charged (credited) $420,000, $314,000 and ($218,000) to Biomedicals for interest on the average balance outstanding during 1993, 1992 and 1991, respectively.\nOther\nCertain outside directors have provided legal and other consultation services to ICN, which amounted to $148,000, $811,000 and $58,000 during 1993, 1992 and 1991, respectively.\nDuring first quarter 1993, Biomedicals transferred its Dublin, Virginia, facility to ICN in exchange for a reduction in the intercompany amounts due to ICN of $586,000 representing the net book value at the date of the transfer.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nEffective January 1, 1992, Viratek and Biomedicals entered into an agreement whereby Biomedicals agreed to transfer rights, title and interest in certain of its research and development assets to Viratek. Biomedicals shall retain a right of first refusal to the marketing and distribution rights for any product developed from the transferred assets and pay a royalty to Viratek. Future royalties will be recognized as income when earned. During 1993 and 1992 there have been no sales of product subject to this royalty.\nIn 1991 SPI's 75%-owned subsidiary, Galenika, purchased equipment from Viratek at its net book amount of $333,000.\nIn 1991, SPI's Mexican subsidiary purchased inventory from Biomedicals for approximately $500,000, which was returned for credit in 1992.\nDuring 1991, ICN transferred to SPI an idle manufacturing facility in Brooksville, Mississippi at its net book amount of $3,114,000.\nSince SPI assumed production and sales of Virazole, effective March 1, 1991, Viratek transferred to SPI all inventory at its net book amount of $2,943,000.\nDuring 1991, Biomedicals charged $250,000 to SPI representing costs expended by Biomedicals for a product development program launched for SPI which SPI determined not to pursue.\nEffective May 1, 1991, Viratek and ICN transferred the rights to four compounds, in various stages of development, to SPI for $1,350,000 and $250,000, respectively, plus a royalty of 6.8% of future sales representing a non-cash transaction. These amounts have been credited to additional capital. Future royalties will be recognized as income when earned. During 1993 and 1992, there have been no sales of product subject to this royalty. Viratek has reclassified the intercompany receivable from SPI to a receivable due from ICN in the amount of $1,350,000.\nSee Note 4 \"ICN Biomedicals, Inc.\" concerning Biomedicals' preferred stock transaction.\nSee Note 9 \"Commitments and Contingencies--Other\" concerning transactions with management.\n6. ACQUISITIONS\nEffective May 1, 1991, SPI formed a new joint company with Galenika Pharmaceuticals headquartered in Belgrade, Yugoslavia. The joint company, Galenika, is 75%-owned by SPI and 25%-owned by Galenika Holding (\"Galenika Holding\"). Galenika, the leading pharmaceutical company in Yugoslavia, produces, markets and distributes over 450 pharmaceutical, veterinary, dental and other products in Yugoslavia, Eastern Europe and Russia.\nIn connection with the agreement, the Company contributed assets totaling $58,301,000, consisting of $14,453,000 cash, an obligation to pay $13,550,000 and 1,200,000 unregistered shares of common stock of SPI issued to the employees (\"owners\" in Socialist Yugoslavia) of Galenika Holding with a fair value of $9,000,000. On December 31, 1991, the Company, on behalf of SPI, contributed 1,468,000 shares of common stock of SPI to Galenika with a cost basis of $11,555,000, the minority interest share of the excess of the fair value of the common stock of the Company contributed by ICN and ICN's cost basis or $6,743,000, and\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nacquisition costs of $3,000,000. Under the terms of the Galenika agreement, SPI had an obligation to contribute, in part, $50,000,000 in cash and 1,200,000 shares of SPI stock or $12,000,000 in cash. However, the agreement was subsequently changed in December 1991 whereby the Company, on behalf of SPI, contributed shares of SPI stock in lieu of the $40,000,000 (after a cash payment of $10,000,000) and SPI issued 1,200,000 shares of SPI stock in lieu of cash to comply with the original intent of the parties.\nThe Galenika transaction has been accounted for by the purchase method of accounting, and accordingly, SPI's investment has been allocated, based on SPI's ownership percentage, to the assets acquired and the liabilities assumed based on the estimated fair values at the effective date of formation, May 1, 1991. Assuming that the acquisition of Galenika occurred at January 1, 1991, the Company's 1991 pro forma revenues for the full year ended December 31, 1991, would have been $548,467,000 with net income of $19,825,000. The pro forma information presented does not purport to be indicative of the results that would have been obtained if the operations were combined during the year presented and is not intended to be a projection of future results or trends.\n7. DEBT\nLong-term debt and obligations under capital leases consist of the following:\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nOther long-term debt includes notes payable, mortgages, margin borrowings and the present value of capital lease obligations due in various installments through 2002.\nOn March 25, 1987, the Company completed an underwritten public offering in Switzerland of SFr. 60,000,000 principal amount (approximately $38,961,000) of 3 1\/4% Subordinated Double Convertible Bonds due 1997 \"Double Convertible Bonds\". These bonds are convertible at the option of the holder into one of the following: (1) entirely into 1,500,000 shares of Common Stock of ICN at a conversion price of $26.14 per share (at a fixed exchange rate of SFr.1.53 per $1.00); or (2) entirely into 15,000 shares of common stock of Ciba-Geigy Ltd. at a conversion price of SFr. 4,000 per share; or (3) a combination of 750,000 shares of Common Stock of ICN and 7,500 shares of common stock of Ciba-Geigy Ltd. at conversion prices of $26.14 and SFr. 4,000 per share, respectively, subject to adjustment for dilutive issues. In connection with this offering, the Company placed in escrow 15,000 shares of Ciba-Geigy Ltd. common stock, of which 1,928 shares remain at December 31, 1993 which are reflected in the Consolidated Balance Sheet as investment in other equity securities. Conversions during 1992 and 1991 were not material and there were no conversions during 1993. Fair value of these bonds was approximately $6,021,000 at December 31, 1993.\nIn 1987, Bio Capital Holding (\"Bio Capital\"), a trust established by ICN and Biomedicals, completed a public offering in Switzerland of Swiss Francs (SFr.) 70,000,000 principal amount of 5 1\/2% Swiss Franc Exchangeable Certificates (\"Old Certificates\"). At the option of the certificate holder, the Old Certificates are exchangeable into shares of Biomedicals common stock. Net proceeds were used by Bio Capital to purchase SFr. 70,000,000 face amount of zero coupon Swiss Franc Debt Notes due 2002 of the Kingdom of Denmark (the \"Danish Bonds\") for SFr. 33,772,000 and 15 series of zero coupon Swiss Franc Guaranteed Bonds of the Company (the \"Zero Coupon Guaranteed Bonds\") for SFr. 32,440,000, which are guaranteed by ICN. Each series of the Zero Coupon Guaranteed Bonds are in an aggregate principal amount of SFr. 3,850,000 maturing in February of each year through 2002. ICN and Biomedicals have no obligation with respect to the payment of the principal amount of the Old Certificates since they will be paid upon maturity by the Danish bonds.\nDuring 1990, Biomedicals offered to exchange, to all certificate holders, the Old Certificates for newly issued certificates (\"New Certificates\"), the terms of which remain the same except that 334 shares per SFr. 5,000 principal certificate can be exchanged at $10.02 using a fixed exchange rate of SFr. 1.49 to U.S. $1.00. Substantially all of the outstanding Old Certificates were exchanged for New Certificates (together referred to as \"Certificates\"). This exchange was accounted for as an extinguishment of debt and the effect on net income was not material.\nDuring 1992, Biomedicals repurchased SFr. 5,640,000 of Bio Capital Certificates, representing long-term debt of $1,859,000. During 1991, SFr. 1,245,000 ($918,000) principal amount of Certificates were exchanged into 83,166 shares of Biomedicals' common stock. No repurchases were made in 1993.\nAs of December 31, 1993, the consolidated financial statements include outstanding debt of SFr. 12,534,000 ($8,441,000) which represents the present value of the Company's obligation to pay the Zero Coupon Guaranteed Bonds. When Certificates are exchanged into common stock, Biomedicals' obligation to pay the Zero Coupon Guaranteed Bonds is reduced and the Danish Bonds are released by Bio Capital to Biomedicals, both on a pro rata basis. As of December 31, 1993, SFr. 39,615,000 ($26,677,000) principal of Certificates were outstanding which, if exchanged for common stock, would result in the issuance of 2,608,241 shares of Biomedicals' common stock, a reduction of long-term debt of SFr. 11,330,000 ($7,630,000), a reduction of SFr. 1,204,000 ($811,000) of current maturities of long-term debt, and an increase in marketable\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nsecurities of SFr. 20,204,000 ($13,605,000) from the release of Bio Capital of the Danish Bonds to Biomedicals. Fair value of these bonds was approximately $7,850,000 at December 31, 1993.\nIn October 1986, the Company completed an underwritten public offering of $75,000,000 principal amount of 6 3\/4% Subordinated Convertible Bonds Due 2001 (the \"6 3\/4% Bonds\") convertible into 3,626,692 shares of ICN Common Stock at a conversion price of $20.68 per share, subject to adjustment for dilutive issues. During 1993, $7,824,000 principal amount of the bonds were redeemed at the bondholder's option. Fair value of these bonds was approximately $442,000 at December 31, 1993.\nIn October 1986, Pharma Capital Holdings (\"Pharma Capital\"), a trust established by the Company, completed an underwritten public offering in Europe of ECU 40,000,000 principal amount of 7 1\/4% Exchangeable Certificates Due 1996 (the \"Pharma Certificates\") of which ECU 16,195,000 remain outstanding at December 31, 1993. The Pharma Certificates are exchangeable into 1,936,000 shares of Common Stock of ICN at an initial exchange price of $21.1364 per share, at a fixed exchange rate of ECU .9775 per $1.00. The net proceeds of approximately ECU 19,400,000 were used by Pharma Capital to purchase nine series of Zero Coupon ECU Subordinated Bonds of ICN (consisting of one series, payable in two installments, the first on May 30, 1987 in the amount of ECU 1,756,111 and the second on May 30, 1988 in the amount of ECU 2,900,000, and eight series each in the aggregate principal amount of ECU 2,900,000 maturing on May 30 in each of the years 1989 to 1996) (the \"ICN-ECU Bonds\") and ECU 40,000,000 aggregate principal amount of ECU 200,000,000 Zero Coupon Guaranteed Bonds Due May 30, 1996, Series 119, of The Mortgage Bank and Financial Agency of the Kingdom of Denmark (unconditionally guaranteed by the Kingdom of Denmark). The Company has no obligation with respect to the payment of the face amount of the Pharma Certificates since these are to be paid upon maturity by the Kingdom of Denmark Zero Coupon Guaranteed Bonds (except for payment of certain additional amounts in the event of the imposition of U.S. withholding taxes on either the Pharma Certificates or ICN-ECU Bonds and funds required for redemption of the Pharma Certificates in the event the Company exercises its optional right to redeem). Fair value of these bonds was approximately $3,204,000 at December 31, 1993.\nIn October 1986, Xr Capital Holding (\"Xr Capital\"), a trust established by the Company, completed an underwritten public offering in Switzerland of Swiss Francs 100,000,000 principal amount of 5 5\/8% Swiss Franc Exchangeable Certificates (the \"Xr Certificates\") of which SFr 66,510,000 remain outstanding at December 31, 1993. The Xr Certificates are exchangeable through 2001 for 1,250,000 shares of Common Stock of ICN and 860,000 shares of Common Stock of SPI owned by ICN at initial exchange prices of $24.10 and $35.02 per share, respectively, at a fixed exchange rate of SFr. 1.66 per $1.00. The net proceeds of the offering were used by Xr Capital to purchase from the Company 14 series of Swiss Franc Subordinated Bonds due 1988-2001 (the \"ICN-Swiss Franc Xr Bonds\") for approximately $27,944,000 and SFr. 45,700,000 principal amount of cumulative coupon 5.4 percent Italian Electrical Agency Bonds due 2001 for approximately $27,202,000. The Company has no obligation with respect to the payment of the face amount of the Xr Certificates since these are to be paid upon maturity by the Italian Bonds (except for payment of certain additional amounts in the event of the imposition of U.S. withholding taxes on either the Xr Certificates or ICN-Swiss Franc XR Bonds and funds required for redemption of the Xr Certificates in the event the Company exercises its optional right to redeem). Fair value of these bonds was approximately $14,314,000 at December 31, 1993.\nIn September 1986, the Company completed an underwritten public offering in the Netherlands of Dutch Guilders 75,000,000 principal amount (approximately $32,751,000 at date of issuance) of 6%\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nSubordinated Convertible Bonds due 1990-1994 (the \"Dutch Guilder Bonds\"). These bonds are convertible into 1,259,657 shares of ICN Common Stock at a conversion price of $26 per share at a fixed exchange rate of Dfl. 2.29 per $1.00, subject to adjustment for dilutive issues. Fair value of these bonds was approximately $6,032,000 at December 31, 1993.\nThe Company has the optional right to redeem the 6 3\/4% Bonds, ICN-ECU Bonds, ICN-Swiss Franc Xr Bonds, Bio Certificates, Double Convertible Bonds, and the Dutch Guilder Bonds in the event that the market price of ICN Common Stock meets certain conditions.\nIn July 1986, the Company sold $115,000,000 principal amount of 12 7\/8% Sinking Fund Debentures (the \"12 7\/8% Debentures\"), due July 15, 1998, in an underwritten public offering. The 12 7\/8% Debentures are redeemable, in whole or in part, at the option of the Company, at any time on or after July 15, 1991, at specified redemption prices, plus accrued interest. Mandatory annual sinking fund payments, commencing on July 15, 1994, are calculated to retire 80% of the issue prior to maturity. The indenture imposes limitations on, among other things, (i) the issuance or assumption by the Company or its subsidiaries of additional debt which is senior to the 12 7\/8% Debentures, (ii) dividends and distributions on, or repurchases and redemptions of, Common Stock of the Company and (iii) the Company becoming an investment company. The fair value of these debentures was approximately $72,641,000 at December 31, 1993.\nIn May 1984, the Company completed a public offering of $30,000,000 of 12 1\/2 percent Senior Subordinated Debentures (the \"12 1\/2% Debentures\") due 1999. The 12 1\/2% Debentures provide for annual sinking fund payments of $3,215,000 commencing May 15, 1992. The 12 1\/2% Debentures are redeemable at any time after May 15, 1989 at the Company's option and are subordinated to all senior indebtedness. The net proceeds from the 12 1\/2% Debentures were $21,390,000. The original issue discount and costs associated with the offering are being amortized over the life of the 12 1\/2% Debentures. This results in an effective interest rate to the Company (exclusive of sinking fund requirements) of 16.75%. The indenture agreement for the 12 1\/2% Debentures is less restrictive than the indenture relating to the 12 7\/8% Debentures. The fair value of these debentures was approximately $18,619,000 at December 31, 1993.\nAnnual aggregate maturities of long-term debt, including obligations under capitalized leases subsequent to December 31, 1993 are as follows:\nAt December 31, 1993 and 1992, the Company had $7,600,000 and $16,584,000, respectively, of margin borrowings and notes payable. At December 31, 1993, 1,107,898 and 402,000 shares of ICN-owned shares of SPI and Viratek, respectively, collateralized these borrowings. The Company may use as collateral or sell additional shares of its common stock or common stock of its subsidiaries or equity investment in order to meet its short term cash requirements or other corporate goals.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nThe fair value of the Company's debt is estimated based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The carrying amount of all short-term and variable interest rate borrowings approximates fair value.\n8. INCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). The new statement supersedes the Company's previous policy of accounting for income taxes under Statement of Financial Accounting Standards No. 96 \"Accounting for Income Taxes \" (SFAS 96). Both statements require the use of the liability method of accounting for income taxes, but the recognition of deferred tax assets was limited under SFAS 96. Under SFAS 109, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The change in the method of accounting for income taxes from SFAS 96 to SFAS 109 resulted in no cumulative effect adjustment.\nIncome (loss) before provision for income taxes, minority interests and extraordinary income for 1993, 1992 and 1991, consists of the following:\nThe income tax (benefit) provision consists of the following:\nOf the 1992 current federal tax provision of $5,928,000, $956,000 relates to the tax benefit from the exercise of stock options. Such amount was credited to additional capital.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nThe primary components of temporary differences which give rise to the Company's net deferred taxes are as follows:\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nA reconciliation of the federal statutory income tax rate to the Company's effective income tax rate is as follows:\nThe Company files its Federal income tax return on a stand-alone basis. In years prior to 1993, tax sharing agreements allocated taxes for periods when a subsidiary was included in the Company's consolidated tax return. The following table indicates inclusion of subsidiaries in the Company's consolidated tax return.\nThe Company conducts business in a number of different tax jurisdictions. Accordingly, losses sustained in one jurisdiction generally cannot be applied to reduce taxable income in another jurisdiction. The income of certain foreign subsidiaries is not subject to U.S. income taxes, except when such income is paid to the U.S. parent company or one of its domestic subsidiaries. No U.S. taxes have been provided on the Company's foreign subsidiaries since management intends to reinvest those amounts in foreign operations. Included in consolidated retained earnings (deficit) at December 31, 1993 is approximately $1,820,000 of accumulated earnings of foreign operations that would be subject to U.S. income taxes if and when repatriated.\nThe Company has domestic net operating loss carryforwards (\"NOL\") of approximately $190,000,000 (of which $17,800,000 will be credited to additional capital when utilized) at December 31, 1993, expiring at various dates from 1994 through the year 2008.\nIncluded in the $190,000,000 NOL is approximately $47,500,000 of NOL attributable to Viratek. Of the $47,500,000 NOL attributable to Viratek, $10,900,000 will be credited to capital when utilized. Viratek's\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nNOL can only be utilized by the Company to offset Viratek taxable income generated on a separate company basis.\nAlso included in the $190,000,000 NOL is approximately $39,000,000 of domestic NOL and $38,000,000 of foreign NOL attributable to Biomedicals of which $458,000 will be credited to additional capital when utilized. Biomedicals' NOL's are restricted to utilization by that company. In connection with the acquisition of Flow, Biomedicals acquired Flow's domestic net operating loss carryforwards of $9,771,000. Biomedicals has agreed to pay Flow the first $500,000 of any benefits realized. In the event this amount is not realized by November 1994, it will become due and payable to Flow including interest at 10%. Tax benefits realized in excess of $500,000 will be shared equally with Flow.\nThe Company is currently under examination by the U.S. Internal Revenue Service (\"IRS\") for the tax years ended November 30, 1989 and 1988. While the proposed adjustments, if upheld, would not result in a significant additional tax liability, they would result in significant reductions in the NOL carryforwards available to the Company in the future.\n9. COMMITMENTS AND CONTINGENCIES\nOperating and capital leases\nAt December 31, 1993, the Company and its consolidated subsidiaries were committed under noncancellable operating and capital leases for minimum aggregate lease payments as follows:\nRental expense on operating leases was $870,000 in 1993, $2,934,000 (including SPI) in 1992 and $2,107,000 (including SPI) in 1991.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nPost approval studies\nBy letter dated December 31, 1985, the FDA advised Viratek that the FDA had approved Viratek's NDA for the hospital use of aerosolized ribavirin for the treatment of RSV in infants. As a condition of the approval, Viratek agreed to conduct certain additional studies. The future costs of such studies are not expected to be significant.\nLitigation\nThe Company is a defendant in certain consolidated class actions pending in the United States District Court for the Southern District of New York entitled In re Paine Webber Securities Litigation (Case No. 86 Civ. 6776 (VLB); In re ICN\/Viratek Securities Litigation (Case No. 87 Civ. 4296 (VLB)). The plaintiffs represent alleged classes of persons who purchased ICN, Viratek or SPI common stock during the period January 7, 1986 to and including April 15, 1987. In their memorandum of law, dated February 4, 1994, the ICN Defendants argue that class certification may only be granted for purchasers of ICN common stock for the period August 12, 1986 through February 20, 1987 and for purchasers of Viratek common stock for the period December 9, 1986 through February 20, 1987. The ICN Defendants assert that no class should be certified for purchasers of the common stock of SPI for any period. The plaintiffs allege that during such period the defendants made, or aided and abetted other defendants in making, misrepresentations of material fact and omitted to state material facts concerning the business, financial condition and future prospects of ICN, Viratek and SPI in certain public announcements, Paine Webber, Inc. research reports and filings with the Commission. The alleged misstatements and omissions primarily concern developments regarding VirazoleR, including the efficacy and safety of the drug and the market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. The plaintiffs seek an unspecified amount of monetary damages, together with interest thereon, and their costs and expenses incurred in the action, including reasonable attorneys' and experts' fees. The ICN defendants moved to dismiss the consolidated complaint in March 1988, for failure to state a claim upon which relief may be granted and for failure to plead the allegations of fraud and misrepresentation with sufficient particularity. On September 18, 1992, the Court denied the ICN defendants' motion to dismiss and for summary judgment. The ICN defendants filed their answer on February 17, 1993. On October 20, 1993, plaintiffs informed the Court that they had reached an agreement to settle with co-defendant Paine Webber, Inc. and that they would submit a proposed settlement stipulation to the Court. Expert discovery, which commenced in September 1993, is expected to conclude by the end of April 1994. Plaintiffs' damages expert, utilizing assumptions and methodologies that the ICN Defendants' damages experts find to be inappropriate under the circumstances, has testified that, assuming that classes were certified for purchasers of ICN, Viratek and SPI common stock for the entire class periods alleged by plaintiffs, January 7, 1986 through April 15, 1987, and further assuming that all of the plaintiffs' allegations were proven, potential damages against ICN, Viratek and SPI would, in the aggregate, amount to $315,000,000. The ICN Defendants' four damages experts have testified that damages are zero. Management believes, having extensively reviewed the issues in the above referenced matters, that there are strong defenses and that the Company intends to defend the litigation vigorously. While the ultimate outcome of these lawsuits cannot be predicted with certainty, and an unfavorable outcome could have an adverse effect on the Company, at this time management does not expect that these matters will have a material adverse effect on the financial position, result of operations or liquidity of the Company. The attorney's fees and other costs of the litigation are allocated equally between ICN and Viratek.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nIn August 1992, an action was filed in United States District Court for the Southern District of New York, entitled Rossi v. ICN Pharmaceuticals, Inc. (Case No. 92 Cir. 4819 (CL6)). The plaintiffs, citing theories of product liability, negligence and strict liability in tort, allege that birth defects in an infant were caused by the mother's exposure to ribavirin during pregnancy. The plaintiff's counsel has agreed to place the case on the courts \"suspense calendar\" pending completion of ICN's investigation of the underlying facts. Based on such investigation, the case was dismissed with prejudice pursuant to stipulation by the parties in December 1993. Pursuant to a license agreement, SPI has indemnified Viratek and ICN for lawsuits involving the use of VirazoleR.\nOn September 27, 1993, ICN and Biomedicals filed a complaint in the California State Superior Court for Orange County, California, against GRC International Inc., alleging fraud, negligent misrepresentation in the sale of securities in California and violations of state and federal securities laws. The precise amount of damages is unknown at this time. The lawsuit arises out of the acquisition of all of the issued and outstanding shares of Flow Laboratories, Inc. (\"Flow\") and Flow Laboratories B.V. by Biomedicals in November 1989 from GRC International Inc., (formerly known as Flow General Inc.). Defendant GRC's motion to compel arbitration was granted as to the Biomedicals claims. The action is stayed until April 7, 1994, as to ICN's causes of action.\nOn April 5, 1993, ICN and Viratek filed suit against Rafi Khan (\"Khan\") in the United States District Court for the Southern District of New York. The complaint alleges, inter alia, that Khan violated numerous provisions of the ----------- securities laws and breached his fiduciary duty to ICN and Viratek by attempting to effectuate a change in control of ICN while acting as an agent and fiduciary of ICN and Viratek. As relief, ICN and Viratek, among other things, sought an injunction enjoining Khan from effectuating a change in control of ICN and compensatory and punitive damages in the amount of $25,000,000. Khan filed a counterclaim on April 12, 1993, naming the then ICN directors and ICN, as a nominal defendant sued only in a derivative capacity. The counterclaim contains causes of action for slander, interference with economic relations, and a shareholders' derivative action for breach of fiduciary duties. Khan seeks compensatory damages for interest in an unspecified amount, and exemplary damages of $29,000,000. On December 22, 1993, Khan filed a notice of appeal from a prior injunction granted by the court, to the Court of Appeals for the Second Circuit. On March 13, 1994, that appeal was dismissed on the grounds that Khan had defaulted for failure to comply with the Court's scheduling order. Management believes that Khan's counterclaim is without merit and the Company intends to vigorously defend this matter.\nThe Company is a party to a number of other pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. In the opinion of management, these various other pending lawsuits will not have a material adverse effect on the consolidated financial position or operations of the Company.\nPurchase Commitment\nBiomedicals has a purchase commitment with a major supplier for which the remaining purchase of inventory under agreement which will be due June 1994 in the amount of approximately $1,727,000 (Finnish Markka 10,000,000).\nBiomedicals is also a guarantor on a note payable to the same supplier for which ICN is primarily liable. On June 30, 1993, ICN filed a claim in arbitration alleging breach of agreement entered into with such supplier and withheld final payment due on that date of approximately $1,295,000 (Finnish Markka 7,500,000). In addition, ICN is seeking declaration and award that Biomedicals is not obligated to honor the aforementioned purchase commitment or installments on the note. Arbitration is set for October 4, 1994.\nAcquisition Commitments\nUnder the terms of the Flow purchase agreement, Biomedicals issued 100,000 shares of common stock to the seller, which shares have a guaranteed value of $20 per share on November 8, 1994. If the fair value, as defined, of Biomedicals' common stock is less than $20 per share on that date, Biomedicals must pay the difference in cash. Biomedicals may redeem such shares for the $20 guaranteed value prior to November 8, 1994. At December 31, 1993, Biomedicals would have paid $1,575,000 to honor the guarantee.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nProduct Liability Insurance\nDuring 1985, after reviewing costs, availability and related factors, management decided not to continue to maintain product liability insurance. While to date no material adverse claim for personal injury resulting from allegedly defective products, including ribavirin, has been successfully maintained against the Company, a substantial claim, if successful, could have a material adverse effect on the Company.\nOther\nMilan Panic, the Company's Chairman of the Board, President and Chief Executive Officer, is employed under a contract expiring November 30, 1994 that provides for, among other things, certain retirement benefits. Mr. Panic, at his option, may provide consulting services upon his retirement for $120,000 per year for life, subject to annual cost-of-living adjustments from the base year of 1967 currently estimated to be in excess of $520,000 per year. The consulting fee shall not at any time exceed the annual compensation as adjusted, paid to Mr. Panic. Upon Mr. Panic's retirement, the consulting fee shall not be subject to further cost of living adjustments.\nThe Board of Directors of the Company adopted Employment Agreements during 1993 which contain \"change in control\" benefits for six key senior executive officers of the Company and its subsidiaries. Upon a \"change in control\" of the Company or the respective subsidiary as defined in the Contract, the employee shall receive severance benefits equal to three times salary and other benefits. The executives include Mr. Jerney, Mr. Giordani, Mr. MacDonald and Mr. Watt, officers of the Company, Mr. Phillips and Mr. Sholl, officers of SPI.\nOn April 1, 1992, the Board of Directors of the Company voted to grant to Mr. Panic, a bonus of 200,000 shares of the common stock of SPI in consideration of his extraordinary efforts in negotiating and closing the Galenika transaction, which was paid in 1992.\nIn July 1992, Milan Panic, Chairman of the Board, President and Chief Executive Officer of the Company, with the approval of the Company's Board of Directors, became Prime Minister of Yugoslavia and was granted a paid leave of absence from all duties to the Company while retaining his title as Chairman of the Board. Mr. Panic and the Company entered into a Leave of Absence and Reemployment Agreement which contained mutual obligations, requiring, among other things, that the Company reemploy Mr. Panic and that Mr. Panic return to his previous positions with the Company. Mr. Panic was succeeded as Prime Minister on March 4, 1993, and pursuant to the Leave of Absence and Reemployment Agreement, returned to his duties at the Company. In addition to the salaries of Mr. Panic and certain Company employees assisting him during his leave of absence, the Company has incurred certain other expenses of which the net amount outstanding totalled $103,000 at December 31, 1992 in connection with Mr. Panic's transition to and return from his leave of absence. Mr. Panic reimbursed the Company for expenses paid by the Company in 1992, subject to a review by an independent outside party and the Audit Committee of the Board. Amounts incurred by the Company during the first quarter of 1993 for approximately $362,000 remain unpaid at December 31, 1993. In addition, Mr. Panic reimbursed certain withholding taxes due as of December 31, 1992, previously advanced by the Company, in connection with the exercise of stock options, in the amount of $1,351,000. Mr. Panic paid these amounts, during 1993, in the form of cash in the amount of $678,000 and common stock of Viratek, Inc. in the amount of $776,000 valued at fair market value.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nBenefit plans\nThe Company adopted a 401(k) plan in 1988 that provides all U.S. employees with the opportunity to defer a portion of their compensation for payout at a subsequent date. The Company makes a contribution equal to one half of the employee's contribution up to a maximum of approximately $4,000 per year. The employer and employee contributions are given to a trustee on a monthly basis and invested by the trustee in fixed or variable interest-bearing investments or a common stock fund. The Company has made such matching contributions for 1993, 1992, 1991 of $447,000, $397,000 and $398,000, respectively.\nBiomedical's United Kingdom subsidiary has a defined benefit retirement plan which covers all eligible U.K. employees. The plan is actuarily reviewed approximately every three years. Annual contributions are based on total pensionable salaries. It is estimated that the plan's assets exceeded the actuarial computed value of vested benefits as of December 31, 1993 and 1992. The total expense under this plan for 1993, 1992 and 1991 was approximately $248,000, $32,000 and $440,000, respectively.\nThe Company also has deferred compensation agreements with certain officers and certain key employees, with benefits commencing at death or retirement. As of December 31, 1993, the present value of the deferred compensation benefits to be paid has been accrued in the amount of $2,481,000. Interest at 11.75% as of December 31, 1993, accrues until all payments are made. No new contributions are being made, however, interest continues to accrue on the present value of the benefits expected to be paid. The expense for 1993, 1992 and 1991 was $217,000, $309,000 and $453,000, respectively.\n10. COMMON STOCK\nUnder the Company's 1981 Employee Stock Option Plan, 700,000 shares of common stock have been reserved for granting to key employees, officers and directors of the Company. The exercise price of these options may not be less than the fair market value of the stock at date of grant and may not have a term exceeding ten years. At December 31, 1993, options under the 1981 Employee Incentive Stock Option Plan for 35,878 shares were outstanding and exercisable (at prices ranging from $3.00 to $9.25). The number of shares exercised were: 1993 - 30,256; 1992 - 2,250; 1991 - 5,000, at average prices of $4.655, $3.00 and $6.375, respectively.\nAt December 31, 1993, options under the 1981 non-qualified stock option agreements with key employees and officers of the Company for 215,863 shares were outstanding (at prices ranging from $3.00 to $5.75) with 126,863 shares exercisable. The number of shares exercised were: 1993 - 153,808; 1992 - 181,855; 1991 - 348,007, at average prices of $4.736, $3.55 and $3.00, respectively.\nDuring 1992, the stockholders of the Company approved the 1992 Non-Qualified Stock Option Plan (\"1992 Option Plan\") and the 1992 Employee Incentive Stock Option Plan (\"1992 Incentive Plan\"), reserving 500,000 shares per plan of the Company's common stock for issuance to employees and directors of the Company. The Company has granted options for shares of its common stock under both plans. Options under both plans are exercisable over a period to be determined by the Compensation Committee, which shall not exceed ten years from the date of grant and will expire at the end of the option period. At December 31, 1993, under the 1992 Option Plan, options of 85,000 were outstanding (at prices ranging from $6.375 to $22.875), 11,000 shares were exercisable and none have been exercised. At December 31, 1993, under the 1992\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nIncentive Plan, options of 255,000 were outstanding (at prices ranging from $6.375 to $9.50), 26,250 shares were exercisable and none have been exercised.\nIn addition, the Company entered into non-qualified stock option agreements with Mr. Panic pursuant to which he could purchase 932,000 shares of common stock of the Company at $3.00 per share of which 832,000 shares were exercised in 1993. There were no shares exercised in 1992 and 100,000 shares were exercised in 1991. As of December 31, 1993, no shares were outstanding.\nDuring 1993 and 1992, the Company sold, under various agreements, 3,000,000 and 4,198,000 shares of its common stock to a foreign bank for $21,861,000 and $30,608,000, respectively, which is net of transaction fees and commissions.\n11. DETAIL OF CERTAIN ACCOUNTS\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nPrepaid expenses and other current assets include assets held for sale of $1,218,000 at December 31, 1993 and $10,225,000 at December 31, 1992, which are recorded at the lower of cost or net realizable value. During the fourth quarter of 1993, Biomedicals moved its Italian operation from Cassina de Pecchi, Italy, a leased facility, back to Opera, an owned facility. Therefore, the Opera facility was reclassified from assets held for disposition to Property, Plant and Equipment.\nOther (income) expense, net:\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\n12. BUSINESS SEGMENTS AND GEOGRAPHICAL DATA\nThe Company operates in two industry segments: pharmaceuticals (the \"Pharmaceuticals group\") and biomedicals (the \"Biomedicals group\"). The Pharmaceuticals group is composed of SPI (accounted for as an unconsolidated equity investee effective December 31, 1992), which produces and markets pharmaceutical products in the United States, Mexico, Canada and Europe; and Viratek, which conducts the Company's research and development efforts on compounds derived from nucleic acids. The Biomedicals group is composed of Biomedicals, which markets research chemical and cell biology products and related services, biomedical instrumentation and immunodiagnostic reagents and instrumentation.\nInformation regarding the Company's business segments and geographic data for the years ended 1993, 1992 and 1991 is as follows:\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\n(1) Sales between industry segments and geographic areas are not material.\n(2) Corporate and other includes corporate general and administrative expenses, net interest expense, other non-operating income and expense, and unrealized gains and losses.\n(3) Corporate assets exclude intercompany receivables, loans, advances and investments.\n(4) Excludes the amounts of SPI Pharmaceuticals, Inc. which was deconsolidated at December 31, 1992, but includes ICN's investment in SPI in the \"Pharmaceuticals Group\" and in the \"United States\".\n(5) Included in Income (loss) before provision for taxes and minority interest and extraordinary income for the United States and Pharmaceuticals group for 1993 is $11,646,000 representing the equity in earnings of SPI.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nThe following tables set for the amount of net sales, income before provision for income taxes and minority interest and identifiable assets of SPI by geographical areas for 1993 (in thousands):\nDuring the year ended December 31, 1993, approximately 68% of Galenika's sales were to the Federal Republic of Yugoslavia or government sponsored entities. At December 31, 1993, there were no significant receivables from the Yugoslavian government, however future sales of Galenika could be dependent on the ability of the Yugoslavian government to generate cash to purchase pharmaceuticals and the continuation of its current policy to buy products from Galenika. No other customer accounts for more than 10% of SPI's net sales.\nExport sales shipped from the United States for 1993, 1992 and 1991 were $3,892,000, $8,857,000 (including SPI) and $8,034,000 (including SPI), respectively.\n13. SUPPLEMENTAL CASH FLOWS DISCLOSURES:\nSupplemental information\nThe following table sets forth the amounts of interest and income taxes paid for the years ended 1993, 1992 and 1991.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nOn August 30, 1993, Biomedicals issued 300,000 and 390,000 shares of preferred stock series \"A\" and \"B\", respectively, to ICN. In exchange, ICN retired $11,000,000 of debt owed to ICN by Biomedicals and exchanged 13,368,449 shares of Biomedicals' common stock that ICN owned. See Note 4 \"ICN Biomedicals, Inc.\" concerning Biomedicals' preferred stock transaction.\nDuring 1991, SPI acquired Galenika as follows:\n14. RESTRUCTURING COSTS AND SPECIAL CHARGES\nIn November 1989, Biomedicals acquired for $37,700,000 all of the issued and outstanding common shares of Flow Laboratories, Inc. and Flow Laboratories B.V. from GRC International, Inc. (formerly Flow General Inc.). These companies together with their respective subsidiaries (\"Flow\"), constitutes the Biomedical division of Flow General. The excess of the total purchase price (including acquisition costs) over the fair value of net assets acquired was $35,245,000, which was allocated to the excess of costs over net assets of purchased subsidiaries and was being amortized over 40 years. Flow was a manufacturer and distributor of several thousand biochemical products worldwide. At the time of the acquisition, Biomedicals had concluded that Flow was a significant complement to the company, since Flow had a major presence in the European markets, which Biomedicals lacked at the time. Therefore, more than products, Biomedicals acquired an international distribution network. Since 1990, Biomedicals utilized this distribution network to introduce ICN products. At the same time, it decided to phase out or to eliminate Flow low margin products, certain other product lines which did not fit Biomedicals' long-term strategies and to close down inefficient operations.\nIn prior years and the first three quarters of 1992, recoverability of goodwill associated with the Flow acquisition was focused on the European operations as Biomedicals had only a limited presence in Europe prior to the Flow acquisition. Accordingly, Biomedicals used the expected future operating income of the European operations in evaluating the recoverability of the Flow goodwill. During 1991, Biomedicals initiated a restructuring program designed to reduce costs, and improve operating efficiencies. The program included, among other items, the consolidation, relocation and closure of certain manufacturing and distribution facilities within the U.S. and Europe, which were acquired in the Flow acquisition. Those measures, including a fifteen percent reduction in the work force, were largely enacted during 1991 and continued in 1992. Costs incurred relating to this restructuring plan during 1991 were $6,087,000.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nDuring the fourth quarter of 1992, as a result of a continued decline in sales and other factors, Biomedicals reassessed their business plan and prospects for 1993 and beyond which included, among other things, the decision to sell the last remaining major European manufacturing facility and to restructure the previously acquired distribution network and European operations in line with the revised sales estimates. Consequently, based upon the continuing decline in European revenue and profitability relating to Flow, Flow facility closures and an ineffective distribution network, management concluded that there was no current or expected future benefit associated from the Flow acquisition. Accordingly, Biomedicals wrote off goodwill and other intangibles, primarily from the Flow acquisition of $37,714,000.\nThe relocation of various U.S., and European operations was re-evaluated. It was determined that many of the operations did not support the costs of maintaining separate facilities. Therefore, estimated costs associated with lease termination, employee termination, facility shut-down (of facilities held for disposition) were expensed primarily in the fourth quarter of 1992, and amounted to $4,858,000.\nDuring the fourth quarter of 1992, Biomedicals reassessed the valuation of inventory, given the decline in sales and lack of effective integration of Biomedicals' and Flow's product lines. Accordingly, Biomedicals recorded a provision for abnormal write-downs of inventory to estimated realizable value of $9,924,000 and discontinued products of $3,377,000.\nIn addition, during the fourth quarter of 1992, Biomedicals determined that the unamortized costs of the catalog marketing program would not be recovered within a reasonable period, therefore, costs totaling $6,659,000 were written off. In the future, specifically focused customer or \"product line\" catalogs will be used for customer product lines and a more focused general catalog for others.\nRestructuring and special charges of $63,032,000 and $6,087,000 are shown as a separate item in the Consolidated Statement of Operations and include the following for the years 1992 and 1991, no similar charges were incurred during 1993:\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\n15. CONCENTRATIONS OF CREDIT RISK\nFinancial instruments that potentially expose the Company to concentrations of credit risk, as defined by SFAS No. 105, consist primarily of cash deposits and trade receivables. The Company places its cash deposits with respected financial institutions and limits the amount of credit exposure to any one financial institution. Biomedicals has $3,506,000 and $7,013,000 of trade receivables in Italy at December 31, 1993 and 1992, respectively. The ability to collect these receivables is influenced by the general economic conditions in that country.\n16. LEASE VACANCY COSTS\nDuring 1993, Biomedicals vacated its High Wycombe facility in England and moved to a facility more suitable to Biomedicals' operating needs in Thame, England. Biomedicals pursued various subleasing agreements for which none were consummated as of December 31, 1993. Consequently, Biomedicals accrued approximately $1,200,000 which represents management's best estimate of the net present value of future leasing costs to be incurred for High Wycombe. During 1993, Biomedicals expensed an additional $236,000 of leasing costs related to this facility.\n17. EQUITY INVESTMENT\nEffective December 31, 1992, the Company's ownership percentage of SPI fell below 50%, resulting in the deconsolidation of SPI in the Company's consolidated financial statements as of December 31, 1992. The investment is currently accounted for using the equity method of accounting. During 1993, ICN received $2,159,000 in dividends from SPI. The condensed results of operations for the year ended December 31, 1993 and the condensed financial position of SPI as of December 31, 1993 and 1992 are summarized below.\nSPI FINANCIAL POSITION AS OF DECEMBER 31, 1993 AND 1992 (IN THOUSANDS) --------------------------------\nOn October 21, 1992, SPI announced that it had concluded an agreement with the Leningrad Industrial Chemical and Pharmaceutical Association to form a pharmaceutical joint venture in Russia, ICN Oktyabr, in which SPI will have a 75% interest. The new joint venture was registered with the Russian Federation on March 9, 1993. The joint venture represents a new business, and not the acquisition of the existing business or assets of Oktyabr. Business operations of the joint venture will commence on the completion of a business plan. Oktyabr, which recently privatized, will contribute output from its current production facilities until construction of a new facility is completed. SPI will contribute management expertise, technology, equipment, intellectual property, training and technical assistance to the new joint venture. Because of the transition of the Russian economy into a free market oriented economy, SPI plans for a gradual phase-in of the joint venture in 1994 and 1995. During this phase-in period, the joint venture will develop training and marketing strategies and begin constructing a new manufacturing facility in 1995 that is scheduled to be fully operational in 1996. Because of this phase-in period, SPI does not expect any current material effects on it operating results, as well as, its capital resources and liquidity.\nIn addition to the joint venture, on March 24, 1994, SPI entered into an Agreement with the City of St. Petersburg to acquire 15% of the outstanding shares of its joint venture partner, Oktyabr, in exchange for approximately 30,000 shares of SPI's common stock. As part of this Agreement, SPI may qualify to receive newly issued shares of Oktyabr pursuant to Russian privatization regulations that will raise its total investment in Oktyabr to 43%. The issuance of these additional shares is subject to approval and completion of an \"investment plan.\" The completion of the investment plan will not require any additional financial resources of SPI. SPI has also extended an offer to the employees of Oktyabr to exchange their Oktyabr shares for SPI shares. The Oktyabr employees currently own approximately 33% of the outstanding shares, however, the number of employees that will exchange their shares is uncertain. In the event that SPI qualifies under the investment plan to raise its investment to 43%, it is possible that a sufficient number of employees might exchange their Oktyabr shares for SPI shares so that total SPI investment in Oktyabr would exceed 50%. If this event occurs, SPI would be required to consolidate the financial results of Oktyabr into the financial statements of SPI.\nThe condensed financial position of Galenika, a consolidated 75% owned Yugoslavian subsidiary of SPI, as of December 31, 1993 and 1992, and the condensed statements of income before provision for income taxes and minority interest for the years ended December 31, 1993 and 1992 are presented below.\nGALENIKA FINANCIAL POSITION AS OF DECEMBER 31, 1993 AND 1992 (IN THOUSANDS) ---------------------------------\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nGALENIKA CONDENSED RESULTS OF OPERATIONS BEFORE PROVISION FOR INCOME TAXES FOR THE YEAR ENDED DECEMBER 31, 1993 AND 1992 (IN THOUSANDS) -----------------------------------------------\nSanctions:\nA substantial majority of Galenika's business is conducted in the Federal Republic of Yugoslavia (Serbia and Montenegro). On May 30, 1992, the UNSC adopted a resolution that imposed economic sanctions on the Federal Republic of Yugoslavia and on April 17, 1993, the UNSC adopted a resolution that imposed additional economic sanctions on the Federal Republic of Yugoslavia. On April 26, 1993, the United States issued an executive order that implemented the additional sanctions pursuant to the United Nations resolution. The new sanctions continue to specifically exempt certain medical supplies for humanitarian purposes, a portion of which are distributed by Galenika.\nGalenika continues to apply for, and has received, licenses under the new sanctions. The renewed efforts to enforce sanctions will create additional administrative burdens that will slow the shipments of licensed raw materials to Yugoslavia. Shipments of imported raw materials declined in 1993 to 38% of prior year levels. Additionally, the new sanctions have contributed to an overall deteriorating business environment in which Galenika must operate.\nThe new sanctions provide for the freezing of bank accounts of Yugoslavian commercial and industrial entities. The implementation of new sanctions may create a restriction on Galenika's cash holdings that are maintained in a bank outside of Yugoslavia. Management believes, however, that these funds will be available for drawdowns on lines of credit for shipments specifically licensed under the new and prior sanctions. As a result of continuing political and economic instability within Yugoslavia, including the long-term impact of the sanctions, wage and price controls and devaluations, there may be further limits on the availability of hard and local currency and consequently, an adverse impact on the future operating results of SPI.\nAt December 31, 1992, Galenika had cash and cash equivalents of $44,700,000 of which $15,200,000 was restricted as to use, invested with a financial institution outside of Yugoslavia. These funds have been used for letters of guarantee on Galenika's raw material purchases and to collateralize the payment of dividends. During the first quarter 1993, $731,000 was withdrawn under the letters of guarantee. Before the implementation of additional sanctions in April 1993, approximately $9,885,000 was withdrawn under the letters of guarantee. In October 1993, Galenika acquired marketable securities with these funds in order to maximize their interest earned. The marketable securities are maintained at the same financial institution. As of December 31, 1993, at this institution, Galenika had $834,000 of hard currency and $32,587,000 of marketable securities which are used to collateralize a $10,000,000 note payable.\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nIn order to conserve operating cash, the wages of all Galenika employees were reduced to Yugoslavian minimum wage levels beginning in the fourth quarter 1993. To help alleviate the burden of sanctions and wage reductions, SPI intends to expend funds for humanitarian aid in the form of food assistance for Galenika employees. This aid will be subject to approval and licensing required by UNSC sanctions. In the first quarter 1994, SPI obtained licenses for approximately $280,000 of aid. The expenditure of future aid will be dependent on the conditions in Yugoslavia and will be subject to obtaining approval and licenses under UNSC sanctions.\nHyperinflation and Price Controls:\nUnder existing Yugoslavian price controls imposed in July 1992, Galenika can no longer continue the unrestricted practice of increasing selling prices in anticipation of inflation. Rather, price increases must be approved by the government prior to implementation. The imposition of price controls along with the effect of sanctions and recurring currency devaluations resulted in reduced sales levels in the last half of 1992 and for 1993. This trend of reduced sales levels is expected to continue as long as sanctions are in place. As a result of decreased sales levels, management expects that profit margins will decrease and overall operating expenses as a percentage of sales will increase.\nAs a result of the hyperinflation in Yugoslavia, the Yugoslavian government devalued the dinar on several occasions during 1993 and, on October 1, 1993, changed the denomination of the currency. The effect of the devaluations, adjusted for the change in currency denomination, was to increase the exchange rate from less than one dinar per $1 U.S. at the beginning of 1993 to over one trillion dinars per $1 U.S. at the end of 1993. In anticipation of devaluations in 1993, SPI implemented a plan described below, to minimize its monetary exposure. As a result of the devaluations and subsequent exchange losses from obtaining hard currencies, Galenika experienced translation losses of $173,000. While SPI cannot predict with any certainty the actual remeasurement and exchange gains or losses that may occur in 1994, such amounts may be substantial. Annual inflation is very high with some estimates of over 1 billion percent. Future devaluations are likely in the near term. At December 31, 1993, Galenika's net monetary liability exposure was $2,093,000. As a result of the non-tradability of the dinar, SPI is unable to effectively hedge against the loss from devaluation.\nSPI is taking action to generate the dinar cash needed to acquire hard currency to reduce its monetary exposure. Galenika has access to short-term borrowings at interest rates below the level of inflation. Galenika plans to maximize its borrowings under these arrangements and use the proceeds to acquire hard currency for the purchase of inventory. This strategy will provide hard currency, accelerate the purchase of inventory to minimize the effects of inflation, and reduce future transaction losses. This strategy will also increase Galenika's monetary liabilities, and lower its risk of loss from devaluations. This strategy, however, has resulted in increased interest expense in 1993 and will result in high levels of interest expense in 1994.\nIn conjunction with a currency devaluation on July 23, 1993, the Yugoslavian government announced that businesses in Yugoslavia can no longer buy and sell hard currency in privately negotiated transactions. All purchases of hard currency must be made through the National Bank of Yugoslavia based on government approved allocations. This action could possibly limit the availability of hard currency in the future for Galenika. However, if the government is successful in controlling access to hard currency, SPI's operations in Yugoslavia may benefit through increased allocations of hard currency. Due to the strategic nature of pharmaceutical drugs in Yugoslavia, Galenika has, in the past, received relatively favorable allocations of hard\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\ncurrency from the government. For the year ended December 31, 1993, Galenika received $12,744,000 in currency allocations.\nOn January 24, 1994, the Yugoslavian government enacted a \"Stabilization Program\" designed to strengthen its currency. Under this program the official exchange rate of the dinar is fixed at a ratio of one dinar to one Deutsche mark. The Yugoslavian government guarantees the conversion of dinars to Deutsche marks and is able to do so by exercising restraint in the amount of dinars that it prints. Since the inception of this program the exchange rate of dinars to Deutsche marks has remained stable. The impact of this change on the future operations of Galenika is uncertain.\nAs required by Generally Accepted Accounting Principles (\"GAAP\"), SPI translates Galenika financial results at the dividend payment rate established by the National Bank of Yugoslavia. To the extent that changes in this rate lag behind the level of inflation, sales and expenses will, at times, tend to be inflated. Future sales and expenses can substantial increase if the timing of future devaluations falls significantly behind the level of inflation. While the impact of sanctions, price controls, and devaluations on the future sales and net income cannot be determined with certainty, they may, under the present political and economic environment, result in an adverse impact in the future.\nAt December 31, 1993, Galenika has U.S. $33,421,000 invested with a financial institution outside of Yugoslavia. These funds came from the initial cash investment made by SPI of $14,453,000 and from the sale of SPI's stock transferred to Galenika by ICN, also in conjunction with the acquisition. Under the terms of the acquisition agreement, these funds were originally intended to finance business expansion. However, in light of the current economic conditions in Yugoslavia, these funds are used for letters of guarantee on Galenika's raw material purchases and to collateralize the payment of dividends. These funds are encumbered by a letter of guarantee for raw material purchases, of which no amount was outstanding at December 31, 1993, and $5,200,000 was outstanding at December 31, 1992, and as collateral for $10,000,000 of loans included in Notes Payable bearing interest at 4.5%, that were issued to pay the 1992 dividend of the same amount. Other uses of these funds in the future, such as capital investment, additional letters of guarantee, or future dividends are subject to review and licensing under the UNSC sanctions. At December 31, 1993, these funds have been invested in bonds and are recorded as marketable securities which were used to collateralize a $10,000,000 notes payable. At December 31, 1992, these funds are included in cash with $15,200,000 reflected as restricted cash.\nAs noted above, Galenika paid a $10,000,000 dividend in 1992 of which SPI received 75% or $7,500,000. Yugoslavian law allows free distribution of earnings whether to domestic (Yugoslavian) or international investors. Galenika is allowed to pay dividends out of earnings calculated under Yugoslavian Accounting Practices (\"YAP\"), not earnings calculated under GAAP. As a result of the current level of inflation, the accumulated YAP earnings of ICN Galenika are insignificant when stated in dollars. Future dividends from Galenika will depend heavily on future earnings. Under GAAP, Galenika had accumulated earnings, which are not available for distributions, of approximately $61,787,000 at December 31, 1993. However, additional repatriation of cash could be declared from contributed capital as provided for in the original purchase agreement. In 1992, SPI made the decision to no longer repatriate the earnings of Galenika and instead will use these earnings for local operations and reduction of debt.\nThe current political and economic conditions in Yugoslavia could continue to deteriorate to the point that SPI's investment in Galenika would be threatened. Worsening political and economic conditions could also result in a situation where SPI may be unable to exercise control over Galenika's operations or be unable\nICN PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993\nto receive dividends from Galenika. Under these conditions, SPI would no longer be able to continue to consolidate the financial information of Galenika. In this situation, SPI would be required to deconsolidate Galenika and account for its investment using the cost method of accounting and the investment in Galenika would be carried at the lower of cost or realizable value.\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY\nThe following condensed financial statements reflect the parent company only, ICN Pharmaceuticals, Inc. (\"ICN\"), accounting for its majority owned subsidiaries, ICN Biomedicals, Inc. and Viratek, Inc., on the equity method of accounting. Certain footnote disclosure has been omitted since the information has been included in the ICN Pharmaceuticals, Inc. consolidated financial statements included elsewhere in this Form 10-K.\nICN PHARMACEUTICALS, INC. (PARENT COMPANY ONLY) CONDENSED BALANCE SHEET DECEMBER 31, 1993 (IN THOUSANDS)\nSee Notes to Condensed Financial Information\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY\nICN PHARMACEUTICALS, INC. (PARENT COMPANY ONLY) CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nSee Notes to Condensed Financial Information\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY\nICN PHARMACEUTICALS, INC. (PARENT COMPANY ONLY) CONDENSED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nSee Notes to Condensed Financial Information\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY\nICN PHARMACEUTICALS, INC. (PARENT COMPANY ONLY) NOTES TO CONDENSED FINANCIAL INFORMATION YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)\nNote 1 -- Dividends\nDuring the year ended December 31, 1993 ICN received cash dividends of $2,159 and $1,553, from SPI Pharmaceuticals, Inc. (a 39% owned equity investment) and ICN Biomedicals, Inc., respectively.\nNote 2 -- Long-Term Debt\nSee Note 7 of Notes to Consolidated Financial Statements for information relating to long-term debt of ICN.\nAnnual aggregate maturities of long-term debt of ICN is as follows:\nNote 3 -- Commitments and Contingencies\nICN has an agreement with ICN Biomedicals, Inc., that ICN is prepared, if necessary, to provide financial support to ICN Biomedicals, Inc. in order for it to meet its financial obligations through April 15, 1995.\nFor disclosure of additional commitments and contingencies, see Note 9 of Notes to Consolidated Financial Statements included elsewhere in this Form 10-K.\nICN PHARMACEUTICALS, INC.\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n(1) The credit to other accounts is primarily due to the impact of devaluations on outstanding allowance for doubtful accounts of SPI. In hyperinflationary countries such as Yugoslavia a devaluation will result in a reduction of accounts receivable and a proportionate reduction in the accounts receivable allowance. The reduction of accounts receivable is recorded as a foreign currency translation loss and the reduction of the allowance is recorded as a translation gain. After the devaluation the level of accounts receivable will rise as a result of subsequent price increases. In conjunction with the rise in receivables, additions to the allowance for receivables will be made for existing doubtful accounts. This process will repeat itself for each devaluation that occurs during the year. The effect of this process results in a high level of bad debt expense that does not necessarily reflect difficulties in collecting receivables. In 1992, general and administrative expenses increased significantly due primarily to provisions for doubtful accounts at Galenika of $48,279. The reduction of accounts receivable allowance from devaluations resulted in a translation gain of $40,191 resulting in a net expense from bad debts and bad debt translation gains of $8,088.\n(2) Results principally from Galenika purchase price allocation.\n(3) Reflects a $(10,188) deduction from the allowance for doubtful accounts and a $(3,671) deduction from the allowance for inventory obsolescence relating to the deconsolidation of SPI Pharmaceuticals, Inc. effective December 31, 1992.\nICN PHARMACEUTICALS, INC.\nSCHEDULE IX -- SHORT-TERM BORROWINGS (IN THOUSANDS)\n(1) Calculated by dividing the total month-end outstanding borrowings by 12 months.\n(2) Calculated by dividing the total interest expense during the period on short-term borrowings by the monthly average short-term borrowings outstanding during the period.\nICN PHARMACEUTICALS, INC.\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION (In thousands)\nREPORT OF INDEPENDENT AUDITORS\nTo SPI Pharmaceuticals, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedules of SPI Pharmaceuticals, Inc. (a Delaware corporation) and subsidiaries listed in the index on page 26 of this Form 10-K. These consolidated financial statements and financial statement schedules are the responsibility of the Company's Management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nThe Company has had certain transactions with its parent and Affiliated Corporations as more fully described in Notes 1, 3 and 4 to the consolidated financial statements. Whether the terms of these transactions would have been the same had they been between wholly unrelated parties cannot be determined.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPI Pharmaceuticals, Inc. and subsidiaries as of December 31, 1993 and 1992, the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND\nLos Angeles, California February 24, 1994, except for Note 15, as to which the date is March 24, 1994\nSPI PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS\nDecember 31, 1993 and 1992\nASSETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated statements.\nSPI PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF INCOME\nFor the years ended December 31, 1993, 1992 and 1991\nThe accompanying notes are an integral part of these consolidated statements.\nSPI PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nThe accompanying notes are an integral part of these consolidated statements.\nSPI PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nThe accompanying notes are an integral part of these consolidated statements.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. RELATIONSHIP WITH ICN PHARMACEUTICALS, INC., ICN BIOMEDICALS, INC. AND VIRATEK, INC.:\nSPI Pharmaceuticals, Inc. (\"SPI\" or the \"Company\") was incorporated on November 30, 1981, as a wholly-owned subsidiary of ICN Pharmaceuticals, Inc. (\"ICN\") and is 39%-owned by ICN at December 31, 1993. ICN Biomedicals, Inc. (\"Biomedicals\") is 69%-owned by ICN and Viratek, Inc. (\"Viratek\") is 63%-owned by ICN at December 31, 1993.\nDuring 1993, ICN sold 1,618,200 shares of the Company's common stock for an aggregate sales price of $19,995,000 in open market transactions and privately negotiated sales. During 1992, ICN sold 690,000 shares of the Company's common stock for an aggregate sales price of $13,786,000 in open market transactions and privately negotiated sales and in 1991 used 1,468,000 shares in the formation of ICN Galenika, of which 1,200,000 shares were sold for cash during 1992 by ICN Galenika.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nReclassifications\nCertain prior year items have been reclassified to conform with the current year presentation.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and all subsidiaries after elimination of all significant intercompany account balances and transactions. ICN Galenika has been consolidated since the effective date of acquisition, May 1, 1991 (see Note 11 of Notes to Consolidated Financial Statements).\nGoodwill\nThe difference between the purchase price and the fair value of net assets purchased at the date of acquisition is included in the accompanying Consolidated Balance Sheets as Goodwill. Goodwill amortization periods are five years for single product line businesses acquired through November 30, 1986, and 10 to 23 years for certain businesses acquired in 1987, which have other intangibles (patents, trademarks, etc.), and whose values and lives can be reasonably estimated. The Company periodically evaluates the carrying value of goodwill including the related amortization periods. The Company determines whether there has been impairment, if any, by comparing the anticipated undiscounted future operating income of the acquired entity with the carrying value of the goodwill. In 1991, goodwill was reduced by $1,174,000 due to the utilization for federal income tax purposes of net operating loss (\"NOL\") carryforwards from domestic subsidiaries acquired in 1987 (see Note 4 of Notes to Consolidated Financial Statements.\nCash and Cash Equivalents\nCash and cash equivalents at December 31, 1993 and 1992, includes $1,247,000 and $45,362,000, respectively, of commercial paper and bonds, both of which have maturities of three months or less. For purposes of the Statements of Cash Flows, the Company considers highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The carrying amount of those assets approximates fair value due to the short-term maturity of these instruments. Of the above cash and cash equivalents at December 31, 1992, $15,200,000 was utilized to guarantee ICN Galenika's raw material purchases and to collateralize notes payable, and is reflected as restricted cash.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1993\nMarketable Securities\nMarketable securities, which consist of bond investments, are stated at the lower of cost of market, based upon quoted market prices. Unrealized gains and losses on marketable securities are charged to income. Realized gains or losses are determined on the specific identification method and are reflected in income. Marketable securities had an aggregate cost at December 31, 1993, of $33,899,000. A valuation allowance in the amount of $1,312,000 has been recorded to reduce the carrying amount of the portfolio to fair value, which represents the net unrealized loss included in the determination of net income for 1993. These investments are used to collateralize a note payable of $10,000,000.\nInventories\nInventories, which include material, direct labor and factory overhead, are stated at the lower of cost or market. Cost is determined on a first-in, first-out (\"FIFO\") basis.\nProperty, Plant and Equipment\nThe Company primarily uses the straight-line method for depreciating property, plant and equipment over their estimated useful lives. Buildings and related improvements are depreciated from 7-50 years, machinery and equipment from 5-15 years, furniture and fixtures from 5-10 years, and leasehold improvements are amortized over their useful lives, limited to the life of the lease.\nThe Company follows the policy of capitalizing expenditures that materially increase the lives of the related assets and charges maintenance and repairs to expense. Upon sale or retirement, the costs and related accumulated depreciation or amortization are eliminated from the respective accounts, and the resulting gain or loss is included in income.\nNotes Payable\nThe Company classifies bank borrowings with initial terms of one year or less as Notes Payable. At December 31, 1993, these notes had average interest rates of 10% in Spain and 4% to 25% in Yugoslavia. The comparatively low year-end interest rates in Yugoslavia are a result of the favorable effect on variable interest rates arising from the Yugoslavian \"Stabilization Program\" that was started in January 1994. See Note 12 of Notes to Consolidated Financial Statements for information on the \"Stabilization Program.\" The carrying amount of notes payable approximates fair value due to the short-term maturity of these instruments.\nForeign Currency Translation\nThe assets and liabilities of the Company's foreign operations, except those in highly inflationary economies, are translated at the end of period exchange rates. Revenues and expenses are translated at the average exchange rates prevailing during the period. The effects of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated in Stockholders' equity. The monetary assets and liabilities of foreign subsidiaries in highly inflationary economies are remeasured into U.S. dollars at the year-end exchange rates and non-monetary assets and liabilities at historical rates. In accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 52, \"Foreign Currency Translation,\" the Company has included in operating income all foreign exchange (gains) and losses arising from foreign currency transactions and the effects of foreign exchang rate fluctuations on subsidiaries operating in highly inflationary economies. The (gains) losses included in operations from foreign exchange translation and transactions for 1993, 1992 and 1991, were ($3,282,000), $25,039,000, and $6,697,000, respectively.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nIncome Taxes\nIn January 1993, the Company adopted SFAS 109, Accounting for Income Taxes. SFAS 109 requires an asset and liability approach be used in the recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been recognized in the Company's financial statements or tax returns.\nPer Share Information\nPer share information is based on the weighted average number of common shares outstanding and dilutive common share equivalents. Common equivalent shares represent shares issuable for outstanding options, on the assumption that the proceeds would be used to repurchase shares in the open market.\nIn March and July 1991, the Company declared 10% and 15% stock distributions, respectively, which resulted in a 26% stock split. In January 1993, the Company issued a fourth quarter 1992 stock dividend of 2%. During 1993, the Company issued quarterly stock dividends which totaled 6%. In January 1994, the Company declared a first quarter 1994 stock dividend of 1.4%. All share and per share amounts used in computing earnings per share have been restated to reflect these stock splits and dividends. The number of shares used in the per share computations were 19,898,000 in 1993, 19,594,000 in 1992, and 19,131,000 in 1991.\n3. RELATED PARTY TRANSACTIONS:\nGeneral\nICN controls Biomedicals and Viratek through stock ownership, voting control and board representation and is affiliated with the Company. Certain officers of ICN occupy similar positions with SPI, Biomedicals and Viratek and are affiliated with the Company. ICN, SPI, Biomedicals and Viratek (collectively, the \"Affiliated Corporations\") have engaged in, and will continue to engage in, certain transactions with each other.\nAn Oversight Committee of the Boards of Directors of ICN, SPI, Biomedicals and Viratek reviews transactions between or among the affiliated corporations to determine whether a conflict of interest exists with respect to aparticular transaction and the manner in which such a conflict can be resolved. The Oversight Committee has advisory authority only and makes recommendations to the Boards of Directors of each of the Affiliated Corporations. The Oversight Committee consists of one non-management director of each Affiliated Corporation and a non-voting chairman. The significant related party transactions have been reviewed and recommended for approval by the Oversight Committee, and approved by the respective Boards of Directors.\nRoyalty Agreements\nEffective December 1, 1990, the Company entered into a royalty agreement with Viratek whereby a royalty of 20% on all sales of Virazole is paid to Viratek. Sales of Virazole for 1993, 1992 and 1991 were $29,515,000, $27,240,000 and $21,315,000, respectively, which generated royalties to Viratek for 1993, 1992 and 1991 of $5,903,000, $5,448,000 and $4,263,000, respectively.\nDuring 1991, the Company purchased $235,000 of Virazole from Viratek and received $2,943,000 of Virazole from Viratek at its cost.\nUnder an agreement between ICN and the employer of a director of Viratek, the Company is required to pay a 2% royalty to the employer on all sales of Virazole in aerosolized form. Such royalties for 1993, 1992 and 1991 were $422,000, $430,000 and $313,000, respectively.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nThe Company markets products under license from ICN for the treatment of myasthenia gravis, a disease characterized by muscle weakness and atrophy. ICN charged the Company royalties at the rate of 9% of net sales. Effective September 1, 1990, SPI prepaid royalties to ICN in the amount of $9,590,000, which has been recorded in Other Assets and is being amortized using the straight-line method over fifteen years. There are no future royalties due to ICN for these products.\nBeginning in December 1986, the Company began selling Brown Pharmaceuticals, Inc. products under license from ICN. ICN charges the Company royalties at the rate of 8-1\/2% of net sales. During 1993, 1992 and 1991, the Company paid ICN $218,000, $65,000 and $93,000, respectively, in royalties under this agreement.\nCost Allocations\nThe Affiliated Corporations occupy ICN's facility in Costa Mesa, California. The accompanying consolidated statements of income include charges for rent and property taxes from ICN of $279,000 for each of the last three years. In addition, the costs of common services such as maintenance, purchasing and personnel are incurred by the Company and allocated to ICN, Viratek and Biomedicals based on services utilized. The total of such costs were $2,584,000 in 1993, $2,556,000 in 1992 and $2,617,000 in 1991 of which $1,733,000, $1,679,000 and $1,568,000, were allocated to the Affiliated Corporations, respectively. It is Management's belief that the methods used and amounts allocated for facility costs and common services are reasonable based upon the usage by the respective companies.\nInvestment Policy\nICN and the Company have a policy covering intercompany advances and interest rates, and the types of investments (marketable equity securities, high yield bonds, etc.) to be made by ICN and its subsidiaries. Under this policy excess cash held by ICN's subsidiaries is transferred to ICN and, in turn, cash advances are made to ICN's subsidiaries to fund certain transactions. ICN charges or credits interest based on the amounts invested or advanced, current interest rates and the cost of capital. During 1993, 1992 and 1991, the Company was (charged) or credited interest of ($800,000), ($1,195,000), and $2,486,000 respectively. During 1993 and 1992, the Company reclassified its Biomedicals intercompany receivable of $2,333,000 and $3,631,000 and its Viratek intercompany payable of $5,228,000 and $6,332,000, respectively, to the Company's ICN intercompany account resulting in a net increase in the Company's liability to ICN of $2,041,000 and $2,701,000, respectively.\nDebt and Equity Transactions\nIn accordance with its investment policy, ICN has advanced funds to the Company for acquisitions, certain investments and to provide working capital. Interest is charged on these advances at prime (6% at December 31, 1993) plus 1\/2%.\nOn November 15, 1993, the Company issued 200,000 shares of common stock to ICN in exchange for reducing its debt outstanding to ICN by $3,075,000. The value of the shares issued was based on the quoted share price on the transaction date.\nOn December 31, 1991, in connection with the ICN Galenika agreement, ICN, on behalf of the Company, contributed 1,468,000 shares of common stock of the Company to ICN Galenika. The transfer of the stock resulted in a liability of the Company to ICN based on the stock's fair value of $38,528,000. ICN's cost basis in the stock of $11,555,000 was used to record the Company's investment in ICN Galenika. In consolidation, the Company recorded 1,101,000 shares of stock for $8,665,000 as treasury stock which represents its 75% interest in ICN Galenika. The remaining 367,000 shares for $2,890,000 were recorded as a component of minority interest and are considered issued and outstanding. Pending sale of the stock to third parties, the $26,973,000 difference between\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nthe fair value of the stock and the predecessor basis (ICN's cost) was recorded as a reduction of paid-in capital. As the stock is sold, the excess of the stock proceeds over the predecessor basis represents an additional investment by SPI, resulting in an increase in paid-in capital. During 1992, ICN Galenika sold 1,200,000 shares of SPI stock for proceeds of $30,822,000. Net of amounts attributable to minority interest, the sale of the stock increased paid-in capital and decreased treasury stock by $28,628,000.\nOther\nDuring 1991, the Company's Mexican subsidiary purchased inventory from Biomedicals for approximately $500,000 which was returned to Biomedicals for credit in 1992.\nDuring 1991, the Company acquired a manufacturing facility in Mississippi from ICN at ICN's cost of $3,114,000.\nDuring 1991, the Company acquired various licenses and patents from ICN and Viratek which it has contributed to ICN Galenika as part of the acquisition agreement. The Company incurred a liability to ICN and Viratek totaling $1,600,000 and a corresponding reduction of paid-in-capital.\nFollowing is a summary of transactions, as described above, between the Company and ICN and its subsidiaries for 1993, 1992 and 1991 (in thousands) :\nThe average balances due to (from) ICN were $26,439,000, $29,289,000, and $(18,326,000) for 1993, 1992 and 1991, respectively.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 1993\n4. Income taxes:\nIn January 1993, the Company adopted SFAS 109, Accounting for Income Taxes. SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactment of changes in the tax law or rates. Previously, the Company used the SFAS 96 asset and liability approach that gave no recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. The adoption of SFAS 109 did not result in a cumulative effect adjustment in the consolidated statements of income.\nPretax income from continuing operations before minority interest for the years ended December 31 consists of the following:\nThe current federal tax provision has not been reduced for the tax benefit associated with the exercise of employee stock options. The tax benefit from the exercise of employee stock options was credited to paid-in capital in 1993, 1992, and 1991, in the amounts of $727,000, $956,000, and $2,308,000, respectively.\nThe 1993 foreign deferred tax provision benefit relates primarily to the tax effect of litigation reserves. The 1991 federal deferred tax provision relates primarily to U.S. taxes provided on the undistributed earnings of ICN Galenika.\nDuring 1991, the Company provided U.S. deferred tax on the undistributed earnings of ICN Galenika due to the Company's intention to repatriate (rather than permanently reinvest) the earnings of this foreign subsidiary. However in 1992, the Company reversed the previously provided U.S. deferred tax. The U.S. deferred tax on the undistributed earnings of ICN Galenika was reversed due to the Company's intention to use these earnings to fund the Company's planned Eastern European expansion. In the future, U.S. tax will only be provided on ICN Galenika's earnings when such earnings are repatriated via dividend or are deemed distributed to the Company under U.S. tax law.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 1993\nIn 1987, the Company acquired certain domestic corporations with existing net operating loss (\"\"NOL\"\") carryforwards. On November 30, 1989, these corporations were merged into the Company and the NOL carryforwards from these subsidiaries were utilized by the Company to partially offset domestic taxable income for 1991 and 1990. The federal tax benefit of $1,174,000 related to the utilization of the NOL for 1991 was credited to goodwill.\nThe primary components of the Company's net deferred tax liability at December 31, 1993, and January 1, 1993, are as follows:\nThe Company's effective tax rate differs from the applicable U.S. statutory federal income tax rate due to the following:\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 1993\nThe Company files its federal tax return on a stand-alone basis. Prior to August 1991, the Company filed a consolidated tax return with ICN and was subject to a tax sharing agreement. In accordance with the terms of the tax sharing agreement, the Company was required to pay ICN for federal taxes otherwise payable on a stand-alone basis. The federal tax sharing agreement and consolidated federal filing terminated in August 1991 when ICN's ownership of the Company dropped below 80 percent.\nUpon leaving the consolidated group, the Company was allocated $17,000,000 of NOLs which represents the Company's share of the consolidated NOL carryforward at deconsolidation. The allocated NOL was utilized for book purposes in 1991 to reduce deferred tax liabilities resulting in a reduction of income tax expense. For tax purposes, the Company's net operating loss carryforward at December 31, 1993, is $4,279,000. The utilization of this NOL carryforward is limited to $540,000 per year until the year 2003.\nDuring 1993, no U.S. income or foreign withholding taxes were provided on the undistributed earnings of the Company's foreign subsidiaries with the exception of the Company's Panamanian subsidiary, Alpha Pharmaceutical, since Management intends to reinvest those amounts in the foreign operations. Included in consolidated retained earnings at December 31, 1993, is approximately $49,000,000 of accumulated earnings of foreign operations that would be subject to U.S. income or foreign withholding taxes if and when repatriated.\n5. Debt:\nLong-term debt consists of the following:\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 1993\nAnnual aggregate maturities of long-term debt, subsequent to December 31, 1993, are as follows: 1994--$3,866,000; 1995--$3,628,000; 1996--$4,604,000; 1997- -$1,996,000; 1998--$1,084,000 and $5,668,000 thereafter.\nThe Spanish mortgage and bank credit lines and long-term loans totaling $14,682,000, which approximates fair value, are collateralized by accounts receivable totaling $3,909,000 and land and building with a net book value totaling $11,252,000.\nThe mortgage payable of $615,000 in Dutch guilders is collateralized by land and buildings with a net book value of $895,000. The fair value of this note payable at December 31, 1993, was $736,000. The Mexican bank variable interest rate loan payable of $3,530,000 is collateralized by fixed assets with a net book value of $11,432,000. The U.S. mortgage of $1,295,000 is collateralized by land and buildings with a net book value of $3,590,000. The U.S. mortgage amount of $1,295,000 represents its fair value.\nThe fair value of the Company's debt is estimated based on current rates available to the Company for debt of the same remaining maturities. The carrying amount of all short-term and variable interest rate borrowings approximates fair value.\nSubsidiaries of the Company have short and long-term lines of credit aggregating $17,147,000, of which $7,220,000 was outstanding at December 31, 1993.\n6. Commitments and Contingencies:\nLitigation\nThe Company is a defendant in certain consolidated class actions pending in the United States District Court for the Southern District of New York entitled In re Paine Webber Securities Litigation (Case No. 86 Civ. 6776 (VLB); In re ICN\/Viratek Securities Litigation (Case No. 87 Civ. 4296 (VLB)). The plaintiffs represent alleged classes of persons who purchased ICN, Viratek or SPI common stock during the period January 7, 1986 to and including April 15, 1987. In their memorandum of law, dated February 4, 1994, the ICN defendants argue that class certification may only be granted for purchasers of ICN common stock for the period August 12, 1986 through February 20, 1987 and for purchasers of Viratek common stock for the period December 9, 1986 through February 20, 1987. The ICN defendants assert that no class should be certified for purchasers of common stock of SPI for any period. The plaintiffs allege that during such period the defendants made, or aided and abetted other defendants in making, misrepresentations of material fact and omitted to state material facts concerning the business, financial condition and future prospects of ICN, Viratek and SPI in certain public announcements, Paine Webber, Inc. research reports and filings with the Commission. The alleged misstatements and omissions primarily concern developments regarding Virazole, including the efficacy and safety of the drug and the market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Securities Exchange Act of 1934 (the \"Exchange Act\") and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. The plaintiffs seek an unspecified amount of monetary damages, together with interest thereon, and their costs and expenses incurred in the action, including reasonable attorneys' and experts' fees. The ICN defendants moved to dismiss the consolidated complaint in March 1988, for failure to state a claim upon which relief may be granted and for failure to plead the allegations of fraud and misrepresentation with sufficient particularity. In June 1991, the Court granted the ICN defendants' motion to dismiss the Amended Consolidated Complaint and provided the plaintiffs 30 days to replead. In July 1991, plaintiffs filed a Third Amended Complaint which contained the same substantive allegations as the Amended Consolidated Complaint. In September 1991, the ICN defendants moved to dismiss the Third Amended Complaint on the same grounds as stated above, and also moved for summary judgment. On September 18, 1992, the Court denied the ICN defendants' motion to dismiss and for summary judgment. The ICN defendant's filed their answer on February 19, 1993. On October 20, 1993, plaintiffs informed the Court that they had reached an agreement to settle with co- defendant Paine Webber, Inc. and\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) DECEMBER 31, 1993\nthat they would submit a proposed settlement stipulation to the Court. Expert discovery, which commenced in September 1993, is expected to conclude by the end of April 1994. Plaintiffs' damages expert, utilizing assumptions and methodologies that the ICN defendants' damages experts find inappropriate under the circumstances has testified that, assuming that classes were certified for purchasers of ICN, Viratek and SPI common stock for the entire class periods alleged by plaintiffs, January 7, 1986 through April 15, 1987, and further assuming that all the plaintiff's allegations were proven, potential damages against ICN, Viratek and SPI would, in the aggregate, amount to $315,000,000. The ICN defendants' four damages experts have testified that damages are zero. Management believes, having extensively reviewed the issues in the above referenced matters, that there are strong defenses and that the Company intends to defend the litigation vigorously. While the ultimate outcome of these lawsuits cannot be predicted with certainty and an unfavorable outcome could have an adverse effect on the Company, at this time Management does not expect that these matters will have a material adverse effect on the financial position, results of operations or liquidity of the Company. All of the Company's attorney fees and other costs of this litigation are borne by ICN pursuant to an agreement between ICN and Viratek.\nIn August 1992, an action was filed in United States District Court for the Southern District of New York, entitled Rossi v. ICN Pharmaceuticals, Inc. (Case No. 92 Cir. 4819 (CL6)). The plaintiffs, citing theories of product liability, negligence and strict liability in tort, alleged that birth defects in an infant were caused by the mother's exposure to Virazoleduring pregnancy. The case was placed on the court's \"suspense calendar\" pending completion of the parties' investigation of the underlying facts. Based on such investigation, the case was dismissed without prejudice pursuant to stipulation by the parties in December 1993. Per the License Agreement, SPI has indemnified Viratek and ICN for lawsuits involving the use of Virazole.\nIn February 1992, an action was filed in California Superior Court for the County of Orange by Gencon Pharmaceuticals, Inc. (\"\"Gencon\"\") against ICN Canada Limited (\"\"ICN Canada\"\"), its parent, the Company, and ICN alleging breach of contract and related claims arising out of a manufacturing contract between Gencon and ICN Canada. ICN and the Company were dismissed from the action in March 1993 based on the Company's agreement to guarantee any judgment against ICN Canada. Following trial in October and November 1993, the judge signed a decision granting judgment in favor of Gencon for breach of contract in the amount of approximately $2,100,000 plus interest, costs and attorney's fees. Trial counsel has advised the Company that the decision contains serious errors of law and fact. ICN Canada intends to prosecute vigorously its post-trial motions and any necessary appeal. The Company's December 31, 1993 financial statements includes an accrual amount equivalent to what the Company believes is the maximum exposure with regard to this contingency.\nThe Company is a party to a number of other pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. In the opinion of Management, neither the lawsuits discussed above nor various other pending lawsuits will have a material adverse effect on the consolidated financial position or operations of the Company.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) DECEMBER 31, 1993\nProduct Liability Insurance\nThe Company could be exposed to possible claims for personal injury resulting from allegedly defective products. While to date no material adverse claim for personal injury resulting from allegedly defective products has been successfully maintained against the Company, a substantial claim, if successful, could have a material adverse effect on the Company.\n7. COMMON STOCK:\nAt December 31, 1993, 1,369 shares of common stock were reserved for issuance to officers, directors and key employees under the Company's 1982 Employee Incentive Stock Option Plan. The option price may not be less than fair market value at date of grant and may not have a term exceeding 10 years. At December 31, 1993, options for 1,369 shares were outstanding under this plan (at a price of $4.84 per share), of which 1,369 shares were exercisable. No shares were exercised during 1993. The number of shares exercised were: 1992 - 2,322 and 1991 -7,000 at average prices of $5.16 and $5.27, respectively.\nIn addition, at December 31, 1993, a total of 856,232 shares of common stock were reserved for issuance to officers, directors, key employees, scientific advisors and consultants under the Company's 1982 Non-Qualified Stock Option Plan. The option price may not be less than fair market value at date of grant and may not have a term exceeding 10 years. At December 31, 1993, options for 856,232 shares were outstanding under this plan (at an average price of $11.59), of which 456,887 shares were exercisable. The number of shares exercised were: 1993--180,446; 1992--229,153; 1991--587,000, at average prices of $5.10, $7.16, and $5.16, respectively.\nAt December 31, 1993, 541,292 shares of common stock were reserved for issuance to officers, directors and key employees under the Company's 1992 Employee Incentive Stock Option Plan. The option price may not be less than fair market value at date of grant and may not have a term exceeding 10 years. At December 1993, 505,838 shares were outstanding under this plan (at an average price of $16.78 per share), of which 89,899 shares were exercisable.\nIn addition, at December 31, 1993, a total of 1,483,007 shares of common stock had been granted to officers, directors, key employees, scientific advisors and consultants under the Company's 1992 Non-Qualified Stock Option Plan. The option price per share may not be less than the fair value at date of grant and may not have a term exceeding 10 years. Of these shares, a total of 1,082, 586 shares were reserved and outstanding under this plan and 400,421 shares were not reserved and outstanding under this plan at the time of grant, but were granted to key employees pursuant to authorization by the Board of Directors, subject to the approval of the shareholders at the next meeting of shareholders' to be held in 1994. At December 31, 1993, the average price per share of the shares granted was $21 and 551,438 options were exercisable.\nIn addition to those shares reserved for the above noted plans, 342,422 shares were reserved for certain officers of the Company. At December 31, 1993, options for 62,290 were outstanding and exercisable at an average price of $4.84. The number of shares exercised were: 1993--280,132 and 1992--102,000, at an average price of $4.84 and $5.13, respectively.\nOn January 13, 1993, the Company's Board of Directors approved a fourth quarter 1992 stock dividend of 2%. During 1993, the Company issued quarterly stock dividends which totaled 6%. In January, 1994, the Company declared a first quarter 1994 stock dividend of 1.4%. Accordingly, all numbers of common shares, except shares authorized, stock option data and per share data have been restated to reflect the dividends. Fractional shares resulting from the dividends will be settled in cash.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) DECEMBER 31, 1993\n8. DETAIL OF CERTAIN ACCOUNTS:\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nIt is the Company's policy to segregate significant non-operating items and report them separately as Other expense, net, as follows:\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\n9. GEOGRAPHIC DATA:\nThe Company operates in the pharmaceutical industry, which includes the production and marketing of proprietary pharmaceutical products, nutritional supplements and optical products.\nThe following tables set forth the amounts of net sales, income before provision for income taxes and minority interest and identifiable assets of the Company by geographical areas for 1993, 1992 and 1991 (in thousands):\nINCOME (LOSS) BEFORE INTEREST, PROVISION FOR INCOME TAXES AND MINORITY INTEREST.\nDuring the year ended December 31, 1993, approximately 68% of ICN Galenika's sales were to the Federal Republic of Yugoslavia or government sponsored entities. At December 31, 1993, there were no significant receivables from the Yugoslavian government, however future sales of ICN Galenika could be dependent on the ability of the Yugoslavian government to generate cash to purchase pharmaceuticals and the continuation of its current policy to buy products from ICN Galenika. No other customer accounts for more than 10% of the Company's net sales.\n(1) Export sales shipped from the United States for 1993, 1992 and 1991 were $6,166,000, $4,824,000, and $3,576,000, respectively.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\n(2) During 1991, the Company wrote off goodwill, inventory and other assets totaling $13,124,000, of which $10,878,000 relates to the domestic nutritional group.\n(3) During 1991, the Mexico subsidiary wrote off $909,000 of inventory.\n(4) During 1991, the Western European group wrote off $1,051,000 in inventory and receivables.\n(5) Corporate includes corporate general and administrative expenses and other non-operating income and expense. Corporate identifiable assets are not determinable for 1991.\n10. SUPPLEMENTAL CASH FLOWS DISCLOSURES:\nNon-cash Transactions\nIn September 1993, the Company issued 200,000 shares of common stock to ICN in exchange for reducing its debt outstanding to ICN by $3,075,000.\nDuring 1993 and 1992, the Company issued common stock dividends of $20,634,000 and $3,440,000, respectively.\nCash and non-cash financing activities consisted of the following in 1991 (in thousands):\nThe following table sets forth the amounts of interest and income taxes paid during 1993, 1992 and 1991 (in thousands):\n11. ACQUISITION:\nEffective May 1, 1991, SPI formed a new joint company with Galenika Pharmaceuticals headquartered in Belgrade, Yugoslavia. The joint company, ICN Galenika, is 75%-owned by the Company and 25%-owned by Galenika Holding (\"Galenika Holding\"). Galenika, the leading pharmaceutical company in Yugoslavia, produces, markets and distributes over 450 pharmaceutical, veterinary, dental and other products in Yugoslavia, Eastern Europe and Russia.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nIn connection with the agreement, the Company contributed assets totaling $58,301,000, consisting of $14,453,000 cash, an obligation to pay $13,550,000 and 1,200,000 unregistered shares of common stock of the Company issued to the employees (\"owners\" in Socialist Yugoslavia) of Galenika Holding with a fair value of $9,000,000. On December 31, 1991, ICN, on behalf of SPI, contributed: 1,468,000 shares of SPI common stock to ICN Galenika with a cost basis of $11,555,000; the minority interest share of the excess of the fair value of the common stock of the Company contributed by ICN and ICN's cost basis equaling $6,743,000; and acquisition costs of $3,000,000. Under the terms of the ICN Galenika agreement, SPI had an obligation to contribute, in part, $50,000,000 in cash and either 1,200,000 shares of SPI stock or $12,000,000 in cash. However, the agreement was subsequently changed in December 1991 whereby ICN, on behalf of SPI, contributed shares of SPI stock in lieu of the $40,000,000 (after a cash payment of $10,000,000) and SPI issued 1,200,000 shares of SPI stock in lieu of cash, to comply with the original intent of the parties.\nThe ICN Galenika transaction has been accounted for by the purchase method of accounting, and accordingly, the Company's investment has been allocated, based on the Company's ownership percentage, to the assets acquired and the liabilities assumed based on the estimated fair values at the effective date of formation, May 1, 1991. Assuming that the acquisition of ICN Galenika occurred at the beginning of the year, the Company's 1991 pro forma revenues for the full year ended December 31, 1991, would have been $452,460,000 with net income of $44,096,000. The pro forma information presented does not purport to be indicative of the results that would have been obtained if the operations were combined during the year presented and is not intended to be a projection of future results or trends.\nIn connection with the ICN Galenika transaction, the Company changed its fiscal year end from November 30 to December 31, which conforms to ICN Galenika's year end. The Company's separate results of operation for the month of December 1990, therefore, are not reflected in the statement of income but have been charged directly to retained earnings.\n12. ICN GALENIKA:\nThe summary balance sheets of ICN Galenika as of December 31, 1993 and 1992, and the summary income statements for the years ended December 31, 1993, 1992 and the eight months ended December 31, 1991, are presented below.\nICN GALENIKA SUMMARY BALANCE SHEETS AS OF DECEMBER 31, 1993 AND 1992 (IN THOUSANDS)\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nICN GALENIKA SUMMARY STATEMENTS OF INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND EIGHT MONTHS ENDED DECEMBER 31, 1991\nSANCTIONS:\nA substantial majority of ICN Galenika's business is conducted in the Federal Republic of Yugoslavia (Serbia and Montenegro). On May 30, 1992, the UNSC adopted a resolution that imposed economic sanctions on the Federal Republic of Yugoslavia and on April 17, 1993, the UNSC adopted a resolution that imposed additional economic sanctions on the Federal Republic of Yugoslavia. On April 26, 1993, the United States issued an executive order that implemented the additional sanctions pursuant to the United Nations resolution. The new sanctions continue to specifically exempt certain medical supplies for humanitarian purposes, a portion of which are distributed by ICN Galenika.\nICN Galenika continues to apply for, and has received, licenses under the new sanctions. The renewed efforts to enforce sanctions will create additional administrative burdens that will slow the shipments of licensed raw materials to Yugoslavia. Shipments of imported raw materials declined in 1993 to 38% of prior year levels. Additionally, the new sanctions have contributed to an overall deteriorating business environment in which ICN Galenika must operate.\nThe new sanctions provide for the freezing of bank accounts of Yugoslavian commercial and industrial entities. The implementation of new sanctions may create a restriction on ICN Galenika's cash holdings that are maintained in a bank outside of Yugoslavia. Management believes, however, that these funds will be available for drawdowns on lines of credit for shipments specifically licensed under the new and prior sanctions. As a result of continuing political and economic instability within Yugoslavia, including the long-term impact of the sanctions, wage and price controls, and devaluations, there may be further limits on the availability of hard and local currency and consequently, an adverse impact on the future operating results of the Company.\nAt December 31, 1992, ICN Galenika had cash and cash equivalents of $44,700,000, of which $15,200,000 was restricted as to use, invested with a financial institution outside of Yugoslavia. These funds have been used for letters of guarantee on ICN Galenika's raw material purchases and to collateralize the payment of dividends. During the first quarter 1993, $731,000 was withdrawn under the letters of guarantee. Before the implementation of additional sanctions in April 1993, approximately $9,885,000 was withdrawn under the letters of guarantee. In October 1993, ICN Galenika acquired marketable securities with these funds in order to maximize their interest earned. The marketable securities are maintained at the same financial institution. As of December 31, 1993, at this institution, ICN Galenika had $834,000 of hard currency and $32,587,000 of marketable securities which are used to collateralize a $10,000,000 note payable.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nIn order to conserve operating cash, the wages of all ICN Galenika employees were reduced to Yugoslavian minimum wage levels beginning in the fourth quarter 1993. To help alleviate the burden of sanctions and wage reductions, the Company intends to expend funds for humanitarian aid in the form of food assistance for ICN Galenika employees. This aid will be subject to approval and licensing required by UNSC sanctions. In the first quarter 1994, the Company obtained licenses for approximately $280,000 of aid. The expenditure of future aid will be dependent on the conditions in Yugoslavia and will be subject to obtaining approval and licenses under UNSC sanctions.\nHYPERINFLATION AND PRICE CONTROLS:\nUnder existing Yugoslavian price controls imposed in July 1992, ICN Galenika can no longer continue the unrestricted practice of increasing selling prices in anticipation of inflation. Rather, price increases must be approved by the government prior to implementation. The imposition of price controls along with the effect of sanctions and recurring currency devaluations resulted in reduced sales levels in the last half of 1992 and for 1993. This trend of reduced sales levels is expected to continue as long as sanctions are in place.\nAs a result of decreased sales levels, Management expects that profit margins will decrease and overall operating expenses as a percentage of sales will increase.\nAs a result of the hyperinflation in Yugoslavia, the Yugoslavian government devalued the dinar on several occasions during 1993 and, on October 1, 1993, changed the denomination of the currency. The effect of the devaluations, adjusted for the change in currency denomination, was to increase the exchange rate from less than one dinar per $1 U.S. at the beginning of 1993 to over one trillion dinars per $1 U.S. at the end of 1993. In anticipation of devaluations in 1993, the Company implemented a plan described below, to minimize its monetary exposure. As a result of the devaluations and subsequent exchange losses from obtaining hard currencies, ICN Galenika experienced translation losses of $173,000. While the Company cannot predict with any certainty the actual remeasurement and exchange gains or losses that may occur in 1994, such amounts may be substantial. Annual inflation is very high with some estimates of over 1 billion percent. Future devaluations are likely in the near term. At December 31, 1993, ICN Galenika's net monetary liability exposure was $2,093,000. As a result of the non-tradability of the dinar, the Company is unable to effectively hedge against the loss from devaluation.\nThe Company is taking action to generate the dinar cash needed to acquire hard currency to reduce its monetary exposure. ICN Galenika has access to short- term borrowings at interest rates below the level of inflation. ICN Galenika plans to maximize its borrowings under these arrangements and use the proceeds to acquire hard currency for the purchase of inventory. This strategy will provide hard currency, accelerate the purchase of inventory to minimize the effects of inflation, and reduce future transaction losses. This strategy will also increase ICN Galenika's monetary liabilities, and lower its risk of loss from devaluations. This strategy, however, has resulted in increased interest expense in 1993 and may result in high levels of interest expense in 1994.\nIn conjunction with a currency devaluation on July 23, 1993, the Yugoslavian government announced that businesses in Yugoslavia can no longer buy and sell hard currency in privately negotiated transactions. All purchases of hard currency must be made through the National Bank of Yugoslavia based on government approved allocations. This action could possibly limit the availability of hard currency in the future for ICN Galenika. However, if the government is successful in controlling access to hard currency, the Company's operations in Yugoslavia may benefit through increased allocations of hard currency. Due to the strategic nature of pharmaceutical drugs in Yugoslavia, ICN Galenika has, in the past, received relatively favorable allocations of hard currency from the government. For the year ended December 31, 1993, ICN Galenika received $12,744,000 in currency allocations.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\nOn January 24, 1994, the Yugoslavian government enacted a \"Stabilization Program\" designed to strengthen its currency. Under this program the official exchange rate of the dinar is fixed at a ratio of one dinar to one Duetsche mark. The Yugoslavian government guarantees the conversion of dinars to Duetsche marks and is able to do so by exercising restraint in the amount of dinars that it prints. Since the inception of this program the exchange rate of dinars to Duetsche marks has remained stable. The impact of this change on the future operations of ICN Galenika is uncertain.\nAs required by GAAP, the Company translates ICN Galenika financial results at the dividend payment rate established by the National Bank of Yugoslavia. To the extent that changes in this rate lag behind the level of inflation, sales and expenses will, at times, tend to be inflated. Future sales and expenses can substantially increase if the timing of future devaluations falls significantly behind the level of inflation. While the impact of sanctions, price controls, and devaluations on future sales and net income cannot be determined with certainty, they may, under the present political and economic environment, result in an adverse impact in the future.\nAt December 31, 1993, ICN Galenika has U.S. $33,421,000 invested with a financial institution outside of Yugoslavia. These funds came from the initial cash investment made by the Company of $14,453,000 and from the sale of the Company's stock transferred to ICN Galenika by ICN, also in conjunction with the acquisition. Under the terms of the acquisition agreement, these funds were originally intended to finance business expansion. However, in light of the current economic conditions in Yugoslavia, these funds are used for letters of guarantee on ICN Galenika's raw material purchases and to collateralize the payment of dividends. These funds are encumbered by a letter of guarantee for raw material purchases, of which no amount was outstanding at December 31, 1993, and $5,200,000 was outstanding at December 31, 1992, and as collateral for $10,000,000 of loans, included in Notes Payable bearing interest at 4.5% that were issued to pay the 1992 dividend of the same amount. Other uses of these funds in the future, such as capital investment, additional letters of guarantee, or future dividends are subject to review and licensing under the UNSC sanctions. At December 31, 1993, these funds have been invested in bonds and are recorded as marketable securities which are used to collateralize a $10,000,000 notes payable. At December 31, 1992, these funds were included in cash with $15,200,000 reflected as restricted cash.\nAs noted above, ICN Galenika paid a $10,000,000 dividend in 1992 of which the Company received 75% or $7,500,000. Yugoslavian law allows free distribution of earnings whether to domestic (Yugoslavian) or international investors. ICN Galenika is allowed to pay dividends out of earnings calculated under Yugoslavian Accounting Practices (\"YAP\"), not earnings calculated under GAAP.\nAs a result of the current level of inflation, the accumulated YAP earnings of ICN Galenika are insignificant when stated in dollars. Future dividends from ICN Galenika will depend heavily on future earnings. Under GAAP, ICN Galenika had accumulated earnings, which are not available for distributions, of approximately $61,787,000 at December 31, 1993. However, additional repatriation of cash could be declared from contributed capital as provided for in the original purchase agreement. In 1992, the Company made the decision to no longer repatriate the earnings of ICN Galenika and instead will use these earnings for local operations and reduction of debt.\nThe current political and economic conditions in Yugoslavia could continue to deteriorate to the point that the Company's investment in ICN Galenika would be threatened. Worsening political and economic conditions could also result in a situation where the Company may be unable to exercise control over ICN Galenika's operations or be unable to receive dividends from ICN Galenika. Under these conditions, the Company would no longer be able to continue to consolidate the financial information of ICN Galenika. In this situation the Company would be required to deconsolidate ICN Galenika and account for its investment using the cost method of accounting and the investment in ICN Galenika would be carried at the lower of cost or realizable value.\nSPI PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1993\n13. CONCENTRATIONS OF CREDIT RISK:\nFinancial instruments that potentially expose the Company to concentrations of credit risk, as defined by SFAS No. 105, consist primarily of cash deposits. The Company places its cash deposits with respected financial institutions and limits the amount of credit exposure to any one financial institution, however, in connection with the acquisition of ICN Galenika, the cash contributed to ICN Galenika was required, under the terms of the agreement, to be placed on deposit in a single high credit quality financial institution outside of Yugoslavia. At December 31, 1993, ICN Galenika had hard currency of $834,000 and marketable securities of $32,587,000 on deposit with this financial institution.\n14. INVESTMENT IN RUSSIA\nOn October 21, 1992, the Company announced that it had concluded an agreement with the Leningrad Industrial Chemical and Pharmaceutical Association (\"\"Oktyabr\"\") to form a pharmaceutical joint venture in Russia, ICN Oktyabr, in which the Company will have a 75% interest. The new joint venture was registered with the Russian Federation on March 9, 1993. The joint venture represents a new business, and not the acquisition of the existing business or assets of Oktyabr. Business operations of the joint venture will commence on the completion of a business plan. Oktyabr, which recently was privatized, will contribute output from its current production facilities. The Company's contribution will be management expertise, technology, equipment, intellectual property, training and technical assistance to the new joint venture. Because of the transition of the Russian economy into a free market oriented economy, the Company plans for a gradual phase-in of the joint venture in 1994 and 1995. During this phase-in period, the joint venture will develop training and marketing strategies and begin constructing a new manufacturing facility in 1995 that is scheduled to be fully operational in 1996. Because of this phase-in period, the Company does not expect any current material effects on it operating results, as well as, its capital resources and liquidity.\n15. SUBSEQUENT EVENT\nIn addition to the joint venture in Russia, on March 24, 1994, SPI entered into an Agreement with the City of St. Petersburg to acquire 15% of the outstanding shares of its joint venture partner, Oktyabr, in exchange for approximately 30,000 shares of the Company's stock. As part of this Agreement, SPI may qualify to receive newly issued shares of Oktyabr pursuant to Russian privatization regulations that will raise its total investment in Oktyabr to 43%. The issuance of these additional shares is subject to approval and completion of an \"investment plan.\" The completion of the investment plan will not require any additional financial resources of the Company. The Company has also extended an offer to the employees of Oktyabr to exchange their Oktyabr shares for SPI shares. The Oktyabr employees currently own approximately 33% of the outstanding shares, however, the number of employees that will exchange their shares is uncertain. In the event that SPI qualifies under the investment plan to raise its investment to 43%, it is possible that a sufficient number of employees might exchange their Oktyabr shares for SPI shares so that the total SPI investment in Oktyabr would exceed 50%. If this event occurs, the Company would be required to consolidate the financial results of Oktyabr into the financial statements of the Company.\nSPI PHARMACUETICALS, INC. SCHEDULE I--MARKETABLE SECURITIES\nSPI PHARMACUETICALS, INC. SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n(1) The credit to other accounts is primarily due to the impact of devaluations on the outstanding allowance for doubtful accounts. In hyperinflationary countries such as Yugoslavia, a devaluation will result in a reduction of accounts receivable and a proportionate reduction in the accounts receivable allowance. The reduction of accounts receivable is recorded as a foreign currency translation loss and the reduction of the allowance is recorded as a translation gain. Shortly after a devaluation the level of accounts receivable will rise as a result of subsequent price increases. In conjunction with the rise in receivables, additions to the allowance for receivables will be made for existing doubtful accounts. This process will repeat itself for each devaluation that occurs during the year. The effect of this process results in a high level of bad debt expense that does not necessarily reflect credit risk or difficulties in collecting receivables. For the year ended 1993, ICN Galenika recorded provisions for doubtful accounts of $10,968,000 compared to $48,279,000 for 1992. The timing of devaluations has a material impact on the size of the provision for doubtful accounts. The decrease in the 1993 provision is primarily a result of devaluations occurring more frequently in the current year, smaller price increases in 1993 compared to 1992, and lower levels of accounts receivable compared to the prior year. The reduction of the accounts receivable allowance from devaluation resulted in a translation gain of $9,118,000 and $40,191,000 resulting in a net expense from bad debts and bad debt translation gain of $1,850,000 and $8,088,000 for 1993 and 1992, respectively.\n(2) Results principally from ICN Galenika purchase price allocation.\nSPI PHARMACEUTICALS, INC. SCHEDULE IX--SHORT-TERM BORROWINGS\n(In thousands)\n(1) Calculated by dividing the total month-end outstanding borrowings by 12 months.\n(2) Calculated by dividing the total interest accrued during the period on short-term borrowings by the monthly average short-term borrowings outstanding during the period.\n(3) Weighted average interest rates were heavily influenced by the magnitude and duration of local currency borrowings in highly inflationary Yugoslavia, where interest rates obtained on borrowings usually reflect the underlying levels of local inflation.\nSPI PHARMACEUTICALS, INC. SCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION\n(IN THOUSANDS)\n(1) These amounts do not include royalties to affiliates, which are separately disclosed in Note 3 of Notes to Consolidated Financial Statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required under this item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1994 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Information Concerning Nominees and Directors.\" Information regarding the Company's executive officers is included in Part I of this Form 10-K under the caption \"Management.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required under this item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1994 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Executive Compensation and Related Matters.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required under this item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1994 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Ownership of the Company's Securities.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required under this item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1994 annual meeting of stockholders. Reference is made to those portions of the Proxy Statement entitled \"Executive Compensation and Related Matters\" and \"Certain Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nFinancial Statements of the Registrant are listed in the index to Consolidated Financial Statements and filed under Item 8, \"Financial Statements and Supplementary Data\", included elsewhere in this Form 10-K.\n2. Financial Statement Schedules\nFinancial Statement Schedules of the Registrant are listed in the index to Consolidated Financial Statements and filed under Item 8, \"Financial Statements and Supplementary Data,\" included elsewhere in this Form 10-K.\n3. Exhibits\n3.1 Certificate of Incorporation of Registrant, previously filed as Exhibit 3.1 to Registrant's Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n3.2 Bylaws of Registrant, previously filed as Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n4.2 Indenture between ICN Pharmaceuticals, Inc. and J. Henry Schroeder Bank & Trust Company, previously filed as Exhibit 4.1 to Registration Statement No. 33-5919 on Form S-3, which is incorporated herein by reference. First Supplemental Indenture dated as of October 1, 1986, between ICN Pharmaceuticals, Inc. and J. Henry Schroeder Bank & Trust Company.\n10.1 1981 Employee Incentive Stock Option Plan, previously filed as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the fiscal year ended November 30, 1981, which is incorporated herein by reference.\n10.2 Non-Qualified Stock Option Agreement dated as of May 24, 1984, between ICN Pharmaceuticals, Inc. and Milan Panic, previously filed as Exhibit 10.20 to Registrant's Annual Report on Form 10-K for the fiscal year ended November 30, 1984, which is incorporated herein by reference.\n10.3 Public Bond Issue Agreement dated as of June 13, 1985 between ICN Pharmaceuticals, Inc. and Banque Gutzwiller, Kurz, Bungener S.A., previously filed as Exhibit 10 to Registrant's Form 8 Amendment of Quarterly Report on Form 10-Q for the quarter ended August 31, 1985, which is incorporated herein by reference.\n10.4 Subscription Agreement dated January 20, 1986 between the Company, SPI Pharmaceuticals, Inc., Banque Gutzwiller, Kurz, Bungener, S.A. and the Trustee and Banks named therein, previously filed as Exhibit 10.33 to Amendment No. 1 to Annual Report on Form 10-K for the fiscal year ended November 30, 1985, which is incorporated herein by reference.\n10.5 Purchase Agreement dated as of September 5, 1986, for an issue by ICN Pharmaceuticals, Inc. of Dfl. 75,000,000 Subordinated Convertible Bonds due 1990\/1994 convertible into Shares of Common Stock, between ICN Pharmaceuticals, Inc. and Van Haften & Co. N.V. and the other Managers named therein; Trust Deed dated as of September 15, 1986, between ICN Pharmaceuticals, Inc. and B.V. Algemeen Administratieen Trustkantoor; and Paying Agency Agreement dated as of September 15, 1986, for an issue by ICN Pharmaceuticals, Inc. of Dfl. 75,000,000 Subordinated Convertible Bonds due 1990\/1994 Convertible into Shares of Common Stock among ICN Pharmaceuticals, Inc., Nederlands Credietbank N.V., Kerdietbank S.A. Luxembourgeoise, and Banque Gutzwiller, Kurz, Bungener S.A., previously filed as Exhibit 10 to Registration Statement No. 33-10706 on Form S-3, which is incorporated herein by reference.\n10.6 Xr Capital Holding Trust Instrument between ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited dated as of September 17, 1986; Subscription Agreement between Ansbacher (C.I.) Limited, ICN Pharmaceuticals, Inc., SPI Pharmaceuticals, Inc., and Banque Gutzwiller, Kurz, Bungener S.A. and the other financial institutions named therein dated as of September 17, 1986; Bond Issue Agreement between ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited dated as of September 17, 1986; and Exchange Agency Agreement between ICN Pharmaceuticals, Inc., SPI Pharmaceuticals, Inc., Banque Gutzwiller, Kurz, Bungener S.A., and the other financial institutions named therein dated as of September 17, 1986 previously filed as Exhibit 10.36 to Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n10.7 Indenture dated as of October 30, 1986 between ICN Pharmaceuticals, Inc. and Citibank, N.A.; and Subscription Agreement dated as of October 8, 1986 between ICN Pharmaceuticals, Inc., J. Henry Schroder Wagg and Co. Ltd. and the other financial institutions named therein previously filed as Exhibit 10.37 to Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n10.8 Pharma Capital Holdings Trust Instrument between ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited, dated as of October 16, 1986; Subscription Agreement between Ansbacher (C.I.) Limited, ICN Pharmaceuticals, Inc. and the Managers named therein, dated as of October 16, 1986; Paying Agency Agreement between ICN Pharmaceuticals, Inc., Ansbacher (C.I.) Limited, Banque Paribas (Luxembourg) S.A. and the other financial institutions named therein dated as of October 22, 1986; and the Exchange Agency Agreement between ICN Pharmaceuticals, Inc., Banque Paribas (Luxembourg) S.A. and the other Exchange Agents named therein dated as of October 22, 1986 previously filed as Exhibit 10.38 to Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n10.9 Bio Capital Holding Trust Instrument between ICN Biomedicals, Inc., Ansbacher (C.I.) Limited and ICN Pharmaceuticals, Inc. dated as of January 26, 1987; Subscription Agreement between ICN Biomedicals, Inc., Ansbacher (C.I.) Limited, ICN Pharmaceuticals, Inc., Banque Gutzwiller, Kurz, Bungener S.A. and the other financial institutions named therein dated as of January 26, 1987; Bond Issue Agreement between ICN Biomedicals, Inc., ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited dated as of January 26, 1987; Exchange Agency Agreement between ICN Biomedicals, Inc., Banque Gutzwiller, Kurz, Bungener, S.A., and the other financial institutions named therein dated as of January 26, 1987; and Guaranty between ICN Pharmaceuticals, Inc. and ICN Biomedicals, Inc. dated as of February 17, 1987, previously filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 1987, which is incorporated herein by reference.\n10.10 Public Bond Issue Agreement dated as of February 20, 1987, between ICN Pharmaceuticals, Inc. and Fintrelex, S.A. and the other banks named therein; Conversion Agency Agreement dated as of February 20, 1987 between ICN Pharmaceuticals, Inc., E. Gutzwiller & Cie, and the other financial institutions named therein; and Escrow Agreement dated as of February 20, 1987 between ICN Pharmaceuticals, Inc., Fintrelex, S.A. and E. Gutzwiller & Cie, previously filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 1987, which is incorporated herein by reference.\n10.11 License agreement dated as of January 1, 1987 between ICN Pharmaceuticals, Inc. and SPI Pharmaceuticals, Inc. regarding Brown Pharmaceutical Company, Inc. previously filed as Exhibit 10.50 to Annual Report on Form 10-K for the fiscal year ended November 30, 1987, which is incorporated herein by reference.\n10.12 Employment Agreement dated October 1, 1988 between ICN Pharmaceuticals, Inc. and Milan Panic, incorporated herein by reference.\n10.13 Tax Sharing Agreement effective June 1, 1990 between SPI Pharmaceuticals, Inc. and ICN Pharmaceuticals, Inc incorporated herein by reference.\n10.14 Asset Transfer Agreement between ICN Pharmaceuticals, Inc. and SPI Pharmaceuticals, Inc. dated April 26, 1991 incorporated herein by reference.\n10.15 1992 Employee Incentive Stock Option Plan, incorporated herein by reference.\n10.16 1992 Non-Qualified Stock Option Plan, incorporated herein by reference.\n10.17 Milan Panic Leave of Absence of Reemployment Agreement, incorporated herein by reference.\n11 Statement re computation of per share earnings.\n22 Subsidiaries of the registrant.\n23 Consent of Coopers & Lybrand.\nSIGNATURES\nPursuant 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.\nICN PHARMACEUTICALS, INC. Registrant\nDate: March 30, 1994\nBy \/s\/ MILAN PANIC ------------------------------------------ Milan Panic Chairman of the Board, President and Chief Executive Officer\nPursuant 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 and on the dates indicated.\nEXHIBIT INDEX","section_15":""}
{"filename":"92244_1993.txt","cik":"92244","year":"1993","section_1":"Item 1. Business\nGENERAL\nThe Southern New England Telephone Company (\"Telephone Company\") was incorporated in 1882 under the laws of the State of Connecticut and has its principal executive offices at 227 Church Street, New Haven, Connecticut 06510 (telephone number (203) 771-5200). The Telephone Company is a wholly owned subsidiary of Southern New England Telecommunications Corporation (\"Corporation\").\nThe Telephone Company, a local exchange carrier (\"LEC\"), is engaged in the provision of telecommunications services in the State of Connecticut, most of which are subject to rate regulation. These telecommunications services include (i) local and intrastate toll services, (ii) exchange access service, which links customers' premises equipment (\"CPE\") to the facilities of other carriers, and (iii) other services such as digital transmission of data and transmission of radio and television programs, packet switched data network and private line services. Through its directory publishing operations, the Telephone Company publishes and distributes telephone directories throughout Connecticut and certain adjacent communities.\nIn 1993, approximately 87% of the Telephone Company's revenues were derived from the rate regulated telecommunication services. The remainder were derived principally from directory publishing operations and activities associated with the provision of facilities and non-access services to interexchange carriers. About 71% of the operating revenues from rate regulated services were attributable to intrastate operations, with the remainder attributable to interstate access services.\nState Regulatory Matters\nThe Telephone Company, in providing telecommunications services in the State of Connecticut, is subject to regulation by the Connecticut Department of Public Utility Control (\"DPUC\"), which has jurisdiction with respect to intrastate rates and services, and other matters such as the approval of accounting procedures, the issuance of securities and the setting of depreciation rates on telephone plant utilized in intrastate operations. The DPUC has adopted for intrastate ratemaking purposes accounting and cost allocation rules, similar to those adopted by the Federal Communications Commission (\"FCC\"), for the separation of costs of regulated from non-regulated activities.\nState Regulation\nOn May 24, 1993, the DPUC issued a final decision on the capital recovery portion of the November 1992 rate request submitted by the Telephone Company (\"Rate Request\"). The Telephone Company was granted an increase in the composite intrastate depreciation rate from 5.7% to approximately 7.3%. This equated to an increase in Telephone Company revenue requirement of approximately $40 million annually. The new depreciation rates were implemented effective July 1, 1993.\nOn July 7, 1993, the DPUC issued a final decision (\"Final Decision-I\") in its three-phase review of the current and future telecommunications requirements of Connecticut and a final decision (\"Final Decision-II\") in the remainder of the Rate Request docket. The Final Decision-I addressed the issues of (i) competition [see Item 1., \"Competition\"]; (ii) infrastructure modernization; (iii) rate design and pricing principles; and (iv) regulatory and legislative frameworks. With respect to \"rate design and pricing principles,\" the DPUC stated that the pricing of all services must be more in line with the costs of providing these services. Historically, to provide universal service, basic residential services have been subsidized by other tariffed services, primarily message toll and business services. In regard to the regulatory and legislative framework, the DPUC endorsed the concept of incentive-based regulation as a potentially more effective and efficient regulatory system than the present rate of return regulation.\nThe Final Decision-II authorized a rate of return on the Telephone Company's common equity (\"ROE\") of 11.65% and an increase in intrastate revenue of $37.5 million effective July 7, 1993. The Telephone Company was authorized previously to earn a 12.75% ROE. On August 13, 1993, the DPUC granted the Telephone Company an additional revenue requirement of $1.9 million to the $37.5 million previously awarded based on a review of certain areas requested by the Telephone Company. The total increase in intrastate revenue of $39.4 million is virtually offset by the approximate $40 million increase in capital recovery. In addition, the Final Decision-II addressed areas of infrastructure modernization and incentive regulation. Under infrastructure modernization, the Final Decision-II supported, but did not mandate, implementation of an infrastructure modernization program.\nOn December 3, 1993, the Telephone Company sought approval from the DPUC to allow the Telephone Company to develop and provide electronic information services (\"EIS\"), including electronic publishing services. Since 1984, dramatic industry changes in technology, regulation and competition have eliminated any need for such a restriction. For the last three years, AT&T and the Regional Bell Operating Companies (\"RBOCs\") have been permitted to enter the electronic publishing and information services markets. For the same reasons that the U.S. District Court lifted the ban on information services and electronic publishing services for AT&T and the RBOCs, the Company believes that the DPUC should lift the ban on the Telephone Company offering of EIS. A hearing in this matter is expected in the first half of 1994.\nState legislation, signed into law effective July 1, 1993, authorized the formation of a task force to study Connecticut's telecommunications infrastructure and policies. Draft legislation, based on the recommendations the task force submitted in February 1994, provides a framework to move forward with a new regulatory model for Connecticut. This model would move telecommunications toward a fully competitive marketplace and provide alternative forms of regulation. Overall, the goals of the draft legislation are to: (i) ensure high-quality and affordable universal telecommunications service for Connecticut customers; (ii) promote effective competition and the development of an advanced infrastructure; and (iii) enhance the efficiency of government, educational, and health care facilities through telecommunications.\nIntrastate Rates\nThe Final Decision-II established rates designed to achieve the increase in intrastate revenue of $39.4 million. The following major provisions were included in the Final Decision-II: (i) reductions in intrastate toll rates including several toll discount plans; (ii) an increase in basic local exchange rates for residential and business customers to be phased in over a two-year period; (iii) a reduction in the pricing ratio gap between business and residential basic local service over a two-year period: (iv) a $7.00 per month Lifeline credit for low-income residential customer; (v) an increase in local calling service areas for most customers with none being reduced: (vi) an increase in the local coin telephone rate from $.10 to $.25; (vii) an increase in the directory assistance charge from $.24 to $.40 and a decrease in the number of \"free\" directory assistance calls; and (viii) a late payment charge of 1% monthly effective January 1, 1994. This rate award was implemented on July 9, 1993 through a combination of increases for coin telephone calls, directory assistance calls along with an approximate 15% interim surcharge on the remaining products and services with authorized increases including local exchange. On July 22, 1993, the DPUC issued a supplemental decision reducing the interim surcharge implemented on July 9, 1993 to approximately 8%. The Telephone Company issued credits during August of 1993 to customers who were charged at the higher rate. The 8% surcharge was in effect until October 9, 1993, when the remaining new rates became effective, including an average increase in residential basic local exchange rates of $.32 a month and a slight decrease in average monthly business rates. In addition, residential basic local exchange rates will increase $.31 a month and business rates will decrease an average of $.84 a month beginning in July 1994. At December 31, 1993, the Telephone Company's intrastate ROE was below the authorized 11.65%.\nFederal Regulatory Matters\nThe Telephone Company is subject to the jurisdiction of the FCC with respect to interstate rates, services, video dial tone, access charges and other matters, including the prescription of a uniform system of accounts and the setting of depreciation rates on plant utilized in interstate operations. The FCC also prescribes the principles and procedures (referred to as \"separations procedures\") used to separate investments, revenues, expenses, taxes and reserves between the interstate and intrastate jurisdictions. In addition, the FCC has adopted accounting and cost allocation rules for the separation of costs of regulated from non-regulated telecommunications services for interstate ratemaking purposes.\nFederal Regulation\nOn July 1, 1993, the FCC, in connection with its normal triennial review of depreciation, granted the Telephone Company new depreciation rates retroactive to January 1, 1993. The new rates increased depreciation expense by approximately $11 million in 1993. Under current price cap regulation, however, any changes in depreciation rates cannot be reflected in interstate access rates (see \"Interstate Rates,\" below).\nOn January 19, 1994, the Telephone Company filed suit in the U.S. District Court in New Haven claiming that the Cable Communications Policy Act of 1984 (\"Cable Act\") violates the Telephone Company's First and Fifth Amendment rights. The Cable Act limits the in-territory provision of cable programming by LECs such as the Telephone Company. The Cable Act currently prohibits\nLECs from owning more than 5% of any company that provides cable programming in their local service area.\nSince January 1, 1988, the Telephone Company has utilized an FCC approved, company specific Cost Allocation Manual (\"CAM\"), which apportions costs between regulated and non-regulated activities, and describes transactions between the Telephone Company and its affiliates. In addition, the FCC requires larger LECs, including the Telephone Company, to undergo an annual independent audit to determine whether the LEC is in compliance with its approved CAM. The Telephone Company has received audit reports for 1988 through 1992 indicating it is in compliance with its CAM, and is currently undergoing an audit for the year 1993.\nInterstate Rates\nThe Telephone Company elected price cap regulation effective July 1, 1991. Under price cap regulation, which replaces traditional rate of return regulation, prices are no longer tied directly to the costs of providing service, but instead are capped by a formula that includes adjustments for inflation, assumed productivity increases, and \"exogenous\" factors, such as changes in accounting principles, in FCC cost separation rules, and taxes. The treatment as exogenous of various factors affecting a company's costs is subject to FCC interpretation.\nBy electing price cap regulation, the Telephone Company is provided the opportunity to earn a higher interstate rate of return than that allowed under traditional rate of return regulation. However, price cap regulation presents additional risks since it establishes limits by which the Telephone Company is able to increase rates, even if the Telephone Company's interstate rate of return falls below the authorized rate of return. The Telephone Company is allowed to annually elect a productivity offset factor of 3.3% or 4.3%. Since price cap regulation was elected in July 1991, the Telephone Company has selected the 3.3% productivity factor and does not anticipate changing its election for the next tariff period. Choosing the 3.3% factor, the Telephone Company is allowed to earn up to a 12.25% interstate rate of return annually. Earnings between 12.25% and 16.25% would be shared equally with customers, and earnings over 16.25% would be returned to customers. Any amounts returned to customers would be in the form of prospective rate reductions. In addition, the Telephone Company's ability to achieve or exceed its interstate rate of return will depend, in part, on its ability to meet or exceed the assumed productivity increase. As of December 31, 1993, the Telephone Company's interstate rate of return was below the 12.25% threshold.\nThe Telephone Company filed tariffs under price cap regulation on April 2, 1993 which took effect on July 2, 1993, subject to the FCC's further investigation. The Telephone Company will file its 1994 annual interstate access tariff filing on April 1, 1994 to become effective July 1, 1994. The filing will adjust interstate access rates for an experienced rate of inflation, the FCC's productivity target, and exogenous cost changes, if any. In January 1994, the FCC began its scheduled inquiry into the price cap plan for LECs, to determine whether to revise the current plan to improve its performance in meeting the FCC's objectives. Results of this inquiry are expected in late 1994 or early 1995.\nIn an order released on January 9, 1990, which did not directly apply to the Telephone Company, the FCC established a precedent whereby a customer has a right to recover damages if they can establish that a LEC exceeded its authorized rate of return. The FCC, in a March 1993 order responding to a complaint filed by Sprint Communications Company (\"Sprint\") alleging overearnings in switched traffic sensitive access charges, affirmed the Telephone Company's right to offset overearnings in one access category with underearnings in another category, and held that the Telephone Company had no liability. Sprint has appealed the order to the U.S. Court of Appeals.\nRegulated Operations\nThe network access lines provided by the Telephone Company to customers' premises can be interconnected with the access lines of other telephone companies in the United States and with telephone systems in most other countries. The following table sets forth, for the Telephone Company, the number of network access lines in service at the end of each year and the number of intrastate toll and intrastate WATS messages handled for each year:\n1993 1992 1991 1990 1989\nNetwork Access Lines in Service 1,964 1,937 1,922 1,904 1,875 (in thousands)\nIntrastate Toll and WATS Messages 524 526 516 521 523 (in millions)\nThe Telephone Company has been making, and expects to continue to make, significant capital expenditures to meet the demand for regulated telecommunications services and to further improve such services (see discussion of I-SNET in \"Competition\"). The total gross investment in telephone plant increased from approximately $3.4 billion at December 31, 1988 to approximately $4.0 billion at December 31, 1993, after giving effect to retirements, but before deducting accumulated depreciation at either date. Since 1989, cash expended for capital additions was as follows:\nDollars in millions 1993 1992 1991 1990 1989\nCash Expended for Capital Additions $231.6 $269.1 $296.3 $370.0 $338.8\nIn 1993, the Telephone Company funded its cash expenditures for capital additions entirely through cash flows from operations. In 1994, capital additions are expected to be approximately $230 million. The Telephone Company expects to fund substantially all of its 1994 capital additions through cash flows from operations.\nThe Telephone Company currently accounts for the economic effects of regulation in accordance with the provisions of SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" In the event recoverability of operating costs through rates becomes unlikely or uncertain, whether resulting from competitive effects or specific regulatory actions, SFAS No. 71 would no longer apply. The financial impact of an accounting change, should the Telephone Company no longer qualify for the provisions of SFAS No. 71, would be material.\nCompetition\nThe Telephone Company's regulated operations are subject to competition from companies, carriers and competitive access providers which construct and operate their own communications systems and networks for the provision of services to others. At present, regulation continues to provide for a system of subsidies which prevent the Telephone Company's prices from moving toward the cost of providing the service. The Telephone Company's ability to compete depends to some degree on the action of regulators regarding the pricing of local, toll and network access services, and on the Telephone Company's continuing ability to manage its costs effectively.\nIn the Final Decision-I, the DPUC concluded that currently authorized intrastate competition has not adversely affected either service availability or cost, and that a broadened scope of intrastate competitive participation was prudent and warranted. Accordingly, the DPUC found that 10XXX calling and resale competition were in the public interest and should be allowed beginning July 7, 1993 in accordance with recently enacted State legislation. Using 10XXX calling, customers can use any certified carrier for interexchange calling within Connecticut by dialing 1, 0, and XXX (a three-digit carrier code). Terms and conditions associated with the provision of specialized\/ancillary services, including monitoring, reporting and compensation, would no longer apply.\nSince the issuance of Final Decision-I, several interexchange carriers have filed applications with and received approval from the DPUC to offer 10XXX intrastate long-distance service. In addition, a number of resellers have filed for initial certificates of public convenience and necessity. The Telephone Company anticipates additional applications will be filed. The introduction of competition to intrastate long- distance service and the Telephone Company's reduction in intrastate toll rates will further erode the Telephone Company's intrastate toll revenues. Pursuant to Final Decision-I, the Telephone Company filed on October 1, 1993 its proposed implementation plan for equal access based on customer preference for dual primary interexchange carrier capability (ability to choose one carrier for interstate calling and either the same or a different carrier for intrastate long distance calling). The Telephone Company's position regarding cost recovery remains that interexchange carriers should pay for the direct costs of implementing equal access.\nRegarding competition for local exchange services, in January 1994, MCI announced plans to construct and operate local communication networks in large markets throughout the United States, including parts of Connecticut in which the Telephone Company operates. These networks would allow MCI to bypass the Telephone Company's facilities and provide services directly to customers. Pending DPUC approval, these services are expected to be available in Connecticut within two to three years. Also in January 1994, the Telephone Company announced that it had reached an agreement to lease part of its existing digital fiber optic ring network in the greater Hartford metropolitan area to MFS Communications, Inc. (\"MFS\"). This agreement allows MFS to provide services to large business customers on an intraexchange basis and eliminates the need for MFS to construct their own facilities. Teleport Communications Group, another competitive access provider, recently announced plans to provide local telephone links for interstate services to businesses and long distance companies in the Hartford area.\nIn an order adopted in September 1992, the FCC required certain LECs, including the Telephone Company, to offer expanded special access interconnection to all interested parties, permitting competitors to terminate their own transmission facilities in LEC central offices. The Telephone Company filed tariffs which were implemented in June 1993, subject to investigation, and was granted some additional pricing flexibility in light of this increased competition. In August 1993, the FCC adopted rules, which largely mirror the requirements adopted in September 1992 for special access interconnection, requiring certain LECs, including the Telephone Company, to offer expanded interstate switched access interconnection. The Telephone Company tariffs which implemented changes associated with switched access interconnection became effective in February 1994. The Telephone Company has received applications from competitive access providers for special access interconnection in selected central offices of the Telephone Company. The Telephone Company anticipates additional applications for both special and switched access interconnection will be filed. A number of LECs, including the Telephone Company, have appealed the FCC's orders to offer special and switched access interconnection. Oral arguments on the appeal of the special access order were heard in February 1994 with a decision expected later in 1994. The appeal of the switched access order has been delayed pending a decision on the special access appeal.\nThe Telephone Company, expecting to see continued movement toward a fully competitive telecommunications marketplace, both on an interexchange and intraexchange basis, has taken several steps to effectively position itself. On January 13, 1994, the Telephone Company announced its intention to invest $4.5 billion over the next 15 years to build a statewide information superhighway (\"I-SNET\"). I-SNET will be an interactive multimedia network capable of delivering voice, video and a full range of information and interactive services. The Telephone Company expects I-SNET will reach approximately 500,000 residences and businesses thru 1997. In addition, the Telephone Company has reduced its intrastate toll rates beginning in July 1993 [see Item 1., \"Intrastate Rates\"], is committed to reducing its cost structure, remains focused on providing quality customer service and has introduced several new services as mentioned below.\nNew Services\nOn March 31, 1993, the Telephone Company together with Sprint announced the introduction of 800 CustomLink Service[SM]. This service allows the Telephone Company to offer its business customers an 800 service enabling them to receive calls from anywhere in the United States as well as international locations.\nIn 1993, the Telephone Company launched the next generation of CentraLink products, CentraLink[SM] 3100. CentraLink 3100 is a central-office based product that allows flexibility to add additional phone lines, locations and features to adapt to customers' changing telecommunications requirements.\nOn October 21, 1993, the FCC approved the Telephone Company's application to construct, operate, own, and maintain facilities to conduct a technology and marketing trial for use in providing video dial tone service in West Hartford, Connecticut. With construction of the fiber optic and coaxial facilities completed, the trial began in early 1994. The trial, offered to approximately 500 customers, provides hundreds of choices of videos. On December 15, 1993, the Telephone Company filed a request with the FCC for an expansion of this trial. The proposal seeks to provide this service to an additional 20,000 customers in other areas of Connecticut.\nOn December 22, 1993, the Telephone Company filed with the DPUC its application to conduct a twenty-four month market trial for Digital Enhancer, an Integrated Services Digital Network offering. Digital Enhancer provides customers with integrated voice and data communications capabilities on a single telephone access line. Digital Enhancer will be offered from specially equipped digital central offices and will require customer-provided terminal equipment to access and use the service. This service will enable customers to reduce their telecommunications costs by reducing wiring requirements, increase productivity through increased data transmission speed, and improve quality of service through reduced data error rates.\nDirectory Publishing\nThe Telephone Company's directory publishing operation remains sensitive to the Connecticut economy. The continuing decline in new business formations and the acceleration of business failures within the State will further suppress advertising growth potential in the near term.\nThe Connecticut advertising marketplace continues to undergo major structural changes and is becoming increasingly more fragmented and competitive. Directory publishing faces potential increased competition from non-traditional services such as desktop publishing, electronic shopping services and the expansion of cable television. Furthermore, additional competition may arise from the RBOCs' ability to now offer information services. The Telephone Company's directory publishing operation will continue to strategically widen its business focus and respond to emerging market opportunities to position itself effectively against this potential competition [see discussion of EIS in Item 1., \"State Regulation\"].\nEmployee Relations\nThe Telephone Company employed approximately 9,300 persons at February 28, 1994, of whom approximately 70% are represented by The Connecticut Union of Telephone Workers, Inc. (\"CUTW\"), an unaffiliated union.\nIn December 1993, the Telephone Company announced a business restructuring program designed to reduce costs and will result in approximately 2,500 employees exiting the business over the next two to three year period including those that began in January 1994 [see Note 10].\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Telephone Company do not lend themselves to a detailed description by character and location. Of the Telephone Company's investment in telephone plant, property and equipment at December 31, 1993, central office equipment represented 40%; connecting lines not on customers' premises, the majority of which are on or under public roads highways or streets and the remainder on or under private property, represented 37%; land and buildings (occupied principally by central offices) represented 10%; telephone instruments and related wiring and equipment, including private branch exchanges, substantially all of which are on the premises of customers, represented 1%; and other, principally vehicles and general office equipment, represented 12%.\nSubstantially all of the central office equipment installations and administrative offices are located in Connecticut in buildings owned by the Telephone Company situated on land which it owns in fee. Many garages, service centers and some administrative offices are located in rented quarters.\nThe Telephone Company has a significant investment in the properties, facilities and equipment necessary to conduct its business wherein the overwhelming majority of this investment relates to telephone operations. Management believes that the Telephone Company's facilities and equipment are suitable and adequate for the business.\nAs discussed previously, the Telephone Company plans to invest $4.5 billion over the next 15 years to build I-SNET. The Telephone Company plans to support this investment primarily through increased productivity from the new technology deployed, ongoing cost containment initiatives and customer demand for the new services offered. The Telephone Company does not plan to request a rate increase for this investment.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Telephone Company is involved in various claims and lawsuits that arise in the normal conduct of their business. In the opinion of management, upon advice of counsel, these claims will not have a material adverse effect on the Telephone Company.\nItems 4 through 6.\nInformation required under Items 4 through 6 is omitted pursuant to General Instruction J(2).\nPART II\nItem 7.","section_4":"","section_5":"","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations\nRevenues\nTotal revenues, comprised of local service revenues, intrastate (Connecticut) toll revenues, network access (primarily interstate) revenues, and publishing and other revenues, were $1,442.4 million in 1993 as compared with $1,402.6 million in 1992.\nLocal service revenues, derived from the provision of local exchange, public telephone and local private line services, increased $43.7 million, or 8.4%, in 1993. The increase in 1993 was due primarily to new rates for basic local service implemented in accordance with the 1993 general rate award [see Item 1., \"Intrastate Rates\"]. A portion of the new rates was implemented on July 9, 1993 with the remainder of the new rates implemented in the form of a temporary surcharge which amounted to approximately $9 million. The temporary surcharge was in effect until October 9, 1993, when the remaining new rates became effective. Revenue from directory assistance and coin telephone increased primarily as a result of the July 9th increase in rates. Also contributing to the increase in local service revenues was an increase in access lines in service and an expansion of the local-calling service area in several exchanges during September of 1993, which resulted in a shift of intrastate toll revenue to local service revenue. Access lines in service grew 1.4% to 1,963,972 at December 31, 1993 from 1,936,577 at December 31, 1992. In addition, growth experienced in subscriptions to premium services, such as a 9.4% increase in Totalphone[SM], also contributed to the increase in local service revenues.\nIn 1993, intrastate toll revenues, which includes revenues from toll and WATS services, decreased $20.1 million, or 5.6%. Of the total decrease in 1993, $12.6 million was due primarily to reductions in intrastate toll rates, including several toll discount plans, which were implemented in accordance with the 1993 general rate award [see Item 1., \"Intrastate Rates\"]. Toll message volumes grew approximately 2%, but were negatively impacted by the expansion of the local-calling service area in several exchanges as discussed with local service revenues. In addition, WATS revenues (which includes \"800\" services) decreased $7.4 million due primarily to: lower WATS message volumes; customer migration to lower priced services offered by the Telephone Company in response to competition; and the continued impact of competitive providers on this market.\nNetwork access charges are assessed on interexchange carriers and end users as a means for the Telephone Company to recover its costs and earn a return on its investment in facilities that provide access to the local exchange network. In 1993, network access revenues increased $14.3 million or 4.4%. The increase in 1993 was due primarily to an increase in interstate minutes of use of approximately 5%. Partially offsetting the impact of the increase in minutes of use was a decrease in tariff rates implemented on July 2, 1993, in accordance with the Telephone Company's 1993 annual FCC filing under price cap regulation [see Item 1., \"Interstate Rates\"].\nPublishing and other revenues (which includes revenues from (i) directory publishing, (ii) marketing, billing and collection, and other non-access services rendered on behalf of interexchange carriers, and (iii) provision for uncollectible accounts receivable) increased $1.9 million, or 1.0%, in 1993. The provision for uncollectible accounts receivable for the Telephone Company's residence, business and\ndirectory customers decreased $4.6 million in 1993. This decrease is due primarily to lower directory publishing uncollectible activity. Revenue from billing and collection services increased $3.6 million. Partially offsetting the impact of these items was a decrease in publishing revenues of $7.1 million, or 3.8%. Publishing revenues, a significant portion of which reflect directory contracts entered into during the prior year, have decreased, as anticipated, due primarily to economic conditions in 1992 having deteriorated from 1991. Due primarily to the economic conditions in Connecticut, management expects that revenues from directory publishing for 1994 as compared with 1993 will continue to decline.\nCosts and Expenses\nTotal costs and expenses, excluding depreciation, amortization and interest, were $1,183.3 million in 1993 as compared with $833.4 million in 1992. Total costs and expenses in 1993 include a $335.0 million before-tax charge relating to business restructuring as discussed in Note 10 to the financial statements. Excluding the effect of this item as well as depreciation, amortization and interest, total costs and expenses would have been $848.3 million in 1993.\nThe restructuring charge recorded in 1993 by the Telephone Company is part of a restructuring plan announced in December 1993. The total restructuring plan includes costs that will be incurred for work force reductions involving approximately 2,500 employees over the next two to three year period including those that began in January 1994. The charge also includes the incremental costs of analyzing and implementing reengineering solutions; designing and developing new processes and tools to continue the Telephone Company's provision of excellent service; and the training of employees to help them keep pace with the changes the Telephone Company is implementing to streamline its business and meet the changing demands of customers.\nOperating and maintenance expenses of $790.3 million increased $13.3 million, or 1.7%, in 1993. These costs are composed primarily of: (i) wages and salaries; (ii) pension and other employee-benefit costs; and (iii) other general and administrative expenses.\nIn August of 1992, a new three-year labor contract was ratified by members of the CUTW. CUTW members received an initial 2.0% wage increase on September 20, 1992, 3.0% in October 1993 and will receive an additional increase of 5.0% in October 1994. As part of the new bargaining-unit contract, approximately 525 bargaining-unit employees accepted an early retirement incentive offer, Special Pension Option (\"SPO\"), with most leaving the Telephone Company by March 19, 1993 and the remainder by September 17, 1993 [see Note 2]. The Telephone Company recorded a before-tax pension gain of $6.0 million in 1993 as a result of the SPO.\nWage and salary costs of the Telephone Company increased approximately $3 million, or 1% in 1993. The increase in wage and salary costs in 1993 was primarily a result of wage increases for bargaining-unit employees mentioned previously. In addition, management employees received an average 3.5% salary increase effective April 1992. Partially offsetting these wage increases was a decrease in the Telephone Company's average work force of 2.4%. The average work force was reduced primarily through the SPO partially offset by an increase in employees resulting from the reorganization of an affiliate which occurred in the first quarter of 1993. Cost savings are anticipated to be realized beginning in 1994 as the Telephone Company has begun to implement the first phase of the work force reduction portion of the restructuring plan.\nThe Telephone Company participates in the Corporation's pension and other employee benefit plans and is allocated a portion of these costs based on the relative number of Telephone Company employees to total employees participating in these plans. Its portion of the Corporation's pension and benefit costs was approximately 90% in 1993 and 1992. Pension and other employee benefit costs of the Corporation increased $5.0 million, or 3.0%, in 1993, exclusive of costs related to the voluntary separation offers and amortization of the postretirement benefit transition obligation discussed below. Health care benefit costs remained relatively unchanged in 1993 as a result of cost-containment efforts by the Corporation. As discussed in Note 2, the Corporation has reserved the right to require, beginning on July 1, 1996, all employees who retire after a specified date to share premium costs of health care benefits if these costs exceed certain limits. Beginning in 1994, employees began to share a larger portion of health care benefit costs. Management continues to seek additional means to effectively manage its provision for health care benefits for both active and retired employees consistent with its need to offer employees a competitive benefits package.\nEffective January 1, 1993, the Telephone Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" [see Note 2]. With the adoption of SFAS No. 106, the Telephone Company elected to defer, in accordance with an FCC accounting order and final decision issued by the DPUC on July 7, 1993, recognition of the accumulated postretirement benefit obligation in excess of the fair value of plan assets (\"transition obligation\") and amortize it over the average remaining service period of 18.4 years. In 1993, amortization of the transition obligation resulting from the adoption of SFAS No. 106 amounted to $18.5 million and is included in operating and maintenance expenses. SFAS No. 112 requires employers to accrue benefits provided to former or inactive employees after employment but before retirement. For the Telephone Company, these benefits include workers' compensation and disability benefits. The cumulative effect of this accounting change reduced 1993 net income reported in the statement of income by $6.5 million.\nPartially offsetting these increases was a decrease in agency commissions of $7.0 million. Agency commissions decreased due primarily to an affiliate no longer providing these services for the Telephone Company since their reorganization in the first quarter of 1993.\nDepreciation and Amortization\nIn 1993, depreciation and amortization expense increased $36.0 million, or 15.7%. The increase in depreciation and amortization was attributable primarily to revised depreciation rate schedules for both intrastate and interstate plant, as approved by the DPUC and FCC, respectively [see Item 1., State and Federal Regulation]. Depreciation expense related to intrastate plant increased approximately $20 million while interstate plant increased approximately $11 million. An increase in the average depreciable telephone plant, property and equipment also contributed to the increase in depreciation and amortization expense.\nInterest Expense\nInterest expense decreased $4.4 million, or 6.1%, in 1993. This decrease is due primarily to lower interest rates charged on short-term debt, interest savings from debt refinancings and a decrease in average debt outstanding of approximately $38 million. The debt refinancings completed in December 1993 [see Note 6] are anticipated to save approximately $8 million in interest expense annually.\nIncome Taxes\nThe combined federal and state effective tax rate in 1993 was a benefit of 58.6%. The unusually high effective tax rate in 1993 reflects the benefit of the operating loss coupled with the amortization of investment tax credits and the turn around of temporary deferred income taxes. A reconciliation of this effective tax rate to the statutory tax rate is disclosed in Note 3.\nEffective January 1, 1993, the Telephone Company adopted SFAS No. 109, \"Accounting for Income Taxes\" [see Note 3].\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholder of The Southern New England Telephone Company:\nWe have audited the accompanying financial statements and the financial statement schedules of The Southern New England Telephone Company listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Telephone Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Southern New England Telephone Company as of December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 1 to the financial statements, the Corporation has changed its method of accounting for postretirement benefits other than pensions, postemployment benefits and income taxes.\nHartford, Connecticut COOPERS & LYBRAND January 24, 1994\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSTATEMENT OF (LOSS) INCOME AND RETAINED EARNINGS\nDollars in millions, For the years ended December 31, 1993 1992 1991\nRevenues Local service $ 566.7 $ 523.0 $ 509.1 Intrastate toll 339.8 359.9 356.7 Network access 342.8 328.5 316.6 Publishing and other 193.1 191.2 211.2\nTotal Revenues 1,442.4 1,402.6 1,393.6\nCosts and Expenses Operating 467.9 469.2 460.0 Maintenance 322.4 307.8 315.1 Provision for business 335.0 - - restructuring Depreciation and amortization 265.2 229.2 232.3 Property and other taxes 58.0 56.4 55.8 Provision for employee separation benefits - - 33.9\nTotal Costs and Expenses 1,448.5 1,062.6 1,097.1\nOperating (Loss) Income (6.1) 340.0 296.5\nOther (expense) income, net (.8) 1.5 2.4\nInterest expense 68.0 72.4 75.2\n(Loss) Income Before Income Taxes, Extraordinary Charge and Accounting change (74.9) 269.1 223.7\nIncome taxes (43.9) 108.6 92.8\n(Loss) Income Before Extraordinary Charge and Accounting Change (31.0) 160.5 130.9\nExtraordinary charge from early extinguishment of debt, net of related taxes of $38.0, $2.0 and $1.7, respectively 44.0 2.7 2.2\nAccounting Change - cumulative effect to January 1, 1993 6.5 - -\nNet (Loss) Income $ (81.5) $ 157.8 $ 128.7\nRetained Earnings, Beginning of Period $ 763.7 $ 713.4 $ 671.7\nNet (loss) income (81.5) 157.8 128.7 Less: Dividends declared to parent 110.0 107.5 87.0\nRetained Earnings, End of Period $ 572.2 $ 763.7 $ 713.4\nThe accompanying notes are an integral part of these financial statements.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nBALANCE SHEET\nDollars in millions, at December 31, 1993 1992\nASSETS\nCash and temporary cash investments $ 214.5 $ 6.4 Accounts receivable, net of allowance for uncollectibles of $20.4 and $18.7, respectively 226.3 241.5\nAccounts receivable from affiliates 24.7 26.4 Prepaid publishing 40.5 43.5 Materials and supplies 8.0 10.4 Deferred income taxes, prepaid taxes and other 80.2 26.2\nTotal Current Assets 594.2 354.4\nLand 16.9 16.4 Buildings 375.9 358.7 Central office equipment 1,594.9 1,579.2 Outside plant facilities and equipment 1,601.8 1,547.4 Furniture and office equipment 354.6 331.0 Station equipment and connections 21.7 19.2 Plant under construction 74.0 70.3\nTotal telephone plant, at cost 4,039.8 3,922.2\nLess: Accumulated depreciation 1,429.2 1,301.3\nNet Telephone Plant 2,610.6 2,620.9\nDeferred charges and other assets 265.7 148.9\nTotal Assets $3,470.5 $3,124.2\nThe accompanying notes are an integral part of these financial statements.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nBALANCE SHEET (Cont.)\nDollars in millions, at December 31, 1993 1992\nLIABILITIES AND STOCKHOLDER'S EQUITY\nAccounts payable and accrued expenses $ 180.3 $ 164.2 Short-term borrowings from parent - 72.6 Obligations maturing within one year 240.0 .3 Restructuring charge - current 103.0 - Accrued compensated absences 33.9 33.5 Accounts payable to affiliates 12.4 24.3 Advance billing and customer deposits 41.0 41.5 Other current liabilities 70.4 66.5\nTotal Current Liabilities 681.0 402.9\nLong-term obligations 746.1 760.5 Deferred income taxes 424.2 566.4 Restructuring charge - long-term 232.0 - Unamortized investment tax credits 50.8 61.3 Other liabilities and deferred credits 233.1 38.3\nTotal Liabilities 2,367.2 1,829.4\nStockholder's Equity Common stock, $12.50 par value; (30,428,596 shares issued and 30,385,900 outstanding at each period end) 380.4 380.4 Proceeds in excess of par value 152.1 152.1 Retained earnings 572.2 763.7 Less: Treasury stock (42,696 shares at each period end) (1.4) (1.4)\nTotal Stockholder's Equity 1,103.3 1,294.8\nTotal Liabilities and Stockholder's Equity $3,470.5 $3,124.2\nThe accompanying notes are an integral part of these financial statements.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSTATEMENT OF CASH FLOWS\nDollars in millions, For the years ended December 31, 1993 1992 1991\nCASH FLOWS FROM OPERATING ACTIVITIES Consolidated net (loss) income $ (81.5) $ 157.8 $128.7 Adjustments to reconcile consolidated net (loss) income to cash provided by operating activities: Depreciation and amortization 265.2 229.2 232.3 Provision for business restructuring, before tax 335.0 - - Cumulative effect of accounting change, net of tax 6.5 - - Provision for employee separation benefits - - 33.9 Extraordinary charge from early extinguishment of debt, before tax 82.0 4.7 3.9 Provision for uncollectible accounts 24.9 30.0 24.3 Allowance for funds used during construction (1.7) (3.0) (2.4) Operating cash flows from Increase in accounts receivable (11.1) (20.8) (30.1) Decrease (increase) in materials and supplies 2.4 2.3 (1.4) (Decrease) increase in accounts payable (16.7) 1.8 (23.3) (Decrease) increase in deferred income taxes (160.4) 21.9 5.5 Decrease in investment tax credits (10.5) (7.0) (7.0) Net change in other assets and liabilities (11.6) 19.6 1.7 Other, net 12.9 9.1 1.0\nNet Cash Provided by Operating Activities 435.4 445.6 367.1\nCASH FLOWS FROM INVESTING ACTIVITIES Cash expended for capital additions (231.6) (269.1) (296.3) Other, Net (4.0) .8 (2.6)\nNet Cash Used by Investing Activities (235.6) (268.3) (298.9)\nCASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term borrowings 420.1 173.8 79.3 Repayments of long-term borrowings (171.5) (258.5) (30.0) Net proceeds (payments) of short- term borrowings from affiliate (72.6) 31.9 (63.5) Cash dividends (105.2) (120.7) (58.0) Amounts placed in trust for debt refinancing (62.1) - - Other, net (.4) (3.3) (.5)\nNet Cash Provided (Used) by Financing Activities 8.3 (176.8) (72.7)\nIncrease (Decrease) in Cash and Temporary Cash Investments 208.1 .5 (4.5) Cash and temporary cash investments, beginning of year 6.4 5.9 10.4\nCash and temporary cash investments, end of year $214.5 $ 6.4 $ 5.9\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Southern New England Telephone Company (\"Telephone Company\") is a wholly owned subsidiary of the Southern New England Telecommunications Corporation (\"Corporation\"). The accounting policies of the Telephone Company are in conformity with generally accepted accounting principles and conform with accounting prescribed for telephone operating companies by the Federal Communications Commission (\"FCC\") and the Connecticut Department of Public Utility Control (\"DPUC\"). Substantially all of the Telephone Company's operations and customer base are located in the State of Connecticut.\nREVENUE RECOGNITION: Revenues are recognized when earned regardless of the period in which billed. Revenues for directory advertising are recognized over the life of the related directory, normally one year.\nACCOUNTING CHANGES: The Telephone Company implemented Statements of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" and SFAS No. 109, \"Accounting for Income Taxes\" effective January 1, 1993. The cumulative effect of the accounting change as of January 1, 1993 resulted in a one-time, non-cash charge which reduced net income reported in the statement of income by $6.5 million for SFAS No. 112. For SFAS No. 106, the Telephone Company elected to amortize the transition obligation over the average remaining service period, therefore a cumulative effect was not recorded. In addition, a cumulative effect was not recorded for the adoption of SFAS No. 109 in compliance with the methods of adoption for regulated entities.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION: Regulatory authorities require the Telephone Company to provide for a return on capital invested in certain new telephone plant while under construction by including an allowance for funds used during construction (\"AFUDC\"), which includes both an interest and equity return component, as an item of income during the construction period and as an addition to the cost of the plant constructed. Such income is not realized in cash currently but will be realized over the service life of the related plant as the resulting higher depreciation expense is recovered in the form of increased revenues.\nDEPRECIATION AND AMORTIZATION: The provision for depreciation for interstate telephone plant is based on the FCC approved equal life group (\"ELG\") straight-line depreciation method using a remaining-life formula on a phased-in basis which began in 1982. Vintages of interstate plant in service prior to the phase in of ELG are being depreciated using a composite vintage group method. For intrastate plant, the DPUC approved ELG for 1993 vintages and subsequent periods. Vintages of intrastate plant in service prior to 1993 are being depreciated using a composite vintage group method. Assets acquired under capital leases are generally amortized over the life of the lease using the straight-line method.\nTRANSACTIONS WITH AFFILIATES: The Telephone Company provides certain services for the Corporation and affiliates. The Telephone Company records substantially all the revenue from such services as a reduction of the cost incurred to provide such services. Amounts billed to affiliates for such services totaled $35.6 million in 1993, $32.4 million in 1992 and $37.4 million in 1991. In addition, the Telephone Company charges affiliates for network services at tariffed rates. These amounts are included in revenue and totaled $9.2 million in 1993, $7.8 million in 1992 and $7.5 million in 1991. The Telephone Company is charged for management functions performed by the Corporation. The cost of these management functions totaled $24.5 million in 1993, $23.3 million in 1992 and $22.5 million in 1991.\nINCOME TAXES: The Telephone Company is included in the consolidated federal income tax return and, where applicable, combined state income tax returns filed by the Corporation. Effective January 1, 1993, the Telephone Company changed the method of computing income taxes from the deferred method under Accounting Principles Board (\"APB\") Opinion No. 11 to the liability method with the adoption of SFAS No. 109. Under the liability method, deferred tax assets and liabilities are determined based on all temporary differences between the financial statement and tax bases of assets and liabilities using the currently enacted rates. Additionally, under SFAS No. 109, the Telephone Company may recognize deferred tax assets if it is more likely than not that the benefit will be realized.\nDepreciation for income tax purposes is generally based upon accelerated methods and shorter lives causing such depreciation to be greater during the early years of plant life than the depreciation charges for such assets reflected in these financial statements. The accumulated net tax effects of these and other temporary differences are recorded as deferred income taxes in the accompanying consolidated balance sheet.\nInvestment tax credits realized in prior years are being amortized as a reduction to income taxes over the life of the related plant that gave rise to the credits.\nCASH: The Telephone Company records payments made by draft as accounts payable until the banks honoring the drafts have presented them for payment.\nMATERIALS AND SUPPLIES: Materials and supplies, which are carried at original cost, are primarily for the construction and maintenance of telephone plant.\nTELEPHONE PLANT: Telephone plant is stated at original cost less accumulated depreciation and includes certain employee- benefit costs and payroll taxes applicable to self-constructed assets. The amounts shown do not purport to represent replacement cost or current market value. The cost of depreciable telephone plant retired, net of removal costs and salvage, is charged to accumulated depreciation. Replacements, renewals and betterments of telephone plant that materially increase an asset's usefulness or remaining life are capitalized. Minor replacements and all repairs and maintenance are charged to expense.\nDEFERRED CHARGES: Regulatory authorities require or permit the exclusion of certain costs of the Telephone Company from entering into ratemaking when they are incurred. When such costs will be recovered through future rates, the Telephone Company records these costs as deferred charges.\nNOTE 2: EMPLOYEE BENEFITS\nSEPARATION OFFERS: As part of the new bargaining-unit contract negotiated in August 1992, pension benefits for bargaining-unit employees were enhanced. Also, as part of the contract, employees electing to retire or terminate their employment between December 15, 1992 and February 16, 1993 were offered an early retirement incentive offer, Special Pension Option (\"SPO\"). Most employees electing to retire or terminate left the Telephone Company by March 19, 1993, with the remainder having left by September 17, 1993. Approximately 525 employees accepted the early retirement offer. The Telephone Company recorded a before-tax $6.0 million pension gain in 1993 as a result of the SPO.\nIn May 1991, the Corporation announced the 1991 Voluntary Separation Option Plan (\"VSOP\") for substantially all bargaining-unit employees. Of the total number of Telephone Company bargaining-unit employees, approximately 7% accepted the VSOP and left the Telephone Company by September 1991. In July 1991, the Corporation announced a separation offer, the Voluntary Management Offer (\"VMO\"), for substantially all management employees with at least one year of service. Of the total number of Telephone Company management employees, approximately 15% accepted the VMO and left the Corporation by December 31, 1991. As a result of these offers, the Telephone Company recorded a before-tax charge of $33.9 million in 1991 consisting of $17.4 million in severance costs and $16.5 million in pension costs. On an after-tax basis, the charge reduced 1991 net income by $19.3 million.\nPENSION PLANS: The Telephone Company participates in two non- contributory, defined benefit pension plans of the Corporation: one for management employees and one for bargaining-unit employees. Benefits for management employees are based on an adjusted career average pay plan. Benefits for bargaining-unit employees are based on years of service and pay during 1987 to 1991 as well as a cash balance component.\nFunding of the plans is achieved through irrevocable contributions made to a trust fund. Plan assets consist primarily of listed stocks, corporate and governmental debt, and real estate. The Corporation's policy is to fund pension cost for these plans in conformity with the Employee Retirement Income Security Act of 1974 using the aggregate cost method. For purposes of determining contributions, the assumed investment earnings rate on plan assets was 8.5% in 1993 and declines to 6.0% by 1998.\nThe Telephone Company's portion of the Corporation's pension (income) cost computed using the projected unit credit actuarial method was approximately $(7.7) million, $(2.9) million and $16.6 million for 1993, 1992 and 1991, respectively. The increase in pension income for 1993 is due primarily to the net effect of a settlement gain and charges for special termination benefits associated with the SPO that resulted in a gain of $6.0 million in 1993. Pension expense decreased in 1992 as compared with 1991 due primarily to the absence of the charge for special benefits relating to a management retirement offer in 1991 and an increase in the discount rate from 1990 to 1991.\nWhen it is economically feasible to do so, the Corporation amends periodically the benefit formulas under its pension plans. Accordingly, pension cost has been determined in such a manner as to anticipate that modifications to the pension plans would continue in the future.\nPOSTRETIREMENT HEALTH CARE: The Telephone Company participates in the health care benefit plans for retired employees provided by the Corporation. Substantially all of the Telephone Company's employees may become eligible for these benefits if they retire with a service pension. In addition, an employee's spouse and eligible dependents may become eligible for health care benefits. Effective July 1, 1996, all bargaining-unit employees who retire after December 31, 1989 and all management employees who retire after December 31, 1991 may have to share with the Corporation the premium costs of postretirement health care benefits if these costs exceed certain limits.\nPrior to January 1, 1993, these benefits were recognized as an expense only when paid (referred to as the \"pay-as-you-go\" method). In 1991, in accordance with a DPUC decision in a rate proceeding, the Telephone Company began to fund the postretirement health care benefits. These costs have been contributed to Voluntary Employees' Beneficiary Association (\"VEBA\") trusts. The Corporation's funding policy with regard to health care costs has been to contribute an amount equal to the service and interest cost of active employees, subject to tax deductible limits, in order to contain the growth of the unfunded postretirement health care liability. Based on the DPUC's July 7, 1993 general rate award decision, the Corporation contributed additional amounts to the VEBAs in the fourth quarter of 1993. The additional amounts began to fund the accumulated liability. In 1992 and 1991, the pay-as-you- go expense combined with the VEBA contributions amounted to $32.4 million and $25.2 million, respectively.\nEffective January 1, 1993, the Telephone Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires that employers accrue, during the years an employee renders service, the expected cost, based on actuarial valuations, of health care and other non-pension benefits provided to retirees and their eligible dependents. With the adoption of SFAS No. 106, the Telephone Company elected to defer, in accordance with an FCC accounting order and final decision issued by the DPUC on July 7, 1993, recognition of the accumulated postretirement benefit obligation in excess of the fair value of plan assets (\"transition obligation\") and amortize it over the average remaining service period of 18.4 years. The Telephone Company's portion of the postretirement benefit cost for 1993, including the amortization of the transition obligation, was approximately $45 million.\nPOSTEMPLOYMENT BENEFITS: Effective January 1, 1993, the Telephone Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This statement requires employers to accrue benefits provided to former or inactive employees after employment but before retirement. These benefits include workers' compensation, disability benefits and health care continuation coverage for a limited period of time after employment. The standard generally requires that these benefits be accrued as earned when the right to the benefits accumulate or vest. The cumulative effect of this accounting change reduced 1993 net income reported in the statement of income by $6.5 million. Health care continuation costs, which do not vest, continue to be paid from company funds and are expensed when paid.\nNOTE 3: INCOME TAXES\nEffective January 1, 1993, the Telephone Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" As required under SFAS No. 109, and in accordance with SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" the Telephone Company has a regulatory asset of $71.0 million (recorded in Deferred charges and other assets) related to the cumulative amount of income taxes on temporary differences previously flowed through to ratepayers. These amounts relate principally to capitalization of certain general overhead, taxes and payroll-related construction costs for financial statement purposes. In addition, the Telephone Company has a regulatory liability of $98.9 million (recorded in Other liabilities and deferred credits) relating to future tax benefits to be flowed back to ratepayers associated with unamortized investment tax credits and decreases in both federal and state statutory tax rates. Both the regulatory asset and liability are recognized over the regulatory lives of the related taxable bases concurrent with the realization in rates, except for the liability related to intrastate excess state tax rates, which in accordance with the DPUC final decision issued on July 7, 1993, will be returned to ratepayers over three years. This method is a more accelerated turnaround than the normal recognition period.\nIncome tax (benefit) expense includes the following components:\nDollars in Millions For the Years Ended December 31, 1993 1992 1991\nFEDERAL Current $ 77.2 $ 65.2 $ 63.4 Deferred (103.9) 12.9 1.5 Investment tax credits, net (10.5) (7.0) (7.1) Total Federal (37.2) 71.1 57.8\nSTATE Current 28.6 29.3 29.7 Deferred (35.3) 8.2 5.3 Total State (6.7) 37.5 35.0 Total Income Taxes $(43.9) $108.6 $ 92.8\nDeferred income tax (benefit) expense results primarily from temporary differences involving accelerated tax depreciation and shorter tax lives for income tax purposes offset by the 1993 accrual for the restructuring charge, which was deductible for financial statements purposes but not for tax. In August 1993, the federal corporate income tax rate increased from 34.0% to 35.0%, retroactive to January 1, 1993. In addition, the enacted state corporate income tax rate will be gradually reduced from the current 11.5% to 10.0% by January 1, 1998. The net impact of these changes in the enacted tax rates was not material to total income taxes or to net deferred tax liabilities.\nThe effective federal income tax rates varied from the statutory federal rate for the reasons set forth below:\nFor the Years Ended December 31, 1993 1992 1991\nStatutory federal rate (35.0)% 34.0% 34.0% a.State income taxes, net of (5.8) 9.2 10.4 federal income tax effect. b.Temporary differences associated with depreciation on certain general overhead, taxes 8.4 1.6 2.1 and payroll-related construction costs and AFUDC. c.Amounts currently included in taxable income for which deferred taxes were provided in (10.7) (2.1) (2.7) prior years at tax rates greater than the statutory tax rate. d.Amortization of investment tax credits over the life of the plant that gave rise to the credits. Such amortization reduced income tax expense for (14.0) (2.6) (3.1) the years 1991 through 1993 by the amounts shown in Note 11. e.Prior years' tax adjustments. (1.1) .3 .9 f.Other differences, net. (.4) - (.1)\nEffective Rate (58.6)% 40.4% 41.5%\nDeferred income tax liabilities (assets) are composed of the following at December 31, 1993 (in millions):\nTax Effect of Temporary Differences for:\nDepreciation $ 488.3 Items previously flowed through to ratepayers 71.0 Deferred gross earnings tax 19.1 Restructuring charge (98.6) Unamortized investment tax credits (37.0) Other (18.6) Net Deferred Income Tax Liabilities - Long-Term $ 424.2\nNOTE 4: DEFERRED CHARGES\nIn accordance with the regulatory accounting practices described in Note 1, deferred charges include the following costs: (i) the Telephone Company's 1990 final gross earnings tax (\"GET\") payment, which is being amortized over ten years through 1999; (ii) accrued but unexpensed compensated absences at December 31, 1987, which are being amortized over ten years through December 31, 1997; (iii) debt refinancing costs occurring prior to 1988, which were being amortized over the life of the related new debt until 1993, when they were written off as part of the extraordinary charge related to the early extinguishment of debt [see Note 6], and (iv) expenses incurred prior to April 1, 1988 in connection with modifying the Telephone Company's network to provide customers with equal access to interexchange carriers of their choice, which were amortized over eight years through December 31, 1993. Amortization of these costs is on a straight-line basis.\nAmounts related to these costs are as follows:\nIn Millions, at December 31, 1993 1992\nGET $46.5 $54.2\nCompensated Absences $13.3 $16.6\nDebt Refinancings - $33.6\nEqual Access - $ 2.9\nNOTE 5: SHORT-TERM DEBT\nThe Telephone Company has obtained short-term financing through intercompany borrowings from the Corporation, which obtains, when necessary, short-term funds for its subsidiaries as a group. There were no amounts payable to the Corporation for temporary cash needs as of December 31, 1993. As of December 31, 1992 and 1991, the amounts payable to the Corporation totaled $72.6 million and $40.8 million, respectively.\nAdditional information regarding notes payable outstanding during the year is as follows:\nDollars in Millions, For the Years Ended December 31, 1993 1992 1991\nAverage amount outstanding during the year (based on daily amounts) $ 46.8 $ 94.6 $107.6\nWeighted average interest rate during the year (based on daily 3.15% 3.81% 6.02% amounts)\nMaximum amount outstanding at any month's end during the year $107.0 $129.3 $139.2\nWeighted average interest rate at - 3.47% 4.76% year end\nNOTE 6: LONG-TERM OBLIGATIONS\nThe components of long-term obligations at December 31 are as follows:\nDollars in Millions Interest 1993 1992 Rates\nDebentures 4.38% to 5.75% $ 45.0 $ 90.0 8.63% 200.0 200.0\nTotal Debentures 245.0 290.0\nUnsecured notes 6.13% to 7.25% 625.0 180.0 8.70% to 9.63% 120.0 300.0\nTotal Unsecured Notes 745.0 480.0\nTotal Long-Term Debt 990.0 770.0 Unamortized discount and (4.0) (9.7) premium, net Capital lease obligations .1 .5 Current portion of long-term (240.0 (.3) obligations\nTotal Long-Term Obligations $746.1 $760.5\nMaturities of long-term debt outstanding at December 31, 1993 by type of obligation are as follows (in millions):\nUnsecured Maturities Debentures Notes Total\n1994 $200.0 $ 40.0 $240.0 1995 - - - 1996 - - - 1997 - - - 1998 - - - 1999-2008 45.0 380.0 425.0 2009-2018 - - - Thereafter - 325.0 325.0\nTotal $245.0 $745.0 $990.0\nOn September 15, 1993, the Telephone Company called $45.0 million of 5.750% debentures due November 1, 1996. The debentures were redeemed on November 1, 1993. The unamortized costs associated with this redemption did not result in a significant charge to the 1993 consolidated statement of income.\nOn December 8, 1993, the Telephone Company filed a shelf registration statement with the Securities and Exchange Commission (\"SEC\") to sell up to $540.0 million in medium-term notes. On December 14, 1993, the Telephone Company announced that it would repurchase any and all of its $120.0 million of 9.625% and $100.0 million of 9.600% medium-term notes. The Telephone Company repurchased $166.5 million of these notes and on December 30, 1993, executed an \"in-substance defeasance\" for the remainder of the medium-term notes not repurchased. Sufficient U.S. Government securities were deposited in an irrevocable trust to cover the outstanding principal, interest and call premium payable February 15, 1995. Pursuant to this registration statement, the Telephone Company sold, on December 21, 1993, with DPUC approval: (i) $200.0 million of 6.125% notes due December 15, 2003 at 99.160 to yield 6.239%; and (ii) $245.0 million of 7.250% notes due December 15, 2033 at 99.300 to yield 7.304%. The proceeds of the $245.0 million issue were used to repurchase the debt issues discussed previously and purchase securities placed in the irrevocable trust established for the \"in-substance defeasance.\" On January 14, 1994, the proceeds of the $200.0 million issue were used to redeem $200.0 million of 8.625% debentures called irrevocably on December 14, 1993. The call premium, unamortized costs, defeasance premiums and tender costs associated with these redemptions have been classified as an extraordinary charge in the 1993 statement of income. The extraordinary charge totaled $44.0 million, net of applicable tax benefits of $38.0 million.\nOn April 2, 1992, the Telephone Company filed a shelf registration statement with the SEC to sell up to $180.0 million in medium-term notes with maturities of up to 25 years. Pursuant to this registration statement, the Telephone Company sold, on August 5, 1992, with DPUC approval, $110.0 million of 7.125% notes due August 1, 2007 at 99.317 to yield 7.200%, and $70.0 million of 7.000% notes due August 1, 2004 at face value. On September 8, 1992, the proceeds from the sale of these medium-term notes were used to redeem $65.0 million of 7.750% debentures due June 1, 2004 and $110.0 million of 8.125% debentures due May 1, 2008, both of which were called on August 6, 1992. The call premium, unamortized debt issuance costs, and unamortized premium associated with the redeemed debentures have been classified as an extraordinary charge in the 1992 income statement. This charge totaled $2.7 million, net of applicable tax benefits of $2.0 million.\nPursuant to a shelf registration filed in December 1989 with the SEC to register $300.0 million of debt securities, the Telephone Company sold, with DPUC approval, $80.0 million, the remainder of the shelf registration, of 8.700% unsecured notes in December 1991, which matures on August 15, 2031. The proceeds of the $80.0 million issue were used to redeem $80.0 million of 9.625% debentures called irrevocably on December 20, 1991. Related to this redemption, the call premium and unamortized costs associated with the called debentures have been classified as extraordinary charges in the 1991 statement of income. The extraordinary charge totaled $2.2 million, net of applicable tax benefits of $1.7 million.\nNOTE 7: LEASE OBLIGATIONS\nThe Telephone Company has entered into both capital and operating leases for facilities and equipment used in its operations. Rental expense under operating leases was $30.3 million, $32.9 million and $32.0 for 1993, 1992 and 1991, respectively. Aggregate future minimum rental commitments under noncancelable leases at December 31, 1993 were as follows (in millions):\nOperating Year Leases\n1994 $ 17.5 1995 17.4 1996 16.2 1997 15.3 1998 14.8 Thereafter 61.6\nTotal Minimum Lease Payments $142.8\nFuture minimum lease payments under capital leases as of December 31, 1993 were $.1 million through 1998 and $.3 million thereafter, included in the total $.4 million minimum lease payments is $.3 million, which represents future interest.\nIncluded in future minimum rental commitments for operating leases are amounts attributable to leases with affiliates totaling $55.3 million.\nNOTE 8: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS No. 107, \"Disclosures About Fair Value of Financial Instruments,\" requires companies to disclose the fair value of all their financial instruments, including both assets and liabilities. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCASH AND TEMPORARY CASH INVESTMENTS: The carrying amount approximates fair value because of the short maturity of those instruments.\nSHORT-TERM BORROWINGS FROM PARENT: The carrying amount approximates fair value because of the short maturity of those instruments.\nOBLIGATIONS MATURING WITHIN ONE YEAR: The carrying amount approximates fair value because of the short maturity of those instruments. The fair value of long-term debt called in 1993 and redeemed in 1994 is estimated based on the call price for those issues.\nLONG-TERM DEBT: The fair value of the Telephone Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Telephone Company for debt of the same remaining maturities.\nThe estimated fair values of the Telephone Company's financial instruments are as follows:\n1993 1992 Dollars in Millions, Carry Fair Carrying Fair At December 31, Amount Value Amount Value\nCash and temporary cash $214.5 $214.5 $ 6.4 $ 6.4 investments Short-term borrowings from Parent - - (72.6) (72.6) Obligations maturing within one (240.0) (253.9) (.3) (.3) year Long-term debt (746.1) (760.0) (760.5) (791.6)\nNOTE 9: STOCKHOLDER'S EQUITY\nCOMMON, PREFERRED AND PREFERENCE SHARES The Telephone Company has authorization for 70,000,000 shares of common stock at a par value of $12.50 per share. The Telephone Company also has authorization for 500,000 shares of preferred stock at a par value of $50.00 per share and 50,000,000 shares of preference stock at a par value of $1.00 per share. No shares of preferred or preference stock have been issued pursuant to these authorizations.\nTREASURY STOCK In February 1984, AT&T returned 42,000 shares of common stock to the Telephone Company without payment. The 42,000 shares, valued at the market price on the date received, represent the original shares, adjusted for stock splits, that were issued in 1884 for licenses provided to the Telephone Company. In addition, the Telephone Company purchased at market price 696 shares of common stock in June 1986 from stockholders dissenting to a reorganization that took effect on July 1, 1986 whereby the Telephone Company became a wholly owned subsidiary of the Corporation.\nNOTE 10: RESTRUCTURING CHARGE\nIn December 1993, the Telephone Company announced a business restructuring program designed to reduce costs. The program includes costs that will be incurred for work force reductions involving approximately 2,500 employees over the next two to three year period including those that began in January 1994. The charge also includes the incremental costs of analyzing and implementing reengineering solutions; designing and developing new processes and tools to continue the Corporation's provision of excellent service; and the training of employees to help them keep pace with the changes the Corporation is implementing to streamline its business and meet the changing demands of customers. The estimated costs of this restructuring program is $335.0 million and is shown as a separate line item in the statement of income and resulted in an after-tax charge of $192.7 million to operations.\nManagement anticipates that expenditures, net of tax, for the restructuring charge will approximate $55 million in 1994, $75 million in 1995 and $55 million in 1996. These expenditures are expected to be funded from cash flows from operations.\nAs a result of this work force reduction coupled with the election to amortize the transition obligation for postretirement health care benefits, the Telephone Company recognized a curtailment loss of $86 million. The curtailment loss was recorded on the balance sheet as a regulatory asset and is currently being recovered in rates.\nNOTE 11: SUPPLEMENTAL FINANCIAL INFORMATION\nDollars in Millions, For the Years Ended December 31, 1993 1992 1991\nAmortization of investment tax $ 10.5 $ 7.0 $ 6.7 credits\nProperty and other taxes Property $ 45.0 $ 43.2 $ 45.8 Other 13.0 13.2 10.0\nTotal Property and Other Taxes $ 58.0 $ 56.4 $ 55.8\nAdvertising expense $ 11.2 $ 9.7 $ 11.0\nInterest expense Long-term obligations $ 64.4 $ 66.9 $ 66.3 Short-term obligations 1.5 3.6 6.5 Other 2.1 1.9 2.4\nTotal Interest Expense $ 68.0 $ 72.4 $ 75.2\nInterest paid $ 74.0 $ 68.2 $ 75.5\nIncome taxes paid $ 98.8 $ 87.0 $ 94.5\nDollars in Millions 1993 1992\nOther current liabilities Dividends payable $ 22.0 $ 17.7 Interest accrued 17.8 23.8 Postemployment benefits accrued 11.0 - Taxes accrued 1.6 7.6 Other current liabilities 18.0 17.4 Total Other Current Liabilities $ 70.4 $ 66.5\nDuring 1993, 1992 and 1991, revenues earned from providing services to AT&T accounted for approximately 12.3%, 12.1% and 12.9%, respectively, of operating revenues. No other customer accounted for more than 10% of operating revenues.\nNOTE 12: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nDollars in Millions 1stQTR 2ndQTR 3rdQTR 4thQTR Total\nRevenues $353.4 $360.4 $363.2 $365.4 $1,442.4\nOperating (Loss) 80.5 86.5 90.4 (263.5)(1) (6.1) Income\n(Loss) Income Before Extraordinary Charge and Accounting Change 38.7 44.1 45.2 (159.0) (31.0)\nExtraordinary Charge - - - (44.0) (44.0)\nCumulative Effect of Accounting Change (6.5) - - - (6.5)\nNet (Loss) Income $ 32.2 $ 44.1 $45.2 $(203.0) (81.5)\nRevenues $348.1 $352.0 $350.4 $352.1 $1,402.6\nOperating Income 86.2 82.7 82.1 89.0 340.0\nIncome Before Extraordinary Charge 40.2 40.3 37.9 42.1 160.5 Extraordinary Charge - - (2.7) - (2.7)\nNet (Loss) Income $ 40.2 $ 40.3 $35.2 $42.1 $157.8\n(1) Includes a before-tax charge of $335.0 million for restructuring which reduced net income $192.7 million.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNo changes in or disagreements with accountants on any matter of accounting or financial disclosure occurred during the period covered by this report.\nItems 10 through 13.\nInformation required under Items 10 through 13 is omitted pursuant to General Instruction J(2).\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of the report: Page\n(1) Report of Independent Accountants 16\nFinancial Statements Covered by Report of Independent Accountants\nStatement of (Loss) Income and Retained Earnings - for the years ended 17 December 31, 1993, 1992 and 1991\nBalance Sheet - as of December 31, 1993 18 and 1992\nStatement of Cash Flows - for the years ended December 31, 1993, 1992 and 1991 20\nNotes to Financial Statements 21\n(2) Financial Statement Schedules Covered by Report of Independent Accountants for the three years ended December 31, 1993:\nV - Telephone Plant 39\nVI - Accumulated Depreciation 43\nVIII - Valuation and Qualifying Accounts 43\nSchedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not applicable.\n(3) Exhibits:\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3a to 1990 Form 10-K dated 3\/25\/91, File No. 1- 6654).\n3b By-Laws of the registrant as amended and restated through May 11, 1988 (Exhibit 3b to 1988 Form 10-K dated 3\/23\/89, File No. 1-6654).\n4 No instrument which defines the rights of holders of long-term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)1 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)5 SNET Executive Non-Qualified Pension Plan and Excess Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated December 8, 1993 (Exhibit 10(iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n(3) Exhibits (continued):\nExhibit Number\n10(iii)(A)6 SNET Management Pension Plan as amended November 1, 1987 (Exhibit 10-C to Form SE dated 3\/21\/88-1, File No. 1-9157). Amendments dated September 1, 1988 and January 1, 1989 (Exhibit 10-C to Form SE dated 3\/21\/89, File No. 1-9157). Amendments dated January 1, 1989 through August 6, 1989 (Exhibit 10-B to Form SE dated 3\/20\/90, File No. 1-9157). Amendments dated June 5, 1991 through September 25, 1991 (Exhibit 10-B to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated January 1, 1993 (Exhibit 10(iii)(A)6 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654). Amendments dated September 8, 1993 through December 8, 1993 (Exhibit 10(iii)(A)6 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993. (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated December 8, 1993 (Exhibit 10(iii)(A)8 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993. (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3\/15\/91, File No. 1-9157).\n10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993. (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration Statement No. 33-51055, File No. 1-9157)\n10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n12 Computation of Ratio of Earnings to Fixed Charges.\n23 Consent of Independent Accountants.\n(3) Exhibits (continued):\nExhibit Number\n24a Powers of Attorney.\n24b Board of Directors' Resolution.\n99a Annual Report on Form 11-K for the plan year ended December 31, 1993 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1994.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1993 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1994.\n(b) Reports on Form 8-K:\nOn November 3, 1993, the Telephone Company filed a report on Form 8-K, dated November 3, 1993, announcing that effective December 1, 1993, Donald R. Shassian, will assume the position of Senior Vice President and Chief Financial Officer of both the Corporation and the Telephone Company.\nOn December 8, 1993, the Telephone Company filed a report on Form 8-K, dated December 8, 1993, announcing charges against fourth quarter earnings totaling $4.08 per common share. These charges include a restructuring charge for reengineering and work force reductions, a refinancing charge and a charge for discontinued operations.\nOn January 25, 1994, the Telephone Company filed a report on Form 8-K, dated January 24, 1994, announcing the Corporation's 1993 financial results.\nSIGNATURES\nPursuant 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.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nBy \/s\/ J. A. Sadek J. A. Sadek, Vice President and Comptroller, March 23, 1994\nPursuant 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 and on the date indicated.\nPRINCIPAL EXECUTIVE OFFICER:\nD. J. Miglio* Chairman, President, Chief Executive Officer and Director\nPRINCIPAL FINANCIAL AND ACCOUNTING OFFICERS:\nD. R. Shassian* Senior Vice President and Chief Financial Officer\nJ. A. Sadek By: \/s\/ J. A. Sadek Vice President and Comptroller (J. A. Sadek, as attorney- in-fact and on his own behalf)\nDIRECTORS:\nF. G. Adams* William F. Andrews* Richard H. Ayers* Zoe Baird* Barry M. Bloom* March 23, 1994 F. J. Connor* William R. Fenoglio* Claire L. Gaudiani* J. R. Greenfield* N. L. Greenman* Worth Loomis* Burton G. Malkiel* Frank R. O'Keefe, Jr.*\n* by power of attorney\nSchedule V - Sheet 1\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSCHEDULE V--TELEPHONE PLANT (Millions of Dollars)\nCOL. A COL. B COL. C COL. D COL. E COL. F\nBalance at Additions Other Balance Year 1993 beginning at cost Retirements changes at end Classification of period -Note(a) -Note(b) - Note(c) of period\nLand $ 16.4 $ .5 $ - $ - $ 16.9 Buildings 358.7 26.8 9.2 (.4) 375.9 Central Office Equipment 1,579.2 97.2 81.2 (.3) 1,594.9 Station Apparatus 19.2 3.2 .6 (.1) 21.7 Pole Lines 135.6 5.5 2.4 .2 138.9 Cable 1,083.6 50.8 13.6 .1 1,120.9 Underground Conduit 212.3 9.5 .7 (.9) 220.2 Public Telephone Equipment 16.9 4.3 (1.7) - 22.9 Other Communications Equipment 65.8 7.2 1.9 .1 71.2 Furniture and Office Equipment 265.2 36.6 17.5 (.9) 283.4 Vehicles and Other Work Equipment 99.0 7.6 7.5 (.2) 98.9 Total Telephone Plant in Service Note(d) 3,851.9 249.2 132.9 (2.4) 3,965.8 Under Construction 70.3 1.9 - 1.8 74.0\nTOTAL TELEPHONE PLANT $3,922.2 $251.1 $132.9 $ (.6) $4,039.8\nThe notes on Sheet 4 are an integral part of this Schedule.\nSchedule V - Sheet 2\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSCHEDULE V--TELEPHONE PLANT (Millions of Dollars)\nCOL. A COL. B COL. C COL. D COL. E COL. F\nBalance at Additions Other Balance Year 1992 beginning at cost Retirements changes at end Classification of period -Note(a) -Note(b) - Note(c) of period\nLand $ 15.5 $ .8 $ - $ .1 $ 16.4 Buildings 343.9 20.2 4.8 (.6) 358.7 Central Office Equipment 1,532.0 129.4 84.0 1.8 1,579.2 Station Apparatus 14.7 6.0 1.5 - 19.2 Pole Lines 131.3 5.9 1.6 - 135.6 Cable 1,029.8 69.2 15.3 (.1) 1,083.6 Underground Conduit 197.4 15.1 .2 - 212.3 Public Telephone Equipment 19.3 .5 2.9 - 16.9 Other Communications Equipment 63.6 5.9 3.6 (.1) 65.8 Furniture and Office Equipment 248.9 28.0 10.7 (1.0) 265.2 Vehicles and Other Work Equipment 91.5 13.2 5.5 (.2) 99.0 Total Telephone Plant in Service Note(d) 3,687.9 294.2 130.1 (.1) 3,851.9 Under Construction 82.1 (10.9) - (.9) 70.3\nTOTAL TELEPHONE PLANT $3,770.0 $283.3 $130.1 $(1.0) $3,922.2\nThe notes on Sheet 4 are an integral part of this Schedule.\nSchedule V - Sheet 3\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSCHEDULE V--TELEPHONE PLANT (Millions of Dollars)\nCOL. A COL. B COL. C COL. D COL. E COL. F\nBalance at Additions Other Balance Year 1991 beginning at cost Retirements changes at end Classification of period -Note(a) -Note(b) - Note(c) of period\nLand $ 15.5 $ - $ - $ - $ 15.5 Buildings 322.2 23.0 1.3 - 343.9 Central Office Equipment 1,496.6 126.4 91.0 - 1,532.0 Station Apparatus 16.0 1.3 2.6 - 14.7 Pole Lines 124.6 7.7 1.0 - 131.3 Cable 979.3 65.6 15.1 - 1,029.8 Underground Conduit 188.1 9.5 .2 - 197.4 Public Telephone Equipment 18.4 1.0 .1 - 19.3 Other Communications Equipment 59.5 6.3 2.2 - 63.6 Furniture and Office Equipment 239.1 33.0 23.2 - 248.9 Vehicles and Other Work Equipment 82.0 13.8 4.3 - 91.5 Total Telephone Plant in Service Note(d) 3,541.3 287.6 141.0 - 3,687.9 Under Construction 76.0 6.1 - - 82.1\nTOTAL TELEPHONE PLANT $3,617.3 $293.7 $141.0 - $3,770.0\nThe notes on Sheet 4 are an integral part of this Schedule.\nSchedule V - Sheet 4\nNotes to Schedule V\n(a) Additions shown include (1) the original cost of reused material, which is concurrently credited to Material and Supplies, and (2) an Allowance for Funds Used During Construction.\n(b) Items of telephone plant when retired, sold or reclassified are deducted from the property accounts at original cost.\n(c) Represents current year transfers between classifications, and other minor adjustments.\n(d) For interstate telephone plant, the FCC has approved the equal life group (\"ELG\") depreciation method using a remaining-life formula on a phased-in basis beginning in 1982. Vintages of interstate plant in service prior to the phase-in of ELG are being depreciated using a composite vintage group method. In addition, the FCC approved the use of straight-line amortization effective January 1, 1987 to recover an interstate reserve deficiency over a five-year period ended December 31, 1993. For intrastate plant, the DPUC approved ELG for 1993 vintages and subsequent periods. Vintages of intrastate plant in service prior to 1993 are being depreciated using a composite vintage group method. For the years 1993, 1992 and 1991, depreciation expense on telephone plant expressed as a percentage of average depreciable plant was 6.8%, 6.1% and 6.4%, respectively. Assets acquired under capital leases are generally amortized over the life of the lease using the straight- line method.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nSCHEDULE VI--ACCUMULATED DEPRECIATION (Millions of Dollars)\nCOL. A COL. B COL. C COL. D COL. E COL. F\nBalance at Additions Balance beginning charged at end of to Retirements Other of Description period expense - Note (a) Changes period\nYear 1993 $1,301.3 $263.8 $135.9 $ - $1,429.2 Year 1992 1,204.1 227.7 130.5 - 1,301.3 Year 1991 1,117.6 230.9 144.4 - 1,204.1\n(a) Includes net salvage.\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS (Millions of Dollars)\nCOL. A COL. B COL. C COL. D COL. E COL. F\nAdditions\nBalance at Additions Balance beginning charged Charged to at end of to other accounts Deductions of Description period expense - Note (a) - Note (b) period\nAllowance for Uncollectible Accounts Receivable:\nYear 1993 $18.7 $ 25.3 $2.3 $25.9 $ 20.4 Year 1992 15.0 30.6 3.6 30.5 18.7 Year 1991 9.5 30.1 3.4 28.0 15.0\nRestructuring Charge:\nYear 1993 $ - $335.0 $ - $ - $335.0\n(a) Includes amounts previously written off that were credited directly to this account when recovered and miscellaneous debits and credits. (b) Includes amounts written off as uncollectible.\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3a to 1990 Form 10-K dated 3\/25\/91, File No. 1- 6654).\n3b By-Laws of the registrant as amended and restated through May 11, 1988 (Exhibit 3b to 1988 Form 10-K dated 3\/23\/89, File No. 1-6654).\n4 No instrument which defines the rights of holders of long-term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)1 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)5 SNET Executive Non-Qualified Pension Plan and Excess Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated December 8, 1993 (Exhibit 10(iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)6 SNET Management Pension Plan as amended November 1, 1987 (Exhibit 10-C to Form SE dated 3\/21\/88-1, File No. 1-9157). Amendments dated September 1, 1988 and January 1, 1989 (Exhibit 10-C to Form SE dated 3\/21\/89, File No. 1-9157). Amendments dated January 1, 1989 through August 6, 1989 (Exhibit 10-B to Form SE dated 3\/20\/90, File No. 1-9157). Amendments dated June 5, 1991 through September 25, 1991 (Exhibit 10-B to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated January 1, 1993 (Exhibit 10(iii)(A)6 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654). Amendments dated September 8, 1993 through December 8, 1993 (Exhibit 10(iii)(A)6 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993. (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3\/20\/92, File No. 1-9157). Amendments dated December 8, 1993 (Exhibit 10(iii)(A)8 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993. (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3\/15\/91, File No. 1-9157).\n10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993. (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3\/23\/93, File No. 1-6654).\n10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration Statement No. 33-51055, File No. 1-9157)\n10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n12 Computation of Ratio of Earnings to Fixed Charges.\n23 Consent of Independent Accountants.\n24a Powers of Attorney.\n24b Board of Directors' Resolution.\n99a Annual Report on Form 11-K for the plan year ended December 31, 1993 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1994.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1993 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1994.","section_15":""}
{"filename":"92275_1993.txt","cik":"92275","year":"1993","section_1":"Item 1. Business. - ------ -------- and Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - ------ ----------\nGENERAL. Norfolk Southern Railway Company (Norfolk Southern Railway) was incorporated in 1894 under the name Southern Railway Company (Southern) in the Commonwealth of Virginia and, together with its consolidated subsidiaries (collectively, NS Rail), is primarily engaged in the transportation of freight by rail.\nOn June 1, l982, Southern and Norfolk and Western Railway Company (NW) became subsidiaries of Norfolk Southern Corporation (NS), a transportation holding company. Effective December 31, 1990, NS transferred all the common stock of NW to Southern, and Southern's name was changed to Norfolk Southern Railway Company. Accordingly, all the common stock of NW, which is its only voting security, is owned by Norfolk Southern Railway, and all the common stock of Norfolk Southern Railway (16,668,997 shares) is owned directly by NS. NS common stock is publicly held and listed on the New York Stock Exchange.\nThere remain issued and outstanding as of February 28, 1994, 1,197,027 shares of Norfolk Southern Railway's $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,096,907 shares (including 74 shares not entitled to vote) were held by other than subsidiaries. The Series A Stock is entitled to one vote per share, is nonconvertible, and is traded on the New York Stock Exchange.\nSTOCK PURCHASE PROGRAM. On June 2, 1989, NS announced that it intended to purchase up to 250,000 shares of Norfolk Southern Railway's Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. As of February 28, 1994, NS had purchased 77,626 shares of preferred stock at a total cost of approximately $2.67 million. Consequently, as of February 28, 1994, NS held 94.3 percent of the voting stock of Norfolk Southern Railway.\nOPERATIONS. As of December 3l, l993, NS Rail operated 14,589 miles of road in the states of Alabama, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Virginia and West Virginia, and the Province of Ontario, Canada. Of this total, 12,761 miles are owned, 677 miles are leased and 1,151 miles are operated under trackage\nrights. Of the operated mileage, 11,870 miles are main line and 2,719 miles are branch line. In addition, NS Rail operates approximately 11,266 miles of passing, industrial, yard and side tracks.\nNS Rail has major leased lines in North Carolina and between Cincinnati, Oh., and Chattanooga, Tn. The North Carolina leases, covering approximately 300 miles, expire at the end of 1994, and NS Rail is discussing possible renewals with the lessor. If these leases are not renewed, NS Rail could be required to continue using the lines subject to conditions prescribed by the Interstate Commerce Commission (ICC) or might find it necessary ultimately to operate over an alternate route or routes. It is not expected that the resolution of this matter, whether resulting in renewal of the leases, continued use of the leased lines under prescribed conditions or operation over one or more alternate routes, will have a material effect on NS Rail's consolidated financial position. The Cincinnati-Chattanooga lease, also covering about 335 miles, expires in 2026, subject to an option to extend the lease for an additional 25 years at terms to be agreed upon.\nNS Rail's lines carry raw materials, intermediate products and finished goods primarily in the Southeast and Midwest and to and from the rest of the United States and parts of Canada. These lines also transport overseas freight through several Atlantic and Gulf Coast ports. Atlantic ports served by NS Rail include: Norfolk, Va.; Morehead City, N.C.; Charleston, S.C.; Savannah and Brunswick, Ga.; and Jacksonville, Fl. Gulf Coast ports served include: Mobile, Al., and New Orleans, La.\nNS Rail's lines reach most of the larger industrial and trading centers of the Southeast and Midwest, with the exception of those in central and southern Florida. Atlanta, Birmingham, New Orleans, Memphis, St. Louis, Kansas City (Missouri), Chicago, Detroit, Cincinnati, Buffalo, Norfolk, Charleston, Savannah and Jacksonville are among the leading centers originating and terminating freight traffic on the system. In addition to serving other established centers, its lines reach many industries, mines (in western Virginia, eastern Kentucky and southern West Virginia) and businesses located in smaller communities in its service area. The traffic corridors carrying the heaviest volumes of freight include those from the Appalachian coal fields of Virginia, West Virginia and Kentucky to Norfolk and Sandusky, Oh.; Buffalo to Chicago and Kansas City; Chicago to Jacksonville (via Cincinnati, Chattanooga and Atlanta); and Washington, D.C.\/Hagerstown, Md., to New Orleans (via Atlanta and Birmingham).\nBuffalo, Chicago, Hagerstown, Jacksonville, Kansas City, Memphis, New Orleans and St. Louis are major gateways for interterritorial system traffic.\nREVENUES. NS Rail's railway operating revenues were $3.7 billion in 1993. These revenues were received for the transportation of 262.3 million tons of revenue freight of which approximately 210.4 million tons originated on line, approximately 222.8 million tons terminated on line (including 177.1 million tons of local traffic -- originating and terminating on line) and approximately 6.2 million tons was overhead traffic (neither originating nor terminating on line).\nRevenue and revenue ton mile (one ton of freight moved one mile) contributions by principal railway operating revenue sources for the period 1989 through 1993 are set forth in the following table:\nCOAL TRAFFIC - The commodity group moving in largest tonnage volume over NS Rail is coal, coke and iron ore, most of which is bituminous coal. NS Rail originated 112.1 million tons of coal, coke and iron ore in 1993 and handled a total of 118.0 million tons. Originated tonnage decreased 5 percent from 118.0 million tons in 1992, and total tons handled decreased 5 percent from 124.4 million tons. Revenues from coal, coke and iron ore, which accounted for 33 percent of NS Rail's total railway operating revenues and 37 percent of total revenue ton miles in 1993, were $1.21 billion, a decrease of 6 percent from $1.30 billion in 1992.\nThe following table shows total coal tonnage originated on NS Rail, received from connections and handled for the five years ended December 31, 1993:\nOf the 109.8 million tons of coal originating on NS Rail in 1993, the approximate breakdown is as follows: 37.9 million tons from West Virginia, 37.6 million tons came from Virginia, 22.9 million tons from Kentucky, 7.6 million tons from Alabama, 1.7 million tons from Tennessee, 1.1 million tons from Illinois, and 1.0 million tons from Indiana. Of this NS Rail-origin coal, approximately 25.3 million tons moved for export, principally through NS Rail's pier facilities at Norfolk (Lamberts Point), Virginia; 20.1 million tons moved to domestic and Canadian steel industries; 55.6 million tons of steam coal moved to electric utilities; and 8.8 million tons moved to other industrial and miscellaneous users. NS Rail moved 9.7 million tons of originated coal to various docks on the Ohio River for further movement by barge and 5.1 million tons to various Lake Erie ports. Other than coal moving for export, virtually all coal tonnage handled by NS Rail was terminated in states situated east of the Mississippi River.\nTotal NS Rail coal tonnage handled through all system ports in 1993 was 42.4 million. Of this total, 65 percent moved through the pier facilities at Lamberts Point. In 1993, total tonnage handled at Lamberts Point, including coastwise traffic, was 27.6 million tons, a 20 percent decrease from the 34.7 million tons handled in 1992.\nThe quantities of NS Rail coal handled for export only through Lamberts Point for the five years ended December 31, 1993, were as follows:\nThe recession in Europe and high stockpiles of coal overseas continued to affect NS Rail's export coal shipments in 1993, as did the UMWA strike at several mines served by NS Rail. Domestic coal was essentially flat, compared with 1992, although the market for utility coals increased slightly because of the hot weather in our service region and continued spot tonnage purchases. Increased shipments to steel producers were attributed to strike-related problems encountered by suppliers served by other carriers; the industrial market stayed even with the previous year.\nMERCHANDISE RAIL TRAFFIC - The merchandise traffic group consists of Intermodal and five major commodity groupings (Paper\/ Forest; Chemicals; Automotive; Agriculture; and Metals\/Construction). Total NS Rail merchandise revenues increased in 1993 to $2.39 billion, a 4 percent increase over 1992. Merchandise carloads handled in 1993 were 2.82 million, compared with 2.66 million handled in 1992, an increase of 6 percent.\nIn 1993, 97.8 million tons of merchandise freight, or approximately 68 percent of total merchandise tonnage handled by NS Rail, originated on line. The balance of NS Rail's merchandise traffic was received from connecting carriers (mostly railroads, with some intermodal, water and highway as well), usually at interterritorial gateways. The principal interchange points for NS Rail-received traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas City, Detroit, Hagerstown, St. Louis\/East St. Louis, and Louisville.\nThe economy improved in 1993, but the pace of recovery was still below the average of post-war recoveries. All merchandise commodity groups showed improvement over 1992. The biggest gains were in Intermodal, up $30.9 million; Automotive, up $28.0 million; Metals\/ Construction, up $19.8 million and Agriculture, up $18.3 million. There were smaller gains in Paper\/Forest and Chemicals.\nPAPER\/FOREST traffic (including paper, paperboard, wood pulp, pulpwood, wood chips, lumber, kaolin clay and waste paper) accounted for 13 percent of NS Rail's total operating revenues and 13 percent of total revenue ton miles during 1993. Compared with 1992, Paper\/Forest revenues increased 1 percent and revenue ton miles increased 3 percent.\nWeak domestic and overseas demand for paper depressed NS Rail shipments for much of the year. Lumber, however, posted a 4 percent gain in revenue due to a strong recovery in housing construction. Moderate growth, somewhat higher than industry production, is expected over the next few years due to growth in market share.\nCHEMICALS traffic (including petroleum products, plastics, fertilizers, nonmetallic minerals, sulfur, chloral-alkali chemicals, rubber, miscellaneous chemicals and waste\/hazardous chemicals) accounted for 13 percent of NS Rail's total operating revenues and 13 percent of total revenue ton miles during 1993. Compared with 1992, NS Rail's total revenue for chemicals was up 0.3 percent and revenue ton miles increased 3 percent. The lower gain in revenue was due to a change in the mix of traffic.\nGains in general chemicals and plastics were offset by weakness in movements of export fertilizer due to sluggish conditions overseas. Stronger growth is expected in 1994 and beyond, paced by additional rail-truck distribution facilities for bulk chemicals. While environmental concerns could adversely affect production of pesticides and chlorine, increased environmental awareness is likely to have a positive impact on movements of recyclables, hazardous wastes and alternative fuels such as ethanol.\nAUTOMOTIVE traffic (including motor vehicles, vehicle parts, miscellaneous transportation and ordnance, and tires) accounted for 11 percent of NS Rail's total operating revenues and 4 percent of revenue ton miles during 1993. Compared with 1992, NS Rail Automotive revenues increased 7 percent and revenue ton miles increased 14 percent.\nThe gain was due to strong demand for vehicles produced at plants served by NS Rail. NS Rail's largest customer, Ford Motor Company, produced the top-selling automobile and truck in 1993. In addition, NS Rail benefited from a full year of production at the Ford\/Nissan plant located near Avon Lake, Oh. Successful marketing efforts, such as an innovative program with GM for just-in-time movement of auto parts, also contributed to the gain.\nFurther growth in Automotive is expected in 1994 and beyond, as U.S. automotive production is anticipated to increase for the next few years. Within this growing market, NS Rail will pursue innovative marketing programs and aggressive industrial development. From 1994 to 1997, operations will begin at three new or expanded automotive assembly plants located on NS Rail--the second Toyota Plant at Georgetown, Ky., in 1994; BMW at Greer, S.C., in 1995; and Mercedes- Benz at Tuscaloosa, Al., in 1997. The retooling of GM's Wentzville, Mo., and Doraville, Ga., plants for van production should also increase traffic.\nAGRICULTURE traffic (including grains and soybeans, feed and feed ingredients, sweeteners, beverages, consumer products, and various other agricultural and food commodities) accounted for 9 percent of NS Rail's total operating revenues and 12 percent of total revenue ton miles during 1993. Compared with 1992, agricultural revenues increased 6 percent and revenue ton miles increased 8 percent.\nIn the early part of the year, NS Rail benefited from a record harvest, that continued well into 1993. During the summer, the flood in the Midwest diverted traffic to rail that formerly moved by barge. In the fall, good crop conditions in NS Rail's sourcing areas and poor conditions elsewhere produced strong NS Rail traffic gains.\nAlthough the special conditions present during 1993 are not likely to recur in 1994, a small increase in agriculture revenue is expected, driven by growth in poultry production in the Southeast, a prime NS Rail feed grain market.\nMETALS\/CONSTRUCTION traffic (including aluminum ore, iron and steel, aluminum products, scrap metal, machinery, sand and gravel, cement, brick, miscellaneous construction, and nonhazardous waste) accounted for 8 percent of NS Rail's total operating revenues and 9 percent of total revenue ton miles during 1993. Compared with 1992, NS Rail's total revenues for Metals\/Construction were up 7 percent and revenue ton miles were up 13 percent.\nMost of the revenue gain was in shipments of iron and steel, where strong industry production and new plants located on NS Rail's lines boosted revenue $10 million. Shipments of construction commodities were also strong due to a recovery in housing.\nFurther gains are expected over the next few years. NS Rail has initiatives under way intended to win back truck business in aluminum, and several new movements of municipal solid waste are expected.\nINTERMODAL traffic (including trailers, containers, and Triple Crown) accounted for 10 percent of NS Rail's total operating revenues and 12 percent of total revenue ton miles during 1993. Compared with 1992, intermodal revenues increased 9 percent, and revenue ton miles increased 9 percent.\nIntermodal growth in 1993 was led by a 21 percent increase in services provided to Triple Crown Services Company (a partnership between subsidiaries of NS and Consolidated Rail Corporation which provides RoadRailer (Registered Trademark) (RT) and domestic container services) due to strong automotive shipments and expansion of service to the Northeast. Container revenues were up 6 percent, a smaller increase than previous years due to less international traffic caused by the continuing recession in Europe and Japan. Trailer revenue was up 11 percent, boosted by gains from haulage arrangements with truckload carriers.\nStrong growth is expected in 1994 and for the next several years. Container traffic is expected to improve as recoveries overseas produce steady growth in international shipments. Trailer business also is expected to grow, as leading truckload carriers, such as Schneider National and J.B. Hunt, use rail for the long-haul portion of their shipments.\nRAIL OPERATING STATISTICS. The following table sets forth certain statistics relating to NS Rail's operations during the periods indicated:\nFREIGHT RATES. In the pricing of freight services, NS Rail continued in 1993 to increase its reliance on private contracts which, coupled with traffic that has been exempted from regulation by the ICC (e.g., boxcar and intermodal traffic), presently account for over 80 percent of freight operating revenues. Thus, a major portion of NS Rail's freight business is not economically regulated by the government. In general, market forces have been substituted for government regulation and now are the primary determinant of rail service prices.\nIn 1993, the ICC found NS Rail \"revenue adequate\" based on results for the year 1992. A railroad is \"revenue adequate\" under the Interstate Commerce Act when its return on net investment exceeds the rail industry's cost of capital. The condition of \"revenue adequacy\" determines whether a railroad can take advantage of a provision in the Interstate Commerce Act allowing freedom to increase regulated rates by a specific percentage. However, with the decreasing importance of regulated tariff traffic to NS Rail, the ICC's \"revenue adequacy\" findings have less impact than formerly.\nPASSENGER OPERATIONS. Regularly scheduled passenger operations on NS Rail's lines consist of Amtrak trains operating between Alexandria and New Orleans, and between Charlotte and Selma, N.C. Former Amtrak operations between East St. Louis and Centralia, Il., were discontinued by Amtrak November 3, 1993. Commuter trains continued operations on the NS Rail line between Manassas and Alexandria under contract with two transportation commissions of the Commonwealth of Virginia, providing for reimbursement of related expenses incurred by NS Rail. During 1993, a lease of the Chicago to Manhattan, Il., line to the Commuter Rail Division of the Regional Transportation Authority of Northeast Illinois replaced a purchase of service agreement by which NS Rail had provided commuter rail service for the Authority.\nOTHER RAILWAY OPERATIONS. Revenues from switching, demurrage and miscellaneous services amounted to $121.5 million, or approximately 3 percent of total railway operating revenues, during 1993 and $121.7 million, or approximately 3 percent of total railway operating revenues, in 1992.\nThe average age of the freight car fleet at December 31, 1993, was 20.8 years. During 1993, NS Rail retired 5,576 freight cars. As of December 31, 1993, the average age of the locomotive fleet was 14.6 years. During 1993, NS Rail retired 37 locomotives, the average age of which was 24.7 years. Since 1989, NS Rail has rebodied over 14,000 coal cars. As a result, the remaining serviceability of the freight car fleet is greater than is indicated by the percentage of freight cars built in earlier years.\nNS Rail continues freight car and locomotive maintenance programs to ensure the highest standards of safety, reliability, customer satisfaction and equipment marketability. In recent years, as illustrated in the table below, the bad order ratio has risen or remained fairly stable primarily due to the storage of certain types of cars which are not in high demand. Funds were not spent to repair certain types of cars for which present and future customers' needs could be adequately met without such repair programs. Also, NS Rail's own standards of what constitutes a \"serviceable\" car have risen, and NS continues a rational disposition program for underutilized, unserviceable and overage cars.\nTRACKAGE - All NS Rail trackage is standard gauge, and the rail in approximately 95 percent of the main line trackage (including first, second, third and branch main tracks, all excluding trackage rights) is heavyweight rail ranging from 90 to 155 pounds per yard. Of the 23,512 miles of track maintained by NS Rail as of December 31, 1993, 15,621 miles were laid with welded rail.\nThe density of traffic on NS Rail running track (main line trackage plus passing track) during 1993 was as follows:\nMICROWAVE SYSTEM - The NS Rail microwave system, consisting of 6,584 radio path miles, 374 active stations and 7 passive repeater stations, provides communication services between Norfolk, Buffalo, Detroit, Fort Wayne, Chicago, Kansas City, St. Louis, Washington, D.C., Atlanta, New Orleans, Jacksonville, Memphis, Cincinnati and most operating locations between these cities. The microwave system provides approximately 2,152,600 individual voice channel miles of circuits, and NS Rail began a conversion of the system from analog to digital technology in 1993. Conversion is under way on all microwave facilities between St. Louis, Mo., and Danville, Ky.; the process is also under way between Roanoke and Norfolk, Va. The microwave communication system is used principally for voice communications, VHF radio control circuits, data and facsimile transmissions, traffic control operations, AEI data transmissions, and relay of intelligence from defective equipment detectors. Extension of microwave communications to low density or operations support facilities is accomplished via microwave interface to buried fiber-optic or copper cables.\nTRAFFIC CONTROL - Of a total of 13,438 road miles operated by NS Rail, excluding trackage rights over foreign lines, 5,274 road miles are governed by centralized traffic control systems and 2,734 road miles are equipped for automatic block system operation.\nCOMPUTERS - Data processing facilities connect the yards, terminals, transportation offices, rolling stock repair points, sales offices and other key locations on NS Rail to the central computer complex in Atlanta, Ga. System operating and traffic data are compiled and stored to provide customers with information on their shipments throughout the system. Data processing facilities are capable of providing current information on the location of every train and each car on line, as well as related waybill and other train and car movement data. Additionally, this facility affords substantial capacity for, and is utilized to assist management in the performance of, a wide variety of functions and services, including payroll, car and revenue accounting, billing, material management activities and controls, and special studies.\nOTHER - NS Rail has extensive facilities for support of railroad operations, including freight depots, car construction shops, maintenance shops, office buildings, and signals and communications facilities.\nENCUMBRANCES. Most of NS Rail's properties are subject to liens securing as of December 31, 1993, and 1992, approximately $74.8 million and $146.6 million of mortgage debt, respectively. In addition, certain of the rolling stock is subject to the prior lien of equipment financing obligations amounting to approximately $521.8 million as of December 31, 1993, and $558.2 million as of December 31, 1992.\nCAPITAL EXPENDITURES. During the five calendar years ended December 31, 1993, capital expenditures for road, equipment and other property were as follows:\nNS Rail's capital spending and maintenance programs are and have been designed to assure the Corporation's ability to provide safe, efficient and reliable transportation services. For 1994, NS Rail is planning $627 million of capital spending and anticipates new equipment financing of approximately $72 million. Looking further ahead, capital spending is likely to increase moderately over the next few years. The proposed construction of a $100 million coal ground storage facility in Isle of Wight County, Va., may affect capital spending in future years. However, because of delays in the permitting process and reduced demand for export coal, any significant spending on this project is not expected until after 1994. In addition to boosting capacity, this new facility should further increase the efficiency of coal transportation service and reduce the need for new coal hopper cars. A substantial portion of future capital spending is expected to be funded through internally generated cash, although debt financing will continue as the primary funding source for equipment acquisitions.\nENVIRONMENTAL MATTERS. Compliance with federal, state and local laws and regulations relating to the protection of the environment is a principal NS Rail goal. To date, such compliance has not affected materially NS Rail's capital additions, earnings, liquidity or competitive position.\nCosts for environmental protection for 1993 were approximately $32.9 million, of which $28.9 million were operating expenses and $4.0 million were capitalized. Such NS Rail expenditures historically have been associated with the cleanup of real estate used for operating and nonoperating purposes, solid\/hazardous waste handling and disposal, water pollution control, asbestos removal projects and removal\/remediation work related to underground tanks.\nTo promote achievement of NS Rail's environmental objectives and to assure continuous improvement in its programs, environmental engineers perform ongoing analyses of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are recorded (and expensed or capitalized, as appropriate). Evaluations of other sites are ongoing. NS Rail also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives and undertake environmental awareness programs through which NS Rail employees will receive training.\nNorfolk Southern Railway and certain subsidiaries have received notices from the Environmental Protection Agency that they are potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) which generally imposes joint and several liability for cleanup costs. State agencies also have notified Norfolk Southern Railway and certain subsidiaries that they may be potentially responsible for environmental damages, and in several instances they have agreed voluntarily to initiate cleanup.\nFor CERCLA sites and all other known environmental incidents where loss or liability is probable, NS Rail has recorded an estimated liability. The amount of that liability, which includes estimated costs of remediation (and any associated restoration) on a site-by-site basis, is expected to be paid over several years. Although the estimated liability usually is expensed in the year it is recorded, certain expenditures relating to real estate development projects have been capitalized. Claims, if any, against third parties for recovery of remediation costs incurred by NS Rail are reflected as receivables in the balance sheet and not netted against the associated NS Rail liability.\nEstimates of a company's potential financial exposure even for known environmental claims or incidents are necessarily imprecise because of the widely varying costs of available remediation techniques, the difficulty of determining in advance the nature and extent of contamination and each potential participant's share of an estimated loss, and evolving statutory and regulatory standards governing liability.\nThe risk of incurring environmental liability--for acts and omissions, both past and current--is inherent in railroad operations. Moreover, some of the commodities, particularly those classified as hazardous materials, in NS Rail's traffic mix can pose special risks, which NS Rail works diligently to minimize. In addition, NS Rail has land holdings that may be leased (and operated by others) or held for sale. Because certain conditions may exist on these properties for which NS Rail ultimately may bear some financial responsibility, there can be no assurance that NS Rail will not incur liabilities or costs, the amount and materiality of which, to a single accounting period or in the aggregate, cannot be estimated reliably now, related to environmental problems that are latent or undiscovered.\nHowever, based on its assessments of the facts and circumstances now known and after consulting with its legal counsel, Management believes that it has recorded appropriate estimates of liability for those environmental matters of which NS Rail is aware.\nAt year end, a grand jury investigation was under way regarding possible violations of certain environmental statutes in 1989 at Moberly Yard, Moberly, Mo. A more detailed report of this incident, including information concerning its resolution since year end, is set forth under the heading \"Item 3.","section_3":"Item 3. Legal Proceedings - ------ ----------------- New Orleans, Louisiana - Tank Car Fire. A number of lawsuits have been filed as a result of a tank car fire which occurred in New Orleans, La., on September 9, 1987, and resulted in the evacuation of many residents of the surrounding area. Plaintiffs allege that they were injured and sustained other economic loss when a chemical called butadiene leaked from a tank car under the control of either CSX Transportation, Inc., or New Orleans Terminal Company (a subsidiary of Norfolk Southern Railway) or both. In addition to the rail defendants, defendants in one or more of the suits include the City of New Orleans, the owner of the tank car (General American Transportation Corporation), the loader of the tank car (GATX Terminals Corporation), and the shipper (Mitsui & Co. (USA Inc.)). The suits, which are pending in the Civil District Court for the parish of Orleans, seek damages ranging from $10,000 to $20,000,000,000. Management, after consulting with its legal counsel, is of the opinion that ultimate liability will not materially affect the consolidated financial position of NS Rail. This matter has been reported previously by NS Rail in Part II, Item 1, of its Form 10-Q Reports for the quarters ending September 30, 1987, and March 31, 1990; and in Part I, Item 3, of its Form 10-K Annual Reports for 1987, 1988, 1989, 1990, 1991 and 1992.\nMoberly, Missouri - Burial of Paint and Solvent. On or about May 16 and May 23, 1991, respectively, certain employees and NW were served with subpoenas duces tecum requiring production of various documents and information, all related to a federal grand jury's investigation of possible violations of certain environmental statutes in 1989 at Moberly Yard, Moberly, Mo. A search warrant also was served on NW at Moberly, and various company records were seized. A second subpoena duces tecum was served on September 19, 1991, concerning the relationship between NS and NW. The investigation resulted from employees' having buried containers of paint and one container of solvent.\nNW management first learned of the incident in June 1990 from the Missouri Department of Natural Resources (\"DNR\"). Promptly thereafter, NW initiated appropriate remediation efforts and notified the National Response Center. The burial of paint and solvent violated long-standing NW policy and instructions.\nNW cooperated fully with the DNR; at year end 1993, the grand jury's investigation was continuing. The paint and paint cans (along with the single drum which contained a solvent and appears not to have leaked) and any associated contaminated dirt have been excavated and properly disposed of under the DNR's direction.\nOn February 23, 1994, NW settled this matter with the federal and state governments by pleading guilty to a single violation of the federal Resource Conservation and Recovery Act and by making or committing to make penalty and restitution payments of up to $4,400,000. Of that amount, $1.7 million is to purchase equipment for state environmental enforcement purposes and, in line with NW's suggestion, $1.0 million is for the Katy Trail State Park which was damaged severely in the 1993 Missouri River flood. In addition, NW made certain commitments with respect to an organization-wide environmental awareness program.\nManagement believes the February 23 settlements conclude this matter and expects to make no further reports about it. This matter has been reported previously by NS Rail in Part II, Item 1, of its Form 10-Q Report for the quarter ending June 30, 1991, and in Part I, Item 3, of its Form 10-K Annual Reports for 1991 and 1992.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. - ------ --------------------------------------------------- There were no matters submitted to a vote of security holders during the fourth quarter of 1993.\nExecutive Officers of the Registrant. - ------------------------------------ Norfolk Southern Railway's officers are elected annually by the Board of Directors at its first meeting held after the annual meeting of stockholders, and they hold office until their successors are elected. There are no family relationships among the officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information, as of March 1, 1994, relating to these officers:\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- David R. Goode, 53, Present position since September 1992. President and Chief Also, Chairman, President and Chief Executive Officer Executive Officer of Norfolk Southern Corporation since September 1992, President from October 1991 to September 1992, and Executive Vice President-Administration from January to October 1991. Served as Vice President-Administration of Norfolk Southern Railway from January 1991 to February 1992, Vice President from February to September 1992, and prior thereto as Vice President-Taxation of Norfolk Southern Railway and NS.\nWilliam B. Bales, 59, Vice Present position since August 1993. President-Coal Marketing Also, Vice President-Coal Marketing of Norfolk Southern Corporation since August 1993. Served prior thereto as Vice President-Coal and Ore Traffic of Norfolk Southern Railway and NS.\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- R. Alan Brogan, 53, Vice Present position since December 1992. President-Transportation Also, Executive Vice President- Logistics Transportation Logistics of Norfolk Southern Corporation since December 1992, Vice President- Quality Management from April 1991 to December 1992, Vice President- Material Management and Property Services from July 1990 to April 1991, and prior thereto as Vice President of Material Management. Served as Vice President-Quality Management of Norfolk Southern Railway from June 1991 to December 1992, and prior thereto as Vice President-Material Management.\nThomas L. Finkbiner, 41, Vice Present position since August 1993. President-Intermodal Also, Vice President-Intermodal of Norfolk Southern Corporation since August 1993. Served as Senior Assistant Vice President- International and Intermodal of NS from April to August 1993, and prior thereto as Assistant Vice President- International and Intermodal.\nJames A. Hixon, 40, Vice Present position since June 1993. President-Taxation Also, Vice President-Taxation of Norfolk Southern Corporation since June 1993. Served as Assistant Vice President-Tax Counsel of NS from January 1991 to June 1993, and prior thereto as General Tax Attorney.\nHarold C. Mauney, Jr., 55, Present position since December 1992. Vice President-Quality Also, Vice President-Quality Management Management of Norfolk Southern Corporation since December 1992. Served as Assistant Vice President- Quality Management of NS from April 1991 to December 1992, and prior thereto as General Manager- Intermodal Transportation Services.\nDonald W. Mayberry, 50, Vice Present position since October 1987. President-Mechanical Also, Vice President-Mechanical of Norfolk Southern Corporation since October 1987.\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- James W. McClellan, 54, Vice Present position since October 1993. President-Strategic Planning Also, Vice President-Strategic Planning of Norfolk Southern Corporation since October 1993. Served as Assistant Vice President- Corporate Planning of NS from March 1992 to October 1993, and prior thereto as Director-Corporate Development.\nKathryn B. McQuade, 37, Vice Present position since December 1992. President-Internal Audit Also, Vice President-Internal Audit of Norfolk Southern Corporation since December 1992. Served as Director-Income Tax Administration of NS from May 1991 to December 1992, and prior thereto as Director-Federal Income Tax Administration.\nCharles W. Moorman, 42, Vice Present position since October 1993. President-Information Also, Vice President-Information Technology Technology of Norfolk Southern Corporation since October 1993. Served as Vice President-Employee Relations of Norfolk Southern Railway and NS from December 1992 to October 1993, Vice President-Personnel and Labor Relations from February to December 1992, Assistant Vice President-Stations, Terminals and Transportation Planning of NS from March 1991 to February 1992, Senior Director Transportation Planning from March 1990 to March 1991, and prior thereto as Director, Transportation Planning.\nPhillip R. Ogden, 53, Vice Present position since December 1992. President-Engineering Also, Vice President-Engineering of Norfolk Southern Corporation since December 1992. Served as Assistant Vice President-Maintenance of NS from November 1990 to December 1992, Chief Engineer-Line Maintenance North from February 1989 to November 1990, and prior thereto as Chief Engineer-Program Maintenance.\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- L. I. Prillaman, Jr., 50, Present position since December 1992. Vice President-Properties Also, Vice President-Properties of Norfolk Southern Corporation since December 1992. Served prior thereto as Vice President and Controller of Norfolk Southern Railway and NS.\nJohn P. Rathbone, 42, Vice Present position since December 1992. President and Controller Also, Vice President and Controller of Norfolk Southern Corporation since December 1992. Served as Assistant Vice President- Internal Audit of NS from January 1990 to December 1992, and prior thereto as Director-Internal Audit.\nWilliam J. Romig, 49, Present position since December 1992. Vice President Also, Vice President and Treasurer of Norfolk Southern Corporation since December 1992. Served prior thereto as Assistant Vice President-Finance of NS.\nPaul R. Rudder, 61, Vice Present position since March 1990. President-Operations Also, Executive Vice President- Operations of Norfolk Southern Corporation since March 1990. Served as Vice President of Norfolk Southern Railway and Senior Vice President-Operations of NS from October 1989 to March 1990, and prior thereto as Vice President- Engineering of Norfolk Southern Railway and NS.\nDonald W. Seale, 41, Vice Present position since August 1993. President-Merchandise Also, Vice President-Merchandise Marketing Marketing of Norfolk Southern Corporation since August 1993. Served as Assistant Vice President- Sales and Service of NS from May 1992 to August 1993, Director- Metals, Waste and Construction from March 1990 to May 1992, and prior thereto as Director-Marketing Development.\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- John S. Shannon, 63, Vice Present position since May 1984. President-Law Also, Executive Vice President- Law of Norfolk Southern Corporation since June 1982.\nThomas C. Sheller, 63, Vice Present position since February 1992. President-Administration Also, Executive Vice President- Administration of Norfolk Southern Corporation since October 1991. Served prior thereto as Vice President-Personnel and Labor Relations of Norfolk Southern Railway and NS.\nPowell F. Sigmon, 54, Vice Present position since October 1993. President-Safety, Environ- Also, Vice President Safety, mental and Research Environmental and Research Development Development of Norfolk Southern Corporation since October 1993. Served as Assistant Vice President- Mechanical (Car) of NS from January 1991 to October 1993, and prior thereto as General Manager- Mechanical Facilities.\nStephen C. Tobias, 49, Present position since October 1993. Vice President Also, Senior Vice President- Operations of Norfolk Southern Corporation since October 1993. Served as Vice President-Strategic Planning of Norfolk Southern Railway and NS from December 1992 to October 1993, Vice President- Transportation from October 1989 to December 1992, and prior thereto as General Manager-Western Lines.\nJohn R. Turbyfill, 62, Vice Present position since June 1993. President Also, Vice Chairman of Norfolk Southern Corporation since June 1993. Served prior thereto as Executive Vice President-Finance of NS since June 1982, and Vice President-Finance of Norfolk Southern Railway since March 1984.\nBusiness Experience during Name, Age, Present Position past 5 Years - --------------------------- -------------------------------------- D. Henry Watts, 62, Vice Present position since July 1986. President and Chief Also, Executive Vice President- Traffic Officer Marketing of Norfolk Southern Corporation since July 1986.\nHenry C. Wolf, 51, Vice Present position since June 1993. President-Finance Also, Executive Vice President- Finance of Norfolk Southern Corporation since June 1993. Served as Vice President-Taxation of Norfolk Southern Railway and NS from January 1991 to June 1993, and prior thereto as Assistant Vice President-Tax Counsel.\nDezora M. Martin, 46, Present position since October 1993. Corporate Secretary Served prior thereto as Assistant Corporate Secretary of Norfolk Southern Railway and NS.\nRonald E. Sink, 51, Present position since September Treasurer 1987.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related - ------ ---------------------------------------------------- Stockholder Matters. -------------------\nCOMMON STOCK - ------------ Since June 1, 1982, NS has owned all the common stock of Norfolk Southern Railway Company. The common stock is not publicly traded.\nSERIAL PREFERRED STOCK - ---------------------- There are 10,000,000 shares of no par value serial preferred stock authorized. This stock may be issued in series from time to time at the discretion of the Board of Directors with any series having such voting and other powers, designations, dividends and other preferences as deemed appropriate at the time of issuance.\nThe $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,197,027 shares were issued and 1,096,907 shares were held other than by subsidiaries as of February 28, 1994, has no par value but has a $50 per share stated value. As indicated in the title, the stock pays a dividend of $2.60 per share annually, payable quarterly on March 15, June 15, September 15 and December 15. Dividends on this stock are cumulative and in preference to dividends on all other classes of stock. Except for any shares held by Norfolk Southern Railway Company subsidiaries and\/or in a fiduciary capacity, each share is entitled to one vote per share on all matters, voting as a single class with holders of other stock. Should dividends become delinquent for six quarters, this class of stock, voting as a class, may elect two directors so long as any default in dividend payments continues. The stock is redeemable at the option of Norfolk Southern Railway Company at $50 per share plus accrued dividends. On liquidation, the stock is entitled to $50 per share plus accrued dividends before any amounts are paid on any other class of stock.\nIn June 1989, NS announced that it intended to purchase up to 250,000 shares of the outstanding Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. As of February 28, 1994, NS had purchased 77,626 shares of Series A Stock at a total cost of $2,671,986; as of the same date, NS held a total of 77,721 shares.\nItem 6.","section_6":"Item 6. Selected Financial Data. - ------ -----------------------\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ------------------------------------ See pages 39-50 for \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - ------ --------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) - ------ --------------------------------------------\nThe Index to Financial Statements follows, and the Index to Financial Statement Schedules appears in Item 14 on page 34.\nThe financial statements and related documents for Norfolk Southern Railway Company and Subsidiaries are as follows:\nIndex to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1993, 1992 and 1991 51\nConsolidated Balance Sheets As of December 31, 1993 and 1992 52\nConsolidated Statements of Cash Flows Years ended December 31, 1993, 1992 and 1991 53-54\nConsolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1993, 1992 and 1991 55\nNotes to Consolidated Financial Statements 56-75\nIndependent Auditors' Report 76\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting - ------ ----------------------------------------------------------- and Financial Disclosure. ------------------------ None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. - ------- -------------------------------------------------- Item 11.","section_11":"Item 11. Executive Compensation. - ------- ---------------------- Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners - ------- ----------------------------------------------- and Management. -------------- and Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - ------- ---------------------------------------------- In accordance with General Instruction G(3), the information called for by Part III is incorporated herein by reference from Norfolk Southern Railway's definitive Proxy Statement, to be dated April 19, 1994, for the Norfolk Southern Railway Annual Meeting of Stockholders to be held on May 24, 1994, which definitive Proxy Statement will be filed electronically with the Commission pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I beginning on page 23 under \"Executive Officers of the Registrant.\"\nPART IV\nItem l4. Exhibits, Financial Statement Schedules, and Reports on - ------- ------------------------------------------------------- Form 8-K. -------- (a) The following documents are filed as part of this report:\n1. Financial Statement Schedules:\nThe following consolidated financial statement schedules should be read in connection with the consolidated financial statements:\nIndex to Consolidated Financial Statement Schedules Page --------------------------------------------------- ---- Schedule I - Marketable Securities-Other Investments 77 Schedule V - Property, Plant and Equipment 78 Schedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 79 Schedule VII - Guarantees of Securities of Other Issuers 80 Schedule VIII - Valuation and Qualifying Accounts 81 Schedule IX - Short-Term Borrowings 82 Schedule X - Supplementary Income Statement Information 83\nSchedules other than those listed above are omitted for reasons that they are not required, are not applicable or the information is included in the consolidated financial statements or related notes.\n2. Exhibits\nExhibit Number Description - ------- ------------------------------------------------- 3 Articles of Incorporation and Bylaws -\n3(a) The amended Restated Articles of Incorporation of Norfolk Southern Railway Company are incorporated herein by reference from Exhibit 3(a) of Norfolk Southern Railway's 1990 Annual Report on Form 10-K.\n3(b) The Bylaws of Norfolk Southern Railway Company, as last amended March 3, 1993, are incorporated herein by reference from Exhibit 3(b) of Norfolk Southern Railway's 1992 Annual Report on Form 10-K.\nItem l4. Exhibits, Financial Statement Schedules, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) --------\nExhibit Number Description - ------- ------------------------------------------------- 4 Instruments Defining the Rights of Security Holders, Including Indentures -\nIn accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of instruments of Norfolk Southern Railway and its subsidiaries with respect to the rights of holders of long-term debt are not filed herewith, or incorporated by reference, but will be furnished to the Commission upon request.\n10 Material Contracts -\n(a) The Agreement of Merger and Reorganization dated as of July 31, 1980, among Southern Railway Company (name changed to Norfolk Southern Railway Company by Certificate of Amendment issued by the State Corporation Commission of Virginia as of December 31, 1990), Southern Railroad Company of Virginia, NWS Enterprises, Inc. (name changed to Norfolk Southern Corporation by Certificate of Amendment issued by the State Corporation Commission of Virginia on November 2, 1981), Norfolk and Western Railway Company, and Norfolk and Western Railroad Company of Virginia, and the related Plans of Merger (Exhibits B and C to the Agreement) are incorporated herein by reference from Appendix A to NW's and Southern's definitive Proxy Statements dated October 1, 1980, for NW's and Southern's Special Meetings of Stockholders held on November 7, 1980.\n(b) The lease between The Cincinnati, New Orleans and Texas Pacific Railway Company, a subsidiary of Norfolk Southern Railway, as lessee, and the Trustees of the Cincinnati Southern Railway, as lessor, dated as of October 11, 1881, is incorporated herein by reference from Exhibit 5 of Southern's 1980 Annual Report on Form 10-K. The Supplementary Agreement to the lease, dated as of January 1, 1987, is incorporated herein by reference from Exhibit 10(b) of Southern's 1987 Annual Report on Form 10-K.\nItem l4. Exhibits, Financial Statement Schedules, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) --------\nExhibit Number Description - ------- ------------------------------------------------- (c) The lease between The North Carolina Railroad Company, as lessor, and Norfolk Southern Railway, as lessee, dated as of January 1, 1896, is incorporated herein by reference from Exhibit 6 of Southern's 1980 Annual Report on Form 10-K.\n(d) The lease between Atlantic and North Carolina Railroad Company (The North Carolina Railroad Company, successor by merger, September 29, 1989), as lessor, and Atlantic and East Carolina Railway Company, a subsidiary of Norfolk Southern Railway, as lessee, dated as of April 20, 1939, is incorporated herein by reference from Exhibit 7 of Southern's 1980 Annual Report on Form 10-K.\n21 Subsidiaries of the Registrant.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed for the three months ended December 31, 1993.\n(c) Exhibits.\nThe Exhibits required by Item 601 of Regulation S-K as listed in Item 14(a)2 are filed herewith or incorporated herein by reference.\n(d) Financial Statement Schedules.\nFinancial statement schedules and separate financial statements specified by this Item are included in Item 14(a)1 or are otherwise not required or are not applicable.\nPOWER OF ATTORNEY ----------------- Each person whose signature appears below under \"SIGNATURES\" hereby authorizes Henry C. Wolf and John S. Shannon, or either of them, to execute in the name of each such person, and to file, any amendment to this report and hereby appoints Henry C. Wolf and John S. Shannon, or either of them, as attorneys-in-fact to sign on his behalf, individually and in each capacity stated below, and to file, any and all amendments to this report.\nSIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Norfolk Southern Railway Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 22nd day of March, 1994.\nNORFOLK SOUTHERN RAILWAY COMPANY\nBy \/s\/ David R. Goode ----------------------------------------- (David R. Goode, President and Chief Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 22nd day of March, 1994, by the following persons on behalf of Norfolk Southern Railway Company and in the capacities indicated.\nSignature Title --------- -----\n\/s\/ David R. Goode - -------------------------- President and Chief Executive (David R. Goode) Officer and Director (Principal Executive Officer)\n\/s\/ John P. Rathbone - -------------------------- Vice President and Controller (John P. Rathbone) (Principal Accounting Officer)\n\/s\/ Henry C. Wolf - -------------------------- Vice President-Finance (Henry C. Wolf) (Principal Financial Officer)\nSignature Title --------- -----\n\/s\/ Paul R. Rudder - -------------------------- Director (Paul R. Rudder)\n\/s\/ John S. Shannon - -------------------------- Director (John S. Shannon)\n\/s\/ Thomas C. Sheller - -------------------------- Director (Thomas C. Sheller)\n\/s\/ John R. Turbyfill - -------------------------- Director (John R. Turbyfill)\n\/s\/ D. Henry Watts - -------------------------- Director (D. Henry Watts)\n(ITEM 7) NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes beginning on page 51 and the Five-Year Financial Review on page 30. The Condensed Summary provides a brief overview of results of operations, and the text beginning under \"Results of Operations\" is a more detailed analytical discussion.\nCONDENSED SUMMARY OF RESULTS OF OPERATIONS\n1993 Compared with 1992 - ----------------------- Net income was $782.0 million in 1993, a substantial increase over the $606.5 million reported in 1992. Results for 1993 were significantly affected by required accounting changes (see Note 1 on page 56) and by an increase in the federal income tax rate (see Note 3 on page 59). Excluding the impact of the accounting changes and the federal tax rate increase related to prior years, 1993 earnings would have been $585.8 million, a $20.7 million decrease from 1992. Total railway operating revenues increased less than 1%, compared with 1992, as gains in merchandise traffic were substantially offset by lower coal traffic levels. Total railway operating expenses increased 1%, compared with 1992. Nonoperating income reflected in the Consolidated Statements of Income as \"Other income-net\" rose $8.1 million due to gains from property sales (see Note 4 on page 63).\n1992 Compared with 1991 - ----------------------- Net income was $606.5 million in 1992, a significant increase over the $230.6 million reported in 1991. Earnings in 1991 were adversely affected by a $483 million special charge (see Note 14 on page 72). Excluding the impact of the special charge in 1991, 1992 earnings increased by $72.9 million, or 14%, compared with 1991. Railway operating revenues were up 3%, compared with 1991, despite a decline in coal traffic. Railway operating expenses were down 1%, compared with 1991 (excluding the special charge). Nonoperating income declined $20.7 million, reflecting lower interest income on less cash available to invest, lower interest rates and reduced gains from stock sales (see Note 4 on page 63).\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nRESULTS OF OPERATIONS\nRailway Operating Revenues - -------------------------- Railway operating revenues were $3.73 billion in 1993, compared with $3.71 billion in 1992 and $3.60 billion in 1991. The following table presents a three-year comparison of revenues by market group.\nMost NS Rail traffic, particularly coal traffic, moves under contractually negotiated rates as opposed to the typically higher regulated tariff rates. In 1993, 91% of NS Rail origin coal moved under contract, compared with 88% in 1992 and 90% in 1991.\nTraffic volume increased for all market groups except coal. The reduction in the revenue per unit\/mix was due to the decline in coal traffic and to new business that was short-haul and lowered overall average revenue.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nCOAL (which includes coke and iron ore) traffic volume in 1993 decreased 6%, and revenues, which represented 33% of total railway operating revenues, were down 6% from 1992. Coal accounted for about 97% of this market group's volume, and 95% of coal shipments originated on NS Rail's lines. As shown in the following table, small tonnage gains in utility and steel coal were more than offset by declines in export coal, down 22%, compared with 1992.\nThe export coal market continues to be weak. The recession in Europe deepened as the year progressed. Additionally, stockpiles remain at high levels in the United Kingdom, and two Italian coal-fired generating stations that closed in 1992 remained closed for all of 1993. The UMWA strike, which was settled in December 1993, also had an adverse effect on the export market, as some U.S. producers deferred export shipments to take advantage of higher domestic spot market prices. Although the strike was not widespread at mines served by NS Rail, it idled four operations that are heavily oriented toward export shipments. NS Rail's export coal business is expected to remain somewhat depressed in 1994. Expanded coal output and export capacity by foreign producers may make this market very competitive, especially for steam coal. Export coal opportunities for NS Rail are expected to continue to be greatest in Europe, and moderate growth is expected over the next five- year period. In contrast to the export market, domestic coal remained steady. Extended periods of warmer-than-usual temperatures in the Southeast resulted in increased business for a number of utility customers. NS Rail was able to provide coal service to some whose customary carriers were adversely affected by flooding in the Midwest and the UMWA strike. NS Rail continued to do well in domestic steel markets, especially in the Midwest. While total volumes in the domestic steel market remained relatively flat, compared with 1992, NS Rail was able to increase its market share. The outlook for domestic NS Rail coal traffic remains promising. New movements of western coal to an eastern utility began late in 1993 and are expected to reach 3 million tons in 1994 and to grow to nearly 7 million tons annually in the next few years. Changes in emissions regulations for sulfur dioxide included in the Clean Air Act Amendments of 1990 may increase NS Rail utility traffic. Coal volume in 1992 decreased 2%, compared with 1991, and revenues were down 3% from 1991. Traffic volume in 1991 represented NS Rail's second best year since the 1982 consolidation. As shown in the table on the previous page, NS Rail had mixed results in 1992 in the four basic coal market segments it serves. The largest decline in coal tonnage was in export coal, down 8%, compared with 1991. Beginning in 1992, the European economies slumped badly, reducing demand for U.S. coal in both steel and electricity production. Domestic utility tonnages showed the second greatest decline, 2% below 1991, reflecting weakness in the overall economy and unusually mild weather in NS Rail's service region. On the positive side, coal traffic to domestic steel companies in 1992 showed improvement. Compared with 1991, tonnage increased 15%, and NS Rail increased its market share.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nMERCHANDISE TRAFFIC volume in 1993 increased 6%, and revenues increased by $101.4 million, or 4%, compared with 1992. Merchandise carloads handled in 1993 were 2.8 million, compared with 2.7 million in 1992. Despite the slow economic recovery, all six market groups comprising merchandise traffic showed revenue improvement over 1992. The largest gains were in intermodal, up $30.9 million, or 9%; automotive, up $28.0 million, or 7%; and metals\/construction, up $19.8 million, or 7%. PAPER\/FOREST traffic was about even with 1992, and revenues increased 1%. Weak domestic and overseas demand for paper depressed NS Rail's shipments for much of the year. Lumber, however, posted a solid 4% revenue gain due to a strong recovery in housing construction. Moderate growth, somewhat higher than industry production, is expected over the next few years due to growth in market share. CHEMICALS traffic rose 4% over 1992; however, revenues increased less than 1% due to a change in the mix of the traffic. There were solid gains in general chemicals and plastics, but this was offset by weakness in movements of export fertilizer due to sluggish conditions overseas. Stronger growth is expected in 1994 and beyond, paced by additional rail- truck distribution facilities for bulk chemicals. While environmental concerns could adversely affect production of pesticides and chlorine, increased environmental awareness is likely to have a positive impact on movements of recyclables, hazardous wastes and alternative fuels such as ethanol. AUTOMOTIVE traffic rose 8% and revenues increased 7%, compared with 1992. The gain was due to strong demand for vehicles produced at plants served by NS Rail. NS Rail's largest customer, Ford Motor Company, produced the top-selling automobile and truck in 1993. In addition, NS Rail benefited from a full year of production at the Ford\/Nissan plant located near Avon Lake, Oh. Successful marketing efforts, such as an innovative program with GM for just-in-time movement of auto parts, also contributed to the higher traffic levels. Further growth in automotive traffic is expected in 1994 and beyond, as U.S. automotive production is anticipated to increase for the next few years. From 1994 to 1997, operations will begin at three new or expanded automotive assembly plants located on NS Rail's lines: the second Toyota plant at Georgetown, Ky., in 1994; BMW at Greer, S.C., in 1995; and Mercedes-Benz at Tuscaloosa, Al., in 1997. The retooling of GM's Wentzville, Mo., and Doraville, Ga., plants for van production should also increase traffic. AGRICULTURE traffic rose 4%, and revenues increased 6%, compared with 1992. In the early part of the year, NS Rail benefited from a record harvest that continued well into 1993. During the summer, the flood in the Midwest diverted traffic to rail that formerly moved by barge. In the fall, good crop conditions in NS Rail's sourcing areas and poor conditions elsewhere produced strong NS Rail traffic gains. Although the special conditions present during 1993 are not likely to recur in 1994, a small increase in agriculture revenues is expected, driven by growth in poultry production in the Southeast, a prime NS Rail feed grain market. METALS\/CONSTRUCTION traffic rose 9%, and revenues increased 7%, compared with 1992. Most of the revenue gain was in shipments of iron and steel; strong industry production and new plants located on NS Rail's lines boosted revenue $10 million. Shipments of construction commodities were also strong due to a recovery in housing. Further gains are expected over the next few years, as NS Rail has initiatives under way intended to win back truck business in aluminum, and several new movements of municipal solid waste are expected.\nNORFOLK-SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nINTERMODAL traffic rose 9%, and revenues increased 9%, compared with 1992. Intermodal revenue growth in 1993 was led by a 21% increase in services provided to Triple Crown Services Company (a partnership between subsidiaries of NS and Consolidated Rail Corporation) due to strong automotive shipments and expansion of service to the Northeast. Container revenues were up 6%, a smaller increase than previous years, reflecting reduced international traffic caused by the continuing recessions in Europe and Japan. Trailer revenues were up 11%, boosted by gains from haulage arrangements with truckload carriers. Strong growth in intermodal traffic is expected in 1994 and for the next several years. Container traffic is expected to improve as recoveries overseas produce steady growth in international shipments. Trailer business also is expected to grow, as leading truckload carriers, such as Schneider National and J.B. Hunt, use rail for the long-haul portion of their shipments. During 1992, all six merchandise market groups showed improvement over 1991. Traffic volume increased 6%, and revenues increased $147.5 million, or 7%. The largest revenue increases were in the automotive group, up $75.6 million, or 23%, over a weak 1991. The intermodal group was up $16.4 million, or 5%, over 1991, and the paper\/forest and chemicals groups each reported 5% revenue gains. The growth in the automotive group was the result of a national rise in automobile production, especially increased production of popular models at plants which NS Rail serves. All segments of intermodal traffic showed growth during 1992. Triple Crown(RT), the fastest growing segment, which accounted for 24% of the intermodal traffic, began a new domestic container service in the eastern part of the NS Rail system, in addition to its RoadRailer(RT) business. Paper\/forest revenues improved as the result of increased housing starts and greater paper production. Chemical revenues were higher because of a general recovery in chemical production over the recessionary levels of 1991.\nRailway Operating Expenses - -------------------------- Railway operating expenses increased 1% in 1993, compared with 1992, and decreased 15% in 1992, compared with 1991. Included in 1991's expenses was a $483.0 million special charge discussed below. Excluding the 1991 special charge, railway operating expenses decreased 1% in 1992, compared with 1991. SPECIAL CHARGE IN 1991 (see Note 14 on page 72): By the end of 1991, after several years of negotiations and a brief nationwide strike, new rail labor agreements were in place that allowed NS Rail to begin operating trains with reduced crew sizes. The agreements also provide for future crew size reductions. To achieve the reductions in employment and other labor savings permitted by the new agreement, NS Rail recorded a special charge that included $450 million to cover the cost of future separation payments, protective payments and amounts to buy out productivity funds. The special charge, which totalled $483 million, also included a $33 million write-down of certain properties to be sold or abandoned.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following table compares, on a year-to-year basis, railway operating expenses summarized by major classifications. The special charge also is summarized, as well as comparative railway operating expenses, excluding the special charge.\nThe narrative expense analysis presented in the following paragraphs focuses on the major factors contributing to changes in railway operating expenses, excluding the effects of the 1991 special charge discussed above and in Note 14 on page 72. COMPENSATION AND BENEFITS, which includes salaries, wages and fringe benefits, represents about half of total railway operating expenses and increased 1% in 1993, compared with 1992, and declined 2% in 1992, compared with 1991. The higher expenses in 1993 were mainly due to accruals for postretirement and postemployment benefits which were previously accounted for on a pay-as-you-go basis (see \"Required Accounting Changes\" in Note 1 on page 56) and higher costs for stock- based compensation plans. A voluntary early retirement program was completed in 1993, which resulted in a $42.4 million charge in compensation and benefits expense (see Note 12 on page 68). Also in 1993, a $46 million credit was recorded in compensation and benefits, reflecting a partial reversal of the 1991 special charge (see Note 14 on page 72). Labor expenses were favorably affected by a lower average train crew size, which was 2.6 in 1993, a moderate decline compared with 1992. The lower expenses in 1992, compared with 1991, were mainly due to savings associated with reduced train crew sizes. The average train crew size in 1992 was 2.7 compared with 3.5 in 1991. MATERIALS, SERVICES AND RENTS consists of items used for maintenance of road (rail line and related structures) and equipment (locomotives and freight cars); equipment rents representing the cost to NS Rail of using freight equipment owned by other railroads or private owners, less the rent paid to NS Rail for the use of its equipment; and the cost of services purchased from outside contractors, including the net costs of operating joint (or leased) facilities with other railroads. This category was up less than 1%, compared with 1992, but was up 9% in 1992, compared with 1991. The increase in 1992 largely was a result of that year's greatly expanded equipment maintenance program. Also contributing to the 1992 increase were higher roadway maintenance activity, increased gross ton miles and accruals related to a lease with Canadian National Railway.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nDEPRECIATION expense (see Note 1 \"Properties\" on page 56 for NS Rail's depreciation policy) was up 5% in 1993, compared with 1992, and up 4% in 1992, compared with 1991. The increases in both periods were due to property additions, reflecting substantial levels of capital spending during the three-year period ended December 31, 1993. DIESEL FUEL costs declined 2% in 1993, compared with 1992, and declined 5% in 1992, compared with 1991. NS Rail consumes substantial quantities of diesel fuel; therefore, changes in price per gallon or consumption have a significant impact on the cost of providing transportation services. The lower costs in 1993 were due to a lower price per gallon, offset in part by a 2% increase in consumption related to the 3% increase in gross ton miles. Expenses declined in 1992, compared with 1991, mainly due to a lower price per gallon offset partially by increased consumption. CASUALTIES AND OTHER CLAIMS (which includes insurance costs, estimates of costs related to personal injury, property damage and environmental- related costs) declined 2% in 1993, compared with 1992, and decreased 22% in 1992, compared with 1991. By far the largest component, personal injury expenses, which relate primarily to the cost of on-the-job employee injuries, has shown favorable trends since 1990, reflecting both success in reducing accidental employee injuries and effective claims handling. Unfortunately, the favorable trend in accidental injury claims has been more than offset by increased costs of nonaccidental \"occupational\" claims. The rail industry remains uniquely susceptible to both accidental injury and occupational claims because of an outmoded law, the Federal Employers' Liability Act (FELA), originally passed in 1908 and applicable only to railroads. This law provides the sole basis for compensating railroad employees who sustain job-related injuries. Under the FELA, claimants unable to reach an agreement with the railroad concerning compensation may file a civil suit to recover damages. In most cases, a jury must then determine whether the claimant is entitled to any damages and, if so, the amount. The system produces results that are unpredictable, inconsistent and frequently unfair, at a cost to the rail industry that is two or three times greater than the no-fault workers' compensation systems to which nonrail competitors are universally subject. The railroads have been unsuccessful so far in efforts to persuade Congress to replace the FELA with a no-fault workers' compensation act. OTHER expenses decreased 3% in 1993, compared with 1992, and 7% in 1992, compared with 1991. These decreases were largely the result of favorable settlements of issues related to property and other state taxes. The NS Rail operating ratio (the percentage of operating revenues consumed by operating expenses) continues to be the best among the major railroads in the United States. NS Rail will continue to pursue cost- containment efforts to assure that its rail subsidiaries are operated efficiently. The operating ratios for past six years were as follows:\nOther Income-Net - ---------------- Nonoperating income increased $8.1 million, or 16%, in 1993, compared with 1992, but decreased $20.7 million, or 29%, in 1992, compared with 1991 (see Note 4 on page 63). The 1993 increase arose from gains on property sales, partially offset by declines in interest income and rental income (see also Note 2 \"Noncash Dividend\" on page 58). The 1992 decline was a result of an absence of stock sales in 1992, coupled with a decline in interest income due to lower cash and short-term investments balances and lower rates.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nInterest Expense on Debt - ------------------------ Interest expense on debt decreased 28% in 1993, compared with 1992, and 8% in 1992, compared with 1991, due principally to lower levels of equipment debt and lower interest rates.\nIncome Taxes - ------------ Income tax expense in 1993 was $412.8 million for an effective rate of 43.6%, compared with an effective rate of 34.9% in 1992 and 34.6% in 1991, excluding the special charge. Income tax expense in 1993 was accrued under SFAS 109, rather than under the prior accounting rules (see Note 1 on page 56). Absent the federal income tax rate increase imposed by the Revenue Reconciliation Act of 1993, income tax expense in 1993 would have been $352.0 million for an effective rate of 37.2%. Current income tax expense increased from $249.0 million in 1992 to $319.9 million in 1993, primarily due to tax payments made in anticipation of Revenue Agent Reports for the 1988-1989 federal income tax audit. Deferred tax expense for 1993, compared with 1992, decreased primarily for the same reason. Current and deferred tax expenses for 1991 were affected significantly by the special charge. Much of the tax benefit resulting from this charge was not deductible in 1991 and therefore was recorded as a deferred tax benefit. Excluding the payment discussed above and the federal tax rate increase, the portion of the special charge that reversed in 1993 and 1992, combined with property-related adjustments, including depreciation, were the principal causes for the increase in deferred tax expense over the 1991 level. As a result of changes in tax law that limit or defer the timing of deductions and recent tax rate increases, NS Rail expects current taxes to remain high in relation to pretax earnings (see Note 3 on page 59 for the components of income tax expense).\nRequired Accounting Changes - --------------------------- Effective January 1, 1993, NS Rail adopted required accounting for postretirement benefits other than pensions, postemployment benefits and income taxes (see Note 1 on page 56 for a discussion of these accounting changes). The net cumulative effect of these noncash adjustments increased 1993's net income by $247.8 million. The balance sheet effects of these accrual adjustments are reflected primarily in \"Other liabilities\" for the postretirement and postemployment benefits and in \"Deferred income taxes\" for the income tax accounting change.\nImpact of New Accounting Pronouncements - --------------------------------------- In May 1993, the Financial Accounting Standards Board issued a new standard, \"Accounting for Certain Investments in Debt and Equity Securities,\" which addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. This standard will require NS Rail to increase the recorded carrying value for its investment in NS stock to fair value, with a corresponding increase, net of taxes, as a separate component of stockholders' equity (see Note 1 \"New Statement of Financial Accounting Standards\" on page 56 for further details.)\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nFINANCIAL CONDITION refers to the assets, liabilities and stockholders' equity of an organization, including the value of those individual elements in relation to each other. Generally, financial condition is evaluated at a point in time using an organization's balance sheet (see page 52). LIQUIDITY refers to the ability of an organization to generate adequate amounts of cash, principally from operating results or through borrowing power (based on net income or financial condition), to meet its short-term and long-term cash requirements. CAPITAL RESOURCES refers to the ability of an organization to attract investors through the sale of either debt or equity (stock) securities.\nCASH PROVIDED BY OPERATING ACTIVITIES, which is NS Rail's principal source of liquidity, declined 9% in 1993, compared with 1992, but was up 32% in 1992, compared with 1991. These fluctuations were primarily due to the timing of income tax payments. In 1993, tax payments were $146.0 million higher than in 1992 due to payments related to the 1988-1989 federal income tax audit, higher 1993 earnings and the fact that 1992's tax payments were low. In 1992, tax payments were $70.8 million less than 1991 primarily due to the higher tax payments in 1991 related to the federal income tax audit for 1986 and 1987, and to estimated tax payments in 1991 utilized in 1992. In addition, net income in 1992, excluding the special charge in 1991, was up $72.9 million, and depreciation increased $13.4 million. Implementation of the labor portion of the 1991 special charge also contributed to the fluctuations in cash provided by operations. In 1993, only $36.1 million was used for labor costs related to the special charge, compared with $134.7 million in 1992 and $108.0 million in 1991. The decline in 1993 was partly due to the failure to reach agreement on terms for certain further labor savings. This situation also led to a partial reversal of the 1991 special charge (see discussion in Note 14). Looking ahead, the labor portion of the special charge is expected to continue to require the use of cash to achieve productivity gains permitted by the agreements, although at a level somewhat lower than previously anticipated. NS Rail regards this cash outflow as an investment because, in view of the high cost of labor and fringe benefits, these payments are expected to produce significant future labor savings. It is estimated that NS Rail's labor-related payments will be reduced by about $150 million per year upon full implementation of the new labor agreements. Since consolidation, cash provided by operating activities has been sufficient to fund dividend requirements, debt repayments and a significant portion of capital spending (see Consolidated Statements of Cash Flows on page 53).\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nCASH USED FOR INVESTING ACTIVITIES declined 22% in 1993, compared with 1992, but was up 6% in 1992, compared with 1991. Repayment received from NS on short-term advances (see Note 2 on page 58) and higher proceeds from property sales were primarily responsible for the improvement in 1993. An absence of investment sales caused the 1992 over 1991 increase. Although the high level of property sales that occurred in 1993 is not expected to continue, efforts to hold down capital spending will be ongoing as NS Rail seeks to maximize utilization of all its assets. In this connection, NS Rail continues to review its route network to identify areas where efficiency can be enhanced by coordinated agreements with other railroads, or through sale or abandonment. The following table summarizes capital spending over the last five years, as well as track maintenance statistics and the average ages of railway equipment.\nThe average age of locomotives retired during 1993 was 24.7 years. In recent years, NS Rail has rebodied over 14,000 coal cars and plans to continue that program at the rate of about 3,000 cars per year for the next several years. This process, performed at NS Rail's Roanoke Car Shop, converts hopper cars into high-capacity steel gondolas or hoppers. As a result, the remaining serviceability of the freight car fleet is greater than indicated by the increasing average age of the freight car fleet. Construction of two surge silos at the coal transloading facility in Norfolk was completed in 1993. The silos, which have a total capacity of 8,150 tons, allow for continuous dumping which reduces operating costs and loading time. For 1994, NS Rail is planning $627 million of capital spending. NS Rail anticipates new equipment financing of approximately $72 million in 1994. Rail capital spending is likely to increase moderately over the next few years. The proposed construction of a $100 million coal ground storage facility in Isle of Wight County, Va., may affect capital spending in future years. However because of delays in the permitting process and reduced demand for export coal, any significant spending on this project is not expected until after 1994. In addition to adding capacity, this new facility should further increase the efficiency of coal transportation service and reduce the need for new coal hopper cars. A substantial portion of future capital spending is expected to be funded through internally generated cash, although debt financing will continue as the primary funding source for equipment acquisitions. Investments and advances (see Note 5 on page 63) decreased $110.1 million in 1993, compared with 1992. This decline reflects a $220 million reclassification to \"Other current assets\" for the cash surrender value of certain corporate owned life insurance (COLI) which is expected to be borrowed in April 1994, and accounts for the increase in working capital. Absent this reclassification, \"Investments\" would have increased almost $110 million, principally reflecting premium payments on COLI, which increase the cash surrender value of the underlying insurance policies.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nCASH USED FOR FINANCING ACTIVITIES increased 16% in 1993, compared with 1992, and 45% in 1992, compared with 1991. These increases were principally a result of lower borrowing. Debt activity over the past five years was as follows:\nDebt requirements for 1994 are expected to remain moderate partly because another source of cash, borrowing on the cash surrender value of COLI, will satisfy some of 1994's cash requirements (see Note 5 on page 63).\nENVIRONMENTAL MATTERS\nNS Rail is subject to various jurisdictions' environmental laws and regulations. NS Rail and certain subsidiaries have received notices from the Environmental Protection Agency that they are potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), which generally imposes joint and several liability for cleanup costs. State agencies also have notified NS Rail and certain subsidiaries that they may be potentially responsible for environmental damages, and in several instances they have agreed voluntarily to initiate cleanup. For CERCLA sites and all other known environmental incidents where loss or liability is probable, NS Rail has recorded an estimated liability. The amount of that liability, which includes estimated costs of remediation (and any associated restoration) on a site-by-site basis, is expected to be paid over several years. Claims, if any, against third parties for recovery of remediation costs incurred by NS Rail are reflected as receivables in the balance sheet and are not netted against the associated NS Rail liability. Environmental engineers perform ongoing analyses of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are recorded. NS also established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives. Estimates of a company's potential financial exposure even for known environmental claims or incidents are necessarily imprecise because of the widely varying costs of available remediation techniques, the difficulty of determining in advance the nature and extent of contamination and each potential participant's share of an estimated loss, and evolving statutory and regulatory standards governing liability. The risk of incurring environmental liability--for acts and omissions, both past and current--is inherent in railroad operations. Moreover, some of the commodities, particularly those classified as hazardous materials, in NS Rail's traffic mix can pose special risks that NS Rail and its subsidiaries work diligently to minimize. In addition, several NS Rail subsidiaries have land holdings that may be leased (and operated by others) or held for sale. Because certain conditions may exist on these properties for which NS Rail ultimately may bear some financial responsibility, there can be no assurance that NS Rail will not incur liabilities or costs, the amount and materiality of which, to a single accounting period or in the aggregate, cannot be estimated reliably now, related to environmental problems that are latent or undiscovered. However, based on its assessments of the facts and circumstances now known and after consulting with its legal counsel, Management believes that it has recorded appropriate estimates of liability for those environmental matters of which the Company is aware.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations\nINFLATION\nGenerally accepted accounting principles require the use of historical costs in preparing financial statements. This approach disregards the effects of inflation on the replacement cost of property and equipment. NS Rail, a capital-intensive company, has approximately $12.1 billion invested in such assets. The replacement costs of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical costs.\nRAIL INDUSTRY TRENDS\nNS Rail and other railroads are continuing to seek opportunities to share traffic routes and facilities, furthering the goals of providing seamless service to customers, making railroads more competitive with trucks and maximizing efficiency of the respective railroads.\nNS Rail is responding to concerns regarding the emission of coal dust from in-transit coal trains. Testing is under way of various methods of controlling such emissions. However, at this time final results of the testing and estimated costs that may be incurred to implement the conclusions resulting therefrom are not available.\nNS Rail and the rail industry are continuing their efforts to replace the FELA with a no-fault workers' compensation system, which we strongly believe to be fairer both to the rail industry and to its employees.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\nThe following notes are an integral part of the consolidated financial statements.\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation - --------------------------- The consolidated financial statements include Norfolk Southern Railway Company, Norfolk and Western Railway Company (NW) and their majority- owned and controlled subsidiaries (collectively, NS Rail). All significant intercompany balances and transactions have been eliminated in consolidation (see Note 15 for NW's summarized consolidated financial information).\nCash Equivalents - ---------------- Cash equivalents are highly liquid investments purchased three months or less from maturity. The carrying value approximates fair value because of the short maturity of these investments.\nMaterials and Supplies - ---------------------- Materials and supplies, which consist mainly of fuel oil and items for maintenance of property and equipment, are stated at average cost. The cost of materials and supplies expected to be used in capital additions or improvements is included in properties.\nProperties - ---------- Properties are stated principally at cost and are depreciated using group depreciation. Rail is primarily depreciated on the basis of use measured by gross ton miles. The effect of this method is to write off these assets over 42 years on average. Other properties are depreciated generally using the straight-line method over estimated service lives at annual rates that range from 1% to 20%. The overall depreciation rate averaged 2.6% for roadway and 4.0% for equipment. NS Rail capitalizes interest on major capital projects during the period of their construction. Maintenance expense is recognized when repairs are performed. When properties other than land are sold or retired in the ordinary course of business, the cost of the assets less the sale proceeds or salvage is charged to accumulated depreciation rather than recognized through income. Gains and losses on disposal of land, which is a nondepreciable asset, are included in other income.\nRevenue Recognition - ------------------- Revenue is recognized proportionally as a shipment moves from origin to destination.\nBalance Sheet Classification - ---------------------------- Beginning with 1991, the balance sheet classification of certain revenue-related balances appears on an actual (net) basis rather than an estimated (gross) basis due to the earlier availability of certain settlement data with other railroads. This modification, which had no income statement effect, resulted in large offsetting declines in accounts receivable and accounts payable as illustrated in the Statement of Cash Flows for 1991.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies (continued)\nRequired Accounting Changes - --------------------------- Effective January 1, 1993, NS Rail adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS 106), and Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS 112). SFAS 106 requires NS Rail to accrue the cost of specified health care and death benefits over an employee's active service period rather than, as was the previously prevailing practice, accounting for such expenses on a pay-as-you-go basis. SFAS 112 requires corporations to recognize the cost of benefits payable to former or inactive employees after employment but before retirement on an accrual basis. For NS Rail, such postemployment benefits consist principally of benefit obligations related to participants in the long-term disability plan. NS Rail recognized the effects of these changes in accounting on the immediate recognition basis. The cumulative effects on years prior to 1993 of adopting SFAS 106 and 112 increased pretax expenses $336.3 million ($208.4 million after-tax), and $22.8 million ($14.2 million after-tax), respectively (see Note 13). The impact on 1993 expenses is not material. The pro forma effects of applying SFAS 106 and SFAS 112 on individual prior years is not presented, as the effect on each separate year also is not material. Also effective January 1, 1993, NS Rail adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). SFAS 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Under the deferred method, which applied for 1992 and prior years, deferred income taxes were recognized for income and expense items that were reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation, and deferred taxes were not adjusted for subsequent changes in tax rates. The cumulative effect on years prior to 1993 of adopting SFAS 109 increased net income by $470.4 million (see also Note 3).\nNew Statement of Financial Accounting Standards - ----------------------------------------------- \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115) was issued in May 1993. This standard, which is effective for 1994, addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Investments are to be categorized as one of the following types of securities: \"held-to-maturity,\" \"trading\" or \"available-for-sale.\" The carrying value and timing of gain\/loss realization is dependent upon the categorization of the investment. For NS Rail, the only significant effect will be a change in the carrying value of its investments in NS stock. As described in Note 5, NS Rail owns approximately 7.3 million shares of NS stock, the fair market value of which far exceeds the original cost. Under SFAS 115, NS Rail will report this investment at fair value with the unrealized gain reported, net of taxes, as a separate component of stockholders' equity.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n2. Related Parties\nGeneral - ------- NS is the parent holding company of NS Rail. The costs of functions performed by NS are allocated among its rail operating subsidiaries. Rail operations are coordinated at the holding company level by the NS Executive Vice President-Operations.\nNoncash Dividend - ---------------- On April 1, 1993, NS Rail declared and issued to NS a $104.7 million noncash dividend representing the net assets of several nonrailroad subsidiaries. These subsidiaries, principally involved in real estate, produce a small amount of rental income which will no longer be part of NS Rail's results. Noncash dividends are excluded from the Consolidated Statements of Cash Flows.\nAssets Acquired - --------------- During 1991, NS Rail acquired $66.6 million of assets from a related party (see Note 6).\nDuring 1993, NW issued a demand note for $112.6 million to an NS subsidiary for the purchase of a portfolio of short-term investments. This noncash transaction was excluded from the Consolidated Statement of Cash Flows. Interest is applied to short-term advances at the average NS yield on short-term investments.\nIntercompany Federal Income Tax Accounts - ---------------------------------------- In accordance with the NS Tax Allocation Agreement, intercompany federal income tax accounts are recorded between companies in the NS consolidated group. At December 31, 1993 and 1992, NS Rail had intercompany federal income tax payables (which are included in \"Deferred income taxes\" in the Consolidated Balance Sheets) of $175.1 million and $139.5 million, respectively.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n2. Related Parties (continued)\nCash Required for NS Stock Purchase Program and NS Debt - ------------------------------------------------------- Since 1987, the NS Board of Directors has authorized the purchase and retirement of up to 65 million shares of NS common stock. Purchases under the programs initially were made with internally generated cash. Beginning in May 1990, NS financed some purchases with proceeds from the sale of commercial paper notes. As of December 31, 1993 and 1992, NS had recorded $521.8 million and $520.5 million, respectively, of notes under this program. In March 1991, NS issued $250 million of long-term notes and, in February 1992, NS issued an additional $250 million of long-term notes in part to repay a portion of the commercial paper notes, as well as to fund additional stock purchases. On January 29, 1992, NS announced that, primarily related to issues surrounding the 1991 special charge (see Note 14), the purchase program would continue, but at a slower pace and over a longer authorized period, with actual purchases dependent on market conditions, the economy, cash needs and alternative investment opportunities. Since the first purchases in December 1987 and through December 31, 1993, NS has purchased and retired 53,615,800 shares of its common stock under these programs at a cost of $2.2 billion. Consistent with the earlier cash purchases, a significant portion of the funding for future NS stock purchases, either in the form of direct cash or cash used for debt service, will come from NS Rail through intercompany advances or dividends to NS. Cash required to service NS debt issued to fund labor costs related to the special charge (see Note 14) also will come principally from NS Rail. Included in interest income is $6.7 million, $7.7 million and $8.8 million in 1993, 1992 and 1991, respectively, related to amounts due from NS.\nTransfers of Investment from NS - ------------------------------- In August 1991, NS transferred its $15.2 million equity interest in a railroad equipment leasing subsidiary to Norfolk Southern Railway Company. This transfer was recorded at historical cost and reflected as a contribution to capital.\n3. Income Taxes\nFederal Income Tax Rate Increase - -------------------------------- In August 1993, Congress enacted the Revenue Reconciliation Act of 1993, which increased the federal corporate income tax rate from 34% to 35%, retroactive to January 1, 1993. The tax rate increase had two components which, as required by SFAS 109, were recognized in 1993's earnings.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n3. Income Taxes (continued)\nThe first component relates to the increased income tax rate's effect on 1993's earnings, which increased the provision for income taxes and reduced net income by $9.2 million. The second component increased the provision for the net deferred tax liability in the Consolidated Balance Sheet, which reduced net income by $51.6 million.\nInclusion in Consolidated Return - -------------------------------- NS Rail is included in the consolidated federal income tax return of NS. The provision for current income taxes in the Consolidated Statements of Income reflects NS Rail's portion of NS' consolidated tax provision. Tax expense or tax benefit is recorded on a separate company basis whether or not such benefit would be currently available on a separate company basis.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n3. Income Taxes (continued)\nDeferred Income Tax Expense - --------------------------- Some income and expense items are reported differently for financial reporting and income tax purposes. Provisions for deferred income taxes were made in recognition of these differences in accordance with APB Opinion No. 11 for years prior to 1993, and SFAS 109 for 1993 (see Note 1 for an explanation of this required accounting change). For 1993, the components of deferred income tax expense were as follows: (1) $51.6 million in adjustments to deferred tax assets and liabilities for the enacted tax rate increase; (2) $1.4 million decrease in the valuation allowance for deferred tax\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n3. Income Taxes (continued)\nassets, and (3) $42.7 million net for all other deferred tax expense items, for a total of $92.9 million. The significant components of deferred income tax expense for 1992 and 1991 were as follows:\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n3. Income Taxes (continued)\nExcept for amounts for which a valuation allowance is provided, Management believes the other deferred tax assets will be realized. The valuation allowance for deferred tax assets as of January 1, 1993, was $3.4 million. The net change in the total valuation allowance for the year ended December 31, 1993, was a decrease of $1.4 million.\nInternal Revenue Service (IRS) Reviews - -------------------------------------- Consolidated federal income tax returns have been examined and Revenue Agent Reports have been received for all years up to and including 1989. The consolidated federal income tax returns for 1990 through 1992 are being audited by the IRS. Management believes that adequate provision has been made for any additional taxes and interest thereon that might arise as a result of these examinations.\nCorporate Owned Life Insurance - ------------------------------ The cash surrender value of certain corporate owned life insurance, amounting to approximately $220 million, which is expected to be borrowed in April 1994, has been reclassified in the Consolidated Balance Sheet from \"Investments and advances\" to \"Other current assets.\"\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n5. Investments and Advances (continued)\nFair Values - ----------- At December 31, 1993, the fair value of investments approximated $904 million. The fair values of marketable securities were based on quoted market prices. At December 31, 1993 and 1992, the market value of marketable equity securities, which consist principally of 7,252,634 shares of NS common stock, was $511.9 million and $444.6 million, respectively. The fair values of stock in nonmarketable securities were estimated based on the underlying net assets. For the remaining investments and advances, consisting principally of corporate owned life insurance and long-term advances to NS, the carrying value approximates fair value.\nNoncash Property Transactions Excluded from the Consolidated Statements - ----------------------------------------------------------------------- of Cash Flows - ------------- Additions to \"Other property\" in 1991 included $66.6 million for assets acquired from a real estate partnership in which an NS Rail subsidiary owned an equity interest. Of this transaction, $10.6 million was noncash and related to amounts invested in or advanced to that partnership which previously had been classified in \"Investments and advances.\"\nCapitalized Interest - -------------------- Total interest cost incurred on long-term debt for 1993, 1992 and 1991 was $53.9 million, $62.5 million and $66.0 million, respectively, of which $21.6 million, $17.9 million and $17.6 million was capitalized.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n8. Debt\nShort-Term Debt - --------------- Short-term debt consists of $27.2 million of notes assumed in connection with the 1990 acquisition of a coal terminal facility.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n8. Debt (continued)\nA substantial portion of NS Rail's properties and certain investments in affiliated companies are pledged as collateral for much of the secured debt.\nFair Values - ----------- The carrying value of short-term debt approximates fair value. The fair value of long-term debt, including current maturities, approximated $670 million at December 31, 1993. The fair values of debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating and remaining maturity.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n9. Lease Commitments\nAmong NS Rail's leased properties are approximately 300 miles of road in North Carolina. The leases expire in 1994, and NS Rail is discussing renewals with the lessor (see also page 5).\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n11. Stock\nPreferred - --------- There are 10,000,000 shares of no par value serial preferred stock authorized. This stock may be issued in series from time to time at the discretion of the Board of Directors with any series having such voting and other powers, dividends and other preferences as deemed appropriate at the time of issuance. At December 31, 1993 and 1992, 1,197,027 and 1,197,131 shares of $2.60 Cumulative Preferred Stock, Series A (Series A Stock) were issued, and 1,096,907 and 1,097,011 shares were held other than by subsidiaries. The Series A Stock has a $50 per share stated value. The Series A Stock is callable at any time at $50 per share plus accrued dividends and has one vote per share on all matters, voting as a single class with holders of other stock. On June 2, 1989, NS announced that it intended to purchase up to 250,000 shares of the outstanding Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. NS had purchased 77,626 shares at a total cost of approximately $2.7 million as of December 31, 1993. NS purchased the shares in regular brokerage transactions on the open market at prevailing prices. At year end 1993 and 1992, NS held 77,721 shares and 75,721 shares, respectively.\nPreference - ---------- There are 10,000,000 shares of no par value serial preference stock authorized. None of these shares has been issued.\nCommon - ------ There are 50,000,000 shares of no par value common stock with a stated value of $10 per share authorized. NS owns all 16,668,997 shares issued and outstanding at December 31, 1993 and 1992.\n12. Pension Plans\nNS Rail's defined benefit pension plans, which principally cover salaried employees, are part of NS' retirement plans. Pension benefits are based primarily on years of creditable service with NS and its participating subsidiary companies and compensation rates near retirement. Contributions to the plans are made on the basis of not less than the minimum funding standards set forth in the Employee Retirement Income Security Act of 1974, as amended. Assets in the plans consist mainly of common stocks. The following data relate principally to NS Rail's portion of the combined NS plans, since no separate NS Rail data are available.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n12. Pension Plans (continued)\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n12. Pension Plans (continued)\nEarly Retirement Program - ------------------------ During 1993, NS Rail completed a voluntary early retirement program for salaried employees that resulted in a $42.4 million charge in compensation and benefits expense. The principal benefit for those who participated in the program was enhanced pension benefits which are reflected in the accumulated benefit obligation at December 31, 1993.\nTransfer of Pension Plan Assets - ------------------------------- During 1991, the NS Retirement Plan was amended to establish a Section 401(h) account for the purpose of transferring a portion of pension plan assets in excess of the projected actuarial liability to fund current- year medical payments for retirees. In December 1993, 1992 and 1991, $13.0 million, $15.0 million and $14.5 million, respectively, were transferred from this account to reimburse NS for such payments. NS contributed equal amounts to a Voluntary Employee Beneficiary Association account in those years to fund future benefit costs for retirees (see Note 13).\n401(k) Plan - ----------- NS Rail provides a 401(k) savings plan for salaried employees. Under the plan, NS Rail matches a portion of the employee contributions, subject to applicable limitations. NS Rail's expenses under this plan were $5.1 million, $4.7 million and $4.4 million in 1993, 1992 and 1991, respectively.\n13. Postretirement Benefits Other Than Pensions\nNS Rail provides specified health care and death benefits to eligible retired employees, principally salaried employees. Under the present plans, which may be amended or terminated at NS Rail's option, a defined percentage of health care expenses is covered, reduced by any deductibles, co-payments, Medicare payments and, in some cases, coverage provided by other group insurance policies. The cost of such health care coverage to a retiree may be determined, in part, by the retiree's years of creditable service with NS Rail prior to retirement. Death benefits are determined based on various factors, including, in some cases, salary at time of retirement. NS Rail continues to fund benefit costs principally on a pay-as-you-go basis. However, in 1991, NS Rail established a Voluntary Employee Beneficiary Association (VEBA) account to fund a portion of the cost of future health care benefits for retirees (see \"Transfer of Pension Plan Assets\" in Note 12).\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n13. Postretirement Benefits Other Than Pensions (continued)\nFor measurement purposes, a 12% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1993; the rate was assumed to decrease gradually to an ultimate rate of 6% for 2005 and remain at that level thereafter. The health care cost trend rate has a significant effect on the amounts reported in the financial statements. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993, by about $53 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year 1993 by about $4.7 million.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n13. Postretirement Benefits Other Than Pensions (continued)\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25%. A 6% salary increase assumption was used for death benefits based on salary at the time of retirement. The VEBA trust holding the plan assets is not expected to be subject to federal income taxes as the assets are invested entirely in trust- owned life insurance. The long-term rate of return on plan assets, as determined by the growth in cash surrender value of the life insurance policies, is expected to be 9%. Under collective bargaining agreements, NS Rail and certain subsidiaries participate in a multi-employer benefit plan, which provides certain postretirement health care and life insurance benefits to eligible union employees. Premiums under this plan are expensed as incurred and amounted to $6.4 million, $6.2 million and $6.2 million in 1993, 1992 and 1991, respectively.\n14. Special Charge in 1991 and Subsequent Partial Reversal in 1993\nIncluded in 1991 results was a $483 million special charge for labor force reductions and asset write-downs. The special charge reduced net income by $303 million. The principal components of the special charge were as follows:\nLabor - ----- Significant new labor agreements were reached late in 1991 following a Presidential Emergency Board's recommendations that railroads be permitted to modify long-standing unproductive work rules. The principal feature of the new agreements concerned a change in crew consist (the required number of crew members on a train) from four to two members to be implemented over a five-year period across most of NS Rail's system. Surplus employees whose positions were eliminated as a result of the restructured crew size are entitled to protective pay and may be offered voluntary separation incentives. Related to crew-consist changes, separate agreements were reached concerning the buy out of certain productivity funds (payments to train service employees whenever a train operates with a reduced crew). The labor portion of the special charge amounted to $450 million and represented the estimated costs of achieving the productivity gains provided by these new agreements.\nProperty - -------- The property portion of the special charge, which amounted to $33 million, was for marginally productive railroad property that was scheduled for sale or abandonment.\nSpecial Charge Reversal - ----------------------- Based on NS Rail's success in eliminating reserve board positions in 1992 and 1993, and on events occurring in the third quarter of 1993, the accrual included in the 1991 special charge related to labor was reduced by $46 million and was reflected as a credit in compensation and benefits expenses. The principal factor contributing to the reversal was that, in 1993, agreement on terms for certain further labor savings could not be reached. Accordingly, it became apparent that a surplus existed in the labor portion of the provision established in the 1991 special charge.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n15. Norfolk and Western Railway Company and Subsidiaries (NW)-- Summarized Consolidated Financial Information\nNW is operated as an integral part of NS Rail. Revenues are allocated to NW based on actual traffic movements as determined by revenue ton miles within market groups. Expenses are allocated to NW based on criteria considered appropriate for the type of expense. The costs of functions performed by NS, the parent holding company of NS Rail, are also allocated to its rail operating subsidiaries.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n15. Norfolk and Western Railway Company and Subsidiaries (NW)-- Summarized Consolidated Financial Information (continued)\n16. Contingencies\nLawsuits - -------- Norfolk Southern Railway Company and certain subsidiaries are defendants in numerous lawsuits relating principally to railroad operations. While the final outcome of these lawsuits cannot be predicted with certainty, it is the opinion of Management, after consulting with its legal counsel, that ultimate liability will not materially affect the consolidated financial position of NS Rail.\nDebt Guarantees - --------------- As of December 31, 1993, NS Rail and certain subsidiaries are contingently liable as guarantors with respect to $37 million of indebtedness of related entities.\nNORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements\n16. Contingencies (continued)\nEnvironmental Matters - --------------------- NS Rail is subject to various jurisdictions' environmental laws and regulations. NS Rail and certain subsidiaries have received notices from the Environmental Protection Agency that they are potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), which generally imposes joint and several liability for cleanup costs. State agencies also have notified NS Rail and certain subsidiaries that they may be potentially responsible for environmental damages, and in several instances they have agreed voluntarily to initiate cleanup. For CERCLA sites and all other known environmental incidents where loss or liability is probable, NS Rail has recorded an estimated liability. The amount of that liability, which includes estimated costs of remediation (and any associated restoration) on a site-by-site basis, is expected to be paid over several years. Claims, if any, against third parties for recovery of remediation costs incurred by NS Rail are reflected as receivables in the balance sheet and are not netted against the associated NS Rail liability. Environmental engineers perform ongoing analyses of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are recorded. NS Rail also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives. Estimates of a company's potential financial exposure even for known environmental claims or incidents are necessarily imprecise because of the widely varying costs of available remediation techniques, the difficulty of determining in advance the nature and extent of contamination and each potential participant's share of an estimated loss, and evolving statutory and regulatory standards governing liability. The risk of incurring environmental liability--for acts and omissions, both past and current--is inherent in railroad operations. Moreover, some of the commodities, particularly those classified as hazardous materials, in NS Rail's traffic mix can pose special risks that NS Rail and its subsidiaries work diligently to minimize. In addition, several NS Rail subsidiaries have land holdings that may be leased (and operated by others) or held for sale. Because certain conditions may exist on these properties for which NS Rail ultimately may bear some financial responsibility, there can be no assurance that NS Rail will not incur liabilities or costs, the amount of and materiality of which, to a single accounting period or in the aggregate, cannot be estimated reliably now, related to environmental problems that are latent or undiscovered. However, based on its assessments of the facts and circumstances now known and after consulting with its legal counsel, Management believes that it has recorded appropriate estimates of liability for those environmental matters of which the Company is aware.\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Board of Directors Norfolk Southern Railway Company:\nWe have audited the consolidated financial statements of Norfolk Southern Railway Company and subsidiaries (a majority-owned subsidiary of Norfolk Southern Corporation) as listed in Item 8. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedules as listed in Item 14(a)1. These consolidated financial statements and consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norfolk Southern Railway Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1, the Company changed its methods of accounting in 1993 by adopting the provisions of the Financial Accounting Standards Board's Statement 109, Accounting for Income Taxes; Statement 106, Employers' Accounting for Postretirement Benefits Other Than Pensions; and Statement 112, Employers' Accounting for Postemployment Benefits.\n\/s\/ KPMG Peat Marwick\nNorfolk, Virginia January 25, 1994, except as to Note 11, which is as of March 3, 1994\nEXHIBIT INDEX ------------- Electronic Submission Exhibit Number Description Page Number - ---------- -------------------------------------------- -----------\nSubsidiaries of Norfolk Southern Railway. 85","section_14":"","section_15":""}
{"filename":"92103_1993.txt","cik":"92103","year":"1993","section_1":"ITEM 1. BUSINESS\nSouthern California Edison Company (\"Edison\") was incorporated under California law in 1909. Edison is a public utility primarily engaged in the business of supplying electric energy to a 50,000 square-mile area of central and southern California, excluding the City of Los Angeles and certain other cities. This area includes some 800 cities and communities and a population of nearly 11 million people. As of December 31, 1993, Edison had 16,487 full-time employees. During 1993, 37% of Edison's total operating revenue was derived from commercial customers, 36% from residential customers, 13% from industrial customers, 8% from public authorities, 4% from agricultural and other customers and 2% from resale customers. Edison comprises the major portion of the assets and revenues of SCEcorp, its parent holding company.\nREGULATION\nEdison's retail operations are subject to regulation by the California Public Utilities Commission (\"CPUC\"). The CPUC has the authority to regulate, among other things, retail rates, issuances of securities and accounting and depreciation practices. Edison's resale operations are subject to regulation by the Federal Energy Regulatory Commission (\"FERC\"). The FERC has the authority to regulate resale rates as well as other matters, including transmission service pricing, accounting and depreciation practices and licensing of hydroelectric projects.\nEdison is subject to the jurisdiction of the Nuclear Regulatory Commission (\"NRC\") with respect to its nuclear power plants. NRC regulations govern the granting of licenses for the construction and operation of nuclear power plants and subject those power plants to continuing review and regulation.\nThe construction, planning and siting of Edison's power plants within California are subject to the jurisdiction of the California Energy Commission and the CPUC. Edison is subject to rules and regulations promulgated by the California Air Resources Board and local air pollution control districts with respect to the emission of pollutants into the atmosphere, the regulatory requirements of the California State Water Resources Control Board and regional boards with respect to the discharge of pollutants into waters of the state and the requirements of the California Department of Toxic Substances Control with respect to handling and disposal of hazardous materials and wastes. Edison is also subject to regulation by the U.S. Environmental Protection Agency (\"EPA\"), which administers certain federal statutes relating to environmental matters. Other federal, state and local laws and regulations relating to environmental protection, land use and water rights also impact Edison.\nThe California Coastal Commission has continuing jurisdiction over the coastal permit for San Onofre Nuclear Generating Station (\"San Onofre\") Units 2 and 3. Although the units are operating, the permit remains open. This jurisdiction may continue for several years because it involves oversight on mitigation measures arising from the permit.\nThe Department of Energy (\"DOE\") has regulatory authority over certain aspects of Edison's operations and business relating to energy conservation, solar energy development, power plant fuel use and disposal, coal conversion, public utility regulatory policy and natural gas pricing.\nRATE MATTERS\nCPUC Retail Ratemaking\nThe rates for electricity provided by Edison to its retail customers comprise several major components established by the CPUC to compensate Edison for basic business and operational costs, fuel and purchased power costs, and the costs of adding major new facilities.\nBasic business and operational costs are recovered through base rates, which are determined in general rate case proceedings held before the CPUC every three years. During a general rate case, the CPUC critically reviews Edison's operations and general costs to provide service (excluding energy costs and, in certain instances, major plant additions). The CPUC then determines the revenue requirement to cover those costs, including items such as depreciation, taxes, cost of capital, operation, maintenance, and administrative and general expenses. The revenue requirement is forecasted on the basis of a specified test year. Following the revenue requirement phase of a general rate case, Edison and the CPUC proceed to a rate phase which allocates revenue requirements and establishes rate levels for customers.\nBase rates may be adjusted in the years between general rate case years through an attrition year allowance. The attrition year allowance is intended to allow Edison to recover, without lengthy hearings, specific uncontrollable cost changes in its base rate revenue requirement and thereby preserve Edison's opportunity to earn its authorized rate of return in the years that are not general rate case test years.\nIn December 1993, Edison filed an application with the CPUC in which it proposed a performance-based ratemaking procedure for recovery of operation and maintenance (\"O&M\") expenses and capital-related costs. Such costs have traditionally been recovered through general rate cases, attrition proceedings, and cost of capital proceedings.\nEdison proposed that the CPUC authorize a base rate revenue indexing formula which would combine O&M and capital-related cost recovery. In addition, Edison proposed that the period between general rate cases be lengthened from three to six years. Cost of capital proceedings would occur only after significant changes in utility capital markets.\nEdison's fuel, purchased power and energy-related costs of providing electrical service are recovered through a balancing account mechanism called the Energy Cost Adjustment Clause (\"ECAC\"). Under the ECAC balancing account procedure, fuel, purchased power and energy-related revenues and costs are compared and the difference is recorded as either an undercollection or overcollection. The amount recorded in the balancing account is periodically amortized through rate changes which return overcollections to customers by reducing rates or collect undercollections from customers by increasing rates. The costs recorded in the ECAC balancing account are subject to review by the CPUC and allowed for rate recovery only to the extent they are found to be reasonable. Certain incentive provisions are included in the ECAC that can affect the amount of fuel and energy-related costs actually recovered. Edison is required to make an ECAC filing for each calendar year, and must also make a second filing for a mid-year adjustment if such filing would result in an ECAC rate change exceeding 5% of total annual revenue.\nFor Edison's interest in the three units of the Palo Verde Nuclear Generating Station (\"Palo Verde\"), the CPUC authorized a 10-year rate phase-in plan which deferred $200,000,000 of investment-related revenue\nduring the first four years of operations for each of the three units, commencing on their respective commercial operation dates. Revenue deferred for each unit under the plan for years one through four was $80,000,000, $60,000,000, $40,000,000 and $20,000,000, respectively. The deferrals and related interest are being recovered over the final six years of each unit's phase-in plan.\nThe CPUC has also adopted a nuclear unit incentive procedure which provides for a sharing of additional energy costs or savings between Edison and its ratepayers when operation of any of the units of San Onofre or Palo Verde is outside a specified target capacity factor (\"TCF\") range. For San Onofre Units 2 and 3, and Palo Verde Units 1, 2 and 3 the TCF range is 55% to 80% of their rated capacity.\nThe Electric Revenue Adjustment Mechanism (\"ERAM\") reflects the difference between the recorded level of base rate revenue and the authorized level of base rate revenue. This mechanism has been adopted by the CPUC primarily to minimize the effect on earnings of fluctuations in retail kilowatt-hour sales.\nGeneral Rate Case (\"GRC\")\nIn December 1991, the CPUC issued a decision on the revenue requirement phase of Edison's 1992 test year GRC application. The CPUC authorized a $72,000,000 or 1% increase in Edison's base rate revenues, effective January 20, 1992. The decision did not adopt Edison's request to capitalize, rather than expense, computer software development and research, development and demonstration (\"RD&D\") expenditures, but did allow Edison to file additional information regarding such capitalization.\nIn April 1992, Edison filed supplemental testimony supporting its request to capitalize application software development costs, and proposed to decrease its authorized level of base rate revenues (\"ALBRR\") by $53,000,000 in 1993 and 1994. Edison and the CPUC's Division of Ratepayer Advocates (\"DRA\") entered into a settlement agreement to allow rate recovery of capitalized software expenditures in which Edison agreed to an additional $32,000,000 base rate revenue decrease. The CPUC approved the settlement agreement in November 1992, and authorized a $48,900,000 decrease to Edison's ALBRR effective January 1, 1993. The related base rate revenue decrease was included in Edison's January 15, 1993, consolidated revenue change. The CPUC also authorized a $12,900,000 increase to Edison's ALBRR effective January 1, 1994. The related base rate revenue increase was included in Edison's January 24, 1994, consolidated revenue change.\nIn September 1992, Edison filed supplemental testimony supporting its request to capitalize RD&D expenditures. In the additional filing, Edison proposed to capitalize approximately $9,000,000 in RD&D project expenditures. The DRA's supplemental testimony alleged that Edison did not comply with a CPUC order regarding joint remote meter reading and recommended a $10,000,000 penalty for non-compliance. Additionally, the DRA proposed to disallow approximately $4,500,000 of capital costs associated with Edison's research on off-grid generation technology. The CPUC's decision is expected by the end of 1994.\nIn December 1992, the CPUC approved an ALBRR increase of $110,000,000, effective January 1, 1993, for the 1993 attrition year allowance. The related base rate revenue increase was included in Edison's January 15, 1993 consolidated revenue change. In April 1993, the CPUC modified its decision (pursuant to a petition by Edison), and approved an ALBRR increase of $10,400,000 effective April 28, 1993. The related base rate\nrevenue increase was included in Edison's January 24, 1994, consolidated revenue change.\nIn December 1993, the CPUC approved an ALBRR increase of $97,200,000 effective January 1, 1994, for: (1) the 1994 attrition year allowance; (2) increased federal income taxes pursuant to the Revenue Reconciliation Act of 1993; and, (3) reduction in Edison's California property tax liability resulting from a settlement agreement with the California State Board of Equalization.\nEach year, the CPUC reviews the components of the cost of capital for all the California energy utilities in a generic cost of capital proceeding. On December 3, 1993, the CPUC issued a final decision resulting in a $108,000,000 reduction to Edison's ALBRR effective January 1, 1994. The decision also resulted in a reduction of Edison's overall rate of return from 9.94% to 9.17%, a reduction in return on common equity from 11.80% to 11.00%, and an increase to Edison's common equity capital ratio from 46.00% to 47.25% effective January 1, 1994. The related base rate revenue decrease was included in Edison's January 24, 1994, consolidated revenue change.\nIn December 1993, Edison filed with the CPUC its 1995 GRC application. In its application, Edison requested an increase to the ALBRR of $117,000,000 above the expected year-end 1994 ALBRR level to become effective January 1, 1995. On March 14, 1994, the DRA issued a report which, based on Edison's preliminary review, recommended a $269,000,000 reduction to Edison's expected year-end 1994 authorized level of base rate revenue. Evidentiary hearings are expected to commence in April 1994, with a final CPUC decision anticipated in December 1994.\nIn January 1994, the CPUC approved an ALBRR increase of $8,800,000 effective January 24, 1994, for base rate recovery of the permanent component of Edison's fuel oil inventory. The related base rate revenue increase was included in Edison's January 24, 1994, consolidated revenue change.\nIn November 1993, the CPUC approved an ALBRR increase of: (1) $64,400,000 effective December 31, 1993; and (2) $63,100,000 effective January 1, 1994, to reflect cost recovery of employee post-retirement benefits other than pensions (\"PBOP\"). In addition, the CPUC approved an ALBRR reduction of $39,500,000 effective December 30, 1993, to reflect the removal of costs associated with Edison's 1992 PBOP contributions. The related base rate revenue reduction associated with the PBOP ALBRR changes was included in Edison's January 24, 1994, consolidated revenue change, less $16,000,000 of rate recovery deferred until 1995.\nEnergy Cost Adjustment Clause\nIn January 1992, the DRA issued a report on the reasonableness of Edison's non-standard, non-affiliate qualifying facilities (\"QF\") power purchase contracts included in Edison's 1989 and 1990 annual ECAC applications. With respect to both ECAC periods, the DRA asserted that Edison had incorrectly calculated firm capacity payments and bonus capacity payments to QFs by including certain energy deliveries which the DRA contended should be excluded or \"truncated\" from the calculation. The DRA recommended disallowances of $2,500,000, for the 1989 record period and $4,800,000 for the 1990 record period. On April 26, 1993, the DRA withdrew its January 1992 testimony pursuant to an Edison-DRA agreement to jointly petition the CPUC for clarification of the CPUC's intent regarding truncation and two other QF contract administration issues. Edison and the DRA filed their joint petition on April 23, 1993. On November 2, 1993, the CPUC voted to dismiss the joint petition on the\nbasis that the issues presented were complex and could be developed more appropriately in an ECAC proceeding or through direct negotiations among the affected parties. Pursuant to the Edison-DRA agreement, a dismissal on this basis permits the DRA to renew its challenge to Edison's truncation practice beginning with the 1991 ECAC record period and thereafter in each subsequent ECAC record period. To date, the DRA has not recommended further disallowances attributable to the truncation issue.\nIn March 1992, Edison and the DRA settled disputes relating to Edison's power purchases from the 13 non- utility generation facilities partially owned by Mission Energy. Pursuant to the settlements, Edison agreed not to enter into new power-purchase contracts with Mission Energy and to a one-time disallowance. On March 10, 1993, the CPUC issued a decision approving the settlement and authorizing a ratepayer refund of $250,000,000 over a two-year period beginning January 1, 1994. The decision also ordered an immediate adjustment to Edison's ECAC balancing account with interest accruing until the rate reduction takes effect. The $250,000,000 disallowance is fully reflected in Edison's financial statements.\nIn October 1993, the DRA issued its report on QF reasonableness issues for the ECAC record period April 1990 through March 1991. In its report, the DRA recommended that the CPUC disallow $1,574,000 in power purchase expenses incurred as a result of purchases during the record period under a QF contract with Mojave Cogeneration Company, a nonutility generator. In its report, the DRA also alleged that in 1990 and 1991 Edison imprudently renegotiated Mojave Cogeneration Company's contract with Edison, resulting in higher ratepayer costs. The DRA further alleged that ratepayers may be harmed in the amount of $31,600,000 (present value) over the contract's twenty-year life. The DRA found the execution of five other QF contracts to be reasonable. Hearings will likely be held no earlier than the second half of 1994.\nThe DRA issued four reports addressing Edison's non-QF reasonableness showing for the April 1, 1991 through March 31, 1992 period. The DRA recommended: 1) a disallowance of $2,205,000 of replacement power costs associated with extended outage duration or reduced power production at Edison's nuclear units, which was allegedly caused by human error; and 2) a reduction of $1,203,000 to Edison's proposed TCF reward for San Onofre Unit 3, based on excluding generation above the unit capacity rating. A January 25, 1994 ALJ proposed decision found three nuclear plant outages unreasonable, resulting in a potential $1,600,000 disallowance, but rejected the DRA's recommendations for reducing Edison's TCF reward. Edison filed comments on the proposed decision on February 14, 1994. The final CPUC decision is expected in March 1994.\nOn May 28, 1993, Edison requested a $152,000,000 annual rate increase for service beginning January 1, 1994, for changes to the Energy Cost Adjustment Billing Factor, Electric Revenue Adjustment Balancing Accounts (\"ERABF\"), Low Income Surcharge and base rate levels. Edison also made a rate stabilization proposal which defers recovery of approximately $200,000,000 of 1994 fuel and purchased-power expenses until 1995. In July 1993, Edison updated its ECAC request to a $181,000,000 increase. The DRA proposed a $105,000,000 increase. In October 1993, Edison and the DRA stipulated to a proposed $164,688,000 ECAC revenue increase subject to adjustment for incorporating Edison's forecast December 31, 1993 balance in the ECAC, Low Income Ratepayer Assistance, and ERABF to reflect more recent recorded data. On January 19, 1994, the CPUC issued its decision which adopted a revenue increase of $274,600,000. When this revenue change is combined with other revenue changes which occurred on\nor before January 1, 1994, the total combined revenue change is $232,101,000.\nOn May 28, 1993, Edison filed the non-QF portion of its Reasonableness of Operations Report, which included power purchases and exchanges and the operation of its hydro, coal, gas and nuclear resources for the period April 1, 1992 through March 31, 1993. In February 1994, the DRA recommended: (1) a $7,200,000 disallowance relating to fuel oil inventory management; and (2) a $5,000,000 disallowance for transmission loss revenues. Hearings on this matter are scheduled for October 1994.\nEdison filed its QF Reasonableness of Operations Report on September 1, 1993. It is presently unknown when the DRA will file testimony in the QF reasonableness phase.\nPalo Verde Outage Review\nIn March 1989, Palo Verde Units 1 and 3 experienced automatic shutdowns. Since the resultant outages overlapped previously scheduled refueling outages, normal refueling, maintenance, inspection, surveillance, modification and testing activities were conducted at the units, as well as modifications to the plants required by the NRC. Unit 3 was restored to service on December 30, 1989, and Unit 1 was restored to service on July 5, 1990.\nIn December 1989, the CPUC instituted an investigation into the outages pursuant to the California Public Utilities Code (\"Code\"). The Code requires the CPUC to institute an investigation when any portion of a utility's generating facilities has been out of service for nine consecutive months. The CPUC order required that the subsequent collection of rates associated with Palo Verde Units 1 and 3 be subject to refund pending review of the outages. In November 1991, the DRA issued a report recommending disallowances totaling more than $160,000,000 including a $63,000,000 disallowance for revenue collected during the outages (including interest).\nIn September 1993, Edison and the DRA agreed to settle these disputes for $38,000,000 (including $29,000,000 for replacement power costs, $2,000,000 for capital projects and approximately $7,000,000 for interest), subject to CPUC approval. The settlement resolves all issues related to the 1989-1990 outages at Palo Verde. The effect of the settlement has been fully reflected in the financial statements. Edison expects a CPUC decision regarding the settlement in mid-1994.\nMohave Order Instituting Investigation (\"OII\")\nIn April 1986, the CPUC began investigating the 1985 rupture of a high pressure steam pipe at the Mohave Generating Station (\"Mohave\"). Edison is the plant operator and 56% owner. The CPUC's OII reviewed Edison's share of repair costs and replacement fuel and energy related costs associated with the outage. Edison incurred costs of approximately $90,000,000 (including interest) to repair damage from the accident and provide replacement power during the six-month outage. This total is net of Edison's recovery of expenses from the settlement of lawsuits with contractors and insurance.\nIn May 1991, the DRA and its consultant issued reports alleging that Edison imprudently operated the Mohave plant and therefore contributed to the accident. As a result, the DRA recommended that all expenses incurred because of the accident be disallowed in rates. The DRA did not quantify\nits proposed disallowance. Edison believes that metallurgical and physical characteristics of a weld reduced the otherwise expected pipe life to the point of failure after 15 years of service. Edison filed testimony contesting the allegations in May 1992, in December 1992, and on March 1, 1993. In March 1994, the CPUC issued a decision finding that Edison acted unreasonably in failing to implement an inspection program. The CPUC decision ordered a second phase of this proceeding to quantify the disallowance.\nHigh Voltage Direct Current Expansion Project (\"HVDCEP\")\nThe HVDCEP began operation in 1989. In October 1989, Edison filed a report with the CPUC requesting recovery of $72,600,000 in project costs. Subsequently, Edison and the DRA agreed on an accounting adjustment of $150,000, and a settlement agreement was filed. A February 3, 1993 CPUC decision upheld the settlement agreement allowing Edison recovery in rates of approximately $72,450,000. In its 1995 GRC, Edison is requesting rate recovery of an additional $7,000,000 associated with completion items and other HVDCEP related expenditures. The total amount of rate recovery for the HVDCEP that Edison will be allowed remains subject to further adjustment pending a final determination of the cost-effectiveness of the project in comparison with the power exchange agreement between Edison and the Los Angeles Department of Water and Power.\nFERC Resale Ratemaking\nEdison sells electricity to public power utilities (the cities of Anaheim, Azusa, Banning, Colton, Riverside and Vernon), Southern California Water Company and Arizona Public Service Company (\"APS\") under rates subject to FERC jurisdiction. In accordance with FERC procedures, resale rates are subject to refund with interest if subsequently disallowed. Edison believes any refunds from pending rate proceedings, would not materially affect its results of operations or financial position.\nFUEL SUPPLY\nFuel and purchased-power costs amounted to approximately $3.29 billion in 1993, a 7% increase over 1992. Sources of energy and unit costs of fuel for 1989 through 1993 were as follows:\n_______________ (1) British Thermal Unit (\"BTU\") is the standard unit of measure for the heat content of fuels. One BTU is the amount of heat required to raise the temperature of one pound of water, at 39.1 degrees Fahrenheit, by one degree Fahrenheit.\n(2) There are no fuel costs associated with these categories.\n*Indicates a source of less than 1%\nAverage fuel costs, expressed in cents per kilowatt-hour, for the year ended December 31, 1993, were: oil, 7.996 cents; natural gas, 2.930 cents; nuclear, 0.537 cents; and coal, 1.226 cents.\nNatural Gas Supply\nTwelve of Edison's major steam electric generating units are designed to burn oil or natural gas as a primary boiler fuel. In 1990, Edison adopted an all-gas strategy to comply with air quality goals by eliminating burning oil in all but very extreme conditions. In August 1991, the CPUC adopted regulations which made Edison fully responsible for all gas procurement activities previously performed by local distribution companies for natural gas. To implement its all-gas strategy, Edison acquired a balanced portfolio of gas supply and transportation arrangements. Traditionally, natural gas needs in southern California were met from gas production in the southwest region of the country. To diversify its gas supply, Edison entered into four 15-year natural gas supply agreements with major producers in western Canada. These contracts, totaling 200,000,000 cubic feet per day, have market-sensitive pricing arrangements. This represents about 40% of Edison's current average annual supply needs. The rest of Edison's gas supply is acquired under short-term contracts from West Texas, New Mexico, and the Rocky Mountain region.\nFirm transportation arrangements provide the necessary long-term reliability for supply deliverability. To transport Canadian supplies, Edison contracted for 200,000,000 cubic feet per day of firm transportation arrangements on the Pacific Gas Transmission and Pacific Gas & Electric Expansion Project connecting southern California to the low-cost gas producing regions of western Canada. Edison has a 30-year commitment to this project, construction of which was completed in late 1993. In addition, Edison has a 15-year commitment to 200,000,000 cubic feet per day of firm transportation rights on El Paso Natural Gas' pipeline to transport Southwest U.S. gas supplies.\nNuclear Fuel Supply\nEdison has contractual arrangements covering 100% of the projected nuclear fuel cycle requirements for San Onofre through the years indicated below:\n_______________ (1) Assumes the San Onofre participants meet their supply obligations in a timely manner.\n(2) Assumes full utilization of expanded on-site storage capacity and normal operation of the units, including interpool transfers and maintaining full-core reserve. To supplement existing spent fuel storage, a contingency plan is being developed to construct additional on-site storage capacity with initial operation scheduled for no later than 2002. The Nuclear Waste Policy Act of 1982 requires that the DOE provide for the disposal of utility spent nuclear fuel beginning in 1998. The DOE has stated that it is unlikely that it will be able to start accepting spent nuclear fuel at its permanent repository before 2010.\nParticipants in Palo Verde have purchased uranium concentrates sufficient to meet projected requirements through 1997. Independent of arrangements made by other participants, Edison will furnish its share of uranium concentrates requirements through at least 1995 from existing contracts. Contracts to provide conversion services cover requirements through 1994. Enrichment and fabrication contracts will meet Palo Verde requirements through 1995 and 1997, respectively.\nPalo Verde on-site expanded spent fuel storage capacity will accommodate needs through 2005 for Units 1 and 2 and 2006 for Unit 3, while maintaining full-core reserve.\nENVIRONMENTAL MATTERS\nLegislative and regulatory activities in the areas of air and water pollution, waste management, hazardous chemical use, noise abatement, land use, aesthetics and nuclear control continue to result in the imposition of numerous restrictions on Edison's operation of existing facilities, on the timing, cost, location, design, construction and operation by Edison of new facilities required to meet its future load requirements, and on the cost of mitigating the effect of past operations on the environment.\nThese activities substantially affect future planning and will continue to require modifications of Edison's existing facilities and operating procedures. Edison is unable to predict the extent to which additional regulations may affect its operations and capital expenditure requirements.\nThe Clean Air Act provides the statutory framework to implement a program for achieving national ambient air quality standards and provides for maintenance of air quality in areas exceeding such standards. The Clean Air Act was amended in 1990, giving the South Coast Air Quality Management District (\"SCAQMD\") 20 years to achieve all the federal air quality standards. The SCAQMD's Air Quality Management Plan (\"AQMP\"), adopted in 1991, demonstrates a commitment to attain federal air quality standards within 20 years. Consistent with the requirements of the AQMP and the Clean Air Act Amendments of 1990 (\"CAAA\"), the SCAQMD adopted rules to reduce emissions of oxides of nitrogen (\"NOx\") from combustion turbines, internal combustion engines, industrial coolers and utility boilers. On October 15, 1993, the SCAQMD adopted the Regional Clean Air Incentives Market (\"RECLAIM\") which replaces most of the previous rule requirements with a market mechanism for NOx emission trading (trading credits). RECLAIM will, however, still require Edison to reduce NOx emissions through retrofit or purchase of trading credits on all basin generation by over 86% by 2003. In Ventura County, a NOx rule was adopted requiring more than an 88% NOx reduction by June 1996 at all utility boilers. Edison's expected total cost to meet these requirements is approximately $330,000,000 of capital expenditures.\nThe CAAA do not require any significant additional emissions control expenditures that are identifiable at this time. The amendments call for a five-year study of the sources and causes of regional haze in the southwestern U.S. The extent to which this study may require sulfur dioxide emissions reductions at the Mohave plant is not known. The acid rain provisions of the amended Clean Air Act also put an annual limit on sulfur dioxide emissions allowed from power plants. Edison will receive more sulfur dioxide allowances than it requires for its projected operations. The CAAA also require the EPA to carry out a three-year study of risk to public health from emissions of toxic air contaminants from power plants, and to regulate such emissions only if required. As a result of a petition by Mohave County in the State of Arizona, the Nevada Department of Environmental Protection (\"NDEP\") studied the impact of the plume from the Mohave plant on the Mohave area air quality. The regulatory outcome requires Edison to meet a new lower opacity limit in early 1994. The NDEP will review the opacity limit again in 1995 in conjunction with an ongoing tracer study being conducted by the EPA and evaluate potential impacts on visibility in the Grand Canyon from sulfur dioxide emissions. Until more definitive information on tracer study results are available, Edison expects to meet all the present regulations through improved operations at the plant.\nRegulations under the Clean Water Act require permits for the discharge of certain pollutants into waters of the United States. Under this act, the EPA issues effluent limitation guidelines, pretreatment standards and new source performance standards for the control of certain pollutants. Individual states may impose even more stringent limitations. In order to comply with guidelines and standards applicable to steam electric power plants, Edison incurs additional expenses and capital expenditures. Edison presently has discharge permits for all applicable facilities.\nThe Safe Drinking Water and Toxic Enforcement Act prohibits the exposure to individuals of chemicals known to the State of California to cause cancer or reproductive harm and the discharge of such listed chemicals into potential sources of drinking water. Additional chemicals\nare continuously being put on the state's list, requiring constant monitoring by Edison.\nThe State of California has adopted a policy discouraging the use of fresh water for plant cooling purposes at inland locations. Such a policy, when taken in conjunction with existing federal and state water quality regulations and coastal zone land use restrictions, could substantially increase the difficulty of siting new generating plants anywhere in California.\nEdison has identified 42 sites for which it is, or may be, responsible for remediation under environmental laws. Edison is participating in investigations and cleanups at a number of these sites and has recorded a $60,000,000 liability for its estimated minimum costs to clean up several sites. Additional costs may be incurred as progress is made in determining the magnitude of required remedial actions, as Edison's share of these costs in proportion to other responsible parties is determined and as additional investigations and cleanups are performed.\nThe CPUC currently allows rate recovery of environmental-cleanup costs, subject to reasonableness reviews. Edison filed for a reasonableness review of costs incurred through 1991 at two hazardous substance sites. Hearings have been delayed due to a 1992 CPUC decision involving another California utility, which concluded that the current procedure may not be appropriate for these costs and requested interested parties to recommend alternatives. In November 1993, the major California utilities, the DRA and others filed a collaborative report recommending an incentive mechanism, which would require shareholders to fund 10% of cleanup costs. Shareholders would have the opportunity to recover these costs through insurance. Accordingly, Edison has recorded a regulatory asset which represents 90% of the estimated cleanup costs for sites covered by this proposed mechanism. The remaining sites' cleanup costs are expected to be immaterial and would be recovered through base rates. If approved by the CPUC, Edison would be allowed to recover 90% of cleanup costs incurred to date under the reasonableness review procedure ($11,000,000). A March 11, 1994 proposed decision issued by a CPUC ALJ accepted the collaborative report's recommendation. A final CPUC decision is expected in early 1994.\nTwenty of the 42 sites identified are former manufactured gas plant sites. Edison's cleanup responsibility for these sites is based on Edison's, or a predecessor company's, ownership or operation of the plants. These gas plants were operated for the production of gas prior to the widespread availability of natural gas. The EPA and the California Department of Toxic Substances Control have determined that specified constituents of the gas plant by-products are hazardous substances or hazardous wastes, and may require removal or other remedial action.\nThe Resource Conservation and Recovery Act (\"RCRA\") provides the statutory authority for the EPA to implement a regulatory program for the safe treatment, recycling, storage and disposal of solid and hazardous wastes. There is an unresolved issue regarding the degree to which coal wastes should be regulated under RCRA. Increased regulation may result in an increase in expenses related to the operation of Mohave.\nThe Toxic Substance Control Act and accompanying regulations govern the manufacturing, processing, distribution in commerce, use and disposal of polychlorinated biphenyls, a toxic substance used in certain electrical equipment (\"PCB waste\"). Current costs for disposal of PCB waste are immaterial.\nEdison's capitalized expenditures for environmental protection for the years 1969 through 1993 and its currently estimated capital expenditures for such purpose for the years 1994 through 1998 are as follows:\nThese estimates include budgeted and forecasted plant expenditures responsive to currently effective legislation. Projected capital expenditures for environmental protection are subject to continuous review and periodic revisions because of escalation in engineering and construction costs, additions and deletions of planned facilities, changes in technology, evolving environmental regulatory requirements and other factors beyond Edison's control. Edison believes that costs incurred for these environmental purposes will be recognized by the CPUC and the FERC as reasonable and necessary costs of service for rate recovery purposes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nEXISTING GENERATING FACILITIES\nEdison owns and operates 12 oil- and gas-fueled electric generating plants, one diesel-fueled generating plant, 38 hydroelectric plants and an undivided 75.05% interest (1,614 MW net) in Units 2 and 3 at San Onofre. These plants are located in central and southern California. Palo Verde (15.8% Edison-owned, 579 MW net) is located near Phoenix, Arizona. Palo Verde Units 1, 2 and 3 started commercial operation on February 1, 1986, September 19, 1986, and January 20, 1988, respectively. Edison owns a 48% undivided interest (754 MW) in Units 4 and 5 at the Four Corners Generating Station (\"Four Corners Project\"), a coal-fueled steam electric generating plant in New Mexico. Palo Verde and the Four Corners Project are operated by other utilities. Edison operates and owns a 56% undivided interest (885 MW) in Mohave, which consists of two coal-fueled steam electric generating units in Clark County, Nevada. Edison receives an entitlement of 277 MW from the DOE's Hoover Dam Hydroelectric Project. At year-end 1993, the existing Edison-owned generating capacity (summer effective rating) was comprised of approximately 67% gas, 14% nuclear, 11% coal and 8% hydroelectric.\nSan Onofre, the Four Corners Project, certain of Edison's substations and portions of its transmission, distribution and communication systems are located on lands of the United States or others under (with minor exceptions) licenses, permits, easements or leases or on public streets or highways pursuant to franchises. Certain of such documents obligate Edison, under specified circumstances and at its expense, to relocate transmission, distribution and communication facilities located on lands owned or controlled by federal, state or local governments.\nWith certain exceptions, major and certain minor hydroelectric projects with related reservoirs, currently having an effective operating capacity of 1,154 MW and located in whole or in part on lands of the United States, are owned and operated by Edison under governmental licenses which expire\nat various times between 1994 and 2022. Such licenses impose numerous restrictions and obligations on Edison, including the right of the United States to acquire the project upon payment of specified compensation. When existing licenses expire, FERC has the authority to issue new licenses to third parties, but only if their license application is superior to Edison's and then only upon payment of specified compensation to Edison. Any new licenses issued to Edison are expected to be issued under terms and conditions less favorable than those of the expired licenses. Edison's applications for the relicensing of certain hydroelectric projects referred to above with an aggregate effective operating capacity of 89.0 MW are pending. Annual licenses issued for all Edison projects, whose licenses have expired and are undergoing relicensing, will be renewed until the new licenses are issued.\nIn 1993, Edison's peak demand was 16,475 MW, set on September 9, 1993. The 1993 peak was 1,938 MW less than Edison's record peak demand of 18,413 MW that occurred on August 17, 1992. Total area system operating capacity of 20,606 MW was available to Edison at the time of the 1993 record peak.\nSubstantially all of Edison's properties are subject to the lien of a trust indenture securing First and Refunding Mortgage Bonds (\"Trust Indenture\"), of which approximately $3.5 billion principal amount was outstanding at December 31, 1993. Such lien and Edison's title to its properties are subject to the terms of franchises, licenses, easements, leases, permits, contracts and other instruments under which properties are held or operated, certain statutes and governmental regulations, liens for taxes and assessments, and liens of the trustees under the Trust Indenture. In addition, such lien and Edison's title to its properties are subject to certain other liens, prior rights and other encumbrances, none of which, with minor or unsubstantial exceptions, affects Edison's right to use such properties in its business, unless the matters with respect to Edison's interest in the Four Corners Project and the related easement and lease referred to below may be so considered.\nEdison's rights in the Four Corners Project, which is located on land of The Navajo Tribe of Indians under an easement from the United States and a lease from The Navajo Tribe, may be subject to possible defects. These defects include possible conflicting grants or encumbrances not ascertainable because of the absence of, or inadequacies in, the applicable recording law and the record systems of the Bureau of Indian Affairs and The Navajo Tribe, the possible inability of Edison to resort to legal process to enforce its rights against The Navajo Tribe without Congressional consent, possible impairment or termination under certain circumstances of the easement and lease by The Navajo Tribe, Congress or the Secretary of the Interior and the possible invalidity of the Trust Indenture lien against Edison's interest in the easement, lease and improvements on the Four Corners Project.\nEL PASO ELECTRIC COMPANY (\"EL PASO\") BANKRUPTCY\nEl Paso owns and leases a combined 15.8% interest in Palo Verde and owns a 7% interest in Units 4 and 5 of the Four Corners Project. In January 1992, El Paso filed a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Western District of Texas. Pursuant to an agreement among the Palo Verde participants and an agreement among the participants in Four Corners Units 4 and 5, each participant is required to fund its proportionate share of operation and maintenance, capital and fuel costs of Palo Verde and Four Corners Units 4 and 5, respectively. The participation agreements provide that if a participant fails to meet its payment obligation, each non-defaulting participant must pay its proportionate share of the payments owed by the defaulting participant.\nIn February 1992, the bankruptcy court approved a stipulation between El Paso and APS, as the operating agent of Palo Verde, pursuant to which El Paso agreed to pay its proportionate share of all Palo Verde invoices delivered to El Paso after February 6, 1992. El Paso agreed to make these payments until such time, if ever, the bankruptcy court orders El Paso's rejection of the participation agreement governing the relations among the Palo Verde participants. The stipulation also specifies that approximately $9,200,000 of El Paso's Palo Verde payment obligations invoiced prior to February 7, 1992, are to be considered \"pre- petition\" general unsecured claims of the other Palo Verde participants.\nOn August 27, 1993, El Paso filed with the bankruptcy court an Amended Plan of Reorganization and Disclosure Statement (\"Amended Plan\"). The Amended Plan, which is subject to numerous conditions, proposes a reorganization pursuant to which El Paso will become a wholly-owned subsidiary of Central and South West Corporation. The Amended Plan also proposes, among other things, (i) rejection of the El Paso leases and reacquisition by El Paso of the Palo Verde interests represented by the leases, and (ii) El Paso's assumption of the Four Corners Operating Agreement and the Arizona Nuclear Power Project Participation Agreement. On November 19, 1993, the bankruptcy court approved a Cure and Assumption Agreement among El Paso and the Palo Verde Participants, in which El Paso shall (i) assume the Participation Agreement on the date the Amended Plan becomes effective, and (ii) cure its pre-petition default on the date the court approves the Order Confirming El Paso's Amended Plan. On December 8, 1993, the bankruptcy court confirmed El Paso's Amended Plan. Effectiveness of the Amended Plan is still subject to approval by numerous state and federal agencies. El Paso estimates that it will take about 18 months to obtain all necessary regulatory approvals.\nCONSTRUCTION PROGRAM AND CAPITAL EXPENDITURES\nIn April 1992, the CPUC decided how Edison and other California utilities will meet their resource needs through 2002. The CPUC ruled that Edison must obtain 624 MW of new generation through competitive bidding. The decision required that 175 MW be reserved for renewables, such as wind, hydro and geothermal. The competitive bid solicitation was issued in August 1993 and suspended in December 1993 due to the discovery of a bidding anomaly that raised prices above those allowed by the rules of the solicitation. After the suspension, Edison requested the solicitation be cancelled because current forecasts show that Edison has no need for additional generating capacity until at least 2005.\nFrom the solicitation results, Edison has estimated that the cost of these resources would be approximately $530,000,000 (present value in 1997 dollars). However, two events have occurred that should reduce Edison's cost exposure resulting from power purchases under this CPUC mandated process. First, on March 15, 1994, Edison and Kenetech Corporation, a potential winning bidder in Edison's solicitation, signed a memorandum of understanding for a wind resource power purchase. Contingent upon CPUC approval, Kenetech, under this proposed agreement, will provide lower cost resources than those potentially awarded through Edison's solicitation. Second, on March 16, 1994, the CPUC issued an interim decision that reduces Edison's solicitation by 25% and gives Edison authority to eliminate the added costs from the bidding anomaly. Although Edison will likely continue to request cancellation of the competitive solicitation, these two events reduce Edison's exposure. The exact amount of this reduction cannot be estimated until the methodology the CPUC intends for implementation of these changes is known.\nCash required by Edison for its capital expenditures totaled $1,040,000,000 in 1993, $787,000,000 in 1992 and $964,000,000 in 1991. Construction expenditures for the 1994-1998 period are estimated as follows:\nEdison's construction program and related expenditures are continuously reviewed and periodically revised because of changes in estimated system load growth, rates of inflation, receipt of adequate and timely rate relief, the availability and timing of environmental, siting and other regulatory approvals, the scope of modifications required by regulatory agencies, the availability and costs of external sources of capital, the development of new technology and other factors beyond Edison's control.\nSince the completion of San Onofre Units 2 and 3 and Palo Verde Units 1, 2 and 3, construction work in progress has been significantly reduced. The reduction in construction work in progress caused allowance for funds used during construction (\"AFUDC\"), which does not represent current cash income, to decline accordingly. Pre-tax AFUDC represented 5.7% of earnings for 1993.\nIn addition to cash required for construction expenditures for the next five years as discussed above, $1.3 billion is needed to meet requirements for long-term debt maturities, and sinking fund redemption requirements. The majority of these capital requirements are expected to be met by internally generated sources.\nEdison's estimates of cash available for operations for the five years through 1998 assume, among other things, the receipt of adequate and timely rate relief and the realization of its assumptions regarding cost increases, including the cost of capital. Edison's estimates and underlying assumptions are subject to continuous review and periodic revision.\nThe timing, type and amount of all additional long-term financing are also influenced by market conditions, rate relief and other factors, including limitations imposed by Edison's Articles of Incorporation and Trust Indenture.\nNUCLEAR POWER MATTERS\nAlthough higher energy costs will be incurred for replacement generation during any periods the San Onofre and Palo Verde Units are not in operation, substantially all such costs will be included in future ECAC filings. Edison cannot predict what other effects, if any, legislative or regulatory actions may have upon it or upon the future operation of the San Onofre or Palo Verde Units or the extent of any additional costs it may incur as a result thereof, except for those that follow.\nSan Onofre Unit 1\nOn November 30, 1992, Edison discontinued operation of San Onofre Unit 1. The CPUC approved an agreement between Edison and the DRA which allows Edison recovery of its investment of approximately $350,000,000 (after deferred taxes), including an 8.98% rate of return, by August 1996.\nThe agreement does not affect Unit 1's decommissioning, scheduled to start in 2013. The estimated current-dollar decommissioning costs for Unit 1 have been recorded as a liability.\nSan Onofre Units 2 and 3\nIn 1974, the California Coastal Commission, as a condition of the San Onofre Units 2 and 3 coastal permit, established a three-member Marine Review Committee (\"MRC\") to assess the marine environmental effects caused by the Units. In August 1989, the MRC issued its final report which alleged, in part, that San Onofre Units 2 and 3 caused adverse effects to several species of marine life and to the environment.\nBased on the MRC findings, the Coastal Commission in 1991 revised the coastal permit for Units 2 and 3 and required Edison to restore 150 acres of degraded wetlands, construct a 300-acre artificial kelp reef, and install fish behavioral barriers inside the Units' cooling water intake structure. Edison is currently in the process of planning and designing these projects, all of which must receive the approval of the Coastal Commission and state and federal resource and regulatory agencies. Current estimates place Edison's share of these capital costs at about $83,000,000 which is expected to be spent over the next 10 to 12 years.\nPalo Verde Nuclear Generating Station\nOn March 14, 1993, APS, as operating agent, manually shut down Palo Verde Unit 2 as a result of a steam generator tube leak. Unit 2 remained shut down and began its scheduled refueling outage on March 19, 1993.\nAn extensive inspection of the Palo Verde Unit 2 steam generators was performed prior to the unit's return to service on September 1, 1993. APS determined that intergranular attack\/intergranular stress corrosion cracking was a major contributor to the tube leak. APS is continuing its evaluation of the effects of possible steam generator tube degradation in all three units (six steam generators) and has instituted several avenues of study and corrective action.\nPalo Verde Units 1, 2, and 3 will be operated at reduced power (85%) until the investigation and other associated activities are completed. APS expects to be able to return the units to full power after implementing corrective action.\nNuclear Facility Decommissioning\nEdison's share of costs to decommission nuclear generation facilities is estimated to be $225,500,000 for San Onofre Unit 1; $280,900,000 for San Onofre Unit 2; $365,400,000 for San Onofre Unit 3; $50,200,000 for Palo Verde Unit 1; $49,800,000 for Palo Verde Unit 2; and $55,400,000 for Palo Verde Unit 3. These costs are all in 1993 dollars.\nEdison is currently collecting $104,255,000 annually in rates for its share of decommissioning costs for San Onofre Units 1, 2 and 3 and Palo Verde Units 1, 2 and 3. As of December 31, 1993, Edison's decommissioning trust funds totaled approximately $853,000,000 (market value).\nIn accordance with the Energy Policy Act of 1992, Edison's recorded liability at December 31, 1993, of $72,300,000 represents its share of the estimated costs to decommission three federal nuclear enrichment facilities. This cost is based on San Onofre's and Palo Verde's past purchases of enrichment services and will be paid over 15 years. These costs are expected to be recovered through the ECAC procedure and from participants.\nNuclear Facility Depreciation\nTo reduce Edison nuclear facilities' capital cost effect on future customer rates, Edison has filed for a $75,000,000 per year accelerated recovery of its nuclear investments. To offset the increased cost recovery, Edison proposes to lengthen its recovery period for transmission and distribution assets. This proposal would have no significant effect on customer rates. The CPUC held hearings in October 1993 and Edison expects a decision in mid-1994.\nNuclear Insurance\nEdison carries the maximum insurance coverage reasonably available to protect against losses from damage to its nuclear units and to provide some of its replacement energy costs in the unlikely event of an accident at any of its nuclear units. A description of this insurance is included in Note 10 of \"Notes to Consolidated Financial Statements\" incorporated herein. Although Edison believes an accident at its nuclear units is extremely unlikely, in the event of an accident, regardless of fault, Edison's insurance coverage might be inadequate to cover the losses to Edison. In addition, such an accident could result in NRC action to suspend operation of the damaged unit. Further, the NRC could suspend operation at Edison's undamaged nuclear units and the CPUC and FERC could deny rate recovery of related costs. Such an accident, therefore, could materially and adversely affect the operations and earnings of Edison.\nNUCLEAR WASTE POLICY ACT\nUnder the Nuclear Waste Policy Act of 1982, Edison, acting as agent for the San Onofre participants, has entered into a contract with the DOE for disposal of spent nuclear fuel for San Onofre Units 1, 2 and 3. Under the terms of the contract, Edison is required to pay a quarterly fee of one mill per kilowatt hour to the DOE for net nuclear power generated and sold on and after April 7, 1983. During 1992, DOE implemented a refund process for overpayments to the Nuclear Waste Fund through credits against future quarterly payments.\nFor generation prior to April 7, 1983, the contract required payment of a one-time fee equivalent to one mill per kilowatt hour, plus accrued interest. The obligation for this one-time fee was being discharged by equal quarterly payments. In October 1992 and 1993, DOE credits arising from overpayments to the Nuclear Waste Fund were also applied to this obligation. In October 1993, this obligation was paid in full. Expenses associated with the disposal of spent nuclear fuel are recovered through the ECAC procedure and from participants.\nCOMPETITIVE ENVIRONMENT\nUnder various acts of Congress, federal power projects have been constructed in California and neighboring states. Municipally owned utilities, cooperative utilities and other public bodies have certain preferences over investor-owned utilities in the purchase of electric power provided by federally funded power projects and, in addition, have certain preferences over investor-owned utilities in connection with the\nacquisition of licenses to build and\/or operate hydroelectric power plants. Any energy which is or may be generated at these projects and transmitted for the account of such other utilities and public bodies over present or future government or utility-owned lines into the territory or markets served by Edison would result in a loss of sales by Edison.\nUnder the laws of California, utility districts may include incorporated as well as unincorporated territory. Such districts, as well as municipalities, have the right to construct, purchase or condemn and operate electric facilities. In addition, when a city owning an electric system annexes adjacent unincorporated territory which Edison has previously served, Edison may experience a loss of customers.\nEdison's construction permits for San Onofre Units 2 and 3 contain certain conditions which require Edison (i) on timely notice, to permit privately or publicly owned utilities, including Edison's resale customers within or adjacent to Edison's service area, to participate on mutually agreeable terms in future nuclear units initiated by Edison, and (ii) to interconnect and coordinate reserves with, furnish emergency service to, sell bulk power to and purchase bulk power from, and provide certain transmission services for such utilities. Edison has also entered into agreements with certain of its resale customers which contemplate their possible participation in jointly owned generating projects initiated by Edison, and the integration of power sources acquired by each such customer, including the dispatching, reserve sharing, partial power-supply requirements and transmission service required in connection with such integrated operations. Pursuant to these agreements, two resale customers exercised an option to participate in Edison's ownership entitlement in San Onofre Units 2 and 3. Effective November 1977, Edison sold an undivided 3.45% interest in San Onofre Units 2 and 3 to these two resale customers for approximately $90,000,000. Effective September 1981, a further 1.5% interest in Units 2 and 3 was sold to one of these resale customers for approximately $50,000,000. In addition, since 1986, six of Edison's resale customers have acquired ownership interests in other generating sources and made purchases from other utilities in such amounts as to decrease Edison's revenues from resale cities from 4.4% to 1.6% of sales. This revenue loss has not had a substantial effect on Edison's business and opportunities.\nThe Public Utility Regulatory Policies Act of 1978 (\"PURPA\") has fostered the entry of nonutility companies into the electric generation business. Under PURPA, nonutility power producers are allowed to construct QFs for the production of electricity from certain alternative or renewable energy resources, and utilities are required to purchase the electrical output of these QFs at prices set pursuant to state regulations and, in the future, pursuant to a CPUC-approved competitive bidding process.\nEdison is required by contracts and state regulation to continue to buy power generated by QFs, under long-term contracts negotiated earlier at prices that are most often higher than the power Edison can produce or purchase from other sources. Edison is presently managing contracts with QF developers to reduce ratepayer impacts and to more closely match Edison's needs with proposed development. Further, certain operators of QFs sell power they produce to large industrial and commercial customers of Edison from projects located on-site. Further loss of sales from such customers may be aggravated in the future as a result of attempts by these producers to gain access to a utility's transmission lines to sell power directly to retail customers now being served by that utility--an activity called \"retail wheeling.\" Edison opposes any attempt to impose mandatory wheeling to Edison's retail customers.\nIn late 1992, Congress passed the Energy Policy Act of 1992. This Act creates a new class of Exempt Wholesale Generators (\"EWGs\") who are exempt from the restrictions otherwise imposed on utilities under the Public Utility Holding Company Act. The effect of this exemption is to facilitate the development of more independent third-party generators potentially available to satisfy utilities' needs for increased power supplies. However, unlike purchases from QFs, utilities have no statutory obligation to purchase power from EWGs. Furthermore, EWGs are precluded from making direct sales to retail electricity customers.\nThe Energy Policy Act also broadens the authority of the FERC to require a utility to transmit power produced by a wholesale producer to another utility. Municipal utilities are eligible applicants for such transmission service. However, the FERC is precluded from ordering a utility to transmit power from another entity directly to a retail customer. The authority of states to order such retail wheeling is unclear; but, to the extent such authority exists, it is explicitly preserved by the Energy Policy Act.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nANTITRUST MATTERS\nIn 1983, a public power utility, the City of Vernon, filed a complaint against Edison in the United States District Court for the Central District of California, alleging violation of certain antitrust laws. The complaint alleged that Edison engaged in anticompetitive behavior by restricting access to Edison transmission facilities and foreclosing Vernon from purchasing bulk power supplies from other sources. Vernon also alleged that Edison unlawfully designed its resale rates and claimed damages of approximately $60,000,000 before trebling. Edison filed three motions for Summary Judgment and the District Court entered final judgment in favor of Edison in August 1990. In October 1990, Vernon appealed the District Court decision to the Ninth Circuit Court of Appeals. In February 1992, the Court of Appeals affirmed the District Court's rulings on all issues but one, involving injunctive relief only, and remanded that issue back to the District Court for consideration. In July 1992, Vernon filed a writ of certiorari to the U.S. Supreme Court which was denied. On July 13, 1993, Edison and Vernon settled the remaining issue regarding injunctive relief. The settlement is part of a broader settlement of regulatory issues that was approved by the FERC on October 27, 1993.\nOn January 31, 1991, California Energy Company (\"CEC\") filed a lawsuit in United States District Court for the Northern District of California against SCEcorp, Edison, several nonutility subsidiaries, selected individuals, and Kidder, Peabody & Co. CEC alleged antitrust violations of the Sherman Act, conspiracy to interfere with contractual relations and common law unfair competition. CEC asked for treble damages (as proved at trial) for antitrust violations and compensatory and punitive damages for the pendent claims. Furthermore, CEC requested that SCEcorp divest itself of Mission Energy. On April 30, 1993, Edison and CEC reached a settlement which dismissed the lawsuit.\nTransphase Systems, Inc. filed a lawsuit on May 3, 1993, in the United States District Court for the Central District of California against Edison and San Diego Gas & Electric Company (\"SDG&E\"). The complaint alleged that Transphase was competitively disadvantaged because it could not directly access the demand side management funds Edison collects from its ratepayers to fund conservation and demand side management activities and that the utilities willfully acquired and maintain monopoly power in the energy conservation industry. The complaint sought $50,000,000 in damages before trebling. Edison filed a motion to dismiss the complaint\non the grounds that it was without merit. The court granted Edison's motion on October 7, 1993, and denied plaintiffs the opportunity to replead the case. Plaintiffs have appealed to the Ninth Circuit Court of Appeals.\nENVIRONMENTAL LITIGATION\nOn November 8, 1990, an environmental organization and two individuals filed a lawsuit against Edison in United States Federal District Court for the Southern District of California. The lawsuit alleges Edison's operation of San Onofre Units 2 and 3 is in violation of its National Pollutant Discharge Elimination System permits. The basis for the allegations was a report prepared for the California Coastal Commission on the marine environmental effects of the generating station. The plaintiffs requested that the Court enjoin operation of Units 2 and 3, impose civil penalties, and order Edison to repair the alleged damage to the marine environment. After mediation by the court, the parties agreed on a settlement that includes: (i) $2,000,000 in wetlands research which will be undertaken by the Pacific Estuarine Research Laboratory at San Diego State University; (ii) $7,500,000 in additional wetland restoration within the San Dieguito River Valley; (iii) a $5,500,000, 10 year, Marine Education Program which will be based at Edison's Redondo Generating Station; and (iv) $1,400,000 in attorney's fees. The court approved the settlement on June 15, 1993.\nOn September 23, 1993, the California Department of Toxic Substances Control (\"DTSC\") issued a Report of Violation to Edison, alleging various hazardous waste violations of the California Health & Safety Code at several Edison facilities. Edison is currently in settlement negotiations with DTSC regarding these alleged violations and tentatively has reached an agreement in principle for settlement in the amount of $1,900,000.\nSAN ONOFRE PERSONAL INJURY LITIGATION\nIn 1993, a former NRC inspector who was assigned to San Onofre in 1985 and 1986 filed a lawsuit against Edison, SDG&E and a fuel rod manufacturer in Los Angeles County Superior Court, Central District. The case was subsequently transferred to the Federal District Court for the Southern District of California. The inspector claimed that exposure to radioactive materials at the plant caused her leukemia. Plant records showed that the inspector's exposure to radiation was well below NRC regulatory levels. Plaintiff nevertheless alleged that she was exposed to radioactive fuel particles, that this caused a radiation exposure above the NRC levels and that this exposure was a legal cause for her illness. Plaintiff sought compensatory and punitive damages. The defendants denied having liability for plaintiff's illness.\nA jury trial began on January 4, 1994. In closing arguments at the end of the trial, plaintiff's counsel requested damages between $4,000,000 and $4,500,000 for medical costs and economic losses and asked for three to five times that amount for pain and suffering compensatory damages. After deliberations, the jury reported that it was \"hung\" and could not reach a unanimous verdict on the threshold question of whether plaintiff was exposed to radiation levels above the NRC-defined levels. (A 7-2 majority of the jury had concluded that plaintiff's exposure did exceed these levels). Finding itself hung on the exposure question, the jury did not decide the other questions regarding causation, the amount of compensatory damages and whether Edison's conduct warranted punitive damages. If the jury had found that punitive damages should be assessed, the trial would have resumed to decide the amount of such damages.\nOn February 8, 1994, the trial judge declared a mistrial because of the hung jury. The second trial was scheduled to begin on March 15, 1994. On March 14, 1994, the case was settled. The amount of the settlement payment will not have a material adverse effect on Edison's net income.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInapplicable.\nPursuant to Form 10-K's General Instruction (\"General Instruction\") G(3), the following information is included as an additional item in Part I:\nEXECUTIVE OFFICERS(1) OF THE REGISTRANT\n- ---------------\n(1) Effective March 1, 1993, Michael R. Peevey retired from his position as President of Edison, and Harry E. Morgan, Jr. retired from his position as Vice President of Edison and Site Manager of San Onofre. At December 31, 1993, Charles B. McCarthy, Jr. was Senior Vice President of Edison; however, effective January 1, 1994, Mr. McCarthy retired from this position. (2) Messrs. Bryson, Danner, Bushey and Stewart also hold the same positions with SCEcorp. Mr. Fohrer holds the office of Senior Vice President, Treasurer and Chief Financial Officer of SCEcorp. SCEcorp is the parent holding company of Edison.\nNone of Edison's executive officers are related to each other by blood or marriage. As set forth in Article IV of Edison's Bylaws, the officers of Edison are chosen annually by and serve at the pleasure of Edison's Board of Directors and hold their respective offices until their resignation, removal, other disqualification from service, or until their respective successors are elected. All of the executive officers have been actively engaged in the business of Edison for more than five years except for Bryant C. Danner and Margaret H. Jordan. Those officers who have not held their present position for the past five years had the following business experience during that period:\n- ---------------- (1) Prior to leaving the law firm of Latham & Watkins, Mr. Danner was in the firm's environmental department. (2) As Vice President of the Kaiser Foundation Health Plan of Texas, Ms. Jordan was responsible for serving over 124,000 members in 10 multispecialty medical offices in the Dallas\/Fort Worth area. (3) This entity is not a parent, subsidiary or other affiliate of Edison.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCertain information responding to Item 5 with respect to frequency and amount of cash dividends is included in Edison's Annual Report to Shareholders for the year ended December 31, 1993, (\"Annual Report\") under \"Quarterly Financial Data\" on page 6 and is incorporated by reference pursuant to General Instruction G(2). As a result of the formation of a holding company described above in Item 1, all of the issued and outstanding common stock of Edison is owned by SCEcorp and there is no market for such stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation responding to Item 6 is included in the Annual Report under \"Selected Financial and Operating Data: 1989-1993\" on page 1 and is incorporated herein by reference pursuant to General Instruction G(2).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nInformation responding to Item 7 is included in the Annual Report under \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 2 through 6 and is incorporated herein by reference pursuant to General Instruction G(2).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCertain information responding to Item 8 is set forth after Item 14 in Part IV. Other information responding to Item 8 is included in the Annual Report on page 6 under \"Quarterly Financial Data\" and on pages 7 through 21 and is incorporated herein by reference pursuant to General Instruction G(2).\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning executive officers of Edison is set forth in Part I in accordance with General Instruction G(3), pursuant to Instruction 3 to Item 401(b) of Regulation S-K. Other information responding to Item 10 is included in the Joint Proxy Statement (\"Proxy Statement\") filed with the Commission in connection with Edison's Annual Meeting of Shareholders to be held on April 21, 1994, under the heading \"Election of Directors of SCEcorp and Edison,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation responding to Item 11 is included in the Proxy Statement under the heading \"Election of Directors of SCEcorp and Edison,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation responding to Item 12 is included in the Proxy Statement under the headings \"Election of Directors of SCEcorp and Edison,\" and \"Stock Ownership of Certain Shareholders\" and is incorporated herein by reference pursuant to General Instruction G(3).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation responding to Item 13 is included in the Proxy Statement under the heading \"Election of Directors of SCEcorp and Edison,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A)(1) FINANCIAL STATEMENTS\nThe following items contained in the 1993 Annual Report to Shareholders are incorporated by reference in this report.\nManagement's Discussion and Analysis of Results of Operations and Financial Condition Consolidated Statements of Income -- Years Ended December 31, 1993, 1992 and 1991 Consolidated Statements of Retained Earnings -- Years Ended December 31, 1993, 1992 and 1991 Consolidated Balance Sheets -- December 31, 1993, and 1992 Consolidated Statements of Cash Flows -- Years Ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements Responsibility for Financial Reporting Report of Independent Public Accountants\n(2) REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AND SCHEDULES SUPPLEMENTING FINANCIAL STATEMENTS\nThe following documents may be found in this report at the indicated page numbers.\nSchedules I through XIII, except those referred to above, are omitted as not required or not applicable.\n(3) EXHIBITS\nSee Exhibit Index on page 40 of this report.\n(B) REPORTS ON FORM 8-K\nOctober 5, 1993 Item 5: Other Events: Palo Verde Settlement\nDecember 20, 1993 Item 5: Other Events: Cost of Capital Financing Results\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULES\nTo Southern California Edison Company:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in the 1993 Annual Report to Shareholders of Southern California Edison Company, incorporated by reference in this Form 10-K, and have issued our report thereon dated February 4, 1994. Our audits of the consolidated financial statements were made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The supplemental schedules listed in Part IV of this Form 10-K which are the responsibility of the Company's management are presented for purposes of complying with the Securities and Exchange Commission's rules and regulations, and are not part of the basic consolidated financial statements. These supplemental schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nLos Angeles, California February 4, 1994\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1993\n_______________ (a) Reflects transfers to plant in service, which are net of additions to construction work in progress.\n(b) Reflects prior-year adjustments.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1992\n_______________ (a) Reflects transfers to plant in service, which are net of additions to construction work in progress.\n(b) Reflects removal from service of nuclear generating plant under an agreement reached with the California Public Utilities Commission.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1991\n_______________ (a) Reflects transfers to plant in service, which are net of additions to construction work in progress.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1993\n_______________ (a) Includes removal costs related to facilities retired, damage claims and relocation costs collected from others, and various other adjustments of depreciation and amortization.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1992\n_______________ (a) Includes removal costs related to facilities retired, damage claims and relocation costs collected from others, and various other adjustments of depreciation and amortization.\n(b) Reflects removal from service of nuclear generating plant under an agreement reached with the California Public Utilities Commission.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEAR ENDED DECEMBER 31, 1991\n_______________ (a) Includes removal costs related to facilities retired, damage claims and relocation costs collected from others, and various other adjustments of depreciation and amortization.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1993\n________________\n(a) Accounts written off, net.\n(b) Represents final settlement with the California Public Utilities Commission's Division of Ratepayer Advocates regarding affiliated company power purchases.\n(c) Represents new estimate based on actual billings.\n(d) Represents amounts paid.\n(e) Primarily represents transfers from the acrued paid absense allowance account for required additions to the comprehensive disability plan accounts.\n(f) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(g) Amounts charge to operations that were not covered by insurance.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1992\n_______________ (a) Accounts written off, net.\n(b) Represents reserve addition for the settlement with the California Public Utilities Commission's Division of Ratepayer Advocates regarding affiliated company power purchases.\n(c) Represents the amortization of the difference between the nominal value and the present value.\n(d) Represents the estimated long-term costs to be incurred and recovered through rates over 15 years; reclassified from account 253, other deferred credits.\n(e) Represents an additional estimated liability established for environmental cleanup costs expected to be incurred and recovered through rates in future years.\n(f) Amount reclassified to account 253.\n(g) Primarily represents transfers from the accrued paid absence allowance account for required additioins to the comprehensive disability plan accounts.\n(h) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(i) Amounts charged to operations that were not covered by insurance.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1991\n_______________ (a) Accounts written off, net.\n(b) Represents a reserve addition for a proposed settlement with the California Public Utilities Commission's Division of Ratepayer Advocates regarding affiliated company power purchases.\n(c) Represents an estimated minimum liability established for environmental cleanup costs expected to be incurred and recovered through rates in future years.\n(d) Primarily represents transfers from the accrued paid absence allowance account for required additions to the comprehensive disability plan accounts.\n(e) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(f) Amounts charged to operations that were not covered by insurance.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE IX -- SHORT-TERM BORROWINGS\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1993\n_______________ (a) Average amount outstanding during the period is computed by dividing the total of daily outstanding principal balances by 365.\n(b) Weighted-average interest rate during the period is computed by dividing the total interest expense by the average amount outstanding.\n(c) Under credit agreements with commercial banks which allow Edison to refinance short-term borrowings on a long-term basis, borrowings of $70,000,000 as of December 31, 1993, $63,000,000 as of December 31, 1992, and $151,000,000 as of December 31, 1991, have been reclassified as long-term debt on the Consolidated Balance Sheets in the 1993 Annual Report to reflect the anticipated timing of repayment of nuclear fuel indebtedness.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1993\n_______________ Note: Depreciation and maintenance expenses appear on the Consolidated Statements of Income. Royalties paid and advertising costs included in Other Operating Expenses are less than 1% of total operating revenue.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE XIII -- OTHER INVESTMENTS\nDECEMBER 31, 1993 (IN THOUSANDS)\nSIGNATURES\nPursuant 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.\nSOUTHERN CALIFORNIA EDISON COMPANY\nBy W. J. Scilacci ----------------------------- (W. J. Scilacci Assistant Treasurer)\nDate: March 17, 1994\nPursuant 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 and on the dates indicated.\n*By W. J. Scilacci --------------------------------- (W. J. Scilacci, Attorney-in-fact)\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\n_______________ * Incorporated by reference pursuant to Rule 12b-32.","section_15":""}
{"filename":"107263_1993.txt","cik":"107263","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee Item 1(c) for description of properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOther than as described under Item 1 -- Business and in Note 14 of Notes to Consolidated Financial Statements, there are no material pending legal proceedings. Williams is subject to ordinary routine litigation incidental to its businesses.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF WILLIAMS\nThe names, ages, positions and election dates of the executive officers of Williams are:\nAll of the above officers have been employed by Williams or its subsidiaries as officers or otherwise for more than the past five years and have had no other employment during such period.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWilliams' Common Stock is listed on the New York and Pacific Stock Exchanges under the symbol \"WMB.\" At the close of business on December 31, 1993, Williams had 7,620 holders of record of its Common Stock. The daily closing price ranges (composite transactions) and dividends declared by quarter for each of the past two years are as follows, adjusted to reflect the 2-for-1 stock distribution in 1993:\nTerms of certain subsidiaries' borrowing arrangements limit transfer of funds to Williams. Terms of other borrowing arrangements limit the payment of dividends on Williams' Common Stock. These restrictions have not impeded, nor are they expected to in the future, Williams' ability to meet its cash obligations. See Note 10 of Notes to Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following financial data are an integral part of, and should be read in conjunction with, the consolidated financial statements and notes thereto. Information concerning significant trends in the financial condition and results of operations is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations on pages through of this report.\n- ---------------\n*Certain amounts have been restated or reclassified as described in Notes 1 and 11 of Notes to Consolidated Financial Statements.\n**See Note 3 of Notes to Consolidated Financial Statements for discussion of significant asset dispositions in 1993 and 1992.\n***Includes redeemable preferred stock of Northwest Pipeline.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1993 vs. 1992\nNorthwest Pipeline's revenues increased 10 percent reflecting increased firm transportation service and higher average transportation rates, partially offset by lower average gas sales prices. Total mainline throughput increased 2 percent. Firm transportation service increased due to a mainline expansion, supported by 15-year firm transportation contracts, being placed into service on April 1, 1993. Northwest Pipeline also placed new, increased transportation rates into effect on April 1, 1993, (subject to refund) that reflected the new mainline expansion and straight-fixed-variable rate design that moderates seasonal swings in operating revenues. Costs and operating expenses decreased 10 percent due primarily to lower gas purchase volumes and per-unit costs and decreased operation and maintenance expenses, partially offset by increased depreciation. General and administrative expenses increased due primarily to higher supplemental retirement expenses and increased outside technical and professional fees. Operating profit increased 49 percent due primarily to increased firm transportation service, higher average transportation rates and lower operation and maintenance expenses, partially offset by higher depreciation and general and administrative expenses and lower gas sales margins.\nWilliams Natural Gas' revenues decreased 7 percent primarily as a result of lower natural gas sales volumes reflecting implementation of Federal Energy Regulatory Commission (FERC) Order 636 on October 1, 1993, partially offset by higher average transportation rates and volumes and revenues generated from the sale of working gas in storage. Total throughput increased 2 percent due primarily to cooler weather in the first quarter of 1993 and increased on-system industrial demand, partially offset by lower off-system activity. Costs and operating expenses decreased 9 percent primarily as a result of decreased gas supply volumes, partially offset by increased operating and maintenance expenses, increased amortization of recoverable contract-reformation costs and higher per-unit gas supply costs. Operating profit increased 4 percent primarily due to higher average transportation rates and volumes, reversal of excess contract-reformation costs that had been previously accrued and the regulatory accounting for an income tax rate increase. Largely offsetting operating profit increases were lower natural gas sales volumes and higher operating and maintenance expenses. The impact of the regulatory accounting adjustment was offset by additional deferred income tax expense.\nWilliams Field Services Group's revenues decreased 24 percent due primarily to lower natural gas sales volumes, partially offset by increased gathering, liquid product and processing volumes, and higher average gathering, processing and natural gas sales prices. Gathering volumes increased 18 percent, natural gas liquids volumes increased 11 percent and processing volumes increased 21 percent when compared with volumes from the prior year. The lower natural gas sales volumes were due to the March 1993 sale of Williams' intrastate natural gas pipeline system and related marketing operations in Louisiana. Costs and operating expenses decreased due primarily to lower natural gas purchase volumes, partially offset by higher gas costs associated with the liquids extraction process and increased operating and maintenance expenses at expanded gathering and processing facilities. Operating profit increased 9 percent due primarily to increased volumes at expanded facilities and a favorable settlement involving processing revenues from prior periods, partially offset by decreased gas sales volumes, lower liquids margins and increased operating costs from expanded facilities. Other income -- net and operating profit in 1992 also included a gain on the sale of a gathering facility and the reversal of a loss accrual made in prior years.\nWilliams Pipe Line's revenues increased 21 percent due primarily to 12 percent higher shipments, increased other revenues primarily related to gas liquids and fractionator operations, partially offset by a slightly lower transportation rate per barrel. The lower average transportation rate per barrel reflects a 5 percent decrease in the length of the average haul, partially offset by increased tariff rates for portions of both 1992 and 1993. Costs and operating expenses increased due primarily to gas liquids and fractionator operations. Operating profit increased primarily as a result of higher shipments and lower general and administrative expenses. During the fourth quarter, Williams Pipe Line completed the acquisition of a 300-mile pipeline that connects with the southern portion of its system in Oklahoma. The additional pipeline will provide more direct access to key refining areas and open new markets.\nWilliams Energy Ventures' revenues and operating costs decreased approximately 27 percent due primarily to reporting refined product trading activities on a \"net margin\" basis effective July 1, 1993. Selling, general and administrative expenses increased significantly from costs associated with establishing this company's operations, pursuing new business development and equipping the company to pursue a growing range of financial and information-based opportunities in the energy industry. Operating profit decreased as improved results from price-risk management activities were more than offset by the expense associated with the development and marketing of new information-based products and exploring other growth opportunities in the energy industry. Improved results in price-risk management activities relate to increases in marketing of commodities and derivatives products in addition to increased refined product trading volumes.\nWilTel's revenues increased 26 percent due primarily to a $173 million increase in the network services business. Switched-services revenues increased reflecting a 127 percent increase in billable calls. Dedicated services' interexchange revenues increased as a result of a 32 percent increase in billable circuits, partially offset by a decrease in the weighted average price per circuit. Cost and operating expenses increased primarily as a result of increased volumes in the switched-services and dedicated network services businesses. Selling, general and administrative expenses declined due primarily to lower provisions for bad debt expense and recoveries of receivables that had been written off in prior years, partially offset by higher network services expenses associated with increased volumes. Excluding the effects of bad debt expense, selling, general and administrative expenses as a percentage of revenues declined this year as compared to the prior year. Operating profit increased due primarily to increased network services sales volumes, higher margins in the customer premises equipment business and lower provisions for bad debt expense. Operating profit in 1992 was impacted by the costs associated with internal restructuring in the customer premises equipment business. One of WilTel's large carriers is scheduled to remove significant traffic from WilTel's system during 1994. While this will slow WilTel's growth, operating profit for 1994 should not be materially affected as overall growth is expected to significantly offset the loss of this carrier.\nGeneral corporate expenses increased, reflecting higher supplemental retirement benefits (see Note 6) and incentive compensation accruals in addition to a contribution to The Williams Companies Foundation. Interest accrued increased primarily because of higher average borrowing levels, partially offset by a lower effective interest rate including the effects of interest-rate swap agreements (see Note 10). Investing income increased, reflecting higher equity earnings from the Kern River Gas Transmission Company pipeline, which\nbecame operational February 1992, and higher levels of short-term investments. The gain on sales of assets in 1993 results from the sale of 6.1 million units in the Williams Coal Seam Gas Royalty Trust and the sale of the intrastate natural gas pipeline system and other related assets in Louisiana. The 1992 gain on sales of assets results from the sale of a tract of land in Florida that had been retained from the assets of Agrico Chemical Company, which was sold several years ago. Other income (expense) -- net is unfavorable to 1992 primarily because of decreased equity allowance for funds used during construction (AFUDC) related to Northwest Pipeline's mainline expansion and expense accruals for certain costs associated with businesses previously sold. The increase in the provision for income taxes is primarily a result of higher pretax income and the $15.8 million cumulative effect of the 1 percent increase in the federal income tax rate. The effective income tax rate in 1993 is higher than the statutory rate primarily because of the effect of the federal income tax rate increase and state income taxes, partially offset by income tax credits from coal-seam gas production. The effective income tax rate in 1992 is lower than the statutory rate primarily because of income tax credits from coal-seam gas production, partially offset by state income taxes (see Note 4). Preferred stock dividends decreased reflecting the redemption of 3,000,000 shares of outstanding $3.875 convertible exchangeable preferred stock during the second quarter of 1993 (see Note 11).\n1992 vs. 1991\nNorthwest Pipeline's revenues decreased as a result of decreased natural gas sales volumes, partially offset by higher average natural gas sales prices and increased transportation volumes. Total mainline throughput increased 2 percent, reflecting higher Pacific Northwest market demand; the increase was partially offset by warmer weather and decreased off-system demand. Costs and operating expenses decreased primarily as a result of decreased gas supply volumes and lower amortization of recoverable contract-reformation costs. Operating profit increased as a result of higher transportation volumes and average natural gas sales margins, partially offset by lower natural gas sales volumes.\nWilliams Natural Gas' revenues decreased primarily as a result of lower natural gas sales volumes; the decrease was partially offset by higher average transportation rates. Total 1992 mainline throughput decreased 3 percent, reflecting 15 percent warmer weather in the first quarter of 1992, a period when the company normally experiences higher volumes from customer heating demands. Costs and operating expenses decreased primarily as a result of decreased gas supply volumes and lower amortization of recoverable contract-reformation costs. Operating profit decreased as a result of warmer weather and increased operating and maintenance and depreciation expenses, partially offset by higher transportation revenues.\nWilliams Field Services Group's revenues increased primarily as a result of higher average natural gas sales prices ($85 million) and volumes ($77 million), increased gathering, processing and liquids volumes, and higher spot market sales from company-owned production. Gathering volumes increased 35 percent, third-party processing volumes increased 70 percent and liquids product volumes increased 15 percent, primarily reflecting higher demand and increased utilization of expanded facilities. Costs and operating expenses increased primarily because of higher natural gas purchase volumes and average costs and the continued growth of gathering and processing activities. Operating profit increased primarily as a result of increased gathering and processing volumes, and increased spot market gas sales. In addition, other income-net and operating profit include a gain from the sale of a gathering facility and the reversal of a loss accrual made in prior years. Operating profit increases were partially offset by lower per-unit natural gas sales margins, higher operating and maintenance expenses, increased depreciation and the absence of a prior-year rate refund from an interstate pipeline.\nWilliams Pipe Line's revenues increased primarily as a result of a 4 percent increase in barrels shipped, a higher tariff in place the last half of 1992 and increased tank rental and other revenues. The average transportation rate per barrel was unchanged, reflecting a 6 percent decrease in the length of the average haul, offset by the increased tariff rates effective in the second quarter. Costs and operating expenses increased primarily as a result of higher maintenance and environmental remediation expenses. Selling, general and administrative expenses decreased primarily as a result of lower legal and professional fees from a 1991 FERC rate case defense. Operating profit increased primarily as a result of higher shipments, tank rental and other\nrevenues in addition to lower selling, general and administrative expenses; increases were partially offset by higher maintenance and environmental remediation expenses.\nWilliams Energy Ventures' revenues, operating costs and operating profit increased due primarily to increased inventory-risk management activities.\nWilTel's revenues increased primarily in the switched-services ($72 million) and customer-premises equipment ($52 million) businesses. Switched services' billable calls increased 207 percent in 1992, principally resulting from a November 1991 acquisition. Customer-premises equipment revenues were higher primarily because of increased installations and outsourcing services as well as a full year's activity in 1992 vs. 11 months in 1991. Interexchange revenues increased slightly as a 20 percent increase in the number of billable circuits at the respective years' end was substantially offset by a decrease in the weighted average price per circuit. Costs and operating and selling, general and administrative expenses increased primarily as a result of increased volumes in the switched-services, customer-premises equipment and dedicated business-network areas. Selling, general and administrative expenses included $10 million and $7 million provisions for uncollectible amounts in 1992 and 1991, respectively, from significant customers. Operating profit decreased primarily as a result of costs associated with the integration and deployment of a nationwide switched-services network, lower margins and internal restructuring costs in the customer premises equipment business and, in 1991, the effect of a favorable service fee settlement with a major customer.\nGeneral corporate expenses decreased, reflecting a decline in contributions to The Williams Companies Foundation. Interest accrued decreased slightly, resulting primarily from the $11.7 million benefit from interest-rate exchange agreements, substantially offset by higher borrowing levels. Interest capitalized increased primarily because of the Northwest Pipeline mainline expansion. Investing income increased, reflecting higher equity earnings ($15 million) resulting from start-up of the Kern River Gas Transmission Company pipeline, partially offset by a decreased dividend from Texasgulf Inc. and lower levels of short-term investments and interest-bearing receivables. The 1992 gain on sales of assets results from the sale of a tract of land in Florida that had been retained from the assets of Agrico Chemical Company, which was sold several years ago. Other income (expense) -- net is favorable to 1991 primarily because of increased equity AFUDC related to Northwest Pipeline's mainline expansion, lower loss on sale of receivables and the absence of a 1991 environmental accrual related to assets sold in prior years, partially offset by the effects of a 1991 reversal of loss accruals previously provided on advances made to Kern River Gas Transmission Company. The increase in the provision for income taxes is primarily a result of higher pretax income, partially offset by an increase in tax credits from coal-seam gas production. The effective income tax rate in both years is lower than the statutory rate primarily because of income tax credits from coal-seam gas production and the effects of a dividend exclusion, partially offset by state income taxes. The extraordinary credit results from the early extinguishment of debt (see Note 5). Preferred stock dividends increased as the result of the issuance of $100 million of preferred stock in 1992 (see Note 11).\nFINANCIAL CONDITION AND LIQUIDITY\nLiquidity\nWilliams considers its liquidity to come from two sources: internal liquidity, consisting of available cash investments, and external liquidity, consisting of borrowing capacity from available bank-credit facilities, which can be utilized without limitation under existing loan covenants. At December 31, 1993, Williams had access to $639 million of liquidity, representing the unborrowed portion of its $600 million bank-credit facility plus cash-equivalent investments. This compares with liquidity of $780 million at December 31, 1992, including $178 million from Northwest Pipeline, and $350 million at December 31, 1991. During 1994, Williams expects to finance capital expenditures, investments and working-capital requirements through the use of its $600 million bank-credit facility or public debt\/equity offerings. During 1993, Williams filed a $300 million shelf registration statement with the Securities and Exchange Commission increasing the total amount available to $400 million. The registration statement may be used to issue Williams common or preferred stock, preferred stock purchase rights, debt securities, warrants to purchase Williams common stock\nor warrants to purchase debt securities. In addition, Northwest Pipeline has $50 million remaining on a registration statement filed with the Securities and Exchange Commission in 1992. Williams does not anticipate the need for additional financing; however, Williams believes it could be obtained on reasonable terms if required.\nWilliams had a net working-capital deficit of $106 million at December 31, 1993, and $235 million at December 31, 1992. Williams manages its financing to keep cash and cash equivalents at a minimum and has relied on bank-credit facilities to provide flexibility for its cash needs. As a result, it historically has reported negative working capital. The 1992 working capital deficit includes $178 million of cash equivalents at Northwest Pipeline for funding expansion projects, substantially offset by $165 million of long-term debt due within one year.\nTerms of certain borrowing agreements limit transfer of funds to Williams from its subsidiaries. The restrictions have not impeded, nor are they expected to impede, Williams' ability to meet its cash requirements in the future.\nOperating Activities\nCash provided by operating activities was: 1993 -- $349 million; 1992 -- $254 million; and 1991 -- $399 million. Williams' gas pipeline subsidiaries and WilTel have agreements to sell receivables and, at December 31, 1993 and 1992, had sold $35 million and $130 million of receivables, respectively. Under a different arrangement, WilTel sold $18 million of receivables in 1992. The decline in accounts receivable and accounts payable reflects the March 1993 sale of Williams' intrastate natural gas pipeline system and other related assets and the reduction of gas sales by the interstate natural gas pipelines because of the Order 636 restructuring. The decrease in accounts receivable is largely offset by a lower level of receivables sold.\nFinancing Activities\nNet cash provided (used) by financing activities was: 1993 -- ($220) million; 1992 -- $421 million; and 1991 -- $40 million. Long-term debt principal payments totalled $192 million during 1993. Long-term debt proceeds, net of principal payments, during 1992 and 1991 were $264 million and $102 million, respectively. The increases in net new borrowings during 1992 and 1991 were primarily to fund capital expenditures and investments and advances to affiliates. New debt in 1992 primarily consisted of $300 million of notes and debentures issued by Williams and $150 million of debentures issued by Northwest Pipeline. The increase in 1991 resulted from the issuance by Williams of $300 million in notes and debentures.\nThe majority of the proceeds from issuance of common stock in 1993 resulted from exercise of stock options under Williams' stock plan (see Note 11). During 1992, Williams received net proceeds of $96 million from the sale of 4,000,000 shares of $2.21 cumulative preferred stock and $119 million from the sale of 7,100,000 shares (on a post-split basis) of common stock.\nDuring 1993, Williams called for redemption of its 3,000,000 shares of outstanding $3.875 convertible exchangeable preferred stock. Substantially all of the preferred shares were converted into 7,600,000 shares (on a post-split basis) of Williams common stock.\nLong-term debt at December 31, 1993, was $1.6 billion compared with $1.7 billion at December 31, 1992, and $1.5 billion at December 31, 1991. The long-term debt to debt-plus-equity ratio was 48.2 percent at year-end compared with 52.6 percent and 55.8 percent at December 31, 1992 and 1991, respectively.\nSee Note 5 for information regarding early extinguishment of debt by Williams' subsidiaries during 1992.\nInvesting Activities\nNet cash used by investing activities was: 1993 -- $277 million; 1992 -- $511 million; and 1991 -- $442 million. During 1991, Williams advanced $100 million to Kern River Gas Transmission Company.\nCapital expenditures to expand and enhance WilTel's network were $109 million in 1993; $69 million in 1992; and $73 million in 1991. Capital expenditures of pipeline subsidiaries, primarily to expand and\nmodernize systems, were $405 million in 1993; $500 million in 1992; and $227 million in 1991. Expenditures in 1993 include the completion of Northwest Pipeline's mainline expansion and the expansion of various gathering and processing facilities. Approximately two-thirds of the 1992 expenditures relate to Northwest Pipeline's mainline expansion. Construction of a coal-seam gas gathering system in the San Juan Basin was completed in 1991. Budgeted capital expenditures for 1994 are approximately $750 million, primarily to expand pipeline systems and gathering and processing facilities.\nDuring 1993, Williams received net proceeds of $113 million from the sale of 6.1 million units in the Williams Coal Seam Gas Royalty Trust. In addition, Williams sold its intrastate natural gas pipeline system and other related assets in Louisiana for $170 million (see Note 3).\nSubsequent to December 31, 1993, Williams signed a letter of intent to purchase certain gathering and processing assets in New Mexico for approximately $155 million.\nDuring 1994, Williams will consider selling a portion of its interest in the Northern Border Pipeline partnerships and part or all of the remaining 3.6 million units in the Williams Coal Seam Gas Royalty Trust.\nEFFECTS OF INFLATION\nWilliams has experienced increased costs in recent years due to the effects of inflation. However, more than 90 percent of Williams' property, plant and equipment has been purchased since 1982, a period of relatively low inflation. A substantial portion of Williams' property, plant and equipment is subject to regulation, which limits recovery to historical cost. While Williams believes it will be allowed the opportunity to earn a return based on the actual cost incurred to replace existing assets, competition or other market factors may limit the ability to recover such increased costs.\nOTHER\nIn 1992, the FERC issued Order 636, Order 636-A and Order 636-B. These orders, which have been challenged in various respects by various parties in proceedings pending in the U.S. Court of Appeals for the 11th Circuit, require interstate gas pipeline companies to change the manner in which they provide services. Williams Natural Gas implemented its restructuring on October 1, 1993, and Northwest Pipeline implemented its restructuring on November 1, 1993. Transition costs associated with Order 636 are expected to be recovered in the future through rates. Certain aspects of each pipeline company's restructuring are under appeal (see Note 14).\nWilliams is a participant in certain environmental activities in various stages involving assessment studies, cleanup operations and\/or remedial processes. The sites, some of which are not currently owned by Williams (see Note 14), are being monitored by Williams, other potentially responsible parties, U.S. Environmental Protection Agency (EPA), or other governmental authorities in a coordinated effort. In addition, Williams maintains an active monitoring program for its continued remediation and cleanup of certain sites connected with its refined products pipeline activities. Williams has both joint and several liability in some of these activities and sole responsibility in others. Current estimates of the most likely costs of such cleanup activities, after payments by other parties, are approximately $45 million, substantially all of which is accrued at December 31, 1993. Williams expects to seek recovery of approximately $30 million of these costs through future rates. Williams will fund these costs from operations and\/or available bank-credit facilities. The actual costs incurred will depend on the final amount, type and extent of contamination discovered at these sites, the final cleanup standards mandated by the EPA or other governmental authorities, and other factors.\nSee Note 4 for the effects of a new accounting standard on accounting for income taxes; Note 6 for the effects of new accounting standards on other postretirement and postemployment benefits; Note 12 for fair value and off-balance-sheet risk of financial instruments; and Note 14 for contingencies.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nTo The Stockholders of The Williams Companies, Inc.\nWe have audited the accompanying consolidated balance sheet of The Williams Companies, Inc. as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Williams Companies, Inc. at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nERNST & YOUNG\nTulsa, Oklahoma February 10, 1994\nTHE WILLIAMS COMPANIES, INC.\nCONSOLIDATED STATEMENT OF INCOME\n- ---------------\n* Restated as described in Note 1.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nCONSOLIDATED STATEMENT OF INCOME -- (CONCLUDED)\n* Restated as described in Note 1.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nCONSOLIDATED BALANCE SHEET\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\n- ---------------\n* Restated for stock split and distribution.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS\n- ---------------\n*Reclassified as described in Note 1.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of presentation\nRevenues and operating profit amounts for 1992 and 1991 have been restated to conform to current-year classifications. Williams Field Services Group includes all of Williams' natural gas gathering, processing and liquids activities and the natural gas marketing and Louisiana-based transportation operations previously reported as Williams Energy Company (see Note 3). Williams Energy Ventures primarily includes the non-transportation business activities formerly conducted by Williams Pipe Line.\nDuring 1993, Williams reclassified its income taxes associated with equity earnings from investing income to the provision for income taxes. Prior years' amounts have been reclassified, and equity earnings and the provision for income taxes have been increased $14.8 million and $9.3 million in 1992 and 1991, respectively.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of The Williams Companies, Inc. and majority-owned subsidiaries (Williams). Companies in which Williams and its subsidiaries own 20 percent to 50 percent of the voting common stock, or otherwise exercise sufficient influence over operating and financial policies of the company, are accounted for under the equity method.\nCash and cash equivalents\nCash and cash equivalents include demand and time deposits, certificates of deposit and other marketable securities with maturities of three months or less when acquired.\nInventory valuation\nInventories are stated at cost, which is not in excess of market, except for those held by Williams Energy Ventures (see price-risk management accounting policy). Inventories of natural gas are determined using the average-cost method by Northwest Pipeline and Williams Field Services Group and the last-in, first-out (LIFO) method by Williams Natural Gas. Williams Pipe Line's inventories of petroleum products are principally determined using average cost. The cost of materials and supplies inventories is determined principally using the first-in, first-out method by WilTel and the average-cost method by other subsidiaries.\nProperty, plant and equipment\nProperty, plant and equipment is recorded at cost. Depreciation is provided primarily on the straight-line method over estimated useful lives. Gains or losses from the ordinary sale or retirement of property, plant and equipment for regulated pipeline subsidiaries are credited or charged to accumulated depreciation; other gains or losses are recorded in net income.\nRevenue recognition\nRevenues generally are recorded when services have been performed or products have been delivered. Natural gas transportation revenues are recognized based upon contractual terms and the related transported volume through month end. Williams Pipe Line bills customers when products are shipped and defers the estimated revenues for shipments in transit. WilTel bills interexchange services monthly in advance and defers revenues until earned.\nPrice-risk management activities\nWilliams Energy Ventures enters into energy-related financial instruments to hedge against market price fluctuations of certain refined products inventories and natural gas sales and purchase commitments. Gains or\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nlosses on these hedge contracts are recognized when the associated inventory is sold or the hedged contractual commitment is consummated.\nWilliams Energy Ventures also uses energy-related financial instruments and physical inventory for market speculation purposes. These investments are valued at market. The resulting change in unrealized market gains and losses is recognized in income currently. In the absence of independent market prices, management will determine a fair value based on valuation pricing models which take into account time value and volatility factors underlying the positions.\nCapitalization of interest\nWilliams capitalizes interest on major projects during construction. Interest is capitalized on borrowed funds and, where regulation by the Federal Energy Regulatory Commission (FERC) exists, on internally generated funds. The rates used by regulated companies are calculated in accordance with FERC rules. Rates used by unregulated companies approximate the average interest rate on related debt. Interest capitalized on internally generated funds is included in other income (expense) -- net.\nIncome taxes\nWilliams includes the operations of its subsidiaries in its consolidated federal income tax return. Provision is made for deferred income taxes applicable to temporary differences between financial and taxable income.\nEarnings per share\nPrimary earnings per share are based on the sum of the average number of common shares outstanding and common-share equivalents resulting from stock options and deferred shares. Fully diluted earnings per share assumes conversion of the convertible exchangeable preferred stock (CEPS) into common stock effective January 1, 1993. The CEPS were not dilutive in 1992 or 1991. Shares used in determination of primary earnings per share are as follows (in thousands): 1993 -- 99,911; 1992 -- 90,816; and 1991 -- 83,780. Shares used in determination of fully diluted earnings per share are as follows (in thousands): 1993 -- 103,171; 1992 -- 90,816; and 1991 -- 83,780. The number of shares for 1992 and 1991 have been restated to reflect the effect of a two-for-one common stock split and distribution (see Note 11).\nNOTE 2 -- INVESTING ACTIVITIES\n- ---------------\n* Accounted for on the equity method.\nWilliams' investment in Texasgulf Inc. is subject to certain rights under a shareholder agreement. Williams has the right to sell the shares to the majority owner under various specified terms and to require Texasgulf to register the shares for public offering. Most of the rights under the shareholder agreement, including the right to sell to the majority owner, are not transferable in the event Williams sells the shares or there is a change in control of Williams.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nUnder disposition rights currently in effect, Williams would realize substantially less than the carrying value of the Texasgulf shares. However, Williams believes the fair value of the investment in Texasgulf approximates the $150 million carrying value because of significant underlying phosphate reserves and related mining equipment. While current market prices for phosphate reserves are affected by depressed market conditions for chemical fertilizer, prices are expected to be only temporarily low, based on historical trends in the business. Williams has received dividends approximating a 4 percent annual pretax return over the last three years and its 15 percent equity in the book value of Texasgulf 's net assets approximates Williams' carrying value. Because of the above factors, Williams does not believe it will incur a loss on this investment.\nAt December 31, 1993, other investments carried at $29 million have a market value of $83 million.\nInvesting income:\nDividends and distributions received from companies carried on an equity basis were $39 million in 1993; $10 million in 1992; and $14 million in 1991.\nSummarized financial position and results of operations for Kern River Gas Transmission Company are presented below. Kern River operations began in February 1992.\nNOTE 3 -- SALES OF ASSETS\nIn a 1993 public offering, Williams sold 6.1 million units in the Williams Coal Seam Gas Royalty Trust (Trust), which resulted in net proceeds of $113 million and a pretax gain of $51.6 million. The Trust owns defined net profits interests in the developed coal-seam properties in the San Juan Basin of New Mexico and Colorado, which were conveyed to the Trust by Williams Production Company. An additional 3.6 million units may be sold by Williams in the future.\nIn March 1993, Williams sold its intrastate natural gas pipeline system and other related assets in Louisiana for $170 million in cash, resulting in a pretax gain of $45.9 million.\nThe 1992 gain of $14.6 million resulted from the sale of a tract of land in Florida that had been retained from the assets of Agrico Chemical Company, which was sold several years ago.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 4 -- PROVISION FOR INCOME TAXES\nEffective January 1, 1993, Williams adopted Statement of Financial Accounting Standards (FAS) No. 109, \"Accounting for Income Taxes.\" Adoption of the standard had a cumulative favorable effect of approximately $2 million on net income. The effect is recorded in income tax expense because of immateriality. Prior to 1993, Williams accounted for deferred income taxes under FAS No. 96. As permitted under the new rules, prior years' financial statements have not been restated.\nThe provision (credit) for income taxes includes:\nThe 1993 provision for income taxes includes the effect of a 1 percent increase in the federal income tax rate, which was made retroactive to January 1, 1993.\nReconciliations from the provision for income taxes at the statutory rate to the provision for income taxes are as follows:\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSignificant components of deferred tax liabilities and assets as of December 31, 1993, are as follows:\nThe valuation allowance for deferred tax assets decreased $3.4 million during 1993.\nAt December 31, 1993, Williams had a minimum tax credit of $8.5 million available to reduce future regular income taxes. The credit has been utilized to reduce deferred income taxes.\nCash payments for income taxes are as follows: 1993 -- $129 million; 1992 -- $50 million; and 1991 -- $62 million, before refunds of $26 million.\nNOTE 5 -- EXTRAORDINARY CREDIT\nThe extraordinary credit in 1992 results from early extinguishment of debt. Two of Williams' subsidiaries paid a total of $55.7 million to redeem debt resulting in a $9.9 million net gain (including a $.7 million benefit for income taxes).\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 6 -- EMPLOYEE BENEFIT PLANS\nPensions\nWilliams maintains non-contributory defined-benefit pension plans covering the majority of employees. Benefits are based on years of service and average final compensation. Pension costs are funded to satisfy minimum requirements prescribed by the Employee Retirement Income Security Act of 1974.\nNet pension expense consists of the following:\nDuring 1993, certain supplemental retirement plan participants elected to receive lump-sum benefits, which resulted in a settlement loss of $5.7 million.\nThe following table presents the funded status of the plans.\nAt December 31, 1992, assets of two of Williams' pension plans exceeded the projected benefit obligations by $6 million. However, the preceding table includes pension plans that had projected benefit obligations of $25 million and assets of $12 million in 1992.\nThe discount rate used to measure the present value of benefit obligations is 7 1\/4 percent (8 percent in 1992); the assumed rate of increase in future compensation levels is 5 percent (6 percent in 1992); and the expected long-term rate of return on assets is 10 percent. Plan assets consist primarily of commingled funds and assets held in a master trust. The master trust is comprised primarily of domestic and foreign common and preferred stocks, United States government securities, commercial paper and corporate bonds.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPostretirement benefits other than pensions\nWilliams sponsors a health care plan that provides postretirement medical benefits to retired employees who were employed full time, hired prior to January 1, 1992, have worked five years, attained age 55 while in service with Williams and are a participant in the Williams pension plans. The plan provides for retiree contributions and contains other cost-sharing features such as deductibles and coinsurance. The accounting for the plan anticipates future cost-sharing changes to the written plan that are consistent with Williams' expressed intent to increase the retiree contribution rate annually for the expected general inflation rate for that year. A portion of the cost has been funded in trusts by Williams' FERC-regulated natural gas pipeline subsidiaries to the extent recovery from customers can be achieved. Plan assets consist of assets held in a master trust (previously described) and money market funds.\nEffective January 1, 1993, Williams prospectively adopted FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Williams estimates that application of the standard has reduced 1993 net income by approximately $2 million.\nNet postretirement benefit expense for the year ended December 31, 1993, consists of the following:\nThe estimated expense of providing these benefits to retirees was $8 million in both 1992 and 1991 and included accruals of $4 million in both years for future benefits payable to eligible active employees.\nThe following table presents the funded status of the plan at December 31, 1993:\nThe discount rate used to measure the present value of benefit obligations is 7 1\/4 percent. The expected long-term rate of return on plan assets is 10 percent. The annual assumed rate of increase in the health care cost trend rate for 1994 is 11 to 15 percent, systematically decreasing to 6 percent by 2003. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rate by 1 percent in each year would increase the aggregate of the service and interest cost\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ncomponents of postretirement benefit expense for the year ended December 31, 1993, by $2 million and the accumulated postretirement benefit obligation as of December 31, 1993, by $17 million.\nOther\nWilliams maintains various defined-contribution plans covering substantially all employees. Company contributions are based on employees' compensation and, in part, match employee contributions. Company contributions are invested primarily in Williams common stock. Williams' contributions to these plans were $13 million in 1993, $11 million in 1992 and $9 million in 1991.\nThe Financial Accounting Standards Board has issued a new accounting standard, FAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective for fiscal years beginning after December 15, 1993. The standard, which will be adopted in the first quarter of 1994, requires the accrual of benefits provided to former or inactive employees after employment but before retirement. Application of this standard at December 31, 1993, would have reduced 1993 net income by less than 2 percent.\nNOTE 7 -- INVENTORIES\nIf inventories valued on the LIFO method at December 31, 1992, were valued at current average cost, the balance would be increased by $24 million.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 8 -- PROPERTY, PLANT AND EQUIPMENT\nCommitments for construction and acquisition of property, plant and equipment are approximately $136 million at December 31, 1993.\nNOTE 9 -- ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nUnder Williams' cash-management system, certain subsidiaries' cash accounts reflect credit balances to the extent checks written have not been presented for payment. The amounts of these credit balances included in accounts payable are $53 million at December 31, 1993, and $66 million at December 31, 1992.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 10 -- LONG-TERM DEBT, LEASES AND BANKING ARRANGEMENTS\n- ---------------\n* At December 31, 1993\nUnder Williams' $600 million credit agreement, Northwest Pipeline, Williams Natural Gas and Williams Pipe Line have access to various amounts of the facility while Williams (parent) has access to all unborrowed amounts. The agreement terminates in December 1995 and interest rates vary with current market conditions.\nDuring 1993, Williams sold to financial institutions options to enter into future interest-rate swap agreements on $220 million of fixed-rate debt. Net proceeds of $22 million from the sale of these options have been deferred and are being amortized as a reduction of interest expense over the remaining term of the original debt agreements.\nDuring 1992, Williams entered into interest-rate swap agreements to effectively convert $450 million of fixed-rate debt to variable-rate debt. Subsequently, Williams entered into a forward termination of the agreements, effective March 1993, which resulted in Williams receiving $29 million in net proceeds. This amount has been deferred and is being amortized as a reduction of interest expense over the remaining term of the original agreements.\nTerms of borrowings require maintenance of certain financial ratios, limit the sale or encumbrance of assets and limit the amount of additional borrowings. In addition, certain debt agreements include a restriction on the payment of dividends on common stock and the amount that can be expended to acquire Williams common stock. At December 31, 1993, Williams had $784 million of flexibility under this covenant. Terms of certain subsidiaries' borrowing arrangements with institutional lenders limit the transfer of funds to Williams. Net assets of consolidated subsidiaries at December 31, 1993, are $2.7 billion, of which approximately $818 million is restricted. Undistributed earnings of companies and partnerships accounted for under the equity method of $67 million are included in Williams' consolidated retained earnings at December 31, 1993.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAggregate minimum maturities and sinking-fund requirements, excluding lease payments, for each of the next five years are as follows:\nCash payments for interest (net of amounts capitalized) are as follows: 1993 -- $160 million, 1992 -- $137 million; and 1991 -- $140 million.\nFuture minimum annual rentals under non-cancelable leases are as follows:\nTotal rent expense was $81 million in 1993, $71 million in 1992 and $67 million in 1991. The majority of the future minimum annual rentals for operating leases relates to telecommunications facilities, including those sold and leased back. The leases for facilities sold have primary lease terms ranging from 15 to 20 years with both fixed and fair-market renewal options permitting WilTel to extend the leases to 2012-2019. The leases also have fair-market purchase options at various times.\nNOTE 11 -- STOCKHOLDERS' EQUITY\nThe $2.21 cumulative preferred shares outstanding at December 31, 1993 and 1992, are redeemable by Williams at a price of $25, beginning in September 1997. Dividends per share of $2.21 and $.72 were recorded during 1993 and 1992, respectively.\nDuring 1993, Williams called for redemption of its 3,000,000 shares of outstanding $3.875 convertible exchangeable preferred stock. Substantially all of the preferred shares were converted into 7.6 million shares (on a post-split basis) of Williams common stock. Dividends per share of $.97 in 1993 and $3.875 in 1992 and 1991 were recorded.\nOn September 19, 1993, the board of directors of Williams declared a two-for-one common stock split and distribution; 51.4 million shares were issued on November 5, 1993. All references in the financial statements and notes to the number of shares outstanding and per-share amounts reflect the effect of the split.\nEach outstanding share of common stock has one-half of a preferred stock purchase right attached. Under certain conditions, each right may be exercised to purchase, at an exercise price of $75 (subject to\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nadjustment), one two-hundredth of a share of a new series of junior participating preferred stock. The rights may be exercised only if an Acquiring Person acquires (or obtains the right to acquire) 20 percent or more of Williams common stock; or commences an offer for 30 percent or more of Williams common stock; or the board of directors determines an Adverse Person has become the owner of 10 percent or more of Williams common stock. The rights, which do not have voting rights, expire in 1996 and may be redeemed at a price of $.05 per right prior to their expiration, or within a specified period of time after the occurrence of certain events. In the event a person becomes the owner of more than 20 percent of Williams common stock or the board of directors determines that a person is an Adverse Person, each holder of a right (except an Acquiring Person or an Adverse Person) shall have the right to receive, upon exercise, common stock having a value equal to two times the exercise price of the right. In the event Williams is acquired in a merger or other business combination, each holder of a right (except an Acquiring Person or an Adverse Person) shall have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the right.\nThe 1990 Stock Plan (the Plan) permits granting of various types of awards including, but not limited to, stock options, stock appreciation rights, restricted stock and deferred stock. The Plan provides for granting of awards to key employees, including officers and directors who are employees. Such awards may be granted for no consideration other than prior and future services. The purchase price per share for stock options and stock-appreciation rights may not be less than the fair-market value of the stock on the date of grant. Another stock option plan provides for the granting of non-qualified options to non-employee directors. At December 31, 1993, 5,863,555 shares of common stock were reserved for stock awards, of which 3,200,354 were available for future grants (4,035,718 at December 31, 1992). Options generally become exercisable in three annual installments beginning within one year after grant, and they expire 10 years after grant.\nThe following summary reflects option transactions during 1993.\nUnder the Plan, Williams granted 97,504, 108,920 and 104,060 deferred shares in 1993, 1992 and 1991, respectively, to key employees. Deferred shares are valued at the date of award and generally charged to expense in the year of award. Williams issued 191,007, 70,958 and 2,304 of previously deferred shares in 1993, 1992 and 1991, respectively. Williams also issued 62,000 and 40,000 shares of restricted stock in 1993 and 1992, respectively. Restricted stock is valued on the issuance date, and the related expense is amortized over the vesting period of three to five years.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 12 -- FINANCIAL INSTRUMENTS\nFair value\nThe following methods and assumptions were used by Williams in estimating its fair-value disclosures for financial instruments:\nCASH AND CASH EQUIVALENTS: The carrying amount reported in the balance sheet for cash and cash equivalents approximates fair value due to the short-term maturity of these instruments.\nNOTES RECEIVABLE: For those notes with interest rates approximating market or maturities of less than three years, fair value is estimated to approximate historically recorded amounts. For those notes with maturities beyond three years and fixed interest rates, fair value is calculated using discounted cash flow analysis based on current market rates.\nLONG-TERM DEBT: The fair value of Williams' long-term debt is valued using indicative year-end traded bond market prices for publicly traded issues, while private debt is valued based on the prices of similar securities with similar terms and credit ratings. At December 31, 1993 and 1992, 76 percent and 73 percent, respectively, of Williams' long-term debt was publicly traded. Williams used the expertise of an outside investment banking firm to estimate the fair value of long-term debt.\nCALL OPTIONS SOLD ON INTEREST-RATE SWAPS: Fair value is determined by discounting estimated future cash flows using forward interest rates implied by the year-end yield curve and standard option pricing techniques. Fair value was calculated by the two financial institutions holding the options.\nThe carrying amounts and fair values of Williams' financial instruments are as follows:\nWilliams has recorded liabilities of $37 million and $26 million at December 31, 1993 and 1992, respectively, for certain guarantees that qualify as financial instruments. It is not practicable to estimate the fair value of these guarantees because of their unusual nature and unique characteristics.\nOff-balance-sheet credit and market risk\nWilliams is a participant in numerous transactions and arrangements that involve financial instruments that have off-balance-sheet risk of accounting loss. It is not practicable to estimate the fair value of these off- balance-sheet financial instruments because of their unusual nature and unique characteristics.\nWilliams sells, with limited recourse, certain receivables. The aggregate limit under these receivables facilities was $180 million at December 31, 1993 and 1992. Williams received no additional net proceeds in 1993 and received proceeds of $171 million and $191 million in 1992 and 1991, respectively. At December 31, 1993 and 1992, $35 million and $130 million, respectively, of such receivables had been sold. Under a different arrangement, one of Williams' subsidiaries sold $18 million of receivables with limited recourse in 1992. Based on amounts outstanding at December 31, 1993 and 1992, the maximum contractual credit loss under these arrangements is approximately $37 million and $51 million, respectively, but the likelihood of a loss is remote.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn connection with discontinued operations and the related disposition of certain assets in 1987, Williams guaranteed certain lease rentals sufficient for the purchaser to meet a portion of debt service. At December 31, 1993 and 1992, the maximum possible loss under this arrangement was approximately $15 million and $26 million, respectively, before consideration of future contractual and estimated sublease income, which is expected to be substantial. After consideration of amounts accrued, Williams believes the likelihood of a material loss from this guarantee is remote.\nIn connection with the sale of units in the Williams Coal Seam Gas Royalty Trust (Trust), Williams indemnified the Trust against losses from certain litigation (see Note 14), guaranteed certain minimum ownership interests based on natural gas reserve volumes and guaranteed minimum gas prices through 1997. Williams has a recorded liability of $15 million for these items, representing the maximum amounts for the first two guarantees and an estimate of the gas price exposure based on historical operating trends and an assessment of market conditions. For most of 1993 and at year end, natural gas prices exceeded the contractual minimum guarantee of $1.70 per MMBtu. While Williams' maximum exposure from this guarantee exceeds amounts accrued, it is not practicable to determine such amount because of the unique aspects of the guarantee.\nWilliams has issued other guarantees and letters of credit with off-balance-sheet risk that total approximately $20 million at both December 31, 1993 and 1992. Williams believes it will not have to perform under these agreements because the likelihood of default by the primary party is remote and\/or because of certain indemnifications received from other third parties.\nIn accordance with historical industry practice, Williams' natural gas subsidiaries have gas purchase contracts with commitments to buy minimum quantities of natural gas, primarily at market prices, for varying periods estimated to extend through at least 2014. The subsidiaries currently have or will enter into gas sales contracts for these volumes, or the subsidiaries will negotiate the termination of contracts that are not required to meet gas sales demand (see Note 14).\nWilliams Energy Ventures enters into futures contracts, option agreements and natural gas price-swap agreements for price speculation as described in Note 1. The natural gas price-swap agreements call for Williams Energy Ventures to make payments to (or receive payments from) counterparties based upon the differential between a fixed and variable price or variable prices for different locations. These swap agreements extend for various periods through April 1996. Williams Energy Ventures is the fixed-rate payor and fixed-rate receiver on agreements having notional values of $96 million and $93 million, respectively. In addition, Williams Energy Ventures is the payor and receiver on differential location variable-priced swap agreements having notional values of $196 million and $201 million, respectively. Williams Energy Ventures manages risk from financial instruments by making various logistical commitments which manage profit margins through offsetting financial instruments. As a result, price movements can result in losses on certain contracts offset by gains on others.\nWilliams Energy Ventures takes an active role in managing and controlling market and counterparty risks and has established formal control procedures which are reviewed on an ongoing basis. Williams Energy Ventures attempts to minimize credit-risk exposure to trading counterparties and brokers through formal credit policies and monitoring procedures. In the normal course of business, collateral is not required for financial instruments with credit risk.\nConcentration of credit risk\nWilliams' cash equivalents consist of high quality securities placed with various major financial institutions with high credit ratings. Williams' investment policy limits the company's credit exposure to any one financial institution.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAt December 31, 1993 and 1992, approximately 48 percent and 62 percent, respectively, of receivables are for the sale or transportation of natural gas and related products or services. Approximately 43 percent and 31 percent of receivables at December 31, 1993 and 1992, respectively, are for telecommunications and related services. Natural gas customers include pipelines, distribution companies, producers, gas marketers and industrial users primarily located in the northwestern and central United States. Telecommunications customers include common carriers and numerous corporations. As a general policy, collateral is not required for receivables, but customers' financial conditions and credit worthiness are evaluated regularly.\nNOTE 13 -- OTHER FINANCIAL INFORMATION\nIntercompany revenues (at prices that generally apply to sales to unaffiliated parties) are as follows:\nWilliams Natural Gas had sales to a natural gas distributor that accounted for 11 percent in 1993; 9 percent in 1992; and 12 percent in 1991 of Williams' revenues.\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nInformation for business segments is as follows:\nNOTE 14 -- CONTINGENT LIABILITIES AND COMMITMENTS\nRate and regulatory matters and related litigation\nIn June 1990, a producer brought suit against Williams Natural Gas alleging antitrust and interference with contract claims regarding the transportation of gas and seeking actual, treble and punitive damages and injunctive relief. Williams Natural Gas has denied any liability. In April 1991, Williams Natural Gas was granted summary judgment on the antitrust claim, and at the close of the plaintiff's case, a directed verdict was granted in favor of Williams Natural Gas on the remaining claims. The plaintiff filed an appeal on November 18, 1992.\nIn 1989, the FERC issued an order to Northwest Pipeline instituting a formal investigation related to the assignment of certain gas supply contracts to an affiliate and ordering Northwest Pipeline to show cause why the assignments did not violate certain federal statutes and FERC regulations. Following a hearing, an administrative law judge (ALJ), on May 13, 1993, issued an initial decision finding in Northwest Pipeline's favor. On June 14, 1993, the FERC staff filed a brief taking exceptions to the ALJ's decision. Northwest\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPipeline filed an answering brief and is awaiting a final decision by the FERC. Northwest Pipeline could be subject to civil penalties if it is ultimately determined the assignments violated FERC regulations. Northwest Pipeline believes it has fully complied with all applicable laws and regulations and will continue to challenge any allegations to the contrary.\nWilliams' interstate pipeline subsidiaries, including Williams Pipe Line, have various regulatory proceedings pending. As a result of rulings in certain of these proceedings, a portion of the revenues of these subsidiaries has been collected subject to refund. As to Williams Pipe Line, revenues collected subject to refund were $80 million at December 31, 1993; it is not expected that the amount of any refunds ordered would be significant. Accordingly, no portion of these revenues has been reserved for refund. As to the other pipelines, see Note 9 for the amount of revenues reserved for potential refund as of December 31, 1993.\nIn 1992, the FERC issued Order 636, Order 636-A and Order 636-B. These orders, which have been challenged in various respects by various parties in proceedings pending in the U.S. Court of Appeals for the Eleventh Circuit, require interstate gas pipeline companies to change the manner in which they provide services. Williams Natural Gas implemented its restructuring on October 1, 1993, and Northwest Pipeline implemented its restructuring on November 1, 1993. Certain aspects of each pipeline company's restructuring are under appeal.\nContract reformations and gas purchase deficiencies\nWilliams Natural Gas has undertaken the reformation of its respective gas supply contracts to settle gas purchase deficiencies, avoid future gas purchase deficiencies, reduce prices to market levels or make other appropriate modifications. As of December 31, 1993, Williams Natural Gas had total supplier take-or-pay, ratable-take and minimum-take claims totaling approximately $233 million. This amount includes a take-or-pay claim of $203 million plus interest and ratable-take claims exceeding $23 million plus interest from a producer that Williams Natural Gas believes will be resolved in conformance with an agreement in principle discussed below.\nWilliams Natural Gas also has commitments under gas supply contracts reflecting prices in excess of market-based prices. The estimated commitment amounts at December 31, 1993, attributable to these contracts are:\nNorthwest Pipeline's only remaining significant gas purchase contract with a non-market responsive pricing provision has been assigned to certain customers.\nWilliams has an accounting policy of determining accruals taking into consideration both historical and future gas quantities and appropriate prices to determine an estimated total exposure. This exposure is discounted and risk-weighted to determine the appropriate accrual. The estimated portion recoverable from sales and transportation customers is deferred based on Williams' estimate of its expected recovery of the amounts allowed by FERC policy. As of December 31, 1993, Williams Natural Gas had accrued $66 million for take-or-pay settlements and reformation of the non-market responsive contracts. Although Williams believes these accruals are adequate, the actual amount paid for take-or-pay settlements and contract reformation will depend on the outcome of various court proceedings; the provisions and enforceability of each gas purchase contract; the success of settlement negotiations; and other factors.\nCurrent FERC policy associated with Orders 436 and 500 requires interstate gas pipelines to absorb some of the cost of reforming gas supply contracts before allowing any recovery through direct bill or surcharges to transportation as well as sales commodity rates. Pursuant to FERC Order 500, Northwest Pipeline and\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nWilliams Natural Gas have filed to recover a portion of previously incurred take-or-pay and contract-reformation costs. As of December 31, 1993, these subsidiaries had $66 million included in recoverable contract-reformation and take-or-pay settlement costs, $55 million of which had not yet been paid and filed for recovery with the FERC. Under Orders 636, 636-A and 636-B, costs incurred to comply with these rules are permitted to be recovered in full, although 10 percent of such costs must be allocated to interruptible transportation service.\nThe FERC initially approved a method for Northwest Pipeline to direct bill its contract-reformation costs, but when challenged on appeal, sought a remand to reassess such method. Northwest Pipeline has received an order from the FERC that requires a different allocation of such costs. Northwest Pipeline filed with the FERC several alternative methods to comply with this order and Northwest Pipeline is awaiting the FERC's decision. Northwest Pipeline expects to be permitted to recover these costs in excess of amounts previously charged to expense.\nPursuant to a stipulation and agreement approved by the FERC, Williams Natural Gas has made a cost-sharing direct recovery filing covering amounts that had been paid to producers and in part previously billed to Williams Natural Gas customers under Orders 436, 500 and 528. Williams Natural Gas will make further filings under the stipulation and agreement to recover future contract-reformation payments under those orders and Order 636. Further, Williams Natural Gas has settled all rate issues for the period December 1, 1989, through October 31, 1993. All open processing issues have also been resolved in an unopposed settlement which has been approved by the FERC.\nIn light of Orders 636, 636-A and 636-B, Williams Natural Gas and a producer have agreed to various amendments to an agreement in principle previously reached to reform or terminate its largest gas purchase contract and resolve various other issues. When finalized and approved by various regulatory agencies, the revised agreement will resolve all disputes and litigation between the parties, including a claim by the producer for take-or-pay deficiencies under certain gas purchase contracts with the producer of not less than $203 million plus interest. There is no assurance that the contingencies contemplated by the agreement will be satisfied. However, the parties are fully cooperating in attempting to complete and implement definitive agreements.\nCertain Williams Natural Gas purchase contracts provide for the purchase of minimum volumes or for ratable purchases. In some cases, minimum volumes have not been taken; however, Williams is not currently able to determine Williams Natural Gas' obligations, if any, for failure to do so.\nOther legal matters\nWilliams Natural Gas has identified polychlorinated biphenyl (PCB) contamination in air compressor systems, disposal pits and related properties at certain compressor station sites and has been involved in negotiations with the U.S. Environmental Protection Agency (EPA) to develop additional screening, detailed sampling and cleanup programs. In addition, negotiations concerning investigative and remedial actions relative to potential mercury contamination at certain gas metering sites have commenced with certain environmental authorities. As of December 31, 1993, Williams Natural Gas had recorded a liability for approximately $30 million, representing the current estimate of future environmental cleanup costs to be incurred over the next six to 10 years. Actual costs incurred will depend on the actual number of contaminated sites identified, the actual amount and extent of contamination discovered, the final cleanup standards mandated by the EPA and other governmental authorities and other factors. Williams Natural Gas deferred these costs pending recovery as incurred through future rates and other means.\nIn connection with the 1987 sale of the assets of Agrico Chemical Company, Williams agreed to indemnify the purchaser for environmental cleanup costs resulting from certain conditions at specified\nTHE WILLIAMS COMPANIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nlocations, to the extent such costs exceed a specified amount. It appears probable that such costs will exceed this amount. At December 31, 1993, Williams had approximately $6 million accrued for such excess costs. The actual costs incurred will depend on the actual amount and extent of contamination discovered, the final cleanup standards mandated by the EPA or other governmental authorities, and other factors.\nA lawsuit was filed on May 14, 1993, in a state court in Colorado in which certain claims have been made against various defendants, including Northwest Pipeline, contending that gas exploration and development activities in portions of the San Juan Basin have caused air, water and other contamination. The plaintiffs in the case are seeking certification of a plaintiff class. Northwest Pipeline and the other defendants are vigorously defending the lawsuit.\nOn December 31, 1991, the Southern Ute Indian Tribe (the Tribe) filed a lawsuit against Williams Production Company, a wholly owned subsidiary of Williams, and other gas producers in the San Juan Basin area, alleging that certain coal strata were reserved by the United States for the benefit of the Tribe and that the extraction of coal-seam gas from the coal strata was wrongful. The Tribe seeks compensation for the value of the coal-seam gas. The Tribe also seeks an order transferring to the Tribe ownership of all of the defendants' equipment and facilities utilized in the extraction of the coal-seam gas. Williams Production, together with the other defendants named in the lawsuit, is vigorously defending the lawsuit. Williams Production has agreed to indemnify the Williams Coal Seam Gas Royalty Trust (Trust) against any losses that may arise in respect of certain properties subject to the lawsuit. In addition, if the Tribe is successful in showing that Williams Production has no rights in the coal-seam gas, Williams Production has agreed to pay to the Trust for distribution to then-current unitholders, an amount representing a return of a portion of the original purchase price paid for the units. While Williams believes that such a payment is not probable, it has reserved a portion of the proceeds from the sale of the units in the Trust.\nIn addition to the foregoing, various other proceedings are pending against Williams or its subsidiaries incidental to their operations.\nSummary\nWilliams does not believe that the ultimate resolution of the foregoing matters, taken as a whole and after consideration of amounts accrued, insurance coverage or other indemnification arrangements, will have a materially adverse financial effect upon Williams in the future.\nTHE WILLIAMS COMPANIES, INC.\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data are as follows (millions, except per-share amounts). Certain amounts have been restated as described in Note 1 of Notes to Consolidated Financial Statements.\nThe sum of earnings per share for the four quarters may not equal the total earnings per share for the year due to changes in the average number of common shares outstanding.\nFirst-quarter 1993 includes gains totaling $95 million from the sales of assets (see Note 3 of Notes to Consolidated Financial Statements). Third-quarter 1993 net income was reduced $15 million related to the cumulative effect of the 1 percent increase in the federal income tax rate.\nFirst-quarter 1992 includes a $15 million gain on sale of land. In second-quarter 1992, WilTel recorded loss provisions totaling $11 million, primarily for uncollectible receivables from a significant customer. Second-quarter 1992 net income includes a $10 million extraordinary credit from the early extinguishment of debt (see Note 5 of Notes to Consolidated Financial Statements).\nSelected comparative fourth-quarter data are as follows (millions, except per-share amounts). Certain 1992 amounts have been restated as described in Note 1 of Notes to Consolidated Financial Statements.\nIn fourth-quarter 1993, Williams Field Services Group recorded an $11 million favorable settlement involving processing revenues from prior periods. WilTel's 1993 fourth-quarter operating profit includes favorable adjustments of approximately $6 million relating to bad debt recoveries and accrual reversals. General corporate expenses in the fourth quarter of 1993 include $5 million of additional accruals for supplemental retirement benefits.\nIn fourth-quarter 1992, Williams Field Services Group recorded a total of $8 million for the gain from the sale of a gathering facility and the reversal of certain loss accruals made in prior years.\nPART III\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information regarding the Directors and nominees for Director of Williams required by Item 401 of Regulation S-K is presented under the heading \"Election of Directors\" in Williams' Proxy Statement dated March 25, 1994 (the \"Proxy Statement\"), which information is incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to the Form 10-K. Information regarding the executive officers of Williams is presented following Item 4 herein, as permitted by General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. Information required by Item 405 of Regulation S-K is included under the heading \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Proxy Statement, which information is incorporated by reference herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 402 of Regulation S-K regarding executive compensation is presented under the headings \"Election of Directors\" and \"Executive Compensation and Other Information\" in the Proxy Statement, which information is incorporated by reference herein. Notwithstanding the foregoing, the information provided under the headings \"Compensation Committee Report on Executive Compensation\" and \"Stockholder Return Performance Presentation\" in the Proxy Statement are not incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to the Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information regarding the security ownership of certain beneficial owners and management required by Item 403 of Regulation S-K is presented under the headings \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement, which information is incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to the Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is no information regarding certain relationships and related transactions required by Item 404 of Regulation S-K to be reported in response to this Item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1 and 2. The financial statements and schedules listed in the accompanying index to consolidated financial statements are filed as part of this annual report.\n(a) 3 and (c). The exhibits listed below are filed as part of this annual report.\nExhibit 3 --\n*(a) Restated Certificate of Incorporation of Williams (filed as Exhibit 4(a) to Form 8-B Registration Statement, filed August 20, 1987).\n*(b) Certificate of Designation with respect to the $2.21 Cumulative Preferred Stock (filed as Exhibit 4.3 to the Registration Statement on Form S-3, filed August 19, 1992).\n*(c) Certificate of Increase of Authorized Number of Shares of Series A Junior Participating Preferred Stock (filed as Exhibit 3(c) to Form 10-K for the year ended December 31, 1988).\n*(d) Amended and Restated Rights Agreement, dated as of July 12, 1988, between Williams and First Chicago Trust Company of New York (filed as Exhibit 4(c) to Williams Form 8, dated July 28, 1988).\n*(e) By-laws of Williams (filed as Exhibit 3 to Form 10-Q for the quarter ended September 30, 1993).\nExhibit 4 --\n*(a) Form of Indenture between Williams and The Chase Manhattan Bank (National Association), Trustee, relating to the 9 7\/8% Notes, due 1998 (filed as Exhibit 4.2 to Form S-3 Registration Statement No. 33-20798, filed March 23, 1988).\n*(b) Form of Senior Debt Indenture between the Company and Chemical Bank, Trustee, relating to the 10 1\/4% Debentures, due 2020; the 9 3\/8% Debentures, due 2021; the 8 1\/4% Notes, due 1998; Medium-Term Notes (8.50%-9.31%), due 1996 through 2001; the 7 1\/2% Notes, due 1999, and the 8 7\/8% Debentures, due 2012 (filed as Exhibit 4.1 to Form S-3 Registration Statement No. 33-33294, filed February 2, 1990).\n*(c) U.S. $600,000,000 Credit Agreement, dated as of December 23, 1992, among Williams and certain of its subsidiaries and the banks named therein and Citibank, N.A., as agent (filed as Exhibit 4(d) to Form 10-K for the year ended December 31, 1992).\n*(d) Note Agreement, dated December 15, 1984, among Williams and the lenders named therein (filed as Exhibit 4 to Form 10-K, filed March 27, 1985).\n*(e) Senior Note Agreement, dated as of July 15, 1990, among Williams and the lenders named therein (filed as Exhibit 4(g) to Form 10-K for the year ended December 31, 1991).\nExhibit 10(iii) --\n*(a) The Williams Companies, Inc. Supplemental Retirement Plan, effective as of January 1, 1988 (filed as Exhibit 10(iii)(c) to Form 10-K for the year ended December 31, 1987).\n*(b) Form of Employment Agreement, dated January 1, 1990, between Williams and certain executive officers (filed as Exhibit 10(iii) (d) to Form 10-K for the year ended December 31, 1989).\n*(c) Form of The Williams Companies, Inc. Change in Control Protection Plan between Williams and employees (filed as Exhibit 10(iii) (e) to Form 10-K for the year ended December 31, 1989).\n*(d) The Williams Companies, Inc. 1980 Stock Option Plan (filed as Exhibit I to Form S-8 Registration Statement No. 2-68810, dated August 11, 1980).\n*(e) The Williams Companies, Inc. 1985 Stock Option Plan (filed as Exhibit A to Williams' Proxy Statement, dated March 13, 1985).\n*(f) The Williams Companies, Inc. 1988 Stock Option Plan for Non-Employee Directors (filed as Exhibit A to Williams' Proxy Statement, dated March 14, 1988).\n*(g) The Williams Companies, Inc. 1990 Stock Plan (filed as Exhibit A to Williams' Proxy Statement, dated March 12, 1990).\n*(h) Indemnification Agreement, effective as of August 1, 1986, between Williams and members of the Board of Directors and certain officers of Williams (filed as Exhibit 10(iii) (e) to Form 10-K for the year ended December 31, 1986).\n*(i) The Williams Telecommunications Group, Inc. Long-Term Equity Incentive Plan (filed as Exhibit 10(iii)(i) to Form 10-K for the year ended December 31, 1992).\n*(j) The Williams Telecommunications Group, Inc. Founders Award Plan (filed as Exhibit 10(iii)(j) to Form 10-K for the year ended December 31, 1992).\nExhibit 11 -- Computation of Earnings Per Common and Common-equivalent Share.\nExhibit 12 -- Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements.\nExhibit 20 -- Definitive Proxy Statement of Williams, dated March 25, 1994 (which is not to be deemed \"filed\" as part of this Form 10-K, except to the extent incorporated by reference under Part III of this Form 10-K).\nExhibit 21 -- Subsidiaries of the registrant.\nExhibit 23 -- Consent of Independent Auditors.\nExhibit 24 -- Power of Attorney together with certified resolution.\n(b) Reports on Form 8-K.\nOne report on Form 8-K was filed by Williams with the Securities and Exchange Commission during the last quarter of 1993.\n(d) The financial statements of partially owned companies are not presented herein since none of them individually, or in the aggregate, constitute a significant subsidiary.\n- ---------------\n* Each such exhibit has heretofore been filed with the Securities and Exchange Commission as part of the filing indicated and is incorporated herein by reference.\nTHE WILLIAMS COMPANIES, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS ITEM 14(A) 1 AND 2\nAll other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes thereto.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\nExcept for amounts attributable to Mr. Hirsch, these are demand promissory notes fully payable within three years of date of issuance and secured by Williams' common stock.\nMr. Hirsch's loan was incurred in connection with his relocation; the principal is due in annual installments beginning in 1996-1998, or earlier upon the sale of his residence. The loan is non-interest bearing in accordance with IRS regulations. The amount collected was not settled in cash, but reduced reimbursements of relocation and employee expenses.\nA substantial portion of Mr. Elliott's loan was settled in cash; the remainder was charged to compensation expense.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF INCOME (PARENT)\n- ---------------\n* Certain amounts have been restated or reclassified as described in Note 1.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED)\nBALANCE SHEET (PARENT)\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED)\nSTATEMENT OF CASH FLOWS (PARENT)\n- ---------------\n* Reclassified as described in Note 1.\nSee accompanying notes.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONCLUDED)\nNOTES TO FINANCIAL INFORMATION (PARENT)\nNOTE 1. BASIS OF PRESENTATION\nDuring 1993, Williams (parent) reclassified its income taxes associated with equity earnings from investing income to the credit for income taxes. Prior years' amounts have been reclassified, increasing investing income and decreasing the credit for income taxes by $3.1 million and $3.4 million in 1992 and 1991, respectively.\nOn September 19, 1993, the board of directors of Williams declared a two-for-one common stock split and distribution; 51.4 million shares were issued on November 5, 1993. All references in the financial statements to the number of shares outstanding and per-share amounts reflect the effect of the split.\nNOTE 2. SALES OF ASSETS\nIn a 1993 public offering, Williams sold 6.1 million units in the Williams Coal Seam Gas Royalty Trust (Trust), which resulted in net proceeds of $113 million and a pretax gain of $51.6 million. The Trust owns defined net profits interests in the developed coal-seam properties in the San Juan Basin of New Mexico and Colorado, which were conveyed to the Trust by Williams Production Company for units in the Trust. Williams Production Company transferred its units to Williams (parent). An additional 3.6 million units may be sold by Williams in the future.\nNOTE 3. LONG-TERM DEBT AND LEASES\nAggregate minimum maturities and sinking-fund requirements, excluding lease payments, for each of the next five years are as follows: 1994 -- $11 million; 1995 -- $61 million; 1996 -- $23 million; 1997 -- none; and 1998 -- $210 million.\nFuture minimum annual rentals under non-cancelable capital leases for each of the next five years are $4 million. See Note 10 of Notes to Consolidated Financial Statements for additional information on long-term debt.\nWilliams (parent) has guaranteed the performance and obligations of WilTel for non-cancelable operating leases related to facilities sold and leased back. Future minimum annual lease rentals are as follows: 1994 -- $20 million; 1995 -- $21 million; 1996 -- $22 million; 1997 -- $22 million; 1998 -- $26 million; and an aggregate $110 million thereafter.\nNOTE 4. DIVIDENDS RECEIVED\nCash dividends from subsidiaries and companies accounted for on an equity basis are as follows: 1993 -- $142.6 million; 1992 -- $36 million; and 1991 -- $5 million.\nNOTE 5. INCOME TAX AND INTEREST PAYMENTS\nCash payments for income taxes are as follows: 1993 -- $118 million; 1992 -- $49.6 million; and 1991 -- $59.7 million, before refunds of $25.4 million.\nCash payments for interest are as follows: 1993 -- $96.6 million; 1992 -- $79.2 million; and 1991 -- $65.9 million.\nNOTE 6. FINANCIAL INSTRUMENTS\nDisclosure of financial instruments for the parent company are included in the consolidated disclosures. See Note 12 of Notes to Consolidated Financial Statements.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\n- ---------------\n(a) Primarily relates to additions to mainline transmission facilities.\n(b) Primarily relates to additions to gathering and processing systems.\n(c) Primarily relates to the sale of an intrastate natural gas pipeline system and other related assets in Louisiana.\n(d) Primarily relates to the expansion and enhancement of telecommunication transmission facilities.\n(e) Certain amounts have been reclassified. See Note 1 of Notes to Consolidated Financial Statements.\n(f) Reclassification of certain assets from gathering and processing to transmission.\nNOTE: Principal annual depreciation rates are shown on Schedule VI.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\n- ---------------\n(a) Primarily relates to the sale of an intrastate natural gas pipeline system and other related assets in Louisiana.\n(b) Certain amounts have been reclassified. See Note 1 of Notes to Consolidated Financial Statements.\nNOTE: The principal annual depreciation rates are as follows:\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS(a)\n- ---------------\n(a) Deducted from related assets.\n(b) Represents balances written off, net of recoveries and reclassifications.\n(c) Includes $4.1 million reversal of amounts previously accrued.\n(d) Represents transfers from other accounts.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE IX -- SHORT-TERM BORROWINGS\nThe average amount outstanding was computed based on the average daily balances. The weighted average interest rate was computed by dividing interest accrued by the average amount outstanding.\nTHE WILLIAMS COMPANIES, INC.\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION\n- ---------------\n(a) All other items are not present in amounts sufficient to require disclosure.\nSIGNATURES\nPURSUANT 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.\nTHE WILLIAMS COMPANIES, INC. (Registrant)\nBy: \/s\/ DAVID M. HIGBEE David M. Higbee Attorney-in-Fact\nDated: March 29, 1994\nPURSUANT 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 IN THE CAPACITIES AND ON THE DATES INDICATED.\nII-1\nDated: March 29, 1994\nII-2","section_15":""}
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{"filename":"36090_1993.txt","cik":"36090","year":"1993","section_1":"ITEM 1 BUSINESS\nBANC ONE CORPORATION (\"Registrant\" or \"BANC ONE\") became an Ohio chartered bank holding company in 1989 and was a Delaware chartered holding company from 1968 to 1989. For a description of the Business of BANC ONE refer to \"Corporate Profile\" on the inside front cover of BANC ONE's 1993 Annual Report to Shareholders \"Market Presence by State\" and \"Other Affiliates\" and Note 2, \"Affiliations and Pending Affiliations,\" on pages 20-21 and 29-30 and 80 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nCOMPETITION\nActive competition exists in all principal areas in which BANC ONE or one or more of its subsidiaries is presently engaged, not only with respect to commercial banks, but also with savings and loan associations, credit unions, finance companies, mortgage companies, leasing companies, insurance companies, money market mutual funds and brokerage houses together with other domestic and foreign financial and non-financial institutions such as General Electric, General Motors and Ford.\nEMPLOYEES\nAs of December 31, 1993 BANC ONE and its consolidated subsidiaries had approximately 45,300 full-time equivalent employees.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nBANC ONE leases its principal offices in Columbus, Ohio under several long-term leases expiring at dates ranging from 1994 through 2022. As of December 31, 1993 BANC ONE's affiliate banks had 1,331 banking offices located in Arizona, California, Colorado, Illinois, Indiana, Kentucky, Michigan, Ohio, Oklahoma, Texas, Utah, West Virginia and Wisconsin. BANC ONE and its subsidiaries own or lease various office space, computer centers and warehouses. For additional information see Note 16, \"Leases\" on page 44 and Note 6, \"Bank Premises and Equipment,\" on page 36 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nIn October 1993, a purported class-action lawsuit was filed against Bank One, Columbus, NA (Columbus), H & R Block, Inc. and other financial institutions in the United States District Court for the Northern District of Alabama, Western Division. This lawsuit, among other things, alleges that Columbus assessed usurious and unconscionable interest rates in connection with its income tax refund anticipation loan program. This lawsuit is brought on behalf of a purported class of individuals who, during the past six years, had their taxes prepared by H & R Block Inc., and received refund anticipation loans from Columbus or the other unrelated co-defendant financial institutions. This lawsuit seeks various forms of relief including injunctive relief, unspecified compensatory and punitive damages and attorneys' fees. Columbus has denied any liability. Management believes that an adverse decision in this case would not be material to BANC ONE's consolidated financial position.\nThe dismissal of a purported class action lawsuit against Columbus by the Court of Common Pleas of Philadelphia County, Pennsylvania is on appeal to the Pennsylvania Superior Court. This case was one of many class action lawsuits brought against credit card issuing banks challenging whether such banks can impose various types of fees allowed by the state where they are located on cardholders residing in other states that allegedly limit or prohibit such fees. Even if this lawsuit were ultimately decided adversely to Columbus, management believes that such determination would not be material to BANC ONE's consolidated financial position. There can be no assurance that bank affiliates of BANC ONE will not be named as defendants in future similar lawsuits.\nSubstantial damages have been awarded by courts against BANC ONE subsidiaries in two other unrelated cases. In October 1993, the Federal District Court for the Southern District of New York entered a judgment for approximately $27 million against Bank One, Arizona, NA (formerly Valley National Bank) based upon alleged violations by Valley National Bank of the Employee Retirement Income Security Act of 1974. BANC ONE was aware of this case prior to its acquisition of Valley National Bank. In November 1993, the Probate Court of Dallas County, Texas entered a judgment of approximately $26 million against Bank One, Texas, NA (Texas) based on an alleged breach of fiduciary duties associated with the handling of a personal trust. Those judgments, which are being appealed, even if upheld will not have a material adverse effect on BANC ONE's consolidated financial position.\nExcept as stated above neither BANC ONE nor any of its subsidiaries is involved in any material legal proceedings outside the normal course of its business. Similarly, no property owned by any said entities is the subject of any material legal proceeding.\nITEM 4","section_4":"ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter 1993 no matters were submitted to a vote by security holders.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nSee \"Financial Highlights\" and \"Stock Listing\" on page 21, \"Consolidated Quarterly Financial Data\" on pages 60 and 61, Notes 10, 11, 12, and 19 on pages 38, 39 and 48, \"Five Year Performance Summary\" on page 53 and \"Ten Year Performance Summary\" on pages 54 and 55 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nSee \"Five Year Performance Summary\" and \"Ten Year Performance Summary\" on pages 53 through 55 and Note 2 of \"Notes to Financial Statements\" on pages 29 through 30 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSee \"Management's Discussion and Analysis\" on pages 63 through 79, \"Five Year Summary-Average Balances, Income and Expense, Yields and Rates\" on pages 56 and 57, \"Rate-Volume Analysis\" on page 62, \"Reserve for Loan and Lease Losses\" on page 58, \"Loan and Lease Analysis\" on page 59 and \"Consolidated Quarterly Financial Data\" on pages 60 and 61 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee \"Consolidated Financial Statements\" on pages 22 through 52, and \"Consolidated Quarterly Financial Data\" on pages 60 and 61 of the 1993 Annual Report to Shareholders, which are expressly incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nRegistrant has had no disagreement on accounting and financial disclosure matters and has not changed accountants during the two year period ending December 31, 1993.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDirectors and executive officers of the Registrant include those persons enumerated under \"Election of Directors\" and \"Directors Fees and Compensation\" in the Definitive Proxy Statement for the BANC ONE CORPORATION Annual Meeting to be held April 19, 1994, these portions of which are expressly incorporated herein by reference. Executive officers as of March 1, 1994 are set forth below. Unless otherwise designated, they are officers of Banc One Corporation: Others hold the positions indicated in wholly owned subsidiaries.\nAll market transactions in BANC ONE's securities by its Directors and Executive Officers during 1993 were reported promptly and correctly under the Securities and Exchange Commission's rules relating to the reporting of securities transactions by directors and officers, with the exception of the reports noted in \"Certain Reports\" in the Definitive Proxy Statement for the BANC ONE CORPORATION Annual Meeting to be held April 19, 1994, those portions of which are expressly incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nSee \"Election of Directors\", \"Directors Fees and Compensation\" and the following sections of \"Executive Compensation\" (Summary Annual Compensation, 1989 Stock Incentive Plan and Retirement Benefits on pages 8-11 and 13-14) in the Definitive Proxy Statement for the BANC ONE CORPORATION Annual Meeting to be held April 19, 1994, these portions of which are expressly incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee \"Election of Directors\" and \"Ownership of Shares\" in the Definitive Proxy Statement for the BANC ONE CORPORATION Annual Meeting to be held April 19, 1994, these portions of which are expressly incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Transactions with Management and Owners\" in the Definitive Proxy Statement for the BANC ONE CORPORATION Annual Meeting to be held April 19, 1994, this portion of which is expressly incorporated herein by reference, and Note 20 \"Related Party Transactions\" included in the 1993 Annual Report to shareholders, which is expressly incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nBANC ONE CORPORATION and Subsidiaries\nNo schedules are included because they are not required, not applicable, or the required information is contained elsewhere.\nReport on Form 8K filed November 9, 1993 announcing the acquisition of Liberty National Bancorp, Inc., and other pending acquisitions. (June 30, 1993 financial information)\nReport on Form 8K filed November 16, 1993 announcing a purported class-action lawsuit alleging that the Bank assessed usurious and unconscionable interest rates in connection with its refund anticipation loan progam.\nReport on Form 8K filed November 24, 1993 announcing the acquisition of Liberty National Bancorp, Inc., and other pending acquisitions. (September 30, 1993 financial information)\nINDEX TO EXHIBITS\nThere are no agreements with respect to long-term debt of the Registrant to authorize securities in an amount which exceeds 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of any agreement with respect to long-term debt of the Registrant to the Securities and Exchange Commission upon request.\nSIGNATURES\nPursuant 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.\nBANC ONE CORPORATION\nPursuant 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 and on the dates indicated.","section_15":""}
{"filename":"821130_1993.txt","cik":"821130","year":"1993","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nUnited States Cellular Corporation (the \"Company\") is engaged through subsidiaries and joint ventures primarily in the development and operation of and in the acquisition of interests in cellular telephone markets (\"cellular markets\"). The Company is a majority-owned subsidiary of Telephone and Data Systems, Inc. (\"TDS\"), an Iowa corporation.\nThe Company acquires, manages, owns, operates and invests in cellular systems throughout the United States. As of December 31, 1993, the Company owned or had the right to acquire interests in Metropolitan Statistical Areas (\"MSAs\") and Rural Service Areas (\"RSAs\") representing approximately 23.7 million population equivalents in a total of 205 markets. The Company is the seventh largest cellular telephone company in the United States, based on the aggregate number of population equivalents it owns or has the right to acquire. The Company's corporate development strategy is to acquire controlling interests in MSA and RSA licensees in areas adjacent to or in proximity to its other markets in order to build clusters. The Company anticipates that clustering markets will expand its cellular service areas while enabling it to achieve marketing and advertising benefits and to achieve economies in certain capital and operating costs.\nThe following table summarizes the status of the Company's interests in cellular markets at December 31, 1993.\nThe Company served 293,000 customers at December 31, 1993, through 614 cells in 136 managed markets. The average penetration rate (i.e., the percentage of total population of a market represented by customers) in the Company-managed markets was 1.33% at December 31, 1993. The churn rate, or the portion of the Company's customers discontinuing service each month, averaged 2.3% per month during the twelve months ended December 31, 1993. The Company's 116 majority-owned and managed (\"consolidated\") markets served 261,000 customers at December 31, 1993, through 522 cells. The average penetration rate in the consolidated markets was 1.35% at December 31, 1993, and the churn rate in all consolidated markets averaged 2.3% per month for the twelve months ended December 31, 1993.\nThe Company, or TDS for the benefit of the Company, has entered into agreements with third parties to acquire cellular interests which generally require the issuance of securities of the Company or TDS securities. In connection with agreements that require the delivery of TDS securities, the Company reimburses TDS for TDS securities issued to third parties as consideration for the acquisitions.\nIf all acquisitions pending at December 31, 1993, are completed as planned, the Company will issue approximately 3.7 million Common Shares to TDS at or near the respective closing dates of each of these acquisitions and approximately 49,000 Common Shares to third parties. In addition, approximately 5.0 million Common Shares are issuable to third parties at December 31, 1993, in connection with completed acquisitions. At December 31, 1993, the Company also had 197,000 outstanding shares of Preferred Stock, all held by TDS, which are redeemable by the delivery of 1.2 million Common Shares between 1994 and 1996. Certain TDS Preferred Shares delivered in connection with the Company's acquisitions are also redeemable by the delivery of an additional 1.1 million USM Common Shares between 1994 and 1996. The aggregate of 11.0 million Common Shares committed for issuance in future years are scheduled to be issued as follows: approximately 6.8 million shares by March 21, 1994, 1.2 million shares in the remainder of 1994, 1.6 million shares in 1995 and 1.4 million shares in 1996.\nTDS owned an aggregate of 59,548,450 shares of common stock of the Company at December 31, 1993, representing over 85% of the combined total of the Company's outstanding Common and Series A Common Shares and over 97% of their combined voting power. Assuming the Company's Common Shares are issued in all instances in which the Company has the choice to issue its Common Shares or other consideration and assuming all other issuances of the Company's common stock to TDS and third parties for completed and pending acquisitions and redemptions of the Company's Preferred Stock and TDS's Preferred Shares had been completed at December 31, 1993, TDS would have owned approximately 79.5% of the total outstanding common stock of the Company and controlled over 95% of the combined voting power of both classes of its common stock. In the event TDS's ownership of the Company falls below 80% of the total value of all of the outstanding shares of the Company's stock, TDS and the Company would be deconsolidated for federal income tax purposes. TDS and the Company have the ability to defer or prevent deconsolidation, if deferring or preventing deconsolidation would be advantageous, by delivering TDS Common Shares and\/or cash, in lieu of the Company's Common Shares in connection with certain acquisitions.\nThe Company was incorporated in Delaware in 1983. The Company's executive offices are located at 8410 West Bryn Mawr, Chicago, Illinois 60631. Its telephone number is 312-399-8900. The Common Shares of the Company are listed on the American Stock Exchange under the symbol \"USM.\"\nUnless the context indicates otherwise: (i) references to the \"Company\" refer to United States Cellular Corporation and its subsidiaries; (ii) references to \"MSA\" or to a particular city refer to the Metropolitan Statistical Area, as designated by the U.S. Office of Management and Budget and used by the Federal Communications Commission (\"FCC\") in designating metropolitan cellular market areas; (iii) references to \"RSA\" refer to the Rural Service Area, as used by the FCC in designating non-MSA cellular market areas; (iv) references to cellular \"markets\" or \"systems\" refer to MSAs, RSAs or both; (v) references to \"population equivalents\" mean the population of a market, based on 1993 Donnelley Marketing Service Estimates, multiplied by the percentage interests that the Company owns or has the right to acquire in an entity licensed, designated to receive a license or expected to receive a construction permit (\"licensee\") by the FCC to construct or operate a cellular system in such market.\nREGULATORY DEVELOPMENTS\nThe operations of the Company are subject to FCC and state regulation. The licenses held by the Company which are granted by the FCC for the use of radio frequencies are an important component of the overall value of the assets of the Company. As discussed here, recent Congressional legislation and related FCC regulatory proceedings may have significant impact on some or all of its operations by altering FCC and state regulatory responsibilities for mobile service, the procedures for the award by the FCC of licenses to conduct existing and new mobile services, the terms and conditions of business relationships between mobile service providers and Local Exchange Carriers (\"LECs\") and the scope of the competitive opportunities available to mobile service providers.\nThe Omnibus Reconciliation Act of 1993 (the \"Budget Act\"), which became effective in August 1993, amended the Communications Act of 1934 (the \"Communications Act\") by eliminating legislatively enacted distinctions affecting FCC and state regulation of common carrier and private carrier mobile operations and directed the FCC to classify all mobile services, including cellular, paging, Specialized Mobile Radio (\"SMR\") and other services under two categories: Commercial Mobile Radio Services (\"CMRS\"), subject to common carrier regulation; or Private Mobile Radio Services (\"PMRS\"), not subject to common carrier regulation. At its February 3, 1994 public meeting, the FCC adopted a decision classifying mobile service offerings as CMRS operations if they include a service offering to the public, for a fee, which is interconnected to the public switched network. Cellular, SMR and paging, among other services, will be classified as CMRS if they fit this definition. In addition, the FCC decision establishes a regulatory precedent for hybrid CMRS\/PMRS regulation of mobile operations which offer both CMRS service and PMRS service. The Company anticipates that its service offerings will be classified as CMRS. The FCC decision also states that it would forebear from requiring that CMRS providers comply with a number of statutory provisions, otherwise applicable to common carriers, such as the filing of tariffs. It requires LECs to provide reasonable and fair interconnection to all CMRS providers, subject to mutual compensation, reasonable charges for interstate interconnection and reasonable forms of interconnection. Because the text of the FCC's decision has only recently been released and addresses many complex and interrelated aspects of regulatory policy, the impact of these aspects of the FCC proceedings on the Company cannot be predicted with certainty.\nThe Budget Act also amended the Communications Act to authorize the FCC to use a system of competitive bidding to issue initial licenses for the use of radio frequencies for which there are mutually exclusive applications and where the principal use of the license will be to offer service in return for compensation from customers. At its March 8, 1994 public meeting, the FCC adopted a decision, the text of which has not yet been released, that establishes generic rules for competitive bidding, defines eligibility criteria for small businesses, minority-and female-owned businesses and rural telephone companies which qualify for preferential bidding treatment, as required under the Budget Act, and describes the bidding mechanisms to be used by businesses qualifying for preferential treatment in future spectrum auctions. The FCC deferred adoption of the competitive bidding rules for specific licensing situations.\nUnder other amendments to the Communications Act included in the Budget Act, states will generally be prohibited from regulating the entry of, or the rates charged by, any CMRS provider. The new law does not, however, prohibit a state from regulating other terms and conditions of CMRS offerings and permits states to petition the FCC for authority to continue rate regulation. These new statutory provisions will take effect in August 1994.\nOn September 23, 1993, the FCC decided to allocate seven Personal Communications Services (\"PCS\") frequency blocks for licensing, in the aggregate 120 Megahertz (\"MHz\") of spectrum for licensed operations, and an additional 40 MHz for unlicensed operations, including uses such as telephone PBX and wireless local area network operations. Two 30 MHz frequency blocks will be awarded for each of the 51 Rand McNally Major Trading Areas, while one 20 MHz and four 10 MHz frequency blocks will be awarded for each of the 492 Rand McNally Basic Trading Areas. Cellular operators will be permitted to participate in the award of these new PCS licenses, which will be made via a yet-to-be-defined auction process, except for licenses reserved for rural, small, minority-and female- owned businesses and licenses for markets in which such cellular operator owns a 20% or greater interest in a cellular licensee which holds a license covering 10% or more of the population of the\nrespective PCS licensed area. In the latter case, the cellular licensee is limited to one 10 MHz PCS channel block. Numerous requests for reconsideration of the FCC's decision have been filed and remain pending before the FCC. In its March 8, 1994 decision referenced above, the FCC presumptively classified PCS as CMRS. The FCC has not adopted specific competitive bidding rules for the initial licensing of PCS spectrum or established a schedule for the commencement of PCS auctions.\nPCS technology is currently under development and is expected to be similar in some respects to cellular technology. When offered commercially, this technology is expected to offer increased capacity for wireless two-way and one-way voice, data and multimedia communications services and is expected to result in increased competition in the Company's operations. The ability of these future PCS licensees to complement or compete with existing cellular licensees is uncertain and may be affected by future FCC rule-making. These and other future technological developments in the wireless telecommunications industry and the enhancement of current technologies will likely create new products and services that are competitive with the services currently offered by the Company. There can be no assurance that the Company will not be adversely affected by such technological developments.\nCELLULAR TELEPHONE OPERATIONS\nTHE CELLULAR TELEPHONE INDUSTRY. The cellular telephone industry has been in existence for approximately eleven years in the United States. Although the industry is still relatively new, it has grown significantly during this period. According to the Cellular Telecommunications Industry Association, at December 31, 1993, there were estimated to be over 16 million cellular customer units in service in the United States, generating nearly $11 billion of revenue per year. Cellular service is now available throughout the United States. The commercial feasibility of cellular systems in the United States has not, however, been proven over a long period of time.\nCellular telephone technology provides high-quality, high-capacity communications services to in-vehicle cellular telephones and hand-held portable cellular telephones. Cellular technology is a major improvement over earlier mobile telephone technologies. Cellular telephone systems are designed to allow for maximum mobility of the customer. In addition to mobility, cellular telephone systems provide access through system interconnections to local, regional, national and world-wide telecommunications networks. Cellular telephone systems also offer a full range of ancillary services such as conference calling, call-waiting, call-forwarding, voice mail, facsimile and data transmission.\nCellular telephone systems divide each service area into smaller geographic areas or \"cells.\" Each cell is served by radio transmitters and receivers operating on discrete radio frequencies licensed by the FCC. All of the cells in a system are connected to a computer-controlled Mobile Telephone Switching Office (\"MTSO\"). The MTSO is connected to the conventional (\"landline\") telephone network. Each conversation on a cellular phone involves a transmission over a specific range of radio frequencies from the cellular phone to a transmitter\/receiver at a cell site. The transmission is forwarded from the cell site to the MTSO and from there may be forwarded to the landline telephone network to complete the call. As the cellular telephone moves from one cell to another, the MTSO determines radio signal strength and transfers (\"hands off\") the call from one cell to the next. This hand-off is not noticeable to either party on the phone call.\nThe Company provides cellular telephone service under licenses granted by the FCC. The FCC grants only two licenses to provide cellular telephone service in each market. However, competition for customers includes competing communications technologies such as conventional landline and mobile telephone, SMR systems and radio paging. In addition, emerging technologies such as Enhanced Specialized Mobile Radio (\"ESMR\"), mobile satellite communication systems, second generation cordless telephones (\"CT-2\") and PCS may prove to be competitive with cellular service in the future in some or all of the markets where the Company has operations.\nThe services available to cellular customers and the sources of revenue available to cellular system operators are similar to those provided by conventional landline telephone companies. Customers are charged a separate fee for system access, airtime, long-distance calls, and ancillary services.\nTechnical standards require that analog cellular telephones be compatible with all cellular systems in all market areas in the United States. Because of this compatibility feature, cellular system operators\noften provide service to customers of other operators' cellular systems while the customers are temporarily located within the operators' service areas. Customers using service away from their home system are called \"roamers.\" The system that provides the service to these roamers will generate usage revenue. Many operators, including the Company, charge premium rates for this roaming service.\nThere are a number of recent technical developments in the cellular industry. Currently, while most of the MTSOs process information digitally, most of the radio transmission is done on an analog basis. Digital radio technology offers advantages, including less transmission noise, greater system capacity, and potentially lower incremental costs for additional customers. The conversion from analog to digital radio technology is expected to be an industry-wide process that will take a number of years.\nDuring 1992, a new transmission technique was approved for implementation by the cellular industry. Time Division Multiple Access (\"TDMA\") technology was selected as one industry standard by the cellular industry and has been deployed in several markets, including the Company's operations in Tulsa, Oklahoma. However, another digital technology, Code Division Multiple Access (\"CDMA\"), is expected to be in a commercial trial by the end of 1994. The Company expects to deploy some digital radio channels in other markets in the near future.\nThe cellular telephone industry is characterized by high initial fixed costs. Accordingly, if and when revenues less variable costs exceed fixed costs, incremental revenues should yield an operating profit. The amount of profit, if any, under such circumstances is dependent on, among other things, prices and variable marketing costs which in turn are affected by the amount and extent of competition. Until technological limitations on total capacity are approached, additional cellular system capacity can normally be added in increments that closely match demand and at less than the proportionate cost of the initial capacity.\nTHE COMPANY'S OPERATIONS. The Company is building a substantial presence in selected geographic areas throughout the United States where it can efficiently integrate and manage cellular telephone systems. Its cellular interests include market clusters in the Northern Florida, Eastern Tennessee\/Western North Carolina, Eastern North Carolina\/Virginia, Maine\/New Hampshire\/Vermont, West Virginia\/Pennsylvania\/Maryland, Indiana\/Kentucky, Iowa, Wisconsin\/Illinois\/Minnesota, Oklahoma, Missouri, Southwestern Texas, Texas\/Oklahoma, Oregon\/California and Washington\/Idaho areas. See \"The Company's Cellular Interests.\" The Company has acquired its cellular interests through the wireline application process (22%), including settlements and exchanges with other applicants, and through acquisitions (78%), including acquisitions from TDS and third parties.\nManagement plans to retain minority interests in certain cellular markets which it believes will earn a favorable return on investment. Other minority interests may be traded for interests in markets which enhance the Company's market clusters or may be sold for cash or other consideration.\nCERTAIN CONSIDERATIONS REGARDING CELLULAR TELEPHONE OPERATIONS\nSince its inception in 1983, the Company has principally been in a start-up phase in which its activities have been concentrated significantly on the acquisition of interests in entities licensed or designated to receive a license (\"licensees\") from the FCC to provide cellular service and on the construction and initial operation of cellular systems. The development of a cellular system is capital-intensive and requires substantial investment prior to and subsequent to initial operation. The Company has experienced operating losses and net losses in all but a few quarters since its inception. The Company may incur operating losses for the next few quarters, and there is no assurance that future operations, individually or in the aggregate, will be profitable.\nThe licensing (including renewal of licenses), construction, operation, sale, interconnection arrangements and acquisition of cellular systems are regulated by the FCC and various state public utility commissions. Changes in the regulation of cellular operators or their activities and of other mobile service providers (such as the decision by the FCC to permit PCS licensees) could have a material adverse effect on the Company's operations. See \"Legal Proceedings -- La Star Application\" for a discussion of certain FCC proceedings which have suspended the Company's and TDS's licensing authority in a Wisconsin market pending the outcome of an FCC hearing.\nThe number of population equivalents represented by the Company's cellular interests bears no direct relationship to the number of potential cellular customers or the revenues that may be realized from the operation of the related cellular systems. The fair market value of the Company's cellular interests will ultimately depend on the success of its operations. There is no assurance that the value of cellular interests will not be significantly lower in the future than at present.\nWhile there are numerous cellular systems operating in the United States and other countries, the industry has only a limited operating history. As a result, there is uncertainty regarding its future, including, among other factors: (i) the growth in customers; (ii) the usage and pricing of cellular services; (iii) the percentage of customers who terminate service each month (the \"churn rate\"); (iv) the cost of providing cellular services, including the cost of attracting new customers; and (v) continuing technological advances which may provide competitive alternatives.\nMedia reports have suggested that certain radiofrequency (\"RF\") emissions from portable cellular telephones might be linked to cancer. The Company has reviewed relevant scientific information and, based on such information, is not aware of any credible evidence linking the usage of portable cellular telephones with cancer. The FCC currently has a rulemaking proceeding pending to update the guidlines and methods it uses for evaluating RF emissions in radio equipment, including cellular telephones. While the proposal would impose more restrictive standards on RF emissions from low-power devices such as portable cellular telphones, it is anticipated that all cellular telephones currently marketed and in use will comply with those standards.\nCELLULAR SYSTEMS DEVELOPMENT\nACQUISITIONS. During the last three years, the Company has aggressively expanded its size, particularly in markets which share adjacency, through an ongoing acquisition program aimed at strengthening the Company's position in the cellular industry. This growth has resulted primarily from acquisitions of interests in RSAs and has been based on obtaining interests with rights to manage the underlying market.\nIncluding transfers of RSA interests from TDS, the Company has nearly tripled its population equivalents from approximately 8.0 million at December 31, 1988, to approximately 23.7 million at December 31, 1993. Similarly, markets managed or to be managed by the Company have increased from 33 markets at December 31, 1988, to 144 markets at December 31, 1993. As of December 31, 1993, almost 86% of the Company's population equivalents represented interests in markets the Company manages or expects to manage, compared to 62% at December 31, 1988.\nThe Company seeks and is currently negotiating for the acquisition of additional cellular interests and plans to acquire significant additional cellular interests in markets that complement its developing market clusters and in other attractive markets. The Company also seeks to acquire minority interests in markets where it already owns (or has the right to acquire) the majority interest. At the same time the Company continues to evaluate the disposition of interests which are not essential to its corporate development strategy.\nThe Company will ordinarily make acquisitions using securities or cash or by exchanging cellular interests it already owns. There is no assurance that the Company will be able to purchase any additional interests, or that any such additional interests, if purchased, will be purchased on terms that are favorable to the Company.\nThe Company, or TDS for the benefit of the Company, has negotiated acquisitions of cellular interests from third parties primarily in consideration for the Company's Common Shares or TDS's Common or Preferred Shares. Cellular interests acquired by TDS are generally assigned to the Company. At that time, the Company reimburses TDS for the value of TDS securities issued in such transactions, generally by issuing Common Shares and Preferred Stock (redeemable by the delivery of Common Shares) to TDS or by increases to the balance due TDS under the Company's Revolving Credit Agreement in amounts equal to the value of TDS capital stock at the time the acquisitions are closed. The fair market value of the Common Shares and Preferred Stock issued to TDS in connection with these transactions is equal to the fair market value of the TDS securities issued in the transactions and is determined at the time the transactions are closed.\nIn cases where the Company's Common Shares are used as consideration in connection with acquisitions, most of the agreements call for such shares to be delivered in 1994 and later years. In a limited number of transactions, the Company has agreed to pay some portion of the purchase price in cash.\nCOMPLETED ACQUISITIONS. During 1993, the Company completed the acquisition of controlling interests in 25 markets and several additional minority interests representing approximately 3.8 million population equivalents for an aggregate consideration of $284.6 million. The consideration consisted of 5.7 million of the Company's Common Shares, 75,000 of the Company's Series A Common Shares, an increase in the debt to TDS under the Revolving Credit Agreement of $101.5 million, $12.7 million in cash, cash paid by TDS of $9.4 million (treated as an equity contribution to the Company), and the obligation to deliver approximately 140,000 of the Company's Common Shares to third parties in 1994. The debt under the Revolving Credit Agreement and 5.5 million of the Company's Common Shares were issued to TDS to reimburse TDS for TDS Common Shares issued and cash paid to third parties in connection with these acquisitions.\nIncluded in the above transactions is the transfer of a minority interest in one RSA from TDS, representing 35,000 population equivalents. The consideration consisted of the issuance of 31,000 of the Company's Common Shares and 75,000 of the Company's Series A Common Shares to TDS. The Company's Common and Series A Common Shares have been recorded at TDS's book value of the RSA interests transferred, rather than the fair market value of the shares, due to the intercompany nature of the transaction.\nPENDING ACQUISITIONS. At December 31, 1993, the Company, or TDS for the benefit of the Company, had entered into agreements to acquire controlling interests in nine markets and a minority interest representing approximately 1.2 million population equivalents for an aggregate consideration estimated to be approximately $128.4 million. If all of the pending acquisitions are completed as planned, the Company will issue approximately 49,000 of its Common Shares and will pay approximately $4.5 million in cash. TDS will pay approximately $123.0 million in TDS Common Shares and cash. Any interests acquired by TDS in these transactions are expected to be assigned to the Company and at that time, the Company will reimburse TDS for TDS's consideration delivered and costs incurred in such acquisitions in the form of Common Shares of the Company or increases in the balance under the Revolving Credit Agreement. Based on the estimated value of the consideration at the time the agreements were entered into, the Company expects to reimburse TDS by issuing 3.7 million of the Company's Common Shares to TDS and by increasing the balance due TDS under the Revolving Credit Agreement by $400,000.\nIn addition to the agreements discussed above, the Company has agreements to acquire interests representing 302,000 population equivalents in three markets. The consideration for these acquisitions will be determined based on future appraisals of the fair market values of the interests to be acquired. All population equivalents acquirable pursuant to these agreements and the agreements in the previous paragraph are included in the table on pages 11 to 14.\nIn addition to the acquisitions completed in 1993 and the pending acquisitions discussed above, the Company had commitments at December 31, 1993 to issue 4.8 million Common Shares in connection with acquisitions completed prior to 1993. Approximately 3.8 million of these shares were issued in early 1994. The Company also had Preferred Stock outstanding (all of which is held by TDS) which is redeemable into 1.2 million of the Company's Common Shares in 1994 through 1996. Certain series of TDS Preferred Shares are redeemable into an additional 1.1 million of the Company's Common Shares in 1994 through 1996.\nThe Company maintains shelf registration of its Common Shares and Preferred Stock under the Securities Act of 1933 for issuance specifically in connection with acquisitions.\nCELLULAR INTERESTS AND CLUSTERS\nThe Company operates clusters of adjacent cellular systems, enabling its customers to benefit from a larger service area than otherwise possible. The Company's strategy was initially implemented by filing for licenses to operate cellular systems in MSAs. Following the MSA lotteries and settlements, the Company acquired interests in certain additional MSAs through purchases. The Company has acquired\nsubstantial additional population equivalents through the purchase of interests in RSAs. The Company plans to continue to acquire controlling interests in cellular licenses to provide service in systems that complement its developing market clusters and in other attractive systems.\nThe Company anticipates that clustering markets will expand its cellular service areas and provide certain economies in its capital and operating costs. In areas where the Company has clusters of contiguous markets it may offer wide-area coverage. This would allow uninterrupted service within the area and allow the customer to make outgoing and receive incoming calls without special roamer arrangements. Clustering also makes possible greater sharing of facilities, personnel and other costs and may thereby reduce the costs of serving each customer. The extent to which these revenue enhancements and economies of operation will be realized through clustering is dependent upon market conditions, population sizes of the clusters and engineering considerations.\nThe Company's market clusters have grown rapidly. At December 31, 1993, approximately 87%, or 17.7 million, of the Company's managed population equivalents were in contiguous markets within market clusters. Additionally, 92% of the Company's managed markets were adjacent to another Company-managed market at that time. The Company anticipates continuing to pursue strategic acquisitions and trades in order to complement its developing market clusters. The Company has also acquired minority interests in markets where it already owns, or has the right to acquire, a majority interest. From time to time, the Company may consider trading or selling some of its cellular interests which do not fit well with its long-term strategies.\nThe Company owned or had the right to acquire interests in cellular telephone systems in 205 markets at December 31, 1993. At December 31, 1993, approximately 86%, or 20.4 million, of the Company's population equivalents were in markets that the Company manages or expects to manage. At that date, approximately 95% of the Company's managed population equivalents were in markets where cellular service has been initiated and where the Company is currently operating the system. The following table summarizes the growth in the Company's population equivalents in recent years and the development status of these population equivalents.\nThe following section details the Company's cellular interests, including those it owned or had the right to acquire as of December 31, 1993. The table presented therein lists clusters of markets, including both MSAs and RSAs, that the Company operates or anticipates operating. The Company's market clusters show the areas in which the Company is currently focusing its development efforts. These clusters have been devised with a long-term goal of allowing delivery of cellular service to areas of economic interest and along corridors of economic activity.\nTHE COMPANY'S CELLULAR INTERESTS\nThe table below sets forth certain information with respect to the interests in cellular markets which the Company owned or had the right to acquire pursuant to definitive agreements as of December 31, 1993.\nSYSTEM DESIGN AND CONSTRUCTION. The Company designs and constructs its systems in a manner it believes will permit it to provide high-quality service to mobile, transportable and portable cellular telephones, generally based on market and engineering studies which relate to specific markets. Engineering studies are performed by Company personnel or independent engineering firms. The Company's switching equipment is digital, which reduces noise and crosstalk and is capable of interconnecting in a manner which reduces costs of operation. While digital microwave interconnections are typically made between the MTSO and cell sites, primarily analog radio transmission is used between cell sites and the cellular telephones themselves.\nIn accordance with its strategy of building and strengthening market clusters, the Company has selected high capacity with service-upgraded digital cellular switching systems that are capable of serving multiple markets via a single MTSO. The Company's cellular systems are designed to facilitate the installation of equipment which will permit microwave interconnection between the MTSO and each cell site. The Company has implemented such microwave interconnection in most of the cellular systems it manages. In other systems in which the Company owns or has an option to purchase a majority interest and where it is believed to be cost-efficient, such microwave technology will also be implemented. Otherwise, such systems will rely upon landline telephone connections or microwave links owned by others to link cell sites with the MTSO. Although the installation of microwave network interconnection equipment requires a greater initial capital investment, a microwave network enables a system operator to avoid the current and future charges associated with leasing telephone lines from the landline telephone company, while generally improving system reliability. In addition, microwave facilities can be used to connect separate cellular systems to allow shared switching, which reduces the aggregate cost of the equipment necessary to operate both systems.\nThe Company has continued to expand its internal, nationwide seamless network in 1993 to encompass over 100 markets in the United States. This network provides automatic call delivery for the Company's customers and handoff between adjacent markets. The seamless network has also been extended, using IS-41 technology, via links with certain systems operated by several other carriers, including GTE, US West, Ameritech, BellSouth, Centennial Cellular Corp., Southwestern Bell, McCaw Cellular Communications, Vanguard Cellular Systems, Inc. and others. Additionally, the Company has conducted Signaling System 7 field trials with AT&T and with Independent Telephone Network to determine the most viable approach to establish a backbone network that will enable the Company to interface with other national networks.\nDuring 1994, the Company expects to significantly extend the seamless network for its customers into additional areas in Texas, Arkansas, Indiana, Idaho, Utah, California, Louisiana, Massachusetts, Washington, Florida and several other states. Not only will this expanded network increase the area in which customers can automatically receive incoming calls, but it will also reduce the incidence of fraud due to the pre-call validation feature of the IS-41 technology.\nManagement believes that currently available technologies will allow sufficient capacity on the Company's networks to meet anticipated demand over the next few years.\nCOSTS OF SYSTEM CONSTRUCTION AND FINANCING\nConstruction of cellular systems is capital-intensive, requiring substantial investment for land and improvements, buildings, towers, MTSOs, cell site equipment, microwave equipment, customer equipment, engineering and installation. The Company, consistent with FCC control requirements, uses primarily its own personnel to engineer and oversee construction of each cellular system where it owns or has the right to acquire a controlling interest. In so doing, the Company expects to improve the overall quality of its systems and to reduce the expense and time required to make them operational.\nThe costs (exclusive of license costs) of the operational systems in which the Company owns or has the right to acquire an interest are generally financed through capital contributions or intercompany loans to the partnerships or subsidiaries owning the systems, and through certain vendor financing.\nMARKETING AND CUSTOMER SERVICE\nThe Company's marketing plan is designed to capitalize on its clustering strategy and to increase revenue by growing the Company's customer base, increasing customers' usage of cellular service and reducing churn or customer disconnects. The marketing plan stresses service quality and incorporates programs aimed at developing and expanding new and existing distribution channels, stimulating customer usage by offering new and enhanced services and by increasing the public's awareness and understanding of the cellular services offered by the Company. Most of the Company's operations market cellular service under the \"United States Cellular\"-TM- name and service mark.\nThe Company's marketing strategy is to develop a local, customer-oriented operation, the primary goal of which is to provide quality cellular service to its customers. The Company's marketing program focuses on obtaining customers who need cellular service, such as business people who, while out of their offices, need to be in contact with others. The Company plans to follow the same marketing program in the other systems it expects to manage.\nThe Company manages each cellular cluster, and in some cases individual markets, with a local staff, including a manager and customer service representatives. Sales consultants are typically maintained in each market within the clusters. Customers are able to report cellular service problems or concerns 24 hours a day. It is the Company's goal to respond to customers' concerns and to correct reported service deficiencies within 24 hours of notification. The Company has established local service centers in order to repair and maintain most major brands of user equipment.\nThe Company has relied primarily on its own direct and retail sales channels to obtain customers for the cellular markets it manages. The Company maintains an ongoing training program to improve the effectiveness of the sales consultants and retail associates in obtaining customers as well as maximizing the sale of high-user packages. These packages commit customers to pay for a minimum amount of usage at discounted rates per minute, even if usage falls below the monthly minimum amount. The\nCompany also uses agents, dealers and retailers to obtain customers. Agents and dealers are independent business people who sell to customers on a commission basis for the Company. The Company's agents are in the business of selling cellular telephones, cellular service packages and other related products to customers. The Company's dealers include car stereo companies and other companies whose customers are also potential cellular customers. The Company's retailers include car dealers, major appliance dealers, office supply dealers and mass merchants.\nThe Company began to specifically address the fast-growing consumer market by opening its own retail stores in late 1993. These small facilities are located in high-traffic areas and are designed to cater to walk-in customers. The Company plans to open more locations in 1994 to further its presence in the local markets.\nThe Company also actively pursues national retail accounts which may potentially yield new customer additions in multiple markets. The national account effort is expected to enable the Company to reach segments of the market other than those accessed by the local sales force. Agreements have been entered into with such national distributors as Chrysler Corporation, Ford Motor Company, General Motors, Honda, AT&T, Radio Shack, Best Buy, and Sears, Roebuck & Co. for certain of the Company's markets. Upon the sale of a cellular telephone by one of these national distributors, the Company receives, often exclusively within the territories served, the resulting cellular customer. In recognition of the needs of these national accounts, the Company initiated a centralized customer support program. This program allows for customer activation during peak retail business hours (weekends and evenings) when the Company's local office might otherwise be closed.\nThe Company uses a variety of direct mail, billboard, radio, television and newspaper advertising to stimulate interest by prospective customers in cellular service and to establish familiarity with the Company's name. Advertising is directed at gaining customers, increasing usage by existing customers and increasing the public awareness and understanding of the cellular services offered by the Company. The Company attempts to select the advertising and promotion media that are most appealing to the targeted groups of potential customers in each local market. The Company utilizes local advertising media and public relations activities and establishes programs to enhance public awareness of the Company, such as providing telephones and service for public events and emergency uses.\nCUSTOMERS AND SYSTEM USAGE\nCompany data for 1993 indicate that 52% of the Company's customers use their cellular telephones primarily for business. Cellular customers come from a wide range of occupations. They typically include a large proportion of individuals who work outside of their offices such as people in the construction, real estate, wholesale and retail distribution businesses, and professionals. Most of the Company's customers use in-vehicle cellular telephones. However, more customers (71% of new customers in 1993 compared to 21% in 1988) are selecting portable and other transportable cellular telephones as these units become more compact and fully featured as well as more attractively priced.\nThe Company's cellular systems are used most extensively during normal business hours between 7:00 am and 6:00 pm. On average, the local retail customers in the Company's majority-owned and managed systems used their cellular systems approximately 103 minutes per unit each month and generated retail revenue of approximately $49 per month during 1993, compared to 121 minutes and $52 per month in 1992. Revenue generated by roamers, together with local, toll and other revenues, brought the Company's total average monthly service revenue per customer unit in majority-owned and managed markets to $99 during 1993. Average monthly service revenue per customer unit decreased approximately 6% during 1993, reflecting primarily the decline in average local minutes per customer unit. The Company anticipates that average monthly service revenue per customer unit may continue to decline as retail distribution channels provide additional consumer customers who generate fewer local minutes of use and as roamer revenues grow more slowly.\nRoaming is a service offered by the Company which allows a customer to place or receive a call in a cellular service area away from the customer's home market area. The Company has entered into \"roaming agreements\" with operators of other cellular systems covering virtually all systems in the United States and Canada. These agreements offer customers the opportunity to roam in these systems. These reciprocal agreements automatically pre-register the customers of the Company's systems in the other carriers' systems. Also, a customer of a participating system roaming (i.e. travelling) in a Company market where this arrangement is in effect is able to automatically make and receive calls on the Company's system. The charge for this service is typically at premium rates and is billed by the Company to the customer's home system, which then bills the customer. The Company has entered into agreements with other cellular carriers to transfer roaming usage at agreed-upon rates. In some instances, based on competitive factors, the Company may charge a lower amount to its customers than the amount actually charged to the Company by another cellular carrier for roaming; however, these services include call delivery and call handoff.\nThe following table summarizes certain information about customers and market penetration in the Company's managed operations.\nThe following table summarizes, by cluster, the total population, the Company's customer units and penetration for the Company's majority-owned and managed markets that were operational as of December 31, 1993.\nCELLULAR TELEPHONES AND INSTALLATION\nThere are a number of different types of cellular telephones, all of which are currently compatible with cellular systems nationwide. The Company offers a full range of vehicle-mounted, transportable, and hand-held portable cellular telephones. Features offered in some of the cellular telephones include hands-free calling, repeat dialing, horn alert and others.\nThe Company has established service and\/or installation facilities in many of its local markets to ensure quality installation and service of the cellular telephones it sells. These facilities allow the Company to improve its service by promptly assisting customers who experience equipment problems.\nThe Company negotiates volume discounts from its cellular telephone suppliers. The Company discounts cellular telephones in most markets to meet competition or to stimulate sales by reducing the cost of becoming a cellular customer. In these instances, where permitted by law, customers are generally required to sign an extended service contract with the Company. The Company also cooperates with cellular equipment manufacturers in local advertising and promotion of cellular equipment.\nPRODUCTS AND SERVICES\nThe Company's customers are able to choose from a variety of packaged pricing plans which are designed to fit different calling patterns. The Company's customer bills typically show separate charges for custom-calling features, airtime in excess of the packaged amount, and toll calls. Custom-calling features provided by the Company include wide-area call delivery, call forwarding, call waiting, three-way calling and no-answer transfer. The Company also offers a voice message service in many of its markets. This service, which functions like a sophisticated answering machine, allows customers to receive messages from callers when they are not available to take calls.\nREGULATION\nThe construction, operation and transfer of cellular systems in the United States are regulated to varying degrees by the FCC pursuant to the Communications Act. The FCC has promulgated regulations governing construction and operation of cellular systems, and licensing and technical standards for the provision of cellular telephone service.\nFor licensing purposes, the FCC divided the United States into separate geographic markets (MSAs and RSAs). In each market, the allocated cellular frequencies are divided into two equal blocks. During the application process, the FCC reserved one block of frequencies for nonwireline applicants and\nanother block for wireline applicants. Subject to FCC approval, a cellular system may be sold to either a wireline or nonwireline entity, but no entity which controls a cellular system may own an interest in another cellular system in the same MSA or RSA.\nThe completion of acquisitions involving the transfer of control of a cellular system requires prior FCC approval. Acquisitions of minority interests generally do not require FCC approval. Whenever FCC approval is required, any interested party may file a petition to dismiss or deny the Company's application for approval of the proposed transfer.\nWhen the first cell of a cellular system has been constructed, the licensee is required to notify the FCC that construction has been completed. Immediately upon this notification, but not before, FCC rules authorize the licensee to offer commercial service to the public. The licensee is then said to have \"operating authority.\" Initial operating licenses are granted for ten-year periods. The FCC must be notified each time an additional cell is constructed.\nThe FCC's rules also generally require persons or entities holding cellular construction permits or licenses to coordinate their proposed frequency usage with other cellular users and licensees in order to avoid electrical interference between adjacent systems. The height and power of base stations in the cellular system are regulated by FCC rules, as are the types of signals emitted by these stations. In addition to regulation by the FCC, cellular systems are subject to certain Federal Aviation Administration regulations respecting the siting and construction of cellular transmitter towers and antennas.\nOn January 9, 1992, the FCC adopted a Report and Order (\"R&O\") which establishes standards for conducting comparative renewal proceedings between a cellular licensee seeking renewal of its license and challengers filing competing applications. In the R&O, the FCC: (i) established criteria for comparing the renewal applicant to challengers, including the standards under which a \"renewal expectancy\" will be granted to the applicant seeking license renewal; (ii) established basic qualifications standards for challengers; and (iii) provided procedures for preventing possible abuses in the comparative renewal process. The FCC has concluded that it will award a renewal expectancy if the licensee has (i) substantially used its spectrum for its intended purposes; (ii) complied with FCC rules, policies and the Communications Act, as amended; and (iii) not engaged in substantial relevant misconduct. If a renewal expectancy is awarded to an existing licensee, that expectancy will be more significant in the renewal proceeding than any other criterion used to compare the licensee to challengers. Licenses of the Company's affiliates in Knoxville and Tulsa will be its first to come up for renewal in 1994. See \"Legal Proceedings -- La Star Application\" for a discussion of certain FCC proceedings which have suspended the Company's and TDS's licensing authority in a Wisconsin market pending the outcome of an FCC hearing.\nThe Company conducts and plans to conduct its operations in accordance with all relevant FCC rules and regulations and would anticipate being able to qualify for a renewal expectancy. Accordingly, the Company believes that the regulations will have no significant effect on its operations and financial condition.\nThe FCC has also provided that five years after the initial licenses are granted, unserved areas within markets previously granted to licensees may be applied for by both wireline and nonwireline entities and by third parties. The FCC established 1993 filing dates for filing \"unserved area\" applications in MSAs in which the five-year period had expired and many unserved area applications were filed in certain MSAs. The Company's strategy with respect to system construction in its markets has been and will be to build cells covering every area within such markets that the Company considers economically feasible to serve or might conceivably wish to serve and to do so within the five-year period following issuance of the license.\nThe Company is also subject to state and local regulation in some instances. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure. However, certain states require cellular system operators to go through a state certification process to serve communities within their borders. All such certificates can be revoked for cause. In addition, certain state authorities regulate several aspects of a cellular operator's business, including the rates it charges its customers and cellular resellers, the resale of long-distance service to its customers, the technical arrangements and charges for interconnection with the landline network and\nthe transfer of interests in cellular systems. The siting and construction of the cellular facilities, including transmitter towers, antennas and equipment shelters may also be subject to state or local zoning, land use and other local regulations. Public utility or public service commissions (or certain of the commissioners) in several states have expressed an interest in examining whether the cellular industry should be more closely regulated by such states.\nCOMPETITION\nThe Company's only facilities-based competitor for cellular telephone service in each market is the licensee of the second cellular system in that market. Competition for customers between the two systems in each market is principally on the basis of quality of service, price, size of area covered, services offered, and responsiveness of customer service. The competing entities in many of the markets in which the Company has an interest have financial resources which are substantially greater than those of the Company and its partners in such markets.\nThe FCC's rules require all operational cellular systems to provide, on a nondiscriminatory basis, cellular service to resellers which purchase blocks of mobile telephone numbers from an operational system and then resell them to the public.\nIn addition to competition from the other cellular licensee in each market, there is also competition from, among other technologies, conventional mobile telephone and SMR systems, both of which are able to connect with the landline telephone network. The Company believes that conventional mobile telephone systems and conventional SMR systems are competitively disadvantaged because of technological limitations on the capacity of such systems. The FCC has recently given approval, via waivers of its rules, to ESMR, an enhanced SMR system. ESMR systems may have cells and frequency reuse like cellular, thereby potentially eliminating any current technological limitation. The first ESMR systems were implemented in 1993 in Los Angeles. Although less directly a substitute for cellular service, wireless data services and one-way paging service (and in the future, two-way paging services) may be adequate for those who do not need full two-way voice service.\nContinuing technological advances in the communications field make it impossible to predict the extent of additional future competition for cellular systems. For example, the FCC has allocated radio channels to a mobile satellite system in which transmissions from mobile units to satellites would augment or replace transmissions to cell sites, and a consortium to provide such service has been formed. Such a system is designed primarily to serve the communications needs of remote locations and a mobile satellite system could provide viable competition for land-based cellular systems in such areas. It is also possible that the FCC may in the future assign additional frequencies to cellular telephone service to provide for more than two cellular telephone systems per market.\nCT-2, second generation cordless telephones, and PCS, personal communications network services, may prove to be competitive with cellular service in the future. CT-2 will allow a customer to make a call from a personal phone as long as the person is within range of a telepoint base station which connects the call to the public switched telephone network. PCS will be digital, wireless communications systems which currently are primarily targeted for use in very densely populated areas. Various CT-2 and PCS trials are in process throughout the United States. CT-2 and PCS are not anticipated to be significant sources of competition in the Company's markets in the near future. Similar technological advances or regulatory changes in the future may make available other alternatives to cellular service, thereby creating additional sources of competition.\nEMPLOYEES\nThe Company had 1,785 employees as of February 28, 1994. Of these, 1,491 were based at the various cellular markets operated or managed by the Company with only 294 based at its corporate office in Chicago, Illinois. None of the Company's employees is represented by a labor organization. The Company considers its relationship with its employees to be good.\n- --------------------------------------------------------------------------------\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe property for mobile telephone switching offices and cell sites are either owned or leased under long-term leases by the Company, one of its subsidiaries or the partnership or corporation which holds the construction permit or license. The Company has not experienced major problems with obtaining zoning approval for cell sites or operating facilities and does not anticipate any such problems in the future which are or will be material to the Company and its subsidiaries as a whole. The Company's investment in property is small compared to its investment in licenses and equipment.\nThe Company leases approximately 39,000 square feet of office space for its headquarters in Chicago, Illinois.\nThe Company considers the properties owned or leased by it and its subsidiaries to be suitable and adequate for their respective business operations.\n- --------------------------------------------------------------------------------\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in a number of legal proceedings before the FCC and various state and federal courts. In some cases, the litigation involves disputes regarding rights to certain cellular telephone markets. The more significant proceedings affecting the Company are described in the following paragraphs.\nLA STAR APPLICATION. Star Cellular Telephone Company, Inc. (\"Star Cellular\"), an indirect, wholly owned subsidiary of the Company, is a 49% owner of La Star Cellular Telephone Company (\"La Star\"), an applicant for a construction permit for a cellular system in St. Tammany Parish in the New Orleans MSA. In June 1992, the FCC affirmed an Administrative Law Judge's order which had granted the mutually exclusive application of New Orleans CGSA, Inc. (\"NOCGSA\") and dismissed La Star's application. The ground for the FCC's action was its finding that Star Cellular, and not the 51% owner, SJI Cellular, Inc. (\"SJI\"), in fact controlled La Star. La Star, TDS and the Company have appealed that order to the United States Court of Appeals of the District of Columbia Circuit and those appeals are pending.\nIn a footnote to its decision, the FCC stated, in part, that \"Questions regarding the conduct of SJI and [the Company] in this case may be revisited in light of the relevant findings and conclusions here in future proceedings where the other interests of these parties have decisional significance.\" Certain adverse parties have attempted to use the footnote in the LA STAR decision in a number of unrelated, contested proceedings which TDS and the Company have pending before the FCC. In addition, since the LA STAR proceeding, FCC authorizations in uncontested FCC proceedings have been granted subject to any subsequent action the FCC may take concerning the LA STAR footnote.\nOn February 1, 1994, in a proceeding involving a license originally issued to TDS for a rural service area in Wisconsin, the FCC instituted a hearing to determine whether in the La Star case the Company had misrepresented facts to, lacked candor in its dealings with or attempted to mislead the FCC and, if so, whether TDS possesses the requisite character qualifications to hold that Wisconsin license. The FCC stated that, pending resolution of the issues in the Wisconsin proceeding, further grants to TDS and its subsidiaries will be conditioned on the outcome of that proceeding. TDS was granted interim authority to continue to operate the Wisconsin system pending completion of the hearing.\nAn adverse finding in the Wisconsin hearing could result in a variety of possible sanctions, ranging from a fine to loss of the Wisconsin license, and could, as stated in the FCC order, be raised and considered in other proceedings involving TDS and its subsidiaries. TDS and the Company believe they acted properly in connection with the La Star application and that the findings and record in the La Star proceeding are not relevant in any other proceeding involving their FCC license qualifications.\nTOWNES TELECOMMUNICATIONS, INC., ET. AL. V. TDS, ET. AL. Plaintiffs Townes Telecommunications, Inc. (\"Townes\"), Tatum Telephone Company (\"Tatum Telephone\") and Tatum Cellular Telephone Company (\"Tatum Cellular\") filed a suit in the District Court of Rusk County, Texas, against both TDS and the\nCompany as defendants. Plaintiff Townes alleges that it entered into an oral agreement with defendants which established a joint venture to develop cellular business in certain markets. Townes alleges that defendants usurped a joint venture opportunity and breached fiduciary duties to Townes by purchasing interests in nonwireline markets in Texas RSA #11 and the Tyler (Texas) MSA on their own behalf rather than on behalf of the alleged joint venture. In its Fifth Amended Original Petition, Townes seeks unspecified damages not to exceed $33 million for usurpation, breach of fiduciary duty, civil conspiracy, breach of contract and tortious interference. Townes also seeks imposition of a constructive trust on defendants' profits from Texas RSA #11 and the Tyler (Texas) MSA and transfer of those interests to the alleged joint venture. In addition Townes seeks reasonable attorneys' fees equal to one-third of the judgment, along with the prejudgment interest. Plaintiffs Tatum Telephone and Tatum Cellular seek a declaration that transfers by defendants of a 49% interest in Tatum Cellular violated a five-year restriction on alienation of Tatum Cellular shares contained in a written shareholders' agreement. Tatum Telephone and Tatum Cellular seek to void the transfers. All plaintiffs together seek as much as $200 million in punitive damages.\nDefendants have asserted meritorious defenses to each of the plaintiffs' claims and are vigorously defending this case. Discovery is ongoing. A jury trial in this case is set to commence on April 25, 1994.\n- --------------------------------------------------------------------------------\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of securities holders during the fourth quarter of 1993.\n- --------------------------------------------------------------------------------\nPART II\n- --------------------------------------------------------------------------------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference from Exhibit 13, Annual Report section entitled \"United States Cellular Stock and Dividend Information.\"\n- --------------------------------------------------------------------------------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference from Exhibit 13, Annual Report section entitled \"Selected Consolidated Financial Data,\" except for ratios of earnings to fixed charges, which are incorporated herein by reference from Exhibit 12 to this Annual Report on Form 10-K.\n- --------------------------------------------------------------------------------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference from Exhibit 13, Annual Report section entitled \"Management's Discussion and Analysis of Results of Operations and Financial Condition.\"\n- --------------------------------------------------------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference from Exhibit 13, Annual Report sections entitled \"Consolidated Statements of Operations,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Changes in Common Shareholders' Equity,\" \"Notes to Consolidated Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Consolidated Quarterly Income Information (Unaudited).\"\n- --------------------------------------------------------------------------------\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\n- --------------------------------------------------------------------------------\nPART III\n- --------------------------------------------------------------------------------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference from Proxy Statement sections entitled \"Election of Directors\" and \"Executive Officers.\"\n- --------------------------------------------------------------------------------\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference from Proxy Statement section entitled \"Executive Compensation,\" except for the information specified in Item 402(a)(8) of Regulation S-K under the Securities Exchange Act of 1934, as amended.\n- --------------------------------------------------------------------------------\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from Proxy Statement section entitled \"Security Ownership of Certain Beneficial Owners and Management.\"\n- --------------------------------------------------------------------------------\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from Proxy Statement section entitled \"Certain Relationships and Related Transactions.\"\n- --------------------------------------------------------------------------------\nPART IV\n- --------------------------------------------------------------------------------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are filed as a part of this report:\n(a)(1) Financial Statements\nAll other schedules have been omitted because they are not applicable or not required or because the required information is shown in the financial statements or notes thereto.\n(3) Exhibits\nThe exhibits set forth in the accompanying Index to Exhibits are filed as a part of this Report. The following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of this Report.\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1993.\nThe Company filed a Report on Form 8-K dated November 17, 1993, which included as an exhibit a Press Release discussing the Company's completion of its rights offering. No other reports on Form 8-K were filed during the quarter ended December 31, 1993.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Shareholders and Board of Directors of UNITED STATES CELLULAR CORPORATION:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in United States Cellular Corporation and Subsidiaries Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 7, 1994. Our report on the consolidated financial statements includes explanatory paragraphs with respect to the change in the method of accounting for cellular sales commissions and with respect to the change in the method of accounting for income taxes as discussed in Note 1 and Note 10, respectively, of the Notes to Consolidated Financial Statements and the uncertainties discussed in Note 3 of the Notes to Consolidated Financial Statements; and an explanatory paragraph calling attention to certain litigation as discussed in Note 15 of the Notes to Consolidated Financial Statements.\nOur audits were made for the purpose of forming an opinion on those financial statements taken as a whole. The financial statement schedules listed in Item 14(a)(2) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These financial statement schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nChicago, Illinois February 7, 1994\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE II--AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE IV--INDEBTEDNESS OF AND TO RELATED PARTIES--NOT CURRENT\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1993 - --------------------------------------------------------------------------------\nDEPRECIATION\nThe Company and its subsidiaries provide depreciation for book purposes on a straight-line basis over the useful lives of the property ranging from three to twenty-five years. The composite depreciation rate, as applied to the average cost of depreciable property, was 10.5%.\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1992 - --------------------------------------------------------------------------------\nDEPRECIATION\nThe Company and its subsidiaries provide depreciation for book purposes on a straight-line basis over the useful lives of the property ranging from three to twenty-five years. The composite depreciation rate, as applied to the average cost of depreciable property, was 10.5%.\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1991 - --------------------------------------------------------------------------------\nDEPRECIATION\nThe Company and its subsidiaries provide depreciation for book purposes on a straight-line basis over the useful lives of the property ranging from three to twenty-five years. The composite depreciation rate, as applied to the average cost of depreciable property, was 10.4%.\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE VI--RESERVE FOR DEPRECIATION FOR THE YEAR ENDED DECEMBER 31, 1993 - --------------------------------------------------------------------------------\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE VI--RESERVE FOR DEPRECIATION FOR THE YEAR ENDED DECEMBER 31, 1992 - --------------------------------------------------------------------------------\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE VI--RESERVE FOR DEPRECIATION FOR THE YEAR ENDED DECEMBER 31, 1991 - --------------------------------------------------------------------------------\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS\nUNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES\nSCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1993 - --------------------------------------------------------------------------------\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP COMBINED FINANCIAL STATEMENTS\nThe following financial statements are the combined financial statements of the cellular system partnerships listed below which are accounted for by the Company following the equity method. The combined financial statements were compiled from financial statements and other information obtained by the Company as a noncontrolling limited partner of the cellular limited partnerships listed below. The cellular system partnerships included in the combined financial statements, the periods each partnership is included, and the Company's ownership percentage of each cellular system partnership at December 31, 1993 are set forth in the following table.\nCOMPILATION REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of UNITED STATES CELLULAR CORPORATION:\nThe accompanying combined balance sheets of the Los Angeles SMSA Limited Partnership, the Nashville\/Clarksville MSA Limited Partnership and the Baton Rouge MSA Limited Partnership as of December 31, 1993 and 1992 and the related combined statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1993, have been prepared from the separate financial statements, which are not presented separately herein, of the Los Angeles SMSA, Nashville\/Clarksville MSA and Baton Rouge MSA limited partnerships, as described in Note 1. We have reviewed for compilation only the accompanying combined financial statements, and, in our opinion, those statements have been properly compiled from the amounts and notes of the underlying separate financial statements of the Los Angeles SMSA, Nashville\/Clarksville MSA and Baton Rouge MSA limited partnerships, on the basis described in Note 1.\nThe statements for the Los Angeles SMSA, Nashville\/Clarksville MSA and Baton Rouge MSA limited partnerships were audited by other auditors as set forth in their reports included on pages 40 through 43. The report of the other auditors of the Los Angeles SMSA Limited Partnership contains explanatory paragraphs with respect to the uncertainties discussed in the fourth and fifth paragraphs of Note 7. We have not been engaged to audit either the separate financial statements of the aforementioned limited partnerships or the related combined financial statements in accordance with generally accepted auditing standards and to render an opinion as to the fair presentation of such financial statements in accordance with generally accepted accounting principles.\nAs discussed in \"Change in Accounting Principle\" in Note 2, the method of accounting for cellular sales commissions was changed effective January 1, 1991, for the Nashville\/Clarksville MSA Limited Partnership and the Baton Rouge MSA Limited Partnership.\nARTHUR ANDERSEN & CO.\nChicago, Illinois February 11, 1994\nREPORTS OF OTHER INDEPENDENT ACCOUNTANTS\nTo The Partners of LOS ANGELES SMSA LIMITED PARTNERSHIP:\nWe have audited the balance sheets of Los Angeles SMSA Limited Partnership as of December 31, 1993 and 1992, and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1993; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Los Angeles SMSA Limited Partnership as of December 31, 1993 and 1992, and results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 9 to the financial statements, two cellular agents filed complaints against the Partnership. The outcome of these matters is uncertain and, accordingly, no accrual for these matters has been made in the financial statements.\nIn addition, as discussed in Note 9, a class action suit was filed against the Partnership alleging violations of state and federal antitrust laws. The outcome of this matter is uncertain and, accordingly, no accrual for this matter has been made in the financial statements.\nCOOPERS & LYBRAND Newport Beach, California February 4, 1994\nTo The Partners of NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1993, and the related statements of income, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1993, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND Atlanta, Georgia February 11, 1994\nREPORTS OF OTHER INDEPENDENT ACCOUNTANTS\nTo The Partners of NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1992, and the related statements of income, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1992, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND Atlanta, Georgia February 11, 1993\nTo The Partners of NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1991, and the related statements of operations, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Nashville\/Clarksville MSA Limited Partnership as of December 31, 1991, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, the Partnership changed its method of accounting for commissions in 1991.\nCOOPERS & LYBRAND Atlanta, Georgia February 10, 1992\nREPORTS OF OTHER INDEPENDENT ACCOUNTANTS\nTo The Partners of BATON ROUGE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Baton Rouge MSA Limited Partnership as of December 31, 1993, and the related statements of income, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Baton Rouge MSA Limited Partnership as of December 31, 1993, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND Atlanta, Georgia February 11, 1994\nTo The Partners of BATON ROUGE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Baton Rouge MSA Limited Partnership as of December 31, 1992, and the related statements of income, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Baton Rouge MSA Limited Partnership as of December 31, 1992, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND Atlanta, Georgia February 11, 1993\nREPORTS OF OTHER INDEPENDENT ACCOUNTANTS\nTo The Partners of BATON ROUGE MSA LIMITED PARTNERSHIP:\nWe have audited the balance sheet of Baton Rouge MSA Limited Partnership as of December 31, 1991, and the related statements of income, changes in partners' capital and cash flows for the year then ended; such financial statements are not included separately herein. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Baton Rouge MSA Limited Partnership as of December 31, 1991, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, the Partnership changed its method of accounting for commissions in 1991.\nCOOPERS & LYBRAND Atlanta, Georgia February 10, 1992\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP COMBINED STATEMENTS OF OPERATIONS (UNAUDITED)\nThe accompanying notes are an integral part of these combined financial statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP COMBINED BALANCE SHEETS (UNAUDITED) ASSETS\nThe accompanying notes are an integral part of these combined financial statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP COMBINED STATEMENTS OF CASH FLOWS (UNAUDITED)\nThe accompanying notes are an integral part of these combined financial statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP COMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (UNAUDITED)\nThe accompanying notes are an integral part of these combined financial statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS\n1. BASIS OF COMBINATION:\nThe combined financial statements and notes thereto were compiled from the individual financial statements of cellular limited partnerships listed below in which United States Cellular Corporation (AMEX symbol \"USM\") has a noncontrolling ownership interest and which it accounts for using the equity method. The cellular partnerships, the period each partnership is included in the combined financial statements and USM's ownership interest in each partnership are set forth in the table below. The combined financial statements and notes thereto present 100% of each partnership whereas USM's ownership interest is shown in the table.\nProfits, losses and distributable cash are allocated to the partners based upon respective partnership interests. Distributions are made quarterly at the discretion of the General Partner for one of the Partnerships.\nOf the partnerships included in the combined financial statements, the Los Angeles SMSA Limited Partnership is the most significant, accounting for approximately 89% of the combined total assets at December 31, 1993, and substantially all of the combined net income for the year then ended.\nUSM's investment in and advances to Los Angeles SMSA Limited Partnership totalled $15,212,000 as of December 31, 1993, of which $17,398,000 represents its proportionate share of net assets of the Partnership. USM's investment in and advances to the Nashville\/Clarksville MSA Limited Partnership totalled $14,300,000 as of December 31, 1993, which represents its proportionate share of net assets. USM's investment in and advances to the Baton Rouge MSA Limited Partnership totalled $8,935,000 as of December 31, 1993, $6,207,000 of which represents its proportionate share of net assets.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES FOR COMBINED ENTITIES:\nPROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is stated at cost. Depreciation is computed using the straight-line method over the following estimated lives:\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS--(CONTINUED)\nProperty, Plant and Equipment consists of:\nIncluded in buildings are costs relating to the acquisition of cell site leases; such as legal, consulting, and title fees. Lease acquisition costs are capitalized when incurred and amortized over the period of the lease. Costs related to unsuccessful negotiations are expensed in the period the negotiations are terminated.\nGains and losses on disposals are included in income at amounts equal to the difference between net book value and proceeds received upon disposal.\nDuring 1993 and 1992, one of the Partnerships recorded capital lease additions of $827,000 and $513,000, respectively.\nCommitments for future equipment acquisitions amounted to $22,734,000 at December 31, 1993.\nOn January 10, 1994, one of the Partnerships entered into an agreement with its major supplier to purchase $77 million in equipment.\nOTHER ASSETS\nOther assets consist primarily of the costs of acquiring the right to serve certain customers previously served by resellers and are being amortized over three years using the straight-line method. Accumulated amortization was $4,806,000 and $2,797,000 at December 31, 1993 and 1992, respectively.\nCHANGE IN ACCOUNTING PRINCIPLE\nIn the third quarter of 1991, the General Partner of two of the Partnerships changed its policy of capitalizing certain third party sales commissions and amortizing them over the average customer life. The General Partner's parent effected this change to standardize the accounting treatment of sales commissions throughout its consolidated cellular operations. These amounts will be expensed in the period in which they are incurred by the agent. In 1991, this change in accounting principle was retroactively applied as of January 1, 1991. Had the change not been made, 1991 net income before the cumulative effect of a change in accounting principle would have increased $1,838,000.\nREVENUE RECOGNITION\nRevenues from operations primarily consist of charges to customers for monthly access charges, cellular airtime usage, and roamer charges. Revenues are recognized as services are rendered. Unbilled revenues, resulting from cellular service provided from the billing cycle date to the end of each month and from other cellular carriers' customers using the partnership's cellular systems for the last half of each month, are estimated and recorded as receivables. Unearned monthly access charges relating to the periods after month-end are deferred and netted against accounts receivable.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS--(CONTINUED)\nINCOME TAXES\nNo provisions have been made for federal or state income taxes since such taxes, if any, are the responsibility of the individual partners.\n3. LEASE COMMITMENTS:\nFuture minimum rental payments required under operating leases for real estate that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1993, are as follows:\nThe initial lease terms generally range from 5 to 25 years with the majority of them having initial terms of 10 years and providing for one renewal option of 5 years and for rental escalation. Included in selling, general and administrative expense are rental costs of $7,897,000, $5,996,000 and $4,463,000 for the years ended December 31, 1993, 1992 and 1991, respectively. One of the Partnerships leases office facilities under a ten-year lease agreement which provides for free rent incentives for six months and rent escalation over the ten-year period. The Partnership recognizes rent expense on a straight-line basis and recorded the related deferred rent as a noncurrent liability to be amortized as an adjustment to rental costs over the life of the lease.\n4. CAPITAL LEASE OBLIGATION:\nOne of the Partnerships leases equipment under capital lease agreements. At December 31, 1993 and 1992, respectively, the amount of such equipment included in property, plant and equipment is $3,324,000 and $2,638,000 less accumulated amortization of $1,914,000 and $1,451,000. Future minimum annual lease payments on noncancellable capital leases are as follows:\n5. RELATED PARTY TRANSACTIONS:\nCertain affiliates of these cellular limited partnerships provide services for the system operations, legal, financial, management and administration of these entities. These affiliates are reimbursed for both direct and allocated costs (totaling $57.1 million in 1993 $52.2 million in 1992 and $50.0 million in 1991) related to providing these services. In addition, certain affiliates have established a credit facility with certain partnerships to provide working capital to the partnership. One of the partnerships participates in a centralized cash management arrangement with its general partner. At December 31, 1993\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS--(CONTINUED) and 1992, the interest-bearing balance amounted to $29,981,000 and $16,074,000, respectively. Effective January 1, 1989, the general partner pays or charges the Partnership monthly interest, computed using the general partner's average borrowing rate, on the amounts due to or from the Partnership. Interest earned in 1993, 1992 and 1991 was $1,294,000, $1,396,000 and $675,000, respectively.\n6. REGULATORY INVESTIGATIONS:\nThe California Public Utilities Commission (CPUC) has issued an Order Instituting Investigation of the regulation of cellular radiotelephone utilities operating in the State of California under Order Number I.88-11-040. The intent of the investigation was to determine the appropriate regulatory objectives for the cellular industry, and whether current regulations applicable to the cellular industry and its operators meet those objectives or should be modified.\nOn October 6, 1992, the CPUC adopted an Order which, among other things, imposes an accounting methodology on cellular utilities to separate wholesale and retail costs, permits resellers to operate a reseller switch interconnected to the cellular carrier's facilities, and requires the unbundling of certain wholesale rates to the resellers. On May 19, 1993, the CPUC granted limited rehearing of the decision. In addition, the CPUC rescinded its order to modify the method for allocating costs between wholesale and retail operations.\nOn December 17, 1993, the CPUC adopted a new Order Instituting Investigation into the regulation of mobile telephone service and wireless communications, Order Number I.93-12-007. The investigation proposes a regulatory program which would encompass all forms of mobile telephone service. Currently, one of the Partnerships affected is unable to quantify the precise impact of these Orders on its future operations, but that impact may be material to the Partnership under certain circumstances.\nIn January 1992, the CPUC commenced a separate investigation of all cellular companies operating in the State to determine their compliance with General Order number 159 (G.O. 159). The investigation will address whether cellular utilities have complied with local, state or federal regulations governing the approval and construction of cellular sites in the State. The CPUC may advise other agencies of violations in their jurisdictions.\nOne of the Partnerships affected has prepared and filed the information requested by the CPUC. The CPUC will review the information provided by the Partnership and, if violations of G.O. 159 are found, it may assess penalties against the Partnership. The outcome of this investigation is uncertain and accordingly, no accrual for this matter has been made.\n7. CONTINGENCIES AND COMMITMENTS:\nOn June 28, 1993, an applicant for an unserved area license in the Los Angeles market filed an informal objection with the FCC to one of the Partnerships' System Information Update map. The applicant claims the Partnership was not legally authorized to provide service in parts of its described service area. The applicant requests that the FCC correct the Partnership's service area to eliminate such areas and suggests the FCC impose \"such sanctions as it deems appropriate.\" The Partnership filed a response with the FCC in which it reported that, in its review of the applicant's allegations, it found certain errors that were made in its filings but disputed any of these were intentional. The FCC could assess penalties against the Partnership for nonconformance with its license. The outcome of this matter remains uncertain and, accordingly, the Partnership has not recorded an accrual. The Partnership intends to defend its position vigorously.\nThe Partnership filed for its 10-year license renewal for the Los Angeles market on August 30, 1993. The Partnership is currently operating with FCC authority while the renewal application is pending resolution of the FCC's decision on claims mentioned above. The Partnership fully expects that its license will be renewed.\nLOS ANGELES SMSA LIMITED PARTNERSHIP NASHVILLE\/CLARKSVILLE MSA LIMITED PARTNERSHIP BATON ROUGE MSA LIMITED PARTNERSHIP NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS--(CONTINUED)\nTwo agents of a competing carrier have named one of the Partnerships in several complaints against the carrier. The general allegations include violations of California Unfair Practices Act and price fixing. The ultimate outcome of both these actions is uncertain at this time. Accordingly, no accrual for these contingencies has been made. The Partnership intends to defend its position vigorously.\nOn November 24, 1993, a class action suit was filed against one of the Partnerships and another cellular carrier alleging conspiracy to fix the price of cellular service in violation of state and federal antitrust laws. The plaintiffs are seeking substantial monetary damages and injunctive relief in excess of $100 million. The outcome of this matter is uncertain and, accordingly, the Partnership has not recorded an accrual. The Partnership intends to defend its position vigorously.\nOne of the Partnerships is a party to various other lawsuits arising in the ordinary course of business. In the opinion of management, based on a review of such litigation with legal counsel, any losses resulting from these actions are not expected to materially impact the financial condition of the Partnership.\nTwo of the Partnerships provide cellular service and sell cellular telephones to diversified groups of consumers within concentrated geographical areas. The general partner performs credit evaluations of the Partnerships' customers and generally does not require collateral. Receivables are generally due within 30 days. Credit losses related to customers have been within management's expectations.\nOne of the Partnerships purchases substantially all of its equipment from one supplier.\nThe General Partner of two of the Partnerships entered into agreements with an equipment vendor on behalf of the Partnerships to replace the Partnerships' cellular equipment with new cellular technology which will support both analog and digital voice transmissions.\nSIGNATURES\nPursuant 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.\nUNITED STATES CELLULAR CORPORATION\nBy: \/S\/ H. DONALD NELSON\n----------------------------------- H. Donald Nelson PRESIDENT (CHIEF EXECUTIVE OFFICER)\nBy: \/S\/ K. R. MEYERS\n----------------------------------- K. R. Meyers VICE PRESIDENT--FINANCE AND TREASURER (PRINCIPAL FINANCIAL OFFICER)\nBy: \/S\/ PHILLIP A. LORENZINI\n----------------------------------- Phillip A. Lorenzini CONTROLLER (PRINCIPAL ACCOUNTING OFFICER)\nDated March 28, 1994\nPursuant 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 and on the dates indicated.\n- -------------------------------------------------------------------------------- INDEX TO EXHIBITS - --------------------------------------------------------------------------------","section_15":""}
{"filename":"20762_1993.txt","cik":"20762","year":"1993","section_1":"ITEM 1 AND 2. BUSINESS; PROPERTIES\nClark Refining & Marketing, Inc. (formerly known as Clark Oil & Refining Corporation), a Delaware Corporation (the \"Company\" or \"Clark\"), headquartered in St. Louis, Missouri, is one of the leading independent refiners and marketers of petroleum products in the Midwest. Its principal activities consist of crude oil refining, wholesale marketing of refined petroleum products and retail marketing of gasoline and convenience products. These businesses have been operating under the Clark brand name for over 60 years.\nThe assets related to Clark's business were acquired on November 22, 1988 (the \"Acquisition\") out of bankruptcy proceedings. The assets acquired consisted of (i) substantially all of the assets of Apex Oil Company, Inc., a Wisconsin corporation (formerly known as OC Oil & Refining Corporation and prior thereto known as Clark Oil & Refining Corporation, a Wisconsin corporation (\"Old Clark\")) and its subsidiaries and (ii) certain other assets and liabilities of the Novelly\/Goldstein Partnership (formerly known as Apex Oil Company), a Missouri general partnership (\"Apex\"), the indirect owner of Old Clark.\nAll of the outstanding common stock of Clark is owned by Clark R & M Holdings, Inc., a Delaware corporation (\"R & M Holdings\"), an indirect wholly- owned subsidiary of The Horsham Corporation (\"Horsham\"), a Quebec corporation. Horsham acquired an initial 60% ownership in R & M Holdings at the Acquisition and 100% ownership in December 1992. Horsham is a Canadian management and holding company which also owns a controlling 20% interest in American Barrick Resources Corporation (\"Barrick\"), a major gold mining company and 100% of Horsham Properties GmbH which is developing a 600-acre business park near Berlin, Germany. Peter Munk, Horsham's Chairman and Chief Executive Officer and controlling shareholder, is Chairman of the Board and a Director of Clark.\nINDUSTRY ENVIRONMENT\nDuring the period from 1982 to 1993, domestic refining capacity declined by 15.1% from 17.9 million bbls\/day to 15.2 million bbls\/day due primarily to a significant reduction in the total number of domestic refineries. During the same period, refinery throughput, or production, grew in response to market demand, from 11.8 million bbls\/day to 13.9 million bbls\/day principally due to increases in the number of operating vehicles and passenger miles driven. Refining capacity utilization grew from 65.8% in 1982 to 91.4% in 1993. Clark believes that the maximum achievable refining utilization for the industry is approximately 93%, because of the requirements for scheduled and unscheduled maintenance shutdowns. The following table sets forth selected US refinery industry information published by the US Energy Information Administration:\nSELECTED UNITED STATES REFINING INDUSTRY STATISTICS\n- -------- *1993 figures have been obtained from the American Petroleum Institute.\nClark believes that US refining capacity will continue to decline due to a continuing escalation in the cost of new refinery construction combined with the high cost of bringing many older refineries into compliance with current and proposed environmental regulations, such as those mandated by the Clean Air Act. The Clean Air Act Amendments of 1990 provide, among other things, that (i) as of November 1992, the 39 cities which had failed to attain mandated carbon monoxide air quality standards were required to use\noxygenated gasoline for four to twelve months of each year depending upon each area's historical noncompliance period and (ii) beginning in 1995, the nine cities which have the worst ozone quality, including the Chicago and Milwaukee metropolitan areas, will be required to use, and another 87 areas which have failed to attain ozone air quality standards may elect to use, \"reformulated\" gasoline throughout the year in order to decrease the emission of hydrocarbons and toxic pollutants. Because of the expenditures associated with producing reformulated gasoline and compliance with the Clean Air Act and other environmental regulations, various US refiners have announced that they will sell and or close those refineries where capital expenditures needed to ensure compliance would not be economic. Over the near term, many refiners are expected to utilize their capital expenditure budgets to bring their facilities into compliance with environmental requirements, rather than to add to crude oil throughput capacity. Refining and marketing is a cyclical commodity-based business in which individual participants have virtually no control over industry margin levels.\nBUSINESS STRATEGY\nClark's strategic business plan is to position Clark as a low-cost, high- quality refiner and marketer of refined petroleum products. Clark plans to build on its strengths, which include flexibility in feedstock supply and refined product output, a strong integrated wholesale distribution network, a strong retail presence founded in Clark brand name recognition, comprehensive planning and budgeting systems, strong entrepreneurial leadership and a high level of employee participation. Clark is seeking to position itself so that cash flow remains positive even in the worst possible industry margin environment. The refining and marketing industry is mature, highly competitive and extremely capital intensive. However, a highly productive company--in terms of both operational excellence and capital utilization--can produce superior results for its stakeholders. Management believes that there are four critical strategies to achieve these goals:\n. IMPROVE PRODUCTIVITY OF EXISTING OPERATIONS--Clark's refineries are in the lower half of industry productivity benchmarks, providing much opportunity for improvement. On the retail side, Clark's people and assets have been neglected for many years while competitors have invested heavily in upgrading and expanding their facilities. However, Clark's investment and operating cost of a typical store are substantially lower than most of its competitors--a significant competitive advantage. In 1993, Clark set a goal to achieve pre-tax productivity gains of $75 million. This goal assumes no improvement in industry margins and despite deterioration in these margins in 1993, an estimated gain of $20 million was realized in the last half of the year.\n. MINIMIZE CAPITAL INVESTMENT--Clark plans to tie capital spending to cash flow generated. Where alternative product markets exist under environmental regulations, Clark intends to base capital investment decisions on economic returns.\n. CULTURE--Clark believes that it is people, not assets, that make the difference in the success of the organization. The Company is striving to achieve a highly motivated, entrepreneurial workforce where its people understand the goals, objectives and targets of the Company, have the freedom to contribute to the best of their abilities and participate in the organization's success.\n. GROWTH--Clark plans to grow its retail and refining business through acquisition to benefit from the operating, capital and market synergies associated with greater mass, particularly within current markets.\nRETAIL DIVISION\nThe Clark retail system began operations during the 1930s with the opening of Old Clark's first store in Milwaukee, Wisconsin and expanded thereafter to Missouri and Illinois and then throughout the Midwest. At its peak in the early 1970s, Old Clark operated more than 1,800 retail stores and had established a strong market presence for high octane gasoline at discount prices. In subsequent years, Old Clark, in line with the general industry trend, rationalized its operating stores, closing down marginal locations.\nDuring the 1970s, the majority of stores were dealer-operated. However, to ensure more direct control of its marketing and distribution network, Old Clark assumed management of most of its stores from 1973 through 1983. The high proportion of company-operated stores enables Clark to respond more quickly and uniformly to changing market conditions than major oil companies which generally have most of their stores operated by independent dealers or jobbers. This control over retail operations, combined with its over 60 year history and brand strength throughout the Midwest, gives Clark a unique competitive advantage. Clark has initiated an enhancement program aimed at increasing sales volumes and profits while focusing on return on investment. The program is designed to position Clark as the premier value-oriented gasoline marketer in the Midwest.\nClark is reviewing its stores and markets and has developed a long-term retail strategy to capitalize on its over 60 year old franchise, reputation for quality products and efficient distribution network. Recognition of the Clark name may be enhanced by improving the image of the entire network, through superior customer service, graphic reimaging, building improvements and strengthened advertising. Management has adopted \"Market Business Planning\" principles that define preferred markets by developing a market ranking for existing and potential investment opportunities. These techniques combine economic, demographic and market data to arrive at market specific plans that assist in both asset and operational strategies. The Company plans to focus on those core markets where Clark has, or can develop, a competitive advantage. Clark will consider expanding through development and acquisition of stores in those markets where Clark already has a competitive strength on which to build or where similar opportunities have been identified. In those market areas where the Clark brand name is not strong and Clark has a low market ranking, Clark will divest retail locations if favorable sale opportunities arise.\nClark classifies its stores into four categories: basic, upgraded, minimart and \"On The Go\". A basic store is essentially a store as originally built in the 1950s and 1960s and consists of a small kiosk-style building (generally less than 400 total square feet and 200 square feet of selling area) with two to four \"islands\" for pumps. Since 1988, Clark has invested in upgrading and rebuilding selected sites. An upgraded store configuration generally consists of the basic format with the addition of a canopy and other minor cosmetic improvements. Most upgraded stores include the installation of new blending pumps and at many locations existing storage tanks have been replaced. A minimart is an upgraded location where the kiosk-style building has been replaced with a convenience store of at least 900 square feet. In 1992, Clark implemented a strategic enhancement program under which stores in preferred market areas will undergo a sales optimization program to modestly increase the sales area to 400 sq. ft. to emphasize quick and convenient purchasing of gasoline and \"On The Go\" convenience items. This strategy attempts to differentiate Clark stores from (i) major oil company outlets, which typically price gasoline at a higher level, (ii) the convenience store industry, which offers a full range of grocery items in addition to gasoline and (iii) low price independents, whose gasoline quality may be perceived to be inferior.\nClark estimates that previously upgraded locations will require an additional investment of approximately $70,000 per site to incorporate this \"On The Go\" theme and that non-upgraded locations will require approximately $160,000 per site. The Company believes that these investments are significantly less expensive than investments made by competitors for similar upgrading. Emphasis will be placed on the sale of select high volume convenience products without competing directly with the larger convenience store (\"C-Store\") format of major oil companies or other full scale C-Stores. Market research conducted in the fourth quarter of 1992 indicated that gasoline customers are more likely to shop at Clark if store sizes are increased. Furthermore, Clark believes its existing customers are likely to shop more often and are more likely to purchase additional convenience products from larger stores. Virtually all the basic stores have the physical characteristics permitting them to be converted to the \"On The Go\" format.\nThe volume per store varies significantly, depending upon location, competition, type and quality of the store improvements. The configuration of the stores was as follows:\nAs of December 31, 1993, Clark had 846 retail stores located in 12 midwestern states, all of which operated under the Clark trade name. Of these 846 stores (of which 763 are owned and 83 are leased), Clark directly operated 836 and the reminder were dealer operated. Virtually all stores were self-service and all sold convenience products.\nStore locations are geographically diverse. More than half the stores are in suburban areas, with the balance approximately equally divided between urban and rural areas. The geographic distribution of retail stores by state as of December 31, 1993, was as follows:\nGEOGRAPHICAL DISTRIBUTION OF RETAIL STORES\nClark began marketing three grades of gasoline in 1989 with the introduction of special blending dispenser pumps. These pumps enable Clark to improve volumes and margins by marketing a more profitable mid-grade of gasoline without installation of costly additional underground storage tanks. Approximately one-half of Clark's stores now have blending pumps. Management currently expects that by the end of 1995, canopies will have been installed over the pump islands at all of Clark's stores. Management believes that the installation of canopies will improve gasoline sales volume due to the shelter provided from weather conditions.\nUntil early 1989, retail sales were primarily for cash as customers were charged extra for credit card purchases. In 1989, Clark upgraded its credit card processing system, enabling it to receive payments for credit card sales within 48 hours. Simultaneously, to remain competitive, Clark revised its pricing policy to charge the same price for cash and credit card purchases. In late 1989, a business fleet card program was initiated to attract a new segment of customers. Fleet customers are provided with a proprietary credit card and detailed vehicle statistical information which is included on a convenient monthly invoice.\nClark has implemented a number of environmental projects at its retail stores. These projects include the ongoing Clark response to the September 1988 regulations concerning the design, construction, installation, repair and testing of underground storage tanks and the requirement of the Clean Air Act to install Stage II vapor recovery systems at certain retail stores.\nREFINING DIVISION\nThe refining division consists of two refineries in Illinois: Blue Island near Chicago and Hartford near St. Louis, Missouri. The refining division also includes Clark's supply and distribution and wholesale operations. Based upon Clark's current cost structure and business plans, Clark anticipates that it will continue to operate the Blue Island and Hartford refineries at or near their respective full-rated capacities of approximately 70,000 and 60,000 barrels of crude oil per stream day.\nEach refinery specializes in processing different types of crude oil feedstocks, although both operations are sufficiently flexible to process a variety of crude oils. Clark's refineries are capable of producing a complementary product range, as well as shifting production quickly to take advantage of market opportunities as they arise. Clark employs sophisticated linear programming techniques to optimize the operations of both refineries. These techniques enable Clark to predict feedstock performance, select optimal feedstock combinations and produce the most advantageous refined product mix for a given set of market conditions. Feedstock flexibility and linear programs thus enable Clark to take advantage of lower cost crudes and to adjust the output mix in response to changing market prices at any given time. These refineries compare favorably in the amount of light oil products produced per barrel of crude oil and therefore in competitiveness, with major oil company refineries in their market areas.\nIn addition to gasoline, Clark's refineries produce other types of refined products. Number 2 diesel fuel is used mainly as a fuel for diesel burning engines. Number 2 diesel fuel production is moved via pipeline or barge to Clark's 14 product terminals to be sold over Clark's terminal truck racks or sold via refinery pipeline or barge movement. Other production includes residual oils (slurry oil and vacuum tower bottoms) which are used mainly for heavy industrial fuel (e.g., power generation) and in the manufacturing of roofing shingles or for asphalt used in highway paving.\nIn the Clean Air Act Amendments of 1990, the US Environmental Protection Agency (\"EPA\") promulgated regulations mandating maximum sulfur content for diesel fuel offered for sale for on-road consumption beginning in October 1993. Additional EPA regulations include guidelines for reformulated gasoline to be effective by 1995 for nine regions in the US, including the Chicago and Milwaukee metropolitan areas. These regulations are expected to be expanded to most major urban centers by the year 2000. See \"Regulatory Matters.\" Clark, and virtually all other domestic refineries producing gasoline, will be required to make significant capital expenditures to comply with these new requirements.\nOver the period 1994 to 1998, Clark has preliminary plans to complete a number of environmental and other regulatory capital expenditure programs. These environmental expenditures comprise two major categories, those that are mandatory in order to comply with regulations pertaining to ground, water and air contamination and those that are primarily discretionary involving the reformulation of refined fuel for sale into certain defined markets. The total mandatory expenditures for regulatory compliance over the next five years are estimated at approximately $100 million, split evenly between the retail and refining businesses. Costs of potential future regulations cannot be forecast.\nThe expenditures required to comply with reformulated fuels regulations are primarily discretionary, subject to market conditions and economic justification. The reformulated fuels programs impose restrictions on properties of fuels to be refined and marketed, including those pertaining to gasoline volatility, oxygenated fuel, detergent addition and sulfur content. The regulations regarding these fuel properties apply to different markets in which Clark operates, in certain circumstances at different times of the year.\nModifications estimated at $10-15 million to produce reformulated gasoline are being considered for the Blue Island refinery. The decision to proceed with such a project will depend on economic justification. A project initiated to produce low sulfur diesel fuel at the Hartford refinery was delayed in 1992 based on internal and third party analyses that indicated an oversupply of low sulfur diesel fuel capacity in Clark's marketplace. These analyses projected relatively narrow price differentials between low and high sulfur diesel\nproducts which have thus far borne out after the initial transition to the low sulfur regulations. However, if price differentials widen sufficiently to justify investment, Clark could install the necessary equipment over a 14 to 16 month period at an estimated additional cost of $40 million. Furthermore, if Clark decided to install equipment necessary to produce reformulated gasoline and control sulfur emissions at Hartford, the gasoil desulfurizer and related equipment are estimated to cost an additional $90-130 million. These estimates have declined from a year ago as Clark has found more cost-effective methods of complying with the regulations.\nBlue Island Refinery\nThe Blue Island refinery is located in Blue Island, Illinois, approximately 17 miles south of Chicago. The refinery is situated on a 170-acre site, bounded by the town of Blue Island and the Calumet-Sag Canal. The facility was initially constructed in 1945 and, through a series of improvements and expansions, has reached a crude oil capacity of 70,000 barrels per stream day. The Blue Island refinery has a Nelson Complexity Rating of 8.78 versus an average rating of 8.61 for all Petroleum Administration for Defense District (\"PADD\") II refineries. The Nelson Complexity rating is an industry measure of a refinery's ability to produce higher value-added products. Blue Island has among the highest capabilities to produce gasoline relative to the other refineries in its market area. During most of the year, gasoline is the most profitable refinery product.\nThe production of the Blue Island refinery was as follows:\nBLUE ISLAND REFINERY PRODUCTION YIELD (BARRELS IN THOUSANDS)\n- -------- (a) Refinery utilization is production yield relative to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases) which add to the refinery's output are utilized in the refining process. (b) Refinery utilization reflects 1993 maintenance turnaround downtime of approximately two months on selected units. A \"maintenance turnaround\" is a periodically required standard procedure for refurbishing and maintenance of a refinery that is scheduled approximately every three years. During a turnaround, which usually lasts approximately four to six weeks, refinery production is reduced significantly.\nHartford Refinery\nThe Hartford refinery is located in Hartford, Illinois, approximately 17 miles northeast of St. Louis, Missouri. The refinery is situated on a 400-acre site. The facility was initially constructed in 1941 and, through\na series of improvements and expansions, has reached a crude oil refining capacity of approximately 60,000 barrels per stream day. The Hartford refinery has a Nelson Complexity Rating of 9.83 versus an average of 8.61 for all PADD II refineries. The Hartford facility has the ability to process lower cost, heavy, high-sulfur crude oil into higher value products such as gasoline. This upgrading capability allows the refinery to produce a high mix of premium products and permits Clark to benefit from higher margins when high sulfur crude oil, such as Maya crude oil, is available at a significant discount to low sulfur crude oil.\nThe production of the Hartford refinery was as follows:\nHARTFORD REFINERY PRODUCTION YIELD (BARRELS IN THOUSANDS)\n- -------- (a) Refinery utilization is production yield relative to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases) which add to the refinery's output are utilized in the refining process. (b) Refinery utilization reflects 1991 maintenance turnaround downtime of approximately two months on selected units.\nSupply\nClark's integrated refining and marketing assets are strategically located in the Midwest in close proximity to a variety of supply and distribution channels. As a result, Clark has the flexibility to acquire crude oil from a variety of sources around the world and the ability to distribute its products to its own retail system and to most wholesale markets.\nClark's refineries are located on major inland water transportation routes and are connected to various regional, national and Canadian common carrier pipelines, in some of which Clark has a minority interest. The Blue Island refinery can receive delivery of Canadian crude oil through the Lakehead Pipeline from Canada and foreign and domestic crude oil through the Capline Pipeline system originating in the Louisiana Gulf Coast and domestic crude oil originating in West Texas, Oklahoma and the Rocky Mountains through the Arco Pipeline system. The Hartford refinery has access to foreign and domestic crude oil supplies through the Capline\/Capwood Pipeline systems along with access to West Texas, Oklahoma and Rocky Mountain crude oil from the Platte Pipeline system. The fact that both refineries are situated on major water transportation routes provides flexibility to receive crude oil or intermediate feedstocks by barge when economically feasible.\nClark has a sour crude oil supply contract with P.M.I. Comercio Internacional, S.A. de C.V., an affiliate of Petroleos Mexicanos, S.A. de C.V. (\"Pemex\"). This contract is cancelable with three months' notice by either party but it is intended to remain in place for the foreseeable future. The volume is currently 35,000 barrels per day of Maya crude oil, with price determination based on a market related formula applicable to all Pemex-US customers. Other term crude oil supply agreements primarily consist of Canadian crude oil delivered to Blue Island. Approximately 23,000 barrels per day are currently under contract with three Canadian suppliers, cancelable with two months' notice by either party with another 4,000 barrels per day under contract through December 1994 without provision for cancellation. The above- referenced contracts provide approximately 48% of Clark's crude oil requirements which offer some security with respect to supply along with the flexibility to take advantage of spot market opportunities.\nManagement has established product scheduling and supply priorities for gasoline and diesel fuel. These ensure that Clark's retail network needs are met first and then products are distributed to its wholesale operations based on the highest average market returns before being sold into the spot market.\nClark employs several strategies to minimize the adverse impact on profitability of the volatility in feedstock costs and refined product prices. One strategy involves the purchase and sale of futures and options contracts on the New York Mercantile Exchange to minimize, on a short-term basis, Clark's exposure to the risk of fluctuations in crude oil prices and refined product margins. The number of barrels of crude oil and refined products covered by such contracts varies from time to time. Such purchases and sales are closely managed, are balanced daily and are subject to internally established risk standards. The results of these hedging activities affect refining costs of sales or inventory costs.\nClark's dedicated retail network also reduces risk by providing market sales representing approximately 60% of the refineries' gasoline production. In addition, the retail network benefits from a reliable and cost effective source of supply.\nWholesale Marketing and Distribution\nRefined products are distributed primarily through Clark's terminals, company-owned and common carrier product pipelines and by leased barges over the Mississippi, Illinois and Ohio Rivers. Clark owns and operates 14 product terminals which are strategically located throughout its market area, most of which have product blending capabilities. Terminal blending involves the blending of natural gasoline and other blendstocks with finished gasoline which reduces product cost, lowers emission producing potential and improves product quality. While other refiners engage in terminal blending, Clark believes that its degree of blending and refinery\/terminal integration provides Clark with a competitive advantage over other refiners that do not have comparable blending capabilities. In addition to cost efficiencies in supplying its retail network, the terminals provide Clark with an additional source of revenues through sales of gasoline, Number 2 diesel fuel and other refined products to wholesale customers.\nThese terminals allow efficient distribution of refinery production through readily accessible pipeline systems which connect the wholesale distribution network. In addition, the terminals provide flexibility to direct wholesale product sales to more profitable truck rack customers as an alternative to spot market sales as market conditions dictate. Clark plans to broaden its wholesale customer base which is expected to provide, on average, higher margins than spot markets. In anticipation of the October 1993 deadline for low sulfur on- road diesel fuel, Clark focused efforts on building market presence and customer relationships with off-road diesel fuel users.\nClark's terminals and respective capacities as of December 31, 1993, were as follows:\nClark enters into refined product exchange agreements with unaffiliated companies to broaden its geographical distribution capabilities. Products are also received on exchange through 37 exchange terminals and distribution points throughout the Midwest.\nClark's pipeline interests as of December 31, 1993, were as follows:\nThese pipelines are operated as common carriers pursuant to published pipeline tariffs, which also apply to use by Clark. Clark also owns a dedicated pipeline from the Blue Island refinery to the company-owned terminal in Hammond, Indiana. Clark Pipe Line Company, an affiliate of Clark, owns a 33.1% interest in the Capwood Pipeline and leases space of approximately 15,000 barrels per day on the ARCO Pipeline. Each of these pipelines transports crude oil to the Hartford refinery.\nCOMPETITIVE CONSIDERATIONS\nThe petroleum industry is highly competitive in all phases, from the production and procurement of crude oil to the refining, distribution and marketing of refined and intermediate products. Many of Clark's competitors are large, integrated oil companies which, because of their diverse operations, stronger capitalization and better brand name recognition, may be better able than Clark to withstand volatile industry conditions, shortages of crude oil or intense price competition.\nThe principal competitive factors affecting Clark's refining business are crude oil and other feedstock costs, refinery efficiency, refinery product mix and product distribution and marketing transportation costs. Certain of Clark's larger competitors have refineries which are larger and more efficient and as a result, have lower per barrel costs. Clark has no crude oil reserves and is not engaged in exploration. Clark obtains all of its crude oil requirements from unaffiliated sources. Clark believes that it will be able to obtain adequate crude oil and other feedstocks at generally competitive prices for the foreseeable future.\nThe principal competitive factors affecting Clark's retail marketing business are locations of stores, product price and quality, appearance and cleanliness of stores and brand identification. Competition from large, integrated oil and gas companies, as well as convenience stores which sell motor fuel, is expected to continue. Clark believes it competes in the retail sale of gasoline principally on the basis of price, location, store cleanliness and the Clark brand name recognition in the Midwest.\nREGULATORY MATTERS\nThe release or discharge of petroleum and hazardous materials is not an uncommon occurrence at refineries, terminals and stores and may give rise to liability under various federal, state and local regulations relating to soil and ground water contamination. Clark has identified a variety of potential environmental issues at its refineries, terminals and stores. In addition, each refinery has areas on-site which may contain hazardous waste or hazardous constituent contamination and which may have to be addressed in the future at substantial cost. Many of the terminals may also require remediation due to the age of the underground tanks and facilities and as a result of current or past activities at the terminal properties including several significant spills and past on-site waste disposal practices.\nFederal, state and local laws and regulations establishing various health and environmental quality standards and providing penalties for violations thereof affect nearly all of the operations of the Company. Included among such statutes are the Clean Air Act of 1955, as amended (\"CAA\"), the Resource Conservation and Recovery Act of 1977, as amended (\"RCRA\") and the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"). Also significantly affecting the Company are the rules and regulations of the Occupational Safety and Health Administration (\"OSHA\").\nThe CAA requires the Company to meet certain air emission standards and to obtain and comply with the terms of discharge permits. The RCRA empowers the EPA to regulate the treatment and disposal of industrial wastes and to regulate the use and operation of underground storage tanks. CERCLA requires notification to the National Response Center of releases of hazardous materials and provides a program to remediate hazardous releases at uncontrolled or abandoned hazardous waste sites. The Superfund Amendments and Reauthorization Act of 1986 (\"SARA\") is a five year extension of the CERCLA cleanup program. Title III of SARA, the Emergency Planning and Community Right to Know Act of 1986, relates to planning for hazardous material emergencies and provides for a community's right to know about the hazards of chemicals used or manufactured at industrial facilities. The OSHA rules and regulations call for the protection of workers and provide for a worker's right to know about the hazards of chemicals used or produced at the Company's facilities.\nRegulations issued by the EPA in 1988 with respect to underground storage tanks require the Company, over a period of up to ten years, to install, where not already in place, detection devices and corrosion protection on all underground tanks and piping at retail gasoline outlets. The regulations also require periodic tightness testing of underground tanks and piping. Commencing in 1998, operators will be required under these regulations to install continuous monitoring systems for underground tanks.\nIn March 1989, the EPA issued Phase I of regulations under authority of the CAA requiring a reduction for summer months in 1989 in the volatility of gasoline (\"RVP\") (the measure of the amount of light hydrocarbons contained in gasoline, such as normal butane, an octane booster). In June 1990, Phase II of these regulations was issued by the EPA which would require further reduction in RVP beginning in May 1992. The Clean Air Act Amendments also established nationwide RVP standards which will apply as of May 1992, but do not exceed the EPA's Phase II standards.\nThe Clean Air Act Amendments will impact the Company primarily in the following areas: (i) starting in 1995 a \"reformulated\" gasoline (which would include content standards for oxygen, benzenes and\naromatics) is mandated in the nine worst ozone polluting cities, including Chicago and Milwaukee in the Company's market area; (ii) Stage II hose and nozzle controls on gas pumps to capture fuel vapors in nonattainment areas, including 400 company stores; (iii) more stringent refinery permitting requirements; and (iv) stricter refinery waste disposal requirements as a broader group of wastes are classified as hazardous. In addition, EPA regulations required that after October 1, 1993 the sulfur contained in on-road diesel fuel produced in the US must be reduced.\nClark cannot predict what environmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be administered or interpreted with respect to products or activities to which they have not previously been applied. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies or stricter interpretation of existing laws which may develop in the future, could have an adverse effect on the financial position or operations of Clark and could require substantial additional expenditures by Clark for the installation and operation of pollution control systems and equipment. See \"Item 3.","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nGenerators of hazardous substances found in off-site disposal locations at which environmental problems are alleged to exist, as well as the owners of those sites and certain other classes of persons, are subject to claims brought by state and federal agencies under CERCLA and analogous state laws, regardless of fault or the legality of original disposal. Under CERCLA, a potentially responsible party (\"PRP\") may be held jointly and severally liable for any such claims.\nOn or about December 7, 1988, \"Clark Oil\" was named as PRP by the EPA with respect to a solid waste disposal site in Gary, Indiana known as the 9th Avenue Site and was ordered to participate with approximately 250 other PRPs in the interim clean-up of that site. Information from the EPA and other parties involved indicated that Old Clark may have transported waste oils and solvents to the site during the mid 1970s. Pursuant to an Administrative Services Agreement then in effect between Clark and Old Clark, Clark responded to initial inquiries and advanced $160,000 for preliminary studies and clean-up of that site. Upon the expiration of the Administrative Services Agreement on November 30, 1990, Clark notified the EPA and other parties involved with respect to the site that Clark's involvement on behalf of Old Clark was terminated and advised that further contacts with respect to this site should be directed to Old Clark. Clark has received no information concerning the site since that notification. Clark believes it has no liability for this site because of the terms of the Asset Purchase Agreement with Old Clark, as approved by the Bankruptcy Court, which provided that Clark would not assume environmental liabilities arising prior to the date of closing. Based on information received by Clark during its involvement pursuant to the Administrative Services Agreement, the estimated total clean-up of this site ranged from $22 to $35 million. Clark has no information on the current amounts estimated for clean-up or amounts actually spent for clean-up.\nOn or about March 17, 1989, \"Clark Oil\" was named as PRP by the EPA with respect to a solid waste disposal site in Chicago, Illinois known as the U.S. Scrap Site and along with approximately 250 other PRPs was ordered to reimburse the EPA for $1.5 million in costs incurred in performing preliminary work on that\nsite. Information from the EPA and other parties indicated that Old Clark may have sent waste oils to the site during the 1970s. No information has been revealed which would indicate that Clark had any involvement with this site. Pursuant to the Administrative Services Agreement with Old Clark then in effect, Clark responded to initial inquiries about the site. However, Clark has advanced no payments related to the EPA's claim for reimbursement. Upon the expiration of the Administrative Services Agreement, on November 30, 1990, Clark notified the EPA that its involvement on behalf of Old Clark was terminated and advised that all future contacts with respect to the site should be directed to Old Clark. Clark has received no other information concerning the site since that notification. To the best of Clark's knowledge, the estimated amount being sought by the EPA was $1.5 million. Clark believes it has no liability for this site because of the terms of the Asset Purchase Agreement with Old Clark.\nOn September 15, 1989, \"Clark Oil & Refining Corp.\" received an inquiry from the EPA concerning any involvement at a disposal site in Texas City, Texas known as the Tex-Tin Site. On October 17, 1989, Clark responded that it had no connection to the site. Upon the expiration of the Administrative Services Agreement on November 30, 1990, Clark further notified the EPA that its involvement on behalf of Old Clark was terminated and advised that all future contacts with respect to the site should be directed to Old Clark. Clark has never received any information concerning potential costs involved in connection with this site, or any other parties which may be involved as potential PRPs. Clark presumes that all contamination would have been the result of activities of Old Clark and that Clark would have no liability because of terms of the Asset Purchase Agreement.\nAs indicated, Clark does not believe that it is a proper party to any of the above-described EPA claims. Clark cannot estimate costs for which it may ultimately be liable with respect to these three sites, but in the opinion of the management of Clark, these costs should not have a material adverse effect on Clark's operations or financial condition. There can be no assurance that Clark will not be named as a PRP at additional sites in the future or that the costs associated with those sites would not be substantial.\nIn late 1990, Clark received a letter from the Illinois Attorney General Environmental Control Division which included a report prepared by the Illinois Environmental Protection Agency (\"IEPA\") on its investigation of the Village of Hartford, Illinois ground water contamination. The report cited the history of the ground water contamination in the area including the installation by Old Clark in 1978 of recovery systems in Hartford for the removal of hydrocarbons from the surface of the ground water. The report identified Clark or Old Clark and two other oil companies as potential contributors to the contamination. In particular, it contended that Clark or Old Clark is the party primarily responsible for the hydrocarbon contamination and demanded that more aggressive and encompassing efforts be immediately initiated by Clark. Clark submitted its response to the letter and the report on January 15, 1991. In its response Clark indicated that, without admission of legal liability, it would continue to cooperate with the Illinois Attorney General and the IEPA by performing a remediation program meeting the objectives defined by the IEPA in its report. The response also contained data which disputed many of the contentions made by the IEPA. Clark's remediation plan was approved by the IEPA and the IEPA has issued all necessary permits to implement the remediation plan. The IEPA is provided with monthly progress reports. Clark successfully completed a major portion of the remediation work under an implementation plan that was submitted to the IEPA in August 1991. The necessity of future remediation work is being evaluated. Based upon the estimates of an independent environmental engineering firm, Clark established a $10 million provision for the estimated costs of its mitigation and recovery efforts of which $3.6 million has been spent to date.\nForty-one civil suits by residents of Hartford, Illinois have been filed against Clark in Madison County Illinois, alleging damage from ground water contamination. The relief sought in each of these cases is an unspecified dollar amount. The litigation proceedings are in the initial stages. Discovery, which could be lengthy and complex, is only just beginning. Clark moved to dismiss thirty-four cases filed in December 1991 on the ground that Clark is not liable for alleged activity of Old Clark. On September 4, 1992, the trial court granted Clark's motions to dismiss. The plaintiffs were given leave to re-file their complaints but based only on alleged activity of Clark occurring since November 8, 1988, the date on which the bankruptcy court with\njurisdiction over Old Clark's bankruptcy proceedings issued its \"free and clear\" order. In November 1992, the plaintiffs filed thirty-three amended complaints. In addition, one new complaint involving nine plaintiffs was filed. It is too early to predict whether any of these cases will go to trial on the merits and if so, what the risk of exposure to Clark would be at trial. It is also not possible to determine whether or to what extent Clark will have any liability to other individuals arising from the ground water contamination.\nIn November 1991, Clark learned that the EPA, the IEPA and the Cook County Department of Environmental Control were investigating the cause or causes of certain apparent exceedences of ambient air quality standards for sulfur dioxide in the vicinity of the Blue Island refinery. The EPA and the IEPA requested certain specific information from Clark, which Clark supplied. Clark has indicated that it will cooperate with the investigation of the apparent sulfur dioxide exceedences and has undertaken the requested monitoring and engineering procedures. Also in connection with the apparent exceedences, Clark received a Notice of Violation from the EPA in February 1992 and an Administrative Complaint and Notice of Proposed Order Assessing a Penalty of $50,000 in October 1992. Clark paid a penalty of $45,000 to the EPA in March 1994.\nClark received an Administrative Complaint from the EPA on June 12, 1992 alleging record keeping violations of the RCRA concerning 22 stores in Michigan, Indiana and Wisconsin and seeking civil penalties of $0.6 million. On March 18, 1993, Clark received an Amended Complaint from the EPA involving similar allegations but reducing the amount of civil penalties sought to $0.1 million. Clark received an Administrative Complaint from the EPA on January 5, 1993 alleging record keeping and related violations of the Clean Air Act concerning the Hartford refinery and seeking civil penalties of $0.1 million.\nOn May 5, 1993, Clark received correspondence from the Michigan Department of Natural Resources (\"MDNR\") indicating that the MDNR believes Clark may be a PRP in connection with ground water contamination in the vicinity of one of its retail stores in the Sashabaw Road area north of Woodhull Lake and Lake Oakland, Oakland County Michigan. Clark has begun an initial investigation into the matters raised by the MDNR. At the request of the MDNR, Clark has conducted an investigation into the historical use of its site, potential contaminants used at the site, third party sites which may be the source of contaminants and is also conducting a subsurface investigation of its site and the surrounding area. Clark has incurred approximately $25,000 in investigative activities to date. Clark does not know whether MDNR has identified other PRPs in connection with this matter, nor has it received any information from MDNR as to what it believes may be the ultimate cost associated with this site. Clark will not be able to prepare a corrective action plan and estimate potential clean-up costs until its investigatory work is complete.\nAn impoundment at the Hartford refinery contains hazardous wastes that were produced as the result of past operations. Clark has been evaluating remedial options with respect to that waste since 1992 and has been in discussions with the IEPA concerning those options. In April 1993 the IEPA told Clark that the presence of those hazardous wastes may require a permit under the RCRA and that in turn may require corrective action with respect to the entire refinery. Clark has received no formal notice or complaint with respect to these issues from the IEPA. Clark has begun an investigation with respect to the need for a permit and consequent corrective action. Based upon the estimates of an independent engineering firm, Clark established a $9.0 million provision for the estimated costs of site clean-up of which $7.2 million has been spent to date on remedial activities performed after notice to and comments from the IEPA.\nIn addition to the proceedings described above, Clark has various suits and claims against it. While it is impossible to estimate with certainty the ultimate legal and financial liability in respect to these other suits and claims, Clark believes the outcome of these other suits and claims will not be material in relation to its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInapplicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nInapplicable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL DATA\n(IN THOUSANDS, EXCEPT RATIOS AND OPERATING DATA)\nThe following table sets forth, for the periods and dates indicated, selected financial and other data derived from the financial statements and related notes and the underlying books and records of Clark for the years ended December 31, 1993, 1992, 1991, 1990 and 1989. These selected financial and other data should be read in conjunction with the financial statements of Clark and related notes appearing elsewhere in this document.\n- -------- (a) Amortization includes amortization of turnaround costs and organizational costs. (b) Interest and financing costs, net, includes amortization of debt issuance costs of $1.2 million, $2.9 million, $6.0 million, $3.1 million and $9.1 million for the years ended December 31, 1993, 1992, 1991, 1990 and 1989 respectively. Interest and financing costs, net, also includes interest on all indebtedness, net of capitalized interest and interest income. (c) Other income in 1993 includes the final settlement of litigation with Drexel of $8.5 million and a gain from the sale of \"non-core\" stores of $2.9 million. Other income in 1992 includes the settlement of litigation with Apex and Drexel of $9.2 million and $5.5 million, respectively. Other expense in 1990 included a loss provision for $11.6 million representing the full amount of an overnight deposit held by Drexel. An additional 1990 loss provision of $10.0 million represents estimated costs of mitigation and recovery efforts resulting from alleged responsibility for ground water contamination in the town of Hartford, Illinois, adjacent to the Hartford refinery. A 1990 loss provision of $0.7 million reflected the inability of a former affiliate to repay its note due Clark. (d) Extraordinary item includes the recognition of deferred financing costs, premium amount and interest expense from September 30, 1992 through the redemption date of October 26, 1992, net of applicable income taxes on the redemption of the 12 1\/4% First Mortgage Fixed Rate Notes due 1996. (e) On January 1, 1993, Clark adopted SFAS 106. This standard requires that Clark accrue the actuarially determined costs of postretirement benefits during the employees' active service periods. Previously, Clark had accounted for these benefits on a \"pay as you go\" basis, recognizing an expense when an obligation was paid. In accordance with SFAS 106, Clark elected to recognize the cumulative liability, a non-cash \"Transition Obligation\" of $9.6 million, net of the tax benefit of $6.0 million, as of January 1, 1993. On January 1, 1993, Clark adopted SFAS 109 and restated the years ended December 31, 1992 and 1991. The cumulative effect through December 31, 1990 is reflected as an adjustment to income in 1990 in this table. The adoption of this standard changes the method of accounting for income taxes from the deferred method to an asset and liability approach. Previously, Clark deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. (f) The ratio of earnings to fixed charges is computed by dividing (i) earnings before income taxes (adjusted to recognize only distributed earnings from less than 50% owned persons accounted for under the equity method) plus fixed charges by (ii) fixed charges. Fixed charges consist of interest on indebtedness, including amortization of discount and debt issuance costs and the estimated interest components (one-third) of rental and lease expense. (g) As a result of the losses for the years ended December 31, 1993 and 1992, earnings were insufficient to cover fixed charges by $17.3 million and $20.7 million respectively. (h) Retail operating expenses for 1992 exclude $5.8 million of charges that management considers to be unusual. (i) Refinery utilization is the ratio of total production yield to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases), which add to the refinery's output are utilized in the refining process. (j) Refinery operating expenses for 1992 exclude $11.5 million ($0.22 per barrel) of charges that management considers to be unusual.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOverview\nClark's results are impacted significantly by a variety of factors beyond its control, including movements in crude oil prices, demand for refined products, general oil price levels and industry refinery capacity and utilization rates. Clark's net sales and operating revenues fluctuate significantly with movements in industry crude oil prices but they do not have a direct relationship to net earnings. The effect of changes in crude oil prices on Clark's operating results is determined more by the rate at which the prices of refined products adjust to reflect such changes. Management believes that lower crude oil prices benefit operating results over the longer term due to increased demand, decreased working capital requirements and a greater sensitivity by the major integrated oil companies to profitability in their refining and marketing operations. Higher refinery production is typically associated with improved results of operations. Conversely, lower production, which generally occurs during scheduled refinery maintenance turnarounds, negatively impacts results of operations.\nThe following table sets out the approximate pre-tax earnings impact on Clark of changes in: 1) refining margins--the spread between wholesale and spot market product prices and input (e.g. crude oil) costs and 2) retail margins-- the spread between product prices at the retail level and wholesale product costs. While margins are impacted significantly by the industry factors described above, individual companies can influence their own margins through the efficiency of their operations.\n*Changes in crude oil prices may affect the carrying value of inventories.\nFalling crude and product prices reduced 1993 and 1992 net sales and operating revenues, while improved unit volumes partially offset the drop. Crude and product prices have declined from the levels reached during the 1990 Iraqi invasion of Kuwait and the 1991 Soviet coup, which were viewed as potential threats to supply. Net sales and operating revenues were also affected by sales volumes; retail gasoline volumes were up 6% from 1992 and down 1% in 1992 as compared to 1991, and wholesale sales volumes were up 21% from 1992 and up 122% in 1992 as compared with 1991.\nCLARK FINANCIAL HIGHLIGHTS:\n*Management considers certain items in 1992 and 1993 at Clark to be \"unusual\". In 1993, the unusual items netted to a $30.7 million charge before taxes, $18.8 million net of taxes. In 1992, the unusual items netted to a $25.7 million charge before taxes, $13.4 million net of taxes. Detail on these items is presented below.\nNet earnings excluding unusual items improved in 1993 despite a decline in industry refining margins and reduced production associated with the scheduled maintenance turnaround at Clark's Blue Island, Illinois refinery. The gain was due to the combination of improved retail and refinery productivity and better retail market conditions. These improvements became significant in the latter part of 1993. Excluding unusual items, Clark's 1993 fourth quarter net earnings rose to $7.3 million compared to $0.4 million in 1992 and a loss of $2.5 million in 1991.\nUNUSUAL ITEMS\nSeveral items which are considered by management to be \"unusual\" are excluded throughout this discussion of Clark's results of operations. A non-cash accounting charge was taken in the fourth quarter of 1993 to reflect the decline in the value of petroleum inventories below carrying value caused by a substantial drop in prices. If petroleum prices were to recover, earnings would benefit up to the extent of this charge. Further deterioration in prices could result in further charges. Effective January 1, 1993, Clark adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note 12 \"Postretirement Benefits Other Than Pensions\" to the financial statements) and No. 109 \"Accounting for Income Taxes\", which was accounted for by restating prior periods (see Note 13 \"Income Taxes\" to the financial statements). Unusual credits included a 1993 gain related to the sale of 21 retail stores located in \"non-core\" markets and the favorable settlement of litigation. See Note 11 \"Other Income\" to the financial statements. Unusual charges in 1992 included the early retirement of Clark's 12 1\/4% First Mortgage Fixed Rate Notes due July 15, 1996, and provisions related to the environmental clean-up of the storm water basin at the Hartford, Illinois refinery and expected closures of under-performing retail stores. In addition, expenses related to early retirements and a severance program along with a canceled initial public offering were incurred in 1992.\nRetail\nRetail Division Operating Statistics:\n- -------- (1) Excludes unusual charges totaling $5.8 million, primarily related to restructuring and store closures.\nClark's retail division contributed $57.6 million in 1993 to operating income, up from $42.4 million excluding unusual items in 1992 and $55.9 million in 1991. The 1993 improvement is due to improved sales volumes and industry margins, while the decline in 1992 as compared to 1991 was due to decreased margins and the closure in late 1991 of stores representing approximately 2% of 1991 volume. Average monthly volumes per store in 1993 were up 9% over 1992 and 4% in 1992 over 1991 as a result of increased promotional activity, improved productivity and the closure of under-performing units. During selected periods of the year and in selected markets Clark ran promotions, including one that offered premium gasoline at the same price as regular unleaded gasoline. Margins per gallon improved in 1993 over the prior two years due to increased sales of higher margin premium gasoline, stronger retail market conditions and decreased competitive pricing pressures along with more responsive pricing strategies. Excluding unusual items, the retail division contributed $16.0 million to 1993 fourth quarter operating income compared to $14.6 million in the same periods of both 1992 and 1991.\nThe 1993 gross margin from convenience product sales rose 15% from 1992, with 1992 up 6% as compared to 1991. The average monthly contribution from convenience product sales per store for the 1993 was up 19% as compared to 1992 and 1992 was up 12% as compared to 1991. These improvements were principally due to improved vendor allowances, increased promotional activity, enhanced store merchandising and manager training, and store incentive plans.\nThe increase in 1993 operating expenses over 1992 and 1991 is related to costs incurred to implement a strategy to rework Clark's organizational structure to more fully involve the general work force in the operation of the business. These increased costs included higher labor, training, promotion and systems-related expenses. The increased promotional activity related to strengthening the Clark brand name, including purchasing of advertising and point of sale materials. Adding to the increase from 1991 to 1992 were expenses related to additional underground storage tank testing, a store associate bonus program and increased participation in the store health insurance program.\nRefining\nRefining Division Operating Statistics:\n- -------- (1) Excludes unusual charges totaling $11.5 million, primarily related to a provision for environmental remediation and restructuring.\nClark's refining division contributed $51.1 million to operating income in 1993, flat with the $51.2 million excluding unusual items contributed in 1992 and compared to $77.8 million in 1991. Industry refining margins continued the decline experienced in 1992, moving down further from the levels reached following the 1990 Persian Gulf conflict and the 1991 Soviet coup. This downward trend has occurred despite increasing demand for gasoline and distillate products. As reported by the American Petroleum Institute, US gasoline deliveries for 1993 rose by 1.5% versus a 1.1% increase in 1992, while distillates showed an increase of 2.1%. However, demand has been more than offset by high industry refinery runs, which have reached a crude oil throughput utilization rate of 91.5%, the highest level in at least 20 years. In addition, industry yield (as a percentage of crude oil runs) of light products grew, with gasoline and distillate output rising 2.7% and 5.0% respectively, further increasing the supply of these normally higher-margin products. This changing industry yield pattern has resulted from upgraded light-product processing, showing approximately a 10% increase in throughput over the past five years.\nClark's refining margins improved in 1993, especially in the third and fourth quarters and in relation to the decline in industry refining margin indicators. Excluding unusual items, the refining division contributed $20.8 million to 1993 fourth quarter operating income compared to $11.0 million in 1992 and a loss of $0.1 million in the same period of 1991. The third and fourth quarter refining division results improved on the strength of recent productivity initiatives, heavy oil and wholesale margins, and market profit opportunities presented by the mandated transition to low sulfur #2 oil for on-road use. This occurred despite third quarter losses related to a drop in crude and product prices, flooding in the midwestern US, and the significant drop in Midwest #2 oil prices. Refinery production for 1993 was down from 1992 due to the maintenance turnaround at the Blue Island refinery. Production during 1992 exceeded 1991 due to a turnaround at the Hartford refinery in 1991. Another turnaround is scheduled for the Hartford refinery in 1994.\nRefining operating expenses of $108.2 million in 1993 were just over 1992 operating expenses excluding unusual items of $106.5 million and 1991 expenses of $105.4 million. The uninsured portion of the cost associated with a gasoline spill from one of Clark's storage tanks in January 1994 is not expected to have a material effect on earnings.\nOutlook\nClark believes the demand for refined products will experience flat to only slight growth over the next several years, but expects that regulatory requirements and costs of entry will limit the industry's ability to meet demand. High current industry refinery utilization and the expected closure of marginal refineries due to increasing requirements for regulatory capital investments may result in a more positive long-term outlook for the refining and marketing industry.\nIn the near-term, Clark is looking to achieve significant productivity gains to secure its ongoing profitability. Clark has set a goal to achieve additional pre-tax productivity gains of $55 million in 1994, having achieved estimated gains of $20 million in 1993. These gains assume no improvement in industry margins, and in fact, Clark's earnings before depreciation, interest and taxes improved in the second half of 1993 despite deterioration in refining margins, as a result of the productivity gains achieved to date. In addition to this internal earnings growth, Clark is also pursuing growth in its retail and refining businesses through acquisitions.\nGeneral and Administrative Expense\nClark's general and administrative expenses were $27.5 million, higher than 1992 expenses of $24.8 million excluding unusual items and expenses of $20.8 million in 1991. Expenses in 1993 and 1992 were up principally due to higher labor and related costs, as Clark is making significant changes in its management, systems and procedures to benefit productivity in the longer term.\nDepreciation and Amortization\nDepreciation and amortization expenses have increased in the past three years due to the completion of higher cost refinery turnarounds in 1991 and 1993 and the recent higher levels of capital expenditures.\nNet Interest and Financing Costs\nClark's capital structure has changed significantly over the past three years, although the resulting effect on 1993 and 1992 net interest and financing costs has not been substantial. Clark's 1993 net interest and financing cost increase was principally due to lower interest income on less average funds invested and lower rates. See Note 8 \"Long-Term Debt\" to the financial statements.\nOther Income (Expenses)\nSee Note 11 \"Other Income\" to the financial statements for the items that comprise other income.\nLIQUIDITY AND CAPITAL RESOURCES\nFinancial Position\nCash generated by operating activities before working capital changes for the year ended December 31, 1993, was $62.2 million, $25.3 million greater than 1992 but $27.7 million under 1991. Cash flow has been impacted by the fluctuation in Clark's net earnings the past three years. Working capital at December 31, 1993, was $203.8 million, a 1.96 to 1 current ratio, versus working capital of $245.1 million, a 2.31 to 1 current ratio at December 31, 1992, and working capital of $304.1 million, a 2.82 to 1 current ratio, at December 31, 1991. The 1992 decline was principally a result of capital expenditures and the retirement of debt. See Note 8 \"Long-Term Debt\" to the financial statements.\nIn general, Clark's short-term working capital requirements fluctuate with the price of crude oil. Clark expects internally generated cash flows will be sufficient to meet its needs. Clark has in place a $100 million\ncommitted revolving line of credit expiring December 31, 1994, for cash borrowings and for the issuance of letters of credit primarily for purchases of crude oil, other feedstocks and refined products. At December 31, 1993, $51.5 million of the line of credit was utilized for letters of credit. There were no direct borrowings under Clark's line of credit at December 31, 1993 or 1992.\nCash flows from investing activities are primarily impacted by capital expenditures including maintenance turnarounds. During 1993, capital expenditures were $67.9 million compared with $59.5 million in 1992 and $58.0 million in 1991. Refinery division capital expenditures were $39.2 million in 1993 compared with $49.2 million in 1992 and $33.4 million in 1991. In addition, $20.6 million, $2.7 million and $17.2 million was spent for maintenance turnaround expenditures in 1993, 1992 and 1991 respectively. The increased spending in the refining division over the past three years has been primarily related to environmental projects. In 1993, projects included Stretford, crude and FCC unit upgrades at the Blue Island refinery while in 1992 projects included the distillate desulfurization project (subsequently delayed), vapor reduction and a new flare at the Hartford refinery. Retail expenditures were $26.5 million, $8.8 million and $23.6 million in 1993, 1992 and 1991 respectively. In 1993 nearly half of retail expenditures were environmental projects related to tanks, lines, vapor recovery and soil remediation. The balance of 1993 retail expenditures included discretionary projects such as store interior remodeling, systems automation and \"On The Go\" store concept development. Spending declined in 1992 and was limited primarily to environmental projects while a new long-term strategic plan was developed.\nClark projects 1994 capital expenditures to be approximately $80 million. Another $15 million is expected to be spent on a maintenance turnaround at the Hartford refinery. Estimated refining division capital expenditures of $40 million include $10 million for various environmental projects and $30 million of discretionary spending such as improvements to Hartford's crude and FCC units. Retail division capital expenditures are estimated to be $40 million including $20 million for environmental projects and $20 million for discretionary projects such as the addition of canopies and new dispensers to existing sites, the expansion of store interior selling space and \"reimaging\" locations under Clark's new logo and updated color scheme. Discretionary spending in each division will be linked to its operating cash flow.\nOver the period 1994 to 1998, Clark has preliminary plans to complete a number of environmental and other regulatory capital expenditure programs. These environmental expenditures comprise two major categories, those that are mandatory in order to comply with regulations pertaining to ground, water and air contamination, and those that are primarily discretionary involving the reformulation of refined fuel for sale into certain defined markets. The total mandatory expenditures for regulatory compliance over the next five years are estimated at approximately $100 million, split evenly between the retail and refining businesses. Costs of potential future regulations cannot be forecast.\nThe expenditures required to comply with reformulated fuels regulations are primarily discretionary, subject to market conditions and economic justification. The reformulated fuels programs impose restrictions on properties of fuels to be refined and marketed, including those pertaining to gasoline volatility, oxygenated fuel, detergent addition and sulfur content. The regulations regarding these fuel properties apply to different markets in which Clark operates, in certain circumstances at different times of the year.\nModifications estimated at $10-15 million to produce reformulated gasoline are being considered for the Blue Island refinery. The decision to proceed with such a project will depend on economic justification. A project initiated to produce low sulfur diesel fuel at the Hartford refinery was delayed in 1992 based on internal and third party analyses that indicated an oversupply of low sulfur diesel fuel capacity in Clark's marketplace. These analyses projected relatively narrow price differentials between low and high sulfur diesel products which have thus far been borne out after the initial transition to the low sulfur regulations. However, if price differentials widen sufficiently to justify investment, Clark could install the necessary equipment over a 14 to 16 month period at an estimated additional cost of $40 million. Furthermore, if Clark decided to install equipment necessary to produce reformulated gasoline and control sulfur emissions at Hartford, the gasoil desulfurizer and related equipment are estimated to cost an additional $90-130 million. These estimates have declined from a year ago as Clark has found more cost-effective methods of complying with regulations.\nClark's net cash flow used in financing activities was $1.1 million in 1993 and $38.7 million in 1992, while $119.1 million was provided in 1991. In 1991 and 1992, long-term debt was retired early and new debt was issued, principally to increase available cash and extend maturities of debt past the period when Clark expected to incur its largest capital expenditure requirements. See Note 8 \"Long-Term Debt\" to the financial statements. In 1993, Clark entered into several operating leases related to retail store automation equipment, coolers and beverage dispensers, office equipment, refinery lab equipment and a filter press.\nFunds generated from operating activities, together with Clark's existing cash, cash equivalents and marketable investments, are expected to be adequate to fund requirements for working capital and capital expenditure programs for the next year. Clark's future discretionary or environmentally-mandated spending, or acquisitions may require additional debt or equity capital.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is incorporated herein by reference to Part IV Item 14 (a) 1 and 2. Financial Statements and Financial Statement Schedules.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of Clark and their respective ages and positions are set forth in the table below.\nThe Board of Directors of Clark consists of three directors who serve until the next annual meeting of stockholders or until a successor is duly elected. Directors do not receive any compensation for their services as such. Officers of Clark serve at the discretion of the Board of Directors (and in the case of Messrs. Barnholt and Sigurdson, pursuant to employment agreements).\nPeter Munk has served as Chairman of the Board since July 1992, as Chairman of the Board and Chief Executive Officer from August 1990 through July 1992 and as Vice Chairman from November 1988 through August 1990. Mr. Munk has served as a director of the Company since November 1988. Mr. Munk has served as Chairman of the Board of Directors of Horsham since its formation in June 1987 and as Chairman and Chief Executive Officer and a director of Barrick since July 1984.\nPaul D. Melnuk has served as a director since October 1992, as President and Chief Executive Officer since July 1992, as President and Chief Operating Officer from February 1992 through July 1992, as Executive Vice President and Chief Operating Officer from December 1991 through February 1992, as Executive Vice President and Chief Financial Officer from November 1991 through December 1991, as Vice President and Chief Financial Officer from August 1990 through November 1991 and as Vice President from November 1988 through August 1990. Mr. Melnuk has served as President and Chief Operating Officer and as a director of Horsham since March 1992, as Executive Vice President and Chief Financial Officer of Horsham from May 1990 through February 1992 and as Vice President of Horsham from April 1988 through May 1990.\nC. William D. Birchall has been a director of Clark since November 1988. Mr. Birchall has been Chief Financial Officer of Arlington Investments Limited, a private investment holding company located in Nassau, Bahamas, for the last five years. Mr. Birchall has been a director of Barrick since July 1984 and a director of Horsham since 1987.\nBrandon K. Barnholt has served as Executive Vice President-Retail Marketing since December 1993 and Vice President-Retail Marketing from July 1992 through December 1993 and as Managing Director-Retail Marketing from May 1992 through July 1992. Mr. Barnholt previously served as Retail Marketing Manager of Conoco, Inc. from March 1991 through March 1992 and Lubricants Sales Manager from April 1988 through March 1991. During 1990 and 1989, Mr. Barnholt served as President of the Denver Conoco Credit Union.\nKevin P. Pennington has served as Executive Vice President-Corporate Services since December 1993 and as Vice President-Human Resources from July 1993 through December 1993. Previously Mr. Pennington served as Vice President-Human Resources for the Mercy Health System from April 1991 through July 1993 and as Assistant Vice President-Human Resources at GTE from June 1985 through April 1991.\nEric D. Sigurdson has served as Executive Vice President-Refining since December 1993, Vice President-Finance and Administration and Chief Financial Officer from October 1992 through December 1993 and as Vice President-Corporate Development from May 1992 to October 1992. Mr. Sigurdson has served as Vice President and Chief Financial Officer since November 1992 and as Vice President of Horsham since January 1992. From September 1989 through January 1992, Mr. Sigurdson served as President of Toronto Dominion Real Estate Inc. and as Director of Mergers & Acquisitions, Toronto Dominion Securities Inc. From April 1988 through September 1989, he served as corporate finance and real estate consultant at Cormax Capital Ltd.\nPatrick F. Heider has served as Secretary since October 1992. Mr. Heider has served as in-house counsel since April 1990. Mr. Heider previously was employed as an associate with the St. Louis law firm of Shepard, Sandberg & Phoenix from April 1988 through April 1990.\nThere are no arrangements or understandings between any director or executive officer and any other person pursuant to which such person was elected or appointed as a director or executive officer of Clark. There are no family relationships between any director or executive officer and any other director or executive officer.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the compensation paid to the most highly compensated executive officers of Clark earning in excess of $100,000.\n- -------- (a) Mr. Melnuk and Mr. Sigurdson receive compensation from Horsham for their services as President and Chief Operating Officer and Vice President and Chief Financial Officer, respectively, of Horsham. (b) Represents amounts accrued for the accounts of such individuals under the Clark Refining & Marketing, Inc. Savings Plan. (c) Payment of equity protection in sale of personal residence. (d) Number of shares covered by grants which may be exercised as stock options. These shares were granted under the Clark Refining & Marketing Stock Option Plan (the \"Option Plan\") and are exercisable for Subordinate Voting Shares of Horsham. Mr. Melnuk, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson hold options to acquire Subordinate Voting Shares of Horsham received as compensation from Horsham.\nCompensation of Clark's executive officers is determined by Clark's Board of Directors. Mr. Melnuk, Clark's President and Chief Executive Officer, is a member of Clark's Board of Directors.\nOPTION GRANTS IN 1993\nThere were no grants of stock options pursuant to Clark's Option Plan during the year ended December 31, 1993, to the executive officers named above. In 1993, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson received options to acquire Subordinate Voting Shares of Horsham from Horsham.\nYEAR-END OPTION VALUES\nThe following table sets forth information with respect to the number and value of unexercised options to purchase Subordinate Voting Shares of Horsham held by the executive officers named in the Summary Compensation Table at December 31, 1993. None of the named executive officers exercised any stock options during 1993.\n- -------- (a) Based upon the closing price on the New York Stock Exchange--Composite Transactions on December 31, 1993. (b) Mr. Melnuk, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson hold options to acquire Subordinate Voting Shares of Horsham received as compensation from Horsham.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nCompensation of Clark's executive officers is determined by the Board of Directors. Mr. Melnuk, Clark's President and Chief Executive Officer, is a member of the Board of Directors. Other than reimbursement of their expenses, Clark's directors do not receive any compensation for their service as directors.\nEMPLOYMENT AGREEMENTS\nClark has an employment agreement with Mr. Sigurdson which provides for a term of three years commencing January 14, 1992 at a minimum annual salary of $150,000. In addition, Mr. Sigurdson was granted an option to purchase 100,000 shares of Subordinate Voting Shares of Horsham by Horsham which option shall become exercisable as to one-third of the shares on each of the first three anniversary dates of the granting of the option.\nClark has an employment agreement with Mr. Barnholt which provides for a term of three years commencing May 11, 1992 at a base annual salary of $112,500. In addition, Mr. Barnholt was granted an option to purchase 30,000 shares of Subordinate Voting Shares of Horsham, which option shall become exercisable as to one-third of the shares on each of the first three anniversary dates of the granting of the option.\nCLARK REFINING & MARKETING, INC. SAVINGS PLAN\nClark maintains the Clark Refining & Marketing, Inc. Savings Plan (the \"Plan\"), a profit sharing plan which permits employee before-tax contributions and provides for employer incentive matching contributions. The Plan was adopted effective January 1, 1989 and as of January 1, 1994 the assets under the related trust that implements and forms a part of the Plan are held in trust by Boatmen's Trust Company. Under the Plan, each employee of Clark and such other related companies as may adopt the Plan, who has attained age 21 (no age requirement effective April 1, 1994) and completed one year of service (six months of service effective April 1, 1994) may become a participant. Participants are permitted to make elective before-tax contributions to the Plan, effected through payroll reduction, from 2% to 12% (15% effective January 1, 1994) of their compensation. Clark makes matching contributions equal to 100% of a participant's elective before-tax contributions up to 6% of compensation (effective April 1, 1994 a 200% match of up to 3% of compensation). Participants are also permitted to make after-tax voluntary contributions through payroll deduction, from 2% to 5% of compensation, which are not matched by employer contributions. All employer contributions are vested at a rate of 20% per year of service, becoming fully vested after five years of service. Participants' vested accounts are distributable upon a participant's disability, death, retirement or separation from service. Subject to certain restrictions, employees may make loans or withdrawals of employee contributions during the term of their employment.\nCLARK REFINING & MARKETING, INC. STOCK OPTION PLAN\nIn 1991, Clark established a Stock Option Plan (the \"Option Plan\") under which options to purchase Subordinate Voting Shares of Horsham (\"Horsham Shares\") could be granted to certain of its non-employee directors and key employees. Under the Option Plan, options were granted for the purpose of attracting and motivating directors, officers and key employees. The Option Plan is administered by a committee of the Board of Directors consisting of two or more directors. Under the terms of the Option Plan, options granted to purchase Horsham Shares were at the market price of the Horsham Shares at the time of grant. In the event that an option holder ceases to be an employee, the holder (or the holder's estate) has three months to exercise the vested options. The maximum number of Horsham Shares authorized for issuance under the Option Plan, as amended, is 600,000.\nAs of December 31, 1993, there were 363,737 options outstanding to purchase shares of Horsham at prices ranging from $7.19 to $11.88 per share. The Company, under a trust agreement, held 253,738 Horsham shares at December 31, 1993 to meet obligations under the Option Plan.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll of Clark's common stock is owned by R & M Holdings, which is indirectly wholly owned by Horsham. R & M Holdings was formed by Horsham and AOC L.P. to acquire all of the capital stock of Clark and certain other assets. In connection with the Acquisition, AOC L.P., Horsham, R & M Holdings and Clark entered into a shareholder agreement, pursuant to which Horsham purchased 60% of the equity capital of R & M Holdings for $18 million and AOC L.P. purchased the remaining 40% of the equity capital of R & M Holdings for $12 million. AOC L.P. is a Missouri limited partnership, the sole general partner of which is G & N Investments, Inc.\nREPURCHASE OF STOCK\nOn December 30, 1992, R & M Holdings repurchased from AOC L.P. 34.67 shares of its common stock (approximately 87% of the shares of R & M Holdings common stock owned by AOC L.P.) and the option held by AOC L.P. to acquire common stock described above, for a purchase price of $90 million in cash and the transfer of all of the shares of CMAT, Inc. (\"CMAT\"), the principal asset of which is a Colorado ski resort. Horsham purchased the remaining 5.33 shares of common stock (approximately 13% of the shares of R & M Holdings common stock owned by AOC L.P.) for a purchase price of $10 million in cash and a warrant to purchase up to 3,000,000 subordinate voting shares of Horsham at an exercise price of $7.625 per share. In addition, a shareholder agreement was terminated. As of December 31, 1993, Peter Munk held approximately 80.9% voting control of Horsham.\nIn addition, R & M Holdings and Horsham have agreed to pay to AOC L.P. approximately 89% and 11%, respectively, of the Contingent Payment described below. The Contingent Payment is an amount, which shall not exceed in the aggregate $24 million plus interest at 9% per annum, compounded annually, calculated as a percentage of (i) the net cash flow of Clark for the years 1993, 1994, 1995 and 1996, in excess of specified levels and (ii) the net proceeds from sales, prior to January 1, 1997, of any equity security of R & M Holdings or Clark, or of certain assets of Clark or Clark Pipe Line Company or of certain mergers involving R & M Holdings or Clark, at prices in excess of specified levels. Any Contingent Payments due for 1993 were immaterial.\nThe shares of CMAT transferred to AOC L.P. were valued at approximately $9.9 million, following capitalization of certain intercompany debt held by Clark.\nIn connection with the foregoing transaction, AOC L.P., its principals and their affiliates, on the one hand and Horsham, R & M Holdings and Clark, on the other hand, delivered a Mutual Release of all claims, known or unknown, of either party against the other. In consideration of such release, Clark paid to AOC L.P. $2.5 million in cash.\nTo fund the repurchase of shares of its common stock, R & M Holdings borrowed $90 million pursuant to the Horsham Notes. The Horsham Notes consist of (i) a zero coupon note payable to Horsham issued on December 30, 1992 for a price of $75.0 million and maturing on June 28, 1993 in the face amount of approximately $79.6 million and (ii) a zero coupon note payable to a wholly owned subsidiary of Horsham issued on December 21, 1992 for a price of $15.0 million and maturing on June 19, 1993 in the face amount of approximately $15.9 million. The issue price of each of the Horsham Notes represented a yield to maturity of approximately 11.8%. The Horsham Notes were repaid on February 18, 1993 from the proceeds of a private debt placement by R & M Holdings.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nHorsham and Clark have agreements to provide certain management services to each other from time to time. During 1990, Clark arranged interim letter of credit facilities with two banks totaling $125.0 million requiring the guarantee of Horsham. Fees related to this interim financing arrangement and associated\nguarantee paid to Horsham in 1991 totaled $7.0 million. Clark has established trade credit with various suppliers of its petroleum requirements, occasionally requiring the guarantee of Horsham. Fees related to trade credit guarantees totaled $0.4 million during 1991 and $0.1 million in 1992.\nThe business relationships described above and any future business relationships with Horsham will be on terms no less favorable in any respect than those which could be obtained through dealings with third parties.\nRELATIONSHIP WITH R & M HOLDINGS\nFor Federal income tax purposes, Clark has been a member of the consolidated group of which R & M Holdings is the parent corporation (the \"R & M Holdings Group\").\nPursuant to a Tax Sharing Agreement in effect among R & M Holdings and each of its direct and indirect subsidiaries, for any year in which Clark is entitled to file a consolidated Federal income tax return with R & M Holdings, Clark generally is required to pay to R & M Holdings an amount equal to the amount of Federal income tax Clark would have paid had it computed its Federal income tax liability as a separate company in such year and any prior year. If Clark has or would have had an unused tax credit or loss which it could have carried back had it filed separate tax returns for all prior years, R & M Holdings must pay Clark an amount equal to the refund to which Clark would have been entitled. However, if Clark leaves the R & M Holdings Group, the Tax Sharing Agreement will cease to apply to it and it will no longer be entitled to reimbursement for the use of any of its losses, even if those losses result in refunds to the R & M Holdings Group or otherwise reduce the Federal income liability of the R & M Holdings Group, unless R & M Holdings otherwise agrees. Clark also may have to pay an additional amount to R & M Holdings or may be entitled to a payment from R & M Holdings if Clark's separately computed income, losses or credits are adjusted as a result of an audit by the Internal Revenue Service. The principles set forth above with respect to the Federal income taxes also apply to state taxes in those states where a combined income tax return can be filed.\nHolding's address is 8000 South Beech Daly Road, Taylor, Michigan 48180.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. AND 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe financial statements and schedules filed as a part of this Report on Form 10-K are listed in the accompanying index to financial statements and schedules.\n3. EXHIBITS\n(B) REPORTS ON FORM 8-K\nRegistrant filed a Form 8-K dated October 1, 1993 disclosing change of corporate name and trademark.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Clark Refining & Marketing, Inc.:\nWe have audited the accompanying balance sheets of Clark Refining & Marketing, Inc. (formerly Clark Oil & Refining Corporation) (a Delaware corporation and wholly owned subsidiary of Clark R & M Holdings, Inc.) as of December 31, 1993 and 1992 and the related statements of earnings, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Clark Refining & Marketing, Inc. as of December 31, 1993 and 1992 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in notes 12 and 13 to the financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions and its method of accounting for income taxes.\nCoopers & Lybrand\nSt. Louis, Missouri, January 28, 1994\nCLARK REFINING & MARKETING, INC.\nBALANCE SHEETS\n(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nSTATEMENTS OF EARNINGS\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC. STATEMENTS OF CASH FLOWS\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nSTATEMENT OF STOCKHOLDER'S EQUITY\nDECEMBER 31, 1993\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991\n(TABULAR DOLLAR AMOUNTS IN THOUSANDS OF US DOLLARS)\n1. GENERAL\nClark Refining & Marketing, Inc., formerly Clark Oil & Refining Corporation, a Delaware corporation (\"Clark\") was organized in 1988 for the purpose of acquiring the principal assets of OC Oil & Refining Corporation (formerly Clark Oil & Refining Corporation, a Wisconsin Corporation) (\"Old Clark\"), a wholly- owned subsidiary of Apex Oil Company, Inc. (formerly Apex Oil Company) (\"Apex\") and certain other assets of Apex. Clark is wholly-owned by Clark R & M Holdings, Inc., a Delaware corporation (\"R & M Holdings\"), and R & M Holdings is indirectly, wholly-owned by The Horsham Corporation, a Quebec corporation (\"Horsham\"). During December 1992, the 40% ownership interest of R & M Holdings that was held by AOC Limited Partnership, a Missouri limited partnership and affiliate of Apex (\"AOC, LP\"), was acquired by R & M Holdings and Horsham.\nClark's principal operations include crude oil refining, wholesale and retail marketing of refined petroleum products and the retail marketing of convenience store items in the Central United States.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash and Cash Equivalents; Short-term Investments\nClark considers all highly liquid investments, such as time deposits, money market instruments, commercial paper and United States and foreign government securities, purchased within three months of maturity, to be cash equivalents. Short-term investments consist of similar investments, as well as United States government security funds, maturing more than three months from date of purchase and are carried at the lower of cost or market. Clark invests only in AA rated or better fixed income marketable securities or the short-term rated equivalent.\nInventories\nInventories are stated at the lower of cost, predominantly using the last-in, first-out \"LIFO\" method, adjusted for realized hedging gains or losses on petroleum products, or market on an aggregate basis. To limit risk related to price fluctuations, Clark purchases and sells crude oil and refined products futures contracts as hedges of its production requirements and physical inventories. Gains and losses on futures contracts are recognized in earnings as a product cost component and as an adjustment to the carrying amount of petroleum inventories and are reflected when such inventories are consumed or sold.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is computed using the straight- line method over the estimated useful lives of the assets or group of assets. The cost of buildings and marketing facilities on leased land and leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life or the lease term. Clark capitalizes the interest cost associated with major construction projects based on the effective interest rate on aggregate borrowings.\nExpenditures for maintenance and repairs are expensed. Major replacements and additions are capitalized. Gains and losses on assets depreciated on an individual basis are included in current income. Upon disposal of assets depreciated on a group basis, unless unusual in nature or amount, residual cost less salvage is charged against accumulated depreciation.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Environmental Costs\nEnvironmental expenditures are expensed or capitalized depending upon their future economic benefit. Costs which improve a property as compared with the condition of the property when originally constructed or acquired and costs which prevent future environmental contamination are capitalized. Costs which return a property to its condition at the time of acquisition are expensed.\nDeferred Turnaround and Financing Costs\nA turnaround is a periodically required standard procedure for maintenance of a refinery that involves the shutdown and inspection of major processing units and occurs approximately every three years. Turnaround costs, which are included in \"Other assets\", are amortized over three years beginning the month following completion.\nFinancing costs related to obtaining or refinancing of debt are deferred and amortized over the expected life of the debt.\nIncome Taxes\nClark files a consolidated US federal income tax return with R & M Holdings but computes its provision on a separate company basis. On January 1, 1993, Clark adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") (see Note 13, \"Income Taxes\").\nDeferred taxes are classified as current and included in prepaid or accrued expenses or noncurrent depending on the classification of the assets and liabilities to which the temporary differences relate. Deferred taxes arising from temporary differences that are not related to a specific asset or liability are classified as current or noncurrent depending on the periods in which the temporary differences are expected to reverse.\nEmployee Benefit Plans\nThe Clark Refining & Marketing, Inc. Savings Plan and separate Trust (the \"Plan\"), a defined contribution plan covers substantially all employees of Clark. Under terms of the Plan, Clark matches the amount of employee contributions, subject to specified limits. Contributions to the Plan during 1993 were $2.7 million (1992--$2.7 million; 1991--$2.7 million).\nClark provides certain benefits for retirees once they have reached specified years of service. These benefits include health insurance in excess of social security and an employee paid deductible amount, and life insurance equal to one and one-half times the employee's annual salary. On January 1, 1993, Clark adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") which changed the method of accounting for such benefits from a cash to an accrual basis (see Note 12, \"Postretirement Benefits Other Than Pensions\").\n3. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of Clark's financial instruments as of December 31, 1993 was as follows:\nThe estimated fair value amounts were determined using quoted market prices for the same or similar issues.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe Financial Accounting Standards Board has issued SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". The standard generally replaces the historical cost accounting approach to debt securities with one based on fair value. All affected debt and equity securities must be classified as held-to-maturity, trading, or available-for-sale. Classification is critical as it effects the carrying amount of the security, as well as the timing of gain or loss recognition. Clark will adopt this standard beginning January 1, 1994 and expects most securities to be classified as available-for-sale with no material impact on the carrying values of the securities or earnings.\n4. INVENTORIES\nThe carrying value of inventories consisted of the following:\nInventories at December 31, 1993 were written down to market value which was $26.5 million lower than LIFO cost. The market value of inventories at December 31, 1992, was approximately $13.2 million higher than the carrying value.\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of the following:\nAt December 31, 1993, property, plant & equipment included $48.2 million (1992--$57.1 million) of construction in progress.\n6. OTHER ASSETS\nOther assets consisted of the following:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Amortization of deferred financing costs for the year ended December 31, 1993, was $1.2 million (1992--$2.9 million; 1991--$6.0 million). Amortization of turnaround costs during 1993 totaled $11.8 million (1992--$9.2 million; 1991--$7.0 million).\n7. WORKING CAPITAL FACILITY\nClark has in place a working capital facility which provides a revolving line of credit for cash borrowings and for the issuance of letters of credit primarily for securing purchases of crude oil, other feedstocks and refined products. The facility is for $100 million and expires December 31, 1994. There are restrictive limitations on inventory positions, and certain financial ratios are required to be maintained, including a net worth requirement of at least $130.0 million in 1993 and $140.0 million effective January 1, 1994. At December 31, 1993, $51.5 million (1992--$57.4 million) of the line of credit was utilized for letters of credit, of which $8.7 million (1992--$31.8 million) supports commitments for future deliveries of petroleum products. There were no direct borrowings outstanding under the facility at December 31, 1993 or 1992.\n8. LONG-TERM DEBT\nThe 9 1\/2% and 10 1\/2% Senior Notes were issued in September 1992 and December 1991, respectively and are both unsecured. The 9 1\/2% Senior Notes and 10 1\/2% Senior Notes are redeemable by Clark beginning September 1997 and December 1996, respectively at a redemption price which starts at 105% and decreases to 100% of principal two years later. The indentures for the Notes contain certain restrictive covenants including limitations on the payment of dividends, the payment of amounts to related parties, the level of debt, change in control and incurrence of liens. In addition, Clark must maintain a minimum net worth of $100 million.\nThe scheduled maturities of long-term debt during the next five years are (in thousands): 1994--$317 (included in \"Accrued expenses and other\"); 1995--$106; 1996--$99; 1997--$82; 1998--$121; 1999 and thereafter $400,630.\nInterest and financing costs\nInterest and financing costs, net consisted of the following:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Cash paid for interest in 1993 was $40.1 million (1992--$52.1 million; 1991-- $35.1 million).\nInterest income in 1993 includes $0.2 million (1992--$2.0 million; 1991-- $(0.2) million) from CMAT (see Note 10 \"Related Party Transactions\").\nAccrued interest payable at December 31, 1993, of $6.9 million (1992--$6.7 million) is included in \"Accrued expenses and other\".\nEarly Extinguishment of Debt\nIn 1992 Clark repurchased $95.9 million of its First Mortgage Notes on the open market for $103.0 million and redeemed the remaining $104.1 million at 106% of principal amount, or $110.4 million. Available cash was used to extinguish the debt. The costs of the early extinguishment of debt of $11.5 million (net of taxes of $7.2 million) included the premium amount, deferred financing costs, and defeasance-related interest expense.\n9. LEASE COMMITMENTS\nClark leases premises and equipment under lease arrangements, many of which are non-cancelable. Clark leases store property and equipment with lease terms extending to 2013, some of which have escalation clauses based on a set amount or increases in the Consumer Price Index. Clark also has operating lease agreements for certain pieces of equipment at the refineries, retail stores, and the general office. These lease terms range from 3 to 9 years with the option to purchase the equipment at the end of the lease term at fair market value. The leases generally provide that Clark pay taxes, insurance, and maintenance expenses related to the leased assets. At December 31, 1993, future minimum lease payments under capital leases and non-cancelable operating leases were as follows (in millions): 1994--$4.9; 1995--$4.2; 1996--$4.0; 1997--$1.6; 1998--$1.6 and $4.6 thereafter. Rental expense during 1993 was $3.4 million (1992--$3.7 million; 1991--$3.4 million).\n10. RELATED PARTY TRANSACTIONS\nTransactions of significance with related parties not disclosed elsewhere in the footnotes are detailed below:\nApex Oil Company, Inc. and Subsidiaries\nClark had various agreements with Apex related to the sale of products (slurry oil, vacuum tower bottoms, asphalt) produced by the refineries. These agreements were terminated or expired in 1992 or 1991. The purchase and sale of products and services between the parties were made at market terms and prices. During 1992, Clark purchased $1.6 million (1991--$51.0 million) of its crude oil and other petroleum requirements from Apex and sold $0.7 million (1991-- $119.6 million) of refined product to Apex. There were no purchases from or sales to Apex in 1993.\nClark Executive Trust\nClark established a deferred compensation plan called the Clark Refining & Marketing, Inc. Corporation Stock Option Plan (the \"Stock Option Plan\") which became effective May 1, 1991. Under the Stock Option Plan, as amended, options to purchase up to 600,000 subordinate voting shares of Horsham could be granted to certain employees and non-employee directors. Exercise prices reflect the market value of Horsham stock on the date of issuance. As of December 31, 1993, there were 363,737 options outstanding to purchase shares of Horsham at prices ranging from $7.19 to $11.88 per share. The trust held 253,738 Horsham shares at December 31, 1993.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nCMAT, Inc.\nOn December 30, 1992 the stock of CMAT Inc. (\"CMAT\") was transferred to an affiliate of Apex as part of the consideration for the acquisition by R & M Holdings for most of R & M Holdings' shares held by AOC, LP, an affiliate of Apex. As part of this transaction, Clark held a $10.0 million note due from CMAT December 31, 1997. This note was paid in full in early 1993.\n11. OTHER INCOME\nOther income consisted of the following:\nLitigation Settlements\nIn 1993 and 1992, Clark settled litigation and recovered all previous losses incurred relating to a line of credit with a lending syndicate (led by Drexel Trade Finance) that had filed bankruptcy in 1990. Also in 1992, Clark settled litigation against Apex related to a dispute arising out of the November 1988 acquisition of Clark's assets from Apex.\nRetail Stores\nIn June 1993, Clark sold 21 \"non-core\" retail stores in Kentucky and Minnesota, which resulted in the recognition of other income of $2.9 million.\n12. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nOn January 1, 1993, Clark adopted SFAS 106. This standard requires that Clark accrue the actuarially determined costs of postretirement benefits during the employees' active service periods. Previously, Clark had accounted for these benefits on a \"pay as you go\" basis, recognizing an expense when an obligation was paid. The cost of such benefits in 1992 and 1991 was not significant and these years have not been restated. In accordance with SFAS 106, Clark elected to recognize the cumulative liability, a non-cash \"Transition Obligation\" of $9.6 million, net of the tax benefit of $6.0 million, as of January 1, 1993. The current year effect of adopting SFAS 106 was $1.9 million ($1.2 million, net of taxes).\nThe following table sets forth the unfunded status for the post retirement health and life insurance plans as of December 31, 1993:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) A discount rate of 7.25% was assumed as well as a 4.5% rate of increase in the compensation level. For measuring the expected postretirement benefit obligation, the health care cost trend rate ranged from 9.8% to 14.0% in 1993, grading down to an ultimate rate in 2001 of 5.25%. The effect of increasing the average health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation, as of December 31, 1993, by $2.2 million and increase the annual aggregate service and interest costs by $0.3 million.\n13. INCOME TAXES\nOn January 1, 1993, Clark adopted SFAS 109 retroactive to January 1, 1991. The adoption of this standard changes the method of accounting for income taxes from the deferred method to an asset and liability approach. Previously, Clark deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.\nThe 1992 and 1991 financial statements have been restated to give retroactive effect to the adoption of SFAS 109. As a result of the restatement, deferred income tax liabilities have increased and retained earnings has decreased at December 31, 1992 and 1991 by $8.4 million and $5.2 million, respectively. Before retroactive application of SFAS 109, the 1992 net loss was $5.1 million and the 1991 net income was $38.3 million. The respective effect of the retroactive application of SFAS 109 on these years' earnings was a $3.1 million and $1.0 million increase in the tax provision, resulting in a net loss for 1992 of $8.2 million and net earnings for 1993 of $37.3 million.\nThe income tax provision (benefit) including the impact of the accounting change in 1993 and the extraordinary item in 1992 is summarized as follows:\nA reconciliation between the income tax provision computed on pretax income at the statutory federal rate and the actual provision for income taxes is as follows:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe following represents the approximate tax effect of each significant temporary difference giving rise to deferred tax liabilities and assets.\nAs of December 31, 1993, Clark has made payments of $14.3 million under the Federal alternative minimum tax system which are available to reduce future regular income tax payments. Net cash tax refunds of $6.6 million were received during 1993. Net cash paid for income taxes in 1992 was $2.2 million and $3.2 million in 1991.\nFederal income taxes payable at December 31, 1993, of $2.7 million (1992-- $5.9 million receivable) are due to R & M Holdings, an affiliate, in accordance with a tax-sharing agreement between Clark and R & M Holdings and are included in \"Accounts payable\".\n14. CONTINGENCIES\nForty-one civil suits by residents of Hartford, Illinois have been filed against Clark in Madison County Illinois, alleging damage from ground water contamination. The relief sought in each of these cases is an unspecified dollar amount. The litigation proceedings are in the initial stages. Discovery, which could be lengthy and complex, is only just beginning. Clark moved to dismiss thirty-four cases filed in December 1991 on the ground that Clark is not liable for alleged activity of Old Clark. On September 4, 1992, the trial court granted Clark's motions to dismiss. The plaintiffs were given leave to re-file their complaints but based only on alleged activity of Clark occurring since November 8, 1988, the date on which the bankruptcy court with jurisdiction over Old Clark's bankruptcy proceedings issued its \"free and clear\" order. In November 1992, the plaintiffs filed thirty-three amended complaints. In addition, one new complaint involving nine plaintiffs was filed. It is too early to predict whether any of these cases will go to trial on the merits and if so, what the risk of exposure to Clark would be at trial. It is also not possible to determine whether or to what extent Clark will have any liability to other individuals arising from the ground water contamination.\nClark is subject to various legal proceedings related to governmental regulations and other actions arising out of the normal course of business, including legal proceedings related to environmental matters. While it is not possible at this time to establish the ultimate amount of liability with respect to such contingent liabilities, Clark is of the opinion that the aggregate amount of any such liabilities, for which provision has not been made, will not have a material adverse effect on its financial position.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Clark Refining & Marketing, Inc.:\nOur report on the financial statements of Clark Refining & Marketing, Inc. (formerly Clark Oil & Refining Corporation) is included on page 30 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the financial statement schedules as of and for the years ended December 31, 1993, 1992 and 1991 listed in Part IV, Item 14(a)(2) of this Form 10-K.\nIn our opinion, these financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCoopers & Lybrand\nSt. Louis, Missouri, January 28, 1994\nCLARK REFINING & MARKETING, INC.\nSCHEDULE I--MARKETABLE SECURITIES--OTHER INVESTMENTS\n(DOLLARS IN THOUSANDS)\nCLARK REFINING & MARKETING, INC.\nSCHEDULE V--PROPERTY, PLANT & EQUIPMENT (A)\n(DOLLARS IN THOUSANDS)\n- -------- (a) Depreciation of property, plant and equipment is computed using the straight-line method based upon the following estimated useful lives:\n(b) 1993 deductions include assets which transferred among divisions within the Company.\nCLARK REFINING & MARKETING, INC.\nSCHEDULE VI--ACCUMULATED DEPRECIATION OF PROPERTY, PLANT & EQUIPMENT\n(DOLLARS IN THOUSANDS)\nCLARK REFINING & MARKETING, INC.\nSCHEDULE X--SUPPLEMENTARY EARNINGS STATEMENT INFORMATION\n(DOLLARS IN THOUSANDS)\nOther items were not in excess of one percent of total sales and revenues.\nSIGNATURES\nPURSUANT 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.\nClark Refining & Marketing, Inc.\n\/s\/ Paul D. Melnuk By: _________________________________ Paul D. Melnuk President and Chief Executive Officer\nMarch 25, 1994\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT IN THE CAPACITIES AND ON THE DATE INDICATED.\nMarch 25, 1994","section_15":""}
{"filename":"716612_1993.txt","cik":"716612","year":"1993","section_1":"ITEM 1. BUSINESS\n(A) GENERAL DEVELOPMENT OF BUSINESS\nCombined Network, Inc., the predecessor of Allnet Communication Services, Inc., a Michigan corporation (\"Allnet\" or the \"Registrant\"), was founded in Chicago, Illinois in 1980. Its name was changed to Allnet Communication Services, Inc. in 1983. On December 19, 1985, Allnet and Lexitel Corporation (\"Lexitel\"), two long distance companies, became affiliated and commenced business as a wholly owned subsidiary of ALC Communications Corporation, a Delaware corporation (\"ALC\"). Allnet now has the former businesses and operations of both Allnet and Lexitel. ALC conducts no other business other than its position as a holding company for its subsidiary, Allnet.\nUnless the context otherwise requires, the term \"Company\" includes ALC, its wholly owned subsidiary, Allnet, and all of the wholly owned subsidiaries of Allnet. The principal executive offices of the Company are located at 30300 Telegraph Road, Bingham Farms, Michigan 48025 (313\/647-4060).\nIn the summer of 1990 the Company had begun an overall refinancing (the \"Refinancing\") of substantially all of its funded debt and in 1992 concluded the second phase of the Refinancing by substantially deferring or reducing the debt service obligations of the Company.\nIn August 1992, the Company's then majority shareholder, Communications Transmission, Inc. (\"CTI\") conveyed the ALC Common Stock (the \"Common Stock or \"ALC Stock\"), Class B Preferred Stock (the \"Class B Preferred\") and Class C Preferred Stock (the \"Class C Preferred\") it owned to NationsBank of Texas, N.A., The First National Bank of Chicago, National Westminster Bank USA, CoreStates Bank, N.A. and First Union National Bank of North Carolina (the \"Banks\") pro-rata in exchange for the release of certain portions of CTI's obligations to each of the Banks. The Banks, in the aggregate, acquired all of the outstanding Class B Preferred and Class C Preferred, as well as 14,324,000 shares of Common Stock. In October 1992, the Company completed a stock offering (the \"1992 Equity Offering\") for 9,863,600 shares of Common Stock, a portion of which resulted from the exchange of the Class A Preferred Stock (the \"Class A Preferred\") held by individual stockholders and the remainder of which was due to Common Stock held by other entities, including the Banks. The Banks sold, in the aggregate, 3,000,000 shares of Common Stock in the 1992 Equity Offering. In January 1993, the Company filed a registration statement (the \"shelf registration\") under the Securities Act of 1933, as amended (the \"Securities Act\") to permit the sale, from time to time, of up to 19,500,909 shares of Common Stock held by certain stockholders, including the Banks, or issuable upon exercise of certain outstanding warrants or conversion of outstanding Class B Preferred and Class C Preferred. Pursuant to the shelf registration, in March 1993, the Company completed a stock offering (the \"March 1993 Equity Offering\") whereby the Banks and the Prudential Insurance Company of America (\"Prudential\") sold an aggregate of 10,350,000 shares of Common Stock to the public. As part of the March 1993 Equity Offering, the Banks converted all outstanding shares of Class B Preferred and Class C Preferred to Common Stock. The Class B Preferred and Class C Preferred were retired effective March 25, 1993. The Banks subsequently reduced their ownership interest in the Company to a minimal position through subsequent sales and the transfer of other shares to Prudential by four of the five Banks. In February 1994 the one remaining Bank, First Union National Bank of North Carolina, sold shares in a series of brokerage transactions, then transferred the remaining balance of shares to or as directed by Prudential.\nIn May 1993, the Company completed an offering of $85.0 million principal amount 9% Senior Subordinated Notes (\"1993 Notes\") and in June 1993 redeemed all of the 11-7\/8% Subordinated Notes then outstanding, which were issued as part of the note exchange offer which occurred during the 1992 phase of the Refinancing.\nAs of June 30, 1993, the Company executed an agreement for a $40.0 million line of credit (the \"Revolving Credit Facility\"), replacing the Company's prior revolving credit facility.\nEffective December 31, 1993, the Company redeemed the issued and outstanding Class A Preferred Stock (the \"Class A Preferred\"). Following such redemption, the Class A Preferred was retired effective January 4, 1994. For more detailed information regarding stock ownership in the Company, reference is hereby made to \"Item 13. Certain Relationships and Related Transactions.\"\nIn July 1993, the Company acquired the specialized 800 customer base of Call Home America, Inc. Call Home America, Inc. had approximately 50,000 customers, including parents of college students and frequent travelers, who continue to receive services under the Call Home America(R) name. These customers, who were then generating annualized revenue of approximately $20 million, are also able to utilize a wide range of other telecommunications services from the Company.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Company operates in one industry segment. All significant revenues relate to sales of telecommunication services to the general public.\n(C) NARRATIVE DESCRIPTION OF BUSINESS\nALC is the holding company for Allnet and conducts no other business. Allnet provides long distance telecommunications services primarily to commercial and, to a lesser extent, residential subscribers in the majority of the United States and completes subscriber calls to all directly dialable locations worldwide. Allnet is one of the few nationwide carriers of long distance services and in 1993 carried in excess of 800 million calls over its network.\nThe Company operates its own switches, develops and implements its own products, monitors and deploys its transmission facilities and prepares and designs its own billing and reporting systems. The Company focuses on a highly profitable segment of the long distance industry with high operating margins, specifically, commercial accounts, whose calling volume consists primarily of calls made during regular business hours which command peak-hour pricing.\nCommercial subscribers tend to make most of their calls on weekdays during normal business hours, while the Company's residential subscribers tend to make most of their calls in the evening and on weekends, when business usage is lowest. Neither commercial nor residential subscribers' access to the Company's service is limited as to the time of day or day of week.\nSEASONALITY\nThe Company experiences certain limited seasonality in the use of its services due to periods where commercial subscribers experience higher levels of time-off by their employees, such as during national holidays and vacation periods. Fewer business days during a calendar month will also impact usage. The Company will experience decreased commercial usage resulting from these factors. Seasonality in usage from residential subscribers tends to vary with the return of students to college and national holidays. The Company will experience increased residential usage resulting from these factors.\nPRODUCTS AND SERVICES\nThe Company provides a variety of long distance telephone products and services to commercial and residential subscribers nationwide. The bulk of the Company's revenue is derived from outbound and inbound long distance services which are all under the \"Allnet(R)\" trademark. Many of the Company's products, however, differ from those of certain of its competitors due to the level of value-added services the Company offers, the flexibility of product pricing to maintain competitiveness and its broader geographic reach.\nThe variety of products offered are categorized by the Company based upon certain primary characteristics: pricing, value-added services, reporting and 800 Services.\nPricing. All of the Company's customers are identified by their telephone number, dedicated trunk or validated access code, and have a rating which is used to determine the price per minute that they pay on their outbound or inbound long distance calls. Rates typically vary by the volume of usage, the distance of the calls, the time of day that calls are made, the region that originates the call, and whether or not the product is being provided on a promotional basis. The outbound commercial product line is broken into three major types of services.\nRegional: Rates vary by area code or region and subscribers pay a flat rate for all long distance calls within these area codes or regions. Rates are determined by competitive positioning and vary according to the regions which the Company currently services. These products are priced at the area code level, and rates offered on these products are the primary method used to compete with small and more regionalized carriers.\nNationwide: Rates are by mileage bands set at a distance around the call initiating point.\nLong Haul: Rates are designed for users who tend to make substantial bicoastal and international calls. These products offer distance-insensitive domestic pricing and two time-of-day period rates, along with aggressive international pricing options.\nThe Company's outbound residential product line is made up of Allnet \"Dial 1\" Service which also has two special discount options to service employees of commercial accounts (\"EBP\") and members of associations (\"ABP\").\nDifferent rates are applied to inbound telephone services than to outbound telephone services. The inbound product line is provided for commercial accounts which use 800 telephone numbers to receive and pay for calls from customers and potential prospects and for residential accounts wishing similar type services.\nValue-added Services. When customers subscribe to value-added services on the Company's network, their calls are charged a fee based on the services provided. Customers access value-added services through Allnet Access(R), which is an interactive voice response system that allows subscribers to interact with the phone system by pressing numbers on the telephone. Allnet Access(R) is a customized platform or menu from which customers select the desired services to which they have subscribed. For example, a customer who would like to deliver a prerecorded message would dial an Allnet Access(R) 800 number or through a new streamlined dialing method known as \"00 Platform\" from an Allnet presubscribed Touch Tone(R) telephone and select \"call delivery\" from the voice menu. If the customer had subscribed to other services, these services would be offered on the menu as well. Once the customer makes a selection, the call is routed and charged accordingly.\nThe Company's value-added services are aimed primarily at the business subscriber, although the Company also offers products for residential customers. Value-added services include: Allnet Call Delivery(R), a message delivery service which enables a customer to send a prerecorded message to a number; VoiceQuote, an interactive stock quotation service; Allnet InfoReach(R), numerous audio\/text programs such as news and weather; a voice mail service; Option USA(R), a service to provide calls to the U.S. from selected international locations on Allnet Access(R); and three different teleconferencing services.\nDuring 1992 the Company launched a full spectrum of facsimile services including Allnet Broadcast FAX(R), which allows the customer to send or fax documents to multiple locations at the same time; fax on demand, which allows the customer to make a fax document available to people who call\nan 800 number; fax mail, which allows a customer to receive facsimile messages in a fax mailbox and pick them up at a later date; PC software, which allows the customer to manage his facsimile lists and documents from a PC; and special international pricing to accommodate short duration facsimile traffic.\nDuring 1993 the Company began to focus on mobile products and services, offering MobileLine, the resale of cellular service provided by the regional Bell Operating Companies (\"BOCs\"), along with consolidated billing. In addition, the Company currently plans to introduce PageLine, a nationwide paging resale and consolidated billing product, in the second quarter of 1994.\nReporting. The Company offers its customers a variety of billing options and media (two sizes of paper invoices [8-1\/2X11 or 4X7 inches], diskette, and magnetic tape) aimed primarily at business customers. When a new commercial account is opened, the customer is offered the opportunity to custom design the format of its reports. For example, the Company can include company accounting codes or internal auditing codes for each call made with each billing statement. If a customer would like to change a particular reference code for a telephone line, the code can be changed automatically. The Company's primary product in this area is Allnet ESP(R) or Executive Summary Profile. A typical Allnet ESP(R) statement breaks out calls in a number of ways: by initiating caller number, by terminating number, by ranking, by department, by frequently dialed number\/area\/country or by time of day. Allnet customers pay a fixed monthly fee for these custom-tailored billing services. In late 1992, Allnet ESP(R) II was launched which gives customers graphic reports of traffic patterns on a nationwide basis by state, within state by area of dominant influence (\"ADI\") and within ADI by zip code. The Company believes this will be useful to certain customers for direct response and customer service applications.\nIn mid-1992, the Company also launched its proprietary personal computer reporting service Allnet Invoice Manager(sm) (\"AIM\") which allows customers to design their own reports, prepare separate itemized bills, do mark-up reporting and generate numerous other customized reports.\n800 Services. The Company greatly expanded its 800 product offerings, capitalizing on opportunities resulting from FCC mandated portability in May 1993 (which allows customers to select a different long distance carrier without changing their 800 number). These new offerings include area code blocking and routing; time of day routing; Home Connection 800(sm), fractional 800 service which allows residential customers to acquire 800 service utilizing a 4 digit security Personal Identification Number (\"PIN\");\nMulti-Point(sm) 800 services, which allow the customer to use accounting codes on an 800 number or route a single 800 number to numerous locations simultaneously; Follow-Me 800, which allows a customer to change his routing from a Touch Tone(R) telephone; and TargetLine(sm) 800, which routes calls to the closest location and provides custom prompts based upon a customer specific database. To supplement the Company's internal growth in this market, the Company also will evaluate strategic external growth opportunities. For example, in July 1993, the Company acquired the specialized 800 customer base of Call Home America, Inc. These customers, who were then generating annualized revenue of approximately $20 million, are also able to utilize a wide range of other telecommunications services from the Company.\nTRANSMISSION\nThe Company endeavors to have sufficient switching capacity, local access circuits and long distance circuits at and between its network switching centers to permit subscribers to obtain access to the switching centers and its long distance circuits on a basis which exceeds industry standards regarding clarity, busy signals or delays.\nThe network utilizes fiber optic and digital microwave transmission circuits to complete long distance calls. With the exception of a digital microwave system located in California for which Allnet holds the Federal Communications Commission (\"FCC\") licenses, such facilities are leased on a fixed price basis under both short and long term contracts. The California microwave facilities are on leased real estate and are subject to zoning and other land use restrictions. In recent years abundant availability and declining prices have dictated a strategy of generally obtaining new capacity for terms between six months and one year. While the Company has several long term contracts, these contracts have either annual \"mark-to-market\" clauses or, in one case, a \"most favored nation\" clause. These provisions function to keep the price the Company pays at or near current market rates. An important aspect of the Company's operation is planning the mix of the types of circuits and transmission capacity to be leased or used for each network switching center so that calls are completed on a basis which is cost effective for the Company without compromising prompt service and high quality to subscribers. Over 99% of the Company's domestic traffic is carried on owned or leased facilities (\"on-net\").\nIn establishing a network switching center, the Company can select equipment with varying capacities in order to meet the anticipated needs of the service origination region(s) served by the center. The equipment used by the Company is, for the most part, designed to permit expansion to its capacity by the addition of standard components. If the maximum capacity of the equipment in any center is\nreached, the Company replaces it with higher capacity switching equipment and attempts to move the replaced unit to a network switching center in a different service origination region. The Company is dependent upon the local telephone company for installing local access circuits and providing related service when establishing a network switching center. As of December 31, 1993, the Company had 16 network switching centers which originate traffic in all Local Access Transport Areas (\"LATAs\") in the United States. International service is provided through participation in the International Carrier Group (\"ICG\") with three other major long distance companies. The ICG in turn contracts with other long distance companies and foreign entities to provide high quality international service at competitive rates.\nMARKETING\nApproximately 60% of the Company's employees are engaged in sales, marketing or customer services. The Company markets its services and products through personal contacts with an emphasis on customer service, network quality, value-added services, reporting, rating and promotional discounts. Allnet currently operates a sales network with 48 offices in the United States. The Company employs 866 sales, marketing and customer service individuals. Field sales representatives focus on making initial sales to commercial users. They solicit business through face-to-face meetings with small- to medium-sized businesses. Each field sales representative earns a commission dependent on the customer's usage and value-added services. The Company's sales strategy is to make frequent personal contact with existing and potential customers.\nThe prices and promotions offered for the Company's services are designed to be competitive with other long distance carriers. Prices will vary as to interstate or intrastate calls as well as with the distance, duration and time-of-day of a call. In addition, the Company may offer promotional discounts based upon duration of commitment to purchase services, incremental increases in service or \"free\" trial use of the many value-added and reporting services. Volume discounts are also offered based upon amount of monthly usage in the day, evening and night periods or based solely on total volume of usage.\nThe Company has three groups which provide ongoing customer service designed to maximize customer satisfaction and increase usage. First, customer service personnel located in Southfield, Michigan are available telephonically free of charge 24 hours a day, seven days a week. Second, a customer service center in Columbus, Ohio processes calls from customers with significant usage levels who have been enrolled in the Company's \"Select Service\" programs. Third, communications specialists located at the sales offices provide personal service to large commercial accounts.\nThe Company services more than 295,000 customers. Of these customers, approximately 137,000 are commercial accounts, with the remainder being residential accounts. During the past two years, the Company has become more geographically diversified, adding new markets as necessary. The Company is currently focusing on an agent program to increase customer acquisition in specific target markets.\nCOMPETITION AND GOVERNMENT REGULATION\nCompetition is based upon pricing, customer service, network quality and value-added services. The Company views the long distance industry as a three tiered industry which is dominated on a volume basis by the nation's three largest long distance providers: American Telephone and Telegraph Company (\"AT&T\"), MCI Telecommunications Corporation (\"MCI\") and Sprint Communications, Inc. (\"Sprint\"). AT&T, MCI and Sprint, which generate an aggregate of approximately 88% of the nation's long distance revenue of $65 billion, comprise the first tier. Allnet is positioned in the second tier with four other companies with annual revenues of $250 million to $1.5 billion each. The third tier consists of more than 300 companies with annual revenues of less than $250 million each, the majority below $50 million each. Allnet targets small- and medium-sized commercial customers ($100 to $50,000 in monthly long distance volume) with the same focus and attention to customer service that AT&T, MCI and Sprint offer to large commercial customers. Allnet is one of the few long distance companies with the ability to offer high quality value-added services to small- and medium-sized commercial customers on a nationwide basis. A number of the Company's competitors are primarily regional in nature, limited by the size of their transmission systems or dependent on third parties for their billing services and product offerings.\nGenerally, the current trend is toward lessened regulation for both the Company and its competitors. Regulatory trends have had, and may have in the future, both positive and negative effects upon Allnet. For example, more markets are opening up to Allnet, as state regulators allow Allnet to compete in markets from which it was previously barred. On the other hand, the largest competitor, AT&T, has gained increased pricing flexibility over the years, allowing it to price its services more aggressively.\nAs a nondominant Interexchange Carrier (\"IXC\"), the Company is not required to maintain a certificate of public convenience and necessity with the FCC other than with respect to international calls, although the FCC retains general regulatory jurisdiction over the sale of interstate long distance services by IXCs, including the requirement that calls be charged on a nondiscriminatory, just and\nreasonable basis. Although the FCC had previously ruled that nondominant carriers, such as Allnet, do not need to file tariffs for their interstate service offerings, a recent Court of Appeals decision has vacated that FCC ruling. The impact of the Court of Appeals decision on Allnet was minimal and primarily administrative in nature. Allnet has already taken any necessary steps to comply with that decision, including filing an interstate tariff with the FCC. The FCC has since adopted reduced requirements regarding the filing of tariffs for non-dominant carriers, including Allnet. The Company believes that it has operated and continues to operate in compliance with all applicable tariffing and related requirements of the Communications Act of 1934, as amended.\nIn the FCC decision implementing certain provisions of the Telephone Operator Consumer Services Improvement Act (\"TOCSIA\"), Allnet was designated subject to the payment of charges by \"private payphone owners.\" Allnet presently is challenging that designation with the FCC and in the courts, as it does not believe that it is engaged in the sort of activity intended to be regulated under TOCSIA.\nIn addition, by virtue of its ownership of interstate microwave facilities located in California (as described in \"Transmission\"), Allnet is subject to the FCC's common carrier radio service regulations.\nIn 1984, pursuant to the AT&T Divestiture Decree, AT&T divested its 22 Bell Operating Companies (\"BOCs\"). In 1987, as part of the triennial review of the AT&T Divestiture Decree, the U.S. District Court for the District of Columbia denied the BOCs' petition to enter, among other things, the long distance (\"inter-LATA\") telecommunications market. The District Court's ruling was appealed to the United States Court of Appeals for the District of Columbia which, in 1990, affirmed the District Court's decision to retain the inter-LATA prohibition for the BOCs.\nCurrently pending before Congress is legislation that would allow the BOCs into the inter-LATA business in competition with long distance carriers, such as Allnet. The recently introduced \"Brooks-Dingell Bill\" (in the House of Representatives, H.R. 3626) and the \"Hollings Bill\" (in the Senate, S. 1822) set forth various time frames and certain entry requirements for the BOCs to enter certain markets, including the long distance market, from which the BOCs are currently barred under the AT&T Divestiture Decree. As initially proposed, the Brooks-Dingell Bill would allow entry into various segments of the long distance business when various combinations of conditions and timing requirements have been satisfied. Some entry requirements may be successfully applied almost immediately upon the passage of the bill, while others may not be applied until 18 months or 60 months have passed. In contrast, as initially proposed,\nthe Hollings Bill would require that long distance only be offered by a BOC through a separate subsidiary, but only after the FCC, after consultation with the Attorney General, finds that the BOCs have met certain entry requirements. Under the Hollings Bill, there is one set of entry tests for \"out-of-market\" services, and another for \"in-market\" services. To allow a BOC to provide long distance service outside of its market area through a separate subsidiary, the FCC must find there is no substantial possibility that the BOC could use its market power to impede competition in the long distance market that the BOC seeks to enter. To allow a BOC to provide long distance service in its local market (i.e., where it provides telephone exchange or exchange access services), the FCC must make additional findings that the BOC has opened up its local network to competitors, and that it faces actual and demonstrable competition based on objective standards of competitive penetration set forth in the Hollings Bill. It cannot be determined at this time whether these or other bills will be adopted or the timing of such adoption or, if adopted, whether the final legislation will be similar to either of these proposed bills. To the extent final legislation, if any, results in the BOCs being permitted to provide inter-LATA long distance telecommunications services and to compete in the long distance market, existing IXCs, including the Company, would likely face substantial additional competition from local BOC monopolies.\nAs part of the AT&T Divestiture Decree, the divested BOCs were required to charge AT&T and all other carriers (including Allnet) equal per minute rates for \"local transport\" service (the transmission of switched long distance traffic between the BOCs' central offices and the IXCs' points of presence). BOC and other local exchange company (\"LEC\") tariffs for local transport service have been based upon these \"equal per unit\" rules since 1984, pursuant to the AT&T Divestiture Decree and the FCC's waiver of certain local transport pricing rules. Although the portion of the AT&T Divestiture Decree containing this rule ceased to be effective by its terms on September 1, 1991, the FCC had extended its effect until it concluded the rulemaking proceeding in which it considered whether to retain or modify the \"equal per unit\" local transport pricing structure. On September 17, 1992, the FCC voted to maintain the existing \"equal per unit\" pricing rules until late 1993. A two year interim would then begin. Based on the interim plan rates that have now taken effect as of January 1, 1994, Allnet does not anticipate a material impact during 1994 and 1995. To moderate IXC costs, the FCC has ordered that non-recurring charges for reconfiguring a carrier's access lines should be waived until May 1994, to accommodate the change in access pricing structure.\nThe FCC has left open the access rate structure issue for the post 1995 period. The FCC issued a Further\nNotice of Proposed Rulemaking for consideration of a permanent rate structure to take effect beginning no earlier than late 1995. The FCC has also recently voted to allow expanding competition for monopoly local access through expanded local switched access interconnection. This could ultimately provide Allnet with alternatives to purchasing its local access from the monopoly local exchange carriers.\nThe FCC has issued orders stating that carriers, such as Allnet, were entitled to refunds for overcharges paid to a number of local exchange carriers during the 1985-1986 and 1987-1988 periods. These awards have, in most cases, been paid to Allnet. Although these awards are in the aggregate significant, they are not a material portion of the Company's total access costs. Some local exchange carriers have appealed the orders and some of the awards which were paid are conditioned on the outcome of the appeals. In addition Allnet has pending claims for overcharges during the 1989-1990 period. Two of the four claims have been settled. At this time, Allnet is not aware of any pending rulings on the remaining claims.\nThe intrastate long distance telecommunications operations of the Company are also subject to various state laws and regulations, including certification requirements. Generally, the Company must obtain and maintain certificates of public convenience and necessity as well as tariffs from regulatory authorities in most states in which it offers intrastate long distance services, and in most of these jurisdictions, must also file and obtain prior regulatory approval of tariffs for its intrastate offerings. At the present time, the Company can provide originating services to customers in all 50 states and the District of Columbia. Those services may terminate in any state in the United States, and may also terminate to countries abroad. Only 31 states have public utility commissions that actively assert regulatory oversight over the services currently offered by the Company. Like the FCC, many of these regulating jurisdictions are relaxing the regulatory restrictions currently imposed on telecommunication carriers for intrastate service. While some of these states restrict the offering of intra-LATA services by the Company and other IXCs, the general trend is toward opening up these markets to the Company and other IXCs. Those states that do permit the offering of intra-LATA services by IXCs generally require that end users desiring to access these services dial special access codes which place the Company and other IXCs at a disadvantage as compared to LEC intra-LATA toll service which generally requires no access code.\nPATENTS\nIn December 1992, MCI filed a lawsuit in the United States District Court for the District of Columbia against AT&T. The complaint seeks, among other things, a declaration\nthat certain AT&T patents relating to basic long distance services, toll free \"800\" service, and other telephone services are invalid or unenforceable against MCI (and other similarly situated telecommunications providers). AT&T counterclaimed against MCI for patent infringement. Contemporaneously with the filing of its declaratory judgment action, MCI requested the court in the AT&T Divestiture Decree case to rule that AT&T should be barred from asserting its pre-divestiture patents to impede competition in the interexchange telecommunications market. Both of the foregoing actions are currently pending.\nAT&T has generally indicated that it believes that long distance telecommunications companies may be infringing on certain AT&T patents and has offered to license such patents. AT&T has numerous patents, some of which may pertain to the provision of services similar to those currently provided or to be provided by the Company or to equipment similar to that used or to be used by the Company. If it were ultimately determined that the Company has infringed on any AT&T patents and the Company is required to license such patents and pay damages for infringement, such costs could have an adverse effect on the Company.\nEMPLOYEES\nAs of December 31, 1993, the Company employed 1,488 employees in the United States, none of whom were subject to any collective bargaining agreements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOn December 31, 1993, the Company had under lease approximately 113,000 square feet of office space in Bingham Farms, Michigan for executive and administrative functions and approximately 43,000 square feet in Southfield, Michigan for customer service, collections, and data processing. The Company also leases approximately 290,000 square feet in the aggregate for sales and administrative offices, network switching centers and unmanned microwave sites in 90 other locations in the continental United States.\nMost of the leased premises are for an initial term of five-to-ten years with, in many cases, options to renew. All properties presently being used for operations of the Company are suitable, well maintained and equipped for the purposes for which they are used.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOmitted pursuant to General Instruction J.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAllnet is a wholly owned subsidiary of ALC. Therefore, there is no established public trading market for the common stock, no par value, of Allnet (the \"Allnet Common Stock\").\nSince its inception, Allnet has not declared or paid any dividends on the Allnet Common Stock. The Company is allowed to pay dividends by the terms of its Revolving Credit Facility as long as (a) the sum of such dividend distribution does not exceed at any one time an amount equal to 30 percent of cumulative Net Adjusted Income (calculated after January 1, 1993) and (b) no default in payment of any Obligations or Event of Default exists at the time such distribution is made, or would be created by any such distribution (capitalized terms not otherwise defined herein are defined in the Revolving Credit Facility).\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth for the indicated fiscal years and periods ended, selected historical financial information for the Company. Such information is derived from financial statements presented in Part IV, Item 14. of this Annual Report on Form 10-K and should be read in conjunction with such financial statements and related notes thereto.\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY Selected Financial Data\n- ------------- (1) 1989 and 1990 have been restated to reflect the 1:5 reverse stock split. (2) 1989 through 1992 include Class A Preferred Stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nBy 1993, ALC had completed a multi-year series of refinancing transactions which provided for the simplification and improvement of the debt and capital structure of the Company. ALC was successfully transformed from a Company that in 1990 was owned by a controlling interest stockholder, Communications Transmission, Inc. (\"CTI\"), and had an equity structure that included three issues of preferred stock. In addition, at December 31, 1990 the Company had a debt structure which required principal and interest payments of as much as $79 million in 1992, a level which could not be met from operating cash flow and therefore required significant refinancing actions.\nAccordingly, during 1992, the Company completed the Refinancing which included the rescheduling of substantially all debt, resulting in significantly reduced or deferred debt service obligations. In 1992, the Company's major debt instrument represented by the Company's Original Debentures, Replacement Debentures, PIK Debentures and accrued interest was replaced by 11 7\/8% Subordinated Notes of Allnet (\"1992 Notes\"). As part of the restructuring of the Debentures, 3,400,000 ALC Common Stock warrants were issued representing 10.2% of the fully-diluted equity of ALC. These debentures were replaced in May 1993 with 9% Senior Subordinated Notes (\"1993 Notes\") which do not mature until May 2003. Additional debt including the $20.0 million Restructured Promissory Note and the approximately $8.0 million balance on the 1990 Note Agreements was paid in full. As a result, at December 31, 1993 ALC has a single debt instrument outstanding, $85.0 million of 9% Senior Subordinated Notes.\nDuring 1992, the Refinancing also included the restructuring and simplification of the equity of ALC. In August 1992, the equity interest of CTI represented by 14,324,000 shares of ALC Common Stock, and the ALC Class B and Class C Convertible Preferred Stock (\"Preferred Stock\") was transferred to a group of five banks (\"Banks\"). Subsequently such Preferred Stock was converted into 3,796,000 shares of ALC Common Stock.\nA series of stock offerings in 1992 and 1993 was used to facilitate the sale of substantially all of the shares held by the Banks. As part of the stock offering in October 1992, the Company also completed an Exchange Agreement which provided for the exchange of 2,144,044 Class A Preferred Shares for 6,399,227 shares of ALC Common Stock at an effective 40% discount.\nDuring 1992 and continuing throughout 1993, the Company achieved both the successful completion of the Refinancing and a significant financial turnaround which included twelve consecutive quarters of income through the quarter ended December 31, 1993. Net income grew from a level of $3.3 million for the first quarter of 1992 to $12.4 million for the fourth quarter of 1993. Net income for the year ended 1993 increased approximately 90% over the previous year (excluding the effect of the extraordinary item and cumulative effect of the accounting change in 1993). The results of operations for 1992 and 1993 reflect increases in both billable minutes and revenue and a significant reduction in operating expenses as a percent of revenue.\nRESULTS OF OPERATIONS\nThe Company reported net income of $45.7 million for the year ended December 31, 1993. This includes the impact of both the $13.5 million cumulative effect of a change in method of accounting for income taxes and the $7.5 million net loss related to early retirement of debt. Excluding these items, income for the year ended December 31, 1993 totalled $39.7 million on revenue of $436.4 million. This compares to net income of $20.8 million on revenue of $376.1 million and $5.3 million on revenue of $346.9 million for the years ended December 31, 1992 and 1991, respectively.\nOperating income increased from $23.9 million for the year ended December 31, 1991 to $40.7 million in 1992 to $68.9 million in 1993. This improvement is primarily the result of increased revenue from increased billable minutes and improved gross margin.\nREVENUE\nRevenue increased 16.1% to $436.4 million from 1992 to 1993 resulting from an 18.9% increase in billable minutes offset somewhat by a decrease in the revenue per minute. Revenue per minute decreased from 1992 to 1993 resulting from certain changes in the sales mix which were more than offset by additional efficiencies in network costs. Billable minutes have continued to increase since the third quarter of 1990 when compared to the same quarter in the prior year. Most importantly, billable minutes reached their highest level in 1993. The increase in billable minutes results from traffic generated by new customers and increased minutes per customer.\nBeginning in May 1993, the Company benefited from new traffic growth generated from the availability of 800 portability. Beginning in July 1993, the Company had additional revenue from the acquisition of the customer base of Call Home America, Inc. (\"CHA\") which represented 2.5% of the increase in revenue for the year ended December 31, 1993 compared to 1992. In addition, resellers contributed an additional $20.0 million to revenue during 1993.\nRevenue increased from $346.9 million in 1991 to $376.1 million in 1992. The 8.4% increase in revenue represents a 9.6% increase in billable minutes offset by a modest decrease in the revenue per minute. Revenue per minute decreased slightly from 1991 to 1992 resulting from lower unit prices which were more than offset by the impact of reduced cost of communication services as a percent of revenue.\nThe revenue generated from customers' first full month of service in 1993 was 30.7% higher than in 1992 and 7.5% higher in 1992 than in 1991. The increased revenue from new sales along with revenue from existing customers is outpacing revenue lost from customer attrition. Attrition improved from 2.0% in 1991 to 1.8% in 1992. Attrition increased in 1993 to 2.4%, reflecting the change to the portability of 800 numbers from carrier to carrier.\nThe provision for uncollectible revenue, which is deducted from gross revenue to arrive at reported revenue, was 1.9% for the year ended December 31, 1993, 3.0% for the year ended December 31, 1992, and 3.4% for the year ended December 31, 1991. During the last three years, procedures were implemented to improve the collection process and provide earlier detection of credit risks. Procedures include an expanded system for initial credit review and screening, monitoring of early usage levels on new accounts, modification of dunning and collection methods and timing, and improved collection processes on past due accounts.\nCOST OF COMMUNICATION SERVICES\nThe cost of communication services increased from $212.7 million and $216.9 million to $234.8 million for the years 1991, 1992, and 1993, respectively. The increase in cost of communication services is due to the 18.9% and 9.6% increase in billable minutes in 1993 and 1992. These increases were offset by unit cost reductions for transmission capacity experienced in 1992 and further efficiencies gained during 1993.\nThe cost of communication services decreased, however, as a percent of revenue from 61.3% for 1991 to 53.8% in 1993, the lowest rate in the Company's history. Switched access costs per hour as a percent of revenue declined 3.5% reflecting lower tariffed rates. A combination of the use of high volume, fixed price leased facilities to transmit traffic and reduced international costs through contractual agreements have contributed to this percentage decline. In addition, the Company has continued to reconfigure its network to optimize utilization.\nThe Company's use of high volume, fixed price transmission capacity is significantly more cost effective than the use of measured services. By utilizing fixed price leased facilities to transmit traffic, the Company has successfully decreased its network costs without the capital expenditures associated with construction of its own fiber optic or digital microwave network. Over 99% of traffic traverses low cost \"on-net\" digital facilities.\nOTHER EXPENSES\nSales, general and administrative expense was $98.0 million, $107.3 million and $119.8 million for the years 1991, 1992 and 1993, respectively.\nSales, general and administrative expense for 1993 increased $12.5 million or 11.7% compared to 1992. The increase reflects increased commissions, taxes other than income, and other expenses related to sales. Sales, general and administrative expense, however, declined as a percent of revenue which reflects management's continuing focus on cost containment. Procedures implemented to improve efficiencies and contain expenses included improved budgeting techniques, continued review of actual expenses against budgeted levels, incentive programs tied directly to achievement of budget objectives, and detailed review of general expense programs.\nSales, general and administrative expense for 1992 increased $9.3 million or 9.5% compared to 1991. Sales expense increased 19.6% from 1991 which resulted from increased advertising and marketing expenses as well as increased commissions reflecting higher first full month revenue as well as enhancements to the commission plan to encourage customer retention. General and administrative expenses continued to decrease as a percent of net revenue.\nThe increase in depreciation and amortization from $11.2 million in 1992 to $12.8 million in 1993 is primarily the result of depreciation on newly capitalized fixed assets and intangible assets reflecting the increase in capital expenditures in 1992 and 1993 and the purchase of CHA. The decrease from 1991 to 1992 reflected the termination of depreciation on analog multiplex and switch equipment, for which the Company provided a reserve, and the termination of depreciation as assets reach the end of their useful lives. These reductions in depreciation were partially offset by depreciation on assets capitalized during the period.\nINTEREST EXPENSE\nInterest expense has dramatically decreased from $18.1 million in 1991 and $17.2 million in 1992 to $10.5 million in 1993. This resulted from reduced interest related to the replacement of the 11 7\/8% Subordinated Notes, which had an effective interest rate of 13.6%, with the 9% Senior Subordinated Notes. In connection with the Refinancing, the Restructured Promissory Note and the 1990 Note Agreement were paid in full in 1993 and 1992, respectively. Interest expense also declined due to lower average balances on the Revolving Credit Facility, as well as lower interest rate charged under the new Revolving Credit Facility.\nINCOME TAXES\nEffective January 1, 1993, the required implementation date, the Company adopted the Financial Accounting Standards Board Statement 109 \"Accounting for Income Taxes\" (\"Statement 109\"). Application of the new rules resulted in the recording of a net deferred tax asset and additional income of $13.5 million as of January 1, 1993, related primarily to the future tax benefits which are expected to be realized upon utilization of a portion of the Company's tax net operating loss carryforwards (\"NOLs\"). Statement 109 requires that the tax benefit of NOLs be recorded as an asset to the extent that management assesses that the realization of such NOLs is \"more likely than not\". Management believes that realization of the benefit of the NOLs beyond a three-year period is difficult to predict and therefore has recorded a valuation allowance which has the effect of limiting the recognition of future NOL benefits to those expected to be realized within the three year period. The Company has not applied Statement 109\nretroactively and thus did not restate prior year financial statements to reflect adoption of the new rules.\nPrior to January 1, 1993, the Company accounted for income taxes in accordance with Accounting Principles Board Opinion No. 11. The tax provisions for the years ended December 31, 1992 and 1991 included an amount that would have been payable except for the availability of NOLs. The tax benefits of the loss carryforwards utilized were reported as an extraordinary item for the years ended 1992 and 1991. With the adoption of Statement 109, the income tax expense for 1993 includes the benefit of utilizing net operating losses. In 1992 and 1993 the Company was subject to regular tax and due to a Code Section 382 \"ownership change\", the utilization of net operating losses was limited. In 1991, the Company was subject to alternative minimum tax and the operating losses were utilized to offset 90% of the taxable income.\nSECTION 382 LIMITATION\nSection 382 (in conjunction with Sections 383 and 384) of the Code provides rules governing the utilization of certain tax attributes, including a corporation's NOLs, \"built-in-losses,\" capital loss carryforwards, unused investment tax credits (\"ITCs\") and other unused credits, following significant changes in ownership of a corporation's stock. Generally, Section 382 provides that if an ownership change occurs, the taxable income of a corporation available for offset by these tax attributes will be subject to an annual limitation (\"382 Limitation\").\nThe transfer of ALC Common Stock, Class B Preferred and Class C Preferred by CTI to the Banks in August 1992 resulted in an ownership change with a 382 Limitation of approximately $10 million per annum. As a result of this annual limitation, along with the 15 year carryforward limitation, the maximum cumulative NOLs and ITCs which can be utilized for federal income tax purposes in 1994 and future years are limited to approximately $120 million, assuming no future ownership change or built-in gain recognition. The Company is also subject to numerous state and local income tax laws which limit the utilization of NOLs after an ownership change.\nFuture events beyond the control of the Company could reduce or eliminate the Company's ability to utilize the tax benefit of its NOLs and ITCs. Any future ownership change under Section 382 would require a new computation of the 382 Limitation based on the value of the Company and the long term tax-exempt rate in effect at that time. Furthermore, the tax benefit of NOLs would be reduced to zero if the Company fails to satisfy the continuity of business enterprise requirement for the two-year period following an ownership change. Under the continuity of business requirement, the Company must either continue its historic business or use a significant portion of its pre-ownership change assets in a business.\nSEASONALITY\nThe Company's long distance revenue is subject to certain limited seasonal variations. Because most of the Company's revenue is generated by commercial customers, the Company traditionally experiences decreases in long distance usage and revenue in those periods with holidays. In past years the Company's long distance traffic has declined slightly during fourth quarters from previous quarters due to the holiday periods. However, in 1993 and 1992 the impact of this trend was more than offset by strong year over year traffic growth, which was up 26.0% and 12.3% from the fourth quarter of 1992 and 1991, respectively.\nLIQUIDITY AND CAPITAL RESOURCES\nFor the years ended December 31, 1993, 1992 and 1991, the Company generated positive cash flow from operations of $59.4 million, $30.4 million and $27.3 million, respectively, reflecting the strong trend of profitability. The positive cash flow reflects fourteen consecutive quarters of increased revenue and operating profits as of December 31, 1993 versus prior year comparable quarters.\nThe positive cash flow from operations resulted in working capital of $1.4 million at December 31, 1993 compared to negative $31.7 million at December 31, 1992. The increase in working capital is largely attributable to: (a) the pay down of the Revolving Credit Facility which was classified at December 31, 1992 as a short term liability, (b) the increase in accounts receivable due to the increase in revenue, and (c) the reduced balance in the current portion of notes payable due to the payoff of the Restructured Promissory Notes and payments made on capital leases.\nIn addition to the positive cash flow from operations, the Company's short term liquidity position is further strengthened by the unused availability under the Revolving Credit Facility. As of June 30, 1993 the Company executed an agreement for a $40.0 million line of credit, replacing the previous Facility. The new Revolving Credit Facility expires June 30, 1995. Under this Revolving Credit Facility, the Company is able to minimize interest expense by structuring the borrowings under three alternatives. Each alternative has a varying interest rate calculation associated with it. The effective rate under the Facility during 1993 approximated 5.8%. The agreement includes financial covenants which allow the Company to further reduce interest expense on outstanding borrowings beginning in July 1994. A .375% per annum charge is made on the unused portion of the line. Advances under the Revolving Credit Facility are made based on the level of receivables. As of December 31, 1993, the Company had availability of $39.8 million under the line and no balance outstanding.\nFurther evidence of the Company's stronger liquidity position was the Company's ability to finance the cash needs of $19.6 million for the CHA customer base acquisition and $10.4 million for the redemption including accrued dividends of Class A Preferred Stock from cash flow from operations.\nBecause the Company has chosen to lease rather than own its transmission facilities, the Company's requirements for capital expenditures are modest. Capital expenditures totalled $16.2 million in 1993. Capital expenditures during the year ended December 31, 1993 included projects for enhanced efficiency and technical advancement in the network, information systems and customer service. The future investment requirements for capital expenditures relate directly to traffic growth which necessitates the purchase of switching and related equipment. In addition, a major component of the capital budget relates to technological advancements as the Company continually updates its network capabilities to offer enhanced products and services. The level of capital expenditures for 1994 is expected to be $20 - $25 million.\nIn March 1993, an equity offering was completed in which an aggregate of 10,350,000 shares of ALC Common Stock were sold by certain stockholders of ALC at $14.25 per share. ALC did not receive any of the proceeds from the sale of these shares, although it did receive $1.9 million upon exercise of 963,684 warrants.\nIn May 1993, the Company completed an offering of $85.0 million of 9% Senior Subordinated Notes. Interest on the 1993 Notes is payable semiannually commencing November 15, 1993. The 1993 Notes will mature on May 15, 2003 but are redeemable at the option of the Company on or after May 15, 1998. Management used the $84.3 million of proceeds of this offering to repay the outstanding 1992 Notes aggregating $72.4 million, and to reduce the amount outstanding under the Revolving Credit Facility. The 1993 Notes provide additional benefits on both short and long term liquidity by reducing interest expense as well as deferring redemption requirements.\nIn September 1993, an equity offering was completed in which an aggregate of 7,763,391 shares of ALC Common Stock were sold by certain shareholders at $25.50 per share. This offering included the exercise of 3,240,025 warrants. In October 1993, an additional 177,100 warrants were exercised, and the shares subsequently sold to the public. ALC did not receive any proceeds from the sale of any of these shares but did receive $6.9 million from the exercise of warrants.\nIn December 1993, the Company redeemed the remaining 355,956 shares of Class A Preferred for $10.4 million including $3.2 million of accrued dividends.\nManagement believes that the Company's cash flow from operations will provide adequate sources of liquidity to meet the Company's anticipated short and long-term liquidity needs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data required by this Item 8. are set forth in Part IV, Item 14. of this Annual Report on Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOmitted pursuant to General Instruction J.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nOmitted pursuant to General Instruction J.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOmitted pursuant to General Instruction J.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOmitted pursuant to General Instruction J.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as a part of this report 1. Financial Statements. The following consolidated financial statements of the Company required by Part II, Item 8. are included in Part IV of this Report:\n3. Exhibits required by Item 601 of Regulation S-K\nEXHIBIT INDEX [refer to definitions at end of Index]\n____________________________ * Except as otherwise indicated, all references to \"Forms\" are to those of ALC. ** Management contract or compensation plan or arrangement required to be identified by Item 14(a)(3) of this report\n_______________ ** Management contract or compensation plan or arrangement required to be identified by Item 14(a)(3) of this report\nThe Registrant hereby agrees to furnish the Commission a copy of each of the Indentures or other instruments defining the rights of security holders of the long-term debt securities of the Registrant and any of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 1993.\n(c) Refer to Item 14(a)(3) above for Exhibits required by Item 601 of Regulation S-K.\n(d) Schedules other than those set forth in response to Item 14(a)(2) above for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the duly authorized, undersigned individual on the 29th day of March, 1994.\nAllnet Communication Services, Inc. Registrant\nBy: \/s\/ John M. Zrno John M. Zrno, Director, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons in their respective capacities on behalf of the registrant as of the 29th day of March, 1994.\nREPORT OF INDEPENDENT AUDITORS\nBOARD OF DIRECTORS AND STOCKHOLDERS ALC COMMUNICATIONS CORPORATION\nWe have audited the accompanying consolidated balance sheets of ALC Communications Corporation and subsidiary as of December 31,1993 and 1992, and the related consolidated statements of operations, cash flows, and preferred stock and stockholders' equity for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ALC Communications Corporation and subsidiary at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects the information set forth therein.\n\/s\/ ERNST & YOUNG Ernst & Young\nDetroit, Michigan January 25, 1994\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS\nLIABILITIES, CLASS A PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF CLASS A PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF CLASS A PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nYears Ended December 31, 1993, 1992 and 1991 (In Thousands)\nSee notes to consolidated financial statements\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993 AND 1992\nNote A -- Summary of Significant Accounting Policies\nDescription of Business\nAllnet Communication Services, Inc. (\"Allnet\"), the operating subsidiary of ALC Communications Corporation (\"ALC\" or the \"Company\"), provides long distance telecommunications services primarily to commercial and, to a lesser extent, residential subscribers in a majority of the United States and completes subscriber calls to all directly dialable locations worldwide. The Company transmits long distance telephone calls through its network facilities over transmission lines which are leased from other long haul transmission providers. All of the transmission facilities utilized by the Company are digital.\nBasis of Consolidation\nThe consolidated financial statements include the accounts of ALC and its wholly-owned subsidiary, Allnet Communication Services, Inc. Intercompany transactions have been eliminated.\nFixed Assets\nFixed assets are stated at cost. Depreciation is provided on the straight-line method over the estimated useful lives or lease terms of the assets. Maintenance and repairs are charged to operations as incurred.\nIntangible Assets\nThe cost in excess of net assets acquired of $61.0 million, resulting from the acquisition of Lexitel is being amortized on a straight line basis over 40 years.\nIn July 1993, the Company acquired the customer base of Call Home America, Inc. (\"CHA\") (Note C). The purchase price has been allocated between the value of the customer base acquired and the covenant not to compete which are being amortized over seven years and 42 months, respectively. Additionally, the Company is amortizing over five years the costs incurred under a marketing agreement with CHA. Amortization expense related to the acquisition and marketing agreement totaled $1.2 million in 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAmortization expense, including amortization of cost in excess of net assets acquired and cost associated with the issuance of debentures and the Revolving Credit Facility as well as amortization associated with CHA, totaled $3.1 million, $1.8 million and $1.8 million for the years ended December 31, 1993, 1992 and 1991, respectively.\nRevenue Recognition\nCustomers are billed as of monthly cycle dates. Revenue is recognized as service is provided and unbilled usage is accrued.\nAccrued Facility Costs\nIn the normal course of business, the Company estimates its accrual for facility costs. Subsequently, the accrual is adjusted based on invoices received from local exchange carriers.\nIncome Taxes\nThe Company adopted Statement of Financial Standards No. 109 \"Accounting for Income Taxes\" as of January 1, 1993, the required implementation date (Note F). Prior to January 1, 1993, income taxes were accounted for in accordance with Accounting Principles Board Opinion No. 11 (\"APB 11\").\nReclassifications\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nNOTE B -- Refinancing Events\nDuring 1992, the Company completed a comprehensive refinancing plan (\"Refinancing\") which included the rescheduling of substantially all debt and resulted in significantly reduced or deferred debt service obligations. The Refinancing resulted in a simplified equity structure and a revised redemption and maturity schedule. The Company anticipates it will be able to meet these obligations from expected cash flow from operations. Highlights of the Refinancing include the following:\n* A Note Exchange Offer was completed in August 1992 whereby the Company's Original Debentures, Replacement Debentures, PIK Debentures, and accrued interest on the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nnonconsenting Debentures totalling $73.3 million were replaced by 11 7\/8% Subordinated Notes of Allnet (\"1992 Notes\"). As part of the Note Exchange Offer, 3,400,000 Common Stock warrants (\"1992 Warrants\") were issued representing 10.2% of the fully diluted equity of ALC at an exercise price of $5.00 per share of Common Stock.\n* In August 1992, the Restructured Promissory Note was restated and extended to June 30, 1995 and a $5.0 million principal prepayment was made. The note was subsequently paid in full in May 1993.\n* In August 1992, 14,324,000 shares of ALC Common Stock and the ALC Class B and Class C Preferred Stock (\"Preferred Stock\") held by Communications Transmission Inc. (\"CTI\") were transferred to a group of five banks (\"Banks\"). Subsequently, the Preferred Stock was converted into 3,796,000 shares of Common Stock.\n* In October 1992 an equity offering for 9,863,600 shares of ALC Common Stock at $5.50 per share was completed. A portion of the 1992 equity offering relating to 3,464,373 shares was to facilitate the sale of shares for existing major holders.\n* The remaining 6,399,227 shares of the equity offering were issued in conjunction with an Exchange Agreement with the major holders of the Class A Preferred Stock (\"Class A Preferred\"). The major holders of the Class A Preferred agreed to exchange the 2,144,044 shares of Class A Preferred with an aggregate redemption value of $58.7 million, including all accrued and unpaid dividends, for shares of ALC Common Stock at an effective 40% discount.\n* The 1990 Note Agreements with a principal balance of approximately $8.0 million were paid in full by December 1992.\nFinancing activities in 1993 included:\n* In March 1993, an equity offering was completed in which an aggregate of 10,350,000 shares of ALC Common Stock were sold at $14.25 per share. ALC did not receive the proceeds from the sale of these shares by existing major holders, although it did receive $1.9 million upon exercise of 963,784 warrants.\n* In May 1993, the Company completed an offering of $85.0 million 9% Senior Subordinated Notes (\"1993 Notes\").\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe net proceeds of $84.3 million were used to repay the outstanding 11 7\/8% Senior Subordinated Notes of Allnet aggregating $72.4 million and to reduce the amount outstanding under the short term Revolving Credit Facility. The early retirement of the 1992 Notes resulted in an extraordinary loss of $7.5 million, net of the related tax effect of $4.0 million.\n* As of June 30, 1993, the Company executed an agreement for a $40.0 million long term line of credit, replacing the previous Revolving Credit Facility.\n* In September 1993, an equity offering was completed in which an aggregate of 7,763,391 shares of ALC Common Stock were sold at $25.50 per share. This offering included the exercise of 3,240,025 warrants. ALC did not receive any proceeds from the sale of these shares by existing major holders, but did receive $6.9 million from the exercise of warrants.\n* As of December 31, 1993, the Company redeemed the remaining 355,956 shares of Class A Preferred for a total of $10.4 million including $3.2 million of accrued dividends.\nNote C - Purchase of Customer Base\nDuring July 1993, the Company acquired the specialized 800 customer base of Call Home America, Inc. for $15.5 million plus a future payment to be made based on certain average monthly revenue generated by the customers in April, May and June 1994.\nThe Company is also acquiring additional customers from CHA under a marketing agreement from August 1993 through 1994. Under this agreement, an additional $4.1 million has been allocated to the purchase price for customers acquired during 1993.\nThe following unaudited proforma summary presents the Company's revenue and income as if the transaction occurred at the beginning of the periods presented. The proforma financial data is not necessarily indicative of the results that actually would have occurred had the transactions taken place on the dates presented and do not project the Company's results of operations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE D - Long Term Debt and Other Financing\nLong-term debt, including amounts due within one year, consists of:\nRevolving Credit Facility\nThe Company has a $40.0 million Revolving Credit Facility which expires on June 30, 1995. Under this Facility, the Company is able to minimize interest expense by structuring borrowings under three alternatives. Each alternative has a varying interest rate calculation associated with it. The effective rate under the Facility during 1993 approximated 5.8%. The agreement includes financial covenants which allow the Company to further reduce interest expense on outstanding borrowings beginning in July 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nA .375% per annum charge is made on the unused portion of the line. Availability under the Facility is based on the level of eligible accounts receivable. As of December 31, 1993, the Company had $39.8 million of availability under the line. Borrowings under the facility (none at December 31, 1993) are collateralized by accounts receivable.\n9% Senior Subordinated Notes\nIn May 1993, the Company issued the 1993 Notes with a face value of $85.0 million. Interest on the 1993 Notes is payable semi-annually commencing November 15, 1993. The Notes will mature on May 15, 2003, but are redeemable at the option of the Company, in whole or in part, on or after May 15, 1998. In the event of an ownership change, the holders have the right to require the Company to purchase all or part of the 1993 Notes. The 1993 Notes contain restrictive covenants which could limit additional indebtedness and restrict the payment of dividends.\nOther Long-Term Debt\nOther long-term debt represents deferred liabilities relating to certain operating leases.\nFuture Maturities\nThe future maturities of long-term debt at December 31, 1993 are as follows:\nNOTE E - Redeemable Preferred Stock\nAs of December 31, 1991, the Company had 2,500,000 shares of Class A Preferred outstanding with a redemption value of $48.9 million plus accrued dividends. In October 1992, pursuant to the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nExchange Agreement with the major holders of the Class A Preferred the Company exchanged 2,144,044 shares of Class A Preferred for 6,399,227 shares of ALC Common Stock at an effective 40% discount.\nIn September 1992, ALC paid approximately $1.3 million to certain major holders of the Class A Preferred in connection with a concession agreement entered into in June 1990.\nIn July 1993, a dividend of $0.32 per share was declared which was subsequently paid September 30, 1993. In December 1993, the Company redeemed the remaining 355,956 shares of Class A Preferred for $10.4 million including $3.2 million of accrued dividends.\nNOTE F - Taxes on Income\nEffective as of January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement 109\"). Under Statement 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when those differences are expected to reverse.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of the change resulted in recording net deferred tax assets and increasing net income in 1993 by $13.5 million.\nIncome tax expense and the extraordinary item as shown in the Consolidated Statement of Operations are composed of the following:\nDue to the change of ownership which occurred in August 1992 and the resulting limitation on the utilization of net operating loss carryforwards (\"NOLs\"), the Company is subject to the regular tax, resulting in federal taxes currently payable of $6.7 million\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor 1993 and $1.6 million for 1992. In 1991, the Company was subject to alternative minimum tax which was imposed at a 20% rate on the Company's alternative minimum taxable income. NOLs were used to offset 90% of the taxable income resulting in federal taxes currently payable of $100,000 for 1991.\nThe provisions for state and local income taxes reflect the effect of filing separate company state and local income tax returns for members of the consolidated group. This amount is reduced, where appropriate, by the availability to utilize state and local portions of operating loss carryforwards. State and local income taxes currently payable were $1.2 million, $1.1 million, and $200,000 in 1993, 1992, and 1991, respectively.\nThe $5.5 million tax benefit realized from the exercise of stock options in 1993 was added to capital in excess of par value and is not reflected in operations.\nA reconciliation between the statutory federal and the effective income tax rates follows:\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company's deferred taxes as of December 31, 1993 are as follows (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company has tax net operating loss, alternative tax net operating loss and investment tax credit (\"ITC\") carryforwards which can be utilized annually to offset future taxable income. Because of the \"ownership changes\" which occurred in 1989 and 1992 under provisions of Internal Revenue Code Section 382, the utilization of carryforwards is presently limited to approximately $10 million per year through 2005. This annual limitation, coupled with the 15 year carryforward limitation, results in a maximum cumulative NOL and ITC carryforward which may be utilized of approximately $120 million as of December 31, 1993. Because it is difficult to predict the realization of the NOL benefit beyond a period of three years, the Company has established a valuation allowance of $34.9 million as of December 31, 1993.\nNOTE G - Earnings Per Share and Stockholders' Equity\nEarnings per share\nEarnings per share are computed using weighted average shares outstanding, adjusted for the one for five reverse stock split in 1991, and common stock equivalents. To arrive at income available for common stockholders, the Company's net income is adjusted by amounts relating to the accretion of discount and dividends accrued on Class A Preferred, and in 1992 and 1991, the accretion of a contract payment to certain major holders of the Class A Preferred. Anti-dilutive securities for 1992 were warrants and options and for 1991 also included Class B and Class C Preferred Stock. Earnings per share for the third and fourth quarters of 1992 and for all of 1993 include the impact of the exercise of outstanding stock options and warrants utilizing the Treasury Stock Method.\nCommon Stock Warrants\nAs of December 31, 1993, warrants for the purchase of 428,090 shares of Common Stock at $2.00 per share, 3,177,856 shares at $5.00 per share and 660,000 shares at $63.75 per share were outstanding. The warrants expire in June 2005, June 1997 and December 1995, respectively. The $2.00 and $5.00 warrants were issued in connection with the Company's refinancings and the difference between the exercise price and the fair value of the warrants at\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nthe time of issuance was recorded as a discount on the related notes and an increase to Paid-in-capital - warrants.\nEmployee Stock Options\nThe Company has two Employee Stock Option Plans. The maximum number of shares for which options may be granted under both plans is 6,000,000 (adjusted for certain events such as a recapitalization). The plans provide for the granting of stock options and stock appreciation rights to key employees.\nShares under option are summarized below:\nNOTE H - Leases\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFuture minimum rental payments under non-cancelable operating leases with initial or remaining terms of one or more years are $36.4 million, $24.8 million, $20.2 million, $14.7 million, $11.6 million and $15.0 million for 1994, 1995, 1996, 1997, 1998 and 1999 and thereafter, respectively.\nThe Company's lease arrangements frequently include renewal options and\/or bargain purchase or fair market value purchase options, and for leases relating to office space, rent increases based on the Consumer Price Index or similar indices.\nNon-cancelable operating leases relate primarily to intercity transmission facilities, building and office space, and office equipment. Rental expense was $49.9 million, $52.3 million, and $56.9 million for the years ended December 31, 1993, 1992 and 1991, respectively.\nFixed assets include amounts financed by capital leases of $600,000 net of $400,000 of accumulated depreciation, and $11.4 million, net of $9.4 million of accumulated depreciation as of December 31, 1993 and 1992, respectively.\nNOTE I - Transactions with Related Parties\nThe Company leases transmission capacity, multiplexing and various other technical equipment on both capital and operating leases from an affiliate of CTI, a major shareholder through August 1992. Amounts paid under the leases were $17.7 million and $19.7 million for the years ended December 31, 1992 and 1991, respectively.\nIn June 1992, the Company paid $2.0 million to CTI for the purchase of certain assets including an $800,000 note from a major holder of Class A Preferred which was paid in full upon closing of the 1992 equity offering. Consideration for the transaction also included $1.2 million of prepaid transmission capacity to be utilized over a 37 month period.\nDuring August 1992, CTI conveyed 14,324,000 shares of ALC Common Stock, 1,000,000 shares of Class B Preferred Stock and 1,000,000 shares of Class C Preferred Stock to the Banks in exchange for the release of certain obligations of CTI. This exchange effected a transfer of controlling interest in the Company from CTI to the Banks. Pursuant to this transfer, The Prudential Insurance Company of America (\"Prudential\") became a related party through beneficial ownership of options on the stock held by the Banks. During 1992, Prudential held $3.4 million of 1990 Notes which were paid in full in August 1992. As of December 31, 1992, Prudential owned 1990 Warrants to purchase\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1,975,804 shares of ALC Common Stock. During the March 1993 equity offering Prudential sold 1,963,784 shares of which 963,784 represented the exercise of a portion of their warrants. Prudential exercised their remaining 1,012,020 warrants during the September 1993 equity offering and as a result of these sales, no longer has a substantial equity position in ALC.\nThe transfer of stock during August 1992 from CTI to the Banks gave NationsBank of Texas, N.A. and The First National Bank of Chicago related party status through their ownership of Common, Class B Preferred Stock and Class C Preferred Stock. The March 1993 equity offering facilitated the sale by the Banks of 8,386,216 shares of which 3,796,000 were received upon the conversion of all the Class B and Class C Preferred Stock. The Banks further reduced their ownership interest in the Company to a minimal position through subsequent sales and the transfer of other shares to Prudential. The Banks held the Restructured Promissory Note which was paid in full in May 1993.\nAs of December 31, 1993, Grumman Hill Associates, Inc. and Grumman Hill Investments L.P., of which Richard D. Irwin (the Chairman of the Board of Directors of the Company) is the General Partner, held an aggregate of 622,486 warrants to purchase shares of Common Stock. Additionally, Grumman Hill Investments, L.P. holds options to purchase 153,163 shares of Common Stock.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE J - Selected Quarterly Financial Data (Unaudited)\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY SCHEDULE V Property and Equipment\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY SCHEDULE VI Accumulated Depreciation on Property and Equipment\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY SCHEDULE VIII Valuation and Qualifying Accounts and Reserves\n- ----------------------- (1) Amounts accounted for as a reduction of revenue. (2) In connection with the Company's adoption of Statement of Financial Standards No. 109, \"Accounting for Income Taxes\", a valuation allowance for deferred tax assets of $37,000,000 was recorded January 1, 1993. (See Note F to the Consolidated Financial Statements). (3) Uncollectible accounts written off, net of recoveries.\nALC COMMUNICATIONS CORPORATION AND SUBSIDIARY SCHEDULE IX Short-term Borrowings\n(1) Based on month end amounts outstanding during the period (2) Based on total interest expense for the period and average amount outstanding during the period (3) Line of Credit was classified as short-term through May 1993, upon refinancing the line in June 1993, the balance was transfered to long-term.","section_15":""}
{"filename":"797854_1993.txt","cik":"797854","year":"1993","section_1":"Item 1.\tBusiness\nAcquisition of H Space Technologies Inc.\nH Space Technologies Inc. (\"H Space\") is in the business of designing and manufacturing point of sale, promotional and corporate display systems. A discussion with respect to H Space is set out hereafter.\nManagement has conditionally agreed to merge the Corporation with H Space. The agreement is conditional on regulatory and shareholder approval. The Corporation intends to split its existing issued and outstanding shares on a 2:1 basis and thereafter issue 10,799.961 common treasury shares of the Corporation to the shareholders of H Space in exchange for all of the 3.599.987 common shares issued or optioned in H Space. As part of the merger, a private placement of up to 2,000,000 shares of the Corporation for a consideration of $1,000,000 is planned.\nTechnology Profile\nUtilizing a knowledge base gained over the past 20 years in the field of fibre optics, the founders of H Space developed a unique Light Management System, \"LMS\" which will allow the company to launch into two commercial markets which are global in nature. This new \"patent pending\" technology facilitates the design and manufacture of animated point of sale and corporate identification display systems displacing aging neon signage. Low wattage, energy efficient light is transmitted through computer generated light\/colour management system into any array of fibre optic cables which bring to the viewer an exciting array of every changing colours and message patterns. Prototype systems have been presented to major corporate end users. Engineering to prepare for multiple unit manufacturing is in process.\nThe Company will focus its fiscal efforts on the commercialization of fibre optics \"LMS\" for the promotional, point of sale and corporate display market. The Company's sustainable competitive advantages rest in a combination of its technical depth in fibre optics and light transmission, its computer based design system and its seasoned management. Following completion of the commercialization of the above subject technology, the company will avail itself of Canadian government research grants to bring to market readiness equally existing fibre optic lighting systems for \"holographic\" display and interior design applications.\nMarket Profile:\nXzotec Inc. will initially focus on two defined markets:\n1.\tPromotional signage; and \tCorporate display.\nThe total market is estimated to be in the range of $3 billion (U.S.). The following is a brief overview.\nPromotional Signage:\nThe utilization of illuminated promotion or \"point of sale\" signs and displays is a well established marketing tool. Advertising budgets are projected to increasingly focus on point of purchase where the majority of buying decisions are made. Currently, a portion of the point of purchase advertising budget of major corporations is committed to neon signs. Xzotec will be positioned to capture projected budget expenditure growth by offering major corporations enhanced, motion and colour rich sign age not previously available. The price point will be slightly higher than neon but this is not a barrier to entry. Test marketing and prototype work is already underway with a number of consumer product, Fortune 500 companies. Management believes that industries ranging from food and beverage to footwear, computers, clothing, financial services, tobacco, automotive and consumer electronics will be end user customers.\nCorporate Display:\nMost if not all Fortune 500 companies continue to invest in corporate imagery. This market sector will be attracted to the special ability of Xzotec Inc. to provide high profile corporate identification which is individually unique in design but utilizes the company's standard light management system and fibre optics. The marketplace for display systems will range from corporate name\/logo signs to interior building designs and trade show exhibits.\nStrategic Relationship:\nXzotec Inc. has benefited and will continue to derive assistance from its special relationship with Precision Camera Inc. Founded over 15 years ago by Mr. Gerd Kurz, an investor in and shareholder of H Space, Precision is Canada's premiere Company in the growing field of complex video applications. With in-house, state of the art design studios, precision machining, optical, electronic and video testing and repair facilities, Precision Camera has the technical capacity to design, engineer, manufacture and install complex integrated audio\/video systems.\nThe company is certified by Sony of Japan as a broadcast service facility for television and motion picture equipment. Precision has engineered systems from remote control cameras operating in nuclear reactors to the system in Toronto's Skydome Stadium retractable roof. This relationship has assisted management in their prototype development phase and will prove invaluable as the company moves into full commercial production.\nManagement:\nManagement of H Space has a considerable depth of knowledge in marketing, manufacturing, fibre optic and holographic technology. Both Michael Miville, the firm's President and Richard Howard, the Executive Vice- President, have previously built and sold successful companies.\nOther Business:\nOther than the acquisition of H Space, the Corporation has no business activities.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2.\t\tProperties: \t\tN\/A\nItem 3.","section_3":"Item 3.\t\tLegal Proceedings: \t\tNone\nItem 4.","section_4":"Item 4.\t\tSecurity Ownership of Certian Beneficial Owners and Management: \t\tNone\n\t\t\t\tPART II\nItem 5.","section_5":"Item 5. \tMarket for the Registrant's Common Stock and Related \t\tHolder Matters: \t\tNone\nItem 6.","section_6":"Item 6. \tSelected Financial Data: \t\tSee attached information as Exhibit A.\nItem 7.","section_7":"Item 7.\t\tManagement's Discussion and Analysis of Financial Condition \t\tand Results of Operations:\nThe Board of Directors and shareholders have agreed with H Space Technologies Inc. to approve the change of the name of the Corporation to Xzotec Inc. to increase the capital of the Corporation to 30 million common shares without par value to split the issued and outstanding common shares on a 2:1 basis prior to the acquisition of H Space Technologies Inc., to approve the acquisition of H Space Technologies Inc., to approve the stock option plan and to approve the private placement of 2 million treasury shares for a consideration of $1,000,000.\nItem 8.","section_7A":"","section_8":"Item 8.\t\tFinancial Statements and Supplementary Data: \t\tAttached are financial statements for the period ending \t\tAugust 31, 1993.\nItem 9.","section_9":"Item 9.\t\tDisagreements on Accounting and Financial Disclosure \t\tNone\n\t\t\tPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10.\tDirectors and Executive Officers of the Registrant:\nName and Principal \tPresent\t\t Shareholdings\tShareholdings Occupation Shareholdings After Split \t After \t\t\t\t\t Acquisition\t \t Acquisition\nMichael Miville\t\t Nil\t\t\tNil\t\t 2.430,000 President, Xzotec Inc.\nRichard Howard Exec. Vice-President \t Nil\t\t\tNil\t\t 999,999 Xzotec Inc.\nMichael Mewha C.E.O., North American Nil\t\t\tNil\t\t Nil Network Co. Inc.\nBarry Brawn\t\t Nil\t\t 956,463\t\t1,114,797 (2) President, Assistco Inc.\nAnthony Swartz\t\t Nil\t\t\tNil\t\t3,324,960 (1) President, Sussex Investments Inc.\nGerd Kurz President, \t Nil\t\t\tNil\t\t 750,000 Precision Camera Inc.\nJames T. Riley\t\t956,463\t\t\t956,463\t\t 956,463 Chairman Northquest Ventures Inc.\n(1) Assumes conversion of debenture in the principal amount of $150,000. (2) Assumes exercise of option in the amount of 158,334 shares at $1.00 per share. (3) The above directors have approved the acquisition of H Space Technologies Inc.\nItem 11.","section_11":"Item 11.\tExecutive Compensation: \t\tNone\nItem 12.","section_12":"Item 12.\tSecurity Ownership of Certain Beneficial Owners and \t\tManagement: \t\tMr. James T. Riley holds 936,463 shares directly. \t\tHe also is the major shareholder of Northquest Ventures Inc.\nItem 13.","section_13":"Item 13.\tCertain Relationships and Related Transactions \t\tNone\n\t\t\t\tPART IV\nItem 14.","section_14":"Item 14.\tExhibits, Financial Statement Schedules \t\tand Reports on Form 8-K:\n\t\tSee attached Financial Statements. \t\tThe Corporation has no subsidiaries. \t\tSee 8-K Report previously filed.\nSignatures: Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: October 7. 1993 CORNWALL TIN & MINING CORPORATION\nDate: October 7, 1993.\n\"James T. Riley\"\n\t CORNWALL TIN AND MINING CORPORATION (A Delaware Corporation)\n\t\tFINANCIAL STATEMENTS \t August 31, 1993 and 1992 \t\t (in U.S. dollars)\nChartered Accountants BCE Place 181 Bay Street Suite 1400 Toronto, Ontario M5J 2V1\n\t\t\t\tAUDITORS' REPORT\nTo the Shareholders of Cornwall Tin and Mining Corporation Telephone: (416) 601-6150 Telecopier: (416) 601-6151\nWe have audited the balance sheets of Cornwall Tin and Mining Corporation (A Delaware Corporation) as at August 31, 1993 and 1992 and the statements of loss and deficit and of changes in financial position for each of the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.\nIn our opinion, these financial statements present fairly, in all material respects, the financial position of the Corporation as at August 31, 1993 and 1992 and the results of its operations and the changes in its financial position for each of the years then ended in accordance with generally accepted accounting principles.\n\"Deloitte & Touche\" Chartered Accountants\nToronto, Ontario September 16, 1993\n\t\t COMMENTS BY AUDITOR FOR U.S. READERS ON CANADA-U.S. REPORTING CONFLICT\nIn the United States, reporting standards for auditors require the addition of an explanatory paragraph when the financial statements are affected by significant uncertainties such as that referred to in the attached balance sheets as at August 31, 1993 and 1992 and as described in Note 1 to the financial statements. Our report to the shareholders dated September 16, 1993 is expressed in accordance with Canadian reporting standards which do not permit a reference to such an uncertainty in the auditor's report when the uncertainty is adequately disclosed in the financial statements.\n\"Deloitte & Touche\" Chartered Accountants Toronto, Ontario September 16, 1993\nDeloitte Touche Tohmatsu International\n\t\t CORNWALL TIN AND MINING CORPORATION (A Delaware Corporation) BALANCE SHEETS August 31, 1993 and 1992 (in U.S. dollars)\n\t\t\t\t1993\t\t1992\nASSETS\nCURRENT\t\t\t\t$168\t\t$204 Cash\nADVANCE TO RELATED COMPANY \t -\t\t$43,573 (Note 3)\nLIABILITY\nCURRENT Accounts payable and \t\t$1,945\t\t$23,525 accrued liabilities\nCAPITAL DEFICIENCY Share capital Authorized 4,000,000 common shares with a par value of $0.01 each Issued 2,710,800 common shares \t\t27,108\t\t27,108 Contributed surplus\t\t 3,039,388\t 3,039,388 Deficit\t\t\t\t (3,068,273) (3,046,244)\n\t\t\t\t\t1,777\t\t20,252 \t\t\t\t\t $168\t $43,777\nAPPROVED BY THE BOARD \"Jim Riley\" Director \"W Deschamps\" Director\n\t\t CORNWALL TIN AND MINING CORPORATION (A Delaware Corporation) STATEMENTS OF LOSS AND DEFICIT Years ended August 31, 1993 and 1992 (in U.S. dollars)\n\t\t\t\t\t1993\t\t1992\nEXPENSES\nAdministrative services \t $18,114\t\t- (Note 3) Net foreign exchange loss\t\t\t $1,900\t\t$853\nLegal and audit \t\t $1.895\t\t$837 Franchise tax\t\t\t $100 \t\t$97 Bank charges\t\t \t $20\t\t- Transfer agent\t\t\t -\t\t$170\nLOSS FOR THE YEAR\t\t $22,029\t\t$1957\nDEFICIT, BEGINNING OF YEAR\t 3.046.244\t3,044,287\nDEFICIT, END OF YEAR\t\t $ 3,068,273\t$3,046,244\nLOSS PER SHARE\t\t\t $ 0.0081\t\t$0.0007\n\t\t CORNWALL TIN AND MINING CORPORATION (A Delaware Corporation) STATEMENTS OF CHANGES IN FINANCIAL POSITION Years ended August 31,1993 and 1992 (in U.S. dollars)\n\t\t\t\t\t1993\t\t1992\nNET INFLOW (OUTFLOW) OF CASH RELATED TO THE FOLLOWING ACTIVITIES:\nOPERATING Loss for the year\t\t\t$(22,029)\t$(1,957) Change in non-cash operating working capital item Accounts payable and accrued\t\t(21,580)\t (389) liabilities \t\t\t\t\t(43,609)\t(2,346)\nFINANCING Advance to related company\t\t 43,573\t\t 2,353\nNET CASH (OUTFLOW) INFLOW\t\t (36)\t\t 7\nCASH, BEGINNING OF YEAR\t\t\t 204\t\t 197\nCASH, END OF YEAR\t\t\t $168\t\t $204\n\t\t\tCORNWALL TIN AND MINING CORPORATION (A Delaware Corporation) NOTES TO THE FINANCIAL STATEMENTS August 31, 1993 and 1992 (in U.S. dollars)\n1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS\nThe Corporation was incorporated under the laws of the State of Delaware on November 1, 1968. The Corporation has ceased its former operations of Mineral Exploration. Its charter was revived on June 2, 1992 for future undertakings. These financial statements have been prepared on the basis of accounting principles applicable to a going concern. Continuation of the business on this basis is dependent upon the Corporation achieving future profitable operations (see Note 3). There can be no assurance such operations will be successful.\n2. SIGNIFICANT ACCOUNTING POLICY\nThe accompanying financial statements are prepared in accordance with accounting principles generally accepted in Canada and conform in all material respects with accounting principles generally accepted in the United States.\nForeign currency translation\nMonetary assets and liabilities are translated at the effective rate of exchange at the year end.\nForeign currency transactions occurring during the year are translated at the effective rate of exchange on the transaction date.\n3. ADVANCE TO RELATED COMPANY\nThe Corporation has advanced funds to Northquest Ventures Inc. (formerly The Canadian Games Network Inc., a Canadian Company). The President of the Corporation is also the President of Northquest Ventures Inc. During fiscal 1993, Northquest Ventures Inc. agreed to assume the liabilities of the Corporation outstanding as at August 31, 1992 in exchange for an equal reduction in its advance. The remaining balance of the advance was charged to operations in exchange for services provided by Northquest Ventures Inc. up to August 31, 1993.\n4. INCOME TAXES\nThe Corporation has available net operating losses which may be carried forward to be applied against future income for income tax purposes until at least the year 2000.\nCORNWALL TIN AND MINING CORPORATION (A Delaware Corporation) NOTES TO THE FINANCIAL STATEMENTS August 31, 1993 and 1992 (in U.S. dollars) SUBSEQUENT EVENTS At the Annual Meeting of the Shareholders on September 8, 1993, the shareholders approved a resolution by the board of directors to acquire H Space Technologies Inc. (\"H Space\"), subject to regulatory approval. The acquisition would be facilitated by issuing 10,799,961 common shares of the Corporation in exchange for 3,599,987 common shares of H Space, being all the issued and outstanding shares of H Space. H Space Technologies Inc. is a corporation that has developed a unique \"patent pending\" technology which facilitates the design of and manufacture of animated point of sale and corporate identification display systems displacing aging neon signage. Resolutions were also approved: to change the name of the Corporation to \"Xzotec Inc.,\" to increase the number of authorized common shares of the Corporation to 30,000,000; to split the issued and outstanding shares of the Corporation on the basis of two common shares of the new Corporation in exchange for one common share previously issued prior to closing the acquisition of H Space; and to create a stock option plan for the Corporation's senior directors, offices, affiliates as well as key employees and consultants to acquire shares at prices approved from time to time by the various regulatory bodies. Articles of Amendment have not been filed to effect these changes until the acquisition agreement with H Space has been executed.","section_15":""}
{"filename":"60512_1993.txt","cik":"60512","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nInformation presented in Note 15 under the heading \"Notes to Consolidated Financial Statements\" in the Company's Annual Report to Shareholders for 1993 (page 24 of Exhibit 13 filed herewith) is incorporated herein by reference. See also \"Environmental Matters.\"\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nNAME AGE POSITIONS _________________________________________________________________\nH. Leighton Steward (59) Chairman of the Board, President and Chief Executive Officer since 1989.\nRichard A. Bachmann (49) Director since 1989. Executive Vice President, Finance and Administration and Chief Financial Officer since 1985.\nJohn F. Greene (53) Director since 1989. Executive Vice President, Exploration and Production since 1985.\nJerry D. Carlisle (48) Vice President and Controller since 1984.\nRobert J. Chebul (46) Vice President since July, 1991. Held various managerial positions, including District Manager from 1988 to 1991.\nE. J. Leidner, Jr. (57) Vice President since 1986.\nJohn O. Lyles (48) Vice President since 1992. Vice President and Treasurer from 1984 to 1992.\nJoel M. Wilkinson (58) Vice President since 1988.\nJohn A. Williams (49) Vice President since 1988.\nFrederick J. Plaeger, II (40) General Counsel and Corporate Secretary since 1992. Corporate Secretary and Senior Counsel from 1989 to 1992. Partner in the law firm of Milling, Benson, Woodward, Hillyer, Pierson and Miller from 1985 to 1989.\nLouis A. Raspino (42) Treasurer since 1992. Assistant Treasurer from 1984 to 1992.\nEach officer holds office until the first meeting of the Board of Directors following the annual meeting of shareholders and until his successor shall have been elected and qualified, or until he shall have resigned or been removed as provided in the LL&E By- Laws. No family relationship exists between any of the above listed executive officers or between any such executive officer and any Director of LL&E.\nPART II\nIndex\nPage Number __________________________________________________________________\n25 Item 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation presented under the caption \"Capital Stock, Dividends and Other Market Data\" in the Company's Annual Report to Shareholders for 1993 (page 35 of Exhibit 13 filed herewith) and information presented under the caption \"Market Price and Dividend Data\" in the Company's Annual Report to Shareholders for 1993 (page 49 of Exhibit 13 filed herewith) are incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nInformation presented under the caption \"Selected Financial Data\" in the Company's Annual Report to Shareholders for 1993 (page 48 of Exhibit 13 filed herewith) is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nInformation presented under the heading \"Financial Review\" in the Company's Annual Report to Shareholders for 1993 (under the heading \"Management's Discussion and Analysis\" on page 29 of Exhibit 13 filed herewith) is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements of The Louisiana Land and Exploration Company and Subsidiaries, together with the report thereon of KPMG Peat Marwick dated February 9, 1994, and the supplementary data referred to in Item 14(a)(1) hereof, which are contained in the Company's Annual Report to Shareholders for 1993 (Exhibit 13 filed herewith), are incorporated herein by reference. The report of KPMG Peat Marwick covering the aforementioned consolidated financial statements refers to the adoption of the methods of accounting for income taxes and postretirement benefits other than pensions prescribed by Statement of Financial Accounting Standards Nos. 109 and 106, respectively. The consolidated financial statements of MaraLou Netherlands Partnership and Subsidiary (a 50%-owned affiliate accounted for under the equity method), together with the report thereon of KPMG Peat Marwick dated January 28, 1994, as referred to in Item 14(a)(1) hereof, are included herein and filed herewith. The report of KPMG Peat Marwick covering the aforementioned consolidated financial statements refers to the adoption of the method of accounting for income taxes prescribed by Statement of Financial Accounting Standard No. 109.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nIndex\nPage Number __________________________________________________________________\n27 Item 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation relating to directors of the Registrant will be contained in the definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 12, 1994, which the Registrant will file pursuant to Regulation 14A not later than 120 days after December 31, 1993, and such information is incorporated herein by reference in accordance with General Instruction G(3) of Form 10-K. Information relating to executive officers of the Registrant appears at page 23 of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation relating to the compensation of the Registrant's executive officers and directors will be contained in the definitive Proxy Statement referred to above in \"Item 10. Directors and Executive Officers of the Registrant,\" and such information is incorporated herein by reference in accordance with General Instruction G(3) of Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation relating to beneficial ownership of securities will be contained in the definitive Proxy Statement referred to above in \"Item 10. Directors and Executive Officers of the Registrant,\" and such information is incorporated herein by reference in accordance with General Instruction G(3) of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation relating to transactions with management and others and certain business relationships regarding directors will be contained in the definitive Proxy Statement referred to above in \"Item 10. Directors and Executive Officers of the Registrant,\" and such information is incorporated herein by reference in accordance with General Instruction G(3) of Form 10-K.\nPART IV\nIndex\nPage Number __________________________________________________________________\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n29 (a)(1) Financial Statements and Supplementary Data 49 Independent Auditors' Report\n50 (a)(2) Financial Statement Schedules: 50 Schedule V - Property, Plant and Equipment 51 Schedule VI - Accumulated Depletion, Depreciation and Amortization 52 Schedule X - Supplementary Earnings Statement Information\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\n53 (a)(3) Index to Exhibits\n56 (b) Reports on Form 8-K\n57 Signatures\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nFinancial Statements and Supplementary Data (Item 14 (a)(1))\nThe following financial statements and supplementary data included in the Company's Annual Report to Shareholders for 1993 are incorporated herein by reference in response to Item 8:\nPage in Exhibit 13 filed herewith\nFinancial Statements: Consolidated Balance Sheets 3 Consolidated Statements of Earnings (Loss) 4 Consolidated Statements of Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7 Report of Management 26 Independent Auditors' Report 27\nUnaudited Supplemental Data: Data on Oil and Gas Activities 36 Quarterly Data 50\nThe following financial statements of 50% or Less Owned Persons required by Regulation S-X, Rule 3-09, are included herein and filed herewith in response to Item 8:\nPage herein\nMaraLou Netherlands Partnership and its wholly-owned consolidated subsidiary, CLAM Petroleum Company:\nIndependent Auditors' Report 31 Consolidated Balance Sheets 32 Consolidated Statements of Income 33 Consolidated Statements of Partners' Capital 34 Consolidated Statements of Cash Flows 36 Notes to Consolidated Financial Statements 38\nMARALOU NETHERLANDS PARTNERSHIP AND SUBSIDIARY\nCONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993, 1992 AND 1991\n(WITH INDEPENDENT AUDITORS' REPORT THEREON)\nIndependent Auditors' Report\nThe Partners MaraLou Netherlands Partnership:\nWe have audited the accompanying consolidated balance sheets of MaraLou Netherlands Partnership and subsidiary as of December 31, 1993 and 1992, and the related consolidated statements of income, partners' capital, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MaraLou Netherlands Partnership and subsidiary as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in note 4 to the consolidated financial statements, the Partnership adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" in 1993.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nHouston, Texas January 28, 1994\n(Continued)\n(Continued)\nMARALOU NETHERLANDS PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1993, 1992 and 1991\n1. Organization and summary of significant accounting policies\nOrganization and ownership: MaraLou Netherlands Partnership (MaraLou), a Texas general partnership, was formed on March 27, 1985 by LL&E (Netherlands), Inc. (LL&E Netherlands) and Marathon Petroleum Netherlands, Ltd. (Marathon Netherlands) for the purpose of owning their interests in CLAM Petroleum Company (CLAM) and for the purpose of purchasing the outstanding shares of CLAM held by Netherlands-Cities Services, Inc. On March 27, 1985 both partners agreed to contribute their respective ten thousand shares of CLAM to MaraLou. These shares were transferred to MaraLou on June 21, 1985. The remaining shares held by Netherlands-Cities Services, Inc. were acquired by MaraLou for $85,381,881 on March 29, 1985. The acquisition has been accounted for using the purchase method of accounting effective January 1, 1985.\nOn December 6, 1991 an agreement was concluded whereby LL&E Netherlands Petroleum Company, an affiliated company to LL&E Netherlands - both of which are wholly owned subsidiaries of Louisiana Land and Exploration Company, contributed Netherlands North Sea license interests and other assets valued at $11,629,000 for five hundred newly issued shares of CLAM stock. For financial reporting purposes, the contribution made by LL&E Netherlands Petroleum Company in excess of its calculated minority interest is reflected in Partners' capital as an addition to the LL&E Netherlands capital balance. MaraLou made a cash contribution of $11,629,000 for an additional five hundred newly issued shares of CLAM stock. The contributed cash is to be used to develop the North Sea license interest contributed by LL&E Netherlands Petroleum Company. MaraLou subsequently sold all of its newly issued shares of CLAM stock to Marathon Netherlands, a partner in MaraLou, which purchased the shares with a note valued at $11,629,000, on which $6,000,000 was paid in 1991 and $6,000,000, inclusive of interest, was paid in 1992. These newly issued shares of CLAM stock have been pledged as security for MaraLou and CLAM's revolving credit agreement (see Note 6).\nCLAM Petroleum Company, a Delaware Corporation, was formed in October 1975 by LL&E Netherlands, Marathon Netherlands and Netherlands-Cities Service, Inc. (stockholders) for the purpose of owning their interest in certain licenses and agreements covering hydrocarbon operations in The Netherlands and for the purpose of entering into agreements with lending institutions to finance such interest. Effective May 24, 1976 the stockholders assigned their interests and obligations under the licenses and related agreements to CLAM. CLAM has no operations outside the oil and gas industry or in areas other than The Netherlands North Sea.\nThe financial statements reflect the consolidation of CLAM Petroleum Company (the Company) with MaraLou for the period from January 1, 1985. The financial statements also reflect the interests and earnings of the minority shareholders, LL&E Netherlands Petroleum Company and Marathon Netherlands. Currently, MaraLou has no interests other than in the operation of CLAM.\nCash equivalents: Cash equivalents of $11,133,745, $18,721,023 and $23,638,318 at December 31, 1993, 1992 and 1991 respectively, consist of Eurodollar and Euroguilder investments. For purposes of the statements of cash flows, MaraLou considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents.\nJoint venture agreements: CLAM, together with unrelated parties, has interests in certain prospecting and production licenses and related operating agreements which provide for the joint conduct of seismic, geological, exploration and development activities on the continental shelf of The Netherlands. The accompanying financial statements include CLAM's share of operations as reported to it by the operator of the joint venture. The amounts reported by the operator of the joint venture are subject to an annual audit by the non-operators. The audit for the year 1992 has been conducted with the non-operators awaiting the operator's initial response to the audit report.\nPetroleum exploration and development costs: CLAM follows the successful efforts method of accounting for oil and gas properties. Exploration expenses, including geological and geophysical costs, prospecting costs, carrying costs and exploratory dry hole costs are charged against income as incurred. The acquisition costs of unproved properties are capitalized with appropriate provision for impairment based upon periodic assessments of such properties. All development costs, including development dry hole costs, are capitalized. Capitalized costs are adjusted annually for cash adjustments relating to changes in CLAM's share in gas reserve estimates (see Note 7).\nDepletion, amortization and depreciation: Depletion is provided under the unit-of-production method based upon estimates of proved developed reserves. Depreciation is based on estimated useful life. Reserve determinations are management's best estimates and generally are related to economic and operating conditions. Depletion and depreciation rates are adjusted for future estimated salvage values.\nCLAM property, plant and equipment retirements: Upon sale or retirement of property, plant and equipment, the cost and related accumulated depletion, amortization and depreciation are eliminated from the accounts and the gain or loss is reflected in income.\nCLAM platform abandonment amortization: Platform abandonment amortization is provided under the unit- of-production method based upon estimates of proved-developed reserves. Amortization rates are adjusted for future estimated abandonment costs. Platform abandonment amortization is charged to operating expense.\n2. Related party transactions\nCLAM transactions with related parties consisted of charges for geological, geophysical and administrative services rendered by an affiliate under two service contracts and administrative services rendered by another affilate. Such charges were approximately $2,512,536, $2,530,608 and $2,267,479 for 1993, 1992 and 1991, respectively. Salaries and related social charges included therein amounted to $1,685,046, $1,858,876 and $1,512,633 for 1993, 1992 and 1991, respectively.\nMaraLou transactions with related parties consisted of charges for administrative services rendered by an affiliate amounting to $55,800, $58,200 and $57,600 in 1993, 1992 and 1991, respectively.\n3. Property, plant and equipment\nChanges in property, plant and equipment for the years ended December 31, 1993, 1992 and 1991 are as follows (in thousands of U.S. dollars):\n4. Federal and foreign income taxes\nMaraLou is a partnership and, therefore, does not pay income taxes. Since CLAM (wholly owned by MaraLou) is a corporation, income taxes included in the accompanying consolidated financial statements have been determined utilizing applicable domestic and foreign tax rates.\nThe FASB has issued Statement of Financial Accounting Standard (SFAS) No. 109, \"Accounting for Income Taxes\" which superseded SFAS No. 96. \"Accounting for Income Taxes.\" The adoption of SFAS 109 caused an additional deferred income tax liability of $6,003,589 as of January 1, 1993, which has been recorded as a cumulative effect of change in accounting principle. Prior year consolidated financial statements have not been adjusted and are based on SFAS No. 96.\nSFAS 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method. Under the new method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applicable to those years in which the temporary differences between financial statement carrying amounts and tax bases are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period when the change is enacted.\nUnder the deferred method of accounting for income taxes which was applied in 1992 and prior years, deferred income taxes applicable to each year's net temporary differences were provided based on the tax rates in effect during that year and no adjustments were made to the deferred income tax liability amounts for subsequent changes in tax rates.\nDutch investment incentive premiums (WIR) are credited to foreign income tax in the year in which they are claimed. CLAM incurred WIR premium expense of $60,331 and $371,771 in 1993 and 1992, respectively.\nDetails of federal and foreign income taxes (in thousands of U.S. dollars) are as follows:\nTotal income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 35 and 34 percent for 1993 and 1992, respectively, to income before income taxes of CLAM as a result of the following (in thousands of U.S. dollars):\nTemporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1993 and 1992 relate to the following (in thousands of U.S. dollars):\nThe Company's 1993 and 1992 current tax liability was determined on a regular tax basis.\nThe amount of unused foreign tax credit carryforward available on an alternative minimum tax (AMT) basis was $23,354,336 at December 31, 1993. The carryforward expires $5,660,000 in 1994, $5,417,000 in 1995, $5,117,000 in 1996, $3,355,000 in 1997 and $3,805,000 in 1998. The Company did not pay any AMT in 1992 or 1993.\n5. CLAM foreign currency translation adjustment\nAs of January 1, 1983 CLAM adopted Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation\" (SFAS No. 52), under which the functional currency is deemed to be the Dutch guilder. Effective January 1, 1987 CLAM changed its functional currency from the Dutch guilder to the U.S. dollar. The change was precipitated by the significant effect on CLAM's operation of a new dollar-driven gas sales contract which was effective January 1, 1987 and the Tax Reform Act of 1986. In accordance with SFAS No 52 there is no restatement of prior years' financial statements and the translated amounts for nonmonetary assets as of December 31, 1986 have become the accounting basis for those assets in the year of the change.\n6. Debt\nOn July 25, 1985 MaraLou and CLAM entered into a revolving credit agreement, which was amended and restated as of June 19, 1992, with a syndicate of major international banks to fund the purchase by MaraLou of CLAM shares previously owned by Netherlands-Cities Service, Inc. and to provide working capital for CLAM. The banks' total commitment as of December 31, 1993 and December 31, 1992 was $110,000,000. Interest is paid, at the borrower's option, based on the prime rate, the London Interbank Offered Rate (LIBOR), or an adjusted CD rate. A contractual margin is added to LIBOR and CD based borrowings. The all-in interest rates for CLAM for December 31, 1993 and December 31, 1992 were 3.9375% and 4.125%, respectively. During the revolving credit period, the borrowers are obligated to pay a commitment fee of 1\/4% on the unused committed portion of the facility. All of the CLAM common stock held by MaraLou has been pledged as security for the facility. In addition, under certain circumstances MaraLou can exercise an option to purchase the shares held by LL&E Netherlands Petroleum Company and Marathon Petroleum Netherlands, Ltd. for a nominal amount. The option agreement has been assigned to the banks as security for the facility.\nThe credit agreement permits CLAM and MaraLou to incur total debt up to an agreed borrowing base which at December 31, 1993 and December 31, 1992 was $145,000,000. The agreement provides that the borrowing base is reduced periodically over the term of the facilty which is currently scheduled to expire on January 1, 2000. The borrowing base and the scheduled reductions may be adjusted based on a redetermination of the net present value of the projections of certain cash flows included in an Engineering Report prepared by petroleum engineers.\nThe outstanding balances for MaraLou and CLAM, respectively, were $-0- and $87,800,000, at December 31, 1993 of which $-0- was due within one year. The outstanding balances for MaraLou and CLAM, respectively, were $-0- and $97,800,000 at December 31, 1992. At December 31, 1993, the required\nreductions to the borrowing base in each of the next five years are $-0- in 1994, $-0- in 1995, $-0- in 1996, $19,800,000 in 1997, $30,000,000 in 1998 and $38,000,000 thereafter.\nCLAM has an unsecured combined short-term loan and overdraft facility of Dfl. 80,000,000 ($41,152,263 at year-end exchange rate). On December 31, 1993 and December 31, 1992 the outstanding balances relating to this facility were $-0-. Interest rates are determined at the time borrowings are made.\n7. Annual evaluation of gas reserves\nUnder the provisions of the Joint Development Operating Agreement to which CLAM is a party, an annual estimate of gas reserves is to be made and agreed upon by the Area Management Committee. Based upon such estimate, each participant's investment in the area properties, as defined, is to be adjusted so that a participant's investment is in proportion to its interest in the remaining reserves. Adjustments to the investments are made in cash in the year following the date the reserve revision is agreed upon.\nIn 1992, the Area Management Committee agreed to freeze each participant's interest through 1994, at the level agreed upon in 1992. A new gas reserve estimate will be agreed upon in 1995.\n8. Reserves of oil and gas (unaudited)\nCLAM's share of proven gas reserves at January 1, 1994 and 1993 are 317,737 MMCF and 343,432 MMCF, respectively.\n9. Major customer\nCLAM has one major customer from which it derives 98% of its sales revenue. CLAM was required under its production license to offer its production first to this customer, which is partially owned by The Netherlands government.\nUnitization and natural gas sales agreements were executed July 29, 1987 for the K12 - K15 \"B\" structure. CLAM is a K15 Block participant, however this property is operated by a K12 Block participant. This gas is also sold to the major customer.\n10. Net profits interest agreement\nCLAM entered into an agreement dated November 1, 1981 which requires CLAM to pay a portion of its net profits (\"net profits interest\") to an unrelated party in exchange for a 7-1\/2% participation interest in certain blocks. The \"net profits interest\" is equal to one twenty-fourth (1\/24) of CLAM's revenues from the contract area, after various deductions, as defined in the agreement.\n11. Issuance of production licenses\nIn March 1990, a production license was granted by the Minister of Economics Affairs of the Netherlands covering the L12a and L12b\/L15b blocks. As a result, the Dutch Government, through Energie Beheer Nederland (EBN) (a Dutch company wholly-owned by the Dutch Government) exercised its option to participate 40% in the L12a block and 50% in the L12b\/L15b block. CLAM was subsequently reimbursed $10,628,572 during 1990, all of which was included in income because there were costs associated with these blocks which had been written-off in prior years. Components of the reimbursement were:\nExploration well cost (previously written off as dry wells) $ 5,595,076\nExploration administrative expense 1,818,220\nInterest 3,215,276\nTotal reimbursement $10,628,572\nIn 1991, it was determined that the portion of the above noted reimbursement allocable to trapping unit L12-FC, within blocks L12b\/l15b, would be refunded to EBN as production on this trapping unit is not expected to commence within the 48-month requirement stipulated by the contractual agreement with EBN (the Agreement). The refundable amount, which CLAM expects to repay in 1994, was recorded as a long-term receivable of $3.6 million, interest expense of $1.5 million and an accrued liability of $5.1 million. The Agreement calls for EBN to reimburse the funds to CLAM net of interest upon first production from trapping unit L12-FC, which is expected to occur in 1997.\nIn 1992, it was determined that the portion of the above noted reimbursement allocable to trapping units L12-FA and L12-FB, within blocks L12a and L12b\/L15b, would be refunded to EBN as production on these trapping units are not expected to commence within the 48-month requirement stipulated by the Agreement. The refundable amount for L12-FA and L12-FB, which CLAM expects to repay in 1994, was recorded as a long-term receivable of $0.5 and $1.6 million, respectively, interest expense $0.2 million and $0.6 million, respectively and an accrued liability of $0.7 million and $2.2 million respectively. The Agreement calls for EBN to reimburse the respective funds to CLAM net of interest upon first production from trapping units L12-FA and L12-FB, which is expected to occur in 2000 and 1998, respectively.\n12. Disclosures about fair value of financial instruments\nCash and Cash Equivalents, Receivables, Due from Operator of Joint Venture, Due to Affiliated Company, Accounts Payable, and Due to Operator of Joint Venture\n- The carrying amount approximates fair value because of the short maturity of these instruments.\nLong-Term Receivable\n- The estimated fair value of the Company's long-term receivable is as follows (in thousands of U.S. Dollars):\nAt December 31, 1992 Carrying Estimated Amount Fair Value Long-term receivable $5,620 $3,681\nThe fair value of the long-term receivable was based on discounted cash flows.\nLong-Term Debt Due to Banks\n- The carrying amount approximates fair value because of the variable rate of interest associated with this debt.\nIndependent Auditors' Report\nThe Board of Directors and Stockholders The Louisiana Land and Exploration Company:\nUnder date of February 9, 1994, we reported on the consolidated balance sheets of The Louisiana Land and Exploration Company and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of earnings (loss), stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the Annual Report to Shareholders for 1993. As discussed in Notes 11 and 12 to the consolidated financial statements, the Company adopted the methods of accounting for income taxes and postretirement benefits other than pensions prescribed by Statements of Financial Accounting Standards Nos. 109 and 106, respectively. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement Schedules V, VI and X. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick\nKPMG Peat Marwick\nNew Orleans, Louisiana February 9, 1994\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (Item 14(a)(3))\nThe following Exhibits have been filed with the Securities and Exchange Commission:\nExhibit 2.1 Stock Purchase Agreement, dated as of July 18, 1993, between NERCO, Inc. and The Louisiana Land and Exploration Company (excluding the schedules thereto, which will be made available to the Securities and Exchange Commission upon request). (Incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated September 2, 1993, as amended, Commission File No. 1-959.).\nExhibit 2.2 Sale and Purchase Agreement, dated as of August 19, 1993, between British Gas Exploration and Production Limited and LL&E (U.K.) Inc. (excluding the schedules thereto, which will be made available to the Securities and Exchange Commission upon request). (Incorporated by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated September 2, 1993, as amended, Commission File No. 1-959.).\nExhibit 2.3 Amendment, dated October 12, 1993, to Sale and Purchase Agreement in Exhibit 2.2 herein.\nExhibit 3(a) Certificate of Incorporation (Incorporated by reference to Exhibit 1-3(a) to the Registrant's Registration Statement No. 2-45541 on Form S-1); Articles Supplementary pursuant to Section 3- 603(d)(4) of the Maryland General Corporation Law (Incorporated by reference to Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1983 - Commission File No. 1-959); Articles of Amendment of Charter dated May 30, 1985 (Incorporated by reference to Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985 - Commission File No. 1-959.); Articles of Amendment of Charter dated May 12, 1988 (Incorporated by reference to Exhibit 3(c) to the Registrant's Form 8 dated April 24, 1989 - Commission File No. 1-959.).\nExhibit 3(b) By-Laws (Incorporated by reference to Exhibit (1) to the Registrant's Current Report on Form 8-K dated October 1, 1989 - Commission File No. 1- 959.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 4(a) Rights Agreement dated as of May 25, 1986 among the Registrant and The Bank of New York (as Rights Agent) - (Incorporated by reference to Exhibit 4(a) to the Registrant's Current Report on Form 8-K dated May 25, 1986 - Commission File No. 1-959.).\nExhibit 4(b) Indenture dated as of June 15, 1992 among the Registrant and Texas Commerce Bank National Association (as Trustee) (Incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement No. 33-50991 on Form S-3, as amended.).\nExhibit 10(a) Form of Termination Agreement with Senior Management Personnel (Incorporated by reference to Exhibit 10(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(b) The Louisiana Land and Exploration Company 1982 Stock Option Plan as adopted (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 26, 1982) and the amendment thereto dated December 8, 1982 (Incorporated by reference to Exhibit 10(c) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(c) The Louisiana Land and Exploration Company 1988 Long-Term Stock Incentive Plan as amended (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 22, 1993).\nExhibit 10(d) Deferred Compensation Plan for Directors (Incorporated by reference to Exhibit 10(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(e) Pension Agreement, dated November 10, 1988 (Incorporated by reference to Exhibit 10(f) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 - Commission File No. 1-959.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 10(f) The Louisiana Land and Exploration Company 1990 Stock Option Plan for Non-Employee Directors as adopted (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 26, 1990).\nExhibit 10(g) Form of The Louisiana Land and Exploration Company Deferred Compensation Arrangement for Selected Key Employees (Incorporated by reference to Exhibit 10(i) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 - Commission File No. 1-959.).\nExhibit 10(h) Retirement Plan for Directors of The Louisiana Land and Exploration Company dated March 1, 1987 (Incorporated by reference to Exhibit 10(j) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 - Commission File No. 1-959.).\nExhibit 10(i) The LL&E Special Termination Benefit Plan (Incorporated by reference to Exhibit 10(j) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(j) The LL&E Supplemental Excess Plan (Incorporated by reference to Exhibit 10(k) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(k) Form of Compensatory Benefits Agreement (Incorporated by reference to Exhibit 10(l) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(l) Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1993 among the Registrant, the Banks listed therein, Morgan Guaranty Trust Company of New York, as Agent, and Texas Commerce Bank National Association and NationsBank of Texas, N.A., as Co-Agents (Incorporated by reference to Exhibit 10 to the Registrant's Registration Statement No. 33-50161 on Form S-3, as amended.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 11 Computation of Primary and Fully Diluted Earnings (Loss) Per Share - Years Ended December 31, 1993, 1992 and 1991.\nExhibit 13 Annual Report to Shareholders for 1993.\nExhibit 21 Subsidiaries of the Registrant.\nExhibit 23 Consent of Experts.\nExhibit 24 Powers of Attorney.\nCertain debt instruments have not been filed. The Company agrees to furnish a copy of such agreement(s) to the Commission upon request.\nReports on Form 8-K Quarter Ended December 31, 1993 (Item 14(b))\nA Current Report on Form 8-K was filed on September 2, 1993, Items 5 and 7 of which were amended on Form 8-K\/A filed on October 7, 1993. A Current Report on Form 8-K dated October 29, 1993 was filed containing the press release relating to the unaudited financial results for the Registrant's fiscal quarter ended September 30, 1993.\nSIGNATURES\nPursuant 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.\nTHE LOUISIANA LAND AND EXPLORATION COMPANY (Registrant)\nDate: February 18, 1994 By \/s\/ Frederick J. Plaeger, II __________________________________ Frederick J. Plaeger, II General Counsel and Corporate Secretary\nPursuant 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 and on the dates indicated.\nDate: February 18, 1994 *H. Leighton Steward _____________________________________ H. Leighton Steward Director, Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)\nDate: February 18, 1994 *Leland C. Adams _____________________________________ Leland C. Adams Director\nDate: February 18, 1994 *Richard A. Bachmann _____________________________________ Richard A. Bachmann Director, Executive Vice President, Finance and Administration (Principal Financial Officer)\nDate: February 18, 1994 *John F. Greene _____________________________________ John F. Greene Director, Executive Vice President, Exploration and Production\nDate: February 18, 1994 *Eamon M. Kelly _____________________________________ Eamon M. Kelly Director\nDate: February 18, 1994 *Victor A. Rice _____________________________________ Victor A. Rice Director\nDate: February 18, 1994 *Orin R. Smith _____________________________________ Orin R. Smith Director\nDate: February 18, 1994 *Arthur R. Taylor _____________________________________ Arthur R. Taylor Director\nDate: February 18, 1994 *W. R. Timken, Jr. _____________________________________ W. R. Timken, Jr. Director\nDate: February 18, 1994 *Carlisle A.H. Trost _____________________________________ Carlisle A.H. Trost Director\nDate: February 18, 1994 *E. L. Williamson _____________________________________ E. L. Williamson Director\nDate: February 18, 1994 *Jerry D. Carlisle _____________________________________ Jerry D. Carlisle Vice President and Controller (Principal Accounting Officer)\n*\/s\/ Frederick J. Plaeger, II _________________________________________ Frederick J. Plaeger, II General Counsel and Corporate Secretary (As attorney-in-fact for each of the persons indicated)\n________________________________________________________________ ________________________________________________________________\nSECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549\n__________________________\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1993\n__________________________\nTHE LOUISIANA LAND AND EXPLORATION COMPANY (Exact name of registrant as specified in its charter)\nEXHIBITS\n________________________________________________________________ ________________________________________________________________\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (Item 14(a)(3))\nThe following Exhibits have been filed with the Securities and Exchange Commission:\nExhibit 2.1 Stock Purchase Agreement, dated as of July 18, 1993, between NERCO, Inc. and The Louisiana Land and Exploration Company (excluding the schedules thereto, which will be made available to the Securities and Exchange Commission upon request). (Incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated September 2, 1993, as amended, Commission File No. 1-959.).\nExhibit 2.2 Sale and Purchase Agreement, dated as of August 19, 1993, between British Gas Exploration and Production Limited and LL&E (U.K.) Inc. (excluding the schedules thereto, which will be made available to the Securities and Exchange Commission upon request). (Incorporated by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated September 2, 1993, as amended, Commission File No. 1-959.).\nExhibit 2.3 Amendment, dated October 12, 1993, to Sale and Purchase Agreement in Exhibit 2.2 herein.\nExhibit 3(a) Certificate of Incorporation (Incorporated by reference to Exhibit 1-3(a) to the Registrant's Registration Statement No. 2-45541 on Form S-1); Articles Supplementary pursuant to Section 3- 603(d)(4) of the Maryland General Corporation Law (Incorporated by reference to Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1983 - Commission File No. 1-959); Articles of Amendment of Charter dated May 30, 1985 (Incorporated by reference to Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985 - Commission File No. 1-959.); Articles of Amendment of Charter dated May 12, 1988 (Incorporated by reference to Exhibit 3(c) to the Registrant's Form 8 dated April 24, 1989 - Commission File No. 1-959.).\nExhibit 3(b) By-Laws (Incorporated by reference to Exhibit (1) to the Registrant's Current Report on Form 8-K dated October 1, 1989 - Commission File No. 1- 959.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 4(a) Rights Agreement dated as of May 25, 1986 among the Registrant and The Bank of New York (as Rights Agent) - (Incorporated by reference to Exhibit 4(a) to the Registrant's Current Report on Form 8-K dated May 25, 1986 - Commission File No. 1-959.).\nExhibit 4(b) Indenture dated as of June 15, 1992 among the Registrant and Texas Commerce Bank National Association (as Trustee) (Incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement No. 33-50991 on Form S-3, as amended.).\nExhibit 10(a) Form of Termination Agreement with Senior Management Personnel (Incorporated by reference to Exhibit 10(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(b) The Louisiana Land and Exploration Company 1982 Stock Option Plan as adopted (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 26, 1982) and the amendment thereto dated December 8, 1982 (Incorporated by reference to Exhibit 10(c) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(c) The Louisiana Land and Exploration Company 1988 Long-Term Stock Incentive Plan as amended (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 22, 1993).\nExhibit 10(d) Deferred Compensation Plan for Directors (Incorporated by reference to Exhibit 10(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982 - Commission File No. 1-959.).\nExhibit 10(e) Pension Agreement, dated November 10, 1988 (Incorporated by reference to Exhibit 10(f) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 - Commission File No. 1-959.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 10(f) The Louisiana Land and Exploration Company 1990 Stock Option Plan for Non-Employee Directors as adopted (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement dated March 26, 1990).\nExhibit 10(g) Form of The Louisiana Land and Exploration Company Deferred Compensation Arrangement for Selected Key Employees (Incorporated by reference to Exhibit 10(i) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 - Commission File No. 1-959.).\nExhibit 10(h) Retirement Plan for Directors of The Louisiana Land and Exploration Company dated March 1, 1987 (Incorporated by reference to Exhibit 10(j) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 - Commission File No. 1-959.).\nExhibit 10(i) The LL&E Special Termination Benefit Plan (Incorporated by reference to Exhibit 10(j) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(j) The LL&E Supplemental Excess Plan (Incorporated by reference to Exhibit 10(k) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(k) Form of Compensatory Benefits Agreement (Incorporated by reference to Exhibit 10(l) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 - Commission File No. 1-959.).\nExhibit 10(l) Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1993 among the Registrant, the Banks listed therein, Morgan Guaranty Trust Company of New York, as Agent, and Texas Commerce Bank National Association and NationsBank of Texas, N.A., as Co-Agents (Incorporated by reference to Exhibit 10 to the Registrant's Registration Statement No. 33-50161 on Form S-3, as amended.).\n(continued)\nTHE LOUISIANA LAND AND EXPLORATION COMPANY AND SUBSIDIARIES\nIndex to Exhibits (continued) (Item 14(a)(3))\nExhibit 11 Computation of Primary and Fully Diluted Earnings (Loss) Per Share - Years Ended December 31, 1993, 1992 and 1991.\nExhibit 13 Annual Report to Shareholders for 1993.\nExhibit 21 Subsidiaries of the Registrant.\nExhibit 23 Consent of Experts.\nExhibit 24 Powers of Attorney.\nCertain debt instruments have not been filed. The Company agrees to furnish a copy of such agreement(s) to the Commission upon request.\nEXHIBIT 2.3\nExhibit 2.3\nAMENDMENT TO SALE AND PURCHASE AGREEMENT\nTHIS AGREEMENT is made on the 12th day of October, 1993 BETWEEN:-\n(1) BRITISH GAS EXPLORATION AND PRODUCTION LIMITED (registered in England under number 902239) whose registered office is at Rivermill House, 152 Grosvenor Road, London SW1V 3JL (the \"Seller\");\n(2) LL&E (U.K.) INC. whose principal place of business is at LL&E House, 40A Dover Street, London W1X 3RB (\"LL&E\"); and\n(3) MURPHY PETROLEUM LIMITED (registered in England under number 811102) whose registered office is at Winston House, Dollis Park, Finchley, London N3 1HZ (\"Murphy\").\nWHEREAS:\n(A) By a sale and purchase agreement dated 12th August, 1993 between the Seller and LL&E (the \"SPA\"), the Seller agreed to sell to LL&E, subject to certain conditions contained in the SPA, certain Assets (as defined in the SPA) referable to a fourteen percent interest under the Operating Agreement (as defined in the SPA).\n(B) LL&E and Murphy have requested the Seller to suspend the SPA for the time being to enable the Seller to sell to Murphy that portion of the Assets referable to a two point seven four percent. (2.74%) interest under the Operating Agreement (the \"Murphy interest\") and to LL&E that portion of the Assets referable to an eleven point two six percent. (11.26%) interest under the Operating Agreement (the \"LL&E interest\") and the Seller has agreed, subject to and on the terms and conditions of this Agreement, so to suspend the SPA.\n(C) It is the intention of the parties that the Seller be in no worse position as a result of entering into this Agreement than if it had proceeded with the SPA in the form entered into by it with LL&E on 12th August, 1993.\n(D) All relevant pre-emption rights pursuant to the Operating Agreement in respect of the transactions contemplated in this Agreement have been waived.\nIN CONSIDERATION of the mutual promises and undertakings herein contained on the part of the parties hereto IT IS AGREED as follows:\n1. Definitions\nIn this Agreement terms and expressions defined in either the LL&E Agreement or the Murphy Agreement, as appropriate, shall, unless the context otherwise requires, bear the same meanings herein.\n2. Undertaking\n2.1 LL&E and Murphy acknowledge and are aware that the Seller, in entering into this Agreement, is relying on the following undertaking.\nLL&E and Murphy hereby undertake for themselves or either of them that as a result of the Seller entering into this Agreement they will put the Seller fully and effectively into a position which is no worse than it would have been in had it proceeded with the SPA with LL&E, such undertaking to include without limitation payment of all costs (including legal costs), charges and expenses whatsoever which are necessarily suffered or incurred by the Seller in relation to the enforcement of this Agreement, the LL&E Agreement or the Murphy Agreement (each as defined below) or any related or subsequent agreement (including those referred to as Further Documentation in the LL&E Agreement and the Murphy Agreement). The Seller shall not be entitled to make a claim under this undertaking unless it has first served on LL&E and Murphy written notice of the matter complained of within 30 days of becoming aware of the same (giving such outline details as shall then be reasonably practicable).\n2.2 The undertaking contained in clause 2.1 above shall expire twenty four (24) months after the later of the Completion Dates (as revised pursuant to this Agreement, if appropriate) save in respect of claims made prior to such expiry date, such claims to be pursued with reasonable expedition.\n2.3 Murphy shall not be obligated under the undertaking contained in clause 2.1 above for the failure of LL&E to complete the sale and purchase under the LL&E Agreement, save and to the extent that such failure is caused or contributed to by a breach by Murphy of its obligations under clause 6.4 below.\n2.4 LL&E shall not be obligated under the undertaking contained in clause 2.1 above for the failure of Murphy to complete the sale and purchase under the Murphy Agreement, save and to the extent that such failure is caused or contributed to by a breach by LL&E of its obligations under clause 6.4 below.\n3. SPA\n3.1 The SPA shall not be terminated by the execution of this Agreement but shall be suspended and it shall remain suspended until either (a) the Seller is to enforce its rights under the SPA in accordance with clause 6.2.1, 6.2.2 or 6.3.1 below (whereupon it shall come into full force and effect again) or (b) Completion (except a Completion which is deemed not to have occurred pursuant to the provisions of clause 6 below) occurs of either the LL&E Agreement or the Murphy Agreement (whereupon the SPA shall terminate automatically). Neither the Seller nor LL&E shall have any obligations to each other or to any other person under the SPA while it so suspended.\n3.2 During such period as the SPA is not in full force and effect (being when it is either suspended or terminated the provisions of Parts 1 and 2 of the Schedule hereto shall apply as agreements in place of the SPA as provided in clauses 4 and 5 below.\n4. LL&E Agreement\nIn respect of the sale to LL&E there shall be in effect an agreement on the terms as set out in Part 1 of the Schedule hereto, and the provisions applying to that Schedule shall be called the \"LL&E Agreement\".\n5. Murphy Agreement\nIn respect of the sale to Murphy there shall be in effect an agreement on the terms as set out in Part 2 of the Schedule hereto, and the provisions applying to that Schedule shall be called the \"Murphy Agreement\".\n6. Completion\n6.1 Completion of each of the LL&E Agreement and the Murphy Agreement (each and \"Agreement\" and together the \"Agreement\") will take place simultaneously and, notwithstanding anything in each of the Agreements, Completion of each Agreement shall, except as provided below, be dependent upon Completion of the other save only for the provisions of this clause.\nUpon each of the LL&E Agreement and the Murphy Agreement being completed in all respects subject only to the inter-dependence provision in this clause, this clause shall automatically fall away and Completion of each of the Agreements shall be deemed to have occurred.\nIf, but for the provisions of this clause, and except as provided below, one of the Agreements would have been completed but not the other, the first such Agreement shall be deemed not to have been completed, all documents which may have been executed as a part of such Completion shall be null and void and any amounts transferred to the Seller shall be returned immediately without interest.\n6.2 The exceptions referred to in clause 6.1 above are:\n6.2.1 If LL&E has not for whatsoever reason completed the sale and purchase under the LL&E Agreement (ignoring, for this purpose, the inter-dependence provision in clause 6.1 above) but, save for such provision, Murphy would have completed the Murphy Agreement, any amounts transferred to the Seller shall be returned immediately without interest and the Seller shall have the option exercisable within 7 days following the date when Murphy would have completed the Murphy Agreement (ignoring for this purpose the inter-dependence provision in clause 6.1 above) by notice in writing to the parties hereto either: (a) to declare that the inter- dependence provision in clause 6.1 above is waived and that the sale and purchase under the Murphy Agreement is to be completed, or (b) to declare that the inter-dependence provision in clause 6.1 above is not waived. If the Seller does not give a notice within 7 days exercising either option (a) or (b) above, it shall at the expiry of such 7 day period be deemed to have exercised option (b).\nIf the Seller exercises option (a) above, the Murphy Agreement shall be completed (the \"revised Completion Date\"), as soon as the relevant Further Documentation is available and shall contain such amendments as are reasonably necessary to reflect that Completion of only one Agreement is taking place, and on the revised Completion Date Murphy shall transfer to the Seller all amounts due under the Murphy Agreement (save that the Completion Date for the purposes of clause 3.2.3 of the Murphy Agreement shall be the actual date of Completion), the Seller shall be entitled to enforce its rights against LL&E under the LL&E Agreement and the SPA shall terminate. If the Seller exercises or is deemed to have exercised option (b) above, this Agreement shall be deemed to have rescinded and the Seller shall be entitled to enforce its rights against LL&E under the SPA. For the avoidance of doubt, LL&E and Murphy shall upon such deemed rescission be released from the undertaking given by them under clause 2.1 above.\n6.2.2 If Murphy has not for whatsoever reason completed the sale and purchase under the Murphy Agreement (ignoring, for this purpose, the inter-dependence provision in clause 6.1 above) but, save for such provision, LL&E would have completed the sale and purchase under the LL&E Agreement, any amounts transferred to the Seller shall be returned immediately without interest and the Seller shall have the option exercisable within 7 days following the date when LL&E would have completed the LL&E Agreement (ignoring for this purpose the inter- dependence provision in clause 6.1 above) by notice in writing to the parties hereto either: (a) to declare that the inter-dependence provision in clause 6.1 above is waived and that the sale and purchase under the LL&E Agreement is to be completed, or (b) to declare that the inter- dependence provision in clause 6.1 above is not waived. If the Seller does not give a notice within 7 days exercising either option (a) or (b) above, it shall at the expiry of such 7 day period be deemed to have exercised option (b).\nIf the Seller exercises option (a) above, the LL&E Agreement shall be completed (the \"revised Completion Date\"), as soon as the relevant Further Documentation is available and shall contain such amendments as are reasonably necessary to reflect that Completion of only one Agreement is taking place, and on the revised Completion Date LL&E shall transfer to the Seller all amounts due under the LL&E Agreement (save that the Completion Date for the purposes of clause 3.2.3 of the LL&E Agreement shall be the actual date of Completion), the Seller shall be entitled to enforce its rights against Murphy under the Murphy Agreement and the SPA shall terminate. If the Seller exercises or is deemed to have exercised option (b) above, this\nAgreement shall be deemed to have been rescinded and the Seller shall be entitled to enforce its rights against LL&E under the SPA. For the avoidance of doubt, LL&E and Murphy shall upon such deemed rescission be released from the undertaking given by them under clause 2.1 above.\n6.3 If Completion has not taken place under either the Murphy Agreement or the LL&E Agreement by 1st December 1993 (or such later date as the parties may agree in writing) the Seller shall have the option exercisable by written notice to the parties hereto or either:\n6.3.1 rescinding this Agreement and enforcing the Seller's rights against LL&E under the SPA and for the avoidance of doubt LL&E and Murphy shall thereupon be released from the undertaking given by them under clause 3.1 above; or\n6.3.2 enforcing its rights against LL&E under the LL&E Agreement and against Murphy under the Murphy Agreement.\n6.4 Each of the parties shall use reasonable endeavors with all due despatch to procure the satisfaction of the conditions necessary for Completion to be achieved including the obtaining of any amended version of the Further Documents.\n7. Notices\n7.1 Any notice or other document to be served under or in connection with this Agreement may be delivered or sent by first class recorded delivery post or telex or facsimile process to the party to be served at his address, to his telex or facsimile number appearing below or at such other address or to such other number as he may have notified to the other parties in accordance with this clause.\nBritish Gas Exploration Address: 100 Thames Valley Park Drive and Production Limited Reading Barks RG6 1PT Fax No: 0434 292100 Telex: 846231 Attention: Dr. Y. O. Barton\nLL&E (U.K.) Inc. Address: LL&E House 48A Dover Street London W1X 3RB Fax No: 071 499 0677 Telex: 267436 Attention: Dr. J. A. Williams\nMurphy Petroleum Limited Address: Winston House Dollis Park London N3 1HZ Fax No: 081 349 4443 Telex: 21970 Attention: Managing Director\n7.2 Any notice or document shall be deemed to have been served:\n7.2.1 if delivered, at the time of delivery; or\n7.2.2 if posted, at 10:00 a.m. on the second business day after it was put into the post; or\n7.2.3 if sent by telex or facsimile process, at the expiration of two hours after the time of despatch, if despatched before 3:00 p.m. on any business day, and in any other case at 10:00 a.m. on the business day following the date of despatch.\n7.3 In proving service of a notice or document it shall be sufficient to prove that delivery was made or that the envelope containing the notice or document was properly addressed and posted as a prepaid first class recorded delivery letter or that the telex or facsimile message was properly addressed and despatched as the case may be.\n7.4 For the purposes of this paragraph, a business day is a day other than a Saturday or statutory holiday on which banks are or, as the context may require, were generally open for business in England and New York.\n8. Counterpart Execution\nThis Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same agreement and any party may enter into this agreement by executing a counterpart.\n9. Supremacy\nif any conflict or inconsistency arises between provisions in the body of this Agreement and those contained in Parts 1 and 2 of the Schedule hereto or the SPA, then the provisions in the body of this Agreement shall prevail.\n10. Proper Law\nThis Agreement shall be governed by and construed in accordance with English law. The parties hereto submit to the exclusive jurisdiction of the English courts.\nIN WITNESS whereof the parties hereto have executed this Agreement the day and year first above written.\nSigned by J. G. REID ) for and on behalf of ) BRITISH GAS EXPLORATION ) J. G. REID AND PRODUCTION LIMITED )\nSigned by B. WRATHMELL ) for and on behalf of ) LL&E (U.K.) INC. ) B. WRATHMELL\nSigned by I. IQBAL ) for and on behalf of ) MURPHY PETROLEUM LIMITED) I. IQBAL\nEXHIBIT 11\nEXHIBIT 13\nEXHIBIT 13\n1993 ANNUAL REPORT TO SHAREHOLDERS\n(INCORPORATED BY REFERENCE INTO ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1993)\n_________________________________________________________________ FINANCIAL REPORT:\nPage herein\nConsolidated Balance Sheets 3\nConsolidated Statements of Earnings (Loss) 4\nConsolidated Statements of Stockholders' Equity 5\nConsolidated Statements of Cash Flows 6\nNotes to Consolidated Financial Statements 7\nReport of Management 26\nIndependent Auditors' Report 27\nUnaudited Supplemental Data 28\n_________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Louisiana Land and Exploration Company and Subsidiaries December 31, 1993, 1992 and 1991 _________________________________________________________________ 1. Summary of Significant Accounting Policies a. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Investments in affiliates are accounted for under the equity method. Certain amounts have been reclassified to conform to the current period's presentation.\nb. Petroleum Operations The Company uses the successful efforts method of accounting for its oil and gas operations. The costs of unproved leaseholds are capitalized pending the results of exploration efforts. Significant unproved leasehold costs are assessed periodically, on a property-by-property basis, and a loss is recognized to the extent, if any, that the cost of the property has been impaired. The costs of individually insignificant unproved leaseholds estimated to be nonproductive are amortized over estimated holding periods based on historical experience. Exploratory dry holes and geological and geophysical charges are expensed. Depletion of proved leaseholds and amortization and depreciation of the costs of all development and successful exploratory drilling are provided by the unit-of- production method based upon estimates of proved and proved-developed oil and gas reserves, respectively, for each property. The estimated costs of dismantling and abandoning offshore and significant onshore facilities are provided currently using the unit-of-production method; such costs for other onshore facilities are insignificant and are expensed as incurred. The costs of refining and processing equipment and facilities are depreciated on a straight-line basis over their estimated useful lives.\nThe Company uses the entitlement method for recording natural gas sales revenues. Under the entitlement method of accounting, revenue is recorded based on the Company's net working interest in field production. Deliveries of natural gas in excess of the Company's working interest are recorded as liabilities while under- deliveries are recorded as receivables. Such amounts are immaterial.\nThe Company's anticipated purchases and sales of crude oil and refined petroleum products and its committed foreign currency expenditures may be hedged against market risks through the use of forward\/futures contracts. The gains and losses on these contracts are recognized upon the expiration of the contract and are included in the valuation of the anticipated transactions being hedged. A default by a counterparty to a contract would expose the Company to\nmarket risks for the quantity of the contract. There is no material risk to the Company as a result of these contracts and the Company does not anticipate nonperformance by any of the counterparties.\nc. Functional Currency The foreign exploration and production operations of the Company's subsidiaries and its foreign affiliate, CLAM Petroleum Company, are considered an extension of the parent company's operations. The assets, liabilities and operations of these companies are therefore measured using the United States dollar as the functional currency. As a result, foreign currency translation\/transaction adjustments (which were not material) are included in net earnings.\nd. Income Taxes The Company and its domestic subsidiaries file a consolidated federal income tax return.\nThe Company adopted, effective January 1, 1988, Statement of Financial Accounting Standards No. 96 (\"SFAS No. 96\") - \"Accounting For Income Taxes\". Under the liability method specified by SFAS No. 96, the deferred tax liability is determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by existing tax rates which are presumed to be in effect when these differences reverse. Deferred tax expense is the result of changes in the liability for deferred taxes.\nIn February 1992, Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\") - \"Accounting for Income Taxes\" was issued. SFAS No. 109 supersedes SFAS No. 96. SFAS No. 109 was adopted effective as of January 1, 1993. The Company applied the provisions of the SFAS No. 109 without restating prior years' financial statements. For the Company, the most significant change in SFAS No. 109 as compared to SFAS No. 96 is that deferred tax assets will now be recognized and measured based on the likelihood of realization of a tax benefit in future years. Under SFAS No. 109, deferred tax assets are initially recognized for differences between the financial statement carrying amounts and tax bases of assets and liabilities that will result in future deductible amounts and operating loss and tax credit carryforwards. A valuation allowance would then be established to reduce that deferred tax asset if it is more likely than not that the related tax benefits will not be realized. Under SFAS No. 96, the recognition of deferred tax benefits was limited to benefits that would offset deferred tax liabilities and benefits that could be realized through carryback to recover taxes paid for the current year or prior years.\ne. Earnings (Loss) Per Share Primary earnings (loss) per share are calculated on the weighted average number of shares outstanding during each period for capital stock and, when dilutive, capital stock equivalents, which assumes\nexercise of stock options. Fully diluted earnings (loss) per share are calculated on the same basis, but also assumes conversion, when dilutive, of the convertible subordinated debentures for the period outstanding prior to the call for redemption on September 25, 1992, and elimination of the related interest expense, net of income taxes.\n2. 1993 Acquisitions and Dispositions In September 1993, the Company completed the acquisition of all of the issued and outstanding common stock of NERCO Oil & Gas, Inc. (\"NERCO\") for a cash purchase price of approximately $354 million plus associated expenses. The acquisition was financed initially through the credit facility discussed in Note 8. The cost of the acquisition was allocated under the purchase method of accounting based on the fair value of the assets acquired and liabilities assumed.\nThe results of NERCO's operations were consolidated with the Company's effective October 1, 1993. Pro forma combined results of operations of the Company and NERCO, including appropriate purchase accounting adjustments for the years ending December 31, 1993 and 1992, as though the acquisition had taken place on January 1 of the respective years, are as follows:\nIn December 1993, the Company acquired an 11.26% working interest in Block 16\/17 in the U.K. North Sea (\"T-Block\") from British Gas Exploration and Production Limited for approximately $187 million in cash. The purchase was financed initially through the credit facility discussed in Note 8. Initial production from T-Block came onstream in late 1993 and had an insignificant impact on results of operations.\nIn December 1993, the Company completed the sale of certain oil and gas producing properties, undeveloped acreage and seismic data located in southern Alberta, Canada for approximately $42.8 million resulting in a gain, net of associated expenses, of approximately $23.5 million (before income taxes of $10.3 million). The properties sold generated revenues of $12.1 million and $15.3 million and pretax earnings of $1.2 million and $1.6 million in 1993 and 1992, respectively.\n3. Cash Flows All of the Company's cash investments are highly liquid short-term debt instruments and are considered to be cash equivalents. These cash investments are carried in the accompanying balance sheets at cost plus accrued interest, which approximates fair value. Cash flows related to hedging activities through forward\/futures contracts are classified in the same categories as that from the items being hedged.\nIn 1992, the Company acquired certain proved properties for approximately $36 million and incurred a short-term liability which was outstanding at year end, the settlement of which is included in 1993 cash flows from investing activities.\n4. Restructuring and Other Nonrecurring Charges\/Credits In 1992, the Company recorded a charge of $52.4 million (before income tax benefits of approximately $17.8 million) against earnings to provide for the restructuring of its oil and gas operations. This charge included provisions for estimated losses on the disposition of selected domestic properties of $47.6 million (both developed and undeveloped) and costs associated with staff retirements, reductions and related transition expenses of $4.8 million. The Company completed the sale of substantially all of the selected properties for a purchase price of $48.1 million.\nIn addition, during 1992 the Company reduced its litigation accrual for the State of Louisiana gas royalty claim by $25 million (before an income tax charge of $8.5 million). See Note 15.\n5. Inventories\nAt December 31, 1993, the LIFO cost of refinery inventories exceeded their current market values which resulted in a non-cash charge to earnings of $6.5 million (before income tax benefits of $2.3 million) which is included in \"Refinery Cost of Sales and Operating Expenses\" in the accompanying Consolidated Statements of Earnings (Loss).\nThe Company's equity in earnings of affiliates, which is included in \"Other Revenues\" in the accompanying Consolidated Statements of Earnings (Loss), amounted to $2.4 million, $6.9 million and $15 million in 1993, 1992 and 1991, respectively. Cash dividends received from MaraLou\/CLAM in 1993, 1992 and 1991 totaled $10 million, $7.5 million and $18.5 million, respectively.\nThe consolidated financial position of MaraLou and its wholly owned subsidiary, CLAM, as of December 31, 1993 and 1992 and the results of their operations for each of the years in the three-year period ended December 31, 1993 are summarized below.\nMaraLou applied the provisions of SFAS No. 109 as of January 1, 1993 without restating prior years' financial statements. Upon adoption, MaraLou recorded a non-cash charge to earnings of $6 million ($3 million net to the Company's interest).\nThe common stock of CLAM is pledged as collateral under a revolving credit agreement between MaraLou and a group of banks. The credit agreement is nonrecourse to the partners of MaraLou.\n7. Property, Plant and Equipment\n8. Long-term Debt\nThe fair value of the Company's long-term debt as of December 31, 1993 is estimated to be approximately $744 million based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar maturities.\nDebt maturities for the next five years follows.\nTo finance the aforementioned NERCO and T-Block acquisitions (see Note 2), refinance certain existing indebtedness and fund general corporate activities, the Company entered into a $790 million credit facility with a syndicate of banks in September 1993. Commitments under the agreement originally consisted of (i) a $540 million Revolving Credit Facility and (ii) a $250 million Term Loan Facility (which was utilized and repaid and is no longer available to the Company). The Revolving Credit Facility was subsequently reduced to $450 million and will be reduced by approximately $24 million quarterly from June 1994 through September 1999. Amounts outstanding under the Revolving Credit Facility bear interest at fluctuating rates subject to certain options chosen in advance by the Company. Borrowings under the Revolving Credit Facility and the Term Loan Facility during 1993 were at an average interest rates of 5%. A commitment fee of 1\/4% is charged on the unused portion of the facility. Bank fees and other costs associated with this facility totaled $8.1 million of which $6.7 million was charged to interest and debt expenses in the fourth quarter of 1993. The balance will be written off during the first quarter of 1994, at which time the Company intends to renegotiate the facility.\nIn June 1992, the Company registered under the Securities and Exchange Commission's shelf registration rules $300 million of senior unsecured debt securities to be issued from time to time on terms to be then determined. In June 1992, the Company sold $100 million of 8-1\/4% Notes due 2002. In April 1993, the Company completed its second $100 million public offering of debt securities under the existing shelf registration filed in 1992 with the issuance of 7-5\/8% Debentures due 2013. In November 1993, the Company registered up to $500 million of senior unsecured debt securities under the Securities and Exchange Commission's shelf registration rules, which included the $100 million available under the shelf registration filed in 1992. In December 1993, the Company completed a $200 million public offering with the issuance of 7.65% Debentures due 2023.\nThe Company's $20 million Loan Agreement, the $15 million balance of which was repaid in December 1993, was with a group of banks in the form of a revolving credit loan. The interest rate varied with time and market conditions and was determined by the banks subject to certain options chosen in advance by the Company. A commitment fee of 1\/4% was charged on the unused portion of the loan during the revolving credit period. Borrowings under this agreement during 1993 and 1992 were at average interest rates of 4% and 4.5%, respectively.\nIn November 1987, the Company created a leveraged employee stock ownership plan (ESOP) within an existing employee savings plan. To fund the ESOP, in 1987 and 1988 the Company borrowed $10.2 million and $14 million, respectively, from a bank (unsecured) and loaned the proceeds to the ESOP. The ESOP then used the proceeds to acquire shares of the Company's capital stock (374,678 in 1987;\n461,690 in 1988) at average market prices of $27.125 and $30.25, respectively. The capital stock issued was taken from the Company's treasury at a cost of $30 per share; the differences between treasury stock cost and value were recorded in additional paid-in capital. The loans to the ESOP are on substantially the same terms and conditions as the Company's bank loans and, in addition, are secured by the Company's capital stock owned by the ESOP. The ESOP will repay the loans (plus interest) with the proceeds from the Company's monthly contributions and quarterly dividends paid on the capital stock. The Company's bank loans will be similarly repaid monthly through 1995. The interest rates vary with time and market conditions and are determined by the bank subject to certain options chosen in advance by the Company. The average interest rates for both loans in 1993 and 1992 were 3.1% and 3.7%, respectively.\nDuring 1993, the average monthly balance of commercial paper notes outstanding was $38.8 million; the maximum amount outstanding during that period was $94 million. Commercial paper borrowings during 1993 and 1992 were at average interest rates of 3.3% and 4.3%, respectively. The Company's commercial paper program was supported by a $100 million revolving line of credit, which required a commitment fee of 1\/4% per annum. No borrowings were made under the line of credit. As of September 1993, the commercial paper program is supported by the unused portion of the aforementioned Revolving Credit Facility.\nIn September 1992, the Company announced the call for early retirement of the 8-1\/2% Convertible Subordinated Debentures due September 2000. The redemption completed at a price of 101.66% of principal and the premium, along with unamortized discount, resulted in an extraordinary loss of $5.6 million, after income tax benefits of $2.8 million. The Term Loan with banks, which was retired in January 1994, bore interest at 8.92% (discounted to yield 10.7%), was unsecured and was payable in July 1994. The balance has been excluded from current liabilities as the Company refinanced the balance due on a long-term basis utilizing the Revolving Credit Facility. The early retirement was completed at a price of 102.4% of principal and the premium, along with unamortized discount, resulted in an extraordinary loss of $3.3 million, after income tax benefits of $1.7 million.\n9. Interest and Debt Expenses For the years ended December 31, 1993, 1992 and 1991, interest costs incurred, which were essentially the same as interest payments, were $47 million, $37.5 million and $39.5 million, respectively, of which $18.7 million, $12.9 million and $22.6 million, respectively, were capitalized as part of the cost of property, plant and equipment.\nIn 1992 and 1993, the Company participated in interest rate swaps (which were to terminate in 1994 and 1996, respectively) having a notional principal amount totaling $200 million. Under the agreements, the Company received an annual fixed rate and paid a variable rate based on the six-month London Interbank Offering Rate. The rates payable were recalculated in June and December of each year and the amounts received\/paid were credited\/charged to interest expense. In September 1993, the Company terminated both agreements and deferred a gain of approximately $3.6 million which will be recognized over the remaining terms of the respective agreements as reductions of interest expense.\n10. Foreign Currency Contracts The Company hedges its committed British pound expenditures in the U.K. North Sea through the purchase of forward contracts. At December 31, 1993, forward contracts outstanding totaled $24.6 million. The fair value of these contracts, which represents the Company's cost to offset its forward position, is estimated to be approximately $1 million as of December 31, 1993.\n11. Income Taxes As explained in Note 1(d), the Company adopted SFAS No. 109 effective January 1, 1993. Upon adoption, the Company recorded a non-cash credit to earnings of $13.7 million which represented the recognition of deferred tax assets existing at December 31, 1992.\nWith the enactment of the Budget Reconciliation Act of 1993, the Federal statutory corporate income tax rate was increased from 34% to 35% retroactive to January 1, 1993. As a result, the Company increased its deferred income tax liabilities as of January 1, 1993 with a non-cash charge to income tax expense of $3 million.\nThe components of earnings (loss) before income taxes were taxed under the following jurisdictions:\nComponents of income tax expense (benefit) are as follows:\nTax expense (benefit) differs from the amounts computed by applying the U.S. Federal tax rate (1993 - 35%; 1992-91 - 34%) to earnings (loss) before income tax. The reasons for the differences are as follows:\nAs a result of the prospective adoption of SFAS No. 109 effective January 1, 1993, the following additional disclosures are presented as of and for the year ended December 31, 1993.\nTotal income tax expense (benefit) was allocated as follows:\nThe significant components of deferred income tax expense attributable to income from continuing operations are as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:\nThe net change in the valuation allowance for the year ended December 31, 1993 was an increase of $3 million. This change was made to provide for uncertainties surrounding the realization of certain foreign tax credit carryforwards. The remaining balance of the deferred tax assets should be realized through future operating results and the reversal of taxable temporary differences.\nDeferred tax expense (benefit) included the following components, the disclosure of which was prescribed by the now-superseded SFAS No. 96:\nFor the years ended December 31, 1993, 1992 and 1991, the Company's net cash payments (refunds) of income taxes totaled $7.1 million, $(.6) million and $6.5 million, respectively.\nAt December 31, 1993 the Company has foreign tax credit carryforwards for Federal income tax purposes of $10.2 million which are available through 1998 to offset future Federal income taxes, if any. The Company also has alternative minimum tax credit carryforwards of $5.2 million which are available to reduce Federal regular income taxes, if any, over an indefinite period.\n12. Retirement Benefits The Company has a noncontributory defined benefit pension plan covering all eligible employees, with benefits based on years of service and the employee's highest three-year average monthly earnings. The Company's funding policy is intended to provide for both benefits attributed to service to-date and for those expected to be earned in the future. Plan assets consist primarily of stocks, bonds and short-term cash investments. Since the spin-off of the pension plan of a discontinued subsidiary in 1985 and the contribution of excess assets remaining after purchasing annuities for affected employees, the pension plan did not require funding through the year ended December 31,1992. A minimum amount of funding was required in 1993.\nAs a result of an early retirement incentive program and a reduction in force in 1992, benefit obligations of $4.2 million were settled from plan assets, including $1.1 million of early retirement incentive costs included in the restructuring charge described in Note 4. The settlement of the pension obligations related to the restructuring program resulted in a loss of $.3 million, which was also included in the restructuring charge.\nThe following tables set forth the plan's funded status and amounts recognized in the statements of financial position and results of operations at December 31:\nThe Company has postretirement medical and dental care plans for all eligible retirees and their dependents with eligibility based on age and years of service upon retirement. The Company also maintains a Medicare Part B reimbursement plan and life insurance coverage for a closed group of retirees of a former subsidiary for which estimated benefits of approximately $4.7 million were accrued at December 31, 1992. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (SFAS No. 106) - \"Employers' Accounting for Postretirement Benefits Other than Pensions\", which changed the Company's practice of accounting for postretirement benefits on a pay-as-you-go (cash) basis by requiring accrual, during the years that the employee renders the necessary service, of the expected cost of providing those benefits to an employee and the employee's beneficiaries and covered dependents. Upon adoption, the Company recorded a transition liability of approximately $20.5 million ($13.5 million after income taxes) as a one-time, non-cash charge against earnings.\nThe postretirement benefit plans are unfunded and the Company continues to fund claims on a cash basis. The following tables set forth the amounts recognized in the statements of financial position and results of operations.\nAssumptions utilized to measure the accumulated postretirement obligation at December 31, and January 1, 1993 were: discount rates of 7.25% and 8.5%, respectively; health care cost trend rates of 14% declining over 10 years to 5% and 6%, respectively, and held constant thereafter. A 1% increase in the assumed trend rates would have resulted in increases in the accumulated postretirement benefit obligation at December 31, and January 1, 1993 of $2.6 million and $2.1 million, respectively; the aggregate of service cost and interest cost for the year ended December 31, 1993 would have increased by $.4 million.\n13. Capital Stock, Options and Rights In November 1993, the Company completed a public offering of 4.4 million shares of capital stock at a price of $44.625 per share. The capital stock was taken from the Company's treasury at an average cost of $33.125 per share. The excess of net proceeds over the cost of treasury stock issued was credited to additional paid- in-capital. The net proceeds of the offering, after underwriting commissions and expenses, were approximately $188.8 million.\nIn May 1988, the 1988 Long-term Stock Incentive Plan (1988 Plan) was approved by the shareholders to replace the 1982 Stock Option Plan (1982 Plan). Under the 1988 Plan, as amended, the Company may grant to officers and key employees stock options, stock appreciation rights, performance shares, performance units, restricted stock or restricted stock units for up to 2.8 million shares (plus the 22,274 shares not awarded under the 1982 Plan) of the Company's capital stock. As prescribed by both Plans, stock\noptions are exercisable at the market price on the date of the grant, generally over a two-year period at the rate of 50% each year commencing on the first anniversary of the date of grant; all options expire ten years from the date of grant. In 1993 and 1992, options for 277,700 shares and 600,400 shares were granted, respectively. The restricted stock and performance shares awarded under the 1988 Plan entitle the grantee to the rights of a shareholder, including the right to receive dividends and to vote such shares, but the shares are restricted as to sale, transfer or encumbrance. Restricted stock is issued to the grantee over varying periods after a one-year waiting period has expired. In 1993, awards were granted for 34,250 shares of restricted stock. In 1992, no awards were granted. The performance cycle consists of a three-year period, beginning with the year of grant, at the end of which certain performance goals must be attained by the Company for the unrestricted performance shares to be issued to the grantee. Awards granted in 1993 and 1992 for performance shares amounted to 18,900 shares and 26,600 shares, respectively. Performance shares issued in 1993 and 1992 amounted to 15,257 shares and 19,000 shares, respectively. Restricted stock and performance share awards are \"compensatory\" awards and the Company accrued compensation expense of $.7 million, $1 million and $.8 million in 1993, 1992 and 1991, respectively.\nIn May 1990, the 1990 Stock Option Plan for Non-Employee Directors (1990 Plan) was approved by the shareholders, under which the Company will grant stock options to non-employee directors for up to 150,000 shares of the Company's capital stock. As prescribed by the 1990 Plan, the options are exercisable at the market price at the date of grant over a two-year period at the rate of 50% each year commencing on the first anniversary of the date of grant; all options expire ten years from the date of grant. Awards for 20,000 shares were granted in both 1993 and 1992.\nAt December 31, 1993, 1,254,638 shares of capital stock were reserved for future grants under all Plans.\nTotal grants outstanding under the Plans and the changes therein for the periods indicated follows.\nIn 1986, the Company's Board of Directors declared a dividend to shareholders consisting of one Capital Stock Purchase Right on each outstanding share of capital stock. A Right will also be issued with each share of capital stock that becomes outstanding prior to the time the Rights become exercisable or expire. If a person or group acquires beneficial ownership of 20% or more, or announces a tender offer that would result in beneficial ownership of 20% or more, of the shares of outstanding capital stock, the Rights become exercisable ten days thereafter and each Right will entitle its holder to purchase one share of capital stock for $90.\nIf the Company is acquired in a business combination transaction, each Right not owned by the 20% holder will entitle its holder to purchase, for $90, common shares of the acquiring company having a market value of $180. Alternatively, if a 20% holder were to acquire the Company by means of a reverse merger in which the Company and its capital stock survive or were to engage in certain \"self- dealing\" transactions, or if a person or group were to acquire 30% or more of the outstanding capital stock (other than pursuant to a cash offer for all shares), each Right not owned by the acquiring person would entitle its holder to purchase, for $90, capital stock of the Company having a market value of $180. Each Right can be redeemed by the Company for $.05, subject to the occurrence of certain events and other restrictions, and expires in 1996. These Rights may cause substantial ownership dilution to a person or group who attempts to acquire the Company without approval of the Company's Board of Directors. The Rights should not interfere with a business combination transaction that has been approved by the Board of Directors.\nThe table below sets forth estimates of the domestic sulphur reserves attributable to the interests of the Company as of December 31:\n_________________________________________________________________ Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves\nThe following supplemental data on the Company's oil and gas activities were prepared in accordance with the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards No. 69 - \"Disclosures About Oil and Gas Producing Activities.\" Estimated future net cash flows are determined by: (1) applying the respective year-end oil and gas prices to the Company's estimates of future production of proved reserves; (2) deducting estimates of the future costs of development and production of proved reserves based on the assumed continuation of the cost levels and economic conditions existing at the respective year-end; and (3) deducting estimates of future income taxes based on the respective year-end and future statutory tax rates. Present value is determined using the FASB-prescribed discount rate of 10% per annum.\nAlthough the information presented is based on the Company's best estimates of the required data, the methods and assumptions used in preparing the data were those prescribed by the FASB. Although unrealistic, they were specified in order to achieve uniformity in assumptions and to provide for the use of reasonably objective data. It is important to note here that this information is neither fair market value nor the present value of future cash flows and it does not reflect changes in oil and gas prices experienced since the respective year-end. It is primarily a tool designed by the FASB to allow for a reasonable comparison of oil and gas reserves and changes therein through the use of a standardized method. Accordingly, the Company cautions that this data should not be used for other than its intended purpose.\nEXHIBIT 21\nEXHIBIT 23\nExhibit 23\nThe Board of Directors The Louisiana Land and Exploration Company:\nWe consent to incorporation by reference in Registration Statements No. 2-79097, No. 2-98948, No. 33-22108, No. 33-22338 and No. 33-37814 on Form S-8, No. 33-48339 and No. 33-50991 on Form S-3 and No. 33-6593 on Form S-4 of The Louisiana Land and Exploration Company of our reports dated February 9, 1994, relating to the consolidated balance sheets of The Louisiana Land and Exploration Company and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of earnings (loss), stockholders' equity, and cash flows and related schedules for each of the years in the three-year period ended December 31, 1993 which reports appear or are incorporated by reference in the December 31, 1993 annual report on Form 10-K of The Louisiana Land and Exploration Company. Our reports refer to the adoption of the methods of accounting for income taxes and postretirement benefits other than pensions prescribed by Statement of Financial Accounting Standards Nos. 109 and 106, respectively.\nWe also consent to incorporation by reference in the previously referred to Registration Statements of our report dated January 28, 1994, relating to the consolidated balance sheets of MaraLou Netherlands Partnership and subsidiary as of December 31, 1993 and 1992 and the related consolidated statements of income, partners' capital, and cash flows for each of the years in the three-year period ended December 31, 1993 which report appears in the December 31, 1993 annual report on Form 10-K of The Louisiana Land and Exploration Company. Our report refers to the adoption of the method of accounting for income taxes prescribed by Statement of Financial Accounting Standard No. 109.\n\/s\/ KPMG Peat Marwick\nKPMG PEAT MARWICK\nNew Orleans, Louisiana February 18, 1994\nEXHIBIT 24\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director and the principal executive officer of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director and the principal executive officer of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994. \/s\/ H. Leighton Steward _____________________________ H. Leighton Steward\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Leland C. Adams _____________________________ Leland C. Adams\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director and the principal financial officer of The Louisiana Land and Exploration Company hereby appoints Frederick J. Plaeger, II and Jerry D. Carlisle his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director and the principal financial officer of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Richard A. Bachmann _____________________________ Richard A. Bachmann\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ John F. Greene _____________________________ John F. Greene\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Eamon M. Kelly _____________________________ Eamon M. Kelly\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Victor A. Rice _____________________________ Victor A. Rice\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Orin R. Smith _____________________________ Orin R. Smith\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Arthur R. Taylor _____________________________ Arthur R. Taylor\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ W. R. Timken, Jr. _____________________________ W. R. Timken, Jr.\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Carlisle A.H. Trost _____________________________ Carlisle A.H. Trost\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as a director of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann, Frederick J. Plaeger, II and Jerry D. Carlisle and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as a director of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ E. L. Williamson _____________________________ E. L. Williamson\nTHE LOUISIANA LAND AND EXPLORATION COMPANY POWER OF ATTORNEY\nWHEREAS, The Louisiana Land and Exploration Company intends to file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, an Annual Report on Form 10-K; NOW, THEREFORE, the undersigned in his capacity as the principal accounting officer of The Louisiana Land and Exploration Company hereby appoints Richard A. Bachmann and Frederick J. Plaeger, II and each of them severally, his true and lawful attorneys or attorney with power to act with or without the other and with full power of substitution and resubstitution, to execute in his name, place, and stead, in his capacity as the principal accounting officer of The Louisiana Land and Exploration Company, said Annual Report on Form 10-K and any and all amendments thereto and all instruments necessary or incidental in connection therewith, and to file or cause to be filed the same with the Securities and Exchange Commission. Each of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorneys and each of them. IN WITNESS WHEREOF, the undersigned has executed this instrument this 18th day of February, 1994.\n\/s\/ Jerry D. Carlisle _____________________________ Jerry D. Carlisle\n[TYPE] COVER\nTHE LOUISIANA LAND AND EXPLORATION COMPANY 909 Poydras Street New Orleans, LA 70112\nFebruary 22, 1994\nSecurities and Exchange Commission Washington, D.C. 20549\nGentlemen:\nPursuant to the requirements of the Securities Exchange Act of 1934, we are transmitting herewith the attached Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\nSincerely,\nTHE LOUISIANA LAND AND EXPLORATION COMPANY\ns\/Frederick J. Plaeger, II\nFrederick J. Plaeger, II General Counsel and Corporate Secretary","section_15":""}
{"filename":"48896_1993.txt","cik":"48896","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"30067_1993.txt","cik":"30067","year":"1993","section_1":"ITEM 1. BUSINESS - -----------------\n(a) General Development of the Business\nDravo Corporation was incorporated in Pennsylvania in 1936 to consolidate several related corporations then operating various elements of a business started in 1891 by F. R. Dravo. Its corporate offices are located at 3600 One Oliver Plaza, Pittsburgh, Pennsylvania 15222-2682, and its telephone number is 412-566-3000. As used herein, the term Dravo includes its consolidated subsidiaries unless otherwise indicated. In December, 1987, Dravo's Board of Directors approved a major restructuring program which concentrated Dravo's future direction exclusively on opportunities involving its natural resources business. The plan included the sale or other disposition of the former Engineering and Construction segment, as well as the sale of the former Materials Handling and Systems segment approved earlier. All units scheduled for sale were sold by the end of 1989. The remainder of these businesses have been presented as discontinued operations in the financial statements.\nAs a result of this restructuring program, Dravo is a natural resources company operating principally in the United States. Activities include the production of aggregates for construction and industrial uses and lime for industrial, utility, municipal and construction applications. All of the properties on which the company's reserves are located are physically accessible for the purposes of mining, dredging and hauling. Operations are principally carried on by two wholly-owned subsidiaries, Dravo Basic Materials Company, Inc. (Dravo Basic Materials) and Dravo Lime Company (Dravo Lime).\nDravo Basic Materials is a leading producer of construction aggregates in the Ohio Valley and Gulf Coast regions. Principal products include sand and gravel, crushed limestone, shell, slag, ready-mixed concrete, concrete block, industrial filler material and poultry feed calcium supplement. The organization markets approximately 20 million tons of aggregates annually.\nThe company's Ohio Valley operations are located in Cincinnati, Ohio; Pittsburgh, Pennsylvania; Parkersburg, West Virginia; Cave In Rock, Illinois and Smithland, Kentucky. Activity in all of the Ohio Valley locations is historically lower in the first quarter than the remainder of the year because of a seasonal construction market and winter weather conditions.\nThree land-based sand and gravel quarries are owned and operated in the Cincinnati area; two in the Pittsburgh area, one owned and one leased; and one is owned in the West Virginia area. A new owned limestone quarry is currently being developed east of Cincinnati. Also, two dredges are currently operating on the Ohio River under leases held by various governmental agencies and private individuals.\nThe Cave In Rock limestone quarry is operated under a long-term lease with Lafarge Corporation. The quarry is located next to the Ohio River approximately 100 miles from the Ohio's junction with the Mississippi River. Reserves are estimated at 82 million tons, and the facility has an ultimate production capacity in excess of four million tons per year. The company markets the Cave In Rock aggregate along the Ohio, Mississippi and Tennessee river systems and\nITEM 1. BUSINESS (CONTINUED) - -----------------\nthe Gulf Coast. The company also supplies Lafarge's cement plant at Joppa, Illinois with kiln feed stone.\nThe company owns and operates the Smithland, Kentucky limestone quarry located on the Cumberland River near its confluence with the Ohio River. This facility has limestone reserves of approximately 204 million tons and annual production capacity of more than four million tons.\nDravo Basic Materials produces and markets its products in the southern United States in a number of metropolitan and rural areas. Production facilities include three limestone quarries and five sand and gravel quarries in Alabama and one limestone quarry and a river dredging operation in Florida. Aggregates are marketed from distribution facilities in Tampa, Pensacola and Jacksonville, Florida; Brunswick and Savannah, Georgia; Mobile, Birmingham, Montgomery and Auburn, Alabama; New Orleans, Baton Rouge, Westlake, Convent, Houma and Morgan City, Louisiana. Aggregates from the Cave In Rock, Illinois and Smithland, Kentucky facilities are also being marketed in the Gulf Coast area. A crushed slag plant is operated in Tennessee.\nThe company imports limestone from a leased quarry located in The Bahamas. Reserves at this facility are estimated at 45 million tons, while production capacity is over two million tons annually.\nDravo Basic Materials Company resumed shell dredging operations along the Gulf Coast in late 1992 after reaching a joint partnership agreement late in the year with the current reef shell leaseholder. The new leaseholder replaced the operator who was awarded the lease when it was auctioned by the State of Louisiana in 1991. The joint partnership agreement allows Dravo Basic Materials to once again participate in a market in which it has had substantial success historically because of reef shell's desirability for a number of construction and chemical applications.\nThe company completed the sale of its asphaltic concrete operation located in Mobile and Loxley, Alabama in the first half of 1992.\nDravo Lime, one of the nation's largest lime producers with annual capacity of over two million tons, owns and operates two plants in Kentucky and one in Alabama. The largest, a million-ton-per-year facility in Maysville, Kentucky, produces lime that is particularly efficient in removing sulphur dioxide from power plant stack gases. Most of Maysville's output is committed under long- term contracts with utility companies in the Ohio Valley. All contracts contain provisions for price escalation. Owned reserves at the Maysville site are considered adequate to sustain the current three kiln production for approximately thirty years. The Maysville plant also has options on additional reserves adequate to sustain production in excess of fifty years. Dravo Lime's Black River integrated lime facility located along the Ohio River at Butler, Kentucky has an annual quicklime capacity of 660,000 tons-per-year. The facility is currently being expanded to increase its capacity by 700,000 tons. The increased tonnage will be used, in part, to supply 450,000 tons of lime annually\nITEM 1. BUSINESS (CONTINUED) - -----------------\nto American Electric Power's Gavin Station under a 15-year agreement commencing the second quarter of 1995. Reserves at this facility are considered adequate to sustain current production levels in excess of one hundred years. The company's Longview plant, located near Birmingham, Alabama, completed an expansion in April, 1991 that increased its annual production capacity to approximately 550,000 tons per year.\nThe additional production is used primarily to meet the needs of a long-term contract with Mineral Technologies, Inc., formerly Pfizer Specialty Minerals Inc., for the production of precipitated calcium carbonate for the pulp and paper industry. The remainder of Longview's production is marketed to the aluminum, steel, chemical and other industries and for use in water purification, soil stabilization and road building applications. Limestone at the Longview operation comes from an above-ground quarry with recoverable reserves estimated to last twenty-three years at the current production rate. Ultimately, Dravo Lime expects to convert Longview to an underground mine, providing access to additional reserves that would support the current production rate for over one hundred years.\nDravo Lime maintains and operates distribution terminals in Aliquippa and Butler, Pennsylvania; Porterfield, Ohio; Brunswick, Georgia; Tampa, Jacksonville, Fort Lauderdale and Sanford, Florida; and Baton Rouge, Louisiana. Dravo Lime stopped marketing Calcilox\/R\/ in 1992 due to a shortage of suitable low cost raw material. Calcilox is a stabilizing agent used in converting sludge produced in plant air pollution reduction systems into a material suitable for landfill operations.\n(b) Competitive Conditions\nDravo encounters substantial competition in all its operations but believes that its past experience, strategically located reserves and technical expertise gives it certain competitive advantages. Dravo, through its subsidiary Dravo Lime, is engaged in the supply of lime for use in utility sulphur dioxide stack gas scrubbers. Dravo Lime's research and development expenditures for 1993 were $4.2 million, while spending for 1994 is expected to exceed $3.3 million. The company expects the research, much of which is being conducted jointly with utility customers, to lower both the capital and operating costs of the proprietary Thiosorbic\/R\/ scrubbing systems. Other research projects are aimed at increasing the range of applications of proprietary reagents for use in reducing stack gas emissions and at producing and recovering a saleable by- product. Dravo believes that in this field its long-term contracts, accumulated experience and technical skill have provided it a competitive advantage.\nSeveral firms with which Dravo competes have greater resources and income. Dravo competes with other firms for qualified professional personnel, particularly those with technological skills.\n(c) Corporate Development\nDravo's corporate development policy encompasses growth through investment in existing businesses, internal development and acquisition. Additionally, to the extent that business units no longer meet management's long-term profitability performance criteria and business strategies, or do not contribute significantly to corporate objectives or balance, a policy of divestiture is followed.\nITEM 1. BUSINESS (CONTINUED) - -----------------\nContinuing operations of Dravo Corporation, which are principally domestic in nature, function in one segment, a natural resources business, involved in the production, processing and supply of construction materials, primarily aggregates, as well as lime for environmental, chemical and metallurgical applications. Dravo's position as the world's leading producer of lime for flue gas desulfurization applications was enhanced by the passage of the 1990 Clean Air Act Amendments.\nFurther information required by this item is incorporated by reference to the information set forth under the captions indicated below in the 1993 Annual Report to Shareholders which accompanies this report:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe following is a listing of principal offices, plants and mines used in operations:\nITEM 2. PROPERTIES (CONTINUED) - ------------------------------\nOffices and plants associated with businesses treated herein as discontinued operations have been excluded from this presentation.\nMineral reserves include sand, gravel and limestone. The following table shows a summary of the company's reserves at December 31, 1993 and tonnage produced in 1993.\nIn addition to tonnage produced, the company purchased approximately 900,000 tons of aggregate material under various agreements.\nAdditional information required by this item is incorporated by reference to the information set forth under Item 1(a) \"General Development of the Business\" on pages 3 - 6 of this Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nThe company filed an action in 1981 to collect on a promissory note issued by Meladuras Portuguesa, C. A. (Melaport) and its principal, Alberto Caldera (Caldera). In 1985, Melaport and Caldera filed a counterclaim for damages alleging the company breached a contract between Melaport and the company relating to engineering and procurement services rendered between 1973 and 1978 for a sugar cane processing facility. The Fifth Civil, Mercantile and Traffic Court of First Instance for the Federal District and State of Miranda, Venezuela ruled partially in favor of Melaport's counterclaim. The ruling was upheld by the Seventh Court of Appeals in Civil, Mercantile and Traffic Matters for the Judicial Circuit of the Federal District and State of Miranda on September 25, 1992 and by the Supreme Court of Justice of Venezuela on July 8, 1993. The lower courts' ruling does not specify damages to be paid but identifies the following categories of damages to which Caldera and Melaport are entitled: (1) the losses suffered by Melaport from the time it commenced operations in 1974 to 1978; (2) the value of certain equipment and other assets which had been pledged by Melaport to secure borrowings in connection with the project; and (3) the value of approximately 540 acres of land which a corporation controlled by Caldera had mortgaged to secure the borrowing. The amount of damages in these three categories is to be established by an appraisal process conducted by the trial court; damages are to be adjusted for inflation since the counterclaim was filed in 1985 and for interest at 12 percent per year. The company is preparing to vigorously pursue the appraisal proceedings. While opposing counsel has asserted that the damages are in excess of $35 million, the company at this time cannot predict the results of the appraisal proceedings. The company has no assets in Venezuela and will challenge the enforcement in the United States if judgment is finally issued by the Venezuelan Courts. On November 2, 1993, the company filed suit against Melaport and Caldera in the United States District Court for the Western District of Pennsylvania, seeking an injunction and a declaratory judgment with respect to the proceedings in Venezuela. The company is requesting a determination that any judgment in the Venezuelan proceedings is not enforceable against the company and is also seeking indemnification for all costs, expenses, losses and damages incurred and which may be incurred by the company in the Venezuelan proceedings and the costs and expenses of the United States District Court action. On February 25, 1994, Melaport and Caldera filed a motion asking the Court to dismiss the suit based on the lack of personal jurisdiction over the defendants and based on the doctrines of forum non conveniens, res judicata and judicial estoppel. It also asked the Court to dismiss, as premature, the company's demand for injunctive and declaratory relief. The company intends to vigorously pursue this action. If the ruling of the Venezuelan Courts is successfully enforced against the company in the United States, the liability would be material to the company.\nThe company has been notified by the U. S. Environmental Protection Agency (EPA) that the EPA considers the company as a potentially responsible party (PRP) for soil and groundwater contamination at three subsites within the Hastings Ground Water Contamination Site, Hastings, Nebraska. With respect to the Colorado Avenue subsite, in the vicinity of a fabrication facility formerly operated by the company, the EPA has issued an administrative order dated September 28, 1990, to the company and one other PRP to remedy soil contamination. The EPA has also issued a unilateral administrative order, effective March 28, 1993, directing the company and the other PRP to conduct the interim groundwater remediation required by EPA's record of decision. The company has been complying with these orders while reserving its right to seek reimbursement from the United States for its\nITEM 3. LEGAL PROCEEDINGS (CONTINUED) - --------------------------------------\ncosts if it is determined it is not liable for response costs or if it is required to incur costs because of arbitrary, capricious or unreasonable requirements imposed by EPA.\nA contribution claim related to this subsite was filed by the company in the Nebraska District Court against two other parties who are named PRPs, Burlington Northern Railroad and the Zuber Company, but were not served with the EPA's orders. After the company filed its suit, the EPA, over the company's objection, entered into a de minimis settlement agreement with these two PRPs providing for, among other things, contribution protection in return for access to their contaminated property. EPA based its decision on the lack of any evidence indicating these PRPs contributed to contamination at the site, but provided for reconsideration of its decision if such evidence was uncovered. Subsequently, the District Court granted motions for summary judgment filed by these two PRPs based on the contribution protection provisions in their de minimis settlements with the EPA, and the PRPs withdrew their counterclaims. The Eighth Circuit Court of Appeals affirmed this decision on January 12, 1994. The company has also notified the EPA and each PRP of its intent to challenge the decision by the EPA to issue the de minimis order without receiving reimbursement for a share of the response and remediation costs but has not yet filed suit.\nThe company, along with a number of others, is considered a PRP with respect to subsites at the municipally-owned North and South Landfills. The North Landfill closed before the company commenced operations but a predecessor may have used this landfill to dispose of hazardous materials. On December 31, 1991 the EPA issued a formal demand to the company and other PRPs for reimbursement of costs the EPA has incurred at this subsite and has also solicited an offer to conduct or finance remedial work at this subsite for both soil and groundwater contamination. The company has rejected the EPA's demand to reimburse the EPA for its costs and decided not to submit the offer requested. No PRP at this subsite has agreed to pay the EPA's response costs. As a result, statutory interest is being added to the EPA's response costs. Other PRPs, including the local municipality, have agreed to perform the remedial investigation and to design soil and groundwater remediation remedies at this subsite, but no party has agreed to conduct the remediation. Only minimal investigation has been conducted at the South Landfill, and it is not evident that remedial work is warranted. In January, 1994 the EPA sent a specific notice to the company that the EPA considered it and three other parties PRPs at this subsite. The letter invited the company and the other PRPs to make an offer to conduct a remedial investigation and the feasibility study (RI\/FS) of this subsite and stated that the EPA was in the process of preparing a workplan for the RI\/FS.\nIn October of 1990, the company notified its primary and excess general liability insurance carriers of the claims by the EPA at the Colorado Avenue and North Landfill subsites. Although one primary carrier agreed to pay for a part of the company's defense, it has not done so and has refused to pay for expenses the company has already incurred. The company's other primary carrier has declined coverage altogether. On August 10, 1992, the company filed suit in the Alabama District Court against The Hartford Insurance Company and Liberty Mutual Insurance Company seeking a declaratory judgment that the company is entitled to a defense and indemnity under its contracts of insurance (including certain excess policies provided by one of the primary carriers). This complaint is limited to the EPA's claims at the Colorado Avenue subsite. The suit has been\nITEM 3. LEGAL PROCEEDINGS (CONTINUED) - --------------------------------------\namended to include as a defendant Bituminous Casualty Corporation the excess liability carrier of the company's predecessor at the site. An investigation of the coverage provided by the primary carrier of the company's predecessor is also underway. An award of punitive damages is being sought against Hartford and Liberty Mutual for their bad faith in failing to investigate the company's claim and\/or denying the company's claim. The case is proceeding in accordance with a case management order issued by the District Court Magistrate assigned to handle pretrial matters. In February of 1994, the company notified its primary and excess insurers of EPA's specific notice that it considered the company a PRP at the South Landfill Subsite, inviting the company to make an offer to conduct an RI\/FS at the site, and notifying the company that EPA was in the process of preparing a workplan for the RI\/FS. The company has joined with the other PRPs in recommending the use of regional institutional controls for remediation of groundwater at all of the Hastings Ground Water Contamination Subsites.\nA dispute between the company and the Southeast Resource Recovery Facility (SERRF) in Long Beach, California over a contract to design, construct and demonstrate a resource recovery facility has given rise to two lawsuits. On October 17, 1989, the company instituted an action against the SERRF Authority and the City of Long Beach seeking recovery of escrow funds and reimbursement for change orders, extra work, delays and other increased costs. On October 19, 1989, the SERRF Authority and the City of Long Beach filed suit against the company and its surety, The Insurance Company of North America, seeking among other things, damages for breach of contract. Both lawsuits are now pending in the U.S. District Court for the Central District of California. On February 25, 1994, the principal parties to these lawsuits signed a Memorandum of Intent containing the terms of settlement to be entered into among the parties. The settlement is subject to the approval of the U. S. District Court.\nOn February 21, 1990, the company filed suit against Continental Energy Associates (CEA), the owner of a cogeneration facility in Hazleton, Pennsylvania, Continental Cogeneration Corporation (CCC), the owner's general partner, and Swiss Bank Corporation, the project's lender. The company claims damages for breach of contract and unjust enrichment arising out of the termination of the company's contract to construct, as part of the facility, a coal gasification plant. On February 23, 1990, CEA and CCC filed suit against the company which as amended seeks damages for breach of contract, negligent misrepresentation, fraud and tortious interference with the contract of surety. The lawsuits have been consolidated in the Court of Common Pleas of Luzerne County, Pennsylvania.\nOther information required by this item is incorporated by reference to the information set forth under the caption Note 8: \"Contingent Liabilities\" in the Notes to Consolidated Financial Statements on pages 21 through 23 of the 1993 Annual Report to Shareholders which accompanies this report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nThere were no matters submitted to a vote of security holders for the three months ended December 31, 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS -------\nInformation required by this item is incorporated by reference to the information set forth under the captions indicated below in the 1993 Annual Report to Shareholders which accompanies this report:\nDescription of Dravo Capital Stock ----------------------------------\nGeneral\nUnder its Restated Articles of Incorporation (\"the Articles\"), as amended, Dravo is authorized to issue 1,878,870 shares of preference stock, par value $1.00 per share, and 35,000,000 shares of common stock, par value $1.00 per share. At December 31, 1993 issued preference and common shares were 232,386 and 14,967,824, respectively.\nThe Board of Directors has by resolutions established four series of preference stock: $2.20 Cumulative Convertible Series A Preference Stock (\"Series A Preference Stock\"), consisting of 26,817 shares, issued on September 1, 1970; $2.475 Cumulative Convertible Series B Preference Stock (\"Series B Preference Stock\"), consisting of 165,516 shares, issued on June 12, 1973; Series C Preference Stock consisting of 200,000 shares, which are issuable pursuant to the exercise of the rights to purchase stock described below; and Series D Cumulative Convertible Exchangeable Preference Stock (\"Series D Preference Stock\") consisting of 200,000 shares, issued on September 21, 1988. All of the shares of Series A Preference Stock were converted into shares of common stock on April 2, 1978. 32,386 shares of Series B Preference Stock and 200,000 shares of Series D Preference Stock are presently issued and outstanding. No shares of Series C Preference Stock have been issued or are outstanding. Other series of preference stock may be created by resolutions of the Board of Directors with such dividend, liquidation, redemption, sinking fund and conversion rights as shall be specified therein.\nDividend Rights\nThe holders of the preference stock are entitled to cumulative dividends, payable quarterly, which must be paid and the next quarterly dividend set apart before any dividends (except dividends in common stock or any other stock ranking after\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS (CONTINUED) -------\nDividend Rights (continued)\nthe preference stocks as to dividends and assets) are declared, or paid, or monies set apart for the payment of dividends on any class of stock ranking after the preference stock as to dividends or assets. The rate of dividends payable upon the Series B Preference Stock is $2.475 per annum. The rate of dividends payable upon the Series C Preference Stock is an amount per share (rounded to the nearest cent) equal to the greater of $10.00 or 100 times the aggregate per share amount of all cash and non-cash dividends or other distributions, other than a dividend or distribution payable in shares of common stock, paid on the common stock in the immediately preceding quarter, subject to adjustment in certain events. The rate of dividends payable upon the Series D Preference Stock is 12.35 percent per annum or $12.35 per share, which rate shall be increased by 2 percent per annum if such dividends are not paid on any quarterly dividend payment date until accrued and unpaid dividends on the Series D Preference Stock are paid.\nThe holders of the common stock are entitled to such dividends as may be declared by the Board of Directors out of assets properly available for that purpose. No common stock dividends have been declared since April, 1987.\nOther information required by this item is incorporated by reference to the information set forth under the caption \"Note 5: Notes Payable\", in the Notes to Consolidated Financial Statements on page 20 of the 1993 Annual Report to Shareholders which accompanies this report.\nVoting Rights\nEach share of the common stock and the preference stock is entitled to one vote, which is cumulative in the election of directors. The Board of Directors is divided into three classes, and approximately one third of the directors are elected each year for three year terms. The effect of such classification of the Board is to increase the number of shares, voted cumulatively, necessary to elect directors. If dividends on the preference stock shall be unpaid or in arrears for six quarterly dividend periods, the holders of the preference stock voting as a class shall have the right to elect two additional directors.\nLiquidation Rights\nIn the event of the voluntary or involuntary liquidation or dissolution of Dravo, or the sale or other disposition of substantially all of its assets, the holders of the Series B Preference Stock shall be entitled to receive the sum of $55 per share plus all accumulated and unpaid dividends thereon; the holders of Series C Preference Stock shall be entitled to receive $100 per share plus all accrued and unpaid dividends plus an amount equal to the holder's pro rata share of the amount that would be available for distribution after payment of all liabilities,\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS (CONTINUED) -------\nLiquidation Rights (continued)\nliquidation preferences and a distribution on the common stock, if any, as determined according to a formula; and the holders of Series D Preference Stock shall be entitled to receive $100 per share plus all accumulated and unpaid dividends thereon. The holders of any other series of preference stock which may be issued shall be entitled to receive the amounts provided for in the resolutions creating such series. The holders of the common stock shall share ratably in the remaining assets, if any.\nNo Preemptive Rights and Non-assessability\nNo preemptive rights attach to the common stock or the preference stock. Neither the holders of the common stock nor the preference stock are liable to further calls or assessment by Dravo.\nRedemption and Sinking Fund Provisions\nThere are no redemption provisions with respect to the common stock. The Series B Preference Stock may be redeemed, in whole or in part, at the option of Dravo, on not less than 60 days notice, on any quarterly dividend payment date by the payment of $55 per share and all accumulated and unpaid dividends to the redemption date. The Series C Preference Stock may be redeemed as a whole, but not in part, at the option of Dravo, at any time, at a cash price per share based upon the average market value, as defined and adjusted, of the common stock plus all accrued but unpaid dividends. The Series D Preference Stock may be redeemed in whole or in part at the option of Dravo at any time after September 21, 1996, by the payment of $100 per share and all accumulated and unpaid dividends to the redemption date, so long as the current market price (as defined in the Certificate of Designations, Preferences and Rights for the Series D Preference Stock) of the common stock on the date the Board decides to redeem the shares is at least 175 percent of the then effective conversion price for the Series D Preference Stock. Commencing on the first quarterly dividend payment date after September 21, 1998 and annually thereafter, Dravo is required to redeem 50,000 shares of Series D Preference Stock in cash at the redemption price of $100 per share plus all accumulated and unpaid dividends. Dravo is also required (unless certain conditions are met) to redeem all of the then outstanding shares of Series D Preference Stock in cash at $100 per share plus all accumulated and unpaid dividends (a) if Dravo declares or pays or sets apart for payment any dividends or makes any other distribution in cash or other property on or in respect of the common stock or any other class or series of the capital stock of Dravo ranking junior to the Series D Preference Stock as to payment of dividends (\"Junior Dividend Stock\"), or sets apart money for any sinking fund or analogous fund for the redemption or purchase of any Junior Dividend Stock and (b) upon any merger or consolidation of Dravo if, in connection therewith, the holders of the common stock receive cash, debt instruments or preference stock of the surviving entity which ranks on a parity with or senior to the Series D Preference stock with respect to liquidation, dissolution or winding up or dividends. There are no sinking fund provisions with respect to the common stock or the Series B Preference Stock, Series C Preference Stock or Series D Preference Stock.\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS (CONTINUED) -------\nConversion\nThe Series B Preference Stock is presently convertible at any time prior to redemption at the option of the holder into common stock on the basis of 3.216 shares of common stock for each share of Series B Preference Stock, subject to equitable adjustment in the event of certain changes affecting the common stock. The Series D Preference Stock is presently convertible at any time prior to redemption at the option of the holder into common stock on the basis of 8.0 shares of common stock for each share of Series D Preference Stock, subject to adjustment in the event of certain changes affecting the common stock. The Series D Preference Stock is convertible or exchangeable in whole at any time by Dravo for an equal face amount of Dravo Senior Subordinated Convertible Notes due September 21, 2001 containing the same conversion rights, transfer restrictions and other terms (other than voting rights) as the Series D Preference Stock. There are no conversion rights with respect to the Series C Preference Stock or the common stock.\nRights to Purchase Series C Preference Stock\nThe Series C Preference Stock is issuable pursuant to the exercise of rights to purchase Series C Preference Stock. On April 4, 1986, the Board of Directors declared a distribution of one right for each outstanding share of common stock to shareholders of record at the close of business on April 17, 1986 (the \"Record Date\") and with respect to each share of common stock that may be issued by Dravo prior to the Distribution Date described below or the earlier redemption or expiration of the rights. Each right entitles the registered holder, following the occurrence of certain events described below, to purchase from Dravo a unit consisting of one one-hundredth of a share (a \"Unit\") of Series C Preference Stock at a purchase price of $60 per Unit, subject to adjustment (the \"Purchase Price\"). The descriptions and terms of the rights are set forth in a rights agreement (the \"Rights Agreement\") between Dravo and PNC Bank, N. A. (formerly Pittsburgh National Bank), as the rights agent.\nInitially, the rights will be attached to all common stock certificates representing shares then outstanding, and no separate rights certificates will be distributed. The rights will separate from the common stock and a distribution date will occur upon the earlier of (a) 10 days following a public announcement that a person or group of affiliated or associated persons (an \"Acquiring Person\") has acquired, or obtained the right to acquire, beneficial ownership of 20 percent or more of the outstanding shares of common stock of Dravo (the \"Stock Acquisition Date\"), or (b) 10 business days following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 30 percent or more of such outstanding shares of common stock. Until the distribution date, (i) the rights will be evidenced by the common stock certificates and will be transferred with and only with such common stock certificates, (ii) new common stock certificates issued after the Record Date will contain a notation incorporating the Rights Agreement by reference, and (iii) the surrender for transfer of any certificate for common stock outstanding will also constitute the transfer of the rights associated with the common stock represented by such certificate.\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS (CONTINUED) -------\nRights to Purchase Series C Preference Stock (continued)\nThe rights are not exercisable until the distribution date and will expire at the close of business on April 17, 1996, unless earlier redeemed by Dravo as described below.\nIn the event that, at any time following the distribution date, (a) Dravo is the surviving corporation in a merger with an Acquiring Person and its common stock is not changed or exchanged, (b) an Acquiring Person becomes the beneficial owner of 30 percent or more of the then outstanding shares of common stock, (c) an Acquiring Person engages in one or more \"self-dealing\" transactions as set forth in the Rights Agreement, or (d) during such time as there is an Acquiring Person, an event occurs which results in such Acquiring Person's ownership interest being increased by more than one percent (e.g., a reclassification of securities, reverse stock split or recapitalization of Dravo), each holder of a right will thereafter have the right to receive, upon exercise, common stock (or, in certain circumstances, cash, property or other securities of Dravo) having a value equal to two times the Purchase Price of the right. Notwithstanding any of the foregoing, (i) rights are not exercisable following the occurrence of any of the events set forth in this paragraph until such time as the rights are no longer redeemable by Dravo as set forth below, and (ii) following the occurrence of any of the events set forth above, all rights that are, or (under certain circumstances specified in the Rights Agreement) were, beneficially owned by any Acquiring Person will be null and void.\nIn the event that, at any time following the stock acquisition date, (i) Dravo is acquired in a merger or other business combination transaction in which Dravo is not the surviving corporation (other than a merger described in the preceding paragraph), or (ii) 50 percent or more of Dravo assets or earning power is sold or transferred, each holder of a right (except rights which previously have been voided as set forth above) shall thereafter have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the right. The events set forth in this paragraph and in the preceding paragraph are referred to as the \"Triggering Events.\"\nThe Purchase Price payable, and the number of units of Series C Preference Stock or other securities or property issuable, upon exercise of the rights are subject to adjustment from time to time to prevent dilution. No fractional units may be issued and, in lieu thereof, an adjustment in cash may be made based on the market price of the Series C Preference Stock on the last trading date prior to the date of exercise.\nAt any time until ten days following the stock acquisition date, Dravo may redeem the rights in whole, but not in part, at a price of $.01 per right. Under certain circumstances set forth in the Rights Agreement, the decision to redeem shall require the concurrence of a majority of the continuing directors, as defined. After the redemption period has expired and prior to the occurrence of a Triggering Event, Dravo's right of redemption may be reinstated if an Acquiring Person reduces his beneficial ownership to 10 percent or less of the outstanding\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------ MATTERS (CONTINUED) -------\nRights to Purchase Series C Preference Stock (continued)\nshares of common stock in a transaction or series of transactions not involving Dravo. Immediately upon action of the Board of Directors ordering redemption of the rights, with, where required, the concurrence of the continuing directors, the rights will terminate and the only right of the holders of rights will be to receive the $.01 redemption price.\nUntil a right is exercised, the holder thereof, as such, will have no rights as a shareholder of Dravo, including, without limitation, the right to vote or to receive dividends.\nOther than those provisions relating to the principal economic terms of the rights, any of the provisions of the Rights Agreement may be amended by the Board of Directors of Dravo prior to the distribution date. Thereafter, the provisions of the Rights Agreement may be amended by the Board (in certain circumstances, with the concurrence of the continuing directors) in order to cure any ambiguity, to make changes which do not adversely affect the interests of holders of rights (excluding the interests of any Acquiring Person), to suspend the effectiveness of the provision of the Rights Agreement pursuant to which certain rights become void as described above, or to shorten or lengthen any time period under the Rights Agreement; provided, however, that no amendment to adjust the time period governing redemption shall be made at such time as the rights are not redeemable.\nThe rights may have the effect of preventing or discouraging some attempts to acquire control of Dravo. The rights could cause substantial dilution to a person or group that attempts to acquire control of Dravo on terms not approved by its Board of Directors, unless the offer is conditioned on a substantial percentage of rights being tendered to and acquired by the Acquiring Person. The rights should not interfere with any merger or other business combination approved by the Board of Directors prior to the expiration of the redemption period since the rights may be redeemed by Dravo prior to the expiration of such period and Dravo may suspend the provisions that in certain circumstances prevent an Acquiring Person from exercising its rights. The rights could interfere with a negotiated transaction after an acquisition of 20 percent or more voting power if the rights were not redeemed. The rights will not prevent a holder of a controlling interest from exercising control over Dravo.\nA copy of the Rights Agreement has been filed with the Securities and Exchange Commission as an Exhibit to a Report on Form 8-K. A copy of the Rights Agreement is available free of charge from Dravo upon the request of any shareholder. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement.\nOther Information\nDravo may purchase shares of the preference stock whether or not any dividend arrearage shall exist with respect thereto, and may hold and dispose of such shares in such manner as it may elect.\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS (CONTINUED) -------\nOther Information (continued)\nThe holders of the preference stock who comply with applicable provisions of law and object to a merger or consolidation involving Dravo shall have all of the legal rights of objecting shareholders in a merger or consolidation whether or not they constitute a class otherwise entitled to such rights.\nThe transfer agent and registrar for the common stock is Continental Stock Transfer & Trust Company, New York, NY.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nInformation required by this item, with the exception of common stock dividends declared, is incorporated by reference to the information set forth under the caption \"Five-Year Summary\" on page 31 of the 1993 Annual Report to Shareholders which accompanies this report. Dravo has declared no common stock dividends in the five-year period ending December 31, 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS ---------------------\nInformation required by this item is incorporated by reference to the information set forth under the captions \"Overview\", \"Results of Operations\", \"Financial Position and Liquidity\" and \"Outlook\" on pages 8 through 11 of the 1993 Annual Report to Shareholders which accompanies this report, to the information set forth under the caption Note 2: \"Discontinued Operations\" on pages 18 and 19, Note 7: \"Commitments\" on page 21, Note 8: \"Contingent Liabilities\" on pages 21 through 23 and Note 13: \"Income Taxes\" on pages 26 through 28 in the Notes to Consolidated Financial Statements of the Annual Report to Shareholders, and to Item 3 - \"Legal Proceedings\" on pages 9 through 11 of this Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nInformation required by this item is incorporated by reference to the financial statements and notes thereto set forth on pages 12 through 29, and the Independent Auditors' Report set forth on page 30 of the 1993 Annual Report to Shareholders which accompanies this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE --------------------\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nInformation required by this Item as to Directors and nominees for Director is incorporated by reference to the information set forth under the caption \"Information Concerning Directors and Nominees for Director\" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders on April 28, 1994.\nThe following information relates to Executive Officers of Dravo Corporation who are not Directors.\nCarl A. Gilbert, Age 52, Senior Vice President since October, 1988 and President, Dravo Lime Company since February, 1983.\nErnest F. Ladd III, Age 53, Executive Vice President, Finance and Administration since December, 1989, Vice President, Finance, Treasurer and Controller from June, 1988 to December, 1989; prior thereto Executive Vice President, Dravo Natural Resources Company.\nJohn R. Major, age 49, Vice President, Administration since January, 1989; Vice President, Employee Relations from January, 1988 to January, 1989.\nJames J. Puhala, Age 51, Vice President, General Counsel and Secretary since September, 1987.\nH. Donovan Ross, Age 53, Senior Vice President since October, 1988 and President, Dravo Basic Materials Company since July, 1984.\nAlbert H. Tenhundfeld, Jr., Age 46, Vice President, Finance and Treasurer since December, 1989; prior thereto Vice President, Finance and Treasurer, Dravo Natural Resources Company.\nLarry J. Walker, Age 41, Controller since December, 1989; Controller, Dravo Natural Resources Company since July, 1986.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nInformation required by this item is incorporated by reference to the information set forth under the caption \"Executive Compensation\" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders on April 28, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nInformation required by this item is incorporated by reference to the information set forth under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Ownership by Management of Equity Securities\" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders on April 28, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nInformation required by this item is incorporated by reference to the information set forth under the caption \"Information Concerning Directors and Nominees for Director\" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders on April 28, 1994.\nPART - IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------\n(a) 1. Financial Statements\nThe following consolidated financial statements of the registrant are filed pursuant to Item 8 of this Form 10-K and are incorporated herein by reference to the page numbers indicated below in the 1993 Annual Report to Shareholders which accompanies this report.\n2. Financial Statement Schedules\nThe following financial statement schedules of the registrant are required and are filed pursuant to this item in this Form 10-K.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (CONTINUED)\n(a) 3. Exhibits --------\n(3) Articles of Incorporation and By-laws\n(i) Articles of Amendment restating Dravo Corporation's Articles of Incorporation in their entirety and all subsequent amendments thereto including but not limited to the Statement with Respect to Shares of Dravo Corporation as filed with the Secretary of the Commonwealth of Pennsylvania on January 27, 1992 are incorporated by reference to Exhibit 3.1 of the February 12, 1992 Form 8-K of the Registrant.\n(ii) By-laws of the Registrant as amended October 22, 1992 are incorporated by reference to Exhibit (3) of the September 30, 1992 Form 10-Q of the Registrant.\n(4) Instruments Defining the Rights of Security Holders, including Indentures\n(i) Articles of Amendment restating Dravo Corporation's Articles of Incorporation, described in Exhibit (3)(i) in this Form 10-K of the Registrant.\n(ii) Shareholders' Rights Agreement dated as of April 4, 1986 between Dravo Corporation and PNC Bank, N. A. (formerly Pittsburgh National Bank), as rights agent, incorporated by reference to Exhibit (1) of the April, 1986 Form 8-K of the Registrant.\n(iii) Statement with Respect to Shares - Domestic Business Corporation amending Section 3(a) of the Certificate of Designations, Preferences and Rights of Series D Cumulative Convertible Exchangeable Preference Stock is incorporated by reference to exhibit (4) (ii) of the June 30, 1990 Form 10-Q of the Registrant.\n(iv) Form of indemnification agreement between Dravo Corporation and members of its Board of Directors incorporated by reference to Exhibit (10)(xvii) of the December 31, 1987 Form 10-K of the Registrant.\n(v) Statement with respect to amended rules for Form S-8 is incorporated by reference to Exhibit (4)(x) of the December 31, 1990 Form 10-K of the Registrant.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (CONTINUED)\n(a) 3. Exhibits (continued) --------\n(4)(vi) Credit and Note and Stock Purchase Agreement dated as of September 21, 1988 by and among Dravo Corporation, its wholly-owned subsidiaries, Dravo Lime Company and Dravo Basic Materials Company, Inc. and The Prudential Insurance Company of America and Prudential Interfunding Corp. is incorporated by reference to Exhibit (4)(i) of the September 27, 1988 Form 8-K of the Registrant and amendment dated March 13, 1990 to said agreement is incorporated by reference to Exhibit (4)(v) of the December 31, 1989 Form 10-K of the Registrant.\n(vii) Registration agreement dated as of September 21, 1988 between Dravo Corporation and The Prudential Insurance Company of America, is incorporated by reference to Exhibit (4)(vi) to the September 27, 1988 Form 8-K of the Registrant.\n(viii) (a) Revolving Line of Credit Agreement with all attendant schedules and exhibits dated as of September 20, 1990, by and among Dravo Corporation, Dravo Lime Company, Dravo Basic Materials Company, Inc., First Alabama Bank, and PNC Bank, N. A. (formerly Pittsburgh National Bank) is incorporated by reference to Exhibit (4)(i) of the September 30, 1990 Form 10-Q of the Registrant.\n(b) Amendment to Credit and Note and Stock Purchase Agreement dated as of September 21, 1988 by and among Dravo Corporation, Dravo Lime Company, Dravo Basic Materials Company, Inc., The Prudential Insurance Company of America, and Prudential Interfunding Corp., is incorporated by reference to Exhibit (4) (ii) of the September 30, 1990 Form 10-Q of the Registrant.\n(c) First amendment to the Companies' Pledge Agreement dated September 20, 1990 of the Credit and Note and Stock Purchase Agreement dated September 21, 1988 is incorporated by reference to Exhibit (4)(iii) of the September 30, 1990 Form 10-Q of the Registrant.\n(d) First amendment to the Second Intercreditor Agreement dated September 20, 1990 of the Credit and Note and Stock Purchase Agreement dated September 21, 1988 is incorporated by reference to Exhibit (4)(iv) of the September 30, 1990 Form 10-Q of the Registrant.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (CONTINUED)\n(a) 3. Exhibits (continued) --------\n(4) (viii) (e) Intercreditor Agreement dated September 20, 1990 by and among The Prudential Insurance Company of America, First Alabama Bank, PNC Bank, N. A. (formerly Pittsburgh National Bank), Mellon Bank, N. A., and the Royal Bank of Canada is incorporated by reference to Exhibit (4) (v) of the September 30, 1990 Form 10-Q of the Registrant.\n(ix) (a) Promissory Note dated as of January 4, 1979 between Southern Industries Corporation and The Prudential Insurance Company of America.\n(b) Loan Agreement dated as of December 1, 1978 between Dravo Equipment Company and County of Harrison, Ohio.\nThe Registrant hereby agrees to furnish to the Commission upon request a copy of each of the instruments listed under the exhibit (4)(ix), none of which authorizes the issuance of securities in excess of 10 percent of total assets of the Registrant and its subsidiaries on a consolidated basis.\n(x) Override Agreement, dated January 21, 1992, between Dravo Corporation, The Prudential Insurance Company of America, First Alabama Bank, PNC Bank, N. A. (formerly Pittsburgh National Bank) and Continental Bank, N. A. is incorporated by reference to Exhibit 10.1 of the February 12, 1992 Form 8-K of the Registrant.\n(xi) First Amendment, dated March 10, 1993, to the Override Agreement dated January 21, 1992 between Dravo Corporation, The Prudential Insurance Company of America, First Alabama Bank, PNC Bank, N.A. (formerly Pittsburgh National Bank) and Continental Bank N.A. is incorporated by reference to Exhibit 4 (xi) of the December 31, 1992 Form 10-K of the Registrant.\n(xii) Second Amendment, dated March 7, 1994, to the Override Agreement dated January 21, 1992 is filed herein under separate cover.\n(xiii) First Amendment, dated March 7, 1994, to the Amended and Restated Revolving Credit Agreement dated January 21, 1992 is filed herein under separate cover.\n(xiv) Four copies of the First Amendment To Revolving Note, (one each for The Prudential Insurance Company of America, First Alabama Bank, PNC Bank, N.A. and Continental Bank N.A.), dated March 7, 1994, to the Amended and Restated Revolving Credit Agreement dated January 21, 1992 are filed herein under separate cover.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (CONTINUED)\n(a) 3. Exhibits (continued) --------\n(10) Material Contracts (All of the following are Management Contracts or Compensatory Plans or Arrangements required to be filed as an Exhibit to this Form 10-K.)\n(i) Dravo Corporation Executive Death and Disability Income Executive Benefits Plan (now Executive Benefit Plan), approved by the Board of Directors on October 23, 1980, incorporated by reference to Exhibit (10)(i) of the December 31, 1980 Form 10-K of the Registrant, and amendment thereto dated July 1, 1984, incorporated by reference to Exhibit (10)(i) of the December 31, 1984 Form 10-K of the Registrant.\n(ii) Dravo Corporation Stock Option Plan of 1978, as amended, incorporated by reference to Exhibit (10)(vi) of the December 31, 1982 Form 10-K of the Registrant.\n(iii) Dravo Corporation Long-Term Incentive Award Plan of 1983, as amended, incorporated by reference to Exhibit (10)(iv) of the December 31, 1987 Form 10-K of the Registrant.\n(iv) Dravo Corporation Incentive Compensation Plan is incorporated by reference to Exhibit (10)(v) of the December 31, 1990 Form 10-K of the Registrant.\n(v) Dravo Corporation Employee Stock Option Plan of 1988, incorporated by reference to the Proxy Statement for the Annual Meeting of Shareholders on April 28, 1988.\n(vi) Agreement dated April 23, 1992 between Dravo Corporation and William G. Roth, incorporated by reference to Exhibit 10(x) of the December 31, 1992 Form 10-K of the Registrant.\n(vii) Agreement dated June 1, 1993 between Dravo Corporation and C. A. Torbert, Jr. is filed herein under separate cover.\n(viii) Agreement dated June 1, 1993 between Dravo Corporation and Ernest F. Ladd III is filed herein under separate cover.\n(ix) Agreement dated June 1, 1993 between Dravo Corporation and Carl A. Gilbert is filed herein under separate cover.\n(x) Agreement dated June 1, 1993 between Dravo Corporation and H. Donovan Ross is filed herein under separate cover.\n(xi) Agreement dated June 1, 1993 between Dravo Corporation and John R. Major is filed herein under separate cover.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (CONTINUED)\n(a) 3. Exhibits (continued) --------\n(10) Material Contracts\n(xii) Dravo Corporation Stock Option Plan of 1994 is incorporated by reference to the Proxy Statement for the Annual Meeting of Shareholders on April 28, 1994.\n(11) Statement Re Computation of Per Share Earnings filed under this cover.\n(13) 1993 Annual Report to Shareholders attached to this report under this cover. Except for the pages and information thereof expressly incorporated by reference in this Form 10-K, the Annual Report to Shareholders is provided solely for the information of the Securities and Exchange Commission and is not to be deemed \"filed\" as part of the Form 10-K.\n(21) Subsidiaries of the Registrant filed under this cover.\n(23) Consent of Independent Auditors filed under this cover.\n(24) Powers of Attorney are filed herein under separate cover.\n(b) Reports on Form 8-K -------------------\nThere were no reports on Form 8-K for the three months ended December 31, 1993.\nSIGNATURES\nPursuant 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.\nDRAVO CORPORATION\nMarch 29, 1994 By:\/s\/ CARL A. TORBERT, JR. ----------------------------------------------------------- Carl A. Torbert, Jr., President and Chief Executive Officer\nPursuant 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 and on the date indicated.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Dravo Corporation:\nUnder date of February 16, 1994, we reported on the consolidated balance sheets of Dravo Corporation and subsidiaries as of December 31, 1993, and 1992, and the related consolidated statements of operations, retained earnings, and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 annual report to shareholders. As discussed in Notes 10 and 13 to the consolidated financial statements, effective January 1, 1993, the company adopted the methods of accounting for postretirement benefits other than pensions and for income taxes as prescribed by Statements of Financial Accounting Standard Nos. 106 and 109, respectively. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in answer to Item 14(a)(2). These financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nOur audit report on the consolidated financial statements of Dravo Corporation and subsidiaries referred to above contains an explanatory paragraph that states that certain lawsuits, claims and assertions have been brought against the company for environmental costs and contract and claim disputes, the outcome of which presently cannot be determined.\nKPMG PEAT MARWICK\nNew Orleans, Louisiana February 16, 1994\nTHIS PAGE INTENTIONALLY LEFT BLANK\nDRAVO CORPORATION (PARENT COMPANY) Schedule III - Condensed Financial Information of Registrant Balance Sheets\nSee accompanying notes to financial statements.\nDRAVO CORPORATION (PARENT COMPANY) Schedule III - Condensed Financial Information of Registrant Balance Sheets\nSee accompanying notes to financial statements.\nDRAVO CORPORATION (PARENT COMPANY) Schedule III - Condensed Financial Information of Registrant Statements of Operations\nSee accompanying notes to financial statements.\nDRAVO CORPORATION (PARENT COMPANY)\nSchedule III - Condensed Financial Information of Registrant Statements of Cash Flows\nSee accompanying notes to financial statements.\nDRAVO CORPORATION (PARENT COMPANY) Schedule III - Condensed Financial Information of Registrant Statements of Cash Flows\nSee accompanying notes to financial statements.\nDRAVO CORPORATION (PARENT COMPANY) Schedule III - Condensed Financial Information of Registrant Notes to Financial Statements\nNotes 1 through 3, 5 through 14 and 16 to Dravo Corporation's Consolidated Financial Statements have relevance to the parent company financial statements and should be read in conjunction therewith.\nNote 1: Commitments\nThere was no continuing operations rental expense for 1993, 1992 or 1991. The minimum future rentals under noncancelable operating leases and minimum future rental receipts from subleases to third parties as of December 31, 1993 are indicated in the table below. Of the $19.4 million net minimum payments, $10.1 million has been expensed in connection with discontinued operations.\nNote 2: Income Taxes\nThe company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS 109) effective January 1, 1993. The cumulative effect of this change in accounting for income taxes of $276,000 is determined as of January 1, 1993 and is reported separately in the Statements of Operations for the year ended December 31, 1993. Prior years financial statements have not been restated to apply the provisions of SFAS 109.\nDravo Corporation files a consolidated federal income tax return which includes the parent and consolidated subsidiaries. Dravo Corporation parent company financial statements recognize current income tax benefits to the extent the benefits are offset by current income tax liabilities of the consolidated subsidiaries. Long-term deferred income tax benefits are recognized to the extent that it is more likely than not that the company will generate sufficient consolidated taxable income to utilize net operating loss carryforwards prior to their expiration.\nNote 2: Income Taxes (continued)\nThe income tax benefit for the year ended December 31, 1993 is comprised of the following:\nDeferred income taxes of $13.9 million at December 31, 1992 represent deferred benefits offsetting deferred income tax liabilities of the consolidated subsidiaries. Concurrent with the implementation of SFAS 109, this amount was reclassified from deferred income taxes to advances from affiliates.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993 are as follows:\nManagement believes it is more likely than not that the net deferred tax asset of $24.9 million will be realized through the reversal of temporary differences and through its subsidiaries future income. In order to fully realize the net deferred tax asset, the parent company and its subsidiaries will need to generate future taxable income of approximately $73.2 million prior to the expiration of its net operating loss carryforwards. There can be no assurance, however, that the parent, or its subsidiaries, will generate any earnings or any specific level of continued earnings.\nNOTE 3: DIVIDENDS - ------------------\nCash dividends paid to the registrant for the respective years ended December 31:\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule V - Property, Plant and Equipment\nYears Ended December 31, 1993, 1992, and 1991\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule V - Property, Plant and Equipment (continued)\nYears Ended December 31, 1993, 1992, and 1991\n(1) Transfers between accounts.\n(2) $402 represents the establishment of a shell dredging equipment reserve.\n(3) $402 represents the write-off of shell dredging equipment against the reserve. The remaining $7 is an adjustment of asset value.\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment\nYears Ended December 31, 1993, 1992, and 1991\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment (continued)\nYears Ended December 31, 1993, 1992, and 1991\n(1) Transfers between accounts.\n(2) $3 is an adjustment of asset value.\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule IX - Short-term Borrowings\nYears Ended December 31, 1993, 1992, and 1991\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule IX - Short-term Borrowings (continued)\nYears Ended December 31, 1993, 1992, and 1991\n(1) Calculated by dividing the aggregate short-term borrowings by total number of days in the year.\n(2) Calculated by dividing the average aggregate short-term borrowings into the related interest expense for the year.\nDRAVO CORPORATION AND SUBSIDIARIES\nSchedule X - Supplementary Income Statement Information\nYears ended December 31, 1993, 1992 and 1991\n(1) Does not exceed 1% of consolidated revenues in 1993, 1992 or 1991.\nEXHIBIT INDEX","section_15":""}
{"filename":"37664_1993.txt","cik":"37664","year":"1993","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"86521_1993.txt","cik":"86521","year":"1993","section_1":"ITEM 1. BUSINESS - ---------------------------------------------------------------------------\nDESCRIPTION OF BUSINESS\nSan Diego Gas & Electric Company is an operating public utility organized and existing under the laws of the State of California. SDG&E is engaged principally in the electric and natural gas business. It generates and purchases electric energy and distributes it to 1.1 million customers in San Diego County and a portion of Orange County, California. It also purchases natural gas and distributes it to 690,000 customers in San Diego County. In addition, it transports electricity and natural gas for others. Factors affecting SDG&E's utility operations include competition, population growth, customers' bypass of its electric and gas system, nonutility generation, changes in interest and inflation rates, environmental and other laws, regulation, and deregulation.\nSDG&E's diversified interests include three wholly owned subsidiaries: Enova Corporation, which invests in affordable-housing projects; Califia Company, which conducts leasing activities; and Pacific Diversified Capital Company, which is a holding company for SDG&E's other subsidiaries. PDC owns an 80-percent share in Wahlco Environmental Systems, a supplier of air pollution control and energy-saving products and services for utilities and other industries. PDC's wholly owned subsidiary, Phase One Development is a commercial real estate developer. Additional information concerning SDG&E's subsidiaries is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 in the 1993 Annual Report to Shareholders and in Note 2 of the \"Notes to Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nGOVERNMENT REGULATION\nLocal Regulation\nSDG&E has separate electric and gas franchises with the two counties and 25 cities in its service territory. These franchises allow SDG&E to locate facilities for the transmission and distribution of electricity and gas in the streets and other public places. The franchises do not have fixed terms, except for the following:\nGRANTOR TYPE EXPIRATION - -------------------------------------------------------------- City of Chula Vista Electric and gas 1997 City of Encinitas Electric and gas 2012 City of San Diego Electric and gas 2021 City of Coronado Electric and gas 2028 City of Escondido Gas 2036 County of San Diego Gas 2030 - --------------------------------------------------------------\nState Regulation\nThe California Public Utilities Commission consists of five members appointed by the governor and confirmed by the senate. The commissioners serve six-year terms and have the authority to regulate SDG&E's rates and conditions of service, sales of securities, rate of return, rates of depreciation, uniform systems of accounts, examination of records, and long-term resource procurement. The CPUC also conducts various reviews of utility performance and conducts investigations into various matters, such as the environment, deregulation and competition, to determine its future policies.\nThe California Energy Commission has discretion over electric demand forecasts for the state and for specific service territories. Based upon these forecasts, the CEC determines the need for additional plants and for conservation programs. The CEC sponsors alternative-energy research and development projects, promotes energy conservation programs, and maintains a statewide plan of action in case of energy shortages. In addition, the CEC certifies power plant sites and related facilities within California.\nFederal Regulation\nThe Federal Energy Regulatory Commission regulates electric rates involving sales for resale, transmission access, rates of depreciation and uniform systems of accounts. The FERC also regulates the interstate sale and transportation of natural gas.\nThe Nuclear Regulatory Commission oversees the licensing, construction and operation of nuclear facilities. NRC regulations require extensive review of the safety, radiological and environmental aspects of these facilities. Periodically, the NRC requires that newly developed data and techniques be used to reanalyze the design of a nuclear power plant and, as a result, requires plant modifications as a condition of continued operation in some cases.\nLicenses and Permits\nSDG&E obtains a number of permits, authorizations and licenses in connection with the construction and operation of its electric generating plants. Discharge permits, San Diego Air Pollution Control District permits and NRC licenses are the most significant examples. The licenses and permits may be revoked or modified by the granting agency if facts develop or events occur that differ significantly from the facts and projections assumed in granting the approval. Furthermore, discharge permits and other approvals are granted for a term less than the expected life of the facility. They require periodic renewal, which results in continuing regulation by the granting agency.\nOther regulatory matters are described throughout this report.\nCOMPETITION\nThis topic is discussed in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in \"Rate Regulation\" and \"Electric Operations\" herein.\nSOURCES OF REVENUE\n(In Millions of Dollars) 1993 1992 1991 - ----------------------------------------------------------------------------- Utility revenue by type of customer: Electric - Residential $ 615 $ 601 $ 561 Commercial 572 543 503 Industrial 250 245 230 Other 77 58 64 - ----------------------------------------------------------------------------- Total Electric 1,514 1,447 1,358 - ----------------------------------------------------------------------------- Gas - Residential 195 181 184 Commercial 63 61 67 Industrial 40 54 68 Other 49 41 19 - ----------------------------------------------------------------------------- Total Gas 347 337 338 - ----------------------------------------------------------------------------- Total Utility 1,861 1,784 1,696 - ----------------------------------------------------------------------------- Diversified Operations 119 87 93 - ----------------------------------------------------------------------------- Total $1,980 $1,871 $1,789 - -----------------------------------------------------------------------------\nIndustry segment information is contained in \"Statements of Consolidated Financial Information by Segments of Business\" on Page 31 of the 1993 Annual Report to Shareholders.\nELECTRIC OPERATIONS\nINTRODUCTION\nSDG&E's philosophy of providing adequate energy at the lowest possible cost has been based on a combination of production from its own plants and purchases from other producers. The purchases have been a combination of short-term and long-term contracts and spot purchases. All resource acquisitions are obtained through a competitive bidding process. This method of acquisition is encouraged by both the CPUC and the CEC. It is likely this process will continue into the foreseeable future in California. To date, competitive bidding has been limited to generation sources and has not included energy conservation measures that could reduce the need for generation capacity. However, the CPUC has recently ordered utilities in the state to implement pilot demonstration projects to allow others to competitively bid to supply energy conservation services to utilities' customers.\nRESOURCE PLANNING\nIn 1992 the CPUC issued a decision on the Biennial Resource Plan Update proceedings. As a result of the decision, SDG&E was required to allow qualified nonutility power producers that cogenerate or use renewable energy technologies to competitively bid for a portion of SDG&E's future capacity needs. The decision also required SDG&E to implement energy-conservation programs which would reduce SDG&E's future need for additional capacity. In addition, the CPUC granted SDG&E the flexibility to determine how best to meet its remaining capacity requirements.\nIn 1993 SDG&E was involved in various stages of completing three separate solicitations for new power sources. These three solicitations include contract negotiations for short-term purchased power ranging from 200 to 700 mw for the period 1994 through 1997, the BRPU auction for 491 mw of capacity by 1997, and competitive bidding to determine whether the proposed 500-mw South Bay Unit 3 Repower project could be replaced by lower-cost power. Additional information concerning resource planning is discussed in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nELECTRIC RESOURCES\nBased on generating plants in service and purchased power contracts in place as of January 31, 1994, the net megawatts of firm electric power available to SDG&E during the next summer (normally the time of highest demand) are as follows:\nSOURCE NET MEGAWATTS - ------------------------------------------------------------------ Nuclear generating plants 430 Oil\/gas generating plants 1,611 Combustion turbines 332 Long-term contracts with other utilities 675 Short-term contracts with other utilities 342 Contracts with others 217 - ------------------------------------------------------------------ Total 3,607 - ------------------------------------------------------------------\nSDG&E'S 1993 system peak demand of 2,850 mw occurred on September 8, when the net system capability, including power purchases, was 3,474 mw. SDG&E's record system peak demand of 3,285 mw occurred on August 17, 1992, when the net system capability was 3,669 mw.\nNUCLEAR GENERATING PLANTS\nSDG&E owns 20 percent of the three nuclear units at San Onofre Nuclear Generating Station. The cities of Riverside and Anaheim own a total of 5 percent of SONGS 2 and 3. Southern California Edison Company owns the remaining interests and operates the units.\nIn November 1992 the CPUC issued a decision to permanently shut down SONGS 1.\nThe NRC requires that SDG&E and Edison file a decommissioning plan in 1994, although final dismantling will not occur until SONGS 2 and 3 are also retired. The unit's spent nuclear fuel has been removed from the reactor and stored on-site. In March 1993 the NRC issued a Possession-Only License for SONGS 1, and the unit is expected to be in its final long-term permanently defueled storage condition by April 1994.\nSONGS 2 and 3 began commercial operation in August 1983 and April 1984, respectively. SDG&E's share of the capacity is 214 mw of SONGS 2 and 216 mw of SONGS 3.\nBetween 1991 and 1993, SDG&E spent $83 million on capital modifications and additions for all three units and expects to spend $26 million in 1994 on SONGS 2 and 3. SDG&E deposits funds in an external trust to provide for the future dismantling and decontamination of the units. The shutdown of SONGS 1 will not affect contributions to the trust. For additional information, see Note 5 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nIn 1983 the CPUC adopted performance incentive plans for SONGS that set a Target Capacity Factor range of 55 to 80 percent for SONGS 2 and 3. Energy costs or savings outside that range are shared equally by SDG&E and its customers. Since the TCF was adopted, these units have operated above 55 percent for each of their fuel cycles. In addition to always attaining the minimum TCF, SONGS 2 and 3 have exceeded the range a total of four times in the eleven completed cycles. However, there can be no assurance that they will continue to achieve a 55 percent capacity factor.\nAdditional information concerning the SONGS units is described under \"Environmental, Health and Safety\" and \"Legal Proceedings\" herein and in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in Notes 5 and 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nOIL\/GAS GENERATING PLANTS\nSDG&E's South Bay and Encina power plants are equipped to burn either fuel oil or natural gas. The four South Bay units went into operation between 1960 and 1971 and can generate 690 mw. The five Encina units began operation between 1954 and 1978 and can generate 921 mw. SDG&E sold and leased back Encina Unit 5 (315 mw) in 1978. The lease term is through 2004, with renewal options for up to 15 additional years.\nSDG&E has 19 combustion turbines that were placed in service from 1966 to 1979. They are located at various sites and are used only in times of peak demand.\nThe Silver Gate plant is in storage and its 230 mw are not included in the system's capability. Silver Gate is not currently scheduled to return to service. The plant would have to comply with various environmental rules and regulations before returning to service. The cost of compliance could be significant.\nAdditional information concerning SDG&E's power plants is described under \"Environmental, Health and Safety,\" \"Electric Resources\" and \"Electric Properties\" herein and in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nPURCHASED POWER\nThe following table lists significant contracts with other utilities and others:\nMegawatt Supplier Period Commitment Source - ---------------------------------------------------------------------------\nLong-Term Contracts with Other Utilities:\nBonneville Power May Through September 300 Hydro Power Administration (1994, 1995, 1996)\nComision Federal de Through September 1997 150 Geothermal Electricidad (Mexico)\nPortland General Through December 1998 50 Hydro storage Electric Company Through December 2013 75 Coal\nPublic Service Company Through April 2001 100 System supply of New Mexico\nShort-Term Contracts with Other Utilities:\nImperial Irrigation Through March 1994 150 System Supply District\nPacifiCorp Through December 1994 200 System Supply\nRocky Mountain Through December 1994 67 Coal Generation Cooperative\nSalt River Project Through December 1994 75 System Supply\nContracts with Others:\nBayside Cogeneration June 1995 through 50 Cogeneration June 2025\nCities of Azusa, Banning Through December 1994 65 Coal and Colton January-December 1995 40\nGoal Line Limited November 1994 through 50 Cogeneration Partnership November 2024\nSithe Energies Through December 2019 102 Cogeneration USA, Inc.\nYuma Cogeneration June 1994 through 50 Cogeneration Associates June 2024\nThe commitment with CFE is for energy and capacity. The others are for capacity only. The capacity charges are based on the costs of the generating facilities from which purchases are made. These charges generally cover costs such as lease payments, operating and maintenance expenses, transmission expenses, administrative and general expenses, depreciation, state and local taxes, and a return on the seller's rate base (if a utility) or other markup on the seller's cost.\nEnergy costs under the CFE contract are indexed to changes in Mayan crude oil prices and the dollar\/peso exchange rate. Energy costs under the other contracts are based primarily on the cost of fuel used to generate the power.\nThe locations of the suppliers which have long-term contracts with SDG&E and the primary transmission lines (and their capacities) used by SDG&E are shown on the following map of the Western United States. The transmission capacity shown for the Pacific Intertie does not reflect the effects of the temporary earthquake damage discussed under \"Transmission Arrangements - Pacific Intertie\" herein. Where applicable, interconnection to the primary lines is provided by contract.\n[MAP]\nLONG-TERM CONTRACTS WITH OTHER UTILITIES\nBONNEVILLE POWER ADMINISTRATION: In 1993 SDG&E and BPA entered into an agreement for the exchange of capacity and energy. SDG&E provides BPA with off-peak, non-firm energy in exchange for capacity and associated energy. In addition, SDG&E makes energy available for BPA to purchase during the period January through April of each year. To facilitate the exchange, SDG&E has an agreement with Edison for 100 mw of firm transmission service from the Nevada-Oregon border to SONGS.\nCOMISION FEDERAL DE ELECTRICIDAD: In 1986 SDG&E began the 10-year term of a purchase agreement under which SDG&E purchases firm energy and capacity of 150 mw from CFE. In March 1990 SDG&E obtained an option, exercisable on or before September 1, 1994, to extend the purchase agreement by up to 13 months.\nPORTLAND GENERAL ELECTRIC COMPANY: In 1985 SDG&E and PGE entered into an agreement for the purchase of 75 mw of capacity from PGE's Boardman Coal Plant from January 1989 through December 2013. SDG&E pays a monthly capacity charge plus a charge based upon the amount of energy received. In addition, SDG&E has 50 mw of available firm hydro storage service with PGE through\nDecember 1998. SDG&E has also purchased from PGE 75 mw of transmission service in the northern section of the Pacific Intertie through December 2013.\nPUBLIC SERVICE COMPANY OF NEW MEXICO: In 1985 SDG&E and PNM entered into an agreement for the purchase of 100 mw of capacity from PNM's system from June 1988 through April 2001. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nSHORT-TERM CONTRACTS WITH OTHER UTILITIES\nIMPERIAL IRRIGATION DISTRICT: In September 1993 SDG&E and IID entered into an agreement for the purchase of 150 mw of firm energy through March 1994. The energy charge is based on the amount of energy received.\nPACIFICORP: In October 1993 SDG&E entered into an agreement with PacifiCorp for the purchase of 200 mw of capacity during 1994. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nROCKY MOUNTAIN GENERATION COOPERATIVE: In October 1993 SDG&E and RMGC entered into an agreement for the purchase of 67 mw of capacity through December 1994. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nSALT RIVER PROJECT: In December 1993 SDG&E and SRP entered into an agreement for the purchase of 75 mw of capacity through December 1994. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nCONTRACTS WITH OTHERS\nBAYSIDE COGENERATION: SDG&E and Bayside have entered into a 30-year agreement for the purchase of 50 mw of capacity which is scheduled to begin in June 1995. SDG&E will pay a capacity charge plus a charge based on the amount of energy received.\nCITIES OF AZUSA, BANNING AND COLTON: In 1993 SDG&E and the cities entered into an agreement for the purchase of 65 mw of capacity from January 1994 through December 1994 and 40 mw of capacity from January 1995 through December 1995. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nGOAL LINE LIMITED PARTNERSHIP: SDG&E and Goal Line have entered into a 30-year agreement for the purchase of 50 mw of capacity which is scheduled to begin in November 1994. SDG&E will pay a capacity charge plus a charge based on the amount of energy received.\nSITHE ENERGIES USA, INC.: In April 1985 SDG&E entered into three 30-year agreements for the purchase of 102 mw of capacity from December 1989 through December 2019. SDG&E pays a capacity charge plus a charge for the amount of energy received.\nYUMA COGENERATION ASSOCIATES: SDG&E and Yuma Cogeneration Associates have entered into a 30-year agreement for 50 mw of capacity which is scheduled to begin in June 1994. SDG&E will pay a capacity charge plus a charge for the amount of energy received.\nAdditional information concerning SDG&E's purchased power contracts is described in \"Legal Proceedings\" herein and in Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nPOWER POOLS\nIn 1964 SDG&E, Pacific Gas & Electric and Edison entered into the California Power Pool Agreement. It provides for the transfer of electrical capacity and energy by purchase, sale or exchange during emergencies and at other mutually determined times.\nSDG&E is a participant in the Western Systems Power Pool, which involves an electric power and transmission rate agreement with utilities and power agencies located from British Columbia through the western states and as far east as the Mississippi River. The 54 investor-owned and municipal utilities, state and federal power agencies, and energy brokers share power and information in order to increase efficiency and competition in the bulk power market. Participants are able to target and coordinate delivery of cost-effective sources of power from outside their service territories through a centralized exchange of information.\nTRANSMISSION ARRANGEMENTS\nIn addition to interconnections with other California utilities, SDG&E has firm transmission capabilities for purchased power from the Northwest, the Southwest and Mexico.\nPacific Intertie\nSDG&E, PG&E and Edison share transmission capacity on the Pacific Intertie under an agreement that expires in July 2007. The Pacific Intertie enables SDG&E to purchase and receive surplus coal and hydroelectric power from the Northwest. SDG&E's share of the intertie is 266 mw. SDG&E recently purchased up to an additional 200 mw of firm rights on the Pacific Intertie through 1996. In January 1994 a major earthquake centered in Los Angeles County, California temporarily reduced SDG&E's share of the intertie's available capacity to about 100 mw. Repairs to the transmission facilities are scheduled to be completed in December 1994. SDG&E does not expect this to have a significant impact on its transmission capabilities within California.\nSouthwest Powerlink\nSDG&E's 500-kilovolt Southwest Powerlink transmission line, which it shares with Arizona Public Service Company and IID, extends from Palo Verde, Arizona to San Diego and enables SDG&E to import power from the Southwest. SDG&E's share of the line is 914 mw, although it can be less, depending on specific system conditions. Mexico Interconnection\nMexico's Baja California Norte system is connected to SDG&E's system via two 230-kilovolt interconnections with firm capability of 408 mw. SDG&E uses this interconnection for transactions with CFE.\nAdditional Transmission Capabilities\nThrough an agreement with Edison, SDG&E has obtained the option to purchase 100 mw of transmission service on the existing Palo Verde - Devers transmission line in the late 1990s. The agreement is contingent upon Edison's construction of its second transmission line connecting the Palo Verde Nuclear Generating Station in Arizona to the Devers substation near Palm Springs, California. This agreement also provides SDG&E with the option to exchange up to 200 mw of Southwest Powerlink transmission rights for up to 200 additional mw of Edison's rights on the first Palo Verde - Devers transmission line. This exchange would enable both utilities to further diversify their transmission paths.\nSDG&E has indicated an interest in projects to obtain additional transmission capabilities from the Rocky Mountain and Southwest regions and within California.\nTRANSMISSION ACCESS\nAs a result of the enactment of the National Energy Policy Act of 1992, the FERC has established rules to implement the Act's transmission access provisions. These rules specify FERC-required procedures for others' requests for transmission service. Additional information regarding transmission access is described in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nFUEL AND PURCHASED-POWER COSTS\nThe following table shows the percentage of each electric fuel source used by SDG&E and compares the costs of the fuels with each other and with the total cost of purchased power:\nPercent of Kwh Cents per Kwh - ---------------------------------------------------------------------------- 1993 1992 1991 1993 1992 1991 - ---------------------------------------------------------------------------- Fuel oil 3.7% 0.6% 0.7% 2.7 4.0 4.2 Natural gas 24.4 27.4 22.7 3.4 3.1 3.2 Nuclear fuel 17.2 22.3 20.9 0.6 0.8 0.9 - ---------------------------------------------------------------------------- Total generation 45.3 50.3 44.3 Purchased power-net 54.7 49.7 55.7 3.5 3.8 3.5 - ---------------------------------------------------------------------------- Total 100.0% 100.0% 100.0% - ----------------------------------------------------------------------------\nThe cost of purchased power includes capacity costs as well as the costs of fuel. The cost of natural gas includes transportation costs. The costs of fuel oil, natural gas and nuclear fuel do not include SDG&E's capacity costs.\nWhile fuel costs are significantly less for nuclear units than for other units, capacity costs are higher.\nELECTRIC FUEL SUPPLY\nUranium\nThe nuclear fuel cycle includes services performed by others. These services and the dates through which they are under contract are as follows:\nMining and milling of uranium concentrate(1) 1994 Conversion of uranium concentrate to uranium hexafluoride 1995 Enrichment of uranium hexafluoride(2) 1998 Fabrication of fuel assemblies 2000 Storage and disposal of spent fuel(3) _\n1 SDG&E's contracted supplier of uranium concentrate is Pathfinder Mines Corporation. However, the majority of the requirements will be supplied by purchases from the spot market.\n2 The Department of Energy is committed to offer any required enrichment services through 2014.\n3 Spent fuel is being stored at SONGS, where storage capacity will be adequate at least through 2003. If necessary, modifications in fuel-storage technology can be implemented that would provide, at additional cost, on-site storage capacity for operation through 2014, the expiration date of the NRC operating license. The DOE's plan is to make a permanent storage site for the spent nuclear fuel available by 2010.\nTo the extent not currently provided by contract, the availability and the cost of the various components of the nuclear fuel cycle for SDG&E's nuclear facilities cannot be estimated at this time.\nPursuant to the Nuclear Waste Policy Act of 1982, SDG&E entered into a contract with the DOE for spent fuel disposal. Under the agreement, the DOE is responsible for the ultimate disposal of spent fuel. SDG&E is paying a disposal fee of $1 per megawatt-hour of net nuclear generation. Disposal fees average $3 million per year. SDG&E recovers these disposal fees in customer rates.\nAdditional information concerning nuclear fuel costs is discussed in Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nFuel Oil\nSDG&E has no long-term commitments to purchase fuel oil. The use of fuel oil is dependent upon price differences between it and alternative fuels, primarily natural gas. During 1993 SDG&E burned 1.1 million barrels of fuel oil. Fuel oil usage in 1994 will depend on its price relative to natural gas and the availability of natural gas and other alternatives. The lowest-priced fuel will be used in order to minimize fuel costs for electric generation.\nNATURAL GAS OPERATIONS - ---------------------------------------------------------------------------\nSDG&E purchases natural gas for resale to its customers and for fuel in its electric generating plants. All natural gas is delivered to SDG&E under transportation and storage agreement with Southern California Gas Company through two transmission pipelines with a combined capacity of 400 million cubic feet per day. During 1993 SDG&E purchased approximately 102 billion cubic feet of natural gas.\nThe majority of SDG&E's natural gas requirements are met through contracts of less than one year. SDG&E purchases natural gas primarily from various spot-market suppliers and from suppliers under short-term contracts. These supplies originate in New Mexico, Oklahoma and Texas and are transported by El Paso Natural Gas Company and by Transwestern Pipeline Company. In November 1993 natural gas deliveries to SDG&E commenced under long-term contracts with four Canadian suppliers when the Alberta-to-California pipeline expansion project began commercial operation. This natural gas is transported over Pacific Gas Transmission and PG&E pipelines to SDG&E's system. The contracts have varying terms through 2004.\nAdditional information concerning SDG&E's gas operations is described under \"Legal Proceedings\" herein and in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nRATE REGULATION - -----------------------------------------------------------------------------\nThe following ratemaking procedures are changing under SDG&E's proposed incentive-based ratemaking process which is described further under \"Performance-Based Ratemaking\" below:\nBASE RATES\nTraditionally, SDG&E has filed a general rate application with the CPUC every three years to determine its base rates. This allows SDG&E to recover its basic non-fuel business costs such as the cost of operating and maintaining the utility system, taxes, depreciation and the cost of accommodating system growth. Between these general rate cases, an attrition procedure allows adjustments in rates based on inflation and system growth. In addition, SDG&E files an annual application to establish its cost of capital, which reflects the cost of debt and equity. The most recent attrition and cost of capital proceeding went into effect on January 1, 1994.\nFUEL AND ENERGY RATES\nThe CPUC requires balancing accounts for fuel and purchased energy costs and for sales volumes. The CPUC sets balancing account rates based on estimated costs and sales volumes. Revenues are adjusted upward or downward to reflect the differences between the authorized and actual volumes and costs. These differences are accumulated in the balancing accounts and represent amounts to be either recovered from customers or refunded to them. Periodically, the CPUC adjusts SDG&E's rates to amortize the accumulated differences. As a result, changes in SDG&E's fuel and purchased power costs or changes in electric and gas sales volumes normally have not affected SDG&E's net income.\nELECTRIC FUEL COSTS AND SALES VOLUMES\nRates to recover electric fuel and purchased power costs are determined in the Energy Cost Adjustment Clause proceeding. This proceeding take place annually, although a semi-annual review is required if the anticipated rate change exceeds a specified threshold. The proceedings take place in two phases:\nIn the forecast phase, prices are set based on the estimated cost of fuel and purchased power for the following year and are adjusted to reflect any changes from the previous period. These adjustments are made by amortizing any accumulation in the balancing accounts described above.\nIn the other phase, the reasonableness review, the CPUC evaluates the prudence of SDG&E's fuel and purchased power transactions, electric operations, and natural gas transactions and operations. As described under \"Performance-Based Ratemaking\" these reviews will now only be required if SDG&E's recorded fuel and energy expenses result in significant variances from the established benchmarks.\nThe Electric Revenue Adjustment Mechanism compensates for variations in sales volume compared to the estimates used for setting the non-fuel component of rates. ERAM is designed to stabilize revenues, which may otherwise vary due to changes in sales volumes largely resulting from weather fluctuations. Any accumulation in the ERAM balancing account is amortized when new rates are set in the ECAC proceeding.\nNATURAL GAS COSTS AND SALES VOLUMES\nCustomer rates to recover the cost of purchasing and transporting natural gas are determined in the Biennial Cost Allocation Proceeding. The BCAP proceeding normally occurs every two years and is updated in the following year for purposes of amortizing any accumulation in the gas balancing accounts. Transportation costs include intrastate and interstate pipeline charges, take-or-pay obligations, industry restructuring costs resulting from changes in federal and state regulations, and transportation and storage fees.\nBalancing accounts for natural gas costs and sales volumes are similar to those for electric costs and sales volumes. The natural gas balancing accounts include the Purchased Gas Account for gas costs and the Gas Fixed Cost Account for sales volumes. Balancing account coverage includes both core customers (primarily residential and commercial customers) and noncore customers (primarily large industrial customers). However, SDG&E receives balancing account coverage on 75 percent of noncore GFCA overcollections and undercollections.\nOTHER COSTS\nEnergy Conservation Programs\nOver the past several years, SDG&E has promoted conservation programs to encourage efficient use of energy. The programs are designed to conserve energy through the use of energy-efficiency measures that will reduce customers' energy costs and offset the need to build additional power plants.\nThe costs of these programs are being recovered through electric and natural gas rates. The programs contain an incentive mechanism that could increase or decrease SDG&E's earnings, depending upon the performance of the programs in meeting specified efficiency and expenditure targets. The CPUC has encouraged expansion of these programs, authorizing expenditures annually of $54 million for 1993 through 1995. However, the CPUC has also ordered utilities to conduct a test program to determine if others could offer energy conservation services at a lower cost than the utilities'.\nLow Emission Vehicle Programs\nSince 1991 SDG&E has conducted a CPUC-approved natural gas vehicle program. The program includes building refueling stations, demonstrating new technology, providing incentives and converting portions of SDG&E's fleet vehicles to natural gas. The cost of this program is being recovered in natural gas rates.\nIn 1993 SDG&E opened 14 refueling stations at existing gasoline stations under cost-sharing arrangements with major oil companies in order to demonstrate that natural gas is an economical alternative vehicle fuel that\ncould assist automobile companies in meeting federal and state clean air standards. SDG&E plans to add eight more natural gas refueling stations in 1994. During 1993 there were 356 natural gas vehicles operating in San Diego.\nIn July 1993 the CPUC issued a decision adopting guidelines for utility participation in the CPUC's low-emission vehicle program to encourage the use of electric and natural gas-powered vehicles. The six-year program will provide funding to build natural gas vehicle refueling stations and electric vehicle recharging stations, offer incentives for purchasing EVs and NGVs, convert existing vehicles, and educate the public on the benefits of alternative fuels. On November 1, 1993 SDG&E filed an application with the CPUC, requesting $26 million to fund an EV program and to expand its existing NGV program beginning in 1995. On February 3 the CPUC approved a portion of SDG&E's EV program request by establishing a memorandum account for planned expenditures of $530,000 for EV recharging stations and customer incentives to purchase EVs. A final CPUC decision is expected in late 1994.\nPERFORMANCE-BASED RATEMAKING\nIn October 1992 SDG&E applied to the CPUC to implement performance-based ratemaking, requesting incentive regulation for: 1) natural gas procurement and transportation; 2) electric generation and purchased energy; 3) base rates and 4) long-term electric resource procurement.\nOn June 23, 1993 the CPUC approved the first two mechanisms on a two-year experimental basis beginning August 1, 1993. These mechanisms will measure SDG&E's ability to purchase and transport natural gas, and to generate energy or purchase short-term energy at the lowest possible cost, by comparing SDG&E's performance against various market benchmarks. SDG&E's shareholders and customers will share in any savings or excess costs within predetermined ranges.\nUnder the natural gas procurement and transportation mechanism, if SDG&E's natural gas supply and transportation expenses exceed the benchmark by more than 2 percent, SDG&E will recover one-half of the excess. However, if expenses fall below the index, SDG&E's shareholders and customers will share equally in the savings.\nThe benchmark to measure SDG&E's electric generation and purchased energy performance is based upon the difference between SDG&E's actual and authorized electric fuel and short-term purchased energy expenses. SDG&E would be at risk for about one-half of the expenses that exceed the authorized amount by 6 percent or less. SDG&E would be allowed to recover expenses exceeding the 6 percent range, subject to a reasonableness review by the CPUC. However, SDG&E would receive about one-half of the savings if expenses fall below the authorized amount by 6 percent or less. SDG&E's customers would receive 100 percent of the savings if expenses fall below the 6 percent range.\nUnder the proposed base-rate mechanism, SDG&E would forego its next General Rate Case, scheduled for 1996, and utilize the proposed base-rate mechanism for a 5-year period beginning in May 1994. SDG&E's initial revenue requirements would be based on its 1993 General Rate Case Decision. This would replace the CPUC's requirement for a costly and detailed examination of SDG&E's costs every three years in the traditional General Rate Case. However, SDG&E's annual cost of capital proceeding would be continued. This streamlined approach would also allow SDG&E to respond more effectively to competition and to other factors affecting rates.\nThe proposed base-rate mechanism has three components. The first is a formula similar to the current attrition mechanism used to determine SDG&E's annual revenue requirement for operating, maintenance and capital expenditures. The second is a set of indicators which determine performance standards for customer rates, employee safety, electric system reliability and customer satisfaction. Each indicator specifies a range of possible shareholder benefits and risks. SDG&E could be penalized up to a total of $21 million should it fall significantly below these standards or earn up to $19 million if it exceeds all of the performance targets. The third component would set limits on SDG&E's rate of return. If SDG&E realizes an actual rate of return that exceeds its authorized rate of return by one percent to one and a half percent, it would be required to refund 25 percent of the excess over one percent to customers. If SDG&E's rate of return exceeds the authorized level by more than one and a half percent, SDG&E would also refund 50 percent of that excess to customers. SDG&E would be at risk if its rate of return falls less than three percent below the authorized level. However, if SDG&E's rate of return falls three percent or more below\nthe authorized level, a rate case review would automatically occur. SDG&E may request a rate case review any time its rate of return drops one and one half percent or more below the authorized level. A CPUC decision is expected in the second quarter of 1994.\nSDG&E expects the long-term electric resource procurement mechanism to be addressed after proceedings on the base-rate mechanism. This mechanism calls for a bidding system under which SDG&E would compete with other utilities and nonutility producers to provide long-term generating resources, including long-term purchased-power capacity, to SDG&E customers. This mechanism would eliminate the Biennial Resource Plan Update proceeding, replacing it with a market-based approach to long-term electric-resource procurement. The CPUC would have final approval of the resources selected by SDG&E.\nELECTRIC RATES\nThe average price per kilowatt-hour charged to electric customers was 9.4 cents in 1993 and 9.3 cents in 1992.\nNATURAL GAS RATES\nThe average price per therm of natural gas charged to customers was to 55.1 cents in 1993 and 50.7 cents in 1992.\nAdditional information concerning rate regulation is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nENVIRONMENTAL, HEALTH AND SAFETY - ---------------------------------------------------------------------------\nSDG&E's operations are guided by federal, state and local environmental laws and regulations governing air quality, water quality, hazardous substance handling and disposal, land use, and solid waste. Compliance programs to meet these laws and regulations increase the cost of electric and natural gas service by requiring changes or delays in the location, design, construction and operation of new facilities. SDG&E may also incur significant costs to operate its facilities in compliance with these laws and regulations and to mitigate or clean up the environment as a result of prior operations of SDG&E or others. The costs of compliance with environmental laws and regulations are normally recovered in customer rates. The CPUC is expected to continue allowing the recovery of such costs, subject to reasonableness reviews.\nELECTRIC AND MAGNETIC FIELDS\nScientists are researching the possibility that exposure to power frequency magnetic fields causes adverse health effects. This research, although often referred to as relating to electric and magnetic fields, or EMFs, focuses on magnetic fields. To date, some laboratory studies suggest that such exposure creates biological effects, but those effects have not been shown to be harmful.\nThe studies that have most concerned the public are epidemiological studies. Some of those studies reported a weak correlation between the proximity of homes to certain power lines and equipment and childhood leukemia. Other studies reported weak correlations between computer estimates of historic exposure and disease. Various wire configuration categories and the historical computer calculations were used as substitutes for actual personal exposure measurements, which were not available. When actual field levels were measured in those studies, no correlation was found with disease.\nOther epidemiological studies found no correlation between estimated exposure and any disease. Scientists cannot explain why some studies using estimates of past exposure report correlations between estimated fields and disease, while others do not. Neither can scientists explain why no studies correlate measured fields with disease.\nIn November 1993 the CPUC adopted an interim policy regarding EMFs. Consistent with the more than twenty major scientific reviews of available research literature, the CPUC concluded that no health risk has been identified with exposure to low-frequency magnetic fields. To be responsive to public concern and scientific uncertainty, the CPUC created two utility-funded programs, a $2-million public-education program and a\n$6-million research program, and directed utilities to adopt a low-cost EMF reduction policy for new projects. The latter program, which will be implemented until science provides more direction, entails reasonable design changes to new projects to achieve a noticeable reduction of magnetic-field levels. The CPUC indicated that these low-cost measures to reduce field levels should not exceed 4 percent of the cost of new or upgraded facilities.\nSuch design changes will be subject to safety, reliability, efficiency and other normal operational criteria. It is difficult at this time to predict the impact of the CPUC's directives on SDG&E's operations. Final design guidelines should be completed by mid-1994, following a series of workshops scheduled by the CPUC.\nLitigation concerning EMFs is discussed under \"Legal Proceedings\" herein.\nHAZARDOUS SUBSTANCES\nBKK Corporation\nSDG&E was one of several hundred companies using the BKK Corporation's West Covina facility, which operated under a permit for the disposal of hazardous waste prior to its 1984 closure. The site is listed for cleanup in the California Superfund Site Priority List under the Hazardous Substance Account Act, which imposes cleanup liability on the sites' owners, operators or users. The California Department of Toxic Substances Control is working with the site owner\/operator to determine whether a post-closure permit should be issued for the facility. In addition, the U.S. Environmental Protection Agency is overseeing BKK's assessment of potential releases from the site, including releases into the groundwater, to determine whether any remediation will be required. SDG&E believes the site owner\/operator will perform any required assessment and remedial activities. SDG&E is unable to estimate the cost of cleaning up the site or what liability, if any, it may have for such cleanup costs.\nSDG&E was named as a potentially responsible party with respect to two other sites, the Rosen's Electrical Equipment Supply Company site in Pico Rivera, California and the North American Environmental, Inc. site in Clearfield, Utah. Additional information concerning these sites is described in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nWaste Water Treatment\nSDG&E is authorized to operate the waste water treatment facilities at the Encina and South Bay power plants under the California Hazardous Waste Treatment Permit Reform Act of 1992. To comply with the state's regulations, construction of secondary containment for the waste water treatment facilities will be completed in 1994 at a total cost of $3 million. New waste water storage tanks for these facilities, completed in 1991, may not be operated under the plants' existing permits. SDG&E received authorization to operate the new tanks from the California Department of Toxic Substances Control pursuant to a variance from the hazardous waste facility permitting requirements. In June 1993 this variance was withdrawn due to a change in the department's policy. SDG&E is negotiating the terms and conditions of a stipulation and order which would allow the continued operation of these storage tanks. However, the state could withhold authorization and initiate an enforcement action (and the imposition of fines and penalties), preventing continued operation of the storage tanks. Alternative treatment methods, which would not require the use of such tanks, may require additional expenditures of approximately $2 million per year. However, the state is expected to issue new regulations in 1994 which would allow continued operation of the existing storage tanks.\nAboveground Tanks\nCalifornia's 1989 Aboveground Petroleum Storage Act requires SDG&E to establish and maintain monitoring programs to detect leaks in fuel oil storage tanks. All diesel oil storage tanks which could pose a threat to the environment have been reconstructed with a secondary bottom and a leak detection system. The conversion began in 1991 and was completed in 1993 at a total cost of $2 million.\nUnderground Storage\nCalifornia has enacted legislation to protect ground water from contamination by hazardous substances. Underground storage containers require permits, inspections and periodic reports, as well as specific requirements for new tanks, closure of old tanks and monitoring systems for all tanks. SDG&E's capital program to comply with these requirements has cost $3 million to date. It is expected that cleanup of sites previously contaminated by underground tanks will occur for an unknown number of years. SDG&E cannot predict the cost of such cleanup. Additionally, if a facility is reactivated, the removal and replacement of existing tanks may be required.\nSpecific underground locations requiring assessment and\/or remediation are indicated below:\nOn May 29, 1987 the San Diego Regional Water Quality Control Board issued SDG&E a cleanup and abatement order for gasoline contamination originating from an underground storage tank located at SDG&E's Mountain Empire operation and maintenance facility. To comply with the order SDG&E has implemented a \"pump and treat\" program to remediate the site. Because the source of the area's drinking water is near the contamination, the Department of Health Services and the Board are expected to require SDG&E to further assess the extent of the contamination and undertake alternative remediation to further protect the drinking water from contamination. SDG&E is unable to estimate the costs for the assessment or for alternative remediation.\nOn January 7, 1993 SDG&E was issued a notice of corrective action by the Department of Health Services relative to soil contamination from used lubrication oil associated with an underground tank located at SDG&E's South Bay Operation and Maintenance facility. At present, SDG&E is unable to estimate the extent of the contamination or the potential cleanup costs.\nIn 1993 SDG&E discovered a shallow underground tank-like structure while installing underground electric facilities. The structure was located under a public street immediately west of SDG&E's Station A facility. The past ownership, operation and use of the structure is unknown. Hydrocarbon contamination has been found in the vicinity of the structure, but it has not been established whether the structure was the source of the contamination. The San Diego County Department of Health Services has issued a cleanup and abatement order to SDG&E. The order requires SDG&E to conduct a site assessment to delineate the nature and scope of the contamination. SDG&E is unable to estimate the nature and extent of the contamination or the potential cleanup costs.\nStation B\nStation B is located in downtown San Diego and was operated as a generating facility from 1911 until June 1993. During 1986, three 100,000-gallon underground diesel-fuel storage tanks were removed. Pursuant to a cleanup and abatement order, SDG&E remediated the existing hydrocarbon contamination.\nFurther analysis of PCB contamination in the area is required before site closure. SDG&E is unable to estimate the extent of such PCB contamination or what remediation, if any, will be required.\nIn addition, asbestos was used in the construction of the facility. Renovation, reconditioning or demolition of the facility will require the removal of the asbestos in a manner complying with all applicable environmental, health and safety laws. The estimated capital cost of this removal is between $6 million and $12 million.\nAdditionally, reuse of the facility would require the removal or cleanup of PCBs, paints containing heavy metals and fuel oil. SDG&E is unable to estimate the extent of this contamination or the cost of cleaning up these materials.\nEncina Power Plant\nDuring 1993 SDG&E discovered the presence of hydrocarbon contamination in subsurface soil at its Encina power plant. This contamination is located north of its western fuel-storage facilities and is believed to be fuel oil originating from a 1950s refueling spill. SDG&E has reported the discovery of the contamination to governmental agencies and has determined it does not pose a significant risk to the environment or to public health. SDG&E is unable to estimate the cost of assessment and of cleaning up the contamination.\nManufactured Gas Plant Sites\nDuring the late 1800s and early 1900s SDG&E and its predecessors manufactured gas from the combustion of fuel oil at a manufactured gas plant in downtown San Diego (Station A) and at small facilities in the nearby cities of Escondido and Oceanside. Although no tar pits common to town gas sites have been found at the facilities, ash and other residual hazardous byproducts from the gas-manufacturing process were found at the Escondido site during grading for expansion of a substation. Remediation of the Escondido site has been completed at a total cost of about $3 million. Based upon its assessment and remediation activities, SDG&E has applied to the Department of Health Services for a closure certification for the Escondido site.\nSDG&E and the Department of Health Services are aware that hazardous substances resulting from the operation of the Escondido manufactured gas plant may be present on adjacent locations. SDG&E will coordinate any required assessment or cleanup of any such locations with the department.\nSDG&E has not found any similar town gas site residuals at the Station A site. However, ash residue similar to that at Escondido was found on property adjacent to SDG&E's Oceanside gas regulator station. This ash residue has been covered with asphalt to prevent public exposure. Some ash residue has also been observed in soil adjacent to Station A.\nDue to the possibility that town gas residuals exist under the Station A and Oceanside sites, SDG&E will implement an environmental assessment of the sites in 1994 and 1995. SDG&E is unable to estimate the cost of assessment and cleanup of these sites. However, the CPUC has approved SDG&E's application to recover these costs in a future rate proceeding through the reasonableness review process.\nLitigation concerning hazardous substances is discussed in \"Legal Proceedings - - Graybill\/Metropolitan Transit Development Board\" herein.\nAIR QUALITY\nThe San Diego Air Pollution Control District regulates air quality in San Diego County in conformance with the California and federal Clean Air Acts. California's standards are more restrictive than federal government standards.\nAlthough SDG&E facilities already comply with very strict emission limits and contribute only about 3 percent of the air emissions in San Diego County, the APCD is obligated to quantify the benefits of further reducing emissions from all San Diego industry. The APCD has adopted Rule 69 to further reduce nitrogen oxide emissions. This rule will require the retrofit of the Encina and South Bay power plants with catalytic converters to remove approximately 87 percent of current nitrogen oxide emissions. The estimated capital cost to comply with Rule 69 is $130 million. In addition, annual operating costs will increase about $6 million after all units have been retrofitted. SDG&E expects this to be completed by 2001.\nThe acid rain section of the federal Clean Air Act Amendments of 1990 requires SDG&E to upgrade the continuous emission monitors at its Encina and South Bay power plants to provide more-complete emissions data. Installation of the required continuous emission monitor upgrades will be completed in 1994 at an estimated cost of $5 million.\nIn 1990 the South Coast Air Quality Management District passed a rule which will require SDG&E's older natural gas compressor engines at its Moreno facility to either meet new stringent nitrogen oxide emission levels or be converted to electric drive. In October 1993 the Air Quality District adopted a new program called RECLAIM, which will replace existing rules and require SDG&E's natural gas compressor engines at its Moreno facility to reduce their nitrogen oxide emission levels by about 10 percent a year through 2003. This will be accomplished through the installation of new emission monitoring equipment, operational changes to take advantage of low emitting engines, and engine retrofits. The cost of complying with the proposed rule is expected to be $3 million.\nWATER QUALITY\nDischarge permits are required to enable SDG&E to discharge its cooling water and its treated in-plant waste water, and are, therefore, a prerequisite to the continued operation of SDG&E's power plants. The promulgation of water quality-control plans by state and federal agencies may impose increasingly stringent cooling-water and treated waste water discharge requirements on SDG&E.\nSDG&E is unable to predict the terms and conditions of any renewed permits or their effects on plant or unit availability, the cost of constructing new cooling water treatment facilities, or the cost of modifying the existing treatment facilities. However, any modifications required by such permits could involve substantial expenditures, and certain plants or units may be unavailable for electric generation during such modification.\nAdditional information concerning discharge permits for the South Bay, Encina and SONGS plants is provided in \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nASBESTOS\nThe corporate office building at 101 Ash Street in San Diego is being retrofitted with sprinklers over a two-year period in response to a City of San Diego ordinance requiring all high-rise office buildings to be retrofitted for fire protection by 1996. This is expected to be completed in 1994. Asbestos is being removed in the areas where the sprinklers are being installed. The total cost of the asbestos removal will be about $2 million.\nTRANSMISSION LINE AERIAL SAFETY\nCriteria have been established by the State of California to determine the necessity for installing aerial warning devices on overhead powerlines to promote air-space safety. Nine spans on the Southwest Powerlink transmission line in Imperial County fall within the criteria and will be marked at a cost of approximately $115,000. Study of another 132 spans will determine whether or not additional spans will be marked at a cost of approximately $13,000 per span.\nBased upon FAA recommendation, SDG&E is also installing aerial warning markers on various segments of the 230-kv and other transmission lines within its service territory. The cost of this project through 1993 was $2 million, and $1 million is budgeted for 1994.\nAdditional information concerning SDG&E's environmental matters is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nOTHER - ---------------------------------------------------------------------------\nRESEARCH, DEVELOPMENT AND DEMONSTRATION\nSDG&E conducts research and development in areas that provide value to SDG&E and its customers. The Research, Development and Demonstration activities are focused in the following areas:\n1. The improvement of electric generation efficiency.\n2. Development of technologies that enhance electric transmission, distribution and customer utilization efficiency.\n3. Participation in the Gas Research Institute and the Electric Power Research Institute.\nHighlights of the program include demonstration of molten carbonate fuel cells, evaluation and implementation of distributed generation systems, application of advanced telecommunication systems, and the development of technology to reduce service interruptions and make other power quality improvements for customers.\nResearch, development and demonstration costs averaged $7 million annually over the past three years. The CPUC historically has permitted rate recovery of research, development and demonstration expenditures.\nWAGES\nSDG&E and Local 465, International Brotherhood of Electrical Workers have a labor agreement that ended on February 28, 1994. Negotiations for a new agreement are expected to be concluded in early 1994.\nEMPLOYEES OF REGISTRANT\nAs of December 31, 1993 SDG&E had 4,166 full-time employees and 63 part-time employees compared to 4,249 full-time and 61 part-time employees at December 31, 1992. SDG&E's subsidiaries had 818 full-time employees at December 31, 1993 compared to 793 at December 31, 1992.\nFOREIGN OPERATIONS\nSDG&E foreign operations in 1993 included power purchases and sales with CFE in Mexico and purchases of energy and natural gas from suppliers in Canada and purchases of uranium from suppliers in Canada, Germany and Namibia.\nSDG&E's subsidiaries operated in various foreign locations in 1993, including Great Britain, Australia, Canada and Italy.\nAdditional information concerning foreign operations is described under \"Electric Operations\" and \"Natural Gas Operations\" herein and in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ---------------------------------------------------------------------------\nSubstantially all utility plant is subject to the lien of the July 1, 1940 mortgage and deed of trust and its supplemental indentures between SDG&E and the First Trust of California N.A. as trustee, securing the outstanding first mortgage bonds.\nELECTRIC PROPERTIES - -------------------------------------------------------------------------- As of December 31, 1993 SDG&E's installed generating capacity in megawatts, based on summer ratings, was as follows:\nPLANT LOCATION NET MEGAWATTS - ------------------------------------------------------------------------- Encina Carlsbad 921 South Bay Chula Vista 690 San Onofre South of San Clemente 430* Combustion Turbines (19) Various 332 Silver Gate** San Diego 0 - -------------------------------------------------------------------------\n*SDG&E's 20 percent share. **Placed in storage in 1984. Net generating capability is 230 mw.\nExcept for San Onofre and some of the combustion turbines, these plants are equipped to burn either fuel oil or natural gas.\nThe system load factor was 64.2 percent in 1993 and ranged from 55.1 percent to 64.2 percent for the past five years.\nSDG&E's electric transmission and distribution facilities include sufficient substations, and overhead and underground lines to accommodate current customer needs. Various areas of the service territory require expansion periodically to handle customer growth.\nSDG&E owns an approved nuclear power plant site near Blythe, California.\nNATURAL GAS PROPERTIES - ---------------------------------------------------------------------------\nSDG&E's natural gas facilities are located in San Diego and Riverside counties and consist of the Encanto storage facility in San Diego, transmission facilities and various high-pressure transmission pipelines, high-pressure and low-pressure distribution mains, and service lines. SDG&E's natural gas system is sufficient to meet customer demand and short- term growth. SDG&E is currently undergoing an expansion of its high-pressure transmission lines to accommodate expected long-term customer growth.\nGENERAL PROPERTIES - ---------------------------------------------------------------------------\nThe 21-story corporate office building at 101 Ash Street, San Diego is occupied pursuant to an operating lease through the year 2005. The lease has four separate five-year renewal options. The building is currently undergoing a $15 million renovation which is expected to be completed during 1994. Additional information is provided under \"Environmental, Health and Safety\" herein.\nSDG&E also occupies an office complex at Century Park Court in San Diego pursuant to a lease ending in the year 2007. The lease can be renewed for two five-year periods. SDG&E also leases other office space in San Diego to house its computer center under a three-year lease with options to renew for an additional five years.\nIn addition, SDG&E occupies eight operating and maintenance centers, two business centers, seven district offices, and five branch offices.\nSUBSIDIARY PROPERTIES - ---------------------------------------------------------------------------\nWahlco Environmental Systems, Inc. has manufacturing facilities in the continental United States, Puerto Rico, Canada, Great Britain, Australia and Italy, and a sales office in Singapore.\nAdditional information concerning SDG&E's properties is described under \"Electric Operations\" and \"Gas Operations\" herein and in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in Notes 2, 5 and 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -----------------------------------------------------------------------------\nThe following proceedings, described in SDG&E's 1992 Annual Report on Form 10-K, were concluded during the year ended December 31, 1993: San Onofre Nuclear Generating Station Unit 1, Springerville, Zuidema, Energy Factors, American Tool and NCR. Information concerning the conclusion of these proceedings is contained in SDG&E's Quarterly Reports on Form 10-Q for the three-month periods ended March 31, 1993 and September 30, 1993 and in SDG&E's Current Report on Form 8-K dated March 19, 1993.\nCENTURY POWER LITIGATION - ---------------------------------------------------------------------------\nOn April 1, 1987 Century Power Corporation, formerly Alamito Company, submitted a filing to justify its rates for the following 24 months under a power sales and interconnection agreement with SDG&E. The Federal Energy Regulatory Commission permitted the rates to become effective as of June 1, 1987 subject to refund. In 1988 an administrative law judge ruled\nunreasonable a component of rates based on the return on equity of Tucson Electric Power Company, a supplier and former affiliate of Century. If the decision stands, demand charges paid by SDG&E could be reduced by $12 million, plus interest, to be refunded principally to SDG&E customers. On September 23, 1993 SDG&E filed a motion requesting the FERC to decide this matter. On December 23, 1993 the FERC issued an order denying SDG&E's motion on the grounds that the matter had been resolved under a settlement reached by the parties in 1991 and approved by the FERC. On January 24, 1994 SDG&E filed a request for rehearing.\nOn February 11, 1993 SDG&E filed a complaint with the FERC against Tucson and Century seeking to adjust its purchase costs under the power sales and interconnection agreement with Century. The complaint seeks summary disposition and moves for an order directing Century and Tucson to refund amounts that they improperly billed SDG&E in violation of the agreement. If successful, SDG&E would be entitled to approximately $15 million, plus interest, which would be refunded principally to SDG&E's customers. On April 23, 1993 Tucson and Century filed answers to the complaint, denying liability. In addition, Tucson brought a counterclaim of approximately $3 million against SDG&E based on alleged underbillings.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nCITY OF SAN DIEGO FRANCHISE - ---------------------------------------------------------------------------\nOn February 13, 1990 following the announcement of the proposed merger of SDG&E into Southern California Edison Company, the City of San Diego filed a lawsuit in San Diego County Superior Court to confirm its position that SDG&E's franchises with the city could not be transferred to Edison without the consent of the city pursuant to the city charter and to SDG&E's franchises. On December 28, 1993 the parties dismissed the complaint without prejudice.\nAMERICAN TRAILS - ---------------------------------------------------------------------------\nOn August 23, 1985 Michael Bessey and others who owned American Trails, a membership campground company, filed a complaint against Wahlco, Inc. and others in the Superior Court of San Diego County for breach of contract, negligence, fraud, intentional interference with contract, breach of the implied covenant of good faith and fair dealing, and breach of fiduciary duty in connection with contingent payments, which were not realized following the redemption of plaintiffs' interest in American Trails Partners No. 1. The plaintiffs are seeking compensatory damages in the amount of approximately $12 million and punitive damages in an unspecified amount. Wahlco has cross-complained against the plaintiffs for defrauding Wahlco into investing $3 million in American Trails.\nThe trial took place in late 1991 before a superior court judge sitting without a jury. On March 25, 1992 the trial judge indicated that the plaintiffs would be awarded approximately $2 million plus fees. However, on April 20, 1992, prior to entry of any judgments, the trial judge removed himself from the case.\nAnother judge was assigned to the case and a new trial began on February 8, 1993. On March 24, 1993 the jury returned verdicts favorable to all defendants on all of the plaintiffs' causes of action, except for breach of contract and interference with contract claims against defendants Wahlco and Robert Wahler, as to which the jury was not able to reach a verdict. On July 23, 1993 the trial court granted the motions of Wahlco and Robert Wahler for summary judgment on the two remaining causes of action against them and denied the plaintiffs' motion for a new trial. On September 21, 1993 judgment was entered by the court in favor of Wahlco and the other defendants. As a result, all claims and causes of action by the plaintiffs against Wahlco have been determined in favor of Wahlco. On October 7, 1993 the plaintiffs filed a notice of appeal from the court's judgment.\nWahlco intends to continue defending this lawsuit vigorously.\nBy agreements dated September 19, 1987, October 28, 1987, and March 1, 1990, Robert R. Wahler, as Trustee of the Wahler Family Trust; John H. McDonald; and Westfore, a California limited partnership, agreed, subject to certain\nexceptions, to indemnify Pacific Diversified Capital Company and its subsidiaries in connection with the American Trails litigation in diminishing amounts through 1992, when the indemnification amount would decrease to zero.\nWahlco, Inc. notified these parties that it has a claim for indemnification pursuant to the indemnification agreements. However, they have denied that a current claim for indemnification exists.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nSUBSIDIARY SHAREHOLDER - ---------------------------------------------------------------------------\nOn June 22, 1990 an action was instituted in the U.S. District Court for the Southern District of California against SDG&E; PDC; Wahlco Environmental Systems, Inc.; each of the persons who was a director and\/or an officer at the time of WES's initial public offering (including an officer and certain directors of SDG&E); and the managing underwriters for the offering, Prudential-Bache Securities, Inc. and Salomon Brothers, Inc. This action, for which class certification has been granted, was brought by Ronald Kassover on behalf of all persons (other than defendants in the action) who purchased WES's common stock during the class period of April 25, 1990 to June 15, 1990.\nThe complaint, as amended, alleges various violations of federal and state securities laws and various state law claims based upon alleged misrepresentations made in WES's registration statement and prospectus prepared in connection with the offering, WES's Report on Form 10-Q for the first quarter of 1990, press releases, and other public documents and statements. The alleged misrepresentations relate to WES's earnings, customer orders, financial condition and future prospects. The amended complaint further purports that, based upon these alleged misrepresentations and omissions, the price of WES's common stock was inflated during the class period and the plaintiff and the plaintiff class suffered damages as a result of purchasing WES's common stock at inflated prices. The amended complaint seeks a judgment for damages incurred by the plaintiff class during the class period, for costs and attorneys' fees, for punitive damages, and for injunctive relief against the disposition of defendants' assets.\nOn November 5, 1990 a second complaint was filed by Ralph Amanna. The amended Amanna complaint makes allegations similar to those made in the Kassover complaint and has been consolidated with the Kassover action. On November 9, 1992 the court granted the defendants' motion for partial summary judgment, resolving the majority of the material allegations in favor of the defendants. The remaining allegations concern alleged wrong-doing associated with an attempted debenture offering after the initial public offering.\nThe plaintiffs have filed a motion for reconsideration of the partial summary judgment. The underwriters have filed a motion to dismiss all claims against them, and the other defendants have joined in this motion. Hearings on these motions were taken off the court's calendar pending the conclusion of settlement negotiations.\nIn November 1993 a settlement in principle was reached whereby the entire action would be resolved. The settlement requires the defendants to pay a total of approximately $1 million to the plaintiffs in exchange for a dismissal of the action in its entirety. The settlement will bind all of the plaintiff class members who elect to participate in the settlement. It is anticipated that the court will approve the settlement, and the action will be dismissed.\nPUBLIC SERVICE COMPANY OF NEW MEXICO - -----------------------------------------------------------------------------\nOn October 27, 1993 SDG&E filed a complaint with the FERC against Public Service Company of New Mexico, alleging that charges under a 1985 power purchase agreement are unjust, unreasonable and discriminatory. SDG&E requested that the FERC investigate the rates charged under the agreement and establish a refund date effective December 26, 1993. The relief, if granted, would reduce annual demand charges paid by SDG&E to PNM by up to $11 million per year through April 2001. If approved, the proceeds principally would be used to reduce customer bills.\nOn December 8, 1993 PNM answered the complaint and moved that it be dismissed. PNM denied that the rates are unjust, unreasonable or discriminatory and asserted that SDG&E's claims were barred by certain orders issued by the FERC in 1988. SDG&E expects a decision from the FERC in 1994.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nCANADIAN NATURAL GAS - -----------------------------------------------------------------------------\nDuring early 1991 SDG&E signed four long-term natural gas supply contracts with Husky Oil Ltd., Canadian Hunter Ltd. and Noranda Inc., Bow Valley Energy Inc., and Summit Resources Ltd. Canadian-sourced natural gas began flowing to SDG&E under these contracts on November 1, 1993. Disputes have arisen with each of these producers with respect to events which are alleged by the producers to have occurred justifying a revision to the pricing terms of each contract, and possibly their termination. Consequently, during December 1993 SDG&E filed complaints in the United States Federal District Court, Southern District of California, seeking a declaration of SDG&E's contract rights. Specifically, SDG&E states that, neither price revision nor contract termination is warranted.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nAdditional information concerning these contracts is provided under \"Natural Gas Operations\" herein and in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders and in Note 9 of the \"Notes to Consolidated Financial Statements\" beginning on Page 32 of the 1993 Annual Report to Shareholders.\nELECTRIC AND MAGNETIC FIELDS - -----------------------------------------------------------------------------\nMCCARTIN\nOn November 13, 1992 a group of 25 individual plaintiffs filed a complaint against SDG&E in the Orange County Superior Court for medical monitoring, intentional infliction of emotional distress, negligent infliction of emotional distress, strict products liability, negligent product liability, trespass, nuisance, diminution in property value, inverse condemnation and injunctive relief, alleging that plaintiffs have been damaged by EMF radiation from SDG&E's power lines. The plaintiffs have not specified damages.\nOn March 31, 1993 the trial court denied SDG&E's request to set aside all but two of the plaintiffs' claims. On May 25, 1993 the California Court of Appeals denied SDG&E's appeal of the trial court's denial of SDG&E's request to set aside. A subsequent petition for review filed with the California Supreme Court was also denied. On May 27, 1993 SDG&E filed its answer to the complaint and discovery commenced.\nOn December 16, 1993 Martin and Joyce Covalt filed a complaint against SDG&E in Orange County Superior Court for claims identical to those of the original McCartin plaintiffs. The attorneys for the Covalts have indicated that they will attempt to consolidate their complaint with the McCartin complaint.\nSDG&E believes that the allegations made in both complaints are without merit and intends to defend the lawsuit vigorously. The trial is scheduled to begin on April 11, 1994.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nNORTH CITY WEST\nOn June 14, 1993 the Peninsula at Del Mar Highlands Homeowners Association filed a complaint with the Superior Court of San Diego County against the City of San Diego and SDG&E to prevent SDG&E from continuing construction of an electric substation in an area which is known as North City West. In the complaint, plaintiffs sought to have the city either revoke previously issued permits or reopen the hearing process to address alleged EMF concerns. On July 6, 1993 the court denied the plaintiffs' motion for a temporary restraining order. On July 30, 1993 the court denied the plaintiffs' motion for a preliminary injunction. On September 28, 1993 the plaintiffs withdrew their complaint and the court dismissed it without prejudice.\nOn August 18, 1993 the plaintiffs filed a complaint with the CPUC requesting that construction of the substation be immediately halted until the CPUC conducts an initial environmental assessment and determines whether an\nenvironmental impact report is necessary. On September 22, 1993 SDG&E moved to dismiss the complaint on the grounds that the city's environmental review of the project in 1989 was proper and that the city, not the CPUC, has the authority, under the California Environmental Quality Act, to review the potential environmental impacts of substations. On January 7, 1994 the CPUC dismissed the plaintiffs' complaint, ruling that the city had performed all appropriate environmental reviews. One of the plaintiffs has filed an application with the CPUC asking it to reconsider its January 7 decision.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nBLACKBURN VS. WATT\nBeginning on April 4, 1991 approximately 30 homeowners in the \"Mar Lado Highlands\" real estate development filed a series of complaints in San Diego Superior Court against the developer of the subdivision, TBSD Development, and certain of its affiliates. The complaints allege, among other things, that the defendants made fraudulent and negligent misrepresentations to the plaintiffs in the course of the sale of the plaintiffs' homes. One of the allegations involves the defendants' failure to adequately disclose the siting of a SDG&E electric transmission line near a gasoline pipeline, which the plaintiffs allege creates a significant risk of accident. Furthermore, the plaintiffs allege that the defendants failed to disclose the health risks associated with living in proximity to such power lines. The plaintiffs are seeking rescission, restitution, certain specified and unspecified compensatory damages, punitive damages, and attorneys' fees.\nBeginning on June 23, 1993 the defendants filed a series of cross-complaints against several other parties, including SDG&E, for indemnity, breach of warranty, breach of contract, negligence, contribution, declaratory relief and other remedies. The cross-complaints pertaining to SDG&E essentially allege that the defendants had no duty to independently investigate the risks associated with the power lines and that they merely passed along information regarding such risks provided by SDG&E. Therefore, the defendants allege that any liability arising from disclosures or nondisclosures relative to the power lines are the sole responsibility of SDG&E.\nSDG&E has filed answers to all of the cross-complaints. SDG&E believes the cross-complaints are without merit and intends to defend these lawsuits vigorously.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nGRAYBILL\/ METROPOLITAN TRANSIT DEVELOPMENT BOARD - -----------------------------------------------------------------------------\nGRAYBILL\nOn February 14, 1992 Graybill Terminal Company and others who own an oil storage tank farm in San Diego filed a complaint against Union Oil Company of California and others in the U.S. District Court for the Southern District of California. The complaint alleges that the land on which the tank farm is situated is contaminated with petroleum products and other chemicals.\nOn July 21, 1992 three of the defendants, Olson Development Company, 550 El Camino Company and Carl Olson, filed a complaint in the same court against SDG&E and others, alleging, among other things, violation of the Comprehensive Environmental Response Compensation and Liability Act, California Superfund, and other environmental laws. Olson Development and 550 El Camino are previous owners of the allegedly contaminated property. This complaint alleges that SDG&E leased certain tanks, property and pipelines on or adjacent to the allegedly contaminated property and that contamination of soil, ground water, sewer systems and the San Diego Bay occurred during the course of SDG&E's leasing of the tanks, property and pipelines. The plaintiffs are seeking unspecified compensatory damages, indemnity or contribution, and certain declaratory and equitable relief.\nOn August 10, 1992 SDG&E filed a counterclaim to the third-party complaint. On August 17, 1992 SDG&E also filed a third-party complaint against Union Oil Company. The court has dismissed all negligence causes of action against SDG&E, but all other causes of action remain. Trial has been set for April 1994.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nMETROPOLITAN TRANSIT DEVELOPMENT BOARD\nOn October 13, 1993 MTDB filed a complaint in the San Diego County Superior Court against certain of the defendants in the Graybill litigation, including SDG&E. MTDB owns property located adjacent to the Graybill site and has alleged that contamination from the Graybill site migrated beneath its property, contaminating the soil and ground water. (MTDB had attempted to intervene in the Graybill litigation, but the judge denied its motion.)\nMTDB has alleged that SDG&E stored petroleum products at the Graybill site and was also responsible for certain renovations to the site's fixtures and equipment which stored and\/or transported hazardous substances. MTDB has also stated that SDG&E, at one time, owned and operated the MTDB property and also owned certain fuel oil pipelines located on the property. MTDB's complaint alleges, among other things, nuisance, trespass and negligence, and seeks unspecified compensatory and special damages, indemnity, and certain equitable and declaratory relief. On November 24, 1993 SDG&E filed an answer to the complaint denying all of MTDB's allegations.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nTRANSPHASE SYSTEMS LITIGATION - ---------------------------------------------------------------------------\nOn May 3, 1993 Transphase Systems, Inc. filed a complaint against Southern California Edison Company and SDG&E in the United States District Court for the Central District of California. The complaint alleged that Edison and SDG&E unlawfully constrained Transphase from selling its thermal energy storage systems under utility-sponsored demand-side management programs in violation of federal and state antitrust and unfair competition laws. The plaintiff claimed not less than $50 million in actual damages, attorneys' fees, prejudgment interest and costs. The plaintiff also sought certain injunctive relief.\nOn August 25, 1993 Transphase filed a motion for a preliminary injunction to order SDG&E to cease competitive bidding activities for all generation resources until demand-side-resource providers were permitted to participate.\nOn October 7, 1993 the court dismissed all of Transphase's causes of action with prejudice. On October 19, 1993 Transphase filed a notice of appeal of the court's dismissal. The appeal is scheduled to be heard by the Ninth Circuit Court of Appeals in May 1994.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nAdditional information concerning competitive bidding is described under \"Resources Planning\" herein and in the \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" beginning on Page 18 of the 1993 Annual Report to Shareholders.\nTANG LITIGATION - -----------------------------------------------------------------------------\nOn August 10, 1993 R.C. Tang filed a complaint in the Los Angeles County Superior Court against Southern California Edison Company, SDG&E, and SONGS contractors Westinghouse, Bechtel and Combustion Engineering, for negligence, strict products liability, express and implied warranty, statutory liability, negligent and fraudulent misrepresentation, fraudulent concealment, and negligent infliction of emotional distress, alleging that the plaintiff was damaged by the emission of radiation while serving as an on-site Nuclear Regulatory Commission inspector at SONGS from June 1985 through December 1986. The plaintiff has asked for general compensatory damages and punitive damages.\nThe defendants removed the case to the United States District Court for the Southern District of California in San Diego on September 2, 1993 and filed an answer on September 14, 1993. On December 13, 1993 the court denied the defendants' motion for summary judgment based on the defendants' compliance with applicable permissive-dose limits of radiation. On February 7, 1994 the\njudge declared a mistrial after the jury deadlocked with a vote of seven to two in favor of R.C. Tang. A new trial date for the case has been set for March 15, 1994.\nThe defendants believe that the allegations made in this complaint are without merit and intend to defend this lawsuit vigorously.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nENVIRONMENTAL ISSUES - ---------------------------------------------------------------------------\nOther legal matters related to environmental issues are described under \"Environmental, Health and Safety\" herein.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ---------------------------------------------------------------------------\nNone.\nITEM 4. EXECUTIVE OFFICERS OF THE REGISTRANT - ---------------------------------------------------------------------------\nNAME AGE POSITIONS (1989 - CURRENT) - --------------------------------------------------------------------------- Thomas A. Page 60 Chairman and Chief Executive Officer since January 1983 and President from 1983 through 1991 and since January 1994. - --------------------------------------------------------------------------- Jack E. Thomas 61 President and Chief Operating Officer from January 1992 until his retirement in January 1994. Executive Vice President and Chief Operating Officer from 1986 through 1991. - --------------------------------------------------------------------------- Stephen L. Baum 53 Executive Vice President since January 1993. Senior Vice President - Law and Corporate Affairs and General Counsel from January 1992 through December 1992. Senior Vice President and General Counsel from 1987 through 1991. - ---------------------------------------------------------------------------- Donald E. Felsinger 46 Executive Vice President since January 1993. Senior Vice President - Marketing and Resource Development from January 1992 through December 1992. Vice President - Marketing and Resource Development from February 1989 through 1991. Vice President - Marketing from 1986 through January 1989. - --------------------------------------------------------------------------- Gary D. Cotton 53 Senior Vice President - Customer Operations since January 1993. Senior Vice President - Customer Services from January 1992 through December 1992. Senior Vice President - Engineering and Operations from 1986 through 1991. - ----------------------------------------------------------------------------- Edwin A. Guiles 44 Senior Vice President - Energy Supply since January 1993. Vice President - Engineering and Operations from January 1992 through December 1992. Vice President - Corporate Planning from 1990 through 1991. Director - Merger Transition from January through December 1989. - --------------------------------------------------------------------------- R. Lee Haney 54 Senior Vice President - Customer and Marketing Services since January 1993. Senior Vice President - Finance and Chief Financial Officer from 1990 through 1992. Vice President - Finance, Chief Financial Officer and Treasurer from 1988 through 1989. - --------------------------------------------------------------------------- Nad A. Peterson 67 Senior Vice President and General Counsel since June 1993 and Corporate Secretary since January 1994. - --------------------------------------------------------------------------- Frank H. Ault 49 Vice President and Controller since January 1993. Controller from May 1986 through December 1992. - --------------------------------------------------------------------------- Ronald K. Fuller 56 Vice President - Governmental and Regulatory Services since April 1984. - --------------------------------------------------------------------------- Margot A. Kyd 40 Vice President - Human Resources since January 1993. Vice President - Administrative Services from 1988 through 1992. - --------------------------------------------------------------------------- Malyn K. Malquist 41 Vice President - Finance and Treasurer since January 1993. Treasurer from 1990 through 1992. Assistant Treasurer and Director - Finance from 1988 through 1989. - ---------------------------------------------------------------------------- Delroy M. Richardson 55 Secretary from December 1986 until his retirement in January 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSDG&E's common stock is traded on the New York and Pacific stock exchanges. At December 31, 1993, there were 70,389 holders of SDG&E common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -----------------------------------------------------------------------------\nThe information required by Item 6 is incorporated by reference from the Ten-Year Summary beginning on Page 16 of SDG&E's 1993 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -----------------------------------------------------------------------------\nThe information required by Item 7 is incorporated by reference from page 18 of SDG&E's 1993 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - -----------------------------------------------------------------------------\nThe information required by Item 8 is incorporated by reference from Pages 24 through 39 of SDG&E's 1993 Annual Report to Shareholders. See Item 14 of this Form 10-K for a listing of financial statements included in the 1993 Annual Report to Shareholders.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - -------------------------------------------------------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------------------- The information required on Identification of Directors is incorporated by reference from \"Election of Directors\" in SDG&E's March 1994 Proxy Statement.\nThe information required on executive officers is incorporated by reference from Item 4.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by Item 11 is incorporated by reference from \"Executive Compensation and Transactions with Management and Others\" in SDG&E's March 1994 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 is incorporated by reference from \"Security Ownership of Management and Certain Beneficial Holders\" in SDG&E's March 1994 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n1. Financial statements Page in Annual Report*\nResponsibility Report for the Consolidated Financial Statements 24\nStatements of Consolidated Income for the years ended December 31, 1993, 1992 and 1991. 25\nConsolidated Balance Sheets at December 31, 1993 and 1992. 26\nStatements of Consolidated Cash Flows for the years ended December 31, 1993, 1992 and 1991 27\nStatements of Consolidated Changes in Capital Stock and Retained Earnings for the years ended December 31, 1993, 1992 and 1991. 28\nStatements of Consolidated Capital Stock at December 31, 1993 and 1992. 29\nStatements of Consolidated Long-Term Debt at December 31, 1993 and 1992. 30\nStatements of Consolidated Financial Information by Segments of Business for the years ended December 31, 1993, 1992 and 1991 31\nNotes to Consolidated Financial Statements 32\nIndependent Auditors' Report 38\nQuarterly Financial Data (Unaudited). 39\n*Incorporated by reference from the indicated pages of the 1993 Annual Report to Shareholders.\n2. Financial statement schedules\nThe following schedules for the years ended December 31, 1993, 1992 and 1991 and the related independent auditors' report will be filed as an amendment to this report:\nSchedule II Amounts Receivable from Related Parties and Underwriters, Promoters and Employees\nSchedules V and VI Property, Plant and Equipment; and Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment\nSchedule VIII Valuation and Qualifying Accounts\nSchedule IX Short-Term Borrowings\nSchedule X Supplementary Income Statement Information\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the consolidated financial statements and the notes to consolidated financial statements included herein.\n3. Exhibits\nThe Forms 8, 8-K, 10-K and 10-Q referred to herein were filed under Commission File Number 1-3779.\nExhibit 3 -- Bylaws and Articles of Incorporation\n- - Bylaws 3.1 Restated Bylaws - December 20, 1993\n- - Articles of Incorporation 3.2 Restated Articles of Incorporation - December 2, 1992 (Incorporated by reference from SDG&E's 1992 Form 10-K, Ex 3.2)\n3.3 Certificate of Determination of Preferences of Preference Stock (cumulative), $1.82 series, without par value, of San Diego Gas & Electric Company.\n3.4 Certificate of Determination of Preferences of Preference Stock (cumulative), $1.70 series, without par value, of San Diego Gas & Electric Company.\nExhibit 4 -- Instruments Defining the Rights of Security Holders, Including Indentures\n4.1 Mortgage and Deed of Trust dated July 1, 1940. (Incorporated by reference from Registration No. 2-49810, Ex. 2A.)\n4.2 Second Supplemental Indenture dated as of March 1, 1948. (Incorporated by reference from Registration No. 2-49810, Ex. 2C.)\n4.3 Ninth Supplemental Indenture dated as of August 1, 1968. (Incorporated by reference from Registration No. 2-68420, Ex. 2D.)\n4.4 Tenth Supplemental Indenture dated as of December 1, 1968. (Incorporated by reference from Registration No. 2-36042, Ex. 2K.)\n4.5 Sixteenth Supplemental Indenture dated August 28, 1975. (Incorporated by reference from Registration No. 2-68420, Ex. 2E.)\n4.6 Thirtieth Supplemental Indenture dated September 28, 1983. (Incorporated by reference from Registration No. 33-34017, Ex. 4.3.)\nExhibit 10 -- Material Contracts\n10.1 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #3 (1994 compensation).\n10.2 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1994 compensation, 1995 incentive).\n10.3 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Nonemployee Directors (1994 compensation).\n10.4 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1993 restricted stock award agreement.\n10.5 Supplemental Executive Retirement Plan adopted on July 15, 1981 and amended on April 24, 1985, October 20, 1986, April 28, 1987, October 24, 1988, November 21, 1988, October 28, 1991, May 28, 1992, May 24, 1993 and November 22, 1993.\n10.6 Amended 1986 Long-Term Incentive Plan, Restatement as of October 25, 1993.\n10.7 Loan agreement with CIBC Inc. dated as of December 1, 1993.\n10.8 Amendment to San Diego Gas & Electric Company and Southern California Gas Company Restated Long-Term Wholesale Natural Gas Service Contract (see Exhibit 10.53) dated March 26, 1993.\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S JUNE 30, 1993 FORM 10-Q AS REFERENCED BELOW.\n10.9 Loan agreement with the California Pollution Control Financing Authority in connection with the issuance of $80 million of Pollution Control Bonds dated as of June 1, 1993 (Exhibit 10.1).\n10.10 Loan agreement with the City of San Diego in connection with the issuance of $92.7 million of Industrial Development Bonds 1993 Series C dated as of July 1, 1993 (Exhibit 10.2).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S MARCH 31, 1993 FORM 10-Q AS REFERENCED BELOW.\n10.11 Loan agreement with Mellon Bank, N.A dated as of April 15, 1993 (Exhibit 10.1).\n10.12 Loan agreement with First Interstate Bank dated as of April 15, 1993 (Exhibit 10.2).\n10.13 Loan agreement with the City of San Diego in connection with the issuance of Industrial Development Bonds 1993 Series A dated as of April 1, 1993 (Exhibit 10.3).\n10.14 Loan agreement with the City of San Diego in connection with the issuance of Industrial Development Bonds 1993 Series B dated as of April 1, 1993 (Exhibit 10.4).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S 1992 FORM 10-K AS REFERENCED BELOW.\n10.15 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #3 (1993 compensation) (Exhibit 10.1).\n10.16 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1993 compensation, 1994 incentive) (Exhibit 10.2).\n10.17 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Nonemployee Directors (1993 compensation) (Exhibit 10.3).\n10.18 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1992 restricted stock award agreement (Exhibit 10.4).\n10.19 Loan agreement with the City of Chula Vista in connection with the issuance of $250 million of Industrial Development Revenue Bonds, dated as of December 1, 1992 (Exhibit 10.5).\n10.20 Loan agreement with the City of San Diego in connection with the issuance of $25 million of Industrial Development Revenue Bonds, dated as of September 1, 1987 (Exhibit 10.6).\n10.21 Nuclear Facilities Qualified CPUC Decommissioning Master Trust Agreement for San Onofre Nuclear Generating Station, approved November 25, 1987 (Exhibit 10.7).\n10.22 Nuclear Facilities Non-Qualified CPUC Decommissioning Master Trust Agreement for San Onofre Nuclear Generating Station, approved November 25, 1987 (Exhibit 10.8).\n10.23 Amended 1986 Long-Term Incentive Plan (Exhibit 10.9).\n10.24 Loan agreement between Mellon Bank, N.A. and San Diego Gas & Electric Company dated December 15, 1992, as amended (Exhibit 10.10).\n10.25 Fuel Lease dated as of September 8, 1983 between SONGS Fuel Company, as Lessor and San Diego Gas & Electric Company, as Lessee, and Amendment No. 1 to Fuel Lease, dated September 14, 1984 and Amendment No. 2 to Fuel Lease, dated March 2, 1987 (Exhibit 10.11).\nTHE FOLLOWING EXHIBIT IS INCORPORATED BY REFERENCE FROM SDG&E'S SEPTEMBER 30, 1992 FORM 10-Q AS REFERENCED BELOW.\n10.26 Loan Agreement with the City of San Diego in connection with the issuance of $118.6 million of Industrial Development Revenue Bonds dated as of September 1, 1992 (Exhibit 10.1).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S 1991 FORM 10-K AS REFERENCED BELOW.\n10.27 Gas Purchase Agreement, dated March 12, 1991 between Husky Oil Operations Limited and San Diego Gas & Electric Company (Exhibit 10.1).\n10.28 Gas Purchase Agreement, dated March 12, 1991 between Canadian Hunter Marketing Limited and San Diego Gas & Electric Company (Exhibit 10.2).\n10.29 Gas Purchase Agreement, dated March 12, 1991 between Bow Valley Industries Limited and San Diego Gas & Electric Company (Exhibit 10.3).\n10.30 Gas Purchase Agreement, dated March 12, 1991 between Summit Resources Limited and San Diego Gas & Electric Company (Exhibit 10.4).\n10.31 Service Agreement Applicable to Firm Transportation Service under Rate Schedule FS-1, dated May 31, 1991 between Alberta Natural Gas Company Ltd. and San Diego Gas & Electric Company (Exhibit 10.5).\n10.32 Firm Transportation Service Agreement, dated December 31, 1991 between Pacific Gas and Electric Company and San Diego Gas & Electric Company (Exhibit 10.7).\n10.33 Supplemental Executive Retirement Plan adopted on July 15, 1981 and amended on April 24, 1985, October 20, 1986, April 28, 1987, October 24, 1988, November 21, 1988 and October 28, 1991 (Exhibit 10.8).\n10.34 Uranium enrichment services contract between the U. S. Department of Energy and Southern California Edison Company, as agent for SDG&E and others; Contract DE-SC05-84UEO7541, dated November 5, 1984, effective June 1, 1984, as amended by modifications dated September 13, 1985, January 8, April 10, June 17 and August 8, 1986, March 26, 1987, February 20 and July 25, 1990, and October 7, 1991 (Exhibit 10.9).\n10.35 Loan agreement with California Pollution Control Financing Authority, dated as of December 1, 1985, in connection with the issuance of $35 million of pollution control bonds (Exhibit 10.10).\n10.36 Loan agreement with California Pollution Control Financing Authority, dated as of December 1, 1991, in connection with the issuance of $14.4 million of pollution control bonds (Exhibit 10.11).\n10.37 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #3 (1992 compensation) (Exhibit 10.16).\n10.38 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1992 compensation, 1993 incentive) (Exhibit 10.17).\n10.39 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Nonemployee Directors (1992 compensation) (Exhibit 10.18).\n10.40 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1991 compensation, 1992 incentive) (Exhibit 10.20).\n10.41 Loan agreement with the City of San Diego in connection with the issuance of $44.25 million of Industrial Development Revenue Bonds, dated as of July 1, 1986 (Exhibit 10.36).\n10.42 Loan agreement with the City of San Diego in connection with the issuance of $81.35 million of Industrial Development Revenue Bonds, dated as of December 1, 1986 (Exhibit 10.37).\n10.43 Loan agreement with the City of San Diego in connection with the issuance of $100 million of Industrial Development Revenue Bonds, dated as of September 1, 1985 (Exhibit 10.38).\n10.44 Executive Incentive Plan dated April 23, 1985 (Exhibit 10.39).\n10.45 Loan agreement with California Pollution Control Financing Authority dated as of December 1, 1984, in connection with the issuance of $27 million of pollution control bonds (Exhibit 10.40).\n10.46 Loan agreement with California Pollution Control Financing Authority dated as of May 1, 1984, in connection with the issuance of $53 million of pollution control bonds (Exhibit 10.41).\n10.47 Lease agreement dated as of July 14, 1975 with New England Mutual Life Insurance Company, as lessor (Exhibit 10.42).\nTHE FOLLOWING EXHIBIT IS INCORPORATED BY REFERENCE FROM SDG&E'S MARCH 31, 1991 FORM 10-Q AS REFERENCED BELOW.\n10.48 Firm Transportation Service Agreement, dated April 25, 1991 between Pacific Gas Transmission Company and San Diego Gas & Electric Company (Exhibit 28.2).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S 1990 FORM 10-K AS REFERENCED BELOW.\n10.49 Agreement dated March 19, 1987, for the Purchase and Sale of Uranium Concentrates between SDG&E and Saarberg-Interplan Uran GmbH (assigned to Pathfinder Mines Corporation in June 1993) (Exhibit 10.5).\n10.50 Second Amended San Onofre Agreement among Southern California Edison Company, SDG&E, the City of Anaheim and the City of Riverside, dated February 26, 1987 (Exhibit 10.6).\n10.51 San Diego Gas & Electric Company Retirement Plan for Directors, adopted December 17, 1990 Exhibit 10.7).\n10.52 San Diego Gas & Electric Company Executive Severance Allowance Plan, as Amended and Restated, December 17, 1990 (Exhibit 10.8).\n10.53 San Diego Gas & Electric Company and Southern California Gas Company Restated Long-Term Wholesale Natural Gas Service Contract, dated September 1, 1990 (Exhibit 10.9).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S 1989 FORM 10-K AS REFERENCED BELOW.\n10.54 Amendment to the San Diego Gas & Electric Company 1986 Long-Term Incentive Plan adopted January 23, 1989 (Exhibit 10B).\n10.55 Loan agreement between San Diego Trust & Savings Bank and SDG&E dated January 1, 1989 as amended (Exhibit 10H).\n10.56 Loan agreement between Union Bank and SDG&E dated November 1, 1988 as amended (Exhibit 10I).\n10.57 Loan agreement between Bank of America National Trust & Savings Association and SDG&E dated November 1, 1988 as amended (Exhibit 10J).\n10.58 Loan agreement between First Interstate Bank of California and SDG&E dated November 1, 1988 as amended (Exhibit 10K).\nTHE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE FROM SDG&E'S 1988 FORM 10-K AS REFERENCED BELOW.\n10.59 Severance Plan as amended August 22, 1988 (Exhibit 10A).\n10.60 U. S. Navy contract for electric service, Contract N62474-70-C-1200-P00414, dated September 29, 1988 (Exhibit 10C).\n10.61 Employment agreement between San Diego Gas & Electric Company and Thomas A. Page, dated June 15, 1988 (Exhibit 10E).\n10.62 Public Service Company of New Mexico and San Diego Gas & Electric Company 1988-2001 100 MW System Power Agreement dated November 4, 1985 and Letter of Agreement dated April 28, 1986, June 4, 1986 and June 18, 1986 (Exhibit 10H).\n10.63 San Diego Gas & Electric Company and Portland General Electric Company Long-Term Power Sale and Transmission Service agreements dated November 5, 1985 (Exhibit 10I).\n10.64 Comision Federal de Electricidad and San Diego Gas & Electric Company Contract for the Purchase and Sale of Electric Capacity and Energy dated November 20, 1980 and additional Agreement to the contract dated March 22, 1985 (Exhibit 10J).\n10.65 U. S. Department of Energy contract for disposal of spent nuclear fuel and\/or high-level radioactive waste, entered into between the DOE and Southern California Edison Company, as agent for SDG&E and others; Contract DE-CR01-83NE44418, dated June 10, 1983 (Exhibit 10N).\n10.66 Agreement with Arizona Public Service Company for Arizona transmission system participation agreement - contract 790116 (Exhibit 10P).\n10.67 City of San Diego Electric Franchise (Ordinance No.10466) (Exhibit 10Q).\n10.68 City of San Diego Gas Franchise (Ordinance No.10465) (Exhibit 10R).\n10.69 County of San Diego Electric Franchise (Ordinance No.3207) (Exhibit 10S).\n10.70 County of San Diego Gas Franchise (Ordinance No.5669) (Exhibit 10T).\n10.71 Supplemental Pension Agreement with Thomas A. Page, dated as of April 3, 1978 (Exhibit 10V).\n10.72 Lease agreement dated as of June 15, 1978 with Lloyds Bank California, as owner-trustee and lessor - Exhibit B to financing agreement of SDG&E's Encina Unit 5 equipment trust (Exhibit 10W).\nExhibit 12 -- Statement re computation of ratios\n12.1 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends for the years ended December 31, 1993, 1992, 1991, 1990 and 1989.\nExhibit 13 -- The financial statements and other documents listed under Part IV Item 14(a)1. and Management's Discussion and Analysis of Financial Condition and Results of Operations listed under Part II Item 7 of this form 10-K are incorporated by reference from the 1993 Annual Report to Shareholders.\nExhibit 22 - Subsidiaries - See \"Part I, Item 1. Description of Business.\"\nExhibit 24 - Independent Auditors' Consent, Page 37.\n(b) Reports on Form 8-K:\nA Current Report on Form 8-K was filed on December 22, 1993 to report the resignation of Douglas O. Allred from SDG&E's Board of Directors.\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference of our report dated February 25, 1994 (which report contains an explanatory paragraph referring to the Company's consideration of alternative strategies for its 80 percent-owned subsidiary, Wahlco Environmental Systems, Inc.) appearing on page 38 of the 1993 Annual Report to Shareholders of San Diego Gas & Electric Company in this Annual Report on Form 10-K for the year ended December 31, 1993.\nWe also consent to the incorporation by reference of the above-mentioned report in San Diego Gas & Electric Company Post-Effective Amendment No. 1 to Registration Statement No. 33-46736 on Form S-3, Post-Effective Amendment No. 4 to Registration Statement No. 2-71653 on Form S-8, Registration Statement No. 33-7108 on Form S-8, Amendment No. 1 to Registration Statement No. 33-21971 on Form S-3, Registration Statement No. 33-45599 on Form S-3, Registration Statement No. 33-52834 on Form S-3 and Registration Statement No. 33-49837 on Form S-3; and SDO Parent Co., Inc. Registration Statement No. 2-98332 on Form S-4 as amended by Post-Effective Amendment No. 1 on Form S-3.\nDeloitte & Touche San Diego, California March 3, 1994\nSIGNATURES\nPursuant 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.\nSAN DIEGO GAS & ELECTRIC COMPANY\nFebruary 28, 1994 By: \/s\/ Thomas A. Page ----------------------------- Thomas A. Page Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nSignature Title Date - ------------------------------------------------------------------------- Principal Executive Officer:\n\/s\/ Thomas A. Page - --------------------------- Thomas A. Page Chairman, President and Chief February 28, 1994 Executive Officer and a Director\nPrincipal Financial Officer:\n\/s\/ Malyn K. Malquist - --------------------------- Malyn K. Malquist Vice President-Finance and February 28, 1994 Treasurer\nPrincipal Accounting Officer:\n\/s\/ Frank H. Ault - --------------------------- Frank H. Ault Vice President and Controller February 28, 1994\nDirectors:\n\/s\/ Richard C. Atkinson - --------------------------- Richard C. Atkinson Director February 28, 1994\n\/s\/ Ann Burr - --------------------------- Ann Burr Director February 28, 1994\n\/s\/ Richard A. Collato - --------------------------- Richard A. Collato Director February 28, 1994\n\/s\/ Daniel W. Derbes - --------------------------- Daniel W. Derbes Director February 28, 1994\n\/s\/ Robert H. Goldsmith - --------------------------- Robert H. Goldsmith Director February 28, 1994\n\/s\/ Ralph R. Ocampo - ------------------------- Ralph R. Ocampo Director February 28, 1994\n\/s\/ Catherine Fitzgerald Wiggs - -------------------------------- Catherine Fitzgerald Wiggs Director February 28, 1994","section_15":""}
{"filename":"732716_1993.txt","cik":"732716","year":"1993","section_1":"Item 1. Business.\nGENERAL\nPacific Telesis Group (the \"Corporation\") was incorporated in 1983 under the laws of the State of Nevada and has its principal executive offices at 130 Kearny Street, San Francisco, California 94108 (telephone number (415) 394-3000).\nThe Corporation is one of seven regional holding companies (\"RHCs\") formed in connection with the 1984 divestiture by American Telephone and Telegraph Company (\"AT&T\") of its 22 wholly owned operating telephone companies (\"BOCs\") pursuant to a consent decree settling antitrust litigation (the \"Consent Decree\") approved by the United States District Court for the District of Columbia (the \"Court\"), which has retained jurisdiction over the interpreta- tion and enforcement of the Consent Decree.\nUnder the terms of the Consent Decree, all territory served by the BOCs was divided into geographical areas called \"Local Access and Transport Areas\" (\"LATAs\", also referred to as \"service areas\"). The Consent Decree generally prohibits BOCs and their affiliates* from providing communications services that cross service area boundaries; however, the networks of the BOCs interconnect with carriers that provide such services (commonly referred to as \"interexchange carriers\").\nThe Corporation includes a holding company, Pacific Telesis; two BOCs, Pacific Bell and Nevada Bell (the \"Telephone Companies\"); and certain diversified subsidiaries, all described more fully below. The holding company provides financial, strategic planning, legal and general administrative functions on its own behalf and on behalf of its subsidiaries.\nTHE TELEPHONE COMPANIES AND LINE OF BUSINESS RESTRICTIONS\nPacific Bell and its wholly-owned subsidiaries, Pacific Bell Directory and Pacific Bell Information Services, and Nevada Bell provide a variety of communications services in California and Nevada. These services include: (1) dial tone and usage services, including local service (both exchange and private line), message toll services within a service area, Wide Area Toll Service (WATS)\/800 services, Centrex service (a central office-based switching service) and various special and custom calling services; (2) exchange access to interexchange carriers and information service providers for the origination and termination of switched and non-switched (private line) voice and data traffic; (3) billing services for interexchange carriers and information service providers; (4) various operator services; (5) installation and maintenance of customer premises wiring; (6) public communications services (including service for coin telephones); (7) directory publishing; and (8) selected information services, such as voice mail and electronic mail (See also \"Pacific Bell Information Services,\" below). Efforts to develop additional advanced services are described below.\n- -------------------\n* The terms of the Consent Decree, with certain exceptions, apply generally to all the BOCs and their affiliates.\nThe Consent Decree provides that the RHCs shall not engage in certain lines of business. The principal restrictions initially prohibited the provision of interexchange telecommunications, information services and telecommunications equipment. As described below, the information services prohibition was lifted in 1991. The telecommunications businesses permitted by the Consent Decree include the provision of exchange telecommunications* and exchange access services, customer premises equipment (\"CPE\") and printed directory advertising. The RHCs are prohibited from manufacturing telecommunications equipment and CPE. On December 3, 1987, the Court interpreted the manufacturing restriction to mean that the RHCs are prohibited from designing and developing telecommunications equipment and CPE as well as from fabricating them. The Consent Decree provides that the Court may waive the line of business restrictions (i.e., grant a \"Waiver\") upon a showing that there is no substantial possibility that the RHCs could use their monopoly power to impede competition in the market they seek to enter. The Court has placed certain conditions on the Waivers it has granted and may do so again on future Waivers.\nIn May 1993, the U.S. Court of Appeals for the District of Columbia affirmed the Court's removal of the ban on the provision of information services by the Corporation. The removal of this ban in July 1991 allowed the Telephone Companies to offer a variety of new information services, subject to regulatory approvals, such as enhanced voice mail and electronic yellow pages. In November 1993, the U.S. Supreme Court declined to review the Appeals Court decision.\nIn November 1993, legislation was introduced in Congress that would simplify the procedures under which BOCs seek relief from provisions of the Consent Decree that prohibit the Telephone Companies from manufacturing telephone equipment or providing long-distance service. The legislation would set conditions and establish waiting periods of up to five years before the RHCs could seek authority to enter all aspects of these businesses. One of the bills would also impose stringent separate subsidiary requirements on RHC electronic publishing ventures.\nSPIN-OFF OF THE CORPORATION'S WIRELESS OPERATIONS\nIn December 1992, Pacific Telesis' Board of Directors approved a plan to spin off the Corporation's wireless operations. In connection with the separation, AirTouch Communications (\"AirTouch\"), formerly PacTel Corporation, completed an initial public offering of common stock in December 1993.\nThe Corporation will spin off AirTouch and its domestic and international wireless operations as a separate entity. These wireless operations principally include cellular, paging, radiolocation and other wireless telecommunications services in the United States, Europe and Asia. (See \"AirTouch Communications,\" below.) The Corporation will continue to own the Telephone Companies, Pacific Bell's directory publishing and information services subsidiaries, and several smaller diversified entities, including real estate assets.\n- ------------------- * \"Exchange telecommunications\" includes toll or long-distance services within a service area as well as local service.\nIn February 1993, the California Public Utilities Commission (\"CPUC\") instituted an investigation of the proposed spin-off of the Corporation's wireless businesses for the purpose of assessing any effects it might have on telephone customers of Pacific Bell and regulated cellular and paging firms in California. On November 2, 1993, the CPUC adopted a decision permitting the spin-off to proceed. The CPUC further ordered a refund by the Corporation of approximately $50 million (including interest) of cellular pre-operational and development expenses. Further proceedings will determine how the refund will be disbursed. The CPUC decision was effective immediately. The Public Services Commission of Nevada (the \"PSCN\") approved the spin-off in August 1993.\nTwo parties to the CPUC investigation filed Applications for Rehearing by the CPUC of its treatment of the claims for compensation owed to Pacific Bell customers. The CPUC's Division of Ratepayer Advocates filed a Petition for Modification of the CPUC's decision. In March 1994 the CPUC denied these requests. One of these parties further stated that if it were unsuccessful with the CPUC it would seek review by the California Supreme Court. In the event the California Supreme Court were to review and reverse the CPUC's decision, no assurance can be given that the CPUC might not reach a new decision materially less favorable to the Corporation or AirTouch with respect to the compensation issues. In addition, a substantial period of time could elapse before final resolution of these issues should a review be granted. The Corporation believes that the California Supreme Court will deny a review.\nOn March 10, 1994, the Board gave final approval to the spinoff of AirTouch. The spin-off will be effected April 1, 1994. The remaining 86 percent of AirTouch's common shares currently owned by the Corporation will be distributed to the Corporation's shareowners of record on March 21, 1994 in proportion to their shares in the Corporation. The distribution has been ruled as qualifying as a tax-free transaction to shareowners by the Internal Revenue Service. The distribution will be accounted for as a stock dividend by the Corporation when made.\nUpon the spin-off of AirTouch, the Corporation and AirTouch will have no common directors, officers or employees. Philip J. Quigley will become Chairman and Chief Executive Officer of the Corporation and will remain as President and Chief Executive Officer of Pacific Bell. Sam Ginn, currently Chairman and Chief Executive Officer of the Corporation, will leave Pacific Telesis Group but will continue as Chairman and Chief Executive Officer of AirTouch. C. Lee Cox, currently Group President of the PacTel Companies, will also leave Pacific Telesis Group and will continue as President and Chief Operating Officer of AirTouch.\nThe Corporation and AirTouch have entered into a separation agreement that provides for the disengagement of the two corporations' affairs in an orderly manner and their complete separation after the spin-off. For example, the agreement provides for the allocation of procedural and financial responsibility with respect to contingent liabilities that become certain after the spin-off and for the exchange of information necessary for governmental reporting requirements.\nPacific Bell Directory\nPacific Bell Directory (\"Directory\") is a publisher of the Pacific Bell SMART Yellow Pages(R). Directory is the oldest and largest publisher of directory information products in California and is among the largest Yellow Pages publishers in the United States. Directory has enhanced the content, organization and visual appeal of the local information in its directories and improved other features to make the SMART Yellow Pages even more helpful and easier to use. Most recently, a \"Government Officials\" section was added that contains the names, address, telephone numbers and photographs of elected officials, along with a map identifying congressional and state representative boundaries. An audiotext feature called \"Local Talk\" is planned for 60 markets statewide by the end of 1994. In addition, government, business and residential listings have been divided into separate sections in the White Pages for faster accessibility, with colored tabs on the outer edges of the pages identifying each section. As part of its ongoing small business advocacy efforts, Directory also produces Small Business Success in partnership with the U.S. Small Business Administration. Small Business Success is an annual publication now in its seventh year that addresses subjects of critical importance to entrepreneurs.\nPacific Bell Information Services\nEffective January 1, 1993, Pacific Bell transferred its Information Services Group to Pacific Bell Information Services (\"PBIS\"). PBIS provides business and residential voice mail and other selected information services. Current products include The Message Center for home use, Pacific Bell Voice Mail for businesses, and Pacific Bell Call Management, a service that routes incoming business calls and connects computer data bases to answer routine customer questions. (See page of 1994 Proxy Statement* for discussion of CPUC proceeding concerning PBIS.)\n- -------------------\n* All references herein to the 1994 Proxy Statement shall be deemed to incorporate the specific pages or notes into the section of this Form 10-K where the reference appears.\nOTHER SUBSIDIARIES AND TELESIS FOUNDATION\nPacTel Finance, formerly a subsidiary of AirTouch, is now directly owned by the Corporation. Among subsidiaries held by PacTel Finance are PacTel Cable and CalFront Associates (formerly PacTel Properties).\nPacTel Cable has sold all of its wholly-owned subsidiaries which owned cable franchises in the United Kingdom. The final sales were made to a subsidiary of Jones InterCable, Inc. in January 1994. PacTel Cable retains options to purchase from TC Cable, Inc. up to a 75 percent interest in Prime Cable of Chicago, Inc., which acquired certain Chicago cable television properties in June 1990 for $213 million. Under the terms of the current agreements, PacTel Cable would be required to exercise its minority option (for 18.8 percent ownership) if it receives the necessary regulatory approvals, including a Waiver to provide interLATA services. If PacTel Cable does not obtain the necessary regulatory approvals, it will be prohibited from exercising this option but it has guaranteed TC Cable a minimum price for a sale to another party. (See discussion of related loan guarantees on page in Note L to the Consolidated Financial Statements contained in the 1994 Proxy Statement.) PacTel Cable's majority option (for 56.2 percent ownership) is exercisable at its sole discretion.\nCalFront Associates holds a portfolio of real estate assets which the Corporation plans to sell over the next three to five years. As of December 31, 1993, the balance of the reserves taken for real estate losses totaled $338 million. (See discussion of restructuring reserve on page of the 1994 Proxy Statement.)\nPacTel Capital Resources (\"PTCR\") was formed to provide funding for the former PacTel Corporation and its subsidiaries, primarily through the sale of debt securities in the United States and other markets. PTCR has issued commercial paper and medium-term notes guaranteed by the Corporation from time to time since 1987. In the future, PTCR may also provide funding or issue guarantees and other forms of financial support for its other affiliates.\nPacTel Capital Funding (\"PTCF\") was formed to provide funding for the former PacTel Corporation and its subsidiaries and third parties engaged in business with those companies, primarily through the nonpublic sale of debt securities. In the future, PTCF may provide funding or issue guarantees and other forms of financial support for its other affiliates and third parties.\nPacTel Re Insurance Company, Inc. reinsures policies of outside insurance companies covering workers' compensation, general liability and auto liability exposures of the Corporation and its subsidiaries and affiliates. The subsidiary also issues policies of property insurance directly to the Corporation's subsidiaries and engages in property reinsurance transactions in insurance markets worldwide.\nPacific Telesis Group - Washington represents the Corporation's interests in Washington, D.C. before the three branches of the federal government. It also acts as a liaison with other telecommunications companies, trade associations and a wide variety of interest groups.\nTelesis Foundation, a private foundation organized under section 501(c)(3) of the Internal Revenue Code, makes grants in the areas of education, health and welfare, cultural, community and civic activities. Telesis Foundation is a\nnewly formed foundation, replacing Pacific Telesis Foundation. Pacific Telesis Foundation is being terminated and its assets distributed to two new foundations, Telesis Foundation and PacTel Foundation. As of December 31, 1993, Pacific Telesis Foundation had total assets with an estimated market value of $68 million.\nRESEARCH AND DEVELOPMENT\nBell Communications Research, Inc. (\"Bellcore\") furnishes the BOCs, including the Telephone Companies, with technical and consulting assistance to support their provision of exchange telecommunications and exchange access services. Each of the other six RHCs or their BOCs, including Pacific Bell, holds one-seventh of the voting stock of Bellcore, which serves as a central point of contact for coordinating the efforts of the RHCs in meeting the national security and emergency preparedness requirements of the federal government. In addition, the Corporation conducts research and development through Pacific Bell and through Telesis Technologies Laboratory, Inc., a wholly-owned subsidiary of the Corporation. The Corporation, excluding spin-off operations, spent approximately $30 million, $30 million and $31 million in 1993, 1992 and 1991, respectively, on research and development activities.\nFINANCING ACTIVITIES OF THE CORPORATION\nIn 1993, the Corporation redeemed $2.62 billion and issued $2.65 billion of long-term debt. As of December 31, 1993, Pacific Bell had remaining authority to issue up to $1.25 billion in long- and intermediate-term debt pursuant to a CPUC order issued in September 1993. As of December 31, 1993, Pacific Bell had authority to issue up to $650 million in long- and intermediate-term debt through a shelf registration statement on file with the Securities and Exchange Commission (the \"SEC\"). Proceeds from debt issuances in 1993 and future issuances will be used to refund maturing debt and to refinance other debt issues. Effective April 23, 1993, AT&T redeemed $300 million in long- term debt for which Pacific Bell was a secondary obligor. This debt was assumed by AT&T at divestiture.\nPursuant to a shelf registration on file with the SEC, PTCR has authority to issue up to $192 million of medium-term notes, guaranteed by the Corporation as to payment of principal and interest.\nThe following are bond and commercial paper ratings for the Corporation and its subsidiaries: | Long- and |Intermediate-Term Commercial Paper | Debt - ----------------------------------------------------------|----------------- Pacific | Telesis Pacific | Pacific Group PTCR Bell | PTCR Bell - ----------------------------------------------------------|----------------- Moody's Investors Service, Inc. Prime-1 Prime-1 Prime-1 | A1 Aa3 Standard & Poor's Corporation A-1 A-1 A-1+ | A+ AA- Duff and Phelps, Inc. - - Duff 1+ | - AA - -----------------------------------------------------------------------------\nPacific Bell and PTCR are the only subsidiaries of the Corporation with any long- or intermediate-term publicly held debt issues outstanding as of December 31, 1993. The holding company itself has no publicly held debt issues outstanding.\nNo recapitalization of Pacific Bell is planned as a result of the Corporation's spin-off of AirTouch. After the announcement of the Board's decision in December 1992 to spin off AirTouch and its wireless operations, Duff and Phelps, Inc. (\"D&P\") reaffirmed its rating of Pacific Bell's debt. Standard & Poor's (\"S&P\") affirmed its rating on the outstanding long-term debt of PTCR and Pacific Bell, and on the commercial paper programs of Pacific Bell, PTCR and the Corporation. S&P also revised its ratings outlook for the long-term debt of PTCR and Pacific Bell from \"stable\" to \"positive.\" Additionally, Moody's stated that the debt ratings of all three entities are unlikely to be affected by the spin-off.\nThe Corporation expects that each of the separate businesses will continue upon separation to have access to the public and private markets for debt, although the terms are likely to be less favorable for AirTouch. S&P has assigned an implied senior debt rating of BBB+ to the post-spin AirTouch. AirTouch has been capitalized through an initial public offering of stock in December 1993.\nThe ratings noted above reflect the views of the rating agencies; they should be evaluated independently of one another and are not recommendations to buy, sell or hold the securities of the Corporation. There is no assurance that such ratings will continue for any period of time or that they will not be changed or withdrawn.\nAdditional discussion of the Corporation's financing activities is on pages through and in Notes H and I to the 1993 Consolidated Financial Statements contained in the 1994 Proxy Statement.\nPRINCIPAL SERVICES\nDue to the impending spin-off, the operations of AirTouch have been classified separately within the Corporation's financial statements as \"spin-off operations\" and are excluded from the amounts of revenues and expenses of the Corporation's \"continuing operations.\" Under this presentation, the Telephone Companies accounted for almost all of the Corporation's operating revenues in 1993. For these reasons, the following discussion focuses on selected operating information for the Telephone Companies. Additional information regarding revenues, operating profit or loss and assets of the Corporation, relating primarily to the Telephone Companies, is incorporated from the 1994 Proxy Statement by reference in \"Item 8. Financial Statements and Supplementary Data\" below.\nSignificant components of Pacific Telesis Group's operating revenues are depicted in the chart below:\n% of Total Operating Revenues* ------------------------------ Revenues by Major Category 1993 1992 1991 - --------------------------------------------------------------------------- Local Service Recurring .............................. 22% 21% 20% Other Local ............................ 16% 16% 16%\nNetwork Access Carrier Access Charges ................. 18% 18% 18% End User & Other ....................... 7% 7% 7%\nToll Service** Message Toll Service ................... 20% 19% 19% Other .................................. 2% 4% 5%\nOther Service Revenues Directory Advertising .................. 11% 11% 11% Other .................................. 4% 4% 4% ------ ------ ------ TOTAL ...................................... 100% 100% 100% =========================================================================== * Excludes revenues of spin-off operations.\n** Percentages for 1993 are not comparable to prior years' percentages due to reclassifications in the current presentation.\nThe percentages of Pacific Telesis Group's operating revenues attributable to interstate and intrastate telephone operations are displayed below:\n% of Total Operating Revenues* ------------------------------ 1993 1992 1991 - --------------------------------------------------------------------------- Interstate telephone operations ............ 18% 18% 17% Intrastate telephone operations ............ 82% 82% 83% ------ ------ ------ TOTAL ...................................... 100% 100% 100% =========================================================================== * Excludes revenues of spin-off operations.\nAs of December 31, 1993 about 33 percent of the network access lines of Pacific Bell were in Los Angeles and vicinity and about 25 percent were in San Francisco and vicinity. On that date, about 64 percent of Nevada Bell's network access lines were in Reno and vicinity. The Telephone Companies provided approximately 77 percent and 30 percent of the total access lines in California and Nevada, respectively, on December 31, 1993. The Telephone Companies do not furnish local service in certain sizeable areas of California and Nevada which are served by nonaffiliated telephone companies.\nMAJOR CUSTOMER\nPayments from AT&T for access charges and other services accounted for 11 percent of the Corporation's operating revenues during 1993. No other customer accounted for more than 10 percent of the Corporation's operating revenues in 1993.\nSTATE REGULATION\nAs a provider of telecommunications services in California, Pacific Bell is subject to regulation by the CPUC with respect to intrastate rates and services, the issuance of securities and other matters. The Public Service Commission of Nevada (\"PSCN\") regulates Nevada Bell on similar issues.\nThe CPUC adopted a new regulatory framework, which is a form of \"price cap\" or \"incentive\" regulation, for Pacific Bell and one other large local exchange carrier in California in October 1989. The authorized market-based rate of return under the CPUC's new regulatory framework is 11.5 percent. If Pacific Bell's rate of return exceeds 13 percent, earnings above the 13 percent benchmark must be shared 50-50 with customers. Earnings above 16.5 percent must be returned 100 percent to customers. The third phase of the CPUC's ongoing investigation into alternative regulatory frameworks has addressed competition for intra-service area toll and related services. The CPUC's formal authorization of competition into Pacific Bell's intra-service area toll market is expected in 1994. (See \"Toll Services Competition\" below.)\nUnder incentive-based regulation, the CPUC requires Pacific Bell to submit an annual price cap filing to determine prices for categories of services for each new year. Price adjustments reflect the effects of any change in the Gross National Product Price Index (\"GNPPI\") less 4.5 percent, the productivity factor established by the CPUC under the new incentive regulation. The annual price adjustments also reflect the effects on Pacific Bell's costs of exogenous events beyond its control. In December 1993, the CPUC approved Pacific Bell's annual price cap filing for 1994 in which Pacific Bell had proposed a $105 million rate reduction. This reduction includes a decrease of $85 million because the 4.5 percent productivity factor of the price cap formula exceeded the increase in the GNPPI by 1.3 percent. The filing also included several additional factors which will decrease revenues* by an additional $20 million.\nIn 1992, the CPUC began its scheduled review of the current incentive-based regulatory framework. Among other issues, this review has examined elements of the price cap formula, including the productivity factor and the benchmark rate of return on investment adopted in the 1989 New Regulatory Framework (\"NRF\") order. Pacific Bell proposed no significant changes to the new framework because the Corporation's experience to date suggests that it is working as intended.\n- ----------------\n* Unless otherwise indicated, revenue changes from CPUC price cap orders are estimated on an annual basis and may be more or less than the amount ordered, due to later changes in volumes of business.\nIn March 1994, a CPUC Administrative Law Judge issued a proposed decision in the NRF review. The proposed decision would eliminate an element of the regulatory framework which requires equal sharing with customers of earnings exceeding a benchmark rate of return. Earnings above a rate of return of 16.5 percent would continue to be returned to customers. The proposed decision also recommends increasing the productivity factor of the price cap formula from 4.5 percent to 6.0 percent for the period 1994 through 1996. If adopted by the CPUC, the change in the productivity factor would reduce annualized revenues by approximately $100 million each year through 1996. Pacific Bell plans to file comments objecting to the proposed increase in productivity factor. The Corporation is unable to predict the final outcome of these proceedings or the effective date of any rate reductions.\nIn August 1993, the CPUC issued a proposal to allow competition in the provision of intrastate switched transport services. The CPUC proposes to allow competitors to locate transmission facilities in Pacific Bell's central offices; adopt a new transport rate structure that includes pricing flexibility for dedicated traffic; and authorize competition for switched transport services within the state. Revenues from intrastate switched transport services represent approximately four percent of Pacific Bell's total revenues. The Corporation is unable to predict the outcome of this proceeding.\nIn April 1993, the CPUC initiated an investigation to establish a framework to govern open network access i.e., access to so-called \"bottleneck\" services. The CPUC proposes to adopt specific requirements for the unbundling and nondiscriminatory provision of functions underlying services provided by dominant telecommunications providers. Functions considered bottleneck and subject to open access for competitive telecommunications providers include all transport switching, call processing and call management. In comments filed in February 1994, Pacific Bell urged the CPUC to recognize that widespread competition exists throughout the telecommunications industry and asked the CPUC to consider rules for local competition immediately.\nPacific Bell's proposal calls for the separation of the loop (the telephone line between a customer's location and the telephone company's central office) from the switch (the central office equipment that selects the paths to be used for transmission of information.) Pacific Bell has filed an application for authority to conduct tests and trials with a variety of industry participants to test the feasibility of unbundling the loop from the switch and of various points of interconnection. The trials would allow competitors to connect to Pacific Bell's network to carry calls. Eventually, customers would be able to decide whether they want Pacific Bell to provide all of their telecommunications services, including local service, or if they want to subscribe to another provider for dialtone and other services. Pacific Bell also believes it should be given the opportunity to compete in other markets, such as long-distance, cable television programming and manufacturing. The Corporation's entry into these markets would benefit consumers by providing them alternatives to existing sources of products and services. The Corporation is unable to predict the outcome of this proceeding.\nIn December 1993, the CPUC released a report to the Governor of California proposing streamlined regulation of telecommunications companies. The report states that the benefits of deregulation and fostering advanced telecommunications in California would be substantial. It predicts that expanded use of telecommunications will create new products, services and job\nopportunities and could increase the productivity of the state's businesses. The CPUC proposes that within the next year California should: streamline regulation where markets are workably competitive; continue the CPUC's focus on consumer protection in all markets; develop policies and partnerships that encourage consumer demand and the increased use of advanced telecommunications networks; and establish a grant program to enhance development and use of advanced telecommunications in schools and libraries. The report recommends that disincentives to investments (such as the current cap on earnings and sharing mechanisms) be removed, that restrictions on Pacific Bell's ability to provide certain services be removed and that interconnection and interoperability among competing networks be required to expand customer choice.\nAdditionally, the CPUC proposed that within three years California open all markets to all competitors, thereby making the state an \"open competition zone.\" It would also restructure universal service funding, and gradually redefine the concept of basic service to ensure that all residents benefit from advanced telecommunications technologies. In addition, it would make digital access to networks available as a prelude to making switched video and mobile services available throughout the state by the end of the decade.\nBy opening markets to competition, the policies proposed by the CPUC would increase demand for and stimulate the private development of new types of telecommunications and video services, bringing innovative new products into businesses, homes, and communities. Various elements of these proposals require consideration by the California Legislature as well as formal review by the CPUC.\nDiscussion of other CPUC proceedings, including regulatory and ratemaking treatment for postretirement benefits in connection with the adoption of Financial Accounting Standard No. 106, and the limited rehearing of a decision involving certain erroneous late payment charges, is on pages through F- 24 of the 1994 Proxy Statement.\nIn Nevada, the PSCN authorized an Alternative Plan of Regulation for telephone companies, including Nevada Bell, beginning in 1991. Nevada Bell was awarded an equity-based rate of return (\"ROE\") of 13 percent and a sharing formula allows Nevada Bell to share in any earnings above the benchmark ROE of 13 percent. The new incentive-based framework places a five-year cap on basic rates. The earnings and sharing review conducted in 1993 based upon 12 months of results of operations resulted in no sharing due to an ROE under 13 percent.\nThe PSCN has also recently opened a proceeding to consider revising existing regulations for telecommunications providers; we hope this proceeding will streamline regulation in Nevada.\nThe Corporation continues to support changes in public policy and regulation that will allow it to offer the products and services that customers want.\nFEDERAL REGULATION\nThe Telephone Companies are subject to the jurisdiction of the Federal Communications Commission (the \"FCC\") with respect to interstate access charges and other matters. The FCC prescribes a Uniform System of Accounts and\ninterstate depreciation rates for operating telephone companies. The FCC also prescribes \"separations procedures,\" which are the principles and standard procedures used to separate plant investment, expenses, taxes and reserves between those applicable to interstate services under the jurisdiction of the FCC, and intrastate services under the jurisdiction of state regulatory authorities. The Telephone Companies are also required to file tariffs with the FCC for the services they provide. In addition, the FCC establishes procedures for allocating costs and revenues between regulated and unregulated activities.\nBeginning in 1991, the FCC adopted a price cap system of incentive-based regulation for local exchange carriers. Pacific Bell's access rates were retargeted to a new 11.25 percent rate of return on rate base assets. The FCC's price cap system provides a formula for adjusting rates annually for changes in the GNPPI, less a productivity factor and changes in certain costs that are triggered by administrative, legislative or judicial action beyond the control of the local exchange carriers.\nThe FCC's price cap plan allows the Telephone Companies to choose between two productivity offset factors of 3.3 or 4.3 percent on an annual basis. This choice affects both the sharing threshold and the threshold above which all earnings must be returned to customers. In its third annual access filing, Pacific Bell again chose the productivity factor of 3.3 percent, which the FCC approved in June 1993. Nevada Bell elected the productivity factor of 4.3 percent. For Pacific Bell, the 3.3 percent factor sets the benchmark rate of return for sharing of earnings at 12.25 percent. For Nevada Bell, the 4.3 percent factor changes the sharing threshold to 13.25 percent. If earnings for 1993 are determined to exceed their respective sharing thresholds, Pacific Bell and Nevada Bell must share the excess earnings equally with customers. Pacific Bell's earnings above 16.25 percent must be returned entirely to customers. For Nevada Bell, all earnings above 17.25 percent must be returned to customers. New interstate access rates became effective July 1, 1993. Pacific Bell and Nevada Bell's annual interstate access rates were decreased by $17 and $3.7 million, respectively, for the 12 months July 1993 through June 1994. The reductions reflect the net effects of inflation, productivity gains and other required cost adjustments.\nIn February 1994, the FCC issued a notice of proposed rulemaking to review its price cap alternative regulatory framework. Parties, including the Telephone Companies, will file comments with the FCC in April 1994. The FCC is looking for comments on three main sets of issues: (1) refining the goals of price caps to better meet the public interest and the purposes of the Communications Act; (2) whether to revise the current plan (which became effective January 1, 1991) to help it better meet the FCC's goals, or to adjust the plan to changes in circumstances; and (3) possible transition from the baseline price cap plan toward reduced or streamlined regulation of services provided by local exchange carriers (\"LECs\") as competition grows.\nThe FCC released a Notice of Inquiry in December 1991 \"to open public debate on the interrelationship of Open Network Architecture with emerging network design\" and to gather information on future network capabilities. The FCC stated that its goal is to encourage development of future local exchange networks that are as open, responsive and procompetitive as possible, consistent with the FCC's other public interest goals. The Telephone Companies filed comments on March 3, 1993, stating that market forces must drive network evolution. In August 1993, the FCC issued a notice of proposed\nrulemaking to require Tier I local telephone companies implementing intelligent networks to offer third party mediated access to their networks. In comments filed with the FCC, the Telephone Companies asserted that access to intelligent networks should not be mandated because market forces are sufficient to bring about open access.\nEffective in June 1993, the FCC ordered expanded network interconnection for interstate special access services. Special access services are used primarily by large businesses to connect to their branch offices or to interexchange carriers. The decision requires large LECs, including the Telephone Companies, to offer expanded interconnection to customers, including other access providers. The decision permits these customers to locate their transmission facilities in the LECs central offices. The FCC granted additional, but limited, pricing flexibility to the LECs to respond to the increased competition that will result. Along with other LECs, the Telephone Companies have filed a petition for review of this FCC decision with the U.S. Court of Appeals for the D.C. Circuit. We are unable to predict the outcome of this appeal. Pacific Bell currently has orders from Competitive Access Providers to locate facilities in more than 20 of its central offices, with more requests expected to follow. Interstate special access revenues subject to increased competition represent less than three percent of the Telephone Companies' total revenues.\nEffective in February 1994, the FCC ordered LECs, including the Telephone Companies, to provide all interested customers, including competitors, with expanded interconnection for interstate switched transport services. The LECs must allow interconnectors to physically locate their transmission facilities in the LECs' central offices and certain other LEC locations, in order to terminate their own switched transport facilities. Switched transport services help connect a business or residential customer with an interexchange carrier. One of the FCC's goals is to promote increased competition for these services. The FCC granted additional, but limited, pricing flexibility for these services so that the LECs can better respond to the competition that will result. Along with other LECs, the Telephone Companies have filed a petition for review of this FCC decision with the U.S. Court of Appeals for the D.C. Circuit. The Court has held this case in abeyance pending the Court's decision in the appeal of the FCC's special access collocation order. Revenues from interstate switched transport services represent approximately three percent of the Telephone Companies' total revenues. Rates reflecting the new rules became effective in early 1994.\nTo facilitate expanded interconnection for switched transport services, the FCC ordered a new interim rate structure effective December 1993. Under the new structure, interexchange carriers pay different rates based on volume, distance and other factors. The FCC intends these interim rates to be revenue neutral. Pacific Bell and others have petitioned the FCC for reconsideration of this decision, contending that the interim rate structure will cause revenue losses. The Corporation is unable to predict the outcome of this proceeding.\nIn August 1992, the FCC modified its rules to permit LECs, including the Telephone Companies, to provide a tariffed basic platform (\"video dialtone\") that will deliver video programming developed by others on a nondiscriminatory basis. (See \"Video Services,\" below, for a discussion of Pacific Bell's four applications to provide video dialtone services.) The FCC's order has been appealed but the appeals are stayed pending the FCC's reconsideration\ndecision. The FCC also recommended that Congress repeal the statutory cross- ownership restriction imposed on cable and telephone companies. Until Congress acts, additional services authorized by the FCC rules include video gateways, interactive enhanced services, video transport, video customer premises equipment, and billing and collection.\nIn July 1993, five of the RHCs, including the Corporation, filed a petition with the FCC asking for new rules governing the provision of long-distance services. The RHCs are currently prohibited from providing long-distance services by the terms of the Consent Decree. Even with a favorable ruling from the FCC, the RHCs must still obtain relief from the Consent Decree from Congress, or the courts, before providing long-distance services. During 1993, Pacific Bell joined other members of the United States Telephone Association (\"USTA\") in a petition to the FCC to establish a rulemaking for the purpose of reforming regulation of interstate access services. USTA urges the FCC to address several major matters needing reform including existing subsidy funding and recovery mechanisms, the need for greater pricing flexibility as competition increases and the need to revise current price cap rules.\nNEW TECHNOLOGY AND ADVANCED SERVICES\nThe Telephone Companies continue to modernize and expand their telephone networks to meet customer demands for faster and more reliable services as well as demands for new products and services. New technologies being deployed include optical fiber, digital switches and Signaling System 7 (\"SS- 7\"). Digital switches and optical fiber, a technology using thin filaments of glass or other transparent materials to transmit coded light pulses, greatly increase the capacity and reliability of transmitted data while reducing maintenance costs. SS-7 permits faster call setup and new custom calling features. Investments in key technologies are summarized on pages and of the 1994 Proxy Statement.\nSS-7 has made it possible for Pacific Bell to offer many new custom calling features, subject to regulatory approvals. New custom calling features include call return, priority ringing, call trace and other Custom Local Area Signaling Services (\"CLASS\"). Pacific Bell began offering priority ringing, repeat dialing and select call forwarding services in selected areas in 1992. Pacific Bell introduced call trace, call screen and call return services in 1993. Over half a million customers subscribed to these new services in 1993. Pacific Bell will introduce additional features and expand the availability of the \"CLASS\" Services in 1994. However, as a result of a CPUC decision in November 1992, Pacific Bell has decided not to offer caller identification (\"Caller ID\"). The stringent number blocking requirements placed on the service by the CPUC prevent Pacific Bell from offering customers a viable service at a reasonable price. Pacific Bell continues to work with the CPUC in this area, with the goal of providing California customers the benefits of Caller ID service. In March 1994, the FCC adopted free per call blocking as the national standard for the offering of Caller ID on interstate calls, effective April, 1995.\nPacific Bell, either directly or through its subsidiary, Pacific Bell Information Services, also offers voice mail, electronic messaging and interactive voice response services. (See \"Pacific Bell Information Services,\" above.) Other enhanced services may be offered in the future. The\nCorporation does not expect revenues from enhanced services to have a material effect on reported earnings in 1994 but the new services are expected to increase the use of the networks of the Telephone Companies.\nIn November 1993, Pacific Bell announced a capital investment plan totaling $16 billion over the next seven years to upgrade its core network infrastructure and to begin building California's \"communications superhighway.\" This will be an integrated telecommunications, information and entertainment network providing advanced voice, data and video services. Using a combination of fiber optics and coaxial cable, Pacific Bell expects to provide broadband services to more than 1.5 million homes by the end of 1996 and more than 5.0 million homes by the end of the decade. As part of its current plan, Pacific Bell has made purchase commitments totaling nearly $600 million in accordance with its previously announced $1 billion program for deploying an all digital switching platform with ISDN (Integrated Services Digital Network) and SS-7 capabilities. The advanced network will make possible capital and operational cost savings, service quality improvements and new revenues from the array of new service possibilities. The offering of any new advanced services will depend upon their economic and technological feasibility. Construction of the portions of the network that are not video- specific will begin early in the second quarter of 1994. (See \"Video Services,\" below.) The network should be capable of offering fully interactive digital telephone services by the end of 1996.\nIn order to offer the new products and services customers want, the Telephone Companies have been making substantial investments to improve the telephone networks. During 1993, the Telephone Companies invested $1.9 billion in their networks.\nCapital expenditures in 1994 for the Telephone Companies are forecast to be $1.9 billion including $1,136 million for projects designed to generate revenues and $589 million for projects designed to reduce costs. Capital expenditures under Pacific Bell's seven year investment plan are not expected to increase until 1996 due to the timing of capital expenditures associated with the construction of the broadband network.\nThe PSCN has approved CLASS services for Nevada Bell. Effective August 1, 1992, Nevada Bell began offering Caller ID, call return, priority ringing, call tracing, repeat dialing, call screening and select call forwarding. Nevada Bell offers two free blocking options to Caller ID -- per call and per line blocking. Nevada Bell is also working with the Nevada Telephone Association on a major contract to provide a digital telecommunications system for the State of Nevada. This digital microwave network will provide an advanced infrastracture for all communications in the public sector, permitting both video conferencing and high-speed data applications.\nCHANGING INDUSTRY ENVIRONMENT\nOne of the challenges facing the Telephone Companies is the accelerating convergence of the telecommunications, computer and video industries. The new information services industry is being shaped by advances in digital and fiber-optic technologies that will make possible the provision of interactive broadband services by the Telephone Companies as well as others. Although this convergence will bring further competition, it also should mean unprecedented reasons to enter new businesses from which we have been barred historically. The Clinton administration has indicated it will support\nlegislation to remove many of the legal restrictions that have prevented telephone companies from offering video services. The administration has also indicated it will support the removal of restrictions which prevent the RHCs from providing long-distance services. Similar proposals have been made by the CPUC to the Governor of California. The public policy initiatives discussed below will determine the terms and conditions under which the Telephone Companies may offer new services in this dynamic marketplace.\nVideo Services\nAs described above, the FCC currently permits LECs, including the Telephone Companies, to provide a tariffed basic platform that will deliver video programming developed by others (\"video dialtone\") and to provide certain other services to customers of this basic platform. In December 1993, Pacific Bell filed an application with the FCC seeking authority to offer video dialtone services in specific locations in four of its service areas: the San Francisco Bay Area; Los Angeles; San Diego; and Orange County. The advanced integrated broadband telecommunications network which Pacific Bell plans to build over the next seven years will be capable of delivering an array of services including traditional voice, data and video services. Once FCC approval is obtained, Pacific will deploy the video exclusive components of the advanced network.\nIn addition to providing advanced telecommunications services, the new network will also serve as a platform for other information providers, and will offer customers an alternative to existing cable television providers. The integrated network is also expected to spur the development of new interactive consumer services in education, entertainment, government and health care.\nIn November 1993, the Corporation sued to overturn the 1984 Cable Act provision barring telephone companies from providing video programming in their service areas. The Cable Act bars telephone companies from having more than a de minimis ownership stake in video programming services, although it permits them to carry other companies' programs. The Corporation believes that video programming is a form of speech protected by the First Amendment of the United States Constitution. If the suit is successful, the Corporation plans to begin providing programming in California as soon as its video dialtone network is deployed.\nIn November 1993, legislation was introduced in Congress that would permit LECs, including the Telephone Companies, to provide video programming to subscribers in their own service areas, subject to separate subsidiary requirements and other safeguards. The legislation would also permit competition in the provision of local telephone service and allow access to LEC facilities by competitors.\nIn January 1994, Pacific Telesis Video Services, a newly created Pacific Telesis subsidiary, announced an advanced interactive television services trial with AT&T that will test consumer acceptance of sophisticated services such as multi-player games, interactive home shopping and educational programs, movies-on-demand and time-shifted television programs. PTVS will purchase transport from Pacific Bell when video dialtone tariffs are approved.\nPacific Telesis Video Services is also working with Hewlett-Packard Company to build an interactive video system that will offer consumers movies and other programs \"on demand\" by late 1994 or early 1995. Hewlett-Packard will provide\nlarge video servers to distribute digital video \"streams\" to individual subscribers' homes. The servers will be built around a new technology, or \"video transfer engine,\" that is flexible, reliable and upgradeable.\nElectronic Publishing Services\nIn November 1993, legislation was introduced in Congress that would simplify the procedures under which BOCs may seek relief from provisions of the Consent Decree. (See \"The Telephone Companies and Line of Business Restrictions\" above.) However, the bill would also impose stringent separate subsidiary requirements on RHC electronic publishing ventures. In November 1993, Pacific Bell filed an application with the CPUC stating its intent to enter the electronic publishing business, either by itself or through an affiliate.\nIn January 1994, the Los Angeles Times and Pacific Telesis Electronic Publishing Services, a newly created Pacific Telesis Group subsidiary, announced a plan to form a joint venture to design and offer electronic shopping information and transaction services beginning in late 1994. A combination of business listings, classified and display advertising, consumer ratings, and editorial and promotional material will form a comprehensive electronic resource that will give consumers the product, service and business information they want from one convenient, integrated source. The joint venture will also offer consumers in-depth information on a wide variety of topics, including home repair and maintenance, real estate rental and sales, and auto, travel and entertainment services.\nPersonal Communications Services\nIn October 1993, the FCC issued an order allocating radio spectrum and setting forth licensing requirements to provide PCS. PCS relies on a network of transceivers that may be placed throughout a neighborhood, business complex or community to provide customers with mobile voice and data communications. The FCC established two different sizes of service areas nationwide for PCS: 47 large areas referred to as Major Trading Areas (\"MTAs\") and 487 smaller areas. The MTA licenses are for 30 megahertz of spectrum. In any given area, there will be as many as seven licenses, including two MTA licenses. Most of the licenses will be awarded by competitive bidding in auctions expected in late 1994 or early 1995. The Corporation plans to aggressively pursue PCS licenses at these auctions and is well-placed to be part of the expected multi-billion dollar market for PCS.\nOn December 23, 1993, the FCC awarded a \"pioneer preference\" to another company for one of the two larger MTA licenses covering the Los Angeles, San Diego, and Las Vegas market area. That company will receive the license without charge. This is expected to place the successful bidder for the remaining MTA license in that area at a significant competitive disadvantage because of its higher cost structure. Winning bids in major PCS markets are expected to require large capital expenditures. The Corporation has filed petitions for review of the FCC decisions that granted pioneer preferences for PCS licenses without charge with the U.S. Court of Appeals for the D.C. Circuit. We are unable to predict the outcome of these appeals.\nThe Corporation's wholly-owned subsidiary, Telesis Technologies Laboratory, Inc. (\"TTL\"), has been conducting PCS experiments and investigating various technological issues under an experimental license granted by the FCC. With a\nspin-off of the Corporation's wireless operations, the Corporation will be eligible to bid on PCS licenses in the service areas of the Telephone Companies. The Corporation also believes that AirTouch will be eligible to bid on the larger MTA licenses in areas where it does not provide cellular service after the spin-off.\nSome of the assets that have been engaged in PCS research and development work were transferred to AirTouch in late 1993 in accordance with the terms of the Separation Agreement between the Corporation and AirTouch. TTL employees originally employed by AirTouch will transfer back to AirTouch before the spin-off. Pacific Bell will form a new subsidiary to receive remaining assets of TTL that have been engaged in PCS research and development work and it will provide PCS services if the Corporation wins a license at auction. Future TTL research will assess wireless broadband technologies, the effects of consumer electronics on telecommunications networks, and continued work in the area of PCS.\nCOMPETITION\nRegulatory, legislative and judicial actions since the Consent Decree, as well as advances in technology, have expanded the types of available communications services and products and the number of companies offering such services. Various forms of competition are growing steadily and are already having a significant effect on the Telephone Companies' earnings, primarily Pacific Bell's. An increasing amount of this competition is from large companies with substantial capital, technological and marketing resources. There is also increased competition among existing and new common carriers, including subsidiaries of the RHCs and AT&T, for the provision of voice and data communications services.\nToll Services Competition\nIn 1993, the CPUC continued Phase III of its ongoing investigation into alternative regulatory frameworks (See \"State Regulation\" above). In Phase III, the CPUC is considering how to lift its current ban on intra- service area competition for toll and toll-related services and how to rebalance Pacific Bell's rates.\nIn September 1993, the CPUC announced a decision providing that, beginning in 1994, long-distance and other telecommunications companies would be allowed to compete with Pacific Bell and other local telephone companies in providing toll service, among other services. The decision would have also lowered local exchange company toll and switched access rates, while increasing basic rates, bringing each closer to cost. Other rates would have also changed. Overall, the CPUC's order was intended to be revenue neutral; that is, the effect of rate decreases would be offset by the effect of rate increases.\nIn October 1993, the CPUC rescinded its September decision after questions were raised about its decision-making process. The CPUC has requested additional comments on its original decision. The Corporation expects a final decision in 1994, but is unable to predict the revenue impacts of the decision and the increased competition that will follow. In a future proceeding, the CPUC intends to address whether to require LECs to provide a way for customers to presubscribe to their carrier of choice for intra-service area toll services.\nIn 1993, Pacific Bell experienced a decline in revenues from services subject to competition, while revenues from other services continued to grow. The total impact of competition on revenues, however, cannot be quantified separately from the effects of the recession in California. (See \"California Economy\" on page of the 1994 Proxy Statement.)\nIn Nevada, the PSCN adopted a rule change effective October 1993 that permits limited intra-service area competition. Interexchange carriers may complete intra-service area calls either through dedicated special access or if the customer initiates the call with certain designated prefixes.\nInterstate Special Access Competition\nExpanded interconnection for interstate special access services became effective on June 16, 1993. Special access services are used primarily by large businesses to connect their branch offices or to connect directly to interexchange carriers. Expanded interconnection allows customers, including other access providers, to locate their transmission facilities in an LEC central office. This allows interexchange carriers (\"IECs\") to choose among competing providers for transport into the LECs' central offices. (See \"Federal Regulation\" above.)\nSwitched Transport Competition\nEffective February 15, 1994, expanded interconnection became available for the transport portion of interstate switched access services under similar price, terms and conditions as for special access services. Switched access services link IECs with most residential and business customers.\nIn recognition of the local transport competition which exists today and the increased competition that will result from expanded interconnection, the FCC has approved limited rate deaveraging by zones of central offices and volume and term discounts for LEC access transport services, once certain conditions are met.\nIn August 1993, the CPUC also issued a proposal to allow competition in the provision of intrastate switched transport services. The CPUC proposes to allow competitors to locate transmission facilities in Pacific Bell's central offices; adopt a new transport rate structure that includes pricing flexibility for dedicated traffic; and authorize competition for switched transport services within the state. (See \"State Regulation\" and \"Federal Regulation\" above.)\nOpen Network Access\/Local Competition\nEarly in 1993, the CPUC initiated a rulemaking proceeding and set forth a number of proposed policies, rules and issues for comment on ways to establish a receptive environment for competitive providers of telecommunications services. The rulemaking focuses on one approach: Requiring local exchange carriers to unbundle \"bottleneck\" elements of their network and make those elements available to unaffiliated providers on an open and nondiscriminatory basis.\nPacific Bell's response to this rulemaking urges the CPUC to examine the full set of issues that result from a competitive local exchange market. Among such issues are: the need to establish a new universal service mechanism that\nspreads the subsidy burden to all telecommunications providers, to reform pricing rules to be consistent with increasing competition, to remove entry barriers including current in-state long distance restrictions on Pacific Bell, to remove investment disincentives such as sharing and to establish standards for interconnection, interoperability and unbundling of essential facilities that apply to all competing networks and not just those of the LECs. (See \"State Regulation\" above.)\nBypass\nArtificially high prices for toll and access services create an economic incentive for large business users (and IECs) to use alternative communications systems capable of originating and\/or terminating calls and thus bypass the local exchange network. This bypass reduces the revenues that the Telephone Companies collect from toll and access services to support the total costs of the local exchange network and increases the amounts the Telephone Companies have to recover from other services, notably basic exchange services. The Telephone Companies are unable to determine precisely to what extent bypass has occurred and may continue to occur in the future. (See preceding sections, from \"Toll Services Competition\" through \"Open Network Access\/Local Competition\" above.)\nTo reduce the threat of bypass of the local networks, the Telephone Companies have strongly supported the use of cost-based pricing policies before both their state regulatory commissions and the FCC. (See \"State Regulation\" and \"Federal Regulation\" above.)\nCentrex\nThe Telephone Companies provide Centrex service to business customers in California and Nevada. Centrex is a central office-based switching system for customers who require sophisticated call transport and management capabilities as part of their business communication systems. Businesses not using Centrex service generally use Private Branch Exchange (\"PBX\") and other systems provided by other companies. The Telephone Companies offer Centrex by contract, as approved by the CPUC for Pacific Bell, as well as pursuant to tariff. The ability to offer Centrex by contract gives the Telephone Companies pricing flexibility as well as the opportunity to tailor the specific features and conditions of a given transaction. The market for multi-line business telephone products is very competitive and includes large well-financed competitors.\nDirectory Publishing\nOther producers of printed directories offer products that compete with certain Pacific Bell Directory SMART Yellow Pages products. Competitors include large companies that have significant resources. Competition is not limited to directory publishers, but includes newspapers, radio, television and increasingly, direct mail. In addition, new advertising and information products may compete directly or indirectly with the SMART Yellow Pages. The Corporation is unable to predict the extent to which these competitors may affect future revenues of the Corporation.\nAIRTOUCH COMMUNICATIONS (SPIN-OFF OPERATIONS)\nAirTouch Communications (formerly PacTel Corporation) and its wireless operations will be spun off to the Corporation's shareholders in a one-for-one stock distribution effective April 1, 1994.\nThe wireless operations of AirTouch Communications (\"AirTouch\") include cellular, paging, vehicle location and other wireless telecommunications services in the United States, Europe and Asia. AirTouch's worldwide cellular interests represented 75.3 million POPs* and more than 1.2 million proportionate subscribers at December 31, 1993. In the United States, AirTouch has 34.9 million POPs** and controls or shares control over cellular systems in ten of the thirty largest markets, including Los Angeles, San Francisco, San Diego, Detroit and Atlanta. Internationally, AirTouch has 40.4 million POPs and holds significant ownership interests, with board representation and substantial operating influence, in national cellular systems operating in Germany, Portugal and Sweden and in cellular systems under construction in three major metropolitan areas in Japan, including Tokyo and Osaka. AirTouch is also the fourth largest provider of paging services in the United States, with approximately 1.2 million units in service at December 31, 1993.\n- --------------------\n* POPs are the estimated market population multiplied by AirTouch's ownership interest in the cellular licensee for the market. International cellular information reflects networks under construction. Domestic cellular subscriber information reflects subscribers to cellular systems over which AirTouch has or shares operational control.\n** POPs and proportionate subscribers for the Michigan\/Ohio region reflect both AirTouch's 50% interest in a joint venture between AirTouch and Cellular Communications, Inc. (\"CCI\") and AirTouch's ownership of approximately 12% of the equity in CCI at December 31, 1993.\nPrincipal AirTouch operations are discussed below.\nAirTouch Cellular\nAirTouch Cellular is one of the largest providers of cellular services in the United States, with interests in some of the most attractive cellular markets based upon total population and demographic characteristics. AirTouch's United States cellular interests represented 34.9 million POPs and more than 1 million proportionate subscribers at December 31, 1993. AirTouch has or shares operational control over cellular systems in Los Angeles, San Francisco, San Diego, Atlanta, Detroit, Cleveland, San Jose, Sacramento, Cincinnati and Kansas City. These cities represent ten of the thirty largest cellular markets in the United States. AirTouch also has or shares operational control over cellular systems in 34 additional markets, including Columbus, Dayton and Toledo, Ohio, and owns minority interests in cellular systems serving 10 other markets, including Dallas\/Forth Worth, Tucson and Las Vegas.\nAirTouch has formed six regional networks, in Southern California, the San Francisco Bay Area, the Sacramento Valley, Michigan\/Ohio, Georgia and Kansas\/Missouri. Regional networks permit AirTouch to meet customers' needs for broad areas of uninterrupted service, to carry out coordinated marketing efforts and to reduce capital expenditures and administrative expenses. Through its participation in marketing alliances such as MobiLink and Cellular One, AirTouch provides national cellular service to its customers.\nAirTouch's transactions with CCI and McCaw Cellular Communications, Inc. (\"McCaw\") are examples of the implementation of AirTouch's regional network strategy. AirTouch's cellular network in Michigan\/Ohio was created in 1991 through New Par, an equally owned joint venture between AirTouch and CCI (\"New Par\"), in which AirTouch's interests in Michigan and northwestern Ohio were combined with CCI's interests in Cleveland, Cincinnati, Columbus and elsewhere throughout Ohio to create one of the largest regional cellular systems in the United States, covering an area with a total population of over 15 million. In connection with the formation of New Par, AirTouch acquired 5% of the equity of CCI, agreed to purchase up to 12.44 million shares (including shares underlying certain stock options) of CCI's stock in October 1995 at $60 per share (less the exercise price in the case of stock options) and obtained the right to acquire all of CCI's remaining equity in stages over the next several years. (See \"Spin-off Operations\" on page in Note L to the 1993 Consolidated Financial Statements contained in the 1994 Proxy Statement.) AirTouch currently owns approximately 12% of CCI. In September 1993, AirTouch formed an equally owned joint venture with McCaw (\"CMT Partners\") that holds controlling interests in cellular systems serving markets in and around San Francisco, San Jose and Kansas City, thereby permitting AirTouch to broaden its coverage of the San Francisco Bay Area and providing it with shared control over an additional regional network in Kansas\/Missouri.\nInternational Operations\nAirTouch has been highly successful in obtaining significant interests in cellular licenses in some of the world's most attractive markets.\nIn 1990, Mannesmann Mobilfunk GmbH (\"MMO\"), in which AirTouch currently holds a 29.15% interest and is the second largest shareholder, won the second\nnational digital cellular license in Germany. AirTouch's interest in MMO includes a 2.25% interest which, under the terms of MMO's license, AirTouch is under a current obligation to sell to small or medium-sized German businesses. MMO began commercial operations in June 1992 and at December 31, 1993 had approximately 493,000 subscribers. The system presently covers approximately 94% of the population, including all of the major cities and highways.\nIn 1991, Telecel Communicacoes Pessoais. S.A. (\"Telecel\"), in which AirTouch holds a 23% interest, was chosen to construct and operate one of two national digital cellular systems in Portugal. Telecel initiated service in October 1992 and at December 31, 1993 had approximately 40,000 subscribers. Telecel currently covers all of Portugal's major cities and highways and approximately 92% of the population and is required under the terms of its license to cover 99% by October 1996.\nIn 1992, AirTouch's consortia were selected to construct and operate digital cellular systems in the Tokyo, Kansai (Western) and Tokai (Central) regions of Japan. AirTouch has a 15% interest in Tokyo Digital Phone Company and 13% interests in each of Kansai Digital Phone Company and Tokai Digital Phone Company. The three systems are expected to be operational by the end of 1994. Such systems are expected to be able to offer service to approximately 74 million people, or 60% of the Japanese population, by 1997.\nIn February 1994, AirTouch agreed to acquire a 4.5% interest in a fourth company, which plans to build a digital cellular system that will reach about 70% of the population of the Kyushu\/Okinawa region when it begins offering service in 1996. There are approximately 15 million people in the region, which is the fourth most populous of Japan's 11 cellular regions.\nIn October 1993, AirTouch acquired a 51% interest in NordicTel Holdings AB (\"NordicTel\"), which owns and operates one of three national digital cellular systems in Sweden, for $153 million. NordicTel's cellular system began commercial operations in late 1992 and currently covers approximately 80% of Sweden's population and all of the major cities.\nPaging Operations\nAirTouch had approximately 1.2 million paging units in service at December 31, 1993 in 100 markets throughout the United States, including Atlanta, Dallas\/Fort Worth, Detroit, Houston, Los Angeles, Phoenix, St. Louis, San Diego, the San Francisco Bay Area, Seattle and Tampa\/St. Petersburg. AirTouch became one of the first paging companies in the United States to offer paging service through retail outlets and the success of AirTouch's retail marketing efforts has contributed significantly to the growth of its paging business. AirTouch also owns significant interests in paging companies in Portugal, Spain and Thailand. In September 1993, a joint venture in which AirTouch has an 18.5% interest was awarded one of three national digital paging licenses in France.\nOther Operations\nAirTouch owns a majority interest in a provider of vehicle location services (\"Teletrac\") in six markets in the United States. Teletrac is in the start-up phase of its operations and to date its services have not achieved a significant degree of commercial acceptance. In February 1994, AirTouch reduced Teletrac's workforce by 30%, to approximately 200 employees. In addition, AirTouch provides air-to-ground telephone service in four domestic cities. AirTouch also owns interests in a long distance telephone company in Japan and a credit card verification business in South Korea.\nEMPLOYEES\nAs of December 31, 1993, the Corporation and its subsidiaries employed 55,355 persons. This number does not include employees who will continue to be employed by AirTouch Communications after the spin-off. About 70 percent of the employees of the Corporation's continuing operations are represented by unions. In September 1992, the unions which represent these employees ratified labor contracts for a three-year term. The agreements provide for a 12 percent increase in wages, including job upgrades and a 13 percent increase in pensions over the three-year term. In addition, the contracts include incentives for early retirement, enhanced employment security, improvements in work and family life benefits and increases in health and dental care coverage. In 1993, Pacific Bell reduced the number of employees by 1,516, leaving a total of 54,026 employees at year-end.\nLooking ahead, Pacific Bell has begun a major effort to reengineer its internal business processes. This effort confronts an increasingly competitive and complex telecommunications environment by streamlining and consolidating operations, including business offices, network, installation and collection centers, as well as other facilities. As a result, Pacific Bell has announced a force reduction program that will result in a net reduction of 10,000 positions from 1994 through 1997. (See page of the 1994 Proxy Statement for discussion of related 1993 restructuring charge.) The Pacific Telesis holding company and Pacific Bell deferred salary increases for all managers, including officers, for an indefinite period of time pending a review of 1994 business needs.\nAt Nevada Bell, an early retirement program was offered during November 1993 under which approximately 70 employees elected early retirement.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe list below gives the names of executive officers as of March 28, 1994, their present titles and the dates they were elected to these positions.\nName Age Title Since\nS. L. Ginn* ........... 56 Chairman of the Board, President and Chief Executive Officer .......... 4\/88 P. J. Quigley* ........ 51 Group President .................... 1\/88 C. L. Cox ............. 52 Group President .................... 1\/88 R. W. Odgers* ......... 57 Executive Vice President - General Counsel, External Affairs** and Secretary......................... 3\/88 L. L. Christensen* .... 59 Executive Vice President and Chief Financial Officer .......... 5\/92 J. R. Moberg* ......... 58 Executive Vice President - Human Resources ........................ 9\/87 W. E. Downing* ........ 54 Vice President ..................... 3\/93 F. E. Miller .......... 41 Vice President-Corporate Strategy*** and Development ................... 3\/93 A. Sarin .............. 39 Vice President-Organization Design . 3\/93 M. S. Gyani ........... 42 Vice President and Treasurer ....... 3\/93\nEffective upon the spin-off of AirTouch Communications, the executive officers and their titles will be as follows:\nName Age Title\nP. J. Quigley* ........ 51 Chairman of the Board, President and Chief Executive Officer R. W. Odgers* ......... 57 Executive Vice President - General Counsel, External Affairs and Secretary J. R. Moberg* ......... 58 Executive Vice President - Human Resources W. E. Downing* ........ 54 Executive Vice President, Chief Financial Officer and Treasurer F. E. Miller .......... 41 Vice President - Corporate Strategy and Development\nAll of the officers have held responsible managerial positions with the Corporation or one of its subsidiaries for at least the past five years.\nOfficers are not elected for a fixed term, but serve at the discretion of the Corporation's Board of Directors.\n- ------------------\n* Also executive officers of Pacific Bell. ** Executive Vice President - External Affairs since 11\/92. *** Vice President - Corporate Strategy since 3\/94.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of December 31, 1993 the properties of the Telephone Companies represented approximately 98 percent of all plant, property and equipment of the Corporation, excluding spin-off operations.\nThe properties of the Telephone Companies do not lend themselves to description by character and location of principal units. At December 31, 1993, the percentage distribution of total telephone plant by major category for the Telephone Companies was as follows: Pacific Nevada Telephone Property, Plant, and Equipment Bell Bell ------------------------------------------------------------------------- Land and buildings (occupied principally by central offices) ............................ 10% 7%\nCable and conduit ................................ 40% 53%\nCentral office equipment ......................... 37% 32%\nOther ............................................ 13% 8% ------- ------- Total ............................................ 100% 100% =========================================================================\nAt December 31, 1993, the percent utilization of central office equipment capacity for Pacific Bell and Nevada Bell was approximately 90 percent and 95 percent, respectively.\nSubstantially all of the installations of central office equipment and administrative offices are in owned buildings on land held in fee. Many garages, business offices and telephone service centers are in rented quarters.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nContingent Liabilities Related to Predivestiture Events\nThe Plan of Reorganization (\"Plan\") approved by the Court in connection with the Consent Decree provides for the recognition and payment of liabilities of the BOCs and AT&T (collectively, the former \"Bell System\") that are attributable to predivestiture events (including transactions to implement the divestiture), which were not certain and hence not recorded in the books of account until after divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the Bell System's rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws).\nThe Plan provides various rules for the sharing of such contingent liabilities among the BOCs and AT&T which have been followed since divestiture.\nAT&T, its subsidiaries and the BOCs, including the Telephone Companies, may have liability under the contingent liabilities provisions of the Plan in a number of tax matters relating to the audit by various taxing authorities of predivestiture periods and in a number of tort, contract and environmental proceedings relating to predivestiture Bell System operations. While complete assurance cannot be given as to the outcome of any litigation, with respect to such tax matters and tort, contract and environmental proceedings, in the opinion of the Corporation, the likelihood is remote that any liability resulting from them under the contingent liabilities provisions of the Plan would have a material effect on the reported earnings of the Corporation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted for a vote of security holders during the fourth quarter of the year covered by this report.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nDESCRIPTION OF COMMON STOCK AND DIVIDEND AND MARKET INFORMATION\nAll shares of Common Stock (par value $0.10 per share) (See \"Articles of Incorporation and By-Laws - Common Shares\" below) of the Corporation are entitled to participate equally in dividends. Each shareowner has one vote for each share registered in the shareowner's name. All shares of Common Stock would rank equally on liquidation. Owners of shares of Common Stock have no preemptive or cumulative voting rights.\nAt February 28, 1994, there were 798,771 holders of record of the Corporation's Common Stock.\nThe markets for trading in the Common Stock are the New York, Pacific, Chicago, Swiss and London Stock Exchanges.\nThe Corporation from time to time purchases shares of its Common Stock on the open market or through privately negotiated purchases and holds these shares as treasury stock.\nAll shares of Common Stock are fully paid and nonassessable.\nInformation regarding dividends paid on the Common Stock for 1993 and 1992 and the quarterly high and low sales prices of the Common Stock during 1993 and 1992 are included in the 1994 Proxy Statement on page thereof under the heading \"Stock Trading Activity and Dividends Paid,\" incorporated herein by reference pursuant to General Instruction G(2).\nThe declaration and timing of all dividends are at the discretion of the Corporation's Board of Directors and are dependent upon the Corporation's earnings and financial requirements, general business conditions and other factors; there can be no assurances as to the amount or frequency of any future dividends on the Common Stock.\nSHAREOWNER RIGHTS PLAN\nThe Board of Directors of the Corporation adopted a Shareowner Rights Plan in 1989. Under the terms of the plan, shareowners of record as of October 10, 1989 received one right for each share of the Corporation's Common Stock held on that date. Initially, the rights are not exercisable and trade automatically with the Corporation's Common Stock. The rights become exercisable, originally for a 1\/100 share of Preferred Stock of the Corporation, upon the earlier of (i) a person (\"Acquiring Person\") becoming the beneficial owner of securities having 20 percent or more of the voting power of the Corporation, (ii) ten days following the commencement of a tender or exchange offer which would result in a person becoming an Acquiring Person or (iii) ten days after the date on which the Board of Directors of the Corporation declares a person to be an Adverse Person, as defined in the Plan. Once a person becomes an Acquiring or Adverse Person all rights held by such person become void. If a person becomes an Adverse Person or Acquiring Person, the rights will be adjusted so that upon exercise a holder will receive a number of shares of Common Stock of the Corporation having a market value of two times the exercise price of the right. If a person becomes an Acquiring Person and thereafter the Corporation is involved in a merger or other business combination, or 50 percent or more of the Corporation's assets or earning power are sold, then each holder of a right will have the right to receive, on exercise of the right, a number of shares of Common Stock of the surviving corporation having a market value of two times the exercise price of the right. At any time prior to the time a person becomes an Acquiring Person or Adverse Person, the Corporation may redeem the rights at a price of $.01 per right. After a person becomes an Acquiring Person or an Adverse Person, the Board of Directors may exchange each outstanding and exercisable right for one share of Common Stock. The rights do not have any voting rights, may be redeemed under certain circumstances at $0.01 per right, and expire on October 10, 1999.\nARTICLES OF INCORPORATION AND BY-LAWS\nSet forth below is a brief description of some of the important provisions of the Corporation's Articles of Incorporation (the \"Articles\") and By-Laws.\nBoard of Directors\nThe Articles provide for a Board of Directors which is divided into three approximately equal classes of directors serving staggered three-year terms. As a result, approximately one-third of the Board of Directors are elected at each annual meeting.\nThe Articles also provide that the number of directors may be increased or decreased by resolution of the Board of Directors, provided that the number of directors shall not be reduced to less than three. All directors serve until their term of office expires and their successor is elected and qualified, or until their earlier resignation, removal from office, death or incapacity.\nNo director may be removed from office before the end of the term for which such director has been elected except by the affirmative vote of 66-2\/3 percent of the voting power of the shares entitled to vote thereon.\nCommon Shares\nThe Articles provide for the issuance of up to 1.1 billion common shares (par value $.10 per share) in one or more series. The authorized number of the first series of common shares is 1,095,000,000 shares, and that series is designated the \"Common Stock.\" (See \"Description of Common Stock and Dividend and Market Information\" above.) The remaining five million common shares may be issued from time to time as one or more additional series of common shares with such full or limited rights with respect to voting, dividends or distributions upon liquidation, and such other designations, preferences and rights as the Board of Directors may determine.\nPreferred Shares\nThe Articles include a provision for the issuance of up to 50 million preferred shares (par value $.10 per share) in one or more series with full or limited voting powers or without voting powers, and with such designations, preferences and rights as the Board of Directors may determine.\nShareowner Meetings\nThe Corporation has held Annual Meetings of Shareowners each year in April since 1985. Shareowner proposals intended for inclusion in the proxy statement for the 1995 Annual Meeting should be sent to the Corporation's Secretary at 130 Kearny Street, Room 3609, San Francisco, California 94108 no later than November 12, 1994. The Corporation's By-Laws also provide that special meetings of shareowners may be called by certain corporate officers, and that special meetings shall be called at the request in writing of a majority of the Board of Directors or the holders of 66-2\/3 percent of the voting power of the shares entitled to vote at such meetings.\nAmendment of By-Laws\nThe By-Laws further provide that such By-Laws may be amended or repealed at any time by action of the Board of Directors and that they may also be amended or repealed at a meeting of the shareowners by a vote of at least 66-2\/3 percent of the voting power of the shares entitled to vote in the election of directors.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information required by this Item is included in the 1994 Proxy Statement on pages and under the heading \"Selected Financial and Operating Data,\" and is incorporated by reference pursuant to General Instruction G(2).\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe information required by this Item is included in the 1994 Proxy Statement on pages through and is incorporated by reference pursuant to General Instruction G(2).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of Pacific Telesis Group and Subsidiaries has been incorporated by reference in this Form 10-K from page of the 1994 Proxy Statement of Pacific Telesis Group and Subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14 on page 34 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand\nSan Francisco, California March 3, 1994\nAll other information required by this Item is included in the 1994 Proxy Statement on pages and (entire text under the heading \"Report of Management\"), and on pages through thereof (all text and data through Note N on such pages, comprising the Corporation's consolidated financial statements) and is incorporated herein by reference pursuant to General Instruction G(2).\nItem 9.","section_9":"Item 9. Changes in and Disagreements on Accounting and Financial Disclosure.\nNo disagreements with accountants on any accounting or financial disclosure occurred during the period covered by this report.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of Registrant.\nFor information with respect to executive officers of the Corporation, see \"Executive Officers of the Registrant\" at the end of Part I of this report. For information with respect to the directors of the Corporation, see \"Election of Directors\" on pages 4 through 6 of the 1994 Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation.\nFor information with respect to executive compensation, see \"Report of the Compensation and Personnel Committee\" through \"Executive Compensation\" on pages 10 through 12 of the 1994 Proxy Statement. For information with respect to director compensation, see \"Director Compensation and Related Transactions\" on pages 6 through 8 of the 1994 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nFor information with respect to the security ownership of the directors and officers of the Corporation, see page 9 of the 1994 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nFor information with respect to certain relationships and related transactions, see \"Director Compensation and Related Transactions\" on pages 6 through 8 of the 1994 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) Documents filed as part of the report:\n(1) Financial Statements: Page\nReport of Management .............................. *\nReport of Independent Accountants ................. *\nFinancial Statements:\nConsolidated Statements of Income ............. *\nConsolidated Balance Sheets ................... *\nConsolidated Statements of Shareowners' Equity ...................................... *\nConsolidated Statements of Cash Flows ......... *\nNotes to Consolidated Financial Statements .................................. *\nQuarterly Financial Data ...................... *\n(2) Financial Statement Schedules:\nII - Amounts Receivable From Related Parties and Underwriters, Promoters, and Employees Other Than Related Parties ........................ 44\nV - Property, Plant and Equipment ............... 45\nVI - Accumulated Depreciation .................... 49\nVIII - Valuation and Qualifying Accounts ........... 52\nIX - Short-term Borrowings ....................... 55\nFinancial statement schedules other than those listed above have been omitted either because the required information is contained in the Consolidated Financial Statements and the notes thereto or because such schedules are not required or applicable.\n* Incorporated herein by reference to the appropriate portions of the 1994 Proxy Statement (File No. 1-8609). (See Part II.)\n(3) Exhibits:\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Unless otherwise indicated, all exhibits so incorporated are from File No. 1-8609.\nExhibit Number Description ------- -----------\n2a Modification of Final Judgment (Exhibit (28) to Form 8-K, date of report August 24, 1982, File No. 1-1105).\n2b Plan of Reorganization (Exhibit (2) to Form 8-K, date of report December 16, 1982, File No. 1-1105).\n2c March 14, 1983 Motion to Approve Amended Plan of Reorganization (Exhibit (2)a to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2d March 25, 1983 Motion to Approve Plan of Reorganization as Further Amended (Exhibit (2)b to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2e April 7, 1983 Motion to Approve Plan of Reorganization as Further Amended (Exhibit (2)c to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2f Order issued April 20, 1983 in \"U.S. v. Western Electric Company, Incorporated et al.,\" by the United States District Court for the District of Columbia, Civil Action No. 82-0192 (Exhibit (2) to Form 8-K, date of report April 20, 1983, File No. 1-1105).\n2g August 5, 1983 Memorandum and Order of United States District Court for the District of Columbia approving Plan of Reorganization as Amended (Exhibit (2) to Form 8-K, date of report July 8, 1983, File No. 1-1105).\n2h September 10, 1987 Opinion and Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et. al.,\" Civil Action No. 82-0192 (Exhibit 2h to Form SE filed November 10, 1987 in connection with the Corporation's Form 10-Q for the quarter ended September 30, 1987).\n2i March 7, 1988 Opinion and Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated et al.,\" Civil Action No. 82-0192 (Exhibit 2h to Form SE filed March 29, 1988 in connection with the Corporation's Form 10-K for 1987).\n2j April 3, 1990 Opinion of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al., \"Case Nos. 87-5388 et al. (Exhibit 2j to Form SE filed May 11, 1990 in connection with the Corporation's Form 10-Q for the quarter ended March 31, 1990).\n2k July 25, 1991 Opinion & Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Civil Action No. 82-0192 (Exhibit 2k to Form SE filed August 12, 1991 in connection with the Corporation's Form 10-Q for the quarter ended June 30, 1991).\n2l October 7, 1991 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Case Nos. 91-5263, et al. (Exhibit 2l to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n2m May 28, 1993 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al., and National Assn. of Broadcasters, et al.,\" Case Nos. 91-5263, et al. (Exhibit 2m filed August 12, 1993, in connection with the Corporation's Form 10-Q for the quarter ended June 30, 1993).\n2n December 28, 1993 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Case Nos. 92-5111, et al.\n3a Articles of Incorporation of Pacific Telesis Group, as amended to June 17, 1988 (Exhibit 2b to Registration Statement No. 33-24765).\n3b By-Laws of Pacific Telesis Group, as amended to September 24, 1993 (Exhibit 3b to Registration Statement No. 33-50897, filed November 2, 1993, File No. 1-8609).\n4a No instrument which defines the rights of holders of long- and intermediate-term debt of Pacific Telesis Group and its subsidiaries is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, Pacific Telesis Group hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n4b Rights Agreement, dated as of September 22, 1989, between Pacific Telesis Group and The First National Bank of Boston, as successor Rights Agent, which includes as Exhibit B thereto the form of Rights Certificate (Exhibits 1 and 2 to Form SE filed September 25, 1989 as part of Form 8-A, File No. 1-8609).\n10a Reorganization and Divestiture Agreement dated as of November 1, 1983 between American Telephone and Telegraph Company, Pacific Telesis Group and its affiliates (Exhibit (10)a to Form 10-K for 1983).\n10b Agreement Concerning Patents, Technical Information and Copyrights dated as of November 1, 1983 between American Telephone and Telegraph Company and Pacific Telesis Group (Exhibit (10)g to Form 10-K for 1983).\n10c Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements dated as of November 1, 1983 among American Telephone and Telegraph Company, Bell System Operating Companies and Regional Holding Companies (including Pacific Telesis Group and affiliates) (Exhibit (10)j to Form 10-K for 1983).\n10d Agreement Regarding Allocation of Contingent Liabilities dated as of January 28, 1985 between American Telephone and Telegraph Company, American Information Technologies Corporation, Bell Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, Pacific Telesis Group and Southwestern Bell Corporation (Exhibit 10c to Form SE filed March 26, 1986 in connection with the Corporation's Form 10-K for 1985).\n10e Separation Agreement by and between the Corporation and PacTel Corporation dated as of October 7, 1993, and amended November 2, 1993 and March 25, 1994.\n10aa Pacific Telesis Group Senior Management Short Term Incentive Plan (Exhibit 10aa to Registration Statement No. 2-87852).\n10aa(i) Resolutions amending the Plan, effective August 28, 1987 (Exhibit 10aa(i) Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10bb Pacific Telesis Group Senior Management Long Term Incentive Plan (Exhibit 10bb to Form SE filed March 26, 1986 in connection with the Corporation's Form 10-K for 1985).\n10cc Pacific Telesis Group Executive Life Insurance Plan (Exhibit 10cc to Form SE filed March 27, 1987 in connection with the Corporation's Form 10-K for 1986).\n10cc(i) Resolutions amending the Plan, effective April 1, 1994.\n10dd Pacific Telesis Group Senior Management Long Term Disability and Survivor Protection Plan (Exhibit 10dd to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10dd(i) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10dd(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10ee Pacific Telesis Group Senior Management Transfer Program (Exhibit 10ee to Registration Statement No. 2-87852).\n10ff Pacific Telesis Group Senior Management Financial Counseling Program (Exhibit 10ff to Registration Statement No. 2-87852).\n10gg Pacific Telesis Group Deferred Compensation Plan for Nonemployee Directors (Exhibit 10gg to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10gg(i) Resolutions amending the Plan effective December 21, 1990, November 20, 1992 and December 18, 1992 (Exhibit 10gg(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10gg(ii) Resolutions amending the Plan, effective April 1, 1994.\n10hh Description of Pacific Telesis Group Directors' and Officers' Liability Insurance Program.\n10ii Description of Pacific Telesis Group Plan for Nonemployee Directors' Travel Accident Insurance (Exhibit 10ii to Form SE filed March 26, 1990 in connection with the Corporation's Form 10-K for 1989).\n10jj Pacific Telesis Group 1994 Stock Incentive Plan (Attachment A to Pacific Telesis Group's 1994 Proxy Statement, including Pacific Telesis Group's 1993 Consolidated Financial Statements (Filed March 11, 1994, and amended March 14 and March 25, 1994, File No. 1-8609)).\n10kk Pacific Telesis Group Executive Non-Qualified Pension Plan (Exhibit 10kk to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10kk(i) Resolutions amending the Plan, effective as of June 28, 1991. (Exhibit 10kk(i) to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10kk(ii) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10kk(ii) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10kk(iii) Resolutions amending the Plan, effective date April 1, 1994.\n10kk(iv) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with the Corporation's executive supplemental pension benefits.\n10ll Pacific Telesis Group Executive Deferral Plan (Exhibit 10ll to Form SE filed March 26, 1990 in connection with the Corporation's Form 10-K for 1989).\n10ll(i) Resolutions amending the Plan effective November 20, 1992 and December 23, 1992 (Exhibit 10ll(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10ll(ii) Resolutions amending the Plan, effective November 15, 1993 and January 1, 1994.\n10ll(iii) Resolutions amending the Plan, effective April 1, 1994.\n10mm Pacific Telesis Group Mid-Career Hire Program (Exhibit 10mm to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10nn Pacific Telesis Group Mid-Career Pension Plan (Exhibit 10nn to Form SE filed March 27, 1987 in connection with the Corporation's Form 10-K for 1986).\n10nn(i) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10nn(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10nn(ii) Resolutions amending the Plan, effective April 1, 1994 (Filed as exhibit 10kk(iii) to this Form 10- K).\n10nn(iii) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with the Corporation's executive supplemental pension benefits (Filed as Exhibit 10kk(iv) to this Form 10-K).\n10oo Pacific Telesis Group Stock Option and Stock Appreciation Rights Plan (Plan Text, Sections 1-17, in Registration Statement No. 33-15391).\n10oo(i) Resolutions amending the Plan effective November 17, 1989 and June 26, 1992 (Exhibit 10oo(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10oo(ii) Resolutions amending the Plan, effective April 1, 1994.\n10pp Employment Contracts for Certain Senior Officers of Pacific Telesis Group (Exhibit 10pp to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10pp(i) Schedule to Exhibit 10pp.\n10pp(ii) Employment contracts for certain senior officers of Pacific Telesis Group.\n10qq Reserved.\n10rr Executive supplemental benefit agreement.\n10ss Pacific Telesis Group Outside Directors' Retirement Plan (Exhibit 10ss to Form SE filed March 15, 1985 in connection with the Corporation's Form 10-K for 1984).\n10ss(i) Resolution amending the Plan effective May 25, 1990 (Exhibit 10ss(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10tt Representative Indemnity Agreement between Pacific Telesis Group and certain of its officers and each of its directors (Exhibit 10tt to Form SE filed March 29, 1988 in connection with the Corporation's Form 10-K for 1987).\n10uu Trust Agreement between Pacific Telesis Group and Bankers Trust Company, as successor Trustee, in connection with the Pacific Telesis Group Executive Deferral Plan (Exhibit 10uu to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10uu(i) Amendment to Trust Agreement No. 1 effective December 11, 1992 (Exhibit 10uu(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10uu(ii) Amendment to Trust Agreement No. 1, effective May 28, 1993.\n10uu(iii) Amendment to Trust Agreement No. 1, effective November 15, 1993.\n10vv Trust Agreement between Pacific Telesis Group and Bankers Trust Company, as successor Trustee, in connection with the Pacific Telesis Group Deferred Compensation Plan for the Nonemployee Directors (Exhibit 10vv to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10vv(i) Amendment to Trust Agreement No. 2 effective December 11, 1992 (Exhibit 10vv(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10vv(ii) Amendment to Trust Agreement No. 2, effective May 28, 1993.\n10ww Pacific Telesis Group Long Term Incentive Award Deferral Plan (Exhibit 10ww to Form SE filed March 27, 1990 in connection with the Corporation's Form 10-K for 1989).\n10ww(i) Resolutions merging the Plan with the Executive Deferral Plan effective May 22, 1992 (Exhibit 10ww(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10xx Pacific Telesis Group Nonemployee Director Stock Option Plan (Exhibit A to Pacific Telesis Group's 1990 Proxy Statement filed February 26, 1990).\n10xx(i) Resolutions amending the Plan, effective April 1, 1994.\n10xx(ii) Provisions of 1994 Stock Incentive Plan terminating the Plan, contingent upon approval of the 1994 Stock Incentive Plan by the Corporation's shareowners on April 29, 1994. (Exhibit 10jj to this Form 10-K).\n10yy Pacific Telesis Group Supplemental Executive Retirement Plan (Exhibit 10yy to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10yy(i) Resolutions amending the Plan effective November 20, 1992 (Exhibit 10yy(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10yy(ii) Resolutions amending the Plan, effective April 1, 1994 (Filed as Exhibit 10kk(iii) to this Form 10- K).\n10yy(iii) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with the Corporation's executive supplemental pension benefits (Filed as Exhibit 10kk(iv) to this Form 10-K).\n10zz Pacific Telesis Group Nonemployee Director Stock Grant Plan (Exhibit 10zz to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10zz(i) Provisions of 1994 Stock Incentive Plan terminating the Plan, contingent upon approval of the 1994 Stock Incentive Plan by the Corporation's shareowners on April 29, 1994. (Exhibit 10jj to this Form 10-K).\n11 Computation of Earnings per Common Share.\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 Pacific Telesis Group's 1994 Proxy Statement, including Pacific Telesis Group's 1993 Consolidated Financial Statements (Filed March 11, 1994, and amended March 14 and March 25, 1994, File No. 1-8609).\n21 Subsidiaries of Pacific Telesis Group.\n23 Consent of Coopers & Lybrand.\n24 Powers of Attorney executed by Directors and Officers who signed this Form 10-K.\n99a Annual Report on Form 11-K for the Pacific Telesis Group Supplemental Retirement and Savings Plan for Salaried Employees for the year 1993 (To be filed as an amendment within 180 days).\n99b Annual Report on Form 11-K for the Pacific Telesis Group Supplemental Retirement and Savings Plan for Nonsalaried Employees for the year 1993 (To be filed as an amendment within 180 days).\n99c Annual Report on Form 11-K for the AirTouch Communications Retirement Plan for the year 1993 (To be filed as an amendment within 180 days).\nThe Corporation will furnish to a security holder upon request a copy of any exhibit at cost.\n(b) Reports on Form 8-K:\nForm 8-K, date of report November 2, 1993 was filed with the SEC with the Corporation's two press releases, both issued November 2, 1993 with the following titles: \"Pacific Telesis Encouraged by Spin off Decision\" and \"Pacific Telesis Board Approves Public Stock Offering.\"\nSIGNATURES\nPursuant 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.\nPACIFIC TELESIS GROUP\nBY \/s\/ Lydell L. Christensen ------------------------- Lydell L. Christensen, Executive Vice President and Chief Financial Officer (Principal Accounting Officer)\nDATE: March 29, 1994\nPursuant 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 and on the date indicated.\nSam Ginn,* Chairman of the Board, President and Chief Executive Officer\nL. L. Christensen,* Executive Vice President and Chief Financial Officer\nP. J. Quigley,* Group President and Director\nC. L. Cox,* Group President and Director\nWilliam Clark,* Director Ivan J. Houston,* Director\nHerman E. Gallegos,* Director Mary S. Metz,* Director\nDonald E. Guinn,* Director Lewis E. Platt,* Director\nJ. R. Harvey,* Director Toni Rembe,* Director\nP. Hazen,* Director S. Donley Ritchey,* Director\nF. C. Herringer,* Director\n*BY \/s\/ Richard W. Odgers --------------------------------- Richard W. Odgers, attorney-in-fact\nDATE: March 29, 1994\nSheet 1 of 1\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES (Dollars in millions)\n- ----------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ----------------------------------------------------------------------------- Balance Deductions at End of --------------------- Balance Prior Amounts | Amounts at End of Name of Debtor Period Additions Collected|Written-off Period - -----------------------------------------------------------------------------\nAirTouch Communications (a) - -----------------------\n1993 $858 $874 $1,732 - $ - 1992 $523 $971 $ 636 - $858 1991 $244 $765 $ 486 - $523\n- ---------------\n(a) Amounts presented herein reflect intercompany borrowings by AirTouch from PacTel Capital Resources (\"PTCR\"), a wholly owned subsidiary of Pacific Telesis Group. These borrowings, less certain amounts payable to AirTouch, are reflected as current assets within the Corporation's balance sheets as net receivables due from spin-off operations. The borrowings from PTCR were primarily in the form of promissory notes bearing interest at variable rates which averaged 6.1, 5.7, and 8.1 percent, respectively, during 1993, 1992, and 1991. (See also Note J to the 1993 Consolidated Financial Statements contained in the 1994 Proxy Statement.)\nSheet 1 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT, AND EQUIPMENT (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Balance at End of Prior Additions Other End of Period at Cost Retirements Changes Period Classification 12\/31\/92 (a) (b) (c) 12\/31\/93 - --------------------------------------------------------------------------- Year 1993*\nLand and buildings.. $ 2,960 $ 108 $ 88 $ - $ 2,980 Cable, conduit, and connections....... 10,111 506 123 - 10,494 Central office equipment......... 9,493 794 748 3 9,542 Furniture, equipment, and other ........ 3,028 383 405 (1) 3,005 Construction in progress.......... 529 63 6 - 586 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $26,121 $1,854 $1,370 $ 2 $26,607 ===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 2 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT, AND EQUIPMENT (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Balance at End of Prior Additions Other End of Period at Cost Retirements Changes Period Classification 12\/31\/91 (a) (b) (c) 12\/31\/92 - --------------------------------------------------------------------------- Year 1992**\nLand and buildings.. $ 2,784 $ 221 $ 45 $ - $ 2,960 Cable, conduit, and connections....... 9,724 490 103 - 10,111 Central office equipment......... 9,256 645 406 (2) 9,493 Furniture, equipment, and other ........ 2,922 426 320 - 3,028 Construction in progress.......... 469 62 2 - 529 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $25,155 $1,844 $876 $(2) $26,121 ===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 3 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT, AND EQUIPMENT (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Balance at End of Prior Additions Other End of Period at Cost Retirements Changes Period Classification 12\/31\/90 (a) (b) (c) 12\/31\/91 - --------------------------------------------------------------------------- Year 1991**\nLand and buildings.. $ 2,628 $ 196 $ 40 $ - $ 2,784 Cable, conduit, and connections....... 10,905 494 1,675 - 9,724 Central office equipment......... 8,802 793 339 - 9,256 Furniture, equipment, and other ........ 2,902 306 283 (3) 2,922 Construction in progress.......... 507 (34) 4 - 469 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $25,744 $1,755 $2,341 $(3) $25,155 ===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 4 of 4 PACIFIC TELESIS GROUP AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT, AND EQUIPMENT\n- -------------------- * Excludes amounts for spin-off operations.\n** Restated to reflect the planned spin-off of the Corporation's wireless operations, which are excluded from amounts for continuing operations in the current financial statement presentation of Pacific Telesis Group.\n(a) Property, plant, and equipment (which consists primarily of telephone plant dedicated to providing telecommunications services) is carried at cost. The cost of self-constructed plant includes employee wages and benefits, materials, and other costs. Regulators allow the Telephone Companies to accrue an allowance for funds used during construction as a cost of constructing certain plant and as an item of miscellaneous income. Additions to property, plant, and equipment under construction are reported net of amounts transferred to in-service classifications upon completion and, as a result, may be negative.\n(b) When the Telephone Companies retire or sell property, plant, and equipment, the original cost is credited to the corresponding plant accounts and charged to accumulated depreciation. When the Corporation's holding company and its diversified subsidiaries sell or otherwise dispose of property, plant, and equipment, the original cost is credited to the corresponding asset account, the related accumulated depreciation is debited, and any gain or loss realized is included in miscellaneous income (see Consolidated Statements of Income in \"Item 8. Financial Statements and Supplementary Data\").\n(c) Primarily reflects the reclassification of amounts within asset categories.\n- -------------------\nThe Telephone Companies' provision for depreciation is computed primarily using the remaining-life method, essentially a form of straight-line depreciation, using depreciation rates prescribed by state and federal regulatory agencies. The remaining-life method provides for the full recovery of the investment in telephone plant. For the years 1993, 1992, and 1991 depreciation expressed as a percentage of average depreciable plant was 6.9%, 6.9%, and 7.0%, respectively.\n- --------------------\nSheet 1 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Additions\nBalance at End of Prior Charged to Other End of Period Costs and Retire- Changes Period Classification 12\/31\/92 Expenses ments (a) 12\/31\/93 - --------------------------------------------------------------------------- Year 1993*\nLand and buildings.. $ 456 $ 82 $ 26 $(12) $ 500 Cable, conduit, and connections....... 3,458 495 122 (34) 3,797 Central office equipment......... 4,043 797 748 36 4,128 Furniture, equipment, and other ........ 1,554 363 365 (16) 1,536 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $9,511 $1,737 $1,261 $(26) $9,961 =========================================================================== * Excludes amounts for spin-off operations.\n(a) Other changes for 1993 primarily reflects Pacific Bell salvage, cost of removal and reclassifications of amounts within asset categories, offset, in part, by $12 million depreciation charged by the Corporation's real estate subsidiary to a restructuring reserve.\nSheet 2 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Additions\nBalance at End of Prior Charged to Other End of Period Costs and Retire- Changes Period Classification 12\/31\/91 Expenses ments (a) 12\/31\/92 - --------------------------------------------------------------------------- Year 1992*\nLand and buildings.. $ 401 $ 76 $ 23 $ 2 $ 456 Cable, conduit, and connections....... 3,119 459 101 (19) 3,458 Central office equipment......... 3,683 810 404 (46) 4,043 Furniture, equipment, and other ........ 1,458 364 329 61 1,554 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $8,661 $1,709 $857 $ (2) $9,511 ===========================================================================\n* Restated to reflect the planned spin-off of the Corporation's wireless operations, which are excluded from amounts for continuing operations in the current financial statement presentation of Pacific Telesis Group.\n(a) Other changes for 1992 primarily reflects Pacific Bell salvage, cost of removal and reclassifications of amounts within asset categories, the effects of which are significantly offset by $12 million depreciation charged by the Corporation's real estate subsidiary to a restructuring reserve.\nSheet 3 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F - --------------------------------------------------------------------------- Balance at Additions\nBalance at End of Prior Charged to Other End of Period Costs and Retire- Changes Period Classification 12\/31\/90 Expenses ments (a) 12\/31\/91 - --------------------------------------------------------------------------- Year 1991*\nLand and buildings.. $ 355 $ 63 $ 25 $ 8 $ 401 Cable, conduit, and connections....... 4,272 502 1,656 1 3,119 Central office equipment......... 3,186 806 352 43 3,683 Furniture, equipment, and other ........ 1,361 365 276 8 1,458 ------------------------------------------------------- Total Property, Plant, and Equipment ........ $9,174 $1,736 $2,309 $60 $8,661 ===========================================================================\n* Restated to reflect the planned spin-off of the Corporation's wireless operations, which are excluded from amounts for continuing operations in the current financial statement presentation of Pacific Telesis Group.\n(a) Other Changes for 1991 consists of:\nPacific Bell - primarily includes salvage, and amortization deferred to 1992 relating to a depreciation reserve deficiency per FCC order $46 Real estate subsidiary - depreciation charged to a restructuring reserve 11 Other 3 ---- $60 ====\nSheet 1 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------\nAllowance for Doubtful Accounts - ------------------------------- Additions -------------------- (1) (2) Charged to Charged Balance at Costs and to Other Balance at End of Prior Expenses Accounts Deductions End of Period (a) (b) (c) Period - --------------------------------------------------------------------------- Year 1993 $130 $163 $140 $295 $138 Year 1992* $ 98 $160 $165 $293 $130 Year 1991* $ 85 $124 $126 $237 $ 98 ===========================================================================\nReserve for Discontinuance of Real Estate Operations - ----------------------------------------------------\nAdditions -------------------- (1) (2) Charged to Charged Balance at Costs and to Other Balance at End of Prior Expenses Accounts Deductions End of Period (d) Period - --------------------------------------------------------------------------- Year 1993 $ 33 $347 $0 $42 $338 Year 1992 $ 75 $ 0 $0 $42 $ 33 Year 1991 $100 $ 0 $0 $25 $ 75 ===========================================================================\nSee accompanying notes on Sheet 3 of 3.\nSheet 2 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (Dollars in millions)\n- --------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------\nReserve for Restructuring-Pacific Bell - --------------------------------------\nAdditions -------------------- (1) (2) Charged to Charged Balance at Costs and to Other Balance at End of Prior Expenses Accounts End of Period (e) (f) Deductions Period - --------------------------------------------------------------------------- Year 1993 $101 $977 $43 $ 24 $1,097 Year 1992 $165 $ 0 $ 0 $ 64 $ 101 Year 1991 $ 0 $166 $21 $ 22 $ 165 ===========================================================================\nVarious Other Reserves - ---------------------- Additions -------------------- (1) (2) Balance at Charged to Charged Balance at End of Prior Costs and to Other End of Period Expenses Accounts Deductions Period - --------------------------------------------------------------------------- Year 1993 $27 $107 $0 $44 $90 Year 1992 $ 9 $ 18 $0 $ 0 $27 Year 1991 $ 9 $ 0 $0 $ 0 $ 9 ===========================================================================\nSee accompanying notes on Sheet 3 of 3.\nSheet 3 of 3\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\n- --------------------\n* Restated to reflect the planned spin-off of the Corporation's wireless operations, which are excluded from amounts for continuing operations in the current financial statement presentation of Pacific Telesis Group.\n(a) Provision for uncollectibles includes certain direct write-off items which are not reflected in this account.\n(b) Amounts in this column reflect items of uncollectible interstate and intrastate accounts receivable purchased from and billed for AT&T and other interexchange carriers under contract arrangements.\n(c) Amounts in this column reflect items written off, net of amounts previously written off but subsequently recovered.\n(d) Costs and expenses for 1993 reflect an additional pre-tax loss reserve of $347 million to cover potential future losses on real estate sales and estimated operating losses of the Corporation's wholly owned real estate subsidiary during the planned sales period. An earlier reserve of $100 million had been recorded in 1990.\n(e) In 1993 and 1991, respectively, Pacific Bell recorded pre-tax restructuring charges to recognize the incremental cost of force reductions.\n(f) Amounts in this column reflect items capitalized to construction.\n- --------------------\nSheet 1 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS (Dollars in millions)\n- --------------------------------------------------------------------------- Col. A Col. B Col. C Col. D Col. E Col. F - --------------------------------------------------------------------------- Weighted Average Weighted Average Interest Average Maximum Amount Rate Interest Amount Outstanding During Balance Rate at Outstanding During the the at End End of at any Period Period Description of Period Period Month-End (a) (b) - ---------------------------------------------------------------------------\nYear 1993*\nNotes Payable to Banks (c)...... $ 4 6.12% $ 168 $ 45 5.06%\nCommercial Paper (d)...... 586 3.23% $1,002 $567 3.20%\n------ Total ........... $590 ======\n===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 2 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS (Dollars in millions)\n- --------------------------------------------------------------------------- Col. A Col. B Col. C Col. D Col. E Col. F - --------------------------------------------------------------------------- Weighted Average Weighted Average Interest Average Maximum Amount Rate Interest Amount Outstanding During Balance Rate at Outstanding During the the at End End of at any Period Period Description of Period Period Month-End (a) (b) - ---------------------------------------------------------------------------\nYear 1992**\nNotes Payable to Banks (c)...... $ 183 4.44% $283 $212 6.81%\nCommercial Paper (d)...... 880 3.48% $880 $707 3.74%\n------ Total ........... $1,063 ======\n===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 3 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS (Dollars in millions)\n- --------------------------------------------------------------------------- Col. A Col. B Col. C Col. D Col. E Col. F - --------------------------------------------------------------------------- Weighted Average Weighted Average Interest Average Maximum Amount Rate Interest Amount Outstanding During Balance Rate at Outstanding During the the at End End of at any Period Period Description of Period Period Month-End (a) (b) - ---------------------------------------------------------------------------\nYear 1991**\nNotes Payable to Banks (c)....... $204 5.34% $ 215 $201 7.33%\nCommercial Paper (d)....... 707 4.94% $1,143 $752 5.97%\n----\nTotal ............ $911 ====\n===========================================================================\nSee accompanying notes on Sheet 4 of 4.\nSheet 4 of 4\nPACIFIC TELESIS GROUP AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\n- --------------------------\n* Excludes amounts for spin-off operations.\n** Restated to reflect the planned spin-off of the Corporation's wireless operations, which are excluded from amounts for continuing operations in the current financial statement presentation of Pacific Telesis Group.\n(a) Computed by dividing the aggregate daily amount outstanding by the number of days in the year.\n(b) Computed by dividing the aggregate related interest expense by the average amount outstanding during the year.\n(c) Comprised primarily of borrowings under informal lines of credit with original maturities of 360 days or less.\n(d) Original maturities of 120 days or less.\n- --------------------------\nTELESIS(R) is a registered trademark of Pacific Telesis Group.\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. All other exhibits are provided as part of the electronic transmission. Unless otherwise indicated, all exhibits so incorporated are from File No. 1-8609.\nExhibit Number Description ------- -----------\n2a Modification of Final Judgment (Exhibit (28) to Form 8-K, date of report August 24, 1982, File No. 1-1105).\n2b Plan of Reorganization (Exhibit (2) to Form 8-K, date of report December 16, 1982, File No. 1-1105).\n2c March 14, 1983 Motion to Approve Amended Plan of Reorganization (Exhibit (2)a to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2d March 25, 1983 Motion to Approve Plan of Reorganization as Further Amended (Exhibit (2)b to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2e April 7, 1983 Motion to Approve Plan of Reorganization as Further Amended (Exhibit (2)c to Form 8-K, date of report March 14, 1983, File No. 1-1105).\n2f Order issued April 20, 1983 in \"U.S. v. Western Electric Company, Incorporated et al.,\" by the United States District Court for the District of Columbia, Civil Action No. 82-0192 (Exhibit (2) to Form 8-K, date of report April 20, 1983, File No. 1-1105).\n2g August 5, 1983 Memorandum and Order of United States District Court for the District of Columbia approving Plan of Reorganization as Amended (Exhibit (2) to Form 8-K, date of report July 8, 1983, File No. 1-1105).\n2h September 10, 1987 Opinion and Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et. al.,\" Civil Action No. 82-0192. (Exhibit 2h to Form SE filed November 10, 1987 in connection with the Corporation's Form 10-Q for the quarter ended September 30, 1987).\n2i March 7, 1988 Opinion and Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated et al.,\" Civil Action No. 82-0192 (Exhibit 2h to Form SE filed March 29, 1988 in connection with the Corporation's Form 10-K for 1987).\n2j April 3, 1990 Opinion of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al., \"Case Nos. 87-5388 et al. (Exhibit 2j to Form SE filed May 11, 1990 in connection with the Corporation's Form 10-Q for the quarter ended March 31, 1990).\n2k July 25, 1991 Opinion & Order of the United States District Court for the District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Civil Action No. 82-0192 (Exhibit 2k to Form SE filed August 12, 1991 in connection with the Corporation's Form 10-Q for the quarter ended June 30, 1991).\n2l October 7, 1991 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Case Nos. 91-5263, et al. (Exhibit 2l to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n2m May 28, 1993 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al., and National Assn. of Broadcasters, et al.,\" Case Nos. 91-5263, et al. (Exhibit 2m filed August 12, 1993, in connection with the Corporation's Form 10-Q for the quarter ended June 30, 1993).\n2n December 28, 1993 Order of the United States Court of Appeals, District of Columbia in \"U.S. v. Western Electric Company, Incorporated, et al.,\" Case Nos. 92-5111, et al.\n3a Articles of Incorporation of Pacific Telesis Group, as amended to June 17, 1988 (Exhibit 2b to Registration Statement No. 33-24765).\n3b By-Laws of Pacific Telesis Group, as amended to September 24, 1993 (Exhibit 3b to Registration Statement No. 33-50897, filed November 2, 1993, File No. 1-8609).\n4a No instrument which defines the rights of holders of long- and intermediate-term debt of Pacific Telesis Group and its subsidiaries is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, Pacific Telesis Group hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n4b Rights Agreement, dated as of September 22, 1989, between Pacific Telesis Group and The First National Bank of Boston, as successor Rights Agent, which includes as Exhibit B thereto the form of Rights Certificate (Exhibits 1 and 2 to Form SE filed September 25, 1989 as part of Form 8-A, File No. 1-8609).\n10a Reorganization and Divestiture Agreement dated as of November 1, 1983 between American Telephone and Telegraph Company, Pacific Telesis Group and its affiliates (Exhibit (10)a to Form 10-K for 1983).\n10b Agreement Concerning Patents, Technical Information and Copyrights dated as of November 1, 1983 between American Telephone and Telegraph Company and Pacific Telesis Group (Exhibit (10)g to Form 10-K for 1983).\n10c Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements dated as of November 1, 1983 among American Telephone and Telegraph Company, Bell System Operating Companies and Regional Holding Companies (including Pacific Telesis Group and affiliates) (Exhibit (10)j to Form 10-K for 1983).\n10d Agreement Regarding Allocation of Contingent Liabilities dated as of January 28, 1985 between American Telephone and Telegraph Company, American Information Technologies Corporation, Bell Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, Pacific Telesis Group and Southwestern Bell Corporation (Exhibit 10c to Form SE filed March 26, 1986 in connection with the Corporation's Form 10-K for 1985).\n10e Separation Agreement by and between the Corporation and PacTel Corporation dated as of October 7, 1993, and amended November 2, 1993 and March 25, 1993.\n10aa Pacific Telesis Group Senior Management Short Term Incentive Plan (Exhibit 10aa to Registration Statement No. 2-87852).\n10aa(i) Resolutions amending the Plan, effective August 28, 1987 (Exhibit 10aa(i) Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10bb Pacific Telesis Group Senior Management Long Term Incentive Plan (Exhibit 10bb to Form SE filed March 26, 1986 in connection with the Corporation's Form 10-K for 1985).\n10cc Pacific Telesis Group Executive Life Insurance Plan (Exhibit 10cc to Form SE filed March 27, 1987 in connection with the Corporation's Form 10-K for 1986).\n10cc(i) Resolutions amending the Plan, effective April 1, 1994.\n10dd Pacific Telesis Group Senior Management Long Term Disability and Survivor Protection Plan (Exhibit 10dd to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10dd(i) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10dd(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10ee Pacific Telesis Group Senior Management Transfer Program (Exhibit 10ee to Registration Statement No. 2-87852).\n10ff Pacific Telesis Group Senior Management Financial Counseling Program (Exhibit 10ff to Registration Statement No. 2-87852).\n10gg Pacific Telesis Group Deferred Compensation Plan for Nonemployee Directors (Exhibit 10gg to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10gg(i) Resolutions amending the Plan effective December 21, 1990, November 20, 1992 and December 18, 1992 (Exhibit 10gg(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10gg(ii) Resolutions amending the Plan, effective April 1, 1994.\n10hh Description of Pacific Telesis Group Directors' and Officers' Liability Insurance Program.\n10ii Description of Pacific Telesis Group Plan for Nonemployee Directors' Travel Accident Insurance (Exhibit 10ii to Form SE filed March 26, 1990 in connection with the Corporation's Form 10-K for 1989).\n10jj Pacific Telesis Group 1994 Stock Incentive Plan (Attachment A to Pacific Telesis Group's 1994 Proxy Statement, including Pacific Telesis Group's 1993 Consolidated Financial Statements (Filed March 11, 1994, and amended March 14 and March 25, 1994, File No. 1-8609)).\n10kk Pacific Telesis Group Executive Non-Qualified Pension Plan (Exhibit 10kk to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10kk(i) Resolutions amending the Plan, effective as of June 28, 1991. (Exhibit 10kk(i) to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10kk(ii) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10kk(ii) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10kk(iii) Resolutions amending the Plan, effective April 1, 1994.\n10kk(iv) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with Pacific Telesis Group executive supplemental pension benefits.\n10ll Pacific Telesis Group Executive Deferral Plan (Exhibit 10ll to Form SE filed March 26, 1990 in connection with the Corporation's Form 10-K for 1989).\n10ll(i) Resolutions amending the Plan effective November 20, 1992 and December 23, 1992 (Exhibit 10ll(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10ll(ii) Resolutions amending the Plan, effective November 15, 1993 and January 1, 1994.\n10ll(iii) Resolutions amending the Plan, effective April 1, 1994.\n10mm Pacific Telesis Group Mid-Career Hire Program (Exhibit 10mm to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10nn Pacific Telesis Group Mid-Career Pension Plan (Exhibit 10nn to Form SE filed March 27, 1987 in connection with the Corporation's Form 10-K for 1986).\n10nn(i) Resolutions amending the Plan effective May 22, 1992 and November 20, 1992 (Exhibit 10nn(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10nn(ii) Resolutions amending the Plan, effective April 1, 1994 (Filed as exhibit 10kk(iii) to this Form 10-K).\n10nn(iii) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with the Corporation's executive supplemental pension benefits (Filed as Exhibit 10kk(iv) to this Form 10-K).\n10oo Pacific Telesis Group Stock Option and Stock Appreciation Rights Plan (Plan Text, Sections 1-17, in Registration Statement No. 33-15391).\n10oo(i) Resolutions amending the Plan effective November 17, 1989 and June 26, 1992 (Exhibit 10oo(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10oo(ii) Resolutions amending the Plan, effective April 1, 1994.\n10pp Employment Contracts for Certain Senior Officers of Pacific Telesis Group (Exhibit 10pp to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10pp(i) Schedule to Exhibit 10pp.\n10pp(ii) Employment contracts for certain senior officers of Pacific Telesis Group.\n10qq Reserved.\n10rr Executive supplemental benefit agreement.\n10ss Pacific Telesis Group Outside Directors' Retirement Plan (Exhibit 10ss to Form SE filed March 15, 1985 in connection with the Corporation's Form 10-K for 1984).\n10ss(i) Resolution amending the Plan effective May 25, 1990 (Exhibit 10ss(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10tt Representative Indemnity Agreement between Pacific Telesis Group and certain of its officers and each of its directors (Exhibit 10tt to Form SE filed March 29, 1988 in connection with the Corporation's Form 10-K for 1987).\n10uu Trust Agreement between Pacific Telesis Group and and Bankers Trust Company, as successor Trustee, in connection with the Pacific Telesis Group Executive Deferral Plan (Exhibit 10uu to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10uu(i) Amendment to Trust Agreement No. 1 effective December 11, 1992 (Exhibit 10uu(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10uu(ii) Amendment to Trust Agreement No. 1, effective May 28, 1993.\n10uu(iii) Amendment to Trust Agreement No. 1, effective November 15, 1993.\n10vv Trust Agreement between Pacific Telesis Group and Bankers Trust Company, as successor Trustee, in connection with the Pacific Telesis Group Deferred Compensation Plan for the Nonemployee Directors (Exhibit 10vv to Form SE filed March 23, 1989 in connection with the Corporation's Form 10-K for 1988).\n10vv(i) Amendment to Trust Agreement No. 2 effective December 11, 1992 (Exhibit 10vv(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10vv(ii) Amendment to Trust Agreement No. 2, effective May 28, 1994.\n10ww Pacific Telesis Group Long Term Incentive Award Deferral Plan (Exhibit 10ww to Form SE filed March 27, 1990 in connection with the Corporation's Form 10-K for 1989).\n10ww(i) Resolutions merging the Plan with the Executive Deferral Plan effective May 22, 1992 (Exhibit 10ww(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10xx Pacific Telesis Group Nonemployee Director Stock Option Plan (Exhibit A to Pacific Telesis Group's 1990 Proxy Statement filed February 26, 1990).\n10xx(i) Resolutions amending the Plan, effective April 1, 1994.\n10xx(ii) Provisions of 1994 Stock Incentive Plan terminating the Plan, contingent upon approval of the 1994 Stock Incentive Plan by the Corporation's shareowners on April 29, 1994. (Exhibit 10jj to this Form 10-K).\n10yy Pacific Telesis Group Supplemental Executive Retirement Plan (Exhibit 10yy to Form SE filed April 1, 1991 in connection with the Corporation's Form 10-K for 1990).\n10yy(i) Resolutions amending the Plan effective November 20, 1992 (Exhibit 10yy(i) to Form SE filed March 26, 1993 in connection with the Corporation's Form 10-K for 1992).\n10yy(ii) Resolutions amending the Plan, effective April 1, 1994 (Filed as Exhibit 10kk(iii) to this Form 10-K).\n10yy(iii) Trust Agreement No. 3 between Pacific Telesis Group and Bankers Trust Company in connection with the Corporation's executive supplemental pension benefits (Filed as Exhibit 10kk(iv) to this Form 10-K).\n10zz Pacific Telesis Group Nonemployee Director Stock Grant Plan (Exhibit 10zz to Form SE filed March 26, 1992 in connection with the Corporation's Form 10-K for 1991).\n10zz(i) Provisions of 1994 Stock Incentive Plan terminating the Plan, contingent upon approval of the 1994 Stock Incentive Plan by the Corporation's shareowners on April 29, 1994. (Exhibit 10jj to Form 10-K).\n11 Computation of Earnings per Common Share.\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 Pacific Telesis Group's 1994 Proxy Statement, including Pacific Telesis Group's 1993 Consolidated Financial Statements (Filed March 11, 1994, and amended March 14 and March 25, 1994, File No. 1-8609).\n21 Subsidiaries of Pacific Telesis Group.\n23 Consent of Coopers & Lybrand.\n24 Powers of Attorney executed by Directors and Officers who signed this Form 10-K.\n99a Annual Report on Form 11-K for the Pacific Telesis Group Supplemental Retirement and Savings Plan for Salaried Employees for the year 1993 (To be filed as an amendment within 180 days).\n99b Annual Report on Form 11-K for the Pacific Telesis Group Supplemental Retirement and Savings Plan for Nonsalaried Employees for the year 1993 (To be filed as an amendment within 180 days).\n99c Annual Report on Form 11-K for the AirTouch Communications Retirement Plan for the year 1993 (To be filed as an amendment within 180 days).","section_15":""}
{"filename":"66029_1993.txt","cik":"66029","year":"1993","section_1":"ITEM 1. BUSINESS -------- (A) GENERAL ------- Midland Enterprises Inc. (the \"Registrant\"), incorporated under the laws of the State of Delaware in 1961, is a wholly-owned subsidiary of Eastern Enterprises (\"Eastern\") of Weston, Massachusetts. The Registrant is primarily engaged through wholly-owned subsidiaries in the operation of a fleet of towboats, tugboats and barges, principally on the Ohio and Mississippi Rivers and their tributaries and the Gulf Intracoastal Waterway and in the Gulf of Mexico. The Registrant's barge line subsidiaries transport bulk commodities, a major portion of which is coal. In December, 1993, the Company sold its liquid barges and in conjunction, Chotin, a subsidiary, sold its liquid contract and trade name. The Registrant, through other subsidiaries, also performs repair work on marine equipment and operates two coal dumping terminals, a phosphate rock and phosphate chemical fertilizer terminal, a marine fuel supply facility and a barge construction facility. In January 1994, the Company indefinitely suspended the construction of barges at this facility.\nSubstantially all of the barges, towboats and tugboats operated by the Registrant's barge line subsidiaries are owned by and chartered from the Registrant. A substantial portion of this equipment is mortgaged or leased and the payments under related charter agreements with its subsidiaries are pledged to secure long-term debt or to meet lease payments.\nThe Registrant's barge line subsidiaries are The Ohio River Company (\"ORCO\"), Orgulf Transport Co. (\"Orgulf\"), Red Circle Transport Co. (\"Red Circle\"), and Chotin Transportation, Inc. (\"Chotin\"). The Registrant's other principal subsidiaries, all of whose outstanding stock is owned by the Registrant, are Eastern Associated Terminals Company (\"EATCO\"), Port Allen Marine Service, Inc. (\"Port Allen\"), Hartley Marine Corp. (\"Hartley\"), The Ohio River Terminals Company (\"ORTCO\") and West Virginia Terminals Inc.\n(B) INDUSTRY SEGMENTS ----------------- Registrant's only reportable industry segment is barge transportation.\n(C) (1) (I) PRINCIPAL SERVICES AND MARKETS ------------------------------ ORCO is the largest of the Registrant's subsidiaries, accounting for 63% of the Registrant's total 1993 tonnage transported. ORCO operates principally on the Ohio River and certain of its tributaries. Approximately 97% of the tonnage transported by ORCO in 1993 was transported in movements not regulated by the Interstate Commerce Commission (\"ICC\"). The balance of ORCO's tonnage was transported in movements pursuant to a Contract Carrier Permit issued by the ICC. For an explanation of regulated and non-regulated barge transportation see \"Franchises\". The principal commodity transported by ORCO is coal, primarily for electric utilities. Grain, stone, sand, gravel, iron, steel, scrap, and coke are the other groups of commodities which ORCO carries in significant amounts.\nOrgulf operates principally on the Mississippi and Ohio Rivers, and the Illinois, Arkansas-Verdigris, Tennessee-Tombigbee, and Gulf Intracoastal Waterways, transporting principally coal, grain and ores. Approximately 93% of the tonnage transported by Orgulf in 1993 was transported in movements not regulated by the Interstate Commerce Commission (\"ICC\"). The balance of Orgulf's tonnage was transported in movements pursuant to a Contract Carrier Permit issued by the ICC.\nChotin operated principally on the Mississippi, Ohio and Warrior Rivers, and on the Illinois, Tennessee-Tombigbee and Gulf Intracoastal Waterways, transporting refined petroleum products and dry commodities including coal, grain, and ores. Chotin operated without ICC authority by limiting itself to transporting bulk commodities which are exempt from regulation by the ICC.\nRed Circle is engaged primarily in the transportation of phosphate rock in the Gulf of Mexico and grain to Puerto Rico and, because these commodities are exempt from regulation, operates without authority from the ICC. EATCO owns and operates a terminal on leased land at Tampa, Florida. Port Allen operates shipyard facilities in the vicinity of Baton Rouge, Louisiana. Hartley operates shipyard facilities at Paducah, Kentucky, sells fuel at Point Pleasant, West Virginia, and provides towing services principally on the Ohio River and its tributaries. ORTCO owns and operates a coal dumping facility in Huntington, West Virginia. West Virginia Terminals Inc. operates a coal dumping facility in Kenova, West Virginia.\nThe record tonnage in 1993 increased slightly over 1992 with reduced tonnage in coal, grain and phosphate more than offset by increased tonnage in all other commodities. The tonnage in 1992 was up 3% from 1991, primarily reflecting increases in spot coal, iron, scrap and steel, and grain volumes.\nTon miles are the product of tons and distance transported. The slight decrease in ton miles in 1993 reflected lower ton miles from coal, grain and phosphate mostly offset by higher ton miles in all other commodities. The record ton miles in 1992 reflected increased ton miles from grain, aggregates and ores, somewhat offset by lower coal affreightment ton miles as higher tonnages were more than offset by shorter average trip lengths. In addition to changes in ton miles transported, Registrant's revenues and net income are affected by other factors such as competitive conditions, weather and the segment of the river system traveled. See \"Seasonal Aspect.\"\n(C) (1) (II) STATUS OF PRODUCT OR SEGMENT ---------------------------- No significant new product, service or segment requiring a material amount of assets was developed.\n(C) (1) (III) RAW MATERIALS ------------- The only significant raw material required by the Registrant is the diesel fuel to operate towboats. Diesel fuel is purchased from a variety of sources and the Registrant regards the availability of diesel fuel as adequate for presently planned operations.\n(C) (1) (IV) FRANCHISES ---------- The Interstate Commerce Act, as amended in December 1973, exempts from regulation water transportation of dry commodities which were transported in bulk as of June 1, 1939 (including coal, phosphate rock, stone, sand and gravel, grain, and ores). In addition, the Interstate Commerce Act exempts from regulation water transportation of liquid cargoes in bulk in certified liquid barges. Approximately 96% of the 1993 tonnage was exempt from regulation by the ICC. Regulated commodities include iron and steel products, other manufactured products, packaged goods and scrap.\nORCO holds a certificate of Public Convenience and Necessity issued by the ICC authorizing service as a common carrier on the Ohio River and certain of its tributaries, the Mississippi River, the Illinois Waterway, the Arkansas-Verdigris Waterway and the Missouri River, the Warrior System, and the Gulf Intracoastal Waterway, and for regulated movements to and from Tampa, Florida. ORCO also holds a Contract Carrier Permit issued by the ICC, authorizing contract carriage of regulated commodities on the same waterways. Orgulf also holds such a Contract Carrier Permit. Red Circle and Chotin do not hold or require ICC authority since they provide transportation only in non-regulated movements.\n(C) (1) (V) SEASONAL ASPECT --------------- Due to the freezing of some northern rivers and waterways during winter months, and increased coal consumption by electric utilities during the summer months, average winter month revenues tend to be lower than revenues for the remainder of the year.\n(C) (1) (VI) WORKING CAPITAL --------------- No unusual working capital requirements are normally encountered.\n(C) (1) (VII) CUSTOMERS --------- No customer, or group of customers under common control, accounted for 10% or more of the total revenues in 1993. On the basis of past experience and its competitive position, the Registrant considers that the loss of several of its subsidiaries' largest customers simultaneously, while possible, is unlikely to happen. The Registrant's subsidiaries have long-term transportation and terminaling contracts which expire at various dates from January 1995 through December 2007. During 1993, approximately 41% of the Registrant's consolidated revenues resulted from these contracts. A substantial portion of the contracts provide for rate adjustments based on changes in various costs, including diesel fuel costs, and, additionally, contain \"force majeure\" clauses which excuse performance by the parties to the contracts when performance is prevented by circumstances beyond their reasonable control. Many of these contracts have provisions for termination for specified causes, such as material breach of the contract, environmental restrictions on the burning of coal, or loss by the customer of an underlying commodity supply contract. Penalties for termination for such causes are not generally specified. However, some contracts provide that in the event of an uncured material breach by Registrant's subsidiary which results in termination of the contract, Registrant's subsidiary would be responsible for reimbursing its customer for the differential between the contract price and the cost of substituted performance. Due to the capital-intensive, high fixed cost nature of the Registrant's business, the negotiation of long-term contracts which facilitate steady and efficient utilization of equipment is important to profitable operations.\n(C) (1) (VIII) BACKLOG -------\nThe 1993 revenue backlog (which is based on contracts that extend beyond December 31, 1994) is shown at prices current as of December 31, 1993 which are subject to escalation\/de-escalation provisions. Since services under many of the long-term contracts are based on customer requirements, Midland has estimated its backlog based on its forecast of the requirements of these long-term contract customers. About 50% of the decrease in the tonnage backlog is due to the sale of the liquid barge business and its contract. About 40% of the revenue backlog at December 31, 1993 is associated with a disputed contract with Gulf Power Company, for which shipments have been curtailed.\n(C) (1) (IX) GOVERNMENT CONTRACTS -------------------- The Registrant has no material portion of business subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(C) (1) (X) COMPETITIVE CONDITIONS ---------------------- Improvements in operating efficiencies have permitted barge operators to maintain relatively low rate structures. Consequently, the barge industry has generally been able to retain its competitive position with alternate methods of transportation for bulk commodities when the origin and destination of such movements are contiguous to navigable waterways.\nPrimary competitors of the Registrant's barge line subsidiaries include other barge lines and railroads (including one integrated rail-barge carrier). There are a number of companies offering transportation services on the waterways served by the Registrant, including carriers holding operating authority issued by the ICC and carriers not so regulated. Competition among major barge line competitors is intense due to a continuing imbalance between barge supply and demand, and most recently by weak grain and coal exports. This in turn has led to revenue and margin erosion, cost and productivity improvements, and some industry consolidation.\nMany railroads operating in areas served by the inland waterways compete for cargoes carried by river barges. In many cases, these railroads offer unit train service (pursuant to which an entire train is committed to the customer) and dedicated equipment service (pursuant to which equipment is set aside for the exclusive use of a particular customer) for coal, grain and other bulk commodities. In addition, rates charged by both railroads and river barge operators are sometimes designed to reflect special circumstances and requirements of the individual shippers. As a result, it is difficult to compare rates charged for movements of the various commodities between specific points.\nModern diesel powered towboats such as those which comprise the Registrant's towboat fleet are, however, capable of moving in one tow approximately 22,500 tons (equivalent to 225 one hundred-ton capacity railroad cars) on the Ohio River and on the Upper Mississippi River and approximately 60,000 tons (equivalent to 600 one hundred-ton capacity railroad cars) on the Lower Mississippi River, where there are no locks to transit, at average rates per ton mile which are generally below those charged by Class 1 railroads.\n(C) (1) (XI) RESEARCH -------- No significant amount was spent during the last fiscal year on research to improve existing services or develop new services. The task of improving and developing services is a continuing assignment of various operating departments of Registrant's subsidiaries, but such efforts are not segregated and would not generally be regarded as research activities.\n(C) (1) (XII) COMPLIANCE WITH ENVIRONMENTAL STATUTES -------------------------------------- The Registrant and\/or its subsidiaries are subject to the provisions of the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, the Superfund Amendment and Reauthorization Act, the Resource Conservation and Recovery Act of 1976, and the Oil Pollution Act of 1990, which permit the Coast Guard and the Environmental Protection Agency to assess penalties and clean-up costs for oil, hazardous substance, and hazardous waste discharges. Some of these acts also allow third parties to seek damages for losses caused by such discharges. Compliance with these acts has had no material effect on the Registrant's capital expenditures, earnings, or competitive position; and no such effect is anticipated.\n(C) (1) (XIII) EMPLOYEES --------- As of December 31, 1993, Registrant and its subsidiaries employed approximately 1,500 persons, of whom approximately 28% are represented by labor unions.\n(D) FOREIGN OPERATIONS ------------------ Registrant does not engage in material operations in foreign countries, and no material portion of Registrant's revenues is derived from customers in foreign countries.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ---------- (A) AS OF DECEMBER 31, 1993, THE REGISTRANT'S FLOATING EQUIPMENT CONSISTED OF 2,461 BARGES AND 91 BOATS.\nWest Virginia Terminals Inc. leases a coal dumping facility in Kenova, West Virginia. Orco leases office facilities in Cincinnati, Ohio. EATCO owns terminal facilities on leased land in Tampa, Florida. Chotin owns approximately 738 acres of land in West Baton Rouge Parish, Louisiana; and Port Allen owns shipyard facilities located on that land. ORTCO owns coal dumping facilities in Huntington, West Virginia. Hartley owns shipyard facilities in Paducah, Kentucky.\nCapital expenditures for the Registrant in 1993 totalled approximately $14,191,000. These expenditures were made principally for replacement of the barge fleet and for renewal of equipment.\n(B) NOT APPLICABLE.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS ----------------- On August 30, 1993, ORCO and Orgulf filed suit in the United States District Court for the Southern District of Ohio, Western Division, against Gulf Power Company and its affiliate Southern Company Services, Inc., claiming damages for breach of a long-term coal transportation contract. See Item 1(c)(1)(viii) above and Item 7 below.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- Not required\nPART II ------- ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER --------------------------------------------------------------------- MATTERS ------ The Registrant's common stock is held solely by Eastern and is not traded in any market. Dividends were declared in the amount of $10,087,000 in 1993 and $36,837,000 in 1992.\nThe payment of dividends is subject to the restrictions described in Note 4 to the Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ----------------------- Not required. Reference Management Narrative Analysis following Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n1993 COMPARED TO 1992 - --------------------- Midland's 1993 tonnage and tonmile production was unchanged from 1992 despite several significant events that negatively affected the river towing industry and Midland specifically.\nCoal tonnage declined 6% from 1992 primarily reflecting reduced shipments to electric utilities due to the United Mine Worker's (UMW) strike (resolved in December), disruption in river traffic caused by record flooding on the Mississippi River system, and the cessation of coal shipments under a long-term contract. Regarding the latter, in July 1993, Midland was advised by Gulf Power Company, a major customer that it was considering termination of a long-term contract for transportation of coal. This contract, initially executed in 1971 and extended through 2007, generated revenues of $17,200,000 and $9,122,000 in the prior year and 1993, respectively. Midland believes the customer's actions to be a breach of the contract, and has filed suit in U.S. District Court. Presently, the customer has renewed shipments of coal under the contract, although at significantly reduced volumes.\nNon-coal tonnage increased 13% over 1992, despite a 23% reduction in grain tonnage, and served to offset the lower coal volume, although at lower margins. The aforementioned flooding on the Mississippi River system and a poor export market impacted grain tonnage. Increased shipments of alumina, scrap and stone tonnage and towing of non-affiliated barges contributed to the increase in non-coal commodities.\nOperating results of Midland's terminaling and shipyard repair facilities were mixed, with improved results for coal terminaling and shipyards being offset by lower phosphate product terminaling, as export markets continued to be depressed in 1993. As a result of the reduced coal affreightment tonnage and lower phosphate terminaling, consolidated revenues declined 3% as compared to 1992.\nOperating earnings declined nearly 14% as compared to 1992 with all of the shortfall occurring in the second half of 1993. The reduction in coal tonnage as described above, as well as the UMW strikes' related impact on traffic patterns and operating costs, combined with the record flooding on the Upper Mississippi River system were the significant negative factors. The Upper Mississippi River flooding closed or severely restricted operations on that river segment during the third and fourth quarters which: idled equipment, significantly increased operating costs, and shifted business to less profitable markets. Depreciation expense was slightly higher than 1992 due to recent capital spending for fleet renewal, while administrative costs were 10% below 1992 due to lower employment and consulting costs, as well as gains on the purchase of pension annuities for retirees.\nOn December 21, 1993 Midland terminated its participation in the liquid barge affreightment business by the sale of its tank barges, affreightment contract, and \"Chotin\" trade name. The transaction resulted in a pre-tax gain of $7,988,000. In addition, the Company closed its barge construction facility in Port Allen, Louisiana, and recorded a $3,500,000 pre-tax charge to reflect costs associated with the final disposition of the facility. These transactions resulted in a net gain of $4,488,000 included in \"Other Income.\"\nIn addition to the above changes in operating earnings and other income, Midland's 1993 after tax earnings were impacted by the increase in the statutory Federal income tax rate from 34% to 35% (See Note 5 of Notes to Financial Statements), which resulted in an increase to the 1993 tax provision of approximately $1,812,000. Midland's net earnings for 1992 included a one-time benefit of $12,156,000 on the adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") recorded as of January 1, 1992.\n1992 COMPARED TO 1991 - --------------------- Midland's consolidated ton miles transported during 1992 increased 1% from 1991 despite reduced utility coal demand from the mild winter and summer temperatures and the lingering effects of the recession. Total affreightment tonnage increased 3% from 1991. While coal tonnage increased nearly 2% from 1991 levels, principally from increased industrial coal and spot coal shipments, ton miles generated from coal affreightment declined nearly 3% due to shorter hauls. Ton miles generated from other commodities, including grain, aggregates, ores, etc., increased nearly 7% as Midland obtained replacement tonnages to offset the weakness of the coal market. Activity levels at Midland's support operations were generally lower than 1991. Phosphate product terminalling was down substantially from 1991 due to weak export demand. Partially offsetting was coal terminalling activity which was much improved over 1991 results. Shipyard repair activity was also lower in 1992. Consolidated revenues declined 1% from 1991 with slightly reduced revenues from nearly all segments. Affreightment rate levels were essentially unchanged from those in 1991, with lower volumes mainly from support operations accounting for the majority of the slight revenue decline.\nOperating conditions for river transportation were generally good in 1992 and improved slightly over 1991. Diesel fuel costs were basically stable, with 1992 costs averaging below 1991 levels. Depreciation expense from fleet renewal and administrative overhead costs were higher than 1991.\nAs a result of the lower phosphate terminalling, reduced shipyard activity and higher depreciation charges, Midland's operating earnings declined 5% as compared to 1991.\nMidland's net earnings before accounting changes declined 18% from 1991, reflecting the lower operating earnings formerly discussed and higher interest charges associated with Midland's capital expenditure program. Lower earnings in 1992 also reflected an increase in the effective tax rate from 29% to 35%, due to the adoption of Statement of Financial Accounting Standards SFAS No. 109. (See Note 5 of Notes to Financial Statements.)\nThe Company chose to reflect the cumulative effect of adopting SFAS No. 109 as a change in accounting principle at the beginning of fiscal 1992 and recorded a tax credit of $12,156,000 which represents the net decrease to the deferred tax liability as of that date.\nIn 1991, Midland elected early adoption of SFAS No. 106 \"Employers Accounting for Post-Retirement Benefits Other Than Pensions\". The Company chose to reflect the cumulative effect of adopting this statement as a change in accounting principle at as of January 1, 1991 with a charge to earnings of $5,906,000. This non-cash charge reflected the actuarially computed value of accrued non-pension benefits of active and retired employees as of December 31, 1990. Net earnings after the accounting change was $15,005,000.\nAfter the cumulative effect of the accounting change, net earnings increased $14,259,000 over 1991.\nLIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Debt payments, dividends to Parent and capital expenditures of $14,191,000 were funded from cash provided by operating activities in 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- Information with respect to this item appears on page of this report. Such information is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------- Not required.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ---------------------- Not required.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------- Not required.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------- Not required. PART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ---------------------------------------------------------------- (A) (1) AND (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nInformation with respect to these items appears on page of this report. Such information is incorporated herein by reference.\n(3) LIST OF EXHIBITS ---------------- 3.1 Certificate of Incorporation of Midland Enterprises Inc. (filed as Exhibit 3.1 to Registration Statement of Midland Enterprises Inc. on Form S-1 (Registration No. 2-39895, as filed May 5, 1971).1\n3.2 By-Laws of Midland Enterprises Inc. (filed as Exhibit 3.2 to Annual Report of Midland Enterprises Inc. on Form 10-K for the year ended December 31, 1984).1\n4.1 Ship financing agreement dated December 27, 1984.2\n4.2 Promissory note of Midland Enterprises Inc. to Chemical Bank dated January 4, 1985.2\n________________________\n1 Not filed herewith. In accordance with Rule 12-b-32 of the General Rules and Regulations under the Securities Act of 1934, reference is made to the document previously filed with the Commission.\n2 Not filed herewith. Private placements that are less than 10% of the total assets of Registrant and its subsidiaries on a consolidated basis.\n4.3 Indenture between Midland Enterprises Inc. and Shawmut Bank, N.A. dated as of April 1, 1988 (filed as Exhibit 4.2 to Registration Statement No. 33-20789).1\n4.4 Indenture between Midland Enterprises Inc. and The First National Bank of Boston dated as of April 2, 1990 (filed as Exhibit 4.2 to Registration Statement No. 33-32120).1\n(NOTE: The Registrant agrees to furnish to the Securities and Exchange Commission upon request a copy of any instrument with respect to any long-term debt of the Registrant.)\n24.1 Consent of Independent Public Accountants.\n(B) REPORTS ON FORM 8-K ------------------- There were no reports on Form 8-K filed in the fourth quarter of 1993.\n__________________________\n1 Not filed herewith. In accordance with Rule 12-b-32 of the General Rules and Regulations under the Securities Act of 1934, reference is made to the document previously filed with the Commission.\nSIGNATURES ----------\nPursuant 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.\nMIDLAND ENTERPRISES INC. (Registrant)\nBY \/s\/ R. L. DOETTLING ---------------------------- R. L. DOETTLING SENIOR VICE PRESIDENT, FINANCE AND ADMINISTRATION (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nDATE MARCH 16, 1994 --------------------\nPursuant 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 16th day of March, 1994.\nBY: \/s\/ F. C. RASKIN BY: \/s\/ R. L. DOETTLING ----------------------------- ----------------------------- F. C. RASKIN R. L. DOETTLING PRESIDENT; DIRECTOR SENIOR VICE PRESIDENT, FINANCE (PRINCIPAL EXECUTIVE OFFICER) AND ADMINISTRATION; DIRECTOR; (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nBY: \/s\/ P. E. HUBBARD BY: \/s\/ S. A. FRASHER ----------------------------- ----------------------------- P. E. HUBBARD S. A. FRASHER SENIOR VICE PRESIDENT, SALES VICE PRESIDENT, OPERATIONS; AND MARKETING; DIRECTOR DIRECTOR\nSupplemental information to be Furnished With Reports Filed Pursuant to Section 15 (3) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act.\nNo annual reports to security holders covering the Registrant's last fiscal year nor any proxy materials have been sent to the Registrant's security holders.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo Midland Enterprises Inc.:\nWe have audited the accompanying consolidated balance sheets of MIDLAND ENTERPRISES INC. (a Delaware corporation and a wholly-owned subsidiary of Eastern Enterprises) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Midland Enterprises Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the Consolidated Financial Statements, effective January 1, 1992, the Company changed its method of accounting for income taxes. As discussed in Note 3 to the Consolidated Financial Statements, effective January 1, 1991, the Company changed its method of accounting for post-retirement benefits other than pensions.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the Index to Consolidated Financial Statements and Schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nCincinnati, Ohio, February 4, 1994.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1993, 1992 AND 1991\n(1) SIGNIFICANT ACCOUNTING POLICIES\nMidland Enterprises Inc. (the \"Company\") is a wholly-owned subsidiary of Eastern Enterprises (\"Eastern\") of Weston, Massachusetts. The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany balances and transactions have been eliminated. The significant accounting policies followed by the Company and its subsidiaries are described below:\nNote 2 - Retirement and employee benefit plans Note 3 - Post-retirement benefits other than pensions Note 5 - Income taxes Note 6 - Property and equipment\n(a) The Company's principal business is barge transportation with its principal commodity being coal, substantially all of which is transported to electric utilities in the eastern half of the United States.\n(b) Cash Equivalents - Cash equivalents are comprised of highly liquid instruments with original maturities of three months or less.\n(c) Transactions with Parent - Parent receivables represent advances to Eastern which bear interest at the prime rate, 6% at December 31, 1993, 6% at December 31, 1992 and 6 1\/2% at December 31, 1991. The Company was also charged a corporate overhead allocation from its parent computed on several factors including direct corporate management time, revenues, capitalization and employees, which management believes is a reasonable method of allocation.\n(d) Materials, Supplies and Fuel - Materials, supplies and fuel are stated at the lower of cost (first-in, first-out or average) or market.\n(e) Unamortized Debt Expense - Unamortized debt expense represents fees and discounts incurred in obtaining long-term debt. Such costs are being amortized over the terms of the respective bond issues.\n(f) Accounting for Income on Tows in Progress - The Company recognizes income on tows in progress on the percentage of completion method by relating the number of miles completed to date to the total miles to be traveled.\n(g) Reserve for Insurance Claims - The Company is self-insured for personal injury and property claims, certain of which are insured above a deductible amount per occurrence. The Company's estimate of liability for the self-insured claims is included in the \"Reserve for Insurance Claims\" in the Consolidated Balance Sheets and is net of amounts expected to be recovered from its insurance carriers. Payments made for losses incurred are netted against the related liability for the loss.\n(h) Reclassifications - Certain reclassifications of previously reported amounts have been made to conform with current classifications.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(2) RETIREMENT AND EMPLOYEE BENEFIT PLANS\nThe Company and its subsidiaries, through various Company-administered plans and union-administered plans, provide retirement benefits for substantially all of their employees. Normal retirement age is 65, but provision is made for earlier retirement. Benefits under non-union plans are based on salary or wages and years of service, while benefits under union plans are based on negotiated amounts and years of service.\nThe funding of retirement and employee benefit plans is in accordance with the requirements of the plans and collective bargaining agreements and, where applicable, is in sufficient amount to satisfy the \"Minimum Funding Standards\" of the Employee Retirement Income Security Act of 1974.\nDuring 1993 the Company settled portions of its defined benefit pension obligation through the purchase of annuity contracts from insurance companies. In compliance with the provisions of Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans,\" the Company recognized a pre-tax gain of $603,267 in 1993.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(2) RETIREMENT AND EMPLOYEE BENEFIT PLANS (CONTINUED)\nCertain of the Company's subsidiaries participate in one or more multi-employer pension plans, and contribute to such plans in amounts required by the applicable union contracts. Contribution levels are negotiated between the subsidiaries and the unions. A subsidiary would be required under the Federal law to compute its liability for, and accelerate its funding of, its proportionate share of a multi-employer plan's unfunded vested benefits (if any) upon its withdrawal from, or the termination of, such a plan.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) POST-RETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company and its subsidiaries, through various Company-administered plans and other union retirement and welfare plans under collective bargaining agreements, provide certain health care and life insurance benefits for retired employees. The Company's employees, who are participants in the pension plans, become eligible for these benefits if they reach retirement age while working for the Company.\nEffective January 1, 1991, Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Post-Retirement Benefits Other Than Pensions\" was adopted by immediately recognizing the cumulative effect of the accounting change. SFAS 106 requires that the expected cost of post-retirement benefits other than pensions be charged to expense during the period that the employee renders service. In prior years, expense was recognized when claims were paid. At the date of adoption, the cumulative effect of the accounting change (\"transition obligation\") was $8,949,000.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) POST-RETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED)\nThe weighted average discount rate used in determining the accumulated benefit obligation was 7.5%. A 12% and 14% increase in cost of covered health care benefits has been assumed for 1993 and 1992, respectively. This rate of increase is assumed to drop gradually to 5% after 7 years. A one percentage point increase in the assumed health care cost trend would have increased the net periodic post-retirement benefit cost by $48,000 in 1993 and $75,000 in 1992 and the accumulated post-retirement benefit obligation by $561,000 in 1993 and $644,000 in 1992.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) LONG-TERM OBLIGATIONS AND CREDIT AGREEMENTS (CONTINUED)\n(a) Summary of Long-Term Debt (Continued)\nThe First Preferred Ship Mortgage Bonds, Ship Financing Bond, and obligations under capital leases are secured by a substantial portion of the Company's towboats and barges and by assignment of rentals for that equipment payable to the company by its subsidiaries. $25,000,000 and $17,000,000 of First Preferred Ship Mortgage Medium-Term Notes were issued in 1992 and 1991, respectively.\nUnder the most restrictive of the mortgage indentures, the Company, (a) may not pay dividends, reacquire its common stock or make any advances or loans to its stockholder or subsidiaries of its stockholder except to the extent of the sum of (i) Consolidated Net Earnings after December 31, 1988, (ii) the net proceeds of the sale of stock of the Company after December 31, 1988, and (iii) the amount of $50,000,000 with respect to any advances or loans to its stockholder or to subsidiaries of its stockholder, (b) is required to maintain Consolidated Net Current Assets at least equal to $1,250,000, and (c) may not incur or permit any of its subsidiaries to incur additional Senior Unsecured Funded Debt except for refunding unless immediately thereafter Consolidated Net Tangible Assets will aggregate at least 150% of (i) Consolidated Senior Unsecured Funded Debt (excluding therefrom unsecured loans or advances to the company from its stockholder) plus (ii) Consolidated Senior Secured Funded Debt (all terms as defined in the applicable indenture). Under these agreements, $18,197,000 of retained earnings at December 31, 1993 are available for additional dividends to Eastern.\nIncluded in obligations under capital leases is $35,804,000 of barge lease obligations having a weighted average interest rate of 9.8%. Minimum lease payments under these agreements are due in installments through 2003; principal payments due for the next five years amount to $3,070,000 in 1994, $3,378,000 in 1995, $3,719,000 in 1996, $4,095,000 in 1997, and $4,509,000 in 1998.\n(b) Credit Agreements\nEastern maintains a credit agreement with a group of banks which provides for the borrowing by Eastern and certain subsidiaries of up to $60,000,000 at any time through December 31, 1994, with borrowing thereunder maturing not later than December 31, 1995. The Company's maximum available borrowings under the credit agreement are $35,000,000. In addition, Eastern and certain subsidiaries maintain lines of credit totaling $50,000,000, under which the Company can borrow up to $10,000,000. The agreement and lines require facility or commitment fees, which average 1\/5 of 1% of the unused portion. During 1993 and at December 31, 1993, the Company had no borrowings outstanding under these agreements. The interest rate for borrowings is the agent bank's prime rate or, at Eastern's option, various alternatives.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) LONG-TERM OBLIGATIONS AND CREDIT AGREEMENTS (CONTINUED)\n(b) Credit Agreements (continued)\nEastern also maintains a $10,000,000 line of credit available to the Company, which provides for interest at the prime rate or, at Eastern's option, rates tied to Eurodollar, certificate of deposit or money market quotes. During 1993 and at December 31, 1993, the Company had no borrowings outstanding under this line of credit.\n(c) Consolidated Five Year Sinking Funds and Maturities\nThe aggregate annual sinking fund requirements and current maturities of long-term debt, including capital leases, for the next five years amount to $5,871,000 in 1994, $4,360,000 in 1995, $3,905,000 in 1996, $4,095,000 in 1997, and $4,509,000 in 1998.\n(d) Deposited Monies\nMonies on deposit with trustee are netted against long-term debt. In accordance with the provision of certain bond indentures, these amounts represent deposits with the bond trustee for the equipment mortgaged under the bond indenture and subsequently sold. It is the Company's intention to repurchase its own bonds with these funds to be used for sinking fund requirements.\n(5) INCOME TAXES\nThe Company and its subsidiaries are members of an affiliated group of Companies which files a consolidated Federal Income Tax return with Eastern. The Companies follow the policy, established for the group, of providing for Federal Income Taxes which would be payable on a separate company basis. For financial reporting purposes, investment tax credits were deferred and are being amortized to income over the book life of the related property and equipment.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(5) INCOME TAXES (CONTINUED)\nEffective January 1, 1992, Midland adopted the Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\". SFAS 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nAt the date of adoption, Midland recorded a tax credit of approximately $12,156,000 which represents the net decrease to the deferred tax liabilities as of that date. This amount has been reflected in the consolidated statement of earnings as the cumulative effect of an accounting change.\nThe 1991 tax provision was reduced by $1,755,000 of credits no longer applicable under SFAS 109.\nThe Revenue Reconciliation Act of 1993, increased the statutory Federal income tax rate from 34% to 35%, effective January 1, 1993. The provision for income tax in 1993 includes approximately $240,000 for the impact of the rate change in the current earnings, and approximately $1,572,000 to reflect the additional deferred tax requirements as of January 1, 1993, in accordance with SFAS 109.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(5) INCOME TAXES (CONTINUED)\n(6) PROPERTY AND EQUIPMENT\n(a) Depreciation and Amortization - Depreciation and amortization are provided using the straight-line method over the estimated useful lives of property and equipment. Depreciation and amortization as a percentage of average depreciable assets was 4.2%, 4.1%, and 3.9% in 1993, 1992 and 1991, respectively.\n(b) Maintenance & Repairs - The costs of routine maintenance and repairs are charged to expense as incurred. Major renovations and renewals, which benefit future periods or extend the life of the asset, are capitalized and amortized over their estimated useful lives.\n(c) Interest During Construction - The Company reflects as an element of cost in all major construction projects the estimated cost of borrowed funds employed during the period of construction. Capitalized interest is amortized over the estimated useful life of the property or equipment.\n(7) COMMITMENTS\nThe Company and its subsidiaries lease certain facilities, vessels and equipment under long-term leases which expire on various dates through 2008.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nShort-term charter rents, which represent amounts paid for the charter of towboat equipment on a day-to-day, \"fully-found\" (i.e., fully equipped and crew included, with all operating costs included in the charter fee) basis, as well as the costs of chartering barges on a day-to-day basis, have been excluded from the above rentals. Such amounts are not included above since, (1) they are considered to be essentially an \"outside towing\" or barge \"per diem\" expense, (2) they involve no continuing commitments on the part of the Company and its subsidiaries, and (3) the rental amounts contain little or no interest factor.\nAmortization of intangibles, royalties, advertising costs and research and development costs have been omitted as the information is not applicable or not significant.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(9) SIGNIFICANT CUSTOMERS\nNone of the subsidiaries' customers accounted for more than 10% of the Company's total consolidated operating revenues in 1993, 1992 and 1991.\n(10) FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value disclosures for financial instruments:\nCash, trade receivables and accounts payable: The carrying amounts approximates fair value because of the short maturity of these instruments.\nLong-term debt: The fair value of long-term debt is estimated using discounted cash flow analyses based on the current incremental borrowing rates for similar types of borrowing arrangements.\nMIDLAND ENTERPRISES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)","section_15":""}
{"filename":"9466_1993.txt","cik":"9466","year":"1993","section_1":"ITEM 1. BUSINESS\nBaltimore Gas and Electric Company and Subsidiaries are herein collectively referred to as the Company. The Company is engaged in utility operations and related businesses through Baltimore Gas and Electric Company (BGE). The Company is engaged in diversified businesses primarily through BGE's wholly owned subsidiary, Constellation Holdings, Inc. and its subsidiaries (collectively, the Constellation Companies).\nBGE was incorporated under the laws of the State of Maryland on June 20, 1906, and is primarily engaged in the business of producing, purchasing, and selling electricity, and purchasing, transporting, and selling natural gas within the State of Maryland. BGE is qualified to do business in the District of Columbia where its federal affairs office is located. BGE is qualified to do business in the Commonwealth of Pennsylvania where it is participating in the ownership and operation of two electric generating plants as described under ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES -- ELECTRIC. BGE also owns two-thirds of the outstanding capital stock, including one-half of the voting securities, of Safe Harbor Water Power Corporation (Safe Harbor), a hydroelectric producer on the Susquehanna River at Safe Harbor, Pennsylvania. (SEE ITEM 2. PROPERTIES -- ELECTRIC.) BNG, Inc. is a wholly owned subsidiary of BGE which invests in natural gas reserves. Other business of BGE includes the sale and service of gas and electric appliances; BGE intends to emphasize this business in the future and will form a subsidiary during 1994 to direct this effort. For financial information by segment of operation see NOTE 2 TO CONSOLIDATED FINANCIAL STATEMENTS.\nBGE furnishes electric and gas retail services in the City of Baltimore and in all or part of nine counties in Central Maryland. The electric service territory includes an area of approximately 2,300 square miles with an estimated population of 2,602,000. The gas service territory includes an area of approximately 625 square miles with an estimated population of 1,963,000. There are no municipal or cooperative bulk power markets within BGE's service territory.\nElectric utilities presently face competition in the construction of generating units to meet future load growth and in the sale of electricity in the bulk power markets. On March 25, 1993, the Public Service Commission of Maryland (PSC) issued BGE a Certificate of Public Convenience and Necessity authorizing BGE to construct a 140-megawatt combustion turbine at its Perryman site. The PSC further required BGE to implement a competitive bidding program for the selection of a third-party power supplier for the increment of electric generating capacity needed after the Perryman combustion turbine. BGE announced March 11, 1994 that PECO Energy won the competitive bidding with a proposal to supply 140 megawatts for 25 years beginning June 1, 1997. Electric and gas utilities also face the future prospect of competition for electric and gas sales to retail customers. It is not possible to predict the ultimate effect competition will have on BGE's earnings in future years.\nAs discussed throughout this report, the two units at BGE's Calvert Cliffs Nuclear Power Plant are its principal generating facilities and have the lowest fuel cost in BGE's system. An extended shutdown of either of these Units could have a substantial adverse effect on the Company's business and financial condition. Furthermore, BGE does not consider it possible to obtain insurance adequate to cover all the costs that could result from a major incident or an extended outage at either of the Calvert Cliffs Units. (SEE NUCLEAR OPERATIONS AND NOTE 13 TO CONSOLIDATED FINANCIAL STATEMENTS for information regarding prior outages at the Plant.)\nThe Constellation Companies' businesses are discussed under DIVERSIFIED BUSINESSES on page 13 and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A).\nThe percentages of Operating Revenues and Operating Income attributable to electric, gas, and diversified operations are set forth below:\nBGE currently derives approximately 23% of electric revenues and 42% of gas revenues from customers located in the City of Baltimore and 77% and 58%, respectively, from outside the City of Baltimore. No single customer's electric revenues exceed 4% of total electric revenues and no single customer's gas revenues exceed 4% of total gas revenues.\nThe disparity between the percentage of gas operating revenues in relation to the percentage of gas operating income as compared to the same percentages for electric operations is due to BGE's level of investment and its fuel costs in each of these segments. BGE's operating revenue amounts represent recovery of all fuel and operating expenses plus a return on its investment in the business. BGE's net investment for ratemaking purposes in the electric business is $4.5 billion while the comparable investment in its gas business is less than $450 million. Thus, operating revenues include a much greater return component for electric operations than gas operations. Also, as can be seen by referring to ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, CONSOLIDATED STATEMENTS OF INCOME on page 30, gas purchased for resale as a percentage of gas revenues (56%) is greater than electric fuel and purchased energy as a percentage of electric revenues (25%). It should be noted that both purchased gas costs and electric fuel costs are passed through to the customer with no mark-up for profit. The combined effects of these factors yield the observed relationship between operating revenues and income for electric and gas operations.\nCAPITAL REQUIREMENTS\nThe Company's actual capital requirements for 1991 through 1993, along with estimated amounts for 1994 through 1996, are set forth below:\nBGE's actual capital requirements may vary from the estimates set forth above because of a number of factors such as inflation, economic conditions, regulation, legislation, load growth, environmental protection standards, and the cost and availability of capital. The Constellation Companies' capital requirements for diversified businesses may vary from the estimates set forth above due to a number of factors including market and economic conditions and are discussed in detail under MD&A -- DIVERSIFIED BUSINESSES CAPITAL REQUIREMENTS on page 28.\nBGE's estimated construction, nuclear fuel, deferred nuclear expenditures, and deferred energy conservation expenditures are expected to amount to approximately $2.1 billion, $250 million, $12 million, and $200 million, respectively, for the five-year period 1994-1998. Electric construction expenditures reflect the installation of two 5,000 kilowatt diesel generators at Calvert Cliffs Nuclear Power Plant, scheduled to be placed in service in 1995; the construction of a 140-megawatt combustion turbine at Perryman, scheduled to be placed in service in\n1995, which the PSC authorized in an order dated March 25, 1993; and improvements in BGE's existing generating plants and its transmission and distribution facilities. Future electric construction expenditures do not include additional generating units in light of the competitive bidding process established by the PSC as discussed on page 1. The Company estimates currently that expenditures for compliance with the sulfur dioxide provisions of the Clean Air Act of 1990 will total approximately $55 million through 1995.\nDuring the period January 1, 1989 through December 31, 1993, BGE expended $2,299 million for gross additions to utility plant or approximately 32% of its total utility plant (exclusive of nuclear fuel) at December 31, 1993. During the same period, a total of $272 million of utility plant was retired. Nuclear fuel expenditures include uranium purchases and processing charges.\nBGE presently estimates that approximately $750 million will be required for retirements and redemptions of long-term debt (including sinking fund payments) and BGE preference stock during the five-year period 1994-1998.\nFor further information with respect to capital requirements and for a discussion of internal generation of cash, see ITEM 7. MD&A -- LIQUIDITY AND CAPITAL RESOURCES.\nRATE MATTERS\nELECTRIC AND GAS BASE RATE DECISION\nOn April 23, 1993, the PSC issued an Order (the 1993 Rate Order) authorizing BGE annualized electric and gas base rate increases of $84.9 million and $1.6 million, respectively. The increases are equivalent to 4.5% and 0.4% of total electric and gas revenues, respectively. In granting the increases, the PSC provided a return on BGE's higher level of electric and gas rate base and recognized increases in electric operating expenses associated primarily with maintaining and improving system reliability. This was partially offset by a reduction in the authorized rate of return to 9.40% from the 9.94% rate of return previously authorized.\nThe 1993 Rate Order also provided for recovery of one-half of the annual level of the increase in postretirement benefit costs under Statement of Financial Accounting Standards No. 106. The PSC directed BGE to defer the remainder of the annual increase in these costs for inclusion in BGE's next base rate proceeding and provided that costs deferred during the intervening period will be amortized over a fifteen-year period beginning in 1998.\nENERGY CONSERVATION SURCHARGE\nThe PSC approved a base rate surcharge effective July 1, 1992 which provides for the recovery of deferred energy conservation expenditures, a return thereon, lost revenues, and incentives for achievement of predetermined goals for certain conservation programs subject to an earnings test. The compensation for foregone sales due to conservation programs and the incentives for achieving conservation goals must be refunded to customers if BGE is earning in excess of its authorized rate of return, as determined by the PSC. (See discussion in ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.) The surcharge is reset on July 1 of each year.\nELECTRIC FUEL RATE PROCEEDINGS\nBy statute, electric fuel costs are recoverable if the PSC finds that BGE demonstrates that, among other things, it has maintained the productive capacity of its generating plants at a reasonable level. The PSC and Maryland's highest appelate court have interpreted this as permitting a subjective evaluation of each unplanned outage at BGE's generating plants to determine whether or not BGE had implemented all reasonable and cost effective maintenance and operating control procedures appropriate for preventing the outage. The PSC has established a Generating Unit Performance Program (GUPP) to measure annual utility compliance with maintaining the productive capacity of generating plants at reasonable levels by establishing a system-wide generating performance target and individual performance targets for each base load generating unit. As a result, actual generating performance, after adjustment for planned outages, is compared to the system-wide target and, if met, should signify compliance with the requirements of Maryland law. Failure to meet the system-wide target will result in review of each unit's adjusted actual generating performance versus its performance target in determining compliance with the law, and the basis for possibly imposing a penalty on BGE. Failure to meet these targets requires BGE to demonstrate that the outages causing the failure are not the result of mismanagement. Parties to fuel rate hearings may still question the prudence of BGE's actions or inactions with respect to any given generating plant outage, which could result in a disallowance of replacement energy costs. BGE is involved in fuel rate proceedings annually where issues concerning individual plant outages can be raised. Recovery of a portion of replacement energy costs has been denied in past proceedings and BGE cannot estimate the amount that could be denied in future fuel rate proceedings, but such amounts could be material. (See NUCLEAR OPERATIONS.)\nBGE is required to submit to the PSC the actual generating performance data for each calendar year 45 days after year end. The PSC reviews BGE's performance for each calendar year in the first fuel rate proceeding initiated following the submission of the actual generating performance data for that year. BGE must initiate fuel\nrate proceedings in any month following a month during which the calculated fuel rate decreased by more than 5% and may initiate fuel rate proceedings in any month following a month during which the calculated fuel rate increased by more than 5%.\nNUCLEAR OPERATIONS\nDiscussed below are certain events relating to the operations of the Calvert Cliffs Nuclear Power Plant (the Plant) during the period 1987 to the present including issues involving the possible disallowance of replacement energy costs incurred during unplanned outages at the Plant. All outstanding issues will be resolved in fuel rate proceedings before the PSC which are conducted in accordance with the procedures outlined above under RATE MATTERS -- ELECTRIC FUEL RATE PROCEEDINGS.\nOPERATIONS IN 1987\nThe Plant generated 10,069,576 megawatt hours (MWH) in 1987 which resulted in a capacity factor of 70%. In October 1988, BGE filed a fuel rate application for a change in its electric fuel rate under GUPP, which covered BGE's operating performance in 1987. This was the first proceeding filed under this program and BGE's filing demonstrated that it met the system-wide and individual plant performance targets for 1987, including the performance target for the Plant. BGE believes, therefore, it is entitled to recover all fuel costs incurred in 1987 without any disallowances. However, People's Counsel alleges that a number of the outages at the Plant (including the 66-day outage described below) were due to management imprudence and requests that the PSC disallow recovery of the associated replacement energy costs which BGE estimates to be approximately $33 million. (See NOTE 13 TO CONSOLIDATED FINANCIAL STATEMENTS.) This matter is awaiting a decision by a hearing examiner.\nIn late March, 1987, the Nuclear Regulatory Commission (NRC) conducted an inspection of the Plant for the purpose of examining BGE's compliance with environmental qualification requirements mandated by NRC regulations. These regulations require the establishment of a qualification file for the purpose of demonstrating proof of operability of designated electric equipment regarded as important to safety. This written proof of operability is related to the ability of the equipment to function under harsh environments, such as extreme temperatures, humidity, and radiation. The NRC's inspections revealed cable splices that were lacking required documentation demonstrating compliance with NRC regulations. The inspection results from Unit 2, which was shut down for maintenance and refueling at the time of inspection, indicated a sufficient number of equipment qualification problems that BGE shut down Unit 1 on April 1, 1987, in order to inspect for similar nonqualified electrical connections. Subsequently, BGE identified an additional problem regarding the certification of piping system fasteners with mechanical safety requirements. The fasteners must be certified as meeting specified American Society of Mechanical Engineers requirements; however, BGE was unable to document that all of the fasteners in question had been certified. BGE received a notice of violation from the NRC in connection with the environmental qualifications problem and paid civil penalties in the amount of $300,000. In addition, the Calvert Cliffs Units were out of service for a total of 66 days in order to document compliance with these environmental and mechanical qualification requirements.\nOPERATIONS IN 1988\nThe Plant generated 11,733,900 MWH in 1988 which resulted in a capacity factor of 81%. BGE filed a fuel rate application under GUPP in May, 1989 in which it demonstrated that it met the system-wide and individual plant performance targets for 1988. People's Counsel alleged that BGE imprudently managed several outages at the Plant and requested that the PSC disallow recovery of $2 million of replacement energy costs. On November 14, 1991, a Hearing Examiner at the PSC issued a proposed Order, which became final on December 17, 1991 and concluded that no disallowance was warranted. The Hearing Examiner found that BGE maintained the productive capacity of the Plant at a reasonable level, noting that it produced a near record amount of power and exceeded the GUPP standard. Based on this record, the Order concluded there was sufficient cause to excuse any avoidable failures to maintain productive capacity at higher levels.\nOPERATIONS IN 1989 TO 1991 -- EXTENDED OUTAGE\nThe Plant generated 2,719,197 MWH in 1989 and 1,251,416 MWH in 1990. In the Spring of 1989, a leak was discovered around the Unit 2 pressurizer heater sleeves during a refueling outage. BGE shut down Unit 1 as a precautionary measure on May 6, 1989 to inspect for similar leaks and none were found at that time. However, Unit 1 was out of service for the remainder of 1989 and 285 days of 1990 to undergo maintenance and modification work to enhance the reliability of various safety systems, to repair equipment, and to perform required periodic surveillance tests. Unit 2 remained out of service until May 4, 1991 to complete repair of the pressurizer, perform maintenance and modification work, and complete the refueling. The replacement energy costs associated with these extended outages for both Units at Calvert Cliffs, concluding with the return to service of Unit 2, are estimated to be $458 million. This estimate is based on a computer simulation comparing the actual operating conditions during the extended outages with operating conditions assuming the Plant ran at its targeted capacity factor.\nThe extended outages experienced at the Plant are being reviewed by the PSC in the 1989-1991 fuel rate proceeding, and People's Counsel and others have challenged recovery of some part of the associated replacement energy costs. In the PSC's Rate Order issued in BGE's 1990 Base Rate Case, it found that $4 million of operations and maintenance expenses incurred by BGE during the 1989-1990 outages at the Plant should not be recoverable from customers. The PSC concluded that the related work, which was performed at Unit 1 during the 1989-1990 outage, was avoidable and caused by Company actions which were deficient. The work characterized as avoidable had a significant impact on the duration of the Unit 1 outage. The PSC's Order stated that its conclusions in this proceeding did not have a binding effect in the fuel rate proceeding on the recoverability of Calvert Cliffs' replacement energy costs. However, BGE believes that it is doubtful that the PSC will authorize recovery of the full amount of replacement energy costs presently under investigation. Based on a review of the circumstances surrounding the extended outages by BGE personnel as well as independent consultants, in 1990 BGE recorded a provision of $35 million against the possible disallowance of such costs. However, BGE cannot determine whether replacement energy costs may be disallowed in the 1989-1991 fuel rate proceeding in excess of the provision, but such amounts could be material.\nOn March 15, 1994, the PSC Staff and the Office of People's Counsel filed testimony in the 1989-1991 fuel rate proceedings. The PSC Staff concluded that approximately 46% of the outage time was unreasonably incurred and that approximately $200 million of replacement energy costs should be disallowed. People's Counsel concluded that approximately $400 million of the replacement energy costs should be disallowed. BGE is tentatively scheduled to file rebuttal testimony in mid-August of 1994 at which time it will vigorously contest the findings of Staff and People's Counsel. Further hearings in this matter are not scheduled until mid-year of 1995.\nAs previously reported, in December 1988, the NRC categorized the Plant as one requiring close monitoring and increased NRC attention. The NRC did so following certain events that the NRC indicated raised questions about the effectiveness of past corrective action regarding engineering and technical areas and the overall approach to safety at the Plant. Details of such events were described in the Report on Form 10-K for the year ended December 31, 1990 in the section titled \"Nuclear Operations\" on pages 4 through 7. In February 1992, the NRC removed the Plant from its list of nuclear plants categorized as requiring close monitoring as a result of improved performance in previously identified problem areas and the demonstration of a sustained period of safe operation.\nOPERATIONS IN 1991 AFTER THE EXTENDED OUTAGE\nThe Plant generated 9,036,100 MWH in 1991, which resulted in a capacity factor of 63%. BGE filed a fuel rate application under GUPP in June 1992, however, the Hearing Examiner has determined that the 1991 case will not be addressed until the case covering the extended outage has been resolved.\nOPERATIONS IN 1992\nThe Plant generated 10,663,950 MWH in 1992, which resulted in a capacity factor of 74%. BGE's fuel rate application under GUPP for 1992 demonstrated that the Plant exceeded its individual plant performance targets and that system-wide performance exceeded targeted levels. There are no contested performance issues based on 1992 performance.\nOPERATIONS IN 1993\nThe Plant generated 12,300,816 MWH in 1993, which resulted in a capacity factor of 85%. BGE's fuel rate application under GUPP for 1993 demonstrated that the Plant exceeded its individual plant performance targets and that system-wide performance exceeded targeted levels.\nLOAD MANAGEMENT, ENERGY, AND CAPACITY PURCHASES\nBGE has implemented various active load management programs designed to be used when system operating conditions require a reduction in load. These programs include customer-owned generation and curtailable service for large commercial and industrial customers, air conditioning control which is available to residential and commercial customers, and residential water heater control. The load reductions typically have been invoked on peak summer days; the summer peak capacity impact for 1994 from active load management is expected to be approximately 470 megawatts (MW). Cost recovery for these load management programs is attained through the inclusion in rate base of capital investments and the appropriate expenses (including credits on customer bills) for recovery in base rate proceedings.\nThe generating and transmission facilities of BGE are interconnected with those of neighboring utility systems to form the Pennsylvania-New Jersey-Maryland Interconnection (PJM). Under the PJM agreement, the interconnected facilities are used for substantial energy interchange and capacity transactions as well as emergency assistance. In addition, BGE enters into short-term capacity transactions at various times to meet PJM obligations.\nBGE has an agreement with Pennsylvania Power & Light Company (PP&L) to purchase a mix of energy and capacity from June 1, 1990 through May 31, 2001. This agreement, which has been accepted by the Federal Energy Regulatory Commission, is designed to help maintain adequate reserve margins through this decade and provide flexibility in scheduling power plant additions for the latter half of the 1990s. The PP&L agreement entitles BGE to 5.94% of the energy output, and net capacity (currently 124 MW), of PP&L's nuclear Susquehanna Steam Electric Station from October 1, 1991 to May 31, 2001 and also enables BGE to treat a portion of PP&L's capacity as BGE's capacity for purposes of satisfying BGE's installed capacity requirements as a member of the PJM. BGE is not acquiring an ownership interest in any of PP&L's generating units. PP&L will continue to control, manage, operate, and maintain that station and all other PP&L-owned generating facilities. BGE's firm capacity purchases at December 31, 1993 represented 170 MW of rated capacity of Bethlehem Steel Corporation's Sparrows Point complex, 57 MW of rated capacity of the Baltimore Refuse Energy Systems Company, and 124 MW of base load capacity from PP&L.\nAlso, on March 11, 1994, BGE announced that PECO Energy won a competitive bid for additional capacity with a proposal to supply 140 megawatts for 25 years beginning June 1, 1997. BGE anticipates submitting a contract for approval to the PSC in the Spring of 1994.\nFUEL FOR ELECTRIC GENERATION\nInformation regarding BGE's electric generation by fuel type and the cost of fuels in the five-year period 1989-1993 is set forth in the following tables:\nCOAL: BGE obtains a large amount of its coal under supply contracts with mining operators. The remainder of its coal requirements are obtained through spot purchases. BGE believes that it will be able to renew such contracts as they expire or enter into similar contractual arrangements with other coal suppliers. BGE's Brandon Shores Units 1 and 2 have a total annual requirement of approximately 3,200,000 tons of coal (combined) with a sulfur content of less than approximately 0.8%. The average delivered costs per ton paid by BGE for Brandon Shores coal for the years 1989 through 1993 were $40.17, $39.00, $39.80, $39.98, and $39.49, respectively. BGE's Crane Units 1 and 2 have a total annual requirement of about 700,000 tons of coal (combined) with a sulfur content of less than approximately 2.4% and a low ash melting temperature. The average delivered costs per ton paid by BGE for coal at Crane for the years 1989 through 1993 were $42.62, $40.45, $38.88, $38.37, and $37.25, respectively. BGE's Wagner Units 2 and 3 have a total annual requirement of approximately 1,000,000 tons of coal (combined) with a sulfur content of no more than 1%. The average delivered costs per ton paid by BGE for coal at Wagner for the years 1989 through 1993 were $41.45, $41.28, $44.49, $43.19, and $40.62, respectively.\nCoal deliveries to BGE's coal burning facilities are made by rail and barge. The coal used by BGE is produced from mines located in central and northern Appalachia.\nBGE has a 20.99% undivided interest in the Keystone coal-fired generating plant and a 10.56% undivided interest in the Conemaugh coal-fired generating plant. The bulk of the annual coal requirements for the Keystone plant is under contract from Rochester and Pittsburgh Coal Company. The Conemaugh plant purchases coal from local suppliers on the open market. The average delivered costs per ton for coal for these plants for the years 1989 through 1993 were $33.62, $36.69, $33.07, $31.53, and $32.42, respectively.\nOIL: Under normal burn practices, BGE's requirements for residual fuel oil amount to approximately 1,000,000 barrels of low-sulfur oil per year. Deliveries of residual fuel oil are made directly into BGE barges from\nthe suppliers' Baltimore Harbor marine terminal for distribution to the various generating plant locations. The average delivered prices per barrel paid by BGE for residual fuel oil for the years 1989 through 1993 were $17.65, $20.24, $15.53, $17.25, and $15.69 respectively.\nNUCLEAR: The supply of fuel for nuclear generating stations involves the acquisition of uranium concentrates, its conversion to uranium hexafluoride, enrichment of uranium hexafluoride, and the fabrication of nuclear fuel assemblies. Information is set forth below with respect to fuel for Calvert Cliffs Units 1 and 2:\nUnder the Nuclear Waste Policy Act of 1982 (the 1982 Act), spent fuel discharged from nuclear power plants, including Calvert Cliffs, is required to be placed into a federal repository. Such facilities do not currently exist, and, consequently, must be developed and licensed. BGE cannot now predict when such facilities will be available, although the 1982 Act obligates the federal government to accept spent fuel starting in 1998. While BGE cannot now predict what the ultimate cost will be, the 1982 Act assesses a one mill per kilowatt-hour fee on nuclear electricity generated and sold. At anticipated operating levels, it is expected that this fee will be approximately $11 million for Calvert Cliffs each year.\nThe Energy Policy Act of 1992 (the 1992 Act) contains provisions requiring domestic utilities to contribute to a fund for decommissioning and decontaminating the Department of Energy's (DOE) uranium enrichment facilities. These contributions are generally payable over a fifteen-year period with escalation for inflation and are based upon the amount of uranium enriched by DOE for each utility. The 1992 Act provides that these costs are recoverable through utility service rates as a cost of fuel. Information about the cost of decommissioning is discussed in NOTE 1 TO THE CONSOLIDATED FINANCIAL STATEMENTS on page 39 under the heading \"UTILITY PLANT, DEPRECIATION AND AMORTIZATION, AND DECOMMISSIONING.\"\nMaryland law makes it unlawful to establish within the State a facility for the permanent storage of high-level nuclear waste, unless otherwise expressly required by federal law. BGE has received a license from the NRC to operate its new on-site independent spent fuel storage facility. BGE now has storage capacity at Calvert Cliffs that will accommodate spent fuel from operations through the year 2006. In addition, BGE can expand its temporary storage capacity to meet future requirements until federal storage is available.\nExpenditures for nuclear fuel are discussed in MD&A -- LIQUIDITY AND CAPITAL RESOURCES on page 28. Capital requirements for nuclear fuel returned to normal levels in 1992. The 1991 level was abnormally low due to the accumulation in inventory of nuclear fuel purchased and processed over the period of extended outages at Calvert Cliffs during 1989-1991. The 1991 level reflects the use of nuclear fuel from such inventoried stocks rather than new purchases.\nGAS: BGE has a firm natural gas transportation entitlement of 3,500 dekatherms a day to provide ignition and banking at certain power plants. Gas for electric generation is purchased as needed in the spot market using interruptible transportation arrangements. Certain gas fired units can use residual fuel oil as an alternative.\nGAS OPERATIONS\nBGE distributes natural gas purchased directly from several producers and marketers. Transportation to BGE's city gate for these purchases is provided by Columbia Gas Transmission Corporation (Columbia), CNG Transmission Corporation (CNG), and Transcontinental Gas Pipe Line Corporation under various transportation agreements. BGE has upstream transportation capacity under contract on Tennessee Gas Pipeline Company, Texas Eastern Transmission Corporation, Columbia Gulf Transmission Company and ANR Pipeline Company (ANR). BGE has storage service agreements with Columbia, CNG and ANR. The transportation and storage agreements are on file with the Federal Energy Regulatory Commission (FERC).\nBGE's current pipeline firm transportation entitlements to serve its firm loads are 473,597 dekatherms (DTH) per day during the winter period and 291,231 DTH per day during the summer period. BGE uses the firm transportation capacity to move gas from the Gulf of Mexico, Louisiana, south central regions of Texas and Canada to BGE's city gate. The gas is subject to a mix of long and short-term contracts that are managed to provide economic, reliable and flexible service. Additional short-term contracts or exchange agreements with other gas companies can be arranged in the event of short term emergencies.\nTo supplement BGE's gas supply at times of heavy winter demands and to be available in temporary emergencies affecting gas supply, BGE has propane air and liquefied natural gas facilities. The liquefied natural gas facility consists of a plant for the liquefaction and storage of natural gas with a storage capacity of 1,000,000 DTH and an installed daily capacity of 281,760 DTH. The propane air facility consists of a plant with a mined cavern and refrigerated storage facilities having a total storage capacity equivalent to 1,000,000 DTH and a daily capacity of 91,600 DTH. BGE has under contract sufficient volumes of propane for the operation of the propane air facility and is capable of liquefying sufficient volumes of natural gas during the summer months for operation of its liquefied natural gas facility during winter periods.\nBGE offers gas for sale to its residential, commercial and industrial customers on a firm and interruptible basis. BGE also provides its large commercial and industrial customers with a transportation service across its distribution system so that these customers may make direct purchase and transportation arrangements with suppliers and pipelines. A transportation fee is charged by BGE that is equivalent to its operating margin on gas it sells to similar customers for the service from the city gate to the customer's facility. This program enables BGE to maintain throughput at a level which assures that fixed costs are spread over the maximum number of DTH. BGE is authorized by the PSC to provide a balancing service for its transportation customers.\nFuture purchased gas costs are expected to increase due to transition costs incurred by BGE gas pipeline suppliers in implementing FERC Order No. 636. These transition costs, if approved by the PSC and FERC, will be passed on to BGE customers through the purchased gas adjustment clause.\nENVIRONMENTAL MATTERS\nThe Company is subject to regulation with regard to air and water quality, waste disposal, and other environmental matters by various federal, state, and local authorities. Certain of these regulations require substantial expenditures for additions to utility plant and the use of more expensive low-sulfur fuels. While the Company cannot now precisely estimate the total effect of existing and future environmental regulations and standards upon its existing and proposed facilities and operations, the necessity for compliance with existing standards and regulations has caused BGE to increase capital expenditures by approximately $223 million during the five-year period 1989-1993. It is estimated that the capital expenditures necessary to comply with such standards and regulations will be approximately $37 million, $15 million, and $21 million for 1994, 1995, and 1996, respectively.\nAIR: The Federal Clean Air Act (the Act) mandates health and welfare standards for concentrations of air pollutants. The State of Maryland is charged by the Act with the responsibility for setting limits on all major sources of these pollutants in the State so that these standards are not exceeded. Except for Crane Units 1 and 2, BGE's generating units are limited to burning fuel (coal or oil) with sulfur content of 1% or below. All units are limited to emitting particulate matter at or below 0.02 grains per standard cubic foot of exhaust gas for oil fired units and 0.03 grains per standard cubic foot for coal fired units. Brandon Shores, a newer plant, is subject to more stringent standards for sulfur dioxide (1.2 pounds per million Btu), and nitrogen dioxide (0.7 pounds per million Btu). The Crane Units must meet limits of 3.5 pounds per million Btu for sulfur dioxide, which is equivalent to a coal sulfur content of approximately 2.4%. BGE is in compliance with existing air quality regulations. Under a consent order with the Maryland Department of the Environment (MDE) relating to such regulations, BGE is operating two of four units at its Riverside facility at reduced capacity until these units are retired during 1994. The fifth Riverside unit was retired in 1991.\nThe Clean Air Act amendments of 1990 require sulfur dioxide emission reductions at Crane and the jointly owned Conemaugh plant by 1995 and additional controls at other coal plants to be in place by 2000. BGE presently plans to achieve emission reduction at Crane by conversion to low-sulfur coal. The capital costs for equipment changes at the Crane plant are estimated to be approximately $7 million. Scrubbers are being installed at both units of the Conemaugh plant, in which BGE has a 10.56% undivided ownership interest. BGE estimates that its share of the costs of the scrubbers will be approximately $42.7 million. In addition, BGE anticipates incurring other Clean Air Act costs of approximately $10 million for various equipment such as continuous emission monitors and precipitator upgrades by 2000.\nAt this time, plans for complying with nitrogen oxide (NOx) control requirements under the Act are less certain because all implementation regulations have not yet been finalized by the government. It is expected that\nby the year 2000 these regulations will require additional NOx controls for ozone non-attainment at BGE's generating plants and other BGE facilities. The controls will result in additional expenditures that are difficult to predict prior to the issuance of such regulations. Based on existing and proposed ozone non-attainment regulations, BGE currently estimates that the NOx controls at BGE's generating plants will cost approximately $70 million. BGE is currently unable to predict the cost of compliance with the additional requirements at other BGE facilities.\nWATER: The discharge of effluents into the navigable waters of the State of Maryland is regulated by the MDE, in accordance with the National Pollutant Discharge Elimination System (NPDES) permit program, established pursuant to the Federal Clean Water Act. At the present time, all of BGE's steam electric generating plants have the required NPDES permits.\nMDE water quality regulations require, among other things, specifying procedures for determining compliance with State water quality standards. These procedures require extensive studies involving sampling and monitoring of the waters around affected generating plants. Under current regulations, the State of Maryland may require changes in plant operations. At this time BGE is performing studies to determine whether any modifications will be required to comply with these new regulations.\nWASTE DISPOSAL: The United States Environmental Protection Agency (EPA) has promulgated regulations implementing those portions of the Resource Conservation and Recovery Act which deal with management of hazardous wastes. These regulations, and the Hazardous and Solid Waste Amendments of 1984, designate certain spent materials as hazardous wastes and establish standards and permit requirements for those who generate, transport, store, or dispose of such wastes. The State of Maryland has adopted similar regulations governing the management of hazardous wastes, which closely parallel the federal regulations. BGE has implemented procedures for compliance with all applicable federal and state regulations governing the management of hazardous wastes. Certain high volume utility wastes such as fly ash and bottom ash have been exempted from these regulations. The Company currently utilizes almost all of its coal fly ash and bottom ash as structural fill material in a manner approved by the State of Maryland. The remainder of the coal ash is sold to the construction industry for a number of approved applications.\nThe Federal Comprehensive Environmental Response, Compensation and Liability Act (Superfund statute) establishes liability for the cleanup of hazardous wastes found contaminating the soil, water, or air. Those who generated, transported or deposited the waste at the contaminated site are each jointly and severally liable for the cost of the cleanup, as are the current property owner and their predecessors in title at the time of the contamination. In addition, many states have enacted laws similar to the Superfund statute.\nOn October 16, 1989, the EPA filed a complaint in the U.S. District Court for the District of Maryland under the Superfund statute against BGE and seven other defendants to recover past and future expenditures associated with cleanup of a site located at Kane and Lombard Streets in Baltimore. The State of Maryland intervened by filing a similar complaint in the same case and court on February 12, 1990. The complaints allege that BGE arranged for its fly ash to be deposited on the site. The litigation is currently stayed pending settlement discussions among all parties. Additional investigation was initiated on the remainder of the site by the MDE for the EPA but was never completed. BGE and three other defendants agreed to complete the remedial investigation and feasibility study of groundwater contamination around the site in a July 1993 consent order. The remedial action, if any, for the remainder of the site will not be selected until these investigations are concluded. Therefore, neither the total site cleanup costs, nor BGE's share, can presently be estimated.\nIn the early 1970's, BGE shipped an unknown number of scrapped transformers to Metal Bank of America, a metal reclaimer in Philadelphia. Metal Bank's scrap and storage yard has been found to be contaminated with oil containing high levels of PCBs (PCBs are hazardous chemicals frequently used as a fire-resistant coolant in electrical equipment). On December 7, 1987, the EPA notified BGE and other utilities that they are considered potentially responsible parties (PRPs) with respect to the cleanup of the site. A remedial investigation and feasibility study by BGE and the other PRPs is in progress. The investigation costs are estimated to be about $6 million. BGE's share of the investigation costs is estimated to be approximately 15.8%, or $1 million, based on an allocation formula applied to the PRP group. The total cleanup costs are not yet known so BGE's potential liability cannot be estimated, but such liability could be material.\nDuring the early 1970's, BGE disposed of a small amount of low-level nuclear waste at a site in Morehead, Kentucky, known as Maxey Flats. This site was found to have been operated improperly. As a result, low-level radioactive contaminants have been found to be leaking from the site. On November 26, 1986, the EPA notified BGE that it is one of approximately 800 PRPs. A remedial investigation and feasibility study was completed by BGE and other PRPs. The EPA has issued its Record of Decision, recommending a natural stabilization remedy. The cost estimate for this remedy is currently estimated to be approximately $60 million for all PRPs. BGE's\nvolumetric share of the waste on-site is 0.0103 percent of the total, based upon BGE's records of waste shipped to the site compared to the total recorded waste. BGE's potential liability cannot be estimated, but such liability is not likely to be substantial because its volumetric share of the waste on-site is so small.\nFrom 1985 until 1989, BGE shipped waste oil and other materials to the Industrial Solvents and Chemical Company in York County, Pennsylvania for disposal. The Pennsylvania Department of Environmental Resources (Pennsylvania Department) subsequently investigated this site and found it to be heavily contaminated by hazardous wastes. The Pennsylvania Department notified BGE on August 15, 1990, that it and approximately 1,000 other entities were PRPs with respect to the cost of all remedial activities to be conducted at the site. No remedial investigation or feasibility study has been undertaken, but the PRPs agreed to perform waste characterization at the site in a July 1993 consent order. Also, the PRPs agreed to remove and dispose of specified numbers of drums and tanks of waste in a December 1993 consent order. BGE's share of the liability at this site currently is estimated to be approximately 2.39%, but this may change as additional information about the site is obtained. The actual cost of remedial activities has not been determined. As a result of these factors, BGE's potential liability cannot presently be estimated. However, such liability could be material.\nOn March 9, 1993 BGE was served in litigation instituted by the EPA in the United States District Court for the Eastern District of Pennsylvania involving contamination of the Douglassville site in Berks County, Pennsylvania. BGE was named as a third party defendant based upon allegations that BGE had contracted with A&A Waste Oils, an original defendant, to dispose of oils and lubricants. BGE was dismissed as a party to this litigation in August, 1993.\nIn the early part of the century, predecessor gas companies (which were later merged into BGE) manufactured coal gas for residential and industrial use. The residue from this manufacturing process was coal tar, previously thought to be harmless but now found to contain a number of chemicals designated by the EPA as hazardous substances. BGE is coordinating an investigation of these former coal gas plant sites, including exploration of corrective action options to remove coal tar, with the MDE. No formal legal proceedings have been instituted with respect to these sites. The technology for cleaning up such sites is still developing, and potential remedies for these sites have not been identified. As explained in NOTE 13 TO THE CONSOLIDATED FINANCIAL STATEMENTS on page 52, a liability of $25.4 million was accrued in 1993 regarding future estimated expenditures at these sites. Any cleanup costs for these sites in excess of the amount accrued, which could be significant in total, cannot presently be estimated.\nELECTRIC OPERATING STATISTICS\nIn 1993, BGE changed its classification of commercial and industrial customers to present this information on a basis which is more consistent with predominant industry practices. Prior-year amounts have been reclassified to conform to the current year's presentation.\nGAS OPERATING STATISTICS\nIn 1993, BGE changed its classification of commercial and industrial customers to present this information on a basis which is more consistent with predominant industry practices. Prior-year amounts have been reclassified to conform to the current year's presentation.\nFRANCHISES\nBGE has nonexclusive electric and gas franchises to use streets and other highways which are adequate and sufficient to permit BGE to engage in its present business. All such franchises, other than the gas franchises in Manchester, Hampstead, Perryville, Sykesville, Havre de Grace, and Montgomery and Frederick Counties, are unlimited as to time. The gas franchises for these jurisdictions expire at various times from 1994 to 2020, except for Havre de Grace which has the right, exercisable at twenty-year intervals from 1907, to purchase all of BGE's gas properties in that municipality. Conditions of the franchises are satisfactory. BGE also has rights-of-way to maintain 26-inch natural gas mains across certain Baltimore City owned property (principally parks) which expire in 1999 and 2004, each subject to renewal during the last year thereof for an additional period of 25 years on a fair revaluation of the rights so granted. Conditions of the grants are satisfactory.\nFranchise provisions relating to rates have been superseded by the Public Service Commission Law of Maryland.\nDIVERSIFIED BUSINESSES\nGENERAL\nDiversified businesses consist of the operations of the Constellation Companies and BNG, Inc.\nThe Constellation Companies' businesses are concentrated in three major areas -- power generation projects, financial investments, and real estate projects (including senior living facilities). A significant portion of the Constellation Companies' activities are conducted through joint ventures in which they hold varying ownership interests.\nThe Constellation Companies hold up to a 50% ownership interest in 24 power generating projects in operation or under construction accounting for $285 million of the Constellation Companies' assets. One of these power generation construction projects is the Puna project, which is discussed on page 14. These projects, all of which either are qualifying facilities under the Public Utility Regulatory Policies Act of 1978 or are otherwise exempt from the Public Utility Holding Company Act of 1935, are of the following types and aggregate generation capacities: coal 160 MW, solar 170 MW, geothermal 121 MW, waste coal 182 MW, wood burning 70 MW, and hydro 30 MW. In addition, another $6 million has been spent on projects in development. The Constellation Companies also participate in the operation and maintenance of 23 power generation projects existing or under construction, 10 of which are projects in which the Constellation Companies hold an ownership interest. Financial investments account for $213 million of the Constellation Companies' assets. These assets include $91 million in internally and externally managed securities portfolios, $83 million in monoline financial guaranty (credit enhancement) companies, and $39 million in tax-oriented transactions. Real estate projects account for $489 million of the Constellation Companies' assets. These projects include raw land, office buildings, retail, and commercial projects, an entertainment, dining, and retail complex in Orlando, Florida, a mixed-use planned unit development, and senior living facilities. The majority of the real estate projects are in the Baltimore-Washington area and have been adversely affected by the depressed real estate and economic market.\nThe Constellation Companies' investment in wholesale power generating projects includes $163 million representing ownership interests in 16 projects which sell electricity in California under Interim Standard Offer No. 4 power purchase agreements. Under these agreements, the properties supply electricity to purchasing utilities at a fixed energy rate for the first ten years of the agreements and at variable energy rates based on the utilities' avoided cost for the remaining term of the agreements. Avoided cost generally represents a utility's next lowest cost generation to service the demands on its system. These power generation projects are scheduled to convert to supplying electricity at avoided cost rates in various years beginning in late 1996 through the end of 2000. As a result of declines in purchasing utilities' avoided costs after these agreements were signed, revenues at these projects based on current avoided cost levels would be substantially lower than revenues presently being realized under the fixed price terms of the agreements. If current avoided cost levels were to continue into 1996 and beyond, the Constellation Companies could experience reduced earnings or incur losses associated with these projects, which could be significant. The Constellation Companies are investigating alternatives for certain of these power generation projects including, but not limited to, repowering the projects to reduce operating costs, renegotiating the power purchase agreements, and selling their ownership interests in the projects. The Company cannot predict the impact these matters may have on the Constellation Companies or the Company, but the impact could be material.\nThe Constellation Companies contributed approximately $12 million, or 4% to the Company's 1993 after-tax earnings, a decrease from the contribution of approximately $15 million in 1992. For additional information about the Constellation Companies, see MD&A -- RESULTS OF OPERATIONS -- DIVERSIFIED BUSINESSES EARNINGS (which includes the Constellation Companies' earnings information broken down by line of business) and MD&A -- LIQUIDITY AND CAPITAL RESOURCES -- DIVERSIFIED BUSINESSES CAPITAL REQUIREMENTS.\nBNG, Inc. is a wholly owned subsidiary of BGE which invests in natural gas reserves. BNG owns gas producing properties in West Virginia, the output of which is sold to BGE for the life of the reserves under a contract on file with the PSC.\nPUNA PROJECT\nAs discussed in previous filings made by the Company under the Securities Exchange Act of 1934, the Constellation Companies have a 49% ownership interest in a joint venture, Puna Geothermal Venture (PGV). PGV developed and is operating a 25-megawatt geothermal energy project on the island of Hawaii (the Big Island) in the State of Hawaii (the Puna project). Construction of the Puna project was scheduled to be completed during 1991; however, it began generating electricity on April 22, 1993. PGV sells the electricity it generates to Hawaii Electric Light Company, Inc. (\"Hawaii Electric\") under a power purchase agreement that calls for the supply by PGV of at least 22 megawatts.\nThrough the date of this Report, the Constellation Companies' investment in the Puna project was $81.7 million. In addition, the Constellation Companies have loaned $5 million (including accrued interest) to the other partner in PGV for use in funding venture costs. PGV has outstanding a $93.4 million construction loan. In connection with the construction loan, Constellation Investments, Inc. (CII) provided a guarantee to the lending institution that requires the Constellation Companies to put up to $15 million of equity into the Puna project in certain events. The lender has the right to call the guarantee but has not done so. Negotiations are ongoing with the project lenders to convert the construction loan to permanent financing.\nThe diversified businesses section of the capital requirements chart on page 15 includes $15 million for the year 1994 relating to the Puna project. Of this amount, approximately $14 million is additional equity that the Constellation Companies will be required to contribute to PGV under the CII guarantee, and approximately $1 million is additional costs relating to the project. In addition, the Constellation Companies may need to fund $3 million to $20 million during 1994 that is not included in the capital requirements chart to deal with the problem with the production wells described below.\nThe Company cannot predict the impact that the matters involving the Puna project discussed below may have on the Constellation Companies or the Company, but such impact could be material.\nPGV currently has two production wells that provide steam to power the project. Recently, one of the production wells changed from a steam dominated resource to a brine dominated resource. The result is that the well produces considerably more fluid to inject back into the ground. If the second production well also changes from steam dominated to brine dominated, PGV will have insufficient injection capacity to handle the resulting increase in fluid volume and this may affect the project's ability to generate the megawatts required under the power purchase agreement. Studies are underway to determine both the likelihood of the second production well changing to brine dominated and the need for additional injection or production wells. The studies have not reached a point where a prediction about the outcome can be made.\nOn April 13, 1993, Hawaii Electric filed suit, HAWAII ELECTRIC LIGHT COMPANY, INC. v. PUNA GEOTHERMAL VENTURE COMPANY, INC., Civil No. 93-234 (3rd Circuit Ct., Hawaii), seeking to require PGV to pay contractual penalties of $7.5 million (for delays in the scheduled delivery of power to Hawaii Electric) and seeking to require PGV to pay consequential damages. PGV asserts that the delay was caused by a \"force majeure\" event. A tentative settlement has been agreed to which requires no additional capital contributions from the Constellation Companies.\nPGV intervened in WAO KELE O PUNA, ET AL. v. WAIHEE, ET AL., Civil No. 91-3553-10 (1st Circuit Court, Hawaii) on the grounds that plaintiffs improperly are seeking to include the Puna project in an existing suit against the State of Hawaii and the County regarding an unrelated project. If plaintiffs succeed, the State and the County could be enjoined from any further permit review and issuance and from monitoring activity for the Puna project, effectively shutting down the Puna project. The Constellation Companies understand that the unrelated project has been cancelled, but the effect, if any, on this lawsuit are uncertain.\nDuring 1993, EPA informed PGV that it was investigating the circumstances regarding two air releases of hydrogen sulfide from the Puna project's well drilling activities. EPA issued a final preliminary assessment report giving the PGV site a low priority for further assessment action based on the fact there is no residual hydrogen sulfide problem at the site to be remediated.\nThe Constellation Companies' partner in the Puna project continues to experience financial difficulties. The partner has not been meeting its funding obligation to PGV for over two years. Also, the partner is currently in default under the $5 million loan it obtained from the Constellation Companies. On February 22, 1994, the Constellation Companies reached tentative agreement with the partner and certain of the partner's direct and\nindirect shareholders which would result in recapitalization of the project, and repayment of the $5 million loan to Constellation. This agreement is subject to project lender approval and certain approvals by shareholders of the partner. There are no assurances that these approvals will be obtained.\nCAPITAL REQUIREMENTS\nCapital requirements for diversified businesses for 1991 through 1993, along with estimated amounts for 1994 through 1996, are set forth below:\nThe investment requirements shown above include the Constellation Companies' portion of equity funding to committed projects under development as well as net loans made to project partnerships. The investment requirements for past periods reflect actual funding of projects, whereas investment requirements for the years 1994-1996 reflect the Constellation Companies' estimate of funding during such periods for ongoing and anticipated projects. Also, guarantees of $36 million may be called which are not included above. For more information see SCHEDULE VII -- GUARANTEES OF SECURITIES OF OTHER ISSUERS.\nEstimates of the Constellation Companies' investment requirements are subject to continuous review and modification. Actual investment requirements may vary significantly from the amounts above due to the type and number of projects selected for development, the impact of market conditions on those projects, the ability to obtain financing, and the availability of internally generated cash. The Constellation Companies' investment requirements have been met in the past through the internal generation of cash and through borrowings from institutional lenders.\nSee NOTES 3 AND 4 TO CONSOLIDATED FINANCIAL STATEMENTS AND MD&A -- LIQUIDITY AND CAPITAL RESOURCES -- DIVERSIFIED BUSINESSES CAPITAL REQUIREMENTS for additional information about diversified activities.\nEMPLOYEES\nAs of December 31, 1993, BGE employed 9,028 people for its utility operations. Additionally, 135 people were employed by the Constellation Companies. The Constellation Companies' amount excludes the approximately 800 employees at an entertainment, dining, and retail complex in Orlando, Florida and 55 employees of two wholly owned subsidiaries operating two power generation facilities. The number of employees at BGE's utility operations is 7,941 as of the date of this report as a result of the various employee reduction programs initiated in 1993. See NOTE 7 TO CONSOLIDATED FINANCIAL STATEMENTS.\nITEM 2. PROPERTIES\nELECTRIC: The principal electric generating plants of BGE are as follows:\nBGE also owns two-thirds of the outstanding capital stock of Safe Harbor Water Power Corporation, and is currently entitled to 277 megawatts of the rated capacity of the Safe Harbor Hydroelectric Project. Safe Harbor is operated under a FERC license which expires in the year 2030.\nGAS: BGE has propane air and liquefied natural gas facilities as described in Gas Operations on page 7.\nGENERAL: All of the principal plants and other important units of BGE located in Maryland are held in fee except that several properties (not including any principal electric or gas generating plant or the principal headquarters building owned by BGE in downtown Baltimore) in BGE's service area are held under lease arrangements. The leased spaces are used for various office, service and\/or retail merchandising purposes. Electric transmission and electric and gas distribution lines are constructed principally (a) in public streets and highways pursuant to franchises or (b) on permanent fee simple or easement rights-of-way secured for the most part by grants from record owners and as to a relatively small part by condemnation.\nBGE's undivided interests as a tenant in common in the properties acquired for the Keystone and Conemaugh Plants located in Pennsylvania are held in fee by BGE, subject to minor defects and encumbrances which do not materially interfere with the use of the properties by BGE.\nAll of BGE's property referred to above is subject to the lien of the Mortgage securing BGE's First Refunding Mortgage Bonds.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nASBESTOS\nDuring 1993, BGE was served in several actions concerning asbestos. The actions are collectively titled IN RE BALTIMORE CITY PERSONAL INJURIES ASBESTOS CASES in the Circuit Court for Baltimore City, Maryland. The actions are based upon the theory of \"premises liability,\" alleging that BGE knew of and exposed individuals to an asbestos hazard. The actions relate to two types of claims.\nThe first type, direct claims by individuals exposed to asbestos, were described in a Report on Form 8-K filed August 20, 1993. BGE and approximately 70 other defendants are involved. The 260 non-employee plaintiffs each claim $6 million in damages ($2 million compensatory and $4 million punitive). BGE does not know the specific facts necessary for BGE to assess its potential liability for these type claims, such as the identity of the BGE facilities at which the plaintiffs allegedly worked as contractors, the names of the plaintiffs' employers, and the date on which the exposure allegedly occurred.\nThe second type are claims by two manufacturers -- Owens Corning Fiberglass and Pittsburgh Corning Corp. -- against BGE and approximately eight others, as third-party defendants. These relate to approximately 1,500 individual plaintiffs who have settled with the manufacturers. BGE does not know the specific facts necessary for BGE to assess its potential liability for these type claims, such as the identity of BGE facilities containing asbestos manufactured by the two manufacturers, the relationship (if any) of each of the individual plaintiffs to BGE, the settlement amounts for any individual plaintiffs who are shown to have had a relationship to BGE, and the dates on which\/places at which the exposure allegedly occurred.\nUntil the relevant facts for both type claims are determined, BGE is unable to estimate what its liability, if any, might be. Although insurance and hold harmless agreements from contractors who employed the plaintiffs may cover a portion of any ultimate awards in the actions, BGE's potential liability could be material.\nSee ITEM 1. BUSINESS -- RATE MATTERS, NUCLEAR OPERATIONS, ENVIRONMENTAL MATTERS, DIVERSIFIED BUSINESSES -- PUNA PROJECT, and NOTE 13 TO CONSOLIDATED FINANCIAL STATEMENTS.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT\nExecutive Officers of the Registrant are:\nOfficers of the Registrant are elected by, and hold office at the will of, the Board of Directors and do not serve a \"term of office\" as such. There is no arrangement or understanding between any officer and any other person pursuant to which the officer was selected.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSTOCK TRADING\nBGE's Common Stock, which is traded under the ticker symbol BGE, is listed on the New York, Chicago, and Pacific stock exchanges, and has unlisted trading privileges on the Boston, Cincinnati, and Philadelphia exchanges.\nAs of February 28, 1994, there were 82,321 common shareholders of record.\nDIVIDEND POLICY\nThe Common Stock is entitled to dividends when and as declared by the Board of Directors. There are no limitations in any indenture or other agreements on payment of dividends; however, holders of Preferred Stock (first) and holders of Preference Stock (next) are entitled to receive, when and as declared, from the surplus or net profits, cumulative yearly dividends at the fixed preferential rate specified for each series and no more, payable, quarterly, and to receive when due the applicable Preference Stock redemption payments, before any dividend on the Common Stock shall be paid or set apart.\nDividends have been paid on the Common Stock continuously since 1910. Future dividends depend upon future earnings, the financial condition of the Company and other factors. Quarterly dividends were declared on the Common Stock during 1993 and 1992 in the amounts set forth below.\nCOMMON STOCK DIVIDENDS AND PRICE RANGES\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis annual report presents the financial condition and results of operations of Baltimore Gas and Electric Company (BGE) and its subsidiaries (collectively, the Company). Among other information, it provides Consolidated Financial Statements, Notes to Consolidated Financial Statements (Notes), Utility Operating Statistics, and Selected Financial Data. The following discussion explains factors that significantly affect the Company's results of operations, liquidity, and capital resources.\nRESULTS OF OPERATIONS\nEARNINGS PER SHARE OF COMMON STOCK\nConsolidated earnings per share were $1.85 for 1993 and $1.63 for 1992, an increase of $.22 and a decrease of $.04 from prior-year amounts. The changes in earnings per share reflect a higher level of earnings applicable to common stock, offset partially in 1993 and completely in 1992 by the larger number of outstanding common shares. The summary below presents the earnings-per-share amounts.\nEARNINGS APPLICABLE TO COMMON STOCK\nEarnings applicable to common stock increased $45.9 million in 1993 and $11.4 million in 1992. The 1993 increase reflects higher utility earnings, slightly offset by lower earnings of diversified businesses. The 1992 increase reflects increases in both utility and diversified businesses earnings.\nUtility earnings increased in 1993 because BGE sold more electricity than in the previous year and because of increased base rates. Three principal factors produced the increase in sales of electricity: the summer of 1993 was hotter than 1992; commercial customers used more electricity; and the number of residential customers increased. The effect of weather on utility sales is discussed below. The 1993 earnings increases were partially offset by higher operations and maintenance expenses, depreciation expense, and property taxes, and the effect of the Omnibus Budget Reconciliation Act of 1993 (1993 Tax Act), which increased the federal corporate income tax rate to 35% from 34%. Utility earnings increased in 1992 over 1991 because the colder winter in 1992 led to higher electric and gas sales. Operations expenses and interest charges were also lower in 1992, while other income was higher. However, the summer of 1992 was cooler than 1991, and as a result lower electric sales offset a substantial portion of the increase in 1992 utility earnings.\nThe following factors influence BGE's utility operations earnings: regulation by the Public Service Commission of Maryland (PSC), the effect of weather and economic conditions on sales, and competition in the generation and sale of electricity. The base rate increases authorized by the PSC in April 1993 will affect 1994 utility earnings favorably. Several electric fuel rate cases now pending before the PSC discussed in Notes 1 and 13 could also affect future years' earnings. During 1993 and 1992, unfavorable economic conditions diminished electric and gas sales growth in BGE's service territory. Electric utilities presently face competition in the construction of generating units to meet future load growth and in the sale of electricity in the bulk power markets. Electric utilities also face the future prospect of competition for electric sales to retail customers. It is not possible to predict currently the ultimate effect competition will have on BGE's earnings in future years.\nEarnings from diversified businesses, which primarily represent the operations of Constellation Holdings, Inc. and its subsidiaries (collectively, the Constellation Companies), decreased during 1993 and increased during 1992. The reasons for these changes are discussed in the \"Diversified Businesses Earnings\" section on pages 26 and 27.\nEFFECT OF WEATHER ON UTILITY SALES\nWeather conditions affect BGE's utility sales. BGE measures weather conditions using degree days. A degree day is the difference between the average daily temperature and the baseline temperature of 65 degrees. Hotter weather during the summer, measured by more cooling degree days, results in greater demand for electricity to operate cooling systems. Conversely, cooler weather during the summer, measured by fewer cooling degree days, results in less demand for electricity to operate cooling systems. Colder weather during the winter, as measured by greater heating degree days, results in greater demand for electricity and gas to operate heating systems.\nConversely, warmer weather during the winter, measured by fewer heating degree days, results in less demand for electricity and gas to operate heating systems. The degree-days chart below presents information regarding cooling and heating degree days.\nBGE UTILITY REVENUES AND SALES\nElectric revenues changed during 1993 and 1992 because of the following factors:\nElectric system sales represent volumes sold to customers within BGE's service territory at rates determined by the PSC. These amounts exclude interchange sales, discussed separately later. In 1993, BGE changed its classification of commercial and industrial customers to present this information on a basis which is more consistent with predominant industry practices. Prior-year amounts have been reclassified to conform to the current year's presentation. Below is a comparison of the changes in electric system sales volumes.\nHotter summer weather was the main reason for the increase in total sales for 1993. The sales increases to residential and commercial customers reflect significantly hotter summer weather, and to a lesser extent, increased usage and customer growth. Sales to industrial customers reflect increased sales of electricity to Bethlehem Steel to support its increased steel production during 1993. Sales to the residential customers decreased in 1992 because of cooler weather in the summer of 1992. This decrease was partially offset by higher sales because of colder winter weather in 1992 and growth in the total number of customers. Improved economic conditions among commercial customers in 1992 increased sales compared to 1991. Sales to industrial customers in 1992 reflect the negative effect of economic conditions on this segment despite higher sales of electricity to Bethlehem Steel after the start-up of its newly modernized hot strip mill.\nBase rates increased in 1993 for two principal reasons: the PSC's April 1993 rate order and an increased recovery of eligible electric conservation program costs through the energy conservation surcharge. The April 1993 rate order for an annualized electric base rate increase of $84.9 million provided for a higher level of operating expenses and a return on BGE's higher level of electric rate base. The order also reduced the authorized rate of return to 9.40% from the previous rate of 9.94%. Base rates increased in 1992 for similar reasons: the PSC's December 1990 rate order and, to a lesser extent, the recovery of eligible electric conservation program costs through the energy conservation surcharge, which began in July 1992. The December 1990 rate order authorized a $124 million base rate increase to provide rate recognition for BGE's investment and operating expenses at Brandon Shores Unit 2, effective with that Unit's initial commercial operation in May 1991. The order further authorized a $53 million surcharge to base rates in October 1991 to recover certain purchased capacity charges. Although these base rate increases improved BGE's electric revenues during 1992, they had little effect on net income because they were essentially offset by two things: a decrease in the allowance for funds used during construction (AFC) and higher depreciation expense and other taxes because of the completion and commercial operation of Brandon Shores Unit 2; and increased purchased capacity charges.\nThe April 1993 rate order and a continued higher level of recovery of electric conservation program costs under the energy conservation surcharge will favorably affect base rate revenues in 1994. However, if the PSC determines that BGE is earning in excess of its authorized rate of return, BGE will have to refund a portion of\nenergy conservation surcharge revenues to its customers. The portion subject to refund is compensation for foregone sales from conservation programs and incentives for achieving conservation goals. BGE has been earning in excess of its authorized rate of return on electric operations since September 30, 1993. As a result, BGE has deferred the portion of electric energy conservation revenues subject to refund beginning in December 1993. The deferral of these billings is expected to average approximately $1.7 million each month these deferrals continue in 1994. The deferral will continue as long as BGE exceeds its authorized rate of return on electric operations, as determined by the PSC.\nChanges in fuel rate revenues result from the operation of the electric fuel rate formula. The fuel rate formula is designed to recover the actual cost of fuel, net of revenues from interchange sales (see Notes 1 and 13). Changes in fuel rate revenues and interchange sales normally do not affect earnings. However, if the PSC were to disallow recovery of any part of these costs, earnings would be reduced as discussed in Note 13.\nFuel rate revenues decreased during both 1993 and 1992 due to a lower fuel rate. The rate was lower in both years because of a less costly twenty-four month generation mix from greater generation at the Calvert Cliffs Nuclear Power Plant compared to the year before. The 1993 decrease was partially offset by increased electric system sales volumes. The 1992 decrease also reflects $58 million of annual fuel cost savings resulting from the commercial operation of Brandon Shores Unit 2 and the October 1991 expiration of a surcharge to the electric fuel rate. BGE expects electric fuel rate revenues to decrease again in 1994 because of a continued less-costly generation mix.\nInterchange sales are sales of BGE's energy to the Pennsylvania-New Jersey-Maryland Interconnection (PJM), a regional power pool of eight member companies including BGE. Interchange sales occur after BGE has satisfied the demand for system sales of electricity, if BGE's available generation is the least costly available to PJM utilities. Interchange sales increased during 1993 and 1992 because BGE had a less costly generation mix than other PJM utilities. The less costly mix during 1993 reflects the higher generation levels at the Calvert Cliffs Nuclear Power Plant. The less costly mix during 1992 also reflects the operation of the Calvert Cliffs Nuclear Power Plant and a full year of operation of Brandon Shores Unit 2.\nGas revenues increased during 1993 and 1992 because of the following factors:\nIn 1993, BGE changed its classification of commercial and industrial customers to present this information on a basis which is more consistent with predominant industry practices. Prior-year amounts have been reclassified to conform to the current year's presentation. The changes in gas sales volumes compared to the year before were:\nTotal gas sales decreased during 1993 because of lower sales to industrial customers, partially offset by increased sales to the remainder of the gas-system customers. Sales to industrial customers decreased primarily because of lower use of delivery service gas by Bethlehem Steel and interruptible service customers, who increased their use of alternative fuels. Gas sales to Bethlehem Steel also decreased because of a maintenance outage at its L-Blast furnace. The increases in sales to residential and commercial customers reflect the colder winter weather during the first quarter of 1993 and an increase in the number of customers. Sales to residential and commercial customers during 1992 reflect the colder winter of 1992 and growth in the number of customers. Gas sales to industrial customers for 1992 reflect primarily increased sales volumes to Bethlehem Steel because of higher use of gas in its production and processing.\nBase rates increased in 1993 for two principal reasons: the PSC's April 1993 rate order and an increased recovery of eligible gas conservation program costs through the energy conservation surcharge. The April 1993 rate order for an annualized gas base rate increase of $1.6 million provided for a higher level of operating expenses and a return on BGE's higher level of gas rate base. The increased base rates during 1992 represent the\neffects of the PSC's October 1991 rate order. That order authorized a $4 million annualized increase in gas base rate revenues. The April 1993 gas base rate order and continued recovery of gas conservation program costs under the energy conservation surcharge will favorably affect base rate revenues in 1994.\nChanges in gas cost adjustment revenues result from the operation of the purchased gas adjustment (PGA) clause, which is designed to recover actual gas costs incurred (See Note 1). Changes in gas cost adjustment revenues normally do not affect earnings. Gas cost adjustment revenues increased during both years primarily because of increased prices to recover higher costs of purchased gas and higher sales volumes subject to the PGA clause. Delivery service sales volumes are not subject to the PGA clause because these customers purchase their gas directly from third parties.\nBGE UTILITY FUEL AND ENERGY EXPENSES\nElectric fuel and purchased energy expenses were as follows:\nActual electric fuel and purchased energy costs during 1993 increased for two principal reasons: a higher net output of electricity generated to meet the demand of BGE's system and the PJM system, and higher purchased capacity costs under the Pennsylvania Power & Light Company Energy and Capacity Purchase Agreement. Actual electric fuel and purchased energy costs decreased during 1992 because of a less costly generation mix. The cost of the generation mix decreased because of the Calvert Cliffs Nuclear Power Plant's return to operation following the completion of extended maintenance and repair outages and the May 1991 commercial operation of Brandon Shores Unit 2. This decrease was partially offset by purchased capacity charges beginning in October 1991 under the Pennsylvania Power & Light Company Energy and Capacity Purchase Agreement. Purchased gas expenses were as follows:\nActual purchased gas costs went up in both 1993 and 1992 for three principal reasons: higher gas prices caused by market conditions; higher reservation charges; and higher output to meet greater demand for BGE gas. Purchased gas costs exclude gas purchased by delivery service customers, including Bethlehem Steel, who obtain gas directly from third parties. Future purchased gas costs are expected to increase due to transition costs incurred by BGE gas pipeline suppliers in implementing Federal Energy Regulatory Commission (FERC) Order No. 636. These transition costs, if approved by FERC, will be passed on to BGE customers through the purchased gas adjustment clause.\nOTHER OPERATING EXPENSES\nOperations expense increased during 1993 by $50.6 million. The combined effect of higher labor costs, employee reduction expenses (discussed below), amortization of energy conservation program costs, postretirement benefit expenses resulting from the implementation of Statement of Financial Accounting Standards No. 106 (see Note 6), and nuclear operating costs was in total $70.2 million higher compared to 1992. These increases were partially offset by the 1993 reversal of a $9.8 million charge originally recorded in 1992 for termination benefits associated with the Company's 1992 Voluntary Special Early Retirement Program (1992 VSERP) to reflect the ratemaking treatment adopted by the PSC in its April 1993 rate order. In accordance with that order, the Company has deferred this charge and is amortizing it over a five-year period, beginning in May 1993. Operations expense decreased in 1992 because of lower nuclear contractor costs and lower payroll costs attributable to labor savings from the Company's 1992 VSERP and other cost-control measures. These decreased costs were partially offset by the original charge to operations for the $9.8 million cost of termination benefits associated with the 1992 VSERP and by higher fringe-benefit costs.\nThe Company announced several employee reduction programs during the third quarter of 1993 in conjunction with its ongoing cost control efforts. The cost of these programs totaled $105.5 million (see Note 7). Consistent with previous rate actions of the PSC, BGE has deferred and will amortize the $88.3 million of 1993 Voluntary Special Early Retirement Program (1993 VSERP) costs related to regulated activities over a five-year\nperiod beginning in February 1994 . The remaining $17.2 million of these program costs was charged to expense in 1993. Operations expense is expected to be reduced in 1994 by three factors: cost savings from the 1993 employee reduction programs are expected to be realized beginning in 1994; 1993 operations expense reflects the portion of the cost of employee reduction programs charged to expense; and the expected reduction in 1994 operations expense resulting from the sale of a significant portion of the Constellation Companies' investment in senior living facilities (see page 26 for a discussion of the sale of senior living facilities). These decreases will be partially offset by the amortization of the deferred VSERP costs and other increases in operations expenses.\nMaintenance expense increased in 1993 because of higher labor costs and higher costs at the Calvert Cliffs Nuclear Power Plant. Maintenance expense was essentially unchanged in 1992 because lower costs at certain fossil-fuel electric generating plants were offset by higher costs at Calvert Cliffs.\nDepreciation expense increased during 1993 and 1992 compared to the year before because of higher depreciable plant in service. The increase during 1993 resulted from the addition of electric transmission and distribution plant and certain capital additions at the Calvert Cliffs Nuclear Power Plant. The 1992 increase resulted from the addition of Brandon Shores Unit 2, which began commercial operation in May 1991.\nTaxes other than income taxes increased during both years because of higher property taxes from the addition of Brandon Shores Unit 2 to the taxable base effective July 1, 1992. The increase during 1993 also reflects higher franchise taxes because of the increase in total electric and gas revenues and increased payroll taxes.\nInflation affects the Company through increased operating expenses and higher replacement costs for utility plant assets. Although timely rate increases can lessen the effects of inflation, the regulatory process imposes a time lag which can delay BGE's recovery of increased costs. There is a regulatory lag primarily because rate increases are based on historical costs rather than projected costs. The PSC has historically allowed recovery of the cost of replacing plant assets, together with the opportunity to earn a fair return on BGE's investment, beginning at the time of replacement.\nOTHER INCOME AND EXPENSES\nAFC was essentially unchanged in 1993 because the accrual of AFC on a higher level of construction work in progress compared to 1992 was offset by the lower AFC rate approved in the April 1993 PSC rate order. AFC decreased during 1992 because of the completion and commercial operation of Brandon Shores Unit 2, partially offset by the effects of the expansion of the AFC policy as discussed in Note 1.\nInterest charges increased slightly in 1993 as a higher level of outstanding debt was partially offset by a decline in the level of interest rates and the redemption of higher coupon debt of BGE. Interest charges decreased during 1992 primarily because of lower levels of debt outstanding and a decline in the level of interest rates. The decreased debt levels in 1992 are attributable to the additional shares of common stock issued and the recovery of previously deferred electric fuel costs.\nCapitalized interest increased during 1993 because BGE began accruing carrying charges on electric deferred fuel costs excluded from rate base (see Note 5). 1992 capitalized interest decreased because the Constellation Companies discontinued interest capitalization at certain real estate projects.\nIncome tax expense increased during both years because of higher pre-tax earnings. The 1993 increase also reflects the effect of the 1993 Tax Act, which increased the federal corporate income tax rate to 35% from 34%, retroactive to January 1, 1993. As a result, income tax expense related to 1993 operations increased by $4.6 million, and the Company's deferred income tax liability increased by $20.1 million. The Company deferred $12.8 million of the increase in the deferred income tax liability applicable to utility operations for recovery through future rates and charged the remaining $7.3 million to income tax expense. Of this $7.3 million charged to expense, $5.8 million pertains to the Constellation Companies as discussed on page 27.\nDIVERSIFIED BUSINESSES EARNINGS\nEarnings per share from diversified businesses were:\nThe Constellation Companies' power generation systems business includes the development, ownership, management, and operation of wholesale power generating projects in which the Constellation Companies hold ownership interests, as well as the provision of services to power generation projects under operation and maintenance contracts. Power generation systems earnings during 1993 were flat compared to 1992. The recognition of $8 million of energy tax credits on the commercial operation of the Puna geothermal plant was offset by costs incurred at the Panther Creek waste-coal project in order to resolve fuel quality and other start-up problems. Additionally, 1992 earnings reflect the gain on the partial sale of an ownership interest in a power generation project, representing most of the increase in power generation systems earnings compared to 1991.\nThe Constellation Companies' investment in wholesale power generating projects includes $163 million representing ownership interests in 16 projects which sell electricity in California under Interim Standard Offer No. 4 power purchase agreements. Under these agreements, the projects supply electricity to purchasing utilities at a fixed energy rate for the first ten years of the agreements and at variable energy rates based on the utilities' avoided cost for the remaining term of the agreements. Avoided cost generally represents a utility's next lowest cost generation to service the demands on its system. These power generation projects are scheduled to convert to supplying electricity at avoided cost rates in various years beginning in late 1996 through the end of 2000. As a result of declines in purchasing utilities' avoided costs after these agreements were signed, revenues at these projects based on current avoided cost levels would be substantially lower than revenues presently being realized under the fixed price terms of the agreements. If current avoided cost levels were to continue into 1996 and beyond, the Constellation Companies could experience reduced earnings or incur losses associated with these projects, which could be significant. The Constellation Companies are investigating alternatives for certain of these power generation projects including, but not limited to, repowering the projects to reduce operating costs, renegotiating the power purchase agreements, and selling their ownership interests in the projects. The Company cannot predict the impact these matters may have on the Constellation Companies or the Company, but the impact could be material.\nEarnings from the Constellation Companies' portfolio of financial investments include capital gains and losses, dividends, income from financial limited partnerships, and income from financial guaranty insurance companies. 1993 financial investment earnings increased slightly over 1992. $6.1 million in income from an investment in a financial guaranty insurance company was substantially offset by lower investment income compared to 1992, resulting from the decline in the size of the investment portfolio due to the sale of selected assets to provide liquidity for ongoing businesses of the Constellation Companies. Financial investment earnings increased in 1992 primarily because of write-downs taken on certain investments in 1991 and because of an improvement in the performance of certain financial limited partnerships.\nThe Constellation Companies' real estate development business includes land under development; office buildings; retail projects; commercial projects; an entertainment, dining and retail complex in Orlando, Florida; a mixed-use planned-unit-development; and senior living facilities. The majority of these projects are in the Baltimore-Washington corridor. They have been affected adversely by the depressed real estate market and economic conditions, resulting in reduced demand for the purchase or lease of available land, office, and retail space.\nEarnings from real estate development and senior living facilities were essentially unchanged in 1993 compared to 1992 because a $2.1 million gain on the sale of the nursing home portion of the Constellation Companies' investment in senior living facilities was offset by greater operating losses at other real estate projects. The senior living facilities which were sold contributed real estate revenues and operating expenses of approximately $17 million and $16 million, respectively, in 1993. The increase in earnings in 1992 reflects the 1991 write-downs recorded by the Constellation Companies aggregating $10 million on certain real estate\nprojects and a $3.6 million reserve for loans where the value of the collateral was less than the outstanding loan balances. Additionally, the Constellation Companies' real estate portfolio has experienced continuing carrying costs and depreciation and, during 1991, the Constellation Companies began expensing rather than capitalizing interest on certain undeveloped land where development activities were at minimal levels. These factors have affected earnings negatively during 1993 and 1992 and are expected to continue to do so until current market conditions improve. Cash flow from real estate operations has been insufficient to cover the debt service requirements of certain of these projects. Resulting cash shortfalls have been satisfied through cash infusions from Constellation Holdings, Inc., which obtained the funds through a combination of cash flow generated by other Constellation Companies and its corporate borrowings. Until the real estate market shows sustained improvement, earnings from real estate activities are expected to remain depressed.\nThe Constellation Companies' continued investment in real estate projects is a function of market demand, interest rates, credit availability, and the strength of the economy in general. The Constellation Companies' Management believes that although the real estate market is beginning to show signs of improvement, until the economy reflects sustained growth and the excess inventory in the market in the Baltimore-Washington corridor goes down, real estate values will not improve significantly. If the Constellation Companies were to sell their real estate projects in the current depressed market, losses would occur in amounts difficult to determine. Depending upon market conditions, future sales could also result in losses. In addition, were the Constellation Companies to change their intent about any project from an intent to hold until market conditions improve to an intent to sell, applicable accounting rules would require a write-down of the project to market value at the time of such change in intent if market value is below book value.\nThe Effect of the 1993 Tax Act represents a $5.8 million charge to income tax expense to reflect the increase in the Constellation Companies' deferred income tax liability because of the increase in the federal corporate tax rate.\nENVIRONMENTAL MATTERS\nThe Company is subject to increasingly stringent federal, state, and local laws and regulations relating to improving or maintaining the quality of the environment. These laws and regulations require the Company to remove or remedy the effect on the environment of the disposal or release of specified substances at ongoing and former operating sites, including Environmental Protection Agency Superfund sites. Details regarding these matters, including financial information, are presented in Note 13 and in Item 1. Business -- Environmental Matters.\nLIQUIDITY AND CAPITAL RESOURCES\nCAPITAL REQUIREMENTS\nThe Company's capital requirements reflect the capital-intensive nature of the utility business. Actual capital requirements for the years 1991 through 1993, along with estimated amounts for the years 1994 through 1996, are reflected below.\nBGE UTILITY CAPITAL REQUIREMENTS\nBGE's construction program is subject to continuous review and modification, and actual expenditures may vary from the estimates on page 27. Electric construction expenditures include the installation of two 5,000 kilowatt diesel generators at the Calvert Cliffs Nuclear Power Plant, scheduled to be placed in service in 1995; the construction of a 140-megawatt combustion turbine at Perryman, scheduled to be placed in service in 1995, which the PSC authorized in an order dated March 25, 1993; and improvements in BGE's existing generating plants and its transmission and distribution facilities. Future electric construction expenditures do not include additional generating units in light of the competitive bidding process established by the PSC. The Company estimates currently that expenditures for compliance with the sulfur dioxide provisions of the Clean Air Act of 1990 will total approximately $55 million through 1995.\nDuring 1993, 1992, and 1991, the internal generation of cash from utility operations provided 71%, 81%, and 74% respectively, of the funds required for BGE's capital requirements exclusive of retirements and redemptions of debt and preference stock. During the three-year period 1994 through 1996, BGE expects to provide through utility operations approximately 70% of the funds required for BGE's capital requirements, exclusive of retirements and redemptions.\nUtility capital requirements not met through the internal generation of cash are met through the issuance of debt and equity securities. During the three-year period ended December 31, 1993, BGE's issuances of long-term debt, preference stock, and common stock were $1,733 million, $165 million, and $446 million, respectively. During the same period, retirements and redemptions of BGE's long-term debt and preference stock totaled $1,546 million and $167 million, respectively, exclusive of any redemption premiums. The increase in issuances and retirements of long-term debt during 1993 reflects the refinancing of a significant portion of BGE's debt in order to take advantage of the favorable interest rate market. The amount and timing of future issuances and redemptions will depend upon market conditions and BGE's actual capital requirements.\nThe Constellation Companies' capital requirements are discussed below in the section titled \"Diversified Businesses Capital Requirements -- Debt and Liquidity.\" The Constellation Companies plan to meet their capital requirements with a combination of debt and internal generation of cash from their operations. Additionally, from time to time, BGE may make loans to Constellation Holdings, Inc., or contribute equity to Constellation Holdings, Inc.\nDIVERSIFIED BUSINESSES CAPITAL REQUIREMENTS\nDEBT AND LIQUIDITY. During 1993, Constellation Holdings, Inc. (CHI) closed two private placements totaling $225 million of unsecured serial notes with several institutional investors. CHI used proceeds of the private placements to pay off its bank debt facility, which CHI elected to terminate, as well as for other general corporate uses. In addition, CHI entered into a $20 million unsecured revolving credit facility with a bank on September 30, 1993. This facility matures September 29, 1994 and will be used to provide liquidity for general corporate purposes. As of December 31, 1993, CHI had no borrowings under this facility.\nThe Constellation Companies intend to meet capital requirements by refinancing debt as it comes due and through internally generated cash. These sources include cash that may be generated from operations, the sale of assets, and cash generated by tax benefits earned by the Constellation Companies. In the event the Constellation Companies can obtain reasonable value for real estate properties, additional cash may become available through the sale of projects (for additional information see the discussion of the real estate business and market on page 26 under the heading \"Diversified Businesses Earnings\"). The ability of the Constellation Companies to sell or liquidate assets described above will depend on market conditions, and no assurances can be given that such sales or liquidations can be made. Also, to provide additional liquidity to meet interim financial needs, CHI may enter into additional credit facilities.\nINVESTMENT REQUIREMENTS. The investment requirements of the Constellation Companies include its portion of equity funding to committed projects under development, as well as net loans made to project partnerships. Investment requirements for the years 1994 through 1996 reflect the Constellation Companies' estimate of funding for ongoing and anticipated projects and are subject to continuous review and modification. Actual investment requirements may vary significantly from the estimates on page 27 because of the type and number of projects selected for development, the impact of market conditions on those projects, the ability to obtain financing, and the availability of internally generated cash. The Constellation Companies have met their investment requirements in the past through the internal generation of cash and through borrowings from banks and institutional lenders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders of Baltimore Gas and Electric Company\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Baltimore Gas and Electric Company and Subsidiaries at December 31, 1993 and 1992, and the related consolidated statements of income, cash flows, common shareholders' equity, and income taxes for each of the three years in the period ended December 31, 1993, and the consolidated financial statement schedules listed in Item 14(a)(1) and (2) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's Management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baltimore Gas and Electric Company and Subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. In addition, the consolidated financial schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 13 to the consolidated financial statements, the Public Service Commission of Maryland is currently reviewing the replacement energy costs resulting from the outages at the Company's nuclear power plant and the Company provided a reserve of $35 million in 1990 for the possible disallowance of replacement energy costs. The ultimate outcome of the fuel rate proceedings, however, cannot be determined but may result in a disallowance in excess of the reserve provided.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1991.\nWe have also previously audited, in accordance with generally accepted standards, the balance sheets and statements of capitalization at December 31, 1991, 1990 and 1989, and the related statements of income, retained earnings, changes in financial position, and income taxes for each of the two years in the period ended December 31, 1990 (none of which are presented herein); and we expressed unqualified opinions on those financial statements. In our opinion, the information set forth in the Summary of Operations included in the Selected Financial Data for each of the five years in the period ended December 31, 1993, appearing on page 20 is fairly stated in all material respects in relation to the financial statements from which it has been derived.\n\/s\/ Coopers & Lybrand -------------------------------------- COOPERS & LYBRAND\nBaltimore, Maryland January 21, 1994\nCONSOLIDATED STATEMENTS OF INCOME\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED STATEMENTS OF CAPITALIZATION\nCONSOLIDATED STATEMENTS OF CAPITALIZATION (CONTINUED)\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nCONSOLIDATED STATEMENTS OF INCOME TAXES\nSee Notes to Consolidated Financial Statements. Certain prior-year amounts have been restated to conform to the current year's presentation.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF THE BUSINESS\nBaltimore Gas and Electric Company (BGE) and Subsidiaries (collectively, the Company) is primarily an electric and gas utility serving a territory which encompasses Baltimore City and all or part of nine Central Maryland counties. The Company is also engaged in diversified businesses as described further in Note 3.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of BGE and all subsidiaries in which BGE owns directly or indirectly a majority of the voting stock. Intercompany balances and transactions have been eliminated in consolidation. Under this policy, the accounts of Constellation Holdings, Inc. and its subsidiaries (collectively, the Constellation Companies) and BNG, Inc. are consolidated in the financial statements. Safe Harbor Water Power Corporation is reported under the equity method. Corporate joint ventures, partnerships, and affiliated companies in which a 20% to 50% voting interest is held are accounted for under the equity method, unless control is evident, in which case the entity is consolidated. Investments in power generation systems and certain financial investments in which less than a 20% voting interest is held are accounted for under the cost method, unless significant influence is exercised over the entity, in which case the investment is accounted for under the equity method.\nREGULATION OF UTILITY OPERATIONS\nBGE's utility operations are subject to regulation by the Public Service Commission of Maryland (PSC). The accounting policies and practices used in the determination of service rates are also generally used for financial reporting purposes in accordance with generally accepted accounting principles for regulated industries. See Note 5.\nUTILITY REVENUES\nBGE recognizes utility revenues as service is rendered to customers.\nFUEL AND PURCHASED ENERGY COSTS\nSubject to the approval of the PSC, the cost of fuel used in generating electricity, net of revenues from interchange sales, and the cost of gas sold may be recovered through zero-based electric fuel rate (see Note 13) and purchased gas adjustment clauses. The difference between actual fuel costs and fuel revenues is deferred on the balance sheet to be recovered from or refunded to customers in future periods.\nThe electric fuel rate formula is based upon the latest twenty-four-month generation mix, subject to a minimum level of nuclear generation, and the latest three-month average fuel cost for each generating unit. The fuel rate does not change unless the calculated rate is more than 5% above or below the rate then in effect.\nThe purchased gas adjustment is based on recent annual volumes of gas and the related current prices charged by BGE's gas suppliers. Any deferred underrecoveries or overrecoveries of purchased gas costs for the twelve months ended November 30 each year are charged or credited to customers over the ensuing calendar year.\nINCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1991. Statement No. 109 requires the use of the liability method of accounting for income taxes. Under the liability method, the deferred tax liability represents the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities. It is measured using presently enacted tax rates. The portion of BGE's deferred tax liability applicable to utility operations which has not been reflected in current service rates represents income taxes recoverable through future rates. It has been recorded as a regulatory asset on the balance sheet. Deferred income tax expense represents the net change in the deferred tax liability and regulatory asset during the year, exclusive of amounts charged or credited to common shareholders' equity.\nThe 1993 and 1992 current tax expense consists solely of regular tax. The 1991 current tax expense consists of a regular tax of $46.8 million and an alternative minimum tax (AMT) of $14.2 million. The AMT liabilities generated in 1991 and prior years can be carried forward indefinitely as tax credits to future years in which the regular tax liability exceeds the AMT liability. As of December 31, 1993, this carryforward totaled $73.2 million.\nAs a result of its effect on nonregulated activities, the cumulative effect of the change in the method of accounting for income taxes resulted in an increase in 1991 net income of $19.7 million, or 16 CENTS per common share, because of the reversal of deferred income taxes on nonregulated activities accrued in prior years at tax rates in excess of the 34% tax rate in effect at that time.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The investment tax credit (ITC) associated with BGE's regulated utility operations has been deferred and is amortized to income ratably over the lives of the subject property. ITC and other tax credits associated with nonregulated diversified business activities other than leveraged leases are flowed through to income. As of December 31, 1993, the Company had energy and other tax credit carryforwards of $4.8 million which expire in the years 2005 through 2008.\nBGE's utility revenue from system sales is subject to the Maryland public service company franchise tax in lieu of a state income tax. The franchise tax is included in taxes other than income taxes in the Consolidated Statements of Income.\nINVENTORY VALUATION\nFuel stocks and materials and supplies are generally stated at average cost.\nREAL ESTATE PROJECTS\nReal estate projects consist of the Constellation Companies' investment in rental and operating properties and properties under development. Rental and operating properties are held for investment. Properties under development are held for future development and sale. Costs incurred in the acquisition and active development of such properties are capitalized. Rental and operating properties and properties under development are stated at cost unless the amount invested exceeds the amounts expected to be recovered through operations and sales. In these cases, the projects are written down to the amount estimated to be recoverable.\nINVESTMENTS\nMarketable equity securities are stated at the lower of cost or market value, and other securities are stated at cost. Where appropriate, cost reflects amortization of premium and discount computed on a straight-line basis. Gains and losses on the sale of the Constellation Companies' investment securities are included in revenues from diversified activities on the income statement and are recognized upon realization on a specific identification basis. Gains and losses on the sale of BGE's nuclear decommissioning trust fund securities are included in net other income and deductions on the income statement and are recognized upon realization on a specific identification basis.\nStatement of Financial Accounting Standards No. 115, which must be adopted in 1994, requires that investments in equity securities having readily determinable fair values and debt securities other than those which the Company has the positive intent and ability to hold to maturity be recorded at fair value rather than at amortized cost. Changes in the fair value of these securities will be recorded in shareholders' equity except for trading securities, for which such changes will be recorded in income. Adoption of this statement is not expected to have a material impact on the Company's financial statements.\nUTILITY PLANT, DEPRECIATION AND AMORTIZATION, AND DECOMMISSIONING\nUtility plant is stated at original cost, which includes material, labor, and, where applicable, construction overhead costs and an allowance for funds used during construction. Additions to utility plant and replacements of units of property are capitalized to utility plant accounts. Maintenance and repairs of property and replacements of items of property determined to be less than a unit of property are charged to maintenance expense.\nDepreciation is generally computed using composite straightline rates applied to the average investment in classes of depreciable property. The composite depreciation rates by class of depreciable property are 2.80% for the Calvert Cliffs Nuclear Power Plant, 2.75% for the Brandon Shores Power Plant, 3.26% for other electric plant, 3.12% for gas plant, and 4.02% for common plant other than vehicles. Vehicles are depreciated based on their estimated useful lives.\nBGE owns an undivided interest in the Keystone and Conemaugh electric generating plants located in western Pennsylvania, as well as in the transmission line which transports the plants' output to the joint owners' service territories. BGE's ownership interest in these plants is 20.99% and 10.56%, respectively, and represents a net investment of $128 million as of December 31, 1993. Financing and accounting for these properties are the same as for wholly owned utility plant.\nNuclear fuel expenditures are amortized as a component of actual fuel costs based on the energy produced over the life of the fuel. Fees for the future disposal of spent fuel are paid quarterly to the Department of Energy and are accrued based on the kilowatt-hours of electricity generated. Nuclear fuel expenses are subject to recovery through the electric fuel rate.\nNuclear decommissioning costs are accrued by and recovered through a sinking fund methodology. In its April 1993 rate order, the PSC granted BGE revenue to accumulate a decommissioning reserve of $336 million in\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 1992 dollars by the end of Calvert Cliffs' service life in 2016, adjusted to reflect expected inflation, to decommission the radioactive portion of the plant. The total decommissioning reserve of $93.4 million and $77.8 million at December 31, 1993 and 1992, respectively, is included in accumulated depreciation in the Consolidated Balance Sheets. In accordance with Nuclear Regulatory Commission (NRC) regulations, BGE has established an external decommissioning trust to which a portion of accrued decommissioning costs has been contributed.\nThe NRC requires utilities to provide financial assurance that they will accumulate sufficient funds to pay for the cost of nuclear decommissioning based upon either a generic NRC formula or a facility-specific decommissioning cost estimate, provided that the facility-specific estimate is equal to or greater than that of the NRC formula. Subsequent to the PSC's April 1993 rate order, the NRC updated its generic formula to reflect substantially higher waste burial charges. The revised NRC formula generates a decommissioning cost estimate of $703 million in 1992 dollars. Additionally, the Company initiated a facility-specific study which, when completed, is expected to generate an estimate of the cost to decommission the radioactive portion of the plant which is less than the NRC formula estimate. The Company is currently completing the facility-specific study and plans to request the NRC to permit the use of the facility-specific decommissioning cost estimate as a basis of funding these costs and providing the requisite financial assurance.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION AND CAPITALIZED INTEREST\nThe allowance for funds used during construction (AFC) is an accounting procedure which capitalizes the cost of funds used to finance utility construction projects as part of utility plant on the balance sheet, crediting the cost as a noncash item on the income statement. The cost of borrowed and equity funds is segregated between interest expense and other income, respectively. BGE recovers the capitalized AFC and a return thereon after the related utility plant is placed in service and included in depreciable assets and rate base.\nDuring the period January 1, 1991 through April 23, 1993, the Company accrued AFC at a pre-tax rate of 9.94%, compounded annually. Effective April 24, 1993, a rate order of the PSC reduced the pre-tax AFC rate to 9.40%, compounded annually.\nEffective January 1, 1992, the PSC authorized the accrual of AFC on all electric, gas, and common utility construction projects with a construction period of more than one month. Prior to 1992, AFC was accrued on major electric projects only.\nThe Constellation Companies capitalize interest on qualifying real estate and power generation development projects. BGE capitalizes interest on certain deferred fuel costs as discussed in Note 5.\nLONG-TERM DEBT\nThe discount or premium and expense of issuance associated with long-term debt are deferred and amortized over the original lives of the respective debt issues. Gains and losses on the reacquisition of debt are amortized over the remaining original lives of the issuances.\nCASH FLOWS\nFor the purpose of reporting cash flows, highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2. SEGMENT INFORMATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3. SUBSIDIARY INFORMATION\nDiversified businesses consist of the operations of Constellation Holdings, Inc. and its subsidiaries and BNG, Inc.\nConstellation Holdings, Inc., a wholly owned subsidiary, holds all of the stock of three other subsidiaries, Constellation Real Estate Group, Inc., Constellation Energy, Inc., and Constellation Investments, Inc. These companies are engaged in real estate development and ownership of senior living facilities; development, ownership, and operation of power generation systems; and financial investments, respectively.\nBNG, Inc. is a wholly owned subsidiary which invests in natural gas reserves.\nBGE's investment in Safe Harbor Water Power Corporation, a producer of hydroelectric power, represents two-thirds of Safe Harbor's total capital stock, including one-half of the voting stock, and a two-thirds interest in its retained earnings.\nThe following is condensed financial information for Constellation Holdings, Inc. and its subsidiaries. Similar information is not presented for Safe Harbor Water Power Corporation and BNG, Inc. as the financial position and results of operations of these entities are immaterial. The condensed financial information for the Constellation Companies does not reflect the elimination of intercompany balances or transactions which are eliminated in the Company's consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4. REAL ESTATE PROJECTS AND FINANCIAL INVESTMENTS\nReal estate projects consist of the following investments held by the Constellation Companies:\nIn 1991, a subsidiary of Constellation Holdings, Inc. recognized a loss of $10 million to write down the carrying value of certain operating properties and properties under development to reflect the depressed real estate and economic markets.\nFinancial investments consist of the following investments held by the Constellation Companies:\nIn 1991, a subsidiary of Constellation Holdings, Inc. recognized a loss of $10.5 million to write-down the carrying value of financial investments to reflect previously unrealized losses on certain marketable equity securities. The securities written down were subsequently sold. A subsidiary of Constellation Holdings, Inc. also recognized a loss of $3.1 million on two financial limited partnerships that were adjusted to reflect market value when the partnerships were reclassified as short-term investments.\nAs of December 31, 1993, gross unrealized gains and losses applicable to marketable equity securities totaled $1.8 and $0.5 million, respectively. Net realized gains (losses) from financial investments included in net income totaled $6.5 million in 1993, $9.8 million in 1992, and $(11.6) million in 1991.\nNOTE 5. REGULATORY ASSETS\nCertain utility expenses and credits normally reflected in income are deferred on the balance sheet as regulatory assets and liabilities and are recognized in income as the related amounts are included in service rates and recovered from or refunded to customers in utility revenues. The following table sets forth BGE's regulatory assets.\nIncome taxes recoverable through future rates represent principally the tax effect of depreciation differences not normalized and the allowance for equity funds used during construction, offset by unamortized deferred tax rate differentials and deferred taxes on deferred ITC. These amounts are amortized as the related temporary differences reverse. See Note 1 for a further discussion of income taxes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5. REGULATORY ASSETS (CONTINUED) Deferred fuel costs represent the difference between actual fuel costs and the fuel rate revenues under BGE's fuel clauses (see Note 1). Deferred fuel costs are amortized as they are collected from customers.\nThe underrecovered costs deferred under the fuel clauses were as follows:\nDeferred termination benefit costs represent the net unamortized balance of the cost of certain termination benefits (see Note 7) applicable to BGE's regulated operations. These costs are being amortized over a five-year period in accordance with rate actions of the PSC.\nDeferred nuclear expenditures represent the net unamortized balance of certain operations and maintenance costs which are being amortized over the remaining life of the Calvert Cliffs Nuclear Power Plant in accordance with orders of the PSC. These expenditures consist of costs incurred from 1979 through 1982 for inspecting and repairing seismic pipe supports, expenditures incurred from 1989 through 1993 associated with nonrecurring phases of certain nuclear operations projects, and expenditures incurred during 1990 for investigating leaks in the pressurizer heater sleeves.\nDeferred postemployment benefit costs represent the excess of such costs recognized in accordance with Statements of Financial Accounting Standards No. 106 and No. 112 over the amounts reflected in utility rates. These costs will be amortized over a 15-year period beginning no later than 1998 (see Note 6).\nDeferred cost of decommissioning federal uranium enrichment facilities represents the unamortized portion of BGE's required contributions to a fund for decommissioning and decontaminating the Department of Energy's (DOE) uranium enrichment facilities. The Energy Policy Act of 1992 requires domestic utilities to make such contributions, which are generally payable over a fifteen-year period with escalation for inflation and are based upon the amount of uranium enriched by DOE for each utility. These costs are being amortized over the contribution period as a cost of fuel.\nDeferred energy conservation expenditures represent the net unamortized balance of certain operations costs which are being amortized over five years in accordance with orders of the PSC. These expenditures consist of labor, materials, and indirect costs associated with the conservation programs approved by the PSC.\nDeferred environmental costs represent the estimated costs of investigating contamination and performing certain remediation activities at contaminated Company-owned sites (see Note 13). These costs are generally amortized over the estimated term of the remediation process.\nElectric deferred fuel costs in excess of $72.8 million are excluded from rate base by the PSC for ratemaking purposes. Effective April 24, 1993, BGE has been authorized by the PSC to accrue carrying charges on electric deferred fuel costs excluded from rate base. These carrying charges are accrued prospectively at the 9.40% authorized rate of return. The income effect of the equity funds portion of the carrying charges is being deferred until such amounts are recovered in utility service rates subsequent to the completion of the fuel rate proceeding examining the 1989-1991 outages at Calvert Cliffs Nuclear Power Plant as discussed in Note 13.\nNOTE 6. PENSION AND POSTEMPLOYMENT BENEFITS\nPENSION BENEFITS\nThe Company sponsors several noncontributory defined benefit pension plans, the largest of which (the Pension Plan) covers substantially all BGE employees and certain employees of the Constellation Companies. The other plans, which are not material in amount, provide supplemental benefits to certain non-employee directors and key employees. Benefits under the plans are generally based on age, years of service, and compensation levels.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6. PENSION AND POSTEMPLOYMENT BENEFITS (CONTINUED) Prior service cost associated with retroactive plan amendments is amortized on a straightline basis over the average remaining service period of active employees.\nThe Company's funding policy is to contribute annually the cost of the Pension Plan as determined under the projected unit credit cost method. Pension Plan assets at December 31, 1993 consisted primarily of marketable fixed income and equity securities, group annuity contracts, and short-term investments.\nThe following tables set forth the combined funded status of the plans and the composition of total net pension cost. Due to declining interest rates, the Company reduced the discount rate used to measure its liability for pension, postretirement, and postemployment benefits to 7.5% as of December 31, 1993. This decrease in the discount rate, coupled with the increased pension liability resulting from the 1993 Voluntary Special Early Retirement Program, produced an accumulated pension obligation greater than the fair value of the Pension Plan's assets. As a result, the Company recorded a pension liability adjustment, a portion of which was charged to shareholders' equity.\nNet pension cost shown above does not include the cost of termination benefits described in Note 7.\nThe Company also sponsors a defined contribution savings plan covering all eligible BGE employees and certain employees of the Constellation Companies. Under this plan, the Company makes contributions on behalf of participants. Company contributions to this plan totaled $9 million, $14.8 million, and $10.6 million in 1993, 1992, and 1991, respectively.\nPOSTRETIREMENT BENEFITS\nThe Company sponsors defined benefit postretirement health care and life insurance plans which cover substantially all BGE employees and certain employees of the Constellation Companies. Benefits under the plans are generally based on age, years of service, and pension benefit levels. The postretirement benefit (PRB) plans are unfunded. Substantially all of the health care plans are contributory, and participant contributions for employees who retire after June 30, 1992 are based on age and years of service. Retiree contributions increase commensurate with the expected increase in medical costs. The postretirement life insurance plan is noncontributory.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6. PENSION AND POSTEMPLOYMENT BENEFITS (CONTINUED) Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, which requires a change in the method of accounting for postretirement benefits other than pensions from the pay-as-you-go method used prior to 1993 to the accrual method. The transition obligation existing at the beginning of 1993 is being amortized over a twenty-year period.\nIn April 1993, the PSC issued a rate order authorizing BGE to recognize in operating expense one-half of the annual increase in PRB costs applicable to regulated operations as a result of the adoption of Statement No. 106 and to defer the remainder of the annual increase in these costs for inclusion in BGE's next base rate proceeding. In accordance with the PSC's Order, the increase in annual PRB costs applicable to regulated operations for the period January through April 1993, net of amounts capitalized as construction cost, has been deferred. This amount, which totaled $5.7 million, as well as all amounts to be deferred prior to completion of BGE's next base rate proceeding, will be amortized over a 15-year period beginning no later than 1998 in accordance with the PSC's Order. This phase-in approach meets the guidelines established by the Emerging Issues Task Force of the Financial Accounting Standards Board for deferring post-retirement benefit costs as a regulatory asset. Accrual-basis PRB costs applicable to nonregulated operations are charged to expense.\nThe following table sets forth the components of the accumulated postretirement benefit obligation and a reconciliation of these amounts to the accrued postretirement benefit liability.\nThe following table sets forth the composition of net postretirement benefit cost.\nNet postretirement benefit costs shown above do not include the cost of termination benefits described in Note 7.\nPostretirement benefit costs recognized under the pay-as-you-go method were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6. PENSION AND POSTEMPLOYMENT BENEFITS (CONTINUED) OTHER POSTEMPLOYMENT BENEFITS\nThe Company provides certain pay continuation payments and health and life insurance benefits to employees of BGE and certain of the Constellation Companies who are determined to be disabled under BGE's Long-Term Disability Plan. The Company adopted Statement of Financial Accounting Standards No. 112, which requires a change in the method of accounting for these benefits from the pay-as-you-go method to an accrual method, as of December 31, 1993. The liability for these benefits totaled $52.1 million as of December 31, 1993, and the portion of this liability attributable to regulated activities was deferred. The amounts deferred will be amortized over a 15-year period beginning no later than 1998. The adoption of Statement No. 112 did not have a material impact on net income. The increase in the annual cost of these benefits subsequent to the adoption of accrual accounting is not expected to have a material impact on the Company's financial statements.\nASSUMPTIONS\nThe pension and postemployment benefit liabilities were determined using the following assumptions.\nThe health care inflation rates for 1993 are assumed to be 9.5% for Medicare-eligible retirees and 12% for retirees not covered by Medicare. Both rates are assumed to decrease by 0.5% annually to an ultimate rate of 5.5% in the years 2001 and 2006, respectively. A one percentage point increase in the health care inflation rate from the assumed rates would increase the accumulated postretirement benefit obligation by approximately $37.8 million as of December 31, 1993 and would increase the aggregate of the service cost and interest cost components of postretirement benefit cost by approximately $3.8 million annually.\nNOTE 7. TERMINATION BENEFITS\nThe Company offered a Voluntary Special Early Retirement Program (the 1992 VSERP) to eligible employees who retired during the period February 1, 1992 through April 1, 1992. In accordance with Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" the cost of termination benefits associated with the 1992 VSERP, which consisted principally of an enhanced pension benefit, was recognized in 1992 and reduced net income by $6.6 million, or 5 CENTS per common share. In April 1993, the PSC authorized BGE to amortize this charge over a five-year period for ratemaking purposes. Accordingly, BGE established a regulatory asset and recorded a corresponding credit to operating expense for this amount. The reversal of the 1992 VSERP in April 1993 increased net income by $6.6 million, or 5 CENTS per common share.\nThe Company offered a second Voluntary Special Early Retirement Program (the 1993 VSERP) to eligible employees who retired as of February 1, 1994. The one-time cost of the 1993 VSERP consisted of enhanced pension and postretirement benefits. In addition to the 1993 VSERP, further employee reductions have been accomplished through the elimination of certain positions, and various programs have been offered to employees impacted by the eliminations. In accordance with Statement No. 88, the cost of termination benefits associated with the 1993 VSERP and various programs, which totaled $105.5 million, was recognized in 1993. The $88.3 million portion of 1993 VSERP attributable to regulated activities was deferred and will be amortized over a five-year period for ratemaking purposes, beginning in February 1994, consistent with previous rate actions of the PSC. The $17.2 million remaining portion of the cost of termination benefits was charged to expense in 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8. SHORT-TERM BORROWINGS\nInformation concerning commercial paper notes and lines of credit is set forth below. In support of the lines of credit, the Company pays commitment fees and, in some cases, maintains compensating balances which have no withdrawal restrictions. Borrowings under the lines are at the banks' prime rates, base interest rates, or at various money market rates.\nNOTE 9. LONG-TERM DEBT\nFIRST REFUNDING MORTGAGE BONDS OF BGE\nSubstantially all of the principal properties and franchises owned by BGE, as well as the capital stock of Constellation Holdings, Inc., Safe Harbor Water Power Corporation, and BNG, Inc., are subject to the lien of the mortgage under which BGE's outstanding First Refunding Mortgage Bonds have been issued.\nOn August 1 of each year, BGE is required to pay to the mortgage trustee an annual sinking fund payment equal to 1% of the largest principal amount of Mortgage Bonds outstanding under the mortgage during the preceding twelve months. Such funds are to be used, as provided in the mortgage, for the purchase and retirement by the trustee of Mortgage Bonds of any series other than the Installment Series of 2002 and 2009, the 9 1\/8% Series of 1995, the 8.40% Series of 1999, the 5 1\/2% Series of 2000, the 8 3\/8% Series of 2001, the 7 1\/4% Series of 2002, the 6 1\/2% Series of 2003, the 6 1\/8% Series of 2003, the 5 1\/2% Series of 2004, the 6.80% Series of 2004, the 7 1\/2% Series of 2007, and the 6 5\/8% Series of 2008.\nOTHER LONG-TERM DEBT OF BGE\nBGE maintains revolving credit agreements that expire at various times during 1995 and 1996. Under the terms of the agreements, BGE may, at its option, obtain loans at various interest rates. A commitment fee is paid on the daily average of the unborrowed portion of the commitment. At December 31, 1993, BGE had no borrowings under these revolving credit agreements and had available $165 million of unused capacity under these agreements. Effective January 1, 1994, BGE decreased its revolving credit agreements to $125 million.\nThe Medium-term Notes Series A mature at various dates from February 1994 through February 1996. The weighted average interest rate for notes outstanding at December 31, 1993 is 7.93%.\nThe Medium-term Notes Series B mature at various dates from July 1998 through September 2006. The weighted average interest rate for notes outstanding at December 31, 1993 is 8.43%.\nThe Medium-term Notes Series C mature at various dates from June 1996 through June 2003. The weighted average interest rate for notes outstanding at December 31, 1993 is 7.16%.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9. LONG-TERM DEBT (CONTINUED) The principal amounts of Installment Series Mortgage Bonds payable each year are as follows:\nLONG-TERM DEBT OF CONSTELLATION COMPANIES\nThe mortgage and construction loans and other collateralized notes have varying terms. Of the $151.2 million of variable rate notes, $51.1 million requires periodic interest only payments with various maturities from September 1995 through March 1996, and $100.1 million requires periodic payment of principal and interest with various maturities from January 1995 through January 2009. The $6.5 million, 7.73% mortgage note requires quarterly principal and interest payments through March 15, 2009.\nThe unsecured notes outstanding as of December 31, 1993 mature in accordance with the following schedule:\nWEIGHTED AVERAGE INTEREST RATES FOR VARIABLE RATE DEBT\nThe weighted average interest rates for variable rate debt during 1993 and 1992 were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9. LONG-TERM DEBT (CONTINUED) AGGREGATE MATURITIES\nThe combined aggregate maturities and sinking fund requirements for all of the Company's long-term borrowings for each of the next five years are as follows:\nNOTE 10. REDEEMABLE PREFERENCE STOCK\nThe 6.95%, 1987 Series and the 7.80%, 1989 Series are subject to mandatory redemption in their entirety at par on October 1, 1995 and July 1, 1997, respectively.\nThe following series are subject to an annual mandatory redemption of the number of shares shown below at par beginning in the year shown below. At BGE's option, an additional number of shares, not to exceed the same number as are mandatory, may be redeemed at par in any year, commencing in the same year in which the mandatory redemption begins. The 8.25%, 1989 Series, the 8.625%, 1990 Series, and the 7.85%, 1991 Series listed below are not redeemable except through operation of a sinking fund.\nThe combined aggregate redemption requirements for all series of redeemable preference stock for each of the next five years are as follows:\nWith regard to payment of dividends or assets available in the event of liquidation, preferred stock ranks prior to preference and common stock; all issues of preference stock, whether subject to mandatory redemption or not, rank equally; and all preference stock ranks prior to common stock.\nNOTE 11. LEASES\nThe Company, as lessee, contracts for certain facilities and equipment under lease agreements with various expiration dates and renewal options. Consistent with the regulatory treatment, BGE lease payments are charged to expense. Lease expense, which is comprised primarily of operating leases, totaled $13.8 million, $14 million, and $12.6 million for the years ended 1993, 1992, and 1991, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11. LEASES (CONTINUED) The future minimum lease payments at December 31, 1993 for long-term noncancelable operating leases are as follows:\nCertain of the Constellation Companies, as lessor, have entered into operating leases for office and retail space. These leases expire over periods ranging from 1 to 23 years, with options to renew. The net book value of property under operating leases was $187 million at December 31, 1993. The future minimum rentals to be received under operating leases in effect at December 31, 1993 are as follows:\nNOTE 12. TAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes were as follows:\nNOTE 13. COMMITMENTS, GUARANTEES, AND CONTINGENCIES\nCOMMITMENTS\nBGE has made substantial commitments in connection with its construction program for 1994 and subsequent years. In addition, BGE has entered into two long-term contracts for the purchase of electric generating\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13. COMMITMENTS, GUARANTEES, AND CONTINGENCIES (CONTINUED) capacity and energy. The contracts expire in 2001 and 2013. Total payments under these contracts were $68.7 million, $60.6 million, and $30 million during 1993, 1992, and 1991, respectively. At December 31, 1993, the estimated future payments for capacity and energy that BGE is obligated to buy under these contracts are as follows:\nCertain of the Constellation Companies have committed to contribute additional capital and to make additional loans to certain affiliates, joint ventures, and partnerships in which they have an interest. As of December 31, 1993, the total amount of investment requirements committed to by the Constellation Companies is $44 million.\nGUARANTEES\nBGE has agreed to guarantee two-thirds of certain indebtedness incurred by Safe Harbor Water Power Corporation. The amount of such indebtedness totals $40 million, of which $26.7 million represents BGE's share of the guarantee. BGE believes that the risk of material loss on the loans guaranteed is minimal.\nAs of December 31, 1993, the total outstanding loans and letters of credit of certain power generation and real estate projects guaranteed by the Constellation Companies were $50 million. Also, the Constellation Companies have agreed to guarantee certain other borrowings of various power generation and real estate projects. The Company believes that the risk of material loss on the loans guaranteed and performance guarantees is minimal.\nENVIRONMENTAL MATTERS\nThe Clean Air Act of 1990 (the Act) contains provisions designed to reduce sulfur dioxide and nitrogen oxide emissions from electric generating stations in two separate phases. Under Phase I of the Act, which must be implemented by 1995, BGE expects to incur expenditures of approximately $55 million, most of which is attributable to its portion of the cost of installing a flue gas desulfurization system at the Conemaugh generating station, in which BGE owns a 10.56% interest. BGE is currently examining what actions will be required in order to comply with Phase II of the Act, which must be implemented by 2000. However, BGE anticipates that compliance will be attained by some combination of fuel switching, flue gas desulfurization, unit retirements, or allowance trading.\nAt this time, plans for complying with nitrogen oxide (NOx) control requirements under the Act are less certain because all implementation regulations have not yet been finalized by the government. It is expected that by the year 2000 these regulations will require additional NOx controls for ozone attainment at BGE's generating plants and at other BGE facilities. The controls will result in additional expenditures that are difficult to predict prior to the issuance of such regulations. Based on existing and proposed ozone nonattainment regulations, BGE currently estimates that the NOx controls at BGE's generating plants will cost approximately $70 million. BGE is currently unable to predict the cost of compliance with the additional requirements at other BGE facilities.\nBGE has been notified by the Environmental Protection Agency (EPA) and several state agencies that it is being considered a potentially responsible party with respect to the cleanup of certain environmentally contaminated sites owned and operated by third parties. Although the cleanup costs for certain environmentally contaminated sites could be significant, BGE believes that the resolution of these matters will not have a material effect on its financial position or results of operations.\nAlso, BGE is coordinating investigation of several former gas manufacturing plant sites, including exploration of corrective action options to remove coal tar. However, no formal legal proceedings have been instituted. In 1993, BGE accrued a liability of approximately $25.4 million for estimated future environmental costs at these sites. Based on previous actions of the PSC, BGE has deferred these estimated future costs, as well as actual costs\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13. COMMITMENTS, GUARANTEES, AND CONTINGENCIES (CONTINUED) which have been incurred to date, as a regulatory asset (see Note 5). The technology for cleaning up such sites is still developing, and potential remedies for these sites have not been identified. Cleanup costs in excess of the amounts recognized, which could be significant in total, cannot presently be estimated.\nNUCLEAR INSURANCE\nAn accident or an extended outage at either unit of the Calvert Cliffs Nuclear Power Plant could have a substantial adverse effect on BGE. The primary contingencies resulting from an incident at the Calvert Cliffs plant would involve the physical damage to the plant, the recoverability of replacement power costs and BGE's liability to third parties for property damage and bodily injury. Although BGE maintains the various insurance policies currently available to provide coverage for portions of these contingencies, BGE does not consider the available insurance to be adequate to cover the costs that could result from a major accident or an extended outage at either of the Calvert Cliffs units.\nIn addition, in the event of an incident at any commercial nuclear power plant in the country, BGE could be assessed for a portion of any third party claims associated with the incident. Under the provisions of the Price Anderson Act, the limit for third party claims from a nuclear incident is $9.4 billion. If third party claims relating to such an incident exceed $200 million (the amount of primary insurance), BGE's share of the total liability for third party claims could be up to $159 million per incident, that would be payable at a rate of $20 million per year.\nBGE and other operators of commercial nuclear power plants in the United States are required to purchase insurance to cover claims of certain nuclear workers. Other non-governmental commercial nuclear facilities may also purchase such insurance. Coverage of up to $400 million is provided for claims against BGE or others insured by these policies for radiation injuries. If certain claims were made under these policies, BGE and all policyholders could be assessed, with BGE's share being up to $6.2 million in any one year.\nFor physical damage to Calvert Cliffs, BGE has $2.7 billion of property insurance, including $1.4 billion from an industry mutual insurance company. If accidents at any insured plants cause a shortfall of funds at the industry mutual, BGE and all policyholders could be assessed, with BGE's share being up to $14.6 million.\nIf an outage at Calvert Cliffs is caused by an insured physical damage loss and lasts more than 21 weeks, BGE has up to $426 million per unit of insurance, provided by a different industry mutual insurance company for replacement power costs. This amount can be reduced by up to $85 million per unit if an outage to both units at Calvert Cliffs is caused by a singular insured physical damage loss. If an outage at any insured plant causes a short-fall of funds at the industry mutual, BGE and all policyholders could be assessed, with BGE's share being up to $9.4 million.\nRECOVERABILITY OF ELECTRIC FUEL COSTS\nBy statute, actual electric fuel costs are recoverable so long as the PSC finds that BGE demonstrates that, among other things, it has maintained the productive capacity of its generating plants at a reasonable level. The PSC and Maryland's highest appellate court have interpreted this as permitting a subjective evaluation of each unplanned outage at BGE's generating plants to determine whether or not BGE had implemented all reasonable and cost effective maintenance and operating control procedures appropriate for preventing the outage. Effective January 1, 1987, the PSC authorized the establishment of the Generating Unit Performance Program (GUPP) to measure, annually, utility compliance with maintaining the productive capacity of generating plants at reasonable levels by establishing a system-wide generating performance target and individual performance targets for each base load generating unit. In future fuel rate hearings, actual generating performance after adjustment for planned outages will be compared to the system-wide target and, if met, should signify that BGE has complied with the requirements of Maryland law. Failure to meet the system-wide target will result in review of each units adjusted actual generating performance versus its performance target in determining compliance with the law and the basis for possibly imposing a penalty on BGE. Parties to fuel rate hearings may still question the prudence of BGE's actions or inactions with respect to any given generating plant outage, which could result in the disallowance of replacement energy costs by the PSC.\nSince the two units at BGE's Calvert Cliffs Nuclear Power Plant utilize BGE's lowest cost fuel, replacement energy costs associated with outages at these units can be significant. BGE cannot estimate the amount of replacement energy costs that could be challenged or disallowed in future fuel rate proceedings, but such amounts could be material.\nIn October 1988, BGE filed its first fuel rate application for a change in its electric fuel rate under the GUPP program. The resultant case before the PSC covers BGE's operating performance in calendar year 1987, and BGE's filing demonstrated that it met the system-wide and individual nuclear plant performance targets for\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13. COMMITMENTS, GUARANTEES, AND CONTINGENCIES (CONTINUED) 1987. In November 1989, testimony was filed on behalf of Maryland People's Counsel alleging that seven outages at the Calvert Cliffs plant in 1987 were due to management imprudence and that the replacement energy costs associated with those outages should be disallowed by the Commission. Total replacement energy costs associated with the 1987 outages were approximately $33 million.\nIn May 1989, BGE filed its fuel rate case in which 1988 performance was to be examined. BGE met the system-wide and nuclear plant performance targets in 1988. People's Counsel alleges that BGE imprudently managed several outages at Calvert Cliffs, and BGE estimates that the total replacement energy costs associated with these 1988 outages were approximately $2 million.\nOn November 14, 1991, a Hearing Examiner at the PSC issued a proposed Order, which became final on December 17, 1991 and concluded that no disallowance was warranted. The Hearing Examiner found that BGE maintained the productive capacity of the Plant at a reasonable level, noting that it produced a near record amount of power and exceeded the GUPP standard. Based on this record, the Order concluded there was sufficient cause to excuse any avoidable failures to maintain productive capacity at higher levels.\nDuring 1989, 1990, and 1991, BGE experienced extended outages at Calvert Cliffs. In the Spring of 1989, a leak was discovered around the Unit 2 pressurizer heater sleeves during a refueling outage. BGE shut down Unit 1 as a precautionary measure on May 6, 1989 to inspect for similar leaks and none were found. However, Unit 1 was out of service for the remainder of 1989 and 285 days of 1990 to undergo maintenance and modification work to enhance the reliability of various safety systems, to repair equipment, and to perform required periodic surveillance tests. Unit 2, which returned to service on May 4, 1991, remained out of service for the remainder of 1989, 1990, and the first part of 1991 to repair the pressurizer, perform maintenance and modification work, and complete the refueling. The replacement energy costs associated with these extended outages for both units at Calvert Cliffs, concluding with the return to service of Unit 2, are estimated to be $458 million.\nIn a December 1990 order issued by the PSC in a BGE base rate proceeding, the PSC found that certain operations and maintenance expenses incurred at Calvert Cliffs during the test year should not be recovered from ratepayers. The PSC found that this work, which was performed during the 1989-1990 Unit 1 outage and fell within the test year, was avoidable and caused by BGE actions which were deficient.\nThe Commission noted in the order that its review and findings on these issues pertain to the reasonableness of BGE's test-year operations and maintenance expenses for purposes of setting base rates and not to the responsibility for replacement power costs associated with the outages at Calvert Cliffs. The PSC stated that its decision in the base rate case will have no RES JUDICATA (binding) effect in the fuel rate proceeding examining the 1989-1991 outages. The work characterized as avoidable significantly increased the duration of the Unit 1 outage. Despite the PSC's statement regarding no binding effect, BGE recognizes that the views expressed by the PSC make the full recovery of all of the replacement energy costs associated with the Unit 1 outage doubtful. Therefore, in December 1990, BGE recorded a provision of $35 million against the possible disallowance of such costs. BGE cannot determine whether replacement energy costs may be disallowed in the present fuel rate proceedings in excess of the provision, but such amounts could be material.\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following table presents the carrying amount and fair value of financial instruments included in the Consolidated Balance Sheets.\nThe carrying amount of current assets and current liabilities approximates fair value because of the short maturity of these instruments.\nThe fair value of investments and other assets is based on quoted market prices where available. Certain investments with a carrying amount of $70 million at December 31, 1993 and $71 million at December 31, 1992 are excluded from the amounts shown in investments and other assets because it was not practicable to\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) determine their fair values. These investments include partnership investments in public and private equity and debt securities, partnership investments in solar powered energy production facilities, and investments in stock trusts.\nFinancial instruments included in capitalization are long-term debt and redeemable preference stock. The fair value of fixed-rate long-term debt and redeemable preference stock is estimated using quoted market prices where available, or by discounting remaining cash flows at the current market rate. The carrying amount of variable-rate long-term debt approximates fair value.\nBGE and the Constellation Companies have loan guarantees totalling $26.7 million and $36 million, respectively, at December 31, 1993 and $30 and $38 million, respectively, at December 31, 1992 for which it is not practicable to determine fair value. It is not anticipated that these loan guarantees will need to be funded.\nNOTE 15. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following data are unaudited but, in the opinion of Management, include all adjustments necessary for a fair presentation. BGE's utility business is seasonal in nature with the peak sales periods generally occurring during the summer and winter months. Accordingly, comparisons among quarters of a year may not be indicative of overall trends and changes in operations.\nRESULTS FOR THE SECOND QUARTER OF 1993 REFLECT THE REVERSAL OF THE COST OF THE TERMINATION BENEFITS ASSOCIATED WITH THE 1992 VOLUNTARY SPECIAL EARLY RETIREMENT PROGRAM (SEE NOTE 7).\nRESULTS FOR THE THIRD QUARTER OF 1993 REFLECT THE EFFECTS OF THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993.\nRESULTS FOR THE FOURTH QUARTER OF 1993 REFLECT THE COST OF CERTAIN TERMINATION BENEFITS (SEE NOTE 7).\nRESULTS FOR THE FIRST AND THIRD QUARTERS OF 1992 REFLECT THE COST OF TERMINATION BENEFITS ASSOCIATED WITH THE 1992 VOLUNTARY SPECIAL EARLY RETIREMENT PROGRAM (SEE NOTE 7).\nTHE SUM OF THE QUARTERLY EARNINGS PER SHARE AMOUNTS MAY NOT EQUAL THE TOTAL FOR THE YEAR DUE TO CHANGES IN THE AVERAGE NUMBER OF SHARES OUTSTANDING THROUGHOUT THE YEAR.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item with respect to directors is set forth on pages 2 through 4 under \"Item 1. Election of 14 Directors\" in the Proxy Statement and is incorporated herein by reference.\nThe information required by this item with respect to executive officers is, pursuant to instruction 3 of paragraph (b) of Item 401 of Regulation S-K, set forth in Item 10 of Part I of this Form 10-K under \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is set forth on pages 7 through 11 under \"Item 1. Election of 14 Directors -- Compensation of Executive Officers by the Company\" in the Proxy Statement and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is set forth on page 6 under \"Item 1. Election of 14 Directors -- Security Ownership of Directors and Executive Officers\" in the Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is set forth on page 5 under \"Item 1. Election of 14 Directors -- Certain Relationships and Transactions\" in the Proxy Statement and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this Report:\n1. Financial Statements:\nAuditors' Report dated January 21, 1994 of Coopers & Lybrand, Independent Auditors\nConsolidated Statements of Income for three years ended December 31,\nConsolidated Balance Sheets at December 31, 1993 and December 31,\nConsolidated Statements of Cash Flows for three years ended December 31, 1993\nConsolidated Statements of Common Shareholders' Equity for three years ended December 31, 1993\nConsolidated Statements of Capitalization at December 31, 1993 and December 31, 1992\nConsolidated Statements of Income Taxes for three years ended December 31, 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules:\nSchedules other than those listed above are omitted as not applicable or not required.\n3. Exhibits Required by Item 601 of Regulation S-K Including Each Management Contract or Compensatory Plan or Arrangement Required to be Filed as an Exhibit.\n(b) Reports on Form 8-K: None\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\nThe information required by Columns B, C, D, and E is omitted because neither the total additions nor the total deductions during the periods amounted to more than 10% of the closing balances of total property, plant and equipment. Additions and retirements of property, plant and equipment for 1991 through 1993 are set forth below.\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYEAR 1993\nNOTE: For a statement of the Company's depreciation policy, see NOTE 1 TO CONSOLIDATED FINANCIAL STATEMENTS. The Company's Accumulated Provision for Depreciation is not segregated according to the \"Classification\" of property shown under \"Plant in Service\" in Schedule V.\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEAR 1992\nNOTE: For a statement of the Company's depreciation policy, see NOTE 1 TO CONSOLIDATED FINANCIAL STATEMENTS. The Company's Accumulated Provision for Depreciation is not segregated according to the \"Classification\" of property shown under \"Plant in Service\" in Schedule V.\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEAR 1991\nNOTE: For a statement of the Company's depreciation policy, see NOTE 1 TO CONSOLIDATED FINANCIAL STATEMENTS. The Company's Accumulated Provision for Depreciation is not segregated according to the \"Classification\" of property shown under \"Plant in Service\" in Schedule V.\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE VII -- GUARANTEES OF SECURITIES OF OTHER ISSUERS AS OF DECEMBER 31, 1993\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Baltimore Gas and Electric Company, the Registrant, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALTIMORE GAS AND ELECTRIC COMPANY (Registrant)\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of Baltimore Gas and Electric Company, the Registrant, and in the capacities and on the dates indicated.\nEXHIBIT INDEX","section_15":""}